March 16, 2012
Shahid Kardar

Pakistan needs to ramp up its growth rate because the country faces a population bulge for almost the next 35 years; 230 million are projected to be in the labour force by the end of that period. This huge number of young men and women will have to be provided productive jobs to avoid social unrest and reduce the recruitment queues for Taliban-like forces. To absorb this youth the growth rate will have to be boosted from its present lacklustre levels.

How fast must the economy grow to accommodate these annual entrants to the labour force? All estimates suggest a seven-percent rate per annum. However, to reduce both the previously unemployed and underemployed, a rate of eight percent per year may be necessary, as against the average rate of five percent that we have achieved since the mid-70s – reflecting the existing potential of the economy, ignoring one-off events like an exceptional harvest, a spike in export prices.

How can this shift to a higher growth path on a sustainable basis be achieved? I would preface the discussion to follow by arguing that, for reasons of efficiency, the bulk of this growth must come from the private sector. And achieving such growth rates will:

a. Require a much higher rate of investment than our average historic rate of less than 19 percent of GDP. It is not possible to generate a growth rate of around eight percent per annum over a 30-year period without an investment ratio of 30-percent-plus: the East Asian Tigers averaged 30-35 percent, while India is now averaging just under 40 percent and China 46 percent.

b. Necessarily require a sharp increase in domestic savings (less than 15 percent of GDP for most of our history, compared with India’s 35 percent) to finance the investments needed to attain and then maintain such rates of growth. And this can only be achieved gradually over time, and provided adequate incentives and reforms are in place (see discussion below). And—

c. Need continued improvement in the productivity of the resources – capital and labour – employed. Higher growth rates will not only require more capital but, more importantly, higher productivity from all factors of production – necessitating a combination of greater technological progress and more efficient use of these inputs. Between 1970 and 2005 increases in productivity contributed only 20 percent of the growth in our GDP, while between 1998 and 2008 its contribution fell to a mere 11 percent, well below that of India, Sri Lanka and Bangladesh. The impediments to productivity increases include availability of reliable energy at reasonable rates, an educated, skilled and healthy labour force, and entrepreneurial and managerial skills. In our case, entrepreneurial skills hav e not developed partly because of our history of the state providing different industries protection against competition through policy crutches. The deficiency in managerial skills is a product of our weak educational systems, poor work ethic and the incentive structures that do not create a demand for professional skills – an entrenched culture of SROs to protect different sub-sectors of industry renders irrelevant the need for quality skills to improve industrial competitiveness.

Going forward we will have to look at domestic sources to meet our growing investment requirement since international capital flows are destined to become more volatile, the country’s poor image will only make it more difficult to access such funds at affordable rates. This will require more savings both “public” and private. How will these be raised?

Private savings can be stimulated through incentives and the right mix of economic policy and financial, regulatory, goods and labour-market reforms, institutional reforms (the last in the form of better and more accountable civil service structures), availability of skilled labour, technological readiness, etc. – the “software of growth” that the Planning Commission argues for. These are expected to boost investment rates by reducing the cost of doing business – we presently rank lower than other South Asian countries on ease of doing business – and most of these reforms will not require sizeable volumes of expenditures to implement. This will make businesses profitable, thereby providing an incentive to save and invest – a virtuous circle.

As for ways to support the growth in household, savings I would propose: (a) improvement in financial intermediation by ensuring real and increased returns on financial savings, say, on instruments of national savings schemes: this will incentivise the acquisition of financial assets and reduction in currency in circulation, today Rs1.7 trillion (close to 35 percemt of deposits!) and force banks to compete to mobilise deposits; and (b) introduce new institutions and instruments like portable and mandatory savings/pension schemes.

The above reforms to facilitate private investment and savings will need to be supported by complementary government investments in physical infrastructure. However, the financing of infrastructure, education, health, etc., related investments to improve both quantity and quality, will require significantly large resources. Unfortunately, our track record in terms of generating adequate resources (the public savings referred to above) to fund such spending has been abysmal. On the one hand, we have one of the lowest tax-to-GDP ratios and, even considering developing countries, we are amongst the bottom-ranked nations in terms of the proportion of the population registered as taxpayers – less than 5 percent of household population. And on the other hand, these limited resources are deployed on the basis of skewed priorities. And the issue here is not just creation of more assets like schools and hospitals but ensuring that there are adequate budgetary allocations for doctors, nurses, teachers and medicines to keep these facilities functional, providing quality services for which they were established. The enhancement in these public savings can only come through a credible time path for bringing the fiscal deficit under control – more tax revenues and less unproductive expenditures as a percentage of GDP – through a combination of policy, procedural and administrative reforms (tax and expenditure reforms will be subjects of forthcoming articles). The increased fiscal space will enable the financing of social sector expenditures and physical infrastructure, an outcome that will require more than just higher rates of economic growth.

Future economic growth will also face a slowing down of demand in our traditional export markets of Europe and the US, which are struggling with their own recession-like conditions. To overcome this demand insufficiency for our products, we will have to look towards the East, especially our neighbours, with young consumers and growing markets, as opposed to aging populations and contracting Western markets. Growth in exports has become critical for financing our rising import bill, especially with doubts about the continuing robustness of remittances from sluggish Europe and America.

However, to support export enhancement and the competitiveness of the economy, apart from a competitive exchange rate, one would not recommend any generic support to a sector (to avoid creating distortions) but to factors of production and cross-cutting activities (like skill development, investment in key infrastructure or incentives for exports as a way of incentivising performance) that are likely to have an impact upon a broad range of sectors and can draw in other complementary investments or technology or knowledge spill-overs.

(To be continued)

The writer is a former governor of the State Bank of Pakistan.
-The News