Foreign direct investment (FDI) in Pakistan has historically remained uneventful with brief periods of significant inflows attributed to agenda-driven aid through the United States. The post-Musharraf era has seen a shift of politico-economic alliances from the US to China, in the form of the $62 billion OBOR-CPEC initiative, which opened the ‘floodgates’ for Chinese FDI. Apart from the Chinese investments, Pakistan relies on soft power utility through close allies such as Saudi Arabia, who at one point announced its willingness to invest $12 billion in Pakistan. However, such promises are subject to political motivation. Only recently, South Korea and Japan have shown an interest in investing in Pakistan.

Recently, Pakistan has focused on attracting FDI through privatisation and tax incentives. The IMF too has dictated several reforms to improve the ease of doing business in the country. The deregulation of the rupee has made Pakistani goods, raw material and labour affordable for many multi-national firms. However, the human capital in the country is severely depressed and most of the work force is unskilled and informal. Such policy measures can therefore not be relied upon to ensure economic growth.

Stimulated by the CPEC initiative, Pakistan has tried several policy innovations that aim at increasing the FDI attractiveness through the creation of Special Economic Zones (SEZs) that offer tax subsidies to investors. The copy-paste policy has failed to produce the desired effect as it was not adapted to the Pakistani environment. The establishment of these industrial and sectoral zones has been dictated by political agendas.

The state falls short on setting conditional incentives, such as exemptions and subsidies on taxes.

Stimulated by the CPEC initiative, Pakistan has tried several policy innovations that aim at increasing the FDI attractiveness through the creation of Special Economic Zones (SEZs) that offer tax subsidies to investors.

In order for the SEZs to fulfill their potential, they must be located in localities that create strong internal and external linkages across sectors. The ongoing technology transfer mechanism, a key feature of SEZs, is insufficient for meaningful growth. The state must foster an environment that generates a knowledge spillover effect. Currently, this is severely dampened because of a persistent dearth of vertical and horizontal linkages among firms, low workforce mobility, and missing research and development (R&D) support. The productivity and market access spillover are also limited as foreign companies rarely interact or collaborate with local firms, which basically defeats the point of creating SEZs.

The TEVTA alone cannot drive up the country’s labour capital. It only de-localises low value addition in the market. Meaningful economic contribution is driven by high value addition. In addition, Pakistan is not integrated into the global value chains the way it should be for effective growth. This leads to the production of low-value raw materials or semi-finished goods, which is the polar opposite of what is required for meaningful economic contributions i.e. competitive, high value (technologically advanced and innovative) finished goods.

Pakistan mostly favours indirect government involvement in FDI by promoting market imperfections with an undervalued currency, incoherent regulatory environment and absent antitrust laws. The country offers cost reducing policies, via tax breaks that promote opportunistic behaviour by business entities. Firms make minimal investments and shift to other regions when better cost effectiveness is offered. Investment thus remains limited to the short term.

Such policies cannot bring about longevity of investments. A truly long-term economically beneficial FDI policy would favour joint ventures and strategic partnerships (with a focus on R&D investment, labour mobility and skill development). This may require that the government invest in local firms for capacity building. Foreign investors may be enticed through generous tax breaks linked to R&D spending. Such a combination forms a positive feedback loop that will stimulate innovation and value addition among the local industry and help it become more competitive in the global market.

The writer is a master’s student in business and public policy at the Suleman Dawood School of Business at LUMS with a special interest in policy design and analysis. He has a background of working in the development and technology sectors of Pakistan.