Interactive Powerpoint_How to Master effective communication
Pak economic
1. insafresearchwinsafresearchwin
Insaf Research Wing Pakistan Tehreek-e-Insaf
IRW
Insaf Research Wing
ginsafresearchwinginsafresearch
Central Secretariat
Street No. 84,
winginsafresearchwinginsafresea
Finding solutions for a better Pakistan
Sector G-6/4,
Islamabad, Pakistan.
Tel: 92-51-2270744
rchwinginsafresearchwinginsafre
Fax: 92-51-2873893
irw@insaf.pk
searchwinginsafresearchwingins
afresearchwinginsafresearchwin
ginsafresearchwinginsafresearch
Pakistan Economic Research Report
winginsafresearchwinginsafresea
An analysis of the Pakistan’s Economy along with
other countries
rchwinginsafresearchwinginsafre 08 June, 2010
searchwinginsafresearchwingins Author: Asad Mahmood
Committee: Economics
afresearchwinginsafresearchwin Dossier # 001
Version # 001
ginsafresearchwinginsafresearch Nature of Document: Report
winginsafresearchwinginsafresea
rchwinginsafresearchwinginsafre
searchwinginsafredisciplinejusti
cehumanityequalityfaithpietydis
ciplinejusticehumanityequalityin
3. Committee on Economics Pakistan Economic Research Report
Table of Contents
Executive Summary 4
Acknowledgements 5
1.0 Chapter 1: Introduction 6-7
1.1 Background Information 7-9
1.2 Research Aim and Objectives 9-10
2.0 Chapter 2: Functions of an Economy
2.1 Making of an Economy 11-12
2.2 Economic Growth 12-14
2.3 Monetary & Fiscal Policy 14-16
2.4 Types of economic systems 16-20
2.5 Parameters of economic growth 20-22
2.6 Arguments against and for privatization, regulation and deregulation 22-23
3.0 Chapter 3: Different Economies and Systems
3.1 Key factors behind the economic success of Southeast Asian economies 24-26
3.2 Key economic drivers of Nordic countries 27-29
3.3 Research on Venezuelan economy 30-31
3.4 Poverty Reduction Initiatives 31-32
3.5 Hugo Chavez economic policies 32-34
4.0 Chapter 4: The Banking System
4.1 Islamic Banking 35-36
4.2 Role of World Bank, IMF, the Paris Club, Asian Development Bank (ADB) 37-40
4.3 Role of EU, NAFTA, GCC 40-43
5.0 Chapter 5: Current Pakistani Economic State 44
5.1 Manufacturing Industry 45-47
5.2 Services Industry 47-48
5.3 Agriculture Industry 48-50
5.4 Tourism Industry 50
5.5 Role of Foreign Aid 50-51
6.0 Chapter 6: Recommendations 52-56
Bibliography 57-58
Appendix 59-61
3
Insaf Research Wing
4. Committee on Economics Pakistan Economic Research Report
Executive Summary
Pericles, head of the Athenian state, member of the democratic party, statesman, political philosopher and the
ranking member of the board of generals, eloquent about the threats to ancient Athens at the height of its
power around the year 461 B.C., said “what I fear more than the strategies of our enemies is our own
mistakes”. Indeed Pericles was right: our enemy is our own mistakes. The strategies we employ will, in the end
decide our fate.
The incumbent Pakistani governments consistent mistakes threaten to harm ourselves and those associated
with us. At a time when, Pakistan should be expanding the base of public spending, firmly taking control over
its financial institutions, national resources and industries and enlarging public employment opportunities, the
country has gone in to reverse to relinquish national development plans and hand over the economic decision
making to the private banking, foreign companies and multinational corporations. A shame for a country of
170 million people blessed with natural resources both capital and land.
The aim of the report is to analyze the current Pakistani economic state and provide guidance towards a socio
economic policy in line with the manifesto of the party. An extensive secondary research was carried out
examining and presenting various viewpoints. The development challenges for Pakistan include a complete
overhaul of the current economic system. To achieve accelerated and sustained broad-based economic growth
an economic emergency should be declared, a five year Keynesian measures should be implemented, that is
public ownership of key industries and undertaking key infrastructure project in transport, oil gas and minerals
and telecommunication sectors. For the rural areas focusing on the important agriculture sector taking in to
account water management, infrastructure development, livestock and fisheries. Chairman Khan has
announced an education emergency when PTI comes in to power; the author believes an economic emergency
of the same kind should also be considered.
The analysis of the various economic systems and countries highlighted the need for an economy comprising
nd
of 3 tiers: tier 1, a self supporting economy comprising of agricultural and manufacturing, 2 tier consisting of
rd
service based economy incorporating leisure & tourism, banking, arts and entertainment, 3 tier intellectual
based economy focusing on science and technology, armament, space, medicine and genetics.
The fact of the matter is that Pakistan urgently needs an alternative path of political development. It needs
radical progressive economic planning compatible with the emerging revolutionary models being initiated in
several countries in Latin America, notably Venezuela. In short Pakistan needs to deliver viable economic
programs to its general masses and restore its cultural edifice with its ideal historical values of collective
community development, social harmony, heritage, justice and enactment of the principles of a welfare state.
4
Insaf Research Wing
5. Committee on Economics Pakistan Economic Research Report
Acknowledgements
The original idea of the report transpired through the formation of Insaf Research Wing (IRW) conceptualized
by Mr. Ali Hammad Razza. The inception of the economic committee led to invigorating discussions about
various issues affecting the Pakistani economy. This led to the realization of researching an analysis of various
factors, which affect the Pakistani economy and the wider exploration of the field of economics.
Preparation and completion of this study was a challenging and an invigorating experience, as some of the
committee members did not have prior familiarity to the field of economics or the study of this depth. Along
the way personal difficulties led some committee members to curtail their involvement. However I would like
to thank the IRW members for their valuable suggestions.
The economic committee would also like to express thanks to their family and friends for their support,
encouragement, constructive criticism and suggestions throughout the course of the research work.
Lastly it is hoped that this report will be used in stimulating thought, self reflection and valuable discussion
amongst Central Executive Committee (CEC), PTI members, academics and provide as valuable a learning
experience for them as it has for the author.
5
Insaf Research Wing
6. Committee on Economics Economic Research: Pakistan
each zone with manageable community and
Chapter# 1: population size, its own state funded hospital,
health service clinics, elementary and high schools,
Introduction local judicial courts, police and an efficient
transport and communication infrastructures.
However after eight years of General Mushraf’s
rule, incessant preaching of enlightened
1.0 Introduction moderation and the non-stop blowing of trumpets
of an economic recovery miracle the Pakistani
nation stands today at the verge of an economic
Islamic Republic of Pakistan is located in South Asia disaster.4
and borders Central Asia and the Middle East. It has
The state of the Pakistani economy can somewhat
a 1,046 kilometre (650 mile) coastline along the
be compared to the state of the European countries
Arabian Sea and Gulf of Oman in the south, and is
notably Britain which was ravaged by two major
bordered by Afghanistan and Iran in the west, the
world wars. After the Second World War, Britain
Republic of India in the east and the People's
had emerged effectively bankrupt, with an
Republic of China in the far northeast. Tajikistan
overstretched economy and massive popular
also lies adjacent to Pakistan but is separated by
1 expectations of economic and social improvement.
the narrow Wakhan Corridor. Pakistan is a 5
federation of four provinces, a capital territory and
federally administered tribal areas. The estimated The famous economist J M Keynes persuaded the
population of Pakistan is 172,800,000 making it the British policy makers of a big programme of post-
world's sixth most-populous country.2 With a war social reform, and a phased liberalization of
growing population and limited resources the international trade and payments. Keynes
economic challenges for Pakistan are immense; demonstrated that the unemployment rate
moreover these challenges are intertwined with depended upon the level of aggregate demand, the
various geopolitical factors. sum of total consumption and total investment. His
remedy to reduce mass British unemployment was
Though the Pakistani administration claims that
to expand investment by a programme of public
poverty has decreased from 33% to 25%, several
works, which would create additional consumption
international organizations reports indicate that
3 by the workers employed and further waves of
poverty has in fact risen to 37%. Evidently the
consumption and investment as new incomes were
administration is simply manipulating the numbers.
generated and additional expenditure made at each
For example Lahore is a city of six million people. It
round. The Labour governments of 1945-1951
has a single state-run general hospital that provides
enacted a political programme rooted in
treatment to patients with neuro-surgical ailments.
collectivism including the nationalisation of
The sick from Lahore, the surrounding areas and far
industries and state direction of the economy.
off villages in Punjab suffer the indignities of the
overcrowded wards and inadequate facilities of the Economists conventionally divide industry (the
hospital. In the context of the contemporary needs production of goods and services for financial gain)
of the masses, political correctness and a in to primary, secondary and tertiary sectors. The
progressive socio-political ideology, the political primary sector is concerned with growing or
establishment of Pakistan should be planning urban extracting natural products and includes
and rural development based on zonal structures – agriculture, fishing forestry, mining and extraction
1
Encarta Encyclopedia 2000
4
Dr H Mehdi (2007) The Nemesis, political articles &
2
Population reference Bureau - www.prb.org analysis, Lahore, Heritage Publications
3 5
Dr H Mehdi (2007) The Nemesis, political articles & Alan Booth (2001) the British economy in the
analysis, Lahore, Heritage Publications twentieth century, London, Palgrave
Insaf Research Wing 6
7. Committee on Economics Economic Research: Pakistan
of minerals. In the secondary or manufacturing products at higher efficiency levels. The reason for
sector, raw materials are processed in to physical the German advantage in these cases resulted less
goods so they acquire added value. Everything else from vocational skills but from higher attainment in
falls within the tertiary sector, which is concerned mathematics at school and continuing education
with the supply of all forms of service.6 These that enabled German workers to operate computer
distinctions are useful, but the boundaries are not controlled machines that could not be used in
8
always clear, especially between manufacturing Britain. These studies were small in scale and
and services. As economies develop, the primary generally have unknown relevance to the wider
sector becomes relatively less important in terms of
output, though actual output may continue to Although fascinating studies but one should not
grow. The tertiary sector made the biggest single forget they are small in scale, do not control for the
contribution to output growth in most developed state of market demand and have unknown
twentieth century countries. relevance to the wider twentieth century. But what
they do show is unequivocal link between
The importance of human capital formation to the education, training and productivity.
processes and pace of economic growth is
fundamental. For example, the high level of skill For Pakistan the basic economic infrastructure is
among manual workers was a decisive advantage in there however lack of governance and skilled
Britain’s industrial revolution and the shortage of workers is one of the biggest obstacles. With a PTI
skilled workers in those countries seeking to follow government the key will be establishing an expat
Britain’s lead was almost certainly a decisive skills department within each Pakistani high
disadvantage. However Britain’s advantage in the commission in Western Europe, Japan, America and
mid twentieth century sharply declined and during the tiger economies of Southeast Asia. These expat
the phase of high unemployment in the 1970’s skills department will be further subdivided
many manufacturing companies complained that according to various fields i.e. medicine, mechanical
they could not fill vacancies for skilled and technical engineering, poverty alleviation, finance, banking,
workers. In their study of matched (by type of leisure & tourism etc. Mass recruiting of key
product, size of firm, scale of production) firms in individuals with experience and relevant
the British and German machine tools industries, educational qualifications should then be sought
Daly and colleagues (1985) found that Germans and their skills matched in reforming various
productivity levels were 50-80 percent higher than segments of the Pakistani economy.
British. The authors identified three basic
differences between firms in the two countries.
German firms used more production engineers to
1.1 Background information
ensure that workflows and handling equipment
were fully utilized. German supervisory staff tended
to be better qualified than British at ensuring that
The twentieth century saw a major expansion of
the machines were properly set up and used for the
the role of government both as a producer of goods
appropriate tasks and that workers were
and services and as a regulator and stabilizer of the
adequately directed. Finally German firms had
7 national economy. The Western world has come a
proportionately twice as many skilled workers. In a
full circle in their economic approach. Controversy
similar comparison of matched firms in the
raged for many years in the economic world over
furniture trade, German firms made higher quality
the proper role of government in an economy and
6
Prais, S. J. 1995. productivity, education and it was especially fierce during the twentieth
training: an international perspective, Cambridge, century. Left to its own devices the miracle of free
CUP
7
Daly, A. D.M.W.N and Wagner, K (1985) market economic was widely triumphed since the
Productivity Machinery and Skills in a sample of
8
British and German Manufacturing Plants: results of Alt, J and Chrystal A 1983. political economics,
a pilot enquiry’ NIER, 111: 48-61 Brighton, Wheatsheaf
Insaf Research Wing 7
8. Committee on Economics Economic Research: Pakistan
late 1970’s. The unbridled and unregulated western factionalism inside the political parties also divided
economies however came close to a meltdown party politics along regional lines. While the Awami
beginning 2007 and came to rely on government league concentrated its efforts in East Pakistan
for massive bailouts. The state’s role as the only (now Bangladesh) the Muslim league dominated
powerful force to reverse the present decline now the politics in the western wing of the country.
remains unchallenged. Such political factionalism led to frequent dismissal
of governments. From 1947 to 1958 Pakistan had
Whilst the western world comes to term with the seven prime ministers and eight cabinets.
10
present economic crisis and governments praised Furthermore the extravagant and viceregal
for their decisive action to stabilize the market behaviour of the political elite set it apart from the
system. A complete opposite remedy is being common people. The civil bureaucracy was as
prescribed to the Pakistani government to cure its powerful as in India. The main difference, however,
economic ills namely privatization and massive between the two civil bureaucracies was in their
loans. approach to military power and political control.
While the Indian civil bureaucracy recognised and
Since Pakistan’s inception in 1947, the military
accepted the dominance of the politicians and
gained prominence in the state apparatus as a
established control over the armed forces through
result of the first war with India. After the death of
strengthening of the ministry of defence (MoD),
the founding father, Jinnah, in 1948, Pakistani
Pakistan’s civil bureaucracy chose to partner with
politics was riddled was the problem of
the bureaucracy – represented by a bureaucrat
factionalism. The political contest took place on
turned politician Ghulam Mohammad, the governor
three fronts:
general during the early 1950’s viewed the military
- Amongst the various political groups for as a junior partner capable of keeping the raucous
the control of the state. politicians at bay. The governor general’s trust lay
- Between the civil and military bureaucracy more in the army generals than the civilian prime
and the political class ministers. 11 To make itself more relevant for the
- Between the military and other dominant
state, the military strengthened itself institutionally
civilian actors.
through enhancing its control over defence and
One of major cause of the debilitating state of the foreign policy making. The political leadership was
Pakistani economy is the continuous bickering of far too fragmented to establish control over the
the dominant political leadership in the country. military and issues of national security. The senior
For instance, Liaquat Ali Khan, the country’s first generals especially Ayub Khan, who was the first
prime minister manipulated politicians in the army chief, insisted that the defence matters were
12
Punjab in his interest. However, when confronted the military’s forte. The political conflict between
with the situation of losing control of the largest the political and military leadership finally ended in
province to a dominant leader of the Muslim league the first takeover by the army in 1958. The years
in the Punjab, Mumtaz Daultana, Liaquat Ali Khan from 1958-1971 saw a crucial transformation in civil
connived with the governor general to dissolve the military relations, during which the army
assembly and bring the province under the direct established itself as the key political force.
control of the central government. This situation
continued for two years until the elections in March
1951.9 10
Abbas Hassan (1979) the state in post colonial
societies: Pakistan and Bangladesh in harry
The first constitution was promulgated in 1956,
goulbourne (ed), politics and state in the third world,
nine years after the country’s creation. The Hong Kong, Macmillan
11
Clloughly B (1999) the history of Pakistani army,
Karachi, Oxford University Press
9 12
Ayesha Siddiqa (2007) Military INC, inside Ayesha Siddiqa (2007) Military INC, inside
Pakistan’s military economy, London, Oxford Pakistan’s military economy, London, Oxford
University Press University Press
Insaf Research Wing 8
9. Committee on Economics Economic Research: Pakistan
The 1971 saw a return to democracy after the involved in profit making activities. Together with
humiliating loss by the army of East Pakistan. other major economic players such as the House of
Despite the majority won by Rehman’s Awai league Habib Ittefaq Group of companies, Hashoo group,
in the elections of 1970, the west Pakistani Dawod Group and the feudal lords, such as Seth
establishment which included the military and Abid, Ghulam Mohammad Mehr, Ghulam
other dominant classes was uncomfortable with Mustafa, Asif Ali Zardari etc. (Shahid ur-Rahman,
the idea of transferring power to the Bengalis, who owns Pakistan) Thus what emerges is a
13
whom they considered ethnically inferior. quagmire of interrelated interests between the
political, military, landed feudal and the industrial
From 1971-77, Zulfiqar ali Bhutto’s rule saw class. The much-tooted economic growth of
restoration of confidence in Pakistani people, Pakistan is linked with the changing fortunes of
nationalization of industries, land reforms and most these ruling elites and not the common man mired
importantly setting the country towards the path of in poverty.
becoming a nuclear power. To his critics however
Bhutto was like a Machiavellian prince, as he tried
to maximize his power through adopting a dual
approach of propagating populist measures and 1.2 Research Aim and Objectives
coercing other players. From the standpoint of
Bhutto’s relationship with the military he made the
blunder of miscalculating the resilience of the This research papers aims to understand and study
armed forces in thwarting the strategic changes he the various economic factors necessary for
had brought about in their management. The economic growth and then correlating that to
military capitalized in Bhutto’s dependence on provide guidance towards the formation of a socio-
military force for building his personal political economic policy for PTI.
power. It emerged from the ashes of 1971
sufficiently strengthened for another takeover in The introduction mentioned development of Britain
1977. and other European powers ravaged by the two
world wars came out with a complete overhaul of
The period from 1977-88, 1988-99 and 1999-2005 their socio-economic system. Analyzing these
saw martial law, period of unstable democracy and changes, together with investigating different
then back to another coup in 1999, until 2007 when economic models and theories in order to provide
elections were held again following the PTI members a beforehand knowledge of the
assassination of Benazir Bhutto. problems with the current system and their actual
solutions is the aim of this study. It would also
The military in Pakistan is a formidable political
serve as a check on the current government's
player with greater influence than any other actor.
actions on the accounts of economy.
For example the military’s internal economy is
operating at three levels and in three segments of For the purpose of this study, relevant areas were
the economy, agriculture, manufacturing and the researched from the plethora of information
service sector through their main four subsidiaries available. This study entailed the use of
– the Fauji Foundation (FF), Army Welfare Trust interpretative approach that is; it is the people who
(AWT), Shaheen Foundation (SF) and Bahria construct their own reality. As study of human
Foundation (BF). Moreover there are also three nature has always been complex due to the fickle
major public sector organizations National Logistic nature of human beings.
Cell (NLC), Frontier Works Organization (FWO) and
Special Communication Organization (SCO) directly The analysis of the current Pakistani economic state
showed up a dire state of affairs: inadequate
13
Ayesha Siddiqa (2007) Military INC, inside infrastructure, mass unemployment, double-digit
Pakistan’s military economy, London, Oxford inflation, rampant corruption, crony capitalism etc.
University Press
Insaf Research Wing 9
10. Committee on Economics Economic Research: Pakistan
Conflicts of interest in literally every industry have
crippled economic growth; injection of foreign
loans, aid and remittances from overseas
Pakistani’s are currently keeping the economic
system afloat. The state of the Pakistani elite
running the economy can be co-related with what
an American cultural anthropologists Clifford
Geertz asserted; ‘man is an animal trapped in a web
of significance he himself has spun’.
The rest of this study is structured as follows: In
chapter two analysis of the field economics is
undertaken, citing and co-relating theories, models,
and frameworks from a variety of academic
sources. Chapter three describes the different
economic models and examines economic growth
of some of the Southeast Asian countries and the
socialist model currently propagated by the
charismatic Venezuelan leader Hugo Chavez.
Thereafter chapter four describes the Islamic
banking concepts, alongside the role of the IMF,
World Bank and other donor organization. Chapter
five discusses the current state of the Pakistani
economy, looking at key industries such as
agriculture, manufacturing, and services. Finally
chapter six draws conclusion and examines the
issues in respect to the theories and frameworks
outlined in the previous chapters.
Insaf Research Wing 10
11. Committee on Economics Economic Research: Pakistan
services. Economists group buyers and sellers
Chapter# 2: together. For instance there is an international
market for oil where large companies and
Functions of an governments buy and sell oil. There are also
national markets for oil. Not every company or
Economy government involved in the buying and selling of oil
in the UK will be involved in the US or the
Malaysian oil markets. There are also regional and
local oil markets. All these markets are interlinked
but they are also separate.16
2.1 Making of an Economy
The three most important western economists
were: Adam Smith, Karl Marx and John Maynard
Economics is the study of systems of production Keynes. Each developed economic theories that
and distribution. In essence it is the analysis of the were put in to practice and affected the world’s
ways in which societies produce and distribute economies for generations.
goods and services. Any system for deciding what is
produced, how it is produced and who gets to Adam smith (1723-1790), a Scottish philosopher
consume it, whether it is the system of an entire published his famous book, the wealth of nations in
planet as in the global economy or a defined 1776, the year of America’s declaration of
segment of society in an economy and can be independence in which he explained why some
14
understood in economic terms. nations are rich while other are not. Theories of
labour productivity, wealth accumulation and
Economics has two main branches: productivity growth were delved in to by smith,
Macroeconomics and Microeconomics. later expanded by generations of economists.
Smith founded what is known as classical
Macroeconomics focuses on the study of whole
economics i.e. the idea that free markets can
systems of production and distribution, that is,
regulate themselves. The key doctrine of classical
whole economies and large sectors of the
economies. Whereas microeconomics focuses on economics is that a laissez-faire attitude by
individual economic entities, such as a single government toward the marketplace will create the
greatest good for the greatest number of people
business or single household, or on specific
and generate economic growth.17
economic activities such as employment and prices.
Karl Marx (1818-1883) a German economist and
An economy is made up of factors of productions
i.e. land, labour, capital and entrepreneurship political scientist looked at capitalism from a more
combined together to create goods and services for pessimistic and revolutionary viewpoint. Marx
15 believed that once the capitalist has set up the
consumption. Economies are structured in to
means of production, all value is created by the
three main sectors, primary (incorporating the
labour involved in producing. In Marx’s view,
agriculture, forestry, fishing sector) secondary
(manufacturing cars, food processing, steel making presented in his 1867 tome Das Kapital (Capital),
etc) and tertiary (services sector such as transport, capitalist’s profits come from exploiting labour that
leisure & tourism, financial services, health and is underpaying workers for the value that they are
actually creating. This situation of management
education etc) Then there are the markets at
exploiting labour underlies the class struggle that
international, national and local level where buyers
Marx saw at the heart of capitalism and he
and sellers meet for exchange of goods and
14 16 th
Paul A Samuelson & William D Nordhaus (1998) A. Anderton (2006) Economics, 4 edition, Harlow,
Economics, London, McGraw-Hill Causeway Press
15 th 17
A. Anderton (2006) Economics, 4 edition, Harlow, Stephen L Slavin (1988) Economics a self
Causeway Press teaching guide, Wiley & Sons
Insaf Research Wing 11
12. Committee on Economics Economic Research: Pakistan
predicted that the struggle would destroy GNP between 1938 and 1946. In many countries
capitalism in the end. Ultimately in Marx’s view exports had dropped to almost nil, meat production
society moves to a two-class system of a few declined by one third and bread output fell by 60%
wealthy capitalists and a mass of underpaid, of pre war. Malnutrition was serious in occupied
underprivileged workers. Marx’s thinking had a countries. 20 There was much talk of growing chaos
tremendous impact on the USSR (Union of Soviet and discontent followed by another war. This can
Socialist’s Republics) in the twentieth century. be likened to more or less the present situation in
However it is important to note socialist centrally Pakistan, where all areas of the economy are in
planned economies have proven far less efficient at ruin, severe power and water shortages - war
producing and delivering goods and services. raging in the northern areas and constant threat of
terrorism in major cities across the country.
John Maynard Keynes (1883-1946) British
economist came up with different views from those One of the major reasons Western Europe
of Karl Marx and Adam smith. Keynes argued recovered so rapidly was thorough planning mainly
government can play a crucial role in stimulating by the USA but to a lesser extent Britain and
private sector investment. He favoured an Canada. During the last two years of the Second
approach of using the government’s power to World War, the United States directed the creation
spend, tax and borrow to keep the economy of the institutions which would allow the new
18
stable. This policy was adapted in America during world system to function. These fell in to three
the great depression and in Europe after the main areas: money, trade and international
Second World War. During the UK recession of disputes. The first allied conference on long-term
early 1980s the conservative government did the economic problems was held in May 1943. It
opposite and cut government spending. However concentrated on food supply and led to the
the recent recession in the western world has seen creation of the food and agriculture organization of
taking up the Keynes policies again. the United Nations (FAO) at the end of 1944 with
Britain a founding member. The desire to spare the
world further armed conflicts was reflected in
creation of the United Nations organisation set up
2.2 Economic Growth in 1946. The currency problems were to be avoided
in future by setting up of a world currency and
payments systems in which gold reserves would be
Economists define economic growth as the rate of replaced by the US dollar as the basis of the value
change of productive potential over time. of national currencies.21 Unlike gold, the supply of
Productive potential is what the economy can the US dollar would expand in step with the size of
produce when all factors of production (land and the American economy and consequently of the
raw materials, labour, capital and world economy of which it formed so large a part.
entrepreneurship) are fully employed. 19 This system was agreed at the Bretton woods
conference in New Hampshire in 1944. The
In order to understand economic growth, one must
conference led to the establishment in 1945 of the
look at how Western Europe developed so rapidly
international monetary fund (IMF), a US funded
after two major world wars. For example the
structure for international payments. IMF, which
number of deaths caused by the Second World War
was designed to help countries with serious
in Europe is estimated at about 40 million and over
balance of payments deficits to achieve parity, was
30 million Europeans had transplanted or
dispossessed. Most countries suffered a large fall in
20
Anthony Sutcliffe (1996) An economic & social
history of western Europe since 1945, London,
18
Stephen L Slavin (1988) Economics a self Longman Publishing Ltd
21
teaching guide, Wiley & Sons Anthony Sutcliffe (1996) An economic & social
19
Alan Booth (2001) the British economy in the history of western Europe since 1945, London,
twentieth century, London, Palgrave Longman publishing ltd
Insaf Research Wing 12
13. Committee on Economics Economic Research: Pakistan
intended to function for a short time only, until investments during the war yet were unlikely to
member countries had stabilized their accounts. attract private capital quickly enough in the post
More lasting was intended to be the work of the war years. The government also launched a big
World Bank, which was set up by the conference to programme of road improvement and construction
make development loans to third undeveloped in 1955 and the M1 Britain’s first London to
22 23
countries. Birmingham motorway was built. The concept of
the ordered economy achieving full employment
Central to the development of Western Europe was was largely the work of John Maynard Keynes, the
the marshal plan, named after the US secretary of academic economist who became an advisor to the
state, George C Marshal. This plan sought to treasury during the war. The vision of the British
integrate Western Europe in to a single economic welfare state was based on employment and
area, mainly on the basis of free trade but also related services by William Beveridge, an academic
along US approved political lines. The plan involved economist and former civil servant in 1942.
the provision of $13 billion over a period of four Departmental proposals for health services,
years. Officially titled the European recovery education and town planning soon followed. Public
programme (ERP) the fourteen countries had to optimism about the plans was boosted by the
sign agreements committing themselves to a strong increasing success of the British war effort, which
production effort, expansion of their foreign trade, suggested that national planning backed by massive
the maintenance of financial stability and the public expenditure could achieve goals from which
development of European economic cooperation. all would benefit. This confidence which contrasted
with the orthodox budgetary views and non
One criterion of the success of reconstruction in
interventionist policies prevailing before the war
Western Europe is the time it took for economic
contributed to a growing electoral support for the
activity to return to its pre-war level. UK, France
labour party which was able to present itself not
Germany Italy were all at the pre-war level in
only as the party of the masses but also as the party
manufacturing and agriculture in 1950/51, 5 years
of modernity and national progress.
after the war.
France’s economic problem after the liberation was
Britain’s economic growth after the war depended
less acute than in most European countries. She
on boosting its exports, minimising its imports
was virtually self sufficient in food and many raw
together with reducing its borrowing. The Labour
materials. More over French economy recovered
government maintained wartime levels of high
quickly and as early as 1947 industrial production
taxation, the system of production quotas and
had returned to the level of 1938. The idea of
rationing. High taxation financed the new welfare
national planning was hugely anticipated and
activities without heavy borrowing, consumption
widely entertained in the political and
was kept firmly in check and rationing became even
administrative circles at the end of the war. The
less generous then in wartime. The government
leading civil servants led by Charles de Gaulle’s
gave priority to the development of the capital
close associate Jean Monnet were especially
goods and export industries, raw materials and
interested in economic planning. In the late 1945
agriculture. Between 1946 and 1949 the British
Jean Monnet brought together a small team of civil
government passed legislation to nationalise
servants in two rooms at a hotel for his planning
power, transport coalmines, iron, and the bank of
work. This intimate group of the type favoured by
England. This was directed towards efficiency and
Jean Monnet quickly drew up an outline five year
high output than a socialist system of production.
plan (the Monnet plan) taking effect from 1947 the
The industries chosen for nationalisation were
plan was designed to create a climate for the
essential to production rather than consumption.
All had suffered from lack of maintenance and
23
Anthony Sutcliffe (1996) An economic & social
22
D. H. Aldcroft (1993) the European economy history of western Europe since 1945, London,
rd
1914-1990 3 edition, London, Routledge Longman Publishing Ltd
Insaf Research Wing 13
14. Committee on Economics Economic Research: Pakistan
confident growth of industrial production in both generations, the first sought money; the second
the private and public sectors. It emphasized born to money sought social and civic position; the
investment in industries crucial to the growth of third born to comfort and family prestige looked to
production – energy, transport, steel, cement and the life of music. This suggests the changing
agricultural machinery. Its basic feature was the aspirations of generations as they place a low value
setting of growth targets for industrial groups over on what they take for granted and seek new forms
five year periods. Twenty-four modernization of satisfaction.
commission set up in 1946 and 1947 fixed the
details of the targets in each sector. Civil servants,
industrialist and trade unions sat in each
commission. The plan produced a planning 2.3 Monetary & Fiscal Policy
partnership between the state and the industry.
The workers were not only involved in the planning
but also in the execution, through the post war Fiscal Policy
system of factory councils set up by de Gaulle in
February 1945 as an anti-class conflict measure. Fiscal policy is the use of government spending and
The Monnet plan reflected the widespread interest revenue collection to influence the economy. The
two main instruments of fiscal policy are
in Western Europe in achieving full resource
government spending and taxation. 26 Changes in
utilization. More practically however the Monnet the level and composition of taxation and
plan can be seen as the appropriate response to the government spending can impact on the following
needs of an economy, which in some sectors was variables in the economy:
fully developed yet was very backward in others.
French modernization was visible to all by the later Aggregate demand and the level of
1950’s, the government had established a number economic activity; aggregate demand is
of investment funds and these together with the total of all expenditures in the
economy at given price.
existing public resources and the aid from the
The pattern of resource allocation;
marshal plan greatly eased the flow of credit with
The distribution of income.
banks and the stock market providing an increasing Price level
24
volume of capital. Sheer hard work and good
leadership enabled Western Europe to progress Most governments have four major
rapidly from the destruction of the war compared macroeconomic policy goals. These are to achieve
to the rest of the world at the time. full employment with little or no inflation in a high
growth economy with external balance (current
As societies achieved maturity in the twentieth
account) equilibrium. Fiscal policy can be used to
century, three things happened: real income per
achieve a wide variety of objectives. For example, it
head rose to a point where a large number of
can be used to improve standards of healthcare
persons gained a command over consumption
through increased spending on the health services
which transcended basic food, shelter and clothing
of a country. It can be used to make incomes less
and the structure of the working force changed in
unequal by taxing the better and giving benefits to
ways which increased not only the proportion of
the less well off. In Pakistan the key date in the year
urban to total population, but also the proportion
for fiscal policy is the day of the budget which
of the population working in offices or in skilled
occurs in May. In the Budget the treasury minster
factory jobs. 25 In Thomas Mann’s novel of three
gives a forecast of government spending and
taxation in the coming financial year.
24
Anthony Sutcliffe (1996) An economic & social
history of western Europe since 1945, London,
Longman Publishing Ltd
25 26
W.W Rostow. (1990) the stages of economic Sullivan, Arthur; Steven M. Sheffrin (2003).
rd
growth – a non communist manifesto, 3 edition, Economics: Principles in action. Upper Saddle River,
Cambridge, Cambridge University Press New Jersey, Pearson Prentice Hall.
Insaf Research Wing 14
15. Committee on Economics Economic Research: Pakistan
National expenditure is one of the three ways of greater employment levels, leading to a greater
27
calculating national income, usually measures as output, thus resulting in economic growth.
GDP. National expenditure is made up of four
components: Monetary Policy
1. Consumption: This is spending by Monetary policy is the manipulation of monetary
households on good and services. variables, (i.e. interest rates, the money supply and
2. Investment: This is spending by firms and the volume of credit) to maintain a stable, growing
individuals on goods which will aid in
economy with low inflation and unemployment.
production and may well accumulate
wealth in the future. The main instruments of monetary policy include
28
3. Government Spending: This includes the rate of interest, and the money supply.
current spending on wages and salaries. It
also includes spending by government on Rate of interest
investment goods for example, new roads
or new schools. In the UK, US, and EU, the rate of interest is not set
4. Exports minus Imports: Foreigners spend
by the governments, but is set by independent
money on goods produced in the domestic
economy; hence it is part of national central banks, for example, since 1997, monetary
expenditure. However, households, firms policy has been controlled by the independent Bank
and governments also spend money on of England. Central banks are responsible for the
goods produced abroad. issue of notes and coins that are sold to the
banking system and manage a country’s gold and
The UK government has been responsible for currency reserves.
between 40 and 50 % of national expenditure over
the past 20 years. The main areas of national The rate of interest can be altered in order to
expenditure are the National Health Service (NHS), adjust aggregate demand in the economy to ensure
defense, education and roads. In addition the if it as close as it can be to the trend rate of growth.
government is responsible for transferring large Changes in the rate of interest can affect aggregate
sums of money around the economy through its demand in various means, such as:
spending on social security and national insurance
benefits. This is financed mainly through taxes, such Savings: Higher interest rates create
as income tax and Value Added Tax (VAT). incentives to save more, as savers would
receive more interest on their savings
Fiscal policy is used by governments to influence (thus they would save more out of their
the level of aggregate demand in the economy, in disposable income and spend less).
Therefore consumption would fall
an effort to achieve the economic objectives of
reducing aggregate demand.
price stability, full employment, a balance or
The exchange rate: A fall in the rate of
surplus in the current account and economic interest in the domestic economy would
growth. For example, to dampen inflationary lead to less foreign savings, thus there
pressures, the government can increase taxes and would be less demand for the currency. As
keep spending constant, to decrease the level of fewer visitors would buy the domestic
disposable income of individuals thus, inhibiting currency thus reducing its value in the
global markets of currency.
consumers spending power thus reducing demand
The housing market: Most houses in
pull inflation. To stimulate growth and reduce
western economies are bought using
unemployment, the government can decrease mortgages, thus changes in the rate of
income taxes and keep spending constant, to
create greater incentives for the unemployed to
27 th
seek jobs (as disposable income would increase), A. Anderton (2006) Economics, 4 edition, Harlow,
Causeway Press
thus consumption would increase as a result of 28 th
A. Anderton (2006) Economics, 4 edition, Harlow,
Causeway Press
Insaf Research Wing 15
16. Committee on Economics Economic Research: Pakistan
interest would affect the demand of printing money by selling government debt to the
mortgages and in turn the housing market. banking sector.
Consumption and investment: Drops in
the rate of interest would encourage US Monetary Policy
individuals and firms to take out loans in
order to consume and/or invest.
Consumption and investment are The Federal Reserve System is the central bank of
components of aggregate demand thus the United States, which oversees and regulates the
changes in the two components would commercial banking system and formulates and
ultimately alter aggregate demand. implements the monetary policy. The Federal
Reserve has three main responsibilities:
The money supply
1. Oversee and regulate banking institutions
The supply of money in the economy and the rate and protect the rights of consumers who
of interest are completely interlinked as the rate of utilise credit
interest determines the price of money, thus as the 2. Devise and implement a monetary policy
price of money decreases, economic theory would for the nation in order to maintain the
stability of the financial system
suggest an increase in the quantity of money.
3. Provide financial services to certain sectors
of the economy, such as the public sector,
However, using the interest rate to control the financial institutes and the US government
money supply would give an indirect short-term
response. There are a variety of other ways to The Federal Open Market Committee (FOMC) is the
control the money supply in a more direct manner. key policymaking body in the Federal Reserve
System and makes the key decisions regarding the
Firstly, the central bank can assign a percentage of bank’s open market operations. The FOMC has 12
a bank’s financial assets as reserve assets; these are members who meet a minimum of 4 times a year in
kept in liquid form (for example cash) and must be Washington and at each meeting the committee
held if the bank is to lend out money. If the central member’s vote for the ideal long-run policy
bank wishes to increase the money supply, the objective for growth in the money supply.
amount of money being held by the central bank in
the deposit increases, thus they are able to offer
more money. This technique is named open market
operations. 2.4 Types of Economic Systems
Secondly, the central bank can sell different forms
of government debt, such as bonds to the non- Around the world different communities, nations
financial sector; if this is successful, then the money and regions have different economic systems, of
supply would decrease, as money is being which some of the most obvious examples are:
transferred from the public into the central bank
(money held by the central bank is not counted in 1) Traditional economic systems
the money supply). The contrary is also possible i.e.
2) Pure market systems
bonds can be bought back in order to decrease the
money supply. 3) Command and mixed systems
Thirdly, the government can increase the money 1) Traditional Economic Systems: Refer to systems
supply by borrowing; in the UK this is known as the that are based on tradition where children do the
public sector net cash requirement (PSNCR). The same things their parents did and follow their
money is raised in two ways, which includes example. Thus, boys would have the same
borrowing from the non-banking sector and occupation as their fathers and this would involve
farming, hunting, artisanship, etc. Girls on the other
Insaf Research Wing 16
17. Committee on Economics Economic Research: Pakistan
hand, would get involved in the occupation of their 3) Command System: Also called a centrally
mothers, which would typically involve cooking, planned system, is an extreme on the opposite side
cleaning, sewing, fieldwork, housework, etc. of the spectrum. In a command system, a central
Traditional systems of production do not change authority or central planning committee would
significantly overtime and the pattern of production make all the decisions regarding the basic economic
stays the same more or less with the occasional questions of what to produce, how to produce and
new invention. A clear definition of private distribute. The market has no influence in the
property may not exist in a traditional system allocation of resources and state owns or heavily
unlike other economic systems. Accordingly, in a regulates the use of most if not all property and
traditional system a lot of property is common other production resources. Private individuals and
property, such as common grazing lands, fishing the forces of demand and supply will not influence
grounds, agricultural plots, etc. In addition, the the decision process. Instead, a central planning
allocations of certain roles, which include committee will oversee all the production activities
production, within the members of a society and income distribution. Thus, while pure market
depend on long established traditions. This would economies rely on individual decisions and private
mean that members of society would rarely change property, command economies rely on collective
their allocated role in the economy, even after decision-making and collective ownership or
30
generations. Thus, tradition and not resources resources. Central planning was a strong trend
th
answered the basic economic questions of what to during the 20 century and at one point, almost
produce, how to produce and how to distribute. one-third of the population lived under a centrally
Prime examples of the traditionalistic system planned system to deal with basic economic
include remote societies found in such places as the questions. Prime exampled included the former
Canadian arctic, the Himalayas, the Amazon jungle Soviet Union, Cuba, North Korea and China.
29
and isolated parts of Papua New Guinea. However the system is no longer in wide spread use
and many countries begun opting for a mixed
2) Pure Market System: In this type of market, system and enacted reforms to create a market-
there are large numbers of consumers who decide orientated economy.
what goods and services to buy and at what
quantities. In addition, assumptions are made that While the main theories of economic systems
there are a large number of firms who will cater to revolve around traditional, pure market or centrally
the demand of consumers by producing the planned systems, economies in the real world are a
products they want and buying the necessary hybrid of market, traditional and centrally planned
inputs accordingly. In a pure market system, the economies leading to Mixed economies.
individual decisions of both buyers and sellers
determine the allocation of resources and the In a Mixed Economy, both the markets and
distribution of output. The central characteristics of governments have significant influence on the
a pure market system are freedom of choice, economic decisions of resource allocation and
private ownership and competition. These income distribution. The level of mixture of free
decisions are based on the forces of demand and market policies and government control differs
supply. Thus, while the market answers the basic from economy to economy. For example the
economic questions the state is relegated to play a economies of the US and UK are more liberal than
role in maintaining law and order and external the economies of France or China. In addition, this
defence. Pure market systems have never really mixture is not restricted to a general economy but
existed in practice. may also differ from sectors, industries, regions,
etc. Thus the defence sector or industry in many
countries are heavily controlled or monitored by
30
Lipsay, Richard and Chrystal, Alex. (2004)
29
Truett, Lila and Truett, Dale (1987) Economics;. Economics - 10th edition. NewYork, Oxford
London, Times Mirror/Mosby College University Press
Insaf Research Wing 17
18. Committee on Economics Economic Research: Pakistan
governments while commercial industries of system based on cattle, the tribe still adheres to its
31
information and technology are more laissez-faire. rigid cultural guidelines. Innovation is nearly
Governments in mixed economies will seek to impossible since people rarely change their
achieve certain goals through intervention in the occupations and methods of production remain the
markets, with policy tools such as the monitory and same for generations due to tradition and culture.
fiscal policies.
Advantages of a pure market system
Economic Systems Advantages and Disadvantages
A pure market system drew its strength on freedom
of choice and enterprise, Private ownership of
Advantages of a traditional system
resources and competition. These strengths allow a
Traditional systems work well for isolated pure market system to foster an environment of
communities and ensure that resource allocation continuous innovation and the highest possible
and critical jobs are distributed and maintained. levels of efficiency in terms of resource allocation
This sort of system works best for a small and output. The forces of demand and supply are
community that is reliant on a limited number of influenced by price, which allow pure market
critical jobs. In many tribal systems, parents and system to adapt to changes in demand and supply
elders teach the children and there is no sort of efficiently thus minimising waste and poor
formal education system. Thus, it is practical for management. A pure market profit motivated
children to follow on the footsteps of their parents. system presents a strong incentive for individuals
to work hard and for firms to innovate and increase
Another important advantage of this system is that the quality of goods at the same time. Hence in
in most cases, it reduces the problem of over terms of quality and prices, goods produced in
consumption and surpluses since the production of market economies surpass those produced in
32
goods and services are only used when needed. command and traditional systems.
Traditional systems have most often benefited
small tribes and communities such as those found Disadvantages of a pure market system
in Canadian arctic, the Himalayas, the Amazon
Pure market systems also suffer from significant
jungle and isolated parts of Papua New Guinea
drawbacks, referred to as market failures. The
allowing them to function in extreme and isolated
following highlight some of the main market
conditions.
failures:
Disadvantages of a traditional system
- Discrepancy between social and private
Traditional economic systems may help societies benefits and costs: In a pure market
function but one of their biggest flaws is that they system firms and individuals make their
inhibit change and thus keep a society stagnated decisions based on private costs and
socially and economically. For example, the Masai benefits, and almost as always ignore the
tribes of Africa have depended on a traditional total societal benefits and costs.
economy based on cattle rising for centuries.
- Monopolization: Contrary to the
Everyone’s role is determined based on his or her
competitive spirit of a pure market system,
ownership and tending of cattle. Thus, cattle are
there are no inherent characteristics
the symbol of wealth and every family strives to
within a pure market system to prevent
maximise the size of its herd. However, this also
the formation of monopolies or the ability
means as the size of the tribes increase so does the
size of the herds. This in turn has made pasture
lands into deserts due to overgrazing, creating very
31
Truett, Lila and Truett, Dale (1987) Economics;.
harsh conditions for the Masai and their herds. London, Times Mirror/Mosby College
32
Lipsay, Richard and Chrystal, Alex. (2004)
Even with the obvious implications of a wealth Economics - 10th edition. NewYork, Oxford
University Press
Insaf Research Wing 18
19. Committee on Economics Economic Research: Pakistan
for firms and labour to obtain monopolistic The most critical of these flaws included the
power in order to further their own following:
interests at the expense of the interests of
society. - Lack of co-ordination: Central planners had
to co-ordinate all the economic decisions
- Distribution of income: Under a pure of production, investment, trade and
market system, individuals receive their consumption by both producers and
income based on the ownership and use of consumers. This needed a vast amount of
their productive resources. However, not information and predictions that needed
all individuals are born with the same to be collected and processed which
talents or have the same amount of proved to be impossible, resulting in
resources at their disposal. Based on this bottlenecks in production throughout the
principle a pure market system would economy.
imply that individuals who have no talents
or productive resources should receive no - Failure of quality control: Factories were
income. more interested in meeting their quota
requirements than quality control since it
- Specialisation and alienation: A free was meeting the quotas that brought
market economy seeks to encourage rewards and failing to do so brought about
specialisation and the division of labour punishments from the central planning
however this results in monotonous and authority. Thus, managers used whatever
repetitive work that could seriously affect methods possible, including improper
the morale and long-term productivity of production methods and materials to
labour. satisfy their quota requirements instead of
meeting quality standards. This resulted in
A pure market system being a theoretical extreme the production of goods of inferior quality.
has no real world examples since governments will
always intervene to address these flaws. The credit - Misplaced incentives: One of the best
crunch of 2007/08 demonstrates succinctly the features of a command economy was
need for government role and intervention in order complete job security, but this also
to create the necessary safeguards to protect all its crippled industries. As there were no
citizens from market failures. incentives to work hard and no penalty for
sluggish work, which subsequently meant
Advantages of a command system many industries operated below optimum
levels.
The advantages of a command system, as
envisioned by Karl Marx and others were that if the Thus the advantages of command economies were
government plans all of the economic activity it the equitable distribution of national output but at
would create an equal and just distribution of the cost of controlling each element of the
output amongst its citizens. Accordingly, citizens economy. Nations such as the former Soviet Union,
were guaranteed jobs in industries regardless of China, Cuba heavily embraced and were the chief
their efficiency and they were given state advocates of the command economic system until
sponsored goods and services, holidays, pensions, its systematic failure and rejection in the late 20
th
etc. century.33
Disadvantages of a command system
While command systems had grand ideals of
equality and fairness, the system had inherent 33
Lipsay, Richard and Chrystal, Alex. (2004)
flaws and ran into a number of practical difficulties. Economics - 10th edition. NewYork, Oxford
University Press
Insaf Research Wing 19
20. Committee on Economics Economic Research: Pakistan
The advantages of the mixed system GDP based on spending has four major
components:
A mixed economy seeks to combine the advantages
of both systems. Thus a mixed system will benefit 1.0 Private consumption: This refers to spending
from free market principles such as freedom of by individuals on goods and services, produced
choice and enterprise, private ownership of and sold to the final users during the year. This
excludes the purchasing of new houses since it
resources and competition while also addressing
is considered as investment, while including
the flaws of a pure market system by intervening in any final consumption spending of non-profit
markets to achieve goals of economic freedom, making institutions serving households.
equitable distribution of income, full employment 2.0 Government consumption: This refers to all
with price stability and economic growth. Thus, in a spending on goods and services made by the
mixed system the market and the government government over the year. Government
would be significant factors. The market would spending is typically valued based on the cost
address the flaws of the government while the rather than the market value. This is because
government would address market failures. The some services provided by the government
mix of government and market systems ultimately cannot be valued with a specific market price.
decide the effectiveness of a mixed economy. Importantly, in the calculation of GDP only
current spending on goods and services will be
Disadvantages of a mixed system
into account. Thus, expenditure on transfer
The main problem with mixed systems is the payments, which refer to government
chance of imbalance being created where either spending not made in return for currently
the market or the government control more of the produced goods and services will not be
running of the economy. The recent credit crunch included in the calculation of GDP.
in the western world is a prime example of
3.0 Investment: Refers to future spending on
government’s lax attitude towards interferences,
production goods, subdivided into three
which consequently lead to the near melt down of
categories:
many economies around the world. Moreover it is
often the vulnerable elements of society that are
put at risk and suffer the most.
3.1 Changes in inventories: These are the
stocks of finished and unfinished
output held by firms. The main
2.5 The Parameters of Economic Growth purpose of input stocks is to ensure a
smooth production if there is short-
term disruption in the supply of
The main parameters of economic growth are the inputs, while a stock of outputs would
Gross Domestic Product (GDP) and Gross National help firm meet their output
Income (GNI). 34 commitments even if there is a short-
term fluctuation in the price of output
The GDP refers to the value of total output actually sales. Since these stocks are an
produced in the whole economy over a period, investment, an accumulation of these
usually a year. The calculation of the GDP is done stocks are considered to be an
by either adding up total spending (GDP spending increase in current investment while a
based) or adding up total income (GDP income reduction in stocks will count as a
based). decrease in current investment. In
addition, these stocks are accounted
34
Lipsay, Richard and Chrystal, Alex. (2004)
for based on their value on the market
Economics - 10th edition. NewYork, Oxford rather than their cost to firms so far.
University Press
Insaf Research Wing 20
21. Committee on Economics Economic Research: Pakistan
This is because expenditure-based When calculating the GDP, an important difference
35
measure of GDP includes the value of arises in terms of the price of goods and services.
what final spending on these goods This is because the price paid for many goods and
would be, assuming they been sold, services by consumers may not equal the sales
even if that is not the case. revenues of producers. This is especially true when
considering taxes and subsidies. With the
3.2 Fixed capital formation: Capital goods imposition of taxes, producers receive less than
refer to goods manufactured in order what consumers pay while the imposition of
to aid the production process. Thus, subsidies will mean producers receive more than
capital goods may include computers, consumers pay. Accordingly, basic prices will refer
machines, factories, etc. Accordingly, to the prices of products as received by producers.
an increase in capital goods would be While market prices refer to the prices that paid by
an increase in investment. This also consumers. Since all spending categories are
called a fixed investment or fixed calculated using market prices, GDP will also be
capital formulation. calculated using market prices, the price paid by
consumers and not that received by producers.
3.3 Net accumulation of valuables: Some
goods are neither consumed nor used GDP based on income refers to adding up incomes
in the production process. These of owners of resource inputs such as land, labour,
goods are valued for their intrinsic capital, etc. Accordingly, national income is
beauty, sentimental value or for their determined by three main factors:
expected appreciation in value.
Examples of such goods include art, 1.0 Operating Surplus: Business income after
jewellery and music records. The net labour and material costs but before paying
acquisitions of these valuables are direct taxes, levied on a firm’s income (profits).
included in the national accounts as a Operating surpluses may also include the
form investment. financial surplus of organizations other than
companies, such as universities. Once a firm
earns profits it will distribute a portion among
its shareholders while saving the rest. Profits
4.0 Net exports: Refer to the difference between
that are both distributed and undistributed are
total exports and total imports. This is an
included in the calculation of GDP.
important factor since the GDP measures the
amount of goods and services produced within 2.0 Mixed incomes: Certain groups and individuals
a given country. Only a certain amount of the have mixed incomes since it is not clear what
spending value on imported goods or materials proportion of their income is equal to their
can be accounted by the importing country wage and which proportion is equal to the
while the rest will be accounted by the profit of a business. Examples would include
exporting country. Therefore, in order to consultants who work on short-term contracts,
determine the spending value on domestic the self-employed who run sole trader
production activities, the GDP should exclude businesses and partnerships where the
the value of imports since spending on partners of a business own the business as
imported goods and services will contribute to well.
a foreign economy’s GDP. The value of exports
will be included since even though the goods
will not be consumed in the domestic economy
itself, the payments for the exported goods by
foreign economies will contribute towards the 35
Lipsay, Richard and Chrystal, Alex. (2004)
domestic economy’s GDP. Economics - 10th edition. NewYork, Oxford
University Press
Insaf Research Wing 21
