Interaction effects between FDI growth and institutional environment a case of vietnam, 2008 2011

CHAPTER 1 INTRODUCTION 1.1 Problem Statement Foreign Direct Investment FDI has been playing an important role in economic growth of every country all over the world.. Conducting a fuzzy

VIETNAM – NETHERLANDS PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS

INTERACTION EFFECTS BETWEEN FDI GROWTH AND INSTITUTIONAL ENVIRONMENT -

A CASE OF VIETNAM, 2008-2011

A thesis submitted in partial fulfillment of the requirements for the degree of

MASTER OF ART IN DEVELOPMENT ECONOMICS

This thesis is submitted in partial fulfillment of the requirements for the degree of Master

of Art in Development Economics to Vietnam – Netherlands Programme

I hereby declare that this thesis has not been submitted for any degree

To the best of my knowledge, the thesis is my own work All sources used have been cited and acknowledged in the thesis

Đặng Võ Tuấn

I would like to thank all lecturers for the knowledge and lessons they gave me and thank

my classmates for their support during the time I studied at the programme

Last but not least, my sincerest thank is for my family, especially my beloved wife Without their frequent encouragement as well as spiritual support, I would not have been able to complete this thesis

Abstract

This thesis analyzes the interaction effects between FDI growth and institutional environment in Vietnam in the period of 2008 – 2011 Detailed data of FDI, some traditional FDI-related factors and institutional environment are consolidated from the Provincial Competitiveness Index (PCI) Reports of Vietnamese Chamber of Commerce and Industry (VCCI) and the U.S Agency for International Development (USAID) and from Statistical Yearbooks of General Statistics Office of Vietnam Different functional forms are employed using fix-effects technique to identify the factors affecting FDI flow into provinces in Vietnam

The major results of the thesis show that there exists a significant relationship between FDI inflow and institutional environment which is proxied by nine sub-indices of PCI Reports Although not all of those indices are significantly related to FDI in the period 2008-2011, the PCI Reports are becoming more and more popular and a trustworthy reference source for foreign investors prior to investing into Vietnam

Keywords: inward FDI, institutions, Provincial Competitiveness Index (PCI), functional forms, fix-effects technique

TABLE OF CONTENTS

Declaration i

Acknowledgement ii

Abstract iii

Table of contents iv

List of tables vii

List of figures viii

CHAPTER 1: INTRODUCTION 1

1.1 Problem statement 1

1.2 Research objective 3

1.3 Research question 4

1.4 Organization of the study 4

CHAPTER 2: LITERATURE REVIEW 5

2.1 Definition of Foreign Direct Investment (FDI) 5

2.2 The role of FDI in the economy 5

2.3 Factors attracting FDI inflows 6

2.4 FDI theories 7

2.4.1 Portfolio theory 7

2.4.2 International trade theory 7

2.4.3 Market imperfection theory 7

2.5 Concept of Institutions 8

2.6 The role of institutions in the economy 9

2.7 Theories of Institutions and FDI 9

2.8 Empirical studies on Institutions and FDI 10

CHAPTER 3: RESEARCH METHODOLOGY, VARIABLES DESCRIPTION AND DATA SOURCE 15

3.1 Research Methodology 15

3.2 Variables description 17

3.2.1 Foreign Direct Investment (FDI) 17

3.2.2 Provincial Competitiveness Index (PCI) and nine sub-indices 17

3.2.3 Traditional variables 19

3.3 Data source 20

CHAPTER 4: ECONOMETRIC ANALYSIS AND RESULTS 21

4.1 An overview of Foreign direct investment (FDI) and Provincial competitiveness index (PCI) in Vietnam from 2008 to 2011 21

4.1.1 Foreign direct investment (FDI) 21

4.1.2 Provincial competitiveness index (PCI) 22

4.2 Overall descriptive statistics of variables 23

4.3 Econometric analysis and results 24

4.3.1 Entry costs – EC; Land access and security of tenure – LAST; Transparency and access to information – TAI and Proactivity of provincial leadership – PPL 25

4.3.2 Informal charges – IC; Time costs for administrative procedures and inspection – TCPI; Business support service – BSS; Labor training – LT and Legal institutions – LI 28

4.4 Summary of key findings 35

CHAPTER 5: CONCLUSION 39

5.1 Conclusion and recommendation 39

5.2 Limitation 40

REFERENCES 42 APPENDIX 47

LIST OF TABLES

Table 3.1: Summary of variables 15

Table 4.1: FDI of top ten provinces over the period from 2008 to 2011 (in million USD) 22

Table 4.2: PCI of top ten provinces in Vietnam from 2008 to 2011 (100-point scale) 23

Table 4.3: Overall descriptive statistics of variables 23

Table 4.4: Econometric results of five regression models with variable Entry costs – EC 25

Table 4.5: Econometric results of five regression models with variable Informal charges – IC 29

Table 4.6: Regression results of five significant PCI variables 31

Table 4.7: Average marginal effects of nine PCI sub-indices 35

LIST OF FIGURES

Figure 4.1: Registered FDI in Vietnam over the period from 2008 to 2011 21

Figure 4.2: FDI and Entry costs over period 2008-2011 27

Figure 4.3: FDI and Land access and security of tenure over period 2008-2011 27

Figure 4.4: FDI and Transparency and access to information over period 2008-2011 28

Figure 4.5: FDI and Proactivity of provincial leadership over period 2008-2011 28

Figure 4.6: FDI and Informal charges score over period 2008-2011 31

Figure 4.7: FDI and score of Time costs for administrative procedures and inspections over period 2008-2011 34

Figure 4.8: FDI and Business support service score over period 2008-2011 34

Figure 4.9: FDI and Labor training score over period 2008-2011 34

Figure 4.10: FDI and Legal institutions score over period 2008-2011 34

Figure 4.11: Relationship between informal charges score and inward FDI in logarithmic model 36

Figure 4.12: Relationship between the score of time costs for administrative procedures and inspections and inward FDI in logarithmic model 37

Figure 4.13: Relationship between business support service score and inward FDI in linear model 37

Figure 4.14: Relationship between labor training score and inward FDI in logarithmic model 38

Figure 4.15: Relationship between legal institutions score and inward FDI in quadratic model 38

CHAPTER 1 INTRODUCTION

1.1 Problem Statement

Foreign Direct Investment (FDI) has been playing an important role in economic growth of every country all over the world As the observation of UNCTAD (2003), FDI became a more and more crucial factor in the development and integration of global economy during the last decade

of 20th century Specifically, Romer (1993) asserted the importance of FDI to developing countries in the aspect of removing the gap in human capital in comparison with developed countries

Vietnam, a typical developing country, has been paying close attention to FDI for the country’s development How to attract more and more FDI to the country to stimulate job creation and economic growth is considered as one of the top priorities of the country’s government

It is generally accepted that institutional environment is a key factor affecting inward FDI Being aware of this matter, provinces in Vietnam have tried to improve their institution environment in order to increase inward FDI Giang (2008), in a study of FDI in the Northern Mountainous Provinces, proved that due to less transparency of local authority, this area was reported to have poor inward FDI compared with provinces in other areas of Vietnam

The Provincial Competitiveness Index (PCI) was developed in 2005 by the Vietnamese Chamber

of Commerce and Industry (VCCI) and the U.S Agency for International Development (USAID)

to measure and assess the standards of economic governance of 63 provinces in Vietnam The PCI is, in other words, believed to reflect the efficiency of institutional environment According

to the reports of PCI 2009 and 2011, Lao Cai and Bac Ninh tried to apply new initiatives and solutions in economic governance more efficiently to improve their ranking from the third and the tenth in 2009 into the first and the second in 2011 The inward FDI in Lao Cai and Bac Ninh

in 2011 subsequently increased more than 150% and 400% compared to the year 2009 In addition, Vietnam’s government considers PCI one of the most important factors in the enhancement of business environment as stated in Decision 19/NQ-CP dated March 18th 2014 The government subsequently requested all provinces to pay close attention to the improving of institutional environment in order to increase their PCI scores

The institutional environment or institutions mentioned in this thesis could be generally defined

sub-indices which are information transparency, informal charges, administrative procedures and inspections, legal system, entry costs, land access and security of tenure, proactivity of provincial leadership, business support service and labor training In addition, the interpretation of institutions and the effect of institutions on FDI are also broadly argued in the world Rodrik and Subramanian (2003) defined institutions as property rights protection, the application of laws and regulations and corruption Hodgson (2006) argued that institutions could be “as systems of established and prevalent social rules that structure social interactions” These “prevalent social rules” are explained as conventions and rules Kaufman et al (1999), in a study of institutional determinants of FDI, found five indicators related to economic governance which are political instability, government efficiency, regulatory issue, rule of law and corruption Conducting a fuzzy-set analysis on institutions and inflows of FDI, Pajunen (2008) suggested that the relationship between institutions and FDI is frequently generated from a combination of several institutional indicators such as corruption, political stability, labor regulation, legal system, civil liberties, property rights and taxation policies Placing an emphasis on the impact of corruption, Wei (1997, 2000) claimed that corruption and uncertainty related to corruption significantly negatively affects FDI Pournarakis and Varsakelis (2004) posited a hypothesis that “the higher the institutional quality that a country exhibits the higher FDI inflow” The institutional quality is measured by the political institutions (political rights, civil liberties and freedom of the press) and corruption Arguing that institutions are considered as one of the most important advantages

in attracting foreign investors, Bevan, Estrin and Meyer (2004) suggested that FDI is influenced

by several particular institutional indicators which are private business ownership, innovation of banking industry, foreign exchange and trade liberalization, and the enhancement of legal system Busse and Hefeker (2006) conducted a research analyzing the relationship between institutions, political risk and FDI inflows By investigating 12 institutional indicators derived from the dataset of 83 developing countries, the authors conclude six significant determinants of FDI inflows, which are stability of country’s government, conflict inside and outside the country, corruption and ethnic strain, laws and regulations, democratic responsibility of government, and status of bureaucracy “Good institutions in the host country have a positive impact on inward FDI” is the result of an empirical study of Mayer et al (2007) In this study, the authors used

“Institutional Profiles” which include 26 institutional indicators derived from a survey conducted

in 52 countries in 2001 The result shows that only variables of bureaucracy, corruption, information, banking sector and legal institutions play an important role in attracting inward FDI

Besides, weak capital concentration and employment protection tend to deter inward FDI Having the same observation as Mayer et al., Daude and Stein (2007) also generally asserted that more enhanced institutions could be positively and economically significantly related to FDI inflows Especially, the authors claimed that some institutional factors that cause bad impact on inward FDI are the uncertainty of policies, regulations and laws, redundant regulatory difficulty, instability of government and lack of commitment

Based on the argument that more FDI is originated from more enhanced institution environment which is reflected by PCI in this thesis, and based on the fact that provinces in Vietnam have been trying to innovate their institutional environment in order to improve their PCI ranking, it is necessary to investigate whether good PCI result could really be considered as an impetus of provinces’ development especially through the attracting of more inward FDI, which is believed

to positively impact on the economic growth

The findings obtained from this clarification would subsequently be useful for Vietnam’s government and provinces’ authorities in the estimating and assessing if strong PCI would be the stimulus of high FDI and which elements of PCI the government should take close care of to maximize the positive impact of PCI on FDI

1.2 Research Objective

The main objective of this thesis is to examine the effects of institutional environment reflected

by the PCI scores on inward FDI of provinces in Vietnam

The dataset of this thesis is generated from annual PCI reports of Vietnamese Chamber of Commerce and Industry (VCCI) and statistical yearbook of General Statistics Office from 2008

to 2011 By applying several different econometric functional forms and running regression models of each PCI sub-index and traditional variables, the study demonstrates that not all of PCI sub-indices are statistically significant in explaining FDI flow into Vietnam Only five out of nine PCI sub-indices are proved to be determinants of inward FDI, which are informal charges, time costs for administrative procedures and inspections, business support service, labor training and legal institutions The total PCI score, however, is still believed to be one of the decisive factors of attracting inward FDI This finding is also in line with the government’s policy of increasing provincial competitive capacity in order to accelerate the country’s economic growth

1.3 Research Question

The research is expected to answer whether a province with high total PCI score can attract more inward FDI than a low score province Or just the score of some PCI sub-indices, not the total score, can explain the trend of inward FDI between provinces and provinces

1.4 Organization of the study

The thesis includes five chapters The first chapter which is about the importance and the reason

of conducting the thesis is clearly presented as above The remainder of the study is organized as follows In Chapter two, the literature review including theoretical background and empirical studies is outlined to support the research methodology Chapter three provides the methodology

of constructing research model, the interpretation of independent and dependent variables and how the thesis’s dataset is generated The econometric analysis and major results of the study are reported in the fourth Chapter The last Chapter comprises conclusion and policies recommendation

CHAPTER 2 LITERATURE REVIEW

2.1 Definition of Foreign Direct Investment (FDI)

The official definition of FDI from Organization for Economic Co-operation and Development (OECD) states that “FDI is defined as cross-border investment by a resident entity in one economy with the objective of obtaining a lasting interest in an enterprise resident in another economy The lasting interest implies the existence of a long-term relationship between the direct investor and the enterprise and a significant degree of influence by the direct investor on the management of the enterprise Ownership of at least 10% of the voting power, representing the influence by the investor, is the basic criterion used” (OECD, 2008)

2.2 The role of FDI in the economy

The role of FDI in the economy has been discussed by many researchers in the world Wang (2009) in a study of the impact of FDI to 12 Asian countries from 1987 to 1997, using an approach of sector-level FDI, demonstrated that FDI in manufacturing sector plays a very important role in the countries’ economic growth On the contrary, FDI in non-manufacturing sectors is proved to have no significant impact on the enhancement of economic growth By conducting a time-series analysis of the interaction effects between FDI inflows and economic growth in Malaysia over the period of 1970 to 2005, Mun et al (2008) found sufficient evidence

of a strong relationship between FDI inflows and gross domestic production (GDP) and gross national income (GNI) Specifically, the authors asserted that FDI inflows are significantly positively related to GDP growth rate as well as GNI growth rate, which leads to the economic growth of Malaysia Vadlamannati and Tamazian (2009) used panel dataset derived from 80 developing countries from 1980 to 2006 to investigate the impact of FDI on the growth of economic output per worker The authors demonstrated that the improvement of FDI inflows causes positive impact on output growth in developing countries Another interesting empirical study about the relationship between FDI and economic growth in both direct and indirect approach was conducted by Li and Liu (2005) By analyzing a panel dataset collected from 84 countries over the period 1970 to 1999, the authors found that FDI inflows itself directly exert a significant positive impact on the countries’ economic growth Besides, the conjunction of FDI and human capital is proved to indirectly promote economic growth Meanwhile, if FDI inflows

developing countries The role of FDI in the economic growth of Vietnam is the main objective

of the empirical study of Nguyen et al (2012) In this study, Nguyen et al applied fixed-effects estimation method based on a panel dataset of all 63 provinces in Vietnam from 2000 to 2010 and drew an overall conclusion that FDI inflows has a positive impact on the economic growth

of Vietnam

2.3 Factors attracting FDI inflows

By a cointegration estimation study on FDI focusing on South Asia area, in particular five countries India, Bangladesh, Pakistan, Nepal and Sri Lanka, Sahoo (2006) shows that there exists

a long-run equilibrium nexus between FDI and its determinants The author points out that the key factors of FDI in this area comprise of market size, growth of human capital, infrastructure and trade openness, in which the most significant determinants are market size and growth of human capital The author emphasizes that it is essential for South Asian countries to improve development momentum to enhance market size, policies framework to take advantage of their surplus of labor force, enhance infrastructure facilities and promote policies of trade openness for more FDI attracting One of the primary determinants of FDI is education is the result of an econometric model conducted by Nonnemberg and Mendonca (2004) in 38 developing countries FDI in developing countries, in other words, has been demonstrated to involve knowledge-intensity activities In addition, the openness of the economy was proved to play an important and significant role in the attracting of foreign investments Finally, by running a causality test between FDI and gross domestic output, the authors asserted that gross domestic output induces FDI In a report of FDI determinants in China, Dang (2008) claimed that local market is firstly advantage that FDI investor would like to take Secondly, the investors always prefer lower production costs which could be achieve from cheap labor cost in China Next, FDI inflow to China tends to be highly influenced by the quality of infrastructure Qualified infrastructure enables firms to develop their technology in order to gain economies of scale and scope Finally, governmental environment is considered as a significant determinant in the attracting of FDI in China This is because political leaders or policy makers could cause some impacts on the growth and development of the country In a research of FDI of the Northern Mountainous Provinces in Vietnam, Giang (2008) suggested that there are some factors impacting the FDI of this area which are the distance from a business center of a country, infrastructure, FDI policy and FDI environment According to annual surveys conducted by Vietnam Chamber of Commerce and Industry in Northern Mountainous Provinces, FDI environment of this area is

considered not favorable compared to other areas in Vietnam Anh and Thang (2007) observed that some important factors which foreign investors tend to consider when they make a location decision comprise of potential of market, human capital and infrastructure

2.4 FDI theories

2.4.1 Portfolio theory

According to portfolio approach of Markowitz (1952) and Tobin (1958), part of the surplus profits which should be gained in international markets are simply compensation for higher risk associated with this alternative use of capital The rates of return generated from differential investments should be connected to a factor of risk in the selection between substitutable properties to construct an effective portfolio Dunning (1973) provided an explanation why the portfolio theory is only able to partially demonstrate FDI Because this theory neglects the fact that direct investment has no relationship with changes in ownership It is, however, related to the investment of element inputs other than capital, which are entrepreneurship, technology and management experience, and could be influenced by the relative profitability of the use of these factors in different countries as that of money capital

2.4.2 International trade theory

Mundell (1957) developed the classic model to demonstrate that trade and capital transmission could be substitutes In other words, trade tariffs could cause FDI flows into the protected countries This statement is the same as original Heckscher-Ohlin model, in which the barrier on trade could be modified by foreign transmission of factors, specifically capital, given the immobility of labor Kojima (1973), in his macroeconomic approach, classified the aims of FDI into four categories: (i) to exploit natural resources (ii) to use cheap labor cost in host country (iii) to avoid tariff and non-tariff barriers and (iv) to take advantage of oligopolistic capability due to the advantage of technology and knowledge

2.4.3 Market imperfection theory

Hymer (1960), in the Hymer-Kindleberger hypothesis, argued that since there usually exist some disadvantages imposed to foreign firms in comparison with domestic firms such as knowledge and experience of market, communication, foreign firm should maintain some firm-specific advantages in case they have a plan of foreign production In addition, Hymer (1960) emphasized that FDI is not merely about the capital transfer; FDI is also related to the international transmission of possession and intangible assets - techniques, business facilities, and skilled labor Hymer (1960) asserted that the imperfection of the foreign markets for those

assets induces the presence of FDI By taking advantage of direct investment, firms can internalize or remove these market imperfections

2.5 Concept of Institutions

A wide range of theories and approaches of FDI determinants have been conducted due to FDI applicability According to this thesis’s objective, institutional environment or institutions is believed to be crucial theoretical background of FDI decision-making

Conducting a study of institutional economics, Commons (1931) proposed a general definition of institution as “collective action in control, liberation and expansion of individual action”

Commons interpreted collective action is not only the “control of individual action”, but it is also

the “liberation of individual action” from compulsion, pressure, prejudice or injustice in individuals’ competition In addition, collective action is expansion of the determination of the individual much more than what he can do by his own ability

Discussing institutional changes, North (1990) defined “institutions are the rules of the game in society, or more formally, are the humanly devised constraints that shape human interaction In consequence they structure incentives in human exchange, whether political, social, or economic.”

Hodgson (2006) proposed that institutions could be understood as structures of established and common social rules that establish social interactions According to Hodgson (2006), “the term

rule is broadly understood as a socially transmitted and customary normative injunction or immanently normative disposition”, in which “immanently normative requires that if the rule is scrutinized or contested, then normative issues will emerge” and “socially transmitted means that

the replication of such rules depends upon a developed social culture and some use of language” Nelson and Sampat (2001) constructed a concept of institutions as “standard social technologies” The phrase “social technologies” is partly similar to “physical technologies” because in addition to physical engineering, “social technologies” are more associated with human interaction The authors concluded that institutions could be considered as a determinant

of economic performance or economic growth by the combination of physical and social technologies

A new way of the approaching of institutions concept was constructed by Roversi (2013) He introduced two new supplementary concepts which are meta-institutional concept and para-institutional concept Meta-institutional concepts are interpreted as “aim-oriented” and “value-oriented”, in which “aim-oriented” involves the consideration of a purpose or an inside objective

of general social practice; while “value-oriented” is pertained to the ordinary values and basis of general social practice Para-institutional concepts include “act-describing” and “fact-describing”, in which “act-describing” describes common action, performance or planning; while

“fact-describing” describes specific aspects of real institutional practice These two supplementary concepts are linked to each other by “constitutive rules”; “constitutive rules”, in other words, is considered as a crucial determinant of the creation of institutional reality

2.6 The role of institutions in the economy

The theme of analyzing the role of institutions in emerging economies has been conducted by many researchers Scott (1995) suggested that theory of institutions accentuates the impacts of the system around organizations that create behavior of society and organizations Peng and Heath (1996) stated that in transition economies, firms have to face difficulties in the enhancement of internal growth due to institutional constraints Consequently, a strategy focusing on network-based growth is believed to be more reasonable in emerging economies Lau (1998) observed Chinese enterprises and asserted that these enterprises also coped with institutional constraints which are political and market pressure Having the same idea but Suhomlinova (1999) applied the study on Russian enterprises and declared that government institutions and influences could be considered as institutional constraints for the innovation of the enterprises in Russia

Placing an emphasis on the economic reform of large state-owned enterprises, Child and Lu (1996) proved that material, relational, and cultural constraints prevented the reform from moving smoothly Jefferson and Rawski (1995) attributed the success of the industrial reform in China to institutional changes, the mitigation of state ownership and control and development of private property rights Institutional changes are believed to provide appropriate stimulus and changes in enterprises’ culture which empowered firms, even state-owned ones, to make enhancements By applying the same approach of the benefits from institutional changes, Soulsby and Clark (1996) demonstrated that basic and primary institutional changes have contributed to a reinstitutionalization of management through the acquirement of administrative expertise which is more applicable to the new environment and useful for strategic decision making

2.7 Theories of Institutions and FDI

An important point about the effects of institutions on FDI is related to transaction costs North (1990) argued that institutions influence societal interactions and organizational action By

affecting the transaction costs and information costs due to the diminishing of uncertainty and the construction of a substantial structure that promotes interactions, institutions impact on the making decision of FDI and FDI implementation In particular, this mindset highlights that costs are usually incurred when firms are involved in business transactions, which are the cost of collecting information, composing and administering contracts North (1990) also mentions that the effectiveness of political institutions might be assessed by how closely a political market estimates a zero transaction cost result Specifically, about multinational enterprises and FDI decision making, a country is believed to achieve more inward FDI if the institutional environment could estimate transaction costs close to zero Berge (2012) demonstrates that institutions may influence nation-level profitability assessments, and is, therefore, likely to be a significant factor of FDI These profitability assessments comprise lower transportation and communication costs along with more available resources and facilities for multinational enterprises New institutional economics is the theoretical foundation that Gross and Trevino (2005) applied to examine the interaction effects between FDI activity and institutional development The authors argued that FDI is influenced by country-level macroeconomic, microeconomic, and institutional changes These institutional changes are specifically related to factors that diminish or increase the unpredictability and costs pertaining to capital investment in long term

Theories regarding government, legal system, corruption and infrastructure are some other significant aspects in analyzing the effects of institutions and inward FDI Meyer (2001) found that there is increasing evidence that governments in transitional economies, when attempt for more global FDI flows, have adjusted their institutional reality in order to attract inward FDI Mentioning empirical literature on FDI determinants, Blonigen (2005) considered institutions a crucial determinant of FDI, especially for less-developed countries Firstly, insufficient legal protection of assets could lead a firm’s assets to the possibility of expropriation, which in turn probably make investment less possible Next, low quality of institutions required for well-functioning market and corruption could boost business costs and reduce FDI activity correspondingly Last but not least, substandard institutions easily lead to weak infrastructure, low expected profitability, which subsequently decreases FDI flow into a market

2.8 Empirical studies on Institutions and FDI

A typical approach of institutions and FDI has been used by many researchers, which is the analyzing of several countries in some specific regions and pointing out significant institutional

factors affecting inward FDI By conducting a research about FDI flows into Latin America during the period of 1990-2006, Ramirez (2010) mentions some institutional factors pertaining to FDI decision-making, which include political and macroeconomic stability, the nature and extent

of governmental policies related to infrastructure and labor force and an organization of a institutional framework which is favorable for business performance Gross and Trevino (2005)

legal-in an analysis about the relationship between FDI legal-inflows legal-in Central and Eastern Europe and institution building argued that institutional factors which affect FDI decision-making include corruption, political risk, bilateral investment agreements and transaction costs In particular, the existence of corruption and political risk are demonstrated to be negatively related to inward FDI The applying of bilateral investment agreement has positive significant impact on FDI inflows Campos and Kinoshita (2003) conducted a research from transition economies in Central Europe and the former Soviet Union in the period of 1990 and 1998 and found that institutional quality plays an important role in the location decision of foreign investors The authors interpret the good quality of institutions in terms of low level of corruption, an unbiased, predictable and transparent judiciary, and an effective bureaucracy Continue to focus on 45 developing countries in the African, Latin American and Asian regions, Bissoon (2011) attempts

to interpret the crucial role of institutional quality in FDI flows In particular, the study points out that good institutional quality in terms of controllable inflation rate, effective control of corruption, good legal system, political stability and better freedom of the press would have a positive impact on the FDI inflows of the countries Alemu (2012) conducted an empirical study

on FDI inflows and institutions, using panel dataset collected in 16 Asian economies from 1995

to 2009 The author made an emphasis on the effect of corruption level only and found obviously negative impact of corruption on the FDI attractiveness in the Asian countries

Another type of approaching institutions is the examining of multinational enterprises Using evidence from United State multinationals investing in many different regions in China, Du et al (2008) investigated the impacts of economic institutions on location choice of FDI The authors observed that US enterprises prioritize their investment into the regions with high protection of intellectual property rights, less intervention of government in business operations, lower degree

of government corruption, and more efficient contract enforcement

Some other researchers aim to an overall approach of institutions Selecting India which is a country with rapid growth in FDI inflow during five years from 1996 to 2000 to examine the relationship between institutions and inward FDI, Collins et al (2008) proposed hypotheses of

overall institutional environment and three institutional dimensions including “regulative, cognitive and normative institutions” In which, overall institution environment represented by ranking of business environment has a positive relationship with FDI inward Regulative institutions are about rule of law, regulations and policies Cognitive institutions are related to scenarios or frameworks that people obtain meaning from and explain symbolic representations

of the world Normative institutions describe the values and principles that illustrate socially proper ways of behavior The two institutional dimensions – regulative and cognitive institutions – are proved to be positively related to FDI flows into India Regulative institutions are proved to have strongest influence on investment into India It supports potential foreign investors with difficulty in coping with regulatory matters as well as the availability of legal knowledge required for investment transaction into India Meanwhile, cognitive institutions provide firms with appraisal knowledge and deal evaluating expertise Normative institutions, on the contrary, are proved to have no statistically significant impact on FDI flow into India Conducting the same approach of institutional environment in terms of regulative, cognitive and normative institutions, Trevino et al (2008) drew a different conclusion when they apply their study in Latin America between 1970 and 2000 The authors argued that cognitive and normative types proxied by bilateral investment treaties, educational achievement, privatization and political unpredictability were proved to have significant relationship with FDI flow into Latin America Regulative type, whereas, proxied by tax and trade reform, financial account liberalization were not important determinant of inward FDI into this area

Unlike other researchers conducting studies about institutions and FDI at country level, province-level approach and sector-level approach are alternative options Cole et al (2009) had

a new approach of institutions and FDI when they introduced a province-level analysis of the relationship between FDI location and institutions in terms of corruption and governance in China from 1999 to 2003 The authors used the number of convictions of public officials as a proxy for corruption level at each province Besides, anti-corruption effort is proxied by the number of recorded cases under inspection by procurator’s offices Those cases include bribery, misappropriation of public reserves, illegitimate ownership of public funds, unstated source of large property, abuse of power, abandonment of duty and responsibility and deceptive practices The governance efficiency is illustrated in terms of public services, public goods, government scale, and national welfare The empirical results of the study revealed that better governance efficiency could lead to economic growth, which means provinces with good local governance

would be able to attract more inward FDI In addition, foreign investors usually tend to direct their investment into provinces with high achievement in anti-corruption effort, as proved by the study’s econometric results “Do Institutions Matter for FDI?” is the title of an empirical study conducted by Ali et al (2010) The authors used a panel dataset generated from 69 countries over the period from 1981 to 2005 and concluded that a robust determinant of FDI is institutions In addition, the protection of property rights is proved to be the most significant institutional factor that affects FDI inflows Furthermore, by applying sector-level approach to analyze the impact of institutions on FDI, Ali et al argued that institutional quality exerts different effects on different sector in the economy In particular, in primary sector which is proxied by natural resource availability; the level of taxation; and the quality of transport infrastructure, the authors found no significant impact of institutions on FDI On the contrary, institutional quality is proved to significantly matter for FDI in manufacturing sector, particularly in services

Analyzing a new concept of institutions, Seyoum (2009) conducted an empirical study of the relationship between “formal institutions” and FDI inflows According to the author, “formal institutions” is a combination of independence of judicature, effectiveness of legal system, protection of property rights and intellectual property rights, unfairness in the decision making of authorities, capability of law-making parties, and efficiency of antitrust policy The results of the study reveal that host countries with strong formal institutions would be able to attract more FDI inflows Seyoum, in addition, conducted further investigation on the difference in institutional environment between home and host countries and demonstrated that a large distance in institutional levels between the home and host countries would lead to a significant negative impact on FDI inflows

By focusing on a particular region in the world – ASEAN – Masron and Abdullah (2010) made

an observation on the interaction effects between institutional quality and FDI inflows for the period from 1996 to 2008 The authors used six World Bank’s Worldwide Governance Indicators

in order to represent institutional quality, which are (i) political freedom, freedom of expression, association, and the press; (ii) political stability and absence of violence; (iii) government effectiveness; (iv) regulatory quality; (v) rule of law, quality of property rights, the police, and the courts and (vi) corruption level The results of the study reveal that the more enhanced institutional quality, the more FDI inflows would be attracted into the region Besides, the authors claimed that the impact of institutions on FDI in ASEAN in the period 1996-2008 is relatively low This is because ASEAN countries have not focused seriously on the improvement

of institutional quality Therefore, the promoting of the quality of institutional environment should be considered as a decisive future policy strategy for the further significant attraction of FDI inflows into the regions

CHAPTER 3 RESEARCH METHODOLOGY, VARIABLES DESCRIPTION AND DATA SOURCE

3.1 Research Methodology

Investigating the nature of the relationship between FDI inflows and institutional quality as well

as several traditional FDI-related factors in 63 provinces in Vietnam is considered as the major objective of this study

In order to achieve this research objective, a general econometric model is proposed as below:

f(FDI) it = f(Institutions, Traditional) it + u it

In which, the institutions variable is proxied by the Provincial Competitiveness Index – PCI and traditional variables are derived from theoretical background and empirical studies analyzed

above i denotes provinces in dataset, t denotes time (year) from 2008 to 2011 and u denotes

residuals The dependent and independent variables mentioned in this study are briefly introduced in Table 3.1 below

Table 3.1: Summary of variables

Dependent

variable

Foreign direct investment

Registered foreign direct investment

Institutions Entry costs Costs of starting up firms’

10-point scale LAST

Institutions Transparency and

information

Ability of accessing plans and legal documents related to firms’ business

10-point scale TAI

Institutions Informal charges Informal charges that firms

are required to pay

10-point scale IC

Institutions Time costs for

administrative procedures and

Time spent for bureaucratic compliance and inspections

10-point scale TCPI

inspections Institutions Proactivity of

Institutions Labor training The assessment of provinces’

leaders in labor training

10-point scale LT

Institutions Legal institutions Private sector’s trust in the

provincial legal institutions

Four major economic regions

- Northern, Southern, Central and Mekong Delta

Dummy variable with value of 0 and 1

MER

There are some different functional forms that could be employed to analyze the interaction effects between institutional environment and FDI inflow, which are linear, quadratic and logarithmic functional form Five regression models generated from these three functional forms include linear FDI-linear PCI, linear FDI-quadratic PCI, linear FDI-logarithmic PCI, logarithmic FDI-linear PCI and logarithmic FDI-logarithmic PCI In order to avoid multicollinearity which may happen when all PCI sub-indices are included in one model, each PCI sub-index would be analyzed along with five traditional variables instead There are nine PCI sub-indices and this means the total number of regression models generated from five functional forms would be forty five models All of those regression models are conducted by using fixed-effects technique The most appropriate model would be identified and this model would precisely point out which PCI sub-indices are statistically significantly impact FDI inflows

3.2 Variables description

3.2.1 Foreign Direct Investment – FDI

Due to the limitation of collecting the exact and sufficient data of FDI disbursement, the FDI analyzed in this thesis is the FDI registered and licensed to invest in 63 provinces in Vietnam In other words, it is called registered provincial FDI

3.2.2 Provincial Competitiveness Index (PCI) and nine sub-indices

According to PCI Report 2011, PCI data set is generated from a rigorous nationwide survey of

nearly 7,000 firms in 63 provinces in Vietnam as well as published data sources such as General Statistics Office of Vietnam Surveyed firms are chosen from a random sampling method in order to precisely reflect firms’ characteristics in provinces The sample is then stratified to ensure the accurate representation of business operation time, legal type and business sector of the firms Nine sub-indices of PCI is subsequently calculated and standardized into a 10-point scale result Finally, the consolidated PCI result using the 100-point scale would be adjusted based on the weighted average of the nine sub-indices

The following exhibits detailed description of nine PCI sub-indices and some other traditional variables related to the attracting of FDI inflows

Entry Costs - EC

This is an assessment of time and complication that firms could take in the progress of starting

up their business The complication is about the completion of business registration, the procedure of obtaining land use right certificate The measuring of this indicator is demonstrated

to help compare the difference in the entry costs of newly established firms across provinces A province with higher EC score indicates lower entry costs that firms have to encounter in establishing their business in that province, or explains a more effective progress of starting up firms’ business

Land Access and Security of Tenure - LAST

A measure of two problems related to land that firms could encounter, which are the difficulty in land access and the stability of acquired business premises Difficulty in land access is related to the firms’ possession of land use rights certificate as well as the expansion of firms’ premises Security of tenure, on the other hands, emphasizes expropriation risk, compensation for expropriated land and fluctuation in land price

Transparency and Access to Information – TAI

This indicator is used to clarify whether firms are able to fairly access proper planning and legal documents related to firms’ business operation issued by local authorities, whether new regulations and policies are clearly notified to firms and predictably implemented and the

availability and convenience of the provinces’ website

Informal Charges - IC

A measure of informal charges that firms are required to pay and obstacles caused by these charges to firms’ business, in other words, a measure of “rent-seeking phenomenon” in proceeding administrative procedures, whether the effectiveness of the charges in stimulating firms’ operations are clear or they are considered as a form of corruption performed by provincial authorities A high-IC score province demonstrates a good business environment

where firms have to encounter less difficulties caused by informal charges

Time Costs for administrative Procedures and Inspections - TCPI

This indicator describes the time firms have to spend for administrative procedures as well as how often and how long firms are required to temporarily close their operations due to local authorities’ inspections and investigations In addition, this indicator would also evaluate the efficiency and behavior of government officials in handling administrative procedures A province with higher TCPI score indicates less time wasted on bureaucratic compliance or, in other words, more efficiently handled administrative procedures and inspections

Proactivity of Provincial Leadership - PPL

This indicator makes an observation of the proactivity or creativity and ingenuity of provinces’ leaders in terms of implementing governmental policies as well as suggesting constructive initiatives for the development of private sector In addition, the indicator also mentions the capability of provinces’ leaders in the supporting and applying unclear governmental policies in favour of local private firms

Business Support Service - BSS

This is a measure of the availability of provinces’ support service such as the trade promotion of private sector, consultancy of local law and regulations, seeking business associates, develop local industrial zone and provide technological services Besides, this indicator would also reflect the firms’ satisfaction as well as firms’ willingness in using these support services

Labor Training - LT

This indicator shows an assessment of provinces’ leaders in their efforts of accelerating vocational training and skills enhancement used for local industries as well as supporting labor force in job seeking The assessment is displayed by firms’ perception of general education, vocational training and labor exchange services On the other hand, this indicator evaluates firms’ spending on labor training and recruitment as well as firms’ overall satisfaction with labor quality This sub-index also measures provinces’ labor quality by ratio of vocational training school graduates to untrained labor and ratio of secondary school graduates to workforce

Legal Institutions - LI

This is a measure of private sector’s trust in provinces’ judiciary system, and whether these legal institutions are considered efficient solutions for firms’ disputes, and whether they can serve as a channel for firms to lodge their complaints about the corruption of local authorities

3.2.3 Traditional variables

Infrastructure - INF

It is generally accepted that there are many elements that contribute to the development of infrastructure, for example, electricity, telephone lines, internet, and roads In Vietnam, one of the most important factors influencing infrastructure is believed to be roads In this thesis, the infrastructure variable is measured by the percentage of roads paved with asphalt in each province of Vietnam, which is clearly reported in annual PCI Reports 2008-2011 A good roads system could definitely help to improve transportation and trading of products and services, which is an advantage in attracting inward FDI

Market Size - MS

This indicator is calculated by the gross retail sales of goods and services at current prices The retail sales means the direct retail of business entities (such as commercial and production units, farmers, hotels and restaurants, tourism, services supplied by individuals or organizations) to consumers in the market

Industrial Product of province - IP

This indicator represents gross output of provinces’ industry which comprises products manufactured in a province at current prices It is understood that industrial product means a combination of material products and services in a given period of time

Major Economic Region - MER

According to Decisions 145 and 148 (2004), 159 (2007) and 492 (2009) of Vietnam’s Government, there are four major economic regions which are Northern, Southern, Central and Mekong Delta There are 24 provinces and cities belong to these four regions These regions are considered as important regions that directly impact the development of the country These provinces and cities, therefore, usually receive special attention from the Government and national authorities

Labor Force - LF

Vietnam’s population is classified as one of the highest ones in the world This leads to an advantage in cheap labor force, which is a key factor of attracting investment in manufacturing industry In this thesis, the variable of labor force is measured by the population at 15 years of

age and above

3.3 Data source

In addition to the PCI data set which is collected from the annual PCI Reports 2008-2011, data set of other variables including dependent variable which is FDI, and independent traditional variables which are infrastructure, market size, industrial product of province and labor force are consolidated from the statistical yearbooks of Vietnam issued by General Statistics Office over the period from 2008 to 2011 in 63 provinces of Vietnam The data of dummy variable – major economic regions – is derived from Decisions 145 and 148 (2004), 159 (2007) and 492 (2009) of Vietnam’s Government This is a balanced panel data set with 252 observations The data set is selected in the time of 2008-2011 because PCI reports 2008-2011 display the same general framework of determinants of PCI which includes nine sub-indices and employ the same methodology in collecting and analyzing data from practical surveys In addition, data of infrastructure variable used in this thesis is originated from PCI reports and this kind of data is only available in PCI reports 2008-2011

CHAPTER 4 ECONOMETRIC ANALYSIS AND RESULTS

4.1 An overview of Foreign direct investment (FDI) and Provincial competitiveness index (PCI) in Vietnam from 2008 to 2011

4.1.1 Foreign direct investment (FDI)

FDI in Vietnam shows a decreasing trend in four years from 2008 to 2011 Figure 4.1 describes registered FDI in Vietnam each year The significantly high FDI in 2008 is mainly due to a very important event which is Vietnam officially becomes the 150th member of World Trade Organization in November 2007 This is a remarkable advantage for Vietnam in the attracting of foreign investors all over the world However, after 2008, FDI started to go down This could be the impact of the global financial crisis at the end of 2008

Figure 4.1: Registered FDI in Vietnam over the period from 2008 to 2011

(Source: General Statistics Office)

Table 4.1 below displays FDI of top ten provinces in Vietnam from 2008 to 2011 We can see that the order of provinces changes year after year due to the change of key characteristics of each province such as institutional environment, infrastructure, market size, industrial product, labor force, which affects the amount of registered FDI into a province

63.995

22.711

10.000

Table 4.1: FDI of top ten provinces over the period from 2008 to 2011 (in million USD)

(Source: General Statistics Office)

Province FDI Province FDI Province FDI Province FDI

1 Ninh Thuan 9,800.3 BRVT 6,803.5 Quang Nam 4,177.1 HCMC 3,144.6

3 HCMC 9,071.6 Binh Duong 2,722.4 Quang Ninh 2,200.3 Ha Noi 1,106.3

4 Ha Tinh 7,879.1 Dong Nai 2,644.6 HCMC 2,032.3 Binh Duong 1,006.2

5 Thanh Hoa 6,211.3 Phu Yen 1,689 Nghe An 1,327.7 BRVT 954.6

8 Quang Ngai 2,460 Da Nang 275.6 Dong Nai 541.3 Bac Ninh 609.4

9 Kien Giang 2,304 Hai Duong 217.5 Binh Thuan 523.9 Tay Ninh 538.3

10 Dong Nai 1,928.6 Hung Yen 162.8 Binh Duong 486 Da Nang 477.8

4.1.2 Provincial competitiveness index (PCI)

First introduced in 2005 by the Vietnamese Chamber of Commerce and Industry (VCCI) and the U.S Agency for International Development (USAID), the Provincial Competitiveness Index (PCI) includes ten indicators which are used to measure and assess the standards of economic governance of 63 provinces in Vietnam From 2008 to 2011, an important sub-indicator is added

in the calculation of PCI, which is infrastructure However, from 2012, the authors of PCI reports confirmed the factor of infrastructure is temporarily removed from PCI because the authors would like to focus more on other factors such as labor training and capital approach And from

2009, the sub-index related to state-owned enterprises is also removed because the authors claim that most of the state-owned enterprises were equitized and they were no longer an obstacle of the development of provinces’ private sector

The PCI ranking of top ten provinces in Vietnam from 2008 to 2011 is presented in Table 4.2 The changes in ranking are the result of the improvement of each province’s institutional environment