THE NEW BUDGET

The policy makers must also be mindful of the fact that a high growth rate may have little effect on poverty alleviation

By HUSSAIN HAIDER ZAIDI
July 12 - 18, 2004

The budget for the year 2004-05, aims at generating employment, reducing poverty and increasing economic growth and investment. No one will dispute that the fiscal policy in a developing country should be calculated to achieving these objectives. In fact, growth, employment generation and investment are inter-linked. Both economic growth and job creation are a function of investment. Hence, if the budget succeeds in enhancing the level of investment, ceteris paribus, both the level of growth and employment will go up.

Investment itself depends on a number of factors. Of these the most important are savings, the cost of doing business and potential demand and profits. The source of investment is savings. If there are no savings, there is no investment. The higher the level of savings, the higher the level of investment. Savings depend in the main on income. The higher the income, the higher the savings. Of course, there are other factors like the propensity to consume and interest rates, but income remains the key determinant of savings.

Though a necessary condition for investment, savings in themselves are not sufficient to stimulate investment. If the cost of doing business is high, savings will not be translated into productive investment. There is an inverse relationship between investment and the cost of doing business: the higher the cost of doing business, the lower the investment level and vice versa. For instance, if interest rates are high, businesses will not find it desirable to increase their production capacity and will prefer to buy bonds and securities carrying high interests. In addition to the interest rates, the cost of doing business includes internal taxes, custom duties, the regulatory environment and political factors like law and order situation and predictability, transparency and continuity of government policies.

Even if the cost of doing business is low, investment may fall short of the desired level. The reason being low aggregate demand and profits. Businesses will not invest unless there is sufficient potential demand for their products. If potential demand falls, profits also fall. Consequently, businesses cut back on their output and investment falls. The key determinant of demand is income. If income falls, people make fewer purchases. If income goes up, demand also increases.

Thus a budget in order to enhance investment, must prompt savings, curtail the cost of doing business and stimulate aggregate demand. The new federal budget is an attempt to accomplish these tasks. To begin with, it contains several provisions to curtail the cost of doing business. These include cut in electricity charges for business consumers, reduction in tariffs on the import of various capital goods and raw materials, reduction in levies on the inputs for the construction industry, withdrawal of the general sales tax (GST) on certain items, adoption of a uniform GST rate on goods and expediting GST re-fund process, and a substantial (66) per cent cut in interest rate on agriculture loans.

The government has also done well not to fall into the trap of balancing the budget at a time when the level of private sector investment falls well below the desired level due to deficiency of aggregate demand. Understandably the government has presented a deficit budget. However, the deficit does not exceed 4 per cent of the GDP. A healthy amount of Rs 202 billion has been earmarked for public sector investment 26 per cent higher than the last fiscal year's allocation under the public sector development programme (PSDP). The Rs 202 billion investment, which constitutes more than 22 per cent of the total expenditure, will accelerate the economic activity by improving the infrastructure, developing the social sector and creating jobs, and thus increasing income and savings. This will generate additional demand for consumer and business goods.

The increase in demand, coupled with the fall in the cost of doing business, will enhance investment, output and employment. However, a lot depends on political stability and law and order situation. In particular, if the law and order situation does not improve significantly, the fiscal and monetary measures to improve the economy will only be partially effective.

To meet the deficit, the government will resort to borrowing, which will increase public debt and create inflationary pressure. Increase in prices will hit hard the salaried class, which is already finding it difficult to make its both ends meet. So far the government has failed to keep the prices of essential items under control. And the government's ability to do so in the days to come is also doubtful.

That there is also a political side to the budget is borne out by the increase in budgetary allocations for defence. Defence budget has been raised by 8 per cent from Rs 180.5 billion (revised figures) in 2003-04 to Rs 194 billion, which makes up 21.5 per cent of the total expenditure. In the last financial year originally Rs 160 billion were allocated to defence but later defence spending was increased to Rs 180.5 billion an increase of nearly 13 per cent. This fiscal year as well, actual defence spending may go up, as Pakistan will be under pressure to step up fight against international terrorism. The upward shift in the defence spending is also a reminder of who calls the shots in Pakistan.

In contrast to Rs 194 billion defence spending, the education sector has received only Rs 24.76 billion (Rs 12.2 billion under the current expenditure and Rs 12.56 under the development expenditure), which make up 2.7 per cent of the total expenditure. The share of the health sector, which has received Rs 9.9 billion (Rs 3.3 billion under the current expenditure and Rs 6.6 under the development expenditure), in the total expenditure is 1.09 per cent. The budgetary allocations for these two vital sectors are well below the desired level and reflect misplaced government priorities.

The budget also contains direct relief for the ordinary citizen including a 10-paisa cut in power tariffs, an ad hoc 15 per cent increase in salaries for government employees, 8-16 rise in pensions and increase in income tax threshold.

Poverty is a perennial problem of Pakistan. The government claims that the poverty level has come down from 32 per cent to 28 per cent.

However, the claim is based on a rather strange definition of poverty that anyone whose monthly consumption exceeds Rs 748.56 per month is not poor. This definition establishes a standard of poverty which falls below the internationally accepted standard of poverty, which is earning less than $1 a day. If we go by that standard, then at least 33 per cent of the population lives below poverty line.

The thrust of the budget is to eradicate poverty by raising the economy's output and productivity and creating jobs. The government believes that enhanced expenditure will create one million jobs. At present, 8.27 per cent of the labour force is unemployed, whereas in 1996, unemployment level was 5.37 per cent. This means unemployment has increased by 2.9 per cent in eight years. To raise the employment level, besides increasing investment, bringing down population growth rate is also essential. It is a good indicator that population growth rate has come down to 1.9 per cent and is likely to fall further.

Measures to eradicate poverty, however, must seek to increase real incomes of the people. If monetary income increases, but prices also increase, people are not better off. In fact, real comes fall if the increase in prices is higher than that in money incomes, which is generally the case. The real measure of poverty is lack of access to basic amenities of life. And access to the basic amenities is possible only if the increase in incomes is higher than inflation.

The policy makers must also be mindful of the fact that a high growth rate may have little effect on poverty alleviation unless the benefits of economic growth are evened out, which requires government activism and not a laissez-e-faire approach. The government should also not be oblivious of the fact that poverty and other forms of injustices breed social unrest and mayhem, which bottleneck efforts for economic development.