Supporting the Establishment of Vietnam's 2011-20 Socio-Economic
Korea Development Institute Knowledge Sharing Program Sharing Knowledge April 2010 MINISTRY OF STRATEGY MINISTRY AND FINANCE Supporting Establishment the of Vietnam’s 2011-20 Socio-economic Strategy Development
Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy April 2010 www.mosf.go.kr www.kdi.re.kr Tel. 82-2-2150-7712 Tel. 82-2-958-4114 ● ● www.ksp.go.kr P.O. Box 113 Hoegiro 49 Dongdaemun-gu Seoul, 130-740 Tel. 02-958-4224 Knowledge Sharing Program Center for International Development, KDI ● ● ● Ministry of Strategy and Finance, Republic of Korea Government Complex 2, Gwacheon, 427-725, Korea Korea Development Institute 130-740, P.O.Box 113 Hoegiro 49 Dongdaemun-gu Seoul Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy
Project Title Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy
Prepared by Korea Development Institute(KDI)
Supported by Ministry of Strategy and Finance of the Republic of Korea
In cooperation with Development Strategy Institute, Ministry of Planning and Investment of the Socialist Republic of Vietnam
Program Directors Wonhyuk Lim, Director, Policy Research Division, Center for International Development (CID), KDI Taihee Lee, Director, Policy Consultation Division, CID, KDI
Project Coordinator Tae-Jin Joo, Research Associate, Policy Research Division, CID, KDI
Project Manager Sang-Woo Nam, Adjunct Professor, KDI School of Public Policy and Management
Sector-Project Managers Il-Chong Nam, Professor, KDI School of Public Policy and Management Hyun-Sik Kim, Senior Research Fellow, Korea Research Institute for Human Settlements Joon-Kyung Kim, Director, Policy Training Division, KDI Chinhee Hahn, Senior Research Fellow, KDI Joonghae Suh, Research Fellow, KDI Authors I. Search for Development Path and Evaluation of Growth Potential up to 2020 Chinhee Hahn, Senior Fellow, KDI Vo Tri Thanh, Vice President, Central Institute for Economic Management Nguyen Thi Lan Huong, Deputy Head, General Department, Development Strategy Institute II. Monetary and Financial Policy Chapter 1: Myungjig Kim, Professor, Hanyang University Hangyong Lee, Assistant Professor, Hanyang University Nguyen Thi Minh Ngoc, Banking Strategy Institute Chapter 2: Inseok Shin, Associate Professor, Chung-Ang University Nguyen Thi Kim Thanh, Director General, Banking Strategy Institute, State Bank of Vietnam Chapter 3: Joon-Kyung Kim, Professor, KDI School of Public Policy and Management Nguyen Thi Lan Huong, Deputy Head, General Department, Development Strategy Institute Bui Nghi, Deputy Director General, Department of Cooperatives, Ministry of Planning and Investment III. Industrial Technology Development Policy Chapter 1: Taeyoung Shin, Senior Research Fellow, Science Policy Technology Institute Nguyen Viet Hoa, Vice Director, Department for Strategy and Foresight Studies, National Institute for Science and Technology Policy and Strategy Studies Chapter 2: Joonghae Suh, Research Fellow, KDI Tran Ngoc Ca, President, Office of National Council for Science and Technology Policy Chapter 3: Deok-Soon Yim, Director, Office for Policy Studies, Gyeonggi Science & Technology Center, Gyeonggi Research Institute Dinh The Phong, Research Fellow, National Institute for Science and Technology Policy and Strategy Studies (NISTPASS) IV. Efficient and Harmonious Enterprise Policy Chapter 1: Il-Chong Nam, Professor, KDI School of Public Policy and Management Woochan Kim, Associate Professor, KDI School of Public Policy and Management Tran Tien Cuong, Director, Department of Enterprise Reform and Development, Central Institute for Economic Management Chapter 2: Youngrak Choi, Professor, Korea University Bach Tan Sinh, Director, Department of Science and Technology Human Resource Policy and Organization, NISTPASS
English Editors Tae-Jin Joo, Research Associate, Policy Research Division, CID, KDI Mikang Kwak, Reseach Associate, Policy Consultation Division, CID, KDI Sae-Byul Chun, Reseach Associate, Policy Consultation Division, CID, KDI
Government Publications Registration Number 11-1051000-000087-01 ISBN 978-89-8063-434-7 93320 Copyright ⓒ 2008 by Ministry of Strategy and Finance, the Republic of Korea
Knowledge Sharing Program
Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy
April 2010
MINISTRY OF Korea Development STRATEGY AND FINANCE Institute Preface
In the 21st century, knowledge is one of the key factors in determining a country’s level of socio-economic development. Based on the recognition Knowledge Sharing Program (KSP) was launched in 2004 by the Ministry of Strategy and Finance of the Republic of Korea and the Korea Development Institute (KDI) in an effort to contribute to the socio-economic development in the development partner countries by sharing Korea’s unique development experiences. The most distinguishing characteristic of the KSP is that it is a demand-driven, participation-oriented consultation project to tackle development issues from the partner country’s perspective and provide policy implications that are not far-reaching but can be practically implemented in the partner country’s environment.
The first Knowledge Sharing Program with Vietnam was successfully implemented in 2004. One of the great achievements was its contribution to the successful establishmentof the Vietnam Development Bank in 2006. Vietnam has been selected again in 2009 as the first strategic development partner country for KSP, and this is the start of a three-year project which will end in 2011. The principal objective of the first year’s KSP for Vietnam is to provide policy recommendation for the establishment of Vietnam’s 2011-20 socio- economic development strategy by conducting a comprehensive joint research on four key policy areas: 1) macroeconomic policies; 2) monetary and financial policies; 3) industrial technology development policies; and 4) enterprise policies.
I would like to take this opportunity to express my heartfelt gratitude to Project Manager Dr. Sang-Woo Nam, Sector-Project Managers Dr. Il-Chong Nam, Dr. Hyunsik Kim, Dr. Joon-Kyung Kim, Dr. Chinhee Hahn, and Dr. Joonghae Suh, and all those consultants who have participated in the project for their efforts in successfully completing the 2009-2010 KSP for Vietnam. I also thank Program Directors Dr.Wonhyuk Lim and Mr. Taihee Lee, and Project Coordinator Mr. Tae-Jin Joo, all of whom are members of the Center for International Development at KDI, for their dedication and contribution to the project. Lastly my special thanks go to the Development Strategy Institute and the Ministry of Planning and Investment of the Socialist Republic of Vietnam for their active support and cooperation.
Upon this occasion of publishing the results of the 2009-2010 KSP for Vietnam, I sincerely hope that this year’s project results would be of great value to the Governmentof Vietnam in establishing its 2011-20 socio-economic development strategy and be utilized to help Vietnam achieve its goal to become an industrialized middle-income country by 2020. The policy recommendations in this report, however, are based on the Korea’s development experiences, and are solely the opinions and recommendations of the authors.
Oh-Seok Hyun President Korea Development Institute Executive Summary
Sang-Woo Nam (KDI School of Public Policy and Management)
The Vietnamese economy, which has pursued the Doi Moi policy since around the end of the 1980s, continued to grow at about 7% over the last 20 years. In 2010, its gross domestic product (GDP) is estimated to surpass 100 billion dollars while per capita GDP would be over 1,200 dollars. Together with the growth of the economy, its productive structure has also continually been improved: the share of industry in GDP has increased steadily, while the state sector has shown a declining trend. To a large extent, this performance would be attributed to the institutional and policy reforms towards a more matured market economy. There has been progress towards a more level playing field for the economic activities of the state and private sectors and markets for productive factors such as finance, labor and land have increasingly been playing an important role.
Recent performance of the Vietnamese economy suggests that it has made a takeoff so that the economy is expected to grow at a steady pace. Nevertheless, it may be a challenging task for the economy to grow as fast as, or even faster than, in recent past in the next 10 or 20 years. The primary industry and the state sector still play a significant role in the economy. The share of agriculture, forestry and fishery in GDP declined modestly from 24.5% in 2000 to 22.1% in 2008. Although the role of the private sector has increased rather fast in industry (mining, manufacturing and construction), the share of non-state sector in GDP (excluding the state sector and foreign direct investment) showed a slight decrease from 48.2% to 47.0% during the same period. Challenges facing the Vietnamese economy may be summarized into three broad categories. The first is how to enhance its efficiency and international competitiveness, which is closely related to the growth potential of the economy. The technological capacity and skills of Vietnamese industrial human resources remain very low, and so do the entrepreneurship and managerial capacity of corporate executives and managers. University education and vocational training are rather weak in both quantity and quality. The leading role of the state in promoting promising industries on a selective basis and lay the foundation of a knowledge economy is almost absent. In spite of much infrastructure investment so far to support economic growth, the investment need is still enormous. Furthermore, there has been much concern about the low efficiency of overall investment noting that the average growth rate of the Vietnamese economy has not been so impressive in consideration of the high investment rate. This concern seems to be particularly serious for the state sector including state-owned enterprises. There is still a long way to go to solidify various institutions which are essential for the efficient operation of a market economy. They include ensuring fair competition in the market, deregulation of overly cumbersome and unnecessary rules, reform of the state sector for more transparency and accountability, enhanced predictability of government policies, and securing the effectiveness of law enforcement.
The second is the task of securing macroeconomic stability. Before the recent global financial crisis, for three consecutive years from 2005 to 2007, the Vietnamese economy achieved a decent annual growth rate of 8.4% on average. But, this growth was accompanied by a serious macroeconomic imbalance. The trade deficit during 2007-08 amounted to 29% of exports, and consumer price inflation accelerated to 23% in 2008. These macroeconomic imbalances of large trade deficit and high inflation have been eased during 2008-09 in the wake of the global financial imbalance. However, these imbalances are likely to surface again when the economy recovers strongly from the effects of the global financial crisis. In case Vietnamese financial and capital markets are opened further, it cannot be ruled out that the economy fall into crisis as macroeconomic instability can lead to serious instability in the financial and foreign exchange markets. Financial market instability may also be resulted from chronic fiscal deficit, deterioration of the asset quality of financial institutions and inadequate prudential regulation, and rigid management of the exchange rates.
The final challenge is to improve the quality of life and to stop the widening disparity of income and living environment among people and regions. Although absolute poverty has been substantially reduced thanks to rapid economic growth, sense of relative deprivation has got worse. This is due to widening gap in income and wealth in the course of transition to a market economy and progress in globalization. The opportunities and benefits of globalization are not evenly enjoyed between regions and between urban and rural areas. The socialist oriented market economy of Vietnam might face socio political resistance if it fails to address the problems of economic disparity and imbalance and deteriorating quality of life resulting from various social tensions accompanying economic growth.
The Socio-Economic Development Strategy (2011-20) which is now being drafted by the Vietnamese government will present strategies and policy directions to meet these challenges effectively. While the Strategy is still discussed for finalization, the government put forward“an industrialized middle-income country”as the vision up to 2020. Keeping the socialist orientation, Vietnam aims at achieving an annual average GDP growth rate of 7- 8% so that its per capita GDP in 2020 surpasses 3,000 dollars. The Vietnamese economy certainly has high growth potential with many advantages and strengths. It is located in East Asia whose economies are growing most vigorously in the world, and is endowed with rich natural resources as well as young population with high potential. On the basis of political stability, it is widely believed that the reform efforts of the last two decades towards a better- functioning market economy would be continued in the future. With all these strengths, it would not be an easy task to make the best use of these strengths and realize an industrialized middle-income country within a decade.
Both the Vietnamese and Korean governments hoped that Korean development experience would be useful in realizing this longer-term vision of Vietnam and be incorporated in the Socio-Economic Development Strategy (2011-20). This wish of the two governments was materialized as the KSP (Knowledge Sharing Program) Concentrated Support for Vietnam which is sponsored by the Korean Ministry of Strategy and Finance. The launch of this program is particularly significant as it started in 2009 when the two countries upgraded their diplomatic relations to “strategic cooperative partnership.” Furthermore, in the same year, Korea joined the Development Assistance Committee (DAC) of the OECD to become the first member who changed its status from a recipient to a donor. In this unique position, Korea has advantages over other DAC members in sharing its development experience with developing countries. The lessons from Korea are likely to be more relevant and practical since Korean development, together with all the experience of both successes and failures, was achieved within the last half century without any natural resource endowment and from the debris of war.
The first year activity of the three-year KSP for Vietnam was concentrated on joint study between Korean and Vietnamese experts on topics which were expected to contribute most critically to the formulation of the Vietnam’s Socio- Economic Development Strategy (2011-20). Naturally, the emphasis was put on topics which are closely related to the realization of the vision of “an industrialized middle-income country.” They include the following four broad topics: -Search for development path and evaluation of growth potential up to 2020 -Monetary and financial policy -Industrial technology development strategy, and -Efficient and harmonious enterprise policy
Except for the first topic on development path and growth potential, all the topics have three sub-topics. Briefly described below by topic are the key policy issues or concerns, aims of research and basic approaches addressing the issues.
(1) Search for Development Path and Evaluation of Growth Potential up to 2020.
The strengths and weaknesses of the Vietnamese economies are evaluated, which is followed by the analysis of sources of growth on the basis of the growth accounting approach. It indicates how much of the Vietnam’s past economic growth is due to increase in labor and capital input or improvement in total factor productivity. This result is compared with that of other countries obtained by applying the same analytical framework. Finally, the growth potential of the Vietnamese economy for the next 10 years is assessed under different scenarios of total factor productivity improvement and the size of current account deficit. This assessment will indicate how realistic the government’s growth target of 7-8% is and what are the key policy challenges to be met to achieve the goal.
(2) Monetary and Financial Policy
The emphasis is put on how to cope with macroeconomic instability which may be resulted from further opening of the financial and capital markets in the future. First, two early warning models are discussed that would help the Vietnamese government avoid a financial or foreign exchange crisis. One is an early warning model for the financial and foreign exchange markets, which is applied to Vietnam to test its effectiveness in predicting a crisis. Another model discussed is an early warning model geared to indicating the soundness of financial institutions. More specifically, a CAEL rating system for each category of financial market is recommended for Vietnam. Second, strategies for opening the financial/capital markets and related macroeconomic management issues are discussed. Another sub-topic is concerned with people’s credit unions which are considered a suitable type of financial institution in rural areas where the residents usually have difficulty in getting access to other financial institutions. Problems facing Vietnamese credit unions are discussed and basic approaches and policy agenda for the development this financial market subsector are presented. (3) Industrial Technology Development Strategy
This topic covers three related sub-topics including technology foresight, incentives for R&D and technology transfer, and collaboration among industry- university-research institutes and innovation clusters. As for technology foresight, its theoretical concept, methods, and Korean exercises with Delphi and national technology roadmaps are described. On this basis, guidelines for technology foresight in Vietnam are suggested including a framework for S & T planning at the national level and foresight procedures by stage. The sub-topic on incentives for R&D and technology transfer reviews related policy evolution in both Korea and Vietnam as well as Korean experience in technology acquisition and building in-house technological capabilities. This is followed by an evaluation of Vietnamese innovation system and policy suggestions emphasizing the role of FDI and the importance of policy coordination and government’s long-term commitment to R&D investment. The last sub-topic on collaboration among industry-university-research institutes and innovation clusters attempts a SWAT analysis for R&D activities by each of the three actors in Vietnam, and elaborate on the importance of collaboration among them. Also presented is review of the current state of such collaboration and innovation clusters in Vietnam as well as related policy suggestions.
(4) Efficient and Harmonious Enterprise Policy.
Key challenges facing Vietnamese corporate sector are addressed. They include corporate governance and technological human resource development at state-owned economic groups (EGs) as well as promotion of small and medium- sized enterprises (SMEs). As for the governance of EGs, four key concerns are highlighted including the conflicts between commercial and non-commercial objectives and vacuum of such government policies as completion and investor protection, in addition to weak internal and external governance mechanisms. On the basis of the review of corporate governance at Vietnamese EGs and Korean experience, several recommendations are made. Concerning human resource development at SOEs, detailed case studies are conducted on two Vietnamese EGs and three Korean firms. From these case studies and review of Korean policies on human resource development in R&D, policy directions most suitable in Vietnamese situation are presented. Finally, the sub-topic on SME promotion review the role and performance of Vietnamese SMEs together with the bottlenecks they face. The review is followed by suggestion of policy directions including removal of entry barriers as well as stronger supports with credit access, training of technical human resources, establishment of business clusters, etc. Contents
Chapter 01 Macroeconmic Policy
01. Executive Summary ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙30 1. Assessment of Vietnam’s Economic Growth Performance ∙∙∙∙∙∙∙∙∙∙30 2. Projection of GDP Growth∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙31 3. Suggested Policy Priorities for Strengthening and Sustaining Vietna ∙∙∙∙∙33 02. Search for Development Path and Evaluation of Growth Potenial uo to 2020 ∙∙∙34 1. Introduction ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙34 2. Overview and Assessment of the Vietnamese Economic Development: 1986-2009 ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙35 3. Evaluation of Vietnam’s Economic Growth from an International Perspective∙∙85 4. Key Policy Challenges ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙113
Chapter 02 Monetary and Financial Policy 01. Executive Summary ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙122 1. Enhancing Early Warning System and Risk Management Capacity ∙∙∙∙∙∙122 2. Capital Account Liberalization in Vietnam: Past Trends and Future Agena ∙∙∙124 02. Enhancing Early Waming System and Risk Management Copacity ∙∙∙∙∙∙∙128 1. Introduction ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙128 2. Historical Overview of the Vietnamese Economy ∙∙∙∙∙∙∙∙∙∙∙∙∙∙129 3. EWS for Financial Markets: Signal Approach ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙144 4. Early Warning System for Financial Institutions: CAEL Rating System ∙∙∙∙∙152 03. Capital Account Liberalization in Vietnam: Past Trends and Future Agenda ∙∙∙166 1. Introduction ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙166 2. Pre Conditions of Capital Account Liberalization: a Discussion Based on the Korean Experience ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙167 3. Capital Account Liberalization in Vietnam ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙182 4. Recommendations ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙199 04. People’s Credit Funds in Vietnam ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙206 1. Introduction ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙207 2. Overview of Formal and Informal Financial System in Vietnam ∙∙∙∙∙∙∙∙209 3. What is CFIs? ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙220 4. Korea's Experience in the Development of Credit Union ∙∙∙∙∙∙∙∙∙∙221 5. Current Situation of People's Credit Funds (PCFs) ∙∙∙∙∙∙∙∙∙∙∙∙∙225 6. Learning from the Past: The Relationship between Cooperatives and the Government ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙230
Chapter 03 Industrial Technology Development Policy 01. Executive Summary ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙238 1. The Current Status of the Vietnamese Innovation System ∙∙∙∙∙∙∙∙∙∙238 2. S&T Foresight Exercise as Learning Mechanism and Policy Tool ∙∙∙∙∙∙∙239 3. Strengthening the Incentives for R&D and Technology Transfer ∙∙∙∙∙∙∙239 4. Promoting the Relationship of Industry-University-Research Institute and Innovation Cluster ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙240 02. A Guideline of S&T Foresight for Vietnamese Industrial Technology Policy: An Exercise of Technology Roadmapping ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙242 1. Introduction ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙242 2. Technology Foresight and S&T Policy Making in Vietnam ∙∙∙∙∙∙∙∙∙∙244 3. Theoretical Understanding and Applications ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙259 4. Korean TF Exercises ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙271 5. Guidelines for TF Exercise for Vietnamese S&T Foresight ∙∙∙∙∙∙∙∙∙∙290 03. Strengthening the Incentives for R&D and Technology Transfer ∙∙∙∙∙∙∙∙299 1. Introduction ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙299 2. Industrialization and Technology Development: The Korean Experiences ∙∙∙300 Contents
3. Supportive Measures for Industrial Technology Development ∙∙∙∙∙∙∙∙309 4. Technology Transfer at the Firm Level ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙317 5. Conclusion and Policy Lessons ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙328 04. Promoting the Relationship of Industry University Research Institutes and Innovation Cluster ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙333 1. Research Background and Framework ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙333 2. R&D Activities by Actors ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙338 3. Network of Innovation Actors ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙347 4. Innovation Clusters ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙351 5. Conclusion and Suggestion ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙359
Chapter 04 Efficient and Harmonious Enterprise Policy 01. Executive Summary ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙372 02. On the Governance of State Owned Economic Groups in Vietnam∙∙∙∙∙∙∙∙375 1. Introduction ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙375 2. State owned Enterprises in Vietnam ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙376 3. Key Challenges ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙386 4. The Korean Experience ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙389 5. Policy Recommendations ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙393 03. Technical/Technological Human Resources Development in the Economic Groups ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙414 1. Importance of Human Resources Development in SOEs∙∙∙∙∙∙∙∙∙∙∙414 2. Technical/Technological Human Resources Development in SOEs ∙∙∙∙∙∙415 3. Technical/Technological Human Resources Development in the Korean Enterprises ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙424 4. Policy Recommendations ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙433 Contents | LIST OF Tables
Projection of GDP Growth of Vietnam: 2010-2019: Scenario I ∙∙∙∙∙∙∙∙∙∙∙32
Projection of GDP Growth of Vietnam: 2010-2019: Scenario II ∙∙∙∙∙∙∙∙∙∙∙32
Projection of GDP Growth of Vietnam: 2010-2019: Scenario III ∙∙∙∙∙∙∙∙∙∙∙32
GDP Growth Rate in the Period of 1986-2010(%) ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙43
Inflation Rate (GDP Deflator Growth Rate) in Vietnam, 1986-2009 ∙∙∙∙∙∙∙∙∙46
The Growth Rate of Money and Credit Supplies in Vietnam, 2001-2008 ∙∙∙∙∙∙∙46
Balance of Payment, 2001-2008 ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙49
Components of State Budget, 2001~2008 (% GDP)∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙50
Share of Credit by Type of Enterprises ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙57
Total Population and Population Aged Between 15 and 59 in Vietnam ∙∙∙∙∙∙∙∙61
Economic Groups in Vietnam ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙379
Economic Groups vs. Chaebols ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙380
Supervision and Management of Economic Groups by Governmental Agencies ∙∙∙387
Investor Protection Ranking Around the World (as of 2009) ∙∙∙∙∙∙∙∙∙∙∙407
Evolution of Technological Capability and THRD in Developing Economies ∙∙∙∙∙423
Major R&D Statistics in Korea ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙424
Evolution of R&D System in Korea ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙425
International Academic Papers in Korea∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙425
Overseas Patents in Korea ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙425
Evolution of Korean Innovation Model ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙427
Evolution of Korean Innovation Model ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙428 Contents | LIST OF FIGURES
Average GDP Growth Rates (measured by domestic currency) of Vietnam and Some Asian countries, 2001-2010 (%)∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙44 Real GDP, 1986 2010 (VND bil.) ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙44 Nominal GDP per capita, 1986-2008 (US$) ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙45 Dynamics of USD/VND Eexchange Rate, 1986~2008 ∙∙∙∙∙∙∙∙∙∙∙∙∙∙51 Inflation of Vietnam and its Trading Partners : Comparison of Inflation, 2004-2008 ∙∙52 Real Effective Exchange Rate Index, 1998-2008 ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙52 Some Indicators for Commercial Banking System ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙53 NPL ratio, 2000-2007 ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙54 Growth Rate of Credit and Mobilization of The Banking System, 1997-2008 ∙∙∙∙∙54 Market Share in Deposits of Credit Institutions in Vietnam, 2000-2007 ∙∙∙∙∙∙55 Market Share in Lending of Credit Institutions in Vietnam, 2000-2007 ∙∙∙∙∙∙∙55 Credit in Banking System by Customers ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙56 Capital Mobilization Channels of Vietnam Economy, 2005-2008 ∙∙∙∙∙∙∙∙∙57 Labor Structure by Three Economic Sectors in 2008 ∙∙∙∙∙∙∙∙∙∙∙∙∙∙64 Shift in GDP Structure by Economic Subsectors, 1990-2008 ∙∙∙∙∙∙∙∙∙∙∙66 Top Ten Largest Export Products in 2008 ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙69 Technology Classification of Vietnam’s Exports in 2007∙∙∙∙∙∙∙∙∙∙∙∙∙70 Dynamics of Export Composition. 2000-2007 ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙70 Structure of Investment by Ownership, 2001-2008 (%) ∙∙∙∙∙∙∙∙∙∙∙∙∙72 FDI Projects Licensed from 1988 to 2008 by Main Counterparts ∙∙∙∙∙∙∙∙∙73 Volume of FDI Registered by Sector ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙74 Number of SOE Equitized, 1992-2008 ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙77 Structure of Investment Needs in Transport by Subsector, 2008-2020∙∙∙∙∙∙∙79 Structure of Infrastructure Investment by Sources, 2007 ∙∙∙∙∙∙∙∙∙∙∙∙80 GDP Growth of Vietnam (WDI Data) ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙85 GDP Growth of Vietnam (Maddison’s Data) ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙86 Vietnam’s per Capita GDP Relative to Other Regions∙∙∙∙∙∙∙∙∙∙∙∙∙∙86 Contents | LIST OF FIGURES
Vietnam’s Income Level Relative to Other Regions ∙∙∙∙∙∙∙∙∙∙∙∙∙∙86 Vietnam’s Income Level relative to Other Regions ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙87 Typical Patterns of Demographic Transition ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙88 Fertility Rate of Vietnam ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙89 Death Rate of Vietnam ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙89 Population Growth of Vietnam ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙89 Working Population Ratio of Vietnam ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙90 Long Run Trend in GDP per Capita in World’s Major Regions ∙∙∙∙∙∙∙∙∙∙90 Sources of per Worker GDP Growth in Vietnam and Major Regions ∙∙∙∙∙∙∙∙97 Initial Income and Subsequent Growth(1960-2006) ∙∙∙∙∙∙∙∙∙∙∙∙∙∙101 Initial Income and Subsequent Growth(1980-2006) ∙∙∙∙∙∙∙∙∙∙∙∙∙∙102 Initial Income and Subsequent Growth (1990-2006) ∙∙∙∙∙∙∙∙∙∙∙∙∙∙102 Vietnam’s Ddemographic Structure by Age Group, as of 2006 ∙∙∙∙∙∙∙∙∙∙103 TFP growth in the yearsduring the Period 1986-2007 ∙∙∙∙∙∙∙∙∙∙∙∙∙105 Logistic Restrictiveness Undices for Some Economies ∙∙∙∙∙∙∙∙∙∙∙∙∙107 GDP Growth rate trend of Vietnam ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙111 Projection of Sectoral Composition of GDP in Vietnam ∙∙∙∙∙∙∙∙∙∙∙∙∙112 Inflation Rate (2000-2009) ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙136 Financial Stress Index and Crisis Periods (k = 1) ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙145 Financial Stress Index and Crisis Periods (k = 1.5) ∙∙∙∙∙∙∙∙∙∙∙∙∙∙146 Composite Indicator ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙150 Trend of CAEL Ratings and Scores: Case of Bank A ∙∙∙∙∙∙∙∙∙∙∙∙∙∙158 The CAEL Rating System: M/S Excel Based ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙159 The CAEL Rating Forecast System∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙159 EMP (Foreign exchange market pressure) ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙164 SMP (Stock market pressure) ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙164 IRP (Interest rate pressure) ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙164 Growth Rates of Monetary Aggregates. ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙170 Inflation Rates and GDP Growth Rates of the Korean Economy ∙∙∙∙∙∙∙∙∙171 Consolidated Budget Balance (Percent of GDP) ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙172 Reduction in Directed Credit (Proportion to the Total) ∙∙∙∙∙∙∙∙∙∙∙∙∙174 Trends and Composition of Net Capital Inflows to Korea ∙∙∙∙∙∙∙∙∙∙∙∙176 Trend and Composition of External Debts ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙176 M2 Growth Rate and Inflation Rates ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙180 The Won/Dollar Exchange Rate ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙181 Gini Coefficient and Real Per Capita Income Growth(1965 90, Annual Average)∙∙∙208 Growth Rate of Credit and Capital (Deposit) Mobilization of the Banking System ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙210 Market Share in Deposits of Financial Institutions in Vietnam∙∙∙∙∙∙∙∙∙∙211 Market Share in Lending of Financial Institutions in Vietnam ∙∙∙∙∙∙∙∙∙∙211 Capital Mobilization Channels of Vietnam Eeconomy, 2005-2008 ∙∙∙∙∙∙∙∙213 Share of Household Credit by Number of Borrowing Households and Loan Size, 1992-2006 ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙217 Average Annual Iinterest Rate of Household Credit, 1992-2006 ∙∙∙∙∙∙∙∙∙217 Structure of Informal Credit by Funding Sources, 1992-2006 ∙∙∙∙∙∙∙∙∙∙218 Number of Grassroot PCFs and Members, 1994-2008 ∙∙∙∙∙∙∙∙∙∙∙∙227 Total Assets, Loans, Deposits, Borrowings and Equity of PCFs, 1994-2008 ∙∙∙∙227 Total Assets, Loans, Deposits, Borrowings and Equity of CCF, 1995-2008 ∙∙∙∙228 Organization Chart of National System S&T in Vietnam ∙∙∙∙∙∙∙∙∙∙∙249 Decision Making Process for S&T Policies ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙250 Technology Transfer Space∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙261 Process of Technology Forecast∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙262 Korean S&T Governance ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙271 Working Mechanism of S&T System ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙272 Basic Framework of S&T Policy Making ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙273 Organization of Korean Delphi ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙276 Contents | LIST OF FIGURES
Delphi Procedure ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙279 Organization of NTRMs : First Phase ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙280 Organization of NTRMs : Second Phase ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙281 Concept of NTRMs ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙282 National Technology Roadmap (NTRM) : An Example ∙∙∙∙∙∙∙∙∙∙∙283 Characteristics of the Plan ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙284 Process of Planning ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙284 Roles of Committees ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙285 Organization of Committees ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙286 Structure of the Program : Layers of Technologies ∙∙∙∙∙∙∙∙∙∙∙∙286 Process of Selection of Strategic Technologies ∙∙∙∙∙∙∙∙∙∙∙∙∙∙287 Process of Roadmapping ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙288 Macro Roadmap of Agriculture : An Example ∙∙∙∙∙∙∙∙∙∙∙∙∙∙288 Flow of Planning Activities ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙290 The Roles of Committees ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙293 Stages of Technology Foresight ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙294 The Changing Relationship between TI and R&D∙∙∙∙∙∙∙∙∙∙∙∙∙∙309 The Chronology of Major Technology Policies ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙311 Chronology of Major Technology Policies of Vietnam ∙∙∙∙∙∙∙∙∙∙∙∙316 National Innovation System and Actors∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙334 Policy for Industry, University, Reserch Institute Relationship Promotion ∙∙∙336 Success Factors of World Class Innovation Cluster ∙∙∙∙∙∙∙∙∙∙∙∙338 Expenditure on R&D by Government and Business Sector in 2002 ∙∙∙∙∙∙341 Distribution of R&D Researchers by Type of Organizations ∙∙∙∙∙∙∙∙∙348 Innovation Environment with Dominant Role of Commercial Interactions ∙∙∙348 Location of Hoa Lac High-Tech Park ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙352 Organization Chart of Hoa Lac High-Tech Park ∙∙∙∙∙∙∙∙∙∙∙∙∙∙353 Location Map of Saigon High-Tech Park ∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙355 Change of Policy Paradigm for Daedeok∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙358 Evolution of Daedeok Innopolis∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙∙359 Contribution by the Type of Business Enterprises ∙∙∙∙∙∙∙∙∙∙∙∙∙376 Number of Stocks Listed in Stock Exchanges and their Market Capitalization ∙383 Market Capitalization as Percentage of GDP (Year end 2008) ∙∙∙∙∙∙∙∙399
Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy Chapter 01
Macroeconomic Policy
1_ Executive Summary 2_ Search for Development Path and Evaluation of Growth Potential up to 2020 Chapter 01
Executive Summary
1. Assessment of Vietnam’s Economic Growth Performance
Vietnam successfully ignited growth and sustained it for 20 years or so. Growth take off was accompanied with market oriented reforms: integration with the global economy, gradually but rapidly, strengthening “absorptive capacity” or human resources, building up various markets and institutions to enhance efficiency as well as stability, and reforming SOEs. Vietnam has overcome major bottlenecks. Most of them are typical in developing countries, but most of them also seem to be Vietnam specific in their details.
But can Vietnam sustain rapid growth in the future? This is a difficult question to answer in a definitive manner. On one hand, it is assuring to note that there is a tendency for late comers to grow faster, though this is not always the case. On the other hand, it is widely recognized, however, that sustaining growth is more difficult than igniting growth. In order to sustain growth, a country needs, above all, to develop and strengthen institutions that enable the economy to maintain productive dynamism as well as resilience to external shocks, under the changing domestic and external environments (Rodrik, 2005).
How can we evaluate Vietnam’s economic growth from a broad international perspective? Key findings obtained from a cross country comparison of growth accounting results of this report can be summarized as follows:
030 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy •A significant portion of GDP growth is accounted for by the increases in TFPand capital accumulation. From an international perspective, the TFPG of the Vietnamese economy in the 2000s is quite respectable. •Comparison with other open economies shows that Vietnam’s economic growth in the past decade or so was close to its potential at its income level.
Implications of the above findings are as follows.
•In spite of the prevailing concerns about the efficiency of the Vietnamese economy, the rapid growth has a reasonably sound footing. •The results are consistent with the hypothesis that the reforms had a beneficial effect on the Vietnamese economy. •Also, it might be unrealistic to expect that Vietnam can raise its growth rate significantly, e.g., by several percentage points, even if it implements growth promoting policies.
In terms of the growth prospect, the Vietnamese economy currently has the following strengths and weaknesses.
•Vietnam has a favorable geo economic position and in a dynamic region, so that Vietnam can become a new manufacturing hub. •Vietnam has you demographic structure. •Political stability •Strong momentum for further reform, despite debates on its scope and speed
•Macroeconomic/financial risks (Possibility of episodic cyclical instability in a structural uptrend) •Underdevelopment of infrastructure such as transportation and electricity •Weak human resource capacity (Problems of public governance and E&T system) •Low efficient public invesment and SOEs; only few private firms can be focal/leading firms •Improving but still weak institutions (in terms of market consistent legal framework, transparent and accountable administration, and policy predictability and enforcement) + Lack of effective policy reviewing mechanisms/institutions •Production factor (L, K, land) markets are at initial stage of development •Social risks (Poverty and income inequality + adjustment costs) 2. Projection of GDP Growth
In Scenario I, where the TFPG of Vietnam is equal to its annual average (2.81 percent) for
031 Chapter1_Macroeconomic Policy period 2001 2007, the projected annual average GDP growth rate for the period 2010 2019 is 6.51 percent. Over time, some modest slowdown is expected, with the first five year period growth rate (6.79 percent per annum) somewhat higher than the second five year period growth rate (6.51 percent per annum). The modest growth slowdown is likely to come from both capital and labor input. Although the working age population ratio is likely to increase modestly, the effect on the national saving rate is likely to be modest. Hence, with diminishing returns to capital, the growth rate of capital is likely to slow down. As the population growth rate is projected to slow down, the growth of labor input (economically active population) is also likely to slow down, although the expected increase in working age population ratio will have an effect of increasing labor supply. In Scenario II, where the TFPG of Vietnam is equal to that of China for period 1961 2006, the projected annual average growth rate for the period 2010 2019 is 7.01 percent. In Scenario III, where current account deficit (9.5 percent of GDP, 2008) is gradually reduced to zero by 2019 with other conditions the same with Scenario II, the projected growth rate for the period 2010 2019 is 7.46 percent.
Table 1-a | Projection of GDP Growth of Vietnam: 2010-2019: Scenario I
Aggregate GDP K L TFP
2010-2014 6.79 2.90 1.08 2.81
2015-2019 6.22 2.62 0.79 2.81
2010-2019 6.51 2.76 0.94 2.81
Table 1-b | Projection of GDP Growth of Vietnam: 2010-2019: Scenario II
Aggregate GDP K L TFP
2010-2014 7.29 2.90 1.08 3.31
2015-2019 6.72 2.62 0.79 3.31
2010-2019 7.01 2.76 0.94 3.31
Table 1-c | Projection of GDP Growth of Vietnam: 2010-2019: Scenario III
Aggregate GDP K L TFP
2010?2014 8.05 3.66 1.08 3.31
2015?2019 6.86 2.77 0.79 3.31
2010?2019 7.46 3.21 0.94 3.31
032 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy 3. Suggested Policy Priorities for Strengthening and Sustaining Vietnam's Rapid Growth
•Stabilize the macro economy and reduce vulnerability to shocks: In order to do so, a proper “exit strategy” is needed. This includes adjusting monetary policy, reducing fiscal deficit, and allowing exchange rate to reflect market forces. Thus, improve transparency and accountability in the recent fiscal stimulus package, and reduce possible conflict between short term “rescue” policy and longer term structural reforms by strengthening market discipline.
•Need more attention to the financial soundness of the commercial banking system and reduce moral hazard: This includes strengthening financial supervision and increasing transparency in operation of the commercial banks and SOEs. Although official statistics show that “bad debt” problem has been reduced significantly, there are concerns that the problem is larger than announced by international standard.
•Utilize geo economic advantage to become “production hub” in the international production network by reducing trade costs. For example, by lowering trade barriers and by improving trade related infrastructures. Nowadays, rapid wage increase in China is making MNEs to look for low cost locations in other South East Asian countries. Thus reduce both at the border and behind the border barriers to trade and investment. In addition, strengthen infrastructure provision system, including coordination between central and local governments.
•Improve the quality of the education system, since absorptive capacity is necessary to realize the potential benefits from openness.
•Address social risks arising from widening disparity between regions and ethnic groups. Bear in mind that too ambitious redistribution policies could hurt economic dynamism.
•Improve the policy making process and policy making capacity by increasing transparency and accountability of policymaking. This refers to both improving information disclosure and review mechanism through policy analysis, as well as strengthening public communication
033 Chapter1_Macroeconomic Policy Chapter 02 Search for Development Path and Evaluation of Growth Potential up to 2020
Chin hee Hahn (Korea Development Insitute) Nguyen Thi Lan Huong (Contral Institute for Economic managament) Vo Tri Thanh (Development Strategy Institute) Sunghyun Ryu (Korea Development Institue) Ji won Park (Korea Development Institue) Phan Thi Song Thuong* (Development Strategy Institute)
1. Introduction
This study has two main objectives. The first is to evaluate Vietnam’s growth performance since the mid 1980s and identifies some of the key policy challenges that the Vietnamese economy is facing for sustained economic growth. The second objective of this study is to make a medium to long term projection of the Vietnam’s GDP growth as well as its sectoral composition of GDP for the period 2010-2019
This study is organized as follows. In the next section, we provide an overview and assessment of the Vietnam’s economic development for the period 1986-2009. Specifically we provide a historical overview and discuss key characteristics of changes in policies as well as institutional environments. In section 3·1, we provide a quantitative overview of the macroeconomy as well as the changes in sectoral structure of the Vietnam’s economy. Section 3·2 evaluates Vietnam’s economic growth from a broad international perspective, utilizing two widely used methodologies: growth accounting and cross country regressions. Since growth accounting results are often sensitive to methodology and data, international comparison of growth accounting results, which are based on a common methodology and data, are necessary to understand the Vietnam’s economic growth from an appropriate perspective. Based on these assessments, section 3·4 discusses main potentials and weaknesses of the Vietnam’s economy. Next, in section 3·5, we make a projection of the GDP growth as well as the sectoral
* Authors are thankful for the help by Tran Thi Hoang Ngan and Nguyen Thi My Hanh, DSI
034 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy composition of GDP for the period 2010-2019. The final section suggests a set of policy recommendations for strengthening and sustaining Vietnamese economic growth, based on the above discussion. 2. Overview and Assessment of the Vietnamese Economic Development: 1986-2009 2.1. Brief Historical Overview of Vietnamese Economic Development During 1986-2009
Lasting more twenty years of reforms in many fields of the economy, Vietnam has overcome the crisis in 1980s and achieved many outstanding successes of economic, cultural and social developments. Since the Doimoi process was launched in 1986, the economic development and policy changes in Vietnam can be divided into three stages:
Since the postwar period up to 1980, Vietnam adopted a highly centralized Soviet style planned economy with these major characteristics (i) state or collective ownership of production means; (ii) government administered supply of physical input and output; (iii) lack of business autonomy, absence of factor markets, highly regulated goods and services markets; and (iv) a bias toward heavy industry in investments. As a result, there was an agricultural production crisis, no foreign investment and insufficient domestic financial resources for economic development and job creation. Shortages of common goods and annual hyperinflation rate are chronic. After several years adopting a limited market based system and policies to encourage foreign investment and stimulate the economy, the formal “Doimoi” process was finally began at the Sixth Communist Party Congress in December 1986 with the announcement of abandoning virtually the centralized economy and launching a comprehensive economic reform. The ideological change was then reflected in the most dramatic legal reform, including the revised Constitution in 1992, which, among other things, called for the State to “promote a multi component commodity economy functioning in accordance with market mechanism under the management of the State and following a socialist orientation”. The development of all sectors is encouraged. Private property and private enterprise are acknowledged and permitted. Not only showing a much more open and progressive concept of Vietnam’s relations with the rest of the world and capitalism, the 1992 Constitution also encourages foreign investors and grants them legal ownership of their assets as well as guaranteeing that such assets will not be nationalized or condemmed by the State.
To implement the above “Doi Moi” guideline, a series of comprehensive renovation policies have been promulgated, mainly on three areas:
•First, the Government implemented positive real interest rate by offer a very high saving interest rate of 12% per year to withdraw money from circulation. Then, the interest rate was gradually decreased from 12% to 9% and then 6% per year; or from 1.4% to 0.9% and then 0.85% per month.
•Introducing the two tier banking system to replace the mono banking system: Since the late 1980s, the banking system has been a market oriented two tier system that separated central bank’s functions and commercial credit and monetary functions. The State Bank of Vietnam (SBV) takes part as the central bank and the Government agency performing the state management in monetary issues and banking activities. Four state owned commercial banks were established to do business in the monetary industry under the market mechanism. Since 1990, the SBV has made a strong renovation in building and managing monetary policy. They determined the amount of money supply in line with the objectives of economic growth and inflation control.
Exchange Rate Policy
•The SBV has made an important step in adjusting official exchange rate to be consistent with market demand. The previous exchange rate used to apply for only accounting purpose and not reflect the actual cost. Applying the real exchange rate makes people to not hoard goods, gold and dollar and encourager then to save in domestic currency. Next, the SBV announced the implementation of managed flexible exchange rate regime.
Financial Policy
•Government expenditure was cut down sharply: Unprofitable state owned enterprises are to be dissolved. Huge amount of subsidy to the SOEs was cancelled. As a result, a large decrease in government expenditure, aggregate demand, prices and inflation was observed.
•The central treasury was established.
•Money printing for budget deficit was totally abolished: Since 1991, budget deficit has been financed by issuing bonds instead of printing more money as before. Money supply decreased, therefore, inflation also went down. The inflation rate in 1992 was only 17.6% in comparison with that of 1991; especially in 1993, it was only 5.2%.
036 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy 2.1.1.2. Reforming State Owned Enterprises Policies
Reform of SOEs in Vietnam is highly correlated to the development of private sector, firstly in the agricultural sector. Despite of some micro reforms to enhance the rights of household businesses and SOEs’ business autonomy1) were issued, the breakthrough only occurred with the release of the Resolution No.10 in April 1988, which introduced household contract and allowed cooperatives to distribute land to households while retaining the right to adjust landholding in response to demographic changes. Households were free to decide on the organization and marketing of their agricultural production while co operatives simply play a supporting role and collected taxes. Shortly after the Resolution No.10 was passed, in combination with price and trade reforms, Vietnam moved from a persistent rice importer until April 1988 to became the world’s third largest rice exporter after the US and Thailand. Soon afterwards, the non agricultural private sector was brought out of grey zone of semi legality as its right to a legitimate place alongside the state sector was recognized through a series of policies adopted in 1988. After 1989, the Government gradually phased out subsidy and financial support policies for inappropriate SOEs and dissolved inefficient SOEs as well as enforced most of SOEs have business autonomy and self accountability.
2.1.1.3. Trade Liberalization Policies
Trade liberalization was firstly expressed by efforts of completing price liberalization. In April, 1987 the 2nd Central Party’s plenum, 6th tenure promulgated the Resolution about solutions to reform the circulation and distribution of commodities. In the middle of 1989, the two price regime was phased out so that prices were basically set up by market law. In 1990, the Government continued to liberalize prices in key fields comprising traffic, transportation, postal services and energy and eliminate obstacles in commodity circulation such as the forbiddance to cross the river to open up market, as well as remove market prohibitions and monopoly in setting prices.
Not only liberalizing domestic trade, the economy was opened to foreigners all over the world. Facing a blockage and embargo on the economy and witnessing the collapse of the socialism system, the State launched foreign affair policies suitable to the global trend which was to diversify and multilateralize the international relationships in the 6th Party Congress (June 1991). A content of the agenda of the 6th Central Party’s plenum (1989) was “Promoting patiently the normalization of Vietnam China relation, restoring the friendly relationship between two nations”. This was the first attempt to recover the Vietnam-China relationship as well as the relationships to other countries in over the world in the next period.
To encourage foreign investment, the Law on Foreign Investment was enforced in 1987
1) Resolution HD
037 Chapter1_Macroeconomic Policy which permits foreign capital dealing businesses in Vietnam.2) However, FDI inflows was negligible in this period. For instance, during three year from 1988-1990, 214 FDI projects were licensed with US$1.58 bil. of registered capital while FDI inflows were only more than US$ 180 mil.
The initial results of Doi Moi were phenomenal. From 1986 to 1991, average annual real GDP growth was 4.3%, compared to a yearly average of around 1% during the previous decade. Output growth was driven mainly by structural changes and better utilization of excess capacity rather than traditional growth factors of investment and employment. But nearly half of the growth during this period was attributable to oil and coal production. Inflation was reduced impressively from 774% in 1986 to 67.5% in 1991 without international assistance. Moreover, unlike the previous period that Vietnam had to import food, in 1989 it exported nearly one million ton of rice and then soon became the world’s third largest rice exporter. During this period, on average, foreign trade turn over also increased by 28% per year and trade deficit dropped rapidly.
2.1.2. Reform at a Slow Pace and Gradually Integrate into the Global Economy (1993-1999)
The 1992 Constitution has a lot of extremely progressive contents which are suitable to requirements of the economic development, legitimate aspirations of most individuals and enterprises, for example the encouragement of foreign investment and the Governments commitment to ensure the property right of civils and enterprises. These contents became foundations for institutional reforms and construction of the economic law system as well as improvement of the business environment in Vietnam. Property rights and private ownership were further detailed in the first Civil Code in 1995. The Code not only confirms the protection of lawful property right and private ownership, but also covers provisions on the establishment of property rights and provision on transactions in and transfers of these rights and property.
The Government reformed the financial system comprehensively through enforcements of laws and regulations to manage and regulate the system’s operation. After entirely floating the exchange rate in the previous, since 1992 exchange rate system has had a managed floating regime under the controlling by exchange rate fluctuation amplitude. The interbank exchange market was established in 1997; however, the exchange rate policy in this period seemed like fixation than floatation.
Though not as serious as suffered by other neighboring countries, Vietnam’s economy experienced a downturn in economic growth in the late 1990s due to the 1997 Asian financial crisis. Thanks to the crisis, the slow pace of reform in this period then was suddenly powered by
2) Office Gazette, 1987
038 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy promulgating the Enterprise Law in 1999, which has been recognized as one of the most fundamental reforms in business environment.
First, the Law officially acknowledges the right of doing business: ‘citizens are free to do business in all business areas not prohibited by Law’. The Law has helped harness Vietnam’s economic potential and removed constraints which hindered innovation and creativity in business. The Law has also revitalized entrepreneurship and strengthened the trust of investors and entrepreneurs in the reforms and policies initiated by the Party and the Government,
Second, the Law has brought about a fundamental shift in the approach and tools with which the Government manages enterprises. Prior to the Enterprise Law 1999 it was believed that the freedom to do business should only be broadened along with and within the expansion in governance and monitoring capacity of authorities. This view has receded and has been replaced by a more innovative thinking. The Law implicity set up a new principle that management and governance capacity of the Government authorities should be strengthened and developed to the point that it can promote and manage development process. In fact, the Enterprise Law has expanded the autonomy and the ability for initiative in regards to an enterprise’s operations while at the same time creating a legal basis ensuring a more transparent relationship between the State and enterprises.
2.1.2.1. Reforms of State Owned Enterprises
The multi sector economy in this period developed step by step. The role of the private sector in the economy has become more and more important with its increasing proportion in GDP and quicks growth, putting pressure on the economic renovation process. The state sector still play the key role in the economy. In 1994, the Government established 18 general corporations and 64 special corporations which consisted of around 2,000 of the 6,300 SOEs at the end of 1994. This period was the first restructuring stage of SOE system and witnessed the cautious SOE equitization. The pilot scheme was launched in 1992 based on the Resolution of the 10th session of the 8th National Assembly and the Decision 202/CT TTg on equilization programs on 8 June 1992. The pilot scheme was very cautious, with only 5 SOEs equitized during 1992 1996. The Decree 28/ND CP was issued in May 1998 to end the pilot stage and open the new stage for equitization. This Decree required agencies (mainly line ministries and local governments) in charge of SOEs management to select several ones for equitization. However, the process was still slow; only 25 SOEs were selected to be equitized from 1996 to 1998.
2.1.2.2. Changes in Trade Liberalization Progress and International Economic Intergration
Before 1988, under centrally planed mechanism, international trade was conducted just only
039 Chapter1_Macroeconomic Policy by the SOEs. Since 1989, together with the introduction of the market oriented reforms, the crucial steps of abolishing the SOE monopoly on trade have been undertaken. The entry into international trading activities has been gradually relaxed with the more important role of private enterprises. In early 1990s in order to get an import/export license, enterprises in business needed to have a foreign trade contract and a shipment license, and to meet the requirements on minimum working capital and on the so called ‘skills’ in trade. In 1996, together with the elimination of the requirement on foreign trade contract and shipment permission, the barrier was further lowered by reducing a number of ordinary imported goods that need the import/export licenses to sixteen categories. In 1997, some changes were made. Decision 28/TTg dated 13 January 1997 mentions that all enterprises having the import/export license are encouraged to export goods beyond registered items and they can also export commodities not produced by themselves, except some special items regulated by different mechanisms. For the ordinary imported goods, the Decision suggested to control mainly by tariff and not by license. It can be said that before 1998 the different impediments to the entry into international trading activities were used intensively with the intention to protect the trading SOEs and to limit importing consumer goods. In the early 1998, the number of enterprises involved in foreign trade in Vietnam was 2,400. This number is just about two fifth of the SOEs and it is very small in comparison to the number of all enterprises in the economy. Trading activities of the foreign invested enterprises (FIEs) have been governed by the Law on Foreign Invesment In general, FIEs (including the joint ventures) had to commit to export a certain ratio of their output by the investment license, except for the purpose of import substitution or infrastructure projects. At the beginning of 1998, the Ministry of Investment and Planning (MPI) issued a Decision that required the FIEs to export 80% of their output. With the 1997 Asian crisis, this obligation has been revised by allowing these firms to sell more fo their goods in domestic market. The Decree 57/1998/ND CP (31 July 1998) issued by the Government marked a significant change in terms of the entry into international trading activities. The Decree indicates that all enterprises are allowed to trade their goods registered in business license with no need to ask for the import/export license except four groups of the ‘special’ goods. The central point of the Decree is that for goods not under the special regulations, domestic enterprises are encouraged to trade and they only need business licenses and registration of reference trading code to customs office. The number of enterprises registered to foreign trading activities increased from 2,400 in the early of 1998 to 10,000 in November 2000 (4,500 SOEs and 5,500 non SOEs). The FIEs are also encouraged to export goods not produced by themselves (i.e. enterprises can direct export their products or export their products through the FIEs without license except for special products).
In parallel with domestic reforms, international integration was also accelerated. The year 1995 witnessed three major events which included an official membership of Vietnam in the Association of Southeast Asian Nation (ASEAN), a signature in the framework agreement about coordination in trade, science and technology with the European Union and the normalization in the affair relation to the United States. As of the end of 1996, Vietnam had
040 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy official relationship in trade and economic activities with more than 120 countries and the foreign trade turnover increased gradually with the growth rate being 20% per year on average. Many countries and international organizations supported to Vietnam with aids and loans for economic developments; the total Official Development Assistance(ODA) to Vietnam was 8.53 USD billion in the period of 1994-1997.
Owing partly to the enforcement of the Law in Foreign Investment and building a more friendly business environment, the FDI attraction had satisfactory results including a rapid rise in FDI (on average 50% per year) and an important contribution of the FDI sector’s to the Vietnam’s economic development. That most FDI in Vietnam mainly came from Asian multi national corporations in this period had a direct impact on foreign capital flow into Vietnam after the Asian financial crisis in 1997. The registered capital started to fall in 1988 and in some next years.
Generally, with many suitable changes in guidelines and macroeconomic policies, the economy reached a high growth rate (on average, 7.4% per year) and the living standards also improved considerably.
2.1.3. Deeply Integration into the Global Economy (From 2000 Onward)
Although Vietnam applied for WTO membership since 1995, attempts to achieve the target to become WTO’s member were not speeded up till 2000. So far, the Government has done a tremendous amount of work in preparation for the entry. Promulgating legal documents in line with the WTO framework and norms was one of the most crucial task. From 2001 to July 2009, there were 133 Laws, 337 Resolutions, 46 Ordinances, 1,141 Decree, 6,646 Solutions, 663 Directives and 1,229 Circular and thousands of other legal documents being issued. These have formed the legal foundations for formulations of policies, principles to improve and develop the socialist oriented market economy in Vietnam, accelerate the ability of attraction all resources for the industrialization and modernization process.
Alongside with legal reforms, the Government continues to improve monetary policies and financial system’s operations. The State Bank of Vietnam has used monetary policy such as interest rate and exchange rate more flexibly to control inflation and improve the health of the financial system. Moreover, the Government has implemented many solutions to protect and improve environments. The Government has the main concern about social security and poverty alleviation, in which solutions to achieve Millennium Development Goals given by the United Nations with the aims of improvement in living standards, promoting sustainable development and becoming a modern industrial country by 2020.
041 Chapter1_Macroeconomic Policy 2.1.3.1. Reforms of State Owned Enterprises (SOEs)
The promulgation of the 1999 Enterprise Law had a crucial impact to the development of enterprises in this period; that can be proven through the number of enterprises registered. According to data of Agency of Small and Medium Enterprise Development (the Ministry of Planning and Investment), 160,672 enterprises registered in 2000-2005, increasing 3.3 times compared to number of established enterprises in 1991-1999. In addition, the SOE Law in 2003 also contributed to the more sufficient and synchronous legal framework for restructuring and reforming SOEs.
In order to match domestic policies with international commitments, especially with commitments to the WTO, a series of important laws were promulgated to reject all forms of discrimination against foreign products and businesses. Of which the most important laws are the Civil Code amended 2005, the Competition Law 2004, the Investment Law 2005, the Enterprise Law 2005, the Commercial Code amended 2005, the Export and Import Tax amended 2005, the Law on Intellectual Property 2005, the Law on Electronic Transactions, the Law on Bidding, the State Audit Law etc. By promulgating these laws, Vietnam has been widely acknowledged to have established all necessary legal institution for a market economy.
The rapid development of the private sector put more pressure from society on the State to accelerate the SOE reform process. Since the Ho Chi Minh City Stock Exchange was opened in 2000, the speed of equitization has been accelerated. As of February 2008, around 4,000 firms have been equitized, in which 3,400 firms had been equitized since 2000. According to the plan, 1,500 SOEs would be equitized from 2007 to 2010 and by the year 2010, there would remain 554 SOEs including 26 general corporations and special corporations as well as 178 firms in essential fieldssuch as defense and national security
Most important BTAs and FTAs were signed in this period. The Vietnam US Bilateral Trade Agreement was signed in 2000 and came into effect in 2001. The ASEAN Free Trade Area (AFTA)was signed in 1995 and fulfilled in 2006. Being an active member of ASEAN, Vietnam has fulfilled all free trade agreements signed by ASEAN to important partners such as China, Japan, Korea, Autralia and New Zealand. And of course, the highest level of integration is the event of being official member of the WTO in November, 2006. Vietnam’s economy has integrated deeply and widely into the global economy. Therefore it is sure that the reform is irreversible. Now, Vietnam is standing at the crossroad of chosing which type of growth model to avoid the “middle income trap” in the coming development stage.
042 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy 2.2. Quantitative Overview of Macroeconomy and its Structure in the Post Reform Period
2.2.1. The Macroeconomic Framework
2.2.1.1. Economic Growth
Economic growth rate is relatively high and continuously increasing
In the five year plan of 1986- 1990, GDP increased annually by 4.4%. In the period of 1991- 1995, GDP rose by 8.2% per year. Though first two years of the five year plan of 1996-2000 achieved remarkable economic growth rate of over 9% per year, the economy was in slowdown by the Asian financial crisis. The average annual GDP growth rate, hence, only increased by 7% in this period. In the period 2001-2005, thanks to the Government’s efforts to stipulate the economy by expanding both fiscal and monetary policies, Vietnam achieved an average economic growth rate of 7.5% per year in the period of 2001-2005. The 5 year plan of 2006- 2010 was expected to go smoothly with WTO membership (November, 2006), but the economy witnessed macroeconomic instability in 2008 and then stimutaneously was hit very hard by the global economic crisis of 2007-2009, the worst since the one related to the Great Depression of the 1930s. A booming economy since the end of 2006 to 2007 soon faced a dramatic downturn since 2008. To rescue the economy, the Government has enacted large stimulus packages worth, nearly US$ 9 bil. or 10% of GDP during 2009-2010. As of November 2009, the economy is showing green shoots of recovery. The GDP growth rate is estimated to reach 5.32% this year and around 6.5% next year. The estimated annual average GDP growth rate is about 7.2 % in the period of 2001-2010.
Table 1-1 | GDP Growth Rate in the Period of 1986 -2010(%)
Source: General Statistics Office (GSO), Statistical Yearbook
With such a high economic growth rate in the period of 2001 2010, Vietnam is one of Asia’s fastest growing economies. In East Asia, Vietnam ranks third in terms of GDP growth rate, ranking third after China (10%) and Malaysia (9.4%)
043 Chapter1_Macroeconomic Policy Figure 1-1 | Average GDP Growth Rates (measured by domestic currency) of Vietnam and Some Asian countries, 2001-2010 (%)
Source: Authors’ calculation from WDI 2009 and IMF (2009) World Economic Outlook Database
After more than 20 years of achieving relatively high economic growth rate, Vietnam’s GDP volume increased 4.5 times compared to 1986. GDP volume in 2010 at constant 1994 price is estimated 2 times as much as in 2000, reaching about VND 548.000 billion. GDP at current price (USD) in 2008 was US$ 90.7 mil. and the country occupied the 57th position among 182 countries in the World Bank s ranking. The projected GDP in 2010 is over USD 100 million.
Figure 1-2 | Real GDP, 1986 2010 (VND bil.)
Source: GSO, Statistical Yearbook and DSI’s forecast
With such a high GDP growth rate, GDP per capita at current price was over US$ 1.061 in 2008 and is expected to reach USD 1.220 in 2010.
044 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy Figure 1-3 | Nominal GDP per capita, 1986-2008 (US$)
Source: GSO, Statistical Yearbook
In parallel with impressive economic performance, Vietnam attained significant improvement in providing for citizen’s wellbeing. In the periods 1985-2007 , Vietnam’s HDI has increased on average by 1.16 percent per annum. Currently, Vietnam’s HDI was classified in the medium human development group, scored an index value of 0.725 ranked 116/182 countries and up from 0.582 in 1985, 0.603 in 1990, 0.646 in 1995, 0.682 in 2000, and 0.704 in 2005. With such GDP per capita and HDI, Vietnam has achieved the status of a lower middle income country.
2.2.1.2. Inflation
Inflation is always a burning issue in Vietnam, except 4 years of economic downturn from 1999 to 2002 due to negative impacts of the 1997 Asian financial crisis.
Vietnam witnessed the sky rocket inflation rate during the 1980s, soared to its peak in 1986 (700%). The moderate inflation during the 1990s and at the beginning of 2000s therefore was the success of comprehensive reforms of the government in order to sustain the internal balance of the economy.
Over past 20 years, only two short periods (1988-1992) and from the end of 2007-the third quarter of 2008, Vietnam put priority on price stabilization. For 14 years from 1993-2007, economic growth and job creation have been the 1st priority in macroeconomic policy.
As mentioned above, the government proactively implemented expansionary fiscal and monetary policies in order to against the economic recession from the effect of Asia’s financial
045 Chapter1_Macroeconomic Policy crisis in 1997. These policies performed well concerning high economic growth, but simultaneously made the economy more vulnerable to high inflation since 2004.
The booming global economy caused high inflation almost all corners of the world in 2007 and the first half of 2008. Nevertheless, Vietnam’s inflation is far higher than that in neighbouring countries. Both objective and subjective reasons caused double digit inflation
046 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy since the end of 2007. These objective causes include mainly the sharp increase in world price of materials (such as crude oil, mineral, construction materials etc), epidemic diseases (bird flu) natural disaster (storm, flood). The subjective causes associated with immanent factors of the economy such as structure of the economy concerning the supply side (cost push inflation) and demand side (high increasing investment and consumption). Behind the factors causing inflation in the supply side is the expansionary monetary policy overheating growth of money supply and credit.
More importantly, today’s macroeconomic turbulence is directly related to the domestic challenge of upgrading macroeconomic management for the WTO era. For most of the 1986- 2010 period, Vietnam’s economic links with the rest of the world were largely limited to trade, official aid flows and private remittances. However, the country’s accession to the WTO and other trade and investment agreements, combined with the relaxation of control over domestic private transactions, have broadened and intensified Vietnam’s international economic relations. Foreign direct investment and portfolio capital flows have increased sharply, and the financial market is more open to international competition. The dramatical fluctuation of foreign capital flows had not been anticipated by the Government and how to reponse appropriately was really a challenge to government officials. The money supply increased robustly as the SBV purchased a huge amount of US$ (especially in the first six months of 2007) while sterilization solutions have not yet been implemented.
Fixed exchange rate (VND/USD) is also another channel for importing inflation in the context of USD weakness. Meanwhile, the recognition of causes and possible impacts of high trade deficits on the resistance of the BOP and the production capacity was insufficient. A considerable gap between nominal interest rates of VND and CPI together with possibility of worsening BOP give rise to high expectation of further devaluation of VND. The inconsistent macroeconomic policies also encourage financial speculation behaviors, thereby making the allocation of resources less efficient. Liberalization of prices of some goods still controlled by the State should take place. However, this process requires better preparation, including improved supervision capability, transparent information provision, dispute settlement system, market-based intervention instruments (such as development of future market, national reserves if necessary) and gradual development toward a more competitive market structure.
Until early 2008, confusions in management of macroeconomic policies originated from the fact that absence of convincing arguments and explanations about the choice, in the short term, between growth objective and inflation control objective. The coordination in planning and implementation of macroeconomic policies between policy makers and implementers remained limited in many aspects. The implementation of a tightened monetary policy, although necessary, was not sufficiently coordinated with fiscal policy. The lack of adequate information
047 Chapter1_Macroeconomic Policy about the situation of commercial banks together with loose supervision in early 2008 led to regrettable consequence such as the serious liquidity situation in some banks, requiring administrative measures to control the situation
Since the last months of 2008 and the year 2009, thanks to the global economic crisis and the sharp decrease in prices of almost all world commodities like crude oil, materials, minerals, (for example the crude oil price decreased from the peak level US$147 per barrel to roundly US$40 per barrel in the beginning of 2009), inflation was curbed. However, fear over possibility of high inflation in 2010 is rising with the ongoing Government stimulus package.
2.2.1.3. Balance of Payment
Since 2002, Vietnam’s current account deficit has been increasing. In 2008, current account balance deficit was about 12% of GDP.3) High current account deficit is due to dramatic rise in trade deficit in goods which reached the highest record of 14.2% of GDP in 2008. Net transfer, of which private transfer accounts for 96% of net transfer value, achieved high surplus. Current account deficit was high, but still much less than trade deficit(Table 1-4).
Capital account surplus has increased at a faster speed during 10 recent years showing the deep integration of the capital market, especially since WTO accession in November, 2006. In 2001, capital account surplus was very tiny and accounted for only 0.7% in GDP. But in 2008, capital account surplus was about 13.7% of GDP and was 32 times as much as in 2001. Components of capital account achieved highest records compared to previous years. FDI inflows (net) in 2008 rose by 5 folds compared to 2001. FII fluctuated sharply because Vietnamese stock market in particular and financial market in general has become an attractive investment channel for foreign hedge funds. If FII inflow was just negligible in 2005, it soared to about 8.8% of GDP in 2007. Despite FII was hit very hard by the global financial crisis, fell down to US$ 578 mil. in 2008 and remain showing a slowdown in the year to come it is certain that Vietnam’s position in the international financial investment map has considerably improved.
Due to much higher capital account surplus compared to current account deficit, the balance of payment has been in continuous surplus over the past years which helped foreign exchange reserves increase remarkably. By the end of 2008, foreign exchange reserve was over US$20 billion.
However, in the context that the recovery of global economy is at the early stage, if Vietnam’s trade deficit does not decrease sharply next coming years, the economy is highly fragmented concerning the balance of payment as the key funding source compensate for large
3) Except including explanation, data herein on BOP are calculated from IFS (IMF)
048 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy Table 1-4 | Balance of Payment, 2001-2008
2001 2002 2003 2004 2005 2006 2007 2008 Current account balance 682 -604 -1931 -957 -560 -164 -6953 -10706 Trade balance in goods 481 -1054 -2581 -2287 -2439 -2776 -10438 -12782 (FOB) Trade balance in services -572 -750 -778 -872 -296 ?8 -755 -835 Investment income (net) -477 -721 -811 -891 -1205 -1429 -2190 -4400 Transfer (net) 1250 1921 2239 3093 3380 4049 6430 7311 Capital account balance 371 2090 3279.28 2807 3087 3088 17730 12342 Net FDI 1300 1400 1450 1610 1889 2315 6516 9279 FII 865 1313 6243 -578 Medium long term loans 867 912 2243 954 (net) Short term loans (net) 46 -30 79 1971 Money and Deposits -1197 624 1372 35 -634 -1535 2623 677 Total balance of payment 206 448 2146 935 2130 4324 10212 474 (accounted errors)
Source: IFS, IMF trade deficit FDI and transfer (net) reduced significantly and can not recover in the short term. Besides, there is a rising concern about financing the large current account deficit, by short term borrowing which reached 2.12% of GDP or US$1.88 billion. in 2008, approximately 24 times higher than that in 2007.
2.2.1.4. Fiscal Balance
During the period 2001-2010, the state budget has been improved as a result of a rapidly increasing economy base, state budget has been renovated basically toward developing and fostering revenue resources, abolishing subsidiary, revising laws on some types of tax, and mobilizing resources from the public and enterprises through the socialization of some social and economic activities.
Thanks to innovation, budget revenue collection reached about 25.7% of GDP during the period 2001-2008. Although the Government in 2009 carried out the stimulus package to slash the economic slowdown, including tax exemptions, the budget revenue is still estimated at 20 21% of GDP. This high performance shows the stability of the national fiscal position and positive outcome of renovation of fiscal policy, especially the promulgated tax policies.
Besides great achievements of budget revenue collection, budget expenditure also increased rapidly. Budget expenditure was about 30.2% GDP in the period 2001 2008. The structure of
049 Chapter1_Macroeconomic Policy budget expenditure has been reformed. Investment expenditure is considered as the priority task; expense for education is increasing rapidly and expected to be about 20% of the total budget expenditure by 2010; expense for environment protection is not less than 1% of the total budget expenditure. In current expenditure components, expenditure on education and training, heath care, and social security are jumping up. Budget expenditure has been sought toward gradually abolishing subsidies and shifting demands on the state budget by shifting responsibility for funding to enterprises and the public and encouraging the local funding of public activities.
Disclosure of budget revenue and expenditure at the ministerial and local level in compliance with the State Budget Law and Grassroots Democracy Degree creates concensus and encourages a positive response among the public in mobilizing additional sources for state programmes. Moreover, saving budget expenditure through expenditure norm is virtually an obligatory regulation that helps reduce wasteful expenses. Decentralizing state budget to province authorities has raised a sense of initiative reactivations and encouraged the province authority fostering source of revenue.
Table 1-5 | Components of State Budget, 2001~2008 (% GDP)
Source: The Ministry of Planning and Investment (2009)
The budget expenditure increased at a far higher speed compared to the budget revenue. The state budget deficit was on average at 5% of GDP in the period of 2001-2008. Budget deficit is financed by domestic loans and foreign loans. Foreign debt outstanding (including Government borrowing and loans guaranteed by the Government) reached USD 21.8 bil. or 24.4% of GDP at the end of 20084). Foreign interest and debt payment in 2008 reached about USD 1.1 bil or 1.7% of total export turnover.
However, a big problem to Vietnam’s budget balance is the transparency and efficiency of the investment financed by the State. Because Vietnam’s statistical classification does not coincide with international practices, there are many off budget expenditures which should be included according to in the ternational norm. It is expected to be over 10% of state budget deficit if international standard are obeyed. With such a high deficit, fiscal balance is highly fragmented concerning payment capacity in the coming years. Recently, budget deficit has been
4) MOF(2009)
050 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy financed by internal and foreign loans under bond issuance to raise capital for transport, irrigation and education projects. are. Meanwhile, efficiency of state investment continues to be rather low.
Last but not least, since the end of 2008, the Government has been loosening fiscal and monetary policies with a stimulus package worth of US$ 9 bil., equivalent to 10% GDP5). If the Government does not supervise this big stimulus package well, budget deficit and trade deficit will be even higher and finally become sources of both serious internal and external imbalances.
2.2.1.5. Exchange Rate
As mentioned before, in the late 1980s, Vietnam had triple digit inflation, multiple exchange rates, and a rapidly depreciating currency in the parallel market. After containing inflation and stabilizing its currency with a wide variety of effective policies, the exchange rate management has evolved significantly in line with international integration as capital liberalization proceeded and external circumstances changed. From 1991-1996, the fixed exchange rate mechanism was applied to maintaining the currency peg of VND to USD at around 11,000. The gradual overvaluation-a side effect of this policy-in the previous period suddenly became a big problem when VND was much overvalued relative to the regional currencies which devaluated in the Asian financial crisis. Therefore, in February 1999, the SBV introduced a new exchange rate mechanism. The central rate was set daily at the average of interbank exchange rates on the previous transaction day with a very narrow band of ±0.1%. From 1999-2009, the band was adjusted several times and now is ±3%. With this mechanism, VND started to crawl (depreciate) very slowly towards the present level of around 17,941 (26 January, 2010).
Figure 1-4 | Dynamics of USD/VND Exchange Rate, 1986-2008
Source: GSO
5) Bvi Tat Thang etal (2009)
051 Chapter1_Macroeconomic Policy As such, in nominal terms, VND almost always depreciate against the USD. Furthermore, according to F. Nixson et al (2009), the VND’s movement in terms of the nominal effective exchange rate, shows 9.8% depreciation in the recent period (2005-2008).
Nevertheless, Vietnam experienced a much higher inflation rate compared to almost all of its major trading partners. The real effective exchange rate has been appreciated, especially since 2008.
Figure 1-5 | Inflation of Vietnam and its Trading Partners : Comparison of Inflation, 2004-2008
Source: ADB (2009)
Figure 1-6 | Real Effective Exchange Rate Index, 1998-2008
Source: Haver Analytics, Morgan Stanley
From 2005-2008, VND experienced a 21.3% appreciation of its currency relative to its trade
052 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy weighted partners. It seems unlikely that such a large real appreciation can be readily absorbed without some impact on general competitiveness, although the global financial crisis of 2008- 2009, for the moment, made it difficult to discern any impact. It is also true that the import content of Vietnam’s exports is extremely high so any change in exports generates an automatic countervailing movement in imports. In addition, many of Viet nam’s exports are priced in dollars, so that the real appreciation has no direct effect on their international price. However, domestic factors of production, in particular labors, are paid in Dong; it seems difficult to believe that their real incomes have not been squeezed. It is hard to be sanguine about this level of real appreciation.
2.2.1.6. Financial Market
Operation of the Commercial Banking System
Vietnam’s commercial banking system has continuously developed since the official operation in the to 1980s, especially from 2005 onwards. By the end of 2008, seven state owned banks including Vietnam Bank for Social Policies (VBSP), Vietnam Development Bank (VDB), and five state owned commercial banks as well as 1,203 the first level branches and transaction centers were present. There are 40 joint stock commercial banks with 898 the first branches and transaction centers. Especially in 2007, Joint Stock Commercial Bank for Foreign Trade of Vietnam (Vietcombank) become the first state owned commercial bank to issue common stock or share to the public for the first time (IPO-Initial Public Offering). Vietnam Bank for Industry and Trade (Vietinbank) also followed suit in the last of 2008. Because the Government holds over 90% shares of these banks, they are graded state owned bank group. as Non state owned bank group includes 39 branches of foreign banks, 5 banks having 100% foreign capital, and 5 joint venture banks.
Figure 1-7 | Some Indicators for Commercial Banking System
The number of commercial bank over the years Charter capital of commercial bank in 2007
NHTMLD: Joint venture commercial bank CNNHTMNN: Branches of foreign commercial bank NHTMQD: State owned commercial bank NHTMCP: Joint stock commercial bank
Source: SBV
053 Chapter1_Macroeconomic Policy The banking system has provided relatively a huge capital for the economy in the past annually accounting for 16-18% of GDP and approximately 50% of the total amount of social capital. This proves that the banking system has developed dramatically and now plays the prerequisite role in connecting production, consumption, and saving.
The banking system was restructured to improve financial soundness and solved bad debts existing since the 1990s. The rate of non performing loans (NPL) decreased from 20% in the 1990s to less than 2% of total credit outstanding in 2007.
Figure 1-8 | NPL Ratio, 2000-2007
Source: SBV
Figure 1-9 | Growth Rate of Credit and Mobilization of The Banking System, 1997-2008
Source: State Bank of Vietnam, annual reports
054 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy Since the Asian currency financial crisis in 1997, the SBV has actively implemented expansionary monetary policy to help the economy overcome the recession. As a result, the growth of capital mobilization and credit of the banking system of Vietnam always maintains a high level. In the period of 1997 2008, the average growth rate of capital mobilization and credit was 30% and 28.8% per year respectively. Credit service remains the major product of the commercial banks in Vietnam with the proportion of outstanding loans accounting for 70% of
Figure 1-10 | Market Share in Deposits of Credit Institutions in Vietnam, 2000-2007
Source: Vo Tri Thanh and Pham Chi Quang (2008)
Figure 1-11 | Market Share in Lending of Credit Institutions in Vietnam, 2000-2007
Source: Vo Tri Thanh and Pham Chi Quang (2008)
055 Chapter1_Macroeconomic Policy the total assets (2007: 71.2%, 1998: nearly 83% of total assets).
A notable characteristic of the formal financial market in Vietnam is that in both the capital mobilization and credit market, although the role of state owned commercial banks have tended to decrease, at the moment they still hold the largest share (over 55%). The joint stock commercial banking sector has the second position in these markets with a sudden increase in the market share in recent years; now the share is over 30%. The sector of foreign banks has third position in these markets.
Figure 1-12 | Credit in Banking System by Customers
Source: Vo Tri Thanh and Pham Chi Quang (2008)
The state owned enterprises (SOEs) are no longer the most important customers of commercial banks. The debit balance of the banking system for SOEs significantly reduced from 52.7% of total outstanding loans in 1996 down to 31.5% in 2007. Meanwhile, the percentage of outstanding loans to other enterprises (such as private enterprises, firms with foreign investment, etc…) in total debit balance increased from 47.3% in 1996 to 68.% in 2007.
In the context of state owned enterprises accounting for 2.2% of total enterprises in the economy but using nearly 1/3 of total credit of the economy it is clear that the distribution of scarce resource is still seriously distorted in Vietnam. Generally, the companies which can access to banking credit are almost medium sized and large enterprises. Data about structure of outstanding loans of joint stock commercial banks system also show this fact. Indeed, although the segment of formal credit market including private enterprises, households and individuals is considered the crucial market of the joint stock commercial banks sector, the average loan size for a client of many banks often exceeds more than 600 million VND6) (2006). Actually, this shows that the banks have not served low income audiences.
056 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy Table 1-6 | Share of Credit by Type of Enterprises
Source: Vo Tri Thanh and Pham Chi Quang (2008) and *calculation’s author based on data from GSO
Securities Market
In spite of nearly ten years of development, the role of the Vietnam stock market as a capital mobilization channel is still very modest. Exception in 2007, capital mobilization from the securities market accounted for 11.7% of the total capital mobilization of the economy while in other years from 2005-2008; this share is 1.4%, 3.9% and 2.2% respectively.
Stock Market
Apart from the year 2000 the securities market had only 4 listed companies. The number of listed companies was 340 in 2008. The market capital has rapidly increased since 2006; in 2005 it reached only 1.1% of GDP; however this was 22.8% and 43% in 2006 and 2007 respectively.
Figure 1-13 | Capital Mobilization Channels of Vietnam Economy, 2005-2008
Source: Author’s calculation from data of State Securities Commission, annual report 2008 (2009)
6) The Bank for the Poor Network(2008), Vietnam Microfinance Assessment Report
057 Chapter1_Macroeconomic Policy In 2008, there was a sharp decline in the market value by nearly 70% of total value; it led to a decrease in total volume of listed shares to 261.438,6 billion dong, equivalent to 19% of GDP. Notably, the total value of the over the counter (OTC) stock market was estimated to be 3-4 folds higher than in the formal market’s.
Bond Market
Vietnam’s bond market remains at the beginning stage of development. Compared to some countries in the same region, the value of Vietnam’s bond market is still low (about 7% of GDP); while it is 21% of GDP in China’s 35% of GDP in Thailand and 62% of GDP in Malaysia. Moreover, the government bonds are mainly issued. Only some state owned commercial banks such as Vitcom Bank, Bank of Investment and Development of Vietnam and some corporations including Vinashin and EVN have issued bonds in this market. The liquidity of this market is still low even through it has improved significantly compared to the early years most investors buy bonds and hold them up to their maturities.
Insurance Market
From 1964, the insurance market had only one Vietnam insurance Corporation (BaoViet) operating the business and implementing state management function. Realizing the especially important role of insurance business towards socio economic development of each nation in 1994, the Government of Vietnam created the legal environment in order to boosting the market development.
Vietnam’s insurance industry has developed quickly over the past years. From the only one insurance company in 2002, the market has gradually grew up with 22 insurance companies in all economic sectors, including 3 state owned companies, 3 joint stock companies, 5 companies having 100% foreign capital, 11 joint venture companies, and over 76.000 insurance agents. At the end of 2008, according to Association of Vietnamese Insurers, there are 26 non life insurance companies, 11 life insurance companies, 1 reinsurance company, and 10 companies of insurance brokerage with nearly 18,000 billion Dong of the total equity. The insurance market also has over 100 non life insurance products and 60 life insurance products. From 1994 to 2002, the average growth rate of insurance market reached 23 % per year and the premium revenue in 2006 achieved 7,685 billion, increasing by 10.3 times compared to 1994. This number was Dong 13,808 billion in 2005 and rose by 10% compared to 2004. Total chartered capital was Dong 7,420 billion, total precautious capital was 23,696 billions, total asset was 30,657 billion, total investment capital of the economy was 26,276 billion in which purchasing bond and deposits was 20,000 billion, and total investment profit was 2,200 billion. In 2007, the non life insurance turnover achieved Dong 8,500 billion, increased by 30%, and the life insurance turnover reached Dong 9,500 billion, grew by 12%.
058 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy In 2008, the insurance market has maintained sustainable growth and increased by 8.22% compared to 2007. The estimated turnover of the market is Dong 26,082 billion in which premium revenue accounts for 78% and investment operation revenue accounts for 21.9%. At the end of 2008, the insurance industry mobilized about Dong 57,000 billions to be invested increasing by over 10,000 billion compared to 2007.
Besides, the insurance market has contributed to developing capital market and achieved Dong 4.000 billion. Insurance companies are now investing with the average growth rate of 180% per year.The development of insurance market generated 76 thousands new jobs and contributed Dong 300 billion to state budget.
The Recent Problems of Vietnam’s Financial Market
Vietnam’s financial market is now mainly dominated by the bank while the credit market is containing many problems as following:
State owned commercial banks account for over 50% of deposit mobilization of the banking system. Traditional customer group of these banks has still be state owned enterprises (SOEs) while the operating information of state owned commercial banking system has not ever been transparence. Meanwhile, it is difficult to assess the real efficient operation of state owned commercial banking system and SOEs. Credit risks have still remained, especially bad debts situation. The rate of overdue debts over total outstanding of the commercial banking system decreased from 13% in 2000 to 3.4% in 2005. By using the international classification method, however, this rate would be even larger. Moreover, the risk of overdue debts continued to increase due to many investment projects have not verified carefully in terms of efficiency and feasibility.
“The double mismatch” (including maturity mismatch and currency mismatch) problem is also significant concern. Currently, short term deposits account for 75% of total deposit but the banking system can use up to 25-30% of short term deposits for loaning in medium and long terms. Although the maturity mismatch reduced in the past three years, its level has been relatively high and also very sensitive with exchange rate and interest rate fluctuation, especially in robust dollarization environment.
The credit risk may increase as commercial banks turnover rely mainly on revenue from lending, though banking services have rapidly developed for recently years. In 2009, 75-80% of domestic bank’s revenue came from lending while that activity only accounted for 20% of foreign bank’s revenue (other 40% came from trading currencies and bonds; other 40% from bank service fees). Moreover, there remains the pressure of lending under Government appointment and “moral hazard” problems. Most loans were mortgaged by real estate while this market fluctuated strongly. Although the share of loans mortgaged by securities was not too much, the low ability of individual investors and security market still can to generate price fluctuation.
059 Chapter1_Macroeconomic Policy Meanwhile, supervision capacity and banking management have had many restrictions. The supervision has not met the requirement. The remote supervision process still has many inadequacies in collecting and classifying information, especially in the context of accounting and auditing standards which are still not applied consistently and popularly. The credit supervision process also does not embrace most of financial institutions related to credit operation because of the lack of coordination among state management offices and financial management models system by financial institutions. The management regulations according to international standard (such as risk management, assets and liabilities management, internal audition, and so on) were applied, but have not been effective and efficient. In general, the management level of banks never met the international standards like CAMEL and BASEL.
Interest rate of government bonds still has not generated the standard yield curve to issue corporate bonds and investment operation in the security market. Capital mobilization through issuing government bonds in the world market is in lack of vision and not clear about long term goals (mobilizing capital for developing infrastructure or for some industries and SOEs). In fact, buyers of government bonds mainly are state owned commercial banks. The primary market is less developed. Public participation in investing government bonds is limited. The judicial system, the standards of announcing information, account, and payment system should be improved as much as possible. The lack of threshold trust organizations is also another reason to hold back the market. It is said that Vietnam now lacks foundation conditions in order to develop the corporate bonds market.
2.2.2. Labor Market
Along with changes in socio-economic life after nearly two decades of Doi Moi, the labor market as an important component in the market system of production factors has been officially recognized and institutionalized by law. If the Labor Act (1994) only stopped at the recognition of the autonomy of workers in looking for jobs and the rights of employers in recruitment, the amended Labor Code in 2002 and legal documents to instruct the implementation of Labor Code took a step further by encouraging employers to create more jobs. Together with incentives regulated in Enterprise Law and Investment Law, the new rules of the legal framework on labor have worked not only to increase the activeness of the workers in looking for jobs, creating jobs, raising incomes, but also to encourage entrepreneurs to expand production and create more jobs.
Quantity of Labor
According to the Labor Code, in Vietnam, range of working age is from 15-60 years old for men and 15-55 years old for women. By the end of 2008, Vietnam’s population stood at 85.1 million, making it the 13th largest country in the world and the third in Southeast Asia. The
060 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy number of people of working age was 54.2 million, accounting for 63.7% of the total population. Not only did population size increase continuously, but the rate of population of working age rose rapidly, so the number of people of working age has increased at a far higher speed than that of population. As can be seen, Vietnam has a huge labor force Each year, about
Table 1-7 | Total Population and Population Aged Between 15 and 59 in Vietnam
*Population rate from 15 to 59 years old Source: Nguy n Dình C (2008)
1.2 to 1.3 million people join the labor force.
The number of employees working in the economy in 2008 was 44.9 million, accounting for 83.5% of the population of working age. The participation rate of female consisted 48% of the labor force in the entire society.
Quality of Labor
Generally, the literacy rate in the total labor force in Vietnam is relatively high (98%) in comparison with many countries having the same level of income in the world, and this rate tends to increase. Illiteracy rate is 1.97%, equivalent to nearly 1.7 million people and mainly concentrated in the age of over 36 (nearly 1.3 million people).
Proportion of trained workers increased over years: from 16.8% in 2001 to 37% of labor force in 2008. This is a low rate in comparison with population size, market needs and demands of a knowledge economy.
According to Vietnam General Confederation of Labor, elementary school workers accounted for 3.7%, lower secondary school workers made up 14.7%, upper secondary schooling 76.6%, secondary technical education and colleges 13.8% and university level 13.24%. On general assessment, skills of workers are still low, the sense of discipline, industrial working style and labor productivity do not meet requirements.
According to a summary report of the Vietnam General Confederation of Labor, the situation of laborer’s qualification, education and vocational skills in the country are currently different between the economic regions and sectors. There are 8.5% of elementary school workers in Central Highlands, the rate of upper secondary school in Hanoi, Ho Chi Minh City
061 Chapter1_Macroeconomic Policy Dong Nai and Central Highland is 76.4%, 35.79%, 38.9% and 49.8%, respectively. There are
Table 1-8 | Education Performance, 2001-2010
2001 2005 2006 2007 2008 est2009 Projected 2010 1. University, college - Number of student
- New enrolment 1.000 of college and 250.0 473.0 521.0 579.0 824.0 900.0 1,008.0 university people
- Growth rate of new enrolment of college and % 47.8 10.0 11.1 13.0 9.2 12.0 university
2. Vocational training and secondary technical education 2.1. New enrolment of 1.000 secondary 148.0 283.0 321.0 388.0 417.5 465.0 535.0 technical people education
- Growth rate of new enrolment of secondary % 20.9 13.4 20.9 16.0 11.4 15.0 technical education
2.2. New 1.000 enrolment of 887.3 1,200.0 1,340.0 1,436.0 1,540.0 1,640.0 1,760.0 vocational people training - Growth rate of new enrolment of vocational % 4.1 11.7 7.2 7.2 7.0 7.0 training 2.3. Proportion of trained workers % 16.8 25.0 27.8 30.5 37.0 38.0 40.0 3. New enrolment 1.000 of postgraduate people 5.9 15.6 17.0 24.0 24.7 33.0 41.0 - Growth rate % 7.6 9.0 41.2 16.7 34.0 23.3 4. Capacity 1.000 building people 30.0 38.0 44.0 45.0 57.0 70.0 78.0 - Growth rate % ?13.6 1.6 2.3 26.7 22.8 11.1
Source: MOLISA (2009) many illiterate workers in some industrial zones in Central Highlands.
The proportion of untrained workers in Hanoi, Quang Ninh, Dien Bien, the Central
062 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy Highlands, Dong Nai and HCM City was in turn 8.8%, 14.5%, 16.27%, 63.3%, 37.9%, and 52.5%. The share of those with university education was 34.5% in Hanoi, 35.1% in HCM City, 37% in Quang Ninh, while that in the Central Highland accounted for just 6.7%.
Although workers have low skill level, investment for improvement of the workers’ qualification rarely takes place. According to the research of Department of Propaganda and Training, investment for improving the qualification for workers is annuallycarried out mainly in state owned enterprises while non state owned enterprises almost have no fund for this activity.
Currently, only 13.2% of workers reach universal education level and 23.1% of workers are cultivated to increase worker level. Nearly 24% of workers recelved elementary and lower secondary education.
Table 1-8 shows that in Vietnam there is an excessiveness of unskilled labor and shortage of skilled technical workers.
In addition, workers in Vietnam are still physicaly weak and lack sense of discipline. According to the Vietnam Institute of Youth, the average height of the Vietnam youth in 2007 was approximately 163.7 cm for men and 154 cm for women. This index was still much lower than that of the international standard and lower than that of some countries in the region such as Singapore, Thailand from 2 cm to 6 cm. Labor discipline and industrial working style have not been formed Most of Vietnamese employees came from rural areas and still take on the agricultural production manner.
Job and Unemployment
Over the past ten years 1.5 million jobs have been created annually. The urban unemployment rate has quickly diminished from 6.4 percent in 2000 to 4.6 percent in 2008, and is estimated to be less than 5 percent in 2010. The proportion of employment in agriculture fastly decreased from 62.2 percent in 2000 to 52.5 percent in 2008.
Although there has been a shift in the labor structure with reduction of work in agriculture and increasing that in industry and service, the proportion of labor working in agriculture with low productivity has still been large, accounting for over 50 percent of total employment working in the economy.
Although the number of annual job created is rather large, the quality is generally low. Jobs are mainly created in agriculture, the household economy, small and medium-sized enterprises, and in industries with simple technology such as garment, leather and footwear, electronic assembling with low income. For example, according to the report of the Institute for Labor
063 Chapter1_Macroeconomic Policy Figure 1-14 | Labor Structure by Three Economic Sectors in 2008
Source: Author’s calculation from GSO’s database
Science and Social Affair (the Ministry of Labor, Invalids and Social Affairs (MOLISA)) about the employment of female workers in 2009, although there are more opportunities they are mainly simple, popular and low paid. Specifically, the highest income in the electronics industry is just from 1.2 to 1.5 million Dongs per month. After subtracting to the expenses such as rent, the saving level of the labor is only from 200 to 400 thousand dongs per month.
Meanwhile, safety at work in most of companies is not ensured so life conditions of the laborers are extremely difficult. In term of housing conditions, there are currently about 2 to 7 percent of laborers in industrial and export processing zones having the right of renting house built by State and companies, Remaining laborers have to rent house from the honseowners. Because of low income most laborers have to rent a very narrow, unhygienic and unsafe room: there are from 3 to 4 people sharing a room with area less than 10m2 while the toilet and the bathroom must be shared with the crowded7). The situation of destitution, loss of hygiene and housing safeness effected to health of the laborers and was one of causes of social evils in the workers. In term of eating, according to summary data from 2008 of Department of Safety and Hygiene (MoH), in 2008, there were nearly 8,000 cases of food poisoning, increased by 18 percent in comparison with 2007, with 56 deaths. The victims of food poisoning are mainly in industrial and export processing zones in large cities. If many food poisoning cases occur to workers in industrial and export processing zones, it is because ration for workers are being paid by their company to the caterers with very cheap price. For example, Dong Nai’s preventive health detected where they provide meals costs just 3,500 dongs, including tax at the beginning of the 2009 for workers. Ration in collective kitchen in Tan Thuan Exporting processing zone has a variety of prices: from 4,500 dong to 8,000 dong per person. The ration’s price is only
7) Le Thanh Ha (2008) some inadequacies in employment and income of workers in our country today 8) ”Enterprises are economical with workers’meals”: http://www.toquoc.gov.vn/Thongtin/Gio-Thu-25/Doanh- Nghiep-De-Sen-Voi-Bua-An-Cong-Nhan.html
064 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy 2,000 dongs per meal such as No.5 with 29 people cooking 1,400 ration per day8). Although the care of meals for employees is the responsibility of the entrepreneurs, at the present, it just depends all on the conscience of business owners. For the occurred food poisoning, business owners are prosecuted with pecuniary penalty of 450,000 dongs under Decree 45/MOH in violation of not supervising kitchen.
In term of working conditions, the status of laborers working manually and heavily with old machinery and outdated equipment accounts a lot. The situation in which workers must work in hazardous environment with heat, dust, noise and vibration without security guarantee still occurrs commonly in companies of all economic sectors. Currently, there are nearly 40 percent of companies having normal and bad working conditions. About 23.5 percent of enterprises have sanitation level at or below average. Protection tools are not properly provided, with about 22.1 percent of workers not fully equipped or not equipped at all. The situation negatively affects worker’s health. The number of workers getting occupational illness accounts for a high proportion-about 17.5 percent, and it is on the rise. In particular, the number of serious occupational accident in the recent years is quite high and this tends to increase rapidly. According to the Ministry of Labor, Invalids and Social Affair, there has been about 5,000 to 6,000 occupational accidents with about 500 dead and over 1,000 injured per year, but if measures to prevent this situation are not actively implemented the number of labor accidents in Vietnam in 2010 are likely to increase to 120,000-130,000 cases per year with the number of deaths up to 1,200-1,300. Simultaneously, according to the warnings of international organizations, the damage caused by occupational accidents and occupational diseases in Vietnam can eat up 4 percent of the country’s GDP 9).
In addition, the status of violations of labor law is still popular. According to the report of the Institute for Workers and Trade Union, some working laborers has not signed labor contracts; many enterprises build and sign collective labor agreement in formality. Currently, 89.6 percent of workers signed labor contracts, of which, the state owned and collective enterprises account for 95.4 and 82.1 percent, respectively. Besides, many signed employment contracts are temporary or short term ones even with workers who have been worked for a long time. Generally, only 50.8 percent of workers signed labor contract for an unspecified time and 31.2 percent of workers signed contracts for a specified time from 1 to 3 years. Only 41.7 percent of workers in foreign-invested enterprises and 30.7 percent of workers in collective enterprises and 37.7 percent of workers in private enterprises signed labor contracts for an unspecified time.10) Increasing hours to excessive violations of provisions of the Labor Code also happen commonly and seriously affect the long term health of workers. As in above report, most workers have to work intensively and long time, namely: 11.3 percent of workers work on average of 8 to 10 hours per day and 4.4 percent of workers work over 10 hours per day and 24.7 percent of workers have to work on average 7 days per week, without holidays.
9) Interview with Deputy Direction of Department of Work Safety, MOLISA (2008), Occupational accident can kill 1,200 workers per year http://www.vnexpress.net/GL/Xa hoi/2008/01/3B9FE3A4/ 10) Le Thanh Ha (2008), some inadequacies in employment and income of workers in our country today.
In terms of share in GDP at current prices, Vietnam’s economic structure has shifted mainly between the agriculture-forestry-fisheries sector and the industry-construction sector, except in 2008. Share of agriculture in GDP has decreased rapidly from 38.1% in 1990 to 27.2%, 24.5% and 22.1% in 1995, 2000 and 2008, respectively. Share of industry in GDP has increased sharply from 22.7% in 1990 to 28.8%, 36.7% and 39.7% in 1995, 2000 and 2008, respectively. The percentage in GDP of service has not fluctuated much with 38.6% in 1990, 1995: 44.0%, 2000: 38.7% and in 2008 was 38.2%.
Source: GSO, Statistical Yearbooks and DSI’s estimates
The agricultural internal structure has made significant progresses in the orientation of industrialization and modernization. The proportion of industrial production value in rural areas has increased from 17.3% in 2001 to 19.3% in 2007. On that basis, it positively affected the shift in labor structure in rural society by accelevating the restructuring of rural households towards increasing more and more households manufaturing industry, trade and services while decreasing the purely agricurural households. The percentage of agricultural households
Figure 1-15 | Shift in GDP Structure by Economic Subsectors, 1990-2008
35.00 30.00 1990 25.00 2000 20.00 % 2008 15.00 10.00 5.00 Other Trade Mining Industry Real Estate Trading Real Estate Processing Industry Processing Agro-Forestry-Fishery Science and Technology Science Electricity and Water Industry and Water Electricity Transportation, Post and Tourism Post Transportation, Finance, Banking and Journalism Finance,
066 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy (including forestry and fishery) decreased by 9.87 percent while that of industrial households increased by 8.78 percent. In 2007, there are 3.6 million industrial and service households in rural areas, up to 62 percent in comparison to 2000.
Growth rate of industrial value added was very rapid. Between 1990 and 2005 indutrial (and construction) value added grew at an average annual rate of 10.9 percent for a 4.72 fold increase over the fifteen year period.
This high industrial output growth rate has been sustained mainly by industrial firms financed by FDI, and since the year 2000 by domestic private investor. Central state owned industry grew only at 12 percent a year over the past decade and local state industry grew by only 7.7 percent per year while FDI industrial firms grew at 19.6 percent annually and the domestic private sector, all be it from a very small base, at 42.8 percent. (GSO, Statistical Yearbooks).
A further major feature of industry in Vietnam is that it is concentrated in specific locations with large parts of the country receiving little industrial investment of any kind. Most industry is concentrated in and around the Hanoi Haiphong area and Hochiming City and its neighboring provinces. Two thirds of all Vietnamese industry currently was concentrated in these two regions. The one third of industrial out put that is not in these two regions is produced predominantly in state owned enterprises that presumably paid less attention to the rate of return on their investments than would have been the case with foreign and domestic private investors.
The high share of the service sector in GDP has a different implication from the high share in industrial countries, where services are dominated by business supporting services such as information technology, communication, finance and banking, insurance, consultancy, research and development (R&D), which enhance enterprise competitiveness. In Vietnam service are dominated by petty trade and low skilled low value added activities to meet consumer needs. These services generate employment for unskilled labourers who are not qualified for job in factories or high value added services. High value added business supporting service which are critical for business in enhancing competitiveness of the whole economy remain underdeveloped and are not capable of meeting the need of the economy. For instance, R&D was responsible for only 0.59 percent in 2008 compared to 0.63% in 1990 and finance and banking just accounted for2.1 percent of GDP in 2008, a 0.7 percentage point increase from 1990.
Labor has shifted from agriculture to industry and services but at a much lower pace than that of GDP. Until 2008, more than 50% of total labor force are still working in the agriculture sector with low productivity (one tenth that of the industry).
2.2.4. International Trade
067 Chapter1_Macroeconomic Policy Table 1-10 | Labor Structure by Three Economic Sectors (%)
Source: GSO, Statistical Yearbooks and DSI’s estimates
International trade is one of most successful fields under the “Doi moi” process. Major achievements of Vietnam’s foreign trade are showed by statistical figures in the four periods of development from 1986 to 2008.
Annual merchandise export turnover grew at the average rate of 28% in the period 1986- 1990; 17.8% in the period 1991-1995; 21.6% in the period 1996-2000 and estimated around 15.7% in the period 2001-2010. Export value per capita increased from the average of 18.1 US$ in the period 1986-1990 to 737 US$ in 2008. Export turnover as a share of GDP increased from the average of 20.5% of GDP in the period 1986-1990 to 70% of GDP in 2008.
Annual merchandise import turnover grew at the average rate of 8.2% in the period 1986- 1990; 24.3% in the period 1991-1995; 13.9% in ther period 1996-2000 and estimated around 17.1% in the period 2001-2010. Import turnover as a share of GDP increased from the average of 37% of GDP in the period 1986-1990 to 90.5% in 2008. The merchandise trade deficit as a share of export turnover fell significantly from 80.4% in the period 1986-1990 to 28.8% in 2008.
With such a high trade to GDP ratio (161% of GDP), clearly that Vietnam integrated highly in the global economy and is more and more economically sensitive to changes in the level of global trade.
2.2.4.1. Composition of Trade Merchandises
Export commodities mainly concentrated on several major items including natural resources, agricultural products and low tech manufactures. Share of top ten products with export turnover exceed US$ 1 billion including crude oil, coal, rice, rubber, coffee, aquatic products, textile and garment, footwear, wood and wood products, computers and electronic products and spare parts contributed 67.2% of total export turnover in 2008, a 8.4% decrease compared to 2005.
Imports mainly concentrated on materials, fuels, equipments and machinery to serve domestic production and exports. Official statistics reveal that all items above accounted for
068 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy Figure 1-16 | Top Ten Largest Export Products in 2008
Source: CIEM (2009), Vietnam’s Economy 2008 around 90% of total import turnover whereas the share of imported consumer goods rose slightly from 7.5% in the period 1996 2006 to 11.4% in 2007. In reality, the import of consumer goods may be much larger than official data due to impossibility of recording smuggling of goods as well as possible misclassification of imports between production and consumer goods.
2.2.4.2. Trading Partners
Major export markets of Vietnam, in descending order, are the United States, European Union, ASEAN, Japan, China and Australia. In the period 2001 2007, export to all these main trading partners grew impressively, for instance, export turnover to the EU increased 2.8 fold, to Japan increased 2.3 fold and to ASEAN increased 2.8 fold. The most prominent achievement is the soar in export to the United State. Export turnover to this biggest market reached US$10.54 bil. in 2007, rising by 10 folds compared to 2001. This performance is mostly attributed to the US Vietnam Bilateral Trade Agreement signed in 2000 and went into effect in 2001.
Regarding to import market, Vietnam imported most from East Asia including China, Singapore, Taiwan (China), Japan, Korea, Thailand, Malaysia, Hong Kong (China). In 2007, 76.3% of total import turnover came from these above markets, rising by 2.6 percentage point from 2001. Imports from EU and the US remained modest, accounting for 8.2% and 2.7% ò total import turnover, respectively.
Data on international trade above show 2 key features (i) Vietnam is a small economy with very high degree of trade openness and; (ii) export structure is highly concentrated by both products and destinations. Therefore, the fluctuations of main export products and markets performance will have large impacts on export performance as well as economic growth.
069 Chapter1_Macroeconomic Policy Furthermore, the most concern in the current export growth model is that a dominant part of export products are raw materials and low tech manufactures with low value added. Although the annual export rose by 16% per year in the period 2001-2010, export of medium and high tech manufactures only accounts for about 15% of total manufacture export in the period 2001- 2007. About 40% of total export turnover are agricultural products (for instance, rice, coffee, pepper, cashew nut, etc) and about 27% of total export turnover are low tech manufactures such as textile and garment, footwear.
Figure 1-17 | Technology Classification of Vietnam’s Exports in 2007
Source: Nixson et al(2009)
Figure 1-18 | Dynamics of Export Composition. 2000-2007
Source: Nixson et al(2009)
070 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy It’s noteworthy to emphasize that, the export structure by technology classification nearly unchanged after nearly 10 years. (Figure 1-18). Share of primary products in export turnover fell down nearly 10% from 2000 to 2007, nevertheless, most of this reduction was transfer to the increase in share of low tech manufacture export while shares of medium and high tech manufacture export remain very small.
As such, Vietnam’s export has just participated in the global value chain mainly basing on static comparative advantages (natural resources and cheap labor cost) but intensive investment in human resources and technology to improve quality and productivity of production. Hence, Vietnamese exporters have no ability to control a part or the whole value chain to receive high value added instead of the very low value added now. All highest value chain segments such as design and product development, marketing, distribution are hold by importers from developed countries. One example is that, Vietnam ranks third in world rice export, however, the price of Vietnamese export rice is 20% lower than the average world rice price which is the cheapest price among 5 world largest rice exporters (in terms of amount) including Thailand, India, Vietnam, the United States and Pakistan.
In addition, Vietnam didn’t focus on developing the industrial sector to establish high value added export chain. As a result, despite that the export turnover reached US$ 60 bil. per year, accounting for 70% of GDP, the value added is very low, only 20-30% of manufacturing exports and 50% of agricultural products and minerals. Since the foreign invested enterprises account for a large part in export turnover and they will transfer profit to their home countries, the local value added which means the increase in income of the Vietnamese, is even much lower.
2.2.5. Investment
Rapid increase in investment plays a vital role in speeding up high economic growth. In the period 1990-2000, total investment increased by 1.4 folds compared to 1990 while share of investment to GDP increased from 25.2% of GDP in 1990 to 34.2% of GDP in 2000. In the period 2001-2010, thanks to significant improvement in business climate, political stability and state prestige raised confidence in Vietnam’s prospect of medium and long term development. Total investment as well as share of investment to GDP increasingly expanded and maintained at high records.
071 Chapter1_Macroeconomic Policy It is noteworthy that the speed of investment expansion by ownership showed significant difference. Over past 20 years, the FDI and non state sectors are leading investors in terms of annual investment growth rate, which are 24% and 19%, respectively or 3-4 times higher than that of the state sector in the same period. With such a high growth rate, after more than 20 years, the non state sector surpassed the state sector for the first time to become the most important investor in the economy by 2007. By 2008, the FDI sector also replaced the state sector to rank second in structure of investment by ownership.
Figure 1-19 | Structure of Investment by Ownership, 2001-2008 (%)
Source: GSO, Statistical Yearbook
2.2.5.1. Foreign Direct Investment
The Foreign Investment Law was first ratified by the National Assembly in 1987, then experienced many times of revision in 1990, 1992, 1996. In order to reject all forms of discrimination against foreign products and businesses, the Law on Investment applied for both domestic and foreign investors was promulgated and enacted since 2005.
Since 1988, FDI began to flow into Vietnam and up to now become an important part of the economy. In the period 1988 2008, there are 35 countries and territories invested in Vietnam with 10,981 projects approved and implemented, amounting to US$ 163.8 bil. The actual amount of implemented reached US$ 54.5 bil., accounting for more than 33% of total FDI committed in the same period. Especially, implemented FDI in 2008 reached US$ 11.5 bil. representing 26.7% of total FDI disbursement in 1988 2007. According to the World Investment Report released by the UNCTAD, Vietnam ranks sixth in terms of foreign investment attraction after China, India, the United States, Russia and Brazil in 2008.
By counterpart, Taiwan (China) topped the list with a total amount of 2,135 approved cases,
072 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy Figure 1-20 | FDI Projects Licensed from 1988 to 2008 by Main Counterparts
Source: Author’s calculation from the National Yearly Statistics 2008 recording nearly US$ 20.9 billion in the amount registered. Following Taiwan (China) were Malaysia, Japan, Singapore and Korea. Korea ranked fifth with 2,153 cases and almost US$ 16.7 billion in the amount registered. The ten largest partners account for 77% of total FDI registered in the period 1988- 2008.
FDI are highly concentrated by kind of economic activity. FDI registered into the manufacturing sector accounted for 49.7% of total FDI approved. Investments committed in real estate and mining and quarrying ranked second (23.1%) and third (6,4%), respectively. Investment in agriculture, forestry and fisheries were so small, accounting for only 2.5%.
It should also be noted that the actual investments made by foreign corporations after obtaining FDI approval only reached 33% of their planned investments in the period 1988-2008. There are many reasons for this slow progress include (i) complicated and time consuming administrative procedures due to the bureaucracy of the Government, an ambiguous legal system, and corruption among government officials; (ii) motive to record high registered FDI from the local government (for achievement) and foreigners (for receiving more land, especially to real estate projects and accelerating administrative procedures etc). While the former should be improved quickly otherwise these impediments may have led to the scaling down or abandonment of investments in the process of carrying out their businesses in Vietnam, the latter should be a significant change in awareness of Vietnamese authorities of role of FDI in which implemented FDI is more emphasized rather than registered FDI.
Foreign invested enterprises play very important role in growth achievements in Vietnam. In 2008, export value of the FDI sector reached US$ 24.5 bil., representing 40% of total export turnover nationwide. It also ranks first in terms of contribution to industrial output value, accounting for 44.6%
073 Chapter1_Macroeconomic Policy Figure 1-21 | Volume of FDI Registered by Sector
Source: Author’s calculation from the National Yearly Statistics 2008 in 2007. Besides, the FDI sector has created about 1.48 mil. of direct employments and millions of indirect employments in other economic sectors.11)
2.2.6. Education Achievement
In recent years, the state spent much more on education, and social mobilization in training and education has gained initial important results. The share of state expenditure for education and training has increased from 15% in 2000 to 20% since 2007. Socialization of education has increased rapidly: in 2000 there were 2.6 million non-public students (accounted for 11.84%), in
Table 1-12 | Educational Scale Period 2000-2010
Estimated Comparison, % 2000 2008 2010 (2010/2000) 1. Number of pre-school students (1000 students) 2,066.0 2,755.0 2,896.2 140.2 2. Number of primary school students *(1000 students) 9,751.0 7,070.0 7,484.0 76.8 3. Number of lower secondary school students (1000 students) 5,915.8 6,270.0 7,240.0 122.4 4. Number of upper secondary school students (1000 students) 2,199.8 3,350.0 3,660.0 166.4
Note: Number of primary school students decreased because the number of the children in school age decreased as a result of reducing the birth rate
11) GSO
074 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy 2008 these were 3.4 million (account for 15%). Contribution of population accounts for 21.8% of total spending on education in the educational institutions.
Thanks to strong investment in education, the educational institution network has been expanded to every communes and wards nationwide. It is forecasted that there are 11,930 pre schools, 15,390 primary schools, 10,820 lower secondary school and 2,894 upper secondary schools in 2010.
Coverage and quality of education system have continued to develop in response to increasing learning requirements of the population
The pre-school enrollment rate of children under five years old was 92.5 percent in 2008. The primary net enrollment rate reached over 99.15%. The lower secondary net enrollment reached 93.5%; it is expected to finish lower secondary school universalization in the whole country by the end of 2010 (63/63 cities and provinces have been recognized standardized secondary school universalization). The scale of upper secondary education continues to develop and the number of upper secondary school students increases by 6.35% per year on average and the rate of student attending upper secondary school at the right age reached 58.9%.
The size and training courses of universities, colleges, technical and vocational training school have been extending, the number of pupils, vocational training and colleges students and universities students increased rapidly. University student intakes increased by 6.65% per year, technical school intakes increased by 9.8% per year and vocational training intakes increased by 8.35% per year. Recruitment structures of every level are adapted to quickly recruit more students into technical and vocational training institutions.
Table 1-13 | Structure of Eduction System by Type of Training, 2000-2010
Est Comparation,% 2000 2008 2010 (2010/2000) 1.University, college Number of universities and colleges 178 393 395 220,0 Number of students (1000 students) 899,5 1.675,7 1.714,0 190,6 -Students/1000 people 115 188 208 180,1 2. Secondary technical education Number of technical schools 253 282 287 113,4 Number of students (1000 students) 255,4 628,8 650,0 254,5 3. Vocational Training education Number of Students (1000 students) 792 1.603 1.763 222,6
Source: Strategic Development Institute (2009, Human resources quality report in the period 2001-2010
The system of vocational training schools has been developed rapidly. By 2009, there are
075 Chapter1_Macroeconomic Policy 2,270 vocational training schools, including 93 vocational colleges, 245 secondary level vocational schools, 757 vocational training centers and more than a thousand manufacturing establishments, business and vocational services. The capacity of vocational training has increased by about 40%.
The content of teaching programs has been renewed and teaching quality is initially improved. The entire universalizing education textbooks form grade 1 to grade 12 have been renovated in new education program and applied in mass all over the country since the year of 2008 2009. Quality of education and training has been raised in some aspect; applications of information technology in teaching and educational management have gradually expanded. In 2000, the number of kindergartens and schools with internet connection were not significant. In 2010, almost 100% of schools will have internet connection; from 2008, the Ministry of Education and Training has conducted handing over to the next shift nationwide through the network. Methods of modern education and training in international standards have initially been applied in experimental places.
Teacher team is enhanced both in quantity and quality. Comparing 2008 to 2000, pre school teachers increased by 1.34 times; lower secondary school teachers increased by 1.36 times; upper secondary school teachers increased by 1.94 times; university teachers increased 1.88 times and technical training teachers increased by 1.66 times. The rate of standardized pre school teachers in 2000 was 51.5% ,in 2007 was 90.3%, respectively at the primary school were 85.3% and 97.1%, secondary school level were 89.5 % and 96.8%, high school level were 95.3% and 97.6%. The rate of university teachers who has upper graduation level increased from 39.1% in 2000 to 49.9% in 2008, in the technical schools that increased from 5.8% in 2000 to 19.4% in 2008.
State management in education has improved. The autonomy to deliver for training establishments has been implemented. Management is focused on improving the quality of education and training. Specified organizations have been formed to evaluate and test the quality of education and training.
The equity in education has been solved better. State increases investment in universal education level and the development of education in disadvantaged areas. The policy of supporting poor pupils, students and preferable students has been implemented widely, with great social impact: in 2000, only 90 thousand students had preferential credit loans, 2009 is 1.3 million, of which 50% are college and university students.
However, the biggest limitation of Vietnam today is still the quality of education. Although the education system has continued reform over the 20 years, the achievement of education is not adequate to meet the cost of the entire society; quality of human resources is still weak and does not meet the requirements of economic development that require high quality gray. It is
076 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy possible to say that, the entire education and training system is being proved that it can not meet the requirements of the life and times.
2.2.7. State Owned Enterprise Reform
The SOEs renovation is not only one of the focus mission but also a sensitive and most difficult reforms in the transition process from centrally planned to market economy. The SOEs reform usually includes two main contents: first, reducing the size of the SOEs; second, implementing institutional reforms to improve the efficiency of state capital invested in SOEs and enhance the performance of remaining SOEs. Vietnam approaches the method of reform through carrying out gradually equitization, diversifying ownership, transforming SOEs to operate in the regime of the modern company.
SOEs equitization process in Vietnam has started since 1992. The State only selected some small and medium sized profitable enterprises which were voluntary to pilot equitization. In four years, from 1992 to 1996, only five enterprises were equitised but they all became more efficiently profitable than they had been before the process began. With about 3,786 equitized stated owned enterprises has operated effectively during 16 years, this guideline has demonstrated its proper and appropriate with the fact. In fact, SOEs equitized in the recent time are mainly independent enterprises under authorization of all Ministries, local government and are the members of the state run business groups and corporations. The State does not need to hold or dominate the small-scale SOEs. For State run business groups and corporations, by the end of 2008, 10 state owned corporations have been equitized. In these corporations, the State still hold a large percentage of shares to ensure the domination and keep the leading role in operating the business (namely: Vietnam Electronic and Informatics Corporation holds 88% of chartered capital; Vietnam Construction and Export Corporation: 63.4% of chartered capital,
Figure 1-22 | Number of SOE Equitized, 1992-2008
Source: Tran Tien Cuong (2009)
077 Chapter1_Macroeconomic Policy Table 1-14 | Contributions of SOEs, 2001-2007
2001 2002 2003 2004 2005 2006 2007
1-Share in GDP (%) 38.40 38.38 39.08 39.10 38.40 37.39 35.93
2-Number of employees (1000 2114 2259 2264 2250 2037 1899 1763 persons) 3-Share in total employees in all 53.76 48.52 43,77 49,00 32,67 28,29 23.90 kinds of enterprises (%) 4-Share in total revenue of all 51.24 51.15 46.38 41.21 38.85 35.82 31.50 kinds of enterprises (%)
Hanoi Beer, Wine and Beverage Corporation: 81.79% of chartered capital, Saigon Beer, Wine and Beverage Corporation: 89.59% of charter capital, Vietnam Insurance Corporation: 77.54% of chartered capital, South River Road Corporation: 51% of chartered capital, Aquatic Construction Corporation: 60.6% of chartered capital, Bank for Foreign Trade of Vietnam (Vietcombank): 90.7% of charter capital, Vietnam Bank for Industry and Trade (VietinBank: 80% of chartered capital). However, the equitization problem now requires a number of strong solutions. The survey shows that the number of SOEs decreased continuously and just accounts for 3.61%. State enterprises is still the sector attracting a large amount of labor (accounting for 32.69%), concentrating the highest capital source (accounting for 54.06%), with high profits (accounting for 41.19%) and contributing the largest share to the state budget (accounting for 40.76%). This result reflects the actual situation of SOEs in capital accumulation, establishment of powerful groups and more effective operation.
2.2.8. Infrastructure
Total investment reached 41.3% of GDP in 2008, in which domestic investment accounted for 72%. Investment in infrastructure (including transport, electricity, telecommunication, water and sanitation, other urban infrastructure) represented 9-10% of GDP. Though this ratio to GDP is relatively high compared to that of other countries in the region (Table 1-15), international organizations such as the WB and ADB still suggested Vietnam to raise this ratio to 11-12% of GDP.
Total capital needs for investment in transport in the period 2008-2020 is about $126.9 billion12) (VND 2,157,196 billion) or $9.7 billion per year (or VND 165,938 billion), according to the Ministry of Transport.13)
078 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy Table 1-15 | Investment in East Asia (% of GDP)
Investment in Investment in Nations Total investment (2003) infrastructure(1998) infrastructure(2003) Cambodia 22 2.9 2.3 Indonesia 16 3.1 2.7 Philippines 19 5.6 3.6 Laos 20 1.7 4.7 China 44 2.6 7.3 Vietnam 35 9.8 9.9 Thailand 25 5.3 15.4
Source: Data on investment from WDI (2005), WB (2005) Investment in infrastructure is cited from “East Asia linkage”, Appendix A, Table 7.
Figure 1-23 | Structure of Investment Needs in Transport by Subsector, 2008-2020
Source: the MOT (2008)
Nevertheless, the estimated capacity of state investment (including the State budget, ODA and government bonds) reaches only $2-3 billion per annum, cover 20-30% of total capital needs. In this context, mobilizing capital from the private sector in the form of public private partnerships (PPPs) is being considered the key contributor to infrastructure developing. It is estimated that private capital could raise an additional $2.5 billion per year.
However, at the moment, nearly 40% of total investment in infrastructure is financed by external resource. The private sector remains modest in the provision of infrastructure services in Viet Nam. Only 18 Build Operate Transfer (BOT) or Business Co-operation Contract (BCC)
12) Convertation is done by the authors exchange rate: 1 USD=17,000 VND 13) Propulsive forces of infrastructure investment http://www.thesaigontimes.vn/Home/dothi/hatang/7122/
079 Chapter1_Macroeconomic Policy projects have been implemented over the past 12 years. Most of these were concentrated in the energy and telecommunications sectors.
Figure 1-24 | Structure of Infrastructure Investment by Sources, 2007
Source: Pham Sy Liem (2007), Developing infrastructure: Opportunities and Challenges
The great investment capital from the Government together with the work execution capacity of constructing companies haves created an enormous change for the Vietnam’s infrastructure system, specifically:
2.2.8.1. The Transportation Network
Within the 5 years (2001 2005), the total of capital construction investment capital from the Government to the transportation sector was VND 63,738 billion. There were 9,268 Km of the road newly constructed, upgraded and repaired. 79,266m of road bridge and 7,433m of road and rail tunnel were newly constructed. 555 km of railway tracks and 6,800 md of rail bridge were upgraded, repaired and rehabilitated. There were 6,014 seaport docking station successfully completed and brought into operation. 4,8 million m3 of sediment were dredged from both nautical and river fairways. There were 17 out of 22 airports brought into service, in which three of them are international airports. The overall service capacity of the airport system has been doubled in respect to the previous 5 year plan.
There was also progress in rural transportation sector, namely: constructing 15,834m length of new roads, upgrading, repairing 88,105km length of various road classes; 150,306 md of reinforced concrete bridge; 16,196md of metal bridges; 37,595m of suspending bridges; 75,515 wood girder bridges; replacing 32,688m length of foot bridges; constructing and repairing 36,672m length of spill weirs
During the period 2006-2008, the newly increased capacity of the road system (new construction and upgrade) was almost 53,000km, including 3,500km of the national high way,
080 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy 49,500km of the local road, approximately 1000km of rail track (25Km of new construction, the rest is upgraded). By the end of 2008, there were about 310,000km of road, 3,200km of railway, seaport capacity pass though of 187 million ton of cargo, and airport pass through capacity of 63 million tons of cargo per annum in Vietnam.
2.2.8.2. Post and Telecommunication
Currently, Vietnam’s telecommunication technology development level is as modern as that of the countries within the region like the application of the Third Generation technology, broadband internet, which have been employed nationwide. A number of important telecommunication infrastructure projects was implemented during the planned period, namely: The Vinasat project has completed and been in service since the end of 2008, meeting the targeted schedule; the Information Technology and Communication Development Project funded by the WB has been deploying; the Telecommunication Project for 10 Center Region Provinces is gradually completed, so the North South fiber cable line is. In 2006 2008 periods, the average investment capital from the Government on telecommunication sector was VND 353 billion per annum. Hence, the increased capacity of the telecommunication and information has gained a sudden increase during the most 3 recent years: By the end of 2008, the number of telephone subscribers per 100 people was 94.35 (exceed greatly the planned number at 35 subscribers per 100 people). In 2008, the number of internet subscribers was 9.1 per 100 people, in 2010 this number is expected to reach 15 subscribers per 100 people (the planned number is 12.6). By the end of 2008, the percentage of household with internet was 24.4%, being 1.9 times as high as this number in 2005.
2.2.8.3. Water Supply System
Water supply system was invested from various capital sources such as ODA, Government, other economic sectors, etc. By 2008, there were 420 water supply systems of all kinds in Vietnam with the total design capacity of 5.48 million m3/day night and the production capacity was 4.2 million m3/day night, equal to 77% of the design capacity (in 1998, the production capacity was 2.1 million m3/day night). The construction, rehabilitation and expansion of the water supply system have been deployed in all cities and municipalities of Vietnam. There have been 300 out of 673 municipalities whose central water supply systems rank from 500 to 5,000 m3/day night. Industrial zones have been supplied with water for the human and production demand. By 2008, the percentage of urban population with access to tapped water was 80%. The rural population with access to safe water was 75%.
2.2.8.4. Irrigation
The total of social investment capital in the agricultural, rural and persian sectors was estimated at VND 530 billion, equal to 30% of the total social investment in the economy. Of
081 Chapter1_Macroeconomic Policy which, the proportion for irrigation was the highest at about 65%, the others include agriculture at 20%, a fishery at 10% and forestry at 5%. During the recent years, objectives to invest in irrigation are: (1) to construct new big reservoirs in the Central and Highland regions. These reservoirs are to protect the downstream areas from flood, to reserve water, and to prevent drought; (2) to build up flood control systems, increasing the ground base to protect flood and secure the citizen’s activities during the flood season in the Mekong region; (3) to build up and upgrade small irrigation systems in mountainous areas, ensuring water security for both production and domestic activities together with the upgradation and security of water reservoirs. Besides, the investment is to fortify and upgrade the sea dike system (especially from Quang Ninn to Quang Nam Province), build up irrigation systems for fishery production and a part of it is to loan under zero interest condition, helping localities fortify their canals. Irrigation investment is mainly to focus on the system supporting rice cultivation (accounting for 80%). According to Irrigation Office under the MARD, by 2008, Vietnam has had 75 big irrigation systems, nearly 1.970 big and small reservoirs and small dams; more than 10,000 pumping stations and 1,000km of main line canels with the total value of VND 100,000 billions.
2.2.8.5. Waste Treatment
Currently, Vietnam has over 740 municipalities (counted only for cities above the level V) and all the municipalities use landfill as a method to tread waste. Averagely, every municipal has one landfill site, of which 85-90% of these sites are not properly designed and are potentially environmental pollution sources. Minority of municipalities has built waste treatment facilities. By April 2009, there are 13 waste treatment plants operating with their total capacity of 2,000 tonnes per day.
On the other hand, there remain bottlenecks in Vietnam’s infrastructure system. Every industry had its own planning. However, these planning are poor projection quality and low level of cooperation and consistence. Thus, in general, the quality of planning is still low and planning adjustment does not catch up with the real situation. This together with the poor human resource has created gaps, which is not meeting the demand of the economy and domestic activities such as road traffic jam, overload in seaports, poor quality of transport service. All these things do not make it possible for the development of multi modal transportation and logistics service to increase the competitiveness, especially in the global integration context.
The expansion of the urban transport system is not in line with the urbanization process. Urban transport projects proceed slowly, and fail fo meet the planned schedules. This result mainly from the resettlement, compensation and land acquirement. Despite this fact, during years, there remain no effective solutions and the obvious responsibility for the huge dissipation by the lagged projects.
082 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy Transportation projects have not focused on their relationship between inputs and outputs, especially in seaport and airport projects, causing the low efficiency of the invested projects.
Recently, water supply projects attract investment from other sources rather than the Government budget. However, they still have difficulties from users due to the cost recovery issue, which is directed by the Prime Minister.
For many years, although railway and river transport has their comparative advantages over other transportation methods in Vietnam, they are unable to promote these advantages due to issues both from investment and management sides.
The most important thing in investment is the capital sources. Naturally, due to the public service characteristics of infrastructure and the less developed country situation of Vietnam, the investment sources for infrastructure in the country are mainly from ODA, the government budget, those related to the Government like government bonds, corporate bonds under the guarantee of the Government, SOEs(the proportion under the management of the government). This creates the under performance of infrastructure systems due to the lack of capital and burden for the State which has to pay interest over a long period.
Most infrastructure systems when in service do not have proper maintenance system particularly in transportation, water supply and environmental sectors. This results in the quick deterioration for the systems and re-investment before expiration, putting more pressures on investment resources in infrastructure.
2.2.9. Income Distribution
In the period of rapid economic growth, Gini index by income per capita in Vietnam has increased slightly from 0.34 (1993) to 0.35 (1998), 0.37 (2002) and 0.36 (2006) which showed that the income distribution inequality has not been a problem in Vietnam.14) However, concerning inequality among regions and ethnic groups, the level of inequality is much more serious.
Income disparity between the richest households and the poorest households increased continuously over the years. The income difference between 20 percent richest and 20 percent poorest groups increased from 7.6 times in 1999 to 8.1, 8.3, 8.4, 8.5 times in 2002, 2004, 2006 and 2008, respectively.15)
Despite impressive achievements in poverty alleviation across the country, there remains a
14) MPI (2008) 15) MPI (2008, 2009)
083 Chapter1_Macroeconomic Policy large gap between urban and rural areas, including high poverty incidences in mountainous areas and among ethinic minority groups. Urban poverty rate sharply decreased from 25.1 (1993) to 9.2 (1998) and 6.6 (2002) and down to 3.6 (2004) and 3.9 (2006). Meanwhile, rural poverty rate also decreased but not as fast as urban, from 66.4 (1993) to 45.5 (1998) and 35.6 (2002) and down to 25.0 (2004) and 20.4 (2006). This made the difference in poverty rate between urban and rural widen from 2.65 times (1993) to 4.95 times (1998), 5.4 times (2002) and up to 6.94 times (2004).16) In addition, the poverty incidence in the Kinh and Chinese group was 10.3 compared with 52.3 among the ethnic minorities; the poverty gap of Kinh and Chinese group was just 2.0 while that of ethnic minorities was 15.4.17)
State investment in infrastructure varied greatly among regions. Rural road building and upgrading in the mountainous areas and the Mekong River Delta still face many difficulties: about 20% of communes in the North West region and the Mekong River Delta do not have vehicle access to the commune centre. In addition, the hamlet connected road systems are unequal among regions and provinces. The hamlet connected road systems are most developed in the Red River Delta and central southern region. The quality of hamlet connected road systems in other regions especially in the North West, North east regions and Central Highlands is still limited. The number of communes with hamlet connected road systems in those regions with more than 50% concrete paved roads is only around 20%; in the North West region it is only 7.1%. In Ca Mau, only 25.9% of communes have vehicle access to the centers of the commune and there are only 25.9% of the communes with year round vehicle access, and there are only 22.2% of the communes that 50% hamlet-connected-roads which were built by concrete.18)
In short, there is trend shifting from the inequality between rural and urban to the inequality between ethnic minorities and the Kinh/Hoa group in Vietnam. In other words, the significant inequality between urban and rural areas in general are more deeply carved into inequality between rural mountainous areas and delta areas where major residents of two regions are ethnic minorities and the Kinh/Hoa. It is the gap between regions/areas that has been occurring and increasingly being deep from 1993. According to this view, the problem concerns about inequality between rural and urban areas in general are becoming the problems of rural mountainous areas. The attention on poverty problem, therefore, is transferred from rural areas into rural mountainous areas. That means, the poverty problem in Vietnam in the near future (now are starting to clearly show) is the poverty problem of rural mountainous areas and of ethnic minorities.
16) Do Thien Kinh (2007) 17) Do Thien Kinh (2007) 18) MPI (2009)
084 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy 3. Evaluation of Vietnam’s Economic Growth from an International Perspective 3.1. Background
Since 1986, Vietnam has pursued a process of comprehensive market oriented reform and gradually integrated itself into the global economy. At least partly as a result, the growth rate accelerated after the reform and the annual average GDP growth rate since 1992 recorded above 6 percent (Figure 1-25). In addition, growth became much more stable after the reform, as can be seen from the longer time series data (Figure 1-26). As a result of this growth acceleration, Vietnam’s living standard by per capita GDP has improved continuously, not only relative to its own past but also relative to other countries and regions (Figure 1-27). However, there still remains huge income gap to close relative to other countries and regions. Figure 1-28 shows the trends in per capita GDP of Vietnam together with those of other countries and regions. As of 2006, per capita GDP of Vietnam is just comparable to the average of Sub Saharan African countries, but it is far below East Asian or industrial countries.
Figure 1-25 | GDP Growth of Vietnam (WDI Data)
GDP Growth Rate % 8 7
6 5 2.47 6.12 6.19 4 3 2
1 0 1985 1988 1991 1994 1997 2000 2003 2006
The growth acceleration was accompanied by high and rapidly rising investment rate (Figure 1-29). In the mid 1990s, the investment rate of Vietnam was already higher than the averages of industrial countries and Sub Saharan African countries, although it was a little bit lower than the average of other East Asian countries. Since then, the investment rose further to become one of the world’s highest since the 2000s. This high investment rate in the 2000s, which was led by large SOEs together with various symptoms of macroeconomic imbalance discussed earlier, raised concerns about the healthiness of Vietnam’s economy.
085 Chapter1_Macroeconomic Policy Figure 1-26 | GDP Growth of Vietnam (Maddison’s Data)
Vietnam East Asia Korea Industrial Sub -Saharan Africa
086 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy Figure 1-29 | Vietnam’s Income Level Relative to Other Regions
40
35
30
25
20
15
10
5
0 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 Vietnam East Asia Korea Industrial Sub-Saharan Africa
In terms of projecting the growth of Vietnamese economy for the upcoming decade, two questions arise from these developments. The first one is whether Vietnam has successfully made a “take off” and is moving along the catch up transition path, and the second one is, even so, whether the country is likely to sustain its catch up growth. Given that rapid economic growth has sustained for about two decades, the answer to the first question seems apparently obvious.
However, other features of Vietnamese economy, such as the rapid demographic transition, are also consistent with the view that the country has successfully ignited growth and is possibly on a catch up transition path. A class of recent growth theories, so called the unified growth theories, suggest that the growth process of can be viewed as a process of diffusion of Western industrial revolution to the rest of the world. These theories posit two steady state equilibria: one Malthusian equilibrium with high fertility, low human capital investment, and low growth, and the other modern growth equilibrium with low fertility, high human capital investment, and high growth. According to these theories, every country in the world is envisaged to be either on one of these two equilibria or on the transition from the Malthusian to the modern growth equilibrium. Countries that get out of the Malthusian equilibrium and joins the industrialization process receives the benefits of backwardness and catch up with the frontier countries. According to these theories, a country which makes a transition out of the Malthusian poverty trap is expected to experience a rise in the rate of return to human capital investment as well as a drop in fertility rate. As fertility rate falls, a demographic transition is expected to accompany the growth take off. A typical cycle of demographic transition is illustrated in Figure 1-30. A typical demographic transition is preceded by the fall in the death rate, later followed by the fall in the birth rate. As a result, population growth rate initially rises but falls afterwards. The working age population ratio rises, after a brief initial fall, and then falls again at the later stage.
Fertility rate and death rate Population growth and working-age population ratio
Population Birth Growth rate Share Deathrate Working
Birth rate Percent in Birth rate Minus workforce Death rate Death rate Growth Time Time
Figure 1-31 to 1-34 show that the movements of various demographic indicators in Vietnam are consistent with the view that the transition from the Malthusian to modern growth equilibrium has already begun to is already takineg place in Vietnam. The fertility rate, as well as the death rate, has fallen at a rapid pace, reaching the level almost comparable to those of East Asia and industrial countries. Population growth rate has also been declining from the peak in mid 1980s. The working age population ratio of Vietnam has been rising gradually for the past decades, but as of 2000s, it is still below those of other East Asian countries or industrial countries. Furthermore, one recent study shows that there is a tendency that countries with faster speed of demographic transition also experiences faster human capital accumulation and faster growth.19) In this regard, what is notable from these figures is that the speed at which the demographic transition is taking place in Vietnam seems fast relative to other regions: it is comparable to East Asia, which has experienced both the most rapid demographic transition and the most rapid growth during the second half of last century. Thus, the growth acceleration that took place in Vietnam since the late 1980s is likely to reflect some fundamental changes in the working mechanism of the economy.
The second question, whether Vietnam is able to sustain the high growth, is more important for the purpose of projection but difficult to answer. One implication of the unified growth theories is that once a country gets out of the Malthusian poverty trap, the forces of convergence arising from the “advantages of backwardness” makes the country to sustain catch up growth. Although this might be a too simplistic view of the growth process, there is ample evidence that late comers grow faster with international knowledge spillovers working as the force of convergence. In particular, if we look at the long run trends of per capita GDP in various regions, we do see some evidence that is consistent with this view. Figure 1-35, from Lucas (2002), shows that as the industrial revolution spread to other regions of the world, one country
19) Hahn and Park (2008) shows that countries with faster speed of demographic transition experiences faster human capital accumulation and faster growth.
088 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy Figure 1-31 | Fertility Rate of Vietnam
Vietnam East Asia Korea Industrial Sub-Saharan Africa
after another joined the industrialization process. It also shows that, although not without exceptions, there is certainly a tendency that countries/regions that joined this industrialization process grow faster.
Figure 1-35 | Long Run Trend in GDP per Capita in World’s Major Regions
18000 ѓ 15000 є ѕ і 12000 ї
9000 1985 Dollal
6000
3000
0 1700 1750 1800 1850 1900 1950 2000 2050 ѓ: UK, Canada, Australia, New Zealand є: Japan, ѕ: France, Germany, Netherlands, Scandanivia і: Rest of Western Europ, Latin ї: Asia(Except Japan), Africa
However, growth process in reality is more subtle. In particular, sustaining growth is considered to be more difficult than igniting growth (Rodrik 2005). Existing empirical evidence suggests that sustained growth episodes are rare; although there were many growth spurts, not many of them sustained. It is also well understood that developing countries’ growth rates are more volatile and variable over time compared with developed countries’ growth. Rodrik (2005) argues that in order to sustain growth, a country needs, above all, to develop and strengthen institutions that enable the economy to maintain productive dynamism as well as
090 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy resilience to external shocks, under the changing domestic and external environment. He goes on to argue that a country’s growth strategies should reflect policy priorities and that these policy priorities should be based on the assessment of the most binding constraints that particular country faces.
The binding constraints the Vietnamese economy faces are discussed elsewhere in this paper and will be summarized later on. As a complement analysis, in the following sub sections, we use growth accounting and cross country regression approaches to assess the growth performance of the Vietnam in a broad international perspective, with a focus on the 2000s. Although these exercises are a convenient way of summarizing key features of the Vietnamese economic growth, we pay particular attention to the respective roles of total factor productivity growth (TFPG) and inputs accumulation. Our focus reflects the prevailing concern that the rapid economic growth of Vietnam in the 2000s is so much input driven, i.e., investment driven and not productivity driven that it may not be sustainable.
3.2. Sources of Vietnamese Economic Growth: An International Perspective
3.2.1. Methodology and Data
Growth accounting is a methodology that decomposes growth of output into contributions from inputs accumulation and residual (total factor productivity growth: TFPG), and gives us proximate causes (or sources) of growth, not ultimate causes of growth. It is a convenient way of summarizing key characteristics of growth. In this study, we follow the methodologies used by Collins and Bosworth (2003). Specifically, we assume that the aggregate production function is of the Cobb Douglas form with constant returns to scale.
(1)
Here , denotes output (real GDP), capital stock, labor input (economically active population, or EAP), respectively. A is a parameter for the technology level, and is the output elasticity of capital . If we take log differentiation of the above equation, we get the following growth accounting formula.
(2)
Equation (1) decomposes output growth into contribution from TFPG (= ) and contributions from growth of capital stock and growth of labor input.
An alternative way of expressing the aggregate production function is as follows:.
091 Chapter1_Macroeconomic Policy (3)
Where EAP(=L), WAP, and POP denotes economically active population, working age population, and total population, respectively. Log differentiation of the above equation gives us an alternative growth accounting formula.
The country sample in this study covers 84 countries for the period from 1960 to 2006. For Vietnam, the period covered is from 1991 to 2008. The output is the real GDP from Penn World Table 6.2 for the period 1960-2004, and was extended up to the end of the sample period, using real GDP growth rate from Word Development Indicator (WDI). Population, working age population, economically active population were taken from WDI dataset. The capital stock data for countries other than Vietnam was taken from Nehru and Dhareshwar (1993) and extended up to 2006, using real investment data from WDI. Vietnam, however, is not included in the Nehru and Dhareshwar (1993) dataset, so we had to find alternative estimates of Vietnam’s capital stock series. We used two estimates of Vietnam’s capital stock series. The first capital stock data was constructed in the following way. We estimated the initial capital stock for Vietnam that are comparable to other countries by running a simple regression of capital output ratio on per capita GDP. Multiplying the estimated capital output ratio with the real GDP gives us the initial capital stock estimate for the year 1994. Then we used the real gross domestic capital formation data from WDI to construct the capital stock series, following the same perpetual inventory method used by Nehru and Dhareshwar (1993). Here, the depreciation rate was common across countries at 0.04. Since the time period covered in this procedure is fairly short, the growth accounting results might be quite sensitive to the biases in the estimate of the initial capital stock. Thus, we employed an alternative capital stock estimate taken from an existing study (Tran et al. 2005), which is widely quoted in studies on Vietnam. The capital stock from this source covers the period from 1984 to 2004. We used the growth rate of the capital stock to perform growth accounting exercises.20)
3.2.2. Results
Table 1-16 shows the growth accounting results based on equation (2). The upper panel of the table is based on capital stock series estimated in this study, and the lower panel of the table is based on capital stock series from Tran et al. (2005). We discuss the results mainly based on the lower panel. During the period 1991-2008, the annual average GDP growth rate was 6.5 percent. The growth of capital stock accounts for a large portion of this growth, 2.9 percentage points, and the growth of labor input accounts for about 1.3 percentage points. So, the
20) The capital stock series was extended up to 2006 under the assumption that the growth rate of the capital stock for the extended period is the same as that of the annual average growth rate of the capital stock for the period 2000-2004.
092 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy accumulation of inputs accounts for slightly less than two thirds of GDP growth. The contribution from TFP is 2.3 percent, which is slightly more than one third of GDP growth.
Table 1-16 | Sources of Growth in Vietnam
Time Period GDP growth Raw Capital Raw Labor TFP(Raw Input)
Turning to the period 2001-2008, which is the period of our primary concern, we still find that a significant portion of output growth is accounted for by the increase of TFP, which is 2.8 percentage points. If we compare the 2000s with the 1990s, we see an increase in GDP growth rate. Although the contribution from capital stock increased somewhat, reflecting the increase in investment rate in the 2000s, it does not fully account for the increase in GDP growth rate in the later period. As a result, the estimated TFP growth rate in the 2000s is higher than in the 1990s. This result casts some doubt on the validity of the prevailing concern that the respectable growth performance of Vietnam’s economy in the 2000s should be discounted because it was not accompanied by a comparable improvement of aggregate productivity.
An alternative decomposition results are presented in Table 1-17.21) The first column shows that the annual average GDP grow rate increased from 5.8 percent in the 1990s to 7.4 percent. In per capita or per worker22) terms, the increase in growth rate is more pronounced, reflecting the slowdown in the growth of population or economically active population over the two sub periods. The per worker growth rate of Vietnam increased from 3.4 percent per annum in the 1990s to 5.2 percent per annum in the 2000s. The table also shows the decomposition of per worker GDP growth rate into the contribution from TFPG and the contribution from the increase in per worker capital stock. It is clearly seen that although the contribution from the per worker capital stock increased significantly over the two sub periods, the TFPG also increased substantially from about 1.8 percent to 2.8 percent per annum. Table 1-18 shows that the
21) From now on, the growth accounting results we discuss here is based on the capital stock data from Tran et al. (2005) unless otherwise mentioned. 22) Here, worker means economically active population.
093 Chapter1_Macroeconomic Policy difference in per worker GDP growth rate over the two sub periods, which is 1.6 percent per annum, is attributable not only to the increase in per worker capital stock but also to the increase in TFP (about 1.0 percentage point). Thus, our simple growth accounting exercise shows that the improved growth performance in the 2000s was accompanied by non negligible improvement in TFP and, hence, the increased investment rate of the Vietnamese economy in the 2000s was not largely a waste of resources.
Table 1-17 | Alternative Decomposition of GDP Growth in Vietnam (1991-2008)
Contribution by component (percentage point) GDP GDP GDP growth growth Growth growth EAP/ WAP/ per per TFP K/L POP of EAP capita worker WAP POP
A b c D E f G h i =b+h =a-h =a-i =c+i =c+f+g =d+e 1991-2000 5.82 4.20 3.36 1.81 1.55 1.60 -0.77 1.62 2.46 2001-2008 7.43 6.13 5.18 2.81 2.37 1.11 -0.16 1.30 2.25 1991-2008 6.54 5.06 4.17 2.26 1.91 1.38 -0.50 1.48 2.37
Note: EAP = Economically activity population, WAP = Working age population, POP = Total population.
Table 1-18 | Decomposition of Increase in Growth Rate: 2001-2008 VS 1991-2000
Note: EAP = Economically activity active population, WAP = Working age population, POP = Total population. Numbers below the fourth column denotes the magnitude of contributions to GDP growth.
However, examining a single country’s growth experience based on growth accounting might have only a limited relevance. The reason is that since growth accounting results are well known to be sensitive to methodology and data, studies that are different along these dimensions can produce quite different pictures of the growth performance of the country involved. Thus, there is a strong case for comparing the growth accounting results for Vietnam with a broad set of countries, based on common methodology and data.
094 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy Table 1-19 and Figure 1-36 show the results for our 84 country sample. The regional averages were calculated using ppp adjusted GDP as weights. The table shows several well known features of world growth experiences since the 1960s the end of Golden Age and productivity slowdown of industrial countries after the first oil shock, rapid catch up growth of
Table 1-19 | Sources of Growth in Vietnam and Major Regions: 1960~2006
096 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy Figure 1-36 | Sources of per Worker GDP Growth in Vietnam and Major Regions
1961-2006 1961-1970
10 10 TFP TFP 9 9 K/L 8 K/L 8 7 7 6 6 5 5 3.3 4 1.6 4 1.8 2.7 3 3 2.3 1.1 2.1 1.8 1.1 1.9 2 3.0 1.0 2 1.1 0.6 2.8 1.7 1.5 1.5 1.5 1.8 1 2.3 1.7 0.4 1.2 0.3 1.6 1 1.1 1.1 1.0 0.7 0.6 0.1 0 0 a A re East Latin East Latin China Ko Africa China Korea Africa Industrial SouthA Industrial SouthA MiddleA Middle
1971-1980 1981-1990
10 10 TFP TFP 9 8 K/L 8 K/L 7 6 6 5 0.8 4.7 3.4 4 2.1 4 2.2 0.1 3 1.5 3.8 0.4 2.4 2 0.0 2 0.6 2.5 1.3 2.7 1.1 2.8 1.9 1.6 2.2 1.8 0.3 1 1.0 0.9 1.6 1.0 0.7 -1.1 0.1 0.6 0 0 -0.1 -1.7 East rica China Latin Af -2 Korea SouthA Industrial MiddleA A orea East Latin frica China K A Industrial SouthA Middle
-2 -2 ea or East rica A China K Latin Af East Industrial SouthA MiddleA ietnam China Korea Latin Africa iddle V Industrial SouthA M Vietnam -4
East Asian countries, the lost decade of Latin American countries, and growth tragedies of Sub Saharan African countries, the rise of China since the late 1970s, etc. which have been documented and examined numerously elsewhere. In addition, the figures in the table are also
097 Chapter1_Macroeconomic Policy consistent with the findings of Easterly, Kremer, Pritchett, and Summers (1993) that capital accumulation of countries is more persistent over time than TFPG.
Above all, the table clearly shows that Vietnam’s GDP growth or per worker GDP growth is higher than most other countries or regions in the 2000s. Vietnam’s economic growth in the 2000s is even more respectable in the sense that it was achieved in spite of the growth slowdown in the most regions of the world: Vietnam’s GDP growth rate in the 2000s was higher, rather than lower, than in the 1990s. It is true that much of this rapid growth is attributable to capital accumulation, as can be seen from the contribution from per worker capital stock which is large by international standards. However, the TFPG growth rate recorded by Vietnam during the period 2001 2008, which is 2.8 percent, is also higher than most other countries or regions. During the same period, the weighted average TFPG of the 84 country sample, as well as that of industrial countries, is only 0.5 percent per annum, while the TFPG of Korea and other East Asian countries (excluding China) is about 1.5 percent. Vietnam’s TFPG performance in the 2000s is comparable to that of China which recorded 2.7 percent. In terms of TFPG rank, Vietnam ranks the 8th among 84 countries in the 2000s (Table 1-20).
Meanwhile, one might raise a question whether the Vietnam’s high per worker GDP growth, per worker capital growth, and TFPG in the 2000s are, to a large extent, attributable to Vietnam’s low income level. To some extent, they might reflect the beneficial forces of convergence or advantage of backwardness. However, even after we account for these forces using a cross country regressions framework, Vietnam’s growth performance is highly
Table 1-20 | Vietnam’s TFPG Rank in 84 Country Sample
TFP w/o Human capital
Vietnam Korea 25% 50% 75% 39 Finland Egypt New Zealand 1961-70 (1.6) (2.3) (1.5) (0.6) Italy Cameroon Ethiopia 1971-80 47 (0.8) (1.8) (1.1) (0.1) 4 Ireland Australia Colombia 1981-90 (3.4) (1.1) (0.3) (1.2) 16 20 Cyprus Peru Japan 1991-00 (2.1) (1.5) (1.4) (0.8) (0.4) 8 16 Malaysia Algeria Morocco 2001-06 (2.8) (1.7) (1.5) (0.6) (1.3) 11 Spain Indonesia Ethiopia 1961-06 (1.8) (1.3) (0.8) (0.1) respectable in the 2000s (Table 1-21 to 1-24). Thus, even from an international perspective, Vietnam’s economic growth in the 2000s cannot be discounted simply because it was
098 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy Table 1-21 | Vietnam’s per Capita GDP Growth: Cross-Country Regression
Variable Model 1 Model 2 Model 3 Model 4 0.020*** -0.328*** -0.362*** -0.320*** Constant (18.26) (-8.80) (-9.31) (-8.78) 0.022 0.009 0.004 0.008 90 x Vietnam (1.01) (0.48) (0.24) (0.46) 0.042** 0.025 0.020 0.026 00 x Vietnam (1.97) (1.34) (1.10) (1.42) Per capita GDP -0.011*** -0.015*** -0.017*** (relative to US) (-6.83) (-8.08) (-9.46) Life expectancy 0.085*** 0.089*** 0.080 an birth (9.68) (9.70) (9.27) 0.002 0.002 Trade Share (0.70) (0.57) 0.003*** Institutional Quality (3.43) 0.009*** Rule of Law (6.16) Decade dummy X O O O R_square 0.012 0.283 0.326 0.359 Obs. 401 399 369 387
Note: Pooled OLS regressions. Dependent variable is per worker GDP growth rate. Numbers in parenthesis are t statistics. Coefficients with asterisks are 1%(***), 5%(**), and 10%(*) level, respectively. The regressions include decade dummy variables. Table 1-22 | Vietnam’s per Worker GDP Growth: Cross-Country Regression
Variable Model 1 Model 2 Model 3 Model4 0.017*** -0.239*** -0.270*** -0.226*** Constant (14.61) (-5.93) (-6.41) (-5.75) 0.019 0.010 0.005 0.010 90 x Vietnam (0.82) (0.50) (0.25) (0.52) 0.037 0.025 0.021 0.027 00 x Vietnam (1.61) (1.24) (1.02) (1.39) Per capita GDP -0.010*** -0.015*** -0.016*** (relative to US) (-5.52) (-7.08) (-8.40) Life expectancy 0.064*** 0.066*** 0.057*** an birth (6.70) (6.65) (6.15) 0.002 0.000 Trade Share (0.41) (0.10) 0.004*** Institutional Quality (3.96) 0.010*** Rule of Law (6.64) Decade dummy X O O O R_square 0.008 0.246 0.296 0.332 Obs. 401 399 369 387
Note: Pooled OLS regressions. Dependent variable is per worker GDP growth rate. Numbers in parenthesis are t statistics. Coefficients with asterisks are 1%(***), 5%(**), and 10%(*) level, respectively. The regressions include decade dummy variables.
099 Chapter1_Macroeconomic Policy Table 1-23 | Vietnam’s per Worker Capital Growth: Cross-Country Regression
Variable Model 1 Model 2 Model 3 Model 4 0.009*** -0.060*** -0.074*** -0.065*** Constant (15.37) (-2.67) (-3.11) (-2.85) 0.005 0.006 0.005 0.006 90 x Vietnam (0.40) (0.57) (0.48) (0.56) 0.016 0.012 0.011 0.013 00 x Vietnam (1.32) (1.13) (1.02) (1.18) Per capita GDP -0.002** -0.003*** -0.004*** (relative to US) (-2.23) (-2.83) (-3.30) Life expectancy 0.017*** 0.020*** 0.018*** an birth (3.32) (3.58) (3.37) -0.000 -0.001 Trade Share (-0.23) (-0.44) 0.001 Institutional Quality (1.22) 0.002** Rule of Law (2.23) Decade dummy X O O O R_square 0.005 0.167 0.189 0.187 Obs. 396 386 357 375
Note: Pooled OLS regressions. Dependent variable is per worker GDP growth rate. Numbers in parenthesis are t statistics. Coefficients with asterisks are 1%(***), 5%(**), and 10%(*) level, respectively. The regressions include decade dummy variables.
Table 1-24 | Vietnam’s per Worker TFP Growth: Cross-Country Regression
Variable Model 1 Model 2 Model 3 Model 4 0.007*** -0.182*** -0.198*** -0.163*** Constant (7.61) (-5.01) (-5.18) (-4.54) 0.014 0.004 0.000 0.004 90 x Vietnam (0.73) (0.24) (0.02) (0.24) 0.021 0.014 0.010 0.014 00 x Vietnam (1.11) (0.75) (0.56) (0.82) Per capita GDP -0.007*** -0.011*** -0.012*** (relative to US) (-4.61) (-5.73) (-6.87) Life expectancy 0.047*** 0.047*** 0.040*** an birth (5.47) (5.19) (4.66) 0.002 0.001 Trade Share (0.67) (0.46) 0.003*** Institutional Quality (3.19) 0.008*** Rule of Law (5.57) Decade dummy X O O O R_square 0.005 0.152 0.188 0.221 Obs. 388 386 357 375
Note: Pooled OLS regressions. Dependent variable is per worker GDP growth rate. Numbers in parenthesis are t statistics. Coefficients with asterisks are 1%(***), 5%(**), and 10%(*) level, respectively. The regressions include decade dummy variables.
100 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy investment driven. It is true that a large part of the growth is attributable to the rapid capital accumulation, but it should be noted that Vietnam’s rapid growth in the 2000s was accompanied by TFP improvement which is highly respectable by any international standard.
3.3. Vietnam’s Growth in Comparison with“ Open”Economies
It was noted earlier that what makes a country to sustain catch-up growth is a question that is difficult to answer. Although various determinants of growth have been proposed in the literature, unfortunately, the consensus has not emerged yet on what set of policies are sufficient to ensure a country to sustain catch-up growth.23) Nevertheless, there seems to be a wide consensus that openness is one necessary condition, though it may not be a sufficient condition. One prime example is Lucas (2009). Lucas re-interprets the empirical evidence of Sachs and Warner (1995) and suggests that open countries tend to converge. Sachs and Warner (1995) looks at post War growth experience of a broad set of countries and argues that open countries grow faster. Here, they classify a country as open if non of the following conditions are satisfied: 1) average tariff rates higher than 40 percent, 2) non-tariff barriers cover on average more than 40 percent of imports, 3) a socialist economic system, 4) state monopoly of major exports, and 5) black market premium exceeds 20 percent. Figure 1-37 to 1-39 from Lucas (2009) show the relationship between initial income and subsequent per capita GDP growth rate for three periods in varying length, distinguishing between open and closed countries. We added Vietnam into the figures with a solid dot, so that we can see where in the figure Vietnam is located. It is not clear whether Vietnam should be classified as an open or closed economy according to the above criteria. Vietnam is likely to be a closed country in the earlier period, but it is likely to be an open country in later period. As argued by Lucas, there is see a tendency that
Figure 1-37 | Initial Income and Subsequent Growth(1960-2006)
23) See the “Growth Report” of the Commission on Growth by World Bank (2008) for a recent summary of the discussion on this issue.
101 Chapter1_Macroeconomic Policy Figure 1-38 | Initial Income and Subsequent Growth(1980-2006)
8%
6%
4%
2%
0%
-2% 0 5,000 10,000 15,000 20,000
-4%
-6%
-8%
Closed Open Vietnam
Figure 1-39 | Initial Income and Subsequent Growth (1990-2006)
8%
6%
4%
2%
0%
-2% 0 5,000 10,000 15,000 20,000 25,000
-4%
-6%
-8%
Closed Open Vietnam
open countries grow faster for each sub-period; among the set of countries that are open, countries that are poor tend to grow faster. Thus, we observe, what may be called, the convergence frontier for every period.
For the whole period from 1960-2006, Vietnam is located well inside the convergence frontier; Vietnam’s per capita GDP was far below those countries that are as poor as Vietnam but open. However, as we focus on more recent period, we see a tendency that Vietnam is moving to the so-called convergence frontier. For the period 1990-2006, Vietnam seems to be on or close to the frontier. One skeptical interpretation of the figure might be that Vietnam in the 1990-2006 period was still well inside the frontier, but overly expansionary macroeconomic
102 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy policies and other distorting policies promoting investments by large SOEs made Vietnam falsely appear on or close to the convergence frontier. It is hard to refute this story in a rigorous way. But the evidence that we showed above, such as highly respectable TFPG in spite of rapid accumulation of capital, suggests that this might be only part of the story. So, we think that it is reasonable to think of Vietnam in the past decade at least close to the convergence frontier.
This interpretation has an important bearing on the projecting GDP growth rate of Vietnam. If Vietnam is close to the convergence frontier, the extra gains in per capita GDP growth that could be expected from policies that are intended to promote growth are not likely to be large. In other words, it is unrealistic to think of a situation that Vietnam’s per capita GDP growth increases by several percentage points from its own past trend by implementing growth promoting policies. So, in this sense, the objective of Vietnam’s growth strategies seems to be “sustaining”growth, not increasing growth. 3.4. Main Potentials and Weaknesses
3.4.1. Potentials
The market-oriented economic reforms over the past 23 years have made way for the transformation of Vietnam’s potentials into impressive economic performance. The country’s pro-active integration into the regional and world economy has contributed, and is widely expected to further contribute to accelerating such transformation. As noted in Vo and Nguyen (2009a), Vietnam’s gains from integration-WTO accession is one stepping stone depending on the extent and scope of its commitments in such a process.
Figure 1-40 | Vietnam’s Ddemographic Structure by Age Group, as of 2006
103 Chapter1_Macroeconomic Policy The profound economic performance over the years of 2007-09, notwithstanding the economic slowdown from late 2008 to mid-2009, partly confirms the gains anticipated prior to the country’s accession to the WTO and further consolidates the optimism over its growth prospect. More importantly, deeper integration enhances the opportunities for growth and development, via broadening market access, strengthening competition, improving business and investment climate, and attracting FDI inflows. Vietnam arguably possesses high development potential, as it is well integrated in an economically dynamic region, with“ golden”demographic structure (Figure 1-40) and irreversible market-oriented reforms despite continuing debates on its scope and speed.
The global financial crisis and economic recession just lead to a temporary reduction of economic growth in Vietnam. One should, however, believe that future growth potential in the country remains significant. In one projection, Vietnam can expect an economic growth of 7.5%-8.5% per annum in the next 10-15 years (Vo and Nguyen 2009b). In another forecast by Goldman Sachs (2008), Vietnam’s annual average GDP growth in 2007-2020 will be around 8%. This is explained by the increasing contribution from TFP growth over time, while capital stock may remain as the most important element to output growth. This is further affirmed by the authors’projection of Vietnam’s GDP growth in 2010?19, with significant contribution from TFP growth.
Technological progress, especially in the form of technology transfer through FDI, has been an important driver of productivity growth. But, more importantly, the productivity growth in Vietnam should be attributed to the following institutional changes. First, the economic reforms since 1986, including the deregulation of the economy and the fundamental shift from a centrally-planned economy to a market-based economy, have clearly enhanced the efficiency gains. As indicated in Goldman Sachs (2008), such efficiency gains could have come at least from: more efficient allocation and uses of economic and financial resources; better incentive system to reward workers and farmers; and the introduction to foreign markets and foreign direct investment (FDI) which encourages firms to be more innovative and competitive. Also, the market mechanism introduced after Doi Moi allowed private and foreign-invested businesses to reduce efficiency losses by the state sector, thereby accelerating overall productivity growth.
Second, Vietnam’s opening-door policies facilitated trade and foreign investment to increase firms’competitiveness. Vietnam’s trade-and FDI-friendly policies since the introduction of reforms have made a noteworthy contribution to its export successes. The promulgation of the Law on Foreign Investment in 1987, and its subsequent amendments in various years in line with economic context helped mobilize significant source of capital, accompanied by management skills and technology, for the processes of industrialization and socio-economic development in Vietnam. At the same time, the termination of the US embargo in 1992, and the enactment of the US-Vietnam bilateral trade agreement in 2000 all contributed to accelerating Vietnam’s integration into the world market. The country has also been actively engaged in the
104 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy regional and international economic integration, thereby enhancing market access for its exports and boosting investors’confidence in its reform commitments. The integration process is, however, under way. With its past experience, Vietnam is now setting its feet for bolder moves in economic integration, hoping to further enhance its growth performance.
3.4.2. Weaknesses
Along with those potentials, several weaknesses become evident from Vietnam’s socio- economic development process. The WTO membership has further revealed the inherent weaknesses of Vietnam’s economy, the resolutions of which require more comprehensive and determined reforms. Economic growth fails to embody sufficient improvement in quality, as it is largely based on the expansion of investment with worsening efficiency of using capital, while Vietnam’s firms stand at the lowest position in the value chain.24) More importantly, the allocation of resources failed to support sustainable and efficiency-enhancing economic growth, due to the inappropriate and uneven development of markets for production factors (i.e. land, capital, labor). Also, while the policy targets are often multi-faceted and each policy can often serve only a single target, economic policies are still weakly coordinated. The costly lesson from inappropriate response to massive foreign capital inflows since mid-200725) remains relevant.
Figure 1-41 | TFP Growth in the Years During the Period 1986-2007
24) The economic growth of 8.5% in 2007 is not so impressive given the fact that the corresponding figures for 2005 and 2006 were already 8.4% and 8.2%, respectively. As another indication, the financial boom in 2006-07 had no corresponding impact on the creation of value added. The share of 2.0% GDP accounted for by the financial sector was unchanged in the past few years (Vo and Nguyen 2009a). 25) Facing the surge in foreign capital inflows, Vietnam increased the supply of domestic currency (VND) to purchase foreign currencies, whilst failing to undertake appropriate sterilization measures. For more in-depth discussion, see Vo and Nguyen (2009a).
105 Chapter1_Macroeconomic Policy Meanwhile, despite optimism in several studies (for example, by Goldman Sachs 2008 and even in the authors’calculations), high TFP growth may be not robust to methodology for computing TFP. As an instance, the TFP growth calculated by Dinh et al (2009) was generally slow (Figure 1-41). Accordingly, TFP growth made up roughly 15% of economic growth, but could be very small for some time (only around 2.5% in 2007). Comparing to some Asian countries in the period 1980-1990, Vietnam attained roughly equivalent economic growth, but lower TFP growth, in the years 2001-2007 (Table 1-25). This, again, necessitates certain care in interpreting TFP results and, more importantly, more effective measures to enhance productivity growth in the country.
Table 1-25 | GDP and TFP Growth in Some Asian Economies
GDP growth TFP growth Contribution of TFP growth
South Korea 8.90 2.80 31.46 Singapore 6.80 3.90 57.35 Thailand 7.50 1.60 21.33 India 5.40 3.60 66.67 Vietnam (1990-2007) 7.75 1.16 14.96
Source: Dinh et al (2009).
Besides, despite some improvements, institutional capacity remains a key bottleneck for Vietnam’s sustainable development. Meanwhile, despite large investment the infrastructure system is still underdeveloped. Infrastructure services and utilities like transportation and electricity are too expensive and/or inefficient, resulting in high costs of doing business in Vietnam.
The bad logistic system and shortage of energy and transportation are impeding Vietnam’s competitiveness and to a large extent, limiting the country in attracting both domestic and foreign investment. For example, the logistic services fail to sufficiently facilitate trade activities in general and export activities in particular.
The logistic restrictiveness index for Vietnam is high. As can be seen in Figure 1-42, the restrictiveness of domestic logistic services in Vietnam is only smaller than that of Laos. Meanwhile, the restrictiveness of foreign logistic services in Vietnam finds itself only below those of Malaysia, China, Philippines, Indonesia, and Laos. Resolving such problems is no easy task, as often complicated by inappropriate master planning and private-public-partnership schemes, and poor“ soft”infrastructure.
This presents an area of weakness that requires more effective efforts, if Vietnam is to accelerate its economic growth.
106 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy Figure 1-42 | Logistic Restrictiveness Indices for Some Economies
0.7
0.6
0.5
0.4
0.3 Domestic Foriegn 0.2
0.1
0 p. r d an a ore India p Re Laos ysia m p China Ja ala an ietnam Australia rea, M Zealandlippines Thailan V Cambodia Indonesia My w Phi Singa Ko Ne Country Brunei Darussalam Source: Hollweg and Wong (2009).
Another bottleneck in Vietnam is the low quality of its human resource, albeit having high literacy rate. At the same time, the education and training system lags far behind practical demand and it is even considered in crisis. The gaps between demand and supply of labors by sector and by skill are sizeable, while policymakers, managers, and labors at all levels lack adequate skills. Even so, there still exists a huge gap between requirements (professionalism; transparency; accountability) and incentives system for the public machinery and administration to function properly. The coordination among agencies and ministries is still weak and insufficiently effective. The establishment of necessary institutions for developing production factor markets is far from completion. The notable example has been with the financial market: although the financial activities are flourishing, supervision of the financial system remains inadequate.
Besides, weaknesses and even vulnerabilities persist in some critical areas, such as the SOEs, the financial system and efficiency of public investment, and others. As discussed above, firms and enterprises in Vietnam still lack competitiveness, and are mostly small or medium in size. Such a lack of competitiveness was partly because of government intervention, made possible via the dominance of SOEs, and of the tariff barriers which provide protection in a more or less distorted way (Porter 2008). More and more private firms are established, yet very few of them can become focal or leading ones in the field. In another aspect, despite current views of better growth prospects, there remain major concerns about economic development in the subsequent years. First, the risks of macroeconomic instability seem to be increasing. Inflation tends to hike, particularly as economic growth started to recover. Both the ADB and IMF project that inflation in 2010 will be higher than Vietnam’s target. Current account deficit is high, reaching 8.3% GDP26) in 2009, but may increase to 9.4% GDP in 201027), or 9% GDP28). In addition, budget deficit is large in 2009, reaching 9.1% GDP29). This should attract due
107 Chapter1_Macroeconomic Policy attention since the ratio of public and public guaranteed debt over GDP in 2008 was already 46%. Second, Vietnam may face the issue of rising bad debt in 2010. This results largely from the inability to control money flows for speculation in financial and real estate markets. In fact, even the tasks of compiling investment statistics in these markets can not be done with strong justification in Vietnam. Third, the transparency and accountability for resource allocation in the fiscal stimulus package remains questionable. A detailed report on various relevant aspects of the package proves to be necessary, but it has not been in place yet.
3.5. Projection: 2010-2019
3.5.1. Projection of GDP Growth
A. Methodology
In this study, we use the production function, the equation (1) above, as the basis for our projection of GDP growth. We use the so-called“ bottom-up”approach for the projection. That is, we make the projection of each component of the production function.capital, labor, and TFP.and add up the projected values of the components to make a projection of the aggregate GDP growth. Projections of each components of the production function are carried out in the following way.
First, in order to project economically active population, we assume that the participation ratio, which is defined as the ratio of economically active population and working age population (population aged between 15 and 64 years), remains constant at its 2008 value during the projection period 2010-2019.30) Given the forecasts of working age population by Global Insight, we can get the projected values of economically active population.
Second, the projection of TFPG is basically extrapolation of the past trend. In the baseline projection (Senario I, to be explained shortly), the TFPG for the projection period, 2010-2019, is assumed to be equal to its annual average value between 2001-2006, which is about 2.8 percent per annum.
Third, in order to project capital stock growth rate, we first run a cross-country panel regression of the national saving rate on dependency ratio. The regression result is as follows.
Saving Rate = 28.86 -0.19*Dependency Ratio + 4.19*Vietnam Dummy
26) EIU report in January 2010. 27) IMF forecast in October 2009. 28) ADB forecast in September 2009. 29) EIU report in January 2010. 30) Since the data for 2009 values are not available for most of the variables, the projection period effectively starts from 2009.
108 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy The coefficient on dependency ratio is significant at 1 percent level, suggesting that lower dependency ratio increases saving rate. We use the assumption that the investment rate is equal to the saving rate. Then, we use the estimated regression equation to predict the investment rate for Vietnam, using the projected dependency ratio from Global Insight. In order to obtain real investment (gross domestic capital formation), we first change the timing assumption in such a way that real GDP in year t1 is produced with the beginning of the year t capital stock. With this assumption, we are able to predict the first year real output in the projection period, given the projected values of economically active population and the assumed TFPG. Then, if we have a projected real investment/real GDP ratio for year t, we are able to project the real investment in year t. Using the information on the price of investment goods relative to GDP, together with the predicted national investment rate, we can predict the real investment/real GDP ratio in year t. Then, the predicted real investment in year t can be used, relying on a perpetual inventory method, to predict the beginning of the period capital stock in year t +1. Then, we are able to predict real GDP in year t+1 with the predicted value of economically active population and the assumed TFPG. This process can be repeated until year 2019. All real variables are in 1994 Vietnamese Dong.
In this report, we consider three scenarios. Scenario I is the case annual average TFPG for the projection period is equal to 2.8 percent per annum, with the condition that national saving rate is equal to national investment rate for the projected period. Scenario II is the case where the assumed TFP growth rate is 3.3 percent per annum, which is equal to that recorded by China for the period from 1960-2006. Scenario II also assumes that current account is balanced. Given that China’s TFPG is exceptionally high from an international perspective, this scenario is somewhat optimistic. However, the condition of current account balance starting from 2010 in both Scenario I and II might be somewhat unrealistic. In 2008, the current account deficit as percentage of GDP was about 9.5%. So, imposing current account balance condition implies an abrupt adjustment of domestic investment, which could be somewhat implausible. Thus, we consider an alternative case, Scenario III, where current account deficit is gradually reduced over the period from 2010 to 2019 so that by 2019, the current account is balanced. Other conditions in Scenario III is the same with Scenario II. Nevertheless, it should be noted that Scenario III is no more realistic than Scenario I since Scenario III is based on fairly high growth rate of TFP. We do not want to discuss any further which scenario is more likely. But, by comparing the projections under the three scenarios, we can have a better understanding of the projected GDP growth rate figures.
B. Real GDP Growth Projection: 2010-2019
We discuss Scenario II first. Table 1-26b and Figure 1-43 show the projected real GDP growth rate of Vietnam for 2010-2019 for Scenario II. The projected annual average GDP growth rate for the period 2010-2019 is 7.01 percent. Over time, some modest slowdown is expected, with the first five-year period growth rate (7.29 percent per annum) somewhat higher
109 Chapter1_Macroeconomic Policy than the second five-year period growth rate (6.72 percent per annum). The modest growth slowdown is likely to come from both capital and labor input. Although the working-age population ratio is likely to increase modestly, the effect on the national saving rate is likely to be modest. Hence, with diminishing returns to capital, the growth rate of capital is likely to slow down. As the population growth rate is projected to slow down, the growth of labor input (economically active population) is also likely to slow down, though the expected increase in working age population ratio will have an effect of increasing labor supply. In Scenario I (Table 1-26a), the projected figures are lower on average than Scenario II by about 0.5 percent per annum. When the current account deficit is gradually reduced to zero by 2019, which is Scenario III (Table 1-26c), the projected GDP growth rate figures are on average higher than Scenario II by about 0.5 percent per annum. In this case, however, the slow down in growth rate for the next ten years is more pronounced, which is due to the gradual reduction of current account deficit.
Table 1-26a | Projection of Contribution GDP Growth by Component
Aggregate GDP Capital Labor TFP 2010-2014 6.79 2.90 1.08 2.81 2015-2019 6.22 2.62 0.79 2.81 2010-2019 6.51 2.76 0.94 2.81
Table 1-26b | Projection of Contribution GDP Growth by Component
Aggregate GDP Capital Labor TFP 2010-2014 7.29 2.90 1.08 3.31 2015-2019 6.72 2.62 0.79 3.31 2010-2019 7.01 2.76 0.94 3.31
Table 1-26c | Projection of Contribution GDP Growth by Component
Year GDP Capital Labor TFP 2010-2014 8.05 3.66 1.08 3.31 2015-2019 6.86 2.77 0.79 3.31 2010-2019 7.46 3.21 0.94 3.31
Table 1-27 shows the projection of per capita GDP growth and its contributions from components. For 2010-2019 the per capita GDP growth rate is projected to be 5.85 percent per annum, with first five-year average growth rate (6.07 percent) higher than the second five-year growth rate (5.64 percent).
110 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy Figure 1-43 | GDP Growth rate trend of Vietnam
Per capita GDP K L TFP 2010-2014 6.07 2.32 0.44 3.31 2015-2019 5.64 2.20 0.13 3.31 2010-2019 5.85 2.26 0.29 3.31
3.5.2. Projection of Sectoral Composition of GDP:2010-2020.
A. Methodology
We make a projection of the Sectoral Composition of GDP of the Vietnamese economy for 2010-2019 in the following way. First, using the cross-country panel dataset, we run the fixed
Table 1-28 | Regressions of Sectoral GDP Shares
Dependent variable variable Agriculture Industry Services -2.340*** 1.032*** 1.308*** Per capita GDP (-14.71) (6.01) (6.68) 0.043*** -0.024*** -0.018*** Per capita GDP square (11.76) (-6.23) (-4.10) 27.512*** 38.604*** 33.884*** Vietnam Dummy (41.27) (35.99) (38.07) Country dummy O O O R_square 0.950 0.859 0.906 Obs. 1344 1344 1344
111 Chapter1_Macroeconomic Policy effect regressions of sectoral GDP share as follows.
GDPSHj is the GDP share of sector j, and PCGDP is per capita GDP. The subscript i denotes country, and the superscript j denotes sector, which is agriculture, industry, or services. The projection of the sectoral share for Vietnam is based on the predicted values of per capita GDP. The regression results for the above equation are shown in Table 1-28.
Figure 1-44 | Projection of Sectoral Composition of GDP in Vietnam
Table 1-29 | Projection of Sectoral Composition of GDP Shares
YEAR Agriculture Industry Service
2008 19.8 41.9 38.3
2009 19.4 42.1 38.5
2010 18.9 42.3 38.8
2011 18.5 42.5 39.0
2012 18.0 42.7 39.3
2013 17.6 42.9 39.6
2014 17.1 43.1 39.9
2015 16.6 43.3 40.1
2016 16.1 43.5 40.4
2017 15.6 43.7 40.8
2018 15.0 43.9 41.1
2019 14.5 44.1 41.4
112 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy B. Sectoral Composition of GDP: 2010-2019
Table1-29 and Figure 1-41 show the projection of the sectoral GDP shares. The GDP share of agriculture is projected to decline continuously from about 19.8% in 2008 to 14.5 percent in 2019. By contrast, the share of industry as well as the share of services is likely to increase. The GDP share of industry will increase from 41.9% in 2008 to 44.1% in 2019, while that of services will increase from 38.3% to 41.4% during the same period.
4. Key Policy Challenges
The past 23 years have seen Vietnam progressing rapidly towards a market economy. The country has made a number of socio-economic achievements, while the potential for further economic growth remains significant. There are, however, numerous challenges for Vietnam in realizing such growth potential. All these challenges persist in the medium and long-run, necessitating bold and fundamental efforts of the country to address.
On the one hand, the country is still in transition, with low income, and needs to strive for industrialization. At this stage, the transition process in Vietnam is still complex. The complexity lies in the ideology of socialism-oriented market economy, regarding its key components and how to establish and/or improve these components. During such a transition, the legal framework needs to be continually amended and improved. In addition, growth performance for the past years has been impressive, but better human and institutional capacity are a must for Vietnam to go further. It appears nonetheless that the capacity is inadequate, which is highly attributed to the problems of public governance, and the quality of the education and training system.
On the other hand, macroeconomic and social instability are persistent threats, and have become more evident as likelihood together with the country’s deeper involvement in the regional and the world economy. Managing capital flows, avoiding wider poverty and income inequality, and reducing social risks and adjustment costs of trade liberalization and international integration are no less than challenges that Vietnam needs to resolve on its way to sounder and more sustainable development. The financial market has been booming, but various fundamental problems require that measures be continued to deepen financial market reforms (Porter 2008). In addition, administrative procedures are still burdensome, thereby hindering deeper regional economic integration and private sector development. The forthcoming years should see administrative reform being accelerated to pave the way for higher growth in the medium and long-term, though this is no easy task. Vietnam should strive to achieve the target of cutting down 30% of current administrative procedures in 2010, but this just ignites the start for further reduction of unnecessary procedures in the forthcoming years.
113 Chapter1_Macroeconomic Policy The WTO accession and the global financial crisis have sent Vietnam through a period of massive policy changes, from promoting growth to macroeconomic stabilization, and back to economic stimulus. The recent fiscal stimulus has brought about initial positive results (higher growth and decrease in job losses). Yet there exists concern about the possible contradiction between the (necessary) implementation of the short-term“ rescue”policy and longer term structural reforms. As an instance, the interest subsidy scheme applies no discriminatory treatment over firms which can produce efficiently and those which cannot; meanwhile, the longer-term structural reforms seek to encourage good businesses while taking bold measures over inefficient ones, even big ones. Also, the above shift in policy direction was largely driven by the external economic context and, given that the previous inflationary pressures had not been dampened completely, Vietnam should avoid high inflation in the forthcoming years. More importantly, in circumstances like this, the country should be flexible in altering the priorities given to high economic growth and macroeconomic stability.
At the same time, deeper and wider integration may narrow down the policy options available to policymakers, whilst exposing the country further to external shocks. Adhering to international trade rules to ensure effective integration process also reduces the possibility of applying domestic regulations in an administrative manner. This implies more complexity in dealing with issues of macroeconomic management and various social pressures. Coping with macroeconomic instability and social issues such as widening income/asset gap; emerging middle class; activity of vested groups, etc., thus becomes a multi-dimensional exercise, involving actions from economic, financial, social, and political stances.
From the policy perspective, policymakers should also take into account a number of issues upon this era of post-WTO accession. It is very risky if the policy formulation process fails to follow the reality. The role of collecting, extracting, sharing and analyzing information effectively should therefore be emphasized. Besides, as specific policy options can have unwanted/side effects, it is essential to provide support groups that are of high vulnerability and to overcome vested groups. The“ dosages”of macroeconomic policies- including monetary, fiscal, and exchange rate policies- in implementation should be considered carefully so as to achieve the desired results, without unfavorable changes in people’s and investors’ expectations. Effective coordination of these policies also deserves due attention, since the adjustment process often affect various aspects of the macroeconomic condition. Again, the macro policies need supplements from measures at the micro level to, for examples, support small- and medium-sized enterprises, poor people, etc.
To integrate itself to the rapldly chonging regional and world economy, Vietnam should get used to making reasonably quick policy changes. The effectiveness of adjustment policies, in addition, rests heavily on public communication, as transparency and accountability of policymakers are key ingredients for public confidence and consensus. While policy adjustments are important, if not critical, enforcing policy reviewing mechanisms/institutions
114 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy should be of great essence. For instance, those mechanisms/institutions should rely on information and policy analysis, including policy choices and their impacts; forecasts and warnings; cost-benefit analysis of large scale public projects; etc. They should also be independent, transparent with vision and professionalism. However challenging it may seem, the task for policymakers should be no more than acquiring information and institutions for having better policy options, in combination with the“ art”of implementing such policies.
The global financial crisis and economic recession and their massive consequences also necessitate a serious review of the current development paradigm. As a developing country, Vietnam finds itself under little direct effect of the global crisis and recession. Yet this by no means allows the country to ignore the lessons in others, so as to amend its development orientation. Several aspects of Vietnam’s development model for the forthcoming years can be identified. First, the country should attempt to establish efficient markets of all types. In each market, the attempts should focus not only on market development policies and regulations, but also on market participants. This is necessary to ensure efficient resource allocation within each market and across markets, while maintaining consistency with the orientation of developing a multi-sector economy in Vietnam. Second, to better facilitate and encourage economic activities, the country needs a system of efficient“ hard”and“ soft”infrastructures. Third, the State should be capable of stimulating creativity and preventing macroeconomic and social risks. Enhancing and encouraging creativity is necessary to promote technological innovations and progress, thereby improving the efficiency of resource usage. Meanwhile, macroeconomic and social stabilization help prevent distortion to signals to resource allocation and, in particular, any risks that may accompany products of creativity. Finally, Vietnam should continue to strengthen international linkages, aiming at consolidating its geo-economic position. The international linkages should be enhanced via efforts of both government agencies (in reducing at-the-border and behind-the-border barriers to trade and investment) and of Vietnamese enterprises in integrating into regional and global production networks, and in the value chain. The key message here is to improve institutional capacity, socio-economic infrastructure, and international linkages to grasp and take full advantage of arising opportunities.
115 Chapter1_Macroeconomic Policy References
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120 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy Chapter 02
Monetary and Financial Policy
1_ Executive Summary 2_ Enhancing Early Warning System and Risk Management Capacity 3_ Capital Account Liberalization in Vietnam: Past Trends and Future Agenda 4_ People’s Credit Funds in Vietnam Chapter 01
Executive Summary
The objective of this chapter is to study on the development of early warning system (EWS) in Vietnam, capital account liberalization in Vietnam, and development of cooperative self help organizations in Vietnam, using the Korea’s experience.
1. Enhancing Early Warning System and Risk Management Capacity
We introduce two versions of early warning system: EWS for financial markets and EWS for financial institutions. First, we attempt to develop the EWS for Vietnamese financial markets following “signal approach.” The system involves monitoring the evolution of a number of macroeconomic indicators that tend to systematically behave differently prior to a crisis.
Second, we introduce the EWS for financial institutions, which is designed to monitor the soundness of the financial institutions. Since there has been no such system comparable to the CAEL rating system in Vietnam, we first identify the preconditions of introducing such system to Vietnam and propose how to build such a system in an effective way. Then we describe the issues related to the design and the development of the CAEL rating system, followed by the Korean experience and its implication. We also suggest the action plan to introduce the system in Vietnam.
122 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy EWS for Financial Markets: Signal Approach
To develop EWS for financial markets, we first construct financial stress index (FSI). The FSI for Vietnam comprises five variables: exchange rate depreciation, declines in international reserves, stock market returns, stock market volatility, and changes in nominal interest rate Each component is divided by its own standard deviation so that each component has the same conditional variance. Then, the financial stress index is the sum of each standardized component.
In the empirical application, a crisis is identified by the behavior of the financial stress index. Periods in which the index is above its mean by more than its standard deviation are defined as crises.
The choice of leading indicators is dictated by theoretical considerations and by the availability of information on monthly basis. We combine the information of all the indicators by constructing a single composite indicator that we use to compute the probability of a crisis in any given point in time. The composite indicator is defined as a weighted sum of the signaling indicators, where each indicator is weighted by the inverse of its noise to signal ratio. The evidence provides some support for the composite indicator as the value of the composite indicator starts to rise before the periods of crises.
In this paper, we use the database of International Financial Statistics compiled by IMF and other foreign database. If we could access to other source of data (for example, black market exchange rate which is more likely to reflect the market demand for and supply of foreign currency), we might build a more reliable system. Thus, we recommend revising the system with more data collected by the Vietnamese government and the State bank of Vietnam.
In addition, we emphasize that the system should be updated regularly. Future changes in exchange rate system and deregulation of interest rates are likely to affect the behavior of financial stress index and thus require revision of the system. To do this, a specific team in the government or the central bank should be organized and be in charge of operating and revising the early warning system.
Early Warning System for Financial Institutions: CAEL Rating System
Regulatory authorities often assess composite risk ratings of financial institutions by selecting several component variables that represent risk factors, such as capital adequacy (C), asset quality (A), earnings (E), liquidity (L) and the like, and by assigning points for each component variable and weights for each risk factor. The weighted average of constituent series is computed, which is often referred to as a “rating score,” and is mapped to the composite rating scale. This method, called the CAEL rating system, has been known as an effective
123 Chapter 2 _ Monetary and Financial Policy device for routine off site monitoring of the safety and soundness of individual banks and other financial institutions as it provides a convenient way to summarizing the strength of financial institutions.
In order to build the CAEL rating system as a primary supervisory tool for monitoring the safety and soundness of commercial banks and for taking preemptive actions, several problems have to be clarified and resolved:
1. Understanding and consensus among regulatory authorities on the usefulness of the CAEL rating system as a supervisory tool. 2. Reliability of figures of the financial statements reported by the commercial banks. If some banks breach the reporting rule, how the authority recognizes it and implements the penalty. 3. Standard format for electronic reporting to the authority. 4. Adequate database operated by the authority to verify the data and to manipulate them to produce appropriate financial ratios. 5. Regulatory framework to make use of the CAEL ratings for supervisory purposes. 6. Capacity of modeling and implementing the CAEL rating system. 7. Internal network and security to share the information generated by the CAEL rating system.
The successful implementation would depend largely on the availability of the quality data, which takes time to accumulate. It is particularly so if one attempts to build more elaborate system beyond the supervisory CAEL system such as statistical CAEL rating system.
2. Capital Account Liberalization in Vietnam: Past Trends and Future Agenda
The objective of this paper is to provide recommendations for capital account liberalization policy of Vietnam. For the purpose, we discuss the pre conditions that should be in place before the capital account liberalization, to cope with volatility of international capital flows and manage its negative impacts on the real sector of an economy. After reviewing the Korean case, we turn to evaluate the past trend of capital account policy in Vietnam and its effects on recent capital flows. Obviously, the objective is to identify Vietnamese specific ‘flavors’ for the general issues discussed in the Korean context. Finally, based on the discussions, we formulate policy recommendations. Punch lines of the paper are to emphasize four pre conditions for maintaining macroeconomic stability in the face of a liberalized capital account: 1) fiscal discipline; 2) monetary discipline; 3) Soundness of the financial sector; 4) Policy tools for managing short term capital volatility. We argue that these conditions are all binding constraints to maintain long term macroeconomic stability. One cannot selectively choose to satisfy some
124 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy of the pre conditions and expect macroeconomic stability can be preserved.
As a way of concluding the paper, we formulate ten policy recommendations for Vietnam as follows.
Recommendation 1: The stability of money velocity should be examined regularly.
The current monetary policy framework uses the money supply as the intermediary target. Though the framework itself is appropriate for an emerging economy such as Vietnam where financial markets and institutions are yet to be fully liberalized, it is important to recognize that the effectiveness of the policy framework is subject to market environment. Hence, Vietnam should check regularly the effectiveness of the policy framework by examining the stability of the money supply.
Recommendation 2: It should be acknowledged that fiscal discipline is a necessary condition for credibility of the monetary discipline.
For an emerging economy, particularly which is at the early stage of economic development, credibility of price stability is difficult to attain if fiscal discipline is not present. We emphasize that the close relationship between monetary and fiscal discipline should be taken as the first principle of policy making.
Recommendation 3: Projection of medium term fiscal balance should be made to gauge the degree of fiscal soundness over the next 5 years. Based on the assessment, a feasible plan should be formulated to recover and sustain fiscal soundness.
For the recent years, Vietnam fiscal balance continued to show deficits, which was partly due to the policy response to the global financial crisis. We recommend that Vietnam should pursue fiscal discipline first before further liberalization of financial markets and capital flows.
Recommendation 4: A well-functioning prudential supervision mechanism should be established before fully liberalizing short term foreign borrowings by Vietnamese financial institutions.
Whether they are state owned or not, global market players consider foreign exchange liabilities of financial institutions of an emerging economy as protected by ‘implicit’ state insurance. In the presence of ‘implicit insurance’, foreign lenders have an incentive to exploit it. Hence, it is crucial to have an infra to oversee and ensure soundness of the financial sector before liberalizing short term foreign exchange borrowings by financial institutions.
125 Chapter 2 _ Monetary and Financial Policy Recommendation 5: Special attention should be paid to prevent any ‘loophole’ of supervision, which is under explicit or implicit insurance of the government but outside of the supervision.
Recommendation 6: Until fully liberalizing short term capital flows, maintaining a peg system, whether explicit or de facto, is appropriate.
The current exchange rate regime in Vietnam operates within the framework of an announced official exchange rate and an allowable exchange rate band. The current exchange rate system may be viable until other channels of short term capital flows, particularly short term borrowing of financial institutions become more significant.
Recommendation 7: To evaluate the sustainability of a de facto peg system, the ultimate test can be whether the central bank of Vietnam can control a majority of foreign market participants when required.
When market sentiments prevail in foreign exchange markets, the only way to defend the current peg can be to control market participants’ sentiments. If such case occurs, policy makers of Vietnam should identify the set of market participants that are beyond the control of the central bank and carefully devise ways to have them cooperate with the central bank.
Recommendation 8: In operating a de facto peg system, the prior criteria for determining the level of peg rate should be to keep the current account in balance. The specific form of the exchange rate system is of second importance.
Recommendation 9: In operating a de facto peg system, the central bank of Vietnam may resort to sterilized market intervention to cope with temporary capital inflows, accumulating the foreign exchange reserve.
Accepting that short term capital flows may be sometimes directed by market sentiments, to prepare for sudden reversal and prevent the real exchange rate from appreciating, the central bank of an emerging economy can choose to intervene in foreign exchange market while sterilizing impacts on money supply.
Recommendation 10: Vietnam should participate in the ASEAN+3 to contribute its financial cooperation initiatives, including the Chiang Mai Initiative.
126 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy 3. People’s Credit Funds(PCFs) in Vietnam
The objective of this study is to explore how credit cooperatives in Vietnam can mobilize financial savings from the informal credit market and be developed as a self help organization, using Korea’s experience during the take off period in the 1960s and 1970s.
Cooperatives can play an integral part of a country’s development policy. However, experiences in many countries have shown that it usually is a mistake to use credit cooperatives as instruments for the implementation of government policy, rather than allowing them to operate as voluntary self help organizations of their members. The introduction of the credit union in Korea in the 1960s and 1970s through private and not through the government initiative offers unique example among developing countries: Korea was able to successfully introduce self help credit unions through a bottom up approach without government support. There were significant impacts of Korea’s credit union movement. First, Korean poor people were able to have a real deposit account for the first time. Although the amount of saving may have been small, it provided a sense of being part of the greater society, instilling further hope and confidence for better future. Second, the values of cooperatives such as elections based on 1 person/1 vote rule were able to contribute to the initiation of grass root democracy in Korea by emphasizing the importance of education.
According to Münkner (1999), the basic concept of a cooperative is that it is a method of organized self help; in other words, helping others to help themselves through cooperation. It is a method of pooling members’ resources, and the sharing of risk and burden in a disciplined, organized, and coordinated manner. However, for cooperation to work, the members of the cooperative must operate under a system of shared beliefs, values and principles, which must be instilled over time by way of teaching and doing. What are the roles of the government in Vietnam in developing sustainable cooperatives? The initiation and formation of cooperatives should be left to the individuals themselves who are seeking to help themselves by self help organizations. Cooperation in one form or another is part of human nature and exists in every society. The government should not be obligated to initiate cooperatives, since individuals by themselves will seek out and form cooperatives if found to be mutually beneficial. Second, support of cooperatives should only goes as far as helping others help themselves by providing access to knowledge, resources and capital, until it is self sustaining. Third, the government should take active roles in creating an environment that fosters cooperative work, such as 1) ensuring the freedom of the association and the right to exercise any legal economic activity in group, 2) preventing misuse of cooperatives, 3) enacting laws that give autonomy to cooperatives to align its by laws with the needs and objectives of its members, 4) Ensuring equal opportunity with other business organizations, 5) protecting cooperatives against unfair competition, and 6) creating a tax regime in consideration of cooperatives.
127 Chapter 2 _ Monetary and Financial Policy Chapter 02 Enhancing Early Warning Systems and Risk management Capacity
Hangyong Lee (Hanyang University) Myung Jig Kim (Hanyang University) Nguyen Thi Kim Thanh (State Bank of Vietnam) Nguyen Thi Minh Ngoc (State Bank of Vietnam)
1. Introduction
Asian financial crisis in 1997 and the recent global crisis rekindle interest of both academics and policy circles in the potential causes and symptoms of financial crisis. If these symptoms can be detected in advance, government can adopt preemptive and effective measures to prevent the crisis or at least to reduce the adverse impacts of the crisis on the domestic economy. Currently, many countries operate their own early warning system for that purpose.
In Vietnam, however, such a system has not been built. Although several departments in the State Bank of Vietnam and government watch the current domestic and foreign economic conditions, there is no system to monitor macroeconomic and financial stability and predict the likelihood of crisis in a systematic and quantitative way. Therefore, it is important to build up a system that can provide useful information to help the Vietnamese government and central bank to conduct preemptive policies.
We introduce two different versions of early warning system (EWS): EWS for financial markets and EWS for financial institutions. First, we attempt to develop the EWS for Vietnamese financial markets following “signal approach.” The system involves monitoring the evolution of a number of macroeconomic indicators that tend to systematically behave differently prior to a crisis.
Second, we introduce the EWS for financial institutions, which is designed to monitor the
128 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy soundness of the financial institutions. Since there has been no such system comparable to the CAEL rating system in Vietnam, we first identify the preconditions of introducing such system to Vietnam and propose how to build such a system in an effective way. Then we describe the issues related to the design and the development of the CAEL rating system, followed by the Korean experience and its implication. We also suggest the action plan to introduce the system in Vietnam.
2. Historical Overview of the Vietnamese Economy1)
Since 1986, Vietnam has embarked on the course of DOIMOI with the major content: the comprehensive economic renovation which aims to eliminate the subsidy based, bureaucratic, centrally planned mechanism and to develop a socialist oriented multi sector market economy.
Over the 20 years of DOIMOI process, Vietnam has made significant achievements. Thanks to the expansion of the bilateral and multilateral relationships, international trade and foreign investment has increased sharply.2) Vietnam is currently considered as one of the most attractive countries for investment in the world.
2.1. Development of the Vietnamese Economy
2.1.1. Real Sector
Vietnam has recorded quite high economic growth over nearly 20 years. From 1986 to 1990, the average GDP growth rate was 4.4% and the average growth rate increased to 7% during the period 2000-2008. Although GDP growth in Vietnam is expected to increase by 5.2% in 2009 due to the effects of the recent global economic and financial crisis, Vietnam is still considered as one of the countries with high economic growth and rapid recovery.
At the same time, the structure of economy has also gradually shifted towards industrialization and modernization. The proportion of agriculture, forestry and fishery in GDP has declined while the proportion of manufacturing and construction has risen during the period of 2001-2007. In addition, the contribution of service sector also increased from 37% in 2001 to 47% in 2008.
Rapid increase in the size and efficiency of the economy has led to improvement in government budget. For instance, Vietnamese economy has witnessed an increase in budget revenue, a decrease in state subsidy, changes laws and regulations on tax, and arisein capital
1) This section is written by Nguyen Thi Kim Thanh and Nguyen Thi Minh Ngo. 2) Vietnam became a full member of ASEAN on 28 July 1995, entered Asia pacific Economic Cooperation in November 1998 and has participated in ASEAN Free Trade Area. The aountry joined WTO on 11 January 2007. At present, Vietnam has established diplomatic relationship with over 179 countries in the world.
129 Chapter 2 _ Monetary and Financial Policy Table 2-2-1 | GDP Growth Rate and the Contribution of Industries
Manufacturing and 3,68 3,47 3,92 3,93 4,21 4,17 4,19 2,54 Construction
Services 2,52 2,68 2,63 3,02 3,42 3,34 3,57 2,90 from private sectors. Consequently, the size and the structure of budget have remarkably improved. In this period, investment for development is the first priority in budget expenditure. Over expenditure of state budget has been controlled at a low level of below 5%.
During 2001-2007, the balance of payment improved due to the increase in foreign aid and the improvement in current account. In the year of 2007, for example, a large amount of direct and indirect foreign investment contributed to the surplus of USD 10 millions of the balance of payments despite a large trade account deficit. In 2008, however, the indirect foreign investment decreased from USD 6.2 millions in 2007 to USD 0.1 million due to the negative effects of international and domestic economic downturn. Consequently, the balance of payments in 2008 deteriorated. To admit, the surplus of the balance of payments has had positive effects on Vietnam’s foreign reserve and has helped Vietnam stabilize the value of VND. In addition, by a tight control of foreign debt, the ratio foreign debt to GDP decreased in the early 2000s and has been managed less than 40% since then. The ratio recorded 39% in 2000, 37.4% in 2001, 34% in 2002 and 2003, 35.8% in 2005 and 36.5% in 2008 and around 40% in 2009.
2.1.2. Stock and Bond Markets
Although there is improvement in the financial sector in Vietnam, the contribution of financial sector to GDP is still very low. The contribution of the financial sector to the GDP in 2006 and 2007 was only 1.9% and 2.0%, respectively. Over the past years, stock market, bond market and insurance market have expanded although the banking sector still plays the most important role in the financial sector.
The most memorable moment in the development of the stock market in Vietnam include the establishment of the State Securities Commission (SSC) in 1995 and two securities trading centers, the Ho Chi Minh City Securities Trading Centre (HOSTC) in 2000 and the Hanoi Securities Trading Centre (HASTC) in 2005. In parallel with the establishment of the two securities trading centers, the legal frameworks on listing conditions, information transparency and exposure, and supervision have significantly improved. Nevertheless, the greatest concerns of the Vietnamese authorities are how to control speculative activities for the stability of the
130 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy stock market and how to facilitate long term investment for the development of the economy.
Vietnam’s bond market, which is dominated by government bond market, still remains relatively underdeveloped. Despite continuing effort for improvement, the market is still illiquid as investors hold the bonds to maturity. The market is also highly segmented due to multiple issue channels, methods, and registers.
2.1.3. Banking Sector
Up to 1990, Vietnam’s banking system was a mono banking system in which the State Bank of Vietnam (SBV), the country’s Central Bank, performed both central and commercial banking functions. In 1990, the establishment of the Law on the State Bank of Vietnam turned the Vietnamese banking industry into a two tier system. Four SOCBs (state owned commercial banks) were created to take over the SBV’s commercial banking activities while the SBV retained the central banking responsibilities. Given the state driven nature of the Vietnamese economy, the SOCBs traditionally focused on lending to the SOEs (state owned enterprises) until the recent economic reforms. Besides, the Law on Credit Institutions established in 1997, amended in 2003, gave permission for the operation of following financial institutions:
Vietnam Banking industry has carried out some strong reforming steps in the State bank of Vietnam as well as in the commercial bank system. Since 1999, the SBV’s organization structure and operation have been well improved. The State Bank of Vietnam performs the state management of monetary and banking activities, acts as the central bank of Vietnam and performs the state management of public services under the jurisdiction of the state bank. With this central mission, the SBV has continually improved the legal background and tools of monetary policy in order to better satisfy requirements of market economy and economic objectives of the country. The remarkable improvements in 2001-2009 period are interest rate liberalization process (from June 2002, interest rates by common agreement was implemented and interest rates for trade credit was fully liberalized); a shift from an exchange rate regime by which exchange rate was announced periodically to a regime where exchange rate was announced daily according to market signals; a change toward trend of fertilizing economic re structuring in credit policy and the plan of restructuring the commercial banks system.
131 Chapter 2 _ Monetary and Financial Policy Besides, more and more international practices in banking operation have been applied by the SBV as Vietnam is undertaking the commitment to WTO and the bilateral trade agreement with the United State to lift restrictions on foreign banks in terms of the scope as well as the depth of business. According to Vietnam’s commitment to WTO, during 5 years from the date of accession, Vietnam may limit the right of a foreign bank branch to accept deposits in Vietnamese Dong from Vietnamese depositors but on 1st January 2011, Vietnam have to grant foreign banks full national treatment. With respect to the types of business that a foreign bank can enter, from 1st April, 2007, Vietnam permitted foreign banks to open their 100% foreign owned banks provided that the total assets of parent bank is more than US $10 billion at the end of the year prior to application. Up to now, the SBV granted full licenses for HSBC, ANZ, Standard Chartered, Shinhan Vietnam Bank Limited and Hong Leong Bank Vietnam Limited to set up wholly owned banks in Vietnam.
In addition, the SBV’s banking supervision to credit institutions and non financial banking organizations has improved. International standards on supervision and inspection such as CAMELS and BASEL were gradually institutionalized and introduced. Inspection and supervision were reformed in both content and form, with more distant supervision and banking auditing (internal and independent) to support the supervision and inspection, to detect, prevent, and timely deal with violations of laws and prudential regulations of banking. As a result, its efficiency has increased significantly.
An important element that led to the current structure of the Vietnamese banking system including state banks and joint stock banks is the banking system restructuring program. The Asian financial crisis raised the significant questions in the survival of joint stock banks so that a banking system restructuring program was adopted in 1998. Then, the program of restructuring of state owned banks was adopted in 2001. One of the key measures in conjunction with restructuring the banking system is to reform the SOE sector. Since 2005, SOE reform has changed significantly in nature, with its focus shifted to large SOEs with the goal of their equitization and listing on the stock market. Up to now, Vietcombank and Vietinbank completed their equitization and Vietcombank was listed on the stock market as well.
Vietnam’s banking sector is often considered both heavily fragmented and concentrated. First, it is said to be concentrated due to the fact that five state owned banks account for the most of the market share, either on loan or on deposits. Second, it is fragmented as there are many types of banks in Vietnam, 5 state owned banks with 1,405 branches, 38 commercial banks with 1,830 branches and offices; 44 wholly owned branches of foreign banks; 5 wholly owned foreign banks; 5 joint venture banks, 15 financial companies; 13 leasing companies, 1 Center People’s credit funds and nearly 1,000 local people’s credit funds. Hence, Vietnam’s banking sector is a fragmented market structure containing two levels:
•State owned banks with monopolist customers and state owned enterprises. This
132 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy monopoly can be considered as the forced monopoly because state owned banks are all specialized. For example, Agribank is the bank for farmers and Vietcombank is specialized in international commerce. Foreign owned banks targeted high income customers and multinational firms and joint stock banks serves medium and small firms.
2.1.4. Recent Development in Vietnam Banking System
First, organization structure of banks has been improved. The equitization of state owned banks has complied with the approved plan. It is the necessary step for the development of the credit institution system in Vietnam in the next strategic period.
Second, due to the increasing competitive pressure from deepening integration, especially after the VN US BTA and WTO accession, Vietnam’s local banks have rushed into expanding their business operations by setting up new branches and developing retail banking activities in order to build their competitive advantages against potential foreign competitors. Consequently, the credit institution system in Vietnam has well developed in terms of both quantity and quality. The banking services have been expanded in terms of credit and fund raising. In addition to traditional loans such as loans for requirement of expanding production and business, loans for export import, loans for infrastructure building investment, loans for rural and agriculture development, consumer loans such as loans for house and asset purchase, loans for house amendment, loans for car and other household equipment purchase and loans for studying abroad have quickly developed. Regarding fund raising, the sources have been diversified. Consequently, capital from privatization increased to 48% of total deposit. Services of transferring money and foreign currencies have also been more focused by commercial banks.
Third, financial strength and quality of credit system operation have been intensified along with enlarging size and expanding operation scale.
•Total charter capital of credit institutions increased 8.6 times within 8 years, the average growth rate was 37% annually (commercial banks: 64% per year; state owned banks: 33% per year; financial companies; 49% per year and people’s credit funds: 64% per year).
•The average speed of increasing total asset value of credit institution system was 28% annually. At the end of 2008, the total asset value increased by 5.6 times in comparison with that in 2001. Especially, in 2006 and 2007, total asset value of joint stock commercial banks increased by 4.2 times. However, in 2008, the rate reduced to 13% due to the negative effects of international financial crisis.
•Non performing loans reduced from 14% in 2006 to 3% in 2007 and to 2.17% in 2008. Credit quality of joint stock commercial banks was quite good according to comment
133 Chapter 2 _ Monetary and Financial Policy standards as non performing loans in 2007 was 1.5%. In 2009, non performing loans are forecasted to increase as a result of the international financial crisis and downturn of real estate and stock market. Nevertheless, this rate is still under control.
•Furthermore, CAR has been improved. In the end of 2008, the ratio of commercial banks was above 10% (according to the regulations of Vietnam). ROA also increased from 0.65% in 2001 2005 to 1% in 2008.
•Management quality in credit institutions has been more professional. The internal supervision has also improved as well. Consequently, risks have been better controlled and prevented.
Generally, competitiveness of commercial banks increased significantly from 2001 to 2008: quick increase in charter capital, better service quality and penetration ability, M2/GDP and Credit/GDP increased from 58% and 35.15% in 2000 to 123% and 95% in 2008 respectively.
Fourth, banking products and services become more diverse. Some commercial banks have built their e banking system and automatic transaction system. (VCB online, connect 24, ATM, e account, home banking, credit card, TCB FAST ACCESS, etc.) By introducing modern technology, especially IT, the banks are providing more features to their customers, including the substantial improvement in the depth and quality of the banking payment system. There are now more than 8,000 ATM in Vietnam (in 2001, there were only nearly 100 ATM). Thanks to the establishment of Financial Switching Joint stock Companies like Banknetvn and Smartlink, the card business has created favorable conditions for its development. Electronic payments started to develop which establish background for E commerce in Vietnam. Such a remarkable progress of the banking payment system was further marked by the participation to the SWIFT system (in March 1995) and the introduction of the interbank electronic payment system (in May 2002) that allows to develop the wholesale and retail banking in Vietnam, and to connect to the international payment system. Currently, the payment system of Vietnam reaches the average level of the region; money transfers and payment through banks in the country now take only a few second.
2.2. Potential Causes of Economic and Financial Turmoil
2.2.1. Real Sector
Despite the prospect of sustaining high growth over the medium term, vulnerabilities in economic growth and the financial systems still remain in Vietnam. There are a number of reasons for such a concern.
•The efficiency of using inputs is still low as the effects on economic growth of capital and
134 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy labor are much higher than that of technology. Although capital investment for economic development is above 40% of GDP, the efficiency of using capital is still low demonstrated by the increase of ICOR.
•The structure of exports is still not improved as raw materials, primary goods and processed goods account for 75% of total exports.
•The efficiency of investment projects is low as the speed of disbursement of capital is low and the time of implementing projects is prolonged.
•The speed of economic restructuring is low. In fact, the share of agriculture, forestry and fisheries sector in GDP is slowly declined. The share of service sector still accounts for a small part of GDP. For example, financial sector only accounts for less than 2% of GDP.
•National competitiveness is low. The national competitiveness of Vietnam is ranked at 68/131 in 2008, reduced by 15 levels in comparison with 2000. Especially, within ASEAN, Vietnam is only ranked above Cambodia.
Recently Vietnam faces two problems: trade deficit and inflation. As can be seen in the table below, Vietnamese exports increased steadily but the growth rate of exports is lower than the growth rate of imports. Consequently, trade deficit has widened. One of the reasons that might cause trade deficit is the commitments between Vietnam and the US and WTO. Clearly, after joining the WTO, Vietnam’s trade deficit widened as Vietnam had to reduce and remove tariffs, remove non tariff barriers such as quota and exports imports license, remove subsidies and create a fair playground for all domestic and foreign enterprises. The increasing demand for imported goods and the rising price of imported goods are another reason. Furthermore, the depreciation of USD contributed to the trade deficit. The recent global financial and economic crisis also decreased the demand for Vietnam’s exports.
Before 2007, the inflation rate in Vietnam was recorded below 10%, but inflation soared in 2007 and 2008. In particular, the inflation rate was 22.97% in 2008, which had negative effects on economic growth and poverty reduction in Vietnam.
Not only the commercial banks, but also the State Bank faces weaknesses in Vietnam. International integration in banking industry is associated with higher risks due to higher sensitivity of the domestic financial market to the world market. Although the interest rates and exchange rates have been basically liberalized, the essential infrastructure (technical
136 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy infrastructure, macroeconomic environment, institutional setting, market structure, and laws) is not in place to make sure the liberalized exchange rates and interest rates are fully effective. The State Bank and the commercial banks are more prone to adverse impact of external shocks (economic crisis, war, etc.), which may cause turmoil beyond the control by the State Bank. International integration also increases capital flows and thus risks for the banking system, while the management mechanism and banking supervision is incompatible to the international practices, remain ineffective in ensuring the strict adherence to the laws on banking and the systemic safety.
The non performing loans (NPLS) of the banking industry tend to increase. Although it has gone down in recent years but the sustainability of loan quality is seriously questionable in the future. The inefficiency in large SOEs and public investments as well as the conflict of interest could result in the loss of repayment capability of those borrowers. Moreover, the risks associated with real estate and securities related loans, which were substantial in several JSCBs, are quite high in the context of high inflation and asset bubble. While the growth in loans and deposits far exceeds that of GDP, inefficient internal control and monitoring system increased the risk of non performing loans.
The banking industry has also faced a prolonged double mismatch problem (maturity mismatch and currency mismatch). Short term deposits account for 75% of total deposits, but the share of medium and long term loans in total credit rose from 22% in 1995 to about 40% in recent years (this figure is much higher for some JSCBs in 2007). At the same time, commercial banks have only been allowed to use about 25-30% of short term deposits to make medium and long term loans. The risks seem to be magnified in the presence of direct lending and conflict of interest issues, especially for the loans related to questionable real estate deals and other big projects.
There is a big gap between the lending and borrowing interest rates, which creates the vulnerability in both the domestic monetary policy and changes in international finance. Furthermore, the level of dollarization in the Vietnamese economy is quite high, since the foreign currency deposit still represents nearly 30% total deposits in 2004 while loans in foreign currency increased by 24% in 2004. In short, Vietnamese banks generally better manage risk associated with unbalance between credit and debit account in case of the depreciation of VND.
Clearly, to a certain extent, Vietnam’s economy still relies significantly on external resources to finance its investment savings gap. Meanwhile, domestic capability to efficiently serve and absorb those resources is quite limited and the economy has been financially nurtured by rather ailing banking systems. Moreover, the economy can be hit by international trade and capital flow shocks or a global recession. Importantly, there are many weaknesses which are inherited from the past in Vietnam’s banking system: unqualified staff, insufficient equipment and imperfect regulation. In sum, whether Vietnam banking system develops well or not
137 Chapter 2 _ Monetary and Financial Policy depends on the essential role of the government in stabilizing macro economic policy and the result of the ongoing reform process as well.
2.3. Policy Responses
One of the most important objectives of the monetary policy of the SBV is stability of the currency value. Based on the world financial and currency changes as well as the domestic economic condition, the SBV provides decisions in operating the monetary policy in order to retrieve the most important objectives. Basically, there are two main orientations in operating the monetary policy as followed: loosening or tightening the monetary policy. Oriented to each way, the SBV affects the money supply (M2) through some measures:
•Money multiplier by adjusting the ratio of forced reserves in order to control the lending ability of commercial banks.
•Manage the base money through some instruments: Capital refund / rediscount; Intervening in the foreign exchange market; Open market operations; Advance for the State budget
Since the Asian financial and currency crisis, the world financial market has developed more complex and had many negative effects on the Vietnamese financial market, and it also created depreciation pressure to VND. Before the disadvantages, immediate measures carried out by the SBV to deal with different stages as well as different commissions in order to limit risk indicators but also caused sudden changes in interest rates and exchange rate.
Period 1997-2000
Before the pressure of depreciation of VND and the stagnation of capital in commercial banks after the Asian crisis, the SBV has implemented many immediate and reasonable solutions without shocks to the whole economy as well as all enterprises.
In 1997-1998: The SBV devaluated VND step by step (by many measures included changing the operating measure and limiting the fluctuated band).
In 1999: Change of the exchange rate mechanism allowed Vietnam to adjust the exchange rate near the market demand and supply.
In 2000: Stabilization of the ability of operating monetary policy of the SBV. •Implementing liberalization the interest rate (2/8/2000) under the Decision No. 241/2000/QD NHNN dated August 2nd, 2001: the SBV decided to substitute the interest rate operating mechanism: transfer from operating with the ceiling interest rate to
138 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy operating with the basic interest rate with VND lending and the market oriented with management from the SBV in the interest rate mechanism with foreign currencies lending. All these changes stipulated the SBV Law.
•Operating the open market: On July 12th, 2000, the SBV carried out the first open market operation. This showed a new progress in operating the monetary policy, which contributed to adjust the usable capital of credit institutions.
From 2001 Until Now
The progress of international integration has affected the whole economic development of Vietnam as well as its currency market. The financial market has developed more and the dollarization has been widespread. The banking services as well as partners to attend to financial system have also grown more. Before this situation, the SBV continued to implement the renovation in the operation of the monetary policy, and combined all instruments of the monetary policy comprehensively in order to stabilize the value of VND and to liberalize interest rates. These instruments included loosening exchange rate band, using other indirect tools, and open market operations. All operated based on the annual objectives of the monetary policy.
In 2001: The operated objectives of the monetary policy specified by the SBV were loosening monetary policy in prudent way in order to retrieve the objective of currency stability and fostering economic growth through the measures of stimulating demand. •Refund capital interest rate and rediscount of interest rate were adjusted under the declining trend. •Adjust the forced reserves ratio flexibly in order to limit the disadvantage changes in the currency market. •Strengthen open market operations in order to adjust the usable capital of credit institutions. •Apply new monetary policy instruments. •Adjust the exchange rate: depreciate the exchange rate to enhance exports. •Operate the interest rate mechanism as the guideline of liberalizing the interest rate based on the objectives of the monetary policy. Since June 2001, the SBV has changed the lending interest rate operating mechanism with USD from market oriented with management mechanism to market interest rate mechanism (stipulated in the Decision No. 718/2001/QD NNN). The progress of liberalization with foreign currencies lending interest rate has created a more favorable environment to customers as well as credit institutions in providing the suitable level of interest rate.
In 2002: The SBV applied the newly agreed interest rate mechanism to VND. Loosening the transaction band of spot exchange rate between VND and USD against the interbank exchange
139 Chapter 2 _ Monetary and Financial Policy rate from 0.1% to 0.25%.
In 2003: Operating the monetary policy flexibly and effectively, limiting the bad effect of currency risk, controlling inflation in a reasonable level, stabilizing purchasing power of VND, and fostering the economic growth. •These instruments of the monetary policy were combined in a flexible way, limited all disadvantages impacts from the market (enhancing lending power under the way of capital refunding, selling foreign currencies to credit institutions to apply the demand of gold import, operating the interest rate under the trend of creating a sign to reduce market interest rate premises).
In 2004: Before the risk of inflation in the beginning of the year, the SBV has coordinated immediately with other agencies to identify reasons, and adjusted the objectives of the monetary policy according to the prudential trend for the purpose of stabilizing currency, interest rate and exchange rate to control inflation and to foster the economic growth. •Create a signal to stabilize the interest rate, adjust the requirement reserves ratio flexibly, change the method to pay the interest of requirement reserves deposits calculated by VND (stipulated in the Decision No. 923/QD NHNN). •Improve instruments to prevent exchange rate risks in the methods of adjusting stipulation related to forwarded exchange rates under the trend of liberalization, ensuring a central at par level that was defined by considering all commercial relations and investment relations between Vietnam and other countries, and transferring the anchor of VND from USD to currencies basket in the future step by step.
In 2005: Before the pressure of inflation, besides solutions to stabilize the price of the Government and the Ministry of Finance, the SBV has implemented the tightening monetary policy: •Raising the policy interest rates related to the international market and macroeconomic condition.
In 2006: All instruments of the monetary policy continued to adjust in a more flexible way to reduce the pressure to total payment instruments, stabilization the market interest rate, creating the more favorable environment for business of credit institutions. •Operate under the prudential trend, implement flexibly open market operations by transactions of buying and selling valuable papers on the market. •Maintain the stability of the requirement reserves ratio. •Maintain all interest rate levels at the old par (including basic interest rate, capital refunding interest rate as well as discount interest rate) in order to prevent the signal of increasing the premises of domestic interest rate regardless of the high inflation and the premises of international interest rate which followed by the raising tendency. This action created a favorable environment for credit institutions in widening the process of
140 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy mobilizing as well as lending to the economy. •Maintain the exchange rate in a low increasing level (with the trend of small devaluation of VND compared to USD). The SBV intervened initiatively the buying and selling operations on the market and implemented the float mechanism with management from the State.
In order to mitigate and prevent the increasing dollarization in the economy, to create a foreign currency policy consistent with international financial and economic situation, and to gradually liberalize current account and capital account transactions, Vietnam has had suitable solutions which have positive effects on implementing monetary policy and mitigating negative effects of international financial crisis since 1998. Foreign currency management has been changed toward liberalization; gradually removed limits on payment activities, international transfer, foreign currency investment and savings. Consequently, Vietnam has been quite successful in achieving the objectives of international economic integration and avoiding monetary and exchange rate turmoil.
1997: Enhancing foreign currency management through tight control of foreign loans, especially foreign trade loans; late payment L/C limit (Decision No.207/QD NH7); foreign currency and VND situation of foreign banks’ branch.
Table 2-2-4 | Decision Adjusting Exchange Rate
Date Decision adjusting exchange rate
The permitted band for variations in exchange rate was ± 5%. Ask price must not exceed Feb 1997 bid price+ 0.1% (Decision No.45)
The permitted band for variations in exchange rate was ± 5% Oct 1997 (Decision No. 342)
The permitted band for variations in exchange rate was ± 7% Aug 1998 (Decision No. 267)
The permitted band for variations must not exceed interbank average exchange rate (is Feb 1999 daily announced by SBV) ± 0.1%
July 2002 The band for spot exchange rate was increased from ± 0.1% to 0.25%
Dec 2006 The band for spot exchange rate was increased from ± 0.25% to 0.5%
Dec 2007 The band was increased from ± 0.5% to ± 0.75%
Mar 2008 The band was increased from ± 0.75% to ± 1%
Jun 2008 The band was increased from ± 1% to ± 2%
Nov 2008 The band was increased from ± 2% to ± 3%
Mar 2009 The band was increased from ± 3% to ± 5%
Source: GSO, Statistical Yearbook
141 Chapter 2 _ Monetary and Financial Policy In September, 1998 the government issued Decision No. 173 and Circular No.08 guiding the obligation of residents being organizations to sell foreign currency earned from current revenue sources to the banks. Accordingly, foreign currency balance of economic organizations which are residents (excluding businesses FDI) is not made by the Government; and they have to sell 80% of foreign currencies earned from current revenue sources to the banks. Then, the rate continually declined from 50% in 1999, to 40% in 2001, 30% in 2002 and 0% in 2003.
The SBV converted from direct to indirect management of enterprises’ borrowing and settling foreign loans in order to increase enterprises’ responsibilities for their loans.
The SBV has continued to increase official exchange rate and widened the permitted variations in exchange rate. And the exchange rate regime is now based on market demand and supply.
After financial crisis of 1997, Vietnam’s banking system was shown vulnerable with the increasing amount of non performing loans, non transparent public finance and some banks faced highly liquidity risks. Therefore, since 1998, the Government of Vietnam and the SBV have implemented several strong solutions in order to mitigate negative effects of financial crisis to the banking system; enhanced the safety and efficiency of the banking system and integrated in international financial and banking system step by step:
1997: Intensifying banking supervision activities to commercial banks.
1998: Re-structuring joint stock banks •Based on the plan of restructuring joint stock banks which is already approved by the Government, the Governor of the SBV will also approve and guide related departments to implement the plan. In this process, the SBV, together with authorized offices, will implement a variety of solutions such as merger and acquisition or re purchase some joint stock banks; withdraw operation license, place special control, change staff and increase charter capital.
2000: Overall plan of restructuring commercial banks system •Dealing with the increasing amount of non performing loans, the SBV has built an overall plan of solving non performing loans problem of commercial banks in Vietnam: - 15th September, 2000: Decision No. 305/2000/QD NHNN5 regulates the establishment of Debt Management Company and the use of mortgage property. - 27th November, 2000: Decision No. 488/2000/QD NHNN5 regulates the classification of “credit” assets and the use of provision for settling operational risks in credit institutions. •Solutions of re structuring the banking system were established. •In 2000, the plan of restructuring commercial banks was established with the major
142 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy following points: to increase charter capital, clear balance sheet, prevent non performing loans, differentiate credit policy with trade credit, establish Management Company and use mortgage property. Besides, the project for consolidating, perfecting and intensifying the system of People Credit Funds was also approved by the Prime Minister. After the approval, SBV co ordinated with related ministries and People’s Committee of provinces and cities which implemented the project.
2001: Implementing the program of re structuring commercial banks •The project of re structuring commercial banks in the period 2001 2010 and the project of solving existing debts of SBV were approved by the Government. In solving existing debts of commercial banks in order to reduce overdue debts and prevent non performing loans, the SBV promulgated Instruction No. 01/CT NHNN dated 2nd April, 2001 of correcting the solutions for non performing loans in commercial banks and Document No. 288/NHNN TD dated 29th March, 2002 of settling bank loans from 1991 which were categorized as loans of People Society. •In differentiating policy loans and trade loans, the SBV submitted the project of perfecting the organization and operation of Policy Banks, differentiating policy loans and trade loans. •The SBV created the program of amending the Law on Bank
2003: The SBV amended and added some articles of the Law on State Bank. The SBV guided commercial banks to build credit handbook in order to increase operational efficiency and prevent non performing loans to occur.
2004: The SBV required functional departments create the project the equitization of Vietcom Bank and Cuu Long Delta Housing Development Bank and established The Equitization Steering Committee whose members were representatives of related ministries. In order to create favorable conditions for commercial banks to raise capital on stock market, the SBV promulgated temporary Regulation of listed joint stock banks that wish to issue securities to the public.
2005: The SBV required commercial banks to settle down all non performing loans before 31 December, 2000 (Decision No. 149/2001/QD TTg) Referring to international practice of classifying debts, establishing provision for risk and capital safety, the SBV promulgated official documents and laws on debt classification, establishment and use of provision to deal with credit risks in bank operation; safety ratios of credit institutions’ operation (Decision No. 457/2005/QD NHNN dated 19th April 2005 of Safety ratios of credit institutions’ operation; and Decision No. 493/2005/QD NHNN dated of 22nd April 2005 of debt classification, establishment and use of provision to deal with credit risks in bank operation of credit institutions). The SBV amended, added and perfected policy regime related to credit and bank activities according to the trend of creating favorable conditions
143 Chapter 2 _ Monetary and Financial Policy for business activities of credit institutions (circular on borrowing and settling foreign loans, regulation of discount and re discount transferred tools and documents steering credit institutions to increase credit quality, to intensify methods for preventing risks, to better settle non performing loans and to correct lending real estate loans, etc.). The SBV amended credit regimes: amending lending and guaranteeing regime, amending debt classification in order to implement tools of improving credit quality and guaranteeing the system safety. The SBV promulgated Instruction No. 02/2005/CT NHNN dated 20th April, 2005 and Instruction No. 05/2005/CT NHNN dated 25th April, 2005 which required credit institutions to control credit growth speed and to guarantee that development speed is consistent with real capital raising growth.
3. EWS for Financial Markets: Signal Approach
In this section, we develop an early warning system for Vietnamese financial markets following “signal” approach. This methodology, developed by Kaminsky, Lizondo, and Reinhart (1998), involves monitoring the evolution of a number of economic indicators that tend to systematically behave differently prior to a crisis.3)
3.1. Financial Stress Index: Dating Historical Crisis Episodes
In signal approach, we need to have a well defined notion of what is classified as a crisis. Thus, the first step in developing EWS is to determine what constitutes a crisis and, based on this definition, to date historical crisis episodes. Most of the early warning systems using signal approach identify the crisis periods in a statistical way that key financial variables show abnormal values. In this paper, we construct a financial stress index (FSI) in which financial stress is defined as a period when the financial markets in Vietnam is under strain. When measuring stress, the index primarily relies on price movements relative to historical averages or trends to proxy for the presence of strains in financial markets.
The FSI for Vietnam comprises five variables which serve to capture three financial market segments. First, the foreign exchange market pressure (EMP) is measured by exchange rate depreciation and declines in international reserves, and is defined in month t as:
Δe and ΔRES denote the month over month percent changes in the nominal exchange rate (Dong/US dollar) and the total international reserves minus gold (in US dollar), respectively.
µΔe (µΔRES) and ÓΔe (ÓΔRES) denote the mean and the standard deviation of the changes in
3) Kaminsky and Reinhart (1999), Park (2001), Kang, Kim, and Lee(2005), and Asian Development Bank (2005) among others also use signal approach.
144 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy exchange rate (changes in reserves), respectively. Changes in exchange rate and changes in international reserves are divided by standard deviations so that the two components have the same conditional variance. An increase in the EMP with a depreciation of the currency and with a loss of international reserves reflects stronger selling pressure on domestic currency.
Second, the stock market pressure (SMP) is measured by stock market returns and stock market volatility. Stock returns are computed as the year on year changes in the Ho Chi Minh stock exchange index multiplied by minus one, so that a decline in stock prices corresponds to an increased stock market pressure. The measure of stock market volatility is obtained from a GARCH(1,1) specification using month over month stock returns. Third, interest rate pressure (IRP) is measured by the changes in nominal interest rate (deposit rate) divided by its standard deviation.
Finally, the financial stress index (FSI) is the sum of the standardized EMP, SMP, and IRP.
FSI = EMP + SMP + IRP.
In the empirical application, a crisis is identified by the behavior of the financial stress index. Periods in which the index is above its mean by more than k x standard deviations are defined as crises.4)
Figure 2-2-2 | Financial Stress Index and Crisis Periods (k = 1)
12
8
4
0
-4
-8
1996 1998 2000 2002 2004 2006 2008
Figure 2-2-2 shows the FSI for Vietnam for the sample period from 1995 to 2009. The horizontal line depicts the threshold value of the FSI when k is set one. Thus, the periods when
4) Similarly, we can also identify crisis periods for each market segment. Appendix depicts the movements of EMP, SMP, and IRP along with the identified crisis periods when k is set one.
145 Chapter 2 _ Monetary and Financial Policy Figure 2-2-3 | Financial Stress Index and Crisis Periods (k = 1.5)
11 OECD LI OECD leading indicator, 12 month percent changes
12 S&P500 US stock returns, 12 month percent changes multiplied by -1
Nominal Broad 13 Trade weighted US exchange rate, 12 month percent changes Dollar Index -(Demand Deposit + Time & Savings deposit)/CPI, 14 Bank deposits 12 month percent changes
146 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy the FSI exceeds the threshold are considered crises. The vertical lines denote these periods of crises. When k=1, March 1997, October and November 1997, January and February 1998, August 1998, January 2001, June 2001, February to July 2008, March to April 2009, and June 2009 are identified as crisis periods. For higher k, a smaller number of crisis periods are identified as illustrated in Figure 2-2-3 when k=1.5.
Once the crisis periods are identified, the next step is to select leading indicators that can predict the crisis and perform statistical analysis for the forecasting power of the leading indicators. The choice of indicators was dictated by theoretical considerations and by the availability of information on monthly basis. They are CPI inflation rate, lending-deposit rate difference, domestic credit, exports, imports, trade balance, M2/reserves, M2 multiplier, broad money, oil price, OECD leading indicator, US stock returns, nominal broad dollar index, and bank deposit. Details on the indicators are summarized in Table 2-2-5.
An indicator is said to issue a signal whenever it departs from its mean beyond a given threshold level. Given the identified crises periods from the FSI, the threshold levels are chosen so as to balance between the risks of having many false signals and the risks of missing many crises. We select the threshold value on an indicator by indicator basis, by performing a fine grid search. Therefore, for each leading indicator, a threshold divides its distribution into a normal region and a critical region associated with a heightened probability of crisis. For each period, if the observed outcome of an indicator crosses the threshold and falls into the critical region, the indicator would issue a signal.
The maximum interval of time between the signal and the crisis is decided a priori as 12 months. Thus, any signal given within the 12 month period before the beginning of the crisis is labeled a good signal while any other signal outside the 12 month window is labeled a bad signal or noise.
3.3. Empirical Results
Given the crisis periods and 12 month window, each indicator gives one of the four cases at each point of time. Consider the two by two matrix in Table 2-2-6. If an indicator issues a signal and a crisis occurs in the following 12 months, the signal is considered accurate (counted in cell A). If an indicator issues a signal but no crisis occurs in the time interval, the signal is said to be a false alarm or noise (counted in cell B). In contrast, we also have the case that an indicator does not issue a signal but a crisis occurs in the next 12 months (counted in cell C). The last case is that an indicator does not issue a signal and no crisis occurs (counted in cell D). Hence, a perfectly desirable indicator would only have entries in cell A and cell D. Therefore, an extremely nosy indicator would have few entries in A and D, while many entries in B and C. For each indicator, we can calculate the number of entries of each cell and based on this information we can evaluate the predictability of indicators.
147 Chapter 2 _ Monetary and Financial Policy Table 2-2-6 | Signals and Occurrences of Crises
Crisis occurs No crisis occurs in the following 12 month in the following 12 month Indicator issues A B a signal Indicator does not issue C D a signal
Table 2-2-7 provides the empirical results for the selected indicators. The first column of Table 2-2-7 shows a measure of the tendency of individual indicators to issue good signals. It shows the ratio of the number of good signals issued by the indicator to the number of months in which good signals could have been issued (A/(A+C)). If the ratio is one (100 percent) for an indicator, it issued a signal every month during the 12 months prior to every crisis. In terms of the results in the first column, the lending-deposit rate spread is the indicator that issued highest percentage of possible good signals (40 percent) followed by nominal broad dollar index (36 percent), while exports issued the lowest percentage of possible good signals (13 percent).
The second column of Table 2-2-7 measures the performance of individual indicators regarding sending bad signals. It shows the ratio of the number of bad signals issued by the indicator to the number of months in which bad signals could have been issued (B/(B+D)). Other things being equal, the lower the ratio is, the better the indicator. The ratios for most indicators are less than 10 percent, suggesting quite good performances in terms of this ratio. Domestic credit, broad money and inflation rate show the best performance (about 1 percent of possible bad signals), while export shows the poorest performance (issuing 13 percent of possible bad signals).
The information about the indicators’ ability to issue good signals and to avoid bad signals can be combined into a single measure of the performance of the indicators. The third column of Table 2-2-7 shows the noise to signal ratio which is obtained dividing the number in the second column by the number in the first column. Thus, the noise to signal ratios is the ratio of the false signals measured as a proportion of months in which false signals could have been issued, to good signals measured as a proportion of months in which good signals could have been issued. In terms of Table 2-2-6, the noise to signal ratio is defined by ([B/(B+D)]/ [A/(A+C)]). In general, the lower the noise to signal ratio is, the better the indicator.
The various indicators differ significantly with respect to the noise to signal ratios. While this ratio is only 0.03 for broad money and 0.05 for inflation rate, it is 0.93 for export and 0.55 for S&P500.5) The noise to signal ratio can be used as a criterion for deciding which indicators to drop from the list of candidate indicators. An indicator that issues signals at random and thus has no intrinsic predictive power would yield a noise to signal ratio equal to unity in a sufficiently large sample. Therefore, those indicators with noise to signal ratio equal to or
148 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy higher than one may introduce excessive noise rather than not help predict crises. All the indicators considered in Table 2-2-7, however, have the noise to signal ratios less than one, suggesting that the indicators are helpful to predict crises.
Another way of interpreting the above results regarding the noisiness of the indicators is by comparing the probability of a crisis conditional on a signal from the indicator with the unconditional probability of a crisis. The conditional probability can be calculated as P[crisis|signal]=A/(A+B) while the unconditional probability is (A+C)/(A+B+C+D). To the extent that the indicator has useful information, the conditional probability would be higher than the unconditional one.
Table 2-2-7 | Predictability Performance of Leading Indicators
Good Signals as Bad Signals as Percentage of Percentage of P(Crisis Noise P(Crisis) Possible Good Possible Bad /Signal) /Signal P(Crisis Indicator Signals Signals /Signal)- P(Crisis) [B/(B+D)]/ (A+C)/ A/(A+C) B/(B+D) A/(A+B) [A/(A+C)] (A+B+C+D)
5) The noise to signal ratio for domestic credit is zero because the number of bad signals as percentage of possible bad signals is zero.
149 Chapter 2 _ Monetary and Financial Policy The fourth column of Table 2-2-7 presents the conditional probabilities, while the fifth column shows the unconditional probabilities of crises. The numbers in the sixth column are the difference between the conditional and unconditional probabilities for each of the indicators. From the sixth column, it is clear that the conditional probability is greater than the unconditional probability for every indicator. Monetary variables (domestic credit and broad money), inflation rate, and foreign variables (nominal broad dollar index and OECD leading indicator) show the larger differences between the two probabilities. Comparing the numbers in the sixth column with the numbers in the third column, we can find that an indicator with lower noise to signal ratio shows a larger difference in two probabilities, implying the two measures have similar information.
3.4. Composite Indicator
We combine the information of all the indicators by constructing a single composite indicator that we use to compute the probability of a crisis in any given point in time. The composite indicator is defined as a weighted sum of the signaling indicators, where each indicator is weighted by the inverse of its noise to signal ratio. Notice that indicators with low noise to signal ratios are given higher weights, since they are more reliable in predicting crises. The composite indicator is defined as follows:
where Sit is equal to one if indicator i crosses the threshold and zero otherwise and wit is the inverse of noise to signal ratio of indicator i.6)
6) An alternative composite indicator can be a simple sum of binary values, Sit of all thindicators.
150 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy Figure 2-2-4 shows the composite indicator along with the dates of crisis episodes. The evidence presented in Figure 2-2-4 provides some support for the composite indicator. As seen in Figure 2-2-4, the composite indicator starts to rise before the 2001 crisis period and 2008 2009 crisis period, while the composite indicator remains low during 2002-2006.
3.5. Limitations and Recommendations
It is important to recognize that, while an early warning system would be a useful tool for a timely assessment of the likelihood of a crisis, the system is also subject to limitations. The system is based on the past behavior of the economic variables, and thus changing structure of the economy could reduce the predictability of the system. In particular, future institutional changes will strongly affect the relationships among the variables. Therefore, we need a comprehensive assessment of the situation as well as a continuing update of the system for a better performance of the system and a better policy decision.
In this paper, we use the database of International Financial Statistics compiled by IMF and other foreign database. If we could access to other source of data (for example, black market exchange rate which is more likely to reflect the market demand for and supply of foreign currency), we might build a more reliable system. Thus, we recommend revising the system with more data collected by the Vietnamese government and the State bank of Vietnam.
In addition, we emphasize that the system should be updated regularly. Future changes in exchange rate system and deregulation of interest rates are likely to affect the behavior of financial stress index and thus require revision of the system. To do this, a specific team in the government or the central bank should be organized and be in charge of operating and revising the early warning system. We believe that the system developed in this paper can provide a basic tool to monitor macroeconomic soundness and to help predict the likelihood of future crises. Nevertheless, for better performance of the system, it is crucial to update and revise the system regularly based on the experiences from actual operation by Vietnamese experts.
The early warning system for financial markets introduced in this section is designed to predict financial crisis from a macroeconomic point of view. Thus, the system cannot take into account microeconomic soundness of financial institutions. We will explain another important early warning system regarding the soundness of financial institutions in the next section.
151 Chapter 2 _ Monetary and Financial Policy 4. Early Warning System for Financial Institutions: CAEL Rating System 4.1. Background
The safety and soundness of the financial sector such as banking industry play key roles in all phases of economic development. The economic and social costs of the insolvent banks are tremendous as we have witnessed during the ‘97 Asian Crisis and ‘08 Global Financial Crisis.
The Vietnamese banking sector consists of four category of banks: (i) state owned commercial banks, (ii) joint stock commercial banks, (iii) joint stock banks, and (iv) foreign bank branches.7) Although SOCBs account for about 70 per cent of total loan market, the portion of the commercial banks has also been growing steadily. Some banks like Asia Commercial Bank (ACB) have shown that the business is quite profitable. As the banking sector is scheduled to be fully open in 2011, we expect that the industry would expand rapidly and become more competitive. The question is what kind of supervisory tools we have to monitor the safety and soundness of the industry in transition.
Regulatory authorities often assess composite risk ratings of financial institutions by selecting several component variables that represent risk factors, such as capital adequacy (C), asset quality (A), earnings (E), liquidity (L) and the like, and by assigning points for each component variable and weights for each risk factor. The weighted average of constituent series is computed, which is often referred to as a “rating score,” and is mapped to the composite rating scale. Each financial institution is then assigned to one of the five risk groups: composite ratings of 1 or 2 mean financially sound and only a few minor weaknesses. Composite rating of 3 means weakness that, if not corrected, could cause serious financial distress over time and increased risk to the insurance fund. Composite ratings of 4 or 5 mean substantial probability of loss to the fund unless effective corrective measures are taken. This method, called the CAEL rating system, has been known as an effective device for routine off site monitoring of the safety and soundness of individual banks and other financial institutions as it provides a convenient way to summarizing the strength of financial institutions.
In practice, the Financial Supervisory Service (FSS) in Korea operates the Financial Industry Early Warning System (FIEWS) since 2007 in which the CAEL rating system is one integral part of more comprehensive supervisory tools. The Korea Deposit Insurance Corporation (KDIC) has also launched the similar system in 2009, called “Risk Evaluation and Forecasting System” (Refs). By monitoring the trend and distribution of the CAEL ratings each quarter, the supervisory authorities try to identify the most vulnerable financial institutions in a timely
7) As of 2007
152 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy fashion, and therefore, they would implement their preemptive measure to minimize the potential cost arising from the insolvent financial institutions. Next section will describe the method of CAEL rating system in more details using hypothetical data.
4.2. Delineation of CAEL Rating Method
The idea of making up of CAEL rating is similar to the construction of stock market index (summary of rises and falls of stock prices of a particular point in time in a single number) and of the composite index of coincident indicators to measure the real business activities. The CAEL rating system could be constructed in two forms, supervisory CAEL and statistical CAEL. The main difference is whether one gives more weights to supervisory views or to the outcome of the statistical analysis of failing financial institutions in constructing the rating system. This section focuses on the supervisory CAEL rating system.
Supervisory CAEL ratings comprise of ratings for individual indicators, ratings for each risk category such as C, A, E, and L, and the composite rating derived with the ratings of risk categories. Details of each steps of the CAEL method can be explained as follows:
Table 2-2-8 | Illustrative List of CAEL Component Variables
Hypothesis Example Risk Variable Name Code Category (Corr. with Bankruptcy) (Bank A) BIS Capital Adequacy Ratio - C001 11.42 C: Capital Adequacy BIS Tier1 Capital Adequacy Ratio - C002 9.19 Capital to Assets - C003 4.97 Substandard and below loans to total loans +A0011.39
A: Asset Loss-risk weighted loans to total loans + A002 6.56 Quality Delinquency ratio + A003 1.70 Provisions to substandard and below loans -A004105.96 Operating expenses to total assets + E001 1.46
Expenses to net operating income + E002 56.83 E: Earnings Net income to total Income generating assets - E003 2.88 Return on assets - E004 1.81 Net liquid assets to liquid liabilities (in foreign currency) - L001 143.93 Net liquid assets to liquidity liabilities (in L:Liquidity KRW) - L002 126.68
Net short-term loans to loans (in KRW) - L003 4.47
153 Chapter 2 _ Monetary and Financial Policy Step 1: Selecting CAEL Component Variables
The first step of the CAEL method is to collect variables that are believed to contain adequate information about the riskiness of banks. The selection could be based upon the experiences of examiners or upon statistical analysis. These variables are often categorized according to the nature of risks involved such as capital adequacy (C), asset quality (A), earnings (E), and liquidity (L). Table 2-2-8 illustrates four risk categories and fourteen component series of CAEL which were chosen from much broader set of candidate variables. For instance, BIS capital adequacy ratio is deemed to be one of the single most important quantities that represents the adequacy of the bank capital and is listed as a component series in the C category in Table 2-2-8. In the third column of Table 2-2-8, hypothesis indicates the sign of a component variable towards the level of risk. That is, a positive sign means that the higher the value of a series the riskier it is. The last column illustrates actual quantities of component variables of a particular bank. In the example below, we will use fourteen series listed in Table 2-2-8 to illustrate the computation of composite ratings.
Step 2: Setting Rating Intervals for Each Component Series
After determining the component indicators of each risk category of CAEL, we need to set the rating intervals for each indicator to derive the ratings of individual indicators. The rating intervals in supervisory CAEL are usually determined uniformly by supervisory policies. As an alternative, rating intervals can be constructed using either parametric method or non parametric method. For instance, a parametric method would determine the rating intervals of the indicators using the mean and standard deviation as in Table 2-2-9. The intervals are the distance measured as the number of standard deviations (0.5 standard deviation and 1.5 standard deviations) the value of the indicator is away from the mean, and the ratings either become higher or lower in proportion to the distance. The multiples applied to the standard deviation could be set differently at a researcher’s discretion.
On the other hand, a non parametric method would determine the rating intervals of the
Table 2-2-9 | Standards for Rating Intervals of Component Indicators: Case of Parametric Approach
Note: Rating 1 indicates the best rating and Rating 5 indicates the worst.
154 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy Table 2-2-10 | Illustrative Rating Intervals of CAEL Component Variables
Rating Risk Component variable Category Rating 1 Rating 2 Rating 3 Rating 4 Rating 5 BIS Capital Adequacy Ratio Gt 10% Le 10% Le 8% Le 6% Le 4% C: Capital BIS Tier 1 Capital Adequacy Ratio Gt 7% Le 7% Le 4% Le 3% Le 2% Adequacy Capital to Assets Gt 6% Le 6% Le 4% Le 3% Le 2% Substandard and below loans to total loans Lt 1.5% Ge 1.5% Ge 2.5% Ge 4% Ge 7% Loss?risk weighted loans to total A: Asset loans Lt 5% Ge 5% Ge 15% Ge 30% Ge 50% Quality Delinquency ratio Lt 2% Ge 2% Ge 4% Ge 6% Ge 8% Provisions to substandard and below loans Gt 130% Le 130% Le 110% Le 60% Le 40% Net income to total Income generating assets Gt 3.5% Le 3.5% Le 3% Le 2.5% Le 2% Ge 100% Expenses to net operating income Lt 45% Ge 45% Ge 60% Ge 75% Le 0% Greater than and E: Return on equal to 10 trillion Gt 0.85% Le 0.85% Le 0.65% Le 0.45% Le 0% Earnings assets KRW in asset
Operating Greater than and expenses equal to 10 trillion Lt 1.1% Ge 1.1% Ge 1.7% Ge 2.3% Ge 2.9% to total KRW in asset assets Net liquid assets to liquid liabilities (in foreign currency) Gt 100% Le 100% Le 85% Le 75% Le 65% Net liquid assets to liquid L:Liquidity liabilities (in KRW) Gt 120% Le 120% Le100% Le 90% Le 80% Net short-term loans to loans Gt 10% Le 10% Le 0% Le -10% Le -20% (in KRW)
Note: Gt denotes “greater than”, Ge denotes “greater than and equal to”, Lt denotes “less than”, and Le denotes “less than and equal to”. indicators using, say, quantiles of the distribution of the component variable. In this way, one may come up with rating intervals that reflect the non normality of the empirical distribution of the component variables. Whether it is parametric, non parametric, or purely supervisory discretion, it is important for the rating intervals scheme does not yield the rating assignment concentrated to a particular rating. Table 2-2-10 illustrates the reference rating intervals for fourteen variables listed in Table 2-2-8.
Step 3: Assigning Ratings for Each Component Series
Given the reference rating intervals explained in Step 2, a rating is assigned to each variable. For instance, the BIS capital adequacy ratio (labeled as C001) of bank A in Table 2-2-8 was 11.42% and according to reference table in Table 2-2-10, it belongs to Rating 1. Ratings of other component variables are determined likewise and are illustrated in Table 2-2-11. In the
155 Chapter 2 _ Monetary and Financial Policy table, the actual values of each variable are provided in the second row and the corresponding ratings are provided in the third row.
Note: The first row indicates the variable code (refer to Table 2-2-8), the second row indicates the actual values, and the third row indicates the ratings based upon lookup table in Table 2-2-10.
Step 4: Assigning Ratings for Each Risk Category
Once the ratings of individual components are determined, one can construct the ratings for each risk category, namely C, A, E, L ratings. In doing so, one needs to first decide weights to each variable in the same risk category. The simplest way is to assign equal weights. For instance, Category A consists of four variables and each variable would receive a 25% weight in the equal weight scheme. Of course, more elaborate weighting scheme could be devised using, for instance, a statistical method called the Principal Component Analysis (PCA).
Table 2-2-12 illustrates the assignment of ratings for each risk category. In this example, we applied equal weighting scheme to A, E, and L categories, and for illustrative purpose, slightly different scheme is applied to the C category. Namely, one can add more conditions to the rating scheme. For instance, a simple average rating of C category in Table 2-2-11 is 1.33, which may be recorded as 1 after rounding off. This could be changed to the following rule:
Rule for C category: Compare an average rating of C category to a rating of a simple capital ratio (C003) and keep the lower one.
In this case the average rating is 1 and the rating of C003 is 2. Therefore, rating 2 is recorded in Table 2-2-12 (recall that rating 2 is poorer one than rating 1). Other than this exception, we use equal weighting scheme for the remaining three categories, which yielded, respectively, ratings 2, 2, and 1.
Table 2-2-12 | Ratings of Each Risk Category and Composite Ratings
C A E L Composite Rating Composite Category Category Category Category (in decimal) Rating
2 2 2 1 1.90 2
Note: Weights for A, E, and L categories are all equal. In case C category, we compared an average rating of C category to a rating of a simple capital ratio (C003) and kept the lower one.
156 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy Step 5: Assigning Composite Ratings
Given ratings for each risk category explained in Step 4, one can assign the final score, namely, composite rating. Composite rating is simply a weighted average of each rating of risk categories. In doing so, equal weights could be assigned or some statistical method could be applied to compute them. In the latter, the Principal Component Analysis (PCA) could be used. In this section, we assume a particular weighting scheme illustrated in Table 2-1-13.
Table 2-2-13 | Weights of Each Risk Category of Supervisory CAEL
Using this weight, the final CAEL composite rating expressed in decimal is computed as follows:
Composite Rating (in decimal) = 30% * C Rating + 30% * A Rating + 30% * E Rating + 10% * L Rating = 0.2 * 2 + 0.3 * 2 + 0.3 * 2 + 0.1 * 1 = 1.90
This result is illustrated in the second last column of Table 2-2-12. Or one can map this decimal rating to an integer rating using the score scales which is illustrated in Table 2-2-14. Keeping composite rating in decimal would be useful when integer ratings are concentrated in a particular rating. In addition, CAEL rating system can also be designed to yield scores (or points) instead of ratings.
Table 2-2-14 | Score Scales of Supervisory CAEL Ratings
157 Chapter 2 _ Monetary and Financial Policy 4.3. The CAEL Rating System in Practice: Korean Experience
The CAEL rating system can be built in a various platforms such as Client/Server based, Web based, or Microsoft EXCEL based. It is very important, however, to remember that the validity of the system relies heavily on the quality of the component variables.
The main output of the system is of course CAEL ratings, either in points (scores) or ratings or both. Figure 2-2-5 illustrates the quarterly evolution of CAEL ratings (in rectangles) and CAEL scores (in solid line) for a particular bank operating in Korea. It shows that this bank seems to have experienced a great deal of distress in 2004, followed by the substantial improvement during the 2006-2007 periods. Since the third quarter of 2008 when the Lehman Brothers went bankruptcy, the rating of this bank has been deteriorated to 3, which is somewhat expected.
Figure 2-2-5 | Trend of CAEL Ratings and Scores: Case of Bank A
Note: CAEL ratings are in rectangles (right scale) and CAEL scores are in solid line (left scale).
In addition to the monitoring of an individual bank, the CAEL rating system allows supervisors to monitor the trend and distribution of CAEL ratings for the whole banking industry. By doing so, supervisors can determine whether the level of risks are in general increasing or decreasing over time and whether the competitiveness of banks are tightening or diverging a particular point in time. This is illustrated in the top left panel of Figure 2-2-6. From the system one can readily see the distribution of CAEL ratings at a particular quarter of year (top right panel) and the list of the most vulnerable banks, rated 4 or below, from the bottom right panel.
158 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy Figure 2-2-6 | The CAEL Rating System: M/S Excel Based
Note: The pilot CAEL rating system depicted in this figure is developed by the Hanyang Economic Research Institute (HERi).
Figure 2-2-7 | The CAEL Rating Forecast System
CAEL & forecasting 4
3.5
3 CAEL(in-sample) CAEL(out-of-sample) mean 2.5 median CAEL 95% Rating 5% 2 CAEL CAEL(decimal) mean 1.5 median 95% 5% 1
Note: The pilot CAEL rating forecast system depicted in this figure is developed by the Hanyang Economic Research Institute (HERi) in collaboration with FSS. One year ahead forecast, out of sample, on CAEL ratings are made from 2009:Q2. Namely, forecasts on 2009:Q2 CAEL ratings are based upon the information available at 2008:Q2. Also depicted are historical CAEL ratings (in decimal) and their median and 95% band. They show that the median ratings are increasing, indicating the deterioration of average ratings, since 2008:Q3 because of the global financial crisis.
159 Chapter 2 _ Monetary and Financial Policy Once the CAEL rating system is in place, the natural extension to think about would be to develop the system that predicts the future CAEL ratings (Collier et al. (2003)). Using an econometric model such as the ordered logit model one may be able to develop such system. Figure 2-2-7 illustrates such system that produces one-year-ahead CAEL rating forecasts for each bank in Korea. In the figure, one-year-ahead forecast, out-of-sample, on CAEL ratings are made from 2009:Q2. Namely, forecasts on 2009:Q2 CAEL ratings are based upon the information available at 2008:Q2. Again supervisors can monitor the trend (median) and distribution of rating forecasts of the industry and determine which banks are most likely to be vulnerable. Also depicted in the figure are historical CAEL ratings (in decimal) and their median and 95% band. They show that the median ratings are increasing, indicating the deterioration of average ratings, since 2008:Q3 because of the global financial crisis.
Building a good forecasting model is often a daunting task. Fortunately, however, as long as the supervisory CAEL rating system is built upon reliable component variables, the feasibility of this type of forecasting system can be built and tested without having to wait too long to accumulate the data over the period.
4.4. Policy Recommendation: Building Pilot CAEL Rating System for Vietnamese Banking Industry
Building a comprehensive early warning system like FIEWS of FSS or Refs of KDIC is a challenging task. The successful implementation would depend largely on the availability of the quality data, which takes time to accumulate. It is particularly so if one attempts to build more elaborate system like statistical CAEL rating system.
Hence, the recommendation is to start with a simpler CAEL rating system, namely, “supervisory CAEL rating system”. In order to build this system, the supervisory authority needs to collect about ten major financial indicators that represent C, A, E, and L risk categories and to determine the regulatory thresholds for each indicator by benchmarking the experience from other countries and/or by examining the distribution of the Vietnamese data. Using these thresholds, the supervisory CAEL scores and ratings system can be developed using a popular platform like MS Excel and VBA. Table 2-2-15 summarizes a tentative schedule for such task. From the perspective of building the successful pilot CAEL rating system for the Vietnamese banking sector, the first stage of consulting and data collection is expected to be the most challenging because of the lack of the automated data upload and retrieval system operable between the SBV and commercial banks.
Once the database accumulates the sufficient data, say, for more than five years and quarterly, not only the CAEL rating system, but also other models such as statistical CAEL rating system, distress prediction (default vs. normal) and rating prediction system could be developed.
160 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy The Asian Development Bank (ADB) currently operates their early warning system, called “Vulnerability Indicators Early Warning System”(VIEWS). This system resembles the signal approach presented in this chapter and the CAEL rating system would serve as a good companion system. The Korean experiences of operating the signal approach model, CAEL rating system, and other elaborate models of predicting insolvent financial institutions would help the Vietnamese supervisory authorities to define the business process of financial regulation and to design and develop its own blueprint of macro prudential surveillance system.
Table 2-2-15 | Schedule for Building VN Banking CAEL Rating System
Stage Task M1 M2 M3 M4 M5 total
1.1 To define data to be collected 1. Consulting and Data 1.2 To design the database Collection 1.3 To collect data
2.1 To model rating intervals 2. Modeling 2.2 To validate the model 2.3 To modify data collection
3.1 To design the system 3.2 To build the system 3. System Building 3.3 To document and test the system
In order to build the CAEL rating system as a primary supervisory tool for monitoring the safety and soundness of commercial banks and for taking preemptive actions, several problems have to be clarified and met:
1. Understanding and consensus among regulatory authorities on the usefulness of the CAEL rating system as a supervisory tool. 2. Reliability of figures of the financial statements reported by the commercial banks. If some banks breach the reporting rule, how the authority recognizes it and implements the penalty. 3. Standard format for reporting. 4. Adequate database operated by the authority to verify the data and to manipulate them to produce appropriate financial ratios. 5. Regulatory framework to make use of the CAEL ratings for supervisory purposes.
161 Chapter 2 _ Monetary and Financial Policy 6. Capacity of modeling and implementing the CAEL rating system. 7. Internal network and security to share the information generated by the CAEL rating system.
For each of seven problems, tentative resolutions are summarized in the following Table 2-1-16.
Table 2-2-16 | Problems and Resolutions
Problems Description Resolutions/ Milestone
•Regulatory authorities are not familiar with the concept and its usefulness. •Regulatory authorities may prefer on 1. Understanding and consensus site examination to the selective one among regulatory authorities on based upon CAEL ratings. •Quality of data used for the rating To provide workshop. the usefulness of the CAEL rating compilation is not guaranteed. • system as a supervisory tool. •Difficult to understand intuitively the meaning of composite rating compared to a single ratio such as delinquency ratio and BIS capital adequacy ratio.
•To announce the upcoming 2. Reliability of figures of the •Figures reported in the balance sheet and income statement may not be adoption of CAEL rating system to financial statements reported by reliable. commercial banks to remind them the commercial banks. If some that the reporting of disguised •Detecting a disguised financial figures will constitute a severe banks breach the reporting rule, statement may require a high level of breach of the terms and conditions how the authority recognizes it and expertise. of the bank license. •Not enough man power to conduct the implements the penalty. •To conduct selective audits on the full scale audit. bank’s B/S and P/L.
•Financial statements are required to be reported on a quarterly basis. 3. Standard format for reporting. •Data reporting format has to be •To design the standard format and standardized to facilitate the timely to require quarterly reporting. reporting and to be received automatically by the SBV database.
•The CAEL database will provide not only the information for the CAEL rating system, but also for the general 4. Adequate database operated by the •To consult the advanced database authority to verify the data and to purposes of reporting and analysis in system from other countries. the future. To seek external donor program for manipulate them to produce •Building a reliable database for • appropriate financial ratios. analysis, reporting, and information funding disclosure requires a substantial resource and time.
5. Regulatory framework to make •Internal rules and regulations have to use of the CAEL ratings for be modified to enable the use of CAEL •To benchmark foreign experiences. supervisory purposes. ratings for the supervisory purpose.
•Because of the lack of experiences, the 6. Capacity of modeling current capacity of the research and and implementing the CAEL development may not be adequate. •To benchmark foreign experiences. rating system. •Due to the lack of the available data, benchmarking is very important.
•The security of the CAEL ratings is very important because of the contaminant nature of the information of the 7. Internal network and security to financial strength of financial •To define the authorization rule and share the information generated institutions. the information secrecy. by the CAEL rating system. • At the same time, the CAEL ratings have to be shared among the authorized supervisors in a timely fashion.
162 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy References
Asian Development Bank (2005), “Early warning systems for financial crises.”
Collier, C., S. Forbush, D. Nuxoll, and J. O’Keef (2003), “The SCOR system of off site monotoring: Its objectives, functioning, and performance,” FDIC Banking Review, vol. 15, pp 17-32.
D. Kang, J. Kim, and H. Lee (2005), “An early warning system for financial markets in Korea,” Korea Development Institute. (in Korean)
Kaminsky, G. and C. Reinhart (1999), “The twin crises: the causes of banking and balance of payments problems,” American Economic Review, vol. 89, no. 3, pp 473-500.
Kaminsky, G., S. Lizondo, and C. Reinhart (1998), “Leading indicators of currency crises,” IMF Staff Paper, vol. 45, no. 1, pp 1-48.
163 Chapter 2 _ Monetary and Financial Policy [Appendix 1] Components of Financial Index
165 Chapter 2 _ Monetary and Financial Policy Chapter 03 Capital Account Liberalization in Vietnam: Past Trends and Future Agenda
Inseok Shin (Chung Ang University) Nguyen Thi Kim Thanh (State Bank of Vietnam)
1. Introduction
The objective of this paper is to provide recommendations for capital account liberalization policy of Vietnam. When liberalizing the capital account, an emerging economy tends to face a well known policy challenge: “how to manage macroeconomic stability during the opening process?” It is now accepted as a rule that after opening the capital account, an emerging economy becomes subject to whims of international capital flows, which can lead to devastating macroeconomic instability. Recognizing this, the focus of the paper is on formulating policy strategies for Vietnam to avoid negative consequences of the capital account liberalization.
For the purpose, we discuss the pre-conditions that should be in place before the capital account liberalization to cope with volatility of international capital flows and manage its negative impacts on the real sector of an economy. In particular, instead of presenting general lessons, we heavily draw on experiences of Korea during her development and liberalization decades. In that way we hope to highlight practical problems and to vividly illustrate how and why the pre-conditions matter in an actual context. Indeed, Korean experiences can make an ideal case for a practical minded study, since it is assessed as a model case of economic development even though Korea had some difficulties in achieving the goal of maintaining macroeconomic stability while pursuing capital account liberalization.
After reviewing the Korean case, we turn to evaluate the past trend of capital account policy in Vietnam and its effects on recent capital flows. Obviously, the objective is to identify Vietnamese specific ‘flavors’ for the general issues discussed in the Korean context. Finally,
166 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy based on the discussions, we formulate policy recommendations.
Punch lines of the paper are to emphasize four pre-conditions for maintaining macroeconomic stability in the face of a liberalized capital account: 1) Fiscal discipline; 2) Monetary discipline; 3) Soundness of the financial sector; 4) Policy tools for managing short term capital volatility. We argue that these conditions are all binding constraints to maintain long term macroeconomic stability. One cannot selectively choose to satisfy some of the pre- conditions and expect macroeconomic stability can be preserved. We further argue that the last condition is the most important to manage short term capital volatility and its negative impacts. In fact, we are confident that the most valuable lesson from the Korean experiences is that even an economy meeting the other three pre-conditions may fall a victim to a currency and financial crisis, if the last condition is not met. What’s more challenging for an emerging economy is that specificity of institutionalizing the last pre condition can differ across economies to reflect different local conditions.
The rest of the paper is structured as follows. In Section 2, we discuss the pre conditions for capital account liberalization, drawing on the Korean experiences. Section 3 contains the evaluation of the past capital account policy and trends in capital flows in Vietnam. Policy recommendations are presented in Section 4.
2. Pre Conditions of Capital Account Liberalization: a Discussion Based on the Korean Experience 2.1. Overview
In this section, we argue that the four pre-conditions, 1) Fiscal discipline; 2) Monetary discipline; 3) Soundness of the financial sector; 4) Policy tools for managing short term capital volatility are necessary to preserve macroeconomic stability at the backdrop of liberalization capital flows.
In addition to identifying the four pre-conditions, we argue that it is important to understand that the four preconditions are interconnected. For example, monetary discipline is not sustainable without fiscal discipline. In an emerging economy soundness of the financial sector is often a necessary condition for managing short-term capital volatility.
Finally, still there are differences among the four pre-conditions, which should be appreciated in order to apply in a correct way for a specific economy. The monetary and the fiscal discipline are more closely related to the long term stability of an economy, or constitute ‘fundamentals’ of an economy. They are directly related to price stability and so can directly affect current account conditions through real exchange movements. Therefore, they need to be
167 Chapter 2 _ Monetary and Financial Policy preserved as soon as current accounts are liberalized, which precedes capital account liberalization. In this sense, the fiscal and the monetary discipline may be dubbed as pre conditions of the other two preconditions.
On the other hand, soundness of the financial sector and tools for managing short term capital volatility are more responsible for the short term stability of an economy, or constitute underlying factors affecting the short term ‘credibility’ of an economy in international financial markets. Soundness of the financial sector matters when the financial sector is privatized and takes over much of capital account transactions. Logically, tools for managing short term capital volatility take economic significance when short term capital flows become sizable relative to the size of the whole economy. Thus, we can state two points regarding the relation between these two pre-conditions and the former ones. Soundness of the financial sector and having effective tools for managing short term capital volatility become important at the later stage of capital account liberalization. Moreover, considering the fact that short term capital flows are often dictated by ‘sentiments’ in international financial markets, even if the fundamentals of an economy are in place, or the fiscal and the monetary discipline exist, still an economy falls a victim to short term capital volatility. Therefore, establishing the last two pre-conditions are extremely important, separate from the fiscal and the monetary discipline, to preserve macroeconomic stability when capital accounts are liberalized.
2.2. Monetary and Fiscal Discipline
In the context of the Korean economy, establishing monetary and fiscal discipline became a policy agenda in the late 1970s. Current account regulations, particularly including import restrictions, had gradually lifted during the 1970s. Then, at the backdrop of the two waves of the oil price shock in the 1970s, the Korean economy faced severe current account deficit problems, which was in turn due to chronic inflationary bias of the economy. The inflationary bias was rooted in the lack of monetary and fiscal discipline. In the face of a current account crisis, the Korean policy makers introduced reforms to install fiscal and monetary discipline in the economy, which also paved a way to the decade of sound economic growth of the 1980s.
2.2.1. Historical Background
Since 1962 when the Korean government adopted the export oriented growth strategy, the Korean economy had registered accelerating macroeconomic growth during the 1960s and 1970s. The average annual growth rate of GNP rose from about 4 percent in 1953-61 to about 8 percent in 1962-66 and to almost 10 percent in 1967-79. Behind the high economic growth, however, existed chronic inflationary bias, as usual in developing economies. With the inflationary bias, a high rate of inflation became an integral part of the Korean economy. In 1964 when the Korean economy got on the fast growth track, the inflation rate steeply rose to 35 percent. Although it declined to below 10 percent in 1965, during the nine years before the
168 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy oil crisis of 1973-74 annual inflation rates averaged at around 10 percent. After the first oil shock in 1973-74, inflation was all the more accelerating as it jumped to a 25 percent level during 1974-75 (see Table 2-3-1). These high rates were due to more than just the import price hike alone due to the rising prices of oil and other natural resources. They reflected inflationary pressures that had built up over the previous years. For example, during 1976-78, consumer prices still rose by an average of 13 percent, even with virtually no import price increase. As the problem of high inflation turned into a more chronic and serious one after the first oil shock, price stability became the prior concern of the Korean government.
As fast economic growth coupled by high inflation characterized the Korean economy, Korea’s current account balance continued to show deficits after 1965. Partly thanks to the worldwide economic recovery from the recession of 1974-5, Korea’s trade balance improved significantly between 1975 and 1977. Then, the second oil price shock in 1979 ignited inflation spiral and so the inflation rate soared to over 22.8 percent during 1979-81. Under the fixed exchange rate system where the Korean won was fixed to the U.S. Dollar, large disparity in inflation rates between the two countries quickly caused the Korean Won to be overvalued. Appreciation of the Korean Won together with the worldwide recession owing to the oil price shock resulted in widening deficits in the current account balance of Korea and decrease in GNP growth rates (See Table 2-3-1). Apparently internal monetary instability that had been inherent in the economy began worsening and spreading to external instability in the presence of a large negative external shock. Overall macroeconomic stability was falling down altogether, darkening even the long term prospect of the Korean economy.
Table 2-3-1 | Major Macroeconomic Trends of the Korean Economy: 1971-1990
Faced with the fatal challenge, the Korean government recognized that elimination of structural inflationary bias in the economy was necessary to overcome the mounting difficulty and achieve sustainable economic growth. The central policy tool in the stabilization efforts since 1979 had been restriction of the money supply1). The basic approach to stabilization was to let the tight monetary policy reduce inflationary pressure and, at the same time, to stabilize major cost factors such as wages and interest rates. Due to the policy drive, the growth of the money supply had slowed down significantly since 1978. The annual growth of M2 was reduced from 36.1 percent during 1976-78 to 25.5 percent during 1979 81. After temporarily rising to 27.0 percent in 1982 as a result of the policy response to the depressed financial market in the wake of the curb loan scandal, the M2 growth rate was further stabilized to 15.3 percent in 1983 (See Figure 2-3-1).
Figure 2-3-1 | Growth Rates of Monetary Aggregates
70.0 (unit:%, averages)
60.0
50.0
Reserve money 40.0
30.0
20.0 M2
10.0
0.0
-10.0
-20.0 73 75 77 79 81 83 85 87 89 91 93 95 97 99
Source: Monthly Financial Statistics Bulletin, Bank of Korea
Monetary tightening in the early 1980s was more than a one time episode because it was accompanied by a change in the monetary policy rule. To impose strict discipline over monetary management, the Korean government adopted an aggregate money targeting rule by which the Bank of Korea was bound to meet pre set monetary growth rates. Thereby, ‘M2 targeting’ came to existence in Korea, which lasted until the economic crisis of 1997. The impact of M2 targeting has soon been manifested. As Figure 2-3-2 shows, since 1980 M2 growth rates stayed remarkably stable compared to those of the 1970s. And with the strict monetary management,
1) For more detailed explanation, see Nam (1986)
170 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy Figure 2-3-2 | Inflation Rates and GDP Growth Rates of the Korean Economy
Source: Monthly Financial Statistics Bulletin, Bank of Korea. the Korean economy enjoyed price stability together with high GDP growth for the decades (See Figure 2-3-2).
2.2.3. Establishing Fiscal Discipline
The source of the inflationary bias of the Korean economy in the 1970s was fiscal involvement in resource allocation. So without establishing fiscal discipline, monetary discipline could not be sustained, either. In view of this the Korean government pursued aggressive fiscal reform in tandem with monetary reform. Many tax incentives supporting strategic industries were phased out, and the zero base principle was applied to the budget planning. Specifically, the automatic budget increase for government projects year after year came to a halt, and each project was mandated to prove its own justification for the budget increase.
Besides and more importantly, the government addressed two major sources that often drove monetary expansion: government managed funds and preferential policy loans. Government managed funds such as grain management fund, national investment fund and national housing fund incurred monetary expansion as their structural deficits were financed by central bank credit2). And preferential policy loans had the problem of the same nature3). In the early 1980s and thereafter the Korean government adopted various measures to reduce the role of government managed funds and preferential policy loans, and as a result the impacts on monetary expansion from government managed funds and preferential policy loans declined rather quickly.
171 Chapter 2 _ Monetary and Financial Policy Figure 2-3-3 | Consolidated Budget Balance (Percent of GDP)
2
1
0
-1
-2
-3
-4
-5 7173 75 77 79 81 83 85 87 89 91 93 95 97 99
Source: Monthly Financial Statistics Bulletin, Bank of Korea.
A prominent result of all the fiscal reforms was manifested in the negative growth rate of the government expenditure in real terms in 1981. As a result the consolidated budget deficit gradually approached to a balance in the early 1980s, and from then on the balanced budget policy became a tradition in the fiscal body and a highly praised aspect of the Korean economy (see Figure 2-3-3).
2.3. Soundness of the Financial Sector and Tools to Manage Short Term Capital Volatility
2.3.1. Historical Background
Based on the decades of economic development, measures to liberalize financial market activities, international capital flows and foreign exchange markets began to be taken in the 1980s. However, effective financial liberalization of Korea was realized in the 1990s. Aside from the privatization of government owned commercial banks in the early 1980s, no notable efforts toward financial liberalization were put forward. In the 1990s, the Korean government took gradual steps to lift government presence in various dimensions of financial markets.
2) According to Nam (1989), in 1976 contribution of the deficits of the Grain Management Fund and the fertilizer account to M1 growth reached 33.8%. 3) Preferential policy loans refer to those loans with preferential interest rates and availability that are supported by the central bank’s automatic rediscounts. According to the definition, policy loans during the development era in Korea had been substantial. According to the estimate by Cho and Kim (1997), they constituted about half of the total credit by domestic financial institutions in the 1970s. Though directed by the government, fiscal funding for preferential policy loans was limited. Hence, naturally large portion of policy loans had been funded by the central bank.
172 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy Though gradual, through the course of liberalization, Korea experienced a crisis in 1997, which devastated the economy. If the episode of the early 1980s is one of the success stories, getting over a crisis moment through policy reforms, the episode of financial liberalization in Korea adds one more failure case to the long list of the emerging economies that underwent the typical scenario of ‘a crisis followed by liberalization’. Brief history of financial liberalization of Korea until it faced the crisis of 1997 is presented below.
2.3.1.1. Domestic Financial Liberalization
Interest Rate Liberalization
In August of 1991, the government announced a detailed plan for interest liberalization, “The Four Stage Interest Rate Deregulation Plan” in order to promote competition and enhance efficiency in resource allocation. In accordance with this agenda, the government implemented the first stage in November 1991. As a result, those interest rates that were already close to market rates were deregulated. Included in the plan were lending rates for bank overdrafts, discounts on commercial bills, trade bills, and CPs, deposit rates for CDs, large amount commercial CPs, and repurchase agreements (RPs). In the second round of the liberalization in November 1993, all lending interest rates and the deposit interest rate for more than two years of maturity were deregulated, and the bond rate was also liberalized. The third and fourth rounds of the liberalization were enforced in July 1994 and July 1997 respectively and interest rates for the rest of financial products were deregulated.
Reduction in Reserve Requirements and Directed Credit
Together with interest rate liberalization, various efforts were made to improve autonomous asset management of banks. Notably, reserve requirements and directed credit were lowered in the 1990s. Until the late 1980s, the Bank of Korea (BOK) relied mainly on reserve requirements in controlling its money supply and so the required reserve ratio fluctuated according to policy stances of the BOK. Sustained reduction in reserve requirements was undertaken in 1996 as reserve requirements for demand and time deposits were reduced to 9 percent in April 1996, 7 percent in November 1996. In February 1997, reserve requirements were further reduced to 5 percent of demand deposit and 2 percent of time deposit.
Directed credit refers to the loans that are completely or partially financed through borrowings from the government or the central bank. Consequently, the allocation of directed credit is heavily regulated. In Korea, the proportion of directed credit in total credit decreased continuously, even if there were not discrete changes in the policy on directed credit (Figure 2- 3-4). This trend can be regarded as representing enhanced independence of financial intermediaries in their operations.
173 Chapter 2 _ Monetary and Financial Policy Figure 2-3-4 | Reduction in Directed Credit (Proportion to the Total)
Source: Monthly Financial Statistics Bulletin, Bank of Korea.
Privatization of Banks and Authorization of New Banks
All commercial banks in Korea were government owned until the Korea Commercial Bank was first privatized in 1972. And in the early 1980s the government began actively divesting its stake in other government owned banks based on the premise that establishing a market based ownership and governance structure should be the first step to improve efficiency of financial markets. As a result, all of the government owned commercial banks were privatized in the 1980s. And over the 1990s most of the government owned special purpose banks were transformed into commercial banks and privatized subsequently. While privatization of banks was implemented, in order to promote competition in the banking industry, entry barriers were lowered. In the end altogether seven new banks were chartered over the ten years from the early 1980s to the early 1990s.
2.3.1.2. Exchange Rate Policy
In the 1970s Korea maintained a de facto dollar peg system although the system was officially named the unified floating exchange rate system. The nominal anchor approach was changed to a real target approach with the introduction of Multiple Currency Basket Peg System in February 1980. In the wake of realignment of major currencies in the mid 1980s, Korea’s current account showed large surpluses, and the international financial institutions and the U.S. Treasury accused the Korean government of manipulating its exchange rate. This led to an adoption of Market Average Exchange Rate System in March 1990, under which the won dollar exchange rate was determined in the market within a band that was initially set at 0.4 percent above and below the rate of the previous day. The band was gradually widened overtime and eliminated in December 1997, immediately after the currency crisis4. Since then the policy
174 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy maintained floating exchange rate system and limited government intervention in the exchange market to smoothing volatility.
2.3.1.3. Capital Account Liberalization
In the early 1990s market liberalization and opening became an important political objective for the government of Korea.4) Market reform and globalization became key words in policy agenda, upon which capital account liberalization was considered as an objective in its own right for the first time. Balanced current accounts during the years were thought to be favorable conditions for pursuing liberalization.
Given the changed policy environment, the government began capital account liberalization in January 1992 by opening the Korean stock market to foreign investors for the first time. For capital flows involving debt instruments, liberalization measures were taken as well. Commercial loans by domestic firms, which had been prohibited since 1986, were allowed in 1995.
Overseas issuance by domestic firms of foreign currency denominated bonds was deregulated in 1991. However, though the policy stance had been set to liberalize capital flows, the Korean government remained cautious and preferred gradual liberalization. Thus, both explicit quantity restrictions and discretionary controls remained prevalent. For equity investment, a 10% aggregate ceiling on the foreign ownership of listed firms was imposed. This ceiling continued to exist until the crisis of 1997, although it was relaxed to 12% in December 1994 and further to 15% in July 1995. With regard to commercial loans by firms, restrictions on the uses of funds existed and government approval was required. Likewise, the overseas issuance by domestic firms of foreign currency denominated bonds was subject to discretionary quantity control.
Thus, most capital flows led by firms or through the stock market were not free from explicit or implicit quantity control. The only exception was trade related short term financing. Various restrictions on deferred import payments and the receipt of advance payments for exports were lifted step by step without additional discretionary control throughout the 90s.5) In contrast, the government allowed banks to enjoy relatively greater freedom in borrowing from foreign creditors. No explicit quantity regulations existed on long term or short term borrowings of banks in foreign currencies. Though the government exerted discretionary control over banks, it was not binding or restrictive, at least since the mid 90s judging from the rapid increase in capital inflows channeled through banks.
4) The chronology of widening of the band is as follows: 0.6 percent in September 1991,0.8 percent in July 1992,1.0 percent in October 1993,1.4 percent in November 1994,2.25 percent in December 1995, and 10.0 percent in November 1997. 5) Shin (1998) provides detailed liberalization measures in this area.
175 Chapter 2 _ Monetary and Financial Policy 2.3.1.4. Trends in Capital Flows in the 1990s
The Korean economy experienced substantial net private capital inflows from 1990 through the 1997 crisis. The magnitude of inflows remained small in the first four years at 1.2% of GDP on average. But for the three years from 1994 to 1996, the size of inflows more than doubled to 3.5 % of GDP on average (Figure 2-3-6). Increased capital inflows for the three years displayed two salient features. First, debt instruments were the dominant vehicles for capital transactions. Debt instruments accounted for the bulk of total foreign portfolio investment (Figure 2-3-6). Stock investment by foreigners explains only the limited portion of capital inflows, which seems to be a reflection of quantity restrictions mentioned above. Debt contracts and debt portfolios were the major carriers of capital inflows.
Figure 2-3-5 | Trends and Composition of Net Capital Inflows to Korea
176 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy Consequently, the surge in net capital inflows was tantamount to a sharp increase in Korea’s external debt (Figure 2-3-6). Second, the major portion of the increase in external debt involved the banking sector (Table 2-3-2). Out of the total increase in external debt during the three years, the banking sector explains about 70%. The remaining 30% reflect growth of the corporate sector’s external debt, related with trade financing. In addition, foreign currency liabilities of banks were much larger than their external debts.
As part of the liberalization measures, banks were allowed to open and expand operations of overseas branches. Banks exploited this opportunity in increasing foreign currency denominated business as aggressively as through domestic branches, leading to large foreign currency liabilities of overseas branches comparable to external debts of domestic branches (Table 2-3-3).
Table 2-3-2 | External Debt by Sector (US$100million)
Source: Press Release, Ministry of Finance and Economy
177 Chapter 2 _ Monetary and Financial Policy 2.3.2. Failure of Preserving Soundness of the Financial Sector and its Conjectured Cause
Declines in Franchise Values of Korean Banks in the 1990s
Throughout the 1980s and until 1992, stocks of banks in Korea had been market performers. But since 1994 they have become under performers, in stark contrast to the merchant banking industry. This stock market performance suggests that the franchise value of commercial banks was declining, perhaps because of expectations that the financial markets would become more competitive as they were liberalized.
The decline in franchise values was associated with changes in the asset structure of banks. Importantly, banks were taking a large liquidity risk associated with foreign currency denominated operation. By regulation, Korean banks were not allowed to take net open currency positions exceeding certain limits and thus were protected from currency risk. But the maturity mismatch between assets and liabilities in foreign currencies was serious. Measuring the severity of the mismatch problem by a one month mismatch gap, as of early 1997 the seven largest banks were taking large foreign currency liquidity risks.
Hence, declines in franchise values of banks and an increase in risk of asset structure were emerging as a characterizing feature of Korean banks in the 90s. While such a maturity mismatch is usually associated with the risk of rising market interest rates in the case of an emerging market banking system the additional risk of a rise in the Korean premium in the interbank deposit market was very serious.
Despite the dismal stock market performance and risky asset structure, the volume of banking assets was growing rapidly. Over the five years from 1992 to 1996 banks’ assets more than doubled. Considering that annual inflation rates had been moderate at 5.3% on average, this was remarkable growth in real terms. Moreover, the growth was achieved while a corresponding increase in capital was absent, leading to a decline of capital asset ratios. A vicious cycle of declines in franchise values and increase in bank failure risks was at work. In the presence of the government’s implicit guarantee it is easy to understand that bank owners did not have incentives to self monitor or manage risks while franchise values were decreasing.
Caveats in Regulation and Supervision: How Were They Created?
Given the fact that banks’ capital asset ratios were declining, it is clear that regulation and supervision were less than adequate. Capital regulation according to the BIS standard was introduced in 1992 in Korea. And the banks were required to maintain the ratio of at least of 7.25% at the end of 1993 and to meet the full 8% by the end of 1995. On the surface, the Korean banks had no difficulty in meeting the capital requirement. According to published
178 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy statistics by the Office of Supervision, the BIS capital ratios averaged across the city banks had been declining slightly but always over 8%. These numbers are misleading. In general, there can be two ways that regulatory authorities manipulate the BIS capital ratios. One is applying “soft” accounting rules. The other is allowing “flexibility” in enforcing the regulations. Both of these were prevalent in Korea before the crisis.
To better understand failures of banking supervision in Korea, we must look first at the traditional modus operandi of the supervision, which was “direct quantity control”. As is well known, Korea succeeded in keeping fiscal soundness and monetary stability throughout the 1980s and early 1990s until the crisis. And there the major tool at the aggregate level had been monetary targeting based on aggregate quantities like M2. Given that the financial market was repressed, monetary targeting inevitably resulted in the government’s heavy reliance on direct quantity controls in many areas. Controlling the amount of financial flows for the purpose of containing excessive monetary expansion thus became a well established policy operation in Korea. As a result ‘direct discretionary quantity controls’ at both aggregate and microeconomic levels were bread and butter for policy makers in managing all the financial risks. This way of managing financial markets, however, essentially yielded the state that microeconomic risk management of financial market agents was muted while macroeconomic risk management was practically the only mechanism controlling financial risks in the economy. Specifically under the policy setting, the government set the targets for aggregate monetary variables such as money growth rates, inflation rates, exchange rates and interest rates. And then the government utilizes all the available intervention tools to achieve the targets.
Whatever the costs to efficiency, the policy mechanism worked well enough to attain macroeconomic stability of the Korean economy for decades. Therefore, in spite of the environmental change resulting from capital account liberalization, the government did not lose belief in direct control on financial flows and was confident in maintaining financial stability. Hence microeconomic manipulations for macroeconomic targets continued. It seems that to the last minute of 1997 the government succeeded in maintaining macroeconomic stability as desired. Inflation rates were the lowest ever and the fiscal account was balanced. Besides, M2 growth rates seemed to be stable. (Figure 2-3-7)
Then, what went wrong? Why and how did the government fail to detect the increasing vulnerability of the economy? This was so because capital account liberalization provided a loophole in the traditional management system through which banks could increase the risk of insurance attack or run. As aforementioned, about half of the foreign currency operations of the banking sector was handled by overseas branches. Since these transactions were not reflected in domestic monetary indicators by definition, it was impossible for policy makers to detect this new development when watching traditional macroeconomic measures.
In sum, caveats in supervision were there simply because the traditional modus operandi of
179 Chapter 2 _ Monetary and Financial Policy supervision left some areas not watched by the policy makers which quickly became a new source of risks by enabling banks to exploit implicit insurance.
2.3.3. The Role of the Deficiency of Policy Tools to Manage Short Term Capital Volatility
Nature of the Crisis: “Bank Run”
The accumulation of foreign currency liabilities in banks and associated risks culminated in a crisis late in 1997. Foreign creditors ran to the Korean banks in November. Although official data on the creditors’ run in November are not available, it is possible to estimate the magnitude of private withdrawals. As the run occurred, the Bank of Korea acted as the lender of last resort and provided foreign currency liquidity to troubled banks by increasing the BOK’s foreign currency deposits in those banks. Taking the increase in the BOK’s deposits as an indicator for the size of the run, we note that it reached $15 billion in November. About $9 billion of this was deposited directly in foreign branches of Korean banks. This bailout exhausted the ‘available’ foreign exchange reserves of the BOK.
Contagion: An Important Factor
In our view, it is impossible to explain the evolution of the currency crisis without invoking contagious effects from Southeast Asian (SEA) crises. Symptoms of financial market turbulence in Thailand and Indonesia were perceived as early as in 1996. But the situation aggravated precipitously in the first half of 1997, which culminated as full fledged currency
180 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy Figure 2-3-8 | The Won/Dollar Exchange Rate
crises in July as both countries abandoned the long cherished fixed exchange regime.6)
Once crises set in, developments in the region continued to act as a major source of turbulence in the Korean foreign exchange market until the end of October as Figure 2-3-8 shows. The first major impact on the market of the SEA crises showed up in early August, when the Thailand government announced suspension of 42 finance companies. And the second wave came in late October as Asian stock markets crashed. Both events shook the Korean foreign exchange market with a great magnitude as shown by Figure 2-3-8 and characterized the critical moments regarding the Won/Dollar exchange rate movement. Obviously the SEA crises were imposing considerable pressures on the Korean financial markets.
IMF Crisis Package: Korea’s Only Crisis Managment Tool
The Korean government announced its plan to resort to IMF rescue loans on the 21st of November. However, this failed to calm foreign creditors and the severity of the run intensified. According to unofficial data of the BOK, rollover of credits by foreign banks for the 7 largest Korean banks continued to decline in December. This was probably related to a cascade of bad information on the size of Korea’s short term external debt relative to foreign exchange reserves, as well as Moody’s and S&P’s downward adjustment of the sovereign credit of Korea. The run that began in November was followed by a typical banking system panic.
6) For a detailed description on turmoils in the two countries, see Radelet and Sachs(1998).
181 Chapter 2 _ Monetary and Financial Policy 3. Capital Account Liberalization in Vietnam 3.1. Trend in Capital Account Liberalization Policy and Capital Flows
3.1.1. Overview
While generally liberalizing capital account transactions, policy makers in Vietnam adopted different approaches between FDI and other capital flows. The FDI flow was gradually liberalized first, followed by the indirect investment flows (FII). At the same time, in order to ensure the stability of macroeconomy, external debt of the Government and enterprises are still managed and tracked.
It can be said that in the process of economic integration, foreign exchange management policy has been loosened toward the liberalization of current account transactions as well as loosening the capital account transactions step by step. Up to now, the current account liberalization process has been basically completed and capital account transactions have been loosened gradually in accordance with integration requirements. All changes of policy has been based on the guidelines of opening the economy, attracting foreign capital inflow for investment and development, developing financial market and implementing international integration commitments.
3.1.2. External Debt
3.1.2.1. Policy on Foreign Loans of Residents
Policy on foreign loans is regulated in the policy on management of foreign borrowing and repayment of residents:
Decree No. 90/1998/ND/CP issued on 7th November, 1998 of Government issued the Regulation of management foreign borrowing and repayment. According to this, foreign loans of enterprises are loans directly borrowed from the foreign lender in the form of self borrowing and settling.
The borrowing and settling foreign loans of enterprises must be conducted in accordance with the following principles:
(i) Enterprises belonging to all economic sectors set up and operating in accordance with the law of Vietnam have the right to directly obtain foreign loans under the form of self borrowing and payment to the foreign lender according to the committed conditions. Loans of enterprises
182 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy cannot be converted into loans of the Government in any cases, except for loans guaranteed by the Government. Medium and long term foreign loans (including via international bond issuance) of enterprises must be included in the annual total loan value limit plan approved by the Prime Minister and meet conditions regarding medium and long term loans regulated by the State Bank of Vietnam in each specific period;
(ii) Medium and long term foreign loans must be registered at and recognized by the State Bank of Vietnam; be reported periodically to the State Bank of Vietnam regarding the withdrawal of the capital and debt settlement according to the report mechanism set by the Governor of the State Bank of Vietnam. Regarding State owned enterprises, the loan agreement to be signed with the foreign lender must be consulted by the State Bank of Vietnam before the signing takes place.
(iii) Short term foreign loans of enterprises must meet conditions regarding short term loans regulated by the Governor of the State Bank of Vietnam for each specific period. The Governor of the State Bank of Vietnam submits the annual total outstanding loan balance limit to the Prime Minister for approval, including the limit for deferred payment letters of credit (L/Cs) for banks.
(iv) The withdrawal of the loan and money transfer to settle foreign loans of enterprises must be conducted via banks which are operating in the territory of Vietnam and are allowed to perform foreign exchange activities. In case of capital withdrawal and debt settlement by goods or assets (tangible or intangible) not conducted via banks, enterprises must report according to regulations of the State Bank of Vietnam, and if necessary be consulted by the State management body of the related field or branches.
(v) Enterprises borrowing foreign loans are obliged to use the lent money for the right purposes, not to use short term loans to invest in medium and long term projects, repay the loans (both principle and interest) according to the commitments made in the loan contract signed with the foreign lender, suffer all risks and be responsible by law of the State during the process of borrowing and settling.
(vi) Regarding medium and long term loans of enterprises according to this regulation, banks can only withdraw the capital and transfer money to settle the debt to the foreign lender upon the requirements of enterprises as long as the loans are registered and recognized in writing by the State Bank of Vietnam.7)
In general, Decree No. 90/1998/ND/CP provides more concrete guide lines than Decree 58 and clearly defines that foreign loans of firms are not allowed to turn into Government’s debts.
7) Management of borrowing and setting foreign loans of enterprises, Article 22
183 Chapter 2 _ Monetary and Financial Policy Decree No. 134/2005/N CP dated 1st November, 2005 the Government issuing regulations on control of foreign loans and loan repayments has some different points in comparison with that in Decree 90 mentioned above: regulations on state owned management agencies’ responsibility for control of foreign loan repayments are clearer; regulations on control of foreign loans and loan repayments of enterprises are more flexible which creates independence for enterprises and banks (such as the remove of regulations on interest rate conditions, the permit for enterprises to open others capital accounts to receive and repay loans, the permit for commercial banks, on their own, to determine the L/C limit within safety limit)8). The Decree clearly regulates that public sector foreign debt includes foreign loans obtained by the government and outstanding foreign loans (if any) of enterprises guaranteed by the government; enterprises are allowed to issue bonds on international markets; enterprises’ plan of issuance must be commented by SBV and the Ministry of Finance before being approved by authoritative agencies.
It can be said that with the establishment of this Decree, the management of borrowing and settling foreign loans are diverted from direct to indirect management which provides the basis for gradually liberalizing capital account transactions. Besides, SBV is gradually improving the work of constructing the report system of borrowing and settling foreign loans in order to meet the requirements of managing and strategic planning the borrowing and settling foreign loans.
3.1.2.2. Trends in Capital Flows through External Debt
As they have been under heavy regulation, capital flows through external debts into Vietnamese economy has been limited. Table 2-3-4 and 2-3-5 show that increase in external debts by enterprises and the public sector altogether has been less than USD 1 billion. Compared to USD 8 billion (2007) and 10 billion (2008) channeled by FDI, it indicates that the role of external debts in dictating capital flows into Vietnam is limited.
Table 2-3-4 | Foreign Debt of the Government and Enterprises (2002-2008) Unit:million USD
Government 9,075 10,729 12,540 13,299 14,610 17,271 18,916
Enterprises 3,4653 3,073 965 910 1,031 8,268 8,307 (guaranteed by the 38 654 965 910 1,031 1,982 2,900 Government)
8) Before 1999, enterprises wishing to make foreign loans had to satisfy the interest rate conditions as follows: short term interest must be lower than 7.5% per year; medium term interest must be lower than LIBOR + 2.5% per year; regulation on L/C opening limit for banks and enterprises had been strict in 1997 before it was removed in 2001.
184 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy 3.1.3. Foreign Portfolio Investment
3.1.3.1. Policy on Foreign Portfolio Investment
The legal documents regulating indirect investment activities were born later than the direct investment activities. Up to 2005, there was no legal document which defined forms of indirect investment although some documents related to foreign debt management already mentioned that raising capital from international society by issuing bonds is considered as a foreign debt (according to international standards, these types are classified into the form of investment by valuable papers). Investment Law passed by National Assembly on November 2005 which took effect from 1st July, 2007 is the generally legal framework for investment activities. Accordingly, “investment is a form of indirect investment through the sale of shares, stocks, bonds, and other valuable papers, securities and investment funds through financial institutions mediate different that investors do not directly participate in the management of investment activities (2 and 3, Article 3)”.
Thus, whether investors involved in the management of investment activities or not is the basic point to distinguish between direct investment and indirect investment in Vietnam.
Concerning exchange control management of indirect investment regulated in The Ordinance of Foreign Exchange Control, Point No. 4 in Article 13 states that “foreign indirect investment in Vietnam means the purchase and sale of securities and other valuable papers, contribution of capital and purchase of shares in any form by a non resident in accordance with the law of Vietnam but without direct participation in management”. Documents guliding liberalization of indirect investment activities are as follows:
•When stock market began to operate, Decision No. 139/1999/QD TTg dated 10th June 1999 of Prime Minister guided the limit of foreign investors’ capital contribution, share purchase in Vietnamese enterprises as follows (self preparation aution or through financial mediators): Foreign organizations and individuals, that purchase and/or sell shares on Vietnam’s securities market, may hold at most 30% of the total number of listed shares of an issuing organization. In case there is only one foreign investor, the maximum capital contribution proportion of the the foreign party to a joint venture securities company is also 30%.
•Decree No.146/2003/QÐ-TTg dated 17th July 2003 allows foreign organizations and individuals, that purchase and/or sell stocks on Vietnam’s securities market, to hold at most 30% of the total number of listed stocks of an issuing organization. The percentage of capital contribution of a foreign securities trading organization to a joint venture securities company or a joint venture fund management company shall be at most 49% of the charter capital.
185 Chapter 2 _ Monetary and Financial Policy •Decree No.238/QÐ-TTg dated 29th September 2005 allows:
(i) Foreign organizations and individuals, that purchase and/or sell stocks on Vietnam’s securities market, may hold:
•At most 49% of the total number of stocks listed or registered for transaction of a listing or transaction registering organization at a securities trading center. For listing or transaction registering organizations being foreign invested enterprises transformed into joint stock companies under Decree No. 38/2003/ND CP of 15th April, 2003, the total number of listed stocks shall be the number of stocks issued to the public under the plans approved by competent authorities.
•At most 49% of the total number of investment fund certificates listed or registered for transaction of a securities investment fund.
(ii) Foreign security organizations are allowed to hold maximum of 49% charter capital under capital contribution, share buying, joint venture in establishing security companies or security investment fund management companies.
Foreign Currency Management of Indirect Investment through Stock Market
•Decision No.998/2002/QÐ-NHNN dated 13th September, 2002 regulates: Foreign organizations and individuals shall only be entitled to transfer their investment capital (involved in capital transactions) overseas one (01) year after such capital portion is remitted into Vietnam dong securities trading accounts opened at foreign custody members, except for the cases where it is permitted by law. For investment profits, dividends and bond yields (involved in current transactions), foreign organizations and individuals shall be entitled to transfer them overseas at any time; foreign organizations and individuals shall be entitled to use Vietnam Dong sources in their securities trading accounts to purchase foreign currencies from foreign custody members for transfer overseas.
•Decision No. 1550/2004/QÐ-NHNN dated 6th December, 2004 on foreign exchange management over foreign investors’ securities purchase and sale at securities trading centers regulates that:
(i) If foreign investors wish to use their foreign currency, remitted from abroad or maintained on their accounts “foreign currency” at the authorized banks in Vietnam in accordance with provisions of applicable laws on foreign currency control, for securities investment, they must transfer their foreign currency to the account “foreign currency demand
186 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy deposits for special purposes” of the securities company opened at the authorized bank in accordance with provisions in this Decision.
(ii) They must sell foreign currency(ies) to the authorized bank to exchange for Vietnamese Dong for securities purchase.
(iii) After having fulfilled their tax obligations to the State of Vietnam in accordance with provisions of applicable laws, foreign investors shall be entitled to purchase foreign currency at authorized banks to remit overseas in accordance with provisions of applicable laws on foreign exchange control.
(iv) According to this decision, the foreign investors do not have to wait at least one year in order to be permitted to transfer capital back to their countries (previously, Decision No. 998/2002/QD NHNN regulates that foreign investors are allowed to transfer foreign investment (under capital account transactions) after one year from the date that capital is transferred in securities trading account dominated in VND.
The transfer of incomes from security investment activities (ex: dividends and price differences) is easier. According to Decision 1550, foreign investors, after having fulfilled their tax obligations to the State of Vietnam in accordance with provisions of applicable laws, shall be entitled to purchase foreign currency at authorized banks to remit overseas. Besides, investors are permitted to open security trading accounts in security companies which will be responsible for controling capital inflow and outflow of foreign investors through authorization to conduct foreign exchage trading and security account at foreign depository. In the past, Decision No. 998 regulated that foreign investors wishing to purchase or sell listed securities must open depository account and open trading account in depository members in foreign countries.
Through Non-Listed Stock Markets:
•Decision No.36/2003/QD TTg dated March 11st March, 2003 of the Prime Minister on the Regulation of foreign investors’ capital contribution and foreign investors’ purchase of shares in Vietnamese enterprises. Accordingly, the proportion of capital contribution, purchase of shares of foreign investors is 30% charter capital of enterprises in Vietnam.
•In particular, for the banking sector, Article 4, Decree No. 69/2007/ND CP of the Government on foreign investors’ purchase of Vietnam commercial banks’ shares regulates the principle for shares ownership of foreign investors as follows:
(i) The maximum shareholding percentage for foreign investors (including existing foreign shareholders) and their affiliated persons is 30% of the charter capital of a Vietnamese bank.
187 Chapter 2 _ Monetary and Financial Policy (ii) The maximum shareholding percentage for a foreign investor other than foreign credit institution or affiliated person is 5% of the charter capital of a Vietnamese bank.
(iii) The maximum shareholding percentage for a foreign credit institution and its affiliated person is 10% of the charter capital of a Vietnamese bank.
(iv) The maximum shareholding percentage for a foreign strategic investor and his/her/its affiliated person is 15% of the charter capital of a Vietnamese bank. In special cases, the Prime Minister may, at the proposal of the State Bank of Vietnam, decide to allow a foreign strategic investor or his/her/its affiliated person to hold shares exceeding 15% but not exceeding 20% of the charter capital of a Vietnamese bank.
(v) When a foreign credit institution holds convertible bonds, upon the conversion of bonds into stocks, the shareholding percentages specified in Clauses 1, 2, 3 and 4 of this Article must be complied with.
(vi) The total number of shares owned by foreign credit institutions in an equitized state owned commercial bank is the same as that owned by Vietnamese banks at that state owned commercial bank. The Governor of the State Bank of Vietnam shall guide the implementation of this provision.
•Circular No.03/2004/TT NHNN dated 25th May 2004 regulated foreign currency management of foreign investors’ capital contribution and foreign investors’ share purchase in Vietnamese enterprises. Accordingly, in order to make capital contribution by purchasing shares , foreign investors have to open “Capital contribution and share purchase” account dominated in Vietnam dong in one commercial bank operating on Vietnam and conduct all related transactions through this account.
•Concerning government and enterprise bond market, there is no limit of the total bond value which foreign investors are permitted to own.
Remittance Policy:
Before 1990s, Vietnam already had the policy to encourage remittance transferred into Vietnam. However, as the nature of the economy was concentrated economy, remittance policy was not really effective. Since 1990, remittance policy has been continually loosened. The policy which stated that immigrants are not allowed to freely bring foreign currencies, withdrawing foreign currency must be converted into VND, and the amount of withdrawal and deposit of money is limited was removed. Instead, clearer and more loosened regulations have been established creating favorable conditions for depositors in terms of both procedure and economic profit. The new regulations allow authorized organizations such as post offices,
188 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy banks, remittance services companies overseas to receive foreign cash, and participate in remittance from Vietnamese abroad by clearly regulating charges and allowing them to keep foreign currency they earned without income tax applied. As a result, remittance from overseas Vietnamese increased significantly from USD 35 million in 1991 to 4,000 million in 2006.
Policy on the obligation of residents being organizations to sell foreign currency earned from current revenue sources to the banks: Remittance policy is considered as a temporary solution in transition period of Vietnam in order to attract foreign currencies to the banks. It satisfies import needs, reduces foreign currency speculation and pressure on exchange rate. The policy has been gradually loosened.
In September, 1998 the government issued Decision No.173 and Circular No.08 guiding the obligation of residents being organizations to sell foreign currencies earned from current revenue sources to the banks. Accordingly, foreign currency balance of economic organizations which are residents (excluding businesses FDI) is not made by the Government; and they have to sell 80% of foreign currencies earned from current revenue sources to the banks. For non economic organizations, they have to sell 100% of foreign currencies earned from current revenue sources to the banks.
In order to implement the policy of economic integration with the liberalization trend of current transactions, the rate was continually declined from 50% in 1999 to 40% in 2001, 30% in 2002 and 0% in 2003.
3.1.3.2. Trends in Capital Flows through Portfolio Investment
Since 2005, the indirect capital flow entering to Vietnam market has already appeared and grown because the security market as well as bond market was only at the initial stage of development. Besides, the sensitivity of this capital flow is too high compared to others so the process of opening and developing encouragement of this flow is slower than FDI flow, detailed as below:
•Foreign investment funds operating in Vietnam:
Table 2-3-5 | Indirect Capital Flow into Vietnam Unit:million USD Year 2004 2005 2006 2007 2008 Investment of foreign investors in Vietnam 0 115 1,313 6,500 110 (securities and bonds)
Issue government bonds outside Vietnam 0 750 0 0 0 Total capital inflow * 0 865 1,313 6,500 110
Note: *means capital inflow yearly
189 Chapter 2 _ Monetary and Financial Policy (i) 1988-1989: 7 with total of registered capital equivalent to 400 million USD. (ii) 1998-2003: 1 investment fund with capital size equivalent to 35 million USD.
•The trend of indirect capital flow in Vietnam also represents at transitioning level of foreign investors on securities market as bonds market.
The liberalization of capital flow is demonstrated by several amendments of Law on Foreign Investment in 1987. The birth of the Law on Foreign Investment in Vietnam in 1987 created a legal environment to attract more foreign investment into Vietnam. This law supplemented and provided details of sectors in which investment are encouraged according to requirements of new conditions. This is one of the first laws in Vietnam’s innovative period. Promulgating the Law on Foreign Investment in Vietnam institutionalized the attitudes of Communist Party of Vietnam, attracted and effectively used foreign investment capital, diversified foreign trade relationship, contributed to implement the policy of taking advantage of domestic resources, and improved the effectiveness of international cooperation. Since the promulgation in 1987, foreign investment law has been amended and supplemented four times in 1990, 1992, 1996 and 2000.
Characteristics of Amendment and Supplement of the Law on Foreign Investment:
•Concerning investment, amendments only cleared regulated fields of investment but did
190 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy not expand investment field.
•Regarding forms of investment, three later amendments expanded investment forms in accordance with situation and development of the economy.
•For capital contribution ratio, the ratio was almost unchanged. Capital contribution of the foreign parties must not be less than 30% of enterprises’ charter capital and charter capital must be at least 30% of the total investment of enterprises. In special cases, the ratio charter capital/ total investment may be lower than 30%, but must be approved by the Government.
•Concerning foreign exchange management of direct investment activities, FDI enterprises have to open accounts at banks allowed to conduct foreign exchange activities. Only the provision on tax on profit transfer was amended: the tax on profit transfer was applied only after 2000.
•Investment Law 2005: Investment Law 2005 replacing Foreign Investment 1987 and Encouraging Domestic Investment Law was established in 2005 and took effect in 2007 in order to:
(i) Improve business and legal environment along with creating a consistent and fair legal system managing investment activities.
(ii) Simplify investment procedures which establish more favourable conditions for attracting and efficienly using investment.
(iii) Satisfy requirements of international economic integration.
(iv) Enhance state’s control of investment activities.
The prominent points of Investment Law 2005 which are different from the Foreign Investment 1987 and its amendements are as follows: prohibited investment fields and conditioned investments fields were regulated in details. Specifically, Investment Law 2005 regulations that formed direct investment are as follows:
•To establish economic organizations with 100% capital of domestic or foreign investors. •To establish economic organizations being joint ventures between domestic and foreign investors. •To make investment in the form of BCC, BOT, BTO or BT contracts. •To invest in business development. •To buy shares or contribute capital for participation in management of investment
191 Chapter 2 _ Monetary and Financial Policy activities. •To make investment in the merger or acquisition of enterprises. •Other forms of direct investment.
So, it can be seen that policies on managing FDI was made in the direction of gradual liberalization. In the past, FDI enterprises had to balance their plan of receiving and expending foreign currencies on their own, but they were not allowed to buy foreign currency from banks (except the cases that FDI enterprises operate in the field of infrastructure, or production substitutes goods for import) and purchasing foreign currencies was available only with the allowed license. From the end of 1990s, the regulations mentioned above were removed. It means that FDI enterprises wishing to purchase foreign currenc for currency account transactions are allowed to purchase in commercial banks.
Trends in FDI Flows
Table 2-3-7 | Foreign Direct Investment Licensed in Vietnam during 1988-2008 Unit:million USD
Year Project Registered capital Carried - out capital
192 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy Since the first time of intergrading, the Vietnamese government has carried out open policy for the purpose of attracting FDI for development. Table 2-3-7 shows the increased trend of foreign direct investment into Vietnam from 1988 to 2008.
3.2. Exchange Rate Policy and Foreign Currency Reserves Management
3.2.1. Changing Landmarks in the Exchange Rate Policy
In the late 1980s, Vietnam had triple digit inflation, multiple exchange rates, and a rapidly depreciating currency in the parallel market. In the early 1990s, however, Vietnam began to overcome these problems by containing inflation and stabilizing its currency. International integration with the West began in earnest around 1993. Since then, Vietnam’s exchange rate management has evolved significantly as capital liberalization proceeded and new external circumstances arose.
From 1992 to 1996, the exchange rate mechanism was formed based on the official exchange rate announced by the SBV and on the foundation each commercial bank promulgated the owned exchange rate with allowed fluctuating band. With the new mechanism, inflation was brought down to a single digit by 1993. But price stability was fragile and domestic inflation still remained high relative to the international level. In the final stage of disinflation, the State Bank of Vietnam (SBV) kept the VND/USD exchange rate at around 11,000 for more than five years, from late 1991 to early 1997 (moreover, the rate was virtually fixed at that level from early 1994 to late 1996). This “11,000 VND policy” can be interpreted as an attempt to secure lasting price stability by the discipline of a dollar peg. This nominal anchor use of the exchange rate finally succeeded in reducing inflation to a very low level as well as creating a favorable environment for developing investment.
However, the side effect of this policy was gradual overvaluation. According to IMF (1996), the real effective exchange rate (REER) of VND was overvalued at 9% in 1995 and about 2% in the first 8 years from 1996. This created extreme disadvantages to export and caused big deficit to the trade balance as well as balance of payment. From the summer of 1996, the SBV began to effectively depreciate VND by broadening the bandwidth around the official central rate. The actual rate always stayed near the highest end of the band.
From 1997 to 1998, Vietnam had to cope with the impact of the Asian financial crisis. While Vietnam was not directly attacked by speculators, VND became overvalued relative to the regional currencies which fell sharply. The exchange rate band was further broadened to ±5% in February 1997 and to ±10% in October 1997. In February 1998, the official central rate itself was devalued from 11,175 to 11,800 VND/USD. These adjustments brought the actual exchange rate to 12,980, at the most depreciated end of the revised band.
193 Chapter 2 _ Monetary and Financial Policy In February 1999, the SBV introduced a new exchange rate mechanism, called managed floating mechanism. The central rate was set daily at the average of interbank exchange rates on the previous transaction day with a very narrow band of ±0.1%. With this mechanism, the SBV reached success in managing the exchange rate before the impacts of Asian financial and monetary crisis in the period of 1997-1998. The official rate was adjusted to the connection to the market rate closer, and the instability of the mechanism began to improve. Also, the adjusted official rate contributed to stabilize the macroeconomy, and controlled inflation in the period of 1999-2004.
In 2005, after the Ordinance of foreign currency management was promulgated and took effect on 01 January 2006, the new mechanism had to face more difficulties. According to the Ordinance, the current account transactions were liberalized gradually at the same time the capital transactions management was loosened. Besides, Vietnam also accepted to comply with the stipulation of the Article 8, IMF. According to the sections 2, 3 and 4 of Article VIII, all members of IMF committed not to apply any restrictions on payment and remittance of foreign current account transactions. Also, it did not conduct or allow any financial organizations to apply any restrictions which relate to currency or multi currency system unless IMF accepted. By accepting these agreements, Vietnam sent a signal to the international community that Vietnam would pursue economic policies without applying any restrictions on payment or remittance of current account transactions. Besides, it contributed to removing all limitations to the multilateral settlement. The liberalization has created a more favorable environment in enhancing the conversion of VND, but also caused many disadvantages in the exchange rate operation and the exchange currency reserves management in Vietnam.
In order to overcome this difficulty and to apply all stipulations of the new policy, the SBV has improved the new mechanism of exchange rate gradually according to the market rules. In 2005, the SBV removed the regulation of applying exchange rate ceiling in the forward transactions, and instead, allowed credit institutions to determine forward point base on the
Table 2-3-8 | Changing Landmark in the Exchange Rate Mechanism
194 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy interest rates of two currencies (the basic interest rate of VND and the instructing interest rate of US Fed Fund rate). Simultaneously, the SBV gave the credit institutions the flexibility to carry out the option transactions with VND and other derivative transactions. From December 2006 until now, the exchange rate band was extended gradually compared to the previous period.
Besides, the SBV liberalized commercial banks in setting the points of exchanging foreign currency, and also allowed them to converse hard currency and float fees freely in option contracts between USD and VND. Particularly, it allowed to implement the agreed exchange rate.
In conclusion, from 1999 until now, the SBV operated the exchange rate mechanism under the managed floating way with an allowed flexible band. The SBV has implemented 8 times to adjust the band with the trend of raising density since December 2007.
3.2.2.1. Trends in Foreign Exchange Reserves Management Policy
As the current stipulation, the SBV is the agency which had the function to manage the foreign exchange reserves in Vietnam. It was founded for the purpose of implementing the national monetary policy as well as ensuring the ability of international payment.
•The stipulation of The State Bank Law, Item 2, Article 38 and The Ordinance of Foreign Exchange Reserves, Item 1, Article 34, and the Decree No. 86/1999/ND CP, Article 1: “The SBV manage the state foreign exchange reserves as the regulation of the Government to carry out the national monetary policy, ensure the ability of international payment, preserve the state foreign exchange reserves”.
•The stipulation of Item 1.6, Chapter II, Circular No. 35/2006/TT/BTC stipulated about the financial regime of the SBV: “The SBV manage closely the national foreign exchange reserves as the stipulation of the legal system with the purpose of implementing the monetary policy and ensuring the payable ability of the international payment system. The SBV has the responsibility to report quarterly the situation of utilizing the national foreign exchange reserves to the Government and the Ministry of Finance.
•Based on the Decree No. 86/1999/ND CP, the SBV promulgated Decision No. 653/2001/QD NHNN dated 17 May 2001 concerning to the national foreign exchange reserves management. According to the Decision, the national foreign exchange reserves are the asset of the State and represented in the monetary balance sheet of the SBV.
195 Chapter 2 _ Monetary and Financial Policy •The national foreign exchange reserves includes: (i) Foreign cash, deposit by foreign currency at foreign countries; (ii) Securities and valuable papers by foreign currency established by the Government, foreign organizations and international organizations; (iii) Special withdraw right, reserves limits at IMF; (iv) Gold and other foreign currencies.
•The national foreign exchange reserves derived from sources: (i) Foreign currencies from the loans to the State budget and the foreign exchange market; (ii) Foreign currencies from the loans to international banks and international institutions; (iii) Foreign currencies from the deposits of The State Treasury and other credit institutions; (iv) other sources.
The national foreign exchange reserves is established into 2 funds: (i) One fund used to ensure the ability of international payment, regulate the foreign currencies sources, implement the investment decisions and advance to the State Budget in the case of arising the unexpected demand of the State to the foreign exchange currencies under the stipulation of Prime Minister; and (ii) One fund used to stabilize the exchange rate and gold price in the domestic market, regulate the foreign currencies sources when required and implement other short term investment decisions.
The plan to construct the annually national foreign exchange reserves base on (i) The situation of implementing the balance of payment and expectation for the planned year; (ii) Monetary purpose for the planned year; (iii) The minimum level of the foreign exchange reserves to ensure the international payment safety; (iv) Predicting the exchange rate and gold price in the planned year and the necessary foreign currency to intervene to the domestic foreign currency market.
3.2.2.2. Current Situation of Foreign Exchange Reserves Management and the Stability of Financial System.
Since established in 1991, the national foreign exchange reserves have grown rapidly from 1.323 million USD in 1995 to 21.9 million USD in September 2008. This trend represented the stable surplus tendency of the international balance of payment. The foreign exchange reserves increased gradually year by year except the crisis stages such as the Asian crisis 1997 and the world financial crisis 2007 2008. In the stages, foreign investment flows decreased sharply so the SBV had many difficulties to buy foreign currencies in order to stabilize the foreign currency reserves.
3.3. Response of the Monetary Policy due to Changes of Capital Flows
From 1999, the monitoring of the monetary policy of the SBV based on the frame of controlling the volume in the process of implementing the policy that could be detailed as follow:
196 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy •The final objective of the monetary policy: Price stability, economic development, banking system stability. •The short term objective of the monetary policy: Controlling the money supply (for the purpose of sterilizing the foreign currencies on the market and providing loans to commercial banks). •The intermediate objective of the monetary policy: Providing credit for the economy, M2, lending interest rates to the economy, exchange rate and opened market interest rate. •Instruments to implement the monetary policy: The operating of these instruments has renovated remarkably but remained many limitations yet. This problem required the renovation more in the future in order to complex the communication mechanism of the monetary policy.
Box 2-3-1 Diagram of Communication Mechanism of the Monetary Policy
- Controlling money supply (in order to buy foreign - Controling monetary policy Operations currencies, - Openned-market exchange rate Controling monetary policy objectives - Providing loans to - Basic interest rate commercial banks, providing - Refunding capital interest rate loans as instructions
1990-1995 1996-1999 2000-2008
- M2, credit Intermediate M2, Credit M2, credit, exchange rate - Interest rate for the economy objectives - Exchange rate
1990-1995 1996-1999 2000-2008
- Stability VND value - Currency stability - Currency stability Final - Control inflation - Control inflation - Control inflation objectives - Economic growth - Economic growth - Economic growth - System stability - System stability
197 Chapter 2 _ Monetary and Financial Policy In conclusion, the frame of operating the monetary policy of the SBV showed the multi objectives orientation as well as volume control instead of price control.
With the frame of monetary policy, the change of capital inflows has impacted significantly to the implementing progress of the monetary policy. This consideration has been illustrated clearly in 2007 and 2008 when the capital flow has showed the changing direction unexpectedly. In 2007, the foreign capital flow increased rapidly and contrary to this in 2008.
This fact in one way has shown the positive impact in improving the balance account, but in another way, it also has created many challenges to the monetary policy of the SBV in order to control inflation and to keep the currency stable. A significant capital volume pouring into Vietnam in 2007 has led the payment instruments multiplied due to the lack of capacity of the SBV. Besides, as the stipulation of foreign currencies management Ordinance, indirect capital investment into the stock market in Vietnam had to turn into VND and this also increased supply of foreign currencies and created the appreciation pressure on VND. If this situation could not be resolved soon, this would cause inflation as well as negative impact on trade balance. Also, export enterprises would sustain disadvantages due to the appreciation of VND, and at last would create bad impact to the economic growth as well as social life.
Before the situation, the SBV has implemented many solutions to limit the trend of VND appreciation by money supply to buy foreign currencies. This solution not only increased the foreign reserves of the State but also reduced the pressure of VND appreciation. Besides, the SBV used other instruments simultaneously such as open market operations to attract money out of the circulation in order to reduce inflation pressure. On the other hand, the SBV also loosened the exchange rate mechanism by increasing the dealing band from 0.25% to 0.5%. Other operations such as forwards, options, swaps, were to be decided in the market. This dynamic has created positive impact on the foreign currencies stability, and also reduced the pressure of VND appreciation. In reality, even though foreign currencies entered significantly this year VND value depreciated to 1.3% and the inflation calculated at 6.6%.
In the first quarter of 2008, the deficit of the trade balance in Vietnam grew significantly accompanied by the declining stock market. The slow speed of foreign investment attraction created the increasing capital outflow from Vietnam. Besides, at that time many international organizations considered the Vietnamese economy negative. All of these facts impacted badly to the foreign currency and reversed the exchange rate rapidly and created disadvantages of implementing the monetary policy.
In some points of time in the late of May and the beginning of June, the daily exchange rate on the black market sometimes reached 19.400 VND/USD, the gap between the average rate of the interbank market and the black market slackened and many unstable signs appeared on the foreign currency market. In order to stabilize the foreign currency market, the SBV
198 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy implemented many solutions including widening the exchange rate band from 1% to 2%; creating the flexibility for the exchange rate as the market demand and supply; extending objectives to sell foreign currencies to commercial banks, intervening based on the state of daily foreign currencies at commercial banks and the public foreign reserves information. These solutions have applied market expectations and created the belief of the market to the SBV. Besides, the SBV strictly monitored foreign currencies trading, forbad credit institutions trading USD with other currencies, and coordinated with other functioning agencies in the progress of checking and dealing with speculation as well as illegal foreign currencies trading in the market. All these solutions have improved the market rule and created market stability.
In short, all resolutions of the SBV in 2008 showed the correct way that helped to reduce the gap between interbank and black market exchange rate. At the moment, the official exchange rate fluctuated around 16,650 17,000 which showed the success of the SBV in implementing the monetary policy.
4. Recommendations
Our recommendations below are structured along the four pre-conditions for maintaining macroeconomic stability. Recommendations for the monetary and the fiscal discipline are brief, reflecting that our discussion of Vietnamese experiences is focused on capital account liberalization and foreign exchange management.
4.1. Monetary Discipline
Recommendation 1: The stability of money velocity should be examined regularly.
The current Vietnamese monetary policy framework uses the money supply as the intermediary target9), which also had been the Korean monetary policy framework of the 1980s and the 1990s. The framework itself is appropriate for an emerging economy such as Vietnam where financial markets and institutions are yet to be fully liberalized. At the same time, it is important to recognize that the effectiveness of the policy framework is subject to market environment. As repeatedly found in advanced economies in the 1980s and also confirmed by the Korean experience during the 1990s, the effectiveness of the money supply as the intermediary target tends to disappear as financial markets are liberalized. A consensus view has that the phenomenon is due to that the velocity of money in the quantity equation becomes unstable when financial markets are liberalized. Hence, we recommend that Vietnam should check regularly the effectiveness of the policy framework by examining the stability of the money supply which is used as the intermediary target, and prepare in due time to move to the
9) According to the Vietnamese practice, a ‘short term target’ is used to mean ‘the intermediary target’.
199 Chapter 2 _ Monetary and Financial Policy next stage policy framework which utilizes interest rates as a policy target.
4.2. Fiscal Discipline
Recommendation 2: It should be acknowledged that fiscal discipline is a necessary condition for credibility of the monetary discipline.
For an emerging economy, particularly which is at the early stage of economic development, credibility of price stability is difficult to attain if fiscal discipline is not present. Existence of chronic fiscal deficits of an emerging economy tends to be taken as a sign that money financing will be inevitable in the future. We emphasize that the close relationship between monetary and fiscal discipline should be taken as the first principle of policy making.
Recommendation 3: Projection of medium term fiscal balance should be made to gauge the degree of fiscal soundness over the next 5 years. Based on the assessment, a feasible plan should be formulated to recover and sustain fiscal soundness. The road map of future liberalization of foreign exchange markets and capital account transactions should be related to the plan for fiscal soundness.
During the recent years, Vietnam fiscal balance continued to show deficits, which was partly due to the policy response to the global financial crisis. The Korean experience during the 1980s and the 1990s illustrates that both fiscal soundness and economic development can be achieved. We recommend that Vietnam should pursue fiscal discipline first before further liberalizing financial markets and international capital flows.
4.3. Soundness of the Financial Sector
Recommendation 4: A well functioning prudential supervision mechanism should be established before fully liberalizing short term foreign borrowings by Vietnamese financial institutions.
It is a general requirement for an emerging economy to construct a prudential supervision system over financial institutions as it liberalizes the financial sector. What’s more important is to recognize that it is essential to have the supervisory system before allowing financial institutions freely take short term foreign exchange liabilities. Whether they are state owned or not, global market players consider foreign exchange liabilities of financial institutions of an emerging economy as protected by ‘implicit’ state insurance. The presumption has been confirmed repeatedly by every case of currency crisis for the past decades, including the Korean financial crisis of 1997. In the presence of ‘implicit insurance’, foreign lenders have an incentive to exploit it. In global markets, the feasibility of the governmental implicit insurance
200 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy is often considered limited by ‘insurance fund’, where a foreign exchange fund managed by the central bank assumes the role. Given the constraint, global lenders tend to prefer short term loans. In consequence, short term borrowings by domestic financial institutions are not on credit worthiness of an individual financial institution but the capacity of the insurance fund of an economy. Indeed, this was an exact mechanism that gave rise to the rapid growth of short term foreign exchange borrowings by Korea before the financial crisis of 1997. Hence, it is crucial to have infra to oversee and ensure soundness of the financial sector before liberalizing short term foreign exchange borrowings by financial institutions.
Recommendation 5: Special attention should be paid to prevent any ‘loophole’ of supervision, which is under explicit or implicit insurance of the government but outside of the supervision.
As argued above, the Korean policy makers failed to spot building up of problems in the financial sector, as traditional measures of financial soundness did not reflect them. As aforementioned, before the crisis of 1997, the Korean policy makers successfully preserved financial stability by controlling money supply. But, then after liberalization, as about half of the foreign currency operations of the banking sector were handled by overseas branches that were not reflected in domestic monetary indicators by definition, thus it was impossible for policy makers to detect this new development when watching traditional macroeconomic measures. For that matter, it is often a typical scenario that risky transactions occur outside of supervision, but within ‘implicit’ governmental guarantee, and culminate as a crisis.
4.4. Tools to Manage Volatility of Short Term Capital Flows
4.4.1. Exchange Rate Policy
Recommendation 6: Until fully liberalizing short term capital flows, maintaining a peg system, whether explicit or de facto, is appropriate.
Once moving to the floating exchange rate system, maintaining exchange rate stability is almost impossible for an emerging economy. When global financial markets are under turmoil as was the case early last year in the wake of the US sub prime crisis, the value of an emerging market currency can fluctuate following market sentiments instead of fundamentals of the economy. Hence, there is a case for a peg system if it can be sustained. The Korean experience illustrates that a peg system can sustain unless short term capital flows are liberalized.
The current exchange rate regime in Vietnam operates within the framework of an announced official exchange rate and an allowable exchange rate band. In practice, it is considered a de factor peg system. In principle, the system is appropriate if the central bank of Vietnam can manage it in the face of volatile capital flows. Currently, channels of short term
201 Chapter 2 _ Monetary and Financial Policy capital flows in and out of Vietnam seem mostly stock market investment. Though sudden reversal of capital flows is still possible with stock market, compared to other vehicle stock market has a self correction mechanism. As foreign investors sell and leave the market in mass, double loss from stock price fall and depreciation of VND may work as a mechanism of stop selling. Thus, there is a danger that a negative shock may quickly lead to a turmoil. In practice, however, it is often observed in emerging stock markets that such a quick adjustment brings in a new stream of foreign capital by improving short term investment prospect. Hence, the current exchange rate system may be viable until other channels of short term capital flows, particularly short term borrowing of financial institutions become more significant.
Recommendation 7: To evaluate the sustainability of a de facto peg system, the ultimate test can be whether the central bank of Vietnam can control a majority of foreign market participants when required.
When market sentiments prevail in foreign exchange markets, the only way to defend the current peg can be to control market participants’ sentiments. If not, then it indicates that private capital flows are already liberalized enough to dominate market movement. In that case, policy makers of Vietnam should identify the set of market participants that are beyond the control of the central bank and carefully devise ways to have them cooperate with the central bank.
Recommendation 8: In operating a de facto peg system, the prior criteria for determining the level of peg rate should be to keep the current account in balance. The specific form of the exchange rate system is of second importance.
Even when short term capital flows are restricted, if exchange rate is misaligned so that current account deficits accumulate, an economy may face a foreign exchange crisis as evidenced by Latin American currency crises in the 1980s. Hence, a peg should be adjusted to keep the value of VDN evaluated as the effective real exchange rate in equilibrium. Whether a currency system is defined as a nominal peg, a multi currency basket peg, or a managed floating does not matter as much as the system is a de facto peg.
4.4.1.1. Foreign Exchange Reserve Management or Foreign Exchange Market Intervention
Recommendation 9: In operating a de facto peg system, the central bank of Vietnam may resort to sterilized market intervention to cope with temporary capital inflows, accumulating the foreign exchange reserve.
202 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy Accepting that short term capital flows may be sometimes directed by market sentiments, to prepare for sudden reversal and prevent the real exchange rate from appreciating, the central bank of an emerging economy can choose to intervene in foreign exchange market while sterilizing impacts on money supply. Though the sterilized intervention was accused of being ineffective and only delaying adjustment of exchange rates to the equilibrium level in the 1990s by international organization like the IMF, now it can be considered as a legitimate policy option.
4.4.1.2. Measures to Secure Emergency Foreign Exchange Liquidity
Recommendation 10: Vietnam should continue to participate in the ASEAN+3 to contribute its financial cooperation initiatives, including the Chiang Mai Initiative. And it is desirable to explore further possibilities of expanding a mechanism for emergency foreign exchange liquidity.
After the Asian crises of 1997, two proposals have been made to improve financial cooperation among Asian countries: the proposal for the creation of an Asian Monetary Fund and the Chiang Mai Initiative. The former was made by Japan in September 1997 and advocated on the ground that a regional lender of last resort was necessary. However, given the uncertainty regarding the relationship with the existing international organizations such as the IMF and the World Bank, it failed to develop further. The Chiang Mai Initiative (CMI), taken in May 2000 by China, Japan and Korea together with the ASEAN countries, was to expand an existing set of currency swap arrangements and establish a network of currency swap and repurchase arrangements. Finally last year, it was announced that ASEAN+3 reached a consensus on details required for making the plan possible and now in the process of establishing the mechanism. Being a member of ASEAN+3, Vietnam now has an access to this emergency foreign exchange facility.
Still a question remains whether the CMI will provide adequate protection for ASEAN countries from a foreign exchange liquidity crisis. As observed by the Asian crises of 1997, a currency crisis tends to be a ‘regional’ crisis going beyond a ‘country’ crisis. The current framework of the CMI will not be effective in dealing with a regional crisis in the magnitude of the Asian crises of 1997. To be adequately prepared even for a regional crisis, Asian economies need to enhance regional infra such as the CMI and to empower the regional infra by linking it with either the international organizations or the US, the country of the settlement currency, directly.
Currently, Vietnam does not have any international arrangement for emergency foreign exchange liquidity mechanism except the CMI and the IMF. Vietnam should actively participate in the CMI and explore if the facility can be expanded for the benefit of Vietnam. At
203 Chapter 2 _ Monetary and Financial Policy the same time, it should support other international initiatives, whenever raised, to expand emergency liquidity facilities for emerging economies. Since Vietnam does not have a direct access to G20, which currently plays the role of an architect of the new international financial order, it should closely cooperate with G20 member countries in the region.
204 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy References
Cho, Yoon Je and Kim Joonkyung (1997), Credit Policies and the Industrialization of Korea, Seoul: KDI Press..
Nam, Sang Woo (1989), “Liberalization of the Korean Financial and Capital Markets,” mimeo, Korea Development Institute, Seoul.
Nam, Sang Woo (1992), “Korea’s Financial Reform since the Early 1980s,” KDI Working Paper No.9207, Seoul: KDI Press.
Nam, Sang woo (1986), “Korea’s Stabilization Efforts since the Late 1970s,” in Financial Development Policies and Issues, Eidted by Joon woong Kim, Korea Development Institute.
Radelet, S. and J. Sachs (1998), “The East Asian Financial Crisis,” mimeo, Harvard Institute for International Development.
Shin, I. (1998), “The Korean Crisis: on the Mechanics,” KDI Policy Studies, KDI.
205 Chapter 2 _ Monetary and Financial Policy Chapter 04 People’s Credit Funds in Vietnam How to Promote the Development of Cooperative Self Help Organizations: Case of People’s Credit Funds (PCFs) in Vietnam1)
Joon Kyung Kim (KDI School of Public Policy and Management) Pham Thi Thanh Ha (Ministry of Planning and Investment) Nguyen Thi Lan Huong (Ministry of Planning and Investment) Bui Nghi (Ministry of Planning and Investment)
Abstract
The objective of this study is to explore how credit cooperatives in Vietnam can mobilize financial savings from the informal credit market, using Korea’s experience during the take off period.
Cooperatives can play an integral part of a country’s development policy. However, experiences in many countries have shown that it usually is a mistake to use credit cooperatives as instruments for the implementation of government policy, rather than allowing them to operate as voluntary self help organizations of their members. The introduction of the credit union in Korea in the 1960s and 1970s through private and not through the government initiative offers unique example among developing countries: Korea was able to successfully introduce self help credit unions through a bottom up approach without government support. There were significant impacts of Korea’s credit union movement. First, Korean poor people were able to have a real deposit account for the first time. Although the amount of saving may have been small, it provided a sense of being part of the greater society, instilling further hope and confidence for better future. Second, the values of cooperatives such as elections based on 1 person/1 vote rule were able to contribute to the initiation of grass root democracy in Korea by emphasizing the importance of education.
1) Authors are thankful for the help by Nguyen Thi Dieu Thuy and Can Van Tien, Development Strategy Institute, Ministry of Planning and Investment.
206 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy According to Münkner (1999), the basic concept of a cooperative is that it is a method of organized self help; in other words, helping others to help themselves through cooperation. It is a method of pooling members’ resources, and the sharing of risk and burden in a disciplined, organized, and coordinated manner. However, for cooperation to work, the members of the cooperative must operate under a system of shared beliefs, values and principles, which must be instilled over time by way of teaching and doing. What are the roles of the government in Vietnam in developing sustainable cooperatives? The initiation and formation of cooperatives should be left to the individuals themselves who are seeking to help themselves by self help organizations. Cooperation in one form or another is part of human nature and exists in every society. The government should not be obligated to initiate cooperatives, since individuals by themselves will seek out and form cooperatives if found to be mutually beneficial. Second, support of cooperatives should only goes as far as helping others help themselves by providing access to knowledge, resources and capital, until it is self sustaining. Third, the government should take active roles in creating an environment that fosters cooperative work, such as 1) ensuring the freedom of the association and the right to exercise any legal economic activity in group, 2) preventing misuse of cooperatives, 3) enacting laws that give autonomy to cooperatives to align its by laws with the needs and objectives of its members, 4) Ensuring equal opportunity with other business organizations, 5) protecting cooperatives against unfair competition, and 6) creating a tax regime in consideration of cooperatives.
1. Introduction
In Vietnam, the size of the informal credit market (unregulated financial market or unorganized money market) is still large despite the fact that domestic savings has dramatically increased for the past 20 years. Indeed, domestic savings relative to GDP increased to 32% in 2006 from only 4.8% in 1987.2) However, a large portion of loans from regulated financial institutions goes to the state owned enterprises (SOEs) in Vietnam. Despite the large domestic savings, small sized businesses and households still rely on the informal credit markets. As of 2007, 32% of SMEs were not able to access credit from banks at all based on a survey conducted by the Central Institute for Economic Management (CIEM) and Danida organization (Denmark). Moreover, 20-26% of total household relied on informal credit markets, according to the Vietnam Living Standard Survey (VLSS) in 2006.
Vietnam has exhibited a rapid growth for the past 20 years thanks to the success of opening up of its markets. However, income distribution in Vietnam has been worsening as demonstrated by an increase in the Gini coefficient from 0.37 in 1996 to 0.42 in 2004. Such worsening trend can be attributed to many factors, but it would seem that the significant income
2) Such rapid increase in savings was mainly due to two factors: young demographic structure with low dependency ratio as well as rapid income growth during the period.
207 Chapter 2 _ Monetary and Financial Policy disparity between urban workers and farmers was the biggest contributing factor. This phenomenon would also seem to be in line with the Nobel Laureate Kuznets hypothesis where distribution of income would worsen during the early stage of industrialization.
Korea has been cited as one of successful countries with relatively low income inequality and rapid growth, achieving the shared growth during the take off period. As can be seen in Figure 2-4-1, Korea exhibited relatively low Gini coefficient while achieving highest average real growth rate 7.2% on an annualized basis during 1965 1990. Such a shared growth was made possible thanks to the land reform in 1950 as well as the compulsory education system in primary school adopted in 1948. As important, the creation of cooperative financial institution (CFI, or credit cooperative) aimed at assisting low income households also contributed to achieving Korea’s model of shared growth.
With this in mind, the objective of this study is to explore how credit cooperatives as regulated financial institution in Vietnam can mobilize financial savings from the informal credit market, using Korea’s experience during the take off period as a reference. In our study, we focus on the role of People’s Credit Funds (PCFs). Section 2 provides overview of formal and informal financial system in Vietnam. Section 3 introduces general features of cooperative financial institutions which make them different from the banks. Section 4 describes the birth and early development of Korea’s credit union movement which were founded on the pillars of self help, self sustaining and cooperation. Section 5 provides an assessment of the current situation of PCFs by discussing its development in Vietnam and existing shortcomings. Section 6 points out areas that should be improved, and recommend how to promote sustainable development of private, independent and autonomous self help cooperatives in Vietnam.
Figure 2-4-1 | Gini Coefficient and Real Per Capita Iincome Growth(1965 90, Annual Average)
Source: East Asian Miracle(World Bamk, 1993)
208 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy 2. Overview of Formal and Informal Financial System in Vietnam 2.1. Formal Financial System
2.1.1. The Banking System
After the reunification of Vietnam, the State Bank of Vietnam (SBV) was undertaking the functions of a central bank and commercial bank, effectively acting as a de facto mono banking system. This banking system was reformed following the crisis in the late 1980s, which was caused by inadequate deregulation and supervision.
Since the late 1980s, the banking system was market oriented where central bank’s functions were separated from monetary policy and commercial banks. The State Bank of Vietnam takes part as the central bank and the supervisory functions. State owned commercial banks and other credit institutions such as joint stock commercial banks began their banking business under the market mechanism. However, until the mid 1990s, the state owned commercial banks had to perform other government functions such as providing policy loans for state projects or for the poor. Therefore, in 2006, the government separated the social policy functions from the commercial banking system which finally led to the establishment of Bank for the Poor (formerly known as the Bank for Social Policies), and the Vietnam Development Bank (VDB) by reorganizing the system of development financing.3) Furthermore, the People’s Credit Fund (PCF) system was established in 1993.
During over nearly 30 years of reform, the banking system underwent two significant development stages. There was rapid increase in the number and different types of the credit institutions driven by the increased demand for banking services during 1990 96 in the period of the Doi Moi. The number of banks increased dramatically from 9 in 1990 to 84 in 1997. Since 1997, the banking system has been undergoing consolidation and restructuring.
By the end of 2008, there were 7 state owned banks (SOB) including Vietnam Bank for Social Policies, Vietnam Development Bank and 5 state owned commercial banks (SOCB) with 1,203 branches and transaction centers. In addition to the state owned banks, there are 40 joint stock commercial banks with 898 branches and transaction centers. The Bank for Foreign Trade of Vietnam (Vietcombank) was the first SOCB to become a joint stock commercial bank in 2007, followed by the Industrial and Commercial Bank of Vietnam (Vietinbank) in 2008. Despite being joint stock commercial banks, over 90% of total shares of these two banks are
3) Before 2006,development financing system in Vietnam was duplicated by the development financing system and the Bank for Investment and Development of Vietnam (BIDV)
209 Chapter 2 _ Monetary and Financial Policy owned by the State, effectively making them SOCBs. The formal financial sector in Vietnam is also made of 39 branches of foreign banks, 5 foreign wholly owned banks, and 5 joint venture banks. (See Table 2-4-1)
Table 2-4-1 | Financial Institutions in Vietnam
Credit Institutions 1991 1997 1998 2007 2008 State-owned commercial bank (SOCB) 4 5 5 5 5 The Social Policy Bank 0 1 1 1 1 Joint stock commercial bank 4 52 51 34 40 Foreign bank branch 0 25 24 41 39 Joint venture bank 1 4 4 5 5 Fully foreign owned bank 0 0 0 0 5 Vietnam Development Bank 0 0 0 1 1 Central People’s Credit Fund 0 1 1 1 1 People’s Credit Fund 0 948 977 996 1,016 Finance Company 0 4 5 9 17 Leasing company 0 0 8 12 13
Source: State Bank of Vietnam, annual reports
Since the 1997 Asian financial crisis, the SBV has actively carried out expansionary monetary policy to help the economy overcome the recession. As a result, the growth of deposits and credit supply from the banking system increased to high levels. In the period of 1997-2008, the average growth rate of deposits and credit was 30% and 29%, respectively, per year. The provision of credit remains the major product of commercial banks with the proportion of outstanding loans accounting for 70% of total assets (2007: 71.2%, 1998: nearly 83% of total assets) according to the SBV annual reports.
Figure 2-4-2 | Growth Rate of Credit and Capital (Deposit) Mobilization of the Banking System
Source: State Bank of Vietnam, annual reports
210 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy Notably, the market share of SOCBs’ deposits and lending in the formal financial system was still the largest at over 55%, while the role of the SOCBs was gradually being decreased. The joint stock commercial banks hold the second largest market share, having increased suddenly to 30% in recent years. The foreign banks hold the third largest at 9% of market shares. People’s Credit Funds system plays a very small role, accounting for about 1.3-1.5% of market shares.
Figure 2-4-3 | Market Share in Deposits of Financial Institutions in Vietnam
Source: Vo Tri Thanh and Pham Chi Quang (2008), Managing capital flows: The case of Vietnam
Figure 2-4-4 | Market Share in Lending of Financial Institutions in Vietnam
Source: Financing Vietnam’s growth: domestic and foreign sources of development
211 Chapter 2 _ Monetary and Financial Policy As can be seen in Table 2-4-2, the state owned enterprises (SOE) no longer served as the most important customers of commercial banks. The share of bank loans to the SOEs significantly reduced from 52.7% of total outstanding loans in 1996 down to 31.5% in 2007. Meanwhile, the share of bank loans to other enterprises (such as private enterprises, foreign invested firms) rose from 47.3% out of total outstanding loans to 68.5% in the same period. It is clear that the supply of credits is still concentrated on the SOEs. Indeed, nearly 1/3 of total loans outstanding from regulated financial institutions went to SOEs, which accounts for only 2.2% of the total number of firms in Vietnam as of 2007. Generally, access to bank credits is mostly limited to the medium sized and large enterprises. Indeed, although the customers of the joint stock commercial banks include private enterprises, households and individuals, the average loan size for a client of many banks often exceeds more than 600 million VND (2006).4) This seems to indicate that the access to credit is limited for low income customers.
Table 2-4-2 | Share of Credit by Enterprises
1996 1999 2000 2001 2002 2003 2004 2005 2007
Credit to economy (thousand 50.9 113 156 189 231 270 420 553 944 of billion VND)
SOE share (%) 52.7 48.2 44.9 42.1 38.7 35.5 34 32.8 31.5 Others share (%) 47.3 51.8 55.1 57.9 61.3 64.5 66 67.2 68.5 The share of others in total 86.4 89.6 91.5 93.3 95 96.4 97.8 enterprises (%)* Source: Financing Vietnam’s growth: domestic and foreign sources of development; *calculation’s author based on data from GSO
2.1.2. Overview of Vietnam Securities Market
In spite of nearly ten years of development, the role of the Vietnam stock market as a way to raise capital is still very insignificant. Indeed, the share of the securities market financing from the total financing has been low except for 2007, when share of securities market financing was 11.7% while the share was 1.4%-3.9% in the other years (See Figure 2-4-5).
Stock market
State Securities Commission (SSC) was established in 1995 that opened the development of the stock market in Vietnam. On July 20, 2000, the Ho Chi Minh City Stock Exchange (HOSE) was established, and on July 28, 2000, it started operations with listing of two companies called as REE (Refrigeration Electrical Engineering Corporation) and SAM (Cables and
4) The Bank for the Poor Network (2008), Vietnam Microfinance Assessment Report
212 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy Telecommunications Material Joint Stock Company). On March 8, 2005, the Hanoi Securities Trading Centre (HASTC) was established. However, it was not until January 1, 2007, with the enactment of Securities Law that the legal framework for listing requirement, transparency and disclosure was enhanced.
Figure 2-4-5| Capital Mobilization Channels of Vietnam Economy, 2005-2008
Source: Authors’ calculation from data of State Securities Commission, annual report for 2008 (2009)
The number of listed companies in Vietnam increased from only 4 in 2000 to 340 in 2008. The total market capitalization of combined HOSE and HASTC has rapidly increased since 2006. In 2005, it was only 1.1% of GDP, but increased to 23% and 43% in 2006 and 2007, respectively.5) In 2008, there was a sharp decline in the market value by nearly 70% of total market capitalization. Notably, the total value of the over the counter (OTC) stock market is estimated to be 3 to 4 times bigger than the formal markets.
Table 2-4-3 | Listing Securities in HOSE (31 December 2008)
Indicators Total Shares Fund certificates Bonds Number of listed companies* 244 172 4 68 Volume of listed securities** 5,917.1 5,515.4 252.1 149.5 Listed value*** 72,748.3 55,154,7 2,520.5 15,073.0
Source: HOSE
5) Source: the State Securities Commission
213 Chapter 2 _ Monetary and Financial Policy Table 2-4-4 | Listing Securities in HASTC (31 December 2008)
Indicators Total Shares Bonds Number of listed companies* 699 168 531 Volume of listed securities** 3,993.9 2,431.1 1,652.8 Listed value*** 188,690.3 23,411.0 165,279.3
Source: HASTC Unit: *: number of companies, **: million of securities, ***: billion VND
Bond market
Vietnam’s bond market remains underdeveloped. Compared to some Asian countries, the total value of Vietnam’s bond market is still low (about 7% of GDP), while that of China, Thailand, and Malaysia is 21%, 33%, and 62% of GDP, respectively. Moreover, Vietnam bond market is mainly accounted by the government bonds. For instance, out of a total of 92 different types of bonds, only 3 were corporate bonds in 2008.
Only some SOCBs such as Vietnam Foreign Trade Bank and Bank of Investment and Development of Vietnam, and some corporations including Vinashin and EVN have issued bonds in the Vietnam bond market. The liquidity in the bond markets remains low even though it has been improved recently. As such investors buy bonds and hold them up to their maturities.
To summarize, the securities market remains underdeveloped and lacks adequate regulatory framework and supervision. Due to lack of investor’s knowledge and sophistication, investors in Vietnam are prone to herd behaviors. In addition, there is a lack of transparency in the stock market. Accordingly, insider trading as well as stock price manipulation resulted in volatile prices, having negative effects on the economy and the society. At present, only large size profitable firms are able to access to equity financing, while this channel of financing is limited for SMEs.
2.1.3. Cooperative Financial Institutions
Cooperative financial institutions (CFIs) have also been incorporated in Vietnam since the 1950s, but their role as financial intermediaries is still insignificant. Old socialist credit cooperatives collapsed in the late 1980s due to inadequate regulation and lack of management capacity.6) About 7,700 credit cooperatives were closed, resulting in a loss of VND 100 billion in small savers’ deposits. Under the supervision of SBV, a new system of CFIs, called the PCFs, was established in 1993 by the government in an attempt to restore public confidence in the formal rural financial system. At the end of December 2008, 1,015 individual PCFs were operating in 56 cities and provinces reaching almost 1.4 million members, accounting for only 1.6% share of the regulated loan markets. A more detailed analysis of the current situation of
214 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy the PCFs will be covered in Section 5.
2.2. Informal Credit Markets
The informal credit markets used to be prevalent before the establishment of the formal financial system. Today, the informal credit markets are concentrated mainly in household in rural areas and SMEs in urban areas. There are four sources for credits in the informal credit markets in Vietnam.
•Borrowing from relatives and friends: the loans from this source often have very low interest rate or zero interest rate. These loans are usually for sudden consumption needs.
•ROSCA (Rotating Savings and Credit Associations): It can be considered a rotating credit association designed to pool small savings to make large lump sum payout. It is based on a lump sum payout of funds collected through installment deposits where the lump sum is distributed based on predetermined sequence. ROSCA’s operations are regulated by the Law of Civil. Moreover, on November 27th 2006, the government issued Resolution No. 144/2006/Res Gov about ROSCA. That is the step of institutionalization with the aim of ensuring civil responsibilities of members when joining ROSCA.
•Private money lenders: Some individual mobilize funds and then lend to others. In many cases, the interest rates of these loans are very high, compared to bank’s interest rate. Most of the loans are short term without collaterals or with collaterals but it is not enough purse legal recourse.
•Agricultural material merchants: they often lend in the form of deferred payments in the form of goods and materials used in agriculture (such as seeds and fertilizers). They often provide raw materials in advance while receiving payments after harvests at a pre discussed rate.
6) Since late 1986, Vietnam has turned to socialism driven market economy, with encouragement of private business activities and transformation of public sector. However, the cooperative models did not work well and had been seriously undermined. The outdated state management bodies on coop§±eratives were dissolved, the statistic reviewing system disappeared, there was not government authority specialized in cooperatives. Without a defined model, there was nearly no regulations on credit cooperatives’ organization and operation. Lacking in professional executive board as well as in knowledge and skills from the staffs, the credit cooperatives mobilized deposits at very high interest rates (in some cases at the monthly rate of 15 18% without any warning or correcting signal from any government body). In many cases, borrowers were not members of the credit cooperatives and they was not appraised seriously (in some cases, even were not appraised at all). Under such vulnerable system once depositors began to withdraw deposits, a contagious effect of depositor run were quickly spread to the other credit cooperatives, leading to the systematic collapse of the system.
215 Chapter 2 _ Monetary and Financial Policy Access of enterprises to the informal credit market
Also, according to the 2007 SMEs (small and medium sized enterprises) survey conducted by the Central Institute for Economic Management (CIEM) and Danida organization (Denmark), it was report that only 33% of SMEs are able to borrow money from banking system while 35% of SMEs are able to access credit but sometimes with difficulties. And, the remaining 32% of SMEs were not able to access credit from banks at all.
Credit access by farmers and households in the informal credit market
Following a survey in 7 provinces conducted by the Ministry of Agriculture and Food in 1990, it was found that 68% to 94% of households accessed credit from informal credit sources. Also, on average, approximately 68.3% of rural households had loans from the informal credit source (Seibel, 1992). More recently, the amount of borrowings via the informal credit market has decreased significantly due to either the rapid development of microfinance (following the model of Grameen and SHG) or of state led credit programs of such as PCFs, VBARD and VSPB.7)
Based on the Vietnam Living Standards Surveys (VLSS and VHLSS) from 1992 to 2006, we can examine the trends prevailing in the informal and formal credit in Vietnam. In particular, borrowings from the formal credit market are increasing, while borrowings from the informal credit market are decreasing. In the early 1990s, the informal credit channel was the main source of credit for households, accounting for 71.8% of total household borrowing. Household borrowing from VBARD and the Vietnam Bank for the Poor (VBP) only accounted for 16.2% of total household borrowing. In the late 1990s, the share of borrowing from the informal credit market decreased to about 54.4% while the share of borrowings from the formal credit market totaled 45.6%. In 2006, 33.4% of households had borrowings from the informal credit channel and 66.5% had borrowings from formal credit channel.
Also the average loan size has increased overtime. The average loan size in the informal credit market increased from 1.3 million VND (informal) in 1992 to 1.9 million VND in 1998, while it increased from 1.5 million VND to 2.9 million VND in the formal market in 1998. In 2006, the average loan size for informal credit market increased to 9.5 million VND while it increased to 16.1 million in the formal market.
As can be seen in Figure 2-4-7, the interest rate in the both two channels has decreased
7) For example, only a few thousand farm households were borrowing from VBARD in 1991, however, VBARD has more than 10 million borrowers today, accounting for 70% of total borrowing (242,102 billion VND) for household’s economic activities and rural areas. This is equivalents to 90% of total borrowings of the whole banking system in the agriculture and rural areas. (Source: Nguyen Dai Lai PhD., comments on the history of agriculture-rural-farm credit and the commission of the VBARD)
216 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy Figure 2-4-6 | Share of Household Credit by Number of Borrowing Households and Loan Size, 1992- 2006
Source: Authors’ calculations from VLSS1992, VLSS1998 and VHLSS2006 rapidly. On average, the annualized interest rate in the formal credit market was 50.4% in 1992, falling to 13.3% in 1998 while interest rates in the informal credit market decreased from 17.2% in 1992 to 15.9% in 1998. The interest rate decreased further in 2006 to 11.4% in the formal credit market and 7.5% in the informal credit market. Based on this, we can conclude that borrowing in the informal channel is cheaper than the formal channel due to lower interest rates. Indeed, one of the main sources of credit was relatives and friends during this period. In 1998, interest rates in the informal credit market was higher than in the formal credit market unlike
Figure 2-4-7 | Average Annual Interest Rate of Household Credit, 1992-2006
Source: Authors’ calculation from VLSS1992, VLSS1998 and VHLSS2006
217 Chapter 2 _ Monetary and Financial Policy when interest rates were lower in the informal credit market than the formal credit market in 1992 and 2006. This can be explained by the fact that following the Asian financial crisis in 1997, the government carried out the economic stimulus policies and many reforms in the formal credit market in 1998 and 1999.
In VLSS, informal credit sources are divided into 3 main types including relatives and friends, private money lender and other sources. In particular, borrowing from relatives and friends was a key source of credit. The share of borrowings from relatives and friends has increased from 50.7% of borrowing household in 1992 to 69.1% in 2006. The shares of borrowings from private money lenders had a significant share in the informal credit market. It was at 22.1% in 1992 and continued to be at 23.0% in 2006, even though the interest rate charged by these private lenders was always the highest. It was 24.4% in 2006, about two times higher than the interest rate of banks. The rest of the sources of credit include ROSCA and other lending individuals. There is a change in the share of this source, where ROSCAs accounted for 38.2% of informal credit borrowers in 1998; however, the share of this source declined sharply to 7.9% in 2006.
Figure 2-4-8 | Structure of Informal Credit by Funding Sources, 1992-2006
Source: Authors’ calculation from VLSS1992, VLSS1998 and VHLSS2006
The informal credit has several distinct advantages from the formal credit market, as the informal credit market is more flexible and expedient and requires no collaterals. However, the informal credit market in Vietnam has many problems, especially on the legal aspects. In particular, the legal rights of borrowers in the informal channel are not adequately protected. For example, ROSCA is a supporting form among households, however, at the moment there is one legal document treating ROSCAs Resolution No. 144/2006/ND–CP issued in December 27th 2006.
218 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy Table 2-4-5 | Detail Breakdown of Household Credit in 2006
To support members of the business community and society, social political organizations and social career organizations are approved and funded by the government to establish microfinance institutions such as the Vietnam Women’s Union, Vietnam Farm’s Union, CEP fund for Ho Chi Minh labor union, and the Vietnam Belgium program which works together with the Vietnam Women’s Union running in 17 provinces.
The semi formal microfinance institutions are regulated by Resolution No.28/2005/Res Gov which was established in March 9th, 2005. The Resolution No. 165/2007/Res Gov provides the framework for the structure and operation of microfinance institutions in Vietnam. In April 2nd, 2008, the SBV issued Circular No. 02/2008/TT NHNN which directs the enforcement of two Resolutions. The semi formal microfinance institutions can mobilize savings, conduct internal settlements, and provide lending and the insurance agency services.
From the VLSS, the number of households that can borrow from this channel is quite modest. In 1992, it accounted for 5.7% of household borrowings; 6.5% in 1998 and 8.7% in 2006. According to a study on 44 NGO sponsored microfinance institutions (NMP) in the North and Middle regions in Vietnam (Nghiem Hong Son and James Laurenceson, 2003), 79% of the
219 Chapter 2 _ Monetary and Financial Policy credit borrowed by the members was for investment purposes. This reflects rules in 69% of NMPs that loans are only to be used for production purposes. The most common types of investments made by using loan from microfinance include crops, livestock, and non agricultural activities. The proportion of credit extended for agricultural related activities was identified by some NMPs as not generally being in line with the principle of microfinance, which is based on small, regular loan repayments. These types of agricultural related activities funded via microfinance are susceptible to seasonal (or longer) fluctuations in income. Of the credit that was extended for consumption purposes, the most common uses were education fees for children, health care and food. All NMPs applied the principle of social collateral rather than physical collateral in their credit service. In the case a borrower defaults, group members are responsible. In which, the average loan size financed by NMP is near 1 million VND and the average interest rate is 1.28%.
Table 2-4-6 | Data from Survey of NMPs
Units Mean Median Minimum Maximum Number of members Persons 2382 800 68 19508 Number of borrowers Persons 2231 691 48 19608 Average lan size ‘000 VND 988 787 318 4471 Loan interest rate Percent/month 1.28 1.20 0.08 1.70 Loan term Months 14 12 6 36 Number of savers Persons 2045 631 0.00 19508 Average saving amount ‘000 VND 220 149 10 1000 Saving interest rate Percent/month 0.60 0.60 0.40 0.85 Source: The nature of NGO microfinance in Vietnam and stakeholders’ perceptions of effectiveness
3. What is CFIs?
CFIs are composed of member owners who both supply and use the funds (principle of identity). In contrast, owners (shareholders) of banks are clearly separated from clients. For CFIs, another key feature is the principle of one person/one vote. According to the Statement on the Cooperative Identity, promulgated by the International Co operative Alliance (ICA), a co operative is defined as “an autonomous association” of persons united voluntarily working together to meet their common needs. “Cooperatives” are based on the values of self help, self responsibility, democracy, equality, equity and solidarity. In the tradition of cooperative founders, cooperative members believe in the ethical values of honesty, openness, social responsibility and caring for others (ICA 2008). Table 2-4-7 summarizes the key distinctive features of membership of cooperatives compared to the shareholders of banks.
220 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy Table 2-4-7 | Key Differences between Members and Shareholders
Shareholders of a public limited Members of CFIs company
Clear-cut separation between the Inclination of Double capacity, member ≡ client shareholder and the client Valuation → stakeholder value1) → shareholder value
One person, one vote (the member is One share, one vote when applied (the Voting right considered for what he is, not what he shareholder is considered for what he financially represents) financially represents)
Seek high quality products at a convenient What to seek Seek short-term return on shares price, in a long-term relationship with the effective value (possible conflict with the clients) CFIs
Participation Involved at several levels of the Involved in case of significant within the system organization: local, regional and national shareholding, at the central level (board)
Claims on net None2) Yes assets
Remuneration of co-operative share: stable Return on listed shares (more or less) Stability of return over time volatile
Specific benefits for members (products, Benefits No specific events3) services, events)
Note: 1) Thus, there is no ground for a conflict of interests between shareholders and clients. 2) Italian Banche Popolari provides their members a proportional claim to the net assets, as appropriation of operating profit to reserves is subject to company income tax. 3) French Crédit Agricole S.A. provides specific benefits for shareholders Source: European Association of Co-operative Banks, “60 Million Members in Co-operative Banks: What does it mean’ (2007, p.6)
4. Korea’s Experience in the Development of Credit Union
Korea was the typical agrarian economy even until late 1950s. At that time farmers accounted for about 70% of total workers. Indeed, the agricultural sector accounted for large part of the economy.
At that time, the informal credit markets were dominant forms of accessing credits. While the majority of borrowers were households, small merchants, and farmers8), providers of credits consisted of local money lenders9), relatives, friends and neighbors. A form of informal credit
221 Chapter 2 _ Monetary and Financial Policy market known as Kye was commonly accessed in Korea as in other countries in Asia and Africa. The Kye can be considered a rotating credit association designed to pool small savings to make large lump sum payout. The Kye is basically based on a lump sum payout of funds collected through installment deposits where the lump sum is distributed based on predetermined sequence or by a lottery. According to a one survey in 1959, it suggested that 90% of samples in Seoul surveyed indicated that they participated in Kye at one time or another. Moreover, a nation wide survey conducted in 1973 showed a participation rate of 65% among national households, which contributed nearly 32% of their monthly average income as Kye installment payment (Cole and Park, 1983).
In 1960, the first credit union (named Holy Family Credit Union) in Korea was established at Busan by members of catholic church based hospitals. The original members of the Holy Family Credit Union totaled 27 and were made of the staffs of the hospitals and of the NCWC (National Catholic Welfare Conference), a catholic relief service. Sister Mary Gabriella, who has been praised as the Mother of Credit Union Movement10) in Korea, introduced the Antigonish Movement in Canada and established a charter11) for a primary credit union borrowed from the United States. After the introduction of the first credit union, other credit unions began to be established based on the same model.
8) In the rural area, poor farmers borrowed foods and other provisions from the relatively richer farmers and repaid the borrowings after the harvest including interest payments. In the late 1950s, in most cases the farmer that would borrow one bag worth of rice would usually end up repaying the borrowings with two bags (Lee Sangho, 2003:Real Courage Lends to Hop), over 100% interest of the principle. Such forms of informal credit market had a negative social impact as the poor farmers would often become more in debt. According to a survey on the informal credit market with high interest conducted in 1958, total debt outstanding for agricultural household amounted to 88.5 billion Hwan, which accounts for 1/6 of total agricultural production, while the average of outstanding debt obtained in the informal credit market was 40,000 Hwan per household 9) As of 1971, the number of pawn shop totaled 940 that provided a total of loans of 386 million won. (Lee: 1972 10) The Antigonish Movement was grassroots movement based on principles of cooperatives and education. This Movement was voluntary and private-initiative to help small fishermen in Nova Scotia, Canada improve their economic and social circumstances. A group of priests and educators, including Father Jimmy Tompkins and Moses Coady among others led this movement by promoting and instilling ideals of voluntarism among leaders of fishing village. Tompkins and Coady discussed and promoted to the villagers the Antigonish Movement which is based on the ideals of self-help through group forums or study club. This eventually led to the creation of the first maritime cooperatives in Canada. The following conversation between Coady and villagers recorded during Coady’s visit to Antigonish in early 1930s highlights ideals of self-help: Coady: How are you doing these days? Villagers: Life is very difficult. We can barely make a living. When weather conditions are bad, we cannot catch any fish. And when the weather is good and can catch fishes, we cannot get a decent price for fishes. Coady: Who do you sell your fish to? Villagers: We sell our fish to a wholesale merchant in Boston, US. Coady: I see. What is the price of fish per kilogram? Villagers: We can only sell our fish at a very low price Coady: Then, do you know the price the merchant at Boston sells the fish to the customers? Villagers: No. How would we know? Coady: Why don’t you check by calling Boston? Villagers: What? We do not even know how to make a call. Could you call for us? Coady: I am not sure as well. This is your problems so you should find a way to solve it by yourself. (Coady then leaves the villagers)
222 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy The introduction of the first credit union in Korea through private and not through the government initiative offers unique example among developing countries. The conventional thinking has been that some form of government intervention is inevitable in developing countries, however, Korea was able to successfully introduce credit unions through a bottom up approach without government support.
Clearly, we can see the significant impact of Korea’s credit union movement. First, Korean poor people were able to have a real deposit account for the first time. Although the amount of saving may have been small, it provided a sense of being part of the greater society, instilling further hope and confidence for better future. Second, the values of cooperatives such as elections based on 1 person/1 vote rule were able to contribute to the initiation of grass root democracy in Korea by emphasizing the importance of education.
Korea’s Credit Union Association (KCUA) was established in 1964. In the early stage, KCUA received the considerable foreign aid from international organizations such as CUNA International, Asia Foundation, US Aid, and so forth (Table 2-4-8). Despite the foreign aid, the Association initiated efforts to become self sufficient as soon as possible by increasing
Table 2-4-8 | Foreign Aassistance to Korea’s Credit Union Association (As of Jan 31, 1972)
Amount of Type of assistance year financial support
Asia Foundation Education/establishment of new credit unions 500,000 won 1965 CUNA Education and training US $2,500 1965
Pusan Diocese Education and training US $3,000 1965 Catholic Church
Education and financial support for operation of LARA US $2,000 1965 the KCUA
AID Education and Training Support 35,000,000 won 1968
Christian Reform 1971 Education and Training Support Mission 1972
UNDP Education and Training Support 1972 Source: 30 year History of Korea’s Credit Union Movement (p. 169)
11) The Holy Family Credit Union was established under the following charter. Mission: (Article 2) Providing members with the way to save in order to encourage the diligence and prudence among members. By doing so, pooling the resources to be able to provide loans at fair interest rates for productive purpose in a way that serves mutual benefits of the credit union members. Membership eligibility (Article 3): Credit unions must be established to serve their own members only. Credit unions can only be established among members that share the common bond including organizations, occupation, and community. One person One vote (Article 24): One person will be allocated only one vote regardless of ownership amount.
223 Chapter 2 _ Monetary and Financial Policy Table 2-4-9 | Fees for KCUA: Charged and Paid for 1968
Number of CUs Total Amount Total Amount Number of CUs Zone to be charged to be charged paid B/A that paid fees for fees (A) (B)
Seoul 17 10 299,680 215,285 75%
Busan 18 9 351,603 190,245 54%
Inchon 15 8 174,294 102,681 59%
North Choongchung 16 12 105,556 67,647 64%
South Choongchung 7 5 22,684 18,020 79%
North Kyungsang 10 6 39,806 25,803 64%
South Kyungsang 19 6 110,242 50,050 46%
Jeju 6 2 29,354 8,500 28%
Namhae 6 1 8,355 1,724 21%
Geoje 8 1 33,829 3,000 4%
Other 8 4 31,585 19,801 63%
Total 130 64 1,206,988 702,756 58%
Source: 30 year History of Korea’s Credit Union Movement (p. 156) membership fee from primary credit unions. From the beginning, KCUA encouraged primary credit unions to collect fees based on one member/one won. Later, the Association charged 30 won per each member of primary credit union during 1967-73.
In the process of enacting Korea’s law on credit cooperatives, the principle of volunteer based, autonomy and self help was also applied. The Holy Family Credit Union established a committee on its own to study and research the legal aspects of the credit cooperative law in other countries. In particular, since 1964 when the Association was established, the discussions on enacting the credit cooperative law were initiated in earnest. The Association demanded the following principles of cooperatives be included in the law (30-year History of Korea’s Credit Union Movement). First, credit unions should be ensured that they are independent, self sustaining and self help based while ensuring the government’s supervision is limited to only necessary requirements and is minimized as much as possible. Second, the registration process and approval by the Minister of Finance for establishment of new credit unions should be minimized due to their small size. Third, membership should be subject to education and training on cooperative movement. In 1972, the Credit Cooperative Law was enacted. This not only legitimized the establishment of credit unions but also established the legal framework such as providing legal recourse for collection of unpaid loans.
224 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy The Saemaul (New Village) Movement was a government led initiative to improve social and economic conditions that started 10 years after the establishment of the first credit union in 1960. Interestingly, the Saemaul movement shared many of the same ideals of the credit union movement such as self help, diligence and cooperation. In the same way as credit union, the Saemaul movement sought to instill a can do spirit that is vital to the socio economic development for the Korean society.
In February 5-6, 1975, Minister of Finance, Kim Young Hwan, visited primary credit unions in Chonju and Taejon areas, gave an address to the members of the credit unions. He stated that “the credit unions not only share the same values and principles that are trying to be actively promoted by the government under the Saemaul movement but can also themselves be instruments of the Saemaul movement.” He added that “the leaders of the credit unions not only believe but also act on the principles of self help, self sustaining, and cooperation. They should be considered as the role models of the Saemaul movement.”
On October 20 in 1977, the leader of the primary credit union, Sohn Kwan Hyung, chairman of the credit union at Inchon Steel Co, presented the success story in the Monthly Economic Trends Report Meeting, which was prepared by Economic Planning Board and chaired by the President Park Chung Hee. Sohn also received a Saemaul medal for his achievement. This implies that the significance and achievements of credit unions were recognized in the same light as in the Saemaul Movement.
5. Current Situation of People’s Credit Funds (PCFs)
PCFs can be organized into two stages: the pilot stage (July 1993-September 2000) and the latter stage when PCFs undergo further improvement, restructuring, and development. During the pilot stage, the number of PCFs reached to 964 in 53 provinces by 2000. However, it was found that many of the PCFs that were operating were largely inefficient and ineffective. In particular, some PCFs were found to be undisciplined and at times irresponsible when making loans. In response, the State Bank of Vietnam initiated efforts to improve the overall operation and management of PCFs. These efforts have been continuing since the end of 2000 to now. The number of ill performed PCFs (39% of total PCFs at the beginning of the stage) decreased to 2.4% of total PCFs in 2004. NPL (Non performing loan) ratio fell from 3.84% in 1998 to 0.50% in 2007, and 0.53% in 2008.
During this period, the 3 tier PCF system consisted of PCFs at the primary (or local grass roots) and regional levels, which were centralized under a main, central PCF (CPCF). Now it has been changed to a two tier system comprised of primary or local PCFs and a main, central PCF. The regional PCFs were converted to branches of the CPCF. Under this system, the CPCF would receive funds from the government, financial institutions, non government organizations
225 Chapter 2 _ Monetary and Financial Policy and international agencies and then, provide loans to the primary PCFs, while at the same time, it would work to strengthen the financial linkages among PCFs and to guarantee the payment ability of PCFs with financial difficulties.
In late 2005, the Vietnam Association of PCFs (VACPF) was founded and was given several objectives including establishing organizational linkages among the PCFs, protecting the rights and interests of its members, making policy decisions, and ensuring a sound and effective PCF system. Most of the PCFs have joined the Association as of now. Over the past years, the Association has worked with the Banking Academy of Vietnam to provide training for staffs of PCFs. The VACPF has been expanding a pilot program designed to establish a System Safeguard Fund as a way to build up capital reserves to support the primary PCFs when not able to make payments. The VACPF has also been promoting a project on establishing an independent auditing unit which will oversee the operating soundness of primary PCFs as well as the overall system of PCFs. It will also have management of the System Safeguard Fund according to the regulation of the Association.
The members of PCFs in Vietnam consist of three types including: micro enterprises (household enterprises), medium households, and non poor households which are near the poverty line.
5.1. Achievements of PCFs so far
After 15 years of development, the PCFs system has made the following achievements. First, through the pilot on establishing, consolidating and reorganizing PCFs, PCF model that has been selected is suitable for Vietnam’s rural agriculture features. Primary PCFs have completed reorganization and consolidation following guidance by the government and State Bank of Vietnam to meet requirement of improvement.
The management and supervision board has been strengthened by improving working capacity. The cooperation among PCF members also has been consolidated. Operation of PCFs system helps to create jobs, to increase member’s income, and to limit illegally high interest rate in rural areas. In 2008, total number of members recorded was 1.35 million, where 99.9% of total loans went to the members. Figures 2-4-9, 2-4-10 and 2-4-11 illustrate the growth of PCFs system and its contribution in Vietnam’s socio economic development since their establishment.
Up to now, CPCF has grown up remarkably. In 1995, total capital was only 121 billion VND. Also, charter capital was 103 billion VND and, mobilized capital was 11 billion VND, while outstanding loans, which were mainly loans inside the system, was 64 billion VND. But in December 2008, total capital was 6,140 billion VND, which is 51 times higher than that in 1995. Charter capital was 612 billion VND and mobilized capital was 3,985 billion VND, accounting for 74.9% total capital. Borrowings from domestic and international finance
226 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy organizations was 1,101 billion VND. Further, outstanding loans inside and outside the system was 5,066 billion VND (increased 79 times). Loans inside the system was 2,238 billion VND, which accounted for 44.2% total outstanding loans; while non performing loan was 154.843 million VND, accounted for 3.1% of total outstanding loans. Total non performing loans both inside and outside the system was 10 billion VND, accounted for 0.4% outstanding loans.
Since 1998, CPCF has provided billions to regional PCFs in order to overcome difficulties. Then, since 2001, CPCF has been coordinating with the Deposit Insurance Fund to provide a
Figure 2-4-9 | Number of Grassroot PCFs and Members, 1994-2008
Figure 2-4-10 | Total Assets, Loans, Deposits, Borrowings and Equity of PCFs, 1994-2008
227 Chapter 2 _ Monetary and Financial Policy Figure 2-4-11 | Total Assets, Loans, Deposits, Borrowings and Equity of CCF, 1995-2008
guarantee for depositors. In 2008, almost all small scale banks and PCFs faced liquidity difficulties. As PCFs were able to inject capital in grassroots PCFs throughout the whole system, no PCF fell into repayment difficulties and were able to maintain their operations.
CPCF has provided consulting and training services, as well as computer software for PCFs. PCFs also received advise on management of credit risks, capital risks, and liquidity risks. At the same time, it also coordinated with VAPCF to organize training courses to improve management capacity for managements and staffs of PCFs membership.
Second, the PCF system has significantly contributed to social economic development of the country. PCFs have contributed to creating new jobs for farmers, and to reducing poverty by mobilizing savings and providing loans to its members to promote agricultural production and career development. PCFs have also contributed to establish new production relations in rural areas and to helping revive confidence in a collective economy in general and PCFs system in particular.
Although interest rates on loans provided by PCFs are relatively high, it is attractive enough to support farmers in financing agricultural production in general. Loans provided by PCFs remain limited but are helpful in supporting farming households start their own business, maintain a stable living standard and alleviate poverty. For instance, Mr. Nguyen Hai Binh living in the coastal commune of Hai Binh, Gia Tinh district, Thanh Hoa province, who had no land, is now an owner of a seafood company that provides products to domestic and Chinese markets with an annual turnover of 5 billion VND and over 100 employees thanks to a loan of 300,000 VND from PCF which was used to fund equipment nearly 10 years ago. Also, Mrs. Phan Thi Luong living in Tuan Chau commune, Vinh Tuong district, Vinh Phuc province has been able to overcome difficulty and poverty and now is owner of a fishery farm with annual
228 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy turnover of billions VND and thousands of employees thanks to a loan of 10 million VND from PCF.
The PCFs system has developed adequate human resources to a standard that allows for improvement and resilient development. In general, staffs of PCFs have been well trained, being initially provided with management and technical skills. Therefore, they have significantly contributed to enhancement of law compliance and awareness in their organization and improvement in the quality of PCFs’ operation.
5.2. The Existing Shortcomings
The main objective of establishing PCFs is to support members to work together in a cooperative way so that they are able to develop their own businesses and improve their living standards. However, some PCFs have not operated with this objective in mind, especially the PCFs established in urban areas. These PCFs seem to be driven purely by business motives and have for the most ignored the importance of the credit evaluation process. Therefore, there still may be hidden risks in their activities which may affect the system’s security overall.
The administration, management and internal control are sometimes found to be unsound and weak in some of the PCFs. Process of managing and executing has not been conducted in strict compliance of related regulations but instead has been managed loosely and more similar to a family managed style. The controlling boards of several PCFs have not provided effective oversight to ensure the safety of the funds as outlined in the regulations.12)
A linkage connecting the system of PCFs has been established but it has not been integrated, which has resulted in a lack of support of local grass root PCFs. There have not been improvements in regulations on organizational linkage, particularly in the areas of information, internal controls and safety and soundness. Adequate consultation, advice and support to its members have not been provided by the Association of PCFs. It has also not created a reserve fund as a safety measure to support its members when needed.
12) The chairman and the other members of the board of directors, the head and the other members of the supervision board, and director of the grassroot PCFs needs to be approved by the Governor of the State Bank or by the person authorized the Governor before being appointed in order to examine whether the above titles’ levels meet the professional standards regulated by the SBV. For grassroot PCFs, members of the board of directors must have at least one year of working experience in the sectors such as economics, finance, banking or completed a training professional course on PCF. As for the chairmen of the board of directors, they still have at least one year of working experience in the sectors such as economics, finance, banking and used to be manager for at least one year in a organization that belongs one of the sectors such as banking, finance or instate organizations, economic organizations, political organizations, social political organizations and completed a training professional course on PCF. The chairman and the other members of the board of director, andthe head and the other members of the supervision board shall be elected directly and democratically among the PCF members by general meeting for a minimum two year term and maximum five year term in principle of one person one vote
229 Chapter 2 _ Monetary and Financial Policy 6. Learning from the Past: The Relationship between Cooperatives and the Government13)
Experiences in many countries have shown that it usually is a mistake to use cooperatives as instruments for the implementation of government policy, rather than allowing them to operate as voluntary self help organizations of their members. Cuevas and Fischer (2006) pointed that when CFIs are created as a mechanism for distribution of subsidized government credit as was common, for example, in Latin America throughout the 1960 70, “borrower bias” can occur, leading to high loan failure rates due to the imprudent credit risk management (Cuevas and Fischer (2006)). In particular, after the disintegration of the former Soviet Union, many socialist state controlled cooperatives in the form of forced collectives in Central and Eastern Europe and Asia ceased to exist in the process of transformation of socialist regime, as was the case in Vietnam in the late 1980s.
Cooperatives can play an integral part of a country’s developmental policy. Münkner (1999) describes cooperatives as a method of “organized self help,” collective individuals working together towards a common. However, it is important to understand that cooperatives are a means to an end, and not the end itself. To see how cooperatives can contribute to the economic and social development, it is important to understand the basic concept behind cooperatives and the underlying values and principles, the role of the government in promoting cooperatives, and the capabilities and limitations of cooperatives. In doing so, many of the commonly known misconceptions or wrong assumptions of cooperatives borne out of numerous accounts of failures and negative results from empirical studies can be clarified.
Organized Self Help
Cooperatives are often assumed to be direct instruments for economic development, poverty alleviation, or channeling external aid. Furthermore, the government is assumed to play a direct role in creating and managing cooperatives as well as being their beneficiaries. But in fact, as discussed by Münkner (1999), the basic concept of a cooperative is that it is a method of organized self help; in other words, helping others to help themselves through cooperation. It is a collective effort, initiated by individuals themselves bound by common interests, and based on cooperative values of helping others help themselves. It is a method of pooling members’ resources, and the sharing of risk and burden in a disciplined, organized, and coordinated manner. However, for cooperation to work, the members of the cooperative must operate under a system of shared beliefs, values and principles, which must be instilled over time by way of
13) This section is heavily drawn from Hans-H. Munkner (1999), “Rediscovery of Cooperatives in Development Policy” presented at the ICA/ROAP Sub-Regional Workshop on Co-operative Policy Reforms, Kathmandu, 13-16 January 1999, Reprint from COOP Dialogue, An ICA ROAP Journal, Vol. 10, N° 1, January 2000, pp. 8- 13.
230 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy teaching and doing. The values that underlie cooperation such as accountability, sharing of burden, equity, social equality, mutual respect of one another, and voluntarism, often differ from local traditional norms and value systems. As such, these beliefs, values and principles that form the basis of cooperation must be embedded in the culture of the cooperatives which can only be taught through a process of learning and applying the principles of cooperation. Münkner (1999) outlines the principles of helping others help themselves through cooperation.
Principles of Self Help Cooperatives:
•Recognizing common needs and problems •Promoting the values, principles and practices of cooperatives •Fostering cooperation through learning to work together so that individuals and the group can benefit.
Developing Sustainable Cooperatives, and the Role of the Government
For a cooperative society to succeed but more importantly be self sustaining, it must be as Münkner (1999) describes, private, independent and autonomous self help organizations. Though recent failures of government sponsored cooperatives have resulted in misgivings about the role of the government in the development of cooperatives, empirical evidence suggests that cooperatives are often initiated and enhanced by external supporters. As such, Münkner (1999) frames the question of government sponsorship by asking not if but how the government should promote the development of cooperatives. In answering this, Münkner (1999) concludes that the initiation and formation of cooperatives should be left to the individuals themselves who are seeking to help themselves by self help organizations. He also notes that cooperation in one form or another is part of human nature and exists in every society. The government should not be obligated to initiate cooperatives, since individuals by themselves will seek out and form cooperatives if found to be mutually beneficial. Support of cooperatives should only goes as far as helping others help themselves by providing access to knowledge, resources and capital, until it is self sustaining. Furthermore, it is now more commonly accepted that private sector specialist organizations rather than government officials are best positioned to promote and advise in the development of cooperatives. The government should take an active role in supporting the development of cooperatives by fostering an environment for cooperative development but leaving the role of supervision and oversight of cooperatives to the members themselves. Münkner (1999) outlines several ways to promote the development of cooperative self help organizations.
Promoting the Development of Cooperative Self Help Organizations:
•Creating an environment that fosters cooperative work •Ensuring the freedom of association and the right to exercise any legal economic activity
231 Chapter 2 _ Monetary and Financial Policy in groups •Preventing misuse of cooperatives •Enacting laws that give autonomy to cooperatives to align its by laws with the needs and objectives of its members •Ensuring equal opportunity with other business organizations •Protecting cooperatives against unfair competition •Creating a tax regime in consideration of cooperatives.
Understanding the Capabilities and Limits of Cooperatives
Cooperative societies can play a vital role in the economic and social development of developing countries, particularly for the relatively poor. Because of the grass roots nature of cooperative self help organizations (SHO), they are well positioned to reach the relatively poor who need help and to establish the building blocks for more sustainable economic and social development. Cooperative SHOs can work to pool the resources of small economic actors through collective effort, enabling them to rise above poverty. From their small poor grass roots, cooperative SHOs can grow to reach great prominence by building up over a period time networks made of cooperatives following the principle of cooperation. However, as Münkner (1999) points out that it is important to understand the capabilities and limits of cooperatives and to use anti poverty programs for laying the groundwork for self organized cooperation mainly through development of human resources, education, and fostering of environments favorable for cooperative SHOs. Cooperatives can only help those who are not only willing to help themselves but also have the resources and capabilities to participate and benefit from organized self-help. Individuals in absolute poverty are usually confronted by economic challenges that are far beyond the capabilities of cooperatives. Those below the poverty line lack the resources and means to form a cooperative. Furthermore, cooperatives should not be used as a conduit to fight poverty or combined as part of an anti-poverty program. Otherwise, experience show the negative consequences that often result including the weakening of the principles that promote organized self-help, and encouraging dependence on external aid. In worst cases, cooperatives have been used as vehicles to attract external aid for self-serving purposes.
232 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy [Appendix] Concepts and Misconceptions regarding Cooperative Development
Concepts Common Misconceptions
Cooperative societies are self-help Cooperative societies are direct instruments of 1 organizations: Working together to help others economic aid or development. to help themselves.
Development of cooperatives must be Cooperatives take into account the interest of 2 encouraged by incentives and privileges such as the member and the group as a whole subsidies and tax exemptions
Cooperation means to commit, pool and share a Cooperatives can be promoted by transfer of 3 members’own resources external resources
Development of cooperatives starts with Development of cooperatives begins by establishing an enterprises which may be mobilizing people and forming a cooperative 4 initially promoted by external contributions both group. Management of the cooperative is from in terms of money and management until such the outset the responsibility of the members time when members can take over
Membership should be voluntary based on self- Membership is compulsory or is driven by due interest, individual needs, and real benefits to 5 lack of alternatives or to qualify for development being a member. Membership must be aid. meaningful and worthwhile.
Cooperative development is a slow learning Cooperative development can be planned and 6 process, a way of learning by doing at your own timed. pace.
Member commitment is based on social Maintaining membership is easy with little or no 7 responsibility, sense of ownership and commitment, and being a passive stakeholder. accountability, and risk and burden sharing.
Cooperative capital is built up over time, Cooperatives have to be funded initially by 8 controlled and managed by the members. external sources.
In cooperatives, capital is deprived of its usual External capital can be injected and‘ investor- attributes of power (with regard to voting and members’can be invited to join, and yet, 9 profit distribution). Under such conditions only member-user dominance can be maintained members-users will provide capital. and investor power can be restricted.
Members in general meeting are the supreme Members are unaware, and unable to organize 10 authority and operate an effective cooperative enterprise.
Members’capabilities and skills are developed Substituting members’lack of capabilities and 11 through life-long education and training. skills with outside sources.
Cooperatives must promote active and 12 Passive participation by members is accepted. meaningful participation by members.
Leadership of cooperative is elected from among the members and trained for their tasks Recruiting outsiders to manage the cooperative 13 based on their ability and trust of members, to enterprise. lead and to manage the cooperative.
233 Chapter 2 _ Monetary and Financial Policy Concepts Common Misconceptions
Leaders, usually outsiders, focus on business Interests of leaders and managers of success, market share, growth, job security, 14 cooperatives must be aligned with interests of national development goals (institutional the members. efficiency and development-oriented effectiveness)
Cooperatives must be under external control, Cooperatives must be under member control, 15 inspection and supervision, especially where and must undergo an external audit. external funds are involved.
Surplus can be extracted by price control and Surplus earned in the cooperative enterprise state monopolies and used to finance public belongs to the members who decide if the tasks and institutions. Cooperatives can be kept 16 surplus should be invested, put in reserves or away from lucrative business (e.g. import, paid out as dividends to members. export, processing) and left to do provincial work.
Role of promoters should be to encourage Promoters and external aid are substitutes for self-help at the initial stage, to discover new lack of self-help, to help the poor who are 17 ways of putting locally available resources unable to help themselves or to implement to productive use, and to act as external development schemes. ‘development entrepreneurs’.
Anyone with training in operating and managing Promoters need to have deep knowledge of any enterprise or business can promote self- cooperative values, principles and practices, of 18 help cooperatives. There is no need for the mechanics of organized self-help and of specialists with deep understanding of local forms of mutual assistance. cooperatives.
Poverty is mainly due to lack of ability to cope with rapid change, lack of knowledge in pooling Poverty is mainly due to lack of resources. 19 resources and supply and demand, and lack of Hence, transfer of resources will alleviate access to information, technologies, goods, poverty. services and markets.
Source: Hans H, Münner (1999), “Rediscovery of Cooperatives in Development Policy”
234 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy References
Carlos Cuevas and Klaus Fischer (2006), “Financial Institutions: Issues in Governance, Regulation, and Supervision,” World Bank Working Paper No. 82, the World Bank
David Cole and Yung Chul Park (1983), “Financial Development in Korea, 1945-78,” Studies in Modernization of the Republic of Korea, 1945-75, Cambridge, MA: Council on East Asian Studies, Harvard University
European Association of Co operative Banks (2007), “60 Million Members in Co operative Banks: What does it mean”
Son Nghiem Hong and James Laurenceson (2005), The nature of NGO microfianace in Vietnam and stakeholders’ perceptions of effectiveness East Asia Economic Research Group Discussion Paper No. 3
Sangho Lee (2003), Real Courage Lends to Hope
Robert Lensink, Nguyen Van Ngan and Le Khuong Ninh (2008), Determinants of Farming Household’s Access to Formal Credit in the Mekong Delta Vietnam
Hans H. Münkner (1999), “Rediscovery of Cooperatives in Development Policy” presented at the ICA/ROAP Sub Regional Workshop on Co operative Policy Reforms, Kathmandu, 13- 16 January 1999, Reprint from COOP Dialogue, An ICA ROAP Journal, Vol. 10, Nû 1, January 2000, pp. 8-13.
Cuong H. Nguyen (2007), Determinants of Credit Participation and Its Impact on Household Consumption: Evidence from rural Vietnam.
Cuong Viet Nguyen (2008), World Bank Report to the Vietnam
Dai Lai Nguyen, Comments on the history of agriculture rural farm credit and the commission of the Vietnam Bank for Agriculture and Rural Development
Ngoc Son Nguyen and Tran Thi Thanh Tu (2009), Financing Vietnam’s Growth Domestic and Foreign Sources of Development, Publishing House of Social Labour
Xuan Hung Nguyen: PCF System after 15 years of development, Bank Journal, No. 13/2009.
235 Chapter 2 _ Monetary and Financial Policy The Cooperative Credit Department of the State Bank’s Report on operation and consolidation, reorganization situation of PCF’ System.
The State Bank’s Report No. 9643 /NHNN TD dated 29/10/2008 on 2003 Cooperative Law Implementation.
The State Bank’s Document No. 6036 /NHNN TDHT dated 05/6/2007 on Strategy of the PCF System’s Development for period 2006-2020.
The Bank Journal, No. 12/2007.
Information from the Vietnam State Bank website www.sbv.gov.vn (01/10/2009): The Phan Van Khai Prime Minister’s Speech at the preliminary Conference of the Politburo Instruction No. 57 Implementation: “To come to a improved model for safeguard and efficient operation”.
Information from the Vietnam PCF’s website www.hiephoiqtdnd.org.vn (31/9/2009): the Speech of the Central PCF at the third Vietnam Cooperative Union’s Congress: “Some Operation Results of the PCF System and the Role of the Central PCF in supporting Grassroot PCFs for consolidation, improvement and sustainable development”.
Vietnam microfinance report, the Bank for the Poor Network publishing with the cooperation of SEEP Network July 2008
The State Securities Commission, annual report 2008
The State Bank of Vietnam, annual report 1997 2008
Microfinance Assessment Report in Vietnam, the Bank for the Poor Network, 2008
VLSS 1992/1993, VLSS 1998/1999 and VHLSS 2006
236 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy Chapter 03
Industrial Technology Development Policy
1_ Executive Summary 2_ A Guideline of S&T Foresight for Vietnamese Industrial Technology Policy: An Exercise of Technology Roadmapping 3_ Strengthening the Incentives for R&D and Technology Transfer 4_ Promoting the Relationship of Industry University Research Institutes and Innovation Cluster Chapter 01
Executive Summary
1. The Current Status of the Vietnamese Innovation System
Vietnam has built its own version of science and technology system. Under the framework of a socialist planned economy, the old system had been managed by the government's plans. Since the 1980's the old system has been experiencing a big transformation. This transition toward a market economy necessitates more active and autonomous role of research institutions and business enterprises. A system of S&T personnel and institutions to carry out R&D activities has been established over several decades, and the Vietnamese government has introduced several measures and policies to facilitate the transformation.
Vietnam is facing some weaknesses. Infrastructures for industrial production in general and R&D and innovation activities in particular have been continuously improved, but there lies ahead a long way to go to attain the level comparable to that of the peer countries. Even though it has a large number of S&T personnel who are being employed at the national/governmental R&D centers these human resources are not fully utilized. High-caliber researchers tend to move for higher wages at business enterprises but national centers are not able to fill out the vacancies. This results in the deterioration of research quality in national R&D centers, aging of research personnel, and the imbalance problem between locations. The imbalance problem has several aspects. Although there is a network of S&T organizations in place, there is still a strong imbalance of organizations in terms of North-South and between large cities and other locations. Moreover, there is a lack of effective linkage among them. Many research centers still
238 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy remain at a low profile in terms of the linkage with firms, and are not so active in responding to the demand as expected; for example, many are passive in setting research agenda. The function of S&T service institutions and education and training institutions are insufficient.
2. S&T Foresight Exercise as Learning Mechanism and Policy Tool
Recently the Vietnamese economy has shown a rapid economic growth. Fast industrialization of the Vietnamese economy requires increased technology capability and more effective acquisition of foreign advanced technology. Exercising a technology foresight activity is one way to give directions for more effective ITD policies. In Vietnam, it seems that the capacity building for technology foresight is urgent in the public S&T system, like in other developing countries. In addition, R&D investment of the government sector is very low, despite the country has a sizable R&D manpower including universities and research institutes. This is perhaps the main reason why Vietnam has difficulties in practicing S&T foresight. Vietnam as a late comer should pay a greater attention to S&T foresight to speed catch-up. It is because more science and technology resources can be mobilized and deployed more effectively through S&T foresight.
The Vietnamese government can build up the capacity of S&T foresight by practicing S&T foresight. S&T development can be pursued by the domestic S&T experts living within the national border. It is important to mobilize them throughout the innovation cycle, from the technological forecast to implementation of technology. This could be best achieved by exercising S&T foresight.
Korean experience in technology foresights would give a lesson to Vietnam. Korea's R&D investment has rapidly increased since the mid 1990s, during which S&T foresight has been successfully introduced and greatly supported by the public. Since then, the rational R&D planning at the national level became increasingly important, and it was backed by S&T foresight in a systemic way. The foresight exercise in Korea offered a great deal of learning effect not only for scientists and technologists who were engaged in the activity but also for the policy makers. Technology foresight exercises enabled them to take a more systematic, long- term approach in policy planning.
3. Strengthening the Incentives for R&D and Technology Transfer
As an economy develops toward an advanced level, technological competence becomes a
239 Chapter 3 _ Industrial Technology Development Policy critical factor. To build up competence, it is required to nurture high-caliber scientists and engineers who are capable of dealing with developments at scientific and technological frontiers. In other words, advanced education in science and technology should come first in preparing to enter a developed world. The potential for catch-up growth can be utilized more effectively with the continued efforts to learn and indigenize foreign technologies, despite some variations in technology transfer channels.
As the comparative reviews of R&D policies in Korea and Vietnam show, the basic framework of R&D policies are already set in Vietnam. The next challenge is how to make the policies and measures effective. The policies need be matched with the needs of firms and the supply side should be flexible enough to respond to the demand side. Basically, Vietnam needs to make a comprehensive review of policy landscape and environment. The review also includes the current mechanism of policy coordination.
When competition pressure intensifies, business enterprises respond to the incentive schemes more actively. Protectionist policy may be effective in creating initial market opportunities for domestic industries, but if such a policy is prolonged, industries will develop immunity against market pressure for innovation. It may be for this reason that export-oriented firms achieved technological learning more rapidly than import-substituting firms. As for the firms in Vietnam, the capability of self-adjustment and response to change of the majority of firms (especially small and medium-sized enterprises) is weak, partly because of the lack of market-based incentive schemes. In order for the market mechanism to function as a means to foster technology transfer, ownership and property issues are to be clearly delineated.
Long years of gestation and commercialization efforts are needed to draw economically valuable outcomes from R&D investment, especially from that of the government. Government tend to sacrifice R&D investment for the sake of more immediate projects. In these respects, it is very important for the government to make a long-term, consistent and continued effort to allocate resources in R&D areas. As we pointed out as one of the key weaknesses of Vietnam's R&D system, infrastructures for industrial production in general, and R&D and innovation activities in particular, has improved over the recent years, but there lies ahead a long way to go to attain the level comparable to that of the peer countries. Vietnam should continue upgrading infrastructure and facilities to induce innovative activities in both business and public sectors.
4. Promoting the Relationship of Industry-University- Research Institute and Innovation Cluster
There are inconsistencies in the area of IUR linkage. The government has long been strongly engaged in R&D activities, but there is no effective market mechanism on the game of these three actors. Further, there is a strong“ state”bias in the distribution of R&D fund. Another
240 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy issue is that R&D industry is too small compared to those of university and research institute. These issues are also combined with ineffective IUR relationship where the collaboration and technology knowledge transfer are at a minimum level. And we focused on two innovation clusters in Vietnam; Hoa Lac High-Tech Park (HLHTP) and Saigon High-Tech Park (SGHTP). They are attracting a lot of attention from foreign companies but there is a long way to go to develop the whole infrastructure and function as the technology and innovation hub of Vietnam.
With the evaluation of Vietnamese national innovation system, S&T policies and innovation clusters, some suggestions are made for the Vietnam's science and technology policy. First, S&T and innovation policy should include not only the conventional areas of science and technologies but also those of process-related, non technological and“ soft”technologies - which start from R&D to technology transfer and end in technology commercialization. Second, the S&T policies should address the structures and roles of R&D actors in the national innovation system. In particular, Vietnam needs to strengthen the technological capabilities of private industries which are relatively underdeveloped compared to public universities and research institutes. Third, the increase of R&D budget and the willingness of the Vietnamese government are critical for Vietnam to leapfrog to become a technologically advanced nation.
For the effective IUR relationship and the development of innovation clusters, it is necessary to locate the innovation actors as close as possible and make them work together by providing collaborative R&D projects and other innovation activities. There has to be a coordinator, who knows industry, university and research institute and the Technology Business Incubation (TBI) program. TBI is a good means for linking IUR with the market. TBI can link the innovation players and would work as the big coordinator among IUR by providing them with information and business opportunities.
241 Chapter 3 _ Industrial Technology Development Policy Chapter 02 A Guideline of S&T Foresight for Vietnamese Industrial Technology Policy: An Exercise of Technology Roadmapping
Taeyoung Shin (Senior Fellow / STEPI) Nguyen Viet Hoa (Vice Director / Department of Strategy and Forien Studies, NISTPASS)
1. Introduction
The latest change in the economic paradigm is in the broad sense being driven by knowledge. This mainly includes technological advances in physical capital and learning capabilities embodied in human capital. Economic growth and additional job creation are thus built on a foundation of technological progress and human resources development. By the nature of the knowledge based economy, it is expected that a country with greater accumulation of knowledge will be better off, gaining the competing edge. Therefore, the gap of economic performance would widen between the developing and developed countries. This holds valid for workers within an economy.
On the other hand, the technological factors draw a keen interest in the international trade; such as government subsidization of industrial R&D, intellectual property rights, the use of fossil fuels, and nuclear energy, etc. Such trend implies that technology is already taken into account as a resource like other production resources that countries are endowed with. It also envisages that technology is not freely transferable from one country to another.
S&T activities are basically knowledge creating activities. The knowledge here includes knowledge about the facts, scientific knowledge about the principles and laws of nature, tacit knowledge, and information about who knows what and who knows how to do what. However, producing, using and distributing such knowledge are highly costly. Therefore, S&T investment, which is increasingly increased as the R&D scale is being sizably increased,
242 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy involves risks and uncertainties to a high degree. Correct decision making on it is more important. This is why the technology foresight has recently drawn a good deal of attention. The foresight activity in a rational way is increasingly emphasized for policy making and decision of investment at the private and public dimensions.
To cope with such economic and S&T environment, the rational approach to science and technology is necessary with increased R&D investment. Recently, a serious skepticism about rational planning methods has increased due to big discrepancies between real outcome and the impact of formulated plan. Reasons for failure are that planners often have greater concerns on the technology itself, and overlook economic consideration and ignore societal and market reactions, etc. Another reason for the disappointing results in science and technology planning has to do with discontinuity in scientific and technological progress, due to the fact that discoveries and inventions take place more by accident when one is looking for something else, than by well scheduled research programs.
In general, foresight is undertaken to gain better understanding of the future environment and consequently of the nature and magnitude of the changes needed. Thus anticipation enables the decision maker to move into the future in a purposeful fashion in contrast to belated reaction to critical events. Since science and technology is responsible for many of the most important changes in our society, foresight has to be very extensive if some important indication is not to be missed. It must include a wide range of social, economic, environmental and political as well as technological factors. When it is realized that each factor is associated with a high degree of uncertainty, the forecasting might seem impossible. Nonetheless, the decision maker cannot avoid making decisions which will be proved good or bad by future events. He must take a view of the future. If foresight can enable the decision maker to obtain a more accurate picture of the future and in consequence improve his decision making, the effort devoted to it is justified. This only justifies why to forecast.
Recently, the Vietnamese economy has been growing dynamically, showing 7~8% of the annual growth rate. Fast industrialization of the Vietnamese economy requires increased technology capability and more effective acquisition of foreign advanced technology. In doing so, domestic R&D investment has to be increased substantially. To promote R&D investment, the technology foresight activity in a systemic way is one of the critical factors. However, it seems that the rational approach to science and technology of the Vietnamese government is somewhat placed at the lower priority over other economic policies.
On the other hand, Korea has carried out foresight exercises for the last two decades, due to which Korea has been able to increase its R&D investment and technology capability. This made it easier for the transition of the Korean economy to enter the Knowledge economy.1) Since Korea has undertaken technology foresight for the last two decades at various levels, it would be helpful for the future Vietnamese TF to introduce the Korean exercises as one of the best practices.
243 Chapter 3 _ Industrial Technology Development Policy The foresight activity is highly expensive. This is due to a number of factors: mainly due to abundance and hence overload of information from which it is difficult to identify future issues with relevancy, and due to inclusion of a number of experts, if it is carried out in an extensive scale. If any country wants to find out the path of technological advances for various S&T areas and topics through a relevant method of technology foresight, she could hardly have all resources for such an exercise.
Thus, the purpose of this study is to provide a guideline for the technology foresight to harness Vietnamese exercise in technology foresight, after reviewing technology foresight and S&T policy making in Vietnam, and also introducing some of the Korean exercises for the technology foresight, such as Korean Delphi, national technology roadmaps, and others.
This study is organized as follows. In Chapter 2, the study reviews with an assistance of Vietnamese local consultant the Vietnamese technology foresight activities and S&T policy making. In fact, it was found that a formal technology foresight activity is hardly practiced in Vietnam. However, it is noted that there has been a strong emphasis on science and technology by the central government despite the low R&D investment level. Chapter 3 briefly discusses the theoretical backgrounds of technology foresight; defining concepts and relevant terminologies. Chapter 4 introduces major exercise of Korean TF including Korean Delphi and National Technology Roadmaps (NTRM). Chapter 5 summarizes the procedure of technology foresight for the future exercise in Vietnam.
2. Technology Foresight and S&T Policy Making in Vietnam 2.1. Major Government Policy for S&T Development
Vietnam S&T development strategy by 2010 (Decision No 272/2003/Q-TTg dated December 31, 2003 by the Prime Minister) includes; ¥ The purpose of“ S&T development strategy by 2010”is to focus on establishing our S&T foundation towards modern and integrated directions, striving to reach the average advanced level in the region by 2010. In doing so, S&T will become a backbone for speeding up the industrialization and modernization for the country.
The S&T development strategy has the following key tasks: ¥ Strong and motivated S&T managed by appropriate mechanisms; ¥ Strengthening international S&T integration;
1) Simply speaking, more than 80 percent of accumulation of R&D investment since early 1960s has been made after mid 1990s, in which technology foresight and rational planning efforts were made.
244 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy ¥ Contributing as a decisive actor in improving growth and competitiveness of the economy; ¥ Assisting to effectively accomplish the objectives of the Socio Economic Development Strategy from 2001~2010, which was approved by the National Assembly Congress IX.
Key S&T Tasks from 2006~2010 ¥ Direction: - Strengthening R&D capacities of domestic technologies, - Mastering modern technologies, - Increasing the competitiveness and speeds of key products, - Improving the quality of growth for enterprises and the whole economy. ¥ Objectives: - Improving the country’s S&T potentials to reach the average advanced regional level by 2010. - Increasing the S&T volume in trademarked products from Vietnam, creating basic changes in productivity, quality, and efficiency in important economic branches. ¥ Key S&T areas: - ICT; Biology technology; Advanced material technology; Automation, mechanics and machinery technology; Technology in the energy field; Preserving and processing technology of agricultural products and foods; and cosmology technology
Strategic Areas of S&T for 2011~2020 (Draft working of the Viet Nam S&T Strategy for 2011~2020) focuses: ¥ Establish a scientific base for the doctrine of Vietnam’s socio economic development in the orientation of sustainability and international integration; ¥ Play a decisive part in raising quality of economic growth and competitiveness of national economy; ¥ Build and develop the S&T capacity up to the high level of the region.
Some Key S&T development tasks until 2020 are to build and develop a science and technology foundation capable of ensuring scientific tenets for making doctrine and policy towards sustainable socio economic development in Vietnam ¥ Give priority to the research on social development doctrines and socio economic development models; ¥ Recommend scientific doctrines for Vietnam’s social development; ¥ Focus on research of anthropological and ethnological issues; ¥ Improve research on issues relating to futurology and sociology; ¥ Build and develop a science and technology foundation that will strengthen Vietnam’s human and natural resources, and culture; ¥ Focus on research of scientific aspects of globalization and regionalization process within political, national defense, security, economic, cultural, social, environmental, and S&T domains in a way so that it ensures the development of Vietnam on international integration;
245 Chapter 3 _ Industrial Technology Development Policy ¥ Focus on research and making basic surveys on Vietnam’s data about natural resources and conditions, and the ecological environment; ¥ Give priority to research on socio economic management so it ensures a successful administrative reform and the issuance of a social policy system that reflects the world’s modern trend and Vietnam’s characteristics; ¥ Give priority to Vietnam’s studies focusing on history, people, culture, and community factors such as village and commune, religion; ¥ Give priority to harnessing the natural resources, economic infrastructure, information and energy development, effective prevention and mitigation of natural disasters; ¥ Step up the study on basic research orientations for scientific development strategy; select and adapt to imported technologies that would drive economic development; contribute to the training of staff and S&T of human resources; ¥ Step up the research on important S&T factors in order to ensure the long term community based health and food security of the country; ¥ Give priority to the research of social development doctrines and socio economic development models; build and develop a science and technology foundation capable of integrating the international scientific and the technological community contributing to the increase of the awareness and training a basic and long term human resource for Vietnam; ¥ Give priority to the professional and management training and re training at the international level for S&T personnel; ¥ Increase the investment in the development of S&T potential up to the rate of 2% of the GDP by 2020 in order to ensure the modernization of infrastructure facilities for research and development activities until the S&T information system reaches the advanced level in the region; ¥ Step up the research on basic science in the system of universities and special research institutes; ¥ Build a system of S&T development to support funds, form a network of diverse S&T consulting, and transfer organizations to meet the demands of enterprises (particularly small and medium ones and those located in rural areas); ¥ To give priority to the research of social development doctrines and socio economic development models.
High Tech Laws (law no.21/2008/hq12) ¥ Purpose of state policies for high tech activities - Mobilize investment resources, apply the same set of mechanisms and incentives; - Speed up the application, research, and create own high tech, high tech products; - Concentrate investment on the development of high tech manpower in the level of regional and international mechanisms; - Encourage business capacity in building high tech applications and investing in developing high technology; - For the state budget and financial mechanisms to perform specific tasks, programs and projects.
246 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy 2.2. R&D Budget
In order to timely execute solutions to control inflation, stabilize macro economics, ensure social security and sustainable development, the government has focused on guiding ministries, central agencies and localities to implement the 2008 expenditure management as planned by the national assembly. At the same time, the government executed the policy on lowering spending, examining and downsizing the capital expenditures in non urgent projects, giving way for essential and urgent projects that can be completed and put into use in 2008; to save 10% of current expenditures; utilize the contingencies and excessive revenues to ensure social security policies for the poor, the ethnic, and the low income to overcome the difficulties due to inflation.
Total expenditure of the government was 399,402 billion Dongs in 2007. Out of the total budget, the expenditure on science and technology was 612 billion Dongs, only 0.15%. The state budgetary appropriations for S&T activities constituted only 0.2~0.3% of GDP. The trend of the expenditure on science and technology is fairly stable, in contrast with the rapid increase in the total budget. As far as the budget is concerned, it shows that science and technology is not quite emphasized by the central government.
Whereas, specific objectives of renovating the S&T management mechanism is to achieve the ratio of 50/50 between the investment in S&T allocated from the state budget and non state capital sources to diversify investment sources for S&T activities; basically renovating the financial mechanism to create favorable conditions for organizations and individuals working in S&T field.
The investment in S&T development is limited. The investment in developing long term S&T potentials has not been paid proper attention. It has focused on key and prioritized fields, leading to the backward S&T infrastructure and low efficiency. S&T leaders claim that there is a lack of agenda on training high level professional staff in prioritized S&T fields such as “General engineers in charge”.
247 Chapter 3 _ Industrial Technology Development Policy Table 3-2-1 | State Budget Expenditure Final Accounts Bill. Dongs
2000 2001 2002 2003 2004 2005 2006 2007
TOTAL EXPENDITURE
Of which: 108961 1E+05 1E+05 2E+05 214176 3E+05 3E+05 399402
Expenditure on development investment
Of which: Capital expenditure 29624 40236 45218 59629 66115 79199 88341 112160
Expenditure on social and 26211 36139 40740 54430 61746 72842 81078 107440 eco-nomic services
Of which: 61823 71562 78039 95608 107979 1E+05 2E+05 211940
Expenditure on education and training
Expenditure on health care 12677 15432 17844 22881 25343 28611 37332 53774
Expenditure on population 3453 4211 4656 5372 6009 7608 11528 16426 and family planning Exp. on science, technology 559 434 841 666 397 483 489 612 and environment Expenditure on culture and 1243 1625 1852 1853 2362 2584 2540 7604 information Expenditure on broadcasting 919 921 1066 1258 1584 2099 1874 2346 and television
Pension and social relief 387 483 586 648 883 879 956 1005
Expenditure on eco-nomic 10739 13425 13221 16451 17282 17747 22157 36597 services Expenditure on general 5796 6288 7987 8164 10301 11801 14212 16145 public administration Addition to financial reserve 8089 8734 8599 11359 15901 18761 18515 29214 fund
846 849 535 111 78 69 135 185
Source: GOS-Vietnam, 2009
The financial mechanism and policies on S&T have not created motivation and favorable conditions for organizations and individuals to implement S&T activities. These mechanisms
248 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy have let S&T organizations to stand highly dependent. The state investment in S&T is still scattered on key fields and works. There is a lack of efficient measures to mobilize non state capital sources for S&T. In addition, there is a lack of risky investment to promote research and the use of high technologies in production and business.
2.3. Vietnamese S&T Governance and Its Mechanism
S&T management system consists of ¥ Ministry of Science and Technology (minister is a member of the cabinet) ¥ Department of Science and Technology in each line ministry ¥ Department of Science and Technology in each province/city. ¥ 3 levels of S&T management : - Level 1. The national research institutes or centers directly under the Prime Minister, for example, the National Centre for Natural Sciences and Technologies, the National Centre for Social Sciences and Humanities, receive most of their resources from the state budget. - Level 2. The research institutes (natural, social, medical, educational, agricultural) and technological branch institutes under ministries, cities, and provinces are also directly under the Prime Minister and receive most of their resources from the state budget. - Level 3. The local research units in, for example districts or cooperatives, which are to apply the results supplied by those institutes mentioned above need to meet the local conditions.
Figure 3-2-1 | Organization Chart of National System S&T in Vietnam
Vietnam Communist Party National Assembly
CCSTE CSTE
Government National Council for S&T Policy Department of S&T
Line Council Provinces / Vietnam Ministries / MOST for Sectoral Centrainlly Academies of Agencies S&T Policy M anaged Cities S&T
DOST of Ministries DOST of Provinces
R&D Institutions affiliated R&D Institutions under line Universities to localities, asso ciations, Ministries agencies business-entities, joint- venturees and partnerships
Note: MOST and DOST denote Ministry of S&T and Dept of Science and Technology, respectively.
249 Chapter 3 _ Industrial Technology Development Policy The Ministry of Science and Technology (MOST) is a governmental agency which performs the function of state management of science and technology, covering scientific and technological activities, development of scientific and technological potential, intellectual property; standardization, measurement and quality control, atomic energy, radiation and nuclear safety, and state management of public services in the domains under its management in accordance with law.
NISTPASS(National Institute of Science and Technology Policy and Strategy) is a research organization under the Ministry of Science and Technology and Environment established by decision No 248/TTg on 23rd April 1996 by the Prime Minister. According to decision No 101/Q KHHCN signed on 18th Jan 2007, NISTPASS has the following main functions, tasks and jurisdictions: (1) Carry out research to provide foundation for developing S&T strategy, policy, and management towards renovation and sustainable development. (2) Participate in developing strategy, mechanism, policy and legal documents on science and technology; (3) Training masters and PhDs specialized in science and technology policy in pursuant to the Education Law; (4) Associate with other institutions doing research and development, scientific and technological services, training, production trade, both domestic and international, in order to implement the assigned functions and tasks; (5) Realize tasks in relation to international cooperation assigned by the Ministry; (6) Issue publications, magazines based on the research results and activities related to the Institute’s functions, tasks in compliance with laws; (7) Organizational and personnel management as decentralized by the Ministry; (8) Management of assets, equipment and facilities of the Institute in accordance with government regulations.
The state management mechanism of S&T organized from the central to local level has sped up the S&T development, contributing to the implementation of socio economic objectives of branches and localities.
Figure 3-2-2 | Decision Making Process for S&T Policies
Socio-Economic Development Strategy Sectoral Development Approved S&T Starategy by (2001~2010) Strategies Prime Minister (2010~2020)
National Councill for S&T Policy (NCSTP)
Draft workshop Groups from DOST of concerning Supporting research team ministries S&T strategies from NISTPASS staff
Experts comments on Draft (scientists. managers. Draft S&T Startegy bussiness. international (2001~2010) experts and NGOs) (2010~2020)
250 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy The implementation of Law on S&T, Law on IP, Law on High Techs, programs, themes, and projects on S&T has closely focused on the socio-economic development tasks. The mechanism of selecting organizations and individuals to be in charge of S&T tasks has initially been managed with the principles of democracy and publicity.
Operations of S&T organizations have been expanded from research and development to S&T production and service. The autonomy of organizations and individuals in S&T field has been initially strengthened. The autonomy in international cooperation of organizations and individuals working in S&T field has been extended.
Capital sources mobilized for S&T from contracts signed with production business sectors, bank credits, international funds and other sources have been significantly increased thanks to policies on diversifying capital invested in S&T. The budget allocation for scientists has been improved one step by reducing intermediate phases.
The assignment and decentralization in the State management in terms of S&T have gradually been improved through regulations on functions, tasks, and responsibilities of Ministries, ministerial agencies, and the People’s Committee of provinces and cities under the Central government.
Some aspects on mechanism of supporting S&T activities are as follows.
Funding resources for S&T in Vietnam is composed of government, state enterprises and private sector and foreign resources (80% from government, 20% from others). There are some other funding foundations such as S&T foundation and basic research foundation.
Every year the government allocated 2% of total government expenditure for S&T activities. This budget will be spent for research programs, S&T infrastructure building, and support for technology renovations.
S&T Planning: - There are long term plan (5 year plan) and short term plan (one year plan) for S&T development.
Research programs: - State research programs (interdisciplinary issues) - Ministerial research programs (sectoral issues) - Provincial/city/regional research programs.
Every research institute, university and research group, could apply for research fund. The related scientific council will consider proposals, and send their comments to MOST for final decision.
251 Chapter 3 _ Industrial Technology Development Policy An international advisory mechanism on S&T policy and practice has been implemented.
Wishing to support and help Vietnam carry out a successful industrialization and modernization as a developed country in 80 years, IDRC Canada formed a team composed of international experts to give advice to the government of Vietnam in the 1990s. One of the critical issues in Vietnam is that national S&T policies have become obsolete. It is argued that national S&T policies are designed to benefit a national economy by creating and facilitating a competitive edge for the goods and services it produces. A globalized trading arrangement means not only goods, business, and finance but also S&T moves unrestricted to national borders. Thus, any possible benefit from national S&T policies will quickly move “( leak”) outside the country, and in a globalized world, such policies are therefore doomed to failure (IDRC 1997).
However, the need to mainstream innovation for science and technology to truly serve the socio-economic development did not match with Vietnam. The international expert group sometimes provides consulting services.
In October 1997, the international team conducted meetings and discussions throughout Vietnam with about 70 Vietnamese institutions, organizations, and firms and about 325 individuals. In most of these meetings, members of the team were accompanied by representatives of NISTPASS, an arrangement that permitted the team to have ongoing dialogue and seek supplementary data sources. When these could be found, the team would take advantage of the opportunities through spontaneously scheduling follow up discussions. The international advisory was a practice into building the S&T policy process in 1998 with the support from IDRC. Members of the international team returned to Vietnam in February 1998. The report had been very widely distributed and, in preparation for the return visit, NISTPASS had organized a series of discussions with stakeholders. These discussions had been organized in seven working groups where each group addressed one of the main themes. These groups reviewed the relevant sections of the report and made a list of issues for further debate with the international team. These issues were raised in the course of a full day discussion on 12th of February in Hanoi. More than 100 Vietnamese stakeholders participated. In addition, discussions were held with representatives of NISTPASS and with the Minister of Science, Technology, and the Environment on 11th and 13th of February. The NISTPASS team requested brief elaborations on how an international advisory mechanism on S&T policy and practice might be shaped as well as how its composition and the terms of reference would be established.
As a centrally planned economy moves to a market economy, more and more decisions about the role of S&T will be made outside the government. The new environment will require multiple inputs to decision making. These must come from multiple sources, both within and outside of the country. The role of government becomes that of a general facilitator, rather than
252 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy a regulator, and more of a communicator of vision than a principal actor. In such a transition, it is critical to have a reliable mechanism to obtain advice from national and non national sources as well as outside the government channels. Most market economies have a variety of such advisory mechanisms that give advice to individual ministries and agencies of the government. Most also have an advisory council that reports to the prime minister or the president on issues in which S&T draws the interest of several ministries or agencies. These advisory councils are composed of qualified representatives of the business community, higher education, and civil society. In its early drive for modernization, Singapore relied heavily on a number of such mechanisms. Thus, the international team believes that a carefully structured and well supported Vietnam International Science and Technology Advisory Council (VISTAC) would provide a most valuable service to the country.
A model for such a council can be found in the China Council for International Cooperation for Environment and Development (CCICED). The CCICED is a group of about 50 international (including China) leaders in the field of environment and development. The CCICED meets once a year and presents its policy recommendations directly to the senior leaders.
The CCICED has established a number of working groups on different aspects of environment and development. Each working group comprises of about six Chinese and six foreign members, all of whom are experts in the working group theme. The working groups meet twice a year and commission research on carefully selected topics. The working groups draw their conclusions from their research and make recommendations. Their reports are submitted to CCICED for consideration, and after debate, recommendations are forwarded to the Chinese leadership. All of the recommendations are given careful consideration by the Chinese authorities, and many have been implemented. The funding for the CCICED comes mainly from CIDA, which has contributed $15 million over a 5 year period. The funding for each working group comes from different sources.
Our suggestion for Vietnam is to establish something similar to the CCICED but focused on S&T policy. We envision a council of about 30-40 members, half of whom would be Vietnamese, including some Vietnamese from overseas. The rest would be leading international figures from the business world, academia, and people knowledgeable in S&T policy issues. We expect that many of the foreign members will be from East Asia.
Working groups would be established in each of the areas of concern to the Vietnamese authorities. For example, working groups might be established on such topics as, ¥ S&T education and training; ¥ Technology transfer and the role of foreign corporations in Vietnamese industrialization; ¥ S&T and the traditional sector; ¥ International collaboration in S&T; and ¥ Research foresight.
253 Chapter 3 _ Industrial Technology Development Policy Establishing VISTAC would be a way to ensure that the government receive the very best of advice on all matters in the most impartial and authoritative ways. If it is decided to go ahead in principal with VISTAC, then a prospectus should be prepared together with a budget. The detailed draft could be written up within a few weeks by a small team of experienced professionals. Based on this draft prospectus, Vietnam would be able to rouse interest from international donors.
The S&T management mechanism has been slowly reformed and heavily administratively driven. The management of S&T activities is mainly focused on inputs. No proper attention is paid to the management of the output quality and use of research results in practices. S&T tasks do not really link closely with demands of the socio economic development. The assessment and appraisal of research results are neither relevant nor compliant with international standards.
The management mechanism of S&T organizations is not appropriate with specialized characteristics of creative labor and regulations of the socialist oriented market economy. S&T organizations have not been delegated with adequate autonomy on planning, finance, human resource, and international cooperation tobecome dynamic and creative.
The management of S&T staff according to civil service regulations is not suitable for S&T activities with limited staff rotation and changes. There is a lack of assured regulations so that S&T staff can express their opinions, develop creativeness, and show responsibility within the legal framework. There has been a lack of effective policies to create motivations for S&T staff, attract and treat talented people with special attention. In addition, the salary scheme still has much inconsistency and cannot motivate S&T staff to be fully committed with the S&T cause.
The financial management mechanism of S&T activities has not created favorable conditions for scientists and mobilized much non state capital sources; the self financed mechanism of S&T organizations has not been linked with the autonomy in the human resource management so the efficiency is limited. The state management of S&T has not been timely reformed with requirements of shifting into the market economy.
S&T counseling and management agencies are at low capacity levels. The planned, centralized and subsidized mechanism deeply rooted in the thoughts and habits of many S&T staff and managers, have created inertia, which is very difficult to overcome in new mechanisms. Often, they can’t meet the requirements of S&T management renovation in the socialist oriented market economy in the context of the globalization and international integration. The state management for administrative and non productive sectors in the S&T system has not been clearly defined, leading to the fact that the management of S&T organizations is carried out in an administrative manner.
254 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy 2.4. R&D of Research Institutes in Vietnam
Research institutes in Vietnam have almost the same scale of R&D work force as the ones in universities. Most important R&D institutes are public ones. The largest among them is the Vietnam Academy of Science and Technology with 18 research institutes and 9 regional branches in various fields of science and technology. By the end of 2003, this institute had about 3000 staffs. Nowadays, Vietnam has nearly 1,500 inctitutes, reserch aentres from all economic sectors, with about 2.6 million people participating in scientific reserch. Of these, nearly 60,000 people ahrectly working in reserch institutes, universities and enterprise. Vietnam has more than 20,000 masters, 16,000 Ph. D.s, 7,000 associate professors and 1,200 professors.
Table 3-2-2 | R&D Manpower Unit: person
Bachelor Master Ph.D. Total
Colleges 449 106 18 573
Universities 11,758 5,115 3,188 20,061
Research Institutes 14,147 914 3,142 18,203
Total 26,354 6,135 6,348 38,837
Source: MOST (2004)
Table 3-2-3 | Labor by Trained Qualification Unit: person
1/7/2007 change with 1/7/2002 1/7/2002 1/7/2007 Number Rate(%)
Doctor 449 106 18 573
Master degree 11,758 5,115 3,188 20,061
Bachelor degree 14,147 914 3,142 18,203
College degree 26,354 6,135 6,348 38,837
Vocational secondary school
Long-term vocational training
Others
Source: GOS-Vietnam, 2009.
255 Chapter 3 _ Industrial Technology Development Policy Traditionally, public institutes have a privilege to receive funding from central government to carry out the so called“ State S&T missions”. These missions are usually organized into research programs which are aimed to provide scientific foundation for policy making and legislation building process (social science), or creating new S&T outcomes which are significant for economic and social development; for defense and national security; and for human resource and S&T talents development. Lacking an effective mechanism to identify such missions as well as mechanisms to distribute such research results, it is criticized that the state S&T programs are not effective. Over the last few years, the entire process of identifying, conducting, and evaluating state S&T missions has been reviewed for a better solution.
In addition to the above two institutions, there are scientific organizations under ministries and provinces/cities. These institutions also get public funding via their ministries/provinces to do research which address the scientific, technical and policy problems in the field/areas of related line ministries/provinces. In regard to the governance of public scientific organizations, majority of them still belong to ministries and other equivalent government bodies, and get subsidies from government budget.
Public R&D institutes operate in isolation from other innovation actors. They offer few exchanges and do not share much learning with others. They have weak linkage to firms, especially to those not in the same umbrella organization. Firms normally have no link to R&D institutes for their technological innovation. There is a miss match between capacities at R&D institutes and technology demand of enterprises. Enterprises do not expect much from R&D institutes for their technological innovation. Survey of 123 enterprises in 2003 showed that 84% innovation ideas came from own business activities or customers, while only 10% came from R&D institutes. About 60% of the firms had no contact with R&D institutes.2)
2.5. Universities R&D in Vietnam
Although training still dominates the activities of universities, research has been gradually added in. About 4% of public expenditure for S&T now comes from universities which account for approximately 15.3% of universities’expenditure for R&D. The remaining fund of R&D expenditure come from contracts with other organizations of which 29.2% is from enterprises, 6.7% is from other organizations and 48.8 % is from international sources. In period of 1991~1996, universities undertook nearly 200 projects of pilot production relying on their own research results.
In period of 1996~2002, universities under the MOET and two national universities have implemented 3,800 R&D projects and involved in 90 pilot production projects. Many
2) Bach Tan Sinh, "Transformation of Vietnam's National Innovation System: Institutional and policy learning toward sustainable development", Asian CISASIA's Workshop of "Towards Innovative, Livable and Prosperous Asian Mega cities" Project, 18 21, May 2009, Bangkok, Thailand
256 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy universities have established R&D units. By the end of 2002, there were 167 research divisions and 147 centers dealing with technology development and consulting activities within all universities.
Table 3-2-4 | Number of Teachers in Universities and Colleges by Professional Qualification
2000 2001 2002 2003 2004 2005 2006 2007 2008
Person
TOTAL 32357 35941 38671 39985 47613 48541 53364 56120 60651
University and 2603 2403 2877 2594 3563 2640 3495 2342 2891 college graduate
Other degree 47 23 67 38 124 22 53 10 59
Source: GOS-Vietnam, 2009
Research at universities, however, has several drawbacks. In terms of perception and policy, R&D activities within universities system are not well recognized. Many universities are far from being excellent R&D centers. The universities in Vietnam lacked independence. In spite of the fact that their operations have been much more independent than before, they still have to receive many directives and need to be under the regulations of MOET. The staff, especially in public universities, has to face constraints in terms of salary ceiling, human resource management regulations, financial incentives, etc. Basically, they are still deemed as government officials, rather than merely as academics.
257 Chapter 3 _ Industrial Technology Development Policy Despite the move to abolish the separation of teaching and research, it is observed that there is still a lack of research and weak linkage between research and teaching. The present incentive scheme does not promote proactive approach among teaching staff in universities. There is little mechanism to encourage them to interact with other institutions and firms. The cooperation (if any) is usually short term and relies mainly on personal and informal relationship. In the existing system, universities so far do not see technology transfer activities as crucial for their own existence and their technology (if any) is actually not very attractive to the firms. In many instances, facilities and practical engineering knowledge of universities are behind those of the firms.
In terms of infrastructure and other teaching and R&D facilities, although some investment was made for renovation, this tends to be for only the big universities. Many universities still use equipment and facilities of the mid 60 or 70s. Library system in many universities is small and outdated in both the quality and scope of coverage. Foreign languages literature is still mainly in Russian dating back to mid 70s. There has been a lack of electronic links with national library or central information and librarian system. Even if some of the universities have English literature, it is hardly used due to poor English capabilities of the staff and teaching overload. As a result, teaching curricula is old, repetitive and lacks innovative approaches and new knowledge. Weakness in international cooperation is the challenge of the international changes, causing difficulties in long term planning and unsuitable choices of the counterparts in cooperation. Recognizing the need for training to be linked closer to research and serve the need of social and economic development, the government has launched an action plan to renovate management of the university system until 2010 with key content such as setting up linkage mechanisms between training, research and production; combining training with R&D organizations and firms to overcome traditional isolation of teaching from research and industry; increasing investment for R&D in the universities. Still, these efforts prove to be difficult to implement due to many constraints on the linkage system.
Following is a SWOT analysis of university R&D.
< Strength > ¥ Existing legal entities, large number of faculties ¥ Capable, hard working staff at right motivation
< Weakness > ¥ Weak market link to firm, R&D customers ¥ Used only to teach, not to do research with busy teaching schedule ¥ No clear mechanism for making business with research
< Opportunity > ¥ Research labs, hard infrastructure, students available ¥ Capable, clever staff if having been trained at research
258 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy ¥ Trusted by firms if having good marketing
< Threat > ¥ Attracted by foreign R&D, firms if no clear incentives at university. ¥ Conflict among colleagues if no clear mechanism available
2.6. R&D Evaluation and Feedback System
R&D evaluation and feedback system can be categorized into the following three basic types:
Evaluation system for R&D, S&T policy and the feedback consists of a number of organizations under the Ministry of Science and Technology such as Vietnam Science and Technology Evaluation Center (VISTEC), the Department of Technology Appraisal, Examination and Assessment (DTAEA under the Ministry of Science and Technology) and provides technology assessments and help the the minister to fulfill state management functions in terms of technology appraisal, examination and assessment activities, technology transfer and consultancy in these fields.
Evaluation system for S&T, S&T policy and NIS: There were a number of international organizations and foreign scientific and technological organizations supporting Vietnam, such as IDRC Canada, STPEI South Korea, NISTPE Japan, as well as UNIDO. A formal method so far has not been either applied or widely used. However, the evaluation results have not been using the process of building scientific and technological strategies, and planning policies.
To evaluate S&T programs and projects State Science and Technology Program of Key state level Office in the 2006~2010 (STPKO) has taken place. Vietnam has 10 major programs of Science and Technology (KX01-KX10) and 3 major programs of Social Sciences and Humanities (KC01-KC03). The program was implemented to serve the development objectives of science and technology, socio economic Vietnam during 2001~2010.
3. Theoretical Understanding and Applications 3.1. Theoretical Concepts of Technology Foresight
S&T activities are basically knowledge creating activities. However, the cost of knowledge production including transmission and dissemination is rising. In turn, it implies that the investment in S&T activities involves greater risk and uncertainty. To minimize risk and uncertainty and to maximize the effect of knowledge creating activities, it is necessary for the policy maker and decision maker to take a scientific approach to look into the longer term future of environments surrounding science and technology.
259 Chapter 3 _ Industrial Technology Development Policy Today’s technological progress does not occur naturally. It is made to happen. If the forces driving it can be identified and quantified, it should therefore be possible to forecast the rate at which they will produce future advances. Future advances can be directly by the work of individual technologists, but nowadays it is more likely the teams, which would not be in existence without financial supports. Thus, one would expect to find a relationship between the investment and technological progress. The S&T investment is made because benefits to be derived from the enhanced performance are expected to be greater than the cost of achieving it the benefits are not easily measurable, though.
It can be said, therefore, that the fundamental of the foresight activity is in assessment of threats and opportunities, in a systematic way, leading to strategic formulation and planning to meet the needs of the future. In summary, Jantsch (1967) pointed out that the foresight could assist decision making in the following ways; ¥ Wide ranging surveillance of the total environment to identify developments both within and outside the sphere of activities which would influence the economy’s future. ¥ Provision of well refined information about the possibility of a major threat and opportunity; in some cases, an early warning signal. ¥ Estimating the time scale for important events in relation to the decision making and planning horizons; an indication of the urgency of action. ¥ Major reorientation of S&T policy to address situations which may pose a threat and opportunities by; (a) redefinition of economic competitiveness in light of new technological competition, (b) modification of economic strategy as well as R&D strategy. ¥ Improving operational decision making, particularly in relation to; by priority setting, (a) resources allocation between technologies, (b) R&D project selection from the R&D portfolios, and (c) human resources development.
Thus, the foresight could provide rich decision information for S&T policy formulation of both the private and the public. It is noted that the foresight should not be simply outcomes of curiosity of scientists and technologists. It must be a well controlled exercise taking account of related factors.
The technology foresight as a discipline is relatively new to other forecasting studies, such as economic forecasting and business forecasting, etc. In 1967, Jantsch made an extensive survey on various practices of technology foresight. He collected about 400 cases and classified them into four categories, with providing a conceptual framework.
According to him, the forecast/foresight3) is defined as“ probabilistic assessment of future technology transfer.”The technology transfer is referred to a vector, a move from one point to another, on the sphere of S&T activities showing both the vertical and the horizontal technology transfer. The vertical technology transfer is ranging from the scientific knowledge, basic and applied research, development, commercialization, to final effects of innovation over the entire
260 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy society.4) When a technology forecast is carried out, it is important to understand the processes of innovation. It is because the different stage of innovation has different effect and implications for S&T planning, and because the forecast does not always concern only one of those stages. By combining both the vertical and the horizontal technology transfer into one three dimensional space, so called“ technology transfer space,”a technological progress can be described by a vector in this space.
Figure 3-2-3 | Technology Transfer Space
Open Technongy Transfer Space Closed Technology Transfer Space
Ⅷ Ⅶ Ⅵ B Ⅴ Ⅳ Ⅲ Ⅱ Ⅰ A
Stages of Technology Transfer source : Jantsch(1967)
Observing such a move from the point A to B in Figure 3-2-3 on the technology transfer space, what the technology foresight is concerned about is; ¥ Time period moving from one point to the other ¥ Efforts to be made to reach the end point of the vector ¥ Effects of technological consequences at the end point ¥ Optimal starting point in view of the end point
3) In this study, the terms of forecast and foresight are interchangeably used. According to Bright (1978), "technology forecasting is quantified prediction of the timing and of the character or the degree of change of technical parameters and attributes associated with the design, production, and use of devices, materials, and processes, according to a specified system of reasoning." Technology foresight, on the other hand, " involves systematic attempts to look into the longer term future of science, technology, the economy, the environment and society with a view to identifying the emerging generic technologies and the underpinning areas of strategic research likely to yield the greatest economic and social benefits." (Tegart 1988). It seems that forecasting focuses more on the forecasting results, while foresight does more on activities. 4) In explaining such innovation process, there are various models including the linear and the non linear models. For a linear model, see J. Bright (1978).
261 Chapter 3 _ Industrial Technology Development Policy The first three are known as the exploratory forecast taking a view from the present to the future; the last one as the normative one taking a view from the future to the present. Thus, the exploratory forecast is to address technological opportunities S&T push or capability oriented where technological progress takes place, while the normative forecast assumes that needs for the technology demand pull or need oriented is already identified. It will be more desirable if an exploratory opportunity matches social needs in addressing the path of technological progress. Therefore, it can be said that the combination of both the exploratory and the normative approach will produce richer forecasts.
A comprehensive forecast includes four essential elements, i.e., qualitative, quantitative, time and probability. One of most important is the qualitative elements related to“ what to forecast.”This is the area where insights and the general technological awareness of the experts play a crucial role. Forecast without quantification and time scale is useless by and large. This is the question about“ what rate of progress can be expected.”It is often relatively easy to forecast the eventual development of a technology to produce an end state scenario, but it is much more difficult to assess the path by which this end state will be achieved. Without a time scale, S&T policy and planning is of little value. Since forecast is concerned with the future, it is involved with uncertainty to some degree. Therefore, it needs to be associated with a probability assessment, i.e.,“ what confidence has the forecast.”(Martino 1993). Though it is most desirable that a forecast includes those four elements, all methods do not include them.
When the foresight goes into practice, several guidelines can be proposed: ¥ Goals and purposes of the foresight must be identified before selecting appropriate methods. There are a number of methods for technology forecasting. However, selection of methods depends on the purpose of the forecast as well as availability of input factors. It is because different methods may give different answers. For example, without statistical data, any statistical method will not be applicable. ¥ More desirable to use methods in combinations. No one method can answer all questions in consideration. It would be more preferable if exploratory and normative methods are combined, i.e., mixture of S&T push and demand pull approaches. ¥ Too much emphasis has been placed on the accuracy of forecasts and not enough on the
262 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy learning and communication value of the forecasting process. The process should make participants better informed about the topic and better prepared to deal with uncertainty.5)
On the other hand, since science and technology is responsible for the most important changes in our society, forecasting has to be very extensive if some indication is not being missed. Also, it is perceived that interaction between non technological factors and technological factor plays an important role in the course of technological progress. It is recommended, thus, that the foresight should include a wide range of social, economic, cultural and political as well as technological factors.
3.2. Technology Foresight Activities at the Government Level
3.2.1. Recent Development of TF
The first government effort for technological forecast was made in 1930s by the United States. The purpose was to encourage formal governmental efforts to anticipate technological change with a view to ameliorating its impact on society, especially on unemployment and skills training. A landmark effort was the work of T. Von Karman in which he addressed the course of the US Air Force research and development of the 20 years, 1945~65. By doing so, he organized a scientific advisory group to aid in fulfilling the request, which included experts from many technological fields. Using an expert group in the foresight is still a widely employed method nowadays. In 1960, the US Army began a formal program of long range technological forecasts. This eventually evolved into a continuing project known as“ Long Range Technological Forecasts.”(Bright 1978). The Department of Defense has continued to carry out technology foresight. During the 1980s, the National Research Council had been engaged in the technology foresight activities. The methodology was similar to what Von Karman did. A large committee and subcommittees were composed of eminent scientists and technologists. Information collection, documentation, discussions and conceptualization are the main procedures.
It was not until the late 1980s that the United States moved to an explicit technology policy. Before the end of 1980s, technology foresight had drawn relatively less attention in the public sector, and well diversified approaches were taken by various organizations. This is a typical aspect of the US market system with traditionally emphasizing less government intervention. However, in the end of the 1980s, a concern about the US industrial and technological competitiveness, particularly related to Japan, was increased. It was recognized that the United States needs to have a coherent technology policy, and it led to increasing interests in technology foresight.
5) This was well argued in H. Grupp (1996), and T. Shin, et. al. (1998).
263 Chapter 3 _ Industrial Technology Development Policy The outstanding foresight works in the United States in recent years have been to take out the lists of the critical technologies, i.e., technologies critical to the future of the US economy or to national security. The Department of Defense and the Department of Commerce carried out some exercises in producing lists of critical technologies. A panel setup by the Office of Science and Technology Policy was engaged in making the lists of the critical technologies and had to report them the US Presidential Office. The list is to be revised every two years. This foresight work is now carried out by the Critical Technology Institute, affiliated to the RAND Corporation.
Such initiation of the public sector eventually led to further development of methodologies, and to stimulating and promoting the private sector to undertake foresight exercises in the United States. As the private organization, SRI and Data Quest among others, are known as prominent institutions for technology monitoring and foresight.
In the late 1960s, Japan was concerned about technology forecasts. The STA (Science and Technology Agency) undertook in 1973 an extensive Delphi survey for the 30 year forecasts. It was the largest scale Delphi at that time covering all areas of science and technology, and surveying on possible innovations or technological developments; major parameters of the survey were forecast time, the degree of (technological) importance, and barriers to realization, among others. More than a thousand experts participated in the foresight, from industry, universities and government organizations. It provided, to the public and private sectors, the background knowledge on the course of S&T development in the long run, rather than specific priority identification.6) These 30 year forecasts have been repeated approximately every 5 years.
Besides the STA’s Delphi, it is also known that other government agencies, such MITI, EPA and Department of Transportation, among other, are actively engaged in the foresight activities. They employ various methods including brain storming, scenarios and others. Japan is one of the countries that exercises of forecasting futures are most actively carried out. Forecasting is sometimes characterized as self fulfilling (opposed to self defeating). Thus, forecasting has an effect of expectation formulation. As the government produces a number of forecasts, the private sector tends to move towards more likely futures with their own expectation. In turn, it has an effect to make resources allocation guided to a certain direction, possibly with greater efficiency.
In other cases, Korea undertook a major study of technology forecasting in 1994, using Delphi. Like the Japanese Delphi, its purpose is to address the long term path of science and technology in all areas, showing“ where to go.”It included about 1,200 technological topics,
6) Surprisingly, a review in mid 1980s by the NISTEP reported that the accuracy of the forecast time in the first Delphi turned out to be about 60%, including the partially realized cases.
264 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy and forecast was made over next 20 years. Unlike the Japanese Delphi, however, it was thought that selection of technological topics had to be seriously taken into account. It was because Korea may stay in the different stage of S&T development from those of other countries like Japan. At the preliminary stage, thus, idea collection was made through a nation wide survey, simply sending the blank paper to about 25,000 experts. Based on that idea from the brain storming, about 1,200 topics were selected. Out of them about 300 topics were the same as those of the Japanese Delphi, which made an international comparison possible later.
On the other hand, Germany and France also carried out their own Delphi, using the topics of the Japanese Delphi in 1992. Their results received a substantial response, particularly in Germany which decided to undertake it regularly. A few years ago, Germany undertook a joint Delphi with Japan, (Kuwahara 1996), looking for a possibility of the international cooperation in technology forecasting. Meanwhile, the United Kingdom made a good deal of efforts in technology foresight with a huge scale, in which a Delphi was included as a part of the entire exercise. The task force made finally about 600 recommendations on completion of the foresight. It is also known that other European countries like Netherlands, Sweden and Norway, undertake technology foresight using various methods.
Now, some interesting results of an international comparison from the Korean, Japan and German Delphi were shown in Shin (1995). It was found that there was no significant difference in the forecast time of realization over about 300 topics included in all three exercises. However, evaluation of the degree of importance was significantly different from one country to another. This gives an important implication that each country may have different concerns on science and technology, since each country has a different economic environment and different endowment of resources.
All in all, such extensive foresight activities at the government level are usually time consuming and highly expensive. Martin (1996) pointed out some lessons from recent foresight activities reviewing over some countries. Among others, he wrote, ¥ Widespread recognition of the growing importance of new technology for economic competitiveness and social progress. With research costs rising and the number of scientific opportunities expanding, no organization or country can afford to do everything. Choices have to be made. Thus, needs for a systematic approach for the priority setting is increasing. ¥ Foresight assumes that there are numerous possible futures. Exactly which one we will arrive at depends on the choices made today. In other words, foresight involves a more active attitude towards the future through decisions they take today. ¥ Research foresight needs to be carried out at several levels, ranging from bodies responsible for the coordination of overall national S&T policy down to individual companies or research organizations. Thus, some foresight exercises need to be holistic in scope, others more micro level. Furthermore, the foresight activities at different levels
265 Chapter 3 _ Industrial Technology Development Policy should be fully integrated, the results from higher and/or lower levels of foresight being fed into the process, and the results in turn feeding into subsequent foresight efforts at higher or lower levels.
This is an important observation for the domestic activities of technology foresight, guiding the direction and scope of the activity.
3.2.2. TF in Catching Up Countries
3.2.2.1. Southeast Asian Trajectories Towards Science and Technology Development
Southeast Asian countries have long histories with each country showing distinctive characteristics of its own. With the exception of Thailand, all countries in the region have gone through periods of colonization, and all have developed a strong sense of cultural identity. With the exception of a few countries, the region has a very high and sustained economic growth of around 8% per year. This economic success cannot hide that the science and technology achievements are still peripheral by world standards. While there has not been any foresight exercise in Southeast Asia on the scale seen in Japan, Europe or Korea, it is nevertheless possible to report on earlier attempts to shape the future of the national innovation system of these countries and to anticipate the future role of innovation in Southeast Asian societies.
Believing that knowledge generated elsewhere in the world can be applied for economic and social benefit, very little basic research is done in the region. Southeast Asian countries tend to perform better in applied science and technology areas than in basic science. Yet, we witness an unwillingness of the private sector to invest in technology development. Still a large number of students are on scholarships overseas and the governments in the region try to bring back their skilled staff from abroad by a number of incentives. It can generally be regarded as a problem that technology development is largely pursued in a non business environment. What is the responsibility of the market forces in industrialized countries is considered a government task in most Southeast Asian countries having economic and social development plans which typically look forward five years. When these are formulated some elements of short time foresight on major science and technology components are embarked upon. Malaysia, Singapore and Thailand, in addition, have articulated“ visions”.
Recently in Thailand, a study of the future technologies has been undertaken. 400 scientists and engineers were asked to assess the likely future importance of various technologies by the Delphi method. The time of realization, possible constraints and other typical questions were raised. The technology areas chosen for the survey comprised basic technology, biotechnology, biomedical technology, metals and materials, transport, energy & environment and electronics & computer technology (software and hardware). In the questionnaire, economic benefits and welfare criteria for Thailand were broken down into five categories: farmer’s income and agro
266 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy industrial development, the economic value of plants, animals and microbes, the competitiveness on the technology level of industries, the emphasis for shifting labor intensive to knowledge intensive industries and people’s access to, and utilization of, information and technology. This seems to be a very specific operationalization of national, social and economic progress.
The results and conclusion from this Delphi survey, first of its kind in Thailand, will not be elaborated here as a number of identified technologies are quite similar to those expected to be of importance for developed countries. Although we noted that the five criteria to define economic and social progress were specifically designed for Thailand, and hence it could be expected that the findings of the study are equally specific, it seems from the results that the technologies that will be important for Thailand are about the same ones that are important for industrialized countries. This suggests, that“ global competition within technology areas is likely to intensify as the developing countries upgrade their capabilities”.
The most serious obstacles found in the Thai foresight survey relate to the lack of well qualified and high potential personnel in science and technology, to good planning procedures in S&T as well as on efficient organization with good entrepreneurial innovation management for R&D, among others. What concerns the next future, the Thai government is likely to invest a budget to the APEC center for technology foresight over the years 1998 to 2000 in order to conduct a feasibility study. This center is likely to be set up in Thailand at the Chiang Mai university which performed the first Thai Delphi study.
In the Philippines, a technology forecasting committee was created in 1995 which is composed of policy makers, representatives from national scientific and economic authorities, academia and the private sector. The committee used the panel approach but also considered to employ the Delphi method. However, as Delphi involves iteration of expert opinion, synthesis and feed back, due to insufficient time and mainly because the attempt was the first technology foresight access in the country. The outcome of this thinking stage is still unknown.
Likewise, in Indonesia a technology foresight project was implemented by a national agency. The project covers technology topics in eleven fields and employs the usual Delphi method with variations. In some areas investigated there was only a single survey round and also the brainstorming technique was effectively used in some cases before going into the second round and having the respondents work on a list of priority topics previously selected. This project is midway toward its scheduled completion when this article was written. A number of difficulties in collecting responses are already apparent and present a challenge towards successful implementation of the project as initially envisioned. One of those problems is that the pool of available experts is heavily concentrated in government R&D institutions and universities, which is a phenomenon likely to be found in other developing countries as well. Among the highly rated topics of investigation are items such as the development of electric
267 Chapter 3 _ Industrial Technology Development Policy train technology for mass transportation and the development of a model for energy planning that would observe the social, economic and environmental aspects. Other topics concern natural gas fueled motor vehicles and industrial core generation technology. All these topics are less ambitious than in industrial countries but finely tuned towards the needs of Indonesia. In the future, Indonesia is likely to support the above mentioned APEC center for technology foresight and to share the Indonesian experience of conducting the first technology foresight activity with other developing nations.
In 1994, China conducted a technology foresight exercise to select key technologies essential to national development. Reportedly, the technology foresight has played a very important role in S&T decision making at the national level. Likewise, Chinese Taipei has been utilizing technology foresight methodologies to identify major strategies for S&T development in different stages.
3.2.2.2. South African Trajectories Towards S&T Developments
South Africa is reorienting its national science and technology and innovation system drastically. Since recent years the apartheid system was abandoned which triggered off many new activities. The national research and technology audit (NRTA) is a major government initiative to assess the strength and weaknesses of South Africa’s present scientific and technological base and its capacity to respond to the opportunities and risks the nation will face in the future. The audit is the responsibility of the Department of Arts, Culture, Science and Technology (DACST) which has requested the Foundation for Research Development to manage the audit. A central part of the audit is scoping the future trends that are likely to impact on the South African economy, environment and society over the next five to fifteen years, against which the strength and weaknesses of the present science and technology system may be judged.
A national foresight project is running in South Africa as this article is being written. The foresight team is based at the DACST but staff from the Council for Scientific and Industrial Research (CSIR) is participating looking particularly at methodological instruments, for instance scenario development.
The foresight project has been divided into twelve socio economic sectors. Working groups are now being established in each of these sectors in a similar way as in the UK foresight program. As in Britain, a co nomination technique is used to establish the list of respondents. When adopted, these groups will take the work to a foreseen completion at the end of 1998. The methodologies employed will include scenario development both looking at the possible futures for the South African S&T system and at individual sector scenarios and some sort of opinion survey. Wether this will take the form of a modified Delphi for South African conditions, was not decided at the end of 1997.
268 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy At the same time at the CSIR foresighting processes to fit a knowledge based institution are going on.7) The CSIR 2020 foresight exercise was initiated in the mid 1997 with the objectives to incorporate long term perspectives into the business planning process and to identify and monitor trends in science and technology. Also the establishment of a culture of future thinking within the organization is aimed at. This process is scheduled to run annually by foresight champions in each of the CSIR’s divisions. The methodologies adopted include tools such as Delphi surveys, scenario development, co nomination, trend analysis and others to various degrees.
3.2.2.3. Latin American Trajectories Towards S&T Development
In December 1996, representatives of Latin American countries (Argentina, Bolivia, Brazil, Chile, Mexico, Venezuela and Puerto Rico) met in Santa Cruz de la Sierra, Bolivia, to discuss foresight activities and cooperations in foresight. The meeting was initiated and organized by the United Nations Industrial Development Organization (UNIDO). Representatives from European countries (Germany, Italy, the Netherlands, and United Kingdom) and Japan were invited to present their experiences. There had been already smaller foresight activities in Latin America, especially in Brazil, but they are regarded as insufficient.
As a result of the meeting, an agenda was set up which describes the volition of Latin America countries to do foresight activities with different approaches. A core group with representatives from Argentina, Bolivia, Brazil, Mexico and Venezuela met in Madrid twice and elaborated a framework on foresight. This framework is supposed to be the basis of a project document which was just finished, when this contribution was written.
The project shall follow the framework; ¥ To promote the foresight concept ¥ To provide training and technical assistance to foresight practitioners ¥ To give practical experience in the form of two or three multi country studies ¥ To set up a virtual technology foresight center.
The project was supported by the National Science and Technology Councils in Brazil, Chile, Colombia, Uruguay and Venezuela as well as the United Nations Educational, Scientific and Cultural Organization (UNESCO) and ANEP in Spain.
3.3. TF Methods
Technology forecast is mostly based on a long term approach whereas the opposite applied
7) We are grateful to Professor Ben Martin, SPRU, for providing information to us, which he obtained from Marissa Moore from the CSIR.
269 Chapter 3 _ Industrial Technology Development Policy for socio economic forecast. There have been a number of TF methods in practice. A single method can be applied, but forecast results can be improved if multiple methods are used for the same exercise.
Jantsch (1967) collected and classified about 100 TF methods into the intuitive method, quantitative method and feedback method. Jones & Twiss (1978) classified TF methods into qualitative method, quantitative method and probabilistic method. However, their classification shows overlap over the methods to some extent. Shin (1995) classified TF methods into exploratory, normative and mixed models. This classification was made based on the concept and definition of Jantsch (1967).
According to him, the exploratory model is to forecast the S&T development on the science push direction. It forecast the technological trajectory being led by S&T development itself. Major part of TF methods are considered as the exploratory method, such as brainstorming, Delphi, analogy, gap analysis, monitoring, statistical methods (extrapolations, growth curves, substitution curves, correlation analysis, causal models, technometrics, and others)
The normative TF model is to undertake forecast given the optimal endpoint, i.e., purpose oriented method. Therefore, the normative method already considers a certain kind of planning. Major TF methods are relevance trees, morphology and mission flow diagram.
At last, there is a mixed model which is a combination of exploratory and normative approach. Sometimes, forecast results provide richer information when multiple TF methods are used. There could be a combination of the exploratory method and normative method; a combination of exploratory methods and a combination of the normative methods. Because the technology forecast takes extensive factors into consideration, the combination of various TF methods may produce better results.
Table 3-2-5 | TF Methods Approaches TF methods ¥ Brain storming ¥ Delphi ¥ Analogy ¥ Gap analysis ¥ Monitoring ¥ Extrapolation Exploratory model ¥ Growth curves ¥ Substitution curves ¥ Correlation analysis ¥ Causal model ¥ Technometrics ¥ Relevance trees Normative model ¥ Morphology ¥ Mission-flow diagram ¥ Scenarios Mixed model ¥ Cross-impact analysis ¥ Technology roadmaps
270 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy 4. Korean TF Exercises 4.1. S&T Governance of Korea
Since late 1990s, the Korean government had strengthened S&T governance particularly in the public sector. It is most notable to create the NSTC (National Science and Technology Council) which is responsible for the overall coordination across the ministries and decision making of the S&T policy. This is chaired by the President, and the members consist of the ministers of the related ministries and civilian experts. The coordination and final decision making by the NSTC are sent over to MOSF (Ministry of Strategy and Finance) in consideration of budget allocation for the S&T development.
Figure 3-2-5 | Korean S&T Governance
National S&T President PACEST Policy & Cordination MOSF NSTC
B P Ministerial S&T Other Policies / Planing MEST MKE ministries B P B P
R&D mgmt NRF KIAT / KEIT S&T programs/ agencies planning / B P evaluation KRCF ISTK
Performing S&T program
Universties / GRls / Frims
Note : P and B denote policy and budget respectively.
Each S&T related ministry is responsible for formulation and execution of its own S&T policy, which has to be approved by the NSCTC. In so doing, each ministry has the R&D management agency which is responsible for supporting the ministry in S&T foresight/planning exercise, R&D budget control and evaluation, etc. For example, the major S&T players in the government are MEST (Ministry of Education, Science and Technology) and MKE (Ministry of Knowledge Economy). They have R&D management agencies, NRF (National Research foundation) and KIAT/KEIT, respectively. These two ministries also operate the GRIs for their own policy purposes. There are 13 GRIs under the umbrella of each ministry. They are overlooked by the research councils, KRCF (Korea Research Council for Fundamental Science and Technology) and ISTK (Korea Research Council for Industrial Science and Technology).
271 Chapter 3 _ Industrial Technology Development Policy At the level of R&D performing governance, there are universities, GRIs and industrial corporate. In principle, R&D programs are open and carried out on the competitive basis. Once the S&T ministry formulates the R&D programs and secures R&D funds from the budgetary authority, they are carried out by the contract, open for competition among R&D performing organizations. Such a system is to obtain the best results of the government strategic R&D.
Figure 3-2-6 | Working Mechanism of S&T System
S&T level and trend analyses 5 Year national S&T plans National standard S&T foresight S&T classification & Roadmaps S&T indicators and statistical analyses National R&D Technology assessment priority setting
Comprehensive analysis of R&D inverstment survey & national R&D programs
Pre-coordination of National R&D program budget national R&D Evaluation programs
Figure 3-2-6 shows how the system works throughout the R&D programs. The MEST is responsible for making the 5 year national S&T basic plan every five years. To do this, the MEST undertakes extensive policy studies such as S&T level and trend analyses, managing national standard S&T classification, S&T indicators and statistics analyses and technology assessment, etc. Based those studies, the large scale S&T foresight, including a study for the priority setting, is carried out at the government level. By this, once the 5 year national S&T basic plan is made and approved by the NSTC, each S&T related ministry has to lay out its own R&D plan in accordance with the 5 year national S&T basic plan, and it undertakes R&D programs which are evaluated every year. The results of R&D evaluation are reviewed by the NSTC and notified to the MOSF for the next year budgetary consideration.
By implementing and practicing such a system, it is particularly noted that the S&T policy and R&D funding has been changed purposely from the institution base to the program base, which should be relevant to resolve the socio economic issues facing the Korean society. It is said that the system has to be managed on the completion base and hence mobilizes S&T resources more efficiently. In this regard, S&T foresight activities are increasingly important at every level.
272 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy 4.2. Evolution of Korean TF
As investment in science and technology is continuously increasing to cope with a rapidly changing environment, technology foresight activities are required for priority setting, R&D evaluation and control, etc. The foresighting activity in Korea is historically not long rooted, but it is recently observed that various R&D organizations carry out actively technology foresight.
The purpose of this section is to review the foresight activities in Korea. An additional discussion of the first Korean Delphi will follow in the next section in more detail. The foresight activities in Korea are undertaken by and large by the government sector. Due to lack of experience, however, the responsible organizations are still developing methodologies and uses for their own policy formulation. Only the first Korean Delphi has had a substantial stimulation to both the public and private sectors. As technology foresight or forecasting is a relatively new concept in Korea, the activities are undertaken in various ways. Let us first consider the foresight process preceding the HAN Projects. This particular foresight process took about one year and more than 400 experts had participated from industry, academe and government. The foresight procedure included three stages; preliminary stage, main foresight, and commitment stage.
Figure 3-2-7 | Basic Framework of S&T Policy Making
In brief, at the preliminary stage, coordination and communication for the new national R&D program took place between the ministries concerned including various interest groups. A foresight committee was also created. Next, at the main foresight, there were four phases. These included reviewing information about factors related to science and technology, addressing the
273 Chapter 3 _ Industrial Technology Development Policy objectives and selecting the candidate technologies for the R&D program. A survey for the candidate technologies was undertaken for priority setting, and finally the committee selected eleven areas of science and technology. Budget allocation and control and R&D evaluation followed at the final stage.
An evaluation of the HAN projects after 3 years of its initiation showed that the HAN projects turned out to be quite successful. This has been a standard model for the formulating S&T policy and planning the national R&D program. A primary lesson from the foresight of HAN projects places an emphasis on the concerted action among different interest group and resource allocation by priority setting. Such a framework seems now to be inevitable and is frequently employed for major policy making, which was also employed when the MOST initiated to enact the S&T special law in 1997, targeting a substantial increase in S&T capability through the five year plan for S&T development.
However, since only a limited number of experts participate in such foresight activities, it is required that formulation of new R&D program should be based upon more extensive information produced in a systematic way as well as supported by wide ranging consensus among related actors in socio economic system.
Besides the HAN Projects, it was not until the late 1980s that a major concern on technology forecasting at the national level was made firstly by a research team of the Science and Technology Policy Institute (STEPI). Since then, attention had been paid constantly, but not rigorously, to foresight, mainly due to lack of pertinent experts and research funds at the beginning. There had been a series of efforts for technology forecasting in the early 1990s. These were patient efforts devoted by the research team being stimulated and motivated by the Japanese Delphi. In 1992, the research team was able to carry out a Delphi study for the long range technology forecasting. A major step to the practice of technology forecasting could be made in 1993. The Korean Delphi, characterized by three round Delphi, was undertaken through three stages including preliminary activities, pre foresight and main foresight.8) This will be discussed in detail in the following section.
In Korea, many ministries or agencies perform their individual functions related to science, technology and innovation. The Ministry of Science and Technology (MOST) serves as the “lead agency,”specializing in common, interdisciplinary and strategic areas, and assumes responsibility for overall coordination of all other ministries and agencies. For the last three decades, MOST has been responsible for leading S&T activities in both the public and the private sectors. But as the society becomes more diversified in time and importance of science and technology increases in wide ranging socio economic activities, S&T responsibilities and
8) Martin & Irvine (1989) divided foresight activities into pre foresight, main foresight and post foresight. Since the Korean Delphi focused mainly on production of S&T information, the post foresight activity was not carried out. However, the Korean Delphi provided valuable information for policy formulation afterwards.
274 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy resources have been rendered to other ministries. Although the role of MOST is defined to carry out its own S&T operations and policies, while to coordinate R&D programs, it is difficult for the MOST to coordinate the policies and activities of other ministries and agencies. It is mainly because the system is lack of workable institutional mechanisms and its relatively weak position. Major ministries responsible for S&T activities are the MOST, Ministry of Trade, Industry and Energy (MOTIE), Ministry of Information and Communications (MIC), and Ministry of Education (MOEd), among others, particularly in response to changing national needs.
According to such evolution of the government structure and changes in policy making mechanisms, there had been established many agencies for their own R&D management, including technology foresight, planning, evaluation and control, etc. As shown in Table 3-2-6, eight ministries are now engaged in R&D activities and have their own agencies for R&D management. Those agencies are responsible for technology foresight, planning, evaluation and resource allocation, etc. However, most of them started their operation in the beginning of 1990s, so that their TF activities are still focusing on developing methodologies and uses. It is notable under such situation that MOST with an accumulation of three decade experiences in R&D management provided a framework for technology foresight activities in line with R&D management.
Table 3-2-6 | R&D Management Agencies of the Government Sector
Start year of Ministry of R&D Management Agency Area R&D programs Science and Technology Policy Various areas 1982 Science and Institute (STEPI/KIST) Technology (MOST) Korea Science and Engineering Target-oriented basic 1978 Foundation (KOSEF) research Industrial Technology Policy Industrial 1987 Trade, Industry and Institute (ITEP/KITECH) technologies Energy (MOTIE) R&D Management Center for Alternative energy 1988 Energy and Resources (RACER) Information and Institute of Information Technology Information and 1991 Communications (MIC) Assessment (IITA/ETRI) communications Construction and Korea Institute of Construction Construction and civil 1995 Transportation (MOCT) Technology (KICT) engineering Health and Welfare Korea Institute of Health Service Medical care 1995 (MOHW) Management (KIHM) Agriculture and R&D Promotion Center for Agriculture, Agriculture, forestry 1995 Forestry (MAF) Forestry and Fishery (ARPC) and fishery National Institute of Environmental Environment (MOEn) Environment 1992 Research (NIER)
Education (MOEd) Korea Research Foundation(KRF) Academic research 1996
275 Chapter 3 _ Industrial Technology Development Policy Thus, we observe that the technology foresight activities of R&D organizations in Korea are closely related to their respective situations. Some place an emphasis on producing S&T information simply for addressing S&T opportunities, while some focus on strategy formulation of their R&D activities. Somehow, this type of activities is the effort to adopt a proactive and rational approach to S&T activities including S&T resource allocation. Such activities have made a good deal of stimulation to other institutions including industries in Korea.
Since 2008, new government made a significant reform of the administration, so that the MOST has merged into MOEd, creating MEST (Ministry of Education, Science and Technology). MOTIE has been reformed into MKE (Ministry of Knowledge Economy) after being combined with a part of MIC; the other part of MIC became the Committee for Broadcasting and Communications. According to reform of the administration structure, R&D management agencies have been also rearranged. For example, KOSEF and KRF merged into NRF (National Research Foundation), ITEP and other agencies of MOTIE were restructured into KIAT (Korea Institute for Advancement of Technology) and KEIT (Technology Evaluation Institute of Industrial Technology). (See in the previous section).
4.3. Korean Delphi
The Delphi is a well known method for the technology forecasting (TF) particularly for a long range and large scale forecasting at a one time. (Martino, 1993). The nation wide survey for the technology forecasting employed basically the three round Delphi.9) The Korean Delphi was undertaken through three stages, i.e., preliminary stage, pre foresight and main foresight.10)
Figure 3-2-8 | Organization of Korean Delphi
( Expert Panel )
Expert (A)A nonymity Expert (B)
TF Committee and Sub-Committees (12)
Forecast Feedback Feedback Monerator Forecast
9) The classical Delphi used to be done by four round Delphi. However, it could be reduced to two rounds, if topics to be forecasted are already prepared. Many studies show that two round Delphi is good enough to reach stability of experts' opinion. For more discussion, see Martino (1993). 10) Activities in the last part of this paper can be taken account of as a post foresight activity. In fact, the primary purpose of technology forecasting is to assist the decision maker. Therefore, only results of the Delphi may not be good enough to do so. All activities including the post foresight activity should be undertaken along with in order to provide better assistance for decision making.
276 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy At the preliminary stage, we called for ideas to experts in the science and technology community of Korea. It was thought that those topics, which have been forecasted in other countries, might not be appropriate in this country. It is because the technology capability of Korea as a developing country must significantly differ from those of advanced countries. Thus, we send blank papers to about 25,000 experts and asked them to send back their ideas if anything valuable for and relevant to the Korean society, to forecast over next 20 years. It was highly encouraged by that each of about 5,000 experts has suggested more than 5 ideas on average. All in all, about 30,000 ideas were suggested. Out of them, about 9,000 topics were selected and rearranged into 15 areas. Those areas were (1) information, electronics and communications technology, (2) production, (3) materials, (4) fine chemicals, (5) life science, (6) agriculture, forestry and fisheries, (7) medical care and health, (8) energy, (9) environment and safety, (10) minerals and water resources, (11) urbanization and construction, (12) transportation, (13) marine and earth science, (14) astronomy and space, and (15) ultra technology.
It may be said that the technological progress of one country depends on realization and implementation of ideas of those experts working in the S&T community within a border primarily. It is they that attempt domestic implementation of new technologies, by monitoring technological trends from domestic and foreign sources. In comparison of the topics with the Japanese Delphi (1992), about three quarters of the topics were different from those of the Japanese. This implies that technological concerns and attentions of the Korean experts must be influenced by factors unique to Korea as well. With different endowments, different countries may take different strategies for their own technological development. This is a major reason that the results of the Delphi undertaken in other countries cannot simply applicable to the Korean economy. After all, the work at the preliminary stage was highly time consuming and costly. It took a time period of one year.
Secondly, at the outset of the main survey, the TF committee was constructed for the overall decision making and 12 sub committees for covering 15 areas of technologies. The TF committee was necessary because the moderator did not have expertise in all areas of technologies. The TF committee consisted of 9 experts including one expert in TF methodologies. They are one of most renowned experts of each area in the Korean society. Each subcommittee consisted on average of about 6 experts. Total number of experts for the committees was 91 persons; 18 from industries, 48 from universities, 24 from GRIs (government research institutes) and 1 from the government.
Activities of the committees were mainly focused on selecting of topics to be forecasted out of those 9,000 topics and reviewing of verbal descriptions of each topic. After rearranging those topics, similar topics to the Japanese Delphi were found. Those topics were described verbally just the same as Japanese topics for a comparison later on after the survey. This was possible because the Japanese Delphi was already translated into the Korean language. They are 317
277 Chapter 3 _ Industrial Technology Development Policy topics roughly accounting for 25% out of all topics forecasted. Finally, the committees selected 1,127 topics, which were manageable for the survey. On the other hand, the TF committee reviewed and confirmed the final form of the questionnaire for the main foresight. The questionnaires include;11)
(1) Degree of expertise: high, medium and low (2) Degree of importance: high, medium, low and unnecessary (3) Forecast time of realization: domestic and world leader by five year intervals (4) Probability of realization: high, medium and low (5) Current level of R&D: five levels by scaling the level of the world leader (=100%) by 20 percent. (6) Method performing R&D: led by industry or government, joint operation between industry, academy and NPRIs, and international cooperation (multiple choice) (7) Constraints of realization: technological, institutional, social/cultural, funds, manpower, and others (multiple choices)
Thirdly, in the main foresight, two round Delphi was employed. At the first round, entire questionnaires were sent to the 4,905 experts who already expressed their willingness to join the long range technology forecasting at the preliminary stage. It was allowed to choose their major areas as well as other areas related to their research works, after going over the topics. It was thought that the experts might follow up the trends of related technologies to their major areas, although their expertise might be lower. This turned out to be valuable to the experts in the sense that they had an opportunity to review topics of related areas and to obtain information about current events in consideration. The underlying assumption provided throughout the Delphi exercise was that the society would continue to move steady and stable, i.e., there would be no sudden changes in the society; such as war, major natural disaster overwhelming the society, and others.
After the first round, each expert made answers for two areas on average. The return rate of questionnaires was 32.4%, i.e., 1,590 experts responded at the first round. On the other hand, additional topics were suggested in the first round, and out of them 47 topics were added to the second questionnaires.
In the second round, only the areas answered in the first round were sent to the corresponding experts (1,590). Out of them, 1,198 (75.3%) experts replied. About 54% of those experts worked for universities; about 30% for public sector including NPRIs and about 16% for industry. Such a distribution of experts over the professional works had well reflected the distribution of R&D manpower in Korea. On the other hand, more than 60% of those experts had experiences in their field for more than 10 years, and more than 80% held a Ph. D.
11) The definitions of all terminologies were provided, to avoid different interpretations by the experts in the panel.
278 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy Finally, there had been a good deal of comments and suggestions through the Delphi rounds with feedback. Such interaction among experts had brought about a significant learning effect, although such effect is not tangible.
Thus, it is well observed that TF activities of R&D organizations are closely related to their own situations. Some place an emphasis on producing the S&T information simply for addressing S&T opportunities, while some do on the strategy formulation for their R&D activities. Somehow, this type of activities is the effort to adopt a proactive and rational approach to S&T activities including S&T resource allocation. Such activities have made a good deal of stimulation to others including industries.
The private sector was greatly influenced by the first Korean Delphi. Large scale firms have
Figure 3-2-9 | Delphi Procedure
PRELIMINARY STAGE Brain-storming in order tocollect ideas of technologies to be forecasted; Sending blank papers to 25,000 experts About 30,000 ideas collected from abouts 5,000 experts; reduced to about 9,000 technological topics to forecasted
PRE-FORESIGHT Constructing the TF committee and 12 subcommittees Reviewing 9,000 topics obtained from brainstoming and selecting 1,127 topics. Reviewing the questionnaires
MAIN-FORESIGHT Two-round Delphi being carried out by sending the entire set of Questionnaires to about 5,000 expert; about 1,600 returned in the first round and about 1,200 in the second round 47 topic added to the second questionnaires; totaled 1,174 topics. Each expert answered less than 50 topics of two areas on average.
paid greater attention to it, since their R&D investment keeps increasing. For example, the Korea Electric and Power Corporation (KEPCO) carried out in 1995 Delphi for its long term R&D planning with an assistance of the research team of the STEPI. About 400 topics in the area of electricity and new energy sources were dealt with for next 30 years. The Samsung and LG among others established and run their own team for technology forecasting in line with R&D management. Their major role is known as overall surveillance of S&T opportunities and formulation of S&T strategies. Recently, Samsung carried out technology foresight with a
279 Chapter 3 _ Industrial Technology Development Policy consultation of the Mitsubishi Research Institute. In this exercise, market forecast was taken into account for technology forecasting; using Delphi, statistical analysis and documentation of available information in combination.
However, the technology forecasting was firstly known to the public by the Delphi method, it is hardly accepted for a practice mainly due to greater costs for it and limited number of experts available by many R&D organizations, particularly small ones.
Finally, such a large scale Delphi (or extensive foresight exercise) has various effects besides producing strategic information. After the first Delphi exercise, it was realized that there had been a considerable learning effect among the participating experts. Many experts had not only an opportunity to observe the S&T development path in their own areas, but also a valuable experience to look over the information about the related S&T areas, information about the state of art R&D trends. After all, it was the most valuable that a consensus to some degree was obtained as a number of experts were participating in the exercise. It obviously led to precious decision information for the national S&T plan with a concerted recognition. Due to positive responses by both public and S&T community, a law was enacted that the Korean Delphi should be undertaken every five years. The fourth Korean Delphi has been issued so far.
4.4. National Technology Roadmaps (NTRMs)
Technology roadmaps are a technology forecasting and research planning tool. They encompass the opinions from a range of experts to help an organization develop a strategy for the future direction of research and development. Technology roadmaps tend to look at a time range up to five to ten years because this is as far as can be realistically discussed without becoming speculation. The roadmap provides a foundation for planning areas of development both with internal and external partners. Based on the exercise of the private corporate, the Korean government decided to undertake S&T roadmapping at the national level in 2003. We briefly discuss it in the following.
Figure 3-2-10 | Organization of NTRMs : First Phase
Secretariat to NSTC (Ministry of Science and Technology)
Committee of S&T related ministries
NTRM Commission S (Overall Decision-Making) U P P O R Steering Committee T (Work plan & carry-out)
Sub- Sub- Sub- Sub- Committee Committee Committee Committee A B C D
280 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy Figure 3-2-11 | Organization of NTRMs : Second Phase
Secretariat to NSTC (Ministry of Science and Technology)
NTRM Commission (Overall Decision-Making)
S U P Committee Committee Committee Committee Committee P Vision Ⅰ Vision Ⅱ Vision Ⅲ Vision Ⅳ Vision Ⅴ O R T
TFT TFT TFT TFT A B C D
The main purpose of the national technology roadmaps (NTRMs) is to derive the key technologies for increasing industrial competitiveness and economic growth, based on need analyses for future perspectives of industrial development and national strategies. As a national planning tool, the NTRMs would assist to make the national strategies in (1) promoting S&T development by selection and concentration, (2) maximizing synergy effect among industries, academe and GRIs, by pursuing concerted strategies and targets, and (3) maximizing the efficiency of utilization of limited S&T resources in provision a guideline for S&T international cooperation and strengthening S&T infrastructure.
The NTRMs were carried out in two phases. At the first phase, key technologies were selected for the realization of strategic products/functions, which were chosen to achieve the national S&T vision and goals derived from the national needs analyses for the future perspectives of industrial and social development. This was done by industries. That is, technological and non technological factors were identified to secure world competitiveness by 2012 in each industry. It took about 5 months, and reported to the NSTC.
The organization of the first phase for the NTRMs is exhibited in Figure 3-2-10. The Ministry of Science and Technology (MOST) as well as the secretariat to the NSTC was responsible for the entire exercise and after completion of the work it has to report the results to NSTC. The missions and overall decision making was designated to the NTRM commission on the one hand, and there was a committee of S&T related ministries on the other hand. If there would be any conflicts between different interest groups, this committee reviewed the issues and made coordination. This is inevitable because S&T involves many factors, technological or non technological, to influence the final foresight outcomes. For main foresight, there was a steering committee which made the work plan and looked over every detail. Below the steering committee there were several sub committees according to the S&T areas classified for the
281 Chapter 3 _ Industrial Technology Development Policy exercise. Throughout the work, all committees were supported by the support TFT which played a role as the moderator.
At the second phase, technology roadmaps were made for the key areas. The technology roadmaps included vision, technological alternatives, technological target, technological development over time, and other parameters. It was planned at the beginning that the roadmaps would be revised regularly.
Figure 3-2-12 | Concept of NTRMs
Technology
time
Products / Market
time
Infrastructure Legend Technology stage Degree of importance Product market R&D performing Technology development activity Technology development into products TInfrastructure for technology or product development
At the second phase, visions for the areas in consideration were derived. There were five visions for five areas. They are (1) information knowledge intelligence society, (2) society of healthy life, (3) environment/energy frontier, (4) value creation of fundamental and driving industries and (5) improving national security and national prestige. For each area the vision committee was created. The vision committee was responsible to guide making technology roadmaps for the area. Each vision committee had several TFT for the detailed work according to sub areas classified for the work. There was also the support TFT. It played a role as a moderator for the entire work process.
The conceptual framework for the NTRMs can be shown in Figure 3-2-12. In the figure, the vertical axis shows three categories such as technologies, products/market, and infrastructure. In the technology space, the trajectory of technological development is shown along the time path. So are in the products/market and infrastructure spaces.
282 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy Figure 3-2-13 | National Technology Roadmap (NTRM) : An Example
The arrows show the relationship between technology, products/market and infrastructure. On the other hand, some parameters, denoted by the rectangular and small circle, are indicated for the technological stage denoted a large circle. They could be the degree of importance, strategies of performing R&D and others. From the figure all the important strategic information can be read at a glance, but detailed interpretation can be reported in the full text version of the figure. Major parameters shown in the NTRMs are shown in Figure 3-2-13.
4.5. Technology Roadmaps (TRMs) in AFF&F
The agricultural sector of Korea is falling behind relative to other S&T sector. In addition, the Korean system has been changed completely with strengthening planning, evaluation and budget system for S&T sector, but the agricultural sector cannot manage to improve the their own system in accordance with evolution of S&T governance. By such reason, it can be hardly found that strategic R&D program is not well formulated, and evaluation and feedback system is not in good shape. There has been criticism thus that S&T governance in the agricultural sector has to be reformed and R&D programs have to set the strategic target in accordance of the national goal set by the incumbent government. In this line, the Ministry of Agriculture, Forestry, Fishery and Foods (AFF&F) decided to formulate the 5 year basic plan for AFF&F. This would be the first exercise of technology foresight in a full scale in the AFF&F area.
283 Chapter 3 _ Industrial Technology Development Policy Figure 3-2-14 | Characteristics of the Plan
Five Year S&T Basic Plan for Agriculture
Vision Key element
stategic technology Key element Assessment & Targets Future perspective Key element
Other S&T plans for Agriculture, Fishery, forest & foods
2nd National S&T Basic Plan
The 5 year basic plan for AFF&F should make up the deficiency of the former plans for AFF&F, particularly emphasizing the relationship between socio economic issues and strategic R&D programs for AFF&F. Also, the 5 year national S&T basic plan must be in consideration from the start of the project, because both plans have to pursue ultimate goals in the same direction. Therefore, as shown in Figure 3-2-14, the 5 year plan for AFF&F will cover from the left to the right just like the Second national S&T basic plan. The small inner box in the right hand side will be the unit of the program, which connects the socio economic issues. On the other hand, policy issues have to be dealt with for the successful programs.
Figure 3-2-15 | Process of Planning
Step 1.1 : Scope and Objective Necessity and scope of planning Phase 1
Preliminary stage Step 1.2 : Organizing committees and defining its role
Phase 2 Step 2.3 : Vision and targets Main foresight & Program vision & targets, and stategic issues planning stage
Step 2.4 : Selection of stategic technologies technology trees, selecting technologies and setting priority
Step 2.5 : Roadmap and Budget R&D target, time schedule and budget
284 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy Thus, the foresight study has two parts; strategic R&D programs in AFF&F on the one hand and policy issues to support those R&D programs on the other. The strategic R&D programs would be made for the areas of agriculture, forestry, fishery and foods. For the policy issues, we provided a number of policy recommendation for the five issues, such as (1) Improving S&T governance in AFF&F, (2) Increasing R&D investment and R&D investment efficiency in AFF&F, (3) Securing R&D manpower, (4) Promoting technology transfer and distribution, and (5) Developing regional S&T capability.
Figure 3-2-16 | Roles of Committees
S&T Committee
1 . Suggestions and relevancy 5. Allocation of of stategic resources program
Sub-Committees
2 . Section of 3 . Analyses of stategic and technology 4. Writing report key element trends and technologies level
The foresight procedure can be divided into two phases, preliminary stage and main foresight and planning stage. At the first stage, we defined the scope of the planning, according to which the work plan is made up. Thereafter, we classified the S&T area of AFF&F into sub areas. Based on such classification, we organized committees and define their roles. The roles of committees are defined and shown in Figure 3-2-16. S&T committee in AFF&F is responsible for suggesting direction of the planning and reviewing the relevancy of the strategic programs, meanwhile sub committees are responsible for selecting key technologies, analyzing technology trends and levels and writing report about the roadmaps. The organization of committees can be seen in Figure 3-2-17. On the other hand, we made a separate research team to deal with the policy issues.
285 Chapter 3 _ Industrial Technology Development Policy Figure 3-2-17 | Organization of Committees
Research Team S&T Committee
Agriculture Forest Fishery Sub-committee for production Sub-committee for botanical Sub-committee for Fishery Sub-committee for animal Sub-committee for forest environment and system resources resources
Figure 3-2-18 | Structure of the Program : Layers of Technologies
Prevention of Zoonosis
Program
Strategic Strategic Program A Program B Strategic Program C Diagnosis Treatment Vaccination
Stategy C1 Stategy C2
S&T Committee
Key element Key element technology technology C11 C12 Sub-Committee
286 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy At the second phase, assessment of current situation in AFF&F and some analyses about the trend of science and technology in AFF&F including the technological capability. Based on assessment and analyses, the future perspectives, S&T visions and targets are derived. The policy research team was responsible for the assessment and future perspectives, based on which committees derived the vision and target in accordance with the results of policy study.
Figure 3-2-19 | Process of Selection of Strategic Technologies
Selection criteria ●�Consistency Timing Trends in advanced countries ●� ●�Government support Socio-economic issues S&T Committees Vision &
targets Staregic technologies S&T Council for Expert panels Commeeittee AFF&F
Consulting R&D enviorments
S&T information in AFT&F Other plans
Before selecting the strategic and key element technologies, we reviewed the structure of the R&D programs. Possibly, the structure of the R&D program can described as in Figure 3-2-18. For example, consider the R&D program for“ Prevention of zoonosis.”Then, under the R&D program,“ Prevention of zoonosis,”there could be three strategic programs, such as diagnosis, treatment and vaccination. Then, each strategic program would have strategies C1 and C2, etc, at the lower level. Under those strategies key element technologies can be derived out. Thus, such a layer of technologies would consist of a R&D program. If we assume this layer has four levels, the upper two levels are accounted by the S&T committee, and the lower two levels by sub committees. However, in this exercise for AFF&F, we took account of only the top and bottom level, dropping out the two levels in the middle.
287 Chapter 3 _ Industrial Technology Development Policy Figure 3-2-20 | Process of Roadmapping
Future-oriented knowledge-based industry Development of agricultural technology for fossil-energy saving, labor saving and Developing agricultural industry leading production-cost reducing (▣◈◎, 63.9(6.0), C-N) Development of overseas production technology for agricultural products
development in AFF&F (▣◈◎, 57.5(7.0), C-P) Development of production and marketing technologies for exportable agricultural
the future products (▣◈◎, 63.2(6.2), C-P) Development of production and utilization technology for special livestock (▣◈◎, 57.9(6.9), C-N)
Development of next generation agricultural machinery and production technology (▣◈◎, 58.9(7.2), C-N)
Development of intelligent agricultural system and fusion technologies (▣◈◎, 64.3(5.7), C-N)
Development of bio-energy production technologies and system (▣◈◎, 56.5(7.2), C-N)
Degree of technological Importance, Economic importance, Degree of public interests, present technology level(%), and gap(years), Methods of performing R&D (1st & 2nd rank) Legend Methods of performing R&D Technological Economic Public
importance Importance interests U : university High ■◆● Medium ▣◈◎ N : national R&D institutes Low □◇○ R : GRIs, P : firms C : cooperative R&D
288 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy The process of selection of strategic and key technologies is time consuming and costly. It is because there are keen concerns and interests from different interest groups. Therefore, it is very important to build up a consensus for the final selection. Based on various sources and ideas of experts, we made a pool of candidate technologies and pass them over to the committees with other information including our visions and targets for AFF&F. The first selection is made from this pool of candidate technologies, in which we divide them into two groups, strategic technologies and key element technologies. Through the activities of expert panel and committees, the final selection was made, given some criteria, such as consistency with the vision and targets, timing and need for government support, etc. In this process, about 100 experts are involved and finally 95 strategic technologies and 438 key element technologies had been derived out.
To make technology roadmaps for those technologies, we employed one round Delphi it would be more preferable if more two round Delphi had run for various parameters. The survey parameters are the degree of economic importance, technological importance, consistency with strategic issues, and degree of public interest these parameters could be used for making priority setting criteria; technological levels for now and 5 years later, start year of R&D, and R&D period of time; stage of innovation and characteristics of R&D, etc. With those information obtained through the survey over more than 3,000 experts in the area of AFF&F, The final technology roadmaps are made, as seen in Figure 3-2-21.
As we discussed earlier, the technology foresight is firstly undertook in AFF&F. Most experts would not fully understand what the foresight is about. The final outcome of technology roadmaps could lead a criticism in its strategic approach. It is shown in Figure 3-2-21 that most of the R&D period of time continues ever without any difference over strategic technologies. Two interpretations would be possible for such outcomes. First, selection of strategic technologies would not be relevant in regard with strategic R&D programs. It would rather sub areas of technology in AFF&F. Second, it could be said that the expert opinions are biased seriously, such that each expert might put a greater emphasis on his/her own area. It would lead to the biased results.
All in all, however, the experts in the AFF&F community will have a learning effect throughout the exercise. They would learn also a lesson that the government will not increase the R&D fund if there is no strategic approach for the S&T development in AFF&F. Making technology roadmaps and strategic R&D programs in the public sector has also an influence on the management of government research institutes. Therefore, it would take a longer time period for the rational S&T planning. It improves as exercise goes over and again.
289 Chapter 3 _ Industrial Technology Development Policy 5. Guidelines for TF Exercise for Vietnamese S&T Foresight 5.1. A Framework for S&T Planning at the National Level
The flow of S&T planning is shown in Figure 3-2-22. At first, the national goal was set in view that the national economy would have been moving toward a high tech society in the future, pursuing the quality of life and reinforcing competitiveness through increasing S&T capability. Usually the national goal is given by the incumbent government or ruling party. Given the national goal, it is necessary to make a forecast of the future environment. For this, socio economic and technology forecast will be required. Thereafter, evaluation of S&T capability will locate the current situation of the economy in consideration, and of course it goes with the evaluation of the past performance. Based on them, technological interpretation has to be made to set the S&T targets and strategies. This part of planning will make relevancy of the S&T plan in accordance with the ultimate goal of the government dealing with socio economic issues within a period of time.
Evaluation of past Evaluation of S&T performance capability
S&T targets
S&T strategy
Programming S&T system and R&D resources major areas policy
•R&D investment •Information •National •R&D manpower technology innovation system •S&T information •biotechnology •Industrial clusters •Others •manufacturing •Globalization technology •Support policies •Others for SMEs •Others
S&T Plan
290 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy To achieve the national goal and S&T target, three approaches should be considered, such as R&D resources, S&T system and policy and Programming major areas of science and technology. The R&D resources includes R&D investment, R&D manpower, S&T information and others, and the S&T system/policy does, for example, efficiency of national innovation system, industrial clusters, Globalization, innovation activities of SMEs and others. These two approaches are very important to make the successful S&T programs. Major R&D programs can be made, for example, information technology, biotechnology, manufacturing technology and others. The major R&D areas are derived through time consuming and costly foresight activities. If the R&D or S&T programs are determined and approved with relevant policy alternatives for the R&D resources and S&T system, a complete S&T plan will be finally made out.
In this flow, a number of factors interact with one another and requires analysis. Therefore, it is important to make a careful work plan and budget allocation. Sometimes, making S&T plan places greater emphasis on the process of planning. The final S&T plan provides strategic information for the nation S&T development, but there are many effects and consequences in the process of planning. Since many S&T experts are involved in the foresight or planning activities, significant learning effects are easily observed among the experts and experience in many countries. Information dissemination has a positive effect in formulation future R&D projects. Consensus building is also significant effect to secure R&D fund form the budgetary authority. Thus, making S&T plan is not only important for producing strategic information but also for other effects in the process, which has greater effect on national S&T development if any country has a better foresight framework in a systemic way.
5.2. Foresight Procedure
5.2.1. Preliminary Stage
The purpose of the technology foresight has to be well defined and specified. Since technology foresight produces decision information for the S&T strategy, it is needed to understand the key information available for the decision. Not all information is required for the decision making. Even if all information is available, it will be costly to make an analysis of the information relevant to the decision making. Thus, clear understanding of the purpose of the TF exercise is important, and also it leads to the scope of the TF exercise. If the purpose of TF exercise is related to application and development of industrial technologies, then the basic research might be excluded in the TF exercise in consideration.
Available resources must be secured for the TF exercise. Broadly speaking TF resources are a pool of experts and budget, etc. As discussed in the Korean exercises, the consensus building is one of important consequences throughout the TF exercise. It is because there are involved many interest groups in science and technology always. Another reason that the TF exercise
291 Chapter 3 _ Industrial Technology Development Policy requires a pool of experts is that two brains are better than one. More information would be available, and eventually throughout the exercise there would a sizable learning effect over the participating experts. One of byproducts of the TF exercise is a database of the experts in the area considered. Finally, the time period for the TF exercise has to be considered. Although a decision is imminent, the result information of TF cannot be ready. TF exercise is a time consuming work.
When the purpose, TF resources, and work period among others are well defined and secured, we have to select TF method. It could be a single method, either the exploratory or normative methods, or combined method. Suppose that we select TRM as a TF methodology. We can combine other methods into the TRM, just like Korean case for TRM in AFF&F. It is noted, however, that the TF method is a tool to achieve our purpose of TF exercise. It has to be avoided putting the TF exercise into the method. If the TF work is defined well, we can choose a method sometimes we need a consulting service from a TF expert.
5.2.2. Main Foresight
To start the TF exercise, it is necessary to organize workforce, such as committees, moderator, and support team.
The purpose of the TF exercise is well defined by the moderator and support team, who also has authority to dispense the secured TF resources. However, the moderator and the support team might not have expertise in science and technology. Actually, it does not have to be so. If any member of the moderator and support team is an expert in a specific area of science and technology, s/he might have a bias toward a certain area of science and technology. The moderator and support team need to be neutral in science and technology, and if they need special knowledge in science and technology they can obtain it from outsider such as committees and/or other experts.
Once the organization of TF is completed, the first assignment is to derive what to forecast. This is a difficult process. It might be said that‘ what to forecast’could be borrowed from advanced countries, because they are a few steps ahead in science and technology. However, the relevancy of‘ what to forecast’in the advanced countries is not satisfied for the developing countries in consideration. It is because S&T endowment of a country would be different from one to another, and also their economy may have different attributes and competing edge. If S&T development is something to be made within a border of a country, S&T experts of the country will play a key role for the S&T development. Those experts are the ones who bring all information of S&T in advanced countries and who make S&T ideas to be realized in its own country. Therefore, it is very important to make as many as S&T experts participate in the TF exercise. In this sense, a strong political leader could not indicate‘ what to forecast,’but make a strong support.
292 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy Figure 3-2-23 | The Roles of Committees
Roles of Committees
S&T Committee Sub-Committees
□�Function and role □�Function and role �Advice for the direction of �Selecting strategic issues and targets planning �Selecting strategic technologies and �General framework and relevancy key element technologies of the process and foresight results �Report writing for strategic program �Advice for sub-committee's activities including TRM - Selecting strategic technologies - TRM - Others □�Structure and management �Balanced recruit of expert from academe, industries, research institute □�Structure and management �Meeting whenever needed�costly & �Balanced recruit of expert from time-consuming activities academe, industries, research institute �Meeting whenever needed
In general, to produce‘ what to forecast,’large scale brain storming might be helpful. For it, the greater number of S&T experts would be participating, and then it is easier to build a consensus about‘ what to forecast.’Otherwise, it is usual to run the committees to bring out ‘what to forecast.’If this is the case, the moderator/support team has to provide more updated information about S&T trends. From various sources, candidate technological topics can be selected and put on the table of the committee for the discussion. If the final selection of technological topics is made, it is ready to move to the next step.
The second assignment is to produce TF results. To produce decision information, we might consider a number of parameters to be investigated. It has to be careful to put the parameters for the exercise. It is noted that the moderator or supervisor of the exercise sometimes includes irrelevant parameters just for curiosity. However, TF results cannot provide answers to all the questions. When the moderator makes a plan for TF exercise, he has to remind himself what are the most important information for the decision making.
293 Chapter 3 _ Industrial Technology Development Policy Figure 3-2-24 | Stages of Technology Foresight
● Define work ● Purpo se ● Scope Preliminary Stage ● TF resources ● A pool of experts ● Budg et ● W o rk period ● M ethodology : Delphi, TRM , Delphi+ TRM , etc.
● Work organization ● Committees ● M o derato r / supp o rt team
● Derive and select what to forecast ● Key techno lo g ies Main Foresight ● Po licy issue s / strateg ies
● Pro duce TF results ● Realization time ● Reso urces req uired ● R&D strategies and support policies
Post Foresight ● Use and dissemmination of TF results
So far, the moderator derived technological topics and parameters investigated. Various TF methods are available. In case of Vietnam, there is a big pool of S&T experts, relative to other developing countries. This implies that the moderator of TF has a flexible choice over the TF methods. The pool of S&T experts is even enough to run a large scale Delphi in Vietnam. Thus, it could be possible to run a Delphi study, technology roadmaps, and a combined method, etc. If the moderator has no experience to use the method in consideration, a consulting service from the TF expert would be helpful.
After the TF exercise is completed, it has to be reported for the decision making body of the government. The final report has to take into account that the decision making of the government includes social and political processes. Thus, packaging the final outcome of the exercise is important to convey the essence of the TF to the right persons in a right way.
5.2.3. Post Foresight
It is why use and dissemination of TF results are important. First it has to be relevant to the higher decision making over the S&T activities at the government level, which leads to resource allocation. If the TF exercise is more persuasive, the more resource would be allocated for S&T activities. This is why TF results have to go to the public for wide range dissemination.
294 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy On the other hand, the dissemination of TF has also very important influence on the firm’s behavior. If TF exercise produces good information, more S&T experts had participated in the TF process and more resources are allocated in science and technology, the private sector makes an expectation formulation toward S&T development suggested by the TF results. Then, the private firms will make investment in science and technology, facing the improved S&T environment.
Finally in the process of TF many experts are participatory and hence they realize that there has been a sizable effect of learning. It stimulates S&T experts who are engaged in S&T activities, and eventually increase their performance in the labs.
There are many effects we can expect from a TF exercise. But it is difficult to achieve everything from the beginning. Undertaking TF exercises over and again, TF will become one of key factors for S&T development in a country. If any deficiency is found in the TF exercise, it can feedback to the next exercise, and makes an improvement.
6. Concluding Remarks and Policy Suggestions
So far, we had discussion about the Vietnamese capacity of S&T foresight and Korean TF experiences. In the knowledge based economy, every major problem facing the country has a S&T component, either as a cause and cure, in general, and S&T plays a critical role in economic growth in particular. The rational approach to S&T development is necessary as innovation takes place in a complex way. This is why S&T foresight is important. S&T foresight is planning by learning by interacting in consideration of various factors surrounding science and technology.
In Vietnam, it seems that the capacity building for technology foresight is urgent in the public S&T system, like other developing countries. In addition, R&D investment of the government sector is very low, although the country has sizable R&D manpower including universities and research institutes. Probably, this is the main reason that Vietnam has some difficulties in practicing S&T foresight. Vietnam as a late comer should pay a greater attention to S&T foresight to speed catch up. It is because more resources of science and technology can be mobilized and deployed more effectively through S&T foresight
On the other hand, we reviewed some Korean exercises of S&T foresight. It is learned that Korea’s R&D investment had rapidly increased since mid 1990s, in which S&T foresight had been successfully introduced and greatly supported by the public. Since then, the rational R&D planning at the national level became increasingly important, and it was backed by S&T foresight in a systemic way. The foresight in Korea also stimulated scientists and technologists, and considerable learning effect was observed among the participants in the foresight. This was
295 Chapter 3 _ Industrial Technology Development Policy the unexpected results. All in all, it is the foresight activity that has made a major contribution to the S&T development in Korea. Such a lesson has important implications for the Vietnamese S&T foresight in the future.
As a consequence, some policy recommendations can be made for the S&T foresight as follows. ¥ Building up the national capacity of S&T foresight ¥ Practicing S&T foresight in a small scale and accumulating experiences ¥ Securing resources for S&T foresight including the database of R&D manpower and budget ¥ Training the manpower for the S&T foresight ¥ Using foreign resources in the beginning of S&T foresight, if needed, including TF consultants and participating panel. ¥ Promoting international cooperation in S&T foresight ¥ Disseminating foresight results going to the public
It is also pointed out that a consensus building is very important in S&T foresight. Therefore, various factors surrounding science and technology must be in consideration, such as social, economic, political, environmental and ethical factors, etc. Those factors have an increasing influence on S&T development.
In the final note, if there is an opportunity for Korea-Vietnam cooperation in S&T foresight activity, a joint practice of S&T foresight could be undertaken in a small scale, so that the Vietnamese experts may be exposed to foresight practice for later application on their own. It is observed that many Southeast Asian countries attempt to undertake technology foresight but they have great difficulties in implementation, because of no experience, less resources and low perception of its importance. To increase TF capacity in this area, the APEC center for Technology Foresight had established about 15 year ago and has run a training program. There might be an opportunity for an international cooperation through the APEC Center.
296 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy References
Branscomb, L.M. & Choi Y.H., Korea at the Turning Point; Innovation Based Strategies for Development, Praeger, London, 1996.
Bright, J. (1978), Practical Technology Forecasting: Concepts and Exercises, Austin: Industrial Management Center.
Gaudin, T. (1995), 2100, Our Species’Odyssey, Montiers: Foundation 2100.
Grupp, H. (1996),“ Foresight in Science and Technology; Selected Methodologies and Recent Activities in Germany,”STI Review, No.17, pp.71-99.
Jantsch, E. (1967), Technology Forecasting in Perspective, Paris: OECD.
Kuwahara, T. (1996),“ Technology Foresight in Japan; A New Approach in Methodology and Analysis,”STI Review, No.17, pp.51-70.
Martin, B. (1996),“ Technology Foresight; A Review of Recent Government Exercises Summary Report of the OECD Meeting Held on 14 September 1994,”STI Review, No.17, pp.15-50.
Martin, B.R. & J. Irvine (1989), Research Foresight: Priority Setting in Science, London: Printer Publishers.
Martino, J.P. (1993), Technological Forecasting for Decision Making, 3rd Ed., New York: McGraw Hill.
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OECD (1996), Science, Technology and Industry Outlook 1996, Paris: OECD
Shin, T. & Kim, H. (1994),“ Research Foresight Activities in Korea and Technological Development; S&T Policies in National R&D Program,”Technological Forecasting and Social Change.
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Shin, T. (1998),“ Using Delphi for a Long Range Technology Forecasting and Assessing
297 Chapter 3 _ Industrial Technology Development Policy Directions of Future R&D Activities in Korea,”Technological Forecasting and Social Change, Vol.58, pp.125-154.
Shin, T., J.H. Park, K.H. Jung & H.S. Kim (1994), The First Science and Technology Forecast Survey; Korea’s Future Technology, Seoul: STEPI.
Tegart, G. (1998),“ Technology Foresight; Philosophy & Principles,”in NSTDA, Thailand (1998), Application of Technology Foresight, Bangkok.
298 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy Chapter 03 Strengthening the Incentives for R&D and Technology Transfer
Joonghae Suh Korea Development Institute (KDI) Tran Ngoc. Ca, National Institute of Science & Technology Policy & Strategy Studies (NISTPASS), Ministry of Science & Technology of Vietnam
1. Introduction
The acquisition and creation of technological capabilities are basic requirements for the continued growth and development of national economies. The patterns of technological change, however, will be different according to each country’s specific economic situation and overall social environment. The differences between developing and developed economies are a salient example. One of the great differences for underdeveloped and developing economies is the availability of a stock of advanced technology to draw on. The experience of Korea provides a good case for the study of the role of foreign technology in late comers’economic development1). Devastated by 36 years of Japanese occupation and the Korean War, and mired in deep poverty until the early 1960’s, the Korean economy grew at an average annual rate of nearly 9 percent in real terms from 1962 to 1991. It is well known that Korea’s rapid economic growth has been achieved through aggressive export-promotion policies. But a natural question is: how did Korea compete in foreign markets? Where did technologies for the exporting products come from? How has Korea been successful in climbing up the quality ladder in her export products? As Amsden (1989) characterized Korea’s industrialization processes as ‘industrialization through learning‘, the Korean economy has heavily depended on foreign technology throughout its industrialization period. Studying the learning mechanism will be very helpful in understanding the industrialization processes of developing countries in general.
1) The main focus of this paper is not on the overall industrialization processes but on the technological aspect of industrialization. There is vast literature covering whole periods of Korea’s industrialization. For comprehensive treatment, among others, see Mason, et. al., (1980), Amsden (1989), and Sakong (1993).
299 Chapter 3 _ Industrial Technology Development Policy Before the 1980s, Vietnam had been a centrally planned economy where production activities were heavily dependent upon government’s subsidy. Therefore R&D investment and technology transfer in the production sector had been passive to follow on the directions from the government. Every activity was based on the government’s plans and there were no policies to encourage social economy sectors to participate in R&D activities and technology transfer.
Since the 1980s, with the“ Renovation”policy, Vietnam has been transformed into a socialist market-oriented economy. The transition from the planned economy to the socialist market economy necessitates more systematic support for industry’s technology development activities. Taking this into account, the Vietnamese government has introduced many measures and policies to encourage industrial enterprises to invest in R&D and technology transfer. Not with standing that its scale is not as big as in more advanced countries, those policies aim to help increase, enterprises’competitiveness and ability to create new products and new technology for socio-economic development, especially in furthering the industrialization and modernization of the country.
As Vietnam is entering into a new era of economic development, it is of significant importance to accumulate her own indigenous technological capabilities. Although it is too early to assess the effect or the effectiveness of various policies that the Vietnamese government has implemented over the years, it will be very useful for policy makers to juxtapose the development experiences of Korea with that of Vietnam. This chapter will first give a brief review of the Korea’s industrial technology development process. The focus here will be on the interplay between imported technologies and indigenous efforts: how intensively Korea has endeavoured to adapt and learn foreign technologies. Based upon the review, section 3 will juxtapose policies in two countries. This section will show that, despite the differences of development stages, Vietnam is pursuing industrial technology development policies similar to that of Korea’s. The comparison will give some clue for Vietnam where to put more weight in its R&D policies in order to enhance effectiveness. Section 4 contains some cases of successful learning from international technology transfer. The cases will give good guidance to the directions of future policies.
2. Industrialization and Technology Development: The Korean Experiences
When Korea first launched its industrialization drive, it was a typical poor developing country with lack of resource and production base, small domestic market, and a large population, depending on foreign powers for national security. The economic situation in the early 1960s in Korea was more than bleak: Korea’s GNP in 1961 was only 2.3 billion US dollars (in 1980 prices) or 87 US dollars per capita. The main source of income was the primary sectors, with the manufacturing sector accounting for only 15% of GNP. International economic
300 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy interactions were also very limited. In 1961, Korea’s export volume was only 55 million US dollars and imports 390 US dollars. All these state that Korea was then one of the poorest countries in the world, suffering from all the socio-economic problems that poor countries faced in those days.
Scientific and technological situation was even worse. There were only two public institutions for scientific research and technological development: the National Defense R&D Institute created right after the end of the Korean War, and the Korea Atomic Energy Research Institute which was founded in 1959. On such basis, the Korean government invested 9.5 million US dollars on R&D in 1963, employing less than 5,000 research scientists and engineers. So, as far as science and technology was concerned, Korea was no more than a barren land.
2.1. Technology Acquisition for Industrialization
In 1962, Korea launched the first Five-Year Economic Development Plan. This and the subsequent plans created huge demand for new technologies that were in no way available from domestic sources. Lacking in technological capability, Korea had to rely almost completely on imported foreign technologies. In this respect, Korea pursued two objectives at its early stage: promoting the inward transfer of foreign technologies and developing domestic absorptive capacity to digest, assimilate and improve upon the transferred technologies. Of various alternative channels for technology acquisition, such as foreign direct investment (FDI), foreign licensing (FL), and turn-key plant importation, FDI is often advocated as the most effective means for developing countries to acquire new production skills and management expertise. Unlike in other developing countries, however, FDI played less important role in Korea as a source of capital and technology. In contrast to the minimal contribution of FDI to Korea’s acquisition of foreign technologies, arm’s-length methods such as reverse engineering, original equipment manufacturing (OEM), and foreign licensing (FL) have been critical in transferring technologies and supplementing local efforts.
Korea resorted to long-term foreign loans to finance industrial investments. The Korean government brought in large-scale foreign loans and allocated them for investments in selected industries, which led to massive importation of foreign capital goods and turn-key plants. To acquire necessary technologies, industries later reverse-engineered imported capital goods.
Private companies’responses to such restrictive policies varied across industries. In the case of light industries such as shoes, clothing, textiles, and some intermediate goods for import substitution as well as export, the major sources of technological learning were OEM (original equipment manufacturing) production arrangements and technical training as part of turn-key base plant importation. Korean firms benefited the most from the OEM production arrangements because they offered opportunities to work with foreign buyers who provided
301 Chapter 3 _ Industrial Technology Development Policy everything from product designs and materials to quality control at the end of the production. This was especially so in the case of garment and electronic industries. (Hobday 1995)
Table 3-3-1 | Foreign Technology Transfer to Korea, 1962 2006
During the 1970s, Korea made massive investments in machinery and chemical industries. For the development of chemical industries, Korea relied largely upon turn key plant importation, which included technical training programs as part of the packages. In the case of heavy machinery, FL was an important channel for technology acquisition. (Chung and Branscomb 1996) To compensate domestic industries for their technological weakness, the government created GRIs in the fields of heavy machinery and chemicals, such as the Korea
302 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy Institute of Machinery and Metals (KIMM), the Electronics and Telecommunications Research Institute (ETRI), the Korea Research Institute of Chemical Technology (KRICT), the Korea Research Institute of Standards and Science (KRISS), the Korea Institute for Energy Research (KIER), the Korea Ocean R&D Institute (KORDI), etc. These institutes worked with private industries in building technological foundation for industrial development.
In short, Korean industries were dependent more upon informal channels for technology acquisition than formal channels. The Korean approach to technology acquisition resulted in both positive and negative effects. On the positive side, this policy enabled Korea to acquire technologies at lower costs, and precluded the constraints often imposed by multinationals on local firms’efforts to develop their own capability. The approach was effective in maintaining independence from the dominance of multinationals. Negative effect is that Korea had to give up an important access to new technologies that might have been available through direct equity links with foreign firms. By restricting FDI, Korea failed to set global standards in domestic business operation. Much worse, large scale foreign loans that had been brought to finance the massive importation of capital goods, plants and FL contributed to the financial crisis in 1997.
2.2. The Growth of Domestic Technological Activities
As industrial development continued into the 1980s, the technological requirements of Korean industries became more complex and sophisticated. At the same time, advanced countries began to view Korea as a potential competitor in the international market, and, therefore, foreign companies became increasingly reluctant to transfer new technologies to their Korean counterparts. To facilitate international technological interaction of private industries, the government loosened its regulation of FDI and liberalized FL during the 1980s. However, the deregulation and liberalization did not lead to significant increases in FDI inflow and FL.
The government viewed this as a signal that to sustain the development, it is imperative to build indigenous R&D capability. The government launched the National R&D Program in 1982 and took various policy measures to promote and facilitate private R&D activities. Private industries responded to the policy by investing massively in R&D. Thus, the relationship between technology imports and R&D changed. The ratio of technology imports to business R&D declined sharply from about 40% in 1981 to 20% in the mid 1980s and to 10% in the early 1990s. This implies that Korean industries turned to indigenous R&D for technology acquisition. R&D investment has since then undergone a quantum jump. Korea‘s R&D investment, which stood at only 368.8 billion Won (526 million US dollars, 0.81 % GDP) in 1981, rose to 10,878 billion Won (13.5 billion US dollars, 2.8% of GNP) in 1996, to 13,848 billion Won (12.2 billion US dollars, 2.7% of GDP) in 2000, and to 19,068 billion Won (16 billion dollars, 2.6% of GDP) in 2003. Over a period of twenty years, investment in R&D increased almost twenty seven times, with an average annual growth rate of almost 20%. Korea invests in R&D a lot more than others with the same or higher level of income. Korea now is
303 Chapter 3 _ Industrial Technology Development Policy the 6th largest spender in R&D among OECD countries.
Such a phenomenal increase is largely attributed to private industries. In 1981, the government accounted for 53.5% of the nation’s total R&D investment, but the government’s share declined to 19.4% in 1990. The government’s share further decreased to 16% in 1994, but the tendency was a little reversed afterwards and the figure went up to 24.5% in 2002. Now, the private sectors account for 75% of the gross national investments in R&D. As private industries lead R&D investment, R&D activities in Korea are very much focused on applied research and technology development, reflecting the interest of private industries. In the 1980s, about 83% of R&D funds were used for applied research and technology development, but the share increased to 87% in the 1990s. Korea spends far less on basic research than advanced countries, such as the US, Japan, France and Germany. The general tendency is that the richer a country, the more it invests in basic scientific research. But Korea’s investment in basic scientific research has declined over time despite the economic growth, which is against the conventional anticipation.
There may be many factors that have contributed to the rapid increase in private sector R&D investments, but basically such an increase has been possible because Korean firms have been put under market pressure for technology development. The government contributed to such development in two indirect ways. First, the outward looking development strategy (export drive) of the government drove domestic industries out to the international market, putting them under fierce competition. In order to survive the competition, they had to keep up with technological changes by investing heavily in R&D.
Second, the government’s industrial policy that favored large firms gave birth to a unique business organization in Korea,“ Chaebol,”that is similar to“ Zaibatsu”of Japan before WW II. Chaebols enjoy greater financial affluence owing to the economies of both scale and scope of their business operation. Chaebol companies, which are usually big international operators, have deeper pockets and are able to engage in risky and expensive R&D projects that are even unthinkable for small and medium sized firms. This is well explained by the fact that top twenty firms make about 57% of the total industrial R&D investments in Korea. (KITA 2004)
Most importantly, Korea has been able to increase R&D investments at such rapidity, because it has an abundant pool of highly educated manpower that could meet the increasing demand for research and development services in both private and public sectors. Considering the fact that R&D investment is more constrained by the lack of human resources than financial limitation in both developed and developing countries, we can say that Korea prepared itself well for development by investing heavily in education and human resource development.2)
2) There are cases where R&D investments are constrained by the shortage of suitable manpower. OECD (2003) emphasizes the importance of the supply of skilled scientists and engineers as one of the framework conditions for achieving R&D spending target.
304 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy R&D in Korea had been growing rapidly and continuously until Korea was hit by the financial crisis in 1997. R&D was one of the most damaged victims of the crisis. In a survey undertaken in early 1998, many companies responded that they would cut R&D investments and R&D personnel by almost 20% in response to the crisis. Actually, industrial R&D expenditures decreased by 10% in a nominal term from 884.4 billion Won in 1997 to 797.2 billion Won in 1998, and R&D personnel by 15% from 102 thousand in 1997 to 87 thousand in the next year. This was a serious blow to the Korean innovation system. If the crisis had continued several more years, the Korean innovation system would have collapsed. Fortunately, however, Korea recovered from the crisis in a relatively short period of time: it took only two years for the industrial R&D to recover and rise over the level prior to the financial crisis.
There are two factors behind this development: one is the government’s efforts to make up for the decrease in industrial R&D expenditures by increasing government R&D expenditures. The share of government in the gross R&D expenditures increased from less than 20% before the crisis to 27% after the crisis. Government R&D funds flew into private industrial sectors, in particular, small technology based firms and helped them maintain and expand innovation activities. The other is the promotion of IT and IT related ventures that led to an IT boom in the early 2000s. The government’s commitment to IT development is well reflected in the fact that the share of IT in government R&D expenditures rose to 33.5% in 2002 from 13% in 1997.
305 Chapter 3 _ Industrial Technology Development Policy Such a pro IT policy fuelled innovation in IT sector, which then affected innovation activities in other sectors. This policy not just helped the Korean innovation system recover vitality but also resulted in promoting Korea’s transition toward an information society.
Rapid growth in R&D investment has led to a remarkable increase in patent registration. The number of patents granted by the Korea Industrial Property Office (KIPO) increased from 1,808 in 1981 to 120,790 in 2006, with an average annual growth rate of about 17%. What is more encouraging is the growth of patents granted to Koreans. The proportion of the patents granted to Koreans was only 12.8% of the total patents registered (or 232 in number) 1981, but the figure rose to 73.9% in 2006, recording an average annual growth rate of over 24%.
US patent is sometimes used as an indicator of international technological competitiveness of a nation. The number of US patents granted to Koreans was only five in 1969, but grew to 543 in 1992, and to 2,763 in 2001, putting Korea at the seventh place in the world. According to a patent analysis by the US Department of Commerce, Korea has established world prominence in technology areas such as information/telecommunication, pharmaceuticals, advanced materials, and automotive. These indicate that Korea has been rapidly gaining technological competitiveness. Another important development is the remarkable increase in the number of scientific publications in the internationally recognized academic journals. The number of scientific publications by Koreans reported by the Science Citation Index (SCI) increased from a mere 27 in 1973 to 171 in 1980, 1,227 in 1988, 9,124 in 1997, and 15,705 in 2002, raising Korea’s place from 37th in the world in 1988 to 15th in 2002. Although Korea still lags far behind advanced countries in scientific publications, it recorded the highest growth (24.2% per annum during the period of 1973 to 2001).
R&D efforts have also contributed to the development of high tech industries in Korea. Based on in-house R&D, Korean industries have recently emerged as world leaders in semiconductor memory chips, cellular phones, and LCD, and also established themselves in the world market in the areas of shipbuilding, home appliances, automobile, telecommunication, and so on.
306 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy 2.3. The Process of Building Technological Capabilities
Reviewing the process of industrialization since the 1960’s, there appears a general pattern of technological development across industries with some industry specific variations. Table 3- 3-4 presents the pattern in Korea’s machinery industry. The Table shows that technology transfer and in-house R&D are two principal modes of building technological capability in machinery sector and other industries in general. During the early stages of industrialization, technologies are imported in packaged forms. Turn-key based plant imports were most common during those years. And assembling technologies were imported for the purpose of knock-down production and/or OEM. Then, afterwards, self sufficiency of technology was enthusiastically pursued, although it was not achieved in a short period. Localization of some technologies was one of the main goals both for government and the private firms. In this period, imported technologies changed to unpackaged ones and the importation of operation technology increased in order to enhance the productivity. After achieving, in some extent, the goal to promote self reliant technologies, the next step was to let Korean products enter into the world market. In doing this, expansion of domestic market was required. In this period, imported technologies are relatively more sophisticated and advanced, and material related technologies and control and design technologies areimported. Throughout whole period, the ratio of OEM to own brand name (OBN) steadily decreased.
Table 3-3-4 | Technological Capability Building Process in Korea's Machinery Industry
The process of Technology imports Production and R&D development
■ Policy goal: establishment ■ Packaged technology: ■ Knock-down type of production base turn-key based plants production system 1960s ■ Characteristics: heavy ■ Assembling technology ■ OEM-dominated -1970s dependence on imported ■ Almost no in-house R&D technologies
■ Policy goal: promotion of ■ Unpackaged technology: ■ OEM/own brand: high ratio Early self-reliance parts/components-related ■ Product development 1980s ■ Characteristics: Import- technology ■ In-house R&D starts substitution, localisation ■ Operation technology of parts/components production
■ Policy goal: export- ■ Materials-related ■ OEM/own brand: low ratio Late promotion by means of technology ■ Product innovation 1980s expansion of domestic ■ Control technology ■ Process improvement -1990s market ■ Design technology ■ Characteristics: beginning of plant exports, learning advanced and core technologies
307 Chapter 3 _ Industrial Technology Development Policy The pattern of technology transfer differs slightly across industries, particularly in the early years. Unit production industries, such as shipbuilding and machinery, mainly relied on formal transfer in the form of licensing and consultancy for the initiation erection of production facilities and product design. Mass production industries, such as electronics and automobiles, also depended on formal transfer but to a lesser extent. Instead, more emphasis was placed on engineering for implementation. Continuous process industries, such as chemicals, cement, paper, and steel, were established on a turn-key basis.
Since then and throughout the 1970s and 1980s, technology imports prevailed, and it is still an important tool for technological innovation. Recently, however, the outsourcing of foreign technologies has become more sophisticated, and the modes of technology transfer have diversified and became complex. Exchanges or alliances, for the mutual benefit of both parties, are beginning to take over unilateral technology imports. Further, interest in foreign technologies is shifting towards more high tech areas and/or design technologies, and the scope of foreign partners has widened considerably.
The growth pattern of private sector’s R&D activities is also similar to what is outlined above. During the earlier period of industrialization, systematic in-house R&D efforts were hard to find out. It was not until the 1980s that Korean firms endeavored to make efforts to build in- house technological capability. In the early 1980s, R&D activities of private firms were closely related to adaptation and assimilation of imported technologies. Product development was the main feature of R&D in those years. Afterwards, based on accumulated experiences and knowledge, a number of firms in some specific industries have been able to make product innovation. Efforts to improve production process continued.
The pattern outlined above can be clearly illustrated by figure 3-3-1. Figure 3-3-1plots the trend of the relationship between technology imports (TI) noted as payment for foreign technology licensing fees and indigenous R&D efforts noted in terms of R&D expenditure over industrial production from 1973 to 1993. Over the years the trend changed substantially. Until the early 1980s, indigenous R&D efforts had remained at an insignificant level; but afterwards R&D intensities have increased considerably. Consequently, the overall relationships between imported technologies and indigenous R&D effort changed from substituting to complementing.
308 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy Figure 3-3-1 | The Changing Relationship between TI and R&D
2.5 1994 200 2 199 8 199 6 2.0 2000
BERD / Sales 199 2 199 0 1. 5 198 8 198 6
1. 0 198 4
198 2 1978 0.5 1980 1976
0.0 0 2 0 40 60 80 100 120 Royalty Payment / BERD
2.4. Policy Example: What Happened at the Year of 1982?
As figure 3-3-1 indicates, the trend in the interaction between imported technologies and indigenous R&D effort changed around 1982 from a substituting relationship to a complementary one. The turning is not accidental; the year marks the launch of the first national R&D program (NRDP), and during that year private enterprises began to establish in house R&D laboratories. The year is also memorable in that the share of the private sector’s R&D spending reached 50 percent of the national total and continued to increase rapidly. Some of the government’s initiatives were instrumental in the change. The Ministry of Science and Technology’s newly introduced“ Special R&D program,”Korea’s first NRDP, aimed to implement a nationwide, full scale technology development strategy. A year before, the Technology Development Promotion Act was revised to be the legal basis of the special R&D program. The revised act came into effect, with a new clause stating government’s direct financial support for corporate R&D centers. The Military Service Law was also revised in that year to include a special army service exemption for qualified engineers and researchers who opted to work in public and private R&D centers. The government initiatives that supplied financial and human resources, coupled with technology development programs, triggered a burgeoning of R&D activities by private enterprises.
3. Supportive Measures for Industrial Technology Development 3.1. The Korean Experience
309 Chapter 3 _ Industrial Technology Development Policy Korea has implemented various kinds of policy measures that aim to promote industry’s technological activities. These measures can be broadly classified by their characteristics into four schemes: national R&D programmes (NRDP), infra structural programmes, institutional support system, and incentive system. Government’s industrial technology policy has focused mostly on technology programmes, and other policy measures played a minor role. For example, as of 2000, government as a whole spent 3 trillion won in NRDP, which accounted for 82% of the government’s total R&D budget. To complement mission oriented NRDP, the government has other policy measures that intend to enhance technology diffusion and fill the institutional gap between innovation actors. The list of policy tools for such objectives includes educating and training research personnel, compiling and diffusing technical information, encouraging cooperative R&D by establishing cooperative R&D facilities and promoting spin off activities from public research. The direct funding from the government budget to GRI is classified as“ Institutional Support.”The budget of GRI is in general composed of two sources: on the average, one third of GRI budget is funded directly by the government and the rest is filled with revenues from contract research. Incentive measures are to induce and assist private enterprises’technology development activities. The list includes tax exemption for firm’s R&D spending, financial support with preferential loans, and subsidy of technology development.
Table 3-3-5 | The Scheme of Korea’s Industrial Technology Policy
National R&D Infra-structural & Institutional Incentives Programmes Diffusion Support
To induce/assist To develop To enhance intermediary To nurture GRI and private generic functions and to fill the to strengthen GRI’s enterprises’ Objectives industrial gap among innovation research tech. technologies actors capabilities development activities
Research personnel, Funding for GRI’s Tax-exemption Ministries’ technical information, operational Financial support Tools R&D coop. R&D facilities, expenses and Subsidy for programmes regional R&D centers, “basic”research technology spin-off, etc. projects development
To expand To bring up To strengthen Effects knowledge/ To facilitate diffusion and helper/partner for industry’s own On technology pool to make better industry’s industry’s technological Industry for industrial use of technologies tech.development capabilities use
Source: Author's compilation.
The first incentive measure was applied in the early 1960s in which the corporate tax was deducted or exempted for FDI frims that satisfield a technology requirment. Since then, a number of incentive measures were introduced during the 1970s. A majority of supportive
310 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy measures implemented during this period, however, aimed to promote or facilitate technology transfer, rather than internal R&D. The list of measures was considerably expanded or modified during the 1980s. The upsurge of incentive measures during this period was not accidental. Rather, it reflected the changes in private enterprises’technological activities, which had activated in-house R&D at amuch lager scale during the same period. Responding to this trend, the industrial policy of the government shifted the policy paradigm to promote in-house R&D rather than technology import. This change was materialized by the enactment of“ The Industrial Development Law”, which marked a turning point of industrial policy from sectoral support to functional support. Afterwards, the direction of incentive policy has moved towards a more indirect way, such as putting more weight on the construction of science and technology infrastructure and development of human resources. Further, in accordance to the WTO’s subsidy rule, industrial policy emphasizes on R&D support, while reducing the conventional measures.
Figure 3-3-2 | The Chronology of Major Technology Policies
Tax Credit or Special Depreciation for Investment in Equipment to develop Technology and Manpower Duty Abatement or Exemption (A/E) on Goods for Academic Research Tax Credit for Technology and Manpower R&D Investment Development Expenses Promotion Tax Exemption for Real Estates of Private Enterprises’Affiliated Research Centers Tax Exemption for Research Devices and Samples Duty A/E on Goods for Research Deduction and Exemption of the Corporate Tax for the Foreign Investment Accompanied by Technology Requisite Technology Reduction and Exemption of Tax Amount on Transfer Technology Transfer Income Promotion Income Tax Exemption for Foreign Technologists
Technology Provisional Special Consumption Tax Commer- Rate for Technology Commodities cialization Reduction and Exemption of Tax Promotion for Start-up SME
Source: Compiled from Ministry of Science and Technology, (1997c).
311 Chapter 3 _ Industrial Technology Development Policy Box 3-3-1 The Efficacy of Government Policies (Kim, 2003)
Despite the wide and various arrays of policy measures for industrial technology development, there are very few studies on policy effectiveness. Exceptionally, the late Professor Linsu Kim made persuasive judgments on these from three aspects: (1) policies to create market needs for technology development, (2) policies to increase S&T capabilities, and (3) policies to provide the linkage between demands and supply.
Demand side policies can cover three areas: export promotion, competition policy and government procurement. Export promotion, by pushing firms into highly competitive international markets, has been more influential than other policies in forcing firms to expedite technological learning. Exporters also created capacity in excess of local market needs to achieve economies of scale; this led to crises and forced them to accelerate technological learning to maximize capacity utilization. Competition policies also increased the need for technological effort. The government enacted the Fair Trade Act in 1980 to prohibit unfair practices in the market and to restrict the growth of the chaebol. At the same time, the government began to liberalize the local market, bringing down tariff and non tariff barriers, so forcing Korean firms to compete against multinational firms not only in the export but also in the domestic market. In 1986, the government introduced legislation to protect intellectual property rights, pre-empting the reverse engineering of foreign products. These policies forced Korean firms to further intensify technological effort. Government procurement is often mentioned in the literature as an important tool in creating local demand for technological effort. However, except for significant government procurement of personal computers at the formative stage of the industry in the early 1980s, this policy did not play a significant role in Korea in creating demand for technological effort.
Major supply side policies cover human resource development, technology transfer and domestic R&D. The formation of human resources enabled Korean industry to master mature production technologies through reverse engineering in the early years. However, the Korean government made a critical mistake in neglecting to invest in research oriented tertiary education in preparation for knowledge intensive industries, creating a major bottleneck in innovative technological learning in the 1990s. Korea restricted reliance on FDI, enabling local firms to retain managerial independence and allowing them to set the direction of technological learning. The government gradually relaxed restrictions on licensing in the 1970s, as Korean industries progressed into more complex technologies. The government’s role in R&D was relatively small relative to other countries, accounting for only about 20~25 percent of total R&D in the 1990s. The government’s R&D was largely directed to keep increasingly weakening GRIs afloat and to mission oriented national projects. Some national projects had significant results, such as the development of electronic switching systems and CDMA mobile telephone systems. In general, however, R&D policy neglected diffusion oriented projects like upgrading the quality of tertiary education and university research.
Preferential financing and tax incentives are the major instruments that lubricate the linkage process between demand and supply. The impact of the preferential financing on facilitating R&D activities, however, is dubious. Its interest rates, ranging from 6.5 to 15 percent, were far higher than similar loans in other countries. Tax incentives were another indirect mechanism to make funds available for corporate R&D. Preferential financing and tax incentives definitely provided funds for corporate R&D activities and lowered their costs, but were peripheral in promoting R&D in Korea.
312 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy 3.2. The Vietnamese Experience*
Since the 1980s, Vietnam has actively implemented various kinds of policy measures to promote industrial technology. These measures can be classified into four streams: national S&T programs, infra-structure creation programs, institutional support system, and incentive system. Government’s industrial technology policy has focused mostly on technology innovation programs.
By the 1980s, based on the 5 year plan, Vietnam organized the State level S&T program in key fields for socio eco development (in recent years, about 15 to 20 program were organized every year). Half of them were directly related to the creation of new technologies for application in production. The Ministries and provinces also had S&T programs or projects on new technique application research in production and life. Investment for R&D was still limited.
In the 1990s, the government established 4 techno economic programs: new information technology, biotechnology technology, advanced material and automation, for the purpose of technology application and transfer to production and social activities. In the finance matter, besides the government, the enterprise joining in those programs also made financial contribution in technology application and transfer. The government also allowed the organizations to carry on the test production projects to implement the last stages of development and get the new technology. The government lent 30% of the expenditure and reclaimed from 80% to 100% of the spent expenditure. Therefore, the organization which implements the test production projects had to pay about 70% of the expenditure and the reclaimed expenditure. The organizations which implement these projects included independent finance enterprises and S&T organizations (every year, about 20 projects were implemented in most of the technology fields; most of them were independent projects and the results of the major state level S&T programs).
In 1999, the Decree No.119 stated that enterprises operating under the Law on Domestic Investment Promotion shall be entitled to borrow medium term and long term capital loans with a preferential interest rate, and up to 70% of their investment capital may be borrowed from the Development Support Fund, the Export Support Fund and the Scientific and Technological Development Support Fund. The above mentioned Law also stipulated that R&D activities will get preferential treatment in terms of land allocation or land use.
In 2000, Law on Science and Technology regulated that expenses for S&T activities can be deemed as non taxable item for corporate income taxation and also these organizations receive many incentives in land lease fee and land use tax. The same is applied to expenses for training
*) The section has been prepaced with contributrion from Dang Duy Thin, NISTPASS.
313 Chapter 3 _ Industrial Technology Development Policy of S&T personnel of firms. The Law also permitted them to get credit with favorable rates by the National Fund for S&T development.
In 2005, with the new Decree No.115 on autonomy of R&D organizations, these organizations receive many incentives to become more independent in terms of management, financing, human resources, etc. This contributed to more funding and investment from firms for technology innovation and R&D.
In 2006, the Law on Technology Transfer decided the government to establish the National Technology Innovation Program and National Innovation Fund to increase the national technology capacity. In 2008, the Law on High Technology stipulated to create the National Program of High Tech to support the application, research and development on high tech; high tech human resources training and high tech enterprises incubators.
The above mentioned Law on High technology also decided that the national hi tech venture investment fund is a state financial institution which allocates capital and provides consultancy services for organizations and individuals to establish and develop enterprises applying high technologies, manufacturing hi tech products or providing hi tech services.
In addition to key state programs, the government has other policy measures that intend to promote technology innovation and transfer activities among innovation actors. These include educating and training research personnel, compiling and diffusing technical information, encouraging cooperative R&D by establishing R&D facilities and promoting spin off, spin out activities from public research. Training personnel for S&T activities are counted as non tax expenses. Rather, training of high tech human resources receive many incentives in terms of taxation and land allocation. On the average, one fourth of GRI budget is funded directly by the government and the rest is revenues from contract research. Incentive measures are applied to promote and assist both public and private enterprises’technology development activities. These incentives include tax exemption for firm’s R&D spending, financial support with preferential loans, and subsidy of technology development.
Table 3-3-6 | The Scheme of Vietnam's Industrial Technology Policy
National R&D Infra-structural & Institutional Programmes Diffusion Support Incentives To strengthen the linkage To develop key industrial To enhance infrastructure and between GRI and industry, To promote innovation in Objectives technologies, high-tech facilitate innovation creating favorable enterprises environment Ministries’ Research personnel, technical Tax-exemption Tools R&D programmes, information, R&D facilities, regional Funding for GRI’s activities Financial support funds S&T centers, spin-off, spin-out, etc. Other subsidies
Effects To provide knowledge To create linkages and To solve the bottleneck on and To facilitate diffusion and to promote synergy for issues in industry technology supply for industry’s use of technologies industry’s tech. technology learning and Industry industrial activities development accumulation
Source: Compilation from policies.
314 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy 3.3. Policy Implications
As can be seen above, there has been a range of many incentive policy measures that promote R&D and innovation activities from research activities to the marketplace. Starting in the 1980s, these policies took a long period of time to be adopted, and changed to have impact on industrial activities. For example, the opening of direct contact and contractual relationship between firms and R&D organizations created a new period of linkage between these organizations to pursue innovation activities, diversification and increase funding resources for S&T activities, thus enhancing the overall innovation in firms. In many cases, there have been a number of successful spin off and spin out cases of R&D organizations becoming innovative firms.
In industrial activities, this policy impact has helped to create many successful commercializations of R&D and new technologies in areas such as construction, machinery equipment that contributed positively to production. Many financial incentives such as taxation are conducive for firm’s activities and remain quite stable for business.
However, there are still some shortcomings in policy measures. One example is the implementation of the four techno economic programs by inefficient organization. Some effective credit policies were quite slow in implementation by the financial organizations. Some other recent policy measures like National Technology Innovation Program, National Fund for Technology Innovation were quite slow in setting up and starting. The same happened to National Foundation for S&T Development. The support provided to firms in human resources training was still limited. In implementing financial policies, firms still face complicated and cumbersome procedures to apply for refund and get financial incentives.
Overall, government policy measures are begining to have positive impact for industrial activities of firms in promoting innovation. But due to complicated mechanisms and regulations, some still have limited use.
315 Chapter 3 _ Industrial Technology Development Policy Figure 3-3-3 | Chronology of Major Technology Policies of Vietnam
Economic contract between R&D institutes and firms, transfering institutes into firms
Creation of S&T development funds, at the central, ministerial, provincial and firm levels
R&D Credits for R&D, diversification of investment sources for R&D Investment Promotion Tax reduction on corporate income tax, VAT, for R&D, pilot and production; import?export duties for machineries and equipment for R&D
Implementation of test and pilot production
Funding 30% expenditures for R&D projetcs of firms, land preferential allocation for firms in R&D Technology Transfer Promotion Incentive for FDI projects for R&D
Reduction of Taxes for Technology Transfer, application of high-tech, FDI having investment in S&T
Income Tax Exemption for personnel
Incentives for hightech activities Technology Commer- cialization Reduction and Promotion Exemption of Tax for SME in innovation activities
Source: Author's compilation.
316 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy 4. Technology Transfer at the Firm Level 4.1. Introduction
Technology can be understood as information or knowledge related to production. It exists in the form of tangible technology codified in blueprint and/or tacit knowledge embodied in plants, parts and components, human factors such as labor skills and firm specific assets including trade secrets and organizational traits. In other words, technology in this sense encompasses various aspects of firm’s activities ranging from the production know how to operation technique and even to organizational structures. The process of technology transfer includes all of these aspects of technology. Therefore, understanding of the process of technology transfer is much different from that of the transaction process of economic goods in general. Table 3-3-7, quoted from Radosevic (1999), shows types and dimensions of technology transfer.
Table 3-3-7 | Types and Dimensions of Technology Transfer (MISSING)
Type of embodiment Mode of transfer Role of seller/partner Capitale Embodie Disembodie Market Network Hierarchies Active Enabling Passive Embodied d d (explicit) (intermediate) (implicit) Direct foreign investments X X X X X Joint venture X X X X X Licensing X X X Imports of goods X X X X Co-operative alliances* X X X X Sub contrcting X X X X Export X X X Transfer by people X X X Development assistant X X X X X
* Producting sharing agreements, management and marketing contracts, service agreement, R&D consortia other co-operative alliances, franchising, technical service contracts. Source: S.Radosevic, International Technology Transfer and Catch-up in Economic Development, Edward Elgar, 1999, p.21
This section will present some successful cases of international technology transfer. As explained in section 2 and shown in Table 3-1-1, Korea has been active in technology transfer through licensing contracts and technology imports. The Korean case below will highlight how typical Korean firms have learned from imported technologies, and have been successful in competing with their foreign teachers. The Vietnamese cases show a different mode of international technology transfer in that international technology transfer in Vietnam is processed through foreign direct transfer or joint ventures.
317 Chapter 3 _ Industrial Technology Development Policy 4.2. The Case of a Korean SME 3)
A Korean hoist manufacturer, Kuk Dong Co. (KDC, hereafter) was founded in 1983. The founder, who has a bachelor’s degree in mechanical engineering, had worked at a Japanese firm’s marketing branch in Seoul. He was surprised to know that seemingly not so sophisticated machine, hoist, is 100% imported, and then decided to establish his own company to produce hoist. As of early 1980s electric chain hoist was all imported from abroad. There was no Korean producer. The founder was able to maintain a business relationship with the Japanese seller in the Korean market. In the beginning, he made technological ties with two Japanese firms and was successful in signing licensing contracts for hoist technology in 1984. When the original technological ties became not as satisfactory as expected, KDC diversified the business partnership; to sign additional licensing contracts with another Japanese and German firms.
Licensing contract
The first licensing contract that KDC made was in 1984 with a Japanese SME specialist company. During the process of contract negotiation, there were some disagreements between the donor and the receiver regarding the contents and scope of technology transfer, royalty rates, the payment method of royalty, restrictions on export markets, and so on. The most difficult point for KDC was the calculation of reasonable, optimal royalty rates. The final contents of contract are summarized in the following.
Donor: Nitchi Co., Japan Recipient: Kuk Dong Co., Korea Duration of contract: 5 years Technology: on chain block and chain hoist. Contents: Information, documents, technical service, and patent. Payment: running royalty as 5% of sales, 3% when taking over casting. Restrictive clauses: ⅰ) restriction of export, ⅱ) buying raw materials, parts, and intermediate goods, ⅲ) maintenance of secrecy of technology, ⅳ) production of competing or similar products, ⅴ) transfer of imported technology.
The actual technology transfer occurred as the donor supplied drawings on chain block and chain hoist, taught how to assemble the parts supplied by the donor, and trained Korean engineers. But the technology transfer was not so much fully activated as the receiver had expected. KDC found out that the transferred drawings were out of date. Moreover, when Korean engineers were being trained in the Japanese firm, they were not allowed to look around the factory. Despite these limitations, KDC had to maintain the technological tie. It was inevitable in the sense that there was no other choice at the beginning stage.
3) The Korean case is based on Suh (1995). The descriptions in the text are based on the interview with the founder of KDC was taken earlier in 1995.
318 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy KDC shows a swift movement in absorption and assimilation of imported technology. About 5 years after the introduction of foreign technologies, the company made partial improvement and development. They confessed the bottleneck of the technology development is due to the reluctance of donor to transfer core technology. Despite the core technologies were not transferred, the technological ties with foreign firms contributed much to improve the quality and performance of the product and to accumulate technological experiences. Above all, during the period of firm’s growth, import substitution and localization occurred at a significant level. The imported technologies were effective in relation with part/material technology and production technology. However, the imported technologies were weak in relation with the advancement of manufacturing process technology. The difficulty was that at the beginning the quality of KDC’s product was not comparable, i.e. inferior to that of Japanese product. There are two reasons: first, donor firm did not transfer the core technology. KDC found out that the drawings transferred were out of date. The state of art version of drawing had never been disclosed from the donor. Second, as other Korean firms did in the past, the initial production of hoist was achieved by so called K/D (knock down) system. The core parts and materials were imported and the only remaining role was to assemble those parts and materials. KDC realized that by this way of production KDC will never catch up with the Japanese firms, and building its own technological capability is imperative in order to push through the impasse.
In 1988, KDC established an in-house R&D department. The number of researcher was small, about ten people. Having an in-house R&D department, however, enabled KDC to launch systematic investigation on hoist technology and thereby to develop its own new products. KDC’s outstanding performance and research efforts were also publicly acknowledged; in 1987 the presidential medal was awarded for its performance on import substitution. And KS (Korea Standard) and NT (New Technology) marks were awarded from the government in 1988 and in 1994, respectively.
Government’s support and cooperative research with public institutions
The Machinery Industry Promotion Act defines the role of government in promoting industrial activities of machinery manufacturers in Korea. In particular, the Act functions as a legal framework to support SME’s. Based on the Act, various incentives are offered. KDC has benefited in various ways. SME Promotion Foundation assisted KDC by helping plant investment and guiding technology and management. Some favorable bank loans were offered by SME Bank. In addition, military services were exempted for the researchers. The cooperative research with universities and government funded research institutes proved to be helpful and effective. For an example, KDC could not handle the noise in electrics hoist. Through cooperative research with Korea Academy of Industrial Technology (KAITECH), a government funded research institute, KDC found out that in order to lower the noise in electric hoist it needed ⅰ) to increase the precision of hoist parts such as gear case, gear and bearing housing, precision in fabrication and assembling and ⅱ) to maintain the stability of quality,
319 Chapter 3 _ Industrial Technology Development Policy standardization of parts and the production process. With the assistance of KAITECH, KDC was able to handle the noise problem.
4.3. The Role of Foreign Owned Companies in Korea’s R&D System4)
As explained in section 2.1, before the financial crisis in 1997, foreign owned companies had played a minor role in the Korean economy. Inward foreign direct investment (FDI) had been quite low for many years. This is more evident in technology and innovation issues. Although Korea had been heavily dependent upon foreign technologies, technology transfer in the private sector was mostly commonly accomplished through licensing contracts rather than FDI. And technological activities of foreign owned companies in Korea had been mostly product modifications to meet the local demand conditions. The situation has drastically changed after the financial crisis of 1997. FDI inflows into Korea increased sharply thereafter. The sharp increase in FDI since 1997 was due to the favorable investment environment, depreciation of local currency and asset values, the Korean government’s promotion of investment through deregulation, and increased number of company offerings as a result of corporate restructuring and privatization of government owned companies.
What effects did the increases in FDI have on the Korean industry’s technological activities? It is not easy to give a concrete answer to the question. But, we will try to trace the changes that happened to the Korean economy due to the increased FDI and infer the implications based on the findings. Table 3-3-8 shows the number of foreign owned companies that spent on R&D, classified by the share of foreign ownership. The number has increased from 329 in 1997 to 462 in 2000; a 40% increase for three years. Among 462 companies in 2000, 333 are minority owned foreign companies and the remaining 129 are majority owned foreign companies. As is shown at the last column, the number of companies spending on R&D has also increased greatly: from 2,522 in 1997 to 3,269 in 2000, showing a 30% increase over three years. Therefore, the number of foreign owned companies spending on R&D outpaced that of domestic companies’. The numbers in Table 3-3-8 merely show very limited primitive information on technological aspects of the foreign owned companies. A survey by Korea Industrial Technology Association (KITA) tells further aspects. According to the survey, as of 2002 there are 122 R&D centers by foreign owned companies; half of these centers are established after 1997. And most of foreign R&D centers are concentrated on three industries; information and communications, chemicals and machinery. (See Table 3-3-9) The next Table 3-3-10 compares some R&D aspects of foreign owned companies with those of domestic companies. On the average, R&D intensities, in terms of R&D expenditure over sales or R&D personnel per workers, are roughly similar between the two groups. But foreign owned companies are higher in their average R&D expenditure and average number of research
4) This section is taken from Suh(2003).
320 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy personnel than domestic companies. Taking the facts from the two tables together, we can make a brief summary of the status of R&D activities of the foreign owned companies. First, the number of R&D performing foreign owned companies is still small but is increasing faster than that of the domestic owned companies. Second, R&D intensities of foreign owned companies are similar to those of the domestic companies but the former have bigger pool of R&D expenditure and personnel.
Table 3-3-8 | Foreign Owned Companies that Spend on R&D
Share of foreign ownership
More than 0 and Total* 50 to less than 100 % 100 % less than 50 % 1995 236 23 15 274 (2,150)
1997 256 40 33 329 (2,522)
1999 287 97 61 445 (2,601)
2000 333 74 55 462 (3,269)
* Numbers in parenthesis are total number of companies that spend for R&D. Source: Ministry of Science and Technology, R&D Survey, each year.
Table 3-3-9 | R&D Centers by Foreign Owned Companies
Year of establishment IC Chemicals Machinery Others Total
Source: Korea Industrial Technology Association, 2002.
Table 3-3-10 | Comparison between Foreign Owned Companies and Domestic Companies
Average Research Average R&D Number of R&D/sales number of personnel per expenditure companies (%) research thousand (billion won) personnel employees Foreign-owned 1) 63 5.2 1.69 36.0 64.2
Domestic 2) 4,194 2.4 1.98 22.5 68.2
Note: 1) Based on the 63 firms' reply to the survey by Korea Industrial Technology Association. 2) Ministry of Science & Technology, R&D Survey, 2001. Source: Korea Industrial Technology Association, 2002.
321 Chapter 3 _ Industrial Technology Development Policy The Case of Clark Material Handling Asia
CLARK Material Handling Asia (CMHA) was created on July 16, 1998, as CLARK Material Handling Company (MHC) took over the forklift truck division of Samsung Heavy Industry Co. CMHA moved its production lines to the previous factory site of Samsung Watch Co. With its regional headquarter and plant at Changwon city, Kyungsangnamdo, CMHA is the Asian headquarter of CLARK Material Handling Company, with headquarters located in Lexington, Kentucky, USA; Changwon in Korea; and Mulheim in Germany.
CLARK has been in Korea since 1982 and has maintained a good relationship with Samsung. When Samsung decided to sell out its forklift truck division, CLARK was keenly interested in buying it. The acquisition completed CLARK’s global strategy of manufacturing products in three continents. The acquisition in July of 1998 cost approximately $30 million, and over the next two years CLARK spent an additional $7 million in capital improvements. In 2000, after two years of acquisition, CLARK decided to move all engineering, production and research from Lexington headquarters to Korea. CLARK had been studying its reorganization and found that CMHA had the highest productivity among its operations. In addition, the existence of stable and high quality local suppliers and a good work-force were other factors for CLARK’s decision to relocate to Korea.5)
The R&D center of CMHA in Changwon plays a role of“ global R&D center”of CLARK MHC. Certified as a corporate research center by the Korean government in February 1999, the center takes charge of developing new products to the Korean and overseas markets. With its 39 R&D personnel, CMHA spends about 1.8% of sales on R&D activities. (KITA, Directory of Korean R&D Institutes, 2001/2002.) Most of CMHA’s R&D activities focus on developing new products and improving the performances of existing products. CMHA’s R&D center has maintained a close link to CLARK’s German research center.
4.4. Honda Vietnam: The Responsible Transferor 6)
Honda Vietnam (HVN) was established in 1996 as a joint venture between the Honda Group (70% in total, in which Honda Motor Co. Ltd. hold 42% and Asian Honda Motor Co. Ltd., hold 28%) and the Vietnam Engine and Agricultural Machinery Corporation (VEAM, a state owned enterprise). The factory is located in Vinh Phuc province, about 30 km from Hanoi. The operation started in 1997 with the production of Honda’s legendary Dream model (which is named Super Dream in Vietnam). The design capacity of the factory was 450,000 motorcycles per year and it has been extended several times. By October 30th, 2001, the accumulated investment was about USD134.4 million. By January 2002, HVN had 1,143 laborers and a
5) The Korea Times, May 19, 2000 and KOTRA Bi Weekly Magazine, April 17, 2000. 6) Sections 4.4 to 4.6 was reproduced from Tran Ngoc Ca and Ngwyen Vo Hunh, 2009.
322 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy capacity of 450,000 motorcycles per year. By April 2002, it had expanded to a capacity of 600,000 motorcycles per year with about 2000 laborers. However, restrictions on motorcycle registrations in large cities the following year had negative impacts on the whole sector, including HVN. In 2005, this restriction was removed, and HVN reached sales of 620,000 units. From 1996 to the end of 2005, HNV sold 2.5 million motorcycles and is a profitable FDI business in Vietnam.
As a leading motorcycle manufacturer, there is no doubt about the superiority of Honda technology. Honda has selected Thailand as its headquarters in Southeast Asia for R&D and engineering. Affiliates like Honda Vietnam focus mainly on production, assembly, and marketing. The factory was constructed in accordance with the development plans and engineering priorities of Honda. The technology that has been transferred was process technology, which includes the equipment and skills needed to operate and control production processes. Product technology is not transferred fully because design and product development capacity is centralized in Honda R&D and in Honda’s factories located in Thailand. Learning within HVN focuses on production technology, in which assembly is central, marketing targeting the domestic market, and the development of reliable distribution channels, safe drive program, and many other promotional activities.
In terms of machinery and production structure, HVN had six production workshops by the end of 2000: (1) Pressing Workshop using a 200 t, two 400 t pressing machines and a computer numerical control (CNC) pipe framing machine to make frames, gasoline tanks, chain boxes, and other precise parts; (2) Welding Workshop using 5 robots to ensure productivity, precision and quality of components; (3) Plastic Object Workshop using computer controlled machines, which allow high productivity, while providing endurance and aesthetics of plastic parts; (4) Painting Workshop using state of the art technology to ensure the greatest surface protection for metal parts; (5) Assembling Engines and Frames the assembling line is modern, has a relatively high level of automation, and is equipped with on line testing facilities that allows quality to be checked at every step of the production line; and (6) Quality Control Workshop equipped with state of the art modern Japanese testing equipment operated by overseas trained staff. HVN also manages a 500 m test runway, which is the longest in ASEAN. Recently, HVN has started to invest in the local manufacturing of engine components. Starting in 2008, HVN began to produce car in Vietnam with models such as Honda Civic and CRV.
HVN started by assembling standard models that combined some parts produced and sourced locally with sophisticated components (such as the engine) sourced overseas through Honda’s procurement network in the region. The establishment of HVN also brought with it many foreign parts and accessory makers, which created a group of satellite companies around HVN. The next step in the development of HVN was to produce sophisticated components in Vietnam. The capabilities to operate the production system may have been slightly upgraded, but there is little evidence that R&D, design, or engineering capabilities developed locally.
323 Chapter 3 _ Industrial Technology Development Policy This technology was transferred mainly through staff training. Before starting the production, HVN built a core staff consisted of engineers and technicians who were sent to Japan and Thailand for training. A six month course was provided to production line managers, and a three month course was given to managers at lower levels. In total, 100 people received this type of training. After production started, Honda sent its own supervisors on a regular basis to oversee operations and provide guidance on production activities.
Besides overseas training, on the job training has been provided since the start of the operation in the form of short training courses taught by Japanese lecturers. This type of training is targeted at specific problems and issues realized during the operation of the new venture. The training curriculum is based on Honda’s Foundation Course, a program used only within Honda. Teaching methods include classroom lectures, role playing, and scenario building.
HVN recruits local residents who have successfully completed their secondary education to be operational workers. Because many of them have an agricultural background, it takes extra effort to train them as industrial workers. This is one of the challenges Honda must overcome to make its operations in Vietnam a success. Almost all training is in production skills, operational management, and quality management. There is little design training.
The entry of Honda into Vietnam had a strong impact on the development of the motorcycle industry. The local content policy and other commitments forced HVN to develop a network of suppliers in Vietnam. This network is made up of domestic suppliers, who were selected and given technical support by HVN, and other FDI enterprises that in many cases are regional suppliers for Honda. By 2004, Honda had 20 local suppliers. The majority of these suppliers were joint ventures of Japanese parts makers with local firms or 100% foreign invested firms. Honda itself has entered into joint ventures with other local partners to produce motorcycle parts.
The process of seeking local domestic suppliers has had an important impact on the awareness of many local firms. By negotiating with Honda, they have learned more about quality requirements and management. Those who failed to become a supplier for Honda learned why they had failed and what they had to improve. Those who did succeed improved to meet Honda’s requirements. In many cases, they also received technical support from Honda, especially with regard to quality management, which proved to be very valuable.
The entry of Honda also brought about competition, which to some extend triggered learning. The late 1990s and early 2000s were marked by so called Chinese motorcycles (because most of the components were made in China), and the prices ranged from half to a third of Honda’s standard prices. In response, Honda launched a new model called the Wave Alpha, which was aimed at the low end market. This move by HVN drove the cheap, unreliable Chinese motorcycles out of the market and forced domestic assemblers to produce better quality models.
324 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy 4.5. Thang Long Metalware Company: A Local Player to Catch Up
Thang Long Metalware was established in 1968 as a state owned enterprise that belongs to the Hanoi Industrial Department. Thang Long’s headquarter is located in Sai Dong, 10 km from the centre of Hanoi. Thang Long has three factories: one in Hoixa, Gialam, Hanoi, producing moulds and motorcycle components; one in Lang Yen, Hanoi, producing water tanks and eating utensils; and one in Ho Chi Minh City producing fabricated metal products oil cookers, table lamps, and candle lamps; stainless steel utensils; and motorcycle components.
In 2001, Thang Long employed 1059 people, which included 100 engineers and others with bachelor’s degrees, and more than 200 skilled workers. Many retired experienced workers were invited to work for Thang Long, and they have contributed remarkably to the success of the company which has several important customers such as Honda Vietnam and IKEA of Sweden.
With regard to motorcycle components manufacturing, Thang Long’s technology is superior to many other Vietnamese companies. Its products are sold to Honda Vietnam, which has high requirements for quality and stability. The machinery and equipment used by Thang Long is more sophisticated than what is used by the other two companies. It has many large scale brand new computer controlled machines. Being able to operate these machines to produce various kinds of products for different customer demands demonstrates the company’s operational capabilities.
Although it has operated since 1969, the learning activities of the company only started in 1989. This period has been marked by heavy investment in machinery and human resource development. Thanks to various sources of capital, especially the profits gained from its joint venture with Honda and Goshi Giken in Goshi Thang Long Auto Parts, the company has been able to expand its operation into many fields based on improved quality and productivity. The company has also expanded geographically with its factory in Ho Chi Minh City.
To be able to meet the fast changing demands of customers, the company also invested in a mould making factory using brand new CNC machines. This gave them full control of the moulds needed to manufacture different kinds of products and components. It also provided opportunities for some innovation within the company. However, the mould factory and CNC machines also represent a test of the company’s engineering capability because programming of CNC machines for different jobs is a rare skill. So far, the manufacturing of motorcycle components for Honda Vietnam and fabricated metal products for IKEA is based on these customers’designs. The CNC machines are programmed accordingly, and the company does not have much input. Special training for computer aided design and computer aided manufacturing (CAD and CAM) technology is badly needed if the company wants to develop its engineering capability.
325 Chapter 3 _ Industrial Technology Development Policy The company has demonstrated its ability to choose appropriate technology for its needs. The pressing machine is an example. After a time consuming period of consultation, the company decided to choose a Taiwanese vendor. The decision was based on the argument that the machine made by the Taiwanese combined all the desirable features of the Japanese design, used German materials (steel), and was flexibility in component selection, which give the best value for money. This approach could not have been used without a thorough understanding of the technology embedded in such a machine.
Learning by solving problems and learning from working with customers are the main learning channels employed by Thang Long. The company arranges for its staff to work with selected scientists and technicians to address issues that emerge from innovation activities. Technicians from customers and vendors of foreign machines have proven to be valuable sources of technical information.
4.6. VMEP: A Technology Diffuser
VMEP was the first FDI company to invest in the Vietnamese motorcycle industry. This 100% Taiwanese owned enterprise came to Vietnam in 1992 and started production in 1994. For its operations in Vietnam, all machines, equipment, and technology were transferred from Taiwan, and all motorcycle models were made from designs (detailed drawings and illusions and descriptions of manufacturing processes) supplied from the parent firm in Taiwan.
Beginning with models from abroad and using imported parts, VMEP modified some specifications to address the specific requirements of Vietnamese customers (e.g., reducing the noise and shake of the engine). Over time, VMEP has invested in more machines and equipment to produce components for its assembling activities. In the beginning, the machines were simple, but now they include CNC machinery. By 2005, sophisticated engine components were being manufactured at the factory in Dong Nai province. Local staff control production technology, although CNC machines are stilled programmed in Taiwan. Recently, in a move to make VMEP into Sanyang’s Centre in Asia, the technological capability of VMEP has been strongly improved. In an effort to improve design capability, new models are partly designed in Vietnam (although comprehensive design and testing are still carried out in Taiwan). Equipment critical to design and design training have been acquired, and 20 engineers are being trained in Taiwan.
Similar to the case of Honda Vietnam, investment by Sanyang in Dong Nai encouraged many Taiwanese parts makers to set up factories in Vietnam. Together they have changed the landscape of the industrial zone in Dong Nai by making it into a cluster in the motorcycle sector. VMEP has also worked with local parts makers to out source some work. The process of searching for suitable partners revealed weaknesses in the local motorcycle parts sector. VMEP reported that in the 1990s it was extremely difficult to find local firms that could make simple
326 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy motorcycle parts of stable quality. During these early days, VMEP worked with some large well equipped mechanical factories from the Ministry of Defense, but they also failed to meet quality requirements. The problems were not related to technology (because it is quite simple) but to quality management and the reliability of mass production. Lack of standards on motorcycle parts was another problem. As a result, the same part was made with different materials by different parts makers. This situation drove VMEP to rely more on its Taiwanese partners and on its own production capabilities. Later, some of its former engineers set up their own firms and became parts suppliers for VMEP.
With regard to learning, the VMEP case reveals many opportunities for learning and demonstrates the need to develop a continuous process of learning. Technologies were acquired step by step on the basis of technology transfers between the parent firm and VMEP. By 2004, the manufacturing technology for 18 motorcycle models had been transferred, 117 employees (equivalent to 10,930 man-days) had been trained abroad, and 152 foreign experts had come to Vietnam to provide technical support (1606 man-days). The total cost of technology transfer was estimated to be USD 8.7 million, of which USD 7.4 million were paid. Many local staff benefited from this training, and some left the firm to become entrepreneurs.
4.7. Some Policy Implications
The experience of technology transfer of a Korean small medium enterprise (SME), Kuk Dong Co. is instructive. In retrospect, KDC shows considerable performance in growth and product development, and significant accomplishment in building technological competence. As is common in other Korean firms, KDC had been dependent upon foreign technologies in the early stages of firm’s growth. It, however, has made tremendous efforts to absorb the imported technologies. In this process, KDC has benefited from favorable government support and technological assistance from the universities and the government funded research institutes. The success of KDC is the outcome of interplay of imported technologies, own R&D efforts, and support from the government and cooperation with university and public institute.
Selected cases of Vietnam based firms (either branch or JV of multinationals as HVN or VMEP or locally created firm like ThangLong Metalware) show that international technology transfer occurred successfully. The impact of technology transfer has been diffused widely into the local economy and other activities. Spillover effect did take place in cases, especially between international producers as HVN and its network of smaller producers like Thanglong Metalware. Policies aimed at promoting innovation and supporting linkages between international players and local producers have encouraged firms to work together for the common purpose of increasing business performance and technology partnership. Still, the policy landscape has few limited features. As discussed in this chapter, the incentives in terms of finance and other preferential treatments of land use seem not to have very strongly impacted foreign investment firms. Technological capability of firm’s personnel has to be enhanced and
327 Chapter 3 _ Industrial Technology Development Policy training of human resources working in S&T and innovation related activities still need to be improved. The role of local R&D institutes and other organizations has been so far quite limited. Their role needs be strengthened in the absorption process of foreign technologies.
5. Conclusion and Policy Lessons 5.1. Strength and Weakness of the Korean Innovation System
Korea has made enormous development in science and technology over the past four decades. By making continuous and massive investments in human resource development and R&D, Korea succeeded in building up a unique innovation system on a barren land. The factors that have greatly influenced the Korean Innovation System (KIS) are (1) outward looking development strategy, (2) industry targeting development policy, (3) large firm oriented industrial policy, (4) effective human resource development, (5) government led S&T infrastructure building, among others. These are also the sources of the strength and weakness of KIS.
The very strength of KIS is its dynamism that is fueled by the strong commitment of the government to“ technology based national development”and private industries’efforts to attain competitiveness. Despite the short history of R&D, Korea has already harvested rich crops from the endeavor in the forms of patents, scientific papers, and exports of technology intensive products, such as semiconductors, cellular phones, LCD, automobiles, and others.
Yet there are problems, too. R&D activities in Korea have grown very rapidly, led by private industries under active promotion policy of the government. The discussions so far show that Korea has reached near the level of an advanced country in terms of scientific and technological inputs, but also suggest that the country still has a long way to go in terms of R&D productivity. The most important source of inefficiency is the lack of interactions and exchanges between the major actors of innovation, say, universities, research institutes, and industries. Inter sector mobility of scientists and engineers is extremely low in Korea.
The weakness in basic sciences raises a fundamental challenge for KIS, because scientific capability determines the technological potential of a nation. Since the Korean R&D efforts have been overly devoted to industrial technology development, investment in basic science has been nelatively neglected. The lack of strong scientific base already works as a limit to technological progress in Korea. The weakness in science as a matter of fact results not just from the funding policy that favors technology development but also from weak university research capability. Therefore, strengthening the university research base becoms one of the major policy challenges.
328 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy Despite the remarkable performance of Korean industries in technological development, Korean industries harbor fundamental structural problems that have to be redressed to sustain the technological dynamism. First, the extremely high concentration of R&D activities poses a serious problem. High concentration means that only a few large firms are actively involved in R&D, while others are not. If this persists for long, Korean industries may be divided into technologically advanced and retarded firms and sectors. This will result in reducing inter firm and inter industry interactions that are the key elements of innovation. Second problem is the weakness of SMEs in R&D. This is important because even chaebol companies would not be able to sustain competitiveness without technologically strong domestic SMEs. Third problem is the insufficient interactions between industries, universities and GRIs. The lack of active interactions between R&D performers makes the distance further between labs and market. 5.2. Strength and Weakness of the Vietnamese Innovation System
Vietnam has built its own version of science and technology system. Under the framework of a socialist planned economy, the old system had been managed by the government’s plans. Since the 1980s, the old system has been experiencing a fundamental transformation. This transition toward a market economy also necessitates more active and autonomous role of research institutions and business enterprises. The Vietnamese government has introduced several measures and policies to facilitate the transformation of the old science and technology system towards a national innovation system. During the last decade, the re orientation focused more towards innovation took place.
Over the years, the government has put great efforts. Consequently, several key positive features such as strong leadership commitments with all the required laws, decrees, and leadership resolution are in place in Vietnam. A system of S&T personnel and institutions to carry out R&D activities has been accumulated for several decades. The country also set up a system of supporting organizations for innovation such as standardization, metrology, quality control, IPR, information and libraries, consultancy, etc. So far this system did contribute to the production activities, although the impact is still debatable. The most conspicuous outcome is that technology intensive industries and service sectors such as airlines, oil and gas, telecom, transport, textile garment, banking, finance, some high tech manufacturing industries are growing fast in Vietnam. As outlined above, S&T programs and techno economic programs are in place. During the last decade, investment for R&D and higher education has also increased substantially. Especially, the government set up a system of 19 national key laboratories in some high tech areas like ICT, Biotechnology, etc. Two high tech parks in Hoa Lac (North) and HoChiMinh City (South) and some others were established.
Vietnam is facing some weaknesses. Infrastructures for industrial production in general and R&D and innovation activities in particular have been continuously improved, but there lies
329 Chapter 3 _ Industrial Technology Development Policy ahead a long way to go to attain the level comparable to that of the other countries. Its large number of S&T personnel employed at the national/governmental R&D centers are not fully utilized. High caliber researchers tend to move for higher wages at business enterprises, but national centers are not able to fill out the vacancies. This results in deterioration of research quality in national R&D centers, aging of research personnel, and the imbalance problem between geographical locations. The imbalance problem has several aspects. Although a network of S&T organizations is in place, a strong imbalance of organizations in terms of North South and between large cities and other locations still exists. Moreover, there is a lack of effective linkage among them. Many research centers still remain at a low profile in terms of linkage with firms and they are not so active in responding to the demand as expected. For example, they are passive in setting research agenda. The functioning of S&T services institutions and education and training institutions are insufficient. 5.3. Lessons and Policy Recommendations for Vietnam
As an economy develops toward an advanced level, technological competence becomes a critical factor. To build up the competence, it is required to nurture high caliber scientists and engineers who are capable of dealing with the developments at scientific and technological frontiers. In other words, advanced education in science and technology should come first when preparing to enter into a developed world. In the case of Korea, education and industrialization helped each other in sustaining and accelerating mutual development. Education made technological learning and therefore industrialization possible, while industrialization enhanced the rate of return on investment in education, further promoting demand for education.
The potential for catch up growth can be utilized more effectively with the continued efforts to learn and indigenize foreign technologies, despite some variations in channels of technology transfer. Korea’s industrialization evolved from imitation to innovation. In the initial stage, Korean industries attained technological capability through informal channels, such as OEM production arrangements, reverse engineering of imported machines, technical training as part of turn key plant importation, and so on. Contrary to the experiences of other developing countries, FDI played a modest role in technological learning in the course of development in Korea. This approach enabled them to acquire technology at lower cost and maintain independence in business operation. But Korea had to pay a great cost for this; it had to abandon many of the technological opportunities that foreign direct investors might have offered.
In contrast, the more active roles played by FDI in today’s Vietnam imply a different path for the coming years, compared with Korea in her early years of industrialization. The technology transfer effects of FDI are many folds and multi faceted; but the crucial element of successful technology transfer is the interplay of willingness of suppliers and the existence of absorptive capacity of receivers. Hence the policy framework for promoting (international) technology transfer in today’s Vietnam would be different from the old Korea. For example,
330 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy Korea has maintained her NRDP (national R&D program) mostly for the need of the Korean firms; whereas Vietnam would expand the horizon to expand to the needs of foreign companies in Vietnam. The identification of specific needs and necessity of both domestic and foreign companies will be a starting point of designing a more effective policy framework.
As the comparative reviews of R&D policies in Korea and Vietnam show, the basic framework of R&D policies are already prepared in Vietnam. The next challenge is how to make the policies and measures effective. Box 3-3-1 illustrates the issue with three groups of policies; demand side policies, supply side policies and the linkage between demand and supply. The message from Box 3-3-1 is that the policies need be matched with the needs of firms and the supply side should be flexible enough to respond to the demand side. The intermediary roles should be played when markets not working at a socially desired level. With various policies already prepared, what Vietnam needs is to enforce policy effectively and implement the laws into practice. Basically, Vietnam needs to make a comprehensive review of the policy landscape and environment. The review should also include the current mechanism of policy coordination. Concerning the implementation of policies, the mechanism to coordinate related ministries and regional governments is to be strengthened, in a way to pursue common, clear policy goals. This will enhance the effectiveness of the policies as a whole.
When competition pressure is intense, business enterprises respond to the incentive schemes more actively. By adopting an outward looking development strategy, the government drove Korean industries out into the competitive international market, putting them under great pressure for technological learning and/or development. Protectionist policy may be effective in creating initial market opportunities for domestic industries, but if such a policy is prolonged, industries will develop immunity against market pressure for innovation. It may be for this reason that export oriented firms achieved technological learning more rapidly than import substituting firms. As for the firms in Vietnam, the capability of self adjustment and response to change in majority of firms (especially small and medium sized enterprises) is weak, partly because of the lack of market based incentive schemes. In order for the market mechanism to function as a means to technology transfer, ownership and property issues are to be clearly delineated.
Long years of gestation and commercialization efforts are needed to draw some economically valuable outcomes from R&D investment, especially from the government’s investment in R&D. However, governments tend to sacrifice R&D investment for the sake of more immediate projects. In these respects, it is very important for the government to make long term, consistent and continued efforts to get resource allocation in R&D areas. Infrastructures for industrial production in general and R&D and innovation activities in particular have improved over the recent years. Still, as we pointed out as one of the key weaknesses of Vietnam’s R&D system there lies ahead a long way to attain the level comparable to that of the other countries. Vietnam should continue upgrading infrastructure and facilities to induce innovative activities in both business and public sectors.
331 Chapter 3 _ Industrial Technology Development Policy References
Amsden, A., Asia’s Next Giant: South Korea and Late Industrialization, Oxford: Oxford University Press, 1989.
Kim, Linsu,“ Pros and cons of international technology transfer: A developing country’s view,” in Tamir Agmon and Mary Ann Von Glinow, eds., Technology Transfer in International Business, New York and Oxford: Oxford University Press, 1991.
Kim, Linsu,“ The dynamics of technology development: Lessons from the Korean experience,” in Sanjaya Lall and Shujiro Urata eds., Competitiveness, FDI and Technological Activity in East Asia, Cheltenham UK: Edward Elgar, 2003.
Radosevic, S., International Technology Transfer and Catch up in Economic Development, Cheltenham UK: Edward Elgar, 1999.
Suh, Joonghae,“ Conditions for successful technology transfer: Lessons from the experience of a Korean SME,”paper presented at the 1st APEC Technomart Seminar on Technology Transfer, Taejon, Korea, 1995.
Suh, Joonghae,“ The emerging patterns of SMEs’innovation networks in Korea,”in Dong Ju Kim and Joonghae Suh, eds., Innovative Clusters and Regional Economic Development: International Perspectives, Korea Research Institute for Human Settlements and Korea Development Institute, 2003.
Suh, Joonghae and Derek Chen, eds., Korea as a Knowledge Economy: Evolutionary Process and Lessons Learned, Washington DC: The World Bank, 2007.
Tran Ngoc Ca and Nguyen Vo hung, learning by networking with multineation: a study of the Vietnamese automobile industry. in Graham, M. and Woo, J. eds. Fuelling economic growth. The roke of Public private section reserch in development. Practical Action Publishing. UK. 2009.
332 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy Chapter 04 Promoting the Relationship of Industry University Research Institutes and Innovation Cluster
Deok Soon Yim, Ph.D. (Gyeonggi Reserch Institute) Dinh The Phong, Ph.D. (National Institute of Science & Technology Policy & Strategy Studies (NISTPASS)), Ministry of Science & Technology of Vietnam
1. Research Background and Framework 1.1. Importance of Industry, University, and Research Institute Network
The development of industries in Vietnam has largely depended on the increase of the production inputs such as labor and capital. However, the future development of industry would not be possible without proper development of industrial technology capabilities in Vietnam. In the course of Vietnam’s economic development, Science and Technology (S&T) would play a critical role. For Vietnam to utilize technology for further development, it is necessary to have the right science and technology policy in the context of National Innovation System. Under the concept of National Innovation System (NIS), not only direct science and technological development but other factors are also important. In this context, human resource development, incentive system for innovation, innovative culture and financial and legal systems should be treated as S&T policy areas since they are important elements of the NIS.
Especially the Industry University Research Institute (IUR) relation plays a critical role in making the R&D investment effective as well as efficient. Since innovation process normally requires all three actors (industry, university, research institute) to work very closely, it usually decides the performance of national S&T investment. The R&D investment on university would not automatically lead to better innovation for the nation if the industry is not closely linked to university research activities. During the whole innovation process, starting from S&T
333 Chapter 3 _ Industrial Technology Development Policy knowledge creation to commercialization, the three actors need to collaborate or have to be forced to work together.
The collaboration among IUR usually occurs well under geographical proximity. The area or complex can be called as an innovation cluster, regardless of the size and the field of specialization of the industrial fields, which has inherent characteristics to allow a dynamic, networked innovation processes. Innovation cluster, which is another name for traditional Science and Technology Park, is one of the effective tools to mobilize the S&T resource and make the innovation happen. It has a lot of advantages coming from the synergy of clustering such as easy and speedy knowledge sharing, creation and diffusion in S&T, as well as technology business.
This research is aimed to clearly identify and evaluate the status of industry, university, research institute relationship and innovation clusters in Vietnam. At the same time, Korean experience in these areas is explored. Finally, the research concludes with suggestions for the development and improvement of strategies and policies of Vietnamese science, technology and innovation.
1.2. Conceptual Framework of IUR and Innovation Cluster
The National Innovation System (NIS) is consisted of various actors such as government, industry, university and research institute. In addition, financial institutes and business information/consulting companies also play a certain role in the whole national innovation process. The process of innovation is associated with the flow of money, knowledge and people. It is important to see that the NIS interacts with the global innovation system, where global multinational companies and foreign/international research organizations work in the global context.
Figure 3-4-1 | National Innovation System and Actors
Global S&T Envireonment
Government
Research Universities Institutes Knowledge Money, People Industries Financial Institutes
Other related Actors
334 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy The importance of IUR collaboration in the NIS can be summarized as follows. First of all, it is necessary because each actor has limited S&T knowledge. In today’s world, more and more resources are required to produce globally competitive product since the development cost is generally increasing. However, even a global multinational company has limited resource. Therefore, the traditional in-house R&D is not often feasible. Secondly, open and collaborative innovation is more effective than closed innovation. If they collaborate with other actors, the cost of innovation is cheaper and the innovation process is often quicker. Moreover, the quality of innovation is often diverse and better. Thirdly the collaboration with other global players often ensures the cross licensing and global standard setting. So, IUR collaboration is not only domestically but also internationally a must to have for any global innovation to be realized.
The collaboration among the IUR can be categorized according to its purpose. For instance, it can target on R&D and technology development while other collaboration focus on training, production support and so on. The following table shows the types of collaboration and presents a framework for the analysis of IUR relationship in one’s National Innovation System.
Table 3-4-1 | Type of Collaboration Activities Among Industry, University, and Research institute
Purpose Collaboration Activities
Joint research(Government R&D), Commissioned research, Dispatched R&D research, Invited research
Accreditation for engineering education, Student-specific education, Training & Education Student OJT & intern, Employee retraining, Scholarship for employee
Technology transfer between university and institute, Breaking Technology Transfer & technological bottlenecks in the industry field, Sharing research facilities, Production Support Operating incubating center
Personal Exchange Networking & exchanging between researchers, Holding joint seminars
Source: 2008 research on the actual condition of industry, university, research institute collaboration, Korea Industrial Technology Association
Table 3-4-2 | Barriers for the IUR Collaboration
Lack of Lack of Lack of Lack of collaboration in Collaboration in Collaboration in Etc. Total information item Institute’s Institute’s development funding technology ability
20.4% 20.1% 12.3% 10.7% 36.5% 100%
Source: 2008 research on the actual condition of industry, university, research institute collaboration, Korea Industrial Technology Association
335 Chapter 3 _ Industrial Technology Development Policy There are many barriers for IUR collaboration. One survey done in Korea shows the typical barriers faced when pursuing an IUR collaboration. It is interesting to see that IUR face hindrances in developing an item even when they want to collaborate. This suggests that appropriate support is needed from the government to set policies that can provide relevant information and develop collaboration items.
In the IUR relationship, there exist fundamental barriers coming from the differences of information, financial and human resources, S&T knowledge, etc. While the industry has relatively enough financial and human resources, it often does not have creative ideas. University can provide up to date knowledge, but it often does not have the field knowledge. In addition, there are the gaps between sending and receiving capabilities for the collaboration activities. Therefore, it is important to have a coordinator who understands all three sides in promoting the IUR relationship.
Figure 3-4-2 | Policy for Industry, University, Reserch Institute Relationship Promotion
[ Gap ] Industry Info., Fund, Industry HR, Knowledge, S&T Capability
University University
At the
ҭSending Capability Research ҭReceiving Capability Research Institute Institute
[ Coordinator ]
In the developing stage of a IUR relationship, industry, university and research institute initiate some co-planning in order to have co-innovation activities. This process can start with a government policy or with recognition of a need to collaborate in the innovation process. The IUR relationship, when it is fully developed, becomes somewhat like an integrated cluster where collaboration and competition are both active during the whole process of innovation.
336 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy Traditionally, science and technology parks were built by many governments to promote the S&T development. Now, they renamed as innovation cluster and are drawing new attention. Traditional concept of S&T parks focused on the development of Science and Technology itself. However, under the new concept of innovation cluster, innovation is emphasized. Many countries are trying to develop an innovation cluster at a national level since effective innovation cluster can often lead national innovation and be a source of national competiveness. Of course, the success of innovation cluster requires an effective collaboration among the industry, university and research institute.
Table 3-4-3 | Evolutionary Process of Industry, University, Research Institute Relationship
Evolutionary Stage Contents
1st Stage (Planning cluster) Participation in the planning process of innovation activities
Some activities among innovation processes are happening like joint 2nd Stage (Activity cluster) R&D
Compete and collaborate in almost all the innovation process so that 3rd Stage industry, university and research institutes are very closely connected (Integrated cluster) and prosper as the member of whole IUR cluster
Source: Yim(2009), internal materials, Gyeonggi Science and Technology Center
An innovation cluster is a networked group of innovation actors and location(s), where the actor are creating economic and technology For the innovation cluster to succeed, it has to have many success factors. For instance, it has to have strong R&D base, advantages of location and so on. Not only R&D resource, but policy and management are very important success factors in the development of the innovation cluster. Many governments, even with enough resource and good location, fail to develop the science and technology parks because they do not provide good policy and management skills.
337 Chapter 3 _ Industrial Technology Development Policy Figure 3-4-3 | Success Factors of World Class Innovation Cluster
Polisy & Management
Location R&D Base Success Factors of World Class Innovation Cluster Culture Capital Large market?
Human Resource Incubator
Source: Yim et al., (2003), 30 Years' Achievement of Daedeok Science Town and Its Development Direction (in Korean)
2. R&D Activities by Actors 2.1. R&D Activities in Industry
The Vietnamese economy shows steady GDP growth rate over the years. As for the total growth of 8.44 % for the year 2005, the growth of Agriculture, Forestry and Fishing accounted for 4%, Industry and Construction 10.6% (Manufacturing: 13.1%) and Service sector 8.5% respectively. This shows that industry and construction sector is developing at a faster rate.
One of the most important features in the Vietnamese R&D investment is that it is driven by the public (government) sector and the industry is relatively weak in terms of R&D investment and other activities. Therefore, one of the challenging areas in the Vietnamese S&T policies is how to promote the industrial R&D capacity in coordination with government’s policy efforts. One issue which should be mentioned here is that the main part of industry R&D in Vietnam is
1) Keith BEZANSON, A SCIENCE TECHNOLOGY AND INDUSTRY STRATEGY FOR VIETNAM, Document prepared as part of the UNDP/UNIDO project DP/VIE/99/002, March 2000.
338 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy mostly from the government due to a greater number of state owned industries compared to the private ones. It is different from other countries where industry R&D is mainly from the private sector. This characteristic of Vietnam’s R&D has both good and bad impacts. Good impact is that the government can easily increase the industry R&D according to its wish. On the other hand, this increase of industry R&D is not really done by the market but by policy makers. So even with an increase of industry R&D by the Government, its effect might be lower than that occurred based on the real market mechanism.
A portion of private industry in Vietnam has been growing over the last years and is expected to be so in the years to come. About 96.5% firms in Vietnam are small and medium sized (SME).1) Most of innovations in the industry are of minor and incremental changes. Many SMEs innovated by importing embodied technology. Technology transferred from multi national companies (MNC) is only within the companies involved and has very small spill over effect for the Vietnam economy. There are very few R&D cooperation within firms and between industries and organizations. Firms lack of skill and knowledge on technology management. They cannot evaluate technology and do not invest in technology development, not to mention having no knowledge to select and procure appropriate technology. Plus, the firms do not have enough experience in negotiating technology transfer agreements and have to rely heavily on consulting firms. They also have difficulties in accessing capitals to implement technological innovation activities. Most of the firms are not familiar with Intellectual Property Rights(IPR), and the legal framework for IPR still needs to be improved.2)
Innovations in Vietnamese firms are influenced to a large extent by external factors and the condition that many supporting institutions and legal basis for innovation are not absent. Some characteristics of innovation environment for firms in the Vietnamese context are summarized as follows.3) ¥ Majority of firms in Vietnam are small (including FDI and state owned enterprises) and they serve a small, underdeveloped and unstable markets; firms compete mainly on their access to cheap labor and availability of natural resources (including land). There are few firms which compete based on new technology or differentiated products. ¥ Many firms (especially those in exporting sectors) make components for or are subcontractors of foreign business and/or MNCs thus, their level of innovation (if any) is determined by foreign customers. ¥ Weak national and local innovation system; public resources for R&D and other supports for innovation are limited. Central government funding for R&D mainly goes to big public research institution projects which usually don’t have the mandate and mechanism to provide services for firms with various and specific problems. Local government budget
2) Tran Ngoc Ca, Vietnam's innovation system: toward a product innovation Ecosystem, presentation, September 2006. 3) Nguyen Vo Hung, Tran Ngoc Ca, the Role of Academic Institutions in Economic Development: The Case of Vietnam, 2006.
339 Chapter 3 _ Industrial Technology Development Policy for S&T activities is also limited, and in many provinces it is used internally within the bodies of the local government to serve non science technology purposes. ¥ Market for technical and innovation services is not developed. Alternative public services are also present but hardly effective. ¥ The pool of common codified technical knowledge among the Vietnamese is scarce and not well organized, making it difficult for firms to refer to. ¥ Knowledge in engineering is weak, especially among academic institutions. ¥ Codifying technical knowledge is not a common practice in firms and academic institutions; a lot of potentially valuable knowledge is not codified, not generalized, and not appropriated, so are not effectively utilized. ¥ Institutional policy and guidelines are opaque, unpredictable and have not been disseminated well. ¥ Underdeveloped financial market plus informality in business make it very difficult for investors to put their money into innovation projects. Consequently, many promising innovative projects need funding to be actualized. ¥ Not having a playing field makes rent seeking become main priority of many firms, eroding incentives to promote innovation.
A survey conducted in 2003 among textile garment and chemical industries showed that firms spend only 3% of their turnover for technological innovation. Moreover, major part of this 3% was used to import technology rather than to undertake science technology innovation.4) Vietnam’s innovation has so far been concentrated in technology adoption rather than technology adaptation and creation.5)
Table 3-4-5 | GDP Growth Over the Years
Indonesia Thailand Source of funds Malaysia Philippines Vietnam (2001) (2001) Industry-financed GERD as a percentage of 0.01 0.34 0.09 0.11 0.03 GDP Government-financed GERD as a percentage 0.05 0.21 0.03 0.11 0.13 of GDP Percentage of GERD financed by industry 14.69 49.51 67.20 43.62 18.06
Percentage of GERD financed by government 84.51 30.49 19.99 43.62 74.11 Percentage of GERD financed by other 0.15 8.51 7.03 9.63 0.66 national sources
Percentage of GERD financed by abroad na 11.50 5.77 1.38 6.33
Source: ASEAN secretariat, Sub Committee on Science and Technology Infrastructure and Resources Development (SCRID) Note: GERD is Gross Domestic Expenditure on R&D
4) Study done by UNDP and Central Institute of Economic Management CIEM, 2003. 5) Aubert, "Promoting innovation in developing countries: A conceptual framework", 2004.
340 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy According to a survey by Sub Committee on Science and Technology for Infrastructure and Resources Development (SCRID) of the UNDP, expenditure financed for R&D by industry has been only 18.06 % compared to 74.11 % by the government in 2005 as showed in the following table.
Vietnam’s firms spending on R&D is even less than the amount invested in higher education, as indicated in the table below. This shows one of the weak points of the Vietnamese National Innovation System.
Table 3-4-6 | Source of R&D Funds Unit: million current PPS$
Indonesia Source of funds Malaysia Philippines Thailand Vietnam (2001)
Business enterprise 51.2 1,014.35 303.70 401.94 50.63
Higher education 16.6 223.85 63.02 95.35 62.33
Government 290 314.97 80.63 542.78 231.21
Private non-profit na na na na 3.89
Source: ASEAN secretariat, Sub Committee on Science and Technology Infrastructure and Resources Development (SCRID)
Figure 3-4-4 | Expenditure on R&D by Government and Business Sector in 2002
100%
80%
60%
40%
20%
0% Percentage US EU Japan OECD Sweden Germany Vietnam South Korea GOVERD Countris BERD
Source: Bach Tan Sinh, "Transformation of Vietnam's National Innovation System: Institutional and policy learning toward sustainable development", Asian CISASIA's Workshop of "Towards Innovative, Livable and Prosperous Asian Mega cities" Project, May 2009, Bangkok, Thailand Note: GOVERD: government R&D, BERD: business enterprise R&D
341 Chapter 3 _ Industrial Technology Development Policy “State bias”of Vietnam’s expenditure for R&D in 2002 was more obvious compared to other countries as shown in the following chart.
Few enterprises inVietnam have been participating in large state research programs and S&T projects partly because they have not been invited to join large research programs.“ State”firms are interested in R&D not because of innovation or profit but because of the extra state subsidy they get.
The following SWOT analysis summarizes the industry’s R&D situation in Vietnam.
¥ Certain hard infrastructures and legal entities are available ¥ Relatively big quantity of staff ¥ Hard working, clever, eager to learn staff available if the system is right
¥ Weak link to production and to other R&D actors ¥ Financially not self standing ¥ Viewed as a burden for firms, have no self initiative ¥ Technology mostly imported, low value added
¥ Big demand if service is right (due to fast growth of the economy) ¥ Technology is a must for firms to survive
¥ Firms might cut back R&D expenditure ¥ Brain drain occurs as many look for other jobs, work for FDI firms
2.2. R&D Activities in University
Although training still dominates the activities of universities, research has gradually been added in. About 4% of public expenditure for S&T now comes to universities which account for approximately 15.3% of universities’expenditure for R&D. The remaining fund for R&D expenditure comes from contracts with other organizations, in which, 29.2% is from enterprises; 6.7% is from other organizations and 48.8% is from international sources (Tran Ngoc Ca et al, 2005).
In the period of 1991~1996, universities undertook nearly 200 pilot production projects relying on their own research results. In the period of 1996~2002, universities under the MOET and two national universities have implemented 3,800 R&D projects and participated in 90 pilot production projects. Many universities have established R&D units. By the end of 2002, there
342 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy were 167 research divisions and 147 centers dealing with technology development and consulting activities within all universities (Tran Ngoc Ca et al, 2005).
Research at universities, however, has several drawbacks. In terms of perception and policy, R&D activities within university system are not recognized. Many universities are far from being R&D excellent centers. Universities in Vietnam lack independence. In spite of the fact that their operations have been much more independent than before, they still have to receive many directives and be under regulations of the Ministry of Education and Training. The staffs, especially in the public universities, have to face constraints in terms of salary ceiling, human resource management regulations, financial incentives, etc. Basically, they are still deemed as government officials rather than merely as academics. Despite the move to abolish the separation of teaching and research, a lack of research and weak linkages between research and teaching continue to be observed.
The present incentive scheme does not promote proactive approach among teaching staff in universities. There is little mechanism to encourage them to interact with other institutions and firms. The cooperation (if any) is usually short term, and relies mainly on personal and informal relationships. Other than training new labor force, contribution of the university activities, as such, tends to be one-off nature. In the existing system, universities so far do not see technology transfer activities as crucial for their own existence and view that their technology (if any) is not very attractive to the firms. In many instances, facilities and practical engineering knowledge of universities are ways behind those of the firms.
Another drawback of universities is human resources management for teaching and doing research. The number of professors and lecturers is relatively small compared to the number of students. Scope of student enrollment is much larger. From 1995 to 2005, for instance, student numbers increased 4.43 times (from 297,900 to 1,319,754 students), while teaching staff increased only 2.09 times (from 22,750 to 47,616 lecturers). Due to this overload in teaching, the university staff simply does not have time left for R&D or other learning activities. Ageing staff is another issue since the majority of professors and associate professors are above 55 years old with few replacements in pipeline. Over the previous years, many scientific and engineering disciplines have failed to attract young talented students and as such a shortage of human resources in university system is foreseen. Within the higher education system, entrepreneurship is not a tradition. The most entrepreneurial character so far is reflected in the desire of teachers to do“ outside the class”teaching to earn extra money. The low basic salary of the academic staff explains this.
In terms of infrastructure and other teaching and R&D facilities, many upgrades have been made recently. However, this tends to be only for a few number of big universities. Many universities still use equipment and facilities of the mid 60 or 70s. Library system in many universities is small and outdated in both quality and scope of coverage. Foreign language
343 Chapter 3 _ Industrial Technology Development Policy literature is still mainly in Russian dating back to the mid 70s. There has been a lack of electronic links with national library or central information and librarian system. Moreover, even for those universities which provide English materials, the rate of use is low due to low English capability of the staff and overload in teaching. As a result, teaching curriculum is old, repetitive, lacks innovative approaches and fails to provide updated knowledge.
Weakness in international cooperation is a challenge in dealing with international exchanges, causing difficulties in long term planning and choosing counterparts to cooperate with. Recognizing the need for training to be closely linked with research and to serve the need of social and economic development, the government has launched an action plan to renovate management of the university system by 2010. Key contents include setting up linkage mechanisms between training, research and production; combining training with R&D organizations and firms to overcome traditional isolation of teaching from research and industry; increasing investment for R&D in the universities. Still, these efforts prove to be difficult when implementing due to many constraints in the linkage system.
Following is a SWOT analysis of university R&D in Vietnam.
¥ Existing legal entities and large number of faculties ¥ Capable, hard working staff with strong motivation
¥ Weak market link to firms and R&D customers ¥ Used only to teach, not to do research ¥ Busy teaching schedule ¥ No clear mechanism to do business with research
¥ Research labs, hard infrastructure and students available ¥ Capable, clever staff if having been trained at research ¥ Big demand from firms and foreign R&D ¥ Trusted by firms when with good marketing strategy
¥ University R&D is dependent on foreign R&D ¥ Firms are not interested in university R&D ¥ Possible conflict among colleagues because of no clear mechanism to conduct R&D activities
344 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy 2.3. R&D Activities in a Research Institute
First of all, research institutes in Vietnam have almost the same quantity of R&D work force as the universities do.This suggests that the two are very similar in terms of total volume of R&D activities. Most of the important R&D institutes are public ones. The largest among them is the Vietnam Academy of Science and Technology with 18 research institutes and 9 regional branches in various fields of science and technology. By the end of 2003, this institute had about 3,000 staff.
Table 3-4-7 | R&D Workforce in Vietnam
Bachelor Master Ph.D. Total
Colleges 449 106 18 573
Universities 11,758 5,115 3,188 20,061
Research Institutes 14,147 914 3,142 18,203
Total 26,354 6,135 6,348 38,837
Source: MOST (2004)
In general, public institutes have the privilege to receive funding from the central government to carry out the so called“ State S&T missions”. These missions are usually organized into research programs which aim to provide scientific foundation for policy making and legislation building process (social science), or to create new S&T outcomes significant for economic and social development; defense and national security; and for human resource and S&T talents development. Lacking an effective mechanism to identify such missions as well as mechanisms to distribute the research results, the state S&T programs are criticized for not being effective. Over the last few years, the whole process of identifying, conducting, and evaluating state S&T missions has been reviewed to come up with a better solution.
In addition to the above two institutions, there are scientific organizations under line ministries and provinces/cities. These institutions also get public funding via their ministries/provinces to do research and address scientific/technical and/or policy problems in the field/areas of related line ministries/provinces. With regard to the governance of public scientific organizations, majority of them still belong to line ministries and other equivalent government bodies, and thus get subsidies from the government budget.
Public R&D institutes operate in isolation from other innovation actors. They offer few exchange and do not share much learning with the others. They have weak linkages to firms, especially to those which are not under the same umbrella organization like ministry or province. Firms normally have no link to R&D institutes for their technological innovation.
345 Chapter 3 _ Industrial Technology Development Policy There is a mismatch between capacities ofR&D institutes and technology demand from enterprises. Enterprises do not expect much from R&D institutes. Survey of 123 enterprises in 2003 showed that 84% innovation ideas came either from own business activities or customers, while only 10% came from R&D institutes. About 60% of firms had no contact with R&D institutes.6)
Table 3-4-8 | Missmatch between Capacities at R&D Institutes and Technology Demand of Enterprises
Evaluation of Evaluation of Type of S&T activities Research Difference Enterprises Institutes
Industrial R&D 6 1 -5
Engineering design and equipment production 10 6 -4
Industrial pilot production 5 11 6
Adaptation of existing equipments 11 8 -3
Revision of product design 8 7 -1
Provision of analytical service, experiment of 1 4 3 prototype product Provision of installation and operational services 2 10 8 for new equipment Provision of maintenance services for machinery 3 9 6 and technology equipment
Provision of equipment procurement 9 3 -6
Provision of technology information 7 2 -5
Provision of training services 4 5 1
Source: Bach Tan Sinh, Presentation at "Transformation of Vietnam's National Innovation System: The Case of Organizational and Policy Learning in the Technology R&D Institutes", National Institute of Science & Technology Policy & Strategy Studies (NISTPASS)
Mismatch between capacities of R&D institutes and technology demand from enterprises is showed in the following table. In most cases, technology demand of enterprise and capacity (supply) of research institute is quite different.
6) Source: Bach Tan Sinh, "Transformation of Vietnam's National Innovation System: Institutional and policy learning toward sustainable development", Asian CISASIA's Workshop of "Towards Innovative, Livable and Prosperous Asian Mega cities" Project, May 2009, Bangkok, Thailand.
346 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy A SWOT analysis of R&D at a research institute is as follows.
¥ Has hard infrastructure, legal entities, and large pool of staff ¥ Used to conducting research, paid for doing research ¥ Best research brand name in Vietnam
¥ Weak market link to firms ¥ Experience working as bureaucrats; used to doing only the state projects ¥ Similar to a state agency, with rigid structure, and bureaucracy
¥ High R&D demand from domestic and international market ¥ Outsourcing demand (KPO) ¥ Strategic location: Vietnam as good regional research hub ¥ Vietnamese is better at research with good logical thinking
¥ May work for foreign research or abroad ¥ Turn to other jobs if no incentives (switch to other ministry jobs, open private business, etc.)
3. Network of Innovation Actors 3.1 Industry, University and Research Institute relationship
The assessment shows that Industry University Research Institute (IUR) relationship for the R&D activities and innovation in Vietnam is very weak. There is also a lack of institutional framework, incentives and motivations to promote IUR relationship. The poor institutional framework fails to promote interaction and innovation among players as shown in the following areas. ¥ Conflicting policies on technology, finance, manpower, training, industrial property, S&T information, and etc. ¥ Lack of information and intermediary agencies to facilitate innovation process ¥ Centrally planned economy structure is still very dominant
The following facts give reasons for poor IUR ¥ Very difficult to link research institutes and firms ¥ Small expenditure on R&D (2%) mainly for public research institutes and not for enterprises (especially private ones)
347 Chapter 3 _ Industrial Technology Development Policy ¥ Few S&T specialists are in enterprises (32%) compared to 48% in Thailand, 58% in South Korea and 64% in Japan. Lack of incentives and motivations for innovation players to interact result in the following: ¥ The innovation system is too static with limited flow of knowledge, due to the secret keeping tradition and inadequate protection of IPR. ¥ There is a lack of intermediary institutions and services engaged inR&D activity. ¥ Venture capital and other“ soft”infrastructures for R&D and innovation are non absent. This also distorts the distribution of R&D researchers among research institutes, universities and industry, as shown in the below figure.
Figure 3-4-5 | Distribution of R&D Researchers by Type of Organizations
The following figure shows that academic institutions have no direct role in driving the economy and are in the kind of“ lock-out”position in the innovation system.When studying on
Figure 3-4-6 | Innovation Environment with Dominant Role of Commercial Interactions
Services providers
Financial Inst. Large / FDI firms
Suppliers Customer
SMEs
Academic Institutions Government
Source: The Role of Academic Institutions in Economic Development: The case of Vietnam, Nguyen Vo Hung, Tran Ngoc Ca
348 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy the IUR relationship, which is the main pillar of technological innovation in Vietnam, it can be said that an innovation system exists in principle, but it is very weak and fragmented. Innovation linkages among the main actors of the system are either weak or lacking. There are various bottlenecks of the system as a whole, and in particular, in each group under organizations, which hinder the contribution of this system in strengthening national innovation capability as well as limiting overall economic performance of the country.
The main shortcomings of this IUR relationship can be seen in the following. First, current innovation system presents a strong state bias. The players in the innovation system are dominated by the public ones. The number of non-state organizations are very limited. More importantly, vertical linkages between state authorities and public organizations seem to be much stronger than those of private innovators. It is because the majority of public organizations directly belongs to the line ministries or other state agencies and is independent from productive enterprises. They operate like a state agency and receive commands and subsidized fund from the ministries and state agencies. This does not encourage them to collaborate with other organizations or partners in conducting R&D activities. Non-state organizations, meanwhile, seem to be isolated from the state’s innovation mechanism and they do not have any opportunities to get supports directly from the state in knowledge generation. In many cases, private institutes have to be a sub contractor of the public research institute in conducting the state funded projects.
Second, for many years in the past, innovation policies of Vietnam have been concentrated in traditional S&T policies rather than in policies to promote knowledge diffusion, adoption and application of newly generated knowledge. This led to the supply driven mode innovation system, where the S&T policy focused only on knowledge generation while neglecting the process of applying S&T results in reality. Recently, several measures were taken to promote S&T adoption and application in production. Results were, however, still limited. More importantly, the current S&T legal framework does not create an equal basis for all kinds of innovation actors in terms of market access, infrastructure facilities, financial supports, etc. In other words, a truly competitive atmosphere is absent for the innovation actors in Vietnam. Obviously, all these institutional weaknesses create difficulties to further promote innovation capacity and hence, limit its impact on productivity growth of the country.
Third, the number of organizations playing as a bridge between knowledge generators (i.e. the research institutions, universities, etc.) and users (i.e. the firms) has been growing dramatically during the last few years. However, they are still limited in skills and expertise in order to satisfy the users’needs. In addition, such types of innovation supporting mechanism like venture capitals, angel funds or technological transfer supporting funds are either absent or not yet in operation in Vietnam.
Fourth, horizontal relations among the innovation actors in the system are weak. Public
349 Chapter 3 _ Industrial Technology Development Policy R&D institutes, mostly under line ministries, seem to be separated from technical universities and firms. They are not under pressure to commercialize their research results since their activities were subsidized by the state budget regardless of their practical applicability or usefulness. Meanwhile, having a large numberof highly educated professors working at the universities led to only 20% of the university’s teachers being involved in research. The reason is simply that their time has been put to lecture in different training courses and hence having no time to do research.
In Vietnam, only large state firms and very few private companies have set up their own R&D institutes. Only some of them are successful in operation while the rest are very passive in linking their research with the firms’need and commercializing research results. The R&D units at FDI firms operate mainly according to the parent firm’s innovation policy and do not have strong relationship with domestic firms and R&D institutes. All these can partly explain the reason why Vietnam has been ranked at a very low level in term of innovation capacity as mentioned earlier in this study.
Fifth, domestic firms do not have strong motivation to acquire new knowledge locally and are less ready to take on institutional or technological changes. There are many reasons for this situation. Most of Vietnamese enterprises are of small and medium scale, accounting for 96% of the total number of firms. They do not have capacity to organize R&D activities internally and lack sufficient information on new knowledge or financial resource to obtain it.
Meanwhile, the large state firms lack the will to change and they are inactive to innovation since they have their monopolistic position to avoid competition. FDI enterprises do have incentives to pursue innovation, but they do not have strong supply chain linkages with domestic firms. In many cases, FDI firms choose to import materials and technologies rather than to acquire them locally. In short, the market’s demand for technological innovation of Vietnamese businesses is very weak, which can also be seen as a hampering factor in promoting new knowledge application in the firms. The recent institutional reform to establish a level playing field for doing business is expected to create a substantial competition pressure on the firms, making them more interested in undertaking organizational and technology innovation.
In sum, the above analysis exhibits the fact that like other developing countries, the IUR relationship in Vietnam is facing severe challenges in order to become more favorable for knowledge creation, adaptation and application. Despite Vietnam has made efforts over the last decade in introducing reforms in S&T management and measures for fostering technological innovation, what is first required is a paradigm shift in the mindset rather than concrete policy and measures.
Following SWOT analysis shows the IUR relationship in Vietnam.
350 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy ¥ Large in number compared to the given tasks ¥ Hard working under the right system ¥ Clever, good logical thinking
¥ Not used to doing business ¥ Weak link to market actors ¥ No clear market mechanism ¥ Lazy due to state projects, monopoly andsubsidies ¥ Bureaucratic institution
¥ Big demand if business mind is incorporated ¥ Country as an out sourcing destination ¥ Become a regional research hub
¥ Neither national S&T nor private R&D business is successful ¥ Vietnam as supplier of R&D and skilled workers to other regions
4. Innovation Clusters
There are two major innovation clusters (science and technology parks) in Vietnam. One is the Hoa Lac High-Tech Park and the other is the Saigon High-Tech Park. In this part, the two will be described with the evaluation of current status and policy recommendation for the future development.
4.1. Hoa Lac High-Tech Park
As the first Vietnamese High-Tech Park, Hoa Lac High-Tech Park (HLHTP) has been established with several objectives: ¥ Promotion of Research & Development; ¥ Producing and commercializing high technology products; ¥ Incubating High-Tech enterprises; ¥ Developing human resource for high tech.
351 Chapter 3 _ Industrial Technology Development Policy Figure 3-4-7 | Location of Hoa Lac High-Tech Park
Table 3-4-9 | Zone Plan of HLHTP
Zone Space ApplicationHi-Tech National Industrial Zone 1,319 2,703 9,082 59,236 72,831 90,313550 ha 125,476 R&D andForeign Training Zone 3,984 7,884 16,738 19,263 29,179 28,339229 ha 40,173 SoftwareTotal Park 5,303 10,587 25,820 78,499 102,010 118,65276 ha 166,189 GrantedEducation National and Training 232 349 2,554 6,575 22,943 30,525108ha 89,303 CenterForeign Area 1,576 1,919 5,208 5,937 12,013 13,64050 ha 31,487 MixedTotal Use Zone 1,808 2,268 7,762 12,512 34,956 44,16587.5 ha 120,790 Apartment and Office 42 ha Housing Area 26 ha Amenity Zone 110 ha Park and Sport Area 33.5 ha
HLHTP location has several advantages. First, it is located just 30 km west of Hanoi Capital (less than 1 hour driving) and 60 km from Hanoi International Airport. It is also only 20 km
352 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy away from Son Tay Port and along Lang Hoa Lac Highway (6 lanes, 140m wide). It is near Hanoi National University and is in a region with 60% of the country’s S & T capacity. The area is huge (1,650 ha) and has a lot of space for future accommodation of industry and research centers.
HLHTP has various zones and the industrial zone of HLHTP is one of the key attractions for investors. The R&D zone is currently under construction:
Tenants of HLHTP are from various areas including IT, material, R&D, high tech service, e Banking, hi-tech medical equipment, education/training, pharmaceutical product, and precision machinery. Investors and tenants are from Japan, Taiwan, USA, Vietnam Korea JV, Vietnam Italy JV, etc.
HLHTP is under the authority of Ministry of Science and Technology. The ministry is working hard to build a make successful innovation cluster as it is the first kind of science and technology park in Vietnam.
Figure 3-4-8 | Organization Chart of Hoa Lac High-Tech Park
Government
Ministry Science & Technology
Hoa lac Hi-Tech Park Management Board
Dept. of Vietnam IT Dept. of Other Internet Planning. International Education Center Construction, Relations & Functional Center & Environment Investment Departments Promotion
HLHTP offers many incentive schemes including tax reduction, administrative support and competitive rental cost.
353 Chapter 3 _ Industrial Technology Development Policy Table 3-4-10 | HLHTP's Incentives for Investors
FAVORABLE ENVIRONMENT VAT & IMPORT DUTY EXEMPTION FOR � “One-stop” investment application services. � Equipment and machinery for the formation of the fixed assets of the project and spare � On-site and electronic customs clearance. parts and components. � Multipl entry visas for expatriates. � Construction materials imported to build the � Competitive land rental and fees. fixed assets of the project that are not produced locally. � Lowest land rental TAXATION HHTP Application National 1,319 2,7030% 9,082O4 Years 59,236 (from the 72,831first profit making 90,313 year) 125,476 CorporateForeign Income Tax 3,984 7,8845% 16,73809 Years 19,263 (following 29,179the exemption 28,339 period) 40,173 Total 5,303 10,58710% 25,820The remaining 78,499 years 102,010 of the project 118,652 166,189
A SWOT analysis of HLHTP has been made:
¥ One of the first national priorities; lots of subsidies ¥ Japan’s ODA, expertise, maybe also attract more FDI ¥ High expectation and interest from the government ¥ Doing R&D business with the brand name of Vietnam
¥ Clear strategy andgoal is needed ¥ Clearly defined form, model of Institution, stakeholders, etc needed ¥ Neither national S&T capacity building nor hi-tech business ¥ Heavy bureaucracy with many overseeing agencies
¥ Chance of attracting Japanese FDI ¥ Investment and cooperation from Vietnamese residing overseas ¥ Do big strategic national key R&D, S&T projects
¥ Delay caused due to land clearance, building infrastructure, real estate business ¥ Time schedule to finish? Cost? ¥ National show case project, but no economic or development return
4.2. Saigon High-Tech Park
Saigon High-Tech Park (SGHTP), as the second high tech park of Vietnam, is 15km northeast from the downtown of Ho Chi Minh City, which is the center of Vietnam’s dynamic economic region. It is surrounded by 43 industrial and export processing zones and near Ho Chi
354 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy Minh City National University with many research institutions. It is 17 km away from the International Tan Son Nhat Airport and 15 km from Sai Gon Harbor. The area of SGHTP’s is 913 ha (Phase 1: 300ha; Phase 2: 613 ha) and it has main functional
Figure 3-4-9 | Location Map of Saigon High-Tech Park
sections as follows: 1) Hi-Tech Manufacturing Section, 2) R&D Center, 3) Business Incubator, 4) Training Center, and 5) Business Center.
SGHTP focuses on projects in high tech manufacturing; assembling; providing scientific technological services in the area of 1) Microelectronics Information Technologies Telecommunications, 2) Biotechnology in Medical, Pharmaceutical and Environment Applications, 3) Precision Mechanics Automation/Robotics, and 4) Advanced Material Sciences, Nanotechnology.
Tenants of SGHTP are from various industries including 1) Biotech, Medical, Pharmaceutical, Environment, 2) High-Tech Services, 3) Manpower Supply, 4) Microelectronics, Information Technologies, Telecommunications, 5) Precision Mechanics, Automation, Robotics, 6) Supporting Services, 7) Supporting Industries, and 8) Training, Incubation and R&D. Investors are from Denmark, France, Japan, JV Vietnam-Denmark, Vietnam-Korea, Vietnam-Malaysia, VN-Singapore, VN-US, South Korea, Taiwan, US, etc.
A SWOT analysis of SGHTP has been made:
355 Chapter 3 _ Industrial Technology Development Policy ¥ Saigon city’s strong commitment and big subsidy ¥ Can attract US investment ¥ Business minded, extrovert, early tech adopters ¥ Saigon as a dynamic economic hub ¥ No national capacity building task; is more concentrated in business
¥ Clear strategy and goals are needed ¥ Heavy bureaucracy with many overseeing agencies
¥ Saigon as home of many Vietnamese residing overseas => chance for investment and cooperation for the returning Vietnamese ¥ Outsourcing business
¥ Delay in land clearance, building infrastructure, real estate business ¥ Development schedule is not clear and the total development cost may be too high
4.3. Daedeok Innopolis
Daedeok Innopolis is the representative case of Korea’s innovation cluster policy initiative. Conceptualized in 1973 as a national R&D complex, Daedeok Innopolis has significantly contributed to the development of Korea’s science and technology and industry. For instance, the development of semiconductor, CDMA application system and WiBro (which has been adopted as an international standard for mobile communications) made Korean IT industry strong in the world market. Korean style of nuclear power plant, Arirang satellite, and Hubo robot are also the examples of scientific achievement from Daedeok Innopolis. Daedeok Innopolis, the biggest science park in Korea, now houses 977 organizations including 28 big government sponsored research institutes, 6 universities and 898 companies in its 70.4Km2 area. There are 40,338employees (6,800 Ph.D.s) as of the end of 2007.
The Daedeok Innopolis has undergone a series of changes since 1973. First it was conceptualized as Daedeok Science Town (DST) in 1974. In 1970s, it was required to relocate the national science and technology centers located in Seoul due to the land shortage, city noise, high real estate price, etc. As such, the government developed a plan sought to create a new science town to accommodate national research and education functions. Hence, the basic plan was launched to build a research city in Chungnam province where the old DST was located. The Construction commenced following the late president Park’s announcement in 1973.
356 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy Since then DST has undergone four consecutive stages of development; Construction of Infrastructure, Creation of Innovation, Formation of Innovation Cluster, and Growing Innovation Cluster. During the Construction of Infrastructure stage (1973~1992) basic research facilities were built while DST took the role of assisting industrial technology development. After the construction started in 1974, the first overnment sponsored research institute (GRI) moved to DST in 1978 and since then, the number of GRIs and private research institutes has grown steadily. The completion ceremony of Daedeok Science Town was held in November 1992.
In the stage of Innovation Creation (1993~1997), the innovation results became visible. During this period the necessary policies were enacted, such as Daedeok Science Town Administration Law and Daedeok Science Town Management Plan. At this period, many governmental research institutes started to produce great results both in science and technology. However, the synergy or network among the university, industry and research institute was very low in degree and almost no spin-off company was in DST.
In the stage of Innovation Cluster Formation (1998~2003), many companies started to spin- off from the government research institutes. Right after the 1997 financial economic crisis in East Asia, the government research institutes went through restructuring, which promoted spin- offs of researchers in GRIs. As a result, there appeared many venture companies and the technology of GRIs were transferred and commercialized in the private market. In addition, with the help of venture bubble in the stock market, venture start-ups were increased exponentially in late 1999 (Yim, 2004). Daedeok Science Town Administration Law enacted (Law 6090) in 1999 which allowed commercialization of R&D and venture company to move in was, in fact, a big step forward for an innovation cluster for industry, education, and research functions to coexist. An industrial network linking Daedeok Techno Valley and Industrial complex 3 and 4 were formed around DST after Daedeok Valley Proclamation Ceremony in the year 2000.
In the Growing stage of Innovation Cluster (2004-present), Daedeok Special R&D Zone law was enacted. As a result, the area was renamed as“ Daedeok Innopolis”and the size expanded about three times. More importantly, new Daedeok management Office (HQ) was established with more functions and big organization structure. Now it has a bigger budget to promote Daedeok Innopolis to become the world class innovation cluster and also has programs for global marketing, technology commercialization and so on.
Since 2005, when the“ Daedeok Special R&D Zone Law”was enforced to support Daedeok, venture fund worth about 70 billion won was raised for new business support. As of 2008, the total number of companies is 898 and the total revenue has reached 9 trillion won. The amount of R&D budget has gone up to 4.7 trillion won. The number of employment may be relatively small compared to the global standards, but taking into account how professional human
357 Chapter 3 _ Industrial Technology Development Policy resources is concentrated in the area, the regional impacts would not be negligible - 6,800 PhDs out of 21,542 employees.
It is noteworthy to mention the constant efforts of the Korean government for the Daedeok Innopolis. First of all, the central government has been a long time supporter for such a big project since 1973. Secondly, it changed its policies to meet the situational changes. In the beginning, Daedeok was conceptualized to become a science town.. However, the industrial production was allowed in the late 90s with emphasis on venture spin off. And in 2004, the paradigm of innovation cluster was introduced and the new law (Daedeok Special R&D Zone Law) was enacted. Under the new paradigm, the policy goal of Daedeok is to make“ the world class innovation cluster”beyond a simple R&D complex. In order to achieve this goal, there have been many efforts.
Figure 3-4-10 | Change of Policy Paradigm for Daedeok
Model Science Park S&T and Market Innovation Cluster Model Interactive Park Model Model
Policy Science Based S&T + Production + - Network & Synergy Direction Complex Market Interaction - Open Innovation (S&T Island System Approach)
It seems that the results of innovation cluster paradigm show positive signs and Daedeok is being developed into a well functioning Innovation Cluster. For instance, there are now many internal/external networks, and small scale clustering phenomenon is appearing among industry, university and research institute. In Daedeok, there is a dedicated internet newspaper which has been the main information provider and distributor withinthe community. Daejeon Metropolitan City government has organized World Technopolis Association (1998) and the 2010 IASP World Conference was hosted. Considering the growth trend of companies and sales, it seems that Daedeok has entered the path to development in the early stage of Innovation Cluster based on its accumulated technological capabilities. However, the time will tell whether the policy change was successful or not because the networking or cluster dynamics in Daedeok is not as active as we see in other advanced countries.
As the industrial structure of Korea changed, the model of Daedeok evolved from science based park to innovation cluster. To meet the industrial needs, Daedeok has been given new roles and functions. Now, it is required to produce fundamental technologies for Korea to have the industrial competiveness. This can be possible only when the concerned actors, including university, research institute and industry, are networked and work together.
358 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy Figure 3-4-11 | Evolution of Daedeok Innopolis
Global R&D hub
Positioning National R&D Hub of Daeseok Early Stage of Cluster
Simple Agglomeration Top-tier Technology Leader Second-tier Innovator Level of Technology Imitator actor
Direction Expert- Heavy and Technoloy Regional & of Oriented Chemical Intensive Hi-Tech National Industrial Light Industries Industries Innovation Innovative Policy Industries Clusters
Source: Yim et al., (2003), 30 Years' Achievement of Daedeok and Its Development Direction (in Korean)
Daedeok Innopolis is Korea’s unique experience which can be a model to Vietnam. It started in Korea when the country was very much less developed. It was a national/central government project to serve a national purpose rather than for regional innovation. The major player was not university or industry, but Government Research Institutes. Only recently the role of university and industry is relatively increasing. It began with a small market and Science Park as the model instead of business or industry oriented technology complex. But after a series of changes, it is heading to become the world class innovation cluster.
5. Conclusion and Suggestion 5.1. Policy Framework
Vietnamese government is putting a lot of effort to develop its own National Innovation System (NIS). Vietnam has good conditions for the development of NIS. First, the Vietnamese people are eager and ready to learn, which is rarely found in other developing countries. As a result, Vietnam has a pretty large pool of S&T workers despite the quality issues. Second, it has a good economy growing steadily over the years. The country is ambitious and committed for faster development and to catch up other countries.
359 Chapter 3 _ Industrial Technology Development Policy There are also some challenges. Vietnam needs capital and to catch up other technology leading countries. It lacks knowledge about regional, global supply chain and does not have the appropriate awareness on cluster and supporting industries. There is still imperfect market mechanism in Vietnam, especially in S&T including the incentive mechanism for innovation. The country is not yet aware that a radical paradigm shift in the innovation and adopting a new mindset and vision is a necessity for improvement. Plus, the national innovation system is in the process of developing and needs more efforts both in terms of system policy as well as individual sector specific policy.
Now is the time for the policy makers to have a new mind set and take fresh perspectives for the S&T policy and National Innovation System. The S&T and innovation is not only limited to “technological”innovation. They also include those of process related, non technological, and “soft”technologies in the whole innovation process which start from R&D to technology transfer and commercialization. Technologies or knowledge of doing things (integration into global supply chain, adoption, diffusion, application, etc) are to be paid attention as well.
Since S&T policy covers many fields and is closely interrelated with many elements of NIS, it is difficult to cover all the policy aspects here and give a few simple policy suggestions or guidelines. In this research, the policies are suggested in three levels; the macro, mezzo and micro level. The macro level policies deal with policies about national innovation system and its actors, structure and the system mechanism. Micro level policies include many specific policies such as R&D investment policy, human resource policy and so on. In between macro and micro level policies there are mezzo level policies for IUR relationship and innovation cluster policies which are the main focius of this research.
Macro level policies have to be formulated and implemented in a long term context while the micro and mezzo level ones work within a relatively short period of time. However, it should be clear that all the different level policies are very much intertwined and connected so that the policy target and expectation of results also overlap to some extent. In the paper, macro level policies are suggested first, followed by mezzo level policies later. Specific micro level policy is not described here because it is beyond the research scope. However, the micro level policy has to be developed further in the future to have a set of complete range of innovation policies in Vietnam.
Table 3-4-11 | Innovation Policy Framework
Contents Time frame Macro level - National innovation system - Long period policies - The actors of NIS, its structure and mechanism
Mezzo level - Industry, university and research institute (IUR) relationship - Relatively mid period policies - Innovation cluster policies Micro level - R&D investment and project management - Relatively fast and short - Human Resource policies - Other specific policies period
360 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy 5.2. Policy Paradigm and National Innovation System
5.2.1. Policy Paradigm and Process
As said before, innovation policies consist of different level policies which are somehow intertwined. Therefore, individual policy alone cannot lead to a desired outcome in the short period of time, especially when it targets to change the characteristics of NIS. That is why the policy paradigm and consistent policy direction is important in the innovation policy.
The Vietnam science and technology policy has to start with the right vision for innovation. In fact, innovation is a more broad and result oriented concept than science, technology, and R&D. It has to predict and incorporate the effects into the socio economic outcomes. Innovation should be seen as a mean to survive. So, the country should formulate a comprehensive NIS policy and strategy. Broadening the concept of S&T and innovation is necessary. It should not be only“ technological”innovation. Technology should be also that of process related, non technological,“ soft”technologies. Technologies on way of doing things (integration into supply chain, adoption, diffusion, application, etc) are to be paid attention. Innovation policies should answer the challenges in inter-disciplinary issues, complexity problems, etc. For instance, Service Science Management Engineering (SSME) as a new science should be taken into consideration.
After the right approach to innovation policy, there policy process; policy formulation, implementation and feedback cycle. We should first ask which method Vietnam is using to develop its innovation policy. Is it top-down or bottom-up? Is it decentralized or centralized? Top-down and bottom-up approaches are both needed. As the economy grows more and more, participation from all the concerned actors would be needed.
Another important thing to keep in mind is that the experience of other countries, including Korea, will not be duplicable exactly. As time and global innovation environment changes, the same policies cannot be copied to take place and have the same impact in Vietnam. It should be the first priority that Vietnam experts develop their own policies. Especially when the policy deals with innovation, capability to develop one’s own policy is desperately required.
5.2.2. National Innovation System
First of all the vision or first goal of national innovation policy has to be clear. Is it to leapfrog in terms of economy and/or science and technology? Or is it to achieve gradual development? It should well define national interest among promotion vs. open collaboration; S&T capacity building vs. attracting FDI. Be aware that influx of FDI does not necessarily lead to technology transfer, etc.
361 Chapter 3 _ Industrial Technology Development Policy S&T or NIS should not be considered as an organization but a dynamic interactive“ game”. The innovation process is not a determined mechanical game. It is rather a living organ which evolves in the changing innovation environment. Managing innovation and creativity is managing the“ Un-Known.”One should figure out how to best“ know”the Un-Known. Managing uncertainties is quite different from managing tangible things. So, new mindset and methods is required in order to manage S&T and Innovation. The new mindset can be developed in an innovative cultural setting.
There are two opposite approaches in building one’s national innovation system. First is to build with one’s own domestic capabilities while the other is to do so with the help of foreign capabilities. Of course, it is important to utilize the foreign resources while building up one’s own capabilities. S&T policy is not a matter of personal wish or wishful thinking. It depends entirely on the situation and the very context of the country. One cannot have a national approach if the country is too dependent on outside factors. An S&T, innovation and industrial policy has to be designed based on the status of technological dependence on foreign resources. It is necessary to design and implement government policies to learn and digest foreign technologies.
Generally speaking, Vietnam has been a technology adopter rather than a technology adaptor or a creator. Vietnam already opened its market and crossed the river of no return. This means Vietnam can no longer close and protect its market. Technology market is not an exception. Industrial policy and innovation policy have to adapt to this situation. The experiences of Japan, Korea, Taiwan, etc. cannot be copied and applied for Vietnam as their policies took place decades ago. Industrialization of Vietnam is to be designed in an open context. However, designing S&T and innovation strategy for Vietnam only based on national and domestic factors would also not be ideal.
A new paradigm is to be found in order to become the basis for all other policies and measures. It is no longer appropriate to define a country based on its geographical constraints. The“ national”economy has been made not only within the national borders and by domestic forces. It is not possible for many countries, including Vietnam, to exclude foreign economic forces and components’influence. So, policy maker has to deal with a kind of“ heterogenic” economic system. S&T and Innovation policy also has to deal with a“ phenomenon”. Vietnam should find its place in the global network (integration into supply chain, etc.). S&T policy should be worked out not only to address national interest but also foster global cooperation. S&T policy maker should be able to make clear distinction between national goal, and integration into the region as well as the world.
Many industries can no longer be developed vertically within Vietnam due to an open market where no domestic force can dominate. Domestic firms and organizations, including state firms and state R&D institutions, cannot decide the market prices for a certain product or
362 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy services. They can only do so in certain parts of the whole business line. So, they should specialize in some parts of the whole value chain or supply chain in order to sell their “product”, or better parts of product, even within the domestic market. A paradigm shift in the design of the production or the business line is, therefore, necessary. Firms and organizations should not stick to traditional raw material, human resource, products, method and technology any more if they want to become competitive.
In the case of Vietnam, FDI is not expected to bring more technology transfer to the country. Theoretically it is possible but in reality, it is only possible under certain situations. So, it totally depends on the conditions. According to a study by the United Nations Development Program(UNDP) and Vietnam’s Central Institute of Economic Management(CIEM) under the Ministry of Planning and Investment, FDI firms have weak spillover effects in terms of technology transfer. FDI firms take strong measures in order to protect their IPR through patents. From 1995 to 2005, they filed more than 94% of the total patents and industrial solutions in Vietnam
5.2.3. S&T Budget and R&D Program Direction
The R&D program is one of the most important parts in innovation policies. In Vietnam, the R&D program will positively affect the IUR relationship while strengthening the technological capabilities of each actor. Considering the current status of R&D actors, activities and IUR relationship, the following is suggested: ¥ Reduction of S&T budget and subsidy for public institutions; ¥ At the same time, increase the other forms and mechanisms where private firms and institutions can get financial support from the budget (funds, loans, other project mechanism, etc.); ¥ Provide financial support or any form of subsidy for only those R&D, S&T projects carried out on a contractual base between industry and R&D or S&T institution; ¥ No lump sum project budget. R&D or any other S&T project with budget left will be reimbursed in installments. This means that the total budget for a project will be divided into stages. After finishing each stage, a review of the achievement will be done by the project donor to guarantee its quality. Project can be continued only after getting an approval from each stage; ¥ Financial and technical support for private firms to create R&D department or to sign contracts with R&D institutions or universities; ¥ Hire foreign directors to work in domestic R&D institutions and universities.
363 Chapter 3 _ Industrial Technology Development Policy 5.3. Policy for IUR and Innovation Clusters
5.3.1. Industry, University and Research Institute (IUR) Relationship
To improve the IUR relationship, new policies should be made. Maybe the word “improvement”is too“ mild”since one only improves after something has already been created. In Vietnam’s case, one should start from the scratch. This means the IUR should be based mainly on market forces. So, the first thing to do here is to create a right market for IUR. However, this may require conducting another research project. This research focuses on giving policy recommendations based on the given situation.
It is recommended to adopt the following policy direction in order to form an effective IUR relationship. ¥ First, try to create an open, global innovation system. Once the NIS is open and networked, the IUR relationship will automatically be developed. ¥ Locate the innovation actors in near, close place. In this sense, developing an S&T park (innovation cluster) is a good policy since it utilizes location to make room for better networking. ¥ Make the actors work together by providing collaborative R&D projects and other innovation activities. The government has to give more incentives to promote collaborative works and projects and enhance the IUR relationship. ¥ Designate a coordinator, who knows industry, university, and research institute. If there is not enough coordinator, training and education is one of the effective ways to increase the human resource supply. As previously discussed in the beginning chapter, the IUR relationship requires the middle person who understands tri-aspects of IUR. Since there are many holes in the link between the industry, university and research institute, it is important to train and provide an IUR coordinator.
Another recommendation for making IUR in R&D work is the introduction of Technology Business Incubation (TBI). TBI is a good tool to link IUR with market and to create a market, with strategic alliances in S&T. TBI incubates firm with in house R&D. It links the innovation players by providing them with information, business opportunities, etc. TBI incubates not only R&D but also R&D service firms like S&T consulting firms, technology support firms, etc. TBI promotes out sourcing business and provides networking opportunities for IUR. There are many forms and models of TBI. Each country, has to design its own model which fits them the best. TBI can be created at a university, firm, research institute, etc. It can be created by a local to serve the region. Or it can be designed to create and nurture a cluster. Some TBIs can be created by business associations or by a group of businesses, universities and research institutions. TBI can be helpful when enhancing outsourcing business, and integrating into the regional, global value chains, and supply chains.
364 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy 5.3.2. Innovation Cluster Policies
There are many industrial areas and/or complexes in Vietnam. Most of them are industrial parks and there are only two major innovation clusters, one in Hanoi and the other in Saigon. Considering the cases of innovation cluster development in other developing countries, Vietnamese S&T policy is very timely and appropriate because it introduced the innovation cluster policy in the early stage of industrialization.
It is evident that there are certain good conditions for developing this high-tech park in Vietnam. It has relatively stable socio-political environment while many of other developing countries suffer from many instabilities. Vietnam has a competitive tax system, financial incentives, and labor cost. Moreover, it also has a big market of 86million people. There is a high demand on industrial procurement and high-tech for a faster growth. Vietnam is strategically located for manufacturing and logistic supplying base to markets of China, Japan and Southeast Asia, etc.
It seems that there are still many missing parts in the related policy. Since innovation cluster development is a big and long term project including land development and management of tenant companies, it is difficult to cover all the policy aspects here. The two innovation clusters will be the cornerstone for Vietnam to prepare itself for the coming Knowledge Economy. But many aspects of the development process are not clear and appropriate.
Since two innovation clusters of Vietnam are in the early stage without a clear and detailed vision and action plan, it is hard to suggest all the detailed policies here. The following questions need to be addressed in order to give proper suggestions for the policy setting. First question is about the vision and goals. Is the innovation cluster for industrial technology or for scientific knowledge? There is the need to set priority between science and technology. Certainly the SGHTP is more industry and private sector oriented compared to HLHTP. How much importance is given to the clusters in the context of Vietnam NIS? What are the long term vision and the short term needs? What are the short, mid and long term goals for the innovation clusters? In addition, any action plans to realize the goals? From the initial stage of the development, both parks should make sure to attract private industries first. But are they prepared for the next stage of development?
Second question is about the structure of IUR in the clusters. What is the relative importance of university, industry and research institute respectively? Who would be the leading organization in the clusters and why? Is there any policy to promote IUR network within the cluster? How can the IUR in a cluster be connected to outside IUR. Since the innovation cluster provides a better condition to collaborate, the IUR network can be formed more easily than in other regions. What comes first between domestic national S&T capacity building and open networked collaboration with global partners? What is its true area of specialization? What is
365 Chapter 3 _ Industrial Technology Development Policy the structure of the clusters (Oriented to“ physical”or virtual? Developed or naturally evolved? For what products?)
Third, are the clusters for local market or foreign market? What is the focus of targeted value chain in the regional or global value chain? Is it only targeting to be a part of a global supply chain? Should sectors keep in balance within Vietnam or be balanced in a broader scope (region, world)?
Fourth, what is the desirable organization model and governance structure? Does the government allow the market (or tenant company) to decide the activities in the clusters? How much authority and resources does the management organization in the innovation clusters have?
5.4. Collaboration Agenda between Korea and Vietnam
Since Vietnam and Korea share similarities in terms of development, culture, geography, etc., Vietnam may draw many lessons from Korea’s experiences in the development process. Some recommendations and suggestions are given for a possible collaboration with Korea in regards to S&T policy to enhance the IUR relationship.
First agenda is to share the knowledge and experience of industrial policy between the two nations, with focus on Vietnam’s integration into the region and the world. Korea has relative advantages in S&T policy making and is moving from S&T policy to innovation policy setting. Vietnam is pursuing economic development by catching up and adopting export oriented policies. However, the global economic and S&T conditions have changed so much that it needs to have a different approach. The accumulated knowledge of Korea’s experience in S&T policy will be a useful help to Vietnam. With collaboration, Vietnam can make new appropriate policies in the context of global supply/value chain and a knowledge economy paradigm.
Second agenda is to carry out a joint technology business incubator for match making and networking the innovation actors. Since the technology commercialization is the ultimate goal of R&D, it is better to have such a joint project between the two nations. Compared to a typical joint R&D project, this project would bring more feasible outcome. Especially, the IT area seems to have much potential.
Third agenda is to work together to develop innovation clusters in Vietnam. Korea has much more experience in developing the innovation clusters since 1973. Daedeok Innopolis and regional Techno parks are the examples. They have contributed to the development of Korea’s science and technology. Now such innovation clusters are working as the core hub of regional economic development. The development of innovation clusters in Vietnam is in its very early stage. With the Korea’s experience, the two high-tech parks in Vietnam can be developed
366 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy successfully.
Lastly, it is necessary to secure a mechanism for interactive collaboration. In order to do this, relevant public/private organizations should sign MOU with appropriate partners. In Korea, there are many related institutes including Science and Technology Policy Institute (STEPI), Korea Institute of S&T Evaluation and Planning (KISTEP), and Daedeok Innopolis management office. All that is needed is a strong initiative from the government. With government initiatives, much collaboration and cooperation between the two countries will follow.
367 Chapter 3 _ Industrial Technology Development Policy References
Reference in English Aubert (2004),“ Promoting innovation in developing countries: A conceptual framework.”
Bach Tan Sinh (2009),“ Transformation of Vietnam’s National Innovation System: Institutional and policy learning toward sustainable development,”Asian CISASIA’s Workshop of “Towards Innovative, Livable and Prosperous Asian Mega cities”Project, 18 21, May 2009, Bangkok, Thailand.
BEZANSON, Keith (2000), A science, technology and industry strategy for Vietnam, document prepared as part of the UNDP/UNIDO project DP/VIE/99/002, March 2000.
Nguyen Vo Hung and Tran Ngoc Ca (2006), the Role of Academic Institutions in Economic Development: The Case of Vietnam.
OECD (1999), Boosting Innovation: the Cluster Approach, Paris.
OECD (2001), Innovative Clusters: Drivers of National Innovation System, Paris.
Porter, M & CoC (2001), Clusters of Innovation: Regional Foundations of U.S. Competitiveness, Council on Competitiveness.
Saxenian, A. (1994), Regional Advantage: Culture and Competition in Silicon Valley and Route 128, Cambridge: Harvard University Press.
SRI International (1999), Clustering As a Tool for Regional Economic Competitiveness.
Tran Ngoc Ca (2006), Vietnam’s innovation system: toward a product innovation Ecosystem.
Yim, Deok Soon (2008),“ The Development and Success Factors of Innovation Cluster,” Presented at 2008 Daedeok International Conference on Innovation Cluster.
Reference in Korean Bok, D. K. et al (2002), Strategy for Industrial Cluster Development, Samsung Economic Research Institute.
Bok, D. K. et al (2003), Cluster, Samsung Economic Research Institute.
Hong, Sung Bum and Yim, Deok Soon et al (2000), Policy Research on Overseas Emerging
368 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy Innovation Clusters and Global Open Strategy, Science and Technology Policy Institute.
Seol, Sung S. et al (2002), Origins and Evolution of the Daedeok Valley, Science and Technology Policy Institute, 2002-04.
Yim, Deok Soon (2002),“ Innovation Cluster of Indian Software Industry: Is It Evolved or Developed?,”Journal of Korea Technology Innovation Society, Vol. 5, No. 2, 2002.
Yim, Deok Soon (2004),“ The Evolutionary Process of Daedeok Science Town and International Comparison In the Perspective of Innovation Cluster,”Journal of Science and Technology Policy, Vol. 14, No. 5, Science and Technology Policy Institute.
Yim, Deok Soon et al (2003), Evaluation of 30 years’achievement of Daedeok Science Town and Development Strategy, Daedeok Science Town Management Office.
Yim, Deok Soon et al (2005), (Draft) Master Plan for the Daedeok Special R&D Zone, Daejeon Metropolitan City.
369 Chapter 3 _ Industrial Technology Development Policy Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy Chapter 04
Efficient and Harmonious Enterprise Policy
1_ Executive Summary 2_ On the Governance of State Owned Economic Groups in Vietnam 3_ Technical/Technological Human Resources Development in the Economic Groups Chapter 01
Executive Summary
This study assesses the key challenges in Vietnamese corporate sector and suggests a number of policy recommendations. We do so for state owned economic groups and also for small and medium sized enterprises (SMEs). Economic group is a term used in Vietnam referring to state owned business conglomerates in strategically important sectors. Firms comprising the group are in mother subsidiary relationship. This study is composed of three parts. In Chapter 1, we cover the governance structure/practices of state owned economic groups. In Chapter 2, we address technological human resource issues in state owned enterprises. In Chapter 3, we tackle the SME issues in Vietnam.
In “On the Governance of State Owned Economic Groups in Vietnam,” Woochan Kim, Il Chong Nam, and Tran Tien Cuong motivate their study on two grounds. First, large scale business enterprises in Vietnam will have to take the form of state owned economic groups for many years to come. The private sector of Vietnam does not have the sufficient capital base to run large scale corporations on its own and the capital market in Vietnam is also at its early development stage, not capable of efficiently mobilizing capital to finance large scale corporations. Second, the operating efficiency of these economic groups depends heavily on the quality of their governance structure. Therefore, they conclude that it is vital to strengthen the governance structure of economic groups in Vietnam. After giving an overview of state owned enterprises in Vietnam, the authors highlight four key challenges faced by the policy makers: (i) the conflicts between commercial and non commercial objectives, (ii) the weak external governance mechanism (bureaucratic dominance in decision making), (iii) the weak internal governance mechanism, and (iv) the vacuum of other government policies, such as competition and investor protection policies.
372 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy The authors also bring about Korean experiences that may shed some light on the challenges faced by Vietnamese policy makers. They, in particular, introduce the Governance Owned Enterprise Act of 1983 and the 1997 Act on the Managerial Structure Improvement and Privatization of SOE. When explaining the 1983 Act, the authors acknowledge that line Ministries were still heavily involved in the management of SOEs even after the enactment. When going over the 1997 Act, however, the authors point out a number of features that the Vietnamese government may wish to adopt. These include, (i) the 50% non resident directors in boards and their nomination by the shareholders, (ii) the CEO Nomination Committee mainly composed of non resident directors, (iii) the shareholders’ approval of CEO, (iv) the shareholders’ approval of CEO Management Contract, and (v) the restriction on ownership aimed to prevent chaebols or foreigners from acquiring controlling interests.
Lastly, the authors give out eight policy recommendations: (i) re clarifying the objective of economic groups, (ii) reconciling the conflicting objectives, (iii) expanding and strengthening the role of State Capital Investment Corporation (SCIC), (iv) strengthening the internal governance mechanism, (v) developing a well functioning capital market, (vi) limiting diversification into non core business areas, (vii) regulating ownership structure and enhance transparency, and (viii) strengthening investor protection. In particular, the authors see SCIC as an important vehicle that can help separate the role of state as an owner and the role of state as a regulator (or as an industrial policy maker). Specifically, they recommend expanding the current role of SCIC so that it can exercise ownership rights not only for small and medium sized SOCs, but also for general corporations and economic groups. If there are far too many general corporations or economic groups to cover, they also recommend establishing additional SCICs. Alternatively, they recommend establishing a newly created agency exercising ownership rights in economic groups or general corporations and multiple SCICs established in major cities exercising ownership rights in small and medium sized SOCs. The authors also advise economic groups not to diversify their business portfolios and enter into non core business areas. They give out five reasons. First, economic groups are established in industries selected to be strategically important for Vietnam. It does not make sense for economic groups to enter business areas in strategically unimportant industries. Second, the non core business areas, in which diversifying economic groups enter, might be the business areas where private enterprises already exist and can operating without any market failure. Third, diversification strategy is justified when there is a need to form an internal capital market, but state owned economic groups depend heavily upon government funding. Fourth, it is troublesome for manufacturing firms to have a control over commercial banks. Mixing commerce and banking has serious problems, such as conflict of interests and concentration of economic powers. Fifth, many academic studies in the literature show that corporate diversification lowers performance.
In “Importance of Human Resource Development (HRD) in SOEs,” Youngrak Choi and Bach Tan Sinh motivate their study by stressing the importance of human resource when it comes to improving productivity, efficiency and profitability of SOEs. The authors then outline
373 Chapter 4 _ Efficient and Harmonious Enterprise Policy the national innovation system in both countries (Vietnam and Korea) and then go into detailed case studies. In their study on Vinatex, they identify a number challenges, including the lack of product ideas and designing capabilities, the low productivity, the underdevelopment of supporting industries, the difficulty in mobilizing capital to upgrade technology and equipments, the poor incentive mechanism, and the insufficient training programs. In their study on Vinashin, they identify a different set of challenges such as the shortage of skilled engineers and workers and the small scale of shipbuilding projects.
Before going into the detailed case studies of Korean firms, the authors outline the three distinct phases of their technology development, the two of which are relevant for Vietnam. In the first phase, technology import through both formal and informal channels served as a critical factor for technological progress. Also, aggressive in house technological learning activities were vital. In the second phase, there were different set of success factors, such as long term commitment, new product or new idea development, exploitation of accumulated knowledge and experience, and active search for cooperative partners.
In light of their case studies on Korean firms (Hyundai Motor Company, Hyundai Heavy Industries, and POSCO) and given the phase of HRD evolution in Vietnam, the authors give out a number of recommendations: (i) expansion of in house R&D activities as a way of improving technological learning, (ii) active cultivation of qualified field engineers, (iii) aggressive import of technology from various sources and efforts to couple them with technologies accumulated in house, (iv) adoption of effective incentive mechanism (special treatment for top quality technicians), (v) effective government policies ensuring sufficient supply of qualified technological manpower, (vi) massive investment for the modernization of equipments and facilities, and (vii) CEO’s leadership in technology development.
374 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy Chapter 02 On the Governance of State Owned Economic Groups in Vietnam
Il Chong Nam (KDI School of Public Policy and Management) Woochan Kim (KDI School of Public Policy and Management) Tran Tien Cuong (Central Institute for Economic Management)
1. Introduction
The objective of this report is to diagnose the current status of state owned enterprises (SOEs) in Vietnam, identify their key governance challenges, and recommend policy directions in light of Korea’s and other countries’ experiences. Among various types of SOEs in Vietnam, we limit our focus to economic groups introduced since 2006. Economic groups are state owned business conglomerates in strategically important sectors, formed by consolidating independent- accounting SOEs into a holding company structure. At the time of this writing, there are only eight economic groups in industries such as electricity, post and telecommunications, petroleum and natural gas, coal and minerals, textile and garments, shipping, rubber, and insurance. But, the number is expected to grow as increasing number of SOEs are waiting for governmental approval to form economic groups.
Studying the governance of these economic groups is vital for Vietnam. This is basically because large scale business enterprises in Vietnam will have to take the form of state owned economic groups for many years to come and the operating efficiency of these economic groups depends heavily on the quality of their governance structure. Since the historic shift from a command economy to a socialist oriented market economy in 1986, Vietnam made significant progress in many areas of the economy. Despite such progress, however, Vietnam is still a relatively poor country with per capita GDP of USD 1,052 as of 2009.1) This also means that the
1) See IMF (2010).
375 Chapter 4 _ Efficient and Harmonious Enterprise Policy private sector of Vietnam does not have the sufficient capital base to run large scale corporations on its own. Capital market in Vietnam is also at its early development stage, not capable of efficiently mobilizing capital to finance large scale corporations. Under such conditions, a full scale privatization of large scale SOEs is not an option the government can use in the immediate future as it only means selling them to foreigners. Thus, industries requiring heavy capital investments will inevitably be dominated by SOEs and this is expected to be the case for many years to come.
This report is organized as follows. Section 2 gives an overview of state owned enterprises in Vietnam. In Section 3, we highlight a number of challenges faced by policy makers in Vietnam regarding state owned enterprises, and in Section 4, we go over the Korean experiences. Lastly, Section 4 outlines our policy recommendations to the Vietnamese government.
2. State owned Enterprises in Vietnam 2.1. Corporate Sector in General
Presently, three types of business enterprises operate in Vietnam: state owned enterprises (SOEs), non state enterprises, and foreign enterprises. As an economy in transition, SOEs still play a significant role. According to the General Statistics Office (GSO), in 2008, they contribute 34.35% of GDP, generate 31.50% of net revenue, and deliver 20.0% of industrial manufacturing. When compared with the 2000 figures, however, there is a clear downward trend. In 2000, SOEs contributed 38.52% of GDP, generated 54.91% of net revenue, and delivered 34.2% of industrial manufacturing.
Figure 4-2-1 | Contribution by the Type of Business Enterprises
The three business enterprises differ significantly from each other with respect to their ownership structure and legal form. State owned enterprises are mainly established and operate under the SOE Law of 2003 and partly under the Enterprise Law of 2005, while non state enterprises are subject either to the Enterprise Law of 2005 or to the Cooperative Law of 2003. Foreign invested enterprises operate under the Enterprise Law of 2005. The process of equitizing SOEs, however, blurred the distinction between the SOE Law and the Enterprise Law.2 Also, there was a need to remove fragmentation in law and provide a legal environment fair across different types of business enterprises. Against this backdrop, the Vietnamese government decided to subject all business enterprises under the Enterprise Law by July 2010. To this aim, since July 2006, SOEs are being transformed either into limited liability companies or shareholding companies.
2) In Vietnam, the term equitization is more commonly used than the usual term of privatization.
377 Chapter 4 _ Efficient and Harmonious Enterprise Policy 2.2. General Corporations and Economic Groups
SOEs include independent state owned companies (SOCs) and general corporations operating under the SOE Law of 2003, and limited liability companies and shareholding companies operating under the Enterprise Law of 2005. While independent SOCs are small and medium sized SOCs established under various line ministries or provincial people’s, general corporations are large sized SOCs established in strategically important sectors either under the Prime Minister or under other line ministries or provincial committees.3) The latter two are also known as General Corporation 91 and General Corporation 90 for their establishments are based respectively on Decision 91/TTg and Decision 90/TTg issued by the Prime Minister in 1994. Compared to independent SOEs, general corporations are subject to higher governance standards and are established with the aim of forming business conglomerates known as economic groups in Vietnam.4) As of 2008, there are eight economic groups and 12 special general corporations established by the Prime Minister.5) The number of member firms amount to 1,399. Among the eight economic groups, seven are under the control of the Prime Minister and one is under control of the Ministry of Finance (Bao Viet group).6)
Economic groups comprise of legally independent companies forming a mother subsidiary relationship. The group itself does not have a legal identity and therefore does not register under the Enterprise Law. As for seven economic groups under the Prime Minister, mother companies are SOCs organized under the SOE Law of 2003 and their charter capital is 100% held by the government. As for Bao Viet group, which is under the Ministry of Finance, the mother company is organized as a shareholding company where government holds 77.54% of charter capital. All eight economic groups were formed either in 2006 or in 2007. Many of the subsidiaries, on the other hand, are equitized. Some are even listed in the stock exchange. Table 1 provides the list of economic groups in Vietnam.
3) Strategically important industries include (i) post, telecommunication and information technology, (ii) ship building and maintenance, (iii) generating, transmitting and distributing electricity, (iv) exploring, processing, and distributing gas and oil, (v) surveying, exploring, and processing coal and other minerals, (vi) garment and textile, (vii) rubber planting and processing, (viii) fertilizer and other chemicals manufacturing, (ix) real estate investment, (x) construction and mechanics, (xi) finance, banking and insurance, (xii) other sectors in accordance with the decision of the Prime Minister. 4) Independent SOCs do not need to have a management board, while general corporations do. 5) In this report, for simplicity's sake, general corporations refer to General Corporation 91. Other general corporations, classified as General Corporation 90, have characteristics in between General Corporation 91 and independent SOCs. While General Corporation 90 needs to have five board members and book equity of VND 100 billion, General Corporation 91 needs to have seven board members and book equity of VND 1 trillion. Similar to independent SOCs, General Corporation 90 are established under line ministries and provincial governments in less important sectors. 6) Recently, Vietnam also allowed the establishment of private economic groups (Vietnam Plus, Nov. 2, 2009). Also, there are many other economic group candidates waiting for Prime Minister's approval (VietNamNet Bridge, Nov. 21, 2008 and Vietnews, August 7, 2009).
378 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy Table 4-2-1 | Economic Groups in Vietnam
Ownership Supervising Number of Mother Company Group Name Structure of Government Member (or Holding Company) Mother Company Agency Firms
100%: 21 Electricity of www.evn.com.vn 100% state capital Prime Minister >50%: 23 Vietnam Group <50%: 6
Vietnam National 100%: 7 Oil and Gas www.pvn.vn 100% state capital Prime Minister >50%: 14 Group <50%: 2
Vietnam National 100%: 10 Coal and Mineral www.vinacomin.vn 100% state capital Prime Minister >50%: 41 Industries Group <50%:4
Vietnam Post 100%: 11 and www.vnpt.com.vn 100% state capital Prime Minister >50%: 11 Telecommunicat <50%:15 ions Group
Vietnam 100%: 21 Shipbuilding www.vinashinship.com.vn 100% state capital Prime Minister >50%: 26 Industrial Group <50%: 11
Vietnam National 100%: 19 Textile and www.vinatex.com.vn 100% state capital Prime Minister >50%: 17 Garment Group <50%: 20 (Vinatex)
100%: 6 Vietnam Rubber www.vnrubbergroup.eu 100% state capital Prime Minister >50%: 26 Group (VRG) <50%: 13
77.54% (government), 10% (foreign), 3.56% (domestic), 0.81% Ministry of Bao Viet Group www.baoviet.com.vn (employees), 0.12% Finance (insurance agencies), 7.97% (others)
Source: Steering Committee of Enterprise Renovation and Development
379 Chapter 4 _ Efficient and Harmonious Enterprise Policy Unlike the chaebols in Korea, economic groups in Vietnam are specialized in a certain industry. Thus, intra group diversification across different industries is limited.7 Also, Vietnamese economic groups are different from Korean chaebols in that their main intra group ownership structure is based on mother subsidiary relationship, also known as the pyramidal ownership structure in the corporate governance literature.8) Table 2 compares the economic groups in Vietnam against the chaebols in Korea.
Table 4-2-2 | Economic Groups vs. Chaebols
Economic Groups Chaebols
State (some are privatized, but still Controlling controlling interest retained in the Family shareholder hands of the state)
A mixture of circular-ownership and Ownership Mother-subsidiary (pure pyramidal pyramidal?ownership structures structure structure) (recently, many transformed into a pure pyramidal structure)
Degree of Regulated by government No regulation diversification
Areas of Restricted to strategic industries No restriction business
Designed as large business To become a general corporation 91, conglomerates and become subject to total capital must be greater than VND government regulation if the group’s Size threshold 1 trillion and have at least seven total asset size (total sum of member member firms. firms’assets) is greater than 2 trillion won (approximately USD 2 billion) 9)
There are three innovations in Vietnam worth noting that aims to improve the operating efficiency of SOCs.10) One is known as the reward fund that basically gives performance based
8) Korean chaebols mix circular ownership and pyramidal ownership structures. In recent years, however, a considerable number of korean chaebols transformed themselves into a pure holding company structure. 9) Large business conglomerates, designed each year in April by the Fair Trade Commission, include two types of conglomerates: one where the group's controlling shareholder is a natural person (typically known as chaebols) and the other where the group's controlling shareholder is a legal person (usually, privatized ex SOEs). 10) This is based on Cuong (2010).
380 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy pay and target completion pay to SOC managers.11) Another innovation mandates SOCs to keep separate accounts if engaged in non commercial activities, such as carrying out services of general interests. In principle, the losses incurred in the process of carrying out such services are compensated by the national budget.
2.3. State Capital Investment Corporation (SCIC)
The third innovation is to separate the two roles states typical have in regards to SOEs state as an owner and state as a regulator (or as an industrial policy maker). By establishing the State Capital Investment Corporation (SCIC) in 2005, the ownership stakes in many SOEs have been transferred from various line ministries and provincial governments to SCIC.12) In its mission statement, SCIC clearly states its mandate to be an active shareholder that maximizes the value of its portfolio companies.13) This reform measure, which is consistent with the OECD Guidelines on Corporate Governance of State owned Enterprises (2005), is certainly in the right direction.14)
Besides splitting the two roles, the establishment of SCIC also helps to improve the efficiency of state capital utilization, by restructuring inefficient SOEs and divesting SOEs in non core business areas. Since its operation in August 2006, it divested 183 SOEs over a three year period. As of June 2009, SCIC’s total assets amount to USD 2,340 million and the book value of its 754 portfolio companies amounts to USD 473 million. Although SCIC was modeled after Singapore’s Temasek and Malaysia’s Khazanah, SCIC differs from them in that its portfolio companies are mostly small and medium sized SOEs. SOE Law of 2003 currently does not allow SCIC to hold ownership in state owned general corporations and economic groups.
2.4. Equitization of SOEs
The privatization program in Vietnam, officially known as the equitization program, started in June 1992 as part of the state owned enterprise reform program. According to Loc (2006), equitization is defined as the transformation of SOEs into joint stock companies and selling part
11) More specifically, in case of performance based pay, the management can collectively receive up to 5 percent of after tax profit times (self mobilized capital / total capital). This pay is subject to a yearly upper ceiling of VND 200 million (for companies without the Board of Management) or VND 500 million (for companies with the Board of Management). In case of target completion pay, the management can collectively receive up to 2.5 percent of after tax profit times (self mobilized capital / total capital). This pay is subject to a yearly upper ceiling of VND 100 million (for companies without the Board of Management) or VND 250 million (for companies with the Board of Management). 12) SCIC itself can also be classified as a general corporation under the Prime Minister. 13) See SCIC brochure from its homepage (www.sciv.vn). 14) Guideline II D states, "The exercise of ownership rights should be clearly identified within the state administration. This may be facilitated by setting up a coordinating entity or, more appropriately, by the centralization of the ownership function."
381 Chapter 4 _ Efficient and Harmonious Enterprise Policy of the company shares to private investors. Equitization differs from privatization in the usual western sense in that it does not necessarily mean that the government loses its ultimate control over the important firms and sectors. Another difference is that employees and managers of the firms acquire a substantial portion of the shares in the equitization process.
According to Vu (2006) and Loc (2006), the equitization took place in multiple stages. First, there was a pilot program during 1992 1996 where small and medium sized SOEs in non strategic business areas were equitized. The result of this pilot program was minimal. During this five year period, only five SOEs were equitized. Recognizing the need for a more aggressive approach, the government issued Decree 28 in 1996 that expanded the scope of equitization to all non strategic small and medium sized SOEs. It also authorized line ministries and provincial people’s committees to select the enterprise for equitization. The progress made during this stage, however, was far below the expectation. Only 25 additional SOEs were equitizedd during 1996~1998.
In 1998, the government adopted Decree 44 and replaced the previous experimental programs with a more ambitious equitization plan, in which SOEs were no longer given the option to participate in the equitization program. With Decree 44, the government classified all SOEs into three groups according to their level of importance. The progress made between 1998 and 2002 was more impressive. During this four year period, 845 SOEs got equitized. In 2002, Decree 64 replaced Decree 44 to improve the legal framework for equitization. There were a number of notable changes. First, equitization process was further decentralized with more authority given to line ministries, local people’s committees, and general corporations. Second, compensation funds were created for compensating and retraining dismissed workers. Third, non strategic SOEs whose capital is under VND 5 billion were threatened with liquidation if they oppose equitization. Between 2002 and 2004, the number of equitized firms reached 1,292.
In 2004, Decree 187 replaced Decree 64. This Decree helped overcome problems related to SOE’s bad debts and more importantly cleared the way for applying market methods in valuing SOEs subject to equitization. In 2006, the Prime Minister announced two targets to be achieved by the end of 2010.15) One is to transform all SOEs with 100% state capital into either limited liability companies or stock companies. The other is to equitize 71 general corporations. These targets, however, are not likely to be met by 2010. At the end of 2009, there were 1,546 SOEs with 100% state capital which have not yet been transformed. This includes 7 economic groups, 89 general corporations, and 3 state owned commercial banks. As of February 2008, there were around 4,000 firms having been equitized, in which 3,400 had been equitized since 2000 (Hao, 2009).
With the equitization of SOEs, the number of listed firms also increased substantially.
15) See Cuong (2010) on this for details.
382 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy According to Hong and Biallas (2007), 78% of listed firms on the Ho Chi Minh City Stock Exchange are former SOEs. However, only 4% of more than 3,000 SOEs are listed on the stock exchange. Most of the listed former SOEs are small and medium sized SOEs. But, thanks to the Prime Minister’s decision in 2006 to equitize 71 general corporations, many large scale SOEs are also expected to be listed in the stock market. Many IPOs of SOEs have been delayed indefinitely by the government, however, due to recent corrections in the stock market and unfavorable economic conditions. Figure 2 shows the number of firms listed oin the stock exchanges and their market capitalization from 2005 to July 2009.
Figure 4-2-2 | Number of Stocks Listed in Stock Exchanges and Their Market Capitalization
Source: VinaSecurities (2009), originally from Bloomberg, HOSE, and HNX
383 Chapter 4 _ Efficient and Harmonious Enterprise Policy Box 4-2-1 The Stock Exchanges in Vietnam16)
Vietnam has two stock exchanges: the Ho Chi Minh City Stock Exchange (HOSE) and the Hanoi Stock Exchange (HNX). Both are state owned companies supervised under the State Securities Commission (SSC).17) Since 2006, the Vietnamese stock market grew spectacularly. The number of listed stocks increased by 8 times from 2005 to July 2009, while market capitalization jumped by 40 times over the same period. The market capitalization as a percentage of GDP, however, is around 10% at the end of 2008, which is the lowest in the region. The distribution of listed firms is also heavily skewed. Financial institutions account for more than 50% of the combined market capitalization and top 20 companies represents 71% of total market capitalization. There is no publicly available information on the proportion of retail vs. institutional investors, but market participants generally accept the view that most foreign traders are institutional investors while most local traders are retail investors.
In regards to market regulation, various disclosure rules apply when buying and selling stocks in companies in which the investor is a member of the board or is an executive, or when holding more than 5% of the total outstanding shares. Foreign ownership is restricted to 49% for non bank enterprises, and 30% for banks. In regards to taxation, institutions investors pay a 0.1% withholding tax on the value of any stock or investment certificate they sell. There are no capital gains or remittance tax. Dividends are also tax free. Individuals do not pay any taxes on securities transactions, capital gains or dividends.
The unregulated market is shrinking relative to the regulated market due to improvements in the regulatory environment. The enactment of the Securities Law of 2006 and the government grated tax incentive enticed a number of unlisted companies to be listed in the stock exchanges. Broadening the definition of ‘securities’ and the introduction of the ‘public company’ concept also helped. Notwithstanding, the unregulated market is still quite large. Its estimated daily trading value ranges from USD 30 to 35 million compared to the HOSE’s average daily trading value of USD 59 million as of May 2007.18)
2.5. Corporate Governance in Vietnam
The Enterprise Law of 2005 and the Securities Law of 2006 are the two main laws that shape the governance structure of Vietnamese corporations. In March 2007, the Ministry of Finance also issued the Code of Corporate Governance for Listed Companies (hereafter the “Code”). According to Le Minh and Walker (2008), this Code is a piece of subordinate legislation (with mandatory rules) and is therefore different from a voluntary code of corporate governance in advanced economies.
16) See Vina Securities (2009) for details. 17) Under the Securities Law of 2007, the Ministry of Finance (MOF) is responsible for the administration of securities and the securities market, while the State Securities Commission (SSC) regulates securities markets under the Ministry of Finance. The SSC regulates and supervises the two stock exchanges, the central securities depository (Vietnam Securities Depository, VSD), securities companies, securities investment fund management companies, and public companies. 18) See Hong and Biallas (2007) for details.
384 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy There are a number of distinct features in the governance structure of Vietnamese corporations.19) First, certain Vietnam corporations must have a Control Board (also known as the Inspection Committee) that supervises the Board of Management (BOM) and the CEO.20) In some sense, Vietnam has a two tier board structure. A Control Board is consisted of 3 5 members with the tenure that cannot be more than five years. Members of the Control Board may, however, be re appointed for additional terms. To ensure their independence from management, members of the Control Board may not hold managerial positions in the company. Also, relatives of company managers cannot become a member of the Control Board. The head of the Control Board must have specialized accounting qualifications. The Control Board may also report directly to the SSC or other State administrative bodies if it discovers acts committed by a member of the BOM which it considers as a breach of law or the company’s Charter. Lastly, the Control Board is entitled to select an independent auditing organization to audit the financial statements of the listed company, and to request the General Meeting of Shareholders (GMS) to approve its selection.
The second distinct feature has to do with the unique set of provisions regarding shareholders’ rights. As a way of protecting minority shareholders, the Enterprises Law of 2005 increased the requirements (example, quorum) to hold a meeting and to pass a resolution at the General Meeting of Shareholders (GMS). To hold a GMS, a company needs at least 65 percent of voting shares and to pass a resolution, a company needs at least 65 percent of participating shares. Furthermore, companies can voluntarily decide higher requirements. Another interesting feature is the adoption of mandatory cumulative voting when electing Control Board and BOM members. Also, under the Code, shareholders have the right to nominate director candidates. Interestingly, the number of candidates that shareholders can nominate depends on the size of their ownership.21)
The third unique aspect has to do with special provisions in regards to board structure. For example, one third of the members of the BOM must be non executive independent members. Also, the chairman of the BOM must not concurrently hold the position of the CEO, unless approved at the GMS. A member of the BOM of a listed company must not concurrently be a member of the BOM of more than five other companies. A listed company may purchase liability insurance for members of the BOM after obtaining approval from the GMS.
19) This part of the report heavily relies on Le Minh and Walker (2008). 20) The Enterprises Law of 2005 requires that a Control Board must be established when a shareholding company (SC) has more than 11 natural shareholders or one (or more) organization shareholder(s) holding more than 50 per cent of the equity capital. 21) Shareholders holding less than 10 percent of the voting shares for a consecutive period of at least 6 months are entitled to nominate one member; shareholders holding from 10 percent to less than 30 percent are entitled to nominate two members; shareholders holding from 30 per cent to less than 50 per cent are entitled to nominate three members; shareholders holding from 50 percent to less than 65 percent are entitled to nominate four members; and shareholders holding from 65 per cent upwards shall be entitled to nominate all candidates.
385 Chapter 4 _ Efficient and Harmonious Enterprise Policy The fourth distinct feature has to do with the relationship between the board and the CEO. In other countries, the board does not get involved in day to day operations. Daily operations are carried out by the CEO. However, under the Enterprise Law of 2005, the BOM has the power to be involved directly in company management. CEO may have no authority to approve contracts and sign documents on behalf of the company.
3. Key Challenges
The Vietnamese government faces a number of challenges in designing the governance structure of economic groups. They can be grouped into following four main areas:
3.1. Conflicting Objectives
Officially, the raison d’être of economic groups is to consolidate general corporations in strategically important industries so that it can develop into business entities that can compete in the global market.22) In other words, the objective of establishing economic groups is to grant managerial autonomy and commercialize the operation of large scale SOEs despite its ultimate control under the hands of government.23) Unofficially, however, economic groups are also expected to cooperate with the government and asked to pursue policy objectives that may be in conflict with profit maximization. One recent example is the policy objective of curbing inflation. By holding down their service prices, economic groups incurred huge losses.24) Such conflicting objectives make performance evaluation difficult and discourage management from improving operational efficiency. This, however, is a classical problem in any commercially run SOEs and it is not unique to Vietnam.25) It is also worth noting that this problem does not exist to the same extent across all economic groups. In case of Vinatex, which is mainly in the textile and garment industry, there is little need for the government to intervene and ask Vinatex to pursue non commercial policy objectives. On the other hand, in case of EVN, which is in the electricity industries, there is a stronger demand for it to pursue objectives other than profit maximization, such as ensuring stable supply of electricity and setting subsidized prices for low income households.
22) According to Cuong (2010), this is stipulated in the resolution of the 3rd meeting of the Central Communist Party Committee in 2001. 23) Although not explicitly mentioned, the group ownership structure of economic groups helps to increase the total asset size a group can control without diluting the equity stake held by the government. This is because the government holds 100% of mother company shares (with the exception of Bao Viet Holdings), but allow external equity financing by its subsidiary companies. Debt financing by a mother company can magnify this effect. 24) See VietNamNet Bridge (November 11, 2009). 25) Although SOCs are mandated to keep separate accounts if engaged in non commercial activities and the losses incurred in the process are supposed to be compensated by the national budget, it is not clear how well this is implemented.
386 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy 3.2. Bureaucratic Dominance
Currently, many governmental agencies are deeply involved in the management and the supervision of economic groups. Table 2 summarizes the role played by the Prime Minister, the Ministry of Finance, the Ministry of Planning and Investment, the Ministry of Home Affairs, and the Line Ministries. They not only serve the functions a shareholders’ meeting would perform, but also the functions a board of directors would carry out in a typical corporation. That is, they not only approve corporate charters, ownership structure, appointment and dismissal of directors, dividend policies, and directors’ remuneration, but also approve long term corporate strategy, nomination of director candidates, and investments in subsidiaries.26)
Table 4-2-3 | Supervision and Management of Economic Groups by Governmental Agencies
Governmental Agencies Functions ApplicationPrime Minister National 1,319Approves 2,703 mother 9,082company's 59,236 charter; appoints, 72,831 dismisses, 90,313 rewards, 125,476 Foreign 3,984and disciplines 7,884 16,738board members 19,263 (including 29,179 chairman) 28,339 and 40,173senior Total 5,303executives; 10,587 approves 25,820 long term 78,499 corporate 102,010 strategy; 118,652 approve 166,189 charter Granted National 232capital 349 investments 2,554 in mother 6,575 companies; 22,943 approves 30,525 ownership 89,303 Foreign 1,576change 1,919 in mother 5,208company's 5,937subsidiaries 12,013 13,640 31,487 Line Ministry Total 1,808Recommend 2,268 appointment, 7,762 12,512dismissal, 34,956disciplinary 44,165 action of 120,790 board members (including chairman) and senior executives; monitor the execution of long term corporate strategy of mother companies approved by the Prime Minister. Ministry of Finance Execute charter capital investments in mother companies in accordance with the decision made by the Prime Minister; evaluate mother company's policy on subsidiary investments, dividend payouts, and retained earnings. Ministry of Planning and Monitor the execution of tasks assigned to the mother company by Investment the Prime Minister Ministry of Home Affairs Evaluate the criterion, the procedure, and the qualifications used by line ministries to nominate board members (including the chairman)
Source: Cuong (2010) Bureaucrats sometimes even directly participate in the management of economic groups. For example, Vice Minister of Finance and Vice Minister of Industry and Commerce serve as board members of Petro Vietnam (PVN), the mother company of Vietnam National Oil and Gas Group.27) Such micro management by bureaucrats, however, is harmful in a number of ways.
26) Such role played by the government applies not only to the mother companies of economic groups, but also to the son companies that are categorized as General Corporation 90. In other son companies, the mother company exercises such role. 27) See Cuong (2010).
387 Chapter 4 _ Efficient and Harmonious Enterprise Policy First, governmental agencies may have policy objectives that may not be compatible with profit maximization. When the two contradict, bureaucrats will pursue the objective of its agency at the expense of the economic group’s interest. Second, bureaucrats normally do not have the knowledge or the experience to make decisions on business matters. Decisions may be unnecessarily delayed. Third, governmental agencies may favor managers that are obedient to them. These managers, however, may are not be necessarily the most competent ones. Fourth, bureaucrats may pursue their own personal interests by misusing their power over economic groups.
3.3. Weak Internal Governance Mechanism
To develop economic groups into business entities efficient enough to compete in the global market, it is very important that the appointment, the dismissal, the evaluation, and the compensation of their managers are carried out in a manner consistent with profit maximization. As mentioned above, however, this process is dominated by the bureaucrats in Vietnam. Once it is in conflict with the interests of bureaucrats, there is the risk that this process can be compromised. No attempt has been made yet to introduce non executive members that are both independent from line ministries and at the same time representing the public interest.28) The SOE Law of 2003 stipulates minimum qualifications for board members. But, the qualifications are often vaguely defined.29) Also, no rules exists disqualifying board members that directly or indirectly have business relationship with the company they serve. Vietnam also introduced performance based pay and target completion pay for its SOE managers. But, the pays are structured in a way that may distort the incentives of managers. For instance, performance based pay is structured so that it increases with the amount of self mobilized capital. Since self mobilized capital includes debt capital, it may give managers the wrong incentive to build up excessive leverage. Also, pay is not based on long term performance, but solely based on the prior year’s performance. This may induce managers to make myopic business decisions.
Box 4-2-2 Survey on Vietnamese SOEs
International Finance Corporation (IFC) and Mekong Private Sector Development Facility (MPDF) conducted a joint survey in 2006 on the corporate governance practices of Vietnamese business enterprises. 85 firms responded to the survey, among which 56 were either SOEs or equitized former SOEs. The following outlines the survey findings pertained to SOEs:
28) Board of Management has part time board members. But, it is not clear what role they play. The Code of Corporate Governance for Listed Companies requires that one third of BOM members be non executive independent members. However, this is limited to listed firms. 29) The SEO Law of 2003 stipulates that a board member should (i) be a Vietnamese citizen permanently residing in Vietnam, (ii) have a university degree, (iii) have managerial experience, (iv) be healthy with high morale, (v) be honest, incorruptible, and knowledgeable, and (vi) have a law abiding spirit. The Management Board chairman must have at least three years of experience in the management of enterprises in the company's main business areas.
388 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy - 64% of all firms did not think that SOEs adopt good corporate governance practices. - 62% of SOEs agreed that kickbacks are common. - 87% of SOEs rated personal relationships with government agencies important. - SOE directors complain that they have many responsibilities, but not adequate authority to run their companies according to market principles. - 77% of SOEs said they experienced situations where the law gave them the rights for which cannot be put into practice. allowed them to do something, but they could not in practice. - 70% of SOEs agreed that the common approach of SOEs is “to make no loss, but just only a little profit.” - Only 23% of the SOEs agreed that the current reward system motivates them to maximize corporate profit. - Most of the equitized firms are still following the old (SOE) way of doing things.
3.4. Vacuum of Other Government Policies
For a number of reasons, certain SOEs naturally become monopolies. Among the eight economic groups, EVN and VNPT are such examples. For these groups, a well designed governance structure is not enough. A well functioning regulatory system must also be established to set the level of their service charges and prevent unfair trading practices. When monopolies are left unrestrained, they charge monopoly prices. Artificially setting the price level below the cost is also harmful. It prevents them from providing quality services and accumulating retained earnings for future capital expenditures. These groups can also become natural monopsonies and treat subcontractors unfairly if unregulated. A different set of regulations must also be established to protect minority shareholders. This is necessitated by the fact that many subsidiaries of mother companies are equitized and some are now listed in stock exchanges.30) It is well documented in corporate governance literature that holding companies have an incentive to expropriate public subsidiaries’ outside minority shareholders by arranging internal transactions that benefit the subsidiaries with high ownership stakes at the expense of those with low ownership stakes.31)
4. The Korean Experience
During the early part of its industrialization, private sector in Korea did not have enough
30) Nui Beo Coal Company (Vietnam National Coal and Mineral Industries Group) and Petroleum Technical Services Corporation (Vietnam Oil and Gas Group) are such examples. 31) Suppose a mother company A holds 100% of subsidiary B's charter capital and 50% of subsidiary C's charter capital. Also suppose that subsidiary C purchased goods and services from subsidiary B above the market price and incurred a loss of USD 10 million. This internal transaction, however, benefits subsidiary B by USD 10 million. As for the mother company, the net gain is USD 5 million since the loss from subsidiary C is shared with outside minority shareholders. The mother company's net gain of USD 5 million equals the net loss of USD 5 million incurred by outside minority shareholders.
389 Chapter 4 _ Efficient and Harmonious Enterprise Policy capital to run large-scale corporations on its own.32) Instead, they were run by the state either directly in the form of SOEs or indirectly through family controlled business conglomerates chaebols by providing them with generous policy loans. For many decades, large scaled manufacturing firms or financial institutions were exclusively dominated by the two. Many chaebol firms emerged and disappeared. Among the survivors, some evolved into world class corporations in certain industries. By early 1990s, Korean SOEs also achieved the highest level of operating efficiency in industries such as telecommunication, electricity, natural gas, expressway, tobacco, and steel.
In the mid 1980s, the Korean government started to differentiate SOEs that can be run on a commercial basis from those that cannot. As for the former, the government allowed greater autonomy, and as for the latter, it government introduced the Government Owned Enterprise (GOE) Act of 1983.33) Under this Act, the government established a supervisory board, named GOE Management Evaluation Committee, overseeing all the GOEs. This committee was represented by the Economic Planning Board (EPB), the line ministries, and a number of non - resident civilians.34) Despite this innovation, line ministries were heavily involved in the management of SOEs. Line ministries had the authority to approve corporate charter and nominate the director and auditor candidates. See the box below for the details.
Box 4-2-3 Government Owned Enterprise Act of 1983
This Act was introduced in December 1983 to improve the efficiency of government owned enterprises (state ownership greater than 50% of outstanding shares) by giving greater managerial autonomy, while holding managers more accountable to the state. The major innovation was the establishment the GOE Management Evaluation Committee, which had four missions: (i) issuing a guideline on how to set management goals, (ii) coordinating management goals that may conflict with one another, (ii) issuing a guideline on budgeting, and (iv) evaluating managerial performance. This committee was established under the Economic Planning Board (EPB) and its members were comprised of the Minister of Economic Planning Board (chair), the Minister of Finance (excluded since 1987), the heads of line ministries, and a number of civilians appointed by the President. The civilian committee members were non resident members with sufficient knowledge and experience in the area of SOE management. To obtain technical advice, the Committee Chair also had the authority to form a subcommittee, composed of experts.
To set the following year’s management goal, the Minister of EPB had to issue guidelines to each GOEs no later than June 30th in the previous year. Then, the heads of GOEs had to submit their management goal to the line ministries by August 31st, and to the Minister of EPB by September 30th. Upon receiving the
32) For details on the history of SEO reform and privatization, see Nam and Kang (1998). 33) Pohang Steel Co. (later renamed as POSCO) and Korea Heavy Industries & Construction are the examples of SOEs granted with a greater autonomy from the government. They were called government invested enterprises (GIE). 34) Initially, the Minister of Finance was also a member of the committee. But with the revision of the Act in 1987, he Minister of Finance was removed from the committee.
390 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy management goals, the Minister of EPB coordinated those that may conflict with one another and notified the final goal to the heads of GOEs no later than October 31st. Previous year’s managerial performance had to be reported to the line ministries and to the Minister of EPB by March 20th in the following year. The criteria to evaluate performance were also determined by the Minister of EPB. Performance was evaluated on three grounds: public interest, achievement of management goal, and efficiency. The evaluation result had to be finalized by June 20th and reported to the President. Based on the evaluation result, the Minister of EPB had the authority to request corrective measures, including the dismissal of senior managers, to the line ministries. The GOE boards had to be composed of directors (including the board chair and the CEO) and an auditor. They were nominated by the line ministries and appointed by the President. Also, the CEO was not allowed to serve as a board chair at the same time. To prevent any conflict of interests, none of the directors or the auditor was allowed to engage in other for profit businesses. GOE charters had to be approved by the line ministries and external audit was carried out by the Board of Audit and Inspection.
This Act no longer exists and was replaced by the 2009 Act on the Management of Public Enterprises.
By the mid 1990s, the number of large scale commercial SOEs grew significantly and it was clear among policy makers that it was about time to privatize them. Despite the SOEs’ high level of operating efficiency, it was evident that the existing governance structure, where line ministries are heavily involved in management, was not sustainable. Despite such policy stance, however, it was not obvious how to sell the controlling interests of such public enterprises. Selling the controlling block to chaebols was one option. But this was soon dropped as it would aggravate the problem of economic power being increasingly concentrated in the hands of few chaebol families. Also, the size of Korean stock market was too small for the government to sell shares to the general public, and foreigners were subject to various ownership limits.
As an alternative, Korean government decided to take a more gradual approach and introduced the 1997 Act on the Managerial Structure Improvement and Privatization of SOEs. The main motivation of the act was to improve the governance of certain SOEs before their eventual privatization. More specifically, it prescribed an Anglo Saxon type corporate governance system to three large scale public enterprises from the Government Owned Enterprise (GOE) Act of 1983 (KT, KT&G, and KOGAS) and Korea Heavy Industries & Construction.35) For example, the Act stipulated that the board be consisted exclusively of civilians, thus removing the presence of line ministries. The Act also imposed restriction on ownership so that chaebols cannot acquire controlling interests.
Box 4-2-4 1997 Act on the Managerial Structure Improvement and Privatization of SOE
This Act was introduced in August 1997 to improve the managerial efficiency of large scale SOEs and to eventually privatize them. Initially, four commercially run large scale SOEs were subject to the Act: Korea Telecom (KT), Korea Tobacco & Ginseng (KT&G), Korea Gas Corporation (KOGAS), and Korea Heavy
35) POSCO should have also been subject to the 1997 Act, but it was not, without any good reason. It shows the limitation of Korean government back then.
Unlike the GOEs subject to the 1987 Act, all the directors (including the CEO) were elected at the shareholders’ meeting and the board was composed of resident and non resident directors, the latter collectively taking up more than 50% of the total. In case of non resident directors, one third of them had to be replaced each year. To give a greater access to company information, non resident directors were granted with the right to ask for information necessary in carrying out their tasks. In addition, Unlike the GOEs subject to the 1987 Act, the CEO assumed the role of board chair.
To nominate the CEO candidate, SOEs subject to the 1997 Act had to organize a CEO Nomination Committee, composed of non resident directors, one previous CEO, and outside members appointed by the board. In this committee, non resident directors had to take up more than 50% of the total committee members. The board also had to appoint the chair of this committee among non resident directors. The CEO candidates were identified either by posting an ad or by hiring a professional search firm. Before nominating the final CEO candidate, the board had to consult with the candidate on the details of the terms of the contract, including the management goal, and upon nomination, the board also had to submit the CEO contract to the shareholders’ meeting. Once the CEO has been appointed and the CEO contract has been approved at the shareholders’ meeting, the SOEs subject to the 1997 Act had to enter a formal contract with the CEO with his signature. Subsequently, the board had to evaluate the performance of CEO based upon this contract, and when doing so were able to seek outside expert advice. If the CEO underperforms relative to the management goal, the board had the authority to request CEO’s dismissal at the shareholders’ meeting. Detailed criteria on executive compensation had to be reported to the shareholders’ meeting and compensation had to be designed to reflect the CEO’s managerial performance.
For an efficient operation of the shareholders’ meeting, the SOEs subject to the 1997 Act was allowed to organize a Shareholder’s Committee, composed of a subset of shareholders. Resident directors were nominated by the CEO but had to be approved by the board before the shareholders’ meeting. Non resident directors were nominated either by a shareholder or by the Shareholders’ Committee. Non resident directors were not allowed to have any tie with the SOE that may give rise to a conflict of interests problem. Details on how to enforce this provision were stipulated in the Act’s Presidential Decree.
Under the 1997 Act, ownership rights were exercised by the line ministries with prior consultation with the Ministry of Finance and Economy (government agency responsible for managing state owned assets).36) Unlike the GOEs, the SOEs subject to the 1997 Act were exempt from the external audit by the Board of Audit and Inspection. Private accounting firms were appointed to conduct external auditing.
The economic crisis of 1997/98 accelerated the privatization of large public enterprises in Korea. With the exception of KOGAS, it fully privatized other three SOEs under the 1997 Act and also privatized many other commercially run SOEs, such as POSCO. In most of the privatized enterprises, it is reported that the managerial performance of these firms improved after their privatization.37) With the privatization of such large scale SOEs, Korea also succeeded
36) Ministry of Finance and Economic Planning Board were merged in 1994 and became Ministry of Finance and Economy. 37) See Nam and Kim (2004) for this.
392 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy in introducing a new type of corporation, the ownership structure of which is very different from the existing ones. Large stand alone public firms, which are very similar to those in Anglo Saxon countries, are now the third category of large sized enterprises in Korea in addition to SOEs and chaebol firms. We believe the 1997 Act on the Managerial Structure Improvement and Privatization of SOEs was essential in bringing about this outcome. Korean experience, however, is not a model case when it comes to reorganizing the role of government ministries in regards to SOEs. To maximize the benefit of SOE governance reform, the ministries in charge of industrial policy or regulation should not be involved in the management of SOEs. But, this was not the case in Korea for an extended period of years.
5. Policy Recommendations
Selected policy recommendations for state owned economic groups can be summarized as follows:
5.1. Re clarify the Objective of Economic Groups
The Vietnamese government should clarify the objective of its economic groups again, and when doing so, should distinguish between commercial and non commercial objectives. We believe that the official objective of economic groups is to consolidate general corporations in strategically important industries so that the new business entity can develop into those that can compete in the global market. This should still be the main objective of economic groups. Notice, however, that this has two components: one that is static and another that is dynamic. The static component aims to maximize operating efficiency by allowing the economic groups operate on a commercial basis with full managerial autonomy. The dynamic component aims to develop economic groups into those with international competitiveness. Both components should be seriously pursued. The Vietnamese government should also make efforts to identify non commercial policy objectives that the government should care about. There can be a number of them: (i) ensuring a competitive business environment, (ii) preventing the misuse of monopoly power, (iii) meeting the increasing demand of public utility services, and (iv) setting subsidized prices for certain segments of people (such as low income households) or regions.
5.2. Reconcile the Conflicting Objectives
The key is how to reconcile these non commercial objectives with those of maximizing operational efficiency and obtaining international competitiveness. To this end, our recommended solution is twofold. First, the role of state as an owner and the role of state as a regulator (or as an industrial policy maker) should be assumed by different governmental agencies. If not, commercial objectives are likely to be sacrificeds for the sake of non commercial objectives. More specifically, the objective of maximizing operational efficiency
393 Chapter 4 _ Efficient and Harmonious Enterprise Policy and obtaining international competitiveness should be assigned to the agency that will play the role as an owner, while other objectives should be assigned either to the line ministries or to specialized agencies, such as those similar to the Korea Fair Trade Commission (KFTC) or the Korea Communications Commission (KCC).
Box 4-2-5 KFTC 38)
In 1980, Korea introduced the Monopoly Regulation and Fair Trade Act and established an entity that can administer competition policies. AtIn the beginning, KFTC was not a separate government agency. It was established in the name of Fair Trade Office in 1981 within the Economic Planning Board (EPB) as one among many of its departments. It was not until 1994 it became a separate government agency and was renamed as KFTC. Being under the authority of the Prime Minister, it also became independent from EPB (later, the Ministry of Finance and Economy) and other line ministries. In 1996, the status of its chairman evaluated to a ministerial level. In 2007, Korea Consumer Agency also became a part of KFTC.
As of today, KFTC has four mandates: promoting competition, strengthening consumer rights, creating a competitive environment for small and medium sized enterprises (SMEs), and restraining the concentration of economic power. Organizationally, it is consisted of a committee and a secretariat. The committee consists of nine commissioners, who deliberate and make decisions on competition and consumer protection issues. The Chairman and the Vice Chairman are nominated by the Prime Minister and appointed by the President, while other commissioners are nominated by the Chairman and appointed by the President. The secretariat is a working body that is directly involved in drafting and promoting competition policies, investigating antitrust cases, presenting them to the committee, and handling them according to the committee’s decision.
Box 4-2-6 KCC 39)
Korea Communications Commission (KCC) was originally created in 1992 within the Ministry of Information and Communications (MIC) as a semi independent regulatory body with a limited role of dispute resolution. Despite the existence of KCC, MIC retained most of the regulatory power, such as policies over market entry, pricing, and service quality. KCC’s role was only advisory. Since MIC played both roles the role as a regulator and the role as an industry policy maker it gave rise to many conflict of interest problems. In March 2008, the Korean government dissolved MIC and formed KCC as a fully independent regulatory body. It was created by merging Korea Broadcasting Commission (KBC) and some parts of MIC. Before the merger, MIC regulated the telecommunication industry, while KBC regulated the broadcasting industry. The Commission is composed of five full time commissioners (including the Chairman and the Vice Chairman) appointed by the President. Two commissioners (including the Chairman) are directly appointed by the President, while the remaining three are nominated by the National Assembly. Among the three commissioners nominated by the National Assembly, one should be nominated by the party in which the
38) Visit http://eng.ftc.go.kr for details. 39) Visit http://eng.kcc.kr for details.
394 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy President is or was a member, and two should be nominated by other parties.
Despite its main role as a regulator, KCC is also heavily involved in the promotion of broadcasting and telecommunication industries, especially their convergence. This may again give rise to the similar conflict of interest problems Korea experienced when MIC assumed both roles.
Second, if economic groups carry out non commercial activities, they should keep separate financial accounts so that the performance of managers can be evaluated solely based on their commercial activities. It is also recommended that the loss incurred in the process of carrying out non commercial activities be compensated by the national budget. This solution is especially important when economic groups set subsidized prices for certain segments of people (such as low income households) and regions.40)
5.3. Expand and Strengthen the Role of SCIC
The Vietnamese government should try to separate the role of state as an owner and the role of state as a regulator (or as an industrial policy maker) not only for small and medium sized SOEs, but also for general corporations and economic groups. To minimize the conflict between commercial and non commercial objectives, and to grant managerial autonomy, this is essential. In this respect, we recommend that the role of SCIC be expanded so that it can hold ownership also in general corporations and economic groups. Currently, the SCIC charter allows it and SCIC actually holds ownership in some general corporations.41) But, this is against the SOE Law of 2003 that bans such ownership. This discrepancy should be reconciled as soon as possible. It should be noted that similar entities in Singapore, Malaysia, and China are also allowed to hold ownership in large scale SOEs. If there are far too many general corporations or economic groups, the Vietnamese government can also consider establishing additional SCICs. For example, Vietnam can have SCIC I, SCIC II, SCIC III, etc. This can also resolve the problem of monitoring large number of SOEs in distant locations.42)
Once general corporations or economic groups fall under the control of SCIC (or any other new entity created), its Board of Management should take over the role currently carried out by the Prime Minister and other key ministries. The Prime Minister’s Office or a government indepenent agency should, however, retain its supervisory role over SCIC. That is, to surprise appointing, evaluating, and dismissing members of the board. The SCIC board should also be reorganized. To minimize the conflict between commercial and non commercial objectives, we
40) We know that Vietnam already has these rules in place, but we do not know how well they are practiced. 41) According to Cuong (2010), SCIC holds ownership in general corporations like Vinaconex general corporation, Construction and Commerce general corporation, and Electronics and Informatics general corporation. 42) Alternatively, one can think of multiple SCICs established in major cities exercising ownership rights in small and medium sized SOCs plus a newly created agency exercising ownership rights in economic groups or general corporations.
395 Chapter 4 _ Efficient and Harmonious Enterprise Policy recommend that the board not be represented by Ministries other than the Ministry of Finance, which is believed to be responsible for the management of state capital.43) Instead, following the experience with GOE Management Evaluation Committee in Korea, we recommend that the board be filled with highly respected civilians as outside board members representing the public interest. They should play the role as agents that protect SOEs from unwarranted political interferences. It is also vital that the ownership right of SCIC be exercised with great transparency based on carefully designed preset rules.
The performance of SCIC management should be measured by the performance of its subsidiaries. This is obvious since it is SCIC’s mandate to improve the performance of its subsidiaries. If any of the subsidiaries pursue non commercial objectives, the performance should not include any costs incurred during the process. A challenge is to come up with an appropriate performance benchmark to compute excess performance. Average performance of major private equity funds can be one candidate. Given the importance of SCIC’s role as an owner, the exercise of shareholder rights can be considered as a separate evaluation item. To effectively incentivize SCIC managers, their yearly bonus should be directly linked to their excess performance. As a way to limit excessive risk taking, however, SCIC should introduce a system that exposes managers not only to upside risk (gain), but also to downside risk. A bonus bank system is one option. Under this system, a certain fraction of yearly bonus is withheld in the company. If a manger shows a positive excess performance in the following year, the bonus withheld in the previous year is paid out to the manager. If a manager shows a negative excess performance in the following year, however, the bonus withheld in the previous year is not paid out to the company.
When re designing its governance structure, SCIC should make efforts to incorporate the best practices outlined in the Santiago Principles. Santiago Principles, also known as the Generally Accepted Principles and Practices (GAPP), is a code of conduct on the institutional framework, governance, and investment operations of sovereign wealth funds. It is accepted by many leading sovereign wealth funds.
Box 4-2-7 Santiago Principles 44)
In May 2008, sovereign wealth funds established the International Working Group of Sovereign Wealth Funds (IWG) to draft a common set of voluntary principles that would promote a clearer understanding of the institutional framework, governance, and investment operations of sovereign wealth funds and would support the maintenance of an open and stable investment climate globally. The IWG met in working
43) Currently, the SCIC board is composed of seven members. They include four members representing government agencies (Minister of Finance, Vice Minister of Finance, Vice Minister of Planning and Investment, and Vice Minister of Industry and Trade) and three SCIC senior executives (CEO, Chief of Supervisory Board, and Executive Director). 44) Visit http://www.iwg-swf.org for details.
396 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy sessions in Washington D.C., Singapore, and Santiago, Chile, where it reached a preliminary agreement on the Principles. The final version was released in October 2008 when it was presented at the IMF Annual Meetings. The Principles was a concerted reaction by countries with sovereign wealth funds to mitigate the growing concerns over their lack of transparency and unclear objective. The Principles is composed of 24 principles. Listed below are some selected principles with their explanations and commentaries:
GAPP 2: The policy purpose of the SWF should be clearly defined and publicly disclosed. GAPP 6 (explanation and commentary): Regardless of the specific governance framework, the SWF’s operational management should be conducted on a independent basis to ensure its investment decisions and operations are based on economic and financial considerations consistent with its investment policy and objectives, in effect free of political influence or interference. GAPP 9 (explanation and commentary): As owner, the role of the government is to determine the broad policy objectives of the SWF, but not to intervene in decisions relating to particular investments. GAPP 19.1: If investment decisions are subject to other than economic and financial considerations, these should be clearly set out in the investment policy and be publicly disclosed. GAPP 21: The SWF should publicly disclose its general approach to voting securities of listed entities, including the key factors guiding its exercise of ownership rights. GAPP 21 (explanations and commentary): To dispel concerns about potential noneconomic or nonfinancial objectives, SWFs should disclose ex ante whether and how they exercise their voting rights. This could include, for example, a public statement that their voting is guided by the objective to protect the financial interests of the SWF. In addition, SWFs should disclose their general approach to board representation. When SWFs have board representation, their directors will perform the applicable fiduciary duties of directors, including representation of the collective interest of all shareholders. To demonstrate that their voting decisions continue to be based on economic and financial criteria, SWFs could also make appropriate ex post disclosures.
5.4. Strengthen the Internal Governance Mechanism
There are a number of measures the government can adopt to strengthen the internal governance mechanism of economic groups.45) In case a member firm is a stock company with outside shareholders, the usual best practices developed for public firms should apply. Also, shareholders’ meeting will replace the role played by SCIC.46) Among many measures, we would like to highlight the following three. First, at least 50% of its board members should be non executive independent members representing the interest of shareholders in general.47) Its candidates should not have ties with management or SCIC (controlling shareholder) that can jeopardize their independence. The candidates for non executive independent members can be nominated either by the board or by outside shareholders holding at least 1 percent of total outstanding shares. Second, under the board, these firms should have a subcommittee that has
45) Korea's experience with the 1997 Act on the Managerial Structure Improvement and Privatization of SOEs can be useful in designing the internal governance structure of economic groups. We outline here some key measures in the Act modified to the circumstances in Vietnam. 46) We assume here that economic groups will also be under the control of SCIC. 47) The Code of Corporate Governance for Listed Companies requires that one third of BOM members be non executive independent members.
397 Chapter 4 _ Efficient and Harmonious Enterprise Policy the mandate of approving or disproving transactions with other member firms within the group. This subcommittee is recommended to be exclusively composed of non executive independent members. Third, these firms should also seriously consider granting stock options or restricted stocks in addition to performance based pays based on accounting performance measures. These firms should also have a Remuneration Committee, solely composed of non executive independent members, that sets the pay for senior executives. Detailed pay structures by individual board members should be disclosed to the shareholders.
As for member firms where SCIC or mother corporations hold 100% of charter capital, SCIC or the immediate mother firm should assume the role of shareholders’ meeting. For this set of member firms, we recommend the following two measures. First, instead of filling the board with bureaucrats, we recommend to fill the board with non executive independent members representing the interest of general public. At least 50% of board members should be filled with these outside directors that should be nominated by the board and appointed by SCIC or the immediate mother firm. They should have no ties with management that can jeopardize their independence. Second, the Chief Executive Office (CEO) candidate should be nominated by the board and appointed by SCIC or the immediate mother firm. Once appointed, this CEO should enter a contract with the firm that stipulates target performance, performance evaluation criteria and methods, and detailed compensation structure. This contract should be disclosed to the public.
Box 4-2-8 CEO Management Contract at KT
The following outlines the CEO management contract that was approved at the shareholders meeting (August 2002) and signed between KT and CEO Yong Kyung Lee.
The contract is composed of 16 articles. Article 1 stipulates the objective of the contract and Article 2 specifies the CEO’s tenure (three years). Article 3 and 4 outline responsibilities and obligations of the CEO and Article 5 refers to the appendix that lays out the details of the CEO’s management goal that must be achieved during his tenure. Article 6 states that performance evaluation should be carried out by a subcommittee exclusively composed of outside directors. Articles 7 12 provide the details of the COE’s compensation structure. Article 13 stipulates the conditions when the CEO can be dismissed at the shareholders’ meeting. For example, if the CEO’s overall performance score is below 60 out of a total of 100, he can be dismissed at the shareholders’ meeting. Article 14 states that the intellectual property rights developed by the CEO during his tenure are exclusively owned by the company. Article 15 states that problems regarding the interpretation of the contract should be resolved by consultation between the subcommittee exclusively composed of outside directors and the CEO. Article 16 discusses the process how the contract can be revised.
The management goal laid out in the appendix is composed of two parts, one that has to do with managerial system and another pertained to managerial performance. The goal on managerial system is further decomposed into three areas: corporate strategy (5 points), accountability (15 points), and R&D (5 points). These three sub goals are further split into a number of elements. The goal on managerial
398 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy performance is further decomposed into two sets of sub goals: one that has to do with the process and another pertained to outcome. The process related sub goals include customer value added (CVA) of 1.08 (10 points), sales per worker (15 points), quality of telecommunications network (10 points), and achievement of public interests (5 points). The outcome based sub goals include economic value added (EVA) of KRW 300 billion (25 points), 3%p excess return over the benchmark (2 points), and market share (8 points). The total points added up to 100. According to Articles 7 12, the CEO’s compensation is composed of four parts: base salary, incentive bonus, stock options, and severance pay. Article 7 stipulates that the CEO’s base salary is KRW 177 million. Article 8 gives out the explicit formula that should be used when setting the CEO’s incentive bonus. That is, incentive bonus = Max [(150/30) x (total score 70) x (base salary), 0]. According to this formula, the incentive bonus cannot be more than 150% of the base salary. Article 10 states that KT can grant stock options to the CEO and if so, it should follow the provisions in the corporate charter. Article 11 states that KT should give the CEO a severance pay upon his retirement according to the severance pay by law.
5.5. Others
5.5.1. Develop a Well Functioning Capital Market
In the long run, Vietnam should aim to equitize many of its commercially run economic groups.48) Equitization, however, would be severely limited if Vietnam does not have a well functioning capital market. This is because, with a small domestic capital market, state owned shares would have to be sold either to private sector economic groups or to foreigners, but which are both are not the first best solutions for Vietnam. Although the Vietnamese stock market grew spectacularly in recent years, it is still in its early development stage. The market capitalization as a percentage of GDP is only around 10% at the end of 2008.49) Also, most of the domestic traders are individual retail investors. Given the limited size of the stock market, many IPOs of state owned enterprise have recently been delayed indefinitely by the government.
Figure 4-2-3 | Market Capitalization as Percentage of GDP (year end 2008)
160 140 120 100 80 60 40 20 0
India China SingaporeMalaysia ThailandPlilppinesIndonesiapakistan Vietnam source : VinaSecurities (2009), originally from Bloomberg and IMF
399 Chapter 4 _ Efficient and Harmonious Enterprise Policy To enlarge the number and the size of listed firms in the domestic stock market, the Vietnamese government may introduce some policy measures the Korean government adopted back in 1968 when the Capital Market Promotion Act was introduced.50) The Box below gives the details of those measures. The extreme measures adopted in 1972 through the IPO Inducement Act, however, are not recommended. Protecting the interest of outside investors is also crucial when developing a capital market. A country cannot have a large and vibrant stock market without assuring investors that their investments are protected from corporate wrongdoings. Many studies in the corporate governance literature document that countries with higher standards of investor protection have a larger external capital market and a higher larger number of listed firms.51)
For the time being, the Vietnamese government may also want to protect managers of public firms from outside takeover threats. Otherwise, private firms would opt to remain private and not go public. The currently adopted mandatory bid rule may not be enough.52) In case of Korea, managers of public firms were protected from outside takeover threats up until January 1997. No shareholder, together with its specially related parties, was allowed to hold more than 10% of voting shares. The only exception was those who held more than 10% before the IPO. In a not too distant future, however, Vietnam should allow hostile takeovers, as they are one of the most effective devices to discipline the managers.
Box 4-2-9 The Capital Market Promotion Act of 1968 and the IPO Inducement Act of 1972
In 1968, the Korean government introduced the Capital Market Promotion Act. It aimed to induce initial public offerings (IPOs) and thereby provide firms with an alternative source of financing, namely, external equity financing. It also aimed to induce people’s participationing into the stock market. A number of measures were introduced. As a way to encourage IPOs, it lowered the corporate income tax rate applied to public firms compared to those applied to private firms. It also allowed preferential accounting rules so that public firms can accelerate the depreciation of fixed assets.
To induce more participationing into the stock market, it lowered the dividend yield applied to shares held by the government so that other shareholders can receive dividend above a minimum level. It also allowed people to pay deposits to government agencies in stocks and stipulated the 10% mandatory allocation of IPO shares to employees. With this Act, dividend income became tax free and the government
48) Firms directly related to national security (telecommunications), market failure (electricity), or systemic risk (banking), however, should be subject to various ownership restrictions. As for firms with national security concerns, there should be a foreign ownership limit by law. As for firms with market failure, government should keep holding a controlling interest. As for firms with systemic risk, there should be ownership limit at an individual shareholder (together with all its related parties) level. 49) In mid 2007, it reached almost 30% of GDP. 50) The Vietnamese government also took some measures to induce IPOs. The government provided a two year tax waiver incentive (with a third year of 50% reduction in tax) for those companies that listed prior to the 31st December 2006 deadline. Stock earnings are presently not taxed. 51) This is well documented in La Porta et al. (2007). 52) The mandatory tender offer is triggered when the 25 percent threshold is crossed.
400 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy was allowed to sell the shares it owns below the market price if it is either for the public interest or to be sold to its selling them to its employees.
In 1972, the Korean government adopted an extraordinary measure to increase the number of listed firms in the Korean stock market. It basically gave the government the power to order private firms go public. The Ministry of Finance had the authority to select the firms that are appropriate to go public. Once decided at the cabinet level IPO Committee, the selected firms had to go public. The IPO Committee was chaired by the Prime Minister with six ex officio members and civilian members of no more than five appointed by the President. The six ex officio members were the Minister of Economic Planning Board (EPB), the Minister of Finance, the Minister of Commerce and Industry, the Governor of Bank of Korea, the President of Korea Investment Corporation, and the Chairman of Korea Stock Exchange.53)
If the designated firm did not oblige, the firm and its controlling shareholder were subject to unfavorable tax treatments. The Ministry of Finance also had the authority to limit lending to non complying firms. During those days, all the commercial banks were state owned. On the other hand, complying firms and their controlling shareholders were granted with preferential tax treatments.
In 1987, this Act was merged into the Capital Market Promotion Act of 1968.
5.5.2. Diversification into Non Core Business Areas
It is not advisable for economic groups to diversify their business portfolios and enter into non core business areas. First, economic groups are established in industries selected to be strategically important for Vietnam. It does not make sense for economic groups to enter business areas in strategically unimportant industries. Second, the non core business areas, in which diversifying economic groups enter, might be the business areas where private enterprises already exist and can operate without any market failure. Third, diversification strategy is justified when there is a need to form an internal capital market.54) But, state owned economic groups depend heavily upon government funding, which makes the formation of internal capital market unnecessary.55)
Fourth, it is troublesome for manufacturing firms to have control over commercial banks.56) Mixing commerce and banking entails has serious problems, such as conflict of interest and the concentration of economic power. For such reasons, the separation of commerce and banking has been the core principle, which both the U.S. and the Korean government have maintained for many decades. Ownership of commercial banks should be restricted so that economic
53) Korea Investment Corporation established under the Capital Market Promotion Act of 1968 is not the same organization as the Korean Investment Corporation (KIC) set up in 2005 as a sovereign wealth fund. They are two different organizations using the same English name. 54) See Khanna and Palepu (2000). 55) See Cuong (2010) on economic group's external financing. 56) According to VietNamNet Bridge (May 2, 2008), government gave a nod to the establishment of PetroVietnam Bank.
401 Chapter 4 _ Efficient and Harmonious Enterprise Policy groups, whether they are state owned or private, do not have control over them. Fifth, many academic studies in the literatures show that corporate diversification lowers performance.57) If an economic group does not have profitable investment opportunities, earnings should be paid out as dividends either to SCIC or to shareholders.
Box 4-2-10 Separation of Commerce and Banking in Korea
In Korea, the principle of separating commerce (industrial capital) and banking (commercial banks) has been the maintained since 1982. In 1982, the government wanted to privatize commercial banks that hads been in the hands of the state for the past 20 years, but was also concerned with the problem of economic power being concentratedion in few chaebol families. This lead the government to impose an ownership limit of 8%. That is, no shareholder, together with its specially related parties, can own more than 8% of commercial bank shares. In 1994, this ownership limit was relaxed and raised up to 12% for firms mainly engaged in financial business, but lowered down to 4% for others. Immediately after the economic crisis, in 1998, the ownership limit was set again to be 4% regardless of the business the shareholder is in. In 2002, the ownership limit was relaxed to 10%, but there was a 4% cap on the voting rights. In 2009, the cap on voting rights has been relaxed to 9%.
There are basically three reasons why industrial capital should not have a controlling stake in commercial banks. First, the controlling shareholder may pursue his own interest at the expense of depositors. For example, he may influence the bank managers to provide preferential loans to his related parties (conflict of interest). More subtly, he may influence the bank managers not to provide loans to the competitors of his related parties. The government may strictly prohibit such practices by law. But, often times, banking supervision lags behind and for various reasons the laws are not strictly enforced. Second, in countries with deposit insurance, the presence of a controlling shareholder induces banks to take more risks.58) In extreme cases, this may result in a banking crisis(systemic risk). This is because deposit insurance creates a distorted pay-off structure, where shareholders share the upside gain, but do not share the downside loss. Under such incentive structure, taking a greater risk is the optimal choice for shareholders, and such strategy can be actually implemented in the persence of a controlling shareholder. Third, if industrial capital also owns/controls commercial banks, it will aggravate the problem of excessive concentration of economic power(concentration of economic power). In face of such powerful families, banking surpervision and law enforcement may become useless. Not only economic democracy, but also political democracy can be in danger.
Ownership limit in commercial bank shares is not the only policy the Korea government adopted to separate financial capital from industrial capital. There were two other important regulations. One is regulatesing financial institution’s ownership in non financial firms. Specifically, a financial institution, together with other affiliated financial institutions, cannot own more than 20% of non financial firm’s voting shares, unless it secured a prior approval from the Financial Services Commission (5% if the business group where the financial institution belongs to have a de facto influence over the non financial firm). This regulation was introduced in 1991. Another is regulatesing financial institution’s share voting in non financial affiliates. That is, when voting the shares of a non financial affiliate, a financial institution, together with all related parties, cannot exercise more than 15% of the total voting shares.
57) There is a study on Korean chaebols too. Ferris, Kim, and Kitsabunnarat (2003) empirically show that chaebol affiliated firms suffer a value loss relative to non affiliated firms. 58) See Laeven and Levine(2009) for details.
402 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy 5.5.3. Ownership Structure and Transparency
Economic groups are basically resemble pyramids. But, pyramidal ownership structure is a vehicle, through which a controlling shareholder can increase its control rights while keeping its cash flow rights constant.59) It is well documented in the corporate governance literature that the disparity between control and cash flow rights bring about expropriation of minority shareholders, lower firm value, and poor operating performance. To prevent or to limit such negative side effects, Vietnam should consider adopting policies the Korean government introduced in 1999 to regulate the ownership structure of business conglomerates with holding companies. The key measures include (i) the 100% upper limit on holding company’s debt to equity ratio, (ii) the 50% minimum share ownership requirement in subsidiaries (30% in case of public subsidiaries), (iii) the ban to own shares in financial institutions (in case of non financial holding companies),60) and (iv) the ban on subsidiaries holding shares in other subsidiaries.61)
As for firms before privatization, we recommend to limit the fraction of shares any single investor can own. In case of Korea, as for the SOEs subject to the 1997 Act on the Managerial Structure Improvement and Privatization of SOEs, government imposed an ownership limit that any single shareholder, collectively with all of its related parties, cannot own more than 7% of total outstanding shares. This limit is now relaxed up to 15%. This is to prevent the transfer of strategically important companies to the hands of few chaebol familes.
Another issue is to improve the transparency of economic groups’ ownership structure. The Ministry of Finance or SCIC should make efforts so that detailed ownership structure of each economic group is disclosed to the public. Economic groups already have too many member firms. It is even more troublesome that the exact shareholdings among the member firms are not in the public domain. Public scrutiny is a very powerful disciplinary mechanism. Since 2007, the Korean government opened a website that publicly discloses each chaebol’s intra group ownership structure.62)
Box 4-2-11 Regulation on Holding Company Structure in Korea
The establishment of holding company structure was strictly prohibited in Korea until 1999. Holding company structure, especially those with many layers of subsidiaries, was regarded as a vehicle that facilitates the concentration of economic power.63) In February 1999, however, the government gave in and
59) According to Bebchuk, Kraakman, and Triantis (2000), the other two vehicles are dual class shares and cross or circular shareholdings. 60) Likewise, financial holding companies and their member firms cannot own shares in non financial firms. 61) As of December 2009, the government of Vietnam prohibits the member firms of economic groups from investing in the shares of mother company and of other fellow firms (Government decree No.09/2009/ND CP and Circular No.242/TT BTC by the Ministry of Finance). 62) Visit http://groupopni.ftc.go.kr (only in Korean). 63) Morck and Yeung (2004) confirm this view.
403 Chapter 4 _ Efficient and Harmonious Enterprise Policy allowed the establishment of holding company structure, which was considered as a useful group structure to expedit corporate restructuring. This was much needed at those times.
But, the establishment of holding company structure was allowed only under strict conditions.64 These conditions include (i) the 100% upper limit on holding company’s debt to equity ratio, (ii) the 50% minimum share ownership requirement in subsidiaries (30% in case of public subsidiaries), (iii) the ban to have grandson companies in unrelated businesses, (iv) the ban to own shares in financial institutions (in case of non financial holding companies), and (v) the ban on subsidiaries holding shares in other subsidiaries.
Such conditions, however, were relaxed substantially in 2007. The key measures include (i) the relaxation of upper limit on debt to equity ratio from 100% to 200%, (ii) the relaxation of minimum share ownership requirement in it subsidiaries from 50% to 40% (from 30% to 20% in case of public subsidiaries), (iii) the permission to have grandson companies in unrelated businesses, (iv) the permission to have great grandson companies, provided that share ownership in great grandson companies is 100%.
Such dramatic relaxation, however, was met with invited heavy criticism from the academia. It is also reported that, by transforming into a holding company structure, controlling shareholders of chaebols were able to tighten their control over the group without contributing any additional capital.65) Among the top 30 chaebols in Korea, 11 of them have transformed into a holding company structure, as of April 2009.
Box 4-2-12 KFTC's Regulation on Large Business Conglomerates in Korea66)
Ban on cross shareholdings Member firms in the designated large business cannot have cross shareholdings with other member firms in the same conglomerate (cross shareholding refers to firm A holding shares of firm B, and firm B holding shares of firm A; circular shareholding is allowed)
Upper ceiling on equity investment Member firms in the designated large business can make equity investments in other domestic companies in amounts only up to 25% of net assets (= assets book equity invested by other member firms) ■ (April 1987 March 1990) 40% upper ceiling applied to all
64) Holding company itself was defined as a company with total asset size above KRW 100 billion and the valuation of subsidiary stocks taking up more than half of the holding company's total assets. 65) See CGCG (2008). 66) This box is mainly from Kim, Lim, and Sung (2006). Since 1987, the Korea Fair Trade Commission (KFTC) has been designating, each year in April, large business conglomerates to be subject to a number of restrictions. From 1987 to 2001, KFTC designated the top 30 conglomerates in terms of their total asset size. Since 2002, KFTC changed the way it designated the conglomerates. Instead of using asset size ranks, it now uses asset size thresholds. That is, KFTC regulations are imposed only when the total asst size of a conglomerate is above a certain asset size thresholds (e.g. 2 trillion or 5 trillion KRW). Large business conglomerates include two types of conglomerates: one where the group's controlling shareholder is a natural person (typically known as chaebols) and the other where the group's controlling shareholder is a legal person (usually, privatized ex SOEs).
404 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy member firms in the top 30 conglomerates ■ (April 1990 Dec. 1994) Exempt financial institutions ■ (Dec. 1994 Feb. 1998) Upper ceiling lowered down to 25% ■ (Feb. 1998 March 2001) No upper ceiling (regulation lifted to facilitate corporate restructuring) ■ (April 2001 Jan. 2002) Reintroduced the 25% upper ceiling (exemptions allowed) ■ (Jan. 2002 Nov. 2004) Applied to conglomerates above 6 trillion won (more exemptions allowed) ■ (Dec. 2004 March 2007) Applied to conglomerates above 6 trillion won ■ (April 2007 Feb. 2009 ) Upper ceiling relaxed up to 40%; applied to conglomerates above 10 trillion won; applied to member firms above 2 trillion won (March 2009 Present) No upper ceiling
Ban on new debt guarantees Member firms in the designated large business conglomerates cannot provide any new debt guarantee to domestic member firms ■ (April 1993 March 1996) Reduce existing debt guarantee below 200% of book equity ■ (April 1997 March 1999) Reduce existing debt guarantee below 100% of book equity ■ (April 1999 Present) Ban on new debt guarantee
No voting rights for financial Financial institutions in the designated large business institutions on shares issued by conglomerates cannot exercise their voting rights on shares issued member firms by other member firms ■ (April 1993 Jan. 2002) Applied to all the financial institutions in the top 30 business conglomerates ■ (Jan. 2002 Nov. 2004) Voting rights of financial institutions allowed up to 30% of shares issued by member firms in case the resolution items are revision of AOI, appointment/dismissal of directors, or mergers (the controlling shareholder cannot directly or indirectly exercise voting rights above 30%) ■ (Dec. 2004 Present) Maximum voting rights allowed lowered down to 15%
Board approval and disclosure of Related party transactions above KRW 10 billion or 10% of related party transactions book equity should be approved by the board and be disclosed to the public ■ (April 2000 March 2001) Applied to all member firms in top 10 business conglomerates ■ (April 2001 March 2002) Applied to all member firms in top 30 business conglomerates ■ (April 2002 Present) Applied to all member firms in business conglomerates above KRW 2 trillion
405 Chapter 4 _ Efficient and Harmonious Enterprise Policy 5.5.4. Protection of Minority Shareholders
Since many of the subsidiaries belonging to economic groups are public firms, the Vietnamese government should adopt policies which aiming to protect the interest of outside minority shareholders.67) Otherwise, the government would face difficulty selling shares to the public in the future.
According to Le Minh and Walker (2008), investor protection was the major concern for Vietnamese lawmakers when introducing the Enterprises Law of 2005. In general, the Enterprises Law of 2005 has substantially enhanced the investor protection mechanism. For example, shareholders holding over 10 percent of common shares of the company for at least six consecutive months (or a smaller proportion as prescribed in the corporate charter) have the right to require the BOM to convene a shareholders’ meeting. However, the provisions on convening a GMS have certain shortcomings. First, the right to request GMS can be exercised only in limited circumstances, which arise only when (i) the BOM makes a serious breach of rights of shareholders, obligations of managers or makes a decision which falls outside its delegated authority; (ii) the term of the BOM has expired for more than six months and no new BOM has been elected to replace it; (iii) the situation meets other circumstances as prescribed in the corporate charter. On top of this, the requesting shareholder has to show evidence to support that the outlined conditions have been met. of the above circumstances.
The most significant area where Vietnam lags behind in regards to investor protection is that the shareholders, either in their names or on the company’s behalf, cannot take legal actions against the CEO, the directors, and the supervisors of the company. This is noted in a joint report by the World Bank and IFC (2008), which states that the greatest concern has to do with the enforcement of director’s fiduciary duties. Although the Enterprise Law of 2005 introduced fiduciary duties, no commercial tribunal in Vietnam has jurisdiction over investor suits against directors. This is also reflected in Vietnam’s corporate governance rankings and scores. According to the same report in 2009, Vietnam’s investor protection score is only 2.7 out of 10. This ranked Vietnam at 177 among a total of 183 economies covered. Among the three dimensions of investor protection (disclosure, director liability, and shareholder suits), the ease of shareholder suits index scored “2”.68)
67) This part of the report heavily relies on Le Minh and Walker (2008). 68) The average score was 6.1 for East Asia & Pacific jurisdictions and 6.6 for the OECD members.
406 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy Table 4-2-4 | Investor Protection Ranking Around the World (as of 2009)
Most Protected Rank Least Protected Rank
New Zealand 1 Gambia, The 174
Singapore 2 Micronesia, Fed. Sts. 175
Hong Kong, China 3 Palau 176
Malaysia 4 Vietnam 177
Canada 5 Venezuela, R.B. 178
Colombia 6 Djibouti 179
Ireland 7 Suriname 180
Israel 8 Swaziland 181
United States 9 Lao PDR 182
South Africa 9 Afghanistan 183
Source: World Bank and IFC (2009)
Another area that needs serious improvement is in related party transactions. It is true that, in recent years, Vietnam introduced new provisions regulating related party transactions. For example, the definition of related person has been widened under the Enterprises Law of 2005 and the Securities Law of 2006. Also, related party transactions must now be approved by either the shareholders (transactions above 50 percent of the total assets) or the BOM (transactions below 50 percent of the total assets).69) The two laws also increased reporting requirements and disclosure requirements for related party transactions.
However, there are a number of shortcomings. For example, there is no external review mechanism for related party transactions approved by the BOM. Also, the law does not give shareholders the right to challenge the board or to require a court to declare an unfair related party transaction to be invalid. Moreover, the law does not impose responsibilities on the board and its members in unfair related party transactions. Sanctions for violating fiduciary duty should be sufficiently severe so as to deter wrongdoing. But, the Enterprise Law of 2005 lacks the necessary penalties to force directors to fulfill their duties. In the joint survey report by the World Bank and IFC (2009), Vietnam’s score on director liability is “0.” According to the joint survey by International Finance Corporation (IFC) and Mekong Private Sector Development Facility (MPSDF), related party transactions and potential conflicts of interest are among the most serious corporate governance problems.
69) Related party includes (i) shareholders or authorized representative of shareholders holding more than 35 percent of the common shares and their related persons, (ii) members of the BOM, director or general director (CEO), and (iii) enterprises where BOM members, members of Control Board, director or general director (CEO), other managers of the company, or other related person hold more than 35 percent of the equity capital.
407 Chapter 4 _ Efficient and Harmonious Enterprise Policy Another important area that needs improvement is in disclosure. Under the Enterprises Law of 2005, there was an improvement in the mandatory corporate disclosure system through the imposition of many disclosure obligations on directors/managers and the company. However, the Enterprises Law of 2005 lacks legal rules to deal with the violations of disclosure obligations. Lack of appropriate legal rules to enforce a company and directors/managers to comply with their disclosure requirements may result in ‘poor’ disclosure.
Box 4-2-13 Survey on Corporate Governance in Vietnam
International Finance Corporation (IFC) and Mekong Private Sector Development Facility (MPSDF) conducted a joint survey in 2006 on the corporate governance practices in Vietnam. 85 firms responded to the survey. Following outlines the survey findings:
- Only 26% responded that the basic concept and principles of corporate governance are understood by most business people in Vietnam. - 86% rated corporate governance practices as being either important or very important for their company, relative to other tasks. - 78% of all firms agreed that improving corporate governance practices should receive be a high priority from the government. - A majority of firms believe that the current laws and regulations do not provide adequate guidance on corporate governance practices. - A majority of the firms believe that current laws and regulations on corporate governance are not adequately enforced. - A majority of firms believe that companies have insufficient information and knowledge on corporate governance. - Related party transactions and potential conflicts of interest is one of are amongst the most serious corporate governance problems. - Related party transactions and conflicts of interest ranked second among the most frequently occurred corporate governance malpractices, occurring. - Less than 25% of all firms have written guidelines on controlling related party transactions.
There are a number of specific measures the Vietnamese government can adopt to improve the quality of corporate governance. First, the Vietnamese government should introduce a guideline with regard to non executive independent members’ qualifications and nomination procedure. The Code requires that one third of the BOM should be non executive independent members. But the Enterprise Law of 2005, the Code, and the Model Charter of 2007 applicable to listed companies are all silent on the qualifications and nomination procedure of non executive independent members.
Box 4-2-14 Disqualified Outside Director Candidates in Korea
The Commercial Code (revised as of January 2009) lays out the details on who disqualifies as a
408 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy legitimate outside director candidate. Following provisions apply to all stock companies, whether they are private or public. (i) A person who is or was (within the past two years) an officer (directors and auditors) or an employee of the company concerned. (ii) If the largest shareholder is a natural person, the largest shareholder, its spouse, and its lineal descendants/ascendants. (iii) If the largest shareholder is a legal person, its officers (directors and auditors) and employees. (iv) A spouse or a lineal descendant/ascendant of the current officer (directors and auditors) or the employee. (v) A person who is an officer or an employee of a company that is either a mother company or a son company of the company concerned. (vi) A person who is an officer or an employee of the company that has a material business relationship with the company concerned. (vii) A person who is a director or an employee of the company in which the director or the employee of the company concerned is a director.
As for public companies, the Commercial Code lists a few more disqualifying cases. (i) A minor, an incompetent person, or quasi incompetent person. (ii) A bankrupt person who has not been reinstated yet. (iii) A person who has been sentenced to a punishment heavier than imprisonment, and two years have not elapsed since either the execution or the exemption of such punishment. (iv) A person who was dismissed for breaching the law listed in the Presidential enforcement decree, and two years have not elapsed since the dismissal. (v) A person, together with its specially related parties, holds the largest voting rights, and its specially related parties. (vi) Major shareholder (10% of more voting rights or have de facto influence over the appointment and the dismissal of directors and auditors), its spouse, or its lineal descendants/ascendants. (vii) Others that cannot carry out the responsibilities of an outside director with loyalty or that can exert influence over the management of the company concerned.
The Presidential enforcement decree also stipulates who are those that cannot carry out the responsibilities of an outside director with loyalty or that can exert influence over the management of the company concerned. (i) A person who is or was (within the past two years) an officer (directors and auditors) or an employee of the company affiliated to the company concerned. (ii) A person who is or was (within the past two years) an officer (directors and auditors) or an employee of the company that meets at least one of the followings: (ii-1) [Aggregate amount of transactions with the company concerned during the past three years] / [Total assets or sales of the company concerned in the most recent year] > 10% (ii-2) [Amount of any single transaction with the company concerned in the most recent year] / [Total sales of the company concerned in the most recent year] > 10% (ii-3) [Aggregate amount of lending, borrowing, and debt guarantee with the company concerned in the most recent year] / [Total assets of the company concerned in the most recent year] > 10% (ii-4) [Equity ownership by the company concerned at shareholders’ meeting] / [Total book equity of the company concerned] > 5% (ii-5) A company that has a technological alliance contract with the company concerned.
409 Chapter 4 _ Efficient and Harmonious Enterprise Policy (ii-6) External auditor or any company that has a legal or management consulting contract with the company concerned. (i) A person who is already serving either as an outside director, a non executive director, or an auditor in two listed corporations. (ii) A person providing audit, tax, legal, or management consulting service. (iii) A person holding more than 1 percent of outstanding shares. (iv) A person whose outstanding amount of transaction with the company concerned is more than KRW 100 million.
Second, as for large sized listed companies, the Vietnamese government should seriously consider requiring a higher proportion of non executive independent members in BOM. Requiring a majority is one option, following the Koran example.70) Once the board has sufficient number of non executive independent members, it can form a subcommittee, solely composed of non executive independent members, which has the authority of approving or disproving related party transactions. Under the current system, where the board is mainly composed of executives, board approval of related party transactions is not likely to be an effective control device. Forming a remuneration committee, exclusively composed of non executive independent members is another measure the Vietnamese government should consider. Black, Kim, Jang, and Park (2008) study the role of 50% outside director ratio in Korea and empirically show that it was helpful in reducing related party transactions. Given that Vietnamese corporations have a Control Board, one can think of an alternative approach. That is, requiring the Control Board to approve related party transactions.
Third, the Vietnamese government should shorten the tenure of BOM and Control Board members. Currently, they have a five year term that can be renewed. A reasonable alternative is to limit the tenure to be no longer than three years. The shareholders’ ability to replace BOM and Control Board is enhanced by making the BOM and Control Board members face elections every 1 to 3 years. Shortening the tenure alleviates the problem of staggered board and enhances the effectiveness of cumulative voting which is mandated under the Enterprise Law of 2005.71)
Fourth, the Vietnamese government should reconsider which firms should have a Control Board. Currently, the Enterprise Law of 2005 requires that a Control Board must be established when a corporation has more than 11 natural shareholders or one (or more) organization shareholder(s) hold more than 50 percent of equity capital. It is not clear what the government wants to achieve by setting this criteria. For example, consider a corporation where 11 natural
70) Listed firms with total book asset value above 2 trillion won must have a board where outside directors are a majority. In all other firms, the fraction of outside directors must be at least 25%. 71) With five year tenure, terms can end on five different years and board can be staggered over a five year period. In this case, only one fifth of the board members are elected each year, greatly limiting the effectiveness of cumulative voting. With three year tenure, however, terms can end only on three different years and board can be staggered only over a three year period. In this case, one third of the board members will be elected each year.
410 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy shareholders hold 100 percent of equity capital and another corporation where 10 natural shareholders hold 51 percent and 490 organization shareholders hold 49 percent of equity capital. Under the current law, the first corporation needs to establish a Control Board, while the second does not. But, it is not clear why the second corporation needs less supervision than the first.
Fifth, the Vietnamese government should revise the relevant laws so that outside minority shareholders can better monitor and discipline management. For example, it should consider lowering the minimum 10 percent ownership threshold required to nominate a member of the board or to call for an extraordinary GMS. In case of Korea, the minimum shareholding requirements are 1 percent and 3 percent, respectively for nominating a director candidate and calling for an extraordinary GMS. When calling for an extraordinary GMS, the law should not limit the circumstances when shareholders can call for the meeting. Also, it should extend of the current 7 day notice period for GMS to 21 days. 7 days is too short to solicit proxies. It is also recommended to allow electronic voting.
411 Chapter 4 _ Efficient and Harmonious Enterprise Policy References
Bebchuk, Lucian Arye, Reinier Kraakman, and George Triantis (2000), “Stock Pyramids, Cross Ownership, and Dual Class Equity: The Creation and Agency Costs of Separating Control from Cash Flow Rights,” in Randall K. Morck, ed., Concentrated Corporate Ownership, pp. 445- 460.
Black, Bernard, Woochan Kim, Hasung Jang, and Kyung Suh Park (2008), “How Corporate Governance Affects Firm Value: Evidence on Channels from Korea” KDI School Working Paper No. 08-19
Center for Good Corporate Governance (2008), “Strengthening Group Control by Tranforming into a Holding Company Structure,” Quarterly Journal of Good Corporate Governance Vol.26 pp.28-38 (in Korean)
Cuong, Tran Tien (2010), “Ensuring the Effectiveness and the Corporate Governance of State Economic Groups,” mimeo
Ferris, Stephen, Kenneth Kim, and Pattanaporn Kitsanbunnarat (2003), “The Costs (and Benefits?) of Diversified Business Groups: The Case of Korean Chaebols,” Journal of Banking and Finance Vol.27, pp.251-273.
International Finance Corporation (IFC) and Mekong Private Sector Development Facility (MPDF)(2006), Corporate Governance Practices in Vietnam: Some Initial Survey Findings
International Monetary Fund (2010), World Economic Outlook Database October 2009
Hong, Thai Thu and Margarete O. Biallas (2007), Vietnam: Capital Market Diagnostic Review, (International Finance Corporation and Mekong Private Sector Development Facility)
Khanna, Tarun and Krishna Palepu (2000), “Is Group Affiliation Profitable in Emerging Markets? An Analysis of Diversified Indian Business Groups,” The Journal of Finance Vol. 55, pp.867-891.
Kim, Woochan, Youngjae Lim, and Taeyoon Sung (2006), “Group Control Motive as a Determinant of Ownership Structure in Business Conglomerates: Evidence from Korea’s Chaebols,” Pacific Basin Finance Journal No. 15, pp.213-252
412 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy La Porta, Rafael, Florencio Lopez de Silanes, Andrei Shleifer, and Robert Vishny (1997), “Legal Determinants of External Finance,” The Journal of Finance Vol.52, pp.1131-1150
Laeven, Luc and Ross Levine (2009), “Bank Governance, Regulation, and Risk Taking,” Journal of Financial Economics Vol.93 pp.259-275
Le Minh, Toan and Gordon Walker (2008), “Corporate Governance of Listed Companies in Vietnam,” Bond Law Review Vol.20 No.2
Loc, Truong Dong (2006), Equitisation and Stock Market Development: The Case of Vietnam, Ph.D. dissertation, University of Groningen
Morck, Randall and Bernard Yeung (2004), “Special Issues Relating to Corporate Governance and Family Control,” World Bank Policy Research Working Paper No.3406
Nam, Il Chong (2004), “Recent Developments in the Public Enterprise Sector of Korea,” in Takatoshi Ito and Anne O. Krueger, ed., Governance, Regulation, and Privatization in the Asia Pacific Region, University of Chicago Press
Nam, Il Chong and Young Jae Kang (1998), “Privatization Strategy for Korea”, KDI Quarterly Journal (in Korean)
Nam, Il Chong and Woochan Kim (2004), “Corporate Governance of Newly Privatized Firms: The Remaining Issues in Korea,” KDI School Working Paper Series No. 04-05
OECD (2005), OECD Guidelines on Corporate Governance of State Owned Enterprises
VinaSecurities (2009), Vietnam Primer
Vu, Anh T.T (2006), “Competition and Privatization in Vietnam: Substitutes or Complements?” mimeo
World Bank (2006), Corporate Governance Country Assessment: Vietnam
World Bank and International Finance Corporation (2008), Doing Business 2008 Country Briefing: Vietnam
World Bank and International Finance Corporation (2009), Doing Business 2010
413 Chapter 4 _ Efficient and Harmonious Enterprise Policy Chapter 03 Technical/Technological Human Resources Development in the Economic Groups
Youngrak Choi (Korea University) Sinh Tan Bach (NISPASS) Binh Chi Truong (IPSI)
1. Importance of Human Resources Development in SOEs1)
State Owned Enterprises (SOEs) play a dominating role in Vietnam’s economic development and absorb a large proportion of the country’s resources. However, there are two critical issues for human resources development (HRD) in SOEs: One is the effective management system including incentive mechanisms. The other is the underutilization of their work force including lack of training opportunities.
What makes an enterprise effective is not only capital or technology but also human resource which is the most critical. It is widely believed that people are the key to success in any business operation. Massive investment in HRD through education and training has enabled many countries in East and Southeast Asia to achieve significant economic growth.
HRD is a very important element to improve productivity, efficiency and profitability. It is a planned and continuous effort by management to improve employee’s competency levels and organizational performance through education and learning. Development refers to the acquisition of knowledge, skills, and behaviors that improve employee’s ability to meet changes in job requirement and in customer demands. Education and training is an attempt to improve current or future employee’s performance by developing their attitude and enhancing their skills and knowledge.
1) This section is indebted to Quang and Dung (1998)
414 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy Management system in SOEs has not paid much attention to customer satisfaction and would have little concern for dynamic business growth. Management system has not provided the business managers sufficient knowledge and skills required to survive in a competitive environment. Managers in SOEs are not be well equipped and not be motivated to perform their tasks. There lacks Tthe concept of real owners or founders of the business is missing. The criteria for recruitment and promotion of managers do not reflect concrete requirements for business and production. Business management is not considered as a profession. There is a lack of performance based evaluation systems and incentive schemes.
SOEs need a critical mass of skilled work force and competent business managers. A majority of them lack the basic knowledge and managerial skills to lead enterprises into makeing profits and expanding growth. In particular, SOEs should establish concrete plans to improve employee’s performance through education and training programs. Through education and training, employees can get a chance to upgrade their technical skills and to eventually apply the newly acquired skills for the benefit of the enterprise. On the job training is a typical training program provided at the work site. Self study is another method, but the problem is that necessary materials might be inadequate and not be readily available. Job rotation is also an important method, but the difficulty is that there are employee’s fears of losing their jobs and thus, they are reluctant to disclose to trainees all the secrets of their work.
Anyway, management training, promotion, performance appraisal, career development programs, etc. are very powerful measures for effective HRD in SOEs. Unfortunately, however, those programs and systems are not so much developed in Vietnamese SOEs to meet with severely international competitive international environments. All in all, it is very important to exploit the well those talents of Vietnamese people, which have been known widely known to include, being namely skillfulness, hardworking and fast learning.
In this paper, Vietnam Textile and Garment Group and Vietnam Shipbuilding Group, as representative cases among the eight SOEs, are dealt with main focus on thein which technical/technological human resources development (THRD) is mainly focused on.
2. Technical/Technological Human Resources Development in SOEs 2.1. National Innovation System in Vietnam 2)
Vietnam’s innovation system is comprised of both public and private organizations. This includesey are public and private firms, research institutes, universities, and so on. The state
2) This section is indebted to Hong (2007)
415 Chapter 4 _ Efficient and Harmonious Enterprise Policy government plays a very important role in mobilizing and allocating research and development (R&D) resources.
Unlike advanced countries, public sector plays a major role in innovation system in Vietnam. R&D activities have been performed mainly by public research institutes and universities. SOEs have not been proactive in R&D activities unless they are given state budget subsidy to carry out R&D projects based on the science and technology (S&T) plan. In general, Vietnamese enterprises have not been so much concerned with R&D activities. Most of small and medium enterprises (SMEs) in particular have not been involved in R&D activities.
However, the situation was changed recently. The number of R&D institutions in Vietnam increased from 519 to 1,220 in the period 1995 2005. The share of public R&D institutes dropped significantly, from 72% in 1995 down to 52% in 2005. Similarly, gross expenditure on R&D gradually expanded from 0.2% to 0.55% of gross domestic production (GDP) between the years of 1995 and 2004. Compared with other countries in the region, this level is quite moderate; it is the same or even higher than that of level in South East Asian countries’ like Thailand, Indonesia and Philippines. One important feature is that a major portion of R&D expenditure came from the state budget while the private sector and other non state government institutions did not spent much on R&D activities.
By 2005, Vietnam had about 40,000 researchers specialized in R&D who were working in different sectors of the economy. However, the most of the existing pool of scientists and engineers (72%) are employed by either the national centers for R&D, universities, ministries or government agencies. And only a small fraction of researchers (5%) work for attached with business firms in Vietnam.
Given the total population of 83.1 million in 2005, Vietnam is known as a country with abundant human resource and young labor force since 68% of population is at the age between 15-60. Over the last decade, Vietnam succeeded to maintain a high level of primary and secondary enrollment. In 2004, Ggross enrollment of primary school reached 98% and gross enrollment of secondary school was 74%. in 2004. However, the rate of gross tertiary enrollment was quite moderate, only at 10% in 2004. The ratio of university enrollment was even much lower. Vietnam currently has more than 210 universities and colleges teaching around 1.2 million students. Most of them are public ones, accounting for 83% in terms of organizations and 89% in terms of students. In addition, there are about 250 public and private technical and vocational institutes with nearly 300,000 students. These organizations have been actively contributing to the quality improvement of Vietnam’s labor force.
The quality of workers in Vietnam has improved gradually. The skilled workers accounted for only 12% of the total in 1996, but this figure recorded at 27% in 2005. And 80% of unskilled workers were concentrated in rural areas. In addition, only 30% of skilled workers had
416 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy university, college or higher education; the remaining hads experienced either technical or vocational training.
Expenditure on educators in Vietnam has been growing rapidly over time. The share of public expenditure on education in state budget increased from 15% (equivalent to 3.5% of GDP), to 18% in 2005 (or 5.56% of GDP) and was estimated to reach 20% in 2007-2008. 2.2. THRD in Vietnam Textile and Garment Group (Vinatex)
2.2.1. Growth Stages
Textile and garment industry developed rapidly with the establishment of several new plants. The large Sstate textile and garment enterprises (later belonging to Vinatex afterward) manufactured according to the plan by the State Planning Committee, satisfying the demand on apparel and bedding in Vietnam.
<1976~1990> In this period, Vietnamese textile and garment industry developed rapidly in terms of regarding production capacity by due to taking over large enterprises in the south and building of new factories throughout the country overall. Up to 1990, garment industry expanded to large scale with 166 sState enterprises, 620 co operatives and individual households.
<1991~1999> Economic reform created great difficultiesy and challenges. Most equipment and technology was about 30 40 years out of date compareding to that of the region and the world. Responding to this situation and innovation requirements, a lot of enterprises upgraded their old equipment and invested in new technology in order to improve the product quality for market demands. In addition, incentives to foreign investment stimulated the establishment of joint ventures and 100% foreign enterprises. By the end of 1999, total employees in the textile and garment were 1 million, people including 3,000 staff holding a minimum with degree in engineering above engineer degree. And the Vietnam national textile and garment group (Vinatex) was set up in 1997, comprising 60 member units.
<2000~Present> The focus shifted into improving product quality and expanding manufacturing capacity. The top priority went to high quality export products and material supplies for manufacturing. Thus, there emerged as an urgent need for tasks as the efficient management of manufacturing, the level up of labor productivity, the upgrade of product quality, and the promotion of marketing activities, all in all to improve the competitiveness in the world market.
According to statistics of Vinatex, there have been 2,000 enterprises in Vietnamese textile and garment industry until August 2007 including 76% of domestic and 24% of foreign enterprises. Most of the textile and garment enterprises in Vietnam are SMEs. Out of enterprises with charter capital of below VND 5millions account for 75%, only some enterprises are able to compete in international market, namely Viet Tien, Garment 78 company, Garment 10 JSC., and Nha Be Garment Co. And the enterprises with below 1,000 employees make up 87% of the textile and garment industry. The Vietnamese SMEs have not developed their linkages with upstream and downstream sectors. For a long time, this mechanism has not been improved and enterprises remained as small scale ones.
Before 1991, textile and garment enterprises mainly used imported technology from Germany and Japan. After 1991, the enterprises have continuously expanded production capacity and upgraded equipment to meet the quality level of world market. In particular, upgrading of sewing and finishing technology is remarkable. Thus, the catch up with leading countries has been achieved in these processes. Most of sewing machines are advanced ones with high speed and automatically oil pumping for industrial hygiene. The finishing process is conducted in steam iron system to ensure product quality. However, in the beginning stage first processes of garment technology, namely production preparation and cutting, technological innovation has not been carried out successfully.
Vietnamese garment industry has developed rapidly for the last 15 years, especially in the recent 5 years after the when opening of the US market is realized. Vietnamese garment technology is evaluated to have as catch up with advanced level in the world. For example, Vinatex has 126 workshops with 78,000 sewing, cutting and finishing machines with 20% of workshops belonging to group 1; it is evaluated as the advanced degree in which because CAD and CAM are used for technical design and plotting phases and software is used in product development can be used. 70% of Vinatex’s workshops belong to group 2 in which CADM and CAM are used for technical design and plotting phases, with or without software for management or without; the remaining 10% belongs to group 3 in which traditional equipment is used. Some workshops belonging to large companies have applied software for sample design and cutting fabric machine robot from US, Germany or Japan.
Textile and garment is one of thea few industries that have comparative advantages over other countries in the region in terms of labor quality and quantity. As technology is relatively simple, employees in this industry are able to quickly absorb fast new production procedure and technology, to operate manufacturing system well, and to create high quality products. However, high skills and techniques are urgently needed to for sustaining the growth of the industry. Up to now, the Vietnamese textile and garment industry has concentrated on only the fourth phase i. e., production phase, out of the entire manufacturing process, and ignoring other
418 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy phases such as production ideas and design, production preparation, and commercialization.
Total number of employees in this industry by May 2007 was above 2 millions, including 1 million industrial employees, accounting for 5% of total labor force in the country and for 20% of that in the industrial sector. The female ratio accounts for 80% of total employment. Employees in this industry are evaluated to be as being able to absorb new production procedures and technology and to make high quality products for export market. However, the industry greatly lacks technical staff in this industry is insufficient, the opportunities for technical training are low, and technical staff moves to other industries due to salary attraction. Lots of employees rapidly moved from state enterprises to private and foreign ones rapidly. And about 6% of technical staff or engineers already moved from textile and garment industry to other industries.
Another problem is the weakness of supporting industries for textile and garment. Up to now, supporting industries have not yet been developed well despite a lot of efforts taken for many years of effort. By the end of 2006, the industry still had to import up to 90% of cotton, nearly 100% of synthesis textile fiber, dying chemicals, machinery, equipment and accessories, 70% of fabric, and 50% to 70% of parts for export garment.
2.2.3. Critical Issues in THRD
Strengths of the textile and garment industry are as follows: 90% of equipments in the garment industry have been upgraded and modernized. High quality products can be accepted by almost all the customers. Close relationships with international importers and consumption groups are established. Competitive edge in manufacturing cost and in production skills is revealed.
Weaknesses of the textile and garment industry are as follows: Competitiveness in processing technology is acquired, but product ideas and design capability are not developed yet. Productivity in manufacturing is still low. Supporting industries are not developed well which results in manufacturing low value added items. Most of enterprises are SMEs which makes it difficult to mobilize investment capital and to upgrade equipments. Poor management system and insufficient training programs lead to low productivity. A majority of products are commodity ones. Insignificant marketing capacity prevents the industry from having independent brands.
Opportunities for the industry are as follows: Vietnam becomes a new force in this industry, with other leading developing countries, in terms of capital, equipment, production technology, advanced manufacturing experience and skilled labor. Integration to the WTO creates a big opportunity for Vietnamese textile and garment industry to draw attention from investors and open new markets and build business relationships.
419 Chapter 4 _ Efficient and Harmonious Enterprise Policy Threats for the industry are as follows: Lack of sufficient technical staff needs to be solved. Trade barriers in technology, hygiene, safety, environment, social responsibility and anti dumping have increased greatly in large market in order to protect production activities against competitors. Most of enterprises in the industry lack of capital for production; hence they lend short term capital to invest in long term business which might lead to high financial risks and the increase of production cost. Vietnam, as a latecomer, has to compete with big garment competitors such as China, India, and South Asian countries under equal game rules. This also can cause higher production cost for the Vietnamese enterprises. Some other input costs like transportation and communication cost are higher than that in the region.
2.3. THRD in Vietnam Shipbuilding Group (Vinashin)
2.3.1. Growth Stages
Vietnam Shipbuilding Group (Vinashin), a key unit in the Vietnamese shipbuilding industry, is a 100% state owned enterprise established in 1996. Due to the policy priority of the Vietnamese gGovernment on shipbuilding industry, Vianashin has rapidly expanded its production capacity and the scale of production site.
Despite being a newly developed industry, Vietnam currently ranks as one of the top ten shipbuilding countries in the world. Shipbuilding industry was defined as the key strategic industry in Vietnam. In 2007, the Vietnamese Government invested USD 750 million from international bond issuance to Vinashin. Recently, the Government has decided to issue about USD 1 billion of the international bonds, which is the largest amount to invest in Vinashin. At the moment, Vinashin has approximately 70,000 laborers, 282 member units in 34 provinces, including 28 shipbuilding yards.
Besides that, some companies such as Thanh Long, Song Cam, Song Lo, Hai Duong, Nha Trang, etc. have newly built a series of small and medium sized ships, push tugs, barges, fishing ships, etc. for local shippers.
Vinashin has continuously performed exporting strategies of ships and achieved an export of approximately USD 1 billion and 3 million tonnes of many kinds of ships for sea freight, marine petroleum, cement and so on in 2009. Vinashin also has a plan to export more than USD 2 billions/year and 5 million tonnes of ships/year by 2015.
2.3.2. THRD
In the past, the Institute of Ship Engineering under the Department of Mechanics and the Institute of Engineering under the Department of Waterway were the two units that took the work of ship engineering. The capacity of ships designed in Vietnam is small; just less than
420 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy 1,000 tonnes. However, among new shipbuilding projects, there are many large ships such as 6,300 DTW vessels, 15,000 DWT vessels, and 3,750 DWT tankers. Despite the quantity and the size of ships under development, many shipbuilding facilities have just kept their old engineering methods.
For export ships, Shipbuilding Science and Technology Institute currently have enough capacity to test new shipbuilding model by applying many advanced software in technical/technological design for large capacity vessels like 56,000 DWT product tanker and 115,000 DWT tanker.
The Vietnamese shipbuilding industry just focuses on assembling activities. Besides the hull manufacturing, the industry still has not manufactured any component of a ship. Most of the equipments, including steel plates, are imported. However, at the moment, the industry has also applied prefabricated sections in the shipbuilding, plate shearing and automatically downgrading technology on the digital machines, pipe bending technology of CNC, automation technology for manufacturing straight segments, floating technology for vessels on slipway, 1/2 dock ship momentum, etc. that can help achieve high level of efficiency in the production processes.
In 2008, Vinashin signed a contract with UK on new 15 ships with capacity of 53,000 tonnes, in which Ha Long Shipbuilding Company will build 8 new ships. Ha Long Company has many new technological solutions applied to large capacity shipbuilding. The company has invested in equipments such as 300T crane, two 50T cranes, 70,000 slipway, CNC digital shearing machines, CO2 welding machine, 150T slippers, and so on. The company has applied the module method (prefabricated sections) for newly manufacturing the 53,000 DWT vessels. This is the most advanced technology in shipbuilding.
The Vietnamese shipbuilding industry is faced with the human resource problem, which just meets 40-60% of the demand for human resources. Many shipbuilding companies need to recruit a large number of work forces, but they have no enough labor sources. For example, Ha Long Shipbuilding Company needed about 150 200 engineers for hull and ship engines in 2007., however the company only recruited about 30 engineers. According to Vinashin, the industry needs newly recruitment of about 12,000 to 13,000 skillful laborers each year, but the Vinashin training institutes can provide only 5,500 to 6,000 laborers per year for shipbuilding. Besides that, colleges and universities can provide only about 600-700 engineers for shipbuilding. Thus, colleges and universities have plans to expand the number of students specializing in the shipbuilding field.
It is estimated that, within the next 5 years, Vietnam can build ships with capacity from 150,000 tonnes to 250,000 tonnes and repair technologically sophisticated ships. In addition, Vietnam is expected to diversify the products and services in shipbuilding such as tanker, crude
421 Chapter 4 _ Efficient and Harmonious Enterprise Policy oil tanker, container carrier, passenger ships and other ships.
Another strategy is to promote the supporting industries for the shipbuilding industry. The government established a plan to increase the local contents above 60% of products through international technological cooperation.
2.3.3. Critical Issues in THRD
A group of hardworking, creative and low cost workers as well as short time delivery gave the Vietnamese shipbuilding industry a competitive edge in the international market. However, there are some critical problems to be solved to gain competitiveness in the world market.
First of all, the introduction of advanced manufacturing system ought to be implemented. In addition, investment to modern equipments and materials is to be performed to level up the managerial efficiency as well as the productivity in manufacturing.
Second, small capacity and scattered investment should be overcome. The scale of shipbuilding projects is still small and the investment has divided into various fields as large capacity ships, containers, tankers, car carriers and so on.
Third, the cultivation of manpower is an urgent task. At the moment, both engineers and skilled laborers are not sufficiently provided under the existing education system and training programs. Thus, the government policy should give high priority to the expansion of education and training programs for shipbuilding work force.
Fourth, the development of supporting industries for the shipbuilding industry is required to increase the portion of value added products. Until now, supporting industries for shipbuilding have hardly been developed. In order to increase the local contents in shipbuilding industry, technological cooperation and in house R&D activities are to be activated more than before.
Fifth, there emerges the necessity of improving the quality of domestic vessels, especially for the small ones. Up till recently, domestic needs for ships has relatively been neglected, but now there has already clearly been a growing signal of increase in demand for local ships as Vietnam continues to achieve rapid economic growth.
422 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy 2.4. Evolutionary Phases of THRD in SOEs3)
To become an advanced industrialized economy, developing economies needs to follow four phases of accumulating technological capabilities i. e., start up (pre industrialization), assimilation, accumulation, and innovation. The start up phase is the process of economic transformation from agricultural economies toward industrialization. Factors are formed and foreign firms start investing in the country. The assimilation phase is specified by the quick enlargement of firms and industries, and firms assimilate technologies from abroad through various ways such as foreign direct investment (FDI), joint venture, patent purchasing and so on. In the accumulation phase, local firms become more active in technological improvement to adapt to their internal condition. When they have enough technological capabilities, firms switch to develop new technologies. In the innovation phase, the economy joins in the club of developed economies, where innovation is the key for global competitiveness. The four phases can be applicable to the evolutionary processes of technological capability building in the Vietnamese SOEs.
The four phases can be matched with the Korean innovation models described in the next chapter. The start up phase and the assimilation phase can be matched with the path following phase in the Korean innovation model. The accumulation phase can be coined in the path revealing phase while the innovation phase can be similar to the path creating phase in the Korean model.
Table 4-3-1 | Evolution of Technological Capability and THRD in Developing Economies
Phase THRD requirement THRD development
Start-up Craftsman and technician Vocational training centers
Assimilation Technician and engineer Technical education institutes
Polytechnic colleges and engineering Accumulation Meister and engineer schools
Innovation Engineer and researcher Graduate schools
Source: Modified from Pham and Ngo (2008)
3) This section is indebted to Pham and Ngo (2008)
423 Chapter 4 _ Efficient and Harmonious Enterprise Policy The THRD might be the core element in the four phases of technological capability building in Vietnam. Table 4-3-1 describes typical characteristics of THRD in each phase of technological capability building. While in early phases of industrialization craftsman and technician are the key factors for competitiveness, but in later phases, technicians and engineers are the critical elements to have competitiveness in the world market.
3. Technical/Technological Human Resources Development in the Korean Enterprises 3.1. National Innovation System in Korea
Korea’s impressive progress in research and development (R&D) over the last four decades can be largely attributable to the rapid growth in R&D investment and human resources. Korean total R&D expenditure was USD 31 billion and the government portion of GERD was recorded as 27% in 2008, as in the Table 2. The R&D intensity (GERD/GDP) was 3.37% in 2007, which is far beyond the average of advanced countries. The total number of researchers in 2008 was 236,137 which is over the size of U. K. and France in number.
*D/GNP, ** Head Count (Persons) Source: Ministry of Education, Science and Technology
The major performers in Korean R&D are private enterprises. The portion of them in GERD was 75% in 2008, as shown in the Table 4-3-2. In particular, a small number of Korean global companies in high tech industries, such as Samsung Electronics, LG Electronics, and Hyundai Motors, are the core of private R&D activities. In 2008, the top 5 companies accounted for 39% of the private R&D expenditures. However, the government supported research institutes (GRIs) and universities are also very powerful players in Korea.
During this period, Korea’s R&D structure went through a drastic evolution. As evident from the Table 4-3-3, the weight on public research institute rapidly shrunk from 84% in 1970 to 14% in 2008. On the contrary, 75% of research labs belonged to the private sector in 2008 marking a remarkable surge from 13% in 1970.
424 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy Table 4-3-3 | Evolution of R&D System in Korea (GERD, %)
1970 1980 1990 2000 2008
Public Institute 84 49 22 15 14 (GRIs) (25) (27) (16) (11) (10)
University 4 12 7 11 11
Company 13 38 71 74 75
Source: Ministry of Education, Science and Technology
In addition, Korea has achived outstanding outputs in R&D activities during this period. For example, Korea ranked 12th in terms of international academic papers published as shown in Table 4-3-4. The number of overseas patents also increased drastically. Korea ranked 4th in 2007, as in the table 4-3-5, which shows the number of patents registered in the U.S.A.
Table 4-3-4 | International Academic Papers in Korea (SCI)
1997 2000 2001 2005 2006 2007 2008
Number 7,852 12,316 14,733 15,705 23,286 25,494 35,569
Share (%) 0.96 1.39 1.61 2.02 2.05 2.17 2.42
Rank 18 16 15 14 13 12 12
Source: Ministry of Education, Science and Technology
Table 4-3-5 | Overseas Patents in Korea (U.S.A.Registration)
1990 1995 2000 2003 2004 2005 2006 2007
Number 219 1,181 3,352 3,980 4,518 4,388 5,990 6,295
Rank 18 9 9 6 5 5 5 4
Source: Ministry of Education, Science and Technology
The nature of Korean research system and STI policy cannot be separately described without considering the characteristics of Korean economic development. During the sixties and seventies, the labor intensive light industries and the capital intensive heavy industries for import substitution and export expansion were developed. However, this development resulted in generating huge demand for technologies, which were not available from domestic sources. Thus, the Korean STI policies started from promoting an inward transfer of technologies from foreign sources and developing domestic absorptive capacity to assimilate and improve the transferred technologies. The Korean government took a restrictive stance toward direct foreign investment and relied upon long term foreign loans to finance the selected industrial investment.
425 Chapter 4 _ Efficient and Harmonious Enterprise Policy This led to massive importation of foreign capital goods and turnkey plants. Industries acquired appropriate technologies and leveled up technological capabilities through reverse engineering.
Since the eighties, the Korean economic development has required more sophisticated technologies while foreign sources became increasingly reluctant to transfer technologies to Korean industries. The Korean government responded to these challenges by developing national R&D programs and promoting private industrial R&D activities through fiscal and financial incentives. A national R&D program to promote target areas was launched in 1982 by the Ministry of Science and Technology. Following the national program, a series of national R&D programs have been promoted by many other ministries. Ultimately, since the mid eighties, the R&D investment of private sector has rapidly increased and the private enterprises have emerged as the major forces of R&D activities.
The characteristics of Korean innovation policy come from the fact that the Korean economy has pursued export oriented growth, resulting in strong demand and pressure to enhance her technological capabilities. The Korean research system clearly shows powerful dynamism of highly motivated private sector led by global high tech conglomerates with strong government support for indigenous technological capability building. This support includes, GRIs, public R&D programs and high tax/fiscal incentives for private R&D investments. During the course of enhancing technological capabilities, the rich pool of S&T human resources has played a critical role.
3.2. Evolution of S&T Manpower Policies
The government’s S&T manpower policy, during the 1960s, focused on the cultivation of craftsman and technician for mainly light industries, the promotion of technical high schools, the activation of vocational education and training, and the expansion of engineering school at tertiary level.
During the 1970s, the focus of S&T manpower policy shifted to the continuation of technical education and training, the drastic expansion of engineering school at tertiary level, the increase of numbers of university students especially in the field of heavy and chemical industries, the establishment of National Technical Qualification System, and the active recruitment of expatriates mainly from U.S.A.
During the 1980s, the S&T manpower policy articulated the expansion of universities and colleges, the cultivation of graduate school, the encouragement of overseas graduate education and training, the active recruitment of expatriates at private enterprises, and the in house program of training and education at private enterprises.
During the 1990s, the focus moved into the expansion of post graduate education, massive
426 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy supports for basic research activities at graduate school, cultivation of COE (center of excellence) to challenge frontier technologies, and the promotion of international joint R&D activities and exchange of manpower as well as university industry linkages.
3.3. Evolution of Korean Innovation Models4)
The technological innovation of private firms in Korea can be broken down into the following three phases, as shown in the Table 4-3-6. The first phase can be named ‘Path following’, in which technological knowledge and production know how was transferred from more advanced foreign firms the most. The role of the Korean companies in this phase was mainly confined to technological learning and localization as well as make small modifications to the imported technology to make it more befitting for the local production environment. In that sense, the focus of technological innovation activities was to set up countermeasures regarding the imitation issues. By this phase, individual firms were familiarized with the development path of products and the means to develop products.
The second phase can be called ‘Path revealing’. Korean firms have succeeded in generating new frontier products with their in house technological innovations, but the underlying original ideas and core knowledge were borrowed from external parties. That means, the focus of technological innovation was the problem solving for innovation while lacking in technological originality. The technological paths of progress and the development path of products were known to many, but the means to develop competitive products in the world market were unknown to individual firms. This type of technological innovation activities has been quite prevalent in many Korean firms until now.
Table 4-3-6 | Evolution of Korean Innovation Model
Phase I Phase II Phase III Path-following Path-revealing Path-creating Pproblem-solving for Pproblem-solving for Pproblem-defining for Focus imitation innovation innovation Path Known (available) Known (available) Unknown
The third phase can be noted as ‘Path creating’. This is a phase in which new products are developed solely with in house innovative capabilities, and its original ideas and technological novelties derived from its own proprietary R&D efforts. In this phase, it is possible to have certain level of technological inflows from external sources but the initiative and the overall
4) This section is indebted to Choi et al. (2008)
427 Chapter 4 _ Efficient and Harmonious Enterprise Policy management of technological innovation activities lie under the control of in house members. What distinguishes this phase from the previous ones is the ability to acquire its own set of new product architecture from internal resources. Thus, the focus of technological innovation was in problem-defining and solving. The development path of products was unknown, and the means to develop new products competitive in the world market were unknown to individual firms.
Korea has been assessed to be quite successful in the first and the second phases of technological innovation, to be described as the ‘best practices’ within the Korean context. However, the challenge now is a successful transition to the third phase of technological innovation, which is certainly going to be a more acceptable approach in for the 21st century.
Table 4-3-7 | Evolution of Korean Innovation Model
Phase I Phase II Phase III Path-following Path-revealing Path-creating Pproblem-solving for Pproblem-solving for Pproblem-defining for Focus imitation innovation innovation Path Known (available) Known (available) Unknown
Those products developed in the first phase of technological innovation have different types of technological innovation activities according to the nature of the product, the level of in house technological capability, and the maturity of the world market, etc. However, common characteristics do exist.
First, products developed by Korean firms are based on technological knowledge or processing technologies imported from other advanced countries. The technology import through both formal and informal channels of technology transfer had served as an important part of technological progress. Moreover, the aggressive technological learning activities were also the key to enhancing technological capability build ups.
Second, due to the lack of in house R&D capabilities, Korean firms have focused on the so called standardized items with their strength lying in the mass production system. This indirectly illustrates Korean companies’ inclination toward technological development paths with lower technological uncertainties. The target goal was the acquisition of production and process technologies. Technological novelty was not the main concern, particularly at the earlier stages. Tremendous efforts were placed in by in house engineers to internalize and match outside technological sources, and this was what enabled such rapid technological capability buildup. Local engineers were equipped with strong commitments to catch up with the leading
428 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy companies as early as possible, despite the presence of high technological entry barriers.
Third, the key concerns of Korean firms were to catch up with leading firms in a short period of time. Major Korean firms had a strong will to establish an independent brand from the beginning. They carried out aggressive investment even in hard times. They also tried to take initiatives in developing new products by focusing on two step ahead critical technologies. Parallel product development through concurrent engineering was another crucial instrument for Korean firms.
Fourth, Korean firms targeted export market more than the domestic market. Their level of standard was to produce world class quality products with competitiveness in the world market. Exporting products enabled domestic engineers to obtain opportunities to learn the latest technologies. In that sense, “learning by using” contributed to the technological progress of Korean firms. In addition, tough and rapid changes in international market conditions demanded Korean firms to improve the quality of their products, to increase productivity in the production processes, and to sustain a quite high level of investment for technological learning.
Fifth, Korean firms have relied on a certain level of prior experience in terms of technological base or business activity in related areas when they entered in a new market. In addition, while making technological progress, Korean firms had undergone a very tough and critical period of technological core formulation process, and only firms which overcome with challenging period of acquiring core technologies have succeeded in providing competitive products to the world market.
Sixth, another factor shared among many cases was the presence of a pioneering top management with long term vision as well as technological insight ready to make long term commitment to the targeted items. Their direct involvement in the technology development process has been of paramount importance. These pioneers have shown strength in techno management capability, i.e. the ability to combine technology and business know how, and the courage to give up on technological novelty that seems to hold no business prospects.
In the second phase, those common elements of stylized facts in leading Korean enterprises can be summarized as follows: Long term commitment and hard working in developing new products; exploiting accumulated knowledge and experience; developing own new ideas and unique systems; active search for outside sources and cooperative partners; strengths in mass production; market oriented R&D; internally trained local talents leading the efforts; limited technical assistance for production technologies from local public institutes; and so on.
3.4. Automobile Industry: Hyundai Motor Company
The stages of technological capability building in the Hyundai Motor Company can be
429 Chapter 4 _ Efficient and Harmonious Enterprise Policy divided into the stage of assembly manufacturing (1967-1974), the stage of establishing independent brand (1975-1990), and self generating (1990-present).
Technology import had been the key sources of technology development in early stages. And it has evolved in the following stages: Operation technology such as after sales service, material management manuals, parts drawings, etc: Element technologies from diversified sources such as design, engine, manufacturing, etc.: A Technological alliance with technological service companies in the field of test, decoration, exhaust control, etc.: Academic research for fundamental technologies.
Aggressive technological outsourcing have also been carried out as follows: Education and training from finished car makers: Technical advice and consulting from foreign experts: Training and education from technological service companies: Recruitment of high caliber manpower with master degree and Ph.D. degree: Joint R&D activities with outside research institutes.
There also have been very active technological learning activities as follows: Aggressive on the job training for production know hows: Top class engineers were assigned as foremen: Deepening of technological capabilities for target technologies through powerful technological division of labor: Introduction of advanced design and production technologies such as CAD, CAM, 3D design and simulation: Establishment of R&D institutes.
The key success factors (KSFs) of Hyundai Motor were economies of scale with strengths in mass production and CEO leadership to overcome several difficulties in its growth paths. The major driving forces of technological competitiveness were strong desire to establish its independent brand from the beginning, effective ‘constructed crisis’ management to boost up the fast internal learning of key technologies, strong supports from top management in providing favorable R&D infrastructure, and so on.
< Theta Engine: A Best Practice in the Path revealing Phase>
Hyundai succeeded in developing the Alpha Engine in 1991 as its first independent engine. After that, 10 gasoline engines have been developed by Hyundai up until now. On the way, Hyundai developed a new, high performance engine with fuel efficiency improvement that ensures durability, quietness, and is environment friendly to meet the enforced environmental restrictions. This Theta Engine was mounted on NF Sonata platform in September 2004, after four years of development efforts through 2000-2004.
Its functionality of the engine is assumed to be at the same level as that of Toyoda Camry and of Honda Accord. The key features are aluminum alloy, metal timing belt, variable valve timing, balance shaft, etc. It was developed through the joint work with Daimler Chrysler and
430 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy Mitsubishi, receiving a royalty of US$ 57 million from them. Daimler Chrysler and Mitsubishi adopted the engine in 2005. During the development process of the engine, 70 local and overseas patents were acquired. The engine is known to have the largest production capacity; a single engine of 2 million units per year around the world.
3.5. Shipbuilding Industry: Hyundai Heavy Industries
The stages of technological capability building in the Hyundai Heavy Industries can be divided into three stages: imitation and improvement of production technologies during the 1970s; diversification and deepening of its products and of design technology during the 1980s; and self generating from the 1990s up to now.
Technology import has evolved in the following fields: All shipbuilding related technologies such as design drawings, production technologies, etc.: Production technologies: Design technologies: Core technologies for high value added and specialty vessels: Academic research for fundamental technologies.
The major modes of technological outsourcing involved the following: Hiring of foreign engineers: Massive overseas education and training: Technological alliances with and consultations from its counterparts.
Active technological learning has been performed as follows: Aggressive on the job training: Technological learning and education by hired foreign engineers: Top class engineers were assigned as field engineers: Recruitment of capable technicians from other Hyundai companies: Establishment of in house training center to cultivate technical manpower: Establishment of a series of R&D institutes.
The KSFs of Hyundai Heavy Industries were economies of scale with strengths in mass production; top class design manpower and skilled technicians; and stable local supply chains of materials and components particularly steel materials and shipbuilding engines. The major driving forces of technological competitiveness include all-out efforts to foster its own technological manpower, active import of technologies, utilization of foreign engineers and overseas technical training, and introduction of advanced production technologies such as CAM, CAM, and 3D technology.
< On Ground Building Method: A Best Practice in the Path revealing Phase>
Hyundai developed a new method to build its commercial ships on the ground instead of in a dry dock. Hyundai broke the conventional concept that ‘ship is constructed in dry dock’ and opened up a new era in shipbuilding history. The so called “On Ground Building” method had already been verified by the offshore clients through the construction of drilling rigs and other
431 Chapter 4 _ Efficient and Harmonious Enterprise Policy huge offshore structures. But, this method was adopted for building ships by Hyundai for the first time in the world in October 2004. Hyundai was unable to meet a large, drastically increasing order book for shipbuilding due to fully booked dry dock schedule. Thus, it tried to find a new solution to overcome the limitations from the conventional dry dock method.
There had been numerous trial and error processes over one and a half years to develop the method by Hyundai. Key features of the method are as follows: Ship is constructed on the ground by using huge crane, loaded out transversely to quayside and on to double barge unit by skidding system of air pad & skid rail. Then the double barge unit of semi submersible is towed using tugboat to a pre-determined site and ballasted down to float off the ship from the double barge unit. Anyway, Hyundai achieved the same productivity and the construction period as the conventional dry dock method. In particular, other method such as ‘floating dock’ at sea was also developed by other Korean company.
3.6. Steel Industry: POSCO
The stages of technological capability building by POSCO can be divided into three stages: imitation of imported technology during the 1970s; improvement of imported technology during the 1980s; and self generating from the 1990s up to now.
Technology import has evolved as follows: Introduction of performance proved superior facilities; Advanced production systems and quality products; State of the art equipments and components; Literature survey on core technologies; Academic research on fundamental technologies.
The major modes of technological outsourcing include the followings: Massive overseas education and training for operation technologies; Technological advice and consulting by foreign experts, mainly by Japanese; Invitation of foreign experts for core technologies; Overseas education and training for fundamental technologies.
Massive technological learning has been carried out as follows: Aggressive on the job training for operation technologies and production know hows: Top class engineers assigned as foremen in charge of factory operation: Senior meister i.e., special treatment to top quality technicians: Joint problem solving with, and informal learning from foreign engineers: Efforts for technological improvement of equipments and production systems: Establishment of R&D institutes.
The KSFs of POSCO were economies of scale with strengths in mass production, the government’s active supports in early stage including sufficient supply of infrastructure, and adoption of the latest production facilities. The major driving forces of technological competitiveness were in securing long experienced company engineers and technicians with
432 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy powerful internal promotion system, active technological learning through in house and overseas training, acquiring world class operation technologies through skilled engineers in production sites, and active in-house R&D activities to internalize the next generation of technologies.
< FINEX: A Best Practice in the Path revealing Phase>
POSCO became the first company in the world having the 1.5 M TPY (ton per year) scale plant of FINEX (Fine Ore Reduction) in May 2007, which is enough to compete with large scale blast furnace plants. FINEX is a type of a the smelting reduction method which is an alternative way to make virgin iron in the integrated steel mill. Many companies have tried to develop a new iron making processes from 1970s to overcome fundamental limitations of the blast furnace process which has been the dominant design in iron making for more than 100 years, yet none had succeeded in developing one that enables mass production.
POSCO was a latecomer in the steel industry, but leveled up rapidly its capability in high quality product and process technologies and enjoyed its competitiveness in mass production of general steel and top rate operational technologies. However, its capability for basic research and new process development was poor.
As a technological latecomer in developing this new iron making process, long term commitment and hard working during 1990-2007 were performed with large scale investment and long term project teams. Also huge amount of efforts went in to make a thoughtful decision in selecting technology. In-house manpower in R&D, engineering and operation were the strong base. In addition, close collaboration for a long term with capable partner, Siemens VAI, was another key factor to the success. POSCO has plans to replace the first and the second blast furnaces in Pohang Mill with this process in the future. POSCO also is trying to establish large scale plants of FINEX process in India.
4. Policy Recommendations5)
The role of THRD is surely crucial for the growth of SOEs in Vietnam. However, the Vietnamese SOEs seem to be weak in sophisticated technologies and high caliber manpower. They still are in the imitation phase of and catch up process with global leading enterprises. One urgent task is to build up technology intensive enterprises, so that they can compete effectively with foreign competitors in the global market as well as in the domestic market.
5) This section is indebted to Quang and Dung (1998), Hong (2007), Pham and Ngo (2008), Choi et al. (2008), and Bach and Truong (2009)
433 Chapter 4 _ Efficient and Harmonious Enterprise Policy Korean enterprises have achieved a big progress in THRD during the past four decades, which can provide meaningful strategies for THRD in SOEs. Based on the comparison of evolutionary phases of THRD between the Vietnamese SOEs and some major Korean enterprises, following policy recommendations are suggested. Especially the path following and path revealing phases in Korea are expected to provide useful guidelines and implications for the Vietnamese SOEs.
(1) Expansion of in house R&D activities, including massive efforts for technological learning, is urgent
Aggressive technological learning activities are the key to enhancing technological capability build ups. Tremendous efforts by in house engineers to internalize imported technologies and to match with outside technological sources enable enterprises to achieve a rapid technological level up. Aggressive on the job training for operation technologies and production know hows, “learning by using” through exporting to world market, joint problem solving and informal learning from hired foreign engineers, etc. are very powerful tools. In particular, it is very important that top level engineers are assigned as foremen and field engineer in charge of factory operation.
Exporting products enabled domestic engineers to obtain opportunities to learn the latest technologies. In addition, tough and rapid changes in international market conditions demanded enterprises to improve the quality of their products, to increase productivity in the production processes, and to sustain a quite high level of investment for technological learning.
In the later stage of technological progress, technological deepening can be performed through technological division of labor among in house engineers. While making technological progress, Korean enterprises undergo a very tough and critical period of technological core formulation process, and only firms which overcome this challenging period of acquiring core technologies have succeeded in providing competitive products to the world market. And the establishment of in house R&D institutes is a pre-requisite for both speedy technological capability building and internalization of the next generation of technologies.
(2) Active cultivation of manpower for qualified field engineers and field work force is urgent
Technical education and training are very critical elements to provide more skillful labor to increase the productivity of manufacturing and to produce high value added products. One critical factor for the success of the major Korean enterprises is the top level of design manpower and skilled technicians being recruited and cultivated by them as a core work force. Korean enterprises have put their all out efforts to foster their own technological manpower. Active in house and overseas training is crucial to acquire sophisticated operation technologies
434 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy and production technologies.
Acquisition of experienced engineers and technicians is necessary. Particularly, enterprises should pay much attention to recruiting capable mid level engineers who are working in the production site. The target goal of the major Korean enterprises was the acquisition of production and process technologies. Technological novelty was not the main concern, particularly at the earlier stages. It is desirable to keep a full set of capable in house manpower such as operation, engineering and R&D.
The establishment of in house training center is required. Formal and informal education and training from foreign engineers and consultants are also an important element. And the trilateral cooperation for education and training between training institutions, donors, and enterprises is necessary. Related to that, the reform of higher education in curriculum and training programs to solve the shortage of practical experience is urgent.
(3) Aggressive technology import from various sources, including good coupling with in house accumulation, is desirable
Those major products developed by Korean enterprises were based on technological knowledge or processing technologies imported from advanced countries. The technology import through both formal and informal channels had served as an important part of technological progress in Korea.
Technology import has evolved in the following field: Operation technology such as after sales service, material management manuals, parts drawings, etc: Advanced production systems and quality products: State of the art equipments and components: Element technologies from diversified sources such as design, engine, manufacturing, etc.: Technological alliances with technological service companies in the field of test, decoration, exhaust control, etc.: Academic research for fundamental technologies.
Aggressive technological outsourcing has also been carried out as follows: Massive education and training from overseas companies: Hiring of foreign engineers: Technical advice and consulting from foreign experts: Education and training from technological service companies: Technological alliances with and consultations from its counterparts. Recruitment of high caliber manpower with master degree and Ph. D. degree: Invitation of foreign experts for core technologies: Overseas education and training for fundamental technologies: Close collaboration for a long term with capable partner: Joint R&D activities with outside research institutes.
435 Chapter 4 _ Efficient and Harmonious Enterprise Policy (4) Effective management system for human resources and technological manpower is required
The most critical issues to SOEs are the management skills and technological capabilities. Thus, the improvement of management system of human resources as well as technological manpower is urgent. Related to that, sufficient level of compensation for capable workers, performance based incentive system, powerful internal promotion system, special treatment to top quality technicians and human resources such as senior meister at POSCO, etc. are strongly required.
To stimulate an aggressive manpower policy, the establishment of a separate and full fledged Human Resource Department in enterprises and also an integrated human resource strategy with focus on recruitment, selection, training, career development, incentive system and so forth is needed. In addition, the allocation of special budgets for employee training, voluntary education, and management development program is to be carried out.
One typical advantage for Vietnam is the availability of expatriates. To build competent and motivated human resources, it is necessary to make full use of expatriates’ knowledge, skills, and experience in management and technology.
(5) Effective government policies, including sufficient supply of qualified technological manpower is required
The Government would basically focus on creating favorable environment and infrastructure for innovation. Manpower is a pre condition for successful performances of enterprises. Thus, how to utilize Vietnam’s abundant and skillful labor force and to improve investment environment by attracting FDI and technology transfer is a hot issue to Vietnam. In this vein, the reform of higher education is urgent to upgrade the quality of S&T manpower through creativity and team working skills.
The Korean government, during the 1960s, focused on the cultivation of craftsman and technician for mainly light industries. During the 1970s, the focus of S&T manpower policy shifted into the upgrade of technical/vocational education and training, the expansion of university students especially in the field of heavy and chemical industries, and active recruitment of expatriates mainly from U.S.A. During the 1980s, the S&T manpower policy articulated the cultivation of graduate school and the recruitment of expatriates at private enterprises. During the 1990s, the focus moved to giving massive supports for basic research activities at graduate school, the cultivation of COE (center of excellence) to challenge frontier technologies, and the promotion of university industry linkages.
436 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy (6) Massive investment for the modernization of equipment and facilities and for the introduction of advanced manufacturing technology is required
The adoption of the latest production facilities is the key source for improving the productivity and manufacturing high value added products. One of the KSFs in the major Korean enterprises is the aggressive and continuous investments in modern equipment and facilities. In addition, the introduction of advanced design and production technologies such as CAD, CAM, 3D design and simulation is very crucial. In this regard, the role of government in mobilizing financial resources for massive investment of SOEs is critical.
The promotion of supporting industries for the major strategic industries in Vietnam is very important. Vietnam is very weak in those supporting industries which prevent SOEs from improving the benefit cost structure. Stable local supply chains of parts and components, equipments and facilities, necessary accessories, raw materials, etc. are very difficult tasks for SOEs.
(7) CEO’s leadership, including strong supports to technology development, is necessary
One advantage of the Korean enterprises is the presence of a pioneering top management with long term vision as well as technological insight ready to make long term commitment to the targeted items. Their direct involvement in the technology development process has been of paramount importance. These pioneers have shown strength in techno management capability i.e., the ability to combine technology and business know how, and the courage to give up on technological novelty that seems to hold no business prospects.
For example, a key success factor at Hyundai Motor Company was CEO leadership to overcome several difficulties in its growth paths. Effective ‘constructed crisis’ management to boost up the fast internal learning of key technologies, strong supports from top management in providing favorable R&D infrastructure, etc. have been COEOs’ typical role in Korea.
(8) Reform in management of technology such as effective technology strategies, technology planning, and R&D project management is necessary
The key concerns of the major Korean enterprises were to catch up with leading companies in a short period of time. Local engineers were equipped with strong commitments to catch up with the leading companies as early as possible, despite the presence of high technological entry barriers. The major Korean enterprises had a strong will to establish an independent brand from the beginning. They carried out aggressive investment even in hard times. They also tried to take initiatives in developing new products by focusing on two step ahead critical technologies. Parallel product development through concurrent engineering was a powerful instrument for Korean enterprises.
437 Chapter 4 _ Efficient and Harmonious Enterprise Policy The common elements of stylized facts in the “Path revealing” phase of the leading Korean enterprises can be summarized as follows: Long term commitment and hard working in developing new products; large scale investment and long term project teams; exploiting accumulated knowledge and experience; developing own new ideas and unique systems; active search for outside sources and cooperative partners; huge amount of efforts in carefully selecting technologies; market oriented R&D; internally trained local talents leading the efforts; limited technical assistance for production technologies from local public institutes; and so on. All in all, the major Korean enterprises have paid much attention to the management of technology through effective technology strategies, realistic technology planning, and efficient R&D project management.
438 Supporting the Establishment of Vietnam’s 2011-20 Socio-economic Development Strategy References
Sinh Tan Bach and Binh Tri Truong, Technical/Technological Human Resources Development in the Vietnam Shipbuilding Group and Vietnam Textile and Garment Group, 2009
Youngrak Choi et al., A Search for Korean Innovation Model (in Korean), The National Academy of Engineering, 2008
Vu Xuan Nguyet Hong, Promoting Innovation in Vietnam: Trends and Issues, Central Institute for Economic Management (CIEM), 2007
Ministry of Education, Science and Technology in Korea, Annual Survey on R&D Activities (in Korean), Each Year
Truong Hoang Pham and Duc Anh Ngo, Industrial Human Resource Development in Vietnam in New Stage of Industrialization, 2008
Truong Quang and Ha Kim Dung, Human Resource Development in State Owned Enterprises in Vietnam, Research and Practice in Human Resource Management, 6(1), pp. 85- 103, 1998
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