Vietnam remains firmly on the radar screens of the world’s multinational corporations (MNCs), attracted by its rapid recent growth, low wages among a young and highly motivated workforce, an unusually diversified economic profile, world-leading strength in some export sectors, and a growing domestic market. Notwithstanding recent macroeconomic turbulence, many companies continue to see Vietnam as one of the brightest lights in the Asian economic firmament. China is the only Asian economy to have grown faster than Vietnam since 2000.

However, according to the McKinsey Global Institute (MGI) — the business and economics research arm of McKinsey & Company — the drivers of Vietnam’s rapid growth are now waning. And, businesses need to ensure that their strategy takes into account the possibility that growth will not be as rapid in the future. Therefore, in order to sustain Vietnam’s growth, the country needs a productivity revolution to compensate for those weakening growth drivers, and businesses can play their part in forging change.

In the short-term, Vietnam must cope with an uncertain economic environment. The economy faces a state of heightened risk because of macroeconomic pressures, including inflation that has built up as a by-product of the government’s efforts to maintain robust growth despite the global economic crisis. There are some signs of stress in the financial sector, and international credit-ratings agencies have lowered their outlook on Vietnam’s debt. Over the past decade, bank lending has expanded by 33% per annum — the strongest growth of any ASEAN country, India, and China. The reported level of Vietnam’s non-performing loans appears to be under control, but their true volume could be higher than reported figures. There is also a systemic risk of a liquidity crisis. Vietnam’s funding market remains skewed towards the short term.

MNCs should be aware of these risks and carefully monitor developments in the financial services sector. Although the government has imposed a tiered cap on credit growth in commercial banks, it is not clear that these measures are likely to be sufficient to counteract current risks. A new cap on interest rates is only likely to spur more demand for loans. There is additional risk in that state banks run a large part of Vietnam’s financial system. Signs of positive government action that MNCs should look for include moves to enforce stricter standards for recognising bad loans, further equitising of state banks, strengthening independent auditing, bank stress tests, and laying out a clear path towards the adoption of international standards such as Basel II and III.  

Ensure flexible business models

Given Vietnam’s rapid growth rates in recent years, MNCs may not be building into their plans the risk that growth may well slow. It is important to avoid the mistake of locking-in excess capacity that focuses on the domestic market, and which is based on the assumption that the economy will continue to grow at the 7% to 8% long-term annual rate for which the government is aiming.

From 2005 to 2010, about two-thirds of Vietnam’s growth came from an expanding labour pool and a structural shift away from agriculture, with the other third coming from improving productivity. But, those first two growth drivers are weakening. Vietnam’s official statistics suggest that growth in the labour force is likely to decline to only around 0.6% over the next decade, down sharply from the 2.8% rate of the previous 10 years. And it is highly unlikely that the rapid migration from countryside to towns and cities can continue at the same rate as in the recent past, which saw a 13 percentage point decline in just 10 years in agriculture’s share of national employment. Without a productivity revolution that boosts overall labour productivity growth by more than 50%, the economy will not attain a 7% to 8% GDP growth rate. Instead, MGI sees the rate of growth declining to between 4.5% and 5.0% a year.  

Take note of rising wages

Those that view Vietnam primarily as a low-cost economy with an abundance of workers need to adjust their thinking Some MNCs have prospered in Vietnam not only because of rapid growth, but also because of the country’s inexpensive and abundant labour; such firms may no longer be able to rely on either, and need to ensure that their business models can be flexible and sustainable even if wages rise.

Anecdotal and survey evidence consistently indicates that the wage cost advantage is eroding. In most of Vietnam’s regions, wages increased by more than 15% a year between 2003 and 2008. Adjusted for exchange rates, Bangladesh and Cambodia, for instance, now offer lower-cost labour than Vietnam. And, some companies are already reporting labour shortages in major cities. Ageing could compound the problem, though Vietnam’s median age of 27.4 years is still relatively young when compared with China’s 35.2. By 2020, the share of the population aged between five to 19 years old is projected to drop to 22%, from 27% in 2010 and 34% in 1999.  

Engage on win-win initiatives

Tackling skills shortages in Vietnam is one important area where MNCs can bring something to the party, and this can be achieved by collaborating closely with the government. Developing talent is a win-win for both parties. Multinationals complain about a lack of basic work readiness among new recruits in both the manufacturing and service sectors in Vietnam, and in other countries, they have responded effectively to this problem by providing in-house training both before an employee starts working and whilst on the job. According to a 2010 report focusing on global trade and investment by the Japan External Trade Organisation, Vietnam has an even bigger shortage of qualified engineers and middle managers than other rapidly developing economies do. MNCs can work with the government and educational institutions to address this skill gap. Some companies, including Intel and Unilever, are investing heavily in developing local talent. Today, more than 95% of Unilever Vietnam’s managers are local, along with 90% of its directors and 54% of the board of management.

The Vietnamese government is already exploring ways of collaborating with the private sector. The Long Thanh-Dau Giay Expressway — a major link between Ho Chi Minh City and industrial hubs north of the city — is currently being financed by overseas development assistance, but there are plans to get the private sector involved. Vietnam’s state-owned industrial conglomerate Vinaconex has two partnerships with South Korea’s Posco Engineering and Construction, for the expansion of the Lang-Hoa Lac expressway and for the building of a new city called North An Khanh. Vinaconex also has joint ventures with two Japanese companies: Sanwa, a manufacturer of doors and shutters, and construction company Taisei. MNCs need to take a proactive view of the opportunities that may become available as Vietnam’s economy develops — from building infrastructure to professionalising sectors such as fish farming, and to the burgeoning tourism industry.  

Boost your productivity to thrive in the competition

Research into management practices by McKinsey and the London School of Economics in 2007 found that MNCs make a disproportionate contribution to economic growth and productivity gains in the economies where they operate. In the US, MGI found that MNCs contributed 31% of growth in real GDP since 1990, and accounted for 41% of US gains in labour productivity. In the UK, multinationals increase their productivity twice as fast as small firms do. Similarly, MNCs can play a vital role in a Vietnamese pro-productivity growth agenda, bringing not only investment but also know-how and best-practice management and processes.

The Vietnamese government’s efforts to simplify business start-up processes, improve permitting processes, and reduce tax rates have helped to improve Vietnam’s ranking in the World Bank’s Doing Business index. Vietnam’s fundamentals remain strong and, with a serious effort to address the emerging productivity challenges, there will continue to be good opportunities for MNCs in the future. For their part, MNCs need to work closely with the Vietnamese government and other players to create conditions which will allow their businesses in Vietnam to thrive.  

Sustaining Vietnam’s growth: The productivity challenge was published by the McKinsey Global Institute in February 2012. The report is available for download at www.mckinsey.com/mgi.

This article was first published in HQ Asia (Print) Issue 03 (2012)