FOREIGN TRADE UNIVERSITY Faculty of External Economics

INTERNATIONAL DEVELOPMENT ASSIGNMENT

Topic: FDI and its impacts on economic growth of

Viet Nam from 1988 2010

Group members: Dng V Hong Anh
Phm c Anh V Hong Dng L Th Hi Hin Nguyn Th Hnh Minh Phan Duy Quang Tng Th Thanh Thy on Th Qunh Trang

Lecturer: Msc Cao Th Hng Vinh

Ha Noi, May 2012

Group Members
No 1 2 3 4 5 6 7 8 9 Name Dng V Hong Anh Phm c Anh V Hong Dng Bi Hi ng L Th Hi Hin Nguyn Th Hnh Minh Phan Duy Quang on Th Qunh Trang Tng Th Thanh Thy Student ID 095 105 0008 095 105 0013 095 105 0029 095 105 0041 095 105 0073 095 105 0106 095 105 0136 095 105 0177 095 105 0156

Contents
Introduction ................................................................................................................................ 4 I. Theory background .................................................................................................................. 6 1. Definition of FDI ............................................................................................................... 6

2. Determinants affecting FDI ................................................................................................. 7 2.1 Firm-specific determinants of FDI ................................................................................... 7 2.2. Host-country determinants of FDI ................................................................................. 8 2.2.1. Economic determinants ............................................................................................. 8 2.2.2. The policy framework ............................................................................................... 11 2.2.3. Business facilitation .................................................................................................. 12 3. Types of FDI ....................................................................................................................... 12 3.1. Horizontal FDI ............................................................................................................. 12 3.2. Vertical FDI .................................................................................................................. 13 II. Overview of FDI in Vietnam: .................................................................................................. 14 1. Policy framework of FDI attraction: ................................................................................... 14 2. Periods of development:.................................................................................................... 19 1988-1996: First boom ....................................................................................................... 20 1997-1999: Fall from grace ................................................................................................ 21 2000 2005: Slow recovery ............................................................................................... 21 2006 2008: post-WTO strong growth .............................................................................. 21 2009 now: Struggling in world crisis. Turning a new leap. ................................................ 22 3. Some characteristics of FDI in Vietnam: ............................................................................. 23 3.1. Capital size per project: ............................................................................................... 23 3.2. Size of capital resources: ............................................................................................. 23 3.3. Form of ownership: ..................................................................................................... 24
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3.4. Investment composition by sector: ............................................................................. 25 3.5. Investment location: ................................................................................................... 25 3.6. FDI inflow by country. ................................................................................................. 26 4. Determinants of FDI inflow in Vietnam .............................................................................. 27 III. FDI impacts on Economic growth ......................................................................................... 34 1. Current trend..................................................................................................................... 34 2. Econometrics model .......................................................................................................... 36 2.1. Literature review ......................................................................................................... 36 2.2 The model .................................................................................................................... 37 3. Policy suggestions in attracting FDI .................................................................................... 43 Conclusion ................................................................................................................................ 48 Appendix 1: Reference .............................................................................................................. 50 Appendix 2: Contribution .......................................................................................................... 51

Introduction
As a consequence of the Doi Moi process, the year 1988 remarks a significant breakthrough for Vietnamese economy when the foreign investment was officially authorized. After 23 years, FDI inflows of Vietnam have increased rapidly and have taken an important role in boosting the economic development. In 2011, implemented foreign investment capital for Vietnam reach over 11 billion USD; and although the countrys economy still faces numerous difficulties and problems, both registered and implemented FDI capital was predicted to increase in 2012. The role of FDI in the Vietnams economic development seems to be undeniable. Along with the sharp increasing of foreign capital flow into Vietnam, the economy meets a significant growth, especially in the period from 1990 to 1997 and from 2004 to 2006, when the GDP growth reached up to 8% a year. There are several reasons explain for the relation between FDI and economic development. First of all, FDI provide an important source of capital for domestic investment; improve the shortage of fund for projects, financial markets .etc. when the internal sources of capital cannot afford to serve all of those themselves. Secondly, foreign direct investment also helps balancing the macroeconomic situation by increasing the foreign reserve which will also affect the inflation rate, interest rate and the performance of the whole economy. Lastly, by investing in several projects throughout the country, foreign companies and organization will provide Vietnam with employment, and the update, modern technologies for production. Recognized the important role of FDI, Vietnamese Government has continuously taken action in order to attract more and more foreign investment capital. One of those is to improve the legal framework which aims to increase the transparency and to maintain a convenient environment for investors when they decide to invest into Vietnam. Strengthening the legal framework also helps protect the right of foreign investors, for example, intellectual properties right. However, Vietnamese Government is considering being lack of a long term vision that could utilize the current FDI inflow and attract more investors in the future. The fact leads to a need of deep research about the relation between FDI inflow and economic growth along with strengthen the ability to analyze and make prediction about the World economy in order to apply suitable policy for the economy. Therefore, our group decides to
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choose the assignment topic: FDI and its impacts on the economic growth of Vietnam. In this assignment, we will use econometric model to discover the relation between FDI and others factors of the economy. At the end of this empirical study, there will be some suggestions for the policy makers as a conclusion for the analysis. Along with that, the assignment also provides some theory of FDI as well as the overview of FDI in Vietnam.

I. Theory background
1. Definition of FDI
Foreign direct investment (FDI) is direct investment by a company in production located in another country either by buying a company in the country or by expanding operations of an existing business in the country. Foreign direct investment is done for many reasons including to take advantage of cheaper wages in the country, special investment privileges such as tax exemptions offered by the country as an incentive for investment or to gain tariff-free access to the markets of the country or the region. Foreign direct investment is in contrast to portfolio investment which is a passive investment in the securities of another country such as stocks and bonds. As a part of the national accounts of a country FDI refers to the net inflows of investment to acquire a lasting management interest (10 percent or more of voting stock) in an enterprise operating in an economy other than that of the investor. It is the sum of equity capital, other long-term capital, and short-term capital as shown the balance of payments. It usually involves participation in management, joint-venture, transfer of technology and expertise. There are two types of FDI: inward foreign direct investment and outward foreign direct investment, resulting in a net FDI inflow (positive or negative) and "stock of foreign direct investment", which is the cumulative number for a given period. Direct investment excludes investment through purchase of shares. FDI is one example of international factor movements. FDI provides an inflow of foreign capital and funds, investment in addition to an increase in the transfer of skills, technology, and job opportunities. Many of the Four Asian Tigers benefited from investment abroad. A recent meta-analysis of the effects of foreign direct investment on local firms in developing and transition countries suggests that foreign investment robustly increases local productivity growth.[14] The Commitment to Development Index ranks the "development-friendliness" of rich country investment policies.

2. Determinants affecting FDI

The determinants affecting FDI can be grouped into two main factors which can be named Firmspecific determinants, Host-country determinants. 2.1 Firm-specific determinants of FDI It is undeniable that firm-specific or ownership-specific competitive advantages are necessary if firms want to undertake FDI and become transnational companies (TNCs). This is because in any particular market, domestic firms have an intrinsic advantage over foreign firms. It is because they have better local connections and better understanding of the local business environment, the nature of market, business customs, legislation and the like. Consequently, foreign firms wishing to produce in that market have to possess some kind of their own advantages. In order to solve this problem, TNCs or MNCs generally rely on the OLI paradigm, which addresses three questions related to FDI. Ownership-specific advantages (the O factor). Firms investing abroad must possess ownership-specific advantages to overcome the extra costs of operating in a different, less familiar environment (costs of foreigners). These advantages are generally costly to create, but can be transferred to new locations at relatively low cost. The analysis of O advantages draws on industrial organization, resource-based, evolutionary and management theories, with advantages residing mainly in firm-specific technology, brand names, privileged access to factor or product markets or superior technological or management skills. Initial O advantages allow firms to grow and invest abroad, but size and international spread can, in turn, feedback and provide new advantages (accessing capital markets and information, spreading risks and so on). In some cases, firms may go overseas to supplement or enhance their existing O assets, seeking synergies between their own strengths and those of foreign firms or institutions. Location advantages (the L factor). TNCs or MNCs select sites with location advantages that best match the deployment of their O assets. The analysis of L advantages draws on trade and location theory, the main factors

determining location being factor and transport costs, market size and characteristics, and government policies (e.g. stability, predictability, tariffs, taxes and FDI regulations). Internalization advantages (the I factor). The analysis of internalization draws on transaction-cost theories of the firm. It centers on the feasibility of, and returns to, production by firms based on their ownership advantages, as compared with those from contracting the sale of those advantages to other firms, including foreign ones. The most valuable and new advantages tend to be internalized, since these are the most difficult to price and contract over time (they involve important transaction costs). The more mature ones are easier to price, less subject to uncertainty and less valuable to the owner: these are licensed more readily. Internalization can also explain vertical FDI, where a particular process or function is located abroad by TNCs to serve its production system (rather than subcontracted to independent suppliers). Transaction cost analysis can also help explain why it is difficult or costly to contract independent firms for such arrangements, particularly in technology intensive or strategic activities. 2.2. Host-country determinants of FDI A variety of factors determine a countrys ability to attract FDI. These host country determinants may be divided into three broad groups: Economic factors; policy framework; and Business facilitation. 2.2.1. Economic determinants The overall motivation underlying FDI is to improve or sustain the profit position of the firm undertaking it. Broadly speaking, four types of FDI may be identified, according to TNC motivation for investing in foreign countries: Resource-seeking, Market-seeking, Efficiencyseeking, and Strategic asset-seeking. Natural resources Historically, the most important host-country determinant of FDI was the availability of resources specifically, natural resources. In the nineteenth century, much of the FDI by European, US and Japanese firms was prompted by the need to secure an economic and reliable source of minerals and other primary products for the growth of industries in the home
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countries. Up to the eve of World War II, about 60 per cent of the world FDI stock was in natural resources. Since then and particularly since the mid-1970s, however, the relative importance of natural resources as a host-country determinant has decreased considerably. The decline in the importance of natural resources as an FDI determinant can be attributed to a decline in the importance of the primary sector in world output, and to the emergence of large indigenous enterprises or joint ventures in many developing countries, usually State-owned, with sufficient capital and technical skills for the production and distribution of raw or processed products to customers worldwide. Recently, however, as a result of rising mineral prices, the share of extractive industries in global FDI has increased, although it is still much lower than those of services and manufacturing. Though declining in relative importance, the availability of natural resources continues to offer important possibilities for inward investment in resource-rich countries. Raw materials, mainly minerals, still explain much of the inward FDI in a number of countries, developing (e.g. countries in sub-Saharan Africa), developed (e.g. Australia) and countries in transition (Azerbaijan, Kazakhstan and Russian Federation). Natural resources are the basis of tourism that attracts FDI to some small countries, for example, some Caribbean island developing countries. However, as the number of countries with natural -resource endowments that are accessible to FDI has increased over time (due to increased awareness of countries endowments, lower transportation costs, and more liberal inward FDI policies), not only availability but costs of production related to natural resources, and physical infrastructure related to production and distribution have also become important as host-country determinants of resource-seeking FDI. Markets Another important group of economic determinants of inward FDI corresponds to the motivation of firms, including TNCs, to grow and/ or to stay competitive by gaining access to new markets at home and abroad and/or increasing their shares in existing markets. The relevant determinants of market-seeking FDI to a country include market size in terms of the absolute size of a market as well as in relation to the population, as measured by total and per capita income, respectively and market growth. Large markets can accommodate more firms and can help firms to achieve scale and scope economies. A high rate of market growth tends to
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stimulate investment by both domestic and foreign producers, since both are interested in returns to long-term projects. The opening of markets to trade, FDI and technology lows in recent years has created enlarged markets for final and intermediate goods and some (tradable) services, and provided TNCs (and domestic firms) with better access not only to national, regional and global markets for those products but also to markets for factors of production and other resources. This has enlarged the range of choices open to firms regarding the modalities of serving these markets, including especially by FDI (involving equity ownership), trade, licensing, subcontracting and franchising; provided them greater access to immobile resources (e.g. unskilled labor, low-cost skilled labor and created assets) in host countries; and created scope for improving the efficiency of their international production systems. These changes and expanded choices for TNCs mean that large and growing national markets no longer play as important a role as in the past as host-country determinants of FDI in goods and tradable services. Many national markets can be served from elsewhere and it is efficiency rather than local presence that matters for firms seeking to expand markets for their products. At the same time, access to large markets, including regional markets because of geographic location or membership in a regional trade agreement, for example can be a factor that, along with other, efficiency-related determinants (discussed below),attracts FDI to a particular

country. Moreover, national markets continue to be important host-country determinants in the case of most services because of their non-tradability, and in the case of manufactured goods where proximity to buyers is an advantage due to factors such as high trans-port costs, the need for adapting to local tastes and preferences, or the need for responding rapidly to changing demand conditions. Efficiency-related factors A third and increasingly important group of host-country economic determinants of FDI are those sought by TNCs engaged in efficiency-seeking FDI. The motivation behind efficiencyseeking FDI is to rationalize the international production structure of a TNC by taking advantage of differences in the availability and costs of factors of production and in other conditions related to production and markets in different countries, and thereby improve the efficiency of
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the TNC as a whole, reaping benefits from geographic specialization in production and economies of scale and scope. In order for efficiency-seeking international production to take place, cross-border markets must obviously be well-developed and open. Trade liberalization and regional integration in recent decades have given an impetus to efficiency-seeking motives for FDI, which are increasingly intertwined with market-seeking and natural-resource seeking motives as well. Strategic assets The host-country determinants of strategic asset-seeking FDI include firm-specific assets in host countries, such as technological and innovative assets and capabilities; marketing know-how or brand names. The availability of firms with such assets for cross-border mergers and acquisitions is thus a key host-country determinant of such FDI. In most strategic investments, the expectation is that the acquisition or joint venture in the host country will add to the competitive advantages of the rest of the organization of which it is part, by opening up new markets, creating R&D synergies or production economies, buying market power, lowering transaction costs, spreading administrative overheads, advancing strategic flexibility, and enabling risks to be better spread. Strategic considerations and other motivations for FDI, especially efficiency considerations, often go together, however, so that the availability of competitive firms in host countries for M&As may attract TNCs with strategic as well as other motivations. 2.2.2. The policy framework While economic factors are fundamental, host-country policies play an important role as determinants of FDI in a country. This is best illustrated by the obvious fact that FDI cannot take place unless it is allowed to enter a country. On the other hand, even highly liberal and encouraging policies with respect to FDI cannot guarantee that a country attracts FDI in desired amounts if the economic factors sought by TNCs are absent, highlighting the limits of policy as a determinant. National policies affecting inward FDI include core FDI policies or policies directly related to FDI, as well as a number of other policies that indirectly affect FDI. The former, (the inner
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ring of FDI policies), include rules and regulations governing the entry and operations of foreign investors, the standards of treatment accorded to them, and the protection of foreign investors. Policies related to market supervision and competition, although not specific to FDI, directly influence it and can hence be grouped along with core FDI policies. The same applies to investment promotion and other proactive measures to attract FDI (discussed below under business facilitation). Other policies that indirectly influence FDI (the outer ring of policies) include policies related to trade, privatization, taxation, macroeconomic stability and a number of other areas of an economy such as its macro-organizational aspects, labor markets, education, and the environment. 2.2.3. Business facilitation There are increasingly acts complemented by proactive measures by host-country governments, aimed at facilitating FDI and the business that foreign investors undertake in a host country. With more and more countries adopting open FDI policies and actively seeking FDI to supplement their domestic resources and capabilities, such measures have become increasingly routine, pervasive and sophisticated. One important category of such measures relates to FDI promotion, which includes a range of programs and actions, typically undertaken by investment promotion agencies (IPAs) established (or transformed include the provision of incentives to foreign investors, the reduction of the hassle costs of doing business in a host country, and the provision of amenities that contribute to the quality of life of expatriate personnel in host countries.

3. Types of FDI
3.1. Horizontal FDI Horizontal FDI is an investment made by a multinational company in different nations. The investment is made for conducting the similar business operations as already operated by the company. For example, if a soft drink manufacturing company makes its plant outside its national borders then it is horizontal FDI. Horizontal FDI results in expansion of the parent company and brings FDI in the other economy. Two factors are important for the appearance of horizontal FDI: presence of positive trade costs and rm-level scale economies. The main motivation for horizontal FDI is to avoid
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transportation costs or to get access to a foreign market which can only be served locally. The horizontal models predict that multinational activities can arise between similar countries. The intuition behind horizontal FDI is best described in form of an equation with costs on the one side and benets on the other side. Establishing a foreign production instead of serving the market by exports means additional costs of dealing with a new country. Moreover, there are production costs, both xed and variable, depending on factor prices and technology. The plantlevel economies of scales will increase the costs of establishing foreign plants. On the other side of the equation, there are cost savings by switching from exports to local production. The most obvious are transport costs and tariffs. Additional benefits arise from the proximity to the market, as shorter delivery and quicker response to the market becomes easier. Thus, if benefits outweigh the costs, a multinational enterprise will conduct a horizontal FDI. 3.2. Vertical FDI Vertical FDI occurs when a multinational decides to acquire or build an operation that either fulfills the role of a supplier (backward vertical FDI) or the role of a distributor (forward vertical FDI). The modeling of this type of FDI is based on the idea, that different parts of the production process have different input requirements. Since the input prices vary across countries it becomes profitable to split production, conducting for example labor intensive production stages in countries with low labor costs. Similar to the intuition of the horizontal models, the decision to conduct vertical FDI can be described as a trade-off between costs and benefits. The benefits arise from the lower production costs in the new location. The production chain consists of several stages, often with different factors required for each stage. A difference in factor prices makes it then profitable to shift particular stages to the countries, where this factor is relatively cheaper. This is only profitable as long as the costs of fragmentation are lower than the cost savings. The costs of splitting the production process emerge in form of transportation costs, additional costs for acting in a new country, or of having different parts of production in different countries.

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II. Overview of FDI in Vietnam:

1. Policy framework of FDI attraction:
Since economic reform, Vietnam has implemented policies to attract FDI. Such policies have been institutionalized via the promulgation of Law on Foreign Investment in 1987. So far, the Law has been revised 4 times, in year 1990, 1992, 1996, 2000 and been added in Investment Law 2005. At the end of 1987, in the time when Vietnam still got in the trap of economic and social crisis (high inflation, low production and transaction, lack of food) in addition to the fact that barriers were set to Vietnam by West countries and the international relationship was just limited in Council for Mutual Economic Assistance with 12 old socialist countries, Law on Foreign Investment in Vietnam was approved by the Communist Party, which was highly appreciated by international community. At that time, FDI activities were the promotion in joining global market as Vietnam was a potential market for international investors, including countries that are executing barrier to Vietnam like the US. Even though it was not until the end of 1994, President Bill Clinton finally removed barriers to Vietnam, some investors of the US had already invested in many FDI projects since 1989. Actually, after releasing Law on Foreign Investment, FDI didnt show any clear impact on Vietnams economic and social situation in the first 3 years 1988 1990. However, from 1991 to 1997, the number of FDI projects suddenly increased with 2,230 projects, 16.244 billion USD registered capital and 12.98 billion USD realized capital. In addition, just in 1997, realized capital reached the level of 3.115 billion USD, 9.5 times bigger than in 1991. Nevertheless, from 1998 to 2004, as facing with another internal financial crisis, registered capital was only 5.099 billion USD with 3,968 new projects, whereas realized capital in this period was 17.66 billion USD, only increased 36% comparing to the period 1991 1997. The year 2005 shows another increase in FDI in Vietnam with 6.839 billion USD registered capital and 3.3 billion USD realized capital and from that time until now, Vietnam has attracted a big amount of FDI to develop the economy. The table below summarizes the most key changes in FDI policy over time in accordance with each revision. According to this table, we can see that, in general, Vietnam tends to increase rights of foreign investors, to make investment environment more favorable, and narrow the
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policy gap between foreign and domestic investor. These reflect the Governments efforts in creating single investment environment in accordance with Vietnams integration process. The changes in the policy for FDI sector come from various reasons. Along with the performance of FDI sector, those changes for the last 25 years were also derived from three other factors, namely: (1) changes in awareness and viewpoint of the Communist Party and the Government toward foreign economic sector; (2) competition pressures from other countries in the region, and in the world, with respect to FDI attraction; and (3) Vietnams international commitments regarding foreign investment. Table: Key changes in FDI policies in each revised Law on Foreign Investment in Vietnam (source: researchers compilations) Policy areas Registration procedures Revised Law in 1992 Revised Law in 1996 Revised Law in 2000

+ FDI license shall be + FDI enterprises are + Publishing the list of granted within 45 days + After being licensed, FDI enterprises still have to register their business allowed to choose FDI enterprises which permitted to

forms of investment, are rate of capital make

business without

contribution, investment and partner + Enterprises

registration location FDI license

Vietnamese

+ registration

Removing related

with fees

export proportion of more than 80 percent are given priority in granting license Decentralizing registration/ + Encouraging joint + Encouraging FDI + Publishing the list of calling for

venture with domestic enterprise with export- projects

licensing process enterprises; Areas

restriction oriented and hi-tech foreign investment in the period 2001-2005

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of enterprises with 100 industries

percent foreign- owned capital

+ Expanding areas for foreign investment,

allow FDI in housing construction + Diversifying the form;

investment

Allowing foreigner to buy stocks of

domestic enterprises Land + Vietnam is responsible + Local Peoples + May use the

for compensation, site Committee shall help construction attached clearance for foreign- foreign enterprise to to land and value of invested projects + FDI projects may rent land for operation, but are not permitted to rerenting land clear the site when the land project is use right as for

approved. collateral

The enterprises shall borrowing loan make payment for the site clearance to the Peoples Committee + The FDI enterprises may rent out the land in industrial zones,

export

processing

zones to other firms Policies Exchange on + The Government shall + Self guarantee of + rate, guarantee foreign foreign May purchase

currency foreign currency from commercial banks to meet demand, transaction in

foreign currency

currency balance to FDI balance projects infrastructure in facilities + Apply the restriction of international

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and import substitution + FDI enterprises in other areas shall have to arrange exchange foreign

remittance (80 percent) accordance with the due to regional crisis, law and then gradually + Not requiring

release this rate.

approval on capital

balance + The enterprises may transfer; Reducing the foreign fee on profit

themselves; the State purchase shall not be responsible currency for foreign

from remittance abroad. + Reducing the rate of international remittance from 80 percent to 50

exchange commercial banks with the permission from

balance in such projects.

the State Bank

percent, 30 percent and 0 percent Policies import, export on + Foreign firms must + Entirely removing the + Reducing number of ensure export regulation that plan the areas with require for of export proportion of must 80 percent + FDI enterprises may

proportion as declared export in investment license + The products of FDI enterprise

approved by authorities Improving

enterprises must not be + sold in Vietnam

import- act as dealers for exports

via export procedures with imports regard to certification services of origins

dealers + FDI enterprises must not act as dealer for imports - exports Tax policies

+ Preferential tax for FDI + Exemption of import + in areas with

Removing

given duties on machinery, regulation that the

priority: income tax

corporate equipment, specialized FDI enterprise has to of 10 means of transports, allocate their certain
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percent within 15 years raw materials, etc. for profit proportion to of commencement of production operation + The regulation on the business enterprises of and reserve fund FDI + Further reform the tax system; gradually

income tax on whole + Exemption of import reduce the tax gap foreign enterprise does duties for projects in between not allow the deduction prioritized industries, and domestic foreign

of profit in later years regions within 5 years investment. to compensate for the of commencement of loss in previous years operation

+ The FDI enterprises + FDI enterprise those must exclude some cost have export can get tax items from production exemption while import costs + Import duties are raw materials for their production

calculated based on the + The firms supplying low import price applied inputs for calculating tax to export are

enterprises

exempted from import tax on raw materials, intermediate with goods

corresponding

proportions

In 2005, the Communist Party released another Law called Investment Law 2005 to improve business environment, attract both international and internal investment and enlarge production and service sectors in order to push up Vietnams economy. The business environment was improved in the way of easing forms of registering investment as almost big
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projects were classified as popular projects. Therefore, investors only need to register under given forms to receive Register Investment Certification. Obviously, investors would be able to reduce transaction fees so that this improved the relationship between international investors and internal ones aiming at a beneficial ways for both sides. According to Investment Law 2005, there are some changing points in investment form: Treat equally to any kind of corporations including international investment, internal investment or corporations. Ensure freedom in business, whereas corporations can do business in any kind of sectors that are not banned by Law, changing the way of access from list of approving to list of removing and limiting Change the incentive investment system to be more simple Add terms to ensure investment relating to commerce in order to suit with international commitment Concern about both direct and indirect investment to improve international investment Classify forms of registering between business and investment: give opportunities for investors to execute more different projects without setting up company Agree on the controlling right of Government: only Government has right to release, change sectors of banning and limiting investment.

2. Periods of development:
After the Law on Investment being promulgated in 1987, Vietnam has observed a significant wave of FDI inflows over years. By December 2004, Vietnam had attracted 6164 FDI projects with a tremendous value of capital. However, also by the year 2004, it was reported that the total implemented capital made up only 50.1% of registered ones, which means that Vietnam did not take full advantage of FDI inflows. Nevertheless, the situation of Vietnams annual FDI inflows appeared to be unstable since 1997, after its peak in 1996.

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Source: Vietnam General Statistics Office. The history of FDI Vietnam can be divided into 5 main periods as follows: 1988-1996: First boom The amount of FDI inflows into Vietnam was considered rather modest, reaching only 213 million dollars in 1991. However, it robustly rose up from 1992 on, peaking in 1996 with a total of 8.6 billions US dollars of newly-registered capital. To explain for this sudden and sharp rise in this period, the Location advantage of Vietnam can be taken into account. With a market size of about 70 millions consumers, Vietnam was surely a promising land for investors. Moreover, at that time, investors were very eager to take advantage of the freshness of an newly-open economy being in transition. The background of world economy at that time also contributed to the picture. There was a huge wave of FDI flowing into Asia, mainly South East Asia (In 1990, South East Asian countries attracted 36% of FDI inflows in developing countries). Secondly, there was a trend of investing in economies in transition, where everything was new and there were various opportunities. Lastly, some strongest economies in South East Asia also started to reach out for FDI outflows.

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Thats why Vietnam stood many chances of receiving FDI in that period, which played a critical role in covering deficits in Vietnams balance of payment. 1997-1999: Fall from grace This period was marked by a sharp fall in FDI inflows (49% in 1997, 16% in 1998 and 59% in 1999). This decline must be attributed to the financial crisis in Asia, while 5 largest investors to Vietnam were Asians, and they definitely got their own problems. The fall also resulted from the unattractiveness of Vietnam herself. Firstly, after some years, investors figured out that the potential for marker consumption was actually overrated (demand was not as high as they had expected). To make matters worse, the Law on Foreign Investment revised in 1996 took out some favors on foreign investors, discouraging them from making an investing decision in Vietnam at that time. 2000 2005: Slow recovery Registered capital went up again in 2000 (25.8%) and in 2001 (22.6%), yet could not make up for two third of that of 1996. Implemented capital tended to grow, though at a low rate. In 2002, the registered capital was at its minimum despite the peak in the number of projects, implying a low point in average capital per project. The fall and slow recovery of FDI this time resulted from the recession of world economy, following the breakage of tech bubble in US and long lasting crisis in the economy of Japan. From 2004 to mid 2005, total registered capital increased 30% compared to 2003, albeit implemented capital increased only 7.6%. The sharp rise was attributed mainly to amendments in Law on Foreign Investment; in addition, the Government allowed foreign investors to indirectly invest in 35 industries and open access to industries monopolized by the state, namely power (electricity), insurance, banking, communication. All in all, Vietnam policies changed a great deal to support the activity of attracting FDI, yet the lack of transparency, consistency and effectiveness of FDI projects were clear disadvantages. 2006 2008: post-WTO strong growth After Vietnam became a member of WTO in 2006, total registered capital boosted to 12 billion dollars the highest in the last 18 years. 2007, registered capital reached 21.3 billion (surpassed 2006 by 77.9%) before peaking in 2008 at the tremendous value 71.7 billion US dollars. On the
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perspective of total capital of the economy, there was only a rise of 13.3% during the period 2001-2006 while in 2007, this leaped to 27%.

Source: vnexpress.net It was clear that the new membership of WTO brough light to the economy of Vietnam as a whole, and FDI inflows in particular. However, there existed weaknesses in the regulation system and in actual usage of capital, hence this leap did not last long, soon later followed by a fluctuating period affected by the terrible financial crisis. 2009 now: Struggling in world crisis. Turning a new leap. The crisis breaking out in late 2008 no doubt brought clouds to global economy. As a member of WTO, Vietnam was also deeply affected. In the first quarter of 2009, Vietnam only managed to attract 2.1 billion dollars of FDI, 70% lower than last year. This was followed by some a up and a down for next years: a boom in 2010, then continued fall in 2011. However, there was a positive sign in a rise in the capital per project as well as their implementing. This showed that foreign investors still believed that Vietnam was a good market for them. It was not hard to understand this situation. In 2008, the crisis broke out in the US financial system, starting from the death of Lehman Brothers and then some other big institution. The fall of the biggest economy dragged with it a recession in the whole developed world: Japan, EU. Asia and developing countries, on the other hand, showed incredibly fast recovery from the crisis. During the hard time, Vietnam managed to keep a considerable growth rate of around 6% without political unrest and with policies that pay attention to attracting FDI; thats why Vietnam became a promising destination.
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However, in the years to come, Vietnam starts to seek out for qualified FDI projects, with a high rate of effectiveness. There have been too many loss reported in the business of foreign investors, which rings the alarm that the Vietnam should pay more attention to the effectiveness of FDI projects. Attracting capital is important, but learning how to use it to the fullest should essentially be put into account

3. Some characteristics of FDI in Vietnam:

3.1. Capital size per project: Overall, FDI projects in Vietnam are of medium and small scales. The average capital size in the period 1988 2010 was only about USD 15.517 million. To be more specific, there was an upward trend in the number of FDI projects into Viet Nam from 37 to 1237 projects throughout the whole period. Meanwhile, the total amount of FDI inflows experienced substantial fluctuations with a peak of US 71726 million in 2008 due to a surge in real estate sector. Besides, regarding about 500 biggest multinational corporations in the world, only 80 have established their presence in Viet Nam in comparison with 400 firms in China according to CIEM and UNDP, Economic Development Policy: Experiences and lessons of China, vol I,2003. 3.2. Size of capital resources: Currently, more than 35 per cent of FDI companies are highly likely to run businesses at the medium size ranging from 10 to 50 billion VND, or from nearly US 670,000 to more than US 3.3 million at that time. This means that the scale of foreign investment seemed to be limited to quite small and simple businesses relating to exploiting raw materials and producing intermediary goods and services.

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3.3. Form of ownership: Number of active FDI enterprises at 31/12 yearly Unit: Enterprise

Year 100% capital Joint venture TOTAL foreign

2000

2001

2002

2003

2004

2005

2006

854 671 1525

1295 716 2011

1561 747 2308

1869 772 2641

2335 821 3156

2851 846 3697

3342 878 4220

Source: Vietnam General Statistics Office. Due to several reasons including the restriction of establishing the wholly foreign enterprises, till mid 1990s, the FDI projects registered in Viet Nam were mainly in forms of joint venture between State Owned Enterprises (SOEs) and foreign investors. In 1997, the above restriction was removed, which then left a dramatic impacts on the composition of FDI projects by form of ownership. By the end of 1998, the joint venture companies have substituted 59 per cent of the total number of projects and 69 per cent of total registered capital. However, from the time onwards, the wholly foreign firms have dominated Vietnamese markets, leaping from 56 per cent in 2000 to approximately 79 per cent after 6 years and being forecasted to keep on going up in future. In addition, the number of joint ventures between foreign investors and non SOEs are also on the increase.

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3.4. Investment composition by sector:

Source: www.vietpartners.com FDI projects are mainly implemented on industrial sector, thus leading the whole economic structure toward the industrialization. According to the graph of FDI in Vietnam in 2007, industry sector including industry, new apartments and building as well as construction accounted for roughly 77 per cent of the total amount of FDI inflows. At the same time, service sector came the second with the total proportion of 21 percent, mostly specified in hotels and tourism projects (11%). The figure for agricultural industry was totally modest, constituting 2 per cent. In addition, thanks to advances in technologies, more and more kinds of services have turned out to develop in the society, pushing the percentage of FDI inflows to this sector to accelerate steadily from nearly 23 percent in 2006 to almost 46 percent in 2010. 3.5. Investment location: Up to 2010, FDI projects have been present in 55 out of 64 cities and provinces in Viet Nam. However, it is obvious to witness slow changes in distribution of FDI in Viet Nam, which clearly
25

shows that the majority of FDI projects are located in urban areas and industrial zones where it makes sure the availability of favorable infrastructure together with sizeable and skilled labor force. According to Viet Nam General Statistics Officer (GSO) survey, Ha Noi, Binh Duong, Dong Nai, Ba Ria Vung Tau and Ho Chi Minh City attracted US 107,756.6 million in total, accounting for about 55.4 percent of the total registered capital and 73 percent of FDI projects number in Viet Nam. Concerning other provinces, nowadays, many of them have actively and positively improved their business environment, and some have been successful, such as those neighboring areas of Ha Noi and Ho Chi Minh cities such as Quang Ninh, Long An. 3.6. FDI inflow by country.

Source: www.vietpartners.com As illustrated in the pie chart, Taiwan was the biggest foreign investor in Vietnam between 1990 and 2010, making up for 11.8 percent of the total FDI inflows to Vietnam. Very close to the first one, Korea became the runner-up at 11.5 percent, followed by Singapore, which was just 2 percent fewer than the former. Japan and Malaysia came the forth and the fifth with the total amount of capital investing to Vietnam taking up at 10.8 percent and 9.5 percent respectively.
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In general, it is clear to witness the majority of foreign investors coming from Asia, which is forecast to be the stable trend in future due to the similarities in Eastern cultures as well as the advantages of geographical matters. Furthermore, Vietnam has attracted around US$98 billion in 9500 foreign invested projects since 1988. Of these, 2,220 projects are in the north, 818 are in the central region and 5,452 projects are in the south. As far as we are concerned, there are now 82 countries and territories that have made an investment in Vietnam. To be specific, Asia make up 69.8%, Europe 16.7%, and America 6% of the total FDI, other sectors for 7.5%. These first five countries and territories constitutes 58.3% of the licensed projects with a total investment capital accounting for 60.6% of the total foreign investment capital of Viet Nam. It is stated that those top ten countries and territories cover over three-quarters of the total licensed projects and foreignregistered capital in Vietnam. Vietnam lured US$20.3 billion in foreign investment in 2007, which appears to be an increase of 70% against 2006 and approximately equal to the total foreign investment for the 5 years from 2001-2005.

4. Determinants of FDI inflow in Vietnam

Based on the background on determinants of FDI, we form a regression model to analyze the important characteristics of the FDI inflow in host country like Vietnam. Our model uses annual data on 61 provinces of Vietnam in the period from 1996 to 2005: FDIit = 1 + 2Git + 3Yit + 4DIit + 5Xit + 6SKILLit + 7WAit + 8TELit + 9RERit + (FDIit is FDI in province i in period t and so on)

27

In which: Abbreviation Variable definition Unit Thousands FDI Stock capita of FDI per of VND at constant prices Agarwal (1980), Tsai Provincial economic growth rate (1994), Wheeler and Annual % + Mody (1992), Wang and Swain (1997). Billington (1999), Taylor (2000) Thousands Y GDP per capita of VND at constant prices Thousands of VND at constant prices Thousands X Export of goods and of VND at services per capita constant prices Percentage of skilled SKILL labor in total labor force % + + Grosse and Trevino ( 1996), Goldberg and Klein (1999) Teo and Wang (2001) Woodward (1993), Broadman and Spatz (1997), UNCTAD (2002) + Buckley et al. (2007) + Lorce and Guisinger (1995), Chakrabarti (2001), Habib and Zurawicki (2002) Expected signs Theory

Gross DI investment capita

domestic per

28

Root and Ahmed (1979), Hanson (1996), Narula (1996) Smith and Florida Thousands WA Monthly average of VND at constant prices Urata and Hawai (1999), Blonigen and Slaughter (2001) Telephones thousand persons per + (1994), Noorbarkhsk et at (2001) Matsuoka (2002)

wage of employee

TEL

Asiedu ( 2002)

Goldberg and Klein RER Real exchange rate + (1997), Wang and Swain (1997), Blonigen (1997)

Because of the lack of data available, we can not collect enough data to run our regression model and have to make use of a recently released regression result as follow:

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Dependent variable: FDI GMM estimation without regional dummy variable 992.8359 (2.73)* 1.451904 (11.32)* 0.050031 (5.71)* 0.934665 (7.00)* 141.1244 (2.7)* - 5.460528 (- 4.64)* 49.79898 (6.62)* 161.6789 (3.05)* GMM estimation with regional dummy variable 802.3072 (2.34)** 1.460676 (12.53)* 00.052338 (6.64)* 0.934665 (7.47)* 120.3292 (2.44)** - 4.867383 ( - 4.41)* 47.9732 (4.9)* 145.9019 ( 3.05)* 1179.619 (3.05)* - 34,870.23 ( - 3.86)* 0.13 - 31,513.77 ( - 3.83)* 0.12

Independent variables

Economic growth (G) Market size (Y) Domestic investment (DI) Exports (X) Labour skills (SKILL) Labour cost (WA) Infrastructure (TEL) Real exchange rate (RER) Regional dummy (DUMMY) Constant Hansen test (p-value) Durbin - Wu - Hausman test (p-value) Pagan - Hall test (p-value) Observations

0.00 0.01 543

0.00 0.01 543

Note: Robust standard errors in parentheses. ***Significant at 10%; **significant at 5%; *significant at 1%

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FDIit = -34,870.23 +992.8359 Git + 1.451904 Yit + 0.050031 DIit + 0.934665 Xit + 141.124 SKILLit 5.460528 WA+ 49.79898 TEL + 161.6789 RER This result was estimated by making use of the generalized method of moments (GMM). In econometrics, generalized method of moments (GMM) is a generic method for estimating parameters in statistical models. Usually it is applied in the context of semi parametric models, where the parameter of interest is finite-dimensional, whereas the full shape of the distribution function of the data may not be known, and therefore the maximum likelihood estimation is not applicable. The method requires that a certain number of moment conditions were specified for the model. These moment conditions are functions of the model parameters and the data, such that their expectation zero at the true values of the parameters. The GMM method then minimizes a certain norm of the sample averages of the moment conditions. The GMM estimators are known to be consistent, asymptotically normal, and efficient in the class of all estimators that dont use any extra information aside from that contained in the moment conditions. In our following analysis, we only report the result of GMM estimation without regional dummy variable due to the lack of raw data (which made us confused in estimating the impact of dummy variables). All variable, namely G, I, DI, X, SKILL, WA, TEL, RER, are significant at 1% level. The market growth, captured by Provincial economic growth (G) and FDI inflow to Vietnam have a positive relationship. This regression result fitted the theories of Agarwal (1980), Tsai (1994), Wheeler and Mody (1992), Wang and Swain (1997). Billington (1999), Taylor (2000). With 2 = 992.8359, if other things remain constant, 1% increase in economic growth will lead to an increase in FDI per capita by 992.8359 thousand VND. This suggests that higher economic growth in Vietnam does send positive signals to prospective foreign investors. The market size, captured by GDP per capita (Y), shows a positive effect to FDI. This result matched well with the theories of Lorce and Guisinger (1995), Chakrabarti (2001), Habib and Zurawicki (2002). With 3 = 1.451904, if other things remain constant, 1 thousand VND increase in GDP per capita will lead to 1.451904 thousand VND increase in FDI per capita. The size of the
31

host market, which also represents the host countrys economic conditions and the potential demand for their output as well, is an important element in FDI decision-makings because a large market size brings the effect of economies of scale. In case GDP per capita as well as Provincial Economic growth

increase, that means income and living standard of people in Vietnam is improving, that will result in higher demand of goods and services. As a result, foreign firms will have more incentives to invest in our country in order to take advantage of economies of scale as well as potential market. Several empirical studies have shown that an increase in Domestic investment (DI) is associated with the increase in FDI inflows into host country, for example Buckley et al. (2007). With 4 = 0.050031, if other things remain constant, 1 thousand VND increase in Domestic investment will result in 0.050031 thousand increase in FDI per capita. Domestic investment increase will create more employment for Vietnamese people, which will lead to higher income as well as higher GDP. In addition, when the numbers of domestic investment as well as domestic firms increase, the demand for raw materials, machineries, transportation also increase, which encourage more foreign firm to invest in Vietnam. The level of openness, captured by Export of goods and services per capita (X) has positive effect on FDI inflow. Grosse and Trevino (1996), Goldberg and Klein (1999) have used export volume as a measure of the openness of an economy as well as finding the positive relationship between Export and FDI inflows. With 5 = 0.934665, if other things remain constant, 1 thousand VND increase in Export of goods and services per capita will lead to 0.934665 thousand VND increase in FDI per capita. The volume of Export indicates the level of openness in the host country and it also acts as a good signal for foreign investors to invest in country with high level of openness. Most foreign investors invest in Vietnam because they desire to take advantage of low producing cost and then export those products to global market with high price and demand. In the host country, in which the level of openness is high, foreign investors will find it easy to export their product to big market such as US or EU. The labor market conditions, captured by Percentage of skilled labor in total labor force (SKILL) and Monthly average wage of employee (WA) show different effect on FDI inflow. According to Woodward (1993), Broadman and Spatz (1997), UNCTAD (2002), the skill level of labor positively affect the FDI inflows in host country. With 6 = 141.1244, if other things remain
32

constant, 1% increase in the Percentage of skilled labor in total labor force will lead to 141.1244 thousand VND increase in FDI per capita. In case the Percentage of skilled labor in total labor force rises, that means Vietnamese employees can produce high quality products at higher productivity. In addition, in country with labor intensive characteristic like Vietnam, skilled labors are attractive to foreign investors in seeking investing opportunities in Vietnam. However, it seems to be that, foreign investors do not expect an increase in labor cost. Urata and Hawai (1999), Blonigen and Slaughter (2001) have suggested that FDI inflows tend to dry up as the cost of labor increases. With 7 = -5.460528, if other things remain constant, 1 thousand VND increase in Monthly average wage of employee will lead to 5.460528 thousand VND decrease in FDI per capita. As the employees qualification is improved, their expected salaries or wages also increase as a result. Therefore, firms have to spend more money than before on labor cost. Firms operating expenses also rise and their profit maybe lower. So, labor conditions have two side effects on FDI inflow, which can either increase or decrease the volume of FDI inflow to Vietnam. The factor of infrastructure development: a number of empirical studies have used different proxies to measure the level of infrastructure development in host country for example per capita usage of energy by Mudambi (1995); railway transport by Bengoaz and Sanchez Robles (2003). In this model, we use Telephones per thousand persons by Asiedu (2002) as a measure of infrastructure development in Vietnam. With 8 = 49.79898, if other things remain constant, 1 more telephone used per thousand of persons will lead to 49.79898 thousand VND increase in FDI per capita. It means that infrastructure development promote FDI inflow to the country. FDI investors are normally looking for a location that is available and convenient in infrastructure such as road, telecommunication and transportation. If the location is well developed, investors can reduce their expenditure in initial investing and then increase their profit. The positive sign of the real exchange rate (RER) represent a real depreciation of the VND against US dollar. With 9 = 161.6789, if other things remain constant, an increase by real exchange rate by 1 unit will lead to 161.6787 thousand VND increase in FDI per capita. If VND is depreciated, it makes lower the price of local asset and production cost, and therefore leads to higher FDI inflows due to higher international competitiveness.

33

In conclusion, higher economic growth and bigger market size are encouraging FDI inflows into Vietnam. This is consistent with the widely accepted belief that growing market size creates incentive for foreign investors to gain market access. The result also strongly support the hypothesis that well developed infrastructure is an important factor attracting FDI. Good infrastructure increases the productivity of investment and therefore stimulates FDI inflows. In addition, multinational firms engaging in export oriented investments in Vietnam prefer to locate in a more open economy. This is consistent with the results of most other empirical papers. Moreover, depreciation of the exchange rate leads to increase FDI inflows into Vietnam due to greater international competitiveness. Based on our finding, high quality labor is an attracting factor that motivates foreign investors but high wage will discourage them from investing in Vietnam because our industrial sector still consists of industries producing labor intensive goods which have not yet required a large amount of skilled labor with high salary.

III. FDI impacts on Economic growth

1. Current trend
In the recent years, along with the development of the economy, GDP of Vietnam has some remarkable changes. As we try to develop some new high technology industries, there is a significant boost to our economy. That leads to the consequence that the Government has set the target of GDP each year for more than 100 billion USD. In 2000, our GDP was about 30 billion USD. But in the period of only 6 years, the number doubled to reach 60 billion USD in 2006. This number was out of expectation of any economists at that time. But in the last four year of the decade, we even saw a bigger change in the development of Vietnams economy. The amount of GDP has rocketed to reach 106 billion USD in 2010. However, this period saw an unsteady move of the growth rate of GDP. As can be seen from the graph below, the growth rate of GDP declined from 8.5% to 6.2% from 2007 to 2008, and continued to fall to 5.3% in 2009. So what makes rate go out the line of rising? It can only be the world recession in 2008 that affected the whole worlds economy. However, 2010 saw a significant growth in GDP as the rate rises to 6.8%, thanks to the recovery of the worlds economy and the act of Vietnams Government.

34

GDP growth rate of Vietnam from 1999 to 2010

Source: www.indexmundi.com. As mentioned above, as a result of a promising developing country, the FDI that foreign investors investing in Vietnam economies is growing years by years. By December 2004, Vietnam had attracted 6164 FDI projects with a tremendous value of capital. In the period of 2006-2008, the FDI invested in domestic economy rose sharply from 12 billion USD in 2006 to reach a peak at 71.7 billion USD, highest since Doi Moi process. The main reason of this is that Vietnam became a member of WTO in 2006. However, the same as GDP, FDI also declined in the next period as a result of world recession. This period has seen an unsteady trend in FDI invested in Vietnam. In particular, FDI fell in 2009 but rose in 2010 then decreased again in 2011. As the research of our papers, we think that there is a strong connection between FDI and GDP. Now we will turn to empirical study to exactly and quantitatively measure the impact of FDI on the GDP of Vietnam.

35

2. Econometrics model
2.1. Literature review Endogenous growth literature holds that economic growth is primarily the result of endogenous and not external forces, for example: human capital, innovation and knowledge, etc. The theory focuses on positive externalities and spillover effects of a knowledge-based economy which will lead to economic development. Theoretically, multinational corporations (MNCs) being vehicles of FDI that have positive impact on endogenous factors such as human capital in host countries can consequently boost economic growth. For instance, MNCs can organize training courses to their subsidiaries local workers, which benefit all employees ranging from less skilled to highly skilled workers. Considering that benefit in the long term, it can enable the economy to grow sustainably (Balasubramanyam and Salisu 1991, Blomstro m and Kokko 2001).Policy measures are other endogenous factors that can have an impact on the long-run growth rate of an economy. For example, subsidies for research and development or education increase the growth rate in some endogenous growth models by increasing the incentive for innovation. In short, FDI invests in endogenous factors will help economy to grow in long-run. On the other hand, the Eclectic Paradigm by Dunning (1981) has provided another way to approach the relationship between economic growth and FDI. For instance, in the location advantage theory, we consider several factors why a foreign investor chooses the host country instead of another. It could involve several economic factors, the market potential, labor cost, legal frame or political stability. But one of the most important determinants for FDI, as has been shown in the research by Chakrabarti (2011), is the economic growth of the country. In the research, Chakrabarti implied that higher economic growth is the result of increasing FDI inflow. Moreover, recently, there have been a lot of studies using the endogenous growth model to invest the correlation between the FDI and economic growth. For example, in 1998, Borensztein and his co-workers carried out a research on the relation between economic growth and several factors that affect it. Specifically, they are FDI, human capital, Governments expenditure, domestic investment, ination rate and institutions. After utilizing the model, Borensztein concluded that FDI positively influence the economic growth and FDI and domestic investment are in complement relation.

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2.2 The model Determinants of economic growth Human capital: Human capital has long been considered as the main source of growth in several endogenous growth models as well as one of the key extensions of the neoclassical growth model. As a matter of fact, the term human capital relates principally to employees capabilities of gaining skills and practical knowledge through education and training. Therefore, most research recently have used the proxies related to education as means of measurement of the quality of human capital such as school-enrolment rates, tests of mathematics and scientific skills, etc. Significantly, the majority of studies have found evidence suggesting that educated population is regarded as the key determinant of economic growth, as referred by Barro, 1991; Mankiw et al, 1992; Barro and Sala-i-Martin,1995; Brunetti et al, 1998; Hanushek and Kimko, 2000. To make it clearer, this study measures human capital by the number of Vietnamese university and college registration per thousand persons. Learning-by-doing: Another popular term referring to economic growth is learning-by-doing, which involves the capability of workers to improve their productivity by regular practice, self-perfection and minor innovations. This concept has been used by Kenneth Arrow in his design of endogenous growth theory to illustrate effects of innovation and technical change. Yang and Borland(1991) have proved that learning-by-doing plays a part in the evolution of countries to greater specialization in production. In view of these above cases, learning-by-doing provides an engine for long run growth. Similar to the method of measurement from Bende-Nabende et al, 2001, this study also uses manufacturing value added as a percentage of GDP to measure the extent of learning-bydoing. Export Endogenous growth theory holds that economic growth is primarily the result of endogenous and not external forces. Endogenous growth theory holds that investment in human capital , innovation and knowledge are significant contributors to economic growth. From that, a country achieving significant endogenous growth may increase its export power, and vice versa, an increase in export can imply endogenous growth. According to Salvatore and Hatcher, (1991), the two economists generally agree on the positive relationship between export and
37

economic growth. It has been practically proved in Vietnam case that open trade opens ways for export and thus leads to economic growth. Macroeconomics stability In recent years, countries which are considered to be growing too fast, say China and Vietnam, are trying to turn their foremost goals to take control over growth and stabilize it. A economy which experiences too high rate of growth also suffers from high inflation, which in turn harms the economy itself. Real exchange rate has been taken as an implication of macroeconomics stability. By evaluating real exchange rate, the stability of an economy can be clearly analyzed. In his work in 2003, Barry Eichengreen argued that real exchange rate as a sign of macroeconomic stability can be a very important determinant in evaluating economic growth. In this assignment, real exchange rate is used as an indicator of macroeconomics in Vietnam. Financial development in host country In recent decades, financial system has evolved into one of the most important part of an economy. This was strongly proved by the financial crisis breaking out in 2008, which implied that a stable financial system can be the core factor that determines the growth and health of an economy. As argued by Hermes and Lensink in their study in 2003, the development of financial system in the host country can possitively affects its FDI inflows and economic growth as well. In this assignment, to measure the level of financial development, we take domestic investment as a percentage of GDP. Public investment The effect of public investment on economic growth is predicted to be negative in the case of developing countries. According to Durham theory (2004), public investment is financed by increasing taxes which could raise distortions in developing countries and increase input costs. Therefore, the effect on the output growth can be negative. However, public investment is likely to have a positive effect on output growth if there is a direction towards infrastructure improvement and human capital accumulation. Relating to the second factor human capital accumulation, Blankenau and Simpson (2004) have argued that governments also play an important role in this problem as they provide funds for formal schooling. Hence, public education expenditures will directly affect human capital accumulation which leads to another effect on long-term growth. That is the reason why an increase in public investment spending is supposed to have a positive effect on economic growth. In this study, we use the annual
38

government investment expenditure as a percentage of GDP as a measure of public investment in Vietnam. Other determinants There are some kinds of determinants that we think they might take effect on economic growth. The first one is geography, which has been researched by Sachs (2003) and Presbitero (2006) and has been argued that geography plays a direct and essential role in promoting economic growth through following channels: human health, agricultural productivity, physical location, and proximity and ownership of natural resources. Presbitero also further argues that the level of current income will be affected by geographical conditions (climate and natural endowment) through the availability of natural resources as well as enabling access to international trade and commercial routes. On the contrary, geography also influences the disease ecology such as malaria and other tropical diseases that lead to changes in social and economic growth in different ways. The other criteria we might think of are labor force growth rate and FDI which are both included as determinants of economic growth in Vietnam. As the above is not an exhaustive list, we believe that there are still some other major determinants of economic growth we might not have covered. Nevertheless, these above factors are those which we think can explain many problems inside and give a further understanding about economic growth. According to the background of determinants of economic growth, we build the following regression model which covers important characteristics of economic growth to understand the linkage between GDP growth and FDI in Vietnam together with other factors: Git = o + 1 FDIit + 2 SIit + 3XGit + 4 HCit + 5 DIGit +6 LAit +7 LDit + it In which Abbreviation Variable definition Provincial economic growth rate Unit Expected signs Theory

Annual % Thousands of

FDI

Stock of FDI per capita

VND constant prices

at

39

The ratio of annual SI government expenditure to GDP Ratio of exports to GDP Number of university HC and college students per thousand persons The ratio of gross DIG domestic investment to GDP LA The growth rate of labour Annual % Annual manufacturing LD Learning by doing value added as a percentage + + % + + % +/-

Durham theory (2004), Blankenau and Simpson (2004) % + Salvatore and Hatcher, (1991) Endogenous growth theory

XG

Keynesian formula

CobbDouglas function BendeNabende et al, 2001

of GDP is used as a proxy

Because of the lack of data available, we are not able to run our regression model and have to make use of a recently conducted regression result as follows:

40

Dependent variable: provincial economic growth Independent variables GMM estimation without regional dummy variable 0.000054 (4.8)* 0.243119 (1.95)** 0.068351 (0.29) 1.256011 (2.93)* 0.157515 (2.58)* 0.018336 (3.05)* 0.038917 (2.64)* GMM estimation with regional dummy variable 0.000049 (3.99)* 0.245129 (1.92)* 0.417532 (0.41)* 1.184253 (2.71)* 0.408601 (2.88)* 0.017551 (3.08)* 0.037175 (2.85)* 0.391238 (1.13) 18.706020 (6.34)* 0.15 19.005950 (6.46)* 0.29

FDI Exports (XG) Government expenditure (SI) Financial development (DIG) Labor growth (LA) Learning by doing (LD) Human capital (HC) Regional dummy (DUMMY) Constant Hansen test (p-value) Durbin - Wu - Hausman test (p-value) Pagan - Hall test (p-value) Observations

0.00 0.01 563

0.05 0.02 563

Note: Robust standard errors in parentheses. ***Significant at 10%; **significant at 5%; *significant at 1% Without regional dummy variable, almost variables, namely FDI, DIG, LA, LD, HC and RER, are significant at 1% level. Besides, XG is significant at 5% whereas DIG seems to be not statistically significant. FDI is chosen as the most focused of all. The estimated co-efficient of FDI is significant at level of 1%, which means that with 99% confidence we can say that increase in FDI will lead to economic
41

growth. Specifically, as interpreted from the table, 1000 VND in FDI contributes to approximately 0.000054% increase in economic growth, ceteris paribus. This may suggest that in an attempt to make growth in the economy, Vietnam government should pay attention to the growth of FDI inflows into Vietnam. Export, denoted as XG, shows a positive effect to economic growth. With 2 = 0.0243119, ceteris paribus, 1% increase in ratio of Export value to GDP will lead to 0.0243119% increase in economic growth. The ratio of exports to GDP is significant also at 5% level. As expected, Government expenditure also has a positive influence on economic growth. 3 = 0.0683551, ceteris paribus, 1000 VND increase in SI is supposed to result in 0.0683551% increase in economic growth. Although this variable unfortunately meets with the problem of lacking statistic meaning in the regression model, concerning its importance makes us include this term in the model. Financial development, calculated by the proportion of gross domestic investment to GDP, appears to positively affect the economic growth. In other words, with 1 unit increase in development of finance, there would be highly likely to observe the acceleration by 1.256% of provincial economic growth per annum. Thus, it enables economic growth to push up in future. The growth rate of labor annually similarly has a positive effect on economic growth. To specify, 1% increase in labor growth leads to 0.158% rise in economic growth each year. Labor forces improvement help ensure income of working class, thus enabling them to consume more, resulting in economic growth for the whole society. As expected, learning-by-doing ratio shows the same trend in relationship with economic growth. Particularly, economic growth climbs by 0.0183 due to 1 unit going up in this ratio. Employees self-perfection indicates a good sign for economic development on account of raising their productivity while working, which enforces the surge in the speed of production line and makes certain for a wide range of products supplied to the market. Regarding human capital, the factor of number of university and college students per thousand persons is shown positive to economic growth. With 4 = 0.038917, if other things remain constant, 1 more university and college students per thousand persons will lead to 0.038917 % increase in economic growth. This suggests that a higher number of university and college students per thousand persons send positive signals to the growth of Vietnams economy as

42

education plays an essential role in training well-educated students who can contribute their knowledge to develop their countrys economy. In conclusion, all the factors represent the same trend of relationship with economic growth. This is consistent with the widely accepted belief that the growth in export values as well as the enhancement in labor force in terms of both the quantity and the quality containing the productivity together with the progress in practical skills contribute substantially to the climbing of economic indicators. However, as can be seen from the above table, FDI plays only a small part in economic growth of Vietnam during the period from 1996 to 2005. It can be attributed to several reasons. The first and foremost reason is the scale of FDI inflows into Vietnam, which is considered to be almost medium and small. Thus, it cannot push up the growth of GDP in Vietnam in an extreme way. Furthermore, there was a substantial gap between the total amount of registered capital and implemented capital in Vietnam. It means that the capital after being registered took a certain period of time to be invested in projects in Vietnam, which obviously affected the benefits that we should have got from FDI inflows. In addition, it is reported that most of FDI inflows came to infrastructure enhancement, which certainly had long term effects on economic growth. Last but not least, time lags together with low capacity of controlling as well as planning on international investment of the authorities added up to the matter; for example, long time dealing with administrative papers.

3. Policy suggestions in attracting FDI

Git = 18.706020 + 0.000054 FDIit + 0.068351 SIit + 0.243119 XGit + 0.038917 HCit + 1.256011DIGit + 0.157515 LAit + 0.018336 LDit 0.094108 RERit FDIit = -34,870.23 +992.8359 Git + 1.451904 Yit + 0.050031 DIit + 0.934665 Xit + 141.1244 SKILLit 5.460528 WAit+ 49.79898 TELit + 161.6789 RERit The above regression models are the results of Sajid Anwar and Lan Phi Nguyen research. As is clearly shown, we can see the closely-related linkage of GDP growth rate and FDI of Vietnam. With the positive sign of both Git and FDIit in two equations, we can conclude that these two variables are positive interrelated. FDI can boost the growth rate of Vietnamese Economy, as well as GDP plays a substantial part in attracting the amount of FDI to our nation. Being a developing country like Vietnam, we have a much firmer ground to state that the more FDI
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inflows, the better Vietnamese economy will be benefited. Therefore, with the limitation of this topic over the impact of FDI on Vietnamese Economic growth, we will focus most of our policy suggestions on attracting this capital flow to Vietnam, along with improving its efficiency. Based on the models, moreover, we would like to present these following recommendations: Lowering the interest rate: This is a short-term policy suggestion for Vietnam. Although

the effects of interest rate of host countries on FDI inward are smaller than on domestic investment, it still can have some considerable impacts on the investment decision. Recent figures have shown that there are a growing number of firms that go bankruptcy because of limited access to capital. This fact, inevitably, will wipe out a great deal of options in the portfolio of foreign investor. Furthermore, a lower cost of capital, along with some tax relief policies established recently by our government, can produce more profit for firms and create incentives for domestic investment to increase. Then, companies stand a golden chance to reexpand their production, hire more employees (which will definitely add to the GDP), and most importantly, catch the attention of foreign investors again. However, as we state above, this solution is only temporary, because it depends on the situation of the whole economy. Our government is strongly recommended to have specific plan for different periods to control this rate appropriately, in order to benefit our economy, and keep the FDI inflow stable. Aiming structural change: From our point of view, this goal is one of the key to a stable

flow of FDI to Vietnam as well as to sustainable development for the Vietnamese economy. Currently, most of the flows now in Vietnam are heading to the labor intensive industries, such as textiles, leather shoes, etc. These industries have a considerable advantage that attracts a great flow of FDI to it: low labor cost. However, as the whole economy is continuously developing, we cannot rely on this advantage forever, as there are a number of new economies opening their door to the world with much lower cost (Africa, Myanmar and China, etc.). Thus, in the far future, Vietnamese government must have plans to change the economic structure, directing the FDI inflow into knowledge and technology based industries (such as biology, energy, education, medicine, etc.). This will be extremely of great help to improve not only the quantity, but also the quality of the FDI inflow. To achieve this objective, we firmly suggest the government these following policies:

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 Gradually substituting labor supply with technology-based method for laborintensive industries, which will boost the quality of products. Agriculture should be the forefront segment as we apply the method from developed countries like USA, UK with a large scale of production, rather than dividing into small productions like today. Increasing educational and training programs for the labor to improve the level of skills for the whole labor community, leading them to pursue careers in these above industries, especially those in the service segment. Encouraging investors, especially foreign ones, to put their money in these industries by providing incentives such as tax relief, reducing time to register for investment, subsidizing, etc. Even though we consider these steps are ideal, it would be wrong to complete these polices too early. The first two steps might cause a big trouble as the unemployment rate would rise up dramatically, which harmfully affect our economy as well as Vietnamese human capital resource. Thus, the government must create a detailed plan, and apply these polices gradually to avoid shocks and catastrophes for Vietnam. Promoting R&D: Another substantial policy that should be established as soon as

possible. Vietnamese trade of balance has always been one of the most disturbing trouble for the government as we continuously suffer from trade deficit. There are several reasons to explain this phenomenon, and the low quality of product export is one of them. Vietnam mainly imports hi-tech goods, meanwhile exports raw materials, simple manufactured products. This fact steadily reduces the National budget, and, consequently, Vietnamese government did not have enough money to improve infrastructure, a major determinant of FDI inflow. To avoid this, our government must work alongside the private sector to make critical investments, using our limited resources more efficiently to cultivate a true innovation agenda. Promoting R&D is a great choice, which will enhance and intensify the feature of Vietnamese export, add more value to the BOT, which is a great first step to get the interest from foreign investors and raise the standard of FDI inflow. To promote R&D, Vietnamese government is strongly urged to apply these following policies:
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 Partly pay the wage of R&D staffs: Establish funds to increase the income of these professional. Tax relief: Refund percentages of tax for the investment in R&D and training program Reducing trade barriers for materials, tools used for R&D Substantially reduce corporate tax for R&D researchers, especially foreign ones to attract them to Vietnam. Promoting FDI: Promotional activities for FDI have expanded their scope intensely in the

world. The numbers of countries with investment promotion programs have increased rapidly, which was around 227 countries in April 2008 by UNCTAD. Therefore, to compete with other nations, Vietnamese government must plan and set up campaigns to attract the foreign investors. If not, we may lose the capital flow to our competitors, which undeniably lower the development rate of Vietnam. Image building: This issue is about the appearance of the economic and political environment of Vietnam. Overall, we have several advantages to get the capital flow from foreign investors, such as low labor cost, good nature resource. However, the procedure to enter the Vietnamese market is still a notorious feature of Vietnam. Foreign investors find it such a burden complete all the steps for registration to start investing, as well as the situation of red tape and corruption seems to worsen in Vietnam. Thus, it is mandatory to fix this problem in Vietnamese investing environment. Government should progressively create a desirable image of our economy, actively show our investors that Vietnam welcomes all the potential capital flows, and is eager to help them get the highest return from their projects. Targeting main investors: In our opinion, Japan and the USA are still our two potential ones. They have a huge resource of capital and , especially, technology and skills. Thanks to their investment, Vietnam can raise the quality of many industries, through advancing our technology knowledge, developing our labor average skill level. With their investment, we stand the golden chance to boost our economic growth. Furthermore, these nations have a firm position in the political world. Hence, the appearance of Japan and US firms in Vietnam may be a good tools to draw more FDI inflow to our economy as they play some parts in raising our image, directly and indirectly
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 Establishing counseling agencies and institutions to provide sufficient information to foreign firms and companies. Beside, we can offer some privileges, such as tax relief, tax holiday to small and medium-sized firms, or first-time investing in Vietnam companies. According to UNCTAD, FDI promotion is only a supporting factor to capture the capital inflow to our nation. The decisive determinants are the economic ones, like the macroeconomic stability, infrastructure, etc. However, it does not mean that FDI promotions significance is inferior to their. All in all, our government must form a detailed and specific plan to get the FDI inflow to our countries to achieve the goal of sustainable economic growth. Each policy may not be equally important but it can result in a great deal of disadvantages if our government ignores one factor.

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Conclusion
After Doi Moi policy, the economy of Viet Nam has changed substantially. It seems that all barriers were nearly erected to make rooms for more open doors to international trade. Therefore, from 1988 until now, there is an increasing FDI flow into the country. However, this trend is fluctuated during time as a result of different economic event in the world, as well as government policies. FDI flow in Viet Nam showed a good sign when reaching its first peak in 2006 thanks to being a member of WTO. We can divide it into 5 remarkable periods: 1988 1996 (first boom), 1997-1999 (fall from grace), 2000-2005 (slow recovery), 2006-2008 (postWTO strong growth), and 2009-now (struggling in world crisis-turning a new leap). Through the 2-way linkage econometrics model above, we can conclude that FDI and economic growth have an intense relationship. At first, economic growth is one of the main factors affecting the FDI inflow in Viet Nam. Furthermore, we cannot deny the direct effect of FDI on economic growth, which shows a positive sign. This explains the importance of FDI in boosting the development of Viet Nam economy besides other factors such as exports, government expenditure, the growth rate of labor, learning by doing ratio, number of university or college students per 1000 people. Firstly, through FDI channel, investors pour a large amount of capital as well as bring advanced technology to build direct investment enterprises which play part in providing more job opportunities and input demand as well as supply for some domestic industries. This leads to high production capacity of the economy. Secondly, with access to advanced technology, FDI contribute to develop human resources in Viet Nam. Besides, direct investment enterprise activities have forced the domestic enterprises to innovate their technology and management in order to enhance product quality and competition as well. Thirdly, FDI also contribute substantially to the government revenue and macro stability. In brief, economic growth and development is a great desire of our country. However with internal capacity, our country cannot satisfy that desire. So, FDI will continue to play a more and more essential role in Viet Nam. But, you can see that among many registered FDI projects only some projects are implemented, the size of FDI in Viet Nam is still small, and it just focuses on industrial sector in urban areas and industrial zones. In order to create a more attractive

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environment for FDI and direct the FDI to the right orientation, we have some suggestions above and summarize as follows: First, lowering interest rate, this is a short-term suggestion for Viet Nam. Second, aiming structural changes direct the FDI inflow into knowledge and technology based industries (such as biology, energy, education, medicine, etc.) Third, promoting R&D enhance and intensify the quality of export product, add more value to the BOT. Fourth, promoting FDI Vietnamese government must plan and set up campaigns to attract the foreign investors to compete with many program implemented in other nations in the world. Limitations of FDI Although FDI is showing its importance, we together with our government cannot help paying attention to some problems created by illegal and unsuitable FDI projects. One of the most serious problems is environmental pollution. There records cases of direct investment enterprises have discarded their waste including toxic chemical and undissolved substances into environment without treatment. Otherwise, many firms also abuse agricultural land or sea beaches for constructions. All these things absolutely affect on the stable development of our country and it also reflects the loose and poor management capacity and corruptions. To deal with those problems, there is a need for strict intervention of government or competent authorities.

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Appendix 1: Reference
www.vi.unctad.org www.wikipedia.org www.worldbank.org http://www.gso.gov.vn/default_en.aspx?tabid=471&idmid=3 http://www.indembassy.com.vn/tabid/241/default.aspx http://www.vietpartners.com/Statistic-fdi.htm http://www.indexmundi.com/g/g.aspx?c=vm&v=66 Foreign direct investment and economic growth in Vietnam _ Sajid Anwar and Lan Phi Nguyen Research report: The impacts of foreign direct investment on the economic growth in Vietnam by research team : Nguyen Thi Tue Anh, Vu Xuan Nguyet Hong, Tran Toan Thang, Nguyen Manh Hai. (Hanoi 2006)

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Appendix 2: Contribution
No 1 Name V Hong Dng Contribution The leader of the group. He is very responsible and melticulous. He was the one who collected the ideas from all the members and then, suggested the overall outline of the group. Moreover, he was very keen on looking for datas. Because of the lack of numerical datas to build the econometric model, he went to the GSO directly to find the data. Also, Duong was the main man to find the most important reference materials. The part of Policy suggestions was conducted by him. He will present this part in the presentation session. 2 Dng V Hong Anh A key member to the whole group. She took part in all the most important parts of the assignment, from providing suggestions for the outline, collecting numerical datas to writing and revising the assignment. She was mainly responsible for the 2 econometrics model, with focus on the model of Determinants of FDI inflow in Vietnam. As a leader, I totally believe that Hoang Anh is the most eager member, and has the most contribution to the group. 3 on Th Qunh Trang A hardworking girl. Although Trangs writing part in the assignment is not too much as she held responsible for the Conclusion, she is still a very essential member. Trang has several outside-the-paper contributions. She also joined Hoang Anh and conducted the part of model 1. She was extremely productive in finding datas, as well as finding materials for reference to the group. She also had a role in producing the slides. She will present to the class the second model of our paper.

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L Th Hi Hin

Hien is the member who wrote some crucial parts in the assignment. She wrote about the Characteristic of FDI in Vietnam, as well as took some part in writing the 2nd model of Determinants of Economic growth in Vietnam. Hien was very melticulous as she always revised her writing to get the best version of writing for her part.

Nguyn Th Hnh Minh

One of the members who will present. She also contributed to the writing of our paper. She wrote about the Periods of FDI inflow in Vietnam. Also, she was with Hien and Tang Thuy to be responsible for completing the part of 2nd model.

Tng Th Thanh Thy

Researching and writing about the Policy framework of Vietnam to attract FDI. Also, she was with Hien and Hanh Minh to be responsible for completing the part of 2nd model.

Phm c Anh

Writing the Definitions of FDI, Types of FDI and commenting on the Current trend of FDI in Vietnam. He also will present about the overview of FDI in Vietnam.

Bi Hi ng

Writing the Determinants of FDI in the 1st part of our paper. He was mainly responsible for creating the slides, as well as checking the overall content. He also was very eager and enthusiastic in collecting some numerical datas. At the end, he suggested using some available models that have already been conducted due to the lack of data.

Phan Duy Quang

Writing the Introduction and the literature review of the 2nd model. Quang also contributed some datas and materials for our paper. He, Dang and Duc Anh were responsible for conducting the final revision and correction of all the parts in the assignment.

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