The exports multiplier effect

Fiscal policy, having direct and instant impact on key macro-economic indicators like aggregate demand and employment etc., is more persuasive for any government than monetary policy.The public spending being key explanatory variable of Gross Domestic Product (GDP) equation may stimulate overall GDP by undertaking various infrastructure projects; and generating new employment opportunities and income for households through fiscal multiplier effect.Whereas, prior to taking any decision regarding public spending on infrastructure projects or doubling transfer payments like Benazir Income Support Program in any country, especially like Pakistan, there is a profound need to evaluate tentative size of “Fiscal Multiplier”.The fiscal multiplier explains expected total increase in GDP due to additional government spending or reduction in tax. However, higher fiscal multiplier increases overall domestic output (GDP) at a higher level.Size and impact of fiscal multiplier varies due to its various determinants of structural characteristics pertaining to the economy concerned that include trade openness, labour market rigidity, size of automatic stabilizer, exchange rate regime, public finance/revenue management and last but not least, “the debt level” (International Monetary Fund [IMF] 2014).Based on public spending in 44 economies, an empirical study by Ethan, Mendoza, and Vegh (2013) concludes that the government expenditure affects GDP at a higher level in industrial countries than developing economies; size of multiplier is relatively larger in economies being managed under fixed exchange rate but has no effect under flexible exchange rate; multiplier is higher in size in closed economies than open one; and again the last but not least — “the multiplier is even negative in highly-indebted economies.”The government and private investment spending on widening of local industrial base in pursuance of domestic market, exports and import substitution oriented policies may help GDP to grow at a reasonable growth rate on sustainable basis.Aforementioned determinants identified by IMF and findings of empirical study pertaining to multiplier effect do not support the idea of public spending on infrastructure projects and doubling transfer payments during prevalent economic situation in Pakistan. Presently, the industrial sector accounts about 24% of GDP. The increased input prices, under developed human capital, high cost of doing business and weak governance is making it less competitive further, even in domestic market against foreign goods resulting in around $20 billion trade deficit. During previous regime, the instrument of fixed exchange rate mostly served purpose of elite class by facilitating import of luxury items, education and leisure abroad. Therefore, present regime is much inclined to leave exchange rate on market forces that resulted in around 14% devaluation of Pak-Rupee against US$ during last eight months since Sep-2018 with selling price of US$1 at Rs142 in open market.Economies with less trade openness having a lower marginal propensity to import may observe larger fiscal multiplier by addressing issue of demand leakages. Whereas, Pakistan with a high marginal propensity to import with around $63billion imports containing luxury items and consumption goods majorly including mineral fuels, machinery, electronics and electrical equipment; vehicles, plastic and oil seeds is more vulnerable to demand leakages in absence of any practicable policy framework for imports substitution and development of local industrial base.Pakistan’s economy being heavily indebted economy may not enjoy a higher fiscal multiplier in absence of a conspicuous fiscal consolidation policy. A safe level of debt to GDP ratio is 100 and 40 percent in case of advanced and emerging market economies respectively. Whereas, Pakistan’s debt to GDP ratio is anticipated to be 73.50 on close of this quarter with a projection of 75 percent by 2020. At this juncture to attain confidence and credibility, the government needs to address issue of public debt and deficit through fiscal consolidation by improving public finance/revenue management.While recommending the demand side approach to stimulate GDP through “Fiscal Multiplier Effect” there is a need to estimate effect of any fiscal policy on domestic output over a certain period. The GDP is total of consumption, investment and government spending; and net exports. Presently, instead of focusing government spending on infrastructure projects and doubling transfer payments that may only result into a non-sustainable growth push and short-term upward shift in employment, a long-term growth strategy is required. The long-term growth strategy may only be delineated by focusing the “External Sector” through development of local industrial base and strict compliance of imports substitution policy especially pertaining to purely consumption goods that comprise around 72 percent of total imports with a value of around $43.2billion excluding mineral fuels.Government ought to define major economic policies relating to industrial diversification under umbrella policy of imports substitutions and exports expansion industries by considering product life cycle and comparative cost advantages in consultation of local and expatriate business diaspora. There should be a special focus on development of skilled human resource as per requirement of future planned industrial base through vocational training, technology education at school/college level and promoting research and development at university levels.Investment spending, both government and private, on widening of local industrial base in pursuance of domestic market, exports and import substitution oriented policy may help GDP to grow at a reasonable growth rate with the result of employment generation opportunities and higher level of income on sustainable basis. This will further ignite demand and supply cycle at an augmented level in both local market and external sector through an “Exports Multiplier Effect”, on sustainable basis in both short and long-run. (The author holds master degree in International Trade and Economic Cooperation from South Korea. He is serving as Assistant Chief in Planning & Development Board, Punjab)

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