INSTITUTE OF ECONOMICS

INTERNATIONAL DEVELOPMENT

RESEARCH CENTER

INSTITUTE OF ECONOMICS – IDRC/CIDA PROJECT

“Trade Liberalisation and Competitiveness of Selected Manufacturing Industries in Vietnam”

VOLUME 3. TEXTILE AND GARMENT INDUSTRY

IN VIETNAM: AN OVERVIEW

Contact: Trade and Competitiveness Research Team, Institute of Economics, 27 Tran Xuan Soan, Hanoi, Vietnam canpro@hn.vnn.vn

HANOI, NOVEMBER 2001

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ACKNOWLEDGEMENTS This report was prepared by a six-member Technical Group (TG) led by Vu Quoc Huy (Institute of Development Studies, Hanoi National Economics University) and comprised of Nguyen Thanh Ha, Cu Chi Loi and Nguyen Van Tien (Institute of Economics), Vo Tri Thanh (Central Institute of Economic Management), and Nguyen Thang (Institute for Market and Price Research). The Project was directed by Do Hoai Nam, Director of the Institute of Economics and Vice-Chairman of National Centre for Social Sciences and Humanities (NSSSH), who also led its Advisory Group (AG), which comprised of Le Dang Doanh (CIEM) and Vo Dai Luoc (Director, the Institute of the World Economy). The TG members greatly benefited from the guidance by the AG, and effective institutional support from the Institute of Economics, which hosted this project. The Task Force comprised of Vu Xuan Dao, Pham Minh Thuy, Tran Tram Anh, Cao Thi Hoa, Luu Vu Mai, Doan Thi Mai, Bui Thi Kinh (Institute for Market and Price Research), Nguyen Thi Kim Dzung, Nguyen Thi Thuy, Nguyen Thu Thuy (the Institute of Economics), Nguyen Van Binh (Vinatex), Phan Dieu Ha (Export-Import Department, Ministry of Trade), Nguyen Van Trinh (GSO), Nguyen Trung Kien (National Economics University), all of whom actively participated in implementing this project by providing substantive inputs and sharing their invaluable insights. The project would not have been completed nor reached adequate quality standards without extremely effective training and technical assistance provided by John Cockburn and Bernard Decaluwé (CREFA, Université Laval, Quebec, Canada) and Lynn Salinger (AIRD, Cambridge, MA, USA). The members of the Technical Group have learned enormously from the continuous intellectual support and guidance provided by the team of academic advisors. John Cockburn’s involvement in particular was far more than that of an academic advisor and he effectively became the “coach” for the Technical Group. The great contribution in the form of financial and institutional support by IDRC and CIDA (Canada) and their dedicated staff, particularly Marie-Claude Martin, Randy Spence, Rodney Schmidt, Steve McGurk and Vu Cuong, is highly appreciated. IDRC’s continued support to build up research capacity and a research network for Vietnam through policy-oriented applied research projects has proved to be extremely effective. This approach promises to generate long-lasting benefits for Vietnam and thus has received growing recognition from the research community and policy-making bodies in Vietnam. The research team would like to thank the Ministry of Science, Technology and Environment, particularly Mr. Pham Khoi Nguyen, Vice-Minister, Mr. Thach Can, Director and Mr. Le Thanh Binh, Expert, Department for International Relations, for their valuable support and encouragements provided during the process of implementation of the project.

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The research team also benefited greatly from support provided by managers and workers of some 120 textile and garment firms surveyed in various parts of the country. They donated their valuable time to provide data and share their views and insights with members of the Technical Group and the Task Force during long but highly productive interviews. The research team highly appreciates their kind support. Closer links between research and business communities clearly promise to contribute substantially to the development of Vietnam. The peer reviewers were Mr. Nguyen Van Nam (Director of the Institute of Trade, Ministry of Trade), Mr. Adam McCarty (Academic Adviser, Vietnam-Dutch Master in Development Economics Programme) for the trade reports and Mr. Do Huu Hao (Director, Industrial Development Strategy Department, Ministry of Industry) and Mr. Bui Quang Tuan (Senior Research Fellow, the Institute of the World Economy, NCSSH) for the competitiveness reports. The research team also received valuable comments and suggestions from numerous participants in the interim workshop (27 August 1999) and final workshop (28 November 2001). Their contributions are highly appreciated. Document preparation and publishing support were provided by Nguyen Thi Thuy, Nguyen Thi Kim Dzung, Pham Mai Huong and Nguyen Thu Thuy, all from the Institute of Economics.

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TABLE OF CONTENTS ACKNOWLEDGEMENTS ......................................................................................................... 1

TABLE OF CONTENTS ............................................................................................................. 3

TABLES, FIGURES, BOXES AND CHARTS.......................................................................... 5

EXECUTIVE SUMMARY .......................................................................................................... 6

INTRODUCTION ...................................................................................................................... 12

I. RECENT DEVELOPMENT OF INDUSTRY AND STRUCTURAL CHANGE.......... 13 1. HISTORY OF TEXTILE AND GARMENT INDUSTRY .................................................................... 13 2. OUTPUT TRENDS IN 1990S...................................................................................................... 13

II. STRUCTURE OF THE INDUSTRY.............................................................................. 16 1. OWNERSHIP STRUCTURE IN VIETNAM..................................................................................... 16 2. OWNERSHIP STRUCTURE OF TEXTILE AND GARMENT SECTOR ............................................... 17

2.1. Ownership structure of textile industry........................................................................... 17 2.1 Ownership structure of garment industry(Note the numbering is off here. This should be 2.2) ......................................................................................................................... 19 2.2. Employment and establishments structure of T&G industry .......................................... 21

3. PRODUCTION STRUCTURE OF THE INDUSTRY.......................................................................... 23 3.1. Textile production base ................................................................................................... 23 3.2. Garment production base................................................................................................ 25

4. GEOGRAPHICAL DISTRIBUTION OF T&G INDUSTRY ................................................................ 25

III. TECHNOLOGICAL TREND AND EFFICENCY OF T&G INDUSTRY................. 26 1. SITUATION WITH THE INDUSTRY’S EQUIPMENT AND TECHNOLOGY........................................ 26 2. UTILIZATION CAPACITY AND EFFICIENCY OF T&G INDUSTRY ............................................... 27 3. EFFICIENCY OF T&G INDUSTRY.............................................................................................. 28

IV. MARKETS FOR TEXTILE AND GARMENT PRODUCTS ..................................... 29 1. DOMESTIC MARKET ................................................................................................................ 29

1.1. Domestic Market for Textile Products ......................................................................... 30 1.2. Domestic Market for Garment Products......................................................................... 30

2. EXPORTS................................................................................................................................. 31 2.1. T&G Export Markets....................................................................................................... 33 2.2. Sub-contract – A Major Distinctive Feature of Vietnam’s Garment Export ................. 35

V. BUSINESS ENVIRONMENT OF TEXTILE AND GARMENT SECTOR............... 36 1. TRADE POLICY ........................................................................................................................ 37

1.1. Import tariffs ................................................................................................................... 37 1.2. Customs procedure.......................................................................................................... 39 1.3. Quota allocation.............................................................................................................. 40

2. FOREIGN EXCHANGE POLICY................................................................................................... 41 2.1. Exchange rate management ............................................................................................ 41

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2.2. Foreign exchange control ............................................................................................... 42 3. FINANCIAL MARKET................................................................................................................ 43

3.1. Financial system in Vietnam ........................................................................................... 43 3.2. Financing investment capital .......................................................................................... 43 3.3. Financing working capital .............................................................................................. 44

4. TAXATION POLICIES................................................................................................................ 47 4.1. Revenue/VAT taxes: ........................................................................................................ 47 4.2. Profit tax.......................................................................................................................... 48

5. LABOR MARKET...................................................................................................................... 49 5.1. General situation of Vietnam's labor market .................................................................. 49 5.2. Government policies with regards to the labor market .................................................. 50 5.3. Labor market in T&G industry ....................................................................................... 52

6. OTHER POLICIES ..................................................................................................................... 52 6.1. Price policy ..................................................................................................................... 52 6.2. Depeciation policy .......................................................................................................... 53

7. SUMMARY OF POLICY ANALYSIS............................................................................................ 54

CONCLUSIONS ......................................................................................................................... 56

REFERENCES............................................................................................................................ 57

APPENDIX. REVENUE TAX RATES .................................................................................... 58

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TABLES, FIGURES, BOXES AND CHARTS Table I-1: Main Indicators of Vietnam’s Textile and Garment Sector in 1990s (percentage, if

not stated otherwise) ............................................................................................................................14 Table I-2: Annual Growth Rates (%) of Some Major Products of Textile and Garment Industry

1991 – 1998 (in physical units)............................................................................................................15 Table II-1: Output distribution by ownership of textile industry (%) .........................................................17 Table II-2: Output distribution by ownership of garment industry (%) ......................................................19 Table II-3:T&G employment and its share .................................................................................................22 Table II-4: T&G employment by urban/rural and by sex ...........................................................................22 Table II-5: T&G employment, establishment, output by ownership in 1998 .............................................23 Table II-6: Per capita products of Vietnam textile industry........................................................................24 Table III-1: Value Added per Worker of Textile and Garment Industry (Constant Prices in

USD) ....................................................................................................................................................29 Table III-2: Share of labor remuneration in total value added of the textile and clothing industry

in 1996 (%) ..........................................................................................................................................29 Table IV-1: T&G import and its share over total country import ...............................................................30 Table IV-2: Structure of imported textile products (%)..............................................................................30 Table IV-3: Structure of Imported T&G Commodities of Vietnam at Two Digits in 1994, 1995,

1997 and 1998: (%)..............................................................................................................................31 Table IV-4: Structure of T&G Exports in 1994, 1995, 1997 and 1998 (%) ...............................................33 Table V-1: Tariffs of T&G products and some other selected industrial products (percentage) ................39 Table V-2: Ceiling Interest Rates for Working Capital ..............................................................................45 Table V-3: Monthly interest rates by ownership.........................................................................................45 Table V-4: The success/failure of application for loans from the formal banking system in 1997

– 1998 ..................................................................................................................................................46 Table V-5: Selected revenue tax rates (see appendix 1 for more detailed) .................................................47 Table V-6. Average tax rates paid by state and non-state firms in 1998 ....................................................48 Table V-7: Employment distribution by type of employment (percentage) ...............................................50 Table V-8: The average yearly wage per employee (million VND) by ownership and by type of

production in 1997 ...............................................................................................................................52 Table V-9: Import Tariffs on Fuels (%)......................................................................................................53 Table V-10: Summary of Main Policies that Have Impact on T&G industry ............................................54 Figure II-1. Foreign Investors in Vietnam by Origin (1997) ......................................................................21 Figure II-2: Share of clothing and textile production in enterprise titled as textile ones (1997) ................24 Figure III-1:Utilization Rates of Some Manufacturing Industries in 1997 .................................................28 Figure IV-1: Export Share of Textile and Garment 1985-1998 ..................................................................32 Figure IV-2: Export market shares of T&G................................................................................................34 Figure V-1: Interest rates for more than 6 months working capital of T&G firms in 1997........................46 Box 1: Foreign investment in T&G industry ..............................................................................................21 Chart IV-1: Vietnam in the International Manufacturing Triangle...................................................... 35

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EXECUTIVE SUMMARY

History in Brief

• Although the textile and garment handicraft in Vietnam has a long traditional development, Vietnam's textile and garment industry was just set up and developed by the French in the late 19th century with the establishment of Nam Dinh textile factory in Red River Delta, North of Vietnam.

• The end of the war (the middle of 1970s) marked a new period of development of the sector. In the 1980s, the sector performance was rather good with strong development of garment industry. The collapse of the former Soviet Union trade block coupled with internal weaknesses of the economy resulted in the stagnation of the economy in the late 1980s. To overcome these difficulties, a series of economic reforms were launched at both macro and micro levels. As a result, the economy in general and the T&G sector in particular came out of the crisis quite quickly and started a new period of development.

• Although T&G industry as the whole achieved a relatively high average growth rate of 10.4% per year in 1990s, the growth is unequal between textile and garment sub-sectors. The garment industry has by far outperformed the textile industry. Its average growth rate is 21.4% as opposed to 6.9 % of textile. The textile and garment industry’s relative importance in the economy as measured by its output share in the economy in general or in industry or in manufacturing in particular, has declined, which is in turn largely caused by a sharp drop in textile share. Over the same period, share of garment industry has increased, be it measured out of total GDP or industry output or output of manufacturing sector.

Markets

• The impressive success of garment industry is to a large extent attributed to the favorable demand conditions associated with the opening of access to quota-regulated markets in 1992. Access to EU quota markets is widely perceived to have given a jump-start to Vietnam’s textile and garment exports to the large markets of developed countries. Until the recent past, these quota-regulated markets played an important role for Vietnam and its share out of total T&G export increased considerably from 22% in 1993 to 42% in 1998.

• Since the late 1998, a new export trend has emerged. Vietnam’s garment export firms have aggressively explored non-quota markets, most notably Japan, South Korea, Taiwan, and ASEAN. Exports to these non-quota markets are mainly done by foreign invested firms, mostly back to their home countries.

• Despite impressive export achievements, a number of weaknesses of the textile and garment sector have also shown up. First, it appears that Vietnam’s T&G industry is still not fully ready to participate in the world market. In fact, Vietnam’s T&G has

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never used up some categories of the granted quotas, due to the absence of appropriate technology, the lack of some types of skilled labor and appropriate business skills. Second, the slowdown or even decline in export growth of garment industry in recent years (-3.5% in 1998, and 4-5% in 2000) may indicate vulnerability of Vietnam's garment industry in face of shocks and fiercer international competition.

• In the domestic market, local production of garment has been playing an increasingly important role in satisfying local consumption. Domestic production mostly consists of household enterprises, as the majority of formal enterprises are still focusing on foreign markets.

• Meeting local demand for textile products is still heavily dependent on imports due to very limited capacity of the textile industry. Vietnam's textile industry just produces traditional (simple) products by international standards such as fibers, fabrics, canvas, knitwear and most of textile products (except knitwear) target low-income population in the domestic market. Imported goods play a dominant role in meeting demand for high quality products. Because of obsolete technology, which results in low quality of domestic outputs, the textile industry has been losing the domestic market to imported products, which have considerably increased in recent years.

Equipment and Technology

• The Government has made considerable efforts to upgrade technology in the textile sector through providing long-term loans on preferential terms to textile SOEs. Most of the investments were made in foreign currencies and therefore were exposed to foreign exchange rate risk. Foreign exchange rate risk may explain a large part of losses incurred by textile SOEs that borrow in foreign currencies, but mainly target the domestic market.

• Although the efforts to upgrade the equipment have mostly been concentrated in textile enterprises, the technology of garment industry has been generally upgraded much better than that of textile industry. It can easily be understood given the shortage of foreign exchange and the smaller scale of garment enterprises, which made it is easier to modernize them as compared to textile plants. Many garment enterprises are now capable of making rapid production adjustments in response to product style changes. Some enterprises have used new technology and computer in some production functions such as cutting. These changes help to enhance competitiveness of garment producers, most notably their ability to respond quickly to changing demand.

Production

• A distinctive feature of textile industry is that while the vertical linkage between up and down streams is weak, mixed production is relatively common in which textile firms produce both textile and garment items. The excessive labor and the desire to add value to some textile products have motivated textile firms to open garment production

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lines. Firms that succeed in this are normally those that have access to export quotas for their garment products. In other words, an important motive for having garment production lines in textile firms is to take the advantage of their access to export quotas.

• Although the garment industry has developed rapidly, production capacity of this industry cannot meet the diversity of demand, and the industry mostly focuses on production of unsophisticated products such as shirt, jacket, coats, home dressing and the like.

• Utilization: In 1997, the textile industry had utilization rate of 75% or 9 months per year, the rate for garment industry was 81% or 9.8 months. The situation in 1998 was even worse due to the negative impact of regional financial crisis, but likely to have recovered recently.

Ownership Structure

• Although the share of state sector has been decreasing, textile is among industries in which state sector takes a lion share of total output, at around 53% on average in the late 1990s. Most of textile output of state sector have been produced by central SOEs (80% on average) and this share has been rising in recent years, as local SOEs have been facing difficulties due to the capital shortage. Private sector grew quite rapidly up until 1996, but slowed down since then. In general, GDP share of the private sector in the textile industry is smaller than its share in the combined T&G industry (2.1% vs. 3.38%), but both indicate that private sector is under-developed. Cooperatives, although important in the past, are now almost non-existent with share out of total industry output shrinking from 2% in 1995 to about 1% in 1998. Share of household enterprises have been in downward trend too, but the decline was smaller as compared to the collective sector. Foreign invested sector in textile industry has shown its increasing importance as evidenced by its rising share over the past years. It has surpassed the household sector in terms of output share since 1997 and become the second largest ownership sector in the textile industry (30.5% in 1999). Foreign investors used to prefer joint-venture to firms with 100% foreign capital because the former has several advantages over the latter in terms of access to land, workers and authority. However, joint ventures have been growing slower than firms with 100% foreign capital in recent years, due in part to the growing tensions and conflicts between domestic and foreign partners, which resulted in the break-up of a number of joint ventures.

• In the garment industry, ownership structure and the trend of its evolvement are similar to those of the textile industry. State sector is still the most important but its role in the industry is declining. Share of foreign invested sectors has been rising. Private sector is still underdeveloped with the share reaching the peak in 1997 and declining afterwards. Collective sector is almost non-existent while share of the household sector has been shrinking quite sharply.

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Employment

• In 1992/93, total employment in T&G industry (both formal and informal sectors) was 1.04 million people and the figure for 1997/98 was 1.17 million. The annual growth rate for that period was 2.37%.

• A special feature of T&G industry is that formal employment (wage employment) has increased in both absolute and relative terms. Total wage employment in T&G industry was 491.6 thousand persons and 538.9 thousand persons in 1992/1993 and 1997/1998 respectively. Its share out of total industry employment increased from 47% to 54.1%. Geographical Distribution of T&G Industry

• In general, the textile and garment firms are mainly located in two poles of country: the North and the South. The South takes the largest share (50%) of the output followed by the North (40%) and the Center (10%). The main reason for a small share of Central Vietnam is the absence of adequate infrastructures such as seaport, airport, roads and the like.

• In recent years, the Government has made great efforts to promote these industries in remote areas in order to reduce the income gap between urban and remote areas. Quota allocation and financial assistance are major forms of promotion, but this policy does not seem to work well due to the absence of adequate infrastructures, which are critical for being able to access foreign markets and/or brokers.

• The uneven distribution of the T&G industries is clearest in the case of foreign invested firms. Foreign investors in these industries prefer the South to the North. Most of T&G foreign invested enterprises are set up in the South. In textile industry, the South hosts the overwhelming number of projects (93%) with 98% of registered capital. In particular, Dong Nai, Long An, Binh Duong and Ho Chi Minh City make up the dominant share. Situation is similar for garment industry.

Business Environment

• Tariffs: Government policy of heavy protection of domestic production leads to (i) higher import tariffs for products that can be produced domestically; (ii) higher import tariffs on consumer goods as compared to inputs for production. The high tariff rates are a major cause of widespread smuggling of fabrics from China and Thailand, as the price differentials between domestically produced and foreign goods are sufficiently large to make smuggling highly profitable. However, with Vietnam’s commitments under various trade agreements, there is a clear tendency towards lowered import tariffs including those that are directly related to the textile and garment sector.

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• Customs Procedure: In order to offset the negative effect of high import tariffs on international competitiveness of domestic producers who use these items as inputs for their production of export products, the duty drawback scheme is applied. Significant efforts have also been made to simplify the customs procedure. However, there still exist some difficulties that export and/or import firms face when having their goods cleared through customs. The fact that one import item may be subject to different tariff rates depending on the usage causes some troubles for both customs officers and importing firms.

• Quota Allocation: Until the year 2000, quotas to EU, Canada, and Norway markets were distributed based on different criteria such as production capacity, rate of quota utilization in the preceding year, new investment for upgrading product quality and so on. Moreover, quota allocation was also used as “a social policy” for poverty alleviation. However, some progress has been recently made in reforming the quota allocation mechanism with the introduction of auction of a part of quotas in December 1998. A rising share of quotas on garment exports to Europe has been auctioned since then, thus permitting easier and more transparent access to private garment exporters.

• Exchange rate management: The exchange rate regime in Vietnam may be classified as managed floating. Prior to 1999, the State Bank of Vietnam (SBV) regulated exchange rate by setting the ceiling, which had to be strictly followed by all banks and credit organizations. Then, by Decision 88/1998-QD-NHNN7 28th February 1999, the ceiling was replaced by a mechanism according to which SBV announces the daily base rate, which is equal to the average rate in the previous session of forex transactions in the inter-bank market. On this basis, commercial banks are allowed to set their own rates within a band of 0.25% around this base rate. Under these regimes of exchange rate management, be it ceiling-based or base rate setting, the exchange rate in the official market in Vietnam has been apparently distorted.

• Foreign exchange control: The second source of distortions in the forex market is foreign exchange control. The purchase of foreign currencies for import activities or debt services is under control of State Bank of Vietnam. Foreign exchange control in combination with heavily regulated exchange rate is believed to result in overvaluation of the Vietnamese currency. In addition, it is widely recognized that non-state firms have more difficult access to foreign exchange and loans in foreign currencies in the official market than SOEs, particularly during periods of severe foreign exchange shortage. The apparently overvalued exchange rate and the surrender requirements tend to impose higher implicit tax on more export-oriented firms, and tend to benefit firms (normally SOEs) that have access to rationed foreign exchange.

• Financial Policies: The financial market in Vietnam is considerably distorted due to the regulation of lending interest rates in the form of setting ceilings and the excessive reliance of banks on collateral, mostly in the form of land or government’s (central and local) guarantees. As a result, domestic private firms have more limited access to the official credit market and consequently, pay higher interest rates than SOEs. Among SOEs, centrally managed enterprises get more favorable interest rates due to their higher lobbying power to have better access to formal credits.

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• Taxation policies: VAT in Vietnam is non-uniform with 4 rates. Non-uniformity results in distortions. Moreover, in practice, there have been numerous cases of discretionary reductions in rates and exemptions (normally applied to SOEs with lobbying power), which is another source of distortions. With regards to other taxes, it seems that there is no discrimination between SOEs and private firms in practice.

• Labor policies: The labor market both nation-wide and in the T&G sector is relatively mobile across ownership forms and there is no regulation with regards to recruitment and labor firing. Policies do not seem to discriminate between firms with different ownership structure, except recruitment by foreign firms is regulated. With regards to wage regulation, minimum wage policies have been issued and applied to foreign invested firms since 1990 and to formal domestic enterprises since 1997. However, these minimum wages seem to be non-binding. The maximum wage has also been set and applied to state enterprises. The main objective of this policy is to control the wage bill of these firms. This cap, however, makes it more difficult for SOEs to lure qualified managers and/or skilled workers. Some SOEs seem to pay “hidden” wages to these scarce human resources. In addition, the law also regulates the rates for overtime work. However, the regulation is not strictly followed in practice.

• Price policy: The government still controls prices of some “key” commodities such as petrol, electricity, telecommunication etc. Prices of petrol, and telecommunication are considerably higher than world price, which negatively affect international competitiveness of Vietnam’s textile and garment firms.

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INTRODUCTION The last decade witnessed an impressive performance of Vietnam’s textile and garment sector (T&G), which has achieved an average annual growth rate of over 10% over this period. This result is largely attributed to policy reforms, which were carried out by the Government over the last decade to create a more favorable business environment for private sector and foreign investors to actively participate in the economy in general and in the sector in particular. Moreover, the international market conditions for Vietnam’s textile and garment industry have been generally favorable for the development of the industry, particularly for the outward-looking garment sector, which has become a key foreign exchange earner since the second part of the decade1. However, despite the great efforts exerted by both the Government and businesses, there still exist constraints to further development of the sector, particularly in areas of trade, banking system, private sector development, support institutions etc. These issues should be addressed as soon as possible to help the textile and garment sector to develop further. This report will analyze the development of the sector since early 1990s and the policy environment under which the sector operates. It consists of five sections and introduction and conclusion. The report begins with an analysis of the development of the sector over the last decade. The second section provides a concise description of structure of the textile and garment sector by ownership, the nature of products, targeted markest (export vs. domestic sales), employment. The third section discusses technical changes of textile and garment industry in recent years. The fourth section analyses both domestic and foreign markets for textile and garment products. The final section discusses various policies that constitute the business environment of the textile and garment sector. The report uses secondary data from different sources, and also primary data collected from a survey of 96 firms carried out by the study team. In the report, descriptive, empirical, and some statistical methods are employed.

1 Different sources quote different data on the T&G export earnings. Domestic sources indicate that T&G is the second largest earner of foreign exchange while according to IMF data, it is the largest one.

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I. RECENT DEVELOPMENT OF INDUSTRY AND STRUCTURAL CHANGE

1. History of Textile and Garment Industry Although the T&G handicraft of Vietnam has a long traditional development, Vietnam's T&G industry was just set up and developed by the French in the late of last century with establishment of Nam Dinh textile factory in Red River Delta, North of Vietnam. The sector did not develop well, and Nam Dinh factory was a single and the main unit of the industry until the middle of the twentieth century when the war started and the economy slowed down. The end of the war (middle of 1970s) marked a new period of development of the sector. In the 1980s, the sector performance was rather good with strong development of garment industry. The development of the sector in 1980s was closely associated with the cooperation program between Vietnam and former Soviet Unions and Eastern European countries. Under the cooperation program, Vietnam’s T&G industry acted as assemblers of the garment products and some textiles such as embroidered products for those countries. All machines and inputs were invested and/or supplied by foreign partners and borrowing capital (installed machines) was paid back from assembling fees. Prices of assembled products were believed to be not favorable, but these were offset by low price of installed equipment and loose norms of fabrics supplied by clients for garment assembly. As a result, a good number of garment enterprises were set up in this period. However, this cooperation program did not last long due to the collapse of COMECON in the late 1980s, and the industry, as a result, was down badly. The collapse of the former Soviet Union trade block coupled with internal weaknesses of the economy resulted in the stagnation of the economy in the late 1980s. To overcome these difficulties, a series of economic reforms were launched at both macro and micro levels. A number of measures were implemented including removing constraints to private sector participation, encouraging foreign trade and so on. As a result, the economy in general and the T&G sector in particular came out of the crisis quite quickly and started a new period of development. Reforms have created an environment that is more friendly and conducive to businesses. The reforms could not however guarantee the success for all industries. Over the 1990s the garment industry has been performing very well while the performance of the textile industry has been modest. Share of textile in GDP has been declining leading to a drop of the share of total T&G in GDP (Table I-1).

2. Output Trends in 1990s Although T&G industry has achieved a relatively high average growth rate of 10.4% per year in 1990s, the industry’s relative importance in the economy as measured by its output share in the economy in general or in industry or manufacturing in particular, has declined, which is in turn to a large extent caused by a sharp drop in textile share (Table I-1).

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Table I-1: Main Indicators of Vietnam’s Textile and Garment Sector in 1990s (percentage, if not stated otherwise)

1994 1995 1996 1997 1998 Prel.1999 Average GDP (VND billion at 1994 price)

178,534 195,567 213,833 231,264 244,596 256,269 220,010

GDP growth rate 8.8 9.5 9.3 8.2 5.8 4.8 7.7 Growth rate of T&G 20.7 -6.2 7.1 18.5 12.5 9.9 10.4 Growth rate of T2 12.9 -14.8 3.2 13.9 15.2 11.0 6.9 Growth rate of G 51.1 18.9 15.3 27.2 7.9 7.8 21.4 Garment/ Total T&G 25.5 32.3 34.8 37.3 35.8 35.1 33.5 T&G/GDP 5.5 4.0 3.6 3.7 3.6 3.6 4.0 T/GDP 4.1 2.7 2.3 2.3 2.3 2.3 2.7 G/GDP 1.4 1.3 1.2 1.4 1.3 1.3 1.3 T&G/Manufacturing - 11.0 10.3 10.8 10.8 10.8 10.7 T/Manufacturing - 7.4 6.7 6.7 6.9 7.0 7.0 G/Manufacturing - 3.5 3.6 4.0 3.9 3.8 3.8 T&G/Total industry 9.4 8.8 8.3 8.6 8.6 8.6 8.7 T/Total industry 7.0 6.0 5.4 5.4 5.5 5.6 5.8 G/Total industry 2.4 2.9 2.9 3.2 3.1 3.0 2.9 T&G export (Bill. USD current price)

431 850 1150 1503 1450 1750 1189

T&G export growth rate -9.5 97.2 35.3 30.7 -3.5 20.7 28.5 Share of T&G export/total country export

10.6 15.6 15.8 16.4 15.5 15.2 14.8

Share of T&G wage employment/Total wage industrial employment

7.51* - - - 8.2** - -

Source: Statistic Yearbook, 1999. GSO * Based on data of Living Standards Survey 1992/93; ** Based on data of Living Standards Survey 1997/98.

The garment industry has by far outperformed the textile industry. Its average growth rate is 21.4% as opposed to 6.9 % of textile. Thanks to the rapid growth, share of garment industry has increased slightly, be it measured in total GDP or in industry output or in manufacturing output or in total T&G industry. This success of garment industry is to a large extent attributed to the opening of access to quota-regulated foreign markets in the early 1990s. Thanks to the signing of trade agreement with EU in 1992, Vietnam garment export has since enjoyed preferential access to the large EU market. Then Norway and Canada followed to grant quotas for Vietnam’s textile and garment export. Up to the recent past, these quota-regulated markets have played important role for Vietnam with its share out of total T&G export increased from 22% in 1993 to 42% in 1998. But the share dropped back to 35% in 1999.

2 The economic growth rate of the pure textile industry must be lower if garments are taken out from the textile industry. In reality, many textile firms also do garment business. Statistical data on output of textile industry seem to have included garments.

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Since late 1998, Vietnam’s garment export firms have aggressively explored non-quota markets, most notably Japan, South Korea, Taiwan, and ASEAN. Export to these non-quota markets is mainly done by foreign invested firms back to their home countries. While export products to Japanese market go mainly to final consumption, foreign investors from some countries such as Korea, Taiwan, or ASEAN have come to Vietnam to produce and export, and also act as brokers. As a result, a part of Vietnam garment export is implemented for transit trade, i.e. Vietnamese garment products are exported through brokers to their home countries, which will then be re-exported to other countries such as EU or the US. Over the past few years, some Vietnamese firms have strived hard to by-pass brokers to directly export to Japanese market, but the success has been modest so far. Garment industry was hit hard by the Asian financial crisis and the slowdown of Japanese economy. Share of garment export to these markets has recently dropped to 40% from 60% in mid-1990s. As compared to 1997, volume of garment export to these markets declined by 22% and 11% in 1998 and 1999 respectively. The decline in export growth of garment industry in recent years (-3.5% in 1998, and 4-5% in 2000 – preliminary estimate) may indicate vulnerability and probably weaknesses of Vietnam's garment industry in face of fiercer international competition.

Table I-2 shows production volumes of main products of T&G industry. Disaggregated data on total value for individual products is not available. It can be seen that most of textile products had either low or negative average growth rates, whereas garment industry had relatively high average growth rate despite the negative growth in 1998 due largely to the Asian financial crisis.

Table I-2: Annual Growth Rates (%) of Some Major Products of Textile and Garment Industry 1991 – 1998 (in physical units) 1996 1997 1998 1999* Average Fiber 10 3 2 7 6 Knitting wool 36 7 32 1 19 Fabric 8 5 5 1 5 Mosquito net -33 -18 -24 8 -17 Towel 1 3 32 -7 7 Knitting apparel -16 -1 17 3 1 Ready clothes 20 46 -9 11 17 (*: Estimated data) Source: - Statistic yearbook 1998

- Ministry of Industry.

The decline in share of textile industry may be due in part to the fact that textile industry has not kept pace with new trends in demand. Because of the obsolete technology, domestic textiles are of low quality. As a consequence, the industry has been losing the domestic market to imported textile products, which have increased in recent years. For example, the ratio of T&G import value over the value of domestic textile output increased to 197% in 1998 from 94% in 1995 (See section IV.1.1

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It is widely believed in Vietnam that the poor performance of the textile industry is due mainly to the capital shortage, which has led to the obsolescence of technologies and thereby, the low quality of the outputs and low competitiveness of the industry. Although the industry, mostly SOEs, has received considerable financial assistance from the government, that support is still far from sufficient to help SOEs improve technology to meet the quality requirements of the market. In a number of cases, relatively large investments were made in the textile industry over the past few years, but no significant improvements in performance were achieved because of high exchange rate risk and the absence of sound management. Most of the investments were made in foreign currencies and therefore were exposed to foreign exchange rate risk. The risk was high in the recent past, as the domestic currency was devaluated by 25% between 1997 and 1998, and more importantly, these devaluations were not properly projected in the feasibility study. As a consequence, instead of helping firms improve competitiveness, investment has in practice become their burden. A recent study shows that the recent devaluations of the Vietnamese currency have substantially increased the borrowing costs to enterprises that took loans denominated in foreign currencies. For some firms, effective cost of investment capital is as high as 16.4% per year (see Hoang Dat, Det May Viet Nam, 1998). Foreign exchange rate risk may explain a large part of losses incurred by firms that borrow in foreign currencies, but mainly target the domestic market. Because of shortage of long-term loans for investment capital, some firms have to borrow short-term loans to upgrade machines, and the mismatch in maturity makes these firms exposed to a high risk of payment default. As a solution, some firms have to increase the depreciation rate, and this in turn and together with high interest rate raises cost price of output making the firm uncompetitive in the market place (Vietnam Investment Review, 03/16/97).

II. STRUCTURE OF THE INDUSTRY

1. Ownership structure in Vietnam

Ownership structure in Vietnam reflects the transitional characteristics of the Vietnamese economy, which is shifting from centralized to market oriented economy. In the economy in transition, there are a diversity of ownership forms including SOEs, private firms and foreign invested firms. In SOEs, capital is mainly financed by state budget(Note: you should mention this in your discussion of Figure 9 of the qualititative analysis. Maybe this explains the higher use of retained earnings by Southern firms, if they are more likely to be non-SOEs). Other sources of capital of SOEs may include bank loans, loans provided by employees and others. The state sector consists of centrally managed SOEs and locally managed SOEs. According to the Vietnamese statistical system, non-state sector (or ownership) consists of cooperatives, household enterprises, private and mixed firms. Cooperatives are based on collective ownership. Private firms include legally registered firms such as companies with limited liability, joint-stock firms, and private enterprises. Household enterprise is an

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unregistered economic unit and is very small in scale. Enterprises with mixed ownership are jointly formed by the State and various non-state investors and include state-private; state-foreigner, state-private-foreigner firms. In reality, most of mixed firms are joint-ventures between former state firms and foreign investors. In firms with 100% foreign capital, capital is completely owned by foreigners in the form of foreign direct investment.

2. Ownership Structure of Textile and Garment Sector Early 1990s saw fundamental changes in ownership structure of economy. Share of state sector shrank while shares of both domestic private and foreign sectors increased. Since the middle of 1990s, shares of state and formal domestic private sectors have been stabilized at 40% and 3.5% respectively. Over the same period, shares of household and mixed sectors declined, while share of foreign sector increased from 6.3% in 1995 to 11.7% in 1999. The evolvement of ownership structure in T&G industry gives a slightly different picture. Shares of SOEs, cooperatives and household enterprises have been declining, while shares of domestic private, foreign and mixed ownership firms have been rising.

2.1. Ownership structure of textile industry

State Sector Although the share of state sector has been decreasing as shown in Table II-1, textile is among industries in which state sector takes a lion share of total output, at around 53% on average in the late 1990s. Most of textile output of state sector have been produced by central SOEs (80% on average) and this share has been rising in recent years, as local SOEs have been facing difficulties due to the capital shortage.

Table II-1: Output distribution by ownership of textile industry (%) 1995 1996 1997 1998 Prel.1999 Average Central SOEs 43.6 45.9 43.7 40.6 38.9 42.2 Local SOEs 13.2 12.6 11.7 9.7 8.9 10.9 -- Total SOEs 56.8 58.5 55.4 50.3 47.8 53.1 Private companies 1.5 2.1 2.1 1.4 - 1.6 Households 21.6 19.2 16.7 15.4 - 16.9 Cooperative 1.8 1.5 1.3 1.1 - 1.3 Mixed ownership (joint-ventures) 1.0 2.5 4.5 4.7 - 3.1 Firms with 100% foreign capital 17.3 16.2 20.1 27.1 30.5 23.1 Total 100.0 100.0 100.0 100.0 - 100.0

Source: Statistic Yearbook 1999. GSO, 2000

As mentioned earlier, SOE reforms carried out in the early 1990s cut down the number of SOEs by half. However, in the middle of 1990s, the Government strengthened the state sector by setting up general corporations. It is still not fully clear how efficient these

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corporations are, but the dominant role of the corporations in the respective markets makes it difficult for non-state enterprises to grow. In textile and garments industry, the majority of state firms have become members of T&G Corporation named VINATEX. At present, VINATEX has 52 member-enterprises and takes a large share of this industry. It is estimated that VINATEX produces 80% of total fiber, 65% of fabrics and 45% of garment products and shares 40% of total export value of this industry. Although the member enterprises of VINATEX can work independently, VINATEX plays an important role in export quota allocation and allocation of state and bank credits to its member enterprises. This will be further discussed later, in a section on business environment. Local non-state sector Private enterprises in Vietnam have strongly emerged since the early 1990x, when the economic reforms started. Since then, private sector grew relatively fast, with its share out of total GDP rising to 3.5% of total GDP share in middle of 1990s from zero in the early 1990s. But the private sector in Vietnam has developed at a slower pace since the middle of 1990s, as the reforms are widely believed to have slowed down. Similarly, in the textile industry, private sector grew quite rapidly up until 1996, but slowed down since then. Even in the years of high growth rate, share of formal private sector in the textile industry was modest with peaks of 2.1% in 1996 and 1997. In general, GDP share of the private sector in the textile industry is smaller than its share in the whole industry (2.1% vs. 3.38%), but both indicate that private sector is under-developed. The late 1990s has witnessed a large reduction of output shares of two sectors: cooperatives and household enterprises. Household and collective (cooperatives) sectors normally produce traditional products targeting low-income consumers. These sectors face fierce competition from large-scale enterprises and foreign made goods. Cooperatives are a legacy of the centralized economy, and although it was important in the past, it is now almost non-existent with share out of total industry output shrinking from 2% in 1995 to about 1% in 1998. The decline of the collective sector is due to the withdrawal of government assistance, which was common in the past, and to poor economic management, which was largely due to low motivation of managers caused by improperly designed incentive system. Share of household enterprises have been in downward trend too, but the decline was smaller as compared to the collective sector. The sector’s output share in the industry dropped significantly from 22% in 1995 to 15% in 1999. The decline of the household sector in relative terms is mainly explained by the expansion of the formal sector, and to a lesser extent, reduction of the sector in absolute terms as evidenced by a reduction of total employment of this sector from 552 thousand people in 1993 to 539 thousand people in 1998 (Sarah, 2000). Foreign sector Foreign invested sector3 in textile industry has shown its increasing importance as evidenced by its rising share over the past years. It has surpassed the household sector in 3 Include joint-ventures and firms with 100% foreign capital

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terms of output share since 1997 and become the second largest ownership sector in the textile industry (30.5% in 1999). Textile is an import competing industry, which has been favored by Government’s policies. It therefore enjoys preferential treatment in numerous forms including tax reduction, high level of protection from foreign competition with tariffs on imported consumer goods in a range from 40% to 50%. Vietnam’s low labor cost helps attract foreign investors to come in. Asian countries including Korean, Taiwan, Malaysia, and Indonesia top the list with about 85% of total foreign investment in the industry (Box 1). In the textile industry, the most popular form of mixed ownership firms is joint-venture between SOEs and foreign firms. Foreign investors used prefer joint-venture to firms with 100% capital because the former has several advantages over the latter in terms of access to land, workers and authority. A major disadvantage of joint ventures is that tensions and conflicts between partners frequently emerge just shortly after the joint venture was put into operation. In many cases, the tensions and conflicts are excessive to force the joint venture to break up. Although the share of joint ventures has been increasing in recent years, this sub-sector has been growing slower than firms with 100% foreign capital (Table II-1).

2.1 Ownership structure of garment industry(Note the numbering is off here. This should be 2.2)

In general, the industry’s structure and the trend of its evolvement are similar to those of the textile industry. State sector is still the most important but its role in the industry is declining. Shares of mixed and foreign invested sectors have been rising. Private sector is still underdeveloped with the share reaching the peak in 1997 and declining afterwards. Collective sector is almost non-existent while share of the household sector has been shrinking quite sharply.

Table II-2: Output distribution by ownership of garment industry (%) 1995 1996 1997 1998 Prel.1999 Average Central SOEs 13.2 15.5 14.0 14.1 13.8 14.1 Local SOEs 21.6 19.2 20.5 18.6 16.7 19.1 -- Total SOEs 34.8 34.7 34.5 32.7 30.5 33.2 Private 1.6 2.0 2.1 1.9 - 1.8 Households 35.7 33.1 27.9 28.4 - 28.9 Collective 0.3 0.6 0.5 0.7 - 0.5 Mixed 9.4 14.6 14.5 13.7 - 12.5 Firms with 100% foreign capital

18.2 15.0 20.5 22.7 25.4 20.9

Total 100.0 100.0 100.0 100.0 - 100.0

Source: Statistic Yearbook 1999. GSO, 2000

State sector As compared to the textile industry, state sector in the garment sector has a smaller output share (33% vs. 53% on average for the period 1995-1999), yet the share has been

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declining. The reduction is more substantial for local SOEs than central SOEs. The former have their shares shrunk by 5% over the period from 1995 to 1999. The poorer performance of local SOEs may be partly explained by their less favorable conditions in terms of connections with policy-making bodies, access to quota and credit etc. as compared to those of central SOEs. Although the relative importance of local SOEs is declining, it still produces more output than central SOEs. As compared to the textile industry, the output share of local SOEs is much higher. This is partly explained by the government’s efforts to distribute quotas more evenly across localities to encourage local garment SOEs to develop and thus local employment to rise. A disadvantage of this policy is that if for some reasons quotas are not sufficient, firms will have low utilization rate resulting in their poor performance. The reduction of state sector's output share is typical for garment and textile industry and also some other industries. One of the reasons is that a number of SOEs have established joint-ventures with foreign partners and they therefore have become a part of the mixed sector (or in a common classification, the broader foreign invested sector), which has grown fast over the past few years. This fact should be taken into account when interpreting the changes in ownership structure of the industry. Local non-state sector Similar to the textile industry, the role of non-state sector in the garment industry is still modest. One of the reasons is the capital shortage experienced by non-state firms. A more important reason is the lack of favorable environment for non-state firms to flourish. Private firms often complain about the complicated registration procedures4, difficult access to land, credit and quota. Unfavorable business environment has had its negative impact not only on private firms, but also on cooperatives and household enterprises. As a consequence, these sectors have gone down over the past few years. Too small scale of non-state firms is also widely perceived as a cause of their poor performance and their disadvantage vis-à-vis SOEs and foreign invested firms. Also, as the economy develops and people’s income increases, apparel consumption bends towards ready-made clothing which is normally better produced in larger enterprises. Foreign invested sector5 Share of foreign invested sector in garment industry has increased by less than that in textile sector in the late 1990s. However, this share is quite significant and almost comparable to that of state sector. 4 The year 2000 witnessed a new trend in development of the private sector in Vietnam including both formal and informal firms. The number of new establishments was about 30% of total existing private firms at the end of 1999. This improvement is largely explained by the introduction and implementation of Enterprise Law and the progress of administration reform. 5 Foreign invested sector is broadly defined to include the mixed sector consisting of mainly joint-ventures between SOEs and foreign investors with the dominance of the latter

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Similar to the textile sector, the majority of foreign investors (partners) come from Asian countries. Although these foreign firms do not have access to export quotas, they benefit considerably from cheap labor employed to produce goods to be exported to their home countries, or to do transit trade, i.e. re-exporting to other countries such as EU or US. Value of total transit trade of textile or garment products is estimated at 20% of total Vietnam T&G export. This will be discussed further in section IV-2

Box 1: Foreign investment in T&G industry

Figure II-1. Foreign Investors in Vietnam by Origin (1997)

The data of 1997 showed that in the textile sector, there were 19 joint venture enterprises and 40 enterprises with 100% foreign capital with the output share of 20%. The garment sector had 29 joint venture enterprises and 53 enterprises with 100% foreign capital whose output share was almost the same as foreign textile enterprises. Most of foreign investors in textile and garment industry come from Asian countries (for both textile and garments) and up to 1997 the actual foreign capital invested in the textile sector was more than USD 500 million (40 projects) employing about 36,000 workers. Data for 1998 showed that the foreign sector shared 17% of employment and 16.7% of establishments in the textile sector, 24% of employment and 19% of establishments in the garment sector (MPI).

2.2. Employment and establishments structure of T&G industry

The employment data by industry in Vietnam are poorly recorded and inconsistent. Different sources quote different data and it is therefore hard to have a true picture of employment of T&G industry. The Living Standards Surveys, which were conducted in 1992/93 and 1997/98, have revealed that T&G industry plays an important role in job creation. The industry is very labor intensive and creates the largest number of jobs among manufacturing industries. In 1992/93 total employment in T&G industry (both formal and informal sectors) was 1.04 million people and the figure for 1997/98 was 1.17 million. The annual growth rate for

South Korea43%

Malaysia27%

Taiwan16%

Others14%

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that period was 2.37%. A special feature of T&G industry is that formal employment (wage employment) has increased in both absolute and relative terms. Total wage employment in T&G industry was 491.6 thousand people and 538.9 thousand in 1992/1993 and 1997/1998 respectively. Its share out of total industry employment increased from 47% to 54.1%. Table II-3 shows the importance of T&G industry in terms of employment. Data for textile and garment sub-sectors are not available and therefore cannot be shown in the table.

Table II-3:T&G employment and its share 1992/93 1997/98

Wage employment

Self-employment

Total Wage employment

Self-employment

Total

Total T&G employment (people)

491,599 551,187 1,042,786 634,736 538,922 1,173,658

T&G/Industry (%) 20.0 29.4 24.0 20.5 24.6 22.2 T&G/Light industry (%) 28.5 32.3 30.4 33.2 28.6 30.9 T&G/National employment (%)

7.5 1.8 2.9 8.2 1.7 2.9

Source: Vietnam's Labor Situation and Trends, Sarah Bales, 2000

It is noteworthy that share of both wage employment and self-employment in urban area has declined. This indicates a tendency of moving T&G industry toward rural areas to exploit cheap labor cost there. Although it is not possible to separate out data for each sub-sector, this tendency is likely to be for garment industry only which requires much lower relocation costs than textile industry. Yet it is easier for garment industry to absorb low-skilled rural labor than textile industry. Share of male employees out of wage employment dropped considerably, but their share out of total employment almost remained unchanged. This may indicate that registered enterprises prefer to employ female workers whose skills may be more suitable for operations done in these firms.

Table II-4: T&G employment by urban/rural and by sex 1992/93 1997/98

Wage employment

Total Wage employment

Total

Total T&G employment (people) 491599 1042786 634736 1173658 Urban (%) 70.9 42 64.6 40.7 Rural (%) 29.1 58 35.4 59.3 Male (%) 23 23.7 19.8 23 Female (%) 77 76.3 80.2 77

Source: Vietnam's Labor Situation and Trends, Sarah Bales, 2000

It may be useful to break down employment data by ownership, as was done with output in Table II-2. This is however impossible due to data unavailability, and nor is it possible to analyze employment trends by ownership. Table II-5 gives a snapshot of employment distribution by ownership based on data from Industrial Survey carried out by GSO in 1998. The limitation of the data in the table is that the data on labor and establishments of

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garment industry also cover leather industry and these data cannot provide an accurate picture, but can only be seen as a proxy for garment industry. These figures are slightly different from those that are derived from VLSS and presented in previous tables.

Table II-5: T&G employment, establishment, output by ownership in 1998 Textile Garment

State Non-state Foreign Total State Non-state Foreign Total Labor (people) 74708 97199 19354 191261 83537 167680 32932 284149 Labor share (%) 39.1 50.8 10.1 100.0 29.4 59.0 11.6 100.0 Establishment (unit) 82 32225 55 32362 97 68332 83 68512 Estab. share (%) 0.3 99.6 0.2 100.0 0.1 99.7 0.1 100.0 Output (mill, VND) 4410023 1730244 1556604 7696871 1589870 2015957 979129 4584956 Output share (%) 57.3 22.5 20.2 100.0 34.7 44.0 21.4 100.0 Output/labor (mill. VND)

59.0 17.8 80.4 40.2 19.0 12.0 29.7 16.1

Labor/Etab. (people) 911.1 3.0 351.9 5.9 861.2 2.4 396.8 4.1

Source: Results of survey on Industry 1998, GSO 1999

It is clear from Table II-5 that the domestic non-state sector makes up the majority of total employment in both textile and garment industry, followed by state sector. Foreign sector generates the smallest number of jobs. Household enterprises, which dominate the domestic non-state sector, are very small in size, and much smaller than SOEs and foreign invested firms. In terms of employment per establishment, SOE is the largest with size being 2.6 times and 2.2 times bigger than the average foreign firm in textile and garment industry respectively. However, foreign firms have the highest labor productivity with output per employee being 1.4 times and 1.6 times higher than SOEs in textile and garment sub-sectors respectively.

3. Production Structure of the Industry

3.1. Textile production base

Although the fabric sector is more capital-intensive than the garment sector, it is still fairly labor intensive. The fiber production is essentially capital intensive. Vietnam is unlikely to have comparative advantage in up-stream and some mid-stream sectors, since these sectors are relatively capital-intensive while capital is a scarce factor in Vietnam at this stage of development. In fact, those sectors that produce fibers or fabric of high quality are almost non-existent in Vietnam, and the country therefore still heavily relies on imported fabrics. Disaggregated data on a number of products of Vietnam's textile industry are not available, and statistical data show that Vietnam's textile industry just produces traditional products by international standards such as fibers, fabrics, canvas, knitwear. However, the production capacity of these products is still modest and has not increased much in recent years (Table II-6).

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Table II-6: Per capita products of Vietnam textile industry Item 1992 1993 1994 1995 1996 1997 1998 1999 Fiber (kg) 0.6 0.5 0.6 0.8 0.9 0.9 0.9 1.0 Cloth & silk (meter) 4.0 3.1 3.2 3.6 3.9 4.0 4.2 4.1 Canvas (meter) 0.03 0.03 0.04 0.03 0.03 0.03 0.18 0.20 Knitwear (pieces) 0.3 0.4 0.4 0.4 0.3 0.3 0.4 0.4 Ready made cloth (pieces)

1.5 1.3 1.7 2.4 2.8 4.1 3.6 4.0

Population (mill. person) 68.5 69.8 71.0 72.1 73.2 74.3 75.5 76.6

Source: Statistic Yearbook 1999, GSO 2000

In addition to weak production performance of textile industry as reflected by low per capita outputs in Table II-6, the quality of products is also a problem. Most of textile products (except knitwear) target low-income population in the domestic market. Imported goods play a dominant role in meeting demand for high quality products. This is confirmed by the dominance of CMT-type business, in which most of fabrics are either directly supplied by brokers, or imported by producers. A distinctive feature of textile industry is that while the vertical linkage between up and down streams is weak, mixed production is relatively common in which textile firms produce both textile and garment items. Mixed production here is essentially different from the fully integrated production. Some textile firms have recently introduced clothing production in their business. The reasons behind are mixed. Our direct interviews with firms have revealed that the excessive labor and the desire to add value to some textile products have motivated textile firms to open garment production lines. Firms that succeed in this are normally those that have access to export quotas for their garment products. In other words, an important motive for having garment production lines in textile firms is to take the advantage of their access to export quotas.

Figure II-2: Share of clothing and textile production in enterprise titled as textile ones (1997)

Source: Vietnam’s Textile and Garment Competitiveness Survey, 1999 by Institute of Economics

0%

50%

100%

1 3 5 7 9 11 13 15 17 19 21 23 25 27

Ente rprise

C lo th ing

T extile

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3.2. Garment production base

It is difficult to get accurate estimates of production capacity of garment industry. However, the rapid growth of this sector in recent years apparently implies that the capacity of the industry has increased fast. Ready-made-cloth items have grown rapidly in volumes (in physical units) at an average growth rate of 24% per year over the past decade, except a few years in the early 1990s, when production volume dropped. Although the garment industry has developed rapidly, production capacity of this industry cannot meet the diversity of demand, and the industry mostly focuses on production of unsophisticated products such as shirt, jacket, coats, home dressing and the like. This is a main reason why Vietnam’s garment industry can satisfy only a part of categories under the EU-granted quotas. For example, in 1992 among 106 items under the EU quota grants, only a small part of the categories was filled up due to the absence of appropriate production capacity. Under the 1995 framework agreement, the number of quota items was reduced to 54, and then fell further to 29 in 1998 (Vietnam Investment Review November 2nd 1998). Vietnam’s garment industry is not well positioned to tap business opportunities in some special or complicated products such as suite, which require high-tech machines and highly skilled labor.

4. Geographical distribution of T&G industry In general, the textile and garment firms are mainly located in two poles of country: the North and the South. The South takes the largest share (50%) of the output followed by the North (40%) and the Center (10%) (Source: Ministry of Trade). The main reason for a small share of Central Vietnam is the absence of adequate infrastructures such as seaport, airport, roads and the like. In the North or the South, the distribution of these two industries is uneven with the majority of firms being located in big cities such as Hanoi, Hai Phong, Nam Dinh, Ho Chi Minh City, and to a lesser extent, provincial capital cities. In recent years, the Government has made great efforts to promote these industries in remote areas in order to reduce the income gap between urban and rural areas. Quota allocation and financial assistance are major forms of promotion, but this policy does not seem to work well due to poor infrastructures, which do not allow local firms to access foreign markets and/or brokers. The uneven distribution of the T&G industries is clearest in the case of foreign invested firms. Foreign investors in these industries prefer the South to the North. Most of T&G foreign invested enterprises are set up in the South. For example, up to 1997 (before foreign investment began to drop), foreign investment in textile industry was located in 16 provinces/cities. However, the South hosts the overwhelming number of projects (93%) with 98% of registered capital. In particular, Dong Nai, Long An, Binh Duong and Ho Chi Minh City make up the overwhelming share. Situation is similar for garment industry. Up to 1997, foreign investment in garment industry was made in 18 provinces or cities, most of projects (84%) with 96% of registered capital were concentrated in the South. Ho Chi Minh City is the center of garment foreign investment followed by Dong Nai and Binh Duong provinces. Among locations that attract large amount of foreign investment in

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garment industry, Hanoi was ranked as number 6 with 12% of total number of projects and 12% of invested capital in 1997 (Thuy Huong, Det – May Vietnam, 3-1998.) Uneven distribution of foreign investment in theses two industries, as discussed earlier, is mainly due to the absence of adequate infrastructures in various parts of the country. High price of land is a problem too. Price of land in the North, particularly Hanoi is higher than in other regions. Moreover, the South has much better connections with overseas Vietnamese than the North. These people have played an important role either in attracting foreign direct investment and/or in establishing contacts with brokers.

III. TECHNOLOGICAL TREND AND EFFICENCY OF T&G INDUSTRY

1. Situation with the Industry’s Equipment and Technology Situation with equipment and technology of T&G industry varies across sectors. There are 5 types of technologies in T&G industry including fiber spinning, shuttle weaving, knitted weaving, dyeing and printing and garment assembling. Although the effort to upgrade the equipment has mostly concentrated in textile enterprises, the technology of garment industry has been generally upgraded much better than the technology of textile industry, with “nearly 100 per cent of garment firms has been upgraded” (Vietnam Investment Review, March 1997). It can easily be understood given the shortage of foreign exchange and the smaller scale of garment enterprises, which made it is easier to modernize them as compared to textile plants. For example, “the average investment required to start a new garment enterprise is around USD 500,000 to one million USD, while textile enterprise needs at least 10 million USD” (Vietnam Investment Review, March 1997). Among other things, the differences in technology levels between textile and garment industries are main reasons explaining the differences in growth rates of these two industries in recent years. For the fiber spinning: In the late 80s, the industry had 860,000 spindles and 2,000 spinning rotors without spindles belonging to 13 SOEs. The annual output at that time was 60,000 ton with average Nm index of 40. Most of these spindles had been used for over 10 years by that time and they were under the need of renewing. By the year 1996, the industry had 800,124 spindles and 3,520 rotors. Among those spindles, 90,600 were new (about 11.32% of total) of which 55,960 spindles were replaced by West European second hand ones (7.0% of total), 107,000 spindles were upgraded (13.4% of total). The production capacity increased by 72,000-ton of fibers per year. Average Nm indexes is 61. (VINATEX). For the shuttle weaving: The industry had 10,500 weaving machines (by 1996). The newly imported machines accounted for 15%. The share of machines that could be restored is 45%. The rest were in need of selling off. Central SOEs owned 7,973 units, and among those units’ modern, the number of weaving machines was 978 or 12.26%. To that date, a half of total weaving machines of textile industry was too old and unable to run. For example, in the North, approximately 5,000 units (made in China) were dated back to 1950s, 1960s, and early 1970s. In the South, a part of the old textile equipment is ones that were imported from Japan, USA, Korea in the period 1960 – 1974 (VINATEX).

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For knitted weaving: The technologies of knitting industry are relatively more modern than other textile technologies. Most of out-of-date machines that were imported before 1986 from China, Czechoslovakia and East Germany have been liquidated or transferred to localities and all machines in use now are ones that were imported after 1996. The equipment was imported mostly from Japan, Korea, Taiwan, and Germany. 30% of those are machines of new generation with some being controlled by computer, and the rest are of older ages and less advanced. Because of low quality of cotton fiber, almost all enterprises have chosen production plan using Pe/Co fiber to produce simple consumer goods such as mosquito net, valise fabrics, not to produce decorated cloth, carpet, cloth for construction and the like. For dyeing and printing sector: All dyeing, printing and finishing equipment was imported from abroad and belong to SOEs. At present, 35% of dyeing and printing equipment in the industry have been imported since 1986 (about 400 units). All of them are equipment of A2, A3 generations and still operating well. 30% of dyeing and printing equipment were imported in the period 1970 – 1985. This equipment is in need of repair for further use. The rest were imported in the period 1959 – 1969. This equipment should be scrapped gradually (VINATEX). For garment sector: At the beginning, the industry used man-powered sewing machines, which were then gradually replaced by industrial sewing machines made in China, the former Soviet Union, West Germany, Hungary and Japan. From 1991 up to now the industry has invested in technology renovation in order to expand production and improve the quality of products to meet requirements of international market. Almost all sewing machines are modern ones with high speed of 4,000 – 5,000 circles per minute. Some enterprises such as Garment Company No 10, Viet Tien Garment Company are equipped with sewing machines with some automatic functions (VINATEX). The industry has also bought numerous specialized machines. Some enterprises have invested in synchronous production lines by using many specialized machines to produce one category such as shirts, jeans etc. Almost all of garment enterprises use steam-ironing system. Since 1991, technology in garment sector has been renovated. Production lines have been set up with medium and small scale, consisting of 25 – 26 sewing machines with 34 – 38 laborers. Thus garment enterprises now are capable of handling production being stable within two days when product style changes. Some enterprises have used new technology and computer in some production functions such as cutting. These changes help to enhance competitiveness of garment producers, most notably their ability to respond quickly to changing demand. Finishing stage such as ironing, pressing, packaging is considered to be of great importance, as it helps to increase the value added of the final product. There have been relatively few technology innovations at this production stage to ensure a high quality.

2. Utilization Capacity and Efficiency of T&G industry As compared to production capacity, the actual production in the textile sector is low, especially actual production of fabrics has achieved 60% only (VINATEX, 1997). The

28

reason is that shifting from the centralized economy to a market economy, many enterprises could not catch up the situation. Several large scale enterprises equipped with outdated equipment to produce the fabrics with narrow width, low quality and high cost could not be able to sell their products in the market and had to cut down the production or to close the enterprise for waiting of equipment renovation. A bad news for T&G is that these two industries had the lowest level of utilization rates among the manufacturing industries both in 1997 and first half of 1998. And for these two industries, textile has had lower rates of utilization than the rates of garment industry. In 1997 the textile industry had utilization rate of 75% or 9 months per year, the data for garment industry are 81% or 9.8 months. The situation in 1998 was even worse due to the negative impact of regional financial crisis, but likely to have recovered recently.

Figure III-1:Utilization Rates of Some Manufacturing Industries in 1997 Source: Results of survey on Industry 1998, GSO 1999

3. Efficiency of T&G industry Table III-1 shows that labor productivity of Vietnam’s T&G industry as measured by value added per worker was very low in the early 1990s in comparison with other countries. Productivity was particularly low as compared to Korea, Taiwan and Singapore, but in recent years, Vietnam’s ratio of value added per worker has caught up with China. The financial crisis has had a significant negative impact on Asian countries in 1998, and as a consequence, labor productivity in these countries has fallen dramatically while Vietnam and China were less affected and productivity of T&G industry in these countries continued to increase.

70%

80%

90%

100%

Woo

den

Textil

e

Garmen

t

Drinkin

gPa

per

Leathe

r

Publi

catio

n

Rubbe

r

Mac

hinary

Tobac

o

%

29

Table III-1: Value Added per Worker of Textile and Garment Industry (Constant Prices in USD)

Year Vietnam China Indonesia Malaysia Korea Taiwan Singapore1993 870 2,260 3,600 7,260 27,090 22,300 13,9601994 990 1,580 4,600 8,750 29,900 20,000 14,8401995 1,380 1,490 3,900 9,890 37,870 20,300 16,2701996 1,720 1,490 4,000 10,450 37,210 22,500 16,2701997 1,720 1,650 3,700 10,700 33,160 22,900 16,1901998 1,770 1,760 1,100 7,980 20,510 21,100 15,560

Source: estimates by UNIDO and DSI

The Vietnam’s T&G industry is still in early stage of development, and therefore it mainly exploits comparative advantage based on cheap labor. The share of labor cost in total value added of Vietnam’s T&G industry is lower than in other countries. The lower ratio of labor share in total value added could be explained by low relative price of labor over capital in Vietnam, which is much lower than in some other countries. This indicates the scarcity of capital in Vietnam as compared to other countries. Within one country, share of labor in total value added of textile industry is lower than that of garment industry, as textile industry is more capital intensive than garment industry.

Table III-2: Share of labor remuneration in total value added of the textile and clothing industry in 1996 (%) Textile Clothing Other manufacturing Hong Kong 55 70 50 Republic of Korea 51 69 47 Taiwan 53 77 53 Indonesia 33 50 19 Malaysia 53 47 31 Philippines 42 61 36 Singapore 82 74 41 Thailand 20 35 19 China 42 52 37 Vietnam* 31 51 - South Asia 43 53 37

Source: Studies in Trade and Investment 17, United Nations, New York, 1996. *: Data for 1997 are derived from T&G Competitiveness Survey carried out by Institute of Economics

IV. MARKETS FOR TEXTILE AND GARMENT PRODUCTS

1. Domestic market The development of T&G industry over past years as presented in previous parts gives the pattern of local consumption of T&G products. In general, while garment local consumption is increasingly satisfied by local production, meeting local demand for textile products is still heavily dependent on imports due to low output per capita of textiles as shown in Table II-6. It is estimated that the share of domestic garment products in local consumption has substantially increased from about 60% in 1994 to 85% in 1997, while the share of textile domestic production in local consumption has remained unchanged at

30

50% over the past years (Det May Vietnam, 1998). Vietnam now still depends strongly on textile imports, which are used as both inputs for textile production and final consumer products. The import volume of T&G products has increased substantially over the past years and T&G imports have become one of largest components of Vietnam’s total import.

Table IV-1: T&G import and its share over total country import 1994 1995 1997 1998

Total T&G (mill. USD) 391.3 710.9 1049.2 1728.1Country import (mill. USD) 5825.8 8155.4 11592.3 11499.6Growth rate of T&G import - 82% - 65%Share of T&G import/ total country import 6.7% 8.7% 9.1% 15.0%

Source: GSO

1.1. Domestic Market for Textile Products

Textile import products are facing different tariffs depending on the usage of products: for production input or for consumption. For example, cotton, synthetic fiber, filament, dyestuff, machinery the tariffs rank from 0 to 5%, the others are at 10-20%, and 40% for consumer goods. Import tariffs will be discussed in more details later in a section on trade policy. Despite of high tariffs, fabrics still make up a major share of country's total textile imports. The big share of fabric import is because it is imported both for local consumption and for inputs of garment industry for export, which has had high growth rates in last years. In addition, as discussed that the input base of textile industry has poorly developed, and therefore, the fiber and cotton combined still make up a significant share in total textile import (Table IV-2). In general, local consumption of textile products is still considerably dependent on imports, which go to both production and consumption. Local production can satisfy less than half of total local consumption, according official statistics. As smuggled textile products are not reflected in these statistics, but are believed to be very large, the share of imports in total consumption is apparently understated.

Table IV-2: Structure of imported textile products (%)

1997 1998 1999 Fiber 21.8 10.7 24.6 Cotton 15.0 20.4 11.5 Cloth 63.2 68.9 63.9 Textile 100.0 100.0 100.0

Source: VINATEX

1.2. Domestic Market for Garment Products

In general, the local demand for garment products is satisfied by garment informal (household) enterprises. In the countryside, where income of people is very low, most of the demand for garment products is still supplied by tailors with very low service price,

31

and in the cities, demand for ready-made clothes is till not big although has started to rise in recent years. As result of this pattern of consumption, local consumption is mainly met by household enterprises with most of formal enterprises focusing on foreign markets. Some years ago, the imported garment products (including smuggled goods) from China, and some neighboring countries were easy to find. In recent years however, the volume of imported garment products is believed to be reduced sharply due to the development of local production. Table IV-3 shows that the share of garment imports was approximately 40% in 1998 (article HS 62), but this article includes most of materials for garment production of which fabrics are the biggest item. For example, 1994, among garment products (HS 62), share of material was 99.9% in 1995 and 90% in 1997.

Table IV-3: Structure of Imported T&G Commodities of Vietnam at Two Digits in 1994, 1995, 1997 and 1998: (%)

HS COMMODITIES 1994 1995 1997 1998 50 Silk 0.6 0.9 2.4 1.7 51 Wool, fine or coarse animal hair, horsehair yarn and woven fabric 2.6 2.2 1.0 0.4 52 Cotton 15.5 18.4 24.8 11.8 53 Other vegetables textile fibers; paper yarns and woven fabrics of paper

yarn 0.0 0.0 0.0 0.2

54 Man made filaments 1.0 0.2 2.6 9.2 55 Man made stable fibers 40.6 33.8 29.5 25.9 56 Wadding, felt and nonwovens; special yarns; twine, cordage ropes and

cable and articles thereof 0.4 1.0 3.4 2.9

57 Carpet and other textile floor coverings 0.1 0.0 0.8 0.2 58 Special woven fabrics; turreted textile fabrics, lace; tapestries; trimmings,

embroidery 0.0 0.1 8.5 1.8

59 Impregnated, coated, covered or laminated textile fabrics; textile articles of a kind suitable for industrial use

0.3 0.4 9.0 6.9

60 Knitted or crocheted fabrics 0.0 0.5 0.1 61 Article of apparel, and clothing accessories, knitted or crocheted 0.1 0.0 1.6 0.1 62 Article of apparel, and clothing accessories, not knitted or crocheted 38.7 42.9 14.2 38.5 63 Other made up textiles articles; sets; worn; clothing and worn textile

article; rags 0.0 0.1 1.7 0.4

TOTAL 100 100 100 100.0

Source: GSO

2. Exports Since “DoiMoi” started, Vietnam's garment and textile exports have grown up rapidly. The industry has successfully shifted from its traditional CMEA market to Western and Asian markets after the collapse of the CMEA in the early 1990s. Exports have risen from USD 120 million in 1990 to over USD 1.5 billion in 1997, and 1.7 billion USD in 1999. As a result of good export performance, the industry has become the second biggest

32

foreign exchange earner6. Among T&G exports, the garments take the lion share. It is understandable because the textile industry’s technology is more obsolete than technology in the garment industry, and market conditions are more favorable for garment products, which receive preferential treatment in EU markets in the form of quotas.

Figure IV-1: Export Share of Textile and Garment 1985-1998

Source: UNIDO, MPI, and GSO

The Asian crisis has negative impacts on outputs as well as inputs of exported products of the industry. Vietnam has to compete with Southeast Asian countries whose currencies were substantially devaluated, and China, who is believed to be the strongest competitor on the world market of textile and garment products. Because of the regional financial crisis, wages in these countries dropped considerably, which further eroded Vietnam’s T&G competitiveness. It is reported that foreign clients (mostly from Korea and Japan) cancelled orders, or they demand large price cuts of up to 20% for subcontracted orders in which clients provide inputs to Vietnamese producers-exporters. As a result, 1998 and 2000 saw negative and small positive growth rates of T&G export of -3.5% and 5% respectively. In recent years, some textile products were exported but the share of these products is tiny. Export products of textile industry include towels and handkerchiefs and embroideries, and the share of these products in total textile export seems to be insignificant. Recently, some other textile products such as fibers and fabrics started to be exported, but most of these exports are from foreign invested enterprises. For example, in 1998 if knitting is

6 According to IMF data, the T&G exports in 1997 overtook petroleum in terms of export earnings, but according to Vietnamese statistical data, petroleum is still the biggest foreign exchange earner.

0%10%20%30%40%50%60%70%80%90%

100%

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

(%)

GarmentTextile

33

excluded from textile production, total value of textile exports (including yarn and fabrics) was about USD 62 million or 4.8% of total T&G exports.

Table IV-4: Structure of T&G Exports in 1994, 1995, 1997 and 1998 (%) HS COMMODITIES 1994 1995 1997 1998 50 Silk 2.11 1.09 1.32 1.1 51 Wool, fine or coarse animal hair, horsehair yarn and woven fabric 1.61 0.00 0.30 0.0 52 Cotton 1.01 0.61 0.54 0.5 53 Other vegetables textile fibers; paper yarns and woven fabrics of paper

yarn 0.46 0.29 0.22 0.2

54 Man made filaments 0.01 0.57 0.28 1.0 55 Man made stable fibers 2.62 6.39 2.02 3.0 56 Wadding, felt and nonwovens; special yarns; twine, cordage ropes and

cable and articles thereof 0.10 0.11 1.04 0.7

57 Carpet and other textile floor coverings 2.43 1.59 1.39 1.3 58 Special woven fabrics; turreted textile fabrics, lace; tapestries; trimmings,

embroidery 1.71 1.54 0.48 0.0

59 Impregnated, coated, covered or laminated textile fabrics; textile articles of a kind suitable for industrial use

0.00 0.00 0.04 0.0

60 Knitted or crocheted fabrics 0.00 0.00 0.00 0.0 61 Article of apparel, and clothing accessories, knitted or crocheted 8.86 6.04 11.48 15.6 62 Article of apparel, and clothing accessories, not knitted or crocheted 73.72 77.11 77.94 72.6 63 Other made up textiles articles; sets; worn; clothing and worn textile

article; rags 5.35 4.65 2.95 3.8

TOTAL 100 100 100 100.0 SHARE OF T &G EXPORT OVER TOTAL EXPORT 14 16 17 15

Source: GSO

In summary, the main items of Vietnam’s T&G imports are inputs for production and a small share of consumer goods and the main items of T&G exports are consumer goods – garment products and some textile ones. Although the industry has to rely heavily on the imported inputs, totally the industry till gains from trade, which has been growing fast in recent years.

2.1. T&G Export Markets

EU – important market for Vietnam’s T&G7

Figure IV-2 presents the structure of export markets of Vietnam' T&G. In the figure, quota markets are not presented separately, but one can take Europe as proxy for EU market share because the shares of Norway and Canada (quota markets) and other non-quota European markets are tiny at a few percents. Asian countries constitute the largest export market although their importance has declined somewhat since 1995, in part because of the Asian crisis. Japan is the biggest

7 Defined to include quota-regulated markets of Canada and Norway. However, the total export to these two quota markets is not so significant, about 24 million USD in 1998, smaller than fourteenth largest importer – Switzerland

34

market followed by Taiwan and South Korea. It is widely perceived that Asian traders (Taiwanese, Koreans, Singaporean and so on) buy Vietnam’s T&G products not for consumption in their own countries, but to export to other countries.

Figure IV-2: Export market shares of T&G

Source: GSO and Vietnam's Economic News.

Quota granted by EU has played a particularly important role in helping Vietnam’s T&G industry to step into the world markets and to rapidly grow up. The agreement on textile and garment trade between Vietnam and EU was initialed on December 15, 1992 and took effect from January 1, 1993. According to the agreement, Vietnam was entitled to export to EU 151 categories, of which 46 were not subject to quota. In addition, there were 13 categories produced through subcontracts (embroidery, lace etc.), accounting for hundreds of tones per year. Allowed by quotas, Vietnam’s T&G exports to EU markets have sharply jumped up, from USD 250 million in 1993 to USD 350 million in 1995, USD 450 million in 1997 and USD 650 million in 1998 (Vietnam’s Investment Review, April 1998).

It appears that Vietnam’s T&G industry is still not fully ready to participate in the world markets. First, Vietnam’s T&G has never used up some categories of the granted quotas, due to the lack of appropriate technology, and labor and business skills. For example, at the beginning, the quota in 1992 covered 106 items, but Vietnam’s T&G was able to fill up only one third of those items. In 1995, the number of items was revised down to 54, and in 1998 dropped further to 29 while the total volume has almost remained unchanged at around 23 thousand tons per year (Vietnam’s Investment Review, 01/11/1998). The majority these 29 items are uncomplicated products, which do not require modern machine or sophisticated labor skills. These items include, for example, shirt, trousers, home dresses, jackets and so on. The export value of jacket items has made up 50% of total export value to EU market in recent years. (Le Van Thang, Det May Viet Nam, 1998).

0 %

1 0 %

2 0 %

3 0 %

4 0 %

5 0 %

6 0 %

7 0 %

1 9 9 5 1 9 9 7 1 9 9 8 1 9 9 9

A s i a E u r o p e A m e r i c a O t h e r

35

Markets in the Former Soviet Union and East European countries may have a good potential. Up to now Vietnam, has exported to these markets mostly in the form of commodity exchange and debt liquidation. The share of total export to Former Soviet Union is still modest (it was about 2,8% in 1997), although this market was the biggest one in the past. Vietnam's T&G export to the US market is still insignificant. Up to 1999, although Vietnamese T&G producers have tried to access to the US market, their efforts have not resulted in big success, with share of T&G export to the US never reaching 2%. In 2000, Vietnam and US signed Bilateral Trade Agreement, and this will open a new era for Vietnam's T&G industry. Most producers have already begun to make necessary preparations to access this market. Some have sent delegations to participate in trade fairs, others export product without profits to have an early penetration into the market in anticipation of approval of the Agreement by the two countries.

2.2. Sub-contract – A Major Distinctive Feature of Vietnam’s Garment Export

Despite sufficient capacity of production and availability of export quota grants, most of Vietnam’s garment producers have so far mainly worked on subcontracts for foreign brokers due to poor international marketing skills. Under this form, the buyers from EU, Japan, North America) do not give orders directly, but through middleman, mostly from Taiwan, Korea, Hong Kong, Japan. The value added that Vietnamese producers receive is low under this form. On average, Vietnam producers do not receive more than 20% of recorded export value, as they get mainly make-cut-trim payment. The rest, 80% of export value, are captured by foreign buyers and brokers, who normally provide materials, accessories and design. Nearly 80 percent of textile and garment export values are made through processing orders (VINATEX).

Chart IV-1: Vietnam in the International Manufacturing Triangle

Subcontracts with foreigners are not always implemented by firms who signed the contract with foreigners. A part of these subcontracts will be redistributed to other producers who are located far off big cities, normally in remote (rural) areas, and do not have export quota and marketing skills. In fact, some large firms work both as producers/exporters and immediaries. In general, there are some reasons behind this kind of business including uneven quota allocation, the time constraint for large firms to fulfill

Foreign Customers: (EU; Japan; Canada; others)

Vietnam's Producers

Asian Intermediaries: (Taiwan; Korea; Japan; Hong Kong and others)

20%

80%

36

the contracts, and the poor infrastructure that small/remote firms face. Although at present, some important factors such as low labor and land costs of small/remote firms have not fully played their potential role, it is expected that with the rapid improvements of hard and soft infrastructures as happening now in Vietnam, they are playing an increasingly important role to help small and remote firms to connect to international markets.

V. BUSINESS ENVIRONMENT OF TEXTILE AND GARMENT SECTOR The previous sections have shown impressive achievements of the textile and garment sector in Vietnam over the past decade in terms of growth of output, export and employment. It can be seen in Table I-1, the sector has been growing faster than the economy as the whole during the period 1994-1999. In particular, over this period, the garment sub-sector on average grew three times faster than the economy, while export earnings increased by four times. As mentioned earlier, the success is in part attributed to favorable external conditions, particularly to Vietnam’s preferential access to EU market, and its penetration into the large markets of Japan and other East Asian countries. However, it is also widely believed that the big progress in domestic economic reforms makes a significant contribution to the sector’s success. Literature review has identified three plausible policy-related factors that are suggested by Vietnamese and international researchers as playing important role for export success of Vietnam’s textile and garment sector. These factors include (i) a reasonably “realistic” exchange rate; (ii) reasonably effective duty drawback scheme and good functioning of industrial zones; and (iii) the adoption of a policy of a reasonably open posture toward foreign direct investment. The remaining factors that are not directly related to policies, include (i) competitive wage of low-skilled workers; (ii) Vietnam’s fortunate position in a region of (until recently) exceptionally high, export-oriented growth; and (iii) Vietnam’s experience in export of textile and garment prior to Doi Moi8. On the other hand, it is also widely recognized that there still exist visible constraints to further development of the sector and these constraints should be soon removed or at least relaxed if the sector is to sustain its fast growth. The following sections present our analysis of the business environment and relevant policies affecting Vietnam's textile and garment industry with a view to identifying constraints and distortions that affect performance of the whole sector and/or of particular groups of firm. This information will therefore provide important inputs for the subsequent quantitative analysis of cost-based competitiveness of textile and garment firms, which will be presented in a separate report. Aspects of Vietnam's business environment to be considered include the following:

1. Trade policy; 2. Foreign exchange policy 3. Financial market;

8 Hill, H. (2000): "Export Success Against the Odds: A Vietnamese Case Study", World Development, 28(2), pp.283-300.

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4. Taxation policy 5. Labor market. 6. Some other policies

1. Trade policy

This part presents an analysis of key component of trade policies including import tariffs, customs procedures, quota allocation, foreign exchange control and foreign exchange rate.

1.1. Import tariffs

As already shown in a trade policy report that presents our analysis of nominal and effective rates of protection, although the average tariff for the whole economy is modest at between 15-19%, the dispersion of tariff rates is high with coefficient of variation (ratio of mean over standard deviation) being estimated at 0.91-0.96. A major cause of large dispersion of tariff rates, as identified in that report, is Government policy of heavy protection of domestic production at the expense of final consumers and to certain extent, downstream production. Another feature of import tariffs is that they tend to give higher protection to production of consumer goods than production of inputs. There may be several explanations for this. First, as a result of Government’s policy, many domestic producers of consumer goods have emerged in Vietnam since Doimoi began and for the same reason as mentioned above, are more heavily protected9. Second, consumer goods tend to have higher share of value created in this country and therefore need higher level of protection.

These features result in (i) higher import tariffs for products that can be produced domestically; (ii) higher import tariffs on consumer goods as compared to inputs for production. These observations are, as will be shown in what follows, true for the textile and garment sector. For example, the some input of textile production such as cotton, synthetic fiber, filament, dyestuff, machinery, which cannot be produced domestically, the tariffs are low in a range from 0 to 5%. For other items that can be produced by domestic firms, tariff rates are set at 10-30%, or even higher. In order to offset the negative effect on international competitiveness of domestic producers who use these items as inputs for their production of export products, the duty drawback scheme is applied. How this scheme works will be discussed in the following section on customs procedure. With regards to items that are classified as consumer goods, tariffs are normally high or very high. Some textile products such as woven fabrics and clothing accessories are subject to a high tariff rates of 40% and 50% respectively. Some items, although primarily classified as consumer goods on the basis of their major usage, can also be used as inputs for downstream production. In this case, tariffs applied vary considerably depending on the 9 Vietnam’s manufacturing sector has grown rapidly since the renovation process began 15 years ago. Production of consumer goods was one of the three programs promoted by the Government (the other two are export and agriculture). As a result, many items of consumer goods can nowadays be produced domestically and the Government tends to protect these industries.

38

usage (Table V-1). If an imported item is used as an input for production, the tariff imposed is lower than the case when it is used for final consumption. Although there are valid reasons for such discrimination, such practice leads to complicated customs procedure and as will be discussed in the following section, may cause some troubles to garment producers who target the domestic market, particularly when the differentials in applied rates are large. The high tariff rates are also a major cause of widespread smuggling of fabrics from China and Thailand, as the price differentials between domestically produced and foreign goods are sufficiently large to make smuggling highly profitable. Vietnamese market is nowadays flooded with smuggled goods from Thailand and particularly China. However, with Vietnam’s commitments under various trade agreements, there is a clear tendency towards lowered import tariffs including those that are directly related to the textile and garment sector.

39

Table V-1: Tariffs of T&G products and some other selected industrial products (percentage)

HS Item

Input Product Minimum Maximum

Average

34 Soap 0.9 26.2 0.0 50.0 17.3 39 Plastic and articles thereof 1.1 24.2 0.0 45.0 10.8 40 Rubber and articles thereof 1.9 32.1 0.0 50.0 13.0 44 Wood and wood products, wood charcoal 3.0 38.0 0.0 54.0 13.4 48 Paper, paperboard, articles of paperboard 0.4 23.3 0.0 40.0 14.5 50 Silk 2.5 19.4 0.0 35.0 13.8 51 Horsehair yarn and woven fabric 0.2 28.8 0.0 40.0 17.8 51 Cotton 0.0 26.1 0.0 40.0 19.2 53 Other vegetables textile fibers 2.0 21.0 0.0 40.0 11.5 54 Man made filaments 0.5 31.3 0.0 40.0 4.1 55 Man made stable fibers 0.7 16.1 0.0 40.0 11.1 56 Wadding, felt and nonwovens; special yarns 0.0 20.9 0.0 40.0 15.3 57 Carpet and other textile floor coverings - 40.0 40.0 40.0 40.0 58 Special woven fabrics - 39.5 35.0 40.0 39.5 59 Impregnated, coated, covered or laminated

textile fabrics 1.0 22.1 0.0 35.0 10.2

60 Knitted or crocheted fabrics - 35.0 35.0 35.0 35.0 61 Article of apparel, and clothing accessories - 50.0 50.0 50.0 50.0 62 Article of apparel, and clothing accessories,

not knitted or crocheted - 50.0 50.0 50.0 50.0

63 Other made up textiles articles 0.0 38.8 0.0 60.0 25.6 64 Footwear, gaiters and the like - 45.0 20.0 50.0 27.9 65 Headgear and parts thereof 0.2 32.5 0.0 50.0 20.1 69 Ceramic products 0.4 37.3 0.0 45.0 27.1 70 Glass and glassware 1.0 30.4 0.0 45.0 14.6 72 Iron and steel 0.7 28.0 0.0 40.0 4.0 73 Products of iron and steel 0.8 23.1 0.0 60.0 9.7

Total average 0.0 60 14.3

Source: Ministry of Finance

1.2. Customs procedure

Abolishing the import-export license in 1998 by Decision 55/1998/QD-TTg has removed one of the biggest barriers to the free trade of ordinary goods and encouraged private sector participation, whose share in total non-oil exports and imports jumped up sharply, from 12% and 4% in 1997 to 22% and 16% in mid-2000 respectively10. Significant efforts

10 World Bank. Vietnam Development Report 2001 “Vietnam 2010: Entering the 21st century. Pillars of Development”, Hanoi, December 2000, p.24.

40

have also been made to simplify the customs procedure. However, there still exist some difficulties that export and/or import firms face when having their goods cleared through customs. The fact that one import item may be subject to different tariff rates depending on the usage causes some troubles for both customs officers and importing firms. Firms have to prove that imported goods are really used for the stated purpose to be eligible for low tariff rates, which is normally time-consuming. A similar problem exists for CMT-based garment export firms where the customs officers have to carefully check to ensure the right amount of duty free imported inputs that is needed for production of exported goods. As will be shown in a separate report on qualitative analysis of competitiveness of Vietnamese textile and garment firms, these problems, although not too serious, make the concerned firms irritating.

1.3. Quota allocation

Allocation of export quota mainly affects export-oriented garment firms. Until the year 2000, quotas to EU, Canada, and Norway markets were distributed based on different criteria such as production capacity, rate of quota utilization in the preceding year, new investment for upgrading product quality and so on. Moreover, quota allocation was also used as “a social policy” for poverty alleviation (Vietnam Investment Review, 11/17/96). The way that quota was allocated is not transparent with VINATEX playing a decisive role. This leads to rent-seeking behavior of garment export SOEs with associated social loss. It should however be noted that some progress has been recently made in reforming the quota allocation mechanism with the introduction of auction of a part of quotas in December 1998. A rising share of quotas on garment exports to Europe has been auctioned since then, thus permitting easier and more transparent access to private garment exporters. In the first auction, the private sector represented 44 percent of the bidders and 26 percent of the winning bids in that auction11. More importantly, with an increasing share of exports to non-quota markets and in the context of ATC phase-in, export quota has been losing its attractiveness to garment export firms. In short, the mechanism of quota allocation, although led to rent seeking behavior among garment export SOEs in the past, has been rapidly becoming less distortionary due to both the reform of quota allocation mechanism and the rising share of Vietnam’s non-quota markets. In summary, prior to 1999, the trade regime in Vietnam could be characterized as restrictive. However, since then, a number of reforming measures were undertaken in face of Asian financial crisis, which have had a mixed effect on the textile and garment sector. The trade policy has now become more favorable for export-oriented garment firms. For textile firms that mainly target the domestic market, the effect is mixed. On the one hand, they benefit from lowered tariffs on their inputs and from improved customs procedure. On the other hand, pressures of international competition are mounting due to the tendency towards lowered tariffs on competing import goods.

11 World Bank. “Vietnam: Preparing for Take-Off? How Vietnam Can Participate Fully in the East Asian Recovery”, Hanoi, December 1999. p. 41.

41

2. Foreign exchange policy Vietnam still applies tight control over foreign exchange. There are two major interrelated components of the foreign exchange regime: (i) management of exchange rate; (ii) foreign exchange control.

2.1. Exchange rate management

The exchange rate regime in Vietnam may be classified as managed floating. Prior to 1999, the State Bank of Vietnam (SBV) regulated exchange rate by setting the ceiling, which had to be strictly followed by all banks and credit organizations. However, prior to the Asian financial crisis, the capital inflows were so large that frequently made the ceilings non-binding. But after the Asian financial crisis broke out, there were spells when the country experienced severe foreign exchange shortage, which was due to both the weakened capital inflows and the heavily regulated exchange rate. Then, by Decision 88/1998-QD-NHNN7 28th February 1999, the ceiling was replaced by a mechanism according to which SBV announces the daily base rate, which is equal to the average rate in the previous session of forex transactions in the inter-bank market. On this basis, commercial banks are allowed to set their own rates within a band of 0.25% around this base rate. As long as the inter-bank market conducts only three working sessions a week, the maximum changes in exchange rate in the official market are ± 3% per month and that is why the exchange rate regime in Vietnam can be classified as managed floating. This new regulation of foreign exchange rate can be considered as a move forward towards a fully market-based rate, as exchange rate set this way is in principle more responsive to the changing market conditions with regards to demand and supply. Yet, theoretically, this regulation provides less room for SBV’s discretionary intervention in the forex market. However, in practice, there have been complaints from commercial banks about non-transparency of this mechanism, particularly with regards to how the base rate is calculated and set. Foreign banks sometimes complained that the base rate does not seem to be responsive to their heavy transactions in the forex inter-bank market. On the other hand, SBV is cautious about speculative attacks by foreign banks and therefore tends to set the base rate in such a way that helps defend the domestic currency. The stability of exchange rate is given a top priority and sometimes has to be achieved by non-market instruments. Under these regimes of exchange rate management, be it ceiling-based or base rate setting, the exchange rate in the official market in Vietnam has been apparently distorted. The degree of distortions was apparently significant during the Asian financial crisis, when the balance of payments was under huge pressures and so was the exchange rate. During these spells, there was considerable excessive demand for foreign exchange from importing firms and some of them had to buy foreign exchange in the unofficial market to meet their urgent needs. The difference in exchange rates between the official and non-official forex markets in normal times is not very large, estimated at just a few percents. However, at some points in time, the differential was as large as 10% or higher. This happened quite frequently in 1997 and in some spells in 1998. Besides, during normal times, exchange rate in the unofficial market is likely to be also overvalued, as the Government’s strict import control keeps down the overall demand for foreign exchange, although smuggling apparently to a certain extent erodes such an import regime.

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2.2. Foreign exchange control

The second source of distortions in the forex market is foreign exchange control. As mentioned earlier, the purchase of foreign currencies for import activities or debt services is under control of State Bank of Vietnam. In order to purchase foreign exchange from banks, firms are required to prepare and submit their purchase plans for their bank’s approval well in advance, normally in the preceding year. Firms can then purchase foreign exchange in accordance with the approved purchase plan subject to the bank’s forex availability. SBV only guarantees to satisfy demand for foreign exchange for firms that operate in SBV’s specified priority areas. To meet unplanned needs, firms must submit requests for bank’s consideration and the bank’s approval normally takes time and more importantly, is made at the bank’s discretion. For importing firms, foreign exchange control thus acts like a quota and is therefore classified as non-border measure of trade control. It is normally difficult for importing firms, particularly those that mainly target the domestic market, to get the needed amount of foreign exchange when the balance of payment is in deficit. In this case, foreign exchange control in combination with heavily regulated exchange rate is used to contain imports and defend the domestic currency from devaluation pressures. As a consequence, the domestic currency is considerably overvalued as compared to the equilibrium level, when the balance of payment is in difficulty, as was evident during the period of Asian financial crisis from mid-1997 to the late 1999. In addition, it is widely recognized that non-state firms have more difficult access to foreign exchange and loans in foreign currencies than SOEs, particularly during periods of severe foreign exchange shortage. When the Asian financial crisis set on, foreign exchange control was further tightened with the introduction of the surrender requirements according to which firms must immediately sell 80% of their foreign exchange balance to banks. This policy was relaxed in August 1999 with the required surrender ratio kept down to 50%. Although on paper firms are allowed to buy back the amount that it sold to the bank, there is no guarantee that this right can always be exercised. Even if firms can actually buy back the full amount of foreign exchange they sold to the bank, they are still exposed to the risk of exchange rate devaluation, which is high in periods when the balance of payments is in difficulty. In summary, despite some progress observed over the past few years, foreign exchange in Vietnam is still heavily regulated by the Government resulting in distortions in the foreign exchange market and overvaluation of exchange rate. These in turn apparently have had negative effects on the efficiency and competitiveness of the tradable sector in general and textile and garment industry in particular. These effects tend to vary across firms with different ownership structure and different targeted markets. Private firms normally have more limited access to foreign exchange in the official market and therefore tend to suffer more than SOEs. The apparently overvalued exchange rate and the surrender requirements tend to impose higher implicit tax on more export-oriented firms. These points will be discussed further in a separate report on the quantitative analysis of cost competitiveness of textile and garment firms in Vietnam.

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3. Financial market

3.1. Financial system in Vietnam

The banking system in Vietnam has been so far dominated by four large state commercial banks, which count for 80% of total country's deposits and lending. However, the number of commercial banks increased rapidly during the early 90x and by the late 1996, there had emerged 52 joint-stock banks, 23 foreign banks, four joint-venture banks, and 62 representative offices of foreign banks and 68 credit co-operatives operating in Vietnam. There were also about 900 people credit funds, two finance companies, and one state owned insurance company. In addition to theses financial institutions, there are some other state specialized funds of which the newly established investment and development fund is the biggest and plays crucial role in providing long term investment capital. In the late 90x, under SBV’s requirements, some joint-stock banks had to be merged with one another to become more competitive and viable.

T&G industry has its own financial company, the so-called Financial Textile-Garment Company. The company was established in 1996 with the main function of providing credit services to firms operating in the sector. Its major clients are state-owned garment companies under VINATEX and some private garment companies. (MPDF, 1999)

3.2. Financing investment capital

There are four sources of investment capital that domestic firms may access. The first source is long-term credits provided by commercial banks on a commercial basis. The second source of investment capital is the Government’s Investment and Development Support Fund, whose funds comes from state budget and the mobilization of domestic sources in the form of bonds or bank deposit, and from foreign borrowing. Government Investment and Development Support Fund provides long-term investment credit to selected industries or projects at subsidized interest rate. These subsidies are financed by the state budget. The third source of investment capital, which is very special, is soft loans and/or grants from foreign countries, which provided to selected areas/activities or industries through a special supporting program under bilateral agreements. And the fourth source is non-banking capital, including firm’s equity and funds mobilized from the informal banking system including the firm’s employees.

In theory, all domestic firms can access all these sources of investment capital. In practice, however, only state firms have access the Investment and Development Support Fund, which was set up to support government development programs, which provide credits on preferential terms to finance new projects or upgrade the existing plants. For example, interest rate of long-term commercial loan in 1997 was 1.1% per month, but loan from the Investment and Development Support Fund was just 0.8% per month, and the figures for 1998 were 1.25% and 0.81% respectively. It is obvious that firms that can access this Fund receive rent.

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Every year, the government compiles and approves a list of firms (projects) that are eligible to borrow from this Fund. These firms and/or projects are selected from pre-specified industries, which normally produce import-substituting goods or areas, which are normally economic centers or privileged areas. Although eligibility criteria for the Fund are announced officially, the selection process itself does not seem to be transparent. In practice, textile SOEs that produce import-substituting products have much easier access to this fund, because the funding is allocated through VINATEX. Moreover, non-transparency leads to unequal access even among textile SOEs. Firms with more connections and lobbying power have much more chance to get credits on preferential terms. Foreign firms are not entitled to this Fund.

Beside this Fund, ODA funds are also available to both SOEs and domestic private firms at preferential interest rate (0.4% per month in 1997). However, the number of firms that have actually borrowed is very limited. As long as the selection process is also non-transparent, it appears that only firms with significant lobbying power can access this type of financing.

With regards to access to investment capital from banks, officially there is no discrimination between SOEs and private firms, but in practice, SOEs are normally placed in a better position. The reason is rooted from the collateral/guarantee requirements that banks heavily rely on in making loans. Private firms are normally required to have collateral to be able to borrow from banks, while for SOEs, guarantee by authority (central and local) will suffice to get bank loans. In general, Vietnamese banks are in shortage of investment capital, because of the lack of long-term deposits, which in turn due to the regulated interest rate and low reputation of the banking system. As a consequence, it is normally hard to get long-term loans for investment capital. To overcome this, some firms have to take short-term loans for long-term investment. This mismatch of maturity causes many problems to these firms. It should be noted that while some textile SOEs can enjoy preferential treatment in long-term bank borrowing, garment SOEs generally do not have such a privilege.

Due to difficult access to loans from the four state commercial banks, private T&G firms have to borrow from non-state banks. These sources are however very limited. Joint stock banks in Vietnam were established only a few years ago with a (very) low capital base. As a result, they cannot mobilize sufficient funds to meet demand for long-term investment capital of non-state firms. Borrowing from foreign banks is another choice, but can rarely be exercised by non-state firms. Collateral again is a big constraint, because the process of granting the land user rights, which are a main type of collateral, is very slow. As a result, equity is a main source of investment capital of non-state firms, with the rest being mobilized from the non-banking system at considerably higher interest rates. Part of non-bank loans and also equity comes from the firm’s employees. But this form is more commonly used for working capital rather than investment capital.

3.3. Financing working capital

For working capital, there is no special fund like the Investment and Development Support Fund. All firms have to rely on formal banking system or informal capital market. The

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above-mentioned policy constraints to investment capital are also true for working capital, i.e. domestic private firms have very limited access to credit in the formal loadable market due mainly to the lack of collateral, and their poor reputation before these banks.12 Interest rates charged on bank loans are subject to SBV’s regulation, which sets the caps on lending interest rates (Table V-2).

Table V-2: Ceiling Interest Rates for Working Capital Year Currency Interest rates Issued by

VND 1,00 %/ month Decision No.197/QD-NH1 dated 28th June, 1997 1997 USD 8,50 %/ year Decision No.197/QD-NH1 dated 28th June, 1997 VND 1,2%/month Decision No. 39/1998-QD-NHNN1 dated 17th Jan., 1998 1998 USD 7,5%/year Decision No. 309/1998-QD-NHNN1 dated 10th Sep., 1998

1999 VND 0,85%/month Decision No.383/1999/QD-NHNN1 dated 22nd Oct., 1999

The regulation on lending interest rates has had two impacts on the effective borrowing interest rates of textile and garment firms. First, non-state firms tend to bear higher borrowing rates than SOEs due to their more limited access to the formal credit market. Second, although SOEs have better access to formal credits, their demand for loans is not always met, as the heavily regulated interest rate creates shortage of funds in the overall economy. In many cases, SOEs too have to resort to informal credits and consequently, their effective borrowing interest rates exceed the ceilings set by SBV.

These points are confirmed by data of our survey of 96 textile and garment firms for two years 1997 and 1998 (Table V-3). In 1997, the difference in effective borrowing rates for working capital between private firms and SOEs was 0.44% per month, and this figure for 1998 was 0.49%. These differences are both statistically significant at 1% level. For dollar-denominated loans, the difference is 0.1% per month for 1997, which is not statistically significant, and 0.28% for 1998, which is statistically significant at 1% level.

Table V-3: Monthly interest rates by ownership VND working capital USD working capital

1997 1998 1997 1998 Group* Obs Mean Std. Dev. Obs Mean Std. Dev. Obs Mean Std. Dev. Obs Mean Std. Dev.

Non-State 11 1.62 1.15 10 1.61 1.22 2 0.67 0.05 4 0.95 0.29State 36 1.17 0.11 39 1.12 0.07 14 0.66 0.07 16 0.67 0.07

Combined 47 1.28 0.58 49 1.22 0.57 16 0.66 0.07 20 0.73 0.17Diff 0.44 0.49 0.01 0.28t test** 2.341 2.589 0.1518 3.736**: test Ho, if diff = 0; Ha if diff is different form 0

Source: Calculated form the survey done by Institute of Economics, 1998-1999.

12 These problems are discussed in details in Report of Second Consultation Conference on Social-economic Development 2001-2010, MPI, Social-Economic Journal, 46/2000.

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As mentioned earlier, a main reason for higher borrowing rates incurred by domestic private firms is their more limited access to formal credits and this is also confirmed by our survey data (Table V-4). The table shows that the rejection ratio for private firms is significantly higher than for SOEs, for both investment and working capitals.

Table V-4: The success/failure of application for loans from the formal banking system in 1997 – 1998

Investment Capital Working Capital Apply ratio Rejection ratio Applied ratio Rejection ratio

State 52.6% 6.7% 75.4% 2.3%Non-state 46% 50% 50% 54%

Applied ratio = number of applied firms/total firm number Rejected ration = Number of Rejected firms/Number of Applied firms

Source: Calculated from survey data The difference in effective borrowing interest rates also varies across SOEs depending on whether they belong to central or local management. The local SOEs have to pay higher interest rates than central SOEs, but these rates are still lower than the ones paid that private firms have to pay. All the differences are statistically significant at 1% level. This may imply local SOE’s access to formal credit is something in-between those of central SOEs and private firms.

Figure V-1: Interest rates for more than 6 months working capital of T&G firms in 1997

Source: Calculated from survey data In summary, the financial market in Vietnam is considerably distorted due to the regulation of lending interest rates in the form of setting ceilings and the excessive reliance of banks on collateral, mostly in the form of land or government’s (central and local) guarantees. As a result, domestic private firms have more limited access to the

0%

1%

2%

3%

4%

0 1 2 3 4

1= Central state firms(12); 2= Local state firms (11), 3= Private firms (8)

Inte

rest

rate

/ mot

h

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official credit market and consequently, pay higher interest rates than SOEs. Among SOEs, centrally managed enterprises get more favorable interest rates due to their higher lobbying power to have better access to formal credits.

4. Taxation policies Prior to the introduction of VAT and Corporate taxes in the early 1999, Vietnam’s business sector was subject to four main types of taxes: revenue tax; profit tax; special sale tax, and import-export tax. This section will briefly discuss the first two taxes. Special sale tax was not applied to the T&G sector and therefore is not discussed here. Import-export taxes were already discussed in the section on trade policy in Vietnam.

4.1. Revenue/VAT taxes:

Revenue tax, which was promulgated in 1990 and replaced by VAT in the early 1999, had its rates in a range from 0% to 40%. Most of industries were subject to tax rates from 1 to 8%, of which the lower rates were applied to mining and basic machinery industries. Most of manufacturing sectors that produce consumer goods including textile and garment were subject to tax rates from 4% to 8%. The export firms were exempt from revenue tax. Besides, exemption is also applied to extraordinary circumstances, for example disaster. Newly established firms were entitled to 50% tax reduction for one year (and for the first two years if firm produced import-substituting products specially encouraged by the Government). Firms with different ownership structures were equally treated in terms of tax.

Table V-5: Selected revenue tax rates (see appendix 1 for more detailed) Item Tax rate (%) Production (average) 4.7 Construction (average) 3.0 Transport (average) 2.3 Sale (average) 2.9 Restaurant (average) 10.5 Service (average) 10.9 Total average 5.9

T&G (average) 5.5 - Handicraft weaving 4.0 - Engineering weaving 6.0 - Woolen 8.0 - Apparel 4.0

Source: Ministry of Finance

VAT was introduced in 1999 with four tax rates 0%; 5%; 10%; and 20%. Zero tax rate is applied for exporting firms, 5% applied for basic services or basic products, 10% applied for manufacturing or consumption goods producing industries or services, and 20% is for

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special businesses such as hotel, restaurant, jewelry products and the likes. Textile and garment firms are subject to the rate of 10%, and 0% if firms are export ones. In theory, VAT is a better method of taxation than revenue tax, because if properly designed and implemented, VAT leads to less distortions. However, there are two problems with VAT in Vietnam. First, unlike many other countries, VAT in Vietnam is non-uniform with 4 rates. The more non-uniform VAT is, the more distortions it may cause. Second, in practice, there have been numerous cases of discretionary reductions in rates and exemptions (normally applied to SOEs with lobbying power), which is another source of distortions and therefore should be soon withdrawn to ensure easier implementation of VAT and higher revenues in the future.

4.2. Profit tax

Profit tax law was promulgated in 1990 and it was replaced by corporate tax in 1999. The Law stipulated that all business establishments were subject to profit tax except foreign firms, which were regulated by Foreign Investment Law, and agricultural production units. Also according to the Law, heavy industry was subject to a rate of 25%, light industry 35% and commercial and service sector 45% (these were the revised rates). According to Law on Foreign Investment, foreign invested firms enjoyed lower tax rates that do not exceed 25%. Profit surtax was also applied. For private firms, extra profit in excess of VND 10 million per month was subject to a rate of 25%. For SOEs, surtax of 30-40% was charged on extra profit after some deduction for their own funds. Tax exemption was applied in some extremely special cases such as for firms operate in remote areas, or firms that are hit by disaster. Export oriented firms may be exempt from profit tax. The profit tax was replaced since 1999 by corporate tax with one unique rate of 32%. Therefore, by law there was no discrimination between SOEs and private firms in terms of revenue and profit taxes. This is also supported by data collected from our survey. For example, in 1997, the average tax rate for private firms was 2.04% whereas it was 2,25% for SOEs. These figures for 1998 were 2.05% and 2.72% respectively. Differences in effective tax rates are not statistically significant at any conventional levels (Table V-6). These tax averages may however be biased if export-oriented firms are over/underrepresented in each sub-sample (SOEs vs. private firms), as export is exempt from these taxes, regardless of whether the firm in question is a SOE or a private firm.

Table V-6. Average tax rates paid by state and non-state firms in 1998 Rates ranked by Export Ratio whole

sample <20% 20 - 40% 40 - 60% 60 - 80% 80 -.90% >90% Tax rate by

Law Non-state 2.1% 3.94% 3.94% 3.54% 3.54% 4.02% 2.13% Textile: 4-6%State 2.7% 3.66% 3.66% 3.44% 3.32% 3.67% 2.15% Garment: 4%Different -0.7% 0.3% 0.3% 0.1% 0.2% 0.4% 0.0% t-statistic 1.532 0.3384 0.3384 0.1428 0.3317 0.3525 -0.039 Source: Calculated from surveying data

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5. Labor market

5.1. General situation of Vietnam's labor market

With high growth rates of population, Vietnam has become thirteenth biggest country in the world in terms of population size (and the second biggest countries among South East Asia Nations). Its population reached 76.3 million in 1999. High growth rate of population and also high rate of labor force participation are reasons that the labor force of Vietnam has increased fast in recent years, reaching approximately 38 million in 1999. The unemployment rates fell in the period prior the Asian financial crisis, the unemployment rate in urban areas increased gain to reach 7.4% in 1999 as compared to 5.9% in 1995 (Statistic Yearbook 1999). In Vietnam, the share of agricultural employment out of total employment is high, but has been declining. It dropped to 66% in 1997/98 from 71% in 1992/93 (Living Standards Surveys 1992/93 and 1997/98). Labour withdrawn from the agricultural sector mainly moved to work in the industrial and service sectors, whose shares rose to 13.2% and 20.5% respectively in 1997/98. Although Vietnam has achieved relatively good human development indicators such as high rate of literacy, life expectancy, the country still suffers from a severe shortage of skilled labor, as technical, vocational and on-the-job training in Vietnam is weakly developed. For example, data from Living Standards Survey 1997/98 show that out of the population in the working age, more than half just finished primary school (56.6%), 32.8% finished secondary school, 8% received technical training, and 2.56% received training at the college and university levels (VLSS 1997/98). Like in other less-developed countries, employed people in Vietnam get a low pay. According to VLSS 1998, the average wage rate of Vietnam was about 52 USD per month13. The wage rate in agricultural sector was USD 48 per month whereas the rates in the industry and service sector in 1997/98 were higher at 53 USD and 55 USD per month respectively. In the corporate sector, wage rates differ across firms with different ownership structure. The rates are highest in the foreign invested sector, and lowest in cooperatives. Between them are wage rates in SOEs, domestic private and household enterprises, which do not differ much from one another. The low wage rate of cooperatives can be easily understood, as this sector has had a very poor economic performance since early 1990s and its share in GDP has been declining. According to VLSS 1997/98, monthly wage rates are USD 54.1 in state firms, USD 56.1 in domestic private firms, USD 54.7 in household enterprises, USD 26.8 in cooperatives, and USD 60.4 in foreign invested sector.

13 At the applied exchange rate VND 12,500 VND per USD 1.

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Insignificant differences in wage rates across industries and ownership forms suggests that ownership labor in Vietnam is highly mobile. These small differences may reasonably be explained by differences in skills or in job characteristics. However, the data on compensation14 to residents in various parts of the country do not seem to support the hypothesis of perfect labor mobility. For example, in 1997-1998, annual compensation in southeast region was by 44% higher than the average rate of compensation for the whole country, and the rate in Central highlands was by 32% lower than the country’s average. These significant differences in compensation among geographical areas may be due to high relocation cost, family-related additional costs and so on. Over the past years, the economy has experienced significant structural changes. Some industries such as construction, transport, electronics and T&G have been growing fast, while some other industries, notably agriculture have had their shares shrunk. The employment structure has been also moving in the same direction. Employment shares of manufacturing industries and construction have been increasing (especially the share of wage employment), while shares of other sectors have been shrinking.

Table V-7: Employment distribution by type of employment (percentage) 1992/93 1997/98

Wage Self-employed

Total Wage Self-employed

Total

Agriculture 26.6 80.8 71.1 17.6 78.0 66.2 Mining/heavy industry 3.1 0.4 0.9 3.2 0.6 1.1 Foodstuffs and tobacco 4.8 1.8 2.3 5.2 1.8 2.4 T&G 7.5 1.8 2.9 8.2 1.7 2.9 Electronics 0.6 0.1 0.2 1.0 0.0 0.2 Other light industries 13.3 2.0 4.1 10.3 2.4 3.9 Utilities 0.9 0.0 0.2 0.9 0.0 0.2 Construction 7.4 0.2 1.5 11.0 0.4 2.4 Hotel/tourism 2.0 1.9 1.9 1.0 1.6 1.5 Sales 3.2 8.4 7.5 5.3 10.6 9.6 Transport/ communication 4.4 1.2 1.7 5.4 1.3 2.1 Govt. and Social services 20.0 0.2 3.7 22.8 0.4 4.8 Others 6.2 1.3 2.2 8.1 1.3 2.6 Total 100.0 100.0 100.0 100.0 100.0 100.0

Source: VLSS, 1992/93 and 1997/98

5.2. Government policies with regards to the labor market

Minimum and maximum wage, and wage payment Minimum wage policies have been issued and applied to foreign invested firms since 1990 and to formal domestic enterprises since 1997.

14 Compensation is another measurement of income, which is relevant for both wage, and non-wage employees.

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For foreign invested sector, the minimum wage has been changed for several times. It was revised down from USD 50 per month in 1990 (Decision No. 365/LDTBXH-QD dated 29-8-1990) to USD 35 per month for urban areas in 1992 (Decision No. 242/LDTBXH-QD dated 5-5-1992), and then up to USD 40 per month in 1996 (Decision No. 385/LDTBXH-QD dated 1 April 1996). Minimum wage in foreign invested sector is set in USD, but payment is made in Vietnamese currency at the official exchange announced by State Bank. The minimum wage for domestic firms up to the year 2000 was set at VND144,000 per month (promulgated by Decree No. 06/CP dated 21/1/1997). As one can see below, all these minimum wages are non-binding for both domestic and foreign firms. In 1998, average monthly wage was about VND 650,000 in garment firms, VND 801,000 in textile firms, and VND 900,000 in foreign invested firms. The maximum wage has been also set and applied to state enterprises. The main objective of this policy is to control the wage bill of these firms. For example the Decision No. 1069/1998/QD-BLDTBXH made by Ministry of Labor and War Invalid in 1998 set the monthly average per head for state firm was at VND 900,000. Although this rate is much higher than average rate calculated from data of our survey, this cap apparently makes it more difficult for SOEs to lure qualified managers and/or skilled workers. Some SOEs seem to pay “hidden” wages to these scarce human resources. Our interviews have revealed that SOEs tend to under-report wages of these categories of employees. Beside the minimum wage, the law also regulates the rates for overtime work. Rate for overtime work must be 1.5 times the rate for work in normal time, and rate for work at weekend or in holidays must be double the rate for normal time work. However, these provisions of the regulation are not strictly followed in practice. Workers do not generally protest if not properly paid, as they are willing to take normal rate in extra-working time. This situation is mainly due to high competition for work. Labor recruitment Labor Contract Law was promulgated in the early 90s, as soon as Vietnam started to shift towards market economy. In 1995, Labor Recruitment Policy was also issued and put in effect. According to Labor Contract Law and Recruitment Policy, labor recruitment is not regulated and labor fire and the relationship between employer and employee is governed by the contract. Recruitment by foreign firms is however regulated. According to Circular No. 16/LDTBXH-TT dated 9 May 1996 made by Ministry of Labor, foreign invested firms cannot recruit employees directly, but are required to use the services of the Job Center. Although by law, firms are allowed to fire the workers, it is rarely done in SOEs due to strong resistance from trade union and other social organizations. However, overmaning in textile and garment state enterprises seems to be less serious than in other industries.

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5.3. Labor market in T&G industry

As discussed earlier, the wage rates do not considerably vary across firms with different ownership structure, but there exist some differences between textile and garment sub-sectors, which may be explained by differences in skills of workers. This is confirmed by data of our survey (Table V-8).

Table V-8: The average yearly wage per employee (million VND) by ownership and by type of production in 1997 Garment by

ownership Textile by ownership

T&G by ownership T&G by type of production

Group Obs Mean Obs Mean Obs Mean Group Obs Mean Private 23 6.08 7 6.95 30 6.29 T 25 8.01 State 36 6.75 18 8.5 54 7.34 G 59 6.5 Combined 59 6.49 25 8.07 84 6.96 Combined 84 6.9 Diff -0.67 -1.55 -1.05 Diff 1.5 t-test -0.79 -0.85 -1.32 t-test 1.92 Source: Calculated from survey data As shown in the table, the difference in annual average wage among state and non-state firms within each industry (textile or garment) does not vary very much. For example, the annual wage rate of garment state employee in 1997 was just 9% higher than private employee, and this figure for textile industry was 8.6%, both are not statistically different at any conventional levels. However, the t-test value on wage rate difference between textile and garment sub-sectors are statistically significant at 5% level. Tests are also done for sub-groups of employees such as manager, senior worker and worker to see if wages of these categories differ across firms of various types. The tests show that private firms paid lower wage than SOEs, but the differences are not statistically significant. For direct workers, although there is some difference between textile and garment firms, the difference is not statistically significant. In summary, the labor market both nation-wide and in the T&G sector is relatively mobile across ownership forms and there is no regulation with regards to recruitment and labor firing. Policies do not seem to discriminate between firms with different ownership structure, except recruitment by foreign firms is regulated.

6. Other policies

6.1. Price policy

With the shift to a market-based economy, price controls were largely dismantled. However, the government still controls prices of some “key” commodities such as petrol, electricity, telecommunication, cement, water and some others, or basic commodities such as rice. Among these commodities, prices of petrol, and telecommunication are considerably higher than world price. Telecommucnication tariffs are belevied to be

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double the international and regional counterparts. Fuels are frequently subject to very high import tariffs as shown in Table V-9.

Table V-9: Import Tariffs on Fuels (%) Diesel 50 Masout 12 Aircraft fuels (TC1, ZA1) 45 Kerosene 45 Naphtha, Reforate Component and these oils being the basic constituents of the preparations 60 Condensate and of the preparation 15 Others oils 7 Gas 30 Source: Ministry of Finance Although T&G industry does not intensively consume these coomodities, their production costs are affected.

6.2. Depeciation policy

Depreciation is under close supervision of Ministry of Finance. According to Decision No.1062/TC-QD-CSTC dated 14th 11,1996, as soon as new machine, equipment, or construction works start to operate, the firm is required to prepare and submit for approval a proposal on depreciation schedule. The rates of deprecation for each type of equipment are then approved by Ministry of Finance. For textile and garment firms, life cycle for deprecation are set at 10 years for machines or equipment, and 25 years for building and the likes. These rates are uniform among firms with different ownership structure.

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7. Summary of Policy Analysis

Table V-10: Summary of Main Policies that Have Impact on T&G industry

Scope of Impact

Policies

Economy-wide Textile Garment

Trade policies Tariff on inputs Not high, from 0 to 5% Not high and rebated if export Almost not effective due to the

dominance of CMT business Tariff on consumer goods

Very high Very high, at about 40% Very high, at about 50%

Tariff rebate Tax rebate applied if export

Not very effective because of low export share

Not very effective so far because of the dominance of CMT export. But potentially important, as share of FOB export is rising.

Export quota Set by EU for T&G, and quota on rice

Non-binding due to low quality of product

Taking about 50% of total export. Allocation is biased in favor of central SOEs. Only a small part of quota is auctioned out. Quota is traded regardless of prohibition.

Customs procedure

Quite complicated, but has been improved significantly over past few years

Impacted, but not too seriously. Firms have to incur “hidden costs” to overcome

Causes more problems than in the textile case due to the dominance of CMT business. Firms have to incur hidden costs. Problems do not seem to be too serious though.

Foreign exchange

Foreign exchange access

Access is not always easy, even for state firms. Foreign firms normally cannot buy.

SOEs have easier access due to the Government’s import-substitution policy

Access is limited, but it has no big impact due to the export orientation of the sub-sector.

Surrender requirements

80% of foreign earning has to sell to the bank. This ratio has been down to 50%

Almost no impact because little export.

Little impact on CMT export. Exchange rate risk is much greater for FOB export.

Exchange rate management

The gap between formal and informal markets is generally narrow, except some spells of large fluctuations

Apparently overvalued exchange rate has mixed effects on the sub-sector. Benefit from lower cost imported inputs and capital goods, but have to compete with imported products at lower prices.

Implicitly taxed by overvaluation of exchange rate due to the dominance of export over domestic sales.

Financial policies

Access to formal credit

SOEs have easier access than private thanks to government guarantee and their better access to land

Most of firms are SOEs, hence access is easier. But still suffers from the overall shortage of funds in the economy due to regulated lending interest rate. Some firms got subsidized credit for investment capital.

For SOEs, access to credit for working capital is similar as textile SOEs. But for investment capital, access is more limited than textile SOEs. Access of private firms is very limited

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Interest rate Regulation by setting ceiling on lending rates. Several different rates. Subsidies still exist.

SOEs enjoy lower effective borrowing rates due to better access to formal credit market. Some SOEs get subsidized rate for investment capital

Private firms have to pay higher rates due to the lack of access to formal credit market

Taxation policy Revenue, profit, special

sale taxes. In 1999, revenue tax was replaced by VAT, profit tax by corporate tax.

Revenue tax 4-6% for all. Profit tax 35% for all firms except foreign firms, for which a rate of 25% is applied. VAT rate: 10%

Revenue tax 5% for all. Profit tax 35% for all firms except foreign firms, for which a rate of 25% is applied. VAT: 10%

Labor policies Migration No barrier for internal

migration, but crossing border migration is restricted

No negative impact No negative impact

Working hours 48 hours per week Follow the regulation Sometimes worker has to work in extra time with flat pay

Minimum and maximum wage

Minimum VND 144,000 for domestic firms, and USD 35 - 45 for foreign firms

Minimum wage is non-binding. Maximum wage is applied to SOEs, but the impact does not seem to be too severe

Minimum wage is non-binding. Maximum wage is applied to SOEs, but the impact does not seem to be too severe

Recruitment and firing workers

By law, the firm is allowed to lay off, but it is difficult

Overmaning is matter for some SOEs, but it is difficult to lay off. Foreign firms are not allowed to hire workers directly

No big problem, except that foreign firms are not allowed to hire workers directly, and it is difficult for SOEs to lay off workers

Payment for extra-working time

Extra time rate is 1.5 times the normal time rate; rate for working in holidays is double the normal time rate

Not respected Not respected

Price policies Price control Price controls applied to

some key and basic goods such as electricity, telecommunication, petrol and others

No exception No exception

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CONCLUSIONS The overall development of Vietnam’s T&G industry in recent years has been impressive, but achievements have been quite different between sub-sectors. The garment sub-sector has been growing very fast, while the growth rate of the textile sub-sector has been modest. The great success of the garment industry is attributed to both domestic policy reforms and favorable international market conditions. The garment sub-sector has largely succeeded in exploiting Vietnam’s comparative advantage based in low costs of its hard working labor. The modest achievement of the textile sector may be explained by the lack of comparative advantage in relatively capital and skill intensive industries at this stage of development in Vietnam. Although Vietnam has taken major steps in the process of market reforms, there has not yet established a truly level playing field for all the sectors to flourish. Further development of T&G sector will therefore be largely dependent on how the policy reforms will proceed to make the business environment less distorted and more conducive to initiatives and creativity of firms, regardless of whether they come from state or private sector. In face of fast changing demand on the world market, capacity building in terms of business, marketing and technical skills is also essential.

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REFERENCES 1. Annual reports of VINATEX (internal documents) 2. Center for international Economics, 1998, Vietnam Trade policies in 1997. 3. Emiko Fukase and Will Martin, 1998, The effect of the U.S. granting MFN status to

Vietnam. World Bank. 4. General plan for development of textile and garment industry – VINATEX (internal

document). 5. Hal Hill, 1999, Export success against the odds: Vietnamese case study, Australian

National University, Canberra, Australia. 6. Lynn Salinger, 1998, Evolution of global manufacturing, current development,

qualitative competitiveness analysis, and examples of prices distortions. Workshop lecture notes, Hanoi, August 1998.

7. MPI, Direction and measures of production and investment restructuring of the industries in the process of implementing CEPT/AFTA, 30 May 1998.

8. MPDF, 1999, Vietnam garment industry: Moving up the value chain, Hanoi, Vietnam.

9. Sarah Bales, 2000, Vietnam's Labor Situation and Trends: Analysis based on the 1992-93 and 1997-98 Vietnam Living Standards Surveys.

10. Seiichi Masuyama, June 1997, Policy options for development of garment and textile industry in Vietnam. Nomura Research Institute

11. Tran Thi Bich Ngoc, The Vietnamese textile and garment industry in the textile and garment system of the world. Journal: Economic studies, No 4, 1996.

12. Tran Van My and Nguyen Hong Son, 1998, Vietnam's Garment and textile Industry: Facts, Policies and Prospects, Vietnam Economic Review, No. 3, Jan. 1998.

13. UNIDO - DSI/MPI, Vietnam: Industrial competitiveness review. Draft final report, September 1998.

14. Vietnam's economic News, Issues in 1997, 1998 and 1999. 15. Vo Dai Luoc, 1997, Vietnam trade and investment policies. VNCSSH – Institute of

World Economy. 16. Vo Dai Luoc, 1998, Trade & investment policies and development of some main

industrial branches in Vietnam. VNCSSH – Institute of World Economy. Hanoi. 17. World Bank.,Vietnam: Preparing for Take-Off? How Vietnam Can Participate

Fully in the East Asian Recovery, Hanoi, December 1999 18. World Bank. Vietnam Development Report 2001, Vietnam 2010: Entering the 21st

century. Pillars of Development, Hanoi, December 2000

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APPENDIX. REVENUE TAX RATES I. Production 1.Electricity 82. Mining 23. Oil, gas and gold mining 84. Steel (average) 4.76. Engine (average) 36. Electronics 87. Chemical 68. Medicine 19. Construction materials 510. Forestry 411. Wood 512. Paper 413. Ceramics 414. Cereal milling 215. Food processing 616. Marine 217. Marine processing 318. Textile - handicraft weaving 4 - Machinery weaving 6 - Wood fibers 819. Garment and (fabric) footwear

4

20. Leather material 421. Leather products 622. Printing (average) 323. Health care, education instruments

1

24. Sport, music instruments 225. Animal foods 226. Handicraft products 827. Art products 1028. Other production 429. Agriculture II. Construction 1. Including material supply 32. Excluding material supply 5III. Transport 1. Goods transport 22. Passenger transport 4IV. Sale 1. Industrial products 12. Foods, medicine, energy…. 13. Retail gold 2

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4. Other domestic goods 25. imported consumer goods 86. Exports 17. Sale agents 4V. Restaurant 1. Small restaurant 42. Big restaurant 10VI. Service 1. Preparing transport instrument, engines

2

2. Scientific, post services 43. Banking 64. Mortgage, insurance 45. Store 46. Education 47. Photograph 68. Electronic preparing 69. Video, advertising 810. Rents 812. Hairdresser 613 414. Other services 315. Special services Discotheque 30Lottery 30Sea-ship agent 40