Analyzing the Relationship Between FDI, Trade Openness and Real Output Growth: An ECM Application for Pakistan

The standard economic theory points to a direct and positive link between growth variables, FDI and openness indicators, that can affect each other. It is argued that capital inflows in the form of FDI flows can be induced by host country’s economic growth, if the host country offers a large consumer market. Furthermore, it creates economies of scale and causes great reduction in cost of production. Similarly, openness to trade has also been considered as an important determinant of economic growth and welfare. Both the issues are well debated in the recent growth literature. Initially, the developing nations of the world followed restrictive trade policies but with the passage of time and emergence of globalization, all the nations realized the need to liberalize to their economies in terms of trade openness and enhancing FDI. The present study has applied an econometric technique of Error Correction Methods (ECM) for finding the relation between economic growth indicator, FDI, and trade openness. For this purpose study utilized annual data set ranging from 1975 to 2011and time series properties of data are explored prior to estimation by applying Augmented Dicky Fuller (ADF) of testing unit root. The findings suggested that FDI and trade promote growth of real sector of economy of Pakistan.