ANALYSIS OF TAX AND TRADE INCENTIVES FOR FOREIGN DIRECT INVESTMENT: THE CASE OF VIETNAM

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1 ANALYSIS OF TAX AND TRADE INCENTIVES FOR FOREIGN DIRECT INVESTMENT: THE CASE OF VIETNAM A thesis presented by Le Minh Tuan to The Committee on Higher Degrees in Public Policy in partial fulfillment of the requirements for the degree of Doctor of Philosophy in the subject of Public Policy Harvard University Cambridge, Massachusetts January 2003

2 TABLE OF CONTENTS CHAPTERI: INTRODUCTION 1 I. An Overview 1 II. Scope Of The Thesis 6 III. Structure Of The Thesis 9 CHAPTER H: METHODOLOGY AND THE DATA 11 I. Survey Of Literature On Tax Incentives: Methodologies And Empirical Findingsl2 II. Analytical Framework And Methodology 20 III. The Data 28 CHAPTER HI: TAX, TRADE, AND NON-TAX POLICIES FOR FOREIGN DIRECT INVESTMENT IN VIETNAM A COMPARATIVE STUDY 30 I. The Vietnamese Economy: An Overview The Vietnamese economy Mixed import-substitution and export-oriented industrialization strategy 37 II. Tax and Trade for Foreign Direct Investment overall assessment of the tax system in Vietnam corporate income tax Introduction Tax rates Special incentives Summary and Preliminary Comments Value added tax 50 IX

3 3.1. Introduction The VAT rates VAT exemptions The VAT base Methods for VAT calculation VAT administration Summary and preliminary comments Trade taxes and trade policy Introduction Tariff rates, exemptions and other trade incentives General tariff structure Tariff structure for fdi and fdi-funded export-oriented sectors Incentives for import-substituting industries Import-export licensing procedure Summary and preliminary comment 61 I. Non-Tax Incentives for Joint Ventures with SOEs and Hidden Costs of Doing Business in Vietnam Non-tax incentives for joint ventures with soes "Hidden costs" of doing business in Vietnam 65 CHAPTER IV: FDI FROM INTERNATIONAL PERSPECTIVE AND FDI IN VIETNAM 69 I. Benefits and Costs of FDI From The Host Government Perspective and Determinants of FDI: A Literature Review 69

4 II. Trend and Pattern of FDI The world FDI: a general picture Comparative analysis of inward FDI to Vietnam and selected Asian countries 76 Recipient/host countries 81 III. Conclusion 89 CHAPTER V: EVALUATION OF A FOREIGN-FUNDED JOINT VENTURE IN CEMENT: IMPORT - SUBSTITUTING AND HEAVY INDUSTRY 91 I. The cement Industry The cement industry: output, production, and technology The cement industry: characteristics and competitiveness determinants 94 II. The Cement Joint Venture Project: An Integrated Cash Flow Model The project Plant location and main targeted markets Investment Operating and other non-investment cost Working capital Input and output inventory Capacity utilization rate Output price Project life Tax incentives Projected macroeconomic parameters Discount rates 107 XI

5 2. Results of the integrated cash flow model - the base case (scenario 1) Specific incentives - do they matter Impact of fiscal incentives Impact of Trade Protection Trade protection versus fiscal incentives Interactive Impact of Inflation and Trade Protection Can the fiscal incentives and trade protection always "protect" this cement project 128 III. Implications for Vietnamese Government Strategy for the Cement Industry 131 CHAPTER VI: EVALUATION OF FOREIGN DIRECT INVESTMENT IN VEGETABLE OIL MANUFACTURING: IMPORT-SUBSTITUTING LABOR-AND MATERIAL-INTENSIVE INDUSTRY 135 I. The Vegetable Oil Industry The vegetable oil industry: output and production The vegetable oil industry: technology, industry characteristics, and competitiveness determinants 138 II. The Vegetable Oil Processing Joint Venture: An Integrated Cash Flow Model The project Plant location and targeted markets Investment Capital structure and loan schedule Operating costs Working capital 144 XII

6 1.6. Input and output inventory Capital utilization rate Projected output price and sales revenues Project life Fiscal and trade incentives Projected macroeconomic parameters ' Financial discount rate and national economic parameters Results of the integrated cash flow model: the base case (scenario 1) Deterministic analysis: financial, economic, and distributive outcomes of the project Sensitivity analysis: determinants of the project's financial outcomes Special fiscal incentives - do they matter Impact of fiscal incentives Impact of trade protection and comparative impact of fiscal and trade incentives 160 IE. Implications For Vietnamese Government Strategy For the Vegetable Oil Industry 165 CHAPTER VH: EVALUATION OF A FOREIGN-FUNDED JOINT VENTURE IN LEATHER SHOE MANUFACTURING: LABOR-INTENSIVE AND EXPORT- ORIENTED INDUSTRY 169 I. The leather Shoe Industry The leather shoe industry: output, production, and technology The leather shoe industry: characteristics and competitiveness determinants 171 xni

7 2.1. The leather shoe industry characteristics Competitiveness determinants for the leather shoe manufacturing industry 174 n. The Men's Leather Shoe Manufacturing Joint Venture Project: An Integrated Cash Flow Model The project i.l Plant location and targeted markets Investment Operating and other non-investment cost Working capital Input and output inventory Capital utilization rate Output price Project life Fiscal and trade incentives Projected macroeconomic variables Discount rates and national economic parameters Results of the integrated cash flow model: the base case (scenario 1) Deterministic analysis: financial, economic, and distributive outcomes of the project Sensitivity analysis: determinants of the project's financial outcomes Special fiscal incentives - do they matter Impact of fiscal incentives 197 xiv

8 3.2. "Hidden costs" of doing business in Vietnam and their relative impact on the project's financial outcomes 201 m Implications for Vietnamese Government Strategy for The Leather Shoe Manufacturing Industry 205 CHAPTER Vm: EVALUATION OF A FOREIGN-FUNDED PROJECT IN APPAREL MANUFACTURING: LABOR-INTENSIVE AND EXPORT-ORIENTED INDUSTRY 211 I. The Textile and Apparel Industry The textile and apparel industry: output and production The textile and apparel industry: technology, industry characteristics, determinants of competitiveness, and pattern of the world's production and trade 214 II. The Garment Manufacturing Project: An Integrated Cash Flow Model The project Plant location and targeted markets Investment Operating costs Working capital Input and output inventory Capital utilization rate Output price Project life Fiscal and trade incentives Projected macroeconomic variables 224 xv

9 1.11. Financial discount rate and national economic parameters Results of the integrated cash flow model: the base case (scenario 1) Deterministic analysis: financial, economic, and distributive outcomes of the project Sensitivity analysis: determinants of project's financial outcomes Special fiscal incentives - do they matter Impact of fiscal incentives "Hidden costs" and their impact on project's financial outcomes 239 HI. Implications for Vietnamese Government Strategy For the Textiles and Apparel Industry 240 CHAPTER IX: TAX AND TRADE INCENTIVES FOR FOREIGN DIRECT INVESTMENT IN VIETNAM - LESSONS LEARNED 246 I. What Have We Learned from The Industry Analysis 247 II. Policy Implications Trade reform in the context of FDI Tax reform in the context of FDI 262 BIBLIOGRAPHY 272 xvi

Appendix A Specification of the Global Recursive Dynamic Computable General Equilibrium Model

Appendix A Specification of the Global Recursive Dynamic Computable General Equilibrium Model The model is an extension of the computable general equilibrium (CGE) models used in China WTO accession studies