The economy that Covid-19 could not stop

Having impressed the world by taming the virus last year, Vietnam is now in the
middle of its worst outbreak of covid-19 by far. Parts of the country are in strict
lockdown and a swathe of factories, from those making shoes for Nike to those
producing smartphones for Samsung, have either slowed or shut down, disrupting
global supply chains. Yet integration with global manufacturing has helped keep
Vietnam’s economy humming during the pandemic. In 2020 GDP rose by 2.9% even
as most countries recorded deep recessions. Despite the latest outbreak, this year
could see faster growth: the World Bank’s latest forecasts, published on August 24th,
expect an expansion of 4.8% in 2021.

This performance hints at the real reason to be impressed by Vietnam. Its openness to
trade and investment has made it an important link in supply chains. And that in turn
has powered a remarkable and lengthy expansion. Vietnam has been one of the five
fastest-growing countries in the world over the past 30 years, beating its neighbours
hands down (see chart 1). Its record has been characterised not by the fits and starts of
many other frontier markets, but by steady growth. The government is even more
ambitious, wanting Vietnam to become a high-income country by 2045, a task that
requires growing at 7% a year. What is the secret to Vietnam’s success—and can it be
sustained?

Vietnam is often compared to China in the 1990s or early 2000s, and not without
reason. Both are communist countries that, shepherded by a one-party political
system, turned capitalist and focused on export-led growth. But there are big
differences, too. For a start, even describing Vietnam’s economy as export-intensive
does not do justice to just how much it sells abroad. Its goods trade exceeds 200% of
GDP. Few economies in the world, except the most resource-rich countries or city
states dominated by maritime trade, are or have ever been so trade-intensive.

It is not just the level of exports but the nature of the exporters that makes Vietnam
different to China. Indeed, its deep connection to global supply chains and high levels
of foreign investment makes it seem more like Singapore. Since 1990 Vietnam has
received average foreign direct investment inflows worth 6% of GDP each year, more
than twice the global level—far more than China or South Korea have ever recorded
over a sustained period.
As the rest of East Asia developed and wages there rose, global manufacturers were
lured by Vietnam’s low labour costs and stable exchange rate. That fuelled an export
boom. In the past decade, exports by domestic firms have risen by 137%, while those
by foreign-invested companies have surged by 422% (see chart 2).

But the widening gap between foreign and domestic firms now poses a threat to
Vietnam’s expansion. It has become overwhelmingly dependent on investment and
exports by foreign companies, while domestic firms have underperformed.
Foreign firms can continue to grow, providing more employment and output. But
there are limits to how far they can drive Vietnam’s development. The country will
need a productive and efficient services sector. As living standards rise it may become
less attractive to foreign manufacturers over time, and workers will need other
opportunities.

Part of the drag on domestic enterprise comes from state-owned firms. Their
importance to the country’s activity and employment has shrunk (see chart 3). But
they still have an outsize effect on the economy through their preferential position in
the banking system, which lets them borrow cheaply. Banks make up for that
unproductive lending by charging other domestic firms higher rates. Whereas foreign
companies can easily access funding overseas, the average interest rate on a medium-
and long-term bank loan in Vietnamese dong ran to 10.25% last year. Recent research
by academics at the London School of Economics also suggests that productivity
gains in the five years after Vietnam joined the WTO in 2007 would have been 40%
higher without state-owned firms.

To fire up the private sector, the government wants to nurture the equivalent of South
Korea’s chaebol or Japan’s keiretsu, sprawling corporate groups that operate in a
variety of sectors. The government is “trying to create national champions,” says Le
Hong Hiep, a senior fellow at the ISEAS-Yusof Ishak Institute in Singapore, and a
former Vietnamese civil servant.

Vingroup, a dominant conglomerate, is the most obvious candidate. In VinPearl,

VinSchool and VinMec, it has operations that spread across tourism, education and
health. VinHomes, its property arm, is Vietnam’s largest listed private firm by market
capitalisation.

The group’s efforts to break into finished automotive production through VinFast, its
carmaker, may be most important for the economic development of a country that is
usually known for intermediate manufacturing. In July the company’s Fadil car,
which is based on the design for Opel’s Karl make, became Vietnam’s best-selling
model, beating Toyota. VinFast has grand ambitions abroad, too. In July it announced
that it had opened offices in America and Europe and intended to sell electric vehicles
there by March 2022.

Fostering national champions while staying open to foreign investment is not easy,
however. VinFast benefits from a bevy of tax reductions, including a large cut in
corporation tax for its first 15 years of operation. In August, local state media also
reported that the government was considering reinstating a 50% reduction in
registration fees for locally built automobiles that expired last year.

But the country’s membership of the Comprehensive and Progressive Agreement for
Trans-Pacific Partnership, and a range of other trade and investment deals, means that
it cannot offer preferential treatment to domestic producers. It must extend support to
foreign firms that make cars in Vietnam, too. (By contrast, China’s trade policy,
which prefers broad but shallow deals, does not constrain domestic policy in quite the
same way.)
Vietnam may also hope to rely on another source of growth. The economic boom has
encouraged its enormous diaspora to invest, or even to return home. “There aren’t a
lot of economies that are experiencing the sort of thing that Vietnam is,” says Andy
Ho of VinaCapital, an investment firm with $3.7bn in assets. His family moved to
America in 1977, where he was educated and worked in consulting and finance. He
returned to Vietnam with his own family in 2004. “If I were Korean, I might have
gone back in the 1980s, if I were Chinese I might have gone back in 2000.” Its
successful diaspora makes Vietnam one of the largest recipients of remittances in the
world; $17bn flowed in last year, equivalent to 6% of GDP.

The setback from covid-19 aside, it might seem hard not to be rosy about a country
that appears to be in the early stages of emulating an East Asian economic miracle.
But no country has become rich through remittances alone. As Vietnam develops,
sustaining rapid growth from exports of foreign companies will become increasingly
difficult, and the tension between staying open to foreign investment and promoting
national champions will become more acute. All of that makes reforming the domestic
private sector and the financial system paramount. Without it, the government’s lofty
goal of getting rich quick may prove beyond its reach.

Source: Economist