Trade Liberalization and Foreign Direct Investment in Vietnam

Abstract

I. Introduction In December 2001 a bilateral trade agreement (BTA) between Vietnam and the United States came into effect. The United States had lifted its embargo on trade with Vietnam in February 1994, but still levied tariffs on imports from Vietnam at the standard rate--essentially the high tariff rates established by the Smoot-Hawley Act of 1930. After difficult negotiations, a final agreement on the BTA was signed in July 2000, but ratification was delayed, in part because of renewed doubts about the agreement within the government of Vietnam, and in part because the U.S. presidential election cycle pushed it off the agenda for a while. The BTA is expected to lead to a rapid increase in trade between the two countries (Fukase and Martin 1999) as well as to larger inflows of foreign direct investment (FDI). This paper focuses on quantifying the effect of the BTA (and of possible membership in the World Trade Organization, or WTO) on FDI flows into Vietnam. The main finding is that the impact on FDI is likely to be large enough to boost economic growth by as much as 0.6 percentage points annually over the coming decade. Over the long run, this may be the most important single legacy of the BTA, but the gains are also contingent on Vietnam undertaking the reforms necessary to ensure prompt membership in the WTO. The relevant background is provided in the next section, which sets out the main provisions of the BTA, summarizes the research on its trade-creating effects, and outlines the steps that Vietnam is taking towards WTO membership. Section III describes the level, trends, and nature of FDI in Vietnam. This is followed, in Section IV, by a discussion of the determinants of FDI in general, and the role of trade-related factors (such as tariffs) in particular. It is at this point that the nature of the link between the trade-liberalizing features of the BTA, and FDI into Vietnam, is established. The next step is to quantify this link, first by setting up and estimating a regression model of the determinants of FDI in Asia (Section V) and then using the results to simulate the effects of the BTA on FDI into Vietnam (Section VI). The final section brings together the conclusions and suggests directions for future research. II. Vietnam's Trade Regime: BTA and WTO II.1 The United States-Vietnam Bilateral Trade Agreement The salient feature of the BTA is that the United States agrees to accord normal trade relations status (formerly known as most favoured nation, or MFN, status) to Vietnam, albeit subject to annual renewal. Thus, Vietnam will move from column 2 to column 1 tariff rates, allowing Vietnamese goods to enter the United States at the same low tariff rates that apply to almost every other country. In practice, this is expected to reduce the tariff on Vietnamese goods entering the United States from around 40 per cent to 3 per cent (EIU 2001). Over a period of three years Vietnam will reduce the tariffs it charges on imports from the United States, typically by about a third, (1) and will eliminate its quantitative restrictions on many agricultural and industrial products over three to seven years. The real significance of the BTA is that it goes well beyond tariff reductions, and in effect maps out a strategy for Vietnam's economic development. It introduces more competition into the economy, and pushes reform and growth overall, especially in the state sector. Among the other provisions of the agreement are the following: * Vietnam will adopt WTO standards for intellectual property protection within eighteen months, a move that will require significant legal changes within the country. * U.S. companies are to be allowed to enter the services sector, including insurance and banking, accounting and legal services, engineering, computer and related services, market research, construction, education, health and related services, and tourism as well as (after three to nine years) telecommunications. …