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Is GDP Growth Sustainable?
Dr.Akmal Hussain
Newspaper: Daily Times
Dated: Monday, 1st May 2006


“Between the idea and reality falls the shadow.”

T.S. Eliot


Popular scepticism at the government's claims of economic success may not be entirely groundless. After three years of high GDP growth there are already signs that not only has it enriched the few at the expense of the many but that high growth itself may not be sustainable. It may be useful to examine the gap between official perception and economic reality at the level of the people and also in terms of economic science. The purpose is to identify the long delayed structural changes in the economy and governance that need to be undertaken to achieve growth with equity on a sustainable basis.


There is a growing gulf between the government's idea of its economic performance and the economic reality as experienced by the people. The government revels in its high growth achievement, while the majority of the people are experiencing the grim reality of their real incomes squeezed by inflation, amidst a continued deprivation of basic services. The government points to the over 19 percent growth in the large scale manufacturing sector as luxury automobiles that fuel this growth, become a metaphor of popular resentment: The rapidly increasing disparities between the rich and the poor.


It is important for policy makers to realize that the poor experience their poverty not as a percentage of the population but in absolute terms, as the lived human experience of individuals within their community. Therefore what must be pursued is rapid poverty reduction that can bring about a palpable change in the living conditions of communities. Given the fact that every third household in Pakistan is hungry and the majority deprived of basic services, the poor cannot wait for a mere trickle down effect of growth (even if it could be sustained).


Two questions arise at the present moment in Pakistan's economic history: (i) Is the high GDP growth of the past three years sustainable? (ii) Can GDP growth overcome poverty rapidly without a major policy shift towards improving the distribution of income? In this article, I shall examine the first question and in the subsequent article, the second.


Let us begin by identifying the strategic parameters that determine the sustainability of GDP growth. We can then simply check the actual figure for each in Pakistan's case to see whether the government's target GDP growth of 7.5 percent can be maintained. There are four strategic determinants of growth sustainability:


(1)        The investment required to produce an additional unit of output in the economy as a whole. (Economists call it the Incremental Capital Output Ratio or ICOR for short). The ICOR is an indicator of the productivity of capital and underlying it are a variety of qualitative and institutional factors such as the quality of infrastructure, the size and quality of the trained labour force, the quality of university education and research institutions and their linkage with industry, the professional skill of civil servants in key departments and the quality and accountability of democratic governance.


Now in Pakistan's case the latest independent measure of the ICOR value is 4, which is about the average for developing countries. This means that in order to generate (on a sustainable basis) a GDP growth of 7.5 percent the investment rate (investment as a percentage of GDP) must be at least 30 percent. Given the fact that Pakistan's investment rate (more precisely, gross fixed capital formation as a percentage of GDP) is only about 20 percent (according to the Pakistan's Economic Survey 2004-05), it is clear that without a huge increase in the investment rate, it is impossible to sustain the government's target GDP growth of 7.5 percent.


(2)        The second strategic determinant of growth sustainability is the domestic savings rate (savings as a percentage of GDP). If the domestic savings are less than the amount invested in the economy, then clearly the gap is filled either through loans (whether domestic or foreign) or foreign private capital inflows. The problem with loans is that over time they increase the debt-servicing burden of a country to a point where the consequent pressures on the budget and balance of payments force a slow down in GDP growth as happened during the 1990s. In Pakistan domestic savings have historically been inadequate to finance investment thereby resulting in perennial loan dependence. In recent years there has been a further reduction in the domestic savings rate. Consequently, as pointed out by the latest State Bank Report the gap between savings and investment is growing, resulting in sharply increased fiscal and balance of payments pressures. That this is happening even at the existing level of investment, which we have seen is inadequate to sustain a GDP growth of 7.5 percent, casts doubt on the government's claim that it can maintain its growth performance in the future. Dr. Shahid Javed Burki in a recent series of articles in the Daily Dawn has presented an incisive analysis to suggest that Pakistan's recent high growth performance is based essentially on a consumer boom induced by cheap credit, improved capacity utilization and a good harvest. When adjusted for these short terms factors, he argues, the GDP growth rate is still on the trend rate of the 1990s at 3 percent.


(3)        It is necessary to achieve a growth rate of exports sufficiently high to provide the foreign exchange earnings necessary to finance the growing import expenditures associated with a high GDP growth trajectory. Maintaining a high foreign exchange earning capability requires an export structure that is oriented towards goods that have growing export demand and are high value added. Pakistan's export structure meets neither of these two conditions. After five decades, Pakistan's predominant industry (textiles), is (apart from a few exceptions) still predominantly exporting at the low value added, low price end of the textile spectrum and in a world market where the share of low value added textile industry in the global aggregate demand is declining. Consequently, Pakistan continues to suffer from declining terms of trade, which means that it has to export a larger and larger volume of goods to earn the same amount of foreign exchange. Thus without a change in Pakistan's export structure the growth of foreign exchange earnings cannot be expected to keep pace with the import expenditures necessary for high GDP growth. The increase in the trade deficit over which the State Bank has expressed such concern is therefore not a short-term phenomenon. Balance of payments pressures constitute an endemic constraint to sustaining high GDP growth as Pakistan's economic history over five decades has shown. (For a detailed analysis of this issue see my paper titled: Institutions, Economic Structure and Poverty in Pakistan, South Asia Economic Journal, Vol. 5, Number 1, January-June 2004).


(4)        Infrastructure and the institutional framework for efficient markets. GDP growth and the underlying investment rate cannot be sustained unless there is adequate and high quality infrastructure. This includes adequate water reservoirs and efficient irrigation delivery system, transport and communications infrastructure, a highly trained labour force, high quality universities and research institutions. The question is, does Pakistan have the investment capability to undertake such infrastructure projects so vital to sustain growth. Equally important, has the government even begun to establish the institutional framework for translating finance into concrete outcomes in the field of infrastructure?


The work of Nobel Prize winning economist Douglas North and recent research by economists such as Acemoglu, Kuran and Grief have shown, that in order for markets to function for sustained growth an underlying institutional structure is necessary. These institutions include the establishment of private property rights, contract enforcement, stable constitutional structures and a governance system that is both accountable and responsive to change. As both North and Grief have argued, equally important for sustained economic growth are norms and cultural values that underlie these institutions. The question in the context of Pakistan's growth sustainability is, has the government even begun to bring about the fundamental structural changes in the polity and in governance that would lead to the establishment of these institutions?


In this article, I have argued that the gulf between the government's claims of economic success and the experience of economic reality of the citizens is not simply a matter of correcting public perceptions through the throttling of dissenting voices and strident official hype. It is a matter of incorporating the concerns of the people for a profound change in the government's policy focus towards improving the distribution of income and achieving rapid poverty reduction. The latest evidence on the economy suggests that a high GDP growth cannot be sustained on the basis of existing policies. The sustainability of growth with equity requires deep structural changes in both the economy and the polity, which the government has not even begun to address.

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