Silviase/jgov_v1.4_full_ann huggingface dataset:
expenditure on the other hand somewhat facilitated the autonomy of state enterprises' investment financing, it is of essential need to increase public investment for economic development.

## 2 -1-3 Fiscal Deficit

Fiscal deficit has been financed mainly by money printing; as you see in Chart 2-V-3, money supply has moved in parallel with fiscal deficit. Thus fiscal deficit has been a major factor of inflation.

Government expenditure has moved almost flat with some fluctuation during 1988-1992, while government revenue gradually increased from 13.1 percent in 1988 to 21.5 percent in 1992. Accordingly, the fiscal deficit decreased from 8.3 percent of GDP in 1989 to 1.8 percent in 1992 (see Appendix 11, 12, 13).

## 2 -1-4 Relationship between Central and Local Government Finance

The tax collection system in Vietnam is relatively decentralized; a considerable part of tax revenue is collected at the local level. In contrast, the share of the central government is large on the expenditure side. In 1989, central government revenue accounted for only 27 percent of the total revenue while the expenditure share of the central government was 67 percent $ ^{3} $ .

Thus the central government faces a huge imbalance between revenue and expenditure. In 1989, the central revenue covered only 26 percent of the central expenditure. Even after adding the net transfer from the local level, which was equivalent to 20 percent of central government expenditure, the revenue of the central government covered only 46 percent of its expenditure (see Table 2-V-3) $ ^{4} $ . The fiscal deficit at the central level is thus serious, and the imbalance between the central and local government finance gives rise to inefficiency in the budget allocation.

## 2 -2 Financial Reforms

In the planned system, the financial sector played a minor role: it simply accommodated the economic plans from the financial side. In a market economy, an important role is required for the financial sector in achieving efficient allocation of resources. It is of essential need to establish the proper functions of the central bank and commercial banks.

The deficiency of capital is one of the most serious constraints for Vietnamese economic development. The gross domestic investment of Vietnam is quite low, even compared with other developing countries, and reflects low private savings as well as constraints from the budget deficit on public investment (see Tables 2-V-4 and 5). On the other hand, the need for investment is quite large, taking into account the poor infrastructure and the unequipped private sector.

Therefore it is of great necessity to establish an efficient financial sector to mobilize domestic capital and to improve the efficiency of the use of scarce capital.

## 2 -2-1 Institutional Framework

In 1988, in addition to the previously existing two specialized banks (the Bank for
## 2 -4-1 State Enterprise Reform without Transfer of Ownership

The Vietnamese government has implemented several reforms to enhance the autonomy of state enterprises such as transfer of management to the enterprises, abolition of plan targets, elimination of subsidies, reduction of transfer of profits to the state budget, the introduction of unified tax system, etc. However, even though autonomy increased, the monopolistic situation of state enterprises still remains, and there has been little competition among enterprises. Moreover, the autonomy of state enterprises has been spoiled by frequent ad hoc tax concession and easy access to low-interest subsidiary loans provided by state banks. $ ^{8} $ Consequently, the efficiency of state enterprises showed little improvement. Furthermore, managerial abuse of newly acquired rights to control state assets and frequent corrupt practices can be observed. $ ^{9} $

To improve the efficiency of state enterprises and to establish a competitive microeconomy, the state enterprise monopoly should be attacked. Thus, not only the encouragement of autonomy but the division of state enterprises is strongly suggested. Also, it is necessary to establish a clear definition of the managerial rights and ownership to prevent the misuse of them by managers.

## 2 -4-2 Privatization

Privatization in Vietnam is still in the experimental stage. The basic stance of the Vietnamese government about privatization is to keep the important sectors of the Vietnamese economy under state ownership while privatizing unimportant and unprofitable sectors.

In July 1992, the Vietnamese government announced a plan of the experiment of privatization. Seven enterprises were listed, based on the following criteria; (i) balance sheets must be in the black at that time, (ii) medium sized, and (iii) not important to the Vietnamese economy. However, six of them were struck off the list because of their resistance. At present, four companies, including the remaining one, are planned to be converted into stock companies. For the time being the stocks of the two companies among the four will be on sale. $ ^{10} $ The establishment of the stock market remains as a future issue.

## 2 -4-3 Promotion of Newly Emerging Private Sector

Small private agents are rapidly increasing particularly in the trade and service sectors. In the industrial sector, the gap between state and private enterprises in their size, capital equipment and technology has worked as an entry barrier. Although in principle the difference in treatment concerning tax or credit between state and private was removed, in practice the favorable treatment for state enterprises still remains and thus discourages private sector development.

Introduction of foreign capital provides one way to strengthen the private sector, since it provides not only capital but also technology to the private sector.

## 2 -4-4 Performance of Enterprises Sector

Chart 2-V-5 shows the change in industrial production share by private and state sectors. Although the private sector shows a much better response to the market opportunities than
infrastructure, might be future constraints for the development of Vietnamese agriculture.

The confusion concerning land-use rights is another issue. At present, long-term land-use rights (twenty years for annual crops and fifty years for perennial crops) are approved while the ownership of the lands is considered to belong to the entire people. Land-use rights can be transferred or inherited.

## 2 -6 External Sector

## 2 -6-1 Exchange Rate Adjustment

Until 1988, a system of multiple exchange rates -- in which exchange rates differ by transaction -- was in effect, and Vietnamese dong had been largely and deliberately overrated to enable subsidiary imports. The highly overvalued official rate and the inefficiency of the official market led to the development of a large informal market (parallel market).

After several adjustments of official rate towards the parallel rate, Vietnam unified its multiple official rates and moved to the floating rate system in 1989. With the intention of the authorities to establish foreign currency control, in principle the dong remains inconvertible and enterprises are required to deposit earned foreign currency in officially approved banks, retaining the right to use them in part. However the government's control over foreign currency remained weak and the parallel market continued to exist. Thus, Vietnam now has a dual exchange market consisting of the official and the parallel market. Since 1989, the dong has been stable at the level of around 10,000 dong/dollar and the gap between the official rate and the parallel rate has been kept within 10-20 persent, with the official rate still providing virtual subsidies to those who have access.

To supplement, the Vietnamese authorities should give sufficient consideration to the effect of the exploitation of oil resources on the exchange rate. Exportation of oil may bring about appreciation of the dong, which may discourage the development of export oriented manufacturing industries.

## 2 -6-2 Foreign Trade

Until 1988, foreign trade was monopolistically carried out by the government within the framework of the economic plans. To encourage exports under the deliberately overvalued exchange rate, the government purchased export goods from the enterprises at higher prices than the international prices, and the differences were covered by export subsidies. Imports were regulated with licensing and quotas.

Vietnam became the tenth member of the CMEA in 1978, and trade with the CMEA countries accounted for about one third of total exports and two thirds of imports. This trade with the CMEA countries was done based on the mutual trade plans between the governments; the imports from these countries supplied input goods and intermediate goods at low prices.

Since the late 1980s, Vietnam has implemented several trade sector reforms and the Vietnamese economy has increased its openness.

## (1) Reforms of Foreign Trade System

Until 1988, foreign trade was made only through a few state trading companies, each of which had a monopoly on certain commodities, under the control of line ministries or local
expectation by the Vietnamese authorities expressed in the long-term plan toward the year 2000. $ ^{19} $

It should be recognized that the inflow of a great deal of ODA may cause several anxieties. A surging and huge inflow of capital may cause a relapse into inflation. It also gives rise to corruption. There is also the risk of becoming a heavy debtor and relying too much on aid.

## 2 -6-5 External Debt

Vietnam is in considerable debt, with outstanding external debt amounting to 8.1 billion dollars in 1990, which almost equals the Vietnamese GDP. Though the trade balance is improving, the overall balance has not climbed out of the red, and has been financed through the decrease in foreign currency reserves and the arrears on the debts. In 1990 arrears amounted to 1.7 billion dollars, which was one fifth of the total debt (see Table 2-V-13). The debt service ratio of Vietnam was 22.4 percent in 1992 (see Appendix 10).

### 3 Results Achieved. Remaining Problems

The Vietnamese economy is not only a transitional economy but also a developing economy. Thus reform in Vietnam has two aspects: developmental and transitional. In this section we will evaluate the reforms mainly from the development aspect; the evaluation of the transitional aspect will be covered in section 4.

## 3 -1 Macroeconomy Stabilized

The most remarkable success of the reform has been the achievement of macroeconomic stabilization. Radical stabilization measures were massively implemented around 1989: as a result, the macroeconomy stabilized rapidly.

As a result of the tight monetary policy adopted in 1989, three-digit inflation drastically calmed down despite the price liberalization that took place in the same year. The inflation rate in 1993 seems to have quieted down to one digit (see Appendix 3).

The exchange rate has stabilized at the level around 10,000 dong/dollar since the unification of exchange rates in 1989.

The fiscal deficit is on a decreasing trend, reflecting the government’s efforts to reduce expenditure and to establish a stable tax system.

The trade balance has improved with the rapid growth of exports.

The real GDP has grown at 7.1 percent on average during 1981-90 (see Appendix 1).

Thus the macroeconomic indicators of Vietnam show good performance. However, looking at from the microeconomic level, several problems remain.

## 3 -2 Microeconomic Reform Stagnated

In contrast to the aggressive implementation of macroeconomic stabilization measures, microeconomic structural reform, in particular state enterprise reform, is lagging behind. Although the gradualness of the microeconomic reforms helped reduce the shock of the macroeconomic restrictive policies on the supply side and avoid a sharp decline in production on the one hand, it might on the other hand spoil the fruit of the macroeconomic reform in
of forced capital formation.

Efforts also should be made to attract FDI and ODA. The importance of foreign capital is strengthened by the fact that the Vietnamese economy depends on imports for capital goods on imports and thus foreign currency capital is necessary for investment.

## 3 -4 Social Issues

Social problems emerge as economies develop. These include unemployment, widening income gap, gaps in development among regions (see Table 2-V-14), environmental issues, corruption, etc. All are potential obstacles for economic development. The government has to take measures to prevent these problems and to prepare a social safety net. A gradual (but steady) implementation of microeconomic structural reform may help reduce the incidence of some of these social problems, but it might also produce different kinds of costs. $ ^{20} $

## 3 -5 Open Policy

Recent studies on economic development, including those by the World Bank, $ ^{21} $ stress the importance of the openness of the economy to the world. Though the concrete process remains unclear, there is a certain consensus that openness contributes to economic development, since it will facilitate technology transfers and since competition in the world market will bring about an improvement in efficiency. Empirical research in this field also found a correlation between economic growth and openness. $ ^{22} $

In Vietnam, the importance of openness goes beyond these concerns. Vietnam is located among the most dynamically developing economies and can expect rich spillover effect from them. In addition, the introduction of foreign capital (FDI) would solve the two major bottlenecks of the Vietnamese economy; the shortage of capital and the state-enterprise monopoly.

The gap between state and private enterprises combined with the capital shortage in the private sector has been preventing the private sector from developing and has allowed state enterprises to enjoy their monopolistic situation. This has prevented the full blossoming of the market established in the reforms. The introduction of foreign capital in this situation means not only easing the capital shortage but also serving the supply-side structural reform since entry barriers to the private sector (the gap between state and private) would be lower if foreign capital and technology were available. The government will be able to concentrate its investment on infrastructure development, letting foreign capital invest in the private sector. Thus, the introduction of foreign capital provides a way for Vietnamese economy to kill several birds with one stone.

## 4 Evaluation of the Market Economy in Vietnam

## 4 -1 Two Merits of Market Economy

Why is the transition to a market economy required in the planned economies? What are the merits of the market economy compared with the planned economy? The answer is that there are two kinds of mechanisms in a market economy.

The first is what is called the “market mechanism” in the neo-classical economic theory. Under several prerequisites, the market economy provides efficient resource allocation.
through innovation competition but can expect other kinds of merits such as improvement in productivity, development of new products, etc.

For catching-up economies, the implication of innovation competition is quite large since these economies have great potentiality for innovation, which will be one main source of economic growth. For such economies, innovation competition will provide more abundant fruits than perfect competition.

In Vietnam, however, it is difficult to find innovation competition. A huge monopolistic state enterprise keeps control over the market in most fields; consequently there is little incentive for innovation. It is strongly suggested that Vietnam foster competition among enterprises: it should at least strive for oligopolistic competition, if not perfect competition, to promote innovation.

With the poor private capital in Vietnam, one effective way to promote such competition may be the introduction of foreign capital. It will not only bring competition into the market but also facilitate innovation through technology transfers, and thus will accelerate economic growth.

## 4 -2 Role of the Government in a Market Economy

In a market economy, economic decisions are basically made on a market basis: the economic order rises through market transactions. But this does not necessarily mean that there is no role for government to play. In a market economy a government is required to fill the following complementary roles to the market;

(i) to establish and maintain conditions which guarantee the two mechanisms of the market;

(ii) to substitute for the market when the market does not function well because of underdevelopment or market failures.

In most developing countries, the market is still undeveloped. Thus, the government has to consider the balance between the above two roles. On the one hand, with the market undeveloped, the government has to substitute for it and play some role in resource allocation. However, if it goes too far, it will prevent the proper development of the market. The government therefore has to be engaged in the somewhat contradictory business of encouraging the development of the market while substituting for it.

In the following sections, we will highlight the role of government in Vietnam according to the headings corresponding to the previous section.

## 4 -2-1 Static Market Mechanism

## (1) Undeveloped Market

Looking at the environment around the market in Vietnam, as discussed previously, it is far from certain that Vietnam has established good conditions for the market to thrive. The Vietnamese government has to try to improve these conditions and encourage the development of the market (i.e., establishment of a competitive microeconomy through structural adjustment, macroeconomic stabilization, education so that people can adapt themselves to the market smoothly, facilitating factor mobility by removing restrictions or informal pressures on it, etc.), while playing a substitutional role for such undeveloped market.

## (2) Public Goods
other East Asian countries could be justified in this context although it still includes unnecessary government interventions. $ ^{25} $ The experience of these economies are providing a good model of the government roles in the catch-up process for Vietnam.

## 5 Conclusion

What characterizes reform in Vietnam is the fact that the Vietnamese economy is not only a transitional economy but also a developing economy. Thus the reform has two aspects of transition from a planned economy to a market economy and economic development. We have discussed the development aspect of the reform in section 3 and the transitional aspect in section 4. However, these two aspects are intertwined. To conclude this chapter, we will try to synthesize these two aspects.

As discussed in section 4, the transition to a market economy has two merits: the “market mechanism” and the “incentive mechanism”. To give full scope to the market mechanism, “structural adjustment” is effective; to give full scope to the incentive mechanism, “industrial policy” is effective. For developing economies, the incentive mechanism is more important, since it will accelerate economic growth through innovation.

Since the Vietnamese economy has aspects of a developing economy, greater importance should be given to the incentive mechanism. Thus, the Vietnamese government should adopt industrial policy.

Industrial policy consists of the following three pillars:

(i) to provide information about the future perspectives of the economy (through designation of target industries and indicative economic plans);

(ii) to facilitate innovation;

(iii) to control innovation competition.

In addition, if the market is undeveloped, the government itself may have to take some roles in resource allocation to enhance the flow of production factors into the target industries (e.g. subsidies, credits, etc).

In adopting industrial policy in Vietnam, the Vietnamese government should designate labor-intensive industries as target industries, considering its dynamic comparative advantage. In particular, export-oriented labor-intensive industry should be highly promoted since a great spillover effect to the rest of the economy can be expected, considering the dynamism of the neighboring Asian economies.

However, in promoting export-oriented industries, two essential problems exist:

(i) lack of competition in the economy (monopoly of state enterprises);

(ii) shortage of capital.

The introduction of foreign capital would provide a solution which kills these two birds with one stone.

The Vietnamese government therefore should increase the openness of the economy to promote the inflow of foreign capital into the export-oriented, labor-intensive industries.

(Mihira)
## FOOTNOTES

1/ IDCJ [1993, p. 21].

2/ IDCJ [1993, p. 22].

3/ World Bank [1992, pp. 62-63].

4/ IDCJ [1993, p. 23].

5/ There are several figures about inflation rate in Vietnam. This figure is from ADB [1991].

6/ IMF [1990, p.4].

7/ IMF [1990, pp. 4-5].

8/ IDCJ [1993, p. 24]. The Bank for Investment and Development provides low-interest loans to state enterprises. The determination of the receivers of these loans is considered to be under strong influence by the government, and repayment ability is barely taken into consideration. The lending rate often falls below the deposit rates and the back spread between them is, in principal, to be compensated for by the central bank. In reality, compensation is rarely made.

9/ ADB [1993, p. 216].

10/ JETRO, Tsushokoho, [August 5, 1993].

11/ Sekiguchi and Tran [1992, p. 49].

12/ Permanent licenses were given to the firms who exported over five million dollars worth of goods; annual licenses were given to those with the exports of over two million dollars.

14/ Firms producing export goods are exempted from the turnover tax. If those firms invest their profit again in the production of export goods, they will receive the corporate tax reduction.

Firms producing import substitution goods will enjoy the reduction of turnover and corporate taxes at the beginning of production.

Firms who receive contract of processing from foreign companies will be exempted from the import tax for the equipment and raw materials necessary for processing. They are also exempted from the turnover tax.

15/ JETRO, Tsushokoho, [February 23, 1993].

16/ ADB [1993, p.228].

17/ In the Law on Foreign Investment in Vietnam, four kinds of investments are allowed; contractual business cooperation, joint ventures, enterprises with 100 percent foreign invested capital, and construction-business-transfer contract (BOT).

18/ Nihon Keizai Shinbun, [October 21, 1993].

19/ In the plan, about six billion dollars is expected to be provided through ODA in the ten-year period from 1991 to 2000.

20/ There is the risk of unnecessary prolongation of the reforms, which is easily caused by political resistance, and it may fatally damage the achievements of the reforms. Ad hoc determination of the prolongation of reform also gives rise to corruption. The government has to determine the speed of the structural reform taking into account the costs and benefits of the gradual approach.

21/ e.g. World Bank [1993].
22/ e.g. Fukuda and Toya [1993], World Bank [1991], etc.

24/ Vietnam has static comparative advantage in the first industry e.g. rice production, crude oil production, etc. However, developing economies should not stick to static comparative advantage but promote industries with dynamic comparative advantage. See Murakami [1992, chapter 8].

23/ e.g. Murakami [1992, volume II, p. 88].

25/ Murakami [1992, chapter 8].