Avoiding the Middle
Income Trap:
Renovating Industrial Policy
Formulation in Vietnam

Kenichi Ohno (VDF/GRIPS)
October 2008

Topics Vietnam’s challenge:

creating internal value and avoiding themiddle income trap Policy structure Policy making procedure andorganization
 How to break a solidified system:
leadership, technocrat group, andstrategic foreign partnership

1Vietnam’s New Era
 Vietnam is entering a new era where

productivity breakthrough and value
creation are needed.
 Opening up and receiving FDI can attain
middle income ($1,000+), but higher
income ($10,000+) requires good policy
and private dynamism.
 Vietnam’s future depends on:--Creation of internal source of growth--Coping with new social problems--New macroeconomic management

Per Capita GDP in 2004 (＄＄PPP) World Bank data
0Hong KongJapan
TaiwanSingapore
Brunei
S Korea
Malaysia
Thailand
China
Philippines
Indonesia
Vietnam
Cambodia
PNG
Mongolia
Laos
N Korea
MyanmarEast Timor

5000 10000 15000 20000 25000 30000 35000

Green: participants in East
Asian production network

2

Diversity in Governance andEconomic Development
Governance, WGI2005

High correlation(0.90) but
causality cannot
be argued fromthis diagram

600
Sin
500

Hkg
Jpn

S Kor
400

MalMong

Twn

Only circledeconomies
participate inregional dynamism

Bru

Thai300
Phil
VN

China

200
Camb

E TimorIndo

Sources: Compiled
from World Bank,Worldwide GovernanceIndicators, Sep. 2006;
and World Bank, World
Development
Indicators, 2006.

PNG
Lao
N Kor
Mya

100

0100

1000

10000

100000Per capita income ($PPP2004, log scale)Different Speeds of Catching Up
Per capita real income relative to US(Measured by the 1990 international Geary-Khamis dollars)
100%Japan
80%

TaiwanS. Korea

60%

Malaysia
Thailand40%

Indonesia
20%

Philippines
Vietnam
2005

2000

1995

1990

1985

1980

1975

1970

1965

1960

1955

1950

0%

Sources: Angus Maddison, The World Economy: A Millennium Perspective, OECD Development Centre, 2001;
the Central Bank of the Republic of China; and IMF International Financial Statistics (for updating 1998-2006).

3

Catching Up Process
Initial FDI
absorption

Internalizing
parts andcomponents

Internalizing
skills andtechnology

Internalizing
innovation

Creativity

Technology
absorption
STAGE THREE
Agglomeration
STAGE TWO
STAGE ONE
Simplemanufacturing
under foreign
guidance

VietnamHave supporting
industries, but still
under foreignguidanceTechnology &management
mastered, canproduce highquality goods

STAGE FOUR
Full capability ininnovation andproduct design as
global leader

Japan, US, EU

Korea, Taiwan

Thailand, Malaysia
Glass ceiling for
ASEAN countries(Middle income trap)

Lessons fromThailand and Malaysia（Success））Impressive industrialization andgrowth led by FDI and reasonable policy（Failure））Domestic private-sector capability
is still weak after many decades
 Foreign dependency—inability to send
foreign managers home Value and capability are notinternalized—middle income trap Risk of wage pressure and FDI shift toChina/India/Vietnam

4Vietnam’s Changing Sources ofGrowth Doimoi to mid 1990s—liberalization effect Mid 1990s to now—externally driven

growth with large inflows of investment,
capital and aid
 From now—creation of internal value!
7
6
5
4
3
2
1
0
-1
-2

ICOR

2007

2006

2005

2004

2003

2002

2001

2000

1999

1998

1997

1996

1995

1994

1993

1992

1991

1990

TFP change (%)

Vietnam’s Challenge
 AFTA, WTO, FTAs - large inflows of ASEAN

products (esp. Japanese brands) may
destroy VN’s industrial base.
 The risk of losing manufacturing base andkeeping only sales agents (“hollowing-out”).
 Vietnam’s wage becoming too high forlabor-intensive industries, but technology
too low for knowledge-intensive industries.
 Vietnam needs a strategic partner to greatly
increase internal value in manufacturing.

5

Proposed Strategy for 2020
(Presented at VDF Conference, Hanoi, March 2008)

Reform of industrial
policy formulation

Concrete targets
and action plans

Learning integral
manufacturing

Building 3 pillars of industrial strength-Supporting industries-Industrial human resource-Efficient logistics

Effective use ofcapital inflows & ODA

Solvingsocial issues

Proper macro
management

Preconditions for industrialization

Malaysia’s Manufacturing++
Malaysia’s IMP2 (1996-2005) aimed atraising and broadening the value chain.
Leveling up of eachindustrial cluster-Core production-Supporting industries-Supporting services-Human resources-Logistics-R&D

6The Concept of Monozukuri
Japanese Style Skill-based Manufacturing

Monozukuri literally means “making things” in nativeJapanese.
 Pursuit of high quality and customer satisfaction as
the primary goal, with pride and dedication.
 Many of Japan’s excellent companies were foundedby engineers full of monozukuri spirit.
Sakichi Toyota
1867-1930

Konosuke Matsushita
1894-1989

Soichiro Honda
1906-1991

Akio Morita(Sony’s co-founder)
1921-1999

Monozukuri – cont.
Long-term relationship and skill & knowledge
building within companies and among companies(assemblers-suppliers).
 Strong demand for 5S, QCD (quality-costdelivery), kaizen, just-in-time, quality control,and other efforts for constant improvement.
7

Two Types of Business Architecture
Modular manufacturing

Integral manufacturing

Partsinterface

Parts are common and canbe used for any model

Each product has uniqueparts, specifically designed

MeritsQuick results and flexibility

Endless pursuit of quality

Demerits

No differentiation, excessentry, low profit, lack ofR&D

It takes much energy andtime to achieve results

Institutional Openness, quick decision
requirement making, flexible
outsourcing
sLong-term relations,building internal skill &knowledge

Performance

TimeTime

Partnership Possibilities
From the Viewpoint of Business Architecture
Japan=ASEAN (integral) and
USA=China (modular) canform effective partnership

Source: compiled from Prof.
Takahiro Fujimoto’s explanation
to the Joint VDF-MOI mission,
June 2005.

8Policy Structure
East Asian industrial policy making has beencharacterized by: Real-sector pragmatism Goal orientation:
Vision  Strategies  Action plans Enhancing unique strength rather thanremoving general negatives
Vietnam has a vision (Industrialization &Modernization 2020) but it is not backed by
concrete strategies and action plans.
The roadmap is unclear.

<Malaysia>
Vision 2020  IMP  OPP/Malaysia Plan  Budget“Become fully (15 yrs)
(5-10 yrs)
(annual)developed” 1991

<Thailand under Thaksin> (2001-06)
PM’s vision  Auto Master Plan  Action Plan Matrix
Become“Detroit of Asia”

Business-MOI-experts agree on
targets for car/motorcycle production & export<Ethiopia>
ADLI  Ind.Dev.Strategy  M/Ps  Exp.St.Committee
1991

2003:policy principles

Leather/garment/flower/
food processing<Vietnam>Goal 2020  Overall industrial M/P?  Action Plan?
10YS/5YP(Does not exist)(Does not exist)

9Serious Reform in Policy
Method & Organization Needed For continued industrialization, Vietnam

needs a fundamental reform in policy
formulation. Minor repairs of current
system are not enough.
 Government trap – low efficiency, lowmorale, low salary  brain drain from thepublic sector  low-quality policies
 Strong political will and risk-taking at the
top level (Prime Minister) is needed toinitiate such reform.

“VN’s Policy Process Is One and Only”
K Ohno、VietnamNet Interview (May 13&15, 2008)
 VN’s growth thanks to good location andgood workers; not because of good policy.
 Main problems are lack of businessinvolvement and lack of inter-ministerial
coordination. Policies are not supported
by private sector and not implemented.
These are unique weaknesses in VN notseen in other countries.
 The same people from planning years arestill in charge. I propose a technocrat
group directly under PM, as seen in many
East Asian countries.

10

Multilayered
Model

Malaysia
Organization
for drafting
Industrial
Master Plan

Total 338
members+ advisors

Malaysia:
Drafting of Industrial Master Plan 2006-2020 (IMP3)
IPC: Industrial Planning Committee (headed by MITI Minister)
SC: Steering Committee (headed by MITI high official)
TRGs: Technical Resource Groups (headed by various experts)

Business opinions reflected through TRGs and brainstorming

11Central Coordination Model:
Thailand under Thaksin 2001-06

StrongPrime Minister

Order

Industry-specificCommittees

Relevant
MinistryDirectaccessPrivateSectorThailand should become:-“Detroit of Asia”-“Hub of Tropical Fashion”-“Kitchen of the World”

Visions to be
concretizedHigh level

Industry-specific
Institute
Experts

Operational level

Powerful & Intelligent Top Leader
Ethiopia under PM Meles Zenawi (1991-now)<Policy Structure>
Vision - ADLI (Agri.Dev.Led
Industrialization) 1991
Agricultural Strategy 2002
Industrial Strategy 2003
Other sectoral strategies
Medium-term strategies
3-year budget frameworks
Leather M/P (UNIDO-Italy)
Garment M/P (UNIDO)
Flower M/P (Dutch support)

StrongPrime Minister-Advice by Stiglitz-Doing PhD in UK-Writing books(nation’s brain)? Black box

Top-down
Decisions

MoTI

MARD

Advisors: Newey,Simon, Mesfin, Mariam?

MoFED

Ministries as
implementing bodies

UNIDO

Export goals & monthly reviews

GTZ

USAID

Using Individual donors to
execute specific projects

12Vietnam: Traditional M/P Drafting Process
PrimeMinister
Review forapproval

Order

SubmitDraftingTeamMinister
Interministerialreview

Submit

Data

InternalreviewMPI & other
Ministries

MPI & other
Ministries

GovernmentAppeal letter toPrime Minister whenproblems arise

Contact
Ministry whennecessary

Interviews,
symposiums(sometimes)

Technicalassistance(sometimes)

Internationalexperts

Business Community
No permanent channel for continuous policy dialogue(case-by-case, temporary, ad hoc)

Policy Formulation for Vietnam:
A Proposal- Elite technocrat
group under strong
leadership of Prime
Minister- Choose young,well educatedofficials and experts- Simplify policy
authority andprocedure

Prime Minister
Direction, fullauthority forpolicy making

Faithfulexecution andreporting

Technocrat Group(Policy Maker)
Policy,guidance andmonitoring

Experts
DonorsFaithful
executionand reporting

Ministries (Policy Implementers)

13

Under New Policy Structure
Vietnam Should Achieve: Strong top-down visions from PM;

sufficient authority for technocrats toexecute orders
 Action-oriented policy making with speedand flexibility
 Removal of bureaucratic formalism &inaction, nepotism, corruption, secrecy
 Public sector renovation – compact size,
competitive recruitment, attractive salary,
performance-based promotion, pride toserve the countryBreaking a Solidified System
According to comparative institutionalanalysis (CIA), a once-established system
resists change because of: Institutional complementarity
 Strategic complementarity
 Path dependence

But CIA also tells us that a systemic change
may occur under certain circumstances.

14Collective mutation

Foreign pressure

Foreigners whoignore
domestic rules

Dissatisfied
population

PolicyPolicy and foreign pressure
Gov’t as internal
deus ex machina

Strategicinteraction

Vietnam Can Change:
Suggested Entry Points
The following three should be enhanced
and strategically combined: Leadership Technocrat team
 Foreign partnership

The leader’s vision should be concretized by
the technocrat team. Foreign businesses,
donors and experts should be mobilized toachieve this vision.

15

Vietnam-Japan Monozukuri Partnershipfor Supporting Industries
For Leveling Up Vietnam’s Competitiveness in the Age ofDeepening Integration

A VDF Proposal
Drafted in June 2008 at the request of Japanese
Ambassador as guiding ideas for new bilateral
cooperation between VN and Japan. Revised inAug. 2008.
 The content reflects VDF’s studies on specificindustrial sectors, supporting industries, and policy
formulation methodology.
 It also summarizes various opinions of Japaneseexperts working in Vietnam.
Vietnam-Japan Cooperationin the Past
 Japan has contributed to Vietnam throughtrade, FDI, ODA and policy dialogue
 Contribution of Japanese ODA
Infrastructure (esp. transport & power), industrial
skills and HRD, institutional reforms, businessenvironment, urban & regional planning, removing
negative impacts of growth, poverty reduction
 Action-oriented bilateral policy dialogue

Ishikawa Project (1995-2001)
New Miyazawa Plan (1999)
VN-Japan Joint Initiative Phase 1, 2, 3 (2003-09)

16

New Direction ofVietnam-Japan Cooperation Vietnam is no longer a low-income

transition country. Bilateral cooperation
should be more equal and strategic.
 Cooperation should shift from removing
negatives and providing basics to proactive
creation of new competitiveness.
 Jointly produce high skill products throughdivision of labor:
Japan – capital- & knowledge-intensive
monozukuri processes
Vietnam – labor-intensive monozukuri
processes

Japan’s Challenge Japan has high technology, but faces highwages and ageing population.
 The 2007 Problem - Postwar baby boomers(born 1947-49) with high skills began to retirein 2007. Young workers are in shortage.
Situation will only get worse as time goes by.
 Japan needs a young developing country as areliable partner in integral manufacturing
Prof. Fujimoto: Thailand & Vietnam areprime candidates

17

Proposed Features ofMonozukuri Partnership
Resetting the mindset – Vietnamese managers
and workers must be more aggressive in learningand marketing Technology transfer and capacity building Commitment to international standards –quality, safety, environment, intellectual property
 Positioning in the global value chain – jointly
specializing high skilled processes and outsourcing
other inputs
 Reforming policy methodology
 Non-exclusivity (win-win-win) – other countries
can also enjoy the benefits of this partnershipImportance ofSupporting Industries
 Supporting industry promotion is the firstimportant step to realize the vision ofmonozukuri partnership.
 Assembly-type manufactured products –large part cost (80-90%) vs. small
assembly labor cost (5-10%).
 Without quick access to domestic supplierswith QCD, assemblers cannot compete(added transport cost + long lead time).
 ASEAN4 have been promoting supporting
industries for a long time, but with limited
success in creating non-FDI suppliers.

18

The Concept of Supporting Industries

Suggested Policy Menu
 Policy menu (next slides) is based on:- MITI’s New Aid Plan for ASEAN, 1980s- Mizutani Report for Thailand, 1999
- Urata Report for Indonesia, 2000
- Vietnam’s Supporting Industry M/P, 2007
- Vietnam’s Motorbike M/P, 2007
- Opinions of Japanese and Vietnamese experts
 The list is for reference only. Due tolimited time and resources, selectivityand prioritization will be necessary.

19

Policy Menu for Supporting Industry Promotion(A tentative list for discussion)
Policy area
1. Capacity building(for specific firms)

2. Human resource(general orinstitutional)

3. Finance

4. Incentives

Measures- Shindanshi (enterprise evaluation) system- TA for management and technology- Large-scale mobilization of retired Japanese engineers- Intensive support for limited sectors (e.g., die & mold)- Awards, PR and intense support for excellent suppliers- Management/technical centers and programs- Large-scale mobilization of retired Japanese engineers- Alliance between FDI firms and local universities/centers- Monozukuri school (to be upgraded to university)- Meister certification system- Credit guarantee- SME finance institutions- Two-step loans- Exemption or reduction of taxes and custom duties- Grants or loans for specified actions

Policy Menu (cont.)
5. Linkage

6. FDI marketing

7. Policy framework- Database and matching service- FDI-vendor linkage program- Parts Industry Association and Business Study Meetings- Trade fairs and reverse trade fairs- Linkage with Taiwanese suppliers (motorcycles, electronics)- Improving logistics between Hanoi and HCMC
- Creation of strategic industrial clusters- Industrial parks and rental factories- Efficient logistics and infrastructure- FDI marketing targeted to specific sectors or companies- Supporting industry master plan
- SME law
- SME ministry- Business associations and industry-specific institutes- Quality standards and testing centers

20

Steps Proposed by the Japanese Side Sep.2008 – Kick-off Meeting (Hanoi, hostedby VCCI) - Done Formation of 5 sub task forces to decide

Action Plan contents – Ongoing Feb.2009 – Finalization of Action Plan Implementation:
End 2009 – Short-term actions
2013 – Medium-term actions
2020 – Long-term actions

Following mechanisms will be utilized:- VN-JP Joint Initiative Phase 3 (2008-09)- Bilateral cooperation after the conclusion ofVietnam-Japan EPA (very soon?)

THE END

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