To continue on a
strong GDP growth trajectory, the country should work to raise its labor
productivity.
During the past
quarter century, Vietnam has emerged as one of Asia’s great success stories. In a
nation once ravaged by war, the economy has posted annual per capita growth of
5.3 percent since 1986—faster than any other Asian economy apart from China.
Vietnam has benefited from a program of internal restructuring, a transition
from the agricultural base toward manufacturing and services, and a demographic
dividend powered by a youthful population.
The country has also prospered since joining the World Trade
Organization, in 2007, normalizing trade relations with the United States and
ensuring that the economy is consistently ranked as one of Asia’s most
attractive destinations for foreign investors.
The McKinsey Global Institute (MGI) estimates that an expanding labor
pool and the structural shift away from agriculture contributed two-thirds of
Vietnam’s 7 percent annual GDP growth from 2005 to 2010.
The other third came from improving productivity within sectors. But
the first two forces have less and less power to drive further expansion.
According to official Vietnam statistics, growth in the country’s labor force
will probably decline to about 0.6 percent a year over the next decade, down
from 2.8 percent between 2000 and 2010. Given the past decade’s rapid rate of
migration from farm to factory, it seems unlikely that the pace can accelerate
further to raise productivity enough to offset the slowing growth of the labor
force.
Instead, Vietnam should increase its labor productivity growth within
sectors to achieve an economy-wide boost of some 50 percent—to 6.4 percent
annually—if the economy is to meet the government’s target of a 7 to 8 percent
annual GDP expansion by 2020. Without such an increase, we estimate, Vietnam’s
growth will probably decline to about 5 percent annually. The difference sounds
small, but it isn’t: by 2020, Vietnam’s annual GDP will be 30 percent lower
than it would be if the economy continued to grow by 7 percent.
Achieving 6 percent–plus annual growth in economy-wide productivity is
a challenging but not unprecedented goal. Nevertheless, incremental change will
not achieve a revolution of this magnitude. Deep structural reforms within the
Vietnamese economy and a strong and sustained commitment from policy makers and
companies will be necessary (see sidebar, “An agenda for sustaining growth”).
Also, many companies have prospered in Vietnam because of the country’s
strong and stable growth and inexpensive, abundant labor. In the future, they
may no longer be able to rely on either, so they will need to ensure that their
business and financing models are sufficiently robust to withstand a period of
lower growth and, perhaps, economic volatility.
The challenges
facing Vietnam
In the near term, Vietnam must cope with a highly uncertain global
environment. The economy faces a state of heightened risk because of
macroeconomic pressures, including inflation that has built up as a by-product
of the government’s efforts to maintain robust growth despite the global
economic crisis. In early 2009, Vietnam’s global trade and foreign direct
investment declined dramatically, and while exports have recovered, the future
of these two sources of economic activity is quite uncertain.
The slow recovery of the United States and Europe, together with the
nuclear disaster in Japan, has created additional near-term uncertainty. In
response to the global economic downturn, the Vietnamese government relied on
expansive macroeconomic policies that have led not only to inflationary
pressures but also to budget and trade deficits and unstable exchange rates.
Some signs suggest that the financial sector is under stress, and international
credit-ratings agencies have lowered their ratings on Vietnam’s debt.
In the longer term, Vietnam has a larger challenge. Since the key
drivers that powered its robust growth in the past—a young, growing labor force
and the transition from agriculture to manufacturing and services—are beginning
to run out of steam, Vietnam now needs new sources of growth to replace them.
The demographic tailwind responsible for driving a third of Vietnam’s
past growth is slackening. Some companies already report labor shortages in
major cities. By 2020, the share of the population aged 5 to 19 is projected to
drop to 22 percent, from 27 percent in 2010 and 34 percent in 1999. Although
Vietnam’s median age, 27.4 years, is still relatively young compared with that
of countries such as China (35.2), its population is also aging.
According to government projections, Vietnam’s labor force is likely to
grow by about 0.6 percent a year over the next decade, a decline of more than
three-quarters from the annual growth of 2.8 percent from 2000 to 2010. Growth
in the labor force will still make a positive contribution to GDP, but notably
less than it did in the past decade. Vietnam’s growth has also been propelled
by extraordinarily rapid migration from rural areas to towns—from relatively
low-productivity agriculture to the relatively higher-productivity services and
manufacturing sectors.
Economic restructuring is unlikely to continue so quickly. Indeed, even
aggressive assumptions on the pace of the transition away from agriculture
would not compensate for the effects of the decline in overall labor force
growth. Without an improvement in productivity growth patterns within sectors,
agriculture’s share of the labor force would need to decline at twice the rate
of the past decade—unlikely given the aging of rural areas and the decline of
agriculture’s share of the total population, by 13 percentage points, over the
past ten years.
Vietnam should identify sources of growth to replace those now becoming
exhausted. Manufacturing and service industries ought to step up their
productivity growth performance. Vietnam could also further develop the
capabilities across all sectors, become increasingly versatile as an
environment in which companies can constantly innovate and build on recent
successes.
Offshore services such as data, business-process outsourcing, and IT
appear to be promising areas. Vietnam can establish an enabling environment at
the level of individual industries and sectors by enhancing domestic competition
and helping industries move up the value chain. Building on its expanded pool
of university graduates, Vietnam has the potential to become one of the top ten
locations in the world for offshore services.
Because state-owned enterprises still have enormous importance,
accounting for about 40 percent of the nation’s output, reform of their
ownership and management incentives is likely to be crucial, as will the need
to improve their overall capital efficiency.
As we have seen, to achieve GDP growth of about 7 percent a year,
Vietnam needs to raise annual productivity growth to 6.4 percent. Without such
an increase, we estimate, the glide path for Vietnam’s growth would decline to
between 4.5 and 5 percent annually, significantly below the 7 percent more
typical in recent years and the government’s own target, set at the 11th
National Party Congress in January 2011, of 7 to 8 percent annual GDP growth to
2020.
If growth indeed slows to 4.5 to 5 percent a year, the implications
would be significant. By 2020, Vietnam’s annual GDP would be 30 percent (some
$46 billion) lower than it could be with 7 percent annual growth. Assuming
no shift in the structure of the economy as a whole, we estimate that private
consumption would be $31 billion lower. Vietnam’s economy would take 14—rather
than 10—years to double in size.
Implications for
companies
The exposure of companies and investors to different economic growth
outcomes clearly depends on whether they are active primarily in the domestic
or export market. Domestically oriented companies, such as those in the
financial-services or retail sectors, are much more threatened by slower growth
in Vietnam than are companies that use the country as an export base for
manufactured goods. Since prospects for growth vary substantially from sector
to sector, each company must understand and manage its own specific problems.
The expected slowing in the expansion of the labor force also has
significant implications for companies. Those that view Vietnam primarily as a
low-cost economy with an abundance of workers need to adjust their thinking.
Multinationals
Primarily to hedge their exposure to China, many multinational
corporations have opened facilities in Vietnam (or plan to do so), without
adequately assessing the prospects, both positive and negative, for expanding
business in Vietnam itself. These companies should avoid locking in excess
capacity—the country’s economy may not match the strong growth trends of the
past—and ensure that their Vietnamese business models are sustainable even if
wages rise substantially.
Anecdotal and survey evidence consistently indicates that the wage cost
advantage is eroding. Much as domestic and export-oriented companies must boost
their productivity to be competitive, so too must multinationals, which could
also engage with the government to remove barriers to initiatives that clearly
benefit both sides, such as programs to increase capital intensity and improve
training.
Training is especially important. Multinationals complain about a lack
of basic work readiness among new recruits in both the manufacturing and
service sectors. Many companies in other countries have responded effectively
to this problem by providing in-house training both before an employee starts
working and on the job.
Surveys suggest that Vietnam has an even bigger shortage of qualified
engineers and middle managers than other rapidly developing economies do.
Multinational companies can work with the government and educational
institutions to address this skill gap. If the Vietnamese government were to
issue certificates for qualified training programs, companies might feel more
confident in providing such training.
Private-sector
Vietnamese corporations
Improving competitiveness and using the latest global best practices
should be priorities for Vietnamese companies in the private sector. They
should emphasize long-term value and bottom-line profits rather than merely
seeking to increase top-line revenue. Too many domestic Vietnamese companies
spend too much energy competing on price and too little on product quality,
features, and branding and on developing unique offerings that can command
premiums.
These companies must develop programs to recruit employees and train
them so that their skills and productivity improve. They should also take a
more professional approach to retaining and promoting their best workers,
through incentive packages and greater management autonomy. The notion of
increasing the value of each employee’s performance is not yet widely
understood among major Vietnamese companies. Family-owned businesses, which
remain a major part of the economy, have thus far tended to resist efforts to
improve their governance.
State-owned
enterprises
More limited access to capital and increasing competition mean that
state-owned enterprises must lift their productivity before circumstances force
their hand. Improved management and better governance could raise their
competitiveness and overall growth potential. In China, for instance, the
significant gains in productivity that resulted from reform within the
state-owned sector led to increased profitability as well.
Vietnam’s state-owned companies will also need to recognize the gaps in
their pool of talent and to recruit top-drawer, internationally trained
executives to help them become more globally competitive. They will
increasingly have to benchmark themselves against the best international
competitors not only to measure internal operations but also to create
realistic plans for expansion and product development.
In this context, the adoption of international accounting standards
will support the creation of the detailed performance benchmarks required to
identify areas for improvement. Many maturing state-owned enterprises will have
to make hard decisions about which businesses should remain core and which
should be exited because they can no longer be profitable.
Selling shares in these companies remains a focus of many policy
conversations in Vietnam. But most of the sales carried out to date haven’t
fundamentally tackled the efficiency problems, because the state typically
remains the controlling shareholder. More aggressive steps toward fuller
privatization and improvements in the governance of state-owned businesses
might help them adjust more rapidly to an era of increasingly vigorous
international competition.
We think Vietnam can act decisively to head off short-term risks and
embrace a productivity-led agenda. If the country does so, it can build on its
many intrinsic strengths—a young labor force, abundant natural resources, and
political stability, to name a few—to create a second wave of growth and
prosperity. There are challenges, to be sure, but we believe that they can be
overcome.
Marco Breu, Richard Dobbs, and Jaana Remes
Business & Investment Opportunities
YourVietnamExpert is a division of Saigon Business Corporation Pte Ltd, Incorporated in Singapore since 1994. As Your Business Companion, we propose a range of services in Strategy, Investment and Management, focusing Healthcare and Life Science with expertise in ASEAN. We also propose Higher Education, as a bridge between educational structures and industries, by supporting international programmes. Many thanks for visiting www.yourvietnamexpert.com and/or contacting us at contact@yourvietnamexpert.com
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