Investigation of Kaldor's 3 Growth Laws in the Case of Pakistan

Abstract

One of the most important factors for the backwardness of developing regions like Pakistan is the low level of industrial development. In order to test the effect of growth of industrial sector on the overall growth of GDP of Pakistan, we use Kaldor’s three growth laws. These three laws show the relationship between growth of manufacturing sector and growth of GDP, growth of total productivity of labor and growth of employment in industrial sector. For this we use the data of Pakistan from 1980 to 2010. Structural change in favor of industrial activities would almost certainly will help to accelerate the growth of GDP.

Introduction

In 1966 Nicholas Kaldor’s presented three growth laws at Cambridge University. According to first law “The growth of manufacturing output is positively related to the growth of GDP. This means that as the growth of industrial sector increases, the growth of GDP also increases. The second law states, “There exists a strong positive correlation between growth of manufacturing output and growth of productivity of manufacturing sector. Growth of productivity of manufacturing sector means productivity of labor. Third law states “Increase in manufacturing sector induces an increase in sectors other than the manufacturing sector, including agriculture and services sector. This means as the industrial sector grows than the services sector grows as well. (Growth & Development by A.P Thirlwall “seventh edition”)

In Pakistan, agriculture sector is the 2nd largest sector, which accounts for 21% share in the GDP and absorb 45% of total labor force. On the other hand the manufacturing sector is the third largest sector, which accounts for 18.5% share in GDP and absorb 13% of total employment and the services sector is the largest sector, which accounts for 59% share in GDP. (Pakistan Economic survey 2009-10). Our economy is heavily dependent on non-manufacturing sector, i.e, the agriculture sector. An increase in agriculture sector’s growth rate causes an increase in the growth rate of the economy. There is a need to study the extent of impact of the manufacturing sector on the other sectors of the economy.

Kaldor originally tested these laws using the data of 12 OECD countries over period of 1953-1954. Adam B Elhiraikain in 2008 also tests the kaldor’s law using the data of 36 countries over the period of 1980-2007. There are many others who investigated these three laws across different regions (Michl 1985) (Zang and Hansen 1996) (Mc Combie 1985). The main objective of this paper is to empirically investigate the Kaldor’s three growth laws in case of Pakistan by using data from 1980-2010.This investigations will help us to identify the key factor of growth of manufacturing output. This paper draws a policy lesson for Pakistan to promote industrial sector in order to achieve broader economic transformation. There has been hardly any study of Kaldor’s growth laws on Pakistan. This study fills this gap.

Literature review

Across the countries of Africa the Growth of GDP is more related with the growth of manufacturing sector than agricultural sector. There is also some existence of Kaldor’s second Law across these regions. The growth of labor productivity as a whole is strongly affected by the growth of employment in non-manufacturing sector (A.P Thrillwall & Heather wells)

Kaldor’s also argued that the growth of non-manufacturing sector is positively related to the growth of manufacturing sector and this relation was empirically investigated by (Gilberto Libanio 2001) across the states of Latin America. The study concluded that if the non-manufacturing sectors, including, services and agriculture (as a % age of GDP) increase, the manufacturing sector also grows, but if we take data from 2000-09, we observe that the non-manufacturing sector shows an unusual behavior with manufacturing sector declining continuously from 2005-10. This shows that study done by Gilberato and Libanio is not applicable in today’s scenario. (Appendix C)

The relation between industrial growth and GDP growth can be explained by the effect of manufacturing productivity level in the whole economy. Such effects are due to the transfer of labor from low productivity sector to industrial sector and due to the existence of static and dynamic economies of scale in manufacturing. (Gilberto Libanio 2001)

The process of economic development in the Chinese region accelerated between 1979-2004. The expansion of industrial sector played a vital role in the growth of GDP in two ways. First it was the secondary industry that achieved the increasing returns to the scale, which spread to the whole economy of Chinese region. Second reason is that secondary industry played a key role in economic growth in China because of reallocation of labor between industries. (Santa Cruz 2007)

The labor productivity growth is achieved as a result of industrial growth. You can increase the overall growth through the improvement of industrial sector. This result was investigated in India by (Dr. Panchanan Das 2003). If we take the data (2000-09) as percentage of GDP from World Bank website, we find that services remains the largest sector in last 9 years. Thus, we cannot conclude that improvement in the industrial sector, brings improvement in the overall growth of the economy. (Appendix B)

Empirical Evidence

First Law

LOG(GDP)

LOG(MANU)

LOG(GDP)

1

0.998

LOG(MANU)

0.998

1The table shows that there exist high correlation (0.998) between growth of manufacturing sector (MANU) and growth of GDP (GDP), which supports the statement of Kaldor’s first law.

Second Law

LOG(EMP_IN_INDUS01)

LOG(NDU)

LOG(EMP_IN_INDUS01)

1

0.77

LOG(1/INDU)

0.77

1This table shows that there exists correlation (0.77) between employment in industrial sector and growth in industrial sector, which supports the Kaldor’s second law in case of Pakistan.

Third Law

LOG(TOTAL_PROD01)

LOG(INDU)

LOG(TOTAL_PROD01)

1

0.896

LOG(INDU)

0.896

1This shows high correlation (0.86) between growth in industrial sector and total productivity of labor, which supports the statement of Kaldor’s third law in case of Pakistan.

Methodology

Hypothesis

Are Kaldor’s growth laws applicable in case of Pakistan?

As per Kaldor’s laws, does GDP growth depend upon industrial growth?

Does industrial employment depend upon industrial growth?

Does labor productivity depend upon the industrial growth?

Data Source

Data for the variables mentioned below have been collected from “Pakistan Economic Survey” and “Pakistan Labor Force Survey” This paper will attempt to study the annual data from 1980 to 2010.

Variables

gm = Growth of manufacturing sector

gGDP = Growth of GDP

gnm = Growth of non-manufacturing sector

gs = Growth of services sector

gns = Growth of non-services sector

ei = Employment growth in industrial sector

gi = Industrial growth

PT = Total productivity of labor (we use wages of labor as a proxy of total productivity of labor)

Estimation technique and results

For empirical investigation of these three Kaldor’s Laws, the econometric technique of OLS (ordinary least square) will be used. OLS states that the computation of coefficients is done in such a way that errors are minimum.

First Law

Value of coefficient

T value

P value

DW

gGDP = a + bgm

0.78

5.1

0.005

0.98

gGDP = a +b(gnm-gm)

0.72

3.55

0.004

2.4

gnm = a + b(gm )

0.76

3.97

0.0026

0.80

The relationship between the growth rate of manufacture and the growth GDP is positive and significant. The value of coefficient is 0.78. The equation shows the presence of auto correlation in our model the reason behind is that manufacturing is a part of GDP that’s why the first equation shows the presence of auto correlation. The 2nd equation of first law shows the complete effect of other sector on GDP, which shows positive and significant effect. The value of coefficient is 0.72 .If you improve your other sector the GDP also improves. (We get the non-manufacturing sector by taking the difference of GDP and manufacturing sector). The third equation shows the significant impact of manufacturing on non-manufacturing sector. The value coefficient is 0.76. These all three above equation shows the existence of first law in case of Pakistan, which shows that manufacturing sector act as engine for the growth of GDP.

Second and third law

Value of coefficient

T value

P value

DW

ei = a + b(gi)

0.27

2.73

0.005

2.18

PT = a + bgi

0.52

6.06

0.005

1.66

The second laws show the significant impact of growth of industrial sector and employment in industrial sector. It is employment elasticity with respect to industrial sector. The value of coefficient is 0.27. Third law also shows significant impact of growth of industrial sector and growth of productivity of labor. For productivity of labor we use wages as a proxy variable because according to labor economics labor productivity depends on the wages of labor. The equation shows the significant impact on productivity of labor. Value of coefficient is 0.52. The Durbin Watson test shows that there is no auto correlation present is these two equations.

Conclusion and policy implication

The above-mentioned result shows that Kaldor’s three growth laws are applicable in Pakistan. The growth of GDP is associated with the growth of manufacturing sector. The growth of industrial sector improves the employment in industrial sector. The growth in industrial sector also enhance the productivity of labor as a result, it also improves the welfare of society As per theory too, the industrial revolution is path for development therefore manufacturing sector must be the top priority of Pakistan.

References

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Christine, Carton(2009). “Kaldorian mechanism of regional growth: An empirical application to the case of ALADI 1980_2007.” Munich personal RePEc Archive,.

Das, Panchanan Dr. Output and employement growth in registered manufacturing industries in india: Testing the Kaldor’s Hypothesis. Taki Government College West Bengal.

Economic survey several years

Elhiraika, B. Adam(2008). “Promoting manufacturing to accelrate economic growth and reduce volatility in Africa.” African Economic Conference ,.

Jeon, Yongbok(2007). “Regional incme inequality in post 1978 China : A Kaldorian Spatial Econometric Approach.” Center for Global, International and Regional studies.

Libanio, Gilberto. “Manufacturing industry and economic growth in Latin America: Kaldorian approach.”

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Thrilwall, A. P. (1999). Growth and Development, With Special Reference to Developing Economies. London: Macmillan Press.