Academic journal article Journal of Southeast Asian Economies

Does Foreign Direct Investment Promote Economic Growth in Vietnam?

Academic journal article Journal of Southeast Asian Economies

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. As pointed out by Hsiao (1985, 1986), Klevmarken (1989) and Solon (1989), using the panel method is better to control for heterogeneity of explanatory variables, exploit the time-series variation in the data and account for unobserved province-specific effects. The economic techniques could reduce biases and make the results more valuable.

The next section gives a brief background on the economic growth and FDI development in Vietnam. Section III shortly reviews theoretical and empirical evidences on the effect of FDI on economic growth. Section IV provides the methodology and data applied for the empirical study in Vietnam. Section V discusses the empirical results and interpretations. Conclusions are presented in the final part.

II. An Overview of Economic Growth and FDI in Vietnam

Vietnam has been in transition from a centrally planned to a market-oriented economy since December 1986. From that time up to the present, Vietnam had seen amazing economic achievements in growth of gross domestic product (GDP), GDP per capita, FDI, and important trade and economic agreements signed with major partners.

The economic growth rate of Vietnam dramatically increased since 1986 (Table 1). From 4.4 per cent of average GDP growth rate in 198690, it went up to 8.18 per cent in 1991-95. The increase in GDP resulted in increasing per capita income from US$86 in 1988 up to over US$288 in 1995. However, due to the Asian financial crises in 1997-98, the GDP growth rates declined to 5.8 per cent in 1998 and went down further to 4.8 per cent in 1999. The economy successfully recovered and grew at 7.48 per cent during the five-year plan 2001-05. This helped the country increase its national income per capita over time. In 2005, the GDP per capita of Vietnam was US$639.1, double of that in 1997 and more than seven times that of 1986 (GSO 2006). This achievement and the stable development of the society showed that the chosen reforms of Vietnamese leaders were going in the right way, and the contents and implemented measures at the macro level were ensuring growth.

The reason behind the achievements was the fast development of all economic sectors, especially the industrial sector. Since Resolution No. 10 on management renovation in Agriculture came on 5 April 1988, (2) the agriculture-forestry and fishing sector's growth rates had continuously increased from an average 2.72 per cent in the year 1986-90 to 4.12 per cent, 4.4 per cent, 3.84 per cent and 3.4 per cent in 1991-95, 1996-2000, 2001-05 and 2006, respectively (Table 1). Since then, Vietnam has also changed from a rice-importing country (it imported 450,000 tonnes of rice in 1988) to the third biggest exporter of rice in the world (Vietnam exported 1.4 million tonnes in 1989, 1.4 million tonnes in 1990, 4.06 million tonnes in 2004, and 5.25 million tonnes in 2005 (GSO 2006)). Moreover, Vietnam is also one of the largest exporters of pepper, coffee, rubber and tea.

The industry and construction sector had grown remarkably. At the end of 1988, Regulation 217/ HDBT gave the state-owned enterprises (SOEs) autonomy to do business and stated that the government would no longer subsidize them. The SOEs stopped receiving capital from the government budget for their activities and are now required to obtain bank loans and pay interest. During the adaptation period, the industrial and construction sector grew at an average rate of 4.8 per cent during the period 1986-90. However, after adaptation, the industrial sector expanded quickly, about 12.02 per cent in 1991-95 and more than 10 per cent during the 1996-2006 period. Eventually it became the main source of economic growth (Table 1). The development was the result of increasing inflows of foreign capital in heavy industries of gas, electricity, cement, steel, paper and agriculture processing. Some key products of Vietnam's industries are crude oil, gas, aquaculture processing, paper, garment, coal, textiles, chemical, fertilizers, cement, iron and steel.

The service sector has been continuously increasing since 1988 and had a high growth rate (about 8.6 per cent) during the first half of the 1990s. This was due to open economic policies of the government. The rise was mainly from the improvement in administration, banking reform, trade liberalization and tourism.

Besides the increase in GDP growth rates, Vietnamese economic structure has also shifted in the direction of industrialization and modernization. Vietnam's economy transformed itself from being a primary sector dependent economy to a more industry and services sector oriented one (Table 2). During 1986-90, agriculture, forestry and fishing factor accounted for 41 per cent of total GDP output, and it decreased to 22.29 per cent in 2001-05. Industry and services sectors have higher shares of GDP--39.44 per cent and 38.27 per cent respectively in the first five years of the twenty-first century. Even though the share of the services sector decreased during 2001-05, several sub-sectors such as banking and finance, communication, import trade, insurance and tourism grew faster than previously. The change in the economic structure was in the right direction and suitable with the industrialization and modernization policy announced by the government.

With an objective to develop a socialist-oriented market economy under the State's management, the Vietnamese government kept the central leading role of the state sector while facilitating the development of other economic sectors. As a result, the number of state-owned enterprise declined, (3) while the state sector's share of GDP did not change much overtime. The number of the foreign-owned and non-state enterprises is growing. However, foreign investment sector's share of GDP increased, from 1.14 per cent in 1986-90 period to 17 per cent in 2006, and the proportion of the non-state sector in GDP decreased from 63.6 per cent in 1986-90 to 45.6 per cent in 2006.

From the granted legal status for FDI inflows in late 1987 (4) and the fast growth of the 1990s, Vietnam has greatly attracted attention from foreign investors. From 1988 up to December 2006, there were 8,266 FDI projects receiving investment licenses in Vietnam with the total registered capital amounting to US$78,248.2 million. In 2006, there were 987 FDI projects with the registered capital of US$12,003.8 million, accounting for more than one sixth of the total capital FDI registered (GSO 2007).

During these years, Vietnam's economy attracted FDI in all sectors. The share of FDI in the industry sector has been increasing during the time, from 39.9 per cent in 1988-90 to 52.3 per cent in the 1990s and up to 74.2 per cent in the first half of the twenty-first century (Table 3). Following the industry sector in the 2001-05 period, the transport-storage-communication sector accounted for 5.7 per cent of the total FDI invested; the hotel-restaurants-tourism sector reported 4.5 per cent; and the finance and banking sector accounted for 3.3 per cent of the total FDI capital.

Table 4 shows changing trends in the distribution of FDI inflow into the industrial sector during 1995-2006. Manufacturing accounted for 70.1 per cent of the total FDI invested in the industry sector, flowed by the mining and quarrying with 29.4 per cent, and then by the sector of electricity, gas and water supply. However, clearly the crude petroleum and natural gas industry had attracted the largest share of the FDI invested in industry activities during the 1995-2006 period. The crude petroleum and natural gas industry were strongly decreasing their share in the total from 41.7 per cent in 1995 to 31.9 per cent in 2000 and 14 per cent in 2006 because of reduction of the oil and gas exploitable density. The second position was taken by the manufacture of food products and beverages activity, which accounted for 19.9 per cent in 1995 and about 14 per cent in the 2000-2006 period. There was an increase from 4.9 per cent to 7.3 per cent in the tanning and dressing of leather; manufacture of the leather products as well as enlargement in the motor vehicle assembly and repair industry from 4 per cent to 5.4 per cent in 1995 and 2006.

According to the Ministry of Planning and Investment, all eight regions and sixty-four provinces of Vietnam have attracted FDI, but foreign investors predominately concentrate their investments in key economic areas where they can take more advantage. Table 5 shows that during 1996-2006, the South East region accounted for 53.7 per cent of the total FDI invested in Vietnam, followed by the Red River Delta with 27 per cent of the total committed FDI. The South East and the Red River Delta regions attracted most FDI inflows into Vietnam as they are considered the two engines of Vietnam--Ho Chi Minh City and Hanoi. These regions have developed infrastructure (such as volumes of roads, airports, freight, postal services and telecommunications), large numbers of industrial firms as well as developed politics, trade, services, science and technology. From Table 5, Ho Chi Minh City is the top province that attracted FDI inflows over the period 1996-2006 and accounted for 20.3 per cent of the total FDI registered capital in the whole country, followed by Hanoi (15.9 per cent), Dong Nai (12 per cent), Ba Ria-Vung Tau (10.8 per cent) and Binh Duong (9.3 per cent). With all the advantages of location, infrastructure and domestic strategies, the two regions have been quickly increasing the number of invested projects from the foreign investors.

In short, after more than twenty years of Doi Moi in 1986, Vietnam has recorded relatively high growth rates, which have increased from year to year. The annual average GDP growth rate in the 2001-2006 period of about 7.5 per cent satisfied the planned targets. The economic structure has gradually shifted along the lines of industrialization and modernization, closely tied to the market for better efficiency. Even though unequally distributed into different sectors, regions and provinces, FDI inflows in Vietnam are showing a continuous increase in both the registered capital and invested projects in the Vietnamese economy during its transition. Although both the FDI inflow and the economic growth are increasing in volume in Vietnam, the effect of FDI inflow on economic growth is still in question. This will be addressed in the following sections of the paper.

III. Review of Literature

III.1 In World Studies

There are many studies that examine the effect of FDI on economic growth of the host countries. The theoretical foundation for empirical studies on FDI and growth derives from either neoclassical models of growth or endogenous models of growth. In the neoclassical growth models, FDI is traditionally considered as an addition to the capital stock of the host country. With an assumption of diminishing returns to physical capital and technological change being exogenous, FDI has no permanent impact on the growth rate. FDI can only affect the level of income under its contribution to capital accumulation in the host country without influencing the long-term growth rate (long-run growth unchanged). In new endogenous growth models, there are a number of channels through which FDI permanently affects the growth rate in the long run. Like neoclassical models, FDI can affect output directly by increasing the stock of capital. However, this impact is likely to be small under the assumption of perfect substitutability. As new endogenous growth models consider long-run growth as a function of technological progress and human capital augmentation, the main channel that FDI can increase the growth rate is by increasing production through technology transfer, productivity spillovers and externalities (De Mello 1997). FDI is a composite bundle of capital stock, know-how and technology and can increase the exiting stock of knowledge in the recipient economy through labour training, skill acquisition and diffusion and through the introduction of alternative management practices and organizational arrangements.

Empirically, the effects of FDI on economic growth remain ambiguous. While some studies observe a positive impact of FDI on economic growth, others detect a negative relationship between the two variables. Borensztein, Gregorio, and Lee (1998) run regressions using a cross-sectional data on FDI flows from industrial countries and concluded that whether FDI increases the economic growth through the magnitude of its effects depends positively on the level of human capital available in the host country. This level of human capital is reflective of the absorptive capacity of the host country to new technology. The study by Balasubramanyan, Salisu, and Sapsford (1996) found FDI enhances growth in which the host country has adopted trade liberalization policies. They show that FDI is more important for economic growth and helps in export-promoting than in import-substituting countries. Zhang (2001) also had an analysis of FDI effects on growth in China under the theory presented in Barro and Sala-I-Martin (1995) and had a similar result as Balasubramanyan, Salisu, and Sapsford (1996). His paper supported the fact that FDI contributes to China's economic growth through direct effects, such as an increase in productivity and promoting exports, as well as positive externality effects in terms of facilitating transition and diffusing technology.

Lopez-Calva and Rodriguez-Clare (2000) argued that Intel's investment in Costa Rica in 1997 increased growth by generating the substantial spillover benefits for the local economy such as creating new training programmes in higher education institutions and attracting new suppliers to Costa Rica. Moreover, Bengoa and Sanchez-Robles (2003) showed that FDI is positively correlated with economic growth but host countries require human capital, economic stability and liberalized markets in order to benefit from long-term FDI. Using the panel approach, Baharumshah and Thanoon (2005) confirmed the positive effect of FDI on economic growth in East Asian countries, including China, in the short run and long run. They showed that the positive influence of FDI on growth was higher than domestic savings in favour of the hypothesis that FDI inflows are more productive than domestic investment. Moreover, the paper also concluded that the spillover effect of knowledge embodied in FDI might increase domestic productivity, and hence promote growth. The study by Li and Liu (2005) investigated whether FDI affects economic growth based on a panel of data for eighty-four countries over the period 1970-99. Using single equation and simultaneous equation system techniques, the paper concluded a significant endogenous relationship between FDI and economic growth that was identified from the mid-1980s onwards. FDI not only directly promoted economic growth by itself but also indirectly did so via the interaction of FDI with human capital.

While many studies found a positive relationship between FDI and economic growth, other studies have found the opposite. Carkovic and Levine (2002) used the two new databases of World Bank and IMF of seventy-two countries over the period of 1960-95 to analyse the relationship between economic growth and FDI and found that FDI does not exert a robust, influence on economic growth. Moreover, they showed that the impact of FDI on growth does not depend on the stock of human capital. In a case study on Sri Lanka, Athukorala (2003) also found no robust link between FDI and growth. Moreover, the paper showed that the direction of causation was not FDI to GDP growth but GDP growth to FDI. Using data of eighty countries for the period 1979-98, Durham (2004) also failed to identify a positive relationship between FDI and economic growth.

III.2 In Vietnam Studies

There are only a few papers showing the effects of FDI on economic growth in Vietnam over the years. Aiming to analyse the impacts of FDI on poverty reduction in Vietnam in the 1990s, Hoa and Hemmer (2002) presented the indirect impact of the FDI inflow on economic growth. The estimated coefficients of FDI were significantly positive based on panel data covering sixty-one provinces of Vietnam in the 1990-2000 period. Furthermore, FDI interacted positively with the local human capital in affecting economic growth. Economic growth was then estimated to exert significantly positive impacts on the magnitude of poverty reduction results. Giving the same conclusion as the paper of Hoa and Hemmer (2002), Tran Trong Hung (2005) used the ordinary least squares method to examine the effects of FDI on economic growth as well as the effects of FDI and economic growth on poverty incidence of each surveyed province. The paper showed that FDI had indirect impacts on poverty reduction through economic growth, which resulted in the improvement of living standards, technological progress, and productivity growth.

Nguyen Phi Lan (2006) tested the relationship between economic growth and FDI by generalized method of moments (GMM) in a simultaneous equation model. Based on panel data set for sixty-one provinces of Vietnam over the 1996-2003 period, the paper reflected that FDI had a positive and statistically significant impact on economic growth. Moreover, exports, growth of labour, learning by doing and human capital also helped increase economic growth in Vietnam.

The paper of Vu, Noy and Gangnes (2006) estimated the impact of FDI on growth using the sectoral data for FDI inflows to China and Vietnam. The results proved that FDI had statistically significant positive effects on economic growth operating directly and through labour productivity in both countries. However, the effect was not equally distributed across sectors. In both countries, manufacturing seemed to be the only sector to significantly benefit from FDI inflows, with an additional positive impact for FDI on the oil and gas sector in Vietnam. Other sectors appeared to gain very little growth benefit from sector-specific FDI.

In short, most of the empirical studies on FDI and growth show that the impact of FDI on economic growth is positive. However, there are some studies that give the negative and insignificant relationship between the two variables. The impact of FDI on economic growth is far from conclusive. The role of FDI on economic growth seems to be based on the period of analysis, the sectors, countries and regions used in the sample as well as the economic institutional and technological conditions of the recipient countries.

IV. Methodology and Data

IV.1 The Growth Model

The purpose of this research is to examine the effect of FDI on economic growth in Vietnam over the 1995-2006 period. Based on the theoretical models of the neoclassical and endogenous growth and some empirical analysis models such as Romer (1990), Markiw, Romer, and Weil (1992) and Borensztein, Gregorio, and Lee (1998), we have developed the model to examine the effect of FDI on economic growth in Vietnam. The econometric model is derived from a production function in which FDI is introduced as an additional input, besides labour, human capital and domestic capital. The augmented production function will have the following form:

Y = A [L.sup.[beta]1] F [[beta].sup.2] I[[beta].sup.3] H[[beta].sup.4] (1)

where Y represents output or GDP, L is labour. H denotes human capital as a skilled labour. I is domestic investment. F stands for FDI. A is an overall efficiency factor, capturing the control and policy variables that are not accounting for increase in factor inputs I, F, L and H and frequently included as determinants of growth in cross-host-area studies (see in Barro and Sala-i-Martin (1995), Ch. 12).

Assuming the production function to be linear in logarithms, we take the natural logarithm, and then time derivatives of this production function; we get the determinants of the growth rate of GDP.

GY = [[beta].sub.1] GL + [[beta].sub.2] GF + [[beta].sub.3] GI + [[beta].sub.4] GH (2)

where GY, GF, GL, GI, GH and GX are growth rates of GDP, FDI, labour, domestic investment and human capital. [[beta].sub.1], [[beta].sub.2], [[beta].sub.3] and [[beta].sub.4] represents the output elasticities with respect to labour, FDI, domestic investment and human capital.

We follow the common practice of substituting the ratio of investment to GDP for the growth rate of the capital stock. Econometrically, this changes the estimated value of the regression coefficient. But given the way capital stock estimates are normally computed, it does not imply any loss of information or distortion of the significance of the relationship. There is seldom data on actual capital stocks and most time-series of capital stocks are estimates derived by the perpetual inventory method. This method uses annual investment data and adjusts the accumulated investment by an assumed rate of depreciation. Therefore, in these time-series the variation in the capital stock is driven entirely by annual investment from the national accounts, precisely the same investment in the numerator of I/Y. The investment ratio can conveniently be split into the ratio of total investment minus FDI to GDP, which we denote simply as I/Y, and FDI/Y.

We also introduce international trade as an additional factor input into the production function, following the large number of empirical studies which investigate the export-led growth hypothesis (as Feder 1983; Balassa 1985; Salvatore and Hatcher 1991; Greenaway and Sapsford 1994; and Balasubrananyam, Salisu, and Sapsford 1996). By Salvatore and Hatcher (1991), there are three reasons that we can include trade into the production function. Firstly, the neutrality of incentives associated with export orientation is likely to lead to higher factor productivity because of the exploitation of economies of scale, better utilization of capacity and lower capital output ratio. Secondly, exports (imports) are likely to alleviate serious foreign exchange constrains and can provide greater access to international markets. Lastly, exports (imports) like FDI are likely to result in a higher rate of technological innovation and dynamic learning from abroad. Therefore, in our model, FDI could contribute to economic growth directly through additional capital input and labour as well as indirectly through improving human capital and trade.

Letting province i and time t operate within the theoretical framework, the following panel data equation is used to evaluate empirically the effect of FDI on economic growth in Vietnam:


where i = 1, 2, ...., 61, refers to individual province of Vietnam, and t refers to years from 1995 to 2006. [[beta].sub.i], is the individual effect which assumed to be constant over time t and specific to the individual cross-provincial unit i, while error [[epsilon]] is a stochastic disturbance.

The dependent variable GDPG is the GDP growth rate of province i in year t. The independent variables are constructed by a set of province level factors capturing various aspects of endowments relevant to the determinants of economic growth. L presents the ratio of labour force to population in the province i. HS is the ratio of the number of students in upper secondary school, universities, college and vocational school to the population of the province i at time t, proxy human capital in the host country. TRADE is the share of the total trade (exports plus imports) in GDP. DI is the share of state investment to GDP, presenting for domestic investment and FDI is the ratio of FDI inflow to GDP of the province. Rj is a dummy variable, taken into account to present the regional effects on the economic growth.

IV.2 Hypotheses

The effect of FDI on economic growth is one of the most controversial topics in development economics. The empirical growth literature has identified a number of variables that are typically correlated with economic growth. Like many existing studies, this research expects that the FDI inflow can have a positive effect on economic growth in the whole of Vietnam and its regions. The model also predicts that the effect of human capital, exports and domestic investment are positive impacts of economic growth in Vietnam, while population growth is negative.

Through capital accumulation, domestic investment (DI) and foreign direct investment (FDI) bring financial resources to host countries. Output growth can additionally result from a wider range of goods in FDI and domestic investment related production. Moreover, FDI is considered an important source of technological change and human capital augmentation. Inward FDI introduces technological and managerial knowledge, skilled labour and labour training as well as skill acquisition and diffusion (De Mello 1997; UNCTAD 1992; Zhang 2001). Multinational employees and managers with advanced skills and knowledge can transfer such skills and knowledge to their foreign affiliates by bringing experts and by setting up training facilities. Spillovers of technologies and management skills can enhance environmental management in local firms. All these contribute to economic growth in the host economy. Therefore, FDI and DI are expected to have positive effects on economic growth.

Human capital is an important element of economic growth. The greater the level of human capital development leading to expansion of its physical capital to match a high endowment of human capital, the faster a country grows. Moreover, as a production input, a change in HS is correlated with the change in economic growth. Well-developed labour force, in terms of better education and health, is likely to be able to produce more from a given resource base than less skilled workers. In this paper, we hypothesize not only a positive relationship between economic growth and human capital but also a positive interaction between FDI and human capital in advancing economic growth.

Labour force is one of the important factors of economic growth. Increasing labour force could gain in total factor productivity and economic growth. However, if the labour force is growing, then a share of the economy's investment is used to provide capital for new workers, rather than to raise capital per worker. The paper uses the working age people per population to present labour force with the assumption that labour helps increasing economic growth in Vietnam.

How does international trade affect economic growth? The literature shows that trade leads to higher specialization and, thus to gains in total factor productivity and economic growth by allowing countries to exploit their areas of comparative advantage. Moreover, it expands potential markets, which allows domestic firms to take advantage of economies of scale, exposure to competition and the diffusion of technological innovations and improved managerial practices through stronger interactions with foreign firms and markets. These could result in both higher overall efficiency and possibly a higher level of investment. Based on the discussions, our model expects that both the share of export in GDP and the interaction between FDI and export are positive in promoting economic growth.

The model also includes some interaction terms of FDI with trade and domestic investment as well as human capital. We expect a positive interaction between FDI and human capital in promoting economic growth because the application of advanced technologies of FDI requires a sufficient level of human capital in the host areas. It means that the higher the level of human capital in a host area, the higher the effect of FDI on the host areas' economic growth. We also hypothesize positive interactions of FDI-trade and FDI-domestic investment as the expectation of complementary relationships between FDI and trade in addition to FDI and domestic investment in advancing economic growth.

There are some regional dummy variables (R j) to describe how the effects of different designations on economic growth. Rj takes the value of 1 if the observation belongs to a particular region and 0 if it does not belong to that catalogue. It is expected that a region that has high income, high economic growth, good infrastructure, more openness, highly skilled labour and low wages will see greater effect on economic growth than the other regions.

IV.3 Data

The empirical analysis was presented by balance panel model. Because most of the breakdown data for provinces are generally not available before 1995, the sample covers all sixty-one provinces for the period 1995-2006. Data on the economic growth rate, labour, human capital, domestic investment and FDI used in the tests are taken and calculated from various issues of the Statistical Yearbook of Vietnam, Vietnam

General Statistics Office (GSO). The data of exports and imports in the individual provinces are taken from the Department of Trade of the Vietnam's General Statistical Office and the Socio-economic Statistical Data of 64 Provinces and Cities (GSO 2005). Since the data of FDI and exports are in U.S. dollars, they are converted into Vietnam dong (VND) using yearly average VND/ U.S. dollar exchange rate obtained from the socioeconomic data indicators in the Vietnam: 20 years of renovation and development, General Statistics Office, Vietnam.

V. Empirical Results

Table 6 presents the estimation results of the effect of FDI inflow on economic growth in Vietnam. The results from the column (1) present effects of original factors on economic growth. It shows that all FDI, domestic investment, labour force and trade are positive and have significant relations with the country's economic growth. As a result, if the share of FDI on GDP, the share of domestic investment on GDP, the ratio of labour force on population and the trade openness goes up by I per cent, on average, the economic growth rate increases by about 0.012 per cent, 0.12 per cent, 0.18 per cent and 0.03 per cent, respectively. This means that although both depend on the foreign financial development and the level of trade openness, the economic growth rate of Vietnam is much more dependent on its labour force and the domestic financial development. The significant and positive coefficient of FDI suggests that FDI has a positive effect on Vietnamese economic growth. This result is consistent with the proponent of the FDI-led growth hypothesis such as Balasubramanyan, Salisu, and Sapsford (1996), Borensztein, Gregorio, and Lee (1998), Zhang (2001 and 2004), Khawar (2005) and Li and Liu (2005).

In order to assess whether the relationship between FDI and growth varies with the degree of trade openness, the level of human capital and the domestic investment in Vietnam, the interaction terms between FDI with trade, human capital and domestic investment are included in the model. Including interaction terms in the regressions can capture their interaction effects on economic growth. In column (2), we evaluate whether the impact of FDI on growth depends on the stock of human capital. We include the interaction term between FDI and human capital (FDI*HS) in the regression. According to Borensztein, Gregorio, and Lee (1998), in countries with low levels of human capital, the direct effect of FDI on growth is negative or insignificant. However, once human capital passes a threshold, they find that FDI has a positive effect on economic growth. The rationale is that only countries with sufficiently high levels of human capital can exploit the technological spillovers associated with FDI. The result presented in column (2) shows that the coefficient of FDI is positive and significant, while the coefficient of the interaction term does not enter significantly and is negative. The results indicate that the FDI impact on growth does not depend on the stock of human capital.

The model also evaluates whether the relationship between FDI and growth varies with the degree of trade openness. Balasubramanyam, Salisu, and Sapsford (1996, 1999) and Kawai (1994) found evidence that FDI is particularly good for economic growth in countries with open trade regimes. From the result presented in column (3), both the coefficients of FDI and the FDI*TRADE interaction term do not enter significantly. This implies that the flow of advanced technology brought along by FDI cannot increase the growth rate of Vietnam by interacting with Vietnam's trade.

To further investigate the effect of FDI on economic growth, we comprise the interaction term of FDI and domestic investment (FDI*DI) in the regression as we want to assess whether the level of domestic capital in Vietnam influences the Growth-FDI relationship. Beck, Levince and Loayza (2000) stated that better developed financial systems improve capital allocation and stimulate growth. FDI could advance economic growth by augmenting capital accumulation in the host country. This would require that FDI does not crowd out equal amounts of investment from domestic sources by competing in product markets or financial markets. In addition, FDI could increase economic growth if it is more efficient than domestic investment. The result in column (4) shows that the FDI-domestic investment interaction term presents weakly negative and significant coefficient. As we presented in column (1) of Table 6, the effect of domestic investment on economic growth rate is much higher than the effect of FDI. Since adding the interaction term of FDI and domestic investment in the regression, the result shows that even though the effect of the domestic investment on economic growth is higher than that of the FDI, the effect of the domestic investment on economic growth is decreasing while the effect of the FDI is increasing. As a result, we conclude that the FDI inflow crowds out the domestic investment in Vietnam, and then it decreases the economic growth when FDI interacts with domestic investment.

In column (5) of Table 6, three interaction terms are included in the growth regression. The same outcome as in columns (2)-(4) has been estimated. The results show that the interaction terms of FDI-human capital and FDI-trade do not enter significantly and the FDI-domestic investment interaction term presents a negative and significant impact. This indicates that there are no robust links between FDI and economic growth when allowing this relationship to vary with trade and human capital. The negative coefficient of the FDI-domestic investment term would suggest that FDI and domestic investment replace each other, and then lessens economic growth.

The results in column (6) present that all regions of Vietnam have positive effects on the economic growth of the country. The South East shows the highest impact on economic growth, followed by South Central Coast, Red River Delta, North Upland and others. The result is significant with the given information in Table 5 that South East and Red River Delta are the two regions that attracted most FDI inflows in Vietnam. We also believe that the more FDI inflows there are in the region, the better its economic growth.

VI. Conclusions

FDI in Vietnam has increased dramatically since Vietnam's renovation. The study aims to examine the effect of FDI inflow on economic growth in Vietnam by using panel data of sixty-one provinces over the 1995-2006 period. This study shows that there is a strong impact of FDI on economic growth in Vietnam. We find that even though there is a "market stealing" effect on the domestic investment, FDI inflow does exert an independent influence on Vietnamese economic growth. It does not affect economic growth through the interaction effects of FDI with human capital and trade. It implies that the advance technology and knowledge transfer from the FDI inflows in Vietnam are not yet applicable for increasing Vietnam's economic growth. The additional capital from the FDI inflow is the only channel that helps increase the economic growth in Vietnam.

DOI: 10.1355/ae27-3d

Map and Provinces of Vietnam

Red River Delta (11)      South Central Coast (6)
Ha Noi                    Da Nang
Vinh Phuc                 Quang Nam
Bac Ninh                  Quang Ngai
Ha Tay                    Binh Dinh
Hai Duong                 Phu Yen
Hai Phong                 Khanh Hoa
Huang Yen                 Central Highlands (5)
Thai Binh                 Kon Tum
Ha Nam                    Gia Lai
Nam Dinh                  Dak Lak
Ninh Binh                 Dac Nong
North East (11)           Lam Dong
Ha Giang                  South East (8)
Cao Bang                  Ninh Thuan
Bac Kan                   Binh Thuan
Tuyen Quang               Bihn Phuoc
Lao Cai                   Tay Ninh
Yen Bai                   Binh Duong
Thai Nguyen               Dong Nai
Lan Son                   Ba Ria-Vung Tau
Qua Ninh                  Ho Chi Minh City
Bac Giang                 Mekong River Delta (13)
Phu Tho                   Long An
Nath West (4)             Tien Giang
Dien Bien                 Ben Tre
Lai Chau                  Tra Vinh
Son La                    Vinh Long
Hoa Binh                  Dong Thap
North Central Coast (6)   An Giang
Thanh Hoa                 Kien Giang
Nghe An                   Can Tho
Ha Tinh                   Hau Giang
Qua Binh                  Soc Trang
Quan Tri                  Bac Lieu
TT-Hue                    Ca Mau



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The authors thank Associate Professors Suthiphand Chirathivat, Pongsa Pornchaiwiseskul and Professor Stephen Reynolds and anonymous referees for their value comments and suggestions.

(1.) See Carkovic and Levine (2002), Athukorala (2003), Durham (2004) and the references therein.

(2.) Party Resolution No. 10 recognized households as the basis unit of agriculture production. Farmers were given long-term rights to land and could no longer be coerced into joining cooperatives. They were allowed to sell their produce on the open market.

(3.) Numbers of state-owned enterprises (SOEs) were reduced from 12,000 in 1990 to about 6,000 by April 1995 and to 4,845 enterprises at the end of 2003 (GSO 2003).

(4.) Right after Vietnamese economic reforms in 1986, the National Assembly of Socialist Republic of Vietnam introduced the first "Law on Foreign Investment" in December 1987. The major goals of the FDI policy in Vietnam are not only to attract additional capital, advanced technology and management skills, but also to improve Vietnamese living standards and develop the country. To improve the investment environment and further foreign capital attractions, the law was revised in 1990, 1992, 1996, 2000, and 2003 and recently in the new FDI law in 2005 by the amended tax, land, currency and environment policies.

Thu Thi Hoang is Dean of the Faculty of Accounting and Finance, Thai Nguyen University of Economics and Business Administration, Vietnam.

Paitoon Wiboonchutikula is Chairman of the Master of Arts Program in International Economics and Finance, Faculty of Economics, Chulalongkorn University.

Bangorn Tubtimtong is Assistant Professor at the Faculty of Economics, Chulalongkorn University.

Average Annual Growth Rates of GDP in Vietnam

                                       Of which

Period        Annual GDP   Agriculture,
               growth       forestry
              rate (%)    and fishery   Industry   Services

1986-90         4.44          2.72         4.82       5.84
1991-95         8.18          4.12        12.02       8.60
1996-2000       6.98          4.40        10.64       5.72
2001-05         7.48          3.84        10.24       7.04
2006            8.17          3.40        10.37       8.29
1986-2006       6.84          3.77         9.43       6.80

SOURCE: Vietnam Statistical Yearbook, various issues.

Structure of GDP in Vietnam (%)
(In percentages)

                  Share of GDP by sector

Period       Total   Agriculture,   Industry
                     forestry and

1986-90       100       41.15        25.36
1991-95       100       31.78        27.52
1996-2000     100       25.85        33.10
2001-05       100       22.29        39.44
2006          100       20.36        41.56
1986-2006     100       30.27        31.26

                      Share of GDP by ownership

Period       Services   Total   State   Non-     Foreign
                                        State   investment

1986-90       33.49      100    35.26   63.60      1.14
1991-95       40.70      100    33.78   57.54      5.68
1996-2000     41.05      100    39.54   49.82     10.40
2001-05       38.27      100    38.68   46.54     14.60
2006          38.07      100    37.32   45.66     17.02
1986-2006     38.38      100    37.55   54.06      8.39

SOURCE: Calculated from Vietnam Statistical Yearbook 2006.

FDI Registered Capital by Economic Sectors, 1988-2006
(In percentages)

                            1988-   1991-   1996-   2001-
Sectors                     1990    1995    2000    2005    2006

Agriculture and forestry     20.8     2.9     2.4     1.9     1.2
Fishery                       1.4     1.0     0.3     0.7     0.2
Industry                     39.9    49.7    54.8    74.2    70.1
Construction                  0.0     7.7     9.1     2.6     5.3
Hotel, restaurants and       16.6    19.3     7.9     4.5     4.1
Transport, storage and       15.3     2.5     8.7     5.7     0.4
Finance and Banking           0.0     1.4     0.7     3.3     0.3
Culture, Health and           0.0     0.4     1.9     2.9     0.3
Other services                5.9    15.2    14.1     4.2    18.1
Total                       100.0   100.0   100.0   100.0   100.0

SOURCE: GSO 1995, 2000, 2003 and 2007.

FDI Sector in Industry
(In Percentages)

                                        2006    1995   2000   2002

Total Industry activities                 100    100    100    100
Mining and quarrying                     29.4   41.8   31.9   25.9
  Extraction of crude petroleum          29.3   41.7   31.9   25.7
    and natural gas
  Others                                  0.1    0.1      0    0.2
Manufacturing                            70.1   58.1   66.8   73.1
  Food products and beverages            15.7   19.9   13.6   14.1
  Tanning and leather products            6.3    4.9    5.6    5.5
  Radio and communication equipment       5.1    3.7    5      5.1
  Repairing of other transport            5.1    3.3    6.6    6.2
  Non-metallic mineral products           5      1.7    5.6    6.7
  Chemical and chemical products          4.9    2.9    4.6    5.3
  Assembling and repairing motor          4.1    4      3.6    5.1
  Textiles                                3.7    4.1    3.7    3.5
  Basic metal                             3.6    3.9    3.8    4.2
  Wearing apparel                         2.6    2.1    2.1    2.6
  Fabricated metal products, except       2.6    1      2.2    2.3
  Rubber and plastics products            2.3    1.2    2.1    2.6
  Electrical machinery and apparatus      2.3    0.6    1.8    3.1
  Furniture                               2.1    0.6    1.5    2.2
  Others                                  3.7    4.2    5      4.6
  Electricity, gas and water supply       0.5    0.1    1.3    1

                                        2004   2006

Total Industry activities                100    100
Mining and quarrying                    22.3   14.1
  Extraction of crude petroleum         22.1   14
    and natural gas
  Others                                 0.2    0.1
Manufacturing                           77.2   85.4
  Food products and beverages           14.2   14.7
  Tanning and leather products           6.9    7.3
  Radio and communication equipment      4.9    4.6
  Repairing of other transport           6.4    6.5
  Non-metallic mineral products          6      5.5
  Chemical and chemical products         5.6    6.7
  Assembling and repairing motor         5.5    5.4
  Textiles                               3.6    4
  Basic metal                            2.9    3.1
  Wearing apparel                        3.6    3.8
  Fabricated metal products, except      2.9    4.6
  Rubber and plastics products           3.1    3.6
  Electrical machinery and apparatus     3.1    4.3
  Furniture                              3      4.8
  Others                                 5.5    6.5
  Electricity, gas and water supply      0.5    0.5

SOURCE: GSO 1995-2007.

FDI Inflows by Vietnam's Region and Province
(In Percentages)

                          1996-   2001-          1996-
                          2000    2005    2006   2006

Whole country               100     100    100     100
By region
  Red River Delta          29.3    24.4   27.4    27.0
  North East                4.6     4.6    2.7     4.0
  North West                0.2     0.3    0.2     0.2
  North Central Coast       1.5     2.8    0.5     1.6
  South Central Coast      10.4     4.4   12.7     9.2
  Central Highlands         4.2     0.7    0.4     1.8
  South East               48.2    59.5   53.3    53.7
  Mekong River Delta        1.6     3.3    2.8     2.6
By province
  Ho Chi Minh City         23.6    15.5   16.9    20.3
  Ha Noi                   22.1    13.7    9.1    15.9
  Dong Nai                  6.9    17.9    8.4    12.0
  Ba Ria-Vung Tau           8.8    10.7   15.7    10.8
  Binh Duong                6.9    13.4   11.2     9.3
  Hai Phong                 2.8     4.4    1.4     2.9
  Da Nang                   1.3     2.1    3.5     2.4
  Hai Duong                 1.0     1.5    5.3     2.2
  Ha Tay                    1.4     0.1    6.7     2.1
  Quang Ninh                3.9     1.9      3      21

SOURCE: Authors' own calculations based on data obtained from
Vietnam Statistical Yearbook, several issues.

Empirical Results on Economic Growth Effect of FDI in Vietnam
Dependent variable: Economic growth rate (GDPG)

Variable                                 (1)               (2)

Intercept                            0.9093             0.9191
                                    (2.8302) ***       (2.8868) ***

Foreign direct investment (FDI)      0.0124             0.0140
                                    (3.3218) ***       (1.7070) *

Domestic investment (DI)             0.1192             0.1191
                                    (3.1134) ***       (3.0829) ***

Human capital (HS)                   0.0146             0.0158
                                    (0.3824)           (0.4000)

Labor force (L)                      0.1761             0.1730
                                    (2.6711) ***       (2.6127) ***

Trade (TRADE)                        0.0264             0.0269
                                    (2.8732) ***       (3.1212) ***

FDI * HS                                               -0.0016



Red River Delta ( R1)

North East and West (R2)

North Central Coast and
Highlands (R3)

South Central Coast (R4)

South East (R5)

Mekong River Delta (R6)

R-square                             0.250067           0.2502

Adj. R-square                        0.24329            0.2422

DW statistics                        2.1105             2.1085

No. of Obs.                        671                671

Variable                                 (3)               (4)

Intercept                            0.9085             0.9167
                                    (2.8306) ***       (2.7867) ***

Foreign direct investment (FDI)      0.0115             0.0286
                                    (0.9413)           (2.7310) ***

Domestic investment (DI)             0.1188             0.1166
                                    (2.8390) ***       (3.0538) ***

Human capital (HS)                   0.0141             0.0160
                                    (0.3544)           (0.4161)

Labor force (L)                      0.1765             0.1737
                                    (2.6725) ***       (2.6042) ***

Trade (TRADE)                        0.0265             0.0286
                                    (2.8837) ***       (3.0093) ***


FDI * TRADE                          0.0003

FDI * DI                                               -0.0073
                                                      (-1.7385) *

Red River Delta ( R1)

North East and West (R2)

North Central Coast and
Highlands (R3)

South Central Coast (R4)

South East (R5)

Mekong River Delta (R6)

R-square                             0.2505             0.2522

Adj. R-square                        0.2426             0.2443

DW statistics                        2.1111             2.1062

No. of Obs.                          671              671

Variable                                 (5)               (6)

Intercept                            0.9202
                                    (2.8303) ***

Foreign direct investment (FDI)      0.0308             0.0331
                                    -1.7143 *          (1.9868) **

Domestic investment (DI)             0.1171             0.1195
                                    (2.8043) ***       (2.2060) **

Human capital (HS)                   0.0171             0.0261
                                    (0.4180)           (0.5217)

Labor force (L)                      0.1719             0.2332
                                    (2.6008) ***       (3.5768) ***

Trade (TRADE)                        0.0292             0.0155
                                    (3.3259) ***       (1.0201)

FDI * HS                             -0.0013            0.0037
                                    (-0.1717)          (0.5162)

FDI * TRADE                          -0.0002           -0.0032
                                    (-0.0528)         (-0.9479)

FDI * DI                             -0.0073           -0.0080
                                    (-1.6781) *       (-1.7431) *

Red River Delta ( R1)                                   0.7048
                                                       (2.0977) **

North East and West (R2)                                0.6817
                                                       -1.7845 *

North Central Coast and
Highlands (R3)                                          0.7105
                                                       (2.1362) **

South Central Coast (R4)                                0.7205
                                                       (2.0055) **

South East (R5)                                         0.8218
                                                       (2.4628) **

Mekong River Delta (R6)                                 0.6516
                                                       (2.0217) **

R-square                             0.2531             0.2630

Adj. R-square                        0.2430             0.2473

DW statistics                        2.1045             2.1054

No. of Obs.                        671                671


(1) The coefficient of the variable is shown first, followed by the t
statistic is in parentheses

(2) *, **, and *** indicate significance levels of 10, 5 and 1 per
cent, respectively

(3) All variables are in natural log form

(4) Method of regression: Panel Least Squares with White cross section
standard errors & covariance, cross section weight and AR (1)
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