THE IMPACTS OF FOREIGN DIRECT INVESTMENT ON THE …

1 Capacity Building Project for Policy Research to Implement Vietnam s Socio-Economic Development Strategy in the period 2001-2010 RESEARCH REPORT THE IMPACTS OF FOREIGN DIRECT INVESTMENT ON THE ECONOMIC GROWTH IN VIETNAM Research Team: Nguyen Thi Tue Anh Vu Xuan Nguyet Hong Tran Toan Thang Nguyen Manh Hai HANOI, 2006 EFFECT OF FDI ON ECONOMIC GROWTH IN VIETNAM i TABLE OF CONTENTS INTRODUCTION .. 1 CHAPTER 1: FOREIGN DIRECT INVESTMENT IN VIETNAM SINCE 1988 .. 5 I. FOREIGN DIRECT INVESTMENT IN VIETNAM AND THE ROLE OF FOREIGN -INVESTED SECTOR IN THE ECONOMY .. 5 Overview of FDI inflows in Vietnam from 1988 to 2003 .. 5 Periods of development .. 5 Some characteristics of FDI in 8 The role of FDI in Vietnam s 10 The role of FDI in national INVESTMENT and economic 10 The role of FDI in strengthening industrial production and export capacity.

2 11 The role of FDI in employment and human resources .. 12 The role of FDI in State budget revenues and macroeconomic stabilisation .. 13 II. OVERVIEW OF POLICY TO ATTRACT FDI 13 Policy framework of FDI 13 Changes in Vietnam s awareness and view point on FDI .. 17 Comparing current FDI policies in Vietnam and some countries .. 18 Vietnam s international commitment on FOREIGN INVESTMENT .. 22 CHAPTER 2: ANALYTICAL FRAMEWORK .. 24 I. THEORETICAL BACKGROUND OF EFFECTS OF FDI ON ECONOMIC GROWTH .. 24 Effects of FDI .. 24 Theoretical framework of impact of FDI on growth through INVESTMENT .. 25 Theoretical framework to assess the spillover effects of FDI .. 29 Mechanism of 29 Models for estimation .. 32 II. LITERATURE REVIEWS ON EFFECTS OF FDI ON ECONOMIC GROWTH .. 36 CHAPTER 3: THE EFFECT OF FDI ON GROWTH VIA INVESTMENT CHANNEL.

3 39 I. MODELLING THE EFFECT .. 39 II. DATA .. 39 III. ESTIMATION RESULTS .. 40 CHAPTER 4: SPILLOVER EFFECTS OF FOREIGN DIRECT INVESTMENT .. 46 I. SOME QUALITATIVE ANALYSES .. 46 Some general information on the survey 46 Labour, INVESTMENT , and business 47 Identifying the existence of spillover 50 II. QUANTITATIVE ANALYSIS OF SPILLOVER 57 57 2. 2. FDI and labour productivity of 58 The model .. 58 Estimation results .. 60 Spillover effects of FDI on labour productivity of domestic firms .. 66 EFFECT OF FDI ON ECONOMIC GROWTH IN VIETNAM ii The model .. 66 Results and discussion .. 69 CHAPTER 5: CONCLUSIONS AND POLICY RECOMMENDATIONS .. 81 Conclusions .. 81 Policy implications .. 86 APPENDIX: LIST OF VARIABLES USED IN THE ESTIMATIONS .. 91 REFERENCE .. 92 LIST OF CHARTS Chart 1: FOREIGN DIRECT INVESTMENT in the period 1988 - 2004.

4 5 Chart 2: FDI inflows to Vietnam and China versus FDI inflows to South, East and South East Asia .. 7 Chart 3: FDI by sector in 2004 .. 9 Chart 4: Shares of implemented FDI in gross national INVESTMENT .. 11 Chart 5: Capital account balance and FDI inflows to Vietnam, 13 Chart 6: Average Revenues per labour of the Firms .. 49 LIST OF TABLES Table 1: Key changes in FDI policies in each revised Law on FOREIGN INVESTMENT in 14 Table 2: Comparing key FDI policies in Vietnam and some regional and transition countries 19 Table 3: Estimation results of effect of FDI on growth from 1988 to 42 Table 4: FDI on Gross National INVESTMENT and productivity of 45 Table 5: The number of surveyed enterprises .. 47 Table 6: Labour size of Table 7: The capital/labour ratios of enterprises .. 48 Table 8: The proportion of labour movements relative to average labour in 3 51 Table 9: Sources of labours for domestic 51 Table 10: Share of skilled labour in enterprises.

5 53 Table 11: Ratio of R&D expenditure relative to revenues .. 53 Table 12: Sources of inputs to FDI enterprises .. 54 Table 13: Composition of sales of FDI enterprises .. 55 Table 14: Judgment on competition pressure .. 56 Table 15: Basic information on FDI in manufacturing 57 Table 16: Estimation results of model on effect of FDI on labour productivity of all 63 Table 17: Estimation results of FDI impact on labour productivity of domestic enterprises, using the variable 74 Table 18: Estimation results of model on the effect of FDI on labour productivity of domestic enterprises, using the variables sharemajor and 75 Table 19: Estimation results of spillover effects via absorptive 80 LIST OF BOXES Box 1: Competition effect of FDI on domestic 32 EFFECT OF FDI ON ECONOMIC GROWTH IN VIETNAM iii LIST OF ABBREVIATION APEC Asia Pacific Economic Cooperation forum ASEAN Association of South East Asian Nations ASEM Asia Europe Meeting CIEM Central Institute for Economic Management EU European Union FDI FOREIGN DIRECT INVESTMENT GDP Gross Domestic Products GSO General Statistics Office JETRO Japan External Trade Organization MFN Most Favored Nation MPI Ministry of Planning and INVESTMENT R&D Research and Development SMEs Small and Medium Enterprises SOEs State-Owned Enterprises TSLS Two Stage Least Squares UNCTAD United Nations Conference on Trade and Development UNDP United Nations Development

6 Programme USD US dollar WTO World Trade Organization THE IMPACTS OF FDI ON ECONOMIC GROWTH IN VIETNAM 1 INTRODUCTION In nearly 20 years of Doi Moi, Vietnam has made a number of convincing socio-economic achievements. Average annual economic growth was percent, and GDP per capita rose by percent over the period 1990-2004. Meanwhile, poverty rate fell from roughly 80 percent in 1986 to around 29 percent in 2002. For the past decade, Vietnam has always been among the rapidly growing economies, with sharp poverty reduction, in the world. Those promising achievements of the economic transition resulted from the reform policies that Vietnam has been undertaking in the context of rapid globalisation process. Since the late 1980s, Vietnam has advocated economic integration, beginning with the promulgation of the Law on FOREIGN INVESTMENT in 1987, and the signings of number of bilateral and multilateral trade agreements.

7 Vietnam joined the ASEAN, APEC, and Asia-Europe Meeting (ASEM) in 1995, 1998 and 2001, respectively. The most recent and important agreement is the Vietnam-US Bilateral Trade Agreement. Currently Vietnam is negotiating in preparation for WTO accession. In addition to more open trade policy, Vietnam has robustly improved the INVESTMENT environment, particularly legal framework, to attract FOREIGN DIRECT INVESTMENT (FDI). It has signed bilateral agreements on INVESTMENT promotion and protection, which are more relaxing than current regulations as stipulated in the Law on FOREIGN INVESTMENT , with 45 countries and territories. Efforts by the Government to attract FDI inflows have produced encouraging results. By December 12, 2004, Vietnam has attracted 6,072 projects with the total registered capital of approximately billion.

8 The FOREIGN -invested sector has been recognized as an official part of the economy with increasing contribution to GDP, which was estimated to be roughly 14 percent in 2004. Besides, this sector also creates more employment, increases export turnover, helps to shift domestic economic structure, and raises revenue to the State Budget. There, however, have been many comments that Vietnam has yet to entirely take advantages to attract more FDI inflow as well as to maximize its benefits. Such claim is made on the basis of fluctuating movements of FDI inflows, the modest proportion of THE IMPACTS OF FDI ON ECONOMIC GROWTH IN VIETNAM 2 implemented FDI relative to registered FDI, the concentration of FDI in some industries and regions etc.

9 Most FDI projects are small in scale, with moderate technology which originates mainly from Asia. In particular, Vietnam has yet to be a destination for INVESTMENT by most multinational corporations with high technology and transfer of knowledge. This situation, together with increasing competition from China and other regional countries in attracting FDI inflows, are posing big challenges to Vietnam. FDI may affect all economic, cultural and social aspects of the economy. However, for the developing countries, particular those poor countries, the key expectation of FDI is that it will facilitate economic growth. This anticipation is, according to economists and policy makers, due to three reasons. Firstly, FDI inflows help to increase the surplus of capital account, improving balance of payment and macroeconomic stability of the country.

10 Secondly, the poor countries usually have low rates of capital accumulation and thus, FDI is regarded as a vital supplementary source of capital to support domestic INVESTMENT , to achieve economic growth. Thirdly, FDI provides the poor countries with better access to modern technology, easier technology transfer, promotion of knowledge diffusion, improving managerial and labor skills, etc. The phenomenon, usually referred to as spillover effect of FDI, which contribute to the increase in labor productivity of domestic enterprises and ultimately to economic growth. In fact, not all countries succeed in fulfilling these three expectations simultaneously. Some countries have attracted substantial FDI inflows, but the spillover effects are almost non-existent.