Toward Next Generation of FDI Enterprises

The foreign-invested company survey conducted by the Provincial Competitiveness Index (PCI) for the first time as part of the PCI 2010 has been recently released. Although it is not the first FDI company survey in Vietnam, with the highly representative participation of 1,155 companies coming from 47 different countries and operating in all 63 provinces and cities in Vietnam, which according to a 2009 General Statistics Office (GSO) census accounted for over 20 percent of operating foreign investors in Vietnam, this can be considered the largest and most comprehensive survey of this business sector.

 

Dr Edmund Malessky, Primary Author and Lead Researcher of the PCI 2010, said: In general, foreign invested enterprises (FIEs) in Vietnam are relatively small, export-oriented, and operating low margin business that is subcontracting to larger multi-national producers, and is, therefore, usually situated in the lowest node in a product value chain. These FIEs source a surprisingly small amount of intermediate goods and services from domestic producers, which implies that spillovers of technological capacity and management sophistication have been limited.

 

For the most part, these investors were attracted to Vietnam for the cost advantages offered by Vietnam’s wage rates and the political stability of the Vietnamese regime, allowing investors to plan strategically in the confidence that policies will be upheld for some time.

 

According to the report, more than 60 percent of the PCI-FDI respondents received some form of tax incentive from the province. These were predominantly in the form of tax holidays and benefitted manufacturing, agriculture, and natural resource exploiters disproportionately over investors in services or construction. The most intriguing result, however, came from a question asking FIEs that considered multiple provinces before choosing one for their business, how the incentive package of the losing province compared to the province they eventually chose. 59 percent claimed the incentive packages were the same and 12 percent said their current province had a better package. Importantly, however, 29 percent announced that the losing province actually had the preferable incentive package. In essence, for 88 percent of investors, the incentive package was not the critical factor in their investment decision. How will this be explained when the investors consider tax incentive second to labour costs?

 

The answer is that to compete, the province should provide some incentives, but not so that investors decide to choose that province. Instead, they were willing to accept less favourable policy if it is a place of business with many potential advantages. This suggests that the policy of many provinces did not succeed in using tax incentives and land as the main tools to attract investment.

 

FIEs are willing to forego higher incentives for a better business environment that includes a well-trained local labour force and system of business regulations that are more transparent and less burdensome. This has important policy implications for many provinces, which have unsuccessfully used tax and land incentives as their primary source of attraction.

 

Vietnamese strategists are seeking and attracting a new generation of foreign investors for the next period of economic development. According to economic analysts, strategists would like the next generation of FIEs to employ sophisticated technology and management, source broadly from the domestic economy, and be conscientious about environmental and labour concerns. Not only does Vietnam want these FIEs to be involved in high value-added production, but also the new investment should involve higher value-added nodes on production chains, so more of the ultimate returns on production are realized within the Vietnamese economy in terms of higher tax revenue and wage rates. The next generation of FIEs will operate in high-margin businesses, so the quality of labour, intermediate goods, and infrastructure outweigh the cost advantages of production in their utility functions.

 

Unfortunately, very few of the next generation of FIEs have chosen to locate in Vietnam thus far. Nationally, about 5 percent of investors are involved in high-tech production, such as the information and communications technology industry; another 5 percent are involved in scientific and technical services; and 3.5 percent are involved in finance and insurance services, which employ sophisticated management techniques and require highly trained labour.

 

The PCI research team thinks that Vietnamese policymakers need to adopt policies to direct investment into more sophisticated, value-added manufacturing and service sectors, which will grow and prosper with the development of Vietnam. Attracting next generation investors should not mean “picking winners” through targeted incentive strategies, which developing country governments have historically proven unable to do effectively, creating long-term distortions in their economies. Besides, Vietnamese policymakers cannot know what the next big thing will be. Targeting investment around yesterday’s leading high-tech industries could prove disastrous.

It means developing the labour skill sets, infrastructure profiles, protection of property rights, and contract enforcement that sophisticated investors find attractive. These investments will pay dividends regardless of the economic sector that approaches Vietnam.

 

According to the PCI research team, Vietnam also needs to take a serious look at the lack of FIE sourcing from Vietnamese domestic producers. Why are business relations between FIEs and the domestic economy so limited? A simple reason may be the matter of information. Domestic producers are not certain of the quality and technological standards of future investors, while future FIEs may not have a full understanding of domestic capacity. Thus, investment promotion agencies can do a much better job of conveying those standards to domestic producers and investing in better databases for business matchmaking between FIEs and domestic suppliers. Provincial investment promotion agencies that convey information and find partners effectively will end up creating economic clusters organically, as similar FIEs seek out the same high-quality downstream suppliers.

 

Remarkably, even investors interested in low-cost production are unsatisfied with the level of general and vocational training provided in Vietnam. Low quality labour requires substantial internal investment (8 percent of total expenditures), but the high turnover in the Vietnamese labour market means that investors rarely benefit directly from the fruit of the training efforts.

 

To attract more sophisticated investors, Vietnam needs to substantially rethink secondary, tertiary, and vocational education in the country. Education investments targeted at the particular sectors Vietnam would like to see grow or general improvements that create a functional workforce, which can adapt to new technological innovations, could pay huge dividends. Especially, high-tech investors were the most likely to identify labour quality as a disadvantage for their investment strategies. The well-documented difficulties of Intel in finding quality labour for its high-end production facility are a testament to these problems.

 

In addition, matters relating to customs, compliance costs, infrastructure, and informal charges should be addressed by Vietnamese policymakers to create a more competitive, attractive environment.