ABSTRACTJournal has become to be known as one

ABSTRACTJournal of Management and Social SciencesVol. 6, No. 2, (Fall 2010) 84-92CImpact of Foreign Direct Investment on Economic Growth:A Case Study of PakistanPurpose- This research paper aims to analyze the impact of foreign directinvestment (FDI) in Pakistan for the period 1981 to 2010. It evaluated the GDPgrowth performance and assessed the historical trends of the FDI and CPI inPakistan.Methodology/Sample- The link between gross domestic product (GDP,) foreigndirect investment and Inflation is measured with the help of multiple regressionmodels. GDP in this model is used as dependent variable whereas FDI andinflation (CPI) are measured as independent variables.Findings- According to the results, the model is overall significant with thepositive and significant association of GDP and FDI while a negative andsignificant relationship found between GDP and inflation.Practical Implications-On the basis of the empirical results acquired, Policyproposals are advised to attract FDI in Pakistan. Foreign direct investment (FDI)is an essential factor for economic growth in the developing countries. FDIallows the transfer of technology, uplift competition in the domestic inputmarket, contributes to human capital development and Profits created by FDIcontribute to corporate tax revenues in the host country.Amna Muhammad Gudaro *Lecturer, Economics, Civil Aviation College, Karachi.Imran Umer Chhapra*Department of Management Sciences,KASB Institute of Technology (KASBIT) Karachi.Salman Ahmed Sheikh*Faculty Member, Economics Department IBA, Karachi.Keywords : GDP, FDI, CPI.*The material presented by the author does not necessarily portray the viewpoint of the editors and themanagement of the Institute of Business & Technology (IBT) or IBA, Karachi, Civil Aviation College,Karachi & KASB Institute of Technology (KASBIT) Karachi.JMSS is published by the Institute of Business and Technology (IBT).Main Ibrahim Hydri Road, Korangi Creek, Karachi-75190, Pakistan.* Amna Muhammad Gudaro : [email protected]* Imran Umer Chhapra : [email protected]* Salman Ahmed Sheikh :1. INTRODUCTIONForeign direct investment (FDI) has become to be known as one of the mosteffective method of drawing flows from external sources. The use of this technique hasalso become a significant aspect of building capital in developing countries around theworld. However, the share of investment from these countries in other states has beendeclining over the past years. For developing countries, the positive impact of foreigndirect investment is becoming increasingly popular as a tool for economic growth andstrengthening (Muhammad 2007). The most strongest positives of implementing FDI isthe increase in aggregate productivity, increased opportunities of employment, greateroutflow of exports and exchange of technological advancement between the investor andcountry.Having foreign direct investment in a developing country enables the employmentand exploitation of natural and human resources, to implement innovative businessespractices, in terms of management and marketing, and facilitates in reduction of budgetdeficit. Another benefit of FDI is that it does involve the risks and regulations of externaldebt and adds value to the human capital through provision of on the job training. Forcountries that face a scarcity of capital and technological expertise usually experiencegrowth slower than those that do. According to a number of studies, foreign direct investmentcan serve as a means of transfer of technology and knowledge (Dunning & Hamdani 1997).This research paper aims to analyze the impact of foreign direct investment (FDI)in Pakistan for the period 1981 to 2010 and to observe the relationship between inflation(CPI) and economic growth. Pakistan is a young country with an ancient history and withrapidly growing populations. Her economy primarily depends on agriculture, a per capitaincome is low, and much of the population lives in poverty. Therefore policies to slowdown inflation rate and to draw FDI in the country are the central objectives of themacroeconomic policy makers. Pakistan is striving to make its way in the modern worldand being the foremost member of SAARC (South Asian Association for RegionalCooperation) and one of the most important country of this region blessed with massivequantity of resources in the form of mineral assets, population (man power), agriculturetechnology and other God gifted natural resources. FDI and Inflation plays a very vitalrole in its future growth and development.2. LITERATURE REVIEWVarious studies on the subject of inflation, Foreign Direct Investment and growthhave been presented. The majority of this research work has been done internationally.Some of these important empirical studies have been critically reviewed to developobjectives in the context of Pakistan and, further, to analyze it to draw some importantconclusions and policy recommendations.Falki (2009) conducted a study on the impact that FDI had on the economicdevelopment of Pakistan. The study included data on FDI gathered from the Handbookof Pakistan economy of 2005. Data ranged from 1980 and 2006 and held variables suchas domestic variables, labor force and foreign invested capital. Falki used the endogenoustheory of growth and a regression analysis, Falki was able to conclude that FDI had astatistically negative effect on the gross domestic product and foreign direct investmentin the country. Similarly, Agarwal (2000) in his study found that the increase of FDI inSouth Asian countries was in association with the exponential investment by local investors,providing evidence to belief that the relationship between FDI and GDP and the influenceof FDI on GDP was negative till the year 1980. In the following years, early 80s, the linkwas mildly positive and strengthened over the years in the late eighties into the nineties.In contrast, Adam & Tweneboah (2009), economists from Ghana, conducted anindependent study on the FDI and stock market development in the country conclude thatFDI in Ghana had a positive impact on the development of the economy and the stockmarket. The examination included data of market capitalization as a proportion of theLocal GDP and Ghanacedi and Dollar exchange and the net FDI influx of the quartersbetween the years 1991 to 2006. With the use of multivariate co-integration analysis andthe Vector Error Correction Model., the study revealed that the relationship between FDIand the Ghanaian stock market will be beneficial in the long run for the country.85 Journal of Management and Social SciencesAmna Muhammad Gudaro, Imran Umer Chhapra, Salman Ahmed SheikhBarro (1995) examines the issue and finds a significant negative relationshipbetween inflation and economic growth, considering variables like fertility rate, education,etc constant. The study contains a large sample data of more than 100 economies for theperiod 1960 to 1990 and to assess the effects of inflation on growth, a system of regressionequations is used, in which many other determinants of growth are held constant. Thisframework is based on an expanded view of the neoclassical growth model as stated byBarro and Martin (1995). The study indicates that there exists a statistically significantnegative relationship between inflation and economic growth. More specifically, an increasein the average annual inflation by 10 percentage points per year lowers the real GDPgrowth by 0.2 to 0.3 percentage points per year.Similarly another important study by Mubarik (2005) estimates the thresholdlevel of inflation in Pakistan using annual data for the period 1973 to 2000.The empiricalresults from his study suggest 9 percent threshold level of inflation for the economy ofPakistan, above which inflation is very unfavorable for economic growth. The study followsthe work of Khan and Senhadji (2001) in which they calculate threshold level for both thedeveloping, including Pakistan, and developed economies. They use panel data for 140developing and developed economies for the period 1960 to 1998 and suggest thresholdlevels, 1-3 percent and 7-11 percent, for both groups of countries respectively.In addition, Munir et al. (2009) analyze the non linear relationship betweeninflation level and economic growth rate for the period 1970-2005 in the economy ofMalaysia and found significant effect from Inflation to domestic output, in contrast to theabove mentioned studies of Muabrik (2005) and Khan & Senhadji (2001). Using annualdata and applying new endogenous threshold autoregressive (TAR) models proposed byHansen (2000), they find an inflation threshold value existing for Malaysia and verify theview that the relationship between inflation rate and economic growth is nonlinear. Theestimated threshold regression model suggests 3.89 percent as the structural break pointof inflation above which inflation significantly hurts growth rate of real GDP. In addition,below the threshold level, there is statistical significant positive relationship betweeninflation rate and growth.An important study by Abbas et al. (2011) conducted an examination on theinfluence of FDI and CPI on the GDP’s of SAARC member nations. The study concludedthat the general model in these countries developed a positive relationship between ForeignDirect Investment and GDP while negative relationship between Consumer Price Indexand GDP. This conclusion was tested using the multiple regression models. The data ofthe SAARC countries ranged from the year 2001 to 2010. Wu & Chiang (2008) endeavoredto find if FDI can facilitate economic development. The study applied the thresholdregression analysis. The empirical analysis concluded that FDI does play a defining rolein the economic development. This was found out after an analysis of data of 62 countriesfrom the year 1975 to 2000. The study found that FDI depends significantly on the initialGDP and human capital. This means that countries that have a significant GDP and humanprior to FDI showed a positive relationship. Alfaro et al (2004) also carried out a similarexamination of the association of FDI and GDP growth. The study also showed thatcountries with a strong financial system are more capable of exploiting the potential ofFDI. Through empirical analysis of the data between 1975 and 1995, it was found thatFDI had a greater impact in countries with a stable financial system.For studies conducted in Pakistan, a study by Shabir and Mahmood (1992)analyzed the relationship between foreign private investment FPI and economic growthin Pakistan. The study used the data for 1959-60 to 1987-88; the study concluded that netforeign private investment (FPI) and disbursements of grants and external loans had apositive impact on the rate of growth of real GNP. However they did not treat FDI as aseparate variable. Similarly (Ahmed, et.al, 2003) examined the causal relationship betweenFDI, exports and output by employing Granger non-causality procedure over the period1972 to 2001 in Pakistan. They found significant effect from FDI to domestic output.Vol. 6, No. 2, (Fall 2010) 86Impact of Foreign Direct Investment on Economic Growth: A Case Study of Pakistan3. RESEARCH METHODOLOGYThe purpose of this research paper is to examine the relation of Pakistan’s GDPwith FDI and inflation (CPI). Study covers the time period from 1981-2010.As WorldBank is considered as an authentic source of data collection therefore, secondary data ofthe mentioned variables is collected from this reliable source. To examine the relation ofPakistan’s GDP with FDI and inflation (CPI), the following theoretical model is used.GDP=F (FDI & CPI)The core intention of the paper is to study the effect of FDI on GDP of Pakistan.The trend of foreign Direct Investment inflows is also observed with relevance to GDPgrowth and inflation of Pakistan. To examine the relation of Pakistan’s GDP with FDI andinflation (CPI), the following multiple regression model is used,GDP = a + b1 FDI + b2CPI+?Where,FDI = Foreign Direct InvestmentGDP = Gross Domestic ProductCPI = Inflation RateLevel of Significant: 5 to 10 percentThe aforementioned Multiple Regression Model was run on E-Views to find outthe Impact of FDI and CPI on the Gross Domestic Product of Pakistan. In this multipleregression model, GDP is used as dependent variable whereas FDI and CPI are measuredas independent variables. To estimate the effect of FDI on GDP of Pakistan, MultipleRegression Model is applied over the period of 1981 to 2010. Two inputs are used; foreigndirect investment and inflation. Descriptive statistics of GDP, FDI and CPI are as follows,3.1 Measures the Output (GDP)We used GDP, as an output growth indicator in the Multiple Regression Model,specified in equation 1.Data series covers the period from 1981 to 2010 and is taken fromthe World Bank. GDP is measured in million US Dollars. It is used as dependent variablein the proposed model. The vertical axis (X-axis) is the year and horizontal axis (Y-axis)is GDP (in Million Us Dollars). Growth of GDP in these mentioned thirty years is showingthe trend of fluctuations.Figure 1GDPSource: World Bank87 Journal of Management and Social SciencesAmna Muhammad Gudaro, Imran Umer Chhapra, Salman Ahmed Sheikh3.2 Measures the Input (FDI)We used FDI, as an input growth indicator in the Multiple Regression Model,specified in equation 1. Data series covers the period from 1981 to 2010 and is taken fromthe World Bank. FDI is measured in million US Dollars. It is used as independent variablein the proposed model and found highly effective and significant. The vertical axis (Xaxis)is the year and horizontal axis (Y-axis) is FDI (in Million Us Dollars). FDI in thesementioned thirty years is showing the trend of fluctuationsFigure 2FDISource: World Bank3.3 Measures of Input (CPI)We used CPI, as an input growth indicator in the Multiple Regression Model,specified in equation 1.Data series covers the period from 1981 to 2010 and is taken fromthe World Bank. FDI is measured in million US Dollars. It is used as independent variablein the proposed model and found significant. The vertical axis (X-axis) is the year andhorizontal axis (Y-axis) is CPI (in percentage). CPI in these mentioned thirty years isshowing the trend of fluctuations.Figure 3CPISource: World Bank EmpiricalVol. 6, No. 2, (Fall 2010) 88Impact of Foreign Direct Investment on Economic Growth: A Case Study of Pakistan4. EMPIRICAL RESULTSWe used the following multiple regression model for the studyGDP = a + b1 FDI + b2CPI+?Table 1Empirical results of GDP, FDI and CPIThe proposed model empirical results are depicted by the above table. The slopecoefficients of the inputs (FDI) in the multiple regression analyses have positive impacton GDP whereas the slope coefficients of the inputs (CPI) have negative impact on GDP.If one percent change in FDI occurs, it will bring about 0.39% change in GDPwhile 1 percent change in CPI will bring- 1.13% change in GDP by holding other variablesconstant. Estimates (FDI and CPI) are highly significant. As the value of F is too high i.e.,192.2058 and the value of P is so small i.e., 0.000 we can deduce that model is overallvery much significant and the results are not by chance. The r-square of this model is 0.94that means 6% variation in the model is unexplained by FDI and CPI whereas remainingvariation (94%) is explained by FDI and GDP.5. CRITICAL ANALYSESFigure 4GDP&FDISource: World BankRelative changes in growth of inputs and output are illustrated in figure 4 thatrepresents the pattern of output growth with different arrangements of factors input growth.Above figure shows GDP response to FDI which is highly encouraging. Here slowdownincreases of FDI pulled down the growth of output (GDP). Investors attracted from theyear 2000 to invest in Pakistan economy due to the rise in the infrastructure and investmentchances in the country. Encouraging investment facilities attracted a large no of investor89

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