Sunday, 11 August 2013

Estimating the Footprint of the Government on the Economy

Estimating the Footprint of the Government on the Economy

The Planning Commission Framework for Economic Growth (FEG) established that the footprint of the government in the Pakistan economy was very large. Often people note that government expenditures as a percentage of GDP are only 22% and therefore the size of the government in the economy is not large. This line of argument is again used to establish a basis for arguing for increased taxation.

The FEG noted that the percentage of government expenditure in GDP was not the correct measure of the influence of government in the economy where the government is
  1. Still controls a large number of Public sector enterprises (in fact the largest companies listed on the stock exchange are largely owned and managed by the government).
  2. The government still engages in many market transactions often as a dominant player (eg. energy, construction commodities etc).
  3. An aggressive tax subsidy policy as well as tax expenditures (SROs) direct market activities even at the cost of excessive barriers to entry.
  4. A regulatory framework that often inhibits investment and market opportunities (the most egregious example of this is the serious hurdles in the development of the construction industry and city development).

With this in mind we calculated the footprint of the government on the basis of contribution of government in all sectors of the economy, which is measured by government spending, earning of government institutions, price support subsidies and based on market share in these sectors. The final results of the calculation are given below.

Table 1: Size of the government Foot Print


Govt. share in sector
Sector share in the economy
Govt. Share in the economy


Agriculture
43.06
20.91
9.00
Manufacturing
11.90
18.70
2.23
Transport and Communication
73.38
9.99
7.33
Electricity and Gas
77.63
2.20
1.71
Wholesale and Retail
7.90
17.20
1.62
Health and Education
49.26
12.29
7.17
Public Admin and Defense
100.00
6.60
6.60
Finance and Insurance
45.5
4.50
2.03
Construction
75
2.51
1.88
Ownership of Dwellings
100
2.70
2.7
Mining & Quarrying
79.6
2.40
1.91
Total
100.00
44.17
In this calculation the share of government is 44.17%, out of total GDP. This is what the government directly controls in the economy. The decision in these areas are dependent on the government.
In addition to directly influencing the economy, governments also use regulations to control the direction of the economy. These regulations can be in the form of wage control, tariff and non tariff barriers, regulations for starting new businesses and legal framework as an obstacle to competitiveness etc.
Calculating regulatory burden is a complex exercise. For US, regulatory burden accounts for 8% of the national economy. Kaufmann, Kraayand and Mastruzzi (2010) have come up with Worldwide Governance Indicators which also looks at the effectiveness of all the regulations in every country (Regulatory Quality index). The index includes all the variables needed to calculate regulatory burden. US gets a score of 89.5 out of 100 (higher is better) whereas Pakistan gets a score of 33.3 out of 100 ie., Pakistan's regulatory burden is at least 3 times as much as the US (assuming and unrealistic linearity).
Here we will consider to Pakistan's regulatory burden to be only twice that of the US to make our point. Crain and Crain (2010) have estimated this cost of regulation to the economy to be about 8% of GDP. By this reasoning we can expect Pakistan's regulatory burden to be about 16% of GDP. In other words, trade barriers, obstacles to investment etc. are costing Pakistan’s economy 16% of its GDP. I may also add given the reasoning that we have presented in the FEG on the manner in which city development, the services sector and the construction industry are held up through bind regulation, this is likely to be significant underestimate.
However, for discussion purposes let is add the two together we can find an estimate of the size of the government footprint on the economy to be over 60% of GDP.