Vietnam: Selected Issues

International Monetary Fund. Asia and Pacific Dept

doi:10.5089/9781484307571.002.A002

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Vietnam: Selected Issues

Author: International Monetary Fund. Asia and Pacific Dept

Publication Date:: 05 Jul 2017

eISBN:: 9781484307571

Language:: English

Keywords:: ISCR; CR; Vietnam; population share; category productivity; retirement age; size change; age-gender cohort; Labor force participation; Labor force; Total factor productivity

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Selected Issues

Abstract

Selected Issues

Demographics¹

Vietnam has enjoyed a substantial demographic dividend in the last decades. Going forward rapid projected aging could weigh on economic growth and necessitate social security and fiscal reforms. Managed well, this transition can go hand in hand with the Vietnamese living long, healthy, prosperous, and productive lives.²

1. Vietnam is a young country, but projected to undergo a demographic transition marked by slowing population growth and aging. Vietnam has a young population (median age of 26) with the largest age cohorts between 20 and 34 (Figure 1). However, declining fertility rates since the early 1970s and to a lesser extent rising life expectance will lead to an increase in the population’s median age (Figure 2).³ The population growth rate is projected to fall close to zero by 2050. The working-age population share peaked in 2013 and is projected to decline over coming decades (Figure 3). The share of the population age 65 and older (old-age population) will increase rapidly, although from low levels, and reach close to 3½ times the current level by 2050.

2. Aging in Vietnam is projected to occur fast and at a relatively low per capita income level. Figure 4 shows the number of years it takes for the old-age dependency ratio to increase from 15 to 20 percent. This transition is projected to take only 8 years in Vietnam, a speed of aging similar to other Asian economies. In contrast, the same transition took 26 years in Europe and more than 50 years in the United States. The rapid speed of aging has two implications. First, Vietnam will have less time to adapt policies to a more-aged society than many advanced economies had. Second, Vietnam is at risk of becoming old before becoming rich, or, to put it differently, Vietnam is likely to face the challenges of high fiscal costs of aging and demographic headwinds to growth at relatively low per capita income levels. Figure 5 shows per capita income at purchasing power parity relative to the United States at the historical or projected peak of the share of the working-age population in selected advanced and Asian economies. Among these countries, Vietnam’s working age population has reached its peak at the lowest relative per capita income level. All else equal, the contribution of the quantity of labor to growth begins to turn negative following peak working-age population. This underscores the need for Vietnam to sustain high growth rates in the next decades.⁴

3. Demographic trends will turn into headwinds for economic growth. Vietnam has enjoyed a substantial demographic dividend in the last decades that is gradually diminishing and will eventually turn into a drag on growth. Demographic developments affect growth through various channels, including the size of the labor force, productivity, and capital formation. We establish a baseline growth impact of demographic-induced changes in labor force size assuming unchanged total factor productivity (TFP) growth; unchanged age- and gender-specific labor force participation rates (and employment rates); and a constant capital-to-effective-labor ratio. ⁵ Labor force size changes are estimated to add close to ½ percentage point to average annual growth between 2020 and 2050 (Figure 6). The growth effect, however, is lower than previously and could fall to zero by mid-century. On a per capita basis, a declining labor force size is estimated to subtract 0.1 percentage points from annual average growth between 2020 and 2050.

4. Productivity growth could be lower with an aging workforce. Studies suggest that aging has mixed implications for productivity growth. Factors such as accumulation of experience over time, depreciation of knowledge, or age-related trends in physical and mental capabilities all play a role. We estimate the effect of workforce aging (measured by the share of workers 55–65 years old in the total workforce) on productivity for a sample of Asian and European countries.⁶ We find that an increase in the share of older workers is associated with a significant reduction in labor productivity growth. For Vietnam, the share of older workers in the workforce is projected to increase by close to 10 percentage points by 2050. This could reduce growth by 0.2 percentage points per year. The impact of aging may also differ across professions with productivity of workers in physically demanding professions (factory workers, construction, agriculture) declining at older ages, while productivity may increase with age in other professions such as lawyers, managers, and doctors. Vietnam has a high share of its workforce in professions where productivity tends to decline with age (Figure 7). This underscores the importance of structural transformation and moving up the value chain to prepare for an aging workforce.

5. Labor force participation rates (LFPRs) are already high in Vietnam, but there is ample scope to support growth by reallocating labor to productive activities. A gradual increase in LFPRs by 6 percentage points by 2050 could increase growth by 0.2 percentage points per year.⁷ That said, LFPRs in Vietnam for men and women are among the highest in the region, limiting the scope for increases. Notwithstanding, there is room to increase female and older worker participation in the labor force, as well as tackling under- and low-productivity employment. The latter is particularly relevant in Vietnam where productivity outside the FDI sector remains very low, informality is high, and 40 percent of the workforce is still employed in agriculture.

6. Rapid aging will pose fiscal challenges. Under current policies, age-related public expenditures (pensions and health care) are projected to increase by 8 percentage points of GDP by 2050, more than double the current level.⁸ Most of the increase would be related to pensions. Spending on education could fall with a declining number of young people, but this is unlikely to fully offset rising age-related expenditures. On the revenue side, lower growth rates because of demographic change could weigh on fiscal revenues.

7. The existing pension system is a defined benefit pay as you go system that covers public sector workers and workers in formal private sector jobs. The system is unsustainable because its generous benefits. Retirement ages, at 60 and 55 for men and women respectively, are low. General and occupational early retirement rules are generous, reducing effective retirement ages and increasing the system’s unfunded liabilities. Benefit indexation has regularly exceeded CPI. Accrual rates are high both in international comparison and given an actuarially reasonable internal rate of return on contributions, resulting in replacement rates of 75 percent after 30 and 25 years of service for men and women, respectively. Pension fund reserves are poorly invested, with returns below GDP growth. The pension system is also inequitable across private and public sector employees and across the covered and uncovered population. Land reform to give peasants title to land that can be traded and sold could be an effective old age insurance mechanism for large parts of the rural population.

8. Long-term demographic challenges underscore the need for policies to raise the economy’s growth potential and reform the social security system. Vietnam needs to achieve high and sustained growth in the next decades before demographic developments become a significant drag on growth. Faster productivity growth is needed while reducing the factor intensity of growth. Key areas for reform to boost the economy’s growth potential and facilitate structural transformation are SOE and banking reforms to achieve a level playing field for the private sector and improve the allocation of capital. Growth-friendly fiscal consolidation is needed to strengthen public finances before rapid aging sets in. On pensions, near-term reforms should raise retirement ages and address early retirement, accrual rates and indexation.

Prepared by Jochen Schmittmann (APD).

See “Golden Aging”, World Bank 2015.

Vietnam has had population policies advocating a limited number of children since the 1960s. The current policy emphasizes a family size of one to two children.

Vietnam’s low per capita income suggests the possibility of continued rapid real convergence through catch up in technology and structural transformation of the economy from low productivity activities, especially in agriculture where 40 percent of the workforce are employed, to higher productivity activities. However, this process is not automatic and requires good policies that facilitate strong productivity growth.

The estimate is based on a growth accounting framework with capital and labor as inputs. See chapter 2 in the IMF’s Spring 2017 Asia and Pacific Regional Economic Outlook for methodological details.

See chapter 2 in the IMF’s Spring 2017 Asia and Pacific Regional Economic Outlook for methodological details.

This increase in LFPRs is similar to Japan’s experience in the last two decades.

See Box 2.2 in the IMF’s Spring 2017 Asia and Pacific Regional Economic Outlook.

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