FDI and income inequality evidence from panel data of vietnams provinces

UNIVERSITY OF ECONOMICS INSTITUTE OF SOCIAL STUDIES HO CHI MINH CITY THE HAGUE VIETNAM THE NETHERLANDS VIETNAM - NETHERLANDS PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS FDI and Inco

UNIVERSITY OF ECONOMICS INSTITUTE OF SOCIAL STUDIES

HO CHI MINH CITY THE HAGUE

VIETNAM THE NETHERLANDS

VIETNAM - NETHERLANDS

PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS

FDI and Income Inequality:

Evidence from panel data of Vietnam’s provinces

BY

LAM VAN ROI

MASTER OF ARTS IN DEVELOPMENT ECONOMICS

HO CHI MINH CITY, December 2014

UNIVERSITY OF ECONOMICS INSTITUTE OF SOCIAL STUDIES

HO CHI MINH CITY THE HAGUE

VIETNAM THE NETHERLANDS

VIETNAM - NETHERLANDS

PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS

FDI and Income Inequality:

Evidence from panel data of Vietnam’s provinces

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

MASTER OF ARTS IN DEVELOPMENT ECONOMICS

By

LAM VAN ROI

Academic Supervisor:

PHAM KHANH NAM

HO CHI MINH CITY, December 2014

ABSTRACT DOES FDI AFFECT ON INCOME INEQUALITY?

This paper attempts to estimate GINI indices for all provinces of Vietnam and contributes to explore the relationship between FDI and income inequality The thesis uses a balance panel data for 56 provinces in 5 years which includes GDP, FDI and income distribution The thesis found that there is no evidence impact of FDI to income inequality

Contents

Chapter 1: INTRODUCTION 3

1 Problem statements 3

2 Research objectives 5

3 Research Scope and data 5

4 Organization of the thesis 5

Chapter 2: LITERATURE REVIEWS 7

1 Theoretical backgrounds 7

2 Empirical studies 10

Chapter 3: RESEARCH METHOLOGY 14

1 Data 14

1.1 Gini Coefficient 14

1.2 Share of FDI in GDP 15

1.3 Data summary 15

2 Conceptual Framework: 18

3 Model specification 18

Chapter 4: RESULTS OF ANALYSIS ON FDI AND INCOME INEQUALITY 23

1 Foreign Direct Investment in Vietnam – An overview 23

2 Income inequality in Vietnam 27

3 Descriptive statistics 29

4 Regression results 32

Chapter 5: CONCLUSIONS AND POLICY RECOMENDATION 37

1 Conclusions 37

2 Policy Recommendations 38

3 Limitation of the thesis and suggestion of further research 41

REFERENCES 42

APPENDIX 46

A – DATA ON FDI AND GINI 46

Table 1: Information detail for provinces 46

Table 2: Vietnam’s 10 leading FDI investors in 11 months of 2014 47

Table 3: Top 10 provinces in FDI attraction in 11 month of 2014 48

Table 4: 10 sectors attracting FDI head of VN in 9M-2014 48

Table 5: Some facts about income distribution and inequality in Vietnam 49

B - DESRRIPTION OF THE DATASET 49

Table 0: List of provinces and variables detail 49

Table 6: Summary statistic of variables 60

Table 7.1: Results of Pool OLS 61

Table 7.2: Result run Random Effect Model 61

Table 7.3: Result of Fixed Effect Model 62

Table 8: Result of Hausman Test 62

Table 9: Summary of two new regression for Fixed and Random Effect 63

C- Figure of endogeneity test and solution: 64

Figure 1: IV estimator 2SLS 64

Figure 2: First-stage regression and instruments are weak test 65

Figure 3: Endogeneity Test 65

Figure 4: Regression for FDI stock in GDP by lagged of FDI stock in GDP 65

Chapter 1: INTRODUCTION

This chapter of the thesis will introduce the problem statement and research object under the perspective of the social sciences It stated why this thesis was formed for the purpose of explaining the relationship between FDI and income inequality This chapter also presents the essential content and will be explained in detail in the next chapter In addition , the structure of the thesis is also stated in this chapter

1 Problem statements

In recent years, Vietnam has made significant achievements in improving the economy and society The growth of economy is about 7% per year, GDP per capita has increased and poverty ratio has reduced year by year (Mahajan et al., 2014) This achievement is a positive signal for the transitional economy, and Vietnam also changes many policies to follow up with the globalization trend In 2009, Vietnam was a member of Lower-middle income countries and became a success story Vietnam’s economic growth made poverty situation decreasing and improving income inequality Sustainable economic growth is an advantage to attract more FDI from developed countries

Opening economy in Vietnam, after Doi Moi Policy, is also like other developing countries in improving environmental investment in order to attract more FDI from the world According to ASEAN Business Outlook Survey in 2012/2013, there were over 50% of foreign investors wanted to expand their businesses in Vietnam, because Vietnam has the political stability and a safety destination That is the reason why FDI has been increasing year by year

The impact of FDI to Vietnam’s economy is very important because FDI entices the growth rate, alleviate poverty and technology transition However, FDI is often unevenly distributed among provinces of Vietnam, so the impact of FDI to each

province is different from province to province The understanding FDI is important

to make policy

The empirical study about FDI in provinces of Vietnam focused on researching impact of FDI to economic growth, employment generation and technology spillover effect Furthermore, the analysis of FDI in inequality has few studies and the most of studies treats impact of FDI between countries in economic growth

In addition, the role of FDI investment in the country as well as the provinces of the country that generated a strong effect in attracting an abundant labor force of that country where FDI decides to make an investment Therefore, the creation of jobs for the workforce in place that FDI will create the income distribution in the entire region The income distribution is uneven, and it depends greatly on the level of technology, skilled labor, skills of the workforce in the environment So therefore , the required skill level of the labor multinational companies appear and create a greater pressure on the demand of high quality labor but high-quality labor supply in the country has certain restrictions This leads to large disparities in the distribution of wages between skilled and unskilled manual workers who do not have the skills, and create a rise in inequality of workers’ income

The inequalities and FDI in many countries have been much a controversial debate in academic literature Gottschalk and Smeeding (1997) and Acemoglu (2003a) found evidence about FDI which tends to increase the inequalities between skilled and unskilled workers Hence, the purpose of this paper attempts to analyze the impact of FDI to income inequality in provinces of Vietnam in order to understand deeply what the impact of FDI is and suggest some recommendations in making policy Inequality

in this paper is understood as income inequality In other words, this thesis attempts to investigate whether FDI helps provinces to improve income inequality or to make it a larger gap In addition, the paper also estimates details of Gini Coefficient for provinces in Vietnam to capture inequality overview

2 Research objectives

a To estimate GINI Index for provinces in Vietnam

b To examine FDI impact on income inequality in provinces Vietnam

3 Research Scope and data

This thesis concentrates on all provinces in Vietnam because there were few studies which researched about FDI and in equality before In addition, the main aim of this thesis attempts to explore the impact of FDI to the inequality The paper calculates GINI index for each province in order to introduce views of income distribution

The estimation model in this paper is implemented by using panel data with over 50 provinces in Vietnam The data was collected and estimated from VHLSS, GSO’s Statistical Yearbook various years (2002, 2004, 2006, 2008 and 2010)

4 Organization of the thesis

The thesis includes five chapters:

Chapter one introduces about the problem statement which is the guideline of this research Following the introduction, chapter two will collect information from some controversies about FDI and Income inequality

According to theoretical literatures, FDI departs from multinational companies invested into countries with new technology and management skills, and helped labor forces in this country to improve their skills and productivity performances FDI is a tool for those multinational companies to expand their powers to the world, but it does help emerging countries to develop and escape from the poorness FDI also contributes to the economic growth of a country, creates more jobs for the labor forces which should have been jobless without FDI

In chapter three, the thesis attempts to introduce the methodology to analyze the panel data In this section, we use econometric model to find relationships between FDI and Income inequalities by using panel data provinces of Vietnam

The very next chapter which is chapter four will show the estimation’s result derived from the model introduced in the previous chapter This result pointed out the correlation as well as the effect of FDI to the Income Inequality in provinces of Vietnam In addition, this chapter will also show the overview of FDI and Income inequality in Vietnam in recent years

The final chapter will discuss some conclusions which were brought out from chapter four In this section, we also suggest some policy recommendations to improve FDI flow and income inequality

Chapter 2: LITERATURE REVIEWS

This program presents some basic theories as the basic for this thesis building the model of elements necessary to explain the relationship between FDI and income inequality In the first chapter , the thesis will elaborate on the basic economic theory

to provide an overview of the role of FDI impact on the economy where it is invested, then lead to the relationship between FDI and the distribution of income to the employee The next section of the chapter presents the empirical study of economics scholars have studied about the role of FDI and income inequality The last part of the chapter will introduce the analytical framework based on empirical research

1 Theoretical backgrounds

Income inequality is distributed unequally among individuals in a group, among groups in a population or among countries It has always been of the central point of economic theories such as neoclassical theory of Adam Smith (1776) or factors income distribution of Thomas Malthus and David Ricardo (1817) Modern theories define income inequality as distribution of income across individuals and households The causes of income inequality have focused on productivity of different groups (Neoclassical economics), conflicting across labor and capital – intensive (Marxian economics), different gap between demand and supply of labor force (modern theories), tax polices (Krugman, 2009; Saez, 2009), accessing education (Standard & Poor’s rating agency, 2014), Finance industries (Jamie Galbraith and Stiglitz, 2012) and globalization (Krugman and Lawrence 1993)

Globalization is characterized by an increasing and extending inequality which has been one of the leading research topics in 1990s There were a lot of researches on the effects of trade to income inequality within countries, like Chakrabarti (2000), Wei and Wu (2001), Carneiro and Arbache (2003) Globalization is like other definitions would have two side effects, but it scores a remarkable point for developing countries

that it offers a good opportunity for those countries to develop and strengthen their economy as well as increasing their national living standards And FDI, as a heightened factor of economic growth, has been focused on rather than other factors that related to the economic growth This thesis analyses the relationship between FDI and income inequality in Vietnam

The thesis is based on modernization and globalization theory, which used to explain the process of modernization within societies The theory refers to a model which a country can be progressively transformed from traditional country to a modern one The theory supports that a country cannot be only growing by internal factor but also

by external factors which are opening its economy and integrating the world economy

For developing and less-developed countries, including Vietnam, modernization is the best way to develop their economies And, through FDI, there is a shift on production from developed countries to developing countries which will change the state of production factors The theory was popular in mid-20th century The main point in this theory, a country has to improve internal factors by improving their technologies and applying new researches into production progress

However, in order to have new technology, a country should integrate with the world and open the economy to attract more capitals and new technology into domestic economy Globalization can be understood as the integration of economy Globalization means a country needs to open their economy to trade and attract more capitals from developed countries especially from Multi-national Enterprises Therefore, Multi-national Enterprises also need to invest directly in these countries in order to take advantage of and improve their supply chains which are called FDI FDI

is a capital without undertaking any risks linked to the debts of national’s balance budget So, FDI becomes more attractive and important to the economy growth

All FDI theories concentrate on the determinants of FDI under Multinational Enterprise views According to Dunning (1993), there are three main types of FDI based on perspectives of the investing firms such as Market-seeking, resource seeking (horizontal FDI) and export-oriented FDI (vertical FDI) In one hand, Charkrabarti (2001) claimed that all of the potential determinants of FDI are labor cost But there is

no consistence in the study relating to the role of wages in attracting FDI (Goldbrough -1979, Saunder – 1982 and shamsudding -1994) In the other hand, FDI is also positive to the effect of growth (Tsai, 1994; Lunn, 1980; Culen, 1988 and Nigh, 1985) According to Galdraith and Hale (2004), income inequality will be larger among countries which involved in the information technology boom, it means that the countries with higher technology tend to have higher income in comparison with countries without technology-related skills Hence, Multinational Enterprises are likely to employ technology-related skilled labor in order to warrant their businesses

in the host location In addition, Lawrence (2008) argues that technology innovation and automation from multination enterprises created pressure to the labor force in developing countries

Totally, these theory addressed the effect of FDI in the macroeconomic scale on the host countries including: (1) technology transfers and managerial practices; (2) more capital investments; (3) escalations in exports to developed countries (trade-orientation); (4) creating more jobs, improving labor skills and productivities; and (5) growing government’s budget

In contrast with above theories, dependence theories showed the macroeconomic effects of FDI on developing host countries It argued that more FDI in a country leads to be controlled by foreigner power and made income inequality increased (Dornschier and Chase-Dunn, 1985; Gowan, 1999) Dependency theories also mentioned that FDI created chance for local labor with higher wage and made income inequality become greater (Tsai, 1995)

2 Empirical studies

In contrast with these benefits from FDI, Bornschier and Chase-Dunn (1985) and Gowan (1999) argued that FDI not only created opportunities for host labor forces with comparative wages, but also made unemployment rates increased and income inequality gap was greater (Tsai, 1995) As the result of Tsai (1995), Tsai used cross-country data of 33 developing countries in order to examine the correlation between FDI and income inequality, and found that FDI was a cause making inequality rising

in host countries, especially some Asian Countries The limitation of Tsai treats the trade factor have no correlation with the inequality

Fu (2004) used log-liner dynamic panel data mode to capture spillover and migration effects and FDI impact on regional income inequality in China and supported result FDI affect to inequality However, the model of Fu does not mention the role of Chinese government and economic growth which are omitted from the model

Several empirical studies support that FDI is associated with greater inequality by raising the skill premium in low developed-countries such as case of Mexico (Aitken

et al 1996; Feenstra and Hanson 1997) The pressure from skill premium creates the benefit for skilled-labor more than unskilled-labor However, the limitation of Feenstra and Hanson model is that it depend on the statement of free trade

The empirical study research with 119 developing countries from 1970 to 1999, Basu and Guariglia (2003) studied the link between FDI with inequality and economic growth, and used fixed effect technique method They found that the developing countries will be trade-off between FDI – Economic growth and rising inequality With the data of 46 developing countries, Balasubramanyam, Slisu and Sapsford (1996) argued that the beneficial effect of FDI was stronger in these countries which followed outward-oriented trade policy and enhanced economic growth So, FDI may

create an undesirable effect on labor market by increasing wage inequality, and there

is evidence which FDI has positive impact on inequality

Accordingly, Taylor and Driffield (2005) employed the panel data of about 100 manufacturing industries from 1983 to 1992 in United Kingdom Follow their results, FDI has significant statistically effect on wage inequality because the domestic firms tend to use new technology instead of labor-intensive They also found that FDI has a positive impact on wage inequality

As Dierk Herzer, Philipp Hühne and Peter Nunnenkamp (2012) result, after they analyzed the data of five Latin American host countries and found that FDI has contributed to the greater income gap in these countries Their study show that FDI has positive impacts on income inequality by using the panel co-integration analysis method However the result of Uruguay has no evidence to demonstrate that

In host country, FDI enterprises can transfer new technologies and meanwhile establish the pressures on domestic technologies and labor skills to lure renovation, as Freeman (2000) and MPI (2003) In theoretical estimation on impact of FDI in host countries, it requires for learning and skill upgrading for labor force; it leads to distribution income uneven between high-skilled and low-skilled labor

Finigi (2011) used a panel data of more than 100 countries from 1980 to 2002 in order

to analyze the relationship between FDI and wage inequality The authors found that the impact of FDI is different between the level of development (developed and developing countries), and FDI tend to make wage inequality increases in developing countries, but its impact is diminishing with further increases in FDI However, in developed countries, FDI have negative impact to wage inequality

Velde and Morrissey (2003) take the survey the research evidence on FDI about foreign ownership and wages at the micro level data The research indicated that Multinational Enterprise tend to pay higher wage than local firm, and the gap of

wages can be up to 60% Consequently, wages of labor between foreigner firms and local firms have a larger gap In other word, FDI contributed to make income inequality increase

In the North-South model, FDI can be a cause which makes greater inequality by widening the wage gap Moreover, several studies support FDI is associated with greater inequality by raising the skill premium in developing countries (Eitken et al., 1996; Feenstra and Hanson, 1997) The explanation is that FDI raised the relative demand for skilled labors, case in Mexico, so FDI creates benefits for skilled-workers more than unskilled-workers (Hanson, 2003) That can also be applied for Indonesia (Lipsey and Sjöholm, 2004) In South Korea, Mah (2002) found that FDI was associated with income equality Tang and Selvanathan (2005) also examined that FDI inflows were on the main factors which lead to increase regional income inequality at the nation level (rural and urban regions of China) Multination enterprises tend to pay on average higher wages to their workers (Bircan, 2007)

Pertaining to the United State case, Chintrakarn, Herzer and Nunnenkamp (2010) used panel data for 48 states over the period 1997-2001, and found that FDI affected income inequality in long-run and had a negative effect on income inequality in the United States.Furthermore, Jensen and Rosas (2007) found that relationships between investment of multinational enterprises (FDI) and income inequality in Mexico had a negative impact In addition, Vijaya and Kaltani (2007) explored that FDI flows had a negative impact on overall wages in the manufacturing sector by using a cross-country analysis

In the case of Europe, Herzer and Nunnenkamp (2011) provided results showing FDI affects the inequality with negative sign in the long run, but in the short run FDI effect has a positive impact

Meanwhile, in the research of Markusen and Venables (1997), they believed that inflow FDI into a host country will reduce the relative demand on the skilled labor at that country As the phenomenon, most of the skilled labor’s requirements will be needed in the head-quarter at the country which is the original country of FDI Most

of the time they will only build a plant at the host country, so it is obviously there is not necessary to hire skilled labor for that The majority of skilled tasks will be done

in the head-quarter at the mother country Overall, FDI will have adverse effects on improving the skills of local labors

Surprisingly, empirical evidence showing the impact of FDI on income inequality in Vietnam with provinces data level is limited Specially, most empirical studies only focused on analyzing impact of FDI on economic growth, labor productivity of domestic firm and poverty alleviation such as paper concentrates on spillover effects

in the economic growth (Le Viet Anh - 2002, Pham and Ramstetter 2006), FDI and poverty alleviation (Nguyen Phuong Hoa – 2002)

Chapter 3: RESEARCH METHOLOGY

This program involves research methodology of the thesis It introduces the data was collected from, and how is treated before it enters the econometric model In addition , it also provides an insight into the role of the explanatory variables in the model and why build these variables , and integration of variable quality specification Next , this chapter also summarizes the basic data of each of the provinces of Vietnam Explain the reason to adjust the model to fit the data of the provinces were collected

in Vietnam Finally , it refers to the econometric model ( Econometrics model ) based

on empirical research , as well as the model proposed by the United Nations in 2012

1 Data

This paper employs income data from VHLSS 2010 in order to estimate the GINI coefficients for 56 provinces in Vietnam from 2002 to 2010 In addition, the data of FDI implementation was collected by General Statistical Office of Vietnam (GSO’s book various years)

1.1 Gini Coefficient

The Gini Coefficient (or Gini ratio or Gini index) is a popular index measuring income inequality or wealth in a nation The coefficient was developed by an Italian statistician and sociologist Corrado Gini, and many countries applied the Gini coefficient to measure inequality The value of Gini Coefficient is a percentage term and fluctuates from 0 to 100% with higher Gini is associated with more income inequality

Gini coefficient of provinces level in Vietnam is rare not enough to apply specification model in this paper The author has to calculate directly from VHLSS

2010 Based on the definition of Gini index, Gini is calculated from Lorenz Curve However, in reality, the Lorenz Curve is not known or complicated to build So, this

paper uses the following formula, which is represented by Haugton and Khandker (2009), to estimate approximation for Gini:

Where Xk is the cumulated proportion of the population variable and Yk is the cumulated proportion of the income variable (k=[0,n], and X,Y=[0,1])

1.2 Share of FDI in GDP

The data of FDI in provinces is few and not published popular in details, GSO also provides some information of FDI, but it is a summary report The Statistic Year Book’s provinces is separated and not continuously reported

As previous chapter, the purpose of thesis is investigated whether FDI has any impact

on Vietnam provinces, so we use FDI stocks to capture impact instead of using FDI flows as Figini and Görg (2006) and Chinatrakarn et al (2011) referred Moreover, FDI flows are fluctuated from year by year and not sustainable to capture role of FDI for short and long-run FDI inward stock reflects clearly all direct investments held by non-residents in the economy (OECD’s StatExtracts)

Most of the reports from GSO show the flows of FDI for a year and does not have FDI stock Therefore, in order to apply model, the paper lists FDI flow in each year in each province and calculate FDI inward stock for each year and each province The data is not included some provinces, which does not have any FDI investment, or the share of FDI in GDP is nearly zero The purpose of exclusion is that data can make specification model will be bias

1.3 Data summary

The summary of provincial information as follows

Table 1: Information details for provinces

Provinces Average

GINI

Average FDI stock/GDP

Provinces Average

GINI

Average FDI stock/GDP

Vinh Phuc 0.319 0.060 Ba Ria-Vung

Provinces Average

GINI

Average FDI stock/GDP

Provinces Average

GINI

Average FDI stock/GDP

Source: Author’s calculation

In model, the provinces are Ha Giang, Bac Can, Dien Bien, Kon Tum, Dac Lac, Dong Thap and An Giang will not be included in the dataset because these provinces do not have any information about FDI investment, or it is not enough to influent the relationship Thus, to avoid the fact that the model will be bias, the thesis does not include these provinces

In addition, the provinces though only one observation, but still included in the model

to join the regression relationship and increase the amount of observation to ensure sufficient data to serve multiple regression Moreover, due to organizational problems

in the provincial data collection is not constant and therefore a province in 5 years only 1 or 2 observations, but the value is large enough to show the relationship of FDI and inequality income so still put those values into the model

As a result, the dataset have only 56 provinces Detailed information is shown in the appendix

2 Conceptual Framework:

FDI Multinational Enterprises

Premium Labor

Killed-Demand & Supply for skilled-labor

Income inequality

+ -

The analytical framework describes FDI impact on income inequality through Multinational Enterprises, the impact will be:

(+) positive: Bornschier and Chase-Dunn (1985) and Gowan (1999), (Aitken et al 1996; Feenstra and Hanson 1997), Tsai (1995), Fu (2004), Basu and Guariglia (2003)…

(-) negative: Jensen and Rosas (2007), Vijaya and Kaltani (2007), Herzer and Nunnenkamp (2011)

3 Model specification

The thesis will analyze the relationship between FDI and income inequality in provinces of Vietnam using panel estimation According to United Nations (2012), the common practice model refers as following

GINI it = α + βX it + µ t + e t + u it i=[1,N] and t=[1,T]

Where i and t denote country and time period, µt is the time-invariant country’s fixed

effect, and e t is error term for each year and uit is error term of country in time periods

GINI coefficient was estimated from distribution of household data, and vector X is

an explanatory variable which are often referred to be one of elements in the group: (1) trade, migrant remittances and FDI, (2) Growth rate of GDP, (3) Human capital, (4) fiscal policies, and (5) Macroeconomic policies

Chintrakarn et al (2011), the paper suggests that the relation between inequality and FDI stocks is given by the following model:

GINI it = α i + β i t + δ(FDI/GDP) it + ε it

The paper also followed common practice (Figni and Gorg 2011, Chintrakarn et al 2012) then FDI stock was used to capture effect better than FDI flow Because FDI flow is fluctuated time by time and not stable

Finally, we included a fixed effect in this model with α i coefficient and β i t to capture

GINI by time The purpose of expressing αi + βit is that we wanted to capture for any omitted factors and time trends in the model

However, the model is only suitable for capturing impact of FDI in long-run (long panel data), and it has to use panel co-integration method to analyze statement In Vietnam, the data is limited and not continuous for a long time So, it is a reason why the model cannot use panel co-integration method because model needs a long time dataset, as Herzer and Nunnenkamp (2011) and Hühne (2012) use a large data from

1980 to 2000 in order to run the model

With the limitation of data in Vietnam, the thesis refers using short panel data method

to analyze impact of FDI, and we add a new variable which is lagged of FDI stock in GDP to show the impact of the previous FDI which can lead to increase or decrease income inequality in present The paper attempts to explore the impact of FDI stock per GDP into inequality in the past as well as in the present

The model is adjusted as following:

GINI it = α i + β i t + δ(FDI/GDP) it + δ(FDI/GDP) i(t-1) + ε it

Where i=[1,n] is the province id

T=[1,5] is the time id (2002,2004,2006,2008 and 2010)

GINI=[0,1] is estimated from VHLSS 2010 in GINI format

(FDI/GDP) represents the percentage share of FDI in GDP

In this model, we use GINI coefficient as a dependence variable, because it is the most popular measure for income inequality GINI coefficients were estimated by data which we get on the VHLSS 2010 So, the thesis uses the percentage of FDI stock in GDP in order to control the size of host provinces where FDI is put in (as also common practice)

With panel data method, the technique includes three methods: Pooled OLS, Fixed Effect Model and Random Effect Model The Pooled OLS methods estimate the common constant for all cross-sections, and assume error term to be independently and identically distribution εit ~ idd(0, σ2) The Pooled OLS is a simple estimation in panel data and still have some disadvantage

Fixed and Random Effect model mentions the relationship between constant and independent variable and overcome the cons of Pooled OLS In Fixed Effect Model, slopes are constant, and the intercept can differ across provinces however it does not change across time Fixed Effect model can control for omitted variables bias and remove the characteristics of time-variant from response variables, so it also called Least squares dummy variable (LSDV) In the other hand, Random Effect Model assumes that there is uncorrelated between constant and predictors’ variable and can estimate the effects of time-invariant variables However, the cons of Random Effect Model is that it cannot omitted variables and lead to be biased

If constant and independent variable have relationship, we use Fixed Effect is better

It is believed that the model does not any omitted variable and constant – independence without relationship, Random Effect is referred to use

Choosing appropriate model between Fixed Effect model and Random Effect model should be considered whether constant and explanatory are correlated or not The result of Hausman test can be answered for making decisions

Hausmant specification test can be used to differentiate between Random Effect and Fixed Effect in panel data (Wooldridge, 2002) The statistic of method is:

(βFE – βRE)T[Var(βFE) - Var(βRE)]-1(βFE – βRE) ~ χ2 (k) The results of this test:

Ho is true H1 is true

consistent and efficient Inconsistent

βFE Inconsistent effects Fixed effects is consistent

and efficient

The Hausman test based on test examine “if the random effect estimate is insignificantly different from the unbiased fixed effect estimate” (Kennedy, 2008: 286)

In common practices, the short panel data do not need to check serial-correlation because it only applies for macro panels with long time series (over 20-30 years) So, the model in paper is not certainly needed to test for serial-correlation

Finally, the specification model has be to tested with endogeneity problem in order to ensure that the model is consistent and unbiased Because the most of the empirical studies often ignore to consider endogeneity figure, so these models are bias in

estimates, and hence lead to reject the hypothesis that the fact is true (Type I error) or accepts hypothesis that the fact is false (Type II error)

According to Antonakis et al (2012), the most researchers have not been ignorant of the endogeneity problems The causes of problem is that researchers always ignore two key points in which they either depend much on experimental designs and forget that it is not the only way to deliver valid causal inferences, or they don’t realize the fact that many nonexperimetal designs which are failed to indicate the relationship between an endogenous repressor x and y will all be impractical Basically, a successful study is the one which has been tested with the appropriate method The right method will lead to the right result

The reason leading to endogeniety problems in regression are errors in variables, jointly endogenous variables and omitted variables Therefore, the papers need to test endorgeneity specification to ensure that the model is consistent estimation and not biased In order to solve endogeneity problem, the paper uses instrument variable technique Details will be discussed to the next chapter

Chapter 4: RESULTS OF ANALYSIS ON FDI AND INCOME INEQUALITY

This chapter will be presented the overview of Foreign Direct Investment situation and income inequality in Vietnam Moreover, the chapter also shows the result of the regression and introduces more detail the step-by-step of method which has been used

to solve endogenous problem

1 Foreign Direct Investment in Vietnam – An overview

After applying economic renovation policy called “Doi Moi”, Vietnam became a successful case in economic growth and alleviating poverty, and had remarkable economic achievements in improving Gross Domestic Product (GDP), GDP income per capita, trade and integration international trade Hence, a large amount of FDI had flown into Vietnam year by year FDI does not only bring capital to Vietnam’s economy but also bring more technology, product and managerial expertise

At the first stage of opening, we allowed all the FDI projects coming to our countries like never before, as we needed money to stimulate our economy as fast as it could be

We have to say it was a very good decision at that time which proved to be one of the turning point helping Vietnam escaping from poverty after decades affected by the World War II However, the government needs to be more careful and preemptive to receive FDI capital flowing to Vietnam, as those FDI projects could have bad influence to Vietnam’s environment, low technologies therefore using little labor forces We also have to come up with stricter requirements on how companies under FDI projects can use local labors They need to guarantee that there is a significant number of local workers working for them and how those workers are treated

There were more and more industrial park built in recent years, and those parks are absolutely contributing to the whole developing economy in Vietnam Vietnam government has had a clear and long term policy to develop and attract more and more FDI to new provinces and higher FDI in current attracting provinces

In December 1987, Law of Foreign Investment was introduced and created a hit to attract FDI into Vietnam The law was revised continuously in order to improve investment environment from 1990 to 2005 Therefore, Vietnam has achieved encouraging result in attracting FDI inflows By December in 2012, Vietnam has attracted over 17 thousand projects with the total registered capital of approximately USD 246 billion and Implementation capital about USD 100 billion In addition, implementation capital was around 40.4% of total registered capital in end of 2012

Chart 1: Foreign Direct Investment in Vietnam from 1988 to 2012

Source: GSO and MPI Vietnam (2012)

The openness economy has begun since 1987, FDI increased rapidly in the first half

of 1990s and downturn after 1997 – 1998 because of East Asian Crises The trend is also repeated in 2008 because of Financial Crisis in United State The number of project is go up fast after 1998 and go down in 2008

Table 2 shows that top ten countries and territories have invested in Vietnam In 2012, there are over 80 different countries and territories had invested in Vietnam, and the highest total registered capital is Japan with over USD 28 billion and the highest number of project is South Korea with over 3000 projects in Vietnam

As Foreign Investment Agency’s lasted report, the total of FDI in Vietnam is US 11.2 billion in 11 months of 2014 indicating that Vietnam shows early positive signal in economic recovery The main cause is that Vietnam have a macroeconomic stabilities Meanwhile, among 60 countries are investing in Vietnam, South Korea is a leading investor, and the second is Singapore and the third is Japan

Table 2: Vietnam’s 10 leading FDI investors in 11 months of 2014

No Countries/

Territories

No of licensed projects

newly-New registered FDI (million USD)

No of operating projects

FDI added

to operating projects (million USD)

Total FDI (million USD)

(Source: Foreign Investment Agency)

According to Ministry of Planning and Investment report, there are 63 provinces and cities in 8 regions of Vietnam have attracted FDI, but FDI distributes uneven between each provinces Table 3 shows that FDI concentrated in key economic areas where they can take advantage of more developed infrastructure and high-skilled labor as Hanoi, Hochiminh City, Danang city

In the other hand, table 4.2 also indicated that the distribution of FDI into each provinces is a changing trend which is extent to find new locations FDI tends to shift into provinces with more advantages and attractive policies such as Samsung Corporation choose Thai Nguyen Province to invest more than US 1 billion with many goodwill commissions (income tax about 10% in 30 years and is zero for the first 4 year)

Table 3: Top 10 provinces in FDI attraction in 11 month of 2014

No Localities

No licensed projects

newly-New registered FDI (million USD)

No of operating projects to raise capitals

FDI added

to operating projects (million USD)

Total FDI (million USD)

(Source: Foreign Investment Agency)

After many years of opening, Vietnam now has been a good place for the foreign investors to invest in FDI created thousands of enterprises which are able to manage their finances, and import the facility for their own sakes; therefore, they do not cause the burden on the economy as well as the capital supply

Also, the table 4 shows that the FDI capital invested into Vietnam is distributed to 18 industries including manufacturing, producing, gas, water, air conditioner and real

estate were the most three invested areas The following ten industries attracted almost 98.6% of the FDI in Vietnam in 2013

Table 4: 10 sectors attracting FDI head of VN in 9M-2014

Newly registered capital and increase

(million USD) 9M.2014 9M.2013 Difference

1 Industrial processing and manufacturing

7 Wholesale and retail trade; repair (4) 218.41 380.08 -43%

8 Production, electricity distribution, gas,

9 Transportation and storage (13) 115.02 30.46 278%

10 Agriculture, forestry, fisheries (10) 68.45 46.08 49%

(Source: Foreign Investment Agency)

2 Income inequality in Vietnam

The issue of inequality in Vietnam has mentioned in some scholar, papers While most of the papers believe that the income inequality of Vietnam is pretty much remaining stable in the early 2000s However, there is a strong voice demonstrating that the income inequality of Vietnam is strongly increasing during recent years

Specifically in Vietnam, the inequality is derived from nepotism and corruption (Bloomberg 2012) which are the most important factors influencing the income among different classes in Vietnam society

In modern school of thought, it is believed that the narrowing or unequal opportunity referred as something alike the continuously trend of income inequality, for the example that Vietnamese’ young generations whom experience less opportunity to reach outstanding education standards would be likely not to have a bright future and thus prospects for many years to come More than that, potential social unrest would play an important role to the income inequality

As an emerging country like Vietnam, it is not everyone will catch on the boat to go

to what is called “the middle class”, then how about the rest who failed to get on that boat It would be some time when those people would tend to feel left out and therefore their frustrations will increase to the rate which entices them to misbehave Any tension from them would have an undesirably solid effect to the economic modernization progress As the result, FDI probably won’t come to place which is considered as a place of social instability

In the most of papers, they use GINI coefficient as the common indicator specifying degree of inequality It is used to measure the inequality and argued that income inequality remained relatively stable in the early 2000s The table 5 shows that the gap between the richest and the poorest is increased The different coefficient of income gap (average income per capita of the 20% richest and 20% poorest) is risen from 8.1 to 9.2 in 2010, it means that inequality in Vietnam is becoming worse

Table 5: Some facts about income distribution and inequality in Vietnam

Different coefficient of

In provinces level data, Gini index has been rising as a trend time by time The main cause of rising inequality between provinces in Vietnam is uneven income distribution Meanwhile, many provinces have taken the advantage of the infrastructure and education better which lead to attract FDI enterprises than other provinces That is a reason why developed provinces are easy to gain benefits more from FDI

Nevertheless, Thai Nguyen is a unique case to attract a huge FDI capital from Samsung (Korea) and creates a large of job for labor forces in this province

3 Descriptive statistics

The table 6 below describes the summary statistics for all variables in the paper

Table 6: Summary statistic of variables

of GINI coefficient because these provinces did not survey income data in 2002 such

as Hau Giang and Dac Nong province Moreover, Hau Giang and Can Tho used to be the same province in 2002 and database of it also was not collected completely

The FDI stock per GDP with highest value is the value of Binh Duong province In recent years, Binh Duong is the most attractive FDI destination in Vietnam Binh Duong focuses on promoting environment-friendly industry by applying high technology and green technology Now, Binh Duong also improves the modern infrastructure system for trade and services

Chart 2: Gini coefficient, FDI stock per GDP and time

The panel in chart 2 shows the relationship between Gini coefficient and FDI stock per GDP, and all of observation concentrates an area and the line trend is an upward slope The trend is similar with argument of Finigi (2011), Feenstra and Hanson (1999), Tang and Selvanathan (2005) and Taylor and Driffield (2005)…The FDI has positive impact on income inequality However, the graph only analyzes two-way scatter between Gini and FDI stock per GDP, the graph does not include the omitted time variable

The chart 2 also addresses the overview of income inequality time by time and the slope of trend-line is upward showing a positive relationship According to the graph, Gini coefficient has a rising trend from 2002 to 2010, the problem with improving income inequality is not attended adequately, and situation has been a worse trend Furthermore, the gap of urban and rural is widen and indicates a rising trend Although Vietnamese government applies policy to control inequality situation but it becomes worse time by time