Course: Economic Development of Pakistan–I (4659)

Semester: Spring, 2020

ASSIGNMENT No. 2
Q. 1 Highlight the determinants/factors which slow down the pace of economic development.
The skills, education and training of the labor force have a direct effect on the growth of an economy. A
skilled, well-trained workforce is more productive and will produce a high-quality output that adds efficiency
to an economy. A shortage of skilled labor can be a deterrent to economic growth. An under-utilized, illiterate
and unskilled workforce will become a drag on an economy and may possibly lead to higher unemployment.
Improvements and increased investment in physical capital – such as roadways, machinery and factories –
will reduce the cost and increase the efficiency of economic output. Factories and equipment that are modern
and well-maintained are more productive than physical labor. Higher productivity leads to increased output.
Labor becomes more productive as the ratio of capital expenditures per worker increases. An improvement in
labor productivity increases the growth rate of the economy. The quantity and availability of natural resources
affect the rate of economic growth. The discovery of more natural resources, such as oil or mineral deposits,
will give a boost to the economy by increasing a country's production capacity.
The effectiveness of a county at utilizing and exploiting its natural resources is a function of the skills of the
labor force, type of technology and the availability of capital. Skilled and educated workers are able to use
these natural resource to spur the growth of the economy. Improvements in technology have a high impact on
economic growth. As the scientific community makes more discoveries, managers find ways to apply these
innovations as more sophisticated production techniques.
The application of better technology means the same amount of labor will be more productive, and economic
growth will advance at a lower cost.
Countries that recognize the importance of the four factors that affect economic growth will have higher
growth rates and improved standards of living for their people. Technological innovation and more education
for workers will improve economic output which lead to a better living environment for everyone. Increases
in labor productivity are much easier to achieve when investments are made on better equipment that require
less physical work from the labor force.
There are mainly two types of determinants (factors) which influence the economic development of a country.
A) Economic Factors in Economic Development:
In a country’s economic development the role of economic factors is decisive. The stock of capital and the rate
of capital accumulation in most cases settle the question whether at a juven point of time a country will grow or
not. There are a few other economic factors which also have some bearing on development but their importance
is hardly comparable to that of capital formation. The surplus of foodgrains output available to support urban
population, foreign trade conditions and the nature of economic system are some such factors whose role in
economic development has to be analyzed:

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1) Capital Formation:
The strategic role of capital in raising the level of production has traditionally been acknowledged in
economics. It is now universally admitted that a country which wants to accelerate the pace of growth, has m
choice but to save a high ratio-of its income, with the objective of raising the level of investment. Great reliance
on foreign aid is highly risky, and thus has to be avoided. Economists rightly assert that lack of capital is the
principal obstacle to growth and no developmental plan will succeed unless adequate supply of capital is
forthcoming.
Whatever be the economic system, a country cannot hope to achieve economic progress unless a certain
minimum rate of capital accumulation is realized. However, if some country wishes to make spectacular strides,
it will have to raise its rate of capital formation still higher.
2) Natural Resources:
The principal factor affecting the development of an economy is the natural resources. Among the natural
resources, the land area and the quality of the soil, forest wealth, good river system, minerals and oil-resources,
good and bracing climate, etc., are included. For economic growth, the existence of natural resources in
abundance is essential. A country deficient in natural resources may not be in a position to develop rapidly. In
fact, natural resources are a necessary condition for economic growth but not a sufficient one. Japan and India
are the two contradictory examples.
According to Lewis, “Other things being equal man can make better use of rich resources than they can of
poor”. In less developed countries, natural resources are unutilized, under-utilized or mis- utilized. This is one
of the reasons of their backwardness. This is due to economic backwardness and lack of technological factors.
According to Professor Lewis, “A country which is considered to be poor in resources may be considered very
rich in resources some later time, not merely because unknown resources are discovered, but equally because
new methods are discovered for the known resources”. Japan is one such country which is deficient in natural
resources but it is one of the advanced countries of the world because it has been able to discover new use for
limited resources.
3) Marketable Surplus of Agriculture:
Increase in agricultural production accompanied by a rise in productivity is important from the point of view of
the development of a country. But what is more important is that the marketable surplus of agriculture
increases. The term ‘marketable surplus’ refers to the excess of output in the agricultural sector over and above
what is required to allow the rural population to subsist.
The importance of the marketable surplus in a developing economy emanates from the fact that the urban
industrial population subsists on it. With the development of an economy, the ratio of the urban population
increases and increasing demands are made on agriculture for foodgrains. These demands must be met
adequately; otherwise the consequent scarcity of food in urban areas will arrest growth.

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In case a country fails to produce a sufficient marketable surplus, it will be left with no choice except to import
foodgrains which may cause a balance of payments problem. Until 1976-77, India was faced with this problem
precisely. In most of the years during the earlier planning period, market arrivals of foodgrains were not
adequate to support the urban population.
If some country wants to step-up the tempo of industrialization, it must not allow its agriculture to lag behind.
The supply of the farm products particularly foodgrains, must increase, as the setting-up of industries in cities
attracts a steady flow of population from the countryside.
4) Conditions in Foreign Trade:
The classical theory of trade has been used by economists for a long time to argue that trade between nations is
always beneficial to them. In the existing context, the theory suggests that the presently less developed countries
should specialize in production of primary products as they have comparative cost advantage in their
production. The developed countries, on the contrary, have a comparative cost advantage in manufactures
including machines and equipment and should accordingly specialize in them.
In the recent years, a powerful school has emerged under the leadership of Raul Prebisch which questions the
merits of unrestricted trade between developed and under-developed countries on both theoretical and empirical
grounds.
Foreign trade has proved to be beneficial to countries which have been able to set-up industries in a relatively
short period. These countries sooner or later captured international markets for their industrial products.
Therefore, a developing country should not only try to become self-reliant in capital equipment as well as other
industrial products as early as possible, but it should also attempt to push the development of its industries to
such a high level that in course of time manufactured goods replace the primary products as the country’s
principal exports.
In countries like India the macro-economic interconnections are crucial and the solutions of the problems of
these economies cannot be found merely through the foreign trade sector or simple recipes associated with it.
5) Economic System:
The economic system and the historical setting of a country also decide the development prospects to a great
extent. There was a time when a country could have a laissez faire economy and yet face no difficulty in
making economic progress. In today’s entirely different world situation, a country would find it difficult to
grow along the England’s path of development.
The Third World countries of the present times will have to find their own path of development. They cannot
hope to make much progress by adopting a laissez faire economy. Further, these countries cannot raise
necessary resources required for development either through colonial exploitation or by foreign trade. They now
have only two choices before them:
i) They can follow a capitalist path of development which will require an efficient market system supported by a
rational interventionist role of the State.

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ii) The other course open to them is that of economic planning.
The latest experiments in economic planning in China have shown impressive results. Therefore, from the
failure of economic planning in the former Soviet Union and the erstwhile East European socialist countries it
would be wrong to conclude that a planned economy has built-in inefficiencies which are bound to arrest
economic growth.
B) Non-Economic Factors in Economic Development:
From the available historical evidence, it is now obvious that non- economic factors are as much important in
development as economic factors. Here we attempt to explain how they exercise influence on the process of
economic development: Human resources are an important factor in economic development. Man provides
labour power for production and if in a country labour is efficient and skilled, its capacity to contribute to
growth will decidedly be high. The productivity of illiterate, unskilled, disease ridden and superstitious people
is generally low and they do not provide any hope to developmental work in a country. But in case human
resources remain either unutilized or the manpower management remains defective, the same people who could
have made a positive contribution to growth activity prove to be a burden on the economy. It has never been,
doubted that the level of technical know-how has a direct bearing on the pace of development. As the scientific
and technological knowledge advances, man discovers more and more sophisticated techniques of production
which steadily raise the productivity levels. Schumpeter was deeply impressed by the innovations done by the
entrepreneurs, and he attributed much of the capitalist development to this role of the entrepreneurial class.
Since technology has now become highly sophisticated, still greater attention has to be given to Research and
Development for further advancement. Under assumptions of a linear homogeneous production function and a
neutral technical change which does not affect the rate of substitution between capital and labour, Robert M.
Solow has observed that the contribution of education to the increase in output per man hour in the United
States between 1909 and 1949 was more than that of any other factor. Looking to the world history of modern
times one learns that the processes of development and underdevelopment are interlinked and it is wrong to
view them in isolation. We all know that the under-development of India, Pakistan, Bangladesh, Sri Lanka,
Malaysia, Kenya and a few other countries, which were in the past British colonies, was linked with the
development of England. England recklessly exploited them and appropriated a large portion of their economic
surplus.
Dadabhai Naoroji has also candidly explained in his classic work ‘Poverty and Un-British Rule in India’ that
the drain of wealth from India under the British was the major cause of the increase in poverty in India during
that period, which in turn arrested the economic development of the country. Mass participation in development
programs is a pre-condition for accelerating the growth process. However, people show interest in the
development activity only when they feel that the fruits of growth will be fairly distributed. Experiences from a
number of countries suggest that whenever the defective social organisation allows some elite groups to
appropriate the benefits of growth, the general mass of people develop apathy towards State’s development

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programs. Under the circumstances, it is futile to hope that masses will participate in the development projects
undertaken by the State.
India’s experience during the whole period of development planning is a case in point. Growth of monopolies in
industries and concentration of economic power in the modern sector is now an undisputed fact. Furthermore,
the new agricultural strategy has given rise to a class of rich peasantry creating widespread disparities in the
countryside.
Q. 2 Discuss the role of Agriculture sector in the development during the 60’s in Pakistan.
Pakistan as developing economy the employment on consistent level has much importance. In this behalf
agriculture has much importance because it provides employment directly or indirectly to the public.
Employment directly affects the GSP of economy as well as the per capita income. With the increase in per
capita income living standard increases, higher hygiene facilities & better education facilities are also increases.
All these signs are the factors of economic development. So we can say that agriculture has a great contribution
toward economic development by providing the employment. Population growth rate of Pakistan is increasing
rapidly. According to UNDP human development report population growth rate of Pakistan is 2% per year. So
with the rapidly increasing population the food requirement is also increasing rapidly. In this behalf agriculture
is the only the major sector which is the meeting the increasing requirement of food. It also reduces the import
of food from other economies. So we can say that agriculture sector is playing very vital role in development of
Pakistan by providing the food for massive population as well as supporting the economic growth. Major
exports or cash crops of Pakistan are wheat, rice and cotton. 9.8 billion Bales of cotton are produced per year.
Rice crop is produced 4.3 million ton per year. These agricultural commodities are exported to various countries
against foreign exchange. This foreign exchange is utilized for the import of industrial or technological
equipments such as machinery or automobiles. Further this foreign exchange is utilized to improve the
infrastructure of economy or for improving the other sector of economy like education, health and investments.
Industries have great importance for the development of any country specially for developing economies like
Pakistan. Industries need raw material to produce finish goods. In Pakistan agriculture provides raw material to
industries. Cotton is very important agricultural production which is also major export of Pakistan. It is used as
raw material in textile industries. The production of these textile industries is exported to various countries
against foreign exchange. Live stock is also an agricultural sector. It also plays very important role to export
goods by providing the raw material to various industries like sports goods industries and leather industries. So
in this way agriculture helps to Pakistan economy and its growth toward development. Infrastructure plays very
important role to development of any economy. It is fuel to the economy development. Well organised
infrastructure is a key to development because of quick means of transportation of agricultural goods or
commodities (raw material or finish goods) and communication. On distribution purpose of agricultural
products good and quick means of transportation are required this intends to improve the infrastructure rapidly.
So agriculture play important role to the development of transportation for the purpose of distribution of goods.

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Agriculture has huge contribution toward GDP of Pakistan economy. it contributes about 25% of total GDP,
which is larger than other sectors of Pakistan. Increase in GDP shows the developing progress of the economy.
It has played very important role since independence toward GDP of Pakistan. Now agriculture is the 3rd
largest sector of contributing to GDP. Live stock and fisheries are the huge sector of agriculture in order to
providing the employment. Employment contribute to GDP, it is as with the increase in employment the per
capita income will increase which results to increase in GDP rate of the economy.
Agriculture sector has played very important role in order to reduction of rural poverty. Since 1975 to 2000 the
GDP growth rate of agriculture was about 4.1% per year. Green revolution technology in irrigation, improved
seeds and fertilizers played very vital role to increase the agricultural production which results in increase in
GDP. Through this technology farmers with land gain the opportunity to increase their production. So in this
way arable lands became cultivated lands and farmers got the market of agricultural products against some
return.
Agriculture has also contributed a great role toward the development of banking sector. As the government
realized the importance of agriculture, it takes steps to improve the productivity of crops by providing the credit
facilities to the farmers at low interest rates. With utilizing these credits farmers can produce more and more
crops. For this purpose government established the ZTBL and other financial institutes for the provision of
credit facilities. So in this way development of banking sector takes place.
Introduction of farm mechanization in agricultural sector had played very effective role in the development of
economy. With the use of modern machinery in agricultural lands causes more and high quality production of
crops. So the provision of raw material to the industries increases. Due to increase in productivity level the
export rate of major export crops is increased which causes foreign exchange and economic development.
In agricultural sector use of modern technology like nanotechnology has played very vital role in the
development of economy. This technology is used for producing the high yielding variety with high quality
products. High quality products results into high rate of return to the farmers and the per capita income of
farmer increases. Increase in per capita income shows the growth of economy toward development.
Dairy farming from agricultural sector has also played a great role in economic development. Livestock or dairy
farming has huge contribution toward economic growth. The annual protein per capita is 18 kg of meat and 155
litters of milk. This is the highest rate in South Asia. Milk and meat and their by products have a good market.
Farmers can receive a good return by producing and providing these products to the market. This process results
into increase in per capita income as well as increase in national income of the economy.
In economic development textile industries plays very important role. These industries totally depend on
agriculture production in raw form. Cotton is the major crop which is used as raw material for these industries
for production purpose. Further these products are exported to many economies against foreign exchange. So
cotton as raw material from agriculture side contributes toward increase in NI (National Income). Textile

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industries also provide employment level which increases the per capita income of the person. So we can say
that contribution of textile industries in the development of economy has much importance.
Sugar industry is also one of the major sectors of economy which has great importance according to
development of economy. This is totally agricultural based industry. Sugar cane is produced on very large scale
in many areas of Pakistan. This further supplies to sugar industries for the production of sugar and other by
products which has great market. As large scale industries these also helps to provide employment level to the
public. This results into increase in per capita income as well as improves living standards.
Many areas of Pakistan have much importance according to the production of rice crop. In some areas the world
most famous rice crop is produced. A huge quantity is exported to many economies against foreign exchange.
This foreign exchange is further utilized in import of some other products like modern technology or machinery
or this is utilized for the improvement of infrastructure of the economy.
Fishing industry plays very important role in the development of national economy. With a coastline of 814 km
Pakistan has enough resources for that remains to fully development. This is also the major export of Pakistan.
About 4% of land is covered with forests in Pakistan. This is the major source of paper, lumber, fuel wood, and
latex medicine. It is also used for the purpose of wildlife conservation and ecotourism. Development can be
defined as improving the welfare of a society through appropriate social, political, and economic conditions.
The expected outcomes are quantitative and qualitative improvements in human capital (e.g. income and
education levels) as well as physical capital such as infrastructures (utilities, transport, telecommunications).
The development of transportation systems takes place in a socioeconomic context. While development policies
and strategies tend to focus on physical capital, recent years have seen a better balance by including human
capital issues. Irrespective of the relative importance of physical versus human capital, development cannot
occur without both interacting as infrastructures cannot remain effective without proper operations and
maintenance. At the same time, economic activities cannot take place without an infrastructure base. The highly
transactional and service-oriented functions of many transport activities underline the complex relationship
between its physical and human capital needs. For instance, effective logistics rely on infrastructures and
managerial expertise.
Because of its intensive use of infrastructures, the transport sector is an important component of the economy
and a common tool used for development. This is even more so in a global economy where economic
opportunities have been increasingly related to the mobility of people and freight, including information and
communication technologies. A relation between the quantity and quality of transport infrastructure and the
level of economic development is apparent. High-density transport infrastructure and highly connected
networks are commonly associated with high levels of development. When transport systems are efficient, they
provide economic and social opportunities and benefits that result in positive multiplier effects such as better
accessibility to markets, employment, and additional investments. When transport systems are deficient in terms

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of capacity or reliability, they can have an economic cost such as reduced or missed opportunities and lower
quality of life.
Role of fishery:
Fishing industry plays very important role in the development of national economy. With a coastline of 814 km
Pakistan has enough resources for that remains to fully development. This is also the major export of Pakistan.
Forestry:
About 4% of land is covered with forests in Pakistan. This is the major source of paper, lumber, fuel wood, and
latex medicine. It is also used for the purpose of wildlife conservation and ecotourism.
Measure to improve the efficiency of agricultural sector for development of economy:
Yield collection problems:
The collection of yield from small farmers is very expensive & difficult process. So it is a great problem of
marketing. There should be some easy way for collection of yield from the farmers.
Rough grading Products:
Commodities or products which are graded have higher price in the market. In Pakistan mixing of poor & good
qualities are common. So grading problems must reduce.
Storage problems:
The storage facilities in markets are not enough, seller can not store & wait for a higher price of the product due
to lack of warehouses. Because of this some perishable produce suffers loss.
Middleman’s role:
The middleman takes a big share of farmer crop without doing anything. The farmers borrow the money from
them & sell their products at low prices. So this is a big loss to the farmers.
Transportation problems:
Our sources of transportation are insufficient, so regular supply of product is not possible to the market. The
village are not properly linked to the markets. For proper provision of products to the market their must be
sufficient as well as fast means of transportation.
Q. 3 Identify the role and performance of industrial sector in the economic development of Pakistan.
Industry plays a complex role in economic development, but these are some of its most important effects.
Industrialization allows countries to make optimal use of their scarce resources. It increases the quantity and
quality of goods manufactured in that company, which makes a larger contribution to gross national product
(GNP). In an industrialized society, workers' labor is worth more. In addition, because of higher productivity,
individual income increases. This rise in income raises the standard of living for ordinary people.
A nation that depends on the production and export of raw material alone cannot achieve a rapid rate of
economic growth. The restricted and fluctuating demand for agricultural products and raw materials—along
with the uncertainties of nature itself—hampers economic progress and leads to an unstable economy.
Industrialization is the best way of providing economic stability.

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Industrialization changes the pattern of foreign trade in the country. It increases the export of manufactured
goods, which are more profitable in foreign exchange. But at the same time, processing the raw material at
home curtails the import of goods, thereby helping to conserve foreign exchange. The export-orientation and
import-substitution effects of industrialization help to improve the balance of payments. In Pakistan in
particular, the exports of semi-manufactured and manufactured goods resulted in favorable trade.
Industrialization provides increased employment opportunities in small- and large-scale industries. In an
industrial economy, industry absorbs underemployed and unemployed workers from the agricultural sector,
thereby increasing the income of the community.
Industrialization promotes specialized labor. This division of work increases the marginal value product of
labor. In other words, specialized labor is more profitable. The income of a worker in the industrial sector will
be higher on average than that of a worker in the agricultural sector.
At the time of independence, Pakistan has inherited only 34 industrial units out of 921 industrial units in
subcontinent.  They were cotton textile, cigarettes, sugar, rice husking, cotton ginning and flour milling
industries; and together they contributed only 7% of GDP and employed a little over 26,000 employees.
Industrial development or history of industries in Pakistan can be divided into six phases:
Phase 1 (1947-1957):
1.       This phase started from 1947 ended to 1958.  During this period, the country was newly born and
politically immature.  During this 11-years period, 8 prime ministers came into power.  Not a single prime
minister was strong enough to pursue the industrial policy well.
2.       During this period, the policy emphasis was on import substitution.
3.       Government had established a committee to formulate industrial policy.
4.       This committee emphasized on manufacturing industries, reduction of imports, and net social and
economic advantages to the country.
5.       Pakistan Industrial Finance Corporation (PIFC) and Pakistan Industrial Credit and Investment
Corporation (PICIC) were established in 1948.
6.       To create skilled labour, a Swedish-Pak Institute of Technology was established in 1955.
7.       Pakistan Industrial Technical Assistance Centre (PITAC) was established in 1956.
Phase 2 (1958-1969):
1.       In 1958, a military government of Ayub came into power in Pakistan and announces a new industrial
policy in 1959.  This phase witnessed the massive industrial growth in the country.
2.       This industrial policy emphasis on private sector and the development of agro-based industries.
3.       During this period, the government gave emphasis on intermediate and capital goods, i.e., electrical,
chemical, machine tools, etc.
4.       Various types of funds were established to promote the industrial development in the country.
Phase 3 (1973-1977):

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1.       During this period, a new democratic government of Bhutto came into power and adopted the principles
of mixed economy.
2.       Government ruthlessly nationalized 34 industrial units belonging to the following basic units:
(a)    Vegetable ghee and oil industries (26 industrial units)
(b)   Shipping industry
(c)    Iron and steel industries
(d)   Basic metal industries
(e)   Heavy engineering industries
(f)     Assembly and manufacture of motor vehicles
(g)    Tractor plants
(h)   Heavy and basic chemicals
(i)      Petro-chemical industries
(j)     Cement industries
(k)    Public utilities including electric generations, gas and oil industries.
3.       The nationalized industries were put under the management of Board of Industrial Management
(BIM).
4.       Pakistan Industrial Development Corporation (PIDC) was established.
5.       Other reforms were taken by the government were:
(a)    Labour reforms
(b)   Abolition of bonus voucher system
(c)    Reduction of sales tax on imported items
(d)   Revision of import policy
(e)   Establishment of industrial units in less developed / rural areas.
Phase 4 (1977-1988):
1.       A new martial law government by Zia came into power in 1977.  The new military government in 1977
announced the reversal of previous government’s nationalization policy and introduced a new industrial policy.
2.       The federal government offered for the transfer of shares of nationalized industries to their former
owners, under Economic Reforms Order 1978, and thus the new open way for denationalization of industries.
3.       Government announced tax holidays and revised import policy.
4.       To boost private industrial development, following measures were taken:
(a)    Reduction in interest charges by banks to 12.5% on all fixed investments.
(b)   Removal of taxes on issuance of bonus shares.
(c)    Fixing standard rebates of excise duty on additional 17 items.
Phase 5 (1988-2008):

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 1.       During the first half of this phase, i.e., 1988 to 1999 the country had faced worst political conditions in
the history of Pakistan.
2.       Two governments had come into power for twice, i.e., Benazir’s Government and Nawaz’s Government,
and not even governed for more than three years.  Therefore, the industrial policy was never the top priority of
those two governments.
3.       Nawaz Sharif, however, lightly emphasized on infrastructural development in Pakistan, but interrupted by
the bloodless coup d’etat by Musharraf in 1999.  Although Nawaz had adopted considerable economic policies,
i.e., deletion policy, deregulation policy and privatization policy, which were also pursued by succeeding
governments.  Much of these policies were influenced by IMF.
4.       During the second half of this phase (i.e., 2000-2008), industries of Pakistan faced greater influence of
cheaper goods imported under WTO agreements.
Q. 4 Highlight the general trends of Pakistan’s foreign trade and its role and importance in economic
development.
The role of foreign trade can be judged by the following faces:
Foreign trade and economic development
All the countries export a lot of agricultural product to other countries and import capital goods. Hence, it the
economic development of a country highly depends of foreign trade.
Foreign exchange earning
Foreign trade provides foreign exchange that is used to remove the poverty and for other productive purposes.
Market expansion
International trade plays an important role in increasing the production of any country. The foreign trade is
remarkable factor in expanding the market and encouraging the producers. In countries where home market is
limited it is necessary to sell product in other countries.
Increase in investment
Foreign trade encourages the businessmen to increase the investment to produce more goods. So the rate of
investment increases.
Foreign investment
Foreign trade provides incentives for the foreign investors, besides local investment, to invest in those countries
where there is a shortage of investment.
The significance of international trade on economic, political, and social conditions has been theorized in the
Industrial Age also. It is essential for the growth of globalization.
ari afilalo, an expert professor and researcher on international trade, has a strong insight over this method. His
research and training are based on methods like:
    International trade
    International business transactions

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    European Union laws
He is also a proud and responsible member of the Sephardic Jewish community. He is a celebrated author of the
book the new global trading order

Pakistan’s international trade: The potential for expansion towards east and west
Share this project
  Liberalisation of Pakistan’s overland trade to both the east and west offers an important opportunity
for economic growth.
 This project sought to identify the barriers to Pakistan’s east-west trade and to explore the
potential of their reduction for trade expansion.
 We found that undeveloped overland trade routes with China and policy-induced restrictions on
trade with India have significantly reduced Pakistan’s exports to and imports from these countries.
Recent developments present an opportunity for Pakistan to lower barriers to trade not only with India in the
east but also a number of countries (including China) in the west and north, which are accessible via westward
land routes. East-west liberalisation of Pakistan’s international trade could lead to a large expansion in imports
and exports, and have a major impact on Pakistan’s economy.
To identify the trade effect of east-west barriers, we used a large data set to estimate a model that explains
bilateral trade flows for most trading pairs in the world. We found that the cost of barriers to trade between
Pakistan and both India and China are substantial. In the case of trade with India, policy restrictions are the
most significant barriers. The most important barrier to trade between China and Pakistan is the high cost of
land transportation. Our findings suggest a potential for substantial expansion of trade with China and India if
these barriers can be reduced or removed.
Q. 5 Critically analyze the role and importance of monetary and fiscal policy in the process of economic
development of Pakistan.
Central banks typically have used monetary policy to either stimulate an economy or to check its growth. By
incentivizing individuals and businesses to borrow and spend, the monetary policy aims to spur economic
activity. Conversely, by restricting spending and incentivizing savings, monetary policy can act as a brake on
inflation and other issues associated with an overheated economy.
The Federal Reserve, also known as the "Fed," frequently has used three different policy tools to influence the
economy: open market operations, changing reserve requirements for banks and setting the discount rate. Open
market operations are carried out on a daily basis when the Fed buys and sells U.S. government bonds to either
inject money into the economy or pull money out of circulation. 3 By setting the reserve ratio, or the percentage
of deposits that banks are required to keep in reserve, the Fed directly influences the amount of money created
when banks make loans. The Fed also can target changes in the discount rate (the interest rate it charges on

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loans it makes to financial institutions), which is intended to impact short-term interest rates across the entire
economy.
Monetary policy is more of a blunt tool in terms of expanding and contracting the money supply to influence
inflation and growth and it has less impact on the real economy. For example, the Fed was aggressive during
the Great Depression. Its actions prevented deflation and economic collapse but did not generate significant
economic growth to reverse the lost output and jobs.
Expansionary monetary policy can have limited effects on growth by increasing asset prices and lowering the
costs of borrowing, making companies more profitable.
Generally speaking, the aim of most government fiscal policies is to target the total level of spending, the total
composition of spending, or both in an economy.2
If a government believes there is not enough business activity in an economy, it can increase the amount of
money it spends, often referred to as stimulus spending. If there are not enough tax receipts to pay for the
spending increases, governments borrow money by issuing debt securities such as government bonds and, in the
process, accumulate debt. This is referred to as deficit spending.
In comparing the two, fiscal policy generally has a greater impact on consumers than monetary policy, as it can
lead to increased employment and income.
By increasing taxes, governments pull money out of the economy and slow business activity. Typically, fiscal
policy is used when the government seeks to stimulate the economy. It might lower taxes or offer tax rebates in
an effort to encourage economic growth. Influencing economic outcomes via fiscal policy is one of the core
tenets of Keynesian economics.
When a government spends money or changes tax policy, it must choose where to spend or what to tax. In
doing so, government fiscal policy can target specific communities, industries, investments, or commodities to
either favor or discourage production—sometimes, its actions are based on considerations that are not entirely
economic. For this reason, fiscal policy often is hotly debated among economists and political observers.
Essentially, it is targeting aggregate demand. Companies also benefit as they see increased revenues. However,
if the economy is near full capacity, expansionary fiscal policy risks sparking inflation. This inflation eats away
at the margins of certain corporations in competitive industries that may not be able to easily pass on costs to
customers; it also eats away at the funds of people on a fixed income.
Both fiscal and monetary policy play a large role in managing the economy and both have direct and indirect
impacts on personal and household finances. Fiscal policy involves tax and spending decisions set by the
government, and will impact individuals' tax bill or provide them with employment from government projects.
Monetary policy is set by the central bank and can boost consumer spending through lower interest rates that
make borrowing cheaper on everything from credit cards to mortgages.
The economic decisions of households can have a significant impact on an economy. For example, a decision
on the part of households to consume more and to save less can lead to an increase in employment, investment,

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and ultimately profits. Equally, the investment decisions made by corporations can have an important impact on
the real economy and on corporate profits. But individual corporations can rarely affect large economies on
their own; the decisions of a single household concerning consumption will have a negligible impact on the
wider economy.
By contrast, the decisions made by governments can have an enormous impact on even the largest and most
developed of economies for two main reasons. First, the public sectors of most developed economies normally
employ a significant proportion of the population, and they are usually responsible for a significant proportion
of spending in an economy. Second, governments are also the largest borrowers in world debt markets.
Government policy is ultimately expressed through its borrowing and spending activities. In this reading, we
identify and discuss two types of government policy that can affect the macroeconomy and financial markets:
monetary policy and fiscal policy. 
Monetary policy refers to central bank activities that are directed toward influencing the quantity of money and
credit in an economy. By contrast, fiscal policy refers to the government’s decisions about taxation and
spending. Both monetary and fiscal policies are used to regulate economic activity over time. They can be used
to accelerate growth when an economy starts to slow or to moderate growth and activity when an economy
starts to overheat. In addition, fiscal policy can be used to redistribute income and wealth.
The overarching goal of both monetary and fiscal policy is normally the creation of an economic environment
where growth is stable and positive and inflation is stable and low. Crucially, the aim is therefore to steer the
underlying economy so that it does not experience economic booms that may be followed by extended periods
of low or negative growth and high levels of unemployment. In such a stable economic environment,
householders can feel secure in their consumption and saving decisions, while corporations can concentrate on
their investment decisions, on making their regular coupon payments to their bond holders and on making
profits for their shareholders.
The challenges to achieving this overarching goal are many. Not only are economies frequently buffeted by
shocks (such as oil price jumps), but some economists believe that natural cycles in the economy also exist.
Moreover, there are plenty of examples from history where government policies—either monetary, fiscal, or
both—have exacerbated an economic expansion that eventually led to damaging consequences for the real
economy, for financial markets, and for investors.
The balance of the reading is organized as follows. Section 2 provides an introduction to monetary policy and
related topics. Section 3 presents fiscal policy. The interactions between monetary policy and fiscal policy are
the subject of Section 4. A summary and practice problems conclude the reading. 
Learning Outcomes
The member should be able to:
 compare monetary and fiscal policy;
 describe functions and definitions of money;

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  explain the money creation process;
 describe theories of the demand for and supply of money;
 describe the Fisher effect;
 describe roles and objectives of central banks;
 contrast the costs of expected and unexpected inflation;
 describe tools used to implement monetary policy;
 describe the monetary transmission mechanism;
 describe qualities of effective central banks;
 explain the relationships between monetary policy and economic growth, inflation, interest, and
exchange rates;
 contrast the use of inflation, interest rate, and exchange rate targeting by central banks;
 determine whether a monetary policy is expansionary or contractionary;
 describe limitations of monetary policy;
 describe roles and objectives of fiscal policy;
 describe tools of fiscal policy, including their advantages and disadvantages;
 describe the arguments about whether the size of a national debt relative to GDP matters;
 explain the implementation of fiscal policy and difficulties of implementation;
 determine whether a fiscal policy is expansionary or contractionary;
 explain the interaction of monetary and fiscal policy.
Summary
In this reading, we have sought to explain the practices of both monetary and fiscal policy. Both can have a
significant impact on economic activity, and it is for this reason that financial analysts need to be aware of the
tools of both monetary and fiscal policy, the goals of the monetary and fiscal authorities, and most important the
monetary and fiscal policy transmission mechanisms.
 Governments can influence the performance of their economies by using combinations of monetary and
fiscal policy. Monetary policy refers to central bank activities that are directed toward influencing the
quantity of money and credit in an economy. By contrast, fiscal policy refers to the government’s decisions
about taxation and spending. The two sets of policies affect the economy via different mechanisms.
 Money fulfills three important functions: It acts as a medium of exchange, provides individuals with a
way of storing wealth, and provides society with a convenient unit of account. Via the process of fractional
reserve banking, the banking system can create money.
 The amount of wealth that the citizens of an economy choose to hold in the form of money—as opposed
to, for example, bonds or equities—is known as the demand for money. There are three basic motives for
holding money: transactions-related, precautionary, and speculative.

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 The addition of 1 unit of additional reserves to a fractional reserve banking system can support an
expansion of the money supply by an amount equal to the money multiplier, defined as 1/reserve
requirement (stated as a decimal).
 The nominal rate of interest is comprised of three components: a real required rate of return, a
component to compensate lenders for future inflation, and a risk premium to compensate lenders for
uncertainty (e.g., about the future rate of inflation).
 Central banks take on multiple roles in modern economies. They are usually the monopoly supplier of
their currency, the lender of last resort to the banking sector, the government’s bank and bank of the banks,
and they often supervise banks. Although they may express their objectives in different ways, the
overarching objective of most central banks is price stability.
 For a central bank to be able to implement monetary policy objectively, it should have a degree of
independence from government, be credible, and be transparent in its goals and objectives.
 The ultimate challenge for central banks as they try to manipulate the supply of money to influence the
economy is that they cannot control the amount of money that households and corporations put in banks on
deposit, nor can they easily control the willingness of banks to create money by expanding credit. Taken
together, this also means that they cannot always control the money supply. Therefore, there are definite
limits to the power of monetary policy.
 The concept of money neutrality is usually interpreted as meaning that money cannot influence the real
economy in the long run. However, by the setting of its policy rate, a central bank hopes to influence the
real economy via the policy rate’s impact on other market interest rates, asset prices, the exchange rate, and
the expectations of economic agents. 
 Inflation targeting is the most common monetary policy—although exchange rate targeting is also used,
particularly in developing economies. Quantitative easing attempts to spur aggregate demand by drastically
increasing the money supply.
 Fiscal policy involves the use of government spending and revenue raising (taxation) to impact a
number of aspects of the economy: the overall level of aggregate demand in an economy and hence the
level of economic activity; the distribution of income and wealth among different segments of the
population; and hence ultimately the allocation of resources between different sectors and economic
agents.

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