An Analysis of Agglomeration E ffects and the Determinants ofLocation Choice of Japanese Manufacturing Firms in Vietnam

ShoHaneda
Graduate School of Economics, Nihon University

Abstract

This paper formally investigates how Supplier Access (SA) and Market Access(MA) affect the location choice byJapanesemanufacturing firms in Vietnam. We
use province level dataset of Vietnam’s 47 provinces.Conditional logit analysis of
the location choice by 117 Japanese manufacturing firms in Vietnam during theperiod 2001-2007 confirms a major impact of SA.The results imply that forward
linkage effect within province isquite important for Japanese firms in Vietnam.
Additionally, itand the trade data imply that there is arelationshipbetween
Japan and Vietnam in international division of labor.

Ⅰ . Introduction

In recent years, international trade is characterized byclose relationshipbetween international trade (both productand service) and international divisionof labor (fragmentation of production process). Thus, the role of firmsis of
growing importance in international trade. In addition,an analysis of firm’s
behavior is essential for understanding recent international trade.
In this situation, an analysis of the determinants of location of firms is one of
the most important issuesfor understanding international division of labor in
East Asia i . In this paper, we use New Economic Geography (NEG) model toanalyze the determinants of location choice of Japanese manufacturing firms in
Vietnamduringtheperiod

2001-2007.

Additionally,

we

use

agglomeration effects as market access (MA) and supplier access (SA).

117

the

term

The paper is organized as follows. In the next section we review some of earlystudies which analyze an important relationship between location choice andagglomeration effects. Section 3 shows FDI trends in Vietnam. Section 4
expounds the model which is used in this paper. Section 5 conducts conditional
logit analysis. Section 6 presents empirical results and Section 7 concludes.

Ⅱ . Early studies

Location choice is one of key issue for multinational firms when they goabroad via FDI. Firms determine the location after considering the regional
characteristics. If regional characteristicsare profitable for firms, they locate
there and vice versa. In fact, Vietnam’s FDI inflows from Japan and othercountries differ between provinces. We consider that an analysis of its FDI fromJapan is notable because we can investigate the determinants of location ofJapanese firms in Vietnam by observing the differences.
New economic theories on location choice of firms emphasize a tension amongproduction costs and access to large final goods market and input suppliers.
There are many early studies which analyze determinants of location choice inthe U.S and Europe.
Head,Ries,Swenson (1995) use data on 751Japanese manufacturing firms
established from 1980 to 1992 in order to estimate the determinants of location
choice. They have shown that Japanese manufacturing firms tend to choice thelocation that Japanese manufacturing firms already locate. In addition, theiranalysisconfirms

theimportantrelationshipbetweenkeiretsu

specific

agglomeration effect and location choice by Japanese firms in automobile
industry.
Urata and Kawai (2000), Belderbos and Carree (2002), and Inui, Matsuura,
Poncet (2008) analyze the relationships among agglomeration, firm heterogeneity,and location decision.
Urata and Kawai (2000) investigate main determinants of location of118

Japanese firms by using the data on its FDI in China. They conclude that bothdemand side and supply side factor, in terms of agglomeration, is important for
theirlocationchoices.

Furthermore,

empirical

results

indicate

that

the

determinants of location are differ between large firms and small andmedium-sized firms.
Belderbos and Carree (2002) conduct an analysis of the determinants ofJapanese manufacturing firms in China during the period 1990-1995. They
classify agglomeration into agglomeration, Japanese firm-agglomeration, andkeiretu-agglomeration in the paper. The results illustrate that both distance fromJapan and local Japanese firm-agglomeration are more important for small andmedium-sized firms than large firms (over 500 employees). Additionally, they
indicate that both local keiretu-agglomeration and infrastructure are importantfor exporting firms and market size is important for local-market-oriented-firms.
Inui, Matsuura, Poncet (2008) investigate the location choice of Japanese firms
by using firm-level micro data. In their paper, they conduct nested logit analysis
the determinants of Japanese firms. The results indicate that agglomeration andspillover between local firms are important factors for Japanese firms. The pointis that important factors differ depending on the firm’s characteristics.
Milner, Reed, Talerngsri (2006), Maeno (2008), and Wakasugi (2008)
investigate the determinants of location of Japanese firms and international
division of labor in East Asia.
Milner,Reed,Talerngsri(2006)

investigate

therelationshipbetweenintra-industry transaction and inter-industry transaction in Thailand. In t heir
analysis, they make a classification of transaction of intermediate productsinto
intra-industry

transaction(intra-industry

linkage)andinter-industry

transaction (inter-industry linkage). They assume that there are two types (1 and
2) of firms operating in industry A in Japan. Type 1 firms are large assemblingfirms, and they use intermediate products partly supplied by type 2 firms. They
assume that each of type 1 and 2 firms produce a differentiated products. They
conclude that many Japanese firms move into Thailand for supply intermediate119

goods to local firms which moved from Japan. Additionally, it implies thatJapanese firms agglomerate in particular regions and form the production
network in the regions.
Maeno (2008) analyze the determinants of location of Japanese firms in
China and the role of FDI in the international fragmentation of production. The
results indicate that market access, firm agglomeration, and infrastructure havepositive effect on location choice of Japanese firms.
Wakasugi (2008) investigate the determinants of Japanese manufacturingfirms in China by using firm-level micro data. The results of conditional logit
analysis

illustratethat agglomeration,

infrastructure, institution, humanresources have positive effect and wage has negative effect on location choiceprobability of Japanese firms in China.
Amiti and Javorcik (2008) and Ijiri (2010) analyze the relationship between
agglomeration effects and location decision of multinational firms.
Amiti and Javorcik (2008) investigate the determinants of location ofmultinational firms in China by using the province level 515 industrial data
during the period 1998-2001. They stress the impacts of agglomeration effects,
supplier access and market access, on location decision of multinational firms in
China. The results indicate that supplier access and market access have positiveeffect on location decision of multinational firms. Additionally, inner provincial
agglomeration effects have more impacts on the location decision of them thaninter provincial agglomeration effects.
Ijiri(2010)

conduct

thecomparative

analysisoflocationchoiceofmultinational firms in China and those in Vietnam by using panel data during
the period 2000-2007. His empirical results illustrate that supplier access,foreign supplier access, and foreign market access have positive effects on thelocation choice of multinational firms in Vietnam.
Nguyan and Nguyan (2007) investigate determinants of location of FDI in
Vietnam by using province level data during the period 1988-2005. Empiricalresults show that local market, quality of labor, and infrastructures have the120

positive effects on the determinants of location of FDI in Vietnam.
Unfortunately, there are a small number of studies which investigate thedeterminants of location of firms in Vietnam. In the next chapter, we review thetrends of Vietnam’s FDI.

Ⅲ . Inward FDI in Vietnam

In this chapter, we outline major trends in Vietnam’s inward FDI.
There is no data that shows the location of foreign firms in Vietnam.
Therefore,

we

use

Kaigaishinshutsukigyousouran that includes locational

information of Japanese firms. In addition, we see the distribution of Japanese
FDI in Vietnam. ii In this paper, we develop conditional logit analysis of thedeterminants of location choice of Japanese manufacturing firms in Vietnam byusing FDI data of Japanese manufacturing firms which was expanding into
Vietnam during the period 2001-2007.

Figure 1

Vietnam’s inward FDI from the world

120000100000
80000
60000
40000
20000
0

Unit: Hundred thousand dollars
Source: World Develop Indicators,World Bank

121

Figure 1 represents the value of inward FDI of Vietnam during the period of
1990-2008. There were two FDI booms in Vietnam in 1996 and 2007. We employ
the data during the period 2001-2007, which remove the influences of Asiancurrency crisis.

Figure2 Vietnam’s inward FDI from Japan
35
30
25
20
15
10
5
0

Unit: Projects
Source: Kaigaishinsyutsukigyousouran2008, Toyokeizaishimposha

Figure 2 depicts the number of Japan’s FDI projects in Vietnam during theperiod of 2001-2007. It shows that inward FDI differ between provinces inVietnam. iii
If we assume that rational choice of firm is to choice the province which canmaximize its profit, we can recognize that the province which attracts more
inward FDI than other provinces has economic characteristics that are important
for the firm’s profits. In the next chapter, we review the model which is used inthis paper.

122

Ⅳ . Theory

1. Production activities of local firms
In this paper, we employ analytical framework of Wakasugi (2008). iv
We suppose that Japanese firms establish local firm in Vietnam and conduct local
production. Production function of local firm is given by

qij = a0 A βj 1 S βj 2 (a j Lij )α1 K ijα 2 Rijγ

(1)

At this time, q ij is defined as production output (quantity of production) of
local firm i in province j where price of goods and inputs is given. Local firms
select optimal combination of inputs: Labor, Lij , capital stock, K ij , technicalknowledge stock, Rij . Then, agglomeration, A j , social capital stock, S j , and qualityof labor, a j , represent the characteristics of province j . Therefore, thesecharacteristics are common for local firms in province j . In addition, β i (i = 1,2) isdefined as effects of the characteristics of province j on the production of local
firms.

We

assumethat β i > 0 ,

which

means

that

productivity

of

local

firmsimproves with increase in agglomeration and social capital. Additionally, we
assume that rent of capital goods is common in all provinces. On the contrary,
wage and quality of labor are different in each province. Furthermore, local firms
do not carry out R&D activities and use Rij which is transferred fromheadquarters to local firms as inputs.

2. Profit maximizationGiven

economiccharacteristics

and

price

of

goods

and

inputs,firm

i determines the quantity of output, technical knowledge stock, and factor input.
Then, profit maximization equation of local firms in province j can be written as

max π ij = pq ij − ( w j Lij + rK ij ) − T ( Rij )Lij , K ij , Rij

s.t . qij = a0 A βj 1 S βj 2 (a j Lij )α1 K ijα 2 Rijγ
123

(2)

At this time, p is price of goods, w j is wage in province j , and r is rent of
capital. By using equation (1), optimal output and maximum profit of firm i inprovince j can be written as

1

γ
ρ
α1

α2
η ⋅γ a
γ 2 2 β1 β 2 1− ρ α1 α 2  j   1 q ij = a 0 A j S j p α 1 α 2h w   r   δ  j 

j 
0 





(3)

1

γ
α1

ρ
α2
2 η ⋅γ


a


γ
1


j
π ij = ρp ρ a 0 A βj 1 S βj 2 α 1α1 α 2α 2       h j 2 
 w j   r  δ 0 


1

(4)

Propositions of this model are as follows.
In this model, if there are differences in economic characteristics amongprovinces in Vietnam, the higher level of agglomeration, social capital stock,
human resources, and the lower level of wage have positive effects on local firm’s
profit. Therefore, the provinces which have the characteristics that can increase
local firm’s profit attract inward FDI.

3. Conditional logit analysis
In this paper, we assume that Japanese firms choose one location from 64
provinces in Vietnam, and that all local firms are identical. Each province has
different characteristics, so profits of local firms depend where local firms locate.
Then, Japanese firms shouldchoose the province that they can achieve profit
maximization. In other words, it would appear that the province which is chosen
by Japanese firms has the characteristics that can generate profits of local firms.
Therefore, estimated profit of local firm can be written as

∧

∧

∧

∧

ln π ij = c 0 + c1 ln A j + c 2 ln S j + c 3 ln(

wj
aj

∧

) + c 4 ln h j + ε ij (5)∧At this point, c i (i = 1,...,5) represent each parameter which is estimated in124this analysis and ε ij is the error term. Estimated profit function is consist of
agglomeration, social capital stock, wage, quality of labor, human resources, h j ,and error term.As is the case with Train (2003), we assume that ε ij complies
with vP (ε ij < x) = exp(− exp(− x))(6)

At this time, according to Mcfadden(1974), the probability that firm i chooses

j province from J provinces can be written as

exp(c0 + c1 ln Aij + c 2 ln S ij + c3 ln(
Pr(Yi = j ) =

wij

α ij

) + c 4 ln hij )
(7)

wij

∑ exp(c + c ln A + c ln S + c ln(α ) + c ln h )
j∈J

0

1

ij

2

ij

3

4

ij

ij

Then, Pr(Yi = j ) representslogit type function which is the probability thatfirm i chooses j province from J provinces. The right-hand side of this equation is
the proportion of the profit of firm i locatedin province j to the profits of the total
profits of firm i located in province other than j .This exponent function represents
the location choice probability that firm i chooses province j. If sign condition of
estimated parameters is positive, the characteristics have positive impacts on thelocation choice probability of them. On the other hand, negative sigh means thatthe characteristics have negative effects on those of them. Then,the location choice probabilities that firm i chooses each province can be
written as likelihood function,J

L = ∏ (Pr( Yi = j )) j
n

j =1

(8)

J

ln L = ∑ n j ln Pr(Yi = j )
j =1

125

(9)

At this time, N =

J

∑n
j =1

j

means that each firm chooses only one province to locate.

Besides, each parameter is estimated by maximum-likelihood method by using
equation (9). vi

Ⅴ . Data and measurement

1. Data(1)Kaigaishinsyutsukigyousouran
Kaigaishinsyutsukigyousouran hasbeen collected by the Toyokeizaishinposha
at the Japanese firm level.

(2)Statistics Office of Vietnam, Statistical Data.
The data coverspopulation, GDP, the number of employees, FDI, andinfrastructure by city.

2. Measurement
Table 1 illustrates the definition of independent variables.

Table-1 Definition of independent variables
126

(1)Agglomeration
Agglomeration is increasing function of profit of local firms. Thus,
agglomeration has positive effects on the location choice probability ofJapanese firms.

Agglomerat ion : Employed population of province j in time t -1

(2) Supplier access
We employ calculation methods of Leamer (1997) and Hariss (1954) tocalculate SA1 and SA5. vii SA1 represents supplier access within the province andSA5 illustrate supplier access to all markets in Vietnam. The increase in both
SA1 and SA5 has positive effects on location choice of Japanese firms. However,SA5 has the diversion effects on inward FDI when transaction cost is too high inthe province.

SA1 =IndstrialOutput jt −1
IndstrialOutputVt −1* Dii−1 , where Dii =

Areai

π

( j ≠ k)IndstrialOutput kt −1nIndstrialOutputVt −1
SA5 = ∑DISTANCE jk
j =1

IndustrialOutput jt −1 : Industrial output of province j in time t -1

IndustrialOutputVt −1 : Industrial output of Vietnam in time t -1
D ii =

Area iπ:

The radius of province j

DISTANCE jk : Distance between province j and k(3) Market Access
The increase in MA1 and MA5 has positive effects on inward FDI. Yet,
MA5 has diversion effect on it when the cost of access to local market is toohigh in the province.

127MA1 = (Income jt −1
IncomeVt −1+

RETAILSALE jt −1
RETAILSALEVt −1) * Dii−1 , where Dii =

Areai

π

( j ≠ k)Incomekt −1 RETAILSALE kt −1+)
IncomeVt −1 RETAILSALEVt −1
MA5 = ∑DISTANCE jk
j =1
n

(

Income jt −1 : Average income per employee of province j in time t -1

IncomeVt −1 : Average income per employee of Vietnam in time t -1
RETAILSALE jt −1 : Retail sales of province j in time t -1

RETAILSALEVt −1 : Retail sales of Vietnam in time t -1

(4) Social capital stock
The increase in volume of freight of province j means that infrastructure isdeveloped in province j . Therefore, the increase in social capital stock attracts
inward FDI.

Volue _ Freight : Volume of freight of province j in time t -1

(5) Wage
There is s strong relationship between profit maximization of firms and wage.
Therefore, the decrease in wage rate is positive effects on inward FDI.

Wage : Average income per employee of province j in time t -1

(6) Human resources
Human resource is increasing function of profit of local firms in this paper.
Hence, the increase in human resource has positive impacts on location choice byJapanese firms.

Slila : The number of students in universities and colleges of province j in time t -1

128

As is case with early studies, we use each data with time lag. viii We can remove
the problem of simultaneity by using this approach. ix

Ⅵ . Empiricalresults

In this analysis, if sigh condition of estimated parameter is positive, itbolsters profit of firms.Thus the characteristics has positive effects on theprobabilities of location choice of them while negative sigh imply that thecharacteristics has negative effects on those of them. Table 2 illustrates theempirical results of conditional logit analysis.

Table-2

Empirical results

We summarize the findings of this analysis.
There are four findings in the results. First, agglomeration has positive or
negative effects on location choice by Japanese firms, which means that results

129are mixed. Second, SA1 has significant and positive effects while SA5 hassignificant and negative effects on inward FDI. Third, social capital stock andhuman resource have significant and positive effects on location choice of them.
Finally, wage has significant and negative effects on those of them.

Ⅶ . Conclusion

In this paper, we investigate the relationship between agglomeration effects
and the determinants of location of Japanese manufacturing firms in Vietnam.
We conduct conditional logit analysis by using locational data of Japanese firms
during the period 2001-2007.
The results indicate that SA1, MA5, infrastructure, and human resource
have positive effects and that wage has negative effects on the location choice ofJapanese firms in Vietnam. However,the impacts of agglomeration effects on thelocation choice of them are still mixed.
SA1 has positive effects on location choice of Japanese manufacturing firms
while SA5 has negative effects on location choice of them. That is to say, access to
suppliers of parts and components within a province is important for Japanesemanufacturing firms when they determine the location in Vietnam.This implies
that there is the relationship between Japan and Vietnam in international
division of labor. In addition, parts and components goods trade between Japan
and Vietnam has grown during the period 1990-2007. x The fact also supports theearly studies of international division of labor in East Asia.
MA1 has negative effects on location choice of Japanese manufacturing firms
while MA5 has positive effects on them.This mean access to all market issignificant for location decision of them in Vietnam.Fukunaga (2010) indicates
thatJapanese

firms

have

shiftedthepurpose

of

FDI

from

producing

manufacturing products locally to sellingthose to local markets in Vietnam.
However, Vietnam’s GDP per capita is $2,520 while that of Japan is $34,760 in2007. Therefore, we recognize that the number of market oriented FDI by

130

Japanese firms is still small.
We have four problems which should be improved in the next analysis. First,
we need the comparison between Vietnam and other countries, especially China.
Second, calculation methods of agglomerationand agglomeration effects need to
be improved. This is because Japanese firm-agglomeration has positive effects on
the location decision of Japanese firms. We do not classify the agglomeration into
local firm-agglomeration and Japanese firm-agglomeration. Third, it is better toincorporate the idea of Economic Development Area into this analysis. Wakasugi(2008) includes this idea into the model which is used in his paper. Finally, it isimportant for this paper to investigate trade structures in detail for theunderstanding of relationship between Japan and Vietnam in international
division of labor.

References
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Base to Consumer Market,” MUFJ Economic Review,・ Harris. C（ 1954） , “The Market as a Factor in the Localization of Industry in the UnitedStates,” Annals of Association of American Geographers, Vol. 44, No. 4,pp.315-348.
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Appendix A

Vietnam’s map

132

Appendix B

Intermediate and final goods trade (HS96, BEC)

Unit: Hundred thousand dollars
Source: UN Comtrade , HS96

i We assume that East Asia consist of ASEAN10, Japan, Korea, and China.
i i AppendixA illustrates Vietnam’s map.
i i i Ha Noi（ 27.8%） ,Hai Phong(13.9%),Binh Duong(11.3%),Ho Chi Minh（ 9.5％ ） ,Bac Ninh

（ 7.8%） .
i v See Wakasugi(2008) pp.61-65.
v Train (2003) pp.36-50.
v i Equation (9) is log of equation (8).
v i i As is case with Leamer (1997), we assume that each province is circular.
v i i i We employ 1 year time lag method.
i x Wakasugi(2008) p.69.
x See AppendixB.

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