Impact of Bilateral Investment Treaties on Foreign Direct Investment Inflows To Vietnam

Impact of Bilateral Investment Treaties on Foreign Direct Investment Inflows To Vietnam Quynh Hoa Le Thu Dau Mot University, Vietnam Abstract The effect of Bilateral Investment Treat

Impact of Bilateral Investment Treaties on Foreign Direct Investment

Inflows To Vietnam

Quynh Hoa Le

Thu Dau Mot University, Vietnam

Abstract

The effect of Bilateral Investment Treaties (BITs) on FDI inflows to Vietnam remains unexplored despite the proliferation of treaties that the government efforts to sign to attract foreign investment at the end of last century This paper asks whether BITs stimulate FDI flows to Vietnam by using different explanation variables and various estimation technique to test the robustness I find a very weak positive relationship between BITs and FDI, though effects of FTAs and WTO are estimated to promote FDI flows into Vietnam My results show the importance of accounting for guiding investment policies to narrow down the gap between law regulations and provision of BITs

Keywords: BITs, FTAs, FDI, Vietnam,

JEL codes: F15, F21, F36, F37

1 Introduction

The last century has proven that international economic integration is an indispensable trend The evidence

is that barriers of trade and investment among countries decrease through Free Trade Agreements (FTAs) and Bilateral Investment Treaties (BITs) In recent decades, many countries, especially developing countries, try to sign a number of BITs in order to attract more foreign direct investment (FDI) that boost economic growth, enhance nation’s capital and skilled labor force

Not apart from that trend, in recent years, Vietnam has participated in a total of 65 BITs and has started to implement the policy of attracting FDI since 1987 So far, after over 30 years, this source of capital has become one of the important driving forces for promoting economic development In the period of 3 decades, Vietnam has witnessed the presence of foreign investors, typically multinational corporations such as Samsung, Honda, Intel, Yamaha, Panasonic, Microsoft, LG The "billion" projects of these multi-national corporations show that Vietnam has been an attractive investment destination for foreign investors According to UNCTAD statistics (2017), FDI inflows into Vietnam increased dramatically with total stock about 370 billion USD in

2017, the number is ten times more than that of the year 1997

However, the impact of BITs to FDIs of developing countries remains a controversy subject among scientists As suggested by Egger and Pfaffermayr (2004), Neumayer and Spess (2005), Desbordes and Vicard (2007), Lejour and Salfi (2015), Nguyen and Cao (2017), signing a treaty has a positive effect on FDI On the other hand, Hallward-Driemaier (2003), Tobin and Rose-Ackerman (2003) and Yackee (2007) have tended to find that BITs fail to boost inward FDI into the developing countries that sign them

Therefore, the previous empirical studies of the impact of BITs on FDI have had mixed results and the question is whether or not signing BIT does help Vietnam to attract more FDI and more favorable BITs lead to further FDI inflows to Vietnam

To answer this question, I develops a theoretical argument to explain the mixed results of previous studies and to advance the understanding of BITs and their impacts on FDI with the data collected from the period of 1996-2017

Since the introduction of the paper has been given, the next section gives a brief overview BITs and FDI inflow to Vietnam; the third discusses the related literature review Section four illustrations the research design, including variables, methodology and estimation framework Then, section five comes to the results and discussion Lastly, final section summarizes the findings of the paper and policy implications

2 Overview Of Bits And Fdi Inflows To Vietnam

As for Vietnam, foreign investment has made positive and impressive contributions in many aspects in the process of integration and socio-economic development in each period of development By 2017, there has been 120 countries pouring FDI into Vietnam with a total capital of over USD 350 billion

Figure 3 FDI inflows and stocks in Vietnam from 1996 to 2017

Source: Author’s calculation from UNCTAD database on FDI

As can be seen from the figure 1, total FDI stocks in Vietnam increased continuously over the years from

1996 to 2007, especially in 2008 there was a sudden increase when Vietnam became a WTO member In the next period between 2009 and 2017, FDI remained an upward trend and reached over 370 billion USD at the end of 2017

However, the growth rate of FDI fluctuated within three decades and it can be summarized as follows In term of FDI inflows, within the first five years from 1996 to 2000, FDI inflows into Vietnam decreased both in registered capital and the number of projects due to the impact of the Asian financial crisis in 1997 Then, in the next five years (2001-2005), FDI started to recover but the pace was slow The explanation for this could be that Vietnam's investment environment and policies at that time were slowly improving, while being subject

to strong competition from the other countries like China, Thailand, Singapore, etc

After Vietnam participated in WTO (2007), the capital of FDI poured into Vietnam increased rapidly and reached its peak at over 70 billion USD in 2008 Moreover, the domestic investment and business environment had been improved and the legal framework for investment had become more and more consistent with international practice, resulting in large waves of investment from Korea, the United States and Japan, etc However, in 2009 and 2010, due to the impact of the global economic crisis, FDI inflows into Vietnam also decreased significantly and remained stable at about 20 billion USD per year between 2011 and 2016

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FDI inflows and stocks in Vietnam

1996-2017

FDI inflows FDI stocks

Overall, in the period of 1996-2017, the FDI into Vietnam have been fluctuating but always positive and has an upward trend

Bilateral investment treaties, or BITs, is defined "agreements between two countries for the reciprocal

encouragement, promotion and protection of investments in each other's territories by companies based in either country." (UNCTAD’s definition)

Initially, BITs were signed between developed and developing countries For developed countries, which export capital, BITs have been part of a long-term efforts to establish international rules that facilitate and protect the foreign investments of its citizens and enterprises Developing countries have joined in BITs in order to improve the policy framework and attract more FDI Moreover, by becoming more and more involved

in BITs, developing countries have begun to see BITs as an investment protection device for their own investors

Figure 4 Proliferation of BITs between Vietnam and partners

Source: Author’s calculation from UNCTAD database on Bilateral investment treaties

The number of new treaties of Vietnam and total cumulative BITs can be seen in figure 2

Vietnam ratified the first bilateral investment treaties with Italia in the 1990 but 4 years later, it came into force Until the 1990s at most twenty-five treaties were ratified After 20 years, BITs have become popular and

in 2010, Vietnam has signed total 62 BITs with several countries, most of these are developed countries, which have abundant capital

However, in the period of 2010-2017, only 3 BITs were signed representing the lowest annual number of treaties in the last 27 years

3 Literature Review

Previous studies examine whether the BITs have actually had an important role in increasing the FDI flows

to the signatory country with various economic methods, different samples, time periods, and outcomes

On the one hand, some studies have found that the signing of a BIT could attract a greater amount of investment to the country

Using both random-effects and fixed effects models in the research about whether BITs increase the investment to developing countries, Neumayer and Spess (2005) indicate some explanatory variables (including: GDP, population, economic growth, inflation, resource rents, BITs, WTO membership, institutional quality, composite political risk, investment profile, government stability, law and order) to estimate the role

of BITs plays in attracting FDI They claim that developing nations that engage in more BITs with developed

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Proliferation of BITs between Vietnam and partners

1990-2017

VNM BIT's signed per year Cumulative

partners receive larger amount of FDI inflows In specifically, a developing country signing a BIT is expected

to attract FDI inflows with an increase amount from 40 to 90 percent

Similarly, Büthe and Milner, in the study of “The Politics of Foreign Direct Investment into Developing Countries Increasing FDI through international Trade Agreements” in 2008, have examined the effect of BITs

on inward FDI into developing countries They conclude that foreign investors consider BITs as government commitments to broaden economically liberal, which alleviates or reduce the political risks to FDI in developing countries According to their results, there is a predicted positive, statistically and substantively significant correlation between BITs and FDI inflow into developing countries from 1970 to 2000

Using extensive data from 1985 until 2011 to assess the impact of the treaties on bilateral FDI stocks, Lejour and Salfi (2014) make an investigation conducted for 34 OECD countries reporting FDI inward and outward stocks towards 217 partners They find that engaging in BITs increase bilateral FDI stocks by 35% on average compared to those of non-treaty countries In addition, less developed countries receive larger inward FDI stocks from developed partners and distinguishing by region, FDI stocks increase mainly in East Asia and Middle and Eastern Europe

On the other hand, some empirical analyses of bilateral investment flows, in particular, indicate that developing countries could not use BITs to attract more FDI (Hallward-Driemeier’s, 2003)

Hallward-Dreimer (2003) and Tobin & Rose-Ackerman (2005) find that there is very weak positive link relationship between the treaties and investor’s behavior In the earlier study by Hallward-Dreimer (2003), analyzing bilateral FDI flows in the period of 20 years from the OECD members to developing partners finds little evidence that BITs have stimulated additional investment Tobin and Rose-Ackerman (2005) apply a two-pronged approach and use panel data from the first BIT signed in 1959 through 2000 for low- and middle-income countries (176 countries) They find that BITs only have a positive effect on investment when countries have a stable business environment; whereas the opposite occurs or BITs affect negatively FDI inflows if the country has a high political risk

These results are consistent with the research of Yackee (2008) focuses on whether the presence of BITs meaningfully influences investment decisions and finds no evidence in support of the impact of BITs on investment decisions

Overall, the previous studies only focus on the link between the treaties and FDI flows from developed regions to developing countries without considering the impact on a particular country In term of Vietnam, despite Vietnam has signed 65 BITs and 16 FTAs, there is little research has been done on the impact of these agreements Can say about the study by Cao and Nguyen (2016), the investigation has been conducted to examine the impact of BITs in general and on FDI inflows to Vietnam in particular Basing on the study of Chaisse and Bellak (2011) and using the principal component analysis, they apply the gravity model with the estimation techniques for panel data such as Fixed and Random effect to affirm the consistent positive effects

of BITs on FDI inflows to Vietnam with various independent variables (proxies for openness, institution…) Beside a connection between BITs and bilateral FDI flows, joining free trade agreements affect the changes

in inward FDI because of several reasons, such as: improving policies and economic environment of the country, decreasing political risk, lower tax rate and giving more incentives for investors However, the previous researchers only evaluate the impact of BITs and the WTO, and some of the major agreements on FDI, not measure the effect of FTAs and BITs simultaneously on the investment inflow, specifically in Vietnam

4 Research Design

This paper focuses on the hypothesis that the more BITs a developing country joins in, the more attracted foreign investors consider it as an investment destination, and the more FDI the country will receive Therefore, dependent variable and explanatory variables are identified to examine the hypothesis

Dependent variable

To test the hypothesis statistically, statistical analyses of inward FDI stocks into Vietnam are collected from the UNCTAD FDI database and Statistical yearbook of the General Statistics Office of Vietnam from 1996 to

2017 The research uses total FDI stock instead of FDI flows because stocks, due to the accumulation of flows, may more effectively capture long-run effects (Neumayer and Spess, 2005) Moreover, the absolute volume provides the most accurate base for the analysis technique used in the study Then, the natural log of the dependent variable is taken to reduce the skewness of its distribution and increases the model fit substantially

Explanatory variables

The model applies a total cumulative number of ratified BITs as a key explanatory variable and data about the date of signature and the date of entry into force of BITs are available from a listing published by UNCTAD

I use the cumulative BITs instead of new BITs that Vietnam signs in every year, because the negotiation and signing of a treaty is a lengthy process and Vietnam doesn’t participate in new BITs every year Therefore, the cumulative number will reflect more accurately the growth of BITs and its impact in the model

Moreover, if a developing country have signed more FTAs with a developed country, it might receive more FDI inflows because such agreements sometimes also contain provisions on policies which might be beneficial

to foreign investors and it is easier to export or import commodities with low taxes This indicator is evaluated

by a dummy variable indicating whether Vietnam becomes a WTO member as well as a variable counting the number of trade agreements Vietnam has concluded, based on information are obtained from WTO (2017) Based on the findings of Chakrabarti (2001) about the determinants of foreign direct investment, the paper uses some control variables including: market size (GDP per capital and POP), economic growth (GDP growth), trade openness, inflation, natural resource rents

Market size has been the most widely accepted as a leading determinant of FDI inflows in past empirical

studies and economic theory GDP per capital and population of the countries are two popular proxies to estimate the specification of variables The study doesn’t use the absolute GDP because it is a relatively poor indicator

of market potential for investors, especially in many developing economies, as it reflects size of the population rather than income (Chakrabarti, 2001) As finding of most of previous papers, like Tobin and Rose (2005), Yakee (2008), Frenkel and Walter (2017), etc, GDP per capital has a significantly positive impact on FDI inflows

to developing countries On the one hand, to be able to distinguish any possible remain determinant of market size, the country’s population seems to be appropriate scale to measure this variable Both GDP per capital and population are drawn from the World Bank’s World Development Indicators (WDI) database

Economic growth, or growth rate of GDP, is a crucial factor in influencing the inflow of foreign investment

There are a number of reasons why foreign investors may prefer a faster-growing market (Busse (2008), Yakee (2008), Buthe (2009) and Frenkle (2017)) For example, a country with high economic growth provides relatively better opportunities, like more efficient production or a larger market, for making profits Moreover, the growth is a measure and signal of market demand which attracts FDI

Low rate of inflation is considered an incentive for FDI inflows in many empirical studies (Alshamsi et al

(2015)) Khan and Mitra (2014) indicate that a low and stable rate of inflation can be considered as a sign of internal economic stability because it reduces the risks and increases the confidence of people and businesses

to make investment decisions Otherwise, a high inflation rate can impact the preservation of foreign capital and may affect profitability as higher prices can lead to higher costs and lower profits (Aijaz, Siddiqui, & Aumeboonsuke, 2014)

Natural resource rents variable can be calculated by the total value of natural resource as a share of the GDP

and estimated by the Bank of the World (2017) as the price of the resource minus the average cost multiplied

by the amount of resources extracted

Wage has been a potential determinant influencing on FDI and estimated by the Bank of the World (2017)

Theoretically, the importance of cheap labor in attracting multinationals is agreed upon by the proponents of the dependency hypothesis as well as those of the modernization hypothesis

I expect a positive association of GDPpc, POP, Growth, WTO, FTAs and BITs with FDI; the opposite applies to Inflation, resource rents and wage as these variables can be interpreted as a proxy for macroeconomic distortions

This study applies the following general structure of the estimation model:

Ln(FDIvnt) = 1*Ln(GDPpcvnt) + 2*Ln(POPvnt) + 3*Inf + 4*Growth + 5*Resource_rents + 6*Wage+ 7*BITs + 8*FTAs + 9*WTO + const

Where:

Ln: Natural logarithm of variables

FDIvnt is the log of total inward FDI to Vietnam in year t

GDPpcvnt is value of GDP per capital of Vietnam in year t

POPvnt is the Vietnamese population in year t

Inf is the percentage of inflation of Vietnam in year t

Growth is the annual growth rate of GDP of Vietnam

Resource rents is total natural resources rents as a share of GDP

Wage is calculated by WDI database and modeled ILO estimate; It is wage and salaried workers, total (%

of total employment)

BITs are the total cumulative number of BITs Vietnam ratified in year t

FTAs is the total cumulative number of FTAs Vietnam ratified in year t

WTO is a dummy which is 1 in years after Vietnam is a WTO and zero otherwise

Const is a constant of model

Estimation Methods

Different techniques are applied in the regression analysis: simple ordinary least square (OLS) regression, generalized least squares (GLS) estimation and Tobit regression The use of several alternative estimation methods in this research to examine the robustness of the results

5 Results And Discussion

Table 10 Estimates of the Effects of Bilateral Investment Treaties

on Total Foreign Direct Investment Activity

(1.82) (2.46) (2.46)

t statistics in parentheses

* p<0.10, ** p<0.05, *** p<0.01

Source: Author’s calculation by STATA

I have explored the robustness of the results by testing the sensitivity of key variables with different techniques in the regression analysis The result shows that the coefficients of the explanatory variables have

a low fluctuation, which means that the model is highly robust and reliable

Firstly, GDP per capita and trade agreements and WTO that Vietnam participates in have a positive impact

on FDI inflows This result is consistent with the hypothesis and previous studies, for example, Neumaye and Spess (2005) and Büthe and Milner (2009) Secondly, the elasticity coefficient between inflation rate and dependent variable is 0.007, which means that the inflation has positive and statistically significant effect on FDI It is against the expected negative relationship between the two in the findings of recent researchers According to the argument of Romer (1990), the inflation can have a positive effect on FDI provided that it does not exceed a certain threshold

In contrast, natural resource rents and labor’s wage have the effect of reducing the flow of FDI The result

is in line with previous papers, as the low cost of resource extraction and labor cost are the key incentives for foreign investor’s decision (Frenkel and Walter (2017) and Tobin and Rose-Ackerman (2005))

In terms of economic growth, the empirical study reports negative effects of GDP growth rate on FDI It is similar to the findings of several scientists (e.g Wint and Williams (2002), Tobin (2005) and Buchanan et al (2012)) One explanation for such result is that it is a scaling effect (Jensen (2003) and Tsai (1994)) Another argues that a negative correlation between economic growth and FDI can also occur if low economic growth in Vietnam means greater opportunities for future profits For instance, a country has a low growth economy that is relatively poor capital, which means that labor and natural resources are relatively abundant and cheap There may here be an opportunity for investors to benefit with the hope of realizing unexploited opportunities for profit

From the findings, there is no association between population and inward FDI stocks, this is similar in Aisbett's study (2007) The reasonable explanation for this could be that developed countries are more concerned about labor productivity and labor costs than absolute amount of population While Vietnam's quality labor is not high and labor productivity is much lower than its neighbors such as Thailand, Indonesia, Malaysia, etc

Ideally, if the BIT is considered input, the increase in FDI must be the output Though the provisions of BITs are expected to provide a healthy investment environment, which is beneficial for investors; nevertheless,

in my findings, BITs do not have the significant effect of attracting FDI into Vietnam, because there is a gap between policy and enforcement in Vietnam For example, despite the Vietnamese government’s recent attempts to negotiate more balanced investment rules in the provision of BITs and ensure consistency within the body of investment treaties and then national laws and regulations, but it is far from sufficient to deal with these challenges To bridge the gap, though Vietnam just reformed the new Law on Investment and the new Law on Enterprisewhich became effective on 1 July 2015, so it takes time for the effect of increased democracy

to show, for which our sample is too short

Moreover, as for Vietnam, since it is not a member of the International Centre for Settlement of Investment Disputes (ICSID) Convention; therefore, when a dispute arises, the foreign investors can only litigate the Vietnamese government in accordance with BIT regulations And this is one of the terms that investors are afraid of because it will be detrimental to them

In fact, Vietnam's economy still has many internal obstacles that have not been overcome, such as lack of high quality human resources, low productivity, poor infrastructure and services compared to many countries

in the neighbor region According to research by Sachs and Sauvant (2009) “There is no clear evidence that BITs have significant impact on FDI inflows in developing countries BITs only have a positive impact on FDI

in the country with an stable economic environment and strong policy If a BIT is signed while the government

is in institutional reform and liberalization to encourage investment, this reform will affect the investment decision of the investor rather than the BIT.”

On the contrary, the WTO has the most positive impact on FDI inflows as the WTO content strictly regulates commitments that Vietnam must make and change policies in line with international regulations This creates

a more competitive environment and a more opening market for investors than BITs regulations

6 Conclusion

Vietnam is considered as one of the dominant destination of FDI from many developed economies in the world In recent years, Vietnam has participated in a total of 65 BITs and has started to implement the policy

of attracting FDI since 1987 The study set out to find the potential impact of these BITs on FDI to Vietnam by using different explanation variables and various estimation technique to test the robustness Consequently, GDP per capita of Vietnam and trade agreements and WTO have a positive effect on FDI inflows; while, natural resource rents and labor’s wage have the reverse effect on the flow of FDI These results are consistent with previous studies and are explained in discussion section However, the impact of inflation rate and economic growth are against the expected relationship with FDI in the findings of recent researchers More importantly, BITs appear to have little impact on FDI inflows to Vietnam due to a gap between policy and enforcement

Therefore, some measures should be implemented to improve the effectiveness of BITs, such as: A necessary first step is therefore the contemplation of a new model treaty text that takes domestic laws and policy priorities into account Secondly, the government should consider to participate in the ICSID Convention to attract foreign investment and Vietnam can use ICSID experts and arbitrators, provide technical assistance and capacity for the ISCID dispute resolution process, simplify arbitral awards In addition to these, rigorous regulations in BITs will create competitive pressures in domestic enterprises, so Vietnamese businesses must understand the relevant issues in BITs, learn and promote innovation to improve their capabilities

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Appendix 1: Countries sign BITs with Vietnam

No Partners Status Date of signature Date of entry into force

10 Korea, Republic of Terminated 13/05/1993 04/09/1993

25 Tajikistan Signed (not in force) 19/01/1999

26 Chile Signed (not in force) 16/09/1999

27 Cambodia Signed (not in force) 01/09/2001

29 Korea, Republic of In force 15/09/2003 05/06/2004

31 Bangladesh Signed (not in force) 01/05/2005

32 United Arab Emirates Signed (not in force) 16/02/2009

33 Oman Signed (not in force) 10/01/2011

34 Morocco Signed (not in force) 15/06/2012

41 Venezuela, Bolivarian Republic of In force 20/11/2008 17/06/2009

48 Russian Federation In force 16/06/1994 03/07/1996