Making Markets Work Better for the Poor II

The provision of infrastructure has not kept pace with Vietnam’s rapid growth. The country is deficient in most types of infrastructure despite investing nearly 10% of GDP for the best part of a decade, a ratio of spending only exceeded by Thailand in the region. The investment to date on infrastructure has been felt through sustaining high GDP growth rates of between 7-8% per annum for the past decade and also supporting a dramatic fall in poverty incidence from 58% to 29%.

Over the next decade the continuing changes in Vietnam’s economy, including urbanization, industrialization and global integration, will mean increasing demands for infrastructure services in  critical areas such as power, transportation, telecommunications, and water. In addition, a desire for more inclusive patterns of growth means extending access to infrastructure networks to poorer and more remote regions, especially in terms of roads, improved water and sanitation services. The unit costs of delivering rural infrastructure in sparsely populated areas are often higher than urban infrastructure, and striking the balance between urban and rural is difficult, especially when budgets are constrained. Providing rural infrastructure as cost-effectively as possible is one of the key challenges.

Thus despite the significant impact on poverty and growth there is an emerging consensus, within the donor community that in order to sustain this level of growth over the coming decade, infrastructure investments will need to rise to around 11-12% of GDP. This will require a sizeable increase in investment. Concerns have already been raised about emerging infrastructure “bottlenecks” in power generation and port capacity that could have a strong negative impact on growth.

The impact of the global economic crisis and Vietnam’s response through its fiscal stimulus package means that government resources are likely to remain stretched and it seems unrealistic to expect that it would be able to increase its share in infrastructure financing beyond current levels. With most infrastructure investment in Vietnam financed from either the central government budget or Overseas Development Assistance (ODA), it is unlikely that future needs will be met by these traditional sources:

• Central government budgets are not sufficient to accommodate needs. The demands on the central budget are too great to finance the growing infrastructure needs of local authorities. Furthermore, continued decentralization of investment responsibilities to local governments will mean that use of central government funds for this purpose will diminish over time
• ODA sources are significant, but not sustainable. Continued economic growth in Vietnam is likely to mean that the amount of ODA funds available to Vietnam will decrease over the next five years and as well as becoming less concessional in nature.

The emerging gap in infrastructure finance (see figure below), taken together with the anticipated decline in future ODA flows, generates a heightened sense of urgency, and presents an immediate motivation for mobilizing greater and sustainable magnitudes of private infrastructure finance.

Note: Financing sources for 2010 assume that ODA grows at 2% p.a., while government and user financing (retained earnings) grow at the same pace as GDP (7% p.a.) from their 2002 levels.

One of the important policies that the Government is pursuing is what it refers to as “socialization” in investment, development, management and operation of the power, ports, and road and water supply sectors. A set of reforms and measures have been initiated to attract private participation (foreign and local) in infrastructure. These efforts have concentrated on issues related to the implementation of BOT projects as well as to institutional competence. Some progress has been made in terms of liberalization of trade and investment regime as well as improvement of the legal framework. However, private sector participation in the development of infrastructure has not, as yet, become significant.

Although commercial financing could potentially be sustainable over the longer term, local capital markets are undeveloped. It is estimated that private sources of financing, and user charges (incorporating the retained earnings of infrastructure enterprises as well as community financing of facilities such as small-scale rural water systems) account for approximately 21% and 15% of infrastructure investments, respectively.

Tea has been an agricultural success story in Vietnam, in just under 15 years Vietnam has become the fifth largest global exporter of tea in volume terms. This has been achieved through a rapid increase in area planted to tea and in yield improvements – Vietnam’s yield is significantly above world average at around 1,500 kg / ha and ranks 6th in term of planted area.  A recent 2010 report from the Ministry of Agriculture and Rural Development has again demonstrated the reliance of the sector, with tea exports surging 11 per cent in value terms by November 2010 against the same period last year.

The crop has a strong potential for poverty reduction in Vietnam as it is cultivated mainly on small farms by ethnic minorities and the poor in remote areas of the country. Tea production is labour intensive in those Provinces, particularly in Northern Uplands, the North Central and Central Highland areas, where it is cultivated and contributes significantly to the livelihoods and incomes of many poor households. With 400,000 households engaged in tea cultivation and more people working in processing and trading, the Vietnamese tea industry has created over 1.5 million jobs. Women and men are equally engaged in the value chain, however, not all tasks are equally shared.

30% of Vietnamese tea production is consumed domestically, most of it as green tea. Many tea farmers have their own small processing equipment for green tea, which they use for their own consumption and for local sales. The rest of the tea is exported to over 90 countries. About 60% of exports are in the form of black tea, for which the main importers are Pakistan, India, and Russia. Green tea makes up 20% of exports and mainly goes to Taiwan and China. Another 20% is exported as speciality teas, such as Oolong, Jasmine, and yellow tea.

Despite the rapid progress achieved, Vietnam is currently poorly aligned with world market trends in the tea sector, due to the following:

• Despite a strong trend towards green and black CTC production (particularly at the fast growing lower end of the market), Vietnam focused on increasing black orthodox teas. The orthodox or traditional method adds production costs of between 10% – 20% above CTC production and requires on average 5 MT of green leaf for 1 MT of processed tea as opposed to 4.5 MT of green leaf for 1 MT of processed tea under CTC (various industry sources)
• Green tea quality is of insufficient quality for premium prices and high growth experienced in the EU and USA markets. This is primarily due to a number of problems including: lack of planting material tailored to Vietnamese conditions which means bush quality is poor; Inferior plucking techniques of less than 7 leaves and a bud that leads to high stem fibre in the tea impacting its liquor; Time between plucking and processing is too long leading to the tea to start fermenting prematurely; And mixing of teas from different mini-factories reduces quality and leads to ‘grey’ colour and flat liquor of Vietnamese tea.
• Farmers reluctant to use pesticides responsibly as to avoid residue levels in the tea and as required by major higher quality and expanding markets in the EU and the US. There is little incentive to reduce pesticides as mini-factories are short of green leaves and will buy tea regardless of residue levels. Consequently Vietnam exports only 11% of its exports to EU and a mere 2.4% to the US.
• No branding of Vietnamese tea; it is used as a filler and cost reducer in better quality teas to which is blended. Thus products remain of low quality, low value and undifferentiated.

Thus due to the issues highlighted above most of Vietnam’s tea goes to countries paying below average import unit values – as can be seen from the chart below:

Thus Vietnam has failed to exploit and move up the global value chain to higher price segments of the market or position itself adequately into the growing segments at the lower quality end. Thus whilst ranking fifth largest in terms of global export volumes, Vietnam ranks only 16th with respect to its export unit value. Whilst constant prices have been falling continuously over the past decade, Vietnam gets lower prices for its tea compared to its major competitors.

Vietnam has unlike many tea exporters failed to develop an auction system. The auction system could improve transparency and allow for more effective market clearing at lower costs of administration. However, most exporters are keen to pursue established long term relationships with buyers. In part this continuation of the system may be due to the commanding presence that VINATEA still holds over the export markets. Although no longer the sole exporter it still controls up to 50% of exports as compared to 42% for limited companies and 8% for joint venture companies.

Thus despite its success the industry could perform even more robustly and have a greater impact on poverty reduction if these issues can be addressed. The M4P2 project is working with private sector tea companies to examine how this situation can be improved and provide wider benefits to the many ethnic minority communities which depend on tea for a significant proportion of their livelihoods.

Vietnam has been one of the fastest growing countries in the world. Since the onset of Vietnam’s doi moi reforms the country has experienced a period of remarkable success in economic growth and an extraordinary reduction of aggregate poverty. Vietnam’s economy averaged growth of 7.6% over the past 17 years resulting in poverty incidence falling from over 37 percent in 1998 to around 16 percent by 2006 (based on household survey data).

Recent rapid growth has allowed Vietnam to climb from a GDP per person of 413 dollars in 2001 to 836 in 2007. The optimism seem over the past few years has led to many commentators seeing Vietnam as a new economic tiger in the making, the “+1” country in a “China+1” investment strategy. Much of the growth has been fuelled by a robust increase in domestic demand and stellar export performance and relative macroeconomic stability.

Growth in consumption has been underpinned by higher farm gate incomes (reflecting rising prices for agricultural commodities), increases in the employment share of manufacturing and service sectors, and buoyant inward remittances. Prior to the global economic downturn, the rapid rise in nominal domestic consumption, recording an average 14 percent per annum increase between 2004 and 2006 (IMF, 2009), and changes in income distribution patterns, has seen a significant increase in the urban middle class. The goods and services demanded by the middle class have also enjoyed a very rapid growth of demand. However, rural / urban income disparities have increased.

Since the late 1990s, the share of capital in the manufacturing sector has been increasing in real terms as well as share of total investment, implying significant capacity development in manufacturing industry. While other countries in the region focus mostly on the final assembly of products, most of Vietnam’s manufacturing activities still remain at the lower end of the value chain, continuing its reliance on low skilled labour and land.

Vietnam has been able to gain rapid market share in the world’s export market, particularly in industries for which world markets are also growing, by focusing on labour-intensive sectors and natural resources. However, despite impressive gains in these sectors, Vietnam remains rooted in the low value added, low skills sectors in many markets, failing to migrate into higher value added segments of markets or to higher value added sectors such as electronics.

Importance of Investment to the Recent Growth Process

Over the past decade investment has grown much faster than GDP in Vietnam. The share of total output dedicated to gross capital accumulation has increased from 35 percent in 2001 to a high of over 45 percent by 2007 – one of the highest investment rates in the world. Up to the middle of 2008, the growth in investment has been faster in the private sector than in the state sector, with the strongest performance (both in absolute and in relative terms) corresponding to the domestic private sector, as highlighted in Figure 1. In 2001, the state sector accounted for almost 60 percent of total capital accumulation in Vietnam, whilst by 2007 private sector accounted for 60 percent, with more than half of the amount contributed by domestic enterprises (World Bank, 2009 Vietnam Development Report).

Despite the rapid increase in investment, capital productivity remains low (as reflected in an incremental capital output ratio of 4.8:1) – Asian Development Bank, 2007. (ICOR measures how many units of capital are associated with every additional unit of output. The higher the ICOR the less efficient investment is because more units of capital are needed to generate one additional unit of output). Evidence also shows that returns on equity from the state sector are low.

The bulk of investment is deployed in state owned enterprises some of which are shedding labour as they seek to commercialize their operations. The non-state domestic sector, responsible for the bulk of job creation between 2001 and 2006, is dominated by micro enterprises that suffer from inadequate access to finance and poor management and so are unable to fulfil their potential as the engine for job creation.

With significant number of new workers entering the labour force each year, and an economy which has been growing but been primarily driven by increases in investment, the ability of the economy to develop jobs will remain one of Vietnam’s crucial challenges.

In order to understand the relationship between output growth and employment generation in an economy, economist often use employment elasticities of growth (EEGs)* . EEGs tend to be below one in aggregate which means that as output grows employment generation also increases, but at a slower pace. There are a number of variations amongst sectors, where it is possible to get negative figures, such as agriculture where agricultural growth could take place at the same time as workers move out from agriculture to jobs in non-farming sectors. A number of researchers have developed EEGs for Vietnam, the latest being UNDP in 2009 (Warren-Rodríguez, 2009). The figure below highlights EEGs for Vietnam broken down by economic activity and type of ownership.

The analysis undertaken provides very useful insights as to what at the aggregate level has occurred to employment creation during the past decade:

• FDI has been the main driver of job generation over the past decade, with employment levels growing by an annual average rate of 21.7 percent between 2000 and 2007. However, overall both aggregate tables above show a decline in EEGs over the past decade, which implies the economy is reducing its ability to generate new jobs. This is in line with the observations above that growth is increasingly being driven by a process of capital-intensive investment in activities associated with low levels of employment generation.
• In addition to the decline in the EEG, the analysis from UNDP suggests that by 2007 the figure remained extremely low both in terms of aggregate EEG figures generated in the previous decade but also in relation to the region – between 2000 and 2004 average EGGs for Bangladesh (0.82), Nepal (0.76) and Pakistan (0.71) were considerably higher than the 0.23 recorded by the study for Vietnam.
• The analysis points to the fact that manufacturing activities and the construction sector have been two main generators of employment in the country during the past two decades, and have tended to benefit most from the displacement of labour (estimated to be in the region of 200,000 people each year) from agriculture.

The implications of these observations highlight the need to rethink strategy. According to UNDP studies aggregate growth has needed to progressively increase to ensure that jobs were available for all new entrants to the labour. Thus between 2002-2004 it is estimated that economy needed to grow at a little over 6.5 percent per year, in order to provide jobs to all the workers entering the labour force, whilst prior to this period, in 1999-2001 it needed to grow at around 5 percent (Warren-Rodríguez, 2009).  It is currently estimated that growth driven by maintaining the current structure of the economy will need to surpass 8.5 percent to ensure the same result. Thus without addressing this growing imbalance there is a danger that Vietnam could be sucked into a scenario of jobless growth.

[*] EEGs can be defined using the following formula: Employment growth rate, % / GDP growth rate,% holding all other variables unchanged.