Why Pakistan keeps choosing real estate over growth

The premise: allocation, not just growth

The episode opens with Muzamil framing the conversation around a question that goes beyond the immediate crisis. Pakistan’s economic problems, he notes, are not new — they have repeated themselves across decades. The guest he has brought back for a second appearance is Gonzalo Varela, Lead Economist at the World Bank, who has just co-authored a report titled From Swimming in Sand to High and Sustainable Growth: A Road Map to Reduce Distortions in the Allocation of Resources and Talent in Pakistan’s Economy.

Varela’s opening argument is precise: Pakistan’s growth has been stunted not simply because it is low, but because it is volatile and because the underlying cause of both problems is the same. “The premise of this report is that Pakistan’s growth, economic growth, has been stunted by the inability of Pakistan to allocate its talent and its resources to the best possible uses,” he explains. The boom-bust pattern — fast growth, a balance-of-payments crisis, recovery, repeat — is not random. It is the predictable output of a system of incentives that consistently directs capital toward the wrong places.

Why real estate beats manufacturing every time

The core distortion Varela identifies is a tax regime that makes real estate a structurally superior investment compared to productive, tradable sectors like manufacturing or business services. Taxes on income from manufacturing are relatively higher than taxes on income from land or real estate. The result is rational but damaging: agents put their money where the after-tax returns are best.

The macroeconomic consequence is what makes this more than a fairness complaint. When income grows from real estate investments, it generates demand for imports — but no supply of exports. When income grows from manufacturing or tradable services, it generates both import demand and export supply. Because so much capital flows into real estate, Pakistan ends up with a structural current account deficit: lots of import demand, very little export capacity. “At some point, you accumulated current account deficits that become very large,” Varela says. “And that’s when the balance of payments crisis comes up.”

A second layer of distortion compounds the first. For the small share of capital that does reach manufacturing, high import duties then push firms to sell domestically rather than export. The duty protects them in the local market but offers nothing if they sell abroad. Varela calls this the anti-export bias of import duties: “In principle they are supposed to do import substitution. But in practice they do export substitution.”

The productivity numbers make the cost concrete. Over thirty years, the average Pakistani worker’s productivity rose 40 percent. Over the same period, Vietnam’s rose 330 percent and Bangladesh’s rose 170 percent.

The circular trap of real estate investment

Muzamil pushes on a point that Varela finds important enough to name explicitly: the problem is circular. People invest in real estate because the real economy is volatile. But by investing so heavily in real estate, they make the real economy more volatile. “You are investing in real estate because that’s a store of value, because investments in dynamic sectors are their returns are volatile. But by investing in real estate, you make the whole system volatile.”

The implication is that blaming individual investors is beside the point. No single actor is making an irrational choice. The system itself produces the outcome. That framing matters for policy: you cannot fix a systemic problem by appealing to individual behavior. You have to change the incentives.

On the question of how to tax real estate more effectively, Varela acknowledges the practical difficulties Muzamil raises — DC rates that lag market values, cash transactions that happen off the books, the near-zero effective property tax rate. He points to progressive property taxes as a proven instrument used across the world. He also raises an idea from the book Radical Markets: if you declare your property’s value at a hundred when it is worth two hundred in order to pay less tax, you should be willing to sell at a hundred. The state could exercise that option. He concedes this is currently unrealistic in Pakistan but argues it sets a useful horizon.

Banking the economy: Uruguay’s debit card experiment

The conversation moves to formalization — how to bring more transactions into the banking system so that underreporting becomes harder. Muzamil raises the question of India’s 2016 demonetization as a potential model. Varela is candid: “I haven’t seen to date a good impact evaluation… of this move of India to demonetize.” He does not know whether it worked.

What he does know is the Uruguayan experience. About ten to fifteen years before this conversation, Uruguay introduced a law requiring large transactions to go through the banking system, mandated debit and credit card terminals in businesses of all sizes, and offered a VAT discount to consumers who paid by card. The result was that consumers actively sought out card payments to capture the discount, and the tax authority saw revenues increase dramatically — not because rates went up, but because transactions that had previously been invisible entered the formal record.

“The taxes actually increased even though you were giving tax breaks?” Muzamil asks. Yes, Varela confirms, because far more came into the tax net.

Later in the discussion, Muzamil raises the specific difficulty Pakistan faces: many citizens cannot get banked in the first place because the KYC process is too demanding for people who work informally and have no salary slips or employment letters. Varela does not dismiss this. He frames it as another distortion — one that deters formalization just as surely as high taxes deter manufacturing investment. The principle he returns to is consistent: lower the cost of being in the formal economy, raise the cost of staying outside it.

The free-floating currency debate

Muzamil raises the exchange rate question directly, noting that a professor from LUMS had described the free float as a neoliberal imposition and argued for government control of foreign exchange allocation. Varela’s response is careful but clear.

The exchange rate is a key price in the economy, with consequences for exports, imports, inflation, and the real burden of foreign-currency debt. The question is not simply whether to float or fix — it is whether fixing is even possible. “If you fix the price of the dollar too low, then you need to have a lot of dollars to be able to support that.” Pakistan does not have those reserves. So the practical consequence of fixing the rate below market is rationing: someone has to decide which firms get access to dollars and which do not.

“There is no good experience across the world in which there has been exchange rate rationing and then the economy booms,” Varela says. Rationing creates rent-seeking, arbitrariness, and — as Muzamil adds — the conditions for corruption, because human discretion is deciding who gets an underpriced resource.

Varela also addresses the common argument that depreciation cannot help Pakistan because there is nothing to export. He calls this reasoning circular. If the rupee has been overvalued for a long time, export capacity shrinks. The absence of exports is itself a consequence of the overvaluation, not evidence that depreciation is useless. “Exporters, like anyone else, respond to incentives. And a real depreciation of currency increases the relative profits.”

Female labor force participation: the 23 percent GDP gap

The third major area of the report is female labor force participation, which in Pakistan stands at around 21 percent — among the lowest in the world. Varela is careful to reframe the common shorthand. Women who are not in paid employment are not idle. They work — at home, unpaid, often without having chosen that role. The economic problem is not that they do not work. It is that their talent is misallocated.

He uses an analogy: imagine Babar Azam was assigned to weightlifting and Talha Talib to cricket. They might manage, but the outcome would be far worse than if each were free to choose. “That reallocation of that talent is going to be better for them because they’re going to make much more money. But it’s going to be better for society because the social welfare will increase.”

The Bangladesh comparison is the quantitative anchor. Bangladesh, which shares significant cultural features with Pakistan, has a female labor force participation rate of around 38 percent — nearly double Pakistan’s. The report modeled what would happen to Pakistani GDP if participation rose to match Bangladesh’s level. The answer: GDP could increase by up to 23 percent. And that is a static estimate. Compounding effects over time would be larger.

The barrier in manufacturing — where female employment sits at just 4 percent — is a coordination failure. Firms do not invest in dedicated facilities (washrooms, safe spaces, transport) because not enough women are applying. Women do not apply because the facilities are not there. Varela suggests that mandating dedicated facilities above a certain firm size, subsidizing the initial investment, and improving safe public transport could break the deadlock. He also notes that firms integrated into global value chains already employ more women, because international buyers demand it.

Why Pakistani firms stay small — and what zombie firms cost

By the end of the conversation, Muzamil and Varela have covered the third pillar of the report: why firms in Pakistan do not grow. Varela describes a chart comparing firm age and firm size across Pakistan, Mexico, and the United States. In the US, firms that survive grow large — the “up or out” dynamic. In Pakistan, the line is flat. Firms stay small for decades, and even loss-making firms — what the report calls zombie firms — remain in business rather than exiting.

Two structural causes dominate. First, the government is the dominant borrower in the banking sector, crowding out credit that could go to private firms. Second, insolvency law and court processes are so slow and cumbersome that banks face real difficulty recovering collateral when loans go bad. The rational response is to lend less to the private sector.

There is also an internal constraint: managerial capability. A survey conducted among firms in Punjab, partly by researchers from the Lahore School of Economics, found that managerial practices in Pakistan are below average compared to countries at a similar development level. Family-owned firms — which dominate the landscape — tend to resist professional management, and the protection offered by high import duties reduces the competitive pressure that would otherwise force firms to improve. “When you’re inward looking, perhaps receiving subsidies, being protected by high levels of import duties, incentives to upgrade your managerial capacities are lower, and that limits your ability to grow.”

Varela’s prescription is layered: reform insolvency law, reduce the fiscal deficit so the government crowds out less private credit, and experiment with targeted managerial training programs for high-potential firms — scaling what works, stopping what does not.

The crisis that should not be wasted

Muzamil asks whether Pakistan can realistically act during a crisis, or whether the despondency he sees around him — people leaving, or hoping to — is justified. Varela invokes the phrase attributed to various leaders: never waste a good crisis. He is not dismissive of the difficulty. He acknowledges that some reforms require fiscal space Pakistan does not currently have. But others do not.

Reforming state-owned enterprises — many of which run persistent losses and operate in sectors where the state has no obvious reason to be present, including fisheries — is one. Automating the duty drawback process for exporters is another. The current system requires a bureaucratic body called the Input Output Coefficient Organization to certify how much of each input an exporter used. “That’s a bureaucrat that decides how much metal you should put in your pen,” Varela says. Replacing this with data-driven, automated coefficients drawn from FBR’s existing sales tax records would reduce costs for exporters without costing the government revenue or increasing imports.

Muzamil closes by noting that the report also covers agriculture and foreign direct investment — areas the conversation did not reach. He urges viewers to read it. Gonzalo Varela thanks him for the invitation, and the episode ends with the same quiet register in which it began: a long problem, named carefully, with a road map that is neither simple nor impossible.