Abstract:

This paper establishes the empirical relationship between Foreign Direct Investment and

the Economic Growth in Pakistan over the period of 1990-07. The study is done to

investigate whether the FDI and Economic Growth GDP are positively related or not. The

data has been collected from the Economic Survey of Pakistan 2005-06 and 2009-10 and

also from Federal Bureau of Statistics Pakistan. The results of the study support the

evidence that the FDI and GDP are closely related to each other and have a direct positive

link to each other; more significantly in short run. The results are defined by making first a

good theoretical base by doing literature review and then by interpreting the data collected

on the basis of hypothesis formulated.

Introduction:

FDI stands for Foreign Direct Investment; According to business dictionary Foreign Direct

Investment means Ownership of a country's businesses or properties by entities not

domiciled there. Foreign Direct Investment is a component of a country's national financial

account. Foreign direct investment is investment of foreign assets into domestic structures,

equipment, and organizations.

An investment made by a company or 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.

Whereas the economic growth refers to the increase in a country's productive capacity as

measured by comparing gross national product (GNP) in a year with the GNP in the

previous year. Increase in the capital stock, advances in technology, and improvement in

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the quality and level of literacy are considered to be the principal causes of economic

growth. In recent years, the idea of sustainable development has brought in

additional factors such as environmentally sound processes that must be taken

into account in growing an economy. And the annual rate at which

a country's income increases is called the economic growth rate. When this rate is adjusted

for the effects of inflation, it is termed real economic growth.

Many studies have been done so far to examine the simple relationship between the foreign

direct investment and the economic growth. A well documented literature is being

available everywhere which depicts and describes the positive direct relation of the FDI

and economic growth. The studies show that there is a significant greater impact of FDI on

the economic growth and development of the host country. In other words the economy’s

growth of producing the goods and services experiences momentous and a meaningful

increase as the measure of Foreign Direct Investment rises in the economy.

The other benefits and effects for the increase in the size or magnitude of the FDI – which

indirectly influences the growth – in host country can be the substantial increase in the

quality productivity of the country, increase in the job opportunities and employment

levels, infusion to the new advanced technology, the rise in the stock of human capital via

training, increase in the management skills, the finance generated through this activity can

be then used to fill the current account deficit gaps, potential utilization of the domestic

raw material.

The countries with higher skilled workers and some good infrastructure position tends to

attract drag the attention of the multinational companies to invest and in their company.

Now days the developing countries specially are trying to induce and invite the big multi-

national companies by the trade liberalization policies and laws to start business in their

country as this may benefit them in many ways. A quite higher level of the saving and

investment is necessary to increase the capital formation in the country. But many of the

developing countries; however face the problem of saving investment gap because the

level of domestic saving is below the required level due to low per capita income -

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including Pakistan - face the problem of saving-investment gap and this gap can only be

filled by the transformation of the resources from other foreign countries. The important

aspect in this regard is that the host country must ensures that FDI should also stimulates

the domestic economic activity by making it mandatory for the foreign investors to use

certain amount of the locally made inputs in the production of the final goods.

This increase in the foreign investment can be done by the unrestricted trade policies and

investment regime by relaxing controls and also by presenting financial and trade

incentives like tax concessions and quota abolishment or tariff reductions. Host countries

should pursue active liberalization policies to overcome the trade deficit and more

importantly to encourage the foreign investors to invest in export led sectors. In other

words the host country should adopt the policies which would influence the foreign

investor’s decision and they must provide investor friendly environment, strong

infrastructures and should restore the confidence of the foreign investors.

Literature Review:

Luiz R de Mello (1999) studied the time series analysis between the sixteen (16) OECD

(developed) and seventeen (17) non OECD (developing) countries. His study shows that

the FDI may result in increase growth rates as FDI increases the technology and the

knowledge in the recipient country. But his study also suggests that the degree of FDI

seems to be higher in technologically advanced countries rather than the developing

recipient’s economy.

Robert Lipsey, Mario Zajan, Mangus Blomsrtom (1993) studied the causality between the

investment and the growth rate dividing the post world war II period into five sub periods.

He used the simple and multiple regression with several standard determinants of growth,

which results GDP is more related to investment than investment related to GDP. In other

words he found out that investment do not cause the GDP to increase; it is the increased

GDP which attracts the investors to invest in the country.

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Sridharam (2009) studied the five countries – Brazil, Russia, India, China & South Africa –

He concluded that the impact of FDI on economic growth is constrained with the

availability of the physical capital, & the policy in the host country. An interesting scenario

suggested; countries with faster GDP growth generate more demand for FDI and offer

opportunities for making profits. And also, inward FDI may enhance positive economic

growth through direct and indirect effects in the variables.

Xueli Wan (2010) analyzed the views of many researchers who studied the impact of FDI

on economic growth. According to him the impact of FDI has becoming more important

for the developing and less developed countries. He concluded that there are some

conflicting predictions about the effect of FDI in economic growth; some support it as this

increases the technology and knowledge in the recipient’s country and some oppose due to

the fact that it bring the crowding out effect for the domestic investors.

Renato Vilano & Brain Dollery (2010) studied the impact of FDI on 45 different countries

over the period of 1997-2004; which include both developed and developing countries by

controlling host country infrastructure. According to him, FDI inflow exerts a positive

impact on GDP in the presence of highly skilled labor as FDI itself cannot improve the

efficiency; i.e. a nation cannot absorb the advance technology accompanying FDI unless

there is well trained skilled labor.

G Harana, Kishor K, Deergha R (2011) did the time series analysis of Chinese economy.

This study focused on post liberalization period and so results strongly support that FDI

inflows and exports led economic growth in China. They also discussed the benefits of FDI

in an economy and also showed some results of previously done studies in this field. He,

also, found out a bi directional casualty between the FDI inflow and the economy’s growth

of production.

M A Khan, Shujat Ali Khan (2011) established the empirical relationship between industry

specific FDI and GDP over the period of 1981-2008. They assessed the growth implication

of FDI in Pakistan using sector specific FDI and output data and apply panel co integration

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technique. The results supports the evidence that FDI has a positive effect on output in the

long run; while in short run the evidence of two way casualty is identified. The results

describes that the effects of FDI on growth vary significantly across sectors.

Laura Alfaro (April, 2003) examined that the benefits of FDI vary greatly across sectors.

An empirical analysis using 47 cross country data of different years for the period of 1981-

1999 suggest that total FDI exerts an ambiguous effect on growth. FDI in primary sector

tend to have positive but low effect on growth, while in investment in manufacturing sector

is the positive one, and in the services sector it is ambiguous.

Maria Carkovic & Ross Levine used the data of 72 countries from 1960 to 1995 and this

investigation provides evidences based on the cross section of countries. Econometric

techniques were applied – Generalized Method of Moments. By this study they concluded

that FDI has more positive impact on macroeconomic variables like economic growth than

micro variables. But they also found out that FDI inflows do not exert independent impact

on economic growth.

Nicholas Apergis, Katerina Lyroudi, & Athanasios Vamvakidis used 27 transitional

economies over the period of 1991-2000. They investigated the direction of FDI and

economic growth in the economies; methodology of panel co integration was used, which

resulted that FDI has significant relationship with economic growth in case when all

countries were in same sample. However after splitting into low and high income countries

the same conclusion resulted for the countries with high income.

Atrayee Ghosh Roy and Hendrik F. Van den Berg (2006) found that most FDI occurs in

developed economies. A time series data for the year 1970-2000 was studied for US and a

simultaneous equation model (SEM) was used that captured the positive bidirectional

relationship between FDI and US growth. The results imply that technologically advanced

countries benefit from FDI, the gains of FDI are substantial in long run and also that FDI

has positive impact on productivity.

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Nuzhat Falki (2009) investigated the same impact of FDI and economic growth for the

period of 1980-2006. The result however does not show a significant relationship between

FDI and GDP. She suggested that FDI will affect the GDP with the preconditions include

presence of liberal trade regime, a threshold level of human capital, an adequate market for

domestic goods produced, an effective competition from locally owned firms and an

improving infrastructure with stable macroeconomic framework.

Scenario of Foreign Direct Investment in Pakistan:

Initially Pakistan followed a restricted and unliberalized trade policies for the reasons to

protect the domestic and local producer. But in 1990’s the government of Pakistan

initialized the liberalization and unrestricted trade and investment regime by providing

various facilities like tax concession, tariff reduction on many of the products, lessening of

the import duties, credit facilities, and easing foreign exchange controls. A number of

policies were set, regulatory measurements were taken and improvements were made in

the business environment for the increase and the attraction of the foreign investment.

Restrictions on the capital outflow and inflow were lifted, and the foreign investors were

allowed to hold 100% of the equity of industrial projects without any approval. And

furthermore, the establishment of the interbank foreign exchange market also marked up an

important step towards decentralizing the management of foreign exchange and allowing

market forces to play a greater role in exchange rate determination.

The salient features of Pakistan’s regulatory regime for the foreign investment are: free to

hold bring and take out the foreign currency in and from Pakistan in any form, the foreign

investors were not subjected to any additional tax other than the taxes levied on the local

investor, there should be a freedom for both the foreign and local investor for the imports

and exports of commodities or goods, the foreign investors are allowed to earn as much

profit as they can and there will be protection for Privatization; it neither can be

nationalized nor the government can take over the enterprise.

Custom duties in the imported goods – most of the primary raw material – is not more than

5% while in imported machinery it is between 0 to 10 %. Many facilities and services have

been provided by the Pakistani government to attract the foreign investor to invest in our

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country, like the copyright and patent laws have been amended, there is no difficulty in

getting the NOC (No Objection Certificate) from the provincial government to start a

project in any area except the areas that are notified as negative.

With all these facilities and conveniences, the foreign investment is not at a very high

level. This is all due to the inconsistency and irregularity of the government policies and

activities the ratio of the FDI remains at a decreasing level, when compared to other

countries. In the last decade, the era of Musharf, the government tried really hard to attract

the foreigners to invest in Pakistan by making market investment oriented policies and

enabling an environment for the investment purposes.

The FDI is of low level and also this is only concentrated in the few sectors like

telecommunication, finance, and Oil and Gas exploration. The reasons for this low level

and concentrated Net FDI inflows are the inconsistent economic policies of successive and

working governments, imbalances in the macroeconomic variables, lack of political

stability, inadequate facility of the infrastructure, past disputes between foreign investors

and government, slow bureaucratic process, delays in the privatization of state owned

enterprises, nontransparent application of government regulations or the piracy of

intellectual property.

According to a news article in Pulse Islamabad on May 25, 2012 the inflows in Pakistan

are dropping day by day, as the recent data released by the State Bank of Pakistan, shows

that the net inflow of foreign investment in Pakistan have sharply reduced by 64.7% and it

plunged to $2.15 billion in FY10 and further declined to $1.573 billion in FY11. And the

economic growth in year 2010 was only 3.0% and in 2011 it was 3.7% and the subjected

growth in 2012 is reduced to 3.5%.

We can conclude that Pakistan is now days becoming unknown for the international

investment as this country is followed by the prolonged energy shortages, worst law and

order situation and most importantly amorphous economic policies of the incumbent

government. The other unfortunate aspect about this is that the government is not at all

serious about this issue, as because of this government the country has seen four finance

ministers in the last four years.

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Pakistan has a lot of potential to attract foreign investment. Although the rising trend of

FDI reflects the success of policy; however, FDI inflows are considerably hindered by

institutional weakness, corruption, ineffective legal institutions, political uncertainty, poor

law, weak regulatory systems, law and order situation, and low labor productivity.

Variables Involved:

In this study we are involving only two variables the Foreign Direct Investment and the

Growth Rate. We will study the impact of FDI on growth rate in Pakistan, and all the other

variables are kept constant. Growth Rate is dependent and Foreign Direct Investment is

independent variable, means we will study the change in Economic Growth Rate due to the

change in the FDI.

Hypothesis Development:

We will formulate two hypotheses, a null and an alternative hypothesis as follows:

Null Hypothesis Ho: The two variables, Foreign Direct Investment (FDI) and

Economic Growth have no significant relationship with each

other.

Alternative Hypothesis H1: The two variables, Foreign Direct Investment (FDI) and

Economic Growth, are related to each other with positive

relationship.

Data Collection:

We have collected the data for unemployment rate and the crime rate in Pakistan for the

years of 1990 – 2007. This data is being shown below:

Years FDI GDP8

1987-88 162.2 6.41988-89 210.2 4.71989-90 216.2 4.41990-91 246 5.61991-92 335.1 7.61992-93 306.4 2.11993-94 354.1 4.41994-95 442.4 5.11995-96 1101.7 6.61996-97 682.7 1.71997-98 601.3 3.51998-99 376.0 4.21999-00 469.9 3.92000-01 322.4 2.02001-02 484.7 3.12002-03 798.0 4.72003-04 949.6 7.52004-05 1524.0 9.02005-06 3521.0 5.82006-07 5139.6 6.82007-08 5152.8 3.7

*Source: Federal Bureau of Statistics.

Economic Survey of Pakistan 2005-06

Economic Survey of Pakistan 2009-10

Methodology and Calculation:

Gross Domestic Product

Linear Model

Variables Entered/Removed(b)

ModelVariables Entered

Variables Removed Method

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1 Foreign Direct Investment(a)

. Enter

a All requested variables entered.b Dependent Variable: Gross Domestic Product

Model Summary

Model R R SquareAdjusted R

SquareStd. Error of the Estimate

1 .394(a) .155 .099 2.01574

a Predictors: (Constant), Foreign Direct Investment

ANOVA

Sum of

Squares df Mean Square F Sig.Regression 11.216 1 11.216 2.760 .117Residual 60.948 15 4.063 Total 72.165 16

a Predictors: (Constant), Foreign Direct Investmentb Dependent Variable: Gross Domestic Product

Coefficients

Unstandardized Coefficients

Standardized Coefficients

t Sig.

95% Confidence interval

B Std. Error Beta Lower Bound

Upper Bound

Foreign Direct Investment .001 .000 .394 1.661 .117 2.913

.000

5.600

.001(Constant) 4.256 .630 6.752

.000

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Data Analysis:

Now we will analyze

the data collected

through recognized and

reliable institutions of

government of Pakistan for the years of 1990-2007 – the Economic Survey of Pakistan and

Federal Bureau of Statistics.

The GDP ratio in Pakistan overall is not much high, from 1990 – 99 the FDI inflows were

very low in comparison to next year’s because of the political instability prevailed in the

country. Pakistan experienced changing in the government four times in just eight to nine

years. The investors; no matter domestic or foreign, become uncertain about the market

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and economy’s situation when the country experiences the lack of political stability. As we

can observe form the data that, FDI in 1990-91 was $246 million and in 2007-08 it has

reached to $5152 million.

Now we will analyze the data, the FDI from year 1990-92 increased from $246 million to

$335.1 million; but in 1992-93 it decreased. The main reason presently for the reduction in

FDI ratio is the lack of steady law and order situation; but back in 1990’s main reason was

the shaky political situation of the country. From the year 1990-92 the FDI increased from

$246 million to $335 million and so GDP increased from 5.6 % to 7.6%. And in the year

1992-93 the FDI contracts to $306.4 and this resulted in the reduction of GDP to 2.1%; in

comparison to the previous year 1991-92.

Surprisingly, from 1993-96 the FDI in the country observed to be expanding and the GDP

ratio also gain expansion from 4.4% in 1993-94 to 6.6% in 1995-96. From year 1993-96

the FDI also rose from $354.1 to up till $1101.7 million; this rise in FDI caused GDP also

to rise. However in the year 1996-97 the FDI and GDP fall off substantially to 1.7%, in

comparison to previous year 1995-96. This contraction was due to the huge flood

destructions in 1995. The after effects of the flood damages in the country showed in next

year.

Although the GDP started to maintain in next four years but the FDI did not increased, the

FDI in 1997-98 was $601.3 million and in 2000-01 it reached to $322 million. FDI flows

picked up after 2001-02 due to the revival of closer US-Pak ties and the liberalization

foreign investment environment. FDI in 2001-02 was $484.7 million and reached to $

1524.0 million in 2004-05 and so the GDP grows also in 2001-05 from 3.1% to 9.0%.

From the year 2000-05 the results were same, there occurs the positive relationship

between the FDI inflows and GDP ratio. However in the next three years it observed the

decreasing trend and reached to 3.7% in 2007-08.

As in 2008 the global economic slowdown caused by the financial crisis; fears of Pakistan

running bankrupt and deteriorating security conditions as fallout of War on Terrorism

caused growth rate fall.

The years 1990-97 shows the positive relationship between FDI and the economic growth.

But from the years 1997-00 and 2005-07 the FDI and GDP does not show the significant

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positive relationship; this may be because of some other exogenous factors involving in the

situation. Although the FDI inflows in grow due to the liberalization and unrestricted

policies made by the Musharaf government, but the GDP didn’t rose. This was due to the

fact that other macro economic variables contributing towards GDP and output, were not

working well.

Data Interpretation:

Now we will interpret the data from the year 1990 – 2007. The years 1990-97 shows the

positive relationship between FDI and the economic growth. We have used the regression

line analysis to test the defined positive relationship in the literature reviews and the

analysis done by studying the data of 17 years.

The regression line is calculated as

Ŷ = 4.256α + 0.001β

the intercept α of the line is ‘4.256’ and the slope β, which shows the rate of change in the

dependent variable, GDP, due to a change in the independent variable, FDI, is ‘.001’.

This means that our line starts from the point of intercept of ‘4.256’ and have the positive

slope of ‘.001’, i.e. if the independent variable changes by one unit, then the dependent

variable will increase by the amount of slope which is ‘.001’.

The positive sign in the regression line shows the positive relationship of the variables

(GDP and FDI). This positive relationship can also be expressed by another additional

measure, ‘r’, Co-efficient of Co-relation; which shows the degree of association between

the two variables. Here the value of r is ‘0.394’ which is greater than zero i.e. positive, so

relationship is also positive.

In doing this calculation we also have come up with a value of R2 co-efficient of

determination; which shows how much of the total variation in the dependent variable is

explained with its linear relationship of the independent variable. Here R2 is ‘0.155’ so we

can say that 15.5% of the variation is explained by the FDI in the GDP, the value

calculated is not much larger, this is due to the fact that many other factors (which include

inflation, education level, domestic investment etc.) also affect the GDP growth rate, and

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also due to the reason that the number of years studies in this study is not much larger. The

values of the co-efficient of the regression line α, β are also calculated as insignificant

because of the same reason of the smaller number of years being studied in the study.

Conclusion:

From the theoretical study, analysation and interpretation of the data collected; we are able

to conclude that the FDI and GDP have the positive relationship. The study shows the co

integration analysis of the two variables – GDP and FDI – in short run. We have also

applied the regression line analysis to test that if there exists a positive relationship

between the GDP and FDI. The results suggested that FDI promotes output i.e. if the FDI

increase in the country the output or the GDP ratio will also rise. In other words the change

in the independent variable – FDI– brings the change in the dependent variable – FDI.

The government or the policy makers should make policies and take actions to increase

FDI so that the economy’s GDP can also rise to a suitable level in the short run.

We showed that a change in the FDI a change in the GDP ratio, but this study does not

show that about which magnitude these two variables change. So, this study shows the

angle to the new researchers that they may search about the magnitude change in these

variables.

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Recommendations:

The government should made policies about the liberalization of the foreign

investors so that they may attract to invest and produce in our country which will

benefit us in many ways, most importantly will increase the GDP ratio prevailing in

the country.

The law and order situation of the country should also be improved which will

result that the foreign investors will not hesitate at all to invest.

Moreover, the energy crisis – gas & electricity – shortages are fulfilled on the

emergency basis. As this shortage is forcing many of the investors, foreigners or

domestic, to exit from the market.

The policy makers should provide the investor friendly environment. There should

be political stability in the country as the uncertain situation will leak out

investment from the country.

The imports and exports or trade policies should be more unrestricted which may

ease the investors – both foreign and domestic – to produce goods by importing the

inputs from other countries

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Ahmad. K. 2012 “Pakistan no more destination for foreign investment.” Pulse.

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Apergis Nicholas, Lyrondi Katerina & Vanvakidis Athanasios. 2004 “The Relationship between Foreign Direct Investment snd Economic Growth: Evidence from Transitional Countries”. University of Mecedonia.

Blomstrom Magnus, Lipesy E. Robert, Zejan Mario; 1993 “Is Fixed Investment the Key to Economic Growth”. NBER Working Paper Series.

Carkovic M. , Levine R. 2004 “Does Foreign Direct Investment accelarate Economic Growth”. University of Minnesota.

De Mello Luiz R, Jr. 1999 “Foreign Direct Investment- led growth: Evidence from Time Series and Panel Data”. Oxford Economic Papers.

Economic Survey of Pakistan 2005 – 06, 2009 – 10 & 2011 – 12.

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Fasih ud Din. 2004 “Foreign Investment Prospects in Pakistan” World Trade Review.

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Roy Ghosh Atayee & Den Berg Hendrik Van. (2006) “Foreign Direct Investment and Economic Growth: A time series Approach”. University of Nebraska Lincoln; Economic Department Publications.

Sridharan. P (Octobar 2009) “Casual Relationship between Foreign direct Investment and Growth Evidence form BRICS Countries”. Pondicherry University Vol 2, No 4.

Wan Xueli (Januarary 2010) “A Literature Review on the Relationship between Foreign Direct Investment and Economic Growth”. Interational Business Researh. Vol 3, No 1.

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