The comprehensive free trade agreement between Japan and Vietnam that will come into effect later this year is the latest manifestation of the crucial role that Japan has played in Vietnam’s evolution from command economy to market-oriented one.

The Japanese parliament ratified the agreement, referred to as the Vietnam-Japan Economic Partnership Agreement, in June. It paves the way for a significant two-way increase in the flow of goods and services as well as improvement in other areas such as investment and labor movement. Its implementation will be one of the cornerstones of the “strategic partnership for peace and prosperity in Asia” that the two countries are currently working on.

Japan’s contribution in transforming Vietnam’s economy can be seen in the three important areas of official development assistance (ODA), trade and investment.

In terms of development, Japan is Vietnam’s largest provider (Vietnam is the second largest destination for Japanese ODA after India). For this year alone, even in the face of its own economic hardship, Japan is committed to providing Vietnam with at least US$900 million.

In loans, grant aid, and technical cooperation, Japanese ODA has helped Vietnam to improve its physical infrastructure, enhance the living and social environments, and engage in necessary economic and legal reforms to further economic development.

Trade Surplus

Japan is Vietnam’s second largest export market after the U.S. According to statistics of the Japan External Trade Organization (JETRO), Vietnam has consistently enjoyed an annual trade surplus with Japan over the past five years, with the 2008 surplus reaching US$1.26 billion. Two-way trade has expanded rapidly, increasing from around US$7 billion in 2004 to US$16.8 billion in 2008. With the coming implementation of the FTA, this number will surely continue to rise.

Under the FTA, the two countries agree to abolish tariffs on 92 percent of the goods traded between them within the next 10 years. In particular, Japan will give significant access to those products in which Vietnam currently has a comparative advantage (such as farm products and garments/textiles). For example, Vietnamese shrimp and durian will enter the Japanese market duty-free immediately upon the FTA’s taking effect, not only increasing Vietnamese exports but also boosting local employment.

In terms of investment, to support Vietnam’s economic growth through the attraction of foreign direct investment (FDI), the two governments launched “the Japan-Vietnam Joint Initiative to Improve Business Environment with a View to Strengthen Vietnam’s Competitiveness” in 2003. In implementing this initiative, solutions to investment’s obstacles have been carried out in such forms as changing relevant laws, improving physical infrastructure, and building institutions.

This joint initiative together with the bilateral investment agreement which came into effect in December of 2003, has drastically increased the flow of Japanese FDI into Vietnam. According to Jetro’s statistics, while the number for 2004 was US$128 million, it jumped to nearly US$1.1 billion for 2008. The latest data from Vietnam’s Ministry of Planning and Investment also showed that, as of June 2009, Japan ranked third in terms of the sources of FDI, with 1,113 investment projects amounting to US$17.6 billion.

More importantly, since Japanese FDI has mainly focused on manufacturing, it has helped spur the development of new industries ranging from motorbikes to cars. Currently, Japan is interested in helping to develop supporting industries, where Vietnam lags far behind its ASEAN counterparts like Thailand and Indonesia.

The lack of effective supporting industries has not only prevented Vietnam from capturing the associated benefits of positive externalities to further promote industrialization but has also significantly contributed to the country’s persistent trade deficit since it has to import many of the components that go into the final products. In this regard, the successful development of supporting industries would be the key for Vietnam to move up the development ladder.

Japan is also aiming to help Vietnam develop high tech industries such as nuclear energy and space. For instance, Vietnam will build its first space center (the Hoa Lac Space Center) with Japanese ODA loans of US$350 million. This center is to be completed by 2017 when Vietnam will be able to produce small satellites. During the process, Japan will transfer its relevant space technology and provide training to Vietnamese personnel. Vietnam will certainly benefit from this type of cooperation since the Japanese brand is generally a trusted name in the area of technologies in the world market.

While Vietnam has enjoyed significant benefits from Japanese ODA, trade, and FDI, Japan has also tried to achieve its interests in the relationship as well. First, with a population of more than 86 million and a growing economy, Vietnam is both a potential lucrative market and an attractive manufacturing site for Japanese firms. According to a 2008 survey conducted by the Japan Bank for International Cooperation on Japanese manufacturers’ oversea business operations, Vietnam ranked as the third promising country (after China and India) and was the destination for many new Japanese investment. It was also considered as a good place for risk diversification.

Second, Vietnam has human and natural resources that would potentially supply to the need of Japan. For instance, with its aging population and a relatively very low birth rate, Japan will potentially experience a significant shortage of workers in its more labor-intensive sectors, such as healthcare and agriculture. In this regard, Vietnamese young workers are regarded as fit to help fill the gap.

Third, as a strategically located ASEAN member, Vietnam can serve as bridge for Japan to reinforce and enhance its relationship with the treaty organization. Being a relatively dynamic economic region, ASEAN has been important for Japanese investors and products. Japan has bilateral FTAs with most ASEAN members (except Cambodia, Laos, and Myanmar) and an FTA with the whole ASEAN. Since Japan sees a strong and well-developed ASEAN as a whole important to its own development, it has also tried to help relatively less-developed ASEAN members (Cambodia, Laos, Burma, and Vietnam) integrate well into the regional economy. This effort can be seen through the various types of cooperation that Japan has with the Mekong Region countries (the above four plus Thailand), ranging from developing regional economic corridors to cultural exchanges.

Win-Win

It is clear that the current Vietnam-Japan relationship is a win-win one. From the strategic standpoint, each side can accommodate the other’s interests largely without complicating its own internal and external relations. For instance, while the Vietnamese government has to deal with intense public opposition on some controversial Chinese FDI projects, it does not have that problem with Japanese FDI. Furthermore, there is no inherent competition between the two countries both in terms of economics and politics. One example of this can be seen in the fact that there is no competition in the goods that each country has a comparative advantage.

However, continued success should not be taken for granted. The following two cases make the point, one of which is related to the implementation of Japanese ODA. Last year, the government of Japan decided to suspend the release of new ODA to Vietnam for six months (from August 2008 to February 2009) after a significant corruption case (known as the PCI corruption case) related to the Japanese-funded Saigon East-West Highway Construction Project was revealed.

Japan resumed its ODA disbursement after the two governments formed the “Japan-Vietnam Joint Committee for Preventing Japanese ODA-related Corruption” to come up with effective measures to prevent such similar cases from happening again. (The committee already issued its report on February 23, 2009). This is an important step. But for real positive results, careful and ongoing monitoring must take place to make sure that the corruption preventing measures are implemented in full faith.

Another point is related to the two sides’ cooperation on developing supporting industries. According to the Japanese ambassador to Vietnam Mitsuo Sakaba,Vietnam did not have a detailed action plan to effectively carry out strategy to develop supporting industries. In a somewhat similar line, Kenichi Ohno, a Japanese expert who has very close knowledge of the situation, said that while Japan was active in coming up with an action plan, there was a lack of interest in cooperating from the Vietnamese side.

At any rate, the ball is pretty much in Vietnam’s court. It should strategically take advantage of the current very positive and well-intended Japanese involvement to promote economic development for the sake of maintaining social stability and national security. Vietnam certainly has a lot more to lose if it fails to truly secure a strategic partnership with Japan.

Dr. Anh Le Tran is a professor at Lasell College in Massachusetts in the United States.