Revisiting exports and foreign direct investment in vietna

Revisiting Exports and Foreign DirectInvestment in Vietnam Vo Tri THANH† and Nguyen Anh DUONG Central Institute for Economic Management Since 1986, Vietnam has undertaken various reform

Revisiting Exports and Foreign Direct

Investment in Vietnam

Vo Tri THANH† and Nguyen Anh DUONG

Central Institute for Economic Management

Since 1986, Vietnam has undertaken various reform measures in the trade and foreign investment area This paper finds significant contributions of world trade, and competitiveness and liberaliza-tion effects to Vietnam’s export growth over the period 1997–2008 Vietnam’s exports became more competitive and better complemented the import demand of Vietnam’s trade partners In addition, dynamic comparative advantage became evident in many products, but significant room remains for improving export competitiveness Foreign direct investment (FDI) inflows also increased and helped stimulate Vietnam’s exports FDI inflows have increased in both the short- and long-term, yet are only of a limited magnitude This necessitates more effective measures to enhance the linkages between FDI and domestic enterprises.aepr_1187 112 131

Key words: CMS decomposition, export competitiveness, FDI policy reform, spillover impact,

trade liberalization

JEL codes: F14, F15, F21

1 Introduction

The Doi Moi (Renovation) in 1986 started a period of more fundamental changes in Vietnam, particularly in resource allocation, trade restrictions, and macroeconomic man-agement The Sixth Party Congress in 1986 officially rejected the rationale and legitimacy

of the central planning model, and declared Vietnam’s move toward a somewhat mixed market economy, with an emphasis on broadening opportunities and choices for every-one Thus, the Doi Moi started Vietnam’s transformation from a centrally planned economy into a market one with a socialist orientation

In such a process, together with establishing and strengthening market institutions and promoting private sector development, Vietnam has embarked on proactive inter-national economic integration Specifically, the country has enhanced economic cooperation with all countries and territories, particularly the major economies Trade in general and exports in particular have been expanded, while foreign investment tended

to increase and helped fill the domestic savings–investment gap and the technology gap

of an economy at a low development level The paces of export and foreign investment expansion and, accordingly, economic growth, were generally fast in times of deepening economic integration

†Correspondence: Vo Tri Thanh, Central Institute for Economic Management, 68 Phan Dinh Phung Street, Ba Dinh District, Ha Noi 10000, Vietnam Email: votrithanh@mpi.gov.vn; votrithanh98@ yahoo.com

doi: 10.1111/j.1748-3131.2011.01187.x Asian Economic Policy Review (2011) 6, 112–131

© 2011 The Authors Asian Economic Policy Review © 2011 Japan Center for Economic Research

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This paper attempts to revisit the roles of exports and foreign direct investment (FDI)

in Vietnam’s new development context In doing so, the paper starts by reviewing the reforms in trade and foreign investment policies The analysis of Vietnam’s export com-petitiveness follows using both trade indicators and trade decompositions The paper then investigates the importance of FDI in light of the spillover effect on Vietnam’s enterprises

On that basis, the paper draws some conclusions and identifies measures through which the contributions of FDI and exports to Vietnam’s economy can be improved

The remainder of the paper is structured as follows Section 2 reviews the reforms Vietnam has made in the trade and foreign investment area over the period 1986–2009 Section 3 discusses Vietnam’s export performance over the past decades, as well as Vietnam’s export competitiveness using different trade indicators and a decomposition via the constant-market-share (CMS) approach Section 4 then analyzes the link between FDI and exports Section 5, finally, summarizes the key findings in the previous sections and recommends key policy measures to enhance the roles of FDI and exports in Vietnam

2 Vietnam’s Reforms in Trade and Foreign Investment, 1986–2009

Despite the ideological change toward Vietnam’s economic model in 1986, bold and effective reform measures only began a couple of years later During 1988 and in early

1989, Vietnam adopted a radical and comprehensive reform package Key measures were undertaken toward domestic reform, seeking to enhance competition and the freedom of choice for all economic units and measures The state-owned enterprises (SOEs) were permitted to have autonomy in production and business activities, independent account-ing, and to use revenues to finance expenditures, with no loss of compensation from the State In late 1987, Vietnam abolished controls on domestic trade and enhanced the autonomy of SOEs Since 1989, structural reforms – such as SOE reform, banking reform, and the promotion of private sector development – have also been implemented Until

1996, economic reform focused mainly on agricultural reform, price reform, exchange rate reform (a drastic devaluation of the Vietnamese dong and the unification of exchange rates), budget reform, SOE reform, and private sector development The wide range of areas that underwent reform and the numerous measures undertaken in each area show-cased the comprehensiveness of Vietnam’s reform in this period

Despite slowing down in 1997–1999 due to impacts of the Asian economic-financial crisis, economic policy reforms got back on track since 2000, with an acceleration of SOE reform and private sector development The legal framework for the market economy has been improved further The Enterprise Law in 2000 enforces the freedom to do business, while the later version in 2005 regulates enterprises of all ownership forms in Vietnam Similarly, the Investment Law, which came into effect in July 2006, marked a major step to improving the investment environment, aiming at creating a more level playing field for all The regulations on production factor markets have been gradually improved The Labor Code also went through various amendments thereby enhancing the flexibility of the labor market, promoting production, and improving the people’s lives Similarly, the

Land Law has been revised several times The legal framework for various components of the capital markets, including the securities and bond markets, has also been established and enforced

In another aspect, Vietnam attempted to facilitate trade expansion and attract FDI by laying the legal foundations for such activities Entry to foreign trade, previously restricted

to SOEs, has been gradually relaxed for the private sector since 1989 In 1998, all enter-prises were allowed to trade most goods registered in business licence without export/ import licenses and, since 2001, this right has become available for all legal entities (including enterprises with foreign capital) Nontariff barriers (NTBs) were a key com-ponent of Vietnam’s trade policy until the early 1990s and were gradually and significantly replaced by tariffs Vietnam gradually phased out quantitative restrictions on imports, while relaxing foreign exchange control.1Currently, NTBs are mainly comprised of tariff quotas on a limited range of agricultural products

Since 1992, the tariff system has been continually revised and elaborated Tariff rates were originally set for broad products under the 6-digit Harmonized System (HS) classi-fication, and became further particularized to the 8-digit level in 1999 and to 10-digit level

in 2006 The number of tariff lines also went up from 2806 in 1992, to 3223 in 1998, 6221

in 1999, 10,648 in 2003, and 11,124 in 2007 The tariff system, however, becomes increas-ingly complicated as Vietnam engages more deeply into economic integration The simple average tariff rate, on a most-favored-nation’s (MFN’s) basis, initially rose from around 7.5% in 1992 to almost 16.1% in 1999, 18.5% in 2003, before falling to 14.2% in 2007 Imports from other trading partners such as member countries of the Association of South East Asian Nations (ASEAN), China, Korea, and Japan were treated with different tariff rates under different free trade agreements (FTAs)

To facilitate FDI inflows, Vietnam promulgated the Law on Foreign Investment in as early as 1987 The Law subsequently underwent four revisions in 1990, 1992, 1996, and

2000 Such revisions were mainly sought to increase the rights of foreign investors, to make the investment environment more favorable, and to narrow the policy gap between foreign and domestic investors The improvements were comprehensive, ranging from registration procedures, the decentralization of investment licensing, land access, trade policy, foreign exchange control, and tax policies These improvements were induced by such factors as the performance of the FDI sector, changes in the awareness of and views toward the FDI sector, competitive pressures in attracting FDI, and international com-mitments regarding foreign investment The Investment Law in 2005 went even further by establishing a more level investment environment for all investors, while simplifying the registration procedures for foreign investment

To further promote trade and FDI, Vietnam also undertook a proactive open-door policy and international economic integration In 1995, Vietnam joined ASEAN and signed the Framework Agreement on cooperation with the European Union (EU) The process was rather slow in the 1997–1999 period due to the Asian monetary-financial crisis The years since 2000 up to now have seen strong investment and trade liberalization

as well as deeper integration into the world economy Integration was the most rapid in this period Vietnam signed a bilateral trade agreement (BTA) with the USA in 2000 which

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came into effect in 2001 The country also became a member of the World Trade Orga-nization (WTO) as well as a signatory to various FTAs under the ASEAN umbrella, such

as those with China, Korea, Japan, Australia and New Zealand, and India

Overall, Vietnam has made significant attempts to reform her trade and FDI policies, and to enhance the roles of these factors as drivers of economic growth Such reforms were not separate; instead, they took place in concert with domestic reforms The domestic structural and institutional reforms improved the efficiency and capacity of enterprises, and required trade and FDI reforms to broaden the opportunities for such enterprises Conversely, the trade and FDI reforms together with economic integration, particularly after Vietnam’s accession to the WTO in 2007, reveal further weaknesses of the economy that necessitate bolder domestic reforms That is, analysing trade and FDI policy reforms requires the consideration of their interactions with domestic reforms Looking into actual export and FDI performance and their linkages, the purpose of the following sections can complement such an analysis

3 Analysis of Vietnam’s Exports

3.1 Vietnam’s export performance

Together with the domestic reforms and economic integration, Vietnam’s exports grew almost continuously Average export growth reached almost 18.2% p.a in the period 1995–2009, albeit with significant variations in different sub-periods Export growth fell from over 33% in 1996 to nearly 2% in 1998 due to the Asian monetary – financial crisis, and then recovered quickly to 25% in 2000 Again, export growth dropped to below 4% in

2001, after which it accelerated to over 31% in 2004, partly due to the Vietnam – US BTA Over the years 2005–2007, exports grew at a rather stable rate of around 22% per annum Although export growth later went up to 29% in 2008, it dropped sharply to a negative level in 2009 due to the impact of the global financial crisis and economic recession Notably, WTO accession brought about no significant improvement in Vietnam’s export growth (Central Institute for Economic Management [CIEM], 2010)

Total export turnover of primary commodities went up continuously from around USD3.7 billion in 1995 to over USD5.0 billion in 1998, and over USD19.2 billion in 2006 After Vietnam’s WTO accession, exports of primary commodities rose further to approxi-mately USD21.7 billion and around USD27.7 billion in 2007 and 2008, respectively Nevertheless, the share of primary commodities in Vietnam’s exports went down almost continuously, from over 67% in 1995 to over 44% in 2008 Key export products in this category are rubber, coffee, crude oil, and coal

Meanwhile, exports of processed and purified products exhibited increases in both absolute and relative terms The total turnover of processed and purified products went up from below USD1.7 billion in 1995 to over USD4.3 billion in 1998, and around USD20.6 billion in 2006 Exports of processed or purified products also grew faster after the WTO accession, to reach USD26.9 billion in 2007 and over USD34.6 billion in 2008 The share

of this category in Vietnam’s exports rose accordingly from nearly 33% in 1995 to over

55% in 2008 That is, export growth in Vietnam has been accompanied by a shift in the export structure toward a larger share of products with higher processing content ASEAN, APEC, and the EU are the key groups of trade partners for Vietnam Exports

to ASEAN rose from below USD1 billion in 1995 to around USD8.6 billion in 2009 As a group, APEC imported a lot from Vietnam, and such imports rose even faster (from around USD4.0 billion in 1995 to over USD44.2 billion in 2008) than ASEAN’s imports The EU also saw their role in Vietnam’s exports improve, as Vietnam’s exports to the EU went up from below USD0.7 billion in 1995 to almost USD9.4 billion in 2009 By country and territory, the USA, Japan, and China are the three largest markets for Vietnam’s exports in recent years However, the rankings of these countries have changed, reflecting some diversion of Vietnam’s exports In 1995, Japan was the largest importer for Viet-nam’s products; yet in 2009, the USA became the largest export market for Vietnam

3.2 Analysis of Vietnam’s trade and export indicators

Methodology

To deepen our understanding of Vietnam’s exports, this subsection follows the CMS analysis developed by Leamer and Stern (1970) Accordingly, export differences between

any two points in time are decomposed into four components: (i) the general change in

world exports; (ii) the initial commodity composition of the exporting country; (iii) the initial market distribution of exports; and (iv) an unexplained residual – the competitive-ness effect indicating the differences between actual export increase and the hypothetical increase if the exporting country had maintained export shares of each commodity group

to each country

A couple of trade indicators can be employed to complement the analysis First, the revealed comparative advantage (RCA) index is calculated for each category of Vietnam’s export products, using the following formula: RCAj= (xj/Xt)/(xwj/Xwt) where xijand xwjare the respective values of Vietnam’s exports of product j and world exports of product j at time t; Xitand Xwtare Vietnam’s total exports and world total exports, respectively (both

at time t) The index implies export potential in particular products, with a value greater

than unity implying a revealed comparative advantage and a value of less than unity implying a revealed comparative disadvantage.

Second, we compute the trade complementarity (TC) index, showcasing the prospects for exports between Vietnam and her trade partners by matching the structure of Viet-nam’s exports with those of her partners’ imports The formula is

i

n

=100−∑= −

2

where m ik is the share of good i in country k’s imports and x i is the share of good i in

Vietnam’s exports A value of zero indicates that none of Vietnam’s exports is imported by

the other and a value of 100 indicates Vietnam’s export structure and country k’s import

structure exactly match

This Section uses relevant trade data from the COMTRADE database The adopted product classification is the Standard International Trade Classification (SITC) at the

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2-digit level The key trade partners of interest are ASEAN, China, South Korea, Japan, the USA, Australia, and New Zealand The period under consideration is from 1997 to 2008 For more accurate results, import flows of all other partners are selected as the proxy for Vietnam’s exports.2

Analytical results

Table 1 shows the results of the CMS decomposition of Vietnam’s exports over the period 1997–2008 Throughout this period, Vietnam’s exports increased by over USD56.2 billion According to the CMS decomposition, this increase is explained largely by the world trade effect and the unexplained residual Growth in world trade accounts for almost USD16.8 billion, or nearly 30% of the increase in Vietnam’s exports Simultaneously, the unex-plained residual explains around USD37.3 billion, or over 66%, of the increase in Vietnam’s exports The decomposed changes in exports due to product composition and market distribution are negligible, accounting for only around 4% of the export increase

in 1997–2008

Theoretically, the unexplained residual reflects the excess of the actual export increase over the hypothetical level if the exporting country had maintained the export

shares of each commodity group to each existing partner For a transition economy like

Vietnam, however, the unexplained residual also includes the impacts of trade liberal-ization Together with trade and FDI policy reforms and efforts toward economic integration, Vietnam has gradually gained access to new markets and/or for new prod-ucts As an example, the Vietnam–USA BTA significantly enhanced the access of Vietnam’s exports to the US market since 2001, leading to the rise of Vietnam’s mer-chandise exports to the USA from USD1.07 billion in 2001 to USD5.02 billion in 2004 Such access provides new sources of export growth for Vietnam, even if traditional export products fail to better penetrate traditional markets In addition, the liberalization effect helps restore Vietnam’s previously constrained trade and exports to the “norm.” Separating the impact of trade liberalization from the unexplained residual is, however, impossible as it cannot identify “new access” to new markets and/or for new products Thus, as a caveat, the unexplained residual should not be interpreted as solely due to improvements in competitiveness.3

More interesting insights can be drawn from the CMS decomposition results in different subperiods (Table 1) In all subperiods, the export increase was mainly driven by world trade growth and improved competitiveness and liberalization, and the signs of these impacts were all positive The increase in exports explained by competitiveness improvements and liberalization rose from USD3.9 billion in 1997–

2000 to USD6.5 billion in 2001–2004, over USD8.6 billion in 2004–2007, before decreasing to USD6.4 billion in 2007–2008 Meanwhile, the product composition effect was negative in three subperiods: 1997–2000, 2001–2004, and 2004–2007, while being positive in 2007–2008 Conversely, the market distribution effect was only negative in 1997–2000

The relative magnitude of the decomposed impacts also changed Between 1997 and

2000, the share of the world trade effect in the export increase was 32% The figure then

Table 1 CMS decomposition results for Vietnam, 1997–2008

Value (million

Value (million

Value (million

Value (million

Value (million

Change in Vietnam’s export 4861 100.00 13,801 100.00 22,374 100.00 14,868 100.00 56,265 100.00 World trade effect 1575 32.40 7,381 53.48 13,693 61.20 7,202 48.44 16,798 29.85 Product composition effect -464 -9.54 -1272 -9.22 -319 -1.43 695 4.67 -194 -0.34 Market distribution effect -166 -3.42 1,201 8.70 364 1.63 619 4.16 2,361 4.20 Unexplained residual 3916 80.56 6,491 47.03 8,636 38.60 6,353 42.73 37,300 66.29 Source: Authors’ calculation from COMTRADE database

rose to 53% in 2001–2004, and 61% in 2004–2007 Consequently, the world trade effect dominated the competitiveness and liberalization effect Due to the global financial crisis, world trade grew more slowly, and only accounted for 48% of Vietnam’s export increase

in 2007–2008 That is, together with trade liberalization and economic integration, Viet-nam’s exports have become increasing aligned with world trade

The contribution of the competitiveness and liberalization effects to the export increase fell from 81% in 1997–2000 to 47% in 2001–2004 and 39% in 2004–2007, before rising to 43% in 2007–2008 Such a general fall seems understandable since the availability

of access to new markets gets smaller along with Vietnam’s expansion of trade relations and deepening of economic integration with more partners This argument is further strengthened by the better alignment of Vietnam’s exports with world trade, leading to the greater role of the latter From this perspective, such a decrease in the contribution of the competitiveness and liberalization effects is less than alarming Instead, it merely reflects the convergence of the residual to the competitiveness effect, with a smaller impact of the liberalization effect

The aggregate impact on export increases due to product composition and market distribution also exhibited an interesting pattern In the years 1997–2000, both effects had negative signs, and altogether accounted for almost 13% of the export increase In the subperiods 2001–2004 and 2004–2007, both effects almost canceled each other out Between 2007 and 2008, meanwhile, the impacts of product composition and market distribution are positive and contribute nearly 9% to the export increase This presents a favorable shift in Vietnam’s export structure, as the sources of Vietnam’s export growth became more diversified, which makes the country’s exports less vulnerable to unfavor-able developments specific to any single partner or product

Interesting insights can also be drawn from the comparison of Vietnam’s decom-posed export growth with that of China (Table 2) for the same period 1997–2008 The export increase of China in this period was of a dramatically larger magnitude The unexplained residual, that is, the “competitiveness effect,” made up the largest share (76%) of China’s export increase, which dominates that of the world trade effect (37%) Similar to Vietnam’s case, competitiveness improvements initially (i.e in 1997– 2000) contributed more to China’s export increase, but since 2004 they have been dominated by the world trade effect Unlike Vietnam, China is a big player in world exports; therefore, her alignment with world trade seems to be slower than that of Vietnam

The importance of competitiveness improvements in China’s export growth has gen-erally decreased over time The share of the unexplained residual in the export increase rose slightly from 66% in 1997–2000 to 67% in 2001–2004, before falling to 55% in 2004–2007 and 40% in 2007–2008 Meanwhile, the share of the world trade effect increased sharply from 41% in 1997–2000, to 59% in 2004–2007 and to 112% in 2007–

2008 The difference in the export structure of China compared to that of the world caused consecutive decreases in China’s exports Moreover, such decreases got larger over time, even in relative terms, from 4% in 1997–2000 to 12% in 2004–2007 and 54% in 2007–2008

Table 2 CMS decomposition results for China, 1997–2008

Value (billion

Value (billion

Value (billion

Value (billion

Value (billion

Change in China’s exports 120.90 100.00 413.10 100.00 683.09 100.00 193.20 100.00 1421.26 100.00 World trade effect 49.57 41.00 215.19 52.09 404.50 59.22 215.93 111.76 528.73 37.20 Product composition effect -4.16 -3.44 -52.97 -12.82 -83.73 -12.26 -104.78 -54.23 -129.63 -9.12 Market distribution effect -4.90 -4.05 -25.93 -6.28 -10.34 -1.51 4.55 2.35 -55.08 -3.88 Unexplained residual 80.39 66.49 276.81 67.01 372.66 54.55 77.51 40.12 1077.23 75.79 Source: Authors’ calculation from COMTRADE database CMS, constant market share

Such trade indicators as RCAs and TCs further reflect the pattern of Vietnam’s export competitiveness across different product categories and over time Table 3 lists the calcu-lated RCA index for some SITC product categories in the period 1997–2008 Vietnam had comparative advantages mainly in primary, labor- or resource-intensive products Foot-wear has the largest comparative advantage Other sectors with significant comparative advantages, especially in recent years, include fish, crustaceans, mollusk; coffee, tea, cocoa, spices; articles of apparels and clothing accessories Yet some sectors – including even footwear and rubber – experienced a decline in their comparative advantages Some others – particularly coffee, tea, cocoa, spices, and manufactures thereof; furniture, and parts thereof; bedding, mattresses, mattress supports, cushions, and similar stuffed furnishings; and leather, leather manufactures, and dressed furskins – became significantly more competitive

The products with RCA >1 account for the majority of Vietnam’s exports, although their share decreased continuously from over 84% in 1997 to just above 74% in 2008 (Table 4) This reflects the shift in export structure away from labor- and resource-intensive products – those that generate only low value added Even for many products with no comparative advantage (i.e RCA <1 in 2008), Vietnam has its improved competitiveness with the calculated RCA indices increasing over time The share of these products in Vietnam’s exports rose from 8% in 1997 to over 21% in 2008 Due to the relatively higher manufacturing content of these products, the improvement indicated positive shifts of the country’s export structure toward manufacturing prod-ucts That is, despite the prevalent lack of comparative advantage across a range of products, the advantages have been strengthened over time To this end, the integration process, in general, and FTAs and the WTO accession, in particular, have been jointly beneficial

Table 5 illustrates how well Vietnam’s exports complement the import demand of her various trading partners The degree of complementarity was the smallest with China, while

Table 3 RCA indices of some export products of Vietnam, 1997–2008

Fish, crustaceans, molluscs, and aquatic invertebrates, and

preparations thereof

8.593 10.218 10.105 9.994

Coffee, tea, cocoa, spices, and manufactures thereof 11.651 7.662 10.599 9.154 Crude rubber (including synthetic and reclaimed) 3.622 4.569 5.244 3.814 Leather, leather manufactures, n.e.s., and dressed furskins 0.301 0.640 1.196 2.049 Furniture, and parts thereof; bedding, mattresses, mattress

supports, cushions and similar stuffed furnishings

Source: Authors’ calculations from COMTRADE database n.e.s., not easily separable; RCA, revealed comparative advantage