DETERMINANTS OF GOVERNMENT EFFECTIVENESS IN PAKISTAN

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1 DETERMINANTS OF GOVERNMENT EFFECTIVENESS IN PAKISTAN *Dr. Amtul Hafeez, **Misbah Bibi *Assistant Professors, National University Of Modern Languages (NUML) Islamabad **Graduate from NUML. ABSTRACT The study analysis the government effectiveness in Pakistan over the time period Augmented Dickey-Fuller (ADF) is used to check the stationary level of the variables employed in the model. Cointegration analysis is applied to check the existence of a long-run relationship between variables. Error correction model is used to find the short run adjustments for the government effectiveness in Pakistan. The results show that trade openness and literacy rate are found to have significant positive effect on the dependant variable. However population growth rate and exchange rate are found to have strong negative effect on the dependant variable in Pakistan. Key Words: government effectiveness, good governance, Investment, trade openness INTRODUCTION Over the past decade, good governance has attained great importance all over the world. Recently, good governance has gained the attention of economists, politicians, national and financial institutions. Good governance can be regarded as the instrument of the effectiveness of a society s institutions for economic growth and development. If the government run institutions work efficiently and honestly, then outcome should be economic growth. The idea of government effectiveness as a dimension of good governance is an instrument for sustained development and reducing poverty. Governance has been defined as the use of authority to manage a nation s affairs and assets. The great stumbling block was to implement such policies in practice. The first donor institution was the World Bank to properly implement the concept of government effectiveness especially surrounded by developing countries. During 1990s, as compared to other developing countries in Asia, Pakistan s competitive shortcomings have resulted in slowed economic growth while the country managed to achieve a little growth during 2000s. However this expansion was largely consumption-demand-driven, rather than the result of a major increase in investment-led productivity. Recently, the ineffective efforts in governance by bureaucracy and other state structures were unable to cope with the country s economic challenges. As a result of non-compliance with the international standard, 43

2 the country s effective governance now depend on a combination of massive foreign assistance and remittances of overseas. More modern studies have revealed that to enhance the capacity of people to work together, trust and partnership within voluntary associations is mandatory. The emphasis on private investment motivates our investigations that rely on the linkages between effective government and capital formation in the private sector Everhart et al. (2001). Effective government creates an efficient environment for investment, including investment in human that leads to higher income, reduces poverty, and provides better social indicators. Good governance mutually builds relationships between government, society, and the private sector. According to United Nations Development Program (UNDP), governance as economic, political and administrative authorities can be worked to manage a country's affairs. The standards of government effectiveness applied on the national, global and corporate environments would become instrumental for achieving the goals of poverty alleviation and sustainable development, Coleman (1988). Our study focus on second dimension of good governance is government effectiveness. Government effectiveness means the capacity of government to mange resources. Government in good governance is said to be effective when it provide good investment environment through the implementing sound policies and run institutions without any corruption. This super investment climate includes opportunities and incentives for firms to invest profitably, create jobs that leads in expanding output. So, there will be higher growth by increasing the levels of private investment. However, in the poorest countries, business seeks to maximize rate of return to investment after tax. This study will locate the variables that have supplementary impact on the government effectiveness in perspective of good governance. Good Governance throughout the world has addressed the concerns of economic operators for economic development but unfortunately, Pakistan has not yet experienced empirically its benefits due to bad governance here. To fill this gap in the literature, purpose of the study is to analyze the determinants of government effectiveness in Pakistan. Thus, the hypothesis tested in this analysis is stated as follows: how do social and economic variables in Pakistan contribute to better governance? REVIEW OF LITERATURE Lipset (1959) discussed that human capital including education and health concern with better governance institutions. On the one hand, political instability can be reduced through educational attainment by generating more avenues to reconcile the opposing parties. While on the other 44

3 hand, it encourages private capital formation by raising the profitability of investment. Human capital is a positive catalyst that leads to economic growth through the effective work of governance because skilled workers are better in dealing with organizational changes. Skillful work force is indispensable for firms to adopt new and more productive technologies and techniques. In addition, new technologies generally require effective changes, which are handled better by a skilled labor force. In this way education gives the opportunity to the enterprises to expand or enter new markets. This idea states in the classical approaches of the published reports to highlight the importance of education in bringing better governance institutions. These considerations justify that human capital becomes as an explanatory factor of private investment through its effect on the quality of governance institutions. Khan and Rinluhart (1990) studied private investment as a proxy of government effectiveness in the developing countries and described how those countries are facing many economic problems such as low growth rate, inflation and foreign debt, deficit in trade balance and low standard of living. They suggested that the developing countries should more focus on private investment as compared to public investment for the economic growth. It was found that private investment had larger impact on economic growth than public investment. Focus of government investment shifted from large scale manufacturing to energy sector which helped in attracting private investment in the country. William and Levine (1996) found that the financial development is an important component of private investment decisions, by providing more opportunities and incentives for the firms to invest. A developed financial system mobilizes and allocates resources to the enterprises. A developed financial system is also expected to be more efficient due to an increasing technological specialization that leads to best selection of projects. This allows the firms to finance more investment projects and to increases the productivity of new investments efficiently. According to the neoclassical assumption of the flexible accelerator model about the availability of credit supply, given the lack of well-functioning financial markets by the banking sector cannot be taken for granted in developing countries. This discrepancy also arises due to the public deficits and public debt, which can lead to financial depression and become a hurdle for private investment. Daniel and Marion (1999) discussed that governance work well at the level of government, duty bearers and decision makers and at the level of citizen due to importance of information literacy. If the government run the institutions effectively, then access of information is easy for poor people. They can do the work efficiently and they can do a better job. To achieve better governance, the district level and community need to have a stronger link between the two. Government is said to be effective, when they concern with social accountability tools in make policies, according to law courts,planning, auditing of public expenditures.social accountability tools includes community scorecards, social audits.budget tracking and 45

4 monitoring. When government use social accountability process, then people can be able to participate directly in the accountability process. Child protection is very necessary and people need to ensure that their contribution is risk free. Government uses existing spaces for collaboration and dialogue among the various actors. It become helpful to builds skills and capacities in both citizens and government officials. For the development of partnerships and networks, children and youth necessitate to have capacities to work effectively together, organize, influence, use media and new communication technologies and methods, access information and analyze it. And policy-makers need to make strong capacities to connect with children and young people, to hear, respond. Government institutions need to make the resources to be more responsive to citizens needs and rights.in this way, decision-makers will listen to them, showcase their capacities and abilities and consider their opinions in policy making. According to Pretty and Ward (2001) demonstrated that emphasis on the problems of developing countries can be helpful in stressing the importance of social capital in sustainable social and economic development. This study analyzed that how this capital is connected with the improvement in the natural capital of rural societies, if social capital is in the form of relations of trust, connectedness in institutions, common rules, norms. According to the report of World Bank (2003) effective governance is a part of the investment climate of a country. Investment decisions are mainly driven by profitability motives.the forward-looking nature of investment things to see the importance of a stable and secure environment, predominantly the security of property rights. Effective governance institutions are concerned for reducing uncertainty and promoting efficiency. Better governance improves the investment climate by improving bureaucratic performances and predictability. As a reward, this reduces uncertainty, as well as the cost of doing business. Effective governance also contributes by the effective delivery of public goods that are obligatory for productive business. Dios, and Martin, (2010) modified the role of governance and institutions in growth for the developing countries like Pakistan. This study relation of measurement of governance and institutional quality with growth. There is positive long run association between both the institutional quality and the governance, and income and growth. The result also explained that Asia economy grow faster in , by controlling the per capita income that had regulatory quality, rule of law, and government effectiveness. So they suggested that measure of governance and institutional quality needs to be improved to enhance the betterment of the future researches. Hafeez and Safdar (2015) examined the impact of different economic factors on investment behavior in Pakistan. The study is based on time series data over the time period The results show that domestic and foreign savings, gross domestic investment are found to have 46

5 significant positive effect on investment. However interest rate and inflation rate are found to have strong negative effect on investment behavior in Pakistan. DATA AND METHODOLOGY The study used time series data for the time period Data is liberated from different sources; Pakistan Economic Survey (various issues) and International Finance Corporation (IFC). The variables are selected in accordance with the detailed review of literature. To analyze the impact of independent variables on government effectiveness, we use time series data. We use proxy of private investment as a proxy of government effectiveness and good governance. Government has responsibility to create the environment for private investment. The description of the variables is shown in Table 1. We analyze the factors which affect government effectiveness in the Pakistan by using time series data. We first check the stationary of data through Augumented Dickey Fuller test. Our endogenous and exogenous variables are stationary at Ist-difference that all are integrated of order one. The results of unit root test are shown in Table 2. INV_pri = f (TR_open, LITERACY, POPU, UNEMP, BDEFICIT, EX ) (1) INV_pri = β 0 + β 1 TR_open + β 2 LITERACY+ β 3 POPU+ β 4 UNEMP +β 5 BDEFICIT+ β 6 EX + ei (2) Table 1: Description Of variables Abbreviation Names Of variables Description of variables INV_pri Private Investment Money is invested by business, companies and financial institutions, rather than by a government. TR_open Trade Openess It is measured as the share of imports and exports over GDP. LITERACY Literacy rate Percentage of the population of age fifteen and above, who have writing and reading skills that incorporates social practices. POPU Population growth rate Population growth rate in Pakistan. UNEMP Unemployment rate Percentage of total work force who are unemployed but actively seeking jobs. BDEFICIT Budget deficit An excess of government expenditure over 47

6 government revenues. EXR Exchange rate Conversion of one currency into another currency at current market price. Table 2: Augumented Dickey Fuller Test ( Unit Root test) Variables Level Ist difference t-statistics INV_ Pri TR_open LITERACY POPU UNEMP BDEFICIT EX The results of Augumented Dickey Fuller test indicate our time series data are non stationary at level and we make it stationary at first difference. Long Run Analysis Since our variables are stationary at first difference, we use Johansen Co-integration technique to find long run relation between dependent and independent variables. We use Error correction model (ECM) to identify the short run relation between variables. Results of Co-integration Rank test for government effectiveness model are shown in Table 3. Table 3: Results of Co-integration Rank test Hypothesized No. of CE (s) Trace statistics Critical Values at 5% None * At most 1 * At most 2 * At most 3 * Results of normalized Co-integration technique are shown in Table 4. The results show that government effectiveness model has three co-integrating vectors at 5 % on the basis of comparing Trace Value Test with critical values. The trace values are greater than 48

7 critical values and show that long run impact exists between dependant and independent variables. PINV= β 0 + β 1 TR_open + β 2 LITERACY + β 3 POPU+ β 4 UNEMP + β 5BDEFICIT + β 6 EX + ei (3) Results indicate that trade openness has positive effect on volume of private investment. We find that 1 % increase in trade openness leads to 22 % increase in private investment. This means that when exports are increased, our foreign reserves start increasing. More government revenues are generated and consequently government facilitates private sector investment by investing capital funds in long run. Table 4: Results of Normalized Co-integration Technique Variables Coefficients t values TR_open * LITERACY * POPU * UNEMP *** BDEFICIT * EX * Note: *, ** shows t-values are significant at 1% and 10%. If there is 1% increase in literacy rate, it leads to 28.7% increase in private investment. As the literacy can be taken as skill of the people and skilful people know how to best use productive methods to produce more output level with low cost. Hence increase in productive efficiency -- can increase the private investment in the country. In developing countries, population increases geometrically and resources increases arithmetically. It badly affects output level. Government has limited resources to feed a large proportion of population. Then government will have short funds for technological innovations. Therefore 1% increase in population will cause about 24% reduction in private investment. We find that 1% increase in unemployment rate leads to about 20% decrease in private investment. It shows that shortage of employment opportunities leads to low savings rate and low private sector investment. Since unemployed people do not pay taxes. Therefore government will not be able to venture capital funds for creating better environment for private investment. Government has no revenues to facilitate private sector investment and private sector investment falls consequently. 49

8 Result show that 1 % increase in budget deficit leads to 47% decrease in private investment. That is when government expenditures are more than revenues, the national savings also decreases. Government will face high economic burden and charges more taxes which will decrease s demand. So producers are reluctant to invest money in projects for production. In this way government badly affected to show good governance. One percent increase in exchange rate causes 65% decrease in private investment. The reason is that exchange rate plays a crucial role in investment decisions by entrepreneur. Government tax the private sector to pay more for imported goods and therefore, private sector investment is discouraged. It shows that government policy negatively affect good governance. Short Run Analysis In the government effectiveness model, the shock showed the way from the co-integrating equilibrium path to a short term departure. The short run relationship among the variables was confined by taking the first difference of the variables included in the error correction mechanism. The results of the error correction mechanism are reported in Table 5. Table 5: Results of Error Correction Model (ECM) Variables Coefficient Standard Error t- values D(INV_pri) * D(TR_open) * D(LITERACY) * D(POP) * D(UNEMP) D(BDEFICIT) * D(EX) Error Correction Model assumes the effects of budget deficit, population, trade openness, and literacy rate on private investment for short time period. Negative coefficient values shows there is reverse long run adjustment between private investment, trade openness, unemployment, budget deficit, and literacy rate. It means errors are reduced (adjusted) in short run. The impact of these variables on private investment has also short time equilibrium with errors corrections. The results of error correction mechanism revealed that the, unemployment, population, exchange rate, and budget deficit negatively related with the government effectiveness in Pakistan in the short run period. The estimated coefficient of private investment is 69 % and it is significant. That is 69 % percent of the disequilibrium in private investment will be corrected in short period. 50

9 CONCLUSION The finding of empirical analysis suggests that social and economic variables have great impact on governance in the country both in the short run as well as long run. These exhibit a significant influence on the quality of governance and give empirical support to our hypothesis. More specifically, measure to expand general social variables like literacy, and population, become the cause of good governance. This research provide an empirical bases for the achievement of goal geared towards the strengthening of civil society and democratic institution. The result of this analysis should have interesting implications for advocacy program and policy making. Better governance should be attentive and concentrated in the areas where more active and trusting citizenry can help to do well REFERENCES Daniel, S. and Steven, G. (2003). International Business Studies, Journal of International Business Studies Vol. 34, No. 1 William, E. and Levine, R. (2003). Tropics, Germs, and Crops: How Endowments Affect Economic Development. Journal of Monetary Economics, 50 (January): Everhart, et al. (2001). Trends in Private Investment in Developing Countries, Statistics for , and the Impact on Private Investment of Corruption and the Quality of Public Investment, IFC Discussion Paper, 44, Washington, D.C. Hafeez, A. and Safdar, S. (2015). Factors Affecting Investment Behavior In Pakistan. The Explorer: Journal of Social Sciences, vol.1, no. 9. Government of Pakistan (various issues). Economic Survey. Finance Division, Economic Advisors Wing, Islamabad, Pakistan. International Monetary Fund (2003). World Economic Outlook, Growth, and Institutions. World Economic and Financial Surveys, Washington, D.C. International Finance Statistics Database (IFS), the International Monetary Fund, Washington, D.C. Khan M. and Rinluhart, C. (1990) Private Investment and Economic Growth in developing Countries IMF Staff Papers 29, pp Lipset, S. M. (1959). Some Social Requisites of Democracy: Economic Development and Political Legitimacy. American Political Science Review 53, no. 1:

10 Pretty, J. and Ward, H. (2001). Social Capital and the Environment. World Development, 29 (2): World Bank.( 2003). Better Governance for Development in the Middle East and North Africa: Enhancing Inclusiveness and Accountability, MENA Development Report. Washington, DC: World Bank. 52