Political and Economic Uncertainty and Investment Behaviour in Pakistan

Abstract

This study analyses the effect of political stability and macroeconomic uncertainty on aggregate investment behaviour in Pakistan over the period 1960–2015. The Auto-Regressive Distributed Lags (ARDL) methodology is applied to explore both the long-run equilibrium relationship and short-run behaviour of investment. The macroeconomic uncertainty variable is derived from real exchange rate and is computed by the best-fitted GARCH model. The results reveal robust effects of political stability and macroeconomic uncertainty on overall investment activity in Pakistan. The government nationalisation policy, GDP growth, user cost of capital, credit availability and degree of openness are found to be the other key determining factors for investment both in long- and short-run. However, the favourable impact of physical infrastructure on investment holds in long-run only, while its effect is adverse though insignificantly in short-run. The findings support the neoclassical flexible accelerator principle and are consistent with economic theory. The volume of available funds is the binding constraint for investment and the McKinnon-Shaw hypothesis is validated in the short-run. Keywords: Aggregate Investment, Irreversibility, Macroeconomic Uncertainty, Political Stability, GARCH, ARDL, Bound Testing Approach, Pakista