The immediate and long-term concerns: Vietnam's rise and China's industrial exodus
by Shen Jianguang, PhD. in Economics, currently Vice President of Jingdong Group and Chief Economist of Jingdong Digital Technology. Formerly Managing Director and Chief Economist at Mizuho Securities Asia. Previously, he was a senior economist at the European Central Bank, where he was responsible for Asia-Pacific economic forecasting and analysis.
FT.com 2022-05-26 18:10
Vietnam's current manufacturing position is not likely to shake China's status as the world's factory, but in the medium to long term, the "de-Chinaisation of the industrial chain" strategy in Europe, the US and Japan will provide an excellent boost to emerging manufacturing countries such as Vietnam.
Since this year, the emerging economies of Southeast Asia, represented by Vietnam, have recovered significantly, especially the high increase in exports from Vietnam, which has caused concern. While China entered March economic downward pressure increased, April data show that both supply and demand weakened at the same time, since 2020 a long time to support the growth of export growth has also declined significantly. In the short term the substitution of Southeast Asia's share of China's commodity exports is taking place, and market concerns about China's industrial chain moving out of the country are rising again.
In my opinion, Vietnam and other Southeast Asian countries will indeed bring pressure on China's exports this year, but due to the economic volume gap, low education level of the workforce, insufficient investment in technology and research and development, backward infrastructure and other core shortcomings, so we do not need to overstate the threat of the rise of Vietnamese manufacturing, raising the fear of China's industrial chain relocation; on the other hand, it is a fact that Vietnam enjoys a demographic dividend and an open-door policy, and that the US, Europe and Japan are helping to "de-Chineseise" their industrial chains, so we should pay close attention to preventing the medium- and long-term competitive pressure and the risk of relocation of the middle and upper reaches of the industrial chain.
Short-term share substitution increases the downside risk of China's exports
Downward pressure on the Chinese economy has increased since March this year. On 19 May, Premier Li Keqiang hosted a forum on stabilising growth and market players to ensure employment, clearly pointing out that "some industries and enterprises are experiencing increased difficulties, and the new downward pressure on the economy has further intensified ".
At the same time, the major economies of Southeast Asia, represented by Vietnam, are recovering rapidly. Official data shows that in the first quarter of this year, Vietnam, Indonesia and Malaysia's GDP actually reached about 5% year-on-year; IMF predicts that Vietnam will achieve 6% and 7.2% growth in 2022 and 2023 respectively. In the manufacturing sector, the manufacturing PMI of Vietnam and other countries has continued to be in the expansion range since this year under the rapid promotion of the resumption of work and production, and the industrial production index of Vietnam has maintained a near double-digit year-on-year growth rate since February. In the service sector, countries in Southeast Asia are gradually relaxing their policies on COVID19 testing for inbound tourists, and retail sales in Vietnam have so far returned to pre-epidemic levels. Exports are the biggest highlight, with exports from Southeast Asian countries rebounding significantly since March, and Vietnam's high export growth has become a hot topic of discussion recently, with official data showing its growth rate of up to 25% in April.
Fundamentally misaligned, share substitution will put considerable pressure on China's exports this year. In total, the substitution of market share for the US and Europe is already happening. The United States International Trade Commission (USITC) data show that in March this year, the United States from ASEAN, Vietnam imports growth rate of 27%, 30%, respectively, are more than the growth rate of imports from China (18%); that month, the United States from ASEAN imports accounted for 13.6%, compared with December last year, a significant increase in China's share of the same period from 19.2% down to 16%. Further data from Chinese and Vietnamese customs shows that the growth rate of Vietnamese exports to the US and EU in April rose sharply to over 30%, while the growth rate of Chinese exports to the US and EU both fell significantly to single digits (9.4% and 7.1%).
In terms of categories, share substitution mainly occurs in labour-intensive and consumer electronics goods, which is highly relevant to the existing industrial structure of emerging manufacturing countries. On the one hand, the share substitution of labour-intensive goods by ASEAN and Vietnam is obvious, concentrated in such categories as plastics and their products (HS39), leather and their products (HS42), knitted garments and accessories (HS61), shoes and boots and their products (HS64), furniture and their products (HS94), toys and their products (HS95). On the other hand, the share of consumer electronics products such as computers and mobile phones has also been squeezed to a certain extent, and the share of communication equipment and parts (HS8517) imported by the US from ASEAN has increased since this year, while the share of China has been decreasing during the same period.
The rapid rise of Vietnamese manufacturing, competitive pressure should not be underestimated
In addition to the downward pressure on short-term exports, the market is buzzing about the high growth of Vietnam's exports behind the concerns about China's "world factory" status. There is no doubt that Vietnam is sitting on multiple competitive advantages such as demographic dividend and open policy, providing a natural soil for the rapid rise of its manufacturing industry in recent years, and since 2019 has directly benefited from the trade friction between China and the United States, has grown into a competitive force to be reckoned with.
In terms of demographic conditions, Vietnam's national population will be over 98 million in 2021, with an average age of less than 33 years. Among them, the working population is over 52 million, with a very desirable spindle-shaped age structure, with the top five age groups of 25-29, 30-34, 35-39, 40-44 and 45-49 years old, accounting for 11.97%, 13.95%, 14.59%, 12.92% and 11.67% respectively. Low labour costs continue to constitute their core competitiveness. According to the latest "Survey Report on the Status of Japanese Enterprises Investing Abroad in Fiscal Year 2021" released by the Japan External Trade Organization (JETRO), the per capita labour costs borne by a sample of Japanese enterprises in Vietnam for manufacturing operators, senior employees and managers were US$4,571, US$8,707 and US$17,014 respectively, compared to US$12,923, 19,199 and 31,444 for Japanese enterprises in China in the same period.
In terms of policy conditions, Vietnam's economic and trade openness has continued to increase, not only as a member of the ASEAN Community Free Trade Market and the ASEAN+1 series of FTAs (including China, Japan, South Korea, Australia, New Zealand, India, etc.), but also as a member of the high-standard CPTPP and RCEP, which includes China, and as a member of the European Union, which is known as the "new generation" of FTAs. The signing of the Vietnam-EU Free Trade Agreement (EVFTA) with the European Union (EU), which has been described as a "new generation of FTAs", will gradually reduce tariffs to zero for the EU, and the US-China trade war has also highlighted Vietnam's low tariff advantage in recent years. In addition, the Vietnamese government has provided strong policy support to attract foreign investors, introducing a number of preferential measures to improve the business environment, such as lowering the corporate income tax rate to 20% below that of China.
Vietnam's shortcomings are also evident
Based on these advantages and the impressive pace of development, market concerns about the risk of China's industrial chain moving out of the country rise sharply whenever short-term export substitution occurs, and this is no exception. But there is still a long way to go before Vietnam really replaces China.
As already mentioned, the commodity categories that have recently shown export substitution are still concentrated in labour-intensive, downstream processing and assembly manufacturing. The author's further research based on labour quality, FDI composition and other latest fundamentals shows that Vietnam's core industrial composition has not changed much after the epidemic, and the basic development conditions have not been substantially improved. In the medium to long term, Vietnam is still constrained by the core shortcomings of low labour force education, insufficient investment in technology and R&D, and backward infrastructure, and the economic volume gap makes it difficult for Vietnam to replace China.
First, the epidemic has led to an employment gap and the quality of the workforce remains low in the medium to long term. Although the economy is recovering rapidly, the impact of the epidemic on employment in Vietnam looks longer. The latest data shows that Vietnam's labour force participation rate was only 68.1 per cent in the first quarter of 2022, 2.2 percentage points lower than before the epidemic (Q1 2020), with the Vietnam Statistics Department hinting at an employment gap for the fourth consecutive quarter and recent news reports of recruitment difficulties across Vietnam.
In terms of labour quality, according to the Labour Force Survey Report released by the Vietnam Statistics Department, as of the first quarter of 2021, only 15.5% of the total working population had a combined college, bachelor's degree or higher, and 74.02% had no training experience; in contrast, the share of middle and senior level technical and professional jobs in the total employed population was only 10.9%, and manufacturing employment was still dominated by Employment in the manufacturing sector is still dominated by elementary jobs at low skill levels.
Secondly, there is a serious reliance on foreign trade and the value added of products under the foundry model is not high. At the aggregate level, in the first four months of this year, Vietnam's exports amounted to US$122.36 billion, or 16.4% year-on-year, while imports amounted to US$119.83 billion, or 15.7% year-on-year. At the same time, Vietnam's trade surplus continued to be low, with a cumulative surplus of US$2.53 billion in the first four months of this year.
At the structural level, the top three export destinations for Vietnam in the first four months of this year were the United States, China and the European Union, with the United States accounting for 29.6% of the total. In the first quarter, Vietnam imported 27.4%, 22.3%, 6.3% and 5.2% of its total imports of telephones and parts, computers and parts, cameras and parts, and fibre materials from China respectively.
It is worth noting that in the first four months of this year, Vietnam's imports from China and South Korea and exports to the United States and Europe increased significantly compared to the same period last year, showing that the core of Vietnamese manufacturing is still the foundry, "transit station" model of importing raw materials for garments and textiles, consumer electronics parts and components from China and South Korea for processing and assembly, and finally exporting to Europe and the United States.
Third, the negative growth of FDI after the epidemic, the proportion of new projects declined. At the aggregate level, Vietnam's FDI rose steeply in 2019, reflecting to some extent the outward migration trend of the industrial chain at that time, with South Korea, Japan and the EU all accelerating their investments in Vietnam. However, Vietnam's FDI has generally shown negative growth since the epidemic, with foreign investment overall less attractive than in China. Combined with the impact of the deteriorating external environment such as the Russia-Ukraine conflict, the registered capital of projects attracting FDI in Vietnam has slowed for four consecutive months this year, with a year-on-year drop of 11.7% from January to April, and the actual arrival situation is also not optimistic.
At the structural level, nearly 60 per cent of Vietnam's FDI stock by the end of 2021 was invested in the downstream processing and manufacturing sector, followed by the real estate sector (15.1%), electricity, gas and air conditioning supply (8.3%) and a very low proportion in the mid- and upstream manufacturing sector. In the first four months of this year, the investment pattern of mainly downstream processing and manufacturing did not change much, except for the increase in the proportion of the amount invested in wholesale and retail (6.2%). It is worth noting that in 2019-2020, when the trade war was at its peak, a higher proportion of incremental FDI in Vietnam came from new projects, but since this year it has been mainly contributed by incremental capital from stock projects and funded-in capital.
In addition, with the rising knowledge intensity of global trade and the spread of automation technology, the degree of industry chain integrity and business environment are becoming more important considerations than labour costs. In these circumstances, barriers such as incomplete industrial systems, insufficient investment in R&D, geographical dispersion and poor infrastructure will also constrain the clustering of factors and the formation of industrial clusters in Vietnam in the long term.
The immediate and long-term concerns of China's industrial chain relocation
In fact, its rapid rise is both competitive and complementary to China's industrial chain, which should be viewed rationally, and there is no need to exaggerate its negative impact in the short term.
However, in the medium to long term, the industrial shift under the game of great powers is a major trend that has already emerged. Although there are no concrete results in the economic sphere, the US has made clear its demand to ASEAN to replace China's industrial chain, and has offered limited technology transfer if necessary. China should pay close attention to the risk of increased competition and the relocation of its mid- and high-end industrial chain in the medium and long term.