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VIEW: Is GDP growth sustainable? — Akmal Hussain

There is a growing gulf between the government’s idea of its economic performance and the economic reality as experienced by the people. While the government revels in its achievement of high growth, a majority of the people are experiencing the grim reality of continued deprivation of basic services and inflation-squeezed real incomes

“Between the idea and reality falls the shadow.” — TS Eliot

Popular scepticism towards the
government’s claims of economic success may not be entirely baseless. After three years of high GDP growth there are already signs that this has not only enriched the few at the expense of the many but also that it may not be sustainable. An examination of the gap between (official) perception and economic reality (at the level of the people and in terms of economic science) may therefore be useful. The purpose here is to identify the long-delayed structural changes in the economy and governance needed to achieve equitable and sustainable growth.

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

It is important for policymakers to realise that the poor experience their poverty not as a percentage of the population but in absolute terms. Bringing about a change in their living conditions requires pursuing rapid poverty reduction policies. Given that every third household in Pakistan is malnourished and the majority deprived of basic services, the poor cannot wait for a mere trickle down 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 this GDP growth rapidly reduce poverty without a major policy shift towards income distribution? I shall examine the first question in this article and the second in a subsequent one.

Let us begin by identifying the strategic parameters that determine the sustainability of GDP growth. We can then check the figures for Pakistan to see whether the 7.5 percent GDP growth targeted by the government 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, ICOR for short). The ICOR, an indicator of the productivity of capital, is influenced by a variety of qualitative and institutional factors including 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, professional skills of civil servants in key departments and the quality and accountability of democratic governance.

In Pakistan’s case the latest independent measure of the ICOR is 4 — 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 Economic Survey of Pakistan 2004-05), it is clear that it is impossible to sustain a GDP growth rate of 7.5 percent without a huge increase in the investment rate.

(2) The domestic savings rate (savings as a percentage of GDP). If the domestic savings are less than the amount invested in the economy, 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 a perennial dependence on loans. In recent years there has been a further reduction in the domestic savings rate. Consequently, as pointed out by the latest report of the State Bank the gap between savings and investment is growing, resulting in a sharp increase in fiscal and balance-of-payments pressures. That this is happening even at a level of investment inadequate to sustain a GDP growth of 7.5 percent, casts doubt on the government’s claim that its growth performance can be maintained in the future. In a recent series of articles Dr Shahid Javed Burki has presented an incisive analysis suggesting that the recent high growth is based essentially on a consumer boom induced by cheap credit, improved capacity utilisation and a good harvest. When adjusted for these short terms factors, he argues, the GDP growth rate is still on the 1990s’ trend rate of 3 percent.

(3) An export growth rate sufficiently high to provide the foreign exchange needed to finance the growing imports associated with a high GDP growth trajectory. This requires that an export structure built around highly value-added goods have growing demand. Pakistan’s export structure meets neither condition. Its predominant industry (textiles), is (apart from a few exceptions) still predominantly exporting at the low value addition end of the spectrum 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 increasing trade deficit, over which the State Bank has expressed concern, is therefore not a short-term phenomenon. Balance-of-payments pressures constitute an endemic constraint to sustaining high GDP growth. (For a detailed analysis 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 an 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. Does Pakistan have the investment capability to undertake such infrastructure projects? 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 laureate Douglas North and recent research by economists such as Acemoglu, Kuran and Grief have shown, that an underlying institutional structure is necessary in order for markets to function for sustained growth. These institutions include the establishment of private property rights, contract enforcement, stable constitutional structures and a governance system both accountable and responsive to change. For sustained economic growth, as both North and Grief have argued, norms and cultural values underlying these institutions are equally important. Has the government even started bringing about the fundamental structural changes in the polity and in governance that can 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 citizens’ experience of economic reality is not simply a matter of correcting public perceptions by throttling the dissenting voices. It is a matter of incorporating the concerns of the people for a profound change in the government’s policy focus towards rapid poverty reduction and improving income distribution. Evidence suggests that a high GDP growth cannot be sustained on the basis of existing policies. The sustainability of growth and equity require deep structural changes in both the economy and the polity, which the government has not even begun to address.

This is the first in a two-part series of articles. Dr Akmal Hussain is a leading economist and author/co-author of several books

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