There is little doubt that the economic performance of the incumbent government has been poor. The budget deficit, the balance of trade and the inflation rate all give cause for concern. Yet these short term features of the financial sphere are merely the manifestation of two underlying endemic problems in the real economy. (1) The inability to sustain GDP growth beyond brief, aid dependent spurts. (2) A structure of growth that tends to increase inequality and hence has a constrained capacity for poverty reduction. It is now well known that for a given GDP growth rate of an economy, the higher the income inequality the smaller the trickle-down effect of growth.

The question that arises is not how to treat the symptoms of financial indicators but the underlying malaise in the real economy. The central task of policy makers is to identify the determinants of placing the economy on the path of sustained economic growth. If GDP growth can be sustained at the required level of about 7 percent, the resultant acceleration in both revenues and exports will bring the budget and balance of payments deficits down to a healthy level. The financial sphere and the real economy are organically inter-related, with growth in the real economy being the determinant of financial indicators in the last instance.

The corpus of research associated with the New Institutional Economics (NIE), shows that the fundamental determinant of sustained economic growth is the institutional structure of an economy. This is the set of rules, both formal rules and informal norms, which embody incentives and disincentives and hence shape the behavior of individuals and economic organizations. The central policy challenge therefore is institutional change which would eliminate rents (unearned income) through wider competition, create incentives for hard work, hiring based on merit, efficiency, productivity increase, innovation and thereby sustained GDP growth. That is why the New Growth Policy announced by the present government is a step in the right direction. For it to be meaningful however it needs to move from the abstract to the concrete. What is the necessary and sufficient set of institutional reforms in the specific economic cultural and historical context of Pakistan that will place it on the path of sustained economic growth?  Equally important, through which institutional changes can the growth process be restructured so as to make it equitable and hence capable of giving a life of dignity to all rather than a few citizens? Finally, who will change the rules? The NIE shows that the fundamental determinant of economic performance is the polity, for it is in the realm of politics that the rules are made.

By contrast the IMF and World Bank view is that policy should focus on reducing the twin budget and balance of payments deficits through a “Stabilization” programme of economic contraction, (high interest rates and reduced public expenditure). This is fundamentally flawed for two reasons: (a) The proposition implicit in their proposed “Stabilization Programmes’’  that once the twin deficits have been reduced, GDP growth will accelerate, has a dubious empirical basis. At a conceptual level it is an oxymoron:  How can GDP growth accelerate after a program of explicit economic contraction? (2) The idea that reducing government expenditure together with financial deregulation will lead to efficiently functioning markets has lost its sheen as the second great recession in a century grips the world economy. As Nobel prize winning economist Joseph Stiglitz put it recently, the global economic crisis has done to Neo Classical economics (on which IMF policy is based), what the collapse of the Soviet Union did to Communism. It is time to revisit ideology. Thus each one of the developed countries has used massive increases in public expenditure as a device for staving off the depression. At the same time there is now a global consensus that it was precisely the failure to regulate financial markets that led to the present crisis.

Change requires taking up the challenge of thinking anew. Economic policy formulation must be based on new research on the specific institutional structure, politics, culture and history of Pakistan.