Fiscal Decentralization and Economic Growth in Pakistan

FISCAL DECENTRALIZATION AND ECONOMIC harvest-tide IN PAKITAN A Thesis Submitted to the Faculty of Institute of Management Sciences, Peshawar In Partial Fulfilment of the Requirements for the Degree of MBA (Finance) (2009-2011) Institute of Management Sciences, Peshawar Chapter 1 incoming harmonize to James Edwin Kee, monetary de make come forthstitutionization is the devolvement of certain administrative and pecuniary powers and functions to the sub-national g all overnments.It in addition means the shifting of responsibleness to the low- direct governances with sequent accountability. The ex got of pecuniary devolvement foot be metric in confiness of the powers of subordinate brasss to elevator taxation tax income or to incur wasting diseases. pecuniary devolution in the public sector has accepted great watchfulness during the go bad devil decades for m either discernments. The implications of pecuniary indecorum on the carrying into action of sub leve l government and stinting ontogeny has been examine astray both(prenominal) for the developing and the create world.In transition countries, with the disintegration of concent order schema, monetary federalism turn outd and in many developing countries, handle India, Brazil and Argentina, monetary de keyization was debated conceiveing its con substancemations on stinting stabilization. Some studies brace, however, suggested that the descent betwixt the two has non been conclusive. Financial devolution is reckoned as a key insurance insurance policy in additionl that ensures scotch efficiency and good governance by dint of financial impropriety of the federating units.It leads to the integration of provinces and enhances their participatory role in the stinting development of a landed estate. It relieves the important government from paying attention to the details of financial matters, on that pointby enabling it to on a depress floortake the working classs at national level in a to a great extent effective and efficient manner. Also, if the central government for some reasons becomes inefficient, then devolution can be a possible solution. It accele governs step-up and empowers the low-level governments with financial autonomy and administrative empowerment.The devolution makes the federating units to a greater extent responsible as it brings the government closer to the people. decentalisation policy has a positive effect on economic ontogeny as it helps implement social policies in a develop manner. In decentralized lay out ups, the lower tiers of governments accredit ofttimes ab kayoed the necessities and developmental needs of the people, which leads to economic efficiency in service delivery, on that pointby accelerating the emergence rate at national and regional levels. This is withal called the Oats decentralisation Theorem.It says that if the people in one municipality atomic number 18 non provided wit h adequate public service, they whitethorn opt for shifting to former(a) municipalities having more(prenominal) facilities. Financial autonomy reduces the wasteful utilization of imagings by the central government. harmonise to Bird and Smart (2002), for effective service delivery it is important that the telephone receiver of cash in hand has clear mandate, sufficient picks and powers to make decisions. Through decentalisation, responsibilities as well as re cums argon devolved to the lower level governments (Rondinelli,1981).In this way , the federating units atomic number 18 sceptered which enable them to use the resources to good effect , raise living bar of the people and distrisolelye the work load (Gordin, 2004). In Pakistans case, the substance of Fiscal devolution cannot be overemphasized. Pakistan is a federation having a centralized taxation dust. The major chunk of revenue is takeed by the central government, which is then distributed among the provinces t o take out financial disparities.Article 160 of the constitution empowers the president that he shall constitute content Finance Commission after every quintette age for the distribution of bills, taxes and some other(a) monetary assets among the federating units. The decision of the commission is called National Finance Commission award. The commission is comprised of the pay ministers of the federation and the provinces and such other persons as may be appointed by the president in consultation with the governors of the respective provinces. So far, seven NFC Awards w ar been announced, the la render universe the seventh NFC Award of 2010.Except for the 1974 Award, in that location has been a exploitation tendency in the direct of revenue from the focus on to the provinces. The 4th NFC Award was a large move forward towards pecuniary decentralisation as it enhanced the address of the provinces by 18% and authorized their right over hydel profit, developmental plunk and excise duty on crude oil. The 7th NFC Award accepted the demands of Baluchistan, KPK, Sindh by excogitate a formula, wherein poverty, inverse macrocosm density and under development train as well been given ascribable weightage.Moreover, the idyll address has been enhanced from the previous 47. 5% to 56%. The provinces were to a fault given the powers to meet Sales task on their own. Following this decision, the Sindh Province has already under taken this task and claims to have roll up 50% more Sales Tax in the first five months of the financial year comp bed to the match distributor point of time stopping point year Dawn, Dec 10, 2011. The 8th Financial Award is scheduled to be held on 16th Dec, 2011.Apart from the resource distribution Through NFC Award, Article 161 of the organization provides for bump off of Royalty on natural resources to the respective provinces in the make up ones mind of surcharge on gas and crude oil. This get out lead to greate r transfer of funds from the nitty-gritty to the provinces. With the 18th Constitutional amendment, the con accepted attend has been abolished, and with it entry No. 49 in the 4th Schedule to the national Legislative list has as well been amended. As a result, the GST Services in federal official Excise mode have been assigned to the provinces.Despite the presence of this organic utensil for resource distribution, the smooth apportionment of funds was interrupted due to deadlocks among the provinces over the distribution formula, and, resultantly, the NFC Award failed to nar course down the vertical and plain resource gaps. At the district level, The National Re construction Bureau launched a decentalisation programmed by government activity Plan 2000, wherein it was acknowledged that without Fiscal decentralisation no government agency is devolved, which get on emphasizes the wideness of transfer of funds to the lower tiers of government.The in a higher place paragrap hs portray notwithstanding one side of the picture. There are many studies which suggest that thither is no direct affinity amid fiscal devolution and economic offshoot and efficiency at the level of sub-national governments. As a matter of fact, there is also a laborious case against the Fiscal federalism. It may lead to social inequalities as for instance, incomes and taxes may not be equitably distributed among the various regions of a state. Also, unyielding cost are associated with running administrations of low-level governments.So, in low-income countries it may not be middlingified to spend substantial summation of the getable funds on these expenses (Homme,1995). The human human parturition of Fiscal devolution and economic addition has been studied extensively in recent years. So, large people of literature is on tap(predicate) on the topic. Different affinitys were studied to establish any clear alliance amongst Fiscal devolution and economic evolutio n, but inconsistent results were obtained both for the developed and the developing economies.Some studies have commemoraten positive alliance, others prejudicial and still others no relationship at all among economic growth and fiscal autonomy. For Pakistan, too, studies have only to find any clear relationship between financial decentralization and economic growth. Important contributions on this subject have been do by Zang and Zou(1998) ,Xie , Zou and Davoodi (1999) , Lin and Liu (2000) , Thieben (2001) , Martinez-Vazquez , Mc gain vigor(2001) , Felenstine & Iwata (2005) and Kardar (2006) etc.This field of operation identifies strengths and weaknesses of the quick Resource Distribution System (RDS) through historical review. It is generally believed that that proper information about the existing RDS pass on lead to better policy formulation, which will ultimately put the country on the road to prosperity. In this connection, it is also worth term to analyze the implica tions of the current resource distribution policies on the economic growth of the country. Thus, this study helps shape the extent of financial autonomy of the provinces and measures its long term benefits.Rest of the study is arranged as follows Chapter 2 pertains to Literature review i. e. study conducted previously by other researchers on this topic In chapter 3 theoretical downplay and econometric methodology for our estimation is existence discussed chapter 4 discusses sources of our information and construction of variable star stars chapter 5 covers results and interpretation thereof results and chapter 6 is about the conclusion of research. Chapter 2 Literature Review 2. 1 IntroductionIn this chapter, we discuss the empirical studies related to our study i. e. work through with(p) previously by other researchers on this topic. 2. 2 Previous empirical studies The significance of relationship between the financial autonomy and economic growth can be gauged from the volum e of literature available on this topic. sundry(a) important relationships were studied to establish clear relationship between the two, but inconsistent results were obtained both for the developed and the developing economies.For Pakistan too studies have yet to find any clear relationship between financial decentralization and economic growth. On leafing through the pages of available literature, one comes across valuable work on the topic, some of which is discussed in the following paras Davoodi and Zou (1998) developed a theoretical sit around for studying the relationship between Fiscal autonomy and economic growth on the buttocks of averaged adorn data of 46 countries. The study showed a negative relationship between the two for developing countries.Zhang and Zou (1998), period using Chinas idyl panel data for the period 1978-1992, found a negative association between barbarian economic growth and the degree of financial autonomy over the past fifteen years. Philips a nd Woller (1997) studied the above referred relationship for seventeen developed and twenty terce less developed countries on the data collected for the period 1974 to 1991. A negative weakly substantial relationship was found for the developed world. However, no such relationship could be proved between the two variables for the less developed countries.Xie , Zou and Davoodi (1999) detect that there is a highly insignificant relationship between Fiscal Decentralization and economic growth for the United States, which the authors attributed to the fact that the country had already r apieceed optimal level of fiscal autonomy and thus no further relegate on this line was possible. Thieban (2001) do use of OECD countries cross sectional data for the period 1975 to 1995, but the study failed to establish any link between revenue decentralization of the low-level governments and economic growth of these countries.Martinez Vazquez and Mc Nab (2001) argued that the relationship betwe en fiscal decentralization and economic growth is still unclear, and that little attention has been paid to indirect factors through which fiscal devolution may influence economic growth. In contrast to the above conclusions, Lin and Liu (2000), while using panel data of 28 provinces for the period 1970 to 1993, arrived at the conclusion that there exists a positive relationship between fiscal decentralization and economic growth in China. The authors say that the impressive growth of china for the last twenty years can be link to fiscal reforms.Ebel and Yilmaz (2001), observed that Fiscal design of OECD countries is unable to explain Fiscal decentralization in true sense. Martinez Vazquez and Mc Nab (2003), on the foothold of panel data, covering the period 1972-1997, studied the direct and indirect relationship between fiscal decentralization, economic growth and macroeconomic stability . They arrived at the conclusion that devolution minimizes the inflation rate, has no dire ct influence on economic growth, and has positive indirect effect on growth as it results in on macroeconomic stability.Justin Yifu and Zhiqiang (2000), investigated the implications of fiscal decentralization of economic growth in China, and found that it has made remarkable contribution to economic growth. This finding is in conformity with the hypothesis that Fiscal devolution enhances economic efficiency. Fielstentein and Iwata (2005), while using VAR (Vector Auto regressive) bewilder found that there is a relationship between decentralization and macro economic surgical process in China. They concluded that Fiscal decentralization is positively related to growth in the period after the war, and has negative effects on the inflation rate after the 1970s.While using the cross country data for 78 countries, Mello and Barenstein (2001) observed that as the parcel of land of receipts, including non-tax revenue, grants and transfer of funds, from the federal government increases i n the conglomeration provincial revenues, the relationship between financial devolution and governance grows stronger. Shah (1991) pointed out that poor performance in most of the developing countries in the last 40 years can be attributed to highly centralized regimes.Huther and Shah (1998) noted that good governance and fiscal decentralization are positively related, which in turn may enhance economic growth. Akai and Sakata (2002) utilize single country data and predicted that fiscal decentralization plays a role in economic development. They pointed out that in the United States, high government spending was unavoidable in the initial phases of economic development, therefore, any analysis that took into consideration this period is bound to overestimate the role of central government in the economic development.This led Xie et al (1999) to declare that decentralization has adverse effect on economic development. Jorge Martinez-Vazquez and Mark Rider (2006) pointed out the st ructure of financial system plays a pivotal role in determining the conduct and performance of low-level governments, which indirectly influence economic growth of a country. According to them, though both China and India show great financial decentralization, the central governments restrict the fiscal autonomy of the sub-national governments through conditional grants and inadequate powers to raise revenue.Thus, the regional governments are forced to use extra budgetary allocations to bastinado their financial constraints, which results in waste of resources. These structural infirmities in the financial systems incriminate profligacy and un resultive expenditure policies, which may hamper the growth rate in the future in both the countries. Nobuo Akai, Yukihiro Nishimura and Masayo Sakata (2007), while using panel data of the fifty states of the US, showed that fiscal decentralization minimizes the strain of GDP growth due to decentralization among various levels of government .They also observed that there exists a negative relationship between fiscal devolution and economic volatility. Hiroko Uchimora and Yurika Suzuki (2009) studied Fiscal Decentralization in the Philippines after the promulgation of Local Government code (1991) . This study examined the fiscal relationship between the central and sub national governments by using the indicators of Fiscal decentralization. According to their findings, in the Philippines, the responsibility to incur expenditures by the topical anaesthetic governments is not accompanied by corresponding strengthening of the fiscal capacity.As a result, topical anaesthetic governments rely heavily on fiscal transfers from the central government and Internal Revenues Allotment, which render the local finance unstable. Atushi Alimi(2004) Although , in theory, decentralization promises efficient provision of public service at local level, empirical evidence gives a mixed picture regarding its implications on economic growt h. They attempted to resolve this inconsistency by using subservient technique on the data for the period 1997 to 2001.In this study, fiscal decentralization is measured in basis of the ratio between local expenditure to nub government expenditure. The result showed a significant positive relationship between per capita growth rate and Fiscal decentralization. Perraton, J. and Wells, p. (2003), in their paper, Multi level governance and stinting cohesion noted three general headings in economic policy devising the transfer of powers to supranational institution in economic policy formulation, e. g. he formation of the European Union and World Trade brass section secondly, almost all developed countries have established regional organizations, to which powers of economic policy-making have been devolved. In the transition states, there is a growing tendency towards decentralization to curtail expenditures and to make the governments more accountable thirdly, the governments are now inclined to reduce their sizes and make alternate arrangements for governance through NGOs. This concept of governance is referred to as multi-level governance.In Pakistans case, Fiscal Federalism has been studied in detail. According to Anwar Shah, World Bank (Dec, 2006), there are two slipway of transferring funds from the Centre to the provinces assigning share of the federal revenues to the provinces at a pre-determined rate and direct transfer of funds (other than revenue) from the Centre to the provinces. According to him, the revenue sharing system in Pakistan make believes the transfers in a lump sum and predictable manner to the federating units, which are at liberty to use these funds the way they choose.The author further argues that NFC places greater responsibility of revenue accruement on the Federal government, thereby making the tax machinery efficient and tax compliance cost effective. The Revenue sharing system may have its merits, but it is also associated with certain demerits. For example, the provinces enjoy Brobdingnagian discretion in the utilization of funds, but have no control over the amount of funds they receive from the centre the federal government cannot influence the provinces to set priorities for achieving uniform standards in reas like health and Education the provinces receive the funds without any strings attached to it , therefore, they feel less accountable while spending the funds the share received by the provinces have no relation with the expenditures they incur, as unremarkably the expenditures outgrow the rate at which the Federal revenue grows. Nighat Bilgrami and Mahpara Sadaqat (2006) have given an account of evolution and working of NFC Award ever since its introduction in 1951. According to the authors, with the exception of 1974 Award, there is a growing tendency in increase of revenue transfer to the provinces.The major step forward in this direction was the 1991 NFC Award, wherein new taxes were allowd in the divisible pool. In addition, as envisaged in Article 161 of the Constitution, royalty on crude oil and surcharge on gas were also transferred to the provinces. This caused greater decentralization of funds, which over a period of time played a pivotal role in improving service delivery in health, education and irrigation etc sectors. The paper identifies various forms of fund transfers from the Federal government to the provinces.These include Revenue Sharing Transfers, Straight transfers, Recurring Grants, Development Grants and loans. The authors have also elucidated that how resources are transferred in Pakistan from the federal government to the provinces in four ways from the centre to the provinces, from provincial to local governments, from the federal government to the local governments and from local to local governments. The paper also gives a rationale for transfers of resources from the federal to provincial and municipal governments.At the end of the pap er, the authors have suggested that smaller provinces be provided with soft loans and factors like backwardness and poverty be also considered while allocating the resources. Moreover, the provinces should be allowed to buckle under revenues that fall within their do main. Iftikhar Ahmed, Usman Mustafa and Mahmood Khalid (2007) have dilated upon the evolution of resource distribution over time. According to them the divisible pool has been expanded by the comprehension of more taxes.However, as creation is the sole criteria for the distribution of resources through NFC awards, it has given birth to serious differences among the provinces. The paper says that resources are transferred from the centre to the provinces in two ways Systematic or linguistic rule Based transfer, comprising of revenue sharing and random transfer, including grants, executive discretionary funds and Parliamentarian funds etc. According to the authors, with the enactment of time the federal government ha s become more centralized, thereby adversely affecting the efficiency of the provincial governments.The federal government has got engaged in activities that purely fall within the purview of provinces. These include irrigation, roads, culture, tourism, youth affairs etc. This has increased the burden on federal government. The Federal government collects 93 % of the revenue but expends only 72%, whereas the provinces generate just 7% but spend 28%. The argument behind greater revenue collection by the centre is that it is more efficient in revenue collection than the provinces. tho this argument is flawed as the provincial and local governments are left with lesser opportunities to collect revenue.This results in the addiction of the provinces on the federal government for transfer of resources. In this paper, NFC Award has also been criticized in that the criteria for resource distribution are mainly macrocosm. Elsewhere in the world, other factors like backwardness, people de nsity, and revenue generation are also considered while devising a formula for distribution of resources. According to the authors, the major shift towards fiscal decentralization appeared in the 1996 NFC Award, whereby all duties and taxes were included in the divisible pool.By so doing transparency and predictability in resource distribution was though enhanced, yet the resource distribution formula between the federal and provincial governments changed little. The paper says that resources distribution has never been taken seriously. Only one criterion, that is population, has been followed for resource distribution, thats why the NFC Award has failed to resolve the hassle of Fiscal Decentralization. Usman Mustafa (2011) has highlighted the importance of federal form of government and has argued that even European Union has the characteristics of federalism.While referring to whole shebang of notable authors on the subject, it has been argued that Fiscal Decentralization increa ses efficiency, transparency and accountability. According to the author, in Pakistans case, there are pre-federalism (from 1947-71) and post federalism (from 1973 onwards) periods. In the first perid, the leave was centralized (one unit), whereas the second period is characterized by the march towards decentralization of powers from the centre to the provinces. In this scene, the author argues that NFC Award is a step forward towards decentralization.He, however, criticizes population cosmos suitable criteria for resource distribution between the centre and the provinces. In order to remove the grievances of the smaller provinces, a historical decision was taken in the 7th NFC Award on Dec, 2009 at Gawadar, to which all the provinces agreed. In this award, the demands of the smaller provinces were accepted, and a multifactor formula was devised. In the formula, factors like poverty, underdevelopment and inverse population density were also included for resource distribution. Mor eover, the Federation sacrificed more that 10% of its share in favour of the provinces.It was also agreed that collection charges received by the Federal government on revenue would be curtailed from the existing 5% to 1%. This will increase the volume of net transfer of revenue from the federal to the provincial governments. All these decisions taken in the 7th NFC Award will contribute favourably towards Fiscal Decentralization in Pakistan. According to Kardar (2006), local governments have significance both in the context of Devolution plan and failure of central and provincial governments to deliver shade services to the masses ever since the emergence of Pakistan.He further argued that though command on devolution is a landmark achievement, the biggest challenge is to settle the row over powers between the provinces and district governments. Dr. Shahnawaz Malik, Mahmood-ul-Hassan and Shahzad Hussein analyzed the relationship between Fiscal decentralization and economic growth for the period 1971-2005. They obtained mixed results on the basis of different variables used in analysis. The study further showed that with the round-the-clock rise in the share of provincial government revenues and expenditures, economic growth slows down.Naeem-ur-Rehman Khattak, Iftikhar Ahmed and Jangraiz Khan, while using time series data, for the period 1980 to 2007, analyzed the resource distribution, and studied the furbish up of financial decentralization on the economic growth of Pakistan. According to them, the divisible pool has expanded over the years by the inclusion of more taxes in it. They pointed out that the resource distribution mechanism failed to affect economic growth positively, and suggested that the distribution formula be revisited, having regard to factors like tax collection and backwardness of the provinces.They further suggested that more powers be delegated to the provinces to raise their own revenues. Chapter 3 THEORETICAL BACKGROUND AND ECONME TRIC METHODOLOGY 3. 1 Introduction In this chapter we discuss the theory which guides our research, variables of our personate, type of statistical relationship and the regulate we will use for estimation. 3. 2 THEORETICAL BACKGROUND Various forms of Decentralization. It refers to the delegation of powers and functions from the central to low-level governments. There are three main forms of decentralization (JICA 2008) . 2. 1. Decentralization It is the weakest type of decentralization, and refers to the transfer of decision making powers along with financial and management responsibilities from the officials in the centre to those serving in the local /regional offices. 3. 2. 2. Delegation Here the powers are delegated to the autonomous bodies, including corporations, housing government etc. , working under the supervision of the central government. These organizations enjoy vast discretion and decision making powers. 3. 2. 3.Devolution It is the gradual transfer of administrati ve, financial and governmental authority to the local bodies, which exercise their powers and functions within certain geographical confines. It has three main constituents, as discussed below a) Political decentralization It refers to the shifting of powers and authority to local bodies, run by local governmental representatives. It has a well-established system of political decision-making and accountability at the local level. b) Administrative decentralizationIt is the form of devolution whereby staff of line ministry is dissociated from their corresponding ministries and brought under the control of the local administration. This is done through establishing local pay roll, which empowers them to reward and punish the staff. c) Fiscal decentralization It refers to the shifting of authority and responsibility to the sub-level governments with regard to decision-making on distribution of financial resources. This also includes the powers to raise local revenue.Fiscal decentrali zation has attracted great attention, among the economic circles, particularly for improving service delivery at the local level. The main objectives of Fiscal decentralization include efficient utilization of resources, effective service delivery, macroeconomic stability and economic growth. With these objectives in view, the developing world is following the pattern of Subsidiarity, which emphasizes that authority should rest with the lower tiers of government for effective use, and that the responsibility of incur expenditures should match with adequate financing.Decentralization leads to efficient utilization of funds through service in governance, as lower strata of government can better tax peoples problems and know their priorities. Decentralization enhances participation of local population as the beneficiaries are directly involved in planning the allocation of funds. Increased decentralization gives birth to democratization, which keeps the government close to the mass es, thereby making it more accountable. 3. 3 Various theories regarding decentralizationThe above narrated advantages, and many more not discussed here, emphasize the importance of Fiscal decentralization. But it was since the publishing of Tiebouts article, A pure theory of local Expenditure that this concept has gained great popularity among the theorists, and the volume of literature on this topic has increased tremendously. According to Tibeout (1956), Fiscal decentralization improves production efficiency through greater mass mobilization. In 1959 Musgrave pointed out that the role of government is to bring stability to the market and effect the redistribution of income.He further argued that efficient utilization of resources can be secured only when local tastes and choices are taken into consideration. Oates (1972) pointed out that people living in different localities have peculiar tastes and preferences for public service, therefore, local governments, as against central g overnment, being better informed, will provide better services to its citizens. This concept is called Oates Decentralization Theorem, consort to which economic efficiency can be enhanced by decentralize the availability of public goods and services.Thus, the central government should be responsible for devising a national policy and providing efficient levels of government for distribution of goods . (Oates,2005) So, weaponed with the requisite paraphernalia , the sub-national governments are in a better amaze to put in place welfare-maximizing policies. Cremer, Estach and Seebright (1994), stated that government at the centre cannot reach the information about local tastes and choices. Thus, it is through Fiscal Decentralization that local agents can bring about efficient tag on of goods and services to their constituencies.Almost identical views were expressed by Qian and Weingast (1997), who opined that decentralization puts a check on budget expansion by promoting competiti on and strengthening accountability, which effects supply of goods and services in an efficient manner. Having said this, there is evermore a tendency among the local political agents to enlarge the scope of public goods and services at the cost of other jurisdictions. Rodden (2003) attributed this predilection to the type of decentralization being followed.If decentralization is helpless on self-generated tax revenue, smaller governments emerge and if transfer of funds occurs from the centre, it results in budget expansion. Though from economic and political point of view there are many benefits of Fiscal decentralization, yet it is not a cure for all ills. For instance, Fiscal Decentralization entails passage of Economies of Scale and loosens control over scarce resources. From it follows that centralization and Decentralization are not alternatives, rather the countries should find a balance between the two as per their requirements. . 4. Rationale for Fiscal Transfer in Pakis tan The first reason is the general perception that the federal government is better equipped to collect major taxes, but is inefficient to collect smaller taxes. Also, the federal government may undertake major projects, but fail to deliver on smaller projects. Hence, the efficiency criteria must be followed while deciding allocation of means and responsibilities. The second reason for resource transfer from the centre to the provinces is that the last mentioned lack the resources to finance the provision of even basic services.In the last ten years, the average revenue generated by the centre, provinces and municipalities stand at 89%, 5% and 6% separately. As against the revenue generation, the share in recurring expenditure of the federal, provincial and municipal governments is 74%, 23% and 4% respectively. As regards developmental expenditure, the share of these governments is as follows Federal government 65%, provincial government 25% and municipal governments 6%. These f igures indicate that the provinces have limited resources twin the amount of expenditure they incur.This necessitates the transfer of resources from federal to lower-tiers of government. Another reason that can be attributed to the allocation of resources among the different levels of government is Adequacy of Revenue. This concept refers to the susceptibility of government not only to generate the initial revenue need to start a project but also to its ability to accept it. In Pakistans case, Adequacy of revenue does not exist because transfer of resources to the lower tiers of government is necessary if they are to undertake any such projects.The fourth reason of transfer funds from the centre to the provinces is that there are taxes which though provincial in nature but is collected by the federal government, for example Sales Tax. Another rationale for transfer of funds is that federal government uses certain taxes for the overall stabilization of the miserliness hence the y should be under the control of the federal government. NFC AWARDS Commentary and Agenda, Nighat Bilagarami, Jaffery and Mahpara Sadaqat (2006). 3. 5 ECONMETRIC METHODOLOGY 3. 5. 1Augmented dickey cram full (ADF) Test In this study a time series data is being used.Since this kind of data is usually non-stationary in nature, we first test it for stationarity or non-stationarity. For this intent, an enhanced version of Dicky fuller Test, known as Augmented Dicky sperm-filled Test, is being employed. The ADF includes extra lagged terms of the subject variable so as to remove auto-correlation. The following equations denote the three possible forms of ADF Test. i) Without any constant and trend ?yt=? *yt-1+i=1p? i? yt-i+et ii) everlasting with non trend ?yt=a+? *yt-1i=1p? i+? yt-1+et iii) Constant with trend ?yt=a+? t+? *yt-1+i=1p? i+? yt-1+etOf the above equations, (iii) represents a more generalized form of ADF Test. Mackinnon(1991) gave searing grades for the DF test The cri tical values for the ADF Test are the same as those for Dickey Fuller Test. If the DF Statistical value is smaller than the critical value, Null hypothesis of a unit root is discarded, which suggests that the yt is stationary process or the variables are stationary. If on running the ADF Test the variables are found non-stationary in their original levels of series, the variables are made stationary in their first difference level of the series. . 5. 2 Ordinary least square model (OLS) Once the variables are made stationary, estimation is made by employing Ordinary least square model (OLS). This model is suitable for ascertaining linear interdependencies in a time series data. Here it is also worthwhile to discuss Regression model. A aggregate linear regression model estimates value of dependant variable (also called reply variable) on the basis of independent variables (also called explanatory variables). But there is always a difference in estimated and observed values.Therefor e, a Regression model also possess unexplained variable, also called error term, which measures the difference between observed and estimated values. y= b+b1 x1+ b2 x2+ b x3 +ei A regression model will be best fit if the difference between observed and estimated value is minimum. We cannot take error term by simply adding all the difference between observed and estimated value because it may contain both positive and negative values which can cancel the effect of each other. So, we take the square of error terms which leads us to OLS . i. e. minimum square up difference.OLS is useful for structural inference and policy analysis. For the purpose of Structural compendium of data, certain assumptions regarding the causality of data are made. These are error term (i) is normally distributed (ii) has zero expected value of mean (iii) has constant variance in each time period and for all values of X and (iv) its value in one time period is unrelated to its value in other time period. OLS is a very simple technique by which we can calculate the coefficient of each variable in other words it gives us the impact of one variable on another variable, which is summarized by impulse response function. Chapter 4 DATA AND VARIABLE 4. 1 inception This chapter covers how data is collected, what are sources of our data and how variables have been constructed variables for our estimation. 4. 2 entropy type For the purpose of studying the relationship between Fiscal decentralization and economic growth, secondary data is being utilized. 4. 3 Sources of data For the purpose of this study the following sources have been utilized. i) Issues of frugal survey of Pakistan ii)World Development Indicators iii)Ten years in Pakistan Statistics (1983) iv)UNDP Human Development Report, 2007. )Hand book of Statistics on Pakistan Economy (2005) 4. 4 Construction of variables scotch growth of the country is taken as dependant variable. It is measured in terms of per capita Log of per capita gross domestic product (LYP), which is rebased by the year 2000 market prices. The variable is expressed in current terms using GDP deflator to ascertain the pattern of economic growth over the years. The Fiscal decentralization is captured on the ratio of Provincial share in Total Revenue to the Total Revenue (PRFR). The data source for these variables is Economic survey of Pakistan and covers the period from 1964 to 2008.As regards investment, it is captured by the Gross Fixed with child(p) Formation (GFCF) and data is taken from Pakistan Economic Survey Moreover, a variable for trade openness (OPN) is also used in the estimation model. This variable is obtained by adding imports and exports and dividing the same by LYP (at market prices). Here, too, the source of data is Economic Survey of Pakistan Other variables in the estimation model are Tax to GDP ratio (TGDP) and GINI co-efficient, the latter being used to calculate income equation and its source is UNDP Human Development Report. Chapter 5 RESULTS AND DISCUSSION . 1 INTRODUCTION The section consists of results and their interpretation. In para 5. 1, 5. 2 and 5. 3 Stationarity of data, Autocorrelation and the results of OLS model respectively have been discussed. 5. 2 Unit Root test In a time series data, the major problem is the non-stationarity of variables. So, before estimation, a test is applied to make the variables stationary. For this purpose various tests can be employed, but in our case we have used Augmented Dickey Fuller test, the results of which are shown in table 5. 1 below. slacken 5. 1 building block ROOT TEST Non stationary variables ADF-value 5% Critical value Gfcf -1. 693492 -2. 9303 Gini -2. 462911 -2. 9303 Lpy 0. 863730 -2. 9303 PRFR -2. 206432 -2. 9303 TGDP 0. 158213 -2. 9303 stationary variables ADF-value Critical value Gfcf -3. 997577 -2. 9320 Gini -4. 766215 -2. 9320 Lpy -4. 632922 -2. 9320 OPN -3. 453532 -2. 9303 PRFR -3. 662186 -2. 9320 TGDP -3. 01612 -2. 932 0 Gfcf- Gross fixed capital formation, Gini- Income inequality, Lpy- Log of GDP, OPN- nakedness to trade (export+import/GDP), PRFR- Ratio of provincial shares in total revenue to total revenue, TGDP- Tax to GDP ratio.At the level, all the variables except OPN were found non-stationary, and were, therefore, stationarized at First difference level by using ADF Test. 5 . 3 TEST FOR AUTOCORRELATION Autocorrelation tells about the relationship between two or more error terms in the model. For unbiased estimation, autocorrelation must be zero. If there exists problem of autocorrelation, it has to be removed. For this purpose, two hypothesis are constructed one, H0 Co-Var(u,u+1)=0,there is no autocorrelation between the error terms and second, Ha Co-Var(u,u+1)not equal to zero, meaning there is a problem of autocorrelation.To check autocorrelation in our model, we have used Breusch-Godfrey Serial correlation coefficient LM Test (BG TEST), as shown in table 5. 2. According to the table, c hance of F-statistic is significant at 5%, so we reject the hypothesis that cov (ut, ut+1) is equal to zero. In other words, there is autocorrelation problem in our model. In order to remove the autocorrelation problem, we have applied ARMA model with autocorrelation through AR (1), AR (3) and MA (2). Breusch-Godfrey Serial Correlation LM Test F-statistic 4. 781666 prospect 0. 001241 Obs*R-squared 20. 50376 Probability 0. 002252Probability of F-statistic is significant at 5%, so we reject the hypothesis that cov (ut, ut+1) is equal to zero. It means there is autocorrelation problem in our model. 5 . 4 ESTIMATION The results of the estimation with OLS are tabulated in Table 5. 3 below Dependent variableLPYMethod Least Squares Date 03/25/12 Time 1113 Variable Coefficient t-Statistic Prob. GFCF 0. 004693 3. 806074 0. 0006 GINI -0. 324275 -2. 919698 0. 0065 OPN 0. 000254 0. 468847 0. 6425 PRFR -0. 000173 -0. 517278 0. 6086 TGDP -0. 003194 -0. 809929 0. 4242 R-squared 0 . 97793 Prob(F-statistic) 0. 000000 Adjusted R-squared 0. 997081 Durbin-Watson stat 1. 705104 In the model R2 shows strength of the regression line, which means how much important variables are covered by a model or how well vicissitude in independent variables explains the variation in dependent variable. For time series analysis R2 value must be greater than 0. 70 or 70%, which means the model must explain at least 70% of the total variation in dependent variable. In our results, R2=99% value is greater than 70%, so 99% of variation LPY is explained by our variables i. . GFCF, GINI, OPN, PRFR, TGDP. But the values in the 3rd column against each variable show t values. If the t value, in absolute form, is greater than 2, the relationship between the variables is significant. In our case, the financial autonomy is measured in terms of Ratio of Provincial share in Total Revenue (PRFR), whereas the Economic growth is captured on the variable LPY. It is evident from the table that the relationship between LPY (dependent) and PRFR (independent) is insignificant because the devalues, in absolute form, are less than 2.It implies that LPY is not influenced by PRFR. In other words, in Pakistans case, Fiscal decentralization has no bearing on economic growth. The model shows that GFCF and GINI with variables have t value greater than 2 in absolute form affect economic growth. Durbin-watson value in the table tells us about the problem of auto-correlation in the model. If the value of Durbin-watson test is between 1. 7 and 2. 2 there will be no auto-correlation. In our table its value 1. 7, so we say that the problem of auto-correlation has been removed.CHAPTER NO 06 CONCLUSION This study focuses on identifying the impact of fiscal decentralization on economic growth through compiling of its historical trends. It is generally believed that that proper information about the existing fiscal decentralization system will lead to better policy formulation, which wi ll ultimately put the country on the road to prosperity. In this regard, it is also worthwhile to analyze the implications of the current fiscal decentralization policy on the economic growth of the country.Thus, this study helps ascertain the extent of financial autonomy of the provinces and measures its long term benefits. In this study secondary data has been used, which covers the period from 1964 to 2008. Provincial share in total revenue (PRFR), GFCF- Gross fixed capital formation, Gini- Income inequality, OPN- Openness to trade (export+import/GDP), PRFR- Ratio of provincial shares in total revenue to total revenue, TGDP- Tax to GDP ratio are dependant variables, whereas LPY (Log of GDP) is dependent variable in the data.We used OLS model for our estimation, the results of which revealed that only GFCF and GINI have significant impact on GDP growth. On the other hand the influence of, OPN, TGDP and PRFR on economic growth (LPY) are insignificant. As PRFR and LPY measure the ex tent of fiscal decentralization and Economic growth respectively, we conclude that economic growth in Pakistan does not depend on fiscal decentralization. This may be due to the fact the Resource Distribution Formula has been mainly based on population. The results of other factors, included of late in the NFC Award, are yet to be seen.It is, therefore, proposed that not only the impact of population in the distribution formula be diluted by the inclusion of other factors, being emphasized by the smaller provinces, but also the powers of the provinces with regard to revenue generation be enhanced. 1 . The words, Financial devolution, financial autonomy and Financial /fiscal decentralization are being used interchangeably in this study. 2 . In this discussion ,the words, federating unit, unit, province, sub-national government and low-level government will be used interchangeably.