Hank Snowden CMC '21 interviewed Dr. Malesky on Oct. 2, 2018.
The ongoing trade war between the United States and China has begun to shift production within the global supply chain away from China. One of the favored destinations in Southeast Asia is Vietnam. In what ways has the U.S.-China trade war already begun to affect Vietnam’s economy?
We have already seen a few effects from this development in Vietnam. It looks pretty clear that some industries in Vietnam are going to benefit. Some garment companies have already seen a small increase in exports and it looks like that may increase further.
One of the really interesting features of the Vietnamese economy that we've seen over time is the changing composition of Vietnamese manufacturing, moving from low value-added products to higher value-added products. The firms that produce these higher value-added products are also some of the beneficiaries, including those that produce electronics, optical products, and computers.
The major reason why this is happening is that, for a long time, foreign companies invested in China have had a “China plus-one strategy.” The purpose is to slowly move some of their production into Vietnam as China's wage rates increase and also as China's technology improves. The trade war with the US has only accelerated that phenomenon.
However, there are some other effects from the trade war. While in some ways it looks like Vietnam may be the big winner as production shifts, that's only one of the different global trends going on; there are others. The way global supply chains work is that many of the Vietnamese companies actually sell to China, which then sells those products on to the United States. Roughly $5 billion of exports from Vietnam to China run through global supply chains. Companies that are in that position are hurt, which includes some domestic companies as well as a large number of foreign companies, including Japanese, Korean and even Taiwanese companies operating in Vietnam.
Secondly, there is a macroeconomic effect of these tariffs in Vietnam. Through the US increasing the cost of Chinese exports, it has caused the dollar to appreciate against the Yuan. Since the Vietnamese currency is fixed to the US dollar, this has made Chinese goods relatively cheaper in Vietnam. This originally led to a small surge of Chinese imports into Vietnam, especially in consumer goods and consumer non-durables. So, one of the interesting things happening along the sidelines of this trade war has been that the Vietnamese government has been working to devalue the Vietnamese currency in order to be able to adjust and allow the Vietnamese products to be sold at cheaper rates.
A third important factor to consider is that neither Vietnam, China nor the United States are stuck in their current strategies and a lot of people are expecting two things to happen as a result of Chinese actors taking actions to ameliorate the effects of these tariffs. One thing China can do is “tariff jumping”: moving Chinese production into Vietnam and re-labeling it as Vietnamese production. This was happening a few years ago with steel, and eventually US trade authorities figured this out and tariffs were slapped on to the Vietnamese exports of steel. A lot of people are wondering if that could happen again. One final thing that the Chinese government has already started to do is to slash tariffs on products from other Asian countries, including from Vietnam into China, as a way of shifting trade away from the United States into China.
So, to reiterate we've seen a shifting of some exports and some investment that's leading Vietnam to become a big winner, however, Vietnamese companies already in supply chains selling through China are likely to be hurt. Also, the exchange rate effect is likely to be severe. This may end up hurting Vietnamese products and could actually undermine the benefits from the Trump tariffs. Finally, there are these strategic effects that might take place: tariff jumping and Chinese reciprocal tariff cutting in Asia.
What role does location play in this supply chain shift towards Vietnam? Do the country’s various ports and proximity to China increase its likely benefits? Does Vietnam have the necessary infrastructure to maximize the benefits of the relocation of part of the global supply chain?
Proximity is definitely a major benefit for Vietnam; it is right on the Chinese border. Already it was reported in the New York Times that 72 Japanese businessmen who operate investments in China went to Quảng Ninh Province and it's not an accident that they went there. Quảng Ninh fits right on the border of China and there's a border gate there. If firms want to incrementally change the way their supply chain management works, moving operations to Quảng Ninh makes a lot of sense. They can keep some of their existing operations in China and slowly move things into Vietnam without disrupting transport networks very much.
The second thing about Quảng Ninh is that over the years, the local government has done a lot to improve the investment environment there. Every year, and I helped them with this, the Vietnamese Chamber of Commerce puts out rankings of the best investment environments in Vietnam. It is called the Provincial Competitiveness Index. This year Quảng Ninh ranked first and that is almost entirely due to the efforts of its investment promotion office that has done a really great job facilitating regulation and taking care of a number of the issues that investors face.
Vietnam is also relevant because of its ports. Vietnam has three or four major ports that are advantageous. We've seen Vietnam do a lot over the past few years to try and improve the efficiency and facilitation of those ports. In the Provincial Competitiveness Index that I mentioned we’ve seen a rapid decline in transaction costs, fees and hold ups for customs at those ports. There's been a lot of efforts to improve these things, so the ports are probably well set up to deal with recent developments.
We've also seen a tremendous improvement in infrastructure in Vietnam related to foreign investment. In soft infrastructure (telephone and internet), Vietnam has had a massive expansion, so every firm has highly adequate telephone services and internet services. There has also been an expansion of hard infrastructure. There's a beautiful new road that leads from Hanoi to Hai Phong Port that has cut down travel time. Similar efforts are being made to connect Ho Chi Minh City to ports, however, there is still more to be done. In the annual survey, roads and bridges are still a frustration for many companies and what they're most concerned with is connectivity, mainly with roads to railroads, ports and airports. These are the next big projects for Vietnam.
Many experts are saying that another reason Vietnam is poised to pick up much of the production is due to its highly skilled, low-cost workforce. Can you explain what has contributed to Vietnam’s human capital development? How competitive is Vietnam’s labor cost relative to other countries in the region?
I don't have the exact numbers on this, but I think the labor cost of the Vietnamese worker per hour is about 1/2 that of a Chinese worker. And while the Vietnamese labor is still relatively more expensive than similar factory workers in Cambodia and Bangladesh, the big benefit for companies working in Vietnam is that the labor is low cost and really well educated. Vietnam’s literacy rates vary, but between 94 and 99 percent of people have at least an elementary school education. Companies that work in Vietnam have praised the efficiency and entrepreneurialism of the Vietnamese labor force, due to this widespread excellent primary and secondary school education. Basic literacy skills and basic numeracy skills are all excellent in Vietnam. There’s been a big investment in teaching quality. A feature here is that many companies have talked about how the Romanized Vietnamese alphabet, as compared to character or Sanskrit based languages, allows the Vietnamese to more easily adapt to English language instructions. Even learning things like computer code is easier for Vietnamese because of the way their alphabet works.
However, a major policy issue in Vietnam has been that while primary and secondary school education have been excellent, tertiary education and vocational education have not been as good. Companies operating in Vietnam praise the ability to find high-quality manual workers, they've been less excited about their ability to find managers or technicians. In fact 55 percent of foreign investors find it difficult and 19 percent find it very difficult to recruit highly-skilled technicians to their companies. And, the few technicians that are good are actually quite expensive. There was a big debate in May in the Vietnamese National Assembly about educational law and the key focus of that debate was how to improve tertiary and vocational education for a more modern economy. The Vietnamese have recognized that they need to transition from that low-end workforce to a higher end workforce and they need workers that are more suitable for that.
Will the influx of foreign capital hurt any sectors in the Vietnamese economy?
This influx of foreign capital is not a recent phenomenon; it has been going on since Vietnam joined the WTO in 2007. The classic measure is to take FDI per capita / GDP per capita, and by that ratio Vietnam is the most attractive country in the world for foreign investment by quite a margin. It punches way above its weight in terms of its wealth, and has attracted billions of dollars into the economy. As a result, the foreign investment sector has taken a major role in the economy. Roughly 70 percent of Vietnamese exports are produced by foreign companies, and the manufacturing sector is absolutely dominated by these foreign companies. The Vietnamese private sector has instead been participating in the service and retail sector. So far Vietnam has not been able to develop large, domestic, globally-competitive firms. A major concern for Vietnamese policymakers has been how to leverage the energy, productivity and efficiency of the foreign sector, while not paralyzing the domestic private sector going forward.
One of the things they have been working on very hard is trying to figure out how to improve contracting so that domestic Vietnamese companies can enter that global supply chain. How can they better produce the intermediate goods and services that those foreign companies need, so that they can eventually step into that role that the foreign companies are currently playing in Vietnam.
We can separate these when thinking about the tariff effects: If we say that the tariffs are going to increase the attractiveness of Vietnamese exports, that might be good for Vietnamese domestic producers; but if it also simultaneously increases that massive flow of foreign investment into Vietnam, this problem will probably be exacerbated.
As demand continues to rise for Vietnamese labor, will it eventually result in the labor becoming more expensive, and thus end up pushing the work somewhere else?
It's likely to become an issue, and the Vietnamese government is well aware of it. They're not banking on this low-end, labor-intensive foreign investment for very long. The major competitors for Vietnam are likely to be Cambodia, Laos, Bangladesh and Myanmar, although the attractiveness of Myanmar has waned over time.
It’s absolutely true that wages will be pushed up, and the Vietnamese government has already started to think about the next generation of workers. They’re trying to train workers that are not just attractive because of their low cost, but rather attractive because they have skills and more technological and management ability. That’s been the focus of the educational debates in Vietnam for a while. This shift is already beginning to occur, as we’ve seen that the sectors that have grown the most recently have been in those technological industries, where as we've seen a decline in low-end manufacturing. Garments have already begun to move away from Vietnam.
One potential challenge to Vietnam is that, unlike a continental economy such as China, it does not have strong and large upstream industries, such as steel, chemical and other sectors that supply critical intermediate goods. How will this reality affect Vietnam as key player in the global supply chain?
This is definitely going to be an issue, and it's not just the raw materials. While Vietnam does have some steel, chemical, cement and industrial materials production, a lot of that production is in the relatively inefficient state-owned sector. The costs are high, they haven’t been able to meet the demand, and there's the related problem that the private sector has not been able to produce the intermediate goods and services that would be attractive to foreign companies. Even to this day, companies in Vietnam are outsourcing a large portion of their input. At this point, between 49 and 60 percent of their input is sourced from abroad through the supply chain or through third parties and I think that will be a problem.
The first thing that the Vietnamese economy needs to work on is how to run the upstream base material industries in a cheaper and more efficient way, and that has to do with the reform of the state-owned sector. The second thing is to further develop the production of the intermediate goods and services that are vital in supply chains which are not being produced in Vietnam.
There has been an effort to try and help companies adjust and see these market opportunities. More effort has gone to matchmaking between Vietnamese private firms and the foreign sector. Samsung, which is alone responsible for 30 percent of Vietnamese exports, has actually done a really good job of trying to work with Vietnamese suppliers in order to meet their standards and create that intermediate production industry that they’ll need to rely upon. The more companies that move the bulk of their activities into Vietnam like this, the more that the domestic private-sector needs to develop.
One inevitable result of the relocation of supply chain to Vietnam is the rise of American trade deficit with Vietnam. Do you see that will eventually make Vietnam a target of American protectionism?
When President Trump visited Vietnam for the APEC Summit and had a one-on-one meeting with the prime minister, he actually already raised this issue. It came in the discussion because Vietnam is fifth in terms of surplus with the US as a percentage of GDP. It’s a complicated question, because I don't necessarily agree with our president here. The analysis is a little bit naive and short-sighted. The surplus Vietnam has with the U.S. is not in products that compete directly with American companies, but rather in low-end products like raw materials, processed foods, and garments. Vietnam is competing against products from other emerging markets. Vietnam’s exports to the US actually may end up being beneficial to the United States in the sense that they lower the cost of goods for American consumers. We should probably should have a better understanding of that as we approach this issue.
As the relations between the US and China decline and as Vietnamese relations with the US have strengthened during the Trump presidency, this fell by the wayside and some other issues became more important. But, due to the current administration’s focus policy-wise, I suspect it will come up again. When it does, I hope they have a more sophisticated analysis of this issue, because the most sophisticated analysis to date on this shows that Vietnam is not costing the US many jobs. I would argue that they are probably helping the US gain jobs in terms of lowering the cost of production for many American companies and lowering the cost of the everyday cost of living for most Americans.
By Mstyslav Chernov [CC BY-SA 3.0 (https://creativecommons.org/licenses/by-sa/3.0)], from Wikimedia Commons