The Impact of Foreign Direct Investment on Economic Growth: A case study of Vietnam Name: Luong Hai Dinh Student ID: 22080922... The FDI, economic growth, job creation, impoverishment, a
INTRODUCTION
Background
Economic growth is a crucial indicator of a country's development, especially for emerging nations striving for social stability Governments in these countries focus on reducing unemployment and poverty Although Vietnam has made significant progress since the end of the war in 1975, it remains a developing nation with limited domestic revenue and private sector investment Consequently, over the past decade, foreign direct investment (FDI) has become a vital funding source for Vietnam's economic advancement (UNCTAD, 2023).
The table below shows the growth of FDI inflows in Vietnam:
Figure 1.1 FDI in Vietnam 1986 – 2022 (USD billions)
Vietnam has adopted various investment-friendly policies to attract foreign direct investment (FDI), aiming to accelerate economic growth and reduce unemployment Since gaining independence in 1975, the Government of Vietnam has prioritized economic reforms to entice FDI from Europe and America, ultimately improving the standard of living in the country As a result of these reforms, FDI in Vietnam has significantly increased, soaring from USD 30 million in 1985 to USD 4,146.13 million.
Foreign Direct Investment (FDI) has significantly enhanced Vietnam's economic growth and improved living standards While research has explored the impact of FDI on the nation's economy, existing studies face limitations in their methodologies and reference periods, necessitating updates for more accurate insights.
Research problem
Since 1985, foreign direct investment (FDI) has positively impacted the Vietnamese economy by boosting economic growth, creating jobs, and alleviating poverty over time However, research shows mixed results regarding FDI's contributions to host economies, particularly in developing nations Key factors influencing these varying outcomes include total factor productivity, as outlined by the Solow-Swan Model, and other elements highlighted by the Malign Model, such as the host nation's absorptive capacity and the potential crowding out of local firms, especially with market-seeking FDI While some countries have benefited significantly from FDI, others have experienced negative effects.
A 2013 study examining the effects of foreign direct investment (FDI) on employment across seven developing countries produced varied outcomes; specifically, FDI reduced unemployment in Thailand but increased it in Turkey and Argentina This study aims to explore the impact of FDI on economic growth in Vietnam, highlighting the existing gap in knowledge surrounding this important topic.
Newly industrialized nations such as Hong Kong, Singapore, and Korea have demonstrated that attracting foreign direct investment (FDI) can lead to significant economic growth, offering valuable insights for Vietnam This study's findings are crucial for Vietnamese policymakers, investors, communities, and academics, as they highlight the need for effective regulations to enhance FDI in key sectors that stimulate regional economies and create job opportunities By implementing pro-investment policies, Vietnam can position itself as a more appealing destination for FDI, ultimately fostering growth and improving income and welfare, particularly for the rural and urban poor, thereby aiding in poverty alleviation.
Research objectives
The main objective of this study is to examine how FDI affects employment and economic growth in Vietnam The impacts include:
to provide an analysis of economic growth in Vietnam in recent decades
to provide in-depth understanding of FDI, including its worldwide trend, advantages, and disadvantages
to assess the extent to which FDI has influenced employment in Vietnam;
to assess the impact of other economic factors (human capital, inflation, trade openness and domestic investment) contributed to Vietnam’s economic growth.
Data and Methodology
This analysis examines the relationship between Foreign Direct Investment (FDI), economic growth, job creation, impoverishment, and human capital in Vietnam, utilizing annual time series data from 2000 to 2021 Key data sources include the Vietnam Bureau of Statistics and the World Bank Development Indicators (WDI), supplemented by information from the IMF and the Bank of Vietnam.
United Nations Conference on Trade and Development (UNCTAD) were other sources of data.
Dissertation Outline
There are 7 chapters in this dissertation
In Chapter 1, a background of the research topic will be provided, including research objectives and research problems
In Chapter 2, the political, governmental and economic history of Vietnam is given an overview
It examines the transition of Vietnamese economy since independence
In Chapter 3, the historical context of foreign investment in Vietnam is analysed along with the legal framework that creates an enabling environment for investment
In Chapter 4, theories about FDI will be discussed as well as its importance to an economy
Chapter 5 presents the theoretical framework and defines the variables and data collection process An explanation of the hypotheses proposed in the research is also provided
In Chapter 6, the effects of FDI as well as some other factors on economic growth in Vietnam will be discussed in depth
In Chapter 7, the study is summarised, along with its conclusions, limitations, and some recommendations for future research topics.
Vietnam – a developing economy
Overview of Vietnam
Vietnam boasts rich natural resources, including mineral deposits, freshwater fish, fertile land, and a tropical climate with ample rainfall Agriculture is the backbone of the economy, employing over 70% of the workforce (GSOV, 2021) At the time of its independence, Vietnam had a dynamic, youthful, and diverse economy.
1975, and this was due to the country's enormous natural resources.
Economic reforms
Following its independence from the USA, the government initiated significant economic reforms aimed at stimulating growth and reducing poverty, with support from the World Bank and IMF In 1997, the government launched the Poverty Eradication Action Plan (PEAP), which comprised five key components to facilitate the Economic Reform Program (ERP).
Managing the economy; Pillar 2: Improving output, competitiveness, and income; Pillar 3: Disaster management; Pillar 4: Good governance; and Pillar 5: Human development
PEAP aims to alleviate poverty by fostering robust economic growth and job creation It focuses on enhancing human capital development and optimizing fiscal policy reforms Additionally, it addresses inflation through targeted monetary and financial reforms Finally, the initiative implements trade strategies to boost private investment while facilitating global trade, communication, and tourism.
With the implementation of these reforms, the GDP went up from more than USD 6.29 billion in
From 1989 to 2022, Vietnam's GDP surged from USD 408.80 billion, reflecting a consistent growth trend with GDP growth rates consistently exceeding 6% Economic and social indicators demonstrate robust growth in Vietnam's economy from 1986 to 2022, largely attributed to the government's implementation of significant macroeconomic reforms.
Government expenditure reforms
The Medium-Term Economic Framework implemented by the government introduced significant fiscal policy changes aimed at enhancing management, accountability, and efficient use of public resources while reducing poverty By funding public projects through domestic tax revenue and grants, these fiscal reforms sought to promote transparency in the national budget process Consequently, government spending surged dramatically since 1990, totaling nearly 785,000 billion VND (approximately USD 32.63 billion) by 2022.
Figure 2.4: Total government spending in billion VND from 1990 – 2022
The sectoral composition of government spending reflects the GOV's priorities The government's primary interests are public administration, defense, and education.
Vietnam’s openness policy
A country's openness is demonstrated through its trade policies and foreign direct investment (FDI), facilitating access to global markets that foster innovation and technology transfer (Ramanayake & Lee, 2015) For developing nations like Vietnam, such openness provides access to niche export markets and affordable advanced manufacturing technologies, enhancing the standard of living by offering cheaper goods and boosting domestic production The government promotes openness to stimulate trade and investment, aiming to drive economic growth, create jobs, and reduce poverty, exemplified by the Export-Led Growth Strategy (ELGS) initiative.
Openness in Vietnam plays a crucial role in enhancing capital accumulation and productivity, significantly contributing to the growth of GDP per capita.
International flows from industrialized to developing nations are facilitated by greater openness, enabling Vietnamese products and services to access global markets This openness allows businesses in Vietnam to benefit from technology transfers, particularly in information communication technology (ICT), through imports The movement of people enhances the transfer of skills acquired both domestically and abroad Furthermore, Vietnam has the potential to become an even more attractive tourist destination Foreign Direct Investment (FDI) fosters capital accumulation, which in turn boosts output and productivity The advantages of trade for Vietnam can be measured through four key factors: contributions to the current account, tax revenue, production levels, and overall productivity.
Economic growth after the adoption of Economic Reforms
In the early 1980s, Vietnam initiated economic reforms that spurred remarkable growth, with GDP at constant market prices soaring from USD 2,708 million in 2000 to USD 16,406 million in 2022 The capital stock also saw significant expansion, increasing from approximately USD 12,900 million to USD 81,500 million, representing an annual accumulation of USD 35,300 million and a growth rate of 6.6% per year Concurrently, inflation rates dramatically decreased from 158% to 4.3%, indicating Vietnam's successful efforts towards achieving macroeconomic stability.
Vietnam's economy has experienced remarkable growth following significant reforms, with GDP growth rates consistently exceeding 6% from 2003 to 2022 Notably, the country demonstrated resilience during the 2008–2009 global financial crisis, showcasing its adaptability and diverse economic foundation The implementation of economic reforms, trade liberalization, and strategic policies to attract foreign investment have been pivotal in establishing Vietnam as a manufacturing and export hub, thereby enhancing overall economic performance.
Between 2000 and 2005, Vietnam experienced robust economic growth, with an average GDP increase of 6.9% annually, peaking at 7.5% in 2005, making it the third-largest GDP growth globally, behind China and India However, the subsequent periods of 2006–2010 and 2011–2015 saw a decline in average GDP growth to 6.3% and 5.9%, respectively, largely influenced by the 2007–2008 financial crisis, which caused a significant drop to 5.6% in 2008 Following this, Vietnam's GDP growth showed signs of recovery, reaching 6.4% in 2010, but then decreased to 6.2% in 2011 and 5.3% in 2012 From 2016 to 2019, the average GDP growth rebounded to 6.8%, surpassing the five-year plan's target.
In 2020, the global economy faced severe challenges due to the COVID-19 pandemic, yet Vietnam managed to achieve approximately 3% growth, distinguishing itself as one of the few countries worldwide to experience positive economic expansion during this crisis (World Bank, 2023).
Vietnam has experienced significant economic growth, leading to substantial improvements in the well-being and living standards of its citizens This transformation has enabled the country to transition from a poor, underdeveloped nation to a recognized middle-income country on the global stage.
2008 GDP increased by 18 times from the first year of the economic reform to about 262 billion USD in 2019 (World Bank, 2023)
Figure 2.5 – GPD growth rate in Vietnam from 2003 – 2022 (World Bank, 2023)
The percentage of the population living in poverty has decreased, going from roughly 66% in
Between 1985 and 2022, the percentage of people living in poverty decreased significantly from 20%, while GDP per capita rose from $185 to $434 Despite this economic growth, approximately 43% of the population, equating to over 15 million individuals, were categorized as insecure non-poor in 2022 Additionally, income inequality worsened during this period, as evidenced by an increase in the Gini coefficient from 0.36 in 1992 to 0.40.
2014 The administration continues to prioritise eliminating poverty.
FDI and Investment regulations in Vietnam
FDI Inflows into Vietnam
After gaining independence, the new government focused on restructuring the economy with two main objectives: diversifying the economy and enhancing national prosperity With the US no longer in control, it was crucial to establish both economic and political influence, empowering local communities and fostering an indigenous economy To achieve these goals, the government enacted the Vietnam Industrial Act in 1978, which aimed to attract international investors while promoting local participation in industrial development.
Vietnam remains a prime destination for foreign investment, driven by robust economic growth Recent data from the Ministry of Planning reveals that the country's provinces attracted over $27.5 billion in foreign direct investment (FDI), highlighting its appeal to international companies.
In 2022, Vietnam attracted foreign direct investment (FDI) from 108 countries and territories, with Singapore leading the way by contributing approximately $6.5 billion, which represents about 25% of the total FDI for the year South Korea followed as the second-largest investor, registering around $5 billion, bolstered by major tech firms like LG and Samsung, and has cumulatively invested over $80 billion in Vietnam since its entry 30 years ago Japan, China, and Hong Kong ranked as the third, fourth, and fifth largest sources of FDI in Vietnam for 2022, highlighting the country's growing appeal to East Asian investors.
Denmark, which made a $1 billion investment in Vietnam to construct its Lego factory in Binh Duong, came in 6 th (Alpuerto, 2022)
Recent modifications in Vietnam's investment landscape indicate a notable shift from agriculture to other sectors, particularly manufacturing, which has attracted significant foreign investment in import-substitution consumer goods such as sugar, tea, bread, and soap Additionally, emerging industries in real estate, hospitality, catering, and community services, including educational institutions and hospitals, are gaining traction This trend positions Vietnam as an attractive investment destination, bolstered by donor support for the establishment of an investment-friendly regulatory environment.
Investment regulations in Vietnam
Vietnam actively engages in bilateral agreements, regional trade agreements (RTAs), and investment treaties, while being a member of the United Nations and its affiliated organizations The country's foreign direct investment (FDI) regulations embody international and regional commitments related to equality, transparency, conflict resolution, property rights, financial standards, and taxation restrictions.
The Most-Favored-Nation (MFN) clause prohibits countries from discriminating against their trading and investment partners under WTO agreements, and this principle is reflected in Vietnam's border regulations In Vietnam, both trade and investment partners receive equal treatment, adhering to the principle of reciprocity Consequently, all visitors, including tourists, are required to pay an entry visa fee of approximately USD $50 for a single-entry visa.
Company registration Investment license Obtain other licenses
Apply for utilities Obtain work permits Tax registration Implementation
Vietnam's liberalized economy allows international investors to establish businesses across various industries, having welcomed foreign direct investment (FDI) from approximately 108 countries among the 164 WTO members The process for initiating projects is streamlined, as all registered businesses under the Investment Law of Vietnam (UIA) adhere to a clear step-by-step procedure.
Figure 3.10: Necessary steps to start an FDI project in Vietnam
Investors must register their businesses as corporations with the Ministry of Justice upon entering Vietnam In accordance with the Vietnam Enterprise Law - 68/2014/QH13, it is essential for businesses to obtain a certificate of their Memorandum and Articles of Association, as well as a Certificate of Incorporation.
Step Two: Obtaining Investment Licence
Foreign Direct Investment (FDI) requires a minimum projected investment of USD 100,000 to obtain an investment license Once licensed, investors can access a range of services and additional licenses as part of an One-Stop Center (OSC) for investments.
Step Three: Obtaining Other Licences
Investment levels and areas of focus vary according to national priorities such as environmental concerns, job creation, and land use While all industries have undergone liberalization, each sector is governed by specific regulations, necessitating that some investors obtain additional secondary licenses.
Step Four: Application for Utilities
Electricity and water are essential utilities for investment Utility applications are required in order for investors to access services
Step Five: Obtaining Work Permits
According to the Decree 152/2020/ND-CP (Decree 152), foreign workers must obtain work permits
Every business is required to obtain tax identification numbers for its employees and VAT identification numbers for its operations The primary regulations governing these requirements include the Income Tax Regulations and Statutory Instruments, as well as VAT regulations and their associated statutory instruments.
In Vietnam, financial regulations are established to oversee the operations of financial institutions, including banks, brokers, insurance firms, and investment companies These regulations aim to protect investors, markets, and consumers, ensuring a level playing field and promoting financial stability By setting minimum requirements, they facilitate the flow of capital, investment, and savings mobilization, ultimately enhancing the economic performance of the country.
In 1997, the Vietnamese government eliminated all capital-account controls and restrictions on capital transfers, aligning with its liberalization policies Currently, there are no limits on imports, exports, or investments, except in specific cases related to GATS Regulations governing conversion and transfers are based on the Law on the State Bank of Vietnam 2010, ensuring monetary stability through strict oversight of financial institutions On June 26, 2019, the State Bank of Vietnam issued Circular 06/2019/TT-NHNN to regulate foreign exchange control for foreign direct investment (FDI), providing guidelines for fund transfers and promoting financial stability in the country.
Foreign Direct Investment (FDI) enterprises and investors engaging in business cooperation must establish direct investment accounts at licensed credit institutions, through which all capital contributions, transfers of principal capital, profits, and legitimate income must be conducted Non-residential foreign investors are also required to open indirect investment capital accounts in VND for indirect investments in Vietnam, with foreign currency investments needing to be converted to Vietnam Dong Additionally, residents who are not credit institutions must open bank accounts to facilitate the transfer of investment capital abroad and to repatriate profits and other earnings to Vietnam, adhering to regulations set by the State Bank of Vietnam (SBV).
To combat fraud and money laundering, various financial regulations, including the Anti-Money Laundering Act of 2012, have been established These regulations mandate that both senders and financial institutions gather customer information during financial remittances Foreign investors are permitted to transfer and exchange currencies relevant to their transactions, although certain exceptions apply to specific foreign investments that benefit from government incentives As per these restrictions, foreign direct investments (FDI) that seek government incentives must obtain approval from the Vietnamese Authority for Investment, and all transfers must align with the intended repatriation goals.
To comply with Vietnamese sanitary and phytosanitary standards, all investments must adhere to additional regulations Businesses are obligated to pay various taxes, which include both direct and indirect taxes, categorized as domestic and customs taxes.
FDI Theories and its economic importance
Definitions
To explain the theories of FDI, this chapter begins by defining some key terms
Portfolio investment refers to transactions involving securities without a lasting relationship or effective management control over the enterprise Securities include both negotiable and non-negotiable instruments, encompassing equity and debt securities, as well as investment fund shares Debt securities, such as bonds and notes, represent evidence of a debt, while equity securities consist of shares that provide claims on a corporation's residual value after creditor obligations are fulfilled Income from debt securities primarily comes from interest, and issuers must pay a minimum principal and interest to owners In contrast, equity shares generate revenue through dividends, requiring investors to contribute a mix of financial and non-financial assets.
Investments in a portfolio can be either domestic or international, with International Portfolio Investment (IPI) referring to cross-border investments where foreign investors acquire stakes in another country through stocks, bonds, and various assets without establishing long-term relationships or managerial control (Alfaro, 2014) Additionally, there are other forms of IPI where investors do not seek long-term connections or management control Capital flows primarily consist of two components: financial derivatives and residual investments.
Foreign Direct Investment (FDI) refers to a long-term investment made by a resident company in one economy (the direct investor) into a business (the direct investment enterprise) located in a different economy This enduring relationship indicates a significant level of influence on the management of the business, highlighting the commitment and interest of the direct investor in the foreign enterprise.
Foreign Direct Investment (FDI) involves the cross-border transfer of equity ownership by investors, providing them access to the assets of foreign businesses and additional resources such as loans and portfolio investments Unlike traditional investment portfolios, FDI offers unique privileges that facilitate deeper engagement FDI investors often maintain long-term involvement and direct management of the companies they invest in, which complicates the process of liquidation.
FDI Theories
The 'theory of absolute advantage' by Adam Smith and the 'comparative advantage theory' by David Ricardo established the groundwork for modern international trade theories Unlike earlier mercantilist views, these theories overlooked the role of Foreign Direct Investment (FDI) in production The Heckscher-Ohlin (H-O) theory, or factor endowment theory, later identified three key factors influencing a nation's trade: consumer tastes and preferences, the competitive advantage of utilizing accessible and low-cost factor inputs, and the role of technology in production Although FDI was not explicitly addressed in earlier theories, the H-O theory paved the way for subsequent FDI frameworks, including the Portfolio Investment Theory (PIT).
The Portfolio Investment Theory (PIT), initially rooted in market-based principles, was first introduced by Markowitz in 1952 Markowitz emphasized that portfolio selection should leverage the law of large numbers, ensuring that the actual yield closely aligns with the expected yield This approach advocates for diversification, enabling investors to enhance their expected returns by selecting securities that offer the highest potential returns.
In 1958, the Portfolio Theory of Money was developed based on four key assumptions: first, investors exhibit risk aversion; second, wealth is held in both monetary and non-monetary assets; third, the interest rate and real wealth allow investors to rank portfolios for optimal utility; and fourth, portfolio decisions are influenced by specific time frames.
Mundell's Capital Movements Theory, established in 1957, was a pioneering attempt to elucidate foreign direct investment (FDI) by building on the foundations of international commerce theories This model, an extension of the Heckscher-Ohlin (H-O) Theory and a response to the early Product Life Cycle Theory (PIT), illustrates how capital flows from high-tariff to low-tariff countries, assuming similar products and production factors As a result, trade and capital movements act as substitutes, leading to reduced imports However, Mundell's model did not address FDI's role as a factor input, highlighting the distinction between trade and capital flows Despite its limitations, Mundell's Capital Movements Theory remains a significant component of FDI theory.
4.2.3 Transaction Cost Theory as a Basis for FDI
Transaction costs, encompassing all expenses related to a company's operations, play a crucial role in influencing foreign direct investment (FDI) flows by enabling businesses to reduce costs and increase profits According to internalisation theory (Buckley & Casson, 1976), FDI arises for two main reasons: companies tend to establish operations in low-cost countries, and they may continue to localise their activities to minimize expenses until the benefits of further internalisation outweigh the associated disadvantages While this theory provides insight into FDI, it remains somewhat ambiguous in explaining the underlying reasons for internalisation and does not adequately account for short-term FDI dynamics.
Kojima distinguishes between trade-oriented FDI from Japan and anti-trade FDI from the USA, identifying five key driving forces based on the H-O and Rybczynski theories of comparative advantage He notes that trade-oriented FDI seeks natural resources, with multinational enterprises (MNEs) investing in products where the host nation has a comparative advantage due to disadvantages in the home country This results in increased imports of basic and manufactured goods, fostering vertical specialization Additionally, as wages rise in developed countries, developing nations gain a comparative advantage in labor-intensive industries, prompting developed countries to relocate these businesses to low-wage regions Consequently, labor-focused investment is characterized as export-oriented rather than import-substituting.
The FDI Exchange Rates Theory, proposed by Aliber in 1970, suggests that companies in countries with strong currencies, like the USA and the UK, are more likely to invest abroad, while those in countries with weak currencies face challenges in doing so For example, Vietnam attracts foreign direct investment (FDI) from nations with strong currencies, as currency depreciation enhances the host economy's international competitiveness and FDI profitability This trend indicates that regions experiencing currency devaluation tend to attract more FDI Additionally, businesses from strong-currency countries can easily borrow funds if they hold a better reputation than local firms in weaker currency nations Moreover, the value of foreign investments and assets in host countries tends to depreciate, as fewer units of foreign currency are required to purchase larger quantities in the host economy.
2015) Strong currency becomes revenue for foreign investors and enables foreign firms to invest abroad (Nelson, 2015).
The Economic Importance of FDI
Economic growth leads to increased employment and reduced poverty levels The mercantilists were the pioneers of export marketing techniques, promoting exports to achieve a favorable trade balance while discouraging imports (Carbaugh, 2004) However, their failure to recognize the role of international trade in economic development drew criticism Despite this, developing nations like the Asian Tigers have thrived since the early 1970s by implementing an export-oriented industrialization strategy grounded in comparative advantage (Palley, 2014).
Governments aim to enhance their terms of trade and address balance of payments issues through Foreign Direct Investment (FDI) and an Import Substitution Strategy (ISS) This strategy, initiated by developing countries like Mexico in the 1950s, focuses on fostering local production to reduce reliance on imported consumer goods While developing nations acknowledge their competitive advantages in certain sectors, they struggle to compete with industrialized countries due to trade barriers and advanced industrialization Ultimately, these countries anticipate that implementing ISS will lead to faster employment growth, reduced foreign exchange constraints, increased productivity, and lower poverty levels.
Brooks, Fan, and Sumulong (2003) identified five key advantages of Foreign Direct Investment (FDI) using panel data from 58 developing countries First, a 50% increase in domestic investment is linked to each dollar of capital inflow Second, the entry of foreign enterprises enhances sectoral output and reduces local prices by fostering entrepreneurship and increasing competition, leading to improved productivity through local firms' capacity expansion via education and training Third, foreign companies introduce technological innovations that significantly boost domestic production capabilities and GDP Fourth, FDI facilitates foreign exchange and offers local businesses substantial opportunities for capital infusion, driving long-term investment growth Finally, foreign businesses create innovative marketing and distribution channels that enhance access to international markets Hacke et al (2015) suggest that understanding a community's capacity to absorb capital is crucial for leveraging FDI to stimulate economic growth.
4.3.2 The Negative Effects of FDI on a nation
The Malign Model illustrates the adverse effects of Foreign Direct Investment (FDI) on a host country's economic prosperity According to Moran (1998), FDI has four primary negative impacts: it diminishes domestic savings and investment by extracting rent and draining local capital and foreign exchange resources Additionally, while FDI seeks to narrow the investment gap between developed and developing nations, it often displaces local producers, as foreign inputs frequently replace indigenous ones, thereby reducing domestic output Furthermore, although FDI is expected to benefit local suppliers through backward linkages, developing countries often do not extend similar advantages to their citizens Lastly, many multinational enterprises violate safety, health, and environmental regulations in the host countries where they operate.
Stiglitz (2001) critiques globalization by highlighting the detrimental impacts of foreign direct investment (FDI) on developing nations He notes that the IMF and World Bank promote economic reforms that often lead to multinational corporations (MNCs) exploiting natural resources through incentives like tax breaks and free land This low-cost project implementation results in significant tax revenue losses and diminished employment opportunities for heavily indebted poor countries (HIPCs) such as Vietnam Furthermore, while developing countries are urged to privatize state-owned enterprises (SOEs) and adopt market-based economies, MNCs that take over these SOEs frequently lack the incentive to invest in local communities, undermining potential benefits for the host nations.
Foreign Direct Investment (FDI) has varying impacts across different regions and countries, playing a vital role in poverty reduction despite mixed findings It facilitates technological transfer and provides essential physical capital, which underpins production, creates jobs, and contributes to the long-term alleviation of poverty To accurately assess the effects of FDI on host nations, Chowdhury & Mavrotas (2005) recommend conducting research tailored to specific countries.
Methodology and data
Modelling Economic Growth
The HDM is based on two key assumptions regarding economic growth: it posits that growth is driven by capital earned through investment in a closed economy, relying on limited capital and abundant labor Critics argue that this theory is outdated, particularly in the context of globalization, as it inaccurately suggests a closed economy to foreign capital flows and assumes a fixed capital output ratio without considering government influence While the model may effectively explain development in developed nations where savings are prevalent, it provides a foundational framework for identifying a savings gap in developing countries Consequently, saving emerges as a vital tool for future investments aimed at fostering economic growth Additionally, the model highlights the importance of technology in reducing the labor-to-capital ratio The discussion will further extend to the Solow-Swan Model and New Growth theory to explain economic development.
The Solow-Swan Model, an exogenous growth model, has its origins in the Harrod-Domar Model (HMD) and is named after economists Robert Solow and Trevor Swan.
In 1956, neo-classical economic growth theories marked a significant turning point, as highlighted by Dewan and Hussein (2001) Researchers Slow and Swan discovered that while labour and capital are variable, technological advancements significantly enhance productivity Consequently, a nation's GDP output is influenced by the effectiveness of labour and physical capital The Solow-Swan Model illustrates this relationship through the production function, which defines the output generated from specific inputs (Pindyck & Rubinfeld, 2001) This model operates under the premise that production relies on two primary inputs: labour and capital.
In which: Y = Output; A = Technical / productivity factor; K = Capital and L = Labour
Being the first proposed by Romer (1986), the theory asserted that constant growth can be produced endogenously Hence, the theory can be also known as the Endogenous Growth
The theory posits that technology and human capital are integral to economic growth, exhibiting increasing returns unlike physical resources Proponents of New Growth Theory argue that while capital can be accumulated, other inputs like labor and land cannot contribute similarly to economic expansion.
Figure 5.1: Links between democracy, economic level, FDI, and human capital
Endogenous economic growth is significantly influenced by foreign direct investment (FDI), particularly when it generates growing production returns through externalities and spillover effects (Hassan et al., 2013) Additionally, the accumulation of human and physical capital creates externalities that enhance long-term productivity Consequently, technological advancement is not a free resource; it is cultivated by market forces stemming from economic activities Ultimately, economic growth relies on the interplay between human capital and technology, with no presence of declining returns-to-scale.
Measuring Economic Growth
To assess a nation's economic growth, three primary methods are utilized: the income approach, which sums all payments made by businesses for production inputs to determine national income; the expenditure approach, which measures total payments for resources such as salaries and rent through final expenditures on goods and services; and the production approach, which calculates economic growth based on the total output of goods and services produced by businesses This research focuses on GDP, which quantifies a country's output in logarithmic terms.
Moreover, the Solow-Swan Model uses GDP to describe national output (y) As a result, GDP growth can be used as a substitute for economic growth ln(GDPGRt) = ln(GDPt) − ln(GDPt–1)
By employing GDP annual time-series data shown in logarithmic terms, the GDP rate of growth indicative of economic growth can be calculated using this methodology.
Methodologies and data
This study investigates qualitative research methodologies utilizing diverse techniques such as statistics, synthesis, interpretation, comparison, and induction In contrast, the quantitative research approach assesses the linear relationships between the variables in the model.
This study employs the Solow-Swan growth model, utilizing a Cobb-Douglas neo-classical aggregate production function to link macroeconomic growth with microeconomic principles It explores long-term economic growth through the lenses of capital accumulation, labor growth, and population increase Additionally, the inclusion of human capital is crucial, as it is widely regarded as a significant factor influencing foreign direct investment (FDI) spillover The accompanying table details all the variables utilized in the model.
GDP (GDPt – GDPt-1)/ GDPt GDP growth (annual %)
FDI Total FDI registered capital % of GDP
Domestic investment (DI) Domestic investment/GDP % of GDP
Labour (LABO) Percentage of employed workers who age 15 and above
% of total working age population
Trade openness (TO) Sum of exports and imports % of GDP
Inflation rate (IR) (CPIt – CPIt-1)/ CPIt CPI growth (annual %)
Table 5.3 List of variables used
Research by Borensztein et al (1998) and Adhikary (2015) has led to the development of an econometric model that integrates Foreign Direct Investment (FDI) along with key factors such as domestic investment, trade openness, inflation rate, and human capital as critical explanatory variables influencing economic growth.
The model designed for this research is:
Ln(GGR t ) = β 0 + β 1 Ln(FDI t ) + β 2 Ln(DI t ) + β 3 Ln(TO t ) + β 4 Ln(IR t ) + β 5 Ln(LABO) + àt
In which: β1, β2, …, β5 are coefficients of each independent variable
Ln is the natural logarithm of variables à is the error term,
The log-linear specification is commonly employed to estimate variable coefficients due to the nonlinear relationships among various factors This approach allows the coefficients of the log model to be interpreted as percentages or elasticities rather than fixed units Additionally, it is expected that foreign direct investment (FDI) inflows, domestic investment, trade openness, and human capital will positively influence economic development.
Vietnam, while the inflation rate tends to have a negative impact
Hypotheses of the study are as follows:
H1 (+): An increase in FDI inflows will boost economic growth
H2 (+): An increase in domestic investment will boost economic growth
H3 (+): An increase in trade openess will boost economic growth
H4 (+): An increase in human capital inflows will boost economic growth
H5 (-): An increase in inflation rate will hinder economic growth
This study analyzes the impact of foreign direct investment (FDI) on economic growth using annual time-series data from 2000 to 2021 The data collection began in 2000, following the implementation of the Law on FDI.
Foreign Investment in Vietnam, and FDI had little effect on growth at that time The General
The Statistics Office of Vietnam, in collaboration with the World Bank's World Development Indicators, will gather and compile essential statistics Foreign Direct Investment (FDI), export, and import figures will be converted into Vietnamese Dong using the annual average exchange rate, as these figures are initially reported in US dollars.
GDP FDI DI LABO TO IR
The table presents descriptive statistics for various variables, highlighting that Vietnam's GDP peaked at 9.34% and reached a low of 2.91% during the reference period, indicating significant fluctuations in economic performance.
In 2008, the highest Foreign Direct Investment (FDI) to GDP ratio was recorded at 9.71%, while the lowest was noted in 2006 at 3.39% Notably, FY2019 marked the peak in absolute FDI dollars, reaching approximately 7.2 billion dollars.
Figure 5.3 Vietnam FDI inflows from 1999 to 2021 period
In addition, it is worth noting that the labour rate has been always above 75% of the total population.
Results and Discussions
Regression analysis
To ensure the reliability of the scale, we must assess its internal consistency using the Cronbach's alpha coefficient, which should exceed 0.6, alongside a Corrected Item-Total Correlation ratio greater than 0.3 (Gliem & Gliem, 2003) This coefficient reflects the correlation level among the questionnaire's variables Following this evaluation, we can eliminate any variables that fail to meet these criteria and proceed with the remaining variables for further analysis.
We have the results of the first Cronbach's Alpha coefficient test:
Table 6.1 Cronbach's Alpha coefficient test
Cronbach's Alpha if Item Deleted
The initial results of the Cronbach's Alpha coefficient test indicate that all five variables have a Cronbach's alpha coefficient exceeding 0.6 and a variable-total correlation coefficient greater than 0.3 Therefore, these variables are deemed suitable for the subsequent correlation analysis.
Ln(FDI) Ln(DI) Ln(LABO) Ln(TO) Ln(IR)
** Correlation is significant at the 0.01 level (2-tailed)
As p-value of the independent variables are all less than 5%, we can conclude that these variables are correlated with the dependant variable (Ln(GDP)) at a 5% significance level
Variable Coefficient Std Error t-Statistics Prob
Table 6.3 illustrates the relationship between the dependent variable and five independent variables, highlighting that Foreign Direct Investment (FDI) positively influences economic growth, evidenced by a statistically significant coefficient of 0.2431 This indicates that a 1% increase in FDI inflows corresponds to a 0.243% rise in GDP growth, aligning with the views of FDI-led growth proponents (Borensztein et al., 1998; Lean & Tan, 2011; Insah, 2013; Iqbal & Abbas, 2015) FDI has been instrumental in establishing various industrial sectors in Vietnam, particularly those requiring advanced technology and high-value products, such as machinery, energy, computers, and telecommunications Furthermore, FDI has played an increasingly vital role in Vietnam's import and export activities, contributing significantly to the supply of foreign currency and the national balance of payments.
At a 5% significance level, domestic investment shows a strong and statistically significant relationship with economic growth in Vietnam This finding aligns with both economic and statistical expectations The beta coefficient of 1.6079 indicates that local investment positively influences Vietnam's economic growth more significantly than foreign direct investment, as evidenced by the higher beta value.
The adoption of the Enterprise Law in 2001 significantly simplified the formation of domestic private businesses, alongside political support for private enterprises, marking a pivotal moment in the development of the private sector Consequently, since 2001, there has been a consistent rise in the number of newly established private enterprises (Kokko & Tran, 2014).
Vietnam's economic growth is positively influenced by trade openness, including both imports and exports A reduction in trade restrictions tends to enhance economic growth in the country This aligns with research indicating a strong positive correlation between economic development and trade openness (Yaseen, 2014; Adhikary).
Over the past two decades, Vietnam has actively pursued trade policies that promote export growth while safeguarding local businesses, although the level of protection has notably decreased To date, Vietnam has signed over 90 bilateral trade agreements, including significant accords such as the Vietnam-US bilateral trade agreement and the ASEAN free trade agreement, as well as agreements with China, Japan, and South Korea Additionally, Vietnam's participation in the World Trade Organization (WTO) underscores its commitment to integrating into the global economy.
2007, and most recently the Trans-Pacific Partnership free trade agreements signed in 2015 As a result, numerous chances to draw investment into Vietnam have emerged
The hypothesis regarding the inflation rate has been validated, revealing that inflation negatively affects economic growth in a statistically significant manner Specifically, a 1% rise in inflation correlates with a decline of approximately 0.194% in economic growth Supporting this conclusion, Yaseen (2014) noted that elevated inflation rates diminish investment returns, heighten economic instability, and restrict business and industrial investments, ultimately leading to a slowdown in economic growth.
At the 5% significance level, human capital significantly influences economic growth, with a 1% increase in the labor force correlating to a 0.187% rise in economic growth This underscores the critical role of a skilled workforce in enhancing Vietnam's economic prospects Adhikary (2015) notes that greater human capital fosters economic growth by boosting aggregate output, mitigating declines in marginal productivity, promoting cross-sector knowledge transfer, and enabling reverse engineering Supporting this perspective, Olatunji and Shahid (2015) argue that higher educational attainment among workers can further stimulate economic growth.
Diagnostic tests
A diagnostic test is essential for confirming the quality of an estimated model, as shown by Salim et al (2015) The results indicate that the model successfully passes key diagnostic tests, including the Breusch-Godfrey Serial Correlation LM test, the Jacque-Berra normality test, and the ARCH test With all estimated statistics showing non-significant results (p-value > 0.05), the model exhibits no issues related to serial correlation, heteroscedasticity, or non-normality at a 95% confidence level.
Breusch-Godfrey Serial Correlation LM 1.726 0.1890
Conclusion and Recommendations
Foreign direct investment (FDI) plays a crucial role in transferring money and technology between developed and developing nations, significantly enhancing societal welfare This study employs time series analysis to explore the effects of inward FDI on Vietnam's economic growth from 2000 to 2021 The findings reveal that FDI inflows, along with domestic investment, trade openness, and human capital, positively influence economic growth, while inflation rates have a negative impact These results align with previous research on the subject.
Foreign Direct Investment (FDI) plays a crucial role in driving Vietnam's economic growth, necessitating the implementation of more fiscal and monetary policies to maximize the benefits of foreign investments The government should embrace openness as a fundamental philosophy in international trade to enhance FDI and boost exports Additionally, maintaining macroeconomic stability through effective inflation control is vital, as poor monetary policy can adversely affect domestic economic growth.
This study suggests that the Vietnamese government should simplify business startup procedures, minimize bureaucratic obstacles, manage costs effectively, enhance compliance with trade agreements, boost public investment in education and training, and foster collaboration between educational institutions and foreign-owned companies Implementing these strategies could enhance the attractiveness of foreign direct investment (FDI) and promote economic growth in Vietnam.
While this study presents significant findings, it has notable limitations Firstly, the lack of comparable regional or provincial data from 2000 to 2021 hinders the ability to assess the impact of foreign direct investment (FDI) on economic growth across different Vietnamese provinces Future research should focus on regional datasets and industry-specific FDI data to enhance understanding Secondly, employing the Granger causality test could provide valuable insights into the relationship between FDI and economic growth in Vietnam Additionally, examining how factors like industrial structure, policy regimes, infrastructure development, interest rates, and exchange rates influence FDI's impact on economic growth is essential Expanding the study to explore the effects of FDI-led growth on income distribution and poverty reduction could further enrich the analysis Lastly, while the Vietnamese government has made numerous changes to monetary, trade, and fiscal policies, the study could not evaluate the effects of financial and commercial liberalization on economic development and employment due to resource constraints Future research should investigate the influence of monetary policy variables, such as interest rates, on Vietnam's economic growth.
Adhikary, B K (2015) Dynamic Effects of FDI, Trade Openness, Capital Formation and Human Capital on the Economic Growth Rate in the Least Developed Economies: Evidence from Nepal
International Journal of Trade, Economics and Finance, 6(1)1-7
Adamu, J., Idi, A., & Hajara, B (2015) FDI and Economic Growth Nexus: Empirical Evidence from Nigeria (1970-2012) Journal of Economics and Sustainable Development, 6(6):87-89 Aliber, RZ (1970) A theory of direct foreign investment The International Corporation
Alpuerto, A (2022) Vietnam FDI In 2022: Biggest Investors And Top Recipients Retrieved from https://vietcetera.com/en/vietnam-fdi-in-2022-biggest-investors-and-top-recipients
Apergis, N, Asteriou, D & Papathoma, K (2012) The Explanatory Variables of Outward Foreign Direct Investment: Panel Evidence American Journal of Economics and Business Administration 4(4):207
Babula, R & Andersen, L (2008) The link between openness and long-run economic growth
Journal of International Commerce and Economics 2:31-50
Barry, F (2005) FDI, transfer pricing and the measurement of R&D intensity Research Policy, 34(5):673–681
Bahname, M (2012) Foreign Direct Investment and Economic Growth: Evidence from Southern Asia Atlantic Review of Economics, 2(2):34-48
Borensztein, E., De Gregorio, J and Lee, J W (1998) How does foreign direct investment affect economic growth? Journal of International Economics, 45(1):115–135
In 2023, Vietnam's landscape for Foreign Direct Investment (FDI) presents significant challenges that are yet to be addressed Despite its potential for economic growth, the country faces obstacles including regulatory complexities, infrastructure deficits, and geopolitical tensions that could impact investor confidence As Vietnam continues to attract global investors, understanding these challenges is crucial for navigating the evolving FDI environment Addressing these issues will be vital for sustaining economic momentum and enhancing the country's appeal as a prime investment destination.
Buckley, PJ & Casson, M (1976) Future of The Multinational Enterprise Springer
Carbaugh, RJ (2004) International Economics Thomson Southern Western
Chowdhury, A & Mavrotas, G (2005) FDI and growth: a causal relationship', Journal of Economic Literature 39
Circular 06/2019/TT-NHNN on Foreign Exchange Control of Foreign Direct Investment
Cortright, J.C (2001) New growth theory, technology and learning: A practitioner’s guide,
Denisia, V (2010) Foreign direct investment theories: An overview of the main FDI theories
European Journal of Interdisciplinary Studies 2(2):1-7
Fan, S & Zhang, X (2008) Public expenditure, growth and poverty reduction in rural Uganda
Foreign Investment Law and Investment Law 2014
Gamal, N (2008) How to attract foreign direct investment to invest in housing in Libya
University of Salford, Manchester, UK
Hassan, G., Aslam, M & Sakar, A (2013) Foreign Direct Investment, Human Capital and Economic Growth in Malaysia MPRA Paper 51930, University Library of Munich, Germany
Herring, RJ & Santomero, AM (2000) What is optimal financial regulation? The new financial architecture: Banking regulation in the twenty-first century, Wharton Financial Institutions
Idoko, C U., Idachaba, D., & Emmanuel, A (2015) The Effects of Foreign Direct Investment on Sustainable Development in Nigeria European Journal of Business and Management, 7(6):82-86
Iqbal, Z., & Abbas, K (2015) An Econometric Analysis of Foreign Direct Investment and Economic Growth of Pakistan Developing Country Studies, 5(11):16-25
Kokko, A., & Tran, T T (2014) Foreign Direct Investment and the Survival of Domestic Private Firms in Viet Nam Asian Development Review, 31(1):53-91
Khun, S (2018) The Impact of Foreign Direct Investment on the Economic Growth in Cambodia: Empirical Evidence International Journal of Innovation and Economics Development, 4:31–38 Law Foreign Investment in Vietnam in 1987
Law on State Bank of Vietnam 2010
Le Thao Huong, N (2022) Impacts of Foreign Direct Investment on Economic growth in Vietnam Journal of Economic and Banking Studies, 4:1-15
Lean, H H., & Tan, B W (2011) Linkages between Foreign Direct Investment, Domestic Investment and Economic Growth in Malaysia Journal of Economic Cooperation and Development, 32(4):75-96
Lin, C., Officer, MS & Shen, B (2014) Currency appreciation shocks and shareholder wealth creation in cross-border mergers and acquisitions Journal of Economic Literature 34
Macrotrends (2023) Vietnam GDP Growth Rate 1985-2023 Retrieved from https://www.macrotrends.net/countries/VNM/vietnam/gdp-growth-rate
Markowitz, H (1952) Portfolio selection The Journal of Finance 7(1):77-91
Moran, TH (1998) Foreign direct investment and development: The new policy agenda for developing countries and economies in transition Peterson Institute
Mundell, RA (1957) International trade and factor mobility The American Economic Review
Nam Hoai, T and Quynh Anh Mai, N (2015) The Impact of Foreign Direct Investment on Economic Growth: Evidence from Vietnam Developing Country Studies, 5(20):1-9
Nelson, RM (2015) US Sanctions on Russia: Economic Implications', Current Politics and Economics of Russia, Eastern and Central Europe 30(1-2):187
Palley, TI (2014) Milton Friedmans economics and political economy: an old Keynesian critique Hans-Bửckler-Stiftung, Germany
Pindyck, RS & Rubinfeld, DL (2001) Microeconomics 5 th edition, London: Prentice Hall International Inc
Olatunji, L., & Shahid, M S (2015) FDI and Economic Growth in Nigeria: A Co-integration Analysis Business and Economic Research, 5(1):243-261
PwC (2023) The New Anti-Money Laundering Law 2022 Retrieved from https://www.pwc.com/vn/en/publications/vietnam-publications/new-anti-money-laundering-law- 2023.html
Ramanayake, SS & Lee, K (2015) Does openness lead to sustained economic growth? Export growth versus other variables as determinants of economic growth Journal of the Asia
Romer, P.M (1986) Increasing returns and long-run growth The Journal of Political Economy 94(5):1002 – 1037
Salim, N J., Mustaffa, R., & Hanafiah, N J A (2015) FDI and Economic Growth Linkages in Malaysia Mediterranean Journal of Social Sciences, 6(4):652-657
Stiglitz, J (2001) Globalization and its discontents, 1st edition W.W Norton, New York
In 2021, Vietnam experienced significant foreign direct investment (FDI) activity, with China leading the way by contributing 472 projects, followed closely by Singapore with 410 projects and Hong Kong with 315 This influx of FDI highlights Vietnam's growing appeal as a destination for international investment, reflecting broader economic trends and opportunities within the region Statista provides comprehensive data and insights into these developments, showcasing the dynamics of FDI across various countries and industries For detailed statistics and further analysis, refer to Statista's resources.
Tobin, J (1958) Liquidity preference as behavior towards risk The Review of Economic Studies, 25(2):65-86
UNCTAD (2019) New regulations on foreign exchange took effect Retrieved from https://investmentpolicy.unctad.org/investment-policy-monitor/measures/3428/viet-nam-new- regulations-on-foreign-exchange-took-effect
World Bank (2023) Vietnam Overview Retrieved from https://www.worldbank.org/en/country/vietnam/overview#2
Word Data (2023) Inflation rates in Vietnam Retrieved from https://www.worlddata.info/asia/vietnam/inflation-rates.php
Yaseen, H (2014) The Impact of Foreign Direct Investment FDI on Economic Growth of Jordan European Journal of Business and Management, 6(39):121-128
Zhou, D., Li, S and Tse, D K (2002) The impact of FDI on the productivity of domestic firms: the case of China International Business Review, 11(4)465–484
Real GDP growth (Annual percent change)
GDP, current prices (Billions of U.S dollars)
Inflation rate, average consumer prices (Annual percent change)
Domestic Investment (Millions of US Dollars)