Austerity theater: How Pakistan’s wasteful state fuels its debt crisis

Exactly a year ago, amidst a burgeoning fiscal deficit, Prime Minister Shehbaz Sharif gave a televised address to the nation, committing to reign in government expenditure and adopt austerity. He promised to reduce lavish expenses, eliminate government departments that were not serving the public, and shutter loss-making institutions. To this end, he announced the formation of a committee to help “right-size” the federal government.

At a press conference held in January of this year, this committee announced their achievements to date and upcoming plans. Among the innovative reforms this high-powered committee of seasoned former bankers and management consultants proposed was the outsourcing of non-core positions—like peons and gardeners—to the private sector. The Finance Minister declined to comment on exactly how much would be saved from outsourcing peons, but he assured the press pool that the government was committed to curtailing expenses. Less than a month later, the Prime Minister doubled the size of his cabinet from 21 members to 43 and approved a raise that nearly tripled the salaries of all MNAs.

This kind of dissonance permeates the government. Just prior to the announcement of the budget, the FBR indicated that it would likely miss its annual revenue target by nearly a trillion rupees. Yet this underperformance did not give the institution pause to reconsider the profligacy of its Rs. 2.2 billion vehicle procurement plan, to be paid for with money loaned by the World Bank. To the contrary, the FBR defended the purchase, which included bullet-proof SUVs, citing the vehicles as necessary for their operations.

An administration that lays off peons while giving raises to MNAs is not a fiscally responsible government, but in fact, a caricature of elite capture. And a government that buys SUVs for tax collectors doesn’t have a revenue problem; it has a spending problem.

Rigidity or rigor mortis

A long-held axiom among those analyzing Pakistan’s economic and fiscal policies is that Pakistan has a uniquely rigid set of expenditures which are not amenable to rationalization. In the recently announced budget for 2025-26, a full 75% of total expenditure falls into this category of untouchable outflows. Just under half of the allocated expenditure is earmarked for interest payments on Pakistan’s debt. These are pre-committed financial obligations and immutable in the short-term. So are pensions, which comprise another 5% of total expenses. Nor does there appear to be much latitude in defense spending—15% of budgeted expenditure—especially in the wake of recent hostilities with India. These 3 expenditure heads, along with subsidies, exceed anticipated total government revenue by nearly Rs. 2 trillion, even before the cost of running the civil government is factored in.

It is no wonder then that development spending is the first to get axed when funds are short. This has adverse implications for longer-term economic growth and results in the country falling ever deeper into a vicious cycle of borrowing and indebtedness. Given these constraints, the argument goes, there is no alternative to increasing revenue: where Pakistan is today—Rs. 75 trillion in debt and needing to borrow just to pay interest—the only way out is to increase inflows, specifically tax revenue.

This is not entirely correct though.

It’s the economy, stupid

Pakistan’s tax revenue could indeed be higher. The public’s lingering suspicion that large pockets of privileged groups are avoiding paying their fair share of taxes is not unjustified. Much of the tax collected comes from regressive, indirect taxes on consumption rather than direct taxes on income or wealth. And the federal government has demonstrated a consistent reluctance to tax the agriculture sector or to enforce tax collection from powerful retailers, wholesalers, and even doctors and lawyers.

But even with its low tax base, Pakistan has seen better days. Twenty years ago, Pakistan’s interest expenses on debt represented about 30% of total revenue, compared to 70% today. Even with defense spending consuming a quarter of the country’s revenue, there was substantial fiscal space remaining for government operations and investment in future growth.

This relatively stable fiscal position which Pakistan found itself in twenty years ago was the result of a concerted effort—the Debt Reduction and Management Strategy—initiated by the government in 2001 to bring public debt down to manageable levels.

The government at the time had developed and implemented a genuine medium- to long-term economic reform effort, principally aimed at reviving economic growth, and leveraging this as the mechanism through which to bring down debt. Rather than simply cranking taxes up on those already in the tax net—a least effort approach that the present dispensation seems fixated on—debt repayment capacity was augmented by pushing for growth in exports, and reducing the cost of government borrowing. To the extent that revenue growth was pursued, it was through growth in economic activity rather than increases in tax rates.

This was a long-term approach that yielded surprisingly quick results in terms of bringing about a fiscal balance. But the reforms needed to be sustained over a much longer period in order to expand export-oriented sectors, deepen the corporate base, continue attracting foreign investment, bring down the debt stock, and improve Pakistan’s sovereign risk profile.

Needless to say, this momentum was not sustained. Instead of building on this, investing productively, and spending prudently, the government returned to political infighting and short-term expediency over long-term reform. Financial indiscipline led to aggressive deficit spending and external economic shocks led to investment inflows drying up. From a near surplus in 2005, the annual fiscal deficit ballooned to over a trillion rupees by 2010, and has been widening every year since.

Those responsible for running Pakistan’s finances today are managing the country as if it were a company, and the IMF was its main shareholder. For all the Finance Minister’s bromides on structural reforms, what his policies are actually geared towards is extracting additional revenue from already over-taxed segments to meet short-term targets - even if it decimates the economy in the process.

Countries are not like individuals or companies, who have a limited set of levers available to manage budgets and debt levels. Pakistan can continue to run fiscal deficits if the spending is geared towards productive investments that grow the economy, bolster export competitiveness, and inspire investor confidence. Strong economies can also borrow more cheaply to finance their deficits. More than 150 countries run persistent fiscal deficits. Pakistan is the only one among them that ends up on the verge of bankruptcy every 5 years.

Pakistan undoubtedly needs more revenue, but this should be generated by growing the economy, and incentivizing businesses to formalize. Not by harassing profitable corporations and scaring small businesses into staying informal. And it certainly shouldn’t be generated by granting tax collectors—who are not exactly known for their integrity—powers to arrest taxpayers.

But the fixation on revenue distracts from the core issue that led to the growing fiscal deficit in the first place: excessive and wasteful spending by the government. This needs to be reigned in.

A penny saved is a penny earned

The need for additional revenue, however legitimate, does not absolve the government of their fiscal responsibilities to manage taxpayer money in an effective and judicious manner. In the “austerity” budget that was announced just last week, the salaries of all civilian government employees were increased by 10%, while those of the armed forces were increased by 25%. The faithful public servants of the country may need to be rewarded, but not at the cost of the country.

Meanwhile, the cost-cutting measures taken by the Prime Minister’s committee on right-sizing have been largely performative. One measure, the abolishing of 150,000 posts across federal ministries and their attached departments, will have zero financial impact, given that the posts were already vacant and their budget allocations never actually spent. This is austerity theater, not real cost-control.

What is needed is material reduction in spending underpinned by a framework for prioritizing expenditures and evaluating their purpose, intended results, actual impact, and cost effectiveness.

Pakistan needs to prioritize people over perks for parliamentarians and pork-barrel projects. The path to fiscal responsibility and macroeconomic health requires:

1. Building trust through accountability and real austerity

There is a large trust deficit between Pakistan’s public and its public officials. And for good reason. Government officials in Pakistan live far better than the vast majority of the country. Even the wages of the lowest grade BPS 1 employees are double the national average. More senior officers, meanwhile, enjoy perks and privileges that include government accommodation, vehicles, and unlimited utility usage. The Pakistan Institute of Development Economics estimates that the perks and cash allowances of public sector employees—which are not taxed—increase their compensation by an average of 60%, taking them far above private sector compensation levels at equivalent education and experience levels.

This compensation is not linked to performance or productivity, and the public has no say in the appointments, promotions, or transfers of the public servants ostensibly there to serve them. It is unreasonable for a government to provide bureaucrats and parliamentarians with generous benefits while operating on borrowed money and remaining unaccountable to the public.

If the government practices austerity on itself before imposing it on the voiceless, and curbs its own expenses before demanding more taxes, it can potentially inspire confidence among taxpayers and yield a trust dividend. Over time, this may even translate into improved revenue collection.

2. Improving service delivery through competence and impactful spending

Contrary to popular opinion, Pakistan suffers far more from incompetence than it does from corruption. Punjab spent over Rs. 500 billion on education last year, translating into expenditure of more than Rs. 40,000 per student. When Punjab’s low-cost private schools deliver better academic outcomes at one third the cost of government schools, while still turning a profit, it exposes several truths. For one, government spending lacks value for money. But another insight that has greater fiscal implications is that government can potentially do a lot with very limited resources if governance is strengthened.

Citizens who end up paying out of pocket for private schooling, private healthcare, private transportation, and private security are right to question why they should fund government’s incompetence. But start to show genuinely decent service delivery, and confidence in government can grow, leading to a host of positive ancillary benefits.

Spending effectiveness can be improved in nearly every sphere of government. Even the defense sector, which has recently been given a 20% budget increase in context of heightened tensions with India, can learn a thing or two about better use of funds. Instead of spending the country’s limited reserves of foreign currency importing expensive foreign equipment and jets, investing in a domestic defense industry could prove far more cost effective. Bringing in private sector defense contractors rather than trying to do it at a government level could yield a further economic multiplier.

Turkey, for example, has benefited substantially from this approach. Restricted from acquiring US-made Predator drones, Turkey initiated its own drone program in 2009, and within 6 years, test-fired rockets from its highly effective, domestically manufactured Bayraktar TB2 drones. At an estimated cost of USD 5 million, these drones are a fraction of the cost of equivalent Western-made drones, and have helped Turkey launch a vibrant new export-oriented industry. Similarly, Iran’s domestically developed Shahed-129 drone costs approximately USD 20,000, several orders of magnitude cheaper than its American counterpart, the MQ-1 Predator.

Pakistan’s military would do well to recognize that future conflicts will be won or lost on the back of indigenous technological capabilities and economic strength. True security is not measured in missiles, but in self-reliance.

3. Curbing wastage by shedding dead weight

Pakistan spent just over Rs.1 trillion in 2023, or 10% of its budget outlay, supporting its 200-odd state-owned entities. The sheer losses from these inefficient and badly managed companies burned through the entire income tax revenue collected that year from individual taxpayers. It begs the question: who are these companies being run for?

Efforts to turn these companies around over the years have not met with much success. It is unrealistic to expect that a transformation can be achieved in the near term to make these entities start contributing positively to the exchequer. But if the losses can be reduced—by shuttering the hopeless cases, such as Pakistan Steel Mills, and divesting at any price other loss-making organizations such as the power distribution companies—the country would be much better off.

As politically expedient as it may be in the short-term to continue tolerating loss-making public sector entities for the sake of political patronage, in the medium term the weakening of sovereign autonomy due to increased indebtedness and the inevitable inflationary pressure from devaluation will erode any accrued political mileage.

We know what to do

On his first working day, when asked how Pakistan could rebuild its economy, the Finance Minister had confidently replied, “We do not need too many policy prescriptions. We know what to do.” From the measures he has been implementing since, it is not clear that he does. But a successful reform blueprint exists from which he can draw lessons should he be open to it.

As the results of 2001’s Debt Reduction and Management Strategy showed, a few improvements can compound into substantial gains. Pakistan does not need to completely eliminate its deficit. But it can easily reduce spending by a trillion rupees and get more results from the rest of its spending.

A responsible and prudent fiscal message sends a strong positive signal to investors and markets. Respecting taxpayers’ money and investing it in developing domestic productive capacity rather than in salary increases and SUVs for government officers may end up generating far more revenue for the government than its proposed extractive tax regime ever can.