The article is published in money matters with a name"Saving to invest" on Jully 16, 2013
Individuals consume and save part of their income which eventually becomes future consumption. They save to get a higher standard of living in future. After saving they invest in saving deposits, bonds, stock market shares or start their own businesses. Thus, an individual’s savings eventually become part of investment. This is one reason that in macroeconomics we always equate savings with investment. In the Harod-Domar Model, it is specifically pointed out that if we need more investment we either need to raise our savings or invite foreign savings into our country.
Why do we need investment and especially where do we need it? This question is frequently asked by the government while it formulates policies. Investors ponder where to invest. As far as the first question is concerned, the answer is very straight forward - growth.
Nevertheless, different investments have diverse outcomes depending on the time periods. For example, investment in education will have positive outcomes in the long run. Another example would be investing in infrastructure; roads and buildings which require significant amounts of investment and facilitate big businesses. Another area would be investing in reforms, which cost less money but take more time. The impact of reforms may not necessarily become evident right away but will certainly help people grow.
Aside from interest rate, a sole determinant of investment, four theories are discussed: (1) Accelerator (2) Profitability (3) Capital Accumulation and (4) Tobins q. All the studies have their theoretical justifications. Accelerator theory tells us how much investment is needed to get a certain level of GDP growth rate considering the current economic situation, even without a change in the measurement of GDP and other variables.
The theory of profitability treats profitability as a determinant to investment. Neo classical theories consider rental cost of capital and marginal productivity of capital that in the end results in capital accumulation if future discounted net revenues are maximised.
Capital accumulation overtime is the overtime investment in the country or any specific sector. Tobin’s q is a modified version of neo classical model, which says that if the market value of already installed capital is more than the replacement cost of the capital then firm keeps on investing.
Having talked about all the theories built on numerous assumptions, the question arises: what does the investor seek while making an investment decision? He looks at the profitability, cost of doing business, the country’s current economic situation, infrastructure, both hard and soft size of the market and provision of extra facilities. In a nutshell, if the investor thinks that his investment gives him good profit and the system runs smoothly then he will invest in the country. This implies there will be little or no hurdles and constraints.
Constraints are important in restricting and/or creating the investment climate. In the last PIDE Business Barometer, firms have pointed out that the energy crisis is the number one constraint in the current scenario followed by the law and order situation, inconsistent government policies and tax anomalies. Nevertheless, they have problems with a shortage of skilled labour, a high cost of doing business, corruption, too much bureaucracy involved in the system but they somehow know to deal with these things at higher transaction costs which reduce their profitability. The energy shortage cannot be considered to have been resolved until uninterrupted power is supplied to the industries.
The PML-N team started working on energy solutions before assuming power. The process has gained more momentum since the PML-N is now in a position to implement its plans. Budget 2013-14 focused more on economic revival than anything else. Even though several taxes have been imposed on the people such as GST and slabs of income tax have increased, to boost investment the industrial sector has got exemptions and corporate income tax has been reduced from 35 percent to 30 percent to encourage investment. However, as long as the energy problem persists, we can expect little investment in the country.
Aside from law and order, investment is also discouraged by a massive fiscal deficit and rising public debt. The government either prints money or borrows from the scheduled banks. In the case of the former, inflation is created, which pushes nominal interest rate up. The latter policy acts to crowd out private investment. Therefore, in both the cases, investment effectively declines. The present government is trying to reduce the fiscal deficit while repaying the public debt servicing payments. Moreover, a sum of Rs500 billion has been allocated for circular debt, which will mitigate the energy problem but will also place a burden on the fiscal deficit.
Last week, Ihtasham ul Haque pointed out several measures such as the visit to China and making policies with the UK even though Dubai group is also eager to finance several projects. These show that the government is striving to fix things quickly. It has short term policies and it is hoped that it also has some protection in place against long term repercussions which may include accumulating external debt, exchange rate stability and inflation stability. These three things would then effect investment and growth in the long run.
The prime minister’s visit to China was fruitful as China has promised to initiate several projects in Pakistan including those related to energy. However, the PML-N government is also interested in investing in roads and larger infrastructure, which costs large sums of money. If these projects are carried out under the PSDP program, then we are ignoring some important issues which need to be addressed such as education, health and reforms in all the sectors.
We have a history of the government sector investing in sectors such as the agriculture sector, manufacturing sector and services sector etc. Too much government involvement leads to inefficiency, corruption and a lack of governance. Moreover, the government’s presence in any sector crowds out private investment. Sajawal and Khan at PIDE studied the determinants of private investment and came up with the same results that to encourage private investment, the government needs to strengthen institutions, quality governance structure needs to be established, and entrepreneurship should also be promoted.
Returning to the question of where to investment, energy is undoubtedly a big problem currently going on in the country. However, do we need motorways from M1 to M10? Do we need bullet trains? Do we need ring roads? Yes, we do need these things but if these things are made with the help of foreign investors then let’s invest part of our PSDP on soft infrastructure which promotes a healthy environment for local entrepreneurs and foreign investors, facilitates the smooth running of the system, exterminates the hurdles of investment, registers land records and secures property rights, trims down the cost of doing business, reduces delivery time, needs less paperwork and involves less bureaucracy. These reforms would lead to vibrant markets which would enhance investment in the country.
Apart from investment in the bigger projects, certain reforms are needed which promote domestic commerce. In Islamabad Centaurus is the only mall and metro is the only big shopping departmental store, however, if city land laws are amended in such a way that anyone can open a big departmental store and build a mall at CDA-designated places, then lots of investment will be attracted to this sector as well, which will have a multiplier effect on GDP. Similarly, lots of other investment opportunities are present, especially in the service sector, which the private sector would have availed given that the laws too were properly implemented.- See more at: http://magazine.thenews.com.pk/mag/moneymatter_detail.asp?id=5680&magId=10&catId=170#sthash.NPgrR4Ec.dpuf