UNIVERSITY OF ECONOMICS INSTITUTE OF SOCIAL STUDIES HO CHI MINH CITY THE HAGUE VIETNAM THE NETHERLANDS VIETNAM - NETHERLANDS PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS THE IMPACTS OF INSTITUTIONAL FACTORS ON PROVINCIAL ECONOMIC PERFORMANCE: THE CASE OF VIETNAM (2007-2011) By PHAN THACH TRUC MASTER OF ARTS IN DEVELOPMENT ECONOMICS Ho Chi Minh City, December, 2013 UNIVERSITY OF ECONOMICS INSTITUTE OF SOCIAL STUDIES HO CHI MINH CITY THE HAGUE VIETNAM THE NETHERLANDS VIETNAM - NETHERLANDS PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS THE IMPACTS OF INSTITUTIONAL FACTORS ON PROVINCIAL ECONOMIC PERFORMANCE: THE CASE OF VIETNAM (2007-2011) A thesis submitted in partial fulfillment of the requirements for the degree of Master of Arts in Development Economics By PHAN THACH TRUC Academic supervisor Dr TRUONG DANG THUY Ho Chi Minh City, December, 2013 DECLARATION I declare that: "The impacts of institutional factors on provincial economic performance: The case of Vietnam (2007-2011)" is my own work; it has not been submitted to any degree at other universities I confirm that I have made all possible effort and applied all knowledge for finishing this thesis to the best of my ability Ho Chi Minh City, December 2013 PHAN THACH TRUC i ACKNOWLEDGEMENTS First and foremost I would like to extend my gratitude to my supervisor, Dr Truong Dang Thuy, for invaluable comments, guidance and engagement through the learning process of the thesis I am much obliged to Dr Pham Khanh Nam for introducing me to the topic as well as for the availability of the dataset In addition, I am thankful for Le Duc Anh for all your kind help during my time in class 17 Then I feel lucky to have time doing the thesis with Nguyen Thi Ngoc Linh and Nguyen Quang, from whom I have a lot of things to learn Lastly and obviously, I am deeply indebted to my family members for all the kind understanding and spiritual support Forever, I will be wholeheartedly grateful for your love ii ABSTRACT Given the intensive PCI score race among Vietnamese provinces in the past year so as to improve the enabling environment for local economic development, this study is to justify the imperativeness of such a race Employing the PCI and its nine sub-indices as proxies for institutional quality, we explore the institutional impacts on GDP for the dataset of 58 Vietnamese provinces from 2007 to 2011 In realizing this objective, we make an attempt to incorporate into the estimation models of both Cobb-Douglas and Translog functional form the de facto overstatement of provincial GDP While the positive impacts of PCI on provincial GDP are statistically confirmed, the regression results obtained for the nine sub-indices are divergent across functional forms and outlier treatment approaches To the extent that the economic significance of different institutional factors is assessed, our research objective is realized and respective policy implications are then suggested Key words: PCI, GDP overstatement, institution, Cobb-Douglas, Translog iii TABLE OF CONTENTS DECLARATION i ACKNOWLEDGEMENT ii ABSTRACT iii TABLE OF CONTENTS iv Chapter INTRODUCTION 1.1 Problem statement 1.2 Research objective and research questions 1.3 Contribution of the study 1.4 Organization of the study Chapter LITERATURE REVIEW 2.1 Theoretical literature: The New Institutional Economics 2.1.1 A renewed interest – some distinct features 2.1.2 Institutions matter for economic performance 2.2 2.1.2.1 Theoretical approaches 2.1.2.2 Mechanism and channels of influence Theoretical model: the aggregate production functions 11 2.2.1 History of the production functions 11 2.2.2 Properties of the production function 14 2.3 Empirical literature 15 Chapter DATA AND RESEARCH METHODOLOGY 19 3.1 Data and variable measurement 19 iv 3.1.1 Data collection 19 3.1.2 Variable measurement 21 3.1.2.1 Response variable 21 3.1.2.2 Explanatory variables 21 3.1.3 3.2 Descriptive statistics 29 Research methodology 33 3.2.1 Model specifications 33 3.2.2 Estimation methods 35 3.2.2.1 Data cleaning – OLS regression for panel data 35 3.2.2.2 Modeling the overstatement of growth data – The Stochastic Frontier Analysis (SFA) 37 3.2.3 Model validation 41 3.2.3.1 Testing the model overall significance 41 3.2.3.2 Statistical test of individual coefficient significance 41 3.2.4 Analytical framework 42 Chapter EMPIRICAL RESULTS AND DISCUSSION 43 4.1 Overall explanation and hypothesis testing 43 4.1.1 Overall explanation of model regression 43 4.1.2 Hypothesis testing 44 4.1.2.1 Statistical test of model overall significance 44 4.1.2.2 Statistical test of individual significance of institution variables 45 4.2 Model estimation – Institutional impacts on GDP 46 4.2.1 Transaction cost institution: Entry cost, Time cost and Informal charges 46 4.2.2 Property right and Contract enforcement institution: Access to Land and Legal Institution 53 v 4.2.3 Information problem institution: Access to information, Private sector development and Pro-activity of provincial leaders 56 4.2.4 Labor policy and training 62 4.2.5 The PCI 64 Chapter CONCLUSION AND PERTAINING ISSUES 70 5.1 Conclusion 67 5.2 Policy implications 68 5.3 Limitations and further studies 69 REFEERENCES 70 APPENDIX 74 vi LIST OF TABLES Table 3.1 Variable summary 28 Table 3.2 Summary statistics of key variables 29 Table 3.3 Between and within variations of key variables 30 Table 3.4 Overstatement of provincial growth data 35 Table 4.1 Attempted regressions of this study 44 Table 4.2 Hypothesis testing of overall significance of multiple regression 44 Table 4.3 Hypothesis testing of individual significance for institution variables 45 Table 4.4 Regression result– Transaction cost institution 48 Table 4.5 Regression result - Property right and Contract enforcement institution 54 Table 4.6 Regression result – Information problem institution 56 Table 4.7 Regression result – Labor policy and training 62 Table 4.8 Regression result –the PCI 64 vii LIST OF FIGURES Figure 3.1 Institution and economic outcomes: mechanism and channels of influence 27 Figure 3.2 Time-series plots of real GDP against year and PCI against year 31 Figure 3.3 Overall scatter plot of real GDP against PCI 32 Figure 3.4 Scatter plots for within and between variations of real GDP against PCI 32 Figure 3.5 Illustration of growth data overstatement 38 Figure 3.6 Different distributions of u 39 Figure 4.1 Effects of Time cost scores on GDP 51 Figures 4.2 Effects of Informal charge scores on GDP 52 Figure 4.3 Effects of Information access scores on GDP 59 Figure 4.4 Effects of Private sector development scores on GDP 60 Figure 4.5 Effects of Pro-activity of provincial leader scores on GDP 61 Figure 4.6 Effects of Labor policy and training scores on GDP 63 Figure 4.7 Effects of the PCI scores on GDP 65 viii As can be inferred from the figure, an increase in the PCI scores is associated with an increase in provincial GDP for the whole data range of around 35 to 80 point scores If PCI scores go up by 1%, on average, provincial real GDP will go up by about 0.14%, with other factors remain unchanged (regression result from Table 4.8) Additionally, the monotonic upward concave curvature reveals that moving up along the score ladder, an improvement in the PCI score is associated with a smaller increment in provincial GDP, which is consistent with the Law of diminishing returns To sum up, out of the three models applied, CD(III) proves to be mostly preferred as being the only model delivering the reasonable sign of (+) for the labor input variable across regression equations of PCI and its nine sub-indices Concerning institutional effects on provincial GDP, there are substantive differences in empirical results obtained From the statistical perspective, Land access, Legal institution and Entry costs not significantly contribute to explaining cross-province GDP differentials In addition, whereas the PCI along with Time cost, Informal charges, Labor policy and Pro-activity positively impacts on provincial GDP with discernible patterns, no concluding remarks could be drawn on the institution-growth relationship for Access to Information and Private sector development Rather, these two sub-indices offer empirical evidences for the sensitivity of the sample data set to functional forms and outliers In passing, although divergent results are obtained among the PCI and the nine sub-indices, the overall picture is supportive for our argument that institution matters for provincial economic performance Notably, except for the Time cost sub-index, the documented methodological change in constructing the PCI as well as its sub-indices in the year 2009 did not bring about a structural break in the respective institution-growth relationship 66 Chapter CONCLUSION AND PERTAINING ISSUES 5.1 Conclusion In the context that there has been an intensive race to improve PCI scores among Vietnamese provinces in the past year so as to enhance the enabling environment for better provincial economic performance, this study was conducted to justify the imperativeness of such a “race” Employing PCI and its nine sub-indices as proxies for institutional quality, our study has empirically investigated the impacts of institutional implementation on economic performance of Vietnam’s provinces for the 2007-2011 period Taking into account the crucial fact that there is overstatement of provincial GDP data, we estimate the models in two ways As a conventional approach, we remove outliers following the data cleaning process presented in the previous chapter before running the respective regressions Alternatively, we explicitly model the over-reported GDP data by incorporating such a proven over-statement into the model estimation We then run three rounds of model regressions corresponding to the full-data (or trial) model, the outlier-free model and the socalled over-statement treatment model In these three rounds of model estimation, we attempt to employ both Cobb-Douglas and Translog functional form for each round However, the last model fails to deliver feasible outputs for the TL case, making the total number of model estimation amount to five for PCI as well as each sub-index Notably, out of the three models put into result analysis, including the Translog case for the first two rounds, which is respectively coded TL(I) and TL(2), and the Cobb-Douglas for the last round, namely the CD(III), the last model proves to deliver the most reliable estimation results While the economic significance of PCI’s impact on provincial GDP is statistically confirmed, Land access, Legal institution and Entry costs not significantly contribute to explaining cross-province GDP differentials In addition, whereas Time cost, Informal charges, Labor policy and Pro-activity positively impacts on provincial GDP with discernible patterns, no concluding remarks could be drawn on the institution-growth relationship for Access to Information and Private sector development Although empirical results obtained are divergent across PCI and its nine indices as well as across the three models employed, the broad picture supports our argument that institutions matter for economic performance 67 In light of the fact that findings from the study can help in justifying such a PCI score race and to the extent that the economic significance of institutional effects on provincial economic outcome is assessed, our research objective is realized and research questions are successfully solved 5.2 Policy implications Participating in the PCI score race, which has now been empirically justified, provinces should have their energies and limited resources channeled into specific institutional areas critically conducive to economic development With our empirical results utilized as actionable policy information, our following discussion on policy implication will be rested on those sub-indices exhibiting a discernible pattern of significant impacts on provincial economic outcomes As revealed by our empirical results, Time cost and Informal charge sub-index significantly contributes to explaining provincial economic variations This finding implies that intensive actions should be taken at provincial level to eliminate these transaction costs in conducting business In particular, the costliness of bureaucratic regulation and paperwork as well as the unofficial payments to “grease the wheel” of business operation should be ultimately eradicated Another institutional factor significantly matters for provincial economic performance is Proactivity of provincial leaders As a result, provincial investments should be geared towards enhancing the dynamism of officials in working with regulatory framework as well as realizing their initiatives to support private sector development With Labor policy and training sub-index showing significant explanatory power to crossprovince GDP differentials, the implication is that provincial leaders’ efforts in enhancing vocational training and labor placement for local enterprises should be, in which way or another, strongly encouraged and imperatively promoted 68 5.3 Limitations and further studies The most prominent limitation of the study lies in its failure to address the potential endogeneity of institution Because one of the two types of data used to construct the PCI is perception data, it is much likely that the index is prone to perception bias In which sense, the data is collected via surveys whose respondents’ perceptions of the existing institutional environment are more or less affected by the state of the economy at a given time, which is called endogeneity problem Meanwhile, the data set used in the study does not support the employment of an instrument variable for endogeneity treatment Working on a sensitive data set is another important limitation of the study Since divergent results are obtained across functional forms as well as outlier treatment approaches, conclusions drawn are, in some cases, too conservative to deliver any actionable policy information This point was empirically evidenced by the case of Access to Information and Private sector development As a definite conclusion on the institution-growth relationship could not be drawn, no policy implications have been suggested concerning these two institutional factors Due to limited resources, we encounter the technical problems of computational capacity when the software (STATA) fails to deliver feasible outputs for Stochastic Frontier Analysis with Translog functional forms As a consequence, the respective models are excluded from our study To conclude, the above arguments present the extent to which our study has not worked nicely More research and more data are therefore needed to overcome the limitations of our study Besides, there are some other institution-growth related matters that could be investigated for the case of Vietnam, such as institutional threshold effects via parameter 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Dien Bien (b) Outlier I - Hai Duong (d) Outlier I - Hoa Binh (c) Outlier I - Phu Tho 75 Table A.4 Outlier II detection 2007 2008 2009 2010 2011 76 Table A.5 Summary of empirical studies No Author (s) and study Data set Methodology Dias & Tebaldi (2012)Institutions, human capital, and growth: The institutional mechanism -Panel data 61 countries (1965-2005) - Formal growth model -GMM dynamic Siddiqui & Ahmed (2013) The Effect of Institutions on Economic Growth: A Global Analysis Based on GMM Dynamic Panel Estimation Panel of 84 countries 2002-2006 - Formal extended growth model -GMM - based Arellano-Bond linear dynamic Atul and Sal (2012) On the relation between regulation and economic growth Gagliardi (2008) Institutions and economic change: A critical survey of the new institution approaches andl evidence Panel 23 OCD Countries (2002-2008) Theoretical approaches and empirical evidences on the subject Proxy variable -Political institution: Polity-IV measure of democracy and autocracy -Structural institution: share of educated labor in the economy (steady state condition) Index of Institutionalized Social Technologies (sub-indices: institutional and political rents, policy rents and riskreducing technologies) -Solow’s growth model -Fixed and Random effect Governance indicators from World Bank Meta analysis -Historical perspective approach -Institutional comparative approach -Imperfect information theory 79 Key findings The importance of interactions between institution and human capital accumulation is highlighted Policy implication: the growth path is tied to structural institutions, not political ones Good institutions favor economic growth For a developing country, institutional and political rent index is more important than the other two factors Higher quality of regulation leads to higher growth Institutional framework substantially influences economic outcomes Sobel (2008) Testing Baumol: Institutional quality and the productivity of entrepreneuship Panel China’s 31 provinces, 1986-2002 -Barro’s (1991) growth equation - OLS -System GMM (annual and three year average) -Size of private sector: private sector total fixed investment/ overall fixed investment -Rule of law: number of lawyers/10,000 people - Awareness of property rights: number of domestic trademark applications/ number of firms Institutional development plays an important role in economic development Hasan et al (2007) Institutional development, financial deepening and economic growth: evidence from China Jalilian, Kirkpatrick & Parker, (2007) The impact of regulation on economic growth in developing countries: A cross-country analysis - 117 countries 1989 – 1999 - 96 countries 1980- 2000 - Cross-section regression - Panel regression (fixed effects) Two regulatory indicators: RQ (regulatory quality) and GE (government effectiveness) A strong causal link exists for the institution – growth nexus in developing countries Tran et al.(2009) Institutions matter: The case of Vietnam PCI 2006 Firm-level data 2005 OLS PCI: proxy for institutional quality Local governance quality is an essential factor explaining differences in firm’s economic performance Glaeser et al (2004) Do institutions cause growth? Cross-country 1960-2000 OLS regression with country fixed effects Executive constraints, Democracy, Autocracy-polity IV, Expropriation risk, Autocracy-Alvarez, Government effectiveness It is challenging to establish a causal link between institutions and economic growth due to problems in institutional measurements and limitations in econometric techniques Cross-section 48 USA’s states OLS Institutional quality scores: economic freedom index Good institutions channel resources to productive entrepreneurship, thus leading to higher economic growth 80 Jenny Minier (2007) Institutions and parameter 10 heterogeneity Panel data -OLS Executive constraint variable (Jaggers Investigate the indirect effects of 70 countries Endogenous and Marshall , 2000) institution on growth allowing for (1960-2000) sample splitting parameter heterogeneity Evidence shows technique that institutions influence the marginal effect of policy variables on growth 81 Table A6 Marginal effects of institutional factors on GDP – HCMC case 2011 - CD(III) Institution variables (1 unit score change )  RGDP (million VND) dy Y  (3  5 )* dx X PCI 369,450** Entry costs -677,050 Time costs 3,770,401*** Informal charges 155,054 Land access 1,360,516 Legal institution -896,819 Access to information 3,513,714** Private sector development 895,911*** Pro-activity of leaders 3,089,269** Labor policy and training 2,550,986** 82 ... FACTORS ON PROVINCIAL ECONOMIC PERFORMANCE: THE CASE OF VIETNAM (2007- 2011) A thesis submitted in partial fulfillment of the requirements for the degree of Master of Arts in Development Economics... higher volume of transactions Institutions are, therefore, conducive to better economic performance in the long run The relevance of the underlying institution economic theory of information problems... literature on the central role of institution quality on economic performance The chapter is divided into three sections The first section reviews the prominent economic theory underlying the relationship