Foreign Direct Investment in Real Estate Projects and Macroeconomic Instability

By Nguyen, Thanh Nga | Journal of Southeast Asian Economies, April 2011 | Go to article overview

Foreign Direct Investment in Real Estate Projects and Macroeconomic Instability


Nguyen, Thanh Nga, Journal of Southeast Asian Economies


I. Introduction

Bhagwati (1988) argues that the beneficial effect of foreign direct investment (FDI), in terms of enhanced economic growth is stronger in those countries which pursue an outwardly oriented trade policy than it is in those countries adopting an inwardly oriented policy. The more open economies, thanks to their neutral trade policy and free play of market forces, can facilitate the efficient allocation of FDI on the basis of comparative advantage and through competition mechanism, and encourage gains from learning (positive externalities) such as transfers of technology and management skills and innovation. Many studies have provided evidence of such positive effects of FDI on emerging open economies. However, few studies have raised the causal linkages between FDI inflows and macroeconomic instability.

This paper argues that as business entities are enticed by profit, FDI can rush into the speculative sectors like real estate development and construction during property market bubbles in emerging open economies like Vietnam and lead to macroeconomic instability. As the government has welcomed such FDI to finance the current account deficit as well as fuel the planned economic growth, this practice can potentially lead to the Dutch disease. The consequences are reinforced when the banking sector and the giant state-owned general corporations (GCs) have also become active players in such risky investments.

The Vietnamese central government does not have much policy space to deal with the consequences. First, high decentralization relating to FDI approval in the context of local governments' large budget deficits and widespread corruption leads to FDIs mushrooming in real estate projects without long-term cost and benefit analysis. Second, the inflexible exchange rate and dollarized economy make it difficult for the authorities to sterilize foreign inflows to avoid the consequential macroeconomic instability. The occurrence of the global financial crisis, which originated from the plump of the property markets, has luckily helped Vietnam avoid disastrous consequences of the oversupply of risky capital. However, the causes of instability are still there and can lead to disasters at any time. What the central government should do is to put more supervision on the approval and implementation of FDI projects in real estate and construction on the one hand and re-encourage investment in labour-intensive manufacturing sectors on the other hand. Disciplining state general corporations (GCs) and commercial banks from diversifying into real estate trading should be done continuously. The ongoing effort to slowly depreciate the Vietnamese dong is on the right track to increase export competitiveness and reduce imports in order to avoid the Dutch disease effects in the long run.

The rest of the paper includes seven sections. Section II provides evidence about the FDI surge in real estate development and constructions. Sections HI, IV and V explain and illustrate the negative impacts of such FDI surge on the macroeconomic stability and efficient economic structure. Section V gives a case study, and the last section concludes.

II. FDI Surge in Real Estate Development and Constructions

Until 2005, FDI into Vietnam increased rapidly, with a heavy concentration in export-oriented manufacturing industries such as garment and textile, footwear, furniture, other wood industries and automobiles according to the country's comparative advantage in abundant labour. Manufacturing is estimated to account for 42 per cent of cumulative approved FDI in 2005. From 2000 to 2006, the share of foreign invested enterprises (FIEs) in total manufacturing exports increased from 20 per cent to over 50 percent (Athukorala 2009). The spillover effects of FDI are evidenced in its contribution to improving total factor productivity (TFP) in manufacturing by 2.2 per cent while pure local firms can only record an increase of mere 0. …

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