In Cobb-Douglas production function the 'golden rule' is denoted by ..... the growth rate of income will positively related to saving ratio and capital formation.
HUMAN CAPITAL FORMATION AND ECONOMIC GROWTH IN PAKISTAN
A thesis submitted to the Department of Economics in partial fulfillment of the requirements for the degree of Masters of Philosophy in Economics By
SAJID ALI ROLL NO. 02 SESSION: 2009-2011 SEPERVISED By
DR. IMRAN SHARIF CHAUDRY ASSOCIATE PROFESSOR
DEPARTMENT OF ECONOMICS BAHAUDDIN ZAKARIYA UNIVERSITY, MULTAN
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ALL PRAISE FOR ALLAH ALMIGHTY, WHO IS THE MOST BENEFICIENT, THE MOST MERCIFULL……!!!!!
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DEDICATION I DEDICATE THIS THESIS TO MY LOVING PARENTS MAY THEY LIVE LONG…. AMEEN!!!!
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CERTIFICATE This Dissertation entitled “Human Capital Formation and Economic Growth in Pakistan” by Sajid Ali is accepted in its present form by the department of Economics as satisfying the thesis requirement for the degree of Masters of Philosophy in Economics.
Supervisor:
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Chairman:
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External Examiner:
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ACKNOWLEDGEMENT
Words are always a poor approximation of what we want to say. All praise for the Allah Almighty, the omnipresent, the Merciful, the most Gracious, who is the entire source of all knowledge and wisdom. All praises are for Holy Prophet Hazrat Muhammad (SAW) who bought the message of peace and happiness to all creatures. I am thankful to Allah who gave me courage to undertake and complete this task assigned to me. I am fortunate to have Dr.Imran Sharif Chaudary as my supervisor, and I am thankful to him from the core of my heart on his encouragement, prioritized feedback, more boosting, sympathetic attitude and generous transfer of knowledge for this write up. With the encouraging support of my supervisor it becomes possible for me to accomplish the present study. He helped me to solve all problems at each and every step, helped me large heartily whenever I need his help he neither disappointed me nor spared my questioning. I owe to express my gratitude to the chairman Prof. Dr. Shah Nawaz Malik and all my respected teachers for guiding and encouraging me every time. I gratefully acknowledge the efforts and support of my friend Muhammad Ayub and my sister Sadia for guiding me, without their support it was not possible for me to complete this task. Last but not the least; I would like to pay my heartiest gratitude to my family for their love, support, care and guidance. Without them I am unable to accomplish anything worthwhile. May Allah bless them All…
Sajid Ali
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TABLE OF CONTENTS List of Tables……………………………………………………………………………..X Chapter 1 ………………………………………………………………………………1-6
Background of the Study and Statement of the Problem 1.1 Introduction …………………………………………………………………………………..1 1.2 Human Capital Formation in Pakistan………………………………………………….….2 1.3 Economic Growth in Pakistan……………………………………………………….……...2 1.4 Statement of the Problem …………………………………………………….…………….4
1.5 Objective of the Study………………………………………………………………...5 1.6 Organization of the Study……………………………………………………………..6
Chapter 2 ..................................................................................................................................7-20
Human Capital Formation: The Case of Pakistan 2.1 Introduction …………………………………………………………………..……….7 2.2 Prospectus of Economic Growth ………………………………………….………….7 2.2.1 Public and Private Rate of Returns ………………………………………..………. 8 2.2.2 Prominent Characteristics of the Population of Pakistan………………………..…. 8 2.2.3 Demographic Features of the Population………………………………..................11 2.3 Human Resource Planning in Pakistan…………………………………...………….12 2.4 Education Environment in Pakistan……………………………………………...…..12 2.4.1 Education Expenditures in Pakistan…………………………………………...…...13 2.4.2 Educational System and Structure in Pakistan………………………………...…...14 2.4.3 Technical Education and Skill Development…………………………………....…16 2.5 Health facilities in Pakistan……………………………………………………….....16 6
2.5.1 Nutrition and Food……………………………………………………………........17 2.5.2 Access to Safe Drinking Water and Adequate Sanitation …………………….…..18 2.6 Distribution of Income and Gini Coefficient ……………………………..........……18 2.7 Sectoral Contribution to the GDP Growth……………………………………….…..19 2.8 Conclusion……………………………………………………………………...……20 Chapter 3 ……………………………………………………………………………21-34
Human Capital Formation: A Theory 3.1Introduction…………………………………………………………………...…...….21 3.2 Human Capital Formation…………………………………………………………....21 3.3 Scope of Human Capital Formation………………………………………………....22 3.4 Approaches to Investment in Human Capital Formation……………………....……23 3.5 The Origins of Human Capital Theory………………………………………....……24 3.5.1 Human Beings as Capital…………………………………………………….….…25 3.5.2 Knowledge Creation and Human Capital Formation…………………………..…..26 3.5.3 Human Capital as Knowledge……………………………………………..........…27 3.6 Human Capital Formation for the Life-Cycle Framework…………………….…….27 3.6.1 Primary and Secondary Education…………………………………………........…27 3.6.2 Higher Education and/or Vocational Training………………………………….….28 3.6.3 On-the-job Training…………………………………………………………….….28 3.6.4 Retirement………………………………………………………………………….29 3.7 Models of Economic Growth……………………………………………………...…29 3.7.1 Harrod-Domar Model of Economic Growth…………………………………….…29 3.7.2 Solow Swan Model of Economic Growth…………………………………...….....30 3.7.3 Endogenous Growth Theory……………………………………………………….32 3.7.4 Lucas’s Human Capital Model………………………………………………….....33 3.8Conclusion…………………………………………………………………...……….34 Chapter 4…………………………………………………………………………….35-53
Human Capital Formation: A Review 4.1 Introduction…………………………………………………………………………...………35
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4.2 General Studies………………………………………………………………...….…35
4.3 Studies on Developing Countries…………………………………………...……….38 4.4 Studies on Developed Countries……………………………………………………..50 4.5 Conclusion……………………………………………………………………...……53 Chapter 5………………………………………………………………………….…54-60
Data and Methodology 5.1 Introduction…………………………………………………………………………..54 5.2 Sources of data……………………………………………………………………….54 5.3 Definitions of variables…………………………………………………………....…54 5.3.1 Gross Domestic production………………………………………………………...55 5.3.2 Education Enrollment Index (EEI)…………………………………………...……55 5.3.3 Head Count Ratio (HCR)…………………………………………………………..56 5.3.4 Gross Fixed Capital Formation (GFCF)………………………………………...…56 5.3.5 Infant Mortality Rate (IMR)……………………………………………………….57 5.3.6 Gini Coefficient (GINI)……………………………………………………...…….57 5.3.7 Investment Growth Rate (IGR)…………………………………………………….57 5.3.8 CPI Inflation Rate (INF)…………………………………………………………...58 5.4 Methodology…………………………………………………………………………59 5.4.1 Granger Causality Test………………………………………………………...…..59 5.5 Model Specification……………………………………………………………....….59 5.6 Conclusion……………………………………………………………………...……60 Chapter 6……………………………………………………………………………61-70
Human Capital Formation and Economic Growth: An Analysis 6.1 Introduction………………………………………………………………………….61 6.2 Elementary Data Analysis…………………………………………………………..61 6.2.1 Descriptive Analysis………………………………………………………………61 6.2.2 Correlation Matrix of the Specified Model……………………………………….63 6.3 Econometric Analysis of the Specified Model………………………………………66 6.3.1 Estimation and Results……………………………………………………………66 8
6.3.2 Granger Causality Test……………………………………………………………68 6.4 Conclusion………………………………………………………………………….70 Chapter 7………………………………………………………………………….....71-74
Conclusion and Policy Recommendations 7.1 Conclusion…………………………………………………………………………...71 7.2 Recommendations……………………………………………………………………71 References ………………………………………………………………………………………74
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LIST OF TABLES Table 2.1 Growth Rate of Population in Pakistan (1972-2010)……………………….....10 Table 2.2 Important Demographic Variables (2000-2009)………………………………11 Table 2.3 Education Expenditures in Pakistan …………………………………………...13
Table 2.4 Public expenditures on Health (percent of GDP)………………………….….17 Table 2.5 Household Income Share………………………………………………...……19 Table2.6 Sectoral Contribution to the GNP Growth (% Points)…………………...…….20 Table 5.1 Variables and their Explanation………………………………………….……55 Table5.2 List of Attempted Explanatory Variables with their Expected Results……..….58 Table6.1Discriptive Analysis…………………………………………………………….62 Table6.2 Correlation Matrix……………………………………………………………..63 Table 6.3 Parameter Estimates of Human Capital Formation Model………….………...67
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Chapter1
Background of the Study and Statement of the Problem “When we plan for one year, there’s nothing better than planting a grain. When we plan for ten years, there’s nothing better than planting trees. When we plan for a life time, there’s nothing better than planting men.” (Chinese Philosopher’ Guanzi’ 551 -479 BC).
1.1 Introduction Investing in people accelerates their individual development and gives them the ability to get rid from poverty. This requires education and health facilities as well as some measure of income security (World Bank 2000:105). It is considered that capital and natural resources are the slow factors while human capital is an active factor of production. Human beings can accrue capital and build up social and economic organizations. We can never develop any thing for economic growth, if we cannot develop the skills of our human beings. It is clear that if we want to use other resources effectively then we have to develop the capacity of our human beings through literacy, skill development and by quality enhancement so that we may trim down unemployment and enhance the process of growth. By human capital we consider acquired mental and physical ability of human beings through education, skill development, training, health care and activity of some spiritual methods like yoga. (Singh, 1999). Generally, the concept of Human Capital is used for education, skill development, health and other capacities of people that can enhance their productivity and efficiency. (Todaro, 2002). According to some economists the human capital is very essential and main component of growth. Because without sufficient and qualitative human power in terms of health, knowledge and skills, it is difficult to exploit other means of production such as capital and natural resources effectively.
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1.2 Human Capital Formation in Pakistan After the Pakistan came into being in 1947, the government gave its attention to build up human and physical capital in Pakistan. For the first time in history, the Zulfiqar Ali Bhutto, the Prime Minister of Pakistan gave attention to the education sector as well as to the manpower planning. For this purpose, he decided to nationalize different sectors of economy including education. He tried to provide free education for all the people of Pakistan. Although, it is considered that the government of Bhutto has not some good period in history but it is reality that he exported a huge amount of labor (Surplus labor) to developed countries especially to the Gulf countries. Now a day, the situation is very critical because Pakistani government has not been spending more than 2 percent of its gross national product on education sector. In health sector, the situation is also miserable because only about 2 percent of GDP has been spent for health sector in Pakistan. Human capital and economic development both are interrelated to each other for some additional basis. In Pakistan, a huge portion of population is residing below the national poverty line. It is commonly said that through economic growth, we can curtail unemployment and poverty but the situation is different in case of Pakistan. In Pakistan, we cannot reduce the poverty through only economic growth. It is the need to improve all indicators of economic growth. Furthermore, it is also necessary for the government to spend additional amounts on education and health sector. Human capital of Pakistan can also be used to accelerate the economic growth of the economy. Investment to increase literacy and skill development is necessary for the growth process of a country. Economic benefits are also higher if we invest in people and it has significant effects on the wages of the people.
1.3 Economic Growth in Pakistan According to the criteria of purchasing power, the Pakistan is ranked at 27 th in the world. Economy of Pakistan is agri-based and it has second biggest water irrigation or canal system in 12
the world. In 1947, the economic situation of country is very miserable but till 1960s, the Pakistan was able to increase its economic growth to 11 percent per annum. During this era, economy of Pakistan showed many achievements in almost all sectors. But later on, this period of prosperity ended by the separation of Pakistan into West Pakistan and East Pakistan. The present Pakistan (West Pakistan), during 1970s has grown at the rate of 5 percent approximately. This period of 1970s is considered a turn-up situation of economic policies from 1960s. Growth rate of Pakistan remained near about 5 percent per annum in entire history. With this rate of economic growth, Pakistan lags behind in major social or economic indicators from many other countries of the world. The growth rate of Pakistan has remained incapable to digest the growing population and it has also unable to absorb the increasing labor force. As a result, the income distribution has become more unequal and there is prevailing high inequality among the human beings. During 1990s, the growth rate remained very low because of Structural Adjustment Program (SAP), but growth rate again started to move upward during 2000s.
From 2000 to 2007, government raised development expenditures and so the poverty level decreased by 8 percent. During 2004-07, the growth rate of Pakistan reached to 6-8 percent per annum due to expansion in different sectors especially in services sector and industrial sector. Later on, during 2008-10, unemployment level raised with decline in industrial production due to heavy shortfall in electricity. Pakistani rupee has also lost its value since 2007 due to lack of stability in political and economic atmosphere in the country. Pakistan is lagged behind from many other countries of the South Asia for example Singapore, China and Malaysia though Pakistan has a plenty of natural resources, minerals and labor force. The average growth rate during 1990s is almost 4 percent and this growth rate had decreased to 3 percent in the end of the decade. After 2000, during the reign of General Musharaf, GDP started to increase and it had arrived at 8 percent in 2004-05. The growth rate of different sectors was also satisfactory. During this era, the Pakistan became the 3 rd fastest growing country in South Asia after the Singapore and China. Production of manufacturing and agricultural products increased and the burden of foreign debt also started to decline. During this decade, Pakistan showed gigantic economic growth .This period of economic affluence ended when great 13
depression of 2008 reached. After this, the Pakistan has to face many problems like shortage of electricity, crises in financial matters and economic instability. Now a day, per capita income of Pakistan is $1254 according to the economic survey of 2010-11. But despite of this, 23 percent of population is under the poverty line. 39 percent of population has no approach to sanitation facilities. Literacy rate is also only 57.7 percent, which is very low from other underdeveloped countries of the world. Rising inflation, which has reached at double digit value, is another main obstacle in the economic growth. Foreign investment level is also very low due to worst political instability and terrorism in Pakistan. After the above discussion, now a question comes in mind that why our economy is in vulnerable situation that it is unable to bear any type of economic recession or shock? The answer of this question is that the government just spent heavy amounts in the form of investment in fixed capital and due to this, the economy reached to its boom. But when economy reached at boom then it became difficult to maintain this level of growth due to low or lack of investment in human beings or human capital. Now when we talk about the social indicators then we came to know that Pakistan is also far behind in this respect from other countries of the region. Bangladesh, the former East Pakistan is world’s 47th largest country has a growth rate of 6.5 percent in 2011. In other hand, Pakistan has very low growth rate (only 2.4 percent) according to economic survey of 2010-11.
1.4 Statement of the Problem “Development of human resource is one of the essential conditions for economic growth”. (Harbinson and Myers, 1964). The common concept that investment in human beings results in increased economic growth is very old and link to the period of Adam Smith (1776). The economists of classical school of thought also stressed upon the investment in human beings. Very close relation among economic performance, human capital and other factors is the main reason of the formulation of human capital theory. According to new growth theory, there are strong economic effects of education on the micro and macro economic level.
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Human capital formation has a inner role for the development of society. This is very critical situation in Pakistan that despite of significant growth rate, the indicators of human capital are not satisfactory. Almost all economic indicators that can measure the situation of human development are very low in Pakistan i.e. literacy rate, enrolment rate at school level, facilities of health and clean water etc. During the past period, all the concentration of government remained in the investment in physical capital only, while government ignored the human capital sector. Due to this lack of investment in human capital, today the result is in the form of unemployment, high poverty level, illiteracy and shortfall of electricity. In Pakistan, the accumulation of capital is lower than the growth rate of population. Lack of skilled labor, low production and lack of resources are some other obstacles in the way of economic growth. Many countries of the world especially the countries of South Asia are growing faster than Pakistan. So, in this situation, following questions aroused: a) Why other economies of the world are achieving growth rate more than the growth rate of Pakistan? b) Which factors is the main cause of high economic growth in other countries of the world? c) Why Pakistan is incapable of achieving the high ranks in social and economic indicators? d) What are the effects of enrolment rate on economic growth and GDP? e) Either reducing poverty (HCR) is more productive or provision of health services is better by reducing infant mortality rate?
1.5 Objective of the Study The main objective of this study is to find the answers of some questions and give some proposals to resolve these questions or problems. Other objectives of our study are following: a) To intricate the development of human capital in the country. b) To clear the idea and some theoretical concepts about formation of human capital and economic growth. c) To access some historical trends and aspects of human capital formation in Pakistan along with other factors which effect human capital formation and make their impact on economic growth.
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d) To find the empirical relationships among the variables which affect the human capital and economic growth in Pakistan. e) To wind up the results of the research and to define some recommendations about the subject matter.
1.6 Organization of the Study This thesis has been assembled as follows; the starting chapter gives the brief idea and concept of the study. Chapter two describes the profile of the economy of Pakistan, manpower planning, institutional framework, and efforts made by the different governments regarding the human capital formation. Chapter 3 defines the idea of human capital, objectives of human capital formation and importance of human capital formation. It also defines the origin of the theory of human capital growth and it also clarifies about different models of economic growth. Chapter 4 has been reserved for the brief literature review about the study. Chapter 5 deals with methodology, definitions of important variables and model specification of the study. We analyze the effects of human capital on the process of growth using some econometric techniques in chapter 6. In the end there comes the chapter 7 that postulate the conclusion and policy recommendations. In last there come references.
Chapter 2
Human Capital Formation: The Case of Pakistan
2.1 Introduction Pakistan came into existence as an independent state on 14th august 1947 but it was separated into two parts; East Pakistan and West Pakistan after 1971. East Pakistan is now known as ‘Bangla Desh’ and West Pakistan is now called ‘Islamic Republic of Pakistan’ which has four 16
provinces i.e. Punjab, Sindh, Balochistan and Khaiber Pakhtunkhwa. Pakistan is facing the major problems of terrorism, natural disasters, energy crises and inflation now a days along with the other problems of over population, low literacy rate, bad economic conditions, corruption, poverty, unemployment, low human skills etc. This chapter certainly elucidates the economic profile of Pakistan and shows its facts and figures. We demonstrate the economic condition of Pakistan after 1971 in terms of economic indicators because after 1971, major changes were occurred in West Pakistan due to its partition. In Section 2.2, we define the curriculum of economic growth. Section 2.3 describes the situation of manpower planning in Pakistan. Section 2.4 and section 2.5 define the situation of education and health respectively .Section 2.6 defines income distribution in Pakistan. Section 2.7 shows the share of different sectors in GDP growth. Last section gives the concluding remarks.
2.2 Prospectus of Economic Growth It has been observed that there is main importance of many social and cultural determinants in the process of economic growth. Population can be changed in the form of human capital according to the need of these determinants. So we can say that population, health facilities, technical education, immigration and structural adjustment programs are the main and significant factors of economic growth. Investment in education and health sector is also necessary for the process of economic growth.
2.2.1 Public and Private Rate of Returns Based on available data about economy of Pakistan, several studies remark less benefits received from different level of year of schooling than other underdeveloped countries of the world. We observed a positive relationship between education and earnings while negative relationship is observed between inequality and the level of education. In 1979, the literacy rate was just 25.9 percent. In 1980s, the Structural Adjustment Program (SAP) was started and so literacy rate started to increase. Due to fiscal limitations, the opportunities of employment in government sector are decreasing and the role of private sector is 17
increasing. Due to these reasons, it is necessary that we re-examine the role of human capital with reference to other factors which may affect the human capital and economic growth. Many other factors such as skills, quality of education and health have serious effect on the earnings of the people. It is noted that the students of private schools have more practical approach, so they may earn more money after completion of their study compare with the students of public schools. There is also a significant impact of technical education on the earnings of the people. A primary input to accelerate the growth process is the skilled labor and manpower. Records of economic growth of Pakistan during last several decades are sound. However, the social sector of Pakistan needs a lot of investment for improvement. During 1980s, the growth rate of population remained high. Due to this high rate of population growth, the infrastructure or communication system of social sector has been destroyed.
2.2.2 Prominent Characteristics of the Population of Pakistan a) Data on education reveals that literacy rate is 57.7 percent in 2010-11. The literacy rate between male and female is 69.5 percent and 45.2 percent respectively. (Economic survey of Pakistan 2010-11). b) In the past history of Pakistan, the policy makers stressed on the investment in only physical capital while human capital was completely ignored. c) The presentation or work of social sector in our country is not satisfactory. It is due to the low education and employment opportunities, no proper health facilities and unskilled labor. d) High gender imbalance is prevailing regarding availability of social services. Females are deprived of many social services and facilities in Pakistan. e) Pakistan occupies very small portion (only 0.66 percent) of the world but has only about 2 percent population of the world. When Pakistan came into being in 1947, the total population was about 32.4 million. But during the last sixty four years, population has become more than
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five times. Population growth rate was 1.8 percent in 1947 and 3.1 percent in 1982. Now it is about 2 percent in 2010-11. f) The two main health factors that may affect the population growth rate are total fertility rate of women and the mortality rate. Due to better health services and prevention of diseases in Pakistan, the mortality rate is starting to decline. g) In Pakistan, the people are living in two areas i.e. in urban areas and in rural areas. A strong disproportion in growth structure and demographic features of population are prevailing between urban and rural areas. h) Another indicator used for mortality is life expectancy at birth. In 1951, the life expectancy at birth was just 33.7 years. It rose to 67.2 years in 2010-11. i) According to economists, if we want to fully utilize our economic resources then effective employment level and planning is necessary. Manpower planning is also essential for generation of employment opportunities. j) Participation rate of women in workforce is very small in Pakistan. According to UN Report, the female participation rate during 2000 in Pakistan was just 14.4 percent while in India, it was 28.2 percent and in Iran, it was 19.2 percent. k) Now Employment opportunities in rural areas have started to increase due to increasing the education level in these areas. One interesting point is that, participation of female students in higher education is more than the participation of male students. l) Due to increased use of capital intensive technology, the engagement of labor has significantly reduced in Pakistan. In formal sector, only educated and skilled workers can do job so illiterate or unskilled workers find jobs in some other or informal sector. m) Technical education is necessary for the skilled development and betterment of human capital. It enhances the efficiency level of workers and also increases the level of productivity. An educated worker can earn more wages than an uneducated worker.
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n) According to UNO Report (2010), Pakistan was ranked at 125 th in the basis of HDI among 170 countries of the world. The HDI measures the availability of health, education and other indicators in which performance of Pakistan is very poor.
Table 2.1 Growth Rate of Population in Pakistan (1972-2010) Year Population Year Population 1972 2.58 1991 2.88 Growth Rate Growth Rate 1973 2.51 1992 2.22 1974 2.47 1993 2.08 1975 2.33 1994 2.49 1976 2.22 1995 2.63 1977 2.43 1996 2.77 1978 2.90 1997 2.56 1979 3.44 1998 2.42 1980 3.38 1999 2.41 1981 3.26 2000 2.72 1982 3.42 2001 2.86 1983 2.96 2002 2.21 1984 2.55 2003 1.81 1985 2.73 2004 1.87 1986 3.10 2005 1.84 1987 3.18 2006 1.82 1988 3.17 2007 1.81 1989 3.03 2008 1.7 1990 2.93 2009 2.08 2010 2.05 Source: Pakistan economic survey various issues.
2.2.3 Demographic Features of the Population According to World Bank Report, population of Pakistan has shown the increase of 57 million from 1992 to 2010. During the same period, there is indicated 5 percent growth in population while in India, only 33 percent growth in population was occurred. According to United Nations estimates, in 1950, the population of Pakistan was 37.5 million. In 2010, it is 173.6 million. In 1981, the population growth rate was 3.2 percent and according to economic survey of Pakistan 20
2010-11, it is now decreased to 2.05 percent per annum. Growth rates of population from 1972 to 2010 are given in Table 2.1 which shows the decreasing trend in population growth rate.
Table 2.2 Important Demographic Variables (2000-2009) CBR/1000 TFR/ IMR/1000 CDR /1000 Years Population Woman Live birth Population 2000 32.11 4.56 82.49 9.52 2001 31.21 4.41 80.5 9.26 2002 30.4 4.25 78.51 9.01 2003 29.59 4.1 76.53 8.79 2004 31.22 4.29 74.43 8.66 2005 30.41 4.12 72.41 8.44 2006 29.74 4.00 70.45 8.28 2007 27.52 3.71 68.84 8.00 2008 28.34 3.72 66.93 7.85 2009 28.4 3.7 68.2 7.6 Source: CIA world fact book 2011
Table 2.2 shows demographic variables which are also considered health variables i.e. CBR (Crude Birth Rate), IMR (Infant Mortality Rate), TFR (Total Fertility Rate) and CDR (Crude Death Rate) in Pakistan. In 2000, the infant mortality rate was 82.49 which is reduced to 68.2 in 2009. Total fertility rate in 2000 was 4.56 which was reduced to 3.7 in 2009. The sex ratio at the time of birth in Pakistan is 1.05 male per female. In table, we see that there is declining trend in both infant mortality rate and total fertility rate but total mortality rate declines relatively faster than total fertility rate.
2.3 Human Resource Planning in Pakistan Human resource planning is also known as manpower planning. It consists of putting the right people for the right task. Three main elements for better human resource planning are forecasting
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the demand for labor, analyzing the present supply of labor, and at the end; to balance the projected supply and demand for labor. Economists say that family planning is same as the human resource planning because the goals of both plannings are to improve or develop the quality and standard of living of the people. In all past five year plans in Pakistan, the major focus remained on human resource planning, providing health and education facilities, technical and vocational programs, nutrition and clean water. In Pakistan, empirical studies have suggested that education is the key factor for accelerating the economic growth. In Pakistan, there is eight times more cost on establishing a formal education institute than non formal one. So, non formal schools can play vital role to increase literacy rate in Pakistan. In 1993, Pakistan started Social Action Program (SAP) for human resource planning. The purposes of this program are to provide a number of basic needs i.e. health facilities, clean water, improve education and family planning. Providing primary education is the basic goal of this program. The primary enrolment ratio increases significantly through this program. After completion of first phase of Social Action Program (SAP), the next phase of this program was started in 1996 for the period of four years i.e. 1996 to 2000. The purpose of this second phase is to establish primary and middle schools, increase enrolment ratio and to provide technical education.
2.4 Education Environment in Pakistan In Pakistan, prior to the 18th Amendment in constitution, the education system was the responsibility of central government. The Federal Ministry of Education was responsible for Promotion of education across the country. But after the 18th Amendment, the responsibility of Education in Pakistan has been divided among the Federation and the Provinces.
2.4.1 Education Expenditures in Pakistan The government spending on education (percentage of public expenditure) in Pakistan was 11.2 percent in 2009 according to a World Bank Report (2010). Government or public expenditures on education sector consists all of current government expenditures on education sector i.e.
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expenditures on educational institutions, expenditures on administration of education sector and all the government subsidies for education.
Years 1970’s 1980’s 1990’s 2000’s 1999-00 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10
Table 2.3 Education Expenditures in Pakistan As percent of GDP percent of total 0.79 -Expenditures 0.8 -2.3 -2.1 9.0 2.2 9.7 1.82 10.6 1.79 9.49 1.86 10.1 2.20 13.0 2.16 12.5 2.24 12.2 2.49 12.1 2.47 9.8 2.10 11.51 Sources: Pakistan Economic Survey (1972 to 2010)
Table 2.3 indicates that total educational expenditures as the percent of GDP and as the percent of total expenditures from 1970 to 2010. In 1980’s, education expenditures were 0.79 percent of GDP compared with 1990’s with 2.3percent of GDP. Education expenditures decreased in 2000 and again in 2010 while expenditures in 2009-10 are 11.51 percent of total public expenditures. The total number of primary and middle schools in Pakistan are 19,022 and 5,525 respectively. There are 1,377 degree colleges and 132 universities in Pakistan. The total number of middle school and high school teachers is 320,480 and 439,316 respectively. The total number of university teachers is 50,825.
2.4.2 Educational System and Structure in Pakistan
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In Pakistan, two education systems are prevailing: one is the religious education and the other one is the formal education system. The formal education system is started from British colonial rule and it continued even after the independence of the country. Since independence, many governments have made their struggle to improve the education system of Pakistan. In present days, our education system is composed of following different stages: Primary Stage
Grades 1-5 (Age 5 to 9 years)
Middle Stage
Grades 6-8 (Age 10 to 12 years)
Matriculation
Grades 9-10 (Age 13 to 14 years)
Higher Secondary
Grades 11-12 (Age 15+)
College level
Grades 13-14 (Age 18+)
University level
Grades 15 and above (Age 21+)
The modern or formal education system consists of six stages as defined in above. The primary level stage lasts for five years and the students of primary level are ranged from 5 to 9 years. Then middle school stage comes which is applicable on the children of 10 to 12 years old and it covers the grade six to eight. After that, a two years stage of high school or matriculation comes. It consists of grade 9 and 10 and it is applicable to the children of age 13 to 14 years. After this, a two years higher secondary level stage comes. It consists of grade 11 and 12. After that, there comes college level stage which consists of grade 13 to 14. The sixth and last stage comprises of grade 15 and above and called university level stage. According to some economists, education is the cheapest defense of a country. But the miserable condition of education sector in Pakistan shows that our government is incapable to defend its own sector. In recent years, there is economic and political instability in Pakistan which also badly affect the education sector of Pakistan. There are following main problems of education sector of Pakistan:
a)
Low enrollment ratio
b)
Regional disparity regarding education facilities 24
c)
Gender discrimination in education
d)
Week supervisory and administrative structure.
e)
Very low salary paid to teachers.
f)
Lack of public infrastructure and educational buildings.
g)
Out dated syllabus is being taught in educational institutions.
h)
Low quality performance of schools.
i)
Lack of technical skills and proper training of teachers
One of the main reasons of bad performance in education sector is low level of investment in education by the government. In Pakistan, government invests heavily in higher education where only upper class of people gets benefits from opportunities of higher education. So, the poorer or low income class is unable to get any kind of subsidy on primary and secondary education. So, literacy rate in Pakistan is lowest with compare to other countries of the region. Gender disparity also exists in Pakistan as its worst form. There are great differences in the enrollment rates of male students as compared to female students. According to the report of UNESCO, enrolment of female students in primary school level stands at 60 percent as compared to 83 percent for male students. In Pakistan, at secondary level, the enrolment rate is 33 percent for female students and 45 percent for male students.
2.4.3 Technical Education and Skill Development It is necessary to give technical and vocational education and training to our growing population so that we can compete with the other economies of the world. Technical education is essential device to get better employment opportunities in competitive world. In Pakistan, the sector of technical and vocational education is being neglected and this sector has several problems such as:
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a) Lack of skilled and efficient staff in technical institutions. b) No reasonable opportunities for technical education in rural areas. c) No separate technical or vocational institutes for women. d) No clear relationship or link between vocational education and general education. e) Lack of planning in promotion of technical education. f) Less participation of private sector in vocational education and training activities. g) No data banks for the record of skilled workers and technical persons. One of the reasons of low attainments in vocational education of Pakistan is lack of proper planning and negligence. It is necessary that we should develop our economy at technical basis. Twenty first century is the time for only those countries which are advanced in technology.
2.5 Health facilities in Pakistan Public expenditures on health are considered essential part of the activity for poverty alleviation. Health indicators show the quality of life of the people. Although, Pakistan has shown significant improvements in some health indicators but still Pakistan is ranked at lower level in the world on this count. Expectancy of life for male and female in Pakistan is lower and infant mortality rate remains higher than many other countries of the world. Infant mortality rate and maternal mortality rate are also higher in Pakistan than other countries. In Table 2.4, the health expenditures, development expenditures and current expenditures of government from 19992000 to 2009-2010 are given. These expenditures show the clear situation about the government intention towards the health sector of the economy of Pakistan.
Years
1999-2000
Table 2.4 Public expenditures on Health (percent of GDP) Health Health Development expenditures(perc expenditures(in expenditures ent of GDP) Rs. Billions) (billions) 0.72
22.08
5.89
Current expenditures(billion s) 16.19 26
2000-01 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10
0.72 0.59 .58 .57 .57 .51 .57 .57 .56 .54
24.28 25.41 28.81 32.81 38.00 40.00 50.00 60.00 74.00 79.00
5.94 6.69 6.61 8.50 11.00 16.00 20.00 27.22 33.00 38.00
18.34 18.72 22.21 24.31 27.00 24.00 30.00 32.67 41.10 41.00
Sources; Pakistan economic survey
Total expenditure on health and nutrition increased from 22.08 billions in 2000 to 79 billions in 2010 and the health expenditure as percent of GDP were increased from 0.72 billion to 0.54 billion in these years. According to economic survey of Pakistan 2010-11, there are 144,901 registered doctors and 73,244 registered nurses in Pakistan. For 1,222 people, one doctor is available and for 1701 people, one bed in hospital is available.
2.5.1 Nutrition and Food Specific expenditures on food and nutrition provide the evidence of the health situation of human beings. Food is required for survival and is basic requirement for physical growth and mental development of human beings. According to National Nutrition Survey (NNS) conducted in 2011, 58 percent people in Pakistan are suffering from food insecurity. Majority of children less than 5 years of age in Pakistan are suffering from malnutrition. Poor households in Pakistan spend the major portion of their income on primary items of food i.e. wheat while they are incapable to buy high cost items like meat and fish and so they remained under-nourished.
2.5.2 Access to Safe Drinking Water and Adequate Sanitation Availability of clean and safe drinking water and sanitation facilities are necessary for the sustainable environment and reducing the diseases like diarrhea, hepatitis and malaria in Pakistan. So, government’s expenditure to provide safe drinking water and sanitation facilities is not only a growth oriented strategy but it can also give some other socioeconomic benefits in the 27
form of improved health and life status and reduced burden of diseases. Sanitation and Water sector is the most neglected sector in Pakistan. Most of the people in Pakistan have no proper access to safe drinking water and lack of sanitation facilities. These poor people are living in mostly rural areas or urban slum areas. In Pakistan, WASA (Water and Sanitation Agency) is responsible to provide water supply and sanitation facilities in mostly urban areas. But unfortunately, WASA is also in miserable condition and it does not even cover its costs of maintenance due to shortage of funds and poor efficiency. To solve the problem of sanitation and safe drinking water, the government of Pakistan started a Medium Term Development Framework (MTDF). This program was started for 5 years from 2005 to 2010. It was decided that through this framework, $404 million would be spend every year to provide safe drinking water and sanitation facilities.
2.6 Distribution of Income and Gini Coefficient The Gini coefficient shows the income inequality and its value ranges from 0 to 1. In some times it is also expressed as a percentage which ranges from 0 to 100. A low value of Gini coefficient indicates a more equal income distribution while high value shows unequal distribution. Zero (0) value shows complete equality while value of 1 shows complete inequality in income distribution. Gini coefficient allows us to make comparison of income distributions across different groups as well as countries. In table 2.5, the Gini coefficient of various years of Pakistan along household income share is given.
Table 2.5 Household Income Share Years 1984-85 1985-86
Gini coefficient 0.369 0.355
Lowest 20percen t 7.3 7.6
Middle
Highest
60percent
20percent
47.7 48.4
45.0 44.0
Ratio (highest to lowest) 6.2 5.8 28
1986-87 1987-88 1988-89 1989-90 1990-91 1991-92 1995-96 2009-10
0.346 0.348 0.407 0.41 0.40 0.40 0.41 0.41
7.9 8.0 5.7 6.2 6.5 7.0 9.0 25.7
48.5 45.3 45.0 45.6 46.3 43.6 41.2 35.0
43.6 43.7 49.3 48.2 47.2 49.4 49.8 --
5.5 5.5 8.6 7.8 7.3 7.1 7.0 --
Sources: Pakistan economic survey (1972 to 2010)
Gini coefficient of Pakistan was 0.369 in 1984-85 and 0.40 in 1990-91. Gini index of Income distribution in Pakistan in 2009-10 is 0.41. Household income by percentage share in various years is as follows: lowest 10 percent: 4.1percent, highest10 percent: 27.7 percent (in 1996), lowest 20 percent: 27.7 percent (in 2006). In 1980’s, household income share was lowest 20 percent: 7.3 percent, and in 1995 it was 7.0 percent. Middle 60 percent was 47.7 percent and highest 20 percent was 45.0 percent in 1985 and in 1992, they were 43.6 percent and 49.4 percent respectively.
2.7 Sectoral Contribution to the GDP Growth In table 2.6, the contribution of different sectors; agriculture, industry, manufacturing and services in GNP growth are given. It shows the contribution of different sectors in GNP growth from 1980’s to 2010-11. In 1980’s, manufacturing’s share was highest (8.2 percent) followed by services sector (6.6 percent), agriculture (5.4 percent) and construction (4.7 percent). In 1990’s, in Pakistan, share of every sector was decreased considerably and share of manufacturing sector was 4.8 that was more than other sectors, services sector (4.6 percent), agriculture sector (4.4 percent) and construction sector (2.6 percent). In 2000, agriculture (2.7 percent) and construction (6 percent) show much reduction but the situation was little bit better for manufacturing sector (7.4 percent) and services (5.1 percent). In 2008-09, results are showing very worst condition as share of construction sector into GNP growth is -10.8 percent, and manufacturing is -3.3 percent.
Table2.6 Sectoral Contribution to the GNP Growth (% Points) Sectors 1980’s
Agricultur
Constructio
Manufacturin
Service
Real
5.4 e
4.7 n
8.2 g
6.6 s
5.5 GNP 29
1990’s 2000’s 2002200303 200404 200505 200606 200707 200808 200909 201010
4.4 2.7 4.1 2.4 6.5 6.3 4.1 1.1 4.7 0.6 1.2
2.6 6.0 4.0 -10.7 18.6 10.2 24.3 -3.9 -10.8 28.4 0.8
4.8 7.4 6.9 14.0 15.5 8.7 8.3 4.8 -3.3 5.5 3.0
4.6 5.1 5.2 5.8 8.5 6.5 7.0 6.6 3.6 2.9 4.1
4.0 5.3 7.5 6.4 8.7 5.6 6.7 4.1 2.6 4.8 2.9
Source: Pakistan economic survey (1972 to 2011)
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2.8 Conclusion In above, brief discussion about Pakistan’s socioeconomic profile clears the situation. We sum up that health facilities, skill development, education, vocational training and safe drinking water are necessary and significant determinants for economic growth in Pakistan. The key improvements in literacy rate health facilities and skills would cause hefty economic gains. Improved human skills and adequate distribution of income are also necessary for human capital formation and quality of life.
Chapter 3
Human Capital Formation: A Theory 3.1 Introduction The major function of this chapter is to elaborate some important concepts and theories about the human capital formation and economic growth. We organized this chapter as follows: Section 3.1 presents introduction followed by the concept of human capital formation in section 3.2. Section 3.3 defines scope of human capital formation. Section 3.4 comprises different approaches to human capital. Section 3.5 is about the origins of human capital theory. In section 3.6 the new concept of the human capital formation for the life-cycle is given. Different models of economic growth are also given in section 3.7. Conclusion is presented at the end of this chapter in section 3.8. 30
3.2 Human Capital Formation Many economists and international institutions have described the definition of human capital formation in different ways e.g. International Labor Organization (ILO) defines as “the total skills of population in relation to economy’s development are called human capital formation”. Generally, human capital formation contains following aspects of human beings: a) To increase the competency, knowledge and skills of human beings. b) To optimize the utilization of workforce. c) To give inspiration and motivation of work. d) To create better working environment for workers. e) To integrate the process of education, skill formation and personal development. According to ‘Kindle Berger’ “Investment in human capital has many forms i.e. education, skill development and health facilities”. T.W. Schultz defined human capital as: “An improvement in human skills due to which a person proves himself more productive and more efficient than before, is called human capital formation”. So we can say that human capital formation is connected with investment in human beings and development of their cognitive skills. The concept of human capital shows that all labor is not equal and so, the quality of labor or workforce can be improved through investment in education and training. After above discussion, we can say that all those behaviors which enhance the abilities of people in the form of increased production are called human capital formation i.e. a) Increase in knowledge, education and technology. b) Increase in health status and better availability of safe water and nutrition. c) Skill development and vocational training. d) Information of any kind. 31
e) Better manpower planning. f) Migration.
3.3 Scope of Human Capital Formation The concept of human capital has great importance in labor-surplus countries because in these countries, there is more labor due to high population growth rate. In these countries, the surplus labor is available in more quantity than tangible capital. This surplus labor can be transformed into human capital through education and skill development. In this way, crude human resource can be transformed into highly productive human resource. This process is also called human capital formation. Human capital is related with the concept of human development. United Nations measures human capital formation with the help of Human Development Index (HDI). It is a statistical indicator to judge the situation and quality of human capital in different countries of the world. Education is a tool to enhance economic development. Only those nations can compete in global world that have acquired new technology, skills and efficiency. Many countries have developed themselves with the help of their rich human capital. The example of these countries is South Korea, Malaysia, Thailand and Singapore. Through skill labor and advanced technology, they transformed their poverty into richness and capture global market through raising the productivity of labor. In two studies of World Bank (1995b and 1995a), strong arguments in the support of human capital formation was presented. By examining 193 countries, it came to know that atleast 2/3 rd of the total wealth of the world consist of human capital and social capital. Social capital advocates to establish better institutions, sound infrastructure and good governance in a country which mainly depends on the quality of education and skill development. It is estimated that in advance countries, for example in Japan, the total proportion of human and social capital in national wealth is 85 percent. While physical capital and natural capital contribute only 14 percent and one percent share in national product respectively. In Japan, there 32
is deficiency of natural resources, but they compensated this deficiency by building up their human resource.
3.4 Approaches to Investment in Human Capital Different theories are presented which shows the concept of productivity of investment in human capital. For human capital formation, all the expenditures to promote technical and vocational education are called investment, while all the expenditures on general education are considered consumption. But this point of difference is not easily drawn. For this purpose, we should compare education to all other productive investment. We should know that how much amount we are spending on education and how much amount we are getting from it. So, this is a case of calculating the returns of education. To calculate these returns, various approaches are used and some of them are: a) The criterion of rate of return b) Contribution of education in GNP criterion c) The residual factor criterion d) Cost benefit approach (CBA) criterion e) Cob Douglas production function
3.5 The Origins of Human Capital Theory Human beings have historically been recognized as a key factor in the creation of wealth of nations. Classical and neo-classical schools have considered people as an important factor from the point of view of their physical capacities to perform particular tasks. In several classical and neoclassical approaches people are being counted merely in quantitative terms. Human beings are analytically treated in such theories as homogeneous stock of capital where every unit of labor is considered identical to any other unit of any industry, sector or region. Thus the productive capacities of human beings are considered as being indistinct. On the other hand, several economists have studied the humans’ contribution to wealth creation from a wider perspective and without neglecting their role in pure quantitative terms. They have 33
stressed on their qualitative nature. This line of thought has basically assumed that the skills, education, knowledge and inner capacities represent important human aspects. This approach also holds the view that humans rather than being treated as ‘homogeneous’ should be regarded as being heterogeneous. Human capital theory claims that the diversity and different levels of knowledge and skills enclosed in human beings does make of a potential source for economic growth and wealth creation. Initially economists’ idea on human beings treated as capital is the desire to draw attention to the protection of human life and the desire to know the potential impact of educational investment on earnings and their distribution. For example, it was William Petty who first time made a serious effort to measure the social value of a person. He was the first economist who used the term ‘capital’ for people. William Patty (1662) stressed on the monetary estimation of human capital and on the economic effects of migration. He stated that expenditures to move people and to save lives would be considered financially wise investment. It was Adam Smith (1776) who first established an idea that person’s skills, abilities and knowledge are known as important qualities of people when considering their economic activities. His major contribution to human capital theory was the recognition of the economic value of education in the acquisition of personal knowledge and skill formation. Smith’s analysis advanced the idea that knowledge embodied in common workmen was a important source for innovation and technological change. He was the first person who proposed that human knowledge and skills were closely intermix with Innovation, technological change and economic performance. Although Smith did not generally make use of the term ‘capital’ to refer human beings. He included the skills and the useful abilities of human beings in the list of ‘fixed capital’. According to him, human skills should be treated as machines that have a genuine cost and return profits. He may be viewed as the first economist who draws attention to the idea of the tacit character of knowledge and he also differentiates between technological knowledge and scientific Knowledge.
34
The German economist Fried List (1841) also contributed to the foundation of human capital theory. He emphasized the important idea that skills and other human abilities were largely an inheritance from past to present generations and that they were the result of past labor and selfretraining. Marshall said that an estimation of the capital value of a person might be useful but disregarded the notion of human capital as unrealistic because human beings are not marketable. So, in spite of the worthy attempts of classical economists, no reliable theory on human capital had been presented before the 1960s.
3.5.1 Human Beings as Capital The difficulty in considering human beings as capital develops not from their quantitative but from their qualitative aspect. Now the problem is that whether knowledge and skills should be recognized as a type of capital. The solution to this puzzle should not be too difficult. If knowledge and skills acquired by people are considered as capital, then they show the same properties as shown for physical capital. To throw some light on this problem, a review of the meaning of the term ‘capital’ is carried out to identify its nature. a) Man made means of production like capital goods considered to be used in the production process for example buildings, machinery, vehicles and supplementary goods (Oxford dictionary of Economics). b) One of the important characteristic of capital is that it corresponds to a portion of wealth devoted to the production of more wealth (Robertson, 1918).
c) The stock of capital in the form of means of production can be accumulated over time by investment in it. So doing this, the amount of means of production increases and improves their quality as a function of rate of investment (Robertson, 1918). d) The ‘capital’ is generally subject to processes of depreciation so that the means of production undergoes a process of devaluation whether they are used in the production process or not (Marx, 1872). 35
3.5.2 Knowledge Creation and Human Capital Formation Although it is considered that human capital is knowledge and a distinction between creation of knowledge and formation of human capital. Knowledge creation is a process happening inside a human mind and by this process the individual who is generating new knowledge and skills, increases his personal knowledge, skills and abilities. By this act or process, the human capital stock in the society also increases. It is said that knowledge creation would increase the formation of human capital but this formation would not be improved without generating new knowledge and skills. This is possible by allocating the knowledge and skills that are already exist in a particular society to an extended number of people. Some kinds of information and skill might be utterly new for a particular individual, but not for the society as a whole. Thus, by acquiring knowledge and skills, societies with larger population increase the process of human capital formation without necessarily enlarging their stock of new knowledge.
3.5.3 Human Capital as Knowledge Scholars from different fields have presented many definitions of what they understand by ‘human capital’ but they do not vary significantly in this respect. They assert on one or other aspect of human capital depending on their particular purposes. For example, some have stressed the role of human health while others have been paying attention to human skills and training. The main aspect of human capital is concern to the knowledge and skills embodied in people and enhanced by schooling, training, and experiences that are useful in the production of goods, services, and quality enhancement. Human capital is defined as the knowledge, skills, ideas and other aspects which individuals may acquire during their life time and use them to produce goods, services or production in market according to conditions. It has been generally recognized that knowledge and skills which are
36
qualitative properties of human beings are different in origin and applications. They also have important similarities and differences. Certainly skills embodied in human capital accumulation may be considered as a particular kind of knowledge that is commonly called’ know-how’.
3.6 Human Capital Formation for the Life-Cycle Framework One of the problems of human capital formation is to discover the factors which are playing their role in life cycle framework of human capital formation. For this reason, we can scrutinize the problem by making some critical decisions which are discussed below about the life-cycle framework of an individual. 3.6.1 Primary and Secondary Education Many studies suggest that there is positive impact of education on growth. Topel (1998) collected data about the output of worker and educational level for 111 countries for the period of 30 years. The results indicated that a one year increase in year of education increases output of worker by 15 percentage points. It is evidence in Pakistan that cities which have higher literacy ratio have also higher rate of growth. It is also found that the parent’s year of schooling especially the mother’s year of schooling has a significant importance on child’s year of schooling. 3.6.2 Higher Education and/or Vocational Training
Higher education and vocational training both donate in overall economic growth. A preliminary examination of recent European Union statistics measuring GNP, employment, unemployment and different educational and vocational training investments recommended that economic growth across the member countries is connected with increases in both higher education and vocational training programs.
37
Technological transformation of production may involve transformation of knowledge and skills. Improvement in technology leads to less labor per unit of production but more educated and skilled labor. Therefore, the production effect of technological transformation comes from an increase in factor productivity and skills ( Prakash, 1977). Rise in productivity induced by technological and knowledge up-gradation of the production base is both labor displacing and labor reinforcing. It raises the productive capacity of labor per unit of time and finally reduces employment per unit of output. 3.6.3 On-the-job Training On-the-job training is significant for enhancement of efficiency of worker because it creates that type of abilities that are not attained by normal education or technical education. The literature relating to on-the-job training has primarily focused on the relationship between investment in on-the-job training and its returns. It is noted that the individual workers who are receiving onthe-job training have always been found to earn higher wages (Mincer,1962) .
3.6.4 Retirement One thing present in literature of human capital is that it ignores the issue of retirement. Some economists have believed that retired people have a specific type of capital which can also be called as ‘tangible capital’. The retired people have extra need to take part in complicated markets like pensions and facilities about medical. To finance training for these people to learn about above issues is very difficult task for this group of people. Heckman (1976) in his study says that the age of retirement is an endogenous variable. He says that an employee does work till his retirement. When technology becomes old, then worker depreciates in his human capital. The lower level of human capital has then lower life-time
38
income. He also says that there is trade off between higher quality of life and a long period of retirement.
3.7 Models of Economic Growth There are so many growth models which describe the process of economic growth and various other factors. Some of these models are defined here.
3.7.1 Harrod-Domar Model of Economic Growth An economist of Cambridge University named ‘Harrod’ formulated the long-run growth model in 1939. Another economist named ‘Domar’ of MIT also contributed in this model in 1946. With respect to work of both these economists, the model is known as ‘Harrod-Domar Model’. This model describes the rate of growth in the form of productivity of capital and saving. This model of economic growth has following main assumptions: a) Production of economy is a function of stock of capital in economy. b) We assume that there is constant return to scale. c) We assume that average and propensities to save also remain same. d) Change in capital stock is measured by the difference of total investment and total depreciation in economy. e) The product of the saving rate and total output equals to savings which equals to investment. According to above assumptions, the Harrod-Domar model concludes that if we increase the marginal physical product of capital (MPPK) or reduce the rate of depreciation then economic growth will be increased. So, in this way, this model suggests the method through which we can obtain the full employment level in the economy without any inflation or deflation. There are three concepts about the economic growth in this model: natural rate of growth, actual rate of growth and warranted rate of growth. Warranted rate of growth is that rate of growth which could maintain the full employment level in the economy without any inflation or deflation. If we add the labor growth rate and labor productivity, then we obtain natural rate of growth. The growth rate which is prevailing in the economy in some specific period is called actual rate of growth. According to Harrod-Domar 39
model, if we want to achieve the equilibrium level of full employment, then all above three growth rates should be equal to each other. Although, Harrod-Domar model has significant importance in economic theory but it has also some drawbacks. This theory says that if the warranted rate of growth is different from the actual rate of growth, then there would be unemployment, which is unrealistic in practical point of view. Another shortcoming in this model is that, it assumes that the capital-labor ratio in the economy remains constant. It means that there is no substitution i.e. relative price of capital and labor remains constant. This assumption is not applicable in underdeveloped countries where labor is in surplus and hence cheap in price.
3.7.2 Solow Swan Model of Economic Growth Robert Solow from MIT in his article presented a growth model in 1956, which was latter interpreted by T.W Swan in 1987 by using the data on U.S economic growth. Solow-Swan model is infact an extension to Harrod-Domar model and it helped to generate the growth process by removing the shortcomings of Harrod-Domar model of economic growth. Solow made the following changes in the Harrod-Domar model to present his own model: He added labor as a factor of production in his model. The ratios of capital output and capital labor were assumed constant in Harrod-Domar model. Solow assumes that technical coefficients can be changed in both labor intensive and capital intensive sectors. It was assumed that diminishing returns are applied in both factors of production. But in combined form there are applied constant returns to scales.
Fig 3.1………Graphical Representation of the Model
40
Sollow model starts with the production function Y/L = F (K/L), rearranged as y = f (k). From the production function, the output per worker is considered as a function of capital per worker. The production function assumes that there is diminishing returns to scale as denoted by the slope of the production function. n = Population growth rate d = Depreciation k = Capital per worker y = Output per worker L= Labor force S= Saving rate Changes in the capital per worker are determined by three variables: a) Investment per worker b) Population growth c) Depreciation in capital stock
41
In figure 3.1, we see that when the savings rate sy > (n + d) k is greater than both the population growth rate and the depreciation rate, then capital (k) per worker is increasing. This is known as ‘capital deepening’. While where capital is increasing at a rate only enough to meet the increase in population and depreciation it is known as ‘capital widening’. The two curves intersect each other at point A, which is called ‘steady state’ point. Here output per worker remains constant. But total output is growing at the rate of population growth (n). The optimal savings rate is called as ‘golden rule’. In Cobb-Douglas production function the ‘golden rule’ is denoted by ‘Alpha’. Left of point A, at point k1, the saving per worker is more than the amount required to maintain a steady state level of capital, so capital per worker is increasing. Due to capital deepening from y1 to y0 output per worker increasing. Right of point A where sy < (n + d) k, point k2, capital per worker is falling, as investment is not sufficient to meet population growth and depreciation. So, output per worker is falling from y2 to y0.
3.7.3 Endogenous Growth Theory Endogenous growth theory states that economic growth is caused by the result of endogenous and not external factor. In this theory, investment in human capital, knowledge and research and development are significant contributors to economic growth. The theory also stresses on positive
externalities and spillover effects of knowledge based economy which will lead to economic development. The endogenous growth theory also describes that policy measures have significant impact on long-run growth rate of an economy. For instance, subsidies on research or education enhance the growth rate by increasing the incentive to innovation. This theory argues that economic growth can be achieved from within a system as a direct result of internal process. Further more, theory notes that the enhancement of human capital will lead to economic growth by means of the development of new technology and efficient and effective means of production. The above view contrasts with new classical economists who assert that technological improvements and other external factors are the main source of economic development. Proponents of endogenous growth theory claim that the productivity and economies of today's 42
industrialized countries compared to the same countries in before the industrialized period are evidence that growth was created and continued from within the country and not through trade.
3.7.4 Lucas’ Human Capital Model Robert Lucas presented a special growth model in 1988 by introducing the term ‘human capital’ in production function. According to this model, all the inputs could be accumulated over time and there exist constant returns to scales in these inputs. He also said that process of growth can be generated by investing in human capital. Lucas used the production function Y= A K α (UHL)
1-α
in his model. Here ‘Y’ refers to Production, ‘A’ refers to constant co-efficiency
parameter, ‘K’ denotes to capital, ‘U’ defines the Proportion of total labor time spent working, H and L are stock of human capital and labor respectively. The production function shows that there is constant returns in K and uh. Lucas model is called the two sector model of economic growth. Human capital is used in this model as a mean to produce new human capital. To include human capital in Lucas model may lead to the steady state equilibrium in the economy. The increasing returns to the production process of human capital are the engine for long run growth in this model.
3.8 Conclusion Economists while presenting their theories reach a variety of conclusions about the relationship between human capital formation and economic growth. Theories are useful as they account for some observed evidences. In above discussion we explain the concept, scope and significance of human capital formation. We also discuss different theories regarding human capital and growth. All the above presented theories describe the growth process in the economy as well as the involvement of human capital in the process of growth and development.
Chapter 4
Human Capital Formation: A Review 43
4.1 Introduction Many studies have been carried out to observe the relationship between human capital and economic growth in different countries. These studies suggest that human capital formation deals with such capabilities like literacy, skill development, health facilities and experience. Furthermore, it is said that the share of human capital in economic growth is greater than the amount of physical capital. Economists believe that skill development of labor force can suck up the population growth and then it helps to enhance the development process. This chapter is organized as follows: section 4.1 is concerned about introduction of the chapter. Brief review of the research regarding general studies is carried out in section 4.2 while section 4.3 comprises studies on developing countries. Section 4.4 contains studies regarding developed countries. In section 4.5, there comes conclusion.
4.2 General Studies Tech (1988) attempted to use the theoretical work in the field of international trade to define the relationships among the value added per worker and technical progress. He showed that for a large country, capital accumulation raised the real value added per worker in industries. He analyzed the relationship between value added per worker and capital accumulation on one respect, and value added per worker and technical progress on the other. In his analysis, there was two tradable goods, one was capital intensive and the other was labor intensive. There are two factors of production i.e. K (capital) and L (labor). There was constant return to scale in the production of both goods. If the capital accumulation occurs in the economy then industry Y (capital intensive) expands while industry X (labor intensive) declines. It is noted that workers from the labor intensive industry will be shifted into capital intensive industry. According to the idea of 2×2×2 model, he indicated that because of the practice of human capital accumulation,the average per worker output increases. If the economy is large then there is presumption for the average output per worker in the labor-intensive industry will rise. With neutral technical progress occurring in the
44
L-intensive industry, the average output per worker in both the capital and labor intensive industries will rise.
Ashtoon et al.(2002) analyzed that human capital was helpul in growth process by encouraging the growth of some other factors especially investment in physical capital which is considered necessary for the country. It is considered that human capital has positive link with the physical capital growth. Improved skills help individuals to become more productive and spend more amount of money for capacity building. It raises the employment level and also increases rate of return on investment. It also helps to start various developments Bosworth and Collins (2003) used growth accounting approach for analysing cross-country differences in economic growth. They argued that capital factors alone cannot define economic growth but it is the ‘A’ in Cobb-Douglas production function Yf = Atf (Kt, Lt) which is helpful for economic growth. There are a lot of studies which define the link between level of education and common growth. Attainment of better and higher education enhances economic growth and improves the productivity of workers. It is believed that if the workforce is educated then it can implem,ent new technologies in a better way. Rodrik (2003) argued that enhancing economic growth and maintaining it are two different things. He said that that for starting the process of growth, we need only small reforms but if we want to maintain or sustain the growth, then we need continuous institutional reforms which can maintain productive dynamism. He believes that there are few principals that may help in for strong growth i.e security of property rights, competition in market and low inflation. These principals can be converted into some policy packages which further translated into institutional designs.
4.3 Studies on Developing Countries
45
Bjorkman(1986) examined the health sector regarding health policies and situation of health facilities in Pakistan. He said that health care has become a major component of the economy. The advanced countries of the world consume reasonable proportions (6-12 percent) of their gross national product on health services. In developing countries, health care estimated to consume two percent or less of GNP. Health services use resources including imports and highly educated manpower which might alternatively be used in other sectors of development. In terms of health service research, a health service is an activity whose basic objective is health, its maintenance and its improvement, and in case of lose of health; its recovery. The scope of benefits such as physician services in hospitals, drugs, and dental care are different in different countries. Water polluted by human and animal waste is supposed to contribute at least 30 percent of all reported diseases in Pakistan. In 1978, about 61 percent of the urban population had access to safe drinking water while 35 percent had sewerage and drainage facilities. In rural areas, only 14 percent of the population had access to portable water while sanitation facilities were nearly non existent. In Pakistan there are two medical colleges in 1947 .A separate medical college for women was started in 1948 at Lahore. Later on, between 1970 and 1981, medical education expanded in Pakistan and the number of medical colleges increased from 6 to 16 while the output of doctors went up from 805 to 3552 per annum. GDP of Pakistan increased 2.5 times in terms of factor cost during the period of 1960 to 1971, while public health expenditures rose 3.2 times in the same period. Compared to the base-year of 1961, the GDP increased 9.5 times in 1978 and doubled to 18.2 times by 1982. During the same years, public health expenditures increased 18.8 times and 43.8 times respectively. That behavior of health expenditures indicated a steady increase in relative resources. The rate of growth in health expenditures steadily outpaced the growth in GDP. During 1960 to 1978, the later increased at the rate of 9.2 percent per year while the former increased 23.8 percent per year. Sabot (1989) worked on the project of human capital formation in post-green revolution in rural areas of Pakistan’. It was designed to assess the determinants and results of human capital accumulation in rural areas of Pakistan. Growth in the supply of educated workers has exposed demand in urban areas at the same time that new opportunities for the educated persons are 46
emerging in post-green revolution in rural areas. The net result is significant increase in the educational attainment of rural populations and a shift toward rural areas the benefits of human capital accumulation. He said that human capital accumulation also has the potential of raising the probability of escape from poverty and provide better opportunities for those who born into low income families. He estimated a human capital wage function with the help of OLS method. He included measures of reasoning ability and cognitive skills and the usual variables measuring the employment experience and the education level of the employee. The log of monthly wages was used as a dependent variable. The results have shown that the variable ‘experience’ is significant and positive while its square is significant and negative. The variable ‘cognitive skills’ was positive and significant. The production functions included a gender variable. Males performed significantly better on the math exam than females with the same level of ability and qualification. Females performed significantly better in the reading exam. The education of father has a significant and positive impact on the achievement of cognitive skills by sons. It has no clear influence on the cognitive skills and acquisition process of daughters.
Barkley (1991) studied the determinants of inter-district labor migration in Pakistan using data of Population Censuses of 1972 and 1981. He computed district in-migration rates and also estimated regression analysis to identify the major determinants of inter-district migration during 1971-1980. He found a significant positive correlation between district in-migration rates and urbanization, higher levels of years of education, developed infrastructure and roads, and the percentage of previous migrants in a district’s population. He estimated the result that interdistrict migration appeared to be the outcome of a rational decision making process for better economic prospects. Birdsall et al. (1993) estimated the costs of Pakistan in terms of income growth foregone over the last three decades in Pakistan of relatively low investments in education. They used an econometric analysis of the relationship between years of schooling and economic growth in different countries to compare Pakistan’s actual rate of growth. In 1965, and again in 1987, Pakistan’s primary enrolment rate was much below the level predicted for countries at the 47
Pakistan level of income while the enrolment rates for Korea, Indonesia, Philippine and Malaysia are near above the predicted level. Pakistan’s relative performance at the primary and the secondary level was similar as at both levels enrollment rates were much below the rates achieved by Indonesia, Korea, Philippine and Malaysia. The share of public expenditure dedicated to primary and secondary education was 92 percent in Indonesia, 89 percent in Korea and 83 percent in Malaysia in 1986. In Pakistan the share of public expenditures allocated to primary education in the same year was 73 percent. Malaysia’s primary enrollment ratio (.92) was 47 percentage points higher than Pakistan’s (.44). From pooled cross section equation, it was exposed that the combined effect of these increase on annual growth in per capita GDP between 1980 and 1985 was 2.08 percentage points. Much of the difference between Pakistan and East Asia countries in enrollment ratio is due to the gender gaps in enrollments in Pakistan. In 1960, Pakistan’s enrolment ratio of females at primary school level was 33 percent of the male enrolment ratio. The result was estimated by equating primary enrollment ratios for girls in 1960 to the enrollment ratios for boys. This simulation raised primary enrollments from 30 to 44 percent and secondary enrollments from 11 to 18 percent. When these changes in enrollment rates applied to the coefficients they indicate an increase in the annual growth rate of 0.61 percentage points in analysis. Pritchet (1996) showed that the growth of educational capital per worker has had a negative or no impact on the growth of under developed economies. He presented three reasons for this contradiction: 1st Due to its quality, schooling doesnot actually raise cognitive schools or productivity. 2nd expanding the supply of education in the presence of inactive demand for educated labor causes the economic return to education to decrease rapidly. 3rd Due to the institutional and structural set up in these countries. The improved cognitive skills acquired through education engage in privately profitable but socially wasteful activities so that aggregate output stagnates or even decrease. Mustafa et al (2005) explored the role of vocational education and skills development programmes in human capital formation.They argued that training and skills development were 48
fundamental part of human capital formation. Individuals with better skills can become more productive. They reviewed the status of vocational training and its impact on human capital formation in Pakistan. The main source of data for analysis was obtained from different issues of labor force survey. Government policies and plans related to vocational training were also analyzed and reviewed from Medium Term Development Framework (MTDF) 2005-10. The effect of the rate and changeability of increase in institutions, education enrolment and teachers on output growth was indicated. They checked the output growth variability and it was regressed by using appropriate lags and Ordinary Least Square (OLS) method. The Labor Market Survey [ADB (2005)] revealed that 58 percent enterprises affirm that the passouts of vocational education after employment needed 3-6 months on-the-job training specific to the plant for improving general skill proficiency. Growth rates of vocational institutions and GDP is presented which shows that impact of vocational indicators emerges from 3 rd to 10th lags. They suggested that effective planning is required to attain the results and benefits of economic policies. It is also estimated that enrolment rate has also played a important role in determining the output growth variability at the 10th and 4th lags, respectively. Faridi et al.(2010) estimated the effect of education level on level of employment. They collected primary data from Bahawalpur district of Pakistan. They made a comprehensive statistical analysis of the workers and applied econometrical technique by using logit model. Their operational model consists of different variables i.e. years of education, enrolment, health status, household assets and marital status. Logit estimates found that experience of worker has significant and positive impact on level odf education. Opportunities of employment and level of education both were positively correlated. Furthermore, the health of worker has also positive and significant impact on employment. Bils and Klenow (2000) said that countries which have high enrollment rate in schools can made more growth in per capita income. High enrolment rate in education causes speedy improvements in level of productivity. According to education statistics of 2009, the literacy rate was more in urban areas than rural areas. Moreover, literacy rate in men was more than women. The model that is used in this study is based on production function. The data used in this study 49
is taken from different sources including the 1State Bank of Pakistan and Economic Survey of Pakistan. The variables used in this study include GDP, fixed capital formation, government spendings on education and labor force participation rate. Natural log has been taken for all variables of the study. To solve the problem of stationerity, the ADF test has been used. In order to determine the long run relationship between variables, Johansen cointegration test has been employed. The ADF test is applied at level as well as first difference. The outcome of ADF indicated that not all the variables were stationery at level form but at first difference all the variables became stationery. To determine the long run relationship between the GDP growth and all variables Johansen cointegration test is used. The test indicated that the model possess a long run relationship among variables. The results also show the presence of error correction model. The error correction equation indicated correct negative sign for GDP and labor force participation shows that it was highly significant. Gross fixed capital formation indicated insignificant and education expenditure indicated no short run impact. The results have confirmed that education has a long run and significant relationship with growth. They suggested that progress in education standards will enhance the productivity and also effect the growth in the long run.
4.4 Studies on Developed Countries Abosetegne (2000) observed that the main causes of unemployment for tertiary level graduates were actually the absence of association between higher education and the labor market. This was also due to non-existence of any policy of employment for graduates and language barriers. There was also a serious difference between what the educational institutions and schools are producing and what the employers need. He found that the major factors that resolve the opportunity of employment of the graduates from vocational schools were connections between schools and companies which were found to be weakly developed especially in the government schools or institutions. 50
4.5 Conclusion This chapter relates with review of literature on the subject. It highlights as how human capital formation is significant for the economic growth. Different studies on the topic have been reviewed. This review of literature is divided into three categories: a) General studies, b) Studies for developed countries and c) Studies for under developing countries.
Chapter 5 Data and Methodology 5.1 Introduction A satisfactory source of the data and building of variables are necessary for empirical analysis and for the validity of the research. Data and methodological issues have great importance in economic research. The present chapter is related to the data and methodology which define the relationship between human capital formation and economic growth and arranged as follows. Section 5.2 is consisted of outlines of data sources and section 5.3 is reserved for definitions of important variables used in the analysis. Section 5.4 and 5.5 are reserved for methodology and model specification respectively. Section5.6 comprises the conclusion of this chapter.
5.2 Sources of Data This study is based on the secondary sources of data. The data is collected for the period of 1973 to 2010.The data for this study are obtained from Pakistan Economic Survey (of various years), Ministry of Finance Pakistan, ‘Fifty Year Economy of Pakistan’ by State Bank of Pakistan and World Bank Quick Query selected from World Development Indicators.
5.3 Definitions of Variables 51
This section is reserved to focus on the attempted variables in our analysis of human capital formation. These variables have been selected keeping in view their relative importance on theoretical and empirical ground. It is also necessary to include the variables which determine the relationship between human capital formation and economic growth in Pakistan. The choice of variables is consistent with the choice made by some other researchers (Mankiw 1992, Romer 1990, Barro and Lee 2000 ). The Explanation of attempted variables and their hypothetical impact are described as follows:
Table 5.1
Variables GDP EEI HCR GFCF IMR GINI IGR INF
Explanation
Gross Domestic Product Education Enrollment Index Head Count Ratio Gross Fixed Capital Formation Infant Mortality Rate Gini Coefficient Investment Growth Rate Inflation Rate (CPI Index)
5.3.1 Gross Domestic Product Economic growth of a country is determined by increase in the size of the economy of a nation. A wide indicator to show the size of an economy is its output. Commonly, various economists measure economic output of a country through its Gross Domestic Product (GDP). Technical improvements and positive external forces usually bring about economic growth in economy. It can be achieved by adding more raw inputs, trained labor and machines, or by improving the physical and human capital of the country. We have taken Gross Domestic Product as a dependent variable in our study.
52
5.3.2 Education Enrollment Index The human capital proxy that we use in our study is ‘school enrollment ratio’. It measures the number of students enrolled at a specific grade level. Barro and Lee (2000) and Mankiw (1992) have also used this proxy in their study. In this study the method used by Barro and Lee (2000) for generation of human capital has been used and we have used ‘Education Enrolment Index (EEI)’ as a proxy for Human Capital. EEI = (5EDt + 8EDt + 10EDt + 16EDt) / Population
Where: EEI = Education Enrolment Index 5EDt = Enrolment of primary education 8EDt = Enrolment of middle education 10EDt = Enrollment of secondary education 16EDt = Enrolment of higher secondary education
5.3.3 Head Count Ratio The headcount ratio is the proportion of the population whose incomes are below the official threshold set by the government. Changes in the poverty headcount of any country can be described to one of the three factors: per capita economic growth, changes in the share of domestic product (GDP), and distribution of consumption among individuals within the country. Head count ratio is an important determinant of human capital formation. Poverty level of people has a strong impact on human capital formation and further on an economic growth.
5.3.4 Gross Fixed Capital Formation Gross Fixed Capital Formation calculates the value of acquisitions of new or existing fixed assets by the governments and households in the economy. Fluctuations in this indicator are considered to indicate something about future business activities and the outline of economic development. The relationship between human capital and economic growth has been a primary matter for 53
growth economists in recent years. There is also a significant relationship between the rate of growth of gross fixed capital formation and the rate of growth of GDP. In Harrod-Domar model, the growth rate of income will positively related to saving ratio and capital formation. So, we can say that the more a country is able to save and invest out of given national income, the greater will be the growth of that national income.
5.3.5 Infant Mortality Rate The infant mortality rate is calculated by estimating total number of children dying under a year of age divided by the total number of children born in that year. One of the health indicator ‘the infant mortality rate’ is also called the ‘infant death rate’ is an important measure for estimate the welfare of infants, children and pregnant females .It is connected with different factors such as health of mother, access to medical facilities and socioeconomic conditions in a country. The two-way causality exists between income level and health status, is expected to have status of the population considering the level of growth of the country’s gross domestic product. It is said that health is influenced by income level and on the other hand health status influences the level of income. It discovered that health variables influence per capita GDP positively while per capita GDP, in turn, impacts health variables (e.g. IMR) positively.
5.3.6 Gini Coefficient The Gini coefficient shows the income inequality and its value ranges from 0 to 1. In some times it is also expressed as a percentage which ranges from 0 to 100. A low value of Gini coefficient indicates a more equal income distribution while high value shows unequal distribution. Zero (0) value shows complete equality while value of 1 shows complete inequality in income distribution. Gini coefficient allows us to make comparison of income distributions across different groups as well as countries. Inequality of income has also a significant impact on human capital formation. Inequality in income is positively correlated with the schooling inequality and it is negatively correlated with the level of schooling. It also shows that higher level of schooling reduces the inequality of income.
54
5.3.7 Investment Growth Rate Growth models of neoclassical economists stress on investment and population growth in the regression analysis. An increase in investment along with a reduction in growth rate of population will promote economic growth. This theory promotes capital accumulation as the engine of economic growth. The investment growth is limited by the availability of resources and it is in this sense that capital scarcity plays an important role in the determination of economic growth. It is assumed that the variations in the available technology smooth the progress of growth process. So the focus should be to allow the inputs in demand to flow into different sectors of the economy. Return on capital determines investments. In this study we include investment growth rate (as percentage of GDP) in our analysis.
5.3.8 CPI Inflation Rate Inflation in Pakistan has been estimated as annual percentage change of average consumer price index. CPI inflation which is an independent variable of our study, has many advantages of using it in the model rather than other inflation rates. Some economists recommended to use CPI inflation in the model due to the reason that it reduces the probability of negative correlation between inflation and growth rates (Sarel, 1996). Another advantage of using it in the model is that, CPI indices are independent of output volume, so its use in the model prevents correlation problems to occur in the model. Investment in human capital is a significant factor that contributes to long run economic growth. Many models of growth and inflation have taken human capital in the form of an endogenous variable. These models of growth show neutral or negative impact of inflation on investment in human capital. In our analysis in next chapter we show that inflation has negative effect on GDP. Table 5.2 List of Attempted Explanatory Variables with their Expected Results
Variable Description Education Enrollment Index (EEI) Head Count Ratio (HCR) Gross Fixed Capital Formation (GFCF) Infant Mortality Rate (IMR) Gini Coefficient (GINI)
Expected Sign
+ + + 55
Investment Growth Rate (IGR) CPI Inflation Rate (INF)
+ -
5.4 Methodology To examine the relationship between human capital formation and economic growth, the above specified model has been analyzed by employing the method of Ordinary Least Squares (OLS). GDP is dependent variable while EEI, HCR, GFCF, IMR, GINI, IGR, INF are independent variables of our model. Regression errors in equations of these models will be tested for autocorrelation with the help of Durban Watson (DW) test statistic.
5.4.1 Granger Causality Test In economics, causality is an important issue in econometric techniques. It considers to the ability of one variable to predict the other. Granger Causality Test is used to check that if Y is caused by X then whether Y is caused by the past values of X i.e. whether the lagged value of X can improve the explanation of Y. Granger Causality Test is used to check the two way causation of variables that is, whether X causes Y or/and Y causes X. Y is said to be Granger Caused by X if the coefficient on lagged X is statistically significant and vice versa.
5.5 Model Specification In the specified model, the GDP is a dependent variable while EEI, HCR, GFCF, IMR, GINI, IGR and INF are independent variables. Following Mankiw, Romer and Weil (1992), our econometric model of the selected variables used in this study is given as follows:
LGDP = β0 + β1(LEEI) + β2(HCR) + β3(LGFCF) + β4(LIMR) + β5(GINI) + β6(IGR) + β7(INF) + ε Where LGDP LEEI
= =
Log of Gross Domestic Product Log of Education Enrollment Index 56
HCR LGFC LIMR GINI IGR INF
= = = = = = =
Head Count Ratio Log of Gross Fixed Capital Formation Log of Infant Mortality Rate Gini Coefficient Investment Growth Rate CPI Inflation Error Term
5.6 Conclusion The core purpose of this chapter is to make the viewer familiar with the all used concepts, related data, model specification and methods of this study. The definitions of all the attempted variables and their supposed results are also included so that it makes the reader clear about the further supposed results. Furthermore, elementary data analysis, correlation matrix and empirical analysis of specified model will be explained in next chapter.
Chapter 6
Human Capital Formation and Economic Growth: An Analysis
6.1 Introduction
Econometric analysis is helpful in understanding the relationship among different variables. It also shows the impact of the variables on dependent variable. In this chapter, we will estimate the relationship between human capital formation and economic growth by using econometric techniques. Section 6.1 is an introductory section. Explanation of the descriptive analysis and correlation matrix of variables of the model is addressed in section 6.2. Econometric analysis of the specified model is presented in section 6.3. Last section comprises the conclusion.
6.2 Elementary Data Analysis
57
Elementary data analysis performs an important role in the understanding of the study. It helps the researcher and the viewer to prepare their minds for further explanation of the econometric analysis of the specified model.
6.2.1 Descriptive Analysis Descriptive statistics is the discipline of describing the main quantitative features of a collection of data. They give uncomplicated and simple summaries about the data and the measures. It is used for quantitative analysis of data. Descriptive statistics of the variables of our model is given in following table.
Mean Median Maximum Minimum Std. Dev. Skewness Kurtosis
Table 6.1 Descriptive Statistics of the Variables LGFC LGDP LEEI HCR LIMR F 13.81 -2.12 26.26 12.04 4.53 13.80 -2.04 24.79 12.21 4.58 16.44 -1.83 39.49 14.65 4.84 11.03 -2.41 17.32 8.94 4.22 1.54 0.22 5.37 1.64 0.15 -0.02 -0.10 0.76 -0.14 -0.28 1.87 1.42 2.80 2.00 2.15
GINI
IGR
INF
18.31 18.52 22.52 12.93 1.96 -0.42 4.34
18.17 18.50 22.50 12.80 2.13 -0.44 3.57
9.04 9.60 14.10 3.10 2.95 -0.40 2.21
Jarque-Bera Probability
2.01 0.37
4.03 0.13
3.70 0.16
1.72 0.42
1.63 0.44
3.96 0.14
1.72 0.42
1.97 0.37
Observations
38.00
38.00
38.00
38.00
38.00
38.00
38.00
38.00
All the estimations are carried out by E-views 3.1 (Quantitative Micro Software)
58
In Table 6.1 a detailed descriptive analysis is explained. Our data consists of thirty eight years of annual observation from 1973 to 2010. The descriptive statistics exhibits that the average of gross domestic product is 13.81 with standard deviation of 1.54. The average education enrollment index is -2.17 with standard deviation of .22. The average for head count ratio is 26.26 with the standard deviation of 5.37. The average for gross domestic fixed capital formation is 12.04 with standard deviation of 1.64. The average for infant mortality rate is 4.53 with standard deviation of 0.15. The average for coefficient index is 18.31 with standard deviation of1.96. The average investment growth rate is 18.17 with standard deviation of 2.13. The average for inflation is 9.04 with the standard deviation of 2.95. The skewness is measure of the lack of symmetry in the data. Education enrollment index and gross fixed capital formation are little skewed as compared to the rest of the variables.
Kurtosis describes the shape of a probability distribution. It shows that whether the data are peaked or flat relative to a normal distribution, therefore it is often said to be the measure of ‘peakedness’ of the probability distribution of a real-valued random variable. Kurtosis statistic of the variables shows that education enrollment index and gross fixed capital formation are platykurtic (flat or short tailed ) and all other variables are relatively leptokurtic (long-tailed or higher peak).
6.2.2 Correlation Matrix of the Specified Model Correlation coefficient shows the degree of linear relationship between two variables. A Correlation Matix is a table which shows all possible correlation coefficients between a set of variables. Correlation matrix of the variables of our model is given in following table.
Table 6.2 Correlation Matrix of the Variables LGDP
LEEI
HCR
LGFC
LIMR
GINI
IGR
INF 59
F LGDP LEEI HCR LGFC F LIMR GINI IGR INF
1.00 0.93 -0.46
1.00 -0.29
1.00
0.97
0.91
-0.42
1.00
-0.79 0.40 0.22 -0.26
-0.79 0.31 0.15 -0.25
-0.02 -0.67 -0.62 0.07
-0.77 0.43 0.26 -0.19
1.00 -0.16 0.00 0.06
1.00 0.94 0.21
1.00 0.22
1.00
All the estimations are carried out by E-views 3.1 (Quantitative Micro Software)
The correlation matrix Table 6.2 explains the association and strength of relationship of GDP with some other desired variables. The diagonal row of ones is the correlation of each asset with itself. We can see in this matrix that the correlations between the variables range from moderately negatively correlated to moderately positively correlated. The results describe that there is strong positive correlation of LGDP with LEEI and LGFCF because the correlation coefficients of LEEI and LGFCF are 0.93 and 0.97 respectively. It indicates that any increase in LEEI and LGFCF will cause LGDP to increase and vice versa. There is weak positive association of LGDP with GINI and IGR as the correlation coefficients of these variables are 0.40 and 0.22 respectively. Above table also shows that there is weak negative correlation of LGDP with HCR and INF. It indicates that any increase in HCR and INF will cause LGDP to decrease and vice versa. The correlation between LGDP and LIMR is negatively strong as the value of correlation coefficient is -0.79 .This explains that both the variables are depending upon each other in a negative and strong way. It indicates that any increase in the infant mortality rate will cause gross domestic product to decrease and vice versa. There is weak negative association of LEEI with HCR and INF because the correlation coefficients of HCR and INF are -0.29 and -0.25 respectively. It indicates that any increase in HCR or INF will cause LEEI to decrease and vice versa. There is weak positive association of LEEI with GINI and IGR as the correlation coefficients of these variables are 0.31 and 0.15 respectively. It indicates that any increase in GINI or IGR will cause LEEI to increase and vice 60
versa. There is highly correlation between LEEI and LGFCF as the coefficient between these two variables is 0.91. This explains that both the variables are depending upon each other in a positive and strong way. There is relatively strong negative correlation between LEEI and LIMR. Association of HCR with LGFC and LIMR is negative and weak showing the value of -0.42 and -0.2 respectively. It indicates that any increase in LGFCF or LIMR will cause HCR to decrease and vice versa. There is strong negative association of HCR with GINI and IGR. There is weak positive association between HCR and CPI inflation (INF).This explains that both the variables are depending upon each other in a positive and less sensitive way. Any increase in CPI inflation has a positive impact on the head count ratio (HCR). In table 6.2 we see that there is strong negative correlation between LGFCF and LIMR as the value of correlation coefficient is -0.77. This explains that both the variables are depending upon each other in a negative and strong way. It indicates that any increase in the infant mortality rate will cause gross fixed capital formation to decrease and vice versa. Association of LGFCF with GINI and IGR is positive and weak showing the value of 0.43 and 0.26. It indicates that any increase in gini coefficient (GINI) or investment growth rate (IGR) will cause LGFCF to raise and vice versa. There is weak negative association between LGFCF and INF as the value of correlation is -0.19. There is weak negative association between LIMR and GINI. This explains that both the variables are depending upon each other in a negative and less sensitive way. Any increase in gini coefficient has an inverse impact on infant mortality rate. It is also noted from table 6.2 that there is zero interdependence between LIMR and IGR. Positive correlation coefficient between LIMR and INF is ignorable as this has value of 0.06, which shows very weak association between two variables. There is weak positive association between GINI and INF as the value of correlation coefficients of is 0.21. This explains that both the variables are depending upon each other in a positive and less sensitive way. Any increase in CPI inflation has an positive impact on the gini coefficient. There is highly correlation between GINI and IGR as the coefficient between these 61
two variables is 0.94. This explains that both the variables are depending upon each other in a positive and strong way. It also shows that there is weak positive association of IGR and INF. Any increase in CPI inflation (INF) will result in increase in investment growth rate (IGR).
6.3 Econometric Analysis of the Specified Model Econometric analysis is helpful in understanding the relationship among different variables. It also shows the impact of the variables on dependent variable. Econometric techniques are commonly used for this purpose and are equally considered efficient for such type of empirical analysis. Therefore, this section is especially reserved to analyze and examine the exact relationship of human capital formation and economic growth.
6.3.1 Estimation and Results The results of the estimated model are arranged in Table 6.3, which explains that our specified model performed very well in terms of F-statistic. The results describe that our model is highly significant. R2’ the coefficient of determination explains how much linear relationship has the dependent variable with independent variables. The value of R 2 is 0.98, which explains that 98 percent variations in the gross domestic product are explained by the concerned independent variables. The value of Durbin Watson (DW) statistic is 1.97 which indicates that there is no problem of autocorrelation in this model. Explaining the impact of regression coefficient, we first look at the coefficient of LEEI. It shows that there is a significant positive impact of education enrollment index on gross domestic product. It is significant at 1% level.
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Table 6.3 Parameter Estimates of Human Capital Formation Model (Dependent Variable is Log of Gross Domestic Product) Independent Variables Equation of the Model 24.852 Intercept (9.183)* 1.319 Log of Education Enrollment Index (LEEI) (3.230)* -0.0649 Head Count Ratio (HCR) (-6.559)* 0.453 Log of Gross Fixed Capital Formation (LGFCF) (7.192)* -2.477 Log of Infant Mortality Rate (LIMR) (-5.640)* 0.146 Gini Coefficient (GINI) (2.254)** -0.170 Investment Growth Rate (IGR) (-3.162)* CPI Inflation (INF) R-Squared
-0.039 0.98
63
Adjusted R-Squared
0.98
D W Statistic
1.97
Sample Size
38
Note: The t-Statistics (in Parenthesis) significant at 1% and 5% level are indicated by * and ** respectively. All the estimations are carried out by E-views 3.1 (Quantitative Micro Software).
This explains that increase in education enrollment index causes gross domestic product to increase. The estimated result indicates that about one percent increase in education enrollment index causes 1.32 percent increase in gross domestic product. The estimated statistic explains that there is negative and significant impact of Head Count Ratio on LGDP. This shows that about 1 percent change in head count ratio will bring about (100)0.06 = 6 percent change in LGDP in an inverse direction. Gross Fixed Capital Formation (LGFCF) describes positive and significant impact on LGDP. It is significant at 1 % level. Our results shows that about one percent increase in LGFCF is required to bring about 0.45 percent increase in LGDP. There is negative and significant impact of LIMR on LGDP. This shows that about one percent change in infant mortality rate will bring about 2.47 percentage points change in LGDP in inverse direction. GINI describes positive and significant impact on LGDP. It is significant at 5 % level. Results shows that about 1 percent increase in GINI will bring about (100)0.14 =14 percent increase in LGDP. There is negative and significant impact of investment growth rate on LGDP. This shows that about one percent change in investment growth rate will bring about (100)0.17 = 17 percent change in LGDP in inverse direction. There is negative and significant impact of CPI inflation on LGDP. This shows that about one percent change in CPI inflation will bring about (100)0.04 = 4 percent change in LGDP in inverse direction. Though the magnitude of impact is low but it is significant at 1% level.
6.3.2 Granger Causality Test The Granger causality test is used for determining whether one time series is useful in forecasting another or not. A time series X is said to be Granger-cause Y if it can be shown that lagged X values provide statistically significant information about future values of Y. Following table shows the results of Granger
64
Causality test. Opposite direction of causation is also an important issue in regression analysis.
The results of Granger Causality have been reported in below Table.
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Pairwise Granger Causality Tests Sample: 1973 2010 Lags: 1 Null Hypothesis: GINI does not Granger Cause LGDP LGDP does not Granger Cause GINI HCR does not Granger Cause LGDP LGDP does not Granger Cause HCR INF does not Granger Cause LGDP LGDP does not Granger Cause INF LEEI does not Granger Cause LGDP LGDP does not Granger Cause LEEI LGFCF does not Granger Cause LGDP LGDP does not Granger Cause LGFCF LIMR does not Granger Cause LGDP LGDP does not Granger Cause LIMR HCR does not Granger Cause GINI GINI does not Granger Cause HCR INF does not Granger Cause GINI GINI does not Granger Cause INF LEEI does not Granger Cause GINI GINI does not Granger Cause LEEI LGFCF does not Granger Cause GINI GINI does not Granger Cause LGFCF LIMR does not Granger Cause GINI GINI does not Granger Cause LIMR INF does not Granger Cause HCR HCR does not Granger Cause INF LEEI does not Granger Cause HCR HCR does not Granger Cause LEEI LGFCF does not Granger Cause HCR HCR does not Granger Cause LGFCF LIMR does not Granger Cause HCR HCR does not Granger Cause LIMR LEEI does not Granger Cause INF INF does not Granger Cause LEEI LGFCF does not Granger Cause INF INF does not Granger Cause LGFCF LIMR does not Granger Cause INF INF does not Granger Cause LIMR LGFCF does not Granger Cause LEEI LEEI does not Granger Cause LGFCF LIMR does not Granger Cause LEEI LEEI does not Granger Cause LIMR LIMR does not Granger Cause LGFCF LGFCF does not Granger Cause LIMR
Obs 38 38 38 38 38 38 38 38 38 38 38 38 38 38 38 38 38 38 38 38 38
F-Statistic Probability 1.33584 0.25583 0.01840 0.89289 1.95626 0.17097 0.24427 0.62432 1.83316 0.18469 0.32886 0.57011 2.10292 0.15618 3.05894 0.08932 0.43085 0.51599 30.2918 3.8E-06 2.90410 0.09748 2.69245 0.11004 0.84546 0.36432 0.25777 0.61493 0.07170 0.79049 2.26402 0.14164 0.01831 0.89315 0.98210 0.32868 0.01231 0.91229 0.04729 0.82914 0.10293 0.75030 0.00949 0.92297 1.29467 0.26314 0.85431 0.36185 1.42229 0.24128 2.34688 0.13479 0.08714 0.76963 0.20792 0.65130 1.35215 0.25300 0.35959 0.55271 0.29138 0.59286 2.17703 0.14929 0.43503 0.51398 0.17850 0.67533 0.32481 0.57248 0.10659 0.74606 2.29066 0.13940 7.33048 0.01053 0.23355 0.63200 11.0264 0.00215 2.27016 0.14112 3.31883 0.07730
All the estimations are carried out by Eviews 3.1
(Quantitative Micro Software).
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The results imply that education enrollment (proxy for human capital), health and physical capital are important to boost the economic growth in Pakistan. Human capital, fixed capital and employed labor force affects the GDP and results in unidirectional and non-unidirectional causality.
6.4 Conclusion In the light of above estimated model discussion, we can conclude that education enrollment index, gross fixed capital formation and Gini coefficient have positive and significant impact on gross domestic product. Head count ratio, infant mortality rate, CPI inflation and investment growth rate have negative and significant impact on gross domestic product. All independent variables are significant at 1% level except Gini coefficient which is significant at 5% level.
Chapter 7
Conclusion and Policy Recommendations
7.1 Conclusion The study has been an attempt to provide the empirical confirmation on the relationship between human capital formation and economic growth. This analysis is based on the annual data for the period from 1972-73 to 2009-10.The results of test indicated that there are long run relationship between economic growth, education enrollment, CPI inflation, investment growth, head count ratio and fixed capital formation. Education enrollment index (EEI) has significant and positive impact on economic growth which is according to the theory. It means increase in education enrollment stimulates economic growth. Head count ratio (HCR) which is used as a proxy for poverty, has negative relationship with economic growth. It indicates as poverty increases, the process of economic growth will slow down .Gini coefficient (GINI) and gross domestic fixed capital formation (GFCF) have positive and significant effect on economic growth. 67
Results show that investment growth rate (IGR) has negative impact on economic growth in Pakistan which is reverse to the theory. This is because of insufficient investment in Pakistan. The capital investment is low in Pakistan which reduces new capacity for the demand for goods. Low demand and output of goods further discourage investment in new machinery. So due to low investment, the IGR has negative effect on economic growth. Moreover, in Pakistan, mostly investment expenditures by government have carried out for non productive purposes. This is also a major reason for the negative impact of investment growth rate on economic growth. The relationships among variables are also shown by Granger Causality Test.
7.2 Recommendations a) As improved technology and efficiency are the factors essential to economic growth so more attention should be given to advanced technology, training and skill development of human capital. Technology should be improved and developed according to the needs of the economy and since it saves labor. b) Government should increase job opportunities for people so that the increasing population could improve the economic growth of country and become a mean of growth rather than a obstacle in the way of economic development of the country. c) Poverty is another major hurdle in the path of growth. A large share of government expenditures goes in the way of transaction rather than the development activities. Government should make measures to alleviate poverty so that the fruits of government expenditures could be achieved. d) Inflation should be managed because high or unpredictable inflation rates are observed as destructive for an overall economy of a country. They create inefficiencies in businessess and in this situation, it is difficult for companies to plan their budget for long term.
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e) Investment in capital should be increased which will enhance new capacity for the demand for goods. Increased demand and output will support investment in new capital machinery which will further help to maintain the growth in the economy by rising long run aggregate supply. f) Government should increase the enrolment ratio at all education levels. Education contributes to economic development through the production of knowledge and skills. It also increases labor productivity and quality of life, reinforces civil society and encourages democracy. It will be done by producing public goods i.e. new knowledge and by providing a safe freedom for the free and open discussion of the values of the economy. These values describe the character of economic growth in an economy.
g) Government should increase opportunities for the education of female. Education of female will develop child health. This will lower infant mortality rate. Moreover, it appears that education of female increases the age of marriage and due to this delay, total fertility rate of females lowers. Education of mother has a significant and greater impact on the educational achievement of children than education of father. So, it is concluded that education of female contributes more significantly in human capital formation. It contributes in productivity and economic growth not only in recent generation but also in the next generation. h) Income inequality should be reduced through appropriate government policies for economic growth because there is a two-way positive association between a more equal distribution of income and a higher rate of economic growth. It can be said that we have a virtuous circle where policies that encourage economic equality promote growth and vice versa.
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