Taking Vietnam’s economy to the next level

mc kinsey global institute

Taking Vietnam’s economy to
the next level
To continue on a strong GDP growth trajectory,
the country should work to raise its labor productivity.
Marco Breu, Richard Dobbs, and Jaana Remes

http://viet-studies.info/kinhte/VN_McKinseyFeb12.PDF

http://tailieu.tapchithoidai.org/McKinsey_FullReport.pdf

During the past quarter century, Vietnam has emerged as one of Asia’s great success
stories. In a nation once ravaged by war, the economy has posted annual per capita growth of 5.3 percent since 1986—faster than any other Asian economy apart from China. Vietnam has benefited from a program of internal restructuring, a transition from the agricultural base toward manufacturing and services, and a demographic dividend powered by a youthful population. The country has also prospered since joining the World Trade Organization, in 2007, normalizing trade relations with the United States and ensuring that the economy is consistently ranked as one of Asia’s most attractive destinations forforeign investors.
The McKinsey Global Institute (MGI) estimates that an expanding labor pool and
the structural shift away from agriculture contributed two-thirds of Vietnam’s 7
percent annual GDP growth from 2005 to 2010.1 The other third came from improving
productivity within sectors. But the first two forces have less and less power to drive
further expansion. According to official Vietnam statistics, growth in the country’s labor
force will probably decline to about 0.6 percent a year over the next decade, down from
2.8 percent between 2000 and 2010. Given the past decade’s rapid rate of migration from
farm to factory, it seems unlikely that the pace can accelerate further to raise productivity
enough to offset the slowing growth of the labor force.
Instead, Vietnam should increase its labor productivity growth within sectors to achieve
an economy-wide boost of some 50 percent—to 6.4 percent annually—if the economy is to meet the government’s target of a 7 to 8 percent annual GDP expansion by 2020. Without such an increase, we estimate, Vietnam’s growth will probably decline to about 5 percent annually. The difference sounds small, but it isn’t: by 2020, Vietnam’s annual GDP will be 30 percent lower than it would be if the economy continued to grow by 7 percent.
Achieving 6 percent–plus annual growth in economy-wide productivity is a challenging but
not unprecedented goal. Nevertheless, incremental change will not achieve a revolution of
this magnitude. Deep structural reforms within the Vietnamese economy and a strong and
sustained commitment from policy makers and companies will be necessary (see sidebar,
“An agenda for sustaining growth”). Also, many companies have prospered in Vietnam
because of the country’s strong and stable growth and inexpensive, abundant labor. In
the future, they may no longer be able to rely on either, so they will need to ensure that
their business and financing models are sufficiently robust to withstand a period of lower
growth and, perhaps, economic volatility.
The challenges facing Vietnam

In the near term, Vietnam must cope with a highly uncertain global environment. The
economy faces a state of heightened risk because of macroeconomic pressures, including

inflation that has built up as a by-product of the government’s efforts to maintain robust
growth despite the global economic crisis. In early 2009, Vietnam’s global trade and
foreign direct investment declined dramatically, and while exports have recovered, the
future of these two sources of economic activity is quite uncertain. The slow recovery of
the United States and Europe, together with the nuclear disaster in Japan, has created
additional near-term uncertainty. In response to the global economic downturn, the
Vietnamese government relied on expansive macroeconomic policies that have led not
only to inflationary pressures but also to budget and trade deficits and unstable exchange
rates. Some signs suggest that the financial sector is under stress, and international creditratings
agencies have lowered their ratings on Vietnam’s debt.
In the longer term, Vietnam has a larger challenge. Since the key drivers that powered
its robust growth in the past—a young, growing labor force and the transition from
agriculture to manufacturing and services—are beginning to run out of steam, Vietnam
now needs new sources of growth to replace them. The demographic tailwind responsible
for driving a third of Vietnam’s past growth is slackening. Some companies already
report labor shortages in major cities. By 2020, the share of the population aged 5 to 19 is projected to drop to 22 percent, from 27 percent in 2010 and 34 percent in 1999. Although
Vietnam’s median age, 27.4 years, is still relatively young compared with that of countries
such as China (35.2), its population is also aging.
According to government projections, Vietnam’s labor force is likely to grow by about
0.6 percent a year over the next decade, a decline of more than three-quarters from the
annual growth of 2.8 percent from 2000 to 2010. Growth in the labor force will still make
a positive contribution to GDP, but notably less than it did in the past decade. Vietnam’s
growth has also been propelled by extraordinarily rapid migration from rural areas to
towns—from relatively low-productivity agriculture to the relatively higher-productivity
services and manufacturing sectors. Economic restructuring is unlikely to continue
so quickly. Indeed, even aggressive assumptions on the pace of the transition away
from agriculture would not compensate for the effects of the decline in overall labor
force growth. Without an improvement in productivity growth patterns within sectors,
agriculture’s share of the labor force would need to decline at twice the rate of the past
decade—unlikely given the aging of rural areas and the decline of agriculture’s share of the
total population, by 13 percentage points, over the past ten years.

Vietnam should identify sources of growth to replace those now becoming exhausted.
Manufacturing and service industries ought to step up their productivity growth
performance. Vietnam could also further develop the capabilities across all sectors,
become increasingly versatile as an environment in which companies can constantly
innovate and build on recent successes. Offshore services such as data, business-process
outsourcing, and IT appear to be promising areas. Vietnam can establish an enabling
environment at the level of individual industries and sectors by enhancing domestic
competition and helping industries move up the value chain. Building on its expanded pool
of university graduates, Vietnam has the potential to become one of the top ten locations
in the world for offshore services. Because state-owned enterprises still have enormous
importance, accounting for about 40 percent of the nation’s output, reform of their
ownership and management incentives is likely to be crucial, as will the need to improve
their overall capital efficiency.
As we have seen, to achieve GDP growth of about 7 percent a year, Vietnam needs to raise annual productivity growth to 6.4 percent. Without such an increase, we estimate, the glide path for Vietnam’s growth would decline to between 4.5 and 5 percent annually, significantly below the 7 percent more typical in recent years and the government’s own
target, set at the 11th National Party Congress in January 2011, of 7 to 8 percent annual
GDP growth to 2020. If growth indeed slows to 4.5 to 5 percent a year, the implications
would be significant. By 2020, Vietnam’s annual GDP would be 30 percent (some $46
billion) lower than it could be with 7 percent annual growth. Assuming no shift in the
structure of the economy as a whole, we estimate that private consumption would be $31
billion lower. Vietnam’s economy would take 14—rather than 10—years to double in size.
Implications for companies
The exposure of companies and investors to different economic growth outcomes
clearly depends on whether they are active primarily in the domestic or export market.
Domestically oriented companies, such as those in the financial-services or retail sectors,
are much more threatened by slower growth in Vietnam than are companies that use
the country as an export base for manufactured goods. Since prospects for growth vary
substantially from sector to sector, each company must understand and manage its own
specific problems. The expected slowing in the expansion of the labor force also has
significant implications for companies. Those that view Vietnam primarily as a low-cost
economy with an abundance of workers need to adjust their thinking.
Multinationals
Primarily to hedge their exposure to China, many multinational corporations have opened
facilities in Vietnam (or plan to do so), without adequately assessing the prospects, both
positive and negative, for expanding business in Vietnam itself. These companies should
avoid locking in excess capacity—the country’s economy may not match the strong growth
trends of the past—and ensure that their Vietnamese business models are sustainable even
if wages rise substantially. Anecdotal and survey evidence consistently indicates that the
wage cost advantage is eroding. Much as domestic and export-oriented companies must
boost their productivity to be competitive, so too must multinationals, which could also
engage with the government to remove barriers to initiatives that clearly benefit both sides,
such as programs to increase capital intensity and improve training.
Training is especially important. Multinationals complain about a lack of basic work
readiness among new recruits in both the manufacturing and service sectors. Many
companies in other countries have responded effectively to this problem by providing inhouse
training both before an employee starts working and on the job. Surveys suggest
that Vietnam has an even bigger shortage of qualified engineers and middle managers
than other rapidly developing economies do. Multinational companies can work with
the government and educational institutions to address this skill gap. If the Vietnamese
government were to issue certificates for qualified training programs, companies might
feel more confident in providing such training.

Private-sector Vietnamese corporations
Improving competitiveness and using the latest global best practices should be priorities
for Vietnamese companies in the private sector. They should emphasize long-term value
and bottom-line profits rather than merely seeking to increase top-line revenue. Too many
domestic Vietnamese companies spend too much energy competing on price and too little
on product quality, features, and branding and on developing unique offerings that can
command premiums.
These companies must develop programs to recruit employees and train them so that
their skills and productivity improve. They should also take a more professional approach
to retaining and promoting their best workers, through incentive packages and greater
management autonomy. The notion of increasing the value of each employee’s performance
is not yet widely understood among major Vietnamese companies. Family-owned
businesses, which remain a major part of the economy, have thus far tended to resist
efforts to improve their governance.
State-owned enterprises
More limited access to capital and increasing competition mean that state-owned
enterprises must lift their productivity before circumstances force their hand. Improved
management and better governance could raise their competitiveness and overall growth
potential. In China, for instance, the significant gains in productivity that resulted from
reform within the state-owned sector led to increased profitability as well.
Vietnam’s state-owned companies will also need to recognize the gaps in their pool of
talent and to recruit top-drawer, internationally trained executives to help them become
more globally competitive. They will increasingly have to benchmark themselves against
the best international competitors not only to measure internal operations but also to
create realistic plans for expansion and product development.
In this context, the adoption of international accounting standards will support
the creation of the detailed performance benchmarks required to identify areas for
improvement. Many maturing state-owned enterprises will have to make hard decisions
about which businesses should remain core and which should be exited because they can
no longer be profitable.
Selling shares in these companies remains a focus of many policy conversations in
Vietnam. But most of the sales carried out to date haven’t fundamentally tackled the
efficiency problems, because the state typically remains the controlling shareholder. More
aggressive steps toward fuller privatization and improvements in the governance of stateowned businesses might help them adjust more rapidly to an era of increasingly vigorous international competition.

We think Vietnam can act decisively to head off short-term risks and embrace a
productivity-led agenda. If the country does so, it can build on its many intrinsic
strengths—a young labor force, abundant natural resources, and political stability,
to name a few—to create a second wave of growth and prosperity. There are challenges,
to be sure, but we believe that they can be overcome.
The authors wish to acknowledge the contributions of Tu Ha, Jinwook Kim, and Diaan-Yi Lin to the development
of this article.
Marco Breu is a principal in McKinsey’s Hanoi office; Richard Dobbs is a director of the McKinsey Global Institute
(MGI) and a director in the Seoul office; Jaana Remes is a senior fellow of MGI and is based in the San Francisco office.
Copyright © 2012 McKinsey & Company. All rights reserved.