Theme for 2010: Picking up the stimulus tab

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Vietnam's economy grew at an impressive rate in 2009 despite headwinds from the global financial crisis.

The government's stimulus package boosted domestic demand, picking up some of the slack from falling exports and foreign investment.

While the stimulus package helped sustain growth, it has also created imbalances in the macro economy. The government's budget deficit (including off-budget spending and net lending) is more than 9 percent of gross domestic product. This will need to come down in the near future as financing becomes more costly and inflationary pressures build up.

The current account deficit also widened to 10.5 percent of GDP as imports and exports fell at about the same rate in 2009. Exports will pick up again in 2010, but it is unlikely that they will grow at pre-crisis rates given sluggish demand in the rich countries. However, import growth could spike as the domestic economy expands and foreign direct investment gathers pace. An increase in the trade deficit from current levels would put the dong under additional pressure.

Inflation is another serious problem. It has accelerated in recent months as a result of the government deficit, rapid growth in bank lending and the fall in the value of the dong against other currencies.

Most economists think food and fuel prices will rise in 2010 as the global economy recovers, which will mean more upward pressure on prices in Vietnam. Asset bubbles have also formed again in the equity and property markets, particularly in the Hanoi land market.

If the main theme of 2009 was sustaining growth in difficult times, the theme for 2010 will be “sharing the burden.” The government reacted quickly to the global recession, injecting demand to keep the economy growing. But it is easier to allocate extra spending than it is to distribute the cost burden that necessarily follows. The main aim of policy makers in 2010 will be to find ways to cover the costs of the 2009 recovery package in a way that sustains growth, promotes macroeconomic stability and is fair, meaning that the heaviest burden does not fall on the poor.

Many people ask why rapid growth in Vietnam tends to be accompanied by inflation, trade deficits and asset bubbles. Why can't Vietnam grow more quickly without price rises and big trade deficits? The reasons are complex, but we can begin to get a grip on the problem if we remember the old saying that inflation is the macroeconomic expression of a lapse in discipline. The economy has a fixed amount of resources to consume and invest, and if the country is intent on spending much more than this amount over a long period of time then price inflation will ultimately emerge. The monetary authorities will eventually need to restore discipline by tightening access to credit, while the government can reduce demand directly by trimming its own spending on public investment and consumption, raising taxes, or both.

In Vietnam, this lapse in discipline has generally taken the form of excessive and unproductive public investment. According to Jim Adams, Vice President of the World Bank for

East Asia and the Pacific, “weakness in public investment processes have been highlighted during the recent macroeconomic turbulence.” The government has not always selected the right investment projects, and some projects have not been implemented efficiently. The result is that public investment does not yield enough additional economic output to justify the cost. The same can be said about many of the investments undertaken by state-owned companies, particularly property sector projects and the mushrooming of numerous, largely unrelated child and grandchild companies.

Vietnam currently invests about 40 percent of GDP. If investment is more efficient, the country could achieve higher rates of noninflationary growth. Each unit of investment would yield more output, which would create more potential for domestic consumption and investment without price rises.

Moreover, higher rates of return on investment would yield higher profits, which would in turn translate into higher levels of domestic savings. Vietnam is a net importer of capital in part because the profitability of its firms is low. If they are more profitable the country would be less dependent on FDI and overseas borrowing. By way of comparison, China also invests more than 40 percent of national income, but since its firms are more profitable the domestic savings rate is also higher. China is famously a net exporter of savings to the rest of the world.

Vietnam needs to invest heavily in essential infrastructure to create jobs, boost incomes, and increase its economic competitiveness. But sharing the burden of this year's extra spending must mean a sharp improvement in the quality of public investment.

Projects should be chosen based on their contribution to the economy rather than political considerations. Vietnam needs ports and airports, but should not build two, three, or four when one will do. Expensive prestige projects can be set aside for another day or redesigned in a more cost conscious manner. Though it would be nice to have a bullet train, from an economic perspective a high speed north-south highway would probably be more cost-effective. More transparent and accountable state-owned companies would also be a big step forward. After all, these businesses are owned by the people, so the people should be able to access their balance sheets, cash flow, and income statements.

The money saved from more efficient public investment would go a long way toward helping poor households meet their education and health expenses.

Part of the solution should also include efforts to stimulate exports and discourage imports. This has been difficult in the past because Vietnam's exports are so import-intensive. For example, the country exports garments worth billions of dollars but also imports more than US$1 billion in cotton cloth from China. The country would create more value addition and jobs and reduce the trade deficit faster if more of this cloth could be sourced domestically. On the scale of economic priorities, efficient textile factories are from this perspective more important than nuclear power plants.

The depreciation of the dong against the currencies of most trading partners in 2009 was a good thing from the perspective of export competitiveness and import compression. A cheaper currency lowers the cost of domestic inputs relative to imports. There may be one-off inflationary effects associated with a depreciation of the dong, so shifts in the value of the currency should be moderate and gradual. But Vietnam needs to find ways that are consistent with its WTO and other trade commitments to reduce dependence on imported inputs and consumer goods.

Sharing the burden is never as easy, or as gratifying, as sharing the wealth. Vietnam's leaders will need to face up to some hard choices in 2010. But doing the right thing now will create the conditions for faster, more sustainable and equitable growth in the years to come.

By Jonathan Pincus

* Jonathan Pincus is Dean at Fulbright Economics Teaching Program

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