Inflation and Poverty Alleviation

The high rate of inflation in Pakistan in recent years has hampered the progress towards poverty alleviation because inflation is a regressive form of taxation, adding to economic hardships of the poor who are not in a position to shield their real incomes or purchasing power from its effects. Pensioners, widows and other fixed-income or low-income segments of the population have no potential to hedge themselves against inflation or have their income streams adjusted for the eroding effects of inflation. Unlike some wealthy groups they are also unable to make wind-fall profits out of an inflationary environment through the hoarding of goods, investment in real estate and the like. As the poor keep their savings mainly in the form of bank deposits or other financial instruments, and since rates of return on savings have been low in relation to inflation, this has led to a transfer of resources from savers to borrowers.

Inflation also has serious work disincentive effects on the poor. The incentive to work is taken away from labor when it sees the real purchasing power of already low wages going down further. In addition, inflation causes relative price distortions and dead-weight efficiency losses, which directly lower the productive base of the economy, discourages savings and channels them into less productive activities like speculation in real estate. As a result, the factor proportions problem is exacerbated by the low rate of capital accumulation in the context of the high growth of the labour force.

The major reason for the high rate of inflation in Pakistan in recent years has been the sharp divergence between the growth rates of money supply and real output. During the last five years, money supply has increased at an average annual rate of about 20 percent but the average growth rate of the economy has been less than 5 percent, which meant an “inflationary gap” of about 15 percent per annum. This gap must be reduced through high growth on a sustained basis and reduction in public-sector borrowings which has, in the past, been the main cause of monetary expansion in Pakistan. The greater emphasis that is now being placed on fiscal discipline and monetary restraint, together with expected high output growth in 1995-96 and beyond, should lead to lower inflation and ease at least this burden that the poor have been carrying for too long.

Source: Poverty Alleviation in Pakistan: Present Scenario and Future Strategy, Mohibul Haq Sahibzada. Republished with permission.