Inequality & development
By Shahid Javed BurkiTuesday,June 26, 2007
IF budgets are meant to deliver marginal changes in the established fiscal order, they don’t deserve the hoopla that accompanies their announcement. With the private sector now playing the role which is unprecedented in Pakistan’s history, much that happens to the economy is not the result of what Islamabad does but what thousands of entrepreneurs think and do.
When the history of the economy under President Musharraf gets to be written it is the role that he and his associates have assigned to private entrepreneurship that will be singled out as the most important economic initiative of the period.
However, if the people in power choose to use the budget to bring about a major change in the structure of the economy then the changes in the fiscal policy they announce should deserve the attention that the budget normally receives.
From my way of looking at the Pakistani economy, there are two areas that deserve the policymakers’ attention. The first is making the current high rate of GDP growth sustainable. The second is to address the problem of growing inequality in the distribution of both income and wealth.
I will deal with the second issue in this article, having covered the first in several articles contributed earlier to this space. Both the government and independent observers of economic trends in the country have focused a great deal on the incidence of poverty and the rate at which it is declining.
At issue is not the exact estimate of the number of poor who live in absolute poverty (with incomes of less than one dollar a day) or in poverty (with incomes of less than two dollars a day) but the rates at which their proportion in the total population is falling.
The government contends that the incidence of poverty is declining at a significant rate. If this is indeed the case and if the high GDP growth rate of recent years (seven per cent increase per year over the last five years) is resulting in a fairly significant reduction in the proportion of poor in the population then public policy is set on the right course.
Contrary to Pakistan’s own experience in the 1960s and that of a number of other high-growth developing countries, the trickle-down effect may finally be working to help the poor.
However, the government’s critics maintain that the rate of decline in the level of poverty is exaggerated by Islamabad; that, for the rewards of recent high rates of GDP growth to travel down to the poor, public policy needs to be fashioned in a different way.
If the critics are correct then the trickle-down approach would need a helping hand. One way of coming to a conclusion about this argument is to analyse what is happening to economic equality as a result of the rapid growth in GDP in recent years. This is an area of analysis that has even less reliable data and information available than is the case with the incidence of poverty and its decline over time.
Concern with growth’s impact with equality is not confined to Pakistan. This is being debated in the academia as well as in a number of developed countries. Academics have come to it by following a circuitous route. It was in the 1990s that mainstream economists turned to growth as a concept that needed analysis and understanding.Then Robert Lucas of the University of Chicago and Paul Romer of Stanford University published path-breaking papers that laid the basis for what economists call the endogenous model of economic growth.“Endogenous”, as dictionaries inform us, means a process involved in “producing or growing from within.” Until then, economists had tended to describe growth as dependent on the quantities of factors of production – labour and capital – that were used in the process of production.
But there was a limit to the amount of labour that could be applied for economic production, even in a country such as Pakistan that had a rapidly growing population. Adding machines (i.e. capital) to the workplace resulted in what the economists called “diminishing returns”.
This theory had produced a puzzle for economists. With the countries such as those in Europe that had reached the stage of zero population increase, this theory implied a slowdown in the rate of economic growth to the point where developing countries with growing populations would begin to catch up. That was not happening. Economic theory predicted the closing of the gap between the rich and poor nations. Instead, the gap continued to widen.
This is when Lucas and Romer entered the picture by including in the production function inputs such as the quality of human capital and technological developments. This model implied that economies could continue to grow even if the size of the work did not increase. They could do this by investing in improving the quality of the workforce through education and training. Technological improvements would also contribute to growth.
With Lucas and Romer helping us, we begin to understand what is keeping Pakistan well below the growth trajectories being followed by a number of Asian countries, the government’s protestations notwithstanding.
Conventional economic theory informs us that capital accumulation drives economic growth up to a point. Our own experience tells us that capital accumulation, unless it is financed from resources obtained from within the economy, will remain dependent on external capital flows. These may come from sources other than the largesse of friendly rich nations.
In an article contributed to this newspaper a few weeks ago, Ishrat Husain provided some compelling statistics to show why a sudden cut off in American aid will not have the devastating effect it did in 1966 and 1990. Pakistan could survive a spell of bad relations with the United States because it has found new sources of external finance not dependent on Washington’s goodwill.
That said, the remittances sent by the Pakistani resident community in the Middle East, Britain and North America and the large amounts of investment capital that is pouring into the country from the Middle East are not good substitutes for domestic savings. No country has ever been able to secure for itself a good economic future by depending almost exclusively on foreign savings. It would be wrong for Pakistan to rely on this resource.
But there are other weaknesses. Pakistan has a large and young population which is poorly educated and poorly trained. It cannot contribute to sustainable economic growth. Moreover, the economy’s technological base is poor. Neither the state nor the private sector has invested much in technology; the country continues to rely on the technologies imported from abroad.
Even the development of nuclear weapons was made possible by technologies obtained from abroad, mostly be stealth. India, on the other hand, used indigenous technologies to build nuclear weapons.
I should mention two other advances in economic thinking before returning to the subject of the budget and what could it have done to set the economy on the high growth trajectory. The first reference is to the work done by the economist Douglas North on the importance of institutions for economic growth. Following North, institutional economists define institutions not as structures and organisations but as the laws, rules and regulations that govern human relations.
If these are weak, economies cannot grow rapidly. Institutional weakness is defined as the absence of established observable rules that don’t distinguish between the circumstances of the people.
The same set of rules applies to the poor as to the rich, to those who have little influence over the government and to those that are part of the government, to those who have influence over other human beings to those who have to exist within the orbit of other people’s influence.
Economists also borrowed some insights from sociologists and anthropologists to focus on what they began to call social capital. This is defined by the way, or ways, in which people interact with one another.
Economic growth is faster and economic modernisation is more rapid in societies that are well-endowed with social capital. With the rise in ethnic tensions and sectarianism, the quality of social capital is declining in Pakistan. Only political development can reverse this process.
The third major advance in policy thinking is the focus on inequality. For decades, economists have found it difficult to factor inequality in the subject of growth. For some years, thinkers such as Simon Kuznets who looked at the empirical evidence on growth and distribution, decided that in the early stages of development, inequality is an inevitable consequence of growth. But that has changed.
In recent times, economists such as Paul Romer who had pioneered the thinking about new growth models, have begun to focus their attention on income inequality as an obstacle to sustained economic advance.
Writes one commentator: “During the 1990s, Paul Romer, a Stanford economist, emerged as one of the leading theorists on economic growth. Recently though, Romer has changed his focus, and he told me that the country, too, is entering a new phase. For most of the 20th century, he explained, economists focused on stability — that is understanding and controlling inflation and depressions. Then, towards the end of the century, growth became the central obsession. Now, Romer said, we are embarking on the next great challenge in American economics: mitigating inequality.”
What is true for America is even truer for Pakistan where economic and social inequalities are considerably more pronounced. It is often political scientists who help economists understand why certain distortions created by the strategies they advocate can create social turbulence. Concentrating on growth without caring for its distributional impact is one area where policymakers can go wrong. This is the case in Pakistan.
It should be clear from the above discussion that the conditions just don’t exist in Pakistan which can support a high rate of economic growth, alleviate poverty and improve the distribution of income. We don’t save enough from our national income to accumulate capital. We have not trained our large and growing workforce to help modernise the economy and take advantage of the window of opportunity that exists as a result of falling rates of fertility in the developed world.
We have not invested in the development of technologies that would help improve worker productivity. We have not only under-invested in institutional development, we have destroyed even those institutions that were left behind by the British.
What we need, therefore, is a comprehensive strategy of growth that would help deal with these shortcomings. The budget could have started the process but was confined to introducing only marginal fiscal changes. What could have been done? I will pick up this question next week.
http://www.dawn.com/2007/06/26/op.htm#1