Vietnam: The next Asian economic success story
A little history
It would have been impossible, in 1975, to imagine anything but a dismal future for Vietnam. The end of the war left the former French colony in ruins, and the newly unified country now faced more than a decade of grueling domestic and foreign challenges before its revolutionary reforms took hold by 1988. Millions were made homeless, more than a seventh of the population had been killed, and major floods and draughts in the early 1970s dramatically reduced food production in a primarily agrarian economy. Partly due to the institutional effects of French colonialism, the Vietnamese bureaucracy was poorly equipped to orchestrate or attend to the needs of a nation at its infancy. Attempted alliances with Cambodia and Laos soured their relationship with China, while the lingering legacy of the war and the tensions of the Cold War made relations with the US nearly impossible. The 1978 Vietnamese invasion of Cambodia (for the admittedly noble task of toppling the Khmer Rouge) further escalated the conflict with China and other Asian countries, who joined in to support guerilla movements against the Vietnamese occupying forces. Vietnam was abandoned at the coast of the Pacific, surrounded by hostile neighbors and facing economic embargos levied by the United States and Western Europe. Their only supporter was the USSR — too far away and lacking sufficient resources to help. Further, the northern Hanoi government still found it difficult to establish complete control over southern provinces, and couldn’t adapt Ho Chi Minh City (the former French colonial capital of Saigon) to a socialist economy. The final nail in Vietnam’s economic coffin was seemingly the 1985 price-wage-currency adjustment scheme, the failure of which led to a severe economic crisis and an inflation rate of 775% in 1986.
An age of reform
The Doi Moi — a top down economic and institutional reform — designed to create a ‘socialist market economy’ was introduced in 1986. Economic crisis, global isolation, and declining Soviet support forced Vietnam’s hand. They had no choice but to court foreign investment through improved diplomatic relations, to change the government support and spending regime, and to encourage trade and market involvement.
The world was opening up during the fall of the Iron Curtain and the unification of Europe, and companies were on the lookout for cheap manufacturing and industrial centers. In 1987, a new foreign investment law was signed, which enabled capital inflows and soon made Vietnam the largest recipient of FDI flows (10% of GDP) for a country of its size. Various other liberalization measures included decollectivizing agriculture, the ending of fixed price subsidies, and reducing the number and power of State Owned Enterprises. An agrarian economy which had seen a constant decline in its food output since the 1970s, Vietnam became the world’s third largest exporter of rice in 1989. The effect of the reforms — especially on the once-feudal agricultural sector, through the introduction of market incentives and the withdrawal of wasteful and ultimately hurtful government support — is clear.
Vietnam withdrew its troops from Cambodia in 1989, and by 1995 was admitted into the ASEAN group, and had reestablished diplomatic relations with the United States. These diplomatic victories brought with them the end of trade embargos imposed by the US and Western Europe. The resulting inflows of foreign capital made their way into the light manufacturing and crude oil sectors, making Vietnam a hotbed of economic activity. As tourism grew, Vietnam expanded its trade relations with other East Asian countries like South Korea, Singapore, Japan and Taiwan. High growth in consumption, exports and investment contributed to GDP growth rates of 9.5% and 9.3% in 1995 and 1996.
Institutions are difficult to change, and in Vietnam they were buoyed by country’s socialist legacy. The Communist Part of Vietnam (CPV) entrenched as its tenants of economic growth that political stability and gradualism had to be the key to development, and that keeping the country’s doors open was the key to achieving its economic goals. These pillars ensured that Vietnam didn’t make abrupt radical reorientations to its policies, giving the economy time to adapt to new realities. This is a lesson many policy makers don’t appreciate adequately. Gradualism certainly had its blemishes — in the 1990s, unprofitable and ineffective State Owned Enterprises still accounted for a third of GDP and were quicksand to government expenditure. There was still some antagonism to the liberalization measures, which prevented the signing of free trade agreements with the US and delayed Vietnam’s WTO membership. However, it was purportedly Vietnam’s gradualist approach to its globalization that ameliorated the effects of the bloody Asian Financial Crisis of 1997. Vietnam hadn’t yet developed a stock market, and a majority of its banking sector was controlled by the government. The contagion that hit East Asia thus flowed moderately into Vietnam as compared to its Asian peers. Although FDI inflows fell to half their 1996 level and the growth rate reduced to 4.7% as a result of the crisis, Vietnam was less damaged by the crisis than were countries like Thailand, Indonesia and South Korea.
Into the 21st century
Vietnam’s newly formed stock market boomed between 2000 and 2006, its total capitalization moving from 1% to 22% of GDP in those years. With inflation tamed, FDI inflows growing strong, and dramatic improvements in the standard of living, Vietnam boasted some of the strongest macro statistics in the emerging market world. Its admission into the World Trade Organization (WTO) in 2007 provided additional flair to an already booming economy. During the early 2000s, the poverty rate reduced by half to almost 15% in 2006 from close to 30% in 2002; inflation, once in triple digits, was maintained at close to 4.5%; and a large number of SOEs were privatized. Access to sanitation and water are some of Vietnam’s most significant Human Development achievements.
These growth numbers weren’t without their problems, as inflation turned negative for a brief period at the start of the new millennia, and an increasing ‘Incremental Capital to Output Ratio (ICOR)’ indicated Vietnam’s disposition to consume more resources in the achievement of their growth targets as compared to other countries. Problems that seem perennial in emerging markets, such as corruption and inefficiency of public enterprise persist just as strongly in Vietnam. Mismanagement of monetary and fiscal policy, a rising budget deficit, and declining foreign reserves proved to be a drag on the economy in the late 2000s, especially after the Great Recession of 2008–09.
Still, Vietnam has shown the world its resilience by withstanding a crisis brought on by a property bubble in 2011, and by consistently being one of the fastest growing economies in the world since 1990. Sharing a border with China made it easy for Vietnam’s Northern provinces to attract Chinese manufacturing activity looking for frugal alternatives. Foreign firms account for more than 60% of Vietnamese exports, although only 36% of firms are involved in export activity. The World Bank notes that the manufacturing and processing industries account for above 70% of FDI committed in the first half of 2017, and that this is expected to further expand the production base in the medium-term. However, while benefitting from high productive FDI enterprise, participation of domestic private enterprises in global manufacturing remains relatively limited. The service sector grew by close to 7% in the first half of 2017, and will continue to be a large contributor to Vietnamese growth in the medium term. Consumption (through retail sales) and tourism have both shown solid growth over the last few years. Many Vietnamese cities are designed perfectly for tourism. The drive from the Ho Chi Minh City airport to the city’s District 1 (called Saigon by many) is one of the smoothest drives I have ever experienced, and the district itself makes you feel like you’re in a much wealthier country. In fact, most vendors accept the US dollar. Once you reach the outskirts of many cities, the roads are slightly less smooth, and the vendors slightly less urbane, but there is an abundance of consumption and market activity — indicated by two wheeler and retail sales. The country’s increasingly diversified economy is helping it sustain growth at an impressive and largely unnoticed rate.
Vietnam today continues to be one of the fastest growing economies in the world — by September 2017, their GDP growth rate was already at 6.41%, bolstered by growing factories and FDI inflows. With foreign reserves of close to $45 billion, the country is confident in its ability to hold the value of their currency, the dong. Healthy yields of 5.4% on their government bonds indicate confidence in the stability of the Vietnamese economy, and public debt has thus far remained at healthy levels. In July, Vietnam removed the 49% foreign ownership limits on Vinamilk (the country’s largest dairy company), which will hopefully serve as a model for the augmentation of their liberalization. It also sold shares of more than 200 SOEs to combat the growing deficit, a step in the right direction. Having now achieved middle income status, the Vietnamese economic success story continues.
The Vietnamese Central Bank eased its monetary policy in 2017, making rank as one of the only countries to do so this year. This cut went against the recommendations of the IMF, and has raised some concerns about the country’s debt levels. After the speculative property bubble of 2011, the central bank set up an asset management fund in order to manducate all of the country’s bad debt. But the credit growth target of 18% has raised concerns about the country’s NPL ratios, which was as at 3.9% in 2015. The aim of meeting the growth target of 6.7% should not be the only reason to drop down interest rates. The central bank has ensured that there is enough liquidity in the economy to take on lower interest rates, but it is still important to keep an eye on credit performance in Vietnam to ensure that the country is avoiding excesses. The decreasing productivity of credit can be a hurdle to growth, and needs to be watched over. With inflation under control, it can be expected that the lower interest rates will help Vietnam buoy its growth rate and encourage private investment.
As the population starts to age, labor productivity and especially manufacturing productivity cannot continue to drive of growth at the same level as they did in the 1990s. Vietnam has shown enough foresight to adapt. The country acknowledges these challenges in the 2016 Socio-Economic Development Plan (SEDP) — targeting skills development, innovation, better infrastructure, and the improvement of market institutions. By shifting more industries from state control over to private enterprise, Vietnam will likely encourage the development and augmentation of these industries. There are serious challenges to be tackled. Bloomberg reports that despite a 97% literacy rate, less than a third of the Vietnamese workforce had a high school diploma in 2016. The joblessness rate among the young is as high as 17%. As Vietnam’s per capita income rises, manufacturing will look for cheaper destinations, and the country will have to increasingly rely on its service industry. The country has planned on expanding the number and capacity of its schools and universities, and companies are increasingly providing training to new hires. Vietnam has a bad record of labor productivity, lagging behind its neighbors like Singapore and Malaysia. McKinsey Global Institute finds that between 2005 and 2010, an expanding labor pool and the structural shift away from agriculture contributed two-thirds of Vietnam’s GDP growth. The other one-third came from improving productivity within sectors. But the first two drivers are now waning in their power to drive growth and Vietnam needs to boost its labor productivity growth by more than 50%.
Vietnam spends 5.7% of its GDP on Infrastructure, second among Asian countries only to China. Massive investments into sea ports, metro systems, energy plants, and water treatment facilities are still needed. And foreign investors seem to be conspicuously missing from this space. Diversification has been a key integrant of the Vietnamese growth model thus far, and in the coming decades the country will have to perpetuate their economic diversity. Investments in improving infrastructure, education, productivity in agriculture and manufacturing through modern technology, and reduction in SOE dominance will be quintessential in the future of Vietnam. Thus we can see that there’s much left to do.
A model for development
Global economics doesn’t lack sobriquets — BRICS, Asian Tigers, ISBA, and so on. But among countries climbing the development ladder, Vietnam holds a special place. It is a country that has made an incredibly high number of sensible decisions, building an economy on the pillars of gradualism and diversification. Normalizing trade and diplomatic relations with its neighbors and with the west started a growth story that is far from over. State Owned Enterprises remain bloated, productivity remains low, and labor development and infrastructure are still major challenges. Bringing in private investment and ownership are as important for Vietnam as is increased FDI flows and the growth of the service sector. While allowing for credit expansion, Vietnam needs to keep check on its bad loans and NPAs. By claiming a ‘middle income’ classification, Vietnam has gone further up the development ladder than most, and has beaten any and all expectations that observers could have had 30 years ago.
Development is not a single set of policy prescriptions. It is about finding the right balance and understanding what a country needs. Vietnam epitomizes this. Now, by continuing to improve trade relations, by cutting loose off its bloated SOEs and tracking credit, and by tacking its productivity problems, Vietnam can go one step further — and become the next Asian economic success story. The road from here is tougher still, but Vietnam has beaten the odds before.
The citations column:
https://www.britannica.com/place/Vietnam/The-two-Vietnams-1954-65
https://worldview.stratfor.com/article/vietnams-political-economy-transition-1986-2016
http://www3.weforum.org/docs/WEF_Enabling_Trade_2016.pdf
https://www.mckinsey.com/global-themes/asia-pacific/sustaining-growth-in-vietnam
