UNDP Report-Part 2

3.
Public Financial Management
In this section we review the strengths and challenges

faced by Vietnam in terms of public financial management. In
particular, we review issues related to fiscal sustainability,
composition of public expenditure, its institutions for public
expenditure management, financial accountability and
transparency, public investment management and public
procurement.
Table X provides a summary of the strengths and

challenges of public financial management in Vietnam. As the
table shows, Vietnam is faced with considerable challenges in
terms of fiscal sustainability especially those related to off
budget bond issuance, monitoring of fiscal risks (especially by
SOEs and local government units). The composition of public
expenditure especially the budget for infrastructure
maintenance has not kept pace with capital investment. There
is also the need to strengthen joint efforts by finance /
planning / sector ministries / provinces for the implementation
of the Medium Expenditure Plan. There is also scope for
improving public investment management especially the
relationship between national and sub-national governments, a
subject that will be more extensively discussed in the next
section.
Table X: Summary of Public Financial Management in Vietnam
Strengths Challenges / Threats
Fiscal Sustainability
Can Vietnam Catch Up with East Asia? 2
From 2000-2008
•Fiscal prudence •Off budget bond issuance
•Small budget deficit •Current expenditure arrears
•Small stock of debt (transport, agriculture and rural
•Positive fiscal trends development)
•Sustainable fiscal balance •Monitoring / management of fiscal
risks
•Implementation of Medium Term
Fiscal Framework
Composition of public expenditure
•Increase in public investment •Budget for infrastructure

by 16% average annual rate maintenance is not keeping pace
•Education / training with capital investment
•Science and technology
•More budget transfers to poor
provinces
•Capital expenditures increased
40%
Institutions for public expenditure management
• Passage of State Budget Law • Need to strengthen joint efforts

•Clarification of powers and by finance / planning / sector
responsibilities ministries / provinces for MTEF
•Strengthening of • Need to strengthen links between
decentralization budget and performance indicators
•Promotion of administrative • Pilot testing of MTEF
reform • Implementation of the Treasury
•Improving transparency and and Budget Mgt. Information
accountability in public finance System (TABMIS)
Financial accountability and transparency

•Significant steps to improve •Independence of the State Audit
transparency and accountability of Vietnam
•Greater oversight by the •Public access to audit reports
National Assembly / People’s •Further rationalize audit /
Councils inspection functions
Public investment management

•Public investment has grown •PIP should evolve into a

rapidly comprehensive screening /
•Capacity of MPI to manage approval process
strengthened through PIP •Strategic review of roles of
•Role of provinces in PI national and sub-national
increasing governments
•MPI to strengthen capacity to
guide, train, support, supervise
implementers
•Investment planning manual and
standards
•Balance capital & recurring costs
Public procurement management

•Significant increased in public •How to handle procurement
procurement complaints
•Strengthening of Department of •Capacity building for
Procurement at MPI procurement, supervision and
•Public procurement bulletin enforcement
•Standardized bid documents
D. Decentralization and Deregulation
Decentralization has often been regarded as a panacea to

development problems. Donors routinely recommend
decentralization as a solution to the problems of its borrowers
and for good reason. Studies have shown that decentralization
leads to more efficient delivery of public services (Oakerson
1998; Wunsch and Olowu 1995); lower transaction cost;
facilitate self-governance (Ostrom 1990); more equitable
outcomes (Maro 1990); more flexible government policies (Bish
and Ostrom 1973); builds local institutional capacity (Rondinelli
et al 1989); more accountability (Ribot 1999; Agrawal and
Ostrom 2001); and better match of public services to local
needs (Crook and Manor 1998). Decisions that are made with
greater participation will be better informed and more relevant
to diverse interests in society than those only made by national
political authorities.
Vietnam has a remarkable record at decentralization. In
2001, local governments undertook some 50 percent of
investments. By 2007, the share had increased to 61.8 percent
in which provincial governments and lower levels of government
were in charge of 48.8 and 13 percent respectively. The share
directly controlled by the central government is expected to
decline even further in 2008, from 38.2 percent to a mere 33
percent. 1
In the last three years alone, a number of laws and

decrees were passed to further strengthen local autonomy,
especially for provincial governments. These include Decree
12/2009 which delegates further authority to local governments
on matters of public investment except in cases of national
importance. Law 30/2009 on urban planning gave city
governments more power to define zoning and building
legislation. Decrees 117, 88 and 59 (all of 2007) gave LGUs
more power on water, sanitation and waste. Equally important,
Decree 138 (2007) created an investment fund and gave
provinces with financial authority. 2
Decentralization, however, has its downsides. There is

now an emerging view among donors that decentralization in
Vietnam has gone too fast too soon. First, along with the
decentralization from central to sub-national governments and
resource transfers among provincial governments, Vietnam
adopted Decree 10/2002/ND-CP which formalized the practice of
administrative and service delivery units charging user fees.
These units include schools and universities, hospitals and
clinics, cultural units, research institutes and agricultural
1
Albrecht, Hocquard and Papin, 2010
2
Ibid
extension services.
In addition to charging user fees, these service units are
also free to re-allocate resources across line items within each
of four blocks of expenditures: wages and salaries, operations
and maintenance, capital and other. Discretion plus the lack of
effective monitoring and accountability has led to increases in
the prices of basic services such as education and health
thereby increasing the burden to the poor. For instance,
hospitals have for more many years relied on user charges and
mark-ups on the sale of drugs to support their operations.
Second, many local governments still lack the capacity to
undertake investment appraisal and project implementation. At
present, there is no agency in government with the capacity
and the authority to review public projects prepared by local
government units and recommend changes, including their
postponement or cancellation, when they do not meet minimum
cost-effectiveness standards. There is therefore the risk of
proliferation of poor quality public projects undertaken by
provincial governments.
Third, empirical studies to monitor the economic
governance / competitiveness of provinces suggest that overall
progress has been noted in the areas of 1) entry costs; 2)
access to and security of land; 3) time costs; 4) labor quality; 5)
confidence in legal institutions 3. However, there has been a
decline in the areas of transparency, informal charges and
proactivity of local leaders. Two out of three survey
respondents believe that personal connections in the
government are necessary to obtain documentation. 4
The decline in transparency of provincial governments
3
Malensky, 2009
4
ibid
(according to the 2009 survey) is particularly a concern because

of the way it affects the business climate. For instance, studies
have shown that a one point improvement in transparency is
associated with a 13 percent improvement in enterprise per
capita, a 17 per cent increase in investment per capita and a
VND 62 million increase in firm profitability. 5
Fourth, the passage of Decree 137/2007 – which paved

the way for the widespread implementation of the Local
Development Investment Fund (LDIF) (21 as of 2010) has raised
some concerns on their governance practices. For instance,
LDIF have a legal status as a locally based state financial
institution with charter capital and specific accounting which is
not consolidated with that of the Province they are dependent
on (i.e. this raises the risk of contingent liabilities arising from
off budget items).
In addition, the World Bank has expressed concern that

some LDIFs borrow a lot in the short term with about 80% of
capital borrowed for less than one year, 20% for less than 5
years and almost no long term debt. This pattern is about the
same as the lending conditions of local commercial financial
institutions that do not lend over the long term. In addition,
most LDIFs do not yet have professional management and
supervision. There are concerns, however, that the certification
of LDIF accounts according to Vietnamese standards probably
does not constitute an adequate guarantee of financial control.
6
They note the potential conflict of interest because the
Chairman of the People’s Committee, who appoints the LDIF’s
5
ibid
6
Albrecht et al, 2010
Board of Directors, Supervisory Board, Director and Chief

Accountant, also appoints the accounting certification body.
Overall Quality of Governance
By governance, we refer to the traditions and institutions

by which authority in a country is exercised. This includes the
process by which governments are selected, monitored and
replaced; the capacity of the government to effectively
formulate and implement sound policies; and the respect of
citizens and the state for the institutions that govern economic
and social interactions among them (World Bank, 2011).
Good governance is important because, as Professor
Douglas North (Nobel Laureate in Economics) has argued, they
are the long-term determinants of economic growth. There are
at least six indicators of governance, namely: voice and
accountability, government effectiveness, regulatory quality,
control of corruption, political stability and absence of violence
and rule of law
Voice and accountability captures perceptions of the
extent to which a country's citizens are able to participate in
selecting their government, as well as freedom of expression,
freedom of association, and a free media. Political stability and
absence of violence measures the perceptions of the likelihood
that he government will be destabilized or overthrown by
unconstitutional or violent means, including domestic violence
and terrorism. Government effectiveness captures perceptions
of the quality of public services, the quality of the civil service
and the degree of its independence from political pressures, the
quality of policy formulation and implementation, and the
credibility of the government's commitment to such policies.

Regulatory quality captures perceptions of the ability of
the government to formulate and implement sound policies and
regulations that permit and promote private sector
development. Rule of law captures perceptions of the extent to
which agents have confidence in and abide by the rules of
society, and in particular the quality of contract enforcement,
property rights, the police, and the courts, as well as the
likelihood of crime and violence. Control of corruption captures
perceptions of the extent to which public power is exercised for
private gain, including both petty and grand forms of corruption,
as well as "capture" of the state by elites and private interests.
In almost all indicators of governance – voice and

accountability, government effectiveness, regulatory quality
and rule of law - Vietnam is at the bottom of the rankings
compared with other countries in East Asia. Vietnam’s rankings
on the indicators of good governance are summarized in Figure
X below. The data for these rankings came from the World
Bank Governance Index study (2009).
Figure X: Vietnam’s Ranking in Governance Indicators from East

Asia
IV. CONCLUSIONS AND RECOMMENDATIONS
In this concluding section, we summarize our conclusions

and outline our key recommendations. We offer two
conclusions. First, despite significant progress in the last 25
years, Vietnam is still in the lowest stage of economic
development. Its economy remains characterized by simple
manufacture, reliance on unskilled labor, low productivity and
weak capacity to absorb and develop technology. In addition,
Vietnam is faced with an inefficient and ineffective state sector
that is substituting for, crowding out and competing with the
private sector. The state remains weak in its capacity to
effectively implement policy reforms as well as weak in
managing domestic and global market forces. It is also having
difficulty fending off vested interests, fighting corruption,
demanding accountability and disciplining large inefficient
SOEs.
As a result, Vietnam’s GDP per capita still lags behind its

Southeast Asian neighbors and much further behind its role
model – the East Asian economies. Unless Vietnam’s new set of
leaders decisively confront these constraints, Vietnam will most
likely follow in the path of other Southeast Asian economies
(Thailand, Indonesia, Malaysia and the Philippines), which have
been caught in the middle-income trap and which are finding it
difficult to break free from.
Second, Vietnam will be faced with a vastly challenging

situation in the next five years that may derail the goals of
SEDS 2011-2020. These internal challenges include a strenuous
fiscal situation, the substantial risks arising from recent credit
downgrades of large SOEs and State owned commercial banks
which threatens macroeconomic stability because of their
substantial risks of contingent liabilities, a stubborn double digit
inflation and the ensuing demand from workers for higher
wages and a potential property bubble. External challenges
include continuing volatility in the global markets driven by
inflationary pressures in China and India, uncertainties in the
middle East that impacts energy prices, the looming food
inflation, the short term impact of the crises in Japan and debt
sustainability issues in the United States and difficult to resolve
issues in the Euro zone.
Road Map to Strategic Reform
Given these development challenges faced by Vietnam,

we propose a road map of strategic governance reforms to
improve the efficiency, effectiveness and accountability of the
public sector in Vietnam to achieve the goals of SEDS 2020. The

roadmap consists of proposals for rethinking the goals of
development, models of economic growth and capital
accumulation, the relationship between the state and market,
the forms of government interventions and priorities for policy
reform. We summarize the roadmap in Figure X below and
provide an elaboration in the section that follows.
Figure X: Roadmap for Governance Reform
The sequence of reforms need not be linear and in fact it

is desirable for Vietnam to pole vault in its governance reform
agenda just as what it did in 1986 with the doi moi reforms. We
illustrate this with four recommendations. First, we recommend
that Vietnam’s leaders initiate an open and serious debate on
the goals of development – whether or not the addiction to rapid
GDP growth should now be replaced with a more focus on
sustainable and stable development. As will be discussed in
the following sections, this shift in goal would have important
implications in terms of monetary, fiscal and macro-economic
policy, trade and industrial policy, environment and social

development policy, among others.
The second recommendation for governance pole vaulting
is in the realm of capital accumulation. Vietnam’s monetary,
infrastructure and human capital remains at levels not sufficient
enough to propel the country to be a middle-income economy
by 2020. In particular, Vietnam needs to accelerate the process
of capital accumulation, especially for knowledge capital
(tertiary education). Also, while Vietnam has taken the first
steps to encourage public-private partnerships for infrastructure
development, the current regulatory framework is insufficient to
attract investors because the framework has not addressed
A third example of pole vaulting is the need to decisively
address market and government failures while also
developing capacity to address new market failures (or risks
such as macroeconomic instability, inflation, impact of volatility
of global financial markets, contingent liabilities from SOEs and
state owned banks, etc). Another example is the need to shift
in focus from programming and State led planning to
harnessing the potentials of public-private partnerships which
remain underdeveloped in Vietnam.
Finally, in terms of priorities for policy reform, just as
Vietnam is trying to get prices right (removal and targeting of
subsidies, allowing currency to float at market rates, pricing of
services, etc), it must not lose sight of the importance of
investing in institutions and good governance. As the Nobel
Laureate Douglass North has argued, institutions are the long
run determinants of economic growth.
1. Rethinking the goal of development

As we have pointed out, the debate in Vietnam today is

still muddled by what should be the goals of development.
There appears to be a fixation on rapid GDP growth as the end
goal of development with the State playing the leading role.
While progress has been made on poverty alleviation, Human
Development Index and the Millennium Development Goals, the
goal of sustainable development and what it means for Vietnam
has not yet been vigorously debated nor understood by policy
makers in practice. This is a strategic question for Vietnam
because its current model of growth – based on reliance on low
wages and foreign investments – is not sustainable.
Reframing the goal of Vietnam’s development as one of
sustainable development would reopen fundamental
questions such as the sustainability of the current model of
growth and capital accumulation, the role of the state vs. the
market and their implications for investing in good governance
and building modern institutions such as a professional
bureaucracy and judiciary.
The debate on sustainable development would also open,
for example, the question whether its current model of
development – based on over reliance on low wages, low
technology and dependence on exports and foreign investments
– should be the way forward for Vietnam. It will also bring into
question how to balance growth, inflation and macro-economic
stability as well as an examination of the driver’s of Vietnam’s
competitiveness and new engines of long term economic
growth.
Vietnam’s leaders should heed the lessons from the
experience of the Philippines because both countries share
striking similarities in structure and pattern of development.

Both countries have about the same land area and population
size and the structure of Vietnam’s economy today is similar to
that of the Philippines in the 1960s. Like Vietnam today, the
Philippines was the favored destination of foreign investors in
the 1950s and 60s. It was also a favorite of donors, which
poured vast amounts of aid to the country. Growth rates in the
1950s and 60s averaged 8%. During this period, the Philippine’s
GDP per capita was one of the highest in Asia, next only to
Japan. In fact in the 1950s, the Philippines was regarded by the
United Nations as one of the most promising developing
countries in Asia in the 1950s.
Like Vietnam, the Philippines pursued a policy of low

wages, high dependence on aid and foreign investors, low levels
of investment in education and large inefficient state owned
enterprises. By the late 1970s and throughout 1980s growth of
the Philippines economy sharply slowed down to around 2% as
a result of policy mistakes in the 1970s, external shocks and the
ensuing macroeconomic instability, ballooning foreign debt,
budget deficits, balance of payment problems, sharp
devaluation of the currency, uncontrolled corruption and
deteriorating governance, and the resulting political and social
unrest. It would be wise for Vietnam’s leaders not to repeat
these mistakes by the Philippines.
2. Rethinking the current model of growth and capital

accumulation
Along with the need to rethink the goal of development, it

is equally important for Vietnam’s leaders to seriously rethink

its current model of growth and capital accumulation. Vietnam’s
model of growth is unsustainable because of its reliance on
simple manufacture, unskilled labor and the resulting low
productivity and weak capacity to absorb and develop
technology. Even as Vietnam continues to accelerate efforts
towards capital accumulation - particularly physical capital
(infrastructure), human capital (health) and knowledge capital
(tertiary education) - we recommend a deliberate shift towards
a policy of increasing total factor productivity – driven
about by technological innovation and public sector reforms to
improve efficiency, effectiveness and accountability of
governance.
We argue that increasing total factor productivity in both
the private and public sectors would be the key driver for long-
term growth because capital accumulation becomes less
important than technological and governance innovation in the
long run. In this regard, Vietnam should carefully study the
lessons from Taiwan and S. Korea.
Technological innovation through significant investments
in R&D and vocational and tertiary education is what has set S.
Korea and Taiwan apart from middle-income countries in
Southeast Asia. S. Korea in particular evolved from labor-
intensive manufacturing to a more knowledge-based and
capital-intensive economy while Taiwan was also able to
transform itself from an agriculture economy to a technology
driven economy in less than 30 years time.
In addition to technological innovation, these two
countries also introduced critical institutions for good
governance that supported the high and sustained growth of
these two countries. These include a strong rule of law and

impartial judiciary, a professional, capable and well-paid
bureaucracy able to discipline the private sector and SOEs in
exchange for state support a political and civil service system
relatively insulated from vested economic interests, among
others. Today, these institutions for good governance are
functioning robustly – for example high ranking political and
business leaders are routinely held accountable for their
actions. In the next section, we discuss these critical
institutions for good governance and the lessons that Vietnam
can draw from other countries particularly China.
3. Rethinking the roles of the state and market
Once Vietnam rethinks the goal of development and its

model of growth, the next step is to rethink the roles of the
state and market in a socialist market economy. In our view, the
state should play three roles in a socialist market economy: 1)
providing a key role in economic development through SOEs
and various instruments of public policy; 2) addressing
traditional and new market failures such as macroeconomic
instability and external shocks from globalization; and 3)
addressing a variety of government and governance failures. In
the following sections, we examine these roles and offer our
recommendations how they can be improved.
3.1 Reforming governance of state owned enterprises
As China, Malaysia and Singapore have shown, SOEs can

play a key role in economic catch up. In the case of Taiwan,
Japan and S. Korea, private sector conglomerates drove
economic catch with substantial but disciplined support from the

government in the form of subsidies, preferential treatment and
other forms of industrial policy. China, Malaysia and Singapore
have to rely much more on their SOEs as they do not have
strong indigenous conglomerates to power their economic
development unlike the Taiwan, Japan and Korea. Vietnam has
a similar model as China and Singapore with its reliance on SOEs
but Vietnam’s model of SOE governance is seriously is flawed.
As we have pointed out in the paper, SOEs in Vietnam

have not lived up to their expectations to be a driving force of
economic development despite the substantial support they
have received and the length of time they were given to prove
themselves. Most SOEs are heavily in debt particularly
construction SOEs.
Although they contributed 31.5 percent the total gross output
(2008) of all enterprises in Vietnam, they contributed only about
7 percent income tax to the state budget and employed only
about 4.4 percent of total national employment.
As a first step, we recommend a comprehensive review

and audit of all large SOEs to assess 1) their strategic value to
the economy; 2) their contingent liabilities and their impact on
systemic country risk and 3) their corporate governance
practices. We recommend in particular that the governance
standards of large state owned enterprises be upgraded to
global standards if they would continue to play a leading role
in economic. More specifically, we recommend the following.
First, there should be meaningful autonomy with

effective accountability. Meaningful autonomy requires

minimizing political influence in SOE management by banning
appointment of outsiders for senior executive positions and
effectively removing the control of ministries over the SOEs.
Appointments based on merit rather than patronage should be
strictly and consistently enforced. Autonomy will only be given
to an SOE if there is credible system of performance
measurement and management and a meritocratic system of
human resource management.
Second, Vietnam’s SOE’s should be assessed in terms of

how they build intrinsic and lasting shareholder value
through technology, product and market development and how
they contribute to strategic national interests instead of
engaging in speculative short-term property market speculation
and diversifying into non-core business.
Third, incentives have to be aligned with

performance. In Singapore, in the case of Temasek for
example, its incentive plan includes annual cash bonuses linked
to individual, unit or company annual targets, and risk-reward
sharing incentives over the longer term, linked to Wealth Added
(WA) or Total Shareholder Return (TSR). Senior management
have the bulk of their performance incentives deferred between
three and 12 years (to ensure long term outlook) while junior
staff have theirs paid proportionately more in cash.
Fourth and a related practice, large SOEs should be

required to adopt a risk-based approach to corporate
governance with a particular focus on financial, commercial,
credit, contingent liability, macro-economic stability and country

risks. This way, their impacts to the macro economy can be
better anticipated and managed. In particular, SOEs should be
required to separate their commercial and financial interests
because this leads to a conflict of interest in investment
appraisal.
Fifth, Vietnam can also learn from the best practices in

Singapore and S. Korea on how they ensure performance and
accountability in their SOEs. These include 1) creating an
independent and competent SOE Evaluation Board similar to S.
Korea; 2) having an independent board of directors who are
focused on the commercial and strategic goals of the SOE such
as in Singapore; 3) requiring public disclosure of independently
audited financial statements and other key indicators of
performance like Singapore; 4) addressing the moral hazard
problem by imposing credible hard budget constraints or limited
conditional support with no implicit, contingent liabilities; and
most importantly 5) disciplining the SOE by exposing them to
market discipline.
The principle in Singapore is that SOEs that are critical to

the economy, have natural monopoly characteristics (power,
water, seaport) and have strategic value (media) are majority
owned and controlled by the government. For all others, the
government is better off exposing them to market discipline
such as Singapore Airlines (54% government owned),
Development Bank of Singapore (28%), Capital Land (property)
(39%), Singapore Changi Airport (44%), Keppel (ship building)
(21%), among others. This way, the government can unlock the
intrinsic market values of these companies, improve their

efficiencies and enhance their profitability.
A major reason for the continuing inefficiency of the SOEs

in Vietnam is that they are not subjected to the rigors of market
discipline. Vietnam should learn the principle that if the State
cannot adequately discipline the SOEs, the market should be
made to discipline them. Vice versa, if the government cannot
discipline itself or do not heed market forces, the government
will eventually find itself being disciplined by the market, for
example credit and credit rating downgrade, currency
devaluation, labor unrest, property bubbles, SOE bankruptcy.
Unless the government can effectively discipline its large

inefficient SOEs, then the argument that they play a leading role
in the economy will increasingly become untenable.
3.2. Addressing traditional and new market failures
Vietnam today continues to be faced with challenges in

addressing traditional market failures such as ensuring quality
primary education, accessible primary health care, urban
congestion, among others while at the same time being
confronted with new market failures such as property and stock
market bubbles, systemic risks from SOEs and macroeconomic
volatility arising from external challenges.
Of particular concern to Vietnam is macroeconomic

stability, a key requirement to sustainable economic
development. The Government needs to take some decisive
steps to effectively manage risks in the macro economy by

effectively regulating market forces (property and currency
market speculation), large state owned enterprises and state
owned commercial banks through a risk based approach to
regulation. The banking system in Vietnam today is still poorly
regulated combined with excessive direct control and
government interference. The recent downgrade of state owned
commercial banks and the huge contingent liabilities stemming
from the debts of large SOEs is an example of what could
happen to the banking system if these issues are not
addressed. Also, poor regulation and excessive government
intervention hinders the development of an efficient system of
financial intermediation which Vietnam needs at this juncture of
its development.
3.3 Addressing government failures
Addressing government failures is the third major role of

the government in a socialist market economy. In this section,
we examine three types of government failures – accountability,
rule of law, corruption and state capture by vested interests -
and outline their implications for reform in Vietnam.
Accountability with Socialist Characteristics
Vietnam can learn from the recent experiment of China in

promoting accountability in a one party state. In the Chinese
model, the evolving power structure is based on the principles
of reasonable structure, scientific distribution of checks
and balances, rigorous procedures and effective
restraint. As previously illustrated and reproduced in Figure X
below, this socialist system of checks and balances consists of
intra-Party supervision in the CPC, supervision by the National

People's Congress and the local people's congresses (NPCs),
supervision within the governments, and democratic
supervision by the Chinese People' s Political Consultative
Conference National Committee and local people's political
consultative conferences (CPPCCs).
In addition, there is also judicial supervision, supervision
by the general public and supervision by public opinion through
the media. These relatively independent supervision
mechanisms collaborate closely with one another to form an
integrated force.
Figure X. Model of accountability with socialist characteristics
Rule of Law
The development of the rule of law and impartial courts is

crucial to creating a sustainable and conducive environment for
investment and exchange and therefore crucial to sustainable
economic development. Vietnam has also much to learn from
the recent experience of China in terms of rule of law reforms.
These include 1) strengthening the constitutional separation
and independence of judicial and procuratorial organs; 2)
reform of procuratorial organs; and 3) reform in judicial
practices such as open trials, peoples jurors, people’s
supervisors, defining the rights and obligations of lawyers,
strengthening of legal assistance and mediation.
China’s reform of its procuratorial organs, which Vietnam

could learn from, includes making public their operations,
adopting a system of notifying litigants of their rights and
obligations, adopting a system of public review of non-
prosecution cases, criminal appeals and civil administrative
counter-appeals, and a working mechanism that guarantees
that lawyers perform in accordance with the law in handling
criminal lawsuits.
Resisting State Capture and Corruption
The particular type of corruption that poses a serious

concern to Vietnam is the problem of state capture, the ability
of interest groups (private firms, SOEs, public officials) to
subvert the political process to ensure that policies and
regulations favorable to their interests are implemented.
State capture has large adverse consequences to

sustainable economic development. It could undermine the
functioning of markets, serves as a barrier to entry, lowers

return to investments, lowers tax revenues, distorts the
composition of government expenditure (subsidies to powerful
groups) and eventually subverts the legitimacy of public
institutions that support markets. State capture also has large
and adverse effects on economic growth by lowering incentives
to invest, acts as a pernicious tax and reduce growth by
lowering quality of public infrastructure and services. We
recommend that Vietnam also consider the following principles
of fighting state capture in China. We do recognize that some of
these principles are already on paper in Vietnam but their
enforcement is something that can be consistently improved.
Box x: Principles and practices in fighting State Capture in China
Principles and practices in fighting State

Capture in China
Principle 1. Sunshine is the best antiseptic and

therefore transparency represents the best
supervision of power. Transparency is the rule and
holding back of information as the exception.
Principle 2. Protection of the media. The law shall

protect the right of the media to interview and
expose unhealthy tendencies and violations of law
and discipline by Party and government organs.
Principle 3. Education and training. Appointees to

the party and government are required to pass
examinations in laws and regulations related to clean
government before they are selected to take leading
positions.
Principle 4. Disclosure of assets and interests.

Leading cadres are required to honestly report their
incomes, housing and investment owned or made
either by themselves or together with their spouses
and children living with them, as well as the
employment status of their spouses and children.
This should be made mandatory.
Principle 5. Clearly define liabilities. Liabilities of

corruption-related crimes, such as embezzlement,
bribery, dereliction of duty and holding a huge
amount of property with an unidentified source are to
be clearly defined.
Principle 6. Whistleblower. Encourage whistle blowers

to come out by giving them protection under the law.
Principle 7. Strengthen investigation and prosecution

and ensure “swift and sure and firm but fair” action
regardless of the stature of the suspects.
In the next section, we explain why resisting state capture

is only one side of the equation. Equally important, Vietnam’s
leaders should carefully study the idea of embedded autonomy.
Embedded autonomy
Earlier studies, such as the 2008 Harvard Report, has

warned of the problem of state capture and crony capitalism
that could hamper Vietnam’s aspirations to be a middle income
economy. The report has forcefully recommended the creation
of a firewall to separate political from economic power. It argues
that a key lesson from successful East Asian economies—
Korea, Taiwan and Singapore — was their government’s ability
to discipline economic interests opposed to efficient capital
accumulation, rapid industrialization and national economic
competitiveness, including disciplining their state owned
enterprises.
We strongly agree with this but we also recognize that

economic and political interests are naturally intertwined. Like
China, Vietnam has taken steps to welcome successful
businessmen into the ranks of the Communist Party as partners
in economic development on the belief that this relationship is
beneficial to economic development. However, like fire – which,
can either help you cook your food or burn down you house- this
arrangement can turn out to be either good or bad for the
future of Vietnam. Embeddedness can be good if the
government has the capacity to align private interests with the
national interest and effectively discipline economic interests
opposed to efficient capital accumulation, rapid industrialization
and national economic competitiveness, including disciplining
SOEs.
The key is ensuring embedded autonomy between

business and political interests. Being embedded alone would

lead to state capture while being autonomous alone would not
be effective as government needs the help of business to
achieve strategic national objectives. Thus, instead of just
creating firewalls, we recommend that the government further
study the model of embedded autonomy as a guiding principle
to govern the relationship between political and economic
power in Vietnam. Embedded autonomous models in Japan,
Singapore, Taiwan, Korea and some cases in China are good
examples to study.
Modern Bureaucracy
Embedded autonomy will only be effective if there is
modern bureaucracy composed of technocratic elites who are
well paid, highly educated and capable, reform minded and who
are able to design, implement, adjust and monitor a program for
sustained growth. A modern bureaucracy is one that is able to
instill discipline and exact performance among business groups
in exchange for state subsidies and other forms of support. A
modern bureaucracy is one that is able to provide high quality
and far sighted policy analysis to support national leaders in
making well-informed strategic decisions. A modern
bureaucracy is also one that encourages an open, constructive
and active debate within government, academic and business
circles on the content and direction of economic policy.
Currently, Vietnam remains overly dependent on donor funded
external advice, which is not healthy in terms of building the
capacity of its technocratic elite.
The first step in building a modern bureaucracy is for

Vietnam’s leadership to reexamine the notion of an elite
bureaucracy as something that is greatly beneficial for
Vietnam’s future. Likewise, Vietnam’s leadership should rethink

the old notion of an egalitarian bureaucracy whether this idea is
still appropriate for a highly competitive and uncertain global
economy. The idea of an egalitarian bureaucracy could be
justified in the context that existed 40 years ago when the
sacrifices of those who fought for national liberation were
appropriately honored. While Vietnam honors such legacy, it
should also be strategic and forward looking to enable it to
achieve the goals of SEDS 2020.
We therefore recommend in the short term that Vietnam,

like China, consider creating its own elite National Reform
and Development Commission to design, implement, adjust
and monitor the implementation of the SEDS 2010. The
creation of the Commission – as a top priority - will provide a
fresh signal to investors, creditors, donors, bureaucracy, Party
and Vietnamese citizens at a time when confidence in the
reform agenda and the viability of SEDS 2020 is being called
into question. We also urge donors to invest their resources in
establishing this Commission as this is the correct long term
approach to developing national capacity instead of
overreliance on short term, external consultants.
In the next five years, we urge the National Assembly of

Vietnam to seriously debate the necessity for a modern,
professional bureaucracy as an imperative for achieving the
goal of a middle-income country by 2020. One example of such
a modern, professional bureaucracy is the elite Singapore civil
service – highly educated, meritocratic, well paid, honest, global
orientation and forward looking. In particular, we encourage the
government to decompress its salary scale in such a way that it

would attract and reward top talent at the same time putting in
place mechanism to ensure meritocracy, performance and
accountability in the civil service. We do not recommend a
salary increase across the board. Instead, we recommend that
Vietnam study Singapore’s principles of compensation for its
civil service.
Box x: Compensation Principles in Singapore’s Civil Service
Compensation Principles in Singapore’s Civil

Service
1. To pay civil servants market rates commensurate with

their abilities and responsibilities
2. To keep pace with the private sector
3. To pay clean wages (“pure cash”)
4. Move from pension scheme to CPF scheme
5. To have a flexible wage system that can respond to
economic conditions
6. To strengthen link between pay and performance.
We understand not all principles can be applied at this

stage of Vietnam’s economic development but some of these –
for example principles 1, 5 and 6 are vital for Vietnam’s modern
bureaucracy and should be seriously debated.
These principles need not be applied throughout the

bureaucracy but rather can be targeted at key Ministries and for
certain categories of top civil servants who play crucial roles in
achieving the goals of SEDS 2020. In this case, Vietnam can

learn from the example of Indonesia, which introduced salary
reforms in the last few years by targeting only key Ministries.
For example, key personnel at the Ministry of Finance receive
about 5 times their counterpart in other Ministries because of
the high qualification requirements needed to run an important
ministry.
Finally, we recommend the creation of a Commission for a

Modern Bureaucracy that will study these recommendations
further. The goal of the Commission is to explore the options for
creating a modern professional bureaucracy that will help
propel Vietnam to become the next Asian tiger. Without a
strong modern bureaucracy, Vietnam’s development will remain
stuck under the old model of growth that will increasingly
become uncompetitive in a globalized world characterized by
persistent macroeconomic instability.
Decentralization
Our review of Vietnam’s experience on decentralization

suggests that it has been beneficial in many respects but
appears to have gone too fast too soon with negative
consequences. We highlight three problems. First, the discretion
exercised by local governments in charging service fees for
basic social services plus the lack of effective monitoring and
accountability has led to increases in the prices of basic
services such as education and health thereby increasing the
burden to the poor.
Second, many local governments still lack the capacity to
undertake investment appraisal and project implementation.
There is no agency in government with the capacity and

authority to review public projects prepared by local
government units. There is therefore the risk of proliferation of
poor quality public projects undertaken by provincial
governments.
Third, the governance of Local Development Investment
Funds (LDIF) poses three serious risks: 1) their borrowing
practices raises the risk of contingent liabilities arising from off
budget items; 2) their accounting practices do not meet
international standards and are prone to conflicts of interest;
and 3) 80% of the capital borrowed by these entities are short
term in nature which exposes them to significant repayment
default risks if their projects gets into trouble servicing their
debt obligations. This pattern of problem is also appearing in
China and causing serious concern among national officials on
the contingent liabilities of these sub-national entities. National
authorities should act now before these risks become real which
could seriously harm the economy.
To deal with these risks, we strongly recommend the
creation of
the Ministry of Home Affairs and Local Government to
regulate some the risky functions of local governments which
has negative externalities. The entity is not necessarily new
because it will be attached to the Ministry of Home Affairs but
there will be a new focus on better supervision of LGUs. It has
be emphasized that the supervisory functions be limited initially
to these three problem areas. At the minimum, we recommend
a systematic audit of the contingent liabilities arising from LDIF
borrowing as well as an audit of their corporate governance
practices.
Public Private Partnership
While we argued in the previous section for a modern
bureaucracy, we do recognize that without the private sector, a
modern bureaucracy can only do so much. Vietnam has to be
commended for recently recognizing officially (Decision 7, 2011)
the importance of public private partnerships, especially for
infrastructure development. Whereas in the past, the private
sector has been relegated as a junior partner of the government
with the government taking the lead role, today the private
sector is increasingly being recognized as equal partners in
some spheres of economic development.
There remain some issues, however, that could be an
impediment to the success of the PPP in Vietnam. For example,
a closer review of Decision 7 would show that the while the
current regulatory framework has adequate provisions to
protect the interests of the government, it does not have
enough incentives to attract private investors for major
infrastructure projects. The main issue is that the regulatory
framework has not adequately addressed major risks in
infrastructure. In this section we identify some of these risks,
which we discuss below.

Government participation and guarantees
The recent PPP regulatory framework provides that the

extent of government participation in a PPP project must not
exceed 30% of the total investment level of a project, except as
otherwise decided by the Prime Minister. The issue with this is
that 30% may not be sufficient to attract private investors if the
gap between the project's financial feasibility and economic
desirability is substantial. In the end, there will be little interest
in the PPP project.
As defined in the regulatory framework, government

participation means a combination of all forms of state
participation, including state capital, investment incentives and
relevant financial policies, which are included in the total
investment level (total investment capital) of a project with a
view to increasing its feasibility.
While Vietnam may have the resources to contribute its

30% share of the partnership, such projects - low financial
feasibility-high economic benefits - are better financed by ODAs,
because they are subject to clearer rules than through a hybrid
PPP that has none of the financial discipline of the private
sector. Since such financing is a disguised public expenditure, it
is actually a subsidy that should be treated as sunk costs, e.g.
right of way acquisition, feasibility studies, etc. It should be
made clearer in the implementation guidelines if such sunk
costs are treated as part of the 30% ceiling on government
participation in PPP.
Regulatory Risks
Regulatory risk is the threat associated with a change of
laws or regulations governing a given industry, country or
project that negatively impacts on investments. It may also take
the form of investors being unable to adjust rates or tariffs to
contractually agreed levels by virtue of orders issued by
regulatory agencies or the courts.
More important than financial guarantee is assurance to
the private proponents that the government can credibly
commit to minimize regulatory risks and will actually enforce
contractual commitments. This is an important issue for private
investors because the current regulatory framework does not
clearly spell out the regulatory mechanism, formula and process
for rate adjustment, compensation for expropriation and
repatriation of profits. There is uncertainty for private investors
whether government regulatory bodies responsible for hearing
petitions for user-charge adjustments will act in a timely and
decisive manner.
In addition, mechanisms for dispute resolution including
arbitration, insurance, and recourse to international disputes
resolution are also not explicitly addressed in the regulatory
framework. There is also the lingering perception among
foreign investors of uneven playing field when competing with
SOEs and Local Development Investment Funds (LDIF) in PPP
projects. The operation of these SOEs and LDIF are non
transparent which is what turns off potential private foreign
investors. The role of SOEs and LDIFs in the PPP process needs
to be clarified and differentiated i.e. either as project
implementers or as investors but not both.
Take or pay arrangements

The current regulatory framework on PPP in Vietnam is
vague on the subject of “take or pay provision” and do not
categorically rule out indirect guarantees for commercial risks.
As shown by the experience of the Philippines, this can lead to
abuse. Take or pay provision essentially allowed independent
power producers (IPP) in the Philippines to be paid whether or
not the power plants they have built are producing electricity.
This has to be clarified in the implementation guidelines
particularly whether or not this falls under the ambit of the 30%
ceiling of government participation in a PPP project.
Financial Risks
In the current regulatory framework, there is little
reference how to deal with financial risks such as debt-service
coverage; project or sovereign risk and exchange rate risk
including denomination of contracts. Exchange rate risks are
particularly problematic for Vietnam whose economy suffers
from the effects of dollarization. The value of the dong –
Vietnam’s currency – has also dropped by 20 percent since
2007 in large part because of currency controls adopted by the
government. These issues are particularly important for foreign
investors and would be interested to have them clarified.
Procurement issues
There are also a number of outstanding procurement
issues in PPP in Vietnam such as bidding procedure, the
mechanism for rate-setting and adjustment, funding of future
capital upgrading and expansions, restriction of ownership

transfer (i.e. the government wants to lock the private partner
who wants to be able to change its portfolio over investment
lifetime). There also remain unclear provisions on issues of tax
concessions such as rates and exemptions, energy tariffs and
credits or waivers for certain outstanding liabilities. Moreover,
issues on investment protection such as mechanisms for
dispute resolution, repurchase or bailout options are yet to be
clarified under the current legal and regulatory framework.
Risk Based Regulation

As the current PPP regulatory framework would show,
there remains a problem of inadequate understanding or
appreciation of the importance of a risk based approach to PPP
and the principles of risk allocation. For instance, the framework
in Vietnam does not explicitly recognize principles of risk
allocation: 1) that risk should be allocated to the party with the
best capability to control the events that might trigger its
occurrence; 2) that risks must be properly identified and
understood by all parties involved in the project; 3) that the
party must have the technical and managerial capability to
manage risks; 4) that a party must have the financial ability to
sustain the consequences of the risks or prevent the risks from
occurring; and 5) the party must be willing to accept the risks.
Implementation Issues
Even while the regulatory and legal framework for PPP in
Vietnam has been defined, a major challenge is in its
implementation. Some of these likely challenges include 1)
weak capacity (in terms of staff competence and resources and
ability to identify, appraise, and package PPP projects); 2)

credible-commitment problems in dealing with line agencies
which could discourage reliance on contracts (and therefore
increases transaction costs); 3) weak accountability that results
to collusive and rent seeking behavior; and 4) weak fiscal
capacity that makes it more difficult for the government to
provide subsidies for regulated industries and provide adequate
resources for State participation. These issues are important
because based on the experience of the Philippines, PPP
projects which failed were the ones which were poorly designed
in terms of technical, legal, financial and economic viability.
Getting institutions and governance right
Our final set of recommendations has to do with a focus

on building and getting institutions and governance right. By
institutions we refer to the rules of the game including their
enforcement mechanisms and by governance we refer to how
the game is played – how government, in the pursuit of public
interest, exercises power. Professor Douglas North (Nobel
Laureate in Economics) has argued and shown that institutions
are the long-term determinants of economic growth.
As we have previously discussed, in almost all indicators
of governance – voice and accountability, government
effectiveness, regulatory quality and rule of law - Vietnam is at
the bottom of the rankings compared with other countries in
East Asia. Vietnam still lacks institutions for a robust market
economy which China has already adopted - for example clear
and secure property rights, particularly land rights and
intellectual property rights, an effective competition and anti-

trust law to level the playing field, effective institutions for
controlling corruption, judicial and regulatory reforms and
effective enforcement mechanism and a modern civil service,
among others.
Improving the quality of governance in Vietnam will take
time and lots of political will as the experience of developed
economies and East Asian economies has shown. In order for
Vietnam to catch up with the East Asian economies, it is
important that its new set of leaders recognize why investment
in good governance now is central to its aspirations of becoming
a middle income country by 2020.

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3.

Public Financial Management

In this section we review the strengths and challenges

Table X provides a summary of the strengths and

Table X: Summary of Public Financial Management in Vietnam

Strengths Challenges / Threats

•Increase in public investment •Budget for infrastructure

• Passage of State Budget Law • Need to strengthen joint efforts

Financial accountability and transparency

Public investment management

•Public investment has grown •PIP should evolve into a

Public procurement management

D. Decentralization and Deregulation

Decentralization has often been regarded as a panacea to

In the last three years alone, a number of laws and

Decentralization, however, has its downsides. There is

The decline in transparency of provincial governments

(according to the 2009 survey) is particularly a concern because

Fourth, the passage of Decree 137/2007 – which paved

In addition, the World Bank has expressed concern that

Board of Directors, Supervisory Board, Director and Chief

Overall Quality of Governance

By governance, we refer to the traditions and institutions

credibility of the government's commitment to such policies.

In almost all indicators of governance – voice and

Figure X: Vietnam’s Ranking in Governance Indicators from East

IV. CONCLUSIONS AND RECOMMENDATIONS

In this concluding section, we summarize our conclusions

As a result, Vietnam’s GDP per capita still lags behind its

Second, Vietnam will be faced with a vastly challenging

Road Map to Strategic Reform

Given these development challenges faced by Vietnam,

public sector in Vietnam to achieve the goals of SEDS 2020. The

Figure X: Roadmap for Governance Reform

The sequence of reforms need not be linear and in fact it

policy, trade and industrial policy, environment and social

1. Rethinking the goal of development

As we have pointed out, the debate in Vietnam today is

striking similarities in structure and pattern of development.

Like Vietnam, the Philippines pursued a policy of low

2. Rethinking the current model of growth and capital

Along with the need to rethink the goal of development, it

is equally important for Vietnam’s leaders to seriously rethink

these two countries. These include a strong rule of law and

3. Rethinking the roles of the state and market

Once Vietnam rethinks the goal of development and its

3.1 Reforming governance of state owned enterprises

As China, Malaysia and Singapore have shown, SOEs can

economic catch with substantial but disciplined support from the

As we have pointed out in the paper, SOEs in Vietnam

As a first step, we recommend a comprehensive review

First, there should be meaningful autonomy with

effective accountability. Meaningful autonomy requires

Second, Vietnam’s SOE’s should be assessed in terms of

Third, incentives have to be aligned with

Fourth and a related practice, large SOEs should be

credit, contingent liability, macro-economic stability and country

Fifth, Vietnam can also learn from the best practices in

The principle in Singapore is that SOEs that are critical to

intrinsic market values of these companies, improve their