The role of FDI in Vietnam's socio economic development

The role of FDI in Vietnam's socio-economic development

Foreign direct investment (FDI) has played a crucial role in catalyzing Vietnam’s socio-economic development and its economic integration into the global scene since it started transitioning to a market-oriented model three decades ago. Easing restrictions for foreign investors encouraged a substantial mobilization of overseas capital into the strategically located economy. Investors were drawn to Vietnam’s enormous untapped potential promising high returns, along with a cheap workforce and high endowment of natural resources. A seismic shift in Vietnam’s economic structure from agriculture to industry, since the 1986 Doi Moi economic reforms were implemented, spurred a massive movement of workers from one industry to the other, encouraging the emergence of private domestic and foreign enterprises.

Accession into the World Trade Organization in 2007 marked another turning point, helping lead to an almost three-fold jump in FDI that year compared to the levels in 2006. The inflows facilitated the development of Vietnam’s key export-oriented manufacturing industries, helping stabilize the economy, bring rampant inflation under control and lift living standards. Lauded as one of East Asia’s new economic tigers, Vietnam has achieved the second-fastest growth rate per capita worldwide since 1990, behind only China. A surge in government revenues through strong exports and higher average household incomes have enabled transformative social development over the last two decades. Notably, the proportion of people living below the national poverty line has plummeted, and access to health, education and basic infrastructure has significantly improved, drastically reducing mortality rates, advancing learning outcomes and improving the quality of life.

Vietnam’s labor-intensive industries, namely the manufacturing and processing sectors have up until now been the biggest beneficiaries of FDI. Cheap labor has diminishing advantages, however, becoming increasingly weaker as a driver of growth. Sustaining growth at advanced stages of development demands a new model based on improving productivity and creating jobs that add higher value. Vietnam’s exports are largely concentrated in low-value added products compared to China and other ASEAN countries (Indonesia, Malaysia, the Philippines and Thailand). Through the acquisition of advanced technology into high-value added areas, the government aims to diversify the economy and sustain annual growth rates of 6.5%–7.5% by boosting total factor productivity—which is essentially the efficiency of labor and capital inputs combined.  

Attracting FDI to high value-added activities is integral to the government’s vision of boosting economic growth to new levels, with an ambitious target of ultimately breaking through the middle-income trap. This year, FDI is expected to account for around 70% of export turnover; a preliminary estimate shows that exports accounted for 93.6% of GDP in 2016. Featuring as a key goal in the government’s latest five-year socio-economic development plan for 2016–2020, boosting levels of FDI in high value-added sectors such as high-tech and environmentally-friendly projects will be critical to achieving social and environmental goals, including expanding health coverage, reducing unemployment and the poverty rate, extending access to clean water in rural and urban areas, and better managing pollutants.

Prospects for attracting more FDI to high value-added activities

In a bid to attract FDI into high value-added areas, the Ministry of Planning and Investment, in collaboration with the World Bank, is currently drafting a new five-year FDI strategy for 2018–2023. The strategy’s primary aims will be to lure more investment into high-tech industries than labor intensive ones and focus on the quality of investments in four priority sectors: manufacturing, services, agriculture and travel. Moreover, strengthening the capabilities of local enterprises will be crucial to facilitating linkages with foreign firms and strengthening participation in global value chains.

In the near term, priority will be given to industries with fewer opportunities for competition, which include the manufacture of automotive and transport equipment, and the development of environmentally friendly technologies (water conservation, and solar and wind energy). In the longer term, the focus will be on cultivating advanced skills in pharmaceuticals and medical equipment manufacturing, education, health, financial services, Fintech and the IT sector. Investment incentives are being designed to lure capital into regions with high potential in these sectors, such as the Tay Ngyuen region.

The government’s push to extend trade and investment liberalization through free-trade agreements should also help boost and streamline investment from partners, as reduced tariffs make exports more accessible. Among notable trade agreements include one with the EU and another coined the Regional Comprehensive Economic Partnership (RCEP). RCEP is a deal between the ten Association of Southeast Asian Nations (ASEAN) nations, and six Asia-Pacific heavyweights (China, India, Japan, South Korea, Australia and New Zealand). Vietnam is trying to diversify not the only the type of foreign investment, but also the partners from where FDI is sourced, especially from outside Asia.

FDI policies in Vietnam: Shortfalls and opportunities

Recently, there has been a shift in the preferences of multinationals to relocate operations from China to Vietnam, because of Vietnam’s low labor cost advantage—which it has not only over China, but also other regional players including Thailand and the Philippines—and somewhat less complex regulatory apparatus. Vietnam’s increasingly favorable tax and financial incentives have made it a hot spot for low-cost manufacturing. However, its cheap labor advantage has diminishing returns for an economy that is past the early stages of development and needs to restructure to high-value added sectors.

Cultivating a highly skilled workforce will be crucial to attracting FDI to high value-added sectors, as one of Vietnam’s primary shortfalls in terms of attracting FDI to high-value areas is a lack of skilled workers. In this regard, it trails far behind China, Singapore, Malaysia and Thailand. Reports indicate an acute skills gap as international firms in the technical, professional and managerial spheres find a mismatch in the skills needed and those of Vietnamese workers. A framework for skills development and training workers aligned to the economy’s long-term vision will be essential to luring FDI into high-tech industries.

Vietnam was the second most attractive destination for foreign investors among ASEAN countries in 2016, losing out to Singapore for the top spot. Vietnam’s business environment has significantly improved, propelling the country to number 68 out of 190 in the World Bank’s 2018 “Ease of Doing Business” report, a big jump up from a ranking of 82 just one year ago. While strides have been made in improving access to credit and electricity, and enhancing the tax system and procedures for enforcing contracts, Vietnam’s ranking is well below Singapore’s. Vietnam lags behind Singapore in every category of the index, signaling the need for faster progress in these areas to make it a bigger magnet for attracting FDI.

A complicated and unclear licensing environment, along with corruption, continue to impede investment, which helps explains Vietnam’s low ranking for starting a business. These are key areas of improvement; others include an improvement in trading across borders, protection of minority investors and resolving insolvency. Addressing these issues, together with upskilling the workforce amid a continued expansion in trade and investment liberalization, will be critical to attracting higher FDI inflows and keeping the economy on track to achieving its long-term vision.

Vietnam Economic Outlook

A surge in foreign investment inflows—amounting to USD 33.09 billion in the first eleven months of the year—is keeping the economy on a robust expansion path. Reports indicate that the processing and manufacturing sectors have been the biggest beneficiaries of the inflows. November recorded another month of stellar year-on-year industrial production growth, which hit the highest rate in close to three years, driven by a jump in manufacturing output. On the downside, the mining and quarrying sector contracted in November after expanding for the first time in 22 months in October, as the downturn in the oil and gas industry persists. Seeking to boost overall productivity and diversify the economy away from labor-intensive industries into high-value added sectors, Vietnam’s Ministry of Planning and Investment is currently formulating a new Foreign Direct Investment (FDI) strategy for 2018–2023, with assistance from the World Bank. The strategy will be specifically aimed at encouraging foreign investment into high-tech industries.

Vietnam Economic Growth

The economy is expected to grow at a strong pace next year, thanks to a record expansion in FDI inflows and a robust performance in exports. A weak banking sector, embroiled by a high proliferation of non-performing loans, and the ongoing boom in private sector credit continue to be downside risks to financial stability, however. FocusEconomics panelists expect the economy to expand 6.5% in 2018, which is up 0.1 percentage points from last month’s forecast, and 6.6% in 2019.


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Author: Nihad Ahmed, Economist

Date: January 3, 2018

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