J. Basic. Appl. Sci. Res., 5(2)14-23, 2015 © 2015, TextRoad Publication ISSN 2090-4304 Journal of Basic and Applied Scientific Research www.textroad.com Corresponding Author: Khalil Jebran, MS Scholars at Mohammad Ali Jinnah University Islamabad Pakistan. Contact # 00923459517844; khaliljebranuom@gmail.com Effects of Government Expenditure on Private Investment: Evidence from Pakistan Mohib Ur Rahman, Irfan Ullah and Khalil Jebran MS Scholars at Mohammad Ali Jinnah University Islamabad Pakistan Received: September 16, 2014 Accepted: January 16, 2015 ABSTRACT This study has examined the impact of different components of government expenditures on private investment in Pakistan over the period of 1974 to 2010. The Johansen and Juselius co-integration approach along with VECM are applied in order to check the direction of long and short-run liaison for Pakistan. Results indicate that the real impact of government expenditure depends upon on the type of expenditure under consideration. The government expenditures on agriculture, health and transport & communication along with inflation show a crowding-in (positive) impact on private investment in the long-run while community servicing and debt servicing expenditures show a crowding out (negative) impact on private investment. Outlays on education (positive) and defence (negative) were insignificantly related with private investment. The analysis suggests that more priorities should be given to those expenditures which have complimentary impact on private investment rather than spending on expenditures that are substituting (hindering) private investment. KEY WORDS: Government expenditures, private investment, inflation, crowded in, crowded out. Jel Classification: C22, E62 INTRODUCTION Investment is a well-established fact for economic development and growth in any developing country. It is the devotion of money for a certain period of time in order to get future benefits. It is a common opinion of the economists that investment has a favorable impact on economic growth. Still, it is vague that which investment (public or private) bear superior influence on economic development. Private investment has been recommended as more fertile and superior determinant of economic growth by financial and empirical evidences from around the globe [1]. Private investment (PI) is the gross fixed capital formation of the private sector, where gross fixed capital formation is spending on acquirement of fixed assets which includes spending on equipment, building construction, machinery and similar goods like constructions of dams, tunnels, drainage, roads, harbors and ports, transport and communication equipment. It also incorporates the capital maintenances while abstracts the sale of fixed assets [2]. Public investment on the other hand, refers to Government investment i.e. Government expenditures or spending, which are carried out by Central, State and Local governments of any country in order to satisfy the mutual and social wants of the people of the country. The problem of whether or not government expenditure crowded out or crowded in private sector investment (PSI) has brought considerable attention within the financial literature. From a theoretical point of view, a rise in government expenditure might have two consequences on PI. First, the increase regarding government expenditure has to be financed that might imply a lot more taxation or perhaps inflict a greater demand for capital from the government in the capital market, as a result triggering interest rates to increase. This will reduce the amount of financial savings available for private investors and also decrease the expected rate regarding the return of private capital leading to a substitutary effect on private expense. Secondly, government expenditure can create a favorable impact on private investment, for instance, by spending or perhaps investing in related infrastructure like streets, highways, sewage methods, harbors or perhaps international airports will reduce cost of transportation and hence facilitate an environment for private investment. Thus the existence of infrastructure facilities may raise the productivity of the private sector, which can then benefit from better overall infrastructures and also potentially improved business environment. This will lead to enhance (crowds-in) private investment. Background of Investment Policies in Pakistan After getting independence in 1947, the new government of Pakistan was lacking the necessary institutions, workforces and resources in order to develop the economy. The role of government was limited to only four basic 14