Vietnam as a rising star in global supply chains

Cheap labor costs, big investment incentives, political and policy stability, and strong trade relations appeal Vietnam as an alternative investment destination to China, according to a special report published by The Economist Intelligence Unit. The country is now rated more highly than competitors such as China, Indonesia, India, Bangladesh and Pakistan. [Interestingly, Sri Lanka is rated the most favorable in South Asia in terms of business environment.]

The report focuses on labor, investment incentives, and trade relations, which are central to Vietnam’s competitiveness as a manufacturing hub.

First, the report argues that the ample supply of low-skilled labor will remain a core strength of Vietnam. Working age population is estimated at 68 million, which is about 70% of total population. It appears to be enjoying a “demographic dividend”, which refers to a share of working-age population being larger than those under 15 and over 64 years of age. Agricultural sector accounts for over one-third of the employed workforce, and workers from rural areas have been a key source of labor in manufacturing sector. There is still a stock of surplus labor in the agricultural sector, which means wages growth among low-skilled and unskilled workers in manufacturing sector will remain restrained. However, the availability of skilled labor force will still be an issue.

Second, the report states that Vietnam is offering generous concessions for high-tech manufacturers thinking to relocate labor-intensive processes. Incentives for lower-value added industries will be continue to be rolled back. Vietnam offers various incentives for FDI in industrial zones (industrial parks and export-processing zones), special economic zones, and technology parks. Most are export-oriented industries. It offers corporate and personal income tax exemption and rate reduction. High-tech sectors such as automotive, machinery, and production of advanced capital goods are offered below-market land rents, which is a major incentive amidst rising rent costs. Eligibility criteria are made flexible, especially for large firms. EPZs are not that popular these days because of reduction of import tariffs, which have made duty-free intermediate imports under EPZs largely redundant. The report notes that going forward the eligibility criteria for investment incentives will focus on higher value-added industries. 

Industrial clusters in Vietnam are concentrated in four geographical areas that were designated as priority regions for industrial development: Northern, Central, Southern and Mekong Delta Key Economic Zones. Footwear, textile and garment industries are well developed with advanced labor specialization and scaled-up manufacturing operations. Electronics exports have limited domestic value added, which the government is trying to change through vertical integration in the production of smartphones (Samsung is opening a R&D facility and a phone screen manufacturing plant).

Third, the report notes that Vietnam participates in more trade agreements and has better trading relations with major trading partners than its regional neighbors. This helps in promoting competitive export. It is a member of ASEAN Economic Community, Regional Comprehensive Partnership Framework, Comprehensive and Progressive Agreement for Trans-Pacific Partnership, and the EU-Vietnam Free Trade Agreement. For instance, CPTTP opens up more access to Canada and Mexico (with whom it did not have agreements before) for Vietnamese sports footwear, telephone sets, electrical machinery, and clothing and apparel.

COVID-19 pandemic pushed 1.2 million people below the poverty line in Nepal

According to a news report, which cites a recent study done by National Planning Commission, supply, demand and income shocks due to the COVID-19 pandemic likely have pushed 1.2 million Nepali people below the poverty line (or an additional 4% of the population). This, according to the NPC, increases the number of poor people to 6.8 million (or about 22.7% of the population). The news report was published in Nayapatrika daily on 20 January 2021.

The NPC has also estimated that it would take NRs 668 billion for relief and recovery efforts. Specifically, NRs 69.84 billion for pandemic containment and relief, NRs 92.62 billion for employment, NRs114 billion for project continuity, NRs 111 billion for technology and its implementation, and NRs 73.44 billion for self-reliant initiatives. These are based on immediate term, medium term and long term needs projection. It states that NRs 242 billion is required for the immediate term, NRs 287 billion for medium term, and NRs 135 billion for the long term. 

Tradeoff between AI and jobs

Excerpts from an interesting piece on the jobs displacement effect of AI from The Economist (16 January 2021 edition):

---

The robots are indeed coming, they reckon—just a bit more slowly and stealthily than you might have expected. If new technologies largely assist current workers or boost productivity by enough to spark expansion, then more AI might well go hand-in-hand with more employment. This does not appear to be happening.

[...]Take work by Daron Acemoglu and David Autor of the Massachusetts Institute of Technology, Jonathon Hazell of Princeton University and Pascual Restrepo of Boston University, which was presented at the recent meeting of the American Economic Association (AEA). The authors use rich data provided by Burning Glass Technologies, a software company that maintains and analyses fine-grained job information gleaned from 40,000 firms. They identify tasks and jobs in the dataset that could be done by AI today (and are therefore vulnerable to displacement). Unsurprisingly, the researchers find that businesses that are well-suited to the adoption of AI are indeed hiring people with AI expertise. Since 2010 there has been substantial growth in the number of AI-related job vacancies advertised by firms with lots of AI-vulnerable jobs. At the same time, there has been a sharp decline in these firms’ demand for capabilities that compete with those of existing AI.

An AI-induced change in the mix of jobs need not translate into less hiring overall. If new technologies largely assist current workers or boost productivity by enough to spark expansion, then more AI might well go hand-in-hand with more employment. This does not appear to be happening. Instead the authors find that firms with more AI-vulnerable jobs have done much less hiring on net; that was especially the case in 2014-18, when AI-related vacancies in the database surged. But the relationship between greater use of AI and reduced hiring that is present at the firm level does not show up in aggregate data, the authors note. Machines are not yet depressing labour demand across the economy as a whole. As machines become cleverer, however, that could change.

Evidence that AI affects labour markets primarily by taking over human tasks is at odds with some earlier studies of how firms use the technology. A paper from 2019 by Timothy Bresnahan of Stanford University argues that the most valuable applications of AI have nothing to do with displacing humans. Rather, they are examples of “capital deepening”, or the accumulation of more and better capital per worker, in very specific contexts, such as the matching algorithms used by Amazon and Google to offer better product recommendations and ads to users. To the extent that AI leads to disruption, it is at a “system level”, says Mr Bresnahan—as Amazon’s sales displace those of other firms, say.

[...] Does more automation mean a surge in productivity is just over the horizon? Not necessarily. Speaking at the (virtual) aea meeting, Mr Acemoglu mused that automation comes in different sorts, with different economic consequences. “Good” automation generates large productivity increases, and its transformative nature leads to the creation of many new tasks (and therefore jobs) for humans. Advanced robotics, for example, eliminates production jobs while creating work for robot technicians and programmers. “So-so” automation, by contrast, displaces workers but generates only meagre benefits. Mr Acemoglu cites automated check-out kiosks as an example; though they save some time and money, their deployment is hardly revolutionary. From 1947 to 1987, the displacement effect of new technologies was generally offset by a “reinstatement” effect, he reckons, through which new tasks occupied displaced workers. The rate of reinstatement has since fallen, though, while displacement has not, suggesting an increase in so-so automation relative to the good kind.

---

Noha Smith has a techno-optimism roundup here, arguing that the COVID vaccine was a turning point. Meanwhile, Eli Douardo argues that it is not easy to unleash total factor productivity growth as easily as tech adoption.

---

TFP only budges when new technologies are adopted at scale, and generally this means products, not just science. Science lays critical groundwork for new technology, but after all the science is done, much work remains. Someone must shepherd the breakthrough to the product stage, where it can actually affect TFP. This means building businesses, surmounting regulatory obstacles, and scaling production.

---

Hardware and software of economic reforms in India

Subramanian and Felman on the inherited problems, macro-economic stability, and "hardware" and software" of economic reforms (detailed analysis here):

---

The infrastructure investment boom of the early 2000s ran into major difficulties, especially after the GFC. But bankrupt firms were not allowed to exit, resulting in overcapacity that dragged down profits for the entire sector and led to burgeoning non-performing assets (NPAs) at the banks. This Twin Balance Sheet (TBS) crisis undermined growth because it meant that many firms weren’t sufficiently strong enough to expand—even if they were, banks were reluctant to lend. Real credit growth—the lubricant of any economy—consequently slid to historically low levels, and turned negative in recent years.

Summing up, the government has still not been able to overcome the problems it inherited. Now covid-19 has dealt another blow. Currently, 2020 growth estimates are being upgraded as economies are normalizing, but even revised IMF forecasts are likely to show India’s growth to be amongst the worst in the world. At the same time, macro-economic stability has been set back, as the fiscal position and inflation have deteriorated significantly. So, the RBI forecast that under the baseline scenario, the NPA ratio will almost double to 13.5% by September 2021.

[…] What then needs to be done? Consider why the government’s measures have so far failed to achieve the desired results. Transformational measures always require tweaking to ensure that they work properly. […] One possibility is that the “hardware" of reform measures has not been accompanied by sufficient “software". What is the software of economic reforms? Traversing the sequence from planning to implementation sound policies require accurate data, fair decisions, statecraft to win support, policy consistency over time, and rule of law in implementation.

[…] In the fiscal accounts, despite improvements, increasing off-budget expenditures have rendered the deficit figure less meaningful.

[…] The current government has made extensive efforts to create a level playing field, including a reliance on auctions and use of technology to automate public procurement and tax filing. But certain decisions—in retail, telecom, airports—have been perceived as demonstrating favouritism, reinforced by the reduction in Parliamentary discussion of policy initiatives. Stigmatized capitalism remains a serious problem.

[…] Once a policy is formulated, statecraft is needed to gain support of the stakeholders, especially the states, because nearly every major issue requires joint action.

[…] Once consensus is achieved and a major policy initiative launched, governments need to ensure that subsequent measures remain in line with the strategic objective. Often this does not occur. […] Widening the tax base was set back when in 2019 the income tax threshold was raised dramatically, removing about three-quarters of taxpayers from the tax net.

[…] this government, like all its predecessors, is embroiled in contract disputes with its contractors, especially on infrastructure projects. Its arrears to suppliers run high and there is anxiety about arbitrary tax enforcement.

---

Indian economy to contract by 7.7% in FY2021

The first advance estimate of economic activities in FY2021 (April 2020 to March 2021) released by Ministry of Statistics and Programme Implementation shows that the Indian economy will likely contract by 7.7% in FY2021. GVA (at basic prices) contraction is expected to be 7.2%. This is due to the severe economic disruptions— supplies as well as demand shocks— caused by the pandemic and the ensuing lockdowns that started from March 25 and was relaxed in a phased manner since June. The Indian economy had been slowing down even before the pandemic, especially since FY2017, when the economy grew by 8.3%. 

The only saving grace is agricultural sector, which is expected to grow by 3.4% on the back of favorable monsoon and the output surge as labor reverse migrated to villages after the lockdowns. All other sectors are expected to contract. Industry sector, which accounts for about 30% of the economy, as a whole will likely contract by 9.6%. The pandemic accelerated its slowdown as it was already losing steam, especially since FY2017. For the 2011-12 national accounts data, industrial sector growth peaked at 9.6% in FY2016. Within the industry sector, manufacturing activities have slowed down the most. It barely grew last fiscal (0.03%). In FY2021, it is expected to contract by 9.4%. Mining & quarrying activities are expected to contract by 12.4% and construction by 8.8%. However, electricity, gas, water supply and other utilities are expected to post a 2.7% growth. 

Services sector, which accounts for about 54% of the economy, is expected to contract by 8.8%, with the largest contraction in trade, hotels, transport and communications activities (-21.4%). These were severely affected during the lockdowns and continue to be partially affected even after relaxation of lockdowns. Financial services were not that affected compared to other activities (-0.8% growth). The slowdown in public spending is reflected in 3.7% contraction in public administration, defense and other services. 

On the expenditure side, consumption and investment are expected to contract sharply, but net exports are expected to improve largely because of slower deceleration of exports compared to imports. While public consumption is expected to grow by 5.8%, private consumption is expected to contract by 9.5%. Similarly, gross fixed capital formation is expected to contract by 14.5%, and change in stocks by 4.3%, indicating that the surge in pent-up demand has not been strong enough yet to clear and restock inventories. Exports and imports are expected to contract by 8.3% and 20.5%, respectively.  

The current forecast is based on the expectation of pickup in economic activities in the second half of FY2021. The economy contracted 23.9% and 7.5% in the first and second quarters, respectively. As expected, the most severe contraction was in services sector. 

Overall, the already slowing economy is expected to slowdown even faster due to the lockdowns and the lingering effect of the pandemic. Specifically, the slowdown in industrial sector since FY2017 is concerning. This is even more concerning in the case of manufacturing activities, which account for about 17% of the economy (one percentage point higher than the agriculture sector). This slowdown is actually reflected as a drop in capital formation, which contracted by 2% in FY2020 and is expected to further contract by 15.3% in FY2021. Note that first advanced estimate of GDP is based on data available (and its extrapolation) up to the first six to eight months of the fiscal year. 

Historically, FY2021 is going to be the worst fiscal year in terms of GDP growth (2011-12 constant prices series starting from FY1952). Previously, the economy contracted five times: FY1958 (-0.4%), FY1966 (-2.6%), FY1967 (-0.1%), FY1973 (-0.6%), and FY1980 (-5.2%).

The FY2022 central budget will focus on economic recovery and vaccine rollout. All eyes will be on how the government manages to increase public capital investment as well as secure financing for vaccine and its eventual coordinate, distribution and administration right up to the last mile. Gradual normalization of economic activities, income earnings and government’s fiscal support in terms of social security payments will prop up consumption. 

The expected slow pace of vaccine rollout in the initial phase and myriad challenges in its distribution and eventual administration might drag growth prospects, especially that of travel and tourism sector, in addition to the impending financial and fiscal sector stresses, which are expected to hit private as well as public investment. 

A sharp recovery in FY2022’s GDP growth inherently will have a large base effect component. The pace of the recovery in the following years may not be that fast without a sharp pick up in capital spending/investment (watch out for the additional NIP investment). 

In its January 2020 GEP, the World Bank estimated that the Indian economy will grow at 5.4% in FY2022 as “the rebound from a low base is offset by muted private investment growth given financial sector weaknesses”.