Macro Bites

Macro Bite # 4

5 min read

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How have low levels of savings and investment affected Pakistan?

To understand the link between savings and investments, read the full article below. To summarize:

Income (Y): We already know this equals private consumption (C), investment (I), government expenditure (G) and the trade balance (X-M).

Private saving (Y-C-T): If we take out taxes and private consumption from our incomes, we are left with private saving.

Public saving (T-G): If we take taxes and subtract government expenditure, we are left with public saving.

Trade Balance (M-X): If we take imports and subtract exports, we are left with how much money we owe to the rest of the world, which is foreign saving.

All of this to say, if we need to invest in the country, either the private sector has to save, the public sector has to save or we will have to rely on foreign assistance.

Wage against the machine

First, let’s talk about where incomes (Y) come from. ~60% Pakistanis rely on wages/salaries for income with slight differences across quintiles. Wages play a bigger role in lower income households as compared to higher income households. We discussed in the last article how housing takes up a significant chunk of private consumption – the rich are the biggest benefactors of that expenditure, deriving 18% of their income from property.

Source: Household Integrated Economic Survey 2018-19

The number of income earners per household also portray a non-trivial fact: rich people work less than poor people. If you are rich, your household probably has 1.5 earners but if you are poor, more hands will be on deck.

Rich Dad Rich Son

One key reason could be that the inherited family advantage in Pakistan is quite high which means inter-generational economic mobility is quite low. What this means is, if my father made a healthy income, I am more likely to make a healthy income.

Source: Adapted from Rawi Abdelal’s Fragile State of the World; Miles Corak “Inequality from Generation to Generation: The United States in Comparison”

Basically the one time we are used as a global benchmark against the US is to show how poor our upward mobility is. The ranking for Pakistan of 46% means that if father A makes $100 more than father B, then the adult son A is likely to earn $46 more than the adult son B.

We do not reap what we sow

Source: Economist Intelligence Unit; PM Analysis

A high proportion of wages in our income mix means we have a lot of unskilled labor in the economy. Modern economic theory says wages should equal marginal productivity of labor. However, in Pakistan, while labor productivity (green line) has increased by 50% in the last 30 years, real incomes (red line) have increased by over 150% meaning workers have been compensated more than their productivity has increased. On average in 2019, monthly wages were PKR 21,000, which were more than 10 times what they were in 1990. Interestingly, if you calculate how much prices have changed by since then, it comes to around 10x. This means workers have also been compensated more than inflation has increased in the last 30 years.

One potential reason behind this mismatch of wages and productivity could be minimum wage regulations in Pakistan

If you are part of the documented economy (which most of Pakistan is not), you need to pay your unskilled laborers a minimum wage. Notice that the biggest spikes in minimum wage come during election years (2012-13 and 2018-19). New governments come in and have to show you they care about wage earners and increase minimum wages without any real thought behind the productivity derived from these workers.

We want more FDI

If your citizens do not save enough of their incomes and (as we will discuss in more detail later) your government does not save, you will need foreigners to come in and save to have investment in the country. This foreign investment is called FDI or Foreign Direct Investment. All governments want it to complement their private and public savings for investment.

Source: Pakistan Economic Survey 2018-19; Economist Intelligence Unit

However, notice every time foreign saving (lightest blue) rises, productivity measures (black and red) tank. This is because foreign direct investment in Pakistan has historically not been efficiency seeking. We instead have market-seeking FDI aimed at serving a large country with a large population.

We don’t want more FDI

How can there be an almost negative correlation between FDI and productivity in Pakistan?

Source: State Bank of Pakistan

We will dig into investment and productivity by major sectors of the Pakistani economy next to really understand pain points of the supply side of GDP. That will help us better envisage what the full impact of COVID-19 is going to be on our economy and how long this impact will last.

Read the full article in the link below

How have low levels of savings and investment affected Pakistan?

Deep dive into the structural issues facing Pakistan with a focus on savings and investment as part of the Macro Pakistani series on the economy.

Read more

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Faiz Ahmed

MBA Candidate at Harvard Business School with prior experience at Bain & Company, International Finance Corporation and State Bank of Pakistan. He is also the Founder of Macro Pakistani.

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