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Introduction and background of poverty

All the developing economies are entrapped by the vicious circle of poverty. These countries lack the basic capital resources. Income of the people is very low due to which savings are low and ultimately it ends in lower investments. In addition, due to the lower income levels the taxable capacity is low meaning that government’s earning is also low. Under such circumstances these countries had to face saving-investment gap & Balance of payment gap. To fulfill these gaps these developing countries had to rely on Foreign Capital Investment to accelerate the growth process and to fill saving-investment gap & BOP gap. Foreign Capital Investment can come in many forms including; Foreign Aid, Official Development Assistance, Official Aid, FDI, Foreign Portfolio Investment and borrowing (Mohey-ud-din, 2006). Regardless of the fact that all the developing economies must rely on any of these sources to accelerate the process of growth, the amount and the form of FCI differs from country to country and depends on the individual economic condition of that particular country. In case of Pakistan, FCI plays a significant role in the economic development. On one side Pakistan lack basic capital investment, technology and human resource and on the other side country’s political and economic condition forces it to rely on FCI.

During the period of 1950, Pakistan along with the other south Asian countries pursued a policy of import substitution. In 1970 Srilanka took a progressive step toward policy reforms in favor of progressive liberalization and globalization. These macro economic reforms were adopted by all south Asian courtiers due to the derived benefits. This Post reform period in all south Asian countries is characterized by high growth and economic development. Pakistan introduced these reforms in late 1980’s. One of the most important benefits of these economic reforms was the increased inflow of FDI (Mehta, 2006).

The current research only concentrates on foreign direct investment rather than capital flows in general because it is intimately connected to not only the transfer of capital but also helps in transfer of capital, management & marketing skills and advanced technologies between nations. And secondly, for the past 40 years and so the inflow of FDI specifically in South Asia has increased drastically.

FDI is the investment made by a company outside its home country. For the home country it is the outflow and for the host country it is the inflow of, long time investment based on long term profit sharing involved in international production. This definition is correct but not complete as the important issues of control and management are not included in it. International investment can take two forms. It could either be portfolio investment, where the investors buy some non-controlling portion of the stock, bond or any other financial security, or direct investment where the investor participates in the control and management of such business venture. This is the type of investment by multinational companies and it tends to contribute more to economic growth than the portfolio investment (Adewum, 2006).

FDI brings in costless capital and technology necessary for rapid growth as well as it provides access to global production and marketing networks. As noted above, South Asian countries had a somewhat conservative mechanism. From last couple of decades this region had opened up and became encouraging for foreign investment. Primarily, FDI was allowed but with a lot of limitations and on equally profitable conditions where majority stake were to be held by domestic firms. However, South Asian countries worked hard to attract FDI more assertively in the nineties, by making changes in macroeconomic, trade & FDI policies (Mehta, 2006).

The intensity to attract FDI for all the major South Asian countries in the era of 1990-2003 had more than doubled except for Pakistan. It can therefore be interpreted that although the macro economic reforms had been successful in attracting greater FDI inflows but the inflows were not significant when compared with other countries of the same region.

Table1: Ratio of FDI Inflows to GDP (in %)

 

1990

2003

Bangladesh

0.01

0.2

India

0.03

0.71

Nepal

0

0.25

Pakistan

0.57

0.65

Srilanka

0.54

1.25

Source: (Mehta, 2006).

As per the information in the above table, Pakistan was not able to attract enough amount of FDI to accelerate the growth process because of the prevailing economic policies at that time. Sri Lanka had the largest intensity to attract FDI inflows (1.25% of GDP) followed by India and Pakistan (Mehta, 2006).

This research will discuss whether the changes in those reforms bring any impact on the growth process or not. And if it does, then is it worthwhile for the government to modify those policies to attract more MNCs to bring FDI in Pakistan?

The purpose of this research is to demonstrate the role played by FDI in accelerating GDP growth, so as to know whether the call for more FDI is truly justified.

The flow of FDI has been drastically increased in the last couple of decades making it a key area for the further research. Increasing attention has been paid in all developing countries in recent years to answer the question of “how to attract more FDI”. This emphasis on one side has increased the flow of FDI in the host country and on the other side it gives rise to uncertainties regarding the profitability analysis of making such decision. Such as whether the impact of FDI on domestic employment pays more or costs more? So a lot of researches had been done on this topic so that these questions can be addressed (OECD, 2002).

The topic is of great importance because of the advantages that FDI brings to the home country. one of the main gain from FDI is that it supports development of the host country where the investment is being made through; overcoming financial crisis, by permitting transfer of technology, human skills, intellectual property, enhancing skills of human capital, increasing government’s revenue through taxation, by creating new jobs, by improving the quality of goods and services being produced, it boosts the exports sector etc in addition there is also some range for new research actions.

This research will help the government in formulating and modifying the right policy mix to attract the targeted level of FDI. It will also help the Central Bank in making the fiscal policy where it can set the tax targets, helps in determining the tax rates as well as in the making of monetary policy. The students can get the grip of FDI on GDP by understanding the importance of this research which will be a source for the future research, also making a think tank they can come up with new ideas and provide consultancy to the local firms and entrepreneurs so that they can merge with MNCs to gain the knowledge of advanced technologies and skills.

Considering the significance of the topic, this research has been planned. The core purpose of this research study is to examine the impact of the FDI on GDP growth of Pakistan. The organization of this thesis follows as: a detailed review of literature on the impact of FDI on GDP of the developing countries, the theoretical background of economic theories on FDI is presented in Section chapter II. Chapter III deals with the data and methodology. Chapter 1V discusses the results and interpretations while chapter V gives the conclusion and the policy recommendations.

CHAPTER 2: REVIEW OF THE RELATED LITERATURE

The literature review is divided in to two parts; the first part mainly focuses on the basic theories underlying the foreign direct investment and the second part emphasizes on the theoretical framework of FDI Flow and its impact on GDP growth of developing economies.

2.1. THEORIES OF FOREIGN DIRECT INVESTMENT

Theories played a significant role in determining legal attitudes both nationally and internationally. Theories of FDI asserted that the basis for such investment lies in the transaction costs of transferring technical and other knowledge. Three important theories of FDI are discussed below:

2.1.1 Neoclassical Economic Theory of FDI

According to the Bergten, Horst & Moran (1978) the neoclassical economic theory stated that FDI positively contributed to the economic development of the host country and increased the level of public welfare. Some of the supporters of Neoclassical economic theory and the researchers who had further worked in that field includes; Seid (2002), Kojima (1978), Antonelli (1991), Reuber (1973); Sornarajah (1994); Bergten, et al. (1978), Kennedy (1992), Chu (1989), Lall (1993).

The rationale behind this theory was that, that the MNC’s by bringing FDI in to the host country influenced the quality and quantity of capital formation in that country. On one hand this inflow of capital from MNCs and its reinvestments of profits increase the total savings of the country, increases government’s revenue via tax and other payments and on the other hand this infusion of capital reduces the BOP pressure of the host country (Seid, 2002).

The other argument that supported the neoclassical theory was that FDI did not only brings advanced technology but managerial skills, marketing skills, market information, organizational experience, and the training of workers as well (Kojima, 1978).

MNCs served as a primary channel for the transfer of technology from developed to developing countries. But the benefits derived from this transfer of technology depended on the extent to which these innovations are diffused locally. This cost of technology transfer got affected by a number of factors. And due to the general scarcity of these factors in developing countries, the cost of adoption of new technology remained high (Antonelli, 1991).

The proponents of neoclassical theory further argued that FDI raised competition in an industry with an ultimate improvement in productivity. This increased competition lead to better allocation of resources, better utilization of capital, efficient management and increased in market efficiency. MNCs through Foreign direct investment provided local industry the exposure of international markets, which lead to greater competition, more opportunity of technology transfer and ultimately resulted in economic development (Kojima, 1978).

FDI helped in employment generation which ultimately influenced distribution of income. It also helped in generation foreign exchange which facilitated in filling balance of payment gap Reuber (1973); Sornarajah (1994); Bergten et al. (1978). FDI also helped in upgrading the local infrastructure facilities which resulted in economic development Sornarajah (1994). FDI accelerated the economic development by enhancing the administrative, technical and managerial capabilities of the host country (Kennedy, 1992).

The guiding principle on the Treatment of Foreign Direct Investment incorporated the neoclassical theory and stated that a larger flow of foreign direct investment brought significant benefits to the world economy in general and for the developing countries in specific in terms of technological advancement, greater competition, expansion of international trade, enhanced marketing & management skills and access to international market. The World Bank guiding principles on the Treatment of FDI demonstrated that a proper policy mix and openness to FDI had brought more benefits to the host country (Chu, 1989).

2.1.2 Dependency Theory of FDI

According to the Dependency school theory, the impact of foreign direct investment from developed countries through multinational corporations (MNCs) on developing countries was harmful for long term economic growth of the developing nations. Dependency theory’s thoughts were based on Karl Marx’s theory of development and underdevelopment; Paul Baran’s analysis of economic backwardness and economic growth; Andre Gunder Frank’s analysis of the development of underdevelopment; and the writings of Samir Amin on unequal development (Fan, 2003).

Dependency theory argued that FDI and MNCs were harmful for the long term economic development of the developing countries in specific. It believed that the rich countries becomes richer and exploits the labor and other natural resources of the developing nations. And the developing nations thereby put in to conditions of continuing poverty. It caused exploitation of labor, hindered growth and caused income inequality. So keeping in mind the above harmful affects, the developing nations must develop independently without depending on FDI or MNCs.

The influence of dependency theory peaked in 1970s. Various countries including East Asian and Latin American adopted this point of view and demonstrated a hostile attitude toward FDI. But after seeing the harmful affects of adopting these policies on the economy, these countries shifted the attention to more liberal policies to attract foreign direct investment. This theory is out of the scope for this research. Hence it’s not discussed extensively.

2.2. Theoretical Framework of FDI Flows and Growth

The role played by the Foreign Direct Investment in the economic development of developing countries remains debatable in the literature. Many researchers had proved that FDI is positively related to GDP growth and FDI enhances the process of GDP growth. The researchers that proved its significant and positive impact on economic development, includes; Chenery & Strout (1966), Bosworth, Collins & Reinhart (1999) , Loungani & Razin (2001), Moss, Ramachandran & Shah (2005), De Gregorio (2003), Feridunm (2004), Bornsztein, Gregorio & Lee (1998), Sanchez-Robles (1998), North (1956), Borensztein, De Gregario & Lee (1998), Glass & Saggi (1998), Blomstrom, Lipsey & Zegan (1994), Balasubramanyan, Mohammed, Salisu &Sapsford (1996), Bengos & Sanchez-Robles (2003), Nabenende,Ford, Sen & Slater (2002), Aluko (1961), Brown (1962), Obinna (1983), Oseghale & Amonkhienan (1987), Das (1987) , Din (1994), Balasubramanyam, Mohammad, Salisu & Sapsford (1996), Dees (1998), De Mello (1997), Adewumi (2006), Hasen & Giorgioni (2006), Athukorala (2003), Zhang (2004), Trevino & Upadhyaya (2003), Sjoholm (1999) & Agrawal (2000). While some researchers had highlighted its negative aspects as well.

On the basis of a research on least developed economies, it had been concluded that Foreign Direct Investment had a major and optimistic impact on GDP & it helped in raising the economic activity. The study also made an important statement, saying that FDI played a very vital role in rousing the economic growth (Chenery & Strout, 1966).

Bosworth et al. (1999) analyzed the impact of various form of FCI on GDP. The research proved that, out of various forms of FCI including loans, borrowing, portfolio investment and other forms of FCI, FDI had a stronger positive impact on GDP in developing economies. It had a strong positive effect on investment and saving which eventually lead towards more economic development while other forms of FCI may had a negative impact on saving and investment, leading to a negative impact on GDP. This research concluded that FDI is the most effective form of FCI which helped in fastening the process of GDP growth.

It had been concluded that out of the different forms of capital flow (FDI, portfolio investment and primary bank loans) to the Least Developed Economies, FDI was discovered to be the most resilient. It greatly helped in accelerating the growth process of developing countries (Loungani & Razin, 2001).

A similar conclusion had been given in a study by Moss et al. (2005). The study revealed that FDI contributed more to GDP as compared to local investment. So rather than making efforts to increase local investment, the government must emphasize more on attracting Foreign Direct Investment because FDI not only bring capital but technology, management and international exposure which in combination resulted in more effective and efficient mix in accelerating the process of economic growth (GDP).It might end up in wiping local firms out of the market but for that the government had to make the right policy mix keeping in mind the cost and benefits of MNCs.

It had been proved that the contribution of FDI to GDP is three times more than that of local investment De Gregorio (2003). The study revealed that FDI brings in new expertise in the local market with the benefit of having access to foreign markets. According to the analysis, the researcher found out that increasing aggregate investment by 1 percentage point of GDP increased economic growth of Latin American countries by 0.1% to 0.2% a year, but increasing FDI by the same amount increased growth by approximately 0.6% a year during the period 1950–1985, proving that FDI is more competent than local investment.

Feridunm (2004) conducted a study to examine the relationship between GDP and FDI in the economy of Cyprus. The study verified that there is a strong positive relationship between GDP and FDI and stated that if the economy of Cyprus manages to get the higher FDI, its GDP will increase and vice versa. Further the results of the research suggested that the economic development of the country resides on its ability to get more FDI. So the government must make policies that can help the country in attracting more FDI.

Bornsztein et al. (1998) also carried out a research to test the impact of Foreign Direct Investment on a country’s economic development. The data on the FDI flow from 16 countries was taken and the cross country regression framework was applied. The analysis reported that FDI played a positive and significant role in boosting the economic growth through technology transmission. However, the analysis was based on an assumption that the host country must had minimum threshold of human capital so that new technology can be utilized more efficiently.

Robles (1998) also tested the relationship between FDI and GDP in Latin America in the period of 1975-1985 and reported that FDI and GDP had a very strong relation. Increase in FDI had caused a definite increase in GDP growth. And the impact of FDI on GDP was highly significant and positive for this particular region.

FDI had a positive impact on GDP and Foreign Direct Investment played an important role in supporting the import surplus and in enhancing total investment that helped in the economic development (North 1956).

Borensztein et al. (1998) & Glass & Saggi’s (1998) research proved that FDI is assumed to enhance domestic capital which ultimately lead to stimulate the productivity of domestic investments which thereby had a significant positive impact on GDP. Therefore, FDI had empirically been found to stimulate economic growth.

Blomstrom et.al (1994) reported a positive impact of FDI on economic development with a condition that the host economy must have a threshold level of income above which Foreign Direct Investment seems to have a positive impact on GDP and below which it does not.

Balasubramanyan et al. (1996) reported positive impact of FDI on economic development.

The impact of FDI varied across countries. It largely depended on the trade policy of the host country. This study revealed that the impact of FDI on GDP is more in export promoting than import substituting countries. Therefore the trade policy must be made in such a way that it can attract more FDI to support the country’s economic growth.

Bengos & Robles (2003) proved that FDI is significantly and positively correlated with economic growth. Minimum capital (human), economic stability and stable markets are the necessary preconditions that need to be met if the country wants to benefit from FDI.

Nabende et al. (2002) research proved that the long-term impact of FDI on GDP is significant and positive for comparatively economically less advanced economies but negative for the economically advanced countries.

Aluko (1961), Brown (1962) & Obinna (1983) reported positive linkages between FDI and economic growth in Nigeria. Oseghale & Amonkhienen (1987) and founded that FDI had been positively associated with GDP, concluding that greater inflow of FDI spelled a better economic performance for the country.

Das (1987); Din (1994); Balasubramanyam et al. (1996) and Borensztein et al. (1998) stated that FDI had been introduced as the factor explaining positive impact on GDP growth through technology transfer in addition to human capital. Dees (1998) submitted that FDI had been important in explaining China’s economic growth, while De Mello (1997) presented a positive correlation between FDI & GDP for selected Latin American countries. Findings of Xu (2000) for US FDI in 40 countries for the period 1966-94 also supported the finding of De Mello that the transfer of technology through FDI contributed more to the productivity of developed countries as compared to developing countries, which the research attributed to lack of adequate human capital. The OECD (2002) simply stated that FDI increased efficiency of resources and raised factor productivity in the host country, so it affirmed positive influence of FDI on GDP growth as positive.

Adewumi (2006) examined the contribution of foreign direct investment in Africa’s economic growth. The countries used for the analysis includes; Angola, Botswana, Burkina Faso, Central African Republic, Cote d’ Ivoire, Egypt, Mali, Nigeria, South Africa, Tunisia and Republic of Benin. Eleven countries were selected based on the following criteria: growth rate, strong currency value, population and Geographical spread. It was discovered that the contribution of FDI to growth is estimated to be positive in most of the countries but not significant. GDP growth rate was used as a dependent variable while FDI growth rate was used as independent variable. Other variables that were considered for the study include; gross capital formation and net exports. From the analysis it was proved that the impact of FDI on GDP is estimated to be positive for most of the countries. But in the other countries where the effect is not positive, did not indicate that FDI’s impact on GDP is negative. The reason for this negative impact was that some impact of FDI in the host country can not be measured quantitatively, e.g. knowledge acquisition, technology, international image, and it may take a considerable time before these variables affect growth.

Hasen & Giorgioni’s (2006) research had assessed the impact of FDI on GDP growth of four AMU countries including; Algeria, Libya, Morocco and Tunisia1 - between 1990 and 2006. The variables under analysis included; total output, total factor productivity, domestic capital, foreign capital, labor input and human skills. These countries were chosen for analysis because as most other developing countries these countries were the one which were transitioning toward the policies of attracting inflows of FDI. The research empirically proved that FDI and GDP had a strong relation. The FDI inflows were an important determinant of GDP growth. The research analyzed that the positive impact of FDI on the economy depended on its interaction with open trade policy, macroeconomic stability, better education level and filling of technology gap. The research suggested that AMU countries would do better by concentrating on human capital, developing domestic firms, creating a stable macroeconomic framework and providing productive investments to start up the process of economic development.

However, some economists had analyzed negative impacts of FDI on economic growth. Leff (1969) & Griffin (1970) had argued that the foreign investment could negatively affect the economic growth by substituting the domestic savings. One of the main argument against the inflow of FDI was that multinational companies (MNCs) replaced domestic firms, introduced unsuitable production technology and created BOP crisis through transfer of profits from the host country (Sahoo (2006).

MNCs bringing FDI generally had advanced technology, skills and resources through which the market share of the domestic firms get eroded and can crowd out the local investment Markusen & Venables, (1999); Agosin & Mayer, (2000) & Kumar & Prakash, (2002). These MNCs also made use of advanced technologies in the production process which lowered the demand of labour. These phenomenons lead to higher rates of unemployment which lowered the economic development.

Carkovic & Levine (2002) concluded that FDI did not had a positive impact on economic development. Mwlima (2003) also concluded that the incentives that most African countries were offering to attract the FDI ended up in adding to the economic problems leading to a situation where the incentives being offered offsite any gains from FDI. Zambia was the classic example which explained the proved this research. Findings of the research claimed that the aim of any MNC is to make profit rather than providing economic development, therefore the host countries must be very cautious in formulating any policies to attract FDI.

FOREIGN DIRECT INVESTMENT IN ASIA

Athukorala (2003) had examined the relationship between FDI and GDP using time series data from the Srilanka’s economy. The variables used includes; Trade Liberalization, FDI, GDP and Domestic Investment. Despite of the fact that FDI in Srilanka had increased dramatically since 1980’s, the econometric results showed that FDI inflow did not exert an independent influence on economic growth. The direction of causation was also from GDP to FDI and not from FDI to GDP. The main reason of this result was the political instability and disturbance, poor law and order situation, direct and indirect regulatory barriers, political & policy instability, poorly developed infrastructure, low levels of human capital and lack of transparency in trade policy of the country. The research suggested the government of Srilanka that if the ultimate objective of the country is to attract FDI for development, poverty reduction and growth, then an appropriate policy mix is necessary to achieve the objective.

Zhang (2004) tested the widespread belief about the beneficial growth of Foreign Direct Investment in China. The regression estimates in the study showed favorable effect of FDI on economic development of China. The used variables include; real Output, Labor Input, Stock Of Domestic Capital and Stock of Foreign Direct Investment. According to the analysis, FDI contributed positively to China’s economic development by raising productivity, promoting exports and diffusing technology. The effect of foreign invested enterprise in the Chinese economy seemed to increase with FDI inflows from 1992-2004. The analysis also proved that the marginal product of FDI seems to be larger than that of domestic investment.

Another recent research by Trevino & Upadhyaya (2003) using time series data from five developing countries of Asia found that FDI was positively related to economic growth and in an open economy, the impact of FDI on GDP is positive. The research suggested that inflows of foreign direct investment positively affected the economic growth of these five developing economies of Asia.

Sjoholm (1999) reported that inter-industry spillovers from FDI were found at national level in Indonesia where local establishments in industries with a large foreign presence had shown high productivity growth. The research demonstrated that the FDI accelerated economic development more than the domestic investment.

Agrawal (2000) conducted a study to evaluate the economic impact of FDI on economic development in South Asia. The research that the impact of FDI inflows on GDP growth rate was negative prior to 1980, mildly got positive in early eighties and got strongly positive over the late eighties and early nineties. The research also supported the view that FDI was more likely to be beneficial in more open economies. The analysis concluded that since 1980, in South Asia FDI contributed more to GDP then equal amount of foreign borrowing.

Sahoo (2006) also determined that; one FDI had positive and significant effect on the growth of four major South Asian countries, secondly FDI did not immediately affected the rate of capital formation but had dynamics affect on it over the period of time and last it had a positive and significant effect on exports.

From the above literature it can be concluded that FDI stimulated the GDP growth on one end and substituted the domestic savings on the other hand. Accordingly the positive or negative impact of FDI on GDP growth mainly depends on the economic policies of the host country.

Since the impact of FDI on economic growth is not clear from either the theoretical and empirical perspectives and thus need to examine in the case of South Asian countries (Mehta, 2004).

FDI IN PAKISTAN

Initially Pakistan followed comparatively restricted economic policies. In the period of 1990’s, government undertook a number of measures to attract FDI and initiated market-based policies. The policy mainly included gradual liberalization of trade and investment through credit facilities, tariff reduction, tax concession and easing of foreign exchange controls (Khan, 1997).

Restrictions on the inflow and outflow of capital were gradually lifted. Without any prior approval foreign investors were allowed to hold 100%of the equity of industrial projects. Investment shares issued to non-residents could be exported, and remittance of dividends and disinvestments proceeds was permissible without any prior permission of State Bank of Pakistan (SBP). Some more limitations were relaxed in the 1994 including; restrictions on some capital transactions were partially relaxed, foreign borrowing was allowed and certain outward investments were allowed to some extent. Pak-rupee’s full convertibility was established on current international transactions. An interbank foreign exchange market was also established allowing market forces to play a greater role in exchange rate determination (Khan, 2007).

Initially Pakistan received very low amount of FDI because of the pre-reforms policies. Due to those restricted policies the flow of FDI was insignificant till 1991. The FDI flow steadily increased in the post liberalization period due to market based investment policies but the level of FDI remained low as compared to other developing countries. Actual inflows of FDI to Pakistan had increased from $119.6 million in the 1975-79 to $3299.8 millions in the 1995-99. The FDI inflow increased from $469.9 million in 1999-2000 to $798 million 2002-03 showing 65 percent increase and stood $3521 million in 2005-06. FDI reached to $1.5 billion in 2005, 61percent higher than in 2004.

Though the inflow of FDI to Pakistan increased drastically, but this increase become insignificant when compared with other South Asian countries. The reasons for low level of FDI inflows includes ;political instability, bureaucratic process, lack of infrastructure facilities, macroeconomic imbalances, inconsistent economic policies of successive governments, delays in the privatization of state-owned enterprises, disputes between foreign investors and the government, problems of intellectual property, and lack of transparency applications of government regulations (Khan, 2007).

Pakistan had a lot of potential to attract FDI. Although the rising trends of FDI reflected the success of the policy. However FDI is considerably hindered due to the above mentioned reasons. The current research mainly focuses on the impact of FDI on GDP of Pakistan in the recent times to see whether FDI plays any role in economic development and more work should be done to attract FDI or not.

CHAPTER 3: METHODOLOGY

Various researches had been conducted throughout the world in order to understand the impacts of FDI on GDP growth. In Pakistan also many researchers had tried to find out the impact of FDI on economic development.

De Gregorio (2003), Bosworth et al. (1999) analyzed the impact of various forms of FCI on GDP. Loungani & Razin’s (2001) concluded that out of the various form of FCI, FDI was discovered to be the most resilient Khan, Shabbir & Mahmood (1992) estimated the impact of FDI on domestic savings in Pakistan from 1950 – 1988. Khan et al. (1992), Khan & Rahim (1993) analyzed the impact of FDI on GDP growth rate. Mohey-ud-din (2004) checked the impact of FCI on economic growth in Pakistan. Khan (1997) studied the impact of FDI on GDP growth, considering the role of financial sectors. Ahmad et al. (2003) checked the impact of FDI on exports and domestic output.

It is difficult to analyze the impact of foreign direct investment on all the sectors and variables in a single research paper. Therefore, the current research narrows down its analysis only to the impact of FDI on GDP growth as per the hypothesis of the research. Only two variables i.e. FDI and GDP are under consideration for research purpose. FDI is taken as an independent variable; GDP is taken as the dependent variable.

The literature had extensively accepted that FDI is a very crucial financial source for fulfilling saving-investment gap and Balance of Payment gap Mohey-Ud-Din (2007). It brought in costless capital and technology necessary for rapid growth as well as it provided access to global production and marketing networks Mehta (2006). It is a very key source of non-debt inflow to the home country Bajpai & Sachs (2000). FDI helped in accelerating economic growth not only through capital inflow, tax revenue and employment generation but also through adoption of advanced technologies, improved managerial skills, modern production and marketing skills and global exposure Sjoholm (1999) and Zhang (2004). This transfer of skills and technology did not occur automatically but depended on the host country’s absorptive capacity to provide targeted benefits (Borensztein et al.1998).

Considering the importance of this topic from the above literature and its findings it can be concluded that FDI had a very significant and positive impact on GDP. This is the main reason why governments of all the countries are constantly updating its foreign policies and trying hard to attract as much FDI as possible to accelerate the process of economic growth (GDP).

As many countries had empirically proved the positive role played by FDI in accelerating the process of economic growth, this research mainly emphasizes on testing the impact of FDI on GDP in Pakistan. So the derived hypothesis for the research is:

HYPOTHESIS

“FDI has a positive impact on GDP”.

DATA

The test this hypothesis, the current research is based on 32 annual observations over the period of 1976 to 2007. Based on the previous literature of Mohey-Ud-Din (2007), economic growth is expressed in term of current GDP and FDI is taken as current net inflow of FDI in Pakistan.

Table 1: Foreign Direct Investment and GDP in Pakistan (1976-2007)

 

GDP (Current US$ in

FDI (Current US$ in

 

Millions )

Millions)

 

 

 

1976

13338.4 

8.2

1977

15126.0 

15.2

1978

17820.1 

32.3

1979

19707.9 

58.3

1980

23689.6 

63.6

1981

28100.6 

108.1

1982

30725.9 

63.8 

1983

28691.8 

29.4

1984

31151.8 

60.1

1985

31144.9

139.2

1986

31899.0

106.3

1987

33351.5

110.1

1988

38472.7 

173.7

1989

40171.0 

167.5 

1990

40010.4 

243.3

1991

45451.9 

262.1 

1992

48635.2 

348.0 

1993

51478.3 

350.7 

1994

51894.7 

420.0 

1995

60636.0 

722.2 

1996

63320.1 

915.1 

1997

62433.3 

740.5 

1998

62191.9 

456.0 

1999

62973.8 

511.0 

2000

73952.3 

297.0 

2001

72309.7 

352.0 

2002

72306.8 

795.0 

2003

83244.8 

515.0 

2004

97994.7 

1062.0 

2005

10950.2 

2157.0 

2006

12732.5 

4164.0 

2007

14289.3 

5235.0 

All the variables are expressed in logarithmic form. The variable’s data has been collected from the official site of World Bank. As this source is not available publically, so the service of State Bank of Pakistan has been used to collect the data on above variables from World Bank.

So to estimate the impact of FDI on GDP in Pakistan, Multiple Regression will be run on FDI and GDP data for 32 years (1976-2007). The Multiple Linear Regression Model is given as:

Log GDP = log FDI (Eq. I)

Where,

GDP = Current Gross Domestic Product

FDI = Current Foreign Direct Investment, net inflow

Both the variables had been transformed to normalize its distribution.

The results of the Model (as shown in Eq. No. 1) are estimated as:

Log GDP = 17.138 + 0.384 log FDI

Other estimated results and statistics are given in the next chapter.

CHAPTER 4: INTERPRETATION OF RESULTS

Table 2: Goodness of Fit Test

Model

R

R Square

Adjusted R Square

Std.Error of Estimate

1

0.960

0.922

0.92

0.17015

The Goodness of Fit Test tables represent the power of the correlation between the model and the dependent variable. The value of R or Multiple Coefficient of Correlation is 0.960. It means that there is 96% correlation between GDP and FDI. Its large value indicates a strong relationship between the two variables.

R2 or Coefficient of determination is 0.922 which means that in this model FDI can predict 92% of the variance in GDP. The model shows higher values of both R & R2 whereas the standard error of the estimate is 0.17015 which is considerably low.

Table 3: Overall Significance of the Model (ANOVA/F-Statistic)

Model

Sum of Square

F

Sig

1

Regression

10.313

356.224

0.000

Residual

0.869

Total

11.181

This table investigates the adequacy of the model from a statistical point of view. The Regression row shows the information about the deviation accounted for by the model used. The Residual row shows information about the deviation or variation that is not accounted for by the used model. The regression and residual sums of squares are approximately equal, which indicates that about half of the variation in GDP is explained by the FDI. The value of the F-Statistic is 356.224 significant at lower than 1% as shown as 0.000 in the above table. So as per the above results of ANOVA, the model is statistically significant.

Table 4: Regression Coefficients

 

 

Unstandardized Coefficients

 

 

 

Model

 

B

St.Error

T

Sig

1

(constant)

17.138

0.393

43.602

0.000

 

Logfdi

0.384

0.02

18.874

0.000

The table of Regression Coefficient explains the coefficients of the regression line and related statistics for the model including β Coefficients of the regression equation and its level of significance. The coefficients estimate for FDI is positive and significant even at 1% level of significance.

From the regression analysis, a unit increase in log FDI is estimated to cause the GDP growth to increase by 0.384 percentage points. The value of the β1 is 0.384 which shows strong positive impact of the FDI on the GDP growth in Pakistan during the period of 1975-2009. Therefore, the estimated results of the model demonstrate that that there is a strong positive impact of the FDI on the GDP.

Hypothesis Assessment Summary

Hypothesis

R

R Square

F

Sig

B (Log FDI)

Result

 

 

 

 

 

 

 

FDI has a positive impact on GDP

0.960

0.922

356.224

0.000

+0.384

Accepted

Both the variables are highly correlated as the value of R is 0.960 proving that 96% correlation exists between FDI & GDP. R2 is 0.922 indicating that 92% variance in GDP is caused or explained by FDI. The higher value of F statistics proves that the model is highly statistically significant. The value of the β1 is 0.384 which means that a unit increase in log FDI is estimated to cause the GDP growth to increase by +0.384 percentage points. All the values of Regression analysis verify that the model is highly significant accepting the hypothesis of the research that FDI has a positive impact on GDP in Pakistan.

CHAPTER 5: CONCLUSION & RECOMMENDATIONS

The current research has analyzed the role played by FDI in economic development of developing countries. Using time series data of Pakistan economy from 1976-2007, it has been proved in the current research that, FDI positively helps in accelerating the GDP growth. In case of Pakistan, the research statistically demonstrates that there is a strong and positive relationship between the two variables. It proved the discussion of chapter 4 and accepted the research hypothesis that FDI is positively related to GDP growth and it has a positive impact on Pakistan’s economic growth. This research found out that both variables are highly correlated and 92% variance in GDP is explained in FDI. The Anova table accepted the model statistically and gave the value of the F-Statistic to be 356.224 significant at lower than 1% and the regression coefficients are also significant as shown in methodology section. FDI is considered to be one of the key sources of fulfilling saving-investment gap, BOP gap and is one of the fastest modes of technology transfer from advanced countries.

In Pakistan FDI has increased dramatically since the 1991s i.e. after the post reform period. Pakistan managed to attract higher level of FDI than ever before due to its market oriented investment policies. Actual inflows of FDI to Pakistan had increased from $119.6 million in the 1975-79 to $3299.8 millions in the 1995-99. The FDI inflow increased from $469.9 million in 1999-2000 to $798 million 2002-03 showing 65 percent increase and stood $3521 million in 2005-06 (Khan, 2007). But due to the inconsistency of government policies, the level of FDI remained low as compared to other developing countries.

The reason for this low level of FDI in Pakistan is that the investment environment in Pakistan has not improved due to various reasons including; law & order situation, regulatory barriers, political instability and the implied policy instability, poor infrastructure, low levels of literacy and investment in human capital, lack of transparency in the trade policy, discrimination against non- export oriented sectors like plantations, high lending rate and the war against terrorism (in the first place this has diverted the country’s resources and also this created uncertainty and risk which discourage investment), are found as the major constraints to FDI flows in Pakistan.

It can be concluded that availability of better stock of human capital, sound macro economic policy, institutional stability are necessary preconditions for FDI-driven growth to materialize. And the benefits from FDI can only be enjoyed and enhanced once the preconditions are met. And if the government is really looking forward to attract more FDI then an appropriate policy mix is a must.

Some studies had highlighted the negative aspects of FDI as well. But just one point need to be considered that some impacts of FDI in the host country can not be measured quantitatively, e.g. knowledge acquisition, technology and international image, and it may take a considerable time before these variables affect growth.

For further studies, it is very important to work on the determinants of FDI. This will help the host country in doing its homework before formulating any policy to attract more FDI. It will also be interesting to examine how FDI inflow contributes to development of specific sectors e.g. agriculture, mining etc would increase the knowledge of FDI and indicate in which sector it is really needed and will benefit more. Another important area would be to examine the relationship of FDI & trade and FDI & domestic investment. To check the impact of FDI on Tax revenue which is the vital source of revenue for the government can also be an important area.

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