Financing the Budget Deficit of Pakistan: A study of the Revenue and Expenditure Nexus

NATIONAL UNIVERSITY OF SCIENCES AND TECHNOLOGY

SCHOOL OF SOCIAL SCIENCES AND HUMANITIES

UNDERGRADUATE THESIS
Financing the Budget Deficit of Pakistan: A study of the Revenue and Expenditure Nexus

 
Abstract
This paper examines the Revenue-Expenditure nexus for Pakistan over a period of 39 years,
from 1976 – 2014. It studies whether there exists causality between total revenue and total
expenditure, as well as their components: non tax revenue, tax revenue, development expenditure
and current expenditure.
It employs a five-step procedure which includes the stationarity testing using both ADF and PP
tests, there determination of optimal lags using AIC criteria, and the long run and short run
relationships using the Ordinary Least Square (OLS) method and Vector Auto Regressive (VAR)
framework respectively. At the end, the Granger causality is used to determine the existence of
the causality.
The paper comes to find that for Pakistan, there is no causality between total revenue and total
expenditure, total expenditure and tax revenue, development expenditure and tax revenue,
current expenditure and tax revenue, and, total revenue and development expenditure thereby
showing that the institutional separation hypothesis holds true in this context.
However, there does exist a positive uni-directional causality running from Total Revenue to
Current Expenditure, Non-Tax Revenue to Total Expenditure, Development Expenditure and
Current Expenditure, which suggests that the government should target revenues before
spending, i.e. Spend-and-tax hypothesis.
Keywords: Government Revenue, Government Expenditure, Tax Revenue, Non-Tax Revenue,
Current Expenditure, OLS, VAR, Granger-Causality
Introduction
In the simplest terms, a budget deficit occurs when a Government’s expenditure exceeds its
revenue that is; government spends more than the revenues it collects from its potential
resources. Within economics, there are variations amongst different economists and school of
thoughts on the understanding and handling of problems. In this context the Neoclassical,
Keynesian and Ricardian paradigms hold the greatest significance.
The Neo-classical view is such that an individual plans his/her consumption over their life cycle,
therefore when consumption increases the saving rate is going down. Interest rate is then
required to rise in order for the money market to be at equilibrium. This view does not hold
importance in the context of this paper because given the current economic conditions, such a
persistent deficit would crowd out the savings, creating havoc in the economy.
According to the Keynesian school of thought, an individual has a high propensity to consume
out of the current income, therefore a tax reduction would have a spontaneous and substantial
impact on the aggregate demand. In this school of thought, the budget deficit was regarded as the
definitive propellant of economic growth; these economists believed that a high rate of
employment and stability could be achieved through appropriate maneuvering of the government
budget.
The Ricardian school of thought explains that individuals save over generations by transferring
resources and therefore consumption could be a function of these dynamic resources. Since these
deficits shift the payment of taxes to future generations by prolonging them, the dynamics
resources aren’t affected.
More recently these deficits are being blamed for various economic problems, including high
inflation rates, unemployment, stagnant economic growth, stock market crashes, high interest
rates and balance of payment issues as well as exchange rates and other economics concerns. A
budget deficit when viewed as a percentage of the GDP decreases as the economy progresses.
This is because increased tax revenues coupled with a high employment lead to economic growth
and therefore lessen the need for government support, especially for welfare purposes.
Governments counter these budget deficits by reducing the government taxes and increasing the
taxation, hence promoting economic growth.
The Ricardian equivalence model is built on the notion that increasing the amount a government
borrows would not have impact consumer expenditure since these rational consumers would
predict tax cuts and they realize that this higher expenditure would be penalized later. In short,
this means that a cut in taxation, which is financed by further borrowing, should have no affect
on the aggregate demand. This is because the rational individual realizes that extra consumption
today would cost them higher future taxation and the concept of consumption smoothing comes
into play. If this model is assumed to be an accurate depiction of the ground reality then it makes
fiscal policy redundant.
Contrary to the Barro-Ricardo equivalence theorem, budget deficits and their proceeding fiscal
policy measures do matter substantially. Hence, understanding the “revenue-expenditure nexus”
has important implications for the formation of fiscal policies. In order to finance and eventually
reduce the budget deficit, it is essential for the country’s government to know the relationship
between revenues and expenditures.
Whether and how the revenues should be increased to finance the budget or whether the
expenditures should be reduced is a major question faced by the decision makers. In order to
answer this question, it is imperative to know whether a causal relationship exists amongst the
two factors. Whether increasing resource mobilization to increase revenues also increases
expenditure or is it the increased expenditure on resource mobilization, which increases
revenues, is the key question in this context.
Objective
The objective of this paper is to study the relationship between expenditures and revenues, one
that is crucial to Pakistan’s current fiscal situation. The Government’s budget deficit is in a
deplorable condition and every year large sums have to be borrowed externally or domestically
in order to meet this deficit. This continuous borrowing and accumulation has had detrimental
effects on the economy, leading to internal and external debt. Moreover, factors such as
exchange rate, trade gap and the balance of payments have also been negatively impacted by this
increasing debt.
Our study objective is to answer the fundamental question of budget deficit financing by
investigating the variables causing the deficit. The paper observes, through empirical testing the
data, whether there exists a unidirectional or bidirectional relationship between the variables, of
budget deficit, both in the long run and short run and whether this is positive or negative
causality.
The study aims to identify the type of causality that exists amongst the variables, or whether one
exists at all. This is of core importance as Revenue and Expenditure are the foundations that set
course for the budget policy. The study also decomposes these variables into their constituents,
that is, non-tax and tax revenues as well as current and development expenditure.
Eventually, this paper makes some conclusion regarding what policy should the government of
Pakistan adopt while setting its Revenues and spending targets based on the results of the
econometric analysis that it employs. It is hoped that these will aid in policy making and will rid
the country of the nuisance that the budget deficit holds.

Questions this paper aims to answer:
• Does an increase resource mobilization also raise expenditures as a consequence,
reducing the effect of increased revenue?
• Does a change in non-tax revenue result in a change of development, current or total
expenditures?
• Does a change in tax revenue result in a change of development, current or total
expenditures?
• Does the reduction in expenditures reduce the revenues as a consequence, reducing the
impact of minimized spending?
• Should the government target both revenue and expenditure simultaneously since they
both affect and cause each other?
• Should the government work regardless of the relation between the revenues and
expenditures, that is, independently because they have no causal relation?
• Should the government set targets for revenue before spending or vice versa because
there is a uni-directional relation between them?

 
Hypothesis
In light of the budget deficit there are four extensively used hypothesis, as shown in the
preceding literature, as follows:
• The revenue-spend hypothesis: whereby there exists a unidirectional causality from
government revenue to government expenditure
• The spend-revenue hypothesis: whereby there exists a unidirectional causality from
government expenditure to government revenue
• The fiscal synchronization hypothesis: whereby there exists bidirectional causality
between government revenue and government expenditure
• The institutional separation hypothesis: Where there is no causality between government
revenue and government expenditure.
Theoretical Framework
Revenue and Expenditure are the two key factors of a Government Budget Equation, this
relationship has been a central issue for researchers in the realm of economics as it has important
implications on policy making. Within this context, there are four main hypotheses that help to
explain the relationship between government revenues and expenditure.
Tax-and-Spend hypothesis
This hypothesis is based on the argument that changes in taxation take lead on variation in
spending: that is the level of spending adjusts to the level of taxation. This theory was led by
Friedman (1978) who argued that as Taxes increase; government spending will also increase,
thus showing a positive causal relationship. Buchanan and Wagner (1977), also worked along the
same hypothesis and came to the conclusion that government spending will lead to higher budget
deficits and an increase in taxation is the cure to deficit.
Wagner’s version of the hypothesis was based on the concept of fiscal illusion, whereby the
consumers perceived prices of goods provided by the government to be lowered, hence
increasing their demand. The public, through this means actually faces higher costs because of
inflation associated with money creation and because the government has to pay a greater
interest on the cost it incurs. Through their interpretation, the remedies proposed by Wagner and
Buchanan were to increase the taxes in order to cure deficit in the budget. They were also in the
favor of curtailing the government’s ability to resort to deficit financing in its attempt to reduce
expenditure. Friedman on the other hand, argued that decreasing taxes would be an appropriate
measure and a long-term solution.
Spend-and-Tax hypothesis
This hypothesis is based on the notion that government decides expenditures first and then does
the changes in revenues; that taxes react to level of government spending. Robert (1978)
suggested a version of this hypothesis which was furthered by Peacock and Wiseman (1979),
they suggested that during a time of political or economic crisis, the government will increase
taxes in order to pay for the increased expenditures; this escalation in taxes might become
permanent. This is because the citizens’ tolerance towards a high tax rate develops and they are
thus willing to pay more, because of this the government expenditure also increases.
This interpretation is in line with Barro’s (1979) notion that expenditure financed by debt would
invariably mean an increased tax rate in the future in context to the Ricardian equivalence that
rules out the concept of fiscal illusion as discussed in the previous hypothesis. The Ricardian
Equivalence proposition states that the government cannot stimulate private consumption
through tax cuts and finance the deficit through bonds. That is, forward looking individuals will
understand that these tax cuts will be offset by greater interest rates plus the debt incurred at a
later point, hence they will have to pay higher taxes in the future. This hypothesis suggests that
expenditure decreases are the desired solution to reducing budget deficit.
The Ricardian modification to standard budget deficit observes that for a given path of
government spending, a cut in current taxes will lead to higher future taxes, which has the same
value as the present value of the initial cut. The Ricardian model therefore states that the national
saving does not change as the households’ demands for goods depend on the expected present
value of taxes.
Fiscal Synchronization hypothesis
This hypothesis suggests that the government decides its revenue and expenditures
simultaneously. It suggests that government spending and revenues are jointly determined by the
electorate in order to maximize the voter’s welfares. Musgrave (1966) and Meltzer and Richard
(1981) reflect the traditional theories of Public goods, they show that the level of taxation needed
is based on the comparisons of marginal costs and benefits that are associated with the
government spending programs. In essence, the hypothesis shows that the causal relationship
between government revenue and spending is bidirectional.
Institutional Separation hypothesis
This hypothesis states that government revenues and expenditures are independent of each other.
Wildaskvy (1988) says that separate institutions such as the executive and legislative branches of
the governments are part of the budgetary proceedings in order to determine the optimum level
of taxation and spending. This budgeting can be incremental and changes can be made in order
to reach a consensus amongst the stake holders.
Baghestani and McNown (1994), and further worked upon by Darrat (1998) also relates the
institutional separation of this expenditure and revenue decisions of the government. The
expenditure is defined on the basis of the requirements expressed by the citizens and revenue
would depend on the maximum tax burden as tolerated by the population.

 

Budget Deficit with context to Pakistan
Since independence in 1947, Pakistan has experienced a constant budget deficit, with the
exception of few years. The annual fiscal deficit has staggered around 6 percent of the GDP
since 1990, over a period of time; this deficit has translated into a debt, which is now a
permanent part of the economy. Although, growth was notable for a few years, the
accompanying fiscal deficit has increased the public debt, thus causing the vicious circle to
become further pronounced.
The extent of budget deficit and its consequences has been a hotly debated issue in recent years
due to the reason that Pakistan has experienced a continuous and growing political influence in
all the sectors of the economy. Political instability and the lack of an effective democracy is
routine in Pakistan and since the country has not been able to enjoy a stable socio-political
scenario the macro economic framework has suffered massively.
The government of Pakistan formulates a budget every year, which indicates its expected returns
and expenditures in the coming financial year. Receipts of the Government are expected from
different sectors, such from financial institutes, interest from loans given to other Governments,
tax revenues, local bodies’ etc. Expenses of Government consist of different projects,
developmental and non-developmental projects. If returns of the Government are equal to its
expenditures then the budget is balanced. The budget is in deficit if the expenses of the
Government are more than its receipts.
Amongst the developing countries, Pakistan is facing a large budget deficit, with the fiscal deficit
to GDP ratio hovering between 6 -8% over the decades. In 1990’s the situation was especially
dismal, with a chronic budget deficit. Accepting the gravity of the situation, a concentrated set of
reforms were initiated in early 2000, the continuous rise in revenues and fall in expenditures
from 2000 through to 2005 resulted in the deficit being reduced to 3% of the GDP.
When a Government finances its budget deficit through public debt (non-bank borrowing) and
bank borrowing, it is termed as deficit financing. There are many reasons why deficit financing
in Pakistan requires a sound fiscal policy in place, which is an essential pre requisite for a
functioning, stable macroeconomic environment.
The Government covers its budget deficit by borrowing from the State Bank in terms of printing
money or use State Bank to float various financial instruments to the Commercial banks and
borrow from them.. The effects of the both financing methods are an increase the money supply
in the country and this creates an inflationary pressure in the economy. Non-bank borrowing by
the Government is done through the sale of short-term federal bonds, treasury bills, defense
saving certificates etc.
This continuous process of borrowing form banks and non-bank sources increases interest rate,
inflation and discourages the private investment. There are also adverse effects of continuous
external borrowing these include imbalances in balance of trade, low GDP, capital flight from
the country.
The Government of Pakistan decided to face the challenge of deficit by employing a rule based
fiscal policy in 2002-2003. At that time the country had a fiscal deficit at 7% of GDP. This plan
was later on approved as a law in the parliament in June 2005 and was referred to as the “Fiscal
Responsibility and Debt Limitation Act”. The aim of the act was to ensure strict fiscal
discipline in future for the country.

Given below are some key postulates of the Act:
1) Within a period of 10 years beginning from July 1, 2003 public debt should not exceed
60% of GDP beyond June 2013.
2) Eliminating revenue deficit by June 2008.
3) Reducing public debt by at least 2.5 percentage point of GDP each year until June 2013
4) Not issuing guarantees to the borrowing of public service enterprises (PSEs) by more
than 2.0 percent of GDP in a given year.
5) Maintaining the level of spending on social sector and poverty-related programs above
4.5 percent of GDP in a given year and ensuring that expenditure on education and health
is doubled in terms of percentage of GDP by June 2013.
After the introduction of this act, all the rules were followed rigorously until June 2007 and
showed impressive results. The public debt as a percentage of GDP decreased from 75.1% (in
2002-2003) to 55.4% (in 2006-2007). The Revenue Balance decreased to 0.9% of GDP by 2006-
07 and was before on average at 3.1% of GDP during 1997-98 to 1999-2000.
Unfortunately after 2007 these rules were violated, and this resulted in a worsening situation and
public debt, for example, increased to 61.5% of GDP by 2011-2012 (which was 55.4% of GDP
in 2006-2007) and revenue deficit also worsened and increased to over 3% of GDP

 
Literature review:
We aim to study the strategy of budget deficit reduction for Pakistan by thoroughly studying its
components and their relation. For this purpose, we have composed our study in four portions
whereby we first take into account the scenario of budget deficits in Pakistan, followed by the
rest of the world including studies of budget deficit and relation between revenues and
expenditures under all four hypotheses mentioned above. Once, having studied the cases
throughout the world, we will empirically test our findings across Pakistan.
The literature that we have undertaken is varied and shows various contexts in which the budget
deficit has been studied. It shows us that Fiscal Synchronization is the most significant
hypothesis, with the majority of the countries under study are facing this sort of a relationship
amongst the two variables under scrutiny.
Using a Granger Test, Daniel K. Moulasi tested for an empirical relationship between revenue
and expenditure for Botswana. He found that a uni-directional relationship existed from revenues
to expenditures in the Short Run. Similarly, Ewing and Payne examined the inter-temporal
relationship amongst revenues in expenditures for five Latin American countries, for three of
these countries the Tax Spend hypothesis was shown to hold true.
Nwosu and Okafor analyzed data for the Government Revenue and Expenditure in Nigeria, they
used the VAR model, coming to the conclusion that there exists a Long Run relationship
between Government Revenues and Expenditures. For Ghana, a similar analysis yielded the
same result, whereby a Short Run causality exists, that is the Tax Spend Hypothesis is being
followed.

Mehrara, Pahalvani and Elyasi look at the relationship in 40 Asian country and they showed that
in the long run and the short run the same causality, that is bi-directional causality exists.
Similarly, for Malaysia and Switzerland the same hypothesis is being followed, as shown by the
Granger Causality testing. For the USA, using a bivariate model and Building on the argument of
Darrat and Suliman they show that there exists no definitive causality amongst the two variables.
We see that amongst the sample taken, there exists a definitive relationship for every country that
is studied; these results however, vary over the long run and short run. The literature review is
arranged in a manner whereby the countries are divided by the hypothesis that is being followed
in the economy.
It is important to understand this crucial relationship between the variables, as it has very
significant implications for the policy-making regime. Pakistan, being one of Asia’s developing
countries has a significant budget deficit and this has not been extensively studied. Over the
recent past, the trends in the budget deficit equation have changed drastically, the motivation to
work on the topic stems from the face that the existing data is outdated.
Pakistan
Monetary expansion, especially in developing countries is usually associated with a large amount
government borrowing from within the banking system as well as international aid agencies in
order to finance the existing gap in the budget. This borrowing takes place because the
government is incapable of domestic resource mobilization, its narrow taxation base and
stringent tax structure. Moreover, the capital markets are not developed and the environment is
financially biased towards the expansion of supply of money.
Pakistan also has a fairly large budget deficit that is growing over time and although this is
usually blamed on the high inflation, low growth there are other factors such as a lack of private
investment and consumption which have contributed to this short fall. Over the past two decades,
the budget deficit has varied between 5.4% and 8.7% of the GDP, although many measures have
been taken in order to reduce this deficit but all efforts have proved fruitless.
In the late 1990’s the deficit went down to 6.4% because the government reduced its
expenditures in development, but this was cosmetic as this change was not achieved by
increasing the tax-to-GDP ratio but by reducing the amount spent on infrastructure work. This
was, therefore unsustainable and this was shown when the deficit grew in the proceeding year.
Until Pakistan broadens its taxation base and implements stringent policies to monitor tax
evasion, the menace will keep on growing.
In the past fifty years, the country has had a constant budget deficit resulting in a current account
deficit and this has largely been filled in using loans from abroad, creating a large pool of
international debt-beyond what can be repaid. And this debt servicing has cost us in excess to 5%
of Pakistan’s GDP growth.

The budget deficit that is so big requires the swift expansion of domestic credit, as this change
would cause the foreign reserves to attain equilibrium at a new level. In countries such as
Pakistan, the free capital market intervention is very minimal and not very well developed.
The authors Abdul Waheed, Bashir Ahmad Khilji & Mubashir Ahmad in their article titled
“Revenue and Expenditure: What causes what? Empirical Evidence from Pakistan” tried to
analyze the causal relationship between expenditure and revenue of Pakistan in the period 1981
to 2010.They analyzed the spending and income of the Pakistani government. Here they used
three variables Government Revenues, Government Expenditure and Gross Domestic Product of
Pakistan (which is treated as a control variable).The hypothesis of the study was that revenue
changes the expenditure. They carried out the unit root tests with Augmented Dickey Fuller and
Phillips and Perron tests to test for causality and co-integration between expenditure and revenue
the Johansen co-integration test and VECM were used. The results showed that no causal
relationship existed between the variables, which were a different result from other studies in the
literature.
Tahir Sadiq examines the causal relationship between federal and provincial taxes as well as
expenditure. This analysis was done in order to find a viable strategy to control budget deficit.
Methodology used included the Granger causality test which was applied on the data spanning
from 1980-81 to 2009-10. Granger method says that future revenues and expenditure can be
predicted based on past revenues and expenditures. If past revenue values can be used to explain
present expenditure values than we can say that causality exits and its direction is from revenue
to expenditure (unidirectional causality).If the opposite case occurs then we say that the direction
of causality is from expenditure to revenue.

Mr. Sadiq had two equations in there empirical testing, one for revenue and the other for
revenue.
The hypothesis for the expenditure equation was
Ho: Revenue does not Granger Cause Expenditure
H1: Revenue does Granger Cause expenditure
The hypothesis for the second revenue equation was
Ho: Expenditure does not Granger cause Revenue.
H1: Expenditure does Granger Cause Revenue
The data used in this particular research was collected from the Pakistan economic survey and
the state Bank of Pakistan (1980-81 to 2009-10). Data collected for empirical testing included
the federal and provincial tax revenues as well as current and development expenditure. Non tax
revenues (like interest income, profits and dividends) were not included in the estimation
because they are mostly exogenous in nature. To avoid the problem of non-stationary the data
was transformed into real per capita values.
In the first part, regression to test for causality was run between” total tax revenue and total
expenditure”, where total expenditure includes federal and provincial current and development
expenditure. Total revenue variable consisted of federal and provincial total tax revenues.
The results indicated that there is no causal relationship between total government revenue and
expenditure. So for both equations the null hypothesis was accepted (at 5% significance level)
which say that “Ho: total Revenue does not Granger Cause total Expenditure” and “Ho: total
Expenditure does not Granger cause total Revenue.”
Another researcher, Hussain (2005), in his article published in 2005 for Pakistani data showed
that in the data up to 2002-03 a causal relationship did indeed exist between revenue and
expenditure, but the results of this research by Tahir Sadiq indicate that the past relationship does
no longer exist due to the severe changes in our expenses and lack of taxation revenue.
In the second part of the research regression to test for causality, was executed between “total tax
revenue and total current expenditure”. Here too no causal relationship existed between the two
variables. The null hypothesis that “Ho: total Revenue does not Granger Cause total current
Expenditure” and “Ho: total current expenditure does not Granger cause total revenue” are both
accepted.
Thirdly a causality test was conducted between “Tax Revenue and Development Expenditure”.
Here the null hypothesis that “Ho: total revenue does not granger cause total development
expenditure” and “Ho: total development expenditure does not Granger cause total revenue” are
both accepted at 5% significance level.
The results showed that there is no strong causal relationship (from any direction) between
federal and provincial tax revenue and expenditure which implied that governments in the past
have failed to control the budget deficit. Either the expenditures increased out of control or they
were unable to mobilize tax revenues.
As there is no causality between revenue and expenditure according to this research then an
increase in the tax to GDP ratio will not result into increase in the expenditure, so this way the
fiscal deficit will decline. Conversely, if expenditure decreases then this will not affect the efforts
made on the fiscal front and therefore the fiscal deficit will tend to decrease. This research
recommends that we should concentrate on reducing the fiscal deficit by focusing on both
revenue and expenditure which eventually will lead to reduction in inflation in Pakistani
economy.
Nadeem Iqbal, in his paper on studying the impact and relation of revenues and expenditures for
Pakistan concludes that budget deficit and debt have close relationship. Budget deficit is
financed through borrowing; it has effect neither on government expenditures nor on taxes. So a
deficit does not generate long run stabilizing effect on total revenues and government
expenditures.
By taking data from 1961 to 2008, he finds that Government expenditures have insignificant
effect on future taxes and similarly lag value of taxes has no effect on future taxes. So neither
‘spend-and-tax hypothesis’ and nor ‘tax-and-spend hypothesis’ is satisfied.
He finds that taxes and spending decision are taken independently and there is no long run cointegration
between taxes and expenditures. He gets another interesting result that in case of
Pakistan budget imbalances are reduced either through borrowing or through monetization of
debt. Results show that budget deficit has no impact on the behavior of government expenditures
and taxes.
Moreover change in taxes is not followed by change in government expenditures and vice versa.
It means there is no co-integration between taxes and spending. The historical behavior of
Pakistan’s inter-temporal budget constraint shows that taxes and spending decisions are
independent of each other.

 
The Tax-Spend hypothesis
ASEAN
This study aims to find the relationship between revenue and expenditure in the ASEAN
countries using data for 22 years fro 1980-2012 in its ten member states in order to asses the
relationship in these countries.
The study finds that a sound fiscal policy is imperative to promote internal equilibrium such as
stable price and sustainable growth in employment and output.
The study, after checking for stationary and cross dependence shows that panel co-integration
and cross-dependence is present in the long run relationship between expenditure and revenue.
The tax and spend hypothesis holds for five out of the ten countries whereby the changes in
government revenues lead to changes in expenditure.
Botswana
In their case study over Botswana, the author Daniel K. Moalusi tested causality between
government expenditures and revenue using Granger test and finds a unidirectional link running
from revenues to spending in the short run and a bi-directional link in the long run. They
conclude that Botswana must raise taxes to reduce the deficit in budget.
Latin America
In their paper, Government Revenue-Expenditure Nexus: Evidence from Latin America, Ewing
and Payne examine the inter-temporal relationship amongst revenues and expenditures across
five Latin American countries. They emphasize that understanding the link between spending
and taxation is primary in understanding where and how the resources are allocated by the
government. The paper uses the Engle-Granger Bivariate co-integration approach to test several
hypotheses. For two of the countries, Chile and Paraguay a bi-directional causality is found to
support the fiscal synchronization hypothesis whilst the other three are based on the tax-spend
hypothesis, meaning that these countries should focus on fixing revenues to control the the
deficit.
Cebula (1989) measures another impact of Budget deficit, which is that if the government sells
more bonds to finance the deficit, this will most likely cause interest rates to increase. This is
because the government needs to increase interest rates in order to attract investors and compete
with private institutions for the available funds. If government interest rates increase, this will
push up other interest rates as well; therefore this study focuses on the fiscal framework of the
government policies. The paper shows that the budget deficit increases the long term interest
rate, even with the high visibility of Ricardian Equivalence.
Barbados
In this paper the impact of seasonal behavior is examined with respect to the government
revenue and expenditure. The paper provides a detailed study of the effect of taxation and
expenditure reform on the fiscal deficit. In the paper, quarterly data is used to empirically test for
interdependence between these two parts of the deficit that Barbados faces from 1973-1989. The
Granger testing assumes that the time series are weakly stationary, and non-deterministic,
meaning that the comparison of forecasts can be done through a bivariate causality between
government expenditure and revenue.
The statistical steps are a three staged process, whereby the orders of integrability of the data
series are determined, then transformed in to their stationary counterparts. And then the test for
co-integration for the appropriate frequencies was done. The results show that there is zero
frequency co-integration between country’s expenditure and revenue, and a unidirectional
causation from revenue to expenditure. The results show that the government revenue
information obtained during the time period could have been used to improve the forecasts of the
government expenditure in Barbados.
This is consistent with the Buchanan-Wagner view that revenue leads to expenditure.

 

 
The Spend-Tax hypothesis
Nigeria
Authors Damian C. Nwosu and Harrison O. Okafor in their article “Government Revenue and
Expenditure in Nigeria: A Disaggregated Analysis” examined the relationship between total
expenditure and disaggregated government expenditure with the total revenue and disaggregated
revenue of Nigeria. The data used was time series from the time period 1970 to 2011. The
empirical method focused on co-integration techniques and VAR models like the Error
Correction Mechanism (ECM) for analyses purposes. The results show that a long run
relationship is at work between government expenditure and revenue.
The results from VAR analyses show a unidirectional relationship between revenue and
expenditure variables. These result advocate spend-tax Hypothesis in Nigeria. This shows that
changes in expenditure initiate changes in revenue.
Ghana
In this study the authors have tried to analyze the relationship between expenditure and revenue
in Ghana. For their empirical analyses they have used Engle-Granger bivariate co-integration and
error correction model.
The data used was taken from “Bank of Ghana, Ministry of Finance and Economic Planning, and
Ghana Statistical Service”. The data spanned from 1983 to 2007 and was converted from annual
data into quarterly data.
Engle-Granger bivariate test showed that revenue and expenditure were co-integrated. In real
terms if the expenditure increased in Ghana by 1% (as a percentage of GDP) that would increase
the revenues by 0.86 percent (as a % of GDP).On the other hand a 1% increase in government
revenue would increase government expenditures by 1.03%.
If there is a 1% nominal increase in government revenue that will elicit an increase of 0.88% in
government expenditure. On the other hand a nominal rise of 1% in government expenditure
would lead to 0.99% increase in government revenues. The results showed that both government
revenue and expenditures were positively related.
Long run analyses showed that a unidirectional causality existed from expenditure to revenue.
Thus it supported the spend-tax hypothesis in the long run for Ghana.
The author suggests that the medium budgeting framework in Ghana has to be improved, which
can be done if more attention is given to controlling expenditure rather than increasing revenues.
So while making the budget they must focus on ways to control spending.
Portugal, Ireland, Italy, Greece and Spain (PIIGS)
The paper looks at the government revenue-expenditure nexus in the case or Portugal, Ireland,
Italy, Greece and Spain (PIIGS) and the analysis covers a period from 1988-2014 using a
modified Granger causality, as proposed by Konya in 2006. Cross Sectional Dependence is
checked using three different tests, the given test assumes cross sectional dependence and cross country
heterogeneity.
The countries given in this context have strong influence through globalization and have a
comparable economic climate, since they all are part of the European union. The data is used on
level and both expenditure and revenue are expressed as a percentage of the GDP, the results
show that there is cross sectional dependence in the countries, any shock in one country will
affect the other country. The second result is that there is no cross country homogeneity and
every important significant relationship is independent to the country in focus.
The results show that there is a uni-directional causality that runs from revenues to expenditure
in the case of Greece and Italy, the same causality is also seen for Portugal, however it runs in
the opposite direction. Spain and Ireland show no Granger Causality.

 
The Fiscal Synchronization hypothesis
Switzerland
The study analyses the relationship between expenditures and revenues of the Swiss government
from 1872 to 2002. The data was checked for structural breaks and it showed that during the two
world wars there was a significant surge in expenditures couples with a drop in revenues, thereby
showing a clear budget deficit. The paper firstly inspects the cause behind a budget deficit,
checking whether it is the increase in revenues or the drop in expenditures. It uses a multivariate
error correction model in order to estimate short run as well as long run causal relations, it also
checks whether there was a structural break(or breaks) present which formed this causality.
The paper’s outcome is that it shows revenues and expenditures to be closely co-integrated. It
shows that there were major changes to the budgetary policy framework following the Second
World War. The error correction model shows a bi-directional causality that runs between
revenues and expenditures, thus relation them both in the long and short-term relationships. The
results conclude that Swiss policy makers consider the allocation policy when making decisions
regarding the taxation policy. Since the causality is bi-directional, the converse also holds true.
Asian Countries
In their article “Government Revenue and Government Expenditure Nexus in Asian Countries:
Panel Co-integration and Causality” authors Mohsen Mehrara , Mosayeb Pahlavani and Yousef
Elyasi focus on the relationship between government revenue and expenditure which plays a
major role in the policy making. The authors investigated the relationship between government
revenue and expenditure of 40 Asian countries .The time period under focus is from 1995-
35
2008.GDP was treated as a control variable in the model. The research found a co-integration
relation between government expenditure and revenue. The method the used was the Kao panel
co-integration test. They showed that in long run as well as short run a bidirectional causal
relationship exist government revenue and expenditure. According to this research
interdependence existed between the expenditure and revenues. The government must make its
decisions of expenditure and revenues at the same time.so countries in this region must decrease
their expenses and increase their revenues at the same time in order to overcome the budget
deficit.
The authors used government expenditure, revenue and GDP as the three variables in its model.
They used the panel unit root test proposed by Levin et al. (2002), panel co-integration using the
approach suggested by Kao (1999) and finally they used the Granger causality
Malaysia
Using yearly direct tax revenues, indirect tax revenues, non-tax revenues and government
spending of Malaysia, from period of 1970 to 2006, with 36 observations on each of the
variables, the results show that Granger-causality is running in both directions between
government spending and tax revenues. This means that for the case of Malaysia direct and
indirect tax revenues have a causal impact on government spending. That is, when the
government raises salaries, the purchasing power will also increase, indirectly affecting the sales
tax or service tax collection. Therefore, there is a long run bidirectional causality relationship
between government spending, direct tax revenue and indirect tax revenues.

India
Yashobanta and Smruti analyze the causal relationship between central government revenue and
expenditure for India using annual data over the period 1970-2008. The
Johansen co-integration test suggested that there is a long-run relationship between central
government revenue and expenditure. In the short run, unidirectional causality from expenditure
to revenue supporting “Spend-and-Tax” hypothesis exists but the result from Granger causality
test based on Vector Error Correction Models (VECM) suggests bidirectional causality between
central government revenues and expenditures in the long-run supporting Fiscal Synchronization
hypothesis.
China
To solve the problem of continuously increasing budget deficits, Chang and Ho (2002) state that
the government of China needs to know if raising revenue, cutting expenditures, or simply
changing both sides without taking into account of the interdependence between the two, should
be the way to continue on fiscal situation in China. In this study, the hypothesis of tax-andspend,
spend-and-tax, or fiscal synchronization was tested using annual time series data for
China over the period 1977 to 1999. The results from Granger causality test show feedback
between government revenues and government expenditures, supporting the fiscal
synchronization hypothesis for China and recommending it to raise revenues and reduce
expenditures in order to tackle deficits.

Iran
In this particular article the researchers Yousef Elyasi and Mohammad Rahimi have tried to find
the causal relationship, for Iran, between the two variables government expenditure and
government revenue. They used time series yearly data which spanned from 1963 to 2007.
The results of the empirical testing showed that a bidirectional causal relationship exists between
the two variables and this relationship exists both in the long run as well as the short run. So this
research supports the fiscal synchronization hypothesis. Hence for the case of Iran, expenditure
should be decreased and at the same time government revenue should be increased, this action
plan will control the budget deficit. In Iran’s case, fiscal synchronization might be the reason
why government’s spending plans for the year are dependent its oil revenues.
These revenues then directly affect the expenditure of the government and also the rate at which
the economy grows. If we look at the expenditure side, if the government expenditure increases
it boosts up the economy which then leads to increase in the government’s revenue from other
sources besides oil revenues. The author concludes by saying that such bi-directional causality
might even make it harder for the government to control budget deficit.
Gulf Cooperation Council
In the paper to examine the relationship between government revenues, government spending
and economic growth for Gulf Cooperation Council (GCC) countries for the period from 1990 to
2010, the authors find that government expenditures Granger cause government revenues for
Qatar and the United Arab Emirates only. Hence, there is no evidence for spend-and-tax
hypothesis for 4 countries of sample. Moreover, government revenues Granger cause
government expenditures for Saudi Arabia only. Therefore, there is no evidence for tax-and38
spend hypothesis for 5 countries of sample. They also found a unidirectional causality running
from government expenditures to GDP in Bahrain only. For Kuwait, Qatar and Saudi Arabia,
GDP Granger causes government revenues while GDP Granger causes government expenditures
for Oman and Qatar.
Romania
Researchers in the article tried to find the relationship between national public budget revenue
and expenditure in Romania. They used the granger causality test as an empirical tool.
Controlling the budget deficit has been a very difficult task for the Romanian governments.
Different methods have been used to control this problem. They either focus on cutting down
expenditure or on increasing taxes. In order to examine the relationship between expenditure and
revenue this article used the Granger causality test.
The monthly data set for this analysis was taken from National Bank of Romania; during 1991-
2005.The two variables under analyses were “national public budget revenues” and “national
expenditure”. Co-integration and VAR was used to examine the relationship between these two
variables. They also applied the unit root test on the data and it showed that the variables were
not stationary (integrated of order one). Absence of stationarity means that co-integration tests
could be applied on the given Romanian data.
They used the following regressions to estimate for co-integration and to test for the stationarity
for residuals.
Rt = β0 + β1Gt + πt, and Gt = α0 + α1Rt + λt,
The results showed that the residuals and deficit in this case would be stationary. Any shocks in
revenue and expenditure will temporarily impact the fiscal deficit.
The granger test results showed a bidirectional causality which meant that fiscal synchronization
exists in Romania. VAR was also used to find out the impact of shocks in revenue and
expenditure. First they saw that a fluctuation in state budget revenue affected state budget
expenditure a lot and then the same strong impact was of shocks in state budget expenditure on
the state budget revenue.
So the results showed that government revenue causes the expenditure and government
expenditure causes revenue in other words the synchronization hypothesis was accepted in the
case of Romania. Only decreasing the expenditure as a fiscal policy will not help in this case
because that will lead to a fall in revenue as well.

 
The Institutional Separation hypothesis

 

United States of America
This paper examines the causality between revenues and expenditures through co-integration and
Hsiao’s modified Granger Causality test for the data post World War 2,that is 1946 up till 1996.
A bivariate model is used in the study, building on the argument of Darrat and Suliman (1994)
who argue that if variable x is not causing variable y, over a time period t then we cannot infer
that this causality holds true in the larger economic context.
The data testing for stationarity using three different tests was done and it was found that
expenditures do not granger cause revenues and hence taxes, this is contrary to Barro’s views
which state that higher government expenditure would result in a surge in taxes.
The results show that neither of our two variables depends on the other, instead taxes and
expenditure adjust to the disequilibrium independently of each other. Changes in expenditure
results due to a change in the economic growth, it shows a growth when there is a rise in the
demand for Government provided services such as higher incomes, growth in the population and
due to some local or external event. An increase in tax revenues, on the other hand is usually
caused due to an increase the GDP. In simpler words: in the United States spending is not
proceeded by taxation.
The paper concludes that there is no evidence of any causality between revenue and expenditure
and it is shown that GDP causes both these variables. This shows that using a bivariate model
excludes possible relevant variables and these may generate spurious results. This is because of
the institutional separation of the functions allocation and collection of tax of the Government.

 
European Union
This paper analyses panel data from 1976-2006 the European Union in order to test the four
hypothesis of budget deficit. Panel data is used because most countries are very similar in the
composition of their institutional structures; moreover the EU countries have to meet a predetermined
target so they can comply with the primary economic policy. This bootstrap method
is used on the general government spending and revenue collection. Through this procedure, the
panel is homogenous and thus we can test each individual panel using the Granger Causality test.
It requires a lag and it is not contradictory in results and allows the authors to detect how many
and what causality exists.
All four hypotheses have been analyzed using data from developed and developing countries and
the Granger causality has been examined. Using data modeling it was seen that government
expenditure Granger causes government revenue for France and Portugal, consistent with the
“spend-tax hypothesis”, “tax-spend hypothesis” for Germany, Italy, and Netherlands and finally,
and “institutional separation hypothesis” or “fiscal independence hypothesis” for Austria,
Belgium, Denmark, Finland, and UK.
Nigeria
The study aimed at finding whether there was a relationship between government revenues and
expenditures in the long run over the period 1961-2010. They used Augmented Dickey Fuller
and Phillip-Perron testing followed by an Engle-Granger Causality test. The results show that
there is no relationship amongst the variables. They took up to three lags in their data and were
unable to find some causality amongst the variables.
A model is specified, which shows the functional relationship between Government Expenditure
and Revenues as well as the real GDP, showing that changes in expenditure could be due to
changes in real GDP as well, therefore the model incorporates the changes in the output, and it’s
implications on the budget deficit. The result showed that there was no bidirectional or
unidirectional causality amongst the two variables and it shows that the government’s spending
decision and the government’s sources of revenue function completely independently of each
other. Hence the institutional independence hypothesis is being followed in Nigeria.

 

 

 

 
Data
This paper uses the data covering a period of 1976-2014, which includes a total of 38
observations. The data sources are from the Pakistan Economic Survey and State Bank of
Pakistan. For the previous year, that is 2014, we are using the data as targeted by the ministry of
finance. The revenue and expenditure variables are a taken as a sum of both federal and
provincial level, showing the holistic figures. Nominal variable series have been used to study
the correlation and causality.
Our variables include
Ø Tax Revenues
Ø Non-Tax Revenues
Ø Total Government Revenues
Ø Current Expenditure
Ø Development Expenditure
Ø Total Government Expenditure.

 
Methodology
This paper uses a five-step methodology, whereby we first take the unit root test, followed by an
OLS regression analysis, optimal lag determination through AIC, VAR analysis, and finishing
with a Granger Causality test. We used the E-views software to carry out the testing.
We use a bi-variate regression equation to observe the relationships between the following sets
of variables Total Revenue and Total Expenditure, Total Revenue and Current Expenditure,
Total Revenue and Development Expenditure, Non tax Revenue And Total Expenditure, Non-
Tax Revenue and Current Expenditure, Non-Tax Revenue and Development Expenditure, Tax
Revenue and Current Expenditure, Tax Revenue and Development Expenditure and Tax
Revenue and Total Expenditure. This way we have explored all sets of possible combinations of
interplay between the collections and spending of government of Pakistan.
A bi-variate regression equation is used to investigate the relationship between Government
expenditure and government revenue. The relationship is determined both ways. Therefore, the
nine sets of equations are given as below, please note that ‘t’ in the OLS equation denotes the
first difference lag of all variables it accompanies.

1. Total Revenue and Total Expenditure
!”!! = !! + !!!”!! + !!(1a)
!”!! = ! + !!!”!! + !!(1b)
‘R’ and ‘E’ represent the total revenue and the total expenditure. !! & !! are the respective
coefficients of Revenue and Expenditure. Taking the natural log of the variables allows us to
interpret the relationship in term of elasticities. !! & !! are the respective error terms associated
with our equations.
2. Total Revenue and Current Expenditure
!”!”! = !! + !!!”!! + !!(2a)
!”!! = ! + !!!”!”! + !!(2b)
‘R’ and ‘CE’ represent the total revenue and the current expenditure. !! & !! are the respective
coefficients of Revenue and Expenditure. Taking the natural log of the variables allows us to
interpret the relationship in term of elasticities. !! & !! are the respective error terms associated
with our equations.
3. Non tax Revenue And Total Expenditure
!”!! = !! + !!!”#!! + !!(3a)
!”#!! = ! + !!!!!! + !!(3b)
‘NR’ and ‘E’ represent the non tax t revenue and the total expenditure. !! & !! are the respective
coefficients of Revenue and Expenditure. Taking the natural log of the variables allows us to
interpret the relationship in term of elasticities. !! & !! are the respective error terms associated
with our equations.

 

4. Tax Revenue and Total Expenditure
!”!! = !! + !!!”#!! + !!(4a)
!”#!! = ! + !!!”!! + !!(4b)
‘TR’ and ‘E’ represent the tax revenue and the total expenditure. !! & !! are the respective
coefficients of revenue and expenditure. Taking the natural log of the variables allows us to
interpret the relationship in term of elasticities. !! & !! are the respective error terms associated
with our equations.
5. Tax Revenue and Current Expenditure
!”!”! = !! + !!!”#!! + !!(5a)
!”#!! = ! + !!!”!”! + !!(5b)
‘TR’ and ‘CE’ represent the tax revenue and the current expenditure. !! & !! are the respective
coefficients of Revenue and Expenditure. Taking the natural log of the variables allows us to
interpret the relationship in term of elasticities. !! & !! are the respective error terms associated
with our equations.

6. Non-­‐Tax Revenue and Development Expenditure
!”!”! = !! + !!!””#!! + !!(6a)
!””#!! = ! + !!!”!”! + !!(6b)
‘nTR’ and ‘dE’ represent the non-tax revenue and the development expenditure. !! & !! are the
respective coefficients of Revenue and Expenditure. Taking the natural log of the variables
allows us to interpret the relationship in term of elasticities. !! & !! are the respective error terms
associated with our equations.
7. Non-­‐TaxRevenue and CurrentExpenditure
!”!”! = !! + !!!””#!! + !!(7a)
!””#!! = ! + !!!”!”! + !!(7b)
‘nTR’ and ‘CE’ represent the non-tax revenue and the current expenditure. !! & !! are the
respective coefficients of Revenue and Expenditure. Taking the natural log of the variables
allows us to interpret the relationship in term of elasticities. !! & !! are the respective error terms
associated with our equations.

8. Tax Revenue and Development Expenditure
!”!”! = !! + !!!”#!! + !!(8a)
!”#!! = ! + !!!”!”! + !!(8b)
‘TR’ and ‘DE’ represent the tax revenue and the development expenditure. !1 & !1 are the respective
coefficients of Revenue and Expenditure. Taking the natural log of the variables allows us to interpret the
relationship in term of elasticities. !! & !! are the respective error terms associated with our equation.
9. Total Revenue and Development Expenditure
!”!”! = !! + !!!”!! + !!(9a)
!”!! = ! + !!!”!”! + !!(9b)
‘R’ and ‘DE’ represent the total revenue and the development expenditure. !1 & !1 are the respective
coefficients of Revenue and Expenditure. Taking the natural log of the variables allows us to interpret the
relationship in term of elasticities. !! & !! are the respective error terms associated with our equations

 
Unit Root Test
To test for stationarity in the series, we used two tests, the Augmented Dickey Fuller test and the
Phillip Peron test. The ADF test is used to test for unit roots in time series data, the more
negative the number, the stronger is the rejection of the null hypothesis, that is, there is a unit
root at some level of confidence. The PP test builds on the ADF with the same null hypothesis, it
differs because it uses a lag in order to make the test endogenous, thereby nullifying the ADF
test. The test makes a non-parametric correction to the t-statistic and hence the test result is
robust.
The null hypothesis for a unit root (stationarity) is tested against the hypothesis of no unit root
(non-stationarity). If the mean, variance and covariance of a given series are not varying over
time then the series is used at level. If they become stationary after taking the first difference, it
is used as such.
For both the ADF and PP, we conduct tests at level and at first difference of both the series. We
also use both the constant and the constant and trend for both our variables. Finally, the Akaike
Information Criterion (AIC), which measures the relative quality of the statistical model for the
given data is used to determine the lag length. The maximum lag length that we take is 2.

 
Ordinary Least Square Regression (OLS)
The Ordinary Least square regression estimates unknown parameters in a liner model of
regression, its goal is to minimize the differences between the data sets. The result is an estimator
that can be expressed using a simple linear formula.
We are using OLS Regression to test the existence and validity of the long run relationship using
between the two variables in each combination. Not only do we see how much one variable, say
tax, is explained by the other, say development expenditure; but also we see the whether this
relationship is positive or negative which will strengthen the results by appointing direction to
the causality indicated by Granger test. We use Ordinary Least Square method to run the
regression and Granger Causality Test with a level of significance at 5% (**).
Vector Auto-regression (VAR)
In order to capture the linear interdependence amongst the variables in the time series, we use the
VAR model. This model is useful for determining the dynamic behavior of economic and
financial time series and for forecasting. It allows researchers to determine relationships between
variables and their lags in the short run.
If the coefficients found using the VAR technique are jointly significant then this could mean the
possible existence of causality amongst the two variables.
Granger Causality Test
We are using Granger Causality Testing to test the relationship between revenues and
expenditure for Pakistan. The data being used is from the period 1976-2014. The variables we
have used are total government expenditure, current expenditure, development expenditure and
total government revenues, non-tax revenues, tax revenues. The source of data is the State Bank
of Pakistan and Pakistan Economic survey.
The Granger model says that if the past values of expenditure explain the revenue then there is a
causal relation from expenditure to revenues. And if the past values of expenditure explain the
revenues then there is a causal relationship from revenues to expenditure. The Granger test
employs the following equations where Y is given as expenditure and X is the revenue.
1: Xt = ΣaXt-j + ΣbjYt-j + μ
2: Yt = ΣcXt-j + ΣdYt-j + μ
The first equation explains revenue as function of the lag of revenue and lag of expenditure. The
second equation shows expenditure as a function of the lags of revenue and expenditure.
The hypotheses from both equations are as follows:
Equation 1:
• H0: REV does not Granger cause EXP
• H1: REV does Granger cause EXP
Equation 2:
• H0: EXP does not Granger cause REV
• H1: EXP does Granger cause REV

The Hypothesis can be checked for the existence of our aforementioned hypothesis using the
following as a guideline. (*)
Fiscal Synchronization
Ø If b≠0 and c≠0 and b≠0 and d≠0: Then there is bi-directional causality between revenues
and expenditures.
Fiscal Illusion Hypothesis
Ø If b=0 and c=0, and b=0 and d=0: Then there is no casualty between revenues and
expenditures.
Tax and Spend Hypothesis
Ø If b=0 in the equation 1 and d≠0 in Equation 2: Then there exists, a uni-directional
causality from revenues to expenditure.
Spend and Tax Hypothesis
Ø If b≠0 in Equation 1 and d=0 in Equation 2: Then there is a uni-directional casualty from
expenditure to revenue.
*Where a, b, c and d are elasticities.

Instead of the typical causality tests involving only the use of Granger Causality to conclude on
the relationship, we are using the aforementioned 5-step procedure which employs the following
tests:
1. Making the nominal data stationary.
2. Finding the optimal lag lengths using Akaike Information Criteria
3. Using OLS regression to find the elasticities i.e. how much one variable explains the
other and whether this relation is positive or negative. This gives the Long Run relation
between two variables.
4. Using VAR to find the Short Run correlation between the two variables and their lags,
taking both variables as endogenous and effecting each other. (This helps to predict if
causality can exist or not.)
5. Using the Granger causality to find the direction of causality between both variables
whether it is bi-directional or uni-directional.

Results
Unit-root Test Results
We conducted the unit roots using both Augment Dickey Fuller and Phillips Perron Unit root
tests for the following 6 variables that were used in different combinations for our OLS
regression and VAR, and Granger causality tests.
Total Revenue
Using ADF-unit root test, the series were non-stationary at level, with constant and constant and
intercept. The series became stationary at first difference, with constant and constant and
intercept.
Using PP-unit root test, the series were non-stationary at level, with constant and constant and
intercept. The series became stationary at first difference, with constant and constant and
intercept
Total Expenditure
Using ADF-unit root test, the series were non-stationary at level, with constant and constant and
intercept. The series became stationary at first difference, with constant and constant and
intercept.
Using PP-unit root test, the series were non-stationary at level, with constant and constant and
intercept. The series became stationary at first difference, with constant and constant and
intercept
Non-Tax Revenue
Using ADF-unit root test, the series were non-stationary at level, with constant and constant and
intercept. The series became stationary at first difference, with constant and constant and
intercept.
Using PP-unit root test, the series were non-stationary at level, with constant and constant and
intercept. The series became stationary at first difference, with constant and constant and
intercept
Tax Revenue
Using ADF-unit root test, the series were non-stationary at level, with constant and constant and
intercept. The series became stationary at first difference, with constant and constant and
intercept.
Using PP-unit root test, the series were non-stationary at level, with constant and constant and
intercept. The series became stationary at first difference, with constant and constant and
intercept
Current Expenditure
Using ADF-unit root test, the series were non-stationary at level, with constant and constant and
intercept. The series became stationary at first difference, with constant and constant and
intercept.
Using PP-unit root test, the series were non-stationary at level, with constant and constant and
intercept. The series became stationary at first difference, with constant and constant and
intercept

Development Expenditure
Using ADF-unit root test, the series were non-stationary at level, with constant and constant and
intercept. The series became stationary at first difference, with constant and constant and
intercept.
Using PP-unit root test, the series were non-stationary at level, with constant and constant and
intercept. The series became stationary at first difference, with constant and constant and
intercept

We have organized our results in a way, whereby, every set of variables (as explained in the
methodology) is being assessed one by one, first by conducting the unit root tests, then running
OLS Regression, then testing for VAR and finally by applying the Granger Causality.
Total Revenue and Total Expenditure

 

RESULT:  (THE MATHEMATICAL EQUATIONS, TESTS, SOFTWARE RESULTS NOT SHOWN IN THIS LINK)

Conclusion and Policy implications
The paper found the data to be stationary using the ADF and PP tests at first difference and the
optimal lag determined by the Akaike Information Criteria was found to be 2. The OLS
Regression explained the relationship between both variables in each of the nine permutations.
VAR testing was done amongst all endogenous variables in order to determine the short run
relation and indicate whether causality existed. Finally, Granger Causality testing was achieved
and the null hypothesis was accepted or rejected.
We can safely conclude that the results of our empirical analysis support the fourth hypothesis of
Institutional independence in Pakistan for the following five sets of combinations taken in the
study, these include. :
1. Total Expenditure and Total Revenue
2. Total Expenditure and Tax Revenue
3. Development Expenditure and Tax Revenue
4. Current Expenditure and Tax Revenue
5. Total Revenue and Development Expenditure
These results hold for both Short Run and Long Run in Pakistan, thus suggesting that the
Government of Pakistan can work to reduce and also finance fiscal deficit. This can be done
without regard to the relation amongst the aforementioned components because it has been
empirically proven that they are independent of each other.
Pakistan can work to increase resource mobilization by broadening its tax base as well as making
the taxation process simple, efficient, equitable, transparent and compliant. Since there is no
85
causality relation between the five pairs, these steps can be taken without any fear of increasing
the expenditures simultaneously.
It has also been found that a change in Tax Revenue collection does not cause any subsequent
changes in any of the components of expenditure. The tax revenues are independent of
expenditures and do not cause them. Hence, a budget deficit reduction strategy should aim at
increasing the resource mobilization through tax collection whilst simultaneously reducing the
unnecessary expenditures that the Government is incurring.
The results from our study are a true depiction of the reality that Pakistan’s budget formation has
faced over the years. Successive governments have formulated the budget policies without taking
into account either Friedman or Baro’s mechanisms of tax and spend or spend and tax. The
presence of Fiscal Independence show that the government has been spending and collecting
without taking into account the impact of these closely associated variables on each other.
Tax revenue has been a major component of total revenues as over the past 40 years, tax revenue
has yielded between 65-85% of the total revenue collection averaging at around 78% of total
revenue. Current Expenditure, on the other hand, comprises almost 75% of the total spending,
and is therefore a major component of total expenditure. There are thee main factors of current
expenditure, these are defense servicing, debt servicing and general administration expenditure.
Pakistan has been a fragile state ever since its inception, after the accession of East Pakistan, the
martial rule of the 1980’s and the constant transition from democracy to dictatorship has had a
negative impact on the macro economy of the country. Adding fuel to fire is the on-going war on
terror that has made defense spending a constant priority for every government. Defense
expenditure is a major component of current expenditure and each year it is set without regard to
the available resources. This shows that Pakistan doesn’t consider its revenue collection targets
whilst spending on defense.
Deficit, over a period of time translates into debt, and therefore, the same argument is applicable
to the current debt situation. Due to a constant balance of payment crisis, the permanent fiscal
deficit and the war on terror, the country is heavily indebted not only domestically but also
internationally.
Debt servicing is a significant part of government spending and it is independent of the tax
collection, since debts have to be repaid as soon as the bond matures or the country would
default. Henceforth, this also suggests that there no attention is given to the empirical evidence
whilst deciding where to spend the revenues collected.
The study also shows the counter argument to the aforementioned results, for four of our
permutations; we deduce that there exists a positive uni-directional causality amongst the
following four pairs.
1. Total Revenue and Current Expenditure
2. Non-Tax Revenue and Total Expenditure and
3. Non-Tax Revenue and Development Expenditure
4. Non-Tax Revenue and Current Expenditure
It can be seen that a positive uni-directional causality is running from non-tax revenues to total
expenditures, from non-tax to development expenditure, from non-tax revenues to current
expenditures and from total revenues to current expenditure.

These relationships have important policy implications for Pakistan. A positive uni-directional
from Total Revenues to Current Expenditure shows that Friedman’s tax and spend hypothesis
exists in Pakistan. This implies that the Government must set revenues before incurring any
expenditure, especially those associated with general administration. A rise in total revenue
collection would result in an increase in the current expenditure of the Government and vice
versa.
Therefore, when reducing it’s current expenditures the government has to reduce revenues as
well. Conversely, raising revenues means that the Government would end up spending more on
current expenditure. Hence, to finance the Revenue Deficit where by current expenditure is
greater than total revenue, the government can only rely on tax collection or broaden its tax base.
A rise in taxes has been empirically shown to be independent of current expenditure.
The results also suggest that the strategy to finance the budget deficit through increasing non-tax
receipts, causes the expenditures to rise as a consequence. A change in non tax revenues causes
the same change in the total expenditure, current expenditure and development expenditure. Thus
the Government of Pakistan has to rely heavily on tax revenue as a source for expenditure
financing.
The taxation sector is the major source of revenue. Streamlining, strengthening and reforming
the taxation process as well as simplifying it will result in increased tax payments, as tax evaders
and there would be a greater population paying their due tax burden. Another major hurdle in the
tax collection process is the vice of corruption, eliminating corruption and making processes
more transparent would increase taxes manifold. Another important implication would be to
reform the entitlement programs, alter the defense budget and improve welfare programs –
minimizing these and other non-necessary payments such as protocol expenditure can reduce the
amount the government spends.
The aforementioned measures, if implemented would reduce the budget deficit by reforming not
only the revenue collection structures but also the expenditure outlets, hence leading to long term
macro economic stability

 

 
References
1. Amoah.B., Loloh.F.R.( August 2008): Causal Linkages Between Government
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Appendices

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Probing into IMF’s program for Pakistan

Very recently, I had the occasion of meeting the current IMF Mission Chief for Pakistan, Mr. Harald Finger in Serena Islamabad to ask him about the essence of the IMF program for Pakistan but habitual of questioning the problem area, I ended up with a round of inquiries reasoning the IMF policies and challenging their theoretical and practical feasibility. Some of the major domains of the argument circled around the following teasers.

page

 

When out of the shady attitude of IMF for the economy of Pakistan, I opted for a mocking question over why IMF always wants a sudden implementation of its conditions, and should it not allow the time for building the capacity to meet the conditions? Also, why it is more sever on its terms and restrictions towards the less developed countries such as Pakistan, when it is felt that it allows more concession to Europe, an example being Greece. When Europe is in crisis, IMF’s help comes readily and its conditions are not very restrictive but in terms of Pakistan it has adopted strict policies of liberalization even with such a bad investment environment, should not IMF focus on protection of industry and give us time to grow? The Chief’s reply was just as sarcastic as is the overall stance of IMF. He said:

“Talk to Greece they will tell you just the opposite and they have a point too. It depends on severity of the problem and the Greek problem is much more severe than Pakistan. We do give time where the situation needs time but some circumstances cannot wait.”

As for the point where I probed into the liberal approach towards Pakistan, he chose to stay on the safe side by agreeing with me verbally in saying that you do not need sudden liberalization and gradual liberalization is what we are focusing on, but obviously I doubt this is how it is in their program too.

The Chief went on to quote Leo Tolstoy while laughing and enjoying his job of controlling the bad economies in saying that ‘All happy families are happy in their own way; all unhappy families are unhappy in the same way’, most countries approach IMF with the same situation of BOP crisis and IMF deals with everyone the same way.

A very typical and layman question I threw at him was simply put as why does IMF  help, why not let a country fix itself because market should, theoretically, adjust itself automatically to which he said that ‘we put an institutional structure in place, not every country can protect itself. It gets ugly for the people. You cannot unbankrupt the companies when they become bankrupt.’ It seemed from his reply that the IMF cared more about the people and multinationals than the BOP or the economy of a country which questions the welfare existence of IMF as a financial institute or is it for matters more related to controlling a country’s policies.

When I commented on the very recent statement of IMF with regard to Benazir Income Support Program (BISP) having found I million more poor people which indicated a sense of pride and relief, he laughed but also said ‘it is not a matter one should laugh at. We have two choices for an economy, private or public, and in Pakistan there are a lot of governance issues, nepotism, we can fix or close companies. It is a very serious issue. The BISP admin faces a lot of challenges in expanding to new households every year. There are a lot more poor people out there. BISP is just a mechanism to find them. Poor people don’t benefit from subsidies. BISP is a way to change that. Instead of a blanket subsidy, we find the poor and assist them.’

When I questioned him if he believes that giving a man a fish is better than teaching him how to fish because social spending programs such as BISP do not increase equality or welfare, then what is the advocacy behind BISP, preference of IMF on cash transfer over skills, which is both theoretically and practically not the right choice as it is not making productive citizens or contributing to the economy in anyway? His reply rather shocked me when he said ‘Personally I see cash transfers better than any other form of development. BISP gives cash transfers and education conditional transfers. BISP amounts are small but atleast it’s a starting point. We are not a development institute. We talk about inclusive growth. But we have this social program for poor for past 20 years, because we realize growth has to be inclusive. The cash transfer of BISP increased by 50% and will increase more… we have to make it bearable for everyone to live.’

When I questioned him why there is such a wide perception gap and if IMF can give us the same lenz with which it sees us because IMF does not seem to consider how the targets it sets for us our achieved, if our government is doing numerical manipulation of stats because there has been empirical evidence on the current government that it has manipulated the figures for growth and production. His reply was once again indifferent and curt ‘We are not auditors frankly!’ Monetary policy is audited by the IMF but fiscal authority is audited by auditor in general. We do take the accusation on figure manipulations seriously. There were accusation of squeezing and stocking on different elements and we always checked. The method to see if government is refunding or stocking something is to see its trend over the year. Such activities show a trend behavior. And we did not find so in any of the points made. However, if such an activity does happen then what can we say, the government itself should be responsible and see what it’s doing.’

When asked about his view on 70 to 80% of IMF money being held with politicians and still IMF gives more money, he was correct enough to say that ‘We can’t say no to corruption or eradicate it, we can minimize the risk of abuse by setting policies of safeguard in a national system’ but I was not convinced by his indifference. If IMF exits to solve the economic problems of countries though customized programs then it must not be so indifferent to the real issues with the economy of that country, even if they are outside of the economic domain of issues, after all, the IMF money  makes each and every person of this country indebted to IMF, if it was lent to solve a crisis issue but was instead eaten up by government officials then IMF cannot get away with saying that their problem ended with lending the money; they must also make sure that the project was completed and audit the cost allocation. But the chief’s reply was ‘There is no mechanism to see if a government is using the money well as you cannot pin money. A gambler can make a 100 excuses while taking money from you that it for his children’s education, for medical reasons or he can say to you that it’s for gambling but in the end he will gamble with it no matter what he tells you.’ As our argument went on on the subject of IMG giving loan on top of loan when government fails to repay and if IMF should still pay, once again I was disappointed to hear him say ‘Government borrows and repays when it is comfortable enough o repay; usually everyone repays and if someone fails to repay it shows that something is wrong with the program and the system and in such a condition we have a choice to forgive and start a new program let them fall! So we give them to time to repay and pay them in the mean time to develop.’ It seems like IMF does not mind a mound of debt on a country and lends anyway which once again challenges the purpose of IMF, whether it is to change the financial state of a country or if it is to make a slave of debt out of that country, because nomatter how philanthropic and warm-hearted the chief made it sound, we all know that IMF is the last organization to be characterized as a charity business. It was very disheartening to see that IMF has no issue with continuous loans when it is aware of corruption and default in the government, such an intention can only be understood in the context of controlling the sovereignty of a country only because it fell into the pit once upon a time from which it never got out because it befriended IMF and then began the lifelong romance of debt and slavery.

When I pushed him to answer me clearly what is his advocacy behind cash transfers and not creating opportunity for the poor from that pool of fund (BISP) and same being the case with loaning even when an economy is not improving enough to be able to pay back, he made it easy for me by generalizing my question as being that of ‘moral hazard’, someone getting assistance and not becoming better! Be it a country or a person under BISP net. His answer, however, once again beats all economics I ever learnt and falls in the radius of welfare economics when he first said ‘In 1998 Korea was under IMF program, today it is a big contributor; in 1998 Pakistan was under IMF program and it still is.’  When he was done laughing on his joke, he went on to close the debate by saying that ‘our program is to provide an opportunity, what the recipient does with it is up to them. Pakistan is as much a member of IMF as another country and if it needs money it can rely on the pool, that’s what we are for. As for BISP, ultimately it’s upto your government .They are your people. It is upto you whether you want to take them along or leave them. But providing a lifeline, an opportunity is important.’

While Mr. Finger left me in the best impression of himself as a good man who cares too much for the poor in Pakistan, it was very clear to me that he was trying his best to justify IMF’s role play, so much that he seemed not to have noticed that the organization he is serving existed to improve the financial crisis and introduce programs for economic uplift; not for social uplift which involve giving Rs1200 to 5.3 million people every month and keep indebting a country till its’ ministry of finance’s sole objective becomes making the IMF happy and repaying the loan when there was a lot more to fix in the economy in the first place.

His love for Her

How could have I not loved her…in her eyes were a thousand worlds which I could see all at the same time when I have never even seen this world that I live in. In her smile were a hundred sorrows which only I could see, while at the same time her smile was all it took to make me feel like I have achieved everything there is and as for her sorrows, they made me feel that I was born for a purpose, the purpose being to be there by her side forever. She came in my life like a blow, a blow of the wind which picks up a lonesome, fallen, fragile leaf and takes it to a nearby lake where the leaf floats on the waves of fresh water, never fearing to drown. She was there all along, in this world, in my world, all these years but it was this one blow of the wind that brought her in the stream of my eyes and I swear, never once after that, have I been able to look at anything else. She is all I see and want to see; all I look at, all I look into, and all I look up to. I can never get enough of her. Her world, it is a beautiful place, where everything is at is, simple, truthful, trusting; and for some reasons of the unknown, it pulls me towards itself as if I am drunk, as if I’m under some spell. I have all the riches of this world, I have travelled far and wide, I own so many houses around this world but it is only inside her when I know I’m in my real home. I get whatever I want, I have never felt deprivation; whatever I like, set my eyes on, fix my mind on, I have enough wealth to bring it into my possession. Everything I lay my hand on, it is mine. But she, I lay my hands on her and I am hers. She makes me feel deprived of her every time she is away. The more near I am, the more I see her, the less I possess her, and the more she possesses me. It is as if none of the riches of this world can buy her for me, or make her mine, for she is not of this world. And a penny, no, it does not even take that to make me hers.  How could I have not loved her… I want to stand by her side, in deserts, on mountains, under the sea and over all lands; I want to live by her, for her, with her, in her. To the world I am a rich man who can have whatever he wants, but ever since I have looked at her, I know I am the poorest. She makes me feel a strange kind of deprivation. I have been deprived of her all these years…I am deprived of her grace, her shadow, her shelter, her gaze, and that smile. I will give up anything in the world for that smile, and a hundred sorrows hiding there in. How could I have not loved her?

ECONOMIC PROGRESS AND UNEMPLOYMENT: is there any correlation?

Abstract

This paper examines how a common labour force statistic, such as the unemployment rate, can play a vital role in the economic progress of a developing country like Pakistan.

Empirical evidence abroad suggests that unemployment is a key variable when it comes to any discussion of economic improvement; this finding is supported through both primary and secondary sources. Annual unemployment rates and GDP (per capita) are in fact related to each other, and the extent of this relationship is further examined in this article through a basic regression model on data from the 1980s to 2010.

The findings of this study are supported by evidence published in online journals and research papers, by vast global organisations such as the International Labour Organisation (ILO) and other Pakistan-based research groups.

 

Keywords: Gross Domestic Product, unemployment, labor force statistics, Pakistan.

 

Introduction:

The future looks bleak for the citizens of Pakistan as the end of the Fiscal Year 13-14 looms closer. Amid political unrest, rising inflation and the accumulating indebtedness, Pakistan currently lies amongst the lower middle income developing countries of the world, with relatively low GDP growth (annual).

Amongst all the other current ‘hot’ topics of discussion is rise of unemployment rates that the country is facing this year. A recent report published by the ILO states that Pakistan is predicted to see a surge in unemployment rates this year (2014) followed by five years of near stagnant unemployment from 5.29 pc to 5.5 percent (Global Employment Trends Report, ILO 2014).

Another article in a local newspaper states: “…creating jobs should be difficult in 2014. The persistent uncertainty and political unrest implies that Pakistan’s economy may lag behind the progress-oriented countries in South Asia” (Express Tribune, 22/01/14)

It is a well-established fact that unemployment rates and annual GDP are two correlated variables. Empirical evidence from the US suggests that economic growth (measured via GDP as an indicator) and unemployment are negatively correlated, with the correlation figure quoted as -0.38 (Forbes, 2012). This paper attempts to examine this relationship for Pakistan, to see whether the current surge in unemployment can be traced to Pakistan’s GDP trends.

The article has been divided into two sections, for the ease of the reader. The first part deals with providing a background to the study, and an explanation of the variables through an intensive literature review. The second part attempts to form a basic model of unemployment rates and GDP per capita for Pakistan for the past 30 years, to see whether the relationship does in fact exist. These two sections are followed up by a short conclusion that sums up the importance of these findings, and how they are a vital indicator for the economy of the country.

 

 

Objective of the Paper:

To see whether a significant relationship does in fact exist between both unemployment rates and economic growth in a country, and what this means for future growth and sustainability (via empirical and secondary research).

 

Literature Review:

This first part of the paper basically deals  with providing background and secondary evidence for our area of study.

  1. In the article, Economic growth and the unemployment rate, Linda Levine discusses relationships between unemployment and the annual growth rate of a country. The author states that the relation remains partly undefined in the short run but in the long run, there exists a negative relation between the two, i.e. as growth rate decreases, unemployment increases. The author establishes how Okun’s law can be incorporated into the system, and how the findings of the law help us study the modern day economic standings of different countries. According to the findings, if growth in GDP exceeds the growth in labor productivity (GDP growth rate increases with increased productivity).  In the US, a minimum growth rate of 2.5% is required to decrease unemployment from its current standing. (Levine, 2013)

This article proves our hypothesis correct as the results show that GDP growth rate is inversely related to the unemployment in the country.

 

  1. Reviewing the Okun’s law:

Arthur Okun first talked about the long term relation between the annual growth rate and unemployment in 1960s. It basically studies that how much of the annual growth is lost due to the unemployment rate above the natural level of unemployment. Since there is a positive relation between output (growth dependent on output) and employment, there naturally exists a negative relation between output and unemployment. The law includes that to decrease unemployment the growth rate of the economy must exceed its set potential. According to the regression results of Okun, for every 1% decrease in unemployment, the GDP grows at a rate of 3%. (Okun, 1960)

The Okun’s law helps prove our hypothesis correct, as according to the results of the research of Arthur Okun, a negative relation between unemployment and the GDP growth rate.

 

  1. In the Highlights of the Pakistan Economic Survey 2012-13, it is stated that the economy of Pakistan grew on average at the rate of 2.9 percent per year during the last five years. The deterioration of the power sector has proved to be the main reason for this steady growth and has destroyed any possibility of achieving the potential growth rate of 6.5 percent per annum. Real GDP growth for 2012-13 has been estimated at 3.6 percent as compared to 4.4 percent in the previous year. The reason to these issues has been noted as the constantly increasing unemployment in the country. Unemployment has followed an upward trend as total unemployment rate increased to 6.0 percent in 2010-11. The number of unemployed people increased from 1.94 million to 2.1 million in Punjab, in Sindh from 0.57 million to 0.70 million in 2010-11. However, In KPK the situation is different the unemployed people decreased from 0.55 million to 0.53 million and in Baluchistan unemployed people increased from 0.06 million to 0.07 million in 2010-11. (Highlights of the Pakistan Economic Survey 2013, 2013)

This article further cements our hypothesis, as it not only approves our variables, but also our study area, i.e. Pakistan. It clearly states that though unemployment in KPK has decreased but the overall rate of unemployment has only increased throughout the country, and so has the annual growth rate, which fell short of the estimated growth rate.

 

  1. In the report, Poverty, Inequality, and Unemployment in Pakistan, the authors Ghulam Muhammad Arif and Shujaat Farooq have discussed that the overall unemployment rate increased from 6 percent in 2000/01 to 8.3 percent in 2003/04. However, it declined during the next four years until 2008 to 5.2 percent. During this period, the economy witnessed comparatively high growth and poverty reduced sharply. But the years 2009-2011 have seen an increase in unemployment. But this increase is not the case for the women in the urban areas of the country, and the males in the rural areas of the country. The major increase is seen in the youth, they have high unemployment rates. A comparison between Pakistan and the other South Asian countries has been drawn, which shows that no matter what the basic unemployment level is, the unemployment rate in youth is comparatively high in this region. (Ghulam Muhammad Arif, 2011)

This report supports our hypothesis.

 

  1. A report on the Social Sector of Pakistan discusses key elements of the economy, and establishes a relation between the unemployment and the growth rate.  It highlights how hindrances in social sector developments cause the unemployment to increase. But these hindrances at times result from decreased GDP growth, resulting in unemployment, or at times  these hindrances cause unemployment, leaving the economy crippled in its own way (more unemployment, less the output)

This report again partly accepts our hypothesis.

 

The literature available in this regard was limited for Pakistan, but sufficient to draw a secondary result. That is, up until now, our hypothesis remains accepted.

 

Data analysis:

The data for unemployment and GDP per capita have been taken from The World Bank

In 1982, Pakistan’s GDP per capita was Rs812.6 which steadily grew over an expanse of 26 years to Rs2720.5 in 2010. This is almost an increase of Rs2000. The GDP per capita has shown a steady increase but remained committed to an overall rising trend with no single year showing any fall.

The unemployment rate was at 3.75% in 1834, which increased in 2010 to being 9.3%. overall, all throughout the 26 years, Pakistan has witnessed an increasing unemployment rate constantly due to it increasing population and literacy but a very narrow base for economic growth to absorb the growing labor force.

Due to the data constraints, errors in measurement, a large amount of population living outside the umbrella of labor force survey and population census, coupled with migration of Afghans, it is expected that the unemployment rate may be much higher than that shown by the data.

 

 

Results:

Regressions equation:

log( unemployment) = c + log( gdp per capita) + u

1

 

The regressions analysis above shows that there is a significant relation between  GDP per capita and Unemployment in Pakistan. GDP per capita as the explanatory variable explains unemployment upto 87% as shown by the R^2 value. Hence the model is a good fit.

1 percent change in GDP per capita reduces unemployment by 0.93 percent, as shown by the analysis, the data analysis being free of heterogeneity and autocorrelation.

This explains that the findings of our result support the theory that economic growth which causes rise in per capita income reduces unemployment, therefore GDP per capita was used as the major factor explaining reduction in the unemployment and the result shows that it it indeed does so upto 87%.

The regression through simple OLS shows a significant relation between reduction in unemployment through a rise in per Capita GDP from a spread of 26 years in Pakistan.

The elasticity of unemployment to GDP per capita is 0.93.

 

 

Conclusion:

The results of this paper show that the prevalent unemployment rates, and the gross domestic product per capita do share a common time trend, and an inversely significant relationship.

Pakistan’s economic situation affects the unemployment pattern of the country, as the past thirty years’ worth of data show.  As the GDP grows in the country, the unemployment level generally falls; while the converse is true. While the relationship is a cycle in itself (i.e. increase in GDP causes a decline in unemployment rates, which further increases economic growth through worker productivity), it works in a single direction too, as reflected by our model.

This finding highlights a very important point for policy makers while dealing with labour market issues and poor productivity. An increase in economic activity in the country can help create jobs, thus lessening the burden of the unemployed on the country’s resources. Similarly, training unskilled workers can convert unemployed labourers into productive citizens, thus bringing the country closer to its goal of inducing economic growth, and hence progress.

 

 

References:

 

Express Tribune (January 22, 2014) Unemployment in Pakistan set to increase in 2014: ILO report

http://tribune.com.pk/story/662013/ilo-report-pakistans-unemployment-rate-to-remain-same-till-2018/

 

The Key to Economic Growth: Reduce The Unemployment Rate. (Forbes, 27/8/12) Accessed Online

http://www.forbes.com/sites/mikepatton/2012/08/27/the-key-to-economic-growth-reduce-the-unemployment-rate/

 

Highlights of the Pakistan Economic Survey 2013.

Ghulam Muhammad Arif, S. F. (2011). Poverty, Inequality, and Unemployment in Pakistan. PIDE.

Levine, L. (2013). Economic growth and the unemployment rate. Congressional Research Service, 3-6.

Okun, A. (1960). Okun’s Law.

 

 

 

A meeting with IMF Mission Chief in Islamabad to discuss IMF plan for Pakistan

AUTHORS: HIRA NISAR KHAN, MARYAM ALI

IMG_20140512_104728

IMF mission chief Mr. Jeffrey Franks was in town and invited some of Pakistan’s prospective economists to meet with them and discuss the newly implemented IMP program in the country. A total of approximately 15 economics students belonging to prestigious universities were in attendance of the event which took place in Serena Hotel Islamabad, last Monday. NUST nominated the two of us to participate in the session and it was there that we got to learn, question, reason, analyze, and lastly to form our opinion on the current IMF program for Pakistan.

The purpose of the meeting was to discuss and analyze the new IMF program in Pakistan and to encourage students to engage in stimulating debate regarding macroeconomic and fiscal stability in the country and explain the role of IMF in promoting so. Mr. Franks presentation comprised of impressive statistics regarding various monetary, exchange rate and fiscal targets which need to be achieved to promote macroeconomic stability and fiscal sustainability in Pakistan. However, despite the fancy figures that have been set and dictated to the government, the program sounds rather rigid and overly ambitious for a developing country like Pakistan whose economy is largely prone to exogenous shocks and macroeconomic crises.

Let us begin by highlighting the important proceedings of the session. Mr. Franks began by addressing the problems with past IMF programs. He confessed that treating the macroeconomic problems without addressing the structural components has not been successful and that social protection also needs to integrate into the program. However, looking at the current program, we cannot help but question if these lessons from past have actually been dealt with or merely learned. For instance, IMF suggests that to bring fiscal sustainability, the fiscal deficit must be reduced from 8.5% of GDP to 3.5% GDP by 2016/17. However, once again IMF has failed to deal with the structural flaw that has been contributing to large fiscal deficit. Pakistan is pre dominantly a consumption oriented society where people love to spend but hate to collect taxes. This explains why revenue is treated as a residual component of the fiscal equation and thus, whatever fiscal deficit target is achieved; it is done by adjusting expenditure component and not by raising tax revenue. This is evident by the fact that fiscal deficit target of 5.5% for end March was met by drastic cuts in development expenditure and not by tax revenues. When I raised this point in the session, it received a rather indifferent response by Mr. Franks which made it clear that IMF clearly has little interest in the health of Pakistan’s economy and the quality of fiscal adjustment which it keeps emphasizing in every program.

Mr. Franks demonstrated optimism in the country’s ability to achieve the growth target of 6% to 7% as laid down in the program. Development expenditure is the fiscal push in an economy which is necessary to accelerate economic growth; however, with the recent cut down in this expenditure, it is almost illusionary of IMF to even hope that this target will be met.

Furthermore, IMF acknowledged the need of integrating social protection into the program. This was probably one of the few things that received welcoming remarks at the session. Mr. Franks praised the new government’s decision to retain the Benazir Income Support Program (BISP) and suggested that the government should increase the size of benefit and magnitude of the program so the number of beneficiaries can be increased. Additionally, IMF will offer further support to households who will enroll at least one child in a school. On this, a student suggested that instead of encouraging the policy of giving money to the poor, the IMF should invest in promoting job creation in the economy which will be much more sustainable in the long run.

What we noticed and were rather displeased with was Mr. Franks’ use of mocking tone and snide remarks as he talked about Pakistan economy. At certain points in the session, Mr. Franks’ choice of words not only reflected his lack of professionalism but also offended us. One such instance was his response when we questioned him about the Euro Bond. He said: “Pakistan is like your uncle who does not know how to manage his money, so when he goes to the bank, the bank denies him loans. Then a few years later your uncle (Pakistan) learns to manage his money and then when he goes to the bank, he receives a loan. So instead of being so critical about the Euro bond, you should appreciate the fact that at least now you are able to raise money because your credit rating has improved.”

Similarly, when questioned upon the $53.4 billion worth of borrowing that the present government has done in matter of less than a year, mortgaging Pakistan’s two generations as pointed out by a senior economist, Hafeez Pasha, the IMF chief once again could not refrain from his mocking replies to avoid discussion on IMF’s responsibility to manage the debt of its member country by criticizing and denying Pasha’s report claiming he is confused between the stock and flow of loans.

Mr. Franks confessed the failure of the program in increasing the tax to GDP ratio despite its persistent efforts and attributed this to governance and structural issues in the economy. He further stated that the tax net along with being small is filled with legal holes which further hamper the tax collection process. According to him, there’s only a limit to which reforms can be implemented in a country as too many reforms put a country into a condition known to IMF as reform fatigue.

Moreover, the IMF lacked any interest towards working for employment other than relying on economic growth which would take its time to pick up. According to the chief, ‘Most of the poor in Pakistan are not unemployed. They are already working. It is just that they are not making a lot of money. So creating new jobs through government supported schemes will neither create too many jobs nor help many. It will only add to budget deficit.’ Such statements coming from a prestigious institution like IMF not only sound absurd but also raise some doubt to their understanding of Pakistan’s economy.

The discussion on energy sector proceeded fairly as expected. After stating the gap is demand and supply of energy, Mr. Franks suggested that the country must adopt some price adjustment mechanism to bring demand curve downwards which obviously pointed towards removing subsidies from energy. When questioned over why IMF does not make the government invest in Pakistan’s resources of oil and gas, which remain untapped while being enough to self-sustain its economy, he replied rather systematically in saying that, one, IMF cannot force a government; it can only ‘convince’ the government while we are well aware of the policy dictations of IMF in other walks of the economy. Two, the chief retorted with a kick that if he was asked to drill for gas in Balochistan, he would first ask for an armed body guard, implying that the uncertain security situation was to blame. Three, that any such investment cannot be done by the government alone without the help and partnership of foreign investors, but if it is so then why does the IMF not focus on creating investment with an emphasis on growth strategies as opposed to stabilization first. Four, the IMF has convinced the government to raise prices of imported oil and gas from the new import partners in future which goes even more against the common man down trodden with inflation and unable to sustain survival but maybe in its illusion of assuming ‘electricity and gas as the luxury items’ in Pakistan which only the rich consume and derive utility from and that the ‘luxury cannot be subsidized’, the IMF seems to have no concern for the poor chunk of the population in the rural areas. Thus, it appears that IMF’s goal of integrating social protection in the new program has been forgone. Maybe for IMF, electricity and gas are still luxury items even in the 21st century, and with such a concept it is obvious that no policies will be designed keeping the common man in mind and energy sector reforms seems a farfetched idea with this mindset.

Towards the end of the session, Mr. Franks discussed various policies and reforms which need to be implemented for Pakistan to stay in the category of emerging marketing economies. Mr. Franks claimed that “if the country fails to achieve fiscal and monetary stability, it will lose its position as an emerging market economy and move towards, well frankly, no market at all.”

The session proved to be a great learning experience for us, however, pessimistic remarks such as the one mentioned above made us wonder if our economy has actually progressed under IMF programs or we have merely lost our sovereignty by asking for money over and over again.

We are thankful to IMF for organizing this insightful session and providing the future economists of Pakistan an opportunity to discuss the ongoing IMF program in the country.

 

The authors are students of Economics at NUST School of Social Sciences & Humanities and can be contacted at: maryam.ali.929@gmail.com & hiranisarkhan.sada@gmail.com

 

 

 

 

 

 

 

EFFECT OF PUBLIC DEBT ON ECONOMIC GROWTH, INVESTMENT AND UNEMPLOYMENT

AUTHORS:

HIRA NISAR KHAN, MAHAM KHAWAR, INAM KHAN

 

ABSTRACT:

This paper examines the effect of Public Debt in Pakistan since the 1980s to 2014. The three economic fundamentals studied include the economic growth, investment and unemployment and the effect of public debt, across the three decades, has been examined on each of the fundamental. The paper’s findings through the simple regression models and Ordinary Least Square method emphasize and strengthen the theoretical approach that public debt is a deterrent for economic growth, employment opportunity and investment cloud. The causality test was also conducted to study causation between Public Debt with each of the variables. The study finds that Public debt reduces growth, investment and increases unemployment in Pakistan.

 

Keywords:

Public Debt, GDP, Investment, Unemployment, FDI, Energy Consumption, Debt Law

 

Introduction:

Definition of Public debt: This entry records the cumulative total of all government borrowings less repayments that are denominated in a country’s home currency. Public debt should not be confused with external debt, which reflects the foreign currency liabilities of both the private and public sector and must be financed out of foreign exchange earnings.

Public debts have bad effects on economic development of many countries but they are a vital tool and an imperative source of financing government budget deficit.  Where as a better utilization of public debt can promote economic growth and facilitate to improve social welfare of the citizen, it has also been observed that public debt works like a double-edged sword. Too much dependence on public debt enlarges macroeconomic risks, obstructs economic growth, and hinders economic development. A large number of literatures are available showing negative relationship between public debts and economic growth. Investment is a major component and driving factor of growth which is also directly affected by the accumulation of debt. FDI in turn reduces for a country with rising public debt. When the shadow of public debt takes over an economy, it not only affects the macroeconomic picture by deteriorating growth and investment but has far reaching consequences on micro economic level by increasing unemployment.

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Objectives of the Study:

The following objectives have been set:

To examine empirically the impact of public debt in Pakistan on:

A: GDP growth rate

B: Investment

C: Unemployment

 

 

Literature Review:

Debt is said to be a two edged sword, at low levels it help the economy to grow and provide welfare but if debt is taken excessively it can destroy the economy. If governments take too much debt then they are unable to provide basic service to the people. Finance and debt is vital for growth or else the poor economies will remain to be poor. Debt is not a bad thing, but up to a certain limit. If this limit is surpassed then the government has to bear the burden of high levels of debt which can harm the domestic economy. In the paper The real effects of debt, authors Stephen G Cecchetti, M S Mohanty and Fabrizio Zampolli(Sept 2011),  tries to examine and study the Effect of debt on economic growth and also find out the level of debt at which it becomes a problem. A controlled and small level of debt in the economy helps in economic growth and increasing welfare. If too much debt is taken it becomes a huge burden. In their analysis they used data from 18 OECD (Organization for Economic Co-operation and Development) countries from 1980 to 2010.The data collected was on government debt, non-financial corporate debt and household’s debt of different countries.

The results of their research supported their initial hypothesis that after a certain level of debt accumulation the economic growth suffered. The results indicated that for government debt beyond 85% of GDP became a burden and a problem. Similarly for corporate debt 90% of GDP and for household debt 85% of GDP was the threshold after which the debt caused problems in the economy. Governments that have high debt levels should take quick action to make sure this debt burden decreases to a more bearable level. In the long run its better for governments to maintain a debt level well below the threshold level the reason being that an unforeseen calamity or a disaster might occur in the future which might  force the government to take more loans.

The paper titled “External Debt, Public Investment, and Growth in Low-Income Countries” written by Benedict Clements, Rina Bhattacharya and Toan Quoc Nguyen focuses on how the external debt of low income countries effects their growth. They have also highlighted the impact of rising external debt on public investment.

The results of their research showed that the per capita income of these highly indebted countries rises by 1% points if the total stock of external debt is decreased by a considerable amount. If the debt servicing is reduced in these countries and the finances are directed towards public investment this would boost up the economic growth and the growth would increase by an additional 0.5% points per annum.

The research said that high levels of debt slowed down the economic growth. In presence of high debt there is inefficient use of resources which was found to be the main reason for negative effect on growth. Debt seems to be a problem if it passes a certain threshold. An average figure for External debt of 50% of the GDP is considered as the threshold level. Substantial decrease in the external debt would increase the GDP growth by 0.8-1.1%.

Another finding of the research was that public debt indirectly effects growth via public investment. Directly public debt has no effect on investment but debt servicing has an inverse relation with public investment. A 1% point increase in debt servicing (as a % of GDP) decreases the public investment by 0.2% points. So if we decrease debt servicing (or get debt relief) that would lead to a rise in investment. Countries can increase growth and reduce poverty if a good portion of debt relief is allocated towards public investment.

In the literature the negative effect of stock of external debt on growth is termed as “debt overhang”. Krugman in 1988 in in his article “Financing vs. forgiving a debt overhang: Some analytical issues” defined debt overhang as situation where the countries accumulated debt exceeds the countries debt repayment ability. This debt accumulation has a bad impact on the investment and growth of the country. As the debt increases uncertainty rises regarding the fact that the government might adopt distortionary measures to finance the debt (one of the measure could be to increase taxes) .Such type of uncertainty in the economy discourages the investors from investing they tend to wait .It might also contribute to capital flight as the private investors would want to avoid the increased taxes.

 

Naeem Akram in his article “Impact of Public Debt on the economic growth of Pakistan” studies the effects of public debt on economic growth and investment in Pakistan, the time period examined was from 1972-2009.

Pakistan in the past has been unsuccessful to generate enough revenue match its budget deficit. Secondly majority of Pakistan’s developmental projects have financed through loans from external or domestic sources. A certain level of debt is vital for a country like Pakistan that faces scarcity of funds/resources. Such loans help Pakistan to develop and increase its economic growth which would not be possible to do on the bases of their own revenue. But the negative side of debt is seen through the “crowding out” effect and the “Debt overhang” effect.

The author has designed a model that also takes into account the effect of public debt on the growth equation and has used the Autoregressive Distributed Lag (ARDL) technique to estimate the model.

The results of the article support the past literature by confirming the presence of the overhang effect in the economy and show a negative relationship between public debt and investment and per capita GDP.

The results however didn’t confirm the existence of crowding out effect as the relationship between debt servicing and investment as well as per capita GDP was insignificant. But domestic debt was negatively effecting investment and the relationship was significant so we can say that domestic debt has crowded out private investment.

The research suggested that dependence on external debt should be minimized. External debt harms the investment in the country and slows down the economic growth. Secondly Pakistan should focus on ways to increase revenue and decrease the level of expenditure instead of relying too much on domestic debt which has already crowded out private investment.

One paper by Reinhart and Rogoff (2010) examined the relationship between high public debt levels and growth. It was a multi-country analysis based on historical data. 44 countries were included in the sample, spanning over 200 years. The researchers found that at normal levels of debt, the relationship between growth and debt is relatively weak but as the debt levels rise over 90 percent, median growth rates for these countries are about one percent lower while the average (mean) growth rates are several percent lower. In advanced economies, in particular, debt in excess of 90 percent over the past two centuries has generally been associated with mean growth of 1.7 percent versus 3.7 percent when debt is low (under 30 percent of GDP), and compared with growth rates of over 3 percent for the two middle categories (debt between 30 and 90 percent of GDP). Similarly, for emerging economies, median and average GDP growth is around 4–4.5 percent for levels of debt below 90 percent of GDP, but median growth falls markedly to 2.9 percent for high debt (above 90 percent); the decline is even greater for the average growth rate, which falls to 1 percent.

Another paper by Wolfgang Streeck (2013) showed that average public indebtedness among OECD countries more than doubled in the roughly four decades between the 1970s and 2010 from about 40 percent of GDP to more than 90 percent. This lead to declining growth rates and rising unemployment in the OECD world, which in turn lead to greater income and social inequality.

One study by García-Jiménez and Ashok K. Mishra in 2010 examined the role of government debt on determining the level of employment in United States. The model used in the study employed a standard Cobb Douglas production function having government debt affecting the growth of productivity, and it was found that increasing levels of public debt lead to higher unemployment. The US debt to GDP ratio gross has increased from 43.57% in 1980 to 63.25% in 2008. It was seen through the study that for 1% increase in debt, employment was reduced by 0.042%.

 

 

Data Analysis and Regression:

While doing the regression, the fiscal limitaion and debt law (2005) was used as a policy dummy for the data of public debt in all three regression analysis. This way the study took into account the effect of debt limitation law to keeping debt as 60% of GDP and then study the impact of the Public Debt on GDP, Investment and Unemployment.

The regressional analysis with GDP as the dependent variable and Public Debt and Change in Energy Concumption as the explanatory variables shows that Debt reduces GDp growth rate in Pakistan and the relation is significant.

The causality test also shows that Public Debt causes a reduction in GDP growth rate with a level of siginificance at 5% and a lag of 4 years.

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The regression analysis with unemployment as the dependent variable and Public Debt and GDP growth rate as the explanatory variable shows that unemployment increases as debt increases, as shown by the positive relation which is significant.

The causality test also shows that a rise in Public Debt causes unemployment with a lag of 6 years.

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The regression analysis with Investment as dependent variable and Public Debt with change in GDP and Interest rate as the explanatory variables shows a significant and negative relation between investment and debt. As debt rises, investment falls.

The causality test also shows that public debt causes investment to reduce with a lag of 4 years, at 5% significance level.

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Conclusion:

The report shows that the rising burden of debt in Pakistan has had a negative impact on the country’s GDP growth rate and has decreased investment in the country. The economy has been affected negatively with debt accumulation and debt is a causing factor for poor growth and limited investment. Also, the public is directly affected with debt burden when the unemployment rates rise. Since the data covers a timeline of almost 30 years and the trends in the relation are significant, it can be safely said that Pakistan must reduce its debt burden by following the debt limitation law of 2005 in order to prevent a decline in its growth, investment and employment rates.

 

 

 

Reference:

Carmen M. Reinhart and Kenneth S. Rogoff, 2010, “Growth in a Time of Debt” American Economic Review: Papers & Proceedings, 573–578

Carlos I. García-Jiménez1 and Ashok K. Mishra, 2010, “The Effects of Public Debt on Labor Demand in the United States”

Wolfgang Streeck, 2013, “The Politics of Public Debt: Neoliberalism, Capitalist Development, and the Restructuring of the State”

Naeem Akram, “Impact of Public Debt on the economic growth of Pakistan” http://pide.org.pk/psde/25/pdf/AGM27/Naeem%20Akram.pdf

Benedict Clements, Rina Bhattacharya and Toan Quoc Nguyen, “External Debt, Public Investment, and Growth in Low-Income Countries”http://www.mafhoum.com/press6/176E15.pdf

Stephen G Cecchetti, M S Mohanty and Fabrizio Zampolli, Sept 2011, “The real effects of debt” http://www.bis.org/publ/othp16.pdf

 

DATA:

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Pakistan: stats in spotlight

All data sources:

  1. WORLD BANK DATA
  2. Pakistan bureau of statistics
  3. INDEX-MUNDI  at http://www.indexmundi.com/g/g.aspx?v=145&c=pk&l=en

date of access: March 2014

 

PAKISTAN

Population: 193,238,868 (July 2013 est.)

Population growth rate:

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Gender ratio:

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Labor force participation and unemployment:

Labor force participation rate was at

2000: 53%

2012: 59.21%

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Labor force participation rate of entire population

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Labor force participation rate of females

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Unemployment rate was at 5.6% in 2011.

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GDP growth rate and sectoral composition:

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Investment:

 

2

 

Industrial growth:

3

 

TRADE:

Major exports:

  1. raw cotton
  2. cotton yarn
  3. cotton fabrics
  4. bed wear
  5. knit wear
  6. fish
  7. fruits
  8. woolen carpets and rugs
  9. vegetables
  10. sports goods
  11. leather
  12. rice

 

Major imports:

  1. raw materials
  2. consumer goods
  3. capital goods

 

 

EXPORT PARTNERS:

USA, CHINA, UAE, AFGHANISTAN, UK, GERMANY, BANGLADESH, NETHERLANDS, ITALY, SPAIN, BELGIUM, S.KOREA, INDIA

 

IMPORT PARTNERS:

UAE, CHINA, S.ARABIA, KUWAIT, JAPAN, MALAYSIA, USA, INDIA, GERMANY, OMAN

 

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Trade deficit as a percentage of GDP= 6.3% of GDP 2012

Trade deficit as a percentage of exports earnings= -4.63billion/24.63billion= 18.8%

Budget deficit as a percentage of GDP= 4.6%

Current Account Balance: -$4.632 billion (2012 est.) 

 

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Inflation rate, interest rate and debt rates:

 

Central bank discount rate:

12% (31 January 2012 est.)
14% (31 December 2010 est.)

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External debt: 

$56.19 billion (31 December 2012 est.)
$60.18 billion (31 December 2011 est.)

Internal debt = 38.4%

External debt=21.1%

Debt to GDP

2013: 59%

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Inflation rate:

9.7% ( 2012)

a

b

 

Exchange rate of Pakistan Rupees:

As of feb 2014

c

 

Poverty and income inequality:

Poverty in 2007: 21.04%

Gini coeeficient 2007: 30.02

HDI 2012: 0.515

 

 

Literacy:

v

 

 

 

ECONOMIC COSTS AND BENEFITS OF PAKISTAN’S WAR ON TERRORISM

 

Before a cost benefit analysis based on facts and figures of direct and indirect, short and long term consequences and the influence of Pakistan’s fight against terrorism on its culture, society, people, peace and social living standards, we must take first reflect on the intellectual debate made on issues of similar narrative and magnitude.

All war is deception. (Sun Tzu)

whether war on terror, after having persisted for 13 years now is Pakistan’s war or a proxy war, or a chess being played in Pakistan’s land by parties against Pakistan’s interest is not the objective of this analysis but we cannot ignore as Friedrich Nietzsche had put it that ‘The best weapon against an enemy (AFGHANITSAN) is another enemy ( PAKISTAN).’

 

War on Terror (WOT), brief history:

The fight against terrorism is also known as the Global War on Terrorism (WOT). It started on 11th September 2001, after the terrorist attacks in United Stated. It was an international military campaign to eliminate Al-Qaeda and other militant organizations. Following the 11 September 2001 attacks, former President of Pakistan, Pervez Musharraf sided with the US against the Taliban government in Afghanistan which was accused of the attacks in US; Musharraf agreed to give the US the use of three airbases in Pakistan for Operation Enduring Freedom. He unequivocally condemned all acts of terrorism and pledged to combat Islamic extremism and lawlessness within Pakistan itself. Hence began the terrorism in the lands of Pakistan.

Everybody’s worried about stopping terrorism. Well, there’s a really easy way: stop participating in it.”
Noam Chomsky

 

 

A Factual analysis of WOT on the Economy of Pakistan:

Costs:

  1. Destruction of infrastructure,
  2.  internal migration of millions of people from parts of northwestern Pakistan,
  3.  nose diving of production,
  4.  growing unemployment,
  5. reduced demands of Imports,
  6. foreign investments decline,
  7.  tax collection difficult due to security concerns,
  8. terrorist activities in Pakistan,
  9. western countries including USA imposed travel bans for  their citizens to Pakistan.
  10. tourism activities have all been drastically reduced.

FACTS:

  1. At least 8,141 terrorist attacks
    injured 20,675,
    Civilian casualties upto 35000

 

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  1. Direct or indirect cost: $67.93 billion.
  2. 5x [economic loss] > aid from US
  3. US financial assistance:$8.5 billion VS government estimates losses $43 billion
  4. PAKISTAN’S MILITARY EXPENDITURE In RS:
  • 1991: 75.8m
  • 2001: 182m
  • 2007: 327m
  • 2012: 641m
  1. Pakistan may face a “permanent” degree of loss due to the diversion of development spending toward the security budget, capital flight and brain drain, and due to the trade diversion it has suffered since 2001. The allocated budget for defense drastically increased after the 9/11 attacks, leaving behind lesser and lesser for education. The NWFP Department of Education reported that education for students in the province has been affected because of damaged or destroyed schools. This includes 65% in Swat and 35% in Buner, Upper and Lower Dir, Shangla and Malakand Districts.  This damage is expected to increase with the increase in radicalization, especially after the Malala episode. In Swat, female education has been prohibited by the militants and more than 42% of boys’ schools were also destroyed.  Nearly 150,000 students have been deprived of education and in addition, more than 190 government schools have been burnt. Approximately 45,504 students enrolled in these schools in the war affected area of Swat have been affected.

 

  1. Gilgit-Baltistan and the NWFP are important tourist destinations in Pakistan. However, most parts of Pakistan’s northern belt and NWFP have fallen into the terrorists’ grip. There has been drastic reduction of tourism in Swat. According to government’s own estimates, the hotel industry in Swat valley has suffered a loss of Rs.60 billion from 2007 to 2009. There has been a loss of jobs due to reduction in tourism. According to the World Economic Forum, Pakistan ranked 113 out of 130 countries in 2009 as a tourist destination.

 

  1. Agriculture is the main source of revenue in most of the terrorism-affected areas, including FATA and NWFP. A survey by the National Agricultural Research Centre (NARC) shows that nearly 48% of Pakistan’s total fruit is produced by the NWFP, with Swat district being a major contributor. Swat also produces 13% of total national production of tomato. Swat farming system was a model for the rest of the NWFP in particular and the country in general in the pre-war period. Due to the insurgency, the loss to agriculture alone amounts to Rs.35 billion in Swat. The local media, citing Swat-based agricultural officials has reported that 55 to 70% of the total fruit produce has gone waste.  Overall, the Economic Survey of Pakistan report shows that the share of agriculture in the GDP has been constantly falling. It accounted for 25.9 % of GDP in 1999-2000; however, gradually its share shrank to 21.3% in 2007-2008

 

  1. In Trade, Pakistan’s economy is also suffering $ 6 billion export losses annually due to the ongoing war on terror. Pakistan’s exports largely consist of the textile industry, which has been declining. Textile exports fell to 10.8 billion in June 2007.  In 2008, they fell to Rs.10.6 billion. In 2009, they were at 9.78 billion. In 2010, they had a drastic fall to Rs. 2.44 billion.
  2. Manufacturing has the lowest-ever share of 18.2 % in the GDP over the last five years. The small and medium-sized industries have been drastically affected, especially in war-affected areas. The energy crisis has had an adverse impact on industries. Pakistan at the moment faces a 33% shortage of energy, around 6000MW of shortfall. The mining and quarry sector has also failed to grow in the post-war period. It grew by only 1.3 % in 2008-2009, as compared to 4.4% in the year before. The contribution of this sector to the GDP has remained low at around 2.5%
  3. Impact on Foreign Direct Investment (FDI) is such that the FDI, which had witnessed a steep rise before the 9/11 attacks, was adversely affected by the terrorist acts, especially in FATA and other areas of NWFP.  According to a Harvard study (December 2000), higher levels of terrorism risk are associated with lower levels of net FDI. Markets face high risk premiums and the cost of protecting assets rises, reducing investment inflows. Post-war there is a lowered credit rating of Pakistan in World Bank. FDI fell by over 58% in the years following the 9/11 attacks and WOT. In the year after the attacks, The State Bank of Pakistan reported that the FDI fell to $463 million during the first quarter against $1.116 billion during the same period last year, a decline of 58.5%.
  4. Massive loss in employment opportunities, hence loss in income.
  5. Increase in poverty. Rural poverty reached 37.5% from 23.9% in 2007-2008;
  6. Increase in the Internally Displaced Persons (IDPs)

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“A brick represents all the evil in the world. We should start a War on Bricks. And why not? It’s more tangible, yet just as non-sensical, as the War on Terror.” 

― Jarod Kintz, A brick and a blanket walk into a bar

 

BENEFITS:

 

Participation in the WOT has led to a substantial increase in the inflow of concessional assistance, especially in the form of grants from the USA.

  1. 2001-02 Pakistan has cumulatively received $ 12.2 billion funding from the USA. This includes almost 70 percent of reimbursement for the costs incurred by the military in counter-terrorism.
  2. Development and economic assistance aggregated to $ 3.2 billion in 2012.
  3. Rapid buildup in the foreign exchange reserves of the country, reserves increased to $ 12,389 million by the end of 2003-04.
  4. 2002-2007, average GDP growth rate almost of 7 percent.
  5. Large inflows of aid, along with higher remittances and, more recently, foreign direct investment, led to symptoms of ‘Dutch Disease’ in the Pakistani economy. The currency appreciated promoting import-based consumption-led growth.

5B

Interestingly, this growth was unsustainable and a rapid decline in growth averaging at 3%, inflation and the current account deficit at 5% and more followed right after 2008 till present. This shows that the the benefits of WOT were a temporary appeal.

 

References:

http://www.issi.org.pk/publication-files/1299569657_66503137.pdf

http://crss.pk/downloads/Reports/Research-Reports/Cost-of-Conflict-in-Pakistan.pdf

http://data.worldbank.org/country/pakistan

http://milexdata.sipri.org/result.php4

http://dawn.com/2012/08/05/pakistan-to-repay-imf-2-9bn-in-fy13/

http://www.springfieldnewssun.com/news/news/world/timeline-key-events-in-the-war-on-terror-1/nMrD7/

http://www.pakistan.web.pk/threads/budget-2012-13-rs-545-billion-allocated-for-defence.25768/

http://centralasiaonline.com/en_GB/articles/caii/features/pakistan/2010/06/18/feature-01

http://www.finance.gov.pk/survey/chapter_11/Special%20Section_1.pdf