Exchange Rate, Market Size and Human Capital Nexus Foreign Direct Investment – A Bound Testing Approach for Pakistan

This study investigates the role of exchange rate, market size and human capital for attracting foreign direct investment (FDI). In this regard, time series data on annual basis has been collected for the period 1985–2010 and an Augmented Dickey–Fuller (ADF) and Phillips–Perron (PP) unit root tests are utilized to determine the stationarity of the variables. An autoregressive distributed lag (ARDL) bounds testing approach to co-integration was applied as all the variables in the model are first level stationary,e.g. I(1). The empirical findings of this study confirm the long run relationship among the variables. However, market size and human capital have strong positive and significant impact – in short- and long-run – for attracting FDI but exchange rate shows negative impact in this regard. The coefficient ECM is negative and significant, which means that it converges towards equilibrium. CUSUM and CUSUMSQ tests were utilized to test the model’s stability and the plots of each test did not cross the lines of critical value, which indicates the stability of the estimated parameters and this model can be used by Pakistan in policy and decision making. For achieving higher economic growth and economies of scale, the country should concentrate on the ingredients of this study so that it could attract more FDI as compared to the other countries.