INTRODUCTION
Problem statement
Economic growth can be analyzed from both supply-side and demand-side perspectives Supply-side factors include inputs, productivity, research, and technology, with Krugman (1989) highlighting that each country has a unique growth rate due to variations in total factor productivity Solow (1957) emphasizes that long-term growth is influenced by total factor productivity as captured in the Solow residual On the demand side, Keynesian theory (1936) examines how aggregate demand impacts growth through multipliers, while Thirlwall (1979) argues that international trade plays a crucial role in either accelerating or constraining growth in open economies, linking demand constraints to the balance of payments Thirlwall's initial balance of payments constrained growth model (BPCG) faced limitations in explaining growth in developing countries, prompting the development of an extended model by Thirlwall and Hussain (1982) that incorporates the effects of foreign capital flows.
The Balance of Payment (BOP) constrained growth model posits that a country's actual economic growth rate cannot exceed the estimated rates outlined in the BOP framework unless it has the means to finance any deficits A current account deficit occurs when imports surpass exports, necessitating the pursuit of financing sources such as foreign borrowing or net transfers, including direct foreign investment (DFI) to bolster capital inflows Aggregate demand, which encompasses total income, is determined by consumption, investments, government spending, and exports Notably, while all components of aggregate demand are influenced by a nation's total income, exports are uniquely dependent on global income levels.
In the absence of exports and capital inflow, aggregate demand can be significantly repressed due to a lack of foreign currency, hindering the import of essential modern machinery for domestic production This situation can lead to increased unemployment and underutilization of resources Even when exports exist, a higher growth rate of imports compared to exports can temporarily alleviate demand repression through capital inflow However, persistent trade deficits cannot be indefinitely financed by capital inflow, ultimately constraining aggregate demand due to balance of payments (BOP) limitations These BOP constraints can impact economic growth both in the short and long term, necessitating that economic growth operates within these financial boundaries While supply factors and technological advancements are crucial for economic growth, it is important to recognize that demand constraints often become a pressing issue long before supply constraints are encountered (Thirlwall, 2002).
From 1990 to 2010, Vietnam experienced remarkable annual economic growth rates, with the exception of three years: 1998 (5.8%) and 1999 (4.8%) following the Asian financial crisis, and 2009 (5.32%) after the global financial crisis This period is recognized as a significant achievement due to the country's effective economic strategies.
“open door” policies by relaxing exchange rate controls, internal and external trade impediments.
Export and import growth have generally risen, with the exception of 1996 and a few subsequent years when the government imposed import restrictions in response to a significant current account deficit of -11.5% of GDP Despite these measures, the growth rate of exports occasionally surpasses that of imports.
0.00 growth rate, but it is still smaller than import growth in absolute values in most of the years in the period of 1990-2010, trade deficit therefore still exists Furthermore, trade deficit is a chronic issue in Vietnam because of imports-exports structure, as less of competiveness in exporting sector as it mainly comprises of low value-added goods, raw materials and intermediate products Current account is in deficit as a consequence of deficit in trade balance.
A current account deficit does not always negatively impact the balance of payments, as it can be offset by a surplus in the capital account However, relying on foreign borrowing or foreign direct investment (FDI) to finance a persistent current account deficit is not sustainable in the long term While FDI can temporarily support the balance of payments and foster short-term economic growth, dependence on external sources can lead to unsustainable growth patterns Additionally, fluctuations in FDI flows can have detrimental effects on the economy.
19901991 domestic economy such as uncontrollable production, unemployment rate and therefore economic growth.
Balance of payments issues can affect both developing and developed nations, although they are frequently associated with the developing world This paper aims to reevaluate Thirwall’s law regarding the balance of payments constraint on economic growth, specifically in the context of the Vietnamese economy By analyzing time series data from 1990 to 2010, the study compares Vietnam's economic performance against its potential growth rate under recent scenarios.
Research questions
This study is to examine
1 Whether balance of payments in Vietnam constrained economic growth or not?
2 Which factors behind balance of payments restrict economic growth?
3 What policy implications are for the balance of payments constrained economic growth in Vietnam?
Structure of Study
The thesis is organized into five chapters, beginning with an introductory chapter Chapter 2 offers a comprehensive literature review, while Chapter 3 presents an analysis of Vietnam's economic growth and balance of payments Chapter 4 details the model specifications and findings of the research Finally, Chapter 5 concludes the thesis and provides recommendations for future study.
LITERATURE REVIEW
Theories
The balance of payments constrained growth model, which was developed by Thirlwall’s
In 1979, Thirlwall established that the long-term economic growth rate of an open economy is constrained by its trade balance He defined the equilibrium growth rate as the ratio of export growth to the income elasticity of demand for imports This model has been extensively tested across a wide range of developing and developed countries using various techniques and methods.
The initial BPCG model overlooked the significance of international capital flows and interest payments, which are critical components of the balance of payments (BOP) To address this gap, Thirlwall and Hussain (1982) introduced an extended model that incorporates trade deficits and capital inflows This revised model illustrates that in an open economy, the growth rate can be limited by both capital inflows and trade factors, indicating that fluctuations in capital inflows can either restrict or enhance balance of payments-constrained growth.
To improve the capital inflows limitation, BPCG model was redefined by Moreno-Brid
(1998, 1999) with the assumption that accumulating foreign debt has sufficient condition It combines interest payments from imports of goods with non-factor services in the analysis of debt accumulation.
In his 1997 research, McCombie analyzed time series data from various nations and discovered that balance of payments equilibrium can hinder consistent growth rates in exports and imports in the short run He noted that when growth rates exceed the sustainable level aligned with external account equilibrium, capital inflows can cover debt repayments However, over the long term, balance of payments equilibrium aligns with the growth rates of exports and imports once again Thus, while estimation models may prove ineffective in the short term, they remain valid in the long run.
Moreno-Brid (2003) highlighted that interest payments are not accounted for in Thirlwall’s law, a factor often overlooked in traditional research This omission can result in inadequate analyses of long-term growth, particularly for developing countries burdened with substantial net interest payments abroad To address this gap, the author proposed an extension of the balance of payments constrained growth model that incorporates foreign interest payments into the analytical framework.
Since Thirlwall's work in 1979, numerous studies focused on specific countries and regions have emerged, generally supporting the long-run hypothesis, particularly in the context of developing nations McCombie (1997) effectively summarized the findings of these earlier studies.
Balance of Payments in Supporting and Constraining Growth
The balance of payments account is divided into two main components: the current account and the capital account, each influencing economic growth in distinct ways While numerous sub-accounts exist within these categories, economists typically emphasize the merchandise account of the current account and private foreign investment, debt, and official development assistance within the capital account, collectively referred to as capital inflows Additionally, research highlights other sub-accounts such as debt servicing, factor income, and remittances This discussion focuses on two critical elements: trade balance and capital inflow, which play a significant role in shaping a country's economic landscape.
The role of the balance of payments in economic growth is viewed differently among various economic schools of thought Post-Keynesian economists focus on the demand side, highlighting the significance of the balance of payments in fostering economic growth In contrast, classical, neo-classical, and endogenous growth economists often overlook the demand side, concentrating instead on supply-side factors These schools advocate for free competition and trade, which inevitably leads to criticism from post-Keynesian economists regarding their approach to economic growth.
Before delving into post-Keynesian theory regarding the role of balance of payments in economic growth, it is essential to highlight the shortcomings of the free-trade doctrine, particularly its neglect of balance-of-payments considerations Proponents of free trade often overlook the balance-of-payments impacts and the influence of trade on terms of trade It is crucial to analyze free trade, terms of trade, and balance-of-payments collectively, as the deterioration of terms of trade can overshadow the benefits of trade, adversely affecting balance of payments and, consequently, economic growth Additionally, the theory of comparative advantage leads developing countries to focus on labor-intensive goods, which tend to have diminishing returns, while developed countries benefit from capital-intensive goods with increasing returns This disparity can result in developing nations facing Engel's law and deteriorating terms of trade, further straining their balance of payments and hindering growth Furthermore, the emphasis on comparative advantage may narrow the range of products, leading to significant balance-of-payments instability that threatens development Lastly, comparative advantage can fluctuate due to government policies, and intra-industrial trade persists because of variations in consumer preferences and technologies.
Comparative advantage theory primarily considers private costs, but when social costs exceed these due to externalities in industrial projects, particularly in developing countries, it raises concerns for protecting domestic industries over free trade Additionally, while export growth of primary commodities has minimal impact on other sectors, the expansion of manufactured goods significantly influences related activities through backward and forward linkages Although free trade has its disadvantages for development, halting trade liberalization is not a viable option; instead, it is essential for economic growth The critical questions now focus on the timing and sequencing of trade liberalization.
Classical, neoclassical, and new endogenous growth economists emphasize the role of supply-side factors in driving trade and economic growth, while post-Keynesian economists highlight the significance of demand-side influences, particularly regarding current account deficits and financial elements within capital accounts.
Findlay (1984) emphasized that the Balance of Payments is a critical constraint on economic growth, while Keynes (1936) challenged classical economists by asserting that aggregate demand—comprising consumption, investment, government expenditure, and net exports—drives economic growth He argued that changes in any of these components can lead to variations in growth through multipliers, such as the government-purchases and investment multipliers Keynes believed all components of aggregate demand equally influence growth, whereas other economists assign varying degrees of importance to each Thirlwall (2002) highlighted the significance of exports, noting that they uniquely originate from outside the economic system and can stimulate other components of aggregate demand and overall economic growth.
Exports significantly influence aggregate demand by directly affecting demand and indirectly supporting consumption and investment They can finance imports and provide essential intermediary goods that are costly to produce domestically A current account deficit often coincides with a trade balance deficit, highlighting the importance of trade balance in assessing current account status Foreign exchange gaps can only be bridged by surpluses in the capital account, derived from foreign debt and direct investment However, when foreign debt reaches critical levels, investor confidence wanes, making it difficult to fill the foreign exchange gap with capital inflows This situation can hinder growth due to insufficient foreign currency for necessary production inputs, particularly in less developed countries that face challenges in substituting domestic and foreign resources without incurring high costs.
The balance of payments plays a crucial role in influencing economic growth, both by accelerating and constraining it This article will explore various models that illustrate the relationship between balance-of-payments constraints and economic growth, starting with the dual-gap model.
Conceptual framework for the study
Thirwall’s model posits that the foreign multiplier plays a crucial role in determining long-term economic growth, with variations in growth rates attributed to differing supply factors and productivity levels across countries, as outlined in the Neoclassical approach Furthermore, Thirwall's law, supported by the Harrod foreign trade multiplier, emphasizes that in an open economy, economic growth is primarily influenced by demand factors, which are reflected in the balance of payments, as discussed by Thirwall (1979), Thirwall & Hussain (1982), and McCombie & Thirwall (1994).
In addressing the trade deficit challenges faced by developing countries, Thirlwall and Hussain (1982) introduced the "Extended Model" with an initial equilibrium condition Elliot and Rhodd (1999) emphasized the importance of debt servicing within this equilibrium framework Additionally, economists have suggested modifications to the initial equilibrium by highlighting various factors influencing the balance-of-payments account, such as capital flows, interest payments, and debt (Brid, 2001), as well as interest, dividends, and profits from the current account (Ferreira and Canuto, 2003) Notably, remittances play a crucial role in mitigating trade balance deficits, particularly in countries like Vietnam, making it essential to incorporate remittances into the economic equation.
The balance of payments varies by country due to unique characteristics, leading to different constraints on economic growth This diversity accounts for the existence of various models that reflect these specific conditions.
We have equilibrium in accounting form is represented as:
In economic terms, P represents the export price while P_d denotes the import price The variables X and M indicate the volumes of exports and imports of goods and services, respectively The exchange rate, E, is defined as the domestic price of foreign currency Additionally, F signifies the value of nominal net capital inflows, with F > 0 indicating capital inflow and F < 0 indicating capital outflow R refers to the value of remittances, and D represents debt service obligations.
Taking log and derivative of both sides of above equations, we have: p d + x = p f + m + e (5) θ(p d + x) + (1- θ)f = p f + m + e (6) ω(p d + x) + (1- ω)r = p f + m + e (7) θ(p d + x) + (1- θ)f =p( p f + m + e)+ (1-p)d (8)
The growth rates of variables θ and (1-θ) represent the shares of exports and capital flows, while ω and (1-ω) indicate the shares of exports and remittances Additionally, ρ and (1-ρ) reflect the shares of imports and debt service in relation to total expenditure.
On the other hand, we have the normal multiplicative import and export demand functions with constant elasticity:
In this economic model, constants a and b represent key parameters, while ψ denotes the price elasticity of demand for imports, indicating a negative relationship (ψ < 0) Conversely, η reflects the positive price elasticity of demand for exports (η > 0) Additionally, Y signifies domestic income, Z represents world income levels, π indicates the income elasticity of demand for imports, and ε describes the income elasticity of demand for exports Understanding these variables is crucial for analyzing trade dynamics and their impact on economic performance.
Taking log and derivative of the above two equations we have imports and export demand functions: m = ψ (p f + e - p d ) + πy Imports demand function (11) x = η (p d - e - p f ) + εz Exports demand function (12)
Substituting (11) and (12) into (5), (6), (7) and (8), we have (13), (14),(15) and (16) y = [(1+ η+ ψ)(p d - e - p f ) + εz]/ π (13) y =[θεz+ (1- θ)f + θp d - e – p f +(θη+ ψ)( p d - e – p f )]/ π (14) y =[ ωεz+ (1- ω)r + ωp d - e – p f +( ωη+ ψ)( p d - e – p f )]/ π (15) y =[θεz+ (1- θ)f + θp d - (1-p)d - pe – pp f +(θη+ pψ)( p d - e – p f )]/ pπ (16)
With assumption that the Marshall-Lerner condition hold, or considering that the relative prices are constant (p d - e - p f ) =0; we obtain: ybasic = x/π (17) y ext = [θx + (1- θ)(f- p d )]/ π (18) yremit = [ωx + (1- ω)(r- p d )]/ π (19) ydebt = [θx + (1- θ)(f- p d )-(1-p)(d- p d) ]/ pπ (20)
Where ybasic, y ext , y remit, y debt represents the income growth rate consistent with BOP equilibrium.
Finally, we can have with four forms of the balance-of-payments constrained economic growth models under different conditions.
Thirlwall's growth law, as articulated by McCombie and Thirlwall (1994), elucidates why developing countries experience lower economic growth rates compared to developed nations, challenging the classical economists' prediction of convergence This disparity in growth rates can be attributed to variations in export growth rates and the income elasticity of demand for imports The growth of exports is influenced by both the income elasticity of demand for exports and global income levels However, it is crucial to recognize that each country possesses unique economic conditions, necessitating the application of modified models to better align with these specific characteristics.
In developing countries, the export of primary products is often labor-intensive, characterized by low price and income elasticity of demand This results in production challenges, such as diminishing returns and marginal productivity, which hinder export growth Conversely, these countries experience high income elasticity of demand for imports, as they rely on capital-intensive goods and intermediate inputs from developed nations to support their growth Consequently, a one percent increase in growth leads to a more than one percent rise in import demand The combination of stagnant export growth and high import demand contributes to a lower overall growth rate in developing countries compared to their developed counterparts.
Export-led growth can result in long-term balance of payments constraints if the income elasticity of imports is sufficiently high to counterbalance export increases The post-Keynesian tradition emphasizes not only the significance of exports but also the critical role of income elasticity in import demand Consequently, both post-Keynesian and structuralist perspectives advocate for structural adjustments to reduce external dependence, necessitating government policies that establish trade barriers to protect domestic industries These industries generate positive externalities and have social costs that surpass private costs, thereby stimulating demand for economic growth However, it is essential to consider balance of payments constraints, as they can hinder overall economic growth.
Empirical studies
Currently, there are many empirical researches relating to balance of payments together with economic growth such as Jayme Jr (2003), Parikh A (2004), Lopez (2003), Modud.J.K
(2000), Moreno-Brid (2001), Bajo-Rubio (2010), ect.
Jayme Jr (2003) explores the relationship between balance of payments constraints and economic growth in Brazil using Thirlwall's model to assess whether the predicted growth rate aligns with actual growth By incorporating capital flows and the effects of external debt accumulation, he enhances the model's predictive accuracy Utilizing the Autoregressive Distributed Lag (ARDL) technique, he analyzes fourteen sub-periods from 1973 to 1999 through rolling regression, revealing a significant increase in income elasticity of demand for imports He concludes that Brazil's economic growth has slowed due to a rise in long-run income elasticity of imports, which has not been offset by export expansion, indicating that Brazil's growth is limited by its balance of payments, while economic growth positively influences exports.
Jorgen and Virmantas (2004) analyzed economic growth in the Baltic countries—Estonia, Latvia, and Lithuania—through the lens of the balance of payments constrained growth model Their research employed an extended model that incorporated capital inflow, utilizing quarterly data from 1995.
In 2003, limited data from the Baltic countries revealed that their economic growth rates align with balance of payment equilibrium and the growth rate of capital imports The findings indicate that the economic growth of these Baltic nations is constrained by their balance of payments position.
Pham (2006) investigates the growth rate of Vietnam from 1990 to 2004, utilizing various models related to Thirlwall's law to determine if growth is constrained by the balance of payments The study explores how these models can accurately predict Vietnam's actual growth, including Thirlwall's growth law, an extended model accounting for trade deficits filled by capital inflows, and a financial rule considering nominal revenues and expenditures of invisible services While Elliot and Rhodd (1999) introduced debt servicing as a constraint on economic growth, they overlooked the impact of changing investor expectations on current account deficits Despite this, Pham applied all models to estimate Vietnam's predicted growth rate, concluding that the balance of payments does indeed limit economic growth, even as trade and current account deficits are somewhat mitigated by external capital inflows such as foreign direct investment and official development assistance.
Ferreira and Canuto (2003) employed the ARDL model to analyze Brazil's economic data from 1949 to 1999, demonstrating the concept of balance of payments constrained growth Their findings revealed an income elasticity of demand for imports of 1.05, consistent with Lopez and Cruz (2000) However, their regression analysis indicated that the function lacked significance during the 1980s By utilizing an extended balance of payments model that incorporated capital inflows, they estimated the growth rate with a coefficient of 0.40, aligning with the actual growth rate They concluded that both simple rules and financial simple rules are effective, at least partially, for predicting actual growth rates Brazil's average income growth rate was found to be 5.14% per year, while predictions using the simple rule and financial simple rule estimated growth rates of 6.18% and 5.23%, respectively.
Bajo-Rubio (2010) analyzed the case of if trade balance could constrain Spain economic growth in relation with Western Europe in the period 1850-2000 He uses Phillips and Hansen
In 1990, a method was introduced to estimate the elasticity of exports and imports, effectively minimizing biases associated with Ordinary Least Squares (OLS) estimation through the application of Wald tests The author subsequently employs a straightforward approach to determine the relative income elasticity of export and import demands, juxtaposing these figures with the relative GDP growth rates of Spain and the European Union This analysis ultimately leads to the identification of the balance of payments constrained growth rate.
This article explores the balance of payments constraints model and its impact on economic growth, highlighting the intricate relationship between these two concepts It discusses the fundamental principles of balance of payments and economic growth, emphasizing how the balance of payments can both promote and hinder growth A thorough examination of the balance-of-payments constrained economic growth model is provided, along with a review of empirical studies that underscore the significance of balance of payments in fostering economic growth Numerous global studies demonstrate that balance of payments constraints significantly affect the growth rates of various nations, particularly in developing countries The next chapter will focus on the specific case of Vietnam's economic growth and balance of payments from 1995 to 2010.
ECONOMIC GROWTH AND BALANCE OF PAYMENT OF VIETNAM
Vietnam Economic Growth Overview
After 1975, Vietnam implemented a centrally planned economy focused primarily on agriculture, where the government controlled production inputs, outputs, and pricing This included establishing trade barriers, particularly in foreign trade, and setting dual foreign exchange and interest rates Consequently, the country experienced high inflation and low economic growth.
In December 1986, Vietnam implemented the economic reform known as "Doi Moi," transitioning from a centrally planned economy to a market-oriented approach This reform aimed to enhance economic performance by leveraging market strategies and setting incentives Prior to "Doi Moi," the Vietnamese economy faced severe stagnation and triple-digit inflation due to systemic issues The government's commitment to reducing the size of state-owned enterprises marked a significant shift As a result of the "Doi Moi" policy, Vietnam experienced remarkable economic growth in the 1990s, with a notable increase in international trade, foreign direct investment (FDI), and capital inflows.
The 1997 Asian economic crisis impacted the Vietnamese economy, but its effects were less severe compared to many other Southeast Asian nations This resilience was largely due to Vietnam's lack of an internationally traded currency and a stock market at that time Additionally, the country's dollarized economy contributed to greater currency stability during the crisis, which originated in Thailand and rapidly affected countries like Indonesia, Malaysia, and South Korea.
The 1997 financial crisis, while not directly affecting Vietnam's economy, had significant indirect repercussions that halted the high growth rates of previous years In 1998, the growth rate plummeted to 5.76%, and this low growth persisted from 1998 to 2001 Additionally, inflation rates during this period were notably low, with a disinflation rate that even dipped into deflation at -0.6% in 2000, highlighting a state of economic stagnation characterized by both low inflation and growth.
Vietnam joined APEC in 1998 and signed a Bilateral Trade Agreement with the USA in 2000, marking significant steps in its economic integration During this time, the country also laid the groundwork for its accession to the WTO.
Vietnam's economy remained relatively unscathed during the global dot-com crisis, particularly in the high-tech sector, as the country primarily focused on basic manufacturing industries that are labor-intensive and rely on low-end technology, such as footwear and apparel The approval of the bilateral trade bill with the United States in 2001 significantly boosted Vietnam's exports, granting access to the world's largest market.
Following the Asian financial crisis, Vietnam experienced a partial economic recovery, with inflation rates peaking at 9.5% in 2004 While the crisis served as a valuable lesson, it also compelled Vietnam to reform its financial institutions and economy to enhance international competitiveness and integrate into the global market From 2001 to 2007, the country achieved an impressive average GDP growth of 7.5%, reaching 8.5% in 2007, largely driven by the private sector which saw a 26% increase in new enterprises Furthermore, poverty rates significantly declined from nearly 60% in the early 1990s to below 20% Vietnam's accession to the WTO in January 2001 necessitated substantial revisions to its trading and investment laws, ultimately benefiting both foreign investors and local businesses through improved legislation and reduced trade barriers However, local firms also faced heightened competition from domestic and international markets.
Between 2004 and 2007, Vietnam experienced impressive economic growth, exceeding 8 percent annually However, the global financial crisis that began in 2008 in the United States had a detrimental effect on the Vietnamese economy As Vietnam increasingly integrated into the global economy, it became more susceptible to fluctuations in international economic conditions.
As a result, the growth suffered and GDP declines in 2008 (6.2%) and 2009 (5.3%) and in 2010 (6.7%) Another impact of the financial crisis was high inflation in 2006 (6%), 2007 (12%), 2008 (23%).
In 2010, Vietnam transitioned from a low-income to a middle-income country, driven by significant development and a substantial rise in international trade and foreign direct investment over the past twenty years The nation is focused on building a solid foundation to achieve its goal of becoming a modern, industrialized country by 2020.
Balance of Payment of Vietnam
In the balance of payments, there are two main accounts: current account and capital account.
The current account is a key component of the Balance of Payments (BOP), and Vietnam's current account achieved a surplus of 0.20% of GDP in 2011 Looking back from 1990 to 2010, Vietnam's current account averaged -3.15% of GDP, with a peak deficit of 4.10% recorded in December.
1999 and the lowest of all time is -11.88% in December of 2008 The Current account balance as a percent of GDP is an indicator to show the international competitiveness of a country
Figure 2: Current account balance (% of GDP)
Vietnam's current account deficit indicates a reliance on strong imports and a high consumption rate, coupled with a low savings rate Unlike countries with a current account surplus that typically exhibit high export dependence and weak domestic demand, Vietnam's economic landscape reveals a different dynamic A comprehensive analysis of trade balance, including imports and exports, as well as net transfers and net income from abroad, will provide a clearer understanding of the current account situation.
The trade balance plays a crucial role in the current account, as it can either be in deficit or surplus, directly influencing the overall current account status Essentially, the trade balance provides insights into the current account's performance, which is illustrated in Figure 3, where the trends of the trade balance and current account balance closely align.
Current account balance(current US$) Trade Balance (current US$)
Figure 3: Trade balance and current account balance
According to Dollar and Kraay (2001), the ratio of imports and exports to GDP serves as a key indicator of trade openness, while the World Bank (2002) uses the trade/GDP ratio to classify countries as globalizers or non-globalizers In Vietnam, significant trade liberalization occurred between 1990 and 2010, driven by various trade policies that relaxed exchange rate, tariff, and non-tariff barriers, including quotas, customs surcharges, and quality inspections This shift towards more liberal and open trade was particularly pronounced following Vietnam's accession to the WTO.
2007 One of the most popular indicators to measure level of how open an economy is the ratio of trade and gross domestic products as figure 4.
Since 1990 until 2010, Vietnam Trade Balance averaged -3567.94 USD Million with the highest is -403.13 USD Million in December of 1992 and the lowest - 13852.57 USD Million in
2008 In 1990-2006, the deficit in trade was not too large but it is suddenly extensive in 2007
Imports Exports Trade Balance (current US$) and reached to alarming level in 2008 with the largest contributor to the current account deficit, at US$12.3 billion.
Figure 4: Ratio of trade and gross domestic products, 1900-2010 (Trade/GDP)
The country's exports primarily consist of raw materials, rubber, oil, seafood, and electronics, with the United States, Australia, Japan, and China being the main destinations Additionally, significant imports include petroleum, steel, fabrics, and plastics, primarily sourced from Japan, South Korea, China, Thailand, and Singapore.
Figure 5: Imports, Exports and Trade balance, 1990-2010
Since 1990, exports have experienced an average growth rate of 16.12%, surpassing the 15.02% growth rate of imports; however, the total value of exports remains lower than that of imports This trend is not particularly concerning, as imports play a crucial role in supporting domestic production and exports.
Transfers play a crucial role in enhancing the absorptive capacity of the recipient economy, supporting the Balance of Payments (BOP) While these non-debt inflows are generally less volatile than other foreign exchange sources, they still pose potential risks, such as Dutch Disease and challenges in managing money supply due to the threat of dollarization.
Figure 6: Net Transfers from abroad, 1990-2010
From 1990 to 2010, remittances from overseas Vietnamese played a crucial role in Vietnam's net transfer values, consistently remaining positive Between 1990 and 1995, the average net transfer was approximately US$ 142 million, which surged to US$ 1,045 million in 1996, largely influenced by the Asian financial crisis.
Net income from abroad (current US$)
In 1997, the value decreased to US$ 712 million, but from 1998 to 2008, it experienced a steady increase, reaching US$ 7,378.4 million However, in 2009, it fell sharply to US$ 672 million due to the adverse impact of the 2008 global financial crisis The value rebounded in 2010, achieving an all-time high of US$ 8,815.5 million.
Sakr (2006) explored the dual purposes of remittances, highlighting their significance in both "portfolio" and "altruism" contexts The study revealed a positive correlation between remittances and Vietnam's economic conditions, investment climate, and regulatory environment Consequently, remittances are identified as a crucial driver of economic growth through investment, positioning them as an essential source of balance of payments support.
Net income from abroad includes labor compensation (such as wages, salaries and bonus) and net property and entrepreneurial income, investment income (such as interest and profit) (IMF, 1993).
Figure 7: Net Income from abroad, 1990-2010
In 2010, Vietnam's net income from abroad reached US$ 4,418 million, as illustrated in Figure 6 Over the past two decades, this figure has varied significantly, ranging from a low of US$ -226 million in 1995 to a peak deficit of US$ -4,566 million in 2009.
Between 1990 and 2010, the economy frequently experienced current account and trade deficits, which hindered economic growth due to balance of payment issues Although capital account inflows helped bridge the gap in the current account and foster economic growth, they also introduced various costs and risks The following section will delve deeper into the capital account's role and implications.
The capital account tracks the net changes in a nation's assets, encompassing all investment flows, including foreign direct investment (FDI), portfolio investments, and other financial transactions, along with the reserve account.
Foreign direct investment (FDI) in Vietnam reached US$ 8.0 billion in 2010, reflecting a significant increase from US$ 180 million in 1990 Over two decades, FDI inflows grew at an impressive annual rate of 29.2% Notably, FDI surged from US$ 2.4 billion in 2006 to US$ 6.7 billion in 2007, marking a remarkable growth rate of 180%, largely driven by Vietnam's accession to the WTO in January 2007 The peak of FDI was achieved in 2008, with inflows totaling US$ 9.27 billion.
Foreign Direct Investment (FDI) plays a crucial role in enhancing foreign capital and savings, which helps stabilize the current account balance in Vietnam The country relies on importing essential capital goods, including machinery, parts, and petroleum products, often leading to a current account deficit Additionally, FDI not only fosters the development of more effective policies for the host nation but also promotes technology transfer, further contributing to economic growth.
MODEL SPECIFICATION AND FINDING
Model Specification and Data
This study investigates the consistency between Balance of Payments (BOP) equilibriums and actual GDP growth rates by determining the income elasticity of demand for imports (π) Many research papers utilize a multiplicative import function, represented as equation (9) By applying logarithmic transformations and calculating growth rates, this function is reformulated into equation (11), which is expressed as m = ψ (p f + e - p d ) + πy.
In this equilibrium, the growth of imports is influenced by the growth of terms of trade, which is multiplied by the price elasticity of demand for imports, as well as by domestic income, multiplied by the income elasticity of demand for imports.
Adding constant term α, error term ut, and subscript t into above equation, it turns out m t = α+ ψ (p ft + e t - p dt ) + π(y t ) + u t
We can rewrite the equilibrium by settting pt = (p ft + e t - p dt ) m t = α+ ψ.p t + π.y t + u t (21) m t : Rate of growth of import, p t is Rate of growth of relative price, y t is Rate of growth of GDP.
Instead of using directly growth rate of import and GDP growth rate in equilibrium, I use log (import) and log (GDP) to calculate the growth rate.
To determine the income elasticity of demand for imports (π), we utilize equation (22) Subsequently, we will integrate this elasticity into the balance-of-payments constraint equations (17), (18), (19), and (20) to analyze its relationship with economic growth Finally, we will compare these findings with Vietnam's real growth rate from 1995 to 2010.
Gathering data for my thesis presents challenges, but I am dedicated to sourcing information from reputable institutions I utilize official data from the International Monetary Fund, World Bank, and Vietnam General Statistical Office Specifically, I obtain quarterly export and import prices from the General Statistical Office, while the nominal exchange rates and quarterly gross domestic product figures are sourced from the IMF.
Regression results and findings
4.2.1Unit root tests for stationary
We conducted a unit root test to assess the stationarity of our time series data The results indicated that the absolute value of the ADF statistic for all variables—M (Import), Y (GDP), and Pt (rate of growth of relative price)—was less than the critical value, leading us to reject the null hypothesis Consequently, we conclude that all examined variables are stationary.
Table 1: Unit root test for stationary Variable Description 1% level 5% level 10% level Properties
M Growth rate of import -4.130526 -3.492149 -3.174802 Stationary
Y Growth rate of GDP -4.127338 -3.490662 -3.173943 Stationary p Growth rate of relative price -4.124265 -3.489228 -3.173114 Stationary
4.2.2Estimate income elasticity of import
We use OLS method to estimate coefficients of the equation [22] the result is showed in below table.
Variable Coefficient t-Statistic P Value LOG(GDP) 2.185929** 22.53676 0.0007
Note: ** denote the significance at the 5 per cent level
We find out the income elasticity of demand for imports in long run is 2.18.
The calculated income elasticity of demand for imports reveals statistically significant coefficients, indicating that the structure of imports primarily consists of intermediate inputs for production This suggests a limited correlation with both nominal and real exchange rates Notably, the income elasticity of demand for imports exceeds 1, a finding consistent with developing countries, which often rely on imported intermediate goods to bolster domestic production and economic growth This theoretical framework is particularly applicable to the case of Vietnam.
The econometric model passes several key diagnostic tests, including the LM test for serial correlation, CUSUM test for parameter stability, White’s test for heteroscedasticity, Jarque-Bera test for normality, and Ramsey’s RESET test for functional form These results confirm that the model's coefficients are unbiased, efficient, and consistent.
Thirwall’s law in Vietnam
In Chapter II, we analyze the Balance of Payments (BOP) growth rates under various initial equilibrium conditions relevant to Vietnam, considering factors such as capital inflow, remittances, and debt For clarity, we outline four forms of BOP for Vietnam: the basic form is represented by the equation ybasic = x/π, while the external form is given by yext = [θx + (1- θ)(f- p d)]/π Additionally, the remittance form is expressed as yremit = [ωx + (1- ω)(r- p d)]/π, and the debt form is detailed in the equation ydebt = [θx + (1- θ)(f- p d) - (1-p)(d- p d)]/pπ.
This study analyzes the income elasticity of demand for imports in Vietnam, utilizing empirical data to assess the variables ybasic, yext, yremit, and ydebt from 1995 onwards.
2010 after that we compare with the actual growth rate in order to know if economic growth in Vietnam constrained with the balance of payment or not.
Table 3: Actual Growth Rate and Estimated BOP Constrained Growth Rates
Year Real Y Ybasic Yext Yremit Ydebt
The analysis of Table 3 reveals strong correlation coefficients among the variables, with the actual value (y) showing a correlation of 0.825 with the extended value (yext), 0.722 with the remittance value (yremit), and 0.765 with the debt value (ydebt), as illustrated in Table 4.
Table 4: Correlation coefficients of Actual Growth Rate and Estimated Growth Rates
The model employs various testing steps, including unit root tests for stationarity, Granger causality tests, Jarque-Bera tests for normality, LM tests for serial correlation, and CUSUM tests for parameter stability The long-run income elasticity of demand for imports is estimated at 2.18, which is shown to be unbiased, efficient, and consistent after the aforementioned tests Utilizing this result, we derive estimated balance of payments (BOP) constrained economic growth rates under different equilibrium conditions as detailed in Chapter II Additionally, the coefficients of correlation between actual income and external income sources, such as remittances and debt, are found to be closely aligned, as illustrated in Table 4.
Between 1990 and 2010, Vietnam experienced significant trade and current account deficits, which, if left unaddressed, could hinder economic growth due to balance of payments constraints Therefore, capital account financial sources, including foreign direct investment (FDI) and external debt, are crucial for promoting economic growth in the country.
Foreign Direct Investment (FDI) not only provides essential funding to address foreign exchange and savings-investment gaps but also delivers a comprehensive array of physical capital, production techniques, managerial expertise, and effective business practices These elements contribute to positive externalities in host countries through processes such as transmission, diffusion, and spillover effects, often referred to as the demonstration effect.
External debt is crucial for addressing the current account deficit, as it facilitates necessary financial inflows However, the accumulation of high external debt has led to rising scheduled amortization and interest payments in recent years Since 1990, the total debt as a percentage of GDP and exports has significantly decreased, indicating improved financial health Notably, the debt-to-export ratio suggests a strong capacity for debt servicing, reflecting an optimistic outlook for economic stability.
Vietnam has addressed its foreign exchange shortage primarily through foreign direct investment (FDI), along with some support from debt and net transfers Additionally, the influx of FDI has generated positive externalities, such as technology transfer and diffusion, which have significantly enhanced total factor productivity and, consequently, fueled economic growth.
Vietnam's economy has experienced several shocks that affect business cycles and lead to fluctuations in economic growth The growth trajectory can be divided into three distinct sub-periods: stabilization and acceleration from 1990 to 1997, recovery from 1998 to 2001, and integration from 2002 to 2007, each characterized by unique features and policy responses to internal and external changes Additionally, the structural transformation of the economy has been gradual, which is unexpected given the ongoing industrialization efforts and the push for enhanced competitiveness Furthermore, there exists an inverse relationship between economic growth and trade balance, with current account deficits being addressed through foreign direct investment (FDI), debt, and net transfers.
Economic growth would have faced limitations due to balance of payments issues if capital inflows had not offset the trade balance and current account deficits Consequently, the author will outline key conclusions and policy implications in the following chapter.
CONCLUSION AND RECOMENDATION
Conclusion
Between 1995 and 2010, Vietnam's economic growth was significantly driven by capital inflows from foreign direct investment (FDI), debt, and net transfers, primarily through remittances, despite facing a trade deficit The balance of payments could have hindered economic growth if not for these capital inflows Since 1995, Vietnam's investment environment has rapidly improved, marked by economic and political stability, fostering a positive outlook for foreign investors and leading to a substantial increase in capital inflows However, despite achieving a high economic growth rate, challenges related to trade balance and capital inflows remain.
Vietnam's trade balance challenges stem from its reliance on low value-added exports, primarily agricultural commodities and raw materials, which are susceptible to global price fluctuations and technical barriers from importing countries This dependency on low-priced goods, characterized by low income elasticity of demand, poses a risk of diminishing returns to scale Consequently, solely increasing export value through expanded production may not yield sustainable economic growth for the country.
Vietnam's import value is significant, primarily consisting of capital goods and intermediate products essential for domestic production and exports However, the reliance on inefficient import-substituting industries results in a trade-off, sacrificing consumer benefits for the advantage of producers over time Additionally, the government's obligation to open markets, a consequence of joining the WTO, is expected to exacerbate the trade deficit while aiming for robust economic growth.
Foreign Direct Investment (FDI) presents challenges related to debt and financial investment portfolios, particularly impacting Vietnam's current and capital accounts, especially the trade balance As highlighted in previous analyses, FDI carries inherent risks and is vulnerable to adverse economic and political shocks, influenced by foreign investor expectations Additionally, short-term capital inflows, such as portfolio investments, are even more susceptible to economic volatility and political changes, resulting in higher associated risks.
Vietnam's pursuit of high economic growth is unsustainable without addressing the ongoing challenges of large capital inflows and a persistent trade deficit To tackle these issues effectively, it is essential to implement policy measures that operate within the constraints of the balance of payments.
Recommendation
To achieve a high growth rate, Vietnam must address the balance of payments constraint by prioritizing the trade balance, which encompasses exports, imports, foreign direct investment (FDI), and external debt, as these elements are crucial to the country's balance of payments.
To enhance export growth, it is essential to diversify export markets by targeting new, non-traditional markets and providing subsidies for new export products to reduce market risks The government can address market failures, as highlighted by Stiglitz (2002), by actively working to alleviate asymmetric information issues, ensuring that investors receive comprehensive and timely information about market conditions.
To enhance productivity, export structures must focus on transitioning domestic production towards high value-added products while phasing out protections for inefficient industries and state-owned enterprises Additionally, the government can bolster domestic entrepreneurs by investing in robust infrastructure, which will lower production costs and time, thereby facilitating smoother market entry and exit for production firms.
The government should support domestic production of intermediate goods in Vietnam, as the country heavily relies on imports for capital and intermediate goods, which are essential for production and exports While concerns about trade deficits may prompt restrictions on imports, such measures could hinder economic growth This approach should be seen as a temporary solution In the long term, the government must promote market diversification and export structure improvements to secure foreign exchange for imports Additionally, creating suitable pathways for opening the domestic market can encourage protected industries to enhance their competitiveness.
Vietnam's capital flows consist of both equity and debt, increasing the cost of financing its current account deficit To address the trade and current account deficits, the government should enhance its legal framework and foster a favorable market environment to attract foreign direct investment (FDI) This approach will help eliminate inefficient enterprises while promoting efficient ones, thereby optimizing resource allocation Prioritizing FDI in the production of intermediate goods will reduce imports and lower the trade deficit Additionally, encouraging FDI in high-tech industries can elevate the value added to domestic and export goods An improved legal framework, aligned with international standards, is essential for ensuring fair treatment between domestic and foreign investors and minimizing corruption, especially as Vietnam is a member of the WTO.
External debt presents both risks and costs, with a notable rise in non-concessionary loans despite the majority being concessionary and long-term with no repayment bunching (IMF, 2009) The government must assess and prioritize the allocation of capital inflows to ensure they are directed towards the most efficient projects and programs, optimizing the benefits of financing.
Limitation
While I have made efforts to address various issues in this research project, there are areas for improvement, particularly in the data collection stage The reliance on multiple sources may compromise data reliability, and the availability of only yearly data limits the ability to run comprehensive regression analyses, despite its advantages for this thesis Additionally, the constraints of the model used hinder a detailed exploration of policy implications It is advisable for the government to diversify the structure of exports, yet the question of how to achieve this remains unresolved Future research should aim to obtain more extensive yearly data and provide a thorough examination of strategies for structural change.
OLS Regression result
Dependent Variable: LOG(IMPORT) Method: Least Squares
Date: 09/05/12 Time: 14:56 Sample: 1995Q2 2010Q4 Included observations: 63
Variable Coefficient Std Error t-Statistic Prob.
Adjusted R-squared 0.891245 S.D dependent var 0.787574 S.E of regression 0.259726 Akaike info criterion 0.188069 Sum squared resid 4.047458 Schwarz criterion 0.290123 Log likelihood -2.924187 Hannan-Quinn criter 0.228208
Unit root tests for stationary
Null Hypothesis: D(IMPORT) has a unit root Exogenous: Constant, Linear Trend
Lag Length: 5 (Automatic based on SIC, MAXLAG) t-Statistic Prob.*
Augmented Dickey-Fuller test statistic -5.688887 0.0001 Test critical values: 1% level -4.130526
Augmented Dickey-Fuller Test Equation Dependent Variable: D(IMPORT,2) Method: Least Squares
Date: 10/16/12 Time: 15:41 Sample (adjusted): 1997Q1 2010Q4Included observations: 56 after adjustments
Variable Coefficient Std Error t-Statistic Prob.
D(IMPORT(-1)) -2.359573 0.414769 -5.688887 0.0000 D(IMPORT(-1),2) 1.333195 0.378929 3.518328 0.0010 D(IMPORT(-2),2) 0.996153 0.326934 3.046953 0.0038 D(IMPORT(-3),2) 1.035517 0.269861 3.837223 0.0004 D(IMPORT(-4),2) 0.611413 0.195309 3.130496 0.0030 D(IMPORT(-5),2) 0.709146 0.135725 5.224874 0.0000
Adjusted R-squared 0.695372 S.D dependent var 1.51E+09 S.E of regression 8.33E+08 Akaike info criterion 44.04949 Sum squared resid 3.33E+19 Schwarz criterion 44.33883 Log likelihood -1225.386 Hannan-Quinn criter 44.16167
Null Hypothesis: D(GDP,2) has a unit root
Lag Length: 3 (Automatic based on SIC, MAXLAG) t-Statistic Prob.*
Augmented Dickey-Fuller test statistic -11.84121 0.0000 Test critical values: 1% level -4.127338
Augmented Dickey-Fuller Test Equation
Variable Coefficient Std Error t-Statistic Prob.
Adjusted R-squared 0.998678 S.D dependent var 80048.07S.E of regression 2910.990 Akaike info criterion 18.88967
Sum squared resid 4.32E+08 Schwarz criterion 19.10473 Log likelihood -532.3557 Hannan-Quinn criter 18.97325
Test with p series (relative Price)
Null Hypothesis: PRICE has a unit root
Lag Length: 4 (Automatic based on SIC, MAXLAG) t-Statistic Prob.*
Augmented Dickey-Fuller test statistic -3.812947 0.0228 Test critical values: 1% level -4.124265
Augmented Dickey-Fuller Test Equation
Variable Coefficient Std Error t-Statistic Prob.
PRICE(-1) -0.719912 0.188807 -3.812947 0.0004 D(PRICE(-1)) 0.283438 0.198048 1.431155 0.1585 D(PRICE(-2)) 0.139611 0.170586 0.818424 0.4169 D(PRICE(-3)) 0.000267 0.151777 0.001758 0.9986 D(PRICE(-4)) 0.521847 0.131280 3.975075 0.0002
Adjusted R-squared 0.500557 S.D dependent var 2.362166 S.E of regression 1.669372 Akaike info criterion 3.975534 Sum squared resid 142.1270 Schwarz criterion 4.224208 Log likelihood -108.2905 Hannan-Quinn criter 4.072398
Granger Test for Causality
In order to test the causality between variables in regression I use Granger test and the result show that all the variables do not Granger Cause each other.
Pairwise Granger Causality Tests Date: 10/16/12 Time: 16:52 Sample: 1995Q2 2010Q4 Lags: 2
Null Hypothesis: Obs F-Statistic Prob.
IMPORT does not Granger Cause GDP 61 20.0072 3.E-07
GDP does not Granger Cause IMPORT 3.32413 0.0432
PRICE does not Granger Cause GDP 61 6.51491 0.0029
GDP does not Granger Cause PRICE 11.2962 8.E-05
PRICE does not Granger Cause IMPORT 61 1.82621 0.1705IMPORT does not Granger Cause PRICE 0.14612 0.8644
LM-test for serial correlation
The Breusch–Godfrey serial correlation LM test, developed by Breusch and Godfrey in 1978, is designed to detect autocorrelation in the residuals of a regression model This test utilizes the model's residuals to derive a test statistic, with the null hypothesis stating that there is no serial correlation, while the alternative hypothesis suggests the presence of autocorrelation At a 5 percent significance level, if the null hypothesis cannot be rejected, it indicates that autocorrelation is not present in the model's errors.
Breusch-Godfrey Serial Correlation LM Test:
Obs*R-squared 18.94532 Prob Chi-Square(2) 0.0001
Dependent Variable: RESID Method: Least Squares Date: 10/16/12 Time: 16:00Sample: 1995Q2 2010Q4Included observations: 63Presample missing value lagged residuals set to zero.
Variable Coefficient Std Error t-Statistic Prob.
Adjusted R-squared 0.252493 S.D dependent var 0.255503 S.E of regression 0.220904 Akaike info criterion -0.106142 Sum squared resid 2.830309 Schwarz criterion 0.063948 Log likelihood 8.343460 Hannan-Quinn criter -0.039244
Test for Normality with Jarque-Bera test
The Jarque-Bera (JB) test is a widely used standard normality test that evaluates the null hypothesis, which states that the residuals are normally distributed This test aims to determine whether the null hypothesis of normality can be accepted at significance levels of 5 percent or 1 percent.
White's test for Heteroscedasticity
Obs*R-squared 13.84003 Prob Chi-Square(5) 0.0167 Scaled explained SS 8.669172 Prob Chi-Square(5) 0.1230
Variable Coefficient Std Error t-Statistic Prob.
(LOG(GDP))^2 -0.104878 0.081133 -1.292669 0.2013 (LOG(GDP))*PRICE 0.029601 0.014161 2.090369 0.0411
R-squared 0.219683 Mean dependent var 0.064245Adjusted R-squared 0.151234 S.D dependent var 0.076110S.E of regression 0.070119 Akaike info criterion -2.386857Sum squared resid 0.280249 Schwarz criterion -2.182749Log likelihood 81.18601 Hannan-Quinn criter -2.306581F-statistic 3.209447 Durbin-Watson stat 1.817671Prob(F-statistic) 0.012728
Ramsey RESET Test
Log likelihood ratio 4.237437 Prob Chi-Square(2) 0.1202
Variable Coefficient Std Error t-Statistic Prob.
Adjusted R-squared 0.894813 S.D dependent var 0.787574 S.E of regression 0.255430 Akaike info criterion 0.184301 Sum squared resid 3.784176 Schwarz criterion 0.354391 Log likelihood -0.805468 Hannan-Quinn criter 0.251198
CUSUM test for stability of the estimated parameters
To assess the parameter stability of the model, we employed the CUSUM test, which utilizes cumulative sums of scaled recursive residuals and visualizes the CUSUM statistic over time Under the null hypothesis of constant parameters, the expected value of the CUSUM statistics is zero The results indicate that, with a 5 percent significance confidence bound, the CUSUM statistics remain within the confidence bounds around zero Consequently, we do not reject the null hypothesis of parameter constancy, confirming that the CUSUM test supports the null hypothesis at the 5% level.
The estimated growth rate in the basic model
The estimated growth rate in the extended model
The estimated growth rate in the extended model with remittance
The estimated growth rate in the extended model with debt
Year x θ 1-θ Pd f f-Pd p d d-Pd 1-p Ydebt
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