Public investment efficiency and sectoral economic growth in Pakistan

Abstract

AbstractMotivationThe issue of the effect of public investment on private investment and consequently on growth is much debated in economic literature. On the one hand the classical school believes that increment in public spending reduces economic growth by crowding out private investment, whereas Keynesians, on the other hand, consider government spending a key variable for economic growth.PurposeLike other developing economies Pakistan is also facing a high budget deficit which curtails public spending. This study estimates the relative effects of public investment in physical (infrastructure and energy) and social (health and education) sectors on output by estimating long term marginal productivity.Approach and MethodsThis study used the vector autoregressive/vector error correction model (VAR/VECM) technique to measure the effect of public investment on output, private investment and employment; separate VAR models are estimated for each sector and each type of public spending. Further, in order to attain these uncorrelated residuals, Cholesky decomposition is used and the resulting accumulated impulse response measures the cumulative response of all variables due to change in policy variable i.e. public investment.FindingsThis study indicates that public investments have a crowding in effect in 49 cases, while in 21 cases there is crowding out, 34 cases indicate labour absorption effect, while 36 cases show labour substitutions and 52 cases show a positive output effect, while in 18 cases output effects are negative. Overall, these results indicate that all types of public investments are growth stimulating through both crowding‐in and labour absorption effects.Policy ImplicationsThe overwhelming results illuminate that public investment had attracted private investment in Pakistan in the past and therefore to attract private investment in future, the government of Pakistan should increase public investment. This lesson can also be substantiated from the experience of several developing countries, particularly India. In India, the last 20 years have seen very high public investment despite high fiscal deficit, which has led to very high economic growth.