INFLATION, LABOR FORCE AND EXPORTS & IMPORTS; AS DETERMINANTS OF ECONOMIC GROWTH; A CASE OF PAKISTAN

ABSTRACT: Purpose The basic objective of our paper is to present theoretical arguments for economic growth of Pakistan by using inflation, imports, exports and labor force as indicators of economic growth. Design/methodology/approach This paper inspects whether the determinants of economic growth has impact on the economy of Pakistan. This study uses ORDINARY LEAST SQUARE (OLS) MODEL. Economic growth is regressed by inflation, imports, exports and labor force, over the period of 1990-2010 Findings The interface of economic growth with its determinants shows a strong correlation. Our findings indicate that there exist positive relations among the determinants and growth. Research limitations/implications The limitations of this paper is that its results are only applicable to the Pakistan. These results are not generalizable to the whole developing world and it uses data of only 21 years. Originality/value The primary purpose of this study is to determine the major impact of indicators of economic growth on Pakistani economy. The secondary objective is to explore the different behaviors of economic growth due to these indicators in a developing economy. Keywords Economic growth, Inflation, Exports, Imports and Labor force. Type of paper: Research paper

1.

INTRODUCTION:

Over the year the downward and unpredictable trends of Pakistans economy has a deep effect on FDI, capital markets, police makers, professions and foreign agencies. The blame of this un-sustainability is given to high inflation rate, a huge amount of foreign debt and debt servicing, lower demand of Pakistans product, human and physical capital, political instability, poorly established law and order throughout the Pakistan. All cross countries studies have found that economic growth of a country is determined by per capita income distributing, inflation, balance of payments, human capital, government expenditure, law and order and political stability (Barro, 1991, 1997; Barro and lee, 1993; Chan &Feng, 1996; Feng, 1997; Persson & Tabellini, 1992). In the previous studies different researchers have investigate empirically the association between determinants of economic growth and their impact on the economy. They argue that there is a negative relation between long term growth and inflation and long term growth is positively related with freight exchange markets (Barro& lee, 1992; Romer, 1990; Fischer, 1993). In this regard human capital, FDI, technological changes, openness to trade and low inflation rate is necessary to economic growth of developing countries. Pakistans economic management was based on structural adjustment program (SAP) since 1988. SAP focus on balance of payments through devaluation of local currency and cross border trade. Some other Pakistani researchers analyze the impact of structural adjustment on real growth output in Pakistan. (Iqbal, 1995, 1994; Khilji Mahmood, 1997; Shabir Mahmood, 1992) It is quoted by Khilji & Mahmood, 1997 that there is negative correlation between GDP growth and defense burden. Shabir & Mahmood, 1992 concluded that the effect of foreign private investment has a significant positive impact on real GDP output.

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3.

LITERATURE REVIEW

Many determinants have been considered of economic growth in different articles. We have considered labor force, imports, exports and inflation and studied their impact on economic growth. Labor force, imports and exports are showing the same relation as depicted in other studies i.e. they are carrying a positive relation with growth. While inflation is also showing a positive relation for which different studies are present that states that inflation van show a positive relation with growth in some cases. In our article we are testing market friendly theory. Market friendly theory is basically established for developing economies. This theory supports the low inflation rate for developing economies. It suggests that fiscal policies and fixed exchange rates play very much important role, in keeping the inflation low. It also

argues that it is the duty of government to provide stable environment by keeping these two variables under control. Normally inflation carries a negative relation with growth which means that high inflation hinders economic growth of a country. But in our article which is a case of Pakistan, inflation is depicting a negative relation. This relation is also seen in some articles. (Datta & Mukhopadhyay, 2011) In their study they have analyzed the relation among inflation and growth and for that purpose they have used vector error correction modeling to depict short run relation among the variables and a vector auto-regression model is being used to ascertain long term relation. They concluded that there may be a short run significant positive relation present among the variables. (Gokal & Hanif, 2004) explained in their paper that historically when there was no concept of persistent inflation, there was no exactly upward or downward trend observed in inflation and is was considered as a lazy god and this theory declared that there is a positive correlation present within inflation and growth. (Mubarik, 2005) Used a threshold model in the article to explain the relation among inflation and economic growth. He concluded that up to a certain threshold level i.e. 9% there is a positive and significant relation present among the variables and above that particular level the relation becomes negative. Our results for labor force are same as seen in the article of (Abelti, 2009). There exist a positive relation among labor force and economic growth and labor force is considered to be a basic element in accelerating growth of a developing country. IQBAL & ZAHID (1998) concluded that external debt and per capita real income growth has negative effect on economic growth while per capita real income growth effects positively if it is related with human capital which increases the growth of economy. Mihret (2004) also concluded in his study that human capital has positive and significant affect on growth in short run but negatively related in long run. Nelson and Phelps (1966) discussed that a labor force which is large in size can make easy for the country to attract innovative products or ideas. Authors concluded that much growth can be accounted for by capital, growth and

improvement in labor.( F. Desmond McCarthy, James A. Hanson, Soon won Kwon). All these studies have shown the same effect that is being depicted in our paper as well. Exports and imports together are named as trade is also an essential part in enhancing the growth opportunities for a developing country like Pakistan. Although in Pakistan there are not many trade opportunities present but still they are contributing positively towards Pakistani economy. Our results are same as depicted in the study of (Amjad & Khan, 2009), they concluded in their paper that exports and imports are positively related with economic growth.

4.

DATA AND METHODOLOGY:

3.1 Data Definition: The basic aim of this study is to determine the impact of inflation, exports, imports and labor force on the economic growth of Pakistan. The selection of variables for this study is on the basis of past literature. These variables are used by different researchers for Pakistan and as well as for advance countries. Researchers such as (Barro, 1996; Dollar and Kraay, 2002a; Lederman et al., 2002) conduct their investigation on the determinants of economic growth. This study is primary conducted on Pakistan, so in this regard time series data of 21 years is used. The source of data collection is World Development Indicators. There is no considerable problem while collecting data on Pakistans economy for the time period of 1990 -2010. This section of the paper will provide a brief definition of the explained and explanatory variables. Here economic growth is an explained variable while inflation, imports, exports and labor force are explanatory variables. 4.1.1. Economic Growth (Current US$): Economic growth is an increase in the capacity of an economy to produce goods and services, with regard to time. Economic growth is measured in nominal terms. The proxy to measure economic growth is GDP current US$. The data source is World Development Indicators.

4.1.2. Inflation (Inflation, GDP Deflator Annual %): Inflation is sustained increase in general price level of consumer goods. The proxy to measure the inflation is inflation, GDP deflator annual %. The expected sign for inflation is negative with respect to economic growth.). The data source is World Bank National Accounts. 4.1.3. Labor Force (Labor force, total) : The total number of employed persons in a country are referred as labor force. The proxy to measure labor force is labor force, total. The expected sign for labor force, in relation with economic growth is positive. The source of data is International Labor Organization. 4.1.4. Exports (Exports of goods and services % of GDP): Exports are the goods and services of a country, which they sell to some other country. The expected sign for exports is positive, as an indicator of economic growth. The proxy for exports is exports of goods and services % of GDP. The data source is World Bank National Accounts. 4.1.5. Imports (Imports of goods and services % of GDP): Imports are referred as the goods and services purchased by other country for domestic use .The proxy for imports are imports of goods and services % of GDP. It has a positive expected relation with the explained variable. The source of data collection is World Bank National Accounts. 3.2. Methodology: The basic motive of our study is to investigate the economic growth of Pakistan. Now a days the economic condition as well as the political conditions of Pakistan are very adverse due to which the Pakistani economy is in a big shock. This section presents an economic model which attempts to depict the current status of Pakistani economy. The model used in this study is ORDINARY LEAST SQUARE MODEL (OLS), which is a common method for regression analysis. OLS provides a line that explains relationship between tow variables on a graph

and the sum of square of these values are minimum.OLS model in used by many researchers in their studies (Amjad and Khan, 2004; Tasi, 1994; Anwar and Nguyen, 2010). We regress economic growth on imports, exports, inflation and labor force. 3.3. Econometric Model The econometrics equation is as follows: EG = + EXP + IMP + INF LABFOR + e Here EG represents the economic growth, EXP stands for exports, IMP shows the imports of Pakistan while INF represents the inflation of Pakistan and LABFOR stands for Pakistani labor force finally there is e which is errors in the model. B represents the co-efficient of explanatory variables while errors are the indicators which have effect on our model but we are not considering them in our model.

5. EMPIRIACL RESULTS : The empirical findings of this paper are as follows:

Table 2: Descriptive Statistics:

Variables Economic growth Exports Imports Inflation Labor force Observations 21 21 21 21 21 Means 584.9334 15.43327 19.22348 10.51758 4.36e+07 Standard deviation 210.2186 1.374546 2.895482 5.2602 8807315 Minimum value 357.7321 12.84805 14.63323 2.463093 3.19e+07 Maximum value 1018.873 17.3593 23.88019 24.89115 5.94e+07

This table describes the data in detail such as observations, means, standard deviation and maximum, minimum values of variables of interest. There are 21 observations for all variables used in this study. The average value of economic growth is 584.9334 with the standard deviation of 210.2186, while the minimum

value is 357.7321 and maximum value is 1018.873.the next variable is exports which has a mean value of 15.43327 with the standard deviation of 1.374546 and minimum value is 12.84805 while maximum value is 17.3593. The third variable of study is imports whos average value is 19.22348 with the standard deviation of 2.895482 and maximum value is 23.88019 and 14.63323 is its minimum value. Inflation is the next variable with the 10.51758 mean values; inflation has a standard deviation of 5.2602 with the minimum value of2.463093 and maximum value of 24.89115. Laborforce is the final variable of this study with the average value of 4.36e+07 and standard deviation of 8807315 having a maximum value of 5.94e+07 with minimum value of 3.19e+07. This table depicts the whole comprehensive picture of the dataset. Table 3: Empirical Results:
Variables Co-efficient Standard errors Economic Growth ---------------------Exports 8.119753** 11.25172 Imports 18.39222*** 2.846367 Inflation 6.124245*** 1.937496 Labor Force .0000204 *** 1.51e-06 Intercept -868.2815*** 247.223 R- Square 0.9706 *** Significant at 1%, **significant at 5 %, *significant at 10% p. values ------------0.482 0.000 0.006 0.000 0.003

The above table shows the results of OLS model. We have employed different tests to deduct the problems in the data such as we applied Breusch-pagan test to detect the problem of heteroscedasticity, Durbin Watson test for auto correlation and variance inflation factor for multicollinearity, but the data is free from all these problems. The first explanatory variable of this paper is exports, exports has a direct relation with the explained variable i.e. economic growth. This implies that one unit change in exports will leads to increase in exports by 8.119753. Exports give the same results as what we are expecting in the data & methodology section. Imports also have the same sign as we were expecting it in the section of data. Imports will lead to increase in economic growth of Pakistan by 18.39222, due to one unit increase in it. Inflation is very important variable for the Pakistani economy because inflation is severely destroying the Pakistani economy. Here the results are different from what we expecting i.e. inflation has a positive direct relation with the Pakistani economy. It means that as the Pakistani economy grow,

inflation will also increase or in other words as inflation increase in Pakistan, the Pakistani economy will also grow. The rational for this result is that in spite of political instability, high inflation rate and budget deficit, Pakistan is an attractive target market for foreign investors. Although foreign investors hesitate to invest in Pakistan but they cannot afford to miss or ignore such a huge market. So despite of unstable conditions the Pakistani economy is kept on growing with high inflation and steady growth rate. Lastly we have labor force whos results are also what we are expecting i.e. it has a positive relation with the growth. One unit change in labor force will bring .0000204 changes in growth in direct proportion. All these finding are standardized and leads to a conclusion that exports, imports, inflation and labor force are the important determinants of economic growth in Pakistan. They have a deep effect on Pakistans economy. 6. Conclusion: The basic aim in this paper was to judge the importance of the selected variables on economic growth of Pakistan. We have selected Pakistan for our study because it is a developing country so we wanted to see the effect of the variables in case of a developing country. Study is conducted for a period of 21 years from 1990 to 2010. Previous years are not being included in the study because of unavailability of certain values of variables. Our study revealed almost the same results as present and concluded in previous studies. Imports, exports and labor force are showing a positive and significant relation with the economic growth of Pakistan. Inflation however shows a surprisingly different effect in our study. But certain studies are also present that depicts the same relation as concluded in our paper such as (Datta & Mukhopadhyay, 2011), (Gokal & Hanif, 2004), (Mubarik, 2005) etc which also showed a positive relation among inflation and economic growth. Our study will help in understanding and evaluating the determinants of growth in more details with considering that the relation of inflation and growth can be positive.

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