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Chapter 2: Evolution of the CLMV’s Trade

Author(s):
Koshy Mathai, Geoff Gottlieb, Gee Hee Hong, Sung Eun Jung, Jochen M. Schmittmann, and Jiangyan Yu
Published Date:
September 2016
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Having documented the changes in China’s trading patterns, the paper now turns to a close look at the CLMV and their trading patterns. It starts with a basic description of the region and offers additional detail on each of the four countries. It examines the sectoral composition of each country’s exports and imports and the main trading partners, using both gross and value-added trade data sets. Finally, it examines the degree of integration between these countries and China. The chapter establishes that the CLMV are open, export-dependent economies that are increasingly integrated with China and thus stand to be affected by changes in that country.

Overview

The CLMV are very heterogeneous. Cambodia and Lao P.D.R. have populations of less than 20 million and are geographically small, while Myanmar boasts a population of some 50 million, and Vietnam more than 90 million, along with much larger landmasses. Vietnam is clearly the most dynamic trading nation in the group—it is well diversified and is a major participant in global supply chains for electronics. The other three countries are at an earlier stage of trade development. Cambodia has long been a major garments exporter (to the United States and Europe) but has not gone much beyond this sector, while Lao P.D.R. and Myanmar focus on natural resources and energy, exported largely to ASEAN and China. Myanmar is just at the start of its economic liberalization and could witness a major transformation in its trade over the coming years. The Appendix to this paper offers more detailed profiles of the countries.

At the same time, the four countries share many common features. All four countries are China’s close neighbors to the southwest and are in close proximity to Asian supply chains. All four are poor—in fact, the poorest nations in Southeast Asia—and continue to have low wages. All were originally centrally planned economies and are at different stages of transitioning away from that model. And all are now following an export-led growth strategy that has seen them becoming an attractive destination for foreign investors and integrating into global and regional trade at an impressive pace over the past decade. Regional integration has been a key driver for the CLMV—Asia is the destination for between 30 percent (Cambodia) and 80 percent (Lao P.D.R.) of these countries’ exports—and the reshaping of trade patterns via bilateral, multilateral, and plurilateral agreements will have significant implications for the four countries’ future trade and growth.

CLMV trade has grown rapidly. Starting in the late 1980s, Cambodia, Lao P.D.R., and Vietnam put trade and investment at the center of their respective development strategies. Trade barriers were lowered, bilateral Free Trade Agreements (FTAs) negotiated, structural reforms passed to attract FDI, and SEZs established. Vietnam was the first among the CLMV to join ASEAN in 1995, followed by Lao P.D.R. and Myanmar two years later, and Cambodia in 1999. All four countries are WTO members. The CLMV also benefited from the China-ASEAN, Korea-ASEAN, and other free trade agreements. All these contributed to a substantial increase in trade openness, and in recent years, the countries have also seen substantial FDI inflows from China, Japan, and Korea.

Figure 2.1.Trade Openness

(Percent)

Sources: World Bank, World Development Indicators; and IMF staff calculations.

Figure 2.2.Foreign Direct Investment

(Percent of GDP, average 2010–14)

Sources: IMF, World Economic Outlook; and IMF staff calculations.

With the exception of Vietnam, the CLMV are poorly diversified and focused on exporting goods of low technological sophistication. Benefiting from low wages, the countries initially focused on labor-intensive sectors such as garments. Lao P.D.R. has since shifted its primary focus to hydro power and mining, and Myanmar, given its rich natural resource endowments, has become heavily dependent on natural gas, gems, and lumber exports, mostly to neighboring countries like Thailand and China. Cambodia remains almost exclusively focused on garments. Vietnam is well diversified—it depends heavily on labor-intensive manufacturing, including not only garments but also electronics, as the country has become an important player in global supply chains; but at the same time, Vietnam also maintains a strong position in a variety of agricultural sectors, including coffee, rice, and farmed seafood.

Most of the CLMV countries have increased their participation in GVCs. Such participation can offer opportunities to move up the value chain, to diversify the export portfolio, and to promote economic growth (OECD 2013b). Value-added trade data suggest that Cambodia and Vietnam are participating in the final stages of GVCs, doing relatively simple processing and assembly work with low value-added. Nonetheless, prospects exist for moving upstream, at least eventually. Lao P.D.R. and Myanmar are less involved in GVCs.

The CLMV and China are increasingly integrated and thus form a natural cluster to study. Trade linkages have increased faster than those between China and other regions. Lao P.D.R. and Myanmar are exposed to China’s commodity demand, Cambodia and Vietnam receive substantial imports from China, and Vietnam also competes with China in certain segments. Finally, exports of consumption goods from Vietnam to China have boomed in recent years. Going beyond the scope of this paper, Chinese outbound tourism, including to Southeast Asia, has also grown substantially. These strong ties imply that the CLMV are exposed to changes in China and may thus face both opportunities and challenges as China rebalances.18

Basic Facts of CLMV Trade

The CLMV are growing rapidly as buyers from, and sellers to, the world.19 All four countries have been gaining global export and import market share since 2000, though since they are small economies, these market shares remain small in absolute terms. Vietnam has quadrupled its share of world exports from 0.2 percent in 2000 to 0.9 percent in 2014. Lao P.D.R. has also seen its export market share roughly quadruple to 0.025 percent in 2014. Cambodia has more than tripled its world export market share (to 0.07 percent), while Myanmar has doubled its share (to 0.06 percent). At the same time, global import shares across the region have grown roughly fourfold—faster than the growth of exports, on average, possibly consistent with the increase in GVC integration (see below). Following a temporary deceleration in 2009 during the global financial crisis, trade growth has rebounded and continues to strengthen.

Figure 2.3.Cambodia Market Share

(Percent of world trade)

Sources: UN Comtrade; and IMF staff estimates.

Figure 2.4.Lao P.D.R. Market Share

(Percent of world trade)

Sources: UN Comtrade; and IMF staff estimates.

Figure 2.5.Myanmar Market Share

(Percent of world trade)

1/ 2014 Myanmar exports figure comes from CEIC Data Company Ltd.

Sources: UN Comtrade; and IMF staff estimates.

Figure 2.6.Vietnam Market Share

(Percent of world trade)

Sources: UN Comtrade; and IMF staff estimates.

These gains in trade are roughly in line with predictions of a gravity model, with only Vietnam appearing to be an outlier. The gravity model shown in Table 2.1, estimated using global trade data for 187 countries over the period 2001–12, attempts to explain bilateral trade volumes by countries’ economic size and their distance from one another.20 These two factors alone explain a large proportion of the variation in trade volumes. The levels of trade in Cambodia, Lao P.D.R., and Myanmar are broadly in line with—and sometimes even below the levels suggested by—their size and distance from partners, but Vietnam appears to be exceptionally open.

Table 2.1.Trade Gravity Regressions1
(1)(2)(3)(4)(5)(6)(7)(8)(9)(10)(11)
GDP source1.066***1.067***1.066***1.066***1.066***1.066***1.066***1.065***1.066***1.066***1.066***
(140.923)(140.836)(140.915)(140.842)(140.896)(140.871)(141.164)(140.909)(140.942)(141.113)(141.149)
GDP destination1.092***1.091***1.091***1.092***1.092***1.092***1.091***1.091***1.092***1.090***1.091***
(169.915)(170.260)(170.061)(170.017)(170.057)(169.865)(169.145)(169.864)(169.522)(169.238)(169.841)
Distance pairwise−1.219***−1.220***−1.220***−1.219***−1.220***−1.219***−1.218***−1.222***−1.220***−1.219***−1.218***
(−73.908)(−73.974)(−73.975)(−73.915)(−73.900)(−73.913)(−73.568)(−74.073)(−73.840)(−73.819)(−73.725)
Dummy CLMV source0.441
(1.622)
From VNM0.993***
(2.812)
From KHM0.119
(0.187)
From LAO−0.680
(−0.783)
From MMR0.022
(0.046)
Dummy CLMV destinatio−0.237**
(−2.027)
To VNM1.016***
(5.083)
To KHM0.017
(0.084)
To LAO−0.872***
(−4.147)
To MMR−1.206***
(−6.043)
Sources: IMF World Economic Outlook; World Bank, World Development Indicators; UN Comtrade; and IMF staff estimates.

These trade gravity regressions assess the intensity of trade between a pair of countries from a global sample, given those countries’ economic size and the geographical distance between them. The baseline regression in column (1) is as follows:

Columns (2) – (11) include dummy variables for the CLMV—as a group, individually, and as both source and destination of trade. Country abbreviations are: KHM = Cambodia; LAO = Lao P.D.R.; MMR = Myanmar; VNM = Vietnam

Sources: IMF World Economic Outlook; World Bank, World Development Indicators; UN Comtrade; and IMF staff estimates.

These trade gravity regressions assess the intensity of trade between a pair of countries from a global sample, given those countries’ economic size and the geographical distance between them. The baseline regression in column (1) is as follows:

Columns (2) – (11) include dummy variables for the CLMV—as a group, individually, and as both source and destination of trade. Country abbreviations are: KHM = Cambodia; LAO = Lao P.D.R.; MMR = Myanmar; VNM = Vietnam

Trade patterns have changed substantially in recent years. This is particularly true of Vietnam, which started as a commodity exporter 20 years ago, and then added garments and, more recently, electronics. In fact, Vietnam is the country gaining the most market share in major light manufactures worldwide in recent years, especially apparel and footwear, while China has been losing in this category (Figure 2.11). In electronic goods Vietnam is the second biggest gainer of market share, surpassed only by China (Figure 2.12). Vietnam also has the most diversified set of export markets in the CLMV. Myanmar is another striking case—in 1990, the economy was essentially closed off, but imports have grown sharply in recent years, and the country has become a substantial exporter of commodities, especially natural gas; while 40 percent is directed to ASEAN, China’s share is growing rapidly. Lao P.D.R. too is a commodity exporter, though the country’s reliance on commodities is a recent phenomenon, with machinery (assembly of motorbike kits) and apparel accounting for more than half of exports as recently as 2005 (Figure 2.8). Cambodia remains focused on garments but has lost share in the U.S. market while gaining in the European Union (EU), partly on account of preferential trade access, and continues to gain global market share in this segment (Figure 2.11).

Figure 2.7.Composition of Exports: Cambodia

(Percent of total)

Sources: UN Comtrade; and IMF staff estimates.

Figure 2.8.Composition of Exports: Lao P.D.R.

(Percent of total)

Sources: UN Comtrade; and IMF staff estimates.

Figure 2.9.Composition of Exports: Myanmar

(Percent of total)

Sources: UN Comtrade; and IMF staff estimates.

Figure 2.10.Composition of Exports: Vietnam

(Percent of total)

Sources: UN Comtrade; and IMF staff estimates.

Figure 2.11.Change in Market Share in Major Light Manufactures

(Percentage point, 2014–10; five largest and smallest changes)

Sources: UN Comtrade; and IMF staff estimates.

Figure 2.12.Change in Market Share in Final Electronic Goods

(Percentage point, 2014–10; five largest and smallest changes)

Sources: UN Comtrade; and IMF staff estimates.

FDI has played a crucial role in the CLMV. In Cambodia, the rapid expansion of FDI-driven garments exports has become a major source of employment and income for female workers, reducing poverty and helping narrow the urban–rural income gap. Recently, FDI has begun expanding into other labor-intensive export industries, such as shoes, toys, and wood products. In Lao P.D.R., foreign investment in hydroelectric power and mining is boosting GDP growth and employment. Myanmar has not seen much FDI yet in the manufacturing sector, but this is likely to change given the liberalization and transformation the economy is undergoing—in particular, the establishment of special economic zones. In Vietnam, FDI—which at times approached 10 percent of GDP—played and still plays a central role in transforming the economy; inflows went first to light manufacturing, including garments, but more recently have gone into electronics and machinery manufacturing. In fact, Vietnam has turned into a major production center for several of the largest global technology manufacturers, leveraging its open investment climate and low-cost but skilled labor force. FDI flows from Korea to Vietnam have risen as those to China have fallen, suggesting that Vietnam is offering some competition to China in supply chain trade. (See Box 2.1 on the importance of foreign ownership in the exports of the CLMV, with implications on spillovers and growth.)

Figure 2.13.CLMV Inward FDI Flows1

(Millions of U.S. dollars)

1/ Myanmar on committment basis, not realized.

Sources: National authorities; and United Nations Conference on Trade and Development (UNCTAD).

Aside from Vietnam, the CLMV have not been impressive in terms of export diversification or sophistication. Hausman, Hwang, and Rodrik (2007) emphasize the productivity and growth benefits associated with specializing in more “sophisticated” and “complex” products. Using their measure for sophistication, it appears that while Vietnam has managed to move increasingly into more sophisticated products, Cambodia, Lao P.D.R., and Myanmar have not advanced much. Lack of export diversification has been a challenge for many LICs, and while the empirical evidence on the causal relationship between diversification and economic growth is mixed (see, for instance, Cadot and others 2011a, and IMF 2014), diversification does, as expected, help countries manage shocks. Using a Hirschman index of export concentration, we find that Vietnam has improved and caught up with the level of diversification of China, while the rest of the CLMV have stagnated or even deteriorated in recent years.

Figure 2.14.Export Concentration Index

(Index from 0 to 1; higher values indicate lower diversification)

Sources: UNCTAD; and IMF staff estimates.

Diversification in terms of partners, which can also help in insulating a country from external shocks, has been mixed across the CLMV. Vietnam has expanded its portfolio of both import and export partners, although the reliance on China for intermediate inputs and investment goods has increased. The other three CLMV countries are increasingly reliant on a narrow set of partners in the region. Cambodia is amply diversified in its export destinations (mostly within the OECD), but inputs for Cambodian garments have come increasingly from regional partners—in 2014, China, Thailand, and Vietnam accounted for more than 60 percent of imports by Cambodia, up from just over 31 percent in 2000. Lao P.D.R. and Myanmar rely heavily on regional partners for both exports and imports—China and Thailand together account for more than 55 percent of Lao P.D.R.’s exports and 82 percent of imports, and over 60 percent of Myanmar’s exports and imports.

Figure 2.15.Cambodia Export Partners, 2014

(Percent)

Sources: UN Comtrade; and IMF staff estimates.

Figure 2.16.Lao P.D.R. Export Partners, 2014

(Percent)

Sources: UN Comtrade; and IMF staff estimates.

Figure 2.17.Myanmar Export Partners, 2014

(Percent)

Sources: UN Comtrade; and IMF staff estimates.

Figure 2.18.Vietnam Export Partners, 2014

(Percent)

Sources: UN Comtrade; and IMF staff estimates.

Figure 2.19.Cambodia Import Partners, 2014

(Percent)

Sources: UN Comtrade; and IMF staff estimates.

Figure 2.20.Lao P.D.R. Import Partners, 2014

(Percent)

Sources: UN Comtrade; and IMF staff estimates.

Figure 2.21.Myanmar Import Partners, 2014

(Percent)

Sources: UN Comtrade; and IMF staff estimates.

Figure 2.22.Vietnam Import Partners, 2014

(Percent)

Sources: UN Comtrade; and IMF staff estimates.

Participation of the CLMV in Global Value Chains

TiVA data—which are not available for Lao P.D.R. or Myanmar—suggest increasing integration of Cambodia and Vietnam in global and Asian value chains. High foreign value added in key noncommodity sectors for both Vietnam and Cambodia suggests that both countries do a lot of low-value-added processing. FVA accounts for about 60 percent of Vietnam’s and Cambodia’s gross exports of electronics, garments and footwear, and machinery, among the highest in the data sample. For Vietnam, declining import intensities in some electronic product categories (for example, cell phones) suggest that more production steps and increasing value added take place in Vietnam. This is not the case, however, for garments, where both Vietnam and Cambodia continue to heavily rely on Chinese fabric imports.

Figure 2.23.Domestic Value-Added Content of Exports by Country, 2011

(Percent of gross exports)

Sources: OECD TiVA; and IMF staff estimates.

Figure 2.24.Change in Domestic Value-Added Ratio by Country between 1995 and 2011

(Percentage points)

Sources: OECD TiVA; and IMF staff estimates.

Vietnam and Cambodia exhibit very strong backward linkages, though forward linkages are weak—that is, FVA accounts for a large share of the value of Vietnamese and Cambodian exports, while Vietnamese and Cambodian value-added do not figure prominently in the value of other countries’ exports. Such a pattern supports the view that both countries are still mostly engaged in final-assembly manufacturing. Other countries with high FVA in these industries are central European countries integrated with the German supply chain (IMF 2013) and middle-income ASEAN countries. China tends to internalize a higher share of value in its exports in these industries than do Vietnam or Cambodia.

Figure 2.25.Foreign Value-Added Content: Apparel and Footwear, 2011

(Percent of gross exports)

Sources: OECD TiVA; and IMF staff estimates.

Figure 2.26.Foreign Value-Added Content: Machinery and Equipment, 2011

(Percent of gross exports)

Sources: OECD TiVA; and IMF staff estimates.

Figure 2.27.Foreign Value-Added Content: Electrical and Optical Equipment, 2011

(Percent of gross exports)

Sources: OECD TiVA; and IMF staff estimates.

Lao P.D.R. and Myanmar are not heavily involved in supply chain relationships. As noted above, both economies focus largely on commodity and energy exports to the rest of Asia. It seems evident, however, that Myanmar, with its large population and landmass, will have opportunities to get further into manufacturing in years to come, and supply chain integration seems a likely result.

Integration with China

China and the CLMV have grown increasingly integrated and form a natural cluster of countries to study jointly. All four CLMV countries import substantially from China, Myanmar and Lao P.D.R. depend heavily on Chinese demand for their commodity exports, and Cambodia and Vietnam are interdependent with China on account of supply chain linkages in garments and electronics. China is also the main supplier of investment goods to the CLMV. Moreover, China’s trade links with the CLMV have grown more rapidly than those with most other regions. China supplies 25 percent of the CLMV’s imports and demands between 10 and 25 percent of their exports (Cambodia is an exception, with almost all of its garments going to the United States and Europe). On the other side, while, as small countries, the CLMV naturally account for a small share of China’s total imports and exports, the share of imports has risen fourfold since 2000, and the share of exports has more than tripled. These gains have been driven mostly by Vietnam, which in fact since 2008 has seen the largest dollar increase in Chinese imports of any country in the world (see Figure 1.8).

China is an important supplier of goods to the CLMV. About 15 percent of China’s exports to CLMV are consumption items, 28 percent are capital goods like machinery, and 57 percent are intermediate inputs like iron/steel and fabrics/yarn. And viewed from another angle, 14 percent of CLMV’s consumption imports come from China, 17 percent for capital goods, and 68 percent for intermediate inputs. These patterns vary across countries, with intermediate inputs relatively more important in Cambodia and Vietnam—as one would expect given their substantial assembly/manufacturing activities—and China a relatively more important source country for Myanmar than for the rest of CLMV. Fabric and other textile materials accounted for about 60 percent of China’s exports to Cambodia, but in Myanmar and Lao P.D.R., machinery and vehicles were much more important. Vietnam imports predominantly investment goods (machinery, equipment, steel) and intermediate inputs (electronic components and fabric) from China.

China’s imports from the CLMV are quite diversified. The CLMV accounts for only a small share of China’s total imports—just 1½ percent in 2014, though this is up sharply from 2000. These relatively small flows relate mainly to raw materials such as wood, rubber, and fresh food (all four CLMV countries), mining products (Lao P.D.R. and Myanmar), natural gas and gems (Myanmar), garments (Cambodia, Vietnam), and consumer electronics (Vietnam). Vietnam’s main exports to China are electronics, followed by agricultural products and garments. China’s demand for raw materials will continue along with rapid industrial expansion, though this may moderate for some commodities (and rise for others) as the economy rebalances (Helbling and others 2016).

Figure 2.28.Share of CLMV in China’s Exports

(Percent)

Sources: UN Comtrade; and IMF staff estimates.

Figure 2.29.Share of CLMV in China’s Imports

(Percent)

1/ 2014 Myanmar exports figure comes from CEIC Data Company Ltd.

Sources: UN Comtrade; and IMF staff estimates.

Figure 2.30.Composition of Exports to China: Cambodia

(Percent of total)

Sources: UN Comtrade; and IMF staff estimates.

Figure 2.31.Composition of Exports to China: Lao P.D.R.

(Percent of total)

Sources: UN Comtrade; and IMF staff estimates.

Figure 2.32.Composition of Exports to China: Myanmar

(Percent of total)

Sources: UN Comtrade; and IMF staff estimates.

Figure 2.33.Composition of Exports to China: Vietnam

(Percent of total)

Sources: UN Comtrade; and IMF staff estimates.

In aggregate, the CLMV continues to run a large trade deficit with China. While both exports to and imports from China have surged, each CLMV country maintains a bilateral trade deficit with China. Gravity equations confirm that the close trade connections between China and the CLMV go beyond what would be expected based on country size and location alone. By contrast, CLMV trade with ASEAN is not stronger than size and distance would suggest.

Trade links between China and the CLMV are complemented by investment links, which presage continued deepening of trade relationships in the future (World Economic Forum 2013). China is an increasingly important investor in Cambodia, Lao P.D.R., and Myanmar. For Vietnam, however, Chinese FDI does not play a big role, while other upstream countries, such as Japan and Korea, are more important—Vietnam is, in this sense at least, more a competitor with China than a collaborator. In the rest of the CLMV, the main interest of Chinese investors has been in the primary sector—forest development, timber processing, power, and farming, plus textiles in Cambodia; energy and mining in Lao P.D.R.; and natural gas in Myanmar.

China’s rebalancing may have major implications for the CLMV. First, a decline in demand for intermediate goods used for investment will affect countries that rely heavily on their raw material exports to China, such as Lao P.D.R. and Myanmar.21 Second, while some of the increased demand for (imported) consumption goods in China may be oriented toward high-end or luxury goods, and thus may mostly benefit producers in advanced economies, the general trend toward increased consumption goods imports can offer opportunities for the CLMV to export—indeed, there is already evidence that the CLMV, and in particular Vietnam, have increased their penetration of Chinese consumption goods markets substantially. And looking beyond the goods trade, Chinese tourism, including to Southeast Asia, has grown substantially.

Integration has benefited from formal regional agreements. To support its economic development and also enhance its role in the region, China initiated the ASEAN-China FTA, and the Framework Agreement of the FTA, which laid out a timetable for tariff reduction, was signed in November 2002. Another initiative that has shaped China-CLMV economic ties is the Greater Mekong Sub-region program, proposed by the Asian Development Bank in 1992. Supported by China’s official assistance, the program has promoted the integration of trade, tourism, transport, and power between China’s western areas and the CLMV.

The value-added trade data also confirm the region’s increasing integration with China. Cambodia and Vietnam appear to be downstream assemblers and processers of Chinese inputs, in both garments and electronics. China’s value added in the exports of Cambodia and Vietnam (for whom these data are available) has increased sharply, outpacing the growth of China’s value added in world exports in general. And in level terms, China is now more important than Korea or Japan as a supplier of production inputs. Yin (2012) notes that the import intensity of Cambodian garment exports increased significantly from 2006 to 2010, with almost all of those imports coming from China; similarly, in Vietnam, the import intensity of the electrical machinery sector grew dramatically as well.

Figure 2.34.Chinese Value Added in Vietnam, Cambodia, and World Exports

(Percent of respective total exports)

Sources: OECD TiVA; and IMF staff estimates.

Figure 2.35.Japanese Value Added in Vietnam, Cambodia, and World Exports

(Percent of respective total exports)

Sources: OECD TiVA; and IMF staff estimates.

Figure 2.36.Korean Value Added in Vietnam, Cambodia and World Exports

(Percent of respective total exports)

Sources: OECD TiVA; and IMF staff estimates.

Figure 2.37.Chinese, Japanese, and Korean Value Added in Vietnam and Cambodia Exports, 2009

(Percent of respective total exports)

Sources: OECD TiVA; and IMF staff estimates.

China’s supply chain relationships with Cambodia and Vietnam are qualitatively different from each other. China and Cambodia are more clearly collaborators, with Chinese textiles stitched in Cambodia into garment exports.22 But while Chinese inputs go into Vietnam’s production too, Vietnam’s products compete directly with those of China on the world market; for example, Samsung phones assembled in Hanoi from Chinese parts are sold in the United States alongside Huawei phones assembled in Guangdong. More recently, there is evidence of a two-way supply chain relationship between China and Vietnam in electronics, with Vietnam exporting components to China. As Vietnam’s export profile becomes more similar to China’s, with increasing overlap of target markets, the trade linkages between Vietnam and China are not only within a single supply chain, but also across different supply chains led by different upstream countries. And with the advent of the Trans Pacific Partnership (TPP), which includes Vietnam but not China, supply chain relationships may evolve further—in particular, rules of origin might stimulate a move of more intermediate goods production from China to Vietnam.

Box 2.1.FDI, Foreign Ownership, and Development in the CLMV

The CLMV have become an attractive destination for foreign direct investment. In relation to their economic size, they have received more FDI than most other Asian economies in recent years. As a result foreign enterprises contribute significantly to growth, employment, and exports in the CLMV. This box briefly summarizes the literature on the effect of FDI and foreign ownership on development. It then proceeds to discuss Cambodia’s and Vietnam’s experience in recent years.

The cross-country evidence for the role of FDI in development is mixed. The literature finds fairly consistently that openness to trade is associated with higher GDP growth (Sachs and Warner 1995; Frankel and Romer 1999). It is also true that there have been many successful cases of domestic spillovers from FDI—in manufacturing more than in natural resources—though the literature here is more mixed (see Baltabaev 2014 for a recent review). Export-led growth strategies, however, do not necessarily require foreign investment. In Asia, China and many Southeast Asian countries have encouraged and received large FDI, while Korea, Japan, and Taiwan Province of China followed development strategies in which foreign ownership and investment played no role and was even discouraged (Perkins 2013). In the latter, domestic enterprises developed into successful exporters, often supported by government policies that encouraged exports.

The impact of FDI on export diversification/sophistication is ambiguous (Iwamoto and Nabeshima 2012; Banga 2006). FDI can increase export diversification/sophistication by allowing host countries to enter new export categories; for example, Vietnam’s rapid rise as an electronics exporter is due to foreign enterprises. However, if primarily directed at sectors that are already dominating a host country’s exports—for example, commodities (Lao P.D.R., Myanmar)—FDI can increase export concentration and hamper diversification by drawing scarce domestic resources toward these sectors.

The presence of foreign firms and FDI can help countries to move into higher-value production, enhance human capital, and support technology diffusion. OECD (2013b) identifies FDI as a key enabler for low-income countries to link into global value chains, which supports growth and technological upgrading. However, while there exists ample evidence that foreign-owned firms are more efficient than domestic firms (Caves 1974; Djankov and Hoekman 2000; Sabirianova, Svejnar, and Terrell 2012). the evidence on positive FDI spillovers to local firms and the local economy remains mixed. A number of studies find spillovers to domestic firms, especially in joint ventures and through supplier relationships (Cheung and Lin 2004; Liu 2008), while other studies suggest that spillover effects regarding wages, technology, and productivity are not present or even negative (See, for example studies of Morocco by Haddad and Harrison (1993); Mexico by Aitken, Harrison, and Lipsey (1996); Venezuela by Aitken and Harrison (1999); Bulgaria and Romania by Konigs (2001); Czech Republic by Kosova (2010); China by Abraham, Konings, and Slootmaekers (2006); Malaysia by Cherif and Hasanov (2015). Firm-level evidence points to the importance of absorptive capacity by domestic firms to create positive spillovers from FDI (Keller 2004).

In Cambodia, the garment industry is the major recipient of FDI inflows, accounting for a quarter of the total FDI stock (UNCTAD 2013). Cambodia’s economy is heavily reliant on garments; the sector accounts for 9.1 percent of GDP, more than 70 percent of export revenues, and 27 percent of manufacturing employment. The sector relies mostly on foreign investment from Asia.

So far, the FDI-driven garment sector in Cambodia has remained concentrated in low-value-added activities. The sector has contributed to growth and employment over the past two decades, but Cambodian garment factories are mostly engaged in cut-make-trim processes. Design and higher-level production, export, and management decisions are predominantly made at the headquarters of the foreign parent companies, and technology spillovers have been limited to date.

FDI and foreign companies have transformed Vietnam’s exports over the past decade. Vietnam has moved from being a commodity exporter to exporting a diversified set of products, with electronics being the biggest category. Foreign companies account for close to 70 percent of exports, mostly in electronics manufacturing and apparel. In recent years, the foreign sector has generated substantial trade surpluses that more than offset the structural trade deficit of the domestic economy. FDI continues to be strong, with companies from Korea, Japan, and Singapore among the largest investors. In electronics, some of the largest global firms, including Samsung, Intel, and Foxconn, have built up significant production capacity in Vietnam. Samsung alone employs over 100,000 people in Vietnam and generates close to US$30 billion in exports. Vietnam’s increasing stock of FDI is mirrored by rising payments to foreign firm headquarters, resulting in increasing income debits in Vietnam’s balance of payments.

Vietnam has greatly benefited from the vibrant FDI sector through growth and employment, but technology and growth spillovers to domestic industry remain limited so far. Domestic value added in the key export sectors of electronics and apparel is among the lowest worldwide, suggesting that most foreign firms use Vietnam as a manufacturing base for final assembly while importing most high-value-added inputs. Domestic private businesses generally lack the technological capacity and scale to form supplier relationships with the FDI sector. State-owned enterprises continue to play a large role in Vietnam’s economy but remain relatively inefficient. The domestic private sector faces structural headwinds including from a weak banking sector, and competition from state-owned enterprises with preferential access to resources. Property rights and the enforcement of antitrust policy need to be strengthened to encourage domestic private firms to scale up and join the formal sector. Tax incentives to attract FDI are limiting direct state revenues from foreign enterprises.

Government policy can help to attract FDI and influence the effects of FDI on host countries. FDI can bring positive effects (market access, technology, finance, skills), but these are not automatic for host countries. Governments can support positive spillovers from foreign companies through policies including local research and development requirements and by undertaking structural reforms and by improving the business environment for domestic firms, which enhances their absorptive capability and ability to partner with foreign firms (OECD 2001). Policy efforts to improve the business environment will also clearly help to attract FDI in the first place. In the case of Vietnam, substantial foreign investments in non-apparel manufacturing have occurred only in the past decade, and stronger links between the FDI sector and domestic industry may yet form. For Cambodia, the more immediate challenge is to diversify and upgrade its exports from apparel and attract FDI to support this transition.

Box Figure 2.1.Foreign Direct Investment

(Percent of GDP, average 2010–14)

Sources: IMF, World Economic Outlook; and IMF staff calculations.

Box Figure 2.2.Vietnam Exports: Domestic and Foreign Invested Enterprise (FIE) Sector

(Rolling 12-months, billions of U.S. dollars)

Sources: Vietnamese Authorities; and IMF staff calculations.

Box Figure 2.3.Vietnam Trade Balance: Domestic and FIE Sector

(Percent of GDP)

Sources: Vietnamese Authorities; and IMF staff calculations.

Box Figure 2.4.Vietnam Inward FDI and Income Debits

(Billions of U.S. dollars)

Sources: Vietnamese Authorities; and IMF staff calculations.

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