© Kamla-Raj 2010 J Economics, 1 (2): 99-104 (2010) Economic Determinants of Foreign Direct Investment in Pakistan Rana Ejaz Ali Khan and Muhammad Atif Nawaz* Department of Economics, The Islamia University of Bahawalpur. Bahawalpur, Pakistan Telephone: +92 062 9255456-64 ext. 433 (O), Mobile: +92 0345 8724744 E-mail: ranaejazalikhan@iub.edu.pk *Telephone: +92 063 9240298 (O), *Mobile: +92 0314 6864997, *E-mail: atifnawaz_iub@yahoo.com JEL Classification: F21, F31, E22, E31, H2. KEYWORDS Capital Inflow. Exports. National Income. Tariff ABSTRACT Pakistan aims to increase the investment GDP ratio by attracting foreign direct investment (FDI). The foreign investors mostly from the developed dynamic centers are enhancing international production by investing in resource abundant economies. Having an overview of the influx of cross border investments, this paper empirically attempted to investigate the determinants of foreign direct investment in Pakistan. The analysis enabled identification of some economic determinants of FDI in Pakistan, like GDP growth rate, volume of exports, human population, tariff on imports, and price index. Volume of exports has been emerged the most powerful determinant of FDI. The government should make a paradigm shift in its investment policy to attract FDI. It should focus on export-oriented industries instead of encouraging FDI for domestic consumption. 1. INTRODUCTION Economic development of a country involves utilization of resources for increasing productive capacity. In many developing countries such as Pakistan, utilization of resources is rendered impossible by the scarcity of domestic capital. Lizondo (1991) acknowledged a better choice by developing countries of foreign direct invest- ment (FDI) rather than to depend on bank loans and bonds. These countries could promote their economic growth, by receiving FDI (China is a classic example, where in 1997, FDI contributed about 15 percent of domestic investment, 41 per- cent of total exports, 19 percent of industrial output, 13 percent of tax revenue and 18 million employment). First, FDI transfer financial re- sources to recipients or host countries which could be used to expand production facilities in the host countries. Second, technology and mana- gerial know-how, which play crucial roles in pro- moting economic growth, may be transferred to the host countries to participate in various net- works such as sales and procurement networks of foreign investors. Using international net- works, host countries could not only expand ex- ports, which in turn would improve productivity in the host countries. On the other hand, the crit- ics of FDI claim that foreign investors monopo- lize resources, supplant domestic enterprise, in- troduce inappropriate products and technology, and aggravate the balance of payments problem through high remittances. They often use trans- fer pricing to minimize their tax liabilities. They may also come to wield considerable political influence, distort the path of development, exac- erbate income inequality, and exploit the weak environmental standards in developing countries. Being a capital-deficit country, Pakistan needs FDI. Since late 1990s the Government of Paki- stan has initiated a number of policy and regula- tory measures to attract FDI. For example, the requirement of Government approval for foreign investment has been removed and 100 percent of ownership by foreigners is permitted, with exception of few projects. Foreign investment is prohibted in the area of agricultural land, for- estry, irrigation, real estate, insurance, health and related services. In the petroleum sector, the government has enacted a new petroleum policy which is significantly conducive for foreign in- vestment. One of the most important measures to attract FDI is liberalization of the foreign ex- change regime. Resident and non-resident Paki- stanis and foreigners are now allowed to bring in, possess and take out foreign currency, open accounts and hold certificates in foreign currency. Export incentives have been broadened. The 55 percent income tax rebates for exports of high value-added products, and a 50 percent rebate for all other products is implemented. Import policy has been liberalized to attract FDI. Im- port of machinery not manufactured locally is fully or partially exempted from import duties,