How foreign direct investment promote institutional quality: Evidence from Vietnam

Journal of Comparative Economics xxx (2013) xxx–xxx

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How foreign direct investment promote institutional quality:Evidence from Vietnam

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1 There are also studies that have investigated the effects of local institutional quality on foreign invest investment. Some of them are Wei (2000a,b)and Kinoshita (2003), Julan et al. (2008), Javorcik and Wei (2009).

Please cite this article in press as: Dang, D.A. How foreign direct investment promote institutional quality: Evidence from Vietnam.of Comparative Economics (2013), http://dx.doi.org/10.1016/j.jce.2013.05.010

Duc Anh Dang ⇑Research School of Economics, College of Business and Economics, Copland Building, Australian National University, ACT 0200, Australia

a r t i c l e i n f o a b s t r a c t

Article history:Received 15 November 2012Revised 20 May 2013Available online xxxx

JEL classification:O17P26

Keywords:Foreign investmentInstitutionsVietnam

Dang, Duc Anh—How foreign direct investment promote institutional quality: Evidencefrom Vietnam

Using a unique dataset from a provincial competitiveness survey and the rising foreigndirect investment (FDI) from joining the World Trade Organization (WTO), I find that vari-ations in economic institutions across the provinces of Vietnam are associated with theflow of foreign investment. To overcome endogeneity problems, I use the minimum dis-tance from each province to a main economic centre as an instrument for foreign invest-ment inflows. The instrumental variable approach shows that the direction of influenceis from greater foreign investment to better institutions. These results hold after control-ling for various additional covariates, and are also robust to various alternative measuresof institutions. I also find that foreign direct investment has greater short-term impactson institutional quality in the northern provinces. Journal of Comparative Economics xxx(xx) (2013) xxx–xxx. Research School of Economics, College of Business and Economics,Copland Building, Australian National University, ACT 0200, Australia.� 2013 Association for Comparative Economic Studies Published by Elsevier Inc. All rights

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1. Introduction

The flow of foreign direct investment (FDI) has been viewed as a major contributor to growth for developing countries(UNCTAD, 2006). FDI may affect economic performance through transferring skills, technology, and management know-how that increase productivity and enable domestic companies to compete on world markets (Lipsey, 2002; Javorcik,2004). It also provides capital and employment opportunities that may not be available locally. Moreover, FDI affects insti-tutional quality of host countries.1 For example, some recent studies find that inward FDI has the potential to impact corrup-tion levels. Larrain and Tavares (2004) empirically find that FDI significantly lower corruption level for a sample of countriesover the period 1970–1994. Pinto and Zhu (2009) demonstrate that the effect of FDI on corruption is positive in authoritarianand poor countries, and turns negative as countries become more democratic. FDI that allows higher rents could possibly beshared between investors and government officials, associated with weak institutions to detect bribe payments, can increasethe level of corruption. Islam and Montenegro (2002) argue that a more open an economy results in better institutions and fas-ter economic growth because foreign or domestic companies lobby governments for change. Higher competition among agentsmay also reduce the rents for bribery and make corruption more difficult (e.g. Ades and Di Tella, 1999). In other studies, Hewko

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(2003) and Lewis (2005) provide different examples of foreign investors impacting the policy environment in Eastern Europeand the Former Soviet Union. Malesky (2009) find that the more important foreign investment is in a transition country’s econ-omy (and therefore the stronger the bargaining power of the FDI community as a whole), the more likely the country is to pur-sue economic reform. He finds positive effects of FDI on economic reform through a panel analysis of investor influence in 27transitional countries. The relationship is particularly strong in the manufacturing and service sectors, but does not hold for con-struction, utilities, or natural resource based projects.

Many useful insights are gained from this literature; however, current studies are undesirable on two grounds. First, mostanalyses use institutional measures created by an idiosyncratic weighting of several institutions or categories of institutions.These aggregates are often based on subjective perceptions and are likely to be biased or contaminated by perceptions of acountry’s economic performance (Glaeser et al., 2004). Moreover, it seems that there has not yet been an attempt to aggre-gate these measures into more reliable synthetic measure of institutions (Jellema and Roland, 2009). Second, current anal-yses have mainly employed cross-country regressions. Therefore, it is generally difficult to control for differences in cultures,legal systems and other institutions that may be relevant for the outcome variable under study.

This paper complements current studies by investigating the relationship between foreign investment and institutionalquality within countries. In this context, Vietnam is likely to be an appropriate test for several reasons. First, before 1990, thecountry had a relatively small amount of FDI. The amount of foreign investment increased rapidly along with signing tradeagreements, particularly after Vietnam joined the WTO in early 2007. Second, the quality of institutional development hasbeen uneven across provinces. Some provinces show better economic governance and business investment, while others lagbehind (Malesky, 2007). Diversity in initial structural conditions, such as geography and proximity to markets can partly ex-plain these differences. However, they cannot explain the substantial differences in the quality of economic institutionsamong provinces with similar conditions. This variation across space provides a good opportunity to study the impact of for-eign investment on institutions while holding political systems and government structure constant.

Using a unique dataset for 60 provinces in Vietnam, this study tests the idea that the variation in economic institutionswithin the country is associated with disbursed foreign direct investment.2 The quality of economic institutions is measuredby surveyed index on the perception of private sector businesses on the quality of provincial economic governance. To overcomethe shortcoming of using subjective perception variables, I use certain indicators of the effectiveness of provincial governmentthat are not derived from the survey but reflect the actual activities of local governments.

I start my analysis by correlating the flow of foreign direct investment with institutional index. I find some evidence thathigher FDI correlates positively with quality of provincial institutions. However, the result can be the outcome of a thirdomitted factor that is jointly correlated with both higher foreign investment and institutional quality. In addition, reversecausality from the quality of institution to higher foreign investment also biases the result. I pursue a number of strategiesto address these concerns.

My first strategy is to control for other variables that may correlate with both foreign direct investment and quality ofinstitutions. These results are stable after controlling for various additional covariates. My second strategy is to use the dis-tance from the capital of each province to main economic centres as an instrument for foreign investment. The results fromthe instrumental variable (IV) approach suggest that the greater in flow of foreign investment generates better institutions.They are also robust to various alternative measures of institutional indices, such as business environment, labour training,corruption and pro-activeness of provincial leaders. The effects are found to be greater on provinces in the north. To confirmthe findings from IV approach, I carry out some sensitivity tests on the validity of instrumental variable. The results showthat, even allowing for plausible amounts of imperfect exogeneity of the instrument, I still find that the coefficients of theforeign investment estimated by the IV approach have positive effects on institutional quality.

The remainder of this paper is organised as follows. Section 2 briefly describes the background of the trade liberalisationand foreign investment in Vietnam. Section 3 outlines the potential channels through which high foreign investment flowscould lead to institutional changes within the country. Section 4 justifies the data used. Section 5 introduces the empiricalstrategy. Section 6 presents the results and Section 7 offers concluding remarks.

2. Trade liberalisation agreements and foreign investment in Vietnam

Vietnam began to liberalise international trade in the late 1980s and early 1990s from a position as one of the pooresteconomies in the world. In an effort to integrate into global markets, Vietnam has promoted a policy towards regional inte-gration and was committed to the Association of Southeast Asian Nations (ASEAN) Free Trade Agreement (AFTA) in 1995,ASEAN-China FTA (ACFTA) in 2002, ASEAN-Korea FTA in 2006 and is negotiating a number of other bilateral trade agree-ments, such as agreements between ASEAN and Japan, India and Australia and New Zealand. Vietnam’s bilateral agreementwith the United States (US), signed in 2001, marked a major effort to liberalise and guarantee a stable trading environmentfor trade flows between the US and Vietnam. In early 2007, Vietnam officially became a member of the WTO.

With the signing of these trade liberalisation agreements, the country’s investment regimes have been gradually liberal-ised to attract foreign investment. Stimulated by Vietnam’s impressive economic growth and the liberalisation progress, the

2 Disbursed FDI is the amount of money that foreign investors actually invest in each province. This amount may be different with the amount of investmentthat they have committed/registered to local governments.

Please cite this article in press as: Dang, D.A. How foreign direct investment promote institutional quality: Evidence from Vietnam. Journalof Comparative Economics (2013), http://dx.doi.org/10.1016/j.jce.2013.05.010


VN-US BTA

WTO membership

020

,000

40,0

0060

,000

Mill

ion

USD

1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

Source: General Statistics Office

Foreign direct investment over 1996 - 2008

Registered FDI Disbursed FDI

Fig. 1. FDI inflows into Vietnam during 1996–2008.

D.A. Dang / Journal of Comparative Economics xxx (2013) xxx–xxx 3

inflows of FDI to Vietnam have steadily increased since the late 1980s. Fig. 1 shows that the amount of FDI increased sub-stantially after obtaining membership of the WTO in 2007. The amount of registered FDI flow reached over 10 billion USD in2006, and surged to over 20 billion USD in 2007 and more than 60 billion USD in 2008.

However, this FDI was not distributed evenly throughout the country. It clustered around relatively few geographicallocations and business sectors. Fig. 2 demonstrates the distribution of FDI in each province in 2007. The darker the colour,the more concentrated the FDI. Roughly 60% of Vietnam’s FDI flow is located in Hochiminh city, Ha Noi and Dong Nai prov-ince. Although it is not surprising that some of the remote rural provinces have missed out FDI inflow, even large cities likeHai Phong and Da Nang have attracted less FDI than one might expect for such major urban centres (Freeman, 2002).

3. The potential effects of rising foreign investment on quality of local governance in Vietnam

There are several channels through which foreign investors could substantially affect provincial economic activity andgovernance. Of which, three mechanisms appear more effective to improve local governance quality.

First, foreign investors may provide policy-makers, who are new to technical economic and regulatory issues, with infor-mation on laws in other countries in which the foreign companies operates (Prakash and Potoski, 2007; Luo, 2001).

The second mechanism is that they force leaders to reform by threatening to leave for more favourable investment envi-ronments, taking away the province of employment and tax revenue (Olarreaga, 1999). Malesky (2004) describes the processthat foreign investors may lobby provincial government leaders to reform policies to lower their transactions costs and facil-itate the competitiveness of their products on markets as follows: ‘‘At each Vietnam Business Forum, foreign investors havepresented a checklist of demands for policy changes and grade Vietnamese government on its effort to reform, ranging fromadministrative procedures and land-use rights, to tax laws, infrastructure and dispute resolution procedures. Through pro-vincial governments do not be explicitly ranked, they are aware of the issues and of their reputations among investorsgroups. Therefore, some provinces made their own local changes to accommodate investors’’. He also recognises that in prov-inces where foreign investment is the dominant source of local revenue, foreign investors are more successful to lobby pro-vincial government to change.

Finally, higher FDI flow makes provinces to be more autonomy to experiment with policy reforms, since they are to someextent insulated from central regulations. Therefore, they are freer to implement experiments and have room to interpretcentral laws in their own ways (Malesky, 2004, 2008).

Due to the positive relationship between foreign investment and business environment, it would be expected that thedomestic private sector also benefits from provincial governance reforms and improved public services. For example, trans-parency and enhanced appeals procedures will lead to reductions in informal charges. Transparency requirements should beexpected to significantly improve access by the private sector to legal normative documents at the national and provinciallevels (Malesky, 2007).

4. Model specification

To examine the relationship between FDI and quality of local governments, I estimate the following equation:

Pleaseof Com

INSi07 ¼ a0 þ c1 logðFDI=popÞi06-07 þ X 006-07Cþ c2INSi05 þ ei ð1Þ

cite this article in press as: Dang, D.A. How foreign direct investment promote institutional quality: Evidence from Vietnam. Journalparative Economics (2013), http://dx.doi.org/10.1016/j.jce.2013.05.010


Hanoi

Danang

Hochiminh city

(1734,12689](749,1734](338,749](177.5,338](107.5,177.5](50,107.5](16,50](2,16](0,2][0,0]

Fig. 2. Regional distribution of disbursed foreign direct investment 2006–2007.


where INSi07 is a measure of institutional quality in province i in 2007, log(FDI/pop)i06-07 is average disbursed FDI per capita in2006–2007, and X06-07 is a vector of other control variables. INSi05 controls for the initial institutional condition in eachprovince.3

I expected the coefficient on FDI to be positive and statistically significant. However, it is not straightforward to interpretOLS estimates of c1 as a causal effect. There are challenges of reverse causality and omitted variable bias that must be ad-dressed in order to interpret c1 as a causal effect. First, reverse causality could lead to bias in my estimates. I argue that for-eign investment improves institutional quality. However, it is also possible that causality runs in the opposite direction. Thatis, local governments may improve policies to attract more foreign investors, while at the same time investors put more ef-fort into lobbying provincial governments to modify their policies. Second, some unobserved factors may affect both the

3 Because the institutional quality index is ranked from 10 to 100, I expect that provinces with lower level ranking will have an opportunity to increase theirscore faster than that of higher ranking ones. Therefore, I adopt a standard growth regression and control for the initial institutional condition.




decisions of investors and governance quality, resulting in a correlation between the two, but that is not a direct causal rela-tionship. Adding initial institutional condition may capture most of the factors that affect the past and current institutions.However, it may not capture other provincial unobservable factors such as cultural norms and geographic characteristicswhich may influence both institutions and FDI.4 These also lead to inconsistent estimates.

To address the remaining of reverse causality and omitted variable bias, I estimate the model using the two-step efficientGeneralised Method of Moments (GMM) in the two-stage least squares (2SLS) estimation. One advantage of GMM-IV is toexploit the optimal weighting matrix of the orthogonality conditions to allow for efficient estimation in the presence of het-eroscedasticity with unknown form. Therefore, this estimator is more efficient than the traditional IV-2SLS estimator (Baumet al., 2003).

An instrumental variable must satisfy the twin conditions that it is (highly) correlated with the suspected endogenousvariables, but uncorrelated with the error term in the regression. Recent studies have proposed different instrumental vari-ables for foreign investment inflows, such as predicted exchange rate (Malesky, 2009); distance from the border (Jensen andRosas, 2007); weighted average of the geographical distance between the host country and the richest economies in theworld (Pinto and Zhu, 2009).

To construct instrument for FDI at the province level, I follow the technique employed by Wei and Wu (2001) using thelog minimum distance to main economic centres. I take advantage of the special geographic features of the Vietnamese ter-ritory to construct an instrumental variable for FDI. I observe that a difference in the degree of foreign investment largelyreflects the difference in degree of access to major economic centres. Provinces that are far from economics centres are morelikely to have lower registered and disbursed FDI. FDI projects that take advantage of economic scale tend to be located nearwell-developed cosmopolitan areas such as Ha Noi and Hochiminh City (HCMC). There are many benefits available to pro-jects that are close to Ha Noi and HCMC. The first is convenient access to international markets, as the two cities possess, orare in close proximity to, the most dynamic airports and seaports in the country. This reduces cost and complexity of domes-tic and international travel. Second, FDI projects located in or near Ha Noi and HCMC obtain positive agglomeration effectswith investors clustered near each which benefit them from vertical linkages (Vu et al., 2007). Currently, HCMC and its sur-rounding area receive more than two-thirds of all FDI, while the Red River Delta (Ha Noi and its surrounding regions) re-ceives 20% of the total. In total, the country’s two leading economic regions attract some 85% of total disbursed foreigninvestment.

I note that while Hanoi and HCMC are the top two economic centres in Vietnam, they certainly do not cover all FDI. Forprovinces in the central region, the minimum distance from the economic centre in this region may be a more relevant deter-minant for their disbursement of FDI. The biggest economic centre in this area is Da Nang. With these observations in mind, Iused the shortest road distance from a provincial capital to either Ha Noi, Da Nang or HCMC as an instrumental variable forFDI inflows in that province. To be more precise, assume d(pi, Ha Noi) [or d(pi, HCMC) or d(pi, Da Nang)] is the distance be-tween province i and Ha Noi (or HCMC or Danang), then, the instrumental variable for that province is:

Log(DISTi) = min{log[d(pi, Hanoi)], log[d(pi, HCMC)], log[d(pi, Danang)]}5

Thus, the first stage estimation of the FDI inflow can be written as:

4 Thethe inte

5 Han6 The

factor w

Pleaseof Com

LogðFDI=popÞi06-07 ¼ a1 þu logðDISTÞi þ X006-07Cþ INSi05 þxi ð2Þ

where X06-07 and INSi05 as the same controls used in Eq. (1). If the instrument is valid, the IV strategy will mitigate the omit-ted variables bias and reverse causality problems, and the c1 parameters should be estimated consistently.

4.1. Potential violations of the exclusion restriction

A remaining econometric concern is whether the instrumental variable violates the exclusion restriction in the sense thatdistance to main economic centres has an independent impact on institutions beyond any effects working through FDI (con-ditional on other control variables). Many of the omitted observed and unobserved factors such as cultural norms or localpolicies influencing disbursed FDI can be correlated with institutions. These potential variables are also likely to correlatewith distance and influence institutions. Some of the obvious ones are infrastructure, inequality, education, budget transferand real gross domestic product (GDP) per capita.6 I try to control for them as a robustness check. However, I can never beentirely sure that I have adequately controlled for all omitted factors.

One mechanism through which distance might be correlated with error terms is through education. Provinces near majoreconomic centres have a higher concentration of colleges and universities and also attract more high-quality workers work-ing in the public sector. Glaeser et al. (2004) show that schooling positively influences institutional quality. To account for

re is also a possibility of measurement error in the amount of FDI distribution at the provincial level and spatial auto-correlation of the error term due tordependence of institutional quality across provinces.oi, HCMC and Da Nang were dropped from the regressions in order to avoid the problem of having influent observations that may bias the results.percentage of ethnic minorities is possible to correlate with the distance to main economic centres and impacts on economic institutions. However, thisas expected to indirectly affect economic institutions through quality of education.




this, I use the average years of schooling of people working in the public sector and the education level of the main leaders ineach province to control for education.7

Provinces further away from Ha Noi, HCMC and Da Nang have less favourable infrastructure conditions than the prov-inces near these economic centres. A highly developed communication and transportation network help to increase acces-sibility and decrease the cost of transaction and transportation for investors. Therefore, provinces with good infrastructureare likely to attract more FDI. However, it is also possible that these conditions may affect the policy selection of provincialleaders. Leaders of provinces with an advantage of good infrastructure tend to make pro-investor policies, whereas leaders ofprovinces with poor infrastructure and low competitiveness may not have incentives to do so (Shirk, 1994; Zweig, 2002; Caiand Treisman, 2005; Malesky, 2008). To account for this, I used the number of telephone subscribers per capita as a proxy forthe effects of infrastructure.

It is an open debate as to whether the southern provinces had a special advantage in leading the reform agenda andattracting investment. They benefited from a legacy of a specific market mechanism (Malesky, 2008). Before 1975, the southfollowed a market-oriented economy. When the country was unified in 1975, the centrally planned economic system wasapplied in both the north and the south. Because the centrally planned system has only implemented in the south for11 years (between 1975 and 1986), as opposed to 32 years (1954–1986) in the northern provinces, and since key compo-nents of a centrally planned economy such as the collectivisation of land and agriculture were never fully implementedin the south, the southern provinces had an enormous advantage for developing streamlined economic governance afterthe beginning of the economic reforms (Dinh, 2009). To capture the unique characteristics of the south and its potential cor-relation with the distance to main economic centres, I used a control dummy variable based on whether a province was lo-cated north or south of the 1954 Geneva Armistice’s border declaration at the 17th parallel.

Vietnam has managed to transfer considerable wealth from the most developed provinces to the least developed onesover the course of the reform era. Only some provinces have routinely run fiscal surpluses. Together, they account for about73% of national revenue.8 The remaining provinces have been frequent recipients of fiscal transfers from the central govern-ment. The poor provinces far away from major economic centres in the northeast, northwest and central highland districts re-ceive large subsidies. Malesky and Taussig (2009) argue that these poorly endowed provinces have looked to the centralgovernment for transfers, rather than exploring independent reform strategies or attempting to converge on the successfulstrategies of other high-flying provinces. Therefore, to control for the potentially positive correlation between distance to maineconomic centres and budget transfer, I included the average budget transfer per capita over the period 2006–2007.

Provinces near main economic centres grow faster than others that are further away. Barro (1997) and Lipset (1959) ar-gue that institutional development is normally associated with economic growth. In addition, provinces with higher eco-nomic growth tend to have a wider gap in income inequality. There is some evidence showing that inequality has anegative effect on institutions (Engerman and Sokoloff, 1997; Jong-sung and Khagram, 2005). I controlled GDP per capitaand GINI as a proxy for growth and inequality respectively, to check the robustness of the instrumental variable.

Another concern is that the minimum distance to main economic centres is likely to have effects on provincial institutionsthrough regional policy diffusion (Simmons and Elkins, 2004; Tiebout, 1956). Provinces can exchange ideas and replicate themodel of economic governance from their neighbours. It is expected that policy ideas should spread to neighbouring prov-inces and should diffuse more rapidly across provinces with similar geography, climate and topology (Malesky, 2008). Toisolate the potential effects of policy diffusion, I first include regional dummy variables to examine the effect of foreigninvestment within region and later implemented another formal test to check sensitivity.

4.2. Sensitivity analysis of potential violation of exclusion restriction

Even controlling for all the possible effects, it may be still possible that there are other uncontrolled channels throughwhich the instrument may affect the institution. To gain a sense of the robustness of the IV estimates, I adopt two strategiesto draw inferences when the instrumental variable does not perfectly satisfy the orthogonality condition.

The first strategy is to examine the bounds that I am able to place on the effect of foreign direction investment on eco-nomic governance when I deviate from perfect exogeneity. The bounds approach, which has been developed by Conley et al.(2012) to check potential violation of the exclusion restriction assumption, can be represented as the following system ofequations:

7 The8 The

Pleaseof Com

INSi07 ¼ a0 þ c1 logðFDI=popÞi06-07 þ c2 logðDISTÞi þ X006-07Uþ INSi05 þ ei ð3ÞLogðFDI=popÞi06-07 ¼ a1 þu logðDISTÞi þ X006-07Nþ INSi05 þxi ð4Þ

The difference in this system with a normal IV setup is that the term, log(DIST)i, appears in Eq. (3). Suppose that exclusionrestriction assumption holds, then c2 = 0 and the two equations can be estimated using normal GMM-2SLS regression.

If the exclusion restriction assumption is violated then c2 – 0. Based on these two equations, sensitivity analyses can beconducted using prior knowledge of the magnitude of c2 and checking to what extent the coefficient of foreign investment isstill positive within certain confidence intervals.

main leaders include either chair (or standing deputy) of people committee or chair (or standing deputy) of party committee.se include Quang Ninh, Ha Noi, Hai Phong, Vinh Phuc, HCMC, Da Nang, Khanh Hoa, Dong Nai, Ba Ria-Vung Tau, Can Tho and Binh Duong.




In this case, there is a reason to believe that even if c2 – 0, it should be small. If I knew that the true value of c2 is c0, Icould consistently estimate c2 from:

9 Thi10 All11 Thi

many stDijk (20

12 For

Pleaseof Com

ðINSi07 � c2 logðDISTÞiÞ ¼ a0 þ c1 logðFDI=popÞi06-07 þ X 006-07Uþ INSi05 þ ei ð5Þ

with 2SLS using log(DIST)i as instruments for log(FDI/pop)i06-07. However, since I do not know c0, I can perform sensitivityanalysis by studying the implications of different assumptions about its values. Conley et al. (2012) suggest that we can as-sume some specific support interval [�d; +d] for c2 > 0 and estimate the union of confidence intervals for c1 given any c2 inthat support.The second strategy is based on Berkowitz et al. (2012) to make inferences when an instrumental variable doesnot perfectly satisfy the exclusive restriction condition. Berkowitz et al. (2008, 2012) shows that when there is a minor vio-lation of the orthogonality condition, the Anderson and Rubin test over-rejects the null hypothesis (c1 = 0). To correct thisproblem, they derive the fractionally resampled Anderson–Rubin test to draw valid, but conservative inferences.9

5. Data description

5.1. Economic governance variables

Although the overall importance of institutions for economic development has been emphasised in the literature, there isless agreement on how to measure the quality of institutions. For cross-country studies, researchers who undertake empir-ical work on the effects of institutions rely on several sources to measure differences in institutional quality across countriessuch as the International Country Risk Guide (ICRG) expropriation risk index (Acemoglu et al., 2001); the composite ICRG andBusiness Environmental Risk Intelligence (BERI) indices (Knack and Keefer, 1995); an index combining five ICRG indicatorswith the Sachs-Warner openness index (Hall and Jones, 1999); the bureaucratic efficiency, political stability and institutionalefficiency indexes composed of nine Business International (BI) indicators (Mauro, 1995); and the composite ICRG index andthe Freedom House democracy index (Rodrik, 1999).10

In this study, data on institutions are obtained from the Vietnam Provincial Competitiveness Index (PCI) survey. This sur-vey is product of a United States Agency for International Development project conducted by the Vietnam CompetitivenessInitiative and the Vietnam Chamber of Commerce and Industry to assess and rank provincial governments by their regula-tory environments for private sector development.11 The survey asks private businesses a wide range of questions rangingfrom their performance to perceptions about the support to the business environment and pro-activity of provincial leaders.The primary output of this survey is the Provincial Competitiveness Index, which ranks all provinces by their universal regula-tions. The main index has a possible range of 10–100 and is a weighted combination of 10 sub-indices with higher values rep-resenting better regulations.12

The goal of weighting is to ensure that the PCI scores reflect private sector performance. Therefore, the PCI relates themost policy-relevant information to provincial officials regarding the impact of provincial policies on private sector activity.Sub-indices that have the largest association with private sector growth, investment, and profitability have the highestweight of 15%. Those performance indices which are not strongly correlated with private sector development outcomes re-ceive the lowest weight of 5%. Medium weights of 10% are given to average correlations across the three outcome variablesor a large substantive effect on one outcome (i.e., profitability), but a minimal relationship with the other two (Malesky,2007).

These sub-indices, ranging from 1 to 10, are arranged into three factor groups. The first factor group contains sub-indicesthat are generally concerned with post-registration policies and regulation in the provincial business environment: (1) TheTransparency and Access to Information (a measure of whether firms have access to the proper planning and legal docu-ments necessary to run their businesses); (2) Labour and Training (a measure of the efforts by provincial authorities to pro-mote vocational training and skills development for local industries and to assist in the placement of local labour); (3) Pro-activity of Provincial Leadership (a measure of the creativity and cleverness of provinces in implementing central policy,designing their own initiatives for private sector development); (4) Time Costs and Regulatory Compliance (a measure ofhow much time firms waste on bureaucratic compliance) indices are related to the local level policy initiatives or decisionsto implement those policy choices and (5) Business Development Services (a measure of provincial services for private sectortrade promotion, provision of regulatory information to firms, business partner matchmaking, provision of industrial zonesor industrial clusters, and technological services for firms).

The second factor uncovers a general conception of property rights, including: (1) the ability to access land and the secu-rity of business premises (Land Access); (2) the faith firms have that provincial courts will enforce contracts (Confidence inLegal Institutions), and (3) firm perceptions of the corruption of provincial officials (Informal Charges). These sub-indices ex-plore the formal restraints placed on the ‘grabbing hand’ of bureaucrats. Good scores on property rights represent state

s test is based on the jackknife histogram estimator of Wu (1990) and the resampled fraction fn is be modified as: fn = 1/2 � jn, where jn ¼ j=ffiffiffi

np

.these measures of institutional quality are only available at country levels.s study uses the data that was surveyed in 2008 for the perception and performance of over 7820 private enterprises in the year 2007. PCI was used inudies on provincial governance in Vietnam such as Malesky and Taussig (2009), Malesky (2008), Tran et al. (2008), Vu et al. (2007) and Nguyen and van12).detailed construction of the composite and sub-indices, go to the website: http://www.pcivietnam.org.


http://www.pcivietnam.org


Table 1Descriptive statistics.

Variables Obs. Mean SD Min. Max.

Overall economic institutional indicesProvincial Competitive Index 2007 60 53.02 7.68 36.39 71.76Provincial Competitive Index 2005 60 52.12 7.03 36.67 76.23

Economic institutional sub-indices 2007Entry Costs 60 8.22 0.57 6.31 9.17Land Access & Security of Tenure 60 6.70 0.69 5.18 8.05Transparency of Business Information 60 5.97 1.11 2.99 7.72Time Costs of Regulatory Compliance 60 5.20 0.81 2.85 6.52Informal Charges (Corruption) 60 6.71 0.51 5.70 8.30Bias toward State Owned Sector 60 7.47 0.54 5.99 8.77Proactivity of Provincial Leadership 60 5.42 1.42 2.32 8.45Business Development Services 60 3.31 1.09 1.40 6.14Labour Training and Matchmaking 60 4.38 1.31 1.84 7.93Confidence in Legal Institutions 60 4.66 1.09 2.50 6.70

Economic institutional sub-indices 2005Entry Costs 60 7.38 0.85 4.96 8.83Land Access & Security of Tenure 60 6.00 0.79 3.84 7.98Transparency of Business Information 60 5.27 1.25 2.15 8.50Time Costs of Regulatory Compliance 60 4.43 0.82 2.64 7.12Informal Charges (Corruption) 60 6.41 0.69 5.05 8.35Bias toward State Owned Sector 60 6.63 0.67 5.07 8.40Proactivity of Provincial Leadership 60 5.01 1.33 2.36 9.08Business Development Services 60 5.08 1.38 2.40 8.86Labour Training and Matchmaking 60 5.13 1.21 1.99 8.45Confidence in Legal Institutions 60 3.74 0.79 2.13 6.55

Actual economic institutional sub-indices 2007No of trade fairs held by provinces 60 0.82 0.48 0.09 2.05No of locally managed vocational schools per 10,000 citizens 60 1.60 0.56 0.58 3.21Share of the liability/revenue of state-owned enterprises 60 3.34 0.28 2.35 3.78Percentage of legal cases filed by private firms 60 1.77 0.74 0.40 3.41

Actual economic institutional sub-indices 2005No of trade fairs held by provinces 60 0.82 1.59 0.00 6.00No of locally managed vocational schools per 10,000 citizens 60 0.71 0.42 0.10 2.03Share of the liability/revenue of state-owned enterprises 60 1.39 0.58 0.50 4.13Percentage of legal cases filed by private firms 60 0.87 1.63 0.00 9.49

Other variablesLog average foreign direct investment per capita 2006–2007 60 �2.94 2.45 �7.61 2.24Log distance to main economic centres 60 4.95 0.78 2.56 6.07Log real average GDP per capita 2006–2007 60 2.18 0.50 1.34 4.88Average year of schooling of public sector 2006 60 12.81 0.88 10.33 14.45Education level of main provincial leaders 60 1.25 0.65 0.00 3.00Log budget transfer per capita 60 6.71 0.90 3.81 8.34Inequality (GINI) 2006 60 0.32 0.04 0.24 0.44Log average telephone per capita 2006–2007 60 �2.18 0.32 �2.90 �1.28


retreat from intervention in the affairs of private firms, as opposed to the first factor, where good scores represent policyinterventions.

The final factor comprises two sub-indices: (1) Entry Costs and (2) Bias to the State Sector, which address entry barriers toprivate entrepreneurs. Entry Costs describe the direct financial costs of entry, whereas SOE bias represents the implicit bar-riers to private sector entry posed by the economic strength of the existing state sector or the ideological convictions of pro-vincial bureaucrats (Malesky, 2007).

Table 1 presents the average governance index by year. It shows that the average score in 2007 is higher than thatin 2005 although the difference is small. Fig. 3 shows the spatial variation in institutional quality across provinces in2007. On average, it shows that institutional performances were better in the southern provinces. In addition, the pro-portion of provinces with the lowest rankings of economic governance is higher in the northern mountainousprovinces.



Ha Noi

Da Nang

Hochiminh city(60.67,72.18](56.32,60.67](53.725,56.32](49.52,53.725](46.03,49.52][36.39,46.03]

Fig. 3. Ranking of provincial economic governance 2007.


5.2. The foreign direct investment variable

The main independent variable is the log of annual FDI per capita. The data on disbursed FDI was taken from the GeneralStatistics Offices’ provincial yearbooks and are averaged over 2 years, 2006–2007.13

Other data on the number of telephones and the real GDP per capita were taken from Vietnam’s Statistical Yearbook. Thedata on inequality and public sector education were calculated from the Vietnam Living Standard Survey 2006. The budgettransfer per capita data was obtained from the website of the Ministry of Finance. The descriptive statistics of the main vari-ables are represented in Table 1.

Table 2 represents the bivariate correlation matrix among variables and demonstrates that the provincial economic gov-ernance index is highly correlated with foreign investment inflows.

13 The sample only includes 60 provinces, which exclude Ha Noi, HCMC and Da Nang, to make the results comparable with IV estimates. The averaged foreigninvestment inflows intend to mitigate potential measurement errors due to statistical issues.



Table 2Bivariate correlation.

Variables 1 2 3 4 5 6 7

1. Provincial competitive index 2007 12. Log average foreign direct investment per capita 2006–2007 0.294* 13. Log distance to main economic centres �0.498* �0.528* 14. Log real average GDP per capita 2006–2007 0.421* 0.416* �0.308* 15. Education level of main provincial leader �0.126 0.119 �0.181 �0.186 16. Log budget transfer per capita 2006–2007 �0.608* �0.417* 0.502* �0.718* 0.153 17. Log average telephone per capita 2006–2007 0.274* 0.479* �0.340* 0.658* �0.110 �0.617* 1

* Significant at .05 level.

Table 3OLS estimates.

Provincial Competitiveness Index 2007

(1) (2) (3) (4) (5) (6) (7) (8)

Log(FDI/pop) 0.18 0.37 0.35 0.38 0.37 0.37 0.42 0.37[0.31] [0.36] [0.37] [0.37] [0.37] [0.38] [0.39] [0.38]

Provincial competitive index 2005 0.72*** 0.71*** 0.74*** 0.72*** 0.72*** 0.72*** 0.73***

[0.10] [0.11] [0.11] [0.12] [0.12] [0.13] [0.13]Log GDP per capita 2006–2007 0.51 1.09 0.90 0.92 2.30 3.13*

[1.60] [1.43] [1.54] [1.56] [1.56] [1.62]Average year of schooling of public sector �0.84 �0.91 �0.95 �0.95 �1.08

[0.84] [0.86] [0.92] [0.96] [0.85]Education level of main leaders �0.45 �0.45 �0.45 �0.73 �1.12

[1.15] [1.14] [1.16] [1.19] [0.92]Average budget transfer per capita 2006–2007 �0.54 �0.57 �1.09 �1.06

[1.22] [1.24] [1.34] [1.31]Inequality 2006 �3.46 �2.59 �8.58

[13.04] [12.07] [13.97]Log telephone per capita 2006–2007 �3.94 �6.45**

[1.94] [2.70]South dummy 5.76*

[2.86]

Regional fixed effects No Yes Yes Yes Yes Yes Yes YesR-square 0.57 0.70 0.70 0.71 0.71 0.71 0.72 0.74Number obs. 60 60 60 60 60 60 60 60

Notes: Standard errors are robust to arbitrary heteroskedasticity. Regional fixed effects control for Red River Delta, North East, North Central Coast, SouthCentral Coast, South East and Mekong River Delta regions.* Significance level of 10%.** Significance level of 5%.*** Significance level of 1%.


6. Empirical results

This section tests whether foreign investment leads to institutional development. I start by correlating FDI with institu-tions using OLS. As shown in Table 3, there is some evidence that higher FDI correlates positively on institutions, althoughnone of the coefficients is statistically significant. However, the coefficients are nearly identical when additional controls areincluded. In the final column including all variables, one time increase in foreign investment per capita is associated with a0.37 point increase in the institutional index.14

The OLS estimates are likely to be inconsistent as they do not adequately account for reverse causality and omitted var-iable problems.15 To deal with these problems, I used a GMM-2SLS regression model with the instrument constructed in theSection 4. The results of the first stage estimation are presented in the lower panel of Table 4. The results show that the instru-ment strongly predicts the provincial levels of foreign investment. The F-statistics of the excluded instrument were above 10 inalmost cases, showing that the instrument is strong (Staiger and Stock, 1997).

The IV estimates are reported in the upper panel of Table 4. Note that all variables in the first stage are also included in thesecond stage estimation. The first column reports estimates that only control for the initial conditions in 2005, without con-trolling for other variables. The estimates indicate that FDI has significant and positive effects on the quality of economicgovernance.

14 The average disbursed FDI per capita in 2006–2007 is $US35.15 Using spatial regression to correct for potential spatial auto-correlation of the error term provides identical results.



Table 4IV regressions.

IV estimates

(1) (2) (3) (4) (5) (6) (7) (8)

Second stage. Provincial Competitiveness Index 2007Log(FDI/pop) 1.43** 1.42* 1.87** 1.55* 2.00** 1.76** 1.76** 1.97***

[0.69] [0.80] [0.84] [0.83] [0.86] [0.74] [0.69] [0.60]Provincial competitive Index 2005 0.66*** 0.66*** 0.65*** 0.61*** 0.59*** 0.62*** 0.61*** 0.68***

[0.11] [0.11] [0.13] [0.12] [0.13] [0.13] [0.11] [0.12]Log GDP per capita 2006–2007 0.12 �1.23 �2.17 �3.34* �2.63 �0.42 2.26

[0.80] [1.89] [1.85] [1.99] [1.96] [1.51] [1.73]Average years of schooling of public sector �0.19 �0.39 �0.21 �0.52 �0.22 �1.01

[0.71] [0.76] [0.78] [0.78] [0.86] [0.89]Education level of main leaders �2.39* �2.02* �1.96 �1.77 �1.97 �1.68

[1.29] [1.16] [1.20] [1.11] [1.25] [1.06]Average budget transfer per capita 2006–2007 �1.55 �0.96 �1.04 �1.90 �1.66

[1.55] [1.62] [1.53] [1.60] [1.33]South dummy 2.56 2.67 1.56 4.81**

[1.48] [1.39] [1.53] [2.08]Inequality 2006 �25.02 �19.19 �12.25

[14.28] [13.22] [12.85]Log telephone per capita 2006–2007 �7.30** �8.26***

[3.39] [3.03]

First stage. Dependent variable is average foreign direct investment over population 2006–2007Log distance �1.49*** �1.34*** �1.29*** �1.29*** �1.34*** �1.43*** �1.43*** �1.41***

[0.341] [0.341] [0.36] [0.42] [0.40] [0.40] [0.38] [0.39]Provincial competitive Index 2005 0.04 0.01 0.02 0.02 0.02 0.01 0.02 0.006

[0.04] [0.04] [0.04] [0.05] [0.05] [0.05] [0.05] [0.05]Log GDP per capita 2006–2007 1.33*** 1.51*** 1.53*** 1.48*** 1.39*** 0.66 0.44

[0.36] [0.34] [0.44] [0.49] [0.50] [0.55] [0.58]Average years of schooling of public sector �0.15 �0.14 �0.13 �0.06 �0.16 �0.16

[0.28] [0.29] [0.30] [0.31] [0.33] [0.33]Education level of main leaders 0.41 0.41 0.43 0.41 0.47 0.45

[0.40] [0.41] [0.41] [0.40] [0.42] [0.42]Average budget transfer per capita 2006–2007 0.01 0.07 0.09 0.38 0.45

[0.07] [0.48] [0.47] [0.47] [0.47]South dummy 0.24 0.23 0.60 �0.03

[0.57] [0.58] [0.60] [0.78]Inequality 2006 6.64 4.71 3.84

[6.95] [6.71] 5.92]Log telephone per capita 2006–2007 2.41* 1.93

[1.32] [1.33]

Regional fixed effects No No No No No No No YesF-stat. 17.98 19.07 14.56 12.53 11.56 10.17 9.35 9.02F test for excluded IVs 19.15 15.43 12.46 9.62 11.13 12.93 14.26 12.91Number of observations 60 60 60 60 60 60 60 60Stock-Yogo critical values 5.53/16.38

Notes: Robust standard errors to heteroskedasticity are in the square brackets. F statistics on excluded IV for weak-instrument tests are also reported. Thenull hypothesis in this case is that the instrument is weak. Stock-Yogo critical values are the 5% significance level critical values for weak instruments testsbased on, respectively, 25% and 10% maximal IV size. The null hypothesis of weak instruments is rejected in the case that the F statistics on excluded IVexceeds the Stock-Yogo critical values. Regional fixed effects control for Red River Delta, North East, North Central Coast, South Central Coast, South East andMekong River Delta regions.* Significance level of 10% against a two sided alternative.** Significance level of 5% against a two sided alternative.*** Significance level of 1% against a two sided alternative.


The results from Column 2 show the estimates after including additional covariates to check the robustness to exclusionrestrictions. The result shows a positive and statistically significant effect of FDI inflow on institutions is robust to the inclu-sion of inequality, schooling, budget transfer, real GDP per capita, the south dummy variable, the number of telephones var-iable and regional dummies. The results are significant as the control variables are added either one by one orsimultaneously. On average, one time increase in foreign investment per capita is associated with 1.42–2 point increasein the index of institutional quality, which is equal to 19.1–25.3% of the institutional index standard deviation in 2007.

The results were then further scrutinised as follows: because the impacts of foreign investment on economic governanceare not homogenous across regions, I assess whether the results outlined above are driven by any particular group of prov-inces. Provinces that may be outliers were omitted to see if this influenced the results. The first row of Table 5 reports theresult obtained with the full sample. In the second row, I re-estimated the regression with a sub-sample that includes onlysouthern provinces. The results indicated that the impact of foreign investment is less profound in the south. In the third



Table 5Institutions and foreign direct investment: Robustness to subsamples.

Sample Coef. SE N

Full sample 1.97*** 0.60 60Only South 1.85** 0.80 31Excluded Northeast, Northwest and Central Highland 2.44*** 0.73 41Only Southeast, Read River Delta and South Central Coast 2.59* 1.35 25

Notes: Dependent variable is provincial competitiveness index 2007. Robust standard errors to heteroskedasticity. Other control variables at provinciallevel include: provincial competitiveness index 2005, average income per capita 2006–2007, public sector education, main leader education, averagenumber of telephone per capita 2006–2007, average budget transfer per capita 2006–2007, inequality 2006, dummy variables for Red River Delta, SouthCentral Coast and South East regions.* Significance level of 10% against a two sided alternative.** Significance level of 5% against a two sided alternative.*** Significance level of 1% against a two sided alternative.


row, I report the results when the provinces in northeast, central highlands and northwest regions are omitted from the sam-ple. Since these provinces are mountainous and have poor infrastructure, they attract little FDI. Therefore, the impact of for-eign investment on institutional quality is likely to be negligible in these provinces. Since FDI mainly concentrates in theSoutheast, the Red River Delta and the South Central Coast regions, in the last row, I re-estimated the model including onlythe provinces in these three regions. Overall, the results remained robust to this procedure. In general, it seems that foreigndirect investment influences mainly the FDI concentrated regions.

To examine the impact of foreign investment on the current level of institutional development in more detail, I unbundlethe impact of foreign investment on different measures of economic governance. I correlate FDI with subgroup measures ofinstitutions using the GMM-IV method. There are several PCI indicators that are likely to provide insight into how economicgovernance is affected by WTO-related reforms over the last few years. Table 6 reports the IV results of the regressions esti-mated using different measures of institutional quality used as the dependent variable without controls. I also include allother control variables in the regressions and present the results in Table 7. The results both with and without other controlvariables show similar patterns.

The findings in Table 7 indicate that the that foreign direct investment has a positive impact on the improvement of la-bour training, pro-activeness of provincial leadership, private business development, confidence in legal institutions andreduction of informal charges. For example, one time increase in foreign investment per capita leads to a corresponding0.29 point improvement in private business development, which is equal to 23.13% standard deviation of the private busi-ness development index in 2007. Higher foreign investment also creates a catalyst to prevent corruption. On average, theinstitutional index on informal charges rises by 0.19 points with one time increase in FDI per capita (or 36% standard devi-ation of the informal charge index in 2007). A separate estimation was implemented for the provinces in the north, and theresults demonstrated that higher foreign investment has a greater positive impact on these provinces in almost cases.

6.1. Robustness test of subjective perception

One of the important features of this survey is that it includes information about many aspects of institutional settings,which allows a more accurate examination of the impact of foreign investment on institutional quality. However, this data-set faces the problem indicated in Glaeser et al. (2004) and Rodrik et al. (2004): these indicators are likely to measure inves-tors’ perceptions rather than any actual aspects of economic institutions. They are likely to represent institutional outcomesrather than economic institutions themselves. In addition, even they do represent to some degree of the economic institu-tions, these perceptions are likely also to be influenced by many other aspects of the economic environment, such as culturalnorms. Therefore, it is possible that the measurement error of the dependent variables correlates with the error terms andbiases the results.

To test for robustness, I estimate the same regressions using dependent variables that are not derived from the survey andthus less likely to be subject to the biases of individual respondents’ perceptions. I am only able to find four objective mea-sures which can proxy for four of ten subjective aspects of the institutional quality indices. They are: (i) the share of the lia-bility/revenue of state-owned enterprises to measure provincial bias to state enterprises on access to capital; (ii) the numberof locally managed vocational schools per 10,000 citizens to measure labour policy; (iii) the number of trade fairs held byprovinces in the previous year and registered for the present year as a proxy for private sector development policies; and(iv) the percentage of legal cases filed by private firms, measuring private sector confidence in legal institutions. The resultspresented in Table 8 confirm the above results that only the proxy for trade fairs is statistically significant after controllingfor all variables. One time increase in foreign investment per capita leads to a corresponding 0.13 increase in the number oftrade fairs. The results also indicate that foreign investment results in better effects on labour training policies in thenorthern provinces.



Table 6FDI inflow and different institutional measures. Without other control variables.

Dependent variable (1) (2) (3) (4) (5) (6) (7) (8) (9) (10)

Regulation in business environment Property rights Accountability

EntryCost

Bias to theState Sector

Labourtraining

Proactivity ofProvincialLeadership

Private BusinessDevelopment

Time Costs ofRegulatoryCompliance

Land Access andSecurity of tenure

Confidence inLegal Institutions

InformalCharges(corruption)

Transparency ofbusinessinformation

Full sampleLog(FDI/pop) �0.04 0.04 0.29** 0.095 0.267** 0.248*** 0.031 0.224* 0.180*** 0.188*

[0.06] [0.04] [0.13] [0.08] [0.11] [0.08] [0.05] [0.12] [0.05] [0.10]Lagged subgroup indices in 2005 Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes

F-stat. 1.65 22.99 15.94 48.52 20.67 8.15 15.23 1.66 7.43 9.38Number obs. 60 60 60 60 60 60 60 60 60 60F test of excluded IV 31.32 28.18 16.61 24.58 24.46 31.99 28.23 24.41 28.09 26.85

Only North provincesLog(FDI/pop) �0.145 0.057 0.519*** 0.063 0.294* 0.268** 0.007 0.17 0.227*** 0.145

[0.116] [0.072] [0.178] [0.133] [0.173] [0.121] [0.072] [0.121] [0.076] [0.172]Lagged subgroup indices in 2005 Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes

F-stat. 1.65 4.38 9.84 22.7 9.36 3.51 4.59 0.89 5.4 2.67F test of excluded IV 22.46 38.20 12.62 12.35 13.38 24.31 24.01 24.79 27.54 16.24Number obs. 29 29 29 29 29 29 29 29 29 29

Notes: Robust standard errors are in squared brackets. F statistics on excluded IV for weak-instrument tests are also reported. The null hypothesis in this case is that the instrument is weak. Stock-Yogo criticalvalues are the 5% significance level critical values for weak instruments tests based on, respectively, 25% and 10% maximal IV size (5.53/16.38). The null hypothesis of weak instrument is rejected in the case thatthe F statistics on excluded IV exceeds the Stock-Yogo critical values.* Significance level of 10% against a two sided alternative.** Significance level of 5% against a two sided alternative.*** Significance level of 1% against a two sided alternative.

D.A

.Dang

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ang,D.A

.How

foreigndirect

investment

promote

institutionalquality:

Evidencefrom

Vietnam

.Journalof

Comparative

Economics

(2013),http://dx.doi.org/10.1016/j.jce.2013.05.010


Table 7FDI inflow and different institutional measures. Adding other control variables.

Dependentvariable

(1) (2) (3) (4) (5) (6) (7) (8) (9) (10)

Regulation in business environment Property rights Accountability

EntryCost

Bias to theState Sector

Labourtraining

Proactivity ofProvincial Leadership


Time Costs ofRegulatory Compliance


Confidence in LegalInstitutions

Informal Charges(corruption)

Transparency ofbusiness information

Full sampleLog(FDI/pop) 0.02 0.09 0.22* 0.29*** 0.29*** �0.01 0.05 0.45** 0.19*** 0.18

[0.09] [0.056] [0.13] [0.10] [0.10] [0.12] [0.06] [0.20] [0.07] [0.13]

F-stat. 1.94 6.78 10.71 10.51 12.84 7.03 10.39 1.69 2.73 4.32F stat. for

excludedIV

14.76 14.38 10.21 14.04 14.39 14.04 14.42 9.44 13.93 14.77

Number obs. 60 60 60 60 60 60 60 60 60 60

Only Northern provincesLog(FDI/pop) �0.09 �0.03 0.44** 1.16 0.23** �0.18 0.06 0.16 0.09* �0.13

[0.13] [0.09] [0.21] [0.17] [0.11] [0.17] [0.07] [0.18] [0.06] [0.14]

F-stat. 0.85 1.98 2.94 7.51 9.45 6.63 4.54 0.52 6.16 4.89F stat for

excludedIV

10.67 11.24 6.57 9.38 9.70 11.28 11.29 12.78 12.52 7.65

Number obs. 29 29 29 29 29 29 29 29 29 29

Notes: Robust standard errors are in squared brackets. Other control variables include: Lagged subgroup indices in 2005, average income per capita 2006–2007, public sector education, education level of mainprovincial leaders, average number of telephone per capita 2006–2007, average budget transfer per capita 2006–2007 and inequality 2006, dummy variables for Red River Delta, South Central Coast and South Eastregions. F statistics on excluded IV for weak-instrument tests are also reported. The null hypothesis in this case is that the instrument is weak. Stock-Yogo critical values are the 5% significance level critical valuesfor weak instruments tests based on, respectively, 25% and 10% maximal IV size (5.53/16.38). The null hypothesis of weak instrument is rejected in the case that the F statistics on excluded IV exceeds the Stock-Yogo critical values.* Significance level of 10% against a two sided alternative.** Significance level of 5% against a two sided alternative.*** Significance level of 1% against a two sided alternative.

14D

.A.D

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ofCom

parativeEconom

icsxxx

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ang,D.A

.How

foreigndirect

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promote

institutionalquality:Evidence

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ietnam.Journal

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parativeEconom

ics(2013),http://dx.doi.org/10.1016/j.jce.2013.05.010


Table 8Foreign investment and different institutional measures. Actual indicators.

(1) (2) (3) (4)Dependent variable SOEs share of liability/revenue Trade fair Vocational Training Cases of non-state entities filed by courts

Full sample without controlsLog(FDI/pop) 0.034 0.11** 0.06 0.08

[0.03] [0.05] [0.04] [0.08]

F-stat. 6.84 2.96 16.75 3.36F statistics for excluded IV 27.86 30.01 22.49 25.97Number obs. 60 60 60 60

Full sample with other controlsLog(FDI/pop) 0.02 0.13* 0.04 0.13

[0.02] [0.07] [0.06] [0.09]


Only Northern provinces with other controlsLog(FDI/pop) 0.04 0.27*** 0.21 0.03

[0.03] [0.09] [0.15] [0.13]


Notes: Robust standard errors are in squared brackets. Other control variables include: subgroup indices 2005, average income per capita 2006–2007,public sector education, education level of main provincial leaders, average number of telephone per capita 2006–2007, average budget transfer per capita2006–2007 and inequality 2006, dummy variables for Red River Delta, South Central Coast and South East regions. F statistics on excluded IV for weak-instrument tests are also reported. The null hypothesis in this case is that the instrument is weak. Stock-Yogo critical values are the 5% significance levelcritical values for weak instruments tests based on, respectively, 25% and 10% maximal IV size (5.53/16.38). The null hypothesis of weak instrument isrejected in the case that the F statistics on excluded IV exceeds the Stock-Yogo critical values.* Significance level of 10% against a two sided alternative.** Significance level of 5% against a two sided alternative.*** Significance level of 1% against a two sided alternative.


6.2. Sensitivity test of exclusion restriction

Table 9 reports the test of the potential violation of exclusion restriction following Conley et al.’s approach. I select severalintervals with d = 0.2; 0.4 and 0.6. The maximum value, 0.6, approximates to 30% of the foreign investment coefficient in theIV model. The estimated bounds are reported for the 95% confidence intervals.

Table 9Bounds for the effect of foreign direct investment on economic governance.

Support interval for possible values of c2 95% confidence interval

Lower Upper

c2 � [�0.2,+0.2] 1.12 3.60c2 � [�0.4,+0.4] 1.11 3.70c2 � [�0.6,+0.6] 1.04 3.80

Notes: (1) Other control variables include: provincial competitiveness index 2005,average income per capita 2006–2007, public sector education 2006, education level ofmain provincial leaders, average number of telephone per capita 2006–2007, averagebudget transfer per capita in 2006–2007 and inequality 2006. (2) Bounds are estimatedusing the approach by Conley et al. (2012). (3) Number of observations: 60.

Table 10Fractionally resampled Anderson and Rubin test.

j values Full sample statistic Full sample p-value F-Resampled p-value Reps. N

2.3 8.092 0.004 0.091 10000 602.2 8.092 0.004 0.093 10000 602.1 8.092 0.004 0.103 10000 602.0 8.092 0.004 0.110 10000 60

Notes: The results based on the regression in the last Column in Table 4. The full sample AR statistic is reported in Columns 2. The full sample and resampledAR p-values are presented in Columns 3 and 4. The null hypothesis in this case is that the foreign direct investment has no effect on provincial economicgovernance. The fractionally resampled Anderson and Rubin test is based on Berkowitz et al. (2012) and Riquelme et al. (forthcoming).



Table A.1Foreign direct investment and different institutional measures. Full sample with control variables.

(1) (2) (3) (4) (5) (6) (7) (8) (9) (10)Dependent Variable Entry

CostBias to theState Sector

Labourtraining

Proactivity ofProvincialLeadership


Time Costs ofRegulatoryCompliance


Confidence inLegal Institutions

Informal Charges(corruption)

Transparency ofbusiness information

Log(FDI/pop) 0.02 0.09 0.22* 0.29*** 0.29*** �0.01 0.05 0.45** 0.19*** 0.18(0.09) (0.06) (0.13) (0.10) (0.10) (0.12) (0.06) (0.20) (0.07) (0.13)

Lagged sub-index 2005 0.178* 0.428*** 0.592*** 0.720*** 0.483*** 0.424*** 0.468*** �0.200 0.264*** 0.344***

(0.0940) (0.0978) (0.133) (0.104) (0.131) (0.133) (0.0688) (0.221) (0.0987) (0.123)Log GDP per capita 2006–

20070.343** �0.219 0.442 0.161 0.859*** 0.815*** 0.185 �0.0551 0.0808 �0.0932(0.171) (0.164) (0.309) (0.290) (0.264) (0.235) (0.158) (0.391) (0.149) (0.431)

Average years of schoolingof public sector

0.0152 0.0994 0.0178 �0.139 �0.154 �0.0577 0.0307 �0.275 0.00434 0.00615(0.0888) (0.0772) (0.137) (0.163) (0.155) (0.143) (0.0787) (0.199) (0.0701) (0.162)

Education level of mainleaders

�0.173** �0.145* 0.0363 �0.509*** �0.151 0.159 �0.228** �0.241 �0.216** �0.239(0.0794) (0.0801) (0.178) (0.189) (0.185) (0.205) (0.0949) (0.281) (0.107) (0.222)

Average budget transferper capita 2006–2007

0.0627 �0.0111 �0.298 �0.169 �0.145 �0.488** 0.0861 0.0202 �0.150 �0.522**

(0.120) (0.0903) (0.221) (0.224) (0.226) (0.223) (0.111) (0.301) (0.0921) (0.216)South dummy �0.178 0.0266 1.045*** 0.335 0.327 0.511 0.411** 1.197*** 0.0150 0.0886

(0.192) (0.159) (0.343) (0.339) (0.340) (0.329) (0.195) (0.432) (0.159) (0.411)Inequality 2006 2.207 1.843* �0.368 �1.282 �1.823 �5.438** �0.914 �3.511 �1.281 �0.270

(1.440) (1.005) (2.247) (2.780) (2.508) (2.195) (1.429) (3.501) (1.594) (2.256)Log telephone per capita

2006–2007�0.524* �0.114 �1.645*** �0.701 �1.626*** �0.354 �1.152*** �0.128 �0.346 �0.384(0.272) (0.285) (0.443) (0.498) (0.531) (0.505) (0.239) (0.768) (0.280) (0.555)

First stage. Dependent variable is average foreign direct investment over population 2006–2007Log distance �1.445*** �1.406*** �1.357*** �1.446*** �1.423*** �1.423*** �1.420*** �1.350*** �1.415*** �1.422***

(0.376) (0.371) (0.425) (0.386) (0.375) (0.380) (0.374) (0.440) (0.379) (0.370)Lagged sub-index 2005 0.202 0.212 0.108 �0.0423 0.0160 �0.000 �0.0463 0.155 �0.283 �0.0174

(0.323) (0.411) (0.276) (0.220) (0.267) (0.267) (0.390) (0.394) (0.416) (0.246)Log GDP per capita 2006–

20070.472 0.481 0.460 0.453 0.440 0.429 0.414 0.397 0.441 0.423(0.566) (0.562) (0.591) (0.613) (0.588) (0.587) (0.586) (0.590) (0.574) (0.580)

Average years of schoolingof public sector

�0.186 �0.185 �0.170 �0.153 �0.158 �0.151 �0.152 �0.185 �0.173 �0.148(0.319) (0.328) (0.311) (0.317) (0.351) (0.317) (0.316) (0.336) (0.319) (0.325)

Education level of mainleaders

0.408 0.448 0.440 0.447 0.449 0.447 0.446 0.480 0.462 0.447(0.418) (0.417) (0.421) (0.424) (0.422) (0.420) (0.421) (0.448) (0.400) (0.423)

Average budget transferper capita 2006–2007

0.431 0.459 0.461 0.402 0.444 0.429 0.405 0.354 0.346 0.417(0.460) (0.440) (0.451) (0.461) (0.483) (0.445) (0.464) (0.481) (0.477) (0.463)

South dummy 0.0624 0.0729 0.0119 �0.0141 �0.0324 �0.0355 �0.0161 �0.0614 0.0328 �0.0440(0.784) (0.816) (0.795) (0.769) (0.777) (0.803) (0.769) (0.766) (0.796) (0.787)

Inequality 2006 4.232 3.874 3.725 4.107 3.800 3.915 3.803 3.409 2.996 3.874(5.655) (5.751) (5.762) (5.982) (6.374) (5.643) (5.718) (5.900) (5.734) (5.701)

Log telephone per capita2006–2007

1.814 2.073 1.825 1.855 1.928 1.930 1.917 1.893 1.865 1.939(1.333) (1.383) (1.333) (1.379) (1.329) (1.326) (1.338) (1.337) (1.327) (1.316)

F-stat. 1.94 6.78 10.71 10.51 12.84 7.03 10.39 1.69 2.73 4.32F stat for excluded IV 14.76 14.38 10.21 14.04 14.39 14.04 14.42 9.44 13.93 14.77Number obs. 60 60 60 60 60 60 60 60 60 60

Notes: Robust standard errors are in squared brackets. F statistics on excluded IV for weak-instrument tests are also reported. The null hypothesis in this case is that the instrument is weak. Stock-Yogo criticalvalues are the 5% significance level critical values for weak instruments tests based on, respectively, 25% and 10% maximal IV size (5.53/16.38). The null hypothesis of weak instrument is rejected in the case thatthe F statistics on excluded IV exceeds the Stock-Yogo critical values.* Significance level of 10% against a two sided alternative.** Significance level of 5% against a two sided alternative.*** Significance level of 1% against a two sided alternative.

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The results show that the estimated bounds do not vary significantly with different values of c2. Moreover, none of the95% confidence intervals contain zero. This provides strong evidence in favour of a robust positive impact of foreign invest-ment on economic governance. It also confirms that even if I allow a non-zero level direct geographic distance to affect eco-nomic governance directly then remove this part of the influence on the instrument, the fundamental conclusion that foreigninvestment improves institutional quality remains unchanged. Even in the most conservative case, one time increase in FDIper capita still increases economic governance substantially, by 1.04 points.

Table 10 shows the fractionally resampled Anderson–Rubin test for the significance of the foreign investment coefficient.Due to a small sample of 60 observations, I follow Berkowitz et al. (2012) to choose j values, which is less than 2.4, to gen-erate reliable and stable results. The results represented in Table 10 indicate that even in the more cautious test, the log offoreign direct investment still shows significant effects on local institutional quality for some values of j. Moreover, the re-sults from these two robustness tests indicate that it is less likely that the estimated effect of the foreign direct investment iscompletely driven by unobservable omitted biases.

7. Conclusion

In this paper, I demonstrate the short-term impacts foreign direct investment on institutional quality across Vietnam’sprovinces. Using data on 60 provinces, I document a positive association between institutions and FDI inflows. In particular,provinces that have had a larger amount of disbursed FDI witness a better institutional quality. The instrumental variableapproach suggests that the direction of influence is from greater foreign investment flow to better institutions. This resultholds after controlling for various additional covariates. It is also robust to various alternative measures of institutionsand different samples. The results also show that FDI inflows have greater institutional impacts on provinces in the northcompared to those on the national performance.

This paper provides a useful complement to studies based on cross-country regressions. The results indicate that devel-oping countries can use foreign direct investment as a catalyst for domestic institutional reform and to promote convergenceof institutional quality across regions. However, the Vietnamese experience does not necessarily imply that the effect of for-eign investment on institutional quality will be the same in other countries. Differences in institutions and government pol-icies may matter. It would be very useful to undertake similar case studies for other countries to better understand thechannels through which foreign direct investment impact on institutions.

Acknowledgments

I would like to thank Daniel Berkowitz, Xin Meng and two anonymous referees for comments that substantially improvedthe paper. I also thank Tao (Sherry) Kong, Tue Gorgens as well as seminar participants at the Australian National University,40th Australian Conference of Economists for valuable comments and suggestions.

Appendix A.

See Table A1.

Appendix B.

Plof

Variables

ease cite this article in press as: DangComparative Economics (2013), http

Explanation

, D.A. How foreign direct investment promote institutional quality: Eviden://dx.doi.org/10.1016/j.jce.2013.05.010

Source

Log GDP per capita 2006–2007
Log of provincial real average GDP per capita in 2006–2007 GSO (2009) Log average foreign direct
investment per capita 2006–2007

Log of provincial average disbursed foreign direct investmentper capita in 2006–2007

GSO (2009)

Average years of schooling ofpublic sector

Average year of schooling of public sector, calculated fromVietnam Household Living Standard Survey 2006

GSO (2006)

Average budget transfer percapita 2006–2007

Log average budget transfer per capita in 2006–2007
Ministry of Finance
Education level of main leaders
The education level of main leaders include either chair (orstanding deputy) of people committee or chair (or standingdeputy) of party committee
Author’s calculationfrom many sources

Inequality 2006
GINI coefficient, calculated from Vietnam Household LivingStandard Survey 2006
GSO (2006)

South
Dummy variable for provinces in the south of 17th parallel Author’s calculation Log telephone per capita 2006– Log of provincial average telephone per capita in 2006–2007 GSO (2009)
(continued on next page)

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Po

Appendix B. (continued)

Variables

lease cite this article in press as: Dangf Comparative Economics (2013), http

Explanation

, D.A. How foreign direct investment promote institutional quality: Eviden://dx.doi.org/10.1016/j.jce.2013.05.010

Source

2007Distance to main economic

centres
Distance from capital of each province to nearest main tradingcentres (Hanoi, Da Nang or HCM) by road
Author’s calculation

Provincial CompetitivenessIndex

Ranking of economic governance in Vietnam’s 63 provinces bythe Vietnam Chamber of Commerce and Industry and VietnamCompetitiveness Initiative

PCI Survey 2006 and2008

Entry Costs
A measure of: (i) the time it takes a firm to register and acquireland; (ii) the time to receive all the necessary licenses neededto start a business; (iii) the number of licenses required tooperate a business; and (iv) the perceived degree of difficulty toobtain all licenses/permits

Land Access & Security ofTenure

A measure combining two dimensions of the land problemsconfronting entrepreneurs: how easy it is to access land and thesecurity of tenure once land is acquired


Transparency of BusinessInformation

A measure of whether firms have access to the proper planningand legal documents necessary to run their businesses,whether those documents are equitably available, whether newpolicies and laws are communicated to firms and predictablyimplemented, and the business utility of the provincialwebpage


Time Costs of RegulatoryCompliance

A measure of how much time firms waste on bureaucraticcompliance, as well as how often and for how long firms mustshut their operations down for inspections by local regulatoryagencies


Informal Charges (Corruption)
A measure of how much firms pay in informal charges, howmuch of an obstacle those extra fees pose for their businessoperations, whether payment of those extra fees results inexpected results or ‘services,’ and whether provincial officialsuse compliance with local regulations to extract rents

Bias toward State OwnedSector

A measure focusing on the perceived bias of provincialgovernments toward state-owned enterprises, equitized firms,and other provincial champions in terms of incentives, policy,and access to capital


Proactivity of ProvincialLeadership

A measure of the creativity and cleverness of provinces inimplementing central policy, designing their own initiatives forprivate sector development, and working within sometimesunclear national regulatory frameworks to assist and interpretin favour of local private firms


Business DevelopmentServices

A measure of provincial services for private sector tradepromotion, provision of regulatory information to firms,business partner matchmaking, provision of industrial zones orindustrial clusters, and technological services for firms


Labour Training andMatchmaking

A measure of the efforts by provincial authorities to promotevocational training and skills development for local industriesand to assist in the placement of local labour


Confidence in LegalInstitutions

A measure of the private sector’s confidence in provincial legalinstitutions; whether firms regard provincial legal institutionsas an effective vehicle for dispute resolution, or as an avenuefor lodging appeals against corrupt official behaviour


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How foreign direct investment promote institutional quality: Evidence from Vietnam

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