Foreign direct investment has played a vital role in Viet Nam’s economic growth strategy during the reform period. Foreign investors bring much needed capital, technology, access to international markets and improved management practices to Viet Nam. Local authorities, well aware of the benefits of foreign investment to the local economy, compete with each other to attract investors to their provinces and districts. Competition is always healthy, but the question arises as to whether local authorities understand what investors need. If they do not, they may offer incentives that do not attract investment but that undermine the fiscal position of local and central government.

This UNDP Policy Dialogue Paper addresses the issue of competition for foreign direct investment in Viet Nam. It finds that many provinces offer extra-legal fiscal incentives to attract foreign companies. However, the impact of these incentives on firms’ location decisions is negligible. Firms decide on where to invest on the basis of fundamental factors such as access to land and natural resources, infrastructure, the availability of skilled workers and the quality of local governance. Extra-legal tax incentives reduce government revenues but do not increase foreign investment in fence-breaking provinces.

This finding has important implications for decentralisation policy in Viet Nam. Local authorities resort to extralegal incentives because they lack the ability or capacity to address more fundamental issues such as the development of infrastructure and the quality of education and vocational training. Therefore, the answer to extra-legal incentives lies less in enforcement of the rules than improvements to public investment and education policies at the central and local levels. UNDP Policy Dialogue Papers contribute to key policy debates in Viet Nam through an impartial consideration of the country’s development situation and potential implications for the future. Our aim is to encourage informed discussion and debate through the presentation of information and evidence collected and presented in a clear and objective manner.