An Analysis of Foreign Direct investment Impact On Labor Productivity At Firm level in VietNam Luận văn thạc sĩ

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 MAS

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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

BY PHAM KHAC DUY

BO GIAO DUC DAO TAO TRU'ONG D.l;\1 HQC KINH TE'TP.HCM

ACADEMIC SUPERVISOR: DR LE THI THANH LOAN

Ho Chi Minh City, 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 do 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

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 4 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 4 sub-industrial 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

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TABLE OF CONTENTS

CHAPTER 1: INTRODUCTION 1

1.1 Problem statement I 1.2 Objectives of the research 2

1 3 Research questions 2

1.4 Research hypotheses 3

1 5 Organization of the research 3

CHAPTER II: LITERATURE REVIEW 5

2.1 Introduction 5

2.2 Concepts and definitions 5

2.2.1 Foreign direct investment (FDI) 5

2.2.2 Productivity and labor productivity 6

2.3 Economic theories , 8

2.3.1 Production theories 8

2.3.1.1 Cobb-Douglas production function 8

2.3.1.2 Pindyck and Rubinfeld production theory 9

2.3.2 Theoretical background ofFDI impacts 9

2.3 2.1 Channel effects of foreign direct investment 1 0 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

3 1 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

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

4 3 2 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 3 7 5.2 Descriptive statistic analysis of regression sample and variables 37

5.2.1 Descriptive statistics of sample 3 7 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

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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

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 4 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

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Gross Domestic Product General Enterprise's Cost Survey Gross Output

General Statistics Office Intermediate Cost International Monetary Fund Non-Governmental Organization Newly Industrial Countries Organization for Economic Co-operation and Development Ordinary Least Square

Random Effects Regression Specification Error Test Seemingly Unrelated Regression United States

United States Dollar Value Added

Vietnam Enterprise Survey Variance Inflation Factor Vietnamese Dong

World Trade Organization

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

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identify main significant determinants of the FDI impacts to examine whether they vary due to different forms of ownership as well as different locations

Specifically, the present research aims to answer whether FDI increases the overall labor productivity which is helpful for Vietnamese policymakers in planning effective policies

to improve and maximize local labor productivity that can serve to develop and monitor the effects of local labor market policies, to ensure the equitable development among regions as well as achieve sustainable development

1.2 Research objectives

The general objective of the research will investigate whether FDI increases the overall labor productivity in Vietnam, as measured by term of value added per labor, focusing on enterprises of four sub-industries; food processing, hotels and restaurants, textile, garment and footwear and electronics and mechanics including domestic and FDI firms located over the country

To meet this overall objective, the research will also target two specific objectives, to evaluate whether:

(i) The impact of FDI has enhanced on labor productivity in Vietnam more than

domestically-owned firms including state owned firms and non-state owned firms?

(ii) Make recommendations to policy-makers in Vietnam as to how to best channel

FDI so as to improve and maximize the value added oflabor

1.3 Research questions

Based on the research objectives, the study will aim to find out the answers for the following questions:

1) Does FDI significantly impact on labor productivity in Vietnam?

2) Does the impact ofFDI on labor productivity in Vietnam differ significantly across regions as well as the ownership structure of firms?

3) Are there any significant differences and gaps of FDI impacts on labor productivity among these four sub-industries in this research?

2) The impact of FDI on the labor productivity significantly enhances on labor productivity in Vietnam but differs significantly across regions and among four sub-industries in the research

3) The determinants on the labor productivity m Vietnam vanes based on the ownership structure of firms and amongst, FDI firms make the most productive in increasing labor productivity compared with state owned firms and non-state owned firms

1.5 Organization of the research

The thesis consists of six chapters The frrst chapter is Introduction, which presents the problem statement of the research, the objectives of the research, research questions as well as hypotheses, and the organization of this thesis The next chapter is Literature review This chapter discusses concepts; reviews theoretical arguments and examines empirical studies relating in the research field An overview of FDI in Vietnam since 1988

is discussed mainly in chapter 3 which introduces a general view about FDI characteristics, roles and inflows in national economy, FDI enterprises' activity as well as socio-economic effectiveness of these enterprises in Vietnam Following, chapter 4:

Research methodology concentrates on model specification and the justification of variable selection as well as dig deeply econometric problems The practical results of FDI impact on labor productivity at firm level in Vietnam are analyzed and presented in chapter 5: Result analysis Finally, chapter 6: Conclusions and recommendations,

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provides the summary of main fmdings and drawings on the past analysis to suggest implications for policy

CHAPTER II LITERATURE REVIEW

2.1 Introduction

This chapter aims at reviewing literature related to the topic to make sure that the study is conducted based on a scientific background The chapter is developed into three major parts Firstly, core concepts and defmitions relevant to the research topic such as FDI, productivity as well as labor productivity will be discussed clearly In the second part, economic theories supporting for the research are presented I n addition, theoretical background of FDI impacts that give overview about channels of FDI effects as well as empirical analysis models ofFDI impacts on labor productivity is also stated Especially, the research model is also suggested in this part Finally, empirical studies regarding FDI impacts on labor productivity in some countries are discussed and commented in the last part Through this chapter, the analysis of FDI impact on labor productivity at firm level

is generally figured out on the basis of economic theories and empirical studies

2.2 Concepts and definitions

2.2.1 Foreign Direct Investment (FDI):

There are several ways to define FDI such as International Monetary Fund's FDI definition or United Nations' FDI defmition However one of the clear and popular definitions comes from Organization for Economic Co-operation and Development (OECD) According to OECD (1996), FDI is defined as follows:

"Foreign direct investment reflects the objective of obtaining a lasting interest by a resident entity in one economy (''direct investor'') in an entity resident in an economy other than that of the investor (''direct investment enterprise'') The lasting interest implies the existence of a long-term relationship between the direct investor and the enterprise and a significant degree of influence on the management of the enterprise Direct investment involves both the initial transaction between the two entities and all

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subsequent capital transactions between them and among affiliated enterprises, both incorporated and unincorporated."

The OECD (1996) also recommends in its Benchmark definition that for the existence of

a direct investment relationship the "full consolidated system" should be followed In other words, it means that when there is a cascade of participations, the percentage of the parent company in any affiliated companies should be calculated assuming the 100% of the subsidiaries and the corresponding percentage of the associates However, this criterion does not correspond with the consolidation concept in the accounting statement Besides OECD's FDI definition, Vietnam's GSO (2007) also explained Foreign Direct Investment as the bringing of capital into Vietnam in the form of money or any assets by foreign investors for the purpose of carrying on investment activities in accordance with the provisions of the law on foreign investment in Vietnam

2.2.2 Productivity and labor productivity

Also according to OECD (2001), Productivity is commonly defmed as a ratio of a volume measure of output to a volume measure of input use and labor productivity is defined as output per unit of labor input Labor productivity is a useful measure because

it relates to the most important factor of production labor and it is relatively easy to measure, Ngoc (2008) In addition, Circular No 06/2001/TT-BLDTBXH states that the labor productivity to be determined by enterprises must be equal to the number of wage unit prices they formulate for expertise in January 29, 2001 in guiding the calculation of the average labor productivity growth rate and the average wage increase rate in State owned enterprises

Although labor productivity can be measured in physical terms or in price terms for a frrm, a process or a country, measured labor productivity will vary as a function of both other input factors and the efficiency with which the factors ofproduction are used The three most commonly used measures of input are: hours worked; workforce jobs; and number of people in employment Meanwhile, output per worker corresponds to the

"average product of labor" and can be seemingly contrasted with the marginal product of

labor, which refers to the increase in output resulting from a corresponding marginal

increase in labor input Economists argue that the output produced is generally measurable in the private sector; it may be difficult to measure in the public sector or in NGOs Therefore, measured labor productivity can depend on many ways; the purpose of measurement or the availability of data about factors affecting performance

In a survey of manufacturing growth and performance in Britain and other countries of IRS (2003), it was found that the factors affecting labor productivity or the performance

of individual work roles are ofbroadly the same type as those that affect the performance

of manufacturing firms as a whole They include: (1) physical-organic, location, and technological factors; (2) cultural belief-value and individual attitudinal, motivational and behavioral factors; (3) international influences - for instance, levels of innovativeness and efficiency on the part of the owners and managers of inward FDI companies; (4) managerial-organizational and wider economic and political-legal environments; (5) levels of flexibility in internal labor markets and the organization of work activities - for example, the presence or absence of traditional craft demarcation lines and barriers to occupational entry; and (6) individual rewards and payment systems, the effectiveness of personnel managers as well as others in recruiting, training, communicating and performance-motivating employees on the basis of pay and other incentives

Prior to IRS (2003) survey, Pindyck and Rubinfeld (1997) stated labor productivity is also tied to natural resource of an economy As oil and other resources began to be depleted, the output per worker fell somewhat Especially, environmental regulations magnified this effect as the public became more concerned with the importance of natural resources (for example, the need to restore land to its original condition after strip mining for coal as well as cleaner air and water)

In this thesis, value added per labor is the term which is used to measure labor productivity Depending on each field of four sub-industries; Food processing, hotels and restaurants, electronics and mechanics or textile, garment and footwear respectively, GSO (2007) set up suitable methods to calculate labor productivity that will be explained

in details in later chapter: Research methodology

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2.3 Economic theories

2.3.1 Production theories

2.3.1.1 Cobb-Douglas production function

According to Cobb-Douglas (1928), production function is the functional form used to represent the relationship of an output to inputs It was the first time that an aggregate production function which was estimated econometrically by Cobb and Douglas in 1928 and the results presented to the economics profession Today, it is known as "Cobb-Douglas production function" that is the most ubiquitous form in theoretical and empirical analyses of growth and productivity The estimation of the parameters of aggregate production functions is central on much of today's work on growth, technological change, productivity, mid labor Empirical estimates of aggregate production functions are a tool of analysis essential in macroeconomics and microeconomics as well as important theoretical constructs, such as potential output, technical change, or the demand for labor The production function has the form as follows:

(1) Where:

• Y denotes output , L: labor input, K: capital input

• A is a constant depending on the units in which inputs and outputs are measured

• a and are the output elasticities of labor and capital, respectively These values are constants determined by available technology

Output elasticity measures the responsiveness of output to a change in levels of either labor or capital used in production, ceteris paribus For example if a= 0.1, a 1% increase

in labor would lead to approximately a 0.1% increase in output The Cobb-Douglas production function is usually expressed in logarithmic form: logY= log A+ a log L + log K which is useful and easy when performing a regression analysis

2.3.1.2 Pindyck and Rubinfeld production theory

Pindyck and Rubinfeld (1997) stated that the relationship between the inputs to the production process and the resulting output is described by a production function indicating the output Q that a firm produces for every specified combination of inputs They assumed that a production function consists of two inputs, labor Land capital K and

it can be described as

This equation that applies to a given technology relates the quantity of output to the quantities of the two inputs capital K and labor L For instance, the production function might describe the crop that a farmer can obtain with a specific amount of machinery and workers Because production function describes the maximum output feasible for a given set of inputs in a technically efficient manner, it allows for inputs to be combined in varying proportions to produce maximum output in many ways through labor-intensive

or capital-intensive choice Furthermore, production functions show what is technically feasible when a firm or an economy works efficiently; this explains that a given knowledge might be used to transform inputs into output When technology is improved and the production function changes, a firm can get more output for a given quantity of inputs

Although the Cobb-Douglas production function is a widely-used approach to present the relationship between an output and inputs in many analyses of economic researches, it is often replaced and developed into other more complicated functions in industry studies of growth and productivity for some reasons One of the considerably typical reasons according to Pindyck and Rubinfeld (1997) is that the Cobb-Douglas production function

is rarely able to happen in the reality The possibility is that the firm's production process shows increasing returns at low output levels, constant returns at intermediate output as well as decreasing returns at high output levels might be real

2.3.2 Theoretical background of FDI impacts

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2.3.2.1 Channel effects of foreign direct investment

In general perspective, FDI may effect on host countries in a number ways According to Vahter (2004), the important channel effects of FDI on growth happen via technology transfer and spillover effects Foreign direct investment is considered a prominent force

of growth for most of developing economies Because it brings new capital, technology and know-how from parent firms to host firms However, Blomstrom and Kokko (1998) who explain that the spillovers from FDI to host countries may occur through three channels: knowledge shifts with skilled labor, technology transfer, and effective resource allocation due to competition

Javorcik and Arnold (2005) stated that foreign direct investment comes either in the form

of a "Green field" project, where a new plant is built and therefore a new firm is born, or

in the form of foreign capital inflow to an existing domestic company In both cases, this company is typically characterized by higher productivity and competitiveness

In the previous research in 2004, Javorcik showed that besides direct effects from FDI,

there are also varieties of indirect effects The entry of any FDI-high productivity company naturally put pressure on domestic companies within the same sector to improve their performance and competitiveness The increase in efficiency of the production process can happen by copying new technologies or by hiring trained workers and managers from foreign-owned companies On the other hand, those domestic companies that are not able to catch up with the higher performance of other companies within the sector may be crowded out of the market In general, these effects are referred

to as horizontal spillovers

However, companies from sectors other than that of the foreign enterprise might be affected by its presence as well if they are in direct business contact with it This includes companies that supply or provide services for foreign frrms, as well as companies that are supplied by foreign frrms It is likely that foreign companies require higher standards from their suppliers In other words, it is also likely that higher standards are provided by foreign companies to domestic companies as well, which might improve the domestic

companies' efficiency and performance And these effects are referred to as vertical spillovers

As Lipsey (2002) mentions, one of the main reasons to examine productivity spillovers from foreign-owned to domestically owned firms is to understand the contribution of inward FDI to host country economic growth If foreign firms at the expense of lower productivity in domestic firms achieve higher productivity, there might be no implications for aggregate output or growth However, there might be growth effects without spillovers just from the operation of foreign frrms, which can be analyzed in terms of the impact of FDI on a country's output or growth Moreover, because multinationals seek to minimize technology leakages to competitors while improving the productivity of suppliers by transferring knowledge, were FDI to generate spillovers they would more likely be vertical than horizontal through applying macro-level data to study overall effects ofFDI in his study

In recent research about The Impact of Foreign Direct Investment on the Economic Growth in Vietnam, Anh et al (2006), they stated that there is still one more concern with the presence of FDI that has indirect effects on local labor productivity in Vietnam FDI may exert the competition pressure on domestic firms so that the later have to improve business efficiency or they may promote the diffusion and transfer of technology etc that are also called the "spillover effects" of FDI They also suggested that the development should be enhanced to promote the spillover effects for FDI However, the data available for this aspect is unclear and enough, thus this research will not test the impact of FDI on the productivity in general through the technological spillovers channel

as mentioned at the beginning of thesis, but focus on analysis of FDI impact on the labor productivity at firm level in Vietnam as a whole

2.3.2.2 Theoretical framework of FDI impact on labor productivity

Based on Cobb-Douglas (1928), Tong and Hu (2003), in their current study in estimating the impact of foreign presence on Chinese domestic productivity, they represented the simple model for this relation

Y,-f(FS;, X;)

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(3)

Where Y measures the productivity of domestic industries, FS measures the intensities of foreign presence in the industries, and X denotes the other factors that would have significant impact on the productivity of domestic industries

However when examining the effects of FDI on productivity, Blomstrom and Sjoholm (1999) proposed a production function in which labor productivity of firm i in the jth

industry is dependent on capital intensity, size of capital, skilled labor, scale of FDI projects And if Y stands for values added, K is (physical) capital assets; L and FDI

respectively denote labor and contribution by foreign partner in total capital assets of firm

i the above relationship can be constructed by the productivity function of firm i in industry j as follow:

In this productivity function, Skillij and Scaleij are firm-specific variables The first variable measures the skilled labor, while the second denotes the size/ scale of the firm in the industry and D!ndustryj is the industry-specific dummy variable of the jth industry

In general, there have been many empirical analyses (see, among others, Kokko, A., et al., 1996; Liu, Xiaming et al., 2004; Javorcik, B S., 2004; Yingqi, Wei., et al., 2004) to examine the effects of FDI on labor productivity on domestic firms where firm-level performance is regressed based on a foreign-presence variable and a series of independent variables measuring the characteristics of firms One of popular and general models for this type of researches is normally suggested as follows:

sectorial output produced in firms with foreign ownership; LQ denotes labor quality in each firm; CU is a variable representing capital utilization, defmed as the share of actual output to potential output; SIZE is the firm's output as a share of the average output in the sector to which the firm belongs, and fmally, OV represents other explanatory variables that can raise possibilities to affect labor productivity

2.3.2.3 Suggested research model

Based on the above economic theories and the theoretical background from empirical analyses, the suggested research model can be described in a function with dependent and independent variables as follows:

Labproductivity;=f(Cap _intensity;, MI_ scale;, Skill;, Dlocation, Fshare;, Dindustry; )( 6) Where: i denotes firm i and

• Lab productivity, the dependent variable measures labor productivity of the firms

in terms of values added per labor

• Cap _intensity measures the capital intensity per labor of the firms

• MI_scale denotes the size of material input purchases per labor in four industries including food processing, hotels and restaurants, electronics and mechanics, textile, garment and footwear

sub-• Skill reflects the quality of labor in the firms as it measures the proportion of labor finishing at least college or vocational training

• Dlocation is dummy variable that is equal to unity if the headquarters of firms located in big cities and provinces with better performance of FDI inflows, including Hanoi, Hochiminh, Danang cities and the surrounding provinces of key industrial centers such as Haiduong, Haiphong, Quangninh - Baria Vungtau, Binhduong, Dongnai And equal to zero otherwise

• The dummy variable Fshare denotes the types of ownership of firms that are foreign ownership firms, state owned firms or non-state owned firms

• The last remaining dummy variable Dindustry captures the effect of each industry of food processing, hotels and restaurants, electronics and mechanics,

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textile, garment and footwear on the overall productivity level of firm sector in cross sectional data

2.4 Empirical studies

There are a great number of empirical studies estimating the impact of FDI on labor productivity in many countries around the world However the researches can be separated into two groups; one which concludes that FDI enhances and improves the productivity of domestic firms while the other argues that the impact of FDI is mixed, unclear or even negative

2.4.1 FDI impacts enhance labor productivity in host countries

According to Liu et al (2004), in the working paper research about the overall effects of inward FDI on labor productivity in the Chinese electronics industry with official data of

41 sub-sectors of the industry in 1996 and 1997 Labor productivity is regressed as dependent on the level of foreign presence in the industry and other control variables, namely capital intensity, human capital and firm size for scale factors They indicate that FDI has a positive impact on labor productivity when the econometric results suggest that foreign presence in the industry is associated with higher labor productivity and they also conclude that the most significant determinant is labor quality by using various econometric estimation techniques for panel data in Chinese electric industry t o get appropriate statistical model

In the current research of Ludo et al.(2008) about the impact of FDI on local labor productivity in Cambodia's manufacturing sector where their analysis ofFDI impact was examined on the basis of a number of control variables including capital intensity, material and labor inputs, labor equality, size of establishment, and payments for royalties, copyrights and patents In addition, two proxies for the presence of foreign owned enterprises were also used in their study because it was expected that such presence could be reflected in terms of either the employment or the output level The main contribution of the research comparing to other empirical studies is that several statistical diagnostic tests were carried out to avoid misleading econometric results The

analysis shows that the coefficients ofthe two proxy variables for the influence of foreign owned enterprises are positive and highly significant They found out that FDI played a positive role in enhancing labor productivity in the Cambodian manufacturing sector Similarly, capital intensity was also shown to positively affect domestic labor productivity However their results show that variables such as labor quality, labor inputs, size of establishment, material inputs and payments for royalties, copyrights and patents

do not seem to be related to labor productivity in Cambodia

Supporting Liu et al (2004 )' s study, Anh et al (2006) undertook the tests on the determinants of productivity in enterprises in three groups of industries: food processing, textiles and garment, mechanics-electronics in Vietnam roughly 12 thousand enterprises used in estimation that is in logarithm· form The results show that capital intensity, skilled labors, size of firms positively affects labor productivity of the firms including domestic and FDI firms However the results did not indicate the impact of FDI that differs significantly based on forms of FDI as well as varies across the provinces around the countries Moreover the test did not show the spillovers of FDI to labor productivity Making the same findings as authors mentioned above, Vani (2000) undertook the research on the impact and incidence ofFDI in India to analyze and explore whether FDI

is the economic driver of this growth engine as well as detailed picture of the impact of FDI on labor productivity and employment across 19 different major states of India for the post reform period from 1991 to 2000 He hypothesized that FDI with intervening variables such as gross capital formation; wage rate and per capita income exert direct influence on labour productivity and employment In the research, he made use of three methods including Fixed Effects (FE), Random Effects (RE) and Seemingly Unrelated Regression (SUR) models Results show that overall FDI has a positive impact on labor productivity but across region the benefit of FDI is quite uneven The impact of FDI is negative in less developed states, while it is significant and positive in catching up states However the labor productivity is growing only at the expense of employment This tends

to ponder that liberalization will make rich states richer with the poor states lagging behind or there can be convergence across states through the presence ofFDI

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2.4.2 The opposite results of FDI impacts on labor productivity

While the above studies conclude that the impact of FDI on the labor productivity is clear

and positive however, in the research about the effects of FDI on labor productivity in

Estonia and Slovenia, Vahter (2004) found out the results ofthe negative impacts ofFDI

in Estonia and positive impacts in Slovenia Besides that he also suggested that different types of FDI can have different effects on the host country and that the existence of positive spillovers may depend on the level of the economic growth ofthe host country Although many studies have confirmed that FDI is a catalyst for enhancing labor productivity in the host economy, FDI activities can also have a negative impact on domestic labor productivity According to recent empirical investigations, Aitken and Harrison (1999) used a firm-level panel data set of over 4,000 plants for the period 1976-

1989, they have shown that an increase in foreign ownership is negatively related to the productivity of wholly domestically-owned firms in the same industry The entry of foreign firms producing for the domestic market can force domestic firms to reduce output, especially when domestic and foreign firms are active in the same market As a result, the productivity of domestic firms may fall as they are moving towards lower output levels along their average cost curves

In addition, the ideas that FDI has positive impact on the productivity in manufacturing whereas its effects on growth of agriculture and mining sectors are negative through the conclusion of Alfaro (2003) who applied linear regression method to study the relationship between FDI and labor productivity in various industries, based on the panel data of 47 countries from 1980 to 1999

When examining the impact of FDI flows on economic growth and labor productivity in Chile, one of the important countries of Latin America during the 1960-2000 period by using macro time series data Miguel ( ) discovered several major fmdings that show the mixture of FDI impacts on labor productivity growth in Chile Although FDI flows have been substantial during the second half of the eighties and nineties, particularly in relation to domestic capital formation, a large proportion of these funds has been directed

to traditional sectors such as mining and agriculture where labor productivity is relatively low However first results suggested that the impact of FDI flows were negative and were not being channeled to innovative "greenfield" investments in the manufacturing sector where technological spillover effects are likely to be greater until late of 1995 On the other hand, the econometric results suggest that the variables included in the production function have a stable and non-spurious relationship with labor productivity later from the 1996-2000 periods Public investment variable, as well as outward-oriented policies were also found to have the expected sign and statistically significant effect on labor productivity growth

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1988 after the FDI law came into effect so that it reveals that the research is analyzed based on the reality background This chapter consists of three main parts Firstly, part one introduces the overview of FDI inflows from 1988 to 2008 and some characteristics

of FDI in Vietnam The roles of FDI in national economy are stated in the second part And the fmal part briefly sums up the socio-economic effectiveness of these enterprises during the period in Vietnam

3.2 Overview of FDI inflows and periods of development from 1988 to 2008 3.2.1 FDI inflows in period 1988- 2008

After the approval of the law on Foreign Investment in 1987, Vietnam has achieved considerably impressive results in attracting FDI flows into country Initially, the number

of projects was just 37 with total capital registered approximately at 342 million USD in

1988 In the following year, the number of projects nearly doubled with 67 projects and

526 million USD of total registered capital Then, they increased gradually by year within

around 7 years after that Until 1995, the number of projects particularly reached at 415 and total capital registered obtained 6,937 million USD However the total of capital registered just reached a peak at 10, 164 million USD in 1996 despite there was a slight decrease in the number of projects at 372 in that year A noteworthy point is that just one year after that; 1997, FDI inflows to Vietnam declined dramatically Although the total of implementation capital from period 1988-1997 reached at 14,714 million USD, the total registered capital reduced nearly a half and stayed at 5,591 million USD with 349 projects compared with that of the previous year Explaining for this reason, many experts and researchers pointed out that the causes of decline originated from the Asian Economic Crisis in that year Then, FDI flows continued declining significantly and bottomed out at 2,839 million USD in 2000; 5 years after reaching at peak in 1996 However, these FDI flows have increased considerably in recent years and reached at 987 projects by 2006 Total of registered capital and implementation capital were 12,004 million USD and 4,001 million USD respectively at the same year Typically, in 2007, When Vietnam became an official member of WTO, the total registered capital gained a jump to over 20,000 million USD with 1544 projects Surprisingly, this number exploded spectacularly up to 60,011 million USD in preliminary 2008, the highest number since

1988 (Figure 3.1)

Figure 3.1: Foreign direct investment projects licensed in period 1988- 2008

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-Registered Capital -Implementation Capital Nlllnber ofProjects

Source: Author's calculation based on the data ofGS0-2008, available at:

http://www.gso.gov.vn/default en.aspx?tabid=4 71 &idmid=3&ItemiD=871 0

Up to preliminary 2008, after around 20 years in FDI inflows, Vietnam has attracted 10,981 FDI projects with total of registered and implementation capital of approximately 220.653 billion USD which played an extremely crucial part in Vietnam's socio-economic development (GS0-2008)

3.2.2 Some characteristics of FDI in Vietnam

After over 20 years since the first days when Vietnam started to attract FDI flows there have been rises and falls both in the number of projects and registered as well as implementation capital Although Vietnam's FDI inflows have been changeable and unstable, those periods of development also indicated remarkable characteristics of FDI activity clearly as follows:

'

Investment by kind of economic activity: In total1 0,981 FDI projects licensed from period 1988-2008, there has been an unequal distribution ofFDI projects As shown in table 3.1,

61.7% of total projects focused mainly on the manufacturing sector with total registered capital of 81,247.8 million USD meanwhile just approximately 0.3% number of projects was invested in electricity, gas and water supply The distribution of registered capital manifested similarly in the kind of economic activity as well However the concentration

of FDI flows 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 the economic structure toward Industrialization and

No Kind of economic activity Number of capital total

projects (Mill USD)

Wholesale and retail trade; Repair of motor

7 vehicles, motor cycles and personal and 137 696.7 1.2%

Capital scale per FDI project: In addition to the unequal distribution of FDI flows, capital size of FDI project in Vietnam generally has small and medium scale The average capital size in period 1988-2008 is just around 14.89 million USD According to GSO (2008), the average capital size increases monotonously from period 1990- 1995 with 6.87 million USD per project in 1990 and 16.72 million USD in 1995 Typically, in

1996 this average capital size reached a peak at 27.32 million USD However the average capital size per project has reduced continuously year by year down to 5.66 million USD after obtaining the peak in 1996 and then it bottomed at 3.71 million USD per project in

2002 In current years, the capital size per project has increased considerably and up to preliminary 2008 this average capital size per project has reached at 54.66 million USD per project dramatically, the highest point since 1988 This boom was obviously generated from the result ofVietnam's WTO joining in 2007 As depicted from table 3.1,

it is easy to figure out that the highest average capital scale is implemented mainly in mining and quarrying with 84 million USD per project Surprisingly, while electricity, gas and water supply have the lowest number of projects invested but stay in the second position of average capital size of 62.63 million USD per project The results in the large concentration of capital size in such areas also originate from 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 has attracted total 10,981 FDI projects with total registered capital of nearly 163,607.2 million USD which have been present in 63 of 64 cities and provinces of Vietnam However the majority of FDI projects as well as registered capital are distributed mainly

in three big economic regions including Red River Delta, North Central and Central coastal area and South East that have better infrastructure systems, sizable, skilled labor force and are near international harbors than the rests Among those, South East takes lead with total 71,858 million USD, second is North Central and Central coastal area with 43,887 million USD and Red River Delta keeps third position with total of33,626 million USD of registered capital (Figure 3.2) Particularly, in these three regions, most of registered capital and FDI projects are located in big cities and provinces such as Hanoi,

Hai Phong,Thanh Hoa, Ha Tinh, Quang Nam, Quang'Ngai, Phu Yen, Ho Chi Minh, Dong Nai, Binh Duong and Vung Tau As for in preliminary 2008, Hanoi, Ho Chi Minh, Ninh Thuan, Binh Duong and Vung Tau attracted 32,424 million USD in total, accounting for around 51% of total registered capital and 65.67% of FDI projects which

' were higher than the average level in Vietnam However in recent time, many provinces have improved actively and positively their policies and investment environment a lot in attracting more FDI projects to invest, especially surrounding areas around Hanoi and Ho Chi Minh

Figure 3.2: Foreign direct investment projects licensed in period 1988-2008 by

Northern North midlands and Central area mountain and Central areas coastal area

Central Highlands

n Registered capital

71,858

South East Mekong Petroleum &

River Delta Gas

Source: Author's calculation based on the data of Statisticaf Yearbook of Vietnam, GSO -2008

Structure of investment by ownership: Due to numerous reasons concerning to government's restriction regulations of setting up 100% foreign owned enterprises, complicated policies for this kind of investment, tilt 1995, FDI enterprise's capital

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including both wholly foreign owned enterprises and joint ventures contribute around 30% of total social investment capital Although the proportion is unstable and changeable in decreasing tendency for many years later, state and none-state enterprises' ratio increased steadily by years (Figure 3.3) In preliminary 2008, the capital contribution of FDI enterprises reached at 31% equivalent to 192,360 billion VND meanwhile none-state ones obtained 40% and 244,081 billion VND higher than state sector with just 29% and 174,435 billion VND respectively (Figure 3.4) The exceeding ratio of non-state enterprises over state sector comes from different reasons however it is also the results ofFDI spillover affects after Vietnam's WTO accession (GS0-2008)

Figure 3.3: Structure of investment at current prices by types of ownership from

-State -None State lllllllfill Foreign Invested Sector of FDI

Source: Author's calculation based on the data of Statistical Yearbook of Vietnam, GSO -2008

Figure 3.4: Structure of investment at current prices by types of ownership in 2008

•state • Non- State • Foreign invested sector

Source: Author's calculation based on the data of Statistical Yearbook of Vietnam,

GSO-2008 3.3 The role ofFDI in national economy

So far, FDI sector has been playing and consolidating its important role in Vietnam's economy Since period 1987- 2008, annually average capital contribution is around 21%

in total of social investment capital It is really the important and supplementary capital mobilization source for Vietnam's economic growth, and improved the balance of payment during the process of Industrialization and Modernization in the period Besides that, foreign invested enterprises which have higher technology, advanced management methods, highly-skilled labor force and better experiences as well as conditions in business relation with international markets help Vietnam to strengthen the production capacity and production efficiency, to innovate technology and penetrate into international trade markets through bringing new capital, modern technology and know-how from parent firms to host frrms In addition, FDI enterprises also create jobs for

'

domestic employees with higher income and raise the living standard of whole society, Although the role of FDI widespread over different aspects in Vietnam's economy, the purpose ofthe research just concentrates on introducing generally about the role ofFDI in national economic growth and the role ofFDI in employment and human resources

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The role of FDI in national economic growth: As illustrated in the figure 3.5, the share of

FDI sector in GDP has been increasing steadily with the average rate of 13.75% per year that is much higher than the average rate of country's growth rate with 7.8% and average share ofFDI sector in GDP is equivalent to 94,623 billion VND per year since 1995 In preliminary 2008, FDI sector accounted for 18.68% of GDP higher than that of approximately 12.38% in 1995 Meanwhile, the share of state sector and none-state sector

in GDP decreased considerably with 40.18% and 53.52% respectively in 1995 compared with 34.35% for state sector and 46.97% for none-state 2008, GSO (2008) This result showed the proof of FDI sector's important and vibrant role in Vietnam's economic growth not only last decade but also in coming years

Figure 3.5: Structure of gross domestic product at current prices by ownership

4.00%

2.00%

0.00%

Source: Author's calculation based on the data of Statistical Yearbook of Vietnam, GSO -2008

The role of FDI in employment and human resources: One of remarkable points, that are

appropriate for the research, is related to the role of FDI in employment and human resources During approximately the first decade of 21st century, foreign investment sector have been creating jobs for hundred thousands of employees each year The