Monday, August 12, 2013

Harnessing services for inclusive growth in Vietnam and PNG

 August 11th, 2013

Authors: Aaron Batten and Dominic Mellor, ADB, in East Asia Forum


In spite of their institutional, economic and demographic differences, Vietnam and Papua New Guinea (PNG) share something in common: neither have managed to fully harness the opportunities of a vibrant services sector.

It is generally the case that the share of services in a country's total economic output will increase as its per capita income rises. Services are a key input of nearly every business and are a primary determinant of productivity growth. Yet as a recently released ADB Working Paper shows large differences have emerged between the ability of low-income countries in the Asia Pacific to use their service sector industries to create employment, boost productivity and lift per capita incomes.

The share of services in PNG's economy remains at the low-end of all Asia Pacific countries, comprising roughly 29 per cent of GDP, which is well below the ASEAN average of 45 per cent. Output is dominated by the industrial sector, focused on a number of mining and oil operations, which runs in parallel to a large subsistence and cash crop based agricultural industry. For the most part, the services sector remains focused on domestic wholesale and retail trade, along with transport, finance, and business services in support of the larger industrial and agriculture sectors.

Despite an impressive period of growth since the launch of economic reforms in the 1980s, Vietnam's service sector, comprising approximately 35 per cent of its GDP, is also much smaller than other countries at similar stages of economic development. Vietnam's economy of 87 million people is dominated by a low value-added manufacturing sector, with agriculture also making up a large, albeit declining, share of output. Against this backdrop, service businesses have been largely confined to tourism, wholesale and retail trade, transport and storage, telecommunications, and real estate.

Many of the underlying reasons for the underdeveloped service sectors in both countries are similar, despite varying in their intensity. The biggest reason is low productivity which has prevented the emergence of higher value-add service sector activities. Domestic educational institutions in both countries have been unable to produce sufficient quantities of the highly qualified staff that many service industries are heavily reliant on. In PNG the situation is exacerbated by the migration of skilled graduates toward high paying jobs in the mineral sector. Both countries also have weak, often burdensome, business environments. Regulations often impede commerce, and state-owned enterprises (SOEs) operate with many advantages, crowding out more efficient private sector entrepreneurs. In Vietnam, while many services industries have been liberalised in recent years, the government is still heavily involved in production and investment, particularly in the finance and telecommunications sectors. Likewise, PNG continues to operate inefficient government monopolies in aviation, power, ports, telecommunications, and postal and water services.

Yet both countries have also demonstrated over the last decade that rapid progress can be made in increasing the size and scope of service sector activities. Indeed, although PNG's services sector remains small, a number of reforms have dramatically increased growth in the sector over the last decade. The first was a series of banking reforms that privatised the Papua New Guinea Banking Corporation, and established the central bank as an independent regulator with a clear mandate for price and market stability. In 2006, the state also removed its monopoly in the mobile telephone market. The government has also introduced limited competition into the aviation sector, where a number of new service providers have challenged the state's monopoly, and reduced freight and passenger costs on some routes. As a result of these reforms the services sector has become a major driver of the increase in formal private sector employment opportunities. Employment in transport and telecommunications increased from an average of 0.7 per cent from 2001–05 to 5.5 per cent from 2006–12, while employment in financial services rose by 4.5 per cent during the same period.

Likewise, Vietnam has made a number of legal reforms to address foreign exchange regulations, SOEs, discriminatory price controls, and intellectual property after joining the World Trade Organization and several bilateral trade agreements. These reforms have facilitated trade in services by improving transparency and increasing regulatory certainty for domestic and foreign firms. They have also paved the way for some much-needed foreign direct investment into service industries, particularly in the tourism and real estate sectors. Almost 50 per cent of FDI in the 2007–11 period was channelled into the service sector, helping to stimulate annual employment growth of about 7 per cent (up from 5 per cent during 2001–06).

Overall, while the size of Vietnam's and PNG's services sectors currently lag behind that of other Asia Pacific countries, their growth prospects are actually quite promising. Vietnam's labour productivity, while starting from a low base, is expected to grow by 3.8 per cent per annum between 2011 and 2020. On the back of rising mining and petroleum revenues, PNG is currently undertaking a significant boost to its investment in education and skills development, while business confidence is being supported by a strong medium-term growth outlook.

But both countries still have a number of hard reforms ahead of them, particularly when it comes to addressing the distortions that SOEs create in their economies, and cleaning up the myriad of constraints imposed on free enterprise by their complicated, burdensome business environments. Further efforts are required to lower bureaucratic and structural barriers that discourage entrepreneurship. This includes ensuring that adequate financial resources are invested into improving physical infrastructure and closing skill gaps among workers. Continuing efforts toward regional economic integration, such as the creation of an ASEAN Community, is also likely to spur further progress. Only then will both Vietnam and PNG be able to fully benefit from their service sectors during the next phase of their economic development.

Aaron Batten is the Asian Development Bank Country Economist in Papua New Guinea. Dominic Mellor is the Asian Development Bank Country Economist in Vietnam

The Asian Development Bank's recent Working Paper on the service sector in lower-income Asian countries can be found here

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