The Dynamic Relationship of Capital Formation and Economic Growth in Pakistan

Abstract

This article investigate the dynamic link between 'capital formation' and 'economic growth' in Pakistan during the period 1972 to 2020. Using the econometric techniques—unit root tests, Johansen co-integration techniques, t-bound and f-bound tests, and vector error correction models (VECM) both short and long-run interactions between them are examined. Granger causality is used to examine causal relationships between government expenditure (GE) and GDP, GFCF and discount rate (DR), Foreign direct investment (FDI), and gross national saving (GNS) and FDI. The unit root tests guarantee the stationarity of the data while co-integration analysis and the f-bound and t-bound tests reveal the existence of both short-run and long run equilibrium links between "Capital Formation" and "Economic Growth".

The results reveal that, over the long run, capital accumulation and economic growth are mutually reinforcing under specific causal routes leading to significant areas for policy action. The study underlines the need of putting strategic policies into action to raise the GDP-to---savings ratio, therefore increasing strong capacity for capital formation and investment capabilities. The study provides policy insight to boost economic stability and growth by means of targeted financial and investment strategies with analytical examination of how capital formation influences economic development.