International Journal of Economic Practices and Theories, Vol. 3, No.

3, 2013 (July), e-ISSN 22477225

www.ijept.org

Exports Performance under the Role of Foreign Direct Investment in Pakistan: An

ARDL Approach
by
Muhammad Ayaz, Muhammad Umair Yousuf, Muhammad Asghar
Lecturer, Department of Economics,
University of Baluchistan, Quetta, Pakistan
M.Phil Research Fellow, Applied Economics Research Centre,
University of Karachi, Karachi, Pakistan
M.Phil Research Fellow, Applied Economics Research Centre,
University of Karachi, Karachi, Pakistan
ayaz.economics@uob.edu.pk, umair.aerc@hotmail.com, m.asghar.ly@gmail.com

Abstract: Foreign Direct Investment (FDI) is the largest source of inflow of foreign earnings for the countries of the
developing world. This study examines the short and long run association between FDI, exports and growth for Pakistan by
employing the Autoregressive and Distributed Lags (ARDL) approach in the time series framework from 1975 to 2011.
Augmented Dickey Fuller (ADF) test is applied for checking the stationarity of data, while ARDL technique is applied for
the presence of cointegration; long run relationship and short run relationship among macroeconomic variables in case of
Pakistan. The ARDL model found cointegration at level among the variables while the Error Correction Term (ECT) is
insignificant at 1% significance level. The positive relationship between FDI and exports in the short run as well as in the
long run is predicted by the parameters of ARDL. The study suggests that government should attract FDI in those sectors
which mainly contribute to exports directly (like textile manufacturing) or indirectly (like power generation sector) to make
exports competitive in the international market.
Key Words: ARDL, exports, foreign direct investment (FDI), terms of trade.
JEL Classification: F14, F21

the major growth enhancing factors for the

development of the economy. FDI is one of the
most important tools which make nations
especially the developing ones to achieve the
investment levels beyond their levels of saving
because every country has limited opportunities
to grow and save in autarky condition. In this
era, it is almost impossible for every nation to
close their boundaries for international trade
The
impacts
of
these
factors
are
multidimensional and they have influences on
common man whether they are social,
economical, political or cultural. World Trade
Organization (WTO) has now become an
international trading system with a framework
of principles and laws between the trading
partners. Pakistan (like other developing
nations) having problems of low productivity
and under utilization of resources due to nonspecialization and diseconomies of scale in
different sectors of the economy like agriculture
etc. There are different classical theories, which

1 Introduction
The importance of exports and FDI has been
increasing with the passage of time. We are
living in the age of globalization and those
nations who are recognized as the world leaders
in the prevailing times are improving their
economies through increasing trade for mutual
benefits. This current structure of nations to
trade with other countries is not an instant
process. Different countries experienced
different situations with international trade
depending upon their factor endowments. As
occurred in the history of the developing world,
countries had Import Substitution policies in the
late 1950s as well as in the early 1960s are
considering international trade between nations
(on the basis of their incomplete specialization)
significantly and optimistically. They are
reaping advantages of mutual gain, promotions
of relations, reasonable prices and market
expansions. Exports and FDI are considered as
192

favor the positive impact of international trade

and FDI inflows. The increasing globalization
all over the world has led to the increasing
competition to attract FDI in the developing
countries. Export led growth (ELG) hypothesis
states that exports are one of the most important
growth accelerating factors for the economy.
FDI allows the nations to get more benefits
(compared to others) by efficient use of their
productive resources, whether they are natural
resources, human capital etc. At the same time,
the host countries also enjoys the benefits in the
form of advanced technology (particularly from
the developed to the developing world),
improved production levels, up gradation of
physical and human capital as well, but also
have ambiguous impacts (in favor of or against)
on the social and cultural values.
The performance of exports shows the nations
capability to sell goods and services produce in
a domestic country to other nations in the
world. FDI inflows to the developing world
having positive externalities and may be
considered as an important component in the
development strategies made by the policy
makers because of its spillover effect on the
exports (Ahmad, Alam and Butt, 2003). Import
Substitution policies in the 1950s and 1960s
which were followed by Exports Promotion
policies in the 1970s, improved resource
allocation and increase productivity through
technological development and economies of
scale (Shirazi and Manap, 2004). There is also a
big impact of political integration between the
countries to attract FDI. Pakistan should
improve its relationship with economically
strong countries of the world on the basis of
bilateral gains and benefits (Khan, 2011).

developing countries are having different

sources of foreign earnings but FDI remains the
largest one since 1994. They continued to be
increasing from 1993 to 2008 then declined due
to global crises but improving with the
recovery. These financial flows help the
developing economies to deal with the problems
of financial constraints, low investment
opportunities etc.

Figure 1. FDI and Other Resource Flows to the

developing countries (1991-2009) Source: Migration and
Remittances Fact book (2011), World Bank, pp. 17.

1.2 Pakistans exports structure

Pakistan had been promoted from low income
group in 2008 to middle income group in 2011.
(World Banks Country Classifications, World
Bank, 2010). The structure of Pakistan exports
is presented in Figure-2 of appendix-d, which
shows that the exports of Pakistan are divided
into primary (17%); manufactured (74%) and
semi manufactured (9%) products. At the time
of independence 99% of Pakistans GDP share
was agriculture products and raw material but
today agriculture contributes only 23% in the
gross domestic product. Small portion of
exports belong to semi manufactured and
primary or raw materials. The manufactured
exports have the lion share of intermediate and
furnished textile products.

1.1 FDI compared to other foreign financial

flows to the developing world
According to Migration and Remittances Fact
book (2011), FDI inflows are considered as the
largest source of overseas receiving for the
developing economies if compared with other
financial flows like workers remittances,
Official Development Assistance (ODA) and
Private Debt and Portfolio Equity (PD&PE).
Figure-1of appendix-d shows that the

Figure 2. Structure of Pakistan Export. Source: economic

survey report of Pakistan, 2009-10

193

Figure 3 presents major exports of Pakistans

exports. More than half of Pakistans exports
belong to textile manufacturing; agro food
exports contribute 17 percent. Both of which
consist of 70 percent of total exports. Although
Pakistan remained under world economic and
political influence and subject to follow the
policies imposed by world leading economies
such as economic sanctions of 1998, issue of
9/11, political interruption by the west to
mitigate terrorism, capital flight and various
other factors contributed to economic slowdown
of Pakistan economy but in last decade Pakistan
improved its balance of payment by increasing
its manufactured export. The export structure is
presented in following figure:

would yield the highest economic returns

for Pakistan.
Rest of the paper consists of review of the
related literature, data and methodology,
empirical results and discussion of the results
and finally we may draw some conclusions and
have some policy measures in this regards.
2 Literature review
The ambiguous results of different time series,
cross sectional and panel data analysis have
been analyzed in the literature. The relationship
between FDI, exports and output for Pakistan is
investigated by Ahmad et al (2003). The time
series data for the period 1972-2001 found that
there exists a long run relationship between
FDI, exports and domestic output. The
association between FDI inflows and growth for
Pakistan is analyzed by Falki (2009). These
inflows act as the growth enhancing catalyst for
countries of the developing world. However, the
positive impact of the FDI on growth is
productive through different channels like
increase in the domestic investment and human
capital with the transmission of the
technological factors.
Zhang and Song (2000) analyze the role of FDI
inflows to China from 1986 to 1997. In the
provincial panel data analysis, the role of FDI
on the exports of the country has been linked
and the conclusion of this study is that these
foreign inflows have direct impact on exports of
the manufacturing sector. Franco (2012)
analyzes the productivity spillover effects of the
foreign investment flows on the recipient
countries. This study uses data from 1990 to
2001 to evaluate the impact of the US FDI on
the exports strength at different sectors in 16
OECD countries. The conclusion of this study is
that FDI inflows positively influence the
exports performance of the host countries.
Javed et al (2012) finds out the link between
four South Asian economies (India, Pakistan,
Bangladesh and Sri Lanka) with panel data
analysis of 38 years (1973-2010). By employing
Generalized Method of Moments (GMM), this
study concludes the direct relation between
exports and growth in all the four major

Figure 3. Major products of Pakistans exports. Source:

Trade development authority of Pakistan, 2009-10

1.3 Significance and objectives of the study

This study will examine FDI and exports
performance for the period 1976-2011 for
Pakistan. It also investigates whether the
expansion of FDI has had any significant effect
on the exports performance of Pakistan. Further
it will help in identifying the key sectors where
Pakistan should attract FDI in order to increase
the exports performance. Theoretically it seems
that FDI significantly impact on the exports
performance, however we need to check this
phenomenon in the context of Pakistans
economy. Besides this, there is a need to do the
sector analysis of exports to understand and
interpret the empirical results.
With the help of empirical analysis, the aim is
to answer the following research questions.
To what extent FDI is more important in
determining the exports performance?
To find out the important sectors for
attracting FDI and formulating policies that

194

economies while ambiguous relationship with

FDI.
Dritsaki, Dritsaki and Adamopoulos (2004)
analyze the long run relationship between FDI,
growth and trade. The time series analyses for
Greece from 1960 to 2002 also justify causal
relationship between the said variables and
conclude that growth, FDI and trade have
amalgamated affect on the country.
FDI and workers remittances are among the
two major sources of foreign earnings for many
developing countries. These foreign earnings
may lead to appreciation of real exchange rate
for Pakistan [Rehmen, Jaffri and Ahmed
(2010)]. Yousaf et al (2011) examines the
influence of FDI on the growth of Pakistan from
1980 to 2009. The important aspects to increase
economic growth through foreign investment
are
favorable
exports
policies,
local
infrastructure and production capacity with
improved human capital. Siddiqui and Ahmad
(2012) investigate the linkage between FDI and
current account by utilizing Johansen Juselius
cointegration technique and Granger causality
test on quarterly data of Pakistan from 1976 to
2005 and found long run relationship with the
unidirectional causality respectively. Vural and
Zortuk (2011) discuss the case study of Turkey
from 1982 to 2009 to find relationship between
FDI and exports. The data analysis of Turkish
economy shows that exports growth is
comparatively greater than the GDP growth and
FDI is one of the important factors that can
increase Turkish exports. No short run causality
is seen between FDI and current account. It also
suggests exports based investment flows are
valuable if profit outflows are less.
Mahmood and EhsanUllah (2011) explore the
impact of different macroeconomic variables
(population, import duties, political structure,
and manufacturing sector, exchange rate,
exports and education level) on FDI for
Pakistan from 1972 to 2005. By employing
ADF test and OLS regression analysis, this
study suggests that the size of the economy,
democracy and increasing education are the pull
factors of FDI while all the other variable shave
negative impact on the inflows of FDI. Rabiei
and Masoudi (2012) study the panel data of
eight Islamic developing countries including

Pakistan. The data set from 1980 to 2009

strongly supports FDI as the growth enhancing
factor. FDI inflows work as one of the vital
factor to boost economic growth and
development of the countries. Technological
transfer, efficient allocation of scarce
productive
resources
and
employment
opportunities in the recipient countries are some
of the important long run benefits of these
foreign inflows. The directions of FDI should
be diverted from the services sector to the
exports oriented sectors to get real advantages
of these earnings [Muhammad et al (2010)].
Jayachandran and Seilan (2010) explore the
causal relation between FDI, trade and growth.
The analysis from 1970 to 2007 for India
exposes the long run relationship between the
macroeconomic variables which jointly
strengthen the benefits with the open-door
policy.
3 Data sources
Our study is based on four major
macroeconomic variables; export (LEXP),
foreign direct investment (LFDI) and
productivity (LGDP) along with terms of trade
(LTOT). Variables are expressed in logarithmic
form for the ease of interpretation. Data for all
variables has been taken from 1975 to 2011
annually. Data on terms of trade has been taken
from various issues of Economic Survey of
Pakistan while all other variables are sourced
from World Development Indicators.
4 Methodological frameworks
Theoretically; export of goods and services is
related to the number of macroeconomic
variables. But for the sake of simplicity, we
hypothesize that export is a function of gross
domestic product, foreign direct investment and
terms of trade. Mathematically:
LEXP f LGDP, LFDI , LTOT
LEXPt 1 2 LGDPt 3 LFDI t 4 LTOTt t

The expected signs of coefficients of gross

domestic product and foreign direct investment
195

are positive while exports are negatively related

with the terms of trade. There are numbers of
methods available for the estimation of short as
well as long run relation among these variables.
Among these methods some are like Angelgranger (1987) test, Johansen (1991) test and
OLS based autoregressive and distributed lag
(ARDL) model. First two tests that is Angelgranger and johansen tests are of low power
because both of these tests are subject to
stationarity test, if for example at 5%
significance level we test the stationarity of a
variable. There is 5% chance of making type-I
error, that is making an incorrect conclusion of
placing stationary series as a non-stationary. As
a result the test based on such data stationarity
test will also be of low power that is there is a
high chance of making an incorrect conclusion.
In case of ARDL model there is no need pre

testing for data stationarity. In johansen and

Angel-granger test it is necessary for all series
to be I(1) in order to test the cointegation
among variables but in case of ARDL it is not
necessary, we can test the presence of
cointegration among variables of different order
of integration. In our case one variable that is
FDI is not I(1) but is only a trend stationary. For
the above two reasons we have used ARDL
technique for analysis in this study.
4.1 Estimation
The ARDL framework of equations addresses
three basic questions. Firstly; is there exist any
long run relation among the variables? This
question is addressed by the following equation
(3):

p1

p2

p3

p4

i 1

i 0

i 0

i 0

LEXPt 0 i LEXPt i i LGDPt i i LFDI t i i LTOTt i 1LEXPt 1

(3)

2 LGDPt 1 3 LFDI t 1 4 LTOTt 1 t

H A : 1 2 3 4 0

In above equation i, i, i, and i are short run

coefficients while i are long run coefficients.
P1, p2, p3, and p4 are number of lags used for
each variable like LEXP, LGDP, LFDI and
LTOT respectively. We used Akaike
information criteria (AIC) for the determination
of lag structure of each variable. The null
hypothesis in equation (3) is:

There exists a long run relationship among the

variables. Secondly: we will calculate the long
run equation based on level of variables, if we
first find the existence of cointegration among
variables. We calculated the long run equation
which is normalized by coefficient of export
(LEXP). The long run model based on level of
variables can be estimated by equation (4):

H 0 : 1 2 3 4 0
It means that all variables do not have any long
run relation. Alternatively;
p1

p2

p3

p4

i 1

i 0

i 0

i 0

LEXPt 0 i LEXPt i i LGDPt i i LFDI t i i LTOTt i t

where i, i, i and i are long run coefficients of
export, output, FDI and terms of trade
respectively. Finally the short run dynamics

(4)

were captured by estimating the equation (5),

which consists of only difference term and error
correction term (ECT) as given below:

p1

p2

p3

p4

i 1

i 0

i 0

i 0

LEXPt 0 i LEXPt i i LGDPt i i LFDI t i i LTOTt i 1ECTt 1 t

In the above equation; i, i, i, and i are

representing short run coefficients, while 1 is
an adjustment coefficient. It depicts the speed

(5)

and direction of change toward equilibrium in

the long run. Some diagnostic techniques were
applied to check the suitability of the model
196

used. They suggest that there is no serial

correlation, violation of normality assumption
and none of the problems associated with
functional form. The reader may verify all
results presented in appendix C.

growth driven hypothesis. Due to increase in

income; the demand for exportable goods
directly influences the large scale production
which enhances the exports. The coefficient of
terms of trade is negatively correlated. It shows
that as the export prices goes on increasing, it
will cause to reduce the demand for exportable
commodities. Akaike information criteria
suggested a short run model with ECT of order
(2,4,2,3) and results are presented in table-2:

5 Empirical results and discussion

In ARDL framework it is important to test the
data for stationarity in order to determine short
run dynamics. We applied ADF (1979) and
Philip Perron (1988) tests for testing data
stationarity. The outcomes are included in
appendix A. Table (1) shows that all variables;
output, terms of trade and export are I(1) except
foreign direct investment which becomes
stationary after de-trending it and hence it is
denoted by LFDIT.
Next part of the analysis examines the estimate
of ARDL framework of equations. The study
provides evidence in the support of existence of
long run relationship among the variables.
Because F-statistics value is almost high and the
null of no long run relationship is rejected
significant at 1% level of significance. Akaike
information criteria suggested a long run model
of order (3,3,3,3) is given in the appendix. (B)
The normalized form of the model is given in
table-1:
Table.1. Long run equation of LEXPD.
=Variable Coefficients t-statistics
C
-0.839420
-0.536597
LFDIt-2
0.059798
2.048613
LFDIt-3
-0.110348
-4.009872
LGDPt-3
1.262984
7.340525
LTOT
-0.550944
-4.426146
LTOTt-3
-0.224639
-1.887577
MA(3)
0.92964
16.78285
R2
= F-stat
= DW
=
0.994522
453.8760
2.058455
AIC = - Prob
= RSS
=
2.813760
0.000000
0.054747

Table.2. Short run equation

(DLEXPD).
Variable
Coefficients
C
-1.3643
LEXPt-1
0.3201
LEXPt-2
0.2277
LFDITt-1
0.0868
LFDITt-3
-0.0940
LFDITt-4
0.0749
LGDPt-2
-0.7110
LTOT
-0.4073
LTOTt-3
-0.5720
ECTt-1
-0.9293
R2
= F-stat
=
0.689335
4.437797
AIC = - Prob
=
2.117191
0.003490

with error correction term

t-statistics
-3.814486
1.875666
1.384320
2.628093
-2.644217
1.801374
-0.843503
-2.364415
-3.009933
-4.001668
DW
=
2.011981
RSS
=
0.096603

Probability
0.0013
0.0770
0.1832
0.0171
0.0165
0.0884
0.4100
0.0295
0.0075
0.0008
Log
likelihood =
39.64068

The short run and long run coefficients of

foreign direct investment and terms of trade
shows the analogous relationship with export
and are positively correlated, while there exists
negative relation with output and is not
significant. Output does not have any impact on
export in short run suggested by ARDL
equation; the coefficient of output is statistically
insignificant in that equation. The coefficient of
ECTt-1 is large and highly significant. The sign
of error correction term shows that when there
is any disequilibrium from normal situation it
will converge back to equilibrium. The speed of
adjustment is fast as the magnitude of
coefficient of ECTt-1 is very large; it suggests
that 93% of adjustment towards equilibrium
will occurs within one year. Generally speaking
our estimates provide evidence in the support of
short run as well as long run relationship among
the variables.

Probability
0.5975
0.0499
0.0007
0.0000
0.0003
0.0737
0.0000
Log
likelihood
=49.79952

The equation above depicts that output is

positively correlated with foreign direct
investment upto 2nd lag but negatively from 3rd
lag. It suggests that profit patriot investors dont
re-invest their profit in host country due to some
problems faced while conducting profitable
operations of business. The study also favors
197

Journal of the American Statistical Association 74, 427431

6 Conclusion and policy recommendations

Dritsaki, M., Dritsaki, C and Adamopoulos, A (2004): A

Causal Relationship between Trade, Foreign Direct
Investment and Economic Growth for Greece, American
Journal of Applied Sciences, 2004, 230-235,

This study analyzed the impact of FDI on

exports using annual times series data from
1970 to 2011 by employing ARDL technique.
The results conclude that there is short run as
well as long run positive relationship between
exports and FDI, whereas output has positive
impact on FDI in the long run but statistically
no significant impact in the short run. All
variables are non-stationary at their level except
FDI, which is trend stationary at level. The
model shows that there is quick adjustment
towards equilibrium in case of any
disequilibrium from equilibrium level.
The study advocates that exports may be
increased due to enlarging FDI. The policy
makers should make policies to attract FDI in
prominent
exports
sectors
(textile
manufacturing) or in those which indirectly
contribute to exports (power generation) to
make it competitive in the international market.
The work also proposes that law and order
conditions should be improved in the country to
attract comparatively more FDI. This inflow of
FDI in manufacturing sector can be helpful to
increase exports and economic growth which
will lead to prosperity in the country. Increase
in FDI leads to stabilization of the deficit in
balance of payment in two ways that is directly
due to inflow of foreign exchange and indirectly
due to increase in export receipts.
The study suggest that in order to remove
deficit in balance of payment and get rid of
IMF, instead of foreign assistance government
should focus on economic policies like
attracting foreign direct investment by bringing
betterment in law and order situation and
attractive
investment
opportunities
for
foreigners.

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199

Appendix. A. Unit Root test results

Variable
LEXP
LTOT
LGDP
LFDIT

Augmented-Dicky Fuller Test

t-statistic (At level)
Probability
-2.833048
0.1955
-1.606945
0.7691
-1.042354
0.9249
-5.423436
0.0004
t-stat(1st Difference)

Phillips Perron Test

t-statistic (At level)
-2.890946
-1.606945
-1.518186
-5.704175
t-stat(
1st
Difference)
-6.134945
-5.241003
-4.538719

Probability
0.1772
0.7691
0.8045
0.0002

LEXP
-6.139081
0.0000
0.0000
LTOT
-5.258778
0.0001
0.0001
LGDP
-4.526907
0.0009
0.0009
LFDI
@5% level of significance; the critical value for t-stat is (1) At Level =-3.548490 (2) At first difference
=-2.948404
Appendix. B. Long run equation coefficient equation
Dependent Variable: LEXPD, Non normalized long run ARDL equation
Variable
Coefficients
t-statistics
Probability
C
-0.536597
0.5975
LEXP t-1
0.839420
4.470446
0.0002
LEXPt-3
0.417162
-4.086462
0.0006
LFDIt-2
2.048613
0.0499
LFDIt-3
0.387040
-4.009872
0.0007
LGDPt-3
0.058298
7.340525
0.0000
LTOT
-4.426146
0.0003
LTOTt-3
0.107348
-1.887577
0.0737
MA(3)
1.225984
16.78285
0.0000
0.534944
0.218639
0.898964
2
R = 0.994522
F-stat = 453.8760
DW = 2.058455
Log
likelihood
AIC = -2.813760
Prob
= 0.000000
RSS = 0.054747
=49.79952
Appendix .C
C.1 Diagnostic checking results
TEST
Ramsys functional form
Normality
Serial correlation LM TEST
ARCH TEST
Heterosedacity

PROBABALITY
0.3564
0.9685
0.4364
0.2714
0.7754

200

C.2 Recursive residuals

.20
.15
.10
.05
.00
-.05
-.10
-.15
-.20
1990

1992

1994

1996

1998

2000

Recursive Residuals

2002

2004

2006

2 S.E.

C.3 Cusum test

15
10
5
0
-5
-10
-15
1990

1992

1994

1996

1998

CUSUM

2000

2002

2004

2006

5% Significance

C.4 Cusum square test

1.6
1.2
0.8
0.4
0.0
-0.4
1990

1992

1994

1996

1998

CUSUM of Squares

2000

2002

2004

5% Significance

201

2006

C.5 Recursive coefficients test

t

202