Impact Of Foreign Direct Investment

The word “investment” can be defined in many ways according to different theories and principles. It is a term that can be used in a number of contexts. However, the different meanings of “investment” are more alike than dissimilar. Generally, investment is the application of money for earning more money. Investment also means savings or savings made through delayed consumption. According to economics, investment is the utilization of resources in order to increase income or production output in the future. An amount deposited into a bank or machinery that is purchased in anticipation of earning income in the long run is both examples investments. According to economists, investment refers to any physical or tangible asset, for example, a building or machinery and equipment. On the other hand, finance professionals define an investment as money utilized for buying financial assets, for example stocks, bonds, gold, real properties, and precious items. In general term, Investment means the purchase of goods which are invest and not used today, which will give benefit in future. The money you earn is partly spent and rest saved for future expenses. Instead of keeping savings ideal this money is invested to earn additional income this is called investment. When an asset is bought or a given amount of money is invested in the bank, there is anticipation that some return will be received from the investment in the future. (Meaning Of Investment, 2009 ). Investment by domestic residents (individuals, companies, financial institutions and governments) in the acquisition of overseas financial securities and physical assets. Overseas investment in financial assets, in particular by institutional investors, is undertaken primarily to diversify risk and to obtain higher returns than would be achievable on comparable domestic investment. Physical foreign direct investment(FDI) in new manufacturing plants and sales subsidiaries, or the acquisition of established businesses, provide the multinational company with a more flexible approach to supplying foreign markets.

Interest, profits and dividends gained on these foreign investments count as invisible earnings in the balance of payments, though some of this income may be reinvested overseas rather than repatriated. (Christopher Pass, 1995). The income tax treatment of foreign investment income is frequently governed by Tax Treaties between the country of the investment owner and the state where the investment is situated. (Friedman, 2007 ).Foreign Direct Investment (FDI) An investment abroad, usually where the company is being invested in is controlled by the foreign corporation. A company from one country making a physical investment into building a factory in another country. The direct investment in buildings, machinery and equipment is in contrast with making a portfolio investment, which is considered an indirect investment. (Spaulding, 2004).Foreign direct investment (FDI) is a major driver of globalization. As investment patterns of multinational enterprises become more and more complex, reliable and internationally comparable, FDI statistics are necessary for sound policy decision making. The OECD Benchmark Definition of Foreign Direct Investment sets the world standard for FDI statistics. It provides a single point of reference for statisticians and users on all aspect of FDI statistics, while remaining compatible with other internationally accepted statistical standards. (OECD, 2008) . In the past decade, FDI has come to play a major role in the internationalization of business. Reacting to changes in technology, growing liberalization of the national regulatory framework governing investment in enterprises, and changes in capital markets profound changes have occurred in the size, scope and methods of FDI. New information technology systems, decline in global communication costs have made management of foreign investments far easier than in the past. (Spaulding, Foreign Direct Investment, 2005).In recent years, given rapid growth and change in global investment patterns, the definition has been broadened to include the acquisition of a lasting management interest in a company or enterprise outside the investing firm’s home country. As such, it may take many forms, such as a direct acquisition of a foreign firm, construction of a facility, or investment in a joint venture or strategic alliance with a local firm with attendant input of technology, licensing of intellectual property. (Graham, 2005). According to the benchmark definition of the OECD and World Investment Report 2009, a direct investment enterprise is an incorporated or unincorporated enterprise in which a single foreign investor either owns 10 percent or more of the ordinary shares or voting power of an enterprise (unless it can be proved that the 10 percent ownership does not allow the investor an effective voice in the management) or owns less than 10 percent the ordinary shares or voting power of an enterprise, yet still maintains an effective voice in management. An effective voice in management only implies that direct investors are able to influence the management of an enterprise and does not imply that they have absolute control. The most important characteristics of FDI, which distinguishes it from portfolio investment, is that it is undertaken with the intention of exercising control over an enterprise. (GlobStat, 2009).Probably the most important role of FDI in a developing economy is the supply of capital, as capital deficiency is the fundamental problem in case of a developing economy. Capital formation depends on investment, which, however, implies sacrifice of consumption. (Zaidi, 2009). Developing countries [] , emerging economies and countries in transition have come increasingly to see FDI as a source of economic development and modernization, income growth and employment. Countries have liberalized their FDI regimes and pursued other policies to attract investment. They have addressed the issue of how best to pursue domestic policies to maximize the benefits of foreign presence in the domestic economy. The study Foreign Direct Investment for Development attempts primarily to shed light on the second issue, by focusing on the overall effect of FDI on macroeconomic growth and other welfare-enhancing processes, and on the channels through which these benefits take effect. (Andru Pascal, 2002). The most profound effect has been seen in developing countries, where yearly foreign direct investment flows have increased from an average of less than $10 billion in the 1970’s to a yearly average of less than $20 billion in the 1980’s, to explode in the 1990s from $26.7billion in 1990 to $179 billion in 1998 and $208 billion in 1999 and now comprise a large portion of global FDI.. Driven by mergers and acquisitions and internationalization of production in a range of industries, FDI into developed countries last year rose to $636 billion, from $481 billion in 1998 but in south Asian developing countries in which India $123 billion of FDI inward and Pakistan $31 billion of FDI inward in 2008. (UNCTAD, 2009)

History:

Early Investment

There have been international organizations engaged in trading activities as far back in time as 2500BC, with banks and churches also having formed international organizations throughout history (Allen, 1984). The appearance of the modern MNE, incorporating control over foreign production units, did not occur until the Nineteenth Century (Wilkins, 1977), but early resemblances to the modern MNE appeared in the 1600s and 1700s, when large trading companies from the UK and the Netherlands entered parts of Asia, the Indies and America [] . The two largest enterprises were the British East India Company and the Dutch East India Company (Nicholas, 1988). These dominated the well-paid markets of spices, cottons and silks, and are credited as being the true pioneers of international commercial activities. Investment also later took place in the UK and French colonial territories of Latin America, Asia, Africa and Australia, with most investments being supply oriented, in the form of resource exploitation (Medard Gabel, 2003) [] . International companies also emerged with the aim of colonizing foreign lands. One of the first was the London-based, British Virginia Company, Whose strategy was to profit from the development and colonization of Virginia in the US. Similar projects across North America were undertaken by the Dutch, the French and the Swedes. (Wren, 2006).

It is generally accepted that the true birth of the modern multinational arose in Europe in the Nineteenth Century (Wilkins, History of FDI , 2004) [] . Examples are the Cocker ill steelworks of England that set up in Prussia; Bayer’s of Germany that set up chemical plants in the US; and Nobel’s of Sweden that set up dynamite production in Germany (Tugendhat, 1981). However, it was not until the latter part of the Nineteenth Century that larger-scale foreign direct investment started to emerge. A major motivation for the spread of these firms was the increase in the protectionist behavior of countries, which in turn was a by-product of increased nationalism. As customers mostly-preferred goods produced locally, as opposed to imported goods, firms had to set-up abroad (John Micklethwait, 2003 ). Other important reasons for the upsurge in FDI and the growth of MNE’s was the search for larger markets, as enterprises began to grow in size, and improvements occurred in transportation and communication, most notably the railways and telegraphs (Wilkins, FDI , 1998). These advances not only made it easier for parent companies to control their subsidiaries but to control them over longer distances. Up until the end of the Nineteenth Century, European firms dominated the MNE scene, but US multinationals were beginning to increase, both in number and size. Examples of US multinationals at this time include singers, which set up sewing-machine plants in Scotland, and the electrical-manufacturers Thomson-Houston, which set up in England (Attack, 1994). The increase in FDI at the turn of the Twentieth Century was halted in the inter-war period both by the destruction caused by the First World War and the threat of another war leading to discrimination against foreigners by the occupants of many countries. The First World War also resulted in European multinationals being forced to sell their pre-war investments, with political upheaval and border changes also impacting on cross-border activities (Dunning, 1983). Other factors leading to a worldwide fall in investment included the Great Depression of late 1920s and early 1930s and the substantial rise in inflation in Europe (Jones, 1995 ). By the time of the Second World War, the main stock of FDI was still held by the UK 40 per cent, while the US held 28 per cent (Jones Eric Lionel, 2000). However, after the Second World War a new wave of FDI began to emerge, arising mainly from the US. The factors behind this improvement in technology and Communication systems, greater economic and political stability, the formation of trading blocks and a more liberalized attitude from host governments (Hood, 1999). In the years after the Second World War global FDI was dominated by the United States, as much of the world recovered from the destruction brought by the conflict. The US accounted for around three-quarters of new FDI (including reinvested profits) between 1945 and 1960. Since that time FDI has spread to become a truly global phenomenon, no longer the exclusive preserve of Organization for Economic Corporation and Development (OECD) countries. FDI has grown in importance in the global economy with FDI stocks now constituting over 20 percent of global GDP.

Pakistan History

Soon after independence in 1947, Pakistan moved from a parliamentary system to a presidential one and then finally reverted to the original parliamentary system. Pakistan has a checkered history of trade liberalization and FDI promotion. Following some trade liberalization attempts in the 1960s, Pakistan qualified for Article VIII status at the IMF in 1970. Even by the mid-1980s there was still a long way to go in lifting quantitative restrictions QRs and reducing tariffs. From the mid-1980s, controls on foreign investment in manufacturing have diminished sharply, those for the service sector less so (Athukoralge, 2007)

“In spite of various bureaucratic controls, the government attitude throughout the 1950s and 1960s was favorable to private investment, the FDI regime was more liberal, although there was greater emphasis on joint ventures with minority foreign ownership and technology licensing than on FDI in fully foreign owned ventures. However, supremacy of the state and socialist ideology under a socialist government dominated policy in the 1970s. As a result, a large-scale program of nationalization of key industrial units and wide-spread control of domestic and foreign trade were instituted. The dismal economic outcome of the interventionist policies eventually paved the way for market-oriented reform. Reforms started slowly in the early 1980s as part of a widespread reform package in conformity with the World Bank conditionality. Removal of restrictions on foreign investment was a major element of the reform program. Full foreign ownership of firms, with full freedom for remittance of profit and investment proceeds, is now allowed in almost all sectors of the economy” (Athukoralge, FDI History of Pakistan, 2007).

“Independence in 1971, the Bangladesh government adopted a state-led import-substitution development strategy, which was far more interventionist than that of the united Pakistan. The new government nationalized a larger number of industrial enterprises owned by Pakistani entrepreneurs as well as all industrial enterprises with fixed assets exceeding a certain threshold level. The scope of the private sector was limited to small and cottage industry, and foreign investment was allowed only in collaboration with the public sector with minority equity participation. However, existing foreign investments (excluding those belonging to Pakistan) were spared from the sweeping nationalization drive. The socialist-oriented industrial policy of 1973 assigned a very minor role for the private sector, with some investment ceiling on new investment” (Athukoralge, History of Pakistan , 2007).

Foreign Direct Investment (FDI) has been a small but growing part of total investment in Pakistan. Data indicates that FDI in Pakistan has grown from $8 million US dollars in 1976 to $346 million dollars in 1993. During the same period, total gross fixed capital formation grew from $2.4 to $9.2 Billion dollars (international Monetary Fund). Nevertheless, excluding the non-capital part, FDI is even a smaller part of total capital formation in Pakistan than these figures reflect (Kaynak, 1999).

General Musharraf vowed to make all out efforts to improve the deteriorating economic conditions in order to eradicate poverty and hunger in the country. The bank defined essential problem areas where urgent action is needed as: (1) Build investor confidence; (2) Structural change in fiscal policy; (3) Reduction in budget deficit to more sustainable level; (4) Address the national debt servicing issue; (5) Improve exports; (6) Population control; and (7) Improve human capital. Meanwhile, there is a very low flow of Foreign Direct Investment (FDI) into the country. The FDI peaked in 1996 to $992 Million and declined to $370 Million in 1999. Another report says that FDI amounted to around $600 Million in 1999; the figure is based on the difference between the amount of FDI stocks in 1998($9.2Billion) and 1999 ($9.8 Billion). However, this constituted 0.21 percent of FDI global flows ($4.7 Trillion). FDI stocks in Pakistan in 1999 represented 4.4 percent of its GDP (Mahmood, FDI History of Pakistan , 2001). Increased Foreign Direct Investment (FDI) increased to $3.5 Billion in the last financial year, according to GOP sources. The United Nation’s World Investment Report 2006 stated that Pakistan saw a 95% growth in FDI inflows in 2005 to reach $2.183 Billion (Mahmood, 2007).

Impact of Foreign Direct Investment

Attracting foreign direct investment (FDI) has become a key part of national development strategies for many countries. They see such investments as bolstering domestic capital, productivity, and employment, all of which are crucial to jump-starting economic growth. While many highlight FDI’s positive effects, others blame FDI for “crowding out” domestic investment and lowering certain regulatory standards. The effects of FDI can sometimes barely be perceived, while other times they can be absolutely transformative. While FDI’s impact depends on many conditions, well-developed and implemented policies can help maximize its gains.

The resources in this list focus on the impact of FDI on:

Economic growth: Foreign capital stocks combined with the widespread belief that FDI is beneficial for growth triggered a large body of literature on the determinants of FDI in the Central and Eastern European transition countries. The primary goal was to locate all relevant economic and political factors which could be beneficial for FDI inflows and, by extension, for economic growth(Neuhaus, 2005).

Trade: The direct impact falls into two parts, namely an immediate effect emanating from the actual investment and the effects on the import pattern of the targeted enterprises. The former channel is generally limited to the imports of initial inputs of imported machinery and equipment (especially in Greenfield investment), or, where FDI is large compared with the size of the host economy, it may include the knock-on effect on aggregate imports from rising total domestic demand. The second channel, which essentially depends on the investors’ choice between imported and local inputs, has been studied extensively(OECD, Direct Impact of FDI on Imports, 2002).

Employment and skill levels: In response to the AFL-CIO’s (American Federation of Labor and Congress of Industrial Organizations) earlier claim that job losses result from the impact of runaway firms setting up labor- intensive operations in offshore locations, the US tariff commission analyzed then- new data on the foreign operations of US firms. It found that employment gains generated from associated exports of equipment and parts, etc. and expansion of supporting non-production jobs would be large enough to offset possible job losses arising from production displacement effects(Neil Hood, 1979). In response to the latest concerns of the US labor unions, 23 studies have investigated the impact of FDI on employment. All except one have concluded that it has a positive effect resulting in the net increase of jobs(Lee, 2002).

Technology diffusion and knowledge transfer: Are of great importance for economic development, as the adoption of new techniques, machines, and production processes is a key determinant of productivity growth. Given that most research and development (R&D) and innovation is undertaken in high income countries, most developing economies must rely largely on imported technologies as sources of new productive knowledge. This is not to say that no R&D is undertaken in developing countries; a considerable amount of follow-on innovation and adaptation does occur there, contributing to the global stock of knowledge(Smarzynska Javorcik, 2006).

Linkages and spillover to domestic firms:

FDI spillovers: An increase in the productivity of domestic firms as a consequence of the presence of foreign firms in the domestic economy.

FDI spillovers via horizontal linkages: An increase in the productivity of domestic firms resulting from the presence of foreign firms in the same industry.

FDI spillovers via forward linkages: An increase in productivity resulting from the foreign presence among the supplies of the industry in which the domestic firm operates.

FDI spillovers via backward linkages: An increase in productivity resulting from the foreign presence among the customers of the industry in which the domestic firm operates.

These spillovers may take place among domestic firms but are more likely to occur with foreign affiliated firms given their linkages with large foreign parent companies. In the case of horizontal spillovers, there are not such incentives and firms would rather protect their intellectual assets rather than risk technology leakage to competitors (OECD, FDI spillover, 2008).

Types of Foreign Direct Investment

By Direction

Inward FDI: Inward foreign direct investment is when foreign capital is invested in local resources.

Inward FDI is encouraged by:

Tax breaks, subsidies, low interest loans, grants, lifting of certain restrictions

The thought is that the long term gain is worth short term loss of income

Inward FDI is restricted by:

Ownership restraints or limits

Different performance requirements

Outward FDI: Outward foreign direct investment, sometimes called “direct investment abroad” is when local capital is invested in foreign resources.

Outward FDI is encouraged by

Government-backed insurance to cover risk

Outward FDI is restricted by

Tax incentives or disincentives on firms that invest outside of the home country or on repatriated profits

Subsidies for local businesses

Leftist government policies that support the nationalization of industries (or at least a modicum of government control) Self-interested lobby groups and societal sectors who are supported by inward FDI or state investment, for example labor markets and agriculture. Security industries are often kept safe from outwards FDI to ensure the localized state control of the military industrial complex.

By Target

Greenfield Investment: Direct investment in new facilities or the expansion of existing facilities. Greenfield investments are the primary target of a host nation’s promotional efforts because they create new production capacity and jobs, transfer technology and know-how, and can lead to linkages to the global marketplace. The Organization for International Investment cites the benefits of Greenfield investment (or in sourcing) for regional and national economies to include increased employment (often at higher wages than domestic firms); investments in research and development; and additional capital investments. Criticism of the efficiencies obtained from Greenfield investments includes the loss of market share for competing domestic firms. Another criticism of Greenfield investment is that profits are perceived to bypass local economies, and instead flow back entirely to the multinational’s home economy. Critics contrast this to local industries whose profits are seen to flow back entirely into the domestic economy (Easson, 2004).

Mergers and Acquisitions: Transfers of existing assets from local firms to foreign firms’ takes place; the primary type of FDI. Cross-border mergers occur when the assets and operation of firms from different countries are combined to establish a new legal entity. Cross-border acquisitions occur when the control of assets and operations is transferred from a local to a foreign company, with the local company becoming an affiliate of the foreign company. Unlike Greenfield investment, acquisitions provide no long term benefits to the local economy– even in most deals the owners of the local firm are paid in stock from the acquiring firm, meaning that the money from the sale could never reach the local economy. Nevertheless, mergers and acquisitions are a significant form acquiring firm, meaning that the money from the sale could never reach the local economy. Nevertheless, mergers and acquisitions are a significant form of FDI and until around 1997, accounted for nearly 90% of the FDI flow into the United States. Mergers are the most common way for multinationals to do FDI (Jonathan Jones, 2006).

Horizontal FDI: It refers to FDI in the same industry in which the organization in the home nation.

Vertical FDI: It refers to the FDI by an organization in order to sell the outputs of domestic firms to the investment which provides inputs to the domestic organization (Misra, 2009).

Backward Vertical FDI: Where an industry abroad provides inputs for a firm’s domestic production process.

Forward Vertical FDI: Where an industry abroad sells the outputs of a firm’s domestic production.

By Motive: FDI can also be categorized based on the motive behind the investment from the perspective of the following firm:

Resource-Seeking FDI

Investments which seek to acquire factors of production those are more efficient than those obtainable in the home economy of the firm. In some cases, these resources may not be available in the home economy at all (e.g. cheap labor and natural resources). This typifies FDI into developing countries, for example seeking natural resources in the Middle East and Africa, or cheap labor in Southeast Asia and Eastern Europe (Cohen, 2007).

1.3.3.2 Market-Seeking FDI Investments which aim at either penetrating new markets or maintaining existing ones. FDI of this kind may also be employed as defensive strategy; it is argued that businesses are more likely to be pushed towards this type of investment out of fear of losing a market rather than discovering a new one .This type of FDI can be characterized by the foreign Mergers and Acquisitions in the 1980’s by Accounting, Advertising and Law firms (Cohen, Market-Seeking FDI , 2007).

1.3.3.3 Efficient-Seeking FDI Investments which firms hope will increase their efficiency by exploiting the benefits of economies of scale and scope and also those of common ownership. It is suggested that this type of FDI comes after either resource or market seeking investments have been realized, with the expectation that it further increases the profitability of the firm. Typically, this type of FDI is mostly widely practiced between developed economies; especially those within closely integrated markets (Cohen, Efficiency-Seeking FDI, 2007).

1.3.3.4 Strategic-Asset-Seeking FDI A tactical investment to prevent the loss of resource to a competitor. Easily compared to that of the oil producers, whom may not need the oil at present, but look to prevent their competitors from having it (OECD, Strategic-Asset-Seeking FDI , 2002).

1.3.3.5 Political Oppositions to FDI In the late 1960s and early 1970s foreign direct investment became increasingly politicized. Organized labor, convinced that foreign investment exported jobs, undertook a major campaign to reform the tax provisions which affected foreign direct investment. The Foreign Trade and Investment Act of 1973 (or the Burke-Hartke Bill) would have eliminated both the tax credit and tax deferral. The Nixon Administration, influential members of Congress of both parties, and well-financed lobbying organizations came to the defense of the multinational. The massive counterattack of the multinational corporations and their allies defeated this first major challenge to their interests (Finance, 2006).

1.3.3.6 Private Foreign Investment Few areas in the economics of development arouse so much controversy and are subject to such varying interpretations as the issue of the benefits and costs of private foreign investment. If, however, we look closely at this controversy, we will find that the disagreement is not so much about the influence of MNCs on traditional economics aggregate such as GDP, investment, savings, and manufacturing growth rates (though these disagreements do indeed exist) as about the fundamental economic and social meaning of development as it relates to the diverse activities of MNCs. In other words, the controversy over the role and impact of foreign private investment often has as its basis a fundamental disagreement about the nature, style, and character of a desirable development process (Todaro, 1989).

Components of FDI

The components of FDI are equity capital, reinvested earnings and intra-company loans:

Equity Capital

Equity in unincorporated entities, non-cash acquisition against technology transfer, plant and machinery, goodwill, business development and similar considerations control premium and non-competition fee (Components of FDI, 2004).The foreign direct investor’s net purchase of the share and loans of an enterprise in a country other than its own.

Reinvested Earnings

The part of an affiliates earnings accruing to the foreign investors that is reinvested in that enterprise.

Intra-company Loans (Other Capital)

Short or long-term loans, trade credit, supplier’s credit, financial-leasing, financial derivatives, debt securities from parent firms to affiliate enterprises or vice versa. In the case of banks, deposits, bills and short-term loans are not included.

1.5 Benefits of FDI:

The economic benefits of FDI are real, but they do not accrue automatically. To develop the maximum benefits from foreign corporate presence a healthy enabling environment for business is paramount, which encourages domestic as well as foreign investment, provides incentives for innovation and improvements of skills and contributes to a competitive corporate climate. The net benefits from FDI do not accrue automatically, and their magnitude differs according to host country and context. The magnitude of the benefits from FDI depends on the efforts of host countries to put in place the appropriate frameworks but even less-well performing countries may benefit, inter alia by using FDI as a supplement to scarce financial resources. The factors that hold back the full benefits of FDI in some developing countries include the level of general education and health, the technological level of host country enterprises, insufficient openness to trade, weak competition and inadequate regulatory frameworks. Conversely, a level of technological, educational and infrastructure achievement in a developing country does, other things being equal, equip it better to benefit from a foreign presence in its markets (OECD, Benefits of FDI, 2002)

The Perceived Benefits of FDI

A Zero-Sum Game: As with international trade, it is argued that the free movement of investment capital increases the aggregate sum of global wealth. FDI is not a zero-sum game. If capital is allowed to flow where its owners consider it can be employed most efficiently, then the highest return on capital will be achieved. Restrictions upon FDI necessarily result in the inefficient utilization of capital. This does not, of course, mean that everyone necessarily benefits from FDI- simply that the total benefit should outweigh the total detriment. Nor, of course, does if assume that capital will always be used efficiently- though it is assumed that restrictions upon FDI flows will result in less efficient utilization than if those restrictions did not exist. If one accepts that FDI produces a net benefit in global terms, then everyone should be happy so long as that benefit is shared fairly among the host country, the home country, the firm that undertakes it, and those persons most closely affected by the activities of the firm- its shareholders, customers, suppliers and workers (Easson, Benefits of FDI, 2004).

FDI from the perspective of home countries: FDI is generally considered to have beneficial effects for its host countries; one might suppose that outward FDI would be correspondingly detrimental to capital exporting countries. The home country is being deprived of capital that would be invested there to produce growth, employment and other benefits. The pro-FDI attitude among developed countries is simply the reverse side of the FDI liberalization coin: if countries wish to receive inward FDI they must permit outward FDI (Easson, Perspective of home Countries, 2004).

FDI from the perspective of host countries: FDI requires the concurrence of the country in which the investment is made. As already noted, the past 20 years have witnessed a dramatic change in the attitude of most countries towards inward FDI (Easson, Perspective of Host Countries, 2004). As a general proposition, it is believed that FDI results- For the host country-in:

An increased pool of capital available for investment

Increased revenue for the host government and community;

Increased employment;

The introduction of new skills and technology;

Other “spillover” effects.

Sources of FDI:

Pakistan’s industrial pattern is correlated with the origins of foreign investors as well. The USA has been the single largest source of FDI in Pakistan over the last 17 years followed by UK. During the post reform period, the share of the USA and UK has further risen to 40 percent and 35 percent respectively. If we focus on the patterns of FDI by origin, we will find that almost 60 percent of FDI comes from three sources, namely, the US, EU and Japan. This share jumped to almost 72 percent during the post reform era. It may be noted that Japan, which has emerged as a major investor globally, has invested an insignificant amount in Pakistan. As against an average of $24.4 billion per annum in Pakistan during the same period. In general, FDI in Pakistan shows the absence of “Chinese connection” that has been very important in attracting labor intensive investments to Southeast Asian countries from Hong Kong, Taipei, China and Singapore. This is one of the reasons that why Pakistan could not attract large amounts of FDI in the country (Kemal, 1998).

Measures which Encourage the FDI:

Although many countries have taken some measures to encourage FDI, few have completed the whole agenda of policy reform. Developing countries are in three stages of the reform process:

Leading FDI Hosts: Having removed the major impediments to FDI, Chile, Indonesia, Malaysia, and other liberalized countries receive large amounts. Even within this group of countries, however, some sectors or industries remain effectively closed to FDI. These exceptions include industries still dominated by state enterprises or heavily regulated by government, for example, infrastructure and financial services (Dale Weigel, 1997).

Emerging FDI Hosts: Countries such as Brazil, Ghana, and India have taken a number of important steps toward creating an enabling environment for FDI, but significant obstacles persist. These obstacles keep the FDI flows below their potential, although, as in Brazil, they are already substantial. For this group, further efforts to identify and alleviate remaining obstacles are the key to achieving increased FDI (Gregory, 1997).

Pre-emergent FDI hosts: Still other countries have yet to take the first steps to reorient their policies to attract FDI under a liberal economic framework. Some of them receive some FDI because of their abundant natural resources or large, protected markets and may therefore not see the need to change. Others have not yet made the policy decision to attract FDI. These countries face the most challenging programs of reform, since action may be needed on a number of fronts before a significant pick up in FDI can be expected (Wagle, 1997).

Determinants of Foreign Direct Investment

Economic growth is the key ingredient to a nation’s progress and prosperity. Investment provides the base and pre-requisite for economic growth. The economic well being of a country is, thus, inherently linked with the process of investment, its volume, composition and quality. By positively influencing the inputs and the determinants of the investment process alone, a country can improve its economic fortunes. This calls for the creation of conditions conductive to investment (Paul, 2008). It is widely agreed that foreign direct investment takes place when three sets of determining factors exist simultaneously: the presence of ownership specific competitive advantage in a transnational corporation (TNC), the presence of location advantages in a host country, and the presence of superior commercial benefits in an intra-firm as against an arm’s length relationship between investor and recipient.

• The ownership-specific advantages (e.g. proprietary technology) of a firm, if exploited optimally than it can compensate for the additional costs of establishing production facilities in a foreign environment and can overcome the firm’s disadvantages (Nations, 1999).

• The ownership-specific advantages of the firm should be combined with the location advantages of host countries (Nations, FDI determinants, 1999).

• Finally, the firm finds greater benefits in exploiting both ownership specific and location advantages by internalization, i.e. through FDI rather than arm’s length transactions. This may be the case for several reasons. For one, markets for assets or production inputs (technology, knowledge or management) may be imperfect, if they exist at all, and may involve significant transaction costs or time- lags. For another, it may be in a firm’s interest to retain exclusive rights to assets which confer upon it significant competitive advantage (Nations, FDI Determinants, 1999).

While the first and third conditions are firm specific determinants of FDI, the second is location-specific and has a crucial influence on a host country’s inflows of FDI. If only the first condition is met, firms will rely on the exports, licensing or the sale of patents to service a foreign market. If the third condition is added to the first, FDI becomes the preferred mode of servicing foreign markets, but only in the presence of location-specific advantages. Within the trinity of conditions for FDI to occur, location determinants are the only ones that host governments can influence directly (Nations, FDI Determinants, 1999). The host country determinants begins with the role of national policies and especially the liberalization of policies as FDI determinants. Then follow a review of business facilitation measures: s the world economy becomes more open to international business transactions, countries compete increasingly for FDI not only by improving their policy and economic determinants, but also by implementing pro-active facilitation measures that go beyond policy liberalization. While not as important as the other two sets of determinants, these measures are receiving increased attention. Economic determinants and, in particular, their changing significance in the context of liberalization and globalization (Joong-Wan, 2002).

FDI Policy as a Determinant

The importance of core FDI policy as a determinant is best illustrated by the obvious fact that FDI cannot take place unless it is allowed to enter a country; its potential relevance is also evident when policy changes sharply in the direction of more or less openness. It would be noted, however, that policy changes in the direct of openness differ in an important way from those in the direction of restriction; even when extensive, and they cannot guarantee their desired results, as radically restrictive policies can pretty much guarantee theirs. Open policies are basically intended to induce FDI but the inducement may not be taken. Restrictive policies, on the other hand, such as sweeping nationalizations of foreign affiliates, can effective close the door to FDI (Cho, 2002).

National Markets

An important group of traditional economic determinants of inward FDI corresponds to the need of firms, including TNCs, to grow and / or to say competitive by gaining access to new markets at home and abroad / or increasing existing market shares. From a host country’s perspective, the relevant economic determinants for attracting market-seeking FDI include market size, in absolute terms as well as in relation to the size and income of its population, and market growth. Large markets can accommodate more firms both domestic and foreign. And can help firms producing tradable products to achieve scale and scope economies. As growth is a magnet for firms, a high growth rate in a host country tends to simulate investment by domestic and foreign producers (Bellak, 2009).

PURPOSE STATEMENT

The purpose of this study is test the theory of association that relates the dependent variables and independent variable. Here in this study the factors (exchange rate & growth rate) that affect the Foreign Direct Investment are independent variables and Foreign Direct Investment is dependent variable. Its uniqueness will be statistically control in this study.

OBJECTIVE OF THE STUDY

The following objective will be paying attention to guide the study.

To study the impact of exchange rate on foreign direct investment

To analyze the affect of growth rate on foreign direct investment

SIGINIFICANCE OF THE STUDY

Our study is about the impact of exchange rate and growth rate on foreign direct investment in Pakistan. In which we will see that how the factors are directly or indirectly affect the foreign direct investment, and creates the changing’s in foreign direct investment, based on the available literature.

Literature Review

Investment whether domestic or foreign, has become an important issue to discuss, particularly; in the countries where saving investment gap prevails like Pakistan. The objective of your research is to find out how much growth, foreign exchange and corruption factors that affect the foreign direct investment in Pakistan.

(Mohsin Hussain Ahmad, 2003) examining the determinants and its effects on FDI. Pakistan’s trade pattern and trade policy have been moving towards fewer and fewer controls, tariffs rates have come tumbling down. International trade and development theory suggests that export growth contributes positively to economic growth. The relationship with exports and growth, grounded in endogenous growth theory, has been tested for Pakistan (Lubna Hasan, 1995); (Ahmad Butt, 2000); (Akbar, 2000). The rapid growth in foreign direct investment over the last few decades, 5 percent of world GDP in 1980 to 10 percent in 1995 (World Investment Report, 1997) , The effects of FDI can be wide-reaching, with evidence suggesting that FDI impacts significantly on trade, employment and factor cost. In this context, intrinsic importance of foreign direct investment (FDI), focusing only on trade as a proxy for openness may be misleading (Goldberg, 1999). (Sun Chai, 1998) Summaries the argument about nexus between economic growth and inward FDI as follows; foreign capital inflow augments the supply of funds for investment thus promoting capital formation in the host country. Inward FDI can stimulate local investment by increasing domestic investment through links in the production chain when foreign firms buy locally made inputs or when foreign firms supply source intermediate inputs to local firms. Furthermore, inward FDI can increase the host country’s export capacity causing the developing country to increase its foreign exchange earnings. Thus, we examine the effects of openness in the Pakistan economy by taking into account both the trade and FDI growth links. In this paper, we analyze existence of causality between export, FDI and domestic output in Pakistan over the period 1972-2001. We found the long run relation between foreign direct investment, export and domestic growth. In short, these findings suggest Pakistan’s capacity to progress on economic development will depend on her performance in attracting foreign capital. Pakistan’s outward looking development strategy should include FDI as an essential part in addition to export promotion strategy.

(Lyroudi Katerina, 2004) We focus on our present study to investigate further the effects of FDI on the host country’s growth. The effects of FDI from the viewpoint of the target country have also been examined thoroughly, but the empirical results are contradictory. Foreign direct investments (FDI) as transmitted by the multinational corporations have several welfare implications, one of which is the effect of FDI on the economic growth of the recipient country. Most researchers examining the effects of FDI on economic growth have focused on the U.S. and on Western European economies. The effects of FDI on the target’s growth have significant policy implications. If FDI has a positive impact on economic growth, then a host country should encourage FDI flows by offering tax incentives, infrastructure subsidies, import duty exemptions and other measures to attract FDI. If FDI has a negative impact on economic growth, then a host country should take precautionary measures to discourage and restrict such capital inflows. FDI is one of the three major private capital inflows along with bank loans and portfolio capital to host countries. In 2000 private capital flows to emerging market economies were almost $ 200 billion and FDI accounted for 60 % of that amount (Carcovic, 2002).This study examined the relationship of FDI and economic growth for selected transition economies. The selection was based on data availability. The evidence from the statistical analysis suggests that foreign direct investment (FDI) does not have any significant relationship with economic growth for transition countries. We derive the same conclusions after splitting our sample into low and high income/growth countries. Finally, the use of informative priors did not change the results. Therefore, we conclude that after removing outlier’s effects from our data set, FDI does not apply any strong influence on growth. (Mills, 2002).

(Saqib gulzar, 2005) In this article, the latest econometric time series techniques, an attempt is made to identify some of the factors that influence the exports of Pakistan in the period from financial year (FY) 1972 to 2005. The exports of goods and services play an imperative role in the economic development of a country and signify one of the most important sources of foreign exchange income. Exports not only ease the pressure on the balance of payments but also create employment opportunities. They can increase intra-industry trade, help the country to integrate in the world economy and reduce the impact of external shocks on the domestic economy. Many researchers have investigated the role of exports in economic growth and the factors that influence it. (Gylfason, 1997) has taken the data of 160 countries for the period 1985-1994 and finds that high inflation and an abundance of natural resources tended to be associated with low exports and slow growth. (Mohsin, 2004). Findings do not suggest a kind of FDI-led export growth linkage and confirm that most of multinational firms’ investments in Pakistan were not export-oriented investments under the observed period 1972-2001. (Faisal, 2004) Explain that the basic problem for Pakistan is that, its exports are mostly raw materials, which are subject to severe price fluctuations in international market prices. The main exports of Pakistan, cotton and rice, are less competitive in international markets. (Ali, 2005) Finds that in Pakistan exports are positively affected by exchange rate instability and real devaluation helps in improving the trade balance by reducing imports and increasing exports. (Sadia, 2006) findings show that the import of raw materials and capital goods have an important role in boosting the overall export level of the country; whereas, the country’s exports are more sensitive to the import of raw material rather than capital imports. In this paper, with the help of an econometric model, effort is made to find out how the exports of Pakistan are influenced by different factors such as the agriculture growth rate, commodities producing sector growth rate, domestic saving, inflation rate, manufacturing sector growth rate, GNP per capita, total consumption, and school enrollment. We find that exports are positively correlated with percentage change in the volume of agriculture growth rate, domestic saving, CPI inflation rate, manufacturing sector growth rate, and per capita GNP. It is negatively correlated with percentage change in the volume of total consumption, commodities producing sector growth rate, and school enrollment. Moreover, our estimated results illustrate that the relationship between exports and all the variables are significant; inf, pcgnp, agri, and manu at 1%, cpro at 2%, tcon, and senr at 5% and cpro at 10%.

(Johnson, 2005) Economic growth is one of the fundamental questions in economics and has generated a large body of research. The importance of technology for economic growth provides an important link between FDI inflows and host country economic growth. It is theoretically straightforward to argue that inflows of FDI have a potential for increasing the rate of economic growth in the host country. Inflows of physical capital resulting from FDI could also increase the rate of economic growth but it is argued in this paper that the most important effect comes from spillovers of technology. MNE operations in the host country can result in technology spillovers from FDI whereby domestic firms adopt superior MNE technology which enables them to improve their productivity. Technology spillovers thereby generate a positive externality that should allow the host country to enhance its long-run growth rate. The paper starts by discussing and modeling the potential of FDI to affect host country economic growth. The paper argues that out of two primary channels for FDI effects on economic growth, inflows of physical capital and technology spillovers respectively, it is technology spillovers that have the strongest potential to enhance economic growth in the host country. Using panel data analysis the empirical part of the paper finds indications that FDI inflows enhance economic growth in developing economies but not in developed economies.

(Neumayer, 2005) First, unlike these studies that mainly addresses trade openness, we look also at penetration by foreign direct investment (FDI) defined as the stock of FDI over gross domestic product (GDP). Rather than trade openness alone, FDI is often directly accused of engaging in exploitative activities as such notorious cases involving Nike exemplify. Second, like most studies we use the labor force participation rate of 10-14-year old children as the dependent variable in our main estimations, but we also test the robustness of our results on three other dependent variables that capture different aspects of the child labor problem. One of these has never been examined in this context and measures the number of economic sectors in developing countries, in which evidence for child labor can be found. The other two measure the primary school and the secondary school nonattendance rates. Our analysis provides some evidence those countries that are more open to trade and are more penetrated by FDI display a lower incidence of child labor. The primary school nonattendance rate is the only dependent variable, for which we find no effect of globalization throughout, a result, which confirms the (Cigno, 2002) analysis. Indeed, our model does not explain well variation in this dependent variable. Part of the reason for this is likely to be found in the non- availability of data on options for higher levels of schooling and the costs of schooling. For all other dependent variables, either the trade openness or the FDI stock variable is statistically significant, with the exception of the secondary nonattendance rate where trade openness becomes marginally insignificant in the reduced sample size model. For our preferred dependent variable, the labor force participation rate of children between the age 10 and 14, both measures of globalization are significant with the expected sign. This is confirmed by outlier analysis and the exclusion of Eastern European and Central Asian countries from the sample. Both trade openness and FDI are also significant for the dependent variable, which counts the number of economic sectors with child labor incidence.

(Ibrahim, 2005) The main objective if this paper is to test the impact of terrorism on the inflows of FDI to LDCs using a panel of 136 LDC countries. The model of the study takes the following three groups of variables into account; government barriers to FDI, terrorist attacks and other variables such as population and GDP of the receiving country. This paper attempts to test the impact of terrorism on FDI inflows to the LDC receiving countries, using a panel data for a group of 136 LDCs. The model of the study includes a set of three government barriers to FDI; terrorism, population and GDP of FDI receiving countries. Panel unit root tests show that except for GDP the variables of the panel are mainly unit root free either in their levels or first differences. In general GDP was found to be unit root free in its first difference. Co-integration tests show that using Pedroni based co-integration tests; the panel of data for the 136 countries is co-integrated. The same conclusion is found using the (Augmented Dickey Fuller) ADF test.

(Wagner, 2005) “This paper presents the first empirical test with German establishment level data of a hypothesis derived by Helpman, Melitz and Yeaple in a model that explains the decision of heterogeneous firms to serve foreign markets either trough exports or foreign direct investment: only the more productive firms choose to serve the foreign markets, and the most productive among this group will further choose to serve these markets via foreign direct investments. Using a non-parametric test for first order stochastic dominance it is shown that, in line with this hypothesis, the productivity distribution of foreign direct investors dominates that of exporters, which in turn dominates that of national market suppliers. A new literature emerged during the past ten years that used longitudinal data for hundreds of thousands of plants from various countries to demonstrate that exporters and non-exporters differ within industries. A survey of 45 micro econometric studies with data from 33 countries that were published between 1995 and 2004 finds that, details aside, exporters are more productive than their counterparts which sell on the domestic market only, and that the more productive firms self select into export markets, while exporting does not necessarily improve productivity”.

(Velde, 2006) This article examines trends in the relationship between FDI and development in an historical context. This article provides a brief survey of the evolving state of knowledge about the FDI-development. FDI used to be viewed as unhelpful, negative and bringing inappropriate technology to developing countries. More than four decades on, a radically different view from the beginning of the period has emerged. FDI is now seen as beneficial and nearly all countries try to provide a welcoming climate for investment. Countries increasingly recognize that they can affect the attraction of FDI using both general economic policies and appropriate specific FDI policies. However, at the same time as country governments have begun to realize the positive aspects of FDI, are more on FDI and its development has now emerged in the research community, which views the impact of FDI on economic growth as not only positive or negative, but that the effects depend on the type of FDI, firm characteristics, economic conditions and policies. The type and sequencing of general and specific policies in areas covering investment, trade, innovation and human resources are now seen as crucial in affecting the link between FDI and development. While FDI is often superior in terms of capital and technology, spillovers to local economic development is not automatic. Appropriate policies to benefit from FDI include building up local human resource and technological capabilities to raise the absorptive capacity to capture productivity spillovers from Transnational Corporations (TNCs). The roles of investment, especially foreign direct investment (FDI), There have always been views in favor of FDI and against it. Some argue that FDI leads to economic growth and productivity increases in the economy as a whole and hence contributes to differences in economic growth and development performances across countries, but others stress the risk of FDI destroying local capabilities and extracting natural resources without adequately compensating poor countries. The FDI measures were high in the early part of the 20th century, low in the middle part and growing and high towards the end. Recently there has been an increase in FDI to developing countries, with variations across regions and countries. Inward FDI to developing countries has always been concentrated in a handful of countries, in part reflecting their economic wealth and policy barriers. However, the determinants of FDI and hence FDI induced growth prospects have changed over time. While policy barriers to trade and investment have affected the attraction of FDI in many countries for long periods of time, FDI is increasingly looking for “sticky” places in the web of global production processes, and thus in need of good economic fundamentals such as market size and growth, good quality and appropriate skills and infrastructure, and local technological capabilities.

(Mahr Muhammad Yousaf, 2008) The objective of this paper is to analyze the impact FDI on imports, exports and identify the constraints confronting foreign investment. Most developing countries such as Pakistan now considered FDI as the major external source of funding to meet obligations of resources gap and economic growth, however it is difficult to measure economic effects with precision. Nevertheless, various empirical studies showed a significant role of inward FDI in economic growth of the developing countries, through its contribution in human resources, capital formation, enhancing of organizational and managerial skills, and transfer of technology, promoting exports and imports and the network effect of marketing. The other positive spillover effect was that the presence of foreign firm helps expand infrastructure facilities, which makes it easier and profitable for local firms to crowd-in. The negative impacts occur with competition over scarce resources and limited skilled manpower, due to strategic motives by the affiliates of Multinational Corporations (MNCs) or the high technological gap between local and foreign firms. Foreign Direct Investment (FDI) has become an important growth factor in the globalization of the world economy. The countries that experienced faster growth rate of GDP were considered successful and have been attracting larger amount of FDI. In developing countries FDI was helpful to narrow down the Saving-Investment gap. A Multinational company’s decision to expand its business to another country was mostly based on high efficiency, low production cost, availability of strategic raw material and emerging market. The economic benefits of FDI were wide-ranging; it opened new avenues of knowledge, transfer of technology, training of manpower, market networking and many other spillover effects and externalities in the host countries. Numbers of the developing countries including Pakistan have taken effective policies and aggressively pushing economic reforms to attract foreign investments including FDI. However, the local conditions can restrict the potential benefits produced by FDI despite of instrumental policies. This research study empirically analyzed impacts of FDI on Pakistani imports and exports. The analysis relied on annual time series data over the period of 1973 to 2004. This study applied the Unit roots (ADF test) to check the stationary of the data used in the analysis. Co-integration was used to analyze the long run relationship among the variables and Error-Correction (EC) techniques to estimates the FDI and other explanatory variables that affect the dependent variables. The results of the import model showed that FDI has positive relation with real demand for imports in the short run and in the long run. The results of export model expressed that FDI has negative relation with real exports in the short-run and positive relation in the long run. The results of import model expressed that one percent increase in FDI; real demand for import would increase by 0.078 percent in the short-run and 0.522 percent in the long run. The export model estimations indicated that one percent increase in FDI, real export would decrease by -0.079 percent in the short-run and increase by 1.623 percent in the long run.On the basis of this study’s results, the following recommendations are suggested for the long-run economic benefits of FDI in Pakistan:

â- Policy makers should provide conducive and friendly environment to foreign investors to attract more FDI.

â- Foreign investor should be given more incentives for the transfer of technology to host country. This would lubricate the local enterprises.

â- For Pakistan import-substitution policy related FDI may prove good.

(Mughal, 2008)What changes have these inflows brought to the national economy? Have they led to growth in the GDP? Or has their effect been to increase short-term consumption? In other words, have the FDIs been beneficial for the country in the long run, or have the effects been limited to the short term? This article aims at finding answers to these questions. The smallish impact of FDIs on the Pakistani GDP can be explained through their sectoral decomposition. These investments, in the short run, have increased the growth rate as well as the country’s international trade. This sheds light on the fact that entrance of international banks (often through M&As) has coincided with rapid rise of consumer financing-led imports, particularly those of automobiles, mobile telephones and other electronic consumer items. Pakistan, with less than one million mobile phone subscribers in 2000, has now as many as 60 million cell-phone users. All the mobile telecommunication companies are now partly or fully foreign-owned, while the Japanese car-makers in Pakistan have doubled their car production in the last five years. Import of petroleum has risen and the inflating oil import bill has added to the balance of payment deficit. This consumption-based growth should cause inflation in the short term, precisely what shown by our study. Likewise, a considerably slow pace of export growth in the short run compared to imports means that FDI has not improved by much the exportable surplus of the country. In this study, we sought to know what kind of effect foreign investment has had on the Pakistani economy. We determine that FDI does have a positive effect on the economy, particularly in the short-term. FDI is also found to be inflationary. We estimate that the role of foreign investment in the economy is less important than that of domestic investment. We find little evidence of knowledge-transfers through skill development of Pakistani workforce. We can thus say that FDIs neither been an absolute boon, nor a downright bane for Pakistan. They have instead, just like much else in our lives, been a mixed bag.

(Filiz Elmas, 2009) The purpose of this study is to analyze the micro effects of FDI in the Turkish manufacturing industries. Foreign direct investment (FDI) is usually done by multinational corporations. As a matter of fact, direct investors seek to have an effective voice in the management of a nonresident enterprise. The mainstream approach suggests that the importance of FDI has been increasing because it is seen as a way to fill the gaps between saving and investment in developing countries; moreover, it is believed that FDI alters industrial structure and provides bene