Evaluating The Determinants of FDI: A Panel Data Study of Pakistan and Neighboring Countries

Evaluating the Determinants of FDI: A Panel Data Study of Pakistan and
neighboring countries.
Evaluating the Determinants of FDI: A Panel Data Study

of Pakistan and neighboring countries
Zahra Sikander
THE RESEARCH REPORT IS AS PER REQUIREMENT FOR
THE AWARD OF
B.Sc. HONORS DEGREE
IN
ECONOMICS
COMSATS INSTITUTE OF INFORMATION TECHNOLOGY,
LAHORE
SESSION 2013-2017
i
Acknowledgements
All praise to Allah Almighty by the grace of whom I was able to carry out this
research. Working on panel data doesn’t seem to be easy at first but my mentor
and supervisor made it easy for me. So I would like to extend my immense
gratitude towards Dr. Wajiha Manzoor for her guidance and insight of knowledge
that helped me in doing my task. Her unwavering support and criticism is the
reason I was able to complete this task against all odds. I would like to take the
opportunity to thank my special friends Mr. Faizan Riaz and Ms. Memoona Qazi
for their help, support and encouragement in every step of the way.
Lastly, I would like to thank my parents for their love and support in the
completion of this study.
Zahra Sikander.
ii
Abstract
Pulling in foreign direct investment (FDI) help-out the nations in immediately

increasing vital social-economic accomplishments and end up noticeably one of
the auspicious vibrant areas on the earth. FDI inflow is additionally emphatically
accepted to assume a noteworthy part in developing business sector economies.
Thus, this study attempts to explore the important determinants of FDI mainly
through trade and terrorism for Pakistan and its neighboring countries. For this
purpose, analysis has been done in the panel framework for the time period
1996-2015. Durbin Watson Hausman test has been applied to check if fixed effect
is efficient than random effect. We found that GDP growth, infrastructure
development, exchange rate, urban population and political stability are highly
significant with FDI.
iii
List of Figures and Tables
Figure 1.1 FDI Inflows of Pakistan and its Neighboring Countries…………….6
Figure 1.2 FDI Inflows and Terrorism in Pakistan and Neighboring Countries...8
Figure 3.6.1 Theoretical Framework…………….………….……….…….…….22
Table 3.2.1 Data Sources and Expected Signs of Variables ……….…….…….18
Table: 3.5.1 Definitions of Dependent and Independent Variables….…….……20
Table 3.6.1 Form of Market Entry…………….………….……….…….……...24
iv
Table of Contents
Abstract............................................................................................................................. iii
List of Figures and Tables ............................................................................................... iv
Chapter 1 ........................................................................................................................... 1
1.1 Introduction ............................................................................................................ 1
1.2 Problem Statement: ................................................................................................ 7
1.3 Objective of the study: ............................................................................................ 7
1.4 Hypothesis: .............................................................................................................. 7
1.4.1 Market Seeking FDI: ....................................................................................... 7
1.4.2 Efficiency Seeking FDI: ................................................................................... 7
1.4.3 Resource Seeking FDI: .................................................................................... 7
1.4.4 Macroeconomic Condition and FDI:.............................................................. 8
1.4.5 Governance:...................................................................................................... 8
1.4.6 Terrorism: ........................................................................................................ 8
1.4.7 Population:........................................................................................................ 8
1.4.8 Trade: ................................................................................................................ 8
Chapter 2 ......................................................................................................................... 10
Literature Review ........................................................................................................... 10
Chapter 3 ......................................................................................................................... 17
Research Methodology ................................................................................................... 17
3.1 Type of Study ........................................................................................................ 17
3.2 Data Sources .......................................................................................................... 17
3.3 Software ................................................................................................................. 18
3.4 Variable selection criteria .................................................................................... 18
3.5 Variable Definitions .............................................................................................. 19
3.6 Theoretical Framework ........................................................................................ 21
3.7 Model Specification............................................................................................... 24
3.8 Methodology .......................................................................................................... 25
3.8.1 Hausman Test ................................................................................................. 25
Chapter 4 ......................................................................................................................... 26
v
Results and Interpretation ............................................................................................. 26
4.1 Correlation Matrix................................................................................................ 26
4.2 Descriptive Statistics ............................................................................................. 29
4.3 Results without Trade Agreements: .................................................................... 31
4.4 Results with Trade Agreements: ......................................................................... 32
4.5 Interpretations Criterion...................................................................................... 33
4.5.1 Interpretations without Trade Agreements: ............................................... 33
4.5.2 Interpretations with Trade Agreements: ..................................................... 35
4.6 Robust Regression Estimate................................................................................. 37
Chapter 5 ......................................................................................................................... 38
Discussion ........................................................................................................................ 38
Conclusion ....................................................................................................................... 40
Policy Implications .......................................................................................................... 41
Limitations and Future Agenda .................................................................................... 42
References ........................................................................................................................ 43
vi
Chapter 1
1.1 Introduction
Foreign direct investment (FDI) has been continuously investigated by
economists since it is regarded as one of the main driving force for growth and
development in an economy. According to the World Bank, FDI is described as
an investment that is produce by an individual or a corporation in one country
having an organization interest in a different country. It may be reflected as
capital movement crosswise over nationwide frontline in a way that enables the
investors to have a control over the investment. Firms that give FDI are stated as
MNCs. The investors of these MNC’s can put resources into existing business or
can start new ventures. Foreign direct investment assumes a vital part in the
progression and in poverty reduction. They have a few constructive outcomes on
employment, exchange of technology, and thus on the development and economic
growth of the nation. (Saidi et al, 2013)
The importance of FDI is well documented in writings for both developed and
developing nations. Due to the deficiency of capital in developing nations, they
require more capital for their development procedure, that’s why marginal
productivity of capital is higher in these nations. Whereas, financiers in the
developed nations pursue more returns for their capital. Thus there is a shared
advantage in the international movement of capital. During last two decades
world has seen a broad inflow of FDI into developing nations. An ever increasing
number of developing nations are contending with each other to entice this
investment. (Aqeel and Nishat, 2004)
FDI inflows might help economic growth with risk sharing, trade enhancements,
easy excess of foreign markets and technology transfer. In the case of Pakistan
and its neighboring countries, there are many advantages to entice FDI. These
advantages can be a in the form of cheaper input factors, especially labor costs
and natural material costs and many preferential investment policies. (Peter, 2001)
FDI advances economic growth by expanding the volume of investment and its
effectiveness. In this way, all nations, especially developing and least developed
nations, try to pull in Foreign Direct Investment for the bundle of advantages it
carries alongside it into the host nation economy. Foreign investment, particularly
FDI, increases domestic investment resources and moreover turns as an origin of
foreign exchange and can unwind balance of payments imperatives on
development. Seeing the economic advantages and significance of FDI for
advancing economic growth, the greater part of the nations has detailed extensive
changes in their strategies to entice FDI. The empirical writing recommends that
1
FDI increases national prosperity by expanding the volume and proficiency of

investment through improved competitiveness, technological dispersion,
quickened spillover impacts and the accretion of human capital. (Pravakar, 2006)
However, FDI in any economy is dependent on several factors some of which will
be discussed in this study including GDP growth, governance indicators,
terrorism, trade agreements, inflation rate, GDP per person employed, exchange
rate, interest rate, natural resource rent, technological development, infrastructure
development and urban population. This paper analyzes the role of these variables
in evaluating the important determinants of FDI for Pakistan and its neighboring
countries. The results showed that GDP growth, infrastructure development,
exchange rate, urban population and political stability are highly significant with
FDI. Whereas GDP per person employed, real interest rate, technological
development, exports of goods and services and FTA’s showed insignificant
positive relation with FDI.
The preceding graphs are presenting the trend of FDI’s in Pakistan and its
neighboring countries. As we can see there is a non-stationary trend of FDI in
Pakistan and almost in its every neighboring country except in China. For
Pakistan it was growing at lower rates till year 2003 then it shoots up to its
maximum level till the year 2008 and faces a great fall till the year 2012. Almost
similar trend can be perceived for Afghanistan where FDI inflows surges at lower
rates than shoots up to its maximum level till 2006 and then it starts declining.
This same trend has been seen till the year 2015. India remains at lower rates of
FDI till many years; it rises suddenly in the year 2006 and faces many ups and
downs after that. Iran’s trend is different from other countries, the graph exhibit
constant flows till 1999. There is a growing trend in the year 2000 after which
many ups and downs have been seen. However, an increasing trend has been seen
throughout these years in China.
2
Pakistan India
6,000 50,000
5,000
40,000
4,000
30,000
3,000
20,000
2,000
10,000
1,000
0 0
96 98 00 02 04 06 08 10 12 14 96 98 00 02 04 06 08 10 12 14
China Afghanistan
140,000 300
120,000 250
200
100,000
150
80,000
100
60,000
50
40,000 0
20,000 -50
96 98 00 02 04 06 08 10 12 14 96 98 00 02 04 06 08 10 12 14
Iran
5,000
4,000
3,000
2,000
1,000
0
96 98 00 02 04 06 08 10 12 14
Figure 1.1: FDI Inflows of Pakistan and its Neighboring Countries
3
The significance of technology for economic growth gives an imperative

connection between FDI inflows and host nation economic growth. It’s
supposedly clear to contend that FDI inflows have a potential for expanding the
level of economic growth in the host nation. Physical capital inflows coming
about because of FDI could likewise build the rate of economic growth.
Operations of MNE’s in the host nation can bring about technology spillovers
from FDI, by which domestic firms adopt better MNE technology which
empowers them than enhance their productivity. Technology spillovers in this
way produce a positive externality enabling the host nation to improve its long-
run development rate. (Johnson, 2006)
With the expanding pattern of globalization nations are attempting to pull in more
foreign direct investment to thrive their economies. In any case, it’s wholly
possible when foreign investors will put resources into that specific nation.
Furthermore, foreign investors always like to put resources into those nations in
which they feel their transactions as secure one. So any nation like Pakistan and
Afghanistan confronting biting substances of having war on terror is the object of
this reality. So expanding level of terrorism makes obstacles for the economies
prosper. This is because of the rising idea of working together globally. Since the
reality, if at one hand it has made open doors for nations to extend their business
sectors, yet then again it has additionally created ease for having unlawful
exercises to be accomplished all the more soundly. Since the expanding size of
business sectors have additionally expanded the security issue in about all
economies of the world. (Rasheed and Tahir, 2012)
4
Pakistan India
6,000 50,000
5,000
40,000
4,000
30,000
3,000
20,000
2,000
10,000
1,000
0 0
96 98 00 02 04 06 08 10 12 14 96 98 00 02 04 06 08 10 12 14
China Afghanistan
160,000 600
500
120,000
400
300
80,000
200
100
40,000
0
0 -100
96 98 00 02 04 06 08 10 12 14 96 98 00 02 04 06 08 10 12 14
Iran
5,000
4,000
3,000
2,000
1,000
0
96 98 00 02 04 06 08 10 12 14
FDI Inward Flows US Dollars at Current Prices in Millions

TERRORISM
Figure 1.2: FDI Inflows and Terrorism in Pakistan and Neighboring Countries
5
As we can see in the above graphs that terrorism doesn’t have much effect on the
FDI inflows of India, China and Iran as terrorist activities are minor in these
countries. Whereas, positive trend of FDI have been seen in Pakistan and
Afghanistan with terrorism. However, these results may have been clearer with
larger size of data.
Mostly, good institutions positively affect development by empowering

investments. Accordingly, the quality of institutions can draw in FDI through
good governance which constitutes an imperious element for the attraction of
foreign investment. The idea of good governance assumed a more imperative part
in the international development research. Additionally, transparency is an
exceptional factor that has an incredible association with governance and foreign
direct investment. The idea of absence of transparency is connected to the
corruption which demonstrates the nonappearance of good governance. (Saidi et
al, 2013)
6
1.2 Problem Statement:

FDI is essential for the economy of any developing or a developed country. It can
increase the growth and can improve the living standard of the people of any
country by growing the inflows and outflows of goods and services in that
country’s economy. This study will focus on how much the FDI is essential for
the countries like Afghanistan, China, India, Iran and Pakistan. It enables the
readers to understand the important determinants of FDI and how much they can
effect FDI inflows in Pakistan and its neighboring countries during the time
period of 1996-2015 using Panel Data estimation.
Officially, the statement of problem can be expressed as “how much FDI is

affected by its determinants in Pakistan and its neighboring countries.”
1.3 Objective of the study:

The core objective of this study is to determine the important determinants of FDI
for Pakistan and its neighboring countries. Therefore, this study searches the
significant contributions of FDI in these economies.
1.4 Hypothesis:
1.4.1 Market Seeking FDI:
Ho: FDI and GDP Growth are not significant with each other
H1: FDI and GDP Growth are significant with each other
1.4.2 Efficiency Seeking FDI:

Hoa: FDI and GDP/person employed are not significant with each other
H1a: FDI and GDP/person employed are significant with each other
Hob: FDI and Inflation are not significant with each other
H1b: FDI and Inflation are significant with each other
1.4.3 Resource Seeking FDI:

Hoa: FDI and Natural Resources are not significant with each other
H1a: FDI and Natural Resources are significant with each other
7
Hob: FDI and Infrastructure Development are not significant with each other
H1b: FDI and Infrastructure Development are significant with each other
Hoc: FDI and Technological Development are not significant with each other
H1c: FDI and Technological Development are significant with each other
1.4.4 Macroeconomic Condition and FDI:

Hoa: FDI and Exchange Rate are not significant with each other
H1a: FDI and Exchange Rate are significant with each other
Hob: FDI and Interest Rate are not significant with each other
H1b: FDI and Interest Rate are significant with each other
1.4.5 Governance:
Ho: FDI and Governance are not significant with each other
H1: FDI and Governance are significant with each other
1.4.6 Terrorism:
Ho: FDI and Terrorism are not significant with each other
H1: FDI and Terrorism are significant with each other
1.4.7 Population:
Ho: FDI and Urban Population are not significant with each other
H1: FDI and Urban Population are significant with each other
1.4.8 Trade:
Hoa: FDI and Trade Agreements are not significant with each other
H1a: FDI and Trade Agreements are significant with each other
Hob: FDI and Free Trade Agreements are not significant with each other
H1b: FDI and Free Trade Agreements are significant with each other
8
Hoc: FDI and Exports of goods and services are not significant with each other
H1c: FDI and Exports of goods and services are significant with each other
Hod: FDI and Imports of goods and services are not significant with each other
Hd: FDI and Imports of goods and services are significant with each other
The remnants of this paper are organized as follows: Chapter 2 provides the
review of related literature. In chapter 3, we discuss the research methodology
with an econometric model and theoretical framework. Chapter 4 reports the
empirical results and its interpretations and finally, concluding remarks are
discussed in chapter 5.
9
Chapter 2
Literature Review
Schneider & Frey, (1985) studies the economic and political determinants of FDI.
Four models have been used for estimation; Political model, economic model,
amalgamated model and politico-economic model. These models are kept for
testing the impact of political stability on FDI, controlling GNP per capita
contains economic determinants of model and uses Institutional Investors Credit
Rating indicator respectively. Regression analysis is being done over 54
developing countries for three different years i.e. 1976, 1979, 1980. The results
showed that FDI will be greater if real per capita GNP will be higher and there
will be lessen balance of payment deficits. Amongst the political factors, there is a
positive impact of the bilateral trade amount coming from western and capitalist’s
whereas in case of communist countries it is negative. FDI in developing
countries is simultaneously determined by political and economic factors.
Borensztein, Gregorio & Lee, (1998) examines the impact of FDI on economic
growth through a cross-country comparison; make use of FDI streams from
industrial nations to 69 developing nations for most recent two eras. Log of initial
GDP, schooling, government compensation, wars, political rights, inflation rate,
institutions, market premium and consumption are being used as explanatory
variables and FDI is taken as dependent variable. Data on FDI has been taken
from two publications of IMF namely International Financial Statistics and
Balance of Payment Statistics and from OCED publication namely Geographical
Distribution of Financial Flows to Developing Countries. Whereas data Sources
for explanatory variables are Summers & Heston and Barro & Lee. Seemingly
Unrelated Regression techniques (SUR) are being used for estimation. According
to the results FDI is a significant instrument for the improvement of technology
and for the enrichment of human capitals. It is also observed that higher
productivity of FDI depends on the amount of human capital that is being
accumulated. Results also showed that FDI exerts a positive, however not a strong
influence on domestic investment. And finally Economic growth can be achieved
through higher efficiency than more accumulation of human capital. Economic
growth can also be achieved by total factor productivity growth and with the
transfer of new technology; labor also needs to be developed because they are the
ones who could operate that technology efficiently.
10
Globerman and Shapiro, (2002) study the part of governance infrastructure on

worldwide Foreign Direct Investment. Moreover, part of different types of
infrastructure including human capital and environment is likewise being
examined. Authors have used six governance indicators; measures of political
instability, rule of law, graft, regulatory quality, voice and political freedom, and
government eff ectiveness. While GDP is taken as the controlled variable
measured in logarithms, alternate factors (HDI, GII, ESI) are indices and are
subsequently not changed. Data has been taken for the years over 1995–97 for a
wide specimen of created and creating nations. Data sources include Heritage
Foundation, World Bank, World Economic Forum and the Economist Intelligence
Unit. Reported equations are assessed by OLS, heteroskedastic-steady standard
errors while specification error is being tried through a progression of RESET
tests (one and two power). Comes about demonstrated that investments in
governance infrastructure draw in capital, as well as make the conditions under
which domestic MNE's rise and invest abroad. On adjust, for most nations, both
inflows and outflows of FDI react emphatically to good governance. The
outcomes as for human capital and environmental supportability are less
dependably evaluated because of issues of multicollinearity and causality.
Aqeel & Nishat, (2004) precisely arrange the growth factors in foreign direct
investment in Pakistan from 1961 to 2003. The principle worry of the review is to
perceive how diverse factors or pointers reflecting exchange, monetary and
budgetary related part lure FDI in Pakistan. The writers have used tariff rate,
exchange rate, tax rate, credit to private area and rundown of general offer esteem
elements to clear up the inflow of FDI. The review uses the Co-reconciliation and
error correction methodologies to perceive the elements in clarifying the foreign
direct investment. All factors gave revise signs and are quantifiably significant
beside wage rate and offer esteem record. The review unambiguously highlights
the piece of these approach factors in pulling in FDI and choosing its
development in both short run and long run time period in Pakistan. Moreover,
this review likewise exhibits a positive and enormous effect of changes on foreign
direct investment in Pakistan.
11
Li & Liu, (2004) investigates whether foreign direct investment upsets economic
growth based on panel data for 84 countries over the period of 1970-1999. This
estimation has being done using two different equations i.e. growth equation and
FDI equation. Investment, population growth, initial per capita GDP and initial
human capital are the variables used in growth equation along with foreign direct
investment streams as a percentage of GDP. It also includes a set of X variables
comprises of country-group dummies and policy variables. These dummy
variables include Latin American, African fast growing and other developing
countries. Whereas trade, log of GDP, inflation rate, interest rate, fluctuation of
foreign exchange rate and market premium are the variables used in FDI equation.
Durbin-Wu-Hausman (DWH) test is being applied to check the endogeneity
between GDP and FDI along with unit root test. Results suggested that
endogeneity is not significant for the full sample i.e. 1970-1999 but still there is a
significant endogenous relationship between GDP and FDI for the period 1985-
1999. It has been found that in the case of developing countries FDI would be
productive when there is a productive human capital. Lack of technology is a
barrier in long term FDI in case of developing countries.
Toben & Ackerman, (2005) examine the impact of Bilateral Investment Treaties
on FDI and business environment in developing countries. In order to study this
impact, Authors have done two empirical analysis; Bilateral and General. The
model takes into concern the flows of FDI as dependent variable whereas BITs,
Political risk, Inflation rate, the log of per capita income natural log of the
population are taken as proxies of GDP; the variables economic growth, natural
resources and fixed country effects are taken as explanatory variables and have
been estimated using the Ordinary Least Squares (OLS) technique. Data for the
period 1985 to 2000 has been taken from UNCTAD, International Country Risk
Guide (ICRG) and IMF’s International Financial Statistics Database. Findings
show that instead of supporting larger FDI in high-risk situations, BITs simply
have effecting results on FDI flows in different countries with a steady business
environment. The presented models undoubtedly demonstrate the significance of
growth in economic and market and population size for deciding FDI. Overall,
authors have concluded the overall weak relationship between FDI and BITs. All
above, BITs itself, come out to have modest effect on FDI. So, there is a
complicated collaboration among the BITs, FDI and different levels of political
risk.
12
Kwok & Tadesse, (2006) examine the impact of institutional environment of

corruption on multinational corporations (MNCs); using effect on demonstration,
effect of professionalization and regulatory pressure effect. The cross country
comparison has been done in space of corruption and is calculated through the
average of annual corruption perception over the period of 2000-2004 gathered
from TI. This “TI corruption perception index” offers annual ranking of different
countries using total of apparent corruption among public or primarily officials.
Multivariate regression of corruption has been applied on FDI alongside other
control variables. Results showed that multiple levels of corruption are
considerably lesser in countries which are having high flows of FDI in the
previous years and the damaging results of society on corruption are minor and
the advantageous results of higher education on corruption are comparatively
higher in diverse countries with high FDI in previous years.
Alsan, Bloom & Canning, (2006) investigate the consequence of population

physical condition on gross inflows of FDI. Estimations have been done by means
of data collected from panel of 74 developing and industrialized countries over
1980-2000. Total population, bureaucratic quality, GDP per capita, openness of
the economy, gross FDI inflows, extreme corruption, higher education, health and
fitness, population and life expectancy are used as variables. Data of these
variables have been taken from World Bank, Knack & Keefer and Gallup et al.
For misspecification in model authors have applied “Ramsey’s Regression
Specification Error Test (RESET)”. Results of full sample showed positive and
significant coefficient for income, population, bureaucratic quality and market
size. Whereas, element of human capital i.e. Higher education has an optimistic
coefficient except that it is not statistically meaningful. Coefficients here are not
significantly different from unity except corruption which is not significantly
different to zero. Results of countries having very low and average income are
almost same for all variables except for corruption; it is now significant but with
wrong sign. These judgments and analysis put forward that increase in life
expectancy in a single year will also increase the gross FDI inflows through 9%
keeping all other used variables constant.
13
Hajkova, Nicoletti, Vartia & Yeol Yoo, (2006) assess the significance of taxation
on FDI. All the variables include FDI stock, non-policy controls, (non-tax) policy
indicators and relevant tax rate. Study relates the mutual FDI between OECD
countries in 1990s to a latest group of evaluations of business tax that might take
account of several important elements of FDI taxation. The observed approach
emphasizes on various “semi-parametric estimation” techniques that interprets for
a quantity of unseen impacts probably interrupting the preference of investment
locality by means of international organizations. The results exhibits that the
taxation effects on FDI are comparatively of lesser importance in contrast with the
outcomes of other numerous policies that facilitate to create a setting attractive to
investors that are in other countries, such as open-ness, regulatory problems and
labor costs. Concentrating merely on host countries and home taxation while
ignoring extra policies may possibly create a terrible over-estimation of tax
importance for policies and flexibilities.
Gani, (2007) studies the group statistics evaluations of the relation among FDI
and Governance indicators by means of a sample collection of countries from
Latin America and Asia. FDI is taken as dependent variable like share of GDP
whereas various indicators of governance used are: Government effectiveness,
political stability, regulatory quality, rule of law, control of corruption, and
accountability. Data on FDI and governance indicators is selected for the years
1996, 1998, 2000 and 2002 and has been taken from The World Bank (2004) and
Kaufmann et al. (2003) respectively. Pooling technique is used as an estimation
technique which is described by Kmenta (1986). This permits for
heteroscedasticity over numerous cross-sections. Mainly the outcomes firmly
prove that all attainments in good quality governance, control of corruption, rule
of law, regulatory quality, government efficiency and political permanence can
definitely support investment in foreign countries. The outcomes moreover
present strong facts that growth in economic and open-ness are essential for FDI
inflows.
Filatotchev, Strange, Piesse & Lien, (2007) discover the access method and
locality choices of organizations from an Asian NIE (Taiwan) in a rising market
like China. Percentage equity stake (STAKE) is taken as variable that is
dependent in the access method model while, extent of insider rights, particular
shareholdings in the “Domestic financial institutions (DFIN)” and parent “Firms
14
of foreign (FFIN)” are taken as explanatory variables. Authors have obtained the
Firm-level information from the Futures Commission and Securities in Taiwan
which refers to the end of 1999, apart from for the shareholding in the associate
and the company's collective investment in the province. On the other hand,
statistics for all the locality-specific essentials describe to the year earlier than the
significant associate was recognized. The findings show that parent firm's
possession stake in its Chinese associate is absolutely and considerably associated
with share possession of foreign institutional investors while the association
coefficients for domestic institutional and family owners are considerably
unenthusiastic. High-commitment access is established to be completely
connected by the associate that are situated in areas with powerful economic,
historic links and culture with the parent corporation. And finally they found that
the FDI policies of NIE companies that are joining rising markets are a result of a
multifaceted relation of institutional and organizational elements that is
understood on the foundation of an inter-disciplinary research.
Stoian, Carmen R. Filippaios & Fragkiskos, (2008) examine the influence of

possession and locality compensation in describing the internalization
conclusions, proving that eclectic paradigm (OLI) is all-inclusive. A dummy
variable is used as an independent variable assuming the value ‘1’ for the
existence of a direct foreign investment commitment and ‘0’ for need of foreign
investment where the divisions of variables comprise company precise variables,
control variables and location-institutional variables expressing openness and
market size. The data has been taken for six years, i.e.1994 -1999. Authors have
tested the importance of possession and locality compensation for the MNE’s
result to invest out of the country. The authors further wanted to discover the
presence of an education curve which may makes subsequently investors more
competent to enhanced handle riskier situations and therefore employ their
possession benefit in an extra advantageous means. The result demonstrate that
the development of Greek companies occurs mostly in alike countries by means
of small market dimension, and open economies where high corruption and rule
of law proceed as a warning. A significant feature in raising the tendency of
investing in a foreign country is the building of distribution mediums in the host
economy.
15
Tiwari & Mutascu, (2011) analyze the effect of FDI on growth in economics in
Asian countries. The authors have utilized a production function framework
expanding by adding exports and FDI as an extra variable to better analyze their
impact on economic growth. The research has been done in the group structure for
the time 1986 to 2008. Authors have basically used three varieties of group
statistics models; Panel model with random effects, Pooled Ordinary Least Squire
(OLS) regression and Panel model with fixed effects. Wald test and F-test were
applied afterwards to inspect the non-linearity’s linked with FDI and exports in
the economic growth development of Asian countries. The results revealed that
FDI and exports enhance the growth of Asian countries as FDI can produce
economies of scale and effects on linkage, and also raise efficiency and
productivity; another contributing factor to such a conclusion appeared to be that
labor and capital can help the process further.
Rasheed & Tahir, (2012) examine the impact of terrorism on FDI through Co-
integration and Granger causality. Authors have collected the data from years
2003-2011 for different terrorist attacks and FDI and it has been taken from South
Asia Terrorism Portal and Board of investment: Prime minister’s secretariat
Government of Pakistan respectively. Time series modeling and ADF test is being
applied for estimation. Results after applying tests showed that both terrorism and
FDI are stationary rather than being co-integrated with each other therefore we
conclude that by rising terrorism FDI may decline because of loss in investors’
confidence in that particular economy.
16
Chapter 3
Research Methodology
3.1 Type of Study

This is a secondary research in which quantitative data has been collected from
various authentic sites to analyze the variables focused, making it cross-section in
nature. The estimations have been done using Panel Data techniques.
3.2 Data Sources

This study measures the impact of FDI on economic growth data from which has
been taken from World Bank, World Governance Indicators, Global Terrorism
Database and UNCTAD for the years 1996-2015.
Table 3.2.1: Data Sources and Expected Signs of Variables
Variable’s Name Data Source Expected Sign
GDP Growth World Bank Positive
Inflation World Bank Positive
GDP Per Person Employed World Bank Positive
Exchange Rate World Bank Positive/ Negative
Interest Rate World Bank Positive
Urban Population World Bank Positive/ Negative
Natural Resources World Bank Negative
Infrastructure World Bank Positive
Technology World Bank Positive
Trade UNCTAD Positive/ Negative
Governance World Governance Positive

Indicators
Terrorism Global Terrorism Database Negative
17
3.3 Software
Stata SE 11 has been used to run all types of regressions.
3.4 Variable selection criteria

Here is the list of dependent and independent variables:
Dependent Variable:
 FDI
Independent Variables:
 GDP Growth
 Terrorism
 Governance
 GDP Per Person Employed
 Inflation Rate
 Exchange Rate
 Real Interest Rate
 Urban Population
 Natural Resources
 Infrastructure Development
 Technological Development
 Trade Agreements
 Free Trade Agreements
 Exports and Imports of goods & services
18
3.5 Variable Definitions

Table: 3.5.1 Definitions of Dependent and Independent Variables
Foreign Direct Investment FDI is a venture made by an organization or a

person in one nation in any business
enthusiasm for another nation.
Governance The activity of monetary, political and

managerial authority to deal with a nation's
issues at all levels.
GDP Growth It gauges how quick the economy is

developing by contrasting one fourth of the
nation's economic output (GDP) to the last.
GDP/Person Employed It is defined as GDP divided by total

employment in the economy. Here GDP is
converted to 2011 constant international
dollars using purchasing power parity (PPP)
rates.
Inflation The rate at which general price level for goods

and services rises and consequently, the
purchasing power of currency falls.
Natural Resources Resources that exist without actions of

humankind.
Official Exchange Rate It refers to the exchange rate determined by

national authorities or in the legally sanctioned
exchange market.
19
Real Interest Rate An interest rate that has been adjusted to

remove the effects of inflation to reflect real
cost of funds to the borrower and real yield to
the lender.
Trade A basic economic concept involving the

buying and selling of goods and services, with
compensation paid by a buyer to seller.
Terrorism It is defined as the use of violence or threat of

violence in order to purport a political,
religious or ideological change.
Urban Population The residents of any city or town including

metropolitan areas and suburban areas.
Infrastructure It is the basic physical system of a business or

nation. These systems tend to be high-cost
investments; however they are vital to a
county’s economic development.
Trade Agreement These agreements are the product of

negotiations between two or more dominant
countries that dictate the terms of acceptable
exchange of goods and services between
parties.
20
3.6 Theoretical Framework

The theory of eclectic paradigm or OLI was developed by John Dunning. This
theory is of great importance in describing Multinational Enterprises (MNE’s) and
has stimulated a great deal of applied work in economics. It provides a three-faced
framework for a corporation to shadow when determining if it’s constructive to
pursue FDI. There must be a comparative advantage, an ownership advantage and
an internalization advantage for a direct investment to be constructive in any
foreign country. It is considered a universal approach, based on examining the
entireness of relationships and interactions of the numerous components.
Comparative advantage is the first goal to be determined in performing certain

functions within a particular nation. It depends upon the availability and cost of
resources while operative in one location over another. This location depends
upon MNE’s because they are the ones to choose where to locate. Ownership
advantages are related to the patented information and numerous ownership rights
a company may hold. This may include copyrights, trademark and issuing of
name. These rights address the question that why there are few firms to go abroad
and propose some firm-specific advantages that may help in overcoming the cost
of operating in overseas. Now finally, Internalization advantage emphases on
determining if it’s best for an organization to produce the specific product itself or
consider a contract with third party. It put influence on how a company chooses to
work overseas, trading-off savings in transactions, holding up costs against
advantages of another entry mode.
Location
Advantage
Ownership Internalization
Advantage Advantage
The
structure
of
Organizati
on
Figure 3.6.1 Theoretical Framework
21
Ownership advantages to investment are important for explaining the presence of

MNEs. It implies that the firm controls some particular asset which enables it to
produce positive profits. Subsequently of having the particular asset, the firm
could have either bring down expenses or be capable to charge higher costs and
therefore make more prominent economic benefits, both now and later on. For
instance, numerous multinationals, such as Motorola or GlaxoSmithKline, have
reputations for giving excellent items; so they can charge high prices; or they
have access to particular innovations that empower them to produce at a lower
cost than others. A potential firm should pay a sunk cost to decide its efficiency,
and, when this is uncovered, dynamic firms sort themselves into various methods
of productions. Low- efficiency firms deliver only for the home market; medium-
efficiency firms pay the settled cost of exporting; be that as it may, just the
supreme efficient firms pay the advanced settled cost of engaging in foreign direct
investment.
There must be some location advantages to create more prominent profits than
could be accomplished if production is in home nation. Different kinds of location
benefits are set forth. Firstly, natural resources might be expected to produce the
product and those resources must be separated where they are found, and are less
expensive to extract. Secondly, some capital or labor inputs might be less
excessive and the production intensively utilizes those inputs. Thirdly, local
production might be supported by the administration. Fourth, net transportation
expenses are lower if (some portion of) the production is done in home nation.
For instance, much of the time, if the item is being produced abroad and is
available to be purchased in home town, it is on the grounds that the production
costs are adequately lower in abroad. There is a crucial problem that has pulled in
much consideration and that is the difference among “horizontal” and "vertical"
FDI. Horizontal FDI happens when a firm locates a plant abroad so as to enhance
its market access to foreign customers. In its purest shape, this just duplicates its
domestic production facilities at overseas. Vertical FDI, by contrast, is not marked
as production available to be purchased in the foreign market, but instead looks to
the profit of lower production costs. Since in all cases the parent firm holds its
head office in the home nation, and ownership advantages can be viewed as
creating a stream of "head office administrations" to the host-nation plant, there is
a sense in which all FDI is vertical. Thus the difference between market-access
and cost motives for FDI is a vital one.
At last, regardless of the possibility that production is more profitable abroad, it

does not imply that the MNC must possess the facility there. It could permit a
local firm to utilize its innovation and produce the product that would take its
22
image or it could go into a partnership with another firm, which includes imparted
control to the local firm. In this manner, to clarify FDI, or aggregate control of the
utilization of the asset, there should be an internalization advantage. This
advantage emerges only if enabling another firm to utilize the asset would expand
the profitability and estimation of the resource for the MNC would be decreased
by the other firm getting control of utilization of the asset.
Table 3.6.1 Form of Market Entry
Source: http://en.wikipedia.org/wiki/Eclectic_paradigm
The eclectic paradigm additionally declares that the detailed configuration of the
OLI parameters confronting a specific firm, and the reaction of the firm to that
configuration, is clearly logical. Specifically, it will reflect the economic and
political elements of the nation or regions of the investing firms, and of the nation
or area in which they are looking to invest; the industry and the way of the value
added activity in which the firms are locked in; the qualities of the individual
investing firms, including their targets and systems in seeking after these goals for
FDI.
23
3.7 Model Specification

The succeeding two models are proposed to obtain the objectives from
hypothesis. Thus, the linear equation model is being used for the analysis of
results. First model includes GDP growth, GDP per person employed, inflation,
official exchange rate, real interest rate, natural resource rent, urban population,
mobile subscription, high technology exports, political stability, exports of goods
and services and finally terrorism. Whereas, second model includes trade
agreements alongside GDP growth, inflation, official exchange rate, natural
resource rent, mobile subscription, research & development, political stability,
exports & imports of goods and services.
Model 1
FDI= f (GDP, GDPEMP, INF, EXRATE, IR, NRS, UPOP, MSUB, TECH_XM,
PSTAB, XM, TERRORISM)
Econometrically, the above model can be expressed as follows:
Y = β0 + β1GDP + β2GDPEMP + β3INF + β4EXRATE + β5IR + β6NRS + β7UPOP

+ β8MSUB + β9TECH_XM + β10PSTAB + β11XM + β12TERRORISM + µ
Model 2
FDI= f (GDP, INF, EXRATE, NRS, MSUB, R_D, PSTAB, TAS, XM, XI,
FTAS)
Econometrically, the above model can be expressed as follows:
Y= β0 + β1GDP + β2INF + β3EXRATE + β4NRS + β5MSUB + β6R_D + β7PSTAB

+ β8TAS + β9XM + β10XI + β11FTAS + µ
24
3.8 Methodology
3.8.1 Hausman Test
The Durbin-Wu-Hausman test is a statistical hypothesis test in econometrics
named after James Durbin, De-Min Wu and Jerry A. Hausman. The Hausman test
identifies endogenous regressors in a regression display. Endogenous factors have
values that are controlled by different factors in the framework. Having
endogenous regressors in a model will make ordinary least squares estimators
bomb, as one of the uncertainties of OLS is that there is no relationship be
tween’s a predictor variable and the error term. Instrumental factors estimators
can be utilized as an option for this situation. Be that as it may, before you can
settle on the best regression technique, you initially need to make sense of if your
indicator factors are endogenous. This is the thing that the Hausman test will do.
In the panel data analysis, the Hausman test can help to pick between fixed or
random effects model. The null hypothesis exhibits that random effects model is
the preferred one whereas, alternative hypothesis exhibits that fixed effects is
more preferable. Basically, the test hopes to check whether there is a relationship
between the one of unique errors and the regressors in the model. The null
hypothesis is that there is no association between the two.
25
Chapter 4
Results and Interpretation

4.1 Correlation Matrix
FDI GDP GDPEMP INF EXRATE IR NRS UPOP
FDI 1 0.574997 0.544991 -0.467106 -0.896453 -0.599278 0.663391 0.904273
GDP 0.574997 1 0.177343 (0.396253) -0.720459 -0.56238 0.251977 0.633302
GDPEMP 0.544991 0.177343 1 0.161898 (0.197784) (0.494733) 0.419155 0.583189
INF (0.467106) (0.396253) 0.161898 1 0.700001 (0.196903) 0.135987 (0.5536)
EXRATE (0.896453) (0.720459) (0.197784) 0.700001 1 0.49929 (0.419986) (0.865878)
IR (0.599278) (0.56238) (0.494733) (0.196903) 0.49929 1 (0.599881) (0.572913)
NRS 0.663391 0.251977 0.419155 0.135987 (0.419986) (0.599881) 1 0.412615
UPOP 0.904273 0.633302 0.583189 (0.5536) (0.865878) (0.572913) 0.412615 1
MSUB 0.586949 0.237163 0.792513 0.174848 (0.315724) (0.569031) 0.486242 0.46938
TECH_XM 0.950895 0.658356 0.539238 (0.565391) (0.890333) (0.545617) 0.542011 0.954841
R_D 0.957501 0.634411 0.436591 (0.65335) (0.93478) (0.448607) 0.494459 0.899876
FTAS (0.138876) 0.251996 (0.267239) (0.088818) 0.026747 0.021962 (0.042748) (0.103857)
TAS (0.695051) (0.093481) (0.34818) 0.350337 0.588115 0.208458 (0.373801) (0.620889)
XM 0.972218 0.626902 0.604031 (0.45137) (0.854818) (0.592086) 0.645273 0.907965
XI 0.973901 0.598508 0.631399 (0.402153) (0.834496) (0.611596) 0.655976 0.875307
PSTAB__RANK_ 0.795674 0.683421 (0.009166) (0.729194) (0.957176) (0.364936) 0.37551 0.724935
TERRORISM (0.415775) (0.501074) 0.059836 0.783262 0.618566 0.074149 0.055594 (0.629771)
26
MSUB TECH_XM R_D FTAS TAS XM XI PSTAB__RANK_
FDI 0.586949 0.950895 0.957501 (0.13888) (0.69505) 0.972218 0.973901 0.795674
GDP 0.237163 0.658356 0.634411 0.251996 (0.09348) 0.626902 0.598508 0.683421
GDPEMP 0.792513 0.539238 0.436591 (0.26724) (0.34818) 0.604031 0.631399 (0.009166)
INF 0.174848 (0.56539) (0.65335) (0.08882) 0.350337 (0.45137) (0.40215) (0.729194)
EXRATE (0.315724) (0.89033) (0.93478) 0.026747 0.588115 (0.85482) (0.8345) (0.957176)
IR (0.569031) (0.54562) (0.44861) 0.021962 0.208458 (0.59209) (0.6116) (0.364936)
NRS 0.486242 0.542011 0.494459 (0.04275) (0.3738) 0.645273 0.655976 0.37551
UPOP 0.46938 0.954841 0.899876 (0.10386) (0.62089) 0.907965 0.875307 0.724935
MSUB 1 0.469243 0.496527 (0.41226) (0.43116) 0.588075 0.662118 0.15025
TECH_XM 0.469243 1 0.956987 (0.06158) (0.59673) 0.978937 0.951267 0.78282
R_D 0.496527 0.956987 1 (0.13619) (0.65547) 0.949055 0.943776 0.861324
FTAS (0.412259) (0.06158) (0.13619) 1 0.508303 (0.08482) (0.14545) 0.000398
TAS (0.431159) (0.59673) (0.65547) 0.508303 1 (0.58359) (0.59642) (0.517094)
XM 0.588075 0.978937 0.949055 (0.08482) (0.58359) 1 0.990089 0.745694
XI 0.662118 0.951267 0.943776 (0.14545) (0.59642) 0.990089 1 0.722115
PSTAB__RANK_ 0.15025 0.78282 0.861324 0.000398 (0.51709) 0.745694 0.722115 1
TERRORISM 0.351948 (0.60141) (0.52839) (0.31756) 0.171705 (0.45335) (0.35747) (0.617633)
27
TERRORISM
FDI (0.41578)
GDP (0.50107)
GDPEMP 0.059836
INF 0.783262
EXRATE 0.618566
IR 0.074149
NRS 0.055594
UPOP (0.62977)
MSUB 0.351948
TECH_XM (0.60141)
R_D (0.52839)
FTAS (0.31756)
TAS 0.171705
XM (0.45335)
XI (0.35747)
PSTAB__RANK_ (0.61763)
TERRORISM 1
28
Correlation matrix shows the relationship of FDI with independent or explanatory

variables; GDP growth, GDP per person employed, inflation, exchange rate,
interest rate, natural resources, urban population, infrastructure development,
technological development, trade agreements, exports & imports of goods and
services, political stability and terrorism. GDP growth is 57% positively
correlated with FDI. In other words FDI is 57% related with GDP growth.
Similarly, foreign direct investment (FDI) is 54% related with GDP per person
employed, 66% with natural resources, 90% with urban population, 90%, 59%,
95%, 96%, 97% and 80% with mobile subscription, technology exports, research
& development, exports & imports of goods and services and political stability
respectively. Whereas, FDI is 47% negatively correlated with inflation, 90% with
exchange rate, 60%, 14%, 70% and 42% with interest rate, free trade agreements,
trade agreements and terrorism respectively.
4.2 Descriptive Statistics
FDI GDP GDPEMP INF EXRATE IR NRS UPOP
Mean 2.009387 6.221963 17175.3567 8.765676 1908.19734 3.12033 6.89916 39.75176
Median 2.075517 6.267471 12089.7998 7.444625 49.1286755 4.167875 2.579468 33.966
Std. Dev 0.378118 3.906749 15346.68233 7.703723 5025.41862 5.935872 9.137024 16.02571
Minimum 0.583198 -6.60869 4195.859863 -8.28308 6.14343409 -17.3743 0.586302 20.055
Skewness -1.09601 0.290372 1.369136922 1.248445 3.42613717 -0.7324 1.719439 0.858768
Sum 190.8918 572.4206 1631658.886 797.6765 190819.734 224.6638 648.521 3975.176
Observations 95 92 95 91 100 72 94 100
29
MSUB TECH_XM R_D FTAS TAS XM
Mean 30.51543 71485408767 3277.179 1.47826087 1.828571 325395.3
Median 18.935809 1874192268 0.92153 1 2 69100.93
Std. Dev 31.355231 1.53364E+11 8352.153 0.66534784 1.042782 605632.6
Minimum 0 2467415 0.10919 1 1 1475.716
Skewness 0.5284717 2.205922923 2.740889 1.0272854 1.294534 2.489992
Sum 3051.543 5.14695E+12 209739.4 34 64 28634788
Observations 100 72 64 23 35 88
XI PSTAB__RANK_ TERRORISM
Mean 301877.4877 13.63685 154.45
Median 69231.69577 12.79621 42.5
Std. Dev 530166.8753 11.1424 218.1138
Minimum 3844.907 0.473934 0
Skewness 2.453588627 0.436646 1.603892
Sum 26565218.92 1159.132 15445
Observations 88 85 93
30
4.3 Results without Trade Agreements:
VARIABLES 1 2 3 4 5 6
GDP 0.0608 -0.00178 -0.0280 -0.0520* -0.0556* -0.0607*

(0.0455) (0.0292) (0.0346) (0.0291) (0.0299) (0.0346)
LNGDPEMP -0.274 0.174 -0.605 1.689** 1.237 1.239
(0.375) (0.588) (0.693) (0.782) (1.043) (1.111)
INF 0.0137 0.0524** 0.0663*** 0.0448** 0.0417** 0.0364*
(0.0261) (0.0200) (0.0210) (0.0186) (0.0193) (0.0207)
NRS 0.0908*** 0.00281 -0.0242 -0.0146 -0.0223 -0.0273
(0.0321) (0.0279) (0.0292) (0.0245) (0.0273) (0.0285)
LNMSUB 0.195** 0.513*** 0.579*** 0.401*** 0.364*** 0.357***
(0.0875) (0.0694) (0.0787) (0.0807) (0.0993) (0.104)
LNTECH_XM 0.257 -0.419* -0.140 0.0914 0.0465 0.104
(0.155) (0.208) (0.247) (0.213) (0.225) (0.277)
LNEXRATE -1.874*** -2.156*** -2.175*** -2.270*** -2.368***
(0.563) (0.580) (0.479) (0.504) (0.537)
IR 0.0101 0.0151 0.0189 0.0185 0.0186
(0.0204) (0.0202) (0.0167) (0.0168) (0.0176)
LNPSTAB__RANK_ 0.387** 0.166 0.168 0.212
(0.166) (0.153) (0.154) (0.156)
UPOP -0.177*** -0.174*** -0.175***
(0.0410) (0.0415) (0.0437)
LNXM 0.326 0.287

(0.491) (0.519)
LNTERRORISM 0.0377
(0.0674)
Constant 4.370 22.71*** 24.01*** 5.568 7.395 6.607
(4.216) (4.712) (4.967) (6.029) (6.675) (6.979)
Observations 69 54 48 48 48 45
R-squared 0.681 0.809 0.817 0.883 0.885 0.886
Number of ACIIP 4 4 4 4 4 4
Standard errors in parentheses
*** p<0.01, ** p<0.05, *p<0.1
31
4.4 Results with Trade Agreements:
VARIABLES 1 2 3
GDP -0.0108 -0.00866 -0.107**

(0.0411) (0.0410) (0.0472)
INF 0.000873 0.000440 0.0631
(0.0396) (0.0392) (0.0644)
NRS 0.0725 0.0763 -0.0179
(0.0555) (0.0557) (0.0718)
LNMSUB 0.529*** 0.520*** 0.497***
(0.175) (0.151) (0.142)
LNR_D 1.506*** 1.499*** 1.687*
(0.543) (0.517) (0.872)
LNEXRATE 0.118 0.0872 -0.260
(0.228) (0.220) (0.246)
LNPSTAB__RANK_ 0.791*** 0.797*** 0.550***
(0.222) (0.211) (0.166)
LNTAS -0.233 -0.243
(0.161) (0.162)
LNXI -0.196
(0.281)
LNXM -0.193
(0.237)
FTAS 0.115
(0.134)
Constant 8.464*** 8.503*** 8.524***

(2.693) (2.403) (1.099)
Observations 25 25 17
Number of ACIIP 3 3 3
Standard errors in parentheses
*** p<0.01, ** p<0.05, * p<0.1
32
4.5 Interpretations Criterion

The following hypothesis is used for interpreting the results:
Ho=No Relation
H1= Relation
Decision Rule: if p-value < 0.01, 0.005 and 0.1; Reject Ho
4.5.1 Interpretations without Trade Agreements:

Hausman test is being applied to examine whether fixed effect is better for the
significance of variables or random effect. Results of showed that without trade
agreements, fixed effect is more efficient whereas, with trade agreements test
results showed that random effect is more efficient than fixed effect.
Our first model includes GDP growth, GDP per person employed, inflation,
natural resources, infrastructure and technological development. Empirical results
showed that constant FDI is not significant. However, it is seen that it rises with
one unit change in all explanatory variables. Moving on to the relationship
between GDP growth and FDI it is seen that while the coefficient is positive it is
also non-significant, which shows that keeping all other things constant, FDI will
rise by 0.0608 million if GDP growth increases by 1%. Whereas, GDP per person
employed has an insignificant negative relation with FDI, thereby implying that
FDI will fall by 0.274 million if GDP per person employed increases by 1
constant dollar, keeping all other things constant. Looking at the results for the
variable Inflation it is seen that while it has a positive impact on FDI but the non-
significance of the coefficient fails to prove the validity of this relation according
to which FDI will rise by 0.0137 million if inflation increases by 1% keeping all
other things constant. Moreover, natural resources are found to be highly
significant with FDI at 0.01 level of significance due to which FDI will rise by
0.0908 million if natural resource rent increases by 1 dollar. Mobile subscriptions
being used as a proxy of infrastructure development also has a significant positive
impact on FDI which shows that FDI will rise by 0.195 million if mobile
subscription increases by 1 person. Lastly, high technology exports- the proxy of
technological development- has a non-significant positive relation with FDI.
Accordingly, 0.681 value of R-square reflects that 68.1 percent variation in the
dependent variable (FDI) is caused by all the independent variables of the model.
33
However, by including the variables of fourth hypothesis i.e. exchange rate and
interest rate in the model, our results change. The empirical results now showed
that constant FDI is highly significant and it increases with one unit change in all
explanatory variables. Whereas, GDP growth now shows an insignificant negative
relation with FDI, that is, FDI will fall by 0.00178 million if GDP growth
increases by 1%. GDP per person employed now experiences a positive relation
with FDI but it remains to be non-significant, showing that FDI will rise by 0.174
million if GDP per person employed increases by 1 constant dollar. Similarly,
inflation becomes significant at 5% level of significance. The natural resources
now exhibit a non-significant but positive relation with FDI. While mobile
subscription becomes highly significant at 1% level of significance, high
technology exports become significant at 10% level of significance. Exchange
rate in this model is highly significant and is found to have a negative relation
with FDI therefore; FDI will fall by 1.874 million if exchange rate increases by 1
dollar, keeping all other things constant. Finally, interest rate reveals a non-
significant positive result thereby making FDI rise by 0.0101 million if interest
rate increases by 1%. As a result, 0.809 value of R-square reflects that 80.9
percent variation in the dependent variable (FDI) is caused by all the independent
variables of the model.
One of the important governance indicator; political stability is then added to the
model to check its impact on FDI and it brings slight changes to the results. While
the results of the constant term and GDP growth remains the same i.e. highly
significant and negative/insignificant relation with FDI respectively. Results of
GDP per person employed now exhibit an insignificant negative relation with FDI
which reveals that FDI will fall by 0.605 million if GDP per person employed
increases by 1 constant dollar. Inflation becomes more significant with FDI.
While the coefficient for natural resources is now found to be showing negative
relation with FDI, the result is nevertheless insignificant. Mobile subscription
remains highly significant at 1% level of significance while high technology
export becomes non-significant with negative impact on FDI. On the other hand,
the results for exchange rate and interest rate remained positively significant and
non-significant respectively. Lastly, Political stability is found to be significant at
5% level of significance having a positive relation with FDI showing that FDI
will rise by 0.387 million if political stability increases by 1 rank. Therefore,
0.817 value of R-square reflects that 81.7 percent variation in the dependent
variable (FDI) is caused by all the independent variables of the model.
34
Further new variable is being added to the model i.e. urban population. Results
become more significant after adding this variable except constant which doesn’t
remain significant anymore but is still increasing with one unit change in all
explanatory variables. GDP growth now becomes significant at 10% level of
significance and is still exhibiting negative relation with FDI whereas, GDP per
person employed become significant at 5% level of significance now ensuring
positive relation with FDI. Inflation is still significant but at 5% now rather than
1% level of significance. However, results of natural resources, mobile
subscriptions, high technology export, exchange rate and interest rate remains the
same as they were before with a slight change in the values of coefficient. On the
other hand, the result for political stability is no longer significant as it was before
but it still has positive relation with FDI. Lastly, urban population is found to be
highly significant at 1% level of significance having a negative relation with FDI
showing that FDI will fall by 0.177 million if urban population increases by 1%.
Hence, 0.883 value of R-square reflects that 88.3 percent variation in the
dependent variable (FDI) is caused by all the independent variables of the model.
Coefficients are being tested by adding new variable, that is, exports of goods and
services to the model. Results for all the variables remained same as explained in
the above model except for the minor changes in their coefficient values.
However, GDP per person employed become insignificant yet exhibiting a
positive relation with FDI. Lastly, exports of goods and services reveals a non-
significant positive result thereby making FDI rise by 0.326 million if exports of
goods and services increases by 1 dollar. Thus, 0.885 value of R-square reflects
that 88.5 percent variation in the dependent variable (FDI) is caused by all the
independent variables of the model.
Finally, the model includes terrorism alongside all other variables which didn’t
affect any of the coefficient’s value. However, there is a minor change in the
result of inflation, that is, its significance fall from 5% level of significance to
10%. Last of all, terrorism itself reveals a non-significant result. In consequence,
0.886 value of R-square reflects that 88.6 percent variation in the dependent
variable (FDI) is caused by all the independent variables of the model.
4.5.2 Interpretations with Trade Agreements:

The first model here includes GDP growth, inflation, natural resources, mobile
subscription as a proxy of infrastructure development, research & development as
a proxy of technological development, exchange rate, political stability, trade
agreements and imports of goods and services. Results showed that constant
35
variable (FDI) is highly significant under this model and it increases with one unit
change in all explanatory variables. Moving on to the relationship between GDP
growth and FDI it is seen that coefficient is negative and is also insignificant,
which shows that keeping all other things constant, FDI will fall by 0.0108
million if GDP growth increases by 1 constant dollar. Now looking at the results
for the variables inflation and natural resources it is seen that while they both has
a positive impact on FDI but the non-significance of their coefficient fails to
prove the validity of this relation. Whereas, mobile subscription has a highly
significant positive impact on FDI which shows that FDI will rise by 0.529
million if mobile subscription increases by 1 person. Similarly, research and
development also has a highly significant positive impact on FDI therefore; FDI
will rise by 1.506 million if research and development increases by 1 person.
Exchange rate on the other hand exhibits a non-significant but positive relation
with FDI. Moreover, political stability is found to be highly significant with FDI
at 0.01 level of significance due to which FDI will rise by 0.791 million if
political stability increases by 1 rank. Lastly, trade agreements and imports of
goods and services exhibits a non-significant negative relation with FDI according
to which, FDI will fall by 0.233 million if trade agreements increases by 1 dollar
and 0.196 million if imports of goods and services increases by 1 dollar
respectively.
However, minor variation is being observed in the values of coefficients by

excluding imports and including exports of goods and services in our model.
Thus, results for all the variables remained the same as discussed in above model
with slight changes in the values. While looking at the results for exports of goods
and services we see that it has non-significant negative relation with FDI
according to which, FDI will fall by 0.193 million exports increases by 1 dollar.
Lastly, free trade agreements are being added to the model by excluding exports
and imports of goods and services. Empirical results for constant, inflation,
mobile subscription and political stability doesn’t change. Whereas, in describing
the relationship between GDP growth and FDI, it is seen that they both has a
significant but negative relation with each other which shows that keeping all
other things constant, FDI will fall by 0.107 million if GDP growth increases by
1%. Natural resources on the other hand has an insignificant negative relation
with FDI, thereby implying that FDI will fall by 0.0179 million if natural
resources increases by 1 constant dollar, keeping all other things constant.
Research and development is still significant but at 10% level of significance
rather than 1%. Results of exchange rate now exhibit an insignificant negative
relation with FDI which reveals that FDI will fall by 0.260 million if exchange
36
rate increases by 1 constant dollar. Finally, free trade agreements reveals a non-
significant positive result thereby making FDI rise by 0.115 million if these free
trade agreements increases by 1%.
4.6 Robust Regression Estimate
VARIABLES 1 2 3 4 5
GDP -0.0607 -0.0556 -0.0280 -0.00178 0.0608

(0.0419) (0.0377) (0.0590) (0.0508) (0.0834)
LNGDPEMP 1.239 1.237 -0.605 0.174 -0.274
(0.930) (0.712) (0.573) (0.300) (0.652)
INF 0.0364** 0.0417*** 0.0663* 0.0524* 0.0137
(0.00679) (0.00290) (0.0232) (0.0193) (0.0252)
NRS -0.0273 -0.0223 -0.0242 0.00281 0.0908
(0.0263) (0.0301) (0.0270) (0.0269) (0.0532)
LNMSUB 0.357 0.364 0.579*** 0.513*** 0.195
(0.179) (0.195) (0.0699) (0.0558) (0.118)
LNTECH_XM 0.104 0.0465 -0.140 -0.419 0.257
(0.352) (0.313) (0.351) (0.212) (0.377)
LNEXRATE -2.368*** -2.270*** -2.156 -1.874
(0.392) (0.375) (1.030) (0.938)
IR 0.0186 0.0185 0.0151 0.0101
(0.0167) (0.0191) (0.0191) (0.0173)
LNPSTAB 0.212 0.168 0.387
(0.180) (0.211) (0.286)
UPOP -0.175*** -0.174***
(0.0175) (0.0216)
LNXM 0.287 0.326
(0.806) (0.733)
LNTERRORISM 0.0377
(0.0522)
Constant 6.607 7.395 24.01* 22.71** 4.370
(2.915) (3.593) (8.002) (6.641) (4.895)
Observations 45 48 48 54 69
R-squared 0.886 0.885 0.817 0.809 0.681
Number of ACIIP 4 4 4 4 4
Robust standard errors in parentheses
*** p<0.01, ** p<0.05, *p<0.1
37
Chapter 5
Discussion
The study attempts to explore the important determinants of FDI and their impact
on it. Different groups of determinants has been used in this study such as
marketing seeking FDI, efficiency seeking FDI, resource seeking FDI,
macroeconomic condition and FDI alongside terrorism, trade, governance
indicators and population.
With the absence of trade agreements fixed effect results demonstrated that GDP
per person employed- proxy of efficiency seeking FDI do not unambiguously
exert a significant influence on FDI but they do have a positive relation with each
other. This means that with an increase in the level of employment, FDI will tend
to increase as more foreign direct investment creates more employment
opportunities. Apart from the theoretical relation between the two variables, this
result is consolidated with the findings of Habib and Sarwar (2013).
Other variable i.e. natural resources- proxy of resource seeking FDI exert an
insignificant negative impact on FDI which means that with one unit increase in
the utilization of natural resources, FDI will tend to fall. The result is consolidated
with the idea of “resource curse” and with earlier study of Wiig and Kolstad
(2011) and. As idea of resource curse suggest that more use of natural resources
drives up the domestic prices, crowd out the tradeable manufacture sector,
resulting in lower rates of productivity improvement and lower growth in non-
resource sector.
Another variable used as a proxy of infrastructure development in resource

seeking FDI is mobile subscription. It shows highly significant positive impact on
FDI which means with one unit increase in infrastructure development, FDI will
lean towards rise. As great quality and developed infrastructure can increase the
level of productivity in one nation and along these lines animates FDI streams
towards the nation. Apart from theoretical relation between these two variables,
this result is associated with the study of Erdal Demirhan and Mahmut Masca
(2008).
Last variable used in resource seeking FDI is technology exports- proxy of

technological development. This variable exerts insignificant positive relation
with FDI which shows that with one unit rise in technological development, FDI
will lean towards rise. As now we can see boundless acknowledgements regarding
technology exports, its importance in domestic productivity growth and
eventually higher living standards. Thus, FDI will attract countries having more
38
technological development. The results are in line with the study of Hezron
M.Osano & Pauline W. Koine (2016); Pravakar Sahoo (2006).
Moving on to the macro-economic conditions and FDI, exchange rate

demonstrates highly significant negative impact on FDI. This negative sign
exhibit that investors are expecting higher returns on their investment. Thus, this
result is consolidated with study of Anjum Aqeel and Mohammed Nishat (2004).
Alternative variable used in macro-economic conditions and FDI is interest rate

which exhibit insignificant positive impact on FDI. This means that with an
increase in one unit of interest rate, FDI tend to increase. Similar results are also
present in the findings of Rubab Khan and Hijab Zahra (2016); Alie Faroh and
Hongliang Shien (2015).
Another important variable used as a determinant of FDI is political stability-

proxy of governance indicators. It shows significant positive impact on FDI as we
know with increase in political stability, FDI also increases. The finding that FDI
is positively correlated with political stability is similar with the findings of
Azmat Gani (2007); Steven Globerman and Daniel Shapiro (2002). Therefore,
nations acquiring more FDI need to improve their governance structure.
As foreign direct investment leads to the creation of employment and increases

the level of income, this increase in income will tend to increase consumption
expenditures. With rise in expenditures, demand for goods and services and prices
for those goods will tend to rise if supply for those goods and services doesn’t
increase equivalently. Though, with increase in the income level of the society,
there will be a temperate rise in the level of inflation.
Trade is considered as an important determinant of FDI from which exports of

goods and services showed positive relation with FDI. Hence, the foreign direct
investment persuaded by exports expansion can expand social welfare. These
results are similar with the findings of Dr. A. Jayakumar, Kannan .L & Anbalagan
.G (2014) and N. Prasanna (2010). Whereas, imports of goods and services
showed negative relation with FDI thus, this result is consolidated with the study
of Renu Sharma and Mandeep Kaur (2013). Where there is bidirectional causality
between FDI and imports of goods and services. However, free trade agreements
showed insignificant positive relation with FDI and these results are in line with
the findings of Shandre M. Thangavelu and Christopher Findlay (2011).
39
Conclusion
This research explored the important determinants of FDI for Pakistan and its
neighboring countries using market seeking FDI, efficiency seeking FDI, resource
seeking FDI, macroeconomic conditions and FDI, governance indicator,
terrorism, trade and urban population. Hausman test has been applied to check if
fixed effect is more effective on our results than random effect.
By using Hausman test we found interesting results for almost every variable. The
coefficients of GDP growth, infrastructure development, technological
development, exchange rate, political stability and urban population are highly
significant and hence, showed justifiable correct signs. Whereas, GDP per person
employed, natural resources interest rate exports and imports of goods and
services and free trade agreements exhibit insignificant relation with FDI but they
all have shown correct signs.
Lastly, it can be concluded that all these variables which are an important
determinants of FDI, can influence FDI inflows in many ways in the context of
Pakistan and its neighboring countries.
40
Policy Implications
 It is recommended that if governments want to increase FDI, they should
adopt special policy measures to improve infrastructure and technological
development.
 Government should more focus on political stability of its country.
 There must be proper measures and resources to control urban population.
 Governments and industrialists must focus on having more free trade
agreements.
41
Limitations and Future Agenda

Some of the key limitations faced during this research were time duration and
availability of data for some variables especially in the case of Afghanistan. There
were many missing values in Afghanistan’s data which formed problems later.
Many variables and determinants were excluded from this research due to time
limitation but they can be used for further research if anyone wants. Even there
can be a comparison with bilateral trade agreements too.
42
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Evaluating the Determinants of FDI: A Panel Data Study of Pakistan and

Evaluating the Determinants of FDI: A Panel Data Study

B.Sc. HONORS DEGREE

COMSATS INSTITUTE OF INFORMATION TECHNOLOGY,

Pulling in foreign direct investment (FDI) help-out the nations in immediately

List of Figures and Tables

Figure 1.1 FDI Inflows of Pakistan and its Neighboring Countries…………….6

Figure 3.6.1 Theoretical Framework…………….………….……….…….…….22

Table 3.2.1 Data Sources and Expected Signs of Variables ……….…….…….18

Table: 3.5.1 Definitions of Dependent and Independent Variables….…….……20

Table 3.6.1 Form of Market Entry…………….………….……….…….……...24

FDI increases national prosperity by expanding the volume and proficiency of

Figure 1.1: FDI Inflows of Pakistan and its Neighboring Countries

The significance of technology for economic growth gives an imperative

FDI Inward Flows US Dollars at Current Prices in Millions

Mostly, good institutions positively affect development by empowering

1.2 Problem Statement:

Officially, the statement of problem can be expressed as “how much FDI is

1.3 Objective of the study:

1.4.2 Efficiency Seeking FDI:

H1b: FDI and Inflation are significant with each other

1.4.3 Resource Seeking FDI:

1.4.4 Macroeconomic Condition and FDI:

H1: FDI and Governance are significant with each other

H1: FDI and Terrorism are significant with each other

Globerman and Shapiro, (2002) study the part of governance infrastructure on

Kwok & Tadesse, (2006) examine the impact of institutional environment of

Alsan, Bloom & Canning, (2006) investigate the consequence of population

Stoian, Carmen R. Filippaios & Fragkiskos, (2008) examine the influence of

3.1 Type of Study

3.2 Data Sources

Table 3.2.1: Data Sources and Expected Signs of Variables

Variable’s Name Data Source Expected Sign

GDP Growth World Bank Positive

Inflation World Bank Positive

GDP Per Person Employed World Bank Positive

Exchange Rate World Bank Positive/ Negative

Interest Rate World Bank Positive

Urban Population World Bank Positive/ Negative

Natural Resources World Bank Negative

Infrastructure World Bank Positive

Technology World Bank Positive

Trade UNCTAD Positive/ Negative

Governance World Governance Positive

3.4 Variable selection criteria

3.5 Variable Definitions

Foreign Direct Investment FDI is a venture made by an organization or a

Governance The activity of monetary, political and

GDP Growth It gauges how quick the economy is

GDP/Person Employed It is defined as GDP divided by total

Inflation The rate at which general price level for goods

Natural Resources Resources that exist without actions of

Official Exchange Rate It refers to the exchange rate determined by

Real Interest Rate An interest rate that has been adjusted to

Trade A basic economic concept involving the

Terrorism It is defined as the use of violence or threat of

Urban Population The residents of any city or town including

Infrastructure It is the basic physical system of a business or

Trade Agreement These agreements are the product of