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To Spend or Not to Spend
Written by Administrator   
Tuesday, 07 June 2011 07:41

By Shujat Ali Khan

The challenges that Pakistan faces today are colossal; however, what lies ahead is much worse. Reform is needed desperately, but it seems like a lot of the people who had been trying to implement reforms have fallen victim to the callous politics of our country. Reports of several top officials at different institutions in Pakistan resigning as a result of politicians prying into their daily affairs have stripped our country of many sincere leaders. Moreover, inefficient spending is on a rise and certain issues that need to be tackled on a crisis basis have been ignored by our leadership time and again. Their solutions have been sought in policies that have caused Pakistan more harm than good.

One such policy measure has been the Benazir Income Support Program (BISP). It accounts for 1.5% of the total budget and although this might seem small, it is equivalent to Rs. 50 billion (compared to Rs. 34.5 billion for education). The project entails giving away Rs. 2000 cash grants every alternate month to poor families until their livelihoods bounce back. At a time when the economy is being trampled under the debt burden, I feel concerned about such a prolific spending that only adds to the fiscal deficit and fails to achieve its indented goals. Although the ‘intended’ goals of the project are definitely noble, one also has to analyze the effectiveness of such a project in achieving those goals and its impact on the economic growth. While some might be more concerned about the short-run, one also has to consider the medium and long-run.

Two of BISP’s stated goals are to provide short term food security, by increasing the recipients’ purchasing power, and to alleviate long term poverty. Whereas the purchasing power of the recipients does increase, to the extent that inflationary pressures as a result of the stimulus do not counter it, one must ask themselves whether such a mechanism is a solution to the problem; more importantly, whether it is the lack of liquidity or the lack of infrastructure that has resulted in the poor’s plight.

I believe that for a country like Pakistan, which is on the bottom rungs of development, the issue is that of infrastructure rather than liquidity. With a huge population living under the poverty level and inflation rampant, the impact of a project like BISP gets diluted. Nations are not taken out of poverty by giving away money. What reduces poverty is economic growth that results in urbanization, capital growth and empowerment of the poor by integrating them into the economic system. This phenomenon is most clearly observable, in China and India, two of our next-door neighbors. Gross capital formation in Pakistan, as shown in Fig. 11, has been the lowest in the region and has trended downward in recent years.

Investment in infrastructure provides the necessary tools to be productive and efficient enough for a sustained growth that allows rural areas to be urbanized and also integrates more of the poorer population into the labor force of the economy. In countries with high population, this can add to the growth inertia. Availability of adequate infrastructure is also necessary to avail the demographic gift – positive effects of falling fertility rates, resulting in an increase in the labor to total population ratio of countries that previously had a high population growth rate. Lack of infrastructure investment results in lack of employment opportunities for a growing labor force, which can have enduring negative effects on the future productivity and growth of an economy.

Fig. 1. Pakistan’s gross capital formation as a percentage of GDP has been the lowest in the region, indicating a lack of investment in fixed assets/infrastructure.

The effectiveness of stimulus money in increasing the purchasing power and spurring growth is very limited. Firstly, such a spending could add to the inflationary pressures if it persists. That, I believe, is going to be the likely case as BISP does not have the potential to move people out of poverty, which is the requirement for such support to stop. Secondly, at times when people do not have confidence in the economy, they tend to hold back their spending. Hence, we see people putting that extra money in their safes rather than using it to improve their standards of living. The opposite might also be true, as people with low incomes have a higher marginal propensity to consume and with inflation high, people have more incentives to consume the money today rather than tomorrow. Finally, many analysts believe that such grants add to the disincentive to work. This has been observed in the US where jobless claims under the extended and emergency unemployment compensation programs have increased due to the extension of emergency benefits.

The reasoning that goes behind the belief that such stimulus packages promote growth follows the Keynesian school of thought. According to this approach, demand falling short of the potential supply can trigger a contraction in the economy and governments need to stimulate demand by increasing spending. This as a result is expected to increase the consumer spending, which fills the demand shortfall.

Anecdotal and empirical evidence have shown that this does not happen. Stimulus money was ineffective to stir the stagnant economy of Japan in 1990 and the US in the current recession.

Although Pakistan’s annual average CPI for FY 2010 (11.7%) has been brought down significantly from the level in FY 2009 (23.7%) and it must be complimented that the wheat prices (as of August 19) have been significantly reduced from those last year (price of wheat on August 19, 2010 was 2.7% lower than the price last year and that of flour was 9.4% lower than the price last year), the inflation level is still high and the wheat prices are going to change drastically in the next few months. A quick look at the domestic commodity prices shows that as of August 19, 2010, the sensitive price indicator (SPI) was 16.2% higher than the level at the same time last year. Global wheat prices are expected to rise as a result of Russia, the third-largest wheat exporter in 2009, banning the export of wheat due to a severe drought this year.

Although some economists believe that wheat prices are not yet a threat to trigger global food inflation, the same does not apply for Pakistan as its own wheat crops have been destroyed due to the floods and speculators have rarely missed a chance as good as this one to make a few bucks at the cost of the poor of our country. The industry of Pakistan which is already in shambles as a result of the energy crisis is expected to get another blow by the growing cotton prices, which are up 97.7% from the previous year.

Pakistan’s textile sector is expected to import $900 million worth of cotton to fulfill its immediate needs.2
Our leaders must realize that chronic dependence on foreign aid and short-term methods of solving issues by giving away money are only going to make things worse. A fallacy in this approach is that in order to spend that extra dollar, the government has to borrow. This adds to the fiscal deficit and further exacerbates the inflationary pressures that are already damaging our economy and motivating such projects in the first place. Cash grants like the ones proposed in BISP are not the most efficient way of using the already limited funds. Giving grants to communities to start self-sustaining businesses can be one way of empowering the poor; however, that is not the goal of BISP.

At times when the economic situation looks so grim, projects such as BISP that only provide temporary relief to a selected few, without really solving the issue of poverty itself, seem ostentatious. Such projects do serve the purpose of gaining political leverage; however, they also add to the crunching debt burden. Between 2001 and 2006 the public debt-to-GDP ratio of Pakistan fell from 81.4% to 56.1%. However, just before the recent floods, Pakistan’s debt-to-GDP rose to 61%3, which was above the 60% limit set by the Fiscal Responsibility and Debt Limitation Act. This is expected to rise even more in the coming months as a result of the floods. Hence, streamlining the economy and making effective use of the money by terminating projects like BISP and investing in infrastructure is imperative. Obviously the question then arises about the issue of corruption in infrastructure projects, but that is a question that we must ask our elected representative and for which they need to be made accountable.


Shujaat Ali Khan is a research associate at the Fed. He is interested in the applications of deterministic chaos and complexity in the field of economics. He can be contacted at
This e-mail address is being protected from spambots. You need JavaScript enabled to view it
The views expressed herein are solely those of the author and do not necessarily reflect the views of the Federal Reserve System.


(Courtesy Dawn.com)

 
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