How Vietnam can ride out the US–China trade war

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A manufacturer works at an assembly line of Vingroup’s Vsmart phone in Hai Phong, Vietnam. The expansion of mobile phone exports, Vietnam’s largest export, has been accompanied by an expanding trade deficit of high-tech components. Reuters

Vietnam’s economy is highly dependent on foreign trade. In recent years, the sum of its exports and imports increased to as much as 185 per cent of GDP. The United States and China are Vietnam’s largest export markets, accounting for 20 per cent and 17 per cent of Vietnamese exports respectively in the first 11 months of 2018.

Because of its heavy dependence on these markets, Vietnam may be hurt by the US–China trade war. While high US tariffs on imports from China will have diversion effects that stimulate exports from Vietnam and other countries, these effects may be weak for Vietnam. Most Chinese exports to the United States do not directly compete with Vietnamese products.

The major exceptions are labour-intensive goods such as garments. But Vietnam’s share of US imports of these products is already quite high, providing little room for further expansion without risking conflict with US President Donald Trump. Although economically trivial, Vietnam’s large trade surplus with the United States ($38.5 billion in 2017) is a potential problem given the Trump administration’s emphasis on bilateral trade balances.

Vietnam needs a new and wiser strategy to cope with this situation. The US–China trade war is intensifying the shift of a substantial part of some production from China to Vietnam and other Asean countries, initially spurred by increases in Chinese wages. Investors from Japan and other countries are increasingly looking for production locations other than China. This trend involves not only the shift of existing production sites, but also the choice of location for new foreign direct investment (FDI), particularly export-oriented projects.

Vietnam should take this opportunity to deepen and upgrade its industrial structure. Over the past three decades of doi moi (renovation), industrialisation has driven high economic growth (averaging 6.5 per cent annually). Despite this, the current level of industrialisation (the share of industry in GDP) remains low. When East Asia’s advanced economies had a younger population, this share was about 30 per cent or more. In Vietnam, which currently has an older population, it is only about 20 per cent.

Another problem is that the industrialisation process has so far been characterised by high reliance on final processed and fabricated goods at the low end of the supply chain.

As a result, the expansion of production and export of these goods has stimulated the import of related components, parts and other intermediate products. For example, the expansion of apparel exports has been accompanied by expanding imports of yarns and fabrics. And the expansion of mobile phone exports, Vietnam’s largest export, has been accompanied by an expanding trade deficit of high-tech components. Printers, motorcycles, personal computers and other types of machinery produced and exported by Vietnam follow a similar pattern.

A major portion of imported components and parts come from China. A foreign owned printer assembler that has two factories in Northern Vietnam reported that their annual imports of high-tech moulds from China reached $100 million in 2017. This is an impressive figure given that the one component was imported for only two factories. The director of the printer assembler indicated that the high-tech moulds could be produced in Vietnam if appropriate supporting policies were adopted.

The new wave of FDI is a chance for Vietnam to deepen its industrialisation by encouraging the development of supporting industries. The government should introduce new FDI projects on a selective basis, improve infrastructure and offer incentives to induce import substitution for high-tech components, parts and other intermediate industrial products. A list of the products that are particularly encouraged should be announced to stimulate the development of these industries.

Most FDI in Vietnam to date has been by wholly foreign-owned firms, with weak linkages to the local sector. The new FDI policy should aim to correct this division. Local firms should be encouraged to create vertical linkages between FDI assemblers and local suppliers of intermediate goods. Joint ventures between foreign and local firms should also be encouraged. The government should not, of course, force foreign firms to set up joint ventures. Rather, local firms should be nourished and strengthened so that they are selected by foreign firms to be partners.

The trade war between the United States and China may result in a slowdown of Vietnam’s exports. But the new wave of FDI that it creates will enhance import substitution in supporting industries. Net exports are likely to remain at levels similar to previous years. If net external demand remains unchanged, Vietnam can expect to maintain the strong growth rates of late.

Tran Van Tho is currently professor of economics in the School of Social Sciences, Waseda University. This comment first appeared in East Asia Forum and can be assessed at https://bit.ly/2Qh1u6Z

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