UNIVERSITY OF ECONOMICS INSTITUTE OF SOCIAL STUDIES HO CHI MINH CITY THE HAGUE VIETNAM THE NETHERLANDS =====oOo===== VIETNAM- NETHERLANDS PROJECT FOR M.A IN DEVELOPMENT ECONOMICS AN ANALYSIS OF FOREIGN DIRECT INVESTMENT IMPACT ON LABOR PRODUCTIVITY AT FIRM LEVEL IN VIETNAM IN PARTIAL FULFILLMENT OF THE REQUIREMENTS FOR THE DEGREE OF MASTER OF ART IN DEVELOPMENT ECONOMICS BO GIAO DUC DAO TAO BY TRU'ONG D.l;\1 HQC KINH TE'TP.HCM PHAM KHAC DUY THUVIEN • ACADEMIC SUPERVISOR: DR LE THI THANH LOAN Ho Chi Minh City, November 2009 CERTIFICATION I hereby certify that the substance of this thesis has not been submitted for any degrees and is not being currently submitted for any other degrees I also certify that, to the best of my knowledge, and any help received in preparing the thesis and all sources used have been acknowledged in the thesis Signature amKhacDuy Date: November, 2009 ACKNOWLEDGEMENT This research is impossibly completed without the valuable guidance, encouragement and advice from numerous individuals including Vietnam-Netherlands program lecturers, friends and my family members I am really indebted and grateful to what they have done for my thesis completion First of all, I would like to send my deepest gratitude to my supervisor, Dr Le Thi Thanh Loan who always gives valuable instructions, advice and comments during my completion ofthe thesis I am grateful for Professor, Peter Calkins for his precious advice and comments from the initial ideas ofthe theme for my thesis I also send my special thanks to Professor, Nguyen Trong Hoai for his lectures in econometrics and Mr Truong Thanh Vu, the lecturer of Vietnam-Netherlands project, for his kind help and instructions in data analysis by Stata software Many especially respectful thanks are sent to my parents and my dear wife for encouraging and providing me with an opportunity to pursue my desires in higher learning and for their love, affection and sympathy that have helped me to gain more strength and motive to complete this thesis And fmally, I would like to express my special thanks to my friends in MDE class 14 for their supportive friendship from the beginning day I joined in this course and their continuous support during my research completion Above all, please sympathize for me and know that I would be so grateful for those who support me a lot in this thesis completion if I forget to mention their names ii ABSTRACT This research examines and analyses the impact ofFDI on labor productivity at firm level in Vietnam through applying cross-sectional data from VES-2008 which concentrate on 4,654 firms including FDI and domestically owned enterprises in sub-industrial sectors; food processing, hotels - restaurants, electronics - mechanics and textile - garment footwear The regression model is estimated based on the Cobb-Douglas production function and the labor productivity is modeled as dependent on the variables, namely capital intensity, material input cost per labor, proportion of skilled labor and dummy variables including types of ownership and regions that FDI enterprises locate OLS (Ordinary Least Square) and various econometric estimation techniques are employed in order to obtain reliable and appropriate results that show the findings based on the scientific analysis As results, finding results in analysis of FDI impact on labour productivity in the case of this study consequently suggest in general that FDI in subindustrial sectors plays an important and positive role in enhancing labor productivity at firm level in Vietnam Moreover, the results seem to be appropriate to answer research's questions as well as confirm expectation for hypotheses of different impacts of FDI across regions and types of ownership, except for skilled labor that does not appear to affect on labor productivity in this research iii TABLE OF CONTENTS CHAPTER 1: INTRODUCTION 1.1 Problem statement I 1.2 Objectives of the research Research questions 1.4 Research hypotheses Organization of the research CHAPTER II: LITERATURE REVIEW 2.1 Introduction 2.2 Concepts and definitions 2.2.1 Foreign direct investment (FDI) 2.2.2 Productivity and labor productivity 2.3 Economic theories , 2.3.1 Production theories 2.3.1.1 Cobb-Douglas production function 2.3.1.2 Pindyck and Rubinfeld production theory 2.3.2 Theoretical background ofFDI impacts 2.3 2.1 Channel effects of foreign direct investment 10 2.3.2.2 Theoretical framework ofFDI impacts on labor productivity 11 2.3.2.3 Suggested research model 13 2.4 Empirical studies 14 2.4.1 FDI impacts enhance labor productivity in host countries 14 2.4.2 The opposite results ofFDI impacts on labor productivity 16 CHAPTER III: AN OVERVIEW OF FDI IN VIETNAM SINCE 1988 18 Introduction 18 3.2 Overview of FDI inflows and periods of development from 1988 to 2008 18 3.2.1 FDI inflows in period 1988- 2008 18 3.2 Some characteristics ofFDI in Vietnam 20 3.3 The role ofFDI in national economy 25 3.4 The summary ofFDI sector's socio-economic affect on national economy 27 iv CHAPTER IV: RESEARCH METHODOLOGY 29 4.1 Introduction 29 4.2 Model specification 29 4.3 Description ofvariables 30 4.3.1 Dependent variable labor productivity (Labproductivity) 30 4.3.2 Explanatory variables 30 4.3.2.1 Capital intensity (Cap_intensity) 30 4.3.2.2 Scale ofmaterial input cost (MI_scale) 31 3 Labor quality (Skill) 31 4.3.2.4 Firm's location (Dlocation) 31 4.3.2.5 Types of ownership (Fshare) 32 4.3.2.6 Firm's sub-industrial sectors (Dindustry) 32 4.4 Data collection 33 4.5 Estimation strategy 34 4.6 Summary 36 CHAPTER V: RESULT ANNALYSIS 37 5.1 Introduction 37 5.2 Descriptive statistic analysis of regression sample and variables 37 5.2.1 Descriptive statistics of sample 37 5.2.2 Descriptive statistics ofvariables 38 5.2.3 Correlation matrix 41 5.3 Model estimation and finding results 42 5.3.1 Multiple regression results and diagnostic tests 43 5.3.2 Interpretation ofthe fmding results 45 5.3.3 Analysis and discussion about the finding results 47 5.4 Conclusion 49 CHAPTER VI: CONCLUSIONS AND RECOMMENDATION 50 6.1 Conclusion 50 6.2 Recommendations 50 6.3 Limitations of the research 52 v REFFERENCES 53 APPENDICES: 56 APPENDIX 1: , , 56 APPENDIX 2: 61 APPENDIX 3: 62 LIST OF BOXES BOX 5.1: Ramsey RESET test using powers of the independent variables .43 BOX 5.1: Breusch-Pagan I Cook-We is berg test for heteroskedasticity 44 LIST OF FIGURES FIGURE 3.1: Foreign direct investment projects licensed in period 1988- 2008 19 FIGURE 3.2: Foreign direct investment projects licensed in period 1988 - 2008 by region 23 FIGURE 3.3: Structure of investment at current prices by types of ownership from 1995 - 2008 24 FIGURE 3.4: Structure of investment at current prices by types of ownership in 2008 24 FIGURE 3.5: Structure of gross domestic product at current prices by ownership period 1995- 2008 26 FIGURE 5.1: Correlation between proportion of skilled labor and labor productivity .42 FIGURE 5.2: Distribution of labor productivity (Labproductivity) before transforming into logarithm form 56 FIGURE 5.3: Distribution oflabor productivity in logarithm form 57 FIGURE 5.4: Distribution of Capital intensity in logarithm form 59 FIGURE 5.5: Distribution of material input cost per labor in logarithm form 59 FIGURE 5.6: Distribution of proportion or skilled labor in logarithm form 60 vi LIST OF TABLES TABLE 3.1: Foreign direct investment projects licensed from 1988 to 2008 by kind of economic activity 21 TABLE 3.2: Employed population as of annual I July by ownership from 2000-2008 27 TABLE 5.1: Statistics summary of four sub-industries firms in regions according to three types of ownership 37 TABLE 5.2: Distribution oflabor productivity in logarithm form (Lnlabproductivity) 39 TABLE 5.3: Distribution of explanatory variables in logarithm form 40 TABLE 5.4: Distribution of skilled labor in sub-industries according to ownership 40 TABLE 5.5: Correlation matrix from the variables in the regression function 42 TABLE 5.6: The result ofrunning regression (Model5.1) 43 TABLE 5.7: Diagnostic test for multicollinearity 44 TABLE 5.8: The result of running regression (Model5.2) 45 TABLE 5.9: Distribution oflabor productivity (Labproductivity) before transforming into logarithm form 56 TABLE 5.10: Distribution oflabor productivity in logarithm form (Lnlabproductivity) 57 TABLE 5.11: Distribution of explanatory variables in logarithm form 58 TABLE 5.12: Descriptive statistics ofvariables in three types ofenterprises 61 TABLE 5.13: The result of regression with beta number (Model5.3) 62 vii ACRONYMS ASEAN Association of South East-Asian Nations APEC Asia-Pacific Economic Cooperation BLUE Best Linear Unbiased Estimator BTA Bilateral Trade Agreement FDI Foreign Direct Investment FE Fixed Effects GDP Gross Domestic Product GECS General Enterprise's Cost Survey GO Gross Output GSO General Statistics Office IC Intermediate Cost IMF International Monetary Fund NGO Non-Governmental Organization NICs Newly Industrial Countries OECD Organization for Economic Co-operation and Development OLS Ordinary Least Square RE Random Effects RESET Regression Specification Error Test SUR Seemingly Unrelated Regression us United States USD United States Dollar VA Value Added VES Vietnam Enterprise Survey VIF Variance Inflation Factor VND Vietnamese Dong WTO World Trade Organization viii CHAPTER I INTRODUCTION 1.1 Problem Statement Since the late 1980s, on the basis of Doi Moi or the government's socio-economic reforms which started in 1986, Vietnam has initially transited from a centrally planned to a market- oriented economy Typically for this process, Vietnam has advocated economic integration, in addition to its five "tions": urbanization, globalization, industrialization, modernization and privatization to spearhead this process Beginning with the promulgation of the Law on Foreign Investment in 1987 and the signing of bilateral and multilateral trade agreements, Vietnam became a member of the Association of South East-Asian Nations (ASEAN) in 1995 and joined the Asia-Pacific Economic Cooperation (APEC) in 1998 In July 2000, Vietnam signed the Vietnam-US Bilateral Trade Agreement (BTA) and then joined Asia Europe Meeting in the following year, 2001 The most recent and notable event was Vietnam's WTO integration in 2007 During the economic transition from after 1986 to current years, many observers, policy makers and academics contend that foreign direct investment (FDI) played a crucial role which can help jumpstart to Vietnam's economy on its way to accelerating reform and socio-economic growth, Mai (2004) In addition, FDI may affect all economic, cultural and social aspects of the economy and is an indispensable capital source to developing countries including Vietnam, especially Asia's Newly Industrializing Countries (NICs) Through FDI flows, these countries can cover the saving-investment, foreign exchange and fiscal gaps and hence promote socio-economic growth, Taylor (1993) It may seem natural to argue that FDI can convey great advantages to host countries That is why policymakers of developing countries including Vietnam always pay much attention to effects from FDI flows to country's economic growth However this study does not focus on FDI by examining the effects of foreign direct investment on Vietnam's socio-economic growth in a general respect, this research wants to test the impact of FDI on the labor productivity at firm level in Vietnam as a whole and to 5.3.3 Analysis and discussion about the finding results The fmding results almost reasonably answer to the expectations from this research when the capital intensity and material purchase cost per labor are positive and significant This is explained from result of Vietnam's WTO joining and therefore, it became a main driving force for FDI enterprises to raise their large capital investment that gives impacts on the increase in labor productivity of firms including FDI and domestically owned firms in Vietnam According to Ludo (2008), he stated that more inward FDI will give rise to an increase in the capital stock, which in turn will raise labor productivity This statement is really consistent with the finding results as shown by the positive and significant coefficients on the capital intensity and material input cost variable in the estimation results in this research However the result showed a surprising fmding that the proportion of skilled labor seemingly does not have impact on labor productivity This may be explained by labor intensity of FDI enterprises in the sub-industries of the research The typical evidence for this is the low ratio of skilled labor in food processing, textile-garment-footwear and electronic-mechanics that just require relatively low skills and educational levels as well as use cheap and short-term training employees in Vietnam Therefore, they need less demand for skilled labor Albeit, the coefficient of Dlocation is positive and statistically significant which shows that the firms' concentration in big cities have higher labor productivity This is explained by more favorable infrastructures, close distance to consumer market and more comfortable business environment for enterprises than the other regions In other word, with such convenient conditions, firms can reduce many kinds of cost and this is really one of the main results in enhancing more labor productivity compared with other regions In addition, all coefficients of industry dummies are statistically significant; there are explicit differences on labor productivity among sub-industries of the research However this fmding seems not to express complete implication from policy aspect, it sheds lights for the valuable insights and clear implication in methodology aspect to realize the contribution of the impact from each type of those industries in Vietnam Although, results of FDI impact on labor productivity is statistically significant and totally consistent with the theoretical 48 framework and empirical studies as well as research's expectation Its impacts are not really exceeded of that non-state enterprise This can be explained for results of labor turnover, technologies and capital spillover from FDI enterprises to domestic firms that can improve and adjust appropriately with international integration, Anh et al (2006) 5.1 Conclusion In summary, this chapter analyzed and discussed the impacts of FDI and domestically owned enterprises on labor productivity at firm level in Vietnam by applying both descriptive statistics and econometric models Based on the theoretical framework and empirical studies, explanatory variables employed in the multiple regressions are identified, critically discussed and analyzed in order to answer research questions as well as confirm the hypotheses results that indicate the finding results of the research are reliable, useful Besides, the finding results are also analyzed and explained based on scientifically analytical basis 49 CHAPTER VI CONCLUSIONS AND RECOMMENDATIONS 6.1 Conclusion The anticipated fmding results in analysis of FDI impact on labour productivity at firm level in Vietnam from this study consequently suggest in general that FDI in subindustrial sectors plays an important and positive role in enhancing labor productivity This finding gives a reasonable answer to the first question as mentioned in the chapter one Besides that, fmding results also show there are significant differences and gaps of impacts on labor productivity across regions as well as sub-industries in the case of this research Moreover, the fmding is that capital and material inputs intensity are really significant determinants of productivity at firm level in Vietnam Furthermore, once again the research emphasizes the extremely important role of FDI capital not only in increasing labor productivity but also in promoting economic development in developing countries such as Vietnam Especially, through Foreign Direct Investment, the host countries can obtain not only necessary capital, but modern technology, management and marketing skills as well The presence of FDI frrms facilitates competition between enterprises in the host countries, which put pressures on domestically owned frrms to use resources more efficiently, improve technology as well as management methods and in turn improve labor productivity as a whole However, the fmdings that skilled labor does not appear to affect labor productivity and FDI frrms not make the most productive in increasing labor productivity compared with non-state owned frrms are rather different from the expectation of the research hypothesis, despite significant differences and gaps among these types of ownerships The result illustrates that non-state owned frrms in Vietnam are considerably improved and adjusted to adapt to new business conditions under the context of the international integration 6.2 Recommendations so The useful and reliable results of this study aim to help Vietnamese government's policymakers in planning effective policies to improve local labor productivity that can serve to develop and monitor the effects of FDI on local labor market policies In addition, this research help them to have a widen vision of gap of labor productivity as well as unequally competitive abilities between domestic firms (especially state-owned enterprises) and FDI firms in order to issue appropriate policies to narrow these gaps Typically, the insignificant impacts of skilled labor on the overall labor productivity imply that Vietnam, in the short run, may accept FDI firms that tend to apply laborintensive industries or technologies to use the labor force, which is abundant and relative cheap in developing countries including Vietnam However, in the long run, Vietnam should pay more attention to narrowing the capital and technology gaps between domestic and foreign firms through concessionary and subsidiary policies to help these firms in renovating technologies, machines and subsidize capital sources with favorable interest rates etc so that local firms can have better conditions and time to catch up and compete with FDI firms in domestic markets as well as to compete with foreign firms in the international markets In addition, improving the skills of local labor is very important because it seems that under the context of strict competition from international integration, such unskilled or relative cheap labor like Vietnam will no longer be a competitive factor or advantage to attract FDI as well as face with huge inflows of big foreign enterprises' competition in the near future Thus, the Vietnamese government should concentrate on developing necessary skills for local labor through improving educational quality in universities, colleges, and vocational -training center·s It means that education in Vietnam needs to catch up with what is happening in the practice that can lead to a result that domestic labor can be ready to contribute their knowledge and abilities to country's development after graduating Furthermore, the research findings are helpful to policymakers to improve or develop further current policies in attracting FDI to promote investment in less developed regions This suggests that in order to assure equitable development among the regions, the 51 government should encourage investors illcluding foreign and domestic firms to invest in the relatively less developed regions such as mountainous provinces, the remote provinces in Mekong delta of Vietnam through policies as tax and investment incentives Besides, Vietnam's government should upgrade infrastructure systems and examine cautiously the expenditures ofthe national budget on improving roads, hospital, markets and schools so on to ensure that the national budget is invested rightly and efficiently in order to attract more investments as well as raise comparative advantages ofthese areas Those can be considered the prerequisite conditions to gain the equitable development across regions as well as to achieve sustainable long-term socio-economic development for Vietnam 6.3 Limitations of the research Although the data source used in the research which has been gained through VES- 2008 from General Statistics Office of Vietnam is really updated and reliable, it still does have some weaknesses The using of cross-sectional data seems not to capture completely the impact of FDI on labor productivity in a dynamic framework Because FDI impact in Vietnam may be different from over period of time With this reason, future research should concentrate to exploit and analyze FDI impact based on panel data or time-series data that can bring a more explicit result than this research Furthermore, the merging 100 percent foreign owned frrms and joint ventures into one type of ownership in this research does not express the pure impacts of these two types that seemin.gly impacts of joint ventures may give more different results on labor productivity compared with other types of ownerships Thus they should be separated to achieve more obvious results Besides, the research just divides the enterprises' location into two regions this fails to capture the impact on productivity in detail for an individual province In the future this should be expanded at least into regions that can show a clearer picture of FDI impact in Vietnam 52 REFERENCE Aitken, B J and Harrison, A E (1999) Do Domestic Firms Benefit from Direct Foreign Investment?: Evidence from Venezuela, American Economic Review, Vol 89(3), pp 605-618 Alfaro, L (2003) Foreign Direct Investment and Growth: Does the sector matter?, Harvard Business School, the USA Anh, T T Nguyen, et al (2006) The Impact of Foreign Direct Investment on the Economic Growth in Vietnam, ClEM research report, Hanoi Blomstrom, M., and Kokko, Ari (1998) Multinational Corporations and Spillovers Centre for Economic Policy Research, CEPR Discuss Paper: 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Initial evidence from Chinese manufacturing, working paper, Faculty ofBusiness and Economics, The University of Hong Kong Vahter, Priit (2004) The Effect of Foreign Direct Investment on Labor Productivity: Evidence from Estonia and Slovenia Tartu: Tartu University Press Vani Archana, Ph.D (2000) Impact of FDI in India: State-Wise Analysis in a Panel Data Framework Indian Council for Research on International Economic Relations (!CRIER) Indian Institute of Technology India Wooldridge, J.M (2005) Introductory Econometrics- A Mordern Approach, South Western College Pub Yingqi, Wei., et al (2004) The Impact of R&D, Export and FDI on Productivity in Chinese Manufacturing Firms, Lancaster University Management School, Working Paper: No 003 55 APPENDICES APPENDIX! Figure 5.2: Distribution of labor productivity (Labprf?ductivity) before transforming into logarithm form It) I I 'V I (") I I C\1 0 t 2000 6000 4000 8000 Labor Productivity Table 5.9: Distribution of labor productivity (Labproductivity) before transforming into logarithm form variable mean p50 ran'ge skewness kurtosis + -Labproductivityl 67.00986 27.33155 56 7635.275 18.42877 541.6892 Figure 5.3: Distribution of labor productivity in logarithm form (Lnlabproductivity) ' 0 F = 0.0000 = 0.7416 Adj R.:.squared = 0.7411 Root MSE = 60419 MS -+ -Model I 4865.16961 540.574401 Residua1 I 1695 2634 4644 •365043809 -+ -Total I 6560.43306 4653 1.40993618 Lnlabproductiviyl coef std Err Lncap_intensity I 0942483 LnMLsca 1e I 7802366 Lnskill 0003653 olocation 0487457 r::sharell 1372517 r::share2 1855048 Dindustryi 1956656 oindustry2 I 6634135 Di ndustry3 I 1582862 _cons I -.0426519 0091263 0090543 0071799 0286496 053322 0479494 032902 0301468 0301268 0746989 I t 10.33 86.17 os 1.70 2.57 3.87 95 22.01 25 -0.57 P>ltl Beta 000 000 o 959 0.089 0.010 0.000 o 000 0.000 000 0.568 0982518 8618637 •0004294 0142135 0367228 0559181 0657126 2687804 0604 993 Note: Regression with beta number converts variables' values into the same value so that their differences can be compared based on this value 62 ... integration, in addition to its five "tions": urbanization, globalization, industrialization, modernization and privatization to spearhead this process Beginning with the promulgation of the Law on Foreign. .. government''s attracting investment policies in improving and developing infrastructures on the way of international integration Investment by province and region: Since 1988 to preliminary 2008, Vietnam. .. on manufacturing and service sectors, mining and quarrying, construction and transport, storage and communications so on partly expressed the main intention of Vietnam'' s government in shifting