Analyzing Short-Runand Long-Run Causality between FDI Flows, Labour Productivity and Education in Pakistan

Abstract

FDI inflows play a very important role in increasing the productivity of factors of production through the channel of technology transfer and establishment of MNCs. This study empirically analyzes the causal relationship, for both short and long run, between FDI inflows, labor productivity and education in case of Pakistan using time series data from 1971-2016. The present study concentrates only on labor productivity since Pakistan is a labor abundant country using labor-intensive techniques of production. The innovative aspect of this study lies in its proxy measure of education and econometric techniques employed for carrying out empirical analysis. For measuring impact of education, government spending on education as percent of GDP has been used whereas for empirical analysis, it uses the latest test for measuring causality i.e., Breitung-Candelon Granger Causality test in frequency domain (both old and new versions) along-with the traditional approach of Johansen Cointegration test for analyzing long run relationship. Two separate models have been constructed. Model 1 is based on measuring bi-variate causality between FDI inflows and labor productivity whereas, model 2 checks bivariate causality between education and labor productivity. The main reason for measuring separate effects of two variables on labor productivity depends on the argument that education increases labor productivity if it is accessible to common man but this is not the case in Pakistan since Government of Pakistan is allocating very small amounts to education sector and therefore productivity does not increase. But FDI inflows lead to an increase in productivity by providing training to labor converting them into human resource though in this case MNCs hire already educated workers and polish them by imparting new skills in them. Both versions of BC test, i.e., Breitung and Candelon (2006), and Breitung and Schreiber (2016), suggest a univariate causality running from FDI to labor productivity only, whereas Johansen Cointegration approach suggests a long run relationship. Therefore government of Pakistan must give proper attention to education sector in order to gain maximum benefits from FDI inflows.