The Political Economy of Small and Medium-Sized Enterprise Development: Characteristics, Productive Value and Market Constraints in Industrial Manufacturing.

• Author: Ngo, Christine Ngoc

1. Introduction

   Development success among developing countries is rare. Other than the Asian Tigers and Japan's successful experience in the first half of the twentieth century, few countries, most notably China, have been successful in transforming their economies sustainably. Without exception, the successful experience has involved growth and development of key industrial sectors as well as entrepreneurs and firms that force the necessary process of economic and industrial transformation. Vietnam is a latecomer among the few countries that have hit significant milestones, achieving economic and industrial transformation fairly recently. When Vietnam embarked on its economic reform programme in 1986, the government was intentional in using state-owned enterprises (SOEs) and the public sector to maintain control of the development process. In consequence, state resources, rents and investment opportunities were often prioritized towards SOEs and key sectors such as telecommunications, oil and gas, and electricity. Other than the creation of the Vietnam Law on Investment--passed by the National Assembly in 1987 and 1990, and most recently revised in 2014--that lays out the legal framework for market-oriented activities and investment, the private sector was largely neglected. In other words, private firms and entrepreneurs were left to fend for themselves with little government support. (1)

   Despite an uneven playing field while competing with both public and foreign enterprises, local private firms have contributed substantially to Vietnam's economic development in the last few decades. In its 2019 "Productivity and Competitiveness of Vietnam's Enterprises" report, the United Nations Development Programme (UNDP) highlighted that, in the manufacturing sector, private firms generate substantially higher--approximately six times--value-added than SOEs (UNDP 2019). Furthermore, in 2015, private Vietnamese firms hired 7.71 million workers compared to approximately 1.37 million workers employed by SOEs (Ministry of Planning and Investment 2017). Finally, Vietnamese private firms contributed 41.7 per cent to Vietnam's GDP in 2017, compared to the 28.6 per cent contribution by the state-owned sector (Cameron et al. 2019). Vietnam's economy is largely dominated by small and medium-sized firms (SMEs). Therefore, the growth and contribution of the private sector can be attributed mainly to the successful capacity-building of SMEs.

   Industrialization in the manufacturing sector has three main drivers: first, improvement in productivity to expand production at lower costs; second, improvement in value-added of output; and third, adoption of new production techniques and technological innovations by adapting them to local input factors. In the context of a transition economy where firms face a number of constraints and setbacks, satisfying all three performance criteria can be challenging. Combined with investment risks and a severe lack of resources, the probability of failure immediately soars.

   In the context of economic transition and political economy of socialist transformation, Vietnamese firms not only proved to be extremely resilient when faced with challenges, but also achieved a certain level of industrial capacity (Gray 2018; Ngo 2016b, 2020). The measured but successful industrial development of Vietnamese SMEs provides helpful lessons for development. From this perspective, this paper attempts to answer three research questions. First, how have Vietnamese SMEs created enough productive value in their industrial activities to become competitive within production networks at home and abroad? Second, how have they overcome market and institutional failures that are pervasive in the country? And third, what are some of the policy options to further promote the development of SMEs given Vietnam's political economy. This study primarily focuses on the manufacturing sector because it embeds the largest benefits of firms' growth and spillover effects to the country's overall growth and development (Cimoli, Dosi, and Stiglitz 2009; List 1984).

2. Research Method and Data

   This paper utilizes qualitative research, especially analytical case studies, to assess the transformation of Vietnamese SMEs and their contribution to the industrial sectors. We separately observe small and medium firms to tease out details and nuances in their evolution of development, as well as the characteristic differences of the two groups given their size. Based on the insights provided in the case studies, we put forward practical policy suggestions to further promote Vietnamese SMEs. In order to support this qualitative study with statistical analyses and findings, the Appendix presents useful data from a recent survey of SMEs in Vietnam to contextualize some key aspects of their business activities, the constraints they face, and the policies they consider most useful for expansion.

   This paper adopts the World Bank classification of enterprises, which separates all enterprises into three groups. Small enterprises have up to fifty employees, (2) medium enterprises between 51 and 300 employees, and large enterprises over 300 employees. (3) The qualitative data are primarily based on two fieldwork trips conducted in June, July and November 2016, including thirty-four in-depth semi-structured interviews with firms' owners and/or managers, government officials, bank managers and experts. These interviews spanned seven different provinces and cities in Vietnam--Hanoi, Ho Chi Minh City, Hai Duong, Hung Yen, Binh Duong, Vinh Phuc and Dong Nai. We interviewed a total of twenty-six manufacturing firms, including nine small enterprises, seven medium enterprises, six large enterprises, and four large foreign companies that source industrial components from Vietnamese producers. During the interviews, we sought to identify key factors that either enhance the productive value of the firm's output or impede its performance. The interviews were up to three hours long. All thirty interviews were conducted by one of the authors in Vietnamese. The remaining four that involved foreign investors were in English. Most interviews were recorded with the permission of the interviewees and later transcribed into text. If we could not obtain permission to record the interview, notes were taken, and a detailed summary of the interview was prepared later. All qualitative data presented in the case studies were carefully triangulated and cross-checked across different interviews and the literature.

   The rest of the paper is organized as follows. The next section puts forward the conceptual and analytical framework underlying the case studies, with a particular focus on constructing the theoretical concept of "productive value". Further, this section reviews major market failures frequently faced by SMEs and the factors that affect their overall growth. The fourth section analyses how Vietnamese SMEs create productive value and overcome market failures. The subsequent section offers policy suggestions for the development of SMEs in Vietnam. The final section concludes by highlighting the contribution of the paper within the economic development literature.

3. Conceptual and Analytical Framework

   This section provides a conceptual framework of three important aspects of SME development: first, productive value generated by firms' activities and organization; second, identifiable market failures that explain the bottlenecks undermining SMEs' efforts to acquire industrial competitiveness; and third, factors that explain differentials in firm performance.

   3.1 Firms' Creation of Productive Value

   3.1.1 Definition of Productive Value: Conceptually, productive value is defined as the advantages that firms gain through improvements in production, management and business practices. This is achieved through, for example, increasing product quality, improving customer service, guaranteeing product quality and performance after sales, reducing costs and reliance on intermediate goods, and increasing labour productivity by upgrading technical capability, production organization and managerial skills (Cimoli, Dosi, and Stiglitz 2009; Khan 2019; Penrose 2013).

   Economic literature is prolific in identifying the factors contributing to firms' productive value. First, the literature focusing on firm's development stresses the importance of learning by doing and cumulation of tacit knowledge in production (Arrow 1962; Khan 2019; Lall 1992). In their in-depth research into an auto assembly plant over a one-year period, Levitt, List, and Syverson (2013) find "considerable evidence of learning by doing in quality and quantity productivity performance, particularly early in the production year" (p. 635). Interestingly, the researchers found that "most of the knowledge stock built by learning does not stay with the plant's line workers" (ibid., p. 645). "Instead, it quickly becomes embodied in the physical or broader organizational capital of the plant," allowing for tacit knowledge to be permanently integrated into the production processes of the firm (ibid., p. 645). Therefore, productive value created through learning by doing is not a temporary improvement, but would enhance firm's capacity perpetually.

   Second, the availability and effective use of capital and labour are also important for the enhancement of productive value. Tran, Grafton, and Kompas (2009) develop an indexing method that "decomposes the contribution of productivity, prices and firm size to the firm's value-added" (p. 283). Using survey data from 1996 to 2001, the authors find that, in Vietnam, "large firms use capital more efficiently than smaller firms, while labour productivity is somewhat similar among different firm sizes" (ibid., p. 283). In most factories, careful management and arrangement of input/output inventory on the manufacturing floor allow for extra productive space and time, and thus lead to higher...