FOREIGN DIRECT INVESTMENT & PER CAPITA INCOME
QAWEE KHAN, MA Economics (KU)
Jan 29 - Feb 04, 2007
Without generating high growth rate of national income, a country cannot make a sustained attack on poverty, unemployment, and other economic problems. Developing countries generally pursue the goal of rapid economic growth with the help of industrialization. In this regard, an optimal structure of the industries enables a country to experience 'sustainable' economic growth. Countries adopt various trade strategies to allocate resources to their optimal use in order to exploit their industrial potential. Developing countries including Pakistan have adopted the import-substituting (IS) trade strategy to foster industrialization strategy. Developing countries adopting a strategy to attracting foreign financial flows such as foreign private investment, external borrowing to improve the balance of payment ,in that foreign direct investment is supposed to have direct bearing on reducing unemployment, domestic savings, and improvement for welfare. National saving is critically important to help maintain a higher level of investment which in turn a key determinant of economic growth.
Since, it has become debatable issue among economist about adequacy of economic growth that is to what extent the economic growth under the IS strategy has given rise to the unfavorable results with respect to employment, capital accumulation, foreign aid and income distribution.
Substantial trade liberalization has taken place in Pakistan since the late 1980s at a pace that has been accelerating the over time. Import taxes have been reduced, the statutory regulatory orders (SROs) have now been mostly with drawn and Non-Tariff Barriers (NBTBs) have been largely dismantled. In particular, the average tariff rate has declined sharply from 77 percent in 1985 to about 17 percent trade, as measured by the sum of imports and exports, has accelerated as a result of the process of greater openness of the economy, especially over the past 5 years. However, trade performance relative to many other developing Asian economies has not been that impressive while the trade-to-GDP ratio has increased 0.4 percentage points per annum in Pakistan since 1990, it has increased by 0.8 percentage points per annum in India, 1 percentage points per annum in Korea, 1.2 percentage points per annum in Bangladesh, for example. The world average growth trade as a share of GDP, at 1 percent per annum, has also been higher than that of Pakistan. Despite of it, where had import tax incidence been at its 1980s average level, followed since 1990, was 45 percent instead of falling gradually to 9 percent as was actually observed. The evidence indicates, poverty and income inequalities would have been higher without the trade liberalization, although only slightly so, on balance. Thus, the evidence are not consistent with seemingly popular notion that greater trade openness has increased poverty in Pakistan.
Both positive and negative effects are involved in the channels of transmission. Trade liberalization has had a income inequality-reducing effect through enhanced growth, productivity and investment and through price stability. But it also has entailed some cost, in particular costs related to fiscal adjustments. The axe of lower tax revenues resulting from lower import taxes and control of the fiscal deficit fell on developing expenditures. Not only are such expenditures directly pro-poor, but the employment opportunities that could have been created as a consequence of these expenditures were also forgone, adversely affecting the income of the poor.
Process of integration with global economy unleashed numerous forces of inequality that adversely affect the poor. Where the theory or East Asian experience of globalizing world and reducing poverty and reducing the gap of inequality it is naive to expect in the case of contemporary LDCs that distributional outcome of integration with the global economy will be same b/c of difference in initial conditions as in case of Pakistan, in 1970s, there was a large concealed underemployment in public enterprises and gradual elimination, in the initial phase of integration with the world economy, leads to low overall output elasticity of employment in manufacturing industries. Another point the low price of food that was an integral part of the incentive system under the ISI strategy, depressed the poor producers.
Where FDI come into the services sector, i.e. import-competing sector, could not be helpful to enhance welfare of country as affect the balance of payment, by increasing the current account deficit that brought the inflation & causes to affect the income distribution. It also impacts on the employment b/c transfer of technology, i.e. capital- intensive and displacing labour-technology, doesn't enhance employment growth in the Pakistan i.e. labour abundant country, at the optimum, & affects the welfare. It threats to the poorer to participate for the economic activity and thus cause reducing standard of living.
There is issue that FDI in services sector would convert into manufacturing mean that FDI, in the long-run, would come in manufacturing sector, ignoring the argument of capital-intensive technology i.e. it will also displace labor in the huge amount in this particular sector. There is another argument that the rate of innovation, in the rest of world, impact on the national income or reduces it, in the short-run, would be avoided if at the same time there was an increase in the rate of technology transfer with the same rate. But argument is that if the rate of technology transfer is capital-intensive, would again affect welfare in one extent by reducing employment in case of Pakistan.
There is no ignorance of FDI that can be helpful to provide employment opportunity but if she comes with labor-intensive technology, would provide in huge amount the employment to the society.
For encouraging FDI, domestic currency devalued and ER rate increases that encouraging the foreign investor to invest in. Since, this welcoming attitude promotes the govt. to given subsidy FDI like credit subsidy, tax credit, investment tax credit, and etc. increases the demand of money & thus inflation, not in short-run but in long-run, and hamper the society by reducing size of economic activity. It is b/c with the increase in prices; wages doesn't increases to that extent.
Since, evidence suggests that although trade liberalisation by itself leads to a slight reduction in inequality, a rise in Foreign Direct Investment (FDI) appears to increase it.
Where SBP showed, low tax to GDP ratio is cause of fiscal deficit, which was not a sufficient justification to increase the tax burden, as it results in burdening poor in terms of decline in their purchasing power, poor though constituting majority of the population along with fixed income group shrink their purchases which consequently leads to decline in expenditure and decline in government tax collection as major part of the tax collections come from indirect taxes. Hence government should redesign the tax base and tax structure that can be helpful for lessening the burden on poor for which more income generating sectors are required to be included in tax paying brackets as well as more from the poor segment should be engaged in economic activity, and in the long-run, it is easy to collect direct taxes with more revenue. In case of Pakistan, the player of game evade the tax i.e. also cause to low taxes collections.
Tax concession to the foreign enclave in the form of reduction in tax rate on foreign capital income leads to a reduction in national income in the short-run but raises the long-run equilibrium level of national income. Where reduction in tax rate on foreign capital income leads to no change in the urban unemployment rate in the short-run but in the long-run, leads to an increase in the urban unemployment when there is technology transfer from urban foreign enclave to the urban domestic sector. On the other hand, reduction in tax rate on foreign capital income leads to no change in the urban unemployment rate in the short-run but in the long-run, leads to an decrease in the urban unemployment when there is technology transfer from urban foreign enclave to the rural domestic sector.
Another major concern related to the effects of the above stated factors is inequality, rising inequalities do matter in the extent of rising growth. However, it serves the political interest of governments to project rising growth and to ignore rising inequalities. It is easy in our circumstances to confuse growth strategies with distributional implications of growth.
Increased per capita income is used as a common indicator to assess distributional implications of growth in Pakistan, the Per capita income is growing over time but it is less to the extent to attack on social sectors. That's why , such increase may be associated with rising income inequalities or growing incidence of poverty. Likewise development is another vague term that is often misused by various players of the game. Macro-development as a result of increased economic growth may lead to decreased social development.
There is argument that when informal sector produces either final good or intermediate product for the formal sector, liberalization widens the skilled-unskilled wage gap of the economy but with an increase in the foreign capital inflow, the level of welfare of the economy increases, when the informal sector produces a final product. However, it reduces welfare when informal sector produces an intermediate product.
When informal sector produces either final good or intermediate product for the formal sector, liberalization widens the skilled-unskilled wage gap of the economy but with an increase in the foreign capital inflow, the level of welfare of the economy increases, when the informal sector produces a final product. However, it reduces welfare when informal sector produces an intermediate product.
Despite of it, there is a gap b/w skilled worker that is employed in FDI & domestic industries. A person, who is employee of FDI, has high purchasing power, could offer a higher demand, and a person, who is employee of domestic industry, has low purchasing power, would offer lower demand. It would increase the inflation by the side of FDI workers and could reduce the purchasing power of the lower one, can put them into poverty. In the short-run, FDI cannot hurt to the domestic worker, but can affect in the long-run, when FDI's profit increases, and can offer a higher wage that cause to encourage FDI workers' purchasing power & reducing domestic workers' purchasing power.
On the contrary, FDI helps to earn gigantic profit for domestic producer b/c of tax credit subsidy and etc. widened the gap b/w the richer and poorer. Although it is helping producers, it also seems to merging middle-class in lower class.
Economy may experience an improvement in its welfare and a reduction in the urban employment due to a foreign capital inflow when the sector producing the non-traded intermediary is sufficiently capital-intensive relative to the import-competing sector and a sufficiently large amount of the output of the former is used in the export sector of the economy while inflow of foreign capital with full repatriation foreign capital income unambiguously lowers the welfare of the economy and raises the level of urban unemployment if the non-traded intermediately is entirely used in the protected import-competing sector.
Marginal propensity to save increased in the presence of more restrictive trade regime. Where foreign capital inflow has substituted for domestic savings in all trade regime, it depress domestic savings under IS policy. National savings rate get affected b/c of low per capita income and higher dependency ratio as one earning member is taking care of 6 to 7 non earning members of household. It also get affected b/c of low real rate of interest that confirm the existence of financial repression..
On one side, foreign private investment discourages the individual saving while on the other promotes economic growth private sector is affected by FDI b/c of reducing savings, but it is helpful to promote demonstration effect which is defined as whenever a country is engaged with communication to other country, she adopts other country's consumption pattern that reduces savings, that affects the real income not absolute one, Pakistan economy has become more open over the years although volume traded by Pakistan has granted few benefits as compared to cost which is truly reflected in burgeoning trade deficit on one hand and the impact of foreign direct investment in the living style all those working with foreign producers have resulted in the encouragement of 'demonstration effect'.
Now the question arises that what policy should be promoted to enhance growth with reducing inequality? Foreign Direct Investment is not bad for any country if there is increased efficiency and opportunity for poverty reduction & income inequality, that globalization could ultimately bring about, would lead to economy to the prosperity. Foreign Direct Investment should be consistent with the social objective of limiting the dis-equalising effects of growth in this era by synchronized public policy with the effort to decentralize the location of foreign direct investment.
Apart from that use of capital-intensive technology for non-traded intermediary and generating employment be promoted in cases in which it does not turnout to be labor displacing .in case of rural areas where majority of poor still reside in Pakistan, the focus should be on creating opportunities for using biochemical technology rather than labor displacing so that increased crop intensity and increased the pace of double cropping attributed to biochemical technology can directly promise benefits to poor.