The emergence of China as the world's second largest economy, largest recipient of Foreign Direct Investment (FDI) and the single largest investor country in Pakistan have raised concerns that this success has been achieved at the expense of others. With this backdrop, the study finds out whether China is crowding out investment in Pakistan. The study uses the ARDL bounds testing approach by using annual data for the period 1980-2014. The locational factors, including market size, human capital, openness and infrastructure are all important determinants for FDI inflows. Once these factors are controlled for, China does not appear to crowding out inward FDI in Pakistan. China's market size, its inward FDI and direct investment to Pakistan have positive and significant impact on the inflows of FDI in Pakistan. Besides, all locational factors i.e. market size of Pakistan, trade openness, human capital have showed positive and significant impact on FDI inflows. The effect of infrastructure is appeared to be negative as well as significant. The results support the conventional wisdom that the country with growth rates of GDP attracts the foreign investment as this growth indicates larger potential demand for goods. Furthermore, investors feel comfortable with more liberalised economic environment. Investment in human capital also plays a vital role to enhance inward flow of foreign investment.
Keywords: Foreign Direct Investment, Market Size, Human Capital, Trade Openness, Crowding Out, China Effect
The developing and emerging economies know the significance of foreign direct investment (FDI) for their growth and its share in process of development. Its importance for the recipient is well documented in the literature. It stimulates the economy which adapts the advanced technological and management skills [De Mello (1997); Urata and Kawai (2000); Lipsey (2002); Johnson (2006)]. It creates a virtuous circle of confidence building for the host country. The existing local investment climate is reinforced in attracting further local as well as foreign investment. The host countries can achieve their socio-economic objectives of employment generation, poverty alleviation and advancement of technology [Khan and Yun-Hwan (1999)].
In their efforts to accrue benefits from FDI, countries have been undertaking reforms and offering competitive FDI policy packages to foreign investors. This phenomenon has generated a fierce competition among countries to attract the world FDI. According to the United Nations Conference on Trade and Development (UNCATD) statistics, global foreign FDI flows has jumped by 38 percent to $1.76 trillion. FDI inflows to developed economies have almost doubled to $962 billion. Similarly, developing economies have seen their FDI inflows reach a new high of $765 billion which is 9 percent higher than in 2014. Developing Asia has surpassed half a trillion dollars of FDI inflows and the region is the largest FDI recipient in the world. Among top 10 host economies for FDI inflows, half are from developing world [UNCTAD (2016)].
The Developing Asia is the largest recipient region of FDI inflows in the world. The countries like Hong Kong (China), China, Singapore and India received more than three quarters of total inflows...
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