Since this year, the emerging economies of Southeast Asia, represented by Vietnam, have recovered significantly. In particular, Vietnam's high export growth has raised concerns. China, on the other hand, saw increased downward pressure on its economy in March. The data for April showed a simultaneous weakening in both supply and demand. In addition, export growth, which has long supported growth since 2020, has also declined significantly. In the short term, the substitution of the share of South East Asia for some of China's commodity exports is taking place, and market concerns about the relocation of China's industrial chain are rising again.
In my opinion, Vietnam and other Southeast Asian countries will indeed exert pressure on China's exports this year. However, on the one hand, due to the core shortcomings such as the disparity in economic volume, low education of the workforce, insufficient investment in technology and R&D, and poor infrastructure, there is no need for people to overstate the threat of the rise of Made in Vietnam and raise fears of the relocation of China's industrial chain. On the other hand, it is a fact that Vietnam enjoys a demographic dividend and an opening policy. The "de-China-isation of the industrial chain" in the US, Europe, and Japan have also helped it. So, it is essential to monitor the medium and long-term competitive pressure and the risk of relocation of the upstream and midstream industry chains.
The Short-Term Share Substitution Increases the Downside Risk of China's Exports
The downward pressure on the Chinese economy has intensified since March this year. In particular, some economic indicators turned significantly weaker in April, with growth rates of core indicators such as total volume of retail sales, fixed-asset investment, industrial value-added, and exports all declining sharply. On 19 May, Chinese Premier Li Keqiang chaired a forum on stabilizing growth and market bodies to ensure employment. He also clearly pointed out that "the difficulties of some industries and enterprises have intensified, and the new downward pressure on the economy has further increased."
Meanwhile, the major economies of Southeast Asia, represented by Vietnam, are recovering rapidly. Official data show that the real GDP of Vietnam, Indonesia, and Malaysia reached around 5% year-over-year in the first quarter of this year. The IMF forecasts that Vietnam will achieve 6% and 7.2% growth in 2022 and 2023, respectively. In the manufacturing sector, the manufacturing PMI of Vietnam and other countries has been in the expansion zone since this year under the rapid promotion of the resumption of work and production. Since February, Vietnam's industrial production index has even maintained a near double-digit year-over-year growth rate. In the service sector, Southeast Asian countries are gradually easing their policies on COVID-19 testing for inbound tourists. So far, retail sales in Vietnam have returned to pre-pandemic levels. Exports were the biggest highlight, with exports from Southeast Asian countries rebounding significantly since March. Vietnam's high export growth has become a hot topic recently, with official data showing a growth rate of up to 25% in April.
Share substitution under fundamental dislocation will exert considerable pressure on Chinese exports this year. In total, the substitution of market share for the US and Europe has already been happening. US International Trade Commission (USITC) data show that in March this year, the US imports from ASEAN and Vietnam grew at 27% and 30%, respectively, both exceeding the growth rate of imports from China (18%). The share of US imports from ASEAN in the month was 13.6%, a significant increase from December last year, while China's share fell from 19.2% to 16% over the same period. Further data from Chinese and Vietnamese customs show that the growth rate of Vietnam's exports to the US and EU in April rose sharply to over 30%. However, the growth rate of China's exports to the US and EU both fell significantly to single digits (9.4% and 7.1).
In terms of categories, share substitution mainly occurred in labor-intensive and consumer electronics goods, which are highly relevant to the existing industrial structure of emerging manufacturing countries. On the one hand, the share substitution of ASEAN and Vietnam for labor-intensive Chinese goods is evident. It is obvious in the categories of plastics and their products (HS39), leather and their products (HS42), knitted garments and accessories (HS61), shoes and boots and their products (HS64), furniture and their products (HS94), and toys and their products (HS95). On the other hand, there has been the occupation of the share of consumer electronics such as computers and mobile phones. The share of US imports of communications equipment and components from ASEAN (HS8517) has increased so far this year, while China's share has been declining over the same period.
The Competitive Pressure of Vietnam Cannot be Underestimated with the Rapid Rise of Manufacturing
In addition to the downward pressure on exports in the short term, the market is worried about China's status as the "the workshop of the world" with the high increase in Vietnam's exports. There is no doubt that Vietnam is enjoying multiple competitive advantages, such as demographic dividend and opening-up policies, providing background for the rapid rise of its manufacturing industry in recent years. 2019 has seen Vietnam benefit directly from the trade frictions between the US and China and has grown into a competitive force to be reckoned with.
In terms of demographic conditions, the national population of Vietnam in 2021 has exceeded 98 million people, with an average age of smaller than 33 years old. Among them, the working population exceeds 52 million, with a very desirable spindle-shaped age structure. The top five age groups are 25-29, 30-34, 35-39, 40-44 and 45-49 years old, accounting for 11.97%, 13.95%, 14.59%, 12.92% and 11.67% respectively. Low labor costs continue to constitute its core competency. According to the latest "Survey on the Status of Japanese Foreign-Invested Companies in FY 2021" released by the Japan External Trade Organization (JETRO), the per capita labor costs borne by the sample Japanese companies in Vietnam for manufacturing operators, senior employees, and managers were US$4,571, US$8,707 and US$17,014 respectively, compared to US$12,923, US$19,199 and US$31,444 for Japanese companies in China in the same period.
In terms of policy conditions, Vietnam's economic and trade openness continues to increase. Not only does Vietnam enjoy the ASEAN Community Free Trade Market and the ASEAN+1 series of FTAs (including China, Japan, South Korea, Australia, New Zealand, India, etc.) as a member country, but it has also joined the high-standard CPTPP and the RCEP, which includes China. It has also signed the EU-Vietnam Free .as a "new generation of free trade agreements." Its tariffs with the EU will be gradually reduced to zero, and the trade war between the US and China has also made Vietnam's low tariff advantage more prominent in recent years. In addition, the Vietnamese government has provided strong policy support to attract foreign investors and has introduced a number of incentives to improve the business environment. For example, it has reduced the corporate income tax rate to 20%, which is lower than that of China.
The Shortcomings of Vietnam Are Also Evident
Based on these advantages and the impressive pace of development, market concerns about the risk of China's relocation of the industrial chain rise sharply whenever short-term export substitution takes place. This case is no exception. But Vietnam has a long way to go before it really replaces China.
As mentioned earlier, the commodity categories that have recently shown export substitution are still concentrated in labor-intensive, downstream processing, and assembly manufacturing. Further research by the author, based on the quality of the labor force, the composition of FDI, and other latest fundamentals, shows that Vietnam's core industrial composition has not changed much since the pandemic. Moreover, the basic development conditions have not been substantially improved. In the medium to long term, Vietnam still suffers from core shortcomings such as a poorly educated workforce, insufficient investment in technology and R&D, poor infrastructure, and the economic volume gap, making it difficult to replace China.
Firstly, the pandemic has led to an employment gap, and the quality of the labor force remains low in the medium to long term. Although the economy is recovering rapidly, the impact of the pandemic on employment in Vietnam appears to be longer in duration. The latest data shows that Vietnam's labor force participation rate was only 68.1% in the first quarter of 2022, 2.2 percentage points lower than that before the pandemic (Q1 2020). The General Statistics Office of Vietnam has hinted at a job shortfall for four consecutive quarters, and recent news reports of recruitment difficulties across Vietnam have been rife.
In terms of the quality of the workforce, according to the Labour Force Survey Report released by the General Statistics Office of Vietnam, by the first quarter of 2021, only 15.5% of the total working population had a combined college, bachelor's degree, or higher, and 74.02% had no training experience. In contrast, the share of middle and senior skilled and professional jobs in all employment is only 10.9%. Manufacturing employment is still dominated by low-skilled elementary jobs.
Secondly, the reliance on foreign trade is serious, and the added value of products under the foundry model is not high. At the aggregate level, in the first four months of this year, Vietnam's exports amounted to US$122.36 billion, a cumulative increase of 16.4% year-over-year, while imports amounted to US$119.83 billion, a cumulative increase of 15.7% year-over-year. At the same time, Vietnam's trade surplus continued to be low, with a cumulative trade surplus of US$2.53 billion in the first four months of this year.
At the structural level, the top three export destinations of Vietnam in the first four months of this year were the US, China, and the EU, with the US accounting for 29.6 % of the total. The top three sources of imports were China, South Korea, and other ASEAN countries, with China accounting for 31.8 %. In the first quarter, Vietnam's imports of telephones and parts, computers and parts, cameras and parts, and fiber materials from China accounted for 27.4%, 22.3%, 6.3%, and 5.2%, respectively, of its total imports from China in the same period.
It is worth noting that in the first four months of this year, Vietnam's imports from China and South Korea and exports to the US and Europe have increased significantly compared to the same period last year. This shows that the core of Vietnamese manufacturing is still the foundry, "transit station" model of importing raw materials for garments and textiles, consumer electronics parts and components from China and South Korea for processing and assembly, and eventually exporting to Europe and the US.
Thirdly, there was negative FDI growth after the pandemic, with a declining share of new projects. At the aggregate level, FDI in Vietnam rose abruptly in 2019. This partly reflected the trend of relocation of the industrial chain at that time, with South Korea, Japan, and the EU all accelerating their investments in Vietnam. However, Vietnam's FDI has generally shown negative growth since the pandemic, making its value of foreign investment less attractive than China overall. In addition to the impact of the deteriorating external environment, such as the Russia-Ukraine conflict, the registered capital of projects attracting FDI in Vietnam has slowed down for four consecutive months this year, with a year-over-year drop of 11.7% from January to April. The actual situation is also not optimistic.
At the structural level, nearly 60% of Vietnam's FDI stock by the end of 2021 was invested in the downstream processing and manufacturing sector, followed by the real estate sector (15.1%) and the electricity, gas, and air conditioning supply sector (8.3%). The proportion invested in the upstream manufacturing sector was extremely low. In the first four months of this year, the pattern of investment in downstream processing and manufacturing did not change much, except for the increase in the proportion of the amount invested in the wholesale and retail sector (6.2%). It is worth noting that in 2019-2020 when the trade war was at its peak, a higher proportion of the increment of FDI in Vietnam came from new projects. However, since the beginning of the year, it has been mainly contributed by the capital increase of the stock project and the capital contribution to the share capital.
In addition, with the rising knowledge intensity of global trade and the spread of automation technology, the degree of industry chain integrity and business environment is becoming more important considerations than labor costs. In the above context, barriers such as incomplete industrial systems, insufficient investment in R&D, geographical dispersion, and poor infrastructure will also constrain factor clustering and industrial cluster formation in Vietnam in the long term.
Near-Term and Long-Term Concerns about the Relocation of China's Industrial Chain
Based on the above analysis, in my opinion, Vietnamese manufacturing does not have the ability to challenge China's status as "the workshop of the world." In fact, its rapid rise is both competitive and complementary to the Chinese industrial chain, which should be treated rationally. There is also no need to exaggerate its negative impact in the short term.
However, in the medium to long term, the industrial shift under the game of great powers has already emerged as a major trend. The "de-China-isation of the industrial chain" strategy of Europe, the US, and Japan will be elevated to a full-scale war to provide excellent assistance to emerging manufacturing countries such as Vietnam. The US-ASEAN Special Summit, which concluded on 13 May, has outlined a partnership for cooperation between the two sides. Although there are no concrete results in the economic sphere, for the time being, the US has highlighted to ASEAN a clear demand to replace China's industrial chain and has offered limited technology transfer if necessary. Therefore, China should attach great importance to guarding against the resulting risk of increased competition in the medium to long term and the relocation of the mid-to-high-end industrial chain.
Source: m.ftchinese.com