In the race to attract investment, some provinces and cities in Vietnam have provided investors with the most attractive incentives. But according to Dr Vu Thanh Tu Anh, that’s no winning strategy.

In an article in the Saigon Times, Dr Tu Anh, lecturer in the Fulbright Economic Teaching Programme, emphasised that competition among provinces and cities in investment incentives is a race to the bottom. The greatest danger in this race is losing the interest of society with not much to show for it.

Following is a reprint of the article.

Contrary selection

As competition for investment becomes fierce among provinces, one province breaking regulations on investment incentives will lead to the others following suit, as has happened with 33 provinces and cities. Yet offering incentives in tariffs, land lease charges, etc. is still not enough for them.

Let’s ask a serious investor what he or she researches before investing in a place? We naturally think of investment incentives at first but the investor also knows that incentives are only temporary while conditions to turn opportunities into profit (including institutional environment, transparency, reliability of local authorities) are the most important in the end. A serious investor will invest in a place if they have opportunities and a good investment environment even when they don’t receive special incentives.

Moreover, one thing that provinces, especially industrial zones and open economic zones, often don’t pay attention to when trying to attract investment is that overdoing it can lead to “contrary selection”, where they no longer attract large, serious investors but only ineffective investors who lean on incentives just to exist and earn a small profit. They could not survive without preferences because they lack competitiveness.

This “contrary selection” also brings about a latent threat: potential investors often pay attention to companies that are located in the place where they plan to invest in. A group reputed in the world may hesitate investing in a province (an industrial zone, an economic zone) that doesn’t have other reputed companies, but only small investors who come there for special incentives.

For investment promotion, the most effective and reliable advertiser is other investors in that province.

Still, the above-mentioned points are not the biggest dangers in the “race to the bottom”. The greater danger lies in the fact that incentives are still no guarantee that a province will attract more investment yet may lose the interest of the society.

Why? The answer can be found when we analyse a typical example in the theory of games.

Suppose two provinces, A and B, are trying to attract investment and each of them has only two options: observing the regulations on investment incentives or breaking the regulations.

Province A sees that if they go ahead in increasing investment incentives while other provinces still obey the common rules they can attract more investment, including investment that ought to have come to other provinces. The problem is Province B can think the same thing.

Analyzing the situation of the two provinces under the theory of the game, we can see that when the two provinces cooperate with each other (meaning that they observe the common rules), each province will earn the same thing. When Province A breaks the rules but Province B follows them, Province A can attract more investment while investment in Province B may drop. A similar thing will happen when Province B breaks the rules while Province A still obeys the common incentive framework.

When both provinces break the rules, the interest of each province is the same, but any preference still has its cost so the interest for each province is only 1, instead of 3 if the two provinces cooperate.

Thus, as the two provinces cooperate and obey the common incentive framework, they would benefit while the common interest of the two provinces is maximised (3 + 3 = 6), and the economy will benefit as well. If each province only cares for its partial interest, they will break the rules, with the result a race to the bottom with each province and the whole society suffering losses.

The State should step in

The role of the State is very important. If the common incentive framework really benefits the whole society, the State must have strict and clear sanctions to ensure that provinces that break the rules will be punished. Yet sanctions tend to be ineffective and are often disregarded.

As provinces break the rules, apart from having necessary sanctions, it is necessary to research the reasons why provincial officials act the way they do, which would lead to the question: does the problem originate with the rule breaker or from the rules?

Looking at this issue from another angle, breaking rules has its positive aspects. Besides requiring the state to reconsider its regulations, provincial defiance can be seen as an expression of the need to have a wider space to bring into play their initiatives on policy.

Source: TBKTSG