INTRODUCTION

I. OBJECTIVE AND SIGNIFICANCE OF THE STUDY

From 1991, following the 1987 Law on Foreign Investment, the Regulation on EPZ in Vietnam was issued, which was the basis for establishing of Vietnam’s EPZs. With 96 IZs planed to establish to 2010, until 2000, 67 IZs have been established over the country. Initially, there were six EPZs but now only three of them remain EPZs and three others were reclassified as IZs. Recently, some IZs, open economic zones and special economic zones have opened or planned to open, but no more EPZs will be built in the immediate future and the contribution of EPZs to economic development is debatable.

The thesis attempts to analyze the roles of the EPZs in Vietnam’s development process and provides answers to the following questions:

·               What are attractivenesses of Vietnam’s EPZs to foreign investors?

·               What is the contribution of EPZs to the industrialization of Vietnam?

·               What are the causes for the success or failure of Vietnam’s EPZs?

·               What are policy implications for improving the performance of Vietnam’s EPZs?

2. METHODOLOGY

The research applies a descriptive and analytical framework to evaluate the contribution of Vietnam’s EPZs to economic development. The scope of the study is limited to some Asian countries that have most successful EPZs development, which can be drawn lessons for Vietnam. Vietnam’s EPZs will be analysed in the period from 1991 to 2000.

3. ORGANIZATION OF THE PAPER

Excluding introduction, the thesis is organized into four chapters:

Chapter One - Theoretical framework

Chapter Two - Asian country case studies

Chapter Three - Export Processing Zones in Vietnam

Chapter Four - Policy implications and conclusion.

Chapter One: THEORETICAL FRAMEWORK

1.1. OVERVIEW OF EXPORT PROCESSING ZONES

1. Definitions

There are about 30 terms used to describe the EPZs. Basically they are the same and can be defined in either large or narrow meaning. In Vietnam, the EPZ concept is defined in the Regulation on EPZ issued by the Vietnam’s Government as “an industrial zone (IZ) where export processing enterprises specializing in the production of goods for export and in the provision of services for the production of export goods and export activities are concentrated, having delimited geographic boundaries and no inhabitant, established by decision of the Government or the Prime Minister”.

2. Historical background of EPZs

According to Dorkenoo (1999), the FTZ concept has been used in history about 2000 years ago, which involves transportation-shipment, storage and re-exporting of goods.

The modern form of EPZ came from the establishment of the first EPZ in Ireland in 1959. In 1965, the first Asian zone was the Kandla EPZ established by the Indian Government, followed by the establishment of a range of EPZs in many countries. Around the end of twentieth century, EPZs become an attractive strategy to many LDCs as they seem to facilitate the growth of industry and trade.

3. Objectives and characteristics of EPZs

EPZs are the trade policy tools at the disposal of LDC Governments. Typically, they are created as open market oases within a second best economy that is dominated by distorted trade, macro and exchange rate regulation, and other regulatory Government controls. EPZs are commonly established for some primary objectives:

-         To provide foreign exchange earning by promoting non-traditional exports

-         To provide jobs to alleviate unemployment or under-employment problems in the country and assist in income creating

-         To attract FDI and engender technological transfer, knowledge spill-over.

-         To get economies of scale returns from focusing limited infrastructure investments.

Though different in name and size, zones share a few common features:

-       Unlimited, duty-free imports of raw, intermediate input and capital goods necessary for the production of exports.

-       Less Government red tape. More flexibility with labour laws for the firms in the zone than in the domestic market.

-       Generous and long-term tax holidays and concessions to the firms

-       Better standard communication services and infrastructure in comparison with the rest of the country. The utility and land rent are often subsidized by the Government

-       Zone firms can be domestic, international or joint-venture, but the role of FDI is prominent in EPZ activities

-       Further, EPZs are said to under go a four-stage life cycle: formation, take-off, maturity and decline (Oh, 1992).

1.2. COSTS AND BENEFITS OF EXPORT PROCESSING ZONES

1. Neo-classical model

The neo-classical pessimism is pioneered by Hamada (1974) and followed by many others, come to the same conclusion that the EPZs reduce host country welfare. Later, Devereuz and Chen (1995) expand on Hamada’s analysis by adding volume of trade and factor terms of trade effects. They conclude that the EPZ are likely to be welfare improving under a much wider variety of circumstances than previously realized.

The neo-classical analysis is criticized because it does not take into account some positive externalities of FDI; the Hecksher-Ohlin based analysis is based on final goods while most of the EPZ issues are related to intermediate inputs, and while treating the capital as being internationally mobile, it fails to capture the international mobility of capital goods- that is central to the functioning of EPZs. Therefore, the conclusion of most neo-classical theories that EPZs reduce the welfare of the countries is thus largely irrelevant.

2. Cost- benefit analysis

In the point of view of the host country, the net benefit of EPZ in a given year t can be written: N_t = (L_tw + M_tP_M + E_tP_E + R_t + T_t) S^*_F – (L_tw^* + M_tP^*_M + E_tP^*_E + B_tS^*_K) - A_t - K_t

where:    L_t denotes employment in year t, w denotes wage paid, M_t denotes domestic raw material used in year t, P_M denotes the price paid for this raw material, E_t denotes the utilities used in year t,                P_E denotes the price paid for these utilities, R_t denotes interest and principal repayments of domestic loans in year t, T_t denotes taxes paid in year t, S^*_F denotes the ratio of the social over official value of exchange rate, w^* denotes the shadow price of labour, P^*_M denotes the shadow price of domestic raw material, P^*_E denotes the shadow price of utilities, B_t denotes domestic borrowing in year t, S^*_K denotes the ratio of the shadow price of capital to its market price, A_t denotes the administrative costs of the zone in year t, K_t denotes the capital cost of the physical infrastructure of the EPZ provided by the host Government in year t.

This model has been developed by Warr since 1983. Later, he used this method to evaluate some Asian EPZs, come to result that EPZs bring substantial benefits in some cases while create not any net benefit in some other cases. Spinnager (1984) also used the model for some other empirical studies and argued that the incentives, subsidies and spending on infrastructure are very costly for the host country. They concluded that the overall welfare impact of EPZs on the host economy is beneficial but limited.

The main drawback to this approach is the lack of adequate data for the cost-benefit calculations. Assumptions regarding rates of returns to capital, social discount rate and social benefits may also be easily questioned. More generally, while costs may be more readily observable, the extent of the benefits may not be, as there are many possible qualitative benefit that are difficult to be taken into account.

3. New growth model

The new growth approach to the possible welfare implications of EPZ come from emerging endogenous growth literature, which highlights the impact of spillovers from FDI and zone activities on the host economy. These spillovers include labor and management on-the-job training and learning-by-doing, copying, demonstration effects and catalyst factor, and impact the rate and level of human capital formation in host countries. Once these elements are added to the traditional analytical approach, Johanson (1994) argued, the EPZ may be beneficial to a country because of their spillover and their catalytic impact.

4. Costs and benefits of EPZs – statistical analysis

Based on theories have been used to evaluate impact of EPZs performance to host economy and the “enclave model”, the author try to analyse all possible costs and benefits of EPZs in the point of view of the host country Government in order to have a clear framework to evaluate Vietnam’s EPZs.

Figure 1.1: The enclave model

Investment and growth

Usually, EPZs are established to provide favourable conditions including good location, stable macroeconomic conditions, basic infrastructure and goods management mechanism to attract investment and stimulate growth, especially industries use the comparative advantages of the host countries to produce export goods that are able to compete in the international market by attracting ‘footloose’ foreign manufacturers.

To the extent that foreign firms locate in the EPZ, the most visible achievement is the inflow of foreign capital to the EPZ in comparison with foreign capital into the domestic economy as a whole. As the decision factor of the success of the EPZ is the number of the firms that operate within it, it also can be used as a criterion to evaluate an EPZ.

Export and foreign exchange earning

Developing the export of manufacturing products and earning foreign exchange are main benefits expected from an EPZ. The contribution of EPZ may be evaluated by the export revenue of every production firms in the zone, or in comparison with total export revenue of the country. There is also indirect effect of EPZ into host country export, shown by the increasing number of trade partner, as the role of EPZ firms in giving the access to international market to the host country processing goods.

While the contribution of EPZ in host country export is rather clearly, its role in foreign exchange earning is still debatable. The fully foreign owned EPZ firms can treat their foreign exchange earning in three ways: (1) held in liquid form in foreign exchange accounts, whether inside or outside the host country; (2) used for the purchase of imported capital equipment; and (3) converted into the domestic currency to be spent on wages and purchases from the local economy. The gain of domestic economy in term of foreign exchange is not important and can be omitted in the analysis on the impact of EPZ on domestic economy.

Tax revenue/tax loss effects

To create incentives for attracting FDI, the Government often offers tax breaks and tax holidays in both direct and indirect taxes for foreign firms investing in EPZs. Accompanied with significant investment into infrastructure, the tax holidays increase the costs of EPZs. However, though generally quite small, taxes raised from EPZ firms nevertheless represent a clear source of economic benefit for the domestic economy.

In case of Vietnam’s EPZs, because most of EPZ firms now are still in the tax exemption period, the government does not collect any tax from the zones. However, in the near future, when the EPZs are in their take off and mature period, the tax revenue is expected to be significant.

Firms’ profits or losses

Most firms occupying EPZs are fully foreign owned and their profits or losses, to the extent that being retained or incurred themselves, do not have any effect on the domestic economy, except for the profit tax collection as mentioned above. Therefore, the profits of domestically owned firms will be omitted.

Employment effect

EPZs exploit the international mobility of capital goods owned by internationally ‘footloose’ manufacturing firms. EPZs are essentially devices for attracting these firms and their capital equipment into the host country where these capital goods are combined with domestic labour- relatively immobile internationally- to produce trade goods that the firm exports. In this process, for the poor and labour abundant country, the welfare impact is increasing jobs generated, the unemployment and under-employment problems are solved. However, the gain from employment generated by the EPZ may be the exceeding of the wage received by the workers to the opportunity cost of employment in EPZ. There is also a qualitative gain from employment aspect. It is the transfer of skills to EPZ employees through on-the-job training or learning by doing process. It can be treated as positive externality of EPZ that in principle should reduce opportunity cost of EPZ employment.

Environment effects

To create positive relationship between industrialization and development, one urgent measurement is to prevent industrial pollution in the initial stage of industrialization. In EPZs, treatment or disposal measures are more cost-effective because of economies of scale involved. From available data, it is very difficult to analyse the environment effect from an EPZ. Instead, there is may be relevant for a description about the pollutant control measures of both the domestic Government and the foreign firms in an attempt to protect the environment.

Linkages between EPZ and the domestic economy

Under the ‘enclave model’, there are both forward and backward linkages between the EPZ firms and the domestic economy. Both forward and backward linkages bring no net welfare effects but there is existence of positive externalities in these forward and backward linkages. The EPZ can be a connection between the domestic enterprises with the international market, when the domestic enterprises may lack the access to international market. Further, when developing these linkages, the technology as well as knowledge may spill-over and bring some gain to the host country. Therefore, when evaluating the gain from EPZ in term of linkages, the criteria may be the trade volume or revenue between EPZ firms and the host country, or can compare these criteria with total export, import of the EPZ as a whole.

FDI:  technology transfer and knowledge spillover

The obtained technologies, if mastered, yield a higher level of TFP for any given capital-labour ratio, and combined with accumulated physical investment will move the economy from point A in production function f₀ to point B in a new and higher production function f₁ as indicated in the figure 1.2 below

Technology transfer into Vietnam through EPZs mainly came from FDI and knowledge spillover. The FDI inflow into EPZ is considered together with some positive externalities. However, it is difficult to evaluate quantitatively those positive externalities. The suitable way is to use some indicators that are related to the improvement or transfer of technology such as the FDI inflow, the expansion of international market, and the linkages between EPZs firms and the domestic enterprises.

Land rent

In EPZ development, there are two categories of land rent which are rental of land from the government to infrastructure firms that develop the EPZ, and the rental of land with completed infrastructure from these firms to the production firms. In the enclave model of EPZs, the land rent that the Government collects from the EPZ is a source of Government revenue which present the net benefit to the economy. However, with the objective to attract FDI, the Government often set low land rent which is frequently reduced to infrastructure firms (VIZA, 2000). Therefore in the analysis, the rent land is not treated as benefit to the domestic economy. Instead, a comparison between land rents between countries, or between EPZ and elsewhere in the host country is used to analyse the comparative advantage of the country or the EPZ in attracting FDI.

Costs of EPZs

To establish the EPZ, there are costs of clearing the site, compensation for existing works, investing and maintaining the infrastructure system, including transport, communication, water and electricity lines, and other administrative costs to operate and control the EPZs.

In some cases, the EPZs are invested and developed by the Government, every costs above should be treated as economic costs of the EPZs. In other cases, EPZs are invested and developed by a company, who rent the land from the Government to develop the EPZ and then lease it to production firms. For these cases, the costs to the Government include the investment into the connection between the EPZ and the existing infrastructure system, or social infrastructure outside the EPZ such as residential dwelling, schools and health centers. However, it is difficult to evaluate these costs as at the same time they may be used for some other purposes and have significant positive externalities such as improve living condition as well as economic development of surrounding areas of the EPZs, or urbanization of the previously rural poor area, etc.

Chapter Two: ASIAN COUNTRY CASE STUDIES

2.1. EPZs IN TAIWAN

Taiwan is one of pioneer countries to embark on the establishment and development of EPZs. Three EPZs were established at Kauhsiung, Nantze and Taichung in the 1960s (Dorkenoo, 1999). Based on the standard of the World EPZ Authority (WEPZA), all three Taiwan’s EPZs are assessed most successful Asian ones. With average area of 8.81 hectares and average investment capital of USD 3.65 millions, a Taiwan’s EPZ firm can create about 345 direct employment and USD 14.7 millions of export revenue annually. Most exports of Taiwan are produced in EPZs and with well developed backward linkages between EPZ firms and the domestic economy, the EPZs play an important part in the industrialization and economic development of the country.

2.2. EPZs IN KOREA

Two first EPZs of Korea were established in Masan and Iri cities in early 1970s. When operations in Iri’s EPZ remained relatively modest, those in the Masan grew significantly up to 1988 and then declined. Capital inflows into the Masan EPZ, for example, increased from $1.2m in 1970 to $88.9m in 1975. During the late 1970s, there was a drop in the number of enterprises in the zone but the level of investment kept growing and the volume of exports tripled. The number of domestically owned firms in the EPZ increased in 1980s following the Government’s decision to allow local firms to operate in the enclave. Beside, the EPZs contribute to the economic development of the region through the both quantitative and qualitative effects on employment, payment of wages, the procurement of goods and services from local sources, and the conclusion of subcontracting arrangements. Some 300 local subcontractors supplied materials to 44 enterprises in that zone, which benefited from technical support and guidance provided by companies from the zones (Oh, 1992).

2.3. FREE TRADE ZONES IN MALAYSIA

In 1968, Malaysia shifted from ISI to a labour-intensive, export-oriented industrialization with the pass of Investment Incentive Act (IIA). In an endeavour to generate jobs and exports, labour-intensive, export-oriented foreign firms were offered pioneer status, lucrative fiscal incentives, subsidized factory space, and in some cases, factories already built in industrial estates and free trade zones. As a result of favourable economic policies, during the take off period of Malaysian FTZs from early 1970s to 1990, FDI into FTZs, employment and exports increased, which contributed immensely to the growth and development of the country. While in period 1980-1990, the average annual growth rate of real GDP is 6.0%, this rate was 8.6% in next period between 1991 and 1995.

2.4. SPECIAL ECONOMIC ZONES IN CHINA

Since the late 1970s, China has undergone a transition process, which brought about an impressive upsurge in production, trade and the standard of living, began essentially with the establishment of special economic zones (SEZs). Being the most comprehensive form of EPZ, a SEZ is a geographic area within a country where certain economic activities are promoted by a set of policy measures that are not generally applicable to the rest of the country (Ge, 1999). Numerous measures aimed at reforming the existing economic system and reaching a higher degree of economic openness were developed and tested in the SEZs. The rise of SEZs generated a host of impacts on the Chinese economy and on society at large, in which the most direct and immediate impact of the SEZs on the Chinese economy was the successful operation of the zones. The robust economic growth, extending over a considerable period of time, created hundreds of thousands of new, better paying jobs. This, in turn, enhanced economic welfare and improved the standard of living for those SEZ workers. The wage increases in the SEZs were closely tied to the improvement in productivity. The high productivity in the SEZs implied a more efficient utilization of physical and human resources, the result of the SEZs’ continuous efforts to develop a market-oriented, open economic structure.

Figure 2.1: Impacts of SEZs on Chinese economy

Source: Ge (1999)

The attractive policy incentives offered to foreign investors, the improved infrastructure and facilities, and the market-oriented economic and legal reforms all helped to sustain a continued foreign capital inflow and a concurrent accelerated technology transfer. The result of the strengthened forward linkage with the outside world and the vigorous pursuit of economic and institutional reforms was the emergence of an economic structure that was more resilient, efficient, dynamic, and closer in line with the comparative advantages of the SEZs.

Through a backward linkage between the SEZs and the rest of the domestic economy, not only was the SEZ expansion sustained, but more fundamentally, other parts of the country were able to benefit from the SEZ operation in fostering a faster pace of economic growth.

The development of the SEZs did not take place at the expense of the rest of the domestic economy. As the SEZs continued to expand, the zones became not just cost-free but revenue-generating to the state treasury. The amount of tax revenues that Shenzhen generated in the period from 1979 to 1995, for example, grew at an average rate of 50% per annum (Ge, 1999). The cumulative amount that Shenzhen returned to the state and provincial governments between 1980 and 1995 exceed 50 billion RMB yuan, more than offsetting the funds the zone obtained from these sources in the period (Ge, 1999).

2.5. LESSONS FOR VIETNAM

1. Location

A favourable location can be viewed as part of a country’s comparative advantage in economic activities such as trade and investment. Generally, a good location of an EPZ includes:

a/ Access to market:

Because of being an industrial development area for export production, an EPZ should be located near the market of both input and output. Therefore, most EPZs are located in or near the international transport nodes that include international airports, sea or river ports as well as railway stations.

b/ Infrastructure

The EPZ should be located in a commercial or economic center that has relatively good infrastructure system. Located in an area with good and reliable infrastructure, the cost for infrastructure investment, especially the connection between EPZ and the main system will be low. Further, located in the center, the social infrastructure that includes health center, housing, schools, etc. are also in good conditions, that can be utilized for foreign investors or workers who will work in the EPZ.

2. Legal framework

The EPZs established as policy instruments, their development heavily depend on the support of the Government policy. The legal framework should be established to attract FDI, stimulate export and growth, create job and solve the problem of unemployment, stimulate the backward linkage between EPZ firms and the domestic economy, The experience of the Asian EPZs with regards to promotion and support for investors show strong and open intervention and support from the state, which was one of the factors underlying the success of these economies.

3. Capacity of EPZ developers

In most cases the EPZ’s infrastructure provided by the Government. In some other cases, especially for countries that lack capital, the Government stimulates foreign investment into infrastructure of the EPZ. The infrastructure investment is rather significant and require both money as well as the reputation of the developer, as it will face many difficulties in clearing the site, compensation for existing works, investing in infrastructure and advertising to attract the occupying firms. To invest and develop an EPZ efficiently, the developer should have necessary financial resources, well organized, and goods reputation in international market as well as host country market.

Chapter Three: EXPORT PROCESSING ZONES IN VIETNAM

3.1 OVERVIEW OF EXPORT PROCESSING ZONES IN VIETNAM

1. Vietnam’s industrialization in the renovation process and the relevance of the EPZ

The renovation process of Vietnam, launched in the Sixth Party Congress in 1986 and accelerated in 1989, initiated the transition from central planning to a market-oriented economy. A mixed industrialization strategy between ISI and EOI has been introduced. Protection remains for some key heavy industries, but most light manufacturing industries have developed based on the country’s comparative advantages. The Government plays an active role in directing industrialization, and one of its activities is to establish EPZs.

From the national point of view, EPZs are ‘second best’ instruments designed to address temporary economic and institutional bottlenecks in the process of the country’s transition from a centrally planned economy to a market one. EPZs were initially established for the production of export goods to gain access to export markets and technology by providing free trade status to EPZ investors without liberalizing the entire economy. The EPZ will provide the international standard infrastructure, simplified administrative procedures from granting the investment licenses to management of investment activities. EPZs together with IZs are expected to provide jobs to alleviate unemployment or under-employment problems, assist in income creation and create linkages with the local economy. Beside, the EPZs also designed for purpose of balanced regional development.

2. Characteristics of Vietnam’s EPZs

a. Legal framework

Vietnam’s EPZs established and developed under the complete legal system, which are applied synchronously in the whole country toward foreign investment promotion, especially on manufacturing industries for export goods.

b. Location: Market access and infrastructure

All Vietnam’s EPZs are located in good locations:

Table 3.2: Vietnam’s EPZs – some main indicators

Source: Summary from Economics and Forecast Review (1993)

Vietnam’s EPZs are located in the favourable condition in term of market access. Located in economic centers of the region or the country, where the transport is convenient in land, water and airways, their connections to host country as well as international market is very comfortable for the investment as well as trade activities of the EPZ firms. Near the big cities with developed local industrial industries and agricultural, forestry and aquatic products produced locally can provide enough raw materials to process in the zone. Further, with the labour-abundant characteristic of Vietnam, with relatively high literature, can provide enough workers to work for the EPZ firms.

Most infrastructure of Vietnam’s EPZs is provided by joint-venture.  The joint-venture form of investment in infrastructure, beside attract foreign capital investment into infrastructure, makes the foreign investors share the responsibilities and risks, especially in attracting other foreigners who may not have much information about Vietnamese market to lease the zone for their production.

Table 3.3: Infrastructure cost of Vietnam’s and Asian countries’ EPZs