Does Foreign Direct Investment Promote Economic Growth in Vietnam?

Article excerpt

I. Introduction

Foreign direct investment (FDI) plays an increasingly important role in the developing world because it has been recognized as a growth-enhancing factor in developing countries. Literature on economic growth showed that there are a number of channels through which FDI permanently affects economic growth. FDI can affect output and income by increasing the stock of capital, increasing the labour force through job creation, and enhancing the human capital through technology and knowledge transfers via labour training, skill acquisition, new management practices and organizational arrangements. In empirical studies, the effect of FDI on economic growth has been far from conclusive. A large number of applied papers have looked at the FDI-growth nexus such as Markiw, Romer, and Weil (1992), Borensztein, Gregorio, and Lee (1998), De Mello (1997), Flexner (2000), Zhang (2001, 2006), Khawar (2005), and Li and Liu (2005). However, a number of studies do not lend support to the view that FDI promotes economic growth. (1)

Since the launch of market-oriented economic reforms in 1986, it was recognized that the existence and the role of multi-ownership structure in Vietnam's economy needs encouragement of the two sectors: the private sector and FDI. Market orientation and open economy were also two important policies to help Vietnam move towards trade liberalization. Realizing this, the Vietnamese government quickly joined the competition for FDI with other regional and global markets. They did this by restructuring the domestic economy and opening up the economy for external trade and investment. Economic growth and FDI increased dramatically in Vietnam over time. In 2006, the GDP value was nearly four times that of 1986. For two decades since 1986, the Vietnamese economy has grown at a rate of 7 per cent annually. The total registered capital of FDI in Vietnam in 2001-05 was about 13 times that of the 19882000 period. The registered capital in 2006 was the highest (US$12.0 billion) and accounted for 1/6th of the total capital registered. This was achieved due to Vietnam's market-oriented policies and integration into the global economy through large foreign capital inflows.

Although the issue of impact of FDI inflow on the host country's growth have been addressed in previous literature, contribution to this issue in the case of Vietnam is rather limited. There are only some papers analysing the effect of FDI on economic growth in Vietnam over the past years, all showing a positive effect of FDI on economic growth. Hoa and Hemmer (2002) and Tran Trong Hung (2005) examined the effects of FDI on economic growth in Vietnam and analysed indirectly the impact of FDI on poverty reduction in Vietnam in the 1990s. Nguyen Phi Lan (2006) concluded that FDI had a positive and statistically significant impact on economic growth by using the panel data set for sixty-one provinces of Vietnam over the period 1996-2003. However, this study did not test for serial correlation, so that the result may be biased if the variables are correlated with each other.

This study reassesses the effect of FDI on economic growth in Vietnam and contributes to the literature in following aspects. Firstly, the study considers a broader time period (1995-2006) in comparison to previous works. Secondly, the study covers the larger set of the explanatory variables served for the tests. The explanatory variables include the traditional variables used in the growth model (labour, human capital, domestic investment and FDI) as well as the trade variable and the Vietnamese's region dummies. Thirdly, it is the first time interactions of FDI with trade, domestic investment and human capital are introduced to examine whether FDI affects growth by itself or through interaction terms. Finally, the paper uses the Panel Least Square method to extract consistent and efficient estimates of the effects of FDI inflows in economic growth instead of using time-series and cross-section methods as other past works. …