Comparative Analysis of the Socio-economic Determinants of Foreign Direct Investment: Evidence From Pakistan

• Author: HAFEEZ UR REHMAN

Abstract. Foreign direct investment has become an important element in current globalized world. It plays an important role in raising the pace of economic development particularly in developing countries by bridging saving-investment gap and bringing the latest technology from developed countries. The basic objective behind this study is to examine both economic and social determinants of foreign direct investment (FDI) in Pakistan for the period 1984–2015. The study uses cointegration and error correction techniques to examine both the long-run and short-run impact of these determinants on the flow of FDI in Pakistan. Results of the study show that both economic as well as social factors have long-run impact on the flow of FDI in Pakistan. Moreover, vector error correction model confirms the existence of short-run relationship. The results point out that social factors are more important than economic factors in attracting FDI in Pakistan.

Keywords: Foreign direct investment, Socio-economic factors, Cointegration

1. INTRODUCTION

   In recent years, the researchers and policy makers have shown huge interest in FDI and consider it indispensable for capital scarce countries like Pakistan for increasing the pace of economic development. Its importance in developing countries stems from the fact that it helps in bringing capital, improved managerial skills, global links and access to advanced technology. Most of the developed and developing countries have provided incentives and inducement to attract FDI through adopting deregulation policies and these countries remained quite successful in achieving their objectives through attracting the attention of foreign investors. On the other hand, in some developing countries macroeconomic instability has appeared to be significant hurdle in the way of FDI inflows for sustained economic growth. As a result, these countries have failed to attract FDI which has exerted bad impact on the development process of these countries.

   The distribution of foreign direct investment among countries depends on economic, social and some other factors. A country facing recession or social issues may be less attractive for the foreigners to invest as compare to those countries which have economic and social stability.

   Pakistan being a developing country has been facing severe shortage of foreign reserves during the past few decades. Since 1960s’ Pakistan has been receiving heavy doses of external debt but due to poor debt management the burden of debt on Pakistan economy has been increasing overtime and it has exerted adverse impact on the development process of the country. Due to unfavourable socio-economic and political factors Pakistan fails to attract the attention of foreign investors and as a result continues decline in foreign direct investment inflows has been recorded during the past 15 years.

   Several empirical studies are available in literature which has tried to identify the determinants of foreign direct investment but most of them were unable to reach at any definite conclusion because it is difficult to identify the ‘true’ explanatory variables that can be treated as accurate determinants of foreign direct investment in developing countries like Pakistan. Furthermore, several studies related to FDI in Pakistan have identified only economic factors and almost ignored the role of social factors. Not many studies are available, which address empirically the socio-economic factors which help in attracting FDI particularly in the context of Pakistan. This study tries to analyze the economic and social determinants of foreign direct investment in Pakistan separately for the period 1973–2014 using recent development in dynamic modeling. The main objective of this study is to analyze the long run relationship of economic and social factors in attracting flow of foreign direct investment in Pakistan.

   Global Trends in the FDI Flows

   Table 1 represents the inflow of FDI in East Asia remained volatile for the period 1995–1999 and it declined during the period 2000–2004. In Europe and central Asia there has been a rising trend observed from 1975 to 2009 and afterwards it declined. In Latin America and Caribbean (all countries) FDI inflows had shown volatile trends since 1990. In Middle East and North Africa mixed behaviour had been observed during the period 2005–2009. In Sub-Saharan Africa (all income levels) initially a decreasing trend had been observed from 1989 to 2009. Later on the increasing trend was observed during 2010 to 2014. The similar pattern has been observed in other developing counties of the region. When low income countries around the world are taken in to account, initially a reduction in FDI inflows has been observed then afterward an increase in FDI was recorded over the entire range.

   However, in Middle income countries FDI inflows remain stagnant during first one and half decade then a slight increase was recorded till 2009 and afterward there appeared a decline in FDI inflows during 2010–2014. In upper middle income countries there was a reduction in FDI inflows observed from 1979–1989, then it had shown rising trend till 2009 and later on a reduction in FDI net inflow was observed from 2010–2014. In case of heavily indebted poor countries (HIPC) there was a reduction in FDI inflows from 1975 to 1989 then afterward a rising trend was observed till 2014.

   The stylized facts indicate that there has been increasing trend in net FDI inflows from 1975 to 1999 but the reduction in net inflows has been observed during the period 2000–2004 which may be due to the military coup at the end of 1999 in Pakistan which shattered the confidence of foreign investor regarding local business climate in Pakistan. An increase in net inflow of FDI was observed during 2005–2009. The improvement in Pakistan’s macroeconomic performance and an increase in economic credit rating during 2004–2007 helped in attracting large inflow of foreign investment. Furthermore the transition towards democratic process builds the confidence of foreign investors but afterward due to bad governance, rising corruption, poor law and order situation and an increase in terrorists’ attacks cause a sharp and persistent decline in FDI.

   The studies conducted on Pakistan economy have pointed out various factors which are responsible for decline in the inflows of FDI. Some studies have pointed out that economic factors are responsible for decline in FDI inflows in Pakistan. Other studies have stressed on the unfavourable social and political conditions prevailing in Pakistan and consider them responsible for decline in FDI. The present study is an attempt to investigate the role of socio-economic factors in attracting FDI in Pakistan using new dataset on socio-economic variables.

   TABLE 1 Comparative analysis of foreign direct investment, net inflows (% of GDP)

   Country Name 1975-79 1980-84 1985-89 1990-94 1995-99 2000-04 2005-09 2010-14

   Pakistan 0.172 0.228 0.430 0.672 1.091 0.773 2.676 0.685

   East Asia and Pacific

   0.156 0.355 0.446 0.704 1.275 1.633 2.655 3.027

   (all income levels)

   East Asia and Pacific

   0.000 0.376 0.900 2.951 3.812 2.747 4.026 3.799

   (developing only)

   Europe and Central Asia

   0.473 0.445 0.821 0.959 2.167 3.421 5.777 3.291

   (all income levels)

   Europe and Central Asia

   0.091 0.102 0.062 0.377 1.478 2.583 5.475 2.906

   (developing only)

   Latin America and Caribbean

   0.703 0.836 0.733 1.120 3.010 3.133 2.887 3.155

   (all income levels)

   Latin America and Caribbean

   0.836 0.949 0.706 0.953 2.610 3.175 2.783 3.093

   (developing only)

   Middle East and North Africa

   0.584 1.104 0.281 0.687 0.787 1.386 4.158 1.965

   (all income levels)

   Middle East and North Africa

   0.590 0.355 0.370 0.885 0.507 1.565 3.126 1.489

   (developing only)

   Sub-Saharan Africa

   0.647 0.424 0.585 0.773 1.991 2.945 3.150 2.515

   (all income levels)

   Sub-Saharan Africa

   0.643 0.420 0.577 0.761 1.924 2.828 3.093 2.386

   (developing only)

   Arab World 0.582 1.482 0.379 0.736 0.677 1.175 4.608 2.116

   Low income 1.036 0.316 0.472 0.503 1.904 2.755 3.232 5.355

   Middle income 0.578 0.575 0.573 1.353 2.464 2.539 3.509 3.025

   Upper middle income 0.660 0.701 0.578 1.542 2.842 3.050 3.700 3.323

   Heavily indebted poor

   0.877 0.596 0.537 0.716 2.454 3.486 4.085 5.453

   countries (HIPC)

   The remaining part of this study is divided in the following sections. Section II presents the review of...