This is binding. 2. THEORETICAL FRAMEWORK The basic HRV

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Last updated: June 18, 2019

This paper targets the most binding constraintsto recent (2011-2016) low level of private investment and entrepreneurship inPakistan using Husmann-Rodrick-Vilasco (2005) decision tree. I have shown thatgrowth diagnostics of Pakistan undergoes from troubles and huge economiccomplexities. The economic growth of Pakistan is continuously affected bystructural problems domestic energy crisis, low investment, high inflation, andsecurity issues. Growth diagnostics point to four major constraints to economicgrowth of Pakistan: lack of infrastructure, inadequate market development, poorperformance of institutions, and lack of efficient public sector management. 1.

INTRODUCTIONEconomic growthperformance of Pakistan is volatile throughout its history (Annexure-I). Itsgrowth history started with its partition in 1947. Average growth rate was 3.4 % per annum in the1950s.

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During 1960s, Pakistan has experienced higher episodes of growthand average annual real GDP growth rates were shot up 6.8%. In 1970s, the oil price shock of 1970sand the war of Bangladesh, adversely affect the economic growth and averageannual GDP growth rates were decline to 4.8%. Growth rate grew at 6.

5 %annually, during 1980s and again and shrunk to 4.3 % in 1990s. Pakistan became one of the four fastest growing economiesin the Asian region during 2000-07 with its growth averaging 7 % per year. There were a few really shining years during thisperiod (Qayyum et al., 2008).

The volatile performance of growthrate raises the question of what kind of policy reforms should be designedaccording to Pakistan. Hausmann, et al. (2005) explains that targeting the mostbinding constraints has important advantages over other approaches to policyselection.This paper identifies the mostbinding constraints to the growth of Pakistan using Husmann-Rodrick-Vilasco (HRV) decision tree and alsoprovides their empirical evidences. There can be uncertainty about the”position” of each constraint in the economy so we can only make aprobabilistic assessment of which one is binding.2.THEORETICAL FRAMEWORKThebasic HRV decision tree ispresented in Annexure-II. The tree assumes that:EconomicGrowth = f (private investment & Entrepreneurship)Lowlevel of private investment = f (low return to economic activity, high cost offinance and entrepreneurshipLowreturn to economic activity = f (low social returns, low appropriability)Lowsocial returns= f (poor geography, bad infrastructure, low human capital)Lowappropriability = f (Government failure, market failure)Marketfailure = f (self discovery problem, coordination problem)Highcost of finance = f (bad international finance, bad local finance)BadLocal finance = f (low domestic savings and poor intermediation)Where’f’ means ‘function of’Anunder-performing economy is one where market imperfections and distortions are widespread.

Such distortions create a wedge between private and social valuations ofspecific economic activities. These wedges can be represented by ?= {?1,?2,. . . , ?k}                                                                    …….(1)Where ?krepresents the distortion in activity k.

The distortions can be modeled asconstraints on policy-making problem that take the general form.µis (?, …) ? µip (?,…) ? ?i = 0                                                   ……(2)    Where,                                                         µis (?, .

..) net marginal valuation ofactivity i by societyµip(?, …

) net marginal valuation of activity i by private agentTheeconomic activities depend not just of the set ? of distortions, but on levelsof consumption, labor supply, asset- holdings, etc. If u is welfare of theaverage member of society, then the gain in welfare from reducing one of thedistortions marginally isd?/dtj= – ?j * ?i d{?is(t,…) – ?ip(t,…)} / dtj                              …….(3)?i ? 0, i = {1, 2, . . . , k} are the Lagrange multipliers corresponding tothe constraints connected with each of the distortions. The first term on the righthand side of eq.

(3) captures the ‘direct effect’ of a small change in tj:a small reduction in tj increases aggregate welfare by an amountgiven by the multiplier associated with the jth constraint, j. Thesecond term captures the effect of varying tj on the aggregated sum of the gapsbetween the social and the private valuation, with the weights corresponding toeach distorted activity’s own Lagrange multiplier.The standard growth model consists of number ofdistortions in the economy yielding the result that along a (constrained)balanced growth path consumption and capital grow according to.ct/ct=?kt / kt = ? r(1 ? ? ) ? ?                                                  …….(4)Where:Cis consumption; k is capital; r is the rate of return on capital; t is the taxrate on capital; ?is the world rate of interest and a dot over a variable denotes the rate ofchange over time.Inaddition, the private return on capital r is given byr= r (a, ?,x)                                                                                   …

.…(5)where: a = indicatorof total factor productivityx = availability of complementary factors ofproduction.? = index ofexternality (a higher ? means a larger distortion).

Eq.4 & 5 summarize the possible factors that can affect growth performance.13.EMPIRICAL ANALYSIS OF POSSIBLE BINDING CONSTRAINTS IN PAKISTAN3.

1.Low SavingAlarge body of literature on economic growth tends to support the traditionalSolow (1956) growth model and the “New Growth Models” of David Romer’s andothers in which higher savings leads to higher growth. Table 1 shows thatsavings in Pakistan are close to world and high income countries. Table 1: Net Savings—2016, World’s Average Region Gross Savings (% of GNI) Net Savings (% of GNI) Low Income 14.6 –3.

8 Lower Middle Income 27.9 16.1 Upper Middle Income 32.0 17.2 East Asia & Pacific 36.

1 18.1 Europe & Central Asia 22.4 9.

5 Latin America & Carib 17.2 9.4 Middle East & North Africa 33.7 12.9 South Asia 31.

4 18.6 Sub-Sahara Africa 13.6 –3.9 High Income 22.6 9.1 World 24.9 11.7 Pakistan 23.

3 14.9 Source: WorldDevelopment Indicators, 2016.Basedupon empirical evidence, I exclude savings as binding constraints to growth ofPakistan.3.2.

Low Appropriability3.2.1. Failure of Government Pakistan is politically an unstablecountry with various issues. It has experienced 27 Prime Ministers in its 69years history (Qayyum, 2008). Pakistan is ranked 61th most corruptcountries of world by International transparency survey 2016.

Foreign Policymagazine, 2013 has listed Pakistan in ‘Top 10’ failed states of world. Themagazine has listed the “unique set of troubles” the world’s most failed statesface. Called the 12 degrees of failure these are: demographic pressures,refugees, illegitimate governments, brain drain, failure of public services,inequality, group grievances, human rights, economic decline, lack of security,factionalized elites and intervention by external actors.The table 2 shows the poor ranks ofGovernance in Pakistan assigned by Global Competitiveness Report 2016.Table 2 Indicator Value Rank/138 Public trust in politicians 2.

7 85 Judicial independence 3.6 88 Govt, services for improved business performance 3.0 108 Organized crime 3.

1 130 Brain Drain 3.5 62 Source:Global Competitiveness Report 2016Iconclude that failure of Government is one of the major binding constraints togrowth in Pakistan.3.3. Institutional Failure 3.

3.1.Educational InstitutionEducationplays a vital role in human capital formation. It raises the productivity andefficiency of individuals and thus produces skilled manpower that is capable ofleading the economy towards the path of sustainable economic development The quality of education in most of the public schools andcolleges is well below. Moreover, the lack of technical education and research culture in Pakistan educational institutions.  The allocations of fundsfor education are very low.

It is only 2.0 % of the total GDP in 2012The low education budget shows the negligence of education (Memon,2007).                                                                                                                                                                                                                                                                             Human development Report placedPakistan at 136th position for having just 49.

9% literate population.In addition to that, Pakistan is ranked 75th in quality of thehigher educational system and 140th in quality of primary educationout of 138 countries in Global Competitiveness Report 2016. All these empiricalevidences show the failure of Educational institution.3.3.2. Legal InstitutionsInPakistan, there exist two legal systems; Formal legal system and informal legalsystem such as Jirgas.

Due to inadequacy of the judicial system, ordinary casestake years to settle in Pakistan. Investigators are poorly trained and lackaccess to basic data and modern investigation tools. In many cases the partiesinvolved are forced to enter into settlement due to this unbearable delay in justice.Given the absence of scientific evidence collection methods and crediblewitness protection programs, police and prosecutors rely mostly on confessionsby the accused, which are inadmissible in court. Lack of education, awareness,unbearable delay and costs of lawsuits, complexity and bureaucratic nature ofthe system, makes it extremely difficult for the common man to seek justice.The level of corruption in judiciary and the police is however one of the maincauses of failure of legal institutions in Pakistan (Zia, 2007). Table 3 Indicator Value (0-7) Rank/138 Reliability of police services 3.

0 127 Judicial Independence 4.1 57 Property Rights 3.5 116 Intellectual property protection 3.0 106 Organized crime 3.4 136 Source: GlobalCompetitiveness Report 2016. Iconclude that the rule of law is unstable across the country.

The independenceof the legal system is poorly institutionalized, and judicial procedures arecostly, prolonged and subject to political pressure. Property rights are notprotected effectively. Failure of legal institutions is another bindingconstraint to growth in Pakistan.  3.4. Macro Risk/Macro Economic InstabilityGlobalcompetitiveness report 2016 ranked Pakistan as number 116 out of 138 countriesin world in terms of its macro environment. Table 4 shows the poor scores ofmacroeconomic environment .

Governmentof Pakistan has failed to maintain macroeconomic stability.Table 4 Indicator Value (0-7) Rank/138 Macroeconomic environment 3.8 116 Government budget balance, % GDP* -5.3 106 Inflation, annual % change 4.5 93 General government debt, % GDP 64.

4 95 Country credit rating, 0–100 (Best) — 114 Data Source: GlobalCompetitiveness Report, 2016 Thus, I conclude that macroeconomicinstability is another binding constrained to growth in Pakistan.3.5.

Market Failure3.5.1. Lack of Competitiveenvironment and InnovationInnovation plays a crucial role in achieving growth of aneconomy. Risk, initiative and innovation are integral ingredients ofentrepreneurship.

 Pakistan lacks innovative culture due to a lack ofincentives by the government, cases of plagiarism and proper facilities toconduct research on technical and scientific subjects. Almost all sectorsof Pakistan are suffering by lack of innovation and competitive environment (Qayyumet al., 2008).

The global competitiveness report2016, Pakistan is ranked 77 in innovation out of 138 countries (Table 5).Table5 Indicator Value (0-7) Rank/138 Capacity for innovation 3.8 95 Quality of scientific research institutions 3.6 87 Company spending on Research & Development (R&D) 3.3 67 University-industry collaboration in R&D 3.4 68 Source: Global competitiveness Report:2016.3.5.

2. Asymmetric InformationProvision of correctinformation failure is another market failure. If people have different information at the time they act,markets may not perform efficiently. In Pakistan markets, asymmetricinformation prevails widely.

Buyer has limited information about productcompared to seller. The seller gets advantage of this ignorance and charge highprices. In same manner, the moneylender might charge high interest rate toborrower in credit markets (Aleem, 1990).I conclude that market failure is also a bindingconstraint in Pakistan.3.6. Social Returns3.

6.1. GeographyLocationand climate have large effects on economic growth by effecting public health,and agricultural productivity (Gallup et al., 1998). Table6 Country Comparison: Area Country Sq. Km Rank Tanzania 947,300 31 Nigeria 923,768 32 Venezuela 912,050 33 Namibia 824,292 34 Mozambique 799,380 35 Pakistan 796095 36 Source: The World Fact Book, 2016.

 Pakistan is ranked 36thbiggest country by area out of 252 countries of world (Table 6). Pakistan has very uniqueGeographical landscapes equipped with Northern high mountainous Region, theWestern Low Mountainous Region, the Balochistan Plateau, the Potohar Uplands,and high mountains (Geographical Overview of Pakistan, 1969). Pakistanenriches in oil, gas, coal reserves and has emerged as one of the leadingcountry having 6th largest coal reserves in world after the discovery of hugelignite coal resources in Sindh in 1991. (Ministry of Petroleum and NaturalResources, 2015).

I exclude the geography of Pakistanas binding constraints in Pakistan.3.6.2. InfrastructureDevelopment economists have long been recognized that infrastructure is anecessary input in production process. In Pakistan, low infrastructuredevelopment in the past two decadeshas become binding constraints to production sector in the economy.Pakistan’s infrastructure needs are massive and its resources are limited (Imranand Nazli, 2011).Table 7 Indicator Value (0-7) Rank/138 Quality of overall infrastructure 3.

5 93 Quality of roads 3.8 77 Quality of railroad infrastructure 3.1 53 Quality of port infrastructure 3.5 84 Quality of air transport infrastructure 4.

0 91 Quality of electricity supply 2.4 121 Source:World Development Indicators, 2016.Pakistan’score in overall infrastructure is 3.5 in Global Competitiveness Report 2016(Table 7). Analyzing empirical evidences, infrastructure is also included as a bindingconstraint.4. Conclusion &Policy ImplicationsTheobjective of study was to analyze the most binding constraints to Pakistan,which has slow down the present growth (2011-2016) of country.

By empiricalevidences, I have target Government failure, market failure (asymmetricinformation, Lack of innovation), Failure of institutions (educational, Legal),Macro risks, bad infrastructure as binding constraint to growth in Pakistan.While low savings and poor geography were excluded from listing as bindingconstraint to growth of Pakistan.  In short, Pakistan’s economy seems tostuck in multiple binding constraints and in order to get out of thisexceptional adjustment needs to be made. Several areas are important tomake some considerable reforms like; private sector growth, good governance,institutional strength, market development, macroeconomic stability and infrastructuredevelopment.1 The methodology is adopted from Hausman et al., 2005.

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