Impact of Financial Crises on Pakistan and China: A Comparative Study of Six Decades

174 JOURNAL OF GLOBAL BUSINESS AND ECONOMICS

JULY 2011. VOLUME 3. NUMBER 1

IMPACT OF FINANCIAL CRISES ON PAKISTAN AND CHINA: A COMPARATIVE

STUDY OF SIX DECADES

Muhammad Umar Draz

-Lecturer in Accounting and Finance at Department of Commerce,

Bahauddin Zakariya University, Multan, Pakistan

-Doctoral Scholar, Accounting School,

Zhongnan University of Economics and Law, Wuhan, China

[email protected]

ABSTRACT

This work is intended to find out the impact of Financial Crises on Pakistan and China and to conclude

that which country faced more external financial blows in its history of more than sixty years. We have

taken into consideration the Gross Domestic Product (GDP) growth rates of both nations and Chow Break

Point testing is applied individually for tracing whether the years of global and international financial

crises appear in the economy or not. The results of our analysis obtained from EViews illustrate that

China was smacked by the external financial crises more than Pakistan.

Keywords: China, Chow Break-Point Test, Economy, Financial Crises, GDP Growth, Internal

issues, Pakistan.

JEL Classification: G01, O57

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1.0 INTRODUCTION

Financial crises are not a new phenomenon; rather world’s history is replete with them. It has been

observed that besides its numerous virtues, globalization, starting from early years of nineteenth

century’s second half (Eichengreen & Bordo, 2001), changed the nature and impact of financial crises.

Highly connected financial markets proved very useful in many aspects but fell an easy-prey to the

drastic dangers as well. In earlier centuries prior to globalization, if there was any default or financial

epidemic, it was limited to few nations or a continent only but the situation was radically changed with

the steady spread of globalization. Currently, not only sound of financial blow is heard worldwide but it

actually thrashes the globe too within no time. Recent global financial crisis which started from the

United States but traumatized almost all the nations is the best example in this matter. This calamity not

only had severe impact in the origin but also left profound marks almost everywhere in the world.

The prime reason of this comparative study about Pakistan and China is the fact that both of the nations

are developing countries and on this ground Ma & Jalil (2008) have made the comparison of both

countries’ financial development, economic growth and adaptive efficiency while Shah, Yuan, & Zafar

(2010) have also conducted the comparative analyis of Pakistani and Chinese listed companies. Another

fundamental reason of this comparison is the life-span of both nations after being established i.e.

Pakistan achieved freedom in 1947 while Peoples’ Republic of China was founded in 1949, so both



nations had almost equal time to to lay-down the sound brass-tacks and to flourish their economies. As

far as the impact of financial crises on Pakistan and China is concerned, during six decades of their

foundation, as asserted by Draz (2011), both nations have experienced equal number of financial crises

i.e. four out of the seven global financial crises and one severe Asian crisis of 1997 which is another key

factor making these two countries comparable for our study.

The structure of this work contains six parts in total. After the inaugural two parts comprising of

introduction and literature review, the impact of financial crises on Pakistan and China is explored in the

third and fourth part of this paper respectively. Statistical analyses regarding this impact are carried out

in the fifth part whereas conclusion and implications are discussed in the last part. The problem

statement of this brief work is as under:

The Problem Statement

Whether Pakistan was affected more by the financial crises or China; and what was more drastic for the

Pakistan’s economy, internal issues or external financial crises, which caused huge distance between

both of the nations in terms of economic development?

2.0 LITERATURE REVIEW

There is ample amount of research available regarding Pakistan’s economic fluctuations, policy matters

and the factors affecting the economy. Among the most prominent works is the exploration of Arby

(2001) who studied the ups and downs of economy by decomposing the GDP of Pakistan and through

business cycle movements; his work shows the expected rise in GDP growth from fiscal year 2001.

Another remarkable work is done by Husain (2009), the former Governor of State Bank of Pakistan who

summarized comprehensively the six decades of Pakistan’s economy and how it was affected by the

politics and other factors. His work generally notifies the economic history of the country but the

specific issue of impact of financial crises is not included. The work of Khan (2009) is notable regarding

the problems in policy implementation which caused great damage to the economy of Pakistan when it

was facing crises. Another distinguished study regarding the dilemmas of Pakistani economy is done by

Martin and Kronstadt (2009); they summarized the economic problems of Pakistan and relevant

suggestions for the U.S. policy.

When we look for the literature with reference to the impact of financial crises on Pakistan, Sheikh and

Gopang (2009) analyzed the impact of global financial crisis 2008 on the poverty in rural part of Sindh

province of Pakistan and compared it with other provinces. Moreover, Haque (2010) described the

causes of financial distress in Pakistan and steps taken for the economic management of this

catastrophe. Both of these papers are limited to the global financial crisis of 2008 only so there is a need

to study the impact of other financial crises on Pakistan’s economy.

There might be plenty of literature available in Chinese language but as far as impact of financial crises

on China is concerned, we found a severe lack of English work in this subject. Among the available

studies, Schmidt (2009) enumerated the short term and long term impacts of financial crisis 2008 on

China. Chow & Li (2010) used the Cobb-Douglas function to study the growth of labor, capital and total

factor productivity with special reference to China. They conducted their analysis from 1952 to 2010 but

this work only covers the economic growth aspect and the impact of financial crises on China is still

missing.



Among the comparative studies about Pakistan and China, most of the literature addresses the issues of

strategic relations, military and defense cooperation. One of the most prominent work regarding finance

and economy is done by Ma & Jalil (2008) in which, by testing finance-fluctuation nexus hypothesis, they

have observed the decrease in macroeconomic volatility as a result of improvement in financial markets

for Pakistan and China in specific, while for all the developing countries in general. This paper is

proposed to bridge the gap of literature about the following aspects:

1. Which nation (Pakistan or China) was affected greatly by the external financial crises?

2. What were the core reasons that Pakistan is left way-behind in the economic prosperity

as compared to China; was it due to external financial crises or internal issues?

3.0 GLOBAL FINANCIAL CRISES IN THE HISTORY OF PAKISTAN

Facts show that internal matters e.g. political instability, flaws in formation and implementation of

indispensable policies, regular hostility with India and weak law and order conditions caused greater

financial and economic damage to the country as compared to external shocks and global financial

crises. From 1950 to 2000, except first decade only, Pakistan’s average GDP per decade remained higher

than global average (Ashraf & Ghani, 2005). Especially during second decade after its establishment,

Pakistan’s financial and economic position was emerging really impressive (See Figure 1) but afterwards

it became a part of the history and there is absence of any hope until now.

After being hit by Asian financial crisis during last years of twentieth century, Pakistan was already going

through deficits when ongoing financial crisis erupted and situation became worse with the impacts of

this catastrophe (Saleem, 2009). Initially, no big shock was observed but effects were clearly visible later

on and default was hardly avoided by financing from IMF (Ali, 2009).

Table 1: Pakistan’s GDP Growth

Source: Federal Bureau of Statistics (FBS), Govt. of Pakistan



First three of the seven global financial crises (i.e. crises of 1857, 1873 and 1929), as studied by Draz

(2011), are not related to the Pakistan since independence was achieved from the British rule in 1947.

The economic growth during inaugural decade of this newly established country was just 3.5% per

annum and more emphasis was given to the refugees, constitution and political issues (Khan, 2002). Dr.

Ishrat Husain, former governor of State Bank of Pakistan, describes this preliminary decade as ‘Flat

fifties’ and asserts the divided geography (i.e. East and West Pakistan) as a severe matter right at the

foundation time (Husain, 2009). The impact of financial crises on Pakistan’s economy is discussed below:

A. Financial Crisis 1958

First decade in Pakistan’s history was all about recession which lasted up to 1959-60 and recovery was

started from this point forward; as far as global crisis 1958 did not leave any significant effects on

Pakistan since business cycle was already moving towards extreme depression and GDP was also having

downfall from few years (Arby, 2001). Moreover, boom was achieved within 9 years only while this

global crisis was still in progress in some countries during those years as mentioned by Kindleberger &

Aliber (2005).

Figure 1: GDP Growth of Pakistan

B. Financial Crisis 1974-75

Unluckily, Pakistan faced war with India in 1965, continuous political issues and then separation of its

east part in 1971 which is Bangladesh at present. Even after a war, Pakistan’s economy was flourishing

commendably but ‘The Golden Sixties’ for which Harvard experts’ guidelines were infused, as mentioned

by Husain (2009), turned into ‘The Socialist Seventies’ and result was decrease in GDP but increase in

inflation and unequal distribution of income. Along with internal disaster, financial crisis of 1974-75

containing oil prices shock also added fuel to fire meanwhile [For further insights about these issues, see



Husain (2009) Page 05]. After this global financial blow, Pakistan’s recession-facing economy moved

further towards bottom and finally started to recover in 1979-80 (Arby, 2001).

C. Financial Crisis 1979-82

The global crisis of 1979-82 didn’t affect Pakistan so much and economy achieved an average growth of

7% per annum from 1977 to 1988 (Khan, 2002). The business cycle drawn by Arby (2001) also signifies

that Pakistan was in recovery period during this financial crisis time period. Another evident fact which

helped Pakistan during this period was signing agreements with World Bank and IMF, foreign exchange

inflows from overseas and handsome financial assistance during Soviet War (Khan, 2002). On the other

hand, almost all the authors and experts are agreed that Pakistan paid a huge price of War assistance in

the form of guns, groups and drugs culture, which are shaking the nation’s basis even now. ‘The

Revivalist Eighties’ in Husain (2009) and ‘Growth with a Receding State’ in Khan (2002) clearly portray

the real picture of this awful dilemma.

D. Asian Crisis 1997 and Pakistan

Facts are evident that Pakistan was moving towards economic and financial prosperity with incredible

pace and was not much affected by financial crises but huge political, constitutional and other internal

and external issues awe-inspiringly wrecked the nation. Pakistan was among non-defaulter nations till

late 1990s but joined the list during Asian crisis (Reinhart & Rogoff, 2004). The Asian crisis also hit

Pakistan and right after one year, nuclear tests in May 1998 made Pakistan isolated in economic and

financial perspective since many sanctions were imposed from the Western nations. Later on, situation

became better by the crisis management efforts and vigorous policies of military government (Husain,

2005). At this time, it was very hard to restore the investors’ trust since political government had caused

a serious damage in the form of freezing accounts and some media issues (Khan M. Z., 1999).

E. Global Financial Crisis 2008

Having less global connectivity, Pakistan was not hit directly by this crash but was indirectly affected in

shape of trade losses resulting from fall in demand and prices level (Ali, 2009). Internal issues made the

situation worse because appropriate policies for tackling the trade losses could not be made (World

Bank, 2009). Pakistan spared the early days of this crisis and many experts including Dr. Shamshad

Akhtar, governor of State Bank of Pakistan at that time, were of the view that crisis will not influence

Pakistan so much (Subohi, 2008). But this expectation was proved wrong when crisis pressed Pakistan’s

real GDP from around 8% to above 3% accompanied with more than 25% inflation and painstaking

unemployment (Nanto, 2009) and (Martin & Kronstadt, 2009). This crisis shocked the share markets

and share prices too. Index of Karachi Stock Exchange, the biggest stock market of Pakistan, lowered

down to 9144 points on August 27, 2008 (Peiris, 2008) from highest ever peak of 15373 points on April

20 in the same year (Mohammad, Hussain, & Ali, 2009). On the other hand, some after effects of this

crisis were not seen in Pakistan, of which solvency of banking sector and no panic regarding sale of

currency are prominently citable (Haque, 2010).

This crisis has also shown quite intensive impact on common-man which is suffering due to decrease in

purchasing power and people in some rural areas are even selling their children for PKR 25000 i.e.

around $ 300 only (Shaikh & Gopang, 2009). Peiris (2008) also asserted that “household groups with

below PKR 3000 income level” were facing 33% inflation and only cereals were available to 20% of the

poor most population after spending more than half of their income. No doubt, financial crisis 2008 hit



Pakistan but it was not the foremost reason of all financial and economic problems of the nation. The

country was facing more from inside, rather than outside and its misfortune regarding leaders, policies,

political condition and involvement in international issues was still going on (Husain, 2009). Just imagine

about the leadership and political condition from the fact, as reported in Pakistan’s Daily Jang (2010),

that president of country is alleged in 40 judicial cases within Pakistan and 9 cases abroad. [See

Pakistan’s “Daily Jang” dated October 25, 2010.]

4.0 IMPACT OF GLOBAL FINANCIAL CRISES ON CHINA

After starting the journey in 1949, the economy of China faced many ups and downs. At the time of first

three global financial crises, as shown in Figure 2 below, there were quite hard times for its economy.

During the reign of Mao Zedong, economic relations with outer world were not that much but his

ancestors, Deng Xiaoping especially, decided to open the doors of China for whole world in 1978

(MacFarquhar, 1987). The rainy days of Chinese economy are no more now and its economic growth

plus position among economic giants is an open secret.

Table 2: China’s GDP Growth

It is observable in Table 2 that China was going impressive in terms of economic growth during 1950s

but GDP growth percentage went deep down (i.e. -27.30% in 1961) as a result of the global financial

crisis 1958. Its economy again faced the negative GDP growth after the global financial crisis 1974.

During the Asian financial crisis, China successfully avoided the negative GDP growth but the crisis

interrupted this pace of growth by lowering it down from double figures to single digit. It happened

again in the next decade when global financial crisis 2008 smacked down most of the economies. This

financial crash not only wrecked the American and European economies, Asia was thrashed severely as

well. The emerging economy of China also had tough time in terms of rise in unemployment and

inflation along with decline in GDP growth (Schmidt, 2009).



Figure 2: GDP Growth of China

If we look from the GDP growth’s point of view, the economy of China was hit by all the financial crises

and its economy experienced the decline in GDP growth during all the crises at global and international

level.

5.0 RESEARCH METHODOLOGY AND RESULTS

As mentioned earlier, five big financial crises took place during the lifespan of Pakistan and China which

were related to these nations. To analyze the impact of these crises, we have used the data of Pakistan’s

GDP growth, from fiscal year 1951 to 2009, which is taken from the website of Federal Bureau of

Statistics (FBS) while China’s GDP growth from 1953 to 2009 is also used in the analysis. The financial

crises of 1958, 1974, 1979, 1997 and 2008 are taken as break points in our methodology.

A. Chow Break point Test for Pakistan and China’s GDP growth

Chow Break point Test is used by the many researchers to find out the structural breaks of the

relationship studied; see for example Guidolin & Tam (2010) who analyzed the effect of global financial

crisis 2008 on the yield spreads and found, by applying Break point tests, the breaks in yield caused by

this crisis. Chow & Wang (2010) also applied the Chow Test for analyzing the parametre stability while

studying the inflation in China. The same test i.e. Chow Break point test is used by Mukhopadhyay &

Pradhan (2011) for identifying the structural breaks in the finance-growth relationship of Indonesia. Last

but not least, Hossain (2011) employed the Chow break point test and found a structural break in the

money-demand relationship for Indonesia caused by the Asian financial crisis 1997.

The variations of GDP growth for Pakistan and China are analyzed by Chow Break point Test in our study

too. Aforementioned five financial crises are observed by this methodology to conclude which of those



hit the economy of both nations. GDP Growth (GDPGR) and Time (T) are the variables used. For each of

the financial crisis, a separate equation is constructed for examining the relationship of GDPGR and T.

Afterwards, the stability of all those equations is measured by the Chow break point test. The conclusion

from Chow test is based on hypothesis testing which consists of the comparison of the probability of

calculated F-value with Ϝα (α = 0.05). Following econometric equation is used to calculate F-value:

RSST – (RSS1 + RSS2) / K Ϝ = (RSS1 + RSS2) / (T – 2K)

Where RSST = Residual Sum of Squares (Total)

RSS1 = Residual Sum of Squares (for first half of the sample size)

RSS2 = Residual Sum of Squares (for second half of the sample size)

K = Number of Parameters

T = Number of years in the sample size

And Null Hypothesis (H0) = There is no Break point in GDP Growth

Alternative Hypothesis (H1) = There is Break point in GDP Growth

If the probability of calculated F-value is greater than Ϝα (α = 0.05), then accept the null hypothesis (H0)

i.e. there is no break point in GDP Growth.

Table 3: Results of Chow Break point Testing

B. Findings and Discussion

Using the results drawn from EViews shown in the Table 3 above for Pakistan, since the probability of F-

statistic is less than level of significance (α = 0.05) in 1958, 1974 and 1997 so we accept alternative

hypothesis (H1), i.e. there is Break point in GDP Growth. We further observed that break point of the

financial crisis 1979 appears in Pakistan’s GDP during 1982 and 1983 at 10% and 5% level of significance



respectively. This crisis was prominently severe from 1979 to 1982 and our analysis depict that Pakistan

was affected when this crisis was already over; hence it was due to the other issues and not the financial

crisis. For 2008, we accept the null hypothesis (H0) i.e. there is no Break point in GDP Growth because

probability of F-statistic is more than the level of significance. One of its understandable causes is the

deficit crisis of Pakistan’s economy just before this global crisis. Moreover, economy was not affected

directly by this crisis and there were indirect effects on demand and trade.

In case of China, we can easily observe that probability of F-statistic is less than the level of significance

in all the years of financial crises which leads towards the rejection of null hypothesis (H0) and

acceptance of alternative hypothesis (H1) i.e. Break point was discovered in the GDP growth; hence all

the financial crises caused damage to the economy of China. These findings are summarized below:

Table 4: Summary of the Chow Test Results

It is evident from the graphical overviews and statistical results that China faced more financial crises as

compared to the Pakistan. The interesting fact to be noted here is that China was established two years

later than Pakistan and its economy faced more external financial blows but yet has successfully

managed to become the second biggest economy of the world. Another notable reality about China’s

economy is its quick recovery after all the five financial blows discussed in our study. Moreover, the

recovery was not in terms of positive GDP growth rather it was remarkable to maintain the same pace

so quickly. To know the comparative economic performance during these crises, let’s have a look on the

decade-wise GDP growth of both countries.

Table 5: Decade-wise GDP Growth Average



Despite the fact that Chinese economy faced hard times during all the financial crises, its decade-wise

GDP growth percentage is lower than Pakistan only in the 1960s and in all other decades, Pakistan is no-

where near to its growth rates. Pakistan was not hit by the financial crisis 1979 and 2008 but its GDP

growth of 1980s to first decade of the twenty-first century is still far away from China who faced these

crises. It leads towards the opinion that there were other issues which proved harsher than the external

financial crises for Pakistan. Following are the most eminent internal issues of Pakistan during the time

period of 1951 to 2008:

Table 6: Overview of Pakistan’s Internal Issues

It is translucent from the above given details that Pakistan went through severe devastations internally.

Unluckily, this nation lost its eastern part (now Bangladesh), faced four martial laws and equal number

of wars during its 64 years’ history and went to the edge of a nuclear war as well. Incapable and corrupt

leadership was another misfortune of this country.

6.0 CONCLUSION AND IMPLICATIONS OF THE STUDY

Pakistan and China have experienced five big financial catastrophes since their establishment, of which

four were global crises and one was international. Our study concludes that nearly all of these crises

affected Pakistan’s economic and financial position in one way or other except the crises of 1979 and

2008 which were not disastrous for Pakistan at their. Besides external crises, Pakistan’s internal matters

created huge problems and caused severe damage to the economy. On the other hand, out of the six

decades’ journey from 1949 to date, all financial crises affected the economy of China right from their



inception. Referring to the main research question of our study, we conclude that China faced more

external financial crises as compared to Pakistan and internal problems proved more disastrous for

Pakistan than external financial crises.

Our results have some obvious implications for the concerned authorities of the government of Pakistan

regarding financial policies and internal affairs management. There is a strong need to learn from the

economic growth and financial strength of China which was founded two years later than Pakistan (in

1949) and its economy went through more external financial crises but still has gone far beyond with its

enormous progress in various fields. Thus, we suggest sound and firm economic policies, political

stability and most importantly the honest and capable leadership for improving the vulnerable situation

of Pakistan.

ACKNOWLEDGEMENT

The author would like to extend his special thanks to the anonymous reviewer for the much needed

suggestions. The author is also grateful to Prof. Meng Xianglan, Zhongnan University of Economics and

Law, Wuhan, China, for her precious guidelines. Thanks to the friends from Shaheed Zulfiqar Ali Bhutto

Institute of Science and Technology (SZABIST), Karachi and Islamabad, Pakistan, for their highly valuable

assistance and moral support.

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Impact of Financial Crises on Pakistan and China: A Comparative Study of Six Decades

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