The government's supply-side economic approach is portrayed as a departure from its predecessors' emphasis on demand management. The previous government was forced to pursue (or pretend) a policy of reining in consumer demand through higher but mostly indirect levies. The effective demand however did not come down; it hiked up the prices and precipitated a deep recession at the same time. Now, a so-called supply-side approach is being pursued to boost investments, production and, hence, supply of goods by reducing the taxes. It can be argued that the supply-side versus demand-side debate is misleading and without sufficient economic tools this approach, like its predecessors', may end up in the wilderness.

Theoretically, every effort to accelerate production or increase supplies requires manipulation and configuration of the demand of goods and services at the same time, and vice-versa. For example, by providing incentives to the investors through various means, the core of the supply-side approach, the demand of capital goods is increased at the expense of induced reduction in some categories of consumption items. Likewise, by managing the demand-side of the economy, the supply of goods and services is also effected. Therefore, supply versus demand side debate is simplistic and fallacious: these are simply misnomers. Nevertheless, it will be useful to explore the premises, assumptions and instruments used to implement these approaches.

The previous government(s) running huge budget/trade deficits and which near defaulted on foreign debt payments came under pressure from international agencies to reduce the domestic consumption by raising prices and dropping subsidies. The basic purpose of pushing down the domestic demand was to reduce the budget/trade deficits to eliminate government borrowing. Moreover, it was meant to constrain the imports and to increase the exports (to facilitate debt servicing) to enhance foreign exchange reserves. Indirectly, it was also geared to boost the investment and production by freeing up resources.

The government, reluctantly and selectively, acted upon this prescription of reducing domestic demand. It did not succeed because, first, the public sector expenditures, stipulated to be around 40 per cent of the GDP, were not touched and, secondly, the increase of prices in certain sectors were offset by subsidies in others. Furthermore, since a large proportion of the population's consumption demand comprises mainly essential goods, the demand remains relatively inelastic (fixed). Despite high-sounding claims, in practice there was hardly any management of demand -- other than pushing the economy into a deep recession, none of the objectives was achieved

Now, when a so-called supply-side economic policy is being pursued, contrary to professed claims, the primary emphasis is on scaling down the demand by the public sector. To withdraw subsidies is also meant to, indirectly, effect the demand. Some may say that this is the essence of supply-side economics. However, technically, it will be inaccurate to say that, since the private sector's demand is not being targeted directly, it is not a demand-management strategy. This has been true elsewhere also. In the name of the supply-side economics, the Reagan strategists tried to scale back the demand by the lower income groups by reducing or eliminating the benefits granted to them by the State after the second world war.

The logic behind this approach is that, to boost the supply of goods and services, the saving rates of the investment community should be increased. In addition, to further this goal, the prices of the inputs should be reduced by removing the national and international barriers, improving the infrastructure and forcing down the wage compensation (workers' salaries). The business costs, incurred due to government regulations, should also be brought down to the minimum.

In industrialised economies, the investors' saving rate is bolstered by lowering their tax rate. The expected shortfall in revenue collection is compensated through reducing the state benefits or subsidies meant for the lower income groups. It is claimed that, by paying lower taxes, the saving by the investor class increases and, hence, additional funds are ploughed in the capital markets. The higher level of investment is presumed to translate into increased employment and higher wages, compensating for the reduced state's benefits for the poor.

This strategy may work (although it hasn't) in well-documented economies where the tax base is very broad, the tax collection machinery is efficient, State benefits are extensive, public sector, relative to the private sector is much smaller, and the State's role is marginal. In cases like Pakistan, where institutions are configured quite differently, this exercise may prove to be futile because of the following reasons:

(a) The tax base in Pakistan is marginal and the tax collection machinery is extremely inefficient. Therefore, the reduction of tax rates (specifically, income taxes) may not bring the desired change. Overwhelming majority of the upper income groups pay almost zero taxes -- they keep all they make and then some more -- and still, the investment rate remains low. The reduction in tax rates may do other things -- it may or may not increase revenue generation -- in Pakistan, but it is hard to see how it will increase the investments when the upper income groups' relative gains and share in the national wealth are already maximum. Therefore, the essential argument of supply-side economics (if there is any) does not hold in Pakistan's case.

As a matter of fact, Pakistan's upper income groups, feudalists, traders, merchants and industrialists, with varying degrees, have used the institution of the State, in every way, to transfer wealth to themselves. Some of them have made fortunes without making any investments while the others have used the State to subsidise and protect their business ventures. And all is done without paying their due share to the society and the State.

In these circumstances, unlike the industrialised societies where a sizable amount of taxes are collected from the high income groups/corporations and tax reduction can possibly trigger saving/investments, Pakistani state might have to stop transferring unearned wealth to the rich: it will force them to make money through investing. Such a policy will be just the opposite to the supply-side approach.

(b) Direct state benefits for the lower income groups are minimal and a reduction in such entitlements is an academic exercise in Pakistan. However, indirect subsidies may be extensive which are, again, swapped by heavy indirect taxes. Consequently, the withdrawal of subsidies coupled with reducing indirect taxes will balance each other out. This will again nullify supply-siders' approach (as practised in the industrialised countries) who balance the budgets by reducing State benefits to the lower income groups.

(c) In the supply-side approach, to reduce the prices of the inputs free flow of raw material is encouraged, import barriers are eliminated, transportation infrastructure is improved and levies on energy and other key inputs are reduced. In the industrialised economies free markets are reconstituted to achieve these goals. Pakistan cannot use such mechanisms; it cannot afford to lower the cost of inputs by eliminating indirect taxes or improve the infrastructure without raising revenues from the high income groups. Further, it cannot lower the cost of inputs like energy because of international agreements.

(d) Following the supply-side logic, the labour costs are brought down through repressing trade unions. During the Reagan era, exemplary punishments were handed down to striking workers. In addition, the producers were given open-ended powers to hire or dismiss labourers. Merits or demerits notwithstanding, such a policy is hard to replicate in Pakistan by a populist leader like Nawaz Sharif.

(e) The only area where supply-side prescription can have some relevance in Pakistan is in reducing the business costs by streamlining the cumbersome rules and regulations. Again, given the corrupt State machinery, these costs may not be very high for big business; however, it may be prohibitive for smaller outfits.

This analysis shows that supply-side economics is a misnomer. Nobel prize winner economist George Stigler ridiculed it and pioneered the term "voodoo economics" for it in President Reagan's presence who had arranged a dinner in his honour. Nonetheless, if it has any theoretical foundations, its policy prescriptions are irrelevant to Pakistan.

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