U 4875631 Case Study 1

Vietnam: Vision to 2020

Introduction

Vietnam, since 1975, has moved from centrally planned to socialist- oriented market
economy by introducing reforms in economic and social sector and becoming 2 nd largest
rice exporter in the World. Building on the success of socio-economic development of
80’s, Vietnam aspires to be a modern industrialised country in 2020 by doubling its
GDP, increasing the level of savings/investment and improving on HDI.

This paper will identify the major restraint to Vietnam Vision of 2020, identify two
alternative course of action, and adopt one alternative on the criterion.

Traditional drivers of growth, identified by Solow (1956, 1957), are accumulation of

capital and technological change. Luca and Paul Romer (1980’s) introduced role of
‘ideas’ and human capital in growth (Jones 2002, p.2). Neo Classical theories of growth
emphasised that depreciation reduces the capital stock over time and investment is
needed to restore the original capital intensity and capital stock (Helpman 2004, p 11).
Investment raises capital-labour ratio and economy moves further away from it steady
state, resulting in growth. However, long term growth is dependent on technological
progress to offset diminishing marginal returns of capital.

Moreover, Total Factor Productivity (TFP) - a measure of joint effectiveness of all

inputs combined in producing out puts, also accounts for variation in level of growth of
different countries (Helpman 2004, p 20). Technology, as argued by Young (2004),
moves an economy from its steady state and makes inputs more efficient and productive
(cited by Helpman 2004, p.23). Labour and capital inputs improve with technological
progress in a proportional shift called Hicks Neutral technological change (Helpman
2004, p23). As concluded by Yip and Jorgenson (2001), about 50% of Japan’s, 40% of
Germany’s and Italy’s output growth are attributed to TFP growth (p. 68).

With the present level of savings, i.e. 26% of GDP, a gap between investments and
savings, and imports and exports, Vietnam faces declining productivity of capital.
Accumulation of inputs especially capital accounts little for output growth because TFP
or productivity makes capital more profitable and induces capital accumulation

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(Helpman 2004, p. 26). The ineffective use of capital, obsolete technology, slow pace
of economic restructuring and under developed human capital have slowed down
productivity in Vietnam.

Key Issue

Vietnam Vision 2020 is highly jeopardised by low productivity.

Alternative 1: Restructuring the Institutions

Institutions, as defined by North (1990), are the rules of game in a society or, more
formally, the humanly devised constraints that shape human interaction (p. 3). Mokyr
(2002) concluded that accumulation of knowledge that transformed the Western World
into modern economies could not be possible without formation of institutions (p.326).
They determine the ability of countries to accumulate, to innovate, to adopt new
technologies and to re organise in the face of new technologies (Helpman 2004, p. 113).

Vietnam’ productivity prospects are mainly challenged by investment inefficiency and

the widening gap between domestic savings and investment (Ngyuyen 2009, p. 8 &
figure 1). Quality of institutions, as argued by Acemoglu et al. (2004), attracts great
investment by mustering domestic support, avoiding irregular changes and
institutionalising the income redistribution (pp20-51). Vietnam has wide regional,
urban-rural and ethnic inequality of income and poverty (Ngyuyen 2009, table 8, 9).

Urban and rural poverty divide is about 16% while urban and ethnic minority poverty
divide is 48% that suggests that economic growth that resulted from paddy boom had a
temporary effect on poverty reduction in rural and ethnic minority areas. As
international rice prices plunged or agriculture became capital intensive, poverty started
revisiting the rural and ethnic minority areas that is 75% of total population. It resulted
into less income and less savings, thus widening the gap between investment and
savings since 2000 (figure 1). Although the growth rate of Vietnam was 7-8% since
2000 (figure 3) but the gross domestic saving remained at 28% of GDP in that period
while the gross capital formulation increased from 35% of GDP to 47%. Its cause lies in
the inequality of income distribution and exclusion of rural and ethnic minorities from
benefits of growth. However, institutions take a long time to evolve. Even ‘less than

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perfect’ institutions may also help growth as in case of China and India. Lastly Vietnam
has already undergone necessary economic reforms but still lacking social and political
reforms.

Alternative 2: Technology Up gradation

Vietnam may enhance its productivity by technology updating through importing

technology and investing in innovation (R&D).

Technology is at the centre of modern economic growth as argued by Landes (1969),

Rosenberg (1982) and Mokyr (1990). It effects the growth through Hicks neutral
proportional productivity and makes the use of inputs more efficient. It also accounts
for the diminishing marginal return of the capital (Helpman 2004, p. 34).

R & D investment is substantially smaller than investment in physical capital (Helpman

2004). It has both direct and indirect effect of growth. First its rate of return is much
higher than rate of return on machines and equipments and secondly it enhances TFP
and helps capital accumulation in the long run. About 10-50% of growth in output of
major OECD countries is attributed to R & D growth (Mohnen 1996, p. 56).

However, cost of importing technology and R & D is very high that seems onerous for
Vietnam with the declining income. Moreover, cost of R & D reduces over time but
how much time; it is unclear.

Proposal

Two criterions of Time frame and sustainability have been adopted to gauge the
workability of two alternatives.

Updating the existing technological base and improving the quality of institutions both
will have substantial effect on productivity. Building institutions is time consuming
process but the growth built on institutions is more sustainable that is evident from
Vietnam’s success in agriculture.

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Alternative 1 is the preferred option for enhanced and sustainable productivity.

Although Vietnam is already on institutional reform path but it still ranks 93rd in doing
business, 172th in protecting the investors, 147th in paying taxes, 93rd in ease of doing
business, 149th in democracy index, 116th in HDI, 55th in HPI while income inequality
across urban-rural is about three times (Nguyen 2004, table 8, 11, 12, 13 &15). If
economic reforms are not accompanied by social and political reform, growth is short
lived.

Once the institutional foundation is laid in form of equal opportunities, protection of

rights for all, political participation, and equitable distribution of incomes, inputs will
become more productive. It will encourage innovation, organise production, and
accumulate physical and human capital. For these reasons, as concluded by Helpman
(2004), institutions are more fundamental determinant of economic growth than R&D
or capital accumulation (p.139).

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References

Acemoglu, D & et al 2004, ‘Institutions as the fundamental cause of long-run growth’,

NBER Working Paper Series, vol. w10481.

Edison, H 2003, ‘Testing the links: how strong are the links between institutional
quality and economic performance’, World Economic Outlook, International Monetary
Fund, Washington DC.

Helpman, E 2004, The mystery of economic growth, The Belknap Press of Harvard
University Press, Cambridge.

Jones, CI 2002, Introduction to economic growth, 2nd edn, W.W.Norton & Company,
Inc., New York.

Mohnen, P 1996, R & D externalities and productivity growth, STI Review, vol. 18,
pp.39-66.

Mokyr, J 2002, The Gift of Athena, Princeton University Press, Princeton.

Nguyen, H 2009, ‘Vietnam: vision to 2020’, Crawford School of Economics and

Government, Australian National University, Canberra

North, D. C 1990, Institutions, institutional change, and economic performance,

Cambridge University Press, New York.

Yip, E. & Jorgenson, W 2001, What happened to productivity growth, in Charles, R &
eta al , eds., New Development in Productivity Analysis, University of Chicago Press,
Chicago.