Vietnam: The Domino Effect and Inflation

As I have said many times, when it comes to off-shoring, the domino effect prevails. Once a developing country’s manufacturing costs start to rise, global corporations look to the next country in the list. Most of us are aware that whole chains of production–including R&D–have been moving to China. Well, one of the next stops is Vietnam. Here, according to Alex Bryant in Industry Week, are the advantages of the new Asian newcomer:

• In comparison to many of its Asian neighbors, Vietnam has a relatively inexpensive labor rate. For factory operators, the average salary is $200.00/month while key managers and senior engineers are paid $1,500.00/month. Vietnam has a 48 hour work week and the government-mandated social programs are approximately 25% of the salary costs. In comparison, China has a 40 hour work week and social costs are 50-60% of the operator’s salary.
• The Vietnamese workforce is well-educated and hungry. The average age of an operator is 24 and a growing percentage of the workforce has a comfort zone with English as a second language due in large part to the availability of English language centers.
• The government has implemented an aggressive program of corporate income tax incentives. This program involves up to 4 years of tax holiday following (and including) the first year of ‘carried forward’ profitability. Thereafter, the tax rate is 1/2 of the nominal tax rate for a period of up to 7 years, with a total application period of up to 15 years. The nominal tax rate can be 10%, 15%, or 20% — depending on the industry sector, investment classification and location. The standard tax rate is 28%.
• There are also duty free programs for the importation of capital goods (new and refurbished).
• While behind China, the Vietnamese government is committed to developing infrastructural balance, especially electricity and water supply, seaport services and telecom. Bilateral lenders and grants continue to be plentiful.

Economists would do well to read industry magazines and those directly involved in globalization. They know how globalization works.

In conjunction with this piece of good news for the likes of Intel–which is investing one billion dollars in Ho Ching Ming City (an investment Intel’s suppliers will surely supplement as they move to Vietnam as well)–, economists are now finally arguing over the effect of all this offshoring on U.S. GDP. (Read Business Week.) Money is certainly pouring into the U.S. in the form of profits and upper management salaries. For the rest of us who have not been invited to the party, keep a tight grip on whatever benefits you presently have. We have a bifurcated economy.

Eventually, this game will end…and not happily. If we follow its logic, country after country will be squeezed. As soon as it the costs in one country start to rise, as soon as wages, for example go up, capital will move on to the next country. Following the logic further, each time a developing country tries to create a consuming, widespread, middle class, it and the U.S. will experience inflationary pressures as companies try to maintain profits or scramble to find more fertile cheap labor and other benefits.

Countries do not suddenly develop middle classes. Imagine that poor Ipod worker in China. Suppose his salary doubles from sixty cents an hour to $1.20/hour. That is inflationary. But is he now ready to step forward as a consumer? Not really. We have doubled the wage cost of the very goods we expect him to buy, but doubling his salary does not remotely begin to put him in middle class range. Globalization has been profoundly deflationary, both in services and goods, offsetting the rise in the price of energy. Many measure it as “efficiency.” This “efficiency” is an illusion and will come at a future cost. Cheap labor is efficient when it remains cheap–or gets cheaper.

And what will the Fed do as inflationary pressures rise, as the cost of goods rise, or as the dollar slumps against other countries, or as the price of energy increases? Raise rates?

The transition to a consuming society, assuming we get that far, will be very, very bumpy. The discrepancies between the West and developing countries are simply too vast. China’s real consumption so far has been in amazing infrastructure development, not in consumer goods. When the WTO ignored labor, it created a mechanism that cannot succeed. The models are too simplistic. Free trade between impoverished and wealthy nations cannot work as designed. We have created a complex mosaic of falling dominoes. Eventually, everyone will be flattened.