Foreign investment: A double edged sword for Vietnam

By Ha Phuong   August 23, 2016 | 10:55 am GMT+7

Reliance on FDI could lead Vietnam straight into the middle-income trap. 

Vietnam has become an attractive destination for foreign direct investment (FDI) with many international corporations establishing new facilities in the country, known as greenfield investment.

The country topped the emerging markets index for greenfield FDI in 2014 and 2015, surpassing 13 other countries in the annual study by fDi Intelligence at the FT data division, which looked at inbound greenfield investment relative to the size of each country’s economy.

Last year, Vietnam scored 6.45 in the index, meaning the country attracted almost 6.5 times the amount of greenfield FDI that was expected given the size of its economy; leaving behind runners-ups Hungary and Romania and other Southeast Asian peers such as Malaysia and Thailand.

Vietnam is emerging as a major manufacturing hub in electronics, standing fourth in Asia-Pacific in terms of FDI behind India, China and Indonesia. The four countries combined account for nearly two-thirds of FDI capital in the region valued at $320bln.

Business environment improving

During the first seven months of 2016, the country welcomed approximately $13 billion of newly registered capital, 1.5 times higher than the previous year. Big free-trade agreements together with the right mix of ingredients for growth are among the reasons for the appeal.

“A lot of investment has come in expectation of the TPP [the Trans-Pacific Partnership],” said Thomas Jandl, Non-Resident Scholar at Vietnam National University, referring to mammoth U.S.-led free trade agreement whose 12 members comprise nearly 40 percent of global GDP.

“Business is often ahead of politics in preparing early for a new environment. When Vietnam joined the World Trade Organization, the investment boom also started the year before.”

Institutional reforms have also contributed to making Vietnam more foreign investment friendly. Revised investment and enterprise laws have reduced the time needed to establish a new business in Vietnam from 34 days in 2015 to 20 in 2016, according to the World Bank’s latest Doing Business report. Reduced corporate income tax and making it easier to pay are the other key points that are encouraging foreign companies to enter Vietnam.

Investors have also taken heart from the stability of Vietnam’s long-term planning as the recent annual ASEAN Business Outlook Survey showed 40 percent of U.S. enterprises consider the country to be their priority market for future business expansion.

However, such changes to laws and regulations could backfire and actually raise concerns about the legal environment among companies and investors, said business advisory firm Grant Thornton. If policymakers continue to issue new documents without synchronizing the entire legislative system, it could become one of the most critical investment obstacles for Vietnam, the firm said.

Vietnamese labor: on the edge of falling behind

One thing that stands out in Vietnam’s appeal for foreign investment is its competitively young and cheap workforce. Seven in ten Vietnamese live in rural areas, which helps dampen wage pressures.

“Vietnam’s labor is quite competitive when compared with other countries in the region,” said Antonio Sequeros of Tractus Asia, a management consulting company. “Today, the only country in the region that can compete with Vietnam in terms of labor costs is Myanmar,” he added.

Statistics from Vietnam's Foreign Investment Agency (FIA) show that over 70 percent of total FDI projects in the first seven months of this year were manufacturing-related, meaning "the industries that drive Vietnam’s manufacturing sector until now are mainly low value-added and labor-intensive, and use low-level technologies," Huyn H. Son, a specialist for the Asian Development Bank, wrote in a recent blog.

Often, Vietnamese labor is hired especially for the final assembling of products to be exported, Pietro Masina, Associated Professor of Economics at the University of Naples "L'Orientale", Italy, told VnExpress International.

Take Samsung Vietnam as an example; lured by Vietnam's large, cheap workforce, as well as its proximity to China, Samsung has invested about $6.5billion in Bac Ninh Industrial Zone since 2009. Not just Samsung, dozens of electronics producers and suppliers have touched down and commenced operations in Vietnam, such as Japan-based Canon, Taiwan-based Foxconn and U.S.-based Microsoft.

In contrast, FDI to Vietnam gives only a humble contribution to technology diffusion, only accounting for 4 percent in total share of foreign capital inflow in the first seven months of this year, according to the Foreign Investment Agency.

Dependence on cheap-labor may become a risk for developing countries as the world is undergoing a digital revolution. With the rapid development of science and technology, outsourcing in manufacturing will be much less needed as things like 3D printing become widely used.

Sooner or later, "the lowest levels of manufacturing may in the future be done with new technologies at home rather than overseas," Jandl, the East Asia expert, told VnExpress International. “In that case, the cost of labor will become secondary and human capital and technology absorption capacity will become crucial. Vietnam is falling behind."

Should we attract as much FDI as possible?

The pace of investment in Vietnam has slowed recently, according to the Financial Times’ greenfield index assessment 2015. The country’s score fell 1.41 points, the biggest fall among the 14 countries on the index. Vietnam’s share in global greenfield FDI projects also witnessed a slight drop (from 1.89 percent to 1.77 percent).

As percentage of GDP, last year FDI flows to Vietnam stood at 6.1 percent, nearly two times higher than Malaysia (at 3.7 percent), which is notoriously dependent on FDI, data from the World Bank shows. Masina thus sees Vietnam’s current industrialization process is highly dependent on FDI, meaning the country’s economy may become vulnerable when the market fluctuates.

The recent environmental disaster in Vietnam's central coast caused by Taiwanese steel firm Formosa, together with tax-dodging accusations against Coca-Cola in 2013, are the two most notorious scandals involving FDI firms in Vietnam.

“It’s high time to review the impacts FDI has on Vietnam,” said Tran Cung, the director of the Central Institute for Economic Management (CIEM).

It is also worth noting that none of the high performing East Asian economies such as Japan, South Korea and Taiwan have based their industrial development on FDI attractions, said Masina. On the contrary, countries such as Malaysia and Thailand, which followed FDI-led and export-driven models in the late 1980s, are now caught in the so-called middle-income trap.

"Vietnam definitely has to reform its economy to stay competitive. This is not just a function of the digital revolution, but simply the middle-income trap," Jandl told VnExpress International.

Given increasing globalization and several free-trade agreements in the line up, especially the TPP, skills development is vital to Vietnam’s trade and production structure and therefore sustainable growth.

“To be part of the TPP, [Vietnam] agreed on changing many standards,” said Robert Sitkoff from Harvard Law School. To achieve middle-income status through industrialization, the country should move toward more sophisticated export products.

In its Country Partnership Strategy, 2012-2015 Final Review Validation, the Asian Development Bank said Vietnam should stimulate technological innovation and product diversification to continue transitioning to a hub for high value-added manufacturing. 

Speaking of enhancing human resources in Vietnam, Masina said that the country should pursue innovation to improve the quality of goods for the domestic market and to try to increase the quality of Vietnamese firms participating in regional production networks.

"This is a difficult path, but it's the only concrete chance to reduce dependence on volatile FDI," he said.

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