There are many indicators used to assess economic progress. One of them is ‘Incremental Capital-Output Ratio (ICOR)’ which indicates the amount of investment required to generate the next unit of production. Here is the mathematical expression:
ICOR = Investment in terms of percentage of GDP / GDP Growth rate
Here GDP refers to Gross Domestic Product which is a measure of total market value of all goods produced and services delivered in a given year. Investment refers to the purchase of capital goods such as machinery, technology and buildings used to increase the production of consumer goods and services.
It is to be noted that ICOR is a measure of economic productivity. A higher ICOR value shows that economic productivity is low as a higher amount of investment is required to generate the next unit of production.
On the other hand low investment with high growth shows that the economy is productive or efficient; however we should also understand that rise in investment leads to economic growth too – purchase of goods such as machinery, technology and buildings should result in increase in production of goods and services delivered or in other words increase in GDP – consumption-led growth.
Let us calculate Pakistan’s ICOR to illustrate the above phenomenon. Pakistan’s investment is 15% of the GDP and the economic or GDP growth is around 2.4%, for simplification let us take it to 3%. So according to the formula:
Pakistan’s ICOR = 15/3 = 5 which is quite high for a developing country. It should ideally be around 3. In order to generate an ICOR of 3 we need to have investment up to 24% of GDP and a GDP growth rate of 8%. The equation should look like this:
ICOR = 24/8 = 3 (ideal situation)
Now it is up to the economic managers to devise policies to increase investment so that the desired level of economic
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growth could be achieved. In order to enhance investment the possibilities and culture of achieving savings need to be developed as savings are translated into investments and investments onwards fuel economic growth.
Here are some facts about Pakistan’s economy:
- Prevalent is economic mismanagement and inconsistency of highest order;
- In recent years Pakistan’s economy has shown a consumption led economic growth pattern;
- Negative public
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sector savings which could be converted into public investments can only be made through a loan; Debt is being raised to repay debt;
- Very low domestic savings around 10% of GDP. Domestic savings combine both corporate savings and household savings. Corporations are finding it difficult to reinvest profits back into the business due to increased cost of production, hence relying on bank borrowings at high interest rates resulting in inflation. Similarly high inflation rate has marred the potential for household savings – economic glut or catch 22 situation;
- Tax to GDP ratio is very low – a large number of people evade taxes; etc.
Here are some things we can do:
- Rightsizing the Government – less ministries and public bureau;
- Extreme austerity measures from top to bottom;
- Tax evasion should be religiously curtailed; more and more people should be brought under
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the tax net; Systems should be devised to control corruption in the taxation department; tax collection should be on merit and equitable basis and should be modernized;
- Law & order situation should be controlled;
- Low cost sources of energy should be utilized; pricing mechanism of petroleum products should be made to provide relief to public and industry; government should reduce or totally withdraw tax on fuel at consumer level; CNG stations should be shut down in view of the
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prevalent energy crisis;
- Hydel, wind and gas-based power generation projects should be initiated and
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power theft should be eliminated – billing should be judicious and recoveries from habitual defaulters be made on priority basis;
- Loss making public enterprises should be privatized after proper and transparent valuation;
- Pro-active approach should be used to avoid losses due to
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natural calamities and other man-made disasters etc.