Introduction
Problem Statement
The Provincial Competitiveness Index (PCI) aims to clarify the disparities in economic performance across different regions, focusing on private sector dynamism, job creation, and investment attraction By utilizing recent survey data from businesses regarding their local environments, alongside reliable data from official sources, the PCI evaluates provinces on a 100-point scale Initially established in 2005 with nine sub-indices, the index has evolved to include new sub-indices in 2006, reflecting the efforts of Provincial Governments to improve the business climate.
There is a lack of empirical studies examining the independent variables of PCI and other traditional factors that influence provincial FDI in Vietnam, as well as their impact on this investment.
I also did not find any analysis related to the independent variables of PCI whether they have internal relation.
Research Objectives
This research aims to analyze the significant effects of various independent variables, including PCI and traditional factors, on provincial foreign direct investment (FDI) inflows The findings will assist policymakers in identifying critical areas for enhancing the investment climate at both provincial and governmental levels.
There exist some previous studies related to attracting FDI to developing countries; most of these have found what factors ofthe country attracting FDI (across countries)
However, the objectives of the thesis are to identify:
The independent variables of the Provincial Competitiveness Index (PCI) and other traditional factors significantly influence Foreign Direct Investment (FDI) in Vietnam's provinces Additionally, the strong correlation among PCI factors suggests the need for a revision of the PCI framework.
(iii) PCI determinants out of the ten original factors should be included in a new, more significant subset base of PCI determinants
(iv) Interaction effects between PCI improvement and FDI growth.
Research questions
This thesis examines the factors influencing provincial foreign direct investment (FDI) in Vietnam, utilizing the Provincial Competitiveness Index (PCI) alongside traditional variables that may attract FDI to various provinces.
This article explores economic theory and empirical studies related to Foreign Direct Investment (FDI) in Chapter 2, followed by a detailed description of the independent variables utilized in the PCI project survey in Vietnam in Chapter 3 We develop a research model and gather data from the PCI project (www.pcivietnam.org) and the statistical yearbook of Vietnam from the General Statistics Office (www.gso.gov.vn) to address key research questions.
(l)Which independent variables of PCI and other traditional variables are significant impacts to FDI of Provinces in Vietnam?
(2)Factors ofPCI are highly correlated and we should revise PCI set?
(3)Which PCI determinant out of the ten original factors should be included in a new, more significant subset base of PCI determinants?
(4)Are interaction effects between PCI improvement and FDI growth?
Organization of the study
This thesis has five chapters, while the chapter one has presented as above explain the purpose chose the theme The rest of this thesis is organized as follows:
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Chapter two offers an overview of regional development and foreign direct investment (FDI) theory, while also summarizing empirical research focused on attracting FDI, particularly in relation to various provinces within the country.
Chapter three outlines the process of constructing the research model based on the data selection methods discussed in chapter two It emphasizes the significance of defining both dependent and independent variables utilized in the PCI project’s annual surveys, while also incorporating traditional variables.
Chapter four presents the econometric analysis and findings, while the final chapter will offer conclusions and recommendations based on the research.
Theoretical Consideration and Literature Review ll 2.1 The regional development and competitive regionalism theory
FDI theories and its applicability
Foreign Direct Investment (FDI) is influenced by various factors, leading to diverse approaches in understanding its determinants Capital theory emphasizes the importance of profit rates and risks for firms, while international trade theories examine the relationships between FDI and exports, whether as substitutes or complements Theories of industrial organization view FDI as a means to leverage a firm's specific advantages The OLI paradigm offers a dynamic perspective on FDI determinants, and agglomeration economies explore the spatial distribution of FDI.
2.2.1 Capital Theory 2.2.1.1 Differential Rate of Return Theory
Until the 1950s, international direct investment was entirely explained within the traditional theory of international capital movements Like other forms of international
Foreign Direct Investment (FDI) is viewed as a reaction to the varying rates of capital returns across different countries.
Investors aim to create an efficient investment portfolio to mitigate risk The potential returns from various alternative investments are aligned with their associated risks, guiding the selection of substitutable assets for portfolio optimization.
Dunning (1973) argues that portfolio theory only partially accounts for direct foreign investment because it overlooks the fact that direct investment does not entail changes in ownership Instead, it involves the transfer of various factor inputs, such as entrepreneurship, technology, and management expertise Additionally, the relative profitability of utilizing these resources in different countries, compared to money capital, significantly influences direct investment decisions.
The theory argued that the international diversification of portfolios 1s a way of reducing the firm's risk and hedging the risks
Capital theory shows that some determinants related cost factors in PCI set have potential effects to attracting FDI of provinces
2.2.2 The International Trade Arguments 2.2.2.1 Mundell and the Heckscher-Ohlin Model
Mundell (1975) expanded the foundational model to demonstrate that trade and capital movements can act as substitutes He posited that implementing trade tariffs would lead to an influx of foreign direct investment (FDI) into the protected nations This perspective aligns with the original Heckscher-Ohlin model, which suggests that trade restrictions can be offset by international capital movements, particularly in the context of labor immobility.
Kojima (1973) categorizes the motives for foreign direct investment (FDI) into four key areas: (i) the pursuit of natural resources, (ii) the exploitation of low labor costs in the host country, (iii) the avoidance of tariffs and non-tariff barriers, and (iv) the leverage of oligopolistic power derived from technological and knowledge advantages.
The product cycle model, introduced by Vernon in 1966, addresses the rapid international investment by US firms According to Vernon, every product experiences a life cycle consisting of three distinct phases: innovation, maturity, and standardization.
Domestic demand drives innovation, while international demand boosts exports The theory suggests that the combination of the US's highly skilled labor and R&D resources, along with advanced domestic demand, has fostered innovation among American companies.
2.2.3 Market Failures and Industrial Organization 2.2.3.1 The Hymer-Kindleberger hypothesis
Foreign firms face inherent disadvantages compared to domestic companies, such as limited market knowledge and communication barriers, necessitating the possession of firm-specific advantages for successful foreign production Hymer (1960) posits that foreign direct investment (FDI) transcends mere capital transfer, involving the international exchange of proprietary rights and intangible assets, including technology, business techniques, and skilled personnel He argues that FDI arises primarily from international market imperfections related to these assets, prompting firms to "internalize or supersede" market failures through direct investment.
Certain transactions can be more economical when conducted within a firm rather than in the market Internalization occurs when the advantages, including those related to barriers for new entrants, surpass the costs associated with communication, coordination, and control Foreign Direct Investment (FDI) is often pursued to leverage these benefits.
2.2.4 The Eclectic Paradigm and International Investment Path
Dunning ( 1979) suggests that a firm engage in FDI if three conditions are satisfied:
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It possesses net ownership (0-) advantage vis-a-vis firms from other countries;
It is beneficial to internalize (I- advantage) those advantages rather than to use the market to pass them to foreign firms;
There are some location (L-) advantages in using the firm's ownership advantages in a foreign location rather than at home
The IDP approach addresses both inward and outward investments of a country, highlighting the correlation between a nation's development level and its international investment stance, as indicated by net outward investment per capita.
This approach posits that there is a significant relationship between inward and outward investment flows and a country's development As a nation progresses, the conditions encountered by both domestic and foreign firms evolve.
In today's rapidly globalizing world, the location determinants of foreign direct investment (FDI) in host countries have become increasingly significant for multinational enterprises (MNEs) According to UNCTAD (2001), while traditional factors influencing FDI remain relevant, their importance is waning, especially in dynamic and high-tech industries Instead, the attractiveness of FDI locations is increasingly reliant on host countries' capacity to offer complementary skills, robust infrastructure, reliable suppliers, and effective institutions.
Increasing returns in production activities are needed if we want to explain economic agglomerations without appealing to the attributes of physical geography
Agglomeration externalities include the benefits of specialized labor markets, supplier networks, and knowledge spillovers These factors contribute significantly to economic growth and innovation within concentrated areas.
Table 2.1 summarizes the key determinants of regional economic growth in developing countries, highlighting the importance of geography, infrastructure, and the quality of institutions Effective governance, transparent business environments, and secure property rights are crucial for fostering competitive regionalism Additionally, a flexible labor market and a competitive tax regime, along with efficiently supplied public goods, play significant roles in enhancing local businesses and human capital, ultimately connecting these regions to the global economy.
Empirical studies on the determinants ofFDI
Conventional empirical studies on the determinants of Foreign Direct Investment (FDI) have identified ten key variables, as proposed by Dunning and Narula (1996) These variables include: natural and created assets, capital intensity, market size and growth, infrastructural development, labor cost and productivity, and the degree of openness.
(vii) government policies; (viii) political stability; (ix) profitability; (x) geographical proximity
Nonnemberg and Mendonya (2004) analyzed the factors influencing foreign direct investment in developing countries using an econometric model Their study utilized panel data from 38 developing economies covering the period from 1975 to 2000.
The results indicate that education is a key determinant of foreign direct investment (FDI), particularly in developing countries where investments are increasingly focused on knowledge-intensive activities Additionally, the degree of an economy's openness plays a significant role in attracting FDI A causality test revealed that GDP influences FDI, but not the other way around.
Ali and Guo (2005) conducted a survey on FDI determinants, revealing that market size is a significant factor influencing foreign direct investment (FDI), while labor costs and global integration also play crucial roles in attracting FDI.
Sahoo (2006) conducted a panel cointegration study focusing on five South Asian countries—India, Pakistan, Bangladesh, Sri Lanka, and Nepal The analysis indicates a long-run equilibrium relationship between foreign direct investment (FDI) and its key determinants, which include market size, labor force growth, infrastructure index, and trade openness The study emphasizes the need for South Asian countries to sustain growth, enhance market size, develop policies to leverage their labor force, improve infrastructure, and adopt more open trade policies to attract increased FDI.
Kozlova and Smajlovic (2008) identified FDI inflows as the dependent variable in their model, with key explanatory variables including GDP per capita, investment freedom, trade openness, and infrastructure Additionally, a dummy variable indicates whether a country is an oil-exporter or a non-oil exporter.
FDii = ai + ~1 (GDPperCap)i + ~2 (lnvestmentFreedom)i + ~3 (Infrastructure)i + ~4
The findings indicate a significant relationship between infrastructure, trade openness, and foreign direct investment (FDI) in the MENA (Middle East and North Africa) region.
Vijayakumar et al (2010) identified that, aside from Economic Stability and Growth prospects—assessed through inflation rates and industrial production—trade openness, indicated by the ratio of total trade to GDP, is a significant determinant of FDI inflows in BRICS countries.
Most of FDI researches focused to FDI of a country or some countries but they should be reviewed to compare these potential explanation variables with independent variables of provincial FDI.
Geographical literature on Vietnam, China and ASEAN countries l9
Xu et al (2009) reported that agglomeration economies, labor cost, infrastructures greatly influence the spatial distribution ofFDI in China
According to Dang (2008), several key determinants drive foreign direct investment (FDI) in China Firstly, many investors are attracted to the vast Chinese domestic market Secondly, the availability of inexpensive labor presents opportunities for reducing production costs Additionally, the quality of infrastructure plays a significant role in FDI inflows, as it enables firms to enhance their technology and achieve economies of scale and scope Lastly, the political environment is crucial, with China's leadership providing a clear vision for the country's growth and development, further attracting foreign investment.
Luo et al (2007) emphasize the importance of investigating how natural resource endowments can drive local economic growth and attract foreign direct investment (FDI) in under-developed regions.
MNEs prioritize locations that can facilitate high-value activities over those with low labor costs, moving away from the traditional emphasis on China's labor cost advantage.
Havrylchyk and Poncet (2006) found that the positive impact of agglomeration, high labor productivity and low labor costs, market size, infrastructure density, and market reforms on FDI
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Na and Lightfoot (2006) found that three key variables significantly influence foreign direct investment (FDI) across 30 regions in China Firstly, the market demand and size, measured by GDP, positively attract FDI Secondly, regions with higher labor quality are more appealing to foreign investors Lastly, the degree of openness and the level of reform in each region also play a crucial role in attracting FDI.
According to Giang (2008), four key local factors hinder development in Vietnam: the remote location from the country's commercial center, underdeveloped infrastructure, a weak foreign direct investment (FDI) policy, and an unfavorable FDI environment compared to other regions.
The foreign direct investment (FDI) environment in the mountainous provinces (NMPs) of Vietnam is unfavorable, as indicated by annual surveys conducted by the Vietnam Chamber of Commerce and Industry (VCCI) and the Vietnam National Competitiveness Index (VNCI) Most NMPs, with the exception of Uto Cai, exhibit low levels of transparency, and six of these provinces rank among the least transparent in the country.
According to Anh and Thang (2007), key factors influencing the location decisions of foreign direct investors in Vietnam include market potential, labor availability, and infrastructure However, their research did not reveal any significant evidence regarding the influence of local government policies on foreign direct investment.
Anh et al (2007) conducted an empirical evaluation of the effectiveness of incentives in attracting foreign direct investment (FDI) They implemented a two-step difference-in-differences (DD) estimation, beginning with the estimation of a regression model using ordinary least squares (OLS) methodology.
Yst = bO + bl.Xst + b2.Breaks + gst (1)
The level of per capita Foreign Direct Investment (FDI) attracted to provinces in year \( t \) is denoted as \( Y_{st} \), while \( X_{st} \) represents the relevant determinants or control variables influencing FDI attraction to province \( s \) in the same year Additionally, a dummy variable, \( Breaks \), is used, where it equals 0 for non-breakers and 1 for breakers The subsequent step involves estimating the impact of incentives on FDI attraction.
The OLS regression analysis in this two-period panel reveals distinct impacts of labor costs on registered versus implemented foreign direct investment (FDI) The regression model is expressed as \$gsi = b3 + b4.Timesi + usi\$ The dummy variable \$Timesi\$ indicates the period before (0) and after (1) the issuance of incentives The findings show that while the coefficient of wages is positive and statistically significant in the post-investment period, it is negative and statistically insignificant in the pre-investment period This suggests that prior to investment, foreign investors tend to favor locations with lower labor costs However, once the investment is made, the investor's ability to choose cost-effective locations diminishes, leading to a scenario where the presence of FDI projects results in a tighter labor market, increased productivity, and consequently, higher wages, as reflected by the positive wage coefficient in the post-investment regression.
Thu (2007) studied the determinants of the FDI in Vietnam, the specific empirical model of the time-series determinants ofFDI inflows in Vietnam is:
LnFDit = po + 81 lnGDPt + 82 lnGDPGt+ 83 lnTELt + 84 lnHKt + 85 lnOPENt + 86 lnEXCHANGEt + 87 Dl998+ 88ASEAN + ut The results reveal that higher market size and higher GDP growth are encouraging FDI inflows into Vietnam
Ali and Ahmad (2008) reported that important factors in determining the location relationship of FDI in Malaysia are the community, availability of raw materials and fuel
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Spatial Determinants of Inward agglomeration economies, FDI in China: Evidence from labor cost, infrastructures Provinces
FDI in China Economic Growth and Policy
Market size and growth, Government incentive policies; Cheap labor cost;
Na and Determinants of foreign direct market size (GDP),quality labor degree of openness Lightfoot investment at the regional
Foreign Direct Investment in Market stze, labor force South Asia: Policy, Trends, growth, infrastructure index Impact and Determinants and trade openness
Determinants of the FDI and market size, economic growth: a summary of recent growth, macroeconomic literature stability, Infrastructure , regulation, economic barrier
6 Anh and Foreign direct investment m the marker potential, the
Vietnam's infrastructure spatial distribution across provinces is influenced by various labor factors and determinants Analyzing these elements provides insights into the country's development and economic growth Understanding the dynamics of labor and infrastructure can help in formulating effective policies for regional development.
7 Thu Determinants of the FDI m market size; GDP growth
8 Agiomirgi The determinants of foreign the marker size, the trained anakis et direct investment: a panel data labour , and infrastructure al (2006) study for the oecd countries
Most research on Foreign Direct Investment (FDI) has concentrated on the FDI of individual countries or groups of countries However, there are studies from China that examine regional FDI My thesis specifically focuses on provincial FDI in Vietnam, utilizing independent variables from the Provincial Competitiveness Index (PCI) along with several traditional variables.
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Base on Vietnam PCI project proposed general framework for determinants of provincial competition index as follows:
The equation \$PCiit = f(EC_{it}, AL_{it}, TAl_{it}, TCRC_{it}, IC_{it}, PPL_{it}, BSS_{it}, LT_{it}, Li_{it}, INF_{it}, u_{it})\$ represents the factors influencing the performance of private companies in a given region Key variables include Entry Costs (EC), Access to Land (AL), Transparency and Access to Information (TAl), Time Costs of Regulatory Compliance (TCRC), Informal Charges (IC), Proactivity of Provincial Leadership (PPL), Business Support Services (BSS), Labor Training (LT), Legal Institutions (LI), and Infrastructure (INF) Each of these elements plays a crucial role in shaping the business environment and overall company performance.
Base on empirical studies related to FDI, especially regional FDI, economic theory and base on PCI survey as equation ( 1 ), the research question is
(i) Which independent variables of PCI and other traditional variables are significant impacts to FDI of Provinces in Vietnam?,
The first regression model for this study is suggested as follow:
FDI it= a o +a 1 EC it+ a 2 ALit+ a 3 TAl it+ a 4 TCRC it+ as IC it+ a 6 PPL it+ a
1 BSS it +as LTit +a 9 LI it+ o.w IP u +an INF it+ o.n MS it + o.13 KEA it + u it
Where: IP-Industrial Product of province, MS-Market Size, KEA: northern and southern key economic area KEA = 1, other provinces KEA =0
The OLS technique applies for the first regression model to answer for the first research question
Based on economic theory and principal component analysis, we anticipate discovering multicollinearity or significant interaction effects among certain variables Specifically, some independent variables may be categorized into two groups: Cost Factors and Province Policy, allowing for the potential exclusion of less relevant variables.
The Cost Factor (CF), which encompasses Economic Costs (EC), Total Revenue Cost (TCRC), and Investment Costs (IC), along with Province Policies (PP) that include Agricultural Land (AL), Total Agricultural Land (TAl), Provincial Policies on Land (PPL), Basic Service Standards (BSS), Land Tenure (LT), and Land Incentives (LI), should be thoroughly reviewed to incorporate additional significant variables This approach is utilized to address research questions No 2 and No 3.