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Balance of payments constrained growth model the case of vietnam, 1995 2010

UNIVERSITY OF ECONOMICS
HO CHI MINH CITY
VIETNAM

INSTITUTE OF SOCIAL STUDIES
THE HAGUE
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


Table of Contents
CHAPTER I: INTRODUCTION ................................................................................................ 6
1.1.

Problem statement ............................................................................................................. 6

1.2.

Research questions ............................................................................................................. 9

1.3

Structure of Study .............................................................................................................. 9

CHAPTER II: LITERATURE REVIEW ................................................................................ 10
2.1

Theories ............................................................................................................................. 10

2.2

Balance of Payments in Supporting and Constraining Growth .................................. 11

2.3

Conceptual framework for the study ............................................................................. 15

2.4

Empirical studies .............................................................................................................. 19

CHAPTER III: ECONOMIC GROWTH AND BALANCE OF PAYMENT OF VIETNAM
....................................................................................................................................................... 22
3.1



Vietnam Economic Growth Overview ........................................................................... 22

3.2

Balance of Payment of Vietnam...................................................................................... 24

3.2.1

Current account............................................................................................................ 24

3.2.2

Capital Account ............................................................................................................ 30

CHAPTER IV: MODEL SPECIFICATION AND FINDING ............................................... 35
4.1

Model Specification and Data ......................................................................................... 35

4.2

Regression results and findings ...................................................................................... 36

4.3

Thirwall’s law in Vietnam ............................................................................................... 38

CHAPTER V: CONCLUSION AND RECOMENDATION .................................................. 41
4.1

Conclusion ........................................................................................................................ 41

4.2

Recommendation.............................................................................................................. 42

4.3

Limitation ......................................................................................................................... 44

APPENDIXES ............................................................................................................................. 45
References .................................................................................................................................... 54

2


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


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


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


CHAPTER I: INTRODUCTION
1.1.

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.e. via growing of capital inflows. Total
income or aggregate demand mentioned above is defined as a function of consumption,

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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%), 1999 (4.8%) 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:-11.5% of GDP). Although export growth rate is sometimes higher than import

7


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
10.00
8.00

6.00
4.00
2.00
2010

2009

2008

2007

2006

2005

2004

2003

2002

2001

2000

1999

1998

1997

1996

1995

1994

1993

1992

1991

1990

0.00

Source: World Bank
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

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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.
1.2.

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


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

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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.

2.2 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). Despite this, in this sub-section, it
is necessary to stress on two significant factors: trade balance and capital inflow.

11


Role of balance of payments in economic growth is considered differently across different
thought of school. If post-Keynesian economists approach theory of economic growth from
demand side and emphasize role of the balance of payments in economic growth, economists
belonging to other thought of school, such as classical, neo-classical, and endogenous growth
economists, may ignore role of demand side in economic growth when approaching from supply
side. These economists encourage free competition and trade and of course they could not avoid
critics of post-Keynesian economists.
Before stepping into post-Keynesian theory in showing the importance of balance of
payments in fostering or constraining economic growth in more detailed, it is significant to point
out disadvantages of free-trade doctrine from development because economists supporting free
trade omitted aspects of balance-of-payments account in economic growth. Firstly, the balanceof-payments effects of free trade and the effect of free trade on the terms of trade are ignored.
Free trade, the terms of trade, and the balance-of-payments must be put in the box and
investigated together. "Free-traders" convince audiences by giving its advantages but what
happens if the deterioration of terms of trade exceeds the gains from trade that will impact
negatively on balance of payments and this in turn affects passively the economic growth. This is
question without free-traders' answer. Secondly, some activities are subject to increasing returns
and others are subject to diminishing returns. Developing countries, if basing on comparative
advantage theory, will specialize in producing labor-intensive goods that are considered as
having diminishing returns because developing countries are labor-abandon ones. Developed
countries otherwise specialize in producing and export manufactured goods that used capitalintensive technologies and have increasing returns because developed countriesare capitalabandon ones. If this being so, developing countries will face with Engel's law and developed

12


countries have economies of scale, then deterioration of terms of trade may destroy the balance
of payments of developing countries that will in turn constrain economic growth in less
developed countries. Thirdly, the comparative advantage theory appeals to countries for
specialization could lead to narrow excessively range of products and put economy into severe
balance-of-payments instability that can demolish development. Fourthly, comparative
advantage may vary over time by government policies and intra-industrial trade still takes place
due to differences in consumer's tastes, technologies.
Furthermore, comparative advantage theory bases on private cost, what happens if social
costs exceed private costs because of externalities of industrial projects that usually occur in
developing countries. This is an argument for protecting industry other than free trade. Lastly,
but not least, export growth of primary commodities has little secondary impact on other
activities. Conversely, expansion of manufactured goods strongly affects other activities through
backward or forward linkages. Comparative advantage is keystone for free trade supporters.
Although disadvantages of free trade for development can appear, it is hard to say that trade
liberalization should be stopped despite any arguments, trade liberalization is necessary for
economic growth but the questions now are that when free trade are and how sequencing of trade
liberalization are.
Classical, neoclassical, and new endogenous growth economists focus on trade and growth
through supply side, post-Keynesian economists otherwise emphasize demand side of economic
growth, the importance of current account deficits and financial aspects in capital accounts.
Findlay (1984, p. 215) pointed out that "…Balance of Payments situation tended to be a critical
constraint on the rate of growth". Keynes (1936) criticized classical economists, especially Say's
law, by believing that supply creates demand. Keynes considered economic growth is caused by

13


aggregate demand including consumption, investment, government expenditure, and net export.
Change of one of these elements will bring about variation of economic growth through
multiplier such as government-purchases multiplier, investment multiplier. In Keynes's point of
view, components of aggregate demand play equal roles in affecting economic growth. Other
economists consider different importance of each component in contributing to economic
growth. Thirlwall (2002) stressed on exports in aggregate demand by three important respects
that export can promote other components of aggregate demand and economic growth. Firstly,
exports are only true component emanating from outside the economic system meanwhile others
depend on the growth of income.
Secondly, exports impact not only directly on demand but also indirectly through its
influence on other components in aggregate demand. Imports can be financed by exports and
consumption, investment also are partly funded by exports. Thirdly, certain intermediary goods
that are indispensable for development but expensive to produce domestically can be permitted
by exports. This argument lies in the supply-side. Current account deficit often accompanied
with trade balance deficit because trade balance status plays the most crucial role in examining
status of current account. Foreign exchange gap can be only financed by surplus in capital
account that comes from foreign debt, foreign direct investment. However, the gap cannot be
unceasingly financed by foreign debt when debt indicator reaches certain warning level and
investor begins feeling anxiously. Then the foreign exchange gap cannot be filled by capital
inflow from capital account and balance of payments will constrain growth due to lacking
minimum amount of foreign currencies for investing (or purchasing) on necessary inputs for
production to attain targeted economic growth. All analyses here assume that domestic and
foreign resources cannot be substituted easily without costly and the less developed countries

14


usually suffer transfer problem that consists of the budgetary problem and the 'pure' transfer
problem (Thirlwall, 1994).
The role of balance of payments in speeding up and constrain growth has just been seen.
Following subsection will in turn show models that state nexus of balance-of-payments
constraint and economic growth as introduced. We begin from dual-gap model.
2.3

Conceptual framework for the study
Thirwall’s model identifies that the foreign multiplier determines economic growth in

long run. Based on Neoclassical approach, the supply factors and productivity are different
therefore the growth rate varies from country to country. In addition, based on the Harrod foreign
trade multiplier, Thirwall’s law shows that economic growth is determined by demand factors in
open economy which are presented as the balance of payments as Thirwall (1979),
Thirwall&Hussain (1982),McCombie&Thirwall (1994).

For the case that developing countries that face problems with trade deficit, Thirlwall and
Hussain(1982) developed the “Extended Model” with initial equilibrium condition. Furthermore,
Elliot and Rhodd (1999) highlighted the value of debt servicing in equilibrium condition. In
addition, other economists can modify the initial equilibrium condition by putting forward the
significance of certain factors in balance-of-payments account such as capital flows, interest
payments or debt (Brid, 2001), interest, dividends, and observed profits of current account of
balance of payments (Ferreira and Canuto, 2003) in accordance with countries. For the
noteworthiness of remittance in filling the deficit in trade balance faced by many developing
countries, especially in Vietnam, it is vital to add remittance to equation due to the fact that it is
one of the notable elements to fill in the trade deficit.

15


However, depending on the specific characteristics of each country, the balance of
payments would vary and balance of payments constrained on economic growth is therefore
different as well. This explains the existence of various forms of model based on those
conditions above
We have equilibrium in accounting form is represented as:
Pd X = Pf M E

(1)

Pd X + F = Pf M E

(2)

Pd X + R = Pf M E

(3)

Pd X + F = Pf M E + D

(4)

P is the exports price. P is the imports price. X is the volume of exports of goods and
d

f

services. M is the volume of imports of goods and services. E is the exchange rate measured as
the domestic price of foreign currency. F is the value of nominal net capital inflows. F > 0
expresses capital inflow, F < 0 expresses capital outflow. R is value of remittance. D is debt
service.
Taking log and derivative of both sides of above equations, we have:

pd + x = pf + m + e

(5)

θ(pd + x) + (1- θ)f = pf + m + e

(6)

ω(pd + x) + (1- ω)r = pf + m + e

(7)

θ(pd + x) + (1- θ)f =p( pf + m + e)+ (1-p)d

(8)

With lower case letters are rates of growth of variables
θ and (1-θ) are the shares of exports and capital flows. ω and (1- ω) are the shares of
exports and remittance. ρ and

(1- ρ) are the shares of imports and debt service on total

expenditure.
On the other hand, we have the normal multiplicative import and export demand
functions with constant elasticity:

16


M = a[Pf E/Pd] ψ Y π

(9)

X= b[Pd / Pf E] η Z ε

(10)

Where, a and b are constants, ψ is the price elasticity of demand for imports (ψ < 0), η is
the price elasticity of demand for exports (η> 0), Y is the domestic income, Z is the level of
world income, π is the income elasticity of demand for imports, ε is the income elasticity of
demand for exports.
Taking log and derivative of the above two equations we have imports and export
demand functions:

m = ψ (pf + e - pd) + πy Imports demand function

(11)

x = η (pd - e - pf) + εz

(12)

Exports demand function

Substituting (11) and (12) into (5), (6), (7) and (8), we have (13), (14),(15) and (16)

y = [(1+ η+ ψ)(pd - e - pf) + εz]/ π

(13)

y =[θεz+ (1- θ)f + θpd - e – pf +(θη+ ψ)( pd - e – pf)]/ π

(14)

y =[ ωεz+ (1- ω)r + ωpd - e – pf +( ωη+ ψ)( pd - e – pf)]/ π

(15)

y =[θεz+ (1- θ)f + θpd - (1-p)d - pe – ppf +(θη+ pψ)( pd - e – pf)]/ pπ

(16)

With assumption that the Marshall-Lerner condition hold, or considering that the relative
prices are constant (pd - e - pf) =0; we obtain:
ybasic = x/π
yext= [θx + (1- θ)(f- pd)]/ π

(17)
(18)

yremit= [ωx + (1- ω)(r- pd)]/ π

(19)

ydebt = [θx + (1- θ)(f- pd)-(1-p)(d- pd)]/ pπ

(20)

Where ybasic, yext, yremit, ydebt represents the income growth rate consistent with BOP equilibrium.
Finally, we can have with four forms of the balance-of-payments constrained economic
growth models under different conditions.
According to McCombie and Thirlwall (1994), the standard Thirlwall's growth law
explains why developing countries have economic growth rate lower than of developed countries

17


and not convergence as predicted by classical economists. Different growth rate can be explained
by different of growth rates of export and income elasticity of demand for imports. Growth rate
of exports depends on income elasticity of demand for exports and world income (1994, 1997).
However, it is essential to note that each country has its own specific economic condition,
therefore other modified models are also applied to adapt to these characteristics.
In developing countries, primary products for export are usually labor intensive products,
elasticity of demand of primary products with price and income is low and inelastic; however
their production activities of primary goods are facing with diminishing returns of scale and
diminishing marginal product of factors of production. It results in the deterioration of exporting
activities in developing countries. Otherwise, the other factors which determine growth is income
elasticity of demand for imports are usually considerably high. Developing countries usually
import capital intensive products and intermediate inputs of production in supporting growth
from developed countries therefore this will result in simultaneous increase in the demand for
imports by more than one percent if rate of growth increases by one percent. Combining both
low export rate of growth and high income elasticity of demand for imports bring about low
growth rate in developing countries compared with that in developed countries.
Export-led growth alone can lead to balance of payments constraints in the long run if
income elasticity of imports is high enough to offset increase in exports. Thus the postKeynesian tradition not only put forward the importance of exports but also the importance of
income elasticity of demand for imports. From this point, post-Keynesian and structuralism
traditionally support structural adjustment to avoid much external dependence that needs
government's policies for establishing trade barriers to protect domestic industries which have
positive externalities on other economic-social activities and have social costs exceeding private

18


costs,as well as stimulate demand for economic growth. However they should pay more attention
on balance of payments constraints which can constraint economic growth.

2.4

Empirical studies
Currently, there are many empirical researches relating to balance of payments together

with economic growth such as Jayme Jr (2003), Parikh. A. (2004), Lopez (2003), Modud.J.K
(2000), Moreno-Brid (2001), Bajo-Rubio. (2010), ect.
Jayme Jr (2003) uses balance of payments constrained economic growth model to
examine the interaction between balance of payments constraint and economic growth in Brazil
by using Thirlwall's original model to find out if predict growth rate from the model is a good
indicator for actual growth rate although he applies models including capital flow and taking into
account the influence of external debt accumulation in initial equilibrium conditions to enhance
precise predictability. He estimates the long run elasticity of demand for imports by using the
Autoregressive Distributed Lag or ARDL technique for fourteen sub periods from 1973-1999
periods, so called as rolling regression through different overlapping periods. The finding
provided a significant improvement in income elasticity of demand for imports in this context.
Following this, the author concluded that the slowdown of Brazil's economic growth because of
an increase in the long run of income elasticity of imports that has not been filled up by
expansion of exports. In the particular case of Brazil, economic growth is constrained by the
balance of payments. Otherwise, economic growth affects positively exports.
Jorgen and Virmantas (2004), examined economic growth in the three Baltic countries
(Estonia, Latvia, and Lithuania) using balance of payment constrained growth model. In the
research, the author utilized the extended model with capital inflow and quarterly date from 1995
- 2003 due to limited data from these Baltic countries. Economic growth rates are consistent with

19


balance of payment equilibrium and consistent with the growth rate of capital imports. The
results show that the Baltic countries that economic growth is constrained by the balance of
payments position.
Pham (2006) uses several models that relate to Thirlwall's law to investigate whether
growth rate of Vietnam is constrained by balance of payments with the data from 19902004.Instead of approaching directly the question, author raised an issue of how these models
can fit for precise prediction purpose of actual growth in case of Vietnam with several models
which include (1) simple rule that is Thirlwall's growth law only; (2) extended model by
assuming that the country incurs original trade deficit and is filled by capital inflow in capital
account; (3) the financial simple rule that encompasses the values of nominal revenues and
expenditures, in domestic currency, of invisible services related to production factors. Although
Elliot and Rhodd (1999) introduced debt servicing in the initial equilibrium condition to show its
role as one constraint of economic growth, they did not consider the case that ratios could be
changed according to modifications in international investors' expectation, so ratio of current
account deficit and income can be high if investors are optimistic about economy performance,
otherwise in case of overcast economy performance. However, Pham still applied all models to
estimate predicted growth rate. After estimation, the author found that balance-of-payments also
play role as limitation on Vietnam economic growth although deficit in trade and current account
were partly relieved by external inflow of capital such as foreign direct investment, official
development assistance and debt.
Ferreira and Canuto (2003) using ARDL model with the data from 1949 to 1999 of Brazil
to prove the balance of payments constrained growth. 1.05 of income elasticity of demand for
imports and it is similar with Lopez and Cruz’s (2000). Their function was not significance
during the 1980s by using rolling regression. By using extended balance of payments model that

20


is allow capital inflows to estimate the growth rate using ARDL and have the coefficient of 0.40
with the actual growth rate. With these findings they state that simple rule and financial simple
rule at least partially good tools for prediction of actual growth rate. The actual average income
growth rate of Brazil was 5.14% per year while they were 6.18% and 5.23% per year in case of
estimating by using simple rule and financial simple rule, respectively.
Bajo-Rubio (2010) analyzed the case of if trade balance could constrain Spain economic
growth in relation with Western Europe in the period 1850-2000. He uses Phillips and Hansen
(1990) method to estimate the elasticity of exports and imports which can avoid the biases
arising when estimating by OLS with using computing a class of Wald tests. At the end, the
author use a simple approach to calculate calculating the relative income elasticity of the
demands for exports and imports, comparing them with the relative GDP growth rates of Spain
together with the EU and then finding the balance of payments constrained growth rate.
In short, we have just examined balance of payments constraints model and economic
growth in theoretical framework, the relationship of balance of payments and economic growth,
together with empirical studies. In particular, we indicate basic concepts of balance of payments
and economic growth as well as role of balance of payments in fostering and constraining
growth. Moreover, the balance-of-payments constrained economic growth model has been
considered meticulously. In this chapter, empirical review of some studies has also been
indicated to manifest importance of balance-of-payments in economic growth. As mentioned
above, many empirical studies related to balance of payment constraints growth around the
world, showing the evidence that Balance of Payments constrained growth rate of many nations
especially in the case of developing countries. Now, it is time to have a look the economic
growth and balance of payments in case of Vietnam during the 1995-2010 periods which will be
presented in the next chapter.

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CHAPTER III: ECONOMIC GROWTH AND BALANCE OF PAYMENT
OF VIETNAM
3.1

Vietnam Economic Growth Overview
After 1975, Vietnam applied the central planning economy with mainly agricultural

economy. The government controlled and managed means of production as physical input,
output, and prices. Government established trade barriers, especially in foreign trade and set dual
foreign exchange rate as well as interest rate. As a result, there were a very high inflation and
low economic growth.
In December 1986, the economic reform known as “Doi moi” was introduced; the
movement from the central planning economy to market oriented. It improved the economy by
using strategy as market tools in order to get better economic performance by setting incentives.
Before economic reform, Vietnamese economy was struggle with stagnation, triple digit inflation
which was caused by many economic problems was created by the system. The size of state
owned enterprise was reduced by government commitment. With the “Doi moi” policy,
Vietnamese economic system as a whole performance was very impressive in the 1990s. The
economy was shifted toward international trade to make FDI and capital inflows increased
rapidly.
While the 1997 Asian economic crisis negatively affected the Vietnamese economy, the
Vietnamese economy was less inflicted to this crisis than many other countries in South East
Asia that is the result of Vietnam did not have internationally traded currency and a stock market
at that time. Also, Vietnam used to dollarize economy therefore it make currency more stability
during the Asian economic crisis. Asian financial crisis starting from Thailand and quickly
spread out the negative effects over other Asian countries as Indonesia, Malaysia, and Korea in

22


1997. Even though the financial crisis did not impact directly on Vietnam's economy, it did have
indirectly considerable influences on Vietnam's economy and stopped high economic growth in
previous years. Rate of growth was reduced unexpectedly to 5.76% in 1998 and was kept low
growth rate in next years from 1998 to 2001. Inflation rates in the period after Asian financial
crisis were dramatically low (disinflation rate) even minus in 2000 (deflation rate, just -0.6%).
This information was show that it was a symbol of stagnation (low rates of inflation and growth).
In this period, Vietnam effectively became a member of APEC in 1998 and signed the Bilateral
Trade Agreement with the USA in 2000. Also in the period, Vietnam was actively preparing
groundwork for WTO accession.
Vietnam also was hardly impacted on global dot com crisis mainly in high technological
sector because our products were basic manufacturing with high labor intensive and using low
end technology scale for instance footwear and apparel. In 2001 US approved the bilateral trade
bill with Vietnam it help Vietnam export to US market which is the largest market in the world.
After Asian financial crisis, economic growth was partly restored and inflation rate
soared up to higher level (4% in 2002, 3% in 2003, and even 9.5% in 2004).However, as old
difficulties pass, new difficulties come. Although Asian financial crisis becomes a good lesson
for Vietnam in coming years, but Vietnam was forced to reform its financial institutions and
economy under pressure of international competitiveness when Vietnam's economy wants to
integrate into global economy with general laws and obtains high growth as well as stabilization.
Between 2001 and 2007 GDP growth was 7.5% on average, reaching 8.5% in 2007.
Growth was increasingly driven by the private sector with 59 000 new enterprises being
registered in 2007, which is an increase of 26% when compared to the previous year.
Additionally, poverty rates now dropped to less than 20%, down from almost 60% in the early
1990s. In January 2001, Vietnam becomes the 150th member of WTO. To achieve the

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requirements of WTO membership, Vietnam have to revise almost trading and investing laws as
well as to improve the business environment. As a consequence, not only foreign investors but
also Vietnamese people would benefit from the improved legislation and lower trade barriers.
Beside that local firm enjoyed a range of protections in the world market; however it will face
increasing competition from both inside and outside the country.
From 2004 to 2007, economic growth rate was over 8 per cent annually before the global
financial crisis in 2008, which started in the US and spread out to the world which also has a
negative impact on Vietnamese economy. (Due to the fact that the more Vietnam economy
integrated into the world economy, the more affected by the up and down in the world economy)
As a result, the growth suffered and GDP declines in 2008 (6.2%) and 2009 (5.3%) and in 2010
(6.7%). Another impact of the financial crisis was high inflation in 2006 (6%), 2007 (12%), 2008
(23%).
In 2010, Vietnam made its way out of the group of poor countries and became the midincome country for the domestic resources as a result of increase in development and dramatic
expansion of international trade and foreign direct investment in the past two decades. Vietnam
aims to establish steady foundation to become a modern, industrialized country by 2020.

3.2 Balance of Payment of Vietnam
In the balance of payments, there are two main accounts: current account and capital account.
3.2.1 Current account
The current account is one of the two main elements of BOP. Vietnam Current Account is in
surplus with 0.20% of GDP in 2011. Retrospectively speaking, from 1990 until 2010, Vietnam
Current Account to GDP averaged -3.15 with the highest percentage is 4.10% in December of

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1999 and the lowest of all time is -11.88% in December of 2008. The Current account balance as
a percent of GDP is an indicator to show the international competitiveness of a country
Figure 2: Current account balance (% of GDP)
6.00
4.00
2.00
0.00
-2.00 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
-4.00
-6.00
-8.00
-10.00
-12.00
-14.00

Source: World Bank
Normally, if a country has current account surplus, it will has an economy depends on
exports with high saving rate but weak domestic demand. However, Vietnam has current account
deficit which means that Vietnam has strong imports, weak saving rate with high consumption
rate as percentage of disposable. A clearer picture will be shown in the next step when we look at
trade balance together with imports-exports; net transfer and net income from abroad which
belong to current account.

3.2.1.1 Trade Balance
Trade balance is the most important part in current account. Trade balance is in deficit or
surplus often make current account simultaneously. Trade balance tells us what is happening in
current account. This can be shown in following figure 3 as we can see that the trend of trade
balance and current account balance almost the same.

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