WTO accession and benefits from FDI The case

WTO accession and benefits from FDI: The case of Vietnam Jean Louis BRILLET (INSEE) TRAN Thi Anh-Dao (CARE, University of Rouen, and CEPN, University of Paris XIII) LINK spring meeting St Petersburg June 4 -6, 2009

Outline of the presentation The importance of FDI Integrating FDI in a macroeconomic model ◦ Formalizing its determinants ◦ Assessing its impact Applied to the context of WTO accession ◦ The direct measures ◦ The structural changes, the policy decisions

The determinants of FDI The level of skills and labor costs, the production costs -> profitability The infrastructures The access to finance The macroeconomic policy, the regulatory and legal framework, sound institutions The potential markets and the regional context

FDI and development FDI should improve the process By increasing growth ◦ Capacity ◦ Factor productivity ◦ Technology transfers ◦ Exports ◦ Revenue But no statistical evidence The reason : no complete picture

FDI in Viet. Nam

FDI distribution

FDI composition in 2007

The model A structural, econometric model of the Vietnamese economy Built with Vietnamese partners : GSO, NCSEIF Annual, single product Estimated on 1986 -2006 Cobb-Douglas with explicit role of the relative cost Short term : Keynesian with a strong role of the output gap Long term : More neo-classical with profit maximizing

Formalizing FDI determination Relative to total capital evolution, FDI depends on The output gap ◦ Sales prospects on the local and foreign markets The profits rate ◦ Compared implicitly with other countries’ ◦ Contains the output gap ◦ Sensitive also to the margins rate, the productivity of capital, and the ratio of production and demand deflators (sensitive to tariffs) ◦ PR = Marg / (pk K) = MR. pq / pk. UR. prodk Crowding out substitution : -0. 3 (calibrated)

The estimation

The production function

Exports

World demand graph GDP Exports Imports Rate of use Global factor Product Capaci ty Labor Capital Wage rate Prices FDI in the model Final deman d FDI share in capital Foreign Direct Invest ment Factor cost Profita bility

Comments on Shock A : neutral FDI Quite usual results, with a high openness to world trade (GDP # Exports, Final demand # Imports) Imports increase more than exports This comes from tensions and competitiveness Lower unemployment causes substitution With inflation, the current trade balance improves

Comments on Shock A : specific FDI More investment, even more FDI (UR), more factor productivity : more capacities More factor productivity, more capacities : lower prices More demand (investment, exports) but lower UR. Capital more than employment : direct effect, substitution favors capital More cyclic : the higher speed of adaptation generates overshooting Long run : return to normal (no incentive). FDI speeds up the process : this can be interpreted as an additional way to enter the world economy. ◦ But substitution to imports?

Comments on Shock B Ex ante increase of imports, ex post negative demand shock This closes the explanation Also for FDI (only ex post effect)

Comments on Shock C : neutral FDI Again, ex ante increase of imports, ex post negative demand shock With an additional positive supply shock The cost of wages and equipment goes down Creating competitiveness, exports, but also a need for equipment and consumption goods Again, imports increase more than exports But GDP and local demand improve Limiting disinflation in the long run But both real trade balance and terms of trade worsen And of course the State budget

Comments on Shock C : specific FDI Actually similar to shock A But the increase comes mostly from profitability And less (but some) from the rate of use Profitability lasts longer So GDP is never negatively affected Global impact is stronger

Conclusions on shock A (and A’) The access to world markets through quotas and tariffs produces gains which attract FDI, directly, and indirectly through local demand. FDI increases capacities, limits inflation and helps to satisfy foreign demand. Both types of shock have the same consequences, at a variable level. But to really gain from the situation, the conditions of local profitability must be met. Demand is only part of the game. Inflation and costs limit the gains in the medium term.

Conclusions on shock B Increasing local quotas depresses the economy. FDI worsens the situation, as firms prefer exporting to investing in a depressed market. Lower FDI reduces capacities and productivity, limits disinflation and substitution by exports. These results are trivial, as opposite to the above shocks

Conclusions on shock C Decreasing local tariffs will also increase imports, but create profitability and gradually growth. Foreign firms invest in the country, primarily to export, but local conditions improve too (due to FDI. . . ). Losses in competitiveness are limited.

Conclusions on all shocks (1) An initial increase in FDI can be short (medium) lived. More investment and improved factor productivity make capacities adapt faster to demand. The need for additional capacities disappears if profitability does too. The improvement of exports can sustain the effect, the reduction of costs causes deflation and gains in profitability. The inertia on FDI, investment and capacities can actually create overshooting, and sometimes negative medium run consequences. But the actualized gain on GDP is almost always positive.

Conclusions on all shocks (2) FDI has a positive impact on local (non FDI led) activity, including local firms (except when it comes from the reduction of local subsidies). On the trade balance, the impact of FDI is generally positive, but it can increase the import of equipment goods in the short run. But when capacities build up, they will be more productive, more profitable, and create more export potential. Also, a higher disinflation has a cost on the terms of trade.

Conclusions on all shocks (3) Increasing FDI will have a reduced effect on employment, as it increases the role of capital, and the gains in global productivity will limit job creation, However, employment will generally grow. That all these mechanisms interact with each other, with generally expanding properties. For instance, FDI increases factor productivity which creates profitability and FDI. Or FDI creates exports and the need for additional capacities and FDI, which increases productivity and helps satisfy export potential….

Final conclusion (did we need a model? ? ? ) For a pure demand shock, FDI increases the speed of adaptation and makes it smoother ◦ By generating capacities through size and efficiency But the impact disappears in the medium run However, the global impact is positive To sustain the gains, we need ex ante profitability (like local tariffs). But even then, more growth and employment will make profitability disappear in the long run.