Economy’s current state
By Shahid Javed Burki
Tuesday,June 19, 2007
SINCE I write about the Pakistani economy, I am often asked about its health, performance and prospects. These questions are posed more earnestly in May and June as the calendar advances towards two events. The first is the release of the annual Pakistan Economic Survey; the second is the unveiling of the national budget. The Survey takes a detailed look at the financial year that is about to close; the budget views the year that is about to begin.
The Survey for the year 2006-07 was released to the public by the ministry of finance on June 8. Two days later, on June 10, the budget for the year 2007-08 was presented to the National Assembly. In the article today, I will reflect on the current state of the economy.
The most discussed number in the Survey is the rate of economic growth which is estimated at seven per cent. This is an estimate since the government has data for only the first 10 months of the year, from July 2006 to April 2007. This means that the economy continues to expand at a rate three and a half times the increase in population.
At this rate there should be a sizeable reduction in the incidence of poverty. The expansion that began in 2002-03, when the gross domestic product increased by 4.7 per cent, was maintained in the current year. The GDP increased by 7.5 per cent in 2003-04; by another 8.6 per cent in 2004-05; and by a further 6.6 per cent in 2005-06.
Factoring in the increase for this year, the economy has expanded by almost 40 per cent over the last five years — on average an increase in GDP of seven per cent a year. This makes it one of the most impressive periods of economic expansion in the country’s 60-year history, a fact that Islamabad should celebrate by using the right set of numbers.
I am really puzzled why the country’s senior economic leaders continue to use “nominal” rupees and dollars to underscore the good performance of the economy. A nominal rupee or a nominal dollar is the value of the currency in terms of what it can purchase at a given time. The nominal rupee in June 2007 is what it can buy in June 2007. Its value is eroded by inflation. Consequently, what it can buy today is less than what it was able to purchase a year ago or five years ago.
The rate at which a currency depreciates is what economists call the price deflator. It is the amount by which the value of the currency must be adjusted to discount for inflation. When the Economic Survey says that the GDP increased by seven per cent, the estimate is made in real rupees. It takes out the effect of inflation. It is the real expansion in the economy, not the consequence of inflation.
The claim made repeatedly that the size of the economy has been doubled in five years is correct only when the rate of growth is measured in nominal rather than in real rupees or dollars. That is never done. Growth rates should always be provided in real rather than in nominal terms. The difference between the two is important.
Although this “doubling of GDP stance” was dropped from the various presentations made in connection with the budget, the thinking behind some of these claims, unfortunately, has not changed. “The per capita income in dollar terms has grown at an average rate of 13 per cent a year during the last five years, rising from $586 in 2002-03 to $925 in 2006-07,” write the authors of the recently released Economic Survey. “Per capita income grew at a much lower rate of 1.4 per cent per annum in the 1990s.”
It is particularly worrying that this comparison in the performance of the economy in the 1990s and the early 2000s is being made in these terms. The 13 per cent increase in the recent period was in nominal terms, the 1.4 per cent growth in the earlier period was in real terms.
There was a suggestion that since per capita income is approaching $1,000 a year the country should be on the verge of becoming a middle income economy. But the line that separates the poor from middle-income countries continues to be moved up by institutions such as the World Bank that do this kind of accounting to take account of inflation.
When Pakistan crosses the line, the definition of a middle-income country will certainly have changed. Besides, as indicated in the Economic Survey, the country has continued to keep the exchange rate more or less fixed at Rs60 to a dollar. This has been done despite the fact that the rate of inflation in Pakistan is at least seven percentage points more than in the United States.
As I have suggested earlier, the rupee is now seriously overvalued and when the adjustment is finally made, it will result in reducing the size of the economy as well as income per head of the population when these two are expressed in nominal dollars. That would not mean that devaluation would bring back the country from a middle-income status to being once again poor simply because the exchange rate has been adjusted to a more meaningful level.
This is the kind of problem the use of nominal currencies poses. An economy that has grown at seven per cent average over a five-year period will not only be much larger in size, it will also be structurally different. This will be the case in particular if the rates of growth in different parts of the economy are different from the economy as a whole.
The Economic Survey has data on the sources of growth with the contributions estimated for the main sectors of the economy. Of the three main parts — services, agriculture, and manufacturing — the highest rate of growth was registered by manufacturing. This is to be expected of a rapidly growing developing economy.
The sector’s output increased by eight per cent in 2006-07. However, this was lower than the rate of increase in 2005-06, when the value added in the sector grew by 10 per cent. The rate of output increase in what is described as the large-scale manufacturing sector also declined quite significantly. It was 10.7 per cent in 2005-06 but declined to 8.8.per cent in 2006-07.
The service sector output increased by eight per cent while that of agriculture grew by five per cent. Agriculture’s higher than normal rate of increase was largely the consequence of the recovery from the previous year. In 2006-07, the output of major crops increased by 7.6 per cent, coming after a decline of 4.1 per cent in the previous year.
In other words, the high growth rate of the economy in 2006-07 may be due in part to good weather which normally contributes to wide fluctuations in agricultural output. Also, the fact that the value added by major crops was considerably greater than that by minor crops and the sector of livestock means that the sectors which will ensure high rates of sustainable growth are performing below their potential.
These growth rates suggest that the economy’s three major parts grew close to the average rate of economic increase. The contribution they are making to the economy has not changed by much; the proportions in the national GDP of agriculture, manufacturing and services have remained largely unchanged. This may be the sign of long-term weakness since looking at the country’s endowments growth will come from some of the economy’s components that are currently under-performing. Small-scale engineering and high value added agriculture are some of the activities that would provide long-term momentum to the economy.
What is particularly worrying about the state of the economy is the performance of exports. In the first 10 months of the current year, the value of exports increased by only 3.4 per cent, a sharp decline from the 16 per cent average a year increase in the previous four years. The value of imports has also declined from a sharp acceleration in the period between 2002 and 2006 and the financial year about to be completed.
The Survey identifies in some detail the reason for poor performance of exports among them the most important being the inability of the textile sector to remain competitive in a market that has many aggressive participants. This line of thinking represents a major change in
the government’s view of the performance of the textile sector.
The Economic Surveys from earlier years had celebrated the large investments that were made by the entrepreneurs in the textile sector. It was repeatedly pointed out that by investing massively in the modernisation of the industry, textile entrepreneurs had prepared the country well for the time when the quota regimes that had directed international trade in the sector, would be replaced by open competition.
The approach taken this time is correct since it puts emphasis on the sector itself rather than on the crutch that the entrepreneurs continue to demand from the government. It is the ready availability of the support the government was always prepared to provide that has retarded the sector’s development.
According to the Survey, “it is generally argued that Pakistan’s exports are uncompetitive in terms of adherence to contracted quality and delivery schedule. Pakistan’s competitors are investing heavily and creating better economies of scale.
These are structural issues and must be addressed by the industry itself with the government playing its role as a facilitator and providing some temporary assistance to address some short-term issues…” This is the right approach to adopt.
The real problem posed by the poor performance of exports is the burden it is imposing on the economy. The trade balance continues to deteriorate with Islamabad prepared to finance it by a combination of foreign borrowing and sale of government-owned assets.
This can’t be a permanent solution to the problem of large trade deficits; the only way out is to increase exports of merchandise as well as services. In both, public policy needs to take account of the country’s comparative advantage.
It is not right to focus so much attention on increasing the export of textile, a sector in which, as the Economic Survey correctly points out, Pakistan faces stiff competition. Not only must Pakistan compete with China in textile exports, it must also face competition from countries such as Bangladesh that enjoy privileged access to such large markets as the United States and the European Union.
In sum, the continuing expansion of the economy is something Islamabad’s policymakers can take credit for. That said, the economy needs careful tending particularly to ensure that the rapid growth spreads its rewards widely. I will discuss this aspect of economic performance next week.
http://www.dawn.com/2007/06/19/op.htm#1