Pattern Of Foreign Direct Investment Economics Essay

The literature on economic sciences refering to empirical findings and theoretical principle across states tends to show that foreign direct investing is a running blood for an economic system. The construct of foreign direct investing is non new in the literature. Its different facets have been explored and evaluated in the yesteryear. However, the determiners and impact of foreign direct investing in the yesteryear were explained theoretically without giving empirical grounds. With the transition of clip econometric theoretical accounts equations and indices were used to happen out the empirical consequences. These surveies are different from old surveies on assorted evidences. The old surveies were based on “ pure ” economic theory of international trade and house. These theories besides assumed the construct of perfect competition indistinguishable production maps and no transit cost etc. Recent theories on the other manus remainder on the premises of market imperfectnesss, oligopolistic mutuality and ownership of monopolistic advantage. These premises can hold important bearing on the factors which determine foreign direct investing influxs.

Early literature

As with much of the literature of this country we take the traditional neo-classical growing theoretical account as our saying point followed by recent theories and empirical parts. Solow ( 1956 ) argued that productiveness consequences from additions in the sum of capital that each worker is set to run. However, as capital per worker increases the fringy productiveness of capital diminutions. Ultimately the capital labour ratio approaches a changeless and productiveness growing ceases. In this long tally equilibrium GDP, the capital and labour forces all grew at the same exogenously determined rate. It was at this point that technological advancement came into drama. To let for long term growing in GDP per capita, v Solow ( 1956, 1957 ) added an exogenic term labeled “ technological advancement ” . On this premise the neo- classical growing theoretical account of economic growing predicts that on long tally GDP per capita in all states will turn at the same exogenously determined rate of technological advancement. To the extent that capital is internationally nomadic and moves to states where the chances for net incomes are highest this inclination should be well strengthened. Hence the spreads in income degrees between rich and hapless states should be expected to contract and finally disappear. Solow concluded that where capital is scarce compared to labour or where capital labour ration is low should be expected to hold a higher rate of net income on capital a higher rate of capital accretion and higher per capita growing.

Diamond ( 1965 ) holds that the hereafter of the people in the states which export capital is black. He laid particular accent on the productiveness of foreign investing. Otherwise the states having it might non acquire existent benefits. Thus the analysis of early literature of the 1960s shows that the consequence of foreign investing on economic growing are favourable in the short tally, but in the long run the benefits are non sustainable.

Foreign direct investing in context of growing and trade

World economic system has changed over the last two decennaries and it has changed dramatically. While many states were hostile to foreign direct investing in the sixtiess and 19970s, most of them now perceive foreign direct investing as doing a positive part to their development. In this epoch of liberalisation, a figure of surveies have been carried out to analyse the impact of foreign direct investing on economic growing and international trade.

Pattern of foreign direct investing

Foreign direct investing flows to developing states

There is no microeconomic theory of FDI, analysts have used a matter-of-fact attack to place a figure of variables as critical for FDI flows to developing states. These include the Rate of Return on Investment, Openness of the Economy, Political Rights, Infrastructures, Natural Resource Availability, Corruption and Bureaucratic Red Tape, Human Capital, and Macroeconomic Fundamentals.

Rate of Return on Investing: The profitableness of investings is of primary involvement to foreign investors ( UNCTAD, 1999, p.17 ) . The determination to put in a host economic system, hence, depends on the hazard and return on investing in the economic system. Portfolio theory contends that capital tends to flux to economic systems with low hazards and high rates of return. In really hazardous economic systems, the risk-adjusted rate of return on investing must be moderately high in order to pull FDI. Time-series information on the rate of return on FDI are by and large non available for many developing states. Following old surveies ( Asiedu, 2002 ) , I use the log of the opposite of the existent GDP per capita to proxy the rate of return on investing. The intuition behind the pick of this placeholder is that capital-scarce states typically have higher rates of return on investing. These states besides tend to hold low per capita GDP. If RRI is reciprocally related to per capita GDP, it therefore implies that the lower the GDP per capita, the higher the RRI and the flow of FDI. Conversely, an addition in the GDP per capita lowers the RRI and the flow of FDI.

Openness of the Economy ( OPEN ) : Surveies have found a positive relationship between openness and FDI flows ( Chakrabarti, 2001, Morisset, 2000 ) . However, the relationship between openness and FDI is really complex, and needs careful account. To simplify this complexness, distinguish between two classs of openness – “ openness to merchandise ” and “ openness to capital flows. ” While the former refers to the easiness by which goods and services are imported and exported, the latter refers to the absence of controls on the motion of capital. Trade openness attracts export-oriented FDI, while trade limitation attracts “ tariff-jumping ” FDI, whose primary involvement is to take advantage of the domestic market. In this survey, we use the amount of imports and exports as a per centum of GDP to mensurate trade openness. Contrary to old surveies, nevertheless, we expect the mark of the coefficient on OPEN to be indeterminate a priori. While a positive mark is the norm, a negative mark would propose that FDI in a state is tariff-jumping, as foreign investors seek to turn up in the host economic system to avoid high duties.

Political Rights: Analysts have established a nexus between political rights and FDI. Other things changeless, democratic and politically stable economic systems attract more FDI than despotic and unstable states ( Shneider and Frey, 1985 ) . Democratic governments are besides more likely to esteem civil autonomies, the regulation of jurisprudence and belongings rights -features that are more contributing to the flow of FDI. Ngowi ( 2001 ) argues that many developing states have attracted small FDI because they are regarded as “ high hazard and are characterized by a deficiency of political and institutional stableness and predictability. ”

Foreign investors prefer economic systems with a well-developed web of roads, airdromes, H2O supply, uninterrupted power supply, telephones, and Internet entree. Poor infrastructures increase the cost of making concern and cut down the rate of return on investing. Other things changeless, production costs are typically lower in states with well-developed substructures than in states with hapless substructures. States with good substructures are hence expected to pull more FDI ( Morisset, 2000 ) . INFR is placeholders by the figure of telephone lines per 1000 people in a state, and is expected to be positively correlated with FDI. The usage of this placeholder is informed by the fact that states with a big figure of telephone lines are more likely to hold better roads, modern airports/seaports, Internet entree, and water/electricity supply.

Corruptness and Bureaucratic Red Tape: Even in the presence of a contributing macroeconomic environment, corruptness and bureaucratic ruddy tape can discourage foreign investors from puting in a state ( Rivlin, 2001, p.191 ) . Apart from raising the cost of making concern, corruptness slows down the procedure of obtaining the concern permits necessary for operating in the host economic system. There are no time-series indexs of corruptness for most underdeveloped states. Transparency International began roll uping informations on corruptness in 1995, while the World Bank Institute ‘s administration indexs are available merely for the 1996-2002 periods. Given the deficiency of time-series informations on corruptness for the 1975-1999 periods, we use authorities outgo as a per centum of GDP to proxy corruptness and bureaucratic ruddy tape. The principle for utilizing this placeholder is that a big size of the authorities creates chances for abuse of financess by authorities functionaries.

Human Capital: The presence of work force populations that are educated and trained to work in modern concern organisations has been recognized as an of import determiner of FDI flows ( Rivlin, 2001 ) . The Republic of Ireland, for case, has been a major receiver of FDI, partially because of the presence of an educated work force in the state. In this survey, human capital is measured by secondary school registration as a per centum of the population in the secondary school age class. This index is expected to be positively correlated with FDI flows.

Pattern of foreign direct investing in Pakistan

In order to analyse the FDI state of affairs in Pakistan over the old ages and as per centum of GDP, the undermentioned graphs can be utile. The tabular arraies and diagrams provide a comprehensive position of the influxs coming in Pakistan, their composing, part in different sectors and the major participants in FDI in Pakistan.

Foreign Investment influxs in Pakistan ( $ Million )


Greenfield Investment

Denationalization Returns

Entire Foreign Direct investing

Private Portfolio Investment























































Foreign direct investing policy

The effects of Foreign Direct Investment are sometimes barely perceivable, while other times these can be utterly transformative. Although many factors affect the impact of FDI in a state, well-conceived and well-implemented policies can play a major function in maximising its returns. The positive effects of FDI include the constructive technological and trade effects along with a mixture of dynamic outwardnesss like constellating and repute of the state while the negative effects include a scope of possible results like anti-competitive impacts, offering scarce resources off from domestic houses or squashing out domestic supply webs.

Pakistan has designed its investing policy in a mode to do it attractive for the foreign investor by opening up the economic system and marketing the potency for direct foreign investing. Earlier fabricating sector was the lone avenue for foreign investors interested in puting in Pakistan.

Beginnings of foreign direct investing

There was a planetary economic crisis, which peaked during the latter portion of the old decennary. However, there has been a steady recovery, particularly associating to the planetary FDI escape. Harmonizing to the Global Investment Trends Monitor of the United Nations Conference on Trade and Development ( UNCTAD ) , the “ planetary foreign direct investing escapes rose by 16 per cent in 2011, to an estimated US $ 1.66 trillion, exceling the pre-crisis degree, but still 25 per cent short of the 2007 extremum. ” The overall FDI escapes of the US -the largest FDI beginning for Pakistan- has increased to the pre-crisis period, and so has the escapes of the UK, Italy and the Gulf states, such as Bahrain, Kuwait, Qatar, the UAE and Saudi Arabia, who are besides the beginnings of Pakistan ‘s FDI. Clearly, there has been a crisis, but the FDI escapes of the states, which have been traditionally puting in Pakistan has recovered.A Hence, drying of resources can non be a major ground for the crisp diminution of FDI in Pakistan.A

If the security state of affairs is a ground for this diminution, so it would non account for the addition in the FDI degrees between 2001-02 and 2007-08. Pakistan was non an ideal state for investing before 2007-08, given the instability and unstable jurisprudence and order state of affairs. International investing, in fact, has been on the addition, even, in struggle parts including Africa and South Asia.

Theoretical description of variables and informations beginnings


This chapter explains the methodological analysis which has been used to analyze the effects of FDI on economic growing and trade. This of import because the function of FDI as a servant of growing and development is being progressively appreciated and is now mostly reflected in FDI policies. On the other manus, trade and trade policies can exercise assorted influences on the size, way and composing of FDI flows. We focus our attending on econometric techniques that are used to analyse the relationship between FDI economic growing and trade.

The econometric techniques that we employ trade with the appraisal of a set of coincident equations that established the common mutuality among the three variables. Since times series analysis alone presents some jobs we besides consider alternate processs for obtaining statistical illation on the empirical cogency of hypothesis.

Choice of chief variables

It is utile to stipulate the variables that we have taken into history. These variables include end product, FDI, imports and exports and domestic investing. The economic system broad end product is measured by existent GDP that is GDP at changeless monetary values of some basal twelvemonth. Trade-FDI linkages can be analyzed in different ways by type of FDI, by the scheme of transactional corporation by sector of economic activity, by group of states ad their degrees of development or by the development of thought and speculating about the topic. In order to research this FDI-trade linkage we have constructed trade variables as the amount of exports and imports as the per centum of GDP, the ground is that other variables ( i.e. value of trade shortage ) have several troubles ( because partial empirical analysis of trade might give erroneous consequences ) . Since the chief constituents of FDI are equity capital, reinvested net incomes and intra-company loans, the form of these constituents is besides critically analyzed individually. In peculiar, the function of reinvested net incomes is really of import sine they originate as nest eggs from investing antecedently made.

Our survey is fundamentally analyses the interrelatedness between growing, foreign direct investing and trade. In this context the function of domestic investing in the growing procedure can non be denied. This is why domestic investing is besides included in our list of cardinal variables. One of the grounds to include domestic investing is that it leads to better apprehension of the interlink ages and provides a background and footing for treatments at the national degrees as respects appropriate policy agreements.

Data beginnings and method of building

The information set used has been taken from figure of beginnings which include UN beginnings such as international Finance statistics ( IFS ) , statistical twelvemonth book of international trade and Economic study 1997-98, 50 old ages of statistics, province bank of Pakistan ‘s foreign trade 1990-98. To take the values in the existent footings the informations are deflated by unit values indices of imports and exports. The informations on unit value of imports and exports are partly taken from international fiscal statistics which is published by international pecuniary fund.

Datas on FDI were besides taken from 50 old ages of Pakistan in statistic and international fiscal statistics. The information on end product expressed in footings of existent GDP and domestic investing has been obtained from the economic Survey of Pakistan.

Coincident equations theoretical account for foreign direct investing end product and trade

Our specific aim of this subdivision is to develop a set of coincident equations to find the relationship among end product, growing, trade, foreign direct investing and domestic investing. In the undermentioned sub-sections, we consider the finding of each of the five variables under consideration one by one.

Determination of end product

We consider the function of foreign direct investing on economic growing through production map. However, since the production flow of end product is a map of capital stock, a transmutation would be required to replace the stock of capital by flow of investing.

We postulate a conventional neo-classical production map in which the stock of capital is split into two parts viz. domestically owned and foreign owned capital:

Y = F ( L, DK, FK, T ) ( 1 )

Where Y, L, DK, FK are end product, labour input, domestic capital and foreign capital severally. The variable T represents engineering that will be specified subsequently. The grounds for distinguishing between domestic and foreign capital stocks are that the foreign capital is likely to be operated under superior engineering and direction every bit compared to domestic capital.

Since the informations on domestic and foreign stocks of capital are normally non available, the production map needs to be transformed by change overing the stock into flows ( 10 ) .

Therefore taking entire derived function of the production map, we can compose as:

dysprosium = i?¤F/i?¤L ( deciliter ) + i?¤F/i?¤DK ( dDK ) + i?¤F/i?¤FK ( dFK ) + i?¤F/i?¤T ( dT ) aˆ¦aˆ¦aˆ¦ . ( 2 )

Under additive estimate we can compose the above equation as

dysprosium = a1 +a2 deciliter + a3 dFK + a4 dDK + a5 dT + U aˆ¦aˆ¦aˆ¦ ( 3 )

Where the intercept a1 captures the mean ( a systematic ) consequence of prejudice introduced by additive estimate, while U represents random fluctuations.

Determination of foreign direct investing

A simple theoretical attack to the finding of foreign direct investing rests on supply- demand model for capital. However as explained by Ragazzi ( 1973 ) economic experts are of the that FDI theory can non be confined simply to explicating international motions of capital such as the exchange rate para and perfect arbitrage theoretical accounts. There is no well-know difficult nucleus theory specially developed to explicate FDI. Economists have instead developed lose theoretical constructions with the chief focal point on empirical mold.

Ragazzi ( 1973 ) AND Kravis and Lipsey ( 1982 ) sugeested a figure of economic systems variables which determine the degree of FDI in a host state. First and foremost is the macroeconomic public presentation of state itself. Kravis and Lipsey besides suggested that the openness of the economic system is besides a cardinal factor finding the degree if FDI. The degree of domestic investing can infulnce FDI more than one ways. It can function as a complement or a replacement for FDI depending upon the sectors in which domestic and foreign investing take topographic point.

We had developed the undermentioned theoretical account for finding of FDI in instance of Pakistan.

FI1 = i??1 + i??2i?„Y1 + i??3DIt + i??4OP + i??5D1 + i??6Fit-1 + U1

In above equation Opt stands for openness which is measured as the ratio of imports plus exports to GDP and Dt represents the structural displacement silent person defined earlier. Although in the present context the structural displacement silent person is intended to mensurate the consequence of political instability, in pattern it is impossible to insulate the function of political factors from a figure of other events that correspond to the period for which silent person variables is set equal to one. The period of 1990s was characterized by liberalisation of the economic system and the assorted reform policies activity pursued by the authorities. At the same clip the state ‘s debt reached dismaying proportions while political instability and dir debt crisis have discouraged foreign investors, foreign investing has taken topographic point in some sectors due to fiscal reforms ad Pakistan ‘s unfastened door policy. To what extent liberalisation positively affects FDI is an issue to be addressed subsequently on.

FDI is included in the equation maintaining in position the well known partial accommodation mechanism. Unlike equity capital, direct investing is a long-run determination so it is extremely unrealistic for the planned investing to take topographic point outright. Some period slowdown appears sufficient to account for the inactiveness.

Determination of imports and exports

The theory of international trade is rather rich in explicating the significance of international trade in goods and services for economic growing. Since our mold exercising is confined to macroeconomic model we will non touch upon the justnesss of trade theories that built upon microeconomic rules.

Following we consider a really simple theoretical account of international trade that can easy suit into our overall model. It is assumed that both imports and exports are dependent on aggregative existent end product ( GE ) . For imports GDP is taken as income that determines demand for imports and exports GDP enters as a supply side factor.

It is further assumed that imports and exports depend on existent exchange rate as good. The existent exchange rates for exports and imports are severally measured by multiplying the monetary value degrees ( unit value indices ) of imports and exports by exchange rate ( rupees per dollar ) and spliting by the GDP monetary value deflator. Imports and exports besides depend on FDI. An of import characteristic of FDI that distinguishes it from equity investing is that in most instances foreign investors bring works and machinery from their state. Multi-national companies would typically convey their ain equipment from the state where it is available at low cost. Occasionally some constituents of natural stuff are besides bought from abroad. Therefore, with FDI import measure of the host state is likely to travel up.

Foreign companies bring investing in states with inexpensive labour or natural stuff with purpose non merely to capture the local market but besides to cut down the cost of production and hence to better their fight. Thus the foreign companies can bring forth at low cost in host state to sell their merchandises to other states as good. In this manner FDI can besides ensue in increasing the volume of exports of host state.

As with the finding of end product and FDI, imports and exports are besides assumed to depend on the structural displacement silent person which has been defined earlier. As discussed earlier the structural displacement silent person corresponds to a figure of factors and the nature of net consequence of these qualitative alterations on trade can non be predicted.

Finally due to merchandise contracts we expect that both import and exports would set easy to the above factors. As before we include lagged dependent variables in the equations for imports and exports to capture this inactiveness. Therefore in the visible radiation of above observations our imports and exports equations can be written as follows:

X1 = i?¤1 + i?¤2Y + i?¤3DI + i?¤4 PER + i?¤5D1 +i?¤6 Xt-1 + Ut

Where X1 is exports, Yt is end product, DI is domestic investing, PER exchange rate for export.

Determination of domestic investing

To finish the theoretical account we now consider a simple theoretical account for domestic investing. A important factor finding the degree of investing is concern assurance which in bend depends on the degree of economic activity. Approximating the degree of economic activity by existent end product we assume that domestic investing depends on existent GDP. As with FDI we assume that domestic investing can besides depends on FDI and the relationship can be complementary or of a replacement. Finally domestic investing is besides assumed to depend on the structural displacement silent person and one twelvemonth lagged investing. Thus the equation finding domestic investing can be written as:

DI1 = i?¬+ i?¬2 Y+ i?¬3+ FI+ i?¬4 DI+i?¬5 DI1-1 +UI

Empirical findings


FDI is typically based on a longer term position of the market the growing potency and the structural features of receiver states. On this footing it is less prone to reversals in inauspicious state of affairss than bank loaning and portfolio flows. The hazard of herd behaviour is besides less likely than in the instance of other flows. Divestment and reversibility are more hard for FDI than for portfolio investing. The latter can be disposed of more easy in fiscal markets. It has been found that FDI is less volatile than non FDI private flows. From a strictly fiscal position this trait makes FDI utile as a agency of supplementing domestic resources of funding investing.

Whether FDI can be deemed to be accelerator for end product growing and capital accretion and technological advancement seems to be less controversial hypothesis in theory than in pattern. Growth-FDI link is sensitive to several specific factors that protectionist trade and investing policies implemented to safeguard autochthonal industries from foreign competition have inclination to falsify societal and private returns to capital investing and efficiency of FDI.

One more job is measuring the impact of FDI on growing is that FDI is frequently associated with other growing advancing factors. These include the ratio of investing to GDP and the grade of openness of the economic system. Some surveies have pointed to the function of cognition spillovers another factor probably to be associated with FDI across states and overtime. Notwithstanding these troubles our survey finds out rapid growing and high ratio of FDI to GDP be given to travel together. The dominant influence of growing over other factors shows that the scheme of high GDP growing rate is the most successful ingredient to pull higher FDI influxs.