This is binding. 2. THEORETICAL FRAMEWORK The basic HRV

This paper targets the most binding constraints
to recent (2011-2016) low level of private investment and entrepreneurship in
Pakistan using Husmann-Rodrick-Vilasco (2005) decision tree. I have shown that
growth diagnostics of Pakistan undergoes from troubles and huge economic
complexities. The economic growth of Pakistan is continuously affected by
structural problems domestic energy crisis, low investment, high inflation, and
security issues. Growth diagnostics point to four major constraints to economic
growth of Pakistan: lack of infrastructure, inadequate market development, poor
performance of institutions, and lack of efficient public sector management.

1.
INTRODUCTION

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Economic growth
performance of Pakistan is volatile throughout its history (Annexure-I). Its
growth history started with its partition in 1947. Average growth rate was 3.4 % per annum in the
1950s. During 1960s, Pakistan has experienced higher episodes of growth
and average annual real GDP growth rates were shot up 6.8%. In 1970s, the oil price shock of 1970s
and the war of Bangladesh, adversely affect the economic growth and average
annual GDP growth rates were decline to 4.8%. Growth rate grew at 6.5 %
annually, during 1980s and again and shrunk to 4.3 % in 1990s. Pakistan became one of the four fastest growing economies
in the Asian region during 2000-07 with its growth averaging 7 % per year. There were a few really shining years during this
period (Qayyum et al., 2008).

The volatile performance of growth
rate raises the question of what kind of policy reforms should be designed
according to Pakistan. Hausmann, et al. (2005) explains that targeting the most
binding constraints has important advantages over other approaches to policy
selection.

This paper identifies the most
binding constraints to the growth of Pakistan using Husmann-Rodrick-Vilasco (HRV) decision tree and also
provides their empirical evidences. There can be uncertainty about the
“position” of each constraint in the economy so we can only make a
probabilistic assessment of which one is binding.

2.
THEORETICAL FRAMEWORK

The
basic HRV decision tree is
presented in Annexure-II. The tree assumes that:

Economic
Growth = f (private investment & Entrepreneurship)

Low
level of private investment = f (low return to economic activity, high cost of
finance and entrepreneurship

Low
return to economic activity = f (low social returns, low appropriability)

Low
social returns= f (poor geography, bad infrastructure, low human capital)

Low
appropriability = f (Government failure, market failure)

Market
failure = f (self discovery problem, coordination problem)

High
cost of finance = f (bad international finance, bad local finance)

Bad
Local finance = f (low domestic savings and poor intermediation)

Where
‘f’ means ‘function of’

An
under-performing economy is one where market imperfections and distortions are widespread.
Such distortions create a wedge between private and social valuations of
specific economic activities. These wedges can be represented by

 ?
= {?1,
?2,
. . . , ?k}                                                                    
…….(1)

Where ?k
represents the distortion in activity k. The distortions can be modeled as
constraints on policy-making problem that take the general form.

µis
 (?, …) ? µip (?,
…) ? ?i = 0                                                  
 ……(2)   

Where,                                                         

µis
 (?, …) net marginal valuation of
activity i by society

µip
(?, …) net marginal valuation of activity i by private agent

The
economic activities depend not just of the set ? of distortions, but on levels
of consumption, labor supply, asset- holdings, etc. If u is welfare of the
average member of society, then the gain in welfare from reducing one of the
distortions marginally is

d?/dtj
= – ?j * ?i d{?is
(t,…) – ?ip(t,…)} / dtj                              …….(3)

?i ? 0, i = {1, 2, . . . , k} are the Lagrange multipliers corresponding to
the constraints connected with each of the distortions. The first term on the right
hand side of eq. (3) captures the ‘direct effect’ of a small change in tj:
a small reduction in tj increases aggregate welfare by an amount
given by the multiplier associated with the jth constraint, j. The
second term captures the effect of varying tj on the aggregated sum of the gaps
between the social and the private valuation, with the weights corresponding to
each distorted activity’s own Lagrange multiplier.

The standard growth model consists of number of
distortions in the economy yielding the result that along a (constrained)
balanced growth path consumption and capital grow according to

.ct
/ct=?kt / kt = ? r
(1 ? ? ) ? ?                                                  
…….(4)

Where:

C
is consumption; k is capital; r is the rate of return on capital; t is the tax
rate on capital; ?
is the world rate of interest and a dot over a variable denotes the rate of
change over time.

In
addition, the private return on capital r is given by

r
= r (a, ?,
x)                                                                                   ….…(5)

where:

 a = indicator
of total factor productivity

x = availability of complementary factors of
production.

? = index of
externality (a higher ? means a larger distortion).

Eq.
4 & 5 summarize the possible factors that can affect growth performance.1

3.
EMPIRICAL ANALYSIS OF POSSIBLE BINDING CONSTRAINTS IN PAKISTAN

3.1.
Low Saving

A
large body of literature on economic growth tends to support the traditional
Solow (1956) growth model and the “New Growth Models” of David Romer’s and
others in which higher savings leads to higher growth. Table 1 shows that
savings in Pakistan are close to world and high income countries.

Table 1: Net Savings—2016, World’s Average

Region

Gross Savings (% of GNI)

Net Savings (% of GNI)

Low
Income

14.6

–3.8

Lower
Middle Income

27.9

16.1

Upper
Middle Income

32.0

17.2

East
Asia & Pacific

36.1

18.1

Europe
& Central Asia

22.4

9.5

Latin
America & Carib

17.2

9.4

Middle
East & North Africa

33.7

12.9

South
Asia

31.4

18.6

Sub-Sahara
Africa

13.6

–3.9

High
Income

22.6

9.1

World

24.9

11.7

Pakistan

23.3

14.9

Source: World
Development Indicators, 2016.

Based
upon empirical evidence, I exclude savings as binding constraints to growth of
Pakistan.

3.2. Low Appropriability

3.2.1. Failure of Government

Pakistan is politically an unstable
country with various issues. It has experienced 27 Prime Ministers in its 69
years history (Qayyum, 2008). Pakistan is ranked 61th most corrupt
countries of world by International transparency survey 2016. Foreign Policy
magazine, 2013 has listed Pakistan in ‘Top 10′ failed states of world. The
magazine has listed the “unique set of troubles” the world’s most failed states
face. Called the 12 degrees of failure these are: demographic pressures,
refugees, illegitimate governments, brain drain, failure of public services,
inequality, group grievances, human rights, economic decline, lack of security,
factionalized elites and intervention by external actors.

The table 2 shows the poor ranks of
Governance in Pakistan assigned by Global Competitiveness Report 2016.

Table 2

Indicator

Value

Rank/138

Public
trust in politicians

2.7

85

Judicial
independence

3.6

88

Govt,
services for improved business performance

3.0

108

Organized
crime

3.1

130

Brain
Drain

3.5

62

Source:
Global Competitiveness Report 2016

I
conclude that failure of Government is one of the major binding constraints to
growth in Pakistan.

3.3. Institutional Failure

3.3.1.
Educational Institution

Education
plays a vital role in human capital formation. It raises the productivity and
efficiency of individuals and thus produces skilled manpower that is capable of
leading the economy towards the path of sustainable economic development

The quality of education in most of the public schools and
colleges is well below. Moreover, the lack of technical education and research culture in Pakistan educational institutions.  The allocations of funds
for education are very low. It is only 2.0 % of the total GDP in 2012
The low education budget shows the negligence of education (Memon,
2007).                                                                                                                                                                                                                                                                             Human development Report placed
Pakistan at 136th position for having just 49.9% literate population.
In addition to that, Pakistan is ranked 75th in quality of the
higher educational system and 140th in quality of primary education
out of 138 countries in Global Competitiveness Report 2016. All these empirical
evidences show the failure of Educational institution.

3.3.2. Legal Institutions

In
Pakistan, there exist two legal systems; Formal legal system and informal legal
system such as Jirgas. Due to inadequacy of the judicial system, ordinary cases
take years to settle in Pakistan. Investigators are poorly trained and lack
access to basic data and modern investigation tools. In many cases the parties
involved are forced to enter into settlement due to this unbearable delay in justice.
Given the absence of scientific evidence collection methods and credible
witness protection programs, police and prosecutors rely mostly on confessions
by the accused, which are inadmissible in court. Lack of education, awareness,
unbearable delay and costs of lawsuits, complexity and bureaucratic nature of
the system, makes it extremely difficult for the common man to seek justice.
The level of corruption in judiciary and the police is however one of the main
causes of failure of legal institutions in Pakistan (Zia, 2007).

Table 3

Indicator

Value
(0-7)

Rank/138

Reliability of
police services

3.0

127

Judicial
Independence

4.1

57

Property Rights

3.5

116

Intellectual
property protection

3.0

106

Organized crime

3.4

136

Source: Global
Competitiveness Report 2016.

 

I
conclude that the rule of law is unstable across the country. The independence
of the legal system is poorly institutionalized, and judicial procedures are
costly, prolonged and subject to political pressure. Property rights are not
protected effectively. Failure of legal institutions is another binding
constraint to growth in Pakistan. 

3.4. Macro Risk/Macro Economic Instability

Global
competitiveness report 2016 ranked Pakistan as number 116 out of 138 countries
in world in terms of its macro environment. Table 4 shows the poor scores of
macroeconomic environment . Government
of Pakistan has failed to maintain macroeconomic stability.

Table 4

Indicator

Value (0-7)

Rank/138

Macroeconomic
environment

3.8

116

Government
budget balance, % GDP*

-5.3

106

Inflation,
annual % change

4.5

93

General
government debt, % GDP

64.4

95

Country
credit rating, 0–100 (Best)

114

Data Source: Global
Competitiveness Report, 2016

 

Thus, I conclude that macroeconomic
instability is another binding constrained to growth in Pakistan.

3.5.
Market Failure

3.5.1. Lack of Competitive
environment and Innovation

Innovation plays a crucial role in achieving growth of an
economy. Risk, initiative and innovation are integral ingredients of
entrepreneurship.  Pakistan lacks innovative culture due to a lack of
incentives by the government, cases of plagiarism and proper facilities to
conduct research on technical and scientific subjects. Almost all sectors
of Pakistan are suffering by lack of innovation and competitive environment (Qayyum
et al., 2008).

The global competitiveness report
2016, Pakistan is ranked 77 in innovation out of 138 countries (Table 5).

Table
5

Indicator

Value
(0-7)

Rank/138

Capacity for innovation

3.8

95

Quality of scientific research
institutions

3.6

87

Company spending on Research
& Development (R&D)

3.3

67

University-industry collaboration
in R&D

3.4

68

Source: Global competitiveness Report:
2016.

3.5.2. Asymmetric Information

Provision of correct
information failure is another market failure. If people have different information at the time they act,
markets may not perform efficiently. In Pakistan markets, asymmetric
information prevails widely. Buyer has limited information about product
compared to seller. The seller gets advantage of this ignorance and charge high
prices. In same manner, the moneylender might charge high interest rate to
borrower in credit markets (Aleem, 1990).

I conclude that market failure is also a binding
constraint in Pakistan.

3.6. Social Returns

3.6.1. Geography

Location
and climate have large effects on economic growth by effecting public health,
and agricultural productivity (Gallup et al., 1998).

Table
6

Country Comparison: Area

Country

Sq.
Km

Rank

Tanzania

947,300

31

Nigeria

923,768

32

Venezuela

912,050

33

Namibia

824,292

34

Mozambique

799,380

35

Pakistan

796095

36

Source: The World Fact Book, 2016.

 

Pakistan is ranked 36th
biggest country by area out of 252 countries of world (Table 6). Pakistan has very unique
Geographical landscapes equipped with Northern high mountainous Region, the
Western Low Mountainous Region, the Balochistan Plateau, the Potohar Uplands,
and high mountains (Geographical Overview of Pakistan, 1969).

Pakistan
enriches in oil, gas, coal reserves and has emerged as one of the leading
country having 6th largest coal reserves in world after the discovery of huge
lignite coal resources in Sindh in 1991. (Ministry of Petroleum and Natural
Resources, 2015).

I exclude the geography of Pakistan
as binding constraints in Pakistan.

3.6.2. Infrastructure

Development economists have long been recognized that infrastructure is a
necessary input in production process. In Pakistan, low infrastructure
development in the past two decades
has become binding constraints to production sector in the economy.
Pakistan’s infrastructure needs are massive and its resources are limited (Imran
and Nazli, 2011).

Table 7

Indicator

Value
(0-7)

Rank/138

Quality of
overall infrastructure

3.5

93

Quality of roads

3.8

77

Quality of
railroad infrastructure

3.1

53

Quality of port
infrastructure

3.5

84

Quality of air
transport infrastructure

4.0

91

Quality of
electricity supply

2.4

121

Source:
World Development Indicators, 2016.

Pakistan’
score in overall infrastructure is 3.5 in Global Competitiveness Report 2016
(Table 7). Analyzing empirical evidences, infrastructure is also included as a binding
constraint.

4. Conclusion &
Policy Implications

The
objective of study was to analyze the most binding constraints to Pakistan,
which has slow down the present growth (2011-2016) of country. By empirical
evidences, I have target Government failure, market failure (asymmetric
information, Lack of innovation), Failure of institutions (educational, Legal),
Macro risks, bad infrastructure as binding constraint to growth in Pakistan.
While low savings and poor geography were excluded from listing as binding
constraint to growth of Pakistan.  In short, Pakistan’s economy seems to
stuck in multiple binding constraints and in order to get out of this
exceptional adjustment needs to be made. Several areas are important to
make some considerable reforms like; private sector growth, good governance,
institutional strength, market development, macroeconomic stability and infrastructure
development.

1 The methodology is adopted from Hausman et al., 2005.

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