Vietnam’s development model is running out of road
Vietnam’s economic rise has been extraordinary. The country has made a triple transition from central planning to a market economy, from import substitution to export-led integration and from extreme poverty to lower-middle-income status. Yet the growth model, fuelled by bank credit, public investment and exports, is showing signs of fatigue.
Aggressive bank credit expansion has long fuelled Vietnam’s growth. Between 2007–2010, bank lending surged by up to 36 per cent annually, and in 2007 reached 53.8 per cent. The surge supported short-term momentum but triggered macroeconomic instability, most visibly in 2008 and 2011 when inflation spiked at 23 per cent and 18.7 per cent respectively. The lending boom strained the financial system, with non-performing loans officially reported at 4.9–8.8 per cent in 2012. These vulnerabilities prompted banking sector reforms, including the establishment of the Vietnam Asset Management Company in 2013 to address the mounting non-performing loans in the banking sector.
Vietnam’s financial markets remain nascent. Beyond banks, key elements include bonds, equity and insurance. A corporate bond boom between 2018–22, in the absence of effective regulation and mature domestic credit rating agencies, collapsed in 2023. Microfinance remains underdeveloped compared to countries at a similar stage of development, limiting access to capital for underserved groups.
Despite progress, Vietnam’s stock market is still classified as a frontier market due to its limited openness to foreign investors. The insurance sector remains small, with life insurance contributing less than 1.5 per cent of GDP. Private pensions, dominated by the state, and mutual funds are still in the early stages of development, offering limited support for long-term capital formation.
A major constraint on Vietnam’s economic transformation is its underdeveloped private sector. Sustained high growth and transitioning to high-income status require a dynamic and robust private sector. Yet approximately 97 per cent of nearly 1 million registered firms are micro or small enterprises. Medium-sized corporations remain rare, resulting in a structural gap referred to as the ‘missing middle’. The informal sector is expanding but suffers from low productivity and limited social protection.
Private firms and the informal sector face regulatory barriers, inadequate research and development capacity, and restricted access to finance, land and skilled labour, alongside the dominance of state-owned enterprises. The government’s shift to prioritise private sector development is a welcome move. But state-owned enterprises, a key obstacle to private sector competitiveness, are not included in the current reform.
Vietnam’s exports remain heavily reliant on foreign-invested enterprises, raising concerns about economic resilience and domestic value creation. In 2025, foreign investors dominated key export sectors like electronics, textiles and footwear. Foreign-invested enterprises account for approximately 72 per cent of Vietnam’s total export turnover, underscoring the limited role of domestic firms in global value chains.
Foreign direct investment has made Vietnam a competitive manufacturing hub, but has also created structural vulnerabilities. Dependence on external capital and imported inputs expose Vietnam to global supply chain disruptions and geopolitical risks. And the scarcity of medium-sized domestic firms limits the potential for technology transfer, innovation and inclusive growth.
Vietnam’s state budget remains structurally fragile despite strong economic performance. A substantial share of government revenue relies on land-related taxes and fees and excise taxes — sources which are unsustainable and vulnerable to market fluctuations. Ongoing institutional reforms aim to curb the increasing current expenditures, but their effectiveness hinges on more than just reducing headcount. Meaningful institutional change requires a corresponding reduction in state control over the economy.
Vietnam is still pursuing rapid economic growth despite unstable growth foundations, intensifying its pursuit of 8 per cent in 2025 and double-digit growth in the following years. Removing credit quotas and cutting reserve requirements will likely fuel bad debt and amplify systemic risks in the banking sector. The dong continues to depreciate despite a weaker US dollar. Foreign reserves have fallen below the minimum three month-import thresholds. Monetary expansion is also fuelling property and equity bubbles. Environmental degradation and worsening urban living conditions are further weakening growth foundations.
These visible strains point to a deeper and more persistent challenge — the development trap. Vietnam’s investment-centric, export-driven growth model — anchored in the middle-income trap narrative — is no longer sufficient. Achieving high-income status will hold little value if the country remains mired in a low productivity economy and deteriorating environmental conditions.
Despite rapid economic growth after Vietnam attained lower middle-income status in 2009, the Incremental Capital-Output Ratio — a key measure of how effectively investment translates into growth — rose from 7.6 during 2016–20 to 8.5 in 2021–24. This upward trend signals a troubling decline in the productivity of capital, underscoring a growing disconnect between income growth and sustainable development.
Vietnam must recalibrate its growth model and adopt a new paradigm that prioritises sustainability over speed. Achieving high-income status should not come at the cost of macroeconomic stability and the environment. In the increasingly volatile global landscape, Vietnam must complement its investment- and export-led strategy with the development of a resilient domestic economy — one capable of generating robust demand and supply from within. At the heart of this transformation lies a dynamic private sector, which can catalyse multiplier effects across critical segments of the economy.
By Cuong Minh Nguyen – Eastasiaforum.org – September 22, 2025