(Reprinted from HKCER Letters, Vol.48, January 1998)
Small and Medium-Sized Private Companies and the Industrialization of Viet Nam
This article summarizes the findings of a recent study of private companies and their role in the industrialization of Viet Nam. The study is based on in-depth interviews with a sample of about seventy private manufacturing companies, trading companies, and joint-stock banks and was undertaken during the summer and fall of 1996.
Recognizing that the legal basis for a private corporate sector was established in Viet Nam only five years ago, with the adoption of the 1992 constitution, our study set out to determine whether the seeds of a private corporate sector have been firmly planted in Viet Nam and whether its economic environment is conducive to the rapid expansion of a private corporate sector, and in particular to the rapid expansion of the manufacturing sector.
The Importance of Private Companies for Long-Term Growth
Our study is based on the premise that private small and medium-sized companies are critically important to Viet Nam's long-term economic development. This premise in turn rests on three fundamental propositions for which the study provides solid empirical evidence. The three propositions are:
that export-oriented industrialization is the only viable strategy for rapid economic growth in Viet Nam; that Viet Nam satisfies the prerequisites of the strategy in terms of the resource endowment and the policy framework needed to make the strategy work; and that critical to the success of the export-oriented industrialization strategy is the emergence of private small and medium-sized companies as the dominant (but not exclusive) form of industrial organization in the manufacturing sector.
There is no empirical regularity that is more robust or universal over time and across countries than the positive relationship between openness to trade and economic growth. This has not always been known or appreciated, as most developing countries commenced their industrialization by closing their economies and adopting the import-substitution strategy of industrialization. However, the cumulative experience of developing countries over the past four decades has conclusively demonstrated the superiority of an outward-oriented industrialization strategy based on the principle of comparative advantage, which in densely populated, labor-abundant countries dictates specialization in labor-intensive manufacturing.
There is no way for Viet Nam to achieve rapid, long-term growth other than via the export-oriented industrialization strategy. The only countries that have achieved a high level of income without industrializing are those with an extraordinary abundance of natural resources, mainly oil, and Viet Nam is not such a country. It is, however, rich with human resources. Moreover, the level of human resource development in Viet Nam, the study shows, is comparable to the levels of other countries in the region when they successfully launched the export-oriented industrialization strategy. In addition, the study shows that the policy framework needed to make the export-oriented industrialization strategy work has largely been established in Viet Nam.
The only ingredient of an export-oriented industrialization strategy that appears to be missing in Viet Nam is the network of private small and medium-sized private companies that have been the driving force behind the strategy in every economy where it has succeeded, whether the country be socialist (i.e., China, where the equivalent of private companies are "town and village enterprises") or capitalistic (i.e., Taiwan or Hong Kong). The dominance of small and medium-sized private companies in export-oriented industrialization is due to one thing: their superior efficiency and profitability in low-wage, labor-abundant economies that specialize along the lines of their comparative advantage. In Taiwan, for example, our study shows that the average return on capital in small and medium-sized private companies is almost three times higher than it is in large, capital-intensive, state-owned enterprises, and about twice as high as it is in small, very labor-intensive household enterprises. Small and medium-sized companies dominate in export-oriented industrialization because they are large enough to be efficient and small enough to be flexible.
The Size and Structure of the Private Corporate Sector in Viet Nam
It is very difficult to obtain an accurate measure of either the size or the structure of the private manufacturing sector in Viet Nam. Nevertheless, an overall picture does emerge, the broad outline of which is that private companies of the kind that fueled the growth of export-oriented industrialization in other Southeast Asian countries, which in the Viet Namese context are the private limited liability and joint-stock companies, occupy a very small place in the Viet Namese economy. Nevertheless, from a very small (nearly zero) base just five years ago, they have grown and multiplied rapidly. There are fewer than 2,000 companies in the manufacturing sector in Viet Nam. Together they account for only about 8 percent of total registered capital and for about 12 percent of employment in the manufacturing sector. The sectoral distribution of private companies is heavily concentrated in a few branches -- mainly food and foodstuffs and textiles and garments. In total, Viet Nam's private companies account for only about 5 percent of industrial value added, which is equivalent to about 1 percent of the GDP.
The private sector as a whole is generally thought to occupy a share in the economy equivalent to 60 percent of the GDP. Because of the private sector's majority share in the GDP, some members of the Communist Party have come to believe that the balance between the two sectors should be changed in favor of the state sector. However, as our study shows, this belief is in a large part misdirected, since the private sector with which the state vies for resources consists almost entirely of small family farms and household businesses. These are not the kind of businesses that any government -- even a socialist one -- wants to run. The private corporate sector, therefore, poses no threat to state-owned enterprises or to the government's socioeconomic objectives. On the contrary, those objectives, in terms of growth, employment, and equity, and indeed even in terms of the goal of preserving existing state-owned enterprises, rest on the success of Viet Nam's industrialization and hence on the strength of the private corporate sector.
Problems Facing Private Manufacturing Companies
The three most important problems facing private companies, according to the interviews conducted in our study, are "credit, credit, and credit." Firms acknowledged that ambiguities regarding property, restrictions on trade, irrationality in the tax system, and excessive bureaucracy and red tape complicate business and carry cost, but in virtually every case companies identified these problems as secondary to credit, or to be more precise, to the lack thereof.
Although most of the companies interviewed had at one time or another obtained bank loans of three- to six-month maturity to finance working capital, only a very few were able to obtain medium- to long-term bank financing for fixed investment. Most of the companies interviewed had to rely entirely on cash holdings, retained earnings, borrowing from relatives, and informal credit markets to finance fixed investment. The opportunity cost of cash to private companies, and the implicit interest in informal credit markets, are at least five times higher than is the interest rate earned on deposits in the banking system. This situation constitutes an enormous inefficiency of financial intermediation and a significant disincentive to private investment in the manufacturing sector.
Although private companies put credit at the top of their list of problems, they nonetheless recognize the importance of further reform in the areas of property rights, trade policy, taxation, and bureaucratic regulation. Furthermore, it is understood that policy failures in these areas also impinge on the workings of the financial system. Ambiguities over ownership and land-use rights largely preclude real estate as collateral for bank loans. Irrationality in and improper administration of the tax system discourage accurate and transparent record keeping, which further hinders the effective functioning of the financial system. Clearly, the problems facing private companies are interrelated and require a comprehensive approach to policy reform to create a conducive environment for their growth.
The Strength of Viet Nam's New Private Companies
Our study clearly shows that the seeds of a private corporate sector have been planted in Viet Nam and that the emerging young firms are dynamic and profitable; of this there is no doubt. The strength of Viet Nam's new private companies, as one would expect, draws from the strengths of their owners and managers, whom the authors found to be success-driven entrepreneurs. Most of the new entrepreneurs are well educated. Those in the south tended to have more entrepreneurial experience, while those in the north were better educated, in most cases having been trained as engineers in Eastern Europe. As engineers, they tended to know the production end of their businesses better than they knew the marketing end, and they recognized their lack of marketing expertise as a shortcoming that would become increasingly critical. Most of these entrepreneurs had started their businesses only four or five years earlier with modest initial investments of, on average, about US$20,000 and had achieved rapid growth. Revenues, on average, stood between 1 million and 6 million dollars. Almost all the interviewees were very optimistic about the future. Most of the companies had specific and well-developed investment plans. None, however, expressed any realistic hope of being able to finance their planned long-term investments in formal financial markets any time soon.
The inefficiency of Viet Nam's financial system is a burden to all forms of business--public and private, large and small. It is, however, especially critical for emerging private companies, which, unlike state-owned companies, cannot rely on the government to guarantee their bank loans, and which, unlike household firms, have to face relatively large capital investment requirements that have relatively long gestation periods. Without access to formal financial markets, the emerging private companies are forced to either borrow at exorbitant rates in the informal market or amass personal savings to meet the capital requirements for investment. As a result, it must be the case that many potentially able entrepreneurs with projects that could very well be profitable are discouraged from investing, which means that many fewer jobs are created in the manufacturing sector, less foreign exchange is earned from exporting manufactured goods, and less revenue is collected from taxing Viet Nam's most profitable companies.
Finding solutions to the problem of financing private corporate investment should be a top policy priority for Viet Nam. The establishment of the long-awaited stock market is a step in the right direction, but it will not go far toward solving the financing problems of new private companies. Much more important would be measures that deal directly with the problem of securing bank loans and guaranteeing foreign currency credits on imports of machinery and equipment for private companies. Our study concludes with several policy recommendations of this kind, which have proven effective in other counties in the region.
James Riedel is professor of international economics currently on leave from the Johns Hopkins University's School of Advanced International Studies.