Introduction

I.                  Research topic

Recognizing the importance of equality for social stability, economic growth and poverty reduction, in Vietnam economic development with equitable distribution is the basic principle of development strategy, which was already chosen since its early independence in 1945. However, recent economic growth over the past decade has not been equally distributed. Some regions have benefited more than other regions, which is evidenced by the increase of Gini inequality index from 32.2% to 35.8% in the period 1993-1998 (author’s estimates from VLSSs).

The important point to note is that most of the increase in the inequality was explained by the widening gap between rural and urban areas. During the period 1993-98, while rural income increased by 30%, urban income did so twice faster at 61%. This caused the urban-rural per capita expenditure ratio to increase from 1.81 to 2.21 folds (author’s estimates from VLSSs). Therefore, rural-urban gap is the only factor in explaining the inequality increase in Vietnam over the past years.

Although important, there have been very few researches on rural-urban gap in Vietnam. People just want to mention it but do not really focus on explaining it. That is why their explanations are really partial and superficial, not enough to be considered as the underlying causes for the rural-urban gap in Vietnam. Therefore, in the thesis, I will concentrate on pointing out the causes for this gap. By this study, I hope to make some contribution to the current government’s strategy of narrowing down the rural-urban gap and to international organizations in their efforts to alleviate poverty in Vietnam.

II.               Focus and Scope of the thesis

1.      Focus

In the thesis, rural-urban gap mean the difference between rural and urban areas, and this difference is only analyzed in economic terms, particularly in terms of income and expenditure. Some other non-economic differences such as natural condition, cultural and historical heritage, pollution... are omitted from the thesis.

2.      Scope

·        Regional frame

The analysis makes an extensive use of Vietnam Living Standard Survey (VLSS) datasets, which is really nationwide representative.

·        Time frame

Time frame for analysis is from 1993 to 1998. This period is chosen for two reasons. Firstly, two VLSSs were conducted at the beginning and the end of the period that allow a consistent comparison between two periods. Secondly, the reform package, initiated since 1988, was almost finished by 1992, so the period 1993-1998 can truly reflect the impact of reform on rural-urban gap.

III.           Research questions

As I already mentioned, the purpose of the study is to concentrate on explaining the rural-urban gap in Vietnam, so the main research question is:

What are the causes for the rural-urban gap in Vietnam?

The answer of this main research question will require the answers for the following sub-questions:

1.      What is the degree of the rural-urban gap in Vietnam ?

2.      What is the role of various factors in explaining the gap in Vietnam?

3.      What is the impact of government policies on these factors?

IV.            Structure of the thesis

Following the Introduction, Chapter I lays down both theoretical and methodological framework for the analysis of rural-urban gap. Chapter II is devoted to measuring rural-urban gap in Vietnam from 1992-93 to 1997-98 (answering the first sub-question). After understanding the degree of the gap, Chapter III will decompose this gap into various factors (answering the second sub-question). Then, in Chapter IV, the impact of government policies on these factors is thoroughly analyzed (answering the third sub-question). Finally, the Conclusion summarizes the findings in order to target the main research question.

Chapter I.  Theoretical Review and Methodological Framework

Various theories with different approach have quite different explanations for rural-urban gap. So, I will start this chapter by a brief overview of these theories.

I.                  Theoretical Review

A history of ideas on rural-urban gap was closely related with the literature on the agriculture-industry relationship. It began at almost the same time as the birth of economic science in the eighteenth and nineteenth century, when the first economists (Adam Smith, David Ricardo) were so pessimistic about agriculture. They supported movement of resources from rural agriculture to urban industry. In the early twentieth century, the issue of agriculture-industry linkages was confronted in a more elaborate and dramatic manner than ever before, and the Soviet industrialization debate of the 1920s continues to be intellectually important for understanding the agriculture-industry relationship.

Soviet industrialization debate: The issue was how to finance industrialization in the newly born socialist state. The protagonists were Evgeny Preobrazhensky and Nikolai Bukharin. Preobrazhensky argued that the state should turn the terms of trade against agriculture. It should offer the lowest possible prices for farm products and sell the industrial products to the rural areas at the highest possible prices. The surplus thus gained would finance industrialization. In contrast, Bukharin argued in favor of equilibrium prices. Stalin (then the Soviet leader) finally embraced Preobrazhensky’s model for state policy. If the farmers resisted providing food at low price, in Stalin’s reasoning, violence was absolutely necessary. It turned out that Stalin was wrong. So was Preobrazhensky. Food supply dramatically went down causing difficulties to both rural farmers and urban workers.

Lewis’ dualism model: Writing in the middle of the twentieth century, Lewis W. A. (1954) had no doubt that a price-squeeze on stagnant agriculture (Stalin’s way) would only choke off food supplies, thereby hurting industrialization. Lewis found out that labor movement from rural to urban was the best way to achieve income growth in both 2 areas. He postulated that in attracting labor resource from rural to urban areas for industrialization, the wage in the modern industrial sector must equal the “average product of labor” in the traditional rural sector and plus a “gap”. Lewis believed that the “gap” must be reasonable enough to “bring the modern sector as much labor as it wants without at the same time attracting much more than it can handle” and “usually a gap of 30 percent or more between two areas” is suitable (Lewis, 1954:7). In reality, however, the gap between urban and rural sectors is much greater than allowed for in the Lewis’ model. Two views have arisen to deal with this problem: the Neo-classical view and the Institutional view.

Neo-classical View: Neo-classical economists assume perfect labor movement. So under competitive conditions, the same wage must be paid for a given grade of labor no matter where it is (Reder 1971:294). Therefore, rural-urban gap just reflects the difference in individual characteristics between two areas. It means that urban workers have more education, more training than rural farmers and are usually concentrated in high-productivity jobs working under much more pressure than rural farmers.

Institutional view: Institutional economists argue that many barriers, induced by government, have been established, thus severely blockading the labor movement. They are union power, minimum wage, and sticky industrial wages (Tordaro 1971), the public sector (Kwoka 1983), development strategy (Sen 1971), law governing the urban registration (Johnson 1995, Yang 1999). Consequently, labor market is permanently divided into two distinct segments: the rural sector and the urban sector. Each works with its own characteristics and mode of operation. In other word, discrimination exists between the two segments, and urban people are offered a higher income and better working condition than rural people, although both have the same level of characteristics such as education, training, working experiences and so on.

Government influences on rural-urban gap: Lipton with his famous book “Why Poor People Stay Poor” (1977) was perhaps the first prominent economist, who seriously included government’s policies in rural-urban gap analysis. Agreeing with the Institutional economists about the existence of discrimination, Lipton went further by arguing that this discrimination was the consequence of “urban bias” policy, in which the government, under strong political pressure from the urban population, directed resources from rural to urban areas, from agriculture to industry without any consideration of efficiency or equity.

In summary: The brief overview of theories has clearly demonstrated that the rural-urban gap is explained by two leading factors: characteristics gap and discrimination. The former is advocated by the Neoclassical economists, and the latter is advocated by the Institutional economists. Although agreeing with the Institutional economists about the discrimination, Lipton and some other economists go further by arguing that government’s urban-biased policies are the main agent staying behind this discrimination.

II.               Methodological Framework

While Neoclassical economists argued for the characteristics gap, the Institutional economists believed in the discrimination. What needs to be done is to decompose rural-urban gap into the above two factors, so we can understand the role of each factor in explaining the gap in Vietnam.

1.      Econometric decomposition of rural-urban gap

The decomposition starts with standard regression function, which was widely used to analyze determinants of household per capita expenditure (Glewwe 1986, Deaton 1999)

ln Y = a + bX + u                                               (1)

Where: Y is the household per capita expenditure, X is a vector of individual characteristics such as educational attainment, occupation, household demographics.

Because discrimination may exist between the two areas, thus dummy variables are necessary to reflect this discrimination. Equation-1 will be modified as follows:

ln Y = a + a₁U + bX + b₁UX + u                                 (2)

Where: U =1 if urban and U=0 if rural.

A fundamental feature of the least squares estimator is that the fitted regression line will pass through the mean (average) value of both rural and urban areas. This implies that

This Equation states that rural-urban gap ( ) can be decomposed into the three components on the right hand side. The third component is the characteristics gap, which means that urban households have richer characteristics than their counterparts in rural areas such as higher grades of education, working in well-paid jobs, less babies, more adults. The second and first component are the return gap and environment gap, both sum up to discrimination which means the rural-urban gap after controlling for household characteristics.

The great advantage of Equation-4 is that it can be used to reflect both the Institutional and Neoclassical views. The Neoclassical view is reflected by the characteristics gap, and the Institutional view is reflected by discrimination. By computing Equation-4, we can do a test on the accuracy of the two views in explaining rural-urban gap in Vietnam.

Equation (4) can also be used to explain the dynamic change in rural-urban gap over a period of times. For ease of presentation, we replace the gaps with one symbol.

Gap:                              G =                   Environment gap:         E =  a₁

Characteristics gap:        C =                 Return gap:                  R =

Then Equation-4 can be rewritten as follows:

G = E + R + C                                                         (5)

So, dynamic change in the gap from time t to time t+1 is decomposed as follows:

G_t+1 – G_t = ( E_t+1 – E_t ) + ( R_t+1 – R_t ) + ( C_t+1 – C_t )                      (6)

From this decomposition, we can understand the role of each factor in explaining the widening gap in Vietnam over the past years.

2.      Government influences on rural-urban gap

If from econometrics decomposition discrimination exists, then according to Institutional view, government’s policies are the underlying causes for this discrimination. However, if we go further by using the Lipton’s hypothesis we can demonstrate that government’s policies not only widen the gap but also lower the national output (or economic growth).

According to Lipton, to be efficient, government policies must ensure an optimum allocation of resources between two areas. It means that these policies must bring in the maximum output for the whole country (the sum of rural and urban output). If from government intervention, the gain from urban output is less than the loss from rural output, then the total output for the whole country will be reduced. In this case, the total output or economic growth will be lower than what it could be, and the situation of urban bias exists.

Chapter II.  Measuring Rural-Urban Gap in Vietnam

The thesis makes extensive use of the VLSS 1992-93 and 1997-98, the extremely rich datasets for analyzing household economic behaviors and their link to policies.

I.                  General picture of rural-urban gap

Table 1 presents a general picture of rural-urban gap in Vietnam. While the majority of Vietnamese population lived in rural areas (80% in 1992-93 and 76.5% in 1997-98), per capita expenditure in rural areas was much lower than that in urban areas for both 1992-93 and 1997-98. Also, the ratio of expenditure was increasing during that period from 1.81 to 2.21.

Table 1: Average per capita expenditure and income (VND)

Items	1992-93	1997-98
Share of rural population	80%	76.5%
Urban-rural expenditure ratio	1.81	2.21
Per capita expenditure in urban	3,058,229	4,874,854
Per capita expenditure in rural	1,692,291	2,206,269

Source: Author’s estimates from VLSSs

The gap between rural and urban areas is reaffirmed in Figure 1. For each percentage of population in each area, per capita expenditure and per capita income are consistently higher in urban areas than rural areas.

Figure 1: Cumulative distribution functions of per capita expenditure and income:  1997-98

Source: Author’s estimates from VLSSs

However, for formal treatment of rural-urban gap, it is necessary to calculate some inequality indices such as Gini, Theil or Log Variance index.

·        Inequality measurement

In the thesis, I use Theil index because it is decomposable and can provide inequality not only within but also between rural and urban areas.

Table 2: Decomposition of Theil T inequality index

Source: Author’s estimates from VLSSs

For the within-group component, within-rural inequality was lower than within-urban inequality. If combined (both within-rural and within-urban), the within-group component played a big share in total inequality, 88.83% for 1992-93 and 83.18% for 1997-98. However, the within-group component remained rather stable over the period from 1992-93 to 1997-98 (a slight change of 2.31% for within-rural inequality and –0.62% for within-urban inequality). In contrast, comprising a small share in total inequality (11.17% in 1992-93 and 16.82% in 1997-98), the between-group component recorded a dramatic increase of 61.96%. It meant that the dynamic inequality in Vietnam, over the past years, was mainly explained by the between-group component. So, what are the policy implications deriving from state of inequality in Vietnam?

Ø        Firstly, because the within-rural inequality was lower than the within-urban inequality. Therefore, in Vietnam, economic growth targeting rural areas creates more equal distribution (and will thus generate more welfare) than that targeting urban areas.

Ø        Secondly, because the dynamic inequality is mostly explained by the widening gap between rural and urban areas, efforts to prevent inequality from rising must be concentrated on narrowing down rural-urban gap.

·        Poverty measurement

For some economists (Basic Need model, Maoist idea) the state of the poor is the most important indicator for whatever analysis. In their opinions, rural-urban gap is best reflected by comparing the state of the poor within each group.

 

Table 3: Poverty in rural and urban areas

Source: Author’s estimates from VLSSs

Table 3 presents the results of FGT index (see Ravallion 1994 for further information of this index). Thre is a clear conclusion: poverty in Vietnam unambiguously decreased from 1992-93 to 1997-98. However, poverty reduction was not equally distributed. In urban areas, the “incidence of poverty” dramatically fell from 25.1% to 9.2% (a decrease of 63%), while that number in rural areas did not drop as much, just from 66.4% to 45.5% (a decrease of only 31%). The similar situation was observed in “poverty depth” and “poverty severity”.

Beside the FGT index, vulnerability to economic shock is also extensively used in the poverty analysis. Figure 2 shows the vulnerability for both rural and urban areas. In rural areas, a lot of people just pass the poverty line somewhat, a small shock can submerge a large number of rural people into poverty.

1789.71

1789.71

Poverty line

Poverty line

Rural areas

Urban areas

Source: Author’s estimates from VLSSs

Figure 2: The vulnerability of poor people in 1997-98

Ø        From all of these analyses on poverty, we arrive at a clear policy implication: poverty is largely a rural phenomenon, so that any poverty alleviation effort must be concentrated in rural areas.

 

II.               Rural-urban gap in various fields

It becomes clear that there exists a large rural-urban gap in general. In this part, I will try to show that the gap not only exists in general but also in every field in Vietnam.

Table 4: Rural-urban gap in various fields

		Urban-Rural ratio		Change
		1992-93	1997-98
Region
	South East	1.74	1.81	4.24%
	Red River Delta	2.35	2.17	-7.93%
	Central Coast	1.63	1.7	4.51%
	Mekong River Delta	1.6	1.86	16.12%
	North Central Coast	1.42	1.84	29.98%
	Northern Upland	1.52	1.84	20.58%
Economic sector
	Agriculture	1.47	1.53	4.46%
	Electricity & water production, distribution	2.02	2.33	15.29%
	Mining & extracting minerals	1.65	2.02	22.42%
	Industry	1.61	2.08	28.70%
	Transport &  communication	1.34	1.43	6.10%
	Other service categories	1.57	1.87	19.42%
	Commerce	1.61	1.72	6.70%
	Finance	1.42	1.53	7.70%
Ethnicity
	Other minorities	1.92	1.87	-2.63%
	Vietnamese	1.69	2.05	21.19%
	Chinese	1.48	2.41	62.95%
Profession
	Agricultural, forestry & fishery	1.41	1.51	7.09%
	Unskilled workers	1.55	1.92	23.95%
	Skilled manual workers	1.46	2.01	37.70%
	Assemblers & machine operators	1.32	1.54	16.66%
	Service & sales	1.6	1.72	7.70%
	Leaders & professionals	1.67	2.35	40.71%
Education
	Non-education	1.73	2.17	25.09%
	Primary	1.76	1.86	5.85%
	Lower-secondary	1.93	1.94	0.29%
	Upper-secondary	1.85	2.07	12.14%
	University or higher	2.1	2.25	6.90%

Source: Author’s estimates from VLSSs

Whatever fields we use to measure rural-urban gap, there was always significant gap between the two areas. Urban people were significantly better off than rural people across regions, across economic activities, across ethnic groups, and across educational levels. Also, the gap has significantly widened from 1992-93 to 1997-98.

III.           Income structure

The first two parts in this section has presented an obvious rural-urban gap in general picture as well as in various fields. However, it is a static picture, which cannot suggest anything about the future trend of the rural-urban gap. An analysis of income structure can provide some insights to this trend.

In income structure analysis, total household income is divided into two categories: earned income including wage, agriculture, self-employment[1], and unearned income including pensions, remittances and others. Table 5 presents two items: percent receiving (the percentage of households receiving income from each source), and income share (the share of each source in total household income).

Table 5: Income structure in rural and urban areas: 1997-98

Source: Author’s estimates from VLSSs

From this Table, it is clear that income sources varied significantly between the two areas in 1997-98. Looking at “percent receiving” item, in urban areas, 69% of households had at least one member working for wages, and 66.7% received income from self-employment. However, only 49.2% of rural households received wage income and 40.9% received self-employment income. The difference was more marked in the agricultural income. While nearly all rural households (94.4%) received income from agriculture, only a small number of urban households did (23.3%).

 

Looking at the “income share” item, in urban areas, both wage and self-employment accounted for as much as 32.2% and 41.1% of total household income. In contrast, in rural areas, these numbers were reduced by half at 16.9% and 21.6%. The contrast between the two areas was more marked in agriculture, where 44% of household income derived from this source in rural areas, but only 3.5% did in urban areas. It is important to note that 23.3% of household income in urban areas derived from unearned income, while only 17.6% of rural income came from this source. In overall, while urban households well diversified their income sources into wage, self-employment and unearned income, rural households were very vulnerable to risk because income from agriculture - one activity with very unstable operation- accounted for as much as 44% of the total income portfolio.

Income from agriculture is the most important source in rural areas. However, its decline is inevitable. In the reports from UNDP (1999) and WB (1999), they noted that most of the income increase in agriculture, over the past years, mainly derived from the new opportunities created by the reform package in 1988-1993 such as land and ownership reform (through de-collectivization) and agriculture diversification. At present, not many opportunities from reform are left for exploitation, so the pace of agricultural growth in future will be much lower than its pace during 1993-98. Hence, a relative decline of income from agriculture compared with other sources of income is unavoidable. Naturally, rural people will suffer most from agricultural decline.

Chapter III. Factors causing rural-urban gap: Econometrics decomposition

The previous chapter provides a picture of the rural-urban gap in Vietnam. As mentioned in the “theoretical review” there are many factors simultaneously causing this gap. This chapter will quantify the role of each factor.

Table 6: Regression and decomposition results: 1997-98

I.                  Explanation the results

The results of  “return gap” and “characteristics gap” are presented in column C of Table 6. In which, column C6 is “return gap” b₁ , and column C7 is “characteristics gap” . The row “intercept” (near the bottom of Table 6) provides the “environment gap” a₁. In column B of Table 6, the percentage numbers in bracket tell the change in Y (per capita expenditure) from one unit change in X (characteristics), they are computed from EXP(return) – 1.

II.               Decomposition of rural-urban gap

This section consists of two parts. The first part is the static decomposition, which will decompose 1997-98 rural-urban gap. The second part is the dynamic decomposition, which will decompose the change in the gap from 1992-93 to 1997-98.

1.      Static decomposition

Basing on column C of Table 6, we can derive the percentage share of each factor (return gap, characteristics gap and environment gap) into the rural-urban gap ( ). The results are presented in Table 7.

Table 7: Decomposition of rural-urban gap

Characteristics gap: This factor contributed 37.03% to rural-urban gap. Such contribution reaffirms the Neo-classical view that urban people with higher level of living is due to their higher level of education, working in well-paid occupations, less children, more adults.

Return gap: Aggregate return gap actually reduced rural-urban gap by 1.29%. The return gap was mostly observed in the categories of occupation and demographics. While occupation worked in widening the gap (24.09%), demographics worked in reducing the gap (-28.14%).

Environment gap: This is the most important factor, contributing as much as 64.26% to rural-urban gap. Because discrimination is the sum of both return gap and environment gap, discrimination accounted for as much as 62.97% (=64.26% – 1.29%) of rural-urban gap in 1997-98. This result of discrimination reaffirms the Institutional view that there is a high degree of discrimination between urban and rural areas. Urban people are consistently better off than their counterparts in rural areas although both had the same level of characteristics such as education, occupation, demographics and ethnicity.

Ø        The results from decomposition make clear about the fallacy in the normal thinking of some people when they claimed that higher urban living standard was “fair” (Long, Trung 1995). Their justification has rested on arguments that urban people are endowed with many favorable characteristics, such as high level of education, working in high-productivity occupation, more adult and less children. Argument of this type merely reflected a third of the rural-urban gap (37.03%), the rest as much as 62.97% is explained by discrimination.

2.      Dynamic decomposition

In this part, I try to demonstrate that discrimination is not only the main factor in explaining rural-urban gap in 1997-98 but also the main factor in explaining the increase in the rural-urban gap from 1992-93 to 1997-98.

Based on the static decomposition in 1992-93 and 1997-98, Equation-6 (page 7) is computed.

G_t+1 – G_t = ( E_t+1 – E_t ) + ( R_t+1 – R_t ) + ( C_t+1 – C_t )                        (6)

The results from this equation are presented in Table 8. In which, the percentage numbers in the last column tell the share of each factor in the gap’s increase from 1992-93 to 1997-98.

Table 8: Decomposition of the gap’s increase into return, characteristics and environment gap

Source: (1) is from 1992-93 decomposition

(2) is from 1997-98 decomposition

Table 8 shows that the gap’s increase was explained by three factors: the increase in the characteristics gap, the increase in the return gap, and the increase in the environment gap:

Characteristics gap: Excluding “ethnicity” (-1%), all categories in this factor made a positive contribution to the increase in gap, while “education” recorded the biggest increase of all (18%). Overall, the increase in the characteristics gap contributed 24% to the gap’s increase.

Return gap: With a contribution of 72%, increase in the return gap was the dominant factor in explaining the gap’s increase. However, the role of each category in this factor was quite different. Particularly, while “ethnicity” remained the same at zero, “education” and “demographics” actually made a negative contribution to the gap’s increase (-7% for education and –17% for demographics). Most of gap’s increase was explained in the “occupation” category, which was as high as 96%. It suggests that the gap in labor productivity between the two areas was widening extensively during the period.

Environment gap: The contribution of this factor to the rural-urban gap’s increase was small (4%). It means that from 1992-93 to 1997-98, the macro-economic environment was slightly distorted in favor of urban areas.

Ø        All the three gaps worked in the same direction, raising rural-urban gap from 1992-93 to 1997-98. While the increase in characteristics gap accounted for 24% of the gap’s increase, the remaining 76% was explained by the increase in discrimination (both characteristics and environment gap).

Alone, increase in occupation’s return gap accounted for as much as 96% of the total increase in the gap. Because of this widening productivity gap (due to capital concentration as I will demonstrate in the next Chapter), policy is needed to move labor from low-productivity jobs in rural areas to high-productivity jobs in urban areas. This policy not only makes more efficient use of both labor and capital resources but also prevents rural-urban gap from widening in the future.

In summary, both static decomposition and dynamic decomposition have clearly demonstrated that discrimination was the main factor in explaining both the 1997-98 rural-urban gap (62.97%) and the dynamic change in the gap from 1992-93 to 1997-98 (76%). According to the Institutional view and Lipton’s hypothesis, government policies are the main causes for this discrimination. The next chapter is devoted to clarify the impact of government policies on the rural-urban gap.

Chapter IV. Rural-Urban Gap under Government Perspective

Following Lipton’s approach, in this chapter, I will argue that discrimination is mainly derived from government urban-biased policies, which consists of government’s investment strategy and government’s manipulation of price incentives.

I.                  Government’s investment strategy

Because Vietnamese government plays a crucial role in the investment activity, the allocation of government’s investment has strong impact on the rural-urban gap.

1.      Industry versus agriculture

Table 9 shows the allocation of capital between agriculture and industry. In 1997-98, while amounting to 74% of industrial output and 535.6% of industrial employment, net investment in agriculture was much lower than that in industry, at only 16.5% of industrial investment.

Table 9: GDP, Employment and Net Investment from 1995 to 1997

		1995-96				1996-97				1997-98
	Agr.	In.	Agr/In Ratio		Agr.	In.	Agr/In Ratio		Agr.	In.	Agr/In Ratio
GDP	51282	57094	89.8%		53539	65000	82.3%		55895	75473	74.0%
Employment	24765	4375	566%		24775	4417	560.9%		24814	4633	535.6%
Social Net investment	3622.6	19399.4	18.6%		3530	19817.3	17.8%		3761.8	22834.1	16.5%

Source: General Statistical Office   

Unit: GDP in billion VND; Employment in thousand; Social net investment in billion VND

As too much investment was concentrated in industry, the law of diminishing return implies that the return to that investment may be very low, making the investment inefficient. ICOR is the most widely-used indicator to assess the efficiency of the above capital allocation (Harrod-Domard, Lipton). Looking at Figure 3, too much government investment in industry has severely lowered the return to investment, raising the ICOR index in industry. Consequently, ICOR in industry was more than four times higher than ICOR in agriculture. This meant that one unit of capital could raise about four times more output if invested in agriculture rather than in industry.

Figure 3: ICOR and Government Investment

Source:  Government investment (billion VND) is from General Statistical Office.

ICOR is author’s calculation basing on Table 9.

Ø        Clearly, by shifting capital investment from agriculture to industry, government can raise total national output. However, in practice government shows a strong bias toward industry. In 1997-98, government investment in industry was nearly double that in agriculture (Figure 3). Such high level of investment in industry, especially in heavy industry, was usually justified by dynamic efficiency hypothesis, which argued that although the short-run yield from such investment may be low, this investment will lay the basis for long-term growth. However, when investing in industry, Vietnamese government was more influenced by group interest rather than dynamic efficiency (Dollar, Jennie 1998).

2.      Heavy industry versus light industry

According to Lewis’s dualistic theory, economic growth can be achieved if there is continuous movement of surplus labor from rural to urban areas. However, during 1992-1998, while industrial output growth averaged 13 percent annually, industrial employment growth was only 4 percent, less than 30% of the industrial output growth. This Figure was as high as 80% for other NIC countries (South Korea, Taiwan, Singapore). So, despite rapid growth, industry has failed to absorb surplus labors in rural agriculture.

The growth pattern of industry is the main reason for the above consequence. Table 10 provides a sectoral breakdown of top industrial projects to be implemented in 1996-2000 period. All of the projects were in heavy industry and very capital intensive, accounting for approximately 40% of total government investment in industrial sector.

Table 10: Government’s top industrial projects: 1996-2000

Sector	Number of projects	Total investment
Top industrial projects
Oil and gas	2	15.07
Chemical and fertilizer	4	9.35
Steel	5	37.61
Cement	9	17.95
	S=20	S=79.98
Total investment in industrial sector		194.50

Source: Public Investment Program 1996-2000, June 1996                       Unit: VND trillion

Ø        Because of the government concentration of investment in heavy industry, urban workers will be equipped with more capital, resulting in high labor productivity and high wage. In contrast, rural farmers, unable to move to industrial production, struggle with one another for limited land and capital, resulting in low labor productivity and low income. When rural labor is unable to shift from low-productivity work in agriculture to high-productivity work in industry, this is a loss to national output.

3.      Allocation of infrastructure

While urban infrastructure is in rather good condition, rural infrastructure is generally underdeveloped. According to UNDP, some 20% of communes in the Northern Mountainous region are reported to lack motorable roads, and about 30% of district and 50% of commune roads are estimated to be impassable in the wet season (UNDP 1998). However, rural transportation seems not to be a government priority. For the state investment program during 1996-2000, most transportation investment focused on the three developed centers (Hanoi, Ho Chi Minh, Quang Nam-Da Nang), only 5% was left for investment in rural transportation.

Although part of the government agenda, rural electrification is still a big problem. Nearly 6 million Vietnamese households or 30 million people in rural areas have no access to electricity (author’s estimates from VLSS-2). Thus, urban people (20% of total population) consumed 86% of total electricity, they also paid less than half per unit in comparison with rural consumers (UNDP 1999). Because electricity is critical input into production process, restricted access to electricity has created a serious impediment to rural development.

While nearly 100% of urban people had access to clean water, only 32% of rural people had access to clean water, of which only 5% had running water. Unclean water was considered as an important cause leading to high death rate among rural children under 5 years old, amounting to 25% of total deaths (UNDP 1999).

Ø        As government is nearly exclusive provider of infrastructure, poor rural infrastructure clearly reflects the disproportionate government investment between rural and urban areas, although return from rural investment in infrastructure is as high as 20-35% (WB 1998). Such high rates of return strongly suggest that infrastructure acts as a crucial bottleneck in rural economic development. Therefore, some reallocations of infrastructure investment from urban to rural areas will surely raise total output for the whole economy.

II.               Government’s manipulation of the price incentives

1.      Exchange rate

To understand the impact of the exchange rate on rural-urban gap in Vietnam, two questions need to be answered: Firstly, what is the share of each area in import and export activities? Secondly, is the real exchange rate over-valued or under-valued?

·        Rural/urban share in import and export activities

Figure 4 provides some implications about the share of rural/ urban areas in import-export activities. Excluding the small share of “fertilizer”, imports of “consumer goods”, “fuels & raw material”, and “machinery & equipment” mainly serve urban consumption and urban industry. In the period 1992-93 to 1997-98, “fertilizer” import annually accounted for less than 5%, while the rest of 95% mainly went to urban consumption and urban industry.

Source: General Statistical Office

Figure 4: Components of import & export activities

Import

Export

A different pattern exists for export activities. “Agriculture” export had the biggest share of 45% from 1992-93 to 1997-98, while “heavy industry & mineral” had the smallest share of 27.7%. So rural areas appeared to dominate in export activities and urban areas appeared to dominate in import activities

·        Exchange rate valuation

The exchange rate in 1992 is usually used as the benchmark because at that time economic reform almost completed, and a large devaluation consistent with the state of current account has already occurred (Duc and Thu 1995; Le 1995).

Figure 5: Nominal and REER from 1992-93 to 1997-98

Source: Author’s calculation basing on GSO’s data, 1999

Figure 5 shows that while nominal exchange rate remained rather stable over the period, the real exchange rate (REER) sharply declined. It meant that Vietnamese currency has been increasingly over-valued over the period. As mentioned above, in Vietnam rural areas dominated in exports and urban areas dominated in imports, so that urban areas would benefit from the over-valued exchange rate at the cost of rural areas, income was transferred from rural to urban areas.

Ø        Let alone, the exchange rate automatically tends to its equilibrium value although there may be some fluctuation in the short-run, so the persistent over-valuation can only be caused by government intervention (Montiel, Hinkle 1999). Aiming at rapid industrialization, the Vietnamese government has tried to over-value VND to make imports of machinery and materials cheaper for urban industry. However, this came at the expense of rural exports. As Bate (1981:76) said, “under overvalued exchange rate environment, urban businesses prosper at the expense of rural ones”.

2.      Tariff protection for industry and agriculture

The salient feature of Vietnam’s tariff schedule is the highly complex structure with many different rates leading to excessively high protection. However, different activities have quite different levels of protection. The Effective Rate of Protection (ERP) is the most widely used indicator to compare the tariff protection across economic activities.

Table 11: Effective rate of protection for industry and agriculture

	Unweighted ERP	Import weighted ERP	Product weighted ERP	ERP with product weighted for output and import weighted for input
Economy	47.6%	47.1%	48.1%	52.0%
Agriculture	10.1%	9.0%	10.4%	11.6%
Industry 1 (Intermediate products)	26.5%	26.2%	31.5%	36.5%
Industry 2 (Consumer products)	96.4%	95.8%	92.1%	96.2%

Source: IDRC, 1999 “The Nominal and Effective Rates of Protection by Industry in Vietnam”.

In Table 11, the ERPs for agriculture are much lower than the national average, only around 10% for all measurements. ERPs for industries producing intermediate goods are averaged at around 30%. High and very high ERPs are observed for industries producing consumer goods averaging to between 92.1%-96.2%.

Ø        Tariff protection will cause a deadweight loss to the national economy. However, as the level of protection for the whole economy is mainly explained by the ERPs for urban industry, the urban areas still gain somewhat while rural areas suffer most of the loss. Specifically, (i) prices of industrial products are raised relatively higher than prices of agricultural products, leading to negative price scissors against rural farmers. (ii) Private investment such as FDI and domestic investment will tend to flow into protected industry instead of agriculture (around 65% total FDI occurred in the industrial products with the effective rate of protection above 60%, CIE 1998).

3.      Export quotas for agricultural products

While industrial products for exports receive a lot of government favors, most major agricultural exports like rice, coffee, agro-forest must abide by export quotas.

·        General effect of export quotas

Due to export quotas, rural producers of agricultural products suffer lower domestic price (from P_w to P_d), and lower quantity of exports. In contrast, urban consumers benefit from the lower price. The whole society pays a deadweight loss for this rural-urban resource transfer. To understand in greater detail the above rural-urban resource transfer from export quotas, it is necessary to focus on a single product, and rice exports are usually selected.

·        Effect of export quota on rice

Here I would like to reinterpret the results from “Rice Market Monitoring and Policy Option Study” (ADB 1996). Table 12 summarizes the effects of eliminating rice export quota.

Table 12: General effect of rice quota elimination

Measurement	With quota	Without quota	Value change	Percent
Rice price (D/kg)	2771	3319	548	19.8 %
Value export (US $ m)	681	1526	845	124.1 %
Total household income (US $ m/yr)	13514	14446	932	6.9 %

Source: ADB, 1996 “Rice Market Monitoring and Policy Option Study”

According to the study, without the quota, the retail price of rice increases 19.8%. In response to the more attractive prices, rice production expands 11.5%, and domestic consumption reduces by 13.7%. The combined effects are dramatic increase in export value from 681 million to 1.526 billion USD. Total household income rises 6.9% or 932 million USD. In other word, with the imposition of rice quota, Vietnamese households lose 932 million USD in 1995.

That is the nation-wide effect from the elimination of export quota, Table 13 shows the benefit and loss accrued to each group of population. In the Table, the “direct effect” is the immediate effect of rice price increase on income. Then, increase in farmer’s income will have “feedback” on the rest of the economy; the “total effect” measures the change in income of both the direct and feedback effect.

Table 13: Distributional effect of rice quota elimination

Population Sector	Direct Effect	Total Effect
National average	0.4	4.9
Urban sector	-2.9	1.3
Rural sector	1.1	5.7

Source: ADB, 1996 “Rice Market Monitoring and Policy Option Study”

Although, average household gains from quota elimination, there is substantial variation across groups. Urban sector suffers immediately from the direct effect of rice price increase (-2.9%). However, taking into account the feedback effect, the total effect on urban areas is positive (1.3%). Rural households benefit the most, with 1.1% for the direct effect and 5.7% for the total effect.

Ø        National food security is the basic rationale for the imposition of the rice export quota. However, it is achieved at considerable cost to rural farmers. Because nearly 70% of rural people depend on agriculture as the main source of income, and rice accounts for 50% of total agricultural income (author’s estimates from VLSS-2), rice export quota is a big constraint to rural welfare improvement, especially for poverty reduction efforts. The Vietnamese government should reconsider its policy toward rice export quotas. Food security for urban areas should not be put at higher priority than huge rural loss.

Conclusion

Recognizing the important role of rural-urban gap in sustaining social stability, maintaining economic growth and alleviating poverty, the thesis has made some attempts to analyze the degree and the causes for the rural-urban gap in Vietnam. Following are the main findings from the thesis.

·        Measuring the rural-urban gap in Vietnam

Whatever methods we took to measure rural-urban gap, there was always big gap between the two areas. Urban people were significantly better off than rural people across regions, across economic activities, across ethnic groups, and across educational levels.

·        Factors causing the gap

Using econometrics, the above gap is decomposed into two factors: characteristics gap and discrimination. The results from decomposition make clear about the fallacy in the normal thinking of some people when they claimed that higher urban living standard was fair. Their justification has rested on arguments that urban people are  endowed with favorable characteristics such as higher grades of education, concentrating in high-productivity jobs, less children, more adults and so on. This type of argument merely  reflects a third of the rural-urban gap (37.03%), the rest -as much as 62.97%- is explained by discrimination.

·        Government influences

By concentrating investment in urban areas and distorting rural-urban price incentives, government’s policies are the underlying causes for the above discrimination. (i) In terms of the government’s investment strategy, obvious imbalances are observed in various fields such as: industry versus agriculture, heavy industry versus light industry, and urban infrastructure versus rural infrastructure. (ii) In terms of the rural-urban price incentives, they are severely distorted in favor of urban areas, examples of these are overvalued exchange rate, rice export quota and high tariff protection for industrial products.

Surprisingly, none of these government’s policies pass the efficiency or equity criteria as Lipton said, “Resource allocations, within the city and the village as well as between them reflect urban priorities rather than equity or efficiency” (Lipton 1977:56). It meant that these policies create some benefit to urban people, but the resulting loss to rural areas is far greater. By reversing its policies and shifting some resources from urban to rural areas, Vietnamese government will surely achieve both rapid economic growth and moderate rural-urban gap.