It seems like Vietnam has been the next big thing for quite a while. Vietnam did very well in the 1990s and through the turn of the century. For the past two years, however, despite all the advantages it possesses, the Vietnamese government has managed only to destabilize a promising economy. And now, on top of that, the default of state-owned shipbuilder Vinashin and the government’s handling of it have put the spotlight on the failings of Vietnam’s privatization effort.

It is definitely worthwhile for the U.S. to work with Vietnam to improve its economy. The bilateral relationship has a track record of substantive cooperation on reform. Vietnam’s World Trade Organization accession and its bilateral trade agreement with the U.S. have served to bring necessary change to the Vietnamese economy. However, America’s current trade focus, the Trans-Pacific Partnership (TPP), will ask much more of Hanoi. Much of what it will ask—non-discriminatory regulations, non-preferential lending, transparency in governance, lifting of investment barriers—impinges directly on the beleaguered state sector.

Given the present state of its economy, Vietnam may not be capable of meeting these and other extensive commitments. As a result, talks on the TPP could be held hostage to state-imposed Vietnamese inefficiencies. The U.S. should not allow that to happen.

Dangerous Price Instability

Portraits of Vietnam’s economy are exceptionally messy. One of the problems has always been the lack of reliable information. Some countries issue economic results a suspiciously short time after the month, quarter, or year is over. Vietnam neatly avoids this problem by publishing data before the time period in question ends. These are labeled as estimates, but sensible revisions are rare.

Even accurate data might be confusing in the current environment. Prices are changing rapidly, causing the behavior of firms and individuals to continuously shift. On official data, consumer inflation stood at nearly 14 percent year-on-year in March and was still accelerating. Real interest rates—the price of domestic money—have fallen dramatically because nominal rate increases by monetary authorities did not keep pace with inflation. The dong has been devalued four times in 15 months, meaning the price of foreign money in terms of Vietnamese money is soaring.[1]

The outcome has been too much local money and not enough goods and hard currency. Firms have taken advantage of cheap capital by borrowing as much as possible (locally): Credit growth in 2010 was well over 20 percent, much of it subsidized by central and local governments. Because local currency has little value, individuals are hoarding goods, gold, and the U.S. dollar.[2] This is not inflation caused by a major commodity such as grain or coal; it is inflation spread throughout the economy.

Uncertain Outlook

Vietnam may be foremost among countries trying to be the next China. Policymakers emulating the PRC should recall that China had serious bouts of inflation in both the 1980s and ‘90s, one ended by a brutal crackdown and the other by a regional financial crash. Beijing solved the inflation problem by creating massive overcapacity and exporting the excess into a growing world economy. Even putting aside the associated waste and environmental destructiveness, this option is not presently available to Vietnam.

The best option that is available is not nearly as enticing: allow state-owned enterprises (SOEs) to truly fail. Vietnam has been trapped by its clear desire to elevate SOEs. Since they are very poorly operated, they require heavy budgetary and loan support. This has undermined broader fiscal and monetary policy and engendered suspicion about the stability of the financial system.

It is encouraging that Hanoi this year has pledged to roll back its stimulus, but actually doing so to the extent necessary will require the difficult decision of sacrificing some SOEs and permitting the private sector to lead. Moreover, the transition will also bring with it a period of slower GDP growth.

If that sacrifice proves politically unacceptable, Vietnam could see considerable economic difficulty. First quarter growth was reported, in late March, at 5.4 percent, clearly slower than the fourth quarter last year.

The country is bleeding hard currency. The 2010 trade deficit was approximately equal to the size of foreign reserves at the end of the year, meaning that in another year Vietnam could be out of usable funds.[3] As seen in 1997, the prospect of running out of hard currency may not just decrease growth and drive up joblessness but trigger outright economic contraction and a full financial crisis.

Vietnam’s macroeconomic situation is in need of serious and sustained attention. Hanoi’s priority should be to correct its mistakes and encourage some measure of macroeconomic stability. It may not be able to do this and meaningfully liberalize its economy at the same time. This likely, and even reasonable, relegation of reform runs directly counter to American desires for a TPP that is timely and of the highest standard.

Recommendations

• The U.S. should proceed with the TPP as quickly as possible—without regard for Vietnam’s ability to sign or implement an agreement on a timeline that other parties are able to meet. This applies to a deal on modalities expected in November as well as the final accord.
• If Vietnam is not able to join the TPP, an explicit offer should be made for it to join as soon as it can make necessary progress, especially in reducing support for the state sector and permitting the private sector to expand.
• The U.S. should help Vietnam fix its economic house and, ultimately, meet stringent TPP-induced liberalization. American agencies can assist in improving Vietnamese statistics, enhancing transparency. Given the role of the dollar, there should be additional coordination between the U.S. Department of the Treasury and Vietnam’s Ministry of Finance.

Miracle Postponed

Including Vietnam in the negotiations was the correct thing to do. It is in America’s interests for Vietnam to overcome current difficulties and realize more of its potential. But Vietnam has difficult decisions to make and implement. If it cannot do so in a timely manner, the TPP should move ahead without it.

Derek Scissors, Ph.D. , is Research Fellow in Asia Economic Policy in and Walter Lohman is Director of the Asian Studies Center at The Heritage Foundation.