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Should Vietnam remain as Low-cost country sourcing (LCCS)

Friday 04, 09 2020
In the present time, what will be the long-term development goals for developing countries like Vietnam?
Should Vietnam remain as Low-cost country sourcing (LCCS)

Background:

For the past 40 years, Vietnam has been a communist country. As such, the country has a communist economy originally when it was united in 1964, the state owns the factors of production and the wealth is divided equally amongst everyone. This means that the law of demand and supply do not set the price of goods, making it very hard for the state to know what the people want to make adjustments accordingly, this led to high inflation and shortages of certain goods leading to a trade deficit. In 1986, following the Doi Moi economic reform, the economy leans more toward a market economy referred to as a Socialist-oriented market economy. The change allowed private companies to produce commodities, produced products are allowed to be sold on the free market, the land is allowed to be used for private purposes although it is still owned by the state… Opening up an opportunity for for-profit companies to thrive. With the changes of Doi Moi, Vietnam has seen steady growth for over 10 years. This period of growth had been greatly accelerated since Vietnam joined WTO in 2007, the country’s trade policy had been heading toward globalization and free trade. With the country’s accession to WTO, the country had lifted some non-tariff barriers such as the restriction of import quantity, quotas, the requirement of permits and authorization. Since many non-tariff barriers had been lifted, it would be much easier for other countries to export their products to Vietnam. Nonetheless, the import tax rate still hinders the chance for foreign companies to penetrate into the Vietnam market. However, for foreign manufacturing companies wanting to invest in Vietnam, this is not a problem, the import tax rate for factors of production is kept low (this policy will be analyzed further as a comparative advantage of Vietnam). This factor along with the availability of resources, low cost, and abundance of the workforce, and other favorable trade policies had turned Vietnam into one of the most popular investment destinations for many multinational companies in recent years.
 

Vietnam as a destination for low-cost country sourcing (LCCS):

Vietnam as a destination for low-cost country sourcing (LCCS)
Companies seek suitable countries or regions for LCCS to source their manufacturing materials at a low cost. Destinations for them to choose to source from are low-cost countries (LCCs) with lower labor costs and/or lower production costs. Among many other LCCs within Asia like China, Thailand, Cambodia, Malaysia, … Vietnam is a very promising destination due to its low labor cost and trade policies (which will be discussed further later in part III). In order to source from an LCC, companies have to invest in said country with monetary investment, machinery, and equipment, resources, and materials for production. A prime example of this is Samsung, a well-known tech company from Korea, who had invested $670 million into its manufacturing facility in Vietnam through a span of 10 years from 2010-2020. This investment allows Samsung to set up Samsung Electronics Vietnam (SEV) with multiple industrial areas across the country. To Samsung, these industrial areas are crucial as they allow the company to produce around 50% of their mobile phone and generate over $50 billion for the company in 2017 alone. It is not a one-sided benefit either, thanks to the investment of Samsung and the founding of SEV, around 170000 Vietnamese workers are employed spread across multiple facilities. In addition, SEV’s export value had contributed to 25% of the total export value of the nation. Not only does Samsung realize the advantage of investing in Vietnam, other multinational corporations such as Nike, Adidas, or Honda also realize the potential of a country with a majority of the working-age population. The labor force in Vietnam accounts for 68% of the population (about 66 million people). This shows the large scale of the workforce. Moreover, a low basic salary is one of the important factors that help Vietnam become LCCS. According to the latest legislation, the minimum wage for some industries such as the Textile or Food Industry ranges from 2.5 to 3.1 million VND ($ 150) a month. This salary is much lower than other industries such as Mineral and Metallurgy (9.2million VND / month), administrative staff (5 million - 6.5 million VND / month). It is clear that multinational companies will benefit greatly from investing in labor-intensive industries and do not require much skill. 
 

Vietnam trade competitive and comparative advantages:

In terms of trade competitiveness, Vietnam was ranked 74th out of 140 countries in the Global Competitive Report of the World Economic Forum in 2019 and 7th place in ASEAN. This result derived from Vietnam trade competitiveness and comparative advantage through the government’s appropriate policies and the country’s recent trade agreement CP-TPP and EVFTA. 
 
In terms of Vietnam competitiveness, based on the Global Competitiveness Report and the Hecksher-Ohlin international trade framework, it is one of most countries has the lowest labor cost as a rational destination and processes the advantage of relative factor endowments for pulling foreign investment. To specify, apart from the growth of minimum wage from 2010 to 2020, from around $50 to $176.31, Vietnam labor cost still the lowest within the ASEAN region. It might be a positive signal in the short term due to higher in local consumption, investment for higher export value. Furthermore, Vietnam has replaced China and become the main competitor of the labor market due to China’s cost growth.
Vietnam trade competitive and comparative advantages 
Vietnam has the microeconomic competitiveness of local business environment quality. To specify, Vietnam has the competitiveness in factors input condition which is the major investment in Ha Noi and Ho Chi Minh city physical infrastructure and public investment in railways, international seaports, and airports in 2006, $6.5, and $4.8 billion, respectively. This signal shows an opportunity of growth in the extent of logistic delivery, Vietnamese and foreigner's standard of living. Moreover, according to the Executive Opinion Survey, high infrastructure would be an obstacle to any country in production business activities. Furthermore, Vietnam also has growth in telecommunication infrastructure at almost 30% of the population in 2009, this aspect indicates a higher liberalization benefits, competition, lower telecom price, and higher in coverage. Therefore, in dealing with the uncertainty of regulations and unnecessary cost of Vietnamese people, public and private businesses, the number of legal normative documents increased from less than 2000 during 1997 and 2004 to around 7000 in the years between 2005 and 2008. In these rules, Project 30 brings major incentives to improve its administrative and legal environment and gain higher competitiveness, 
 
Furthermore, Vietnam has a high level of openness in the economy in terms of trade and foreign direct investment. Based on the Reformation policies in the late 1980s, encouraging to local companies and reduce the influential power of enterprises (SOEs), having more international trade after becoming Asean member (AFTA) in 1996, (US BTA) and joining (WTO) in 2007. Furthermore, according to the third element - demand condition, Vietnam has a sizeable and growing market due to its higher in local demand and consumption, hence, it was ranked as the 14th most attractive market for retail expansion in 2010. Moreover, there is a higher level of customer orientation and buyer sophistication in the extent of goods and services, thus, with the foreign business penetration into Vietnam local market, it creates a higher competitiveness degree with Vietnamese local companies.
 
In terms of Vietnamese comparative advantage, it has an outstanding advantage referring to two categories including natural resources and unskilled labor. Firstly, Vietnam has the most abundant resources of food and live animals, mineral fuels, and wood and cork manufacture for exporting in comparison with other countries in the ASEAN region while Malaysia and Indonesia are having the most comparative disadvantage in these categories. It was facilitated by the government’s Resolution No 19 on improving the local business environment. Thus, Vietnam’s business environment and its prospect of growth in manufacturing are proved by the cooperation with many multinational firms including Samsung, Intel, Honda, Nike, Vina Capital, etc.. and the flourishing development of many large-size private companies such as Hoa Phat, BRG, Viettel, T & T.
 
Vietnam is able to attract a large number of multinational companies through many different trade policies over the years. One of the important trade policy that makes the country an ideal LCC is its tax rate on factors of production. As the country tries to orient itself toward export-led growth trade policies, policies that aim to increase the production of exported goods, the Vietnamese government set a low or even 0% import tax rate for imported factors of production. As mentioned above, companies have to provide the chosen LCC with machinery, equipment, and resources required for the production of goods they wanted to source. With a lower import rate for factors of productions, the operating cost of manufacturing facilities that set up within Vietnam’s territories is greatly reduced, an important comparative advantage compared to facilities elsewhere.
 
In addition to favorable trade policies, Vietnam also enters trade agreements that provide huge trade advantages to the country, giving manufacturing companies within the country a much easier way for produced products to find its way to foreign markets.
 
One of these agreements is EVFTA, which provides huge incentives, breaking the international trade barriers in many industries in Vietnam such as the textile, electronics, pharmaceuticals, seafood sector, etc. For instance, in the seafood industry, especially, canned tuna and fish ball. Thus, Vietnam seafood industry would be able to strengthen by the growth of export value, for instance, shrimp export value predicted to dramatically increased by the tariff line would reduce sharply in the first year and then cut down to zero percent in the following year, the export value for this type of product might strongly be raised to $4.2 billion worth in 2020 while $1.5 billion export value in EU market, much more than $750 million in 2019.
 
In terms of CPTPP, apart from facilitation in investment regulation and reinforcement in intellectual property protection, corresponding to the seafood sector above, the agriculture and industrial product tariffs are abolished for 98 percent which creates a comparative advantage in price when entering the EU market and CP TPP countries. Hence, these policies do not only end up by tariff reduction but also help local companies learn from foreign country’s high standard of technology for achieving sustainable development and environmental protection.
 

Challenge face as LCCS

 
As a Low-cost country source (LCCS), Vietnam also exists a few challenges that they need to care about.
 
The first is the rising labor cost. By 2020, Vietnam will have nearly 44 million workers (approximately 70% of the labor force) trained. A large number of workers makes labor costs in Vietnam fluctuate low, only approximately 20000 VND ($ 1) per hour in 2019. However, in recent years, Vietnam is one of the countries that has the largest minimum wage growth in Southeast Asia, with 8.8%, behind Laos (14.6%), and China (9.8%). In 2019, Vietnam's minimum wage has increased by 6.5% (ranging from $ 120 - $ 170) and is expected to increase from $ 130 to $ 180 by 2020. One of the main reasons for the increase in the minimum wage in Vietnam is the increasing cost of living each year. In 2018, consumer prices in Vietnam increased by 3.53% and increased gradually to 3.55% in 2019. A survey was conducted in 2019 with the participation of 3,000 workers from over 150 different domestic companies in Vietnam. More than 55% of participating workers point out that their current wages are not enough to cover their lives and feed their families, and they always have to do other jobs. The survey indicated that VND 6.5 million (~ $ 280) is the minimum expenditure for a Vietnamese worker, however, their average basic salary is only about VND 4.5 million. (~ $ 198). This increase in the minimum wage is, in part, driven by the country’s import substitution policy. Such a policy is expressed through the way the Vietnamese government imposes a higher import tax rate for a food product. As a complementary policy employed by the government alongside other export-oriented policies, import-substitution, although it helps to boost economic growth in the short run by increasing domestic consumption, has also contributed to the increase in the cost of living of its population. Eventually, with a higher cost of living, the minimum wage of workers also have to increase to compensate. Unless the government manages to adjust their import substitution policy, the minimum wage of Vietnamese workers will keep on increasing in upcoming years. To date, many large companies such as Zara, H&M, or Nike are considering and reconsidering their investment in Vietnam because they are concerned about high labor costs in this Southeast Asian country in the future.
 
The second challenge is that Vietnam currently lacks skilled workers. Although in recent years, Vietnam's economy is showing signs of clear growth and the demand for labor has increased, but many companies, both domestic and foreign have difficulties in recruiting people. tablets. Many Vietnamese workers tend to lack the necessary skills at work such as language and behavior - which workers in other Southeast Asian countries are ranked by foreign companies and appreciate more. Moreover, less than 15% of the total employees in Hanoi capital can use English and computer fluently. Many foreign companies with branches in Vietnam have to spend a large amount of money annually to train and train their employees. Moreover, 78% of the labor force in Vietnam has a low education level and only 9% have a university degree or higher. It is clear that the lack of skilled workers not only loses the ability to attract foreign investors compared to other Southeast Asian countries but also makes the Vietnamese economy stagnant.
 

Should Vietnam remain as LCCS?

 
In the coming years, Vietnam will remain as an ideal destination for foreign companies to source their products because of cheap labor and also because of the rising labor costs in China. The trade war between the U.S and China is also the reason that leads to many manufacturers, investors and buyers move their supply chains away from China which benefits many Asia countries, including Vietnam. However, in the long-term, Vietnam will have to deal with the same challenges as China which is the labor costs rising. The average hourly wage of Chinese workers reached $ 3.60 last year, up 64% from 2020 which makes firms move away to other developing countries. As Vietnam continues as LCCS in the future, the economic growth and living standards increase along with the increasing demands for workers which leads to the worker shortage, workers will demand higher salary which leads to higher production costs and business might decide to move their factories to other countries with lower labor costs.
 
In order to attract foreign firms, Vietnam must continue to maintain its strengths and at the same time improve weaknesses to attract more FDI firms. One of the advantages that Vietnam has is a stable government which should be maintained and it needs to be more business-friendly in order to attract more foreign firms. The country’s business environment is improving however there are still many inefficient and outdated business conditions that need to be removed. The government needs to make it easier for foreign companies to do business in Vietnam by reducing time and paperwork in some areas like construction permits, company, and property registration, and paying taxes. Starting a business in Vietnam takes about 18 days along with other time-consuming procedures, paying tax also needs to go through the timely process and because of the increasing number of FDI entering Vietnam, government processes cannot keep up to pace. Furthermore, Vietnam needs to maintain a stable economy by stabilizing the value of the Vietnamese currency, avoiding inflation or devaluation which are factors that foreign business concerns when entering the Vietnamese market in the long term. Another aspect that needs to be improved is the shortage of skilled workers as many foreign companies, including high-tech companies, are now coming into Vietnam and the demand for highly skilled workers will increase, especially in the technological age. The Vietnamese workforce above 15 years old is 53.5 million however just 9.99 million individuals, or 18.6% are skilled workers, which means unskilled workers make up 81.4% of the total workforce of the country. The local workforce lacks many important skills such as IT, problem-solving, adaptability, and foreign language proficiency so developing a skilled workforce and improving labor productivity should be prioritized by the government in order to adapt to the requirements of digitization and automation.
 
Vietnam has shown its journey in becoming a low-cost country that motivates foreign companies to invest in the market due to lower labor costs and production costs. As mentioned previously, the government has given out the trade agreement CP-TPP and EVFTA, which enhance the competitive and comparative advantages of the country. Furthermore, the government implemented several regulations and policies that help reduce tariffs on imports for productions in Vietnam to increase export productions. Such advantages have performed impressively in the past few years, but there are challenges that Vietnam has to face as an LCCS such as labor costs rising as the economy and living standards grow. In conclusion, it is ideally for Vietnam to stay as an LCCS in the short-term. However, in order to create an economic boom in the long-run, Vietnam needs to stabilize the economy as well as increase the skills and working environment to further attract investments from foreign businesses.

 Compiled by VietnamCredit. 

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Investment

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