THE PAKISTAN DEVELOPMENT REVIEW
The Impact of Productivity on Foreign Direct Investment in Pakistan: A Structural VAR Analysis
This paper investigates the role of labour productivity in attracting foreign direct investment in Pakistan for the period of 1980 to 2015. The aim of this research study is to examine the contagion effects of productivity variations on FDI flows in Pakistan using SVAR modelling. The results of impulse response function confirm that productivity is a long-term phenomenon in attracting foreign direct investment. It is also found that FDI flows into Pakistan react to consumption changes in the long run. The results of variance decomposition suggest that the productivity of Pakistan is the most dominant factor in predicting forecast error variance of foreign direct investment in Pakistan. Pakistani productivity shocks are stronger as compared to Chinese productivity shocks in explaining variation in FDI. These findings lead to accept the hypothesis that an increase in productivity of Pakistan attracts FDI. The real effective exchange rate behaves negatively to FDI flows in the long run, reflecting that locally produced goods are more expensive. It is recommended that, all the economic policies that increase countries’ productivity and consumption growth in the long run are caused to attract FDI. The findings of this research study also recommend sound policy implications for policy makers to make strategic decisions in the context of China-Pak Economic Corridor (CPEC).