THE HARMONIZATION OF AID AND TRADE POLICIES: THE CASE OF VIETNAM

ORGANISATION FOR ECONOMIC CO-OPERATION AND DEVELOPMENT O E C D P O L I C Y D I A L O G U E W I T H N O N - M E M B E R S O N A I D F O R T R A D E : F R O M P O L I C Y T O P R A C T I C E THE HARMONIZATION OF AID AND TRADE POLICIES: THE CASE OF VIETNAM ARI KOKKO*, TRAN TOAN THANG**, LE THANH FORSBERG*, VU XUAN NGUYET HONG** Monday 6 and Tuesday 7 November 2006 The Ritz-Carlton Doha Hotel Doha, Qatar Disclaimer: the views expressed here are strictly those of author(s) and do not necessarily reflect those of the OECD, the Development Centre, the GOIC or their member countries. * European Institute of Japanese Studies Stockholm School of Economics, Stockholm, Sweden; ** Central Institute of Economic Management, Hanoi, Vietnam. 1

Table of Contents Introduction... 3 The Macroeconomic Context... 5 Official Development Assistance... 8 Institutional setup... 10 Sectoral and geographical distribution of ODA... 12 Trade Policy and Trade Structure... 19 ASEAN Free Trade Agreement... 20 United States... 21 European Union... 22 World Trade Organization... 23 Trade structure... 25 Interactions between ODA and Trade... 29 The relation between ODA flows and trade flows... 31 Development over time: from aid recipient to competitor... 34 Concluding comments... 37 References... 40 List of Figures Figure 1 Inflows of ODA to Vietnam 1993 2003 (current $, thousands)... 15 Figure 2 Poverty incidence and poverty density in Vietnam 1998... 16 Figure 3 Sectoral Distribution of ODA 1993 2003 (per cent)... 18 Figure 4 Vietnam s Merchandise Trade 1986 2005 (million $)... 26 Figure 5 Composition of Exports and Imports 1990 2003 (per cent)... 27 Figure 6 Geographical Distribution of Exports and Imports 1990 2005 (per cent)... 28 List of tables Table 1 Macroeconomic Development in Vietnam 1990 2005... 6 Table 2 Geographical Distribution of ODA 2001 2003 ($ and per cent)... 16 Table 3 Number of Bilateral and Multilateral Trade Agreements... 20 Table 4 Correlation Matrix... 32 Table 5 Estimation Results: Effects of ODA on Trade 1997 2002... 33 Table 6 Trade Disputes 1994 2005... 35 2

Introduction Contrary to most other low income economies, Vietnam has been able to sustain high and relatively stable economic growth for a long time: in fact, Vietnam can look back at almost two decades of uninterrupted growth. The country s solid macroeconomic performance has made it possible to raise the average income level from about $100 to over $600 since the early 1990s, the incidence of poverty has been reduced by more than half during the same period, and most other indicators of the population s standard of living and welfare have improved substantially. Some of these gains are reflected by the changes in Vietnam s Human Development Index. The index, which sums the country s relative performance in terms of income, life expectancy, and education, increased from 0.617 in 1990 to 0.704 in 2003. Only a handful of countries (with China at the helm) posted a stronger performance over this period. Vietnam s recent success also stands in stark contrast to the less successful development during the decade following the end of the war and the reunification of the country in 1975. The attempt to introduce a centrally planned economy of the North Vietnamese type throughout the country was not successful. Following its involvement in the Cambodian conflict in 1978, Vietnam also lost most of the Western development aid that had started flowing in after the end of the war. This left the economy heavily dependent on the trade and aid relations with the Soviet Union. The combination of weak economic growth, budget deficits, and high inflation that followed in the mid 1980s made it clear that reforms were needed. Although various piecemeal reforms and policy experiments were carried out throughout the 1980s, the turning point did not come until the end of the decade. At the Sixth Party Congress in 1986, the Vietnamese Communist Party introduced a comprehensive reform program entitled Doi Moi (renovation). It aimed to replace central planning with a multisector economy characterized by decentralized decision making, free markets, and prices reflecting supply and demand forces, albeit with the state in a central position. A few years later, the collapse of the Soviet Union necessitated further reforms, including a shift from collective agriculture to independent family farms and a currency devaluation to promote exports. More generally, the reforms after 1989 have been characterized by increasing outward orientation, both economically and politically. In terms of economic structure and development, the result has been a steady increase in the importance of international trade and inward foreign direct investment. Although most observers have focused on the country s rapidly growing exports which reached 50 per cent of GDP in 2004 it is important to note that the increasing import capacity has probably been even more important from a development perspective. The ability to import ideas, technologies, and equipment from abroad has helped create an industrial base, but it has also been essential for the upgrading of transportation, health care, and other services. In many cases, these imports have been managed by foreign multinational corporations, who now account for about onethird of manufacturing output and about half of the country s imports and exports. 3

The increasing outward orientation in the geo political arena contributed significantly to both trade and FDI inflows: in particular, the withdrawal of troops from Cambodia in 1989 and the normalization of relations with the US in 1994 were important steps in legitimizing Vietnam as a trade partner and investment location. In addition, both bilateral and multilateral aid organizations returned to Vietnam. Finland, Sweden, and the UNDP were the only Western donors that had maintained aid operations in Vietnam during the 1980s, but the number of actors increased rapidly after 1994. At present, there are about 25 bilateral aid agencies, all of the large multilateral banks and UN organizations, and hundreds of NGOs working to support various aspects of Vietnam s development process. The annual inflows of ODA (as reported by DAC) have amounted to about $1.8 billion in recent years, which makes Vietnam the world s third largest ODA recipient, after Iraq and Afghanistan. The inflows of ODA from various sources have arguably been beneficial for Vietnam s development. The financial resources and technical assistance provided by bilateral and multilateral donors have made it possible to undertake reforms that would have been more complicated without access to external support. Moreover, foreign donors have financed substantial investments in infrastructure and production capacity, contributing to Vietnam s ability to manage the internationalization process. To some extent, ODA has also had a more direct impact on Vietnam s integration with the world economy, both in the policy arena (e.g. in the form of support to Vietnam s WTO application) and in the business sector (through various export promotion programs). However, aid policy is not the only channel through which more developed countries influence the pace and character of economic and social progress in Vietnam. The role of political and ideological disagreements has been obvious during the past century, with armed conflicts and embargoes often dominating other determinants of development. In times of peace, trade, investment, and migration policies have been more important. The trade policies of richer countries determine the market potential for Vietnam s exporters. As long as Vietnamese producers have guaranteed access to OECD markets, they are able to make long term investments in areas where Vietnam holds comparative advantages, creating employment, incomes, tax revenues, and import capacity. If market access is limited or uncertain, fewer investments will be made. Similarly, the outward investment and migration policies of rich nations can be expected to have some impact on the incentives for and character of economic activity in Vietnam The purpose of this paper is to examine to what extent the ODA and trade policies of OECD countries are harmonized, in the sense that they have similar effects, intended or unintended, on Vietnam s development. The following section will provide a brief overview of Vietnam s recent macroeconomic development. Section 3 outlines the institutional setting for development aid, discusses the policy objectives of Vietnam s donors, and describes the distribution of ODA across donors and sectors. Section 4 turns to a discussion of trade policies and trade structure, and Section 5 examines the coherence of the ODA and trade policy relations between Vietnam and other (richer) countries. Section 6 provides a brief summary and some concluding comments. 4

The Macroeconomic Context Vietnam s macroeconomic development during the past decades has been remarkably successful, with high growth rates and reasonably stable prices. Real annual GDP growth has averaged nearly 7.5 per cent since 1990, with an official growth rate of 8.4 per cent reported for 2005. As a result, real per capita incomes have tripled during this period, with the nominal per capita income growing from about $100 in 1990 to over $600 in 2005. After some years of high inflation following the liberalization of state controlled prices in the mid 1980s, the inflation rate dropped to single digit levels, and has remained below 10 per cent since 1990. Initially, growth was fuelled by the opportunities opening up as decision making was decentralized to individual state owned enterprises and the contacts with market economies and their multinational corporations started growing. The domestic private sector emerged as an important actor in the late 1990s, and number of registered private enterprises has increased dramatically since the introduction of a new enterprise law in 2000. This law did was not only a sign that private enterprise had become politically acceptable, but it also simplified the complex licensing procedures that had been required to set up new private firms. As a result, more than 150,000 new private enterprises have been registered since 2000 (CIEM, 2005). Although many of these were probably active in the informal sector already before their formal registration, the modern private sector appears to be the most dynamic part of the Vietnamese business community today. One indication is that the non state sector is accounting for an increasing share of gross investment, as shown in Table 1. In recent years, growth has been fuelled mainly by high investment rates more than one third of GDP is devoted to investment and rapid export expansion. Vietnam s export volume has more than doubled since 2000. In 2005 alone, export revenue increased by almost 30 per cent, reaching a total value of $33 billion or 60 per cent of GDP. Table 1 summarizes the data on these achievements, together with some additional information about the structure of the Vietnamese economy. Foreign investors have been important both for investments and export growth since the mid 1990s. The inflows of FDI grew rapidly from around 1993, and the annual investments have amounted to $2 3 billion since that time, with a slump following the Asia crisis in 1998. During the last couple of years, the foreign investment inflows have reached nearly $4 billion (Nguyen et al., 2006). 1 Foreign invested enterprises account for some 15 per cent of GDP, nearly one fifth of total investment, and more than half of total exports including crude oil (excluding crude oil, the FDI share of exports is about one third). Yet, the state sector still dominates, controlling over 50 per cent of total investment and nearly 40 per cent of GDP. In fact, the state s share of GDP has hardly fallen since 2000, which may be appear contradictory taking into account the progress of the private sector. However, the GDP share of the non state sector includes agriculture, where growth rates are substantially lower than the average the private sector s shares of industrial output and employment are growing steadily. 1 The data on implemented FDI from the Ministry of Planning and Investment are systematically higher than the data on FDI disbursements from the State Bank of Vietnam. One reason is that the MPI figures include the local capital shares, but the difference is still disturbingly large. In 2004, the SBV reported FDI disbursements of $1.6 billion. 5

Table 1 Macroeconomic Development in Vietnam 1990 2005 1990 1995 2000 2005 GDP (billion $) 6 21 31 53 Real GDP growth (%) 5.1 9.5 6.8 8.4 GDP per capita ($) 98 288 402 635 Inflation rate (GDP deflator) 72.8 17.0 3.4 8.0 Merchandise exports (billion $) 2.4 5.4 14.5 32.7 Merchandise imports (billion $) 2.7 8.2 15.6 37.8 Current account (% of GDP) 4.0 8.3 3.6 1.5 External debt (% of GDP) 359.6 122.6 41.1 40.0 GDP composition by economic sector (% of GDP) Agriculture 38.7 27.2 24.5 20.9 Industry and construction 22.7 28.8 36.7 39.5 Services 38.6 44.0 38.8 38.0 GDP composition by ownership (% of GDP) State 31.7 40.2 38.5 38.4 Non state 63.0 53.5 48.2 45.6 FDI 5.3 6.3 13.3 16.0 Structure of investment by ownership (% of total investment) State investment 34.2 38.3 58.2 51.5 Non state investment 33.7 29.4 19.4 32.2 FDI 32.1 32.3 22.4 16.3 Source: EAEP (2006); CIEM (2006); Nguyen et al. (2006). It is not only in the economic sphere where substantial improvements have been achieved during the two decades since Vietnam s market oriented reforms were initiated. Vietnam s health indicators have improved substantially since the late 1980s (although many of the improvements did not commence until 1992 1993). For instance, life expectancy at birth increased from about 65 years around 1990 to about 72 years in 2004. The total fertility rate declined sharply over the same period, from 3.8 to below 2 (SRV, 2005). Child mortality and maternal mortality rates diminished even faster. Many vaccine preventable diseases have also been brought under control through broad immunization programs, and the share of deaths caused by infectious disease declined from over one half in the mid 1980s to about one third in 1999 (MoH, 2002). Some diseases like polio and infant tetanus have been eliminated altogether (MoH, 2002, SRV 2005). However, in spite of Vietnam s overall success, there are also macroeconomic issues that may cause some concern for the future. Price stability is one example. The high GDP growth rate reflects high aggregate demand, and there is a risk that bottlenecks in the domestic economy will generate inflationary pressures. The increase in the inflation rate in 2004 and 2005 is partly a reflection of this process. While the Vietnamese authorities have demonstrated that they are able to control domestic demand reasonably well, there is a worry that simultaneous external price shocks might complicate macroeconomic management severely. In particular, these fears are related to the development of the international oil price: Vietnam is a major exporter of crude oil, but also a substantial importer of refined oil products. Rapid increases in oil and gas prices might have severe 6

effects, both directly and indirectly. Higher energy prices leave a strong direct imprint on consumer prices and contribute to the general problems related to high inflation: increasing uncertainty, higher nominal interest rates, and redistribution of wealth from current income earners to holders of real assets are all likely to reduce the growth rate of the economy. At the same time, there may be significant effects on public finances. In particular, rapid increases in oil and gasoline prices may create public pressure for subsidization of energy costs, putting pressure on the government budget. It may be politically tempting to yield to these demands, since the rising oil price boosts public revenue and creates a margin that could be used for subsidization. The continuing dominance of the state sector is another example. Although the state sector controls most of the country s investment resources, there are worries that the investments are not efficient. The direct employment generated through state investment is small the total employment in the state sector amounts to about 10 per cent of the labor force, and has barely increased during the past decade and there are frequent complaints about problems at all stages in the public investment process, ranging from planning to implementation (CIEM, 2005). One of the long term responses to these weaknesses is the equitization of stateowned enterprises, which is intended to establish harder budget constraints and more efficient and business oriented management practices in the state sector. However, the equitization targets have been missed each year, and there are numerous problems slowing down the process. The most important ones appear to be resistance from SOE managers, problems regarding the valuation of state assets, and legal uncertainties connected to the restructuring and equitization of General Corporations. Although some 1,500 SOEs had gone through the equitization process by the end of 2004, they accounted for only 6 7 per cent of the total state capital in the SOE sector (CIEM, 2005). To maintain high growth rates, it will be necessary to accelerate the pace of SOE reform in coming years: one consequence of Vietnam s impeding WTO membership is that it will be more difficult to discriminate other enterprise types in order to protect inefficient SOEs. Another potential problem is related to the country s external balance. In 2005, Vietnam s merchandise trade balance recorded a deficit of more than $5 billion, or nearly 10 per cent of GDP. Adding other current account transactions (services and transfers, e.g. overseas remittances and ODA), the deficit was reduced to about 1.5 per cent of GDP, as shown in Table 1. While Vietnam does not appear to have any problems in covering this deficit in the short run the inflows of FDI and foreign credits are more than sufficient to cover the current account balance, and external debt is not alarmingly high it is essential that the import surplus is used to raise the country s long term competitiveness. The concerns in this area are instead related to the efficiency of investment, including state investment. Much of the deficit is probably directed to investments in SOEs and public infrastructure, which are expected to raise future production capacity. However, this assumes that the investment resources are used for projects that yield a sufficiently high social return. For investments in industry, a key question is whether the enterprise will be able to survive in the more competitive climate that is expected as Vietnam joins the WTO in the near future. For infrastructure projects, the requirements are related to how well public investments are able to crowd in private investments. The fact that the capital inflows to Vietnam are presently 7

at a high level roughly comparable to those in China 2 does not reduce these concerns. On the contrary, the availability of large amounts of capital makes it important to invest these funds efficiently, since there are often important lock in effects of investments. Once large amounts of funds are committed to specific projects, they create interest groups that benefit from these investments and that are likely to try to maintain status quo even when it would be socially beneficial to change the direction of policies. Some of the difficulties in the negotiations about Vietnam s WTO membership in recent years may, for instance, stem from investment decisions made in the state sector in the mid 1990s (see Kokko, 1997). Yet another area of concern is related to the emerging income and welfare gaps in Vietnam. Although the overall growth performance of the economy has been laudable and although Vietnam has managed to cut the incidence of poverty by more than half since the introduction of market oriented economic reforms in the late 1980s there are still worries about the distribution of income and wealth. High economic growth is a strong priority for the Vietnamese leadership, for several reasons. A high economic growth rate provides some degree of legitimacy to Vietnam s one party Communist rule: it may be argued that alternative political systems might be less efficient, consuming more resources for the political struggle between parties and interest groups and leaving less for productive investments. Even more importantly, a high growth rate is considered as a precondition for social stability. Given that initial wealth, human skills, and opportunities are not perfectly equally distributed in any society, and that economic development is a process where relative prices are in constant change, it can be argued that a certain minimum growth rate is necessary to ensure that all (or almost all) social groups benefit from economic development. Growth rates lower than this minimum might leave some groups worse off, which would cause discontent and might result in political protests and opposition against a system that is not perceived as fair : hence the need to generate sufficiently high growth. However, it is clear that income inequality has been rising in Vietnam over the past decade (see Glewwe et al., 2004). This is true both in a geographical and a social dimension some regions are growing substantially faster than others, at the same time as some social groups fare much better than others. Geographically, it is obvious that growth is centred on Vietnam s two urban centres Hanoi and Ho Chi Minh City. The so called socialization of health and education, which entails moving a larger part of the financing burden from the state budget to the users of the services (i.e. the social groups), is an example of a policy that may have contributed to increasing social gaps. There is no doubt that some of these gaps will need to be addressed by policy makers to ensure continued smooth macroeconomic development. Official Development Assistance Over the past decade, Vietnam has become one of the favourite aid recipients of many multilateral and bilateral donors: as noted above, it is presently the world s third largest recipient of ODA after Iraq and Afghanistan. Aside from its good performance regarding poverty reduction and economic growth, Vietnam is popular because it is perceived as a 2 The capital inflows to Vietnam in 2004 included FDI valued at between $1.5 billion (according to SBV) and $4 billion (according to MPI), officially recorded overseas remittances of $2.4 billion, and ODA inflows of about $2 billion (in 2003). To reach an equally large inflow of foreign capital per capita, China would require between $85 billion and $115 billion per year, which is roughly in line with the capital account balance of the Chinese balance of payments in recent years (Prasad and Wei 2005, Table 6). 8

good aid recipient. In fact, Vietnam is sometimes identified as the best practice example of ODA management and recipient ownership of the development agenda (GRIPS, 2002; UNDP, 1996). During the past few years, most donors have also aligned their activities to the government s development strategy (Jacquemin and Bainbridge, 2005). Vietnam s strong ownership and the present framework for ODA management are largely based on experiences from the 1970s and 1980s, when the country became heavily dependent on the Soviet Union. Since that time, Vietnam has been careful to avoid similar dependency in the relations with other foreign countries a prime rule for engagement with foreign countries has been to preserve the autonomy of the nation. The economic sanctions that were introduced by the West and many Asian countries after the Vietnamese decision to send troops to Cambodia in 1978 led to the withdrawal of most of the ODA that had started to flow into the country after the end of the Vietnam War in 1975. Sweden, Finland, and the UNDP were the only Western donors that continued supporting Vietnam, albeit at a small scale. Instead, Vietnam was forced to move closer to the Soviet Union and the European communist bloc for external assistance and trade relations. Throughout the 1980s, when the weaknesses in the centrally planned economy resulted in stagnation and macroeconomic instabilty, the Vietnamese economy survived primarily thanks to Soviet aid. According to Pike (1987), at its peak in the mid 1980s, Soviet aid made up about 10 per cent of GDP and covered more than 40 per cent of the government budget and 75 per cent of total public investment. At the same time, the share of trade with the Soviet Union reached about 70 per cent of Vietnam s total foreign trade. The support from Sweden, Finland, and the UNDP is estimated to have reached only about one tenth of what was provided by the Soviet bloc. The reliance on aid from the Soviet bloc forced Vietnam to implement a political agenda both domestically and internationally that was largely outlined by the Soviet Union. However, the substantial aid flows did not contribute much to Vietnam s ability to create a sustainable foundation for economic development. The disintegration of the Soviet Union at the end of the 1980s, which ended the aid inflows from the Communist block, therefore had a severe impact on the country. The economy stagnated at the same time as inflation accelerated. One particularly troublesome consequence was a fall in food production although few people suffered from starvation, it is clear that a majority of the population was below the food poverty line. These circumstances led up to the introduction of the market oriented reform package that became know as Doi Moi. Together with the withdrawal of Vietnamese troops from Cambodia in 1989, the reforms contributed to the return of aid from Western countries a few years later. The government quickly facilitated the normalization of relationships with major donors and introduced aid as an important external resource to the on going reform process (MPI, 2004). This notwithstanding, the Vietnamese government has been cautious in its aid relationships. Vietnam s leaders concluded that too much dependency on one power must be avoided and became hesitant towards dealing with donors as a unified bloc. This caution remained for a long time after the Doi Moi reforms to avoid the risk that foreign assistance could be used as a tool for external influence on Vietnam s domestic affairs. The principles laid down by the Politburo state that the relations with external actors should contribute to self determined 9

integration, bringing into play the nation s internal forces and taking most advantage of integration in order to strengthen effectiveness of international cooperation, ensuring independence and ownership as well as national interests (Politburo Resolution No.07 NQ/TW 2001:3, Central Party Committee). Consequently, the government has often resisted development projects where a donor s policies and aid disbursements are tied to strong political or economic conditions. Strong autonomy and ownership of ODA policies has been maintained to avoid aid dependency. Another explanation for the strong sense of recipient ownership is that many donors represented in Vietnam today arrived after the market oriented reforms were initiated by the Vietnamese leadership. This is important for Vietnam s relations to donors, as it makes it clear that foreign aid was not the initial driver of the economic advances that have taken place over the past two decades. Moreover, the reforms resulted in rapid economic development that enabled Vietnam to avoid taking on substantial amounts of foreign debt. Taken together, these factors have strengthened Vietnam s bargaining position, making Vietnam different from many other aid recipients and their relations to donors: the Vietnamese government controls its agenda to a higher degree. Today, donor support remains strong, with annual aid flows increasing from a few hundred million dollars in 1990 to over $1.5 billion since the late 1990s. Experience shows that apart from aid s economic role, the donor community has increasingly become an important policy dialogue partner (UNDP, 2005). Aid is now a flexible and much wanted resource for the government s public investment programs (MPI, 2004). Over time, the government has learned to maximize the support to various development programs in Vietnam while maintaining reform autonomy and policy initiative. Institutional setup Given the lessons from the relationship with the Soviet Union, the Vietnamese government has a strong ambition to control its domestic politics. In the area of development cooperation, central planning has been the fundamental tool of the government to manage and regulate socio economic policy and development. The institutional set up put the Ministry of Planning and Investment (MPI) at the centre of the country s overall national development planning. In this central role, MPI drafts and formulates the overall national development strategies and short term plans, and is responsible for the management of public investment and resource allocation. MPI is rightly considered a super ministry a conductor of the whole development concert in which the musical players in the orchestra are inputs from different ministries, as noted by MPI officials. The main task of MPI is to pursue the government s development priorities and to balance stakeholder interests between sectoral and regional concerns, as well as between national and international actors. The integration of ODA into the national development plans is part of this institutional setup, making MPI the central actor for aid integration and coordination. This suits the central planning system, but has also been a wish from donors, especially multilateral donors such as UNDP and the WB. Hence, MPI has the leading role among the ODA coordinating agencies, which also include the State Bank of Vietnam, the Ministry of Foreign Affairs, the Ministry of Finance, and the Office of Government. Within MPI the main responsibility has been given to the Foreign Economic Relations Department (FERD). MPI/FERD coordinates 10

and manages ODA resources at the national level, including negotiating, supervising and coordinating the allocation of most ODA programs, in particular large scale and capitalintensive loan projects. Vietnam s national development plans are the instruments used to integrate donors aid programs with the government s preferences. Based on the socioeconomic development plan and the 5 Year Public Investment Programs (PIP) prepared by MPI, FERD prepares a priority list of national projects calling for ODA investment during the current five year planning period. This priority list is in fact a menu for donors to select projects for their development cooperation. In this setting, it has been clear that donors are expected to conform and operate within the framework given by Vietnam s development plans. What characterizes the system is that MPI is responsible for the overall development as well as aid integration and donor coordination, which helps the government exercise strong ownership over the overall development agenda. Hence, MPI s most important task is to make sure that ODA matches Vietnam s development priorities and to oversee when development plans require aid interaction. The resulting structure for ODA management has three main characteristics: (i) (ii) (iii) The state regulates not only domestic development planning, but also the allocation of aid and the relations with donors. The central position of MPI is instrumental in creating strong ownership. If donor and aid management had been outside the body responsible for national economic planning, it would undoubtedly have been more difficult to align aid flows with Vietnamese development priorities. In addition, donors are given a window for policy dialogues, facilitating direct donor impacts on national development planning. MPI is mainly responsible for the coordination and management of loan aid, which has constituted 60 70 per cent of total ODA in financial terms since 1996 (UNDP, 2005). This has arguably given more influence to donors like the WB and Japan, who are behind the major part of loan aid to Vietnam. Smaller bilateral donors, who provide more technical assistance and grant aid projects, are in a weaker position to influence Vietnamese development policy. They do participate in the top level dialogue, e.g. as as contributors to multilateral credit packages, but most of their direct contacts are with provincial and sectoral authorities. Heads of line ministries and provincial people committees are only entitled to approve smaller technical projects at present, the MPI approval is required for projects valued at above $1 million. The incentives and capacity of line ministries and provincial agencies are constrained by the centralization of power to the MPI. Overall, the government has exercised a system in which it plans, steers and controls local governments through the provision of public services and infrastructure, including those investments that are financed by ODA. Dapice (2002) argues that under central planning, aid has become a strongly politicized process, where provinces have to turn to Hanoi in order to convince MPI that their development projects were of higher priority than others, and that they should be included in the priority lists presented to donors. 11

However, the position of MPI is slowly changing. The centralization of power to the centre did not only constrain the dynamism of provincial development and the economic autonomy and accountability of local authorities, but it also created other problems. For example, considering the lack of transparency regarding the criteria and processes for the identification of priority investments, there was reason to worry about how efficiently this power has been exercised and whether there is a risk for corruption. Moreover, the dominance of MPI created a strong bias towards physical investment and economic growth, with much less attention to social issues and pro poor expenditures than what most donors desired. Consequently, considerable legal changes in the direction of decentralization of decision making and accountability of development planning and budgeting are underway, and they can be expected to have a strong impact on the role of MPI in relation to line ministries and provincial authorities (See MPI, 2004, CIEM and GTZ, 2004, Forsberg and Kokko, 2006). Sectoral and geographical distribution of ODA Considering Vietnam s strong ownership of its development agenda, it is reasonable to expect that the ODA flowing to the country will be distributed according to the preferences and priorities of Vietnam. Formally, these are outlined in the 10 Year Socio Economic Development Strategy and the 5 Year Socio Economic Development Plan decided by the Party Congress, which convenes every fifth year. Since the early 1990s, these documents have a strong emphasis on economic growth, with modernization and industrialization as one of the main goals. Indeed, the public investment projects included in the Public Investment Programs and the ODA priority lists have clearly reflected the government s priority to generate economic growth, and the resources for investment have been directed towards the richer cities/provinces where the conditions for further growth are more favourable. The result has been increased inequality between provinces (WB, 2005). The last two five year PIPs are good examples of these priorities. They included priority lists for mobilizing capital investment to enhance growth, but investments for poverty reduction and social development were not given similar prominence. The investments to these social areas were mainly funded through separate national target programs established in the early 1990s (the most prominent are know as Program 135 and Program 143). Throughout the 1990s, aid was concentrated to prioritize growth infrastructure (Nguyen, 2002). For instance, examining the government s 1993 priority list of candidate projects presented to donors, Pham (1996) demonstrated the government s focus on large scale infrastructure. The energy and transport sectors accounted for 70% of total financial requirements for infrastructure projects, while investments for other areas such as social or rural development were very modest (Pham, 1996). Within the large scale infrastructure field, there was a shift from water and sanitation in the early 1990s to energy in 1996 2000, and further to transportation infrastructure since 2001. The imbalances can also be seen in the provincial distribution of ODA. Only limited aid resources were allocated directly to provinces during the 1990s. Somewhat surprisingly, the Northern Central Coast and Mekong Delta regions, which exhibited the highest poverty rates, received only a small share of total aid. Much larger amounts of ODA were allocated to 12

relatively wealthy provinces including the regions surrounding Hanoi and HCMC. 3 This pattern arguably reflected the downside of heavy concentration of decision making power to the central government and the lack of concern for regional disparities in the development planning process (Nguyen, 2004; UNDP, 2005). However, the strong growth focus did not only cause problems in the form of regional and sectoral imbalances, but also some tensions with the donor community. The last few years have seen poverty alleviation emerging as the main development objective of Vietnam s international development partners. Although it is easy to demonstrate the connection between growth, employment generation, and poverty reduction, the traditional Vietnamese development plans were very different from the Poverty Reduction Strategies that the IMF and the World Bank require from their clients. In particular, both multilateral and bilateral donors pushed for more emphasis on social sectors like education and health care (so called pro poor spending), as well as more attention to structural issues (e.g. sustainability) and public administration (e.g. sound public finances). The Vietnamese response was to formulate a Comprehensive Poverty Reduction and Growth Strategy (CPRGS) that addresses some of these problems. Since May 2002, the priorities and plans that are relevant for ODA have therefore been presented separately in the CPRGS, which can be said to have three main functions. Firstly, it serves to convince the donor community that Vietnam s overall development strategy is conducive to socio economic development and poverty reduction. Since aid is fungible, it is not possible to determine exactly what an ODA dollar is used for. Even if a donor makes sure that their dollars are used for some specific project, it is likely that resources are freed elsewhere in the public sector, and used for purposes that are not related to the donors initial intentions. Hence, ODA (in particular budget support and sector programs, but sometimes also individual projects) will, in principle, finance the government s marginal expenditures. Hence, one of the aims of the CPRGS is to demonstrate that the marginal expenditure is likely to be well used. Secondly, the CPRGS serves as a guideline for domestic development policy, providing more concrete and operational targets and objectives than what the 10 Year Strategy, the 5 Year Plan, and other sectoral strategies and plans typically do. Thirdly, it aims to help coordinate donors and defines the scope for donor activities somewhat more broadly than what is done in the Public Investment Program, which is mainly focused on infrastructure investments. What are then the priorities? In its introductory remarks, the CPRGS states eight broad objectives for the country s socio economic development for the period up to 2010 (SRV, 2003). These are to: (i) Promote rapid and sustainable economic growth coupled with attainment of social progress and equity. (ii) Create and equal business environment for all types of enterprises from all economic sectors. (iii) Continue with structural reforms to bring about a transformation of the nation s economic structure. This objective includes further integration with the 3 Further detailed figures and data on regional distribution of aid are provided in UNDP (2005) and Le Thuc Duc et al. 2004; the poverty rate by specific regions is provided in Nguyen Ba An (2004). 13

(iv) (v) (vi) (vii) (viii) international economy and strengthening the competitiveness of Vietnamese industries. Provide poor households with opportunities to raise their income by accelerating broad based growth of agriculture, industry, and services. Encourage human development and reduce inequality. Solve the particular problems of urban poverty with regard to employment, income, and housing. Develop and expand social protection and safety net for the poor. Undertake public administration reform. In comparison with earlier strategy documents, there is clearly a stronger emphasis on equity and social issues, although economic growth remains the prime objective. Even if the CPRGS has only been in force for some years, there are already some changes in the pattern of ODA utilization. Firstly, there has been a reduction in the share of large scale infrastructure, as well as an increase in the share of funds directed directly to provinces. Policy and institutional support have emerged among the biggest aid sectors, with economic management and administration development as the core sub sectors. Pro poor spending, including projects focusing on education, health, and area development, has also increased. However, detailed data on ODA utilization and ODA inflows for the last few years are not available. The most detailed available data sets on ODA in Vietnam cover the period 1993 2003 and have been provided by the UNDP. Figure 1 uses this information to summarize the total inflows of ODA in current US dollars, and shows the steady increase in donor support from less than $300 million in the early 1990s to over $2 billion in 2003. The exception is 2001 2002, when the inflow of aid stagnated. The immediate reasons were the completion of some large energy infrastructure projects coupled with a general reduction of Japanese ODA. In recent years, the aid inflows have amounted to over $20 per capita, which is somewhat higher than the average for all low income countries, but substantially lower than that for HIPC countries. These inflows correspond to around 4 per cent of GDP, which is also higher than the low income country average, but lower than the HIPC average. The largest donors are Japan, the World Bank, and ADB, who jointly account for some 50 60 per cent of total aid disbursements. Most of this aid is loans overall, nearly two thirds of the aid inflows are in the form of credits. The various EU countries and UN agencies provide about one fourth of the total, while the remainder is shared between over one hundred other multilateral and bilateral donor agencies and NGOs. To simplify the enormous task of managing aid inflows from so many donors, Vietnam has encouraged the donor community to coordinate their aid policies. This has resulted in the emergence of two important harmonization groups: the Five Bank Group and the Like Minded Group. The Five Bank Group is made up of the World Bank, the Asian Development Bank, Japanese JBIC, French AFD, and German KfW, and the members of the Like Minded Group include Australia, Canada, Denmark, Finland, Germany, the Netherlands, Norway, Sweden, Switzerland, and the UK. In terms of aid disbursements, the Bank Group hold about 60 per cent of the total, while the Like Minded Group account for 15 20 per cent. However, their combined share of ODA projects has remained below 50 per cent, reflecting in particular the large size of the Bank Group projects. 14

Figure 1 Inflows of ODA to Vietnam 1993 2003 (current $, thousands) 2500000 2000000 Thousand $ 1500000 1000000 500000 0 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 Source: UNDP data set. Figure 2 illustrates the distribution of poverty across Vietnamese provinces and regions in 1998, when the country s second large living standard survey (VLSS 2) was undertaken although the share of the population living in poverty has been reduced from 37 per cent at that time to an estimated 20 per cent at present, the patterns remain roughly similar. The lefthand side of the figure outlines the incidence of poverty across the country s 61 provinces. Poverty rates were highest in the mountainous Northern and Central provinces, where over half of the population was classified as poor. The only regions with poverty rates below 20 per cent were Hanoi and Ho Chi Minh City with surrounding provinces. These regional differences in poverty incidence are to a large extent related to differences in the overall availability of production resources, infrastructure, and social services. It can therefore be expected that various types of physical investments, e.g. in transport infrastructure, schools, and hospitals, will have a substantial impact on poverty. The right hand side of the figure focuses on poverty density: each dot in the figure corresponds to 1,000 people below the poverty line. Even though the mountainous areas have the highest poverty incidence, they are relatively sparsely populated. The largest numbers of poor people are instead found in the far south and the Red River delta southeast of Hanoi, where average incomes are relatively high and the overall poverty incidence is much lower than in the peripheral provinces. This reflects the large social gaps that exist even in the more prosperous parts of the country. The core measures to reduce poverty in these regions are likely to be found in pro poor policies emphasizing access to education, health, and other public goods, rather than increased infrastructure investment. The UNDP data do not provide any perfect picture of the regional distribution of ODA, since a large share of aid resources is directed to national programs managed by the Vietnamese authorities. Although the implementation of these programs has a geographic dimension, 15

there is no reliable information about where the funds are used. What remains is therefore to examine the share of ODA that has an explicitly geographic destination: in recent years, this applies to about half of the aid inflows, in particular the infrastructure investments. Table 2 summarizes the data on ODA inflows per capita and regional ODA shares 2001 2003 for the eight regions that are commonly identified in the Vietnamese policy debate. Comparing aid flows with the patterns of poverty, it seems that there is a reasonable correspondence between aid and poverty incidence: the Northern Uplands, the Central Highlands, and the South Central Coast record high numbers for both indicators. However, there is no similar match between aid and poverty density. The southernmost parts of the country, including the Southeast and the Mekong Delta, receive very little ODA considering that a very large share of poor or nearly poor people are located in those regions. Moreover, looking separately at Hanoi and the rest of the Red River Delta (not shown in the table) shows that Hanoi receives a disproportionately large share of ODA. One way of interpreting these data is to see them as a confirmation of the general Vietnamese philosophy regarding the use of ODA resources. Aid has mainly been used in areas where the need for infrastructure investments is obvious, or where the expected growth effects of aid are strong. Figure 2 Poverty incidence and poverty density in Vietnam 1998. Source: VLSS 1998. Table 2 Geographical Distribution of ODA 2001 2003 ($ and per cent) ODA per capita (current $) Share of regionally allocated ODA (%) 16

Region 2001 2002 2003 2001 2002 2003 Northern Uplands 13.52 14.04 15.74 21.7 20.0 18.3 Red River Delta 8.76 9.44 11.10 21.3 20.5 19.6 North Central Coast 7.45 8.20 8.36 10.7 10.5 8.7 South Central Coast 11.16 17.90 23.10 10.5 15.1 16.0 Central Highlands 11.06 14.14 13.94 6.8 7.7 6.4 Southeast 10.03 8.25 11.57 17.5 12.9 14.9 Mekong Delta 4.92 6.39 9.43 11.5 13.3 16.0 Total 9.00 10.10 12.32 100 100 100 Source: UNDP data set. In terms of sectors and programs, UNDP distinguishes between 16 sectors and categories. These are Economic management, including macroeconomic policy Development administration and ODA management Natural resources Human resources, mainly education Agriculture, forestry, and fisheries Area development, with regional development policy and rural development programs Industry Energy resources International trade, with focus on trade policy formulation Domestic trade Transportation, including road, rail, water, as well as air transportation Communications Social development, including urban development, water and sanitation, housing, prevention of crime and drug abuse, and culture Health Disaster prevention Humanitarian aid Figure 3 shows how the total aid inflows (in real terms, calculated in 2000 prices) during the period 1993 2003 were distributed between the 16 sectors. As noted above, the CPRGS indicated that there would be a stronger focus on social issues, but this is not clearly visible yet in the available data. Instead, capital intensive infrastructure was the main destination for ODA during the period. The two largest sectors were Transport and Energy, accounting for more than one third of the total inflow of aid resources. In recent years, Economic Management has emerged as a third major sector. The main programs included in this category are general budget support and support to public administration reform. Health, education (or human resource development), and social issues received less attention from Vietnamese authorities, and less funding from international donors. As a point of comparison, it can be noted that the recent Vietnamese government budgets have also had a strong emphasis on investment. While public investment has accounted for 8 10 per cent of GDP, the public sector s expenditures for education have stayed below three per cent of GDP and health expenditures have barely reached one per cent of GDP (WB, 2005, Table 5.2). 17