Characteristics of the Vietnamese Business Environment: Evidence from the 2007 Small and Medium Enterprise (SME) Survey Key Results, Policy Implications and Next Steps Finn Tarp Simon McCoy Hanoi, 15 th January 2009

Key Results 2

1.Enterprise Dynamics 2.Bureaucracy, Informality, Tax Evasion and Bribes 3.Employment, Education and Social Insurance 4.Production and Technology 5.Investment and Access to Finance 6.Environment 3

Most Important Constraints to Growth as Perceived by Enterprises Access to finance remains the key problem, though less so in 2007; Fall in perceived competition; – Age of firm a factor here? Overall improvement in business environment observed. 4

Employment Growth Limited employment growth of ‘micro’ enterprises Vast majority remain micro in 2007 Those that did graduate moved only to small category More than ¼ of small enterprises in 2005 fell to micro category two years later 5

Registration Dynamics 6 = 8.4% of total firms = 5% of total firms 79 HH firms graduated to other legal forms Under EL

1.Enterprise Dynamics 2.Bureaucracy, Informality, Tax Evasion and Bribes 3.Employment, Education and Social Insurance 4.Production and Technology 5.Investment and Access to Finance 6.Environment 7

SME Knowledge of Laws and Regulations General lack of knowledge observed, with a worsening from 2005 to 2007; For Household Enterprises, ’formalization’ is associated with performing well economically and firm survival. 8 Proportion of firms who have poor or no knowledge of specific laws or government regulations:

Burden of Bureaucratic Procedures Bureaucratic burden quite low in Vietnam (in confirmation of WB ‘Doing Business’ 2008); Consistent Provincial discrepancies (Lam Dong vs Khanh Hoa). 9

Taxation Low economic tax burden among surveyed firms; Comparison with Mozambique; Majority of non-taxpaying firms are not formally registered; Primary taxes paid are Revenue Tax, VAT, and Stamp Duties ( Figure 4.2 ). 10

Payment of Bribes 11 Large fall in number of firms paying bribes; Bribes are small in relation to total revenue.

1.Enterprise Dynamics 2.Bureaucracy, Informality, Tax Evasion and Bribes 3.Employment, Education and Social Insurance 4.Production and Technology 5.Investment and Access to Finance 6.Environment 12

Labour Constraint Significant labour constraint observed; Increases with size of enterprise; Urban businesses more constrained than Rural. 13

Fringe Benefits 14 Consistent gender difference

1.Enterprise Dynamics 2.Bureaucracy, Informality, Tax Evasion and Bribes 3.Employment, Education and Social Insurance 4.Production and Technology 5.Investment and Access to Finance 6.Environment 15

Diversification and Innovation High, and rising, degree of specialization among SMEs; Sharp decline in innovation rates; Improvement of existing products appears to be most important area of activity. 16

Technology Characteristics Rising level of technology used in production process; Over 85% of technology used is under 10 years old; Purchase of new equipment becoming more common; Firms less credit constrained? Introduction of new technology positively and significantly associated with employment growth and firm survival (Table 6.5). 17

Capacity Utilization By how much would you be able to increase production from current levels using only existing equipment / machinery? 18 High capacity utilization

Determinants of Labour Productivity Larger firms have lower labour productivity; Household Establishments are less productive; Firms in HCMC are more productive than those in other provinces; Introducing a new technology is positively associated with labour productivity. 19

1.Enterprise Dynamics 2.Bureaucracy, Informality, Tax Evasion and Bribes 3.Employment, Education and Social Insurance 4.Production and Technology 5.Investment and Access to Finance 6.Environment 20

New Investments and their Financing High levels of new investment; But falling level; Increases by firm size; Retained earnings remain a major source of investment financing; Easier access to credit for larger urban firms? 21

Access to Credit I Approximately 7.5% of firms in 2007 are clearly ‘credit constrained’; And taking into account those firms wanting more, the proportion rises to over 23% of the sample; This represents a slight fall since

Access to Credit II Why don’t Enterprises apply for loans? 23

Structure 1.Enterprise Dynamics 2.Bureaucracy, Informality, Tax Evasion and Bribes 3.Employment, Education and Social Insurance 4.Production and Technology 5.Investment and Access to Finance 6.Environment 24

Environmental Certificates Under 10% of sample have obtained an Environmental Certificate; Significant Provincial variation; Larger firms more likely to comply. 25

Water: Use, Conservation, and Discharge 26

Concluding Remarks, Policy Implications, and Next Steps 27

Point of Departure and Perspective Key goals: Capacity building Collaborative research Contribute to science/evidence based policy making Complementary scientific approaches Qualitative/stories Quantitative/data Time series versus cross-sectional Association versus causality (omitted variables and reverse causation) Make descriptive and suggestive observations and raise questions in analytical perspective: some selected examples (following outline in Report) – see report for much more 28

1. Enterprise Dynamics Average annual employment growth 7.1% among surveyed firms; Household Enterprises did not, on average, grow as fast (we don’t see dramatic increase).  Are SMEs the key to addressing the employment challenge in Vietnam? (policy: get priorities right) Formal Registration Process has been neither simple nor linear (as in modernisation theory); Some ’backtracking’ among surveyed firms; For Household Enterprises, formalization is associated with performing well economically and firm survival.  There are both costs and benefits to registration under the Enterprise Law… focus policy on firm incentives to register (increase benefits – reduce costs) 29

2. Bureaucracy, Informality, Tax Evasion and Bribes Key reason for perceived bureaucratic burden appears to be lack of knowledge of Laws and Regulations; High proportion of firms actually obtain required documentation within 15 days; Informal charges remain part of day-to-day life for a Vietnamese SME; can provide disincentive to formalize.  Focus policy on information/education of firms (One Stop Shops) and simplify bureaucratic/legal context in which SMEs operate (transparency) Low Tax Burden Firms not formally registered less likely to pay tax; Comparison with other countries: SMEs in Vietnam paying disproportionately low share of total taxes.  SME sector is a potentially very significant tax revenue source in Vietnam – tax reform policy measures critical 30

3. Employment, Education and Social Insurance Labour constraint in SMEs is large and becoming larger; Shortage of skilled labour increasingly an issue.  Much to suggest that phase of unlimited labour supply (and “easy” growth) in Vietnam coming to an end – focus policy on education (quality not quantity), vocational training and quality of capital investment Clear and consistent gender difference in provision of ’fringe benefits’ to employees;  Policy: formalization key to extend fringe benefits, but gender policy can indirectly help increase/broaden social benefits – so not only a matter of equity:  More fringe benefits may help reduce excessive labour turnover (flexibility important, but in a modern economy in service skills are important) 31

4. Production and Technology High degree of specialization; Firms appear less willing than before to innovate (seem not to capture benefits); Larger firms found to be more innovative and diversified.  Policy: create incentives to innovate and invest in R&D  Intellectual Property Rights: Patents, Copyrights (competition important – but market failures must be addressed) Technological upgrading is happening; and has positive impacts on labour productivity; Capacity utilization of existing technology is high.  Policy: “no free lunches” – capacity constraints are starting to bind: how expand capital and ensure access to new machinery/equipment is key. 32

5. Investment and Access to Finance Despite recent expansion in supply of credit, excess demand remains; Lack of access to finance remains the key perceived constraint in survey; High proportion of surveyed firms are credit constrained; Retained earnings remains significant source of financing.  Policy 1: Expansion of formal credit is needed  But quality of supply must be ensured: e.g Credit Rating Schemes;  And risk management and loan appraisal mechanisms need to be introduced / improved;  Policy 2: Training of SMEs to formulate and present coherent loan applications (organized accounts and business plan). 33

6. Environment (exploratory) Compliance with environmental regulations remains weak; Environmental Certificate not mandatory.  Policy 1: One might expect demand for compliance to increase over time (exports, domestic consumer driven demand etc. but more should be done);  Policy 2: Environmental legislation in concert with tax policy (to affect incentives/assessment of costs and benefits) (but remember institutional constraints) 34

Next Steps Hope you will enjoy reading report (much more there). In-depth collaborative research studies and policy briefs considering selected key issues arising from 2007 database. New Survey to be implemented in 2009 with ILSSA, CIEM and DoE; Same firms to be interviewed (panel database); Only small modifications to the questionnaire; Additional module to be incorporated (Environment in 2007)? Report to be published in

Thank you for your attention 36