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Thursday, July 18, 2024

Middle-income trap looms large

By Van Phong

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Despite efforts to address internal difficulties and risks from the global economic slowdown, Vietnam’s economy still faces the threat of falling into the middle-income trap.

From an undeveloped country, Vietnam has made significant strides to reach the 37th position among the world’s largest economies in 2022, according to the International Monetary Fund (IMF). Vietnam’s average income per capita rose from US$200 in the early 1990s to US$3,590 in 2021, as per data from the World Bank.

If Vietnam can successfully overcome the challenges of the middle-income trap, it has the potential to become an upper-middle-income country before 2030.

The threat of falling into the middle-income trap

The middle-income trap is an economic development situation in which a country that attains a certain income (due to given advantages) gets stuck at that level. Upon reaching the threshold of high middle-income status, most countries experience a gradual slowdown in growth and are confronted with challenging economic structural issues.

Additionally, various challenges, such as the aging population, social welfare, environmental degradation, and resource depletion, are also hard to address. Only 13 out of 101 middle-income countries in the 1960s were able to overcome these obstacles and become developed countries with high incomes by 2008, according to experts.

During a session of the National Assembly at the end of 2019, Hoang Quang Ham, a member of the National Assembly Committee on Finance and Budget at that time, expressed concern that Vietnam was lagging behind the rest of the world. According to Ham, Vietnam’s GDP per capita was US$100 when it opened its doors after the war. At the time, the world GDP per capita was estimated at over US$4,000. In 2018, Vietnam’s per capita GDP was around US$2,590, while the global figure was around US$11,000.

“The world’s GDP per capita was US$3,900 higher than Vietnam’s 30 years ago, but now the gap has widened to over US$8,000 and continues to increase yearly,” Ham stated. Vietnam’s economy has taken several steps forward, but these have been relatively short.

Similarly, a report from the National Economics University shows that Vietnam’s growth has been far lower than other countries in the same period. During the 1991-2020 period, Vietnam’s annual GDP growth rate averaged 7.14%. Meanwhile, South Korea maintained an average GDP growth rate of about 8% per year for nearly four decades, while Japan’s reached around 9.4% per year between 1955 and 1973. Additionally, Vietnam’s growth structure reflects its technological backwardness, as the Total Factor Productivity only accounted for 26.1% during the 2011-2018 period. In contrast, this figure was around 40% in other developing countries.

Professor Pham Hong Chuong, the rector of the National Economics University, believes that Vietnam’s market economy is facing many limitations. Specifically, the Government still significantly controls market prices in certain sectors, such as petroleum, electricity, airfare and healthcare services.

State monopoly in certain economic sectors has exposed serious shortcomings recently. Fuel shortages were rampant in many provinces and cities throughout the country. A series of state-owned enterprises, such as Vietnam Electricity Group and Vietnam Airlines, have continuously reported heavy losses in their business results. Moreover, some localities were short of drugs and medical supplies.

Vietnam’s legal system sees many overlaps, making life difficult for businesses. Moreover, officials also risk violating the law if they misinterpret the regulations. It leads to delays in handling administrative procedures. “For example, numerous real estate projects have been delayed for years due to problems with legal procedures,” Chuong said at a recent seminar on economic reform.

Moreover, it seems that the Government has yet to give adequate attention to protecting minority investors in the capital market. Functional agencies have yet to develop a legal framework to protect new types of assets like digital currency. Additionally, many modern markets have yet to be established in Vietnam or still limit the participation of interested people, such as foreign exchange markets, gold derivatives, and commodity derivatives markets.

Which path should Vietnam take?

Currently, most countries worldwide are facing the highest inflationary pressure since the 1980s due to massive spending programs during the Covid-19 pandemic.

To cope with inflation, the U.S. Federal Reserve, the European Central Bank, and many other central banks have all increased their key interest rates, forcing central banks of developing countries, including Vietnam, to raise interest rates. It has strong impact on the prospects of economic development for many countries in the coming years.

Vietnam has learned from previous economic downturns, including the 1997-1998 Asian Financial Crisis and the 2008-2009 global recession, that stimulus programs and public investment alone cannot guarantee sustained economic growth. Instead, economic reforms play a crucial role in promoting long-term development for the country.

For the financial market, Ph.D. Can Van Luc, chief economist of the Bank for Investment and Development of Vietnam, proposes legalizing the handling of bad debts and amending certain laws, including the 2019 Securities Law, the 2010 and 2017 Laws on Credit Institutions, the 2010 Law on the State Bank of Vietnam, the 2012 Deposit Insurance Law, as well as related decrees and circulars that are no longer suitable in the current situation.

It is necessary to adopt appropriate regulations for managing financial corporations and new technology-based business models (peer-to-peer lending, fintech, and crowdfunding). Additionally, the Government should develop policies to manage and promote the development of corporate bond markets, as well as new financial institutions like voluntary retirement savings plans, real estate investment trusts, and venture capital firms. The legal framework should also be improved to ensure a clear distinction between ownership and management functions for financial institutions and markets.

Action should be taken to improve the management, supervision, safety, and stability of the financial system. Accordingly, functional units should strictly follow the Prime Minister’s Decision 986 on developing the banking sector and planning to establish an independent and modern central bank.

Regarding market organization, the State Securities Commission, Banking Supervision Agency, and Insurance Supervisory Authority should be allowed to work more independently. At the same time, it is crucial to set up a management model to control system risks, stabilize financial and monetary systems, and resolve possible crises.

According to Luc, the improvement of the legal framework to distinguish ownership and management functions for financial institutions and markets has to fulfill those two requirements. First, there should be a one-stop-shop mechanism where citizens or businesses only need to complete the administrative procedures at a single location. Second, the roles of shareholder representatives, the Government’s representatives, and independent board members in financial institutions should be clearly clarified and properly enhanced.

“A complete financial market regulatory framework to ensure healthy, sustainable development and enhance the competitiveness of the financial system is a crucial factor in perfecting the market economy system,” said Luc.

For human resources, economist Pham Chi Lan stated that the education and training sector saw slower-than-expected changes and failed to satisfy the current demands of society, especially when the Government tends to attract more foreign investment in new technology in Vietnam. “We need to improve the skills, qualifications, and work habits of Vietnamese workers to adopt new technologies introduced by investors,” Lan recommends.

Vietnam’s economy requires better skills from workers and the application of new technology to develop at the same high speed as before. Otherwise, Vietnam will fall into the middle-income trap like hundreds of other countries worldwide.

Lan suggests that Vietnam should reform its system and policies to maximize the potential of technology and help young Vietnamese people who are creative, quick-witted, and knowledgeable about technology and management to fully utilize their capabilities.

Regarding the macroeconomic factor, Dinh Tuan Minh, director of the Market-based Solutions Center for Social and Economic Issues (MASSEI), emphasized that Vietnam should prioritize improving those two points in institutional reform.

First, it is necessary to maintain a stable currency by ensuring macroeconomic stability and an inflation rate of around 3-4%, as in recent years. The Government should also reconsider the exchange rate regime and allow individual investors to participate in the foreign exchange market on trading floors, thereby improving the freedom to own foreign currency accounts at banks.

Second, international trade freedom is crucial. Specifically, it is important to review non-tariff barriers in a clear, transparent, and stable manner, as well as improve administrative procedures in customs to reduce time and cost. At the same time, the Government should review regulations on capital control to make Vietnam’s capital market even more attractive to foreign investors.

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