KOREA UNIVERSITY – ECONOMICS DEPARTMENT 

               

 

 

 

DISTRIBUTION OF FOREIGN DIRECT INVESTMENT (FDI) 

ON ECONOMIC GROWTH IN VIETNAM 

 

 

Supervisor: Prof. Lee, Hong Sik 

Student: Nguyen, Thi Van Anh 

 

 

 

 

Korea, December 2009 

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DISTRIBUTION OF FOREIGN DIRECT INVESTMENT (FDI) ON ECONOMIC GROWTH IN VIETNAM

 

Motivation:  There are a numerous of research studied about benefits from advanced countries, whose production factors movement enter into developing or lower-developed countries to seek for huge benefits via comparative advantages of capital, management skills, high-technology such as: ownership, locational advantages, internalization, lower cost, competitive improvement, etc. That is why there are lots of companies in developed countries launching their strength to developing countries through capital movement by forms of investment known as Foreign Direct Investment (FDI): Business Corporation Contract (BCC), BOT, BTO, Parent-children Companies, and one of the most popular one is 100% foreign owned. The idea about studying benefits of FDI host countries originally comes from Chapter Seven: “International Factor Movement” in “International Economics: Theory and Policy” by Krugman and Obstfeld, 6th edition. The question is that whether FDI receiving countries benefit from FDI inflows; FDI is a bilateral advantage in spite of home countries only and these economies are better-off by those capitals. This proposal is a very generally viewed level about effects of FDI on economic growth in Vietnam from 1988 to 2007.

1. Objectives of the proposal

The general aim of this study is to show the distribution of FDI on Vietnamese economy’s growth. Although influences of FDI on economic growth are now debated by economists and they are clearly both negative and positive effects but in the modest scale of this proposal, positive effects will be referred in terms of higher GDP rate, larger export capacity and employment improvement.

2. Methodology

Due to the limitation of available data and lacking up-dated information, several research methods have been used in order to analyze the objectives of the proposal, including desk review, quantitative analysis and re-using some available results from experts.

3. Data sources

The proposal mainly uses data from the Annual Investment Report of UNCTAD, reports from Asian Development Bank (ADB), the Government Statistics Office (GSO) of Vietnam, the Ministry of Planning and Investment (MPI), official data from the website: www.vneconomy.vn and annual Statistical year books.

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4. Outline of the proposal

It is divided into 2 parts due to the modest scale of this study including reviewing positive effects of FDI on Vietnamese economy from 1988 to 2007 and giving some comments to improve FDI attraction also economic growth.

I. FDI effects on economic growth

I.1 FDI overview

Vietnam has been quite successful in attracting FDI inflow since the inception of economic reform in 1986 known as “doi moi” (renovation), a comprehensive change by restructuring the economy from a planned economy to a market-oriented one. Since then, the Vietnamese economy had shown a remarkable performance as one of the fastest growing economies in the world. With the average GDP growth rate at over 7.3 percent per year and peaking at 8.5 percent in 2007 (Statistical Year Book, 2007), the living standard has improved substantially. The significant contribution of FDI to economic growth also has been realized through the poverty rate fell down from 80 percent in 1986 to 58.1 percent in 1993 and roughly to 22.0 percent in 2005 (ABD 2006) (MPRA, 2002); GDP per capital increased from US$ 100 in 1990 to over US$ 700 in 2006 and US$ 850 in 2007 (www.vneconomy.vn); total gross domestic product increased from US$ 15 billion to over US$ 53 billion in 2005; annual inflation roughly fell from 774 percent in 1986 to 67.5 percent in 1990; 12,7 percent in 1995; 8.8 percent in 2005 and rose up to 12.6% in 2007.

As a latecomer in the region for attracting FDI and as a transitional economy Vietnam has issued since 1988 up to end of 2007 9,810 licenses with total registered capital amounting to nearly US$ 100 billion in which total implemented capital reached over US$45.5 billion (MPI, 2008), four times greater than that of 1995 (UNCTAD, 2006). In UNCTAD’s ranking, from a host country of low inward FDI potential index during 1988-2001, Vietnam has since 2001 ranked as a “front runner”, with high FDI inflows and performance indices. Especially, FDI inflows attracted in 2007 was extremely impressed and broke any FDI records before. (Chart 1)

 

 

 

 

 

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Chart 1: FDI Registered and Implemented Capital

 

                              Source: Ministry of Planning and Investment in Vietnam (MPI) 

  As we can see from Chart 2, the major form of FDI investment is 100% foreign owned, flowing is joint venture. In the early days of economic reform, the Government had a strong preference for FDI in joint venture; up to 1995, the majority of projects each year were of this form. The trend, however, has been for the share of 100% foreign affiliates to increase over time; from 1996 onwards, mainly new projects have been in this form. Specially, from 2006, 100% foreign owned are significantly larger than joint venture so that, in terms of capital invested, the bulk is still in the form of the former. The four remaining forms of FDI investment (BCC, joint stock, BOT–BTO–BT and Parent – affiliates) share a modest number of projects.

Chart 2: FDI in Vietnam in the forms of investment

              

         Source: General Statistics Office of Vietnam (GSO), 2008 

 

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I.2 FDI effect on GDP growth

The foreign-invested sector is consolidating its important role in Vietnamese economy. FDI has been an important supplementary source of funds for gross national investment and improved the balance of payment for the past years. As depicted in Chart 3, the share of FDI in national investment has fluctuated considerably due to up and down changes in FDI inflows and changes in investment by domestic investor on the other hand. In the period 1994-1995, the share of FDI in gross national investment hit a record high level of 30 to 31 percent. After that, it gradually decreased and in 2005, implemented FDI only accounted for 15.5 percent of gross national investment.  (Chart 3) 

Chart 3: Shares of Implemented FDI in gross national investment and FDI sector in GDP (at 2004 price)

 

Source: after Nguyen et al., 2006

The share of FDI sector in GDP has been increased over the last decade. In 2004, FDI sector accounted for 15.2 percent of GDP, higher than that of about 6.4 percent in 1994. Besides, foreign-invested sector always has the most rapid growth, making it the most economically vibrant sector so far. The growth rate of this sector is always greater than the country average level as shown in Chart 4 below.     

 

 

 

 

 

 

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Chart 4: FDI shares in GDP and industrial output 

 

Source: GSO, 2006 (* estimated data)

With foreign investors increasingly attracted to export-oriented industries, FDI has also played an important role in export growth, especially after the crisis in 1997. During 1992-1994, the share of FDI in total exports was only 4 percent; from 1996 its share presented more than 20 percent of total exports. Since 1999, the share has surpassed 40 percent and climbed to more than half of total export since 2003. It is clear that the growth of exports by FDI sectors have been quite high. On the other hand, exports of domestic firms gradually increased, average growth rates were 14.9 and 12.6 percent for 1995-1999 and 2000-2005, respectively. It may be inferred that FDI certainly has some positive impacts on domestic firms’ exports.

Table 1 more clearly shows the relative of growth to GDP structure in percent:

Table 1: Growth and GDP structures by economic industries (%) 

 

Source: World investment report, 2007

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I.3 FDI effect on export capacity

In strengthening industrial production and export capacity, FDI also plays a crucial role. FDI projects to Vietnam are mainly implemented in industrial sector, as mentioned above. Hence, for the past decade, number industries such as oil and gas exploitation, telecommunication, electronics, etc have been established. In 2004, share of FDI sector in the total industrial output, at 1994 price, was 35.68 percent, showing a rise from that of 25.1 percent in 1995. This sector currently accounts for 100 percent output of some products such as oil and gas, automobiles, steel, machinery, fibers, shoe leathers, food and beverages and so on. In particular, the growth rate of industrial output produced by FDI enterprises was always higher than that of the whole industrial sector in the period from 1995 to 2005 (except the year of 2001). However, in 2004, the growth of this sector is lower that the whole industrial sector, which is largely due to the rapid expansion of the domestic non-SOE sector. (Chart 5)

Chart 5: GDP and export growth rate (percent)

 

Source: GSO 2008

From 1991 to 2004, Vietnam’s export turnover has increased more than 13 times, from US$ 2 billion to US$ 26.5 billion. The share of FDI sector went up accordingly, from 4 to 54.6 percent, respectively. It should be noted that, despite its export share, FDI sector only has modest net export values. This is because FDI projects in industries mainly employ small-scale assembly lines and the majority of their inputs come from imports. (Chart 6)

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Chart 6: Effect of FDI on Export capacity

 

Source: IMF 2006

It cannot be denied the leading role of FDI in export growth, especially after the crisis in 1997. During 2 years from 1996 to 1997, the FDI-invested sector’s contribution to exports registered a growth rate higher than 80 percent, accounting for about 20 percent of exports. In 2000, it accounted for 23.2 percent of total exports and this value has increased during the last two years. Transnational corporations investing in Vietnam during the last decade provided export market access; moreover, FDI has served as a catalyst for other domestic exporters. During 2002, the contribution of FDI to total exports was particularly relevant in some key industries such as footwear; textile and garment; electronics and supplies. It accounted for 82 percent of the later, 42 percent of footwear exports and 25 percent of textile and garment exports (Bui 2004).

Table 2: FDI contribution to GDP and Export (percent)

 

Source: Foreign Investment Agency – MPI (2007)

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I.4 Employment growth rate

  Recently, FDI companies in Vietnam have employed nearly 730,000 labors, accounting for only 1.5 percent of total labors in Vietnam, though higher than it was in 1996 (0.7 percent). The underlying reason is that the presence of FDI is mainly in capital intensive industries which use highly skilled labors. This may also explain why the wage level in FDI sectors is, on average, twice as high as that paid by domestic enterprises in the same industry (MPI, 2005). More importantly, these labors are able to access to advanced technology, with good working disciplines, and modern working methods. In particular, some Vietnamese specialists become gradually capable of taking over the management of firms and modern technology lines. FDI also indirectly creates many jobs in service sector and those have close linkages with FDI enterprises through providing row materials, intermediate products, etc.

However, there is a reality that FDI did not create as much employment as expected. Despite their share of GDP, total investment and exports, foreign-invested enterprise in 2000 accounted for only 2 percent of the total number of people of working age in the labor force, according to Vietnam GSO. Other studies report even lower share. For example, McCarty and Diep (2003) report estimates of FDI’s share of total employment between 1991 and 2000 at 0.6 percent. In terms of contribution to total employment up to 2000, FDI enterprises accounted for 6.4 percent of total labor in industry and construction; 0.2 percent in agriculture, forestry and aquaculture; 0.4 percent in service sectors. (Chart 7)

Chart 7: Direct Jobs created by FDI sector

 

Source: after ERD working paper No.56

Up to the end of 2001, industry played the major role in creating new jobs, accounting for 77 percent of total labor in the FDI sector. Agriculture, forestry and aquaculture reached only 10

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percent and the rest is devoted to services and transportation sectors. During 2002, industry’s share was 83 percent of the over 650,000 jobs created by the FDI sectors while agriculture’s share was 10 percent and 7 percent was obtained by services. In 2001, light industries attracted the largest share, equivalently 50.6 percent of the total labor generated by the FDI sector. (Chart- 8)

Chart 8: Jobs created by FDI sector, 2001

 

II. Conclusion and some comments

II.1 Conclusion

Since the promulgation of Law on Foreign Investment, Vietnam has achieved quite impressive performance in attracting FDI inflows. Together with the magnificent GDP growth, FDI sector accounts for an increasing share in GDP. This resulted from reform policies that Vietnam has pursued for the past two decades, while suggesting the interrelationship between FDI and economic growth. It cannot be denied that FDI inflows is one of the most important levers having huge effects on capital shortage cycle that gives Vietnamese economy an effective and optimal ride to get her objectives more quickly. It is not undoubted that FDI – invested sectors have created a numerous jobs and lots of good opportunities for Vietnamese labor to closely reach modern technologies, new working methods and more professional environment. Thanks to FDI-invested sectors, the living standard is getting higher and higher, indirectly reducing poverty rate in Vietnam. All the figures above already show that FDI is a bilateral benefit for home countries as well as recipients in terms of host countries.

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II.2 Some comments

FDI has represented an extremely important source of growth for the Vietnamese economy. However, its impacts on employment and export capacity have been limited than its potentiality. Even the imposed local content requirements have not yielded the desired results. The elementary reason for these results appears to lie in the underdevelopment of the private sector and its consequent inability to take advantage of the presence of foreign firms through powerful linkages.

Strengthening the competition ability will involve a number of changes. It will require creation of more level playing field between state and private firms, closer co-corporation between Government and firms. And indeed, a more transparent and complete regulatory system will be required to establish a rule- based commercial environment.

If Vietnam continues reforms on governance, the financial sector, and its legal system, regional integration through international economic organization could present the country with a much larger market in which to reveal its comparative advantage, improve its productivity and raise the living standard also growth rate of the economy.

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References

1. Nguyen Phi Lan, "Foreign Direct Investment and its linkage to economic growth in Vietnam: A provincal level analysis", Centre for Regulation and Market, Analysis - University of South Australia, Adelaide, SA 5001, Australia - November 2006

2. Department for International, "Workshop on Globalization and Poverty in Vietnam", DFID Vietnam - British Embassy Central, September 2002 in Hanoi

3. Hoang Thanh Huong, "FDI and Wages: Evidence from Vietnam's FDI Employee Survey", March 2009

4. Le Dang Doanh, Adviser to the MPI-Minister, "Foreign Direct Investment in Vietnam: Results, Achievements, Challenges and Prospect"

5. Michael Klein, Carl Aaron and Bita Hadjimichael, "Foreign Direct Investment and Poverty Reduction", Policy Research Working paper, No.2613

6. Nguyen Ngoc Anh and Nguyen Thang, "Foreign Direct Investment in Vietnam: An overview and analysis the determinants of spatial distribution across provinces", Development and Policies Research Center, June 2007

7. Nguyen Thi Lan Huong, Luu Quang Tuan, "Investment, growth and employment - The case of Vietnam"

8. Prof.Dr.Hans-Rimbert Hemmer, " Contribution of FDI on poverty reduction in case of 1990s", Institute for Development Economics, No. 30, November 2002

9. Rhys Jenkins, UNCTAD, "Globalization, FDI and employment in Vietnam", Transnational Corporations, Vol.15, No.1, April 2006

10. Vittorio Leproux and Douglas H.Brooks, "Vietnam: Foreign Direct Investment and Post crisis Regional Integration", Asian Development Bank, November 2006

11. World Investment Report 2007