Thesis: Seminar in Economic Policy 1

Abstract

This paper is primarily aimed at assessing the high rate of consumption

in Pakistan and its implications. It analyzes the consumption and
savings trend over the past ten years in Pakistan. First of all the
consumption-GDP rates are calculated for past ten years to determine
the savings-GDP ratio trend in Pakistan. The result of the study reveals
that consumption percentage to GDP in last ten years is average 87%
which means that we tend to spend almost 87% of our income and
savings remain as low as average 13%. Study also reveals that there is
a high investment-savings gap in the economy which is financed by
foreign savings in our country.

To supplement the above analysis, study proves high consumption

nature of Pakistani society through analysis of composition of imports
i.e., ratio of import of consumer goods over import of capital goods. In
the end, the trade deficit in services account of the country is analyzed
to further prove that level of consumption is very high which leaves
little for savings resulting in low investments. This significantly effects
our economic growth.

Thus, the paper is divided in three parts to discuss the high

consumption nature and its consequences, (1) Consumption and
Savings rates (2) Composition of imports (3) Trade deficit in Services.

_______________________________________________________________________
_

Hypothesis:

‘Pakistan is a high consumption oriented society which is one

major
constraint on its rate of economic growth.’
 Thesis: Seminar in Economic Policy 2

_____________________________________________________
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 Thesis: Seminar in Economic Policy 3

Introduction

Saving and investment are two key macro variables which can play a
significant role in economic growth, inflation stability and promotion of
employment especially if seen in the context of a developing country.
National savings are critically important to help maintain a higher level
of investment which is a key determinant for economic uplift.
Unfortunately, the consumption oriented nature in Pakistani society
leaves little savings to finance investment.

Trouble is, as a nation we have a notorious history of living beyond our

means. Quaid-e-Azam Mohammad Ali Jinnah, just before his death in
Ziarat in 1948 made this judgment.

“We Musalmans in general and young men in particular do not know the
value of money. A paisa saved today is two paisa tomorrow and four paisa
the day after that and so on and so forth. Because of our addiction to
living beyond means and borrowing money we have lost our sovereignty
over this sub-continent.”

Pakistan’s average consumption to GDP ratio of 87% over the last ten
years is indicative of the continued relevance of those words of
wisdom. What this means is that, on average, we have consumed 87%
of our income.

The Role of Savings in an economy

Savings play an important role in any economy and its role is
important at different levels. To understand the role of savings
one must consider who all the savers are and how it can affect
the overall performance of the economy.

Who saves and why?

Savings are done by three ‘entities’ in the economy: households,
companies and government.

Households save essentially for two reasons: to cover future

expenses (children’s education, buying big-ticket durable goods,
e.g. a car) and for retirement.

Company savings are simply that part of their profits that they
do not pay out to shareholders as dividends, but retain it to
 Thesis: Seminar in Economic Policy 4

finance future investment in the business (expansion of existing

facilities and the replacement of outdated equipment).

Government saves when its tax revenues exceed its

expenditures on recurring items (such as wages, social security
payments, fuel, schoolbooks, medical supplies for hospitals, etc).
If its tax revenues exceed these current expenses, it has money
left to spend on the building of new roads, bridges, hospitals,
schools, etc.

Implications of high consumption and low savings

If households tend to consume more and fail to save sufficiently
to cover future expenses, the outcome is very simple: they will
not have sufficient funds to cover planned future big expenses
and/or they will struggle financially during retirement. They will
eventually become dependent on others or the government. This
is unfortunately a very common occurrence in Pakistan.

If companies do not, or can not, save sufficiently, they will not

have the capital available to finance replacement or
expansionary investment. This will put a dampener on the
company’s efficiency and growth potential, as well as its ability
to employ more people.

If government does not save, it simply means it will have no

money available for fixed investment in social infrastructure
(schools, hospitals, low cost housing, etc) or physical
infrastructure (roads, bridges, harbors, airports, etc). The
implications of underinvestment in people and infrastructure is
easy to understand and need no further explanation

What happens in practice, of course, is that entities in need of

capital (eg businesses or government) will access available
savings (from households or other companies saving for future
investment) through financial intermediaries (banks, capital
market) by borrowing or issuing paper to investors. The trouble
starts if we as a nation do not save enough to meet the country’s
financing (and therefore investment) needs.

If we consume a lot and save too little, the answer is simple: for
the broader economy it will mean that there will be insufficient
funds available to finance investment in physical and social
infrastructure. Any student of economics will very quickly tell you
 Thesis: Seminar in Economic Policy 5

that insufficient investment in an economy also means sub-

optimal economic growth, sub-optimal job creation and inferior
overall living standards relative to nations with a better savings
performance. Indeed, Pakistan today suffers from decades of
underinvestment in social and physical capital.

To make matters worse, these three entities’ respective savings

behavior is not independent of each other. On the contrary, they
are closely interlinked. For example, low saving households will
eventually increase the burden on government to provide social
services, limiting government’s ability to rather spend money on
social and physical infrastructure (ports, roads, bridges, schools,
hospitals, etc). Government could, of course, raise taxes to
generate additional revenue to cover the additional social
expenditure, but this will further limit households’ ability to save
and spend, and, if the additional tax burden falls on companies,
it will reduce their profitability and limit their ability and
willingness to invest.

Because of high consumption and low savings, country’s reliance

on foreign savings increases to finance the investments. But this
can only be the limited solution and relying on foreign savings
indefinitely is threatening to the economy (discussed later).
 Thesis: Seminar in Economic Policy 6

Consumption and Savings rate in Pakistan

Pakistan in its history has showed a high level of consumption and low
rate of savings. One method to determine the savings rate is to simply
see the difference between GDP and consumption. In order to show the
consumption oriented nature of Pakistani society, I have calculated the
percentage of consumption and savings over the last ten years. The
calculations are based on data provided in Appendix.

For this purpose, all the rates are taken at constant prices as constant-
price estimates (or volume measures) help assess how a nation's
economy is changing over time in real terms. The reason for not
choosing rates at current prices is that current price GDP measures
value-added production in today's prices. Increases in current price
GDP can be driven simply by price changes, when one of the key
pieces of information that is needed is whether or not the quantity of
final goods and services available is increasing or not. For this reason
all the estimates used for calculation are taken at constant prices.

Consumptio
GDP (FC) Savings
Year n
(Rs. Million) (% of GDP)
(% of GDP)
1999-00 3562020 90.25 9.75
2000-01 3632091 88.42 11.57
2001-02 3745118 88.09 11.90
2002-03 3922104 85.09 14.90
2003-04 4215582 86.40 13.59
2004-05 4593230 88.55 11.44
2005-06 4860476 88.39 11.60
2006-07 5191709 85.04 14.96
2007-08 5404486 84.58 15.41
2008-09 5512445 84.73 15.27

The table shows clearly the recent history of high consumption

patterns in Pakistani economy. The average consumption to GDP ratio
of 87% over the past ten years shows that we tend to spend almost
87% of our income and savings remain as low as average 13%. A high
consumption to GDP ratio might be justifiable when per capita income
is low. Third world countries with low per capita incomes typically
suffer from this problem. In the middle to lower classes, incomes are so
 Thesis: Seminar in Economic Policy 7

low that nothing can be saved. A high consumption to GDP ratio is the
inevitable by-product.
 Thesis: Seminar in Economic Policy 8

But, then, as a country expands and its per capita income rises, the
consumption to GDP ratio should fall. More specifically, as GDP per
capita increases, marginal propensity to consume should fall. Marginal
propensity to consume measures the proportion of incremental GDP
that is spent on additional consumption.

Marginal propensity to consume = Change in consumption

Change in GDP

In Pakistan, the post 9/11 years (2002-2005) have seen the economy
rebounding and GNP per capita has risen steadily from US$ 500 in
FY01 to US$736 at the end of FY05. True to script, marginal propensity
to consume in FY02 fell to 77.4%. And for three fiscal years, it stayed
around that. Because GDP was rising, even a constant marginal
propensity to consume resulted in a rising savings rate. This
equilibrium, however, reversed sharply in FY05. Marginal propensity to
consume rose from 77.4% to112.6%, as the savings rate fell to a five
year low of 11.44% of GDP. What does a marginal propensity to
consume of 112.6% mean? For example, GDP between FY04 and FY05
increased by PKR 864.2 billion. Consumption increased by PKR 872.04
billion, more than the rise in GDP. This translates into a marginal
propensity to consume of 112.6%. Bottom-line; in a period of record
high growth of 8.4%, the nation as a whole consumed more than it
earned, it dis-saved. A very generic interpretation of this is that the
benefit of the GDP growth was exhausted completely within the year
and no benefit is carried forward to future years.

As we can see from the graphs, the consumption rate is slightly

decreasing as compared to previous years, but still remain as high as
85% in FY 2009.
 Thesis: Seminar in Economic Policy 9

91
90
89
88
87
Consumption % to
86
85 GDP
84
83
82
81
FY FY FY FY FY FY FY FY FY FY
00 01 02 03 04 05 06 07 08 09
 Thesis: Seminar in Economic Policy 10

Low Savings mean Low Investments

Investment or capital formation has a two-fold role in the economy. In

the short-run, investment affects aggregate demand and thus output
and employment. In the long-run, investment affects GDP growth. A
country’s rate of growth largely depends on how much it sacrifices
present consumption to provide for production of capital goods.

Investment depends on several factors including savings, costs,

revenues and future expectations. The most important factor
underlying investment is savings. In case of developing countries,
investment falls below the desired level, mainly because of low
savings.

Generally increase in GDP is accompanied by increase in savings-GDP

and investment-GDP ratio. However, Pakistan is a different story,
where savings-GDP ratio came down during fiscal years 2002-03 to
2004-05 despite rapid economic growth. In 2000-01, savings-GDP ratio
was 11.57 per cent, which increased to 11.90 per cent in 2001-02. But
subsequently, the ratio has decreased till fiscal year 2006 to as low as
11.60% again.

Savings Investment
Year
(% to GDP) (% to GDP)
1999-00 9.75 18.50
2000-01 11.57 18.92
2001-02 11.90 18.31
2002-03 14.90 18.59
2003-04 13.59 16.40
2004-05 11.44 16.99
2005-06 11.60 19.00
2006-07 14.96 20.08
2007-08 15.41 20.05
2008-09 15.27 18.43

The investment-GDP ratio has a better picture. In 1999-00, investment-

GDP ratio was 18.50%, which increased to 19% in FY06 but then again
reached to 18.4% in FY 09. Clearly, the investment-GDP ratio is well
below the desired level. In India, the investment-GDP ratio exceeds 30
per cent, while in case of Bangladesh and Sri Lanka it is 25 per cent
and 24 per cent respectively whereas in Pakistan it has not surpassed
20% rate in previous 10 years.
 Thesis: Seminar in Economic Policy 11

Investment rate in economy largely depends on savings rate. This

means that there is a positive correlation between savings and
investments. When savings increase, investments rise and similarly
low savings result in low investments, which is the case for Pakistan.
The point can further be proved through correlation technique taking
Savings % as variable X and Investments % as variable Y.

Investmen
Savings
Year t X² Y² X*Y
X
Y
1999-00 9.75 18.50 95.06 342.25 180.37
2000-01 11.57 18.92 133.86 357.9 218.9
2001-02 11.90 18.31 141.61 335.25 217.9
2002-03 14.90 18.59 222.01 345.5 276.9
2003-04 13.59 16.40 184.68 268.9 222.8
2004-05 11.44 16.99 130.87 288.6 194.3
2005-06 11.60 19.00 134.56 361 220.4
2006-07 14.96 20.08 223.80 403.2 300.4
2007-08 15.41 20.05 237.46 402 308.9
2008-09 15.27 18.43 233.17 339.6 281.4
∑ 130.42 185.26 1738 3444.1 2423.11

Correlation (r) = NΣXY - (ΣX)(ΣY) / Sqrt([NΣX2 - (ΣX)2]*[NΣY2 - (ΣY)2])

r= 10(2423.11)-(130.42)(185.26)
√ [10(1738)-(130.42²)][10(3444.1)-(185.26²)]

r= 0.39

The positive correlation here shows that the variables are positively
correlated and that rate of investments is dependent on level of
savings in the economy. So, there is no easy answer other than
Pakistanis at all levels need to develop a much stronger culture of
savings to grow the investments in the country. This goes for all three
entities: households, companies and government.
 Thesis: Seminar in Economic Policy 12

Investment-Savings Gap

Throughout the ten years, it can be noticed that investment exceeds

savings. This is known as savings-investment gap which is financed by
borrowings and investments from abroad; this will be country’s
external liabilities. These are also called foreign savings and are equal
to current account deficit of country’s balance of payments.

For the purpose of calculation, investment figures are taken at

constant prices for the reason described earlier. Overall GDP and
investment figures, which are used for following calculations, can be
seen in Appendix while savings rates remain same as in previous
section.

Investment Investment to Savings to Foreign

Year
(Rs. Million) GDP % GDP % Savings %
1999-00 659110 18.50 9.75 8.75
2000-01 687337 18.92 11.57 7.35
2001-02 685625 18.31 11.90 6.41
2002-03 729121 18.59 14.90 3.69
2003-04 691434 16.40 13.59 2.81
2004-05 780477 16.99 11.44 5.55
2005-06 923911 19.00 11.60 7.4
2006-07 1042787 20.08 14.96 5.12
2007-08 1083568 20.05 15.41 4.64
2008-09 1016203 18.43 15.27 3.16

25

20

15
Saving%
10
Investment%
5

0
FY FY FY FY FY FY FY FY FY FY
00 01 02 03 04 05 06 07 08 09

We can notice the wide investment-savings gap in all the years which
is due to inflow of foreign debt and investment. The outcome of foreign
savings inflow is not mainly the increase in the investment rate but the
increase in consumption and foreign indebtedness. High level of
foreign savings means increased foreign debt for the country and so it
 Thesis: Seminar in Economic Policy 13

implies the obligation of remunerating it without a corresponding

increase in the country's productive capacity. Another repercussion of
investments based on foreign savings is appreciated exchange rate.
When a country accepts growth strategy with savings, it is managing
downwards (appreciating) the exchange rate, since the current
account deficit implied by it results necessarily into a more appreciated
exchange rate than the one that would exist in the absence of such a
deficit and in the presence of current account equilibrium.

The SBP annual report 2006-07 pointed to this trend, noting that “the
large saving-investment gap (five per cent by FY07) results in
accumulation of external debt and puts burden on the balance of
payment (BoP) in terms of mounting debt-servicing. As a result, the
country seeks more external debt to service its debt obligation and
falls into a trap.” This vulnerability could prove devastating unless
managed skillfully.

To decrease this reliance on foreign savings and its consequences,

Pakistani people will have to increase national savings which is only
possible if they can get control over the high consumption pattern.
 Thesis: Seminar in Economic Policy 14

Composition of Imports

Study argues that Pakistan is a consumption oriented society and that

Savings rate should be increased domestically in order to increase
growth. To supplement this hypothesis, let’s look at the picture from
another view; Trade account. In this section I have analyzed the
composition of imports of our country for past ten years.

Pakistan has been a victim of Trade deficit since long time. The trade
deficit in FY07 was $ 20.9 billion against the deficit of $ 13.5 billion in
FY06 (see Appendix for complete data). Trade deficit percentage to
GDP has been increasing over the ten years and has reached to as
high as 10.1% in 2007-08.

In order to maintain trade surplus, total imports should be less than

total exports obviously. Exports can be increased by importing capital
goods. Long term economic growth of a developing country depends
on the import of capital goods and machinery that accelerates
economic productivity. Machinery and capital goods imported by
producers are set up and then start production, which impacts the
number of exports. Therefore, imports play vital role in enhancing
 Thesis: Seminar in Economic Policy 15

exports, and these imports could be in the form of raw materials or

machinery.

But problem with Pakistan is that it is highly consumption oriented

society which is leading to rising imports of consumer goods and raw
materials used for consumer goods. This spendthrift nature of
Pakistanis is affecting the economic growth in many ways. The import
data of Pakistan is shown below category wise.

If we analyze the composition of imports data, category wise, we will

find that the overall composition of country’s imports implies that the
share of raw material for consumer goods maintained its higher level
since 1999-00. More recently, the share of imports of raw material for
capital good is exhibiting increasing level in the country. Further
 Thesis: Seminar in Economic Policy 16

details of composition of imports shows that share of imports of capital

goods declined to 27 percent from 29 percent previous year and share
of import of consumer goods increased by 2 percentage points July-
March 2008-09 as against comparable period last year.
 Thesis: Seminar in Economic Policy 17

Consumer goods include things such as some food products, motor

vehicles, gold etc. Capital goods consist of items like power generating
machinery, construction and mining machinery, agricultural
machinery, textile machinery, etc. Capital goods are the only way to
enhance the exports as Machinery and equipment imported by
producers are set up and then start production, which impacts the
number of exports. Whereas import of consumer goods result in higher
consumption and low prospects for future investments.

Ratio of Consumer Goods Import to Capital Goods Import

Ratio of import of consumer goods to import of capital goods indicate

that Pakistan has high consumption patterns and there is low focus on
import of capital goods which results in direction towards low economic
activity.

Ratio of consumer goods to capital goods can be calculated as follows:

= % Share of Import of consumer goods and raw materials for

consumer goods
% Share of Import of capital goods and raw materials for
capital goods

Ratio greater than 1 indicates that an import of consumer goods is

higher than imports of capital goods. Data calculated for ten years
show following trend:

Diff. in imports of
Ratio of
consumer goods &
Year consumer goods
capital goods
to capital goods
(Rs. Million)
1999-00 192278 2.125
2000-01 243276 2.22
2001-02 203150 1.94
2002-03 190056 1.702
2003-04 151041 1.38
2004-05 136586 1.272
2005-06 198910 1.272
2006-07 241689 1.325
2007-08 442060 1.702
2008-09 560851 1.77
 Thesis: Seminar in Economic Policy 18

The table shows that import of consumer goods has always been
higher than import of capital goods. The ratio has never been less than
1 in past ten years at least. In fact in FY00 and FY01, import of
consumer goods is more than double the value of import of capital
goods and its raw materials. However, the ratio started declining from
FY 02 and the declining trend continued till FY06. After that, the ratio
of import of consumer goods to capital goods again rose and reached
to as high as 1.77 in FY09. The difference between import of consumer
and capital goods is also at record high of Rs. 560851 million. The
trend can be seen in the bar chart below.

Share of Import of Consumer Goods and Capital Goods

70
60
50
40
%
30 Import of Consumer Goods
20 Import of Capital Goods

10
0
FY FY FY FY FY FY FY FY FY FY
00 01 02 03 04 05 06 07 08 09
 Thesis: Seminar in Economic Policy 19

Trade Deficit in Services

Till now, the high consumption nature of Pakistan has been proved
through low savings rate and composition of imports. The point will be
further proved by analyzing the trade deficit in services sector of
Pakistan. Trade of services data for past seven years is presented in
the table below which is based on SBP figures in Appendix.

Services are the largest and most dynamic component of both

developed and developing country. It is impossible for any country to
prosper today under the burden of an inefficient and expensive
services infrastructure. In Pakistan, the services sector contributes a
lot in the GDP. We can
see that since 2003, Trade of Services (US $
Pakistan trade deficit in Years million)
Export Import Net
services has been rising
FY 03 2712 2714 -2
significantly. In FY 08, it
FY 04 2644 3960 -1046
has reached to as high as
FY 05 3319 6612 -3293
US $ 6.45 billion. But in FY
FY 06 3769 8199 -4430
09 the overall deficit in
FY 07 4140 8310 -4170
services trade narrowed
FY 08 3589 10046 -6457
by almost 50 percent over
FY 09 4043 7274 -3231
the previous year,
depicting a positive picture. During fiscal 2008-09, the deficit totaled
$3.231 billion against $6.457 billion in the previous year, official
figures indicated. But still, the large deficit shows a widening huge gap
in our import and export of services which can be seen in the bar char
below. This clearly indicates our habit of consuming more, while
saving, investing and producing less.

12000
10000
8000
Million
US $ 6000
Exports
4000 Imports

2000
0
FY FY FY FY FY FY FY
03 04 05 06 07 08 09
Thesis: Seminar in Economic Policy 20
 Thesis: Seminar in Economic Policy 21

The service sector comprises government services, travel services,

transportation services, financial services, communication services,
construction services, computer and information services, royalties and
licenses. Some of these accounts are analyzed for the past seven years
to show the consumption oriented nature of Pakistanis.

Transportation (US $ million)

Years Net
Credit Debit
Pakistan is facing large trade Credit
deficit in services sector. One FY 03 808 1519 -711
FY 04 864 1754 -890
of the major reasons is high
FY 05 1062 2280 -1218
imports of transportation FY 06 1080 2863 -1783
services and inability of FY 07 1102 3177 -2075
exporting more. Another FY 08 1035 3785 -2750
factor for trade deficit is FY 09 1283 3527 -2244
increased expenditure of
Pakistanis on travel and tours Travel (US $ million)
Years Net
services. It includes services Credit Debit
Credit
like hotels, restaurants, travel FY 03 92 494 -402
agencies and tour operator FY 04 164 1198 -1034
services. We tend to spend on FY 05 177 1172 -995
these services which give FY 06 216 1411 -1195
benefit to other countries and FY 07 277 1625 -1348
leave little for us to save. FY 08 264 1578 -1314
FY 09 222 997 -775

Communication services is
the only service sector of Communication Services
(US $ million)
Pakistan which has shown Years
Net
positive performance in terms Credit Debit
Credit
of trade surplus. FY 03 275 45 230
Communications services FY 04 204 38 166
include many services such FY 05 331 59 272
as telecommunication FY 06 198 101 97
services, email, internet, FY 07 123 98 25
intranet services, telex, FY 08 117 107 10
telegraph, facsimile services FY 09 196 144 52
etc. Radio services, satellite
 Thesis: Seminar in Economic Policy 22

based telephony and online information services are also included in

this.
 Thesis: Seminar in Economic Policy 23

Insurance and non life insurance Insurance Services

has also contributed to the trade (US $ million)
Years
Credit Debit Net
deficit of the country. And same is Credit
the case with royalties and FY 03 21 72 -51
services. We tend to spend far FY 04 19 81 -62
more on these services than we FY 05 25 101 -76
earn through them. There are FY 06 29 131 -102
two reasons for this outcome: FY 07 30 126 -96
FY 08 54 152 -98
1. Lack of knowledge about FY 09 59 127 -68
the international regime on
services export, capacity
constraints, inadequate
networking, poor marketing and Royalties and License
politico administrative Fees
Years (US $ million)
environment are the major Credit Debit Net
factors for underperformance in Credit
this very important area of the FY 03 8 23 -15
economy. This results in lower FY 04 10 47 -37
exports. FY 05 13 107 -94
FY 06 33 99 -66
2. Second and more important FY 07 41 115 -74
reason is the high consumption FY 08 51 130 -79
nature which forces us to spend FY 09 11 93 -82
more and more, even beyond our
means and result in higher
imports.
 Thesis: Seminar in Economic Policy 24

Concluding Remarks

Till this point, it has been clarified that Pakistan is a consumption

oriented society and it effects the growth of the country in many ways:

1. High consumption rates leaves little portion for savings which

results in low investments. The consumption rate in past ten
years is average 87% which indicates that savings are no more
than average 13%.

2. Low savings result in low investments directly. Investment or

capital formation has a two-fold role in the economy. In the
short-run, investment affects aggregate demand and thus output
and employment. In the long-run, investment affects GDP
growth. A country’s rate of growth largely depends on how much
it sacrifices present consumption to provide for production of
capital goods.

3. Another way our low savings effect growth is how our

investments are financed through foreign savings increasing our
foreign indebtedness.

4. We tend to import more consumer goods and less capital goods

because of our consumption oriented nature. In this economic
situation where Pakistan in facing high trade deficits over the
years, considerations should be made to increase the exports.
Exports can be increased by importing capital goods like
machinery which accelerates economic productivity.

5. Our expenditure on services imported is far more than we earn

through exporting services. Services like travels and tourism,
medical and personal, insurance, royalties and other business
services make up a major portion of trade deficit in services.

6. Therefore, to accelerate the growth in economy, consumption

has to be decreased and all the three entities, households,
companies, and Government should start saving more to finance
the future investments. This will enable us to reduce our reliance
on foreign savings and thus foreign debt. Low consumption and
high savings will also result in sufficient funds to finance physical
and social infrastructure, optimal growth, and optimal job
creation and overall better living standards for all of us.
Thesis: Seminar in Economic Policy 25
 Thesis: Seminar in Economic Policy 26

Appendix

COMPONENTS OF BALANCE OF PAYMENTS (AS PERCENT OF

GDP)
Thesis: Seminar in Economic Policy 27