Effect of Foreign Direct Investment on Economic Growth of Pakistan: The ARDL Approach

Purpose: This study investigates the effect of foreign direct investment on the economic growth of Pakistan. It also explores the role and contribution of various variables in the growth of the country’s economy. Design/methodology/approach: This study examines both the long run and the short run relationship between the variables over the period 1974 - 2018 by the Auto-Regressive Distributed Lag approach. Findings: We find that in the long run, FDI, gross fixed capital formation and labor force participation have positive effect on the economic growth, whereas military expenditures have negative effect. In the short run model, however, gross fixed capital formation was indicative of having a significantly negative relationship with the economic growth while variables such as FDI, military expenditures and labor force participation were found to have positive impact. Inflation turned out to be significant but negative in both of the models while final consumption expenditure showed insignificance in both of the models. Research limitations/implications: Notwithstanding its contribution to the literature, this study has limitations as well. Apart from those measures adopted in this research, there are also other important measures necessary for a country’s economic growth such as skilled labor, work environment, infrastructure, security, technology, and so on. Yet, due to the lack or unavailability of reliable data source, we have not included these valuables in our research. If incorporated in the analysis, these measures may provide more accurate results. Pakistan is a country where military engages in various business activities such as operating department stores, military schools, universities, and hospitals and as well as constructing roads and buildings. Thus such services and contributions of the military, if studied thoroughly, may provide better statistics regarding inward FDI and its contribution towards economic growth of the country. As a policy implication, this study suggests that the Pakistani government should focus on the necessary reforms to attract more FDI, since a low-capital country like Pakistan cannot underestimate the significance of FDI for a sustainable growth. Further researches may be conducted with a focus on the growth-investment possibilities of China Pakistan Economic Corridor. Studies can also be conducted which incorporate agricultural sectors, public and private investments, trust (between land/firm owners and labor) and the existing work/business environment in order to investigate the determinants of economic development of the country. Originality/Value: To the best of our knowledge, there is only one study by Nilofer & Qayyum (2018) that uses the ARDL model to investigate the impact of FDI on economic growth of Pakistan. While they analyzed the variables including GDP, government consumption expenditure, public investment, FDI and lending rate, our study involves military expenditure, labor force participation, final consumption expenditure, gross fixed capital formation, inflation, and FDI. Also, we investigate the role of FDI on economic growth of Pakistan for a different time period 1974 to 2018 as compared to their study over the period 1970 - 2015.