Vietnam can escape the middle-income trap

Happy Sunday, readers. Time to follow up on my visit to Vietnam in January.

Hanoi, the capital, is buzzing. The Vietnamese people are creative, industrious and welcoming. The food is exceptional.

On paper, things are great too. Vietnam is one of the world’s fastest-growing economies. It has averaged growth close to 7 per cent a year since 1990. Even in 2020, as most nations fell into a pandemic-induced slump, Vietnam kept expanding. The World Bank reckons the south-east Asian nation can muster close to 6.5 per cent growth this year and next.

So, for this week’s contrarian dialectic, I’ll argue that Vietnam can escape the so-called “middle-income trap”.

That’s a tall order for three reasons. First, its export-driven economy is in US President Donald Trump’s crosshairs. After China and Mexico, America’s third highest goods trade deficit is with Vietnam. Second, just over 20 nations have escaped the middle-income trap since 1960. Third, Vietnam is a one-party communist state.

The World Bank defines middle-income countries as those with an income per capita of between $1,136 and $13,845. Vietnam’s is around $4,110. The boundaries are a bit arbitrary, and some economists contest the notion of a middle-income trap altogether.

But the trap generally describes the sharp and sustained fall in growth that nations often experience as they reach “middle-income”. That’s because they get “caught between the rapidly changing advanced technology of rich countries, and competition in mature products from poor countries with low wages”, explains the IMF.

Here are three reasons why I think Vietnam is uniquely placed to make the leap:

First, the country has developed into a major Asian trading hub. That’s down to three advantages (over and above the prerequisite of cheap and plentiful youthful labour): proximity to China (it shares a 1,300km-long land border); a long coastline near key maritime routes (3,300km along the South China Sea); and relatively stable and neutral politics.

This has enabled Vietnam to outcompete others for foreign direct investment. Annual FDI inflows since 2015 average close to 5 per cent of its GDP, well above shares in China and India. (South Korea, Singapore and Japan account for the bulk of investment in recent decades.)

In turn, Vietnam has become more embedded into international supply chains than other industrialising nations. Its share of global goods exports soared from 0.1 per cent in 1996 to 1.7 per cent in 2022, overtaking peers and putting it on par with India.

The agglomeration of global companies has enabled Vietnam to keep growing, even as trade patterns have shifted. Multinationals stay in the country and diversify their production. For measure, between 2007 and 2022, Vietnam added 44 new export products — well over double that of India and China, according to Harvard University’s Atlas of Economic Complexity. Trade tensions between the US and China also place it in a beneficial position, as companies relocate to Vietnam to hedge supply chain risk.

So Vietnam is not only an intermediary country for goods from elsewhere to pass through, but an industrial base in its own right — and that is its strength. (Research by Harvard Business Review suggests only about 16.5 per cent of Vietnam’s exports to the US in 2021 were driven by rerouting to avoid US tariffs.)

As for the tariff-shaped elephant in the room, Trinh Nguyen, an economist covering emerging Asia for Natixis, suggests Vietnam can mitigate any Trump levies through three strategies:

“First it can lay low . . . by staying geopolitically neutral, reducing tariffs for key US goods and purchasing more from America. Second, it can continue to invest . . . to maintain cost competitiveness. Third, continued trade liberalisation to expand market access and trade and investment partners. A softer currency can [also] help.”

Vietnamese officials have already shown a willingness to engage with the US. And, being a hub for global companies situated near key trading nodes, it has the scope to diversify into new markets.

The presence of significant US multinationals using Vietnam as a base — including Apple, Boeing, Intel and Coca-Cola — could also limit any tariff ramp-up. (The Trump Organization recently signed an agreement to develop a $1.5bn golf and hotel complex in the country; Elon Musk’s SpaceX also has plans for investment of a similar size.)

Above all, Vietnam has been able to convert its strengths in manufacturing to move up the value chain. Nations stuck in the middle-income trap often double down on low-end export production, and then lose their cost-advantage to other countries. But high-technology products (smartphones, computer components and circuits) now account for an impressive 43 per cent of Vietnam’s manufactured exports.

That gives its industry staying power: it is harder to shift such production to other locations, and high-tech goods are in high demand globally.

Second, underpinning the country’s sustained, rapid economic growth has been a surprisingly reformist government. After the economic devastation of both the war and famines triggered by central planning, the Communist Party embarked on liberalising market reforms — known as Đổi Mới — in the late 1980s.

Alongside privatisation, the Communist Party opened Vietnam to foreign investments, reduced trade barriers and joined free trade agreements in pursuit of an export-led development model.

This supported Vietnam’s transition from agriculture to manufacturing. But the government has since also shown surprising agility by responding to growth threats with structural reforms, including by reducing the power of state enterprises, investing in infrastructure and energy security, and providing tax and regulatory incentives.

This has underpinned the nation’s ability to move up the industrial value chain and remain competitive. It isn’t superficial either. Vietnam had the world’s most improved business environment over the past two decades, according to the Economist Intelligence Unit.

Last week, Vietnam endorsed its most sweeping reforms since the Đổi Mới, including the elimination of five ministries, four government agencies and five state television channels. Close to 100,000 public sector jobs will be affected. (Eat your heart out, Mr Musk.)

The Communist Party’s surprising openness to liberalising market reforms perhaps emanates from Vietnam’s third unique advantage — its people. (Nguyen reckons benchmarking against China, its more advanced communist neighbour, plays a role too.)

“Economists often underestimate the importance of ‘soft’ factors,” said Rainer Zitelmann, author of How Nations Escape Poverty. “The Vietnamese have great admiration for wealth, entrepreneurship and capitalism, and are among the least socially envious.”

Zitelmann’s research across 13 major economies shows the Vietnamese associate wealth with more positive personality traits than any other country surveyed. For instance, the Vietnamese are more likely to consider the rich to be imaginative, intelligent and honest than Americans, Britons and Germans.

Cultural attitudes play an important role in shaping economies (as I’ll illustrate in next Sunday’s newsletter). For Vietnam’s economy, positive attitudes towards wealth creation have three particular benefits.

First, education and training is highly valued. The government has invested heavily in Vietnam’s school system, which has been lauded globally. The nation punches well above its weight on the World Bank’s Human Capital Index, which combines indicators of health and education into a measure of the human capital that a child born today can expect to obtain by their 18th birthday.

Second, entrepreneurialism is rife. Over 50 per cent of its 100mn population are under the age of 35 — with many youngsters aspiring to start their own company. According to the latest data from Tracxn, a database tracking start-ups, Vietnam currently has 6 unicorns (companies valued at $1bn and above), more than in Spain and Italy.

Third, the nation has a particularly progressive attitude towards the role of women in the workforce. Low female labour participation rates have often been a barrier to countries’ ability to grow faster and capitalise on youth dividends. But Vietnam is unique. It has one of the highest shares of women in work in the world, exceeding the developed world average.

Vietnam has some way to go. It must grow into higher value-add services and quaternary sectors. Skills and infrastructure need more investment. Corruption and state interventionism is still a problem. There are risks, too. Diplomats must skilfully navigate geopolitical winds. FDI can be skittish.

But, as the World Bank explained in a recent report, “the handful of countries that have made speedy transitions from middle- to high-income status have done so by disciplining vested interests, building their talent pool and modernising policies and institutions”.

On its current trajectory — with a reform-minded government and enterprising people — if any country stands a chance of beating the middle-income trap, it’s Vietnam.

Thoughts? Rebuttals? Message me at freelunch@ft.com or on X @tejparikh90.

Food for thought

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