It is well documented in the literature that foreign direct investment (FDI) plays a positive role in the process of economic growth. Thamos, et al. (2008) argued that foreign affiliates of transnational corporation (TNCs) succeed in developing new products and technologies faster than local firms, thereby exerting competitive pressure and forcing local firms to imitate and innovate. This is one of the important reasons why developing countries are eager to attract FDI. Many developing countries including Pakistan faces the problem of saving-investment gap and FDI influences the process of economic growth by filling up this gap, increasing productivity, transferring advanced technology, employment creation and enhancing competition [Kobrin (2005) and Le and Ataullah (2006)]. These benefits have encouraged the developing countries to liberalise their FDI policies in order to attract FDI inflows. In the light of expected benefits of FDI, many studies have been carried out to examine the impacts of FDI on growth. However, theories and empirics appear to provide mixed evidence regarding the impact of FDI on economic growth in developing countries. Like many other developing countries, Pakistan has thrown its doors wide open to FDI, which is expected to bring huge benefits. However, unlike China and India, Pakistan has not been successful in obtaining substantial and consistent FDI inflows. Furthermore, the meagre inflows that the country has received have not been utilised appropriately to enhance the economic performance [Le and Ataullah (2006)]. FDI inflows are still too low and this might be because the economic reforms went far enough to change the character and type of FDI. The type of FDI and its structural composition matter as much for economic growth [Chakraborty and Nunnenkamp (2008)]. The structure and type of FDI are hardly considered in previous studies on the FDI-growth nexus in Pakistan. This paper is an attempt to examine the impact of FDI on economic growth. The paper contributes to the literature on FDI in three ways. First, we review the policy measure that the government of Pakistan has undertaken to attract the FDI. Secondly, we examine the impact of FDI on economic growth using the panel cointegration technique over the period 1981-2008. Finally, we evaluate whether the growth impact of FDI differs between primary, secondary and services sectors. We apply Granger Causality test on the basis of industry specific FDI data. The rest of the paper is organised as follows: Section 2 discusses the theoretical and empirical literature on the relationship between FDI and economic growth. Overview of FDI inflows in Pakistan is given in Section 3. Section 4 describes model, data and methodology. Empirical results are interpreted in Section 5, while some concluding remarks are provided in the final section.

The size of its financial market is very small and its foreign exchange and debt position is precarious. and Malaysia. proper composition of concessional public loans. how to efficiently manage foreign exchange reserves/systems. (ii) official bilateral assistance. However.2 FDI:An investment abroad. and Pakistan¶s increased competition with other least developed countries such as Bangladesh. including how to best supervise financial institutions. the crisis highlights the urgent need to reexamine the optimal combination of foreign capital. commercial loans. poverty. Multilateral development organizations including the Asian Development Bank will focus on poverty alleviation and soft sectors (i. will become increasingly scarce due to domestic financial constraints in major donors. FDI is a significant long-term commitment and a part of the host economy itself. This underscores the importance of FDI in the developing member countries (DMCs). and health).. while the hard sectors (manufacturing and large-scale physical infrastructure) are expected to be invested in by the private sector and foreign investors as well as the Government of Pakistan (GOP). The positive developmental role of FDI in general is well documented (see. and Viet Nam. FDI produces a positive effect on economic growth in host countries. it did not have any relation to foreign direct investment (FDI) due to its high stability. particularly the group of least developed DMCs where domestic financial markets are fragile and liquidity is limited. The crisis poses many challenges to developing countries. In the difficult circumstances described above.e. rural development. which was reinforced by panic withdrawals of short-term commercial loans. for example. environment. foreign exchange reserves in Pakistan have remained at less than $1.. Volatile movements of portfolio investment triggered the Asian crisis. and foreign direct investment. Chen 1992). These developments increase the need for attracting FDI into Pakistan. Importance of Foreign Direct Investment in Pakistan The Asian currency crisis that erupted in Thailand in July 1997 and has since spread to other countries. education. particularly Indonesia.1 Short-term debt has also increased from 12% of total debt in the early 1990s to 20% at present. i. renewed the significance of prudential management of foreign capital flows in developing countries where domestic financial markets are not yet fully developed. usually where the company being invested in is controlled by the foreign corporation. . From the viewpoint of foreign resource mobilization. concessional long-term development assistance.3 billion. Sri Lanka. which was equivalent to only 4-5 weeks of imports of goods. given its very limited absorptive capacity for portfolio investment and commercial bank loans. and (iii) FDI. Over the last two years. portfolio investment. agriculture.e. Pakistan belongs to this group. Republic of Korea (Korea). such as Japan. However. and how to prudentially manage foreign debt and investments. both multilateral and bilateral. Mongolia. Pakistan¶s policy on foreign capital mobilization must attach priority to (i) official multilateral assistance.

inflows of FDI could reinforce the confidence. less than one percent of developing country and Asian country FDI. and according various incentives. a relatively large inflow of FDI into the power sector since 1995 has created some adverse effects. Rather. to both sectors simultaneously. India. Singapore.3 From this undesirable pattern of FDI in Pakistan. tempering or removal of obstacles to foreign investors. Recently. given that foreign exchange earnings through exports of goods and services remain low. they tend to reinvest their profit rather than remit abroad. Pakistan¶s performance in attracting FDI has been lackluster. and the ongoing conflict between the government and foreign independent power producers (IPPs) on the power rate the government needs to pay to IPPs under the purchase contract. FDI had surged into the newly industrialized economies (NIEs) (Hong Kong. technology management. most important of which was the large increase in imports of capital goods for construction of power plants. and Viet Nam. This phenomenon well matches the directions of historical flows of FDI in the Asian and Pacific region. Korea. Initially. . at least. The inflow of FDI into Pakistan is small and concentrated only on a few areas. and 18% of South Asian countries¶ FDI. In those sectors with comparative advantage.3 One convincing argument for that is that FDI consists of a package of capital. very important lessons could be drawn for developing economies: they should be careful in allowing a large amount of FDI to nonforeign-exchangeearning sectors during a short period of time. In 1997 Pakistan accounted for 0. China. and FDI should be promoted in the foreignexchangeearning sector at the initial stage and to the domestic-oriented sector at the subsequent stages.China) and thereafter moved to ASEAN countries.2% of world FDI. and market access. and the pace of economic growth seem to have a positive interrelation in the Asian and Pacific region. and Taipei. For FDI. and key infrastructures that enjoy actual and potential comparative advantage. Another benefit of FDI is a confidence building effect. Why could Pakistan not succeed in attracting sufficiently large FDI despite liberalizing its payments and exchange regime as well as inward FDI regime? The present study attempts to find out the answer. contributing to the creation of a virtuous cycle that affects not only local and foreign investment but also foreign trade and production. or. inflows of FDI. repayment is required only if investors make profit and when they make profit. it has been changing its direction to People¶s Republic of China (PRC). FDI tends to be directed at those manufacturing sectors. While the local economic environment determines the overall degree of investment confidence in a country. FDI would create economies of scale and linkage effects and raise productivity. Another negative effect of FDI concentration on the power sector was that as the remittances by IPPs began to increase. This changing stream of FDI flows suggests that the degree of confidence building.2 In spite of liberalizing its formerly inward-looking FDI regime. mostly in the power sector. it severely constrained the balance of payments.

Pakistan has been making efforts to attract FDI and such efforts have been intensified with the advent of deregulation. However. While FDI flows to all developing countries reached $150 billion in 1997. Although significant by absolute terms. Investment inflows in 1995/1996 increased by 93. With the beginning of the overall liberalization program (1991/1992 onwards) the inflow of foreign investment grew at the compound growth rate of 15. and Economic Impact of FDI The success of FDI policies can be judged by the size of the inflows of capital. Foreign Direct Investment. the increase appears trivial when compared to the relatively more buoyant economies of East and Southeast Asia. privatization.7 million in 1976/1977 to $1296 million in 1995/1996. .4 Foreign Direct Investment in Pakistan Issues. and liberalization policies initiated at the end of the 1980s.3% mainly due to the inflow of investment in power sector. thus growing at the annual compound growth rate of 25.2 percent. it declined to $950 million in 1996/1997. East and Southeast Asia received the bulk of this share. The amount of foreign investment rose from a tiny $10.7 percent. Table 1 documents the size of the inflow of foreign investment in Pakistan during the last two decades.

However. Sectoral Distribution of FDI: Having examined the trends and structural pattern of FDI.0 billion mark in 1994/1995.2% as capital equipment) came from abroad. its share jumped to 55.7% in 1994 mainly due to the equipment brought in for Hubco Power Plant. was excluded. the after tax profit of foreign firms has declined. the reinvested earnings that originate as savings from the investment previously made have slowed down. over the last 15 years but it has made considerable improvement during the postreform period. and re-invested earnings. during 1980-1994. with the beginning of liberalization policies in 1991/1992.5 Total foreign investment consists of direct and portfolio investment. This impressive increase does not reflect the true picture of the trends in portfolio investment witnessed during the postliberalization period. Firstly. If the $862.] Structural Pattern of FDI FDI in Pakistan consists primarily of three elements.0 million prior to reform. The information provided in Table 3 shows that the structure of the sources of financing FDI in Pakistan has undergone a noticeable change. it is worthwhile to review its overall sectoral distribution pattern. 30% of FDI in Pakistan originated from re-invested earnings. The analysis of sectoral distribution of FDI . Secondly. cash brought in.2 million sale of Pakistan Telecommunications Corporation (PTC) vouchers. In particular. whereas 70% (55.4 million during 1991/ 1992 to 1995/1996 as against an average flows of only $9. Re-invested earnings contributed slightly less than one third to FDI over the last 15 years but its share has declined to 23% during the postreform period. falling from 31% in 1989 to 12% in 1994. as a result of chronic inflation. Consequently.7% as cash and 14. portfolio investment has not only been low but also exhibited a fluctuating trend. its share declined slightly (on average 50. Though the major share of FDI in Pakistan comprised cash brought in (on average 55. as a result of liberalization. the entry barriers of foreign firms were removed.8 million in 1994/1995 but followed an average trend of $215. Though all the components of FDI exhibit considerable fluctuations over time. the portfolio investment not only declined to $227. There appears to be two reasons for such a rapid decline. During the postreform a structural shift appears to have taken place as the share of re-invested earnings in total FDI declined to 23% while those coming from abroad rose to 77 percent. the item labeled capital equipment brought in has remained substantially low during 1983-1988. Consequently. the cost of production has gone up considerably and along with the plethora of taxes due to the fiscal consideration. portfolio investment crossed the $1. capital equipment brought in. It is important to note that the share of re-invested earnings in FDI has been declining since 1990. On average. which led to higher inflows of new investment. the relative share of re-invested earnings in total FDI declined considerably after 1990. on average. namely. which was a one-time phenomenon.2% during 1991-1994) during the post-reform period. The share of capital equipment brought in remained low.7% over the last 15 years). Prior to 1991/ 1992.

(2001). A welldeveloped domestic financial sector enhances efficient allocation of financial resources and improves the absorptive capacity of a country with respect to FDI inflows. However. and utilities experienced substantial increase in total FDI during the postreform period.6% in 1982 to 26. A significant change in the composition of FDI was also witnessed during the prereform and postreform periods. a more developed financial system positively contributes to the process of technological diffusion associated with foreign direct investment. sectoral shares also exhibit considerable year-to-year fluctuations. The results further suggest that better domestic financial conditions not only attract foreign companies to invest in Pakistan. mining and quarrying. Particularly.6 may reflect two things: on the one hand. like total FDI flows. it may also indicate the foreign investors¶ own preferences. commerce. The results suggest that FDI inflows exerted positive impact on economic growth in the short-run and the long-run if the domestic financial system has achieved a certain minimum-level development. For example. and on the other hand. Foreign Direct Investment and Economic Growth Recent theoretical and empirical literature suggests that foreign direct investment (FDI) exerted positive impact on economic growth through the process of technological diffusion. we examine the link between FDI.0% in 1983 and once again rising to 54. et al. continued to fluctuate violently overtime. In this study. the sectoral share of manufacturing industries.7% in 1994.6 billion in 1994. falling from 74. which stood next to manufacturing (28. Empirical analysis is based on the bound testing approach of cointegration advanced by Pesaran. On the broad sectoral basis. and commerce are seen to have traditionally dominated the preferences of the foreign investors during 1980-1994 accounting for over 83% of total inflow of FDI. manufacturing industries.15 It may be noted that the share of utilities in total FDI jumped from almost zero in 1993 to 31. construction. The general decline in manufacturing share is largely substituted by the rise in the share of mining and quarrying. but also allow maximising the benefits of foreign investment . It appears that foreign investors preferred the petroleum sector (natural gas in particular) during the period.1%) over the last 15 years. and economic growth for Pakistan over the period 1972 2005. The literature also suggests that the development of the domestic financial system of the host country is an important pre-condition for FDI to have a positive impact on economic growth. This massive increase was entirely due to the inflow of FDI in the power sector with the Hubco Corporation alone accounting for Rs 7 billion out of Rs 7. it may reflect the preferential treatment given by the government to certain sectors while encouraging FDI. domestic financial sector. Manufacturing and mining and quarrying registered a sharp decline during the postreform period as against the prereform era. The share of manufacturing industries in overall FDI averaged only 11% during 1987-1993 but rose to 35% in 1994. As revealed by the information presented in Tables 4 and 5. though highest. a noteworthy change can be easily observed in the sectoral composition of FDI flow into Pakistan over the last 15 years.7% in 1984. On the other hand.

Unfortunately. which rose from $204. the International Asset Management Company (IAMC). Safety of capital and the security for the personnel engaged in the projects are essential ingredients that govern foreign investment.17 In a recent survey. Many investors have paid a heavy price for overlooking or ignoring this factor in other parts of the world (Jegathesan 1995). (ii) Law and Order An unsatisfactory law and order situation keeps prospective foreign investors on the sidelines. particularly after the liberalization program initiated since 1991/1992. Notwithstanding attractive incentives offered to foreign investors. Such a frequent change in government accompanied by abrupt changes in policies and programs are hardly congenial for foreign investors. Lack of political stability has been the hallmark of Pakistan during the last eight years (1988-1996). found that the business environment in Pakistan has deteriorated considerably. In recent years the law and order situation has also deteriorated in the Punjab province. The IAMC surveyed 115 leading listed and . to the growing attractiveness of the PRC. the flow rising from $33.7 Factors Influencing the Flow of FDI in Pakistan: Before the Asian crisis. The East and Southeast Asian countries have attracted $82 billion in FDI in 1997 accounting for 21% of the total world flows and 55% of total developing countries¶ flows. (i) Political Stability This factor is essential to attract foreign direct investment because it creates confidence for foreign investors (see MIGA 1994). allowing disinvestment of the originally invested capital at any time. The Asian countries have also strengthened their role as the largest developing-country FDI recipient region with an estimated $87 billion of inflows in 1997. Incentives like 100% foreign ownership of capital. has been disturbed in varying degrees since 1989. Three elected governments were dismissed on various charges while four caretaker regimes each remained in power for only 90 days over the last eight years. Viewed in the background of these developments. the inflow of FDI in Pakistan remains far from encouraging despite numerous incentives offered to foreign investors. which accounted for 30. no limit for remittance of profits and dividends abroad. this factor has discouraged them to set up their businesses in Pakistan. The gains owe. the world had experienced rapid growth in the flow of FDI. an affiliate of the British-based Morgan Stanley Asset Management.7 billion to nearly $150 billion during the same period.5 billion in 1997 (see Appendix table). Political turmoil could wipe out overnight even the most lucrative investments and endanger the lives of personnel. foreign investors operating their companies without enlisting in the local stock exchanges. Karachi. Pakistan¶s law and order situation has remained far from satisfactory in the major growth poles of the country. the largest industrial and commercial center and the only commercial port of the country.2 billion in 1990 to $400. and no prescribed limits for remittance of royalties and technical fees abroad by foreign investors are highly competitive with incentives offered by many other developing countries to prospective foreignin vestors.4% of total FDI to developing countries in 1997. Developing countries have made impressive gains in attracting FDI. to a large extent.

iv) Government Economic Policies Pakistan¶s track record in maintaining consistent economic policies has been poor. Several instances of change in policy stance in recent years can be identified. Furthermore. and of increased opportunities for business. Some 74% of investors answered that they had no investment plan for 1996/1997. Pressures to raise revenues (for fiscal consideration). and an ad hoc and changing incentive system. financial services and electrical goods. (iii) Economic Strength Investors would not want to invest in a country where the economic fundamentals are so weak that it is unpredictable what the government would do next to prop up a sagging economy.4% in the 1980s. Similarly. As against the privatization of 63 units in two years (1991/1992 and 1992/1993). the investor is assured of a growing of high economic strength. For example. The key reason for the negative sentiment of businessmen was the deteriorating law and order situation in Karachi. insurance. the process of privatization slowed down considerably with the change in government. textile and apparel. chemicals. the large macroeconomic imbalances and slowing down of economic activity must have discouraged FDI in Pakistan. along with the slowdown of economic activity.9% during the 1980s. Slippages on both the revenue and expenditure sides contributed to mounting financial imbalances. It took several months to get the petroleum . as more government development projects and private sector investments put purchasing power in the hands of the people. As compared with the decade of the 1980s.4% of GDP as against 3. The abrupt changes in policies with a change in government as well as a change in policy within the tenure of a government have been quite common. Annual average GDP growth slowed from 6. The sector covered for the survey included automobiles. Pakistan¶s external sector also remained under pressure during the 1990s as compared with the 1980s. with the change in government a drastic change was made in the Lahore±Islamabad motorway project.3% in the 1980s. Revenue measures are not in harmony with the industrial policies. Resource crunch forced the government to withdraw this concession by imposing a 10% regulatory duty in October 1995. energy.8 unlisted companies including multinationals operating in Karachi. The large fiscal deficit has emerged as a major source of macroeconomic imbalances in Pakistan. The rate of inflation has averaged 11% during the 1990s as against an average rate of 7. Increased purchasing power means increased positive multiplier effects on the economy and a source for stability. Thus. large-scale manufacturing has slowed down to 2-3% as against almost 8. Another example concerns the concessions given to the petroleum and power sectors in terms of duty-free imports of machinery. The current account deficit averaged 4. Three out of four businessmen interviewed blamed political instability as the major constraint facing business today and over 59% of the 115 respondents were not pleased with government policies. Pakistan¶s foreign exchange reserves have also fluctuated in an unpredictable manner in the 1990s. Pakistan¶s macroeconomic imbalances worsened in the 1990s. to 3-4% in the 1990s.0% during the 1980s. In particular. and other conflicting objectives have generally led to inconsistencies in investment and industrialization policies. attractive incentives notwithstanding. banks. only 20 units were privatized in three years (1993/1994 to 1995/1996). In countries of high economic strength. while in 1995/1996 some 56% of those had not invested in Pakistan. economy. foreign investors are unlikely to increase their participation in economies that are expected to remain affected by foreign exchange scarcities for several years into the future (UNCTAD 1985).

Pakistan compares unfavorably in infrastructure facilities with other developing countries that have attracted higher levels of foreign investment. It does not matter how efficient the government thinks its investment policy is. Pakistan has only 18% of paved roads in good condition as against 50% in Thailand.²all required both before and during the life of a project. labor taxes have to be paid separately in compliance with labor laws. telecommunications. etc. Another question would be the availability of suitable joint venture partners. private investors continue to face a plethora of federal. 18 Such perception about the slow implementation of policies is not at all conducive to attracting FDI. their quality. (vii) Infrastructure The availability. and the Octroi. regional and local levels still apply to investors. what is critical is the perception of businessmen. Government Bureaucracy This could perhaps be the biggest ³burden´ in any investment environment. and weight and measures fees. Federal levies include custom duties. including a local metropolitan tax. or do they feel that they have to fight the government to get projects off the ground? The general perception of businessmen in Pakistan is that there exists a large gap between the policies and their implementation (Shirouzu 1993). Incentives/concessions to foreign investment apart. reliability. At the federal and provincial levels. Also. and water supplies) are important ingredients for a business environment conducive to foreign investment. provincial.9 sector concession restored but the regulatory duty was reimposed in the 1996/1997 federal budget. there is the question of the availability of ancillary and supporting industries. architects and building contractors. a 5% withholding tax at the import stage as well as restrictions that these firms cannot borrow more than their equity capital have caused serious cash flow problems. and excise duty. and workers participation in profit and group insurance. sales tax. local government taxes are levied. The implementation of policies has been slow and the bureaucracy has not responded to the initiatives with conviction. Numerous permits and clearances from different government agencies at national. (vi) Local Business Environment This covers many factors. accountants. withholding tax at import stage. including the availability of local lawyers. and whether there are lists of potential partners that the investors can choose from. The serious disagreement in 1998 between the GOP and IPPs on the purchase of electricity by the WAPDA aggravated investors¶ confidence. professional taxes. secretarial services. and cost of infrastructure facilities (power. local consultants. All these conditions are not satisfactory in Pakistan. The investment approval requirement has been removed but other regulations instituting the need for other administrative approvals. are still in place. 31% . At the provincial level there are stamp duties. Social Security. worker¶s children¶s education. In particular. and their cost. boiler inspection fees. however. Do businessmen feel that they have the support of government officials in their efforts to set up and operate efficient business units. and local taxes and regulations. In addition. such as the contributions to the Workers Welfare Fund. especially those already in the country.

9% for Philippines. respectively. one of the largest hidden handicaps Pakistan possess against NIEs and ASEAN countries (Shirouzu 1993).19 In most cases the urban infrastructure is grossly inadequate. Besides poor education and health indicators. and 6% for Thailand. congestion in the hazardous cargo results in containers being detained longer in the barge. and 20. Only 80% of primary school age boys are enrolled in school (49% for girls). discouraging job creation.1% for Thailand. Pakistan¶s adult illiteracy rate is 62% as against 17% for Malaysia.20 Karachi Port is six times more expensive than Dubai port (Jebal Ali). 21. Large vessels cannot come to the port because of the lack of dredging of shipping channels. Such labor laws have created unnecessary labor disputes posing problems for management and causing productivity losses.3% for Malaysia (World Bank 1997). It also has by far the worst indicators of public health among the five countries. Such infrastructure deficiencies have discouraged the flow of FDI in Pakistan. due to the lack of maintenance the berths are unsafe. Moreover. There are frequent delays and cancellations of berthing and sailing due to obsolete tugs and pilot boats at Karachi port. and Malaysia. In particular. and disciplined labor force along with a country¶s labor laws are critical factors in attracting foreign investors. and 30% in Indonesia. These factors are less conducive to foreign investors in Pakistan who are accustomed to liberal lifestyles. foreign investors may not find the workforce they need. Pakistan has an acute shortage of technically trained and educated labor. disadvantaged position in terms of education and health compared with other developing countries that have attracted FDI at much higher levels. Karachi port cannot even offer priority berthing for container vessels.1% of total expenditure as against 10% for Indonesia. Pakistan is at a more serious. (viii ) Labor Force A technically trained. Pakistan¶s expenditure on education accounts for only 1. Only 50% of population have access to safe drinking water as against 81. and 78% for Philippines. Karachi port cannot even provide proper container handling equipment and there is a shortage of space and bad planning. the lowest rate for the four reference countries is 93% for Malaysia. Moreover. and twice as expensive as Bombay port. Pakistan¶s labor laws are complicated and overprotective. but is only a fourth of Malaysia¶s and one half of Thailand. which have also discouraged foreign investment. inhibiting business expansion. especially in middle managerial positions and in engineering. All these have made Karachi port much more expensive than ports of neighboring countries (see Table 6 for itemwise costs at Karachi port and other ports of neighboring countries). 16% for Indonesia. Pakistan¶s amount of electricity produced per capita is higher than Indonesia¶s (435 kWh as against 233 kWh). three times more expensive than Colombo port. This is in fact. resulting in high cost to the consignees. With the general level of education and health care being low. Thailand. (ix) Quality of Life Quality of life along with cultural and social taboos is critical to attract foreign investors.000 persons in Pakistan compared with 31 and 112 in Thailand and Malaysia. While other ports offer goods container terminal facilities. 15. and frightening away much needed productive investment. 5% for Philippines. Pakistan¶s extensive but poorly managed railway system does not make good for this disadvantage. respectively.10 in Philippines. educated. Foreign investors find better conditions . Telecommunication is another bottleneck: there are only 10 telephones per 1. which may have discouraged foreign investors. 72.

the balance of payments problems. due to large FDI in the power sector. given its low share in GDP and fixed investment. Concentrated FDI in the Power Sector and its Balance of Payments Implications: If it is not the ³engine of growth´. faster than international trade. diverge regarding the effect of FDI on balance of payments. FDI as a percentage of gross fixed investment averaged 3. Empirically a strong positive association exists between the availability of certain infrastructure²power. the medium-term impact is often negative. As shown in Table 7. and marketing networks by developing countries.11 in Indonesia and Malaysia (both Muslim countries) in the ASEAN region in terms of social life and quality of life. The inflow of FDI in Pakistan is not only a recent phenomenon but it also does not form a high percentage of GDP or domestic fixed investment.5% during 1984/1985 to 1995/1996. Globally. are likely to be small (WTO 1996). any disturbance to the balance between supply and demand for foreign exchange is corrected by a movement in the exchange rate. FDI has grown rapidly in recent years. FDI as percentage of GDP remained less than one percent until 1994/1995 but rose to 1. On the other hand. paved roads. infrastructure is certainly the ³wheels´ of economic activity.23 Views. Economic Effects of FDI FDI has emerged as not only a major source of much needed capital but is also considered to be a major channel for the access to advanced technologies and intangibles such as organizational and managerial skills. FDI is not expected to have a significant impact on various sectors of the economy. FDI has a positive overall effect on economic growth but the magnitude of this effect depends on the stock of human capital available in the host economy. How far have the inflows of FDI affected the level of economic activity in the host countries? This question has been extensively investigated in recent years. telecommunications. however. E. Under flexible exchange rates. while the inflow of FDI tends to increase the host country¶s imports.29 The generally poor performance of state-owned monopolies. reaching as high as $150 billion in 1997. combined with the rapid globalization of world economies. Critics argue that while the initial impact of an inflow of FDI on the host country's balance of payments is positive. Developed countries were the key force behind the record FDI flows but developing countries also experienced a spectacular rise in the flows. Hence. Thus. and access to safe water² and per capita GDP. it is argued that the impact of FDI on the balance of payments depends on the exchange rate regime. as the investors increase imports of intermediate goods and services and begin to repatriate profit.69% in 1995/1996.22 The inflow of FDI can ³crowd in´ or ³crowd out´ domestic investment and its effect on saving is ambiguous. has brought into sharp focus the economic costs of inadequate infrastructure and has prompted a growing number of developing countries to take active steps to promote competition. In the case of a fixed exchange rate regime. A high positive correlation between aggregate inflows of FDI and the host countries¶ aggregate exports has been found. if they do occur. a net increase in the demand for foreign exchange by the FDI project will result in a reduced surplus or increased deficit in the balance of payments. Empirical evidence suggests that an inflow of FDI has a bigger positive impact on host country exports than on host country imports. encourage the private sector including .

The policy was highly welcomed by foreign investors. The policy scene of FDI in Pakistan: Pakistan¶s investment regime is as open as in any other developing country.17 The welcome to foreign investors is longstanding. 21 Incentives for foreign investors include a variety of credit facilities. Two to three years after the initiation of the policy. and the country has an investment incentive structure more generous than most. there are now serious apprehensions about overcapacity and balance of payments implications. Among various infrastructure constraints. power. growth of population. on the other hand. The Task Force on Energy (1994) noted the loss of industrial output due to load shedding in the neighborhood of Rs 12 billion. It is easier to do business in Pakistan than in any of the neighboring . tax holidays. power has emerged as the most serious bottleneck constraining the economy¶s long-term growth and development possibilities. and water in Pakistan.20 A process of policy liberalization ensued from the mid-1970s onward. and repatriation had been greatly relaxed or eliminated. restrictions to entry. per capita income.30 Removing Pakistan¶s power shortages required a large amount of capital and strong incentives that were beyond the resources and institutional capabilities of the public sector. Between 1993 and 1995 the estimated private participation in infrastructure rose from $17 billion to $35 billion in developing countries (see IFC 1996). From 1994 to 1996. property protections and national treatment are stipulated in the constitution and relevant laws. telecommunications. mostly from the US and the UK. efforts to rectify power shortages were focused on encouraging domestic and foreign private investors to participate in the generation of electricity. Investor guarantees. and special investment zones. which was prevalent in the region. 19 new equity inflows collapsed. The supply of these services. including India and Sri Lanka. A notable milestone was the signing with Germany in 1959 of the first bilateral investment treaty (BIT) in the world. concessional customs duties.12 foreign investment in infrastructure. and rapid urbanization have generated a great deal of demand for transport. a favorable visa policy. has not expanded sufficiently fast to prevent the emergence of gross shortage. ownership. admission. In the last decade and a half. The rationing of electricity (load-shedding) to metropolitan and industrial areas has become a common feature in Pakistan since the early 1980s and has given rise to social costs (the frustration of household users) as well as economic costs in terms of lost manufacturing output. in a survey of 200 industrial enterprises in Pakistan found that these firms lost an average of 21 workdays a year to electric power shortages alone. Stone (1995).18 Although foreign enterprises were exempted. The early 1970s were marred by nationalization. By the mid-1990s.

The facility is counter guaranteed and indemnified by the Pakistani Government. which is governed at the provincial level. citing irregularities. The exploration license grants exclusive rights to explore and.22 The privatization program and incentive packages have not been without controversy (i.S. surrounding the transparency of the deals. Overseas Private Investment Corporation and MIGA provide risk insurance for Afghanistan. and provincial authorities are unhappy with the terms of the development project (involving new FDI inflows of US$ 3. Although the weight of terrorism on investment decisions is unclear. The authorities in Balochistan Province have threatened to cancel the mining licence of the Reko Diq copper and gold mine held by a consortium led by the Canadian Barrick Gold Corporation and the Chilean mining company Antofagasta.e.. annulled the divestment of Pakistan Steel Mills. 23 The privatization process was set back in 2006 when the Supreme Court.25 a recent survey ranks political risk as a major investor concern in developing countries and places Pakistan among the five most risky investment destinations. Such facilities are not entirely new. job losses and/or profit repatriations). unlike oil and gas. mine and sell minerals discovered within the license area. There have so far been no terrorist incidents targeting FDI in Pakistan.2 billion). The liability coverage (up to US$ 175 million) may be increased through commercial reinsurance arrangements.26 In order to provide insurance cover against terrorism. the dispute is a blemish on the country¶s otherwise welcoming attitude toward FDI. In the interim. The federal government (i. which is regulated at the federal level. The U.24 A major dispute is looming in the minerals sector. a Political Risk Guarantee Facility was created by the Asian Development Bank in 2002. subject to certain investment requirements. the Prime Minister) has intervened between the provincial authorities and the mining companies.13 countries of South Asia. This fund would be financed from within the foreign aid allocation.27 The United States Congress is also considering a new US$ 300 million enterprise fund to provide upfront risk capital to spur IFDI in Pakistan. also to develop.e. The United States has also set up . The exploration has found significant deposits.

0 1.719.9 3.964.1 43.2 5.9 170.5 3.150.4 119.523.7 521.0 198.1 712.5 18.0 173.6 277.4 41.4 2.005.1 661.7 244.2 9.A.3 46.0 1.1 0.3 205.3 76.7 127.728.6 949.409.9 13.7 103.0 622.8 7.8) 53.9 200001 92.9 516.4 0.3 21.4 357.8 (48.5 57.139.9 363.1 227.4 (3.1 (101.6 14.8 0.512.1 6.160.1 1.3 (92.4 64.0 0.728.5 214.2 7.14 enterprise funds for the transition economies of Eastern and Central Europe.6) 126.0 (86.1 .3 3.2 589. Proceeds Privatisation Proceeds FDI Excluding Pvt.4 1.5 25.6 3.9 2.9 17.3 101.0 2.1 74.6 15.2 3.5 3.8 2009-10 (Jul-Apr) 390.9 0.7 90.8 9.3 137.4 110.2 0.2 5.6 242.0 1.4 178.5 367.5 (6.9 246.5 64.1 3.4 (56.232.2 0.6 5.6 484.4 0.3) 76.0 1.4 32.4 2.3 511.7 21.6 252.1 5.6 15.4 30.2 1.7 2.9 468.6 134.6 266.5 45.6 (133.6) 1.424.3) 9.7 0.2 5.150.2 32.5 219.5 78.1 860.4 31.4 369.2 339.4 322.5 6.0 182.0 1540.3 11.9 263.4 13.3 108. Country Wise FDI Inflows ($ Million) Country USA UK U.9 1.6 869.E Japan Hong Kong Switzerland Saudi Arabia Germany Korea (South) Norway China Others Total including Pvt.3 1.0 176.0 170.0 200304 238. and countries of the former Soviet Union.0 1.2 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 325.4 0.980.8 750.3 200203 211.5 1.0 1.9 181.3 156.6 3.873.6 174.3) 46.7 26.8 169.4) 1.6 1.2 274.4 2010-11 (Jul-Apr) 173.7 14.8 28.7 200102 326.0 165.1 36.1 0.5) 894.6 1.7 2.2 69.5 1.7 913.6 56.0 24.0 146.3 460.0 2.0 3.2 131.3 294.719.3 0.8 133.276.309.3 7.4 4.232.0 1. Proceeds 322.5 5.9 798.521.6 2.6 1.019.3 1.

864.0 1.139.8 36.8 207.1 193.0 89.4 798.8 1. An evidence of uni-directional causality running from FDI to output is also found for the services sector.0 0.232.9 312.6 18.3 222.3 8.4 51.8 86. The primary industries have attracted varying FDI.1 87. Thus.3 266.0 3.4 35.8 66.9 322.0 200304 202.3 52.3 (7.8 1. we found uni-directional causality running from FDI to real GDP in the primary sector.3 93.7 329. In the manufacturing industries.9) 4.9 165.8 269. and applying panel cointegration technique over the period of 1981-2008.2 12. there has been a substantial increase in the FDI flows Pakistan.0 0.9 1.0 707.6 274.7 86.7 (34.0 322.1 763.1 949. However.4 242.9 1980.8 2010-11 (Jul-Apr) 412.4 52.0 0.521.6 32.8 117.4 200102 268.4 176.2 5.9 18.0 750.3 79.6 3.6 21.0 10. For manufacturing sector.409.9) 80.6 517.1 35.6 (120.4 (11.2 12.7 73.3 90.0 (14.7 132.626.6) 112.7 4873. At the sectoral level.8 2009-10 (Jul-Apr) 604.15 Sector Wise FDI Inflows ($ Millions) Sector Oil & Gas Financial Business Textiles Trade Construction Power Chemical Transport Communication (IT&Telecom) Others Total including Pvt.3 61.1 30.9 30.8 363.0 198.4 36.3 622. These results suggest that FDI promotes output in the primary and services sectors.5 34.2 0.8 775.2 1.724.4 10. there is still localmarketseeking FDI.1 - 127.1 175.9 20.3 74.9 2. while services sector has enjoyed a rising share of FDI in recent years.1 42.0 586.1 930. Proceeds Privatisation Proceeds FDI Excluding Pvt.7 133.9 740.4 39.4 24.0 291.9 170.8 221.898.7 1.6 32.4 130.0 118.6 634.937.3 44.0 27.5 5.2) 15.0 1.9 89. in the long-run an evidence of uni-directional causality between FDI and real GDP is observed and in the short-run there exists bi-directional causality.719.6 401.5 320.523.719.8 1. Whereas .0 20.1 132.6 163.6 62.3 59.9 166.2 879.1 39.1 157.2 47.4 3.4 133. FDI is positively related to real output.7 200203 186.5 39.0 45.540. the composition and types of FDI has changed considerably. policymakers should increasingly focus on .6 74. Proceeds 200001 80.2) 320. We found that FDI and real GDP were cointegrated and the DOLS estimates suggested that at the aggregate level.2 1.8 78.2 33.2 5.4 357.4 1.8 764.2 3.6 13.0 70.7 285.4 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 193.150.1 17.8 1.4 26.1 CONCLUSIONS Since the introduction of reforms related to trade and payments system. an evidence of uni-directional causality running from GDP to FDI is found.6 1160.150.4 46.2 484.724.2 NA 140. We assessed the growth implication of FDI in Pakistan using sectorspecific FDI and output data.4 104.6 93.3 2.4 172.0 545.3 20.276.4 12.

this study provides significant information to policy-makers in formulating investment policies in Pakistan. Hence. In the manufacturing sector. there is limited role of FDI in export promotion. by analy sing the sectoral effects of FDI on the domestic economy. Finally. especially the textile sector has received meager FDI inflows.16 attracting FDI in these sectors in order to attain short-term growth. . the inflow of FDI is relatively small. This means that Pakistan has received little export-oriented FDI.

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