FDI-Growth Nexus: Role of Absorptive Capacity in Pakistan
Author: Salman Ahmad

This study is an attempt to revisit the relationship of foreign direct investment and economic growth of Pakistan by investigating the role of absorptive capacity of the host country. This study also provides an analysis on the impacts of FDI on economic growth of Pakistan with formal empirical evidence by including all major determinants of absorptive capacity. Absorptive capacity of Pakistan describes as the ability of absorbing, adjusting and transforming new knowledge into innovation and to utilize financial inflows at optimum level in effective way. The absorptive capacity index is developed by using Principal Component Analysis (PCA) by using financial development, human capital, trade openness and infrastructure development as the major determinants while political stability is also an important determinant of absorptive capacity because it ensures the consistent healthy environment for the business. This study is conducted on the time series data from 1970 to 2017 by using the ARDL bound testing approach (2001) to test the long run relationship among economic growth and explanatory variables. Empirical results show the significant impacts of explanatory variables on the growth of Pakistan and the results become more significant by including the absorptive capacity. Interactive term describes the mutual impact of FDI with absorptive capacity on the economic growth of Pakistan which implies that threshold level of absorptive capacity facilitate FDI to generate more positive significant impact on the economy. The findings verify main hypothesis of this study and also justify the purpose of study which is according to the economic theories and findings on the role and dynamic significant impacts of FDI on economic growth of developing host country. This study concludes that the absorptive capacity of Pakistan determines the maximum spill over impacts of FDI, so it is important to develop the absorptive capacity at high level to attract and get the maximum benefits from FDI. The enhancement of absorptive capacity means that the key sectors of economy are developing at threshold level which contribute in the development of many other sectors and it all contribute to the growth of economy. Pakistan is a hot cake for the foreign investors due to its geography and abundant natural resources but the development process is less as compare to other nations because of the absorptive capacity. Supervisor:- Dr. Abdul Jalil

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Keywords : Absorptive Capacity, ARDL Bound Testing., FDI, Principal Component Analysis
Supervisor: Abdul Jalil

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