AN economy’s output is fundamentally a function of household consumption, government consumption, investments, imports, and exports (including trade and remittances). Total consumption, the sum of household and government consumption, made up 99pc of GDP in FY22. Over the last ten years, total consumption comprised more than 92pc of GDP on average.

Consumption in an economy is effectively demand for goods and services. Such demand can only be satisfied through available supply, which can be domestic or imported. If demand continues to grow, largely driven by population growth and growth in income, the supply needs to catch up — either through investment in domestic capacity or through imports.

Over the last ten years (or even more), the demand has continued to grow, while domestic supply remains constrained, as investment in capacity to enhance aggregate supply remains consistently low. As domestic supply fails to catch up, incremental demand is met through imports.

Over the last ten years, the investment-to-GDP ratio has averaged 15pc, against the South Asian average of 30pc and lower-middle-income countries’ average of 28pc. There has been a dearth of investment in addition to incremental productive capacity that could increase the aggregate supply.

To achieve even a 3pc growth rate, Pakistan needs additional foreign currency of an estimated $7bn annually

Relying on imports to meet incremental demand requires access to foreign currency, as imports are paid through foreign currency. An economy can accumulate foreign currency reserves through exports, remittances, foreign investment, and foreign loans.

The inability to invest in increasing capacity to increase exports means that the ability to earn incremental foreign currency remains constrained. Similarly, the inability of the state to invest in education in the development of human capital has resulted in a scenario in which remittance inflow largely depends on low-value-added human capital exports.

As productivity-oriented routes to generate foreign currency were not emphasised, the economy started relying heavily on foreign currency loans to finance imports, effectively financing consumption.

Over the last ten years, Pakistan has accumulated over $63 billion of foreign loans. Effectively, a significant chunk of foreign currency loans was utilised to increase consumption, which stimulated growth. Any slowdown in access to foreign currency loans resulted in a scenario where growth slowed, eventually picking up when access to foreign currency loans was restored, whether through an International Monetary Fund programme, multilateral funding, or loans by friendly nations.

A consumption-oriented economy that can only achieve growth in excess of population growth through imports remains heavily reliant on foreign currency, which is inadvertently dependent on the ability to raise foreign currency loans in the absence of export capacity.

Effectively, the ability of Pakistan to achieve a sustainable growth rate is contingent on its ability to transition from consumption-oriented growth to investment-led growth. If the composition of growth remains unchanged, it is estimated that even to achieve 3pc in GDP growth, Pakistan would require additional foreign currency of $7bn annually just to meet its consumption requirements. Incremental requirements to service existing debt and interest payments on the same would be on top of this.

It is simply not possible to continue on the consumption-oriented growth trajectory. The country, and its population, is stuck in a trap. The government and the central bank cannot print itself out of trouble at this point. A fundamental rethink and a shift in how the economy is structured remains critical. Any delays in the same will lead to further economic stagnation, higher inflation, and increased unemployment for an already frustrated and grossly underpaid labour force.

There needs to be a fundamental rethink regarding how the economy needs to be configured and how it can achieve sustainable growth. A transition towards investment-led growth is critical, with a gradual move towards increasing the investment-to-GDP ratio to the regional average.

On a more granular level, the investment needs to be redirected towards export-oriented industries, such that the necessary capacity can be developed to generate foreign currency, which can sustain growth.

An investment-led growth model is only possible if there are sufficient formal savings in the system, such that they may catalyse capital formation. Continuation of the existing consumption-oriented model cannot be sustained for long and may only lead to stagnation, erosion of income in real terms, and increased unemployment.

The writer is an independent macroeconomist and energy analyst

Published in Dawn, The Business and Finance Weekly, September 25th, 2023