Central Asia Journal No. 64

Significance of Foreign Direct Investment in the Economic Development of Pakistan and Afghanistan

 

Dr. Muhammad Azam*

 

Abstract

 The present study focuses on the significance of Foreign Direct investment (FDI) in economic development, and a comparison of FDI in Central Asia in general and in Pakistan and Afghanistan in particular. For analysis secondary data has been used, taken from World Development Indicator (2007) over the period of 1991-2006. The study concludes that the inflow of FDI into Pakistan and Afghanistan are gradually increased. The inflow of FDI into Pakistan was US$ 258.42 million in 1991, and in the same year in Afghanistan it was zero but in the year 2007 the inflow of FDI into Pakistan increased to US$ 4273 million and into Afghanistan it was at US$ 288 during 2007. The more profitable areas which have been identified for FDI in both the countries are energy sector, information technology & telecom, education, engineering, mining, machinery, construction, pharmaceutical and the power sector. Thus, it has been concluded that FDI improves the social welfare of the society by providing employment opportunities, increasing per capita income, reducing poverty, improving trade and accelerating economic development of the country. Therefore, for enhancing more FDI this study suggest that both the government of Pakistan and government of Afghanistan need to encourage physical infrastructure and reduce political instability and terrorism, which are the main hindrance in the way of FDI inflow.

 

Introduction

 

Foreign direct investment (hearafter FDI) is direct investment in abroad where the investors have a complete controll over their capital. There is difference between portfolio investment and foreign direct investment. Hence in case of FDI, the investors have direct effective control or managerial involvement on their investing capital while in case of Portfolio investment they have no managerial involvement and control. 

Usually, FDI made by large multinational corporations (MNCs) through merger and acquisition, or through the construction of a new facility. Moreover, FDI composed of three parts as given:

1. Equity capital: It is the foreign direct investors’ purchase of shares of a firm in a country other than its own shares.
2.  Reinvested earnings: It is refers to the retained profits of affiliates that are not distributed as dividends or not remitted to the direct investor but used to reinvest.

iii.  Intra-company loans refer taking loan and providing loan between parent enterprises and member enterprises in the short period or long-term period of time.

 

IMF (2003) defined direct investment is comparatively more stable than the other forms of foreign capital inflows.  This kind of investment not changes quickly the investment environment in the host country while the others form of investment do.

Dunning (1994) , reported that there are four main reasons for undertaking FDI abroad and these are; Market Seeking:  Multinational Enterprises (MNEs) may go abroad to find new purchasers for goods and services. The management authority of the MNEs may understand that their product is better in overseas markets and look to take benefit of this opportunity, or simply to save on operational costs like transportation cost etc. For example General Motors’ investment in China is market seeking because the cars built in China are sold in China. Resource Seeking: The credit of this theory goes to Penrose (1958) , and Cantwell (1989) . Investors, according to this theory, invest abroad to secure a more stable or cheaper supply of inputs. These generally include raw materials, petroleum, natural gas, or timber, but also other factors of production. MNEs also look to take advantage of low cost of production in overseas /foreign market because of cheap inputs of production (i.e., land, labor, capital and natural resources) than at home.  Strategic Asset Seeking: MNEs may invest in abroad in order to help build strategic assets, such as distribution networks or new advanced technology. This may involve the establishment of partnerships with other existing foreign firms that specialize in certain aspects of production. Efficiency Seeking: MNEs also look for to reorganize their overseas holdings in response to broader economic changes. For instance, the introduction of a new free trade agreement among a group of countries may rapidly make a facility located in one of those countries more competitive, because of access for the facility to lower tariff rates within the group. Fluctuations in exchange rates may also change the profit calculations of a firm, leading the firm to shift the allocation of its resources.

 

The Case of Pakistan

 

Pakistan is the 9^th most populous country of the world, with 156 million hardworking people. In Pakistan foreign and domestic investors can direly invest in every sector and even there are no limitations on bringing in or taking out capital. The government of Pakistan desire to encourage investors in order to support investment activities in Pakistan.  Pakistan is gateway for foreign investors into Central Asia through which the volume of external trade can be expanded.

Although Pakistan has succeeded in attracting US$ 4273 million in FDI during the year 2006 as against US$ 2201 million in the period last year, showing a sound increase (World Development Indicator, 2007) . Almost 70 % of FDI has come into power sector; telecommunication sector; chemicals, pharmaceutical and fertilizer; oil and gas; and banking and finance Large size of market, more domestic investment, trade liberalization, little indirect taxes, low inflation, and low external debt are encouraging FDI inflows into Pakistan. Significant improvement in the country’s overall macroeconomic environment and sound policies have helped attract relatively large inflows of FDI in Pakistan. Presently, the key areas for FDI in Pakistan are energy sector, IT, engineering, mining, tourism, pharmaceuticals, beverages, equipments, textiles, and the power sector.

 

The case of Afghanistan

 

Almost more than 20 years of quarrel and due to political and economic instability, at this time, the majority of Afghanis still live in depressing poverty without access to even safe drinking water or electricity to improve their living standards. To attain prosperity and develop Afghanistan, Afghanistan offers broad opportunities for foreign as well as domestic investors. However, poor infrastructure and imbalance security situation make Afghanistan a challenging business environment. Though, the Silk Route, Afghanistan's location makes it a natural hub for trade and transit between Central and South Asia and has 28-million person domestic market. Infact, many foreign companies find great rewards in setting up training programs for Afghan workers. Such as the Afghanistan Transitional Commercial Law Project also helps through the Afghan Embassy in USA to encourage FDI inflows into Afghanistan . Government of Afghanistan is trying to promote a business-friendly environment and to enhance more FDI. However, it has been observed that accurtae data on FDI for Afghanistan are not available and whatever, data available figures are not reliable because of inconsistencies in data collection. FDI inflows has been recorded into Afghanistan during 2007 was US$ 288 million and total FDI stocks at US$1,116 million, representing 12.6% of gross domestic product (GDP). The top FDI destination sectors were services, agriculture, and construction; the largest investors were the USA, Turkey, South Africa, Pakistan, and Iran. It is important to note that AISA's data track approved, rather than actual .

The main objectives of this study are to examine the importance of FDI in the economic development of Pakistan and Afghanistan, to know about the trend of FDI into Pakistan and Afghanistan and further to make some suggestion in the light of findings for encouraging more FDI into the said countries.

 

Data and Methodology

 

This study is based on secondary data as it is clear from the nature of the study. This is a qualitative study using data for the period from 1991 to 2006. The data would be obtained from the World Development Indicator (2007), and Federal Bureau of Statistics, Pakistan (2008) respectively. As this study is qualitative study, therefore, for the data analysis the methods of tabulation and figure are used.

 

Significance of FDI on the Recipient Countries

 

Positive Effects of FDI

 

Though significance of FDI is somehow controversial issue; as many economists are in favour of FDI and many are against of FDI. Some studies have highlighted the role of FDI on economic growth and concludes that FDI from advanced economies has positive effect on economic growth in less developed host economies through the of process technological diffusion (Borensztein et al., 1998 ; Findly, 1978 ; Wang et. al., 1992) .  Also foreign investment has become an important means of financial private external finance for developing countries and also a dynamic catalyst for modern economic development. Due to the shortage of capital, both Pakistan and Afghanistan actively seeks to enhance foreign investment. As well it is claimed, that FDI, influences the process of economic growth by filling up the saving-investment gap, fills trade gap, increasing productivity and employment opportunities, raises the revenues for the development, transferring advanced technology, provides not only capital requirements, but also managerial, technological skills and innovations in techniques, encourages the local enterprise, increase government revenue and so on. Since FDI is often seen as an important catalyst for the economic development of poor economies.

 

Negative Effects of FDI

 

Along with the above mentioned supportive arguments there are some arguments which stand against of FDI. On the basis of thorough literature studies FDI not always contribute positively but it can also worsen (If the value of imported capital goods is greater than the value of final exports of multinational corporations (MNCs), the FDI will have worsened the trade balance) a host country’s balance of payments (BoPs) and FDI flows can be particularly beneficial when access to other types of foreign capital is limited. Moreover, those who are not in favour of FDI, says that, the concentration of FDI is only in urban areas and it discourages or suppresses domestic entrepreneurship. Almost all development economist are not absolutely agree on the positive impact of FDI on economic, while it is stated that FDI provide no benefit to the recipient countries because instead of reinvestment, the foreign companies send back profit into their respective home countries . Though through FDI MNCs (MNCs is a company, firm or enterprise with its headquarter in developed countries) provides multiple products for consumption but in particularly in developing countries it creates biasness because the poor people have no or less purchasing power while the affluent have.  MNCs also generate negative externalities in the form of pollution creation, which discourage welfare of recipient countries. Jocelyn and Saggi (1998) argued that the FDI transmission to developing countries is of lower quality. It means that technology, transfer by the MNCs is absolutely more advanced than indigenous technologies, and some time the technology which transfer to under developing countries are obsolete/outdated and some time it is over-priced.

 

Inflows of FDI into Central Asia and Pakistan

 

The following Table 1 depicts that the inflow of FDI into Central Asia countries and Pakistan is gradually increasing. It is clear from the data which has been taken from the World Development Indicator (2007) that during 1991 except Pakistan all other countries of Central Asia have a negligible amount of FDI inflows. Further, in case of Kazakhstan the inflow of FDI is increasing rapidly if compare with the other Central Asia countries, Pakistan and Afghanistan during last sixteen years.

 

Results and Discussion

 

According to the studies done by various economists and researchers, FDI contribute positively in the process of economic growth.  FDI is seen as a source of financing development and of transferring skills, knowledge and technology from rich countries to poor countries. For poor countries foreign investment particularly FDI is considered a key source of finance, providing a bundle of benefits to the recipient countries. Such benefits include filling up the saving-investment gap, fills trade gap, superior technology, managerial skills, different tastes and life style, increasing productivity and employment opportunities, that all of which contribute to economic development.

It has been observed that inflow of FDI into Central Asia, Pakistan and Afghanistan are increasing as the inflow of FDI into Pakistan was US$ 258.42 million in 1991, and in the same year in Afghanistan it was zero but in the year 2006 the inflow of FDI into Pakistan increased to US$ 4273 million and into Afghanistan it was at US$ 288 during 2007.  Further, the present study finds that in case of Pakistan the major contributors are UAE, USA, UK, Hong Kong, Switzerland and other countries. Similarly, in Afghanistan the largest investors were Turkey, USA, China, UAE, Iran and Pakistan respectively. No doubt, that FDI improves the welfare of the population by providing employment opportunities, reducing poverty, improving trade and accelerating growth and economic development. Moreover, higher amount of FDI contributes to achieving higher level of economic growth, as a result high growth performances would augmented further capital inflows that is called virtuous circle of capital flows and economic growth.

 

Conclusion

 

Due to paucity of capital, finance and lack of appropriate technology both Pakistan and Afghanistan actively seeks to enhance more foreign investment. In this study it has been concluded that FDI is very much crucial for economic development because it provides tangible and intangible assets to the recipient countries. The tangible assets like finance, capital and increases revenue etc, while the intangible assets are managerial skill, creation of job opportunities, provision of different life style and tastes and competition among domestic investors etc. A comparison of the inflows of FDI with other Central Asian countries shows that the inflow of FDI is comparatively high in case of Pakistan and Kazakhstan. But still the inflow of FDI is not desirable in respect of other Asian countries. The more profitable areas that have been identified for FDI both in Pakistan and Afghanistan are energy sector, telecommunications, education, engineering, mining, pharmaceutical, beverages, equipment, and the power sector. Thus, the enhancements of FDI will boost the process of economic development through generating employment opportunities and increasing per capita income and the ultimate result would be prosperity of the society. This study suggest that both the Government of Pakistan and Government of Afghanistan need to encourage domestic infrastructure, reduce political instability and terrorism in the areas, which are the main hindrance in the way of FDI inflow. In addition, management authorities need to formulate adequate policies which are more conducive for FDI enhancement.

 

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