Consumption-driven growth: an economic nightmare

LAHORE: Pakistan’s economic growth is largely driven by consumption rather than domestic production and investment, leading to recurring external account crises. Consumption-based growth exacerbates economic disparities, primarily through unequal access to income, credit and assets.

Growth fuelled by consumption disproportionately benefits those with higher disposable incomes, as they can spend more. This increases demand for goods and services catering to middle- and upper-income groups while neglecting the basic needs of lower-income populations. Rising consumption often drives inflation higher, eroding the real incomes of the poor, who spend a larger share of their earnings on essentials such as food, housing, and utilities. Consumption booms are frequently financed by credit expansion, benefiting those with access to loans -- typically the wealthy. This, in turn, drives asset price inflation in real estate and stocks, widening wealth gaps as asset-owning classes see their wealth multiply.

Consumption-led growth tends to generate jobs in the services and retail sectors, which are often low-wage and insecure. In contrast, investment-led growth -- such as in infrastructure and manufacturing -- typically creates more stable and better-paying jobs. When consumption outpaces domestic production, reliance on imports increases, leading to trade deficits. This weakens local industries and heightens exchange rate volatility, disproportionately affecting the poor through imported inflation.

Pakistan’s current economic growth is primarily consumption-driven, fuelled by household and government spending rather than investment or exports. This short-term consumption-based model undermines long-term productivity, making the economy highly vulnerable to external shocks such as currency depreciation, inflation, and debt crises.

Private consumption accounts for 80-85 per cent of Pakistan’s GDP -- a significantly higher share than in economies that prioritise investment and exports. In contrast, investment-led economies such as China have consumption levels at 40-50 per cent of GDP, with the remainder driven by capital formation and exports. In 2023, household consumption expenditure in India accounted for approximately 60.3 per cent of GDP, while in Bangladesh, it was around 68.6 per cent. Similarly, South Korea’s household consumption expenditure stood at 48.9 per cent of GDP, whereas in Indonesia, it accounted for over half of the country’s GDP.

During periods of rapid, consumption-driven growth, individuals may develop unrealistic financial expectations, such as excessive borrowing for lifestyle spending. In contrast, moderate, employment-driven growth fosters a focus on job security and wages, leading to more rational economic and electoral behaviour.

Pakistan’s investment-to-GDP ratio remains below 15 per cent -- among the lowest in the region -- indicating that people and businesses are spending rather than reinvesting in productive assets. In comparison, countries such as Bangladesh and India maintain savings rates above 25 per cent, supporting long-term investments.

A significant portion of Pakistan’s consumption depends on imported goods, resulting in frequent trade deficits and current account imbalances. Consumer goods, including vehicles, electronics and food items, constitute a major share of imports, while exports remain low and undiversified. The manufacturing sector contributes only 13-14 per cent to GDP, reflecting weak industrial growth. Investment in productive sectors such as machinery, factories and infrastructure remains sluggish, leading to jobless growth.

The government relies heavily on domestic and external borrowing to finance expenditures, particularly for subsidies, government salaries, and defence. Development spending -- critical for long-term economic growth -- remains low compared to current expenditures.

Whenever credit availability increases -- typically through loose monetary policy -- there is a surge in consumption, particularly in real estate, automobiles and imported goods. This leads to rising imports, currency depreciation and inflation, ultimately forcing policy adjustments that slow growth. The cycle repeats itself because investment and productivity growth remain weak. Rising demand without corresponding productivity gains fuels inflation and weakens the rupee. Without industrial and export growth, employment opportunities remain scarce, exacerbating income inequality and youth unemployment.

To achieve sustainable economic growth, Pakistan must increase domestic investment in manufacturing, infrastructure, and technology. It needs to expand its export base beyond textiles and enhance value-added production. Formalising the economy to bring more businesses into the tax net and encourage productive investment is also essential.