Why growth is constrained

TShahid Kardar HE country will soon have a new coalition government at a time when it will be confronted by issues of a massive budget deficit, the repayments of our external obligations and a rupee under continuing pressure.

Predicting when a crisis will hit us is difficult. Will the process be slow and painful as reflected in the symptoms mentioned above and a low growth rate or will we reach the tip- ping point suddenly?

This article looks at the key structural issues underlying this precarious situation because Pakistan faces a population bulge for almost the next 35 years for which it needs to quickly ramp up its growth rate; 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. The economy must grow at eight per cent per annum to accommodate these annual entrants to the labour force, as against the average rate of five per cent that we have achieved since the 1970s and the lacklustre average of under three per cent over the last five years.

Can this shift to a higher growth path be achieved on a sustainable basis? While, for reasons of efficiency, the bulk of this growth must come from the private sector, achieving such growth rates will:

a) Require a much higher rate of investment than our average historic rate of less than 19 per cent of GDP and the present rate of just 12 per cent. To generate a growth rate of around eight per cent per annum over a 30-year period will require an investment ratio of 30 per cent plus — the East Asian Tigers averaged 30 to 35 per cent while India is now averaging just under 40 per cent and China 46 per cent; b) Necessarily require a sharp increase in domestic savings (less than 15 per cent of GDP for most of our history compared with India’s 35 per cent) to finance the investments needed to attain and then maintain such rates of growth. This large historical gap of four to five per cent of GDP between our investments and savings was financed by external flows, essentially in the form of foreign loans, leaving little room for making mistakes in the selection of projects or allowing large amounts as ‘leakages’;

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 per cent of the growth in our GDP, while between 1998 and 2008 its contribution fell to a mere 11 per cent, 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 have not developed, partly because of the history of our 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 ethics and 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, while the ‘poor country’ 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. Most of these reforms will not require sizeable volumes of expenditures to implement but will make businesses profitable, thereby providing an incentive to save and invest — a virtuous circle.