The economic position of Pakistan does not show a very promising picture where most of the revenue still comes from the agriculture sector thereby making the country an agrarian economy, though this agricultural share has slightly declined over the period of time turning to 19.3 percent in the year 2005 decreasing from 21.7 in the year 2001. The economically active population too is only moderately less than half reaching around 44.5 percent in the year 2005. The Gross Domestic Product (GDP) per capita for Pakistan accounts for approximately around US $820 (Role of Agriculture in the Development of Pakistan). The process of industrialization has set in and the industrial sector has been dominated by the textile sector and the construction industry majorly attributing most of the contribution from the exports of textile products and yarn. The tertiary sector on the contrary has still a long way to go where the only financial sector that has managed to flourish over the period of time has been the banks.
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1.1 An Overview of macroeconomic performance of Pakistan
According to the Economic Survey of Pakistan, the decade of 1990s was a lost decade as far as Pakistan’s economic progress was concerned. Recurrent political adjustments and lack of permanence in policies, poor governance and the 1998 developments had created very difficult economic conditions in the country by October 1999. Per Capita economic growth rates had dropped to between 1 and 1.5 percent. Investment rates had fallen down from 20 to 15 percent of GDP, poverty had doubled to 34 percent while external debt had doubled from USD 18 billion to USD 36 billion, debt servicing had increased to a height where it asserted 56 percent of revenues, fiscal deficits averaged about 6 percent of GDP, Development expenditures, particularly on education and health, were reduced by one half from 6 percent of GDP to 3 percent. In 1996, Pakistan was acknowledged as the second most corrupt country in the world. The challenge of prevention of such a status and to move the economy out of such critical conditions therefore was extremely intimidating. The mission was made even trickier by the initial response of the international community to the adjustment in the government and the contradictory demands of a range of segments of population. Accountability, whereby all those found culpable of corruption and misconduct in the earlier period, was one of the major demands expressed by the public at large and the media. This produced tension with the purpose of economic stimulation as the businessmen and bankers felt susceptible by such moves.
The 2000s was a period of sound improvement. During the first half of the decade, economy boomed. However, soon afterwards the Global Economic Crisis got a grip on the entire World Economy in some way or the other. As per information on Pakistan economic environment in the financial year 2008, the value of Pakistani rupee had decreased because of political and economic volatility. Pakistan was one of the fastest developing economies in world. Even though it is a poor country, economic state of affairs in Pakistan point out that growth rate had improved than the worldwide standard rate of growth.
Fiscal deficit in 2009 was benchmarked at 5.5 percent of GDP. This value was 7.4 percent in fiscal year 2008 (Economic Survey of Pakistan). Pakistan’s economic surroundings were not going to get enhanced in 2009 as it had been anticipated that inflation will decline to 20 percent by mid 2009. In the first quarterly review it was found that the situation became stable and an enormous sum was borrowed from central bank.
Pakistan economic conditions did not get any better in 2009 as it had been projected that inflation will get down to 20 percent by July 2009. It had been found out in the first quarterly review of the year that situation became steady, though an enormous sum was borrowed from central bank.
1.2 Business expectations: Relevance of adaptive expectations view for Pakistan
In modern economic theory, particularly in macroeconomics, expectations are given an essential place. The overt account of individuals’ expectations qualifies the endings of the static analysis. To an extent this important place is well founded, since expectations of prospect events do encourage present actions and hence influence social phenomena as they come about in actuality. However, contemporary macroeconomics goes further. It also maintains that a precise model of the development of expectations is vital in order to evaluate the function played by expectations and eventually to build economic theory all by itself.
Adaptive expectations have been defined as follows;
‘The economic-behavior observation that people form their expectations of economic trends solely on the basis of what was the past magnitude and direction of those trends. If these expectations seem erroneous then, depending on the degree of the error, people revise and adapt their future estimates accordingly’. (Business Dictionary).
The pull of the Adaptive Expectations channel is the simplification of its formulation which gives room for a variety of interpretations according to the worth given to the coefficient of review.
‘When we state that expectations affect reality, if he assumes them to be adaptive, he is ultimately assuming that history, not expectations, affects the future. Adaptive expectations always boil down to a hypothesis of how past variables affect current variables. Therefore, formalizing expectations adaptively is contrary to the very purpose of building a theory of expectations. No model based upon the AE hypothesis can portray the autonomous influence of expectations on current or future variables. We can even make the more universal criticism that any hypothetical explanation of expectations by other observable variables can but obfuscate their supposedly independent importance the model purports to exhibit’. (Gertchev, N, 2007)
This study stresses on the impact of social unrest and disharmony that have been plaguing the Pakistan economy since its conception as an independent country. This has impacted business activity significantly with altering expectations for the future time periods. An analysis into the causes and consequences of such fluctuations of business activity due to societal distortions, based on past data on macroeconomic and social variables, may be particularly helpful in drafting a successful public policy for Pakistan, which will lessen the social gap and promote social stability in the country. With a unique blend of business expectations and ‘social’ disharmony, unrest and inequality in Pakistan, the growth of the economy seems to be at stake and needs to be addressed.
1.3 Rational expectations and formulating business expectations: MNCs perspective
Expectations matter immensely for businesses and transformation of business outlook have important macroeconomic impacts at different phases of the economic cycle. The study of the business cycles dates back to the Classical Economists, beginning late 1700s, paving way for Neoclassical Economists and Keynesian Economists to further develop the concept. Contrary to the ‘Adaptive Expectations’ theory, the ‘Rational Expectations’ school of thought is considered when evaluating and forming such expectations.
Robert Lucas, a renowned economist and a 1955 Nobel Prize winner puts forward the following Rational Expectations theory;
‘On average, people can quite correctly predict future conditions and take actions accordingly, even if they do not fully recognize the causal relationships basing the events and their own thinking. Thus, while they do not have perfect foresights, they construct their expectations in a rational manner that, more often than not, turn out to be correct. Any error that creeps in is usually due to random (non-systemic) and unforeseeable causes’. (Business Dictionary)
The main inspiration behind the rational expectations hypothesis is to time and again extend the standard of individual rationality from the dilemma of the allocation of resources to that of the creation of expectations. The individual is expected to use all of the accessible pertinent information when designing his forecast of prices, interest rates, and even public policies.
It is widely observed that MNCs take rational actions to their investment environments, revising investment assessment in the face of new information. Even in the theories of international finance, we see that the motivation from the parent company to give an initial helping hand to its subsidiary is limited by rational expectations. According to this view, rather than send back future income and pay taxes, multinational corporations prefer investing subsidiary income in supplementary expansion.
Moreover, factors that influence the inflow of Foreign Direct Investment (FDI) in any country are the rate of return, tax system, the size of the fiscal deficit and interest rate and exchange rate regimes, to name a few macroeconomic variables. These have to be ‘rationally’ assessed and taken into consideration to evaluate the investment climate of the host country. However, according to the theory of rational expectations, it is quite impossible to estimate, for instance, the consequence of deficit-financed government spending on demand exclusive of specifying how people anticipate the deficit to be paid off in the future. This might affect the FDI decisions, even if slightly, but the theory does give an insight into the assessment of various factors used in such decision-making.
Of the purposes of the study, it becomes imperative to look into the specific economic theories from different schools of thought, connect them to the real world state of affairs and current circumstances of the country, hence relating the theory to the harsh realities of realistic economy of Pakistan.
1.4 Data Vendors and the Investment Climate in Pakistan
François Bourguignon, Senior Vice President & Chief Economist, The World Bank (2004) says,
‘A good investment climate is central to growth and poverty reduction. A vibrant private sector creates jobs, provides the goods and services needed to improve living standards, and contributes taxes necessary for public investment in health, education, and other services. But too often governments stunt the size of those contributions by creating unjustified risks, costs, and barriers to competition’ (The World Bank, 2004)
Financial and market data vendors are the key to obtain information as to help investors in optimal decision-making. They provide data to firms, traders and other investors. Their mode of collection of such valuable data is through, for example, stock exchanges, economic surveys, brokers, dealers and other regulatory filings, to mention a few. Some of the important data vendors are the Economic Intelligence Unit (EIU), The Political Risk Services Group (PRS), Thompson Reuters, Moody’s Analytics and Standard & Poor’s. Many data vendors initially started as local companies, but due to the onset of globalization of the world markets, these vendors now describe themselves as ‘global’.
This study has taken a lot of data and other related material pertinent to Pakistan from the Economic Intelligence Unit (EIU) and the Political Risk Services Group (PRS), which shall be the in the limelight of our analysis. The reports and data files from these companies give Multinational Corporations not only an unbiased analysis of the political and economic situation of a country, but also the monthly, quarterly and annual statistics with a monthly updating online of analyses and forecasts of the most significant economies of the world impacting the foreign policy of each other, and even call-up facility to their analysts. Their methodology of calculating business indicators and other related ratings is discussed in the next chapter.
Shedding some light over the investment climate of Pakistan, a comparison of the current and previous decade is made. Over the past decade 2000-2009, Pakistan achieved an overall good profile on several macroeconomic pointers, became more incorporated in the world economy, and attained notable societal gains in comparison to the last decade of the new millennium. However, the performance of other comparable low-income nations now sheds light on the fact that Pakistan has had sluggish growth, short of its potential. While the nation has managed to uphold a fairly high per capita growth for the last ten years or so, its growth and development has fallen short of other countries with almost the same initial standing. Taking the example of China and India, due to more hasty growth in these countries a huge fissure has opened up in per capita income, even though all three countries stood at comparable income echelons a generation ago. FDI in Pakistan consists chiefly of three essentials namely cash and capital equipment inflow and ploughed-back earnings. Of the inflow of FDI in Pakistan, most originated from abroad mainly is in the type of cash and capital equipments and the other in the form of re-invested earnings. As the State Bank of Pakistan (SBP) reports, the inflows of foreign direct investment (FDI) in Pakistan fell down by 52.2 per cent during the earlier four months of the fiscal 2009-10 in the midst of deceleration in the global economic recuperation and security and other political concerns. Pakistan’s investment climate poses specific impediments to economic growth and development. The call to understand the political and geological state of affairs of the country is crucial. Some of the factors include lack of proper infrastructure, energy shortages ad power outages, pervasive corruption, stringent regulations and extension of credit to investors. These require urgent redressing on the part of the public sector.
1.5 Potential Implications of Weak Ratings on Investment Climate: Issues and Concerns for Pakistan
Despite remarkable macroeconomic indicators, Pakistan’s economy has not shown the type of investment and employment generation performance which is requisite to move the country on to a growth trail which would imply noteworthy reduction in poverty levels and significant development in its social indicators.
As can be seen from the Figure, Pakistan’s investment gap widened with comparable countries during the nineties (1990s).
Source: Nabi, I
Developing countries, such as Pakistan, have not been able to participate much as the developed and certain emerging economies in the vast increase of FDI flows that has taken place in the past decade. Today, still only a small fraction of worldwide foreign investment reaches them. While FDI to these countries as a whole did rise during 2000 to $240bn, their share in world FDI flows declined for the second year in a row to 19 percent compared to the peak of 41 percent in 1994. This state of affairs highlights the need for the developing host countries to have a broader set of policies and institutions in order to draw, absorb and capitalize on the benefits of FDI. In this mission, home countries, multinational corporations (MNCs), international organizations and civil society groups all have a mutual responsibility.
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Foreign direct investment (FDI) is broadly recognized as an influential engine and a chief channel for development, poverty-reducing growth and the worldwide integration process. At a time when FDI levels show signs of a turn down and the competition among nations, especially in the developing world, to pull more and “quality” FDI becomes stringent, promoting investment effectively has become a matter of great importance to governments all over the world. Governments should identify the need to be inventive in responding to the concerns and expectations of investors, while motivated at the same time to optimize the payback of FDI for their national economies.
1.6 Key words and definitions
Keywords: Social Distortion, Business Expectations, Business cycles, Multinational Corporations
Social Distortion; Unfair and improper administration of laws conforming to the natural law- that all persons, irrespective of ethnic origin, gender, possessions, race, religion, etc., are to be treated equally and without prejudice (Wikipedia 2001)
Business Expectations; Business predictions into the future, given past and current observations, which play a role in the determination of prices and profits for businesses. (Investopedia)
Business cycles; Periodic fluctuation in the rate of economic activity, as measured by levels of employment, prices, and production (Encyclopedia Britannica)
Multinational Corporation (MNC); An MNC is a corporation or an enterprise that manages production or delivers services in more than one country. It can also be referred to as an international corporation. (Wikipedia 2001)
1.7 Study objectives
The aim of the thesis is to gauge whether the social disharmony and inequality in Pakistan affects the conception of business expectation for future activity, or not for the time period 1995 to 2009 in Pakistan’s history.
To test the proposition whether the incidence of corruption impacts the formation of business expectations in Pakistan, or not, in a time series setting from 1995 to 2009. Here, a proxy variable to represent corruption has been taken as ‘Tax evasion to GDP ratio’
To test the proposition whether the Political Instability affects the way businesses formulate expectations about future economic activity in Pakistan, or not, in a time series setting from 1995 to 2009. Here, the ‘Political Stability and the Absence of Violence’ component of the World Governance Indicators (World Bank) has been incorporated into the analysis
To test the proposition whether the depreciation of the official exchange rate in Pakistan influences business activity in future, or not, in a time series setting from 1995 to 2009. Here, the official exchange rate has been taken in LCU per $U.S, period average.
To test the proposition whether the energy production and infrastructural development in Pakistan influences business activity in future, or not, in a time series setting from 1995 to 2009. Here, the proxy variable for infrastructure used is ‘Electricity Production’.
To test the proposition whether the Control of Corruption as a measure of Institutional development in Pakistan influences business activity in future, or not, in a time series setting from 1995 to 2009. This variable has also been extracted from the World Governance Indicators (World Bank) and has been incorporated into the analysis.
Business activity and expectations have been duly incorporated into the study using appropriate proxies such as the EIU Overall Business Environment Rating, and the Market Opportunities Rating.