Public Expenditure and Economic Growth in Punjab-Pakistan

Abstract

Economic growth is a complex phenomenon, which is impacted by a host of economic, social, political and policy factors. It is also impacted by the level and composition of public expenditures of the government. Through this expenditure, the government can provide physical infrastructure and enhance productivity of labor through improving their health, education and skills, which in turn crowds-in private investment as this investment now has much higher returns than otherwise. Moreover, as was argued by Keynes, public expenditure increases aggregate demand which in turn impact economic activity (growth). In the subsequent chapters of this study we have shown that Pakistan‘s economic growth has slumped in recent years. Part of this deceleration in growth is attributed to the unaddressed structural problems in the economy and part to the emerging constraints like security and energy crises. Another factor that has both directly and indirectly impacted economic growth is the weak fiscal position of the national and provincial governments. With weak finances, these governments were incapable to counter the economic decline by undertaking expenditures to the level, or at least in areas, which could checked this decline. Moreover, in some odd way the government and its past fiscal decisions have exacerbated the situation through weak revenue mobilization and unbridled spending, which has landed Pakistan in debt situation which has added to country‘s fiscal, and therefore macroeconomic, instability. It is well known fact that Pakistan‘s national saving has always been low, and in the last 15 years have been declining as a percent of GDP. Domestic saving as a percent of GDP has now dropped to single digit. Although due to sharp increase in worker remittances,national saving is considerably higher than domestic saving, yet at 10.7 percent of GDP in 2011-12, savings were about half its position in 2002-03 (20.8 percent of GDP).1 2In comparison, saving rate in India was 31 percent of GDP and China 47 percent of GDP during the 2000s.3 Main reasons for sagging domestic saving rate has been worsening security situation and high inflation that Pakistan witnessed since 2007-08. These low levels of savings are inadequate to support the level of investments required to accelerate Pakistan‘s economic growth to the level of our eastern and northern neighbors. To plug the financing gap (between investment and saving) Pakistan has to rely heavily on inflow of foreign resources, those are very volatile in nature, and provides a clear insight into the cyclical growth trends in Pakistan. As the economy start to grow, additional investment is needed to increase (or even maintain) the investment-to-GDP ratio. With saving rates being so low, large foreign savings are required to finance this investment. As current account deficit of balance of payment increases, Pakistan invariably finds itself in an adverse balance of payment situation, which calls for cutting back the imports. With a very large portion of Pakistan‘s imports consist of capital and intermediate goods, scaling down of imports has an inverse impact on economic growth and thus a start of a down-cycle. Government finances seem to be one important reason for low saving and investment rates. Low levels of tax revenue coupled with high non-development expenditure imply government savings have generally been negative. Tax revenue of Pakistan is among the lowest in the world, most of which is used for current expenditure (current expenditure accounted for 16 percent of GDP in fiscal 2011 as compared to 2.8 percent development expenditure).4 In particular, subsidies for non-performing public sector corporate entities, security, contingency expenditure, and increasing salaries crowd out productive public spending. According to International Monetary Fund (2012), decline in public investment in Pakistan is mainly due to a fall in government resources against rising current expenditure demands. At the same time, decline in private investment is due to political and economic uncertainty, issues with the supply of credit, crowding out by public sector, and infrastructural. Even the latter is due to inadequate public spending to enhancing economic and social wellbeing in some of the most backward areas (e.g. FATA) and on institutions (e.g. social safety nets) which could have served as a buffer for the disfranchised population. According to World Bank (2013), social returns in Pakistan are low mainly due to infrastructural constraint (primarily energy shortage)—which has not only adversely impacted the economic growth over the last decade but is a potential threat to the country‘s future productivity and growth. Due to inadequate investment, Pakistan‘s energy sector is in poor condition, generation and distribution losses due to aging infrastructure, fiscal deficits, and governance issues. The present energy crises has imposed high cost on the economy and by some estimates (Pasha et al.) has lowered economic growth by at least 2 percentage points. At the provincial level, which are responsible for development of human capital by delivering key social services, more than half of public spending goes for payment of wages and salaries. This is not a surprise, as delivery of social services is labor intensive activity and therefore provinces have large labor force in the public sector (teachers, doctors, policemen, etc.). Yet education and skills of the labor force in Pakistan are low. With a literacy rate of 58 percent (Punjab at 61 percent) in 2013-14, the country ranks lower than its South Asian peers including India (74 percent in fiscal 2011), Nepal (60 percent in 2010), and Sri Lanka (91 percent in 2010). The secondary school (matric) enrollment rate is only 58 percent (65 percent for Punjab) much below India and Sri Lanka. The country does not do too well on worker‘s skills either, ranking 77 (out of 98) with a score of 4.1 (World Bank 2009). This implies that human capital is also constraining country‘s economic growth. Compared with other developing countries, social sectors in Pakistan have been perpetually underfinanced,5 indicating the low priority these sectors have held for the policy-makers of the country. To assess the adequacy of social spending, it is important to note that the Seventh NFC Award sharply increased the share of province in federal revenue. This led to a marked increase in spending on health and education (at 19.4% p.a. between 2005/06 and 2013-14).6 However, most of this was eaten away by high inflation and increase in government salaries of employees without any change in the quantity or quality of educational service delivered through public institutions.