Department of Management Sciences SZABIST, Islamabad

MACROECONOMICS
Project Report

Submitted to

Ma’am Zainab Dar
Submitted By: Syed Haseeb Ahmed Hashim Mahmood Kh Muhammad Faizan Khan Aly Abbas Ammar Pervaiz Hafiz Usman Bashir Sarmad janjua Faizan Ali Khan
Date of Submission Monday, May 23, 2011

1011165 1011147 1011121 1011137 1011139 1011145. 1011161 1011140

INTRODUCTION:
We are planning to analyze The Great Depression & factors that were responsible for it. Also the facts and figures that are accountable for this drastic situation of Pakistan’s present economic condition. In this project you will find the complete analysis of The Great depression i.e. in this regard we will touching every single detail specifically the reign of President Hoover, his decisions toward the economy of United States of America and also the decision after the happening of Black Tuesday, the rash of Wall street, economy of USA before and after of the depression, conditions that supported the falling economy and also how 1 factor supported the other which led to a collateral damage. The reason for doing this analysis is to study the causes and also to have the knowledge about the devastating economic conditions in the present scenario, the core reason of doing this project is to have a grip on one of the favourite topic of Economists i.e. 1930’s Depression. This will help us not only academically but also as a Pakistani, so that we can learn from the mistakes of others in order to avoid them in future.

Great Depression:
“The term Great Depression is used to describe the global economic crisis that resulted from the Wall Street stock market crash of October 29, 1929. During this time of minimal investment and low levels of production, unemployment soared. Because many U.S. banks’ reserves were invested in the stock market, the resulting panic forced many to close their doors, taking their customers’ money with them. As a result of the collapse of the U.S. economy, investments abroad were pulled back and the European economy was also devastated. Despite massive government intervention in the years following the stock market crash, it was not until the rearmament preceding World War II that the U.S. economy began to fully recover. This section provides articles with information on the 1929 crash of stock market, unemployment during the Great Depression, causes and effects of the Great Depression, and overall life during the Great Depression”.

Pakistan’s Economic Conditions:
Pakistan’s economy is in a downward spiral. The developing nature of the financial sector has been a saving grace for the Pakistani economy. Less developed linkages with international markets have meant that the direct impact of the financial crisis has not been felt by the Pakistani financial sector. However; effects of the crisis have been felt, even though in a limited manner, by the real sectors of the economy. The effects of the global slowdown have been transmitted through the trade balance; with a slowdown in global demand and fall in commodity prices having varying effects, the capital account; with a significant reduction in private inflows to Pakistan. Pakistan, a fragile economy, has been facing both economic and political crisis which predate the global financial crisis. Inflation, trade deficit, balance of payment, foreign exchange reserves, circular debt, poor performance of banking sector and Karachi stock exchange political instability have remained the key indicators of Pakistan economic crisis. Political and economic stability complement each other. Pakistan is an interesting case since both are in crisis. The war on terror has become a hanging sword overhead the rate of suicide bombing is increasing day by day. GDP growth rate is a significant indicator to access the health of an economy; It becomes worse since 2004-05 from 9.0% to 2.0%in 2008-9.Goverment of Pakistan spends approximately $ 26 billion per year based on the expected revenues of approximately $ 20 billion incurring a huge balance of payment (BOP) crisis when the entire donor community was also going through financial collapse. IMF aided with $ 7.6billion and with the first tranche of $ 3.1 billion Pakistan foreign reserve rose from $ 6billion to $ 9 billion.

Phase 1
The Great Depression:
Easier - The 'Great Depression' was a period in United States History when business was poor and many people were out of work. Harder - The Great Depression began in October 1929, when the stock market in the United States dropped rapidly. Thousands of investors lost large sums of money and many were wiped out, lost everything. The 'crash' led us into the Great Depression. The ensuing period ranked as the longest and worst period of high unemployment and low business activity in modern times. Banks, stores, and factories were closed and left millions of Americans jobless, homeless, and penniless. Many people came to depend on the government or charity to provide them with food. The Depression became a worldwide business slump of the 1930's that affected almost all nations. It led to a sharp decrease in world trade as each country tried to protect their own industries and products by raising tariffs on imported goods. Some nations changed their leader and their type of government. In Germany, poor economic conditions led to the rise to power of the dictator Adolf Hitler. The Japanese invaded China, developing industries and mines in Manchuria. Japan claimed this economic growth would relieve the depression. This militarism of the Germans and Japanese eventually led to World War II (1939-1945). In the United States, President Herbert Hoover held office when the Great Depression began. The economy continued to slump almost every month. Franklin D. Roosevelt was elected President in 1932. Roosevelt's 'new deal' reforms gave the government more power and helped ease the depression. The Great Depression ended as nations increased their production of war materials at the start of World War II. This increased production provided jobs and put large amounts of money back into circulation.

Causes of the Great Depression:
In 1929 the standard economic theory suggested that a calamity such as the Great Depression could not happen: the economy possessed equilibrating mechanisms that would quickly move it toward full employment. For example, high levels of unemployment should put downward pressure on wages, thereby encouraging firms to increase employment. Before the Great Depression, most economists urged governments to concentrate on maintaining a balanced budget. Since tax receipts inevitably fell during a downturn, governments often increased tax rates and reduced spending. By taking money out of the economy, such policies tended to accelerate the downturn, though the effect was likely small. As the depression continued, many economists advised the federal government to increase spending, in order to provide employment. Economists also searched for theoretical justifications for such policies. Some thought the depression was caused by overproduction: consumers did not wish to consume all that was produced. These analysts often attributed overproduction to the increased disparity in income that developed in the 1920s, for the poor spend a greater percentage of their income than do the rich. Others worried about a drop in the number of profitable investment opportunities. Often, these arguments were couched in apocalyptic terms: the Great Depression was thought to be the final crisis of capitalism, a crisis that required major institutional restructuring. Others, notably Joseph Schumpeter, pointed the finger at technology and suggested that the Great Depression reflected the failure of entrepreneurs to bring forth new products. He felt the depression was only temporary and a recovery would eventually occur. The stock market crash of 1929 and the bank panics of the early 1930s were dramatic events. Many commentators emphasized the effect these had in decreasing the spending power of those who lost money. Some went further and blamed the Federal Reserve System for allowing the money supply, and thus average prices, to decline. John Maynard Keynes in 1936 put forward a theory arguing that the amount individuals desired to save might exceed the amount they wanted to invest. In such an event, they would necessarily consume less than was produced (since, if we ignore foreign trade, total income must be either consumed or saved, while total output is the sum of consumption goods and investment goods). Keynes was skeptical of the strength of equilibrating mechanisms and shocked many economists who clung to a faith in the ability of the market system to govern itself. Yet within a decade the profession had largely embraced his approach, in large part because it allowed them to analyze deficient consumption and investment demand without reference to a crisis of capitalism. Moreover, Keynes argued that, because a portion of income was used for taxes and output included government services, governments might be able to correct a situation of deficient demand by spending more than they tax. In the early postwar period, Keynesian theory dominated economic thinking. Economists advised governments to spend more than they taxed during recessions and tax more than spend during expansions. Although governments were not always diligent in following this prescription, the limited severity of early postwar business cycles was seen as a vindication of Keynesian theory. Yet little attention was paid to the question of how well it could explain the Great Depression.

In 1963, Milton Friedman and Anna Schwartz proposed a different view of the depression. They argued that, contrary to Keynesian theory, the deflationary actions of the Federal Reserve were primarily at fault. In the ensuing decades, Keynesians and "monetarists" argued for the supremacy of their favored theory. The result was a recognition that both explanations had limitations. Keynesians struggled to comprehend why either consumption or investment demand would have fallen so precipitously as to trigger the depression (though saturation in the housing and automobile markets, among others, may have been important). Monetarists struggled to explain how smallish decreases in the money supply could trigger such a massive downturn, especially since the price level fell as fast as the supply of money, and thus real (inflationadjusted) aggregate demand need not have fallen. In the 1980s and 1990s, some economists argued that the actions of the Federal Reserve had caused banks to decrease their willingness to loan money, leading to a severe decrease in consumption and, especially, investment. Others argued that the Federal Reserve and central banks in other countries were constrained by the gold standard, under which the value of a particular currency is fixed to the price of gold. Some economists today speak of a consensus that holds the Federal Reserve, the gold standard, or both, largely responsible for the Great Depression. Others suggest that a combination of several theoretical approaches is needed to understand this calamity. Most economists have analyzed the depression from a macroeconomic perspective. This perspective, spawned by the depression and by Keynes's theories, focuses on the interaction of aggregate economic variables, including consumption, investment, and the money supply. Only fairly recently have some macroeconomists begun to consider how other factors, such as technological innovation, would influence the level of economic activity. Beginning initially in the 1930s, however, some students of the Great Depression have examined the unusually high level of process innovation in the 1920s and the lack of product innovation in the decade after 1925. The introduction of new production processes requires investment but may well cause firms to let some of their workforce go; by reducing prices, new processes may also reduce the amount consumers spend. The introduction of new products almost always requires investment and more employees; they also often increase the propensity of individuals to consume. The time path of technological innovation may thus explain much of the observed movements in consumption, investment, and employment during the interwar period. There may also be important interactions with the monetary variables discussed above: in particular, firms are especially dependent on bank finance in the early stages of developing a new product.

Effects of the Great Depression:
The psychological, cultural, and political repercussions of the Great Depression were felt around the world, but it had a significantly different impact in different countries. In particular, it is widely agreed that the rise of the Nazi Party in Germany was associated with the economic turmoil of the 1930s. No similar threat emerged in the United States. While President Franklin Roosevelt did introduce a variety of new

programs, he was initially elected on a traditional platform that pledged to balance the budget. Why did the depression cause less political change in the United States than elsewhere? A much longer experience with democracy may have been important. In addition, a faith in the "American dream," whereby anyone who worked hard could succeed, was apparently retained and limited the agitation for political change.

Effects on individuals:
Much of the unemployment experience of the depression can be accounted for by workers who moved in and out of periods of employment and unemployment that lasted for weeks or months. These individuals suffered financially, to be sure, but they were generally able to save, borrow, or beg enough to avoid the severest hardships. Their intermittent periods of employment helped to stave off a psychological sense of failure. Yet there were also numerous workers who were unemployed for years at a time. Among this group were those with the least skills or the poorest attitudes. Others found that having been unemployed for a long period of time made them less attractive to employers. Long-term unemployment appears to have been concentrated among people in their late teens and early twenties and those older than fifty-five. For many that came of age during the depression, World War II would provide their first experience of full-time employment. With unemployment rates exceeding 25 percent, it was obvious that most of the unemployed were not responsible for their plight. Yet the ideal that success came to those who worked hard remained in place, and thus those who were unemployed generally felt a severe sense of failure. The incidence of mental health problems rose, as did problems of family violence. For both psychological and economic reasons, decisions to marry and to have children were delayed. Although the United States provided more relief to the unemployed than many other countries (including Canada), coverage was still spotty. In particular, recent immigrants to the United States were often denied relief. Severe malnutrition afflicted many, and the palpable fear of it, many more.

Effects by gender and race:
Federal, state, and local governments, as well as many private firms, introduced explicit policies in the 1930s to favor men over women for jobs. Married women were often the first to be laid off. At a time of widespread unemployment, it was felt that jobs should be allocated only to male "breadwinners." Nevertheless, unemployment rates among women were lower than for men during the 1930s, in large part because the labor

market was highly segmented by gender, and the service sector jobs in which women predominated were less affected by the depression. The female labor force participation rate— the proportion of women seeking or possessing paid work—had been rising for decades; the 1930s saw only a slight increase; thus, the depression acted to slow this societal change (which would greatly accelerate during World War II, and then again in the postwar period). Many surveys found unemployment rates among blacks to be 30 to 50 percent higher than among whites. Discrimination was undoubtedly one factor: examples abound of black workers being laid off to make room for white workers. Yet another important factor was the preponderance of black workers in industries (such as automobiles) that experienced the greatest reductions in employment. And the migration of blacks to northern industrial centers during the 1920s may have left them especially prone to seniority-based layoffs.

Cultural effects:
One might expect the Great Depression to have induced great skepticism about the economic system and the cultural attitudes favoring hard work and consumption associated with it. As noted, the ideal of hard work was reinforced during the depression, and those who lived through it would place great value in work after the war. Those who experienced the depression were disposed to thrift, but they were also driven to value their consumption opportunities. Recall that through the 1930s it was commonly thought that one cause of the depression was that people did not wish to consume enough: an obvious response was to value consumption more.

International Effects:
It was long argued that the Great Depression began in the United States and spread to the rest of the world. Many countries, including Canada and Germany, experienced similar levels of economic hardship. In the case of Europe, it was recognized that World War I and the treaties ending it (which required large reparation payments from those countries that started and lost the war) had created weaknesses in the European economy, especially in its financial system. Thus, despite the fact that trade and capital flows were much smaller than today, the American downturn could trigger downturns throughout Europe. As economists have come to emphasize the role the international gold standard played in, at least, exacerbating the depression, the argument that the depression started in the United States has become less central.

With respect to the rest of the world, there can be little doubt that the downturn in economic activity in North America and Europe had a serious impact. Many Third World countries were heavily dependent on exports and suffered economic contractions as these markets dried up. At the same time, they were hit by a decrease in foreign investment flows, especially from the United States, which was a reflection of the monetary contraction in the United States. Many Third World countries, especially in Latin America, responded by introducing high tariffs and striving to become self-sufficient. This may have helped them recover from the depression, but probably served to seriously slow economic growth in the postwar period.

The New Deal:
The nonmilitary spending of the federal government accounted for 1.5 percent of GDP in 1929 but 7.5 percent in 1939. Not only did the government take on new responsibilities, providing temporary relief and temporary public works employment, but it established an ongoing federal presence in social security (both pensions and unemployment insurance), welfare, financial regulation and deposit insurance, and a host of other areas. The size of the federal government would grow even more in the postwar period. Whether the size of government today is larger than it would have been without the depression is an open question. Some scholars argue for a "ratchet effect," whereby government expenditures increase during crises, but do not return to the original level thereafter. Others argue that the increase in government brought on by the depression would have eventually happened anyhow. In the case of unemployment insurance, at least, the United States might today have a more extensive system if not for the depression. Both Congress and the Supreme Court were more oriented toward states' rights in the 1930s than in the early postwar period. The social security system thus gave substantial influence to states. Some have argued that this has encouraged a "race to the bottom," whereby states try to attract employers with lower unemployment insurance levies. The United States spends only a fraction of what countries such as Canada spend per capita on unemployment insurance. Some economists have suggested that public works programs exacerbated the unemployment experience of the depression. They argue that many of those on relief would have otherwise worked elsewhere. However, there were more workers seeking employment than there were job

openings; thus, even if those on relief did find work elsewhere, they would likely be taking the jobs of other people. The introduction of securities regulation in the 1930s has arguably done much to improve the efficiency, fairness, and thus stability of American stock markets. Enhanced bank supervision, and especially the introduction of deposit insurance from 1934, ended the scourge of bank panics: most depositors no longer had an incentive to rush to their bank at the first rumor of trouble. But deposit insurance was not an unmixed blessing; in the wake of the failure of hundreds of small savings and loan institutions decades later, many noted that deposit insurance allowed banks to engage in overly risky activities without being penalized by depositors. The Roosevelt administration also attempted to stem the decline in wages and prices by establishing "industry codes," whereby firms and unions in an industry agreed to maintain set prices and wages. Firms seized the opportunity to collude and agreed in many cases to restrict output in order to inflate prices; this particular element of the New Deal likely served to slow the recovery. Similar attempts to enhance agricultural prices were more successful, at least in the goal of raising farm incomes (but thus increased the cost of food to others).

Phase 2
Pakistan’s Economic Turmoil:
Pakistan, a fragile economy, has been facing both economic and political crisis which predate the global financial crisis. Inflation, trade deficit, balance of payment, foreign exchange reserves, circular debt, poor performance of banking sector and Karachi stock exchange political instability have remained the key indicators of Pakistan economic crisis. Political and economic stability complement each other. Pakistan is an interesting case since both are in crisis. The war on terror has become a hanging sword overhead the rate of suicide bombing is increasing day by day. GDP growth rate is a significant indicator to access the health of an economy; It becomes worse since 2004-05 from 9.0% to 2.0%in 2008-9.Goverment of Pakistan spends approximately $ 26 billion per year based on the expected revenues of approximately $ 20 billion incurring a huge balance of payment (BOP) crisis when the entire donor community was also going through financial collapse. IMF aided with $ 7.6billion and with the first tranche of $ 3.1 billion Pakistan foreign reserve rose from $ 6billion to $ 9 billion. The price of oil fell to $77 a barrel, almost one-half of the level it had reached couple of months ago. This put a strain on the spending plans of a number of countries in the Middle East. Some of these countries had large investments planned in Pakistan. In the light of these developments the question arises as to what is the likely impact on Pakistan’s financial grounds? How should Pakistan’s policy makers respond to the developments in America, Europe and the Middle East as they begin to address the problems the country is already confronted with? The writer will attempt to answer these questions. Pakistan recent period of economic growth was based on a combination with political instability, led to a rapid in inflation, a spike in the trade and current account deficits, and a devaluation of the Pakistani rupee. Although global fuel and food prices are on the decline, the U.S financial crisis has precipitated a possibly extended global recession. For Pakistan, a global recession will likely reduce demand for its exports, inward FDI flows and overseas remittent. Official Pakistan estimates for inward foreign direct investment in 2009 reportedly show a decline of over 32% when compared ran into problems in 2008. Real GDP growth, which had been averaging above 7% per year since fiscal year 2000/2001, declined to 5.8% in fiscal year

2007/2008 and is expected to decline to2.5% in fiscal year 2008/2009.

Economic business sector impact:
Economic activity is the life blood of a nation. For a country to survive it is important that its economy is sound and successful and that business activity flourishes, but the global credit crisis and liquidity problems of many global corporations have already led to net capital outflows from rising markets, uncertain new investment projects. With fast depleting international reserves there is growing fear that the country may be forced into failure to pay on its foreign obligations. It was because of the fear that on October 6, standard and poor’s and Moody’s, two of the largest rating agencies, downgraded Pakistani bonds. This has created a terror and investors have begun to fear weathers’ Pakistan will be able to pay them back.

Impact on textile industry:
Pakistan textile industry is facing an uncertain environment. Following few factors like increase in input cost of minimum wage by 50 percent, increasing interest rates, on-guaranteed energy supplies, lack of R and D and reduction in cotton production, put a negative impact on the industry’s competitiveness internationally, because of the entire situations the companies are downsizing. Production units are being shut down and around 5000000 of the workers lost their

Jobs. After surviving load shedding now industries have face gas load shedding this also increase their cost so that’s why our industry didn’t progress and gets into loss. When light is gone in industry it take almost30 minutes to start work again and that’s the big problem your time also waste and your cost also increasing.

Social Sector Impacts:
Every problem that enters the society has its social costs that the country has to bear. Pakistan where poverty and unemployment is much already, financial crisis increases the situation.

Poverty and unemployment:
Food prices have a large bearing on poverty rate. A review of price trends of essential items during 2007-08 indicates that the prices of daily life such as wheat, flour, rice, edible, oil, vegetables and pulses. Since April 2007, the economy has witnessed over 200% increase in the price of palm oil; and an increase of 150% in wheat prices, while over 100% increase in the price of oil in the international market. The government estimates that about 25% of population live below the poverty line and this average increases just because of food inflation. Economic growth has slowed down considerably during the last three years. The industry and construction sectors have contracted due to the domestic slowdown and energy shortage and also due to global recession. People are being laid-off especially from foreign or multinational companies in order to reduce costs through downsizing. It has become even tougher for a freshman to find a suitable job than it was five years from now. According to one estimate, Pakistan’s unemployment rate in urban areas is nearly 40% and in rural areas over 60%. Increase in poverty means, decrease in average standard of living, poor health and education, and low-paying job, more population which is again makes it difficult to maintain their needs.

IMF: Solution or more pain?
On 24 November 2008, the executive board of the IMF agreed to bail Pakistan out by agreeing to a stand-by arrangement (SBA) valued at $7.6 billion. The two conditions are a cut in the budgetary shortage from around 7 percent to GDP of 4.2percent of GDP and an increase in the taxation from 10 percent of GDP to 10.5 percent of GDP. The fact of the matter is that 2 out of 3 Pakistanis are already at or below $2 a day. An increase in taxation would mean a further slowdown in the economy. A further slowdown would mean increased unemployment. Same thing with the rate of interest this high cost of capital is bound to shut down a lot of our industrial units and that means even more unemployment’s. All this slowdown and all this additional unemployment could very well bring Pakistanis Out on the streets and that means a full blown political crisis.

External Financing:
The global crisis has restricted Pakistan’s ability to tap international debt capital markets to raise funds. An increasing cost of borrowing internationally, coupled with deterioration in the country’s credit rating has ruled out issuance of government prepares a financing mechanism. Pakistan’s presence in the international capital markets in2008-09 was limited to the repayment of Eurobond amounting to US$ 500 million made in February 2009 with no new issuance at the backdrop of financial crisis engulfing the global markets. Banking sector: According to Fitch ratings, “the Pakistani banking system has, over the last decade, gradually evolved from a weak state-owned to a slightly improved and active private sector motivated system. But as of end 2008, data from the banking sector confirms a slowdown. As of October 2008, total deposits fell from RS 3.77 trillion in September to RS 3.67 trillion. Provisions for losses over the same period went up from RS 173 billion in September to Rs178.9 billion in October. Market analyst Muhammad Suhail told the Los Angeles times. “The global crisis has really fuel to the fire. There was a time window earlier this year to address all this, and we missed it.” The drying up of credit internationally has hit Pakistan hard with the banking system suffering a severe liquidity problem. Overnight call rates rises so much and it’s ranging from 32 to 40 percent.

Circular debt:
On 26 January 2009, Raja Pervez Ashraf, Minister for water and power, told the senate that the “federal government will settle half of the RS 400 billion circular debt by the end of January.” Circular debt arises when the Government of Pakistan owes and is unable to pay billions of rupees to oil marketing companies (OMC) a to independent power producers (IPPs). Stock market: The Karachi stock market exchange (KSE) is Pakistan’s largest and the runniest exchange. It was the “Best performing stock market of the world for the year 2002.” Due to the global financial crisis stock market also disturbs very much. As of the last day of December 2008, Karachi stock exchange had a total of653 companies listed with an accumulated market capitalization of RS 1.85trillion ($23 billion). On 26 December 2007, Karachi stock exchange, as represented by the KSE-100 index closed at 14814 points, its highest close ever, with a market capitalization of RS 4.57 trillion ($58 billion). As of 23January 2009, KSE-100 index stood at 4929 points with a market capitalization of RS 1.58 trillion ($20

billion),

a

loss

of

over

65

percent

from

its

highest

point

ever.

Inflation:
Rising food and fuel prices have been a major source of inflationary pressure in South Asian countries especially Pakistan. In Pakistan, food prices mad a bigger impact on inflation than fuel, and wheat prices more than doubled, due to poor domestic production and export restrictions. The combined effects of lower food and fuel prices along with demand management are reducing inflationary pressure in most South Asian countries but conditions have not been that favorable in case of Pakistan. In the year 2009 core inflation rose to 18% from the 14.7% 2008. In year 2009 inflation accelerated at rapid speed mainly because of food prices which increased as a result of high prices of widely consumable items such wheat, wheat flour , sugar and meat etc., owing to their to their supple shortage.

Conculusion:
In our opinion The Great depression and the financial crisis of Pakistan are based on two different scenarios. Some key points are discussed below.  The Great depression was resulted because of demotivation of consumers.  We recorded a downfall in the prices, while in the economic crisis of Pakistan, we saw a rapid increase (almost 250%) from 2007-2011.  We noticed a sharp increase in the inflation rate of both times.  Unemployment rate was increasing in both situations but we can’t compare them because in The Great Depression we saw a rapid increase of 607% which is the highest rate in the history of world. Even in Pakistan we are not facing such a high number.  We noticed a sharp downfall in the industrial production of The Great depression. This downfall was because of people’s demotivation towards purchase, while in Pakistan the downfalls in different industries are because of Government policies and energy crises. People are willing to purchase but goods are available on high cost because of higher production cost.  The Great Depression caused a decrease in wholesale prices while in Pakistan we saw an increase in prices, because people are willing to purchase.  We noticed a stock market crash in both situation but the stock market crash of The Great Depression was worst then KSE crash. It took years to recover the stock market on the time of The Great Depression while our stock market recovered within a year.

We saw a decrease in agriculture production while in the time of The Great Depression but we noticed a sharp increase in agriculture production in Pakistan after crisis because of good government policies.

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