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Capital Economics: Lack of FDI spillovers a concern for exports

Released at: 21:16, 09/01/2018

Capital Economics: Lack of FDI spillovers a concern for exports

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Latest report from Capital Economics notes potential problems from FDI not benefiting domestic companies to the fullest.

by Duy Anh

Exports from Vietnam should continue to grow strongly in the short term but the lack of spillovers from the dynamic foreign sector to the less-productive domestic economy is a cause for concern and could cost the economy over the medium term, Capital Economics wrote in its latest report.

A key driver of Vietnam’s economy over recent years has been exports, helped by booming foreign direct investment (FDI) into the manufacturing sector. The country is reaping the rewards of its entry into the WTO in 2007, and the only Asian economy that has reduced trade tariffs more sharply than Vietnam over the last decade is India.

Trade liberalization has happened in Vietnam while wages in China, which are already significantly above those in Vietnam, have been rising rapidly. A stable political environment and Vietnam’s proximity to existing supply chains are other factors that make it an attractive production base for low-end manufacturers looking for alternatives to China.

Vietnam has continued to attract high levels of FDI, which bodes well for export prospects over the next couple of years at least. Exports could also receive a boost from the TPP. Although the deal will be smaller following the US’s withdrawal, Vietnam stands to be among the top beneficiaries.

There are also encouraging signs that Vietnam is moving beyond a dependence on the assembly of low value textiles. Exports of electronic items, where there is more scope to add value, have surged. Other Asian economies, most recently China, have shown that shifting from textiles to electronics is an important step on the path to development.

Despite these positives, there are clouds on the horizon. A reliance on foreign firms to drive the export boom is a cause for concern. Admittedly, an influx of foreign manufacturers should bring plenty of benefits in terms of generating new jobs and tax revenues. The gains will be even greater if the arrival of foreign companies result in the transfer of the latest technologies and production techniques to domestic firms.

However, there is little sign of this happening in Vietnam.

While exports from foreign-owned firms have soared since 2011, exports from domestic firms have stalled. “This is in marked contrast to China, where exports from domestic companies have grown at a much faster pace than those from foreign firms in recent years,” the report noted.

That foreign companies appear to be creating few spillovers into the domestic economy could spell trouble if Vietnam starts to lose its competitive advantage in contract manufacturing.

Foreign firms are relatively footloose and as costs continue to rise in Vietnam, foreigners could easily decamp to other parts of Asia with even lower labor costs, notably Bangladesh.

There is also a risk that Vietnam will be squeezed by countries above it on the value chain as a result of the rising use of robots in manufacturing. As the cost of automation continues to fall, the incentive to locate factories where labor is cheapest fades. Instead, manufacturers are more likely to locate their factories closer to their main market or existing manufacturing centers.

“China’s increased use of robots is a particular threat to Vietnam, raising the possibility that even as costs in China continue to rise, it will continue to be competitive in many lower-end sectors,” Senior Asia Economist Mr. Gareth Leather said. Strong global demand and rising FDI bode well for export prospects over the next year or so.

Further ahead, the lack of spillovers is a major cause for concern. “Turning this around will be one of the main challenges facing policymakers over the coming years,” Mr. Leather noted.

According to the General Statistics Office, Vietnam’s export turnover reached $213.77 billion in 2017, up 21.1 per cent compared to the previous year; the highest increase ever recorded. The domestic sector contributed $58.53 billion, an increase of 16.2 per cent, while foreign-invested enterprises posted export turnover of $155.24 billion, up 23 per cent year-on-year.

2017 was considered a miracle because previous years’ exports of crude oil and natural resources accounted for a very large share in the export structure, while electronic components and mobile phones occupied the highest proportion last year.

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