Vietnam has aspirations and opportunities up to 2035 (continued series Part III)
In the third and last part of our series on Vietnam, TextileFuture presents the countries aspirations and the resulting opportunities up to 2035. Of course, there is no guarantee that the projections will become reality over 20 years, but at least there are concrete indications of what is planned, allowing our readers to do their own projections in view to their business relationship with Vietnam. In addition, we add some actual sectorial developments of Vietnam’s textile and clothing industry. This is a large volume of food for thought, but TextileFuture is convinced that it is of value to its readers
What is in the pipeline
By 2035, 60 years after reunification, Vietnam aspires to become a modern, industrialized economy—next in a succession of East Asian economies to have made the transformative journey to upper-middle or high-income status. The many achievements since the launch of the Đổi Mới reforms have certainly contributed to the ambitious goals. The strong record of regional peers such as the Republic of Korea, Singapore, Malaysia, China, and Tai- wan, China—together with the fear of being permanently left behind in the region—has further fuelled Vietnam’s ambitions. There is still an inherent de- sire to “catch up” with the world and the modern institutional norms of OECD countries for living standards, the rule of law, and creativity, as reflected in the broad aspirations for 2035 (box O.2). Vietnam has also signed up to the UN’s Sustainable Development Goals (SDGs), which set a comprehensive global development agenda for the next 15 years and will give more concrete shape to some of Vietnam’s key long-term goals.
The Ninth Party Congress adopted the phrase “socialist-oriented market economy” as the official way to describe Vietnam’s economic system in April 2001, codified in the 2013 revision of the constitution. The 2011– 2020 Socio-Economic Development Strategy set forth the objective “to become a basic industrialized country with the foundation of a modern and industrial country by 2020.”
Despite broad acceptance, the precise definition of the term “modern and industrial” economy has not been announced. While any definition would be arbitrary, this report sets forth five specific quantitative criteria for meeting that objective:
• A GDP per capita of at least USD 18,000 (in 2011 PPP), roughly equivalent to Malaysia in 2010.
• A majority (over 50 %) of the Vietnamese population living in urban areas.
• A share of industry and services in GDP at more than 90 % and in employment at more than 70 %.
• A private-sector share in GDP of at least 80 %.
• A score of at least 0.70 on the UN’s Human Development Index.
How well is Vietnam positioned to become a modern, industrial economy by 2035?
Its GDP per capita—at USD 5370 (in 2011 PPP) in 2014—would need to grow at a minimum of 6 % a year to reach the USD 18000 mark by 2035 (figure O.4). This would be significantly higher than the average per capita growth rate of 5.5 % between 1990 and 2014—and well above the 3.8 % average for all middle-income countries over the same period. A lower and more feasible (but still ambitious) per capita growth rate of 5.0 % (Vietnam’s average over the last 10 years) would take its GDP per capita to just under $15,000 by 2035 and put Vietnam on par with Brazil in 2014, well poised to reach $18,000 by 2040. A growth path of 7 percent (Vietnam’s aspirational growth target) would take per capita GDP to $22,200, roughly the income of the Republic of Korea in 2002 or Malaysia in 2013. This higher growth rate would also enhance Vietnam’s chances of catching up with Indonesia and the Philippines.
Also in 2035, at least 54 million of Vietnam’s 108 million citizens would be urban residents, almost 25 million more than today. The urbanization rate, now at around 33 percent, would need to increase 2 percent a year to meet this target, matching the pace of the past 20 years. The non-agriculture sector has grown at twice the pace of the agriculture sector since 1990. This 2:1 ratio of growth rates is also projected over the next two decades, even with agriculture growing at its potential 3.0–3.5 %. That would ensure a 90 % share of the non- agriculture sector in the economy. The 80 % private-sector share in GDP, if feasible, would involve a departure from the past. With the share of the public sector in GDP stuck at around 33 % since the onset of the Đổi Mới reforms, this would involve a more meaningful attempt to restructure the SOEs State Owned Enterprises (including equitizing bigger chunks of them) and providing a bigger stimulus to the private sector.
Thirty years of Đổi Mới reforms have brought many successes. Vietnamese development aspirations for 2035 are bold and significant, but the challenges and risks facing the country are also enormous. In order to achieve the aspirations, six transformations or breakthroughs will be essential:
• Enabling economic modernization with a productive and globally competitive private sector firmly in the lead
• Building the country’s technological and innovative capacity for a creative society
• Managing urbanization and other forms of spatial transformation to achieve economic efficiency
• Charting an environmentally sustainable development path with enhanced capacity for climate resilience
• Promoting equality and inclusion of the marginalized groups for the development of a harmonious middle- class society
• Building a modern, rule of law state with a democratic society and a fully established market economy.
The six breakthroughs serve as the foundation for realizing the 2035 aspirations, and maybe summarized in three pillars: economic prosperity, balanced with environmental sustain- ability considerations; equity and social inclusion; and a rule-of-law state, marked by high capacity and account- ability. The rest of this report is organized around these three critical aspirations for 2035. It covers both the feasibility and challenges of realizing these aspirations under current conditions and lays out a pathway for re- form to enhance the prospects of meeting the 2035 goals. Details of the six breakthroughs are presented in Part II of the final report.
Pillar 1 : Economic Prosperity with Environmental Sustainability
Vietnam is on a trajectory of rapid growth. Past performance has stoked ambitions of even faster growth over the next 20 years, and Vietnamese leaders are keen to see per capita growth accelerate from its average of 5.5 % since 1990 to around 7.0 %. This will require the ratio of gross capital formation to GDP to pick up to around 35 % (from 31 % currently) and stay at that level for at least a decade—and the gross national savings rate to stay at 35 %. Above all, productivity growth, which has been on a long-term declining trend, will require greater attention.
The reform agenda will be demanding, given that the decline in productivity growth has been broad based. The government will need to prioritize reforms with more immediate payoffs such as strengthening the microeconomic foundations of the market economy. The reforms with medium-term impacts would support ongoing structural transformations and the deepening of global integration by developing a market-oriented and commercialized agriculture sector, strengthening Vietnam’s position in global value chains, and building more resilient and credible macroeconomic institutions. Those with longer-term gestation would seek to create more robust learning and in- novation structures, promote efficient urban agglomeration, and ensure environmental sustainability.
Vietnam’s Long-Term Growth in a Global Perspective
“Catch-up growth”- in which late comers benefit from investment and transfer of technology, and know-how from the richer countries – has produced extraordinary episodes of economic success in East Asia and else – where since the end of World War II. Some economies, like Japan, the Republic of Korea, Singapore, and Taiwan, China, sustained high growth for some five decades and were propelled to high-income status. Others, like Brazil, the Arab Republic of Egypt, Indonesia, Mexico, and Thailand, showed promise for two or three decades, but then became mired in the “middle-income trap.” China’s ascent, albeit incomplete, seems on a trajectory similar to the first group’s—and to Vietnam’s.
Having grasped the catch-up opportunities, Vietnam is strongly positioned on its long-term income trajectory relative to its global comparators. A long- term comparison with China is striking on two counts. First, growth accelerations in both countries, although 13 years apart (starting around 1977 and 1990), begin at roughly the same per capita income of around USD 1100 (2005 PPP). Second, 24 years into its growth acceleration (2014), Vietnam had kept up with China over the equivalent period (to 2001) (figure O.5, panel a).
The story remains broadly similar when looking at other successful economies (those with at least a three- and-a-half-fold increase in per capita income in the first 25 years of their growth accelerations) and considering a 50-year period. The starting points for the growth accelerations were close, with Thailand at USD 835 (2005 PPP) at the lower end and Taiwan, China, at USD 1365 at the upper end. About a quarter century into its growth acceleration, Vietnam’s position is broadly at par with those successful economies (figure O.5, panel b).
What happens from here on is even more important. At roughly 25 years into their growth accelerations, where Vietnam is now, the economies that made it into the high-income ranks pulled ahead of the rest. The Republic of Korea and Taiwan, China maintained their growth records of the first 25 years over years 25–50, but Brazil, Egypt, and Thailand started to see growth rates fall.
Vietnam is thus seemingly at a critical juncture. Decisions at this stage matter for meeting long-term income aspirations. If the country can carry out the reforms to pull up its GDP growth to its 7 % per capita tar- get, it would match the trajectory of China and by 2035 stand a strong chance of reaching the incomes of the Republic of Korea and Taiwan, China in the early 2000s. At the higher reaches of upper-middle-income status, it would be strongly positioned for the final ascent to high income. It would also have a stronger chance of catching up with or even overtaking its middle-income neighbours such as Indonesia and the Philippines. But if Vietnam’s per capita growth slips to around 4 percent a year, that will be good enough only to take its average income close to that of Thailand or Brazil today, and its chances of catching up with the neighbouring wealthier middle-income countries would be lower.
What will determine Vietnam’s path?
Productivity is fundamental. Economists generally agree that countries’ inability to break out of the middle- income trap (whether or not they have been growing fast) is almost entirely attributable to stagnating productivity. Summarizing the importance of productivity in development economics, Nobel Prize–winning economist Paul Krugman notes, “Productivity isn’t everything, but in the long run it is al- most everything. A country’s ability to improve its standard of living over time depends almost entirely on its ability to raise its output per worker.” Here, though, the story becomes less rosy for Vietnam.
Trends in productivity growth— A cause for concern
Behind Vietnam’s impressive growth since 1990 are some worrying signs. Two stand out in comparing the 1990s with 2000–13. First, GDP growth was a full percentage point lower in the second period (at 6.6 %) than in the 1990s. While this slowdown was in part a reflection of the weaker environment following the 2008– 09 global financial crisis, a slowdown in labour-productivity (output per worker) growth that started in the late 1990s was also a contributing factor (figure O.6, panel a). In fact, an acceleration in labour-force growth prevented an even steeper decline in GDP growth after 2000. Second, decomposition of labour-productivity growth in the two periods shows that, since the early 2000s, the contributions of capital deepening (panel b) and structural transformation from agriculture to manufacturing and services (panel c) have picked up markedly. Conversely, growth in total factor productivity, which accounted for the bulk of labour- productivity growth in the 1990s, collapsed in the post-millennium period, and labour-productivity growth fell in a majority of the sectors. Labour productivity actually declined in mining, public utilities, construction, and finance, all sectors in which SOEs have kept their dominant role.
Driven by multiple objectives (profit not high among them) and by distorted incentives, SOEs have stayed unproductive. Measures of firm-level asset (capital and land) productivity (figure O.7) and labour productivity through- out the 2000s capture their inefficiencies. Despite a long-running (albeit uneven) SOE equitization process, the public sector’s presence in production and its control over factor markets re- main pervasive. The state still retains a majority stake in more than 3000 SOEs, which account for about a third of GDP (same as in 1990) and close to 40 % of total investment. The state sector also maintains a virtual monopoly (or oligopoly) in critical sec- tors such as fertilizer, mining, utilities, banking, construction, and agriculture. Under growing pressure to restructure, it has at least sought to ensure that its feeble productivity does not deteriorate further.
The situation for private enterprises
Domestic private enterprise gives even more cause for concern. Driven by reforms to first legalize and then facilitate private enterprise, the private sector grew exponentially after the late 1980s. But, its growing presence has been marked by worsening productivity, so much so that there is little day- light between the productivity of labour and that of assets in the domestic private and SOE sectors (see figure O.7). Vietnamese private firms, on average, were using their assets more productively than their Chinese counterparts in the early 2000s, but by 2014 their asset productivity had fallen to less than half that of their Chinese peers. Vietnamese private firms are overwhelmingly small and informal, which prevents productivity gains through specialization and economies of scale. The relatively few large domestic private firms (especially those with more than 300 employees) tend to be even less productive than the smaller private firms (on both asset and labour productivity).
Tends and explanations
What explains these trends, and why do they differ between the two periods? The initial pickup in productivity growth in the 1990s reflected Vietnam’s move toward a market-economy structure and the removal of many distortions (multiple price controls, production quotas, collectivized agriculture, trade and investment restrictions, and a ban on formal private enterprise). Most of these restrictions were lifted in the initial phases of Đổi Mới, with systems more friendly to the market and private sector in place by the early 1990s. These early steps gave a big boost to productivity growth across the economy.
By the end of the 1990s the productivity gains had been exhausted and more fundamental policy and institutional constraints started to bind. Two distortions in Vietnam’s nascent market economy have hurt productivity growth the most. The first is the gradual commercialization of state institutions (discussed in more detail under Pillar 3), such that the narrow commercial interests of those with connections now dominate and determine business viability. The innumerable tacit and explicit preferences handed out to firms with connections (such as all SOEs, most foreign-invested firms, and some large domestic private firms) by officials who also give inadequate attention to economic efficiency make it very difficult for many private firms to thrive, even if they are productive.
Commercialization of state institutions has produced an uneven and partial approach to market reforms, leading to two imbalances. In the first, a warm embrace of markets as the mechanism for resource allocation has coincided with a much more cautious and ambiguous approach to giving up state control of production and to accepting domestic private ownership of productive assets. This has spawned an entrepreneurial business class within (or closely connected to) the state rather than outside it and permitted a continuing heavy presence of SOEs in many sectors.
In the second, the market embrace has itself been two-speed. Impressive progress in liberalizing product markets and integrating them with the global economy under international trade agreements has been accompanied by a more subdued and muddled approach to developing and liberalizing factor markets, as seen in the largely inefficient allocation of land and capital. For example, significant assets (land and capital) were accumulated in the construction, real estate, and banking and finance sectors between 2001 and 2013, even though these sectors were among the least productive. Allocations are likely influenced by arbitrary administrative decisions and connections, at heavy economic cost—as substantiated by a considerable literature. A 2008 study finds that the allocation of bank credit is related to connections and that the most profitable private firms do not even attempt to get bank loans. Updating the analysis to 2013, this report finds that the results hold. Provinces with a high density of SOEs provide less credit to private firms, and require more time to issue land- use rights certificates than other provinces. Easier access of SOEs to credit, land, and export quotas in the garment and textile sector has reduced the profitability and viability of private firms. Another distortion in Vietnam’s market economy that has hurt productivity has been the relative neglect of building critical market institutions. The greatest weaknesses are in those responsible for protecting private- property rights and ensuring free and fair competition. These institutional shortfalls have impeded the emergence of large, competitive, private firms and further discouraged small household firms from entering the formal sector, even though switching from informal to formal activity can raise firms’ productivity and profitability.
The adverse impact on the performance of domestic private firms, while unsurprising, has been substantial. With non-competitive and state- controlled factor markets and inadequately developed formal market institutions, firms turn to informal institutions and networks and often find illegitimate means to enter the market, grow, and become more profitable. There is no reason to believe, however, that those, who are more adept at garnering political capital or exploiting connections are also necessarily better at running businesses.
A Reform Agenda to Reignite Productivity Growth
The imperative to improve productivity growth is therefore clear and strong. GDP growth since the early 2000s has been led by forces that compensated for weak and declining productivity growth but are now reaching their natural limits. Rapid labour-force growth made up for low and declining labour productivity growth economy-wide. Large-scale structural transformations offset the low and declining labour-productivity growth at the sectoral level. An acceleration in capital accumulation counterbalanced the low and declining growth in total factor productivity. In the next phase of development, each of these compensatory factors is projected to have a sharply diminished impact, exposing overall economic growth much more to the weak productivity trends. Moreover, the global context is likely to be far less hospitable than before the global financial crisis.
Vietnam’s advantage is being at an early enough stage of development to reignite productivity growth without compromising its 2035 income objectives. At a similar stage of development (the early 1980s), the Republic of Korea saw a major acceleration in its labor-productivity growth, which is encouraging since it suggests that a turnaround in such growth is possible. It also highlights how demanding the agenda for institutional reforms is. Some of that country’s reforms, launched in the late 1970s and early 1980s macroeconomic stabilization, agricultural modernization, and greater emphasis on competition and market deregulation strongly and quite quickly helped improve productivity growth. Others, in the areas of higher education, research and development (R&D), and urbanization, operated with a significant lag, having begun many years earlier.
Reforms in Vietnam would need to be not only comprehensive (given its broad-based slide in productivity growth) but also carefully sequenced with a fixed eye on long-term growth. The agenda, accordingly, can be bro- ken down into three broad (and over- lapping) time horizons.
• Reforms with immediate impacts. Strengthening the microeconomic foundations of the market economy would have to be the immediate priority, with the payoffs most significant over the next five years. This should help stem the declining trend in productivity growth and, by enabling greater and more efficient participation of the private sector, provide a strong growth stimulus for the next decade or so.
• Reforms with impacts in the medium term. These would comprise measures that are also carried out without delay, but their impact would be felt the most between years five and ten. These would aim to support the ongoing structural transformations and deepening of global integration (including the capital account) by modernizing and commercializing agriculture, strengthening Vietnam’s position in global value chains, and building more resilient and credible macroeconomic institutions.
• Reforms and investments with impacts mostly in the long term. These could be phased in over the next two or three years, with payoffs expected only with a significant lag. They take into account the fact that the cur- rent growth model (supported by the short- to medium-term reforms) is likely to start hitting diminishing returns no later than a decade or so from now, as the economy reaches the upper-middle-income level and environmental degradation reaches its limits. The longer-term focus would be on spurring learning and innovation, promoting urban agglomeration, and ensuring environmentally sustainable development.
The impacts of the reforms are not mutually exclusive. Functioning land markets and strong micro-institutions will be just as important after a decade as they are in the next three years, although the short-term impact will be felt more acutely because of the current distortions that will get eliminated. Elements of stronger macroeconomic institutions will be needed in the next two or three years to ensure fiscal consolidation and greater efficiency of spending. The environmental agenda can also have some immediate payoffs through more efficient pricing systems that internalize environmental costs.
Reforms with immediate impacts— strengthening the microeconomic foundations of the market economy
The immediate priorities have to be stronger microeconomic market- economy foundations. SOE reforms stay an important part of this agenda, but are no longer enough: creating better enabling conditions for the private sector, such as strengthening market institutions and liberalizing factor markets, takes precedence.
Strengthening market institutions
The evidence is compelling that well functioning markets require well-defined rules of the game, enforced transparently and predictably. The agenda calls for strong market institutions whose role is especially important in the early phases when markets are underdeveloped and small distortions can have amplified effects. The emphasis in Vietnam will have to be on enforcing competition policies and ensuring the security of property rights. Restructuring the SOE sector, and levelling the playing field for all enterprise, private or public, domestic or foreign, is an important part of this agenda (discussed under Pillar 3).
Liberalizing factor markets
Vietnam’s financial sector is still relatively underdeveloped, with the banking sector saddled with deep-seated structural problems and capital markets still in their infancy. Land markets are even less developed and complete. Moreover, as noted, state influence on credit and land allocations seems excessive, leading to significant economic inefficiencies. Labour market regulations are less onerous (Pillar 2), but even those are not free of policy concerns. The hộ khẩu household registration system (which, among other problems, impedes rural–urban migration) is less burdensome than in earlier years but still imposes efficiency costs (Pillar 2).
Building financial markets
The financial sector has expanded rap- idly since the early 1990s, but still has wide scope to take on an even bigger role. It has done a reasonably good job of mobilizing savings but fallen short in allocating credit to its most productive uses and providing an inclusive payment system. Much of the lending, especially by state-owned commercial banks, has gone to SOEs, or increasingly to private companies with connections, crowding out lending to productive segments of the domestic private sector. Financial inclusion has increased since the early 1990s, but remains an issue for less well-off Vietnamese, especially those in rural areas. The banking sector is struggling, having taken a big hit after the global financial crisis toppled the real estate market (where the banks had heavy exposure). Banks’ average return on assets has fallen steeply since the crisis (from 1.8 percent in 2007 to 0.5 per- cent in 2012). Their reported non-performing loans (NPLs) have risen and are generally considered understated. And their provisions are lower than in middle-income peer countries in East Asia. Many of the NPLs and restructured loans are related to SOEs. Moreover, cross-ownership of private banks by each other and by enterprises (including SOEs) remains significant. Compliance with Basel Core Principles is improving but still low, and many banks lack Basel II’s capital requirements for market and operational risks, even as the country looks to move toward Basel III. On-site inspec- tions, particularly of the state-owned commercial banks, have been limited, and consolidated supervision of banks is lacking. Off-site monitoring also needs to be improved.
Three items are on the agenda for the financial system over the next 20 years
Reducing the risk of major financial crisis. Vietnam’s response to potential financial crises could be accelerated, if the government strengthens the National Monetary Advisory Council. The council could meet regularly, sup- ported by a dedicated technical team to provide timely reports and drafts of notifications and instructions to banks. Information on the financial system could be improved by better off-site data and supervision from the State Bank of Vietnam (SBV). Improving the capacity for crisis management and the framework for bank resolution will improve the crisis response in the event of illiquidity or insolvency in the banking sector. This could be further strengthened by firming the resources of the Deposit Insurance of Vietnam (DIV) and legally enabling it to undertake a purchase and assumption transaction of failed banks’ assets. This measure would require both a gradual shift in the DIV’s funds from banks to government debt and legal changes that permit the government to borrow from the SBV on behalf of the DIV in large crises, under well-defined conditions.
Developing a larger, more diverse, stable financial sector. This requires steadily increasing bank capital and developing the broader financial sec- tor. The first challenge is resolving the large NPL overhang in banks. A good starting point would be confidential audits (including operational audits) by reputable international firms and strong application of prudential norms, without regulatory forbearance. For banks deemed sound and viable, NPL resolution would involve direct sales of collateral related to the NPLs and transfers of NPLs and collateral, under a more robust legal framework, to a strengthened Vietnam Asset Management Company for management, recovery, and sale. The banks deemed insolvent would be closed, merged with viable banks, or sold (either directly or through the company).
Improving future performance in the banking sector will depend on better enforcement of improved regulation and supervision of risks taken by banks (with closer attention to state-owned banks) and by other sellers of assets such as insurance and pension firms. One major improvement would be to apply macro-prudential supervision and better off-site supervision. A second would be a gradual shift toward international regulatory and accounting norms. Moving toward Basel III would mean higher requirements for capital, including capital for market and operational risks, and reduced incentives for excessive risk-taking by banks (in a context where some banks are struggling to meet even Basel II requirements). Third would be to gather more information on business groups, which could help reduce connected lending.
Deepening the capital markets (starting with the market for government debt) will also need changes to the legal and accounting frameworks to bring them in line with international standards. That would make foreign investment through the capital mar