Determinants of Foreign Direct Investment Flows to Pakistan

By Hakro, Ahmed Nawaz; Ghumro, Ikhtiar Ali | The Journal of Developing Areas, Spring 2011 | Go to article overview

Determinants of Foreign Direct Investment Flows to Pakistan


Hakro, Ahmed Nawaz, Ghumro, Ikhtiar Ali, The Journal of Developing Areas


ABSTRACT

This paper investigates the determinants of foreign direct investment (FDI) flows in dynamic econometric model on Pakistan economy data set (1970-2007). VAR, VEC, generalized impulse response functions, Granger causality, forecasting, three stage least square econometric techniques are used in empirical analysis. Results suggest cost related, macroeconomic factors and cumulative risk index variables are the major determinants emerged in short-run analysis. The results also suggest long run relationships among FDI, openness and macro economic factors consistently. Openness emerges as dominant factor in long run dynamics. Evidence suggests that determinant variables that exhibit short run dynamics may also exhibit long run dynamics and vice versa. The country requires to maintain macroeconomic stability and continuity in openness policies of reform processes of the last 20 years, along with maintaining cost advantage by controlling the level of prices, wage rate, cost of doing business and investment friendly environment. This implies continuity of sustained stable macro economic policies, improvement in country's risk profile followed by cost related and investment environment improving factors.

JEL Classifications: CO1, C5, E37, E60, F21, 23, 42, F50, O53

Keywords: Foreign Direct Investment, VAR model, Granger-causality, Impulse Response Functions, Variance Decompositions, Forecast, Error Variance, Determinants, and Policy Analysis, Pakistan

(ProQuest: ... denotes formula omitted.)

INTRODUCTION

Blonigen (2005) in his survey article recognizes the fact that recent body of literature has begun to set up frameworks and started to generate predictions of how fundamental country-specific factors aggregate country level determines the FDI behavior. Recent literature also suggests that foreign direct investment is linked with economic environment of the host country, e.g. [Dunning (2001); Borensztein et al., (1998); Bosworth and Collins, (1999); De Mello, (1999); Agosin and Mayer, (2000); Agosin and Machado (2007); Lipsey, (2000)] among others. Economic environment in turn is influenced by the development strategies and macro-organizational policies of the host country's government see e.g. Choe (2003). Evidence varies from country to country e.g. see [Apergis et al. 2006; De Mello, 1999; Agosin and Mayer, 2000] and the empirical literature that uses cross-country regressions to search for the determinants of FDI is statistically fragile see e.g. Chakrabarti (2001). Recently, Blonigen and Wang (2005) confirmed in their article and argue that nature and volume of FDI in developed countries and less developed countries is very different and certainly its impact would be different. The pattern of foreign direct investment in Pakistan has been very impressive in recent years. FDI has increased from $322 million in 2000-01 to $3.52 billion in 2005-06 and exceeded $8 billion dollars in 2006-07 (M.O.F 2006-07). Earlier, it has different trends, as Pakistan received a very small amount of FDI1 and the country used to be heavily dependent on external sources, mainly the debt2. By 1996 FDI share increased to 50 percent of net resource flows3. As a result of the openness of the investment regime, foreign investment activity to date registered a substantial increase in FDI flows. Though Pakistan is among the first few countries in the region that opened up the markets in the early nineties, the country does not have an enviable record of accomplishment of economic growth except in the sixties, but, certainly it has the potential to repeat the past. It enjoys some economic advantages. The country is often come out with pro-investment policies. The government under took program of liberal economic reforms including liberalization, privatization, and deregulation to bring the economy into a fully market-oriented system. Foreign investment is generally subject to the same rules as domestic investment, with the exception of certain sensitive areas such as defense, banking, and broadcasting. …

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