Trade openness grows with sub-contracting

Opinions have recently surfaced about Vietnam’s very high degree of trade openness, and the country is even among the economies with the highest degree of trade openness in the world. But this also means the country may be more vulnerable to external economic changes.

The important question regarding this issue is whether or not this high degree of trade openness results from Vietnam’s trade policy and it needs policy revision, especially amid the global trade war, mainly the ongoing U.S.-China trade friction together with its unpredictable risks.

The nature of openness

It is first necessary to differentiate between trade openness and trade liberalization of an economy. Trade openness denotes the relative scale of foreign trade in an economy, measured in total import-export value against the Gross Domestic Product (GDP).

Meanwhile trade liberalization reflects factors obstructive to cross-border commodity trade of a country, such as taxes, import and export quotas, and technical barriers.

With the total import-export value/GDP at 185% as per the 2016 data, Vietnam ranks third in Asia and eighth in the world in trade openness. However, the country has low ranking in trade liberalization.

According to the ranking by the World Economic Forum in 2016, Vietnam is ranked 73rd out of 136 countries in the trade promotion index, much lower than regional competitors like Malaysia (37th), China (61st), Thailand (63rd). Vietnam ranks even below Indonesia (70th). High import tariffs and complicated procedures are two of the biggest trade barriers of Vietnam in comparison with other regional countries.

It may come as a surprise for many people that the openness of an economy is not entirely related to the free trade policy of a country, but is dependent more on the structural factors of that economy.

First, countries with bigger economies have lower openness, as they can produce almost every item and commercial relations take place mainly within their economies. For instance, according to the 2016 figures, the three biggest economies in the world, namely the U.S., China and Japan, have low degrees of trade openness, at 27%, 37% and 31%, respectively. On the contrary, countries with small economies like Vietnam have higher degrees of trade openness.

Second, developing economies with low per capita income tend to have high degrees of trade openness. In developed countries, the service sector has the largest share in the GDP and is impacted little by international trade relations. Meanwhile, in developing countries, the agriculture and industry sectors, which are greatly impacted by international trade relations, have large shares in the GDP.

These countries also have a relatively large non-official economic sector, so the total import-export value/GDP is generally overstated. In the ASEAN (Association of Southeast Asian Nations), Vietnam and Cambodia have higher degrees of trade openness, at 185% and 127% respectively, compared with more developed economies like Thailand (123%), the Philippines (65%) and Indonesia (37%).

Third, trade openness is particularly high for countries which are regional trade transit hubs like Hong Kong and Singapore, or sub-contracting economies like Vietnam. These three economies rank first in Asia in trade openness and their foreign trade values are double counted, both in imports and exports.

In sum, Vietnam’s trade openness is essentially the result of structural factors reflective of the development level of the economy; it is not a policy option that Vietnam can easily change and revise over the short-term. The free trade policy is only one of the factors that affect trade openness of an economy.

In the case of Vietnam, the higher degree of trade openness versus other regional countries simply reflects the sub-contracting nature of the domestic economy, and does not means that Vietnam has a higher level of global economic integration and trade liberalization. The degree of trade openness may decrease when Vietnam can gain a higher position in the global production chain and have a larger service sector thanks to higher per capita income.

Exaggerated risks

Countries with high degrees of trade openness are generally affected more when the global market jitters and are more negatively impacted by global economic shocks. However, for sub-contracting economies like Vietnam, the impact may not be too big as reflected by the degree of trade openness. Economic shocks, once materialized, would affect directly and the most strongly to the foreign direct investment (FDI) sector. However this sector currently does not have close relations with the domestic sector.

Trade openness is widely used partly because it is highly summarized and easily calculated with available data, but it is not a complete benchmark to reflect the severity of external shocks on the economy. It does not tell many factors like the essence of trade relations, competitors, the nature of imports and exports and the diversification of trade partners. To put it differently, Vietnam’s trade openness is very high versus other regional countries, but this does not means the country is more impacted by global trade jitters.