Lahore School of Economics

A distinguished seat of learning, teaching and research

Benefiting from Foreign Direct Investment

Khalil Hamdani*

1.        Introduction

It is commonly held that foreign direct investment (FDI) has played an insignificant role in Pakistan’s economic development.[1] Certainly, the aggregate data supports this view: FDI inflows have accounted for less than 1 percent of gross domestic product (GDP) in most of Pakistan’s 60-plus years, and less than 4 percent in the peak year of 2007 when the country ranked among the 10 largest recipients of FDI in Asia.[2] At the same time, FDI has been more important in Pakistan than in India: annual inflows have been larger in most years from 1947 to 1993, and even now, while our larger neighbor receives four times more inflows, the share of FDI in capital formation is three times as large in Pakistan. Such comparison, while superficial, suggests the relevance of FDI.
This chapter considers the role that FDI can play in moving the economy forward by improving its technological base and placing production on a more dynamic growth path, as other countries have done with great success. It begins with a brief history to remind readers that Pakistan’s economy has always been open to foreign investment, even in the heyday of nationalization. Next, it looks at the particular type of investment and technological profile that has evolved: weighty, but largely insular, statist, and low on competiveness. Finally, the chapter assesses the potential for a more ambitious industrial trajectory: private sector-led, fueled by FDI, and supported by policies and institutions that encourage technological deepening.

2.        Foreign Direct Investment

Foreign companies have operated in Pakistan since even before independence. Standard Chartered Bank claims a heritage of over 140 years, to operations set up in Karachi in 1863. Shell Petroleum dates its operations back to 1903, and Imperial Tobacco to 1905. Siemens opened an office in Lahore in 1922; Grindlays Bank opened branches in Lahore in 1924 and in Peshawar in 1926; Imperial Chemical Industries (ICI) set up a soda ash manufacturing facility in Khewra in 1944; and there were still others.
Pakistan’s formative years were a particularly dynamic period. Economic growth was driven by private investment. The government’s policy of import substitution provided a profitable environment for Muslim migrant families from pre-Partition India with capital to invest and set up their businesses anew.[3] Many were motivated by patriotic zeal. A vibrant domestic private sector, in turn, attracted foreign participation.
FDI was initially permitted in manufacturing, and large investments had to be in the form of joint stock companies with local equity participation.[4] One of the first foreign investments in the new country was a vegetable oil factory built by Lever Brothers in Rahimyar Khan in 1948; today, Unilever is the largest consumer goods manufacturer. The Lakson Group collaborated with several multinationals, such as Colgate-Palmolive, which established operations in 1954. In pharmaceuticals, Glaxo Laboratories was incorporated in 1948 and is today, as GlaxoSmithKline, the largest in the industry; other early entrants were Abbott Laboratories in 1948, Pfizer in 1961, and Searle in 1965.
The domestic Batala Engineering Company (BECO) attracted KSB (a German multinational manufacturer of machines, pumps, and valves) to locate its first subsidiary in the Asia-Pacific market in Pakistan in 1953; today, the KSB Pakistan foundry at Hasan Abdal produces submersible pumps, automotive components, and supplies castings for cars and tractors.
The motor vehicle industry began modestly in 1949, with distributorships of Vauxhall cars by General Motors & Sales, a domestic company, and of Ford trucks by Ali Automobiles. Exide commenced the production of batteries in 1953. Allwin Engineering was manufacturing precision automobile parts by 1961, and Bedford trucks were being assembled by Ghandara Motors in 1962. The Atlas Group set up a Honda motorcycle plant in 1962 among other investments with Japanese partnership.
In the services sector, the banking, insurance, and air transport industries quickly gained prominence. In 1951, Habib Bank became Pakistan’s first multinational corporation with operations in other countries. American Life Insurance Company (ALICO) entered Pakistan in 1952. The precursor to Pakistan International Airlines (PIA) was Ispahani’s privately owned company, Orient Airways, which, in a leasing arrangement with the British Overseas Airways Corporation established a flight service between Karachi and Dhaka in 1954.
Although annual FDI inflows were less than 6 percent of total private industrial investment, FDI was crucial for the success of import substitution and infant industry policies in the post-independence period. There were a number of joint ventures or licensing, franchising, and distribution arrangements between startup Pakistani firms and foreign companies. Some were launched with World Bank lending, such as the 1968 joint venture between the Dawood Group and Hercules Chemicals to manufacture fertilizer. An indicator of the welcoming attitude toward foreign investment was the bilateral investment treaty signed between Pakistan and Germany in 1959—the very first in the world.[5]
FDI inflows increased at an average annual rate of 10 percent between 1965 and 1969 (see Figure 11.1), contributing to investment and facilitating technology transfer. During these years, manufacturing value-added (MVA) grew at 9 percent, and total factor productivity (TFP) is estimated to have increased at 4.3 percent (Kemal, Din, & Qadir, 2002). The relatively good performance in the country’s formative years reflects the infancy of manufacturing and the low initial level of the technological base, but also a dynamic period of technology acquisition, application, and learning through equity and nonequity ties between domestic and foreign companies.[6]
This golden era of Pakistan industry lasted 25 years. A feature of the 1947–1972 expansion was the rapid rise of family businesses into industrial conglomerates,[7] favored with privileged access to financial credit and foreign exchange for the import of industrial inputs (Amjad, 1982).[8] These conglomerates were not very different from those of other countries—the robber-barons of the US, the zaibatsu and keiretsu of Japan, and the chaebols of Korea—and perhaps they might have propelled Pakistan alongside Korea into a newly industrialized country, but this was not to be.
Figure 11.1: FDI inflows in the early years (USD million)
Source: State Bank of Pakistan.
Pakistan’s resort to nationalization in the 1970s was not uncommon at the time.[9] The duration was brief (1972–77) but the impact was widespread and long lasting. A great many different units were seized.[10] The focus was mainly on domestic companies, although some FDI was affected. ALICO, with an investment of more than USD 36 million, was nationalized in 1972. Esso’s petroleum operations were purchased in 1976 and its gas operations in Mari, one of the largest in the country, were acquired in 1983. Some foreign companies, e.g., Shell, reduced shareholdings to below 50 percent in locally registered affiliates. Although nationalization was reversed as early as 1977 in the agro-processing industry, it was slow to unwind in other industries. Banking was not denationalized until 1991. ALICO was denationalized in 1994, and a further decade passed before Habib Bank was denationalized in February 2004.[11] To this day, a number of enterprises remain slated for denationalization, for reasons not unique to Pakistan.[12]
The main effect of nationalization on foreign investment was the lapse of nonequity arrangements and the shelving of investment proposals, such as the proposed collaboration between BECO and Toyota to manufacture textile machinery in Pakistan—a venture that would have kept Pakistan at the forefront of a fiercely competitive global industry.
When private investment subsided, so did foreign investment: FDI inflows fell to zero in 1973, became negative in 1974, and did not recover for a full decade, until 1982 (see Figure 11.1). The Foreign Private Investment (Promotion and Protection) Act of 1976 was enacted to (i) protect foreign investments from nationalization and expropriation, (ii) guarantee capital repatriation and the remittance of profits and dividends, and (iii) encourage investment in capital goods industries. These assurances, however, had little effect on FDI inflows.
Public enterprise and public investment dominated Pakistan’s industry for the next three decades (1972–2002). Although aggregate investment never quite attained its earlier levels, this period was not without expansion and growth. An unanticipated windfall after 1976 was the substantial inflow of overseas workers’ remittances, which sustained consumption and invigorated private investment.[13] In the food industry, Nestlé acquired a 40 percent share in Milkpak in 1988. In transport, Indus Motor was formed as a 1990 joint venture between the House of Habib and Toyota, and in 1992 Atlas Honda expanded production from motorcycles and batteries to cars, among yet other examples.
In the public sector, too, there were a variety of technology-intensive joint ventures between Pakistan’s parastatals (public enterprises) and foreign companies. An example is the 1978 nitrogen (urea) fertilizer project between the quasi-public Fauji Foundation and Haldor Topsoe A/S of Denmark; it further expanded manufacture in 1993, with Jordan Phosphate Mines to include phosphate fertilizer. The fertilizer industry also attracted parastatal investment from China, Saudi Arabia, and the United Arab Emirates (UAE).
Pakistani-Arab joint ventures tapped into the capital of the oil-rich states. A particularly successful joint venture with the Emirate of Abu Dhabi established the Pak-Arab Refinery Ltd. in 1974, which is now active in refining, transportation, storage, and marketing, and has technology partnerships with French, Dutch, Austrian, and American multinationals. A parastatal collaboration with China established the Heavy Mechanical Complex Ltd. in 1979, with fabrication and machining facilities for the design, engineering, and manufacture of industrial plants and machinery.[14] In transport, the state-owned Pakistan Automobile Corporation formed joint ventures with Japanese companies to establish Pak Suzuki Motor Company in 1983, and Hinopak Motors (also with Arab involvement) in 1985.
FDI inflows, attracted both to the private and public sectors, increased at an average annual rate of 22 percent in the 1980s (see Figure 11.1), while MVA grew at 8.1 percent, and TFP is estimated to have increased at 5.4 percent (Kemal et al., 2002). It was an altogether remarkable recovery after the 1970s, though the worst decade was yet to come.
The Achilles’ heel of public enterprise was the inability to generate sufficient earnings for reinvestment. A few publicly owned or managed enterprises flourished into conglomerates—the Fauji Group[15] and Askari Group[16], for instance—but the totality of public enterprises and nationalized banks required government support of some USD 1.7 billion annually.[17] This proved unsustainable, and given the constraints on the public budget, investment (and technology acquisition) in public enterprises slowed significantly in the 1990s. The growth of public investment decelerated from 4.6 percent in the 1980s to 0.5 percent in the 1990s (Hyder & Ahmed, 2004, table 1).
The investment slowdown in the 1990s had a serious impact on growth and productivity. In contrast to the previous decade, growth in MVA slipped from 8.1 percent to 4 percent, and TPF grew by only 1.6 percent (Kemal et al., 2002). FDI inflows grew at an average annual rate of only 8 percent in the 1990s in spite of policy reforms and generous incentives. During this decade, India, which had generally trailed behind Pakistan in FDI inflows, took the lead and went on to become a major investment destination (see Figure 11.2).
Pakistan’s policy liberalization was gradual but comprehensive. In trade policy, the Export Processing Zones Authority was established in 1980, import quotas were largely removed in the 1980s and tariffs were significantly lowered in the 1990s. In foreign exchange policy, currency convertibility was guaranteed in 1994. In FDI policy, the Board of Investment was established in 1990 and restrictions on entry, equity ownership, and royalty payments were eliminated. By 1997, Pakistan had a fully open and progressive foreign investment policy regime—the most liberal in the Subcontinent.
Figure 11.2: FDI stock in Pakistan and India (USD million)
Source: UNCTAD FDI/TNC database.
A major pickup came in 1995/96 when FDI inflows doubled in a year and exceeded USD 1 billion for the first time (see Figure 11.3). The centerpiece was the build-operate-transfer infrastructure project on the Hub River, HUBCO.[18] However, the bulk of new investments were made by some two dozen independent power producers (IPPs) lured by an overly generous incentive scheme that allowed them to acquire fuel to generate power on favorable terms (low taxes, duty-free import of plant and equipment, financing of capital costs, and foreign exchange risk-insurance on external loans) and also guaranteed the purchase of the power produced at a pre-set, dollar-indexed tariff structure for 15–30 years (for details, see Khan & Kim, 1999).
The incentive scheme quickly proved unsustainable for the public sector: Pakistan State Oil (PSO) had difficulty supplying the fuel to the power producers and the Water and Power Development Authority and other utilities had difficulty purchasing the power generated. This meant significant foreign exchange outflows in excess of USD 1 billion per year well into the next decade. Trouble maintaining the set payment schedule disrupted production and built up so-called “circular debt” between the state utilities, IPPs, and PSO.[19] The larger legacy is continuing power shortages, which have adversely affected all industry.
Figure 11.3: FDI inflows in recent years (USD million)
Source: UNCTAD FDI/TNC database.
It took another ten years before annual FDI inflows topped USD 1 billion again, in 2005—this time driven mainly by privatization in banking and telecommunications. Banking attracted FDI from the Arab states (Bahrain, Kuwait, Oman and UAE) and other countries (Malaysia, the Netherlands, UK, US, and Switzerland). These investments infused the industry with fresh capital and managerial know-how—modernizing the now denationalized United Bank, Muslim Commercial Bank, and Habib Bank—and provided competition in the shape of new entrants such as Faysal Bank, Bank Alfalah, and Meezan Bank (Islamic banking).[20]
In telecommunications, Motorola (US) started the first cellular mobile service with Mobilink in 1994, which was subsequently acquired by Orascom (Egypt) in 2001. Telenor (Norway) also acquired a mobile license (GSM) in 2004 and has since made investments in excess of USD 2 billion. The privatization of the Pakistan Telecommunication Company Limited (PTCL) in 1991 bore fruit in 2006, with an investment by Etisalat (UAE) to acquire a 26 percent equity share valued at USD 2.6 billion.[21] China Mobile established its first overseas subsidiary, Zong, in 2008 with investment commitments of USD 1.7 billion. There was also FDI from Oman (to acquire WorldCall), Japan, Singapore, and Qatar. While these investments have generated dividend payments and profit remittances overseas, the significant improvement in the availability, quality, and cost of communication services is also visible throughout the country.
As a consequence of the power and privatization policies, the composition of FDI has shifted from manufacturing to services. Manufacturing was predominant in the early years—receiving 75 percent of the FDI inflows in 1980—but from 1995 onward, the services sector has attracted significant FDI. By 2008, the share of manufacturing in the stock of FDI had fallen to 31 percent, while the share of services had risen to 58 percent (see Table 11.1). Three industries—utilities, financial services, and telecommunications—therefore, account for nearly half the entire FDI stock.
The extractive industries (mining and quarrying) have received a small but steady amount of FDI over the years and account for 10 percent of the FDI stock. At present, they are foreign investors’ main attraction: their share in FDI inflows rose from 13 percent in 2008 to 34 percent in 2010. The government is aggressively awarding concessions for oil and gas exploration. A dozen foreign companies have invested in the country, including BP and Premier Oil (UK), ENI (Italy), BHP Billiton (Australia), OMV (Austria), Petronas (Malaysia), and Petrobras (Brazil), which specifically plans to explore offshore. There were also investments from Canada, China, Hungary, Switzerland, and the UAE.
Table 11.1: FDI by economic sector and industry, 2002, 2008

(USD million or percentage share)

FDI stock
All sectors/industries
Extractive (%)
Oil and gas exploration
Manufacturing (%)
Petroleum refining
Transport equipment
Other manufacturing
Services (%)
Other services
Unspecified (%)
Source: State Bank of Pakistan.
Pakistan has attracted FDI from a variety of sources (see Table 11.2), traditionally from the UK and US, followed by Switzerland, Japan, the Netherlands, and Germany. Newer sources are from Asia, Latin America, and the Middle East, with the UAE being the single largest investor during 2006–08. A third of the inward FDI stock in 2008 originated from developing countries, and was diversified in a range of industries, including telecommunications, financial services, cement, textiles, construction, real estate, logistics, airlines, and oil and gas. FDI from developed countries is relatively more concentrated in manufacturing, while that from developing countries is relatively more so in services.

Table 11.2: FDI by geographic origin, 2002 and 2008 

(USD million or percentage share)

FDI stock
All countries
Developed economies (%)
The Netherlands
United Kingdom
United States
Developing economies (%)
Hong Kong
Saudi Arabia
United Arab Emirates
Unspecified (%)
Source: State Bank of Pakistan.
Pakistan also has FDI in other countries: the stock of outward FDI in 2008 was some USD 2 billion. Two thirds (67 percent) is located in developing countries, mostly in trade and financial services (96 percent), and the largest destinations are the UAE (20 percent), the UK (7 percent), and Bangladesh (6 percent). Pakistani investments in the latter have risen in recent years and Bangladesh is now the second most popular destination, accounting for 12 percent of Pakistan’s outward FDI in 2011.
Overall, FDI inflows averaged USD 4 billion annually during 2005–09—a level commensurate with the size of Pakistan’s population (175 million) and its economy. During this period, FDI comprised 15 percent of gross fixed capital formation compared with an average for developing countries of 12 percent. Pakistan ranked briefly among the top ten FDI recipients in Asia.
FDI flows to Pakistan have since receded by more than half to well below USD 2 billion per year. While current levels are still respectable in the present context of the global downturn and domestic instability, Pakistan can, and should, do better.

3.        FDI and Technology

It is common to value FDI for its contribution to capital inflows but its importance lies more in its accompanying benefits. In addition to the financial capital that supplements savings and adds to investment, jobs, and economic growth, FDI brings technology, skills, technical know-how, and access to inter-industry trade and foreign markets. These other benefits are particularly important in Pakistan’s case; unlike many developing countries, it has had recourse to alternative forms of resource inflows, such as official capital flows (development assistance) and income transfers by migrants (remittances), which have also been substantially greater than FDI inflows.[22]
As already discussed, Pakistan has been reasonably successful in attracting FDI. For many years, it attracted as much or more FDI than its larger neighbor. In more recent years, Pakistan’s stock of inward FDI increased at an average annual rate of 12.5 percent between 1990 and 2009, rising from USD 1.9 billion and reaching USD 18 billion. This marks a reasonably good performance, comparable to that of a number of developing countries that have opened up in an expansive period of worldwide FDI growth.[23]
Pakistan has attracted resource-seeking and, mainly, market-seeking FDI in a wide range of industries, initially in marketing as well as manufacturing and more recently in services. These investments were often undertaken with local partners; at first, some were marketing arrangements and others involved simple manufacturing. Over time, however, marketing expanded to production, and manufacturing expanded into new product lines and more complex assembly operations. In this way, FDI has facilitated the transfer of technology necessary for industrial development.
There are many examples of sequential investment and technological upgrading. In pharmaceuticals, Abbot Pakistan was established in 1948 as a marketing affiliate, and now operates a couple of manufacturing plants. In automobiles, as already noted, the Atlas Honda joint venture began with the assembly of motorcycles (in 1963), diversified to the manufacture of batteries (in 1966) and, with the acquisition of Allwin Engineering (in 1981), became a manufacturer of motorcycle parts and components for other local manufacturers (OEM) and the replacement market.
In addition to this vertical integration, the Atlas Group expanded horizontally into the manufacture of motor vehicles (in 1992), into power generation (taking advantage of the 1997 incentive scheme in a joint venture with the German company, MAN Diesel), and into financial services (with the acquisition of Muslim Insurance in 1980). Such expansion creates value-added and jobs, and deepens the technological base of industry.
The link between FDI and technology is visible in the manufacturing sector’s growth trends. Several studies on TFP in Pakistan typically observe a cyclical pattern in growth rates.[24] Kemal et al. (2002), for example, show that MVA grew at 6.4 percent during 1965–2000 but varied between periods, while the physical capital stock in manufacturing grew at a steady rate at around 2 percent, implying higher (or lower) output growth with about the same input of capital at higher (or lower) levels of productivity.[25] Therefore, TFP in manufacturing followed the pattern of MVA, which also paralleled the trend in FDI inflows (see Figure 11.4). The broad pattern, as previously discussed, is one of:
-       A dynamic 1960s, with high rates of manufacturing expansion, FDI inflow, technology acquisition, and productivity growth (all from an admittedly low base).
-       A regressive 1970s, disrupted by nationalization: negative growth in FDI and slower manufacturing activity.
-       A revived 1980s, with resurgent economic activity, significant FDI, and technological learning in the public and private sectors.
-       A weak 1990s, with declining public sector investment, FDI mainly in services (power), and a relatively sluggish manufacturing sector.
Overall, the trends suggest that FDI contributed to technology transfer and growth in TFP. S. U. Khan (2006) shows TFP, during 1960–2003, to be inversely related to the budget deficit and positively related to government consumption, private credit, domestic investment, and FDI.
Figure 11.4: Growth of manufacturing sector (percent)
Source: Growth rates of manufacturing value added (MVA), capital (K), and total factor productivity (TFP) as presented in Kemal et al. (2002). FDI growth rates are for aggregate inflows and based on data from the State Bank of Pakistan.
The link between FDI and technology is also visible in its industrial concentration. About a third of the entire FDI stock in Pakistan in 2008 was concentrated in manufacturing (30.5 percent; see Table 11.1), which, when disaggregated by technology category according to the standard industrial classification,[26] shows the following:
-       44 percent of the FDI in manufacturing involved resource-based manufacturing (food, beverages, tobacco, sugar, paper, rubber, cement, and petroleum refining).
-       4 percent was in low-technology manufacturing (textiles, leather, ceramics, and metal products).
-       52 percent was in medium- and high-technology industries (chemicals, basic metals, pharmaceuticals, cosmetics, fertilizers, machinery, electrical goods, electronics, and transport equipment).
In the first and last of the categories above, for resource-based and medium- and high-technology industries, managerial efficiency and technology absorption contributed to TFP gains for most years during 1998–2007 (Raheman, Afza, Qayyum, & Bodla, 2008). Overall, FDI appears to have deepened the technology base of manufacturing production.
FDI has also deepened the technology base in key services industries. In telecommunications, the economy leapfrogged from sparse, dysfunctional landlines to mobile telephony almost overnight, with 120 million subscriptions by 2012 and a million new connections a month. In finance, new technologies and managerial practice have modernized banking, reducing costs and nonperforming loans, improving customer service, and extending lending to small enterprises and other inadequately reached segments (Husain, 2005). In port management, transport costs and delays have lessened. In trade, there has been a diffusion of new methods of inventory control, supply chain management, packaging and product development, and advertisement targeting a growing urban middle class. Domestic firms have participated in the growth and spread of these services.
However, FDI has been mainly market seeking and so, its benefits of technology transfer have not flowed directly into the export industries. Ahmad et al. (2003) examine the causal relationships between FDI, MVA, and exports over 1972–2001 and observe that causality runs from FDI to MVA but not from FDI to exports.[27] Weiss and Lall (2004) also observe that, during 1990–2001, technological upgrading in manufacturing was slow but occurred in domestic production rather than in exports. Raheman et al. (2008) find that low technology absorption contributed to a decline in TFP in the textiles sector (a major exporter) during 1998–2007.
A general failure of the foreign manufacturing affiliates operating in Pakistan in all industries has been their reluctance to develop an export-oriented approach, even within the global network of their parent companies. This, in part, is attributable to the protected markets within which they have operated—the downside of the earlier trade and industrial policies that worked so well to attract FDI.[28] However, the experience of other countries is that, over time (as much as a decade), market-seeking affiliates can and do graduate to become world players.
This has begun to happen in Pakistan. Pak Suzuki Motor Company, established in 1983, began exporting pickup vehicles in 1997 to Bangladesh, Nepal, and Afghanistan, and now exports sheet metal parts to Europe. Hinopak Motors began exporting school buses to the UAE in 2010. ICI Pakistan exports to regional markets in the Middle East and Central Asia. Pak Elektron Limited, established in 1956 to manufacture transformers (in collaboration with the German AEG in 1956), added to its product line air-conditioners (with General Corporation of Japan in 1981), refrigerators and freezers (with Iar Siltal and Ariston of Italy in 1986), and now exports its appliances.
The cement industry, set up with FDI, is a major exporter within the Subcontinent and to East Africa and the Middle East. Similarly, the pharmaceutical industry, which includes two dozen multinationals, has begun to export with overseas sales of USD 100 million in 2007. The food industry (beverages, tobacco, etc.) also exports. The national Pakistan Aeronautical Complex (PAC), established in the early 1970s, has had various technical collaborations with China, France, Sweden, the Netherlands, and the US, and now exports aircraft to the Middle East and overhauls those of other countries. Recently, as part of an offset deal for the purchase of aircraft by PIA, Boeing transferred technology to enable PAC to manufacture spare parts in Pakistan for its global supply chain.[29] Weiss and Lall (2004) show that total exports increased at an annual rate of 7.9 percent during 1985–2002, while exports of medium- and high-technology products increased at 8.3 percent, of which automotive exports increased at 14 percent and electronic exports at 16 percent.
The relationship between FDI and technology begins with the acquisition of technology (through capital goods and licensing) and the transfer of skills and know-how to the local workforce (through the use of technology in production). Technology transfer through FDI enhances labor productivity. Based on a 1981 sample of 25 of Pakistan’s large-scale manufacturing industries, Mahmood and Hussain (1991) observe that foreign affiliates have higher labor productivity than domestic firms (of equal capital size and producing similar products). Din, Ghani, and Mahmood (2009) also note that foreign affiliates demonstrate better export performance than local firms.[30]
FDI also diffuses technology through the economy—to competitors, consumers (e.g., mobile phones), and suppliers. An example of the latter is Nestlé Milkpak’s provision of technical assistance to farmers to increase animal feed stock, improve milking techniques, prevent livestock disease, and develop the cattle breed. Such improvements benefit all dairy producers and, as a result, milk production per animal (cattle/buffalo) in Pakistan is the highest in the Subcontinent.
Other benefits include the expansion of the intermediate capital goods industry: the stainless steel milk transport tanks that used to be imported are now manufactured in Pakistan through a joint venture between a Dutch company and a local manufacturer. Burki and Khan (2007) provide evidence that dairy farmers receive higher prices for their milk supplies and earn higher income; concomitantly, girls’ school enrolment is higher in milk-producing districts. The nutritional benefits for consumers are better-quality milk and other food products, as well as bottled water.
An example of industrial maturity is Engro, which started as a USD 43 million fertilizer investment by Esso in 1965/66—at the time, the largest FDI in Pakistan—and grew in technical and managerial competence to the point that, in 1991, it was bought by its own local employees (and financial partners), when the parent company divested out of fertilizer globally. The new owners also acquired fertilizer plants in the UK and US and relocated them to Pakistan. Over the years, Engro’s farmer education programs have improved farming practices and raised crop yields. Engro has also expanded into food, energy, chemical storage, and other industries, and in the process transformed from a turnkey plant into a holding company.
While there are other success stories, two caveats are in order. First, when technology transfer occurs outside a parent–affiliate FDI relationship as a joint venture or technical collaboration between domestic enterprises and foreign companies, greater effort is needed to develop technological capabilities. Without such effort—to move from simply using turnkey technology to learning how that technology works—the domestic enterprise remains reliant on further acquisitions for technological upgrading. In such cases, additional investments are necessary to keep up with technological progress, and a slowing down of investment means falling back technologically and consequent uncompetitiveness.[31] This appears to have been the fate of many of Pakistan’s public enterprises when public investment decelerated in the 1990s.
The second caveat is that the share of FDI in the country’s total investment has been small—2 percent in 1980 and 6 percent in 2000—and so its potential contribution to improving the economy’s technological base has also been small.[32] Therefore, broader economy-wide efforts are needed to build learning capabilities, particularly through human resource development. Pakistan has lagged in this respect.
All the various studies on TFP cited earlier attribute low growth performance to low rates of human capital formation. This is evident in the low levels of our human development indicators (education, health, income) and our low overall ranking relative to other countries.[33] It is also reflected in our low levels of research and development (R&D) expenditures and personnel (Rahman et al., 2005, table 3.5) and in low intensity of technical skill creation (measured in terms of student enrolments in science, mathematics, computing, and engineering at the tertiary school level).[34] Moreover, technical education has few linkages with industry, and there are not many institutions to diffuse technical knowledge (Rahman et al., 2005). It is, therefore, not surprising that the benefits from FDI inflows and technology transfers have not permeated the economy.[35]
One consequence is that Pakistan has a smaller manufacturing base with far less technological content than the average developing country (see Table 11.3). The manufacturing sector grew at 6.8 percent during 2000–10, which was average for developing countries (6.9 percent). However, the share of MVA in GDP was just 19 percent in 2009 and only 25 percent involved medium- or high-technology production. In comparison, the share of MVA in GDP for developing countries as a whole was 22 percent, 43 percent of which consisted of medium- or high-technology manufactures. Also, while Pakistan exports relatively more manufactures than the average developing country, its manufactured exports involve relatively less medium or high technology—only 11 percent as opposed to 56 percent for all developing countries.[36]

Table 11.3: Technological content of manufactures (percent)

Developing countries
Manufacturing value added to GDP
Of which medium- or high-technology
Manufactured exports in total exports
Of which medium- or high-technology
Source: UNIDO (2005, 2009, 2011).
Such comparison suggests that Pakistan is reasonably well industrialized relative to other developing countries, but that its technological base is weak, particularly for engaging in world trade. A ranking of Pakistan’s industrial-technological profile places it as a distant follower to the high performers of East Asia (UNIDO, 2005, table 10.1). Pakistan is also a laggard in trade performance: the share of trade in GDP has stagnated over the past two decades at around 32 percent while neighboring countries have raised their trade shares multiple times (Bangladesh raised its trade share from 18 percent in 1990 to 54 percent in 2011, while India raised its share from 13 percent to 40 percent). Pakistan should be trading twice as much as it does currently, given its economic size.[37] The technological sophistication of its exports, and the intensity of factor use should also be improving faster and in pace with other countries (Waglé, 2011).
Pakistan can, and should, do better.

4.        Policies and Prospects

Pakistan has a planned economy but the extent of government involvement has varied over the years. The private sector played a leading role in the first 25 years after independence; during the next 25 years, the public sector was dominant. Throughout this period, FDI has been both welcome (often with generous government support) and forthcoming: both foreign and private investors helped build the country’s industrial base in the 1960s; foreign investors and public enterprises deepened it in the 1980s. FDI was indifferent to the ownership of the host enterprise, whether public or private; the choice between market and planned economy is, therefore, a false one.
However, Pakistan’s experience also shows that FDI inflows have risen and subsided with domestic investment (usually through joint ventures and technological collaboration); and that the country’s public enterprises have generally not been able to sustain high levels of investment. Looking to the future, it is clear that the economy has reached a size, complexity, and degree of openness where it must be driven largely by the private sector with public institutions providing a supportive role.
The government’s role in industry has evolved over the years: at various times, it has been a player, a coach, and a referee. Looking to the future, the government needs to be less of a player—Pakistan’s public enterprises need to be autonomous and self-sufficient or privatized—and more of a referee to ensure that markets run efficiently, laws are well administered, and policies are implemented. Moreover, the government needs to be a different type of coach—providing protection and subsidies to domestic enterprises is inferior to providing support to improve efficiency and help build up their technological infrastructure; providing incentives to foreign companies is inferior to providing a stable economic environment and world-class infrastructure. In these several ways, a range of policies and priorities need to be rethought. Some change is in process;[38] more is needed.[39]
It is particularly desirable that the government divest its assets in the financial sector. Pakistan’s early experience and that of other countries underscores the importance of fostering a dynamic relationship between finance and industry, rooted in the private sector with public institutions ensuring appropriate regulatory compliance and fiduciary oversight. More generally, a revival of privatization—revamped and made more transparent[40]—would significantly improve FDI prospects, as it did in 2005–07.
While support to industry is desirable, industrial policy should focus on developing technological capabilities and export competitiveness. The era of import protection and export subsidies has run its course, but there is much else that the government can do to improve conditions for production and investment. Various studies have suggested that manufacturing efficiency is low.[41]
A major constraint to efficiency is the high cost and poor quality of infrastructure, particularly in the power sector. According to one survey of small and medium enterprises, production-time losses due to electricity outages average 33 hours per week (State Bank of Pakistan, 2008); larger enterprises have standby power generators but still suffer disruptions and incur added costs. Transport and communications infrastructure are important for export efficiency. The functioning of institutions—administrative, financial, and judicial—affects transaction costs and industrial efficiency. Kemal (2007) notes that Pakistan ranks low, relative to other countries, on most indicators of market efficiency. There has been some improvement in recent years, notably in the ease of doing business, but further efforts are needed, particularly to alleviate the unsatisfactory power situation.
The government could also do more to build technological capabilities. Weiss and Lall (2004) note that Pakistan’s performance in skill creation has worsened since the mid-1980s and is below that of other South Asian countries. They observe that per capita R&D expenditure is low, enterprise-financed R&D is insignificant, and that Pakistan lags behind its neighbors in R&D capacity (e.g., in the per capita number of scientists, technicians, scientific and technical journals, and royalty and technical fees). In order to begin to rectify these shortfalls, the government should accord higher budgetary priority to the social sectors (basic education and health) and invest more in higher education.
Human resource policy and training programs should promote linkages between industry and technical education, which includes some 57 technical colleges and over 700 vocational technical institutions. Public R&D should support industrial clusters in partnership with industry associations and market leaders. The key point is for government to facilitate technological interaction and cooperation between industry, the public sector, and learning institutions nationally and internationally. Rahman et al. (2005) have proposed an ambitious agenda for technology development that deserves serious consideration by policymakers.[42]
An overall context of a private sector-led economy supported by policies and institutions that encourage technological upgrading, provides a fertile basis for attracting and benefiting from FDI. Given Pakistan’s economic size, its natural resource endowments and the experience of other comparator countries, there is every reason to expect annual FDI inflows of at least USD 10 billion, or twice the highest levels attained in the past. The official target is more modest—to attract USD 5.5 billion in FDI inflows per year.[43] Nevertheless, even that goal appears ambitious in the current circumstances of a protracted global downturn and domestic instability: FDI inflows have declined by 70 percent since 2008. Arresting this decline and putting it on an upward trajectory will not be easy.
In the immediate future, Pakistan can expect to continue to receive FDI in extractive industries (which tend to be impervious to the investment climate), and also from the more resilient economies of developing Asia. Market-seeking investment is also likely, particularly in urban areas.[44] However, these inflows are offset by an overall fall in reinvested earnings. Thus, the immediate prospects of reversing the current decline of inward FDI hinge on the government’s efforts to retain investors’ confidence. These include potential as well as existing investors, a number of who have been operating in Pakistan for many years. They also include domestic investors, whose actions shape the perceptions of new investors.
FDI strategy, therefore, should be shaped around the country’s ample natural resource endowment and its considerable market potential, with threefold efforts to (i) retain investors’ confidence; (ii) target new investors; and (iii) work with existing investors, both foreign and domestic.

4.1.      Retaining Investor Confidence

Pakistan has a fully open and progressive foreign investment policy regime as good as that of any developing country, and an incentive structure more generous than most. It also compares well on the ease of doing business, although in recent years (2009–11), the country has slipped nine positions in the global ranking, and within the Subcontinent has dropped from first to third place.[45] A major foreign investor concern is political risk, and Pakistan is ranked among the five riskiest investment destinations (World Bank Group, 2009).
However, risk can be mitigated by investor confidence. A 2009 business perception survey by the Pakistan Overseas Investors’ Chamber of Commerce and Industry shows that more than three quarters of its 124 respondents were willing to invest in 2010/11. Similarly, a 2010 survey by the American Business Council of Pakistan showed that 71 percent of its participating firms had investment plans in the next 12 months, and that 41 percent of them planned to invest USD 250,000 or more. Nevertheless, in both surveys, investors raised similar concerns: law and order, political uncertainty, energy deficiency, the high cost of operations, and infrastructure bottlenecks. In the American survey, 79 percent were pessimistic about short-term prospects but, more importantly, 86 percent were optimistic about long-term prospects.
American investors have reason to be positive: earnings on their equity in Pakistan amounted to 33 percent in 2009. This return is better than in other countries that have received more investment (see Table 11.4). However, incomes appear to fluctuate from one year to the next in Pakistan: earnings on equity were only 7 percent in 2008. A more stable and predictable business environment would align expectations closer to the higher end of actual rates of return and attract large investment inflows as in other comparator countries.
Table 11.4: Income on US direct investment, 2009
Host country
Income/FDI (%)
Source: US Department of Commerce, Bureau of Economic Analysis, Survey of Current Business Online, US Direct Investment Abroad Tables (September 2011), table 14.
It is important, therefore, to solicit the industry perspective in any discussion of measures to move the economy from the short to the long term. Some business groups, such as the Pakistan Business Council, have position papers on fostering economic growth. The channels for public-private dialogue should be utilized fully to engage business involvement and support for future policies, thereby sustaining investor confidence.

4.2.      Targeting New Investors

Pakistan has been successful in diversifying its sources of FDI and attracting investment from developing countries. The most recent data suggests that their share has increased further,[46] indicative perhaps of continuing growth in Asia and also of the greater affinity that Asian investors may have with the country’s investment environment. Efforts to target FDI toward the textiles industry have attracted FDI from the UAE, and the government is also seeking investors from China and other countries with the Special Economic Zones Act 2012. The Haier Group of China has made an initial investment of USD 35 million (in a joint venture with the Ruba General Trading Company) to manufacture household appliances, including for export, in a 63-acre zone in Lahore that will enclose a plant and workers’ colony.
Such proactive FDI promotion efforts are desirable, though it should be noted that Pakistan already has some 82 industrial zones and the majority perform below capacity (Asian Development Bank, 2001). Additionally, incentive schemes should be time-bound and not too generous. A revival of privatization would ignite huge investor interest.

4.3.      Working with Existing Investors

FDI involves long-term commitment to a host location, ideally to expand output, upgrade production, and increase market presence, which frequently justifies reinvesting short-term profits for longer-term gains. When opportunities sour or become uncertain, a greater portion of profits and dividends are repatriated to the parent company, and sometimes investors—“voting with their feet”—disinvest and relocate.
Sizeable investments, such as those in telecommunications in 2004–08, generate commensurate profits that can be retained and reinvested or repatriated. The good news is that companies are making profits;[47] the bad news is that these profits are being repatriated rather than reinvested. Repatriations out of Pakistan have increased in recent years (see Figure 11.5); in 2011/12 (FY2012), foreign investors repatriated USD 1.1 billion in profits and dividends. In some industries, such as textiles, firms are in the process of relocating to Bangladesh (attracted by the prospect of access to continuous, uninterrupted power supply and other promised benefits). In such circumstances, it is important for the government to work with existing investors (foreign and domestic) to encourage and facilitate greater reinvestments.
Figure 11.5: Repatriation of profits and dividends
Source: State Bank of Pakistan. Data given for fiscal years (e.g., FY2012 = July 2011–June 2012).
The experience of other countries should be emulated, particularly policies and programs to support the creation of local supply chains and linkages with domestic firms; R&D projects with universities, science institutes, and technology centers; and the development of export markets. There are many examples, including in Pakistan, of public-private partnerships for building infrastructure and industrial clusters, giving effect to corporate social responsibility—for training workers and disseminating technical advice to farmers—as well as support services and finance for small and medium enterprises.
Pakistan’s private sector has responded generously in helping earthquake and flood victims, and would likely join “win-win” partnerships to accelerate economic growth and deepen industrialization. Their current healthy profits provide the basis, and the prospect of future profits the incentive, to do so. The country’s public institutions should intensify its efforts to work with the private sector to enlarge opportunities and overcome business bottlenecks in the current difficult environment.

5.        Conclusion

FDI can contribute significantly to moving Pakistan’s economy forward. The country’s FDI strategy and policies correctly emphasize the importance of a modern investment framework and regulatory regime, and a conducive, business-friendly environment. There is also a case for special economic zones and time-bound fiscal incentives. However, these efforts must be pursued within a resolute attack on the basic malaise gripping the economy—the energy crisis, the security situation, and the immobilized privatization program. Hopefully, one outcome of the 2013 election will be a renewed willingness on the part of the country’s key institutions to work in unison.
At the same time, there is a longer-term challenge. Although capital inflows can alleviate the external resource constraint and bolster the balance of payments, the real benefits of FDI are longer-term, involving second-order economic impacts that improve the technological base, diversify the export structure, and place production on a more dynamic growth path. These positive spillovers gestate slowly but can be nurtured by a supportive public policy.
Successful examples abound in other countries. Yet, Pakistan has been slow to devise such ‘second-generation’ FDI promotion policies that capture the synergy between investment and trade, and production and technology. Malaysia and other Asian ‘tigers’ have been able to deploy such policies to attract FDI and extract from it substantial technological and other economic benefits. Pakistan’s failure to do so has handicapped its industrial development.
Pakistan must, therefore, arrest the dramatic decline in FDI inflows of recent years, but also seek to benefit from future inflows with greater drive and ingenuity. Other countries are doing so with success and there is every reason to think that it can do the same in a relatively short span within the current decade.

* The author was director of the Investment Division at the United Nations. He is grateful to Faizullah Khilji and Rashid Amjad for comments on an earlier draft of this chapter.
[1] See, for example, A. H. Khan (1997). Even advocates of market-led growth, such as Papanek (1991), have neglected the role of FDI.
[2] The top ten Asian recipients of FDI were China, Hong Kong, Singapore, India, Thailand, Malaysia, Taiwan, Indonesia, Vietnam, and Pakistan (see United Nations Conference on Trade and Development [UNCTAD], 2008, p. 48).
[3] The import substitution experience has been widely debated; for a thoughtful review, see Noman (1991).
[4] These restrictions were relaxed in 1976 and removed in 1997.
[5] There are, today, more than 2,800 such treaties among 181 countries (see UNCTAD, 2012, p. 84).
[6] The International Monetary Fund (2002) attributes the strong economic growth performance in the 1960s to factor accumulation rather than TFP; physical capital stock (which embodied technology) expanded at an annual average rate of 13.1 percent in 1961–71.
[7] Mahbub ul Haq, chief economist of the Planning Commission, noted in April 1968 that Pakistan’s industry was owned largely by just 22 families. Equally, it could also have been noted that agriculture was concentrated among relatively few landowning families. Ownership of large farms (of more than 15 hectares of land) is concentrated among 1 percent of all households (see Anwar, Qureshi, & Ali, 2004).
[8] Subsidized credit and inputs were also provided in agriculture (see M. H. Khan, 1983, table 6).
[9] Industry was also nationalized in India (banking, coal, and petroleum) and Sri Lanka (mining, petroleum, and plantations) during this period.
[10] The largest 31 manufacturing firms (in cement, engineering, electrical goods, iron and steel, metals, motor vehicles, petrochemicals, and utilities) and 13 insurance companies were nationalized in 1972. Others included the emerald mines in Swat in 1972; the vegetable ghee industry in 1973; banking, shipping, cotton ginning, and some 2,000 units in rice-husking and flour-milling in 1974; and some 3,000 private colleges and schools in 1972 (see Junejo, 1996, chap. 16, pp. 79–80).
[11] The original owners reopened operations in Pakistan in 1989 through branches of their bank in Switzerland. The irony of the Habib family operating as a multinational in their own country was commemorated with a five-rupee postage stamp issued by the Pakistan Post Office in March 2001 displaying the logo and headquarters of the Swiss multinational, Habib Bank AG Zurich.
[12] The experience of India is similar (see Srinivasan, 2002).
[13] Remittance inflows began in 1976 and averaged USD 1.8 billion per year during 1976–2002; in the 1980s, remittances amounted to 11 percent of private consumption and 8 percent of GDP (see Siddiqui & Kemal, 2006).
[14] The facility is also a key component of Pakistan’s military-industrial complex.
[15] The Fauji Foundation, a military welfare trust, owns or controls 19 commercial and industrial enterprises in such industries as oil and gas, power, fertilizer, cement, cereals, sugar, and financial services. The enterprises are limited companies listed on stock exchanges, and the general public may also buy and sell shares; however, their chief executive is always a government nominee.
[16] The Askari Group, an army welfare trust, runs 17 business enterprises in agriculture, aviation, banking, cement, insurance, petroleum, and real estate, among others.
[17] “Almost PRs 100 billion a year were spent out of the budget annually on plugging the losses of these corporations, banks and other enterprises,” says Husain (2005).
[18] HUBCO, a limited-liability company privately financed with 13,000 shareholders, was developed during 1985–95 with technical support from the World Bank, loans from 43 offshore banks, guarantees from France, Italy, Japan, the UK, and the US, and equity participation by Saudi Arabia and the UK.
[19] The amount of circular debt reached PRs 382.5 billion or USD 4 billion in July 2012 (see State Bank of Pakistan, 2013, chap. 1, Box 1.1).
[20] For a study on the improved performance of privatized banks, see Khan and Kamal (2006).
[21] Some USD 800 million is pending in the resolution of legal and property issues.
[22] The only year in which FDI and remittances were close to par was 1996: FDI was USD 1,102 million and remittances were USD 1,284 million. In all other years, remittances have been several times larger.
[23] For additional background, see Hamdani (2011).
[24] In addition to Kemal et al. (2002), see H. A. Pasha, Pasha, and Hyder (2002); International Monetary Fund (2002); Sabir and Ahmed (2003); Mahmood and Siddiqui (2000); and S. U. Khan (2006), among others.
[25] Kemal et al. (2002) also control for other factor inputs, namely labor which grew at 0.9 percent during 1965–2000.
[26] United Nations Industrial Development Organization [UNIDO] (2009, Annex II). The technology classification is rough: some segments in each category may involve more (or less) sophisticated skills and complex production. The same classification underpins Table 11.3.
[27] For other studies showing how FDI has had a positive impact on growth, see Shabbir and Mahmood (1992); Atique, Ahmad, and Azhar (2004); Mohey-ud-din (2007); and Rahman and Salahuddin (2010).
[28] For a discussion on trade policy, see Hasan (2008).
[29] The USD 1.8 billion purchase order was made in 2002, the aircraft were delivered over 2004–08, and the manufacturing facility for spare parts was operational by 2006.
[30] Rehman and Wizarat (2010) find that there is significant potential for learning-by-doing in Pakistan’s large-scale manufacturing sector.
[31] There is an extensive literature on technological learning: see, for instance, Lall (1997); UNCTAD (1996); Lall and Urata (2003); and UNIDO (2005).
[32] Even in 1995/96, when FDI surged in the power industry, its share in total investment was only 14 percent.
[33] In a ranking of 186 countries, Pakistan is at 146 on the human development index, with a score below the average for South Asia (see United Nations Development Programme, 2013).
[34] In 1995, Pakistan ranked below India, Bangladesh, Nepal, and Sri Lanka (see Lall & Urata, 2003, Table 2.7).
[35] The food and transport equipment industries have had some positive spillovers, as previously mentioned, but there are few backward linkages in the chemical and pharmaceutical industries.
[36] The findings of Weiss and Lall (2004) are similar.
[37] Waglé (2011) finds that Pakistan’s trade-to-GDP ratio is half its “predicted” ratio of 62 percent when trade shares are estimated in a linear cross-country regression using 2010/11 data for 159 countries and controlling for income, market size, and distance from world markets.
[38] In the budget speech for the fiscal year 2010/11, the government committed to restructuring public enterprises to make them financially solvent. The eight major public sector enterprises (railways, airlines, highways, trading, storage, utilities, power, and steel) incurred an annual loss of USD 2.8 billion in 2009/10.
[39] The Planning Commission recently issued a constructive framework for growth (see Pakistan, Planning Commission, 2011a, 2011b).
[40] During 1991–2008, 167 enterprises were privatized but the process was set back in 2006 when the Supreme Court, citing irregularities, annulled the divestment of Pakistan Steel Mills.
[41] See, for example, Mahmood and Siddiqui (2000); Burki and Khan (2005); Mahmood, Ghani, and Din (2006); Din, Ghani, and Mahmood (2007); Kemal (2007); Raheman et al. (2008); and others.
[42] The Rahman et al. (2005) report was commissioned by the Higher Education Commission, COMSTECH, and the Pakistan Institute of Development Economics, in consultation with experts and the private sector.
[43] The Investment Policy 2013, prepared by the Board of Investment, was approved by the federal Cabinet on 13 March 2013. It aims to increase annual FDI inflows by 40 percent in 2013 to USD 2 billion, and then onward and upward to USD 2.5 billion in 2014, USD 2.7 billion in 2015, USD 3.25 billion in 2016, and USD 4 billion in 2017.
[44] A feature of the current global crisis is the increased market-seeking activity of multinationals in emerging economies (so as to sustain revenue growth through worldwide sales). Examples in Pakistan include the expansion of Coca-Cola (through its affiliate in Turkey), Yamaha motorcycle assembly, Metro Cash & Carry (Germany), and similar greenfield investments from Saudi Arabia and the UAE in retail and wholesale trade, hotels, and shopping complexes.
[45] Pakistan scores low on starting a business, acquiring electricity, and paying taxes (see World Bank Group, 2011).
[46] The share of developing countries in the stock of FDI increased from 33 percent in 2008 to 46 percent in 2009, while that of developed countries declined from 65 percent to 53 percent. The changes also reflect reinvestment.
[47] As noted by Rashid Amjad in Chapter 3 of this volume, companies appear to be doing well with increasing retail sales of consumer goods and food products, and corporate profits growing some 15 percent annually in recent years. For earlier years, Lorie and Iqbal (2005) note that the increase in the after-tax profits of the 700 companies listed on the Karachi Stock Exchange in 2001–03 amounted to more than 1 percent of GDP. 

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