Stalemate: Continuing to suffer from economic stagnation

Lack of investment means GDP growth has remained range-bound

Dr Fahd Rehman February 14, 2016
Lack of investment means GDP growth has remained range-bound. PHOTO: FILE


The average real GDP growth rate of Pakistani economy in the last eight years is 3.4 % which makes a strong case of economic stagnation. This prolonged period of slow economic growth should also manifest through higher unemployment rate.

Interestingly, this lower real GDP growth hasn’t been captured into unemployment data gathered by the Pakistan Bureau of Statistics (PBS). However, there are a host of factors associated with the current period of economic stagnation.

First, the beginning and lengthening of energy problems (gas and electricity) have played a significant role in promoting stagnation since 2007-08. As energy is used up in the production process, the unavailable and less frequent energy have increased the ‘overhead cost’ of business firms. In addition, business firms in developing countries usually operate in an oligopolistic market structure. In order to maintain a reasonable ‘profit share’ in sales, business firms were bound to increase their prices which resulted into higher prices of finished products. As a consequence, the general level of prices almost doubled from 2008 to 2014, though maintaining that level till now.

Budget constraints

Second, successive governments are facing lack of ‘fiscal flexibility’, which constrains their budgets for public investment. The continuous low level of public investment in education, health care and technology is baneful from the perspective of long run economic growth and hence economic development. On top of that, the straitjacket budgetary situation is not allowing the governments to subsidise consumption for the lower income classes, while lower income classes spend most of their incomes and save nothing, which play an important role in increasing the aggregate demand of an economy which aid in increasing the capacity utilisation of business firms. The low level of capacity utilisation of business firms reflect the state of economic stagnation.

Third, business firms operate under the environment of uncertainty and the role of government is to reduce it. If uncertainty increases, the entrepreneurs or capitalists start to do ‘precautionary savings’ rather than investing in ‘real capital’. The capitalists leave their core business of re-investing in business and start investing in other activities. In the context of Pakistan, the best form of ‘precautionary saving’ is investment in land. Similarly, consumers with higher incomes tend to save in land. This type of investment in land misallocates the scarce capital and is counter-productive from the perspective of long run economic growth.

Fourth, since the advent of global financial crisis, big economies like the US, China and the Europe are stuttering and haven’t recovered fully. Since the exports of Pakistan are heavily dependent on these economies, the weakening of global demand is also affecting our exports. In the absence of higher value addition, the impact is being felt heavily. The low level of exports also decreases the level of aggregate demand which is also holding back economic growth.

Finally, the role of multilateral institutions (the IMF and the World Bank) is also important in maintaining an appropriate level of aggregate demand of the developing country. The standby agreement between Pakistan and the IMF from 2008 to 2011 did improve the economy in the short run by averting the Balance of Payment (BOP) crisis and bolstering the foreign exchange reserves despite very high international crude oil prices, but could not yield positive result from the long run perspective.

The Extended Fund Facility (EFF) has stabilised the economy by averting the BOP crisis and bolstering the foreign exchange reserves to the new level with very low international crude oil prices. The cushion of cheap oil prices is being used to increase the indirect-tax revenue without meaningful structural reforms which are indispensable for long run economic growth. Hence, the structural problem of persistent current account deficit is contributing to economic stagnation and would keep on haunting the policy makers in the years to come.

The writer is an Assistant Professor of Economics at Suleman Dawood School of Business, LUMS

Published in The Express Tribune, February 15th,  2016.

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