Pakistan And Attracting Foreign Direct Investment Economics Essay

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Multinational corporations (MNCs) play a critical role in the global economy. They account for an estimated one-fourth of the world's output and one-third of world trade. The investment made by these MNCs is commonly known as foreign direct investment (FDI), and many scholars believe that these FDIs have beneficial effects on economic development, technology spillovers, managerial expertise and capital.

The first joint -stock corporation emerged in England in the 1500s, The Company of the Mines Royal, established in 1564. Such was the form that evolved into the more elaborate moulds of the large trading companies established in the 17th and the 18th centuries, with the English East India Company and the Dutch East India Company among the most prominent.

The East India Company had the unusual distinction of ruling an entire country. Its origins were much humbler. On 31 December 1600, a group of merchants who had incorporated themselves into the East India Company were given monopoly privileges on all trade with the East Indies. The company was managed by a governor and 24 directors chosen from its stockholders. Gradually the British eclipsed the Portuguese and the Dutch and over the years they saw a massive expansion of their trading operations in India. As its trade with the East grew, the East India Company became the largest employer in London and the biggest source of foreign direct investment in India.

In recent years, we have witnessed a fundamental increase in the number of multinational corporations (MNCs) operating throughout the world. Through the removal of trade and investment barriers around the globe, and the ever falling transport and communication costs, MNCs are gearing up in order to exploit new opportunities for division of labor on a global scale.

Like all other developing nations, Pakistan is also considering attracting FDI as a major component of the country's industrial policy. Pakistan in order to attract more FDI has given the investors increased incentives and has made FDI its priority to secure economic development. FDI is being used for a lot of different ventures and not just involving capital but it has now become the source of the latest technology as well as managerial skills. In order to make the investors feel secure the government has given it full protection and a number of measures such as avoidance of double taxation have been taken to ensure the safety and security of the investment. This focus on attracting more FDI has been in coordination with a change in the government polices which fosters the growth of the private sector and relies upon the market forces in order to generate economic activity. In recent times Pakistani has been one of the best and most conductive countries in the whole region for the Multinational corporations as the benefits and incentives that they have offered has been unprecedented and this has converted Pakistan into one of the most friendliest environments for conducting business especially for Foreign companies.

Pakistan did not always follow this liberation principle and this change in policy is a recent trend started by the government in the 1990s when they realized the true potential of attracting multinational corporations. The government policy changed from that point onward and there were a number of reforms in the policies such as fiscal incentives of tariff reduction in order to liberalize trade. A number of measure were introduced in order to encourage FDI such as restrictions on capital was lifted and investors were now able to hold all of their equity without having to get an approval. Additionally remittances and investment shares could be exported without having to notify the State Bank of Pakistan (SBP). Major changes in the policy came in 1994 when a number of restrictions were reduced such as foreign borrowing were now allowed.

Labor cost is an important determinant at which MNCs will choose sites for their investment especially for some labor-intensive manufacturing industries. One contributor to the low labor costs is usually poor compliance with international labor standards and country's own labor laws.

Developing countries like Pakistan do not pay attention at improving their labor standards. The argument is that labor standards will improve automatically after a level of economic growth has been achieved. Any attempt to improve labor standards before that would be expensive and raise the average labor cost, thus hindering their economic growth and most importantly global competitiveness.

The increasing use of child labor and women in various informal and formal sectors, including MNCs, as a cheap source of unskilled labor is one of the biggest violations of labor laws in Pakistan. The prevalence of child labor and gender disparity increases the supply of unskilled worker, which results in low labor cost and thus increasing comparative advantage of the country in the unskilled manufacturing sector. Labor costs are also kept low by discriminating against them by paying them less compared to adults, in most cases, even below the minimum wage rate of Rs. 7000. In Pakistan even if some foreign firms are not directly involved in hiring child labor, their supply chains or associates are involved, to lower the costs.

As a means of attracting substantial amount of FDI, Freedom of association and collective bargaining (FACB) right is also ignored in Pakistan. This standard is concerned with workers rights to participate freely in forming unions, strikes and negotiating collectively with employers. Pakistan experiences fair amount of FDI in spite of its relatively weak FACB rights, and the reason for that is workers have less power to negotiate their wage and other rights with its employers in Pakistan.

The presence of unions in the MNCs operating in Pakistan is an important part of the relevant labor market. A small percentage of the total workforce is registered with the trade unions in Pakistan. According to the latest available figures, only about 10% of the labor force was registered with unions in the industrial sector and only 5% in total labor force.

1.2 RELEVANCE OF THE TOPIC AND RESEARCH TITLE

Foreign direct investment (FDI) is said to be a major influencing factor in generating economic activity for both the developed and the underdeveloped world and therefore is a major concern for all counties and governments. FDI is vital for the creation of jobs, technological advancements and generally increasing the economic conditions of the country which plays host to the investments. Due to these reasons almost all of the countries try and attract foreign firms to invest in their country by providing incentives which has greatly increased the options for these firms. In today's globalized world it has become very important to attract FDI in order to maintain sustained economic growth however according to some the benefits of FDI are debatable. Our focus will, however, be on the MNCs that establish new production facilities in a developing country, like Pakistan, and the labor market distortions and imperfections that they create.

BACKGROUND INFORMATION AND EVOLUTION

The Asian-crisis that erupted in the late 1990s and later spread across other Asian countries, particularly Thailand, Indonesia, Korea, and Malaysia, rehabilitated the significance of prudent FDI management in the developing world. However, policymakers, especially in the developing countries, have come to the conclusion that FDI is needed to enhance economic growth. For a greater part, lack of investment resources to finance long-term investments has been a major problem in the developing countries. FDI is seen as a major source of getting the required funds for investments hence most African countries offer incentives to encourage FDI.

FDI inflows to Pakistan can be explained in terms of its size and percentage of gross domestic product (GDP). Looking at the economic history of FDI's in Pakistan we can clearly see that in the 1970s the FDI represented a very small proportion of Pakistan's GDP, less than 2%. This however changed in the 1980s when the figures increased to 2.27%. Another significant jump was witnessed in the 1990s when this figure rose to 4.29% of GDP which was as a result of the change in policy towards liberalization by the then regime of Nawaz Sharif. Pakistan has however witnessed an increase in FDI in the recent rimes due to change in its orientation and a more liberalized policy.

If we now look at the actual inflows of FDI this is showing a huge increase in period from 1975 to 1995, from $119.6 million up to $3299.8 Million. Another significant increase was from 1999 to 2002, when it increased from $469.9 million to $798 million, showing an overall increase of 65%. Though we see an increasing trend, a significant decrease was witnessed in 2000, primarily due to the US sanctions against Pakistan due to its nuclear program. This however was short lived and the FDI soon picked up really fast from 2001 due to closer ties with the US in accordance to the war on terror, which meant that FDI grew by a staggering 212% since 2000. It has increased ever since and stood at $ 5,135 million in 2007. This being said, Pakistan has witnessed a huge decline of 43% in FDI in the year 2009.

Table 1

Table 2 shows the country wise FDI inflows into Pakistan and is dominated by a handful of countries namely the US, UK, UAE, Italy and Germany. The countries that invested the most in Pakistan in 2005.2006 periods were UAE, US and the UK. Each accounted for 24.1%, 21.4 % and 11.9 % respectively and other sources accounted for 33 % of FDI coming into Pakistan.

Table 2

Important areas of FDI are:

Telecom

Power Generation

Banking and finance

Food and beverages

The four sectors mentioned above make up more than 80% of the FDI inflows coming into Pakistan. The FDI inflows have been dominated by the service sector and this increase has boosted the contribution of the service sector towards the GDP by an impressive 66 %. If we further break down into the service sector the telecom sector is seen as the most central and has played an important part attracting FDI as the contribution in 2005 was more than 55% showing how important this sector is.

The next most important sector in terms of FDI has been power generation. The government has realized the potential for investment in this industry and is making efforts in order to increase the FDI in this sector. This sector was doing very badly in the year 2003 when the investment was at negative $14 million but now this sector has turned around 180 degrees and showing huge potential. One more sector that is really important in terms of FDI is Oil and Gas exploration which has huge potential but has not yet been exploited. Pakistan despite having the fifth largest reserves of coal are able to only mine about 5 million tons a year. This industry is however showing signs of improvement and the FDI in this sector has increased to $312.7 million in 2005.

One more sector that has seen huge increases in FDI in the recent times has been the financial services which have been able to attract quite a lot of FDI. This can easily be judged from the fact that the FDI in this sector has seen a growth of more than 800% in the last decade mainly due to reforms in the this sector. The main reason that can account for this huge increase is the privatization of this sector. If we compare the FDI inflows of this sector from 2004 going on to 2005 there is a huge increase from 269.4 million in 2004 going up to 329.2 million in 2005

There Is huge potential in the economy of Pakistan and this needs to be highlighted in order to attract more FDI. Pakistan over the years has witnessed huge increase in the amount of FDI that it has been able to attract however a few factors have stalled this growth. A number of factors such as corruption, political instability, and low efficiency make this a less lucrative place for investment.

On the contrary, the adverse effects of FDI, especially those pertaining to labor market distortions, are on the rise in the host developing countries. The most important forms of labor market distortions present in Pakistan could be categorized in broad categories:

Minimum wages

Child labor

Gender disparity

Immobility of labor

Imperfect information on the part of the labor force

Displacement of labor

Non-compliance on labor laws

Lack of job security

Restrictions in formulating trade unions and practicing collective bargaining

These market imperfections are, by in large, a product of the existence of MNCs that have exploited and revamped the labor market in the country and specifically, has affected the labor productivity. The East Asian experience with reference to the presence of MNCs and their production units are a classic example of how these MNCs have distorted the labor markets by altering wages, demand for labor and the working conditions. The question however remains as to, whether these labor market imperfections have led to greater labor productivities in these countries or not?

MANAGERIAL CONCERNS PERTAINING TO RESEARCH

The Federal and the Provincial Governments can use this research in determining the effects of the influx of FDIs that the MNCs bring along with them and their effects on the labor markets, as these two governing bodies are generally responsible for regulating the labor markets according to the Constitution. Once the market imperfections/distortions are identified, these governing bodies may use this research paper in determining policy actions in regulating the labor markets more efficiently and effectively so as to enhance the labor productivity.

ACADEMIC CONCERNS PERTAINING TO RESEARCH

Most of the earlier conducted researches have contributed towards determining the factors of FDI coming into a country and their gainful effects of technology transfers or spillovers in host countries. Few, if any, researches have looked at the possible labor market distortions created in Pakistan and the effects of these distortions on the labor productivity in Pakistan.

KEYWORDS AND DEFINITIONS

Market Distortions: It is an economic scenario that occurs when there is an intervention in a given market by a governing body. The intervention may take the form of price ceilings, price floors or tax subsidies. Market distortions create market failures, which is not an economically ideal situation. - Investopedia

MNCs: Multinational corporations or enterprises operating in several countries but managed from one (home) country. Generally, any firm or group that derives a quarter of its revenue from operations outside of its home country is considered an MNC. - BusinessDictionary.com

Labor Productivity: Rate of output per worker (or a group of workers) per unit of time as compared with an established standard or expected rate of output. - BusinessDictionary.com

Child Labor: UNICEF defines child labor as work that exceeds a minimum number of hours, depending on the age of a child and on the type of work. Such work is considered harmful to the child and should therefore be eliminated.

Ages 5-11: At least one hour of economic work or 28 hours of domestic 

work per week.

Ages 12-14: At least 14 hours of economic work or 28 hours of domestic 

work per week.

Ages 15-17: At least 43 hours of economic or domestic work per week. - UNICEF

Labor Mobility: Extent to which the workers are able or willing to move between different jobs, occupations, and geographical areas. It is called horizontal mobility if it does not result in a change in the worker's grading or status, and vertical mobility if it does. Skilled workers have low occupational mobility but high geographical mobility; low-skilled or unskilled workers have high degrees of both types of mobility. Low labor-mobility causes structural unemployment, and governments try to avoid it by worker retraining schemes and by encouraging establishment of new industries in the affected areas. - BusinessDictionary.com

Imperfect Information: Information that only reduces uncertainty but (unlike perfect information) does not eliminate it. - BusinessDictionary.com

Minimum wage: Lowest hourly rate an employer can pay an employee. In some countries the minimum wage is set by a statute while in others it is set by the wage council of each industry. - BusinessDictionary.com

STUDY OBJECTIVES

Learning the potential effects of FDIs on the labor markets in Pakistan

Learning the effects of these labor market distortions on the labor productivity of Pakistan and the indicators indicating different labor market distortions.

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