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

UNIVERSITY OF ECONOMICS

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
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

amKhacDuy

Date: November, 2009


ACKNOWLEDGEMENT

This research is impossibly completed without the valuable guidance, encouragement and
advice from 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 ofthe thesis.
I am grateful for Professor, Peter Calkins for his precious advice and comments from the
initial ideas ofthe theme for my thesis.
I also send my special thanks to Professor, 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 fmally, 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.

ii

ABSTRACT

This research examines and analyses the impact ofFDI 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 subindustrial 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.

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TABLE OF CONTENTS
CHAPTER 1: INTRODUCTION.................................................................................................. . 1
1.1.

Problem statement................................................................................................................... I

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 ofFDI impacts.............................................................................. 9

2.3 .2.1. Channel effects of foreign direct investment................................................................... 10
2.3.2.2. Theoretical framework ofFDI 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 ofFDI 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 ofFDI in Vietnam............................................................................ 20

3.3.

The role ofFDI in national economy................................................................................. 25

3.4.

The summary ofFDI sector's socio-economic affect on national economy ...............27
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CHAPTER IV:

RESEARCH METHODOLOGY.................................................................... 29

4.1.

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

4.2.

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

4.3.

Description ofvariables..................................................................................................... 30

4.3.1.

Dependent variable labor productivity (Labproductivity).......................................... 30

4.3.2.

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

4.3.2.1. Capital intensity (Cap_intensity)...................................................................................... 30
4.3.2.2. Scale ofmaterial input cost (MI_scale)...........................................................................31
4. 3 .2. 3..............................................................................................................................Labor
quality (Skill)......................................................................................................................................... 31
4.3.2.4. Firm's location (Dlocation)............................................................................................... 31
4.3.2.5. Types of ownership (Fshare)............................................................................................ 32
4.3.2.6. Firm's sub-industrial sectors (Dindustry)....................................................................... 32

4.4.

Data collection.................................................................................................................... 33

4.5.

Estimation strategy............................................................................................................. 34

4.6.

Summary............................................................................................................................... 36

CHAPTER V: RESULT ANNALYSIS........................................................................................ 37
5 .1.

Introduction.......................................................................................................................... 3 7

5.2.

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

5.2.1.

Descriptive statistics of sample....................................................................................... 3 7

5.2.2.

Descriptive statistics ofvariables..................................................................................... 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 ofthe fmding 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
v


REFFERENCES
APPENDICES: ............................................................................................................

APPENDIX 1: .......................................
APPENDIX 2: ..............................................................................................................

APPENDIX 3: ..............................................................................................................

LIST OF BOXES
BOX 5.1: Ramsey RESET test using powers of the independent variables .................... .
BOX 5.1: Breusch-Pagan I Cook-We is berg test for heteroskedasticity ...........................

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

region ...........................................................................................................................
FIGURE 3.3: Structure of investment at current prices by types of ownership from 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 ....................................................................................................................
FIGURE 5.1: Correlation between proportion of skilled labor and labor productivity .. .
FIGURE 5.2: Distribution of labor productivity (Labproductivity) before transforming

into logarithm form ........................................................................................................
FIGURE 5.3: Distribution oflabor productivity in logarithm form ...............................
FIGURE 5.4: Distribution of Capital intensity in logarithm form ..................................
FIGURE 5.5: Distribution of material input cost per labor in logarithm form ................
FIGURE 5.6: Distribution of proportion or skilled labor in logarithm form ..................

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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 I July by ownership from 2000-2008 .. 27
TABLE 5.1: Statistics summary of four sub-industries firms in regions according to three
types of ownership................................................................................................................................ 37
TABLE 5.2: Distribution oflabor 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 from the variables in the regression function .........................42
TABLE 5.6: The result ofrunning regression (Model5.1)............................................................. 43
TABLE 5.7: Diagnostic test for multicollinearity........................................................................... 44
TABLE 5.8: The result of running regression (Model5.2)........................................................... .45
TABLE 5.9: Distribution oflabor productivity (Labproductivity) before transforming
into logarithm form............................................................................................................................... 56
TABLE 5.10: Distribution oflabor productivity in logarithm form (Lnlabproductivity) 57

TABLE 5.11: Distribution of explanatory variables in logarithm form....................................... 58
TABLE 5.12: Descriptive statistics ofvariables in three types ofenterprises .............................61
TABLE 5.13: The result of regression with beta number (Model5.3)......................................... 62

vii


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

viii


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 from 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 Asia-Pacific 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 oflabor.

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 ofFDI on labor productivity in Vietnam differ significantly
across regions as well as the ownership structure of firms?
2


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 frrm's scale of material input purchases.
2) The impact of FDI on the labor productivity significantly enhances on labor

productivity in Vietnam but differs significantly across regions and among four
sub-industries in the research.
3) The determinants on the labor productivity m Vietnam vanes based on the

ownership structure of firms and amongst, FDI firms make the most productive in
increasing labor productivity compared with state owned firms and non-state
owned firms.
1.5.

Organization of the research

The thesis consists of six chapters. The frrst 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 Literature
review. This chapter discusses concepts; reviews theoretical arguments and examines

empirical studies relating in the research field. An overview ofFDI 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,
3

provides the summary of main fmdings 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 defmitions 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 ofFDI 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 defmition. 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 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

5


subsequent capital transactions between them and among affiliated enterprises, both
incorporated and unincorporated."

The OECD (1996) also recommends in its Benchmark definition 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
Investment 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 defmed as a ratio of a volume
measure of output to a volume measure of input use and labor productivity 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
frrm, 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 ofproduction 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 in 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 ofbroadly the same type as those that affect the performance of
manufacturing firms as a whole. They include: (1) physical-organic, 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, electronics 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, mid 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:

(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

•

a 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 a= 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: logY= log A+ a log L +
log K which is useful and easy when performing a regression analysis.
8

~


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 Land capital K and it can be described
as
Q=F(K,L)
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 from
parent firms to host firms. However, Blomstrom and Kokko (1998) who explain that the
spillovers from 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 from 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 foreignowned 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 frrms, as well as companies that are supplied by
foreign frrms. 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
10


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 from the operation of foreign frrms, 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 ofFDI
in his study.
In recent research about The Impact of Foreign Direct Investment on the Economic
Growth in Vietnam, Anh et al. (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.
Y,-f(FS;, X;)
11


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 i in

industry is dependent on capital intensity, size

the jth

of capital, skilled labor, scale of FDI

projects. And if Y stands for values added, K is (physical) capital assets; L 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 j as
follow:

In this productivity function, Skillij and Scaleij 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 D!ndustryj is the industry-specific dummy variable of the jth industry.
In general, there have been many empirical analyses (see, among others, Kokko, A., et al.,
1996; Liu, Xiaming et al., 2004; Javorcik, B. S., 2004; Yingqi, Wei., et al., 2004) to examine
the effects of FDI on labor productivity on domestic firms where firm-level 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, 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, defmed 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, defmed 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 fmally, 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:
Labproductivity;=f(Cap_intensity;, MI_ scale;, Skill;,

Dlocation, Fshare;, Dindustry; )(6)

Where: i denotes firm i 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 in four sub-

industries including food processing, hotels and restaurants, electronics and
mechanics, textile, garment and footwear.
•

Skill 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 al. (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 t o get
appropriate statistical model.
In the current research of Ludo et al.(2008) about the impact of FDI on local labor
productivity in Cambodia's manufacturing sector where their analysis ofFDI 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 ofthe 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 al (2004 )' s study, Anh et al. (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 ofFDI 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 from 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 ofFDI.
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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 ofthe negative impacts ofFDI 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 ofthe 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 19761989, 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 fmdings 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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