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What are the Determinants of FDI to Vietnam? Master Thesis For Supply Chain Management Program 1 Author: Juan Du ANR: s908588 Defense date: March 31, 2011 Supervisor: Dr. M.A. Overboom Second reader: Dr. M. Stientsra Word count: 8373 Table of Content Abbreviations--------------------------------------------------------------------------------------------4 Chapter 1 Introduction--------------------------------------------------------------------------------5 1.1 Introduction-----------------------------------------------------------------------------------------5 1.2 Problem Indication---------------------------------------------------------------------------------5 1.3 Problem Statement--------------------------------------------------------------------------------6 1.4 Research Questions--------------------------------------------------------------------------------6 1.5 Structure of the Thesis----------------------------------------------------------------------------7 Chapter 2 Theoretical Framework------------------------------------------------------------------8 2.1 Main Concepts and Definition of FDI----------------------------------------------------------8 2.2 Development of FDI Theories-------------------------------------------------------------------8 2.2.1 The Early Neoclassical Theory---------------------------------------------------------------8 2.2.2 The Product Life Cycle Theory---------------------------------------------------------------9 2.2.3 The Internalization Theory-------------------------------------------------------------------9 2.2.4 The Eclectic Paradigm-----------------------------------------------------------------------10 2.3 Determinants Identification--------------------------------------------------------------------11 2.3.1 Host Market------------------------------------------------------------------------------------11 2.3.2 Natural Resource Endowment-------------------------------------------------------------12 2.3.3 Low Labor Cost--------------------------------------------------------------------------------12 2.3.4 Host Inflation Rate----------------------------------------------------------------------------13 2.3.5 Exchange Rate---------------------------------------------------------------------------------13 2.3.6 Exports and Imports-------------------------------------------------------------------------14 2.3.7 Political Risk------------------------------------------------------------------------------------15 2.3.8 Openness to FDI-------------------------------------------------------------------------------15 2.3.9 Infrastructure Development---------------------------------------------------------------15 2.3.10 Linear Regression Function---------------------------------------------------------------16 Chapter 3 Methodology-----------------------------------------------------------------------------17 3.1 Research Design-----------------------------------------------------------------------------------17 3.2 Data Collection------------------------------------------------------------------------------------17 2 3.3 Method----------------------------------------------------------------------------------------------19 Chapter 4 Results and Discussion-----------------------------------------------------------------21 4.1 Research Background—an Overview of FDI in Vietnam---------------------------------21 4.1.1 Trend of FDI in Vietnam---------------------------------------------------------------------21 4.1.2 Countries of Origin---------------------------------------------------------------------------22 4.1.3 Policy and Environment for FDI-----------------------------------------------------------22 4.2 Results and Discussion---------------------------------------------------------------------------23 4.2.1 Result of Population Estimation-----------------------------------------------------------25 4.2.2 Result of Heterogeneity Research 1: Changes over time----------------------------28 4.2.3 Result of Heterogeneity Research 2: Level of Economic Development---------29 Chapter 5 Conclusions and Limitations----------------------------------------------------------30 Reference------------------------------------------------------------------------------------------------33 Appendix------------------------------------------------------------------------------------------------40 3 Abbreviations ADB Asian Development Bank AFTA ASEAN Free Trade Area ASEAN Association of Southeast Asian Nations BTA Bilateral Trade Agreement FDI Foreign Direct Investment GDP Gross Domestic Production GNI Gross National Income GSO General Statistics Office of Vietnam IMF International Monetary Fund MNE Multinational Enterprise MPI Ministry of Planning and Investment (Vietnam) OECD Organization for Economic Operation and Development OLI Ownership, Location and Internalization OLS Ordinary Least Squares RMB China Currency Renminbi (Yuan) UNCTAD United Nations Conference on Trade and Development VIF Variance Inflation Factor VND Vietnam Currency Dong WTO World Trade Organization 4 1. Introduction 1.1 Introduction This document is a Master thesis for the program MSc Supply Chain Management of the department of Organization and Strategy within the School of Economics and Management of Tilburg University. The purpose of this study is to find out the determinants of foreign direct investment in Vietnam. In the remaining of this chapter, the area of my research and the central question will be introduced, followed by two research questions that will be subsequently answered to be able to solve the central question. And the structure of the thesis will be present at the end of chapter 1. 1.2 Problem Indication Foreign direct investment (FDI) is a traditional method of a company producing outside its national boundary and a significant source of economic growth, and perhaps the clearest sign of globalization. Not only provide investment capital, managerial and technological skills, job creation, industrial upgrading. FDI can also integrate the country’s economy into the global economic network (Kaminski, Bartłomiej, & Smarzynska, 2001). The latter one is more important that, from national view, economic isolation is dead-end, especially in the current time of globalization. Holding some different sounds against numerous FDI inflows from Multinational Enterprises (MNEs), many countries from developing and transitional economies have designed and executed relevant policies to create hospitable and open environment for FDI. FDI inflow to developing countries, in terms of the share of host countries’ Gross Domestic Product (GDP), actually has exceeded those to the developed world. In 1986, after a long evidence of economic hardship, Vietnam came to the way of reform, economically restructuring from centrally planned to market oriented, which was known as ‘doi moi’, in the meaning of renovation. With the high GDP growth rate (7%) and sharply decreasing poverty rate (from 58.1% to 22%) during the last two decades, Vietnam has become one of most rapid growing economies in the world (ADB 2006). 5 Behind the remarkable economic performance is the boost from continual and substantial international trade and FDI inflow (Le Dang Doanh, 2002). The contribution of inward FDI to economic growth has been a consensus in Vietnam’s society, from the common people to policy makers (Nguyen & Nguyen, 2007). How to consolidate the current strengthens and exploit the potential advantages is what the Vietnam’s government concern about in order to keep the position as an attractive FDI host country. Starting from the investigation conducted by Buckley and his colleagues (2007) pointing to the determinants of Chinese outward foreign direct investment, I am going to carry out my research under the similar theoretical structure and with the help of other studies as well, for an in-depth understanding on the characteristics of Vietnam attracting FDI inflow. 1.3 Problem Statement The central question going to deal with is as following: What are the determinants of FDI to Vietnam? This longitudinal research is set from 1986, the first year starting reform policy, to 2009, for the latest data availability. During the period of time, Vietnam witnesses the dramatic change of FDI inflow from nearly zero to 8,050 million US dollars in 2008. 1.4 Research Questions For the problem to be answered, the research questions are formulated as following: 1. What characteristics of host country can be identified influencing location decision of Foreign Direct Investment? After reviewing a body of literatures, a group of characteristics influencing FDI in empirical works can be summarized, and a table will provide more information in detail. 2. What is the significance of each characteristic on the FDI decision in the context of Vietnam? All the characteristics identified will be formulated in a linear regression function, and then process the data collected with the help of SPSS software. The coefficients for characteristics indicate the level of significance. 6 1.5 Structure of the Thesis The research will be split up into six chapters (See Figure 1): Introduction, Theoretical Framework, Methodology, Results and Discussion, and Conclusions and Limitation. Chapter 1 introduces the background and purpose of this research, and leads to central question and research questions. Chapter 2, theoretical framework, does the literature review connecting theories to the research area, creates hypotheses, and finally builds a model involving all characteristics to be tested. Chapter 3, methodology will present the research strategies adopted and what data being used to secure the reliability of source. Chapter 4, results will be present and discussed corresponding to each of hypotheses. The last chapter draws a conclusion based on the results and generalizes limitations about the area my findings cannot explain in this research, and some recommendations for future work. CHAPTER 1 CHAPTER 5 Introduction Conclusions & Limitations CHAPTER 2 Theoretical Framework CHAPTER 3 CHAPTER 4 Methodology Results & Discussion Figure 1: Outline of the thesis 7 2. Theoretical Framework 2.1 Main Concepts and Definition of FDI A country can invest outside its national boundary directly or indirectly. Unlike a portfolio investment, which is considered an indirect investment through the stock and bond markets for a short-term profit, the classic definition of FDI is a company, on a long-term purpose, making physical investment into building machinery and equipment in a different nation district from the company’s country of origin. Not only capital are transferred, a source of advanced technology, managerial skills, and other tangible and intangible assets will also flow to the host country and company, and as such can stimulate the economic development (Granham & Spaulding, 2005). FDI is split up to two categories: inward and outward foreign direct investment. From the global view, the total amounts of inward and outward FDI are always equal to each other; meanwhile, from the view of a nation, the inward and outward FDI lead to a net FDI inflow, which can be either positive or negative. FDI can be classified into the following categories: market-seeking, export-oriented and government initiated FDI (Moosa, 2002). A market-seeking FDI happens on the purpose of the investors’ acquiring the host market and the growth of potential demands. A company in the host country providing raw material, intermediate and final goods mainly for exports, rather than for the domestic market, can be called export-oriented FDI. Governments, normally developing countries, promote investment from overseas to invest in specific sectors and industries aiming at dealing with socio-economic issue, such as regional disparities, unemployment, and so forth (Accolley et al, 1997). More in-depth research about FDI will be present in the following sections. 2.2 Development of FDI Theories 2.2.1 The Early Neoclassical Theory In the traditional theory of macroeconomics, the pressuring margin of domestic market encourages the companies from industrialized countries to engage in FDI activities in less industrialized countries (Pitelis & Sugden, 2000). The neoclassical theory of FDI states that, 8 being rich in wealth and poor in labor quantity or with high expense of labor in affluent countries, the companies tend to transfer productive assets to underdeveloped, labor-intensive countries for higher return of capital (Cantwell, 2000). The theories clearly point out the flow of capital from capital-intensive to capital-poor countries. However, both of the theories hypothesize in a perfect capital market with riskless capital movement assumption (Harrison, 2000), which is too ideal to apply to the reality. 2.2.2 The Product Life Cycle Theory This economic theory of FDI was conceptualized by Raymond Verron in 1966. It is for the relationship analysis concerning product life cycle and possible FDI flow. There is no unified standard for the product at the early stage, e.g. cost per unit and specification of the goods. All the specifications converge with the increasing demand from domestic market at the same time; the clones of standardized products are also introduced. For the home market getting saturated and intensive competition with domestic rivals, the company will export the products to foreign countries, normally seeing cost of production as an determinant of location choice, since there will be no revolutionary changes on the standardized product when the product enters into the phase of maturity. Vietnam becomes more popular with foreign investors when the costs of investment in its rivalrous countries increase, so recently we can find some news report more MNEs cut down part of their production function in China and transfer to their affiliates in Vietnam, such as the advertisement sheet for McDonald’s food has provided by Vietnam instead of China. All FDI can be seen mostly in the maturity and decline stages (Dunning, 1993). Generally, the merit of Verron’s product life cycle theory superior to other theories is the capability of dealing with changes overtime. 2.2.3 The Internalization Theory The Internalization theory was developed by Buckley and Casson in 1976 to explain the existence and functions of MNEs. The costs of some transactions can be reduced by internalized operation, in other words, producing within a company instead of between companies. Consequently, the return on asset (ROA) will be higher for less cost. Another reason of internalization to is to replace imperfect external markets. For instance, an MNE 9 from developed country plans to invest in a developing market where is lack of the qualified relevant personnel, usually from top layer of the management hierarchy or technician from core technology department, and cannot train the local staff well in a short time, and this enterprise will move and make use of the old cast in a different location. In addition, some core technology or know how is the absolute secret to the company that will not transfer to other companies. Finally, some scholars state that internalized operation can present conflict happening when the buyer and producer have different ideas on product price setting, especially in the situation that each of the parties has a monopoly position (Krugman, 2003). 2.2.4 The Eclectic Paradigm The eclectic paradigm developed by John Dunning (1981, 1988) has been the mainstream or generated theory of FDI in the location aspect. Dunning attempted to integrate a variety of isolated theories of international economics in one approach (Hagen, 1998). He drew partly on macroeconomic theory and trade, which is about the characteristics of host countries attracting FDI inflow, as well as microeconomic theory and firm behavior, which is the reason why an MNE invest in a specific location abroad. Three determinants of FDI are identified in this paradigm, including Ownership, Location, and Internalization advantages that determine extent, form and pattern of an company’s international production, it is also known as the OLI-Model. The ownership advantage is the precondition for the company to initiate FDI. It can be not only material such as capital and resource, but also immaterial like technology and managerial skills. The location advantage refers to a certain location that can provide some specific advantage refers to a certain location that can provide some specific advantages to be the company in the host country, e.g. access to cheap inputs, existence of raw material, special taxes or tariffs (Twomey, 2000). The internalization advantage is obtained by directly controlling production and distribution via foreign branches or subsidiaries on the purpose of cost reduction. Corresponding to the three advantages of host country, in Dunning’s theory, there are three primary motivations of international investor to invest abroad (Dunning, 1977, 1993): market, efficiency (cost reduction), cost resource. The market-seeking investors aim at acquiring large and fast growing markets. The efficiency-seeking investors pay more attention on how to minimize the total cost, such as 10