Academic journal article The Lahore Journal of Economics

The Growth and Employment Impacts of the 2008 Global Financial Crisis on Pakistan

Academic journal article The Lahore Journal of Economics

The Growth and Employment Impacts of the 2008 Global Financial Crisis on Pakistan

Article excerpt

(ProQuest: ... denotes formulae omitted.)

1. Introduction

The global financial crisis of 2008, caused by a liquidity shortfall in the US banking system, permeated quickly into other advanced economies, given the increasing interdependence of global financial markets. Its ripple effect ultimately filtered through into developing countries' financial markets. The crisis also had significant effects on the real global economy, accounting for its worst economic performance since the Great Depression: world output growth declined from 5.2 percent in 2007 to -0.6 percent in 2009 (Malik & Janjua, 2011). However, the impact of this global credit crunch has varied from region to region and even from country to country, depending on the degree of financial and economic integration.

At the time of the global financial crisis in 2008, Pakistan's current account balance had deteriorated,1 while poor law and order combined with severe energy shortages had caused a sharp decline in investment. * Assistant Professor, Kashmir Institute of Economics, University of Azad Jammu and Kashmir, Muzaffarabad, Pakistan. This two-pronged effect adversely inflated the terms of trade and worsened the country's overall macroeconomic balance. Pakistan attempted to overcome these challenges by adjusting domestic fuel prices, reducing development spending, and tightening its monetary policy. With the emergence of the global financial crisis, there was a significant decline in foreign capital inflows, further hindering domestic investment. This reduced stock prices as well as foreign reserves, causing the exchange rate to depreciate. Meanwhile, the crisis triggered a significant setback to the real global economy and a reduction in global demand, both of which had severe consequences for Pakistan's economy. The fall in domestic demand as well as in the demand for exports adversely affected the manufacturing, agriculture, construction, and IT sectors.

The aim of this study is to show how these proximate effects were transmitted to the economy in terms of overall economic growth and employment. Our approach differs from that of other studies in at least two respects. First, rather than examining the implications of the crisis in a comparative setting-thereby ignoring the individual characteristics of different economies-we analyze the dynamic effects of the crisis on Pakistan's economy. Second, we employ a more comprehensive approach than most other studies have done.

The rest of the study is organized as follows. Section 2 briefly reviews the literature on the recent financial crisis. We focus not only on studies that explore the implications of the crisis for Pakistan's economy, but also on those relevant to other economies. Section 3 explores the major channels of transmission through which the global financial crisis affected Pakistan. Section 4 presents the estimation methodology, constructs the relevant variables, and describes the data used. Section 5 discusses the empirical findings of the analysis and Section 6 concludes the paper.

2. A Review of the Literature

The 2008 financial crisis has had serious implications for development goals and spurred considerable academic and policy research on the channels and consequences of the crisis. This section divides the existing literature into two categories: descriptive and empirical.

2.1. Descriptive Analysis of the Impact of the Financial Crisis

Characterized by high unemployment rates and the incidence of poverty, South Asia has been particularly vulnerable to international shocks. The World Bank (2009) reports that the region's real GDP growth rate decreased from 8.7 percent in 2007 to 6 percent in 2009. The study attributes this slowdown to the reduction in South Asian exports triggered by the financial crisis. However, the overall impact of the crisis was less severe than it might have been for two reasons. First, the South Asian economies are relatively closed. …

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