Pakistan’s Labor Productivity Stunts its Economic Growth

Since the 1980s, rapid globalisation — driven in part by the unprecedented pace of technological change, especially in information and communications technologies (ICT) — has allowed developing countries such as China and India to achieve exceptionally high rates of economic growth.

Since the 1980s, rapid globalisation — driven in part by the unprecedented pace of technological change, especially in information and communications technologies (ICT) — has allowed developing countries such as China and India to achieve exceptionally high rates of economic growth.

Unfortunately, Pakistan, which was among the 10 fastest-growing economies in the world between 1960 and 1990, has not been one of them. This is despite the fact that Pakistan was in many ways a more open and globalised economy than either China or India in the early 1980s. One underexplored factor behind Pakistan’s generally low and declining economic growth between 1990 and 2015 is labour productivity.

Nobel Laureate Paul Krugman best captures the importance of labour productivity: ‘Productivity isn’t everything, but in the long run it is almost everything. A country’s ability to improve its standard of living over time depends almost entirely on its ability to raise output per worker’.

A closer examination of Pakistan’s labour productivity trend is both revealing and deeply worrying. In the 1980s, labour productivity (defined as GDP divided by the employed labour force) grew at 4.2 percent per annum. By the 1990s, this had plummeted to 1.8 percent, falling further to 1.3 percent during 2000–15. Since 2007, it has been growing at just 1 percent. In India, the trend has moved in the opposite direction, with labour productivity growing to well over 5 percent during 2000–10.

Labour productivity can be attributed to three major factors: increases in physical capital such as machinery and related inputs; increases in human capital, which is measured by average years of schooling; and what economists term ‘total factor productivity’ (TFP), which measures the contribution of technological progress and more efficient use of existing resources.

While the contribution of both capital and labour has been marginal for good reason, the continuing decline in TFP over the last 25 years exposes many of the fundamental weaknesses that bedevil the Pakistani economy.

Despite many attempts at economic reforms under the aegis of the IMF and World Bank, the economy has become more inefficient, even though economic reforms were expected to have exactly the opposite effect. Clearly, the reform process —due to its uneven pace and frequent reversals — has not delivered.

Declining TFP also shows that, despite the widespread use of mobile phones and other ICT-driven gadgets, Pakistan has been unable to take advantage of the extraordinary technological advancements witnessed over the last 25 years.

Underlying causes for the decline in productivity growth are not difficult to identify.

The first is a sharp fall in investment (private, public and foreign), which dropped from 25 percent of GDP in the 1980s to less than 15 percent in recent years, partially due to security concerns. New investment brings with it machinery and equipment, embodying the latest industry knowledge and technology.

The fall in investment means that a large part of Pakistan’s capital stock became increasingly outdated and therefore less productive and competitive in terms of quality and new goods produced.

The second is the poor quality of Pakistan’s workforce. Taking advantage of globalisation, as well as new technology, depends critically on the ability of the workforce to learn new skills and master new technology.

For a workforce, one-third of which is illiterate and another 40 percent of which has less than 10 years of education, this is an almost impossible task.

The third cause is the lack of movement from low-productivity agriculture, to higher-productivity industry and services. In Pakistan, the agricultural share of the total employed labour force has shown no significant decrease and remains over 40 percent. By contrast, in India labour has shifted significantly from agriculture to services, though both India and Pakistan have not yet managed to create jobs in manufacturing.

Given its poor record over the last 25 years, the time has come to admit that the economic paradigm Pakistan has followed since the 1990s has not worked. What is needed now is for policymakers to rethink and modify some of its basic premises. This may be an opportune time to do so.

The economy has achieved a fair degree of macroeconomic stability, thanks mainly to favourable external developments. There is also a significant improvement in the security situation, especially in Karachi. There is much talk of shifting gears from economic stabilisation to a path of high economic growth.

However, ensuring sustained higher growth in output and productivity in the medium and longer term will require more than a one-time stimulus such as the China–Pakistan Economic Corridor. Business confidence, which has been badly bruised in recent years, needs to be revived.

This should be accompanied by a sharp increase in public and private expenditure to overcome binding infrastructure constraints and develop human capital. A modern, skilled workforce cannot be built on poor quality educational foundations.

These are daunting challenges that require deft economic management. Policymakers need to spell out an underlying economic framework that can realise the envisaged shift to higher growth. At the same time, they must ensure macroeconomic stability, particularly in the fiscal and trade balance, in the face of stagnant exports and rising debt repayments.

The government will also need to create a favourable business environment, which ignites entrepreneurship and encourages firms to innovate and invest in new technology and upgrading skills. The time has come to walk the talk seeping out of Islamabad of ‘much better days to come’.

Lethargic labour productivity slows growth in Pakistan is republished with permission from East Asia Forum