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ONE of Adam Smith’s many oft-repeated quotes is “What is prudence in the conduct of every private family, can scarce be folly in that of a great kingdom.” Let us replace the phrase ‘private family’ with a ‘good athlete’. This modified quote would help us understand what the ‘growth potential’ of an athlete as well as the economy is.
How does a person become a good athlete? With patience and an exercise routine which starts slowly and builds up gradually. This continuous training (investment) helps a person strengthen both muscles and stamina. With this regimen, athletic capacity (or potential) is developed and expanded. The person must forgo some other activities in order to concentrate on this exercise routine. These foregone activities become the opportunity costs for the athlete. Investment on athletic skill development comes at a cost, which must be borne by the person. If someone wants to become a good athlete (say a weightlifter) and tries to jumpstart this process the person will obviously be risking unnecessary injury, which will not only constrain athletic output but reduce potential too. This is about good athletes. Just imagine how disciplined and rigorous the regimen would be for extraordinary athletes like the great boxer Muhammad Ali.
Prudence is required by the policymakers in order to avoid overstressing the economy.
What happens if, God forbid, the person contracts coronavirus after a few years of a good athletic career. If the person survives but continues to suffer from weakness after months of recovery, athletic output will vanish for a while. Athletic potential will also reduce in the short term. With full recovery, the person would resume the exercise routine, and both athletic output and potential would gradually go up. Strenuous exercise soon after recovery is likely to be very harmful. Jumpstarting the process immediately after recovery would be sheer folly.
The economy is, of course, not an athlete. But aren’t there many similarities? Economic growth requires investment, which comes from savings, which, in turn, comes from consuming less than income. Consuming less requires less imported consumption which requires pricey foreign exchange. Savings and investment come at a cost. Imported inflation is one of the costs which must be borne. Our economic policies continue to eschew this cost by keeping the dollar cheaper, taking loans and relying on remittances sent mostly by poor labourers who work abroad and live in pathetic conditions. Shouldn’t this reliance be more on our earnings from what we produce and sell to foreigners who are rich, rather than on the money of our poor remitters? The least we can do is to remunerate the latter with a fair amount of rupees to the dollar.
So, what is our economic growth potential? Numbers are essential to understanding the process of growth. An athlete puts in about four hours of daily exercise and foregoes other activities for years before athletic output starts to develop. This is an investment of about 16.7 per cent of the time available in a day. This gradually leads to an increase in athletic output (metres jogged or swum per minute etc). An athlete cannot borrow these exercises (investments), but economies can. More prudence is, therefore, needed by the policymakers than the athlete in order to avoid overstressing the economy beyond its potential.
Our investment-to-GDP ratio is 15.2pc in FY21. We invested an average of around 15.4pc during the last three years, which is about the same level of investment between FY12 and FY16. The average GDP growth during these five years was only 4pc. We should, therefore, not expect substantially higher growth for a couple of years. Our potential growth will start rising again with the containment of Covid-19 and a gradual increase in investment, which requires more saving and less consumption (as a proportion of GDP).
A good thing about the savings-investment gap in FY21 was that it was only about one-half of one percentage point of GDP. This gap also equals the current account deficit and that is why this deficit is so important. The larger the deficit, the higher the savings-investment gap and the higher the external borrowings to finance this. Keeping this deficit at sustainable levels is important not only for maintaining external debt at prudent levels, but also for sustaining economic growth.
How will our investment rise in future? An athlete may invest more time in workouts to increase output. Notice that the savings (from 24 hours) and investment (exercise regimen) are equal. Economies have the luxury of being able to increase investment beyond their savings (by borrowing). There is no saving-investment gap for the athlete. But economies can have a gap, which must be filled by borrowing. Prudence requires this gap to be kept at sensible levels. Prudence also requires reducing consumption to sustainable levels. Savings build up slowly, with the sacrifice of consumption. Policymakers induce these sacrifices through raising taxes and making imported goods costly. Successive governments have misled the people into believing that there is a royal road to economic growth. No such roads exist. Neither for the athlete, nor for the economy.
Policies of increasing or broadening the tax base not only aim to increase revenues, but also to bring consumption to sustainable levels and increase savings. Our consumption-to-GDP ratio is a staggering 93pc in FY21. It had remained over 90pc since FY08. No wonder our savings are so low; domestic savings at around 7pc and national savings around 15pc. National savings are higher because of the ‘net factor income from abroad’. Thanks again to Pakistani nationals (working abroad and sending remittances), whose savings are added to domestic savings to become national savings.
Shouldn’t we be ashamed of using their hard-earned foreign exchange to sustain our national savings? Shouldn’t our policy focus be more on increasing domestic savings? According to Maurice Scott Fitzgerald, a famous growth economist, “If the individual business (or country) is to progress it must invest. It cannot hope that output will increase if nothing is changed, and any change is inconvenient and costly, even from worse to better.”
The writer is a former deputy governor of the State Bank of Pakistan.
Published in Dawn, October 30th, 2021
