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June 15, 2020

VIETNAM: Where reforms will matter the most in the EU-Vietnam FTA

BY Bob Herrera-Lim

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( 5 mins)
  • The Vietnamese government uses free trade agreements not only to pursue growth objectives but to force domestic reforms.
  • Vietnam’s SMEs still suffer from weak integration into global value chains, compared to China and Thailand.
  • The EU-Vietnam FTA imposes strict rules of origin on garments, textile and footwear exports, which the government and private sector can use to force wide-ranging changes from customs procedures to logistics.

Last week, the Vietnamese national assembly ratified the EU-Vietnam free trade agreement (EVFTA). Having already been approved by the European parliament in February, the EVFTA will come into force in July. Upon implementation, tariffs on 65% of EU exports to Vietnam (based on 48.5% of all tariff lines) will be removed, with the remainder to be phased out over ten years, eventually encompassing 99.8% of all exports by value.

For Vietnam, the tariff reduction will immediately cover 70% of its exports to the EU (based on 85% of all tariff lines), with the rest to be cut over the next seven years, eventually encompassing 99.7% of all Vietnamese exports by value. The World Bank estimates that the EVFTA could have an impact on Vietnam’s GDP thrice that of the Comprehensive and Progressive Trans-Pacific Partnership (CPTPP). Vietnam’s Ministry of Planning and Investment expects Vietnam’s export revenue to the EU to increase by around 40% by 2025 because of the agreement. The agreement also provides for non-discrimination between EU companies and Vietnamese state enterprises. EU companies should be able to bid for public infrastructure, power generation, transportation, and healthcare contracts on an equal footing with Vietnamese SOEs.

Ever since the start of economic reforms in the 1980s (“doi moi”), Vietnam has adopted what it calls a multidirectional foreign policy to diversify its external relationships. For the Communist Party of Vietnam (CPV), trade agreements help to not only drive the country’s economic growth but reinforce the notion of Vietnam as being independent of any single economic power — two key domestic political messages that reinforce the legitimacy of its single-party rule.

So far, the broad economic growth of the past three decades and the strong political and social control enforced by the CPV have mitigated the political fallout from economic liberalization, such as inflationary periods and economic crises. For instance, the government blamed the 2009 state enterprise and financial crisis less on its economic strategy and more on the mismanagement of former Prime Minister Nguyen Tan Dung, corruption by his business alliances, and the malfeasances of some state enterprises and banks.

How the EVFTA pressures Vietnam to integrate better into global value chains

The EVFTA will lead to an immediate reduction in tariffs on EU exports to Vietnam of machinery, appliances, and pharmaceuticals, while food, wines, and spirits and automotive exports will see gradual reductions to be completed within five to 10 years. Conversely, the immediate tariff cuts for Vietnamese exports to the EU will be on coffee, fresh fruit, vegetables, and computers and electronics. Seafoods and textiles will see some gradual liberalization, with the tariff phaseout to occur over 3-7 years. Given the nature of the trade between the two economies, the immediate dislocation to Vietnamese production is expected to be relatively low. The greater worry in the near terms seems to be among Thai firms, who fear that the agreement will encourage their electronics auto and auto parts manufacturers, and beverage companies to invest in building Vietnamese capacity.

For Vietnam, the longer-term significance of the trade deal, aside from gaining greater access to European markets, is in moving forward with reforms that improve the ability of its small and medium enterprises to become part of global value chains (GVCs), similar to what has been achieved by Chinese and Thai firms and. After all, the Vietnamese leadership has historically used outside agreements to support its reform efforts, both as political justification and to acquire technical and financial support from multilateral agencies. The EVFTA will not be any different, and it will be used to pressure recalcitrant bureaucrats and resistant state enterprises or local politicians.

For instance, in the case of GVC participation, the integration of export industries with domestic firms is low. Therefore, domestic value-added is limited despite the high levels of export growth and investment over the past three decades. Unaddressed, this would make Vietnam vulnerable to investors relocating as its labor cost advantage shrinks, especially vis-à-vis Indonesia, Cambodia, and even Myanmar. This is evident in the garments, textile and footwear sectors, for instance, where a large proportion of materials are imported, which in fact for now limits the ability of the sector to take immediate advantage of the EVFTA. As one example, the Vietnamese government estimates that only 20% of the value of an athletic shoe accrues to the domestic economy. Achieving reforms in these initiatives for garments exports will benefit other sectors, which is ultimately the goal of the Vietnamese government.

The EVFTA will force Vietnam to comply with strict rules of origin for its garments and footwear exports before they can avail of tariff preferences to prevent the country from merely becoming a transshipment hub for Chinese producers. This will require Vietnamese exporters to produce the fabric (instead of importing it from China as is mostly the case today) or import it from South Korea, which also has an FTA with the EU. Vietnam already faces stiff competition as a garment supplier from countries with preferential rates such as Bangladesh, Turkey, and Cambodia.

However, for Vietnamese to develop its garment supplier networks and economically achieve the type of integration seen in China and Thailand between the final assemblers and their local suppliers requires multiple policy initiatives, including developing efficient transport connections, a general reduction in trade costs, more predictable customs and border procedures, and a better regulatory environment for the logistics sector. Vietnam, therefore, must build up its own national production chain in order to qualify for the tariff reduction — thus further postponing the full realization of benefits from the agreement by years in several garments, textiles and footwear-related sectors.

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