Article

ForeignPolicyMagazine
February23,2012

The new Asian tiger?

ByMarcoBreuandRichardDobbs

It's clear that much has changed in Southeast Asia since the Vietnam War. Over the
past 25 years, Vietnam has transformed itself. But if Vietnam wants to sustain its
remarkable growth, it will need to boost labor productivity in the industrial and
service sectors in the years ahead, write Marco Breu and Richard Dobbs in Foreign
Policy.

Ten things you didn't know about Vietnam's rise.

It's clear that much has changed in Southeast Asia since the Vietnam War. Over the
past 25 years, Vietnam has transformed itself. In 2007, Vietnam became a full-fledged
member of the global economic community through its membership in the World
Trade Organization. It has become a magnet for foreign investment and is evolving
rapidly from an agricultural economy to one focused on higher-value manufacturing
and services. But if Vietnam wants to sustain its remarkable growth, it will need to
boost labor productivity in the industrial and service sectors in the years ahead.

Here are 10 takeaways from the McKinsey Global Institute report "Sustaining
Vietnam's Growth: The Productivity Challenge" that might surprise you.

1. Vietnam has grown more rapidly than any other

Asian economy except China.
Vietnam, a country once ravaged by war, has been one of Asia's economic success
stories over the past quarter-century. Ever since the Communist Party introduced
reforms known as "Doi Moi" ("Renovation") in 1986, the country has reduced barriers
to trade and capital flows and opened the economy more widely to private business.
During this period, the economy has expanded faster than any other Asian economy
except China's, posting annual per capita GDP growth of 5.3 percent. This growth has
continued in the face of the 1990s Asian financial crisis and the recent global economic
downturn (the economy grew 7 percent per year from 2005 to 2010)a more robust
record than many other Asian economies can boast.

2. Vietnam is moving out of the paddy fields.

Vietnam's economy no longer revolves around agriculture. In fact, agriculture's

contribution to the country's GDP has been cut in half from 40 to 20 percent in just 15
years, in a much more rapid shift than we have observed in other Asian economies. A
comparable transformation took 29 years in China and 41 years in India.

Over the past 10 years, agriculture's share of national employment has dropped by 13
percentage points, while the share of workers employed in industry has risen by 9.6
points and in services by 3.4 points. This shift of workers from agriculture to industry
and services has made a powerful contribution to Vietnam's economic expansion
because of the large differences in productivity between these sectors. As a result,
agriculture's share of GDP has fallen by 6.7 percentage points while industry's share
has risen by 7.2 percentage points over the past 10 years.

3. But Vietnam is a leading global exporter of

pepper, cashews, rice, and coffee.

Vietnam is the world's leading exporter of pepper, shipping 116,000 tons of the spice in
2010, and has led the world in exports of cashews for four years in a row. The country is
also the world's second-biggest exporter of rice after Thailand and second only to
Brazil in exports of coffee, which have nearly tripled in just four years. Vietnam ranks
fifth in the world in the production of tea and sixth in exports of seafood such as
catfish, cuttlefish, shrimp, and tuna.
4. Vietnam is not "China+1."

Rising labor costs in China have already spurred some factory owners to shift
production to Vietnam, which has an abundance of low-wage labor. The trend has
fueled talk among many CEOs about Vietnam becoming Asia's next big platform for
manufacturing exportsa smaller version of China, or China+1.

But Vietnam is very different from China in two respects. First, Vietnam's economy is
driven more by personal consumption than China's is. Consumption by households
accounts for 65 percent of Vietnam's GDPan unusually high share in Asia. In China,
by contrast, consumption accounts for just 36 percent of GDP.

Second, while China's rapid economic growth has been fueled by manufacturing
exports and extraordinarily high levels of capital investment, Vietnam's economy is
much more balanced between manufacturing and services, which each accounting for
approximately 40 percent of GDP. Vietnam's growth has been broad-based, with
competitive niches across the economy. Over the past five years, output in the industry
(including construction, manufacturing, mining, and utilities) and service sectors has
grown at comparable annual rates of about 8 percent.

5. Vietnam is a magnet for foreign investment.

Vietnam is on most lists of attractive emerging markets for foreign investors. Surveys
by Britain's trade and investment department and the Economist Intelligence Unit
have consistently ranked Vietnam the most attractive emerging-market destination
for foreign direct investment (FDI) after the BRIC quartet of Brazil, Russia, India, and
China. Registered FDI flows into Vietnam increased from $3.2 billion in 2003 to $71.7
billion in 2008 before falling during the global recession to $21.5 billion in 2009.

Here, again, Vietnam diverges from China. Nearly 60 percent of FDI in China has been
poured into labor-intensive manufacturing, compared with only 20 percent in
Vietnam. In the latter case, much of the remaining investment has found its way to
mining, quarrying, and oil and gas extraction (40 percent) and real estate (15 to 20
percent), reflecting rapid growth in Vietnam's tourism industry. The number of
foreign tourists coming to Vietnam has risen by one-third since 2005.
6. Vietnam has more advanced road infrastructure
than the Philippines or Thailand.

Vietnam has begun to make significant investments in infrastructure. Many visitors to

Vietnam still view the country's roads as pretty basic. But, for its stage of economic
development, Vietnam has been adding road infrastructure at quite a rate. Its road
density reached 0.78 kilometers per square kilometer in 2009, which is higher than the
road density in the Philippines or Thailand, both economies that are further on in
their development than Vietnam is. That same year, electricity networks covered more
than 96 percent of the country. New container ports such as those in Dung Quat and
Cai Mep and airports such as those in Da Nang in central Vietnam and Can Tho in the
Mekong Delta region have improved connections with the rest of the world.

7. Vietnam's young generation is going online.

Vietnam's population is young, well-educated, and increasingly online. Mobile

subscriptions in Vietnam grew nearly 70 percent per year between 2000 and 2010
compared with less than 10 percent per year in the United States in the same decade.
By the end of 2010, Vietnam had 170 million telephone subscribers, of which 154
million had mobile subscriptions.

At 31 percent, Internet penetration in Vietnam is much lower than in other Asian

states such as Malaysia (55 percent) and Taiwan (72 percent). But this is changing
rapidly. Broadband subscriptions in Vietnam increased from 0.5 million in 2006 to
around 3.8 million in 2010, the same year that 3G subscriptions hit 7.7 million. Once
the telecom infrastructure catches up, mobile and Internet use is likely to explode.
Already, 94 percent of Vietnam's Internet users access news online. More than 40
percent of users access the web every day.

8. Vietnam is becoming a top location for

outsourced and offshore services.

Vietnam already employs more than 100,000 people in the outsourcing and offshore
services sector, which today generates annual revenues of more than $1.5 billion.
Several prominent multinational corporations have established operations in
Vietnam, including Hewlett-Packard, IBM, and Panasonic. In fact, the country has the
potential to become one of the top 10 locations in the world in this sector, due to its
relatively large pool of young college graduates (universities send 257,000 young men
and women into the workforce each year) and relatively low wages. A software
programmer in Vietnam can be employed for less than 60 percent of what it costs to
hire one in China, while data-processing and voice-processing agents in Vietnam cost
50 percent less to employ than their counterparts in China.

Outsourcing and offshore services in Vietnam could produce annual revenues of

between $6 billion and $8 billion a year, much of it export-orientedas long as there is
sufficient demand and Vietnam ensures that it can satisfy that demand. This sector
could become an engine of job creation in urban areas, employing an additional
600,000 to 700,000 people by 2020 and contributing 3 to 5 percent to Vietnam's GDP
growth.

9. Vietnamese banks are ending at a faster rate than

their Chinese, Indian, or ASEAN counterparts.

Total outstanding bank loans in Vietnam have increased by 33 percent per year over
the past decadea stronger growth rate than those recorded in China, India, or any
Association of Southeast Asian Nations (ASEAN) country. By the end of 2010, the value
of outstanding loans had reached an estimated 120 percent of GDP, compared with
only 22 percent in 2000. Although this may be evidence of new dynamism in the
Vietnamese economy, oiled by an expanding banking system, the worry is that an
associated rise in non-performing loans could trigger significant economic distress in
Vietnam (as it has elsewhere) and force the government to intervene in the financial
sector to protect depositors, the banking system, and, ultimately, taxpayers.

10. Vietnam's demographic dividend is waning.

Between 2005 and 2010, an expanding pool of young workers and a rapid shift away
from agriculture generated two-thirds of Vietnam's growth. The other one-third came
from enhanced productivity. But now the first two drivers of growth are weakening.
Official statistics predict that growth in the labor force will decline to around 0.6
percent a year over the next decade, compared with annual growth of 2.8 percent from
2000 to 2010. And it seems very unlikely that the transition from farm to factory can
continue at anything like the speed we have seen in the recent past.

Productivity improvements will therefore need to pick up the slack if Vietnam is to

maintain its historical growth rate. More precisely, labor productivity growth in the
service and manufacturing sectors will need to accelerate by more than 50 percent
from 4.1 percent annually to 6.4 percent if the economy is to meet the government's
target of 7 to 8 percent annual growth by 2020. Should that productivity boost not
materialize, Vietnam's growth would likely decline to between 4.5 and 5 percent
annually. At that pace, Vietnam's GDP in 2020 would be 30 percent lower than it would
have been had the economy continued to grow by 7 percent each year.

***

Vietnam has many intrinsic strengthsa young labor force, abundant natural
resources, and political stability. If it acts decisively to head off short-term risks and
pursues a productivity-led growth agenda, it can enter a second wave of growth and
prosperity.

This article originally ran in Foreign Policy Magazine.

The new Asian tiger?