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Spillover effects of FDI: Do Domestic Manufacturing Firms Benefit from Foreign Direct Investment in Vietnam?

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Spillover effects of FDI: Do Domestic Manufacturing Firms Benefit from Foreign Direct Investment in Vietnam?
Introduction

Back in the 1990s, foreign direct investment (FDI) became the largest source of external finance for many developing countries. In Vietnam in particular, the Law on Foreign Investment promulgated in the 1986 Congress to attract FDI was considered the first step of the doi moi (renovation) reform. The cumulative FDI increased from 28 projects of total US$ 140 million FDI in 1988 to 8266 project for roughly US$ 78 billions at the end of 2006. FDI, therefore, has generally lived up to the expectation that it would play a key role in accelerating economic growth (GSO’s Statistical Yearbook, various years). [1]

The most important benefit of FDI in previous literature was proved to create spillover effect. Lipsey (2002), for instance, argued that the expecting FDI inflows would bring about new technologies, know-how and hence contribute to increasing productivity and competitiveness of domestic industries. FDI, on the other hand, is criticized for stealing market share of their domestic counterpart and generating considerable costs (Blomstrom and Kokko, 2003).

The understanding on this spillover effect in the Vietnamese context is currently rather poor. In fact, there appears to be no empirical evidence on this matter. The objective of this research is to focus on FDI flows and its effects on domestic enterprises in Vietnam using a panel on manufacturing firms between 2002 and 2006. Research questions and a review of literature on spillover effect on developing countries are outlined in the next sections. Section 4 and 5 describe data and methodology used for the research. Some remarks are offered in the final section.

Objectives

This project is proposed to empirically examine the spillover effect of FDI on the Vietnam’s manufacturing sector. Particularly, we will concentrate on two specific questions:

i) Does the FDI sector have a positive spillover effect on domestic firms?

ii) Do FDI enterprises exhibit higher productivities than their domestic counterparts?

It is hoped that the project will provide some first insights on the spillover effect of FDI in Vietnam, which will be useful for policy makers as well as further research on this area.

Spillover effects of FDI: a Review

Spillover effect has been considered as one of the most important benefits of inward FDI in developing countries. This spillover effect of FDI on the host country may take place through the two major channels (i) diffusion of know-how by introducing new technology and training workers who will be hired by domestic firms later; and (ii) increase of competition pressures, what will force domestic firms to increase their competitiveness by adapting new technology, improving managerial effectiveness, and spending more efforts on quality assurance and other marketing techniques (see Blomstrom and Kokko, 1998, 2003 for a review).

The spillover effect is however a potential impact of FDI on host countries. UNCTAD (2000) argues that whether spillover of FDI to be realized depends on technological capacity and policy settings of host countries. Furthermore, technology diffusion may also be limited as the number of employees who are hired at high positions in foreign-invested firms is often small. In addition, Inward FDI possibly results in significant environment costs (Ederington, Levinson and Minier, 2004). In many cases, the cost of having incentives for FDI could be high (Lipsey, 2002). Market-seeking MNCs are often criticized for stealing the market share of their domestic counterparts.

There has been growing empirical literature on the spillover effect of FDI in developing countries and the overall picture is however mixed. Blomstrom and Sjoholm (1999) reveal that foreign ownership considerably contributes to improve the productivity of manufacturing in Indonesia. Positive spillover effects of FDI are also reported in Blalock (2001) and Schoors and van der Tol (2001). In contrast, Aiken and Harrison (1999) using the data from Venezuela between the period 1976-1989, report that foreign investment negatively affect the productivity of domestically owned plants. The same negative effect of FDI on domestic enterprises is also found by Djankov and Hoekman (2000) for the case of the Czech Republic. Other studies also suggest positive spillovers in certain circumstances. Kathuria (2002), for instance, points out that only those who invested in R&D could benefit from inward FDI in the Indian manufacturing sector.

In the case of Vietnam, although the FDI sector has played an increasingly important role in the recent economic growth, there is no guarantee that this sector would have positive spillover on domestic enterprises. In this regard, this paper will contribute to the empirical literature by investigating the spillover effect of FDI in the Vietnamese context.

Data

This research will draw on the firm-level data of the Vietnam’s manufacturing sector exploited from the two recent rounds of the Vietnam Enterprises Census, implemented by the GSO in 2002 and 2006. The surveys consist of roughly 80,000 enterprises. One fourth of those are manufacturing firms, while the remaining being dominated by services and agriculture. The list of enterprises was obtained from the tax authorities as thus this excludes the informal sector. As the completed questionnaires were required to be signed and stamped by enterprise managers, the data disclosed are supposed to be as precise as the official data reported to the tax authorities.

It is unfortunate that the access to the database has been retained limited by the GSO due to its data dissemination policies and the data protection law. Some limited results from this census series has been published in aggregate terms in GSO (2004). This paper intends to explore a panel of manufacturing firms located in HCMC and the surrounding provinces (which account for nearly 55 percent of FDI projects and a half of the country’s total industrial output). The focus on the manufacturing is justified as we expect that the spillover effect of FDI will be most inherent in this sector.

Currently, the author has had the data for 2002 and secured a promise from the GSO to provide the data on 2006. Investigating the questionnaire in 2002 reveals a rich source of information necessary for this study including among other output and the use of inputs, year of establishment, sector of operation, locations, type of ownership, capital structure, number of employees, wages bills, main indicators of business activities (including revenue, profit, taxes), whether or not they export, and application of information technology etc.[2]

Methodology

The methodology in this paper will follow, with certain modifications, the models used in Aitken and Harrison (1999) and Smarzynska (2002). A semi-log production function could be expressed as:

[pic] (1)

where Yijt is a measure for output for firm i in sector j at time t; X is a vector of firm-level characteristics (e.g. capital, labour, age of establishment, locations etc.); FSijt measures the share of foreign capital in firms’ total capital, Sjt measures the presence of foreign ownership in the industry, in which foreign equity participation is averaged over all firms in the sector and weighted by each firm’s share in sectoral output as follows

[pic]

Equation (1) will be also tested to see find more significant spillover (more specifically productivity and efficiency) in non-exporting and exporting local firms since export oriented firms already face competition from the world market.

In attempts to test for the robustness of the empirical results, this research will examine and alternative model specification as used in Blomstrom and Sjoholm (1999), who regressed firm-level labour productivity on capital-labour ratio, the skill level of labour force, capacity utilisation, economies of scale, ownership and various industry specified factors. In our case, this specification could be modified as:

[pic] (2)

where Pijt is a measure for labour productivity in establishment i in industry j; X is a vector of firm-level characteristics (e.g. capital/labour ratio, age of establishment, locations etc.); and F is a vector of foreign ownership, which include either dummies for types of ownership or share of capital contributions by foreign investor(s). It should be noted that controls for industry-fixed effects and time are also included in equation (1) and (2).[3]

Expected results and remarks

At this stage, the expected results, as suggested in previous literature and empirical studies, are anticipated to generate spillover effects on domestic firms in Vietnam. Whether it would be a positive or negative is the subject of further investigation.

References

Aitken, B. J. and Harrison, A. E., (1999). Do domestic firms Benefit from Direct Foreign Investment? Evidence from Venezuela. The American Economic Review, Vol. 89, No. 3., pp. 605-618

Blalock, G. (2001), ‘Technology from Foreign Direct Investment: Strategic Transfer through Supply Chains’, mimeo, Haas School of Business, University of California, Berkeley.

Blomstrom, M. and A. Kokko (1998). Multinational corporations and spillovers. Journal of Economic Surveys 12, pp. 247-277.

Blomstrom, M. and Sjoholm, F., (1999). Foreign Direct Investment - Technology transfer and spillovers: Does local participation with multinationals matter? European Economic Review 43, pp. 915-923

Blomstrom, M.; A. Kokko (2003), ‘The Economics of Foreign Direct Investment Incentives’, NBER Working Paper No. 9489, National Bureau for Economic Research.

Djankov, S. and B. Hoekman (2000), ‘Foreign Investment and Productivity Growth in Czech Enterprises’ World Bank Economic Review, 14(1): 49-64.

Ederington, J., A. Levinson, J. Minier (2004), ‘Trade Liberalization and Pollution Havens’, NBER Working Papers 10585, National Bureau of Economic Research.

GSO (General Statistics Office) (2004), Ket qua Dieu tra Cong nghiep Vietnam, Statistical Publishing House, Hanoi.

GSO (General Statistics Office) (various years), Vietnam Statistical Yearbook 1996, 2000, 2004, 2006, Statistical Publishing House, Hanoi.

Kathuria, V. (2002), ‘Liberalization, Productivity, and Spillover - An Analysis of Indian Manufacturing Firms’, Oxford Economics Papers, 54, 688-718.

Lipsey, R.E (2002), ‘Home and Host Country Effects of FDI’, NBER Working Paper No. 9293, National Bureau for Economic Research.

Pham, T. Hung (2004), ‘Backward and Forward Linkages of FDI in Vietnam’s Industrial Estates’, reseach report to the Japanese International Development Agency (JICA).

Schoors, K. and B. van der Tol (2001), ‘The productivity effect of foreign ownership on domestic firms in Hungary’, mimeo, University of Gent.

Smarzynska, B. K.,(2002). Does Foreign Direct Investment increase the productivity of Domestic firms? In search of spillovers through backward linkages. The World Bank Development Research Group. Policy Research Working Paper 2923.

Smarzynska, B.K (2002), ‘Does FDI Increase the Productivity of Domestic Firms: in Search of Spillovers though Backward Linkages’, World Bank Policy Research Working Paper No. 2923, The World Bank: Washington, D.C.

UNCTAD (2002), World Development Report 2002, United Nations Conference for Trade and Development, Geneva.

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[1] According to the GSO, GDP share of the FDI sector rose from almost zero in the 1990s to 16 percent in 2005, while its contribution to industrial output increased to 44 percent. In addition, the FDI is the main exporter; its export share rose from less than five percent up to 55 percent between 1990 and 2005.
[2] In addition to the empirical analysis using this panel, it is also possible to explore parts of the survey conducted the Japanese International Development Agency (JICA) as reported in Pham (2004) on a sample of 250 foreign-invested firms operating in industrial estates throughout the country. This survey could be used to provide some case studies and descriptive analysis issues related to technology transfer, backward and forward linkages of those firms to other domestic enterprises.
[3] At the current stage of the project, this paper has defined the set of variables to be included in these two specifications. This set of regressors will be constructed when having the data for 2006 to form the panel (see the data section).

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