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SHARE IN THE CASE OF PAKISTAN

Applied Econometrics term project

SAGAR ALI KHUHRO (06162)

SHERBAZ KHAN (07400) 1|Page

Table of Contents

Abstract ......................................................................................................................................................... 3

Introduction .................................................................................................................................................. 3

Literature Review: ......................................................................................................................................... 4

Variables: ...................................................................................................................................................... 4

Data: .............................................................................................................................................................. 5

Estimation procedure: .................................................................................................................................. 5

Step:01 Stationarity test ............................................................................................................................... 6

ADF Unit Root Test Results: .......................................................................................................................... 6

Optimal Lag Length: .................................................................................................................................. 7

Step: 02 Johansson Co-integration ............................................................................................................... 7

Following results are approximated through Johnson co-integration test. ................................................. 8

Estimating Vector error correction Model:................................................................................................... 8

Wald test: ................................................................................................................................................ 11

Granger Causality Test: ............................................................................................................................... 13

Impulse Response Function: ....................................................................................................................... 15

Forecasting: ................................................................................................................................................. 17

Conclusion and Suggestions:....................................................................................................................... 18

Bibliography ................................................................................................................................................ 18

2|Page

Abstract

This paper attempts to investigate the co-integration relationship between GDP, consumption,

export, import, agriculture (% of GDP) and FDI in time-series data. To conduct this analysis, we

have applied tests to verify if the time series are non-stationary and co-integrated. We collected a

large data for Pakistan. The study regarded annual observations for a period of 38 years, from

1976 to 2014. We used several tests for stationary of the data. We ensured that all the variables

were I(1) i.e. they all are stationery after first difference and then we applied the test. To test for

Granger causality in the presence of co-integration among the variables, we employ a vector

error correction model rather than a vector autoregressive model. The source of causation in the

long run is found to be the error correction terms in both directions.

Introduction

One of the fundamental goals of each country is to achieve a high desirable economic growth

rate. Planners always regarded this economic signal. Therefore, factors which impact it are

important for planners and policymakers. World Bank studies show causes such as high rates of

savings, investment, a large proportion of exports in GDP, based on export promotion policies

and competitive markets play a key role in East Asia's economic growth (World Bank:

1993).Extra financial savings make it possible more investment in projects with high efficiency

and access to updated technology. On the other hand, Expansion exports Strategy impact

economic growth for several reasons in long-term economic growth as follows.

A: There is ability to offer and sell goods in world markets that have potentially unlimited

demand and possibility able to absorb all the products supplied by small countries in the global

markets.

B: Global competitive markets led to pressures of domestic enterprises.

Pakistans growth performance over the last five years has been striking. Average real GDP

growth during 2003-07 was the best performance since many decades, and it now seems that

Pakistan has decisively broken out of the low growth rut that it was in for more than one decade.

Economic growth has been notably stable and resilient. With economic growth at 7.0 percent in

2006-07, Pakistans real GDP has grown at an average rate of 7.0 percent per annum during the

last five years (2003-07) and over 7.5 percent in the last four year (2004-07) in running.

Compared with other emerging economies in Asia, this puts Pakistan as one of the fastest

growing economies in the region along with China, India, and Vietnam. The good performance

has resulted from a combination of generally sound economic policies, on-going structural

reforms and a benign international economic environment. Based on the performance of half-a-

decade of strong, stable, resilient and broad-based economic growth it appears that Pakistans

economy will continue to be a high mean, low variance economy over the medium-term.

3|Page

Literature Review:

A countrys development depends on output they are producing in their country where factor that

they depends on are Import, Export, Agriculture (value added as % of gdp), FDI, Consumption

etc. Researchers have found out that not all countries enjoy all these factors few have to depend

on one another as they could meet their demand. As Pakistan has been importing goods of

$41.668 and exporting goods of $29.872. In Pakistan 21% GDP depends on Agriculture

(Wikipedia, 2015) as well Government is trying to make agriculture more effective in supporting

sustainable growth rate and reducing poverty in Pakistan. Whereas underdeveloped countries are

focusing more on agriculture as poor people could farm their own land and depends their life on

that. (Pakistan Economic Survey 2014-2015). On a national level countries import and export

level plays a significant role in improving GDP. It provides people to excess the goods of other

countries, without import a country will be only limited to its own border. Developed countries

like Brazil, US, EU, South Africa import and export goods as their market become more

versatile. (Boundless, 2016). FDI component is also taken as of great importance in developed as

well as in less developed countries. In closed economy investment depends on domestic

investment, while in open economy it comes from both resources domestic as well as foreign. In

1997 FDI has taken share of 45% of net flows to developing countries as compared to 16% in

1986. Farkas (2012) has investigated relation between FDI on GDP which shows positive

relationship on GDP and its impact depends upon absorbance of its country. Zeeshan and Atique

investigated the relation of FDI and GDP in Pakistan. They concluded that imports and exports

oriented economies are different which means FDIs effect is much greater in latter economy

than the former economy. (Mehboob, 2014).

In conclusion it was found that by changing the above factors we can change GDP by some high

margin. Also effect of changing the factors depends on country to country.

Variables:

Consumption: It is overall consumption of country either its consumption of agricultural, water,

electricity etc.

Export: Goods and material exported to other countries as full fill the demand of other countries.

4|Page

Dependent variable is GDP which measure how much growth it does and what changes occur

due to change in consumption, import, export, FDI, and agriculture share.

Data:

Data of the variables is taken from World Bank data. The GDP is dependent on following

variables. We have collected the data for 38 years from 1976 to 2014.Name and label of data is

given in following table:

Estimation procedure:

We will conduct here meanly following tests.

1) Stationarity test

2) Co-integration test

3) Estimating VECM

4) Granger causality test to know any short run relationship among variables.

5|Page

Step:01 Stationarity test

30

25

20

15

10

0

1980 1985 1990 1995 2000 2005 2010

LOG(FDI) LOG(CNS) LOG(AG)

In time series analysis, the unit root test has its own importance to avoid from the unit root

problem which results in spurious relationship between dependent and independent variables.

For this purpose, the Augmented Dickey Fuller (ADF) unit root test was used. If all the Variables

of interest found stationary at level, then OLS can also be used. On the contrary, if all variables

are non-stationary at level and become stationary at the first difference, then VAR based

Johansen Co-integration approach can be applied.

Table 1

variables ADF at Level Results ADF at First Results

difference

Ln(gdp) -1.904 Non-stationary -4.93 Stationary

Ln(cns) -1.53 Non-stationary -4.803 Stationary

Ln(exp01) -2.42 Non-stationary -5.12 Stationary

Ln(imp) -1.85 Non-stationary -5.09 Stationary

Ln(fdi) -2.3 Non-stationary -4.9 Stationary

Ln(ag) -1.79 Non-stationary -6.06 Stationary

**at 5% significance level

ADF unit root test results indicate that all variables are non-stationary at the level, but they are

stationary at the first difference. In such situation, we can employ Johansson Co-integration

technique.

6|Page

Optimal Lag Length:

So the indicated results show that finally, findings of the both maximum Eigen value and trace

tests highlighted two co-integrating vectors at 5% level of significance.

7|Page

Following results are approximated through Johnson co-integration test.

It has been explored that following long run relationship is constructed through Johnson co-

integration test.

Ln GDPt = 0.839 Ln CNSt + 0.190 Ln EXP01t - 0.0537 Ln IMPt + 0.0057 Ln FDIt -0.0607 Ln

Agt

Statistically, the results show that in long run, if consumption increases by 1 dollar then GDP of

Pakistan will increase by 0.839 dollar.

If export of Pakistan increase by I dollar then GDP is likely to fall by 0.190 dollars resulting

from competiveness in the world market and higher tariff and non-tariff barriers on imports.

If Import of Pakistan will increase by 1 dollar then GDP will fall by 0.0537 dollars.

Similarly if FDI increase by 1 dollar then GDP will increase by 0.0057 dollars. (Muhammad

Umar Farooq, 2013)

8|Page

9|Page

We will find p values here. We are interested here in just the p-values of the first system i: e C1

to C8.so

Above table shows that just c3 is significant or just coefficient of export is significant in the

equation. Here C1 shows the stochastic error correction term expressing the speed of the

adjustment towards the long period equilibrium. The coefficient of the error correction term gdp

has positive sign.it implies that due to any disturbance in the system, divergence from

equilibrium will take place and system will be unstable. Moreover, the error correction term was

observed insignificant at 5% significance level so this shows that (GDP) does not react to the

co-integrating error.

The error correction term of agriculture growth is significant and shows the convergence of

agriculture growth .This implies that annually adjustment of agricultural growth will be about

138% of the deviation of (ag)t-1 from its co-integrating value 0.6479 Ln(gdp)t-1 . This is a big

rate of adjustment.

Similarly error correction term of export and import are also significant and positive which

indicates that the system is unstable. Due to any disturbance in the system, divergence from

equilibrium will take place and system will be unstable.

10 | P a g e

Wald test:

Wald test is conducted to check whether any individual or joint coefficients are significantly

different from zero of they have are zero. After checking long run causality, now we will check

whether there is any short run Causality between GDP and the other independent variables.

For this purpose we will use Wald test.

H0=C (2) =0

Ha=C (2) is not equal to zero

So here the probability value of Chi-square statistics is greater than 0.05 so we will accept null

hypothesis. Hence we will say lag of GDP has no effect on GDP. Similarly we will check all

coefficients through Wald test.

Outputs are given below.

11 | P a g e

12 | P a g e

This shows that C (3) is significantly different from zero. Hence lag of export has effect on GDP

of Pakistan.

So we will say that there is short Run causality from Export, Import, FDI, Consumption and

agricultural growth to GDP.

This test is conducted to check whether there is any granger causality of not. Our Null and

Alternate Hypothesis is given below

H0=Import (lag 1) cannot cause GDP

Ha=import (lag 1) can cause GDP

13 | P a g e

14 | P a g e

*The p-values show that none of the independent variables cause GDP or GDP causes them.

The following IRF graph shows that agriculture shock is greater than other shocks. Other shocks

are not much significant in response to gdp.

15 | P a g e

Response of..>

Response to Cholesky One S.D. Innovations 2 S.E.

Response of LOG(GDP) to LOG(GDP) Response of LOG(GDP) to LOG(CNS) Response of LOG(GDP) to LOG(EXP01) Response of LOG(GDP) to LOG(IMP) Response of LOG(GDP) to LOG(AG) Response of LOG(GDP) to LOG(FDI)

.2 .2 .2 .2 .2 .2

.1 .1 .1 .1 .1 .1

.0 .0 .0 .0 .0 .0

1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10

Response of LOG(CNS) to LOG(GDP) Response of LOG(CNS) to LOG(CNS) Response of LOG(CNS) to LOG(EXP01) Response of LOG(CNS) to LOG(IMP) Response of LOG(CNS) to LOG(AG) Response of LOG(CNS) to LOG(FDI)

.2 .2 .2 .2 .2 .2

.1 .1 .1 .1 .1 .1

.0 .0 .0 .0 .0 .0

1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10

Response of LOG(EXP01) to LOG(GDP) Response of LOG(EXP01) to LOG(CNS) Response of LOG(EXP01) to LOG(EXP01) Response of LOG(EXP01) to LOG(IMP) Response of LOG(EXP01) to LOG(AG) Response of LOG(EXP01) to LOG(FDI)

.12 .12 .12 .12 .12 .12

1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10

Response of LOG(IMP) to LOG(GDP) Response of LOG(IMP) to LOG(CNS) Response of LOG(IMP) to LOG(EXP01) Response of LOG(IMP) to LOG(IMP) Response of LOG(IMP) to LOG(AG) Response of LOG(IMP) to LOG(FDI)

.3 .3 .3 .3 .3 .3

.2 .2 .2 .2 .2 .2

.1 .1 .1 .1 .1 .1

.0 .0 .0 .0 .0 .0

1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10

Response of LOG(AG) to LOG(GDP) Response of LOG(AG) to LOG(CNS) Response of LOG(AG) to LOG(EXP01) Response of LOG(AG) to LOG(IMP) Response of LOG(AG) to LOG(AG) Response of LOG(AG) to LOG(FDI)

.06 .06 .06 .06 .06 .06

1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10

Response of LOG(FDI) to LOG(GDP) Response of LOG(FDI) to LOG(CNS) Response of LOG(FDI) to LOG(EXP01) Response of LOG(FDI) to LOG(IMP) Response of LOG(FDI) to LOG(AG) Response of LOG(FDI) to LOG(FDI)

.4 .4 .4 .4 .4 .4

.2 .2 .2 .2 .2 .2

.0 .0 .0 .0 .0 .0

1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10

16 | P a g e

Forecasting:

Forecasts are made essentially because they are useful. Financial decisions often involve a long

term commitment of resources, the return to which will depend upon what happens in the future.

So decisions made today will reflect forecasts of the future state of the world, and more accurate

those forecasts are, the more utility is likely to be gained from acting on them.

Following is the forecasting graph of our model.

Forecasting graph

2.4E+11

2.0E+11

1.6E+11

1.2E+11

8.0E+10

4.0E+10

0.0E+00

1980 1985 1990 1995 2000 2005 2010

Actual graph

GDP

2.4E+11

2.0E+11

1.6E+11

1.2E+11

8.0E+10

4.0E+10

0.0E+00

1980 1985 1990 1995 2000 2005 2010

This shows that our model is somehow correctly predicting future values.to check it statistically

we will calculate RMSE.

>..RMSE=1.31E+10 which is within the data.so this model is Predicting future value with

somehow accuracy.

17 | P a g e

Conclusion and Suggestions:

This study analyzed the impact of these factors on the economic growth over the period 1976-

2013 by employing Johnson Co-integration approach. Among the all independent variables the

estimated coefficients of Consumption, export and FDI are found to positive. But agricultural

share as percentage of GDP has small contribution into the economic growth as compare to other

key factors because of energy crisis, shortage of the irrigation water, deficiency of

mechanization, and because of being less competiveness in the world market. Government

should ensure the supply of key inputs like seeds, fertilizers, tractors and latest machines at lower

prices and improve them with the latest technologies to increase agricultural share into GDP.

(Muhammad Umar Farooq, 2013)

On the basis of results, we suggest that extra protection should be given to foreign investors by

the government of Pakistan to provide them welcoming atmosphere. Pakistan should also

increase its export because it also shares a part to increase GDP. Consumption is found to be

very significantly affecting our GDP. (Muhammad ramzan, 2013)

Bibliography

(2015, April 28). Retrieved from Wikipedia: https://en.wikipedia.org/wiki/Agriculture_in_Pakistan

https://www.boundless.com/economics/textbooks/boundless-economics-

textbook/international-trade-31/gains-from-trade-125/imports-the-economics-impacts-of-

buying-goods-from-other-countries-497-12593/

Mehboob, S. K. (2014, January 15). Impact of FDI on GDP: An analysis of Global economy on production

function. Retrieved April 30, 2016, from https://mpra.ub.uni-

muenchen.de/55352/1/MPRA_paper_55352.pdf

Muhammad ramzan, M. A. (2013). Impact of trade openess and macroeconomic variables on gdp

growth of pakistan. paradigms:research journal of economics,commerece,and social sciences,

vol.7,No.1 ,pp.32-41.

Muhammad Umar Farooq, D. H. (2013). Key Factors Affecting GDP in Pakistan Over the period 1975-

2011. Journal of Economics and Sustainable Development, ISSN 2222-1700 (Paper) ISSN 2222-

2855 (Online).

18 | P a g e

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