Download price instability, unemployment and economic growth in pakistan

IMPACT OF PRICE INSTABILITY ON UNEMPLOYMENT
AND ECONOMIC GROWTH IN PAKISTAN;
(An Econometric Approach)
By
Qazi Abdul Subhan
Senior Lecturer (Economics)
E. Mail: [email protected]
Ph.: 0092-51-9260002 Ext: 306
Fax No: 0092-51-9260889
Mobile No. 0092-300-5091039
&
Mahr Asif Hayat
Student of MBA (Finance)
Department of Management Sciences
Bahria University, Islamabad, Pakistan
Abstract
Pakistan is a front ally of war on terror. Due to this
unintended war, allocation of developmental funds with in the
country has been disturbed and Pakistan has to approach IMF
(International Monetary Fund) to restore its economy in November
2008. Due to it, new phase of unrest in the country has created
a massive frustration among general public. In this environment,
there is no question of any new investment by local or foreign
investors. More significantly, the current government is not
serious in solving the problems of deprived people. There are
mere slogans of developments by the government officials but
ground reality is depicting an opposite anecdote.
This research focuses on the impact of price instability on
unemployment and economic growth. To achieve this objective,
certain economic and social variables have been selected which
includes Inflation (CPI), volume of Imports, volume of exports,
balance of trade, GDP growth, agriculture growth rate, share of
large scale manufacturing in GDP, services sector contribution
in GDP, health expenditure as percentage of GDP, education
expenditures as percentage of GDP, gross fixed capital formation
by public & private sector, foreign direct investment and total
consumption in the country. The data period covers from 1980 to
2008. Econometric models have been constructed to identify main
effects of price instability on unemployment and economic
growth. Proposed results are in favor of negative relations
between price instability and economic growth but positive
relation with unemployment.
Key words: Price Instability, Unemployment, Economic Growth
I
Section 1
INTRODUCTION
1.1. BACKGROUND
Pakistan, being an ally of so called terrorism war, is paying
high economic and social costs. Due to public policies in the
past, the current government has to face enormous challenges at
economic and social fronts. The economic problems have become
more crucial with the continuity of previous public policies by
the present government. Secondly, government is not making any
appropriate policy formulation to rectify the major issues like
energy
crisis;
exports,
low
price
foreign
instability,
exchange
high
reserves
unemployment,
and
other
low
social
and
political issues which have negative impact on business activity
and economic growth.
Current research focuses on significant aspects of economic and
social
parameters;
unemployment
price
respectively
instability,
in
Pakistan
economic
which
growth
are
and
momentously
affected by the war on terror. All these three variables are
directly and indirectly interlinked with one another.
Price
instability
in
Pakistan
has
since past three to four decades.
been
persistently
observed
There are several reasons of
this price hike like huge devaluation in 1970’s, due to Western
Hemisphere
between
Europe
and
developing
countries
in
late
1980’s and privatization policies in 1990’s. Price instability
exposes
an
unstable
economy
in
which
the
values
of
goods
depreciate with the passage of time. Employee’s needs high wages
to overcome increasing cost of output. Producers in turn may
raise their selling prices to cover these increases.
i
The factors leading to high levels of inflation include deficit
financing,
decrease
in
foreign
remittances,
dependency
of
economy on foreign economic assistance, terrorism or fear of
terrorism, increase in wages, high prices of imported goods,
devaluation
of
rupee,
decrease
in
foreign
direct
investment,
large scale manufacturing industry, effects imports exports and
balance of trade, agriculture etc.
1.2. SIGNIFICANCE OF THE STUDY
The rising inflation and unemployment are one of the obstacles
in the way of persistent and sustainable economic growth. In
Pakistan, it has squeezed the major part of the population in
terms
of
(2009-10)
consumption.
both
Specially,
inflation
and
during
current
unemployment
rose
fiscal
to
year
very
high
level, CPI goes above 30%, creating an alarming situation for
the consumers and producers. Similarly, due to energy crisis,
industrial
daily
sector
wagers
consumption
are
level
is
inadequately
getting
along
affected
unemployed
with
which
decrease
in
and
is
particularly
reducing
overall
the
economic
activities in the country.
The significance of this research is to explore the reasons that
caused
current
employment
living
and
poverty
below
level
price
hike
economic
the
is
and
growth
poverty
its
subsequent
respectively.
line
continuously
are
The
affecting
increasing
in
the
the
effects
poor
on
people
most.
The
country
and
difference between rich and poor is on high surge after being an
ally in war on terror. Due to capital deficiencies, people are
unable to save capital which creates high dependency ratio. In
budget 2009-2010, Pakistani government is intending to impose
value
added
tax
in
the
place
of
general
sales
intensifies inflationary pressure on general public.
2
tax
which
1.3. OBJECTIVE OF RESEARCH
Main objectives are as follows;
•
To
analyze
relationship
between
price
instability
and
between
price
instability
and
economic growth in Pakistan
•
To
develop
relationships
unemployment in Pakistan
•
How price instability have an effect on unemployment and
economic growth
To
achieve
these
objectives,
econometric
models
have
been
developed to see the impact of price instability on economic
growth.
(Consumer
developed
Price
instability
Price
to
Index).
see
has
Three
the
been
measured
regression
impacts
of
through
equations
price
have
CPI
been
instability
on
unemployment and economic growth. An ordinary Least Square (OLS)
method has been used to take empirical evidence with the help of
econometric software; E. Views.
Key
variables
includes
Inflation
(CPI),
volume
of
Imports,
volume of exports, balance of trade, exchange rate, GDP growth,
agriculture growth rate, share of large scale manufacturing in
GDP, services sector contribution to GDP, health expenditure as
percentage of GDP, education expenditures as percentage of GDP,
gross
fixed
capital
formation
by
public
and
private
sector,
foreign direct investment and total consumption in the country.
1.4. ORGANIZATION OF STUDY
Current research is organized as follows. Section I consists of
introduction,
significance
and
objective
of
the
research.
In
section 2, review of literature has been mentioned. Section 3
reports data and methodology of research. In section 4, results
of
regression
analysis
have
been
discussed.
At
the
findings and conclusion of research has been discussed.
3
end
main
SECTION- 2
REVIEW OF LITERATURE
2.1 INTRODUCTION
This section analyzes relationships between price instability,
unemployment
and
economic
growth.
Several
studies 1
have
highlighted negative and positive effects of price instability
on economic growth and unemployment. Likewise, this section is
segmented into four sections. Section 2.2, 2.3, 2.4 and section
2.5 are highlighting the relationships between price instability
&
economic
growth,
relationship
between
price
instability
&
employment and economic growth & unemployment respectively.
2.2. Relationship between Price Instability and Economic Growth
Mubarik (2005) has analyzed inflationary pressure in Pakistan.
He
has
covered
economic
data
growth;
from
inflation,
1973
to
2000.
population,
Main
variables
Consumer
price
are
index
(1990-91), real GDP (1980-81), population, and total investment
used in research. Growth rate of these variables are calculated
using log alteration method that wipes out strong irregularity
in
inflation
distribution.
The
log
alteration
smoothed
time
trend in the data set. There is volatility in the data to make
it more clear hodrick Prescott filter is used for dataset.
The author applied Granger causality test to measure the linear
causation
between
inflation
and
economic
growth.
T-statistic
demonstrates that the null hypothesis is rejected, which means
that inflation is causing economic growth. Second hypothesis,
growth causes inflation is not rejected at 5 to 10 percent level
of significance, which means that no feedback from output growth
to inflation. He suggests 9 percent inflation is unfavorable for
economic growth.
1
Like Sarel (1996), Khan and Senhadji (2001), Gillman, Harris and Matyas (2004)
4
Barro
(1995)
has
examined
the
relationship
between
economic
growth and inflation. Ha has observed 5 year average data of 100
countries during the period from 1960-1990. The author has used
instrumental
variable
estimation
method
for
analysis.
Instrumental variables estimation result showing that increase
in inflation by 10 percentage point per year slow the growth of
per capita GDP by 2 to 3 percentage points per year.The author
depicts that inflation has an adverse effect on economic growth
with small magnitude but has long term effects on standards of
living with greater scale.
Lee and wong (2005) has used threshold models for inflation in
Taiwan and Japan, using quarterly data from the period 1965 to
2002 for Taiwan and 1970 to 2001 for Japan. Threshold models
suggest that inflation rate beyond 7.25 percent is harmful for
economic growth of Taiwan
They
found
two
threshold
levels
for
Japan,
which
are
2.52
percent and 9.66 percent. It implies that inflation rate below
the estimated level; 2.52% is encouraging the economic growth
and
beyond
this
threshold
value
it
is
detrimental
for
the
there
is
economic growth
According
to
Peter
Rousseau
and
Wachtel
(2002),
negative long term relationship between inflation and economic
growth
and
positive
growth
and
financial
triangle
of
long
term
relationship
development.
relationship
The
between
between
authors
financial
economic
examined
the
development,
inflation and economic growth with the data from 84 countries
covering the period of analysis from 1960 to 1995. Literature
suggests that finance and growth relationship is stronger than
inflation and economic growth relationship.
5
Vaibhav,
Dholakia
and
Kumar
(2008)
has
discussed
interrelationship between inflation, economic growth and saving
rate
for
southeast
framework
using
and
two
south
stage
Asia
in
least
synchronized
squares.
The
equation
relationship
between savings rate and economic growth has found positive.
Inflation has positive effect on saving rate and considerably
negative effect on economic growth. This research shows that at
lower rate of inflation relationship is positive but high rate
of inflation describes negative effect on economic growth. More
over
research
discuss
the
changes
that
occurred
dramatically
over the past forty years
Huybens and smith (1998-99) has analyzed that expected increase
in
the
rate
of
inflation
can
slow
down
economic
growth
by
interfering with the ability of the financial sector to allocate
resources
efficiently.
Number
of
theoretical
studies
has
attempted to explain that how expected changes in the rate of
inflation affect financial system and long term economic growth.
Bruno and easterly (1998) has described negative relationship
between inflation and economic growth in the long run.
Khan and Senhadji (2001) analyzed the effect of inflation and
economic growth using the data of 140 developed and developing
countries. The period of analysis has covered from 1960 to 1998.
Unequal panel data is used in this analysis. Data has gathered
from
World
Economic
Outlook.
The
authors
have
used
several
models for various level of inflation. If inflation is known,
the ordinary least square (OLS) model is used for estimation.
But
if
inflation
regression
is
parameters.
not
The
known,
it
suitable
nonlinear least squares (NLLS).
6
has
measured
method
in
with
this
other
case
is
Erman
and
economic
Aydin
growth
(2008)
and
analyses
inflation.
the
There
relationship
are
between
different
views
of
economists about the relationship between inflation and economic
growth. Accordance with policies, increased in demand has caused
an increase in production as well as inflation. Phillips curve
hypothesizes that inflation positively affect growth by creation
of low unemployment rate.
After
1970s,
inflation
growth
rate
hyperinflations
rates
began
countries,
occurred
to
mainly
in
Latin
decrease
when
high
American
in
the
high
inflation
countries.
and
During
1980s the concept was emerge that inflation has negative effects
on
the
economic
growth
instead
the
view
that
inflation
has
positive effect on economic growth and strengthened these views.
Using the result of export oriented industrial policies which
were effectively carry out in Turkey until the 1970s, inflation
does not create problem but after devaluation accomplished in
1970 and the consistent increase in petroleum prices which is
important
input
for
industry
caused
investment
goods
and
intermediate services more expensive, and the process increase
inflation.
Decision
was
made
on
January
24
1980
to
relieve
domestic demand and decrease inflation rate.
Policies
have
competitiveness,
required
high
the
persistence
interest
rate
and
of
international
foreign
exchange
adjustments have become degenerative issues. High interest rate
and
money
devaluation
process,
constant
increases
in
public
deficits and cost have established the source of the inflation.
Inflation
rate
was
high
during
1989
because
of
financial
liberalization, interest and lost of foreign exchange feature of
being the policy instruments oriented to real objective.
7
The
short
reserves
term
and
inflow
of
monetary
capital
growth
causes
which
is
an
increase
tending
to
in
the
cause
an
increase in inflationary pressures. High inflation decreases the
real
wages
but
increase
credit
costs.
The
result
shows
that
inflation affects economic growth negatively in the long run.
The research uses time series data of GDP and CPI for Turkey
(1987-2006).
The
data
is
gathered
from
electronic
data
distribution system. Real gross domestic product has been formed
by
deflating
nominal
gross
domestic
product.
Inflation
and
economic growth relationship is analyzed with the data from 1987
to 2006 period. The methodology of pesaran (2001) Bound test
approach and toba Yamaota (1995) causality analysis approach are
used.
The
existence
of
relationship
between
two
series
has
been
detected from Bound test. ARDL model is also used to demonstrate
long term and short term relationships among the variables. Main
results are that there is no considerable long term relationship
but has short term relationship. There is no causal relationship
between
inflation
and
economic
growth
which
has
been
cross
verified by Toba Yamamoto (1995) approach which is performed to
determine the causality aspect of relationship. This research
highlights
the
significance
of
macroeconomic
factors
which
provide cost stability and sustainable growth.
Kannan
and
joshi
(1998)
analyze
trade
off
between
economic
growth and inflation. This research examines threshold inflation
rate for India using the methodology of Sarel (1996) with a
sample of (1981-1996). Main results are that inflation more than
6 percent per annum would have considerable downward impact on
growth
in
India.
Researcher
estimates
a
higher
level
of
8
percent for large pooled sample of 87 countries including India
and covering the period from 1970 to 1990. This study depicts
8
that
single
percentage
point
increase
in
the
inflation
rate
above 6 percent per annum harms economic growth in India.
Research results shows that inflation rate below the threshold
inflation have some positive effect on growth. This positive
influence is available up to maximum upper limit of 6 percent.
Gylfason
and
Herbertsson
(2001)
research
demonstrate
that
inflation is monetary phenomenon. Economists find it unlikely
that inflation have lasting logical effect on economic growth.
In this research, inflation and economic growth is studied. An
econometric model is used to determine the potential impact of
inflation
on
variables
like
development,
economic
saving
budget
growth
and
with
real
deficit,
the
help
interest
inflation
of
following
rates,
financial
and
efficiency
in
production.
The data is collected from 170 countries and using the time
period starting from 1960 to 1992. The effect of inflation on
long run growth through these channels is estimated by applying
the random effects panel. Main results are that linkage between
inflation and economic growth are significant and the results
show that if inflation increases from 10 to 20 percent per year
generally harmful to growth.
Osama (2004) depict how inflation effects economic growth. The
data is collected from Jordan using negative structural break
point
method.
One
of
the
aspect
of
the
research
shows
that
inflation has positive effect on economic growth if the rate of
inflation becomes low up to 2% after that the effect becomes
negative.
This study shows same results as the other studies estimates
that inflation rate in Jordan has negative affect on economic
9
growth.
Inflation
rate
decreases
purchasing
power
of
the
population that ultimately reduce the consumption level of the
population of Jordan
M.
khan
(2002)
estimates
nonlinearity
in
the
relationship
between inflation and economic growth. This relationship occurs
from the existence of threshold effect of inflation on growth.
There is significant level of inflation which effect growth and
inflation hinder economic growth.
Higher inflation increases credit ratios and condensed expansion
of
bank
credit
decreased
so
this
economic
relationship
phenomenon
growth.
between
The
inflation
reduced
research
and
investment
estimates
financial
and
nonlinear
development
and
also discussed the relationship between inflation and growth.
When the rate of inflation increased from 5 to 10 percent, it
exercises
negative
effect
on
financial
deepening
and
adverse
relationship
between
effect on economic growth.
2.3. RELATIONSHIP BETWEEN PRICE INSTABILITY AND
UNEMPLOYMENT
Phillips
(1998)
explains
the
negative
inflation and unemployment. When the government takes steps to
reduce
unemployment
then
flow
of
money
is
increased
by
government to improve the consumption level of population. This
phenomenon increased inflation rate. When government tried to
control
trade
inflation
off
rate,
between
unemployment
these
two
will
increase.
There
is
variables
unemployment
and
between
unemployment
and
inflation.
Smyth
(1971)
inflation
rate
predicts
relation
by
data
using
of
11
developed
countries.
The
period for research is from 1950 to 1960. The study depicts that
10
annual increase in the price relating to the GNP measures the
rate of inflation.
Gillman and Harris (2004) portray a considerable negative effect
of inflation on growth rate. Moreover the results repeat the
substantial positive inflation and economic growth relation when
inflation
rate
instrumental
is
low
variable
for
show
emerging
negative
countries.
effects
Results
of
inflation
on
specification
of
of
economic growth.
This
study
shows
monetary
model
for
the
economic growth. Panel data of OECD and APEC countries are used
for the period of 1961 to 1997. Negative inflation effect is
depicted broadly for member countries of OECD.
Totally, three panels of countries are developed to examine.
First panel consist of 29 OECD countries, second panel consists
of 18 APEC member countries and third one include 41 countries.
The data is collected on annual bases for several variables like
per capita GDP, average annual growth rate of real GDP, GDP
deflator,
annual
inflation
rate
and
the
proportion
of
gross
domestic investment in GDP.
2.4. RELATIONSHIP BETWEEN ECONOMIC GROWTH AND UNEMPLOYMENT
Different
studies
regarding
economic
growth
and
unemployment
have been discussed. Main findings of these studies are that
there
is
negative
relationship
between
economic
growth
and
unemployment.
According to Pakistan Institute of Development Economics (PIDE)
report
(2004)
demonstrates
that
in
Pakistan
unemployment
is
increasing gradually. Employment rate in different sectors on
annual bases during last 20 years stayed on 1.14 percent. This
rate of unemployment is very low globally. Employment based on
11
different
sectors
including
Agriculture,
Manufacturing,
Construction, Gas and Power and Transport and Trade are 1.14
percent during the period 1991 to 2002.
Employment ratio in agriculture and in manufacturing is 1.152
and 0.42 percent during last 20 years, construction and power
sectors are 0.02 and 2.02 percent respectively. Transport and
trade
percentages
are
0.42
and
0.45.
The
share
of
services
sector in employment is 0.91 percent for the period of last 10
years.
Unemployment in young population whose age’s ranges from 10 to
14
years
is
unemployment
8.95
between
percent
the
during
ages
of
15
2007-08.
to
19
The
rate
percent
is
of
8.72
percent.6.84 percent of total population between the ages of 20
to 24 years are living jobless in Pakistan.
Economic survey of Pakistan report (2009-10) demonstrates that
unemployment rate distribution based on the education are as
follows,
Under
Matriculate
boys
unemployment
is
37.0%,
while
between girls the rate of unemployment is 16.7 percent. 5.5 %
boys and 4.7% girls having a degree of HSSC are unemployed. The
boys
and
girls
having
graduation
degree
are
unemployed
respectively 5.2 and 4.1 percent.
Moosa (2008) estimates the relationship between unemployment and
economic growth and observed that there is no relation between
economic growth and unemployment. Unemployment is one of the
major
problems
in
the
Arab
countries
especially
non
oil
producing countries. Unemployment in MENA region is highest in
the world.
Two econometric models are used to estimate Okun’s coefficient.
First one is gap model and the second is growth rate model. Gap
model
is
used
to
estimate
dynamic
12
regression
of
rotary
unemployment,
where
as
cyclical
unemployment
is
estimated
by
applying the method of Hodrick Prescott (1997).
Main data sources are international financial statistics (IFS)
(1990-2005).The data are gathered on unemployment and economic
growth in the 4 countries. There are some problems with the
collection of data that there are small numbers of observation
that makes complex to judge vibrant version of the model.
The estimated results of research shows that Okun’s law is not
applicable for the countries that are used in this research.
This study depicts that unemployment in these countries is not
cyclical. Unemployment in the economy is not due to recession in
the economy but due to other factors like high costs of doing
business.
This
research
demonstrates
that
people
don’t
have
skill to fulfill the existing jobs.
The result of study shows insignificance of Okun’s law and the
reduction in growth rate doesn’t interpret unemployment problem
in these 4 countries.
William
(2005)
estimates
the
relationship
between
economic
growth relation with real GDP and employment in 10 developed
countries. Research results demonstrate that economic growth has
direct effect on employment, when economy grows due to capital
formation,
employment
increases
and
improves
the
standard
of
living. The research depicts employment magnitude of economic
growth and shows the flexibility of employment with respect to
real
gross
domestic
product
and
output.
When
employment
increases or decreases there is direct effect on economic growth
and estimation of the model suggest that economic growth gives
momentum to employment.
When economy grows there is a considerable positive impact on
employment
economic
growth.
growth.
Employment
The
growth
amalgamation
13
of
plays
major
economic
role
growth
in
and
employment determination should result in more significant and
persistent gains in employment.
2.5. LINK BETWEEN INFLATION, UNEMPLOYMENT AND ECONOMIC
GROWTH IN PAKISTAN FROM (1981-2007)
Current study is divided the time span into three durations,
first
one
starts
from
1981
to
1997.
In
this
time
period,
inflation rate in Pakistan was in double digits as given in
table 2.1. Due to double digit inflation in country, economic
growth
was
fulfilling
slow
down
and
the
demands
the
in
supply
the
of
products
economy
which
was
not
amplify
unemployment.
One of the reasons of high inflation in the economy was more
supply of money in the economy. Main purpose behind increase of
money supply by state bank of Pakistan was to achieve macro
economic goals. This attempt reduces unemployment for the short
time
and
supports
economic
growth.
The
growth
rates
of
inflation, unemployment and GDP have been mentioned in the table
2.1.
14
TABLE 2.1: Growth Rates of Inflation, Unemployment and GDP (%)
Year
CPI
Unemployment
GDP
1980-1981
13.8
3.6
6.4
1981-1982
11.1
3.9
7.56
1982-1983
4.7
3.8
6.79
1983-1984
7.3
3.7
3.97
1984-1985
5.7
3.7
8.71
1985-1986
4.4
3.4
6.6
1986-1987
3.6
3.1
5.81
1987-1988
6.3
3.3
6.44
1988-1989
10.4
3.1
4.67
1989-1990
6
5.7
4.44
1990-1991
12.7
6.2
5.42
1991-1992
10.6
6.2
7.57
1992-1993
9.8
5.3
2.1
1993-1994
11.3
5.1
4.37
1994-1995
13
5.4
5.06
1995-1996
10.8
5.4
6.6
1996-1997
11.8
6.1
1.7
SOURCE: Federal Bureau of Statistics
According to table 2.1, the trend of CPI is very volatile and it
is
ranging
from
3.6%
to
13%
with
in
17
years
of
analysis.
Comparatively, the trend in unemployment and economic growth is
consistent except 1996-97 where economic growth was merely 1.7%.
Overall
there
is
negative
relation
between
CPI
and
economic
growth. If there is price instability in the economy, economic
growth also follows negative effects.
15
If
the
government
formulates
any
policy
changes
to
support
economic growth like an increase in wage rates of employees then
consumption
level
of
population
will
improve
along
with
an
increase in production level, boost economic growth and reduced
unemployment. But the effect of increasing money supply in the
economy
on
inflation
was
negative
so
the
inflation
rate
increased gradually.
The second period for trend analysis is from 1998 to 2004, in
this
time
inflation
previous
period
making
government
some
duration,
took
changes
in
government
some
steps
fiscal
takes
to
polices.
some
steps
control
As
to
in
the
the
reduce
unemployment which was short term plan and shortly government
control unemployment but when in long run when the monetary and
fiscal policies are changed unemployment increased rapidly and
inflation
rate
decreased
respectively
as
the
government
tightened the policies to control inflation.
TABLE 2.2: Growth Rates of Inflation, Unemployment Rate and GDP (%)
Year
CPI
Unemployment
GDP
1997-1998
7.8
6.1
3.49
1998-1999
5.7
5.9
4.18
1999-2000
3.6
6
3.91
2000-2001
4.4
6
1.96
2001-2002
3.5
7.8
3.11
2002-2003
3.1
8.3
4.73
2003-2004
4.6
7.8
7.48
SOURCE: Federal Bureau of Statistics
According to the table 2.2, as CPI goes down up to 4.4% then it
has negative impact on economic growth. The relationship between
16
CPI
and
economic
growth
become
positive
if
the
inflation
decreases up to certain lowest extent. In 2000-01 CPI increase
from 3.6% to 4.4% and economic growth decreases from 3.91% to
1.96%. In 1998-99, inflation rate decreases from 5.7% to 3.6%
which has negative impact on economic growth.
The growth rates of inflation, unemployment rate and GDP for the
period of 2004-2008 has been mentioned in table 2.3.
TABLE 2.3: Growth Rates of Inflation, Unemployment Rate and GDP
Years
CPI %
UNEMPLOYMENT %
GDP %
2004-2005
9.3
8.3
8.96
2005-2006
7.9
7.7
5.82
2006-2007
7.8
7.6
6.81
2007-2008
12
8.1
4.1
SOURCE: Federal Bureau of Statistics
In this time span, unemployment did not show any big change and
also not significant effect on economic growth. But inflation
rate in Pakistan during this time period shot up dramatically
and
the
effect
of
double
digit
inflation
decreased
economic
growth. The main reason behind this inflation is the shortage of
supply
of
goods
in
the
market
which
doesn’t
meet
demand
requirements. Another reason is severe shortfall of electricity
in different industries which have negative impact on economic
growth
in
Pakistan.
When
the
demands
are
not
fulfilled
domestically then government imports the goods and commodities,
which causes an increase in inflation rate and decrease in GDP
growth rate.
17
SECTION 3
DATA AND METHODOLOGY
3.1 INTRODUCTION
This section focuses on methodology used to determine the effect
of price hike on unemployment and economic growth. Prices become
instable if they are increasing from a certain range which is
around 3% to 5%.
procedure
and
This section also discusses study design,
choice
of
variables.
The
relationships
among
variables have been analyzed with the help of constructing three
econometric models.
3.2 CHOICE OF VARIABLES
Main variables, used in this study, are unemployment, CPI, GDP
growth
rates,
Manufacturing,
Foreign
Interest
Direct
Rate,
Investment,
Health
Large
Expenditure,
Scale
Employment,
Imports, Exports, Balance of Trade, Exchange Rate, Per Capita
GNP,
Agriculture
Growth
Rate,
Manufacturing
Services Growth Rate, Food Inflation and
Growth
Rate,
Non-Food Inflation.
This research expresses the relationship between Unemployment;
CPI and GDP growth using trend analysis then to test regression
models, E. Views (software) is used. The sources of data are
statistical bulletins published by Federal Bureau of Statistic
(FBS),
Economic
surveys
of
Pakistan,
State
Bank
of
Pakistan
publications, Asian development Bank (ADB) annual reports and
Development indicators 2008.
3.3 METHODOLOGY
To analyze the impact of price hike on unemployment and economic
growth,
an
(Ordinary
econometric
Least
Square)
model
has
method
18
been
has
developed.
been
used
Simple
to
see
OLS
the
relationships. The detail of formulation of regression equations
has been explained as below.
There are three regression equations, in which the relationship
between dependent and independent variables have been analyzed.
Regression equation 3.1 is explaining the effect of inflation on
nominal GDP in Pakistan. The equation 3.2 explains the effects
of unemployment and other economic variables on real GDP. The
equation 3.3 have been formulated to describe the consequence of
unemployment
and
effect
of
economic
growth
on
inflation
for
Pakistan
The model specification for three regression equations is as
follows:
3.3.1. Regression Analysis for Economic Growth And Price
Instability
To analyze the effect of price instability on economic growth
following econometric model has been developed.
NGDP = α 0 + α 1 SGRATE + α 2 PCGNP − α 3 CPI + α 4 MANUFGRATE + α 5 INV − α 6 IMP + U 1
(3.1)
Where
NGDP: Nominal Gross domestic Product
SGRATE: Services growth Rate
PCGNP: Per Capita Gross National Product
CPI: Consumer Price Index
MANUFGRATE: Manufacturing Growth Rate
INV: Investment
IMP: Imports
To
analyze
the
effect
of
price
hike
on
the
nominal
gross
domestic product different economic and social variables have
been
selected
like
services
growth
19
rate,
per
capita
GNP,
Consumer price index, manufacturing growth rate, investment and
imports.
All
the
variables
have
significant
effect
on
Nominal
Gross
Domestic Product like services growth rate because when services
growth rate increases employment enhances. This phenomenon rises
income
level
of
population
so
all
this
process
enhances
the
consumption level. Consumption is the largest component in the
economy. It consists of private and public consumption in the
economy. Consumption includes food, rent, clothing, fuel, and
financial services received by individuals.
Per Capita Gross National Product have positive effect on GDP.
It is used as indicator, on the rationale that all the people
would benefit from increased economic production. Per capita GNP
indicates
standard
of
living
frequently,
widely
and
sector,
has
consistently.
Manufacturing
sector,
being
a
second
largest
positive relation with GDP in Pakistan economy. Manufacturing
industry increases employment opportunities in the country and
improves purchasing power of the work force. With an increase in
income,
consumption
level
increase
and
this
activity
has
positive effect on Gross Domestic Product.
The relationships between Consumer Price index (CPI) and Nominal
Gross Domestic Product (NGDP) is negative because an increase in
one of them must decrease the value of other. Investment plays
significant role in economic growth. It contributes to current
demand of capital goods and enlarges the production base that
increases
production
processes,
improves
needs
per
unit
of
capacity.
cost
It
effectiveness
output
thus
modernizes
production
and
the
reduces
potentially
producing
labor
high
productivity with low cost. All these independent variables show
20
that
inflation
have
negative
impact
on
the
gross
domestic
product.
Investment grows at much faster pace than consumption or GDP
irrespective of interest rate movements. Consistent increase of
interest rate would drastically worsen the costs of existing
loans for past investment. Disappointment from demand grow may
combine with this effect to reduce investment dynamics. Positive
expectations toward the economy may also bring leading firms to
invest earlier than the trough. Investment has positive effect
on gross domestic product.
On contrary, imports have negative effect on economic growth
because there is out flow of money. If a country prefers to
import
finish
goods
then
there
are
two
main
losses
for
the
economy; one is outflow of money and the other is damages of
local industry.
3.3.2. Regression Analysis for Effect of Economic Variables on
Real GDP
RGDP = β 0 − β1Unemp + β 2 Fdi + β 3 Fdig + β 4 H exp− β 5 Im p + β 6 Inv + β 7 Irate
+ β 8 Manufgrate + β 9 Ngdp + β10 Pcgnp + β11 Slmgdp − β12 Exrate + β13 Exports + U 2
RGDP=Real gross domestic product
Unemp=Unemployment
FDI=foreign direct investment
FDIG=foreign direct investment
H exp=health expense
IMP=Imports
Inv=investment
I rate= Interest rate
Manuf grate=Manufacturing rate
21
(3.2)
NGDP=Nominal Gross domestic product
PCGNP=Per capita gross national product
Slmgdp= Share of large scale manufacturing in GDP
Exrate=exchange rate
Exp=exports
The relationship between real GDP growth and unemployment is
very important for economists in order to obtain a sustainable
rise
in
living
standards.
If
GDP
growth
rate
is
below
its
natural rate, it is indicated to promote employment because this
rise in total income will not generate inflationary pressures.
If the GDP growth is above its natural level, economists will
decide not to intensively promote the creation of new jobs in
order
to
obtain
a
sustainable
growth
rate
which
will
be
indifferent for inflation.
Investment
has
significant
effect
on
Real
GDP.
Investment
benefits are in terms of increased value added, reduced cost,
larger
production
and
higher
competitiveness,
the
ultimate
effect of investment is improvement in gross domestic product.
Interest payments are the value addition to financial sector.
Many
investors
invest
in
that
economy
whose
interest
rate
payments are evidencing healthy position and it creates positive
effect
on
the
economic
growth.
Exchange
rate
is
a
better
indicator of any country’s international purchasing power and
relative
economic
growth.
Exchange
rate
demonstrates
the
GDP
growth rate and the position of currency in the international
market.
FDI has grown rapidly and considered to be the major source of
capital moving toward emerging economies.
The flow of capital
in Pakistan supports the domestic industry
Real
per
capita
income
in
Pakistan
has
increased
upto
4.7
percent, in the five years analysis of 2002 to 2007.per capita
22
income increased year to year due to speedy increase of real
gross domestic product.
3.3.3. Regression Analysis for Effect of Real GDP on
Unemployment
Unemp = γ 0 − γ 1 RGDP − γ 2 FDI − γ 3 HEXP + γ 4 IMP − γ 5 INV − γ 6 MANUFGRATE −
(3.3)
γ 7 NGDP − γ 8 PCGNP − γ 9 SLSMGDP + γ 10 EXRATE − γ 11 Exports + U 3
Where
Unemp= Unemployment
Rgdp= Real Gross Domestic Product
FDI=Foreign Direct Investment
HEXP=Health expense
IMP=Import
INV=Investment
MANUFGRATE= Manufacturing growth rate
NGDP=Nominal Gross Domestic Product
PCGNP=Per Capita Gross National Product
SLSMGDP=Share
of
Large
Scale
Manufacturing
in
Gross
Domestic
Product
EXRATE=exchange rate
EXP=Exports
Unemployment has adverse effect on GDP because when unemployment
increases Real Gross Domestic Product decreases and vice versa.
In Pakistan, FDI has an adverse effect on unemployment level.
Pakistan is seeking to enhance the inflows of FDI to supplement
domestic
saving
and
strategy
sustains
investment
high
rate
and
of
to
benefit
economic
economy.
growth
This
increasing
employment opportunities and improving living standard.
Imports
have
positive
relationship
with
unemployment.
When
imports of country increase, it means that people have changed
their consumption patterns from local market to foreign. There
23
are certain reasons behind this change. For instance quality and
durability of local products are not up to the mark. Secondly
the people are Status conscious. Thirdly, the price of local
product is higher than foreign product like Chinese products.
Irrespective
to
all
above
reasons,
if
import
of
a
country
increase, local industries become stagnant and ultimately reduce
its production. When production of country decreases the less
labor force is required so this cause rise in unemployment.
Investment
has
Investment
supports
opportunities
concerned,
indirect
in
it
the
relation
with
industrialization
country.
measures
As
which
well
purchasing
unemployment.
power
as
amplifies
Exchange
of
Real
job
rate
is
It
has
country.
positive effect on unemployment. When the exchange rate changes
that
affect
depreciated
goods
market
which
causes
in
country
the
and
reduction
the
in
value
of
money
consumption
and
industrial production and ultimately decrease the employment.
Exports have negative effect on unemployment due to industrial
sector production which raises the employment level. Per capital
gross
national
product
has
negative
relationship
with
unemployment. When Per capital income increases the purchasing
power of people increases this enhances the living standard of
population and decrease unemployment.
Large scale manufacturing has negative effects on unemployment
because
manpower
consumption
in
unemployment in the economy.
24
the
industry
increases
and
SECTION 4
DATA ANALYSIS AND INTERPRETATION
This section presents the research results and their subsequent
interpretations in the following tables.
Table (4.1) Regression Analysis for Economic Growth and Price
Instability
Dependent Variable: NGDP
Variable
Equation
Coefficient Std. Error t-Statistic
C
-455256.53
77108.03
-5.9
SGRATE
10818.2
10114.57
1.07
PCGNP
133.26
5.69
23.41
CPI
-7581.87
4353.91
-1.74
MANUFGRATE
15757.7
4286.25
3.68
INV
0.95
0.16
6.06
IMP
-0.11
0.05
-2.06
R-squared
1
Adjusted R-squared
1
Durbin-Watson stat
1.92
3.1
explains
the
relationship
between
nominal
gross
domestic product and price instability, which has been depicted
in table (4.1). Main results are that nominal GDP has negative
effect
on
demonstrates
Services
price
instability.
inverse
growth
rate
relationship
has
The
and
positive
value
of
has
value
effect
a
on
t-statistic
of
1.74.
nominal
gross
domestic product. The results of t-statistic of services growth
rate is 1.07. It is positive but insignificant effect on nominal
25
GDP
because
in
Pakistan
the
main
focus
of
economists
is
on
agriculture and manufacturing sector. Government is not taking
steps to grow the services sector.
Per capita GNP has positive relation with nominal GDP and it
shows highest t-value 23.41. It means that if we strengthen per
capita GDP either by increasing GDP growth or by reducing the
population growth rate, we can contribute by a long way for
development of economy.
There is positive relationship between manufacturing growth rate
and
nominal
gross
domestic
product.
The
t-value
for
manufacturing growth rate is 3.68 and has significant effect on
nominal GDP. Manufacturing sector is second largest sector of
economy
and
recorded
have
its
19
weakest
percent
growth
share
during
of
GDP.
This
2007-08.the
sector
actual
has
growth
rate is 5.4 against the targeted 10.9 percent. The performance
of manufacturing sector was impressive 10.4 during last five
year. But now due to instability in Pakistan the manufacturing
growth
rate
is
decreasing.
If
the
government
considers
the
critical situation and takes some constructive steps to help
then, manufacturing sector can grow with greater potential.
The relationship between investment and Nominal GDP are strongly
positive and the value of its t-statistic (6.06) is significant.
The investment reaches record level of 22.9 percent of GDP in
2006-07 but now the investment share in GDP has decreased to
21.6 percent due to instability in the economic situation of
Pakistan.There
agriculture
investment
are
sector
with
some
sectors
like
which
have
large
the
a
provision
government.
26
of
energy,
transport
potential
safety
for
measures
and
foreign
by
the
Imports have negative relationship with nominal GDP .The value
of t-statistic is 2.06. The results of equation 3.1 demonstrates
that services growth rate, per capita gross national product,
manufacturing growth rate and investment have positively related
with
nominal
gross
domestic
product.
CPI
and
imports
has
negatively related with nominal gross domestic product. In the
table 4.2, the effects of economic variables on real GDP have
been discussed.
Table 4.2 Effects of Economic Variables on Real Gross Domestic
Product
Dependent Variable: RGDP
Variable
Coefficient Std. Error t-Statistic
C
-535923.09
212741.25
-2.52
UNEMP
-25372.64
26915.9
-1.94
FDI
23.13
12.79
1.81
FDIG
-19330.03
8475.12
-2.28
HEXP
-30.94
9.72
-3.18
IMP
2.14
0.73
2.93
INV
-1.11
0.6
-1.85
IRATE
6064.44
3828.36
1.58
MANUFGRATE
9032.31
8101.56
1.11
NGDP
0.69
0.21
3.25
PCGNP
82.24
47.03
1.75
SLSMGDP
8341.59
3328.4
2.51
EXRATE
20808.32
6113.61
3.4
EXPORTS
-3.43
1.35
-2.53
AR(1)
-1.51
0.21
-7.13
R-squared
1
Adjusted R-squared
1
Durbin-Watson stat
1.95
27
Equation 3.2 explains the relationship between real GDP with
different variables, which has been depicted in the table 4.2.
There
is
negative
unemployment.
negative
The
relationship
t-statistic
significant
between
(1.94)
relationship
shows
between
real
GDP
and
that
there
real
GDP
is
and
unemployment. When unemployment increases real GDP decrease due
to
stagnant
economy
then
there
is
no
growth
in
economic
activities.
The relationship between FDI and real GDP is positive and the tvalue
is
1.81.
investment
This
increases,
result
shows
economic
that
growth
when
also
foreign
increase
direct
due
to
growth in different sectors of economy.
Manufacturing growth rate has positive effect on real GDP and
the t-value is 1.11. It shows that when manufacturing growth
rate increases due to increase in the productively, efficiency
of employees and real GDP also increase. Interest rate t-value
is
1.58
and
has
positive
significant
effect
on
real
gross
domestic product.
Nominal GDP
statistic
of
has
positive
nominal
relationship
gross
domestic
with
real
product
is
GDP.
3.25
The
and
thas
substantial effect on real gross domestic product.
Per capita GNP has strong positive relationship with real gross
domestic
product.
product
is
1.75.
The
t-value
When
of
per
per
capita
capita
gross
national
income
increases
the
consumption level increases.
Equation 3.3 explains the relationship between unemployment and
real GDP and the depicted results of regression analysis are
described
in
the
28
table
4.3.
Table
4.3
Regression
Analysis
for
Effect
of
Real
GDP
on
Unemployment
Dependent variable: UNEMP
Variable
Coefficient Std. Error t-Statistic
C
5.82
1.5
3.89
RGDP
0
0
1.79
FDI
0
0
-1.43
HEXP
0
0
0.84
IMP
0
0
-4.49
INV
0
0
2.93
MANUFGRATE
-0.2
0.05
-3.95
NGDP
0
0
2.12
PCGNP
0
0
-2.6
SLSMGDP
0.05
0.03
1.98
EXRATE
-0.09
0.05
-1.73
EXPORTS
0
0
4.58
AR(1)
-0.29
0.2
-1.45
R-squared
0.94
Adjusted R-
0.9
squared
Durbin-Watson
2.13
stat
According to table 4.2, there is negative relationship between
FDI and unemployment but results show an insignificant impact on
unemployment.
The
t-statistic
(1.43)
for
FDI
shows
negative
relationship.
Manufacturing growth rate has negative effect on unemployment
when manufacturing growth rate increases unemployment decreases
29
and
the
t-statistic
significant
negative
value
3.95
effect
on
proves
that
there
unemployment.
The
is
a
results
demonstrate that per capita GNP and unemployment has negative
relationship which is evident from the t-value (-2.6).
CONCLUSION
Pakistan economy is in crucial phase of its turmoil. A lot of
social
and
economic
health
facilities,
problems,
hyper
like
low
inflation,
high
literacy
rate,
unemployment,
poor
rising
trade deficit, debt on high surge and continuous low economic
growth have been faced by current government. Main cause of this
trough
condition
resolve
these
is
issues
war
by
on
terror
and
government.
lack
The
of
interest
government
has
to
been
indulged in unnecessary debates which have no direct link with
the revival of economy and welfare of general public
In
this
research,
the
effects
of
price
instability
on
unemployment and economic growth in Pakistan are discussed. To
achieve this objective a set of regression equations have been
developed. The variables which have been selected for analysis
are Inflation (CPI), volume of Imports, exchange rate, exports,
balance of trade, GDP growth, agriculture growth rate, share of
large scale manufacturing in GDP, services sector contribution
in
GDP,
health
expenditure
as
percentage
of
GDP,
education
expenditures as percentage of GDP, gross fixed capital formation
by public & private sector, foreign direct investment and total
consumption in the country. The data period covers from 1980 to
2008.
One of the main results of this research is in favor of negative
relationship
between
price
instability,
unemployment
and
economic growth. These results are also supported by khan and
Senhadji (2001) results in which they have used an econometric
30
technique
to
economic
examine
growth
the
and
relationship
strong
negative
between
effect
inflation
of
inflation
and
on
economic growth has been derived.
In this research, Main reason behind this negative relation is
that
as
decrease
because
inflation
increase,
then
consumption
real
the
value
of
money
purchasing
level
will
power
of
consumers
automatically
decreases
reduce
according
to
the
proportion of change in prices. Being an important component of
income identity ( Y = C + I + G , Consumption has direct relation to
GDP, Which means that when consumption decreases GDP of also
decreases. The results are based on the estimation of regression
analysis the t-value between nominal gross domestic product and
inflation
is
significant
1.74
effect
which
on
shows
the
GDP
that
of
the
price
and
instability
there
has
is
negative
and
economic
relationship.
There
is
negative
relation
between
Unemployment
growth. This theory supports Okun law. Okun’s law state that if
unemployment
moves
above
from
normal
point
by
1%
GDP
growth
falls by 2% and vice-versa. In this research, it is estimated
that real GDP and unemployment has indirect relationship. The
regression results indicate negative relationship between real
GDP and unemployment.
31
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