While this success does not immunize Vietnam from an economic slowdown, it raises the country’s brand as the top destination for diversifying beyond or away from China. Vietnam has many attractive features: cheap input costs, stable politics, and increasingly liberalized trade and investment policies, especially after its free trade agreement with the EU. But two factors limit Vietnam’s ability to absorb significantly more manufacturing from China and move up the value chain: its high dependence o­n foreign input for production and its much smaller population size (see figure 1).

Because Vietnam’s labor force is o­nly 7 percent the size of China’s (see figure 1), it can attract o­nly a limited share of the firms looking for an alternative to China’s rising costs. Vietnam has succeeded in targeting sectors such as textiles, footwear, and electronics. But given its smaller scale than China, in electronics, it cannot replace production that requires massive mobilization of the labor force. As a result, firms looking to diversify out of China will find a home in Vietnam—one that can likely meet o­nly a subset of their needs. That will leave more of the pie available to other economies in Asia and beyond, should they make an effort to compete.

Moreover, Vietnam’s relatively youthful population will age. According to UN population projections, Vietnam’s age distribution will be much more top heavy by 2050 (see figure 2). That greater friction to growth explains why the government has mounted a campaign to promote fertility. These trends could leave Vietnam with little time to sit o­n its economic laurels. To avoid that fate, it will have to quickly address its structural weaknesses, particularly through such infrastructure improvements to better connect its domestic firms to the global value chain (GVC).

A second limit o­n Vietnam’s edge against China is that its gross exports include many Chinese and South Korean intermediate goods (see figure 3 for their share of Vietnam’s imports). While Vietnam has seen impressive growth in exports, much of that growth is being captured by foreign rather than domestic firms (see figures 4–6).

Vietnam’s integration with China has risen over the years, with higher dependency o­n Chinese inputs for production, while that of other countries in the Association of Southeast Asian Nations (ASEAN) has declined. That said, Vietnam’s rise in global market share is not all shallow—its participation in the GVC has increased significantly not just via foreign inputs for exports, called foreign value added (FVA), but also through its rising exports of intermediate goods in other countries’ exports, known as indirect domestic value-added exports (DVX), over the past ten years (see figure 7).

Nevertheless, Vietnam’s success in raising its participation in the global supply chain and improve its domestic standard of living offer lessons for other economies. Vietnam has expanded trade through bilateral agreements with ASEAN members Australia, Chile, China, India, Japan, New Zealand, and South Korea. But its greatest prize has been a free trade agreement with the EU, which comes into force in summer 2020. Within ASEAN, Singapore is the o­nly other economy with such a status. Moreover, it is o­ne that has eluded China, providing an especially valuable advantage for firms seeking to diversify their supply chain.

The agreement reduces import duties over seven years in the EU and ten years in Vietnam. Provisions that require the entire supply chain to be within the two markets to qualify for zero duties will further boost Vietnamese production up the value chain. This creates a short-term challenge, given Vietnam’s current dependence o­n China for inputs, but a long-term opportunity.

KEY FEATURES OF THE EU-VIETNAM FREE TRADE AGREEMENT

  • Improves alignment with international standards o­n motor vehicles and pharmaceuticals so that EU products will not require additional Vietnamese testing and certification procedures. Vietnam will also simplify and standardize customs procedures.
  • Grants EU access to Vietnamese public procurement, allowing companies in both markets to compete for o­ne another’s government contracts.
  • Simplifies operations for EU companies in the Vietnamese postal, banking, insurance, environmental, and other service sectors.
  • Allows EU investment in Vietnamese manufacturing sectors such as food, tires, and construction materials.

Vietnam’s free trade access to the largest economic bloc in the world is also a selling point for firms in China and elsewhere in Asia. As a result, inflows of foreign direct investment (FDI) from China rose massively in 2019. Overall, the agreement will further cement Vietnam’s status as Southeast Asia’s friendliest trade and investment hub.

Trinh Nguyen
Trinh Nguyen is a nonresident scholar in the Asia Program at the Carnegie Endowment for International Peace.

Beyond liberalizing its trade policy, Vietnam has set other examples for emerging markets by adopting incentives for foreign firms to set up shop in the country through industrial parks, infrastructure building, and tax breaks. These measures have attracted large brands such as Samsung Electronics, which now relies o­n Vietnam as an offshore center to arbitrage rising costs in China. During the ban o­n foreign visitors due to the coronavirus pandemic, the Vietnamese government granted exemptions to South Korean engineers who needed to visit their plants. The successful containment measures that allowed for such exceptions further burnished Vietnam’s brand as a place to do business.      

In manufacturing, Vietnam has now had the region’s highest increase of global market share in the past five years (see figure 8). That growth has allowed it match Thailand and Malaysia’s levels of gross exports and surpass that of Indonesia, whose GDP is four times larger. Further, Vietnam’s trade and economic policies have pushed up the share of FDI in its GDP (see figure 9).

A third lesson from Vietnam is that its increased production has been made possible by improvements in its electric system, national highways, and air and sea ports. These investments have boosted the country’s place o­n World Bank rankings of national infrastructure from 64 in 2016 to 39 in 2018, driven in large part by upgrades to its logistics services and ability to track consignments. Expected increases in FDI inflows and industrial production will likely propel continued growth in demand for infrastructure investment.

Even as Vietnam’s ability to capture manufacturing activity from China faces limits, therefore, its policies have expanded its share of supply chain activity and value. Its success offers lessons for similar economies to capitalize o­n trends diversifying production outside China and improve the livelihoods of their citizens.

The author is grateful for research and contributions by Junyu Tan.

Covid spillover: Firms shifting from China to Vietnam has a lesson for India

This was being talked about. Now some agencies working o­n the ground have started reporting that companies are shifting out of China. Covid-19 pandemic is not the o­nly reason but it has certainly given the push to what US-China trade war began.

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It was also reported in May that India has identified a land pool of 4.62 hectares to lure businesses from China. (Rep Image)

HIGHLIGHTS

  • Some agencies working o­n the ground have started reporting that companies are shifting out of China
  • According to a report by Qima, there has been sudden surge in the demand for inspections and audits
  • Qima reported 45 per cent surge in demand for South-East Asia

This was being talked about. Now some agencies working o­n the ground have started reporting that companies are shifting out of China. Covid-19 pandemic is not the o­nly reason but it has certainly given the push to what US-China trade war began.

According to a report by Qima, a Hong Kong-based quality control and supply chain inspection company, there has been sudden surge in the demand for inspections and audits by North American and European buyers in South-East Asia and South Asia.

Such inspection and audit reports are used by companies to migrate to new areas. Qima reported 45 per cent surge in demand for South-East Asia (with Vietnam, Myanmar and the Philippines in the lead), and 52 per cent in South Asia, where Bangladesh remained a go-to destination for Textile and Apparel brands.

This demand surge was witnessed during January and February, when China was under coronavirus lockdown. It would not have been significant but for two other findings of the Qima survey.

First, as lockdowns began to lift in China in March, local manufacturing rallied, and inspection and audit volumes headed towards 2019 levels. However, this rebound was cut short and the week of March 23 saw inspection and audits volumes in China collapse again, down 19 per cent. It was helped by lockdown in America and Europe.

Second and more important, in a Qima poll of over 200 businesses with global supply chains, 87 per cent of respondents said coronavirus pandemic would trigger significant changes in the global supply chain. More than 50 per cent noted that they had begun switching to suppliers in unaffected regions. This "shift" sentiment is in sync with the pre-coronavirus outlook emerging from US-China trade war, which does not seem to be ending soon, even if Donald Trump loses the US presidential election in November. The two countries have locked horns too intricately now to untangle them easily. China is additionally involved in trade rows with Australia and European countries.

This "shift" sentiment raised hopes in India that it would be able to attract much of the businesses due to its democratic polity and open market.

It was also reported in May that India has identified a land pool of 4.62 hectares to lure businesses from China. Some 1,000 US firms were approached with incentives for shifting their manufacturing plants in India.

Some states such as Uttar Pradesh formed a special task force for the purpose and also announced changes in labour laws drawing jibes from Chinese Communist Party's mouthpiece Global Times. However, the companies that are moving are not heading towards India.

According to a study by Japanese financial group Nomura, the destination for these companies remains in the East and South-East Asia.

Nomura found that 56 companies moved its bases from China in 2018-19, Vietnam got 26 of them. Taiwan got 11 and Thailand eight. o­nly three companies came to India.

Qima report underscores that the companies are looking "safer" destinations which in post-Covid times also means the countries that have managed coronavirus pandemic better.

Vietnam, incidentally, has emerged as a model country in the fight against coronavirus pandemic. The country reported o­nly 327 Covid-19 cases with no deaths.

For a country with almost 10 crore population, this is a commendable achievement. In India, West Bengal has a comparable population and reported 8,613 cases till Tuesday morning with more than 400 deaths. Bengal has been more daily cases than total caseload of Vietnam for past several days.

To make itself a more attractive destination, Vietnam o­n Monday ratified its trade deal with the European UNI0N. This translates into removal of 85 per cent tariff by the EU o­n exports from goods manufactured in Vietnam, and phased removal of imports from European countries.

This explains why India is not the preferred destination for companies which are actually shifting or have plans to relocate out of China. India's large market access is not the o­nly determining factor for them even when the country is considered the closes rival to China.