Covid and systemic economic issues
Recent forecasts made by two of the principal institutions of global economic governance paint a less gloomy picture of Covid-hit international trade and economy.
According to the World Trade Organisation (WTO), during the current year, world trade is likely to shrink 9.2%, while during 2021, it will expand 7.2%. Earlier, in April this year, the WTO projected world trade would fall between 13% and 32%.
In a similar fashion, the International Monetary Fund (IMF)’s October forecast put global economic contraction during 2020 at 4.4% compared with the 4.9% projection made in June. For 2021, the world economy is projected to expand 5.2% compared with the 5.4% forecast made by the Fund in June.
According to the IMF forecast, Pakistan’s economy will contract 0.4% during the current year compared with the 1.9% actual growth during 2019. In 2021, the economy is predicted to return to expansion, though at a meagre pace of 1%.
On average, emerging and developing economies, taken together, are projected to register 3.3% contraction and 6% growth during 2020 and 2021 respectively. Thus, in terms of both projected contraction and growth, Pakistan stands out differently from other developing and emerging economies on average.
One plausible explanation for this divergence is that growth recession in Pakistan is underpinned by systemic factors, such as low savings and investment, and low productivity of factors of production. The pandemic may have exacerbated some of these factors – savings for instance – but it didn’t cause them.
Hence, even after the pandemic is controlled and full economic activity resumes, these systemic factors will continue to put the skids under economic growth.
From 5.5% in FY18, Pakistan’s economic growth nosedived to 1.9% in FY19, which had nothing to do with the pandemic. During FY20, the economy contracted 0.4%.
While some of the economic contraction during the previous financial year may have been contributed by Covid-19, it was essentially the result of weak fundamentals and government’s attempt to correct them.
Savings, investment
It may be pointed out that the relatively high growth in FY18 was not undergirded by strong fundamentals. The high growth year – FY18 – closed with 10.4% savings-to-gross domestic product (GDP) ratio, 16.7% investment-to-GDP ratio, $23.2 billion in exports (7.4% of GDP) and $19.2 billion in current account deficit (6.1% of GDP).
The low growth year – FY19 – closed with 10.8% savings-to-GDP ratio, 15.4% investment-to-GDP ratio, $22.9 billion in exports (8.1% of GDP) and $13.4 billion in current account deficit (4.8% of GDP).
Thus, during both FY18 and FY19, the share of national savings and investment in GDP remained well below the desired level. The only difference was that in FY18 the difference between savings-to-GDP and investment-to-GDP ratio was 6.3 percentage points, while in FY19, the gap came down to 4.6 percentage points, which was reflected in the corresponding current account-to-GDP ratio during these two years.
During FY19, national savings (10.8%) were 0.4 percentage point higher than those during FY18 (10.4%) whereas during FY18 investment was 1.3 percentage points higher than that during FY19.
Likewise, exports remained around $23 billion during both FY18 and FY19, while export-to-GDP ratio remained low during both years. The difference in growth rates between the two years was undergirded by the demand compression policies pursued by the government during FY19 in an attempt to reduce the current account deficit.
The attempt was successful but only because of reduction in imports from $60.79 billion in FY18 to $54.79 billion in FY19 (down $6 billion, which was almost equal to the decrease in current account deficit) and at the expense of economic growth.
The demand compression policies of the present government have drawn a lot of flak. A common argument is that the government should have persisted with economic policies of the previous government, which had ushered in a relatively high growth rate and a stable exchange rate.
Such an argument lacks substance. No doubt, when growth recedes, jobs are lost and income falls, which pulls down the demand for goods and services. As a result, the output level comes down – and the cycle continues.
However, sustained growth is possible only when it is based on strong fundamentals, otherwise it will give rise to big external and internal deficits, which are difficult to sustain in the long run or even for a few years.
That is the reason soon after its induction in August 2018, the present government in the face of fast depleting foreign exchange reserves was forced to negotiate, and finally conclude, a bailout package with the IMF and pursue demand compression policies, which have costs as well as benefits.
If the economy had been managed astutely during the last few years, there would have been no need to go back to the multilateral donor of last resort.
Expansionary, contractionary policies
But as in the case of expansionary policies, contractionary policies in themselves offer no solution to the systemic economic issues. They, at best, are instrumental in putting the brakes on galloping external and fiscal deficits – though in case of Pakistan containing the fiscal deficit is always a tall order due to the peculiar political economy factors.
Like expansionary policies, contractionary policies are difficult to pursue over a long period. If nothing else, political factors compel the government to cut interest rate to placate big businesses or step up expenditure and create jobs to win over the electorate.
Without improving factor productivity or overcoming supply-side constraints, monetary or fiscal expansion-induced increase in aggregate demand shores up import demand without a corresponding increase in the export capacity or surplus, thus widening trade and current account deficits.
Part of the increased demand is absorbed by the real estate sector, thus raising asset prices, which benefits speculators and rent-seekers at the expense of productive investment.
Hence, whether the government pursues expansionary or contractionary policies, for sustained economic growth, the systemic issues need to be addressed, otherwise the economy will continue moving in a circle.
Coming back to the global growth forecasts, one reason the economy of Pakistan is likely to contract (0.4%) far less than the projected average contraction of developing economies (3.3%) during 2020 is the low export-to-GDP ratio, which is about 8%.
The low share of exports in the total national output means that we are less adversely affected by growth recession or contraction in other economies, particularly those which constitute our major export markets, such as the US, European Union countries, China and the UK.
For the same reason, the economy of Pakistan is less likely to benefit from the projected growth expansion in big economies during 2021.
The writer is an Islamabad-based columnist
Published in The Express Tribune, October 26th, 2020.
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