Communiqué: Vietnam: Avoiding the ‘Middle Income Trap’

May 28, 2010
Communiqué: Vietnam: Avoiding the ‘Middle Income Trap’
Boats bring passengers to a Vietnamese floating market

Center’s Vietnam Program Explores Country’s Socioeconomic Factors to Ensure Success

By Kate Hoagland – Communiqué: Spring 2010, Volume 6

At a Vietnamese floating market in Can Tho, farmers and fishermen stand in wooden boats stacked high with bright green watermelons, light yellow bananas, 25 pound-bags of white rice, and fresh shrimp. It is five a.m., and vendors shout out deals above the noises of rumbling diesel engines and clucking chickens. Small children play along the banks of the Mekong River Delta, while an older man walks the family water buffalo.

The Mekong River Delta is home to over 13 provinces in southwestern Vietnam. Called the “Nine Dragon River Delta,” after the Mekong’s nine tributaries, the region’s rich ecosystem supports much of the country’s agricultural production. Vietnam is the world’s second largest exporter of rice accounting for 20 percent of the world’s traded 30 million tons of rice per year ; many of these rice farms depend on the Delta region’s mineral-rich silt and periodic flooding for production. “The Mekong Delta is the agricultural dynamo of the country,” said Ben Wilkinson, associate director of the Center’s Vietnam Program. “But it is facing a potent cocktail of environmental threats.”

A Potent Cocktail of Environmental Threats
China, Thailand, Laos, and Cambodia have plans to build large-scale hydroelectric projects and dams in different parts of the Mekong Delta. These dams threaten to disrupt the Delta’s delicate ecosystem and restrict water flow during Vietnam’s dry season. With less fresh water, sea water flows up river, filtering into the soil and damaging crops. Even though the largest dams have yet to be constructed, this year’s drought caused a saline intrusion of upwards of 60 miles upstream, something Vietnam Program Economist David Dapice predicts will be a common occurrence. “Drought is a foretaste of what is likely to happen regularly once all of these dams get built, especially if they divert water,” he said.

Increased salinization of the region’s fertile soil is also caused by a decreasing water table. With limited, if any, government oversight of water resource management, rice and fish farmers simply pump water out of their own wells and dig new wells when these run dry. Pumping out fresh water causes the ground to sink and allows salty water to further filter into the ground water creating unfriendly conditions for growing much of the nation’s fruits, vegetables, and rice.

These conditions are compounded by possible future damage caused by changes to the climate. Many scientists argue that Vietnam will be one of the countries most affected by a potential sea rise. Short term irregular weather patterns, such as more frequent typhoons and dramatic flooding, could damage fishery and rice patty ecosystems within the next five to ten years. Such diminished agricultural production along with the region’s public infrastructure – insufficient in the face of damaging typhoons – could force an urban migration.

“For Vietnam, you have the prospect of millions of people having to get off the land in a relatively short period of time, and the possibility of having to invest billions in housing, roads, and other infrastructure to take into account the increase in typhoons and other issues they haven’t dealt with before,” said Dapice.

In addition to changes to the Vietnamese way of life, deteriorating rice production could set off a domino effect in the global economy, weakening political stability among the world’s largest rice importers, primarily within Africa. According to the USDA’s 2010 Rice Outlook, over 440 million tons of rice are grown worldwide. “If you lose 5 to 10 million tons of rice from exports, it’s not catastrophic from a world view, but the global price could double or even triple,” said Dapice.

Dapice recommends that the Vietnamese government take an integrated approach to the Mekong Delta’s water threats by creating a water market for enforcing stricter water resource management policies and researching crop varieties that can better adapt to the longer-term effects of a changing climate.

Avoiding the Middle-Income Trap
The challenges facing the Mekong region are just one issue that could hinder Vietnam’s continued economic success. Over the last 20 years, Vietnam’s economy has improved: the country has tripled its per capita income and opened its economy to foreign investment while encouraging domestic private enterprise. Yet, most industry remains concentrated in low-value items such as apparel and footwear. “But the margins are wafer thin, and you don’t get rich selling t-shirts and windbreakers,” said Wilkinson.

Foreign investors continue to gain ground in the country – Intel and Foxconn, a Taiwanese contract manufacturing company, have set up plants. In addition, the country has been able to attract Foreign Direct Investment (FDI) as well as Official Development Assistance over the past 20 years. Once among the 50 poorest countries in the world, based on purchasing power parity (ppp), Vietnam is now considered a “middle-income country,” defined by the World Bank as a country with a GDP per capita ranging from $1000 to $3700. But such a classification carries a new set of challenges.

Thomas Vallely, director of the Vietnam Program, explains that middle-income countries often fall into the “middle-income trap” whereby lagging institutional and political development slows fair distributional economic growth. Current rapid growth rates become unsustainable in the long term unless such countries improve governance policies and build infrastructure to support a growing economy. In Vietnam’s case, relatively weak public and media engagement, corruption, and inadequate government regulation along with poor infrastructure are strong hints of a weakening future economy. Moreover, Vietnam’s growing private sector strains to compete against a powerful state sector. “The dilemma is the country still has a Jurassic state sector that continues to absorb a lion share of investment,” said Wilkinson. Yet, the state sector creates few jobs and does little to support the country’s economic growth.

Dapice argues that Vietnam suffers from “crony socialism,” whereby powerful state enterprises unfairly win the majority of government contracts, gain easier access to cheap capital, and monopolize market share. Vietnam’s shipping industry exemplifies such ingrained practices.

In 2006, Vietnam announced an ambitious plan to become one of the nation’s top players in the shipbuilding industry. Huynh The Du, MPA 2010 at HKS and professor at the Fulbright School in Vietnam, evaluated this plan in a comprehensive report and concluded that the country’s dearth of highly-skilled nautical engineers and relative lack of competitive advantage would handicap such lofty goals. He suggested such plans were more politically motivated rather than grounded in sound business judgment. Du’s projections proved accurate: the largest state-owned shipbuilder Vinashin reported over US$18.8 million in losses in 2009 and has completed only half its contracted building projects for the year. Plans have been further hindered by the global collapse of the already volatile shipping industry and an 18:1 debt to equity ratio.

In order to escape the middle-income trap, Wilkinson argues that Vietnam must curtail such costly state sector projects and integrate the private and state sectors. China’s solution to this challenge could prove a valuable model for Vietnam: China has successfully used outside international enterprises to pressure state firms into becoming more globally competitive.

Training Tomorrow's Skilled Workers Now
In his 2006 report, Du noted that “Vietnam’s shipbuilding industry does not have the benefit of high technology emerging from its higher education system...to compete for international market share.” While the country demonstrates a respect for education with a successful primary and secondary system, Wilkinson argues that Vietnamese universities are inadequate for training the next generation of highly-skilled workers.

According to the 2008 Population Change, Labor Force, and Family Planning Survey of Vietnam’s General Statistics Office, the literacy rate of Vietnamese over the age of 15 is 93.6 percent, but the same report notes that only 1.9 percent of the population has attained a college degree. Vietnam’s central government has offered substantial financial support to higher education institutions, but has made little headway in improving governance processes in these institutions.

“Many of the problems in creating a strong education system are reflective of a systemic problem that transcends education,” said Wilkinson. The challenges of an inefficient state sector plagued by crony socialism arguably spill over into Vietnam’s education sector, where merit-based performance is not the norm. The World Bank-UNESCO Task Force on Higher Education and Society examined the crisis and made the following key recommendations in the 2000 report Higher Education and Developing Countries: Peril and Promise:

      • Establish strong accreditation standards for both professors and students
      • Create a culture of academic freedom and autonomy
      • Enhance science and technology curricula
      • Improve resources and funding supports to disadvantaged students

The Vietnam Program
Vietnam’s higher education sector is just one of the strategic focus areas of the Ash Center’s Vietnam Program. In January of 2008, a Vietnam Program delegation led by Thomas Vallely presented Prime Minister Nguyen Tan Dung with the ten-year policy framework for Vietnam’s socioeconomic development “Choosing Success: The Lessons of East and Southeast Asia and Vietnam’s Future.” This sobering assessment stated, “Key government decisions taken now and in the near future will set the country on a path that will become increasingly difficult to reverse, and will shape Vietnam’s political economy for years to come.”

To ensure that Vietnam is on the right path for sustained economic growth, Vietnam Program research, teaching, and executive training address the importance of enhancing the governance of both public and private institutions. The Program argues that curbing existing crony socialism practices in support of more merit-based production and innovation will prove invaluable for the country to thrive in the global economy. Its Vietnam Executive Leadership Program and Fulbright School are key elements to the Program’s focus on improving governance issues.

Vietnam Executive Leadership Program
Each year, the Program convenes the Vietnam Executive Leadership Program (VELP) which brings together senior Vietnamese leaders with Harvard faculty and global business leaders to explore the latest thinking on globalization and its relationship to development. At last year’s session, both Deputy Prime Minister Nguyen Thien Nhan and Vice Minister of Foreign Affairs Nguyen Quoc Cuong participated in these discussions.

Fulbright Economics Training Program
The Vietnam Program also enhances education and key policy dialogue through the Fulbright Economics Teaching Program (commonly known as the Fulbright School), a partnership with the University of Economics–Ho Chi Minh City. Founded in 1994, FETP offers senior officials public policy training and the country’s first Master’s of Public Policy for future leaders.

“Vietnam needs to develop the institutional capacity within the public sector to confront these problems of development and competitiveness, and that’s what we try to do at the Fulbright School in preparing Vietnamese civil servants for careers in the public sector,” said Wilkinson.