Faculty of Economics
Master thesis
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ACKNOWLEDGEMENTS
First of all, I would like to extend my special thanks to my Supervisor, Dr. Ger J.
Lanjouw, whose tireless effort and insightful comments from start to the end of the project encouraged me to be enthusiastic in my work, guided me to analyze and develop the topic I had initially chosen with very little knowledge, but, indeed, with so much passion. My sincere thanks also go to my Research Methodology Supervisor, Dr. H. W.
A. Dietzenbacher for his instructions and suggestions that helped me to build up the econometric model and especially in finalize the data panel, which is always a very tough task when doing research about Vietnam; and many other lecturers who have given me the necessary knowledge to complete this work.
I am also grateful to my Master course in International Economics and Business at The University of Groningen, which not only provided me a strong international profile in economics and business, but also helped me to open my point of view and bring me the confidence to enter the labor market.
Finally, I would like to dedicate my work to parents, my brother and the whole family for their love, encouragement and always being there for me; and also my friends in Groningen and back home for tremendous support during my course of study.
“Don’t worry about not being acknowledged by others;
worry about failing to acknowledge them.”
(Adapted from Confucius, Analects 1:16) Groningen, 01/2007
TABLE OF CONTENTS
ACKNOWLEDGEMENTS --- 2
TABLE OF CONTENTS --- 3
List of figures --- 4
List of tables--- 5
ABSTRACT--- 6
CHAPTER I: INTRODUCTION --- 7
1.1. Background and context of the research--- 7
1.2. Aims and Objectives of the research--- 8
1.3. Structure of the research --- 9
CHAPTER II: FOREIGN DIRECT INVESTMENT IN VIETNAM – AN OVERVIEW ---10
2.1. Vietnamese economic reform ---10
2.1.1. International Trade ---10
2.1.2. From State to Market---11
2.2. Overview of Vietnam’s FDI---13
2.2.2. An overview of FDI in Vietnam---15
2.2.3. Vietnam’s policy to attract FDI ---23
CHAPTER III: LITERATURE REVIEW---26
3.1. Theory of FDI ---26
3.2. Determinants of regional distribution of FDI---27
3.2.1. Theoretical Background ---27
3.2.2. Recent Empirical Studies---28
CHAPTER IV: DATA AND METHODOLOGY---35
4.1. Data description ---35
4.2. Methodology---36
CHAPTER V: RESULTS AND DISCUSSION---39
5.1. Descriptive Statistics ---39
5.2. Empirical Analysis---40
5.2.1. Regression Results---40
5.2.2. Discussions ---42
CHAPTER VI: CONCLUSION ---45
BIBLIOGRAPHY---46
List of figures
Figure 01: Key Performance Indicators after Equitization………... 12
Figure 02: Asia & Oceania FDI inflows – Top 10 economies……….. 14
Figure 03: FDI inflows in the period of 1988-2005……….. 16
Figure 04: FDI registered and implemented Capital………. 18
Figure 05: FDI project licensed in period 1988-2005 by main counterparts……… 20
Figure 06: FDI project licensed in period 1988-2005 by regions……… 21
Figure 07: Map of Vietnam by provinces……… 22
Figure 08: FDI in Vietnam by sectors………. 23
List of tables
Table 01: FDI inflow, % share by area of destination ---13
Table 02: Type of investment, 1988-2005---19
Table 03: The possible determinants of FDI distribution in Vietnam---36
Table 04: Descriptive Statistics of Sample Variables---39
Table 05: Correlation Matrix ---40
Table 06: Regression Results---40
ABSTRACT
This study investigates the determinants of FDI inflows in Vietnam. Hypotheses utilizing static trade-off and pecking order theories are empirically examined using a series FDI determinants: infrastructure, degree of industrialization, labor quality, labor cost, degree of openness, and the investment incentives for investment. The hypotheses developed are tested using a sample consisting of 64 Vietnam’s cities and provinces from 1996 to 2005.
The findings of the study suggest that infrastructure, degree of industrialization, and labor quality are important determinants of FDI. The most interesting result is the inverse U- shape relationship between labor quality and FDI consideration. However, there are no significant results are found for the relationship between FDI inflows and labor cost, degree of openness and investment incentives.
CHAPTER I: INTRODUCTION
1.1. Background and context of the research
Nowadays, along with the swift expansion of globalization, foreign direct investment (FDI) has become one of the core features of the economic growth and development process. Growth in FDI is maybe the most obvious sign of globalization in the past decade (Bjorvatn et al., 2001). The importance of FDI for development has dramatically increased in recent years. Moreover, FDI is now considered to be an instrument through which economies are being integrated into the globalizing world economy by bringing capital, technology, managerial and organizational skills, and access to foreign markets.
Currently, because of the expected favorable effects on income generation from capital inflow, advanced technology, management skills, and market know-how; all countries are vigorously seeking to attract FDI (Cho, 2002).
With its impressive growth, FDI becomes a much studied topic. Especially, the key determinants of FDI are widely analyzed and reviewed. Although there has been significant theoretical work on FDI (Hymer (1960); Caves (1982); Buckley and Casson (1976)), there is no agreed model providing the basis for empirical work. John Dunning (1979, 1981) was the first researcher who provided a framework for FDI under normal conditions. Dunning’s (1977, 1979, 1981, 1988a, 1988b, 1998) eclectic paradigm utters that firms will be engage in FDI if conditions of Ownership, Location and Internalization (OLI) advantages are fulfilled. Variables that appear to be principally important in explaining developing countries’ propensity to attract FDI contain: market size (Torrisi (1985); Samsuddin, 1994); export orientation, especially in the manufacturing sector (Singh and Jun (1995); Taylor, 2000) and relative costs (Flamm (1984); Lucas (1993);
Sader (1993)). In his study, Culem (1998) indicates that the key locational factors determining FDI are host country market size, input costs and the risk of investment, both in terms of the economic and political environment. Markusen and Maskus (1999), Lim (2001) and Moosa (2002) highlight how domestic market size and differences in factor costs can relate to the location of FDI. It is also broadly argued that FDI and openness of the economy will be positively related (Caves (1996); Singh and Jun (1995)). In another study by Le (2004), based on the OLI framework proposed by John Dunning, using data
of Vietnam’s FDI during 1988-2002, it is found that agglomeration, labor cost and openness influence FDI.
1.2. Aims and Objectives of the research
Many researches focus on FDI in developing countries but most of them are cross- country analyses1. In such studies, the relationships between social, cultural, economic, and political factors are not easy to delineate. However, the regional distribution of FDI within a country has hardly been investigated. By focusing on only one country, it is clearer to examine the determinants that attract FDI. Thus, this research concentrates only on Vietnam.
Vietnam is chosen because of several reasons. First of all, Vietnam has been considered as one of the most successful transition economies moving from a centrally planned communist economy into a market oriented economy with ‘socialist characteristics’. The country, in 1986, embarked on a path of reform, known as “DOI MOI” (“renovation”).
This comprehensive change decided to stop the centrally planned mechanism and switch to a market mechanism in order to develop a market-oriented economy in Vietnam. Since then, the Vietnam’s economy has shown an outstanding performance as one of the fastest growing economies in the region. Besides, Vietnam has officially become the 150th member of the World Trade organization in January 20072. Moreover, among factors considered as keys to success, foreign direct investment (FDI) has played a decisive role, providing the Vietnamese economy with its comparatively scarce factor, capital and representing a very crucial instrument for integration in the world economy. In fact, attracting foreign investment has been an integral part of the Vietnamese reform process since the late 1980s. Since first enforcing a relatively liberal foreign investment law in 1987, Vietnam has been very successful in attracting FDI inflows into this developing and transitional economy. Actually FDI has an important influence on the economic transition, business liberalization, and macro-economic growth process in Vietnam over the decade or so. By the end of the 1990s, foreign-invested companies cumulatively accounted for around 27 percent of the country’s (non-oil) exports, 35 percent of the country’s total industrial output, they constituted about 13 percent of Vietnam’s GDP and contributed around 25 percent of total tax revenues, although they employed less than 1
1 See Singh and Jun (1995), Nonnemberg and Mendonca (2000), Bevan and Estrin (2000)
2 http://www.iht.com/articles/ap/2006/12/12/business/EU_FIN_ECO_WTO_Vietnam.php
percent of the total workforce in Vietnam3. These strong FDI inflows present a unique opportunity for the study of its development. And among the fundamental and most interesting economic questions are the determinants of FDI across Vietnam and which of them are the most important. Another reason is FDI in Vietnam is distributed unevenly between regions. This research attempts to test differences between Vietnam’s provinces in attracting FDI.
This research, with its findings, may offer references for national and provincial governments as well as policy makers about the importance of different factors in attracting FDI. They may have insightful understanding of determinants of FDI across provinces before issuing much more suitable and reasonable policies and measures to encourage and guarantee activities related to FDI into their provinces and Vietnam as the whole country.
The study, using data of Vietnam’s FDI during 1996-2005 period, endeavors to study the determinants of FDI in Vietnam in the context of the whole country’s ongoing economic reforms. The aim of this research is to analyze variation in FDI among Vietnam’s 64 provinces from 1996 to 2005 in order to examine the important role of FDI determinants through time.
1.3. Structure of the research
The remainder of this research is organized as follows: Following the Introduction, Chapter II introduces the overview of FDI developments and trends in Vietnam. Chapter III discusses the literature review. Chapter IV describes data and empirical methodology.
The results are presented and discussed in chapter V. Chapter VI - Conclusion will sum up with the main findings, limitations and suggest direction for future research.
3 Vietnam Investment Review, 16-21 January 2001, p.9. It was estimated that the foreign invested companies employed 349,000 people in 2000, generated revenues of US$6.5 billion and contributed US$280 million in taxes.
CHAPTER II:
FOREIGN DIRECT INVESTMENT IN VIETNAM – AN OVERVIEW
2.1. Vietnamese economic reform 2.1.1. International Trade
Before Doi Moi in 1986, Vietnam’s international trade was restricted to commodity exchange programs with other former Socialist countries. High tariffs and numerous non- tariff barriers, agreements with foreign countries governed trade. Total trade was low4. In 1980s, only around 10 percent of domestic production was exported and the growth of exports was only 3.5 percent per annum in the period from 1977 to 1988 (World Bank, 1990, p. 59). In addition, prior to the introduction of Doi Moi, Vietnam was closed to foreign investors. Since the implementation of this reform in 1986, the Vietnamese economy has been increasingly open. With the aim of promoting trade, Vietnam had implemented trade liberalization, including tariff reductions and other measures designed to loosen import and export restrictions. Furthermore, Decision 46 of the Prime Minister, which became effective in May 2001, provides a roadmap for future trade liberalization.
This Decision leads to the reduction of non-tariff barriers and more transparent and predictable import and export regulations. International trade had become a gradually more important part of the economy. Vietnam's trade patterns have shifted from the former Eastern Bloc countries to Asia, Western Europe, and even the United States.
Vietnam exports crude oil, textiles, footwear, seafood, and agricultural commodities such as rice, coffee, vegetables, rubber etc., while it imports oil and gasoline, travel vehicles, fertilizers and other chemicals for agriculture, steel, plastic in primary form, and various kinds of consumer goods. In recent years, export value accounts for more than a half of GDP and import-export turnover grows by 20 percent on average per annum. Exports grew at an average annual rate of 24.7 percent for the period from 1990 to 2001. Vietnam is among the 50 largest exporting countries in the world and has been recognized as a country with a strong and vibrant foreign trade5.
4 In 1979, a number of countries imposed trade and financial embargoes on Vietnam as a result of its military intervention in Cambodia
5 Van Khai, Phan. “Putting behind the past and looking forward the future”. Foreign Affairs, 0015-7120, Sept. 1, 2005, Vol. 84, Issue 5
Imports in the period year from 1990 to 2001 grew by 92.2 percent. Their growth rate over the entire year stood at 15.4 percent. The majority of increased imports were inputs for production, such as raw material and machines and equipment, while the proportion of consumer goods declined dramatically from 15.2 percent of imports in 1995 to only 5 percent in 2001. Among imported goods, materials accounted for a large share (65.7 percent in 2001), reflecting the fact that some export industries in Vietnam were processing imported material such as textiles, footwear, and electronics, and took advantage of cheap labor and availability of land6.
2.1.2. From State to Market
Other important features that occurred during the reform period are the emergence of a private sector as well as the ownership transformation process of state-owned enterprises, which is known as equitization to establish a modern enterprise system. The first and most crucial step in perceiving changes in development strategy is the issuance of Decision 217/HDBT in November 1987, which exterminated all factors of the old planning system. Traditionally, state-owned-enterprises (SOEs) played a key role in Vietnam’s economy but after this Decision was enacted, a large number of SOEs encountered difficulties and losses. In the early 1990s, the Government launched a reform program under Decision 143/HDBT and successfully decreased the number of SOEs from over 12,000 to about 6,000 by April 1995. By the end of 1996, Vietnam has 6,020 SOEs, comprising about 1,140 enterprises belonging to them. At the end of 1997, about 60 percent of SOEs made losses or were only marginally profitable (Vu, 2005).
Officially, the first round of SOE reform began in 1989 as a part of Vietnam’s main economic renewal program, Doi Moi, and after halting in the mid 1990s, speeded up once more from mid 1998 (Leung, 2001). The Asian financial crisis and rising SOE losses increased government determination to quicken reform. The Government was determined to downsize the SOE sector by divestiture of SOE ownership. This reform of SOE happened in various ways. Many small SOEs where grouped together into large conglomerates. In Vietnam, the term “equitization” (c ph n hoá), which is used as the main measure of SOEs reform, is considered to be an effective way to draw more capital in to SOEs sector. Unlike many Eastern European countries, equitization in Vietnam mirrors a fundamental dilemma. On the one hand, the government has to carry out
6 East Asian update, March 2006. World Bank
equitization program to lessen the fiscal burden imposed by ineffective SOEs. On the other hand, the government still wants to retain a large public sector, because it provides both the political and economic foundations for the national government (Vu Thanh Tu Anh, 2005). Equitization entitles state-owned firms to govern benefits while choosing the private route which will result in losing many benefits.
Equitization, generally speaking, has had a moderate effect on the ownership structure of the economy. The whole structure of ownership in Vietnam has not been significantly changed by the equitization process. Besides, due to a series of policy reforms such as the establishment of the Private Enterprise Law and the Company Law, as well as the simplification of registration procedures, the number of private enterprises registered has been increased rapidly. The equitization process started very slow with only about 100 firms divested in 1998. However, it become much faster in the subsequent years. At the end of 2004, there were 2,224 SOEs equitized, accounted for 40 percent of the total number of SOEs, whose capital amounted to about 8.2 percent of the total state capital of all SOEs. By the end 2006, there should be about 3500 joint stock companies with state capital, which are firms, partly owned by state and the rests are owned other party such as institutions, individuals and foreign firms. Equitized firms show a great improvement after equitization. By 2004, less than 4 percent of the equitized firms were making losses.
For the rest, the average rate of return is 17 percent, three times higher than in the year before equitization. Also, equitization restricts access to credit from state owned commercial banks for equitized firms (World Bank, 2005).
Figure 01: Key Performance Indicators after Equitization
Source: World Bank
(Average annual growth in percent; Measured from the year before equitization until 2004)
2.2. Overview of Vietnam’s FDI 2.2.1. FDI Trends in developing countries
FDI, or investment by transnational corporations or multinational enterprises in foreign countries has grown at a phenomenal rate since the early 1980s, and the world market for it has become more competitive. World FDI inflows grew rapidly and faster than world GDP and world exports during the period 1981-2000. Particularly, world FDI inflows over the period 1991-2000 increased 4.8 fold in comparison to the previous ten yeas period, and exceeded the 4.5 fold increase attained between the 1970s and the 1980s (Wong and Adams (2002)). In fact, FDI has gone predominantly to advanced countries, but the share of developing countries in attracting this kind of investment has been rising (see table 01). The 1990s witnessed a substantial growth in investment flows to developing economies, with FDI increasing from US$24 billion in 1990 to US$178 billion in 2000 (World Bank, 2001). This trend is not surprising because developing countries lack sufficient domestic resources and they need foreign capital to finance their investments. Besides, it indicated that multinational companies are increasingly considering developing countries to be profitable investment locations. Inflows to developing countries in 2004 surged by 40 percent, to US$233 billion and the share of developing countries in world FDI inflows was 36 percent, the highest level since 19977.
Table 01: FDI inflow, % share by area of destination
Area of origin 1970-73 1974-78 1979-83 1984-88 1989-91 1992-94 1995-97 1998-01 Advanced countries
USA 8.97 13.40 26.04 39.07 24.59 17.27 20.44 22.60
Europe 44.20 43.38 32.44 28.11 46.36 35.12 31.34 49.91
Japan 0.79 0.47 0.59 0.38 0.39 0.68 0.24 0.78
Oceania 6.82 5.11 4.56 5.24 4.33 3.53 3.01 0.45
Total advanced
countries 76.60 75.25 69.34 77.53 78.69 59.58 57.98 78.12
Developing and transition countries
Latin America 11.63 13.69 12.74 7.93 6.38 11.12 12.66 9.53
Africa 5.17 3.41 2.49 2.57 1.89 2.11 1.92 1.22
Asia (excl. Japan) 5.84 7.36 15.10 11.76 12.14 24.24 23.23 8.51
Oceania 0.70 0.20 0.23 0.16 0.13 0.11 0.08 0.02
Central and
Eastern Europe 0.00 0.02 0.03 0.03 0.71 2.66 3.88 2.60
Total developing
and transition 23.40 24.75 30.66 22.47 21.31 40.42 42.02 21.88
7 World Investment Report 2005: Transnational Corporations and the Internationalization of R&D. United Nations, New York and Geneva, 2005
countries
World (%) 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00
World (yearly average, mill.
USD)
15392 26521 54875 102211 184665 215624 397965 976933 Source: UNCTAD, 2003.
In the case of FDI inflows to developing countries in 2004, Asia and Oceania was again the top destination of FDI flows to developing regions. It attracted US$148 billion of FDI, US$46 billion more than 2003, marking the largest increase ever. FDI inflows into this region increased 46 percent in 2004; 34 out of 54 economies received higher flows than in 2003. Nevertheless, they remain concentrated: the top 10 host economies (figure 02) accounted for 92 percent of FDI inflows to the region. South-East Asia’s FDI surged 48 percent while East Asia saw a 46 percent increase in inflows to reach US$105 billion (World Bank 2005).
Source: UNCTAD, FDI/TNC database (www.unctad.org/fdistatistics)
0 10000 20000 30000 40000 50000 60000 70000
China Hong Kong
Singapore Korea, Rep. of
India Malaysia
Turkey Taiwan
Saudi Arabia Vietnam
Figure 02: Asia & Oceania FDI inflows - Top 10 economies
2004 2003 2002
2.2.2. An overview of FDI in Vietnam8
Vietnam was closed to FDI until the adoption of Doi Moi. In 1987, the first foreign investment law was passed. Since then, the FDI legislation has been revised several times, notably in 1990, 1992, 1996, 2000, 2003 and 2006. These amendments have, for example, liberalized the original law in a number of ways to remove obstacles and hurdles for enterprises to operate, reduce risks for foreign – invested enterprises in land clearance by shifting responsibility for employee compensation and land clearance from the foreign to the Vietnamese partner in joint ventures (2000), allow investors more freedom and reducing taxes on profit remittances (1996). Yet, besides many positive impacts, there are still numerous restrictions in the Law on Foreign Investment. These restrictions basically aim to protect the SOE sector as emphasized at the 9th Communist Party Congress (Bui, 2004).
In other words, attracting FDI has been a fundamental part of the Vietnamese reform process from the late 1980s. Since the approval of the Law on Foreign Investment, FDI inflows to Vietnam have increased significantly. Vietnam took forward from virtually no foreign investment in 1988 to over 6,813 licensed projects totaling US$60.4 billion at the end of 2006. Of the total FDI, roughly US$28.8 billion is implemented capital9 (Figure 03). In UNCTAD’s ranking, from a host country of low inward FDI potential index during 1988-2001, Vietnam has now ranked as a “front runner” with high inward FDI potential and performance indices10 . Nonetheless, in comparison with other countries in the region, particularly China, the total amount of FDI inflows is still small. Vietnam has drawn only about 0.2 percent of total FDI inflows to developing countries (UNCTAD,
8 The data on Vietnam’s FDI are rather problematic (Freeman and Nestor, 2002). Official Vietnam sources give data on FDI commitments (which reflect planned investments) and implementations (which reflect actual investment carried out). The commitments are consistently higher than subsequently implemented.
Nevertheless, these figures are not consistent with internationally accepted definitions of FDI, because they contain the contribution of Vietnamese partners to joint ventures and so overstate the real capital flow.
Consequently, World Bank and IMF estimates of actual FDI in Vietnam are about a third lower than the figures provided by the Ministry of Planning and Investment. However, despite differences over the level of FDI in Vietnam, there is general agreement between different sources as far as the trends are concerned.
9 According to data from the Ministry of Planning and Investment and GSO 2006
10 The inward FDI Performance Index ranks countries by the FDI they receive relative to their economic size. It is the ratio of a country’s share in global FDI inflows to its share in global GDP. The inward FDI Potential Index captures several factors expected to affect an economy’s attractiveness to foreign investors.
It is an average of the values of 12 variables such as GDP per capita, the growth of GDP, etc.
Front-runners: countries with high FDI potential and performance
Above potential: countries with low FDI potential but strong FDI performance Below potential: countries with high FDI potential but low FDI performance
Under performers: countries with both low FDI potential and performance (source: UNCTAD, 2004)
2005).
Source: Statistical Yearbook 2005. Statistical Publishing House, Hanoi. 2006. p. 93 Note: the data have been revised in line with Document No. 2338/BKH-DTNN dated 06 April 2006 of the MPI
Registered capital includes supplementary capital to licensed projects in previous years
The history of FDI flows to Vietnam can be divided into two main periods: pre and post 1997-98 Asian crisis (Le, 2005). In the former, together with the world’s trend of capital flowing to emerging and transitional economies, FDI inflows into Vietnam expanded consistently with an annual growth rate of 28 percent and reached its peak of US$3.1 billion of implemented capital in 1997 (figure 04). FDI inflows rose to an average of over 9 percent of GDP between 1994 and 1997, the highest level in any developing and transition economy during this period (FIAS, 1999, fig.1). It was clear that FDI in Vietnam has experienced a euphoria period from 1988 to 1996 with very fast growth in commitments and big projects. And then, even before the Asian financial crisis, FDI into Vietnam has been started to slowdown and plummeted in the following years.
There are various interpretations of the downturn in FDI inflows. The 1997 East Asian crisis and its problem caused Vietnam’s investors to suffer from losses and bankruptcy.
However, the crisis also increased pressure to improve the investment climate for Vietnam to compete as a leading production location in the context of diminished flows of investment funds. This dramatic decline of badly needed FDI inflow, yet, could not be
Figure 03: FDI inflows in the period of 1988-2005
0 5000 10000 15000 20000 25000 30000
1988-1990 1991-1995 1996-2000 2001-2005
mill. US$
0 500 1000 1500 2000 2500 3000 3500 4000 4500
registered capital (mill USD) implementation capital (mill USD) number of projects
totally charged by external factors like the impacts of the crisis. The drop of FDI in Vietnam was more pronounced in comparison with other ASEAN economies, while the recovery of Vietnam’s FDI was slow compared to ASEAN economies and not steady, especially in 2001 and 2002. Internal factors must be considered to explain the situation in Vietnam. Thus, there was also an argument that the decline was due to the slow reform process in the mid-1990s. “The decline in implementation of investment commitments started before 1997, so the regional crisis made evident problems existing prior to the crisis; and that after 1999, investment returned to Korea, Malaysia, and Thailand but not to Vietnam” (Leproux and Brooks, 2004). Other commentators highlighted the
“euphoric” nature of expectations concerning investment opportunities in the country, which were almost bound to be disappointed (Freeman and Nestor, 2002).
In fact, the vertiginous growth of FDI in Vietnam declined sharply after the crisis 1997- 1998, though it began to recover in 2000, remarkably in 2005 with US$6.8 billion of registered capital and US$3.3 billion of implemented capital. New commitments fell by almost a half in 1997 to US$5.6 billion compared to US$10.2 billion in 1996 (figure 04).
Although the amount of implemented capital was still rising in 1997 as a result of pass commitments, actual investment also fell in the following years. However, 2006 can be considered as a bonanza for FDI. The total registered capital was US$10.2 billion, 57 per cent up from 2005 and the highest volume since the promulgation of Vietnam’s Foreign Direct Investment Law in 1987. Of the registered capital in 2006, nearly US$8 billion belongs to 833 new projects and more than US$2.2 billion is from 440 applications for capital expansion of ongoing projects. Besides, the pace of disbursement of FDI rose, in a large part due to projects expanding production. The total released capital was estimated at more than US$4.1 billion, the highest rate in 20 years and around 20 per cent up from 2005 (see figure 04).
Although FDI inflows to Vietnam are not stable from year to year, they were still significant. Even with a low annual inflow of FDI, foreign-invested enterprises now play a vital and growing role in the Vietnamese economy.
Figure 04: FDI registered and implemented Capital
2,209 3,037
4,188 6,937
10,164
5,591 5,100
2,565 2,839 3,143 2,999 3,191 4,548
6,840 10,200
3,309 4,100
1,292
2,853 2,650 2,591 2,451 2,414 2,335 3,115
2,714 2,556 2,041 1,018 329 575
2,367 274
391 555
811 833
372
196
327
808
791
970
415
372 349
152
285
0 2,000 4,000 6,000 8,000 10,000 12,000
1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 year
mill. US$
0 200 400 600 800 1,000 1,200
registered capital (mill. US$) implemented capital (mill. US$) no of licensed projects
Source: Statistical Yearbook 2005, Statistical Publishing House. Hanoi. 2006. p. 93
Modes of entry
Vietnam’s Law on Foreign Investment in 1987 recognized three different forms of investment: joint ventures, 100% foreign-owned companies, business cooperation contracts (BCC)11. It regularizes that for investments in the sectors of oil exploration and telecommunications, the BCC form must be applied while for a wide variety of sectors, for instance, transportation, culture, port construction, airport terminals, tourism, and others the Law on Foreign Investment endorses joint venture as the form of investment.
In 1992, foreign investors in infrastructure construction were allowed to enter on a build- operate-transfer (BOT)12 basis. Since 2000, foreign-owned enterprises and parties to BCCs have been allowed to change the form of investment, and there have been several cases of joint ventures becoming 100% foreign-owned affiliates. During the period from 1988 to 2005, there had been just only 6 BOT projects for a total amount of US$1,370
11 Defined as “a written document signed by two or more parties for the purpose of carrying on investment activities without creating a legal entity” (1996 Law of FDI in Vietnam, Art. 2.9).
12 This is “a written document signed by an authorized state body of Vietnam and a foreign investor(s) for the construction and commercial operation of an infrastructure facility for a fixed duration. Upon expiry of the duration, the foreign investor(s) shall, without compensation, transfer the facility to the State of Vietnam (1996 Law of FDI in Vietnam, Art. 2.11).
million of registered capital while BCC projects accounted for about 8.26 percent of total inflows with 183 projects and US$4,173 million of registered capital. The 100% foreign- owned projects accounted for 74.42 percent of licensed projects with 4,404 projects and 50.65 percent of committed capital (US$25,594 million). Joint ventures accounted for 22.24 percent and 37.96 percent of licensed projects and committed capital, respectively (table 04). Most of the joint ventures have been carried out with Vietnam’s SOEs (98 percent of the projects); joint ventures with the private sector are few and restricted.
Table 02: Type of investment, 1988-2005 Type of investment Number of projects Commitments
(US$ mill.)
Disbursement (US$ mill.)
Joint ventures 1,316 1,9184 1,1142
100% foreign-owned projects 4,404 2,5594 9,869
Business cooperation contracts
(BCC) 183 4,173 5,068
Build-operate-transfer projects
(BOT) 6 1,370 725
Total commitments 5,918 5,0535 26,963
Source: Statistical Yearbook 2005. Statistical Publishing House, Hanoi. 2006
Investors
Up to the end of 2005, investors from 74 countries and territories have invested in Vietnam, but Asian economies accounted for the major part of these capital flows with 76.5 percent of the projects and 69.8 percent of registered capital; European economies accounted for 10 percent of projects and 16.7 percent of registered capital and America percent. Top five investor economies were Taiwan, Singapore, Japan, Korean and Hong Kong accounted for 51.88 percent of projects and 46.34 percent of registered capital.
Among the top five investors, Taiwan is the largest one with 1,615 licensed projects and US$8,657 million of registered capital, accounted for 13.07 percent. The followers are Japan (684 projects and US$6,907 million, accounted for 10.43 percent); Republic of Korea (1,185 projects and US$6,145 million, accounted for 9.28 percent); and Hong Kong, China (520 projects and US$4,707 million, accounted for 7.11 percent) (figure 05).
Source: Investment- Statistical Yearbook 2005, Statistical Publishing House. Hanoi. 2006. p. 95, 96, 97 Since the signing of the US-Vietnam Bilateral Trade Agreement in July 2000, FDI from western countries such as the United States, the United Kingdom, France, the Netherlands has been increasing.
Locations
Until now all 64 cities and provinces in Vietnam have attracted FDI. But indeed, foreign investors focus their investments geographically in key economic areas as South East and the Red River Delta. For example, during the period 1988-2005, the South East region attracted 54.25 percent of FDI inflows to Vietnam, the largest proportion, with US$35,941 million of registered capital; followed by Red River Delta with 25.62 percent of committed capital (US$16,969 million). At the same time, the North East accounted for a very small percentage (3.23 percent, equivalent to US$2,140 million); the Central Highlands made up only 1.55 percent of committed capital with US$1,025 million. North West occupied the smallest proportion, just 0.16 percent of the FDI flows (US$105 million) (figure 06).
Figure 05: FDI project licensed in period 1988-2005 by main counterparts
Others 39.35%
Taiwan 11.97%
Singapore 11.47%
Japan 9.35%
Korean 7.97%
Hong Kong 5.58%
BritishVirgin Islands 4.01%
France 3.28%
Netherlands 2.94%
The USA 2.20%
The UK 1.88%
Figure 06: FDI project licensed in period 1988-2005 by regions
North East 3.23%
Oil and gas offshore 4.37%
Red River Delta 25.62%
North West 0.16%
North Central Coast 2.16%
South Central Coast 5.68%
Central Highlands 1.55%
Mekong river delta 2.99%
South East 54.25%
Source: Investment - Statistical Yearbook 2005. Statistical Publishing House. Hanoi. 2006. p. 98, 99
It is clear that FDI activity has tended to cluster around relatively few geographical locations and business sectors, and policy makers have only had limited success in their attempts to better disbursement this FDI activity. Roughly 60% of Vietnam’s FDI stock is located in Ho Chi Minh City, Hanoi and Dong Nai province. In recent years, as the costs of operating in cities have risen, there has been a tendency for new investment to be established more in neighboring areas rather than in the cities. Over time, Ho Chi Minh City and environs are still leading in attracting FDI projects into their provinces for over half of all FDI registered, while Hanoi and its environs make up over a quarter of the total. Until now, the top five cities and provinces in calling for FDI are Ho Chi Minh City, Hanoi, Dong Nai, Binh Duong; and Ba Ria - Vung Tau. Up to the end of 2005, Ho Chi Minh City attracted US$12,208 million of FDI inflows with 1,834 projects, accounting for 24.16 percent of registered capital over the country. Hanoi was in the second position with US$9,277 million of registered capital (equivalent to 18.26 percent) and 646 licensed projects. Following provinces were Dong Nai (US$8,443, accounted for 16.71 percent); Binh Duong (US$4,934 million, accounted for 9.76 percent); and Ba Ria – Vung Tau (US$22,892 million, accounted for 5.72 percent of total registered capital) (Statistical Yearbook 2005, GSO).
Figure 07: Map of Vietnam by provinces
Sectors
Vietnam’s FDI stock is widely distributed in such diverse areas as: oil and gas, construction, tourism, garments and footwear. Prior to 1994, the oil and gas sector was the focus of FDI in Vietnam, permitting growth in crude oil exports, which represented the leading component of export growth until 1996. Oil and gas accounted for more than half of actual inflows at that time, while the share of manufacturing sector took only about 15 percent (IMF, 1999, table 31). Since 1994, foreign investment expanded to a range of new sectors, such as real estate and other different industrial activities. Over
time, the share of manufacturing has risen drastically. In each year from 1996 onwards, at least 40 percent of FDI has gone into manufacturing, while the share of oil and gas has fallen to between a quarter and a third of the total (IMF, 2002, table 29). At the end of 2005, industrial and constructional sector has the largest proportion with 59.66 percent of cumulative implemented investment. The second position is service sector with 37.26 percent. Agriculture and Forestry, which provides the bulk of employment in Vietnam, has not attracted much FDI and accounted for only 3.08 percent up to 2005 (figure 07).
Figure 08: FDI in Vietnam 2005 by sectors
59.66%
37.26%
3.08%
Industries &
Constructions Services Agriculture &
Forestry
Source: Foreign Investment Department – Ministry of Planning and Investment, 2006 From 1988 to the first 6 months of 2006, industrial sector accounted for 67.7 percent of the total number of projects, followed by service sector with 19.7% number of projects.
12.5% is the share of agriculture sector (GSO, 2006).
There has also been a move in the motivation behind manufacturing FDI. In the early years of Vietnam’s opening, almost all projects were oriented towards the domestic market (Vu, 2005). In the period 1991-1997, there was an extensively higher share of export-oriented projects but their share fluctuated from year to year. After 1997, a significant upward trend appeared. It is clear that FDI inflows during these years played a very important role, not only in providing financial assistance but also in easing export market access, intruding new ideas and processes, lifting skills and know-how; and proposing models that have been copied by domestic investors.
2.2.3. Vietnam’s policy to attract FDI
It has been about two decades ago since Vietnam started its DOI MOI reform. The aim of this economic reform was to restructure the legal, regulatory, administrative, investment
and foreign trade systems and policies to overhaul the centrally planned economic system into a market oriented economy with ‘socialist characteristics’ under the state control.
The country, while endeavoring to mobilize all domestic resources, changes the policy in deepening international economic relations to look for new opportunities for the country’s economic co-operation and development. As part of foreign economic relations activities, FDI was put high on the agenda.
On December 29, 1987, the Law on Foreign Direct Investment was passed. The introduction of the Law on FDI was a milestone in the development of Vietnam’s foreign economic relations. The main principles of FDI in Vietnam are stated in Article 1: “The State of the Socialist Republic of Vietnam welcomes and encourages foreign organizations and nationals to invest capital and technology in Vietnam on the basis of respect for national independence and sovereignty, full observance of the Laws of Vietnam, equality and mutual benefit. The State shall guarantee the ownership of the invested capital and other rights of the foreign investors, and extend to the latter favorable conditions and easy formalities.” After amending, this important law has been revised in 1990, 1992, 1996, 2000, and 2003, moving the law to fit the practice of business and closer to conformity with national treatment (STAR/CIEM 2003).
After the presentation of the Law on FDI, other legal documents were put into effect including Decree No. 18 in 1993 on the forms of enterprises, international organizations and individuals investing and receiving FDI in Vietnam; Decree No. 10/CP in 1998 on the simplification of investment procedures; Decision No. 53/QD-TTg in 1999 on investment priorities, etc. In addition, the Unified Enterprise Law and Common Law on Investment implemented since July 2006 add uniformity to the country’s legal framework and level the playing field for all economic sectors and especially private and foreign sectors. The legal reform is essentially a gradual shift from a Soviet-style legal system to a civil law along German or Japanese legal traditions (van Glinow and Clarke, 1995). In general, the reforms have decentralized some policy responsibilities, for example for the registration process of FDI. Local authorities vary in how they use their newly gained authority. Since the decentralization of responsibilities with respect to FDI, provincial authorities have been varying degrees of developed innovative ways of dealing with foreign investors (Meyer & Nguyen, 2003).
The regulatory system for FDI moved toward a situation characterized by fewer difficulties for foreign-invested firms to operate efficiently with reduced risk. Many changes have been implemented including changes in the procedures and criteria to grant
investment licenses, land lease regulation, regulation of recruitment and salaries, investment guarantee measures and taxation.
In fact, government procedures in FDI management have been progressively improved. A lot of barriers for foreign-invested enterprises have been lifted; currency balancing regulations have been relaxed; and more freedom has been ceded to change investment forms, reorganize enterprises, and transfer capital. Since 2001, FDI regime has been liberalized considerably. Many foreign-invested enterprises can now employ workers directly without the interference of employment centers, and foreign investors can set up export-oriented enterprises through simple registration without waiting for approvals.
In spite of these significant and influential achievements, the regulatory framework for FDI in Vietnam remains quite limiting. It still places many restraints in the industrial sectors in which foreign industries may operate, on the structure of their investment means, and on their capability to finance their operations and their capacity to react to changes in economic circumstances (EIU, 2003c). Relevant limits still affect the regulations on stake and legal capital in joint ventures and 100% foreign-invested enterprises. According to the law, chartered capital must be at least 30 percent of total invested capital, composed of legal capital plus loans. Joint ventures demand at least 30 percent foreign equity, though in some special cases, depending on the field of operation, technology, market, efficiency, and socioeconomic benefits of the projects, it may be reduced to 20 percent of total legal capital. This regulatory measure was not eased progressively, but in contrast during recent years has become stricter. Besides, Vietnam business legislation keeps on being restrictive of either the establishment of equity-based cross border production or related M&A activity. Foreign investors may acquire up to 30 percent of total shares of a local company within one of the 35 approved business sectors, but must get approval from the prime minister’s office before doing so. More to the point, Vietnam has many regulations to attract FDI through different kinds of incentives: taxes, tariffs, and exemption or reduction of land rent. These incentives rely on various factors such as sections or locations (Bui, 2004).
The restrictions in FDI’s regulations are also due to the overall weak legal system in Vietnam: legal instructions and guidelines are fast changing, unpredictable and incoherent in different fields: tax, foreign exchange, land, jurisdiction, etc. (Le, Doanh (2002)).
CHAPTER III: LITERATURE REVIEW
In this chapter, the theoretical literature dealing with the determinants of FDI will be reviewed. Firstly, the theory of FDI will be discussed. Based on previous empirical studies in both developed and developing countries, the final part of this chapter will be devoted to the determinants of FDI, applied in this research.
3.1. Theory of FDI
In general, the concept of FDI refers to the setting up of an overseas operation (Greenfield investment) or the acquisition of an existing enterprise located within another economy.
FDI involves that the investor uses a considerable degree of influence over the management of the enterprise resident in the host country. The management dimension is what differentiates FDI from other forms of investment such as foreign portfolio investment, which contains equity and debt securities; and financial derivatives, which can be divested easily and do not have significant influence over the management of the firm (Navaretti and Venables, 2004).
However, looking closer at the concept of FDI, its definition has changed significantly over time due to the complex character of this phenomenon.
One of the earliest definitions can be found in the 1937 inward investment survey conducted by the US Department of Commerce, which aimed to measure “all foreign equity interests in those American corporations or enterprises which are controlled by a person or group of persons…domiciled in a foreign country” (US Department of Commerce, 1937, p.10).
According to IMF (1993), FDI refers to an investment made to acquire lasting interest in enterprises operating outside of the economy of the investor. Further, in cases of FDI, the investor’s goal is to obtain an effective voice in the management of the enterprise. Some degree of equity ownership is almost always considered to be associated with an efficient voice in the management of an enterprise; the IMF suggests a threshold of 10 percent of equity ownership to qualify an investor as a foreign direct investor.
As stated by OECD (1996), FDI is an investment in a foreign company where the foreign investor owns at least 10% of the ordinary shares, undertake with the objective of establishing a “lasting interest” in the country, a long-term relationship and significant influence on the management of the firm. FDI flows contain the financing of new
investments, retained earnings of subsidiaries, inter-firm loans and cross-border mergers and acquisitions.
These current definitions of FDI seem to emphasize on a “much vaguer concept” (Lipsey, 1999, p. 310) of “lasting interest”. On the word of this new benchmark definition, FDI
“reflects the objective of obtaining a lasting interest by a resident entity in one country (“direct investor”) in an entity resident in an economy other than that of the investor (“direct investment enterprise”).
Despite the efforts of international agencies to push for uniformity, it is important to acknowledge that definitions and measurements of FDI still vary among countries.
Because different countries often have diverse agreements as to what comprises ownership of an enterprise from the point of view of the management of its assets. For instance, while in the USA an equity capital stake of 10 percent of share would be enough to indicate foreign ownership, in the UK a stake of 20 percent or more would be sufficient; and in Vietnam, 30 percent is a requirement for foreign ownership.
3.2. Determinants of regional distribution of FDI 3.2.1. Theoretical Background
As pointed out by Braunerhjelm and Svensson (1996), the theoretical foundation of FDI is rather fragmented. Many explanations for the locational pattern of firms were taken from different fields of economics. One of the first researchers to address the study of FDI was Ohlin (1933). As said by this author, FDI was motivated chiefly by the possibility of high profitability in growing markets, together with the possibility of financing these investments at relatively low rates of interest in host economy.
Hymer (1960) leads a new tradition in the study of multinational enterprises (MNEs). The author views the MNE as an oligopolist. MNEs would prefer to supply the foreign market by way of direct investment (in developing countries) rather than through (direct) exports.
Therefore, FDI is considered to be the result of firms’ strategies and investment decisions of profit-maximizing to face worldwide competition. Kindleberger (1969), to some extent, modifies Hymer’s theory. Hymer concluded that MNEs determine market structure while according to Kindleberger; it is the market structure that decides the behavior of firms by internalizing its production.
Although there has been significant theoretical work on FDI (Hymer (1960); Caves (1982); Buckley and Casson (1976)), there is no agreed model providing the basis for
empirical work. John Dunning (1977, 1981) was the first to adopt an eclectic approach to explain the competitive advantage of both nations and firms. His OLI framework states that FDI can be explained by three categories of factors: firms have market power given by the ownership (O) of products or production processes; location advantages (L) in locating their plant in a foreign country rather than the donor country; and the advantage from internalizing (I) their foreign activities in fully owned subsidiaries, rather than carrying them out through arm’s-length agreements. Based on this paradigm, Dunning draws four reasons for a firm to invest abroad: the searches for resources, for markets, for efficiency; and for new strategic assets. His studies provide some answer about geographic distribution of FDI by analyzing location factor. But his model has been criticized because it does not provide theoretical justification of why certain location factors are important. Bhagwati and Srinavasan (1983) and Grossman and Helpman (1991) use the international trade theory to describe the allocative aspects of FDI.
Though, more relevant to this research is the location theory, which is often used to explain why a MNE would choose to invest in a particular host economy. It can also be used to explain why foreign investor would choose to invest in a specific location within a particular host country.
3.2.2. Recent Empirical Studies
The theory of FDI and related empirical work (Horst (1972), O’Sullivan (1985)) states a great deal about why firms invest abroad, and suggests some guide as to why particular nation is chosen. Nevertheless, there is relatively little indication of how and why a particular location within the host nation is chosen. In fact, a variety of approaches have been attempted in the literature to explain regional patterns of FDI within the host country.
The focus of American research has been on the distribution of FDI between US states.
McConnell (1980) discovered that high state shares of FDI had a relation to variables such as agglomeration, urban population, and social well-being. However, locational incentives were found to be less significant. Continuing studies about US market, Glickman and Woodward (1988) regressed shares of US inward FDI against state characteristics to show how the location of foreign-owned plant within the US is explained by determinants such as energy costs, essential infrastructure and the labor climate. They considered economic evidence of the regional distribution of FDI to be sparse. In another study on state characteristics and the location of FDI within the US,
