The Impact of Economic Factors on Income Inequality in Pakistan: A Cointegration Analysis

Abstract

This paper investigates the effects of nominal devaluation on income distribution in Pakistan, considering a range of economic factors relevant to the country's context. The empirical model incorporates variables such as per capita economic growth, trade openness, foreign direct investment, unemployment, and inflation rates. These variables are chosen based on their significance and potential impact on income distribution within the Pakistani economy. To analyze the long-term relationship among these variables, the Auto Regressive Distributed Lag (ARDL) bounds testing approach to cointegration is employed. Additionally, the short-run dynamics are examined using the Vector Error Correction Model (VECM). The study also tests the Kuznets inverted-U hypothesis, which posits a nonlinear relationship between income inequality and economic growth. The findings reveal several key insights. Firstly, there is evidence of a long-run relationship among the variables under consideration. Secondly, nominal devaluation is found to exacerbate income inequality in Pakistan. While economic growth initially appears to deteriorate income distribution, the analysis reveals a non-linear relationship consistent with Kuznets' inverted-U hypothesis, suggesting that as the economy progresses, income inequality may decrease over the long term. Furthermore, the study highlights the adverse effects of FDI and trade openness on income distribution, indicating that these factors worsen income inequality in Pakistan. Conversely, inflation is found to lower income inequality, although unemployment exacerbates it. These findings provide valuable insights for policymakers in Pakistan, suggesting the importance of carefully managing economic policies related to nominal devaluation, FDI, trade openness, inflation, and unemployment to mitigate income inequality and promote long-term economic development.