Examining the impact of international trade on pakistan’s economic growth : a vector error correction model (VECM) analysis

Abstract

The study examines the dynamic and long-term impact of international trade on Pakistan’s economic growth from 1985 to 2023, using a time-series econometric approach. Based on macroeconomic theory, the study uses specific methods to see how trade openness, foreign direct investment (FDI), and inflation affect GDP over time. Annual data for GDP growth, trade (as a percentage of GDP), FDI inflows, and inflation were collected from the World Bank Indicators. The Augmented Dickey-Fuller (ADF) test confirmed that the data is stable, and the Johansen cointegration method revealed four important long-term relationships between the variables. While the long-run results indicate that trade has a negligible effect on GDP, foreign direct investment (FDI) shows a slightly positive impact, and inflation appears to have a weak positive correlation; however, none of these effects are statistically significant at the 5% level. However, short-run dynamics reveal a meaningful adjustment mechanism, with GDP professing a strong tendency to turn back to its long-term path following short-term fluctuations. Descriptive statistics affirm high volatility in FDI, moderate trade activity, and relatively stable inflation trends. Diagnostic tests, including stability, serial correlation, and heteroscedasticity, confirm the robustness of the findings. The findings offer empirical insights into the trade-growth nexus in Pakistan, which points to the importance of policy reforms focused on export diversification, quality investment attraction, ensuring inflation control, and implementing institutional reforms. These insights are particularly relevant for researchers, economists, and policymakers working on macroeconomic planning within emerging economies.