Case study 2: Viet Nam’s FDI-led structural transformation

Viet Nam opened up to FDI in the late 1980s under the Doi Moi economic reform programme, and the significant flows of foreign investment the country attracted have been a major force driving structural economic transformation (UNCTAD, 2008). This was not due to any “natural” operation of market forces however, but the result of the authorities’ “steer and control” regulatory approach towards FDI.

(a) Choice of sectors

An important aspect of Viet Nam’s FDI strategy has been the channelling of investment to priority sectors, principally in export-oriented manufacturing. The processing and manufacturing industries accounted for 57 per cent of total registered investment at the end of 2015 (Hanh et al, 2017). Initially low-tech labour-intensive industries, such as apparel and footwear, were targeted for FDI, but this increasingly shifted to higher-technology areas such as electronics and automobiles.

The draft FDI strategy for the 2018–2023 period will push this further, promoting the manufacture of pharmaceuticals and medical equipment (Shira, 2017).

In contrast to many developing countries, Vietnamese authorities placed restrictions on FDI in service sectors such as telecommunications and finance (UNCTAD, 2008). As part of Viet Nam’s accession to WTO, it committed to lifting restrictions on FDI in these sectors, but even in 2017 the financial sector remained dominated

by four State-owned banks, which provided half of total credit and accounted for 45 per cent of banking sector assets (IMF, 2017). This gives the State considerable latitude to ensure the orientation of the financial sector is supportive to core policy objectives such as industrialization.

(b) Incentives

Despite Viet Nam’s favourable position in East Asia, cheap labour force and advantageous access to the United States market via a bilateral trade agreement from 2001, industrial competitiveness was initially low and significant subsidies to foreign investors were judged necessary (Gray, 2012). The most important of these were SEZs, which provided duty-free access to inputs, fiscal incentives and subsidized land and infrastructure. An important feature of Viet Nam’s FDI model is the devolution of investment promotion and facilitation functions to provincial governments.

(c) Control mechanisms

Subsidy recipients were compelled to become internationally competitive through a variety of institutional arrangements, or “control mechanisms” (Amsden, 2001). A critical factor was the dominance of State-owned enterprises over the domestic market, such that foreign investors had little choice but to export and therefore become competitive (Gray, 2012). In addition, the State imposed requirements around the balance of imports to exports and foreign exchange controls to promote export orientation, as well as local content requirements (MPI, 2003). Many of these disciplines had to be phased out after Viet Nam’s accession in 2007 to WTO, which bans their use.

(d) Evaluation

Viet Nam has seen huge increases in FDI alongside dramatic changes in the structure of its economy towards manufacturing and industry. Net FDI inflows increased from $180 million in 1990 to $2.4 billion in 2006; increased to $6.981 billion in 2007, when Viet Nam acceded to WTO; and has continued on an upward trend, reaching $12.6 billion in 2016 (UNCTAD, 2018). Meanwhile, GDP per capita increased from $97 in 1989 to $1,903 in 2013, and MVA as a share of GDP increased from 12.3 to 17.5 per cent over the same period (Chang et al, 2016). Manufacturing exports grew from $4.037 billion in 1997 to $92.9 billion in 2013, during which time the share of manufacturing in total merchandise exports increased from 46 per cent to 70 per cent.

While impressive, Viet Nam’s trajectory of structural change has not been on a par with that of China, which grew even faster and expanded its presence in medium

and high-technology sectors more effectively (Chang et al, 2016). Viet Nam has so far focused on low-technology sectors, but even there, technological spillovers from FDI have been limited – the garment industry, for instance, is predominantly based on assembly activities with higher value parts of the value chain located elsewhere (Gray, 2012; Chang et al, 2016). Efforts to promote technology transfer in the automobile sector were ineffective, because manufacturers were able to successfully lobby to prevent the enforcement of localization targets, partly because foreign investors in the sector had partnered with State-owned enterprises (Gray, 2012).

6. Policy implications

The case studies above and broader literature on investment policy in developing countries point towards the following policy implications for Africa and LDCs:

(a) Strategic investment promotion

Investment promotion should be closely aligned with an overarching national development strategy and specific industrial policy objectives. The choice of sectors to promote foreign and domestic investors should reflect the country’s particular long-term vision for economic transformation towards higher value added activities. Sector choice must also be based on an assessment of existing resources and productive capacities, or a clear plan for how they are to be acquired. Beyond targeting at the sector level, Governments should seek to identify clear opportunities for investment by developing specific bankable projects with well-defined business plans (UNCTAD, 2015).

(b) Smart incentive design

Fiscal incentives are commonly used by countries to attract foreign investors, but there is evidence that these are often redundant, as investors would have invested anyway (IMF et al., 2015). For all types of investment incentives, the likely costs (e.g. forgone tax revenue) should be clearly justified by expected benefits (e.g.

employment generation, technology spillovers) which are additional to what would have otherwise occurred. Where incentives aim to promote investment in infant industries, they should be time-bound and conditional on performance to increase competitiveness, with agreed monitoring and enforcement mechanisms aligned with the relevant political settlement (Khan, 2013b).

(c) Local production systems development

Attracting FDI is not an end in itself, but a means to enable the development of domestic production capabilities and a dense set of input–output linkages between sectors. To achieve this, domestic and foreign investment policy should foster the emergence of a well-integrated “local production system”, rather than an “enclave

economy” (Andreoni, 2018). This requires policies that incentivize foreign investors to transfer technology to the host country, procure locally and enter into joint ventures with domestic firms. At the same time, Governments must work actively to develop the productive capacities of domestic firms and workers through effective manufacturing extension services, skills development programmes, industrial financing and infrastructure provision. Investment promotion agencies should be tasked with linking foreign investors with domestic firms through information provision (e.g. supplier databases) and active brokering of supply relationships.

C. Industrial parks and special economic zones