This experienced higher episodes of growth and

This paper targets the most binding constraintsto recent (2011-2016) low level of private investment and entrepreneurship inPakistan using Husmann-Rodrick-Vilasco (2005) decision tree. I have shown thatgrowth diagnostics of Pakistan undergoes from troubles and huge economiccomplexities. The economic growth of Pakistan is continuously affected bystructural problems domestic energy crisis, low investment, high inflation, andsecurity issues. Growth diagnostics point to four major constraints to economicgrowth of Pakistan: lack of infrastructure, inadequate market development, poorperformance of institutions, and lack of efficient public sector management. 1.INTRODUCTIONEconomic growthperformance of Pakistan is volatile throughout its history (Annexure-I).

Itsgrowth history started with its partition in 1947. Average growth rate was 3.4 % per annum in the1950s. During 1960s, Pakistan has experienced higher episodes of growthand average annual real GDP growth rates were shot up 6.8%. In 1970s, the oil price shock of 1970sand the war of Bangladesh, adversely affect the economic growth and averageannual GDP growth rates were decline to 4.8%.

Growth rate grew at 6.5 %annually, during 1980s and again and shrunk to 4.3 % in 1990s. Pakistan became one of the four fastest growing economiesin the Asian region during 2000-07 with its growth averaging 7 % per year. There were a few really shining years during thisperiod (Qayyum et al., 2008).The volatile performance of growthrate raises the question of what kind of policy reforms should be designedaccording to Pakistan.

Hausmann, et al. (2005) explains that targeting the mostbinding constraints has important advantages over other approaches to policyselection.This paper identifies the mostbinding constraints to the growth of Pakistan using Husmann-Rodrick-Vilasco (HRV) decision tree and alsoprovides their empirical evidences. There can be uncertainty about the”position” of each constraint in the economy so we can only make aprobabilistic assessment of which one is binding.2.THEORETICAL FRAMEWORKThebasic HRV decision tree ispresented in Annexure-II. The tree assumes that:EconomicGrowth = f (private investment & Entrepreneurship)Lowlevel of private investment = f (low return to economic activity, high cost offinance and entrepreneurshipLowreturn to economic activity = f (low social returns, low appropriability)Lowsocial returns= f (poor geography, bad infrastructure, low human capital)Lowappropriability = f (Government failure, market failure)Marketfailure = f (self discovery problem, coordination problem)Highcost of finance = f (bad international finance, bad local finance)BadLocal finance = f (low domestic savings and poor intermediation)Where’f’ means ‘function of’Anunder-performing economy is one where market imperfections and distortions are widespread.Such distortions create a wedge between private and social valuations ofspecific economic activities.

These wedges can be represented by ?= {?1,?2,. . .

, ?k}                                                                    …….(1)Where ?krepresents the distortion in activity k. The distortions can be modeled asconstraints on policy-making problem that take the general form.µis (?, …

) ? µip (?,…) ? ?i = 0                                                   ……(2)    Where,                                                         µis (?, .

..) net marginal valuation ofactivity i by societyµip(?, …) net marginal valuation of activity i by private agentTheeconomic activities depend not just of the set ? of distortions, but on levelsof consumption, labor supply, asset- holdings, etc. If u is welfare of theaverage member of society, then the gain in welfare from reducing one of thedistortions marginally isd?/dtj= – ?j * ?i d{?is(t,…) – ?ip(t,…)} / dtj                              …….

(3)?i ? 0, i = {1, 2, . . . , k} are the Lagrange multipliers corresponding tothe constraints connected with each of the distortions. The first term on the righthand side of eq. (3) captures the ‘direct effect’ of a small change in tj:a small reduction in tj increases aggregate welfare by an amountgiven by the multiplier associated with the jth constraint, j. Thesecond term captures the effect of varying tj on the aggregated sum of the gapsbetween the social and the private valuation, with the weights corresponding toeach distorted activity’s own Lagrange multiplier.

The standard growth model consists of number ofdistortions in the economy yielding the result that along a (constrained)balanced growth path consumption and capital grow according to.ct/ct=?kt / kt = ? r(1 ? ? ) ? ?                                                  …….(4)Where:Cis consumption; k is capital; r is the rate of return on capital; t is the taxrate on capital; ?is the world rate of interest and a dot over a variable denotes the rate ofchange over time.Inaddition, the private return on capital r is given byr= r (a, ?,x)                                                                                   ….

…(5)where: a = indicatorof total factor productivityx = availability of complementary factors ofproduction.? = index ofexternality (a higher ? means a larger distortion).Eq.4 & 5 summarize the possible factors that can affect growth performance.13.

EMPIRICAL ANALYSIS OF POSSIBLE BINDING CONSTRAINTS IN PAKISTAN3.1.Low SavingAlarge body of literature on economic growth tends to support the traditionalSolow (1956) growth model and the “New Growth Models” of David Romer’s andothers in which higher savings leads to higher growth. Table 1 shows thatsavings in Pakistan are close to world and high income countries. 1 The methodology is adopted from Hausman et al., 2005.


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