Nguyen Van Phuong et al | 285 FDI spillovers in Vietnam: The overall view of transferring channels, and internal characteristics and international trade policies of domestic firms NGUYEN VAN PHUONG International University, Vietnam National University HCMC – nvphuong@hcmiu.edu.vn TRIEU DOAN XUAN HOA International University, Vietnam National University HCMC HUYNH THI NGOC HIEN International University, Vietnam National University HCMC NGUYEN DINH KHOI International University, Vietnam National University HCMC Abstract The study used a panel data of unlisted Vietnam manufacturing enterprises over the period 2011-2015 surveyed by General Statistic Office (GSO) to investigate the channels by which foreign direct investment firms help raise the productivity of domestic firms in Vietnam We estimate spillovers that occur within an industry and between different industries, whether a technology gap between foreign and domestic firms is a limiting or facilitating factor for technology spillovers The heterogeneity of domestic firms, namely absorptive capacity, technology level related to foreign firms, market share, financial development and international trading policies of domestic firms, has been examined Keywords: FDI spillovers; TFP; technology gap; international trade 286 | ICUEH2017 Acknowledgements We would like to express our deep gratitude for the financial support from Vietnam National University – Ho Chi Minh City within the framework of Agreement No C2016-28- 06/HĐ-KHCN Introduction Attracting foreign direct investment (FDI) has become an integral part of development strategies among developing countries Many offer special incentives to foreign investors, including tax holidays, tariff reductions or exemptions, and subsidies for infrastructure While these policies rest on the premise that foreign investment facilitates technology spillovers from foreign to domestic firms, the empirical evidence is ambiguous FDI has been considered as one of the major sources of economic growth of Vietnam since the introduction of economic reform and renovation in 1986 However, there is a little study on whether FDI has facilitated technology transfers, which benefit domestic firms in Vietnam In this study, we will use a panel data of unlisted Vietnam manufacturing enterprises over the period 2011-2015 conducted by General Statistic Office (GSO) to investigate whether the presence of foreign direct investment helps to raise the productivity of domestic firms in Vietnam We estimate spillovers that occur within an industry and between different industries, whether a technology gap between foreign and domestic firms is a limiting or facilitating factor for technology spillovers We also assess to the roles of absorptive capacity of domestic firms in the context of technology spillovers We differ significantly from much of the empirical literature in that we recognize that the adoption of better technology or managerial know-how is a costly learning process The firm’s productivity may suffer initially because some resources must be devoted to learning However, once the firm successfully adopts the new technology, its productivity will raise at a higher rate, which propels the firm to a steeper growth path and raises the productivity level in the long run In this study, by employing a large panel of Vietnamese manufacturing industries, we seek fresh evidence on three empirical questions First, we explore whether horizontal and vertical FDI spillovers influence the productivity level and the rate of productivity growth of indigenous firms (Liu, 2008) As previous studies showed the presence of FDI in the industry may generate negative spillovers on the productivity level of domestic firms in the short term (Haddad & Nguyen Van Phuong et al | 287 Harrison, 1993; Aitken & Harrison, 1999; and Liu, 2008) However, when considered in the long term, FDI spillovers are more likely to have a positive effect on the rate of productivity growth of domestic firms because FDI spillovers help enhance future productivity capacity (firm-specific capital) of domestic firms, which determines the longterm growth rate of productivity Consequently, our goal is to determine whether the positive rate effect of horizontal spillovers is driven by FDI spillovers in the low-tech or high-tech industries Second, we investigate whether the levels of the technology gap affect the FDI spillovers In previous studies, Findlay (1978) and Wang and Blomstrom (1992) demonstrate that the greater the technology gap between FDI and domestic firms, the more opportunities the domestic firms achieve better levels of efficiency via the imitation of foreign technologies and innovations However, the gap must not be too large Finally, we go to one step further to investigate whether the technology spillovers from FDI firms relate to foreign trading activities of domestic firms Literature review FDI spillover including knowledge and technology spillover from foreign direct investment companies have attracted attention of researchers and policy makers Productivity spillovers from FDI occur when the entry or presence of foreign firms leads to the enhancement of the productivity of domestic While technology can be transferred directly to MNCs’ subsidiaries and locally vertical-linkage firms of the host country, domestic firms can only adopt new and more advanced technology from spillover effect, which will take times and require certain resources (Jude and Levieuge, 2015) Among the most prevalent form of spillover is the imitation of technologies through observation or the mobility of former workers in the multinational enterprises Thus, the companies in the host country will be benefited from the flow of knowledge, and enhance their efficiency Alternatively, fierce competition caused by the foreign firms encourage domestic ones to stay up-to-date to survive in the market They have to either utilize their current resources or seek for more cutting-edge and efficient technology to remain competitiveness (Blomstrom and Kokko, 1998) Consequently, the technological gap is reduced and productivity is enhanced, in turn, force the multinational affiliates to 288 | ICUEH2017 innovate newer technologies (even one that has not been existed before in their host countries) to win the competition In summary, Damijan et al (2013) pointed out four main channels that how FDI inflows generate spillovers from a very beginning form as (1) demonstration/imitation and (2) competition to a well-prepared (3) vertical/ interindustry linkage and (4) training: - The domestic firms could take advantage of demonstration and imitation effects that improved institutional, managerial, and technological practices Prior literatures reported that technological transfer would rise with the existence of FDI More particularly, by observing and imitating operating procedures of foreign enterprises, local ones will be beneficial in several aspects, including advance technologies, essential marketing skills, efficient inventory management, quality control, etc Further, connections and alliances with FDI corporations facilitate the knowledge flows to the domestic ones - The competition effects that FDI firms bring to domestic market pushes domestic firms updating skills and technologies to raise productivity However, Damijan et al (2013) also found risky for the competitive advantages of domestic firms as upstream or downstream partners with FDI firms because the capacity and productivity level of each individual firm will determine whether they can absorb the technology spillover from foreign investors; otherwise, these firms would be failed in a fiercer competition With respect to competition, a framework is constructed by Wang and Blomstrom (1992) to describe the correlation between the level of competition and spillover As competition in the host country increases, FDI corporations have to improve their technologies to gain more market shares As a result, local firms will have to utilize their resources or upgrade their technologies to stay in competitiveness - Foreign linkage effects occur through the strictly demand quality for domestic firms exporting to MNCs or the higher input imported from MNCs Findlay (1978), as a pioneer for this contribution, stated that the larger the technological gaps between the two country, the greater the remaining chances for the less developed countries Yet, the pressure increases as local firms might lose in the harsh competition Therefore, the improvement in the technology will be faster under such circumstances - The speed of technology transfer will be faster if the multinational affiliate is willing to establish upstream and downstream networks, because this helps local firms involved in supply and distribution chains to achieve exposure to advanced technology and Nguyen Van Phuong et al | 289 subsequently to promote technology improvement It is admitted that being a part of the network through upstream and downstream activities enables the domestic suppliers and domestic customers to benefit from the inherited technical and commercial know-how as well as technology spillovers, which lead to a process improvement in the short run and a productivity improvement in the long run (Hamida, 2013) - The moving of employees from MNCs to domestic firms and complementary workers creates training effect of FDI spillovers Wang (1990) extends Findlay’s model by establishing a dynamic two-country model to analyze the interaction between FDI and the growth of domestic human capital With capital moving globally, the model predicts that an increase in the growth rate of human capital and the technology diffusion rate in the less developed country leads to a narrowing of the steady-state income gap The important result from the analysis shows that a greater opening to FDI from more advanced countries leads to facilitating technology spillovers in the host country, and hence increasing its rate of income growth Another potential channel for technology spillovers from FDI to take place is through the acquisition of human capital - The availability of relatively skilled labor is an essential magnet as well as a key driver of agglomeration, helping to increase productivity through adoption of new technology It has been argued that host countries are more likely to benefit from spillovers if they have a large supply of skilled labors (Keller, 1996) Additionally, the labor turnover as the movement of labor from FDI firms to domestic firms can also generate productivity improvements through either a direct spillover to complementary workers or knowledge carried by workers who move to another firm Fosfuri et al (2004) and Glass and Saggi (2002) argue that the knowledge that workers bring with them is the most essential channel for spillovers Providing an overall review of FDI spillover, Wang et al (2013) also found a significantly positive impact of FDI on domestic human capital and economic growth through building capacity for local workers and encouraging innovations Literatures on technological gap emphasized the quality of technological transfer Inconsistent with Findlay, Glass and Saggi (1999) proposed that great distance between the host and home country deteriorated the quality of technological transfer and the effect of spillover due to insufficient human resources, infrastructure and networks They formulated that absorptive capacity and technology gap, thus, are important determinants of technology spillover From a different perspective, Walz (1997) suggested 290 | ICUEH2017 that knowledge spillover is the facilitator of innovative activities in backward countries From an analysis of the endogenous model where FDI is crucial for economic growth and specialization pattern, the author confirmed that imitation of technological and operational aspects in the less developed countries improves R&D behavior, and indirectly stimulates the economic growth Perri and Peruffo (2016) have organized the related theoretical and empirical studies by developing a framework to analyze this phenomenon Three main attributes of spillover, including magnitude, scope and speed are determined by firms’ heterogeneity and the host business environment such as learning efforts and resources, competitive and absorptive capacity, technology gap, financial market, network and regulations In this way, the spillover effect is differed between micro (MNC’s subsidiaries, local firms) and macro level (countries, economies, industries) and between short term and long term Although theoretical research of FDI spillover remained underdeveloped, empirical studies on the issues continue to increase In the very beginning, Caves (1974) investigated and confirmed the positive effect of spillover in Australian manufacturing industry Following this pioneer, numerous scholars have investigated the FDI spillovers Mostly, the framework is constructed using labor productivity or total factor productivity, the presence of FDI, as well as other potential determinants of productivity Measurement of presence of FDI is implemented by calculation of multinational’s share of employment, sales, and output in a particular industry The results of presence of FDI companies and spillover, however, are mixed While some studies confirmed the negative relationship of spillover and the presence of FDI (Haddad & Harrison, 1993; Aitken and Harrison, 1999; Djankov and Heokman, 2000, Jeon et al 2013), positive correlation between the constructed is found in other studies (Liu et al., 2000; Haskel et al., 2007; Liu, 2002; Javorcik, 2004) Possible explanation for the negative impacts might be the increased competition For example, Aitken and Harrison (1999) discovered that FDI enterprises not only stimulate technological transfers, but also cause a competition level to be higher in a given sector Some local companies, not catching up to this higher demand, are eliminated from the market Consequently, the total productivity of domestic organization is reduced to the existence of FDI This is also known as “market-stealing” effect Nguyen Van Phuong et al | 291 Another explanation for the inconsistency is that some studies cannot differentiate between the short-term and long-term effects of FDI spillovers (Liu, 2008) Adoption of a new technology is resource-consuming, and local firms might have to leverage their current resource and reduce some in the production Thus, productivity will be reduced at first sight, and correlations might be found negative In the long run, when domestic firms have already exploited new technologies, they will gain efficiency, and enjoys the higher rate of production growth At this stage, higher efficiency will make up for the initial loss in productivity In brief, the results are heavily dependent on the length of the period of time the study attempted to cover Other researches considered the vertical effects as the potential channel of technological transfer In other words, domestic firms might become suppliers and customers of international organizations, called backward linkages and forward linkages respectively Through these connections, foreign enterprises will provide technical support to local ones to improve it efficiency As an example, local firms have to upgrade their technology and enhance their management skills in order for their intermediate products to meet international standards, and their customers might provide assistance In a similar vein, they might enjoy higher productivity thanks to the high quality inputs from the foreign suppliers This issue received empirical support from recent literatures of vertical spillovers More specifically, backward linkages between local companies and their foreign partners significantly enhance efficient of firms in different geographical contexts such as Lithuania (1996-2000 panel data, Javorcik, 2004), China (1995-1999 panel data, Liu, 2008), and Indonesia (Blalock and Gertler, 2008) Another stream of research focusing on the scope of FDI spillover employed constructs such as domestic firm size, ownership structure of FDI firms, liberalization of trade, and geographic aspects Regarding domestic firm size, Aitken and Harrison (1999) suggested that small firms would not be able to compete with FDI affiliates because of their small production scales that not facilitate technological development On the other hand, large firms will capture these opportunities given their potential capability The effect of international trade on domestic firm productivity and technological spillovers have been extensively discussed on the both theoretical and practical level Theoretically, international trade is proposed to manifest impacts on productivity and 292 | ICUEH2017 international spillover In contrast, empirical studies focused on the influence of international trade on productivity and economic growth For instance, advanced technology imports are considered as a major driving force for innovation, imitation, and economic growth, and then impacts positively on technology transfers (Connolly, 2003) Furthermore, international trade has been studied and reported that they exert a significant impact of efficiency On the one hand, some of these studies have considered learning through export as a driving force of productivity growth (Bernard & Jensen, 1999; and Blalock & Gertler, 2004) Moreover, Javorcik & Spatareanu, 2008, and Girma et al., 2008 investigates vertical and horizontal spillovers from FDI enterprises to domestic ones and extends their investigation to trade orientation in terms of exports In conclusion, the results are mixed and subject to an important variable related to market structure Although many studies have investigated the relationship between exports and technology spillovers through backward and forward linkages, there are a few studies examining the impact of imports on downstream and upstream spillovers Blalock and Veloso (2007), using panel data of Indonesian manufacturers, show that downstream imports are associated with productivity achievements and consider imports as one of the key elements to promote economic growth To our knowledge, this is the first study on FDI spillovers using a large, unbalanced firm-level panel data from Vietnam Methodology 3.1 Data This study will use the Vietnamese annual enterprise surveys conducted during the period 2011–2015 by the GSO (data collection of 2015 was completed in 2016) The dataset covers a great number of enterprises operating across industries and throughout the country, with the number of firms in the annual survey sharply increasing yearly With the suggestions of Rojec and Knell (2017), using firm level panel data analysis of FDI spillovers could eliminate several failures to find unambiguously positive effects in econometric work that be alarmed by Gorg and Greenaway ( 2004) Nguyen Van Phuong et al | 293 We verify the creditable value and reliability of each observation to delete the observations that did not satisfy the minimum criteria, such as negative sales, negative output, negative input, negative capital stock, and missing information of key variables 3.2 Quantitative methodology 3.2.1 Estimate Total Factor productivity: To begin with identify the impact of technology spillovers from FDI enterprises on indigenous ones, we assume the firm’s production function is of the Cobb-Douglas type: !"# = %"# (', ), *, +)-"#/ 0"#1 (1) where Yit represents the value-added output of firm i at time t; Lit and Kit are labor and capital inputs, respectively; and FDI is denoted by f; common technical factors are denoted by a; stock of firm specific capital including human capital and managerial ability is denoted by m; and external sources of knowledge are denoted by g Similar to many previous studies, for instance, Liu (2008) and Javorcik and Spatareanu (2008) which relate productivity to FDI spillovers We first estimate the firm-level total factor productivity (TFP) We then regress from the TFP on proxies for FDI spillovers, and their interactive terms associated with other control variables Taking the natural logs of Equation (1), which is denoted by small letters, we estimate the logarithm function of production function: 2"# = + 67 8"# + 69 :"# + ;"# +