Explaining Pakistan's High Growth Performance Over the Past Two Decades: Can it be Sustained?

Pakistan’s 6.0% p.a. growth rate over the past two decades has been considered by some as a “development puzzle” because this growth performance has been accompanied by three major disconcerting factors-high fiscal and current account deficits, relatively low savings and investment rates, and poor human capital formation. Using a standard statistical growth analysis, the paper shows that, consistent with the predictions of economic theory, the main determinants of growth have been: a rapid pace of physical capital accumulation, the positive contribution of labour force growth, greater competition from external trade, and a policy of economic liberalization since 1978. The growth impact of these traditional factors was augmented by improvements in total factor productivity resulting from greater trade and other economic liberalization that has happened in Pakistan since 1978. The sustainability of this high growth performance over the medium-to-longer term in the future is, however, doubtful. The outlook for the 1990s is that both foreign and domestic real interest rates will remain significantly positive. In this situation, if Pakistan were to continue to run fiscal deficits of the same magnitude as in the past, a financial crisis is likely to emerge pretty rapidly. Using a macroeconomic consistency framework, the paper derives estimates of sustainable current account deficits (i.e., deficits that do not worsen external creditworthingess) in the range of 3% of GDP p.a. Consistent with this and the Government’s inflation target of 5% p.a., the sustainable fiscal deficits are in the range of 4.5-5% of GDP p.a. Given the need to reduce macroeconomic imbalances, the paper also concludes that a substantial adjustment effort will be needed to raise domestic saving and investment in order to ensure the consistency of these macroeconomic targets with the growth target. Lower fiscal deficits will also help reconcile the need for greater financial resource mobilization with the objective of stimulating private investment. Finally, the paper argues that Pakistan’s ability to sustain high growth rates over the longer terms will also depend upon rapid progress with human capital development