Economic Analysis of Foreign Direct Investment and Its Impact on Trade and Growth in Pakistan Essay

SUBMITTED TO THE COURSE FACILITATOR: “SIR FARHAN MEHBOOB” AS PER THE PARTIAL REQUIRMENT OF THE COURSE: “ECONOMIC ANALYSIS FOR MANAGEMENT” SUBMISSION OF RESEARCH PAPER ON TOPIC: “ECONOMIC ANALYSIS OF FOREIGN DIRECT INVESTMENT AND ITS IMPACT ON TRADE AND GROWTH IN PAKISTAN” SUBMITTED BY: “SHIRAZ KHAN” (6001) TOPIC Economic Analysis of Foreign Direct Investment and its Impact on Trade and Growth in Pakistan AUTHOR Shiraz Khan Business Graduate, Iqra University, Karachi, Pakistan.ABSTRACT Foreign direct investment (FDI) in context of Pakistan is one of the major contributors that help Pakistan to minimize the gap of financial resources and funds. FDI has played a significant and vital role in the domestic markets of Pakistan and has contributed in the increase in the exports, capital formation and the human skill development of Pakistan. Net FDI balances in Pakistan in 1976 were $8. 22 million which grew to $1. 24 billion by the end of 2011.The present research study is an empirical analysis of the impact of FDI on Pakistan’s economy with the help of time series data.

The study applied the linear regression analysis and produced a model to determine and predict the impact and relationship of FDI on the overall Gross Domestic Product (GDP) of Pakistan. The results of this study showed that there is a significant relationship between the GDP and FDI of Pakistan and FDI contributes positively towards the GDP. The results of the GDP model suggested that GDP will increase 27. 36 times of FDI with an increase of each unit of the FDI. Key words: Foreign Direct Investment (FDI), Gross Domestic Product (GDP), Pakistan.

INTRODUCTION Foreign Direct Investment refers to the investment made by a company or an entity based in one country, into a company or entity based in another country. Foreign direct investments differ substantially from indirect investments such as portfolio flows, wherein overseas institutions invest in equities listed on a nation’s stock exchange.Entities making direct investments typically have a significant degree of influence and control over the company into which the investment is made. Open economies with skilled workforces and good growth prospects tend to attract larger amounts of foreign direct investment than closed, highly regulated economies. [18] Foreign Direct Investment from the past two decades has changed the traditional economic relations in the world economy. FDI stock of the world reached more than $ 4 trillion by year 1998 about 800% more than what it was in 1980 [17].Integration and liberalization of the world economy has accelerated the fierce competition of many developing countries for such policies to attract as much of the FDI inflows as possible. The selective policies not only improve the fundamentals of the economy but they aim at attracting more foreign investments in the country.

This study is to understand how significant is the contribution of the Foreign Direct Investment and how it will contribute towards the economy of Pakistan.And it will also emphasize on the fact that how important is the removal of the barriers restricting the FDI inflows in the economy. LITERATURE REVIEW Klasra (2011) Researchers have drawn diverse results on the basis of economic growth determinants, and there was no conclusive consensus. Results of the particular hypothesis reveal the interdependency of trade openness ;amp; growth as liberalization process is contributing towards the short-term benefits of Pakistan which is complementing competition in the locale and contributing and enhancing the economy.Zaman (2006) Issue of the FDI is very broad and sensitive as it is far reaching in the economy of Pakistan.

This study precisely focuses on the FDI effects on the concerned economy, as previous researches were more of a big picture. In particular areas this research is particularly contrasting from the previous work, where inflation has a positive relation with FDI and is not related with the service sector. Falki (2009) FDI is not primarily considered an economic contributor directly, as it depends on the overall economic scenario, social conditions and technological levels of the country.Research has shown that FDI contributes significantly in the economy of developed countries but it is contrasting in the case of Pakistan. Yousaf (2008) Analyses of more than 3 decades reveal that FDI has positive relation with imports in short ;amp; long-run where as relationship with exports is negative in short ;amp; positive in the long-run. FDI is an economic influencer of economy of a country specially developing countries experience accelerated GDP when successful in attracting FDI as in case of Pakistan.

Ahmad (2003) FDI not only contributes towards the economic betterment of the host nation but it also provides technological advancements and increased productivity. Investment in Pakistan is not outward-oriented but study suggests that her economic prosperity depends upon the inflow of FDI that can contribute towards the export-oriented strategy. Dar (2004) Economy of the developing countries like Pakistan is volatile and depends upon many other influencers that include political ;amp; social environments in the country.FDI inflows to Pakistan depend upon the socio-political environment and study suggests a long relationship of FDI inflows in Pakistan with the socio-political influencers and the macro-economic factors. Aqeel (2004) FDI inflows to Pakistan have increased over time and are subjected to have a favorable effect on the economy. The majority of policy variables have significant influence in attracting FDI in Pakistan as they are positively related in both short and long-run and study predicts positive impacts of reforms in the FDI sector.

Khan (2004) Despite having all the ingredients, Pakistan has not been that successful in attracting FDI inflows in the country as much as other developing countries in the east ;amp; south-east Asia because of the socio-political environment, volatile ;amp; irregular business environment, law ;amp; order situation, complexities in legal procedures, over taxing, complex labor laws and corruption etc. Khan (1999) Pakistan is one of the least beneficiaries of the FDI inflows in Asia and also faces major setback in the power sector policy which have resulted in massive inflows in the power sector at the cost of industrial development.Large inflows now further involve IPPs repayments, debts and outflows so FDI in the short-run are not necessarily beneficial if the policy implement is not feasible. Hamdani (2009) FDI is not only inflows of payments into the country but it enables a country to develop industry sector and practice international standards of production. Market oriented FDI is feasible in the global recession that is currently faced by the world. FDI for outward-oriented policies is desirable objective of a country.Shahbaz (2008) Strong relationship between FDI and gross domestic saving is observed in the long-run as well as the short in the developing country of Pakistan. Both FDI ;amp; gross domestic savings have complementing relationship and Government of Pakistan should provide incentives to both areas in order to make the most of it.

Shah (2003) Globalization is expanding as pooling resources is deemed critical for reducing burden and boosting technology for outward policies and Pakistan should also purse resource inflows.Public sector should emphasis on attracting FDI inflows by improving domestic market size, conditions ;amp; political soundness as they are directly related to the FDI inflows. Guinsinger (1997) Pakistan must take few steps in further liberalizing noticeably the deletion of investment in some sectors, as the government is successful in removing such barriers previously. Removal of such barriers will boost Pakistan in the elite investment countries of Asia so the public sector has to take such decisions to favor and increase the inflows of FDI.

Atique (2004) FDI being a major influence in the world economy has grown by many folds in the last decades and has resulted globalization, cost reduction and openness in the world economy. But Pakistan hasn’t received heavy FDI up till now but still shows positive signs of growth in FDI due to the market oriented policies adopted by Pakistan over the last couple of decades. Khan (2007) FDIs are stemming throughout the world as an asset for reducing saving and investment gap, and source for the domestic development of a developing country especially like Pakistan.

It also helps improve a country’s labor force efficiency, productivity and technology and Pakistan, like other countries has adopted policies to attract FDI but local conditions limit potential benefits generated by FDI. METHODOLOGY Data: Time series data is used to identify the effects of foreign direct investment (FDI) on Pakistan’s economy for the period of 1976-2011 in this study. The data was sourced from the World Bank (WDI). Variables: Variables included in this research are; * Gross Domestic Product (current US$) * Foreign direct investment, net (BoP, current US$) Exports of goods and services (current US$) * Imports of goods and services (current US$) * Money and quasi money (M2) (current LCU) * Real interest rate (%) * Inflation, GDP deflator (annual %) * Current account balance (BOP) * Official exchange rate (LCU per US$, period average) * Manufacturing, value added (current US$) Technique in Analysis: “Linear Regression” is applied to the data to determine the impact of the FDI on the economy where the dependent variable representing the economy is the GDP and all the remaining variables as the independent variables.Initial Model: A model was derived from the above mentioned independent variables used to predict the GDP by keeping intact out target variable FDI in the independent variables. But the dependency among independent variables (Variance Inflation Factor) of Exports and Imports was above acceptable limit and “multicollinearity” existed. To overcome this problem “Principle Component Method” was used by taking transforming the Exports and Imports into a single variable of Net Exports.The nature of Pakistan’s Net Exports is negative because of the fact that Pakistani Imports significantly exceed its Exports so the actual net variable of both Exports and Imports was named “Net Negative Exports”.

Predictive Validity: The predictive validity of this instrument was also tested in the “Linear Regression” analysis. The model in consideration is perfectly significant . 000 in the ANOVA table above and where as our target variable FDI is also perfectly significant. This model can predict the dependent variable with 65.

% accuracy as per the adjusted R square of the model summary. It can be seen from the results provided in Model Summary that the Adjusted R Square is 0. 654. This indicates that the three independent variables explain 65. 4 percent of the predictions accurately.

Final Model: The following is the final model derived from the coefficients table; GDP = 3. 435E10 + 27. 636(FDI) + 9. 204(BOP) – 7. 130(NNX) This particular model suggests that is a significant and positive relationship between GDP and FDI of Pakistan and FDI contributes positively towards the GDP.The results of the GDP model suggested that GDP will increase 27. 636 times of FDI with an increase of each unit of the FDI. Whereas the Current Account Balance (BOP) is also contributing positively in the GDP and Net Negative Exports have negative relationship with the GDP.

FINDINGS Klasra (2011) emphasized that the trade openness and liberalization process is contributing towards short-term benefits of Pakistan and enhancing domestic conditions. Hamdani (2009) Market oriented FDIs are not only feasible inflows in terms of payments but also technological and production standards.Khan (2007) stated that FDIs are asset for reducing saving and investment gap, domestic development source and helps improve labor and production efficiency especially in country like Pakistan. But local condition limits the potential gain of the FDI.

Khan (1999) found that Pakistan is least beneficiary of the FDIs in Asia, in industrial development due to the inflows to IPPs and furthermore their repayments, debts and outflows. Atique (2004) FDI factor has increased by many folds in the world in few decades and also in Pakistan due to market oriented policies but not any heavy increase is observed.Ahmad (2003) found that FDI contributes towards the economic and technological advancements and Pakistan is not following export-oriented strategy which is ideal for its prosperity. Falki (2009), Dar (2004) and Khan (2004) suggested that FDI is an economic contributor that depends upon political, economical, social and technological environment of an economy and Pakistan is less successful in attracting FDIs because of the volatility in domestic conditions, irregular business environment, law ;amp; order situation, complexities in legal procedures, over taxing, complex labor laws and corruption etc.Zaman (2006) identified the FDI effects on a concerned economy, where inflation has a positive relation with FDI and is not related with the service sector. Yousaf (2008) documented that FDI has positive relation with imports in short ;amp; long-run where as relationship with exports is negative in short ;amp; positive in the long-run, especially in case of Pakistan. Aqeel (2004) Policy variables have significant influence in attracting FDIs to Pakistan and FDI inflows have increased over time.Shahbaz (2008) Observed strong relationship between FDI and GDS and provided that Government of Pakistan can be better off by complementing both of them.

Guinsinger (1997) Found that Pakistan must take steps to disinvest in some sectors such that they become ideal for the foreign investment. Shah (2003) Suggested that Public sector should improve domestic market size, stabilize political environment to maximize the FDI inflows in Pakistan.Khan (2012) in a comparative explanatory study reviewed economic analysis of Foreign Direct Investment and its Impact on Trade and Growth in Pakistan. The study has some useful findings that can boost FDI inflows, as it reviews 17 researches.

Some of the finding and recommendation useful in the context of FDIs in Pakistan are: * FDI is a source and asset to decrease saving and investment gap. * FDI inflows contribute towards the financial and technological advancements in domestic markets of Pakistan. Due to lack of honesty, political and economic instability, and power sector crisis Pakistan is unable to utilize potential benefits from the FDI inflows. * Pakistan is not following outward-oriented policy which is ideal for its prosperity. * FDI has a positive relationship with inflation, exports and gross domestic savings of a country. * Pakistan should liquidate investment is some sector to invite foreign investment in those sectors.

* Public sector should step in to stabilize the overall environment to attract maximum FDI inflows. CONCLUSIONForeign Direct Investment (FDI) has become an important growth factor in the last few decades in the globalization of the world economy especially in developing countries like Pakistan. The countries that experienced faster growth rate of GDP were considered successful and have been attracting larger amount of FDI.

In Pakistan FDI was helpful to narrow down the Saving-Investment gap. The economic benefits of FDI are wide-ranging; it opens new avenues of knowledge, transfer of technology, training of manpower, market networking and many other spillover effects and externalities in the host countries.Numbers of the developing countries including Pakistan and countries in South Asia have taken effective policies and aggressively pushing economic reforms to attract foreign investments including FDI.

Unfortunately Pakistan was unable to attract sufficient FDI inflows as per its stature. Many theoretical and empirical research studies were conducted at national and international level related to FDI impacts on Pakistan and most of them were reviewed in the literature. However, the local conditions can restrict the potential benefits produced by FDI despite of instrumental policies and practices.RECOMMENDATIONS On the basis of this study’s results, the following recommendations are suggested for positive impact on trade and growth in Pakistan by stimulating high levels of FDI inflows in Pakistan: * Law and order situation should be stabilized in order to provide a safe zone for the investor to bring their capital inflows in Pakistan. * Minimal taxation policy should be adapted towards the investors. * Whereas the reverse policy should be implemented to reduce the amount of the capital outflows from the country.

Policy makers should provide conducive and friendly environment to foreign investors to attract more FDI. * Investor should be given more incentives for the transfer of technology to host country. This would lubricate the local enterprises. * For Pakistan import-substitution policy related FDI may prove good. BIBLOGRAPHY [1] Klasra, M. A, Foreign Direct Investment, trade openness and economic growth in Pakistan and Turkey: an investigation using bounds test, Quality ;amp; Quantity, vol. 45 (2011), Issue 04 (September), pages 223 – 231, DOI 10. 1007/s11135-009-9272-5.

2] Zaman, Khair, Hashim, Shumaila, and Awan, Zahid, Economic determinants of Foreign Investment in Pakistan, Zaman et al. , University Journal of Research, vol. 22 (2006), Pages 49-57. [3] Falki, Nuzhat, Impact of Foreign Direct Investment on economic growth in Pakistan, International Review of Business Research Papers, vol. 5 No. 5 September (2009) Pages 110-120. [4] Yousaf, M.

Mahr, Hussain, Zakir and Ahmad, Nasir, Economic evaluation of Foreign Direct Investment in Pakistan, Pakistan Economic and Social Review, vol. 46 no. 1 (2008), Pages 37-56. 5] Ahmad, Alam and Butt, Foreign Direct Investment, Exports and Domestic Output in Pakistan,The Pakistan Development Review, vol.

42: 4 part II (2003) Pages 715-723. [6] Dar, Presley and Malik, Determinants of FDI inflows to Pakistan, Loughborough University, Loughborough, UK. (2004) [7] Aqeel and Nishat, The determinants of Foreign Direct Investment in Pakistan, The Pakistan Development Review, vol.

43 part II (2004) Pages 651-664. [8] Khan, Ashfaque H. , Foreign Direct Investments in Pakistan: Policies and Trends, The Pakistan Development Review, vol. 6: 4 part II (2004) Pages 959-985. [9] Khan, Ashfaque H, and Kim, Yun-Hwan, Foreign Direct Investment in Pakistan: Policy Issues and operational Implications, EDRC Report Series, No. 66.

[10] Hamdani, Khalil, Foreign Direct Investment Prospects of Pakistan, Pakistan Institute of Development Economics, April 2009. [11] Shahbaz, Muhammad, Awan, Remat and Ali, Liaquat, Bi-Directional Causality between FDI ;amp; Savings: A Case Study of Pakistan, International Research Journal of Finance and Economics, vol. 7 (2008) pages 75-83. [12] Shah, Zahir and Ahmed, Qazi, The Determinants of Foreign Direct Investment in Pakistan: An Empirical Investigation, The Pakistan Development Review vol. 42: 4 Part II (2003) pages 697-714. [13] Guinsinger, Stephen, The Effects of the Foreign Direct Investment, The Pakistan Development Review, vol. 36: 4 Part II (1997) 403-418.

[14] Atique, Zeshan, Ahmad, Mohsin and Azhar, Usman, The Impact of FDI on Economic Growth under Foreign Trade Regimes: A case study of Pakistan, (2004). 15] Khan, Muhammad Arshad, Foreign Direct Investment and Economic Growth: The Role of Domestic Financial Sector, PIDE Working Papers, vol 18, Pakistan Institute of Development Economics, Islamabad, Pakistan, (2007). [16] Hakro, Ahmed Nawaz, and Ghumro, Akhtiar Ahmed, Foreign Direct Investment, Determinants and Policy Analysis: Case Study of Pakistan. [17] Nasir, Saeed, (2001), Foreign Direct Investment and its impact on trade and growth in Pakistan, The Islamia Univeristy Bhawalpur. [18] Retrieved 26 December, 2012, from Investor Words: http://www.

investopedia. com/terms/f/fdi. asp#axzz2G5kBBUlg

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