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Foreign Capital Inflows and Economic Growth

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Article in Journal of Transnational Management · May 2017

DOI: 10.1080/15475778.2017.1302784
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Foreign capital inflows and economic growth of

Pakistan
Syed Tehseen Jawaid & Shaikh Muhammad Saleem
To cite this article: Syed Tehseen Jawaid & Shaikh Muhammad Saleem (2017) Foreign capital
inflows and economic growth of Pakistan, Journal of Transnational Management, 22:2, 121-149
To link to this article: http://dx.doi.org/10.1080/15475778.2017.1302784
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JOURNAL OF TRANSNATIONAL MANAGEMENT
2017, VOL. 22, NO. 2, 121–149
http://dx.doi.org/10.1080/15475778.2017.1302784
Foreign capital inflows and economic growth of Pakistan

Syed Tehseen Jawaida and Shaikh Muhammad Saleemb
a
University of Karachi, Karachi, Pakistan; bPakistan Shipowners’ Government College, Karachi, Pakistan
ABSTRACT KEYWORDS
This study investigates the relationship of foreign capital inflows, Economic growth; foreign
namely foreign direct investment, workers’ remittances, and capital inflows; time series
external debt with economic growth of Pakistan by employing analysis
time series data from 1976 to 2015. Cointegration results
indicate that foreign capital inflows and economic growth have
a significant relationship with economic growth in the long run.
Ordinary least square results indicate foreign direct investment
has a significant and negative effect on economic growth,
whereas a significant positive effect of remittances and external
debts on economic growth is found. Rolling windows analysis
highlights the yearly effect of three different models. Two
different sensitivity analyses confirmed that initial results are
robust. The final section concludes the study and provides some
policy implications.
Introduction
Importance of foreign capital inflows (FCI) has increased after trade
liberalization, particularly in emerging economies. Countries move their
resources from inefficient to efficient sectors. FCI encourages the process of
economic growth by filling up the saving-investment gap, (see Khan (2007);
increasing productivity (see Ozturk (2007); transferring advanced technology
(see Balasubramanyam, Salisu, & Sapsford (1996); new entrepreneurship (see
Khan (2007)). These above considered benefits encourage the developing
world to liberalize economies to attract foreign capital. On the other hand,
there is cost associated with these inflows that may be harmful for developing
countries Le and Ataullah (2002). After trade liberalization, South Asian
Region (SAR) became the trade hub for foreign investors and showed
tremendous improvement in growth performance. This constituency is
available to low-wage workers for developed countries because this region
has a huge population that is attractive for investors. Many studies have shown
that foreign direct investment (FDI), remittances (REM), and external debts
(EXD) are key inflows in making an economy more stable (Barajas, Chami,
Fullenkamp, Gapen, & Montiel, 2009; Brooks, Fan, & Sumulong, 2003; Pattillo,
Poirson, & Ricci, 2011).
CONTACT Syed Tehseen Jawaid stjawaid@hotmail.com Applied Economics Research Centre, University
of Karachi, Karachi 75270, Pakistan.
Color versions of one or more figures in the article can be found online at http://www.tandfonline.com/wtnm.
© 2017 Taylor & Francis
122 S. T. JAWAID AND S. M. SALEEM
The role of FDI in economic growth has been a passionate debate,

especially in developing countries. FDI is based on host country’s
circumstances and good financial system helps to attract FDI (Hermes &
Lensink, 2010). FDI can improve the efficiency of the economy during
financial crisis. It helps to smooth consumption pattern, domestic saving that
may lead to stability, increase in production capacity by new technology,
provide employment opportunity, and increase per capita income. Contrary,
it is found that if developing countries rely more on FDI, it may discourage
the local industry because international companies capture market shares that
cause the shutting down of local industry (Reisen & Soto, 2001).
In addition, remittances also consider important inflow to sustain
economic growth and increase the standard of living in the recipient country.
Its structure depends on migrants, where they belong and how much
they spent in the host country and how much they save and send to home
country. Chami, Fullenkamp, and Jahjah (2005) argue that remittances tend
to be negatively correlated with GDP growth, suggesting that they are
compensatory in nature and it does not intend to serve as capital for
economic development. Whereas, Giuliano and Ruiz-Arranz (2006) argue
that remittances boost economic growth with less developing financial system
by providing an alternative way to finance and help to overcome liquidity
constraints. In contrast, external debts have been played important role
in developing countries due to unavailability of funds and technology.
Aizenman, Jinjarak, and Park (2012) investigated when the global crisis
occurred in 2008–2009, in which developing countries faced problems due
to shortage of funds and payment of external liability. This mentioned crisis
provides strong relationship between FCI and economic growth.
Contextual setting
In the South Asian Region, Pakistan plays a vital role because of its unique
location for other neighboring countries and it links east with west. Pakistan
has three neighboring powers, i.e., China, Russia, and India and Pakistan has
the only shortest and cheapest link among China and the Middle East through
CPEC (China-Pakistan Economic Corridor) and Gawader. It has an access to
Muslims’ central Asian states through Afghanistan and also provides interlink
among and to the Gulf States. African and European states can connect south
Asian countries through Gawader port and also offer south East Asian
countries to interconnect through Karachi port. Gawader is the important
port not only for trade but also important for security and defense. Therefore,
for development of Pakistan, it is better to focus on foreign capital to
strengthen the economy and prosperity so it is need to know which type of
FCI efficiently effect on economic growth in Pakistan.
JOURNAL OF TRANSNATIONAL MANAGEMENT 123
Foreign capital inflows in Pakistan: An overview

In this section, the historical trend of FDI, REM, and EXD in Pakistan are
discussed.
FDI is the largest source of external finance for Pakistan. Figure 1 shows
increasing trend from 1976 to 1981 after this decline up to 1984 and between
1986–1987. Trend increased from 1988 to 1997 and later this trend did not
maintain its momentum and it went down during 1998–2001 due to the
Pakistan nuclear test. After the incident of 9/11 in 2001, FDI slightly fell
due to supporting the war against terrorism and this falling trend ended in
2004. This high momentum was maintained up to mid-2008 and later suffered
international economic crisis. At last, increase has been noticed in 2013, 2014,
and 2015.
From Figure 2, it can be seen that remittances in Pakistan have increasing
trends since 1976 to 1983 except 1981 and then trends slightly decline from
1984 to 1988. Later remittances increased during 1989–1990 but hereafter
from 1991 to 2001 it showed mixed decreasing trends and this fall was partly
due to the eruption of the Gulf crisis in the early 1990s. Seizure of Pakistani
foreign accounts and other sanctions were imposed due to the nuclear
explosion in 1998 (Khan & Ashfaq, 2004). Contrarily, inflow momentum
raised during 2002 to 2015 except for a few years.
To develop the desired growth rate and availability of funds, Pakistan is
borrowing to finance their project to lead economic growth and reduce the
gap of inadequate savings - investment. These funds help to buy technology
and equipment that will improve the stability of the country, and effective
use of external debts gives positive impact on economic growth. As shown
in Figure 3, debts showed up and down trends during 1976—1984 and
increased during 1985–1995 except for 1989 and 1995. In the next two years
it increased, whereas in 1998 after the nuclear test, international financial
institution banned loans to Pakistan. Later the debt burden increased due
Figure 1. Historical trend of FDI (percentage of GDP).

Figure 2. Historical trend of remittances (percentage of GDP).
to the need of funds during global economic crisis. After 2004, debts showed
mixed trends, especially during 2012 to 2015.
The previous discussion elaborates that foreign capital inflows may foster
economic growth in developing countries, but how many people of Pakistan
are wealthy and their standard of living high is not clear so far. In general, it
remains debatable whether foreign capital inflows are being effective on econ-
omic growth in Pakistan. Due to this, it needs to investigate the foreign capital
inflows relationship with economic growth to remove the ambiguity. This article
tries to evaluate the impact of foreign capital inflows on the economic perfor-
mance of the country by using long-time series data and applying more rigorous
econometric techniques.
The rest of the article is organized as follows. The next section presents
theoretical channels and empirical studies. Model framework and dataset
are then discussed. After that is a section showing the estimations and results
followed by a section discussing rolling window analysis. This is followed by a
Figure 3. Historical trend of external debts (percentage of GDP).

discussion of causality analyses and sensitivity analysis. The final section con-
cludes the study and provides some policy implication.
Review of related literature

The following literature focuses on foreign capital inflows and economic
growth. In fact, a number of recognized theories give channels that discuss
how FCI affects growth. Therefore, in this section theoretical background
and empirical studies have been discussed separately.
Theoretical background
This section highlights the foreign direct investment, remittance, and external
debts channels that may affect growth performance in different ways.
Foreign direct investment and economic growth

This section discusses foreign investment and growth theory that is based on (i)
Neo-classical theory (ii) Dependency theory, and (iii) Industrialization theory.
Neoclassical growth theory focuses on capital accumulation and total factor
productivity (Ozturk, 2007; Khan, 2007). The inflow of advanced technology
from developed to developing countries in the form of foreign investment
may impact management practices that lead to creating competition in the
market (Balasubramanyam, Salisu, & Sapsford, 1996). Technology maximizes
the productivity spillover in the economy by changing inferior and scares
domestic production process into advanced technology (Khaliq & Noy,
2007). Innovation in production process requires firms to reallocate their
resources and facilitate employment to equal income distribution that will
reduce the gap between savings and investment. This capital formation
produced more government revenues through taxes and reduced the pressure
of balance of payment (Mahmood & Rehman, 2013).
In contrast, “Dependency theory” asserts that foreign investment is harmful
in the long-run growth for developing countries, if this investment came from
the developed country (Khan, 2007). Hein (1992) and Fan (2002) argue that
the world’s developed nations are wealthier by utilizing resources and labor
of developing countries.1 Reasons include inappropriate use of domestic
resources, global division of labor, declining growth rate, increased income
inequality, and poverty in developing nations. It is further argued that if
developing economies cannot become fully modernized in their structure they
remain stuck in the world’s capitalist system. Therefore, it is suggested that
developing nations increase their growth without depending on foreign
investment, then they might quit from the capitalist system.
In the discussion of “industrialization theory” Hymer’s (1976) pioneer
attempt to study of multinational companies (MNCs) drew attention to
neglected aspect of MNCs. His major contribution was to shift attention away
from neoclassical financial theory because Heckscher and Ohlin (H–O model)
(Salvator, 2004) that is based on restrictive assumptions about immobility of
factor of production. Further the (H–O) model argues that no international dif-
ference exists at the technological level and they failed to mention technology
transfer and spillover effects. Foreign investment through MNCs is considered
simply as arbitrageurs of capital and under neoclassical portfolio theory is seen
to flow from nations where returns are low to those where they are higher.
Hymer (1976) further argued that FDI is not simply transfer of capital but
also represents transfer of “package”.2 It is also describing FDI as international
extension of industrial organization theory. When a firm undertakes FDI in a
foreign country, its possesses some special ownership advantages3 over
domestic competitors. Koizumi and Kopecky (1977) imply that increased
savings ratio may reduce dependence of foreign capital. Wang and Blomstrom
(1992) developed a model that assumes foreign subsidiaries and domestic firms
can take their investment decision to boost the profit. Both firms solve their
dynamic optimization issues.
Remittances and economic growth

This section highlights the effect of remittance on economic growth in three
broad ways: (i) capital accumulation, (ii) labor force, and (iii) total factor
productivity.
Inflow of remittances can affect growth by the rate of capital accumulation.
Barajas et al. (2009) firstly argued that remittance increases the rate of capital
accumulation through domestic investment as well as increases the creditworthi-
ness of domestic investors, and then huge inflow may lower the cost of capital.
Secondly, more borrowing is available for new domestic investors and these
funds may be used for debt payment that leads to further stability of the econ-
omy. Imai, Gaiha, Ali, and Kaicker (2011) argued that inflows may reduce the
volatility and risk of premium for investors who tend toward future investment,
which is why investment becomes more attractive in the economy.
On the other hand, labor force participation rate is expected to give
negative impact on economic growth because remittances are income that
transfers from migrants to their families and it leads to diverting investment
to leisure consumption by household. It also discourages labor efforts in the
labor market (Barajas et al., 2009).
Remittances may affect total factor productivity by increasing the effective-
ness of investment. If remittances are considered as capital inflow and
recipients are investing on behalf of the remitter, then the effectiveness of
investment is reduced because of informational drawback as compared with
formal domestic financial intermediaries. Remittances also increase the quan-
tity of funds following through the banking system. This flow leads to improved
financial expansion and therefore makes higher economic growth possible.
From the above discussion based on Barajas et al. (2009), it is clear that remit-
tances may have positive effects on economic growth. However, this positive
effect is very uncertain in terms of magnitude and direction. Overall, the effect
of remittances on the economic growth of the recipient country is hypotheti-
cally ambiguous. Therefore, the relationship between workers’ remittances
and economic growth can be settled only by looking at the empirical evidence.
External debts and economic growth

Debts can impact economic growth by the capital accumulation and total
factor productivity in “growth accounting” framework. At the beginning,
developing countries have scarce capital resources and domestic investors
are expected to make investments with more rate of return than developed
countries. As long as they use the borrowed funds for productive investment,
they do not suffer from instability, distorting incentives, and nonrepayment of
debt. It is suggested that developing countries can enhance their economies
by realistic borrowing.4 Krugman (1988) also argues that in an overhang
situation, creditors do not look forward to fully repay due to the huge burden
of debts in the economy that leads debt-service cost.5 In this situation, inves-
tors are afraid because if they produce more they will be taxed more. This
situation disheartens domestic and foreign investors, thus it leads to lowered
capital accumulation and reduced productivity. Government may have not as
much encouragement in the policy reforms and inferior policy environments
get lower total productivity growth (Pattillo, Poirson, & Ricci, 2004). Specifi-
cally, the low-income economies with debt-serving difficulties do not find the
way in which portion of debt would actually be serviced with the country’s
own resources. The highly uncertain and unstable environment misleads
allocation and quality investment in the projects that may slow productivity
(Chowdhury, 2001). Pattillo et al. (2011) argue few specifications of external
debt; it may be high-level debt, small-level debt, and average-level debt that
impact differently on economic growth in recipient economy.
The theoretical channels show many possible effects of foreign capital
inflows on economic growth with uncertain magnitude. Therefore, this matter
is going through empirical studies for a further clear explanation. The next
section reviews past empirical studies on foreign capital inflows and economic
growth nexus.
Empirical evidence
This section highlights the reviews of related empirical studies to discover the
relationship between foreign capital inflows and economic growth.
Foreign direct investment and economic growth

Many studies have discussed the relationship between foreign direct
investment and economic growth. Barrell and Pain (1997), Borensztein,
De Gregorio, and Lee (1998), Funke, Nunnenkamp, and Schweickert (1992)

and Zebregs (1998) among others argue that FDI stimulates advanced tech-
nology from developed to developing countries. It encourages competition
among multinational companies (MNCs) and domestic investors that seek
to reduce the technology gap and increase human capital productivity when
the recipient country has a minimum threshold stock of human capital and
controls the inflation rate. On the other hand, Nair-Reichert and Weinhold
(1999) discuss FDI and economic growth relationship fairly heterogeneous
in developing countries and conclude that FDI may be beneficial for more
open economy whereas, Athukorala (2003), and Katerina, John, and Athana-
sios (2004) among others argue that FDI inflows do not exert an independent
and significant influence on economic growth.
Johnson (2006) investigates the effect of FDI on economic growth through
cross-sectional and panel data of 90 countries during 1980 to 2002. It is
argued that FDI has a positive effect on growth as a result of physical capital
accumulation inflow and technology spillover. FDI enhanced the market size
and strengthened the incentive for investors.
Khaliq and Noy (2007) examine Indonesian data from 1997–2006 to
investigate the effect of the foreign direct investment on economic growth.
It is observed that FDI has a positive effect on economic growth at the
aggregate level, whereas at the sectoral level (i.e., mining and quarrying) it
has a negative effect. It is suggested that Indonesia makes more subsidizing
policy for attracting FDI inflows in all sectors, which is indeed beneficials
to enhance growth prospect.
Alguacil, Cuadros, and Orts (2008) empirically identify the effect of foreign
investment on economic growth in 15 European Union (EU) countries.
EU-15 consists of two different regions, as new and old member countries.
The study is based on panel data from 1990 to 2001. It is argued that two
different EU regions impact differently. FDI has a positive effect on economic
growth in new member countries, whereas in old member countries FDI has
a negative effect. In advanced economies, motivated investors use FDI by
diversification objective rather than investment needs.6 Therefore, good
impact of FDI on economic performance depends upon domestic conditions
and modernizes physical capital.
Apergis, Lyroudi, and Vamvakidis (2008) investigate the importance of
foreign investment by taking panel data of 27 transition economies during
1991–2004. The sample is further divided into high-level and low-level
income countries. It is proved that FDI significantly impacts economic growth
in all countries, whereas in transition economies with successful privatization
programs can significantly affect economic growth.
Liu (2011) examines the relationship between foreign investment and
economic growth in China by using time series data from 1985 to 2008.
Findings indicate that FDI tends to decrease economic growth in the long
run, whereas development in China seems to be fueled by domestic

capital accumulation and employment growth that may lead to encourage
government investment. On the other hand, FDI may crowd out domestic
capital and reduce employment growth in the long run.
Adeniyi and Omisakin (2012) discuss the long-run relationship between
FDI and economic growth during 1970 to 2005 in sub-Sahara countries
and found positive effect of FDI on economic growth. Few other researchers
such as Devajit (2012); Hassen and Anis (2012); Imoudu (2012); and Ray
(2012), 2012), during 1975 to 2011 also argue that FDI positively affects
different sectors of the economy and government should focus on its policy
making to improve insignificant sectors. It is concluded that FDI is used to
sustain economic growth by focusing on different sectors of an economy.
Contrary, Erhieyovwe and Jimoh (2012) concluded that FDI does not cause
economic growth in Nigeria.
Yasin (2013) focuses on FDI-led growth hypothesis in the case of Pakistan
and has taken time series data from 1976–2010. ARDL (Autoregressive-
Distributed Lag) method has been used to find long-run and short-run relation-
ship. Results confirm that no long-run relationship exists between FDI and
economic growth, whereas the model is good in a short-run relationship.
However, causality analyses and sensitivity analyses have not been performed.
Iqbal, Ahmad, Haider, and Anwar (2014) investigate the relationship
between FDI and economic growth in Pakistan taking data from 1983 to
2012. Results suggest a positive relationship between FDI and economic growth.
It is also concluded that FDI impact may be situation and cultural related, so the
extent of FDI economic benefit cannot be predicted. The basic problem with
their study is that their analysis is based on assumption; the stationary data
are being used. Nowadays, there is convincing evidence that many macroeco-
nomic variables are having non-stationary properties. These types of non-
stationary variables may provide spurious results in OLS estimations.
Azam and Ahmed (2015) discuss growth model through FDI and human
capital consisting of 10 commonwealth countries during 1993 to 2011. The
researcher used fixed and random effect. It is concluded that FDI facilitates
economic growth. Policies suggest that government more facilitates MNCs
and improved local business conditions.
Ibrahim and Dahie (2016) evaluate the impact of FDI, aid, domestic
investment on economic growth in Somalia, taking annual data from 1970
to 2014. Their study concludes that FDI has significant positive effect on
economic growth in Somalia. Similarly, Sjoholm (2016) proved the positive
effect of FDI by value added in local firms in Indonesia.
Remittances and economic growth

Generally, past studies regarding the relationship between remittances and
economic growth can be divided into a positive and negative relationship.
Keely and Tran (1989) evaluate either possible view of remittances from the
period 1960 to 1985 by taking data from 50 countries. It is argued that
remittances have a negative impact on economic growth. Furthermore, Chami
et al. (2005) and Sakka and McNabb (1999), among others, conclude negative
effect of remittances by the pessimistic view hypotheses that remittances
increase dependency, instability, development distortion, and lead to
economic decline. In another way, Buch, Kuckulenz, and Manchec (2002),
Elbadawi and Rocha (1992), and Leon-Ledesma and Piracha (2001), among
others conclude there is positive impact of remittance that improves income
distribution, increases recipient life standard, and effective response to market
forces that lead to economic growth.
Barajas et al. (2009) argued that remittances play a small role in economic
growth for a long-run relationship in remittance-receiving countries, and
often found negative impact among 84 recipient countries by employing
annual data from 1970 to 2004. By the evidence, policymakers should
rethink optimistic views of remittances and shift attention toward a realistic
understanding of their effects because it is not encouraging economic growth.
Remittances are not considered as an investment but rather a social benefit to
help a migrant’s family.
Vargas-Silva, Jha, & Sugiyarto (2009) investigate the potential of
remittances for promoting economic growth and poverty alleviation in the
short run and in the long-run relationship by taking data from 20 Asian
countries from 1988 to 2007. It is argued that remittances positively affect
economic growth in the long run and short run and tend to reduce the
poverty gap in the short run only. This does not mean remittances are not
beneficial in the long run, but it required proper utilizing of the migrant’s
amount that increases welfare, research and development, and reduced
poverty rate. Asian countries also look into others’ complementary ways of
boosting economic growth and development.
Imai et al. (2011) re-examine the effect of remittances on growth with panel
data of 24 Asian and Pacific countries. Results confirm that remittance inflows
have been fruitful for economic growth, whereas it is also confirmed that
volatility of remittance is harmful to economic growth. It is argued that
remittances are beneficial to reduced poverty through direct effects, thus it
is potentially valuable for development efforts. It is suggested that policy
makers become more aware regarding investment decisions to recipients that
may facilitate them.
Jawaid and Raza (2012) examine the effect of remittance on economic
growth in China and Korea by employing time series data from 1980–2009.
Results confirm significant positive effect of remittance on economic growth
in Korea, whereas there is significant negative effect in China. The short-run
analysis proved that remittances have positive and significant effect on
economic growth in Korea, but have insignificant effect in the Chinese
economy. Furthermore, it is suggested that policy makers of Korea must

ensure continuous inflows of remittances and its proper utilization for seeking
growth, whereas China should reduce voluntary unemployment to reduce the
negative effect of workers’ remittances on economic growth.
Barguellil and Zaiem (2013) check the direct and indirect effect of
remittances on economic growth in Tunisia by using time series data from
1976–2006. It is argued that the direct effect of remittances is negative,
whereas indirect effect by adding another variable (education), showed
positive effect on economic growth. In the long run, the study considered that
remittances help to alleviate the recipient’s budgetary limits to have more
funds in hand for children and to reduce child labor.
Jawaid and Raza (2016) investigate the effect of workers’ remittances on
economic growth by taking five south Asian countries and employing time
series data from 1975 to 2009. Results confirm significant positive effect in
the long run between remittances and economic growth in India, Bangladesh,
Sri Lanka, and Nepal, but show significant negative relationship in Pakistan. It
is suggested that to reduce the transaction cost to welcome remittances into
the region and that Pakistan should make policies to discourage voluntary
unemployment. However, they did not perform any causality analysis.
Salahuddin and Gow (2015) find a positive relationship between remit-
tances and growth in Pakistan, Bangladesh, India, and the Philippines using
panel data from 1977 to 2012. Similarly, Aziz, Sen, Sun, and Wu (2015) also
confirm significant relationship between remittances and growth in the sam-
ple. Contrary, Hassan and Shakur (2015) examine the impact of remittances
on economic growth in selected Asian countries and conclude that impact of
remittances is small on economic growth.
Najibullah and Masih (2015) discuss remittance and economic growth
relationship taking time series data over the period 1977–2013. They did
not find long-run relationship; however, short-run relationship exists because
of inflows from non-formal channels. They suggest that government promote
remittances through official channels.
Nwaogu and Ryan (2015) investigate FDI, aid, and remittances impact on
53 African and 34 Latin American and Caribbean economies but all three
variables are not significant in Africa. Contrary, aid and remittances effect
growth in Latin America and the Caribbean.
Ajayi, Akinbobola, Okposin, and Ola-David (2016) check effect of
exchange rate volatility and foreign capital on growth in Nigeria. This study
has the positive and significant effect of FDI, while having negative effect of
remittances. Zafar, Siddique, Ahmed, and Khan (2016) check implications
of remittances, FDI, and aid on economic growth in Pakistan through the
years 1985 to 2014. The study concluded positive significant relationship
among FDI, remittances, and economic growth, while showing the negative
significant effect of aid. Nevertheless, they perform only ordinary least square
estimation, even without performing stationarity analyses. Data have also not
been used as available for Pakistan. Thus, their results are not reliable for
policy implication in the country.
External debts and economic growth

Empirical evidence focuses on external debts and growth relationship to know
whether it plays a significant role in the economy by using time series and
pooled data. Collins and Park (1988) find positive impact of debts on growth
in Korean economy by its successful adjustment and use. Furthermore, Ahmed,
Butt, and Alam (2000), Cohen and Sachs (1985), Devarajan, Swaroop, and Zou
(1996), Dooley, Helkie, Tryon, and Underwood (1983), and Wijnbergen (1989)
argue that debt is productive when planned exports focus on long-run invest-
ment, but it could become unproductive if there is excessive use of it. On the
other hand, high real interest rates shift income toward savings or consumption
rather than investment, whereas high inflows of debt are deleterious to econ-
omic growth in the long run (Checherita & Rother, 2010; Chowdhury, 2001;
Hajivassiliou, 1987; Pattillo, Poirson, & Ricci, 2002; Pattillo et al., 2011).
Clements, Bhattacharya, and Nguyen (2003) examine channels through
debt effects on growth in 55 low-income countries7 by using panel data from
1970 to 1999. It is argued that the reduction in external debts projected for
Highly Indebted Poor Countries (HIPCs) would directly increase per capita
income growth. Reduction in debt service could also provide an indirect boost
to economic growth through their effects on public investment. Debts have a
deleterious effect on growth after it extends its threshold level.
Pattillo et al. (2004) examine the debts-growth relationship by using panel
data of 61 developing countries8 from 1969 to 1998. It is found that high debts
negatively impact economic growth. Choong, Lau, Liew, and Puah (2010)
investigate debts-growth relationship in Malaysia during 1970 to 2006 by
examining different types of debts, namely long-term debt, short-term debt,
multilateral debt service, private non-guaranteed debt, public and publicly
guaranteed debt service, and mainly external debts. It is found that all types
of debts have negative significant effect on long-run economic growth except
external debt and short-run debt. It is concluded that an increase in external
debt level can adversely influence economic performance, whereas the decline
in rate of growth weakens the ability of the country to serve its debt.
Boboye and Ojo (2012) scrutinize the effect of external debts on economic
growth of Nigeria through regression analysis. It indicates that external debt
burden has adverse effect on national income and high-level debt causes devalu-
ation of currency. It is suggested that debt should be invested in profitable ven-
tures that could generate reasonable return, not only for further investment but
also for debt repayment. Kasidi and Said (2013) examine the impact of external
debts on economic growth in Tanzania during 1990–2010. The cointegration
test shows that there is no long-run relationship between debt and growth.
Ramzan and Ahmad (2014) investigate the effect of external debt and econ-
omic growth in Pakistan by employing annual time series data from 1970 to
2009. The result of ARDL (Autoregressive-Distributed Lag)-bound testing
approach indicates significant negative effect of external debt on economic
growth. However, from their findings we cannot decisively conclude that
either external debt has a negative effect on economic growth in all considered
samples. However, samples contain structural break due to separation of east
and west Pakistan and they did not perform any structural break analyses to
capture this effect. Thus, their results are not acceptable for policy implica-
tions. In addition to these weaknesses, we perform rolling window analysis
to find the yearly effect of external debt on the economic growth of Pakistan.
Siddique, Selvanathan, and Selvanathan (2015) investigate long-run and
short-run relationship between external debts and economic growth from
1970 to 2007. The study used panel data consisting of 40 HIPC countries
and concluded that external debt has negative effect on economic growth in
long run and in short run. Similarly, other researchers, Chudik, Mohaddes,
Pesaran, and Raissi (2015) and Lee and Ng (2015) analyzed long-run
relationship between debts and growth and concluded that debts confirm this
negative significant impact on economic growth.
Jebran, Ali, Hayat, and Iqbal (2016) examine the impact of external debt on
economic growth from 1972 to 2012 in the long and short run in Pakistan. The
result showed negative relationship with economic growth in the long run and
short run and suggests less reliance on external debts because of negative effect.
Furthermore, Jilenga, Xu, and Gondje-Dacka (2016) investigate external debt
and FDI relationship with economic growth in Tanzania using time series data
from 1971 to 2011. It was found that external debts show insignificant positive
relationship with economic growth in the long run, whereas no relationship
was found in the short run.
After discussions of theoretical and empirical studies we can illustrate many
possible effects of foreign capital inflows on economic growth, but the magni-
tude is uncertain. Furthermore, this study provides in-depth analyses with
longtime series data and rigorous econometric techniques. This will help policy
makers to make growth-enhancing policies for Pakistan as well as for other
similar developing countries.
Empirical framework
After reviewing the theoretical and empirical literature, three different models
are used to examine the relationship between foreign capital inflows and econ-
omic growth in Pakistan by using the Cobb–Douglas production function
framework. The production functions in general form as follows:
GDP ¼ f ðL; K; AÞ ð3:1Þ
Where GDP is a real gross domestic product, L is total labor force, K is the
capital stock, and A is the foreign direct investment, remittances and external
debts respectively. It has been assumed that effect of foreign capital inflows on
economic growth operates through A.9
A ¼ f ðFDI; REM; EXDÞ ð3:2Þ
Substituting (3.2) in (3.1)
GDP ¼ f ðL; K; FDI; REM; EXDÞ ð3:3Þ
The empirical models for estimations are developed as follows:
GDPt ¼ a0 þ a1 Lt þ a2 Kt þ a3 FDIt þ lt ð3:4Þ
GDPt ¼ b0 þ b1 Lt þ b2 Kt þ b3 REMt þ et ð3:5Þ
GDPt ¼ c0 þ c1 Lt þ c2 Kt þ c3 EXDt þ nt ð3:6Þ
Where μt,εt and ξt are the error term. Data of capital stock is not available
for Pakistan, so K is the real gross fixed capital formation used as a proxy of
capital stock (Jawaid, 2014; Wong, 2004). FDI is the foreign direct investment
as a percentage of GDP (Khan, 2007), REM is the workers’ remittances
(Jawaid & Raza, 2012) and EXD is the external debts (Boboye & Ojo, 2012;
Choong et al., 2010; Clements et al., 2003). Annual time series data have been
used from 1976 to 2015. All data are gathered from the official website of
World Bank and State Bank of Pakistan.
Augmented Dickey—Fuller (ADF), Phillips-Perron (PP), and Dickey–
Fuller generalized least squares (DF-GLS) unit root tests are used to examine
the stationarity properties of time series data. Ordinary least squares (OLS)
estimation and the Johansen and Juselius (JJ) cointegration test are used to
find the long-run coefficients and relationship among FCI and economic
growth respectively. Rolling window estimation method has been used to ana-
lyze the stability of coefficients of long-run model (Jawaid & Raza, 2013).The
causal relationship among FCI and economic growth has been analyzed by
variance decomposition (VDM) method (Jawaid et al. (2016)).Sensitivity
analyses have been performed by adding different variables in the main model
(Jawaid & Waheed (2011) ; Jawaid & Haq (2012) and fully modified ordinary
least squares (FMOLS) to check the robustness of the initial result (Jawaid
(2014); Jawaid & Raza (2015)).
Estimations and results

For long-run relationship in time series analysis, stationarity properties are
checked by unit root tests, namely Augmented Dickey–Fuller (ADF) (see
Dickey & Fuller, 1979), Phillips–Perron (PP) (Phillips & Perron, 1988), and
Dickey–Fuller generalized least squares (DF-GLS) (Elliot, Rothenberg, &
Stock (1996). Results of unit root tests are reported in Table 1.
Table 1. Stationarity test result.

ADF test statistics P–P test statistics DF-GLS test statistics
I (0) I (1) I (0) I (1) I (0) I (1)
Variables C C&T C C&T C C&T C C&T C C&T C C&T
GDP −2.51 −2.52 −3.94 −4.79 −2.59 −1.74 −4.07 −4.80 0.27 −1.59 −3.92 −4.48
K −2.04 −1.79 −4.65 −4.76 −1.94 −1.73 −3.27 −3.55 −0.14 −1.84 −4.40 −4.88
L −1.40 −2.88 −7.14 −7.04 −1.97 −1.37 −10.62 −10.46 0.78 −2.98 −7.23 −7.23
FDI −2.72 −2.89 −4.09 −4.42 −2.19 −2.20 −4.09 −4.09 −2.48 −1.24 −4.21 −3.94
REM −0.85 −1.29 −5.17 −5.15 −1.08 −1.69 −5.17 −5.16 −0.61 −1.43 −2.78 −3.90
EXD −2.54 −2.85 −5.64 −5.96 −2.54 −2.76 −6.72 −6.97 −0.87 −2.40 −5.74 −6.88
Note: The critical values for ADF and P–P tests with Intercept (C) and trend and intercept (C & T) at 1%, 5% &
10% level of significance is −3.615, −2.941, −2.609 and −4.219, −3.533, −3.198 respectively, whereas
DF-GLS values are −2.622, −1.949, −1.611 and −3.770, −3.190, −2.890.
Unit root results confirm that all variables are non-stationary at level {i.e.,
I(0)} and stationary at first difference {i.e., I(1)}. This indicates that the
considered variables may have a long-run relationship.
Table 2 reports long-run determinant of economic growth with all three
considered foreign inflows.10 Results indicate that L and K have significant
positive effect in all models and FDI have negative significant effects on
economic growth. This finding is consistent with Alguacil et al. (2008), Liu
(2011), and Nunnenkamp and Spatz (2004). In contrast, REM and EXD have
significant positive effect on economic growth. These findings are consistent
with Jawaid and Raza (2012) and Siddiqui and Malik (2001).
Johansen and Juselius (1990) have suggested two statistics for cointegration
tests: trace statistics and maximum eigenvalue statistics. The values of trace
and maximum eigen statistics have been calculated with the corresponding
critical values for long-run relationship among considered variables.
The result of Table 3 indicates that the null hypothesis of no cointegration
has been rejected on the basis of trace statistics and max eigenvalue
statistics at 5% level of significance in favor of alternative hypothesis. Results
indicate long-run relationship exists among FCI and economic growth.
Table 2. Long-run determinant of growth.

FDI model REM model EXD model
Variables Coeff. t-stats Prob. Coeff. t-stats Prob. Coeff. t-stats Prob.
Constant −2.270 −2.272 0.029 −1.221 −9.821 0.000 −0.003 −0.007 0.994
K 1.346 10.205 0.000 1.195 78.574 0.000 0.967 10.510 0.000
L 0.185 2.486 0.017 0.077 1.9776 0.055 0.262 1.739 0.090
FDI −0.061 −2.518 0.016 – –
REM – 0.095 6.262 0.000 –
EXD – – 0.142 2.240 0.0314
Adj. R2 0.960 0.967 0.960
D.W 0.785 0.662 0.720
F-statists 316.94 392.33 316.53
(Prob.) (0.000) (0.000) (0.000)
Table 3. Results of cointegration test.

Null hypothesized Trace 5% critical Max. Eigen 5% critical
Models no. of CE(s) statistics values values statistics values
FDI None 65.56 47.85 38.82 27.58
At most 1 26.74 29.79 16.82 21.13
REM None 64.54 47.85 39.30 27.58
At most 1 25.23 29.79 14.00 21.13
EXD None 58.92 47.85 30.70 27.58
At most 1 28.22 29.79 17.39 21.13
Error correction model (ECM) by Engle and Granger (1987), has been applied
to check short-run relationship, but results were insignificant in all three
models.
Rolling window analysis

Long-run stability of coefficient is evaluated by rolling window estimation
method. Figures 4–6 represent the result of rolling window analysis on the
relationship between foreign direct investment, remittances, and external
debts with economic growth, respectively. The standard deviation showed
two bands i.e., upper and lower bounds. A few others’ estimation methods
assume coefficient of the variables remain constant over the period, but in
reality it is not possible due to changing economic condition in long run
(Pesaran & Timmermann, 2003).
Figures 4–6 represent graphically the coefficients each year. The blue line
represents the coefficient, whereas upper and lower lines indicate standard
deviation. Figure 4 indicates that the coefficient of foreign direct investment
is showing positive trend up to 1995 but starts negative trend from 1996–
2015, except in 1999 and 2001. Figure 5 shows the relationship between
remittances and economic growth. The coefficient shows negative trend from
1990 to 2003, except 1993, whereas this coefficient shows positive trend from
2004 to 2015. Furthermore, Figure 6 represents the result of external debts
coefficient is negative in 1990 but turns into positive from 1991 to 1993. After
1993, the trend moves toward negative during 1994–2000 except in 1999.
Years 2001 to 2006 coefficients are positive except 2005 and the next three
years turn negative. At last, from 2010 to 2015 coefficients are positive.
Figure 4. Coefficient of FDI and its two S.E. bands based on rolling OLS (dependent variable: GDP).
Figure 5. Coefficient of REM and its two S.E. bands based on rolling OLS (dependent variable: GDP).
Figure 6. Coefficient of EXD and its two S.E. bands based on rolling OLS (dependent variable: GDP).
Causality analysis
It is argued in empirical studies that causality tests such as Granger causality
and Toda and Yamamoto and have some limitation and cannot capture the
relative strength of causal relation between the variable beyond selected
time periods. To overcome this problem, Pesaran and Shin (1998) developed
variance decomposition method (VDM). VDM shows propositional
contribution in one variable due to innovative stemming in other variables.
Many other researchers used this technique to check robustness of causal
relationship among variables such as Jawaid (2014) and Shahbaz (2012).
The result of FDI and economic growth are reported in Table 4. This table
indicates that a shock in economic growth is explained 100%, 81.48%, and
57.10% by its own innovation in 1st, 5th and 10th periods. Whereas 16.58%
and 38.80% is explained by FDI in 5th and 10th periods. Similarly, FDI is
explained 85.16%, 68.85%, and 68.17% at 1st, 5th and 10th periods by its
own innovation, whereas 3.76%, 6.40%, and 6.50% at 1st, 5th and 10th period
are explained by economic growth. This shows unidirectional causality run
from FDI to GDP.
On the other hand, results of REM and economic growth are reported in
Table 5 and indicate that shock in economic growth is explained 100%,
78.44%, and 46.19% by its own innovation in periods of 1st, 5th and 10th,
whereas 7.88% and 18.63% is explained by REM in the 5th and 10th periods.
Table 4. Result of variance decomposition method of FDI’s model.

Period GDP L K FDI
Variance decomposition of GDP
1 100.0000 0.000000 0.000000 0.000000
2 95.16412 3.411783 0.086653 1.337447
3 91.63016 3.080048 0.062838 5.226958
4 86.95777 2.323716 0.060502 10.65801
5 81.486 1.795978 0.137717 16.5803
6 75.83279 1.553418 0.319742 22.29405
7 70.42128 1.523231 0.613086 27.44241
8 65.46298 1.62366 1.01394 31.89942
9 61.02798 1.792555 1.513479 35.66599
10 57.10887 1.988967 2.100877 38.80129
Variance decomposition of FDI
1 3.762097 3.40004 7.676695 85.16117
2 5.604651 15.40579 4.876011 74.11355
3 6.110261 19.02081 4.053173 70.81575
4 6.311286 20.52079 3.681022 69.4869
5 6.406144 21.26365 3.474072 68.85613
6 6.454526 21.66784 3.346817 68.53081
7 6.479883 21.8991 3.265023 68.356
8 6.493059 22.03488 3.21198 68.26008
9 6.499591 22.11546 3.178284 68.20667
10 6.502465 22.16322 3.158077 68.17623
Similarly, shock in REM is explained 94.81%, 61.07%, and 42.01% at 1st, 5th
and 10th periods by its own innovation and 2.85%, 6.00%, and 5.58% at
period of 1st, 5th and 10th is explained by economic growth. This result also
indicates unidirectional causality run from REM to GDP.
Table 5. Result of variance decomposition method of REM’s model.

Period GDP L K REM
1 100.0000 0.000000 0.000000 0.00000
2 92.93100 5.276153 0.699322 1.09352
3 88.78157 6.158809 2.135466 2.924155
4 84.07981 6.103188 4.546368 5.270633
5 78.44836 5.706375 7.959426 7.885838
6 72.07862 5.166934 12.22063 10.53381
7 65.33388 4.582278 17.05893 13.02491
8 58.58795 4.008558 22.16819 15.2353
9 52.14106 3.47768 27.27455 17.10671
10 46.19015 3.0051 32.17233 18.63242
Variance decomposition of LREM
1 2.855340 2.232215 0.098948 94.81350
2 4.649099 4.191795 5.506929 85.65218
3 5.485439 4.467312 13.56036 76.48689
4 5.868389 4.310532 21.70935 68.11173
5 6.004517 4.042867 28.88195 61.07067
6 6.007047 3.768926 34.84356 55.38047
7 5.939026 3.521596 39.69344 50.84594
8 5.83515 3.307976 43.62122 47.23565
9 5.714431 3.126235 46.81408 44.34525
10 5.587296 2.971967 49.42946 42.01128
Table 6. Result of variance decomposition method of EXD’s model.

Period GDP L K EXD
1 100 0 0 0
2 93.96389 3.615859 2.281936 0.13832
3 89.46642 4.306083 5.660355 0.567139
4 85.24651 4.27885 9.428206 1.046432
5 81.25823 4.068994 13.20573 1.46704
6 77.57333 3.822353 16.79817 1.806146
7 74.22727 3.583383 20.11802 2.071329
8 71.22082 3.365403 23.13661 2.277159
9 68.53529 3.171123 25.85614 2.437444
10 66.14317 2.999527 28.29399 2.56332
Variance decomposition of LED
1 0.94871 6.916337 0.446935 91.68802
2 0.695834 7.129671 1.206769 90.96773
3 0.769593 7.113126 2.80988 89.3074
4 1.107641 6.914245 4.383014 87.5951
5 1.562993 6.763452 5.57765 86.09591
6 2.033978 6.677864 6.360422 84.92774
7 2.474966 6.635368 6.817738 84.07193
8 2.871674 6.616629 7.053003 83.45869
9 3.223461 6.609626 7.151537 83.01538
10 3.534589 6.607587 7.174715 82.68311
Furthermore, results of EXD and economic growth are reported in Table 6.

Results indicate the shock in economic growth is explained 100%, 81.25%, and
66.14% by its own innovation at periods of 1st, 5th and 10th, whereas 1.46%
and 2.56% is explained by EXD in the 5th and 10th periods. In contrast, shock
in EXD is explained 91.68%, 86.09%, and 82.68% at 1st, 5th and 10th periods
by its own innovation; similarly, 0.94%, 1.56%, and 3.53% at period of 1st, 5th
and 10th is explained by economic growth. This finding shows no causal
relationship between EXD and economic growth in Pakistan.
Sensitivity analysis
In this section, two different sensitivity analyses, namely addition of different
variables and fully modified ordinary least squares have been performed.
Addition of variables
This section covers the sensitivity analyses to check the robustness by
inserting different new variables in the main models. Levine and Renelt
(1992) established the degree of confidence among dependent and
independent variables. Once additional variables are put in the main model
and if the coefficients of the focus variable remain the same as in the main
model, then the result is considered to be robust. If there are changes in either
sign of coefficient and significance in focus variables, then results are
considered fragile. Table 7 shows the result of sensitivity analyses by using
Table 7. Results of sensitivity analysis by addition of variables.

FDI REM EXD
t-stat Adj. t-stat Adj. t-stat Adj.
Variables Coeff. (Prob.) R2 D.W Coeff. (Prob.) R2 D.W Coeff. (Prob.) R2 D.W
Main −0.061 −2.518 0.96 0.78 0.095 6.262 0.96 0.66 0.142 2.240 0.96 0.72
Model (0.016) (0.000) (0.031)
Model 2 −0.040 −2.602 0.98 1.22 0.053 3.820 0.98 0.92 0.083 2.716 0.97 1.24
EG (0.013) (0.000) (0.010)
Model 3 −0.100 −3.562 0.96 1.06 0.092 5.298 0.96 0.66 0.165 2.068 0.96 0.83
IG (0.001) (0.000) (0.046)
Model 4 −0.023 −2.651 0.97 0.60 0.036 120.96 0.97 0.57 0.091 3.838 0.97 0.52
GC (0.012) (0.000) (0.000)
Model 5 −0.058 −2.703 0.95 0.80 0.095 7.864 0.96 0.66 0.137 2.389 0.95 0.74
INF (0.010) (0.000) (0.022)
Model 6 −0.066 −11.009 0.99 1.21 0.054 13.30 0.99 0.82 0.144 9.594 0.99 0.98
FR, INF, (0.000) (0.000) (0.000)
IG
additional variables.11 These additional variables are also used by Aizenman

et al. (2012), and Barro (1996) and
It is clear from Table 7 that despite the inclusion of additional variables,
sign of coefficient and significance of FDI, REM, and EXD models are the
same as the main model that shows initial results are robust.12
Fully modified ordinary least squares (FMOLS)

Philips and Hansen (1990) originally designed the fully modified ordinary
least squares (FMOLS) technique. FMOLS modifies the OLS to account for
problems of serial correlation effects and endogeneity in the regressors
that result from the existence of a cointegration relationship. Many other
researchers used FMOLS technique to check robustness in the model such
as An and Jeon (2006), Hye (2009), and Jawaid (2014).
Fully modified ordinary least squares (FMOLS) is reported in Table 8 and
shows consistent results. The coefficient of FDI is significant negative effect
on economic growth, whereas REM and EXD showed significant positive
Table 8. Long-run determinant of economic growth by FMOLS.

FDI REM EXD
Variables Coeff. t-stats Prob. Coeff. t-stats Prob. Coeff. t-stats Prob.
Constant −2.191 −7.262 0.0000 −1.242 −9.976 0.0000 −0.392 −0.486 0.6297
K 1.336 12.332 0.0000 1.192 6.375 0.0000 1.031 7.324 0.0000
L 0.189 4.895 0.0000 0.078 3.670 0.0008 0.274 3.039 0.0045
FDI −0.063 −5.609 0.0000 – –
REM – 0.100 16.858 0.0000 –
EXD – – 0.108 1.730 0.0924
Adj. R2 0.95 0.96 0.95
effect on economic growth. This result confirms the robustness of initial

results.
Discussion and policy implications

This study investigates the relationship between foreign capital inflows,
namely foreign direct investment, workers’ remittances, and external debt
with economic growth by employing time series data from 1976 to 2015.
Cointegration results confirm long-run relationship between FCI and
economic growth. Ordinary least square (OLS) results show that FDI have
negative and significant effect on economic growth, whereas significant
positive effect of REM and ED on economic growth is found. Rolling windows
analysis highlights yearly effect of three different models. Results of all three
models showed positive and negative coefficients in different years with
passing time. Results of VDM indicate unidirectional causal relationship in
FDI and REM models and causality run from FDI to GDP and REM to
GDP. Sensitivity analysis confirmed that initial results are robust.
Currently Pakistan provides an attractive foreign capital policy regime
but the response has not been very encouraging due to political instability
and disturbance, poor law and order situations, direct and indirect regulatory
barriers, implied policy instability, poorly developed infrastructure facilities,
low levels of human capital, and lack of transparency. Accordingly, Pakistan
and other developing economies improve FCI climate through appropriate
measures such as regulation of economic activity, increased domestic serving,
developing the port network, road network, railways and telecommunication
facilities, creating more transparency in the trade policy, more flexible labor
markets, setting a suitable regulatory framework, and tariff structure. It also
involves technological up gradation; labor training, skills acquisition, and
introduction of alternative management practices.
It is proved that the effect of FDI on economic performance is highly
dependent upon the local conditions of the recipient economy. These
conditions also seem to be a necessary requirement for stimulating foreign
as well as domestic investment. Therefore, ensuring the right economic
environment should be a political demand in transition economies if they
are seeking to modernize their physical capital stock. From previous
discussion, results indicate that FDI is not spurring economic growth and
government makes feasibility not only to attract FDI but enhanced
economic growth. A few policy implications are listed following to spur
economic growth, not only for Pakistan but for other developing countries
as well.
Like Pakistan, other developing countries are unable to obtain the benefits
of FDI in absence of domestic facilities such as infrastructure, financial
system evolution, human capital development, and macroeconomic stability.
The government should encourage greenfield structure-based FDI that leads

to expanding industrial employment and makes more stability. As Pakistan
allies in the war against terrorism since the past decade and this war destroyed
infrastructure, government should therefore encourage new investment to
rehabilitate. Political stability and high growth potential in the host country
will also encourage MNCs to transfer technology and this technology may
be beneficial for local industry, either by joint venture or borrowing
technology as a greenfield FDI. Governments should offer a set of incentives
to foreign investors to stimulate the inflow with the additional objective of
increasing foreign exchange reserves. Foreign currency account is fully
protected and it cannot be frozen as it was in 1998 after the nuclear test.
Policy makers rationalized tariff regime and reduced customs duty on capital
goods. Foreign investors face complex policies and burden of laws and
government should empower its agencies to introduce certain changes
through administrative orders and Statutory Regulatory Order when needed.
The laws and regulations should be simplified, updated, modernized, and
made more transparent. Privatization should be fully protected with no fear
of nationalization. Economic liberalization can reduce domestic inefficiency
and stimulate growth, therefore government promotes national industries
by reducing the effect of brownfield FDI and creates links among domestic
investors and foreign investors. These policies not only attract FDI but are
growth enhancing.
Finding of remittances proved to be a viable contribution to the economy
in the long run. Pakistan and other developing countries should provide
helpful terms like high interest rate, exemptions in tax, and flexible currency
conversion in order to increase remittances inflow. In addition to this,
government should also steer remittances toward small business. Existing
financial payment mechanisms make remittances very expensive and
migrants who want to send money home face obstacles such as hidden
charges and fees, slow fulfillment, limited infrastructure for pay points, and
transfers (both countries or within country), legal and regulatory barriers,
coordination failures among institutional actors, individual risk such as loss
of funds in transit, and systemic risk such as money laundering, etc. A policy
should be made convenient and should encourage minimum charges for
funds transfer, availability of safe and secure medium pay point, strong coor-
dination between financial institutions by developing countries to save regu-
latory barriers and risk of money laundering.
The result indicates external debts effects positively on economic growth in
the long run.
Developing economies should make possible utilization of external loans in
those development projects and infrastructure that promise higher returns on
investments and eliminate unproductive and redundant projects. Minimize
the expenditure cost that is paid to consultants and foreign experts for loan
assistance. Develop criteria for selection of only those projects that are in line
with development priority and sustainability. Link new projects to utilize
stock of past investments and seek first highly concessional loans for new
borrowing and do a cost-benefit analysis before accepting debts. Emphasizing
co-financing arrangements through grants for financing expense of overheads
and technical support of the projects.
Developing countries should provide a policy framework that credibly
creates an environment that encourages investors’ confidence to invest in
the country. In the railway and road sector, government must engage the
private sector with leases, concessions, and build-operate-transfer type
contracts. The high cargo handling costs at the Karachi port need to be
controlled. Dredging of shipping channels to accommodate large vessels,
lowering labor costs, upgrading port handling equipment, and improving
documentary procedures need urgent attention.
In the light of previous discussion, policy makers should make FDI growth
enhancing and rely less on external debts. Rolling window analysis is very
helpful to find those years in which FDI has negative effect on economic
growth. After making these inflows better for economic growth, policy makers
should try to substitute EXD for FDI, domestic investment, and REM in
those sectors through which ED enhances economic growth. This would be
ultimately beneficial for the country to reduce debt burden.
Notes
1. Foreign investment penetrates in developing economies through large MNCs.
2. Package includes capital, management, and advanced technology.
3. Ownership advantages are advanced technology, management and marketing skills,
brands awareness, cheaper labor force availability, market access, etc.
4. Realistic borrowing is a level when countries not in doubt for future repayments, they
would have no difficulty in borrowing to serves existing debt (see Krugman, 1988).
5. The debt-serving cost of public debt can crowd out public investment expenditure,
thus reduced total investment directly and indirectly by reducing complementary private
expenditure (also see Chowdhury, 2001).
6. According to diverse objective, investors could invest in technology upgrading, labor
training, and skills acquisition, and alternative management practices.
7. These low-income countries are classified by IMF’s Poverty Reduction and Growth
Facility (PRGF).
8. These countries are from Sub-Saharan Africa, Asia, Latin America, and the Middle East.
9. Kohpaiboon (2003) consider FDI, Jawaid and Raza (2012) consider REM, and Pattillo
et al. (2004) consider EXD in their studies.
10. Initial results show autocorrelation in the model of FDI, REM, and EXD. In these
models we applied Newey-West HAC procedure. The advantage of heteroscedasticity and
autocorrelation consistent (HAC) procedure is that it not only corrects for autocorrelation
but also for heteroscedasticity, if it is present. For more details see Gujrati and Sangeeta
(2007), pp. 451–516.
11. Additional variables are used as government consumption (GC), inflation (INF),
fertility rate (FR), exports goods (EG), and imports goods (IG), respectively.
12. HAC test applied in all additional models.
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Foreign Capital Inflows and Economic Growth

Article in Journal of Transnational Management · May 2017

ISSN: 1547-5778 (Print) 1547-5786 (Online) Journal homepage: http://www.tandfonline.com/loi/wtnm20

Foreign capital inflows and economic growth of

Syed Tehseen Jawaid & Shaikh Muhammad Saleem

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Foreign capital inflows and economic growth of Pakistan

The role of FDI in economic growth has been a passionate debate,

Foreign capital inflows in Pakistan: An overview

Figure 1. Historical trend of FDI (percentage of GDP).

Figure 2. Historical trend of remittances (percentage of GDP).

Figure 3. Historical trend of external debts (percentage of GDP).

Review of related literature

Foreign direct investment and economic growth

Remittances and economic growth

External debts and economic growth

Foreign direct investment and economic growth

De Gregorio, and Lee (1998), Funke, Nunnenkamp, and Schweickert (1992)

run, whereas development in China seems to be fueled by domestic

Remittances and economic growth

economy. Furthermore, it is suggested that policy makers of Korea must

External debts and economic growth

Estimations and results

Table 1. Stationarity test result.

Table 2. Long-run determinant of growth.

Table 3. Results of cointegration test.

Rolling window analysis

Table 4. Result of variance decomposition method of FDI’s model.

Table 5. Result of variance decomposition method of REM’s model.

Table 6. Result of variance decomposition method of EXD’s model.

Furthermore, results of EXD and economic growth are reported in Table 6.

Table 7. Results of sensitivity analysis by addition of variables.

additional variables.11 These additional variables are also used by Aizenman

Fully modified ordinary least squares (FMOLS)

Table 8. Long-run determinant of economic growth by FMOLS.

effect on economic growth. This result confirms the robustness of initial

Discussion and policy implications

The government should encourage greenfield structure-based FDI that leads

Elbadawi, I. A., & Rocha, R. R. (1992). Determinants of expatriate workers’ remittances

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