The IMPACT of Human Capital and Foreign Direct Investment on Productivity in Pakistan

Human capital is a major driving force for better productivity of an economy. Human capital development refers to improvement in skills and efficiency of individuals that leads to higher productivity. This study examines the effect of human capital and foreign direct investment (FDI) on the total factor productivity (TFP) for Pakistan in presence of trade openness, government expenditure and inflation using annual data over the period of 1970 to 2014. The study uses Johansen co-integration technique and error correction method to examine the long run and short run relationship among the above mentioned variables. The results indicate that the variables are co-integrated and therefore exists a long run relationship among the variables. Moreover, a positive long run relationship exists between FDI and TFP in Pakistan. FDI inflows bring in new ideas and technologies in the host country exposing the labor to better methods and skills hence increasing the efficiency of the domestic factors of production and the results of this study are consistent with this theory. Human capital represented by education expenditure is found to have a positive significant effect on TFP in Pakistan. The results also suggest that government expenditure has negative but insignificant impact on TFP. The trade openness however has a significant positive impact on productivity. Pakistan is a labor intensive developing economy and in order to fully utilize its economic resources it needs to improve the quality of human capital to be able to increase productivity growth. An increase in education expenditure, better healthcare facilities and betterment of school conditions is a prerequisite to increase the productive capabilities of people. Government needs to particularly focus on diverting its expenditure on education to create an efficient workforce that would result in an increase in factor productivity which would eventually contribute to long run growth of the economy.