Impacts of foreign dirrect investment on labor productivity of manufacturing industry a case of vietnam luận văn thạc sĩ

UNIVERSITY OF ECONOMICS
HO CHI MINH CITY
VIETNAM

INSTITUTE OF SOCIAL STUDIES
THE HAGUE
THE NETHERLANDS

VIETNAM - NETHERLANDS
PROGRAMME FOR M.A IN DEVELOPMENT
ECONOMICS

BY

VO KHOI NGUYEN

MASTER OF ARTS IN DEVELOPMENT ECONOMICS

HO CHI MINH CITY, APRIL 2011



UNIVERSITY OF ECONOMICS
HO CHI MINH CITY
VIETNAM

•

INSTITUTE OF SOCIAL STUDIES
THE HAGUE
THE NETHERLANDS

VIETNAM - NETHERLANDS
PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS

IMPACTS OF FOREIGN DIRECT INVESTMENT
ON LABOR PRODUCTIVITY OF
MANUFACTURING INDUSTRY:
A CASE OF VIETNAM
A thesis submitted in partial fulfilment of the requirements for the degree of
MASTER OF ARTS IN DEVELOPMENT ECONOMICS

By

VO KHOI NGUYEN

Academic Supervisor:
PhD. NGUYEN VAN PHUONG

HO CHI MINH CITY, APRIL 2011


CERTIFICATION

I hereby certify this thesis has not been submitted for any degrees and is not being
currently submitted for any other degrees.
I also certify that, to the best of my knowledge, and any help received in preparing the
thesis and all sources used have been acknowledged in the thesis.

Signature

Vo Khoi Nguyen
Date: April, 2011


ACKNOWLEDGEMENT

With the valuable guidance and advices from Vietnam-Netherlands program
lecturers and friends, I am really grateful to what they have done for my thesis
completion.
First of all, I would like to illustrate my largest gratitude to my supervisor, PhD.
Nguyen Van Phuong who always gives useful and valuable advices and enthusiastic

comments for my thesis.
I am grateful for Professor, Peter Calkins for his precious advice and comments from
the initial ideas of the thesis.
I also express my special thanks to Professor, Nguyen Trong Hoai for his lectures in
econometrics and PhD. Cao Hao Thi, the lecturer of Vietnam-Netherlands project,
for his kind help and instructions in data analysis by Eview software.
And finally, I would like to show my special thanks to my friends in MDE class 15
for their supports during my research completion.


ABSTRACT
The paper examines whether foreign direct investment increases the overall labor
productivity in Vietnam. Using panel data at firm level from the manufacturing
sector, it finds robust evidence of the positive impacts from foreign direct investment
on labor productivity. Moreover, it also confirms the positive correlation of labor
productivity and capital intensity, labor quality and economic scale. However, it

should fail to establish any significant relationships between productivity and

location; and industry. And the findings illustrate foreign enterprises do not make
more productive than private firms.


TABLE OF CONTENTS
CHAPTER I

1.1.

Introduction--------------------------------------------------------------------------------------------1

1.2.

Research objective and questions---------------------------------------------------------2

1.3.

Research hypotheses----------------------------------------------------------------------2

1.4.

Organization of the study----------------------------------------------------------------2

CHAPTER 2

LITERATURE REVIE

2.1.

Theoretical background---------------------------------------------------------------------3

2.2.

Economic theories---------------------------------------------------------------------------4

2.2.1. Cobb-Douglas production function--------------------------------------------------------4
2.2.2. Theoretical framework of FDI impact on labor productivity----------------------5
2.3.

Empirical studies------------------------------------------------------------------------------6

2.3.1. Channel effects of foreign direct investment---------------------------------------------6
2.3.2. Impacts of FDI on labor productivity------------------------------------------------7
24ua
CHAPTER 3 AN OVERVIEW OF FDI IN VIETNAM----------------------------------9

'

3.1.

Introduction-----------------------------------------------------------------------------------------9

3.2.

Overview of FDI inflows (1988-2009)---------------------------------------------9

3.2.1.

FDI inflows in period 1988 - 2009---------------------------------------------------9

3.2.2.

Some characteristics of foreign direct investment in Vietnam----------------------11

3.3.

The role of FDI in national economy---------------------------------------------------19

3.3.1.

The role of FDI in national economic growth-------------------------------------20

3.3.2.

The role of FDI in employment and human resources----------------------------21

3.4.

Overview of labor productivity in ASEAN---------------------------------------------21


CHAPTER 4 RESEARCH METHODOLOGY-------------------------------------------24
4.1.

Model specification-----------------------------------------------------------------------24

4.2.

Description of variables-------------------------------------------------------------- 24

4.2.1.

Dependent variable labor productivity (Labprod)--------------------------------24

4.2.2.

Explanatory variables--------------------------------------------------------------------25

4.3.

Data collection------------------------------------------------------------------------27

4.4.

Estimation strategy------------------------------------------------------------------- 28

45ua29

CHAPTER 5 RESULT ANALYSIS

CHAPTER 6 CONCLUSIONS AND RECOMMENDATIONS------------------------45
6.1.

Conclusions---------------------------------------------------------------------------- 45

6.2.

Recommendations--------------------------------------------------------------------45

6.3.

Limitation----------------------------------------------------------------------------------47

Reference--------------------------------------------------------------------------------------------- 48


LIST OF TABLES
Table 3.1: FDI projects licensed from 1988 to 2010 by kind of economic activity........12

Table 3.2: Employed population by ownership from 2000-2009.....................................21
Table 3.3: Average annual labor productivity growth by Industry (%).....................22
Table 4.1: Definition summary of variables....................................................................27

Table 5.1: Statistical summary of sample..................................................................31
Table 5.2: Distribution of explanatory variables in logarithm form................................34
Table 5.3: Correlation matrix spreadsheet without logarithmic form..............................35

Table 5.4: Correlation matrix spreadsheet using logarithmic form.................................35
Table 5.5: Regression result from Pooled Least Square..................................................37

Table 5.6: Regression result from fixed effects model..............................................38
Table 5.7: Regression result from random effects model..........................................39
Table 5.8: Hausman test result..................................................................................40
Table 5.9: Regressed result summary...............................................................................41
Table 5. 10: Distribution of explanatory variables without logarithm form....................51
Table 5.11: Descriptive statistics of variables in three types of enterprises...............58
Table 5.12: Result from fixed effects model with PCSE...........................................59
Table 5. 13: Result from fixed effects model with Dummy variable Dfshare...........60

LIST OF FIGURES
Figure 3.1: FDI inflows in period 1988 — 2009---------------------------------------------10

Figure 3.3: FDI inflows licensed by region----------------------------------------------15
Figure 3.4: FDI inflows (million USD) by country of region-----------------------------17
Figure 3.5: FDI inflows in manufacturing sector---------------------------------------------18

Figure 3.6: Industrial output value in manufacturing sector by ownership-----------19
Figure 3.7: Structure of GDP at current prices by ownership period 1995- 2009- - -20
•

Figure 3.8: Comparative Labor Productivity Performance-------------------------------- 23
Figure 5.1: Distribution of labor productivity without logarithm form-------------------32

Figure 5.2: Distribution of labor productivity in logarithm form----------------------33
Figure 5.3: Correlation between Labprod and Fshare

logarithm form----------------36

Figure 5.4: Distribution of correlation between labor productivity Labprod and capital
intensity Capint without logarithm form-----------------------------------------------------52

Figure 5.5: Distribution of correlation between labor productivity Labprod and
capital intensity Capint in logarithm forms---------------------------------------------------53
Figure 5.6: Distribution of correlation between labor productivity Labprod and material
input purchases Scale without logarithm forms---------------------------------------------54


Figure 5.7: Distribution of correlation between labor productivity Labprod and
material

input purchases Scale in logarithm forms----------------------------------------------------55

Figure 5.8: Distribution of correlation between labor productivity Labprod

and

proportion of skilled labor St/// without logarithm forms----------------------------------56

Figure 5.9: Distribution of correlation between labor productivity Labprod and
proportion of skilled labor Skill in logarithm forms----------------------------------------57


CHAPTER 1: INTRODUCTION

CHAPTER 1
INTRODUCTION
1.1.
,

Introduction

The remarkable turnabout in economic fortunes and accelerated growth of Vietnam
economy is well known following Doi Moi in 1986. From growth rates of 3-4% in the

1980s, GDP growth accelerated to an average annual rate of 7-8% for the next 20
years, touching 9% in 2008. These promising achievements of the economic
transition resulted from the reform policies in the context of rapid globalization
process. After the promulgation of the Law on Foreign Investment in 1987, Vietnam
integrated world economy and joined ASEAN in 1995, APEC in 1998, ASEM in
2001 and WTO in 2007. During the economic transition from after 1986 to current

years, many investigators stated that foreign direct investment (FDI) played a crucial
role helping jumpstart to Vietnam’s economy on its way to accelerating reform and
socio-economic growth. Such a large amount of FDI capital demonstrates that
Vietnam’s investment environment is attractive and many foreign investors are
interested in the local market. It is consistent with the fact that FDI in Vietnam
mainly concentrated on labor- intensive and export-oriented manufacturing
activities (accounting for 5,139 projects with total committed capital of 65.7 billion
USD in period 2000-2009).
Therefore, this research is expected to answer whether FDI increases the overall
labor productivity in manufacturing industry. It helps policy makers and enterprise
management deliver effective policies for improving and maximizing local labor
productivity, enhancing export-oriented manufacturing industry and ensuring the
sustainable development among regions.


1


CHAPTER 1: INTRODUCTION

1.2.

Research objective and questions

The general objective of the research will study whether FDI increases the overall
labor productivity in Vietnam, as measured by value added per labor, focusing on three
sub- industries; food processing; textile, garment and footwear and electronics and

mechanics including state, private (non-state) and foreign firms located over the
country. Based on the research objective, the study will investigate the following

questions:
a) Does FDI significantly impact on labor productivity in Vietnam?

b) Does the impact of FDI on labor productivity differ significantly across
provinces, the ownership structure of firms?
1.3.

Research hypotheses

An expectation in the econometric model is to confirm the sign and statistical
significance of following results:
a) FDI impacts positively on labor productivity of manufacturing industry in Vietnam.
b) Foreign sector makes labor productivity more increasingly than others.
c) The impacts of FDI on labor productivity significantly differ across regions.

1.4.

Organization of the study

The research consists of six chapters. First chapter discusses the Introduction. The next
_
chapter

chapter is the Literature review. An overview of FDI in Vietnam is discussed in
3. Research methodology in chapter 4 illustrates statistical model and data. Chapter 5

describes the result analysis and discussion. Finally, chapter 6 will be a concluding
section.

2

CHAPTER 2: LITERATURE REVIEW

CHAPTER 2
LITERATURE REVIEW
2.1.

Theoretical background

The key independent variable of this research is foreign direct investment (FDI).
There are several ways to understand FDI such as International Monetary Fund’s
FDI definition or United Nations’ FDI definition. According to Organization for
Economic Co-operation and Development OECD (1996), FDI is clearly defined as
follows:
“Foreign direct investment reflects the objective of obtaining a lasting interest by a
resident entity in one economy (“direct investor”) in an entity resident in an
economy other than that of the investor (“direct investment enterprise”). The
lasting interest implies the existence of a long-term relationship between the direct
investor and the enterprise and a significant degree of influence on the management
of the enterprise. Direct investment involves both the initial transaction between the
two entities and all subsequent capital transactions between them and among
affiliated enterprises, both incorporated and unincorporated.”
Besides OECD’s FDI definition, GSO (2008) also explained FDI as the bringing of

capital into the host country in the form of money or any assets by foreign investors
for the purpose of carrying on investment activities in accordance with the
provisions of the law on foreign investment in Vietnam.
The dependent variable in this study is labor productivity. According to OECD
(2001), productivity is defined as a ratio of a volume measure of output to a volume

measure of input use. To measure labor productivity, it is commented that the
three most
'

commonly used ways of input are: hours worked; workforce jobs; and number of

people in employment. Output per worker corresponds to the "average product of


CHAPTER 2: LITERATURE REVIEW

labor" and seemed to be contrast with the marginal product of labor, which refers to the

increase in output resulting from a corresponding marginal increase in labor input.

.

2.2.

Economic theories

2.2.1.

Cobb-Douglas production function

According to Cobb-Douglas (1928), they use production function as the functional
form to represent the relationship of an output to inputs. They estimated an
aggregate production function econometrically and the results presented to the
economics profession. It is known as “Cobb-Douglas production function” that is the
most simultaneous form in theoretical and empirical analyses of growth and

productivity. The production function has the formulation as follows:
Y=AL‘K'

Where:
•

Y denotes output, L: labor input, K: capital input

• A is a constant depending on the units in which inputs and outputs are
measured
ã o and Đ are the output elasticities of labor and capital, respectively. These
values are constants determined by available technology.
Output elasticity measures the responsiveness of output to a change in levels of
either labor or capital used in production, ceteris paribus. For example if o = 0.1,
a 1% increase in labor would lead to approximately a 0.1% increase in output. The
Cobb- Douglas production function is usually expressed in logarithmic form: log Y——
log A + a log L + J3 log K which is useful and easy when performing a regression

analysis.


4


CHAPTER 2: LITERATURE REVIEW

2.2.2. Theoretical framework of FDI impact on labor productivity
Based on Cobb-Douglas function, Liu et al. (2001) examine the overall impact of
FDI on the Chinese electronics industry. Productivity function model (logarithmic

form) is normally suggested as follows:
LP = F (CI, FS, LQ, FP)
Where LP is used measures firm performance; CI is the capital-labor ratio; firm size

FS; LQ labor quality or human capital, and foreign presence FP.
Also investigating impacts from FDI, Blomstrom and Sjoholm (1999) examine the
effects of FDI on productivity. Y represents values added; K is (physical) capital
assets; L and FDI respectively denote labor and contribution by foreign partner in
total capital assets of firm /. The productivity function (log-linear form) will follow:

In this productivity function, 5'/ci// measures the skilled labor and Scale denotes the

size/scale of the firm in the industry. Dlndustry is the industry-specific dummy
variable.
The picture is more specific, as the recent work by Peter, Jeremy and Chengqi
(2006), to investigate the impact of FDI on the productivity of China’s electronics
industry. Value added per worker LP in a sub-sector, is a function of foreign
presence FP, the capital labor ratio KL; intangible assets per employee INT; labor
quality LQ and fixed assets per worker FS. The function model (logarithmic form)
will be as below:


5


CHAPTER 2: LITERATURE REVIEW

2.3.

Empirical studies

2.3.1. Channel effects of foreign direct investment
Relating to the impacts of foreign direct investment, Javorcik (2004) argues there are

varieties of direct effects and indirect effects. Under these effects, local companies
must improve competitive capabilities to pursue their competitors in the same sector
before elimination out of industry. These effects are referred to as horizontal
spillovers. Foreign enterprises have higher productivity than domestic firms and
indicate a strong direct effect from foreign investment to the productivity of
individual firms (Mariam, 2003). This positive effect specifies the ways which a
country receives the direct effects of foreign investment are better than potential
spillover benefits of technology transfer.
The picture is more specific about the differences of technological gap between local
plants and its foreign competitors from empirical study conducted by Kokko, Tansini
and Zejan (1996). They conclude that there are significant differences in the impact
of FDI from two separately groups of small and high technology gaps, although
there is no sign of spillovers when testing on the entire sample. In another research,
Aitken and Harrison (1999) point out foreign share is positively correlated with
productivity levels. However, they also postulate that foreign equity participation
has a negative relationship with the productivity of domestic firms in an industry.
Although several statistical results confirm the positive effects of foreign direct
investment, there are some negative findings. For example, Miguel (2006) finds a
large
•

pool of FDI inflows could not make the innovative “green field” investments to
obtain technological spillover effects in high priority sectors of the manufacturing
industry. Besides that, Peter, Jeremy and Chengqi (2007) also suggest that high
inward FDI in

6


CHAPTER 2: LITERATURE REVIEW

Chinese domestic industry creates negligible productivity increase in low-technology
industries due to negative spillovers to local firms.

2.3.2. Impacts of FDI on labor productivity
More recently, empirical evidences confirm FDI seems to have beneficial effects on
the economy of the host country, pointing out to improvements of labor
productivity increase, and gains in competitive efficiency and process innovations.
Making the investigation on the impact of FDI inflows, Blomstrom and Sjoholm

(1999) argue labor productivity is positively related to capital intensity, skilled labor,
capacity utilization and scale of operation. And they suggest that foreign ownership
takes an important role in term of the impacts on labor productivity in Indonesian
manufacturing industry. Moreover, they also indicate intra-industry spillovers from
foreign direct investment exist. However, they postulate that the productivity of
foreign-owned enterprises is not dependent on ownership structure. The same
conclusion is that FDI has a positive impact on labor productivity, especially in the
Chinese electronics industry conducted by Liu et al. (2001). They specify labor
quality is the most contribution in an increase of labor productivity. It follows by
firm size, and then foreign presence. However, regarding to capital intensity, they
conclude that it is insignificant and not an important factor of labor productivity in
this industry.
Furthermore, another empirical evidence confirmed FDI have beneficial effects on
overall labor productivity in the Irish manufacturing sector increased by 158 %
between 1991 and 1999 (Frances and Ali, 2005). Making the same investigation,

Hsu and Chen (2000) complement that small and medium enterprises own FDI
increase labor productivity in the industry. However, they also imply negative
correlation between labor productivity and large size firms.


7


CHAPTER 2: LITERATURE REVIEW

In order to discern more accurately the impact of FDI on labor productivity, Lutz and

Talavera (2004) report that the presence of FDI has a significantly positive influence
on labor productivity. And labor productivity turns out to be relatively different
across industries. However, it argues no significant differences on labor
productivity for investigated regions in the effects of FDI. In other research, Gangti
and Kong (2000) postulate the higher the investment in the larger cities, the higher
the labor efficiency. Especially, the labor efficiency through which labor-intensive
industries receive more FDI inflows is higher. Making the same investigation,
Eric (2004) illustrates the linkages among labor productivity or wages, and
foreign ownership shares in Thai manufacturing industry are relatively weak
Meanwhile, Duy (2009) uses cross sectional data at firm level and indicated results
that FDI positively impacted on labor productivity in Vietnam. And labor
productivity is positively related to capital intensity, but relatively different across
industries and regions.
Based on results from Duy’s study, this research will be aimed to analyze more
deeply about FDI impacts on labor productivity of manufacturing sector in
Vietnam with panel data sets. Moreover, it will examine FDI factor as explanatory
variable to test first hypothesis.
2.4.

Summary

In general, this chapter focuses on theoretical model and empirical studies to
consolidate economic background concerning to the research. Moreover, it will lead
to withdraw the suggested model which established and presented in chapter 4.

8


CHAPTER 3: AN OVERVIEW OF FDI IN VIETNAM

CHAPTER 3
AN OVERVIEW OF FDI IN VIETNAM
3.1.

Introduction

Foreign direct investment inflows have been increasing widespread since 1988 after
Vietnam launched a political and economic renewal campaign (Doi Moi) and opened
the market-oriented economy through the first Foreign Direct Investment Law
th
approved by National Assembly on December 29 1987. Therefore, the purpose of
this chapter is to present the overview of FDI in Vietnam since 1988 after the FDI
law came into effect and the overview of labor productivity in ASEAN in general.
3.2.

Overview of FDI inflows (1988-2009)

3.2.1. FDI inflows in period 1988 - 2009

FDI inflows to Vietnam achieved significant results from the law on Foreign
Investment approved in 1987, reaching 37 projects with total registered capital at
342 million USD. From period 1988-1997, it impressed 2,341 projects, the total
registered capital and implementation capital reached at 35,020 and

12,347

million USD respectively, especially coming at the peak with 10,164 and 2,714
million USD in 1996. However, due to the Asian Economic Crisis in year 1997,
FDI inflows to Vietnam seriously declined. Then FDI flows continued reducing
rapidly at 2,566 million USD of total registered capital but resurged in 2000. After
Vietnam’s World Trade Organization integration in 2007, it robustly achieved 1,557

projects with more 7 times of total registered capital and 4 times of total
implementation capital when compared with 1996. And FDI inflows suddenly
dropped with total registered and implementation capital at 10,108 million USD
in preliminary 2009 due to global financial crisis. It showed a drop of 81.2%
compared to same period in 2008. Of which,

9