STRENGTHENING THE SPILLOVER EFFECTS OF FOREIGN INVESTED ENTERPRISES AND FDI ABSORPTIVE CAPACITY IN VIETNAM: SOME RECOMMENDATIONS FROM VCCI’S SURVEY OF FOREIGN INVESTED ENTERPRISES IN VIETNAM
Summary: Foreign Invested Enterprises (FIEs) are important contributors to employment, industrial output, and exports in Vietnam. Despite these gains, Vietnam has still not benefitted as much from investment inflows as the huge numbers on its balance of payments sheet imply. Nearly 30 years after its foreign investment law, the formal business connections between foreign and domestic investors remain small. As a result, Vietnamese domestic firms have not seen the technology and labor productivity spillovers that come with close cooperation with foreign partners. In spite of positive changes recently when more and more FIEs are about to import inputs from domestic private enterprises, there remains major differences across provinces, sectors, and countries of origin, especially by technology level of FIEs. To improve spillover, Vietnam would benefit most from education improvements that enhance the capacity of its labor force and technological sophistication of domestic enterprises. The strong effect of geographical proximity indicates that the current predilection of policymakers for industrial zones may inadvertently undermine spillover potential. Without basic enhancements in absorptive capacity, lucrative tax breaks and subsidies will likely continue to prove less effective than officials would prefer
Developing countries all over the world have provided hefty benefits to FIEs to attract their investment and Vietnam is no exception. Over the past years, Vietnam has offered FIEs in prioritized sectors a reduced Corporate Income Tax (CIT), lowering the standard rate from 25 percent to 10-20 percent for up to 30 years. In addition, these FIEs can have their land rental fees waived for up to 15 years.1 According to a survey of nearly 1,600 FIEs by end of 2015 conducted by the Vietnam Chamber of Commerce and Industry (VCCI)2, 62 percent of FIEs report receiving investment incentives.
There is indeed a multitude of benefits associated with FDI. For example, FDI can bring cashstrapped developing countries much-needed capital, create employment for booming populations, and is less prone to fleeing during economic downturns than portfolio investment. Therefore, during periods of weak growth, high unemployment, or tepid investment, one can justify incentive programs that encourage investments. However, if FDI is important only for
1Ministry of Planning and Investment. 2011. Investment Incentives. Retrieved February 2, 2016, from http://fia.mpi.gov.vn/detail/689/investment-incentives 2The PCI-FDI 2015 survey received responses from 1,584 enterprises coming from 43 different countries that are operating in 14 provinces and cities across Vietnam. These localities have the highest density of FIEs according to the General Office of Statistics
these reasons, then domestic and foreign investments should be promoted alike.3 In other words, a dollar of domestic investment is no different than a dollar of FDI. A more compelling argument for promoting FDI is that FIEs bring advanced technologies. Through contacts between FIEs and domestic firms, especially through supplier-customer relationships, locals may improve their technological prowess by receiving higher technical specifications, standards, and/or training in the use of new equipment, being held to a higher standard, or simply observing FIEs’ management techniques. The hope is that these technological spillovers will increase domestic firms’ productivity and raise the competitiveness of the Vietnamese private sector on the international stage. In this sense, a dollar of FDI is potentially worth more than a dollar of domestic economic activity because of the advanced technologies foreign firms introduce.
However, several empirical studies have shown that this theoretical benefit of technological spillover is not certain in practice.4 To facilitate such spillover, three conditions must be in place: backward linkages, geographical proximity, and absorptive capacity.
The first factor that facilitates technological transfer is FIEs’ dense backward linkages, i.e FIEs sourcing input from domestic firms. Motivated by the need for a high quality supply chain, corporate social responsibility, or even pressure from governments, FIEs often provide technical assistance to their domestic suppliers. For example, some FIEs have set up educational programs and technical seminars on components or established supplier support funds for its local suppliers to help its qualified suppliers finance “technology development, facility investment, and operations.”5 However, Vietnamese firms’ opportunities to take advantage of such assistance depend on their ability to become the suppliers of and form linkages with FIEs. Indeed, Vietnamese economists have expressed concerns that these backward linkages are limited, leading to little technology transfer.6
Given the importance of backward linkages, we drill deep into a question in the PCIFDI survey asking FIEs where they obtain their inputs. Figure 1 shows the number of FIEs that source their inputs from each type of supplier. The three main types of suppliers for FIEs are 1) domestic private suppliers, 2) foreign suppliers from home, and 3) foreign suppliers from a third country. Although 1,000 FIEs source from domestic private suppliers, 1,500 FIEs import inputs from home or a third country, suggesting that backward linkages between FIEs and domestic suppliers can still be improved
Figure 1: The Number of FIEs Served by Each Supplier Type
Source: PCI-FDI Survey Question A16, “Who are your suppliers of intermediate goods and services?” Note that private includes formally registered firms while household includes only household enterprises.
Importantly, the pattern of backward linkages also varies substantially across sectors. Figure 2 shows the percentage of input expenditure that the average FIE in that sector spends with each of four types of supplier. Finance and service are the two sectors with the most backward linkages because they rely heavily on human capital, which cannot be imported. In contrast, FIEs in manufacturing and mining import over half of their inputs from foreign suppliers. It seems that Vietnamese suppliers still can not meet the demand of these FIEs, limiting the potential for technological transfers in these sectors.
Figure 2: The Percentage of FIEs’ Input Expenditure Served by Each Supplier Type by FIEs’ Sector, 2010-2012
Adding historical perspective, however, paints a more positive picture for Vietnamese suppliers
(Figure 3). In 2013, only 45 percent of FIEs bought inputs from domestic private suppliers. This
number rose steadily in 2014 (62 percent) and in 2015 (68 percent), a statistically significant
increase each year. The percentage of FIEs who buy from other supplier types also all increase
over time (except for in-house sourcing), suggesting that FIEs are diversifying their sourcing
strategy, using more supplier types than before.
Figure 3: The Relationship Between Investment Incentives and FIEs’ Sourcing Strategies