Developing the Vietnamese Automobile Industry

Sakura Institute of Research, Inc.
Ken-ichi Takayasu

Foreword

A considerable period of time has passed since the Vietnamese government switched to an open-door policy and began to seek direct investment from other countries. As far as the automobile industry is concerned, however, the outcome has not been sustained development, despite an influx of foreign automobile assemblers.

In September 1996, Vietnam formed an automobile industry development task force made up of representatives of government agencies involved in the industry. This group has carried out surveys of automobile industries in other countries and produced several preliminary plans for the creation of domestic automobile industry. The Vietnamese government intends to announce an automobile industry development policy, possibly as early as the start of 1998.

This paper will discuss approaches to the development of an automobile industry in Vietnam on the basis of an analysis of domestic and international situation surrounding the automobile industry.

I. Changes in the Domestic and International Economic Environment

1. Trade and Investment Liberalization

Vietnam needs to deal with the issues of trade and investment liberalization. It must make substantial reductions in its tariff rates in preparation for its planned admission to the Common Effective Preferential Tariff (CEPT) system of the ASEAN Free Trade Area (AFTA) in 2006. Vietnam began to develop its automobile industry in the 1990s, some 30 years later than other ASEAN countries. Despite this, it faces the same competitive conditions in terms of tariffs. This means that Vietnam has the difficult task of building a competitive automobile industry in the brief time remaining before liberalization. To make matters worse, the dramatic decline in the values of other ASEAN currencies against the U.S. dollar and other major currencies since July 1997 has brought a relative decline in the price competitiveness of Vietnamese manufactured goods.

Furthermore, if Vietnam hopes to join the World Trade Organization (WTO), it will no longer be able to maintain such discriminatory automobile industry development policies based on TRIM (Trade-Related Investment Measures) exemptions. As a result, there is a strong possibility that it will be unable to employ the approaches used by other ASEAN countries, such as national car concepts and local content regulations. In short, Vietnam will probably be unable to benefit from the strategies used by other ASEAN governments in the past, which curbed external pressure for liberalization while imposing local content requirements on foreign companies that moved into their territories.

2. Changing Trends in the World's Automobile Industry

Changing trends in the world's automobile industry are likely to have a major impact on Vietnam's automobile industry policy. First, major assemblers and parts manufacturers are increasingly establishing divisions of labor on a global scale. The direction in which the automobile industry evolves in a particular country will depend to a large extent on whether or not that industry is included in such divisions of labor. Inclusion in or exclusion from divisions of labor established in the ASEAN region by foreign vehicle assemblers will have a particularly crucial significance for Vietnam. Second, growing concern about environmental problems and safety has brought a rapid rise in the investment burden on manufacturers. Unless production volumes are extremely high, this investment cost cannot be recovered. Third, production methods of cars are changing, and the pace of technological innovation is rapid. It will be difficult for developing countries to catch up with the developed countries in this area.

3. Domestic Economic Environment

The domestic economic environment is a key factor when attempting to predict the future of the Vietnamese automobile industry. One possible view is that rising income levels will trigger a dramatic increase in the demand for automobiles in Vietnam, which has a population of 70 million. Moreover, the emergence of mass-production merits in step with market expansion is expected to lead to reductions in production costs. However, real economic growth rate has been falling on a year-to-year basis since 1996, and the growth rate of 8.1 % predicted for 1998 represents a further decline from the estimated 1997 figure of 8.4%.

A question mark also hangs over Vietnam's ability to earn foreign currency, which is a vital prerequisite for the development of the automobile industry. As the automobile market expands, imports of finished cars and parts will increase, leading to an expanding trade deficit in the automobile sector. The export capacity of the automobile industry is extremely low at present, and it will be necessary to offset the trade deficit in the automobile sector by exporting other items.

The outlook for Vietnam's ability to earn foreign currency by exporting agricultural goods (rice) and light industrial products has started to appear uncertain. In addition, oil-field development efforts havebeen less successful than expected, and thus a major turn-around in the trade balance seems unlikely. The trade deficit is expected to expand from US$3.5 billion in 1997 to $4.0 billion in 1998. Another source of uncertainty is a sharp decline in the pace of foreign direct investment inflows, which have hitherto supplemented Vietnam's foreign currency income and boosted its economic growth.

II. Current Ternds in the Automobile Industry

1. Small Domestic Market

As shown in Table 1, the Vietnamese automobile market is extremely small compared to markets in other ASEAN countries. In addition, the pace of market expansion has been more gradual than what was originally anticipated in the early 1990s. For example, one foreign think-tank predicted in 1992 that domestic automobile ownership in Vietnam would reach 408,000 units by the turn of the century, and that domestic automobile sales would exceed 40,000 units in 1995 and 80,000 units in the year 2000. However, in 1996, the total size of market (sum of domestically produced vehicles, imported finished cars, and imported used cars) was just around 20,000 units. Of these, Vietnam produced 5,523 units (4,168 passenger cars, 1,355 commercial vehicles). Sales of domestically produced vehicles totaled 3,554 units in the first eight months of 1997 and appears to have stabilized at 5,500 - 6,000 units over the whole year, which is about the same level as that of the previous year.

According to the experiences of the other ASEAN countries, automobile ownership suddenly increased when per capita GDP exceeded US$1,500 - 2,000. Vietnam's per capita GDP is currently around $350 (1997 estimate), and thus there is little hope that a major motorization trend will begin in the short-term future. Government agencies and business corporations, including foreign companies, are the main automobile purchasers. Vietnam has not yet reached the stage at which ordinary consumers can afford luxury items such as automobiles.

Another feature of the Vietnamese automobile market is the extremely large number of makes on sale, of which there are about 30 (domestically produced automobiles). Automobile assemblers are trying to boost their market share by increasing the makes of vehicles that they sell. However, this has created a dilemma, because sales per make which were already low have now fallen even further as a result.

Observers have also pointed out that market expansion will require support from the financial sector. Urgent priorities in this context are the popularization of hire purchase, and the development of related financing, insurance and mortgage systems. In addition, Vietnam needs to simplify and unify its automobile registration procedures and documentation requirements. Obviously, there is also a need for continued efforts to improve infrastructure, including road development and the establishment of parking facilities.

2. Excess Supply Capacity

One problem that has been highlighted in relation to the Vietnamese automobile industry is excess supply capacity. The master plan, published by the Ministry of Heavy Industry in 1993, stated that automobile production licenses would be granted to only three commercial vehicle manufacturers and two passenger car manufacturers. In reality, however, production licenses have been granted to a total of 14 companies.

According to Vietnamese government sources, the production plans of automobile assemblers with production licenses add up to a total capacity of 137,000 units. Government officials do not appear to regard this level of capacity as excessive, since they are assuming that demand will reach an annual 105,000 units, or 77% of total production capacity, by 2005. The government's stance is that simultaneous production by all 14 companies will not lead to an over-supply situation, and rather that, competition among the world's leading automobile assemblers will result in the production of more competitive automobiles. In addition, the government sees the large number of old vehicles still in use in Vietnam as evidence that there will be substantial replacement demand.

Assemblers with production operations in Vietnam face a grave over-supply situation. Capacity utilization rates are extremely low, and in one case, a facility capable of producing 10,000 vehicles annually is turning out only around 500. Since plants were built only recently, the depreciation burden is also heavy.

The Vietnamese automobile industry is currently in the grips of a vicious circle, in which the small size of the market prevents assemblers from reaping the mass-production merits, with the result that market growth is hindered by high production costs. Unless the industry can break out of this vicious circle, assemblers will be discouraged from investing and may reduce their efforts in such areas as technology transfers, human resource development and the incubation of local companies. In order to alleviate the situation, the government will at least need to adopt measures such as to prohibit imports of vehicles of the same types that are produced domestically.

III. Automobile Industry Deveolpment Policies

In light of the preceding analysis of the current state of the Vietnamese automobile industry, this section examines the propriety of national car concepts and local content regulations, the attraction and development of parts manufacturers, and the importance of the establishment of cooperative relationships between the Vietnamese government and foreign manufacturers.

1.Current State of the Automobile Industry

Fig.1 shows the development stages and current state of automobile industries in developing countries. In general, they have followed a similar path. The first stage is the limited importing of completely built-up (CBU) vehicles under import licenses. At the second stage, the industry shifts to semi-knock-down (SKD) importing. The third stage is complete knock-down (CKD) importing. After assembly-related technology has been accumulated through this process, the industry can finally advance to the fourth stage, at which domestic souring of parts can begin in earnest. Vietnam is just on the threshold of the fourth stage. According to the experiences of other developing countries, the selection of policies at this stage has had an important bearing on the future direction of automobile industry development in their countries.

2. National Car Concepts and Local Content Regulations

(1) National Car Concepts

The Vietnamese government plans to turn Vietnam into an industrialized nation by 2020, and its industrialization master plan includes the development of the automobile industry. There is debate among the officials responsible for Vietnam's automobile industry policy over whether or not Vietnam should aim to produce a national car.

I would not agree to a national car concept if the government's aim is to create automobiles that can be exported under a Vietnamese brand, through a project that would begin with research and development and culminate in the manufacture and assembly of parts. Admittedly, it would be possible to increase production per make and per manufacturer and achieve mass-production merits by promoting a national car plan based on the provision of incentives to specific assemblers. However, the suitability of a national car concept is compromised by a number of factors, including changes in the international economic environment, the current level of the Vietnamese automobile industry, the size of the domestic market, and the presence of large numbers of assemblers in that market.

According to Vietnamese government sources, an outside organization, which was asked to draw up an automobile industry development master plan in 1992, advised that Vietnam should aim to produce a national car along Malaysian lines. Yet Malaysia began to work on its national car scheme in 1983, and Vietnam's present circumstances are extremely different from Malaysia's back then. The fact that Malaysia's national car concept has enjoyed a certain degree of success should be attributed to a combination of favorable factors, including smooth introduction of foreign technology, the rapid expansion of domestic demand due to sustained economic growth, and the fact that the national car concept did not violate the international rules of the day.

The economic justification for the development of an automobile industry at a time when Vietnam faces difficult economic conditions at home and abroad should not be the desire to have a Vietnamese automobile brand, but rather the creation of employment, the development of parts and materials industries, human resource development, and the improvement of the trade balance.

(2) Local Content Regulations

The Vietnamese government needs to give careful consideration not to the introduction of a national car concept as outlined above, but rather to approaches that will quickly raise local content ratios. The production of automobiles with high local content ratios is in the interests of the both the Vietnamese government and foreign manufacturers. The local content requirements contemplated by the Vietnamese government are subject to debate in terms of its relationship with the WTO. If such regulations are introduced, the following points will need to be taken into account.

First, the Vietnamese government should recognize that raising the local content ratios will take a considerable period of time, that some parts will be easy to produce in Vietnam and others will be difficult, and that the realization of mass-production merits is an important factor in terms of raising local content ratios. In the case of commercial vehicle production in Thailand, for example, local content ratios rose significantly after total national production of automobiles exceeded 300,000 units a year. In addition, there is a risk that a hasty shift to domestic production of sophisticated functional parts, engines and bodies will lead to the production of overpriced automobiles. Domestic production of parts that require substantial investment and frequent model changes should also be avoided. Another priority for Vietnam is to become part of brand-to-brand complementation networks established by Japanese assemblers within the ASEAN region.

The government should not designate which parts to produce domestically and which technology and facilities to use. Such decisions should basically be left to assemblers. This is especially true in the case of Japanese assemblers, which have acquired greater experience than their Western and South Korean counterparts in raising local content ratios in ASEAN.

If the Vietnamese government does introduce local content requirements, it should provide incentives, such as extra local content points or tax benefits, to companies that meet local content targets ahead of deadlines, introduce new technology, or contribute to export expansion. Also, Vietnam should not set local content ratios for individual makes. Since production per make is extremely low, companies will be unable to cope unless local content ratios are set per plant or per manufacturer.

Local content ratios should be calculated not by the given percentage method, whereby the prices of individual parts are assessed and totaled. Instead, Vietnam should introduce the value-added method, which focuses on the differences between wholesale prices and import prices. The value-added method has been adopted for the CEPT system and is internationally recognized. Since calculations can be made from financial statements, administrative processing is also simple. The given percentage method greatly increases administrative processing, since it is necessary to assess and total the prices of all individual parts. In addition, the cost of parts can vary according to the supplier, and even the prices of parts imported by the same company can differ depending on when they are imported.

Therefore, local content ratios should be based on the value-added method, and adjusted to reflect such factors as the value of exports and in-house production of parts. Another advantage of the value-added method is that it allows the inclusion of large-scale investment in plant, such as painting facilities, and locally sourced components into the calculation of local content ratios, thereby giving companies an additional incentive to invest.

(3) Selecting Parts

When considering a shift to domestic production of parts, the Vietnamese government should study the past experience of other ASEAN countries. Fig. 2 is based on the results of a questionnaire survey of Japanese-affiliated companies with operations in the ASEAN region. It lists automobile parts in order of local content ratios. There are 16 items, ranging from batteries to transmission oil, that can be sourced within the ASEAN region (in the country where production facilities have been established, or from other ASEAN countries) without difficulty. This was indicated by responses from 80% or more of the companies replying that they were procuring these items within the region. The only item that manufacturers have already sourced from other ASEAN countries is radiators, while all of the other parts are being procured domestically. It would be reasonable to conclude that these parts are suitable for domestic production.

More than 50% but less than 80% of companies are currently sourcing items from 17th (horns) to 31st (lamps) on the list within the region. Of these, body panels, bumpers, shock absorbers, horns, lamps, seat belts, noise insulation, and intake and exhaust manifolds have already been sourced within the ASEAN region. Parts such as these are easy to fit into brand-to-brand complementation (BBC) networks.

Less than 50% of companies participating in the survey responded that they were sourcing items from mirrors down to engine computers within the ASEAN region, indicating that there has been little progress toward local procurement for these parts. For the time being, Vietnam should avoid switching to domestic production of items in this category.

Fig. 3 shows the levels of procurement of basic and raw materials within the ASEAN region. According to survey responses, the only item that is being procured locally by 50% or more of companies is paint. Local procurement ratios for cold-forged components, and steel for forging and body components are extremely low.

3. Attracting and Fostering Parts Manufactueres

The improvement of local procurement ratios cannot be achieved solely through the efforts of assemblers. There are limits in the extent to which assemblers can produce their own parts in-house, and local content ratios will not rise significantly without the development of a full range of manufacturers producing parts, components and raw materials. If assemblers make unreasonable efforts to produce parts themselves to raise local content ratios, the only result will be in producing parts that cost more than those made in Japan.

At present, the only parts that can be sourced in Vietnam are tool-kits, wiring harnesses, seats and batteries (being sourced by some assemblers). Other items, such as tires, glass, floor-mats, and mud-flaps, are also likely to become available. However, procurement of other parts is expected to remain difficult.

In order to develop the parts industry, it will obviously be necessary both to attract foreign parts manufacturers and foster local manufacturers. In order to attract foreign parts manufacturers, Vietnam will need to take bold policy action, including the flexible application of foreign ownership regulations, substantial reductions in corporate tax, the reduction of tariffs on raw materials needed to produce parts, and the reduction of production costs (land lease charges, energy costs, infrastructure development). Another obstacle to the establishment of operations by foreign parts manufacturers is the fact that some vehicle assembly plants of assemblers they deal with are located near Hanoi and others around Ho Chi Minh City. Vietnam will need to improve its north-south infrastructure links, including roads and telecommunications, and develop better distribution networks.

A key requirement for the development of local parts manufacturers is the achievement of mass-production merits. According to an official working for one automobile manufacturer, local machinary parts manufacturers are unable to reap the mass-production merits at present, since a single plant must handle numerous parts and processes. One solution to this problem would be to restructure and integrate the parts industry to create manufacturers specializing in individual processes, such as machining, welding and electroplating, instead of letting large numbers of companies all with the same production facilities undertake the same production processes. The establishment of agencies responsible for the quality control of parts would also be beneficial, since this would raise quality standards while avoiding the need for individual companies to invest in duplicated facilities.

Tariff policies also have a major impact on local content ratios. First, to ensure a sufficiently large market for finished cars, it will be necessary to impose relatively high tariffs on vehicles of makes that are also produced domestically. From the viewpoint of encouraging domestic production of parts, it will be especially important to set high tariffs on imported parts if they are also produced domestically, and set low tariffs on imported components that are used for producing parts by parts manufacturers.

Import restrictions on second-hand machinery needed for the production of parts should be eased. If only the latest machinery can be imported, foreign companies may postpone investment in imported equipment due to the resulting rise in fixed costs. Companies decide whether or not to import machinery after comprehensive evaluations of profitability and quality. Provided that there is no risk of extreme damage to the trade balance, companies should be allowed to decide forthemselves whether to import the second-hand machinery or the latest models.

4.Building Cooperative Relationships with Foreign Companies

In this article, the purpose of an industry development policy is defined as to raise the competitiveness of an industry to a level at which it can maintain international competitiveness without government protection or incentives. In other words, while government may adopt restrictive measures for competition on a short-term basis, its long-term role should be to ease restrictions and create conditions in which market mechanisms can operate. Although Vietnamese government may continue to restrict competition for the time being, it should assume that sooner or later it will face a challenge of liberalization.

An issue that arises in the initial stages of an industry development policy is the apportionment of industry set-up costs among the government, manufacturers and consumers. A study of the history of automobile industries in ASEAN reveals that governments have given foreign manufacturers access to their domestic markets in exchange for using their management resources. There has also been heavy reliance on foreign companies in the areas of technology transfers and human resource development. Malaysia's Proton could not have reached its present level of development without the support of foreign companies.

In Vietnam, the resources available for investment in the automobile industry are limited. The business resources of foreign companies should therefore be used actively, at least while the industry is in its infancy. Before the Vietnamese government can use the resources of foreign companies, it will be necessary to bridge the perception gap that exists between the two sides. The government should recognize that the pursuit of profit is a reasonable activity for companies in a society under the principle of free competition. The real issue is whether there is an environment in which companies will want to reinvest their profits thus gained in Vietnam. Whatever automobile industry development policy is adopted by the Vietnamese government, companies will be discouraged from sustained investment unless that policy is appropriate for the establishment of business plans based on long-term perspectives.
To encourage reinvestment, it will also be necessary to improve administrative organizations and related institutions while working to expand markets and develop production infrastructure, including supporting industries. Obviously, the legal system must be applied in accordance with basic principles and must not be subject to sudden changes.

In the markets of developed countries in general, consumers benefit from the fact that the creativity and ingenuity of companies increases in proportion to the intensity of competition. In Vietnam, competition is intense in the sense that 14 of the world's leading automobile assemblers have been given production licenses. However, the small size of the market and the limited scale of production mean that there is very little scope for the exercise of creativity and ingenuity for the manufacturers.

The establishment of an automobile industry development policy will also have the effect of setting rules for competition among manufacturers. When setting rules, it is impossible to accommodate all of the interests claimed by those concerned. What is important is to be fully aware of the need to create rules that are fair and easy to understand, and to ensure that those rules are implemented transparently. Any improvement in the level of trust between foreign companies and the government will be determined by the extent to which information is shared. To this end, there should be regular forums at which their views can be exchanged.

The scenario most feared by the Vietnamese automobile industry is one in which Vietnam lags further behind other ASEAN countries due to a prolonged slump in corporate earnings and the resulting stagnation of investment activity. A continuing war of attrition will polarize the industry between companies with superior capital resources and those that specialize in niche markets. There is a risk that this environment will fail to drive the kind of competition that leads to technology innovation and development of new products that meet consumers' needs. The automobile industry faces a harsh economic environment, both domestically and internationally. The industry cannot afford to spend much time awaiting a reconciliation of views between the Vietnamese government and foreign manufacturers.

Conclusion

As outlined in this article, the Vietnamese automobile industry faces a variety of problems. An analysis of these problems highlights a number of issues that need to be taken into account by the Vietnamese government when it drafts and implements automobile industry development policies.

Though the Vietnamese automobile industry is still in its infancy, it will be forced to make the same major decision as the industries in other ASEAN countries. Should the Vietnamese automobile industry specialize in specific makes or parts within international divisions of labor developed by multinational companies, or should it aim to produce automobiles under a Vietnamese brand? The answer to this question must be considered carefully from the viewpoint of which approach will be most effective in terms of the long-term development of Vietnamese industry as a whole.

To reiterate what was said earlier in this article, the Vietnamese government needs to place particular emphasis on three factors when formulating and implementing an automobile industry development policy. First, the Vietnamese government should maintain good relationships with foreign companies so that it can make maximum use of their business resources. Second, every possible policy tool should be employed to attract foreign parts manufacturers and foster local parts manufacturers. Third, instead of promoting a national car concept, which could encourage the production of overpriced automobiles, the government should target its policy toward the production of vehicles with high local content ratios.

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