Vietnam in the Global Economy Development through Integration or Middle-income Trap? - Bibliothek der Friedrich ...
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Vietnam in the Global Economy
Development through Integration
or Middle-income Trap?
Hansjörg Herr, Erwin Schweisshelm, Truong-Minh Vu
Vietnam is at the lowest end of global value chains in industrial
productions and, at the same time, depends on the export of
natural resources. Market mechanisms are reproducing this type
of underdevelopment.
The era of free trade after the 1980s did not bring higher
worldwide growth than the first decades after World War II with
more regulated trade and capital controls. Overall, Vietnam is well
advised to be cautious in its growth and employment expectations
of the TPP and other FTAs.
Vietnam needs to build economic clusters with forward and
backward linkages to exploit economies of scale and scope, as
well as synergies and positive external effects. Big companies
including state-owned enterprises have to build up networks of
domestic suppliers to increase their local content.
A comprehensive industrial policy, which is poor at present in
Vietnam, is needed. Vietnam especially lacks institutions that are
able to select, implement, evaluate, and modify industrial policy
when needed.Contents List of Abbreviations i Foreword ii Introduction 1 Integration of developing countries into the world market and economic development 3 Traditional economic trade models and economic development 3 GVCs and economic development 9 The danger of the MIT 15 Vietnam’s integration into the global economy 17 Overview of Vietnam’s integration into the global economy 17 Structure of exports and imports in Vietnam 18 GVCs in industrial productions 22 Effects of FTAs 25 The role of industrial policy for development 29 Principles of industrial policy 29 The role of the exchange rate 31 Overview of Vietnam’s industrial policy 33 Recommendations for Vietnam 36 Notes 41 Bibliography 43
List of Abbreviations
AFTA ASEAN Free Trade Agreement MIT Middle-Income Trap
ASEAN Association of Southeast Asian Nations OECD Organisation for Economic Co-operation
EPA Economic Partnership Agreement and Development
CIEM Central Institute for Economic RMG Ready-Made Garments
Management R&D Research and Development
CMT Cut, Make, Trim SOE State-owned Enterprise
CPV Communist Party of Vietnam SEDS Socio-economic Development Strategy
EU European Union TPP Trans-Pacific Partnership Agreement
FDI Foreign Direct Investment UNCTAD United Nations Conference on Trade
FOB Free On Board (finished product sourcing) and Development
FTA Free Trade Agreement US United States
GDP Gross Domestic Product VEIA Electronic Industries Association
GVC Global Value Chain of Vietnam
ILO International Labour Organization VITAS Vietnamese Textile and
IMF International Monetary Fund Apparel Association
LEFASO Association of Vietnamese Footwear, WTO World Trade Organization
Leather and Bag Producers
iForeword
The multiple crises crippling our societies – from climate middle-income country, the focus of the EoT project in
change to financial meltdown, from rising inequality to Bangladesh is on economic growths and decent work as
mass migration – are shaking the foundation of the world well as institutional reforms for development.
order. Taken together, these crises go well beyond the
policy level, but call into question the very paradigms that In Thailand, resilient fiscal policy is the focus of the EoT
the foundation of our economies are built around. network. After its founding in 2016, a Policy Community
on Taxation Reform will continue to promote taxation
In 2011, economic thinkers and political decision-makers policy as well as look into the spending to identify needs
from China, Germany, India, Indonesia, Korea, Poland, and perspectives in the context of upcoming challenges of
Sweden, Thailand and Vietnam came together to discuss an aging society.
how our development models need to be adapted. Later
joined by Bangladeshis, Filipinos, Malaysians, Pakistanis Supporting the phase-out of a resource-driven and
and Singaporeans, several regional dialogues discussed therefore extractive economic model, while strengthening
how to reconcile growth and equity, find a balance the promotion of a sustainable manufacturing sector as
between boom and bust cycles, and how to promote well as the maritime and digital economy are the main
green growth and green jobs. The findings, endorsed efforts in Indonesia.
by 50 prominent thought leaders from Asia and Europe,
have been published as “The Economy of Tomorrow. Vietnam is putting emphasis on an export-oriented,
How to produce socially just, resilient and green FDI-driven development strategy, focusing on wage-
dynamic growth for a Good Society”(versions available led growth models, productivity gains and value chain
in English - 5th edition, Bahasa, Korean, Mandarin, Thai improvement to find a way out of the middle income trap.
and Vietnamese, at designated page for Economy of
Tomorrow, www.fes-asia.org.) The EoT Manifesto calls The EoT project in China focusses on the socio-
for an inclusive, balanced and sustainable development economic consequences of innovation-driven changes
model which can provide the conditions for a Good in the manufacturing and service sectors, and explores
Society with full capabilities for all. how China can achieve growth while implementing a
sustainable climate and energy policy.
True to our understanding that development models
need to be tailor-made, in the second phase of the In Pakistan the current focus is on institutionalising the EoT
project national EoT caucuses have worked on adapting discourse by bringing together governmental and non-
these sketches to the local context. At the regional level, governmental think tanks as wells as leading individuals
the focus was on the political and social challenges to develop a common advocacy agenda. A comprehensive
which needed to be addressed to encourage qualitative compilation of previous research work will serve as a
economic growth. The national studies carried out on the blueprint for political discussions during the upcoming
political economy of development as well as the synthesis election campaign.
“Mind the Transformation Trap: Laying the Political
Foundation for Sustainable Development” are available
on the website. Erwin Schweisshelm,
Resident Representative, FES Vietnam Office
In the third phase, the EoT project will focus on specific
Marc Saxer,
sectors of transformation. In India, for example, the focus
Regional Coordinator, “Economy of Tomorrow”
is on energy transformation, urbanization and digital
transformation. After graduating to the status of a low September 2016
iiIntroduction
Introduction
In the mid-1980s at the start of the Đổi The question remains as to whether this
Mới (renovation), Vietnam was a backward spectacular development will be able to
agricultural country under a socialist economic continue. There are a number of experts who
system, based on the centrally directed believe that Vietnam is in danger of falling
allocation of resources through administrative into the middle-income trap (MIT) or might
means. At that time, most of the workforce already be affected by it (Pincus, 2015; Ohno,
was involved in agricultural production, but 2015). The MIT implies that the convergence
the country faced food shortages and had between a developing country and the most
to import rice. Industry was weak and faced developed countries in the world does not
poor productivity. The overwhelming majority become smaller as the developing country is
of the population was deeply stuck in poverty. stuck at a certain level of per capita income.
Vietnam’s approach to economic reform has The only sustainable way to overcome the MIT
been characterised by two main features. and join the group of developed countries is
Firstly, it followed a top-down and step-by- to increase the productivity and innovative
step approach. Pilot projects in some localities power of a country. If developing countries are
were carried out on an experimental basis unable to catch up to the level of productivity
before they were applied to the whole country. of developed countries, a conversion of the
Secondly, there was a consensus among the living standards between developing and
Vietnamese leadership not to combine market- developed countries will not be possible.
oriented reforms with political liberalisation. However, productivity increases are not
In addition, the important role of state-owned the only factor for economic development.
enterprises (SOEs) was maintained during the Besides productivity development, an inclusive
introduction of market-oriented reforms. growth model with not too high income
inequality and a functioning financial system
Since the beginning of the process of Đổi delivering sufficient credit with low interest
Mới, economic growth in Vietnam has rates are also preconditions for sustainable
been remarkable. Between 1991 and 2009, development.
Vietnam’s real gross domestic product (GDP)
grew with an average growth rate of 7.4 The aim of this paper is to analyse the specific
percent. In 1990, Vietnam’s GDP per capita way in which Vietnam has been integrating
of US$98 placed Vietnam among the poorest into the global economy and what kind
countries in the world. In 2009, its GDP of production structure has been created
per capita of US$1,109 led to Vietnam’s in Vietnam as a result. The key question is
attainment of lower middle-income status, whether the type of integration (being carried
according to the World Bank classification out by Vietnam) into the world market is
methodology. In 2014, Vietnam’s GDP per supporting economic development in Vietnam
capita reached US$2,052 (Haughton et via an increased the productivity level or not.
al., 2001; Quan, 2014). Economic reforms It will be asked what kind of integration
resulted in Vietnam’s increased integration different economic approaches expect. This
into the global economy. This integration paper will then determine to what extent the
process is still underway with Vietnam’s trade different theoretical approaches are able to
commitments under ASEAN, its accession to explain development in Vietnam and whether
the World Trade Organization (WTO) in 2007, Vietnam is in danger of getting stuck in the
and Vietnam’s signing of the Trans-Pacific MIT.
Partnership Agreement (TPP) in 2015.
1Vietnam in the global economy: development through integration or middle income trap?
The main conclusion of this paper is that section also concentrates on a phenomenon
theoretical considerations and empirical that gained paramount importance over the
analyses support the hypothesis that an last three decades – global value chains (GVCs)
unregulated integration in the world market and offshoring. It will be asked to what extent
is not beneficial for Vietnam in the long run GVCs increase the chances of economic
and could lead to Vietnam becoming stuck in development for countries like Vietnam.
the MIT. Integration into the word market is
of key importance for a country like Vietnam, The third section analyses in detail how
but it needs to be guided by a comprehensive Vietnam has integrated into the global
industrial policy and government intervention. economy. The theoretical approaches from
To leave the integration of Vietnam completely section two will be used to understand
to the market leads to the reproduction of Vietnam’s role in the international distribution
underdevelopment. A combination of market of labour. Import and export structures will
and government activities is needed to reach be analysed, as well as the role of GVCs in
a sustainable level in order for developing Vietnam. The theoretical prediction will be
countries to catch up. largely supported by the empirical analysis.
Without government intervention, the MIT is
The second section of this paper will give a serious danger for Vietnam.
a review of the most important traditional
economic models to explain international The fourth section draws policy conclusions
distribution of labour. From the perspective for Vietnam. Here, industrial policy and its
of a developing country, the analysis looks adaptation to the situation in Vietnam will be
at what kind of industrial development these discussed.
models predict for a country like Vietnam. The
2Integration of developing countries into the world market and economic development
Integration of developing countries into
the world market and economic development
Traditional economic trade models and quantity of textiles, Vietnam needs 20 units
economic development of labour, whereas the US needs 35 units.
We will start with the model of absolute Without international trade, the production
advantages and then analyse comparative and consumption of the assumed quantities
advantages, as well as different factor of textiles and cars need a total sum of 105
endowments. These trade models assume units of labour in both countries. If each of
that goods are traded as complete goods. the countries concentrates on the goods
This implies that the production process of a with its absolute advantage and produces
good is not divided into different tasks, which twice as much as before and exchanges cars
are produced in different countries through against textiles, the level of consumption in
GVCs. To understand the logic of trade, both countries will stay the same, whereas
usually in these models mobility of capital the needed hours for producing the goods
is assumed to be zero, which automatically can be reduced to 60 hours altogether. The
implies a balanced current account. Finally, conclusion made by Adam Smith was that
these models assume constant returns to international trade (similar to national trade)
scale and competitive markets. increases the wealth of nations and markets,
and leads to specialisation according to
Absolute advantages absolute advantages.
The most simple and obvious model to
explain international trade is the model of Some assumptions are made to come to
absolute advantages. Adam Smith (1776) the welfare conclusion drawn by Smith. The
argued that in the case of one country being most important one is that there is sufficient
good at producing one thing, and another demand so that world output increases and
country being good at producing another the production factors that have become
thing, the welfare of both countries could be unused as a result of efficiency gains will be
increased by trade. Absolute advantages are able to be employed.2 If the 45 units of saved
based on different technological levels and/or labour in our example become unemployed,
different natural conditions which influence the wealth of a nation will not necessarily
productivity. increase. From a Keynesian perspective
there is no guarantee that a switch to more
For example, if Vietnam has higher free trade increases aggregate demand
productivity in textile production and the and output. If Say’s law, which assumes
United States (US) is more productive in car that supply creates its own demand, does
production, to increase the welfare of both not hold, free trade can lead to permanent
countries, Vietnam should concentrate on higher unemployment. It is sometimes argued
the production of textiles and the US should (mainly by non-economists) that free trade
focus on making cars. Table 1 shows the increases the surplus in the trade balance (or
logic behind, and consequences of this type reduces a deficit) and positive employment
of trade. It is assumed that the US has an effects can be expected. However, a switch to
absolute advantage in producing cars – it free trade has nothing to do with surpluses
needs 10 units of labour1 to produce a car, or deficits in the trade and current account
whereas Vietnam needs 40 units of labour balances. Only in a world of lunatics can free
to produce a car. Vietnam has an absolute trade lead to current account surpluses in all
advantage in producing textiles. For a given countries. Secondly, it has to be assumed that
3Vietnam in the global economy: development through integration or middle income trap?
the factors of production move smoothly from in the US increases at an even faster rate, and
When we look
one industry to another one. In a concrete the productivity gap in Vietnam increases
at the areas
economic constellation, such structural to 0.05. The explanation for this is that the
where countries
changes can become difficult for countries. absolute advantage in producing cars is bigger
like Vietnam
In our example, American textile workers may than the absolute advantage of Vietnam in
have absolute not be qualified to become workers in the producing textiles. The figures in Table 1 are
advantages, we car industry. Finally, the model does not show not based on empirical facts. However, the
quickly detect which of the two countries would achieve the constellation shown in the table might not be
the importance biggest welfare gains. Even if it increases the unrealistic for many goods in a country like
of unprocessed welfare of both nations, trade can produce Vietnam.
agricultural some losers in both countries.
products and When we look at the areas where countries
natural resources. In the context of this paper, the most important like Vietnam have absolute advantages, we
question is how productivities change when quickly detect the importance of unprocessed
countries integrate into the global economy. agricultural products and natural resources.
Productivity is defined as output per unit Examples of the first group of goods are
of labour. In our exemplification in Table 1, coffee beans, rice, sugar cane, or fish.
the productivities of producing a car and Examples of the second group of goods are
a given quantity of textiles are calculated.3 coal, manganese, bauxite, chromate, offshore
To calculate average productivity, each of oil, or natural gas. Such absolute advantages
the productions is weighed according to can result from natural conditions, such as
the labour needed in the industry.4 The the climate or locations of rare earths. The
productivity gap for the whole of Vietnam’s possession of such natural advantages is not
economy before international trade is 0.006. necessarily a blessing for countries. While it
Productivity in Vietnam under the condition can allow the earning of hard currency in a
of international trade increases because the relatively easy way, empirically, most countries
country concentrates on the production of the with these advantages have not developed
good with its absolute advantage, which has a in a sound way. There are good theoretical
productivity of 0.05. In addition, productivity explanations for this.
Table 1: International trade with absolute advantages
Before trade After trade
Vietnam US Total hours Vietnam US Total hours
Units of labour needed Units of labour needed
per given quantity of good
Cars 40 10 2x10=20
Textiles 20 35 2x20=40
Total hours 60 45 105 40 20 60
Productivities Productivity Productivities Productivity
without trade* gap Vietnam** with trade* gap Vietnam**
Cars 1:40=0.025 1:10=0.100 2:20=0.100
Textiles 1:20=0.050 1:35=0.029 2:40=0.050
Average (0.66·0.025) (0.22·0.100) 0.006 0.050 0.100 0.050
productivity*** +(0.33·0.050) +(0.78·0.029)
= 0.033 = 0.039
*Quantities produced per labour input, **US productivity minus Vietnamese productivity,
***Each industry is weighted according to its labour input in relation to total labour input
4Integration of developing countries into the world market and economic development
Hans Singer (1950) and Raúl Prebisch (1950) prices based on natural scarcity. In the long
The possession
argued that the producing and exporting run, the price of these natural resources may
of such natural
natural resources, including basic agricultural increase because the production costs to
advantages is
products by countries, would lead to a extract or mine them increase with depletion.
not necessarily
deterioration of the terms of trade in these However, presently and for an uncertain time
countries in the long-term. In the long-term, into the future, prices of natural resources are a blessing for
this means that developing countries that above production costs and prices are based countries.
concentrate on the production of natural on oligopolistic market structures. To what
resources have to exchange more and more of extent such oligopolies are able to increase
their primary products against the industrially prices and keep them high is an open question,
produced products of developed countries. given the fierce competition of natural
Explanations for this effect are manifold. resource producers to export their natural
Productivity growth in industrial productions resources.5 The development of oil prices after
might be higher than in the production of 2008 is a good example of this. However,
agricultural products and natural resources even when prices of natural resources are
extraction. In addition, the price elasticity of high and high rents can be earned possessing
primary goods for single suppliers is higher and exporting natural resources, they are still,
than for industrial products. For example, for many countries, a double-edged sword.
exporters of coffee beans or oil produce The problem is that a country that exports
a relatively homogenous good and are natural resources as a high percentage of its
confronted with competition from exporters total exports will import a high percentage
in many countries. Firms in developed of its consumption and capital goods. Thus,
countries exporting new high-tech or lifestyle a country focusing on the export of natural
products can exploit monopolistic positions resources will make its industrial sector suffer.
and avoid price competition. Also, the income This phenomenon is known as Dutch disease.
elasticity of primary goods is supposed to When in the 1960s the Netherlands found
be lower than for industrial products. The offshore oil, the domestic industrial sector
long-term terms of trade effect expected by found itself in crisis. The global demand for
Singer and Prebisch reflects an overall slower Dutch oil led to an appreciation of the Dutch
productivity growth in developing countries guilder and reduced the competitiveness of By allowing
producing natural resources, as well as a the Dutch industry. As a result, this reduced the market
relative stagnation of the demand of such the dynamic of the Dutch economy. Natural mechanism to
products. By allowing the market mechanism resource rich countries are in danger suffering work, developing
to work, developing countries will be pushed from serious overvaluation, especially when countries will be
towards the production and export of primary the industrial sector is taken as a benchmark. pushed towards
products with relatively low value-added. This The result of such an overvaluation is a lack the production
reduces the possibility of developing countries of competitiveness of the industrial sector and export of
catching up to more developed countries. (Corden, 1984; Corden / Neary, 1982). The primary products
Empirically the Prebisch–Singer terms of problem is that the industrial sector has with relatively
trade hypothesis is supported for most of the a much higher potential for productivity low value-added.
primary products. However, there are some increases and innovation than the natural This reduces
exceptions (Harvey et al., 2010; Arezki et al., resource sector. The outcome is that natural
the possibility
2013). resource rich countries suffer from a lack of
of developing
domestic economic dynamic and transform
countries
The Prebisch–Singer hypothesis seems not to into rent economies.
catching up to
hold for some natural resources, for example,
more developed
for crude oil and rare earths. These resources The reliance on natural resource exports leads
countries.
seem to follow a trend of long-term increasing to other serious potential negative effects.
5Vietnam in the global economy: development through integration or middle income trap?
Natural resource prices and natural resource by Ricardo is that even under such conditions,
Natural resource
exports show a high volatility and expose international trade is welfare-increasing for
prices and natural
natural resource-exporting countries to large all countries. If countries concentrate on the
resource exports
shocks. In many cases, government revenues production of products they are relatively
show a high
depend to a large extent on the development good at producing in the same output in the
volatility and of the natural resource sector. In such cases, world, these products can be produced with
expose natural the volatility of natural resource exports has less input of labour (and other inputs). For a
resource-exporting even bigger negative effects as it distorts the country like Vietnam, this implies the export
countries to large functioning of public households. Lastly, in of goods where the productivity difference
shocks. many cases, natural resource rich countries (compared to developed countries) is the
show a high level of corruption and a low level lowest, and the import of goods where the
of democracy as the incentives for powerful productivity difference is the highest. Indeed,
groups in society to grab some of the natural the market mechanism leads to this structure
resource rents are high (Humphreys / Sachs / of trade.
Stiglitz, 2007). Good institutions are needed
to overcome negative effects of Dutch disease. To reveal the consequences of this type of
Although an exception, Norway serves as a trade, the numerical example in Table 1 is
good example for good institutions and the modified. In Table 2 we assume, as in Table
avoidance of Dutch disease. 1, that Vietnam and the US both produce
textiles and cars. But now the US economy
The question for Vietnam is: does the export is better at producing all goods. To produce
of goods with low terms of trade (for example, one car the US needs 20 labour units, while
coffee and rice) and of natural resources (for to produce a given quantity of textiles it
example, crude oil) with the danger of Dutch needs 40 labour units. The not-so-efficient
disease play an important role? These goods Vietnamese economy needs 40 labour units
play a role in Vietnam’s exports and some to produce one car and 50 labour units to
negative effects must be expected. produce a given quantity of textiles. If both
countries produce both goods and there is no
Comparative advantages and factor international trade, both countries together
endowments need 150 hours to produce the given quantity
One of the most important arguments of of cars and textiles. In the US, the productivity
free trade goes back to David Ricardo (1817) advantage in the car industry is bigger than
and his model of comparative advantages. in the textile industry. For Vietnam, the
International institutions like the WTO or disadvantage of producing textiles is relatively
the International Monetary Fund (IMF) and small. Thus, with international trade, Vietnam
many governments still follow different will produce textiles and the US will produce
versions of Ricardo’s approach today. Ricardo cars – an example with high plausibility. With
assumed different productivity levels in international trade, the same quantity of
different countries. In contrast to Adam goods can be produced with 140 labour units.
Smith, he asked whether international trade Ten units can be saved. Of course, as in the
made sense, under the condition that one example with absolute advantages, a set of
country is less productive in all industries. This conditions must be satisfied to realise positive
assumption very much fits the constellation welfare effects.
of countries like Vietnam, which are with
regard to industrial production characterised Before international trade, the average
by a general low level of technological productivity level of Vietnam (0.022) is below
development compared to developed the US level (0.033) and the productivity gap
countries. The not-so-obvious answer given between the US and Vietnam is 0.011. The
6Integration of developing countries into the world market and economic development
Table 2: International trade with comparative advantages
Before trade After trade
Vietnam US Total hours Vietnam US Total hours
Hours needed per given Units of
quantity of good labour needed
Cars 40 20 2x20=40
Textiles 50 40 2x50=100
Total hours 90 60 150 100 40 140
Productivities Productivity Productivities Productivity
without trade* gap Vietnam** with trade* gap Vietnam**
Cars 1:40=0.025 1:20=0.050 2:40=0.050
Textiles 1:50=0.020 1:40=0.025 2:100=0.020
Average (0.44·0.025) (0.33·0.050) 0.011 0.020 0.050 0.030
productivity*** +(0.56·0.020) +(0.67·0.025)
= 0.022 = 0.033
*Quantities produced per labour input, **US productivity minus Vietnamese productivity,
***Each industry is weighted according to its labour input in relation to total labour input
important point is that now, in the logic of Under a dynamic perspective for a developing
comparative advantages, international trade country, the market determined distribution
reduces the productivity level of Vietnam and of international labour implies a huge
increases the productivity gap with the US. disadvantage. As it is pushed to concentrate
Table 2 shows that trade reduces average on low-tech, labour-intensive, low-skilled
productivity in Vietnam to 0.020 and the productions, it will have a lower chance of
Vietnamese productivity gap widens to 0.030. developing. Friedrich List was very critical
This should not be a big surprise as Vietnam about free trade between countries with
gives up the more demanding and advanced different levels of development. He argued
car industry and concentrates on the less against England, which developed under
productive textile industry. International trade protectionism and then preached free trade:
leads to the breakdown of the car industry in “Any nation which by means of protective
Vietnam and Vietnam specialises in textiles – duties and restrictive navigations has raised
an overall low-tech and low-productivity good. her manufacturing power and her navigation
In the US, the textile industry disappears and to such a degree of development that no
the country concentrates on the production other nation can sustain free competition with
of cars – a high-tech product. her, can do nothing wiser than to throw away
these ladders of her greatness, to preach to
The Prebisch–Singer hypothesis takes a new other nations the benefits of free trade, and to
and more radical form. Under the condition declare in penitent tones that she has hitherto
of different productivity levels of countries, wandered in the path of error, and has now
unregulated international trade pushes for the first time succeeded in discovering
developing countries to produce relatively the truth.” (List, 1855: 295f.) Indeed, Ha-
low-tech and low value-adding products, and Joon Chang (2002) shows that virtually all
concentrates high-tech and high value-adding developed countries nowadays, including the
productions in developed countries. Under a United Kingdom and the US, used industrial
static approach, Ricardo’s argument is correct policy to protect and support their industries
– international trade between counties with in their developmental phase.6 It is worthwhile
different levels of development increases listening to Joan Robinson, who made the
the efficiency of worldwide production. The same argument (1979: 103): “The most
welfare of consumers will increase, at least in misleading feature of the classical case for
the short term.
7Vietnam in the global economy: development through integration or middle income trap?
free trade […] is that it is purely static. It is set This does not mean that countries in
Countries concentrating
out in terms of a comparison of productivity their first development phase should not
on high-tech, high-skilled
of given resources [fully employed] with or concentrate on low-tech, labour-intensive
productions including
without trade. Ricardo took the example of production. They can do so when they enter
services, will gain from
trade between England and Portugal. […] It mass production and exploit economies of
learning-by-doing, by implies that Portugal will gain from specialising scale. Such mass productions will trigger
developing a high-skilled on wine and importing cloth. In reality, the productivity increases through specialisation
workforce, benefitting imposition of free trade on Portugal killed off and learning effects. However, they should
from positive synergies, a promising textile industry and left her with support domestic forward and backward
carrying out more a slow-growing export market for wine, while linkages of mass productions. The positive
firm-based research, for England, exports of cotton cloth led to effects of mass productions need to be
and so on. accumulation, mechanisation and the whole supported by industrial policy in order for the
spiralling growth of the industrial revolution.” country to enter into new and more value-
adding industries. Industrial policy is needed
List’s and Robinson’s argument is valid still at any stage of development; at any stage
today. Countries concentrating on high- of development new industries need to be
tech, high-skilled productions including created and the private sector is not able to
services, will gain from learning-by-doing, develop such industries alone.
by developing a high-skilled workforce,
benefitting from positive synergies, carrying According to mainstream thinking in the
out more firm-based research, and so on. tradition of David Ricardo, international trade
Such countries can build up monopolistic should lead to the specialisation of countries
or oligopolistic constellations of their firms as an element of positive development.
based on technological superiority and can However, this recommendation does not
earn high quasi-technological rents. The fit the empirical development of successful
high profits of these firms will further spur developing countries. Jean Imbs and Romain
innovation and investment in research and Wacziarg (2003: 64) found in a broad empirical
development (R&D). Developed countries analysis that successful developing countries
with a concentration of high-tech, high-skilled “diversify most of their development path”.
productions will benefit from the positive Obviously only a broad spectrum of industries
external effects of markets, as Alfred Marshall is able to create synergies between different
(1890) called it, and from the concentration of industries and increases the likelihood and
industrial high-tech productions and services possibilities of entrepreneurship. Development
(Krugman, 1991). These processes unfold a has a lot to do with random self-discovery,
strong path-dependency, making innovative which cannot be explained by specialisation
countries endogenously more innovative. according to comparative advantages (Rodrik,
These advantages do not exist in developing 2004).
countries, or exist to a much smaller extent.
Free trade will not help to overcome the The Smith-Ricardo model has a great
disadvantages of developing countries; rather, explanatory power for the explanation of
Free trade will not it will add to their problems. This is why the international distribution of labour. If
Joseph Stiglitz (2006) demanded a one-sided countries introduce free trade and the market
help to overcome
protection of developing countries via tariffs is allowed to work freely, the outcomes are as
the disadvantages of
and other instruments to make international follows: developing countries will concentrate
developing countries;
trade fair. He also favoured the transfer of on low-tech, low-skilled productions and
rather, it will add
certain patents to developing countries for developed countries will concentrate on high-
to their problems.
free or a low price. tech, high-skilled productions. Below it will be
shown that Vietnam fits into this first scenario.
8Integration of developing countries into the world market and economic development
The factor-endowment argument for GVCs and economic development
Only a broad
international trade The vision of the old trade models, with trade
spectrum of
Eli Heckscher (1919) and Bertil Ohlin (1933) of goods produced in one industry exchanged
industries is able
assumed the same technological knowledge against goods of another industry, no longer
reflects reality.9 In 2013, trade in intermediate to create synergies
in all countries in the world but different factor
endowments.7 The typical developing country goods had the biggest share in world trade, between different
has a high stock of labour and not much reaching US$7 trillion, followed by primary industries and
capital, while the typical developed country goods with US$4 trillion, consumer goods increases the
has a high stock of capital goods in relation to with US$3.8 trillion, and capital goods likelihood and
labour. The specialisation rule in international with US$2.7 trillion. Almost 50 percent of possibilities of
trade is that countries should concentrate on intermediate goods come from developing entrepreneurship.
productions which especially need the relative countries (UNCTAD, 2014). What we find is
abundant production factor. Developing the dominance of international trade within
countries should concentrate on labour- one industry in intermediate goods, to a
intensive productions because this is the area large extent within multinational companies
of their comparative advantage. Developed or controlled by multinational companies.
countries should therefore concentrate on Alan Blinder (2005) describes the increasing
capital-intensive productions. International role of offshored productions in GVCs within
trade will, as in the Smith-Ricardo model, an industry as a new industrial revolution.
increase the efficiency of world production and Indeed, a new dimension of globalisation
will (sufficient aggregate demand assumed, started to develop during the 1990s due to the
etc.), increase the welfare of countries. revolution in information and communication
technology, the reduction of transportation
The Heckscher-Ohlin model is less important costs, and the implementation of the
for our question. There are not many Washington Consensus policies in developed
industries in developing countries that and developing countries – which deregulated
possess the same technological knowledge international trade and capital flows.
and possibilities as industries in developed These developments allowed multinational
countries. Even if knowledge is free, it is companies in particular to break down their
often difficult to transfer to developing production processes into different stages and
countries. There is a lack of skills; and the outsource these stages to other companies,
experience to use advanced knowledge does which in many cases were in other countries.
not exist. The Heckscher-Ohlin model defines Below it will be shown that Vietnam is also
the development problem by assuming that intensively integrated in GVCs.
developing countries have the same skill and
technology level as developed countries. Trade effect of GVCs
Wassily Leontief (1954) found in his empirical In the case of GVCs, the production process
investigation that US international trade does is cut into different tasks; different companies
not follow the prediction of the Heckscher- all over the world fulfil these tasks. Analytically
Ohlin model. Later, this so-called Leontief the different tasks become their own
paradox was found in many other countries. products. The international allocation of the
The main explanation for the paradox can production of these different tasks depends
be found in the fact that technological to a large extent on comparative advantages.
knowledge, including differences in skill levels, Thus, the old trade models can be applied to
between countries are of key importance for GVCs (Feenstra, 2010). However, the new
international trade and are not captured by trade theory added to the understanding of
the model.8 GVCs (Krugman, 1979; 1991). Most industrial
productions are characterised by economies
9Vietnam in the global economy: development through integration or middle income trap?
of scale and scope, which are based on firms as in traditional trade models. GVCs
The argument
for example, indivisibilities (in research, are characterised by the rent-seeking of
of economies of
marketing, branding, etc. or using the same leading firms and brutal competition between
scale and scope
engine or other parts in different cars of a suppliers at the lower end of the value
also makes clear
company); on production clusters, which chain. Monopsony structures dominate the
that first-mover create synergies and positive external effects interaction between GVCs, at least in a typical
advantages (concentration of high-tech companies in developing country.10
exist with high one region); or on positive network effects.
entry barriers for As soon as economies of scale and scope are In the case of buyer-driven value chains,
latecomers. allowed in economic models, the assumption the leading firm focuses on designing and
of pure competition breaks down. Oligopoly marketing functions while the manufacturing
and monopoly competition becomes the process is completely outsourced as a rule to
norm and with it rent-seeking in the form of legally independent subcontractors producing
technological rents, branding, or asymmetric under strict specification of the buyer (Gereffi,
power relationships between firms. As soon 1999). Typical cases of these types of GVCs
as a country manages to host domestically- are labour intensive industries such as the
owned firms that are in a global oligopolistic apparel and footwear industry, but also the
and monopolistic position, these firms will assembly of parts in the production process
increase domestic income via rent-seeking of mobile phones or simple electronic
(more than normal profits) at the cost of equipment. Producer-driven supply chains
other countries. Strategic trade policy to are typically driven by lead firms, where
support domestic firms to achieve dominant technology or high standards in production
positions becomes rational. The argument play a more important role. Examples are
of economies of scale and scope also makes the production of automobiles, computers,
clear that first-mover advantages exist with and heavy machinery. Lead firms in producer-
high entry barriers for latecomers. driven value chains coordinate a complex
transnational network of production with
The complex production processes in GVCs are subsidiaries, subcontractors, and R&D units
managed by lead firms, in the first place by the where the assembly lines of the final good
headquarters of multinational companies. Of typically remain under direct control of the
course in the hierarchical structure of GVCs, lead firm (Figure 1).
headquarters of fashion firms, global retailers,
or car and electronics manufactures usually Another similar model of GVCs has been
do not directly interact with the lowest levels designed by Baldwin and Venables (2013).
of value chains. Big contract manufacturers They distinguish between “spiders” and
like Foxconn and Quanta (in the electronics “snakes”. In snake value chains, production
sector) or Puo Chen (in the shoe production stages follow an engineering order, which
sector) are located on an intermediate level means each location fulfils one task and then
GVCs are of supply chains. Lead firms and big contract the (un-finished) product moves on to the
characterised by manufacturers are obviously in a dominant next location for new tasks and values to be
the rent-seeking of position as they structure the production added. The chain continues until the product
leading firms and process and its location. They decide which is completely produced. In spider chains, the
brutal competition tasks remain in the headquarters and which production of a good does not follow any
between suppliers tasks are outsourced, in which countries, particular order. Productions of tasks take
at the lower end of and by which companies. In GVCs, there place at different (international) locations and
the value chain. is not the cosy world of international trade the final good is assembled in one location.
between independent and equally strong
10Integration of developing countries into the world market and economic development
Figure 1: Producer-driven and buyer-driven GVCs
Producer-driven chain
Manufacturers Distributors Retailers and dealers
Domestic and foreign subsidiaries
and subcontractors
Buyer-driven chain
Traders
Retailer and branded manufacturers
Overseas buyers
Factories (overseas)
Source: Adopted from Gereffi (1999), author’s illustration
GVCs can also be classified into horizontal volatility in demand for final products, the
and vertical value chains. In horizontal value needed adjustment of production can be
chains, lead firms buy from other firms or shifted to lower levels of the value chain.
produce high quality inputs in subsidiary Just-in-time production allows higher levels
companies. These types of suppliers are of the value chain to minimise inventories.
typically highly specialised and have a high In this paper, we concentrate on the analysis
technological standard. For example, Airbus of vertical value chains, which are mainly of
outsources the production of engines to importance for countries like Vietnam.
Rolls Royce. The motivation of this type of
value chain is to increase the quality of the Vertical value chains dominate the
product and use the cost advantage of high- concentration of low value-adding and low-
tech specialisation. Vertical value chains’ main productivity activities in developing countries
motivation is to reduce production costs. and the intensive competition at the lower
Tasks are outsourced to low-cost producers. end of value chains, which allows only
Following the logic of traditional international low profits of suppliers. This phenomenon
trade theory, developing countries have a can be expressed in what is known as the
comparative advantage in low-productivity, “smile curve”, but should better be called
low-skill, low value-adding tasks. Developed the “exploitation curve”.11 Figure 2 shows Developing
countries, with their higher level of the exploitation curve and the typical countries are
technological standard and higher skill-levels, distribution of value-added in different stages mainly integrated
have a comparative advantage in taking of production. According to the exploitation in vertical value
over high-productivity, high-skill, high value- curve, the upstream and downstream part of chains and the
adding tasks. Developing countries are mainly value chains, which include research, design, main motivation
integrated in vertical value chains and the marketing, and after-sales service, produce to shift tasks
main motivation to shift tasks to developing the highest value-added and are largely kept to developing
countries is to make the final product cheaper. in developed countries. Most offshoring countries is to
to developing countries can be found at make the final
A second motivation of offshoring is to gain the fabrication stage, which is not the core product cheaper.
higher flexibility for lead firms. In case of competency of lead firms. This stage can be
11Vietnam in the global economy: development through integration or middle income trap?
outsourced to less-developed countries to The conclusion is that GVCs can, compared
Lead firms and
reduce costs and gain flexibility. The newest with the Ricardo example, further reduce the
big contract
wave of offshoring increasingly covers services, productivity level in developing countries and
manufacturers
indicating that low value-added activities may further increase the productivity gap with
are in an absolute
be outsourced at all stages of production. developed countries. This is not good news
dominant position for the economic dynamics in developing
and firms at lower The Apple iPhone production is a good countries. The Prebisch–Singer hypothesis
levels of vertical example of the very unequal distribution of thus has a new dimension because under the
value chains are value-added in GVCs. Most of the components trade perspective, GVCs make catching up
dominated by, of the iPhone are manufactured in China. even more difficult for developing countries.
and dependent However, Apple continues to keep most of
on the lead firm its product design, software development, Dominance and technology effects
and big contract product management, marketing, and other GVCs create power asymmetries that are
manufacturers. high value-adding functions in the US. In not known in traditional international
2010, from the sales price of an Apple iPhone trade relationships. Lead firms and big
of around US$500, 58.5 percent were Apple contract manufacturers are in an absolute
profits. Profits of non-Apple US firms were dominant position and firms at lower levels
2.4 percent; firms in South Korea 4.7 percent; of vertical value chains are dominated by,
forms in Japan 0.5 percent; firms in Taiwan and dependent on the lead firm and big
0.5 percent; and firms in the European Union contract manufacturers. A monopsonist firm
(EU) 1.1 percent. Unidentified profits were 5.3 has the market power to reduce prices of
percent. Costs of input material were 21.9 suppliers to a minimum. It will theoretically
percent, cost of labour in China 1.8 percent, push suppliers to profitless production and
and cost of non-Chinese labour 3.5 percent. consequently increase its own profit. As the
For an Apple iPad, Apple profits were “only” main motivation for this type of offshoring
30 percent of its price, with Chinese labour is to cut costs, multinational companies will
costs 2 percent of the price (Kraemer et al., do everything to achieve this goal, as long
2012).
Figure 2: The exploitation curve
Value
Added
Basic and applied Marketing, Advertising and
R&D, Design, Brand management,
Commercialization Specialized logistics,
After-sales services
Manufacturing,
Standardized
R&D services Marketing
Knowledge Knowledge
Inputs Markets
Location 1 Location 2 Location 3 Location 4 Location 5
VALUE CHAIN DISAGGREGATION
Source: Mudambi (2008)
12Integration of developing countries into the world market and economic development
as it does not destroy both their reputation among other things. (UNCTAD, 2001).
and the quality of products. Examples of such The lead firm has no incentive to transfer
constellations are the lower levels of value substantial knowledge to subcontractors, as
chains in the garment or electronics industries, the lead firm has no control over whether
where different suppliers in one country these subcontractors diffuse such knowledge
compete, as well as many suppliers from to other firms. Countries with very low
different countries compete. It is obviously levels of technological and managerial skills
negative for developing countries when the may benefit and be able to increase their
lion’s share of profits in GVCs is transferred to productivity via subcontracting. However,
lead firms in foreign countries and wages are these positive effects remain on a relatively
pushed to a minimum. This reduces domestic low level.
consumption as a result of the lower income of
workers and company owners. It also reduces Vertical foreign direct investment (FDI) takes
domestic investment through the reduced place when a company wants to optimise its
possibility to use its own funds for investment. production costs by fragmenting each part
Companies under competitive pressure will of the value chain in countries with the least
try to save costs by reducing wages, employ costs. This is similar to subcontracting. But
workers under precarious conditions, or try a lead firm or a big contract manufacturer
to avoid safety and environmental standards. will chose FDI instead of subcontracting if
In the case of subcontracting,12 the risk of they do not want the technology used in the
underutilisation of capacities in times of lower production to spread easily to other companies
demand, as well as the hiring and firing of and/or if it wants to control the supply process
workers is transferred to the subcontracting of its own important inputs and/or if there is
firms (Verra, 1999).13 no suitable firm with the needed technology
and management skills to be found in the
However, vertical value chains can also developing country. In FDI, the likelihood of
potentially create positive effects. In vertical knowledge transfer is higher than in the case
GVCs, a lead firm will directly intervene in the of subcontracting. Local firms can benefit
production of the task of the dependent firm. from technologies and the managerial skills of
The lead firm has an interest in the quality of foreign firms through joint ventures, reverse
the tasks being done to a satisfactory level and engineering, and hiring workers who are
fitting smoothly into the global production being trained for the purpose of working in
network. International subcontracting has FDI firms. Foreign firms can also affect local
two main differences compared to traditional companies through developing supply chains
arm’s length transactions. Firstly, it is of long- in host countries and by forcing local firms to
term nature, as lead firms prefer a longer- increase their quality and standards, as well as
term relationship with reliable suppliers; and help them to increase their managerial skills.
secondly, the level of information that the Companies with market seeking motivation
parent companies provide for its suppliers, may establish research centres in host
such as detailed instructions and specifications countries in order to meet special customers’
for the task, is much higher than in the case demands via product localisation. Especially
of normal market interactions (Grossman / because of the last motivation, big countries
Helpman, 2002). Lead firms for example, can have a higher chance of attracting FDI than Technology and
transfer new machinery to suppliers, provide smaller countries. Technology and skill skill spillovers highly
them with technical support for working spillovers highly depend on the development depend on the
with them, and give some consultancies to level of the host country. If local firms do
development level
subcontractors for managing inventories, not have a sufficiently high technological
of the host country.
production planning, and quality testing, and educational level, it might be difficult
13Vietnam in the global economy: development through integration or middle income trap?
to absorb knowledge. The type of FDI (e.g. Fifthly, there are sectors where FDI does not
It is not the rule
wholly owned, joint venture, or mergers and contribute significantly to the development of
that FDI firms will
acquisitions) is important for technological host countries. If FDI is made in the natural
transfer the newest
spillover. For instance, if foreign firms invest resource sector, foreign firms will try to benefit
technologies or
through mergers and acquisitions, the level from some of the rents earned in this sector.
strategic important of technological spillover may be very low as Government policies are necessary to prevent
tasks in a value foreign companies can keep employees and exploitative policies of FDI firms in this sector.
chain to developing production lines unchanged and only displace Additionally, FDI in the retail sector, in order to
countries. the management. A greenfield investment stimulate the selling of foreign products, will
increases the likelihood that the foreign not be very helpful for development. The same
investor transfers technology and skills to the argument holds true for investment in the real
host country. Joint ventures, in comparison estate sector. FDI in this sector will not lead
with wholly foreign-owned companies, to a higher competitiveness of the country.
increase the likelihood of technology and skill Rather, it can add to real estate bubbles in
transfers as a domestic company can directly host countries. FDI in the financial sector can
absorb new technologies and skills. Of key increase the efficiency, but may also reduce
importance is whether the economic policy the credit availability of small and medium-
forces FDI firms to increase the local content sized domestic firms, as foreign owners prefer
of their production and to help to build to give credit to big (and especially foreign
economic clusters. companies) and channel deposits to London
or New York in their home countries where
There are also negative effects of FDI. Firstly, they understand the markets.
FDI firms can, as already mentioned, transfer
all profits to the lead firm. Secondly, FDI There are two key conclusions in respect to
can lead to a crowding out of promising the advantages and disadvantages of FDI for
domestic firms. This is especially the case host countries. Firstly, it appears that a case-
when governments in host countries create by-case evaluation is necessary to come to
favourable conditions for FDI that disadvantage a rational judgement as to whether FDI has
domestic firms. Thirdly, if foreign companies positive or negative effects for host countries.
It appears that invest in host countries only for producing Secondly, government regulations and
a case-by-case and then exporting low value-added goods interventions can substantially improve the
evaluation is or for labour-intensive, low-skill tasks in value quality of FDI and its effects.14
necessary to chains, the advantages for host countries
come to a rational will be low. For example, the assembly of What can we learn from this debate for
judgement as parts in the production of smart phones Vietnam? Vietnam started its Đổi Mới policy
to whether FDI or computers does not bring a lot of new at a very low level of development. We can
has positive or technology to a country. Additionally, positive draw the conclusion that subcontracting and
negative effects spillovers cannot occur if FDI firms import FDI substantially supported the technological
for host countries. all parts and export the produced product level, as well as management and other skills.
without linkages to the domestic economy. In But permanent productivity increases during
Government
any case, it is not the rule that FDI firms will economic upgrading cannot be expected
regulations and
transfer the newest technologies or strategic from foreign firms. Foreign firms only have an
interventions
important tasks in a value chain to developing incentive for a certain level of technology and
can substantially
countries. Fourthly, FDI firms tend to exploit skill transfer. If Vietnam wants to go beyond
improve the quality
existing lax labour market regulations, as this level, it needs to develop its own policies
of FDI and its
well as safety and environmental standards, to do so.
effects.
with some even lobbying for lax standards.
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