LAHORE:
Like other developing economies, Pakistan’s economy is a dualistic one, composed of both formal and informal sectors. The formal sector is modern in character, while the informal sector remains largely traditional. Over the years, the formal sector has stagnated, whereas the informal sector has expanded in the era of financial globalisation.
Development experts generally presume that as an economy grows, the formal sector should expand while the informal sector contracts. This was the case in Pakistan from the 1950s to the late 1970s.
In Pakistan’s context, the formal sector comprises large-scale manufacturing, formal agriculture, and high-value-added services such as banking, insurance, IT, and construction. When the formal sector expands, it absorbs a larger share of the workforce.
Since the 1990s, however, economic growth has been intermittent, and the formal sector has remained largely stagnant. This sector absorbs workers during economic booms and sheds them during recessions.
Meanwhile, the informal sector has continued to grow. In FY 2021, the Pakistan Bureau of Statistics (PBS) estimated that around 73% of the workforce operates in the informal sector, highlighting its dominant position in the economy.
A significant component of the formal sector consists of large-scale manufacturing industries. The index of large-scale manufacturing industries decelerated by 1.9% from July to December 2024, indicating that large-scale industries are operating at low capacity. This also implies weak demand for industrial products – if demand were to rise, capacity utilisation would increase accordingly.
Given Pakistan’s current economic structure, demand for large-scale industrial products primarily comes from workers employed in those industries and the farming sector. Specifically, medium-sized farmers and merchants possess the purchasing power to buy these products. However, in the current financial year, the government has revised tax brackets, increasing taxes on salaried individuals.
These salaried individuals have contributed approximately Rs250 billion to the national treasury in the first six months of the financial year, with their total contribution expected to reach around Rs575 billion. The salaried class has become the third-largest contributor to tax revenues. However, these increased taxes reduce aggregate demand in the economy, which in turn lowers capacity utilisation in the industrial sector.
A dualistic economy also faces a long-term trade-off between consumption and investment. Here, investment refers to economic investment, which enhances the productive potential of the economy. Investments in human capital such as education and healthcare are crucial, alongside investments in machinery, tools, fixtures, and infrastructure.
If the current generation prioritises luxury consumption, the next generation will bear the cost in the form of lower economic investment. For instance, the widespread consumption of imported SUVs may satisfy a small segment of society but comes at the expense of millions of others. Similarly, the import of fruits and household appliances consumes precious foreign exchange reserves.
On the government’s part, the recent drop in international oil prices will reduce the oil import bill, providing a slight relief to Pakistan’s foreign exchange constraints. This financial cushion should be utilised wisely to support the industrial sector.
In short, the challenge lies in curbing luxury consumption – a formidable task given that the economic and political elite will likely resist any such measures. However, by reducing luxury consumption, resources can be redirected towards economic investment.
This shift would enhance the economy’s productive potential and help expand the formal sector. The question remains: will policymakers take the necessary steps?
THE WRITER IS AN INDEPENDENT ECONOMIST WHO WORKED AT SDSB, LAHORE UNIVERSITY OF MANAGEMENT SCIENCES (LUMS)