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Saving-Investment Nexus

Although agriculture sector is dominating sector in Pakistan and is source of employment of majority of its people but industrial sector plays prominent role in macroeconomic adjustments between investment and savings. So what’s come first, it’s saving which is generating investment or investment which is generating savings? We will find out about this phenomenon later. For manufacturing sector there are two types of costs, labour cost and imported intermediate cost. In Pakistan imported component of exports increased more than 60 percent as dependency on imported intermediate goods increased. While labour cot can be reduced through efficient labour which needs investment in human capital. Pakistan has large working population but due to lack of formal and technical education their presence is not significant. One of the major reasons of shortage of skilled labour is school dropout, which is important indicator for multidimensional poverty index (MPI).

Multidimensional poverty line is based on Alkire-Foster methodology and it has three dimensions — education, health and living standard. “It is tailored according to Pakistan’s need and has 15 indicators instead of 10” (OPHI&UNDP, 2016). Three indicators are from education sector — years of schooling, school attendance and education quality. Four indicators are from health — Basic Health Units (BHU), immunisation, ante-natal care and assisted delivery. Last eight indicators fall under category of living standard — water, sanitation, walls, overcrowding, electricity, cooking fuel, assets, and land/livestock. Each broad dimension carries one-third of weightage.

A person is said to be a poor if he/she is deprived of 33.3 percent of total weightage. In Pakistan indicators used for education are only based on primary education and quality of education is based on unavailability of infrastructure, teachers and self-satisfaction and it’s not based on assessment test. In Pakistan nearly half 48.5 percentage of population is deprived of primary education. And overall nearly 40 percent peoples are considered as poor. If nearly half of working population is deprived of even primary education, then how we can encash demographic dividend?

Pakistan is currently passing through an era of demographic dividend where working population is more than dependent population but this working population is useless if it has no skills. Thus for encashment of demographic dividend we have to develop skilled labour. Development of skilled labour will not only improve industrial efficiency but it will also increase entrepreneurs.

Pakistan is heavily dependent on backward linkage and important component of export increased up to 60 percent. It was older concept that the entire product was manufactured in one place. Now different components are prepared at different parts of the world. Such various components are known as backward linkage like intermediate goods or forward linkage like high tech equipment, electronic equipment’s and etc. There are three main advantages of demographic dividend, first is that due to increase in working population ratio over dependency ratio producers to consumers ratio will also increase, which will increase growth rate, second advantage is that as fertility rate will decrease woman’s will get time to join labour force as a result not only woman participation ratio will increase but it will also increase economic growth and third advantage is that as working population will increase competition between workers will also increase as a result workers will pursue for better skills. But advantages of demographic dividend can only be gained if there are appropriate policies educational and health development and development (Durr-E-Nayab, 2008).


Thus beside improving primary school enrolment, attendance and quality and leading it towards secondary and tertiary education development of vocational institute and small and medium enterprises (SME) is important.

In Pakistan more than two-third of working populations is involved in informal sector and one of major reasons for its lacking behind is financial constraints. Thus lack of social justice and empowerment has made informal sector as chronic burden on economy, which gnaws away determination for growth and development as a result unemployment increases.

Modern economies are mediated through money and to its close substitutes in which bank and financial institutes are playing prominent role. According to recent report of Pakistan’s centralized bank “In Pakistan banking sector is not utilizing its deposits into investment and top 20 companies are receiving 30 percent of financing from bank and quite contradictory SME’s receive just 6 percent of banks financing” (Nadeem, 2017). It must be noted that banks in Pakistan are offering individuals loans at much higher rate than policy rate announced by Central Bank. State Bank of Pakistan (SBP) has kept discount rate at lowest rate of 5.75 percent form almost year and a half but has never penalized any bank for charging higher interest rates for individual loans and even public banks charge interest rate in double digits figure.

Continuous declining exports of Pakistan are serious concern for its GDP growth. In previous fiscal year FY2017 trade deficit was $32.5 billion which is 10 percent of its GDP and in only first quarter of current fiscal year FY2018 it reached $9 billion.asset

If we concise deteriorating economic situation of Pakistan into single sentence, then we can say that lack of efficiency in core function of banking sector and other financial institute cause current economic debacle. So it’s investment, which generates savings and not vice versa. In developing economies labour and imported intermediate goods are major component of production cost. While rate of profit is determined throughprofit, price of manufacturing good and fixed assets.

profitWhere ‘P’ is prise of manufacturing good, b is labour coefficient, e is exchange rate, P is price of imported intermediate good, a is intermediate input coefficient, K is capital and w is labour wage. For equilibrium state investment less trade deficit less saving from profit must be zero.


Thus reduction in mark-up rates and increase in capacity utilization of manufacturing sector can increase rate of profit. This can only be achieved through available of credit at policy rate and linkage between core and periphery. If we apply equilibrium equation into Pakistan’s economy then it shows that increase in trade deficit and reduction in investment is mostly due to high cost of important component of export, unfair share of credit for SME and high interest rate on credit. While increase in savings from profits and other savings if Investment is increasing and trade deficit is increasing.

We can conclude that State Bank of Pakistan should impose interest rate celling on bank and financial institutes’ credits and support borrowings from SMEs. At present financial institutes are charging high interest rate to borrowers which also include public sector banks.

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