Vietnam in the Global Economy

Development through Integration

or Middle-income Trap?

Hansjörg Herr, Erwin Schweisshelm, Truong-Minh Vu

Vietnam is at the lowest end of global value chains in industrial

productions and, at the same time, depends on the export of
natural resources. Market mechanisms are reproducing this type
of underdevelopment.

The era of free trade after the 1980s did not bring higher
worldwide growth than the first decades after World War II with
more regulated trade and capital controls. Overall, Vietnam is well
advised to be cautious in its growth and employment expectations
of the TPP and other FTAs.

Vietnam needs to build economic clusters with forward and

backward linkages to exploit economies of scale and scope, as
well as synergies and positive external effects. Big companies
including state-owned enterprises have to build up networks of
domestic suppliers to increase their local content.

A comprehensive industrial policy, which is poor at present in

Vietnam, is needed. Vietnam especially lacks institutions that are
able to select, implement, evaluate, and modify industrial policy
when needed.
 Contents

List of Abbreviations i

Foreword ii

Introduction 1
Integration of developing countries into the world market and economic development 3
Traditional economic trade models and economic development 3
GVCs and economic development 9
The danger of the MIT 15

Vietnam’s integration into the global economy 17

Overview of Vietnam’s integration into the global economy 17
Structure of exports and imports in Vietnam 18
GVCs in industrial productions 22
Effects of FTAs 25

The role of industrial policy for development 29

Principles of industrial policy 29
The role of the exchange rate 31
Overview of Vietnam’s industrial policy 33

Recommendations for Vietnam 36

Notes 41

Bibliography 43
 List of Abbreviations

AFTA ASEAN Free Trade Agreement MIT Middle-Income Trap

ASEAN Association of Southeast Asian Nations OECD Organisation for Economic Co-operation
EPA Economic Partnership Agreement and Development
CIEM Central Institute for Economic RMG Ready-Made Garments
Management R&D Research and Development
CMT Cut, Make, Trim SOE State-owned Enterprise
CPV Communist Party of Vietnam SEDS Socio-economic Development Strategy
EU European Union TPP Trans-Pacific Partnership Agreement
FDI Foreign Direct Investment UNCTAD United Nations Conference on Trade
FOB Free On Board (finished product sourcing) and Development
FTA Free Trade Agreement US United States
GDP Gross Domestic Product VEIA Electronic Industries Association
GVC Global Value Chain of Vietnam
ILO International Labour Organization VITAS Vietnamese Textile and
IMF International Monetary Fund Apparel Association
LEFASO Association of Vietnamese Footwear, WTO World Trade Organization
Leather and Bag Producers

i
 Foreword

The multiple crises crippling our societies – from climate middle-income country, the focus of the EoT project in
change to financial meltdown, from rising inequality to Bangladesh is on economic growths and decent work as
mass migration – are shaking the foundation of the world well as institutional reforms for development.
order. Taken together, these crises go well beyond the
policy level, but call into question the very paradigms that In Thailand, resilient fiscal policy is the focus of the EoT
the foundation of our economies are built around. network. After its founding in 2016, a Policy Community
on Taxation Reform will continue to promote taxation
In 2011, economic thinkers and political decision-makers policy as well as look into the spending to identify needs
from China, Germany, India, Indonesia, Korea, Poland, and perspectives in the context of upcoming challenges of
Sweden, Thailand and Vietnam came together to discuss an aging society.
how our development models need to be adapted. Later
joined by Bangladeshis, Filipinos, Malaysians, Pakistanis Supporting the phase-out of a resource-driven and
and Singaporeans, several regional dialogues discussed therefore extractive economic model, while strengthening
how to reconcile growth and equity, find a balance the promotion of a sustainable manufacturing sector as
between boom and bust cycles, and how to promote well as the maritime and digital economy are the main
green growth and green jobs. The findings, endorsed efforts in Indonesia.
by 50 prominent thought leaders from Asia and Europe,
have been published as “The Economy of Tomorrow. Vietnam is putting emphasis on an export-oriented,
How to produce socially just, resilient and green FDI-driven development strategy, focusing on wage-
dynamic growth for a Good Society”(versions available led growth models, productivity gains and value chain
in English - 5th edition, Bahasa, Korean, Mandarin, Thai improvement to find a way out of the middle income trap.
and Vietnamese, at designated page for Economy of
Tomorrow, www.fes-asia.org.) The EoT Manifesto calls The EoT project in China focusses on the socio-
for an inclusive, balanced and sustainable development economic consequences of innovation-driven changes
model which can provide the conditions for a Good in the manufacturing and service sectors, and explores
Society with full capabilities for all. how China can achieve growth while implementing a
sustainable climate and energy policy.
True to our understanding that development models
need to be tailor-made, in the second phase of the In Pakistan the current focus is on institutionalising the EoT
project national EoT caucuses have worked on adapting discourse by bringing together governmental and non-
these sketches to the local context. At the regional level, governmental think tanks as wells as leading individuals
the focus was on the political and social challenges to develop a common advocacy agenda. A comprehensive
which needed to be addressed to encourage qualitative compilation of previous research work will serve as a
economic growth. The national studies carried out on the blueprint for political discussions during the upcoming
political economy of development as well as the synthesis election campaign.
“Mind the Transformation Trap: Laying the Political
Foundation for Sustainable Development” are available
on the website. Erwin Schweisshelm,
Resident Representative, FES Vietnam Office
In the third phase, the EoT project will focus on specific
Marc Saxer,
sectors of transformation. In India, for example, the focus
Regional Coordinator, “Economy of Tomorrow”
is on energy transformation, urbanization and digital
transformation. After graduating to the status of a low September 2016

ii
 Introduction

Introduction

In the mid-1980s at the start of the Đổi The question remains as to whether this
Mới (renovation), Vietnam was a backward spectacular development will be able to
agricultural country under a socialist economic continue. There are a number of experts who
system, based on the centrally directed believe that Vietnam is in danger of falling
allocation of resources through administrative into the middle-income trap (MIT) or might
means. At that time, most of the workforce already be affected by it (Pincus, 2015; Ohno,
was involved in agricultural production, but 2015). The MIT implies that the convergence
the country faced food shortages and had between a developing country and the most
to import rice. Industry was weak and faced developed countries in the world does not
poor productivity. The overwhelming majority become smaller as the developing country is
of the population was deeply stuck in poverty. stuck at a certain level of per capita income.
Vietnam’s approach to economic reform has The only sustainable way to overcome the MIT
been characterised by two main features. and join the group of developed countries is
Firstly, it followed a top-down and step-by- to increase the productivity and innovative
step approach. Pilot projects in some localities power of a country. If developing countries are
were carried out on an experimental basis unable to catch up to the level of productivity
before they were applied to the whole country. of developed countries, a conversion of the
Secondly, there was a consensus among the living standards between developing and
Vietnamese leadership not to combine market- developed countries will not be possible.
oriented reforms with political liberalisation. However, productivity increases are not
In addition, the important role of state-owned the only factor for economic development.
enterprises (SOEs) was maintained during the Besides productivity development, an inclusive
introduction of market-oriented reforms. growth model with not too high income
inequality and a functioning financial system
Since the beginning of the process of Đổi delivering sufficient credit with low interest
Mới, economic growth in Vietnam has rates are also preconditions for sustainable
been remarkable. Between 1991 and 2009, development.
Vietnam’s real gross domestic product (GDP)
grew with an average growth rate of 7.4 The aim of this paper is to analyse the specific
percent. In 1990, Vietnam’s GDP per capita way in which Vietnam has been integrating
of US$98 placed Vietnam among the poorest into the global economy and what kind
countries in the world. In 2009, its GDP of production structure has been created
per capita of US$1,109 led to Vietnam’s in Vietnam as a result. The key question is
attainment of lower middle-income status, whether the type of integration (being carried
according to the World Bank classification out by Vietnam) into the world market is
methodology. In 2014, Vietnam’s GDP per supporting economic development in Vietnam
capita reached US$2,052 (Haughton et via an increased the productivity level or not.
al., 2001; Quan, 2014). Economic reforms It will be asked what kind of integration
resulted in Vietnam’s increased integration different economic approaches expect. This
into the global economy. This integration paper will then determine to what extent the
process is still underway with Vietnam’s trade different theoretical approaches are able to
commitments under ASEAN, its accession to explain development in Vietnam and whether
the World Trade Organization (WTO) in 2007, Vietnam is in danger of getting stuck in the
and Vietnam’s signing of the Trans-Pacific MIT.
Partnership Agreement (TPP) in 2015.

1
Vietnam in the global economy: development through integration or middle income trap?

The main conclusion of this paper is that section also concentrates on a phenomenon
theoretical considerations and empirical that gained paramount importance over the
analyses support the hypothesis that an last three decades – global value chains (GVCs)
unregulated integration in the world market and offshoring. It will be asked to what extent
is not beneficial for Vietnam in the long run GVCs increase the chances of economic
and could lead to Vietnam becoming stuck in development for countries like Vietnam.
the MIT. Integration into the word market is
of key importance for a country like Vietnam, The third section analyses in detail how
but it needs to be guided by a comprehensive Vietnam has integrated into the global
industrial policy and government intervention. economy. The theoretical approaches from
To leave the integration of Vietnam completely section two will be used to understand
to the market leads to the reproduction of Vietnam’s role in the international distribution
underdevelopment. A combination of market of labour. Import and export structures will
and government activities is needed to reach be analysed, as well as the role of GVCs in
a sustainable level in order for developing Vietnam. The theoretical prediction will be
countries to catch up. largely supported by the empirical analysis.
Without government intervention, the MIT is
The second section of this paper will give a serious danger for Vietnam.
a review of the most important traditional
economic models to explain international The fourth section draws policy conclusions
distribution of labour. From the perspective for Vietnam. Here, industrial policy and its
of a developing country, the analysis looks adaptation to the situation in Vietnam will be
at what kind of industrial development these discussed.
models predict for a country like Vietnam. The

2
 Integration of developing countries into the world market and economic development

Integration of developing countries into

the world market and economic development

Traditional economic trade models and quantity of textiles, Vietnam needs 20 units
economic development of labour, whereas the US needs 35 units.
We will start with the model of absolute Without international trade, the production
advantages and then analyse comparative and consumption of the assumed quantities
advantages, as well as different factor of textiles and cars need a total sum of 105
endowments. These trade models assume units of labour in both countries. If each of
that goods are traded as complete goods. the countries concentrates on the goods
This implies that the production process of a with its absolute advantage and produces
good is not divided into different tasks, which twice as much as before and exchanges cars
are produced in different countries through against textiles, the level of consumption in
GVCs. To understand the logic of trade, both countries will stay the same, whereas
usually in these models mobility of capital the needed hours for producing the goods
is assumed to be zero, which automatically can be reduced to 60 hours altogether. The
implies a balanced current account. Finally, conclusion made by Adam Smith was that
these models assume constant returns to international trade (similar to national trade)
scale and competitive markets. increases the wealth of nations and markets,
and leads to specialisation according to
Absolute advantages absolute advantages.
The most simple and obvious model to
explain international trade is the model of Some assumptions are made to come to
absolute advantages. Adam Smith (1776) the welfare conclusion drawn by Smith. The
argued that in the case of one country being most important one is that there is sufficient
good at producing one thing, and another demand so that world output increases and
country being good at producing another the production factors that have become
thing, the welfare of both countries could be unused as a result of efficiency gains will be
increased by trade. Absolute advantages are able to be employed.2 If the 45 units of saved
based on different technological levels and/or labour in our example become unemployed,
different natural conditions which influence the wealth of a nation will not necessarily
productivity. increase. From a Keynesian perspective
there is no guarantee that a switch to more
For example, if Vietnam has higher free trade increases aggregate demand
productivity in textile production and the and output. If Say’s law, which assumes
United States (US) is more productive in car that supply creates its own demand, does
production, to increase the welfare of both not hold, free trade can lead to permanent
countries, Vietnam should concentrate on higher unemployment. It is sometimes argued
the production of textiles and the US should (mainly by non-economists) that free trade
focus on making cars. Table 1 shows the increases the surplus in the trade balance (or
logic behind, and consequences of this type reduces a deficit) and positive employment
of trade. It is assumed that the US has an effects can be expected. However, a switch to
absolute advantage in producing cars – it free trade has nothing to do with surpluses
needs 10 units of labour1 to produce a car, or deficits in the trade and current account
whereas Vietnam needs 40 units of labour balances. Only in a world of lunatics can free
to produce a car. Vietnam has an absolute trade lead to current account surpluses in all
advantage in producing textiles. For a given countries. Secondly, it has to be assumed that

3
 Vietnam in the global economy: development through integration or middle income trap?

the factors of production move smoothly from in the US increases at an even faster rate, and
When we look
one industry to another one. In a concrete the productivity gap in Vietnam increases
at the areas
economic constellation, such structural to 0.05. The explanation for this is that the
where countries
changes can become difficult for countries. absolute advantage in producing cars is bigger
like Vietnam
In our example, American textile workers may than the absolute advantage of Vietnam in
have absolute not be qualified to become workers in the producing textiles. The figures in Table 1 are
advantages, we car industry. Finally, the model does not show not based on empirical facts. However, the
quickly detect which of the two countries would achieve the constellation shown in the table might not be
the importance biggest welfare gains. Even if it increases the unrealistic for many goods in a country like
of unprocessed welfare of both nations, trade can produce Vietnam.
agricultural some losers in both countries.
products and When we look at the areas where countries
natural resources. In the context of this paper, the most important like Vietnam have absolute advantages, we
question is how productivities change when quickly detect the importance of unprocessed
countries integrate into the global economy. agricultural products and natural resources.
Productivity is defined as output per unit Examples of the first group of goods are
of labour. In our exemplification in Table 1, coffee beans, rice, sugar cane, or fish.
the productivities of producing a car and Examples of the second group of goods are
a given quantity of textiles are calculated.3 coal, manganese, bauxite, chromate, offshore
To calculate average productivity, each of oil, or natural gas. Such absolute advantages
the productions is weighed according to can result from natural conditions, such as
the labour needed in the industry.4 The the climate or locations of rare earths. The
productivity gap for the whole of Vietnam’s possession of such natural advantages is not
economy before international trade is 0.006. necessarily a blessing for countries. While it
Productivity in Vietnam under the condition can allow the earning of hard currency in a
of international trade increases because the relatively easy way, empirically, most countries
country concentrates on the production of the with these advantages have not developed
good with its absolute advantage, which has a in a sound way. There are good theoretical
productivity of 0.05. In addition, productivity explanations for this.

Table 1: International trade with absolute advantages

Before trade After trade

Vietnam US Total hours Vietnam US Total hours
Units of labour needed Units of labour needed
per given quantity of good
Cars 40 10 2x10=20
Textiles 20 35 2x20=40
Total hours 60 45 105 40 20 60
Productivities Productivity Productivities Productivity
without trade* gap Vietnam** with trade* gap Vietnam**
Cars 1:40=0.025 1:10=0.100 2:20=0.100
Textiles 1:20=0.050 1:35=0.029 2:40=0.050
Average (0.66·0.025) (0.22·0.100) 0.006 0.050 0.100 0.050
productivity*** +(0.33·0.050) +(0.78·0.029)
= 0.033 = 0.039

*Quantities produced per labour input, **US productivity minus Vietnamese productivity,
***Each industry is weighted according to its labour input in relation to total labour input

4
 Integration of developing countries into the world market and economic development

Hans Singer (1950) and Raúl Prebisch (1950) prices based on natural scarcity. In the long
The possession
argued that the producing and exporting run, the price of these natural resources may
of such natural
natural resources, including basic agricultural increase because the production costs to
advantages is
products by countries, would lead to a extract or mine them increase with depletion.
not necessarily
deterioration of the terms of trade in these However, presently and for an uncertain time
countries in the long-term. In the long-term, into the future, prices of natural resources are a blessing for
this means that developing countries that above production costs and prices are based countries.
concentrate on the production of natural on oligopolistic market structures. To what
resources have to exchange more and more of extent such oligopolies are able to increase
their primary products against the industrially prices and keep them high is an open question,
produced products of developed countries. given the fierce competition of natural
Explanations for this effect are manifold. resource producers to export their natural
Productivity growth in industrial productions resources.5 The development of oil prices after
might be higher than in the production of 2008 is a good example of this. However,
agricultural products and natural resources even when prices of natural resources are
extraction. In addition, the price elasticity of high and high rents can be earned possessing
primary goods for single suppliers is higher and exporting natural resources, they are still,
than for industrial products. For example, for many countries, a double-edged sword.
exporters of coffee beans or oil produce The problem is that a country that exports
a relatively homogenous good and are natural resources as a high percentage of its
confronted with competition from exporters total exports will import a high percentage
in many countries. Firms in developed of its consumption and capital goods. Thus,
countries exporting new high-tech or lifestyle a country focusing on the export of natural
products can exploit monopolistic positions resources will make its industrial sector suffer.
and avoid price competition. Also, the income This phenomenon is known as Dutch disease.
elasticity of primary goods is supposed to When in the 1960s the Netherlands found
be lower than for industrial products. The offshore oil, the domestic industrial sector
long-term terms of trade effect expected by found itself in crisis. The global demand for
Singer and Prebisch reflects an overall slower Dutch oil led to an appreciation of the Dutch
productivity growth in developing countries guilder and reduced the competitiveness of By allowing
producing natural resources, as well as a the Dutch industry. As a result, this reduced the market
relative stagnation of the demand of such the dynamic of the Dutch economy. Natural mechanism to
products. By allowing the market mechanism resource rich countries are in danger suffering work, developing
to work, developing countries will be pushed from serious overvaluation, especially when countries will be
towards the production and export of primary the industrial sector is taken as a benchmark. pushed towards
products with relatively low value-added. This The result of such an overvaluation is a lack the production
reduces the possibility of developing countries of competitiveness of the industrial sector and export of
catching up to more developed countries. (Corden, 1984; Corden / Neary, 1982). The primary products
Empirically the Prebisch–Singer terms of problem is that the industrial sector has with relatively
trade hypothesis is supported for most of the a much higher potential for productivity low value-added.
primary products. However, there are some increases and innovation than the natural This reduces
exceptions (Harvey et al., 2010; Arezki et al., resource sector. The outcome is that natural
the possibility
2013). resource rich countries suffer from a lack of
of developing
domestic economic dynamic and transform
countries
The Prebisch–Singer hypothesis seems not to into rent economies.
catching up to
hold for some natural resources, for example,
more developed
for crude oil and rare earths. These resources The reliance on natural resource exports leads
countries.
seem to follow a trend of long-term increasing to other serious potential negative effects.

5
 Vietnam in the global economy: development through integration or middle income trap?

Natural resource prices and natural resource by Ricardo is that even under such conditions,
Natural resource
exports show a high volatility and expose international trade is welfare-increasing for
prices and natural
natural resource-exporting countries to large all countries. If countries concentrate on the
resource exports
shocks. In many cases, government revenues production of products they are relatively
show a high
depend to a large extent on the development good at producing in the same output in the
volatility and of the natural resource sector. In such cases, world, these products can be produced with
expose natural the volatility of natural resource exports has less input of labour (and other inputs). For a
resource-exporting even bigger negative effects as it distorts the country like Vietnam, this implies the export
countries to large functioning of public households. Lastly, in of goods where the productivity difference
shocks. many cases, natural resource rich countries (compared to developed countries) is the
show a high level of corruption and a low level lowest, and the import of goods where the
of democracy as the incentives for powerful productivity difference is the highest. Indeed,
groups in society to grab some of the natural the market mechanism leads to this structure
resource rents are high (Humphreys / Sachs / of trade.
Stiglitz, 2007). Good institutions are needed
to overcome negative effects of Dutch disease. To reveal the consequences of this type of
Although an exception, Norway serves as a trade, the numerical example in Table 1 is
good example for good institutions and the modified. In Table 2 we assume, as in Table
avoidance of Dutch disease. 1, that Vietnam and the US both produce
textiles and cars. But now the US economy
The question for Vietnam is: does the export is better at producing all goods. To produce
of goods with low terms of trade (for example, one car the US needs 20 labour units, while
coffee and rice) and of natural resources (for to produce a given quantity of textiles it
example, crude oil) with the danger of Dutch needs 40 labour units. The not-so-efficient
disease play an important role? These goods Vietnamese economy needs 40 labour units
play a role in Vietnam’s exports and some to produce one car and 50 labour units to
negative effects must be expected. produce a given quantity of textiles. If both
countries produce both goods and there is no
Comparative advantages and factor international trade, both countries together
endowments need 150 hours to produce the given quantity
One of the most important arguments of of cars and textiles. In the US, the productivity
free trade goes back to David Ricardo (1817) advantage in the car industry is bigger than
and his model of comparative advantages. in the textile industry. For Vietnam, the
International institutions like the WTO or disadvantage of producing textiles is relatively
the International Monetary Fund (IMF) and small. Thus, with international trade, Vietnam
many governments still follow different will produce textiles and the US will produce
versions of Ricardo’s approach today. Ricardo cars – an example with high plausibility. With
assumed different productivity levels in international trade, the same quantity of
different countries. In contrast to Adam goods can be produced with 140 labour units.
Smith, he asked whether international trade Ten units can be saved. Of course, as in the
made sense, under the condition that one example with absolute advantages, a set of
country is less productive in all industries. This conditions must be satisfied to realise positive
assumption very much fits the constellation welfare effects.
of countries like Vietnam, which are with
regard to industrial production characterised Before international trade, the average
by a general low level of technological productivity level of Vietnam (0.022) is below
development compared to developed the US level (0.033) and the productivity gap
countries. The not-so-obvious answer given between the US and Vietnam is 0.011. The

6
 Integration of developing countries into the world market and economic development

Table 2: International trade with comparative advantages

Before trade After trade

Vietnam US Total hours Vietnam US Total hours
Hours needed per given Units of
quantity of good labour needed
Cars 40 20 2x20=40
Textiles 50 40 2x50=100
Total hours 90 60 150 100 40 140
Productivities Productivity Productivities Productivity
without trade* gap Vietnam** with trade* gap Vietnam**
Cars 1:40=0.025 1:20=0.050 2:40=0.050
Textiles 1:50=0.020 1:40=0.025 2:100=0.020
Average (0.44·0.025) (0.33·0.050) 0.011 0.020 0.050 0.030
productivity*** +(0.56·0.020) +(0.67·0.025)
= 0.022 = 0.033

*Quantities produced per labour input, **US productivity minus Vietnamese productivity,
***Each industry is weighted according to its labour input in relation to total labour input

important point is that now, in the logic of Under a dynamic perspective for a developing
comparative advantages, international trade country, the market determined distribution
reduces the productivity level of Vietnam and of international labour implies a huge
increases the productivity gap with the US. disadvantage. As it is pushed to concentrate
Table 2 shows that trade reduces average on low-tech, labour-intensive, low-skilled
productivity in Vietnam to 0.020 and the productions, it will have a lower chance of
Vietnamese productivity gap widens to 0.030. developing. Friedrich List was very critical
This should not be a big surprise as Vietnam about free trade between countries with
gives up the more demanding and advanced different levels of development. He argued
car industry and concentrates on the less against England, which developed under
productive textile industry. International trade protectionism and then preached free trade:
leads to the breakdown of the car industry in “Any nation which by means of protective
Vietnam and Vietnam specialises in textiles – duties and restrictive navigations has raised
an overall low-tech and low-productivity good. her manufacturing power and her navigation
In the US, the textile industry disappears and to such a degree of development that no
the country concentrates on the production other nation can sustain free competition with
of cars – a high-tech product. her, can do nothing wiser than to throw away
these ladders of her greatness, to preach to
The Prebisch–Singer hypothesis takes a new other nations the benefits of free trade, and to
and more radical form. Under the condition declare in penitent tones that she has hitherto
of different productivity levels of countries, wandered in the path of error, and has now
unregulated international trade pushes for the first time succeeded in discovering
developing countries to produce relatively the truth.” (List, 1855: 295f.) Indeed, Ha-
low-tech and low value-adding products, and Joon Chang (2002) shows that virtually all
concentrates high-tech and high value-adding developed countries nowadays, including the
productions in developed countries. Under a United Kingdom and the US, used industrial
static approach, Ricardo’s argument is correct policy to protect and support their industries
– international trade between counties with in their developmental phase.6 It is worthwhile
different levels of development increases listening to Joan Robinson, who made the
the efficiency of worldwide production. The same argument (1979: 103): “The most
welfare of consumers will increase, at least in misleading feature of the classical case for
the short term.

7
 Vietnam in the global economy: development through integration or middle income trap?

free trade […] is that it is purely static. It is set This does not mean that countries in
Countries concentrating
out in terms of a comparison of productivity their first development phase should not
on high-tech, high-skilled
of given resources [fully employed] with or concentrate on low-tech, labour-intensive
productions including
without trade. Ricardo took the example of production. They can do so when they enter
services, will gain from
trade between England and Portugal. […] It mass production and exploit economies of
learning-by-doing, by implies that Portugal will gain from specialising scale. Such mass productions will trigger
developing a high-skilled on wine and importing cloth. In reality, the productivity increases through specialisation
workforce, benefitting imposition of free trade on Portugal killed off and learning effects. However, they should
from positive synergies, a promising textile industry and left her with support domestic forward and backward
carrying out more a slow-growing export market for wine, while linkages of mass productions. The positive
firm-based research, for England, exports of cotton cloth led to effects of mass productions need to be
and so on. accumulation, mechanisation and the whole supported by industrial policy in order for the
spiralling growth of the industrial revolution.” country to enter into new and more value-
adding industries. Industrial policy is needed
List’s and Robinson’s argument is valid still at any stage of development; at any stage
today. Countries concentrating on high- of development new industries need to be
tech, high-skilled productions including created and the private sector is not able to
services, will gain from learning-by-doing, develop such industries alone.
by developing a high-skilled workforce,
benefitting from positive synergies, carrying According to mainstream thinking in the
out more firm-based research, and so on. tradition of David Ricardo, international trade
Such countries can build up monopolistic should lead to the specialisation of countries
or oligopolistic constellations of their firms as an element of positive development.
based on technological superiority and can However, this recommendation does not
earn high quasi-technological rents. The fit the empirical development of successful
high profits of these firms will further spur developing countries. Jean Imbs and Romain
innovation and investment in research and Wacziarg (2003: 64) found in a broad empirical
development (R&D). Developed countries analysis that successful developing countries
with a concentration of high-tech, high-skilled “diversify most of their development path”.
productions will benefit from the positive Obviously only a broad spectrum of industries
external effects of markets, as Alfred Marshall is able to create synergies between different
(1890) called it, and from the concentration of industries and increases the likelihood and
industrial high-tech productions and services possibilities of entrepreneurship. Development
(Krugman, 1991). These processes unfold a has a lot to do with random self-discovery,
strong path-dependency, making innovative which cannot be explained by specialisation
countries endogenously more innovative. according to comparative advantages (Rodrik,
These advantages do not exist in developing 2004).
countries, or exist to a much smaller extent.
Free trade will not help to overcome the The Smith-Ricardo model has a great
disadvantages of developing countries; rather, explanatory power for the explanation of
Free trade will not it will add to their problems. This is why the international distribution of labour. If
Joseph Stiglitz (2006) demanded a one-sided countries introduce free trade and the market
help to overcome
protection of developing countries via tariffs is allowed to work freely, the outcomes are as
the disadvantages of
and other instruments to make international follows: developing countries will concentrate
developing countries;
trade fair. He also favoured the transfer of on low-tech, low-skilled productions and
rather, it will add
certain patents to developing countries for developed countries will concentrate on high-
to their problems.
free or a low price. tech, high-skilled productions. Below it will be
shown that Vietnam fits into this first scenario.

8
 Integration of developing countries into the world market and economic development

The factor-endowment argument for GVCs and economic development

Only a broad
international trade The vision of the old trade models, with trade
spectrum of
Eli Heckscher (1919) and Bertil Ohlin (1933) of goods produced in one industry exchanged
industries is able
assumed the same technological knowledge against goods of another industry, no longer
reflects reality.9 In 2013, trade in intermediate to create synergies
in all countries in the world but different factor
endowments.7 The typical developing country goods had the biggest share in world trade, between different
has a high stock of labour and not much reaching US$7 trillion, followed by primary industries and
capital, while the typical developed country goods with US$4 trillion, consumer goods increases the
has a high stock of capital goods in relation to with US$3.8 trillion, and capital goods likelihood and
labour. The specialisation rule in international with US$2.7 trillion. Almost 50 percent of possibilities of
trade is that countries should concentrate on intermediate goods come from developing entrepreneurship.
productions which especially need the relative countries (UNCTAD, 2014). What we find is
abundant production factor. Developing the dominance of international trade within
countries should concentrate on labour- one industry in intermediate goods, to a
intensive productions because this is the area large extent within multinational companies
of their comparative advantage. Developed or controlled by multinational companies.
countries should therefore concentrate on Alan Blinder (2005) describes the increasing
capital-intensive productions. International role of offshored productions in GVCs within
trade will, as in the Smith-Ricardo model, an industry as a new industrial revolution.
increase the efficiency of world production and Indeed, a new dimension of globalisation
will (sufficient aggregate demand assumed, started to develop during the 1990s due to the
etc.), increase the welfare of countries. revolution in information and communication
technology, the reduction of transportation
The Heckscher-Ohlin model is less important costs, and the implementation of the
for our question. There are not many Washington Consensus policies in developed
industries in developing countries that and developing countries – which deregulated
possess the same technological knowledge international trade and capital flows.
and possibilities as industries in developed These developments allowed multinational
countries. Even if knowledge is free, it is companies in particular to break down their
often difficult to transfer to developing production processes into different stages and
countries. There is a lack of skills; and the outsource these stages to other companies,
experience to use advanced knowledge does which in many cases were in other countries.
not exist. The Heckscher-Ohlin model defines Below it will be shown that Vietnam is also
the development problem by assuming that intensively integrated in GVCs.
developing countries have the same skill and
technology level as developed countries. Trade effect of GVCs
Wassily Leontief (1954) found in his empirical In the case of GVCs, the production process
investigation that US international trade does is cut into different tasks; different companies
not follow the prediction of the Heckscher- all over the world fulfil these tasks. Analytically
Ohlin model. Later, this so-called Leontief the different tasks become their own
paradox was found in many other countries. products. The international allocation of the
The main explanation for the paradox can production of these different tasks depends
be found in the fact that technological to a large extent on comparative advantages.
knowledge, including differences in skill levels, Thus, the old trade models can be applied to
between countries are of key importance for GVCs (Feenstra, 2010). However, the new
international trade and are not captured by trade theory added to the understanding of
the model.8 GVCs (Krugman, 1979; 1991). Most industrial
productions are characterised by economies

9
 Vietnam in the global economy: development through integration or middle income trap?

of scale and scope, which are based on firms as in traditional trade models. GVCs
The argument
for example, indivisibilities (in research, are characterised by the rent-seeking of
of economies of
marketing, branding, etc. or using the same leading firms and brutal competition between
scale and scope
engine or other parts in different cars of a suppliers at the lower end of the value
also makes clear
company); on production clusters, which chain. Monopsony structures dominate the
that first-mover create synergies and positive external effects interaction between GVCs, at least in a typical
advantages (concentration of high-tech companies in developing country.10
exist with high one region); or on positive network effects.
entry barriers for As soon as economies of scale and scope are In the case of buyer-driven value chains,
latecomers. allowed in economic models, the assumption the leading firm focuses on designing and
of pure competition breaks down. Oligopoly marketing functions while the manufacturing
and monopoly competition becomes the process is completely outsourced as a rule to
norm and with it rent-seeking in the form of legally independent subcontractors producing
technological rents, branding, or asymmetric under strict specification of the buyer (Gereffi,
power relationships between firms. As soon 1999). Typical cases of these types of GVCs
as a country manages to host domestically- are labour intensive industries such as the
owned firms that are in a global oligopolistic apparel and footwear industry, but also the
and monopolistic position, these firms will assembly of parts in the production process
increase domestic income via rent-seeking of mobile phones or simple electronic
(more than normal profits) at the cost of equipment. Producer-driven supply chains
other countries. Strategic trade policy to are typically driven by lead firms, where
support domestic firms to achieve dominant technology or high standards in production
positions becomes rational. The argument play a more important role. Examples are
of economies of scale and scope also makes the production of automobiles, computers,
clear that first-mover advantages exist with and heavy machinery. Lead firms in producer-
high entry barriers for latecomers. driven value chains coordinate a complex
transnational network of production with
The complex production processes in GVCs are subsidiaries, subcontractors, and R&D units
managed by lead firms, in the first place by the where the assembly lines of the final good
headquarters of multinational companies. Of typically remain under direct control of the
course in the hierarchical structure of GVCs, lead firm (Figure 1).
headquarters of fashion firms, global retailers,
or car and electronics manufactures usually Another similar model of GVCs has been
do not directly interact with the lowest levels designed by Baldwin and Venables (2013).
of value chains. Big contract manufacturers They distinguish between “spiders” and
like Foxconn and Quanta (in the electronics “snakes”. In snake value chains, production
sector) or Puo Chen (in the shoe production stages follow an engineering order, which
sector) are located on an intermediate level means each location fulfils one task and then
GVCs are of supply chains. Lead firms and big contract the (un-finished) product moves on to the
characterised by manufacturers are obviously in a dominant next location for new tasks and values to be
the rent-seeking of position as they structure the production added. The chain continues until the product
leading firms and process and its location. They decide which is completely produced. In spider chains, the
brutal competition tasks remain in the headquarters and which production of a good does not follow any
between suppliers tasks are outsourced, in which countries, particular order. Productions of tasks take
at the lower end of and by which companies. In GVCs, there place at different (international) locations and
the value chain. is not the cosy world of international trade the final good is assembled in one location.
between independent and equally strong

10
 Integration of developing countries into the world market and economic development

Figure 1: Producer-driven and buyer-driven GVCs

Producer-driven chain

Manufacturers Distributors Retailers and dealers

Domestic and foreign subsidiaries

and subcontractors

Buyer-driven chain
Traders

Retailer and branded manufacturers

Overseas buyers

Factories (overseas)

Source: Adopted from Gereffi (1999), author’s illustration

GVCs can also be classified into horizontal volatility in demand for final products, the
and vertical value chains. In horizontal value needed adjustment of production can be
chains, lead firms buy from other firms or shifted to lower levels of the value chain.
produce high quality inputs in subsidiary Just-in-time production allows higher levels
companies. These types of suppliers are of the value chain to minimise inventories.
typically highly specialised and have a high In this paper, we concentrate on the analysis
technological standard. For example, Airbus of vertical value chains, which are mainly of
outsources the production of engines to importance for countries like Vietnam.
Rolls Royce. The motivation of this type of
value chain is to increase the quality of the Vertical value chains dominate the
product and use the cost advantage of high- concentration of low value-adding and low-
tech specialisation. Vertical value chains’ main productivity activities in developing countries
motivation is to reduce production costs. and the intensive competition at the lower
Tasks are outsourced to low-cost producers. end of value chains, which allows only
Following the logic of traditional international low profits of suppliers. This phenomenon
trade theory, developing countries have a can be expressed in what is known as the
comparative advantage in low-productivity, “smile curve”, but should better be called
low-skill, low value-adding tasks. Developed the “exploitation curve”.11 Figure 2 shows Developing
countries, with their higher level of the exploitation curve and the typical countries are
technological standard and higher skill-levels, distribution of value-added in different stages mainly integrated
have a comparative advantage in taking of production. According to the exploitation in vertical value
over high-productivity, high-skill, high value- curve, the upstream and downstream part of chains and the
adding tasks. Developing countries are mainly value chains, which include research, design, main motivation
integrated in vertical value chains and the marketing, and after-sales service, produce to shift tasks
main motivation to shift tasks to developing the highest value-added and are largely kept to developing
countries is to make the final product cheaper. in developed countries. Most offshoring countries is to
to developing countries can be found at make the final
A second motivation of offshoring is to gain the fabrication stage, which is not the core product cheaper.
higher flexibility for lead firms. In case of competency of lead firms. This stage can be

11
 Vietnam in the global economy: development through integration or middle income trap?

outsourced to less-developed countries to The conclusion is that GVCs can, compared

Lead firms and
reduce costs and gain flexibility. The newest with the Ricardo example, further reduce the
big contract
wave of offshoring increasingly covers services, productivity level in developing countries and
manufacturers
indicating that low value-added activities may further increase the productivity gap with
are in an absolute
be outsourced at all stages of production. developed countries. This is not good news
dominant position for the economic dynamics in developing
and firms at lower The Apple iPhone production is a good countries. The Prebisch–Singer hypothesis
levels of vertical example of the very unequal distribution of thus has a new dimension because under the
value chains are value-added in GVCs. Most of the components trade perspective, GVCs make catching up
dominated by, of the iPhone are manufactured in China. even more difficult for developing countries.
and dependent However, Apple continues to keep most of
on the lead firm its product design, software development, Dominance and technology effects
and big contract product management, marketing, and other GVCs create power asymmetries that are
manufacturers. high value-adding functions in the US. In not known in traditional international
2010, from the sales price of an Apple iPhone trade relationships. Lead firms and big
of around US$500, 58.5 percent were Apple contract manufacturers are in an absolute
profits. Profits of non-Apple US firms were dominant position and firms at lower levels
2.4 percent; firms in South Korea 4.7 percent; of vertical value chains are dominated by,
forms in Japan 0.5 percent; firms in Taiwan and dependent on the lead firm and big
0.5 percent; and firms in the European Union contract manufacturers. A monopsonist firm
(EU) 1.1 percent. Unidentified profits were 5.3 has the market power to reduce prices of
percent. Costs of input material were 21.9 suppliers to a minimum. It will theoretically
percent, cost of labour in China 1.8 percent, push suppliers to profitless production and
and cost of non-Chinese labour 3.5 percent. consequently increase its own profit. As the
For an Apple iPad, Apple profits were “only” main motivation for this type of offshoring
30 percent of its price, with Chinese labour is to cut costs, multinational companies will
costs 2 percent of the price (Kraemer et al., do everything to achieve this goal, as long
2012).

Figure 2: The exploitation curve

Value
Added
Basic and applied Marketing, Advertising and
R&D, Design, Brand management,
Commercialization Specialized logistics,
After-sales services

Manufacturing,
Standardized
R&D services Marketing
Knowledge Knowledge

Inputs Markets
Location 1 Location 2 Location 3 Location 4 Location 5

VALUE CHAIN DISAGGREGATION

Source: Mudambi (2008)

12
 Integration of developing countries into the world market and economic development

as it does not destroy both their reputation among other things. (UNCTAD, 2001).
and the quality of products. Examples of such The lead firm has no incentive to transfer
constellations are the lower levels of value substantial knowledge to subcontractors, as
chains in the garment or electronics industries, the lead firm has no control over whether
where different suppliers in one country these subcontractors diffuse such knowledge
compete, as well as many suppliers from to other firms. Countries with very low
different countries compete. It is obviously levels of technological and managerial skills
negative for developing countries when the may benefit and be able to increase their
lion’s share of profits in GVCs is transferred to productivity via subcontracting. However,
lead firms in foreign countries and wages are these positive effects remain on a relatively
pushed to a minimum. This reduces domestic low level.
consumption as a result of the lower income of
workers and company owners. It also reduces Vertical foreign direct investment (FDI) takes
domestic investment through the reduced place when a company wants to optimise its
possibility to use its own funds for investment. production costs by fragmenting each part
Companies under competitive pressure will of the value chain in countries with the least
try to save costs by reducing wages, employ costs. This is similar to subcontracting. But
workers under precarious conditions, or try a lead firm or a big contract manufacturer
to avoid safety and environmental standards. will chose FDI instead of subcontracting if
In the case of subcontracting,12 the risk of they do not want the technology used in the
underutilisation of capacities in times of lower production to spread easily to other companies
demand, as well as the hiring and firing of and/or if it wants to control the supply process
workers is transferred to the subcontracting of its own important inputs and/or if there is
firms (Verra, 1999).13 no suitable firm with the needed technology
and management skills to be found in the
However, vertical value chains can also developing country. In FDI, the likelihood of
potentially create positive effects. In vertical knowledge transfer is higher than in the case
GVCs, a lead firm will directly intervene in the of subcontracting. Local firms can benefit
production of the task of the dependent firm. from technologies and the managerial skills of
The lead firm has an interest in the quality of foreign firms through joint ventures, reverse
the tasks being done to a satisfactory level and engineering, and hiring workers who are
fitting smoothly into the global production being trained for the purpose of working in
network. International subcontracting has FDI firms. Foreign firms can also affect local
two main differences compared to traditional companies through developing supply chains
arm’s length transactions. Firstly, it is of long- in host countries and by forcing local firms to
term nature, as lead firms prefer a longer- increase their quality and standards, as well as
term relationship with reliable suppliers; and help them to increase their managerial skills.
secondly, the level of information that the Companies with market seeking motivation
parent companies provide for its suppliers, may establish research centres in host
such as detailed instructions and specifications countries in order to meet special customers’
for the task, is much higher than in the case demands via product localisation. Especially
of normal market interactions (Grossman / because of the last motivation, big countries
Helpman, 2002). Lead firms for example, can have a higher chance of attracting FDI than Technology and
transfer new machinery to suppliers, provide smaller countries. Technology and skill skill spillovers highly
them with technical support for working spillovers highly depend on the development depend on the
with them, and give some consultancies to level of the host country. If local firms do
development level
subcontractors for managing inventories, not have a sufficiently high technological
of the host country.
production planning, and quality testing, and educational level, it might be difficult

13
 Vietnam in the global economy: development through integration or middle income trap?

to absorb knowledge. The type of FDI (e.g. Fifthly, there are sectors where FDI does not
It is not the rule
wholly owned, joint venture, or mergers and contribute significantly to the development of
that FDI firms will
acquisitions) is important for technological host countries. If FDI is made in the natural
transfer the newest
spillover. For instance, if foreign firms invest resource sector, foreign firms will try to benefit
technologies or
through mergers and acquisitions, the level from some of the rents earned in this sector.
strategic important of technological spillover may be very low as Government policies are necessary to prevent
tasks in a value foreign companies can keep employees and exploitative policies of FDI firms in this sector.
chain to developing production lines unchanged and only displace Additionally, FDI in the retail sector, in order to
countries. the management. A greenfield investment stimulate the selling of foreign products, will
increases the likelihood that the foreign not be very helpful for development. The same
investor transfers technology and skills to the argument holds true for investment in the real
host country. Joint ventures, in comparison estate sector. FDI in this sector will not lead
with wholly foreign-owned companies, to a higher competitiveness of the country.
increase the likelihood of technology and skill Rather, it can add to real estate bubbles in
transfers as a domestic company can directly host countries. FDI in the financial sector can
absorb new technologies and skills. Of key increase the efficiency, but may also reduce
importance is whether the economic policy the credit availability of small and medium-
forces FDI firms to increase the local content sized domestic firms, as foreign owners prefer
of their production and to help to build to give credit to big (and especially foreign
economic clusters. companies) and channel deposits to London
or New York in their home countries where
There are also negative effects of FDI. Firstly, they understand the markets.
FDI firms can, as already mentioned, transfer
all profits to the lead firm. Secondly, FDI There are two key conclusions in respect to
can lead to a crowding out of promising the advantages and disadvantages of FDI for
domestic firms. This is especially the case host countries. Firstly, it appears that a case-
when governments in host countries create by-case evaluation is necessary to come to
favourable conditions for FDI that disadvantage a rational judgement as to whether FDI has
domestic firms. Thirdly, if foreign companies positive or negative effects for host countries.
It appears that invest in host countries only for producing Secondly, government regulations and
a case-by-case and then exporting low value-added goods interventions can substantially improve the
evaluation is or for labour-intensive, low-skill tasks in value quality of FDI and its effects.14
necessary to chains, the advantages for host countries
come to a rational will be low. For example, the assembly of What can we learn from this debate for
judgement as parts in the production of smart phones Vietnam? Vietnam started its Đổi Mới policy
to whether FDI or computers does not bring a lot of new at a very low level of development. We can
has positive or technology to a country. Additionally, positive draw the conclusion that subcontracting and
negative effects spillovers cannot occur if FDI firms import FDI substantially supported the technological
for host countries. all parts and export the produced product level, as well as management and other skills.
without linkages to the domestic economy. In But permanent productivity increases during
Government
any case, it is not the rule that FDI firms will economic upgrading cannot be expected
regulations and
transfer the newest technologies or strategic from foreign firms. Foreign firms only have an
interventions
important tasks in a value chain to developing incentive for a certain level of technology and
can substantially
countries. Fourthly, FDI firms tend to exploit skill transfer. If Vietnam wants to go beyond
improve the quality
existing lax labour market regulations, as this level, it needs to develop its own policies
of FDI and its
well as safety and environmental standards, to do so.
effects.
with some even lobbying for lax standards.

14
 Integration of developing countries into the world market and economic development

The danger of the MIT interventions. At the same time, however,

Only a very
The catching up of countries implies that the they integrated in the world market in a
small number
economic difference between developing controlled and regulated way (Stiglitz, 1996;
of developing
countries and the group of the most Stiglitz / Uy, 1996). It was a type of regulated
developed countries becomes smaller. An counties have
capitalism that guaranteed the success of
indicator to measure convergence is real GDP these countries. China also followed the East managed to catch
per capita.15 Looking at this indicator, only Asian tradition (Herr, 2010). up to the group of
a very small number of developing counties industrial countries
have managed to catch up to the group of The MIT can theoretically occur at any income with the highest
industrial countries with the highest GDP level. A country can trigger a growth process GDP per capita.
per capita. Japan in the 1950s and 1960s, connected with productivity increases for
and later South Korea and Taiwan belong to many reasons. For example, the liberalisation
this small group. Most countries stagnate at of a planned economy can lead to a first
a certain level of GDP per capita in relation economic push as markets start to function in
to the level of top countries. The MIT implies the sector of small and medium enterprises;
that countries in their GDP per capita growth an economy can experience a boom of
reach a kind of glass ceiling, as referred to by exports of labour-intensive, low-tech products
Kenichi Ohno (2009). A country in the MIT when it was not previously integrated in the
has exploited certain engines to increase its world market; a natural resource boom can
GDP per capita and is not able to find new trigger a growth process; inflows of foreign
growth engines. Countries such as Brazil or capital and investment can trigger a growth
Malaysia, which have been stagnating during period; aggressive public spending can create
the last decades at a level of around 20 growth for some time; a real estate bubble
percent of real US GDP per capita, belong to can trigger a period of growth; an aggressive
the category of stagnating countries. While depreciation can trigger domestic growth, etc.
China has managed to catch up quickly, it has (Ohno, 2015). Such growth engines sooner or
still not reached the GDP per capita level of later come to an end. If the country does not
Brazil or Malaysia. Many developing countries manage to increase productivity permanently
stagnate even at much lower GDP per capita (because of low innovative power), and at the
levels in relation to the US (Ohno, 2013; Lee, same time create sufficient aggregate demand
2013). to keep the economy growing, falling into
the MIT becomes likely. It is relatively easy to
Taking into account all the market mechanisms trigger a growth process, but it is much harder
in the area of international trade including to maintain high growth that will lead to a
GVCs, which work against a catching up, it catch up with developed countries.
should not be a big surprise that not many
countries have managed to reach the per After the start of reforms, Vietnam achieved
capita real income level of developed western very high GDP growth rates. However,
countries. South Korea and Taiwan, which growth rates became substantially lower in
were successful in this respect, did not the first decade of the 21st century and even
develop under a regime of free markets in the lower after 2008. It is not hard to imagine
logic of the Washington Consensus (Rodrik, that growth rates of real GDP per capita in
2005; Herr /Priewe, 2005). However, neither Vietnam during the last decade were not
did they develop under a planned economy sufficient for a quick catch up (World Bank,
with all-embracing government interventions. 2015). Another challenge for Vietnam is the
They developed in a constellation of guided level of labour productivity. A recent report by
markets with a combination of market the International Labour Organization (ILO)
mechanisms and comprehensive government revealed that Vietnam’s labour productivity

15
Vietnam in the global economy: development through integration or middle income trap?

was among the lowest in the Asia-Pacific productivity increases do not automatically
region. It is 15 times lower than in Singapore, increase aggregate demand. This means that
11 times lower than in Japan, 10 times lower on the other hand, the country must be in a
than in South Korea, five times lower than constellation of sufficient demand creation.
in Malaysia, and 2.5 times lower than in The basis for sustainable high demand is a
Thailand. It is worth noting that Vietnam’s relatively equal income and wealth distribution
growth of labour productivity shows a and an inclusive growth model. High demand
downward trend. From 2002–2007, labour and high GDP growth itself becomes an
productivity increased by an average of 5.2 engine of productivity increases via economies
percent a year; between 2008 and 2013, the of scale and scope and a fast renewal of the
increase in labour productivity slowed down capital stock. High GDP growth also leads
to an annual average of 3.3 percent (ILO, to high profits in the enterprise sector and
2014). It is therefore not surprising that Ohno stimulates investment and the research
(2015: 4) writes about Vietnam: “However, activities of firms. The role of high demand for
after more than two decades of receiving productivity increases was already stressed by
foreign investment and aid, competitiveness Nicolas Kaldor (1978: chapter 4) and became
of Vietnamese industrial capability falls short known as Verdoorn’s Law (1949). A virtuous
of expectations. Foreign firms are still the cycle is triggered when high GDP growth
main drivers of industrial output and export. based on high demand triggers innovations
Policy ownership and the capability of the and productivity developments and the latter
Vietnamese government to build enterprise stimulate demand and growth.
competitiveness and industrial skills remain
weak – and has not improved in the last two The above analysis makes it clear that a
decades. Large inflows of public and private developing country, which is left to market
money from abroad may have generated a mechanisms, is in high danger of falling
culture of complacency and dependency.” into the MIT. Particularly for a country like
Vietnam with a low productivity level, market
Important for sustainable development is the mechanisms can lead to positive economic
need for a dual strategy. On the one hand, developments for some time and to a certain
productivity has to be increased by innovation extent. However, at the same time, market
and technological and social development. mechanisms lead to the reproduction of
Government intervention in the form of dependency on more developed countries and
industrial policy is needed to increase the prevent developing countries from catching
innovative power of an economy. But high up with developed countries.

16
 Vietnam’s integration into the global economy

Vietnam’s integration into the global economy

Overview of Vietnam’s integration into course, net capital inflows allow the import of
the global economy capital goods, which can increase productivity.
Vietnam integrated very quickly into the However, necessary imports of items such as
global economy. From very low levels of machines are also compatible with a balanced
imports and exports as a percentage of GDP, current account or even a surplus (see for
trade increased sharply where imports were example some of the successful Asian miracle
usually higher than exports. In 2015, the sum countries in their development phase).
of exports and imports as a percentage of
GDP reached around 200 percent (Figure 3). Current account deficits have several negative
This is extremely high compared to Germany, repercussions. They can lead to a lack of
for example, with a value in the same year domestic demand. They also lead to foreign
of around 70 percent, the US with a value of debt, which in the case of Vietnam is debt
around 23 percent, or China with 42 percent in foreign currency. Foreign debt implies
(World Bank, 2016a). Especially for a country a dangerous currency mismatch and the
with a population of over 90 million, this possibility of currency crises.
makes Vietnam more dependent on world
market developments than other countries. Figure 5 shows the development of gross
foreign debt of Vietnam in US dollars. Foreign
Most years, the current account balance in debt after 2005 sharply increased but deceased
Vietnam showed negative values, however, somewhat after 2012. Vietnam’s foreign debt
the last year was more or less balanced (Figure is high, with an actual foreign debt level of
4). In some of the years, the current account 45.2 percent of GDP in early 2016 (IMF,
deficit was very high with values of more 2016). In the case of a strong depreciation of
than 5 percent or even 10 percent of GDP. Of the dong, Vietnam’s foreign debt can become

Figure 3: Development of foreign trade in Vietnam as a percentage of GDP

250.00

200.00

150.00

100.00

50.00

0.00
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
201516

-50.00

net exports exports imports trade openess

Source: Author’s compilation based on General Statistics Office of Vietnam (2016);

trade openness is defined as exports plus imports

17
Vietnam in the global economy: development through integration or middle income trap?

Figure 4: Current account balance of Vietnam as a percentage of GDP

VIETNAM CURRENT ACCOUNT TO GDP

10

-5

-10

-15
1981 1988 1995 2002 2009 2016

Source: Trading Economics (2016)

a high burden. Most of the debt is public Since the coming into effect of the Foreign
debt. Public debt to GDP in 2015 was 58.3 Investment Law in 1987, Vietnam has
percent with an increasing trend; at the end achieved substantial FDI inflows. Measured
of 2014, public debt in foreign currency was as a percentage of GDP, Vietnam reached its
39.9 percent of GDP (IMF, 2016; VietNamNet peak of attracting FDI in 1996. In 2008, as
Bridge, 2015). While official loans to Vietnam a result of joining the WTO, Vietnam again
are shrinking, Vietnam might gradually seek successfully attracted large volumes of FDI
to obtain more risky commercial loans with projects. Due to the negative impact of the
floating interest rates. Therefore, the risk global financial crisis and Vietnam’s unstable
of changing interest rates and exchange macroeconomic development, FDI inflows
rates might substantially increase. Vietnam remained relatively low after 2008, but still
should avoid such a dangerous development reached levels of 5 percent of GDP or more
of foreign debt, which could expose the (Figure 6).
country to currency crises and would make
it economically and politically dependent on Structure of exports and imports in
foreign creditors and donors. Vietnam
Figure 7 and 8 show Vietnam’s export
Current account deficits are only possible if and import structure and its development.
a country can realise net capital inflows or Vietnam’s main export items at present
reduces official foreign reserves. For Vietnam, come from raw products, including mineral
FDI inflows play a big role and finance part resources and agriculture, forestry and
of the current account deficit. However, fishery products. In 2014, this group of
FDI inflows, which do not create foreign products accounted for approximately 50
debt, were not big enough to avoid the percent of exports. Processed products like
accumulation of foreign debt in Vietnam. footwear, textiles, or gaiters accounted

18
 Vietnam’s integration into the global economy

Figure 5: Gross foreign debt in Vietnam as a percentage of GDP

VIETNAM TOTAL EXTERNAL DEBT

60000

50000

40000

30000

20000

10000
1986 1992 1998 2004 2010

Source: Trading Economics (2016)

Figure 6: FDI net inflows in Vietnam as a percentage of GDP

11
10
9
8
7
6
5
4
3
2
1
0
1985 1990 1995 2000 2005 2010 2015

Source: World Bank (2016b)

for about 30 percent of total exports. The raw materials or pre-processed outsourced
industrial sector’s share of Vietnamese trade manufacturing based on labour-intensive and
has been continually increasing over the last low value-added productions. Vietnam mostly
10 years, whereas the period has seen a imports machinery, intermediate products for
significant decline in the relative importance manufacturing consumer goods, and other
of agriculture exports. In general, the main products that are not yet made domestically
export merchandise of Vietnam comprises like cars, motorbikes, and refrigerators.

19
Vietnam in the global economy: development through integration or middle income trap?

Figure 7: Vietnam’s export structure

100%

0%
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Others Plastics and articles thereof

Wood and articles of wood, wood charcoal Articles of leather, animal guts, harness, travel goods
Coffee, tea, mate and spices Fish, crustaceans, molluscs, aquatic invertebrates nes
Furniture, lighting, signs, prefabricated buildings Mineral fuels, oils, distillation products, etc
Machinery, nuclear reactors, boilers, etc Articles of apparel, accessories

Source: Author’s compilation based on General Statistics Office of Vietnam (2016)

Figure 8: Vietnam’s import structure

100%

50%

0%
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Others Knitted or crocheted fabric

Articles of apparel, accessories Optical, photo, technical, medical, etc apparatus
Cotton Fish, crustaceans, molluscs, aquatic invertebrates nes
Vehicles other than railway, tramway Plastics and articles thereof
Iron and steel and articles thereof Mineral fuels, oils, distillation products, etc

Source: Author’s compilation based on General Statistics Office of Vietnam (2015)

Crude oil accounts for approximately 20 Small and medium scale enterprises make up
percent of total exports. The mining sector is 60 percent of these enterprises. However,
also important for exports and characteristic enterprises focusing only on post-processing
for the export structure. According to a account for a negligible proportion. Most
government report to the National Assembly post-processing enterprises employ simple
Standing Committee (8/2012 session), the out-dated technology with low economic
number of enterprises involved in mining efficiency. There are only a few rare materials
has increased rapidly, from 427 enterprises such as tin, zinc, copper, iron, and antimony
in 2000 to nearly 2,000 enterprises in 2014. that have complementary post-processing

20
 Vietnam’s integration into the global economy

industries. Despite the government’s exports low-tech, labour-intensive products. If

Budgetary
guidelines and the Prime Minister’s directives imports of intermediate goods for inputs in
pressures in
to thwart unprocessed raw material exports GVCs are neglected, imports are mainly final
certain provinces
and upgrade processing, this could not consumption goods and investment goods.
and cities led to
be achieved, partly because of illegal raw This is exactly what the Smith-Ricardo model
material exports. In many cases, budgetary predicts. Unfortunately, this also means that the permission of
pressures in certain provinces and cities led to all the fears in the tradition of Friedrich List are natural resource
the permission of natural resource exploitation of key importance for Vietnam. Vietnam finds exploitation and
and acceptance of illegal exports. itself in a structure of international trade, acceptance of
which without comprehensive government illegal exports.
Vietnam’s growth model is heavily reliant on interventions reproduces underdevelopment
trade in natural resources for three reasons: and prevents Vietnam from catching up to
(1) the government’s focus on natural resource developed countries.
exploitation as one of the main development
strategies, (2) as a result of this strategy, The high percentage of natural resource
huge capital investment and investment exports leads to an overvaluation of the
in advanced technology takes place in the exchange rate – at least if the industrial sector
exploitation and post-processing of natural is taken as a reference. Looking at this Dutch
resources, with only limited success, (3) at disease effect, it becomes clear that the
the same time, as mentioned, there are many industrial sector in Vietnam has been suffering
private companies exporting natural resources from an exchange rate that is destroying its
on a low technological level. As a result of this competitiveness. Vietnam also suffers from
development, the depletion and exhaustion the volatility of its natural resource prices.
of resources is accelerated, environmental At the same time, the high percentage of
degradation is expedited, and environmental exports of unprocessed agricultural products
costs became higher. involves the risk stressed by the Prebisch-
Singer hypothesis that these products have to
The proportion of exported services in relation be sold for a very low price, leading to bad
to total exports went down from 11.6 percent terms of trade for Vietnam.
in 2005 to 7.6 percent in 2012 and 7.6 percent
in 2014. More importantly, Vietnam’s service FDI inflows are of great importance for
trade balance has been constantly negative. Vietnam’s international trade. Figure 9 shows
As reported in the Online Newspaper of the the structure of the stock of FDI in Vietnam
Vietnamese Government from 13 January in 2015. FDI projects mainly focused on the
2013, only tourism achieved surpluses, while industrial sector and significantly contributed
other crucial services such as transportation, to the process of economic restructuring
telecommunication, finance, insurance etc. all towards industrialisation. A study conducted
suffered from deficits. by the Central Institute for Economic
Management (CIEM) in 2006 showed that
Looking at the structure of international trade while FDI in the 1990s mainly focused on the
and services in Vietnam, the Smith-Ricardo mining industry and import substitution, since
model is largely confirmed. A large proportion 2000, FDI in the processing industries and
of Vietnam’s exports originate from absolute export-oriented fields has been increasing
advantages. This is the case for natural significantly contributing to a surge in
resource exports like crude oil and minerals, Vietnam’s total exports and imports in recent
as well as for most agricultural exports whose years (Tue-Anh et al., 2006). Around 30
competitiveness largely depends on the climate percent of the stock of FDI – a relatively high
in Vietnam. In the industrial sector, Vietnam figure – is in the real estate sector in Vietnam.

21
 Vietnam in the global economy: development through integration or middle income trap?

Figure 9: Structure of FDI inflows to Vietnam, stock of FDI in 2015

Logistics, 3.81 Entertainment Other sectors, 8.20

sectior, 3.64 Mining, 3.39
Information and
communication Agro-forest-fishery
sector, 4.16 sector, 3.84

Commodities market, 4.28

Electricity, gas, and water, 9.90

Accommodation and
food services, 11.25

Construction, 11.63

Manufactured goods, 151.46

Real estate sector, 50.10

Source: Author’s compilation based on General Statistics Office of Vietnam (2016)

FDI in this area has added to the real estate Relatively high labour productivity expected
bubble in Vietnam, and has not been very from the FDI sector is generally thought to
helpful for industrial upgrading. spread to other sectors. However, the case of
Vietnam needs to be considered carefully. The
Due to legal regulations, FDI projects overall productivity development in Vietnam
registered in Vietnam until the mid-1990s is, as shown above, slow and the productivity
largely took the form a joint venture between effects of FDI have been disappointing. The
SOEs and foreign investors. At the end of analysis of how Vietnam is integrated in GVCs
1998, the number of joint ventures accounted makes this point clearer.
for 59 percent of total projects and 69 percent
of total registered capital. Since 1997,
GVCs in industrial productions
ownership restrictions have been removed.
Vietnam is integrated in GVCs. It exports
The overall This had a strong impact on the ownership
and imports large volumes of intermediate
productivity structure of FDI. In 2006, joint venture projects
goods. From the volume of trade especially
development were reduced to just 42.5 percent of total
the textile/garment industry, shoemaking/
in Vietnam is registered foreign capital, while projects with
leather industry, and the electronics industry
slow and the 100 percent foreign capital accounted for
are important to understand Vietnam’s
productivity effects 45.5 percent. Among joint venture projects,
integration into GVCs. In this section these
of FDI have been those between foreign investors and private
Vietnamese enterprises increased significantly three industries are analysed in more detail.
disappointing.
(Tue-Anh et al., 2006). Other sectors where Vietnam is integrated in

22
 Vietnam’s integration into the global economy

GVCs are coffee, tea, and the shrimp farming drop in costs for fibre materials. According to
In the textile and
industry (Tran et al., 2013). the VITAS, in 2015, 52.8 percent of apparel
garment industry,
exports went to the US (Bangladesh 24.1
Vietnam is in
Textile and garment industry percent), while 17 percent was exported to EU
the exploitation
Following the launch of the transition process countries (Bangladesh 59.7 percent), followed
from a planned to a market economy in by Japan, and South Korea (VISTA, 2015). curve, located at
1986, the textile and clothing industry Typically, production in global textile and the lowest level
was one of the first industrial sectors that apparel value chains is divided into five basic with the lowest
starting growing. This trend has continued stages: (1) supply of raw materials, including value-added.
until today and got an additional boost natural cotton, thread, etc.; (2) production Remaining at this
following Vietnam’s accession to the WTO of intermediate goods; products of this level does not open
in 2007. The textile and clothing industry stage are fibres, fabrics provided by weaving, a development
plays a major role in Vietnam’s growth. knitting, and dyeing companies; (3) design perspective.
Ready-made garments (RMG), i.e. clothing and manufacture; finished products used by
products and leather products, contribute garment companies; (4) export by commercial
substantially to the proceeds of the export- intermediaries; (5) marketing and distribution
based Vietnamese economy (Sarah, 2011). (Tot, 2014). The highest value-added is earned
Currently, Vietnam ranks fourth among the in design, marketing, and distribution. The
largest clothing exporters, surpassed only by lowest value-added is in the Cut, Make, Trim
China, Bangladesh, and India (Kak, 2015). (CMT) process. However, in the GVC, Vietnam
is now mainly engaged in CMT, which has
The Vietnamese Textile and Apparel low value-added and is characterised by a
Association (VITAS) estimated that in 2015, labour-intensive production process. Eighty-
the sector comprised a total of more than five percent of Vietnamese enterprises in the
5,000 companies, including approximately sector are engaged in CMT. The remainder
4,500 sewing rooms, 500 weaving mills, and mainly occupy finished product sourcing
100 spinning mills. The annual production is (FOB), but it is still FOB at level 1, which means
5,000 tons of wool, 200,000 tons of yarn and that Vietnamese enterprises are engaged in
fibres, 1.4 billion tons of cloth, and 3 billion subcontracting without much freedom of
ready-made clothing products. In 2015, textile their own (Tot, 2014).
and apparel accounted for 13.6 percent of
Vietnam’s total export value. Accordingly, the In sum, in the textile and garment industry,
sector ranks second in manufacturing after Vietnam is in the exploitation curve, located
electronic products in terms of net proceeds at the lowest level with the lowest value-
(Schweisshelm, 2016). added. Remaining at this level does not open
a development perspective.
In 2013, the share of Vietnam in the global
apparel export market was 3.7 percent Shoemaking and leather industries
(Kak, 2015). The VITAS forecasts a total The shoemaking industry also plays an
export volume that grows much faster than important role in the Vietnam’s export
in China or India. In 2015, approximately economy. Vietnam is the world’s third largest
US$24 billion was achieved in export value. exporter of shoes and handbags after China
However, approximately US$12 billion and Italy. In 2013, the most important markets
must be detracted due to the import of were the US (Vietnam is the second most
intermediate products, such that the value- important supplier for the US behind China),
added in the industry would be approximately followed by Belgium, and Germany. With
US$12 billion in 2015. Further growth is not free trade agreements (FTAs) in the pipeline,
unrealistic given the drop in oil prices and the the Association of Vietnamese Footwear,

23
 Vietnam in the global economy: development through integration or middle income trap?

Leather and Bag Producers (LEFASO) expects Electronics industry

a substantial increase in exports of their The electronics industry is Vietnam’s biggest
products over the coming years (Dezan, export-earner. The largest single investor,
2015). According to government sources, the Samsung, now produces more than half of
shoemaking industry employs around 1 million its smartphones globally in Vietnam; Intel,
workers in 600 companies. The Vietnam Foxconn, and others are following suit.
News from 28 February 2015 reported that According to the evaluation of the Electronic
77 percent of the export value in the shoe Industries Association of Vietnam (VEIA),
making industry for 2015 was generated in Vietnam is one of the largest manufacturing
FDI companies. One contributing factor to hubs of mobile phones, photocopy machines,
the growth of the sector is the increasing printers, etc. in the world. The export of
number of companies relocating production electronics and components in 2013 grew to
from China and Bangladesh to Vietnam. This over 34 percent of Vietnam’s export basket
can be explained by relatively low wages in (VEIA, 2014). However, the value-added is
Vietnam, its strategic geographic location, still low and raw materials have mainly been
and the perspective of upcoming FTAs with imported. In 2014, Vietnam’s electronics
major economic powers. With its lower industry exported over US$32 billion worth of
wages and production costs, India is the main products, but imported goods of US$28 billion
competitor for the industry. (VEIA, 2014). It is noteworthy that the local
content in the electronics industry is limited to
In this sector, Vietnam’s dependence on assembling on the basis of low wages. Most
imported pre-fabrics, mainly from China, intermediate parts are either imported from
South Korea, and Taiwan, is high. Raw China, partly because of China’s location in
material for the production of leather shoes relation to Vietnam and the easily accessible
accounts for 80 percent of the value of ports down its coast, which gives Vietnam an
shoes. Vietnam’s enterprises only produce advantage over Thailand or Cambodia (Lac,
limited items for shoe production, such as 2015; Hung, 2015), or from South Korea,
labels, laces, etc., but completely ignore other with which Vietnam has recently concluded a
accessories such as eyelets, hooks, beads, trade agreement that helps Korean electronic
ornaments, etc. Most Vietnamese businesses companies move production offshore to
in the footwear sector are small and medium- Vietnam.16 A recent survey conducted by the
sized and lack capital, advanced technology, Central Institute for Economic Management
high-quality human resources, initiatives (CIEM) showed that enterprises with 100
by other industries for improvement, and percent foreign investment in the electronics
good management. Both Vietnam News industry in the provinces of Hung Yen, Hai
in its issue from 11 December 2014 and Duong, Ba Ria-Vung Tau, Binh Duong, and
The logic of the Vietnam Business Forum from 26 December Dong Nai performed only the simplest phases
exploitation curve 2014 reported low labour productivity in of the production chain, while the design and
also applies to the sector.. The production of Vietnam’s other sophisticated phases of production were
the shoemaking footwear industry is mainly export-processing; determined by the parent company abroad.
industry where design capability is weak. Seventy percent A study conducted by the Fulbright School in
Vietnam of businesses depend entirely on foreign Ho-Chi-Minh City draws the same conclusion.
concentrates on resources, technical equipment, technology, The process of industrial upgrading, moving
low value-adding, design, and marketing (Hung, 2015). In up the value chain, and gaining a strong
low-tech, substance, the logic of the exploitation curve foothold in global supply chains is slow.
labour-intensive also applies to the shoemaking industry where Value-added from the manufacturing sector
tasks in the GVC. Vietnam concentrates on low value-adding, as a percentage of output declined steadily
low-tech, labour-intensive tasks in the GVC. from 31 percent in 2000 to 21 percent in

24
 Vietnam’s integration into the global economy

2005, and to only 13 percent in 2013 (Tue- in 2009, Vietnam signed a comprehensive
The unregulated
Anh et al., 2014). Economic Partnership Agreement (EPA) with
market mechanism
Japan, which is essentially a bilateral trade
will not lead
To sum up: the three key industries looked agreement. (4) Vietnam concluded a number
to sufficient
at in Vietnam are highly integrated in GVCs. of important trade agreements, including the
However, tasks taken over in Vietnam are Trans-Pacific Partnership Agreement (TPP) upgrading in
mainly low value-adding, low-tech, labour- and the Vietnam-EU FTA. Both could be Vietnam and will
intensive productions. The local content is considered as a high-standard FTA, affecting not allow living
relatively small and intermediate products many fields in the economy and society. In standards in
are mainly imported. In the framework of these agreements, tariff cuts are negotiated Vietnam to catch
the exploitation curve, Vietnam is located at over different periods of time. An overview of up to that of
the lowest level. In the textiles and garment recent agreements is shown in Table 3. more developed
industry and shoemaking and leather countries.
industry, subcontracting and small and The TPP will be especially important for
medium-sized companies play an important Vietnam over the next decade. The debate
role. The technological and managerial level about the TPP revolves around the question of
of most of the enterprises in this sector is low what economic benefits Vietnam would enjoy
in comparison to other countries. Economies if it participated in the completion of the TPP.
of scale are not sufficiently exploited. In The study by Petri et al. (2011) is being widely
the electronics industry, FDI firms dominate discussed in Vietnam. This study argues that
the production of low value tasks. Here, Vietnam would be the largest beneficiary of
economies of scale are exploited. However, the TPP. It is cited as the key economic reason
the local content, the transfer of technology, Vietnam joined the negotiations, and has
and spillover effects to Vietnamese firms and bolstered a growing number of pro-TPP voices
other industries are disappointing. There among the public. The World Bank (2016)
are not many linkages between FDI firms also expects more gains than losses from
and domestic firms. It is obvious that the the TPP. According to a World Bank report,
unregulated market mechanism will not lead Vietnam’s export in apparel and footwear
to sufficient upgrading in Vietnam and will will increase by about 50 percent. The effects
not allow living standards in Vietnam to catch of the TPP can be exemplified by the textile
up to that of more developed countries. sector. In this sector, the TPP will incorporate
Vietnam into the GVC to an even greater
Effects of FTAs extent than has previously been the case.
The economic integration process of TPP member countries represent 40 percent
Vietnam started in 1995 with four significant of global GDP and 30 percent of world trade
milestones. (1) Vietnam negotiated and volume. Vietnam could overtake Bangladesh
signed a bilateral trade agreement with the US in exports in a few years in terms of its market
in 2000. This was an important rehearsal for share in global exports. According to a recent
Vietnam’s broader participation in FTAs and report of the World Bank, if the TPP takes
WTO membership. The US agreement allowed effect, Vietnam’s garment and textile sector
Vietnam to reach the largest export market in could grow by 41 percent by 2020 (World
the world without discrimination. (2) Vietnam Bank, 2016).
joined the Association of Southeast Asian
Nations (ASEAN) and the ASEAN Free Trade These very optimistic expectations are in
Agreement (AFTA) in 1995, followed by an contrast to persistent problems occurring in
FTA with other additional partners (ASEAN+) the Vietnamese apparel, footwear, textile,
in 1997. (3) Vietnam joined the WTO in and clothing industries. The industries
January 2007. Along with these agreements, complain about rising labour costs and their

25
Vietnam in the global economy: development through integration or middle income trap?

Table 3: Overview of Vietnam’s trade agreements

Agreed
Agreements Adjustment time tariff cuts Timing

WTO (World Trade Organisation) 01/01/2007 – 31/12/2018 35.5% 12 years

AFTA (ASEAN Free Trade Area) 1996 – 01/01/2018 ~100% 22 years

ASEAN (Association of Southeast 01/7/2007 – 01/01/2018 90% 10 years

Asian Nations) – China

ASEAN – South Korea 01/06/2007 – 01/01/2018 87% 11 years

ASEAN – Australia and 01/01/2010 – 01/01/2020 90% 10 years

New Zealand

ASEAN – India 01/01/2010 – 31/12/2020 78% 11 years

ASEAN – Japan 01/12/2008 – 31/3/2025 88.6% 16 years

Vietnam – Japan 01/10/2009 – 31/03/2026 92% 16 years

Vietnam – Chile 01/01/2014 – 01/01/2029 87.8% 15 years

Vietnam – South Korea Signed 5/5/2015 89.9% 15 years

Vietnam – Eurasian Signed 29/5/2015 87.8% 10 years

Economic Union

Vietnam – EU Signed 02/12/2015 – 99% 10 years

Implementing 2018

Trans-Pacific Strategic Economic Signed 02/2016 – ~100% 16 years

Partnership (TPP) Implementing 2018

Source: Vietnamese Ministry of Foreign Affairs (2016)

dependence on imported raw materials and Foreign investors from Asian countries in
intermediate goods. One of the conditions the textile, garment, apparel, and footwear
attached to the TPP is that intermediate sectors in Vietnam are so far only interested
goods for exported goods going to TPP areas in Vietnam as a low-wage assembling site
on preferential terms must come from a TPP in the global supply chain. There is a need
member country. Yet, China and South Korea for the domestic industry to invest heavily
for example (neither being TPP member in downward linkages of the value chain.
countries) together account for 54 percent of A number of Vietnamese companies are
all imports in the textile and clothing industry already starting or expanding their own
and are Vietnam’s main source of intermediate fibre manufacturing operations in order to
products (World Bank, 2016). Imports from not be left behind when the TPP is finally
other countries might be substantially more implemented. But foreign investors are also
expensive than imports from China or South flocking to see the establishment of spinning,
Korea. knitting, and dyeing factories in Vietnam. It is

26
 Vietnam’s integration into the global economy

important that the government supports local the logic of the Smith-Ricardo trade model
Foreign investors
producers in the transition period to the full with all the negative consequences of such a
from Asian
enforcement of the TPP rules in order to climb specialisation.
countries in the
up the value chain, establish local brands, and
textile, garment,
also encourage upward linkages in terms of In case of the TPP, as well as in any other
exporting marketing strategies. In that sense, FTA, there are hopes that further trade apparel, and
the TPP agreement could serve as a “driver” deregulation will lead to a stimulation of footwear sectors in
for more upstream investment and downward GDP growth. Caution is also needed here. Vietnam are so far
linkages in the textile sector. How GDP develops after trade deregulation only interested in
largely depends on the development of the Vietnam as a low-
The same situation more or less prevails in the current account balance and especially the wage assembling
electronics sector. Here also, as shown above, trade balance, and not on the development site in the global
the local content is limited to assembling of single export industries. While Vietnam supply chain. There
on the basis of low wages. Large foreign is pleased about the substantial advantages is a need for the
companies are dominating, which makes it the TPP will have in some industries, for domestic industry
even more difficult to trigger an upgrading of example, increasing export in apparel and to invest heavily in
Vietnamese enterprises. footwear by about 50 percent, there are downward linkages
substantial disadvantages in other industries, of the value chain.
Overall, Vietnam is deeply integrated in global which have somehow been forgotten in the
supply chains. However, Vietnam’s export debate. It is implicitly assumed that there is
industry is located at the low-end side of a clear relationship between the deregulation
production with few upward and downward of trade and surpluses (reductions of deficits)
linkages and little local content. In some of the in the trade balance of a country. But such
sectors, foreign companies play a paramount an idea is simply wrong. If net capital flows
role for exports. They can easily leave Vietnam between a country and the rest of the world
to switch productions to other countries do not change, no FTA can change the current
worldwide. account balance of the country in question.
This is what we can learn from David Ricardo
There are open questions about the long-term (1817). Ricardo made the assumption of capita
effects of the TPP on a more fundamental immobility, which implies that the current
level. It appears that the TPP will integrate account is always balanced by definition.
Vietnam deeper into existing GVCs and A switch to more free trade in the logic of
lead to a further specialisation of its export Ricardo correctly benefits some industries,
and production structure. There is a high while others suffer. Can we expect higher
likelihood that this specialisation will not net capital outflows from Vietnam to the rest
lead to economic upgrading – there is no of the world after the TPP is implemented?
good argument that the market mechanism This is hard to predict, probably the opposite The specialisation
will lead to such an upgrading. A further might be the case or net capital flows will not Vietnam may
specialisation in low-tech, labour-intensive change to a large extent. In any case, if there experience under
productions may even reduce the chances of are extremely positive developments in some the TPP fits the
longer-term upgrading. In a comprehensive industries caused by the TPP, there must be logic of the
study, Jean Imbs and Romain Wacziarg (2003) extremely negative effects in other industries, Smith-Ricardo
found out that successful developing countries for example, in agricultural production. The trade model with
in their development phase did not specialise involved structural changes are probably a all the negative
but developed a diversified and broad export challenge for Vietnam’s economy. consequences
and production structure – just the opposite of such a
expected for Vietnam. The specialisation In the usual calculations of the positive effects specialisation.
Vietnam may experience under the TPP fits of free trade, the efficiency gains in the logic of

27
 Vietnam in the global economy: development through integration or middle income trap?

Ricardo are calculated. But these are potential

How GDP
gains. If sufficient demand stimulation is
develops after
missing or structural adjustments are difficult,
trade deregulation
free trade will not lead to positive welfare
largely depends on
gains even in the short-term – not to mention
the development the negative long-term effects of free trade
of the current for developing countries. As an empirical
account balance fact, the era of free trade after the 1980s did
and especially the not bring higher worldwide growth than the
trade balance, first decades after World War II with more
and not on the regulated trade and capital controls. Overall,
development Vietnam is well advised to be cautious in its
of single export growth and employment expectations of the
industries. TPP and other FTAs.

28
 The role of industrial policy for development

The role of industrial policy for development

Principles of industrial policy even a big one, cannot coordinate all these
Industrial policy is needed in all countries in activities. Therefore, a new production or Governments
the world. This is even more so the case in innovation will most likely never take place have to create a
developing countries, which suffer from a without government intervention. In a vision, together
number of market mechanisms that reproduce developing country, FDI can take over such with society as
underdevelopment. The reason for this is functions. In such a case, FDI must flow into whole, about the
that there are two fundamental coordination the right areas and must build up backward direction in which
failures the private sector has difficulties and/or forward linkages. But such types technological
solving (Rodrik, 2004; 2008; Stiglitz, 1996). of FDI are an exception. An FDI firm’s main development
Firstly, there are information externalities. An objective is not the development of a country; should go.
innovation, the production of a new product their objective is to make money for a foreign
previously produced in other countries, owner living in a foreign country.
and the application of a new technology
to produce goods, etc. involve a process of Ha-Joon Chang (1994) makes a similar
discovery or entrepreneurship. By virtue of its argument. He stresses that governments
very character, new things are risky and can have to create a vision, together with
fail; the more fundamental the change is, the society as whole, about the direction in
higher the (not calculable) uncertainty. The which technological development should
high level of uncertainty makes it difficult go. Only such a vision allows the concerted
for private investors to invest alone in new action of societal forces to implement
activities. To make matters worse, if a firm new developments. All changes in society,
is successful in producing a new product, including positive changes, produce losers.
follower firms can, in many cases, easily imitate Part of industrial policy is to compensate the
the successful firm’s product and can also losers and allow a relatively smooth structural
enter the new production. To put it differently: change. If losers are not compensated, they
the social rate of return of a discovery process may block structural change.
is much higher than the private return. This
gives governments an incentive (and a need) A good example for industrial policy is the
to support new activities. creation of the world-class orchid industry in
Taiwan (Rodrik, 2004: 8; Wei et al., 2010).
Secondly, there are coordination externalities. Taiwan used to be a traditional exporter of
Most new productions need a high level of sugar. In the late 1990s to early 2000s, due
investment. Economies of scale and scope to intensive international competition, this
prevent, in many cases, innovative firms industry came under pressure and could no
from starting on a small scale. Even more longer survive in Taiwan. As a result, Taiwan
importantly, in many cases, a number of decided to grow orchids. The government
activities are needed, which go far beyond a paid for a genetic laboratory for orchids,
single firm. A new production of a firm may a quarantine site, shipping and packing
need new infrastructure from transportation areas, new roads, water and electrical hook-
possibilities to communication, which cannot ups, and an exposition hall. Private farmers
be handled by a single firm. A firm may need built greenhouses. In 2001, the Taiwan
its employees to have specific skills, it may Orchid Growers Association, a non-profit
need other firms that produce complementary organisation, was founded with the aim of
goods, or inputs, or to buy the new product, promoting the development of the Taiwanese
etc. In all these cases, an innovative firm, orchid industry.

29
 Vietnam in the global economy: development through integration or middle income trap?

Another example is the abandoning of nuclear of things. For instance, should primary
Problems related to
power in Germany, which would never have education, vocational education, or university
the vested interests
been triggered by the private sector. After education have priority? Are engineers or
of stakeholders
the 2011 Fukushima nuclear catastrophe in managers more important? In which direction
and corruption can
Japan, the German government decided to should research be supported, which streets,
make industrial shut down its last remaining nuclear power ports, airports, and electric grids should be
policy very difficult. station in 2022. Even before this, the German built and where? In addition, especially for
government had already been subsidising developing countries, horizontal industrial
solar and wind energy for a number of years. policy is not sufficient. For industrial policy, it
Thousands of small electric current producers, is important to intervene more directly and in
who had the right to sell their surplus electric a selective way in technological and industrial
current to big electric power producers, were development to overcome information and
created. The infrastructure is built to bring coordination externalities. If in developing
electric power from big offshore wind farms countries, industrial policy is sometimes not
in the north of Germany to the industrial possible due to government failure; a catch
centres in southern Germany. A compromise up of the country is simply not possible. This
with coalmines was found to fade out coal- explains why so many developing countries
based power plants based over a period do not develop, even when they follow
of time. Washington Consensus policies.

There is no doubt that a country without How can government failure be minimised?
a comprehensive industrial policy cannot Of key importance is the flow of information
develop. Thus, the question is not why, but between the government and the enterprise
how to carry out industrial policy (Rodrik, sector and the creation of a process that selects
2008; Ohno, 2015). The question is whether policies in a rational way and checks mistakes.
the government is better than the private Dani Rodrik (2004: 3) gives a good summary of
sector at deciding in which direction to this idea: ”The right model for industrial policy
invest. Is a bureaucrat, probably far away is not that of an autonomous government
from enterprises, able to decide in a rational applying Pigovian taxes or subsidies, but of
way which industries and which companies strategic collaboration between the private
should be supported and which should not? sector and the government with the aim
In addition, problems related to the vested of uncovering where the most significant
interests of stakeholders and corruption can obstacles for restructuring lie und what type of
make industrial policy very difficult. One interventions are most likely to remove them.
could come to the conclusion that the danger Correspondingly, the analysis of industrial
of government failure is bigger than market policy needs to focus not on the policy
failures. Given these arguments, governments outcomes – which are inherently unknowable
should be restricted to horizontal industrial ex ante – but on getting the policy process
policies in line with the Washington Consensus. right.” Institutions have to be created with
This means that governments should invest government and employer associations at the
in general education, general R&D, general centre, but also by including trade unions and
infrastructure, etc. Of course, these types of civil society.
horizontal industrial policies are important.
But it is an illusion that these policies would Rodrik (2004) gives ten principles for industrial
avoid far-reaching discretionary government policy that can also serve as a guideline for
decisions with widespread repercussions. industrial policy in Vietnam.
Looking more closely at horizontal industrial (1) Incentives should be given only for
policy, governments need to decide a lot new activities. This means activities

30
 The role of industrial policy for development

that increase the productive power These guidelines could be adapted to the
An overvalued
of the country. There should be no Vietnamese context. We will come back to this
exchange
discrimination. Private companies, SOEs, point in the recommendations for Vietnam.
rate makes
small and big companies should qualify
the industrial
if they can deliver something new. The role of the exchange rate
(2) There should be clear benchmarks or Some may be surprised to find a subsection development of a
criteria for success or failure. These about the exchange rate under the section country difficult,
criteria need to be checked. of industrial policy, but this is no accident. whereas an
(3) There should be built-in sunset clauses. Exchange rate policy is probably the most undervaluation
After an appropriate period of time, successful horizontal type of industrial policy. supports the
support has to be reduced and faded An overvalued exchange rate makes the industrial sector
out. industrial development of a country difficult, and makes it
(4) Governments should support activities whereas an undervaluation supports the competitive.
not whole sectors. To support the industrial sector and makes it competitive.
tourism or electronics industry is not Despite the fact that David Ricardo (1817)
sufficient. Specific activities that support neglected the negative dynamic effects of
innovation and productivity need to be free trade on productivity development in less
selected. developed countries, there are two important
(5) Supported activities should have spillover lessons to be learned from him. The first one,
and demonstration effects. They should as already mentioned above, is that in case
crowd in additional investment and there are no international capital flows (or net
productivity gains. flows are zero), the current account balance
(6) The authority implementing industrial must be zero. The second one is that a real
policy should demonstrate that they are exchange rate will be established – which
qualified and not corrupt. keeps the current account between the two
(7) Implementing authorities should be countries balanced.
closely monitored by political authorities
of the highest level. A cabinet minister or The Ricardo model assumes a functioning
even president or prime minister should exchange rate mechanism, which depends on
be directly in charge of supervising a number of conditions and does not always
and controlling industrial policy and its work smoothly.
implementation.
(8) The implementation agency for Firstly, a real depreciation does not always
industrial policy should have direct and improve the current account imbalance. The
close information channels with the so-called Marshall-Lerner condition has to
enterprise sector. be fulfilled. This condition states that the
(9) Mistakes of industrial policy will occur. absolute value of the import elasticity plus
It would be a bad sign if no mistakes the export elasticity of a real exchange rate
happened. The private sector also makes movement must be bigger than one to lead to
mistakes in its investment decisions. a “normal” reaction. If, to make an example,
What is important is to detect mistakes a real depreciation does not reduce the
early and minimise their cost. quantity of imported goods, and at the same
(10) Industrial policy is a process. time the export quantities do not increase,
Implementation agencies should be the Marshall-Lerner condition is not fulfilled.
on a path of permanent learning form The likelihood of high import and export
mistakes and successes. elasticities is reduced if a country is integrated

31
 Vietnam in the global economy: development through integration or middle income trap?

in GVCs with high imports of intermediate constellation in which nominal depreciations

Countries that
goods. In developed countries, the Marshall- lead to such an enormous domestic
allow high foreign
Lerner condition holds. In developing inflationary push that the real exchange rate
debt in foreign
countries like Vietnam, the Marshall-Lerner does not change. A high inflationary path-
currency and
condition may not hold or very large exchange trough is likely when the negative effects
international rate movements may be needed to balance of falling real incomes, which accompany
institutions that do the current account. For Vietnam, empirical a real depreciation, are not accepted by the
not warn countries investigations have shown a typical result population and demands for nominal income
against this, for developing countries. A real depreciation increases are fulfilled. If for example a cut in real
are acting in an will have a significant negative impact on the wages immediately leads to a nominal wage
irresponsible way. trade balance in the short-term. However, the increase, a depreciation-inflation-wage-price
trade balance will improve over the long-term spiral is triggered, leaving the real exchange
(Trinh, 2014). rate unchanged. The higher the import quota
and the bigger the real depreciation, the
Secondly, a high level of foreign debt bigger the negative real income effect of the
denominated in foreign currency makes depreciation, and the bigger the challenge to
depreciations difficult. The problem is that keep nominal domestic incomes unchanged.
depreciations increase the real debt burden of Finally, connected to the last point, a
debtors in foreign currency. The consequences real depreciation can lead to political
are liquidity and solvency problems of debtors destabilisation. For example, when a large part
in foreign currency. In addition, for foreign of the consumption basket of the population
debt, the domestic central bank cannot take is imported. If income inequality is high, a
over the function as a lender of last resort. real depreciation can push part of society into
Dollarisation (or euroisation), which means (deeper) poverty. Political destabilisation is
domestic debt in foreign currency, aggravates therefore possible.
the problem. High debt in foreign currency
leads to a fear of floating as sufficient Despite these problems, real depreciations
depreciations are prevented due to the danger have a number of positive effects for
of financial crises (Calvo / Reinhart, 2002). medium and long-term development: (a)
If a big depreciation cannot be avoided, real depreciations increase the profitability of
the outcome is a twin crisis: a crisis of the companies in the exporting sector across the
exchange rate and a crisis of the domestic board; (b) real depreciations can be substantial
financial system (Kaminsky / Reinhart, 1999). and quick; (c) export activities are stimulated,
Countries that allow high foreign debt in which have to compete on the world market
foreign currency and international institutions (and which provides the best benchmark for
that do not warn countries against this, are efficient companies); (d) the subsidies for
acting in an irresponsible way. High foreign export activities are market-friendly and do
debt takes away from countries the very not require a bureaucrat to decide which
important macroeconomic instrument of company should be subsidised. Dani Rodrik,
exchange rate adjustment. Vietnam should using these arguments, summarises: “For
therefore reduce foreign debt as quickly as all these reasons, a credible, sustained real
possible. exchange rate depreciation may constitute
the most efficient industrial policy there
Thirdly, a nominal depreciation may not lead is.” (Rodrik, 2005: 2002) A level of the real
to a real depreciation of a currency. Countries exchange rate, which makes the domestic
that suffer from a high inflation path-trough industry internationally competitive, is a
of nominal depreciations can be caught in a permanent positive industrial policy.

32
 The role of industrial policy for development

Aggregate demand is investment plus Only FDI was welcomed. China’s central bank
For Vietnam, a
consumption plus government demand plus intervened massively in the foreign exchange
balanced current
exports minus imports. Countries with a deficit market and bought hard currency to keep the
account or even
in the current account tend to suffer from a renminbi undervalued (Herr, 2008).18 Capital
a moderate
lack of demand. In many cases, investment, controls and central bank interventions do not
consumption, and government demand do only allow exchange rate development (which surplus is the best
not compensate for a negative trade balance. is beneficial for a country); it also allows the constellation for its
Or to put it differently: as long as capacities in a prevention of high foreign debt in a foreign development.
country are not fully utilised, an improvement currency. Lastly, capital controls can give a
of the current account stimulates domestic country the space to follow domestic oriented
demand, output, and employment. Countries monetary policy. Without such controls, a
with a lack of domestic demand can follow central bank in a country that does not issue an
an export-led growth strategy. Many of important international currency has to follow
the most successful developing countries the worldwide interest rate development.
followed such a strategy (Herr, 2010). From
a global perspective, not all countries in the Under a regime of uncontrolled international
world can have current account surpluses. For capital flows, flexible exchange rates do not
a stable development of the global economy, prevent negative economic developments.
current account imbalances should even be Countries with flexible exchange rates can still
limited. For countries that can only get foreign have current account deficits and foreign debt
debt in foreign currency, current account as high as countries with fixed exchange rates.
deficits financed by foreign debt is very risky. An exchange rate regime with an adjustable
Unpredictable developments at home or in peg or a regime with managed floating, both
the global economy can lead to a sudden stop combined with capital controls, seems to best
in capital inflows and sudden capital outflows. suited for developing countries like Vietnam.
The country is then trapped in a twin crisis, Vietnam has a tendency to overvalue the
which can lead to a period of long-term low exchange rate of the dong. During the last
growth. For Vietnam, a balanced current decade, the current account balance of
account or even a moderate surplus is the Vietnam, as well as the trade balance, was in
best constellation for its development. In any many years negative. If one takes into account
case, Vietnam should avoid current account that a substantial part of Vietnam’s exports are
deficits and should follow an exchange rate natural resources, it becomes obvious that the
policy that prevents such deficits.17 exchange rate of the dong makes it difficult
for Vietnam’s industrial sector to become
An exchange rate policy that protects the competitive. A cautious medium-term real An exchange rate
domestic economy cannot leave capital flows depreciation of the dong seems to be optimal regime with an
and exchange rate movements to market to support industrial development in Vietnam. adjustable peg
forces. For example, a country with net capital or a regime with
inflows (and no central bank interventions) Overview of Vietnam’s industrial policy managed floating,
will be pushed in current account deficits. The national Socio-economic Development both combined
To avoid such a scenario, a country needs Strategy (SEDS) is a master plan that governs with capital
to control capital inflows. China serves as a Vietnam’s industrial policy framework for controls, seems
good example in this policy area. From the each 10 years. In this strategy, two five-year to best suited
beginning of its transition at the end of the socio-economic development plans, as well as for developing
1970s until now, China has had limited capital numerous sectorial and industrial roadmaps
countries like
inflows. Foreign portfolio investment and are introduced. It is the responsibility of the
Vietnam.
foreign bank credits were strictly controlled. Ministry of Industry and Trade to implement

33
 Vietnam in the global economy: development through integration or middle income trap?

and supervise industrial strategies and plans, business climate 2.0; power and logistics 2.8;
Local governments
while the Ministry of Planning and Investment export promotion 1.6; strategic FDI marketing
at different
has the role of implementing the five-year 1.7; industrial parks 2.2; supporting industries
levels have been
plans within the SEDS, including coordination and FDI-local firm linkage 1.5; productivity,
powerful players
with the private sector through its Foreign technology, and innovation 1.4; and standards
in economic Investment Agency, Enterprise Development and testing 1.5. In his ranking, countries like
decision-making Agency, and Department of Economic Zones Singapore, Japan, and South Korea score
and increased (Tue-Anh et al., 2014: 14f.). much higher than Vietnam (with overall
their respective values over 4), whereas India and Rwanda are
bargaining power Since 1996, the Communist Party of Vietnam behind Vietnam.
vis-à-vis the central (CPV) has set a target of turning Vietnam
government. into a modern and industrial country by There are several reasons why Vietnam’s
2020. Since then the words “industrialisation industrial policy has only been partly
and modernisation” have always been successful. Firstly, its central-local
together (CPV, 1996). In 2001, the “Strategy relationship is uncoordinated. Since 1986,
for Acceleration of Socialist-oriented the decentralisation of state power has
Industrialisation” to modernise the country characterised Vietnam’s economic transition.
by 2020 was launched. The aim was building Local governments at different levels have
“some selected important heavy industrial been powerful players in economic decision-
establishments with high technology, which making and increased their respective
produce the necessary means of production bargaining power vis-à-vis the central
to equip and re-equip advanced techniques government. The interaction between central
and technologies for the whole economy and and local governments is still not settled. This
to meet national defence requirements” (CPV, also influences industrial policy. Measures to
2001). Thirteen industries to reach the 2020 tackle regional disparity in industrialisation
target were selected, among them electronics, include nationwide enhancement of
steel, leather and footwear, construction infrastructure. In this regard, infrastructure
materials (including ceramic sanitary wares), investment should adopt a national approach,
mineral processing (coal, bauxite, titan, the opposite to the existing mechanism of
apatite, lead, and zinc), beverages, dairy, and arbitrarily granting infrastructure investments
pulp and paper. At the same time, the strategy to particular provinces. Or, for example,
seeks to mobilise “all possible resources to current policies set targets to construct deep-
achieve a rapid and effective development water ports and airports whose usage is not
of products, sectors and industries that have cautiously scrutinised. Regional positioning of
comparative advantages in order to basically large-scale heavy industry complexes in areas
meet domestic demand and promote exports” far from both their input and output market
(CPV, 2001). is another typical example of the current
industrial policy.
This official strategy remains very abstract,
however, it sounds like a mingle-mangle of Secondly, a full-scale reform of SOEs has not
different targets. Ohno (2015) compared and been fully implemented. The establishment of
evaluated Vietnam’s industrial policy with that large state conglomerates in many cases did
of a number of other countries, and came not lead to globally competitive corporations,
to the conclusion that Vietnam’s industrial despite their massive support. Many of the
policy was poor. In a ranking system from 5 conglomerates do not focus on their core
(highest) to 1 (lowest), Vietnam was given the business and take part, for example, in real
following scores: industrial human resources estate speculation. Without fundamental
1.5; domestic enterprise development 1.8; reforms, these conglomerates will continue to

34
 The role of industrial policy for development

cement the already close relationship between selection of sectors and firms that should
Corruption
politicians and state enterprises. Management be supported. Firms concentrate on good
undermines the
of SOEs needs to be substantially improved. It relations with officials and not on innovations
rational selection
needs to be discussed and decided in which to maximise profits.
of sectors and
areas SOEs are important for development
and in which areas private firms can play a Fourthly and most importantly, there is no firms that should
bigger role. In addition, in the past, SOEs sufficient process to define, implement, and be supported.
were not actively used to create clusters evaluate industrial policy. The weaknesses of Firms concentrate
with private firms. Lastly, SOEs should not be Vietnam’s industrial policy mostly stem from on good relations
systematically supported (in contrast to private the following three missing links: (1) a lack with officials and
firms) if they do not provide public goods or of cooperation among different stakeholders not on innovations
other advantages for society. in the entire drafting and implementation to maximise profits.
process including ministries, the business
Thirdly, industrial policy in Vietnam suffers community, SOEs, and trade unions; (2) a
from corruption. Despite formal government lack of inter-ministerial coordination within
attempts to fight corruption, in Transparency the government in deciding concrete action
International’s Corruption Perceptions Index plans; (3) a lack of evaluation and correction
2015, Vietnam ranked 112th out of 168 (in instances where mistakes have been made)
countries. Corruption undermines the rational of industrial policy (Ohno, 2006; 2013).

35
 Vietnam in the global economy: development through integration or middle income trap?

Recommendations for Vietnam

Countries at any development level can of society. Too high inequality leads to a lack of
A comprehensive
be trapped by low growth, low innovative aggregate demand, as well as negative supply
industrial policy
power, and the inability to catch up to more side effects such as insufficient expenditure
is indispensable
developed countries. In this section, ideas are on education. A lack of an inclusive growth
for economic
presented on how economic policy can help model destroys societal cohesion and makes
development. Vietnam avoid the MIT, and allow permanent economic development unsustainable.
upgrading. We are convinced that a successful
strategy has to be built on three pillars. Firstly, A vision of Vietnam’s general economic
economic policy needs to be built on market development needs to be developed and
mechanisms, which in many areas are the broadly discussed to create a consensus among
best institution to determine good allocation the majority of the population about the
and economic dynamics. Secondly, it needs direction in which it should go. For example,
to be built on government interventions, as Vietnam could decide to make ecological
markets in many areas fail. Karl Polanyi (1944) sustainability one of the principles of its policy,
has correctly shown that markets especially as well as social inclusion, and the control of
fail in the areas of labour, finance, and nature. increasing income inequality. Development
Far-reaching government interventions are, in has to be considered as a national project
any case, needed in these areas. In addition, where all levels of the administration and all
in developing countries markets reproduce social groups have to work together. One
underdevelopment. Markets have to be challenge for the Vietnamese government is
embedded in institutions and government to develop appropriate policy instruments to
policies to allow sustainable development and foster change towards a desired direction and
upgrading. Thirdly, a country like Vietnam to avoid the disruptive effects of structural
needs to integrate into the global economy. change. One of the major tasks will be to
However, its integration also has to be organise structural change without producing
embedded in institutional and government losers who could block necessary structural
interventions to reap the positive effects of changes. The following discusses different
globalisation and minimise the negative ones. dimensions of industrial policy.

The backbone of any catching up policy Good institutions

is an increase in productivity. This implies Following Dani Rodrik (2004), the most
increasing the power to innovate, supporting important point for industrial policy or for
the entrepreneurship of private and public government intervention in the economy in
firms, and searching for a new combination general is creating a process that allows a
of production factors, as well as to foster rational industrial policy and allows mistakes,
research, increase skills, and learn, etc. which will necessarily occur, to be corrected.
Development has Policies in the tradition of the Washington For such an industrial policy, an intensive
Consensus recommended by market radical information flow between the government
to be considered as
economists are not sufficient for a county to institution carrying out industrial policy,
a national project
catch up. A comprehensive industrial policy is and the enterprise sector is needed. Other
where all levels of
indispensable for economic development. important and informed institutions in society
the administration
could also be included in the debate about
and all social
Another important point is that economic industrial policy, for example, trade unions
groups have to
upgrading needs to be combined with social and different types of non-governmental
work together.
upgrading and the participation of all groups organisations. Incentives by the government

36
 Recommendations for Vietnam

should only be given for new activities: risk- would recommend a model without any
The fragmentation
taking and experiments should be possible; industrial policy leaving development primarily
of industrial policy
there should be clear benchmarks or criteria to the market, is not acceptable.
in Vietnam and
for success or failure; there should be built-in
the egoisms of
sunset clauses; mistakes need to be corrected; Instruments of industrial policy
implementing authorities should be closely The instruments of industrial policy are provinces need to
monitored by a political authority of the multifaceted. Two points are especially be overcome.
highest level; and industrial policy institutions important. Firstly, under FTAs and the WTO,
should be able to learn. many of the traditional instruments of
industrial policy like tariffs and quotas can
For Vietnam, two additional challenges exist. only be used in a limited way. Under such
Firstly, a large part of its industrial policy free trade regimes, industrial policies become
needs to be decided at the national level. The more difficult. Secondly, there are sufficient
fragmentation of industrial policy in Vietnam instruments for comprehensive and selective
and the egoisms of provinces need to be industrial policy (Ohno, 2013).
overcome. A recentralisation of economic
policy is necessary. A coherent national policy Among them, development banks can play
also includes inter-ministerial coordination an important role in Vietnam. They can
mechanisms, both at the local and federal mobilise more support for enterprises than
level, to prevent institutional fragmentation government subsidies. Of key importance
that impedes rational policymaking. is the good management of development
banks. Development banks should not
Secondly, to organise sufficient information discriminate between SOEs and private
flows for industrial policy, the government firms; they should finance projects that are
needs partners. Employers’ associations play promising, not whole industries. They should
an important role here. These associations are not concentrate on small and medium-sized
weak in Vietnam and need to be strengthened companies, which in many cases work with
to give the private enterprise sector in backward technologies. To support small and
particular a voice. medium-sized companies, for example in the
agricultural sector, special programmes are
Thirdly, fighting corruption in Vietnam is needed.
important to allow rational policy decisions.
Building high quality institutions is essential In an open economy, the SOE sector can
to prevent rent-seeking and allow for efficient play an important role in industrial policy.
state regulations of complex financial and SOEs can be used for strategic industrial
commercial activities. An efficient bureaucratic development including attracting selected
body that includes qualified and non-corrupt FDI via joint ventures in important strategic
staff depends on merit-based recruitment. In sectors. However, it is important that SOEs are
Vietnam, the practice of “buying jobs”, which managed in a non-corrupt and professional
developed after the start of reforms, needs to way. Institution building is also important
stop. The institution implementing industrial in this field. Privatising SOEs quickly is not a
policy (the agent) and the government solution. In a corrupt environment with bad
institutions (the principal) controlling the institutions, privatisation makes things worse.
it is important that
agent should not tolerate corruption and/ Examples of this are the oligarchs in the
SOEs are managed
or unqualified personnel; otherwise a good countries of the former Soviet Union. A World
in a non-corrupt
industrial policy will not be possible. The Bank commission also warned against quick
and professional
functioning of these institutions is of key liberalisation and fast privatisation (Commission
way.
importance as a second-best solution, which on Growth and Development, 2008).

37
 Vietnam in the global economy: development through integration or middle income trap?

Horizontal industrial policy monopolies (electricity and water supply,

Vietnam should
Governments should invest in public goods garbage collection, rail traffic, postal service,
avoid policies
that are not being delivered in a sufficient toll based motorways, etc.) companies should
that accept
quantity by the private sector. Investment be owned by public households. In other
low labour and
in education is a good example of this. Of areas, SOEs could be actively used for cluster
low ecological particular importance is the enhancement building. SOEs should be well managed
standards to of skills through formal education and the and forbidden from investing in speculative
attract FDI. establishment of occupational training activities like the real estate sector. SOEs
programs to ensure that low-skilled manual should not own banks and credit allocation
workers can switch to high-skilled labour should not systematically privilege SOEs, for
sectors. Investment in research and in public example in case they provide no public goods.
infrastructure fit to this type of industrial policy Foreign companies can play a similar role to
is also important. Heavy public involvement SOEs if they are forced to build clusters with
in each of the aforementioned areas is forward and backward linkages. FDI should
unavoidable. For instance, it is important flow into areas that contribute to economic
that Vietnam’s government invests heavily in development. FDI in such areas is of course
upgrading broadband telecommunication, highly welcomed, but will most likely also be
which plays a crucial in achieving a general limited. Certain activities and areas should be
increase in productivity. closed to foreign companies, for example,
certain real estate investments or investment
A country like Vietnam needs to set priorities in public utilities. The financial sector should
in each of the aforementioned areas and remain, with some exceptions, under domestic
between these areas. Horizontal industrial ownership.
policy also needs nationwide coordination and
supervision, for example, where motorways, Foreign companies should not be privileged
ports, and airports should be built; which vis-à-vis domestic companies. There should be
transportation infrastructure is preferred, an equal playing field between all companies
etc. The idea of horizontal industrial policy in the country. Vietnam should avoid policies
not intervening in certain industries and not that accept low labour and low ecological
supporting certain firms is an illusion. As standards to attract FDI. FDI relying on such
discussed above, institutions are needed to factors will not bring many new types of
select which horizontal industrial policy to technology to Vietnam in any case. Rules for
choose. FDI need to be enforced nationwide to avoid
competition between regions to attract FDI
Economic cluster and forward/backward through the use of tax holidays or other unfair
linkages advantages.
Vietnam needs to build economic clusters
with forward and backward linkages to The integration of a country into GVCs needs
exploit economies of scale and scope, as well an adaptation of its traditional industrial
as synergies and positive external effects. policy. Traditional industrial policy supports the
Big companies have to build up networks production of products that are internationally
of domestic suppliers to increase their local competitive and can be exported, or, it
content. Big companies have to support supports the production of goods that can
domestic suppliers to allow them reach the substitute imports. As soon as GVCs start
skill level and technological standards to to play an important role for a country, such
become suppliers. policies become more difficult. However, a
SOEs can play an important strategic role in country can systematically try to search for an
this field. In the areas of so-called natural upgrade of tasks in GVCs. “The central goal

38
 Recommendations for Vietnam

of industrial policy in the GVC context shifts exports. This also makes it an importance
Vietnam has to
from creating fully blown, vertically integrated sector for development. Vietnam has to
climb up the
national industries to moving into higher- climb up the value chain and build up its
value chain and
value niches in GVCs.” (Gereffi / Sturgeon, own brand names in the production and
build up its own
2013: 337f.) A systematic search and support export of rice, coffee, fish, etc. Farms should
for niches with higher value-added will lead reach a certain size that allows for increases brand names in
to upgrading and productivity increases. High of productivity. Institutional changes are the production
value-adding tasks can also be tried whenever also needed, including land law reforms to and export of rice,
possible. mitigate the problem of land grabbing. The coffee, fish, etc.
lack of enforcement of private ownership
For example, to upgrade in GVC design, of land leads to low agricultural production
marketing or branding are important. due to inefficient investment and use of land
Vietnam should also try to develop its own (World Bank, 2015).
brands. Foreign lead firms, as well as the big
and powerful suppliers of lead firms that are Vietnam should not concentrate on natural
located in the middle range of value chains resource exports, but rather become self-
should be approached to transfer skills and sufficient with its natural resources. This also
technology to Vietnam. Otherwise FDI has implies more processing of resources for
very limited positive effects. Attempts to build domestic use. Focusing on areas other than
clusters in value chains within the country natural resource exports avoids the danger of
or the region can also attract higher value- Dutch disease. In any case, Vietnam should
adding tasks in GVCs. Countries like Vietnam negotiate with China in order for higher
should also shame and negotiate with processed natural resources to be exported to
countries that do not allow them to climb China, without China increasing tariffs.
up in value chains. China, for example, has Export of tourist services is also an area where
increasing tariffs for natural resource imports Vietnam could improve. Vietnam should
with higher processing status. The US and concentrate on all levels on tourism and try to
the EU do the same for the agriculture sector build up its own high quality tourism services.
to protect their own processing industries.
These are unfair practices that are harmful to Do not put all your eggs in one basket – do
Vietnam. Vietnam should try to make such not specialise too much
unfair practices public and put a stop to them. Developing countries are in danger of
specialising too much in the international
Special sectors distribution of labour; for example,
Vietnam needs to support productivity Bangladesh in garment production, or some
development in the industrial sector as it is of the natural resource-exporting countries.
deeply integrated in the world market; i.e. Such specialisation is dangerous as it makes Specialising too
the electronics sector, the textile and garment a country dependent on the world market much in the textile
sector, and the shoemaking and leather sector. and the development of a small number and garment
In these sectors especially, three strategies are of goods. It also reduces the innovative
industry as a result
needed. Firstly, economies of scale should be power of countries and the development of
of the TPP is not
exploited. Secondly, backward and forward new market niches. Vietnam should keep a
an advantage,
linkages need to be built up. Thirdly, any broad spectrum of industrial production and
it can become
chance to attract higher value-adding tasks exports. Specialising too much in the textile
an obstacle
needs to be exploited. and garment industry as a result of the TPP is
to Vietnam’s
not an advantage, it can become an obstacle
development.
The agricultural sector in Vietnam plays an to Vietnam’s development.
important role for employment, but also for

39
 Vietnam in the global economy: development through integration or middle income trap?

Exchange rate policy, export orientation and Besides controlling the exchange rate, central
Central bank
demand management banks should influence credit allocation.
interventions
In the past, Vietnam had partly high current Instruments could be special capital
to prevent
account deficits despite substantial natural requirements, special reserve requirements
appreciation
resource exports. The target for exchange for certain types of bank credits, and a
combined with rate policy should be to realise a balanced general ceiling or the prohibition of certain
sterilisation trade and service balance without taking types of credits. For example, credits form
policies as natural resources into account. Especially the commercial banking system to non-bank
practiced in many when institutions are judged to be weak, the financial institutions or the real estate sector
Asian countries exchange rate has to take over the function of could be strictly limited. However, monetary
can prevent a general protection comparable to a general policy should not only sanction some types
appreciations and high tariff to protect the industry of a country. of credits, it should also subsidise and
keep the exchange To reach this aim, capital imports (except support certain types of credits. For example,
rate competitive. FDI) need to be strictly controlled. Central development banks can get privileged access
bank interventions to prevent appreciation to central bank refinancing.
combined with sterilisation policies as
practiced in many Asian countries can prevent Innovation and productivity increases are
appreciations and keep the exchange rate not likely to occur in stagnating economies.
competitive. At least in developing countries, high GDP
growth and a high rate of innovation are “one
Development should be export-oriented. package”. To realise such a combination,
Successful exporters should be supported industrial policy and demand management
to further improve. Export performance can is needed. Demand management implies
become one of the criteria to support firms sufficient domestic consumption demand,
via industrial policy. In the past, successful which crucially depends on a relatively equal
East Asian economies have concentrated on income distribution (Stiglitz, 1996) and stable
export promotion. Latin American economies investment. The latter can be stabilised by
have concentrated more on import a large SOE sector and investment in big
substitution-based industrialisation. Industrial infrastructure projects. Deficits in the current
policy can do both, but it should not support account have to be avoided as such deficits
weak companies from foreign competition reduce domestic demand.19
long-term, rather, it should support strong
companies with good prospects. In many
cases this will lead to them becoming
successful exporters (Stiglitz, 1996).

40
 Notes

Notes

1. We could also assume production inputs in general.

2. If the population prefers a reduction in working time, the welfare of a nation can increase without increasing output.
However, there is no plausible link between free trade and a preference to more leisure time.

3. The productivity of producing one car in Vietnam is for example 1 unit of output divided by 40 units of labour (1 car:
40 units of labour = 0.025 units of cars per one unit labour).

4. For example, in the case of Vietnam before trade, the car industry counts for 66.66 percent of average productivity,
as two thirds of the workforce is employed by the car industry.

5. Theoretically, future demand of mankind for natural resources should lead to high prices of natural resources today.
But there are no future markets that could signal scarcity of natural resources in 50, 100, or 500 years. The market
fails to lead to a rational intertemporal allocation of such products.

6. Friedrich List was influenced by Alexander Hamilton, one of the founding fathers of the United States, who
advocated for protectionist tariffs and other measures to allow American industry to develop without too much
foreign competition. Indeed, the United States developed, along with many other countries, under a regime of heavy
protection (Chang 2002).

7. The same macroeconomic production function in all countries is assumed.

8. A theoretical weakness of the model is also that the macroeconomic production function, which is essential for
the model, depends on the distribution of income between capital and labour. Any change of functional income
distribution changes the value of capital in the production functions.

9. See also Azarhoushang et al. (2015).

10. A monopsony describes the constellation of one demander of inputs and many suppliers. The demander can in this
case increase its profits at the cost of the suppliers, who compete with each other.

11. The “smile curve” was first designed by Stan Shih (CEO of Acer, a computer producing company from Taiwan) in
order to illustrate the distribution of value-added through global value chains (Everatt et al. 1999).

12. In the case of international subcontracting, the lead firm is signing contracts with legally independent companies in
other countries.

13. For case studies about the apparel and garment industry that show these constellations, see Anner (2015) and Khan
and Wichterich (2015).

14. There is a rich literature about the effects of FDI on industrial development in host countries (Balasubramanyam et
al., 1996; Borensztein et al., 1998; Alfaro et al., 2010; Hansen / Rand, 2006; Basu / Guariglia, 2007; Kurtishi-Kastrati,
2013). However, there is no consensus about the positive effects of FDI on host countries’ industrial development.
Obviously there is no automatism that high FDI will lead to substantial technological and skill upgrading. It depends
on the specific situation of the country and the policy followed.

15. More precise would be GDP per hour worked. GDP per capita does not reflect different working times between
countries. For example, in the United States, working time is much longer than in Europe as among other things
holidays in the United States are much shorter. Actual annual working time in the United States in 2014 was 1,789
hours; the OECD average was 1,770 hours. Working time in Germany was 1,371 hours (OECD, 2015). In addition,
GDP does not reflect distribution of income, life expectancy, etc. and is only a very rough indicator for welfare.

41
 Vietnam in the global economy: development through integration or middle income trap?

16. For instance, after 20 years of investment in Vietnam the localisation rate of parts produced by Samsung currently
(2015) only reaches 36 percent. In earlier times under different regulations Samsung and Honda invested more in
local content, Samsung in Thai Nguyen and Bac Ninh and Honda in Vinh Phuc (Saigon Times Online, 15.07.2015).

17. A balanced current account or even a current account surplus does not automatically lead to low foreign debt. If, for
example, a current account surplus and/or gross capital inflows are combined with gross capital outflows, gross debt
in foreign currency of a country can be high even if there is no net debt. The net position does not help a country
when, let’s say, the rich are allowed to keep a large part of their wealth abroad and the country falls into a currency
crisis.

18. Sterilisation policy of the People’s Bank of China mainly to issue its own bonds and increase minimum reserve
requirements of banks allowed the control of the liquidity effects created by the interventions.

19. For such a development regime see Herr / Kazandziska (2011), Dullien et al. (2011) and Gallas et al. (2016).

42
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48
About the authors Imprint
Hansjörg Herr is Professor for “Supranational @ 2016 Friedrich-Ebert-Stiftung Vietnam Office
Integration” at the Berlin School of Economics and Law 7 Ba Huyen Thanh Quan | Ba Dinh |Hanoi - Vietnam
in Berlin, Germany. He is an expert for the development |IPO Box 44
of the international monetary system, the European
monetary integration, labour markets and development Responsible:
economics. Most of his research and publications are Erwin Schweisshelm | Resident Representative
focused here.
Phone: +84 4 3845 5108
Dr. Truong Minh Vu is Director of the Center for Website: www.fesvietnam.org
International Studies at the University of Social Sciences Facebook: Friedrich-Ebert-Stiftung, Vietnam
and Humanities in Ho Chi Minh City, Vietnam. He is
an expert on international studies, security and foreign To order publication:
policies as well as regional development. info@fesvietnam.org

Erwin Schweisshelm is Head of the office of the

Friedrich-Ebert-Stiftung in Vietnam. He has over 20 years
of experience in working in different countries in South
East Asia.

Commercial use of all media published by the Friedrich-

The views expressed in this publication are not necessarily Ebert-Stiftung (FES) is not permitted without the written
those of the Friedrich-Ebert-Stiftung. consent of the FES.

Friedrich-Ebert-Stiftung (FES) is the oldest political foundation in Germany.

The foundation is named after Friedrich Ebert, the first democratically elected president of Germany.

The Regional Programme in Asia complements FES programmes and projects on the global and national level.
Its approach and focus is going beyond the national level by responding to the trends of globalisation, labour
mobility, regional integration and connectivity in all areas of life. The projects conducted under its framework target
to build transnational networks and coalitions between individuals and organisations and promote change
for more social justice, sustainable peace, economic development in the region.

www.fes-asia.org