It often happens that certain words get beaten into clichés and their true significance fades into a linguistic haze of sorts. When this happens, it is important to hit refresh and take a renewed look at things. This in my view is what has happened to the acronym FDI (Foreign Direct Investment), which has taken on an identity of its own somewhere between a political slogan and a technical term thrown around at social gatherings.
Let us begin by emphasizing that FDI, over the decades, has now become the most critical source of external funding for developing markets; and most critical means it has become even more important than traditional tools such as development assistance extended by multilaterals and development finance institutions. For instance, in 2016, FDI to developing countries globally stood at circa USD 700 billion, nearly 40% of global USD 1.75 trillion FDI. It is also worth emphasizing in the same breath that this still remains a fairly low number, given the economic work that needs to happen in the developing world, and if Sustainable Development Goals (SDGs) are to be realistically met.
It is in understanding the potential of FDI to meet SDGs that one starts to appreciate its true significance. FDI is therefore not just foreign capital coming into the country, it is the means to truly transforming the very foundations of an economy.
FDI can be a way of transferring technology and technical know-how to an economy. It can, equally importantly, be a way to introduce global best practices in terms of managerial and operational expertise. Both of these are important because both would lead to gains in productivity, which cannot be emphasized enough. Let me pause here and quote the Nobel Laureate Paul Krugman, "Productivity isn't everything, but in the long run it is almost everything. A country's ability to improve its standard of living over time depends entirely on its ability to raise output per worker." It is sad to acknowledge that labor productivity hasn't really improved by much in Pakistan. Our labor productivity (GDP divided by employed labor force) has been growing at about 1 percent, down from nearly 4% in the 1980s.
More explicitly, there are two main mechanisms through which FDI's impact on productivity can be immense. Firstly, by developing linkages between foreign companies and their local counterparts, international best practice and new technologies can be directly introduced to the local market. Equally importantly perhaps, in cases where these firms source materials from local suppliers, higher standards and quality expectations can uplift the standards for the entire market, benefitting both the end consumers and the businesses. The second way is through what is often called the demonstration effect, whereby local partners benefit just by virtue of witnessing how an international investor or MNC (multinational company) operates. For instance when workforce that has worked with MNCs moves into local firms, data shows improvement in productivity of those local firms.
This brings us to another point. FDI itself is not one monolith. There are different kinds of FDI, and one could broadly put them into two categories. The first kind is the FDI that seeks to serve large domestic markets. This is the kind of investment in sectors that are generally directly retail oriented, and investors essentially move into a location (country) because they see a sufficiently large unserved or underserved market. Such investment is often in sectors like Food & Beverage, Financial Services, Entertainment, Tourism & Hospitality, Trade & Retail, Education, Health, Telecommunications and so on. These are all essentially consumer facing industries that would directly benefit from a large market.
Pakistan, by virtue of its large market size, certainly offers a huge potential for this kind of FDI. We have seen recent investments of this kind, that Punjab Board of Investments and Trade (PBIT) has been instrumental in facilitating such as for instance by Hayat Kimya (USD 150 million, a Turkish MNC), or in an aluminum-can manufacturing plant backed by Ashmore (USD 80 million, a leading emerging markets focused asset manager).
The second kind of FDI is what is technically called efficiency-seeking FDI, and this may include sectors like IT, machinery and equipment, automotive, electronics, bio-tech, pharma etc. This is the kind of FDI that has the potential to fundamentally change the development trajectory of our economy. In an age dominated by global value chains, where markets compete to consistently go up the ladder and capture more value within their own economies, this is the kind of FDI that would help us climb up. PBIT tries as much as it can to focus on these sectors and recent success in attracting Renault to Punjab's SEZ in Faisalabad is a testament to that; with investments by large auto players in the country, this would spur the development of all related industries in the auto-industry such as spare parts, service centers etc.
With this quick backdrop, it is time to highlight that consistently attracting FDI into a country requires conscious policy decisions - let me clarify here, toughdecision. The story also does not end with the design of right policies because those policies need the appropriate operational mechanism to be implemented efficiently and effectively.
With global competition and race to economic development in a world that is increasingly becoming uncertain in terms of a global economic outlook, given the trade barriers and trade wars that seem imminent, attracting FDI might be an uphill battle. I would return in my next piece to the policy interventions we must make to prepare for the next five years. For now, let us find solace in the fact that Pakistan has all the right fundamentals for becoming an economic power-house, and we are on a growth path.
The writer is CEO at the Punjab Board of Investment & Trade