Given the distribution of income in Pakistan based on 2001-02 estimates, every rupee increment in GDP accrues 48 paisas to the richest 20 percent of the population and 7 paisas to the poorest 20 percent. In other words, the richest segment of the population appropriates seven times more of the national income than the poorest segment of the population.
The ratio worsens if the richest and the poorest 10 percent of the population are compared, with their respective shares being 34 and 3 paisas - an eleven-fold difference.
Powerful evidence of the fact that the nature of growth in Pakistan is 'inequality-increasing' is provided by microanalysis of household level data as well as from simulation results derived from SPDC's 264 equation macroeconomic model.
Simulations show that even if GDP growth is maintained at a high 6 percent level for each of the next five years, unemployment is likely to remain constant at the 8-9 percent level, and the inequality measure - Gini coefficient - will probably rise from 0.419 in year 1 to 0.429 in year 5, and the percentage of population below the poverty line can be expected to continue to increase from 30 percent to 31.7 percent over five years.
It appears that, irrespective of the rate of growth, the economy is structurally locked into a low employment, high inequality and high poverty trap. Clearly, distribution-neutral growth alone cannot be counted upon to reduce poverty.
An effort has been made to simulate a pro-poor or distribution-sensitive growth path for the Pakistan economy over a period of five years. Needless to say, the exercise is notional and its limitations are obvious, particularly with respect to the impacts of political development.
However, the results provide powerful conclusions and highlight the possibilities that exist for reduction of poverty.
RESULTS FROM MODEL SIMULATIONS: Three scenarios have been generated through the macroeconomic model, with the assumption of a constant 6 percent GDP growth rate. The first is the status quo scenario, where the current structure, levels and composition of taxes and expenditures is held constant.
The second and third scenarios incorporate adjustments in the structure, levels and composition of taxes and expenditures, as specified below:
1. Increase in the share of direct tax in total tax revenue from 45 to 60 percent by reducing indirect tax collection by Rs 50 billion and raising direct tax collection by a corresponding amount.
2. Decrease in current expenditure by Rs 75 billion from the following accounts.
a. Defence (non-combat expenditures)
b. Non-food subsidies
c. Abolition/Curtailment of the following Federal Ministries on the Concurrent List of the
CONSTITUTION: Education; Food; Agriculture and Livestock; Health; Housing and Works; Industries; Information and Broadcasting; Information Technology; Labour; Manpower and Overseas Pakistanis; Local Government and Rural Development; Minorities; Culture; Sports; Tourism and Youth Affairs; Population Welfare; Religious Affairs; Zakat and Ushr Science and Technology and Women Development; Social Welfare and Special Education.
3. Increase in Provincial Development Expenditure by Rs 50 billion.
4. Increase in Provincial Non-Development Expenditures on education, health and public health by Rs 25 billion.
The expenditure adjustments, applied on model-generated base year estimates corresponding to the year 2003-04, are spread over a year period at the rate of Rs 15 billion per year. Two approaches to finance this increase are postulated:
1. Increase in money supply through deficit financing, or
2. Expenditure switching from current to development/social sector heads.
Scenario 2 incorporates adjustments 1, 3 and 4, implying an increase of Rs 75 billion in total expenditure. Scenario 3 incorporates adjustments 1, 2, 3 and 4, implying a reduction of Rs 75 billion in current expenditure and a corresponding increase in development expenditure leaving total expenditure constant. Scenario 2 is financed entirely through additional money supply and Scenario 3 is financed entirely expenditure-switching.
The impact of the above adjustments under the scenarios is estimated on the following variables:
1. GDP growth
2. Inflation
3. Unemployment
4. Inequality (Gini coefficient)
5. Poverty incidence
6. Budget deficit/GDP
7. Current Account balance/GDP
The results of the three scenarios are detailed below:
SCENARIO 1: THE STATUS QUO The status quo scenario shows that to sustain an economic growth rate of 6 percent, the required total investment/GDP ratio rises from 16.2 percent in the base year to 18.6 percent and the public investment/GDP ratio is required to be over 5 percent in year 5 - the terminal year of the analysis.
Inflation rises from 4.2 percent in the base year to 5.7 percent in year 5. In this scenario, the budget deficit/GDP ratio declines from 5.1 to 4.8 percent, and the current account balance/GDP ratio deteriorates from a marginal surplus of 0.8 percent to a deficit of 4.3 percent.
The worsening of the current account balance/GDP ratio reflects the fact that GDP growth is a accompanied by a greater rise in imports than in exports. As such, the trade deficit expands, placing pressure on the current account balance.
SCENARIO 2: Financing increased development/social expenditure through growth in money supply.
The simulation shows that the increase in development expenditure and provincial social sector expenditure to the tune of Rs 75 billion over the stipulated period, financed through growth in money supply, ie, through deficit financing, is likely to enhance the GDP growth rate from 6.3 percent in the base year to 7.6 percent in year 5, as against 6 percent in the status quo scenario.
This would require total investment/GDP ratio to rise from 16.2 percent in the base year to 19.8 percent and the public investment/GDP ratio to be nearly 6 percent in year 5.
This scenario shows inflation rising from 4.2 percent in the base year to 4.8 percent in year 1, and then remaining constant at around 5 percent, slightly lower than 5.2 percent in the status quo scenario. Inflation does not rise relative to the base despite the increase in money supply because higher GDP growth occurs largely due to the expansion of output supply and, by itself, puts downward pressure on prices.
Unemployment declines from 8.7 to 6.8 percent. The Gini coefficient continues to rise, although at a lower rate, and stands at 0.424 in year 5 as against 0.429 in the status quo scenario. The budget deficit/GDP ratio rises from 5.1 percent in the base year to 5.8 percent in year 1 and then remains more or less constant.
The current account balance/GDP worsens to a deficit of 6.1 percent as against 4.3 percent in the status quo scenario for the reasons explained above.
SCENARIO 3: Financing increased development/social expenditure through expenditure switching.
Scenario 3 involves the same increase in development and social sector expenditure as simulated in Scenario 2, but it is financed through switching of current expenditure. The increase in the GDP growth rate is the same as in Scenario 2 and would require the same growth in total investment/GDP and public investment/GDP ratios.
Under Scenario 3, inflation rises from 4.2 percent in the base year to 4.7 percent in year 1 and then declines to 4.1 percent in year 5. Unemployment and poverty decline from 8.7 to 6.9 percent and from 30 to 25.6 percent, respectively.
The Gini coefficient continues to rise; although, at a lower rate than in the status quo scenario or in Scenario 2, and stands at 0.422 in year 5. The budget deficit/GDP ratio first rises to 5.5 percent in year 1 and then declines to 4.9 percent by year 5, while the current account balance/GDP ratio deteriorates from a marginal surplus to a deficit of 5.9 percent.
A comparative analysis of the three scenarios clearly demonstrates that a high GDP growth rate, without accompanying equity-promoting policy shifts, is by itself unlikely to reduce the incidence of unemployment or poverty.
As shown in Scenario 1, where the tax and expenditure levels and composition are held constant, a 6 percent annual growth rate over a five-year period does not enhance employment or reduce poverty because inequality continues to rise and high growth serves to redistribute a greater proportion of incremental income in favour of upper income groups.
Moreover, while the budget deficit/GDP ratio is likely to be constant, inflation and the current account deficit are likely to rise.
The partial shift of the tax burden from indirect to direct sources and the allocation of additional resources to developmental and social heads of expenditure accelerates the rate of economic growth. Clearly, the adjustment offers positive efficiency gains.
There are equity gains as well, since it also reduces the rate of growth of the Gini coefficient and effects a small reduction in unemployment and poverty. Most significantly, the rising curve of poverty incidence is reversed.
The rate of increase of the Gini coefficient is lower; consequently, the decline of poverty is somewhat greater under the expenditure-switching scenario than under the increased money supply scenario.
Accordingly, the budget deficit/GDP ratio and inflation are also higher under Scenario 2 than under Scenario 3. Under both scenarios, however, the current account balance/GDP ratio worsens and highlights the need for independent measures to manage the external account. These measures are discussed subsequently in the Sector Study on exports.
As stated above, this exercise is notional, and it is necessary to keep its limitations in mind. However, the results provide meaningful conclusions and highlight the possibilities that exist for economic growth and employment and for reduction of inequality and poverty.
The scenarios - one where financing is through increase in money supply and the other where financing is through expenditure-switching - represent two ends of the spectrum and possibilities exist for various combination of the two.
The notional tax and expenditure shifts - tested for their impact on growth, employment and poverty - are limited to fiscal policy measures. Although the steps serve to reduce unemployment and poverty, the decline is small, and at this rate it would require over 30 years to reduce poverty.
Since independence, two generations have been condemned to poverty and misery, and one more generation cannot be subjected to the same fate at the altar of neo-liberal theology.-Courtesy: Social Development in Pakistan.