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This paper was written while the author was a summer intern in the Fund’s Middle Eastern Department. He wishes to thank Mohamed A. El-Erian, Antonio Furtado, Neven Mates, Syed Rizavi, Ghiath Shabsigh, Shamsuddin Tareq, Ulrich Thiessen, and Kal Wajid for their comments and insights. Any remaining errors are the responsibility of the author.
Fiscal years ending June 30.
This approach can be argued to be better suited than the neoclassical approach in accommodating some of the managerial theories of investment. In the model, the objective function of the managers is not merely to optimize profit, but also includes other objectives which may improve the strategic position of the firm. Accordingly, policies such as expansion and diversification, which are not always accommodated within the neoclassical framework, are included because they can lead to the increase in the market price of the shares.
The situation is further complicated by data limitations in most developing countries.
Although the above factors may also influence investment in industrial countries, they are less relevant there and mainly operate through the traditional determinants of investment. To take government investment as an example, its role in developed countries works mainly through aggregate demand and Is therefore included in the accelerator component of the investment function. In contrast, what is more relevant in the case of developing countries is the role of government investment in creating linkages and externalities. This is not represented in the accelerator component, and, therefore has been represented explicitly in the investment functions specified for these countries. It should be noted, however, that the investment incentives in developing countries do not differ from those in developed countries. Investors are mainly motivated by the expected rate of return which public Investment, in certain circumstances, may raise especially in the case of developing countries.
While there is some debate concerning the efficiency of capital markets in achieving these ends (Singh, 1991), their usefulness in mobilizing investment funds is well established.
In view of the emphasis given to government investment in the following sections, this discussion also reviews model specification and relevant empirical findings.
An interesting point to note is that when government investment is used as a counter-cyclical policy instrument, a negative correlation may appear between it and private investment. Such a correlation does not imply any causality, and this should not be interpreted as crowding out. However, this case is more relevant to the case of developed, rather than developing countries.
In Blejer and Khan (1984), expected change in GDP was estimated, rather than taking actual change as a proxy. The estimation can be made using a distributed-lags model or an adaptive expectation model. Reaching the correct specification Is important in order to avoid excessive approximations. To avoid this problem, the current study takes the realized change in GDP as a proxy for the expected change. There is no a priori reason to believe that any resulting bias would be significantly greater than that which would occur due to the approximation resulting from estimations using the above models. This issue, however, requires some further empirical investigation in order to ascertain which is the most efficient method for representing expected change in GDP.
An attempt was also made to estimate equation (1) using the real interest rate instead of ACRD. The resulting coefficient, however, had the wrong sign and was statistically insignificant.
Two definitions of noninfrastructure investment were used in this paper: a strict definition which included government Investment in manufacturing and wholesale and retail trade only, and a less strict definition where general and provincial government investments are included in noninfrastructure government investment.
This was preferred to the Blejer and Khan (1984) approach which used estimated expected (that which is following the trend) and unexpected (the residual) government investments as proxies for the infra and noninfrastructure components respectively. Using the latter methodology can lead to greater approximation. The reason is that many infrastructure projects are indivisible. When such projects are carried out, they violate the trend and would therefore be counted as noninfrastructure investment according to the latter methodology. On the other hand, a significant part of noninfrastructure investment can follow the trend. This is the case especially when the Government comes under political pressure to keep expanding different items of noninfrastructure or even unproductive investment. If this is the case, infrastructure investment, in contrast with the suggested methodology, may be the residual. These concerns about Blejer and Khan’s classification methodology are shared by Chhibber, Dailami, and Shafik (1992) who also point out that infrastructure investment is often financed by external aid– an important consideration in the case of Pakistan. This leads to less certainty and steadiness concerning such investment, and therefore, implies that it may not follow a steady trend as suggested by Blejer and Khan’s methodology.
Alternative lag structures were also attempted. However, the estimated coefficients of such lags were not significant. For non- infrastructure government investment (GNON), different lags were also experimented with and the results were insignificant suggesting that such investment manifests its main impact on private investment within the same year.
Regarding domestic sources, the availability of finance in Pakistan has been constrained by the low rates of domestic savings. Domestic bank credit has provided the major source of finance for private investment. Moreover, the Government resorted to direct credit as an instrument to promote private investment in certain sectors. As a result, the private credit share in total domestic credit increased from under 45 percent in 1981/82 to almost 60 percent in 1989/90 (Chart 5). It may also be noted that private investment in Pakistan has been less dependent on external borrowing which instead has been mainly geared toward financing government expenditure. An external inflow that may have had a direct impact on private investment is workers’ remittances, although it appears that a good part of this income was spent on improving the living standards of migrants’ families in Pakistan and on informal sector activities. As to portfolio and direct foreign investment, the private sector in Pakistan had only limited access to them in the period under analysis. More recently, the broadening stock market and participation of foreign investment are likely to alter this phenomenon.
According to the beta coefficients estimates, new credit to private investment had a relatively more important positive effect than total government investment (equation 1). This implies that the latter should not be financed at the expense of the former. However, it was also estimated that infrastructural government investment had the most positive impact (see the beta coefficients estimates of equations 2.1 and 2.2).
This analysis, however, requires qualification. As Chhibber, Dailami, and Shafik (1992) argue, the existence of public sector firms in a particular industry may deter private firms from entering even when the levels of both prices and demand are potentially favorable. Thus, private firms are usually cautious of governments’ tendency to favor public firms, thereby giving the latter a competitive advantage in the case of any potential competition in the future.