MAIN REPORT

Introduction(Preliminary draft for internal discussion)
17 August 2001
Prepared by Kenichi Ohno
[This is a preliminary draft for “Introduction” of our Main Report. Ideas contained below areproposed to form our main conclusions. All research members of the NEU-JICA project shouldcarefully examine them. Any comments or suggestions should be communicated to Chuong or
Ohno as soon as possible. This draft will be revised as many times as necessary.]

1. Background
How to achieve industrialization while vigorously pursuing trade and investment
liberalization is a big question for all developing countries including Vietnam. Following doi
moi reform in the late 1980s, Vietnam drastically opened its economy in the early 1990s.
Since then, the integration process has proceeded rapidly.
In the last ten years, Vietnam experienced large inflows of FDI and ODA, entry into
ASEAN and APEC, ongoing negotiations for WTO accession, the Asian crisis and its
aftermath, and accelerating competition in trade and FDI attraction with its neighbors,
especially China. These external factors stimulated growth as well as forced changes on the
Vietnamese economy and society.
From early on, Vietnamese policy makers and business leaders were largely aware of
the opportunities and risks of international integration. They understood that integration
was essential for systemic reforms and economic development, but serious preparations wereneeded to meet this challenge effectively. The importance of having realistic and consistentpolicies for development has been emphasized. The Vietnamese government also knows that,in principle, extreme policies such as big bang liberalization or reversion to control are
impractical and undesirable. It recognizes that market and government must be combined
properly.
Up to now, however, the Vietnamese government and business community have notpresented sufficiently concrete industrial strategies suitable for the age of integration, nor
has the identification of candidate industries for promotion (or downsizing) been made.
Meanwhile, the AFTA deadline of 2006 is approaching and WTO accession talks andtariffication of non-tariff barriers are continuing. Without a clear industrial vision, industrial
policy cannot be designed effectively and coherent tariff structure cannot be proposed to WTO.
The lack of a predictable industrial vision greatly increases uncertainty associated with1

business plans of both domestic and foreign enterprises.
Vietnam is willing to integrate, but preparations remain incomplete. The joint
research project by National Economic University and Japan International Cooperation
Agency was organized in Summer 2000 to produce real-sector studies that could help
overcome this problem. In this project, Vietnamese and Japanese researchers join hands to
produce intellectual inputs for policy makers, which are concrete, realistic and suitable forVietnam’s particular situation. This book is an interim report of our ongoing joint research
effort.1

2. Methodology
Economic theory is useful and necessary as general guidelines, but not concreteenough to answer the urgent and practical questions that the Vietnamese industries actually
face. Theory must be supplemented by in-depth and up-to-date studies of domestic industries
as well as global market trends.
In the global aid community today, poverty reduction is considered to be the primary
goal as well as the most effective means of development. In addition, improvement of thedevelopment process—strengthening partnership, transparency, accountability, ownership,
empowerment, etc—is regarded as high priority. We support these ideas, but we think they
are not enough. In addition to fight against poverty and procedural reforms, we believe policy
makers should pay much more attention to the real-sector issues, analyzing them deeply andrealistically with the help of Vietnamese and foreign experts. Without thoroughunderstanding of Vietnam's industrial position in the context of global competition, no
realistic industrial strategy can be designed or implemented. Without industrial strength,
poverty reduction is very difficult to achieve. Growth orientation may be a bit old-fashioned in
the global aid community, but it is crucial for Vietnam.
Basic trade theory (comparative advantage) is shared by all economists. Our
researchers are also highly proficient in latest trade and investment theories. But policy
implementation requires more than just a model or a regression. As we try to propose viable
policy options, primary emphasis is placed on gathering concrete facts and discussing actual
problems, rather than general advice or additional theoretical modeling. We try to stay awayfrom preconceived conclusions not firmly based on local facts.
We spend much time visiting managers, merchants, markets, factories, trade villages,
officials and foreign investors. We rely heavily on questionnaires and interviews. Technicalexperts often accompany us to advise on the way to consolidate or upgrade production
facilities. International trading companies help us to evaluate the domestic market as well as

1

For more details of the NEU-JICA project, visit our website: http://www.neujica.org.vn.
2the marketability of Vietnamese products. We find interaction of experts from various
backgrounds extremely stimulating and fruitful. Policy dialog with key officials responsible
for Vietnam’s industrial policy is an integral part of our project. When prior theoreticalknowledge

iscombinedwithintensive

examinationofspecific

industries,

policyrecommendations for Vietnam’s particular problems can be generated and meaningfulpreparations for international integration can be made.

3. Toward truly joint research
We would like to avoid one-way flow of advice from foreigners to Vietnamese. Our
project aims to be truly mutual and cooperative.
NEU and JICA researchers conduct research as equal academic partners. Both sides
share the responsibility for the quality of output, from project design to final dissemination.
We conduct joint research trips and discuss the contents of main papers intensively andrepeatedly. Vietnamese and Japanese research styles differ, which adds to the complexity ofour project. Compared with the unilateral approach, this is much more time consuming. But
we believe this is the right way to do research internationally. Our project is part of theongoing and never-ending research on Vietnam's industrialization. Much more has to be donein the future. We consider the very process of this cooperative research to be important, apartfrom whatever tentative conclusions we reach.

4. Shifting global environment
Vietnam must simultaneously achieve economic development, systemic transition
and international integration. External influences including foreign competition, trade, FDI,
ODA, global recession and regional crisis are reshaping Vietnam’s economy and society today.
The need to integrate positively is widely recognized among Vietnamese officials and businessleaders, but the country’s capability to cope with foreign competition is underdeveloped inboth public and private sectors. Technological and institutional gaps are still large, and it is
not easy for Vietnamese industries to compete with China, NIEs or developed countries
without protection.
Nevertheless, there is no way but forward. Vietnam must integrate, and discussion
should now focus on the concrete method and sequencing of integration. As a first step, theglobal market into which Vietnam is integrating must be studied very carefully. Among manyfactors, those that have significant bearings on Vietnam must be recognized.
First, integration pressure has intensified recently. Not just developed andmiddle-income countries but also very latecomer countries are required to liberalize domestic
economies and adopt “international best practice.” The main reason for this trend is the3dominance of the US economy after the collapse of USSR.
Second, the Asian crisis forced rethinking of development strategies in the region.
While the immediate crisis impact is over (except perhaps Indonesia), NIEs and ASEAN
began to re-examine their policies in the aftermath. Rethinking is taking a complex form.
Trade and FDI liberalization is partly accelerated but partly slowed down. Some countries arewilling to accept American standards while others are more careful. Financial sector reforms
are emphasized while real-sector weaknesses are also recognized.
Third, China is emerging as a global factory. In the last few years, China overcame
weak domestic demand and is now attracting a large amount of FDI and strengthening its
export competitiveness. In Southern China, concentration of foreign producers and their parts
suppliers is generating a virtuous circle. Although China also faces the problem of industrial
restructuring and SOE reform as it enters WTO, it will certainly remain the most formidable
competitor for Vietnamese producers in both domestic and overseas markets.
Fourth, Japan’s external economic policies are changing. Japan is the largest trading
partner and ODA provider for Vietnam. However, recent shifts in Japanese policies are notvery favorable for Vietnam. They include reduction of ODA due to fiscal crisis (although howmuch will be cut for Vietnam is uncertain) and rising protection for domestic producers
including the recent imposition of safeguards on goods mainly imported from China(Vietnam’s garments and towels are also potential targets).
Fifth, the US economy is likely to have more influence on Vietnam in the future.
During much of the 1990s, the US economy was buoyant thanks to IT revolution and asset
inflation. Now the tide has turned and Asia’s export-oriented economies (especially IT
equipment producers) are hit hard. With the bilateral trade agreement, Vietnam is about tolink more heavily with the US when the world is entering into recession. [Also discuss EU]

5. The need for an industrial blueprint
Vietnam needs to move strongly toward a full-fledged market economy as a long-term
goal, but we do not believe activation of full market forces at this low stage of development
will necessarily yield good results. Rapid external opening without due preparation as well asbold economic liberalization without necessary policies and institutions should be avoided.
Market-oriented measures must be introduced with proper speed and sequencing. The way tomix market and government should be balanced and flexible. The government should not
replace markets but enhance its development and mend its weaknesses.
In a low-income country with underdeveloped markets like Vietnam, there should bea coherent and concrete national development strategy encompassing trade, FDI, SOE reform,
SMEs, banking, securities markets, exchange rate, budget, money, etc. in order to provide
policy consistency and private-sector guidance. The primary goal should be real-sector
4development while financial-sector concerns are also important but secondary in supporting
the primary goal. It should not be vice versa.
Laissez-faire policy does not work if markets and the private sector are
underdeveloped. Even developed markets often exhibit high instability, let alone undeveloped
ones. In Vietnam, the cycle of boom and bust, accompanied by over-investment andover-capacity, is visible in many industries. Domestic mistakes are multiplied when the
country is globally integrated. The question is not whether government should intervene inmarket activities but how and when it should do so. The skillfulness of intervention will
determine the success or failure of Vietnam’s industrialization and modernization.
In Vietnam the government and ministries already have five-year plans, ten-year
strategies, and other strategies for specific industries. The quality of these strategies is far
from satisfactory. Currently, most industrial strategies remain no more than hopefulquantitative plans for future output and investment. What is lacking is evaluation of suchplans in the context of fierce global competition. Realistic strategies must be firmly based on
the analyses of market trends, technological changes and cost comparison in the world
economy. Few of the present strategies can lead industries into the age of integration.
Vietnam should formulate a comprehensive and concrete long-term development
strategy for the entire economy. In addition, each key industry should have a concrete andrealistic development strategy, with limited and temporary protection if necessary, consistent
with the overall national strategy. All economic policies including trade, FDI, SOEs, SMEs,
banking, rural development, etc. should be integrated under a coherent industrial vision.

6. Different policies for different industries
Vietnam cannot promote all industries. Therefore prioritization is necessary.
Different types of industries should be distinguished since they require different types ofpolicies. Export promotion and import substitution are not necessarily mutually exclusive.
They can proceed in parallel.
Given Vietnam’s initial conditions, exports of labor- and skill-intensive products
should be the first priority. Following that, conditional support for carefully selected
import-substitution industries should be the second priority. As to the IT industry, official
targets are too ambitious and should be deflated.
First priority: garment and footwear, electronics, and food processing: These three
are the industries with clear dynamic comparative advantages. If successfully supported, they
will surely be the main export base by 2020 [projections of export, output and labor structure
up to 2020 will be attempted in Chapter 1]. These industries are already growing
quantitatively, but their growth may stall and technology transfer may be hindered if wrong
policies are taken. By contrast, good policies can accelerate their growth and make them5

firmly rooted in Vietnam’s own skills and management.
For the development of these industries, FDI is crucial. Under the fierce global
competition, Vietnam by itself cannot compete effectively in these industries. This does not
however mean that Vietnam will forever be the supplier of cheap labor force. Over time,
Vietnam’s strength in technology, design and marketing can be improved. But that will
require proper sequencing of policies.
For export-oriented labor- and skill-intensive industries, the proper sequencing
should be (i) accumulation of assembly-type FDI as much as possible (“agglomeration”); (ii)invitation of supporting industries which supply parts to these assemblers; and (iii) gradualabsorption of technology and management skills by the Vietnamese. In short, industrial basemust be first broadened, then deepened, and finally improved. The reverse order will not work.
China has emerged thanks to the successful execution of steps (i) and (ii). In Southern China,
assemblers and parts suppliers are mutually reinforcing to produce an expansionary virtuous
circle. But even in China, technology transfer takes much time.
In Vietnam, first signs of agglomeration are visible in garment and electronics.
However, official policies remain inappropriate. The biggest problem is local contents
requirement that not only violates WTO but goes against the proper sequencing describedabove. Attempts to increase value-added will fail if FDI agglomeration is insufficient. Since
foreign parts suppliers are unlikely to invest in markets where demand is small, assemblers
will be forced to (i) ask for high import protection, (ii) continue to use expensive imported
parts, or (iii) exit from Vietnam. Local contents requirements should be removed, and allexport-oriented FDI should be welcomed regardless of value-added contents and under a low
and neutral trade protection. For their promotion, neither high protection, generous
incentives, nor huge public investment is required (Vietnam may already be giving too muchincentives to FDI). What is important is removal of policy uncertainties and irregularities toensure a stable and predictable business environment for all investors, domestic or foreign.
Second priority: heavy material industries including steel, cement, paper, chemicals,
etc. For these import-substituting industries, official support should be given conditionallyand with caution. There is no guarantee that they will survive the age of integration, andprobably many of them will disappear. The ultimate verdict must be given by market forces.
But the government can help in three ways: (i) helping them formulate a proper strategy; (ii)providing limited support and protection; and (iii) amelioration of transitional pain if they
fail.
These industries should be supported for limited time and amounts only, with budget
expenditure and import protection if necessary, provided that they have a realistic andconcrete long-term development strategy. Realistic here means being able to compete in an
integrated world without permanent protection or social cost. In order to assess suchpotentiality, a large amount of technical, financial, marketing and managerial information
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needs to be collected on the industry as well as relevant global trends.
In supporting weak industries, one perennial problem is political capture by interest
groups. All too often, inefficient industries are protected permanently at the cost of thenational economy under an intense political pressure. There should be a mechanism toprevent this. Decisions to protect must be made openly and by operational criteria. The
amount and length of protection must be properly calculated. The sunset clause—to
terminate protection after a pre-specified period—must be pre-announced and adhered to.
There should be no extension of protection whether the promotion succeeds or fails.
Be more realistic about the IT industry: The Vietnamese government designatessoftware as a high priority industry. Establishment of a high-tech park is also envisioned. We
understand the need to upgrade Vietnam’s technology in the age of IT. However, given thecurrent level of economic development, IT is unlikely to be among the leading industries ofVietnam in the foreseeable future. This does not mean that Vietnam should ignore IT. But
investment in and expectations of IT should be balanced with other needs of the national
economy.
The meaning of IT should be clarified in Vietnam. IT has many dimensions includinginternet and mobile phone use, software production, computer literacy of general public,
production of IT devices, use of IT to improve business efficiency, etc. Vietnam should identify
which aspect is most crucial for the country. Some IT uses may spread without official
intervention. Others may not deserve public support. At any rate, IT policy should be
integrated in the context of a broader development strategy. With a clearer focus, the IT
industry may be supported with properly targeted budgeting, training and education.

7. Integration risk management
Global integration entails both opportunities and risks. With greater external
exposure, global shocks are transmitted to the national economy. Furthermore, domestic
problems may be amplified. In the Asian crisis, domestic banking problems led to huge foreign
overborrowing and subsequent macroeconomic collapse. Economic management must takethese new risks into account.2
One of the most serious risks is the worsening of boom-and-bust cycles. In any
economy, firms over-invest in good times and suffer from over-capacity in bad times. But thesecycles may become more pronounced under integration. First, FDI may reinforce these trends
rather than dampen them. Second, global price swings may trigger large domestic
In the Asian crisis, the most severely hit economies were financially open. Since Vietnam
still remains financially insulated, external financial disturbances (such as speculative
attacks, asset bubbles and interest rate fluctuations) are unlikely to be transmitted fromabroad. But real-sector shocks are possible as discussed in the text.

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over-investment.3 Third, the possibility of foreign borrowing may accelerate over-investment.
When the private sector (including FDI) exhibits unsubstantiated exuberance, government
may slow it down through warning signals as well as some form of taxation and penalty. It
may even wish to coordinate public and private investment more directly.
Another serious integration risk is the adverse impact of global price fluctuations
and recessions. Even with restrained investment, global economic cycles will become a major
source of disturbance beyond the control of the national government. Primary commodities
and electronic goods—which are key export items for Vietnam—both exhibit large pricefluctuations.
The Dutch disease may also affect the Vietnamese economy. Traditionally, the Dutch
disease is a situation where the manufacturing sector is suppressed due to the rapid growth ofan extractive sector (oil, natural gas, minerals, etc). This occurs through overvaluation of theexchange rate caused by large inflows of foreign exchange earnings.4 But more generally, theDutch disease may occur when too much FDI or ODA is received relative to absorptive
capacity, or when primary commodity prices surge. At present, Vietnam’s FDI and ODA do notseem to crowd out other domestic investments; rather, they play a catalytic role in stimulating
more investment in a labor-abundant economy. But government may still wish to monitor the
possibility of the Dutch disease in Vietnam’s development process.

8. WTO entry strategy
The realistic target for WTO accession may be around 2005-06, if not later. Vietnam
should prepare the following so as to join WTO with as much benefits and with “ownership.”First, long-term development strategies for the macroeconomy as well as forindividual industries must be established (see above) in order to use trade liberalization in amost conducive way to Vietnam’s development. WTO must be one key factor in the broaddevelopment framework and entry negotiations should be conducted from this perspective. If
it is desirable for some industries to delay trade liberalization beyond what WTO (or AFTA)
normally permits, realistic promotion plans accompanied by a pre-committed sunset clauseshould be presented. (But whether WTO will accept such exceptions is not certain.)
Second, market access and systemic convergence are often required of new entry
members, but negotiations for them should be done carefully and case by case. From atheoretical viewpoint, the case for accepting these conditions immediately is not strong.
For example, when international coffee prices rose, Vietnamese coffee supply responded
very strongly. Now that their prices have plunged, the domestic producers are forced to scale
down.
4 More theoretically, the Dutch disease is associated with a shift in the relative price of
tradables to nontradables as well as the movement of domestic resources (such as labor) awayfrom the non-extractive tradable sector.
38Third, WTO does not always treat newcomers fairly. An applicant’s position vis-à-vis
existing members is very weak, and some large countries use this opportunity to theircommercial advantage by prying open newcomers’ markets as a precondition for entry.
Moreover, WTO regularly imposes bolder and faster trade liberalization on new LDC
members compared with existing LDC members in similar stages of development. Vietnam
should distinguish WTO’s legitimate requirements and inconsistencies. If unfair treatment oflatecomers is detected, Vietnam may choose to appeal internationally in cooperation withcountries saddled with similar disadvantages.

9. Capacity building through actual industrial promotion
Requirements for successful integration are many, but Vietnam’s domestic capability
is at present limited. Both government and business leaders are ill-prepared for integration.
There is a clear need to improve their capability but the question is how to achieve it. We have
two suggestions.
First, the best way to learn is to do it actually. Instead of arguing general merits anddemerits of industrial policy forever, Vietnam should now start to formulate sharply focusedmeasures suitable for the age of integration for a few selected industries. At first, information
may be lacking and foreign assistance may be needed. Coordination within government may
take time and mistakes will be made along the way. However, the hands-on approach is the
only way to internalize operational policy skill. One successful case will give much pride andconfidence to the nation. Even mistakes can be good lessons. Rather than endless conferences
and seminars, there should be a taskforce to design and implement actual policies.
Second, in order to execute this learning-by-doing strategy, official administration
should be reformed. At present, economic policymaking is too diffused and incoherent. For
WTO negotiations, SOE reform and others, too many ministries and organs are involved; as aresult, no one takes the responsibility or leadership. We propose to create an elite policy team
directly under Prime Minister to design and coordinate all key economic policies (relevant
ministries may actually execute them). The best young people from various ministries andacademia should be assembled. The team should be given full authority and confidence ofPrime Minister. Such a team existed in many NIEs to implement their development policies.
[END]

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