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 Balance of Payments Constrained Growth Model: The Case of Vietnam, 1995-2010 By DOAN TU HAO MASTER OF ARTS IN DEVELOPMENT ECONOMICS Academic supervisor Dr. DINH CONG KHAI Ho Chi Minh City, December 2012 1 123doc Table of Contents CHAPTER I: INTRODUCTION .3 Structure of Study. 9 CHAPTER II: LITERATURE REVIEW .2 Balance of Payments in Supporting and Constraining Growth .3 Conceptual framework for the study. 19 CHAPTER III: ECONOMIC GROWTH AND BALANCE OF PAYMENT OF VIETNAM .1 Vietnam Economic Growth Overview .2 Balance of Payment of Vietnam.
30 CHAPTER IV: MODEL SPECIFICATION AND FINDING .1 Model Specification and Data .2 Regression results and findings .3 Thirwall’s law in Vietnam. 38 CHAPTER V: CONCLUSION AND RECOMENDATION. 54 2 123doc List of Tables Table 1: Unit root test for stationary. 36 Table 2: Estimation results.
37 Table 3: Actual Growth Rate and Estimated BOP Constrained Growth Rates. 38 Table 4: Correlation coefficients of Actual Growth Rate and Estimated Growth Rates. 39 3 123doc List of Figures Figure 1: GDP growth 1990-2010. 8 Figure 2: Current account balance (% of GDP).
25 Figure 3: Trade balance and current account balance. 26 Figure 4: Ratio of trade and gross domestic products, 1900-2010 (Trade/GDP). 27 Figure 5: Imports, Exports and Trade balance, 1990-2010. 27 Figure 6: Net Transfers from abroad, 1990-2010.
28 Figure 7: Net Income from abroad, 1990-2010. 29 Figure 8: Foreign direct investment, 1990-2010. 31 Figure 9: Total debt as percent of export and GDP (%). 33 Figure 10: Debt service ratio.
34 4 123doc List of Appendixes Appendix 1: OLS Regression result. 45 Appendix 2: Unit root tests for stationary. 45 Appendix 3: Granger Test for Causality. 48 Appendix 4: LM-test for serial correlation.
48 Appendix 5: Test for Normality with Jarque-Bera test. 49 Appendix 6: White's test for Heteroscedasticity. 50 Appendix 7: Ramsey RESET Test. 50 Appendix 8: CUSUM test for stability of the estimated parameters.
51 Appendix 9: The estimated growth rate in the basic model. 52 Appendix 10: The estimated growth rate in the extended model. 52 Appendix 11: The estimated growth rate in the extended model with remittance. 53 Appendix 12: The estimated growth rate in the extended model with debt.
53 5 123doc CHAPTER I: INTRODUCTION 1. Problem statement There are many debates about the sources of economic growth from supply side and demand side. On the supply side, economic growth can be explained by the consolidation of factors such as inputs, productivities, research and technology. Krugman (1989) believes that each country has its own growth rate because of different growth of total factor productivity.
Solow (1957) states that total factor productivity in the Solow residual brings growth rate in the long term. On the demand-led growth, Keynesian (1936) considers effects of factors in aggregate demand on growth through multipliers. Thirlwall (1979), a post-Keynesian economist, considers demand, especially international trade, as a principal cause of accelerating or constraining growth in the long run, in other words, growth rate in open economies can be constrained by external demand. The author also suggests that the dominant constraint upon demand is balance of payments in an open economy and his model is so called balance of payments constrained economic growth model (BPCG).
However, his first generation of BPCG model has many limitations in explaining growth performance in developing countries. As a result, the extended model was later developed by Thirlwall and Hussain (1982), which is also known as the second generation of BPCG model, considering the impacts of foreign capital flows. The Balance of Payment constrained growth model with basic concepts that actual economic growth rate cannot be higher than the estimated rates used by BOP model except for having capability to finance the deficit. Current account would be in deficit if import is larger than export, and thus sources of finance must be sought to meet the need of shortfall by either from borrowing abroad, and/or from net transfer, DFI, i.
via growing of capital inflows. Total income or aggregate demand mentioned above is defined as a function of consumption, 6 123doc investments, government expenditure, and exports. In contrast to the case that all other components of aggregate demand depend on the country total income, export depends on the world total income. Assuming that there is no export and no capital inflow, aggregate demand would be repressed certain elements of aggregate demand because of insufficient foreign currency.
For example, if there is no foreign currency to support for importing modern machinery and equipment which are used for domestic production, it would lead to several issues such as increase in unemployment, or resources underutilization. More easily, if we still have export but rate of growth of imports is higher than exports, capital inflow can initially abate aggregate demand repression in the short term. However, trade deficits, in reality, cannot be financed endlessly by capital inflow and this would lead to aggregate demand will be constrained by BOP. Balance of payment constraint can affect aggregate demand in the short term or long term; or this will slow down economic growth.
In other words, economic growth has to be run in balance of payments constraint. Beside that we cannot deny the role of factors supply and technological progress in economic growth but it is very precious to bear in mind that "in most countries demand constraints tend to bite long before supply constraints are ever reached" (Thirlwall, 2002). Considering the period from 1990 to 2010, Vietnam achieved very high annual economic growth rates, except three years 1998 (5.8%) after Asian financial crisis and 2009 (5.32%) after global financial crisis. This is considered as one of achievements of appropriate “open door” policies by relaxing exchange rate controls, internal and external trade impediments.
As a result, export growth and import growth increase, except for 1996 and few years later when government decided to establish restrictions on import due to alarming current account deficit(1996:-11. Although export growth rate is sometimes higher than import 7 123doc growth rate, but it is still smaller than import growth in absolute values in most of the years in the period of 1990-2010, trade deficit therefore still exists. Furthermore, trade deficit is a chronic issue in Vietnam because of imports-exports structure, as less of competiveness in exporting sector as it mainly comprises of low value-added goods, raw materials and intermediate products. Current account is in deficit as a consequence of deficit in trade balance.
Figure 1: GDP growth 1990-2010 12.00 2001 2006 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2002 2003 2004 2005 2007 2008 2009 Source: World Bank 2010 However, current account deficit does not always affect the balance of payments accordingly because this may be compensated by capital account surplus. Obstinate current account deficit following by capital account surplus, for example, borrow from aboard, FDI, is not sustainable in the long run because one country cannot infinitely borrow abroad to finance current account deficit. Financing the deficit by FDI can help the BOP balance and keep the economic growth in the short term, but in the long term this also makes unsustainable growth as it relies on the external sources. The fluctuation in FDI flow would lead to negative impacts on 8 123doc domestic economy such as uncontrollable production, unemployment rate and therefore economic growth.
Balance of payments problems may happen not only with developing countries but also with developed countries. However, it is often referred to the developing world. The aim of this paper is to re-apply the Thirwall’s law of balance of a payments constraint on economic growth on the Vietnam economy with the new scenario recently by comparing it with potential growth rate by using time series data extending over two decades with the period 1990-2010. Research questions This study is to examine 1.
Whether balance of payments in Vietnam constrained economic growth or not? 2. Which factors behind balance of payments restrict economic growth? 3. What policy implications are for the balance of payments constrained economic growth in Vietnam? 1.3 Structure of Study The thesis includes 5 chapters starting with the introduction in Chapter 1.Chapter 2 subsequently provides literature review for thesis. Next, Chapter 3 provides the overview economic growth and balance of payments of Vietnamese scenario.
Chapter 4 shows the model specifications and the findings. Chapter 5 eventually shows the conclusion and further recommendation. 9 123doc CHAPTER II: LITERATURE REVIEW 2.1 Theories The balance of payments constrained growth model, which was developed by Thirlwall’s (1979), identifies the long run the economic growth rate of open economy constrained by trade balance. By Thrilwall, the growth rate equilibrium can be defined by the ratio of export growth rate and the income elasticity of demand for imports.
This model has been tested not only with a large sample of developing and developed countries around the world but also tested by many different techniques and methods. With the first generation of BPCG, the author ignored international capital flows and interest payments. However, capital flows and interest payments are an important part of the BOP. As a result, Thirlwall and Hussain (1982) developed the extended model from the original model to allow trade deficits and capital inflow.
This model shows that in an open economy the growth rate may be constrained by capital inflows together with trade factors which mean that capital inflows tighten or loosen the balance of payment constrained growth. To improve the capital inflows limitation, BPCG model was redefined by Moreno-Brid (1998, 1999) with the assumption that accumulating foreign debt has sufficient condition. It combines interest payments from imports of goods with non-factor services in the analysis of debt accumulation. In his research, McCombie (1997), the author tested with time series data for many nations in the short run.
He found that balance of payments equilibrium may delay the consistent growth rate with the exports and imports growth rate. For example, if growth rates are higher than the consistent level with the external account equilibrium then the capital inflows will fulfill 10 123doc the debt repayment. However in longer time, balance of payments equilibrium will be consistent with exports and imports growth rate again. Therefore, in the short term, the use of estimation model may be unsuccessful but in the long run the law does hold.
Moreno-Brid (2003) stated that interest payments do not include in the Thirlwall’s law clearly and previous research did not count it in by the traditional way. Lacking of these elements may lead to a shortcoming in analysis of long run growth which many developing countries whose have large debit in net interest payments aboard from the balance of payments. Therefore the author developed the extension of balance of payments constrained growth model which includes the foreign interest payment in to the analysis model. There are many countries and region-specific studies have been introduced since Thirlwall (1979) and in general, the long-run hypothesis has held up reasonably well, especially for developing countries.
Based on that, McCombie (1997) summarized those conclusions from earlier studies.2 Balance of Payments in Supporting and Constraining Growth As the balance of payments account consists of two crucial parts: current account and capital account. Each account also contains some items that impulse and constrain the economic growth in different ways. Although there are many sub-accounts in both current and capital accounts, economists often focus on merchandize account of current account and private foreign investment, debt, official development assistance of capital account, the so-called capital inflow or capital imports in general; otherwise some empirical researches pay much attention to other sub-accounts in balance of payments account such as debt servicing (Brid, 2001), factor income (Ferreira and Canuto, 2003), and remittance (Glytsos, 2002).