Impact of Fiscal Decentralization and Social Indicators on Economic Growth in Pakistan

Abstract

Fiscal decentralization is adopted by many developed and developing economies to enhance the provision of public goods and services in accordance with the preferences of citizens. Fiscal decentralization is the devolution of responsibilities from central government to provincial governments comprising of expenditure assignments and revenue generation. This study intends to empirically examine the causal relationship between fiscal decentralization and economic growth and then find the impact of fiscal decentralization on economic growth in Pakistan by employing annual data for the period 1980 to 2018. The analysis is carried out in two parts. In the first part the causal relationship between fiscal decentralization and economic growth is examined by employing Vector Error Correction model (ECM). The results show that fiscal decentralization i.e. expenditure decentralization and revenue decentralization causes economic growth in the long run. In the second part, the impact of fiscal decentralization on the economic growth is analyzed and for that purpose Johansen cointegration and error correction model is employed. The results show that expenditure decentralization has a negative impact on the economic growth while revenue decentralization has a positive impact on the economic growth in the long run and both are statistically significant. Moreover, the ECM model estimation indicates the role of private investment, a key macroeconomic variable that is found negatively affecting economic growth. The results also indicate the role of social indicators like education, health and law and order have a positive and significant impact on the growth. The negative impact of expenditure decentralization highlights the administrative incapacity of provincial governments in designing optimal policies and development planning.