BOOSTERS OF FDI IN PAKISTAN

SYED ALAMDAR ALI
Sep 8 - 14, 2008

Foreign Direct investment is a financial concept and is not the same as capital expenditure on fixed assets. It covers only the money invested in a related enterprise by the parent company, with the enterprise having the discretion of how to use it. A related enterprise may also raise money locally without reference to the parent company. The analysis of inward investment is based on the country of ownership of the immediate parent company. Thus, inward investment in a Pakistani company may be attributed to the country of the intervening foreign subsidiary, rather than the country of the ultimate parent. Coming forward, FDI does not automatically translate to net foreign exchange inflows. Many multinational and transnational "investors" borrow money locally at favorable interest rates and thus finance their projects. This constitutes unfair competition with local firms and crowds the domestic private sector out of the credit markets, displacing its investments in the process. Still many transnational corporations are net consumers of savings, draining the local pool and leaving other entrepreneurs high and dry. For instance, foreign banks tend to collude in this reallocation of financial wherewithal by exclusively catering to the needs of the less risky segments of the business scene (read: foreign investors). Nevertheless, the economists conclude that direct investment benefits both the home and the host country and that the benefits of such investment outweigh the costs, such as FDI is not about foreign exchange. FDI encourages the transfer of management skills, intellectual property, and technology. It creates jobs and improves the quality of goods and services produced in the economy. Above all, it gives a boost to the export sector. There are, of course, a number of different potential determinants of FDI flows. Such as, FDI can be attracted by low tax levels on foreign firms, or by the aggressive use of subsidies. However, competing for FDI by lowering taxes or offering subsidies can lead to what several authors have called a "race to the bottom," where the foreign firms end up appropriating all the benefits associated with their investment. Alternatively, countries can try to make themselves more attractive by educating their labor force or improving the quality of their infrastructure or institutions. Oman (2000b) has called this type of competition a "beauty contest." Isolating the influence of these variables allows for moving on to the main question: What can countries do to attract FDI? The variables amenable to policy action include tax rates on foreign corporations, and the quality of the labor force, infrastructure and, in particular, public institutions. A synopsis of such steps and required improvements therein has been given hereunder:

LEGAL SYSTEM AND ENFORCEMENT OF LAWS

A stable legal framework for investment decisions is a basic requirement for attracting FDI. In Pakistan, Poor implementation of existing legislation seems to be the main problem. The application of legislation is often inconsistent and therefore unpredictable. Frequent changes in legislations produce an unstable platform of enforcement of laws. Lack of a political culture whereby decisions and commitments made by previous authorities are honored and reinforce unpredictability. Insufficient administrative capacity heavily adds to weak and unreliable judicial enforcement.

TAXES AND INCENTIVES

Can countries attract FDI by reducing taxes on foreign corporations? An analysis of data on withholding tax rates on dividends of foreign corporations suggests that higher tax rates on foreign corporations indeed have a negative effect on FDI. Specifically, a one percentage point increase in the tax rate decreases the stock of FDI by about 4 percent. For an efficient and "attractive" tax system, a harmony should be ensured among the amendments to be introduced in the law and the tax strategy. Pakistan therefore has to take immediate action and specify concrete measures to attract more FDI to the country.

UNREGISTERED ECONOMY

In order to improve the investment environment, priority should be given to the struggle against the unrecorded economy.

PRIVATISATION

Although privatizations are important means of generating FDI in the world, Pakistan has not generated FDI as expected by privatizations many big Organizations like MCB and HBL have cheaply privatized over the last period of 18 years! Privatization should be understood as a means of increasing efficiency not as a source of generating income.

LABOR RELATIONS

Labor force is an important contributor of Pakistan's competitiveness. In terms of the availability of skilled labor force, Pakistan performs higher when compared with its competitors. Pakistan has to compensate its increasing labor cost either with another impressive advantage or by improving the investment environment. Private sector has to manage to adjust its cost structure and the excess labor supply. The rise in labor productivity points to a higher potential growth rate.

INTELLECTUAL PROPERTY RIGHTS

Effective protection of intellectual property rights is essential for attracting FDI Concerning legislation, intellectual property rights protection is in place. However, concerning implementation, there are serious concerns. Furthermore, some of the laws are not yet up to the international standards. The problems encountered in the area of effective protection of IPR in Turkey create obstacles to FDI inflows. The priority should be given to effective implementation and enforcement of protected rights.

SECTORAL LICENSES AND OPERATING PERMITS

Sectoral licenses impose the problem of barrier for market entry. Overlapping laws and institutions exist today to govern the implementation of environmental protection. Lack of coordination among different ministries and agencies causes a major problem for effective operation.

INFRASTRUCTURE

Pakistan should enhance its basic and technological infrastructure in order to attract more FDI. Infrastructure is costly and quality is a concern. The lack of infrastructure should not hinder FDI but turn into potential new investments and FDI in the future. Liberalizing the infrastructure sectors properly will help to solve the problems and stimulate FDI.