OSIPP Discussion Paper: DP-2017-E-005

Assessing the Impacts of Deeper Trade Reform in Vietnam*
in a General Equilibrium Framework
November 6, 2017
To Minh Thu
Research Associate, Diplomatic Academy of Vietnam, Hanoi, Vietnam†

Hiro Lee
Professor, Osaka School of International Public Policy, Osaka University

Keywords: Trade reform, economic welfare, sectoral adjustments, Vietnam, CGE model
JEL codes: F13, F15, F17
Abstract: Vietnam is on the way to undertake deeper trade liberalisation, including bothtariff reductions and reforms in other trade-related areas. In this paper, the impacts ofVietnam’s trade reform on its economic welfare and sectoral adjustments are assessedusing a dynamic computable general equilibrium (CGE) model. We consider the effects ofgoods and services trade liberalisation, an increase in foreign direct investment inflows, a
reduction in administrative and technical barriers to trade, and a reduction in the trade andtransport margins. When all effects are combined, Vietnam’s economic welfare is projected to increase by 8.4 per cent in 2020 compared with the baseline. Many manufacturingsectors would expand, whereas agricultural, minerals and fuel sectors would contract. The
output expansion is most significant in the textiles and wearing apparel sectors.

*

This paper has been published in the Journal of Southeast Asian Economies, Vol. 32, No. 1, April 2015,
pp. 140-152. A post-print is provided to enable developing-country researchers who do not have access to
the Journal to view this article. We have benefitted from the helpful comments of two anonymous
reviewers, Tsunehiro Otsuki, Akira Kohsaka and participants of the seminar at Osaka University. Hiro Lee
gratefully acknowledges financial support from the Japan Society for the Promotion of Science (JSPS),
Grant Number JP25285076.
†

Corresponding author. Osaka School of International Public Policy, Osaka University, 1-31 Machikaneyama, Toyonaka, Osaka 560-0043, Japan. Email: hlee@osipp.osaka-u.ac.jp.

1. Introduction
Vietnam started comprehensive economic reform in the mid-1980s in which trade reform
has played an important role. Since then, the country has initiated wide-ranging unilateralliberalization measures and implemented various bilateral and multilateral trade agreements,
including the accession to the WTO in January 2007. After the WTO accession, Vietnam has
continued its path of trade reform with the negotiations of several WTO-plus free trade
initiatives, notably the Trans-Pacific Partnership (TPP) and the Regional Comprehensive
Economic Partnership (RCEP), and has played an active role in the ASEAN Economic
Community (AEC)’s building process. With the AEC scheduled to be established by the endof 2015, and negotiations of the TPP and RCEP are expected to be completed by soon
thereafter, the sources of economic gain would come not only from tariff reduction but also
from other trade facilitation measures and trade-related productivity growth, which areimportant features of these trade arrangements.
Further reform in the external sector is expected to result in wide-ranging social andeconomic impacts on the Vietnamese economy. Smaller differences between domestic andinternational prices, competition in the market for services and new institutions andregulations are predicted to lead to increased market efficiency. Trade liberalisation,
especially with WTO-plus commitments, would result in efficiency gains and graduallytransform the country’s industrial structure to the one that is consistent with its comparativeadvantage. However, its effects generally differ greatly across industries and working groups,
creating both winners and losers.
In this study, we evaluate the effects of Vietnam’s trade liberalisation on its economic
welfare and sectoral adjustments using a dynamic computable general equilibrium (CGE)model. We take into account the impacts of factors such as services liberalisation, an increasein FDI inflows, a reduction in administrative and technical barriers, and a reduction in the
trade and transport margins as aspects of the trade liberalisation process. The effects of eachfactor are assessed separately, but the combined effects of all the factors are also provided.
We make a contribution to the literature by providing a comprehensive assessment of theeffects of trade liberalisation in both goods and services, as well as other accompanying
features of trade reform.

2

The rest of this paper is organised as follows. Section 2 gives an overview of Vietnam’s
trade performance and policy. Section 3 reviews literature regarding empirical analysis of the
impacts of trade liberalisation on the Vietnamese economy. Section 4 presents overview ofthe model, as well as the baseline and policy scenarios used in this study. Section 5 provides
results of the experiments, followed by interpretations of the results. The final section offers
concluding remarks.
2. Background of Vietnam’s Trade Policy Reform and Performance
2.1. Trade policy
Vietnam’s economic and trade reforms have fundamentally transformed the trading
system of Vietnam from a centrally planned and state trading monopoly to a more marketoriented one. Major trade policy reform includes relaxation of controls over trading rights,
unification of exchange rates, creation and amendment of a system of import and export tax,
gradual removal of non-tariff barriers (NTB) and progressive deregulation of trade regimes.
Import quotas have been removed except for some strategic products. The tariff system has
been simplified and the tariff rates have gradually been reduced over the past two decades.
The tariff structure of Vietnam is designed with generally high tariff rates and non-tariffbarriers applied to consumer goods, while capital goods and production inputs are subject to
low tariffs and very few non-tariff barriers. Therefore, effective protection of many industries
is higher than that offered by nominal protection (Athukorala, 2006). Protection of infantindustries is also applied to some manufacturing sectors such as automobile and foodprocessing. This protection raises the price of intermediate inputs, adversely affect productionof downstream industries and export activities.
In addition to unilateral reform measures, Vietnam has sought to become and remain open
by joining bilateral, regional and multilateral trade agreements. On a bilateral basis, thecountry signed trade agreement with the European Union (EU) in 1992, the United States(US) in 2000 and Japan in 2008. On a regional basis, Vietnam became a member of ASEAN
and ASEAN Free Trade Agreement (AFTA) in 1995, and joined Asia Pacific Economic
Cooperation (APEC) Forum in 1998. Together with other ASEAN members, Vietnam
participated in the formation of a number of FTAs between ASEAN and partner countries,3

specifically China, Japan, Korea, Australia and New Zealand, and India. In January 2007,
after a decade of preparation and negotiation, Vietnam became the 150th member of the WTO
with comprehensive and challenging commitments (World Bank, 2006, p. 54). Recently,
Vietnam embarked on a new chapter of economic integration with negotiation of several
WTO-plus FTAs. It is concurrently negotiating five FTAs, namely with Korea, with theEuropean Free Trade Association (EFTA), with the Eurasian Economic Union (EAU), andmost importantly the TPP and RCEP.1 The implementation of these FTAs will require further
changes in Vietnam’s trade and trade-related policies and is expected to create a more liberaland efficient trading system. Figure 1 summarises past and future tariff reduction plans under
MFN scheme and selected regional FTAs.

Figure 1: Vietnam’s past and future tariff reduction plans under MFN
and selected FTAs, 2005-2023
20%
18%
16%

Tariff rate

14%
12%

MFN

10%

AFTA

8%

ASEAN‐China FTA

6%

ASEAN‐Korea FTA

4%ASEAN‐Japan FTA

2%0%2005 2006 2007 2008 2010 2015 2018 2021 2023
Year
Note: All tariff rates are bound rates and not applied rates.
Source: Truong et al. (2011).
1

The members of the EFTA are Iceland, Liechtenstein, Norway and Switzerland; those of the EAU are
Belarus, Kazakhstan and Russia; negotiating countries of the TPP are the US, Canada, Mexico, Chile,
Japan, Singapore, Malaysia, Brunei, Vietnam, Australia and New Zealand, and those of the RCEP are the
10 ASEAN countries, China, Japan, Korea, India, Australia and New Zealand.

42.2. Trade Performance
Trade liberalisation, together with reforms in other areas, has had significant impacts on
Vietnam’s trade and economic performance. Since 1986, total export and import values havegrown at an average annual rate of more than 20 per cent. As a result, export values in 2013reached US$132 billion, about a hundred times that of 1986. This growth rate is remarkableeven though it started from low starting values. From 1995 to 2006, the ratio of total imports
and exports to GDP almost tripled from 54 to 150 per cent and remain around 160 per cent inrecent years.
Table 1 shows Vietnam’s exports by major products from 2002 to 2013. Until the mid2000s, exports of crude oil made a large contribution to the export growth, comprising morethan 20 per cent of total exports. Apart from oil, agriculture and aquaculture products andlabour-intensive products such as garments and footwear are major export items, accounting
for about 20 and 25 per cent of total exports. However, over the last decade, the export shareof crude oil has declined sharply to just 5.5 per cent in 2013. Exports of garments andfootwear continued to grow but their shares in total exports have contracted by 4-5 percentage
Table 1: Exports by major products(% of total exports)
Product
Crude oil
Coal
RubberRice
CoffeeMarine products
Garments
FootwearHandicrafts
Electronic goods and components

2002
19.6
0.9
1.6
4.3
1.9
12.1
16.4
11.2
2.0
3.6

2006
20.8
2.3
3.2
3.2
3.1
8.4
14.6
9.0
1.6
4.3

2010
6.9
2.2
3.3
4.5
2.6
6.9
15.5
7.1
0.3
5.0

2013a
5.5
0.7
1.9
2.2
2.1
5.1
13.6
6.4
0.2
25.3

Other products

26.3

29.5

45.7

37.0

Source: IMF (2007) and General Statistics Office of Vietnam (2014).
aPreliminary.

5

points over the past decade. On the other hand, exports of electronic goods and components
have dramatically increased in recent years, driven by foreign direct investment (FDI) andproduction networks in Asia. Overall, the exports structure has moved gradually fromresource-intensive to unskilled-labour intensive and recently toward higher skilled-labour
intensive products.
Looking at Vietnam’s imports by major products (Table 2), imports of machinery andequipment have been constantly high to meet the demand for capital goods needed for higheconomic growth. Intermediate inputs for production, such as iron and steel, textiles, leather
and garment material, petroleum products, and electronics parts are major import items. In
general, the structure of trade of Vietnam is typical of a developing country at a relatively
early stage of development with a large share of exports of labour-intensive and natural
resource-intensive products and a large share of imports of capital and intermediate goods.
Table 2: Imports by major products(% of total imports)
Product
Petroleum products
Fertilisers
Pesticides
Iron and steel
Motorcycles
Motor cars and trucks
Textile yarn, cotton
Leather and garment material
Machinery and equipment
Other products

2002
10.2
2.4
0.6
6.8
2.1
1.3
2.0
8.7
19.2
46.6

2006
13.3
1.5
0.7
6.5
1.2
0.5
1.7
4.3
14.8
56.6

2010
7.2
1.4
0.6
9.4
1.0
1.2
2.2
9.4
16.1
51.5

2013a
5.3
1.3
0.6
7.2
0.4
0.6
2.1
9.2
14.1
59.2

Source: IMF (2007) and General Statistics Office of Vietnam (2014).
aPreliminary.

As shown in Figure 2, since 1990 imports have been greater than exports except in 2013.
The gap has been financed by inflows of FDI, official development assistance (ODA) andprivate transfers. Until 2006 this trade gap was considered quite acceptable as the majority of6

imports were machinery, equipment and intermediate inputs for production. From 2007 to
2011, the trade gap became large, reaching US$18 billion or around 34 per cent of exports in2008. An important culprit of this situation is the underdevelopment of Vietnam’s supporting
industries, which is unlikely to be improved anytime soon. Thus industrial development
depends heavily on imported intermediate imports for production and exports. In addition, as
many of Vietnam’s trade liberalisation commitments are being realised, the possibility oflarge trade deficits remains.

Figure 2: Vietnam’s trade performance, 1990-2013 (US$ billion)
140
120

US$billion

100
80
60
40
20
0
‐20
1990

1995
Exports

2000
Year

2005

Imports

Balance

2010

2013

Source: Computed from data obtained from General Statistics Office of Vietnam (2014).

Table 3 provides Vietnam’s direction of trade, which shows diverse patterns. In 2013,
about 75 per cent of Vietnam’s imports originate from Asia, whereas only about 40 per cent2of its exports are shipped to the region. The EU, the US and Japan are the largest markets for
Vietnam’s exports. Vietnam’s trade with the EU and the US has been in surplus in the lasttwo decades. In 2013, Vietnam’s trade surplus with the EU was US$5.4 billion and that with
the US was US$9.2 billion. By contrast, East Asian countries, mostly China, Japan, Korea,

2

Calculated based on data from the General Statistics Office of Vietnam.

7

Taiwan and Singapore are major sources of Vietnam’s imports. Among them, imports from
China have increased most dramatically. In 2013, imports from China reached US$36.8
billion, an increase of 26.7 per cent from the previous year (equivalent to US$7.8 billion). As
a result, Vietnam’s trade deficit with China has risen rapidly, from US$11.0 billion in 2008 to
US$23.7 billion in 2013. As a group, ASEAN is an important trading partner of Vietnam.
With the AEC to be established soon, it is expected that the trade interdependence between
Vietnam and other ASEAN member states will be further strengthened.
Table 3: Vietnam’s direction of trade(% of total exports/imports)

Singapore
ASEAN-4
China
Japan
Korea
TaiwanAustralia
Unites States
European Union
ROW

Exports
2001
2008
7.0
4.2
9.1
8.2
9.4
7.2
16.7
13.6
2.7
2.8
5.4
2.2
6.9
6.7
7.1
18.9
20.7
17.3
15.0
18.6

2013
2.0
9.2
10.0
10.3
5.0
1.7
2.7
18.1
18.4
22.6

2001
15.3
9.9
9.9
13.5
11.6
12.4
1.6
2.5
10.0
13.7

Imports
2008
11.6
9.9
19.4
10.2
8.8
10.4
1.7
3.3
6.7
18.1

2013
4.3
10.4
28.0
8.8
15.7
7.1
1.2
4.0
7.2
13.4

Note: ASEAN-4 includes Indonesia, Malaysia, the Philippine and Thailand.
Sources: The 2001 data are calculated from IMF (2006); the 2008 and 2013 data arecalculated using the data obtained General Statistics Office of Vietnam (2014).

3. Literature review
The impact of trade liberalisation in Vietnam has been under scrutiny by both domestic
and international economists. A large number of qualitative analysis provides useful information to understand Vietnam’s trade liberalisation process and the country-specific socioeconomic framework (Le, 1996; Le et al., 2002; Nguyen, 2004; Thanh, 2005). Quantitative
analyses are diverse and can be divided into two groups: sectoral and computable generalequilibrium (CGE) studies. Existing sectoral studies employ different methodologies, such as

8

partial equilibrium models and household surveys. They cover Vietnam’s main exports suchas rice, textiles, sugar, coffee, tea, maize and fisheries (Rama and Le, 2005). Standard CGE
models are applied in many studies.
Fukase and Martin’s (2000, 2001) studies are the first that employ a CGE model inestimating the impacts of trade policy in Vietnam. Their first study (Fukase and Martin, 2000)
investigates the impact of the US granting the Most Favoured Nation (MFN) status toVietnam. It is predicted that total Vietnamese exports to the US would increase by 127 percent. This increase is largely caused by 16-fold increase in clothing exports.3 In the second
study, Fukase and Martin (2001) evaluates the impact of Vietnam’s accession to the AFTA.
Modest effects are predicted on output in most industries, the largest expansion being in theapparel industry, where Vietnamese output is estimated to increase by 7-10 per cent. In
contrast, the outputs of some import competing sectors are likely to contract due to increasing
competition.
Roland-Holst et al. (2002) present a set of assessments of the long-term economic effectsof Vietnam’s accession to the WTO using a dynamic CGE model for the Vietnamese
economy. Their results suggest that considerable gain for Vietnam could be multiplied withcomplementary domestic reform and particularly with negotiated bilateral or regional market
access. Nguyen and Ezaki (2005) attempt to analyse the effects of Vietnam’s ongoingregional economic integration focusing on growth, poverty reductions and income distribution
using a CGE model with ten household groups in both urban and rural areas. Their results
indicate that the regional economic integration generally has positive effects, which is both
welfare enhancing and income-distribution improving for Vietnam. Household income andconsumption would increase, and poor and rural households are predicted to benefit morethan high-income urban households.
Dimaranan et al. (2005) examines the impacts of Vietnam’s merchandise trade liberalisation under the WTO using GTAP-DD model developed by Ianchovichina (2003). They show
an annual gain of US$376 million accruing to Vietnam in a deep trade liberalisation scenario.
3

Abbott et al. (2007) notes that Vietnamese exports to the US increased more than predicted even in the
short period from 1996 to 2000 and more than ten times over the period from 1996 to 2004. The actual data
do not support the huge increase in exports of clothing. Instead, exports of textiles increased. In addition,
exports of electronics and machinery increased significantly, which was more than predicted.

9Huong and Vanzetti (2006) also provide a CGE impact assessment of the WTO accession on
the Vietnamese economy. Six scenarios are simulated using the GTAP model: Unilateral,bilateral, regional, multilateral liberalisation, as well as a harmonised tariff and global free
trade. The results suggest only limited gains in the agricultural and resource sectors, but large
effects on the textiles and apparel sectors. Boumellassa and Valin (2009) attempts to capture
the impact of actual tariff commitments at a disaggregated level using MAcMap-HS6.4 The
research also takes into account other trade arrangement of Vietnam into the baseline and therole of textile and garment sectors. Their results are also in line with previous studies, showing that gains for Vietnam associated with the WTO accession are positive for merchandisecommitments, but highly dependent on the evolution of textiles and apparel sectors, whose
exports were boosted by the commitments.
Most of the existing CGE studies share the same prediction with regard to the expansion
in the garment and textile sectors, while output gains are either limited or even negative inother industries, including agriculture, machinery and transportation equipment. However,different scenarios of tariff reduction results in different magnitudes of changes. Changes inaggregate output also vary greatly from 15 per cent increase in GDP (Huong and Vanzetti,2006)5 to a reduction of 0.68 per cent in Nguyen and Ezaki (2005).
Factors other than tariff are addressed in some studies. Huong and Vanzetti (2006)
consider simulation that permits unemployment. Roland-Holst et al. (2002) allow for
substantial productivity gains, while Dee et al. (2005) include pro-competitive effects ofservices sector reform and imperfect competition. Impacts of trade facilitation and sectorspecific liberalisation are assessed in a number of studies. Ando (2009) separates the effectsof trade facilitation and technical assistance from tariff liberalisation using a static GTAP
model. The finding shows that the impacts of trade facilitation are more profound than
impacts from tariff reduction in all countries. Technical assistance plays large role indeveloping countries, but not in developed countries such as Singapore or Japan. Otsuki
4

The MAcMap-HS6 database, constructed jointly by CEPII (Centre d'Études Prospectives etd’Informations Internationales, Paris) and ITC (International Trade Centre, Geneva), provides detailed
protection data at the six-digit level of the harmonized system based on Market Access Map.

5This result is obtained when the assumption of full employment and endogenous wages is relaxed toaccount for unemployment and underemployment.

10(2011) examines the impact of trade facilitation in ASEAN on both ASEAN and non-ASEAN
countries using a gravity model. The study finds that within ASEAN, Vietnam, Cambodia andthe Philippines tend to experience a greater percentage increase in their trade flows as a resultof their own efforts to improve trade facilitation indicators. Yet, countries with no change intrade facilitation can still enjoy trade gains from their partners’ improvements.
Vietnam’s participation in regional FTAs are assessed in a number of studies. Toh andVansudevan (2004) evaluates Vietnam’s trade liberalization under four scenarios: AFTA,ASEAN-China FTA, ASEAN-Japan FTA and ASEAN-China-Japan FTA. The study, which
employs GTAP model version 5 with the base year of 1997, indicates large welfare and trade
impacts for Vietnam especially in regional trade agreements beyond AFTA due to the“economies of scale” effect in terms of lower cost of adjustment. To (2010) evaluates impactsof some current and hypothetical regional FTAs on Vietnam’s welfare and sectoral output.
The study, which treats rice as a “sensitive sector”, reveals the importance of liberalizing therice sector. When rice is excluded from regional trade liberalization, welfare gains of rice
exporting and importing countries fall significantly. Vietnam’s agricultural production would
expand if rice is liberalized, but would contract otherwise.
Recent papers by Itakura (2013) and Itakura and Lee (2012) evaluate the impact of
ASEAN economic integration, taking into account reduction in trading time resulting fromASEAN’s regional economic integration. The results are positive for ASEAN countries ingeneral and for Vietnam in particular. Vietnam’s GDP is expected to increase as high as 12.1
per cent under five ASEAN+1 FTAs, 12.5 per cent in the ASEAN+3 FTA scenario and 13.4
per cent in the RCEP (ASEAN+6 FTA) scenario. Improvement in Vietnam’s economic
welfare is also significant, but at about 2 percentage points lower than the gain in GDP, whichis caused by deterioration in its terms of trade.

4. Model description and scenarios
4.1. Model description
The model used in this study, known as the LINKAGE model, is a dynamic global CGE
model developed by van der Mensbrugghe (2005), which has been used in assessments of11

various trade policy scenarios and policy-induced price distortions (e.g. Anderson, Martin andvan der Mensbrugghe, 2013).6 A version of the model used in this study spans the period from2004 to 2020. While the model is recursive dynamic and relies on sequential staticcomputation of equilibria, intertemporal trends are specified for factor growth (labour) andaccumulation (capital), as well as changes in productivity. Land is assumed to be priceresponsive, with an overall upper limit to land availability.
On the supply side, all sectors are assumed to be perfectly competitive and operate underconstant returns to scale. Firms employs capital, skilled labour, unskilled labour andintermediate inputs to produce output. Production is modelled using a nested constantelasticity of substitution (CES) structure. Factor inputs are chosen to minimize cost of any
given output level. Firms enter and exit in response to profits and losses, and the prices will
adjust until all firms earn zero economic profit in the long run.
On the demand side, products are differentiated by region of origin and modelled as
imperfect substitutes. This is reflected by the implementation of the Armington (1969)
assumption, where a nested CES specification is used to incorporate imperfect substitution
between domestically produced products and an aggregate import bundle, as well as among
imported products from different trading partners.7
Within each period, capital is classified as being either old or new. New capital isgenerated by the previous period’s investment. This vintage structure of capital allows fordifferentiating the substitution possibilities across inputs by the age of capital.
The model distinguishes between four trade prices. First, producers receive price PE for
exported goods. Second, the FOB price, WPE, includes domestic export taxes or subsidies.
Third, the CIF price, WPM, includes the international trade and transport margins, represented
by the ad valorem wedge ζ, as well as a non-monetary or frictional trade cost, represented by6

For detailed description of the LINKAGE model, see van der Mensbrugghe (2005). Version 7 of themodel is used in this study.
7

At the top nested level, each agent chooses to allocate aggregate demand between locally produced
products and an aggregate import bundle, while minimizing the overall cost of the aggregate demandbundle. At the second level, aggregate import demand is allocated across different trading partners, again
using a CES specification, where the aggregate costs of imports are minimized.

12the iceberg parameter λ. Thus the relationship between the FOB price and the CIF price isgiven by
WPM r ,r ',i  1   r ,r ',i  WPE r ,r ',i  r ,r ',i(1)where subscripts r, r’, and i denote exporting region/country, importing region/country, andcommodity, respectively. Finally, the domestic price of imports, PM, is equal to the CIF price,
WPM, plus tariffs (or tariff-equivalent). In our model, an increase in λr,r’,i represents a
reduction in trade-related risks, lower administrative barriers to trade (e.g. customs
procedures) and/or a fall in technical barriers. In other words, trade facilitation increase thevalue of λr,r’,i.
Most of the data used in the model come from the GTAP database, version 7, which
provides 2004 data on input-output, value added, final demand, bilateral trade, tax andsubsidy data for 112 regions and 57 sectors. For the purpose of the present study, the databaseis aggregated into 12 regions and 20 sectors as shown in Table 4. These regional and sectoral
groupings are chosen to cover Vietnam’s major trade and investment partners as well as major
trading commodities.
4.2. The Baseline Scenario
To evaluate the effect of Vietnam’s unilateral trade liberalisation, we first establish abaseline, which shows the path of each economy over the period 2004-2020 in the absence oftrade liberalisation, an increase in FDI inflows, a reduction in administrative and technicalbarriers, or a reduction in the trade and transport margins. Population and labour force growth
are exogenous and obtained from the US Census Bureau’s International Data Base andInternational Labour Organisation’s Economically Active Population Estimates andPopulations. Labour force growth is equal to the growth of the working age population (1564). Capital accumulation depends on savings, investment and depreciation. Real GDP
growth rates over the period 2010-2020 in the baseline are consistent with the IMF’s World
Economic Outlook Database. We assume that the trade and transport margins decline by 1 percent per annum in every country/region.

13

Table 4: Regional and sectoral aggregation
A. Regional aggregation
Country/region

Corresponding economies/regions in the GTAP database

VietnamSingapore
ASEAN-4
Other ASEAN
China
Japan
Korea
TaiwanAustralia
United States
European Union
Rest of world

VietnamSingapore
Indonesia, Malaysia, Philippines, Thailand
Brunei, Cambodia, Lao PDR, Myanmar
China and Hong Kong
Japan
Korea
TaiwanAustralia
United States
28 member states of the European Union
All the other economies/regions

B. Sectoral aggregation
SectorCorresponding commodities/sectors in the GTAP database

Rice
Other crops

Paddy rice, processed rice
Wheat, other grains, vegetables and fruits, oil seeds, sugar caneand sugar beet, plant-based fibres, crops nec
Livestock, raw milk, wool, forestry, fishingMinerals, mineral products, coal, gas and coal products
Oil
Meat products, vegetable oils and fats, dairy products, sugar, foodproducts nec, beverages and tobacco products
TextilesWearing apparel, leather products
Petroleum products
Chemical, rubber and plastic products
Iron and steel, nonferrous metal, fabricated metal products
Machinery and equipment
Electronic equipment
Motor vehicles, transport equipment nec
Wood products, paper products, publishing, manufactures nec
Construction, electricity, gas distribution, water
Trade, sea transport, air transport, transport nec
Insurance, financial services nec
Communication, business services, recreation and other services
Public administration and defence, education, health services

Other agriculture
Minerals and products
Crude oil
Processed foodTextilesWearing apparel
Petroleum products
Chemicals, rubber and plastics
Metals and products
Machinery
Electronic equipment
Transportation equipment
Other manufactures
Construction and utilities
Trade and transport
Financial services
Other private services
Government services

Note: nec = not elsewhere classified.

14

Several assumptions underline the calibration of productivity. Agricultural productivity isfixed in the baseline using results from previous studies. Sectoral productivity in nonagricultural sector is composed of three components: a uniform economy-wide factor that iscalibrated to achieve the driven GDP target, a sector-specific factor related to openness, and aconstant shifter. The sector-specific factor intended to capture openness-sensitive changes in
productivity i,t, is given byiE  i ,t  i ,i  i ,t  X i ,t 

(2)where Ei,t is exports of commodity i, Xi,t is output of commodity i, i,t is a shift parameter, andηi is the elasticity of productivity with respect to openness. i,t is calibrated in the baseline
scenario so that the trade-sensitivity portion of sectoral productivity is some share of total
productivity.8
4.3. Policy scenarios
Previous assessments of Vietnam’s trade liberalisation are largely based on the removal oftariffs on traded goods. While liberalisation of trade in goods is the most visible, other reform
processes are also important. This paper makes a contribution to the literature by taking into
account and evaluating the impacts of other aspects of the trade liberalisation process inVietnam. The simulation period is from 2010 to 2020, when Vietnam’s tariffs under thecurrently participated regional trade commitments decline significantly. Major tradefacilitation measures are also expected to take place during the 2010-2020 period. Specifically,
the following six policy scenarios are considered in this study:

8

Openness has been linked to increased productivity via three main channels. These consist of the importsof technology-intensive intermediate inputs, imports of capital goods, and export market penetration. The
third effect can arise because of the higher standards required to access and penetrate foreign markets,
relative to those prevailing at home. There is considerable empirical work aimed at ascertaining the extent
to which each one of these different channels operates. For example, Das et al. (2007) examine firm-level
characteristics of export supply responses. Trefler (2004), Chen et al. (2009), and Joanna (2014) show thatexport and/or import penetration exerts a positive effect on productivity.

15

Scenario 1 (S1): Vietnam’s unilateral removal of trade barriers on goods over the period
2010-2020.
Scenario 2 (S2): Vietnam’s unilateral removal of trade barriers on services over the period
2010-2020.
Scenario 3 (S3): Increased FDI inflows to Vietnam during the period 2010-2020 resulting
from further trade liberalisation.
Scenario 4 (S4): Reduction in administrative and technical barriers to trade (TBTs) by 2.5 percent over the period 2010-2020.
Scenario 5 (S5): Reduction in the trade and transport margins by 10 per cent over the period
2010 to 2020.
Scenario 6 (S6): Combination of scenarios 1-5 simultaneously.

In addition to the above policy changes, in all policy scenarios, we allow for increased
sectoral productivity with respect to openness following equation (2).
In Scenario 1, Vietnam’s tariffs on all products are gradually removed from their initiallevels in 2004 by an equal fraction from the year 2010 to reach 0 per cent in the year 2020.
Table 5 provides the tariff rates on products for the year 2004, as well as tariff equivalents of
NTBs on services, the capital-labour ratio, the ratio of skilled labour to unskilled labour andother key sectoral statistics in Vietnam at the base year.
Scenario 2 is included because the commitment to liberalise trade in services is a part ofVietnam’s WTO accession commitments and is an important component of the FTAs in
which Vietnam is a member. Free trade in services is expected to benefit the economy inmany aspects. It would lead to lower prices and a higher quality of services, which benefit
both consumers and producers. In addition, it would enhance competition in the services
sectors and efficiency of the economy. Better services also make a country more attractive to
foreign investors. Thus, it is important to include reductions in barriers ton services trade in
the assessment of Vietnam’s unilateral trade liberalisation. Under Scenario 2, the impacts ofVietnam’s liberalisation in services trade are examined by linearly reducing tariff equivalentsof non-tariff barriers during the 2010-2020 period.

16

Table 5: Some key statistics of Vietnam, 2004

Rice
Other crops
Other agriculture
Minerals and products
Crude oil
Processed foodTextilesWearing apparel and leather
Petroleum products
Chemicals, rubber and plastics
Metals and products
Machinery and equipment
Electronic equipment
Transportation equipment
Other manufactures
Construction and utilities
Trade and transport
Financial services
Other private services
Government services(1)
Tariff rates (%)(2)
Capital-labour
ratio ($ million /thousand persons)(3)
Ratio of skilled
labour tounskilled labour(4)
Ratio of exports
to total output(5)
Ratio of imports
to total demand(6)
Ratio of imported
intermediate inputs
in total output

19.3
11.2
6.0
8.8
26.5
30.7
24.0
14.5
4.6
4.5
6.3
7.0
22.3
13.5
6.0
7.5
17.7
9.5
10.5

0.02
0.02
0.08
1.51
5.43
0.83
0.86
0.80
2.45
1.41
0.87
1.11
1.11
1.34
1.11
1.28
0.12
0.42
0.23
0.34

0.002
0.001
0.002
0.037
0.060
0.037
0.032
0.030
0.069
0.079
0.073
0.101
0.081
0.071
0.047
0.034
0.022
0.069
0.069
0.154

0.230
0.445
0.090
0.192
1.000
0.308
0.345
0.703
0.002
0.206
0.186
0.556
0.309
0.099
0.434
0.011
0.171
0.156
0.251
0.070

0.005
0.291
0.040
0.165
0.000
0.271
0.615
0.277
0.922
0.576
0.658
0.816
0.416
0.450
0.369
0.018
0.312
0.250
0.341
0.074

0.068
0.191
0.163
0.159
0.066
0.129
0.408
0.300
0.164
0.333
0.350
0.530
0.440
0.334
0.249
0.074
0.247
0.267
0.202
0.139

Notes: The tariff rates for five services sectors in column 1 are ad valorem equivalents of non-tariff barriers. Skilled labour includes managers andadministrators, professionals and para-professionals. Unskilled labour consists of clerks, salespersons, personal service workers, plant and machine operatorsand drivers, trades-persons, labourers and farm workers.
Source: General Statistics Office of Vietnam (GSO), GTAP database, version 7, and the authors’ calculation.

17

Trade liberalisation and the attraction of foreign direct investment (FDI) have been two
important processes and sources of economic growth for Vietnam (Hoang et al., 2013; Petri,
Plummer and Zhai, 2012). Vietnam has attracted large FDI inflows during the last two
decades, and average annual inflows in the past several years are comparable to inflows to
Malaysia and Thailand (UNCTAD, various years). Vietnam’s success in attracting FDI haslargely resulted from country-specific advantages.9 Furthermore, its trade liberalisation andreforms have made it more attractive to foreign investors.
Since trade and FDI are closely related, it would be ideal to endogenise FDI flows in themodel so that the interaction between trade, FDI and production can be captured. However,this would require extremely detailed FDI data by source, destination and sector, in the same
way as trade data. Since such FDI data are unavailable, in Scenario 3 the difference between
the growth rates of FDI inflows to Vietnam before and after its accession to the WTO iscomputed, and is used as the percentage increase in the growth rate of FDI inflows (relative tothe baseline) resulting from further trade liberalisation. Using annual disbursed FDI data for
Vietnam shown in Figure 3, the average annual growth rate of FDI inflows over the period
2006-2013 is calculated to be 12.4% higher than that of FDI inflows over the period 19952006 (the pre-WTO accession period). It is assumed that FDI inflows would continue to grow
12.4% higher from 2010 to 2020, compared with the baseline. Since the disbursement of FDI
in Vietnam was $10.0 billion in 2009, additional FDI inflows of $1.24 billion was injected toVietnam each year from 2010 to 2020. In addition, it is assumed that the increase in FDI
inflows from each region during the period 2010-2020 is in proportion with the shares ofVietnam’s FDI stock by source country/region in 2010.
Trade facilitation as a part of trade reform has been a continuing process in Vietnam. It
includes streamlining of customs procedures, usage of modern technology in trade-related
procedures, improved transparency and the acceptance of common technical standards. Overthe past years, the Vietnamese government has undertaken various measures along this line.
For example, with the World Bank’s supports, the General Department of Vietnam Customs
9

Nguyen and Nguyen (2007) point out some advantages that make Vietnam an attractive host country,
such as its strategic location in a rapidly growing region, stable economic and political environment, large
natural resources, abundant, young and relatively well-educated labour force, large and growing domestic
market and liberal investment policies.

18

Figure 3: Annual disbursed FDI in Vietnam, 1995-2013 (US$ billion)
14

Disbursed FDI (US$ billion)

12
10
8
6
4
2

2013

2012

2011

2010

2009

2008

2007

2006

2005

2004

2003

2002

2001

2000

1999

1998

1997

1996

1995

0

Year
Source: General Statistics Office of Vietnam (2014).

has been implementing a modernization project. In January 2013, Vietnam launchedelectronic customs covering electronics submission and processing of customs declarations. In
terms of standards and technical regulation, as of 2012, Vietnam had 6,800 national standards,
Trade facilitation as a part of trade reform has been a continuing process in Vietnam. It
includes streamlining of customs procedures, usage of modern technology in trade-related
procedures, improved transparency and the acceptance of common technical standards. Overthe past years, the Vietnamese government has undertaken various measures along this line.
For example, with the World Bank’s supports, the General Department of Vietnam Customs
has been implementing a modernization project. In January 2013, Vietnam launchedelectronic customs covering electronics submission and processing of customs declarations. In
terms of standards and technical regulation, as of 2012, Vietnam had 6,800 national standards,of which 40% have been harmonized with international, regional, or foreign standards (WTO,
2013, p. 10). The process of standard harmonization is still ongoing, thus the ratio of19

harmonized standards would be higher, making it easier for traders to deal with technicalbarriers. The above cases and similar trade facilitation measures are expected to lead to
reductions in administrative and technical barriers to trade, thereby reducing real trade cost. In
Scenario 4, reductions in these barriers are represented by an increase in the iceberg parameter
λr,r’,i in equation (1). It is assumed that the value of λr,r’,i is increased by the same percentage
for all trading partners and all products. Following Smith and Venables (1988) and Lee, Owen
and van der Mensbrugghe (2009), administrative and technical barriers to trade are reducedby 2.5 per cent over the period 2010-2020.10
The fifth factor that is taken into consideration in the model is transport costs. Reductions
in transport costs have been a major factor contributing to the high growth of international
trade over the last half-century. For developing countries that export low-value and bulk
goods, transport costs often comprise a large percentage of export prices. Due to poor
infrastructure, particularly those that serve international transport of goods such as ports andharbours, transport costs from Vietnam have been higher than that of other neighbouring
countries.11 Such high transport costs have seriously affected the price competitiveness ofVietnamese goods in both overseas and domestic markets. It is expected that with further
reform in Vietnam, infrastructure would be improved, thereby lowering the shipping cost. A
reduction in transport costs would have a direct impact on the competitiveness of the industry,
facilitating trade and investment. Scenario 5 aims at evaluating these impacts.
Statistics on international transport margins show that they tend to remain quite stable
over time or decline at a low rate. Data on ad valorem freight costs in the US show a declining
trend of more than 30 per cent over the period 1974-2004. By contrast, that of New Zealandfluctuated between 7 and 11 per cent of import values during 1963-1997 (Hummels, 2007).
Stone and Strutt (2009) review several studies that assess the effects of improvements ininfrastructure and associated reductions in transportation costs in the Greater Mekong

10

The value of λr,r’,i is increased by 1/(1 – 0.025) – 1 = 0.0256 or 2.56 per cent during 2010-2020.

11

For example, the fee to transport goods in a 40-foot container from Vietnam to the US is US$3,000 on
average, which is relatively higher than China ($2,700) and Thailand ($2,500). Costs for transportation andcommunications services in Vietnam also account for a relatively large share in enterprises’ total
production costs (20%, compared with 5% in Japan, 8.4% in the US and 9% in Australia, 10% in China and
15% in Brazil. See http://vietnambusiness.asia/transport-fees-hurt-business-performance/

20Subregion (GMS) and find the median value to be 45 per cent. This figure may be justified in
the context of the GMS since transportation has been the highlight of the GMS’s regional
cooperation and has received large investments from regional governments and international
donors. Transport costs between Vietnam and its trading partners are likely to be reduced at amuch lower rate. We have chosen to examine the effects of a 10 per cent reduction in the
trade and transport margins between Vietnam and its partners over the period 2010-2020. The
10 per cent reduction over the ten-year period is comparable to that of the US during theperiod 1974-2004.
We evaluate the effects of each factor mentioned above on economic welfare, trade andsectoral outputs. The purpose is to disentangle from one another the effects of the removal oftariffs on goods, the removal of NTBs on services, an increase in FDI inflows, a reduction in
TBTs and a fall in trade and transport margins. All these policy changes are then combined in
Scenario 6 to assess the overall impact of trade liberalisation.
5. Results
5.1. Aggregate results
In this section, we examine changes in economic welfare, total trade and gross output ofVietnam. Since these scenarios present independent policy options, the results of eachscenario are analysed separately.
Scenario 1: Vietnam’s unilateral removal of trade barriers on goods
As indicated in Table 6, the removal of tariffs on traded goods has strong effects on tradeand production in Vietnam. Exports and imports are predicted to be 40.2 and 32.0 per centhigher compared with the baseline for the year 2020. Under Scenario 1, real output rises by
8.8 per cent, but economic welfare increases by only 1.0 per cent. 12 These results are
consistent with the standard trade theory, which suggests that a unilateral tariff liberalisation
would result in relatively large allocative efficiency gains and deterioration in the liberalising
12

Huff and Hertel (2000) show that in the GTAP model the aggregate welfare effect is equal to the sum of
the contributions of allocative efficiency effect, terms-of-trade effect and investment-savings effect. Since
the contribution of the investment-savings effect is rather small, the aggregate welfare effect isapproximately equal to the sum of the first two terms.

21

country’s terms of trade. When Vietnam removes tariffs, its import demand increases
substantially, while the foreign export supply does not change, resulting in a worsening of theterms of trade.13
At the same time, the removal of tariffs would also increase Vietnam’s exports. Since
Vietnamese goods and other countries’ goods in the same product category are treated as
imperfect substitutes, increases in Vietnam’s exports would result in lower world prices of its
exports, further worsening Vietnam’s terms of trade. When the Armington assumption is usedin the model, trade liberalisation leads to large terms-of-trade effects because monopoly
power is implicit in the assumption of national product differentiation (Brown, 1987).

Table 6: Changes in Vietnam’s major economic indicators(Percentage deviations from the baseline in 2020)
S1

S2

S3

S4

S5

S6

Economic welfare

1.0

0.1

1.3

3.1

2.8

8.4

Exports

40.2

1.8

0.3

3.9

4.0

54.7

Imports

32.0

1.5

2.2

5.8

5.5

52.2

Total output

8.8

0.3

1.6

1.2

1.2

14.0

Notes: Hicksian equivalent variation is used as the measure of economic welfare. Total
output includes output of both intermediate and final goods and services.
Source: Simulation results.

Scenario 2: Vietnam’s unilateral removal of trade barriers on services
Liberalisation of the services sectors in Scenario 2 has a limited impact on trade andoutput. Since the services sector is still underdeveloped in Vietnam, accounting for only 7.9
per cent of exports, 10.8 per cent of imports and 28 per cent of total output in the base year
2004, the removal of NTBs on services is predicted to increase exports and imports by only
1.8 and 1.5 per cent respectively. The allocative efficiency effects are modest, hence output
13

Vietnam’s terms of trade is approximately equal to the ratio of a trade-weighted average of the world
prices of Vietnam’s exports to a trade-weighted average of the world prices of Vietnam’s imports.

22

only increases by 0.3 per cent. At the same time, the unilateral removal of NTBs on services
worsens Vietnam’s terms of trade in the same way as the removal of tariffs on goods. The
terms-of-trade loss offsets gains in output, resulting in only 0.1 per cent increase in welfare.
However, these results need to be interpreted with caution. Greater competition in theservices sectors is expected to result in an improvement of quality in many service activities,
such as communication, distribution and transportation, leading to efficiency gains and cost
reductions for firms that use services in the production processes. However, since a quality
improvement is not modelled in our study, the output and welfare estimates are likely to beunderestimated.
Scenario 3: Increase in FDI inflows to Vietnam
In Scenario 3, additional FDI inflows increase investment and demand for intermediate
goods. Thus, production and imports rise. Since tariffs are unchanged, the terms of trade are
not significantly affected. Changes in relative prices are also rather small. The model predicts
that economic welfare and total output would increase by 1.3 and 1.6 per cent, respectively.
However, these projections are likely to be underestimated because positive spillovers
between FDI inflows and productivity are not incorporated in the model. Javorcik (2004)shows that spillovers from foreign affiliates to their suppliers in host countries are positiveand significant. While there is a large body of literature examining spillover effects of theactivities of multinational firms, such effects vary substantially among host countries andindustries (Blomström and Kokko, 1998). Since the incorporation of spillover effects in a
general equilibrium framework is challenging, it is left for future research.
Scenario 4: Reduction in administrative and technical barriers to trade
In Scenario 4, a reduction in administrative and technical barriers to trade is modelled byan increase in the parameter λr,r’,i in equation (1), which represents an improvement in tradefacilitation and thus lowers real trade cost between Vietnam and its trading partners. This has
direct impacts on both export and import prices, causing changes in both foreign and
Vietnam’s export supply and import demand. The direction of change in the terms of trade
would depend on the relative magnitudes of changes in supply and demand of both exports
and imports. It is possible for Vietnam’s terms of trade to increase. The real output gain of 1.1

23

per cent and welfare gain of 3.0 per cent indicates that Vietnam experiences a terms of tradegain under this scenario.
Scenario 5: Reduction in trade and transport margins
A reduction in trade and transport margins has a similar effect to a reduction in TBTs andcan affect the terms of trade in either direction. The results under this scenario show a welfare
gain of 2.8 per cent, which is greater than the real output gain of 1.2 per cent. Trade expands
because of lower trade and transport costs.
In Scenarios 4 and 5, an improvement in the terms of trade resulting from lower TBTs andtrade and transport margins is a reasonable outcome. Because Vietnam’s share of imports andexports constitutes a very small part of total world trade, the increase in its import demand
would be small compared with the increase in foreign export supply. Thus the world price ofVietnam’s imports tends to decline. At the same time, lower real trade costs between Vietnam
and its trading partners would lead to an increase in foreign demand for Vietnamese goods,
which is likely to outweigh the increase in Vietnam’s export supply, leading to a higher world
price of Vietnam’s exports.
Scenario 6: Combination of Scenarios 1-5
When policy scenarios 1-5 are combined, the percentage increases in economic welfare,aggregate exports and imports, and total output are all quite large. The combined effects of thefive scenarios are slightly higher than the sum of five individual effects, which is caused by
non-linear model equations.
The aggregate results suggest that the removal of merchandise trade barriers has a strong
impact on Vietnam’s trade volume and total output, but a relatively small effect on its
economic welfare largely because of deterioration in its terms of trade. Reductions in TBTs
and the transport margins have large positive effects on economic welfare. Increases in FDI
inflows lead to similar percentage gains in output and welfare since the change in relative
prices is rather small.

24

5.2. Sectoral results
The empirical results reveal that trade liberalisation will have a strong impact on many
sectors in Vietnam. Some sectors which can explore Vietnam’s comparative advantage will
expand their productions and exports greatly, while some other sectors are forced to contract
due to competition from imported goods or from the expanding sectors. Table 7 presents theeffects on sectoral output under Scenarios 1-6, which are discussed below.14
Scenario 1: Vietnam’s unilateral removal of trade barriers on goods
The simulation results reveal that the removal of tariffs has a strong impact on thecomposition of sectoral output. The output of manufacturing sectors expands at the expense ofother sectoral groups. The expansion of output is particularly large in textiles and wearing
apparel. These results are consistent with those suggested by the Heckscher-Ohlin (H-O)
model. Vietnam is both labour-abundant relative to capital, and unskilled-labour-abundant
relative to skilled-labour. Thus, one would expect that output of labour-intensive andunskilled-labour-intensive goods to increase after trade reform, provided that the level oftechnology across country and sector is identical. Since wearing apparel has the lowest ratiosof capital to labour and skilled to unskilled labour among the manufacturing sectors (columns
2 and 3 of Table 5), it is reasonable that output increases the most in these sectors. Among theservices sectors, output increases most in the trade and transport sector for the same reason.
The H-O model assumes that countries have identical technology in order to isolate theeffects of differences in relative factor endowments between countries and sectors. Given thattechnology among countries and sectors differ substantially, changes in sectoral output
resulting from unilateral trade liberalisation cannot be explained by the H-O model alone. In
the case of the agricultural sectors, except for other crops, average labour productivity,
measured by the ratio of output to the number of workers, is substantially smaller in Vietnam
than in most of its trading partners. Given that Vietnam requires a greater number of workers
14

Since the percentage changes in sectoral value-added are quite similar to those in sectoral output, weonly report the effects on sectoral output in Table 7. One of the limitations of the GTAP database is that it
only provides the data on the values of wage payments to skilled workers and unskilled workers byindustry; it does not provide the actual number of skilled and unskilled workers employed in each industry.
Due to this data limitation, we are unable to provide the impact on employment (the actual number ofskilled and unskilled workers employed), either at the sectoral level or for the entire economy.

25

Table 7: Effects on sectoral outputs(Percent deviation from the baseline in 2020)
Sector

S1

S2

S3

S4

S5

S6

Agriculture and food
Rice
Other crops
Other agriculture
Processed food

-11.1
-5.4
3.6
-9.1
-17.5

0.1
0.2
0.5
-0.4
0.2

-0.2
-0.6
-2.0
0.7
0.2

-0.4
0.3
-1.3
0.1
-0.5

-0.3
0.5
-1.4
0.2
-0.4

-13.0
-6.1
-0.8
-9.6
-19.7

Mineral and fuelMinerals and products
Crude oil

-9.5
-5.9
-18.2

1.3
1.0
1.9

1.7
1.5
2.0

-1.0
-0.5
-2.2

-2.1
-1.8
-3.0

-12.1
-8.4
-21.2

Manufactures
TextilesWearing apparel
Petroleum products
Chemicals, rubber and plastics
Metals and products
Machinery
Electronic equipment
Transportation equipment
Other manufactures

24.4
31.5
94.1
-49.6
1.1
-2.8
11.8
-1.1
-11.6
-5.7

1.1
1.2
1.1
1.4
1.0
1.3
1.6
0.8
0.7
1.1

1.8
1.2
1.3
2.4
1.3
2.6
1.6
2.6
2.5
1.8

2.5
3.3
7.1
-10.8
-0.2
-0.7
4.3
2.7
-0.2
0.3

2.5
4.1
8.0
-11.4
-0.6
-1.5
2.4
3.0
-0.1
0.0

35.6
43.5
125.9
-60.3
1.0
-2.0
22.3
6.9
-9.0
-3.7

Services
Construction and utilities
Trade and transport
Financial services
Other private services
Government services

-0.7
-1.4
13.7
-5.6
-7.1
-2.4

-1.0
-0.4
-1.9
-3.9
-2.1
0.4

2.0
4.9
1.2
1.5
0.8
-0.8

0.7
1.5
1.8
-0.7
-0.4
0.1

0.8
1.2
2.3
-0.3
0.0
0.1

1.1
5.4
17.8
-10.3
-10.0
-3.5

All sectors

8.8

0.3

1.6

1.2

1.2

14.0

Source: Simulation results.

26

to produce the same units of agricultural output than its trading partners, contraction of output
of rice and other agriculture can be explained by the Ricardian model. In addition, low sharesof imported intermediate inputs in total output in these sectors imply that the extent of
reduction in the intermediate input cost in the rice and other agricultural sectors is rather small.
Fuel and minerals also contract as trade is liberalised. This sector consists mainly of coaland crude oil, which are extracted, then exported or used in other sectors as raw materials.
Like agriculture, these resource-based sectors have low ratios of imported intermediate inputs
in their total outputs (0.159 and 0.066, as shown in column 6 of Table 5). Thus the benefit
from cheaper intermediate inputs is small and the sectors become less competitive comparedwith manufacturing sectors. In a general equilibrium framework, factor constraint plays animportant role in resource allocation. As the wearing apparel and leather, textile, and trade
and transport sectors all expand output, they draw resources from other sectors by bidding up
the factor prices (e.g. the wage rate and the rental rate on capital). As a result, other sectors’
marginal cost will increase and their output levels are likely to decrease. One notable
exception is the machinery and equipment industry, where a large share of imported
intermediate inputs in total output (0.53) result in a considerable fall in the intermediate input
cost after trade liberalisation, more than offsetting an increase in the factor prices and thus
resulting in an output expansion.
Scenario 2: Vietnam’s unilateral removal of trade barriers on services
When trade barriers on services are removed, imports of services expand substantially(16.7%), while exports grow at only 3 per cent, leading to a reduction in output (-1.0%).
Output of other sectors expands slightly as the results of lower costs of intermediate services.
Scenario 3: Increase in FDI inflows to Vietnam
An increase in FDI inflows lead to higher output levels in all sectors other than rice andother crops. This is because the additional FDI will be used for additional capital goods,
which mainly consist of plants, buildings and machinery. Electronic equipment (such as
computers) and transportation equipment purchased by firms for their intermediate inputs arealso classified as capital goods. Demand for construction will increase substantially when newplants and buildings are constructed following additional FDI inflows. Demand for other27

capital goods, such as machinery, electronic equipment and transportation equipment are also
expected to rise. Increases in the output of non-capital goods sectors mainly result fromincreases in intermediate demand. For example, output expansion in construction, machinery,electronic equipment and transportation equipment requires additional intermediate inputs ofsteel, other metal, fuel, and other goods and services. Compared with the baseline scenario,
the increase in FDI inflows over the period 2010-2020 leads to an expansion of nearly 5 percent in the construction and utilities sector, 2.6 per cent in the metal and electronics
equipment sector and 2.5 per cent in the transportation equipment sector. By contrast, somegoods such as rice and other crops are hardly used as intermediate inputs for capital goods
sectors. When the wage rate increases as a result of higher demand for labour, the production
cost will increase, leading to a reduction in the output of rice and other crops.
Scenarios 4 and 5: Reduction in TBTs and trade and transport margins
The effects on sectoral output resulting from reductions in TBTs and trade and transport
margins are quite modest. This is mainly because the reductions in TBTs and transportation
costs are not sector-specific. When TBTs and trade and transport margins decrease,percentage reductions in trade costs are relatively uniform across sectors. However, since theelasticities of substitution between domestic and imported products are different among
sectors, the percentage increases in imports vary from sector to sector. More importantly, theratios of imports to total demand vary greatly across sectors (column 5 of Table 5). In
particular, Vietnam is extremely dependent on imports of refined petroleum products. Whenreal trade cost decreases, the price of imported petroleum products falls and the domestic
refined petroleum sector is forced to contract.15 By contrast, some export-oriented sectors
which are heavily dependent on imported intermediate inputs, such as wearing apparel,
textiles, machinery and electronic equipment, would expand owing to the reduction in trade
and transport related costs.

15

However, the simulated reduction in outputs of petroleum products is small in absolute term due to thesmall size of the sector.

28

Scenario 6: Combination of scenarios 1-5
Sectoral adjustment is most significant in scenario 6 when all policy changes are
combined together. Changes in sectoral outputs are close to the sum of the changes underscenarios 1 to 5. The manufacturing sector as a whole is predicted to expand by 35.6 per centcompared with the baseline. The output of service sectors increase by 1.1 per cent, mainly due
to the positive impact of the additional foreign investment in scenario 2. On the other hand,
agriculture and food, minerals and fuel all suffer significant contractions, largely as a result of
the removal of tariffs on traded goods. In this scenario, the strong growth of wearing apparelleads to a less diversified export structure in which wearing apparels are projected to accountfor 42.9 per cent of total exports in 2020, compared with 25.2 per cent in the baseline for thesame year.
The different impacts on sectoral outputs lead to changes in the output structure. It is clearthat trade liberalisation would be an important catalyst for industrialisation. When all thefactors are combined (scenario 6), the share of manufacturing sectors in total output increases
by nearly 9 per cent compared with the baseline. At the same time, the shares of agriculture,minerals and fuel decline. A very large impact on sectoral adjustments would come from theremoval of tariffs as this reduces distortion in the economy, so that resources are moved tounskilled labour-intensive sectors as predicted by the Heckscher-Ohlin model or to sectors
with relatively high labour productivity as predicted by the Ricardian model. A structural shift
towards a higher share for manufacturing sectors is predicted. However, a reduction inprotection for agriculture, where more than half of the workforce is working, could raise someconcerns. In this model, the assumptions of the homogeneity of unskilled labour, perfectlabour mobility across sectors within a region and full employment guarantee that returns tofactors employed in agricultural sectors improve and farmers benefit from trade liberalisation.
In the reality, however, farmers and unskilled labour in non-agricultural sectors are nothomogeneous, unemployment and underemployment are common, and costs involved inchanging jobs need to be considered. Thus, a large number of farmers may not benefit fromunilateral trade liberalisation.
It is vital that trade liberalisation is supported by domestic policy reforms and assistanceto ease the transition and facilitate the adjustments. If the domestic goods and labour markets

29

do not function properly, then changes in relative prices from tariff reductions will not lead to
optimal resource allocation. Poor infrastructure and communication can hamper movementsof resources in the domestic market, hindering the benefits from trade reform. Thus, economic
policies that enhance the functioning of markets and additional investment to improve
infrastructure should be implemented to support the transition.
In addition, for agricultural workers to benefit from reform, they need to beaccommodated in the new environment. Provisions of adequate education, job training andhealthcare services would be crucial. When these assistances are not provided, there would be
farmers who become unemployed resulting from agricultural contraction but would not beable to find new jobs in manufacturing sectors. This is the area where social supports areneeded, so that the negative impacts of trade reforms would be reduced.
6. Conclusion
This paper has examined the effects of Vietnam’s unilateral trade liberalisation in a
dynamic general equilibrium framework, taking into account additional elements of theliberalisation process. In particular, it provides the economy-wide effects of an increase in
FDI inflows, a reduction in TBTs and lower trade and transport margins. Several points canbe made from the simulation results.
First, the removal of tariffs on traded goods has a strong positive impact on total output,
exports and imports. Welfare gains, however, are much lower than the output expansion. The
limited gain in welfare is caused by deterioration in the terms of trade, which are partly due toVietnam’s high initial tariffs and partly due to the model structure which assumes imperfect
substitution between domestic and imported products. The results of tariff liberalisation in thisstudy are in line with those of the unilateral trade liberalisation scenario in prior studies (e.g.
Dimaranan et al., 2005; Boumellassa and Valin, 2009).
Second, greater inflows of foreign direct investment would result in higher output andeconomic welfare. In addition, foreign investment would facilitate further industrialisation as
it creates higher demand for capital goods. It should be noted that if it were possible toincorporate spillover effects and/or to endogenise FDI flows by source, destination and sector,

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the impacts on trade, particularly trade in intermediate goods, would be enlarged. Thus, thebenefits of FDI inflows are expected to be even greater.
Third, since administrative and technical barriers to trade and transportation costs hinderflows of exports and imports, reductions in these barriers and costs lead to positive welfare
gains. Our results suggest that improvements of physical infrastructure, streamlining ofcustoms procedures and reductions in other administrative and technical barriers to trade
would be an important channel for generating higher economic welfare.
Fourth, at the sectoral level, manufacturing sectors expand at the expense of the
agricultural and minerals and fuel sectors. The output expansion is most significant in the
textiles and wearing apparel sectors, which is unskilled-labour-intensive and low value-added.
Exports are predicted to become heavily dependent on these sectors. Although an analysis ofdynamic structural development is not within the scope of this study, the results point to theneed to enhance the efficiency of the economy by moving its industrial structure up the valueadded ladder from garment and textiles to electronics, machinery and other industrial sectors.
This process requires, apart from an open trade policy, on-going foreign investment as avehicle for attracting capital and technology. In addition, a policy designed to encouragechildren and young people to increase the number of years of schooling, which would in turnincrease the endowment of skilled labour, would be important. This would help build up theability to catch-up and make the best of its trade liberalisation process.
Finally, the contraction of agriculture is in line with our prior expectations and Vietnam’s
development policies. However, since more than half of the working population in Vietnam
are employed in agriculture, the distributional impact would be significant. If workers in the
agricultural sectors can find new jobs with higher salaries in manufacturing sectors, thecontraction can be positive as it will lead to industrialisation and higher income for workers.
However, those who cannot be retrained and adapt to the new environment would see theirincomes worsen. Therefore, on one hand, job training for agricultural workers should befurther developed to facilitate the adjustment process. On the other hand, a social safety net
should be created to help those who would not be able to find a job outside agriculture.

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