IMPACT OF GDP ON FOREIGN DIRECT INVESTMENTS

IMPACT OF GDP ON FOREIGN DIRECT INVESTMENTS

_________________________________________ ACKNOWLEDGMENT

First of all, we would thank Allah Al-mighty whose mercy and grace allowed us to be a part of University of Karachi and work on this detailed analysis of the relationship between Interest Rates and Inflation of three different countries. It gives us immense pleasure to study our degree course from this acknowledged and revered institution in Pakistan. It is by virtue of our university and kind teachers that we have a launching platform to exhibit our hidden talents and skills in the industry. Last, but not the least, we are very thankful to Maam Hunain Zaki who gave us a brilliant topic to explore. The relationship and Impact of GDP over FDI (Foreign Direct Investment) is indeed the most discussed topic in the financial markets. It has been the keen interest of economists to study and develop a strong understanding about the effects and behavior of FDI with respect to GDP. We are also indebted to all other people who played an integral part in completing this assignment, especially the librarians, who helped us in conducting secondary research.

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IMPACT OF GDP ON FOREIGN DIRECT INVESTMENTS

Analysis of the effects of Interest Rates over Inflation of three different economies i.e. Bangladesh, India and United States based on the data of 21 years from 1990 to 2010

Impact of GDP on FDI

Study of the relationship between GDP and FDI

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IMPACT OF GDP ON FOREIGN DIRECT INVESTMENTS

_________________________________________ ABSTRACT

FDI is indeed an integral role player in any countrys economy. The importance and advantages of FDI cannot be ignored as they tend to have a significant importance from many aspects. However, it is still an enigma that whether GDP is an important factor impacting FDI or not. Therefore, this paper attempts to investigate the effect of GDP on FDI of China and Pakistan. To take care of the issue of structural change in economy, time period of the study is taken to be 1990-2010. The relationships between these two factors vary grossly depending upon the economy in consideration. Growing economies like BRICS (Brazil, Russia, India, China and South Africa) have a different responsiveness ratio than what is seen in third world economies. Therefore, it is imperative to analyse two different economies i.e. emerging and a third world economies, before reaching on any conclusion about the impact of GDP on FDI. Keywords: GDP, FDI, BRICS, economy

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IMPACT OF GDP ON FOREIGN DIRECT INVESTMENTS

_________________________________________ TABLE OF CONTENTS

Title Page .i Acknowledgment ...ii Cover Page ........iii Abstract .iv Table of Contents ...v-vi 1. 2. 3. 4. INTRODUCTION 1-2 REVIEW OF LITERATURE .3-4 METHODOLOGY ...5-6 DATA ANALYSIS 4.1 4.2 5. 6. Data Analysis of Pakistan...7-11 Data Analysis of China 12-15

CONCLUSION .16-17 APPENDICES 6.1 6.2 References..18 Secondary Sources 19

IMPACT OF GDP ON FOREIGN DIRECT INVESTMENTS

1
_________________________________________ INTRODUCTION
The term FDI (Foreign Direct Investment) refers to the direct investments into production and businesses in a country by another country. These direct investments can be of many kinds like either by buying a company in the target country or by expanding the operations of an existing business in that country. Examples are as a company in Japan, Toyota has opened a plant in Shah Alam, Malaysia is considered as an FDI inflow of Malaysia. The inflows of FDIs are always beneficial for countries as there are many advantages associated with these FDIs. Some of the advantages that FDI inflows bring are highlighted below: Improves the quality of products and process in a particular sector, increased attempts to better Human Resource. Creates jobs, in an effort to increase productivity, skilled and semiskilled workers needed. Reduces unemployment which ultimately eliminates further social problems

IMPACT OF GDP ON FOREIGN DIRECT INVESTMENTS

Although, there are many advantages of FDI and the host country enjoys the perks and benefits of FDIs by way of hefty inflows, however there are some disadvantages of FDIs too, but that are negligible against the benefits it provide. Since FDI is considered to be a positive impact creator on the overall economy, therefore in this assignment we are going to investigate the behaviour and impact of GDP on FDI. Whether the FDI responds with the change in GDP or not and if it is responsive, then up to what extent? These questions will be answered in this assignment by way of investigating the patterns and trends considering the past data of two different economies i.e. China and Pakistan. The reason for choosing such two different economies is to study the impact of GDP on FDI in two different scenarios. China being the part of BRICS would reveal the fact about emerging economies, whereas Pakistan on the other hand would help to illuminate the other side of the picture. The GDP of China has been on exponential growth since 1990s, whereas the GDP of Pakistan has been through several ups and downs. Similarly, the FDI of Pakistan has a non-linear pattern, whereas on the other hand the FDI of China has been growing since 90s except for a sharp decline in 2009 Global Financial Crisis. In order to make sure that our analysis of impact of GDP on FDI has significant findings and to conclude in a justified manner, 20 years of data of GDP and FDI has been obtained of both countries from reliable sources.
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IMPACT OF GDP ON FOREIGN DIRECT INVESTMENTS

2
_________________________________________ REVIEW OF LITERATURE

The topic of impact of GDP on FDI has always been of prime importance for the economists as every country focuses on increasing its FDI. If it would be evident that GDP brings significant impact on Foreign direct investments, economists will then focus on increasing GDP in order to boost the FDIs. Since this issue has been a burning question, a number of attempts have been made previously by different researchers in order to observe the behavior of FDI with respect to GDP. In this regard, the work of Pakistan Institute of Development Economics is significant. The studies and researches conducted by several researches of PIDE have proved with their analysis that GDP has a positive impact on FDIs. If the GDP is increasing, FDIs will also increase and the ratio of FDI increase to GDP is dependent upon the increase rate of GDP (Arshad & Ali, 2011). According to Agrawal & Khan (2011), several other factors like Labor Force, Human Capital, Government incentives, developed infrastructure and macroeconomic climate also cast an impact of FDIs up to some extent. However, in mature and emerging economies, the GDP is the only factor that
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IMPACT OF GDP ON FOREIGN DIRECT INVESTMENTS

leads FDI growth and stability. On the other hand, third world economies like Pakistan and Bangladesh do not have such significant impact of GDP on FDIs. Since the economic growth of third world economies is always fluctuating, therefore the FDI inflows are dependent upon several other factors too and GDP is not the only factor impacting FDIs in third world economies. In a recent about SAARC countries, published in Global Journal of Management and Business Research (2011), it was clearly shown that in the economy of Pakistan, GDP has a positive impact on FDI. As in the growth rate of Pakistan attracts, regardless of the political instability is attracting investors to invest their capital into Pakistani markets. There are other factors that are mentioned in the paper like the geo-political importance of Pakistan, market needs; consumer behavior and transmuting trends are also casting great impact on FDI inflows. Many of the researches that have previously been done in this area are mostly about how well the economies are doing with their increased FDIs, but they lack about the clarity of whether the FDIs are dependent on GDP growth or not. Therefore, in this paper, we are going to clarify with the help of data analysis through various statistical tools that whether the increase in GDP turns out to be favorable for FDIs or not.

IMPACT OF GDP ON FOREIGN DIRECT INVESTMENTS

3
_________________________________________ METHODOLOGY

To do any form of research, there has to be some underlying assumptions that must govern the research that needs to be done: 1) - The data must be free from all biases 2) The data must be free from all distortion 3) The research should take into factors both the descriptive statistics and the theoretical values of the data 4) - Its also assumed that the available statistic data is true to date 5) Its also assumed that there wont be any drastic change in the overall economic conditions of both the countries due to any other external factor. The overall methodological approach that we are going to use in this assignment will be a single approach of quantitative methods. Since we have collected the quantitative data of FDIs and GDP of both the countries, we are going to treat the data quantitatively without making any further distributions.

IMPACT OF GDP ON FOREIGN DIRECT INVESTMENTS

Unbiased and proper data gathering is a hectic and difficult task. In order to ensure data reliability, data is gathered from reliable sources such as governmental and educational websites like indexmundi, pakboi and worldbank. A rigorous research over internet was carried to make sure that reliable data is available to be worked on. As discussed earlier, the research requires the study of impact of GDP on FDI. Therefore, only the data of two factors i.e. GDP and FDI is gathered for the last 20 years from 1990 to 2010. It is pertinent to mention here that in order to ensure the reliability and validity of the data, a confidence level of 99% will be maintained throughout the analysis. The 99% of confidence level is proposed due to the main practical considerations that might affect the data gathering process or analysis. The analysis of quantitative data will be done with the help of different statistical tools such as Regression, Correlation, and some graphs like XY Scatter and stacked lines will help us finding the pattern between the Growth rate and FDI. MegaStat and Microsoft Excel will be used to perform these statistical operations on the data in order to analyse it properly.

IMPACT OF GDP ON FOREIGN DIRECT INVESTMENTS

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_________________________________________ DATA ANALYSIS
4.1 Data Analysis of Pakistan:
Following are the data Tables of Pakistans GDP and FDI of the past 20 years i.e. from 1990-2010 and their analysis. PAKISTAN GDP DATA YEAR-WISE: YEAR GDP (Current US $) 1990 $40,010,420,000 1991 $45,451,960,000 1992 $48,635,240,000 1993 $51,478,360,000 1994 $51,894,800,000 1995 $60,636,070,000 1996 $63,320,170,000 1997 $62,433,340,000 1998 $62,191,960,000 1999 $62,973,850,000 2000 $73,952,380,000 2001 $72,309,740,000 2002 $72,306,820,000 2003 $83,244,800,000 2004 $97,977,770,000 2005 $109,600,000,000 2006 $127,500,000,000 2007 $143,171,000,000 2008 $163,892,000,000 2009 $161,819,000,000 2010 $176,870,000,000 Source: http://www.indexmundi.com/facts/pakistan/gdp
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IMPACT OF GDP ON FOREIGN DIRECT INVESTMENTS

PAKISTAN GDP (Current US $)

$200,000,000,000 $180,000,000,000 $160,000,000,000 $140,000,000,000 $120,000,000,000 $100,000,000,000 $80,000,000,000 $60,000,000,000 $40,000,000,000 $20,000,000,000 $0

GDP (Current US $)
Linear (GDP (Current US $))

Graphical Representation of the above data including the trend line

The above graph made with the help of GDP data of Pakistan, shows that the GDP of Pakistan has been increased significantly from 1990. However, several ups and downs can also be observed in the chart like the decline in GDP at the time of Kargil war and 2009 Global Financial Crisis.

PAKISTAN FDI DATA YEAR-WISE: YEAR 1990 1991 1992 1993 1994 1995 1996 1997 1998
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Foreign direct investment $245,263,000.00 $258,414,500.00 $336,479,900.00 $348,557,000.00 $421,024,600.00 $722,631,600.00 $921,976,200.00 $716,253,100.00 $506,000,000.00

IMPACT OF GDP ON FOREIGN DIRECT INVESTMENTS

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Data Sources: 1) Index Mundi (http://bit.ly/18r2mw6) 2) PakBoi (http://bit.ly/ZMCGqB)

$532,000,000.00 $308,000,000.00 $383,000,000.00 $823,000,000.00 $534,000,000.00 $1,118,000,000.00 $2,201,000,000.00 $4,273,000,000.00 $5,590,000,000.00 $5,438,000,000.00 $2,338,000,000.00 $2,022,000,000.00

Pakistan's FDI
$6,000,000,000.00
$5,000,000,000.00 $4,000,000,000.00 $3,000,000,000.00 $2,000,000,000.00 $1,000,000,000.00 $0.00 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010

Pakistan's FDI

Graphical Representation of the above data The table of Pakistans FDI data shows that there is a drastic increase in the FDI inflows from 2004 to 2006, whereas on the other hand, this is the period
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IMPACT OF GDP ON FOREIGN DIRECT INVESTMENTS

when the GDP of Pakistan was increasing rapidly. Moreover, at the time of 2009 financial crisis, when the GDP went down, FDI also went down with same pace. Therefore, it is evident enough to show that there is a relationship between GDP and FDI. In order to elucidate this more clearly, a unified graph is given below that would make it easy to compare the trends.

$6,000,000,000.00 $5,000,000,000.00 $4,000,000,000.00 $3,000,000,000.00 $2,000,000,000.00 $1,000,000,000.00 $0.00 Foreign direct investment, net inflows (BoP, current US$) GDP in Billions

Graph Showing GDP and FDI together for Comparison

The graph above is representing the behavior of FDI with respect to the GDP. The data of GDP is adjusted by taking the 100 th values of each year GDP in order to make the graph look more proper and obvious. REGRESSIONAL ANALYSIS OF THE DATA Whenever talking about two variables and to analyze the impact of one variable on the other, we use a proven technique of statistics known as Regression. Regression is a method that is used to observe the pattern or trend between two variables. In our case, we are investigating the impact of GDP on FDI whether there exists some significant impact of GDP on FDIs or not. Therefore, let us look at the XY scatter of GDP and FDI, whereas GDP is on
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IMPACT OF GDP ON FOREIGN DIRECT INVESTMENTS

Horizontal Axis, as it is the independent variable and FDI is on Y Axis as being dependent on GDP.

FDI & GDP

$6,000,000,000.00 $5,000,000,000.00 $4,000,000,000.00 $3,000,000,000.00 $2,000,000,000.00 $1,000,000,000.00 $0.00 $0 ($1,000,000,000.00) $100,000,000,000 $200,000,000,000 y = 0.0314x - 1E+09 R = 0.6433 FDI & GDP Linear (FDI & GDP)

Graph showing the Scatters with the regression line and its equation on right The dependent variable (y) in the above regression graph is FDI, whereas the independent variable (x) is GDP. The regression analysis of Pakistans Data shows that the economys FDI is quite sensitive (The responsiveness of FDI to GDP is high). This can be estimated by the fact that the correlation coefficient of both variable is 0.80206465 and the value of R square is greater than 0.64. This shows that in this small economy, there are some factors other than GDP that has an impact on FDI inflows too. The upward slope shows that there is a positive relationship between the two factors under consideration.

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IMPACT OF GDP ON FOREIGN DIRECT INVESTMENTS

4.2 Data Analysis of China:

Following is the data Table of Chinas GDP and FDI of the past 20 years i.e. from 1990-2010. CHINA GDP DATA YEAR-WISE: Year 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 GDP (Current US $) $356,936,901,184.00 $379,468,656,246.00 $422,660,918,111.00 $440,500,898,965.00 $559,224,707,281.00 $728,007,199,936.00 $856,084,729,312.00 $952,652,693,079.00 $1,019,458,585,326.00 $1,083,277,930,360.00 $1,198,474,934,199.00 $1,324,806,914,358.00 $1,453,827,554,714.00 $1,640,958,732,775.00 $1,931,644,331,142.00 $2,256,902,590,825.00 $2,712,950,886,698.00 $3,494,055,944,791.00 $4,521,827,288,304.00 $4,991,256,406,735.00 $5,930,529,470,799.00

Source: http://data.worldbank.org/indicator/NY.GDP.MKTP.CD?page=4
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IMPACT OF GDP ON FOREIGN DIRECT INVESTMENTS

GDP (Current US $)
$7,000,000,000,000.00 $6,000,000,000,000.00 $5,000,000,000,000.00 $4,000,000,000,000.00 $3,000,000,000,000.00 $2,000,000,000,000.00 $1,000,000,000,000.00 $0.00 GDP (Current US $) Expon. (GDP (Current US $))

Graphical Representation of the above data including the trend line

The above graph made with the help of GDP data of China, shows that the economy of China has been growing exponentially from 1990. Unlike Pakistans economy there are no frequent ups and downs in the economy and the economy is progressing better. CHINA FDI DATA YEAR-WISE: Year 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002
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Foreign Direct Investment $3,487,000,000.00 $4,366,000,000.00 $11,156,000,000.00 $27,515,000,000.00 $33,787,000,000.00 $35,849,200,000.00 $40,180,000,000.00 $44,237,000,000.00 $43,751,000,000.00 $38,753,000,000.00 $38,399,300,000.00 $44,241,000,000.00 $49,307,976,629.00

IMPACT OF GDP ON FOREIGN DIRECT INVESTMENTS

2003 2004 2005 2006 2007 2008 2009 2010 Data Source:

$47,076,718,733.00 $54,936,483,255.00 $104,108,693,870.00 $124,082,035,620.00 $156,249,335,200.00 $171,534,650,310.00 $131,057,052,870.00 $243,703,434,560.00

http://data.worldbank.org/indicator/BX.KLT.DINV.CD.WD?page=4

Foreign direct investment, net inflows (BoP, current US$)

$300,000,000,000.00 $250,000,000,000.00 $200,000,000,000.00 $150,000,000,000.00 $100,000,000,000.00 $50,000,000,000.00 $0.00 Foreign direct investment, net inflows (BoP, current US$)

Graphical Representation of the above Data The above graph represents the increase in the FDIs of China from 1990. Except from the global financial crises, the FDI inflows of China are always increasing every year and there are no major ups and downs. Since the Chinese economy is progressing exponentially, therefore, the FDI inflows are also increasing every year.

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IMPACT OF GDP ON FOREIGN DIRECT INVESTMENTS

REGRESSIONAL ANALYSIS OF THE DATA Let us look at the XY scatter of FDI and GDP where FDI is a dependent variable (Y) and GDP is an independent variable (X). The graph below would be helpful in understanding the relationship and impact of GDP on FDI.

FDI (Y) & GDP (X)

$300,000,000,000.00
$250,000,000,000.00 $200,000,000,000.00 $150,000,000,000.00 $100,000,000,000.00 $50,000,000,000.00 $0.00 $0.00 y = 0.037x + 2E+09 R = 0.9174 FDI (Y) & GDP (X) Linear (FDI (Y) & GDP (X))

$5,000,000,000,000.00 $10,000,000,000,000.00

Graph showing the Scatters with the regression line and its equation on right The above graph shows that there is a strong positive relationship between GDP and FDI. The correlation coefficient of the above data of China is 0.957835691, which shows a strong positive correlation, whereas the R-Squared as mentioned in the graph for the linear trend line is 0.9174 which goes to prove that FDI inflows in the economy of China are highly dependent on its GDP than any other factor. Since China is a progressing economy with exponential growth rate, the FDI inflows are quite significant and are increasing every year because of its GDP. The investors find it a fertile ground for their investments and the stability of economy is attracting more and more investors day by day. This shows that in an economy like China, no other economic factors cast a greater impact on FDI than GDP and the upward slope shows that there is a positive relationship between the two factors under consideration.

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IMPACT OF GDP ON FOREIGN DIRECT INVESTMENTS

5
_________________________________________ CONCLUSION

The above analysis has shown that GDP is indeed a major driver of FDIs in many economies of the world. The analysis and the research that we conducted in this assignment helps us to conclude this generalize statement that whether we are considering slow economies or the emerging one, GDP at every cost casts a great impact on the FDI inflows. Since GDP is a widely used measure to investigate the economic conditions of any country, the investors who are interested in investing their capital into other countries always look at the countrys GDP first. If the countrys economy is progressing and the GDP growth rate is significant, it compels the investors to invest in that country. Same is the case with the countries that we took into consideration. Although the GDP of Pakistan is increasing, but still the responsiveness of FDI inflows is not unitary, instead it is less responsive. This goes to show that third world economies have some other factors too that cast an impact on FDI inflows and it is not solely dependent on GDP. Whereas, on the other hand, the

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analysis of the data of China shows that in emerging economies which are progressing better have GDP the only impact caster on the FDI inflows.

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6
_________________________________________ APPENDICES
6.1 References
Arshad, M., & Ali, S., (2011). FDI and Economic Growth in Pakistan: A Sectorial Analysis. PIDE Working Papers. Vol (67). pp. 6-10 Agrawal, G., & Khan, A., (2011). Impact of FDI on GDP: A Comparative Study of China and India. International Journal of Business and Management. Vol (6), 10. pp. 71-79 Abbas & et. al. (2011). Impact of Foreign Direct Investment on Gross Domestic Product. Global Journal of Management and Business Research . Vol (11), 8. pp. 35-40 World Development Indicators. (n.d.). FDI Annual. Retrieved from

<http://data.worldbank.org/indicator/BX.KLT.DINV.CD.WD?page=4> World Development Indicators (n.d.). GDP Annual (Current US $). Retrieved from <http://data.worldbank.org/indicator/NY.GDP.MKTP.CD?page=4>

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6.2 Secondary Sources

1) http://en.wikipedia.org/wiki/Coefficient_of_determination 2) http://www.tradingeconomics.com/ 3) http://www.digitallibrary.edu.pk/oaebooks.html 4) http://onlinebooks.library.upenn.edu/ 5)http://www.runningromans.com/Academics/Economics/Econ%20Review%20 Notes/Formulas%20and%20Definitions.htm 6) http://quizlet.com/12172179/macroeconomics-formula-sheet-flash-cards/ 7)http://www.pakboi.gov.pk/index.php?option=com_content&view=article&id =180&Itemid=137 8) http://en.wikipedia.org/wiki/Foreign_direct_investment

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