The trouble with the China model

By Roberto Herrera-Lim

Cast as "China-lite," Asia's next major export tiger, Vietnam plays the part with gusto. Its bureaucrats look north to learn China's way of growth. And at first glance Vietnam seems perfect for the role -- affordable labor and plenty of both public and private investment (foreign and domestic) in everything from office buildings and new industrial zones to oil refineries and deepwater ports.

But when Hanoi decided in August to devalue Vietnam's currency, it demonstrated that following China's path to prosperity just isn't that easy. Investors are now taking a step back to watch carefully as Vietnam wrestles with inflation, large trade and balance of payment deficits, and a frothy urban real estate market. They also worry over longer-term problems like official corruption, bureaucratic confusion, shortages of skilled workers, and large gaps in infrastructure investment.

Maybe China is the wrong model. Beijing is wrestling with some of these same problems and makes plenty of mistakes along the way, but China's enormous economy and its access to capital provide advantages that little Vietnam -- and maybe a lot of other small frontier economies -- can't match. China's size and advantages of scale have so far helped Beijing absorb many a self-inflicted blow over the past two decades.

In short, large stores of cash can make up for large amounts of wasteful spending. China has that luxury. Vietnam, and some other would-be Chinas across the developing world, do not.

In search of a better model, Vietnam should look to Thailand which doesn't have the large resource base or labor force found in Indonesia, Philippines and, to some extent, in Malaysia. It's hardly a picture of political stability (and things could get worse). Following the Asian financial crisis a dozen years ago, the country was forced to rebuild roughly from zero.

But Bangkok and the central region near the Gulf of Thailand have become regional and global manufacturing bases. Thailand's eastern seaboard today competes with the provincial manufacturing powerhouses of southeastern China better than any other region in the emerging Asian economies.

How did this happen? The country liberalized. After the Asian financial crisis, Bangkok opened foreign ownership rules, encouraging manufacturers to set up shop rapidly. The country abandoned state-led development of its domestic auto sector, allowing Japanese and American manufacturers (and their suppliers) free entry. Large-scale deregulation and cheap land brought European retailers to the country. Industrial policy has consistently provided the legal and physical infrastructure to encourage continued investment. In fact, Thailand is weakest where government protection has been most evident -- in the telecoms sector.

Vietnamese officials, afraid that commitment to liberalization on that scale would subject its people to economic shocks and social upheaval, have avoided Thailand's path. In the process, Hanoi has slowed private investment (or directed it into chosen sectors) and channeled public investment into projects that don't produce anything worth buying. Given the supposed lessons of the financial crisis -- that liberalized markets will eventually create turmoil and that state management can spur sustainable long-term growth, Vietnam appears more determined that ever to imitate China without China's biggest advantages.

Hanoi will muddle along with decent growth for the foreseeable future. Vietnam still has enough cheap labor and will spend enough on better roads, bridges and ports to lure foreign manufacturers for a few years more.

But if Vietnam really wants to become a new Asian tiger, it will eventually need to embrace the entrepreneurial dynamism that only liberalization can provide. Its officials are better off visiting Bangkok than Beijing.

Roberto Herrera-Lim is an analyst in Eurasia Group's Asia practice.