Foreign capital inflows and economic growth: an empirical study of Pakistan ( )

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1 Foreig capital iflows ad ecoomic growth: a empirical study of Pakista ( ) Goher Fatima Departmet of Maagemet Scieces Bahria Uiversity, Islamabad, Pakista Key words Foreig Capital Iflows, Opeess, Real Exchage Rate Abstract Capital iflows are very importat for the developmet of ay coutry developed or uder developed. May developig coutries deped o foreig capital iflows (FCIs) to assemble their ecoomic resources. There are may types of (FCIs) e.g. foreig direcvestmet (FDI), loas, official developmet assistace, portfolio ivestmet etc. May developig coutries, icludig Pakista are depedig o such types of FCIs to foster their ecoomic growth. The preset study ivestigated the twi impact of all types of FCIs ad exchage rate o GDP of Pakista usig co itegratio techiques coverig time period from ; furthermore, this study also ivestigated the impact of efficiet combiatio of labor ad capital o ecoomic growth of Pakista for the period of Results show that amog all types of FCIs, the FDI has more cotributio i ecoomic growth of Pakista ad remittaces have lower cotributio i ecoomic growth. The results of short-ru ad log-ru aalyses show tha the log ru all idepedet variables positively affect the ecoomic growth except of real exchage rate ad i the short ru employed labour force, real exchage rate ad remittaces have isigificampact o ecoomic growth. 1. Itroductio Ecoomic ad techological forces are playig very importat role i the growth of ay coutry. Bus very difficult for developig coutries to aalyze the factors which help them to foster their ecoomic growth. Trade liberalizatio, foreig capital iflows (FCIs) ad friedly relatio with other developed coutries are also very importat factors which are essetial for ecoomic growth/performace of a developig coutry. Pakista is also a developig coutry ad i recet era this coutry is facig may problems icludig higher iflatio, slow ecoomic growth, higher uemploymet rate etc. The iflow of foreig capital could be helpful to overcome these problems. As metioed by Hye et al. (2010) i their study, which is coducted to ascertai impact of FCI o ecoomic performace of Pakista beig oe of the developig coutries of the globe. They empirically demostrated, by applyig ARDL, a positive impact of FDI o the ecoomic growth of a coutry both i the log-ru as well as i the short-ru. Besides, the differet forms of aid from the foreig world have also cotributed towards the ecoomic growth. They further demostrated that the foreig assistace ad aid provided officially through the govermets have also show positive impacts o ecoomic growth, but oly i log-ru. Foreig capital iflows have multiplier effects o ecoomic growth of ay coutry. Icreases employmet opportuities through Foreig Direct Ivestmet (FDI) ad also provides opportuities to worker to lear how to use ew techologies i productio. Iteratioal Trade & Academic Research Coferece (ITARC), Lodo-UK 24

2 Chaudhary ad Awar (2000) explored that FCIs have sigificampact o ecoomic growth of a coutry ad these iflows cotributed to improve ecoomic situatio of ay coutry. However, some ecoomists have differet view regardig cotributio of iflows. Mosely, 1980 explored hat due to FCIs, the savig ratio remais low ad this leads to reduced domestic ad public ivestmet. The low ratio of savig ad ivestmet leads to lower icomes of people ad due to these lower icomes they are ot able to pay tax ad ultimately govermet faces fiscal deficit. Ahmad (1996) foud that FCIs (aggregate level) ad savig rate are iversely related to each other. I case of Pakista, FCIs has positive impact o ecoomic growth. It helps to icrease savig, public ad private ivestmet ad also reduce the trade gap, which further improves ecoomic growth. Accordig to Khor (2000), FCI positively affects the ecoomic growth as the former cotributes i overcomig the defici balace of paymet, which leads toward the icreased exports, savigs ad ivestmet, hece geeratig employmet; which are the positive idicators of the ecoomic growth. Some studies suggested tha developig coutries the fiacial sector developmet showed a sigificat ad positive impact of FCI o the ecoomic growth (Ljuwal ad Li, 2007). The same are proved by Bailliu (2000) ad Hermes ad Lesik (2003). This article aims to obtai the followig objectives: 1. To ivestigate the impact of foreig capital iflow (FCIs) o GDP growth. 2. To explore the ature of the iter-relatioship betwee capital iflow ad ecoomic growth of Pakista. 3. How much FCIs cotributig i the ecoomic growth of Pakista? 4. To ivestigate thas short ru impact of FCIs o ecoomic growth is differet from log ru impact or ot? The ext sectio of the paper elaborates the curret literature o the issue. The model is specified i sectio 3, moreover detailed methodology ad data sources are provided therei. The results are icorporated i sectio 4 ad the results are cocluded ad some policy implicatios are suggested i the sectio 5, respectively. 2. Literature review Pakista, icludig some other South Asia coutries, has received high amout of foreig loas; however its role is somewhat critical. Kha et al. (1993) cocluded that though foreig aid has a very importat role to foster ecoomic growth of coutry whe is i eed of it but depedece o foreig aid also leads to icrease debt burde of the coutry. Bloomstrom ad Wag (1992) stated that foreig capital iflow i the form of FDI ot oly icrease techological advacemet but also it ehace maufacturig ad service sector side by side. There are some pael researchers who used pael data set to fid relatioship betwee capital iflow ad ecoomic growth ad demostrated positive ad sigificat relatioship betwee them. Easterly (2003) used pael data set to fid the relatioship betwee foreig aid ad ecoomic growth ad foud that there is positive ad vigorous relatioship betwee them. Malik (2008) also used pael dataset of six Africa coutries ad by usig coitegratio techique he foud tha short ru there is positive impact of opeess ad foreig aid o growth whereas i the log ru former variable has egative impact o ecoomic growth. Cheery ad Strout (1966) argued that the differet kids of the foreig capital iflows i the form of loas, grats, aids ad other assistace programs primarily cotributig i overcomig the savigs ad the ivestmets. The miimal the gap the more will be the ecoomic growth of Iteratioal Trade & Academic Research Coferece (ITARC), Lodo-UK 25

3 the coutry, provided other factors of the ecoomy are performig ideally for ecoomic efficiecy. There has bee a very low level of savigs ad ivestmet experieced by the developig coutries across the globe, which attributed towards their icliatio to have relied o the Foreig Capital Iflow. Accordig to Yasmi (2005), Pakista also relies o such FCIs, which helps i the improved ecoomic performace. She coducted research o Pakista by takig data from to for FCI, GNP ad savigs ad demostrated a positive ad sigificampact of FCI o ecoomic growth. The major cotributio i the ecoomic growth accouted for by the foreig direcvestmet, which is oe of the dimesios of the FCI. Mohey-ud-di (2005) coducted a study to explore impact of FCI o the ecoomic growth of Pakista by takig data for the period of ad also explored a positive impact of FCI o the GDP growth of Pakista. Some of the studies i the past had explored a egative impact of the FCI o the ecoomic growth of the coutry (for example see Leff, (1999) ad Griffi (1970). Therefore, FCI-Ecoomic growth relatioship may have differet effects uder differet circumstaces ad give coditios of the ecoomy. Shahbaz ad Rahma (2010) coducted a study while usig time series data from World Bak ad Ecoomic Survey of Pakista for years to fid that how foreig capital iflow affects GDP. They applied ARDL bouds testig techique for the estimatio of the causality betwee the variables ad demostrated a positive impact of CFI o the ecoomic growth. They further explored thaflatio has also affected ecoomic growth positively. Accordig to Lim ad Sidall (1997) ad Cotto ad Ramachadra (2001) i their comprehesive studies o the foreig capital iflows ad domestic ivestmet have demostrated positive impact of the former o the latter. Accordig to the Ecoomic Survey of Pakista ( ), there is substatial fluctuatio i the Gross Fixed Capital Formatio, as it was 5.5% i FY ad declied by 0.6%. Accordig to the report there has bee a declie i the ivestmet durig FY , which was due to dimiishig tred of the FDI, which was decliig across the globe. Accordig to Iteratioal Istitute of Fiace (IIF) there was a 32% declie i the FDI observed durig the FY Capital Iflow i Pakista Figure 1 Source: Iteratioal Fiacial Statistics (2010) Iteratioal Trade & Academic Research Coferece (ITARC), Lodo-UK 26

4 Capital Iflows ad Exchage Rate: Figure 2 Source: Iteratioal Fiacial Statistics (2010) 3. Model specificatio, methodology ad data source MODEL: May studies were coducted to ivestigate the impact of FCIs o ecoomic growth with differessues beig explored while employig differet variables ad techiques. I curret research paper, labor, opeess ad exchage rate alog with all types of Foreig capital iflows (FCIs) which are comig Pakista as idepedet variables ad we will check impact of all these variables o growth rate of real GDP. The differet forms of FCIs are loas, foreig direcvestmet (FDI) ad grats from iteratioal agecies ad Foreig Portfolio Ivestmet (FPI), etc. But FCIs takes three mai forms, which are FDI, Foreig Portfolio Ivestmet-FPI ad the Public ad official Developmet Assistace (ODA) provided by differece sources icludig developed coutries. The last form of FDI also icludes bi-lateral ad multi-lateral Aids, grats, fiacial aids ad grats provided by iteratioal commuity. Cob-Douglas Productio Fuctio with edogeous growth theory is used i this study as is also used by Athukorala (2003 i his study. We will make macroecoomic model to probe the impact of FCIs o ecoomic growth. The ew growth models treated techology ad kowledge (learig by doig) as productio iput. Furthermore, Lucas (1988) demostrated that huma capital (which was take as factor of productio) positively affects ecoomic growth. Cob Douglas Productio Fuctio with edogeous growth theory is Y=f (L, K, E) (1) Where L =Employed labor Force K=Capital E=Real exchage rate Where K is further exteded i four types of capital iflows amely K 1, K 2, K 3, K 4 After substitutig the values of L ad K i equatio (1) the model is fuctioally represeted below: Y= F (L, K 1, K 2, K 3, K 4 O, E) (2) Iteratioal Trade & Academic Research Coferece (ITARC), Lodo-UK 27

5 The mathematical form of the equatio is Y = β 0 + β 1 L +β 2 K 1 +β 3 K 2+β 4 K 3+β 5 K 4+β 6 l O+ β 7 E+V (3) Where; Y= Growth rate of real GDP L= Employed Labor Force (ELF) K 1 = FDI K 2= Foreig Portfolio Ivestmet (FPI) K 3= Official Developmet Assistace(ODA) K 4= Remittaces (REM) O= Opeess (OPN) E= Real Exchage Rate (RER) V= Error Term Whereas β 0, β 1, β 2, β 3,β 4 β 5, β 6, ad β 7 represet parameters. Johase s (1988) also estimated the above model while employig co-itegratio techique. This techique is efficie exploratio of ot oly the short-ru but also useful for explorig the log-ru relatioship betwee the variables. I this case the depedet variable is Y ad the idepedet variables are predictig Y (i.e. causal relatioship betwee the variables of the study). Comparatively, the Co-itegratio techique is more efficiet tha that of the techique suggested by Egel Grager (1987), which yields test statistics that are further used to idetify ad determie the co-itegratig vectors as well as estimates thereof. A dataset for the period of 1975 to 2009 (icludig both the years o aual basis) is used for the purpose of the curret research study. The data are collected from sources provided by the Iteratioal Fiacial Statistics, 2010, Pakista Ecoomic Survey (2010) ad World Developmet Idicator (2010). 4. Data aalysis ad resulterpretatio The statioarity of the data, which is the pre-requisite for estimatig the model, was checked by employig ADF (Augmeted Dickey-Fuller). The results are provided below: Results of Uit Root Test Table-I Variables Level Lags Itercept Tred & itercept Y ( ) ( ) ELF ( ) ( ) FDI ( ) ( ) ODA ( ) ( ) FPI ( ) ( ) REM ( ) ( ) OPN ( ) ( ) RER ( ) ( ) At level all the regressors are statioary ad sigificat at 5% critical value. Subsequetly by employig ADF test the log ru relatioship of the series was explored. The purpose of this exploratio is to come across whether the series have ay log-ru relatioship. The series, for this model, are itegrated at order oe; therefore, the co-itegratio amog the series is further explored. At firsstace the VAR is estimated, which is used to decide the Iteratioal Trade & Academic Research Coferece (ITARC), Lodo-UK 28

6 model s legth of lag. For the curret model the maximum lag legth was set as 1. I additio to that, aother idicator i.e., miimum AIC is also utilized for estimatio. The miimum AIC explores the sigificat lag legth. The Johase s test was employed i the curret study to apply the co-itegratio ad estimatio of the model. The table-2 below shows the results of the co-itegratio test. Is evidet from the results that log-ru relatioship exists i the model betwee the variables selected for this model. Therefore co-itegratio tess employed ad is suitable i curret circumstaces (i.e., the miimum AIC i VAR). Table II Co-itegratio Test (As proposed by Johase) Eige value Likelihood Ratio 5 PCV (Percet Critical Value) 1 PCV (Percet Critical Value) Hypothesized No. of CE(s) ~ Noe ** ~ <= 1 ** ~ <= 2 ** ~ <= 3 ** ~ <= 4 * ~ <= ~ <= ~ <= 7 * * Rejectio of hypothesis at 5 % sigificace level ** 5% sigificace level Y = ELF FDI FPI ODA REM OPN RER (2.7895) (3.2688) (2.5698) (2.749) (2.569) (3.2589) (1.369) These results show that ELF positively ad sigificatly affects the ecoomic performace of Pakista i log-ru. The reaso of this is that as the growth rate i populatio i Pakista is high so more people eter i the labour market. Whe the supply of labour icreases its wage decreases ad the employers employ more labour to reduce its cost of productio. As far as cocer the sig ad sigificace of the variables which shows the impact of FCIs o ecoomic growth of Pakista, amog all types FCIs, FDI has more cotributio the all other types of FCIs. Opeess also positively ad sigificatly affects the growth rate of real GDP of Pakista. May researchers have show that opeess of a ecoomy icreases ecoomic growth through icreased competitio, efficiet allocatio of resources, improved techology, icreased kowledge spillovers, ad access to essetial productio iputs from abroad. Real Exchage rate has egative ad isigificampact o ecoomic growth of Pakista i log ru. Furthermore, higher real exchage rate results i the depreciatio of the domestic currecy ad appreciatio of the competitiveess i ope market. I the last error correctio model is applied to fid the relatioship (short-ru) betwee the variables icluded i the model of the curret study. Iteratioal Trade & Academic Research Coferece (ITARC), Lodo-UK 29

7 Short Ru Relatioship: l Yt EC EFP FDI i t i 1 2 l i 1 3 l REM OPN RER e t i l i l i 1 7 Table III Error Correctio Variables Co-efficiet t-statistics Y ( )* FPI t i l ODA i ti 1 4 ELF ( ) FDI ( )** PI ( )** ODA ( )** REM ( ) OPN ( )** RER ( ) EC ( )** * Sigificat at 10% ** Sigificat at 5% ***Sigificat at 1% At this stage the dyamic error correctio (ECM) model was estimated. All the variables were also estimated i first differece. The error correctio term thas EC i the estimated equatio is sigificat ad bears a theoretically correct sigs. The estimated co-efficiet of EC idicates that approximately 36% of the disequilibrium i ecoomic growth is corrected immediately i.e. i the ext year. The results further show that the coefficiet of lagged chage i ecoomic growth i.e., GDP is positive (shows icreasig tred) ad sigificat at 5 % level of sigificace. This implies tha the short-ru the GDP i the previous period led to a positive chage i the GDP the subsequet period. Remittaces, employed labor force ad real exchage rate have isigificampact o ecoomic growth i short ru. This isigificace of the coefficiet demostrates tha short-ru the iflow of remittaces is slow as compared to logru. I Pakista due to higher populatio growth the problem of uemploymes very grave ad is very itricate for workers to fid jobs therefore this variable has isigificampact o ecoomic growth i short ru. As far as cocer the isigificace impact of real exchage rate o ecoomic growth is also observed that the detritio of exchage rate is commo i Pakista ad ecoomically is evidet that capital iflows have positive relatioship with exchage rate. Chages i RER ot oly affects curret accout but also affects aggregate demad of home output. Is poited out here that rise i RER makes domestic goods ad services cheaper relative to foreig goods ad services, which is due to the appreciatio of the local currecy viza-viz the foreig domiatig currecy. This also icludes the shifts of both domestic ad foreig spedig from foreig good ad services. As a result, curret accout rises ad aggregate demad therefore icreases. Cosequetly, is argued that the depreciatio (real) of home currecy raises the aggregate demad of home output ad higher RER is the attributed towards the real depreciatio of the local currecy (home-currecy). From above discussio is also show thaf RER will be higher the there will be eed of higher capital stock i the ecoomy Iteratioal Trade & Academic Research Coferece (ITARC), Lodo-UK 30

8 i the form of local ad foreig ivestmet to produce more to fulfill aggregate demad. So there is direct relatioship betwee FCIs ad RER. Higher the capital iflow leads to appreciate real exchage rate ad hece it effects ecoomic growth positively (Rehma 2010). Aalytical Tests: Table IV White Heterosacdasticity Test (WHT) (N*R 2 ) (Prob ) Ramsay RESET Test - RRT (F- Statistis) (Prob ) Jarque Bera Test JB-Test (Prob ) I this sectio the heteroscedasticity of the model was tested. The results of the diagostics show that there are o such evideces of the problem of the heteroscedasticity i the curret model, which is employed i the study. For the model specificatio, a differet test amed as Ramsay RESET test was employed. The results of Ramsay RESET test show that the ull hypothesis is rejected, which cofirms that the model is correctly specified, hece fulfilled the pre-requisitio of the model specificatio. Furthermore, the result of the test shows that the calculated F-Value is less tha the tabulated F-value. O the basis of this resuls explored that the ull hypothesis is accepted. The results support the coclusio that the model is correctly specified. For the ormality of the dataset, a desigated test was used uder the ull hypothesis. Normality of error term was showed Jarque Bera ad the coefficiet of Jarque Bera is less tha that of the χ 2 value. 5. Coclusio ad recommedatios The paper empirically idetifies the impact of FCIs ad real exchage rate o ecoomic growth of Pakista over the period Coitegratio ad error-correctio techiques are used to fid short-ru ad log-ru relatioships betwee FCIs ad GDP growth. The aalysis fids tha all types of FCIs, FDI has more cotributio i ecoomic growth of Pakista ad remittaces have the least cotributio i ecoomic growth. The results of shortru ad log-ru aalyses show tha the log ru all idepedet variables positively ad sigificatly affects the ecoomic performace of a ecoomy, except of real exchage rate ad i the short-ru the employed labour force, real exchage rate ad remittaces have o impact o ecoomic performace of Pakista. Besides this, FCIs has a productive impact to fill the three gaps i the ecoomy, budget deficit, import- export, ivestmet- savig. There is a dire eed of such govermet policies, which attract foreig ivestme Pakista. These iflows help to create jobs for skilled workers ad hece helpful to reduce uemploymet. The effective govermet policies are also importat to attract foreig capital, as the FCIs positively affected ecoomic growth. I the presece of poor policies, o the other had, FCIs has o positive effect o growth. There is also eed of moitorig of foreig fuded projects ad utilizatio of foreig aids to avoid miss utilizatio of these resources. The prevailig law ad order situatio of the coutry dissuade foreig ivestors to ivest their capital which results miimal FCIs. Therefore govermet should improve law ad order situatio i the coutry by esurig foolproof security to foreig ivestors i order to pursuit them to ivest their resources. Iteratioal Trade & Academic Research Coferece (ITARC), Lodo-UK 31

9 Refereces Ahmad,E.(1996). Capital Iflows ad Natioal Debt. The Pakista Developmet Review, 35(4) Bailliu, J. (2000). Private Capital Flows, Fiacial Developmet ad Ecoomic Growth i Developig Coutries. Workig Paper , Bak of Caada. Chaudhary,M ad Awar,S (2000). Foreig Debt, Depedecy, ad Ecoomic Growth i South Asia.The Pakista Developmet Review, 39(4), Cotto, L. ad Ramachadra, V. (2001). Foreig Direct Ivestme Emergig Ecoomies. WIDER Discussio Paper No. 82. Cheery,H.B,ad Strout,A.M (1996). Foreig Assistace ad Ecoomic Developmet. America Ecoomic Review, GOP (2010) Pakista Ecoomic Survey. Ecoomic Affairs Divisio, Miistry of Fiace, Govermet of Pakista. Easterlay, W. (2003).The effect of foreig Aid o Ecoomic Growth i developig Coutries. Hye, Q. M., Shahbaz, M. A. ad Hye, A. (2010). Foreig Capital Iflow ad Ecoomic Growth Nexus: A Case Study of Pakista. The IUP Joural of Applied Ecoomics, Vol. IX, No. 1 Hermes, N. ad Lesik, R. (2003). Foreig Direct Ivestmet, Fiacial Developmet ad Ecoomic Growth. Joural of Developmet Studies, 40, Kha, N.Z. ad E. Rahim (1993). Foreig Aid, Domestic Savigs ad Ecoomic Growth Pakista. Pakista Developmet Review, 32 (4), Khor, M. (2000). Globalizatio ad the South: Some Critical Issues, Third World Network, Peag. Lim, L.Y.C. ad N. Sidall (1997). Ivestmet Dyamism i Asia Developig Coutries, i Duig J.H. ad K.A. Hamdai (eds). The New Globalism ad Developig Coutries, Tokyo, Uited Natios Uiversity Press. Ljuwal, ad Li (2007). Fiacial Sector Developmet, FDI ad Ecoomic Growth i Chia. OCER Workig Paper-E , Perkig Uiversity. Leff, N. H. (1969). Depedecy Rates ad Savig Rates. America Ecoomic Review, America Ecoomic Associatio, 59 (5). Lucas, Robert, (1988), O the Mechaics of Ecoomic Developmet, Joural of Moetary Ecoomics, 22 (1), Malik, G (2008).Foreig Aid ad Ecoomic Growth: A Co itegratio Aalysis of six poorest Africa coutries. Ecoomic Aalysis ad Policy, 38(2). Mohey-ud-di, G. (2007). Impact of Foreig Capital Iflow (FCI) o Ecoomic Growth i Pakista. Joural of Idepedet Studies ad Research, 5(1), Mohey-ud-di, G. (2005). Impact of Foreig aid o Ecoomic Developme Pakista. Muich Persoal REPEC Archive. Availble olie at MPRA.No.11. P.P.A Wasatha Athukorala (2003). The Impact of Foreig Direct Ivestmet for Ecoomic Growth: A Case Study i Sri Laka. 9th Iteratioal Coferece o Sri Laka Studies Full Paper Number 092. Shahbaz, M. ad Rahma, M. M (2010). Foreig Capital Iflows-Growth Nexus ad Role of Domestic Fiacial Sector: A ARDL Co-itegratio Approach for Pakista. Joural of Ecoomic Research, 15 (2010), Wag, J.Y ad M. Blomstrom. (1992).Foreig Ivestmet ad techology Trasfer: A simple Model. Europea Ecoomic Review, 36, Yasmi, B. (2005). Foreig Capital Iflows ad Growth i Pakista: A Simultaeous Equatio Model. South Asia Ecoomic Joural, 6 (2), Iteratioal Trade & Academic Research Coferece (ITARC), Lodo-UK 32

An Empirical Study on the Contribution of Foreign Trade to the Economic Growth of Jiangxi Province, China

An Empirical Study on the Contribution of Foreign Trade to the Economic Growth of Jiangxi Province, China usiess, 21, 2, 183-187 doi:1.4236/ib.21.2222 Published Olie Jue 21 (http://www.scirp.org/joural/ib) 183 A Empirical Study o the Cotributio of Foreig Trade to the Ecoomic Growth of Jiagxi Provice, Chia