Recognizing the role of FDI and the requirement of institutional reform in vietnam

 FULBRIGHT ECONOMICS TEACHING PROGRAM 
October, 2015 
DO THIEN ANH TUAN 1 (tuandt@fetp.edu.vn) 
CAO HAO THI 2 (thicaohao@yahoo.com) 
RECOGNIZING THE ROLE OF FDI AND THE REQUIREMENT 
OF INSTITUTIONAL REFORM IN VIETNAM 
1 Fulbright Economics Teaching Program in Vietnam, (+84) 977687968 
2 Saigon Technology University, Vietnam, (+84) 913969384. 
Recognizing The Role Of Fdi And The Requirement Of Institutional Reform In Vietnam 
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Tóm tắt 
Tưởng rằng gia nhập WTO sẽ có thể chắp thêm cánh cho kinh tế Việt Nam bay cao hơn nhưng thực tế lại 
không như mọi người kỳ vọng. Từ năm 2007 đến nay kinh tế Việt Nam liên tục đối mặt với tình trạng bất 
ổn vĩ mô, nhiều yếu kém của nền sản xuất nội địa bắt đầu bộc lộ. Trong khi các cỗ máy của tăng trưởng 
kinh tế trong nước như SOEs và doanh nghiệp nội địa gần như ngưng trệ thì doanh nghiệp FDI vẫn duy 
trì sức tăng trưởng của mình và tiếp tục có những đóng góp quan trọng cho kinh tế Việt Nam. Nghiên 
cứu của FETP (2013) chỉ ra những nút thắt thể chế đã khiến cho khu vực FDI không có động cơ tham gia 
vào các mắt xích của nền sản xuất nội địa nhưng cũng chính nhờ đó mà khu vực FDI gần như miễn 
nhiễm khỏi các trục trặc của nền kinh tế trong nước. Thừa nhận các yếu kém về mặt thể chế đang gây trở 
ngại cho phát triển kinh tế, Chính phủ Việt Nam đang thực hiện nhiều biện pháp nhằm cải cách thể chế 
nhưng đồng thời cũng nhìn nhận lại vai trò của FDI trong giai đoạn phát triển sắp tới của Việt Nam. Bài 
viết này sẽ trình bày khái lược về tình hình thu hút FDI ở Việt Nam kể từ khi Việt Nam thực hiện chiến 
lược đổi mới kinh tế năm 1986 theo mô hình kinh tế mở và hội nhập. Bài viết cũng phân tích những đóng 
góp của FDI đối với kinh tế Việt Nam, đồng thời chỉ ra những bất cập và hạn chế trong chiến lược hơn 25 
năm thu hút FDI của Việt Nam. Cuối cùng, bài viết cũng sẽ phân tích những tranh luận gần đây trong 
giới học giả cũng như các nhà hoạch định chính sách Việt Nam về vai trò của FDI trong bối cảnh Việt 
Nam đang thực hiện chiến lực tái cơ cấu kinh tế gắn với mô hình tăng trưởng mới, đặc biệt là giai đoạn 
chuẩn bị tham gia TPP. 
Abstract 
It was expected that upon the inception of the World Trade Organization (WTO) that Vietnam’s economy 
would sprout wings and soar to unexpected heights, but in all reality it was a disappointment. Since 2007, 
Vietnam’s economy has faced several challenges that rumbled the macro stability and revealed the 
weaknesses of the real domestic sector. While local growth engines like State Owned Enterprises (SOE) 
and domestic firms were stagnant, the Foreign Direct Investment (FDI) sector maintained its growth 
momentum and continued to make important contributions to Vietnam’s economy. According to a 
Fullbright Economics Teaching Program (FETP) study in 2013, there are institutional bottlenecks that 
discouraged the FDI sector to participate in the local production chain and unexpectedly immunized 
them from problems of the domestic economy. With respect to institutional weaknesses, as barriers to 
economic growth, the Vietnamese Government has implemented measures to reform these institutions 
and reviewed the role of FDI in Vietnam’s next phase of development. In this report, I will briefly 
describe the FDI policy of Vietnam since Doi Moi (or Innovation) in 1986 toward an open and integrated 
economy. Further, I will analyze FDI contributions to the economy and show the problems and 
limitations of the last 25-years of FDI policy implementation. Lastly, this report will explore recent 
debates among academia and policy makers in Vietnam about the role of FDI as Vietnam attempts to 
restructure the economy and introduce a new growth model while finalizing Trans-Pacific Partnership 
(TPP) negotiations in the near future. 
Keywords: FDI, Vietnam economy, capital inflows, institutional reform, FDI from Taiwan 
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1. Introduction 
Vietnam’s economic story begins in 1986 when Vietnam began implementing innovative policies and 
economic integration. In its earliest stages, the foreign investment sector was identified as one of the most 
important economic sectors in Vietnam’s economy and contributed to the success of strategic 
industrialization and modernization undertaken by the Vietnamese Government. These innovative ideas, 
policies, and incentiveswere applied by the government at both the central and local levels to attract 
foreign investment. Nearly thirty years later, Vietnam has attracted more FDI than many other countries 
in the region in terms of Gross Domestic Product (GDP) percentage -- far exceeding Thailand, Indonesia, 
India, and even China. The cumulative foreign capital to GDP in Vietnam is much higher than those in 
other countries in the region, including China. Some studies show that FDI has made important 
contributions to Vietnam’s economy in many aspects, such as complementary domestic savings, growth, 
economic structural change, improvement in the investment climate, strengthening of state governance, 
promotion of industrial policy, enhancement of national competitiveness, contributions to exports and 
revenues, job creation and improvement of salaries, etc. In addition to this success, further studies point 
out the inadequacies and limitations of FDI in Vietnam. These inadequacies and limitations include the 
fact that the majority of foreign enterprises employs only unskilled labor, engage in national resource 
extraction, uses outdated technology, contributes to environmental pollution, primarily uses imported 
resources, produces a low added value, provides poor spillover effects on domestic production, 
succumbs to restrictions on the Transfer of Technology (TOT), and so on. 
Especially in recent years, while Vietnam’s economy has begun to fall into attenuation of economic 
growth and macroeconomic instability, the inadequacies and weaknessess of the domestic economy also 
unfold. Among the weaknessess I have pointed out, the biggest weakness is the economic institution. 
Through many years of innovation, the foundation of economic institution in Vietnam has not changed 
much - especially in terms of thinking. State economy and state ownership are and continue to be key 
roles in which SOEs are chosen as the leader of the economy despite the poor growth performance of this 
sector. Many analysts argue that the institutional bottlenecks, which not only hamper Vietnam’s 
economic growth, but also reduces the potential contribution of the FDI on the domestic economy are 
responsible. Although, the Vietnamese Government has recognized these problems and is implementing 
economic reform policies in which institutional reform is considered as a breakthrough. The success of 
institutional reform will not only help create a new impetus for economic growth, but also to encourage 
foreign investors consider domestic production of products, participate in global production value 
chains, and mount the domestic production chain into the global production system. 
2. A glance at Vietnam’s macro-economic context 
Vietnam’s economy has achieved growth of 9-percent or more, but that was the story of the mid-1990s. In 
the years prior to joining the WTO, Vietnam’s economy showed signs of acceleration in which growth 
was very high - as much as 8 - 8.5-percent - until officially joining the WTO in 2007. However, Vietnam’s 
economy in fact did not take off as people expected. After reaching a peak growth in 2007, the economy 
began to decline and continued to plunge since then. Economic growth in Vietnam is always associated 
with the tale of high inflation. Obviously, this is not a new story, because it has been talked about in 
economic textbooks - this is a big challenge for Vietnam with respect to policy management. From 2007 to 
the present, the Government of Vietnam has repeatedly switched between the priority objective of 
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growth and inflation control. This change in policy objectives will certainly affect the business 
environment of enterprises in Vietnam - domestic investors as well as foreign investors. 
Figure 1: GDP growth and inflation in Vietnam 
Source: GSO of Vietnam 
In addition to inflation, the macroeconomic instability in Vietnam is also manifested in the severe trade 
deficit and enormous pressure on the devaluation of currency. The trade deficit has connotations that 
domestic savings are not enough to finance investment, but it also means that the competitiveness of 
Vietnam’s economy is poor. As will be discussed later, foreign investment has partially improved 
Vietnam’s export capacity, but it still does not fully compensate for the weakness of the domestic 
economy. The trade deficit has been financed mainly from foreign capital inflow. Unfortunately, the huge 
capital inflow has directly caused turmoil in Vietnam’s financial markets. The Government of Vietnam 
has not had much experience in managing the flow of international capital while the openness of 
Vietnam’s capital account increased significantly after joining the WTO. More than 9-billion US dollars 
poured into Vietnam’s economy in the first half of 2007, this posed a huge challenge for monetary policy 
while Vietnam pursued a fixed exchange rate. Economists call this situation as a trilemma or an 
impossible trinity. Meanwhile the sterilization policy of the State Bank of Vietnam (SBV) was not effective 
when it could not sterilize the money supply and thus, inadvertently pushed the inflation rate to a very 
high level in 2007. 
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Figure 2: Trade Balance of Vietnam 
Source: GSO of Vietnam 
In addition to the trade deficit, the problems of the public sector such as budget deficits and the increase 
in public debt also exhibited a direct push on Vietnam’s economy and yielded difficulties and 
uncertainties. The budget deficit of the Vietnamese Government has always been maintained at a very 
high level of 4 – 5-percent per year and this endured for a very long time. This has lifted the public debt 
which is currently equivalent to 60-percent of the GDP. The cause of the high budget deficit in Vietnam is 
partly due to budgetary discipline which is very loose. The mechanism of a soft budget constraint also 
raises a moral hazard in the public agencies that are funded by the national budget (Do Thien Anh Tuan 
2014a). Moreover, the increase in Vietnam’s public debt is also due to the Government’s loans to finance 
public investment projects, but the efficiency is very low. SOEs also borrow money from banks, especially 
from the state-owned banks, to invest in a variety of projects and these loans are usually guaranteed by 
the Vietnamese Government. Meanwhile most SOEs have exhibited poor financial performance. After all, 
almost all of the international government bonds were transferred to the state business corporations, but 
the inefficient performance of these corporations has put a burden of debt on the Government’s budget. 
A typical example is the bond debt worth US $750-million that the Government borrowed on the 
international bond market in 2005 and then lent it to Vinashin – a shipbuilding corporation of Vietnam –
eventually this corporation was unable to repay the debt which led to a decline in Vietnam’s credibility 
on the international capital markets. 
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Figure 3: Budget deficit and public debt in Vietnam (% of GDP) 
Source: MOF 
Along with the weakness of the public sector, the Vietnam financial system also began staggering with 
difficulties - in particular the banking system. After a period of explosive growth in credit – as much as 
30-percent to 50-percent in some years - credit growth has started to decline even though the rate of 
domestic credit to GDP in Vietnam has reached over 100-percent of GDP and has surpassed many 
countries in the region. Severe bad debts have pushed many banks in Vietnam to fall into serious 
financial difficulties. Meanwhile, the economic downturn also hindered the resolution of Non-performing 
Loans (NPLs) and the ability to restore stability of the balance sheets of banks (Do Thien Anh Tuan 
2014a). The freezing of the real estate market and stock market also created its own difficulties, which in 
turn had an impact on the banking sector. A large amount of credit previously went into the real estate 
sector, but the freezing of the real estate market also placed a burden of liquidation on banks. 
Nevertheless, the situation of complex cross-ownership in Vietnam’s banking system has caused the 
ineffectiveness of regulations on banking supervision of the SBV (FETP 2014). 
The above analysis partially explains that, perhaps never, since the crisis of the mid-1980s, Vietnam’s 
economy has fallen again into serious and prolonged instability as it has over the most recent past. 
Weakenesses of the old-style growth model, which is based on incremental invested capital, has not 
helped Vietnam in achieving higher growth. The Solow growth model seems to accurately predict the 
case of Vietnam - of course, this is just a hypothesis. So far, the Vietnamese Government has recognized 
the problems and has also developed and implemented projects to repair the economy, but the process is 
still very low compared to the requirements and expectations of many people for having various 
obstacles. It seems that the obstacles from the inside are significant enough that reform is almost at a 
standstill. The Government of Vietnam is currently negotiating to join the Agreement on the TPP and 
many people expect this Agreement will be a boost for Vietnam to promote reform. 
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Figure 4: Domestic Credit to GDP 
Source: EIU 
However, the question is how the TPP Agreement impact to Vietnam’s economy is now still a debate 
among Vietnamese scholars and policy makers. Lessons learned from the WTO inclusion are certainly 
very valuable to businesses as well as the economic management agencies in Vietnam. As indicated, 
Vietnam’s economy not only did not take off after joining the WTO, but it also faced many complex 
challenges. Joining the TPP may create similar or larger challenges. The big question here is whether a 
dose of the TPP is strong enough for the Vietnamese Government to discover the challenges and consider 
those as a driving force for economic reform at this time. 
3. The process of opening up and attracting FDI in Vietnam 
3.1. The period after Renovation of 1986 to the pre-Asian crisis in 1997 
Vietnam has experienced almost 30 years of economic renovation and it has also been app ... clared a loss and had signs of transfer pricing. In early 2014, resulting in 870 
inspections of the General Department of Taxation revealed that up to 720 foreign enterprises violated tax 
policies in Vietnam. 
A myriad of FDEs, especially transnational corporations, are involved in a suspected case of transfer 
pricing in Vietnam. In fact many FDEs haven’t reported their lost operations in a long time, but continued 
to increase investment activities and expand their businesses in Vietnam. Transfer pricing is becoming 
more and more sophisticated and often bypasses tax professionals in Vietnam. 
Inspection results also showed that the common method of transfer pricing used by FDEs is to increase 
inputs materials while lowering export output prices to create a financial loss in order not to succumb to 
the corporate income tax in Vietnam. Foreign enterprises in this category usually operate in the fields that 
have a lot of intangible assets such as patents, exclusive manufacturing formula or practices, and 
proprietary technology. So there are no appropriate criteria or benchmarks for comparison (Do Thien 
Anh Tuan 2014d). Transfer pricing behavior of foreign enterprises not only causes losses to the national 
budget, but also undermines the competitive environment of the economy. 
Technology transfer restrictions 
An evaluation conducted by MOST showed technology transfer activities in FDI projects have a positive 
contribution to the innovation and the improvement of technological capacity of Vietnamese enterprises. 
However, these activities have not yet met the requirements of the practice and the technological 
innovation needs of the whole of enterprises in the economy (MOST 2013). This is not necessarily due in 
part of the FDI, but mainly because the policy of encouraging technology transfer in Vietnam is 
4 See more at  
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inadequate. Some shortcomings pointed out by MOST (2013) include: (i) the direction of attracting high 
technology has not achieved the expected results; (ii) the evaluation of technology is not given adequate 
attention; (iii) the reception and learning of new technology from FDEs is still weak. Although 
technologies transferred to Vietnam mostly have technological levels equal to the available technology in 
Vietnam, but on par with the average level in other countries. In addition, the technology transferred 
under the FDI projects is often based on the interests of the foreign investors, which do not necessarily fit 
the needs of technological innovation that Vietnam wishes. 
5.9. The debate about the role of FDI in recent years in Vietnam 
The above analysis argued that, after nearly three decades of reform and opening up the economy, FDI 
has contributed significantly to the economic growth in Vietnam, helped restructure the economy 
towards industrialization, strengthened the competitiveness of the economy and contributed to the 
annual export turnover, created a significant number of jobs and improved income levels of Vietnamese 
laborers. Many analysts point out, however, that compared to the expectations and goals of growth set by 
the Vietnamese Government, such as low contribution amounts in the labor market, limited tax 
contributions, the use of lower levels of technology, limited technology transfer, investment in resource-
intensive industries, energy consumption and environmental pollution, loose links with local industry, 
etc. there are many inadequacies and limitations of FDI. For this reason, many people started criticizing 
the role of FDI, as well as Vietnam’s FDI attracting policies. However, it is fair to say that the limitations 
of the FDI sector as analyzed are mainly due to the inadequacies of FDI attracting policies of Vietnam, as 
well as the weaknesses of domestic production rather than the FDIs themselves. For decades, the strategy 
to attract FDI in Vietnam has seen almost no changes in quality and mainly attracted as much FDI capital 
as possible without much emphasis on the quality of the project as well as the capacity of the investors. 
The orientation of objectives pertaining to the industrialization policy of Vietnam have not been 
conducted clearly or comprehended completely, such as neglecting to identify the sectors in which 
Vietnam has competitive advantages from which to design policies to attract FDI accordingly. SOEs are 
always assigned to implement investment tasks based on subjective opinions of the government. 
Resources are then pumped into SOEs instead of reforming the investment environment, supporting and 
facilitating private sectors to help them participate in and compete together. Because of such policies, the 
benchmark of results of industrial policy in Vietnam is mainly generated by the SOEs sector, but this all 
too often characteristically the mark of failure (FETP/VELP 2013). 
The critics of policies attracting FDI in Vietnam tend to focus on the incentives that the Vietnamese 
Government allocates to this sector. Furthermore, while the state sector always receives many incentives 
and privileges, the private sector receives almost no incentives at all. This has caused much controversy 
and criticism among Vietnamese economists. Table 1 demonstrates that the domestic private sector has a 
very large important contribution to every achievement of economic growth in Vietnam, while the 
resources used by this sector are very limited. With respect to the strategy of sustainable growth, it is 
imperative that Vietnam positively consider the advantageous role of this sector, however, countless 
obstacles on the policies and resources impede the development of the private sector and remain 
unresolved. Whereas, the Vietnamese Government continues to pump more incentives into FDEs and this 
causes even more controversy. In this context, many Vietnamese economists reconsider the role of FDI 
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and think of it in terms of the incentives and the contributions of this sector to the economy.5 The purpose 
of their analysis is to expose the limitations of policies to attract FDI that Vietnam has been pursuing for 
so long. The analysis also argues that the economic growth of Vietnam in the future will not be 
sustainable once the domestic sector gradually fades as a result of not being able to compete in a policy 
environment that is increasingly less equal (see Bui Trinh 2014). 
5.10. The institutional bottlenecks 
The policy discussion paper of the Vietnam Executive Leadership Program (VELP 2013) argued that there 
have been reasons to slow down the economic growth in Vietnam in recent years. One reason is that the 
economy has been dependent on four separate engines of growth, most of which at present are doing 
poorly. The four engines of growth are the state-owned enterprise sector, the domestic private sector, the 
small-holder agriculture sector, and the FDI sector. Of these four engines, only the FDI sector continues to 
do well in large part because labor intensive FDI industries have begun moving out of China as wages 
there accelerate upward and because these enterprises are largely not affected by either the economic 
difficulties facing the Vietnamese economy or the weaknesses of Vietnamese institutions (VELP 2013). 
An argument of VELP (2013) focuses on encountering the same, weak global economy and a structurally 
problematic domestic economy; domestic firms in Vietnam are still facing a lot of difficulties and even 
bankruptcy while FDI firms are continuing to grow. From a policy perspective, macroeconomic 
instability, high interest rates, and limited access to resources have negatively impacted domestic firms, 
while FDEs have somehow avoided these shocks. 
However, from an institutional perspective, although FDEs have been established in Vietnam to make 
use of cheap labor, resources, and some policy advantages, this sector is still relying on external 
institutions to operate their businesses and production activities (VELP 2013). The legal system governing 
the contractual relationship of FDI firms is from the outside of the country. The model of corporate 
governance extends from overseas and is also the man in that model. Links in production are mainly with 
external firms and capital credit is also provided from foreign banks. Furthermore, interest rates paid by 
FDI firms are often less than local firms. In general, FDEs have “ignored” the majority of the institutions 
of Vietnam, which is considered to hamper business activities of enterprises in the country (VELP 2013). 
The analytical approach of VELP (2013) argued that it is the institutional bottleneck that not only caused 
the short-term macroeconomic instability, but also created many obstacles for sustainable economic 
growth. These institutional weaknesses can help explain why Vietnam is still missing domestic 
supporting industries which are strong enough to supply inputs for the FDEs in Vietnam. Meanwhile, 
FDI enterprise’s reliance on external institutions and avoidance of Vietnamese institutions explains why 
the foreign sector in Vietnam is not deeply rooted in the national economy. Strictly speaking, they do not 
have strong incentives to develop their linkages with domestic producers or help domestic supporting 
firms become part of their global supply chains. As concluded by VELP (2013), as long as Vietnam fails to 
develop effective market-supporting institutions which foreign enterprises can rely upon to expand their 
business activities, the current manufacturing process of low value added products based on imported 
inputs and domestic assembly will continue. 
5 See Bui Trinh (2013, 2014), Nguyen Mai (2014), Le Dang Doanh (2013, 2014), Nguyen Thi Tue Anh (2006, 2008), Do 
Thien Anh Tuan (2014c) and many other authors for more arguments. 
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6. Conclusion remarks 
Despite some debates about the contribution of the FDI sector in Vietnam, the strategic economic reforms 
pursuing Vietnam should not fail to consider the role of this sector. The FDI sector will undoubtedly 
continue to be the driving force for economic growth in Vietnam, at least in the short-term when the 
obstacles of development of the domestic sector are still unresolved and the weaknesses of the state sector 
have not yet been processed. 
The limited contributions of the FDI sector must be considered as the institutional bottlenecks in the 
domestic economy instead of viewing it as the responsibility of the FDI sector. In some ways, like the 
domestic enterprises sector, the FDEs can sometimes be victims of such weaknesses. The incentives that 
the Vietnamese Government gives to the FDI sector may be partially offset by these weaknesses, but the 
domestic private sector may not enjoy the fruits of these incentives. 
The current economic reforms of Vietnam are are looking forward to the completion of a new 
institutional foundation, but there are many obstacles have made the implementation always be delayed. 
Many people are eagerly awaited the events that Vietnam would joint the TPP Agreement and see it as a 
boost to help Vietnam “take off” or to motivate Vietnam to reform its economy. However, lessons from 
the WTO accession in 2007 showed that such reforms should have gone a step ahead for the economy 
could keep adapting. The capacity of the state apparatus must be upgraded to meet new requirements of 
the integration. What expected from this economic reform is a fair competitive environment among the 
economic sectors, not only between the state sector and private sector but also between the foreign sector 
and the domestic private sector./. 
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