GCC correct to Focus on Vietnam’s Economic Success

January 12, 2017
GCC correct to Focus on Vietnam’s Economic Success
Richard Woodward
Richard Woodward Non-Resident Fellow - International Economics

That the world’s centre of economic gravity is shifting towards Asia is now almost universally accepted. Amongst the GCC this is increasingly reflected in the deepening, or the desire to deepen, interdependencies with countries from the Asian region. Perhaps inevitably most discussions have centred on the GCC’s ties with China and India. Clearly connections with Asia’s two behemoths are likely to be paramount but greater attention is now being paid to the GCC’s links with the South-East Asian countries that are emerging in China and India’s slipstream. In addition to the more developed economies in Malaysia and Thailand, Indonesia, the Philippines and even countries like Cambodia and Myanmar are being touted as potential emerging markets. Nonetheless as a number of recent articles have suggested, Vietnam may well be the country with the most untapped potential for GCC countries.

Unlike its more illustrious neighbours, Vietnam’s success story has passed almost unremarked. When it embarked on its economic renovation (Đổi mới) process in 1986 Vietnam was one of the world’s poorest countries.  Between 1991 and 2014 however Vietnam’s GDP per capita expanded at 5.5% per annum, a feat surpassed only by China, and today the country enjoys middle income status. Moreover, these economic advances have been accompanied by rapidly improving social outcomes. Extreme poverty has been all but eradicated and Vietnam surpasses countries with higher GDPs on yardsticks of wellbeing including education, life expectancy, and maternal and infant mortality. Vietnam has many of the raw ingredients associated with successful emerging market economies. Its possession of a relatively young, growing, well educated and increasingly urbanised and prosperous population promises a productive labour force and lucrative new markets. The Boston Consulting Group for example estimates that Vietnam’s middle class will almost triple in size from 12m in 2012 to 33m by 2020. What excites many investors is that these advantages are now being married with policies that should help to sustain Vietnam’s stellar performance.

Although Vietnam’s border with China has not always been beneficial, it proximity to Southern China’s manufacturing hub is now a major boon for its economic prospects. Vietnam has been the principal beneficiary of China’s shift away from low cost manufacturing towards operations further up the value chain. In a recent survey by Standard and Chartered, 40% of companies who said they planned to move capacity out of China said Vietnam was their preferred destination. There are number of motivations for this. First, with the average Vietnamese factory worker’s salary being around a quarter of their Chinese counterpart, the cost and availability of skilled labour is a key factor for those looking to relocate manufacturing within the region. Around two-thirds of the population still live rurally and around half work in agriculture, generating a source of surplus labour that will for the moment prevent wage costs from spiralling. With regard to skills Vietnam spends considerably more (6.3% of GDP) on education than countries with similar income levels and is reaping the rewards. For instance, in the latest iteration of the OECD’s Programme for International Student Assessment (PISA) Vietnam’s students ranked 8th out of 72 countries for educational achievement in science and performed around the OECD average for reading and mathematics.

A second key factor, symbolised by its accession to the World Trade Organisation in 2007, is Vietnam’s growing commitment to openness in trade and investment. This commitment, including the recent conclusion of further trade deals granting Vietnamese exporters better access to large consumer markets in the European Union and South Korea and moves to liberalise its investment regime, has made the country a magnet for foreign direct investment (FDI) and helped knit its firms into regional supply chains. Vietnam has topped a Financial Times index of greenfield investment in emerging markets for the past two years, welcoming 468 new projects in 2014 and 2015. Whereas in the late 1980s Vietnam’s inward investment could be measured in the thousands in 2015 it attracted net FDI worth $11.8bn. Deals in 2016 have already exceeded this amount bringing Vietnam’s total FDI stock to approximately $102bn with sources from over 100 countries. The emergent economic ties between Vietnam and GCC countries that were interrupted by the global financial crisis of 2008 appear to be resuming. According to the International Trade Centre the value of international trade between Vietnam and the GCC leapt from $330m in 2009 to $12.8bn in 2014. In the same year, the UAE accounted for almost 40% ($5bn) of the value of Vietnam’s GCC trade and this relationship continues to thrive. In 2015, bilateral trade between the UAE and Vietnam grew by 27% to over $6.1bn with Vietnam’s ambassador predicting that trade between the two countries will be worth $11bn by 2020. Vietnam’s network of trade and investment treaties also makes it attractive as a location for GCC firms keen to use Vietnam as a gateway to the wider Asian region.

A third key factor is Vietnam’s rising reliance on market oriented approaches to economic policy problems. For instance in seeking to address concerns about slowing productivity Vietnam has embarked on an increasingly ambitious privatisation programme. After a slow start in which it primarily sold minority shares in unappetising firms and sectors, the Vietnamese government is beginning to divest itself of some of its prime assets such as Vinamilk (the country’s dominant diary company), and Sabeco and Habeco (two of the main state owned brewing companies). The loosening of restrictions on foreign ownership and the Vietnam’s rapidly expanding tourism industry look set to offer lucrative opportunities for investment by GCC companies in the property, hospitality and construction sectors. Likewise, GCC companies are well positioned to assist Vietnam to upgrade its infrastructure and satisfy its escalating energy needs.

While the immediate outlook is positive, for the full benefits of these openings to be realised the Vietnamese government must sustain its reformist zeal . In particular, more must be done to address the structural impediments that are beginning to act as a brake on Vietnam’s productivity and wider economic performance. Vietnam’s institutional idiosyncrasies translate into a challenging business environment for prospective GCC investors. Over the last five years Vietnam has oscillated between 80th and 100th place in the World Bank’s Ease of Doing Business Index (ranking 82nd out of 190 countries for 2017). The World Bank notes that in Vietnam the “institutional foundations for an advanced market economy are insufficiently developed, undermining private property rights and competition in product markets”. Fresh trading agreements with advanced industrialised countries have forced Vietnam to tighten the enforcement of intellectual property (IP) rules, but IP theft is likely to deter GCC investors operating in cutting edge sectors. Vietnam’s combination of openness to global financial markets and weaknesses in domestic institutional arrangements for financial governance are also a cause for concern. The Asian Development Bank’s latest Asian Development Outlook notes that in 2016 credit in Vietnam expanded at three times the nominal rate of GDP. Significantly state-owned commercial banks, operating with an implicit government guarantee, account for a substantial portion of this increase. Moreover, many of these loans are not being used to support productive investment but are being funnelled into real estate and other speculative activities raising concerns about their quality. Comparisons with the 1997/98 Asian financial crisis are overblown, nevertheless the bursting of Vietnam’s property bubble in 2011 was a timely reminder of uneven quality of the country’s regulatory infrastructure.

Structural and institutional reforms are also imperative to address some of the other shortcomings arising from Vietnam’s economic model. Despite the privatisation programme state involvement in the economy is widespread either directly through state owned enterprises or indirectly through the power of vested interests. State intervention thwarts private sector activity in a number of ways, most notably through distorting capital allocation and undermining property rights. Weak links between indigenous firms and Vietnam’s thriving export industry are hampering productivity growth. Unlike many of its regional counterparts Vietnam often does not insist that foreign firms source their inputs locally. Whilst this flexibility has made Vietnam more attractive to foreign investors this limits the incorporation of its indigenous firms into regional supply chains. Likewise the influx of multinational companies is crowding out domestic firms leading to the risk that Vietnam simply becomes a branch plant economy with its firms trapped at the lower end of the value chain. Economic growth in Vietnam has been accompanied by enormous environmental costs. Natural resource depletion, the pollution of air and water sources and a staggering increase in greenhouse gas emissions are the most obvious manifestations of this. Vietnam’s vulnerability to climate change may also depress its future prospects. Extreme weather events are estimated to have shaved 1-1.5% per annum off Vietnam’s GDP since the turn of the century.

Over the last two decades, high rates of economic growth, plunging poverty rates and substantial social improvements have made Vietnam one of Asia’s quiet success stories. Vietnam’s continued rise offers ample economic opportunities for members of the GCC, not least as a means of gaining a foothold in the wider South-East Asian region. Following the trail blazed by Kuwait in the 1970s, GCC members are strengthening their diplomatic and commercial relationships not just with Vietnam but across the Asian continent. Intensifying economic relationships will ultimately bring political and security matters to the fore, not least how to protect the trade routes between Asia and the Middle East. With America possibly signalling the abdication of its global leadership role under the leadership of Donald Trump, the GCC’s Asian embrace seems set to tighten.