An analysis of foreign direct investment impact on labor productivity at firm level in vietnam

UNIVERSITY OF

INSTITUTE OF SOCIAL STUDIES

ECONOMICS HO CHI

THE HAGUE

MINH CITY

THE NETHERLANDS

VIETNAM

VIETNAM - NETHERLANDS
PROJECT FOR M.A. IN DEVELOPMENT ECONOMICS

AN ANALYSIS OF FOREIGN DIRECT INVESTMENT
IMPACT ON LABOR PRODUCTIVITY AT FIRM LEVEL
IN VIETNAM

IN PARTIAL FULFILLMENT OF THE REQUIREMENTS FOR THE DEGREE OF
MASTER OF ART IN DEVELOPMENT ECONOMICS

BY

B0 GIAO DIJ C DAO T/\0
TR L/Clf/G DAI HOC KlfJ lJ TE TP.ffCB

PHAM KHAC DUY

ACADEMIC SUPERVISOR: DR. LE THI THANH LOAN

Ho Chi Minh City, November 2009


CERTIFICATION

I hereby certify that the substance of 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

am Khac Duy
Date: November, 2009


ACKNOWLEDGEMENT

This research is impossibly completed without the valuable guidance, encouragement
and advice born numerous individuals including Vietnam-Netherlands program
lecturers, friends and my family members. I am really indebted and grateful to what
they have done for my thesis completion.
First of all, I would like to send my deepest gratitude to my supervisor, Dr. Le Thi Thanh
Loan who always gives valuable instructions, advice and comments during my

completion of the thesis.
I am grateful for Professor, Peter Calkins for his precious advice and comments born the

initial ideas of the theme for my thesis.
I also send my special t hanks to Pr ofessor, Nguyen Trong Hoai for his lectures in

econometrics and Mr. Truong Thanh Vu, the lecturer of Vietnam-Netherlands project,
for his kind help and instructions in data analysis by Stata software.
Many especially respectful thanks are sent to my parents and my dear wife for
encouraging and providing me with an opportunity to pursue my desires in higher
learning and for their love, affection and sympathy that have helped me to gain more
strength and motive to complete this thesis.
And finally, I would like to express my special thanks to my friends in MDE class 14 for
their supportive friendship from the beginning day I joined in this course and their
continuous support during my research completion.

Above all, please sympathize for me and do know that I would be so grateful for
those who support me a lot in this thesis completion if I forget to mention their names.


ABSTRACT

This research examines and analyses the impact of FDI on labor productivity at firm
level in Vietnam through applying cross-sectional data from VES-2008 which
concentrate on 4,654 firms including FDI and domestically owned enterprises in 4
sub-industrial sectors; food processing, hotels - restaurants, electronics - mechanics
and textile — garment - footwear. The regression model is estimated based on the
Cobb-Douglas production function and the labor productivity is modeled as
dependent on the variables, namely capital intensity, material input cost per labor,
proportion of skilled labor and dummy variables including types of ownership and
regions that FDI enterprises locate. OLS (Ordinary Least Square) and various
econometric estimation techniques are employed in order to obtain reliable and
appropriate results that show the findings based on the scientific analysis. As results,

finding results in analysis of FDI impact on labour productivity in the case of this study
consequently suggest in general that FDI in 4 sub- industrial sectors plays an important

and positive role in enhancing labor productivity at firm level in Vietnam. Moreover,
the results seem to be appropriate to answer research’s questions as well as confirm
expectation for hypotheses of different impacts of FDI across regions and types of
ownership, except for skilled labor that does not appear to affect on labor productivity
in this research.


TABLE OF CONTENTS
CHAPTER I: INTRODUCTION.................................................................................

l

1.1.

Problem statement..................................................................................................1

1.2.

Objectives of the research................................................................................2

1.3.

Research questions..............................................................................................2

1.4.

Research hypotheses..............................................................................................3

1.5.

Organization of the research................................................................................3

CHAPTER II: LITERATURE REVIEW........................................................................5

2.1.

Introduction......................................................................................................................5

2.2.

Concepts and definitions........................................................................................5

2.2.1.

Foreign direct investment (FDI)...........................................................................5

2.2.2.

Productivity and labor productivity.......................................................................6

2.3.

Economic theories..................................................................................................8

2.3. 1.

Production theories................................................................................................8

2.3.1.1 Cobb-Douglas production function.......................................................................8
2.3. 1.2. Pindyck and Rubinfeld production theory.............................................................9

2.3.2.

Theoretical background of FDI impacts..............................................................9

2.3.2. 1. Channel effects of foreign direct investment...................................................10
2.3.2.2. Theoretical framework of FDI impacts on labor productivity.........................11
2.3.2.3. Suggested research model....................................................................................13

2.4.

Empirical studies..................................................................................................14

2.4.1.

FDI impacts enhance labor productivity in host countries..............................14

2.4.2.

The opposite results of FDI impacts on labor productivity.............................16

CHAPTER III: AN OVERVIEW OF FDI IN VIETNAM SINCE 1988..................18
3.1.

Introduction.......................................................................................................................18

3.2.

Overview of FDI inflows and periods of development from 1988 to 2008....18

3.2.1.

FDI inflows in period 1988 — 2008............................................................,.......18

3.2.

Some characteristics of FDI in Vietnam..............................................................20

3.3.

The role of FDI in national economy..................................................................25

3.4.

The summary of FDI sector’s socio-economic affect on national economy.......27
iv


CHAPTER IV: RESEARCH METHODOLOGY.........................................................29
4.1.

Introduction....................................................................................................................29

4.2.

Model specification...........................................................................................29

4.3.

Description of variables.......................................................................................30

4.3.1.

Dependent variable labor productivity (±abproducf/viJ)....................................30

4.3.2.

Explanatory variables..........................................................................................30

4.3.2.1. Capital intensity (Cap inieusiJ )......................................................................30
4.3.2.2. Scale of material input cost (M/ see/e)...........................................................31
4.3.2.3. Labor quality (5/c///)............................................................................................31
4.3.2.4. Firm’s location (Dlocation).................................................................................31
4.3.2.5. Types of ownership (where)............................................................................32
4.3.2.6. Firm’s sub-industrial sectors (D/udusiry)............................................................32
4.4.Data collection..............................................................................................................33
4.5.Estimation strategy.......................................................................................................34
4.6.Summary.......................................................................................................................36
CHAPTER V: RESULT ANNALYSIS.........................................................................37
5.1.

Introduction.......................................................................................................................37

5.2,

Descriptive statistic analysis of regression sample and variables........................37

5.2.1.

Descriptive statistics of sample............................................................................37

5.2.2.

Descriptive statistics of variables........................................................................38

5.2.3.

Correlation matrix............................................................................................. 41

5.3.

Model estimation and finding results................................................................42

5.3.1.

Multiple regression results and diagnostic tests..................................................43

5.3.2.

Interpretation of the finding results...............................................................45

5.3.3.

Analysis and discussion about the finding results..............................................47

5.4.

Conclusion........................................................................................................49

CHAPTER VI: CONCLUSIONS AND RECOMMENDATION................................50

6.1.

Conclusion............................................................................................................50

6.2.

Recommendations................................................................................................50

6.3.

Limitations of the research...................................................................................52


REFFERENCES............................................................................................................53
APPENDICES:...................................................................................................................56
APPENDIX 1:....................................................................................................................56
APPENDIX 2:....................................................................................................................61
APPENDIX 3:....................................................................................................................62

LIST OF BOXES
BOX 5.1: Ramsey RESET test using powers of the independent variables.................43
BOX 5.1: Breusch-Pagan / Cook-Weisberg test for heteroskedasticity..............................44

LIST OF FIGURES
FIGURE 3.1: Foreign direct investment projects licensed in period 1988 - 2008............19
FIGURE 3.2: Foreign direct investment projects licensed in period 1988 - 2008 by

region..................................................................................................................................................23
FIGURE 3.3: Structure of investment at current prices by types of ownership born 1995
-

2008............................................................................................................................24

FIGURE 3.4: Structure of investment at current prices by types of ownership in 2008 .24
FIGURE 3.5: Structure of gross domestic product at current prices by ownership period

1995- 2008........................................................................................................................26
FIGURE 5.1: Correlation between proportion of skilled labor and labor productivity ...42
FIGURE 5.2: Distribution of labor productivity (Labproductivity) before transforming
into logarithm form.............................................................................................................56
FIGURE 5.3: Distribution of labor productivity in logarithm form .....................,...........57
FIGURE 5.4: Distribution of Capital intensity in logarithm form....................................59
FIGURE 5.5: Distribution of material input cost per labor in logarithm form.................59
FIGURE 5.6: Distribution of proportion or skilled labor in logarithm form.....................60


LIST OF TABLES
TABLE 3.1: Foreign direct investment projects licensed from 1988 to 2008 by kind of

economic activity..............................................................................................................21
TABLE 3.2: Employed population as of annual 1 July by ownership from 20002008..27 TABLE 5.1: Statistics summary of four sub-industries firms in regions
according to three types of ownership........................................................................37
TABLE 5.2: Distribution of labor productivity in logarithm form (Lnlabproductivity)
..39 TABLE 5.3: Distribution of explanatory variables in logarithm form..................40
TABLE 5.4: Distribution of skilled labor in 4 sub-industries according to ownership. 40
TABLE 5.5: Correlation matrix born the variables in the regression function.............42
TABLE 5.6: The result of running regression (Model 5. 1)...............................................43

TABLE 5.7: Diagnostic test for multicollinearity..............................................................44
TABLE 5.8: The result of running regression (Model 5.2) ...............................,..............45
TABLE 5.9: Distribution of labor productivity (Labproductivity) before transforming

into logarithm form.........................................................................................................56
TABLE 5.10: Distribution of labor productivity in logarithm form (Lnlabproductivity) 57
TABLE 5.11: Distribution of explanatory variables in logarithm form.............................58
TABLE 5.12: Descriptive statistics of variables in three types of enterprises.............61
TABLE 5.13: The result of regression with beta number (Model 5.3)........................62


ACRONYMS
ASEAN

Association of South East-Asian Nations

APEC

Asia-Pacific Economic Cooperation

BLUE

Best Linear Unbiased Estimator

BTA

Bilateral Trade Agreement

FDI

Foreign Direct Investment

FE

Fixed Effects

GDP

Gross Domestic Product

GECS

General Enterprise’s Cost Survey

GO

Gross Output

GSO

General Statistics Office

IC

Intermediate Cost

IMF

International Monetary Fund

NGO

Non-Governmental Organization

NICs

Newly Industrial Countries

OECD

Organization for Economic Co-operation and Development

OLS

Ordinary Least Square

RE

Random Effects

RESET

Regression Specification Error Test

SUR

Seemingly Unrelated Regression

US

United States

USD

United States Dollar

VA

Value Added

VES

Vietnam Enterprise Survey

VIF

Variance Inflation Factor

VND

Vietnamese Dong

WTO

World Trade Organization


CHAPTER I
INTRODUCTION
1.1.

Problem Statement

Since the late 1980s, on the basis of Doi Moi or the government’s socio-economic

reforms which started in 1986, Vietnam has initially transited born a centrally planned
to a market- oriented economy. Typically for this process, Vietnam has advocated
economic integration, in addition to its five “tions”: urbanization, globalization,
industrialization, modernization

and privatization

to spearhead this process.

Beginning with the promulgation of the Law on Foreign Investment in 1987 and the
signing of bilateral and multilateral trade agreements, Vietnam became a member of
the Association of South East-Asian Nations (ASEAN) in 1995 and joined the AsiaPacific Economic Cooperation (APEC) in 1998. In July 2000, Vietnam signed the
Vietnam-US Bilateral Trade Agreement (BTA) and then joined Asia Europe Meeting in
the following year, 2001. The most recent and notable event was Vietnam’s WTO

integration in 2007.
During the economic transition from after 1986 to current years, many observers,
policy makers and academics contend that foreign direct investment (FDI) played a
crucial role which can help jumpstart to Vietnam’s economy on its way to accelerating
reform and socio-economic growth, Mai (2004). In addition, FDI may affect all
economic, cultural and social aspects of the economy and is an indispensable capital
source to

developing countries including Vietnam, especially Asia’s Newly

Industrializing Countries (NICs). Through FDI flows, these countries can cover the
saving-investment, foreign exchange and fiscal gaps and hence promote socio-economic
growth, Taylor (1993).
It may seem natural to argue that FDI can convey great advantages to host countries.
That is why policymakers of developing countries including Vietnam always pay
much attention to effects from FDI flows to country’s economic growth. However this
study does not focus on FDI by examining the effects of foreign direct
investment on Vietnam’s socio-economic growth in a general respect, this research
wants to test the impact of FDI on the labor productivity at firm level in Vietnam as
a whole and to

1


identify main significant determinants of the FDI impacts to examine whether they
vary due to different forms of ownership as well as different locations.
Specifically, the present research aims to answer whether FDI increases the overall
labor productivity which is helpful for Vietnamese policymakers in planning effective
policies to improve and maximize local labor productivity that can serve to develop
and monitor the effects of local labor market policies, to ensure the equitable

development among regions as well as achieve sustainable development.
1.2.

Research objectives

The general objective of the research will investigate whether FDI increases the overall
labor productivity in Vietnam, as measured by term of value added per labor, focusing on
enterprises of four sub-industries; food processing, hotels and restaurants, textile,

garment and footwear and electronics and mechanics including domestic and FDI
firms located over the country.
To meet this overall objective, the research will also target two specific objectives, to
evaluate whether:
(i)

The impact of FDI has enhanced on labor productivity in Vietnam more than
domestically-owned firms including state owned firms and non-state owned
firms?

(ii)

Make recommendations to policy-makers in Vietnam as to how to best channel
FDI so as to improve and maximize the value added of labor.

1.3.

Research questions

Based on the research objectives, the study will aim to find out the answers for the

following questions:
1)

Does FDI significantly impact on labor productivity in Vietnam?

2)

Does the impact of FDI on labor productivity in Vietnam differ
significantly across regions as well as the ownership structure of firms?

3)

Are there any significant differences and gaps of FDI impacts on labor
productivity among these four sub-industries in this research?

1.4.

Research hypotheses

As mentioned in the beginning, the econometric model is expected to confirm the sign
and statistical significance of following results:
1) The determinants on the labor productivity in Vietnam has significantly
positive relation and depend on the terms of industry’s capital intensity,
proportion of labor skills and firm’s scale of material input purchases.

2) The impact of FDI on the labor productivity significantly e nhances o n
labor productivity in Vietnam but differs significantly across regions and
among four sub-industries in the research.
3) The determinants on the labor productivity in Vietnam varies based on the
ownership structure of firms and amongst, FDI firms make the most productive in
increasing labor productivity compared with s tate owned firms and non-state
owned firms.
1.5.

Organization of the research

The thesis consists of six chapters. The first chapter is Introduction, which presents
the problem statement of the research, the objectives of the research, research

questions as well as hypotheses, and the organization of this thesis. The next chapter
is J i/era/ure review. This chapter discusses concepts; reviews theoretical arguments
and examines empirical studies relating in the research field. An overview of FDI in
Vietnam since 1988 is discussed mainly in chapter 3 which introduces a general
view about FDI characteristics, roles and inflows in national economy, FDI
enterprises’ activity as well as socio-economic effectiveness of these enterprises in
Vietnam. Following, chapter 4: Research methodology concentrates on model
specification and the justification of variable selection as well as dig deeply
econometric problems. The practical results of FDI impact on labor productivity at firm
level in Vietnam are analyzed and presented in chapter 5: Result analysis. Finally,
chapter 6: Conclusions and recommendations,


provides the summary of main findings and drawings on the past analysis to suggest
implications for policy.

4


CHAPTER II
LITERATURE REVIEW

2.1.

Introduction

This chapter aims at reviewing literature related to the topic to make sure that the
study is conducted based on a scientific background. The chapter is developed into
three major parts. Firstly, core concepts and definitions relevant to the research topic
such as FDI, productivity as well as labor productivity will be discussed clearly. In the

second part, economic theories supporting for the research are presented. I n
addition, theoretical background of FDI impacts that give overview about channels of
FDI effects as well as empirical analysis models of FDI impacts on labor productivity

is also stated. Especially, the research model is also suggested in this part. Finally,
empirical studies regarding FDI impacts on labor productivity in some countries are
discussed and commented in the last part. Through this chapter, the analysis of FDI
impact on labor productivity at firm level is generally figured out on the basis of
economic theories and empirical studies.

2.2.

Concepts and definitions

2.2.1. Foreign Direct Investment (FDI):
There are several ways to define FDI such as International Monetary Fund’s FDI
definition or United Nations’ FDI definition. However one of the clear and popular

definitions comes from Organization for Economic Co-operation and Development
(OECD). According to OECD (1996), FDI is defined as follows:
“Foreign direct investment rejects 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 infiuence 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.”

The OECD (1996) also recommends in its Benchmark deJizii / /on that for the
existence of a direct investment relationship the “full consolidated system” should be
followed. In other words, it means that when there is a cascade of participations, the
percentage of the parent company in any affiliated companies should be calculated
assuming the 100% of the subsidiaries and the corresponding percentage of the
associates. However, this criterion does not correspond with the consolidation concept in
the accounting statement.
Besides OECD’s FDI definition, Vietnam’s GSO (2007) also explained Foreign Direct

Iuves/men/ as the bringing of capital into Vietnam 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.

2.2.2. Productivity and labor productivity
Also according to OECD (2001), Productivity is commonly defined as a ratio of a
volume measure of output to a volume measure of input use and laboF J9T'Oductivity is

defined as output per unit of labor input. Labor productivity is a useful measure
because it relates to the most important factor of production labor and it is relatively
easy to measure, Ngoc (2008). In addition, Circular No. 06/2001/TT-BLDTBXH
states that the labor productivity to be determined by enterprises must be equal to the
number of wage unit prices they formulate for expertise in January 29, 2001 in guiding
the calculation of the average labor productivity growth rate and the average wage
increase rate in State owned enterprises.
Although labor productivity can be measured in physical terms or in price terms for a
firm, a process or a country, measured labor productivity will vary as a function of both

other input factors and the efficiency with which the factors of production are used.
The three most commonly used measures of input are: hours worked; workforce jobs;

and number of people in employment. Meanwhile, output per worker corresponds to

the "average product of labor" and can be seemingly contrasted with the marginal
product of
6


labor, which refers to the increase output resulting from a corresponding marginal
increase in labor input. Economists argue that the output produced is generally
measurable in the private sector; it may be difficult to measure in the public sector or in
NGOs. Therefore, measured labor productivity can depend on many ways; the purpose of
measurement or the availability of data about factors affecting performance.

In a survey of manufacturing growth and performance in Britain and other countries
of IRS (2003), it was found that the factors affecting labor productivity or the
performance of individual work roles are of broadly the same type as those that affect
the performance of manufacturing firms as a whole. They include: (1) physicalorganic, location, and technological factors; (2) cultural belief-value and individual
attitudinal, motivational and behavioral factors; (3) international influences — for
instance, levels of innovativeness and efficiency on the part of the owners and
managers of inward FDI companies; (4) managerial-organizational and wider
economic and political-legal environments; (5) levels of flexibility in internal labor
markets and the organization of work activities — for example, the presence or
absence of traditional craft demarcation lines and barriers to occupational entry; and
(6) individual rewards and payment systems, the effectiveness of personnel managers as
well as others in recruiting, training, communicating and performance-motivating
employees on the basis of pay and other incentives.

Prior to IRS (2003) survey, Pindyck and Rubinfeld (1997) stated labor productivity is
also tied to natural resource of an economy. As oil and other resources began to be
depleted, the output per worker fell somewhat. Especially, environmental regulations

magnified this effect as the public became more concerned with the importance of
natural resources (for example, the need to restore land to its original condition after
strip mining for coal as well as cleaner air and water).
In this thesis, value added per labor is the term which is used to measure labor
productivity. Depending on each field of four sub-industries; Food processing, hotels
and restaurants, el ectronics and mechanics or textile, garment and footwear
respectively, GSO (2007) set up suitable methods to calculate labor productivity that will
be explained in details in later chapter: Research methodology.
7


2.3.

Economic theories

2.3.1. Production theories
2.3.1.1.

Cobb-Douglas production function

According to Cobb-Douglas (1928), production function is the functional form used to

represent the relationship of an output to inputs. It was the first time that an aggregate
production function which was estimated econometrically by Cobb and Douglas in 1928
and the results presented to the economics profession. Today, it is known as “CobbDouglas production function” that is the most ubiquitous form in theoretical and

empirical analyses of growth and productivity. The estimation of the parameters of
aggregate production functions is central on much of today’s work on growth,

technological change, productivity, and labor. Empirical estimates of aggregate

production functions are a tool of analysis essential in macroeconomics and
microeconomics as well as important theoretical constructs, such as potential output,
technical change, or the demand for labor. The production function has the form as
follows:
Y-AL‘K’

(1)

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

•

o and § 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. I , a 1%
increase in labor would lead to approximately a 0.1% increase in output. The CobbDouglas production function is usually expressed in logarithmic form: log Y= log A +
o log L + § log K which is useful and easy when performing a regression analysis.


2.3.1.2.

Pindyck and Rubinfeld production theory

Pindyck and Rubinfeld (1997) stated that the relationship between the inputs to the
production process and the resulting output is described by a production function
indicating the output Q that a firm produces for every specified combination of inputs.
They assumed that a production function consists of two inputs, labor L and capital K
and it can be described as
Q-F(K,L)

(2)

This equation that applies to a given technology relates the quantity of output to the
quantities of the two inputs capital K and labor L. For instance, the production function
might describe the crop that a farmer can obtain with a specific amount of machinery and

workers. Because production function describes the maximum output feasible for a
given set of inputs in a technically efficient manner, it allows for inputs to be
combined in varying proportions to produce maximum output in many ways through
labor-intensive or capital-intensive choice. Furthermore, production functions show
what is technically feasible when a firm or an economy works efficiently; this
explains that a given knowledge might be used to transform inputs into output. When
technology is improved and the production function changes, a firm can get more
output for a given quantity of inputs.
Although the Cobb-Douglas production function is a widely-used approach to present
the relationship between an output and inputs in many analyses of economic
researches, it is often replaced and developed into other more complicated functions in
industry studies of growth and productivity for some reasons. One of the considerably
typical reasons according to Pindyck and Rubinfeld (1997) is that the Cobb-Douglas

production function is rarely able to happen in the reality. The possibility is that the

firm’s production process shows increasing returns at low output levels, constant
returns at intermediate output as well as decreasing returns at high output levels might
be real.
2.3.2. Theoretical background of FDI impacts
9


2.3.2.1.

Channel effects of foreign direct investment

In general perspective, FDI may effect on host countries in a number ways. According
to Vahter (2004), the important channel effects of FDI on growth happen via
technology transfer and spillover effects. Foreign direct investment is considered a
prominent force of growth for most of developing economies. Because it brings new
capital, technology and know-how born parent firms to host firms. However,

Blomstrom and Kokko (1998) who explain that the spillovers born FDI to host
countries may occur through three channels: knowledge shifts with skilled labor,
technology transfer, and effective resource allocation due to competition.
Javorcik and Arnold (2005) stated that foreign direct investment comes either in the
form of a “Green field” project, where a new plant is built and therefore a new firm is
born, or in the form of foreign capital inflow to an existing domestic company. In both
cases, this company is typically characterized by higher productivity and competitiveness.

In the previous research in 2004, Javorcik showed that besides direct effects 6:om FDI,
there are also varieties of indirect effects. The entry of any FDI-high productivity
company naturally put pressure on domestic companies within the same sector to
improve their performance and competitiveness. The increase in efficiency of the
production process can happen by copying new technologies or by hiring trained

workers and managers from foreign-owned companies. On the other hand, those
domestic companies that are not able to catch up with the higher performance of other
companies within the sector may be crowded out of the market. In general, these
effects are referred to as horizontal spillovers.
However, companies from sectors other than that of the foreign enterprise might be
affected by its presence as well if they are in direct business contact with it. This includes
companies that supply or provide services for foreign firms, as well as companies that are
supplied by foreign firms. It is likely that foreign companies require higher standards
from their suppliers. In other words, it is also likely that higher standards are provided by

foreign companies to domestic companies as well, which might improve the domestic


companies’ efficiency and performance. And these effects are referred to as vertical
spillovers.

As Lipsey (2002) mentions, one of the main reasons to examine productivity
spillovers from foreign-owned to domestically owned firms is to understand the
contribution of inward FDI to host country economic growth. If foreign firms at the
expense of lower productivity in domestic firms achieve higher productivity, there

might be no implications for aggregate output or growth. However, there might be
growth effects without spillovers just born the operation of foreign firms, which can
be analyzed in terms of the impact of FDI on a country’s output or growth.
Moreover,

because multinationals seek to minimize technology leakages to

competitors while improving the productivity of suppliers by transferring knowledge,
were FDI to generate spillovers they would more likely be vertical than horizontal

through applying macro-level data to study overall effects of FDI in his study.
In recent research about The Impact of Foreign Direct Investment on the Economic

Growth in Vietnam, Anh et a1. (2006), they stated that there is still one more concern
with the presence of FDI that has indirect effects on local labor productivity in Vietnam.
FDI may exert the competition pressure on domestic firms so that the later have to
improve business efficiency or they may promote the diffusion and transfer of
technology... etc. that are also called the “spillover effects” of FDI. They also
suggested that the development should be enhanced to promote the spillover effects for

FDI. However, the data available for this aspect is unclear and enough, thus this
research will not test the impact of FDI on the productivity in general through the
technological spillovers channel as mentioned at the beginning of thesis, but focus on
analysis of FDI impact on the labor productivity at firm level in Vietnam as a whole.

2.3.2.2.

Theoretical framework of FDI impact on labor productivity

Based on Cobb-Douglas (1928), Tong and Hu (2003), in their current study in
estimating the impact of foreign presence on Chinese domestic productivity, they
represented the simple model for this relation.


Where Y measures the productivity of domestic industries, FS measures the intensities
of foreign presence in the industries, and X denotes the other factors that would
have significant impact on the productivity of domestic industries.
However when examining the effects of FDI on productivity, Blomstrom and Sjoholm
(1999) proposed a production function in which labor productivity of firm f tthhee j
th

industry is dependent on capital intensity, size of capital, skilled labor, scale of
FDI
projects. And if F stands for values added, K is (physical) capital assets,’ I and FDI
respectively denote labor and contribution by foreign partner in total capital assets of firm
i the above relationship can be constructed by the productivity function of firm i in
industry as follow:
Yij

(4)

In this productivity function, 5/r///, and Scal£!’j are firm-specific variables. The first
variable measures the skilled labor, while the second denotes the size/scale of the firm in

the industry and DIndustrf j is the industry-specific dummy variable of
the j

industry.

In general, there have been many empirical analyses (see, among others, Kokko, A., et
a1., 1996; Liu, Xiaming et a1., 2004; Javorcik, B. S., 2004; Yingqi, Wei., et al., 2004)
to examine the effects of FDI on labor productivity on domestic firms where firmlevel performance is regressed based on a foreign-presence variable and a series of
independent variables measuring the characteristics of firms. One of popular and general
models for this type of researches is normally suggested as follows:

LP- F(KL,FS,LQ,CU,SIZE,OV)
Where LP is used measures firm performance,

(5)

usually representing local labor

productivity; KL is the capital-labor ratio which measures capital intensity per labor in
firms; FS is a variable representing foreign presence, defined as the ratio of foreign
firms’ employment in a sector to the total employment of that sector, or the share of
total
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sectorial output produced in firms with foreign ownership; LQ denotes labor quality in

each firm; CU is a variable representing capital utilization, defined as the share of
actual output to potential output; SIZE is the firm’s output as a share of the average
output in the sector to which the firm belongs, and finally, OV represents other
explanatory variables that can raise possibilities to affect labor productivity.

2.3.2.3.

Suggested research model

Based on the above economic theories and the theoretical background from empirical
analyses, the suggested research model can be described in a function with dependent
and independent variables as follows:
Labproductivlty;——f(Cap_intensity;, Ml_scale;, Skill;, Dlocation, Fshare;, Dindustry; )(6)

Where: i denotes firm / and
•

Labproductivity, the dependent variable measures labor productivity of the firms

in terms of values added per labor.
•

Cap intensity measures the capital intensity per labor of the firms.

•

MI scale denotes the size of material input purchases per labor i n four subindustries including food processing, hotels and restaurants, electronics and
mechanics, textile, garment and footwear.

•

5'/ri// reflects the quality of labor in the firms as it measures the proportion of
labor finishing at least college or vocational training.

•

Dlocation is dummy variable that is equal to unity if the headquarters of firms
located in big cities and provinces with better performance of FDI inflows,
including Hanoi, Hochiminh, Danang cities and the surrounding provinces of key
industrial centers such as Haiduong, Haiphong, Quangninh — Baria Vungtau,
Binhduong, Dongnai. And equal to zero otherwise.

•

The dummy variable Fshare denotes the types of ownership of firms that are
foreign ownership firms, state owned firms or non-state owned firms.

•

The last remaining dummy variable Dindustry captures the effect of each subindustry of food processing, hotels and restaurants, electronics and mechanics,
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textile, garment and footwear on the overall productivity level of firm sector in
cross sectional data.
2.4.

Empirical studies

There are a great number of empirical studies estimating the impact of FDI on labor
productivity in many countries around the world. However the researches can be
separated into two groups; one which concludes that FDI enhances and improves the
productivity of domestic firms while the other argues that the impact of FDI is mixed,
unclear or even negative.
2.4.1. FDI impacts enhance labor productivity in host countries
According to Liu et a1. (2004), in the working paper research about the overall effects
of inward FDI on labor productivity in the Chinese electronics industry with official
data of
41 sub-sectors of the industry in 1996 and 1997. Labor productivity is regressed as
dependent on the level of foreign presence in the industry and other control variables,
namely capital intensity, human capital and firm size for scale factors. They indicate that

FDI has a positive impact on labor productivity when the econometric results suggest
that foreign presence in the industry is associated with higher labor productivity and
they also conclude that the most significant determinant is labor quality by using
various econometric estimation techniques for panel data in Chinese electric
industry I o get appropriate statistical model.
In the current research of Ludo et a1.(2008) about the impact of FDI on local labor
productivity in Cambodia’s manufacturing sector where their analysis of FDI impact

was examined on the basis of a number of control variables including capital
intensity, material and labor inputs, labor equality, size of establishment, and
payments for royalties, copyrights and patents. In addition, two proxies for the
presence of foreign owned enterprises were also used in their study because it was
expected that such presence could be reflected in terms of either the employment or
the output level. The main contribution of the research comparing to other empirical
studies is that several statistical diagnostic tests were carried out to avoid misleading
econometric results. The
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analysis shows that the coefficients of the two proxy variables for the influence of
foreign owned enterprises are positive and highly significant. They found out that FDI
played a positive role in enhancing labor productivity in the Cambodian
manufacturing sector. Similarly, capital intensity was also shown to positively affect
domestic labor productivity. However their results show that variables such as labor
quality, labor inputs, size of establishment, material inputs and payments for royalties,
copyrights and patents do not seem to be related to labor productivity in Cambodia.

Supporting Liu et a1 (2004)’s study, Anh et a1. (2006) undertook the tests on the
determinants of productivity in enterprises in three groups of industries: food
processing, textiles and garment, mechanics-electronics in Vietnam roughly 12
thousand enterprises used in estimation that is in logarithm form. The results show
that capital intensity, skilled labors, size of firms positively affects labor productivity
of the firms including domestic and FDI firms. However the results did not indicate
the impact of FDI that differs significantly based on forms of FDI as well as varies
across the provinces around the countries. Moreover the test did not show the
spillovers of FDI to labor productivity.
Making the same findings as authors mentioned above, Vani (2000) undertook the
research on the impact and incidence of FDI in India to analyze and explore whether

FDI is the economic driver of this growth engine as well as detailed picture of the
impact of FDI on labor productivity and employment across 19 different major states

of India for the post reform period born 1991 to 2000. He hypothesized that FDI with
intervening variables such as gross capital formation; wage rate and per capita income
exert direct influence on labour productivity and employment. In the research, he
made use of three methods including Fixed Effects (FE), Random Effects (RE) and
Seemingly Unrelated Regression (SUR) models. Results show that overall FDI has a
positive impact on labor productivity but across region the benefit of FDI is quite
uneven. The impact of FDI is negative in less developed states, while it is significant
and positive in catching up states. However the labor productivity is growing only at
the expense of employment. This tends to ponder that liberalization will make rich
states richer with the poor states lagging behind or there can be convergence across
states through the presence of FDI.
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2.4.2. The opposite results of FDI impacts on labor productivity
While the above studies conclude that the impact of FDI on the labor productivity is
clear and positive however, in the research about the effects of FDI on labor
productivity in Estonia and Slovenia, Vahter (2004) found out the results of the negative
impacts of FDI in Estonia and positive impacts in Slovenia. Besides that he also
suggested that different types of FDI can have different effects on the host country

and that the existence of positive spillovers may depend on the level of the economic
growth of the host country.
Although many studies have confirmed that FDI is a catalyst for enhancing labor
productivity in the host economy, FDI activities can also have a negative impact on
domestic labor productivity. According to recent empirical investigations, Aitken and
Harrison (1999) used a firm-level panel data set of over 4,000 plants for the period

1976- 1989, they have shown that an increase in foreign ownership is negatively
related to the productivity of wholly domestically-owned firms in the same industry.
The entry of foreign firms producing for the domestic market can force domestic
firms to reduce output, especially when domestic and foreign firms are active in the
same market. As a result, the productivity of domestic firms may fall as they are
moving towards lower output levels along their average cost curves.

In addition, the ideas that FDI has positive impact on the productivity in
manufacturing whereas its effects on growth of agriculture and mining sectors are
negative through the conclusion of Alfaro (2003) who applied linear regression
method to study the relationship between FDI and labor productivity in various
industries, based on the panel data of 47 countries from 1980 to 1999.
When examining the impact of FDI flows on economic growth and labor productivity
in Chile, one of the important countries of Latin America during the 1960-2000 period
by using macro time series data. Miguel (. ..) discovered several major findings that
show the mixture of FDI impacts on labor productivity growth in Chile. Although FDI
flows have been substantial during the second half of the eighties and nineties,
particularly in relation to domestic capital formation, a large proportion of these funds
has been directed
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