An Analysis of Policy and Non-Policy Determinants of Foreign Direct Investment in Pakistan

Abstract

Foreign Direct Investment (FDI) inflows are considered beneficial for host countries as this kind of investment brings a complete package of benefits including capital inflows, management, entrepreneurship, technological skills, a source of business competition and innovation. Therefore, countries provide competitive incentives to attract foreign investors. Pakistan has been offering several policy packages and incentives but has not been able to attract a significant amount of FDI. The dissertation aims to examine the determinants of FDI inflows to Pakistan. Having the knowledge of the factors that determine the inflow of FDI is very crucial for the policymakers in devising FDI relevant policies. They will come to know the factors that motivate or deter FDI inflows. It adds to the existing available literature by providing an extended framework on the determinants adopting a funnel of three different levels: country, sectors, and firms. The econometric technique of Auto Regressive Distributed Lag (ARDL) bounds testing has been used to examine policy and non-policy determinants of FDI inflows at the country and sectoral levels (primary, secondary, tertiary) for the period 1984-2015. The results reveal that corporate tax rate, inflation, and corruption are negatively associated with FDI inflows while infrastructure, trade openness (TO), and GDP per capita (market size) are positively associated with FDI at country level. At the sectoral level, results reveal that corporate tax rate is negatively associated with primary FDI and availability of natural resources is positively associated with primary FDI; inflation and exchange rate volatility have a negative associated with secondary FDI whereas energy, TO, and infrastructure show positive association with secondary FDI; existing services FDI stock, labor quality, infrastructure, and market size are positively associated with tertiary FDI while corporate tax rate and inflation are negatively associated with tertiary FDI. Lastly, at the firm level, the World Bank’s Enterprise Survey data 2013 based on the responses from 1247 firms have been used. The 13 statistical findings reveal that electricity shortfall and corruption are the obstacles to doing business in Pakistan. The manufacturing sector is facing more power outages. The corruption in the provision of different public service is detrimental to investment in the country, especially getting electricity connections. Further, the manufacturing sector experiences more corruption than the services sector. Among sub-sectors of the manufacturing and the services, the firms relating to the business of non-metallic and mineral products experience more bribery, followed by the textile sector. The region, firms operating in Baluchistan are experiencing more bribe. Lastly, the MNEs operating in Pakistan experience more bribe than domestic firms. The research findings have some implications for both policymakers and firms. Pakistan as an investment location has some deterring factors such as corruption, higher tax rates, financial and economic instability, and consistent electricity shortfall. These factors should be dealt with by relevant state institutions to make Pakistan favorable investment location. The factors, corruption and electricity shortage increase the cost of doing business in Pakistan while higher tax rates reduce the profitability margin of the firms.