IMPACT OF FOREIGN DIRECT INVESTMENT AND INFLATION

ON ECONOMIC GROWTH:

A CASE STUDY OF PAKISTAN

By
ZABIR ARSHAD
CIIT/FA17-BEC-003/VHR

B.S. Thesis
In
Economics

COMSATS University Islamabad

Vehari – Pakistan

Fall 21
 COMSATS University Islamabad, Vehari Campus
Impact of Foreign Direct Investment and Inflation on Economic
Growth:
A Case Study of Pakistan

A Thesis Presented to
COMSATS University Islamabad, Vehari
Campus

In partial fulfilment

Of the requirement for the degree of

(B.S. Economics)
By
ZABAIR ARSHAD
CIIT/FA17-BEC-003/VHR
Fall, 2021

I
 Impact Of Foreign Direct Investment and Inflation
On Economic Growth: A Case Study of Pakistan
_____________________________________________________________

An Undergraduate Thesis submitted to the Department of Management

Sciences as partial fulfilment of the requirement for the award of degree
of B.S (Economics).
Student Name Student Registration No.
ZABAIR ARSHAD CIIT/FA17-BEC-003 /VHR

Supervisor
Muhammad Hassan Akhtar.
Department of Management Sciences COMSATS
University Islamabad (CUI) Vehari Campus.

II
 Final Approval
This thesis titled
Impact of Foreign Direct Investment and Inflation
on Economic Growth: A Case Study of Pakistan
By
ZABAIR ARSHAD
CIIT/FA17-BEC-003/VHR
has been approved for the partial fulfillment of the requirements of BS
economics degree at:
COMSATS University Islamabad, Vehari Campus

External Examiner:
_____________________________________________________

Supervisor:
_____________________________________________________
Mr. M Hassan Akhtar
(Lecturer, Department of Management Sciences)

Head of department:
______________________________________________________
Dr. Muhammad Imran Khan
(HOD Management sciences /Vehari)

III
 DECLARATION

I ZABAIR ARSHAD (CIIT/FA17-BEC-003/VHR) hereby declare that I

have produced the work presented in this thesis, during the scheduled period
of study. I also declare that I have not taken any material from any source
expect referred to wherever due the amount of plagiarism is within
acceptable range. If a violation of HEC rules on research has occurred in this
thesis, I shall be liable to punishable action under the plagiarism rules of the
HEC.

Date: _________________ Signature of the student

_________________
ZABAIR ARSHAD
CIIT/FA17-BEC-003/VHR

IV
 CERTIFICATE

It is certified that ZABAIR ARSHAD (CUI/FA17-BEC-003/VHR) has

carried out all the work related to this thesis under my supervision at the
Department of Management Sciences, COMSATS University Islamabad,
Vehari Campus and the work fulfils the thesis requirement for award of B.S.
Economics degree.

Date: _________________ Supervisor:

_________________________
MUHAMMAD HASSAN
AKHTAR
Lecturer (Department of
Management Sciences)

HOD of Department:

_________________________________
Dr. Muhammad Imran Khan
HOD Management Sciences

V
 DEDICATION

This thesis is dedicated to:

The sake of Allah, my Creator and my Master and great teacher and
messenger Muhammed(May Allah bless and grant him), who taught us the
purpose of life. My great and beloved parents, I cannot forget their love
affectionate and support.

VI
 ACKNOWLEDGEMENTS

Words are bounded and knowledge is limited to praise Almighty Allah, The Lord of the
worlds, The Beneficent, The Merciful, who gave me potential and the ability to complete
the work. Special thanks to my supervisor Sir M. Hassan Akhtar for motivating teaching
and patient guidance in my writing process. I will always remember our scholarly
discussions.
Thanks to all my family members for their support and cooperation in the course of my
studies. I am especially thankful to my parents and beloved friends for their prayers and
love.

ZABAIR ARSHAD
CIIT/FA17-BEC-003/VHR

VII
D

Table of Contents
Chapter 1........................................................................................................................................3
INTRODUCTION..............................................................................................................................3
Historical background:...........................................................................................................3
1.2Statement of the Problem:.................................................................................................16
1.3 Objective of the Study:.....................................................................................................17
1.4 Significance of the Study:.................................................................................................17
1.5 Organization of the Study:...............................................................................................17
CHAPTER 2.................................................................................................................................19
LITERATURE REVIEW.............................................................................................................19
2.1 Introduction:.....................................................................................................................19
2.2 Theoretical Background:..................................................................................................19
Chapter 3:.....................................................................................................................................33
Data and Methodology.................................................................................................................33
3.1 Introduction:.....................................................................................................................33
3.2 Data source:.......................................................................................................................33
3.3 Description of variables....................................................................................................33
3.4 definitions of Variables:...................................................................................................34
3.5 Methodological Framework:........................................................................................35
3.5.3 ARDL Model Specification:..........................................................................................36
3.5.4 ARDL Bounds Testing Procedure:...............................................................................37
Chapter 4......................................................................................................................................38
Inflation, Foreign Direct Investment and Economic Growth: An ARDL Analysis.......................38
4.1 Introduction......................................................................................................................38
4.2 Descriptive Statistics and Correlation Analysis..............................................................38
4.2.1 Descriptive Statistics..................................................................................................38
4.3 Unit Root Analysis............................................................................................................40
4.4 ARDL Bounds Analysis....................................................................................................41
ARDL Bounds Analysis..........................................................................................................41
4.5 Long Run Analysis............................................................................................................42

VIII
 4.6 Error Correction Analysis................................................................................................43
4.7 Conclusion.........................................................................................................................44
Chapter 6......................................................................................................................................46
Conclusion & Recommendations.................................................................................................46
5.1 Conclusion.........................................................................................................................46
5.2 Policy Recommendations:................................................................................................47
References……………………………………………….……………………………………………………………………………….48

IX
 Chapter 1

INTRODUCTION
In this chapter we try to explain some economical problems faced by economic growth of
Pakistan. Which cause to decrease the growth rate of the country. There are some
problems like inflation, unemployment and foreign direct investment. There are many
other variables influence the economic growth but inflation and unemployment are the
main two factors. Therefore we used these variables to investigate there relationship with
economic growth. Also we briefly discuss the historical background of Pakistan with
various decades and economic situations. Also the variables like inflation,
unemployment, FDI and economy growth (GDP) are briefly explains in this chapter.

Historical background:

Pakistan is one of the developing and also an agrarian country. The agricultural sector
fulfils the basic requirements of food for human beings. Most of the population depends
on agriculture in Pakistan which is about 65 percent of total labour force of country after
Independence. The income of these people is based on agriculture sector. There were few
industries in country and social and political socks were found in Pakistan. There is no
proper infrastructure, planning and system for development. It means that country was
totally underdeveloped at that time. The agricultural sector of Pakistan contributed 53
percent of total GDP in 1947. While the retail trade contributed 11.9 percent and the
manufacturing sector contributed 7.8 percent in GDP. Pakistan exports are mostly
primary products like tea and jute etc. which are agriculture commodities and produced in
East Pakistan. While on the other hand now Pakistan is still an agrarian country but the
contribution of agriculture sector in GDP has been reduced from 53 percent to around 21
percent. Now the exports nature has also changed from agriculture products to
manufacturing products. Because the manufacturing sector grow and its contribution in
GDP is increased from 7.8 percent to around 25 ypercent in GDP. While the remaining

1
50 percent is covered by service and other sectors. If we see the economy of Pakistan
with different eras of Political parties than we analyse the periods of economic growth
and economic falls with clear understanding. After the independence in 1947 there were
no economic and social policies for implementation. The economy is not able to stand on
behalf of its industrial base because there were 921 industries in subcontinent while there
are only 34 industries given to Pakistan after partition which is only 3.69 % of total
industries. So, there was many problems to start the economy without industrial sector. In
1958-68 there was a significant jump were made in agriculture and industrial production.
That's why it's called decade of development. After the independence the agriculture
sector has been neglected but Ayub Khan give importance to this sector and start
promotes this sector. Ayub Khan was first ruler in Pakistan who ask for land reforms.
With land reforms 2.5 million acers of land transferred from absentee landlords toward
landless peoples. The development of large-scale irrigation system in this era with low-
lift water pumps were there was an issue in irrigation to facilitate the formers to promote
agriculture production. Projects to protect crops from distraction of floods have been
taken up. There were many incentives and facilities from government are given to
industrial sector which promotes the production of industrial sector. The number of
cotton mills has increased to 150 which provide employment for 200,000 workers. The
coffin industries annually produced about 550 million lbs of yarn and also 800 million
yards of cotton clothes. There were 32 jute mills which produced about 4 lakh tons of jute
goods annually earning 580 million. The Karachi shipyard has been restructured to
provide repair and ship construction facilities. Ayub Khan also set up commission for
scientific research education. In 1960 there were only 300 scientists in country but now
there is more than 1200 scientists research in medical, agriculture and industrial
production. Facilities for education system were increased also number of scholarships
given to the students were increased there were 12 universities including two agriculture
and two engineering. The defence system of Pakistan is also reorganized in a way that
with its small size it is able to fight with any type of aggression.1972-1977 is also called
the bad luck era for Pakistan. After this in decade of 1970s due to rising interregional
economic disparities In 1971 East Pakistan become independent after rebelled against
West Pakistan. Which is now called Bangladesh. In (1971-72) 55% increase in poverty.

2
There imports bill of Pakistan was increased due to world oil prices shocks in October
1973. Major flood and insect attacks on crops in country in 1973-74 and 1976-77 also
cotton crops was failed in 1974-75. Pakistan faced a 15% per annum increase in prices
during 1972-1977 which is the worst inflation for country. 8.1% annual average fiscal
deficit ratio in 1973 to 1977. Trade balance deficits were increased from US$ 337 million
to US$ 1184 in 1970-71 to 1976-77. A military coup took place on 5, July 1977 and the
martial law government carried out decommissioning, deregulation and privatization. In
1970s annual agriculture growth grew at rate of 2.4% and annual large-scale
manufacturing growth grew at rate 5.5%. The 75% contribution of value-added is from
large and medium-scale manufacturing which is 70% to 80% of total investment and the
remaining 25% was contributed by small-scale manufacturing in 1970s. After this decade
the decade of 1980s which is called the era of restoring economic growth. In this time
period the Pakistan achieve some economic goal and also face some problems in this
regard. After the nationalization regime of 1970s it is time to restore the industrial
investment if private sector which is cause increase in economic growth. In 1986-1987
there is a reduction in poverty rate from 55% to 29.1%. The unemployment rate is also
decreased from 3.7% to 2.6% in 1980 to 1990. Government started the idea of interest
free baking system and implement policies on this. In this system there is a partnership of
two parties on profit and loss sharing base in 1985 to 1988. The domestic debt increased
from 58 billion PKR to 521 billion PKR in mid of 1981 to 1988. As a result, the public
debt to GDP ratio increased from 77.1% to 81.9% in 1988 to 1989. In the era to 1980-
1990 the average growth rate of GDP is 6.3 per annum in country. In 1990s there was a
reduction in worker remittances and the increase in external deficit which lead to reduce
the GDP growth rates and also cause to second case of worst inflation in 1990. The rate
of unemployment highly increased from 5.9% to 7.2% in 1991 to 2000. The external debt
to GDP ratio increased from 42% to 50% in 1980 to 1995. There was also an increase in
external debt to export ratio from 209% to 258%. There was an increase in domestic debt
ratio to 909 billion PKR in 1996. When the public debt to GDP ratio increased from
57.5% to 102% in 1975-1977 to 1998-1999 respectively then in late 1990s there is a
serious debt crisis occurred. Poverty increased to 30.6% in 1998 to 1990. Economic crisis
starts in the decade of 2000s. The public debt is a reason of reduction in Economic

3
growth rate to less than 4%. The growth rate was 8.6% in 2004 to 2005. After this
improvement the economic crisis starts show down the economic growth which high
inflation rate and energy crisis. First there was a rise in poverty to 34.5% after that it
reduced to 22.3% in 2000-2001 and 2005-2006 respectively. The rate of unemployment
is increased to 7.8% fist and declined to 5% in 2002 and 2008 respectively. Pakistan’s
literacy rate was 55% in 2007-8. There was an economic crisis in 2008 and global
financial crisis in 2009-10. In 2009-2010 there was 4.1% inflation adjusted growth rate,
2% agriculture growth rate, 4.9% industrial output growth rate, 4.4% large-scale
manufacturing growth rate, 4.6% services growth rate. [state bank of Pakistan (2010)].
8160 billion PKR was the total public debt in march 2010 and 56% was total public debt
to GDP ratio. There was history of major development transitions for Pakistan in which
agricultural share of GDP reduced from 53% to 21.2% in 1947 to 2010 respectively. The
share of manufacturing sector increased from 9.6% to 25.4% in 1949-50 to 2010
respectively. And the contribution of Services sector increased from 37.2% in 1950 to
53.4% in 2010. The economic growth rate was 4.7% in 2015 and increased in 2016 and
reached at 5.5% furthermore it increased continuously in 2017 and 2018 from 5.6% to
5.8% respectively. The unemployment rate in 2015 is 5.9% which increased in 2016 to
6.0% and constant in 2017 after that the rate decreased to 5.7% in 2018. Also, the rate of
inflation in 2015 is 2.5% which increased to 3.8%, 4.3% and 5.3% in year 2016, 2017
and 2018 respectively. In this study we see the impact of inflation and Foreign Direct
Investment on economic growth in Pakistan. First of all, we try to know about economic
growth, inflation, Foreign Direct investment and unemployment for clear understanding
of the study.

Gross Domestic Production (GDP)

Economic growth is the most important factor of economy in which we understand that
the economy is growing or not. Mostly every country is judged by its economic growth
no matter the country is developed or developing, rich or poor. Therefore, it is necessary
to keep the economic growth rate rising with implementation of different policies. An
increase in production of goods and services in a economy comparing with one time
period to another time period is known as economic growth. It is the measurement of the

4
capacity of a country’s production of goods and services. The economic growth of a
country is measured by its Gross Domestic Product (GDP). In GDP we saw the total
number of finally produced goods and services in the boundary or territory of a country
with in one year time period.
GDP: (Y) = C+I+G +NX
Where:
Y = GDP (Gross Domestic Product)
C = Consumption
I = Investment
G = Government spending
NX = Net Exports (Export – import)
The GDP can measure with two ways called Nominal GDP and Real GDP.
Nominal Gross Domestic Product is the GDP that includes the inflation in its
calculation. All the produced goods and services within one year in a country that are
sold at a price of that year which is calculated is called Nominal GDP. It is also called
inflation unadjusted GDP which means that the variation of prices from previous year to
current year is not excluded from this GDP. It is not calculating inflation as well as
deflation in its results. When Nominal GDP is greater year to year means that there is a
rise in prices of all goods and services produced in country which shows the inflation.
When inflation increases than prices of all goods and services in the country increases
respectively so when we calculate the nominal GDP it results more than the previous year
nominal GDP every year.
Nominal GDP = Quality of current year (production) × current market prices

Real Gross Domestic Product is totally opposite of nominal GDP. Real GDP calculate
the goods and services produced within one year in a country with previous prices of
goods and services. It is also called inflation-corrected GDP or constant price GDP. Real
GDP measure the value of goods and services according to the previous year prices
which tells about the price change in current year compare with previous year. Real GDP
excludes inflation from calculation that’s why when there is higher inflation then the
value of real GDP is less than the nominal GDP. While there is deflation in the country

5
 then the value of real GDP is higher than the value of nominal GDP. Real GDP is
important in countries which have greater number of goods and services produced within
them. Therefore, they use GDP to measure whether there is need to boost or relax the
economy. Through real GDP they determine inflation rate so they make decisions and
policies according to situation.
Real GDP = Quantity of current year (production) × prices of Base year

GDP Deflator is a tool to measure the change in prices of all goods and services
produced in a country. It is also known as GDP Price Deflator. GDP measure only the
total goods and services produced in the country without calculating the impact of price
change in it's results. GDP Deflator measure the price changes into GDP. It calculates the
price change by selecting a base year and then composting the prices of current year whit
that base year. GDP deflator shows the change in GDP that occurs due to the change in
price level. It measures price level calculated as the ratio of nominal GDP to real GDP.
GDP Deflator = (Nominal GDP ÷ Real GDP) × 100

There are three methods to measure GDP in a country are as follows:

i. Output Method in which calculate all the produced goods and services within the
boundary of a country. To avoid the price changes or inflation in this measurement
we use real GDP or the calculation with constant prices.
GDP (as per Output Method) = GDP at Constant price (Real GDP) – Taxes +
Subsidies

ii. Expenditure Method is used to calculate the GDP of a country by calculating all the
expenditure of all institutions on goods and services within the territory of a country.

GDP (as per Expenditure Method) = C+I+G+NX

While
C = Consumption Expenditures
I = Investment Expenditures
G = Government Spending

6
 NX = Net Exports (Exports – Imports)
iii. Income Method is also a way to calculate the GDP of a country that involves sum of total
income earned by all factor of production. There are four (4) factor of production which
are Land, Labour, Capital and Entrepreneur. By adding all the income of the factors an
estimate can made a total of productive value of economy in a period of time.
GDP (as per Income Method) = Total National Income + Sales Taxes + Depreciation +
Net Foreign Factor Income.
Where
Total national income = sum of all earnings of factor of production like rent, wages,
interest and profits
Sales Tax = Consumption tax that charged by the government from the consumer om
Consumption of goods and services
Depreciation = Cost on use of tangible assets over time period
Net Foreign Factor Income = income generated by the country’s citizens and foreign
companies in foreign countries – income generated by foreign citizens and foreign
companies in domestic country.

Unemployment:
Term Unemployment is used to show the people who are able to do something and also
in search of a job but usable to find a job. Unemployment is an important factor that
affects an economy’s working capacity. When peoples are searching jobs and also want
to do work are included in this term Unemployment. The people who don't want to do a
work but searching a job are not include and not classified as unemployed people. When
due to different reasons like health issues, disability, and for the purpose of higher
education etc. A person who doesn't try or stopped looking for a job in past four weeks
also not include in unemployed persons. All the people in a country who are able to do
something are called Labour Force of country. Pakistan is ranked as ninth (9 th) largest
country in the world according to its labour force. About 57.2 million are included in
labour force of Pakistan because they are able to do something. A 43% of total labour
force is involved in agriculture sector while in industrial sector there is 20.3% labour
force and the remaining labour force is involved in other services sector which is 36.6%

7
of total labour force. Pakistan’s total labour force in 2020 was 72,335,052.
Unemployment rate shows the percentage of people who are not employed in anywhere
in the economy.
Labour Force = Number of Employed people + Number of Unemployed people

Unemployment rate = (unemployed people ÷ Total labour force) × 100

Unemployment is an economic as well as social problem which caused waste human
capital and also lead to increase in poverty rate in any economy. Unemployment affects
the people income level which lead to decrease the consumption level of people. It also
affects the living standards of people. Unemployed people face various problem like
health issues, education issues and hardly able to fulfil beaux requirements and also
unemployed people are not food secure which is the most important thing for life.
Developing countries like Pakistan fighting against unemployment to reduce the poverty
and all the problems associated with unemployment. There are two categories of people
in unemployment. One of them are those people who are searching for a job till last 12
months but not looking for a job from last four weeks. This category is called “marginally
attached to labour force”. Other category defines those people who have given up in
search of a job are called “discouraged workers”. Bureau of labour statistics (BLS)
explain the term employment as people with age 16 and above who put their hours in
work is past week and paid due to self-employment. There are four (4) different types of
unemployment which used to see people who are unemployed.

Frictional Unemployment is a type of unemployment in which an individual's left their

jobs because it does not fulfil their requirements and start searching a job which is
suitable to them. In frictional Unemployment people who leave their jobs and also people
who are entering in workforce are included. People who are not left their jobs but also
searching for new jobs are not included in unemployment because they are employed.
This type of unemployment is always present in every economy.

Frictional Unemployment = (people actively looking for jobs ÷ total labour force)

8
There are three types of people who searching for jobs actually are divided into three
categories including people who left their jobs, people who return to labour force and las
one is those who are newly entering in labour force. People newly graduates from school
who search jobs for the first time are not much efficient in searching a company’s job
which is available and suitable for them. In this type of search, they remain unemployed
and can't find a job. Also moving from one place to another place also add people to
Frictional Unemployment. While on other side when people leave or design their jobs for
getting higher education for the purpose of learning new skills which help them to earn
more income. Also, people who leave their jobs due to different reasons like family
issues, personal issues, health issues or any other issue. After that they again start
searching new jobs are also a part of Frictional Unemployment.

Sessional Unemployment is type of unemployment when people are unemployed in a

specific time period of a year. Some industries don't need labour for a while year so
workers of such industries are employed for a specific time of year after that time when
industries have no production or industries are closed than the workers of that industries
are unemployed. Pakistan is an agrarian country therefore most of industries are related to
agricultural products like what, cotton and rice etc. In these types of industries
employment in on peak point when there is a season of suitable product so people are
employed in these industries. While on other hand when the season is out than industries
cannot afford much labour therefore, they kicked out of them. As a result, seasonal
unemployment occurs. Seasonal unemployment includes both the underutilization of
labour force and also the resources which are used in production. In the season of suitable
crop, the industries increase the demand of capital resources for the purpose of increase
their production. But when the season is gone then the demand of capital resources also
decreased. Most of the time sessional unemployment is predictable when the demand for
goods changes. Sessional unemployment is natural because it is the result of changing
season in a country.

Sessional Unemployment is defined as a difference between the available job and the
skills a person has. It simply means that when a person cannot fulfil job requirements or

9
have less skills from the requirements of job then the individual remain unemployed.
Structural unemployment has long lasting impact on economy and it is also a challenge
for economy and policy makers. In structural unemployment people cannot have jobs due
to lack of skills or lack of education. In countries like Pakistan people are not so skilled
because of no technological advancement. There are old and traditional techniques of
production therefore people are less productive and consume more time and cost. There
are some reasons of structural unemployment in which first one is the competition
between labour force. Increasing population lead to increase the competition for a job in
the whole world. There is a cheap labour in developing countries or in poor countries is
than developed countries. So, for save money the country with higher labour wages easily
hires poor country’s labour on low wages which save its money or cost of production.
Second reason is lack of technological advancement in poor countries which lead to
produced unskilled workers. Awareness of new technologies increase the production
level which save cost and time. To overcome this type of unemployment e educational
training of skills is necessary in countries with high structural unemployment. Because
structural unemployment is not related to the economic condition it occurs even when the
economy is rising.

Cyclical unemployment is the type of unemployment which occurs when cycle of

business or economy changes. When the business is on peak point it needs more labour to
increase its production and meet the demand of that production. So there are more people
employed in the company. But when there is a decrease in the demand of a product so the
company decrease the supply of the product which cause to reduce the production level.
For low production of that good the company need only few workers therefore all the
extra workers are released by the company which caused cyclical unemployment. The
economic downturn or upturn also effect the cyclical unemployment because the upturn
of the economy lead to increase the demand of goods which case to hire more people in
the industries or decrease the unemployment rate. While there is a downturn in the
economy there are increasing rate of unemployment due to a reduction in demand of
goods in the economy.

10
Inflation:
Inflation is the factor which significantly affects any economy in the world. Inflation
describes as an increase in prices of goods and services in the economy. Inflation refers to
a decline in purchasing power of a particular currency over period of time. Inflation rate
reflect in an economy with the average increase of price level of selected goods and
services in a basket over a period of time. An increase in general price level means that
same amount of money can buy less amount of goods and services than previous years. In
this term a currency loss its value and buy fewer goods and services with more money.
Sometimes inflation occurs due to a rise in money supply in the economy. In Pakistan
there are some negative impacts of inflation on economy like increase in the prices of oil
and gas. These are important things for economy due to increase in the prices of oil and
gas all goods and services produced in country are also expensive which affect the Poor
people more than rich ones. It also increases the utility tariff and excise duties. The
standard of living is also affected by inflation. In inflationary time period when prices are
high then the market forces of demand and supply influence by price movements. So,
there is any attempt to decrease prices artificially lead to decrease the quality and
sometimes decrease quantity of goods. Sometimes large variation in food and oil prices is
due to supply shock in economy. Import prices are also influence the market prices of an
economy because if imported goods are expensive then the produced goods from those
imported goods are automatically expensive. Indirect taxes are also a cause to increase
the inflation pressure in economy. There are some types of inflation which are observed
in the economy are:

Demand-pull Inflation is a situation in which the aggregate demand of goods and

services is increased. When people want to buy more good and services in the economy
that lead to increase the prices of that goods and services which is known as demand-pull
inflation. There are two different reasons explain by Classical and Keynesian economists
that said this rise in aggregate demand is occurred due to different reasons. Classical
economist says that the increase in aggregate demand of goods and services is due to
increase in money supply. When people have more money than they want to buy more
goods and services that lead to increase in aggregate demand and also cause to increase

11
prices in economy. While Keynesian economists said that it is not the only way to
increase the aggregate demand there are also some other reasons including (C+I+G+NX)
if the consumption demand is increased or ride in government spending or investment or
a reduction in taxes or also due to an increase in net exports all these happen without
increase in money supply. So, demand pull inflation can caused due to both reasons
monetary and non-monetary.

Cost-push inflation is the other type of inflation in which cost of production increased
due to various reasons there for an increase in prices occurs. Sometimes cost of raw
material increased which cause to increase the production cost. If the raw material is
imported and there are heavy import duties from government than the cost of production
also increases that lead to cost-push inflation in economy. Land, labour and capital are
the main factors used in production when the cost of one of these factors rent, wages and
interest respectively than the cost of production rises. When there are labour strikes
blamed to increase the wages also influence the cost-push inflation.

Currency inflation occurs when state bank print too much current notes that lead to
increase the money supply and ultimately increase in inflation rate.
1. When banks advance more loans to general public to make more profits that cause to
increase money supply in markers that result in increase in prices.
2. Government is also a reason to increase in inflation rate. When there is a budget
deficit in economy then government ask central bank to print some additional money
to meet the budget deficit so it also lead to increase price level.
We have different types of inflation according to the speed level of inflation as first one is
the creeping inflation. Creeping inflation refers to a very low rise in the price level.
When the annual price increase difference is between 2% to 3% that is called creeping
inflation. Creeping inflation is considered helpful in for economic growth. Second type is
walking inflation. Walking inflation occurs when the annual rise in prices is between 3%
to 4%. Also, these two types of inflation are known as moderate inflation. Moderate
inflation is a situation of inflation in which people have trust on monetary system of the
economy. When inflation increases from moderate rate which lead to loss of people’s

12
confidence. Third and last type of inflation accordingly its speed is known as
hyperinflation. Out of controlled inflation is turn into running inflation which is
dangerous for any economy. This type of inflation increases with speed of double or
triple digit like 20, 100 or 200 percent annually. Consumer Price Index (CPI) is a method
generally used to measure the inflation rate in economy. In CPI there is an economic
basket in which prices all the daily used goods and services like milk, eggs etc. It
includes all other good which are purchased by consumers. After that in CPI the past cost
is compared with the present cost of same goods and services.
CPI = (Cost of basket in present year ÷ Cost of fixed basket in base year) × 100
Inflation Rate = (CPI present year – CPI previous year) ÷ CPI previous year × 100

Foreign Direct Investment (FDI):

An investment made by an individual or a firm from one country to another country for
business interests. When an investor establishs business operations in other country. This
investment is mostly made in open economies. When countries offer more profits and
skilled labour force which attracts investors to invest in that country. The main purpose
of investor’s investment is to maximum profit earning. So with that objective investor see
more benefits like cheep and efficient workforce and government subsidies for investors
which reduce the cost of business and profit is increased. There are three types of foreign
direct investment are horizontal investment, vertical investment and conglomerate
investment. Foreign direct investment is beneficial for both countries. The country in
which investor invest capital get benefit by more employment opportunities and capital
inflow and also there is price benefits for local people due to increase in competition.
While on other hand the investor country can benefit from the way to expand their
business to international markets.
Horizontal investmentrefers to a investment which an investor establishing the same
type of business activities in another country as it operates on its domestic country. It
means that an investor invest its capital in other country in a same business operations
which operations investor operates in domestic country.

Vertical investment

13
an investor establish a business in other country which is different but related to its main
business which investor operates in domestic country. Like manufacturer company’s
investor establish a business operations in other country for raw material. The business
for raw material is different from manufacturer company but related to the manufacturer
company.
Conglomerate investment
means that the investor of a country invest in other country to establish a business
operations which is totally unrelated to its operating business. In this type of investment
the investor has no experience and new in the industry because it establish a business
which is not related to its domestic country's business.

1.2Statement of the Problem:

Developing countries face many problems during the transformation towards
advancement. There are some common and most harmful hurdles faced by developing
countries. Thesis problems reduce the speed of economic growth of these developing
countries and caused more economic as well as social problems. Pakistan is one of the
developing countries which also face same problems as other developing countries are
faced. The most common issue in each developing country is the increasing inflation rate
which lead to slow economic growth of these countries. After that the foreign direct
investment is a good determinant for every economy. But in developing countries like
Pakistan there is a small proportion of foreign direct investment in the gross domestic
product. In this study we investigate that either there is a relation between these problems
and economic growth is exists or not in case of Pakistan. Foreign direct investment is
insignificant in economic growth of Pakistan. Also, there are some economic and social
hurdles in foreign direct investment. Unemployment, inflation, higher interest rates and
poverty are some of the determinants that reduces the rate is foreign direct investment in
country. Pakistan faces political instability which is the major reason for the fear of
foreign investors. The foreign investors don't see incentives by investing in Pakistan.
Therefore, foreign direct investment can't play a significant role in economic growth.
If there is a relationship between inflation and economic growth in Pakistan exist than we
estimate how inflation affect economic growth and also determined the rate of inflation

14
that is harmful for country. Inflation and unemployment caused different social and
economic problems like poverty, corruption and social crimes. When people don't have
much money to fulfil, they're beside necessities then they use wrong ways to fulfil their
basic requirements. Higher inflation rate is an important problem for economic growth.
Economic growth means growth in every sector of economy but inflation can't allow
people to save money and invest it in the country for business purposes. When there is a
higher rate of inflation in economy then people can't think about savings. And savings are
the main factor for investment in the country.

1.3 Objective of the Study:

 Explore the link between inflation and economic growth:
Increasing inflation rate is main economic hurdle in every country’s economic growth.
The main purpose and objective of the study is to examine whether there is a relationship
between inflation rate and economic growth rate exists or not in Pakistan’s economy.
Also, this study includes to investigate the impact of this economic as well as social
problems on economic growth. The literature review is providing strong evidences that
there is a negative impact of inflation on economic growth in most countries.
 Explorer the link between Foreign Direct Investment and Economic Growth:
The other objective of the study is to investigate the relationship between Foreign Direct
investment and Economic growth. Also examine the impact of foreign direct investment
in growth in Pakistan. While foreign direct investment is seen as a good ingredient for
economy. The study and literature review describes that the foreign direct investment has
an insignificant positive role in economic growth of countries.

1.4 Significance of the Study:

The study had summed up the impact of inflation and foreign direct investment on
economic growth of Pakistan. It shows that how both of these variables inflation and
foreign direct investment affect the economic growth.Also, the study offers some policy
recommendations on the behalf of estimated results of the study.

1.5 Organization of the Study:

15
The study organized the impact of inflation and foreign direct investment on economic
growth in case of economy of Pakistan. In the first chapter “Introduction” the study
explains the introduction of the study as well as main objective of the study. We explain
that the inflation and foreign direct investment affect the economic growth of Pakistan.
There is a link between all of these variables. Second chapter is “Literature Review”. In
this chapter we describe different national and international articles reviews related to our
study. These articles give us a strong evidence about our study that these variables has
impact on economic growth. Third chapter is the “Data and Methodology”. In this
chapter we describe our source of data and method which we use to estimate our data.
We use ARDL model in our study as well as Unit root test to check the stationary of data.
We used the model to investigate the relationship between variables and also examine the
impact of these variables on economic growth. Our last chapter is chapter five in this
chapter we conclude our study and also give some policy recommendations to solve the
problems occurred by these variables.

CHAPTER 2

LITERATURE REVIEW
2.1 Introduction:
In this section we are going to write literature review of different articles based on
various time period and countries. This literature review provides an evidence to our
study and also help to investigate the further problems related to the study. Our results
will be accepted on the biases on our results and this literature review. To analyse the
impact of both of the independent variables on economic growth we use these literature

16
reviews. Different authors confirm the relationship between variables in their studies. So,
we try to investigate this relationship in case of Pakistan.

2.2 Theoretical Background:

Shiyalini et al. (2021) determine the relationship and effect of inflation and
unemployment on economic growth in a time period of (1990-2016) in Sri Lanka. World
Bank Development Indicators is the source of data used in study. The result indicate that
the inflating and economic growth are stable on level but unemployment stable after
being differenced one. There is a co-integrating relationship between inflation,
unemployment and economic growth. Study shows that unemployment and economic
growth has a negative relationship while inflation and economic growth has a positive
relationship in long-tun. But in short-run there is a significant negative relationship
between inflation and unemployment from one period to three period. While there is a
mixed impact between unemployment and economic growth in short-run from one period
to two period and in third period it has a negative impact on economic growth.

Saha (2021) investigate the impact of inflation on economic growth in India over the
period of 1961 to 2015. There is a unidirectional relationship between inflation and
economic growth. Inflation negatively affects the economic growth. And growth granger
causes the inflation in India over time. It shows that the increasing economic growth
reduce the inflation rate while the increasing inflation rate reduce or slow the economic
growth rate. There is an indirect Causality from economic growth to inflation. Authorities
will be advised to accelerate the economic growth so the inflation rate will fall with
increasing economic growth rate.

(2021) investigate the relationship between unemployment, poverty and economic

growth in case of Nigerian economy. The result of the study after investigates 1980 to
2016 is that there is a negative relationship between variables. The poverty and
unemployment and some other variables like consumer price index (CPI) and household
consumption expenditures are used as explanatory variables while economic growth rate

17
used as explained variable. There is a negative impact of unemployment and poverty on
economic growth rate. While there is a positive impact of household expenses on
economic growth that means with an increase in household consumption there is also rise
in economic growth. The inflation rate is also included and explained in study which has
a negative impact on economic growth. The results shows that 1 percent increase in
unemployment lead to 0.394 percent decrease in economic growth rate and 1 percent
increase in CPI lead to 0.6673 percent decrease in economic growth. On the other hand,
the household expenses have a positive impact as 1 percent increase in household
expenditures lead to 0.4074 percent increase in real economic growth rate. The
authorities should adopt some policies to reduce the rate of unemployment and poverty
by improve the education system so the people aware by the danger and harmful effects
of Unemployment and poverty for economy. And also give attention to the agricultural
sector by diversifying the productivity which case to reduce unemployment level and
improve growth by high productivity.

Xesibe&Nyasha (2020) shows the impact of unemployment on economic growth in case

of south Africa. The data used to examine the relationship between these variables is
from 1st quarter of 1994 to 4th quarter of 2017. There is total 6 variables used in the study
are unemployment rate, economic growth, inflation rate, government expenditures,
investment and household consumption. There is negative and significant impact of
unemployment on economic growth. An increase in rate of unemployment cause to a
decline in economic growth rate as 1 percent increase in unemployment lead to 0.4
percent decrease in economic growth. While inflation also negatively affects economic
growth as 1 percent increase in inflation lead to 0.1 percent decrease in growth rate.
Furthermore, the other variables used in this study have positive impact on economic
growth. There is 1 percent increase in investment lead to increase 0.7 percent in GDP per
capita. And 1 percent increase in government expenditures would increase GDP per
capita by 0.6 percent. If the household consumption increases by 1 percent, then the GDP
per capita will be increase by 0.2 percent. All these variables have significant impact on
economic growth of country. Here is the suggestions for policymakers and authorities to
control the increasing rates of variables which have negative relation with economic

18
growth like inflation and unemployment. Unemployment can be reduced by increasing
government expenditures and lowering taxes and also by increasing investment for
sustainable economic growth.

Korkmaz (2020) investigated the relationship between unemployment and economic

growth in 8 (Italy, Germany, France, Greece, Spain, Ireland, Poland, Belgium) randomly
selected OECD countries in the quarterly period from 2016:01 to 2019:02. In this study
there is examined the impact of unemployment and economic growth. A unidirectional
relationship exists between the variables that means economic growth is required for
unemployment occurs. This unidirectional relationship is from unemployment to
economic growth. Unemployment has a negative and significant impact on economic
growth. Unemployment is an important macroeconomic also social problem for every
economy that’s why governments and policy making authorities try to con tool the
unemployment rate to ensure the economic growth rate. So, the governments use
expansionary monetary and fiscal policies to reduce the unemployment rate by increasing
money supply and also increasing the aggregate demand for goods and services.
Governments also increases spending and reduce the tax rates to increase the consumer’s
purchasing power to increase the aggregate demand. By using one monetary policy tool
that keep the interest rate low which means that there is more investment in economy.
When there is more demand for goods and services there is more investment and the
more people will be employed. So, the unemployment rate will be reduced.

Kryeziu&Durguti (2019) explain the impact of inflation rate on economic growth rate.
They determine that there is a positive impact of inflation rate on economic growth for
(17) Eurozone countries. This study shows that there is a positive relationship between
inflation rate and economic growth rate. But Different researchers in their studies show a
positive as well as negative impact of inflation rate on economic growth rate. The low
inflation rate has economic growth. But the double-digit inflation rate is harmful for
economic growth. Also, there is a level for inflation rate in which the inflation rate is
above than expected or determined level of inflation it will be dangerous for economic
growth and there is a negative impact of inflation rate on economic growth and it led to

19
slow the growth rate while if the inflation rate is below that level so there is a positive
impact of inflation rate on economic growth and that will encourage growth rate. There
are also some other variables are used to determine the impact of inflation rate on
economic growth rate. But there is positive relationship between inflation and economic
growth only when these other variables are kept to be constant. In this study if the
inflation rate is increased by 1 percent annually than the rate go economic growth
increased by 22.4 percent Annually if other variables kept constant.

Sahnoun (2019) investigate the relationship between variables and also determined their
impact on each other. The investigated variables are inflation rate, unemployment rate
and economic growth in North African countries including Algeria, Egypt, Morocco and
Tunisia from the period 1965- to 2016. The variables are co-integrated. There is a
unidirectional casual flow from inflation to economic growth in short run. While in long
run inflation and economic growth mutually casual. The inflation and economic growth
reinforce each other and affect each other. This type of situation provides an ease to
policymakers for better understanding. So, the policy makers aware how to ensure
economic growth without raising inflation. There is a unidirectional relationship from
economic growth to unemployment in both the log-run and short-run. It means that
unemployment can reduce economic growth but the economic growth cannot reduce the
unemployment. So, the authorities make policies to reduce unemployment by providing
more employment opportunities which is helpful to achieve sustainable growth rate. After
that there is also a unidirectional relationship from inflation to unemployment. In this
situation the policy makers face the challenge of how to reduce unemployment rate
without increasing inflation rate.

Apau et al. (2019) determine the impact of unemployment on economic growth of China
for 27 period sets (1991-2018) from Work Development Indicator. There is both short
run and long run relationship exists between unemployment and economic growth.
Unemployment is used as a dependent variable and economic growth is used as
independent variable in the study. There is a casual relationship found between economic
growth and unemployment. The results show that in 1 percent increase in economics

20
growth rate than the rate of unemployment decreases by 0.33 percent in short-run and
0.32 percent reduction in long-run. It means more focus is paid to economic growth rate
to maintain a durable unemployment rate. There is no causality between them but there
are some other factors that that caused a negative relationship between unemployment
and economic growth (i.e., inflation, interest rate, money supply growth and exchange
rate) which are not estimated in this study.

Hayat, Balli et al. (2018) show the impact of inflation on real economic growth in
Pakistan. There is the inflation bias which slows the real economic growth. How much
inflation bias contributes in this intention of economic growth? The more direct
investigation required inflation bias indicators that are observable. which are present
according to desirable inflation threshold and the preferences of the state. The effects of
inflation bias of a discretionary monetary policy of Pakistan were examined. That in the
goal of achieve sustainable growth the inflation bias causes the unfavourable outcomes.
The study shows that the inflation bias was not just inefficient to bring real economic
growth also to significantly unstable it. The strong results indicate that the higher
inflation bias is the higher its intensity of unstable effects. So, the policy makers who
make policies to adjust the inflation rate or to increase the economic growth or to
encourage the real nature of economy make policy which minimize the inflation bias.
That is the positive step which helps to achieve a minimum rate of inflation and also
helps to achieve a sustainable economic growth.

Aslam, Hakeem et al. (2018) determines the relationship between five variables inflation,
imports, exports, tax and economic growth in the economy of Pakistan in period of 1977
to 2016. Economic growth is used as explained variable so it is affected by the remaining
4 explanatory variables which are inflation, imports exports and tax. It determines that
the high inflation rate, high tax rate and high imports are negatively affected the
economic growth in both short-run and long-run. More imports discourage the domestic
investment which lead to other economic problems. While increased inflation rate is also
harmful for developing economies like Pakistan. On the other hand, exports have a
positive relationship with economic growth. Therefore, policy makers make policies to

21
control inflation rate and tax rate and also to reduce imports and encourage exports.
Because high exports lead to high production which affects the economic growth
positively.

Suleiman, Kassim et al. (2017) check the relationship between unemployment and
economic growth in Tanzania from the year 1991 to 2015. There is a unidirectional and
positive relationship between unemployment and economic growth. There exists a causal
relationship between unemployment and economic growth. The direction with economic
growth to unemployment which have positive impact. unemployment has positive
impact but minor influence on economic growth in Tanzania. when the economic growth
rate was 7.1 percent in 2002 and 804 percent in 2007 then the unemployment rate is at
rising rate from 2 percent in 2005 to 2.9 percent in 2013. After government take some
steps to control the unemployment rate then the rate of unemployment reduced to 2.3
percent in 2016. Unemployment rate affects the social progress and also waste the
manpower of an economy which cause to reduce the rate of growth so it is advised to
policy makers to control the rising unemployment rate to boost the economic growth.

Jelilove, Obaka et al. (2016) shows the relationship between inflation, unemployment and
economic growth. Inflation and unemployment are used both dependent and independent
variables to determines their effect on one another and on economic growth. The data
was collected of 10 selected member countries of ECOW|AS. Study shows that the 50%
coefficient of determination is required to implementation of a policy which goal is to
maintain inflation rate and employment rate in economy. To reduce the unemployment
rate proper steps will be taken. Increase in productivity of these 10 countries causes to
decrease the unemployment rate. Also, the implementation of labour-intensive projects is
a positive effort to control and reduce poverty. While the capital-intensive methods of
production affect negatively the employment rate so the labour cannot fulfil the
production level as compare with machinery. When there is trade-off in short run then a
unit increase in unemployment rate led to a slight increase in inflation rate. In long run
when there are no trade-offs then a unit increase in unemployment bring a slight decrease

22
in inflation rate. The increase in unemployment rate has negative effect on growth of
economy. Unemployment does not affect the economic growth of economy. Inflation
improves the economic activities through growth in per capita income

Aydin et al. (2016) Investigates a non-linear relationship between inflation and economic
growth in case of five (5) Turkish republics in a transition period for (1992 - 2013).
Dynamic panel threshold model, which is the extended version (Kremer et al., 2013) of
the static model administered for the endogenous predictors by Hansen (1999), was used.
There are some independent variables used in the study like inflation, Threshold. And
economic growth is a dependant variable in the study. The study determined that the
relationship of inflation and economic growth in seen by the threshold level which is
determined 7.97% in this study. If the inflation rate is more than the threshold so it is a
negative relationship between inflation and economic growth. If the inflation rate is less
than the threshold then the relationship between inflation and economic growth is
positive. It is a positive influence on economic growth it does not indicate the causality of
inflation. It only tells the importance of threshold for decision making and increasing the
efficiency of implemented monetary policies.

Mohseni&Jouzaryah. (2016) shows the impact of inflation and unemployment on

economic growth in Iran. These are two main factors that affects the economics growth
rate. It estimates the data from 1996 to 2012. Inflation and unemployment both have
negative impact on economic growth so the short term and long-term phases was
investigated. In long term inflation and unemployment have significant and negative
impact on growth and reduced the growth rate. Particularly inflation has more impact on
economic growth because there is a nonlinear and direct relationship between inflation
and economic growth so inflation is more harmful for economic growth. The effect of
these was estimated in Iran which is negative and significant impact of inflation and
unemployment on short term GDP and long-term GDP was (-0.764) and (-0.0431)
respectively. The result shows that 1 percent increase in inflation rate cause to decrease in
the gross national product by 0.043 percent in short-run and 0.764 percent in long-run.
While 1 percent increase in unemployment rate led to decrease in gross national product

23
by 2.24 in short-run and 2.58 percent in long-run. So, authorities and policy makers
should pay more attention to the importance of inflation and unemployment on economic
growth to ensure economic development.

Yelwa, David et al. (2015) determines the relationship between inflation, unemployment
and economic growth in Nigeria using secondary data from 1987-2012. The OLS model
was used in study. It described that the inflation and unemployment have a negative
relationship with economic growth in long run while the interest rate and total public
expenditure are also having important impact on economic growth. The inverse
relationship between inflation and economic growth is increase in price level is not
because of demand pressure. It is due to a hiccups in the supply of goods from both
foreign and domestic supply outlets. There is a reasonable link between inflation,
unemployment and economic growth. Policy makers should make favourable policies to
achieve a sustainable growth rate. Some policy prescriptions to solve the problems of
inflation and unemployment in Nigeria. Firstly, the development of agriculture that
would increase the supply of basic necessities. With an increase in supply the prices start
to decrease and employment is increased. Secondly the investment in employment
generated industries which lead toward more production. And the prices of goods and
services also decrease. So, the inflation will be reduced. Thirdly the increase in
information and knowledge about the jobs and that would make the people more skilled
and aware toward the job. Which lead to reduce the unemployment level. Last step is to
set a body that checks the implementation of the policy in the economy.

Ibarra &Truppkin. (2015) estimate the inflation threshold level in a large group of (138)
countries in which the inflating rate above the threshold level is to be considered as
negative for economic growth. The difference of institutions among countries also
determined. Many state banks adopted inflation targeting regime. It is an object of
monetary policy to advice a sustainable growth with lower inflation rate. The threshold
level is high in developing countries than the developer countries inflation has a negative
impact on economic growth so monetary authorities should aim at avoiding and
maintaining low level of inflation. With an increment in the quality of institutions the

24
cost of inflation increased. The threshold level is much higher for non-industrialized
economies (19.1%) compared with threshold level for industrialized economic (4.5%).
There is an immediate impact of inflation on economic growth of non-industrialized
economies while there is a smooth impact in industrialized economies. For better
understanding of the relationship between inflation and economic growth with help of
Institutions proxies in these types of economies. Developing countries act after the
inflation higher and reach the threshold level but developed countries act slowly and well
before the inflation reaches or near to threshold.

Sultan, Shah (2014) study the existence of inflation in Pakistan and also determines the
relationship between inflation and economic growth in Pakistan over period of 2005-
2014. There is a significant and moderate relationship exist between inflation and
economic growth in economy of Pakistan. Inflation affects daily life such as income,
prices of goods and services, education etc. There is a threshold point which is used to
determines the effect of inflation on economic growth. The inflation rate above the
threshold point affects negatively on economic growth. While the inflation rate below the
threshold point has positive effect on economic growth. The current inflation rate is
dangerous for the economy of Pakistan. It is suggested to policy makers to set the
inflation rate below 8% and keep it steady. So, in this way it has positive impact on
economic growth.

Rasool, Rashid et al. (2014) examined that there exists a relationship between inflation
and economic growth and also determine the impact of inflation on economic growth in
Pakistan for the time period of 1972-73 to 2010-11. There is a negative relationship
between inflation and the inflation rate hurts the economic growth after a significant
level. impact of inflation to change economic growth is more than the impact of GDP to
change inflation. In means there is large impact of inflation on economic growth after the
threshold level. However low inflation rate near to zero is also harmful for economic
growth, while high inflation rate is also discouraging economic growth. So, it is a

25
challenge for policy makers that instead of reduce the inflation rate start find a faster
growth rate with stable the inflation rate.
Ali (2014) tries to explain whether there is a relationship exist between inflation, income
inequality and economic growth or not. To investigate the impact of explanatory variable
on economic growth in Pakistan the data is used from 1972 to 2007. There are some other
variables are examined in the study like foreign direct investment FDI, worker’s
remittances and manufacturing value added. There is a positive and significant impact of
inflation on economic growth. But the higher inflation rate is harmful for economic
growth. There is a 9 percent threshold level which means that the inflation rate above this
threshold level negatively affects the growth rate and inflation rate below this threshold
level has positive impact on economic growth. While according to this study the income
inequality has a negative impact on economic growth which affects the poor. The higher
income inequality led to reduction in Economic growth rate. The other variables
including FDI, workers remittances and manufacturing value added are positively affects
economic growth. When there is an increase in FDI than there are more employment
opportunities and aware from modern technologies and production system. Worker’s
remittances also have positive and important impact on economic growth. The current
account deficit is also reduced by increase in worker’s remittances. The manufacturing
sector is important sector for Pakistan as manufacturing sector contribute 18.5 percent in
GDP and provide 13 percent employment opportunities. So as increase in manufacturing
value added lead to increase in economic growth rate in long run.
Shahid (2014) show the impact of inflation and unemployment on economic growth in
case of Pakistan's economy from the period of 1980 to 2010. There is a long-run co-
integration relationship exist between inflation, unemployment and economic growth.
the study revealed that there is negative relation between unemployment and economic
growth. Which means that increasing unemployment rate led to decrease in economic
growth rate. The study shows that there is a negative insignificant relation between
inflation and economic growth. Also that inflation has a negative relation with
unemoployment. There are some policies to reduce the unemployment rate like increase
in government spending and creating more employment opportunities.

26
Khaliq et al. (2014) determines the relationship between unemployment and economic
growth in 9 different countries of Arab from (1994-2010). The result shows that there is a
negative relationship of economic growth on unemployment. Economic growth is used as
independent variable in this study and unemployment is as dependent variable. The study
shows that if the growth increased by 1% then unemployment rate decreased by 0.16%.
The growth rate of population is 5% which has a positive relation with unemployment. If
the growth of population is increased by 1% then the unemployment rate will also
increase by 0.37%. it means that the overpopulation also lead to an increase in
unemployment rate.

Ozulumba (2014) determined the relationship between unemployment and economic

growth in Nigeria and also investigate the factors that increase the unemployment rate in
the economy during the period of 33 years (1980-2012). Unemployment is a major
macroeconomic problem that has significant impact on economic growth of a country.
There is a negative relation between unemployment and economic growth in Nigeria.
Unemployment is used as independent variable and economic growth is used as
dependent variable in the study. Economic growth is adversely affected by
unemployment rate. A decrease in economic growth rate when the unemployment rate
increases. There is corruption and globalization that has positive relationship with
unemployment rate. When corruption and globalization then unemployment occurs.
These are the main reasons for unemployment. While the infrastructure has negative
relationship with unemployment but impact of infrastructure on unemployment is not
significant. So, the policymakers advised to make policies for agriculture, manufacture
and services sector improvements. It is helpful to reduce the unemployment rate and
promote economic growth.

Afzal, Arshad et al (2013) determine the relationship between food inflation, education,
health and economic growth in Pakistan in the time period of 1970-72 to 2010-11. The
food inflation has a negative relationship with economic growth. When there is high food
inflation it means that there is no food security in the country. So, the education is also
affected by food inflation because less food security reduces the chances of education.

27
Education has direct relation with economic growth. The more the labour is educated,
skilled and healthy more they are productive. An efficient productive labour led to
economic growth. The impact of food inflation and education on economic growth is in
both short-run and long-run. The tow-way causality between each variable is found. First
of all, according to this investigation the policy makers and government may estimate the
threshold level for food inflation and then keep the food inflation below the threshold
level which lead to rise more education opportunity that cause more economic growth.

Bitencourt . (2011) examine the relationship in inflation and economic growth in the time
period of 1970-2007 in 4 Latin America countries including Argentina, Bolivia, Brazil
and Peru. There is hyperinflation in these countries during 1980’s to 1990’s. Inflation has
a harmful impact on economic growth. Hyperinflation or increasing inflation cause to
increasing macroeconomic uncertainty or shift toward less productivity. Hyperinflation
ruin the economic activities in the countries which are already suffer from other
economic problems like chronic income inequality. Hyperinflation is used as independent
variable and economic growth is used as dependent variable. Hyperinflation affect the
welfare of poor. Hyperinflation ended up when countries mature politically and
independence of central bank, inflation targeting and fiscal responsibility law in 1990’s.

Hussain, Malik (2011) examined the long run and short run relationship between inflation
and economic growth in Pakistan with time period of 1960-2006. The study also explores
a threshold level to set the inflation in economy. There is a positive relationship between
inflation and economic growth in Pakistan. The findings imply that the both variables
have positively and important impact on each other. The high inflation causes to invest
more in physical capital and cut their real balance holdings. The threshold level is
estimated as 9 percent. If the inflation rate is below the threshold level it has a positive
impact on economic growth while the inflation rate above the threshold level lead to slow
economic growth means a negative impact. So, for the sustainable economic growth
policy maker should keep single digit inflation rate.

28
Javid and Kamal (2011) examine the relationship between foreign direct investment and
economic growth in developing countries especially in Pakistan. Through tiem series data
from 1981 to 2009 the study shows that there a bi-direction relationship between FDI,
exports, imports and economic growth in case of Pakistan. FDI, GDP, exports and
imprtasare the variables used in the study. The economic instability is the reason for low
FDI in Pakistan. The investors have no interest in the country due to bad economic
conditions. After this the political instability is the other reason for this level of FDI in
Pakistan. The loans from IMF and other financial institutions. This type of inflows has
no positive impact on growth because of heavy interest payments on these loans while
FDI has positive impact on economic growth. Some recommendations for authorities to
make policies to attract FDI inflow also to attract investor create efficiency in capital and
financial structure and export improving stretegies.

Hussain & Iqbal et al. (2009) examine the relationship between economic growth and
unemployment in Pakistan. Unemployment is an economic as well as social problem. The
study found a causal relationship between economic growth and unemployment by using
the data from 1972-2006 in case of Pakistan. Unemployment creates inequality and
poverty in economy. In Pakistan the rate of labour force is rising but the capacity of
economy is not expanding so as a result unemployment occurs. There are some other
variables like physical capital, openness of trade, human capital is used as explanatory
variables. The increase in economic growth rate will reduce the increasing rate of
unemployment. The unemployment generates low wage rate in informal sector which
lead to high income inequality. The policies to increase investment in country can also
reduce the unemployment rate while the political stability is also important to increase
investments in country. The establishment of industrial zones in urban surroundings also
in rural areas to reduce income inequality. The cause-and-effect relation between
economic growth and unemployment is long-run. Three implementations of export-
oriented policies are neededt to increase the production level for the purpose of new
employment opportunities which cause to reduce unemployment rate.
Munir& Mansur. (2008) determines the inflation rate and its impact on economic growth
in Malaysia. There is a nonlinear relationship between inflation and economic growth. It

29
investigated with yearly data for period of (1970-2005). It examines the existence of a
threshold level. An increase in oil prices leads government to reduce subsidies over 40%
and inflation increases up to 5%. There is a threshold level which determines the
relationship between inflation rate and economic growth. When the inflation rate below
3.89% than it has a positive impact on growth rate and it promotes the economic growth.
While on the other hand the inflation rate above 3.89% adversely affected the economic
growth so it means there is a negative impact on growth. Policy makers focus on the
monetary policy to maintain the inflation rate below the threshold level for a sustainable
growth. When there is an increasing oil costs force the government to increase oil prices
which caused the higher inflation rate than threshold level and then the consumer
spending were decreased that affects the business investment. GDP growth rate is an
explainedhere are some other explanatory variables like population growth, foreign direct
investment and exports are not estimated.
Hayford et al.2000 shows the Livingston survey measure of a positive correlation
between unemployment uncertainty and inflation uncertainty that is due to higher
inflation rate. The higher inflation rate increases the unemployment uncertainty which is
the real economic activity. There is a negative impact of both inflation uncertainty and
undocumented uncertainty on economic growth. Both have similar effects on GDP
growth rate. An increase in inflation uncertainty increases with inflation and uncertainty
of future unemployment also increase with inflation. The cost of higher inflation is higher
unemployment uncertainty that may deserve equal billing with inflation uncertainty. With
rising inflation rate the future inflation uncertainty also rising so the uncertainty of future
unemployment also increases due to inflation. Inflation and unemployment used as
independent variables and economic growth is used as dependent variable. Inflation
uncertainty and unemployment uncertainty cause each other. They both negatively affect
the economic growth.

30
 Chapter 3:

Data and Methodology

3.1 Introduction:
In this section we try to explain the source of data from which the data of related
variables is taken. And variables used in the study are described in this chapter.
Econometrics model and econometric equation is explained in this. After that unit Root
test and ARDL model are also explain in this chapter. Also, methodology for this study is
explain in this section which we used to estimate our data and able to give a proper result
based on given data.

3.2 Data source:

The data used in this study is in the form of time series data which is collected on annual
base of the time period from 1991 to 2019. This 29 years data is taken from the
“Macrotrends”. In which the data of different variables are taken annually in percentage
(%).

3.3 Description of variables

(a) Explanatory variables:
There are some independent variables are used in this study which explains the dependent
variable. The independent variables are unemployment (UNP), inflation (INF) and

31
foreign direct investment (FDI). All these variables are used to see the trend of dependent
variable due to change in any of these independent variables. All these variables are used
to see whether there is a relationship exist between any of these explanatory variables
with explained variables or not. If there exists a relationship among any variables then
what is the impact of that independent variable on dependent variable.
(b) Explained variable:
Economic growth (GDP) is used as a dependent variable in the study. GDP is explained
by all above independent variables. It is used to check the proportion of change which is
occurred by change in any independent variables.

3.4 definitions of Variables:

Variables Definition
Economic Growth (GDP) Gross domestic product is described as sum of all the
goods and services produced in the boundary of a country
within a year. It is a way to understand the economic
condition by seeing its overall production. A country with
a higher GDP rate simply means that the country is
growing up.
Inflation Term inflation is used to describe the continuous increase
in price levels of goods and services. Inflation is the one
of important determinants of economic growth. The
higher inflation means that there is a decrease in the
purchasing power of people in the country. It is a fall in
the value of money therefore more money can now buy
fewer goods and services.
Unemployment Unemployment simply means that a person who is
willing to do a work and able to do a work but cannot
have a job. When there are more people are in search in

32

Foreign Direct Investment
jobs but the employment opportunities are less than them
so as a result unemployment occurs.
Foreign direct investment is the investment from the
investor of a foreign country into another country. When
the foreign investor sees incentives of high profit due to
some reasons like government tax reduction, government
subsidies, cheap labour, and any other reason, So, the
investor want to invest in that country to maximise their
profits. Foreign direct investment is seen as a good factor
for economic growth because it provides job
opportunities for local people and also it reduces the
monopoly power and create competition which lead to
decrease the prices and improve the quality of goods.

General form of model:

GDPG = f ( LFPR +¿¿,GFCF +¿¿ , INF−¿+¿¿, FDI +¿¿, SSE+¿¿).

Econometric equation:
The econometric representation of the equation is described as:
GDPgt = β 0 + β 1 LFPR t + β 2 GFCF t + β 3 INF t + β 4 FDI t + β 5 SSEt + μ
Here GDPg(t) shows the gross domestic production growth with respect to time period.
While LFPR(t), CFGF(t), INF(t), FDI(t) and SSE(t)described as labour force participation
rate, gross fix capital formation, inflation, foreign direct investment and secondary school
enrollment respectively with respect to time period. Β0 indicate the intercept and β1, β2,
β3 shows the regression coefficient that we want to estimate. And µ is the error term that
is independently and identically distributed. Theoretically the above equation is expected
that the increasing rate of inflation and affects the economic growth negatively. But the
foreign direct investment, labour force participation, gross fix capital formation and
secondary school enrollment affects the economic growth positively.

33
3.5 Methodological Framework:

In this section we going to explain the methodology and test to determine the relationship
between given variables and also the impact of independent variables on dependent
variables. We envisioned the determinants with unique variables and tests.We use ARDL
model to check the short and long run impact of variables. We used distinct variables to
test the effect of human capital on financial boom to begin with we're able to use unit
roots test to test the table bound of variables.
3.5.1 Unit Root Test:
In time series data there is a possibility of spurious results. Therefore, it is necessary to
address the problem of non-stationary to avoid these spurious results. Stationary
properties of the variables are examined by the augmented Dickey-Fuller (ADF) test
(1979). The augmented DF test is the modified form of the standard Dickey-Fuller (DF)
test. The ADF test augmented the Dickey-Fuller equation by including the lagged
difference term of the dependent variable as independent variables so as to remove the
problem of autocorrelation. The ADF test has been applied with or without intercept and/
or a time trend to determine the non-stationary of Vari Framework.
3.5.2 ARDL Cointegration Approach:
The main objective and purpose of the study is to check the share of inflation and foreign
direct investment rate in economic growth. To obtain the objectives of the study, we will
estimate our model by utilizing the ARDL (autoregressive distributed lag) methodology
proposed by Pesaran and Shin (1999) and further proposed by Pesaran et al. (2001). This
methodology is preferred to the Engle-Granger (1987) two-step methodology and
Johansen (1988) and Johansen and Juselius (1990) approach to co-integration, and have
many advantages. By using ARDL approach the long and short run impacts of variables
could be found out at the same time. With the ARDL model, co-integration analysis can
be done without identifying of whether the underlying independent variables are purely
I(0), purely I(1) or a mixture of both, while the other approaches such as the Johansen as
well as EngleGranger methodology are concerned with the long run association among
I(1) variables. In this approach the long run relationship to be assessed by OLS method
once the lag order of the variables is known. This methodology makes progress upon the

34
other approaches since it is superior at controlling small samples and dynamic causes of
bias. Pesaran et al. (2001), Pesaran and Shin (1999), and Haug (2002) further extended
the ARDL approach. It have superiority over other cointegration techniques. This
approach also controls for endogeneity problem. We have been three explanatory
variables. In this situation ARDL approach is an appropriate technique because it
captures the small sample bias.
3.5.3 ARDL Model Specification:
The Unrestricted Errors Correction fashions (UECMs) to provide an explanation for the
connection of human capital and financial increase for Pakistan equations are given
beneath. The Unrestricted Errors Correction fashions (UECMs) to provide an explanation
for the connection of human capital and financial increase for Pakistan equations are
given beneath. The parameters are the corresponding long term multipliers whereas the
short run dynamic coefficients of the ARDL models. Is white noise mistakes and Δ is the
primary distinction operator.

3.5.4 ARDL Bounds Testing Procedure:

Its miles essential to check the existence of long term relationship before estimating long
time factors and errors correction models. For the purpose, ordinary Least Squares (OLS)
technique is hired to find out the price of F or Wald Statistic for the joint importance of
the parameters of lagged variables i.e.
The null hypothesis indicates that the parameters of the lagged variables in equations are
simultaneously equal to 0 indicating no long term dating or no co integration. The
opportunity speculation explains that as a minimum one of the parameters of the lagged
variables is not equal to zero suggesting long time dating or co integration. The null
speculation is tested in the direction of the opportunity speculation the usage of F-
statistic. The F-statistic has a nonpreferred distribution which is predicated upon whether
or not or no longer or now not the variables covered within the ARDL model are
incorporated of order I(0) or I(1) or an aggregate of I(0) and i(1). The computed F is in
comparison with vital values proposed thru Pesaran et al. (1996). Of the computed F
statistic is greater than the upper certain vital fee, the null hypothesis of no long term
courting is rejected. Of F-statistic is a fantastic deal less than the decrease wonderful

35
critical values, the null hypothesis is normal implying that there may be no a longterm
dating or co integration. Ultimately, of the F-statistic lays the various lower and pinnacle
positive essential values, the check is inconclusive for the given diploma of importance of
long run dating exists, the long term parameters may be expected through the usage of the
following equations for every country:In the above equations parameters associated with
the summation signs constitute the short run parameters and the coefficient of ECM in
each equations constitute ( ) indicates the rate of adjustment closer to the long-run
equilibrium. Coefficient of adjustment should be horrofic and statistically extensive for
convergence.

Chapter 4

Inflation, Foreign Direct Investment and Economic Growth:

An ARDL Analysis
4.1 Introduction
In this Chapter we are going to investigate the relationship between inflation, foreign
direct investment and economic growth in the economy of Pakistan. We found that the
inflation has a significant and negative impact which means that rising inflation rate
cause to a decline in GDP growth rate. After that we find a positive relationship between
FDI and GDP growth rate. It shows that increasing rate of FDI inflow leads to increase in
GDP growth rate. We envisioned the determinants with unique variables and tests.

4.2 Descriptive Statistics and Correlation Analysis

4.2.1 Descriptive Statistics
It is a set of descriptive coefficients which reviews a given data set which can be
demonstration of whole population or sample and the measure used to define this data set
are measures of central tendency and measures of dispersion. The measures of dispersion
include the standard deviation, minimum and maximum variables, kurtosis and skewness
while the measures of central tendency include mean, median, mode.
Table 4.1: Descriptive Statistics of Key Variables (1975-2020)

36
   GDPG LFPR GFCF INF FDI SSE
Mean 5.07 30.37 15.63 97.13 0.47 26.55
Median 4.96 30.22 16.49 46.05 0.45 23.64
Maximum 10.22 32.98 19.24 383.37 3.67 46.59
Minimum 1.01 27.46 10.12 6.77 -2.69 16.03
Std. Dev. 2.05 1.77 2.41 110.85 1.21 9.11
Skewness 0.08 0.09 -0.85 1.28 -0.04 0.76
Kurtosis 2.59 1.68 2.59 3.33 4.68 2.30
Jarque-Bera 0.38 3.43 5.82 12.74 5.44 5.38
Probability 0.83 0.18 0.05 0.00 0.07 0.07
Observations 46 46 46 46 46 46
Source: Author's calculations

Mean is the central average value of the data. Centre is known as the middle value of a
range of values and the mode is most repetitive value in a data. In our study we used
1975 to 2020 years’ data. So, the total observation of each variable are 45. The average
value of the Gross Domestic product Growth (GDPG) is 5.07% and median of (GDPG) is
4.96. The maximum value is 10.22 and the minimum value is 1.01 the skewness means
that measure of symmetry distribution of the data. The skewness in Gross Domestic
Product Growth (GDPG) is 2.59. it means that (GDPG) was the positive skewness. and
kurtosis is 2.59. The standard deviation means that to explain the variation for central
value. And the Standard deviation of the Gross Domestic Product Growth (GDPG) is
2.05. this ratio shows that (GDPG) have2.05% variation from the central valve. and the
probability is 0.83
The mean value of Inflation (INF) is 97.13 and the median is 46.05 with maximum
Inflation (INF) 383.37 and minimum is 6.77. The skewness means that measure of
symmetry distribution of the data. The skewness in the Inflation (INF) is 1.28 and the
kurtosis is 3.33. The standard deviation means that to explain the variation for central
valve. The variation in Inflation (INF) is 110.85 and probability is 0.00.
The average value of the Foreign Direct Investment (FDI) is 0.47% and median of (FDI)
is 0.45. The maximum value is 3.67 and the minimum value of (FDI) is –2.69. Skewness
means that measure of symmetry distribution of the data. Skewness in Foreign Direct

37
Investment (FDI) is –0.04. That means the (FDI) was the negative skewness. While
kurtosis is 4.68. The standard deviation means that to explain the variation for central
value. And the Standard deviation of the Foreign Direct Investment (FDI) is 1.21. The
ratio shows that (FDI) have 1.21% variation from the central valve. and the probability is
0.83. Remaining all the variables explain in the same way as the above variables explain.

4.2.2 Correlation of Matrix:

Correlation means that to explain the strength of relationship between two variables. The
meaning of word correlation is relationship between two variables. Correlation can be
positive and negative respectively. Correlation can be positive when both values rise
together. It will be negative when on value increases in the opposite direction of other.
The value of that correlation lies between +1 to -1. There are three classifications of
correlation and these are stronger correlation, medium correlation and weak correlation.
Table 4.2: Correlation Matrix of Key Variables (1975-2020)
Correlation GDPG LFPR GFCF INF FDI SSE
GDPG 1.00          
LFPR 0.00 1.00        
GFCF 0.00 -0.62 1.00      
INF 0.01 0.73 -0.89 1.00    
FDI -0.30 -0.17 0.66 -0.54 1.00  
SSE -0.10 0.70 -0.78 0.96 -0.37 1.00
Source: Author's calculations
Results of the correlation matrix shows there is a positive as well as negative correlation
between different variables. Like gross domestic product Growth (GDPG) and (LFPR)
has the negative +Ve correlation (0.00) this valve shows that this correlation was positive
correlation between them. When we find the correlation between (GDPG) and (FDI) then
result that there is negative correlation between them. (GDPG) and (SSE) have the strong
negative correlation. Inflation rate (INF) and secondary school enrollment (SSE) have
the positive correlation.

38
4.3 Unit Root Analysis
Unit root method is commonly works to check the stationary of the data set and it
is authoritative before the estimate of data. There are two techniques work to check the
stationary of the data that are ADF (Augmented Ducky Fuller) test and PP (Phillips-
Peron) test. Time series data said to be stationary of these conditions are is current mean,
variance, and covariance all are found to be invariant time series data is depending on
time.
Our Null hypothesis and Alternative hypothesis will be stated as:
Null hypothesis H0: ρ = 1 (Data is not stationary)
Alternative hypothesis H1: ρ≠1 (Data is stationary)
Decision rule of ADF* > t critical value then null hypothesis is rejected and conclude
that data is stationary and of ADF* < t null hypothesis is not rejected and conclude that
Data is stationary. ADF test results will decide the technique or method we have to apply
to estimation the model.

Table 4.3: ADF Test

ADF Unit Root Test on Level
Variables None Lags Intercept Lags Intercept Lags Conclusion
and Trend
GDPG -1.16 0 -0.89 0 1.89 0 I(1)
LFPR -1.87 0 -2.55 1 8.99 0 I(0)
GFCF -7.09 0 -8.40 0 5.90 0 I(0)
SSE -2.49 1 0.02 0 0.06 1 I(1)
INF -10.06 1 -6.25 1 7.11 1 I(0)
FDI -1.72 0 1.24 1 0.29 0 I(1)

Results of the Augmented Ducky Fuller test shows that some variables are stationary and
some are non-stationary. In our result labor force participation rate (LFPR) gross fix

39
capital formation (GFCF) and inflation (INF) variables are stationary at level. And gross
domestic product growth (GDPG), secondary school (SSE), and foreign direct
investment (FDI) variables are stationary at first difference. Due to mixed order of
integration we used ARDL bound test approach.

4.4 ARDL Bounds Analysis

ARDL Bounds Analysis
When we check the relationship between variables then we used ARDL bound test
technique for this purpose. Due to ARDL bound test we find that the cointegration exist
or not. The results of ARDL bounds test are given below.

Table 4.4: Results of F-Test

5% Critical Value 10% Critical Value
Model F- Statistic I(0) I(1) I(0) I(1)
GDPG/LFPR,GFCF, 5.39 2.41 3.62 2.11 3.24
SSE,INF,
FDI,INF*FDI,

Source: Author calculations

The result of this test shows that the value of F- Statistic is 5.39 which is greater
than upper bound at 5% level of significance. This results shows that the cointegration
exist between the variables. And long run relationship exist

4.5 Long Run Analysis

When we find the relationship between Economic Growth (GDPG) and other variables
like LFPR, GFCF, INF, FDI etc. Then we used auto Regressive Distributed Lag (ARDL)
model. This model is used to test the existence of long run relationship between variables
in multivariate time series models. The ARDL approach was used because of its
advantage such as the involvement of just a single equation set up making it easy and
simple to interpret compare to other conventional techniques.
Table 4.5: ARDL Estimates of Inflation, FDI and Economic Growth Model (1975-
2020)
Dependent Variable: D(GDPG)

40
 Selected Model: ARDL(1, 1, 0, 0, 4, 2)
Variable Coefficient Std. Error t-Statistic Prob.
LFPR 1.6704 0.4973 3.3589 0.0121
GFCF 2.2472 0.8425 2.6673 0.0321
INF -0.7264 0.1597 -4.5474 0.0001
FDI 2.1984 0.9604 2.2891 0.0559
SSE 0.6343 0.3790 1.6737 0.1381
FDI*INF 1.0568 0.5875 1.7990 0.0812
C 0.3444 0.2217 1.5535 0.1298
Source: Author's calculations
Estimation of the long run results presented as the table 5.5 that indicates LFPR, GFCF
and INF was significant While FDI and SSE was insignificant or non-significant. The
value of the coefficient shows the impact of these variables on economic growth
(GDPG). According to the results When Labour Force Participation rate (LFPR)
increases 1% it causes to 1.6704% increase in the economic growth rate (GDPG). The
LFPR has a positive and significant impact on economic growth. When more portion of
population involves in labour force or people are employed the economic growth
increases. After that the Gross Fix capital formation (GFCF) also has a positive and
significant impact on (GDPG). As 1% increase in GFCF leads to a 2.2472% increase in
the (GDPG). Inflation (INF) has a negative and significant impact on economic growth
(GDPG). As 1% increase in Inflation (INF) leads to –0.7264% decrease in the (GDPG). It
means that in Pakistan the rising rate of inflation affect the economic growth adversely.
The Foreign Direct Investment (FDI) positively but significant affect the economic
growth. When (FDI) increases 1% than the (GDPD) increases 2.1984%. it explains as the
FDI increase in Pakistan it affects the economy significantly. The FDI increase the rate of
economic growth through investment and other linked factors. The Secondary School
enrollment (SSE) also has a significant and positive impact on Economic growth. The
table shows that 1% increase in (SSE) leads toa0.6343% increase in the (GDPG).

4.6 Error Correction Analysis

41
In the error Correction analysis when analyze that When disturbance accurse in the model
then how many time required for recover this error. This is the short run analysis error
correction shows the speed of adjustment. When we find the result of the independent
variables to dependent variables then these shows that some have positive effect and
other are negative effect.
Table 4.6: Error Correction Estimates of Inflation, FDI and Economic Growth
Model (1975-2020)
 Dependent Variable: D(GDPG)
Selected Model: ARDL(1, 1, 0, 0, 4, 2)
Variable Coefficient Std. Error t-Statistic Prob.
D(GDPG(-1)) 1.2656 0.6356 1.9912 0.0867
D(GDPG(-2)) 1.2060 0.6039 1.9972 0.0860
D(GDPG(-3)) 0.8418 0.4081 2.0630 0.0780
D(LFPR) -3.1473 1.7005 -1.8508 0.1066
D(LFPR(-1)) 1.2816 1.5829 0.8097 0.4448
D(LFPR(-2)) -13.9545 5.7195 -2.4398 0.0448
D(LFPR(-3)) 2.1991 1.5528 1.4162 0.1996
D(GFCF) -6.1098 2.6143 -2.3371 0.0521
D(GFCF(-1)) 0.8359 0.7273 1.1494 0.2881
D(GFCF(-2)) -2.5265 1.2597 -2.0057 0.0849
D(GFCF(-3)) 2.7902 1.4052 1.9857 0.0874
D(INF) 0.6589 0.3976 1.6572 0.1414
D(INF) -0.2783 0.2440 -1.1405 0.2916
D(INF) -0.5893 0.1736 -3.3941 0.0115
D(INF) -0.4825 0.2267 -2.1278 0.0709
D(FDI) 4.9060 4.0786 1.2028 0.2681
D(FDI(-1)) -4.4287 3.7948 -1.1670 0.2814
D(FDI(-2)) -21.3538 10.2976 -2.0737 0.0768
D(FDI(-3)) 30.1842 12.0250 2.5101 0.0404
D(SSE) 0.3146 0.2730 1.1523 0.2870
D(SSE(-1)) 1.5207 0.6503 2.3384 0.0520
D(SSE(-2)) -1.6876 0.6120 -2.7576 0.0282
D(SSE(-3)) 0.4385 0.4984 0.8798 0.4081

42
 D(INF * FDI) 0.0591 0.0411 1.4377 0.1937
D(INF * FDI(-1)) -0.1144 0.0740 -1.5457 0.1661
D(INF * FDI(-2)) 0.3913 0.1794 2.1812 0.0655
D(INF * FDI(-3)) -0.4110 0.1634 -2.5155 0.0401
CointEq(-1) -3.4930 0.8930 -3.9117 0.0058
Source: Author's calculations

The short run results reveal that the coefficient of CointEq (-1) is –3.4930, which shows
that the coefficient was negative, and also significant. This value shows the disturbance
in the model and approximately one year required for recover this shock. The result
suggests the speed convergence.

4.7 Conclusion
The study shows that there is a relationship between Inflation (INF), foreign direct
Investment (FDI) and economic growth (GDPG) exists in Pakistan. The study shows that
in Pakistan there is negative relation between inflation (INF) and economic growth
(GDPG) found. Because when the inflation rate increases the economic growth rate
decreases. Inflation has a direct and significant impact on economic growth. Moreover,
rising inflation cause to disturb the other factor of economy like wages, rent, etc. While
on the other hand Foreign Direct investment (FDI) has a positive relationship with
economic growth (GDPG). As the results shows that in Pakistan the (FDI) was
significantly affect the economic growth (GDPG). The (FDI) rate is very low in Pakistan
according to [Javed and Kamal (2011)] because of political instability and loans from
IMF are a threat for foreign investors therefore (FDI) has a insignificant impact on
(GDPG).

43
 Chapter 6

Conclusion & Recommendations

5.1 Conclusion
The study is related to investigate that whether the relationship between inflation, foreign
direct investment and economic growth exits or not in Pakistan. The time series data from
1975-2020 used in study to estimate the impact and relationship of these variables in
Pakistan. The study revealed that there is a long-term relation exist among the variables.
Inflation and foreign direct investment are used as explanatory variables while economic
growth used as explained variables in the study. Economic growth is the factor through
any economy is judged by someone. while inflation is an economic problem which means

44
a continuous increase in prices. Foreign direct investment is the investment by foreigners
in other countries. In our study we examine the relationship of foreign direct investment
to economic growth of Pakistan. The are some different articles used as an evidence for
our study for further investigation. Our estimation of these 45 years shows results
according to these articles of different authors. The ARDL model is used to check the
existence of long-run relationship between variables. Uni root method is used to check
the stationary of the data with ADF (Augmented Ducky fuller) test.
The result explain that the independent variable inflation (INF) has a negative and
significant impact on economic growth rate. Inflation causes to disturb other economic
factors which also affect the economic growth negatively. Our study shows that there is a
direct and negative impact of inflation on economic growth. ARDL estimation show that
if inflation increase by 1% then the Economic growth decrease by –0.7264%. Also,
inflation decrease the living standards of the peoples which leads to other economic and
social problems. Different types of inflation have different impacts on economy. Higher
rate of inflation decreases the value of money which means worsen condition for
economy and it is a big challenge for policy makers. The second independent variable is
foreign direct investment (FDI) is used I is the study which shows the inflow of
investment in Pakistan. The proportion of FDI in Pakistan is very low. There for FDI is
significant for economic growth in Pakistan. But FDI has a positive impact on economic
growth of the country. The 1% increase in FDI leads to an increase of 2.1984% in
economic growth (GDPG).
There are some other variables used in the study to explain the economic growth rate of
Pakistan. (GFCF), (SSE) and (LFPR) are other independent variables. (LFPR) and
(GFCF) has significant and positive relationship with economic growth (GDPG). While
SSE has positive but insignificant impact on economic growth (GDPG).

5.2 Policy Recommendations:

There are some policy recommendations for the authorities and decision-making bodies
who make policies to boost the economic growth rate in the country. First of all, there are
some reasons behind the increasing inflation rate. So, the authorities should try to
investigate these reasons and adopt strategies to solve these reasons. And the monetary

45
policy is used to control the money supply which is also a reason for rising inflation rate
in county.
 Through Monetary policy government should control the inflationary pressure in
the economy
Government should be needed to give attention to Foreign direct investment which shows
as a positive variable for economic growth. Through investment there are many economic
problems can be solved like unemployment rate will be reduces through investment and
also a decline in the poverty rate in the country.
 Government should reduce the restrictions on FDI and provide a favorable
environment for all kinds of firms.
 Government should set up an investment promotion agency that provides a link
between suitable foreign investor and domestic economy’s investor.
 The skilled labor force is more attractive for foreign investor because skilled labor
is more efficient and productive than unskilled labor. Also, government
encourages the spillovers from FDI into domestic economy.

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