vital tool for development and growth of any economy. It helps to exploit and
utilise internal resources within a country for production or manufacturing which
leads to self sufficiency
By Ch. Kamran Naseer
Capital formation is the process through which productive assets like machinery are created in an economy. Capital formation plays a key role in achieving economic growth and prosperity. It expands the productive capacity of different economic sectors by increasing the number of firms or working units. As a result, employment opportunities are increased which helps to break the vicious cycle of poverty. Furthermore, economies of scale are obtained which leads to low production cost and high quality commodities resulting in high economic returns. This not only attracts domestic and foreign investors but also reduces the trade gap and inflationary pressures in an economy.
Capital formation facilitates infrastructure development, which is considered a vital tool for development and growth of any economy. It helps to exploit and utilise internal resources within a country for production or manufacturing which leads to self sufficiency. It increases the motive to save among the general population by increasing the number of financial institutions. These financial institutions offer high profits to depositors because of increased competition among them. This not only changes the consumption behaviour of the general public but also reduces speculative demand for money contributing to high savings.
Capital formation has wide effects on an economy. This is why it is considered as the most important source of economic growth. According to China’s Bureau of Statistics, capital formation contributed 8.0 percentage points to the country’s GDP growth of 8.7 per cent in 2009. Unfortunately, capital formation has remained very sluggish in Pakistan. According to a World Bank study, during the period of 1998-2005 percentage change in gross capital formation in Pakistan remained -1, as compared to 17.4 in Zimbabwe, 8.27 in Iran, 6.92 in Indonesia and 2.44 in Bangladesh. As a result infrastructure development is very slow in the country which hinders foreign and domestic investment. Mega projects cannot be initiated due to which the ratio of employed labour force remains low. Poverty exists leading to a meager level of public consumption. The skills of labour are poor and technological backwardness subsists hampering the process of new inventions and innovations. The industrial and agricultural sectors’ performance are not strong enough to counter the problems of low productivity and inflation. Hence low capital accumulation is the main obstacle faced in achieving the goal of sustained economic growth in Pakistan.
Pakistan’s economy grew by only 2 per cent in 2008-09, against the target of 4.5. By increasing capital formation, barriers that hamper economic growth can be removed thus putting the economy on the track of progress. But for this it is crucial to analyse and assess the entire genesis that leads to low capital formation inside the country. There are three major sources of mobilising capital formation. Domestically, individual savings are considered the most essential source by which resources are directed for capital accumulation. Savings, if utilised properly provides benefits even to those who are not businessmen and lack the skills to invest personally. On the other hand, the business community utilises savings for investment in specific sectors which causes economic growth. In Pakistan due to a variety of reasons people do not save as much as they should. This is because of the fact that the incomes of most of the people are not sufficient enough to allow them to save. The propensity to consume in Pakistan is high as we are a consumer driven society. This naturally declines savings in the country. In addition to this, the high birth rate and excessive amounts of taxes make it difficult to save. Furthermore, the most common factor is food inflation as it has severely affected the general public’s potential to save. All these factors lead to reduction in savings. Domestic savings contributed to only 11.2 per cent of GDP in 2008-09.
The second source that influences capital formation is technological advancement. There is a direct proportional relationship between capital formation and technological improvement. The orthodox route to technological progress and skill development is education. It plays a key role in human capital formation which is necessary for sustainable socio-economic growth. Due to limited educational (both technical and non technical) institutes, lack of research work, government policies, less allocation of budgetary funds to education, neither technological progress nor labour skills has been enriched.
As a result, mostly we export primary commodities that cannot be used as a good exchanger in the international market. For any development project our country has to rely upon developed countries, which by providing financial aid interrupt in our political as well as economic policies. Our country has become an acceptor in every field of life due to which the trade gap is increasing day by day, thus reducing the limited foreign reserves. Though our country depends greatly on agriculture, we still remain unable to meet domestic food requirements and each year our country needs to import different types of food items. All this can be attributed to lack of employment of latest machineries and advanced productive techniques, which cause low per hectare yield. The total public expenditure on education as a percentage of GDP is not only extremely low in Pakistan, but decreasing year by year. During 2008-09, investment on education remained at 2.10 per cent of GDP, as compared to 2.50 per cent and 2.47 per cent in the years 2006-07 and 2007-8 respectively.
The third component is foreign investment which plays a substantial role to accelerate capital formation by increasing funds, eradicating technological backwardness and increasing government revenues. But, unfortunately due to a variety of reasons like lack of government policies regarding provision of necessary facilities to investors, shaky law and order situation, political instability and lack of industrial zones, foreign investment is low in Pakistan.
In the country’s present situation, different sectors of the economy are not performing well and the overall economic growth of the country is not up to mark. Thus, the necessity to mobilise capital formation becomes even more important. There are a number of suggestions to help in this respect, such as to increase depositors profit in the money market in order to mobilise savings among the population. For this the government must play a proactive role to eliminate all types of money speculation. To promote the industrial sector, there should be a renewed focus on the energy policy and alternative forms of energy should be used to provide low cost energy to industries.
By reducing unproductive expenditures, the government must allocate more funds from the budget to education, technological advancement and skill improvement of the labour force. For this it is essential to increase the number of technical institutes and universities. To reduce food inflation there is a need to solve different problems faced by the farming community. Each year a lot of dollars are spent on importing food items. If this amount can be used to facilitate the agricultural community, then the problem of low productivity can be solved.
Pakistan has many areas where investment can take place easily, such as energy, agriculture, communication, fertiliser, automobile etc. To attract domestic and foreign investment the required facilities must be provided to the business community and the lands which are not arable must be converted into industrial zones.
Besides all this, the government must announce an economic plan specifying the issues which the country needs to deal with both in short and long run. This is obligatory as without effective planning, not a single sector of the economy can function in the right direction.
Source: http://jang.com.pk/thenews/mar2010-weekly/busrev-01-03-2010/p6.htm
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