The integration of Vietnam in the global economy and its

Working Paper No. 44 October 2016
The integration of Vietnam in the global economy and its effects for Vietnamese economic development
Hansjörg Herr Erwin Schweisshelm Truong-Minh Vu
GLOBAL LABOUR UNIVERSITY

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Editorial Board Hansjörg Herr (Berlin School of Economics and Law, Germany) Frank Hoffer (International Labour Organisation) Seeraj Mohamed (University of the Witwatersrand, South Africa) Archana Prasad (Jawaharlal Nehru University, India) Helen Schwenken (University of Osnabrück, Germany) Marcelo Weishaupt Proni (Universidade Estadual de Campinas, Brazil)
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THE INTEGRATION OF VIETNAM IN THE GLOBAL ECONOMY AND ITS EFFECTS FOR VIETNAMESE ECONOMIC DEVELOPMENT
Hansjörg Herr Erwin Schweisshelm Truong-Minh Vu
The paper is also published in the digital library of the Friedrich Ebert Foundation in 2016

GLU | Vietnam‘ s Development in the Global Economy
Copyright © International Labour Organization 2016 First published 2016
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ILO Cataloguing in Publication Data Herr, Hansjörg; Schweisshelm, Erwin; Vu, Truong-Minh. The integration of Vietnam in the global economy and its effects for Vietnamese economic development / Hansjörg Herr, Erwin Schweisshelm, Truong-Minh Vu ; International Labour Office ; Global Labour University. - Geneva: ILO, 2016. (Global Labour University working paper ; No. 44, ISSN: 1866-0541 ; 2194-7465 (web pdf)) International Labour Office; Global Labour University. economic development / value chains / foreign investment / industrial policy / Viet Nam 03.02.3
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GLU | Vietnam‘ s Development in the Global Economy
ABSTRACT
When Vietnam started the Đổi Mới (renovation) in the mid-1980s it was a backward agricultural country. Liberalising markets, allowing the establishment of private firms, integrating in the world economy and high FDI inflows stimulated growth and productivity development. However, this first face of development seems to be exploited and Vietnam is in danger to fall in a period of low growth, low productivity increases and no convergence with more developed countries. 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 “liberalisation effect” of Đổi Mới is exhausted and does not create further sufficient development. Comprehensive industrial policy which is at the present stage poor in Vietnam is needed. Vietnam lacks especially institutions which are able to select, implement, evaluate and modify, when needed, industrial policy. This is the case for horizontal industrial policy and even more for needed more selective industrial policy. Foreign direct investment can support development, but it has to be integrated in industrial policy to increase productivity and create economic clusters with forward- and backward linkages. State-owned companies which must be managed in a good way can also play a key role in building economic clusters. Among other instruments development banks can play role to deliver cheap and sufficient credit for sectors and firms which support development. In addition a good macroeconomic management of the economy is needed. Current account deficits have to be avoided and exchange rate policy has to substitute general tariffs which are no longer allowed, guarantee the competitiveness of the industrial sector and to avoid Dutch Disease effects. Last not least an inclusive growth model is needed to avoid a lack of demand, negative supply side effects and incoherent social developments.
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GLU | Vietnam‘ s Development in the Global Economy

TABLE OF CONTENTS
1. INTRODUCTION ......................................................................................................... 1 2. INTEGRATION OF DEVELOPING COUNTRIES IN THE WORLD MARKET
AND ECONOMIC DEVELOPMENT ................................................................. 3 2.1 Traditional economic trade models and economic development.... 3 2.2 Global value chains and economic development.................................11 2.3 The danger of a middle-income trap .........................................................18 3. VIETNAM’S INTEGRATION IN THE WORLD ECONOMY...............................20 3.1 Overview about the integration of Vietnam in the world
economy .........................................................................................................20 3.2 Structure of exports and imports in Vietnam..........................................23 3.3 Global value chains in industrial productions ........................................27 3.4 Effects of free trade agreements..................................................................30 4. THE ROLE OF INDUSTRIAL POLICY FOR DEVELOPMENT ..........................34 4.1 Principles of industrial policy ........................................................................34 4.2 The role of the exchange rate .......................................................................37 4.3 Overview about industrial policy in Vietnam..........................................40
5. RECOMMENDATIONS FOR VIETNAM ...............................................................41 REFERENCES ......................................................................................................................48
LIST OF FIGURES AND TABLES
Figure 1: Producer-driven and Buyer-driven global value chains.....................13
Figure 2: The exploitation curve....................................................................................15
Figure 3: Development of foreign trade in Vietnam in per cent of GDP ........21
Figure 4: Current account balance of Vietnam in per cent of GDP...................21
Figure 5: Gross foreign debt in Vietnam in per cent of GDP ...............................22
Figure 6: FDI net inflows in Vietnam in per cent of GDP ......................................23
Figure 7: Vietnam’s export structure ...........................................................................24
Figure 8: Vietnam’s import structure...........................................................................24
Figure 9: Structure of FDI inflows to Vietnam, stock of FDI in 2015 .................26

Table 1: Table 2: Table 3:

International trade with absolute advantages .......................................... 5 International trade with comparative advantages .................................. 8 Overview about trade agreements in Vietnam.......................................31

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GLU | Vietnam‘ s Development in the Global Economy
1. INTRODUCTION
In mid-1980s at the start of Đổi Mới (renovation) Vietnam was a backward agricultural country under a socialist economic system based on the centrally directed allocation of resources through administrative means. At that time, most of the workforce was involved in agricultural production but the country faced food shortages and had to import rice. Industry was weak facing poor productivity. The overwhelming majority of the population was stuck deeply in poverty. Vietnam’s approach to economic reform has been characterized by two main features. Firstly, it followed a top-down and step-by-step approach. Pilot projects on an experimental basis in some localities were carried out before they are applied to the whole country. Secondly, there was the consensus among the Vietnamese leadership not to combine market-oriented reforms with political liberalization. Also, while introducing market-oriented reforms the important role of state-owned enterprise were maintained. Since the beginning of the process of Đổi Mới, economic growth in Vietnam has been remarkable. Between 1991-2009 Vietnam’s real GDP grew with the average growth rate of 7.4 %. In 1990 Vietnam’s GDP per capita of 98 US dollars placed it among the poorest countries in the world. In 2009 a GDP per capital of 1109 US dollars led to Vietnam’s attainment of the lower middle-income status by the World Bank classification methodology. In the year 2014 GDP per capita reached 2052 US dollars (Haughton et al. 2001; Quan 2014). Economic reforms included an increasing integration of Vietnam in the global economy. This integration process is still underway with trade commitments under ASEAN, accession to the World Trade Organisation (WTO) in 2007 and signing the Trans-Pacific Partnership Agreement (TPP) in 2015. The open question, however, is whether this spectacular development will be able to continue. There are a number of experts who believe that Vietnam is in danger of falling in a middle-income trap or might be already affected by it (see Pincus 2015; Ohno 2015. A middle-income trap implies that the convergence between a developing country and the most developed countries in the world does not become smaller and the developing country is stuck at a certain income per capita level of developed countries. The only sustainable way to overcome a middle-income trap and to join the group of developed countries is to increase productivity and the innovative power of a country. Without a catching-up in the level of productivity in developing countries a conversion of the living standards between developing and developed countries will not be possible. However, productivity increases are not the only factor for economic development. Besides productivity development an inclusive growth model with not too high income inequality and a functioning financial system delivering sufficient credit with low interest rates are also preconditions for sustainable development.
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GLU | Vietnam‘ s Development in the Global Economy
The aim of this paper is to analyse the specific way on how Vietnam has been integrating in the world economy and what kind of production structure results from this in Vietnam. The key question is whether the type of integration in the world market is supporting economic development in Vietnam via increasing the productivity level or not. It will be asked what kind of integration different economic approaches expect. It will then be checked to which extent the different theoretical approaches are able to explain development in Vietnam and whether Vietnam is in danger of a middle-income trap. The main conclusion of the paper is that theoretical considerations and empirical analyses support the hypothesis that an unregulated integration in the world market is not beneficial for Vietnam in the long-run and can lead to a middleincome trap. Integration in the word market is of key importance for a country like Vietnam, but it has to be guided by comprehensive industrial policy and government’s interventions. To leave the integration of Vietnam completely the market leads to the reproduction of underdevelopment. A combination of markets and government activities is needed to reach a sustainable catch-up. In the second section of this paper a review of the most important traditional economic models to explain international distribution of labour will be given. The analysis takes a looks from the perspective of a developing country and asks what kind of industrial development these models for a country like Vietnam predict. The section also concentrates on a phenomenon which gained paramount importance the last three decades - global value chains and offshoring. It will be asked to which extent global value chains increase the chances of economic development for countries like Vietnam. Section three analyses in detail how Vietnam integrated in the world economy. The theoretical approaches from section two will be used to understand Vietnam’s role in the international distribution of labour. Import and export structures will be analysed as well as the role of global value chains in Vietnam. The theoretical prediction will be largely supported by the empirical analysis. Without government interventions a middle-income trap is a serious danger for Vietnam. The fourth section draws policy conclusions for Vietnam. Here especially industrial policy will be discussed and its adaptation to the situation in Vietnam.
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GLU | Vietnam‘ s Development in the Global Economy
2. INTEGRATION OF DEVELOPING COUNTRIES IN THE WORLD MARKET AND ECONOMIC DEVELOPMENT
2.1 Traditional economic trade models and economic development
We will start with the model of absolute advantages and then analyse comparative advantages as well as different factor endowments. These trade models assume trade in complete goods. This implies that the production process of a good is not cut in different tasks which are produced in different countries as in global value chains. To understand the logic of trade usually in these models mobility of capital is assumed to be zero which automatically implies a balanced current account. Finally, these models assume constant returns to scale and competitive markets.
a) Absolute advantages The most simple and obvious model of explaining international trade is the model of absolute advantages. Adam Smith (1776) argued that in the case of one country being good in producing one thing, and the other country good in producing another thing the welfare of both countries could be increased by trade. Absolute advantages are based on different technological levels and/or different natural conditions which influence productivity. To make an example: If Vietnam has a higher productivity in producing textiles and the United States is more productive in producing cars to increase the welfare of both countries Vietnam should concentrate on the production of textiles and the US should focus on making cars. Table 1 shows the logic and consequence behind this type of trade. It is assumed that the US has an absolute advantage in producing cars – it needs 10 units of labour1 to produce a car, whereas Vietnam needs 40 units of labour for a car. Vietnam has an absolute advantage in the production of textiles. For a given quantity of textiles Vietnam needs 20 units of labour and the US 35 units. Without international trade the production and consumption of the assumed quantities of textiles and cars need a total sum of 105 units of labour in both countries. If each of the countries concentrates on the goods with its absolute advantage and produces twice as much as before and exchanges cars against textiles, the level of consumption in both countries will stay the same and the needed hours for producing the goods can be reduced to together 60 hours. The conclusion by Adam Smith was that international trade (similar to national trade) increases the wealth of nations and markets leads to specialisation according to absolute advantages.
1 We could also assume production inputs in general.
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GLU | Vietnam‘ s Development in the Global Economy
Implicitly some assumptions are taken to come to the welfare conclusion drawn by Smith. The most important one is that there is sufficient demand so that world output increases and that the production factors which have become unused as a result of efficiency gains will be able to be employed.2 If the saved 45 units of labour in our example become unemployed, the wealth of nations does not necessarily increase. From a Keynesian perspective there is no guarantee that a switch to more free trade increases aggregate demand and output. If Say’s law which assumes that supply creates its own demand does not hold free trade can lead to permanent higher unemployment. Sometimes, mainly by noneconomists, it is argued that free trade increases the surplus in the trade balance (or reduces a deficit) and positive employment effects can be expected. However, a switch to free trade has nothing to do with surpluses or deficits in the trade and current account balances. Only in a world of lunatics can free trade lead to current account surpluses in all countries. Secondly, it has to be assumed that the factors of production move smoothly from one industry to another one. In a concrete economic constellation such structural changes can become difficult for countries. In our example, US textile workers may not be qualified to become workers in the car industry. Finally the model leaves open which of the two countries realise the biggest welfare gains. And trade, even if it increases the welfare of both nations, can produce some losers in both countries. In the context of this paper the most important question is how productivities change when countries integrate in the global economy. Productivity is defined as output per unit of labour. In our exemplification in Table 1 the productivities of producing a car and a given quantity of textiles are calculated.3 To calculate the average productivity each of the productions is weighed according to the labour needed in the industry.4 The productivity gap for the whole economy in Vietnam before international trade is 0.006. Productivity in Vietnam under the condition of international trade increases because the country concentrates on the production of the good with its absolute advantage which has a productivity of 0.05. But productivity in the US increases even faster and the Vietnamese productivity gap increases to 0.05. The explanation for this is that the absolute advantage to produce cars is bigger than the absolute advantage of Vietnam to produce textiles. The figures in Table 1 are not based on empirical facts. However, the constellation shown in the table might not be unrealistic for many goods in a country like Vietnam.
2 If the population prefers a reduction in working time, the welfare of nations 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% of average productivity as two third of the workforce is employed in the car industry.
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