## 1. Structure of Production

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### I. Introduction
- Papua New Guinea experienced volatile and declining growth since 1960:
  - GDP increased at an average rate of 5.5 percent during 1960–75, slowed to 2.3 percent during 1976–2004, and to less than 1 percent during 1996–2004.
  - Estimated per capita real GDP at the end of 2004 was about 50 percent lower than at independence in 1975.
- Contributing factors to weak performance:
  - Unfavorable external environment, poor governance, law-and-order problems, deep-seated structural impediments, poor physical infrastructure, and inadequately focused macroeconomic policies.
- Purpose and methods:
  - Reviews GDP trends and compares Papua New Guinea with other East Asian and Pacific countries.
  - Uses an aggregate production function and growth accounting framework with annual data for 1960–2004 to estimate TFP growth and its evolution.
  - Analyzes medium-term growth prospects under alternative TFP assumptions and estimates average investment needed for alternative growth projections.
  - Uses time-series analysis to empirically assess determinants of productivity growth.

### II. Structure of the economy
- Composition and sectoral evolution:
  - Economy dominated by a large, labor-intensive agricultural sector and a capital-intensive oil and minerals sector.
  - Formal sector: enclave extractive industries (mining, petroleum, and logging), cash crop production, small import-substituting manufacturing sector. Informal sector: largely subsistence agriculture.
  - Primary sector share of GDP: about 40 percent in the 1970s; about 30 percent in 1985; about 38 percent in 2002–04.
  - Mining sector: negligible in the 1970s → about 30 percent in early 1990s → about 13 percent during 2003–04.
  - Manufacturing: varied 5 to 11 percent since the 1970s; about 6 percent most recently.
  - Construction: around 5 percent of GDP in first half of 1990s; activity picked up since recovery began in 2002.
  - Services: more than 40 percent of GDP during 1970s–1980s; declined to 29 percent in 2004.
- Notable constraints and developments:
  - Mining overwhelmingly foreign-owned; law-and-order issues caused sector disruptions (e.g., Bougainville mine closure in 1989).
  - Significant future projects noted: Ramu Nickel Project and Papua New Guinea-Queensland Gas Project.
  - Structural impediments to manufacturing: shortage of entrepreneurial, managerial, and skilled labor; complicated regulations; high utility and transport overheads; high labor cost relative to productivity.
  - Transport, communications, community and personal services deteriorated or were adversely affected by law-and-order and governance weaknesses.

### III. Trends in GDP and per capita GDP growth
- Historical patterns:
  - 1960–1975: economy grew at an average annual rate of over 5.5 percent; population growth about 1 percent.
  - Late 1970s/early 1980s: slowdown due to first oil price shock and repatriation of Australian expatriates around independence in 1975.
  - 1985–88: brief recovery from strong commodity prices; 1989 decline from Bougainville mine closure and mineral price decline.
  - 1991–94: mineral boom partly offset earlier adverse effects.
  - By 1994: macroeconomic imbalances led to a balance of payments crisis; policy responses included curtailment of public expenditure, devaluation of the kina, abandonment of the “hard kina”.
  - 1997: growth fell due to severe drought, lower external demand from the Asian crisis, low mineral prices, and law-and-order problems.
  - 1996–2002: real GDP grew by less than 1 percent.
- Vulnerability:
  - High dependence on commodity exports increases vulnerability to external shocks.
  - Bougainville mine remained closed as of late 2005.

### IV. Investment
- Aggregate and sectoral patterns:
  - Gross capital formation averaged about 21 percent of GDP during 1984–2004, with considerable fluctuations.
  - High investment during 1976–85 associated with mining and mining-related construction.
  - Real gross fixed capital formation fell to 13.7 percent of GDP in 1998, compared with 21 percent in 1984, driven mainly by outflow of foreign capital since 1994.
- Role of public and foreign investment:
  - Public investment low by global standards but can stimulate private investment (examples: publicly funded airport, Poreporena Highway in Port Moresby).
  - Australia largest foreign investor; U.S., U.K., Canadian mining interests in major mines; Malaysia significant in fisheries, timber, trade and construction subsectors.

### V. International growth comparison (selected per capita PPP growth rates)
- Papua New Guinea per capita growth (select periods shown exactly as in source):
  - 1961-75: 3.4
  - 1976-85: -1.4
  - 1986-95: 1.8
  - 1996-2000: -4.8
- Comparator country entries preserved exactly:
  - Bangladesh: 1961-75: -0.4; 1976-85: 1.9; 1986-95: 2.4; 1996-2000: 2.8.
  - Fiji: 1961-75: 2.8; 1976-85: 0.8; 1986-95: 2.0; 1996-2000: 1.1.
  - Indonesia: 1961-75: 2.8; 1976-85: 4.9; 1986-95: 4.8; 1996-2000: 0.2.
  - Malaysia: 1961-75: 3.6; 1976-85: 4.2; 1986-95: 4.8; 1996-2000: 2.7.
  - Thailand: 1961-75: 4.7; 1976-85: 4.6; 1986-95: 7.5; 1996-2000: 0.5.
  - Australia: 1961-75: 2.6; 1976-85: 1.7; 1986-95: 2.0; 1996-2000: 2.8.
  - New Zealand: 1961-75: 1.9; 1976-85: 0.6; 1986-95: 0.8; 1996-2000: 1.6.

### VI. Growth accounting and total factor productivity (TFP)
- Framework and assumptions:
  - Cobb-Douglas production function: Yt = At Kt^α Lt^(1−α).
  - Output elasticities: capital α = 0.33; labor = 0.67.
  - Capital stock from perpetual inventory method with depreciation rate of 5 percent.
  - Derived capital-output ratio in 1960 is 2.3.
  - Labor proxied by economically active population (labor force).
  - TFP measured as residual (Solow); adjusted using Baxter-King (BK) Filter for business fluctuations.
- Key quantitative results (values preserved exactly):
  - 1965-1975:
    - Real GDP growth: 5.6
    - Capital contribution (percentage points): 6.9
    - Labor contribution (percentage points): 1.9
    - TFP (percentage points): 2.0
    - Capital growth rate (percent): 2.3
    - Labor growth rate (percent): 1.3
    - Trend TFP growth (memorandum): 1.7
  - 1976-2004:
    - Real GDP growth: 2.3
    - Capital contribution (percentage points): 1.6
    - Labor contribution (percentage points): 2.4
    - TFP (percentage points): 0.1
    - Capital growth rate (percent): 0.5
    - Labor growth rate (percent): 1.6
    - Trend TFP growth (memorandum): 0.1
  - 1986-2004:
    - Real GDP growth: 3.0
    - Capital contribution (percentage points): 1.0
    - Labor contribution (percentage points): 2.5
    - TFP (percentage points): 1.0
    - Capital growth rate (percent): 0.3
    - Labor growth rate (percent): 1.7
    - Trend TFP growth (memorandum): 0.7
  - 1996-2004:
    - Real GDP growth: 0.8
    - Capital contribution (percentage points): 0.3
    - Labor contribution (percentage points): 2.6
    - TFP (percentage points): -1.0
    - Capital growth rate (percent): 0.1
    - Labor growth rate (percent): 1.7
    - Potential output growth (memorandum): 0.6
    - Trend TFP growth (memorandum): -1.2
- Interpretation and caveats:
  - Swings in growth during 1975–2004 largely accounted for by changes in capital input and lower TFP growth.
  - Decline in capital contribution reflects slowing investment since independence, except during mineral-production booms.
  - Labor input provided the largest contribution to growth since independence; on average, no productivity improvements achieved since independence.
  - Measured TFP may capture institutional changes, external shocks, policy changes, political disturbances, conflicts, and measurement errors.
  - Analysis did not separately decompose mining vs nonmining sectors or control for changes in human capital quality due to data limitations.

### VII. TFP series and business-cycle adjustment
- Annual TFP estimates for 1968–2004:
  - In most years TFP fell below zero; positive estimates occurred before 1975 and in 1990–96.
- Adjustment:
  - TFP adjusted using Baxter-King filter to remove business fluctuation effects; adjusted series is volatile with negative and positive swings.

### VIII. Implications for medium-term growth — baseline and scenarios
- Baseline assumptions:
  - No new significant hydrocarbon or mineral projects (excludes Highlands-Queensland gas pipeline).
  - Continuous but modest structural reform.
  - Capital stock growth consistent with keeping capital-output ratio constant at 2.3.
  - Labor force grows by 2.4 percent a year.
  - Baseline trend TFP growth assumed at 0.5 percent a year.
  - Potential output = trend TFP + contributions of capital and trend labor inputs.
- Scenario quantitative projections (values preserved exactly where given):
  - Baseline scenario (trend TFP growth of 0.5 percent):
    - GDP would grow at an average rate of 3 percent a year during 2005–10.
    - Potential output grows by 2.7 percent.
    - Per capita incomes would improve marginally, but not enough to impact poverty reduction.
  - High reform scenario:
    - To support GDP growth of 5 percent a year, implied trend TFP growth required is about 3 percent a year—about 2.5 percentage points higher than actual growth over 1976–2004.
    - Characterized as optimistic; requires significant improvements in governance and law and order and acceleration of key reforms under the MTDS.
  - Downside scenario:
    - If TFP reflected the post-1995 experience, growth would fall to about 1 percent.
  - Upside scenario:
    - Acceleration in TFP growth and capital input (e.g., sustained by recent financial reforms and investment in petroleum and mining) could allow GDP to grow by about 5 percent, consistent with government MTDS objectives.

### IX. Medium-term growth scenarios and projections (Table 3 summary preserved exactly)
- Low scenario / Baseline / High scenario (factor contributions in percentage points for 2005-10):
  - Real GDP growth: 1.0 / 3.0 / 5.0
  - Capital: 0.5 / 0.5 / 0.5
  - Labor: 1.5 / 1.5 / 1.5
  - TFP: -1.0 / 1.0 / 3.0
- Memorandum items:
  - Potential GDP growth: 0.7 / 2.7 / 4.7
  - Trend TFP: -1.3 / 0.7 / 2.7

### X. Investment requirements for higher growth (assumptions and required investment-to-GDP ratios)
- Assuming depreciation of the capital stock by 5 percent:
  - Target of 5 percent GDP growth implies a minimum gross rate of investment needed of about 23 percent of GDP.
  - A 7 percent target requires an investment rate of 27 percent of GDP.
- Historical investment:
  - Averaged only 17 percent since 1985.
- Table 4 — Assumptions and required investment-to-GDP ratios (preserved exactly):
  - Steady-state capital-output ratio: 2.3 / 2.3 / 2.3
  - Depreciation (percent a year): 5.00 / 5.00 / 5.00
  - Target growth rate (percent per year): 3 / 5 / 7
  - Required investment-to-GDP ratio: 18 / 23 / 27
- Memo items — Investment to GDP ratio, in percent:
  - 1976-2004: 19
  - 1986-1995: 17
  - 1996-2004: 13

### XI. Determinants of productivity (qualitative assessment)
- Summary drivers:
  - Low growth driven by slowdown in capital inputs and falling productivity growth.
  - TFP affected by economic, social, and political institutions.
- Governance:
  - Poor governance deters investment, undermines competition, encourages rent-seeking, distorts public expenditure, and negatively affects productivity.
  - Rent-seeking high, particularly in resource-based sectors; political interference and politicization hamper public administration.
  - Historical political instability: no government had survived a full five-year term in office historically (note that current Somare government at time of writing had a good chance of being first to do so).
  - Recent political reforms (e.g., Organic Law on the Integrity of Political Parties) expected to bring some stability.
- Business environment (selected indicators preserved exactly where given):
  - Firms report crime, corruption, and political instability as biggest impediments.
  - Average company reported spending about 10 percent of its revenue on private security and losses from theft.
  - Selected Doing Business 2005 indicators for Papua New Guinea:
    - Starting a Business — Number of Procedures: 8.0; Time (days): 56.0; Cost (percent of income per capita): 30.2; Minimum capital (percent of income per capita): 0.0.
    - Closing a Business — Time (years): 2.8; Cost (percent of estate): 38.0; Recover rate (cents on the dollar): 34.2.
- Human capital:
  - Gross enrollment:
    - Primary: 69 percent (most recent).
    - Secondary: 11 percent.
  - Retention low: fewer than 60 percent of children complete grade 6.
  - School enrollment series (selected): gross primary school enrollment — 1970: 51.6; 1980: 58.9; 1990: 66.2; 1998: 74.8; 2002: 73.4; 2003: 68.9.
- Physical infrastructure:
  - Fragmented transport system; about 4 percent of roads and airport runways are paved.
  - Port Moresby accessible only by sea or air; sea-freight costs high and service infrequent.
  - Utilities unreliable and costly; many firms operate own power generators.
  - Telecommunications limited in rural areas; about 2 percent of population has access to residential phone service.
  - Selected transport/communications figures preserved exactly:
    - Roads/person (metres per capita): 3.8
    - Road Density (km/km2): 0.044
    - Percent of Road paved: 4.0
    - Telephone Mainlines /1000 people: 12.6
    - Rail Density (km/000km2): 0.0

### XII. Empirical estimation — methodology and main results
- Variables included (data constrained): inflation (proxy for macro stability), foreign direct investment (FDI, proxy for technology transfer and governance), enrollment rates (proxy for human capital).
- Econometric approach:
  - Unit root tests (ADF) to determine integration order.
  - Johansen cointegration tests (trace and maximum eigenvalue) to identify long-run relationships.
  - Vector error correction model (VECM) for short-run dynamics.
  - Variance decomposition (VDC) and impulse response functions (IRF) with Cholesky ordering: FDI, Education, Inflation, TFP.
- Unit root test results (ADF t-values and p-values preserved exactly from Table 9):
  - CPI: Levels ADF-value -2.1631.000; First differences ADF-value -3.6600.011
  - Education: Levels -2.9020.057; First differences -5.2090.000
  - FDI: Levels -2.6820.089; First differences -5.9780.000
  - TFP: Levels -2.2900.182; First differences -4.1460.003
- Johansen (Trace) cointegration test (Table 10 preserved exactly):
  - Trace statistic rejects null of no cointegration:
    - None * — Eigenvalue 0.7316; Trace Statistic 62.678; 5 percent Critical Value 47.856; P-value 0.001
    - At most 1 — Eigenvalue 0.5262; Trace Statistic 27.212; 5 percent Critical Value 29.797; P-value 0.096
  - Both tests indicate one cointegrating vector at the 5 percent level.
- Variance decomposition of TFP (Table 11 preserved exactly; shares in percent):
  - Period / Standard error / TFP / GFDI/GDP / Education / Inflation
  - 1 / 0.0198 / 49.2 / 21.4 / 16.5 / 12.9
  - 2 / 0.0483 / 48.9 / 23.4 / 15.2 / 12.6
  - 3 / 0.0785 / 47.7 / 25.2 / 16.9 / 10.1
  - 4 / 0.1039 / 48.4 / 25.4 / 18.5 / 7.7
  - 5 / 0.1212 / 49.5 / 25.5 / 19.1 / 5.9
  - 6 / 0.1317 / 49.6 / 26.3 / 19.1 / 5.0
  - 7 / 0.1388 / 48.8 / 27.5 / 19.0 / 4.7
  - 8 / 0.1450 / 47.9 / 27.8 / 19.0 / 4.3
  - 9 / 0.1517 / 47.1 / 27.9 / 19.2 / 4.0
  - 10 / 0.1591 / 46.6 / 30.2 / 19.5 / 3.6
  - 11 / 0.1668 / 46.4 / 30.6 / 19.8 / 3.3
  - 12 / 0.1741 / 46.2 / 30.9 / 19.9 / 3.0
  - 13 / 0.1809 / 46.0 / 31.3 / 19.9 / 2.8
  - 14 / 0.1872 / 45.8 / 31.6 / 20.0 / 2.6
  - 15 / 0.1933 / 45.5 / 32.0 / 20.1 / 2.5
- Interpretation of variance decomposition:
  - About 50 percent of TFP variation explained by own innovations in year 1; falls to under 46 percent after 15 periods.
  - After 15 years: Education explains 20.1 percent, Inflation explains 2.5 percent, and FDI explains 32.0 percent of TFP variation.
  - Governance (proxied by FDI) and human capital have increasing influence on TFP over time; inflation’s impact declines.
- Impulse Response Functions (IRFs):
  - IRFs show TFP responses to shocks in education, inflation, and FDI.
  - Improving institutional governance (bureaucratic quality) is a strong signal for a favorable investment environment and is necessary, along with economic and political stability, to attract foreign investment and boost TFP growth.

### XIII. Summary, conclusions, and policy recommendations
- Historical decomposition:
  - Swings in growth largely due to slowdown in capital input and lower TFP growth.
- Investment and productivity needs:
  - With investment-to-GDP ratio of 13 percent during the last decade, significantly higher productivity growth and investment are required to sustain GDP growth rates at 5 percent or higher.
- Policy prescriptions implied by analysis:
  - (i) Push forward with implementation of structural reforms to improve governance and remove impediments to private sector investment.
  - (ii) Maintain strong capital formation by increasing public investment and improving the focus of these investments to promote crowding-in of private investment, especially in the nonmineral sector.
- Empirical results consistent with literature:
  - Sound macroeconomic fundamentals, price stability, opening up to foreign trade and investment, higher levels of investment, technology transfer, and better public policies to reduce corruption and improve public institutions positively influence real GDP and productivity growth in Papua New Guinea.

### Appendix — Growth accounting (selected annual entries reproduced exactly)
- Annual data rows preserved exactly as in source (selected entries shown):
  - 1975 4.62 14.94 08.10 07.95 0
  - 1976 4.61 35.07 08.07 98.03 0
  - 1977 4.62 35.45 08.08 18.07 0
  - 1978 4.64 45.48 08.08 28.13 0
  - 1979 4.65 05.66 08.08 48.19 0
  - 1980 4.62 35.88 08.08 08.30 0
  - 1981 4.59 05.85 08.10 08.38 0
  - 1982 4.57 05.91 08.09 08.43 0
  - 1983 4.55 06.30 08.02 08.51 0
  - 1984 4.55 06.14 08.09 08.58 0
  - 1985 4.56 05.85 08.13 08.61 0
  - 1986 4.58 35.93 08.19 08.67 0
  - 1987 4.59 75.91 08.10 08.70 0
  - 1988 4.59 06.24 08.04 08.75 0
  - 1989 4.56 36.44 08.13 08.80 0
  - 1990 4.55 66.18 08.17 08.86 0
  - 1991 4.59 65.79 08.17 08.93 0
  - 1992 4.70 05.51 08.13 08.97 0
  - 1993 4.79 74.83 08.15 09.02 0
  - 1994 4.83 74.77 08.04 09.05 0
  - 1995 4.84 95.90 08.08 09.21 0
  - 1996 4.82 85.45 08.19 09.32 0
  - 1997 4.81 04.73 08.24 09.36 0
  - 1998 4.79 35.72 08.16 09.49 0
  - 1999 4.79 45.78 08.13 09.63 0
  - 2000 4.79 05.65 08.10 09.77 0
  - 2001 4.75 75.39 08.08 09.86 0
  - 2002 4.73 35.19 88.01 09.97 0
  - 2003 4.73 05.19 48.02 10.08 0
  - 2004 4.73 25.19 88.04 10.13 0

*Source: _wp06113 (PDF chapter/section) — IMF staff estimates and analysis as presented in the chapter.*

### 1. Structure of Production .............................................................................................

### 1. Structure of Production

### Major Figures and Panels
- 1. Structure of Production ..................................................................................................6
- 2. Actual and Trend GDP, 1960–2004...............................................................................8
- 3. Actual and Trend GDP Per Capita, 1960–2004.............................................................8
- 4. Real Fixed Investment, 1960–2004 ...............................................................................9
- 5. Total Factor Productivity: Actual and Adjusted for Business Fluctuations ................13
- 6. Response of TFP Growth to a One Standard Deviation Cholesky Shock ...................23

### Tables Listed in the Unit
- 1. Average GDP Per Capita Growth Rates for Selected Countries, 1961–2000 .............10
- 2. Papua New Guinea: Sources of Growth, 1965–2004 ..................................................12
- 3. Papua New Guinea: Medium-Term Growth Projections, 2005–10.............................14
- 4. Papua New Guinea: Real GDP Growth and Real Investment .....................................15
- 5. Political Risk by Component .......................................................................................16
- 6. The Business Environment (2005)...............................................................................17
- 7. Papua New Guinea: School Enrollment Rates.............................................................17
- 8.         Transport         and         Communications Indicators ..................................................................18
- 9. Papua New Guinea: Unit Root Statistics .....................................................................19
- 10. Papua New Guinea: Johansen (Trace) Cointegration Test ..........................................20
- 11. Papua New Guinea: Variance Decomposition of TFP ................................................20

### Appendix Material
- Calculating Capital Stock ............................................................................................24

*Source: _wp06113 - 1. Structure of Production (PDF chapter/section)*

### References .............................................................................................................

### _wp06113 - References

### I. Introduction
- Papua New Guinea experienced volatile and declining growth since 1960: GDP increased at an average rate of 5.5 percent during 1960–75, slowed to 2.3 percent during 1976–2004, and to less than 1 percent during 1996–2004.
- Estimated per capita real GDP at the end of 2004 was about 50 percent lower than at independence in 1975.
- Contributing factors to the weak performance include an unfavorable external environment, poor governance, law-and-order problems, deep-seated structural impediments, poor physical infrastructure, and inadequately focused macroeconomic policies.
- Purpose and methods of the paper:
  - Reviews trends in GDP growth and compares Papua New Guinea with other East Asian and Pacific countries.
  - Uses an aggregate production function and growth accounting framework with annual data for 1960–2004 to estimate TFP growth and its evolution.
  - Analyzes medium-term growth prospects under alternative TFP assumptions and estimates the average level of investment needed for alternative growth projections.
  - Uses time-series analysis to empirically assess determinants of productivity growth.

### II. Structure of the economy
- Economic composition and trends:
  - Economy dominated by a large, labor-intensive agricultural sector and a capital-intensive oil and minerals sector.
  - Formal sector: enclave extractive industries (mining, petroleum, and logging), cash crop production, and a small import-substituting manufacturing sector.
  - Informal sector: largely subsistence agriculture.
- Sectoral shares and evolution:
  - Primary sector share of GDP has increased steadily since 1975; tertiary and secondary sectors have declined.
  - Agriculture (including forestry and fisheries): about 40 percent of GDP in the 1970s; declined to about 30 percent in 1985; increased to about 38 percent in 2002–04.
  - Mining sector: increased from negligible in the 1970s to about 30 percent in the early 1990s, then slipped to about 13 percent during 2003–04.
  - Manufacturing sector contribution: varied in the range of 5 to 11 percent since the 1970s, and is now about 6 percent.
  - Construction sector: settled at around 5 percent of GDP during the first half of the 1990s; activity picked up since recovery began in 2002.
  - Services sector: accounted for more than 40 percent of GDP during the 1970s and the 1980s, then declined steadily to 29 percent in 2004.
- Notable developments and constraints:
  - Mining sector is overwhelmingly foreign-owned; domestic law-and-order issues played a role in sector disruptions (e.g., closure of the Bougainville mine in 1989).
  - Significant future developments noted: Ramu Nickel Project and Papua New Guinea-Queensland Gas Project.
  - Structural impediments to manufacturing: shortage of entrepreneurial, managerial, and skilled labor; complicated regulations; high utility and transportation overheads; high cost of labor relative to productivity.
  - Transport, communications, community and personal services have deteriorated or been adversely affected by law-and-order and governance weaknesses.

### III. Trends in GDP and per capita GDP growth
- Historical growth patterns:
  - 1960–1975: economy grew at an average annual rate of over 5.5 percent; population growth about 1 percent.
  - Late 1970s/early 1980s: growth slowed due to the first oil price shock and repatriation of Australian expatriates around independence in 1975.
  - 1985–88: strong commodity prices led to a brief recovery; decline in 1989 due to Bougainville mine closure and mineral price decline.
  - 1991–94: mineral boom (including petroleum) partly offset earlier adverse effects.
  - By 1994: macroeconomic imbalances led to a balance of payments crisis; policy responses included curtailment of public expenditure, devaluation of the kina, abandonment of the “hard kina”.
  - 1997: growth fell due to severe drought, lower external demand from the Asian crisis, low mineral prices, and law-and-order problems.
  - 1996–2002: real GDP grew by less than 1 percent.
- Vulnerability and shocks:
  - Dependence on commodity exports increases vulnerability to external shocks.
  - Bougainville mine remained closed as of late 2005.

### IV. Investment
- Aggregate and sectoral investment patterns:
  - Gross capital formation averaged about 21 percent of GDP during 1984–2004, with considerable fluctuations.
  - High investment during 1976–85 associated with mining and mining-related construction.
  - Sharp drop in mid-1980s due to completion of major construction at OK Tedi; sharp increase from 1990 onward due to Kutubu and Porgera projects.
  - Real gross fixed capital formation fell to 13.7 percent of GDP in 1998, compared with 21 percent in 1984, due mainly to outflow of foreign capital since 1994.
- Role of public and foreign investment:
  - Public investment is low by global standards but has stimulative impact on private investment; examples include publicly funded airport and Poreporena Highway in Port Moresby.
  - Foreign investors: Australia largest foreign investor; U.S., U.K., Canadian mining interests in major mines; Malaysia significant investor in fisheries, timber, trade and construction subsectors.

### V. International growth comparison
- PPP-based GDP per capita growth (selected observations from Table 1):
  - Papua New Guinea per capita growth: about 3.5 percent during 1960–75 (behind only Thailand and Malaysia in the comparator group); fell to negative 1.4 percent during 1976–85 (weakest performance); recovered briefly during 1986–95; declined by around 5 percent from 1996–2004.
- Comparative country growth rates shown in Table 1 (select entries preserved exactly):
  - Papua New Guinea: 1961-75: 3.4; 1976-85: -1.4; 1986-95: 1.8; 1996-2000: -4.8 (table layout indicates periods with these values).
  - Bangladesh: 1961-75: -0.4; 1976-85: 1.9; 1986-95: 2.4; 1996-2000: 2.8.
  - Fiji: 1961-75: 2.8; 1976-85: 0.8; 1986-95: 2.0; 1996-2000: 1.1.
  - Indonesia: 1961-75: 2.8; 1976-85: 4.9; 1986-95: 4.8; 1996-2000: 0.2.
  - Malaysia: 1961-75: 3.6; 1976-85: 4.2; 1986-95: 4.8; 1996-2000: 2.7.
  - Thailand: 1961-75: 4.7; 1976-85: 4.6; 1986-95: 7.5; 1996-2000: 0.5.
  - Australia: 1961-75: 2.6; 1976-85: 1.7; 1986-95: 2.0; 1996-2000: 2.8.
  - New Zealand: 1961-75: 1.9; 1976-85: 0.6; 1986-95: 0.8; 1996-2000: 1.6.

### VI. Growth accounting and total factor productivity (TFP)
- Methodology and assumptions:
  - Uses Cobb-Douglas production function: Yt = At Kt^α Lt^(1−α).
  - Assumed output elasticities: capital α = 0.33 and labor = 0.67.
  - Capital stock derived from gross fixed investment using perpetual inventory method with depreciation rate of 5 percent.
  - Derived capital-output ratio in 1960 is 2.3.
  - Labor input proxied by economically active population (labor force).
  - TFP measured as residual (Solow framework) and adjusted using the Baxter-King (BK) Filter for business fluctuations.
- Key quantitative results (from Table 2 and text; preserve numbers exactly):
  - 1965-1975:
    - Real GDP growth: 5.6
    - Capital contribution (percentage points): 6.9
    - Labor contribution (percentage points): 1.9
    - TFP (percentage points): 2.0
    - Capital growth rate (percent): 2.3
    - Labor growth rate (percent): 1.3
    - Trend TFP growth (memorandum): 1.7
  - 1976-2004:
    - Real GDP growth: 2.3
    - Capital contribution (percentage points): 1.6
    - Labor contribution (percentage points): 2.4
    - TFP (percentage points): 0.1
    - Capital growth rate (percent): 0.5
    - Labor growth rate (percent): 1.6
    - Trend TFP growth (memorandum): 0.1
  - 1986-2004:
    - Real GDP growth: 3.0
    - Capital contribution (percentage points): 1.0
    - Labor contribution (percentage points): 2.5
    - TFP (percentage points): 1.0
    - Capital growth rate (percent): 0.3
    - Labor growth rate (percent): 1.7
    - Trend TFP growth (memorandum): 0.7
  - 1996-2004:
    - Real GDP growth: 0.8
    - Capital contribution (percentage points): 0.3
    - Labor contribution (percentage points): 2.6
    - TFP (percentage points): -1.0
    - Capital growth rate (percent): 0.1
    - Labor growth rate (percent): 1.7
    - Potential output growth (memorandum): 0.6
    - Trend TFP growth (memorandum): -1.2
- Interpretation and limitations:
  - Swings in growth during 1975–2004 are mostly accounted for by changes in capital input and lower TFP growth.
  - Decline in capital contribution reflects slowing of investment since independence, except during mineral-production booms when investment spiked but was not sustained.
  - Since independence, labor input provided the largest contribution to growth; on average, no productivity improvements have been achieved since independence.
  - Measured TFP residual may capture institutional changes, external shocks, policy changes, political disturbances, conflicts, and measurement errors—especially relevant due to law-and-order problems and conflicts in Papua New Guinea.
  - Analysis did not separately decompose mining vs nonmining sectors or control for changes in human capital quality due to data limitations.

### VII. TFP series and business-cycle adjustment
- Annual TFP estimates for 1968–2004 show that in most years TFP fell below zero; positive estimates occurred before 1975 and in 1990–96.
- TFP was adjusted using the Baxter-King filter to remove business fluctuation effects; Figure 5 presents actual and adjusted TFP (contributions to GDP growth, percentage points) showing a volatile series with negative and positive swings (visual plot described in text).

### VIII. Implications for medium-term growth
- Projection framework and baseline assumptions:
  - Baseline assumes no new significant hydrocarbon or mineral projects (excludes Highlands-Queensland gas pipeline).
  - Structural reform assumed continuous but modest.
  - Capital stock growth consistent with keeping capital-output ratio constant at 2.3.
  - Labor force grows by 2.4 percent a year.
  - Baseline trend TFP growth assumed at 0.5 percent a year (broadly in line with trend TFP over the last two decades).
  - Potential output derived as sum of trend TFP and contributions of capital and trend labor inputs.
- Scenario outcomes and quantitative projections:
  - Baseline scenario (with trend TFP growth of 0.5 percent):
    - GDP would grow at an average rate of 3 percent a year during 2005–10.
    - Potential output grows by 2.7 percent.
    - Per capita incomes would improve marginally, but not enough to have an impact on poverty reduction.
  - Alternative “high reform” scenario:
    - To support GDP growth of 5 percent a year over the medium term, implied trend TFP growth required is about 3 percent a year—about 2.5 percentage points higher than actual growth over 1976–2004.
    - Achieving trend TFP growth of 3 percent a year is characterized as optimistic given past experience.
    - Significant improvements in governance and law and order and acceleration of key reforms under the MTDS would be important to reach this TFP growth.
  - Downside scenario (reference to post-1995 experience):
    - If TFP reflected the post-1995 experience, growth would fall to about 1 percent (earlier text: "If, in contrast, TFP reflected the post-1995 experience, growth would fall to about 1 percent").
  - Upside scenario:
    - Acceleration in TFP growth and capital input (spurred, for example, by recent financial reforms and investment in petroleum and mining), if sustained, could allow GDP to grow by about 5 percent, consistent with the government’s objectives in the Medium-Term Development Strategy (MTDS).
- Determinants of TFP (empirical findings):
  - Empirical results suggest that low foreign direct investment, governance factors, and economic conditions were important causes of slow TFP growth.

*Source: IMF staff estimates and analysis as presented in the referenced chapter.*

### 2.5 percent per annum.

### _wp06113 - 2.5 percent per annum.

### Medium-term growth scenarios and projections
- Low reform scenario: extrapolates 1996–2004 low TFP, resulting in GDP growth of only 1.0 percent; per capita incomes would continue to decline with negative growth rates and poverty would increase with continued population growth.
- Table 3 — Factor contributions (in percentage points) for 2005-10 — Alternative TFP Growth Rates:
  - Low scenario / Baseline / High scenario
  - Real GDP growth: 1.0 / 3.0 / 5.0
  - Capital: 0.5 / 0.5 / 0.5
  - Labor: 1.5 / 1.5 / 1.5
  - TFP: -1.0 / 1.0 / 3.0
  - Memorandum items:
    - Potential GDP growth: 0.7 / 2.7 / 4.7
    - Trend TFP: -1.3 / 0.7 / 2.7
  - Source: Fund staff estimates.

### Investment requirements for higher growth
- Assuming depreciation of the capital stock by 5 percent:
  - A target of 5 percent GDP growth over the medium to long term implies a minimum gross rate of investment needed for sustained growth of about 23 percent of GDP.
  - A 7 percent target would require an investment rate of 27 percent of GDP.
- Historical actual rate of investment: averaged only 17 percent since 1985 (Table 4).
- Table 4 — Assumptions and required investment-to-GDP ratios:
  - Steady-state capital-output ratio: 2.3 / 2.3 / 2.3
  - Depreciation (percent a year): 5.00 / 5.00 / 5.00
  - Target growth rate (percent per year): 3 / 5 / 7
  - Required investment-to-GDP ratio: 18 / 23 / 27
  - Memo items — Investment to GDP ratio, in percent:
    - 1976-2004: 19
    - 1986-1995: 17
    - 1996-2004: 13
  - Source: Author's estimates.

### Determinants of productivity (TFP) — qualitative assessment
- Summary: Low growth driven by a significant slowdown in capital inputs and falling productivity growth; TFP affected by economic, social, and political institutions.
- Governance:
  - Poor governance deters investment, undermines competition, encourages rent-seeking, and distorts public expenditure, negatively affecting productivity.
  - Rent-seeking reportedly high, particularly in resource-based sectors; political interference and politicization of decision making hamper public administration.
  - No government has survived a full five-year term in office historically, though current Somare government has a good chance of being the first since independence to do so.
  - Recent political reforms (e.g., Organic Law on the Integrity of Political Parties) expected to bring some stability.
  - Table 5 — Political Risk by Component (ICRG, 2005). Lower number = higher risk. Papua New Guinea scores:
    - Corruption: 1.0
    - Bureaucracy quality: 2.0
    - Ethnic tensions: 2.0
    - Law and Order: 2.5
    - Socioecon. conditions: 3.5
    - Government Stability: 7.0
    - Internal Conflict: 10.0
- Business environment:
  - Private sector surveys report crime, corruption, and political instability as biggest impediments; average company reported spending about 10 percent of its revenue on private security and losses from theft.
  - Table 6 — The Business Environment (2005) — selected indicators (Papua New Guinea vs peers):
    - Starting a Business:
      - Number of Procedures: 8.0
      - Time (days): 56.0
      - Cost (percent of income per capita): 30.2
      - Minimum capital (percent of income per capita): 0.0
    - Closing a Business:
      - Time (years): 2.8
      - Cost (percent of estate): 38.0
      - Recover rate (cents on the dollar): 34.2
    - Other components (Registering Property, Dealing with Licenses, Enforcing Contracts) show comparatively poor performance against regional peers.
  - Source: World Bank - Doing Business Explore Economics.
- Human capital:
  - Gross enrollment in Papua New Guinea:
    - Primary school level: 69 percent (most recent entry in Table 7)
    - Secondary school level: 11 percent
  - Retention rates low; fewer than 60 percent of children complete grade 6.
  - Table 7 — School Enrollment Rates (Percent) — selected series:
    - Gross primary school enrollment: 1970: 51.6; 1980: 58.9; 1990: 66.2; 1998: 74.8; 2002: 73.4; 2003: 68.9
    - Male and Female disaggregations provided in Table 7.
  - Source: World Development Indicators Database, World Bank.
- Physical infrastructure:
  - Fragmented transport system due to mountainous terrain; about 4 percent of roads and airport runways are paved (Table 8).
  - Port Moresby accessible only by sea or air; sea-freight costs high and service infrequent.
  - Utilities unreliable and costly; many firms operate own power generators.
  - Telecommunications limited in rural areas; about 2 percent of the population has access to residential phone service.
  - Table 8 — Transport and Communications Indicators — selected Papua New Guinea figures:
    - Roads/person (metres per capita): 3.8
    - Road Density (km/km2): 0.044
    - Percent of Road paved: 4.0
    - Telephone Mainlines /1000 people: 12.6
    - Rail Density (km/000km2): 0.0
  - Source: Jones (2004).

### Empirical estimation — methodology and results
- Included explanatory variables (data-availability constrained): inflation (proxy for macroeconomic stability), foreign direct investment (proxy for technology transfer and governance), and enrollment rates (proxy for human capital).
- Methodology:
  - Unit root tests to determine integration order.
  - Johansen cointegration tests (trace and maximum eigenvalue) to identify long-run relationships.
  - Vector error correction model (VECM) to capture short-run dynamics.
  - Variance decomposition (VDC) and impulse response functions (IRF) computed with Cholesky ordering: FDI, Education, Inflation, TFP.
- Unit root tests (Table 9) — ADF t-values and p-values:
  - CPI: Levels ADF-value -2.1631.000; First differences ADF-value -3.6600.011
  - Education: Levels -2.9020.057; First differences -5.2090.000
  - FDI: Levels -2.6820.089; First differences -5.9780.000
  - TFP: Levels -2.2900.182; First differences -4.1460.003
  - Each ADF test uses a constant and no trend. Lag length chosen by Schwartz information criterion. P-values from Mackinnon (1996).
- Johansen (Trace) cointegration test (Table 10):
  - Trace statistic rejects null of no cointegration:
    - None * — Eigenvalue 0.7316; Trace Statistic 62.678; 5 percent Critical Value 47.856; P-value 0.001
    - At most 1 — Eigenvalue 0.5262; Trace Statistic 27.212; 5 percent Critical Value 29.797; P-value 0.096
  - Both tests indicate one cointegrating vector at the 5 percent level.
- Variance decomposition of TFP (Table 11) — responses over a 15-year period to a one-standard-deviation shock:
  - Period / Standard error / TFP / GFDI/GDP / Education / Inflation
  - 1 / 0.0198 / 49.2 / 21.4 / 16.5 / 12.9
  - 2 / 0.0483 / 48.9 / 23.4 / 15.2 / 12.6
  - 3 / 0.0785 / 47.7 / 25.2 / 16.9 / 10.1
  - 4 / 0.1039 / 48.4 / 25.4 / 18.5 / 7.7
  - 5 / 0.1212 / 49.5 / 25.5 / 19.1 / 5.9
  - 6 / 0.1317 / 49.6 / 26.3 / 19.1 / 5.0
  - 7 / 0.1388 / 48.8 / 27.5 / 19.0 / 4.7
  - 8 / 0.1450 / 47.9 / 27.8 / 19.0 / 4.3
  - 9 / 0.1517 / 47.1 / 27.9 / 19.2 / 4.0
  - 10 / 0.1591 / 46.6 / 30.2 / 19.5 / 3.6
  - 11 / 0.1668 / 46.4 / 30.6 / 19.8 / 3.3
  - 12 / 0.1741 / 46.2 / 30.9 / 19.9 / 3.0
  - 13 / 0.1809 / 46.0 / 31.3 / 19.9 / 2.8
  - 14 / 0.1872 / 45.8 / 31.6 / 20.0 / 2.6
  - 15 / 0.1933 / 45.5 / 32.0 / 20.1 / 2.5
- Interpretation of variance decomposition:
  - About 50 percent of the variation in TFP is explained by its own innovations in the first year; this influence falls to under 46 percent after 15 periods.
  - After 15 years: Education explains 20 percent, Inflation explains 2.5 percent, and FDI explains 32 percent of TFP variation.
  - Governance (proxied by FDI) and human capital variables have increasing influence on TFP over time.
  - Inflation’s impact on TFP decreases over time; the author suggests this may reflect high volatility of inflation during the sample and recommends testing other proxies for macroeconomic conditions in future studies.
- Impulse Response Functions (IRFs):
  - IRFs examine TFP response to shocks in education, inflation, and FDI.
  - Results and figures indicate that improving institutional governance (bureaucratic quality) is a strong signal for a favorable investment environment and is necessary, along with economic and political stability, to attract foreign investment and boost TFP growth.
  - The response of TFP growth to inflation is described as more in line with intuitive expectations.

### Summary, conclusions, and policy recommendations
- Historical decomposition: swings in growth largely due to slowdown in capital input and lower TFP growth.
- With investment-to-GDP ratio of 13 percent during the last decade, significantly higher productivity growth and investment are required to sustain GDP growth rates at 5 percent or higher.
- In the absence of structural reforms and strong institutions, higher rates of productivity growth will be hard to achieve.
- Policy prescriptions implied by analysis:
  - (i) Push forward with implementation of structural reforms to improve governance and remove impediments to private sector investment.
  - (ii) Maintain strong capital formation by increasing public investment and improving the focus of these investments to promote a crowding-in of private investment, especially in the nonmineral sector.
- Empirical results consistent with literature: sound macroeconomic fundamentals, price stability, opening up to foreign trade and investment, higher levels of investment, technology transfer, and better public policies to reduce corruption and improve public institutions positively influence real GDP and productivity growth in Papua New Guinea.

*Source: Fund staff estimates and author's estimates as presented in the PDF chapter.*

### Appendix Table 1. Papua New Guinea: Growth Accounting

### Appendix Table 1. Papua New Guinea: Growth Accounting

### Factor Contribution to GDP Growth (in percentage points)

- Foreign directConsumer YearTrend TFPinvestmentEducationprice index

### Annual data (rows reproduced exactly as in source)

- 1975 4.62 14.94 08.10 07.95 0
- 1976 4.61 35.07 08.07 98.03 0
- 1977 4.62 35.45 08.08 18.07 0
- 1978 4.64 45.48 08.08 28.13 0
- 1979 4.65 05.66 08.08 48.19 0
- 1980 4.62 35.88 08.08 08.30 0
- 1981 4.59 05.85 08.10 08.38 0
- 1982 4.57 05.91 08.09 08.43 0
- 1983 4.55 06.30 08.02 08.51 0
- 1984 4.55 06.14 08.09 08.58 0
- 1985 4.56 05.85 08.13 08.61 0
- 1986 4.58 35.93 08.19 08.67 0
- 1987 4.59 75.91 08.10 08.70 0
- 1988 4.59 06.24 08.04 08.75 0
- 1989 4.56 36.44 08.13 08.80 0
- 1990 4.55 66.18 08.17 08.86 0
- 1991 4.59 65.79 08.17 08.93 0
- 1992 4.70 05.51 08.13 08.97 0
- 1993 4.79 74.83 08.15 09.02 0
- 1994 4.83 74.77 08.04 09.05 0
- 1995 4.84 95.90 08.08 09.21 0
- 1996 4.82 85.45 08.19 09.32 0
- 1997 4.81 04.73 08.24 09.36 0
- 1998 4.79 35.72 08.16 09.49 0
- 1999 4.79 45.78 08.13 09.63 0
- 2000 4.79 05.65 08.10 09.77 0
- 2001 4.75 75.39 08.08 09.86 0
- 2002 4.73 35.19 88.01 09.97 0
- 2003 4.73 05.19 48.02 10.08 0
- 2004 4.73 25.19 88.04 10.13 0

*Sources: National Statisitcal Office, IFS, and author's estimates.*

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