Human Capital and Economic Growth: A Macroeconomic model for Pakistan

Abstract

This dissertation work enlightens the contribution of human capital in the economic growth of Pakistan through time series analysis and macroeconomic modelling framework. The first objective of this thesis is to find out the most relevant level of education in Pakistan in terms of its contribution to the economic growth. Second objective is to use that level of education as proxy for human capital and to find out its contribution in the sector wise productionn. Third is to develop a desegregated macroeconomic model for Pakistan illuminating the linkages between human capital and economic growth which enable us to analyze the effects of education spending by government on key macroeconomic variables at desegregated level through policy based simulations.

To achieve the first objective, a time series study is conducted. The study employed annual dataset for the period 1981-2014 to find the most relevant level of education in terms of its contribution to the economic growth of Pakistan. The study used three models assuming gross enrolment rates at primary, secondary and tertiary level as human capital and found secondary education as the most relevant level of education for economic growth. The long run coefficients obtained through fully modified ordinary least square (FMOLS) are used to reconfirm the findings of dynamic ordinary least square (DOLS). CUSUM test found that the parameters of equation with secondary education as human capital are stable. It is recommended therefore that secondary education should be given preference in resource allocation to ensure long run economic growth of Pakistan. To address the second objective, another time series study is conducted. This study illuminates the impact of human capital on the production of agriculture, industrial and services sector and compares the strength of this relationship with the coefficients obtained through aggregate data. The study uses an annual data set from 1981-2014 from Pakistan Bureau of Statistics and uses aggregate and sector wise production models. Augmented Dickey Fuller (ADF) is used test the order of integration and J-J co-integration is employed to check the long run relationship. Dynamic Ordinary Least Square (DOLS) and fully modified Ordinary least square (FMOLS) are used to check the consistency of initial findings and sensitivity analysis is performed in order to check the robustness of results. The study found evidences of positive human capital contribution in aggregate and sectoral production however its magnitude is found to be similar in the agricultural and industrial sector which was higher than the magnitude associated with services sector. The results show that human capital contribute directly in the aggregate and sector wise production of Pakistan and its contribution can be enhanced in aggregate or in any specific sector of economy by policies through affecting price level and interest rate.

The third objective is achieved through a study based on macroeconomic modelling. The study develops a medium sized macroeconomic model for Pakistan focusing the role of human capital in economic growth. The model divides supply side of economy into agriculture, industrial and services sector which is modelled as per neo-classical theory of production whereas the demand side is modelled as per Keynesian lines. The model is consisted of 43 equations including 23 behavioral equations estimated through fully modified ordinary least square (FMOLS). The forecasting horizon of this model is set to six years from 2015 to 2020 and the time paths of aggregate and sector wise variables are analyzed under 03 scenarios associated with government spending on education including the one stated in VISION 2025 of planning commission. The study found strong linkage between government spending on education and the production of agricultural and industrial sector. The production and employment of services sector is found to be least affected by government spending on education which reflects lack of synchronizing between the types of skills demanded by and supplied to the services sector. It is recommended therefore to increase the government spending on education along with aligning the skills produced in accordance to the demand of services sector.