INTERNATIONAL TRADE THEORIES ON FDI STILL AT AN INFANCY STAGE

MANZOOR HUSSAIN MEMON*
Sep 8 - 14, 2008

FDI has spread to become a truly global phenomenon, classified into two modes of horizontal and vertical. The horizontal FDI is the investment in the same industry as in the home country to that of the host country abroad. Whereas the motive of vertical FDI includes reduction of cost of production (cheap labour and material), exploring new markets, seeking resources of the host country, and to increase the efficiency by exploiting the benefits of economies of scale. The vertical FDI further divided in to backward and horizontal FDI, gaining its strategic importance.

Vertical backward FDI is the foreign investment in the host country which requires the major inputs from the home country. This in-turn increases the imports of the host country and vice versa boosting the exports of the host country, affecting the balance of payment of both the countries in either ways. The vertical backward FDI have the motive of market seeking.

Vertical forward FDI is the foreign investment in the host country to reduce the cost of production and cost of transportation. This type of FDI boosts the exports of the host country, and increases the profits of the industry in the home country. The motive behind this type of investment is to seek the resources (cheap labor and material resources) which in-turn reduces the cost of the production.

The significance of FDI flows is well documented in literature for both the developing and developed countries. In-spite of increasing importance of FDI due to globalization and increasing interaction among the countries in the world, the theoretical integration among the FDI and the international trade theories are still at an infancy stage reflecting that there is a need of further improvement or development.

Despite the increase in Pakistan's Export, the share in world exports remains stagnant on an average (1980-2004) at 0.16%, declining after a highest share of 0.20% achieved in 1992. As far as the matter is concerned, Pakistan lags behind many Asian countries. Pakistan's Exports base is very limited and this characteristic is considered to be a threat to Pakistan's Economic growth. In 2005-06 the major share of Pakistan exports went to 9 countries, accounted for 55.9% of total exports. 62.6% of Pakistan's total exports are Agriculture Commodities and Textiles Products, 33% of which are Raw or Low value added products.

Imports of Pakistan have been greater than exports since 1980, giving negative balance of trade. Pakistan's major import commodities are Petroleum & Products and Machinery which account for about 36.68 % of the total Imports. Area wise, as the commodities suggest, the major imports are mainly from USA, Japan and European Countries. Combined share of USA and Japan accounts for 20.45% in FY04. Share of Machinery import to total imports was 11.91% in FY80, it increased to 14.97% in FY85, 17.09% in FY90, 20.14% in FY95, decreased to 12.4% in FY00 and increased to 15.96% in FY07. In FY07, the share petroleum group accounted for 24% of the total imports.

Volume of Pakistan's International trade is low as compared to the countries having similar characteristics. India had 0.61% share in world trade in 1980 as compared to Pakistan (0.2%). The figures gets worse when we compare it with developed nations like United States who had 12.6% share in World trade in 1980. However, Pakistan's position was much better than Bangladesh (0.087%) and Sri Lanka (0.08%).

In 1980, the Share of FDI in Mining & Quarrying was almost 75% of the total, which declines to below 1% of total FDI in FY07. The share in the construction sector increase in mid 90s, at its highest in 1992 to 36% of total FDI, remain around 3% of the total FDI in FY07. The power sector dominates in the share of FDI in early 90s due to the policy incentives in the period, and in FY06, 14% of the FDI was in the power sector, mainly due to increasing domestic demand of energy. The other sectors which take the major share in the last five years are banking and telecom sectors. Which reflected in the service led growth in the last three years and consumption led GDP growth in the outgoing year. The telecom sector also has been responsible of the increasing import bill of the country in the last three years.

The role foreign direct investment was observed as a domestic investment and complement for imports in the country. In 2008, Pakistan's population crossed the 160 million mark, where as the steady growth pattern in the last five years increase the domestic purchasing ability. Due to increasing domestic demand, the main focus of the FDI seems to be on Pakistan potentially large markets. This in-turn reflects the horizontal or vertical backward foreign direct investment in the Pakistan.

Pakistan major sources of imports and FDI both includes USA, Saudi-Arabia, Germany, United Kingdom and Malaysia, reflecting the form of vertical backward FDI in the country. The impact can be observed by the increase in imports, deteriorating the balance of payments status of the country. Pakistan has been facing the increasing balance of payment deficit, in particular in the last five years where there is a significant increase in FDI.

Being agriculture based and developing economy, Pakistan should formulate policy with respect to attract the FDI in the commodity producing sector. The agriculture sector which employs almost 44% of the total labor force has the strong backward linkage with the textile sector, accounts for almost 70% of total exports of the country. Pakistan's share in the world exports is declining due to increasing competition and technological advancement over the world, International markets demands higher quality products. We have to adhere to these principles if we have to survive in the export markets of the future.

Beside the communication and commerce, Pakistan should also design it policies to attract the FDI in small scale industries which has the potential to grow and enhance the exports of the country. The FDI in the training and education sector is also important for the country like Pakistan where the literacy rate is far below the developed countries and other developing countries in the Asian region. There is a need to bring the significant change in the composition of FDI, from service sector to commodity producing sector, which will not only cater the domestic demand, but also reduce the pressure on the balance of payments. FDI could be the last resort for Pakistan to come on the track of economic forefront.

RANKING OF COUNTRIES BY FOREIGN DIRECT INVESTMENT (INFLOWS AND OUTFLOWS)

FOREIGN DIRECT INVESTMENT INFLOWS 2006 COUNTRY RANKS

FOREIGN DIRECT INVESTMENT OUTFLOWS 2006 COUNTRY RANKS

RANK

COUNTRY

AMOUNT (MILLION US $)

RANK

COUNTRY

AMOUNT (MILLION US $)

1

United States

175394.00

1

United States

216614.00

2

United Kingdom

139543.36

2

France

115036.11

3

France

81076.00

3

Spain

89678.60

4

Belgium

71996.70

4

Switzerland

81505.41

5

China

69468.00

5

United Kingdom

79457.28

6

Canada

69040.70

6

Germany

79426.56

7

Hong Kong

42891.53

7

Belgium

63005.30

8

Germany

42869.93

8

Japan

50266.12

9

Italy

39159.00

9

Canada

45243.10

10

Luxembourg

29309.20

10

Hong Kong, China

43458.99

11

Russian Federation

28731.52

11

Italy

42035.00

12

Sweden

27230.58

12

Brazil

28202.49

13

Switzerland

25088.58

13

Sweden

24599.74

14

Singapore

24206.66

14

Netherlands

22692.35

15

Australia

24022.16

15

Australia

22347.35

21

India

16881.00

21

India

9676

51

Pakistan

4273.00

74

Pakistan

107

Data Source: UNCTAD, World Investment Report (2007)