PRIVATE INVESTMENT AND FISCAL POLICY IN PAKISTAN

Abstract

This paper has examined linear as well as non-linear impact of fiscal policy variables on private investment in Pakistan. The results imply that it's better to examine different aspects of fiscal policy instead of fiscal policy variables in aggregate form as the impact of fiscal policy variables in aggregate and disaggregate form do not comply with each other. Different categories of expenditures and revenues have different impact on private investment. Secondly, in most of the cases there exists a non-linear relationship, which implies the significance of certain threshold level for the different fiscal policy instruments to encourage private investment.Keywords: Fiscal Policy,Private Investment, Non-Linear RelationshipJEL classification: E22, E62(ProQuest: ... denotes formula omitted.)1. INTRODUCTIONThe importance of private investment for growth and development in the developing countries is a well-established fact. Private investment is regarded as an essential element in promoting a broad-based and sustained growth that in turn would help in reducing poverty. Equally important is the response of private investment to changes in economic policies (including fiscal policy) of the government.The economic difficulties faced by many developing countries in the early 1980s (widening current account and balance of payment deficits, rising inflation rates, growing foreign debt burdens, and falling growth rates) forced policy makers to shift development strategies against large-scale government intervention and more towards market for allocating and utilising the resources; along with the increased role of the private sector. Empirical research also has confirmed a much larger role of the private investment in the growth process as compared to the public investment (Reinhart and Khan, 1989).Since the 1980s the general trend seen in most of the developing countries is the decline in public investment as a result of tightening aggregate demand and increasing role of the private sector in capital formation. Furthermore, it is observed that public resources are earmarked for social sectors, that is, for the alleviation of poverty and for the upgrading of social capital and services (Chibber and Dailami, 1991).On the other hand, there exists strong evidence in the favour of fiscal policy and economic growth relationship in the empirical literature. While in this relationship, private investment is regarded as one of the main channels through which fiscal policy can influence economic growth (Hermes and Lensink, 2001). In endogenous growth models changes in the capital stock can affect the long-run per capita growth rate, either through more investment in quantitative terms or through more efficient investment. Therefore, in these models a positive role of economic policies (fiscal policy included) is assumed in the process of economic growth provided these policies aimed at improving the quantity and/ or the efficiency of capital stock. In these models, it is established that some fiscal policy instruments are good and some are bad for growth.The role of private sector in the Pakistan's economy, undoubtedly, is quite significant; not only as a major producer of goods and services, but also as a major contributor in investment, and the largest employer. Its importance can be gauged from the fact that according to one estimate its contribution to total GDP is around 84%. When undocumented informal economy (private sector) is taken into account its contribution to GDP exceeds even further (ADB, 2008). To elaborate it further, in Pakistan's total investment of 15.2% of GDP in 2008-09 the share of private sector investment is around 88%.Pakistan has seen an asymmetrical real GDP growth rate pattern throughout its history, ranging from around 10% in 1969-70 to just 1% in 2008-09. When average for different decades is estimated, it indicate that the private sector-friendly 1960s recorded the highest GDP growth rate of around 7% followed by 5%, 6%, 4%, and 5% in the 1970s, 1980s, 1990s and in the 2000s respectively. …