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Fiscal Decentralization and Macroeconomic Performance: the Case of Pakistan

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Fiscal Decentralization and Macroeconomic Performance: the Case of Pakistan Fiscal Decentralization and Macroeconomic Performance: The Case of Pakistan By: Imran Hanif Supervised By: Professor. Dr. Imran Sharif Chaudhry School Of Economics, Bahauddin Zakariya University, Multan (Pakistan) A dissertation submitted to the School of Economics, Bahauddin Zakariya University Multan, for the fulfilment of the degree of Doctor of Philosophy (PhD) in Economics (2015) i IN THE NAME OF ALLAH, THE MOST BENEFICENT AND THE MOST MERCIFUL ii DECLARATION I, Imran Hanif, a Ph. D Research Scholar in School of Economics, Bahauddin Zakariya University, Multan (Pakistan), do hereby solemnly affirm and declare that this research work has been accomplished by me under the supervision of Professor Dr. IMRAN SHARIF CHAUDHRY, for the purpose of submitting it as a requirement to grant the degree of “DOCTOR OF PHILOSOPHY IN ECONOMICS”. All the sources of information have been acknowledged in this thesis. (IMRAN HANIF) Ph. D Research Scholar, School of Economics, Bahauddin Zakariya University, Multan (Pakistan) (2015) iii CERTIFICATE It is hereby confirmed that this thesis is based on the research accomplished by Imran Hanif. It is also verified that the research work has not been previously presented for a higher degree. Mr. Imran Hanif has done this research work under supervision of Professor Dr. Imran Sharif Chaudhry. He has fulfilled all the requirements and is qualified to submit the accompanying thesis for the degree of “Doctor of Philosophy in Economics”. SUPERVISOR Professor Dr. Imran Sharif Chaudhry, School of Economics, Bahauddin Zakariya University, Multan EXTERNAL EXAMINER DIRECTOR Professor Dr. Imran Sharif Chaudhry School of Economics Bahauddin Zakariya University, Multan iv Dedicated TO MY PARENTS, BROTHER AND SISTERS Who instruct me how to live diligently, and educate me to live with capability? v TABLE OF CONTENTS TITLE PAGE Declaration iii Certificate iv Table of Contents vi Abbreviations/Acronyms xi List of Tables xiii List of Figures xv Acknowledgements xvi Abstract of the Study xvii CHAPTER 1 INTRODUCTION 1.1 Background of the Study……………………………………... 1 1.2 Statement of the Problem…………………………………….. 5 1.3 Significance of the Study…………………………………...... 7 1.4 Objectives of the Study………...……………………………. 8 1.5 Organization of the Study……………………………………. 9 CHAPTER 2 REVIEW OF LITERATURE 2.1 Introduction…………………………………………………... 11 2.2 A Glance at Fiscal Decentralization Studies………………..... 12 2.3 A Review of Significant Fiscal Decentralization Studies from Pakistan……………………………………………………….. 13 2.4 A Review of Significant Fiscal Decentralization Studies from International Portfolio……………………….. ………………. 16 2.5 Conclusion……………………………………………………. 36 CHAPTER 3 FISCAL DECENTRALIZATION AND PROFILE OF PAKISTAN’S ECONOMY 3.1 Introduction………………………………………………….. 42 3.2 History of the Fiscal Autonomy Campaign in Pakistan ……... 44 3.3 Allocation of Resources in Pakistan………………………….. 45 3.4 Resource Allocation before the Independence of Pakistan in 1947…………………………………………………………… 45 3.5 Resource Allocation after the Independence of Pakistan…...... 46 3.6 Resource Allocation in the Period of One Unit………………. 46 3.6.1 The Prize of 1961………………………………………. 47 3.6.2 National Finance Commission Award of 1964………… 47 3.6.3 National Finance Committee 1970…………………...... 48 vi 3.7 Resource Allocation in the Financial Arrangement of the 1973 Constitution…………………………………………...... 49 3.7.1 The First NFC Award 1974…………………………...... 49 3.7.2 The 2nd NFC Award 1979……………………………… 50 3.7.3 The 3rd NFC Award 1985……………………………… 50 3.7.4 The 4th NFC Award 1990……………………………… 51 3.7.5 The 5th NFC award 1996……………………………... .. 52 3.7.6 The 6th NFC Award 2000………………………………. 54 3.7.7 The 7th NFC Award 2006………………………………. 55 3.7.8 The 8th NFC Award 2009………………………………. 58 3.8 Economic Performance of Pakistan…………………………... 60 3.8.1 Long Run Growth Trends of Basic Economic Indicators in Pakistan……………………………………………… 60 3.9 Development of the Fiscal Situation in Pakistan…………….. 62 3.9.1 Tax Structure in Pakistan………………………………. 65 3.10 Conclusion…………………………………………………... 68 CHAPTER 4 FISCAL DECENTRALIZATION: CONCEPTUAL AND THEORETICAL FRAME WORK 4.1 Introduction…………………………………………………... 69 4.2 Concepts of Decentralization…………………………………. 69 4.2.1 Political Decentralization………………………………. 70 4.2.2 Administrative Decentralization ………………………. 71 4.2.3 Financial or Fiscal Decentralization …………………... 72 4.3 Fiscal Federalism……………………………………………... 74 4.4 Economic Decentralization…………………………………… 74 4.5 On Going Debate Regarding Fiscal Decentralization………... 75 4.6 Conventional Fiscal Decentralization Theories………………. 79 4.6.1 Stabilization ……………………………………………. 79 4.6.2 Distribution …………………………………………..... 80 4.6.3 Allocation ……………………………………………… 81 4.7 Tiebout Hypothesis; “Voting with Your Feet”……………….. 86 4.7.1 Basic Assumptions of the Tiebout Mechanism………… 88 4.7.2 Brief Awareness of the Characteristics of All the Communities…………………………………………… 88 4.7.3 Costless Mobility in Different Competitive Jurisdictions……………………………………………. 89 4.7.4 Impure Public Good Provision…………………………. 89 4.7.5 Large Population Size………………………………...... 89 4.7.6 Dependent on Tax Related Benefits……………………. 89 4.7.7 Externalities Created due to Mobility………………...... 90 vii 4.7.8 Economies of Scale…………………………………...... 91 4.7.9 Benefit Spillover……………………………………….. 92 4.7.10 Non- Static Preferences……………………………..... 92 4.7.11 Production and Location……………………………… 92 4.8 The Tiebout Hypothesis: Empirical Tests……………………. 93 4.8.1 Focus on Capitalization………………………………… 93 4.8.2 Focus on ‘Fiscally Provoked Migration’……………..... 94 4.8.3 Focus on ‘Taxpayer Satisfaction’………………………. 96 4.8.4 Focus on ‘Sorting’……………………………………… 97 4.9 Decentralization and ‘Leviathan’…………………………….. 97 4.10 New-classical Growth Theory……………………………..... 98 4.11 Conclusion…………………………………………………... 99 CHAPTER 5 DATA AND METHODOLOGICAL ISSUES 5.1 Introduction…………………………………………………... 100 5.2 Data Sources …………………………………………………. 100 5.3 Selection of Variables………………………………………… 101 5.4 Application of the Econometric Model………………………. 105 5.4.1 Model for Time Series Data Analysis………………...... 105 CHAPTER 6 FISCAL DECENTRALIZATION AND MACROECONOMIC PERFORMANCE: AN ELEMENTARY DATA ANALYSIS 6.1 Introduction…………………………………………………... 111 6.2 Descriptive Statistics…………………………………………. 111 6.3 Results of Pair-wise Correlation…………………………….... 114 6.4 Short Run Causality Analysis……………………………….... 116 6.5 Conclusion……………………………………………………. 119 CHAPTER 7 IMPACT OF FISCAL DECENTRALIZATION ON GROWTH, INVESTMENT AND INFLATION: A TIME SERIES ANALYSIS 7.1 Introduction…………………………………………………... 120 7.2 Impact of Fiscal Decentralization on Economic Performance of Pakistan: A Time Series Analysis………………………… 121 7.2.1 The Wald Test (F-statistics)……………………............ 122 7.2.2 Long-Run Impact of Fiscal Decentralization on Economic Performance………………………………... 124 7.2.3 Estimation of Error Correction Model………………… 126 7.2.4 Diagnostic and Stability Test………………………….. 127 7.3 Impact of Fiscal Decentralization on Economic Growth in Pakistan………………………………………………………. 130 viii 7.3.1 Fiscal Decentralization Expenditures and Productive Efficiency………………………………………………. 130 7.3.2 Fiscal Decentralization Revenue and Productive Efficiency………………………………………………. 132 7.3.3 Fiscal Decentralization and Economic Growth: A Time Series Analysis…………………………………………. 133 7.4 Impact of Fiscal Decentralization on Public Investment in Pakistan………………………………………………………. 140 7.4.1 Fiscal Decentralization Expenditures and Productive Efficiency of Public Investment……………………….. 140 7.4.2 Fiscal Decentralization Revenue and Productivity of Public Investment……………..……………………….. 142 7.4.3 Fiscal Decentralization and Public Investment: A Time Series Analysis………………………………………… 143 7.5 Impact of Fiscal Decentralization on Inflation in Pakistan…... 150 7.5.1 Productive Efficiency of Fiscal Decentralization (Revenue & Expenditure) and Price Stability…………... 150 7.5.2 Fiscal Decentralization and Price Stability: A Time Series Analysis………………………………………… 151 7.6. Conclusion…………………………………………………... 158 CHAPTER 8 IMPACT OF FISCAL DECENTRALIZATION ON EMPLOYMENT AND SAVINGS: A TIME SERIES ANALYSIS 8.1 Introduction…………………………………………………... 159 8.2 Impact of Fiscal Decentralization on Employment in Pakistan……………………………………………………...... 160 8.2.2 Productive Efficiency of Fiscal Decentralization (Revenue & Expenditures) and Employed Labour Force……………………………………………………. 160 8.2.3 Impact of Fiscal Decentralization on Employment in Pakistan: A Time Series Analysis……………………… 161 8.3 Impact of Fiscal Decentralization on Private Savings in Pakistan………………………………………………………. 167 8.3.1 Fiscal Decentralization (Revenue & Expenditures) and Productive Efficiency of Private Savings ……………... 167 8.3.2 Impact of Fiscal Decentralization on Private Savings: A Time Series Analysis…………………………………... 168 8.4 Conclusion……………………………………………………. 175 CHAPTER 9 SUMMARY, CONCLUSION AND RECOMMENDATION 9.1 Summary……………………………………………………… 177 ix 9.2 Conclusion of the Study………………………........................ 179 9.3 Suggestions……...…………………………………………..... 181 REFERENCES 184 x Abbreviations/acronyms ADF Augmented Dickey-Fuller AIC Akaike Information Criterion ARCH Autoregressive Conditional Heteroskedasticity ARDL Autoregressive Distributive Lags Model CDA Capital Development Authority CE Co-integration Equations CM Chief Minister CPI Consumer Price Index ECM Error Correction Model EJF Efficient Jurisdiction’s Frontier ELF Employed Labour Force EU European Union FBR Federal Board of Revenue FBS Federal Bureau of Statistics FD First Difference FDR Fiscal Decentralization Revenue FGLS Feasible Generalized Least
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