Arguments in favour of foreign investment

The positive developmental role of domestic and foreign investment on economic growth in host countries is well documented in literature. Investment is usually directed in sectors that enjoy comparative advantage, thereby creating economies of scale and linkage effects and hence raising productivity. An important argument in favor of foreign investment is that it consists of a package of capital, technology management, and market access. For foreign investment, repayment is required only if investors make profit and when they make profit, they tend to reinvest their profit rather than remit abroad Zakaria M (2008). Reviewing the investment policies of Pakistan over the last six decades he observes that during 1950s and 1960s the private sector was the principal vehicle for industrial investment in the country and the role of the public sector was curtailed to only three industries out of 27 basic industries. By late 1960s the economy was mainly dominated by the private sector in important areas like banking, insurance, certain basic industries, and international trade in major commodities. During 1970s, government nationalized commercial banks, development financial institutions, insurance companies and ten major categories of industries. There was also acceleration in the direct investment by the public sector in new industries, ranging from the basic manufacture of steel to the production of garments and breads. After the miserable performance of the industrial sector following the nationalization process of the 1970s, a change occurred in the government’s approach toward the role of the public and private sectors. In 1980s, government decided to pursue a pattern of a mixed economy, with the private and public sector reinforcing each other. Despite various incentives, the highly regulated nature of Pakistan’s economy proved a restraint to the inflows of foreign investment. Specifically, foreign investment was discouraged by (a) significant public ownership, strict industrial licensing, and price controls by the government; (b) the inefficient financial sector with mostly public ownership, directed credits, and segmented markets; and (c) a noncompetitive and distorting trade regime with import licensing, bans, and high tariffs. During 1990s government started to apply the same rules and regulations to foreign investors as to domestic investors. The requirement for government approval of foreign investment was removed with the exception of a few industries (arms and ammunition, security printing, currency and mint, high explosives, radioactive substances, and alcoholic beverages). During 2000s government based its investment policies on the principle of privatization, deregulation, fiscal incentives and liberal remittance of profits and capital. The policy is based on promoting investment in sophisticated, high-tech and export-oriented industries while almost the entire economic activity in other fields, encompassing agriculture, services, infrastructure, social sectors, etc. have been thrown open for foreign investment with identical fiscal incentives and other facilities, including loan financing from local banks.

Shahbaz and Khalid (2004) find that investment is considerably responsive to domestic saving, yield and uncertainty in Pakistan. Return on investment is an important determinant of investment in the country. Its role in investment decisions-making carries such a weight that it outweighs negative impact of increased rate of borrowing. Expectations and uncertainties play a major role in investment decisions in Pakistan. Whereas domestic saving is a major source of investment, foreign saving is not effective for investment in Pakistan. Tewolde H (2008) argues that the decision to invest resources is one of the significant drivers of the business financial system. Sound investments that implement well organized strategies are important to creating shareholders value, and must be analyzed both in proper context and sound analytical methods. Whether the decision involves committing resources to new facilities, a research and development project, marketing program, additional working capital, an acquisition, or investing in a financial instrument, an economic trade off must be made between the resources expended now and the expectation of future cash benefits to be obtained. In other words, investing is incurring costs in order to gain benefit during the estimated life of the plant assets or current assets in the future. Bandoi and Berceanu (2008), observe that investment decision is a very difficult for leaders of all firms. By its very nature, the decision affects the investment a company a long time horizon, if not forever. In the idea of adopting an investment decision we can use simple criteria or criteria based on discounting. Of the latter category, net present value criterion (NPV) is most often used. They further argue that inflation is a real fact today which can not be ignored. Their result highlight the fact that if effects of inflation are not taken into account we can do wrong analysis of capital budgeting.

Naheed Zia (2004) argues that although Pakistan’s textiles industry enjoys enormous advantages compared to other manufacturing activities of the country, it has so far failed to achieve competitiveness in terms of quality, value addition and price optimization through Balancing, Modernization and Restructuring (BMR). Pakistan’s textiles producers kept the myopic view of the market and spared themselves the investment efforts which could have brought the industry and the country the dividends of long-run viability and sustainability of high GDP growth rates respectively. However, in all fairness, the Government policy has been equally responsible for the ailment of Pakistan’s textiles sector. In some cases financial institutions provided 100 percent capital, leaving the entire control to the private sector i.e. a state enterprise in private hands. Resultantly, the textiles industry, specifically its weaving and spinning sectors, are currently under heavy burden of loans most of which have become overdue in repayments. Despite frequent rescheduling and all efforts of the Government and the banks, the default levels are high and recovery position is very weak. The largest percentage of stuck-up loans belongs to the textiles sector. Maryia and Vakhitova (2010), find that the influence of FDI on enterprises’ performance across three large sectors (primary, secondary and services). Regarding the direct effect of FDI, the findings are in line with the previous studies and show that firms with the foreign capital perform better than the domestic in all three sectors of the economy. Interestingly, that direct effect in the primary sector is three times larger. This result is consistent with our first hypothesis. They assumed that productivity gap between domestic and foreign firms in the primary sector is much larger than in manufacturing. When such gap differentials are combined with unequal entry opportunities for foreigners in different sectors, differences in the FDI impact across sectors persist. The direct FDI effect in services is the largest in the most restricted primary sector and falls with time in services where substantial liberalization has been undertaken.

Anjum and Nishat (2004), argue that the determinants inward FDI emphasizes the

economic conditions or fundamentals of the host countries relative to the home countries of FDI as determinants of FDI flows. This literature is in line with Dunning’s eclectic paradigm (1993), which suggests that it is the location advantages of the host countries e.g., market size and income levels, skills, infrastructure and political and macroeconomic stability that determines cross-country pattern of FDI. They further argue that the location specific advantages sought by foreign investors are changing in the globalised more open economies of today. Accordingly, Dunning (2002) finds out that FDI from more advanced industrialized countries depends on government policies, transparent governance and supportive infrastructure of the host country. However, very few studies exist that have empirically estimated the impact of selective government policies aimed at FDI. Khan (1997) observes that despite offering competitive incentives over the last 50 years, geographical location, and relatively large size of population, Pakistan could not attract FDI like those of many East and South-East nations. He highlighted some of the factors essential for attracting FDI in Pakistan. One of the main factors in attracting FDI is the improved law and order situation in the country. No amount of fiscal and other concessions in the midst of disturbed law and order situation would draw the attention of foreign investors. Apart from law and order situation, macroeconomic stability and consistent economic policies are also vital to encourage foreign investors to undertake initiatives in Pakistan. Foreign investors in Pakistan have to cope with a complex legal situation. The law and regulations should be simplified, updated, made more transparent and their discretionary application must be discouraged. The availability of better quality and more reliable services in all areas of infrastructure are key ingredients of a business environment conducive to foreign investment.

Sajawal and khan (2007), find that negligible impact in long run as well as in short run of real interest rate on private investment shows the non-responsiveness of private investment to interest rate. Their results show that most of the traditional factors have very weak or no effects on private investment in case of Pakistan. Those results are supportive to view that poor quality institutions are responsible for low investment in Pakistan. The crowding out effect of public investment also indicates the inefficiency in utilizing resources or corruption element on the part of government official. However, these are crude conclusion. Kalim and Ahmed (2003) highlight that due to lack of investor confidence, private investment has reached its lowest point in the recent economic history of the private sector led growth phase (1978 to 2002) in Pakistan. They argue that economic as well as non-economic factors are responsible for this declining investment. Economic policies are formulated in such a manner that the short-term objectives of lowering the fiscal and trade deficits were to some extent achieved but overall economic performance and investment were ignored. In order to control external trade deficits, a policy of devaluation increased the cost of production through an increase in prices of imported raw material especially of plant and machinery. Higher real interest rates due to excessive public borrowing that were due to the failure in reducing fiscal deficits has resulted in financial crowding out and has corroded the savings that might be used to finance private investment. The unexplained part of private investment that is not determined by economic factors can be attributed to non-economic factors

Martin (2007) argues that Investments play a central, multiplying role in economic growth, which can be explained by the fact that the enterprise carrying out the investment addresses fixed assets suppliers and the investment decision has a series of favourable effects on the economy: the suppliers’ turnover increases, benefits and state taxes increase, production in connected branches increases etc. Consequently, the Government is interested in interfering for investment stimulation and for creating favourable conditions, so that investors can resist in international competition. Elena and Radulescu argue that due to the fact that developing countries expand beyond their traditional involvement in international production as recipients of FDI to that of rising sources of FDI, the impact of their outward FDI on the countries of origin, as well as on the host countries, especially host developing countries, assumes increasing significance.

Rafaello and Blasio (2005) find that investment incentives channeled through the Law 488 have represented the main policy instrument for reducing territorial disparities in Italy. The incentives are assigned through competitive auctions according to pre-determined specific criteria, such as the proportion of own funds invested in the project; the number of jobs involved and the proportion of assistance sought. They find that financed firms have substantially increased their investments when compared with the pool of rejected application firms. Banga (2003) demonstrates the important role of labour costs, labour productivity and educational attainment in attracting FDI into Asian countries. Infrastructure has often been mentioned as a factor in FDI. He finds that the availability of electricity is indeed an important factor in FDI flows. His results also confirm that FDI restrictions reduce FDI. He further argues that extensive growth in foreign direct investment flows to developing countries has been accompanied by an increase in competition amongst the developing countries to attract FDI, resulting in higher investment incentives offered by the host governments and removal of restrictions on operations of foreign firms in their countries. He also finds that economic fundamentals, namely, large market size; low labour cost (in terms of real wages); availability of high skill levels (captured by secondary enrolment ratio and productivity of labour); lower external debt; and extent of electricity consumed in the economy are found to be significant determinants of aggregate FDI. After controlling for the effect of economic fundamentals, FDI policies are found to be important determinants of FDI inflows. Results show that lower tariff rates attract FDI inflows. However, fiscal incentives offered by the host governments are found to be less significant as compared to removal of restrictions in attracting FDI inflows. Bilateral investment treaties (BITs) which emphasise on non-discriminatory treatment of FDI, play an important role in attracting FDI inflows into developing countries. However, bilateral investment agreements with developed countries and developing countries may have differential impact. Results show that BITs with developed countries have a stronger and more significant impact on FDI

inflows as compared to BITs with developing countries. With respect to regional

investment agreements we find that different regional investment agreements

have different impact. While APEC is found to have a significant positive impact

on FDI inflows ASEAN is not found to affect FDI inflow. However, it is noted

that regional agreements may be still too new to show an impact in the period

studied. The results of the analysis with respect to FDI from developed and developing

countries show that economic fundamentals differ in terms of their significance in

attracting FDI from developed countries and developing countries. FDI from

developed countries are attracted to large market size, higher education levels,

higher productivity of labour, better transport and communication and lower

domestic lending rates, while cost factors play a more significant role in attracting

FDI from developing countries. The determinants found significant are large

market size, potential market size, lower labour cost, devaluation of exchange

rate, better transport and communication, lower lending rates and lower budget

deficit. The impact of FDI policies also differs on FDI from developed and developing countries. Lower tariff rates are significant determinants of FDI from developing countries but do not attract FDI from developed countries. Fiscal incentives are found to attract FDI from developing countries but it is removal of restrictions on their operations that attract FDI from developed countries.

Antonio (2002) argues that more attention should be devoted to distinguishing FDI by type, and suggests that FDI with high technological content might play a peculiar role. With reference to developing countries, he finds strong evidence that countries with a larger population and a larger stock of human capital, and countries that enjoy lesser uncertainty, are able to attract more FDI with a higher technological content. He also finds evidence pointing towards a positive relationship between the share of technology embodied into FDI and the level of economic development in the host country. Bondoc (2008) finds that the impact of FDI on accumulation of fixed capital between 2003 and 2006. Therefore, they will see the FDI growth over the last few years. According to them Romania has significantly improved in 2004, when the FDI went up to more than 5 bill euro. Nevertheless, the record value of FDI has been registered in 2006, reaching almost 9.1 bill euro. They observed that the FDI was quite relevant in developing the Romanian fixed capital. Vukšiæ ( ) finds that FDI has positively and significantly affected exports, but the extent of this impact was relatively low. This implies that there is a potential for improving the export performance of Croatian manufacturing industry by attracting more FDI into this sector.