Rising star:

Vietnam’s role in Asia’s shifting supply chains

A report by The Economist Intelligence Unit
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RISING STAR:
VIETNAM’S ROLE IN ASIA’S SHIFTING SUPPLY CHAINS

Contents

Introduction 2

Labour: developing from a low base 4

Incentives for foreign investment: continuing to sweeten the deal 6

Trade relations: striding ahead of the competition  10

Cautious optimism 12

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RISING STAR:
VIETNAM’S ROLE IN ASIA’S SHIFTING SUPPLY CHAINS

Introduction

V ietnam has received increasing attention as an alternative manufacturing hub to China amid the
US-China trade war. However, its rise as a low-cost manufacturing base in Asian supply chains
predates these more recent international tensions. Among many aspects, its appeal to investors owes
much to the country’s internal political stability in recent decades. This is in contrast with many of its
regional neighbours, which, while able to offer low-cost labour, have suffered policymaking instability
and intermittent breakdowns in relations with major countries.

The Economist Intelligence Unit (EIU) expects Vietnam’s upcoming leadership transition, at the 13th
National Congress of the Communist Party of Vietnam in late January 2021, to proceed smoothly and
put in place another administration committed to policy continuity in regards to foreign investment
and the improvement of the business environment. This is not to say that Vietnam is not without
major obstacles to doing business—for one, corruption among public officials remains a major
issue. However, the assurance of overall political stability, means that other elements of the business
environment are of more immediate concern: what are Vietnam’s current key advantages over regional
competitors and how will these evolve over time?

Vietnam is rated more highly than China in some aspects of its business environment
(Score out of 10 in key aspects of The EIU’s Business Environment Rankings)
FDI policy Foreign trade & exchange controls Labour market
Singapore 10.0 10.0 7.2
Taiwan 7.8 8.2 7.0
Malaysia 7.3 8.2 6.9
Japan 6.9 8.7 6.8
Thailand 6.4 8.7 6.6
South Korea 6.9 8.2 6.0
Philippines 6.0 7.8 5.8
Vietnam 6.0 7.3 5.6
Sri Lanka 6.0 6.0 6.4
Indonesia 5.1 7.3 5.3
China 5.5 6.4 5.7
India 5.5 5.5 5.4
Bangladesh 4.6 5.5 5.5
Pakistan 6.0 4.6 5.1
Note: Scores cover the forecast period of 2021-25.
Source: The Economist Intelligence Unit, Business Environment Rankings.

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RISING STAR:
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In this paper we consider three areas in Vietnam’s business environment that have contributed
the most to its competitiveness as a manufacturing hub—labour, investment incentives and trade
relations—drawing on proprietary EIU datasets such as the Business Environment Rankings
and Risk Briefing. Analysis of each of these areas will help investors and supply chain managers to
understand Vietnam’s potential compared with the wider region:

lF
 or labour, we highlight how low-skilled manufacturing wages will remain competitive
for years to come, while scarcity of specialised labour will persist as a disadvantage of the
business environment.

l I n regards to investment incentives, Vietnam will continue to offer generous arrangements

for international firms, with the downside that local supply linkages in more advanced
manufacturing will remain limited for the next decade.

lV
 ietnam’s proliferating membership of free trade agreements represents a strong point of
its trade relations, reducing export costs. There are only modest risks to this advantage,
mainly in the form of trade tensions with the US.

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Labour: developing from a low base

For many businesses in the years ahead the main concern will not be rising wages, but rather
a shortage of skilled labour. Advanced manufacturing and services skills will remain scarce.
Nonetheless, the ample supply of low-skilled labour will remain an overarching strength of
Vietnam’s business environment.

As a result of strong growth in the fertility rate after the end of the Vietnam war in 1975, the number
of people of working age in Vietnam is now estimated at 68m, or just over 70% of the total population.
A more recent decline in average births per woman has led to the dependency ratio falling in the last
two decades. Consequently, Vietnam is enjoying a “demographic dividend”: the share of the working-
age population is large relative to those under 15 and over 64 years of age, and we predict that it will
continue to grow in absolute terms until 2045.

The working age share of the population will The agricultural sector continues to dominate
decline slowly over the next two decades employment. As of 2019 over one-third of the
(m) workforce was employed in the combined
Elderly (aged 65 or above) agriculture, fisheries and forestry industries (with
Children (aged 14 or below)
Working age (aged 15-64) agriculture accounting for the vast majority of
120
jobs). Workers from rural areas have been a key
100 source of labour for industry as the manufacturing
80 sector expands.

60 Chronic underemployment within agriculture

40 has allowed the transfer of labour to industry
without negatively affecting productivity in
20
the former. Output per agricultural worker has
0
continued to rise at pace in recent years amid an
2010 20 30 40
Sources: The Economist Intelligence Unit; United Nations. outward flow of labour from the sector, despite no
major land reforms and only modest application
of fixed capital. The continual flow of workers into manufacturing has acted as a restraining factor on
wage growth among low-skilled and unskilled workers. The Economist Intelligence Unit estimates
that the stock of surplus labour in the agricultural sector will not be depleted until the latter half of the
2020s.

Several other factors will also serve to restrain wage growth. In terms of labour supply, government
will maintain flexibility towards labour mobility. Vietnam bears many similarities to China in its legacy
of central planning, but it has a less restrictive household registration system, removing a potential
disincentive to worker relocation. For instance, access to healthcare and government-subsidised
schooling are generally better for Vietnamese internal migrants and their dependents, compared with
their Chinese counterparts.

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RISING STAR:
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In terms of policy restraints on wage growth,

Employment by industry the government has committed to modest annual
(%)
increases in the minimum wage, which have
Agriculture, forestry and fishing Manufacturing
Construction Wholesale and retail trade rarely exceeded 4% in real terms in recent years.
Hotel and restaurants Government administration Meanwhile, industrial action—the formation of
Education and training Other
unions, striking and participation in collective
bargaining—will remain tightly controlled by the
authorities. Most organised labour action will take
the form of occasional “wild cat” strikes, rather
than permanent negotiation and bargaining
2019
processes.

The main weakness that investors will find

in Vietnam’s labour market will continue to be
its lack of skilled labour. The number of holders
Source: Vietnam General Statistics Office. of relevant vocational college or degree-level
qualifications will continue to fall short of
employer demand. This is not so much owing to a lack of higher qualifications overall, but rather
the lack of advanced education directly relevant to the needs of foreign-invested manufacturing
and services firms. Currently close to half of higher-qualified labour is concentrated in public sector
professions such as education and government
administration, partly a result of the legacy of Vietnam will remain wage competitive
state-dominated central planning. (monthly manufacturing worker wages in nominal US$,
forecast exchange rate for 2024; full-time, excluding
The loosening of immigration restrictions is overtime and benefits)
2018 2024
a positive countertrend to this. Amendments 600
to the Law on Immigration (introduced in July
2020) and the new Labour Code (which will
400
come into effect from January 2021) will ease the
process of obtaining work permits for foreign
200
staff. However, this will only partially alleviate
the problem and will not detract from upward
pressure on skilled labour wages. This will be a 0
Vietnam China* Indonesia Philippines India
key bottleneck in the development of Vietnam’s Sources: The Economist Intelligence Unit; JETRO.

business environment in the coming years. *Guangdong, Jiangsu, Shandong and Zhejiang provinces.

5 © The Economist Intelligence Unit Limited 2021

RISING STAR:
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Incentives for foreign investment:

continuing to sweeten the deal
The availability of incentives will be steadily scaled back for lower-value added industries.
However, high-tech manufacturers looking to relocate labour-intensive processes will still find
generous concessions for many years to come.

Since it embarked on liberalising reforms in the 1980s Vietnam has moved towards an export-
oriented development strategy that has prioritised foreign investment in fledgling industries. Zones
that give priority to foreign investment have played a key role in this strategy since the first Industrial
Park opened in Ho Chi Minh City in 1991. Vietnam has incentivised foreign direct investment (FDI)
into specific sectors via a combination of three main types of economic zones: industrial zones, which
include industrial parks and export-processing zones; special economic zones; and technology parks.

Incentives offered under the three broad categories of economic zone vary for different jurisdictions
and industries. Eligible FDIs can benefit from corporate and personal income tax exemption and rate
reduction. Below-market land rents are offered as well. Firms in high-technology sectors, automotive,
machinery, and those involved in the production of advanced capital goods are among those eligible.
A firm may even secure the incentives offered within export-processing zones while operating
outside the zone itself, as an “export processing enterprise”, if it maintains customs procedures on
site. Moreover, eligibility criteria are flexible, with options for large firms to enter discussion with the
government.

Nonetheless, for many firms the array of benefits that they qualify for is of less value than a decade
or so ago. This is largely because of the proliferation of trade deals that Vietnam has secured, leading
to the reduction of import tariffs, which have made the previous benefit of duty-free intermediate
imports under the export-processing zones (EPZ) regime largely redundant. Indeed, EPZs were
formerly a focus of foreign investment activity, but have diminished in popularity among investors and
become less of a priority for the government as Vietnam’s effective tariff rate has fallen.

In the decade ahead, the eligibility for investment incentives will narrow to increasingly focus on
higher value-added industries, as the government deprioritises foreign investment in low-value-added
manufacturing industries, including chemicals, plastics and fabricated metals. Notably, this process
will be much slower for less developed provinces located in the country’s interior. This trend will
signal the end of the government’s long-term strategy to establish major industrial clusters, and to
facilitate foreign technology and knowledge transfer to local firms and labour. For business, the positive
outcomes of this will be increased domestic availability of intermediate inputs and a deepening pool of
skilled labour.

Although a range of manufacturing industries exist in the country, only a few have developed into
large clusters and some are yet to benefit from increasing economies of scale. Many of the major
clusters are based within four geographical areas that the Vietnamese government has also designated
as priority regions for industrial development. These are the Northern, Central, Southern and

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Mekong Delta Key Economic Zones. Notably, these are administrative designations and include
a mix of the above three economic zone types. The Northern and Southern zones host the highest
amount of industrial activity.

Major manufacturing clusters in Vietnam

Hanoi

Northern Key Economic Zone

Ready-made garments
ments
Population : 17.1m
Footwear

Pharmaceuticals

Processed wood products

Central Key Economic Zone
Phones
Population : 6.5m
els
Screens and panels

ances
Household appliances

d related machinery
Automobiles and

ts
Integrated circuits

Major seaports

Southern Key Economic Zone

Population : 21.3m

Ho Chi Minh

Mekong Delta Key Economic Zone

Population : 6.1m

Sources: The Economist Intelligence Unit; General Statistics Office of Vietnam; Population and Housing Census 2019.

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Among these clusters, Vietnam’s footwear, and textile and garment industries are now well
developed with advanced labour specialisation and scaled-up manufacturing operations in multiple
areas throughout the country. The highest concentration is in southern Vietnam, in Ho Chi Minh City
municipality and surrounding provinces, with a smaller cluster in the north close to Hanoi. A longer-
standing but less developed wood-processing cluster that produces intermediate goods exports and
feeds into a growing furniture manufacturing industry is located close to Hanoi, proximate to major
forest areas in the north-west. A new and smaller cluster is located in the far southern province of
Ca Mau.

At the other end of the spectrum, the value of electronics exports has surged in recent years.
Nonetheless, the value of shipped goods conceals an underdeveloped domestic industry with limited
local linkages. Vietnam is beginning to secure vertical integration in the production of smartphones,
with the largest foreign investor in this industry, Samsung, opening a research and development facility
and a phone screen manufacturing plant, in addition to its existing assembly operations.

However, this manufacturing activity is dominated by foreign intermediate inputs (especially

from China) with little domestic contribution. Similarly, the country’s output of integrated circuits
is dominated by a single, large plant operated by Intel in Ho Chi Minh municipality. The facility is for
assembly and product testing with very little demand for domestically produced capital inputs. In this
industry we expect Vietnam to lag behind the indigenous capabilities of middle-income economies
such as Malaysia and Thailand until at least later this decade.

In sum, this varied picture points to a continuation of lucrative incentives for many foreign
manufacturing firms for years to come, as Vietnam struggles to move beyond labour-intensive
production. Lower down the goods value chain incentives will be pared back, but this will be a gradual
process. A bigger concern for businesses will be rising land prices, as rents increase rapidly close to
major port areas. However, the supply of accessible interior options will remain strong, presenting only
modest additional logistics costs.

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independent from one another. However, firms

A unique economic geography
reliant on domestic markets should be aware
of this potential logistical challenge and it is a
Vietnam’s geography is well-suited to export-
major factor behind the country’s low regional
driven activity. It has a long coastline that supports
infrastructure ranking in The EIU’s Business
several deep sea ports and navigable rivers that
Environment Rankings.
reach into major urban centres, including Thai
Binh in the north, and Ho Chi Minh City and Bac
Ninh in the South. This advantage compensates Domestic-facing infrastructure is a
for, and partly explains, a dearth of high-capacity weakness for Vietnam
(Score out of 10 for infrastructure in The EIU’s Business
connections between the north and south of the
Environment Rankings)
country. The only rail link between Hanoi and Score Ranking
Ho Chi Minh city is a single-track narrow-gauge South Korea 7.5 4
railway, and a major new system will not be built Taiwan 7.3 5
within the next ten years. Similarly, Vietnam lacks Malaysia 6.3 8
a fully integrated highway system between the Thailand 5 9
two ends of the country, and we expect a planned China 4.5 10
North-South Expressway to be completed in the Sri Lanka 4.5 10
2030s. The only rapid transit option between the Philippines 3.8 12

two ends is by air. This economic geography does Vietnam 3.5 14

not present a major challenge for most export- Indonesia 3.3 15

oriented firms shipping by sea as industrial clusters India 3 16

Bangladesh 2.3 17
on both sides of the country have developed to be

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RISING STAR:
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Trade relations: striding ahead of the

competition
Vietnam participates in more trade pacts and has better relations with major trading partners
than many of its regional neighbours. This lowers the cost of exporting clothing, footwear
and electronics, among other goods, to major global markets. Vietnam will maintain this
advantageous position with only modest setbacks in trade relations.

A key strength in Vietnam’s business environment is the country’s proliferating membership

of free-trade agreements. As part of the ASEAN Economic Community (AEC), Vietnam is able to
ship almost all goods tariff-free to most other South-east Asian countries. Meanwhile, agreements
between ASEAN and numerous other countries over the last 15 years have opened up more regional
markets; the efficacy of these deals has been reinforced by the recent Regional Comprehensive
Partnership Framework (RCEP). Of particular benefit in the last five years are the Comprehensive and
Progressive Agreement for Trans-Pacific Partnership (CPTPP) and the EU-Vietnam Free Trade
Agreement (EUVFTA).

The CPTPP entered into force for Vietnam in early 2019 and links together 11 economies on both
sides of the Pacific. Vietnam is the only low- or middle-income country in Asia to have ratified the
deal. Although the pact extends well beyond tariff liberalisation, the market access afforded via tariff
reductions alone is substantial. For Vietnam, the largest gains will be made on the back of widened
access to Canada and Mexico, which Vietnam did not have agreements with before. Vietnam
previously traded with these economies under most favoured nation (MFN) arrangements, which
maintained high tariffs for many of Vietnam’s key exports. For instance, sports footwear, Vietnam’s
third-largest export into Canada in 2019, boasted MFN tariffs as high as 16%, while telephone sets,
Vietnam’s top export to Mexico, registered high tariffs of 15%.

Following the implementation of the agreement, Vietnam’s exports of electrical machinery,

footwear, and clothing and apparel have been liberalised substantially. All electrical machinery and
equipment goods produced in Vietnam can now enter Canada and Mexico tariff free, up from around
two-thirds previously. This is a boost to Vietnam’s growing inclusion in upstream electronics supply
chains, as Mexico itself is a major global electronics producer reliant on component imports. In the
case of Canada, tariffs on Vietnam-produced textile and footwear products have been reduced
substantially, opening the door wider to these major Vietnamese consumer products.

The more recently signed EUVFTA came into force in August 2020, providing greater access for
Vietnam to a market that accounted for 15.7% of Vietnam’s merchandise exports in 2019 (or 13.5% as
the EU27). The deal led to the immediate elimination of 71% of EU tariff lines, and will extend to cover
almost all goods over a ten-year period. Similarly, 65% of tariffs on EU goods entering Vietnam were
eliminated immediately, with tariffs on most of the remainder falling to zero over the next decade.
Several industries stand out as key beneficiaries of the deal.

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RISING STAR:
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Footwear manufacturing sees the biggest

Major EU tariff reductions under the EUVFTA gain from the pact. Around 40% of exports
(€ bn; 2019 value of EU27 imports from Vietnam)
(2019 values) to the EU in this category faced
Schedule A - reduced to zero from stated rate on August 2020;
Schedule B3 - reduced to zero in four equal annual stages; 30% tariffs, which were reduced to 0% from
Schedule B5 - reduced to zero in six equal annual stages. August 2020. The majority of these were sports
A B3 B5 Remaining exports shoe products. In contrast, clothing and apparel
0 1 2 3 4 5 recorded a relatively small share of immediate
Footwear (HS-64) A = 30%, tariff reductions. However, over half of knitted or
B3 = 30%
crocheted clothing and apparel exports will see a
Non-knitted or crocheted
clothing & apparel (HS-62) reduction from 20% to 0% over a six-year period.
A = 20%, B3 = 20%
Knitted or crocheted clothing Tariff reductions in the broader furnishings
& apparel (HS-61) A = 20%
B5 = 20%
category are largely for seating products.
Furniture and furnishings
Although tariff elimination will be staggered over
(HS94) B3 = 25% four years it adds to a cumulative increase in
Sources: The Economist Intelligence Unit; European Commission. competitiveness over the last two years, coming
after the US imposition of 25% tariff rates in 2018
on many furniture good types exported from China—a national rival in the industry. Wooden furniture,
in particular, will remain a highly competitive segment in the medium term, as the wood-processing
sub-sector gains from economies of scale yet to be exploited.

Tariffs on roasted coffee (dominated by the robusta variety in Vietnam) fell to 0% in August under
the trade deal, from 9-12% previously. Vietnam is the second-largest source of coffee imports to the
EU. Although there are only modest prospects for market entry by foreign firms into Vietnam’s coffee
industries, the tariff reduction will be a consideration for EU-based coffee importers.

In addition, the implementation of these agreements comes against a backdrop of souring relations
between some regional competitors and Western countries. The US-China trade war has resulted
in the US introducing a wide range of high tariff rates on Chinese merchandise that The Economist
Intelligence Unit does not expect to be fully rescinded within the next two years. Meanwhile,
Cambodia, a rising competitor to Vietnam in the footwear and garments sector, lost preferential trade
access to the EU in mid-2020 owing to concerns over political repression, resulting in an uptick in tariff
rates on these key goods. Its access to the US market is similarly at risk for political reasons.

Vietnam is not entirely free from risks to its current trade relations, but we expect only modest
upward pressure on the cost of trade in the next five years as a result of international tensions. Chief
among these will be frictions with the US over Vietnam’s growing bilateral trade surplus and persistent
currency intervention. We anticipate that the US will impose a narrow range of import tariffs in 2021 on
the grounds of alleged currency manipulation (it has already imposed preliminary tariffs on Vietnam-
manufactured vehicle tyres in late 2020). We expect duties to target industries with low-value added
output, in which the US still has a domestic stake, such as metals, wood manufacturing and fisheries.
Crucially though, these tariffs will be low in value and not wide-ranging enough to seriously damage
Vietnam’s competitiveness.

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RISING STAR:
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Cautious optimism

The brisk pace of FDI into Vietnam and the diversity of foreign-invested industries now operating in
the country suggest that the economy is moving rapidly up the value chain. In reality the economy is
at an incipient stage in its industrial development. Domestic manufacturing capabilities will remain
overwhelmingly labour-intensive in the next few years, and production processes will be limited by a
small pool of skilled labour. Nonetheless, the wide range of incentives offered to foreign businesses and
market access granted by numerous free-trade agreements, combined with competitive wage costs
at the low-skilled end, will ensure Vietnam remains an attractive option for manufacturing operations
and those seeking to diversify their supply chain in Asia.

Whilst continuity in policymaking and favourable international relations will be reassuring to

business, Vietnam will not be free from operational risks. For instance, there is potential for unintended
consequences from the government’s efforts to maintain international competitiveness. The risk of
Vietnam being reprimanded by Western countries (including more severely than we currently expect
by the US) for limiting the appreciation of its local currency could partially jeopardise the tariff-free
access it has to major markets. Moreover, efforts to keep wage costs low for foreign enterprises via
modest minimum wage increases and limited mandatory employee benefits could stoke disquiet,
which could later develop into labour protests. These scenarios and others are explored in greater
depth in our Risk Briefing product.

Key risk scenarios for Vietnam

Scenario Category Probability Impact Intensity
Foreign firms face extensive legal action from regulators relating Legal &
High High 16
to the cybersecurity law regulatory
The government drastically increases rules-of-origin Foreign trade
High High 16
enforcement actions & payments
Protests erupt in response to encroachment by China on
Security Very high Moderate 15
Vietnam’s maritime territorial claims

Inflation surges Macroeconomic Moderate High 12

Plans to expand the capacity of ports and airports suffer

Infrastructure High Moderate 12
multi-year delays

Intensity colour key: 1 to 4 5 to 8 9 to 12 13 to 16 17 to 25

Note: Intensity is a product of the probability and impact ratings, where 'Very low' scores 1 and 'Very high' scores 25.
Source: The Economist Intelligence Unit, Risk Briefing

12 © The Economist Intelligence Unit Limited 2021

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