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Old Saturday, October 11, 2008
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Thumbs up Foreign Direct Investment (FDI)

Foreign Direct Investment (FDI)


1. What is Foreign Direct Investment?
2. Understanding Foreign Direct Investment
3. Determinants of FDI
4. Basic types of FDI
5. FDI based on the motives of the investing firm
6. Importance of FDI
7. Policies to attract Foreign Direct Investment
8. History of FDI
9. Foreign Direct Investment in Asia
10. Foreign Direct Investment in Pakistan
11. Economic policies attracting FDI in Pakistan
12. Foreign Direct Investment and Poverty Reduction
13. Conclusion

What is Foreign Direct Investment?

Foreign direct investment (FDI) is defined as a long-term investment by a foreign direct investor in an enterprise resident in an economy other than that in which the foreign direct investor is based. The FDI relationship consists of a parent enterprise and a foreign affiliate which together form a transnational corporation (TNC). In order to qualify as FDI the investment must afford the parent enterprise control over its foreign affiliate. The UN defines control in this case as owning 10% or more of the ordinary shares or voting power of an incorporated firm or its equivalent for an unincorporated firm.

Understanding Foreign Direct Investment

Foreign direct investment (FDI) plays an extraordinary and growing role in global business. It can provide a firm with new markets and marketing channels, cheaper production facilities, access to new technology, products, skills and financing. For a host country or the foreign firm which receives the investment, it can provide a source of new technologies, capital, processes, products, organizational technologies and management skills, and as such can provide a strong impetus to economic development. Foreign direct investment, in its classic definition, is defined as a company from one country making a physical investment into building a factory in another country. 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, 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. The sea change in trade and investment policies and the regulatory environment globally in the past decade, including trade policy and tariff liberalization, easing of restrictions on foreign investment and acquisition in many nations, and the deregulation and privatization of many industries, has probably been the most significant catalyst for FDI’s expanded role.

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.
Proponents of foreign investment point out that the exchange of investment flows benefits both the home country (the country from which the investment originates) and the host country (the destination of the investment). The push factors indicate the benefits to the investors and the pull factors to the host countries. First, international flows of capital reduce the risk faced by owners of capital by allowing them to diversify their lending and investment. Second, FDI allows capital to seek out the highest rate of return. Third, FDI helps to expand market. For the host countries, it can contribute to the general development as well as to the poverty reduction objective in a variety of ways. Major benefits to host countries are as follows:

• FDI allows transfer of technology—particularly in the form of new varieties of capital inputs—that cannot be achieved through financial investments or trade in goods and services. FDI can also promote competition in the domestic input market.
• Recipients of FDI often gain employee training in the course of operating the new businesses, which contributes to human capital development in the host country.
• Profits generated by FDI contribute to corporate tax revenues in the host country. Thus, it contributes not only to the direct source of investment but also to the government revenue.
• FDI helps to integrate the host countries economy to the global economy.

Determinants of FDI

FDI is the investment decision of profit-maximising firms facing world-wide competition and where significant differences in cost structures (due to say, factor productivity, wage differential) justify cross-border investment and production.
a. Institutional features of the host country: degree of political stability and government intervention in the economy; the existence of property law legislation; the property and tax system; adequate infrastructure, etc.
b. Economic factors: trade and investment regime; the degree of “openness” of the host countries, the absorptive capacity and growth prospects of the host country; fix and variable costs of production relocation; the degree of monopolistic competition which prevents the entry of other (domestic and foreign firms; general macroeconomic performance (inflation, monetary and fiscal policy) etc.
c. Policy related factors: Fiscal (tax rebates and exemptions) and financial incentives (subsidized loans), laws that restrict FDI in certain sectors on the ground of political sensitivity of certain industries (oil, broadcasting, etc.); policy that restricts the degree of foreign ownership, (temporal or permanent) the remittance of interest, dividends and fees for technology and the shares allowed to foreign -owned firms through limits on capital repatriation, minimum investment, etc.
d. Characteristics of the labor force: education, skills, etc.
Some features of world FDI activity

a. The sharp increases in world FDI activities that started after 1985.
b. Increased activity and concentration of FDI. Indeed, in the 1990s, FDI has become one of the most important sources of external finance in developing countries.
USA has become the largest host country in international capital markets, receiving capital from both Japan and Europe. Japan has emerged as a major home country of FDI outflows.

c. Developing countries have liberalized financial markets and offered special incentives (lower taxes, subsidies for infrastructure, etc) to attract FDI in the hope of acquiring technological transfer, know-how, and in general, positive externalities.

Basic types of FDI

· 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. However, it often does this by crowding out local industry; multinationals are able to produce goods more cheaply (because of advanced technology and efficient processes) and uses up resources (labor, intermediate goods, etc). Another downside of greenfield investment is that profits from production do not feed back into the local economy, but instead to the multinational's home economy. This is in contrast to local industries whose profits flow back into the domestic economy to promote growth.

· 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.

· Horizontal Foreign Direct Investment: investment in the same industry abroad as a firm operates in at home.

· Vertical Foreign Direct Investment: Takes two forms:
1) Backward vertical FDI: where an industry abroad provides inputs for a firm's domestic production process.
2) Forward vertical FDI: in which an industry abroad sells the outputs of a firm's domestic production.

FDI based on the motives of the investing firm

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

· Resource Seeking: Investments which seek to acquire factors of production that 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.

· Market Seeking: 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.

· Efficiency Seeking: 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.
Importance of FDI
Making a direct foreign investment allows companies to accomplish several tasks:
Avoiding foreign government pressure for local production.
Circumventing trade barriers, hidden and otherwise.
Making the move from domestic export sales to a locally-based national sales office.
Capability to increase total production capacity.
Opportunities for co-production, joint ventures with local partners, joint marketing arrangements, licensing, etc.

What do companies considering FDI require?

Depending on the industry sector and type of business, a foreign direct investment may be an attractive and viable option. With rapid globalization of many industries and vertical integration rapidly taking place on a global level, at a minimum a firm needs to keep abreast of global trends in their industry. From a competitive standpoint, it is important to be aware of whether a company’s competitors are expanding into a foreign market and how they are doing that. At the same time, it also becomes important to monitor how globalization is affecting domestic clients. Often, it becomes imperative to follow the expansion of key clients overseas if an active business relationship is to be maintained.

New market access is also another major reason to invest in a foreign country. At some stage, export of product or service reaches a critical mass of amount and cost where foreign production or location begins to be more cost effective. Any decision on investing is thus a combination of a number of key factors including:

assessment of internal resources,
market analysis
market expectations.

From an internal resources standpoint, does the firm have senior management support for the investment and the internal management and system capabilities to support the set up time as well as ongoing management of a foreign subsidiary? Has the company conducted extensive market research involving both the industry, product and local regulations governing foreign investment which will set the broad market parameters for any investment decision? Is there a realistic assessment in place of what resource utilization the investment will entail? Has information on local industry and foreign investment regulations, incentives, profit retention, financing, distribution, and other factors been completely analyzed to determine the most viable vehicle for entering the market (greenfield, acquisition, merger, joint venture, etc.)? Has a plan been drawn up with reasonable expectations for expansion into the market through that local vehicle? If the foreign economy, industry or foreign investment climate is characterized by government regulation, have the relevant government agencies been contacted and concurred? Have political risk and foreign exchange risk been factored into the business plan?

Policies to attract Foreign Direct Investment

There is keen competition among developed and developing countries to attract foreign direct investment (FDI).This drive to lure investment often extends to the sub national level, with different regional authorities pursuing their own strategies and assembling their own baskets of incentives to attract new investments. Various reforms and strategies have been implemented, with mixed results. Some are critical of the high costs of many of these initiatives, arguing that it would be more rewarding to improve a country’s general business environment.

The many different methods used by policymakers to attract FDI and their effectiveness are as follows:
· providing targeted fiscal incentives, such as tax concessions, cash grants, and specific subsidies;
· improving domestic infrastructure;
· promoting local skills development to meet investor needs and expectations;
· establishing broad-reaching FDI promotion agencies;
· improving the regulatory environment and decreasing red tape; and
· engaging in international governing arrangements.

Promotional efforts to attract foreign direct investment (FDI) have become the important point of competition among developed and developing countries. This competition is also maintained when countries are adopting economic integration at another level. While some countries lowering standards to attract FDI in a "race to the bottom," others praise FDI for raising standards and welfare in recipient countries.

Countries have adopted their respective policies for attracting more investment. Some countries rely on targeted financial concessions like tax concessions, cash grants and specific subsidies. Some countries focus on improving the infrastructure and skill parameter and creating a base meet the demands and expectations of foreign investors. Others try to improve the general business climate of a country by changing the administrative barriers and red tapism. Many governments have created state agencies to help investors through this administrative paperwork. Finally most of the countries have entered into international governing arrangements to increase their attractiveness for more investment.

Sound investment climate is crucial for economic growth. Microeconomic reforms aimed at simplifying business regulations, strengthening property rights, improving labor market flexibility, and increasing firms' access to finance are necessary for raising living standards and reducing poverty in a country.

Reform is necessary for creating an investment-oriented climate. Reform management matters as investment climate reforms are done politically. They often favor unorganized over organized groups and the benefits tend to accrue only in the long term, while costs are felt up front. Political decisions play a significant role in this context. Each and every country over the globe is stepping forward to change the climate for attracting more investment. Opening up of doors by most of the nations have compelled them for adopting reforms.

Relaxation of rules and regulations, of course, is an essential requirement but not sufficient on its own to bring in FDI. As the study points out, business rules in India still bar FDI in most sectors. It was only last February that the government there decided to allow FDI of upto 51 percent in the single brand retail sector, which is expected to trigger a new flurry of investment.
As things stand, Pakistan is far ahead of India in terms of offering all kinds of incentives to foreign investors - although some administrative bottlenecks still remain to be removed. It also boasts a high economic growth rate and there exists a consensus among all political forces on following the market economy model.

Still, it has failed to catch the fancy of foreign investors at the desired level. The designated target was to raise foreign investment from 1 billion dollars to 27 billion dollars during a five-year period. That target is nowhere near realization.

The government claims to have brought foreign investment to the 3 billion dollars mark this year. But that is a fallacious claim since the money has come in on account of privatization of government-owned entities. There has only been a transfer of assets from the public sector into private hands; no new generation of activity in the retail or production sector, which is badly wanted to address the twin problems of poverty and unemployment.
The situation underscores the need not only to remove administrative hurdles but also to create ease of operations vis-à-vis law and order and the socially restrictive atmosphere.

to be continued
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Old Saturday, October 11, 2008
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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 OECD countries. FDI has grown in importance in the global economy with FDI stocks now constituting over 20 percent of global GDP.

Foreign Direct Investment in Asia

With China leading the way, foreign direct investment is expected to fly high in Asia the next five years according to The Economist Intelligence Unit.
The Economist Intelligence Unit said in a report released in Hong Kong on Thursday that foreign direct investment flows into the Asia-Pacific region had risen dramatically each year since 1992. It was also reported that in 2000 alone, 126.8 billion US dollars was invested in the region led by a wave of merger and acquisition activity.

The report said that the FDI flows into Asia will drop to 123.10 billion in 2001 as the business cycle falters, but would continue to rise to 170.7 billion dollars in 2005. Developed countries attracted the highest FDI, but developing countries would maintain a strong position and are expected to reap a 30% share of the global FDI, a ten percent increase over the next five years.

Ten countries were expected to account for as much as 70% of the world FDI figure between 2001 and 2005. The United States was expected to retain the top position for investment garnering 26.6% of the world share. China was fourth, behind Britain and Germany. However, mainland China was at the top of the list of emerging markets. Hong Kong ranked ninth globally, a remarkable achievement for such a small entity. Singapore was 14th; South Korea was 19th, just ahead of Japan.

Along with its many other problems, Japan’s monoculture and latent hostility to foreign ownership of major Japanese companies make it a difficult country in which to invest.

India ranked 24th in the list of 60 countries with its poor infrastructure, faltering privatization and stifling bureaucracy providing major hurdles to investment.

Foreign Direct Investment in Pakistan

The increase in foreign direct investment in the country during the first eight months of the current financial year (July-June), promises to project the country's investment climate. Pakistan has made new record as regard to Foreign Direct Investment (FDI) in Financial Year 2006-07.

Pakistan’s investment friendly policies have yielded record results as witnessed during the past FY 2006, which touched the record level of US $ 3.9 billion and this accelerating trend has also been witnessed during the first half of the current fiscal year 2006-07 by setting new record of FDI till December 2006 as close to US $ 3.5 billion, which was going to increase further in coming half, heading to set another new record. Pakistan has comprehensive and broad based Privatization Program, which provides exciting and attractive opportunities.

Liberal investment policy includes 100 % foreign equity in all economic sectors, with attractive incentives like remittances of capital, profits, royalty, technical and franchise fees without obtaining permission from the government.

The privatization of public sectors entities has confined the government’s role to policy making, good governance and has foster competition and increased efficiency and revenues. Exciting investment opportunities in an environment of level playing field for both local and foreign investors, effective regulatory framework with liberal policies have made Pakistan an attractive destination for investment, which has also given boost to the investors’ confidence.

The countries, which appeared prominently in raising their investments to Pakistan, were led by the United States which kept its lead among the list of foreign investors with total investments of about $1.1 billion during this period, followed by Britain with investments of $875.8 million followed by China with investments of $678.5 million and the UAE with $328.2 million.

FDI amounted to $ 962.5 million during this period as against $ 1026.0 million last year, showing a decrease of 6.2%. A major factor for this decline is attributed to the fact that during the period under consideration there was no inflow of privatization proceeds. On the other hand, Pakistan received $ 133.2 million as during the same period last year.

The US has been the single largest investor in Pakistan, accounting for 31.4% of the total FDI in the July –September 2007 followed by UK (7.8%), UAE (5.4%), Switzerland (4.1%), Mauritius (3.3%), Oman (2.5%), Japan (2.9%), Norway (2.1%), and so on. Communications along with energy sector (oil & gas, petroleum refining and power) have been the major attraction for foreign investors in Pakistan, accounting for 39.3% and 18.0% respectively, followed by financial businesses (15.4%), both cement and trade (4.6%), construction (2.4%), and transport equipment (automobiles) 2.9%.

Among the destinations towards different sectors, the sharpest rise went to the telecommunications sector, which attracted investments worth $1.28 billion followed by investments of just over $572 million going to the banking sector.

These latest statistics work as the cornerstone of Pakistan's target of foreign investment of about $6 billion during the present financial year, up from $3.87 last year.

However the sustainability of such a policy for domestic development has to be questioned. The usefulness of foreign direct investment, whereby foreign investors bring their capital and repatriate their earnings, profits, debt servicing, royalties, technical fees and even capital, without any restrictions in reality brings no benefit to Pakistan. Under the guise of globalization many western companies place production facilities in the Third world making use of lax laws, cheap labor then sell the very same items for extortionate prices abroad.

Pakistan has not become an important destination for investors as India has over the last decade. India offers the promise of political stability, a legal system that can protect investors, a highly trained workforce, and a fairly large rate of domestic savings. It also has a large domestic market, which is of interest to foreign companies. Pakistan, on the other hand, is a country with a high level of illiteracy (only 54% of people above the age of 15 can read or write), in which political instability continues to threaten the pursuit of economic policies that could be sustained. If foreign investors have been attracted to the country it is only those who either are tapping the large market for basic goods for their own consumption. When the government claims that it has made possible large foreign direct investment into the country, it does not mention that FDI has come in the form of purchase of domestic cigarette manufacturing by America’s Altria group, or by an expansion in the presence of food and beverage companies such as Pepsi Cola and McDonald’s.

But investment in consumer products and domestic services cannot be the basis of long-term sustainable growth. During the Musharraf period, the rate of investment has increased by a third, from 17.2% of GDP in 2001-02 to 23% in 2006-07. However domestic savings have declined from 17.8% to 16.1% of GDP in the same period. This means that the economy is even more dependent on foreign flows than was the case in the 1990s. This dependence may not mean that the continuing political support of western governments and development institutions such as the World Bank is absolutely critical for economic progress. But there is now reliance on foreign companies and the money they invest in Pakistan. Hence Pakistan’s reliance on foreign funds has changed from international institutes to international companies. The claim of Islamabad that the economy is now moving on a sustainable course and that it will not be derailed by political storms is hard to accept. This is because a reliance on foreign funds can never be sustainable as foreign companies will choose the cheapest markets for production facilities that will not always be Pakistan; hence any economy which relies on foreign investment remains vulnerable to external shocks.

Economic policies attracting FDI in Pakistan

Foreign Direct Investment (FDI) and its rising trend is a welcome change in Pakistan. Liberal economic policies adopted by the government are attracting FDI in a big way. Attracting new investment, especially FDI, is the key to job creation and poverty alleviation.
Pakistan has been able to attract FDI of $ 3.5 billion. This has all been possible due to the pragmatic approach of the government to adopt a foreign policy that has contributed to providing an investment-friendly environment to foreign investors. Actually, it was a long and slow process of getting the trust and confidence of foreign investors to invest in Pakistan. The government could not succeed in attracting FDI in a big way, although a breakthrough was made by attracting investment in the power sector. This was basically due to liberalization of the economy and the policy adopted from 1991 onwards.

It was after 9/11 that new investors from the Middle East, Saudi Arabia, the United States, the United Kingdom, Germany, Switzerland, Japan and the Netherlands were attracted to invest in Pakistan. Real estate, power generation, automobiles, steel, and oil and gas exploration are some of the popular sectors in which the foreign investors are now investing. The president and prime minister of Pakistan have been visiting and addressing regional forums in Southeast Asian countries to invite investors to visit Pakistan. This has helped in boosting the confidence of investors.

Foreign investment in the power sector during Benazir’s government (1993-96) was a positive development but it was marred by corruption charges, which was obviously a discouraging factor for foreign investors. The present regime succeeded in raising Pakistan’s credit rating and improving the macroeconomic indicators. The privatization process has contributed a lot in raising the quantum of FDI during the past three years. Euro and Sukuk bonds were helpful in attracting foreign direct investment. The telecom sector is another success story, as it has been able to attract foreign investment in a big way. Nevertheless, chemical, pharmaceutical and banking sectors have impacted growth in foreign direct investment in Pakistan. Small and Medium Enterprises (SMEs) and defense technology are also attracting foreign investment. It is aimed at creating new jobs in bulk and increasing the exports of the country.

Real export growth can be achieved through heavy investment in different sectors of the economy and it needs a lot of confidence building measures by way of pursuing consistent economic policies. It is very important to observe that the present government is committed to help boost investors’ confidence by way of pursuing visionary economic policies. They are allaying the fears of investors by facilitating them by introducing tax reforms, uniformity in tax laws, transparency, and ensuring security to their investments and profits. That is why the European and Middle Eastern investors are showing a great deal of interest in Pakistan.

Expectations are high about prospective investment from China and the Southeast Asian countries. If it happens in large sums, it will play a very significant role, particularly in creating a greater number of jobs and access to financial resources even by the lower classes. It will help to combat poverty and improve the living standard of people.
We have the example of Southeast Asian countries like Singapore, Thailand, Malaysia, Indonesia and China, who have developed their economies through a strategy to attract FDI, which in return contributed to poverty alleviation and social sector development. The government should be careful in attracting FDI through the privatization of profitable state-owned companies. The strategy to provide less than 50 per cent of the shares with transfer of management, as in the case of PTCL, seems to be sound.

It is clear that foreign investors are being allowed to take their profits in dollars. It could affect the current account deficit, which is being supported by the remittances from overseas Pakistanis and the aid/loans from the developed world, especially from the US. The point is that foreign investors earned profits worth $ 2.5 billion last year and are expected to earn $ 3.0 billion in the current year, according to one estimate. If this is the case, it will definitely disturb the current account deficit. If the current account deficit rises, it will definitely disturb all other social development strategies, resulting in a great embarrassment to the government in the long run. So, there is a genuine need to carefully assess the results of the privatization policy, instead of just blindly imitating the developed world. It is believed that FDI through privatization is not that good for the economy.

The liberalization policy adopted by the government in 1991 has brought about a healthy change in the economy. It has succeeded in attracting FDI, although belatedly, which is definitely going to give an impulse to economic growth. The policy is contributing in creating jobs and will ultimately lead to poverty alleviation. It will help improve social and human resource development.

Analysis of FDI inflow in Pakistan 2006-07

FDI Inflow during July 2006 - February 2007 $2,970.8 million compared to $ 1,521.6 million during the corresponding period last year.

Top Investing Countries

Million $
% age









Leading Sectors:

Sector Million $ % age
Communication (IT&T) 1281.4 43.1
Financial Business 572.8 19.3
Oil & Gas Exploration 352.7 11.9
Trade 117.3 3.9
Power 113.8 3.8
Construction 92.8 3.1
Others 440.0 14.8
Total 2,970.8 100.0


Monthly Foreign Direct Inflow in Pakistan

S.No Months 2006-07 2005-06 2004-05 2003-04 2002-03 2001-02 2000-01
1 July 133.2 119.6 52.2 32.0 42.4 24.4 -13.0
2 August 242.2 106.2 56.6 40.4 30.4 26.4 26.0
3 September 653.6 102.9 72.3 44.5 97.4 21.9 22.3
4 October 207.3 137.0 94.2 53.4 228.9 46.9 20.3
5 November 239.7 268.4 52.4 46.6 63.0 42.0 46.8
6 December 393.6 369.2 117.3 60.2 78.3 43.5 44.7
7 January 226.4 123.4 70.0 62.4 53.1 20.0 23.3
8 February 276.9 82.6 45.3 37.2 29.4 28.7
9 March 721.1 195.0 247.5 27.5 32.9 33.2
10 April 795.5 98.9 128.1 37.7 20.2 26.7
11 May 191.8 138.2 142.4 48.8 22.1 28.1
12 June 309.0 494.3 46.6 53.3 155.0 35.3
Total 2,096.0 3,521.0 1524.0 949.4 798.0 484.7 322.4

The communication sector (including Telecom) spearheaded the FDI inflows by accounting for 34.2 percent stake during July-April 2006-07 followed by financial business (20.9 percent), energy including oil & gas and power (14.1 percent), and food, beverages and tobacco (11.8 percent). These four groups accounted for almost 80 percent of FDI inflows in the country. The pace of FDI clearly indicates that foreign investors are upbeat on Pakistan’s current and future economic prospects. The challenge for the government is therefore, to maintain consistency and continuity in economic policies. Continue to maintain macroeconomic stability and continue to pursue structural reforms in different sectors of the economy.

Foreign Direct Investment and Poverty Reduction

The role of FDIs has been crucial in spurring economic growth and poverty reduction in developing countries, especially in the context of globalization and liberalization. In recent years, developing countries have shown tremendous inclination towards attracting FDIs from high- and middle-income economies to accelerate the pace of industrialization by enhancing efficiency and competitiveness and fight against poverty.

FDI contributes to development at least in three ways: (a) It is a perennial source for new investment capital, allowing countries to raise imports and accumulate capital faster, (b) It helps encourage technology transfer and increase human capital stock and thereby stimulates long-term productivity and growth of domestic firms, and (c) It is instrumental in expediting the process of economic integration and competitiveness by helping to link developing economies to global supply and production chains. Economic growth is a critical factor for poverty reduction.

Recent studies suggest that growth tends to lift the incomes of the poor proportionately with overall growth. FDI, as a key vehicle to generate growth, is thus a most important ingredient for poverty reduction. FDI has the potential to improve the quality of growth by: (a) reducing the volatility of capital flows and incomes, (b) improving asset and income distribution at the time of privatization, (c) helping improve social and environmental standards, and (d) helping improve social safety nets and basic services for the poor

Typically, the relationship between FDI and (income) poverty reduction is segmented into the relationship between FDI and (income) growth on the one hand and that between growth and poverty reduction on the other. Regarding the relationship between FDI and growth, it is generally found that inflows of FDI encourage more rapid economic growth. FDI clearly does make a direct contribution, for example through measurable employment and income generation.

In Pakistan, FDI plays a great role in poverty reduction and in generating high growth rate of national income. Substantial trade liberalization has taken place in Pakistan which has resulted in a decrease in income inequality and poverty. But it has also brought with it the axe of lower tax revenues resulting from lower import taxes and control of the fiscal deficit fell on developing expenditures. Not only such expenditures are directly pro poor, but the employment opportunities that could have been created because of these expenditures are also foregone.

FDI is only beneficial if it comes with labor intensive technology instead of capital intensive technology. Since Pakistan is a labor abundant country and a capital intensive technology will not enhance the employment growth.
If we look deeper, then the fact is that in our country the rich is becoming richer and the poor is getting poorer. This can be illustrated by the fact that there is a gap between skilled worker that is employed in FDI and the worker in domestic industry. A person who is employee of FDI has high purchasing power, could offer a higher demand, and a person who is employee of domestic industry, has low purchasing power and would offer lower demand. It would increase the inflation by the side of FDI workers and could reduce the purchasing power of the lower one, resulting in putting them in poverty.
Moreover, FDI in the import-competing sector can not help in enhancing welfare of the country since it will result in the devaluation of the local currency and the increase in demand of the foreign currency.
Thus, FDI should be consistent with the social objective of limiting the unequalizing effects of growth in this era by synchronized public policy with the effort to decentralize the location of foreign direct investment.


FDI provides tentative answers to the five questions posed in the introduction of this paper. First, to attract any type of FDI, host developing countries need an adult population with at least basic schooling. The type of human capital necessary to attract FDI obviously depends on the type of FDI host countries seek. To attract high value-added MNEs, it is necessary to develop the tertiary education sector with close collaboration with the industry so as to formulate demanddriven programmes. Second, MNEs can contribute to the HRD of the host developing country by providing training and supporting formal education. Small and medium domestic firms tend to underinvest in training as compared to MNEs and large domestic firms, even though the former group usually enjoys higher productivity gains from training. The underinvestment appears to be due to market failures including lack of information, financial constraints and training spillovers. Third, MNEs contribute to technology transfers through numerous channels of training spillovers, including vertical/horizontal linkages, labour turnovers, and spin-offs. Host country efforts to improve the absorptive capacity have also been shown to facilitate technology transfers.

Fourth, government policies have been important to facilitate training, to minimise financial constraints and market failures, and to promote MNEs to invest in HRD of the host economy. Most of the successful training policies have been demand-driven, involving industries, MNEs, IPAs, and foreign academic institutions that have close ties with the advanced developments in technology, business administration and management. Lastly, there is limited evidence of a virtuous circle of inward FDI, HRD and technology transfers. Governments that emphasise flexible demand-driven HRD strategies, target MNEs in high value-added areas, and co-ordinate education and training policies are more likely to lead the country into a virtuous circle.

Note: It is a sample essay. Headings in essay must be omitted.
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Last edited by Shooting Star; Sunday, April 22, 2012 at 05:11 PM.
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