Nervous system and development

Cogito, ergo sum

A distinguished African statesman once said to me that an underappreciated problem in development is that decision makers “do not know, what they know not”. There is often discussion about legitimate concerns such as nepotism, vested interests and corruption as causes for lack of development. But what gets neglected is the importance of a well-functioning decision making process that formulates and guides economic policy - in short a nervous system for development.

The world is a complicated place - even proper disease diagnosis for a patient requires a team of competent physicians, labs and technicians to work together. Leave the same job to a bunch of quacks who don’t believe in science, and you can imagine the rest. The same is true for economic policy. As an example, consider Pakistan’s energy policy.

A little less than a decade ago, the government of Pakistan announced a $33 billion dollar (over 10% of then GDP) new energy policy. Pakistan would borrow this amount in dollars, with sovereign guarantees, to get (mostly) fossil-fuel based power plants built. I was quite concerned when I heard about the scale and manner in which these power plants were to be built. Yes, Pakistan needed electricity for its growing domestic needs, but could it afford to do so in the manner it was being proposed?

If Pakistan had a well-functioning nervous system, some simple diagnostics should have been run before embarking on a project of this magnitude. How will the country pay back the principal plus profit in dollars when electricity revenue would be largely rupee based? What if the price of oil goes up, or there is external balance of payment pressure? Wouldn’t the additional external debt burden make such “sudden stop” scenarios more likely? Wouldn’t that crowd out private investment, and lower GDP growth? What if GDP projections are off, wouldn’t the fixed capacity payments make the whole pricing system unsustainable? What about alternative ways of designing an energy policy that harnesses domestic resources and builds domestic value chains for renewables?

I inquired around, but to my dismay could find no evidence of any reasonable, or even half-decent, analysis. No one had done a simple macro risk analysis. For example, rudimentary monte carlo simulations of possible scenarios, estimating demand elasticities to make sure pricing is sustainable etc. It is not just that the analysis was missing, no one was even looking for it. As my African friend would say, “they did not even know, what they know not”.

Today Pakistan is under extreme financial pressure, and it has one of the highest cost of electricity in the world. Households are paying about 21 cents per Kwh - in neighboring India the price is about 9 cents. Even at 21 cents per Kwh, the energy sector is barely financial sustainable¹, as the country struggles with circular debt. There are about two billion dollars of delayed dividend payments owed to foreign power plant investors. In fact, at such high cost, a kind of doom-loop has set in, the higher the price, the lower the demand, which further raises average cost per unit given the fixed capacity payments promised to power producers. Then as the country struggles to pay dividends abroad, exchange rate devalues, which only makes the problem worse.

The sad reality of Pakistan’s energy woes is that the system was designed to fail. It’s fashionable these days to talk about capacity payments and the like. But all the major faults should have been visible a decade ago when such decisions were being made. Unfortunately, Pakistan did not have a nervous system to make the right decisions - for things to change, the country must build a functioning nervous system.

1. about a quarter of 21 cents is paid in taxes, so the pure cost of electricity is about 15-16 cents.