Credit access and innovation activity in vietnamese SME

UNIVERSITY OF ECONOMICS INSTITUTE OF SOCIAL STUDIES HO CHI MINH CITY THE HAGUE VIETNAM THE NETHERLANDS VIETNAM - NETHERLANDS PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS CREDIT ACCESS

UNIVERSITY OF ECONOMICS INSTITUTE OF SOCIAL STUDIES

HO CHI MINH CITY THE HAGUE

VIETNAM THE NETHERLANDS

VIETNAM - NETHERLANDS PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS

CREDIT ACCESS AND INNOVATION ACTIVITY IN VIETNAMESE SME

BY

TRƯƠNG BẢO DUY

MASTER OF ARTS IN DEVELOPMENT ECONOMICS

HO CHI MINH CITY, JANUARY 2015

UNIVERSITY OF ECONOMICS INSTITUTE OF SOCIAL STUDIES

HO CHI MINH CITY THE HAGUE

VIETNAM THE NETHERLANDS

VIETNAM - NETHERLANDS PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS

CREDIT ACCESS AND INNOVATION

ACTIVITY IN VIETNAMESE SME

A thesis submitted in partial fulfilment of the requirements for the degree of

MASTER OF ARTS IN DEVELOPMENT ECONOMICS

ABSTRACT

In the wake of Vietnam banking crisis 2008-2010, there has been more focus on access to finance for small and medium sized firms Even though some studies has already suggested that limit access to credit might stagnate innovative process, scarce studies has put their focus on small firms in developing countries For this reason, our study is tended to reduce that gap by analyzing how credit could have affected innovation activities of Vietnamese’s small and medium sized enterprises (SMEs) using data between 2007 to 2011

Our hypothesis is having access to credit allows Vietnamese SMEs aid their innovation process Since, it would allow them to import new machineries, upgrade outdated production line, to cut cost, produce new products and/or improve their old products In this paper we uses logit models and Fixed-effect models to test the hypothesis Among others, logit models allow us analyzing effect of credit on firms each year, and fixed-effect models help us take advantage of our Vietnamese SMEs panel data sets

This study results suggest that easing credit access increased the likelihood of introducing new technology or applying new production line of Vietnamese SMEs However, the effect of credit access on other types of innovation, like introducing new products and improving old products is inconsistent over the year, thus it needs to be studied further

Key words: Vietnamese SMEs, credit access, innovation

LIST OF TABLES

Table 3.1: expected sign of independent variables 27

Table 4.1: the share of Vietnamese SME by ownership category for the period 2000-2008 31 Table 4.2: the share of SMEs on total number of firms in Vietnam 33 Table 4.3: the share of SME by kind of economic activity 34

LIST OF FIGURES

Figure 2.1: Interest rate and expected return Error! Bookmark not defined Figure 2.2: Enterprise Innovation – Offensive strategy 13 Figure 2.3: Enterprise Innovation – Offensive strategy 14

CHAPTER I INTRODUCTION

For better audience experience, introduction chapter is used to state out the causes and the range of this study Problem statement section is used to briefly describe theories and empirical studies behind firm innovation as well as reveal any possible connections between credit access and innovation It also indicates the need to conduct this research in Vietnam as well as the research objects and the scope of the study They, therefor, determine the goals and the scope of this thesis

1 Problem statement

Although firm innovation got its very first attention in the early twentieth century via the book of Schumpeter’s book (1934), yet public and research interest is disproportionate Unsurprisingly, large and multinational enterprises got the most attention from both governments and scholarships around the world It is properly because when it comes to innovation, we tend to think about breakthrough technologies, which might be creating a whole new industry or dramatic changes of an old industry For example: internet industry or big jumps of agriculture Innovation is also seen as the result of heavy R&D investment which can only be done by large enterprises Yet, innovation is not necessarily breakthrough technologies (Hadjimanolis, 2000) In fact, more studies and better definition (Archibugi & Iammarino, 2002) pointed out that innovation is not large enterprises’ exclusive right, instead it happens anywhere despite size and region through self-learning or adapting That opened the gateway for more recent studies toward innovation activities in small and medium enterprises (SMEs) Nevertheless, most research around this topic (Beck

& Demirguc-Kunt, 2006; Hoffman, Parejo, Bessant, & Perren, 1998; March-Chorda, Gunasekaran, & Lloria-Aramburo, 2002) were still conducted primarily in developed countries, for instance in Western Europe and North American countries Their

contribution as a result were limited within the developed countries’ boundary Thus, there are many areas around this topic need to be explored

Investigating the effect of credit access on SMEs’ innovation in developing countries is an interesting yet challenging task It is interesting because a clear connection between them seems to exist While credit is a main external financial resource of SMEs; Innovation is an indicator of firm’s adaptation ability and sometime growth ability, but it may require heavy investment Yet in developing countries, credit application process may not be transparent thus may require personal connection Beside a firm can use credit for multiple reasons not just innovation, for instance, enlarging its labor force instead of investing on automatic machine This topic is challenging because while many studies has been done so far, they are still limited partly because they only used data of developed countries The reason could be due to the nature of developing countries, data of SMEs is not collected easily As a result, it

is difficult to measure credit access and firm’s innovation

For this reason, our study tries to narrow that gap by investigating the link between credit and enterprise innovation using Vietnamese SME dataset conducted by the Central Institute for Economic Management (CIEM) of the Ministry of Planning and Investment of Vietnam (MPI); the Institute of Labour Science and Social Affairs (ILSSA) of the Ministry of Labour, Invalids and Social Affairs of Vietnam (MoLISA); and the Development Economics Research Group (DERG) of the University of Copenhagen This dataset provides rich information about Vietnamese SME from 2005

to 2011, thus allowing us to build our panel models We hope that our result can be used as reference for government intervention then

There is one more reason that urged us to do this study There was a banking crisis in Vietnam from 2008 to 2010 which might limit access to credit from small firm After the crisis, a report of Rand et al (2012) used 2011 Vietnamese SME survey

data implied a reduction in number of SME innovation activities Although this might have been an coincident and did not necessarily reflect the real connection between those factors, since credit is just one of many barriers of firm’s innovation Many studies (Hall, 2005; Hoffman et al., 1998; Madrid‐Guijarro, Garcia, & Van Auken, 2009) shared the same result where it indicated that financial resource are one of the main causes However, it should be noticed that most of the studies were conducted outside developing countries’ boundary therefore we do not expect our study would share the same result

Though there are only a small number of study investing the role of innovation

in Vietnam, this study considers it to be an important factor of firm growth for two reasons It is claimed to give firm a temperate absolute advantage in the market (Schumpeter, 1934) and also increasing firm survival chance (Christiansen, 1997) Consequently, our study finds its duty to further investigate the existence of credit access and innovation relationship in Vietnam environment

2 Research objects

The first step of our study was finding the best measurement for firm credit access This was considered as a crucial step due to the fact that credit access was difficult to measure and there was still no broaden accept on the way to measure it After that we investigate to see if the firm had better credit position would have innovated more than the firm who did not We were also take into account difference between high technology and low technology firms which consequently influence decisions of the head of the enterprises on innovation Thus, in the end we separated the firms in our data into two groups to see how credit access had affected innovation within each group

In more detail, this study tries to unveil the link between credit access and SME innovation activities and to investigate if the magnitude of that link was different

among technology and non-technology oriented firms For this reason, there are two objects our study is aimed for

- Firstly, it examines the impact of credit access, official and unofficial, on SMEs’ innovation activities Unofficial credit still be a source of firm credit, therefore it should be considered

- Secondly, it investigates whether the effect of the external financial access differed across firms by industry type Ultimately, basing on the final results, we expect to propose better policies for Vietnam government

To solve the study’s research objectives, the main question raised by this paper is: “Is there a relationship between access to credit and SMEs innovation in the case of Vietnam?” Two sub questions are also raised to clarify our objectives: “Is there any difference between official and unofficial credit access to SME innovation activities?”; and “Whether the effect differ across firms by type of technology level (high technology and low technology)?”

we got by removing all fixed effects and thus highlight the real effect of credit access

on innovation in SMEs’ environment

4 Research Outline

CHAPTER II is used for literature review Most of it would go through behind theories and share the result of previous empirical studies, in which we also try to explain the fundamental difference of innovation between technology and non-

technology oriented SME We consider it as vital step due to the fact that the need of innovating is unevenly across different types of firm; Furthermore, different types of firm might also require different kinds of financial resource At the end of this chapter,

we would explain how innovation is defined, which would leading to our discussion on how it should be measured

CHAPTER III would be used to explain our methodology This part would therefore content our Analytical Framework, the Econometric model that we conduct and the data that we use in this study Via this step, we want to discuss the advantages and disadvantages of the Vietnamese SME panel data

In CHAPTER IV, we would discuss the results that we found in our study The beginning of this chapter would be used to review Vietnamese economic situation, focusing on SMEs’ innovation and their credit access conditions It is intended to supply reader a full picture of Vietnamese economy, Innovation , Credit status and events that might be linked to this study The rest of it is used to describe the data and our regression result With this step, we expect to bring up all vital indicators, their trend and their association that we has discovered

CHAPTER V is for our conclusion and policy implication All of our study is summarized here It is also used to indicate the advantages and disadvantages of our methodology, our data as well as our suggestion for future researches Policy implication is where we suggest intervention policies that influenced by this study’s findings

CHAPTER II LITERATURE REVIEW

This chapter is where we recall behind theories as well as results of empirical studies In theories section, we would review the most well-known theories and would also reveal our hypothesis The rest of this chapter was used for empirical studies reviewing In this section, we would summarize findings of previous researches and sort out factors that could have affected firm innovation activities beside credit access

We also summarize ways to measure innovation activities of firms and what measurement we use for this study

1 Theories

Having access to Finance is a key driver in the creation (Cassar, 2004; Popov and Roosenboom, 2013; Kim et al 2016), survival (Tsoukas, 2011) and growth (Rahaman, 2011) process of firms, and especially for smalls (Beck and Demirguc-Kunt, 2006) and innovative firms (Lee et al., 2015) According to studies, SMEs and innovative firms have more constraints and difficulties to access to finance, because their projects tend to be riskier (Lee et al., 2015) Like access to finance is important for firms activities, it can consequently foster economic growth (Kim et al., 2016) and influence positively innovation (Wang, 2014; Brown et al., 2009) Furthermore, it was demonstrated that innovation has a positive impact on economic growth (see e.g Hasan and Tucci, 2010; Galindo and Méndez, 2014) The importance and linkage of this two variables (Figure 1), has placed innovation in the heart of the Europe 2020 Strategy

There are vary types of sources of funding, and source selection is depended on risk level (the firm itself or its projects), firm’s maturity and the amount of funds needed Manigart and Witmeur (2009) It also based on size, age and availability of information of firm as well as it goals, its ownership and sector that firm is in,

according to study of Berger and Udell (1998) For instance, Beck and Demirguc-Kunt

(2006) suggest larger firms have better access to formal sources of external finance

than smaller firms While according to Manigart and Witmeur (2009), small firms

usually rely on private sources, like saving of owners, or his family and friends,

especially when the risk is high Commercial banks usually fund firms with low risk

level instead and therefore Venture Capitalists or Business Angels can be another

option of funding for small firms at their early stage through equity financing

It is undeniable that there are many financial options for large enterprises even

in the context of developing countries, however smaller enterprises on the contrary do

not have such privilege If a small firm needs funding and it cannot get it through

private source, commercial banks seem to be their only choice because equity

financing is not a popular option in developing countries Yet, fund from banking

system does not come with ease, and it is more severe in the case of undeveloped

economies If a firm does not have lands, warehouses, machines or any kinds of

physical asset that can be used as collateral securities, bankers have to base on credit

history and firm information to make a lending decision However, firm information is

hard to obtain accurately and credit history in many cases does not well recorded or

even non-exist For this reason, risk may be too high for bank to bear Even if a

commercial bank accepts to pay high cost to acquire firm information and accept high

risk due the non existence of credit history for long term purpose The debtor can later

use this information and its good credit history to borrow from different bank, which

will be willing to accept a much lower interest because the risk is already diminished

This is the dilemma in banking system and also raise a question for this study:

“Whether small firms use bank lending to fund for their innovative project?”

When we study the relationship between credit access and innovation, we realize that it is a subject of two main stream of theories

When we observe innovation as a risky project, finance theory suggests that high risk goes with high return Studies have already indicated that high technology firms, which require constantly innovating, appeared to expect and have higher return than normal firms (Hall, 2005) For this reason, we can assume that innovative firms are aware the risks when they pursue a creative-oriented project Yet expecting high return makes them accept high interest to get access to external financial resource Studies also has found that high innovative firm has owners that were more favorably inclined toward risk acceptance (Beck & Demirguc-Kunt, 2006; Hall,2005; Hoffman et al., 1998)

According to the European Commission, financial markets and financial institutions are traditionally reluctant to invest in R&D projects, because they bear a higher uncertainty/risk, compared to more traditional business projects This uncertainty and risk is due to the lack of information, in which banks and financial institutes fail to appraise the risk of an innovative project To compensate to the rist lender may want to increase interest rate or deny lending to firm Stiglitz and Weiss (1981) argues that even though creditors can increase interest rate to reduce their risk,

it is a non-linear trade off When the interest rate goes more than a peak point, it attracts more gamblers and because of costly and unavailable information, banks are not easy to distinguish their good creditors from gamber The peak point is especially low in countries where the credit regulations are poorly defined and enforcement methods are weak and unreliable This is reflected in figure 4.1 bellow

Figure 2.: Interest rate and expetected return

R*

Interest rate charged Note: D = demand, S = supply; r = interest rate.

Expected Return to the Bank

Theories also suggested that small innovative firms have more difficulty accessing external financial sources due to their risky activity and more severe asymmetric information problems At the same time, innovative firms have to reply on intangible asset and therefore have less tangible assets to use as collateral (Hall, 2010)

We could see that two theories suggest different final consequence Therefore, understanding what influences innovation decisions and how many kinds of innovation were essential While going over different articles we were acknowledged that there were primarily two kinds of strategy, and what strategy a firm refers would depend on how that firm choose their position in the market We like to call one of those are active (or offensive) strategy, which was chosen when firm try to gain initiative in its

market Innovative firms usually choose this strategy for two reasons: keeping their technical advantage and trying to control (or open) a niche market Inactive (or defense) strategy was where a firm only innovates under market pressure Firms with

no market power choose this strategy because they do not have enough resources to lead or conquer an old market which was fully explored

While the offensive strategy might give firm a great chance to control an unexplored market and get higher profit via technical advantage, it was also a costly option The strategy was visualized by figure 2.2, in which firm innovation decision is mainly decided basing on market provision from the R&D activities or manager’s scope As a result, this strategy requires a firm to invest their resources on innovation projects which their outcomes, in many cases, were highly unpredictable Differing from normal project, the assets in an innovation project are usually intangible assets which are knowledge and humans These kinds of asset probably be vanished immediately when a key employee leaves the project This leads to increasing the vulnerability of an innovation project Moreover, on financial perspective, intangible assets cannot be used as collaterals to get access to bank credit This may lead firm to consider bank’s debt as a poor choice to finance their innovation

Figure 2.2: Enterprise Innovation – Offensive strategy

Defensive strategy may not give firm technical advantage, yet it is a cheap strategy Firms do not have to constantly change their products, but instead study market needs and satisfy it This may not give those firms first hand in the market, but still can give them enough profit, especially where the product cycle is long When

Market provision Innovation decisions New (or improving existing) products

New (or improving existing) process R&D/ manager/

owner

Production

firms found their need to innovate, they can choose to do one of two things First, they

can slightly change their products appear so they can satisfy customer aesthetic

requirements or introduce new products yet share the same characteristic of the old

ones This choice does not require much financial resource since they can rely on old

technology and existing production line Thus, finding external resource is not

necessary; another choice of firm is investing in the production process where they can

optimize their production and increase their marginal profit This usually requires a

firm to buy new machines or invest in physical assets, like land, store or workshop,

which can be used as collateral securities if it seeks for credit access

Figure 2.3: Enterprise Innovation – Offensive strategy

Eventually a firm does not have to choose to glue to one strategy or one

innovation type during its life In fact, it can prefer one more than other or even choose

to follow both strategies if its situation allows them to do so Unfortunately, even

though it is very important, we cannot clarify which strategy firm is following and

consequently what kind of innovation they persuade unless doing a survey We can

only assume that high technology enterprises highly refer active strategy due to their

need to secure their future by trying to seize market power through technology

advantage Previous research backed this assumption by showing that high technology

enterprises in European spend heavy cost to introduce a new product or adjust old

product through R&D activities (Hoffman et al., 1998), while low technology

Market

needs Innovation decisions New (or improving existing) products

New (or improving existing) process

Production

enterprises may refer passive strategy since they have no market power at all and their product have longer life cycle This leads us to our hypothesis:

H1: For Vietnamese low technology SMEs, increasing credit access motivate the innovation carried out by firms

H2: For Vietnamese high technology SMEs, increasing credit access does not affect the innovation carried out by firm

2 Empirical studies

1.1) Credit access

Bank loan can be considered as the most common debt finance which selection process is essentially based on credit risk According to Zribi and Boujelbène (2011), Louzis et al (2012), Chaibi and Ftiti (2015), the determinants of credit risk rest both on macroeconomic and microeconomic dimensions At the macro level GDP growth rate, inflation rate, exchange rate, interest rate, unemployment rate and public debt are influential factors of risk level While firms performance, size and structure of ownership are micro influential factors It is unsurprisingly, firms’ size affect the credit risk level, in which smaller firm has lower chance to get loan from bank (Beck and Demirgürç-Kunt, 2006) and the obstacles however still affect innovative firms (Lee et al., 2015) Nevertheless, according to Angilella and Mazzù (2015) when bank assess credit risk of innovative firms, the uncertainty can be improved by experts’ judgments, since firm performance, their structure and market margin would be not enough

In term of direct link between bank loan and firm innovation process, studies (Hewitt-Dundas, 2006) argued a link between budget constraint and firm innovative strength, they also suggested that firms mainly use their internal resource to fund their innovation This could mean bank loan is a less attracted choice when firms are looking

to fund their risky innovation projects Yet, those studies used data from developing

countries and and it is notable that mature financial markets have other options than bank loan to get external financial resource For instance, small firms can fund their projects using equity or debt instruments Furthermore, risk ventures play a huge role

in funding risky projects Ventures also supply knowledge and experience through training and monitor process so the entrepreneur can have better performance, and reduce risk Some government may boost firms’ innovation through intervention, like tax cutting or loan guaranteeing, to lighten firms’ financial pressure

When focusing our interest on a smaller picture, where we only observe the association between credit access and innovation, we find various results from empirical studies For instance, Girma, Gong, and Görg (2008) found positive correlation between credit access and innovation when using the data of Chinese enterprises Yet at the same time their result suggested government intervention played

a crucial role They pointed out that enterprises that had close connections with government get better credit access This means firms, received government supports, were only required to pay a smaller cost to get access to external financial resource to fund their projects This, in a way, satisfied finance theory with high risk high return

On the other hand, a contrary picture was shown in the result of Madrid‐Guijarro et al (2009) study It indicated that firms with better financial position innovate better In this study, financial position was built using bank’s debt, firm liquidity and loans’ cost Meaning, firms, that had more debt than average, were having

a poor position and thus innovated less The result fits transaction cost theory and agency theory where they claimed large debt actually discourage innovation Thus, this result can only be used as reference for our study Since financial position cannot be used as a proxy for credit access Because Spanish firms may choose not to use bank loan to finance their research activities, does not mean they cannot get access to it

1.2) Other factors

Though we believe that credit access is among crucial factors, we have to take into account other factors that can influence firm innovation Those can be gathered into 3 main groups The first group is manager’s (or owner’s) characteristics The second group is the characteristics of firm, or internal factors The final group includes factors that belong to firm’s environment, or external factors

The characteristics of firm owner or manager has been widely believed to play a huge role in firm innovation among studies Changing or introducing a product is always a risky activity due to its uncertain outcome and high cost requirement, that may go along Therefore, a high risk taker person might find this kind of activity more attractive than others This characteristic seems to be magnified in small and medium enterprise environment, where owners’ decision receives less pressure from inside the enterprise Yet, critical ideas, in some cases, may increase the rate of success through monitor methods

Another crucial characteristic is education High educated owners have their own advantage since most innovation projects require a certain level of knowledge As

a result, better education would give firms’ owner a better chance to understand of innovative process and foresee its outcome This could lead to in time judgement and intervention This positive association has been already confirmed by the empirical study of Hadjimanolis (2000) Higher education may also help a firm owner to maintain a better relationship with education institutions or technology associations which provide firm quality human resource and necessary technologies

Nevertheless, owner's characteristics may not always be innovative promoters For example, young owner may not have enough experience and knowledge to keep firm stay in a well performance state Lacking of management skills or market experience are claimed to make owner makes poor decisions thus leading to bad

outcomes This is why owner’s age is considered as a barrier of firm innovation However, it seems that the empirical result (Hadjimanolis, 2000) proved it differently when it reported a weak and negative correlation instead This result may suggest that older owners are risk averse or slower adapters than younger ones

Internal factors

Firm’s characteristics are believed to play their own roles The first characteristic which has been suggested by various studies were firm’s size Large enterprises are claimed to innovate more frequently than smaller ones It could be because larger enterprises are more stable and easier in mobilizing resources which exist inside or outside firm The effect of size has also been confirmed in studies’ results (Hadjimanolis, 2000), yet it seems that size does not always play a major role

Human resource could be another key role in firm innovative progress Better human resource may carry with them better knowledge and research experience that was needed in any research process Scientific knowledge is also important when a firm want to apply their discovery, or in broader terms the technology that they bought, into practice Human resource quality could be measured by the number of highly educated employees, or the amount of human investment Hadjimanolis (2000) revealed in his study that the larger the number of highly educated employees, scientists or engineers, a firm has the more innovative it would be Study of Girma et

al (2008), giving nearly the same result when it indicates labor training have positively associated with innovation spillovers

Internal financial resources are doubtlessly associate with innovation’s cost When facing activities that require high cost and result uncertain outcome, firms are suggested to rely on internal financial resources to fund those risky activities since it was a cheap solution For measurement methods, some studies used revenue as a proxy for firm financial health However, previous researches have believed that profit or

cash flow were a better measurement Liquidity can also be used to estimate firm finance position according to Madrid‐Guijarro et al (2009)

Other factors like firm age or level of firm internationalization are also worth mention Age markes firm maturation A firm that has survived for many years is less likely to face financial difficulties and more likely to perform better than a less mature one Thus, it may face less trouble while innovating (Girma et al., 2008) Enterprises that compete in international market has been suspected to get easier access to foreign investment or new technologies On the other hand, they also face more competitors and must satisfy technical requirements of importing countries These could urge them into improving their products to compete more effectively and achieve goods standard

of importing countries Girma et al (2008) confirmed this in his study when he proved that firm received more FDI innovated more than other using data of Chinese enterprises Nevertheless, when using export sales as a proxy for firm internationalization, only a weak correlation has been showed (Hadjimanolis, 2000)

External factors

External factors has been suggested to play a role in firm innovativeness Competition seems to be the first factor that worth mention When a firm is under heavy competitive pressure, there is many chance that it have to improve their current products to compete its rivals It may also try to introduce a new product to test the new market where the number of competitor is still low; Or it can also choose to upgrade or introduce new production process to reduce production cost The result of Kim et al., (1993) confirm a significant association, yet Hadjimanolis (2000) study do not share the same result It could be because there are various options that firm can choose like cost cutting or applying new marketing rather than invest in a risky project

Connection with University and technological institutions has been believed to have a strong impact on firm innovation Gemünden and Heydebreck (1997) calls it

‘technological interweavement’ in their study Education institutions can play as suppliers of high quality human force as well as technology hubs of the region To measure the education network’s impact on enterprises’ innovation activities Madrid‐Guijarro et al (2009) use the distance between firm and institution as proxy

Other factors like social networks or government support can also be considered Joining an industrial association are supposed to allow firms to get contact with new technology While government supports are various from approaching foreign investment, loan guarantee, human training to introducing to firms new technology They all may have positive effects on firm innovation

3 Innovation measurement

There is no unique way to measure innovation activities in firms Some studies relied on firms’ R&D expenditure Yet this is the limitation of those studies since innovation cannot be measured correctly using one of its inputs as proxy Furthermore, R&D expenditure is only relatively accurate in the context of large enterprises only where that activity seems to be the root of enterprises new products or product improvements In SMEs’ environment, however, R&D costs are usually not recorded separated from other costs Thus, some studies use the sale ratio between new products and old products as indicator This gave them an advantage in using firm’s output as measurement of innovation However, some believed this method is not a fair judgement of firm innovation rate, because it only takes into account successful innovation projects As a result, it also did not suit our purpose, since we wanted to observe innovation effort without evaluating its result

In an act to find better measurement, we first lean on the definition of

Schumpeter (1934), an economist who is often considered as the first one drawing

attention on the importance of innovation within firms In his book he defined 5 types

of innovation as following:

1 Introducing a new product or adjusting old product

2 Introducing a new industrial process

3 Opening a new market

4 Developing a new supply of raw material or other kind of input

5 Create changing in industrial organization

The definition is clear yet it might be too complex for any empirical study Thus, to simplify this matter, this study chose the definition of Oslo Manual (Manual, 1997) which focus exclusively on the first two types of innovation of Joseph Schumpter’s definition Even though it only captures a fraction of the original definition, it makes innovation concept easier to be measured In this definition, introducing new products or improving old product has to be ‘significantly’ different compared to old product through applying new technology, knowledge or material It states that a new process has to be new or its improving has to be significant, this also includes introducing new delivery method The weakness of Oslo Manual definition is, even though this definition distinguish carefully what is “new”, as well as well define what is “significantly improved” and what is “minor” improving, yet this increase the complexity of the definition In practice, a complicated definition makes it hard to gather data Moreover, Oslo Manual definition also does not consider improvements which involve purely creative or aesthetic as innovation This could be considered as a step back of this definition In model economy, we can see a lot of products from different producers with nearly the same features but different appearance Fashion industry, personal computer industry, smartphone industry are good examples In these types of market, while the cycle of a product is shorter than the cycle of a technical breakthrough, producers do not have any choice but invest their resources on aesthetic features instead of technical features to improve their old products or create a new one

The new products may not always increase producers’ marginal profit, because their role is replacing the old fashioned ones, but rather increase their likelihood of survival

by satisfying customers’ needs

To overcome the disadvantages of Oslo Manual definition, ABS of Australia gives a more simple definition of innovation ABS defined Innovation as new or improving in a product or service that has been commercialized, or applying new process or improving the old process to produce a commercialized product “New” in this context means new to firm In return, they have to accept that the survey respondents have their own clarification of innovation

Phillips and Phillips (1997) distinguished technological innovation and technological innovation in his definition In which, technological innovation occurs if firm introduces a new product or substantially improve product or its process in a three year period Likewise, non-technological innovation occurs if the firm changes its marketing strategies or management techniques or organizational structure in a three year period

non-In this study the definition of ABS is used Even though the Oslo Manual definition is stronger and more accurate, it also makes it more complex Furthermore, that definition does not include aesthetic change as innovation, we consider it does not well qualified for this study Because changing product appearing can be a way for SMEs to satisfy niche market and therefore increase their profit as well as their likelihood of survive Non-technological innovation in Phillips’ definition may occur frequently in SME environment Due to the lacking of manager skill of SMEs’ owner Yet these changes are an attempting to find a better performance through trial and error They may be too minor to make any significant change Also, it is also hard to explain to survey anticipate what kind of non-technological innovation that we want to take into account

CHAPTER II METHODOLOGY

We use this chapter to set out our model, the way we approach and present the data we use This part would content our Analytical Framework, the Econometric model that we conduct and the data that we use in this study Via this step, we want to deliver the advantages and disadvantages of the Vietnamese SME panel data

1 Analytical Framework

Figure 3.1: Analytical Framework

Figure 3.1 is used to describe our analytical framework This framework indicates that firm innovation are under influence of many factors While the effect of bank loan on innovation still is an object for argument, the effects of other factors has been proved in many empirical studies For this reason, we use them as control variables for our model

2 Methodology

To evaluate the relationship between credit access and firm innovation, six logit models are constructed In which three dependent variables are used to measure firm’s innovation, a same variable for two models Firm’s innovation is distinguished into

INNOVATIO

N INTERNAL FACTORS

EXTERNAL FACTORS

CREDIT ACCESS

OWNER’S

CHARACTERISTICS

three categories: introducing new products, improving old product, applying new progress

Introducing new product is given a value equal 0 if a firm fails to introduce a new product since the last survey or in the period two years before the survey and its value would be 1 if firm succeeded in introducing at least one product

Improving old product would be 0 if firm did not deliver any major improvements of existing products or changed specification since the last survey or in the period two years before the survey and its value would be 1 if firm did not

Applying new progress had a value equal 0 if firm did not introduce new production processes/new technology since the last survey or in the period two years before the survey and the value would be 1 if firm did

With independent variables, we kept the same control variables in all six models These control variables can be grouped into 3 smaller groups which represented: owner’s characteristics, firm’s characteristics and environment factors For credit access measurement, we used two different measurements First measurement, we used only firm total debt growth as our independent variable For second measurement, we used a vector of four independent variables: the growths of formal short-term debt, informal short-term debt, formal long-term debt, informal long-term debt By doing this we tried to distinguish the individual effect of each type of firm debt on innovation activities

The models as a result were formed like following:

            =   0 +   ′1      +   2    _      +  

            =   0+   ′1      +   2      _            +   3        _            +

  4      _            +   5        _            +  

Where Innovation = Introducing new product, Improving old product, Applying new progress

X is a vector which includes factors that can be gathered into 3 smaller groups: owner’s characteristics, firm’s characteristics and environment factors

1.1) Owner/manager characteristics:

Age of owner/manager: is the age of owner/manager It is expected to have a positive relationship with innovation, since experience and are expected to be positive influence factors

Finishing High school: a dummy variable which value equal 1 if owner/manager has finished high school and 0 if he did not We expect a positive association, since better education may lead to rational thinking which motivates innovation

Higher Education: is a dummy variable which value equal 1 if owner/manager had University degree or higher and 0 if he did not High educated owner/manager is claimed to get better a conception which allows him easier access to new technology Thus it is expected to have a positive effect

Experience: is a dummy variable Its value equal 1 if owner/manager used to own other enterprise, before establishing the present enterprise and equal 0 if he did not Having management experience is believed to help owner/manager make better decision on firm’s activities

1.2) Firm’s characteristics:

Firm Size: is measured by the number of employees of enterprise A large enterprise is claimed to be more innovative than small enterprise in comparison It could be due to the stability which goes along with the size or because bigger firms are more easy to access resources

R&D investment: R&D activities are believed to be the source of innovation of firms and one of the most important input of this activity Therefore, we put R&D

investment as one control variable and expected to see a positive relationship with firm innovation Though we should stress that since we were studying SME, we observe that many enterprises did not invest in R&D It may be due to the fact that in micro enterprises’ enviroment, many costs, including R&D, were unclarified One unit of this variable equals one billion VND

Human investment: Human investment is another input for firm innovation, since firm needs highly educated and well trained employees for this type of activity Consequently, we expect a positive correlation Human investment is measured by using the amount of money, in billion VND, which enterprise use for employee development activities

Profit: Using accumulated profit is a cheap way for firm to fund their innovation than mobilizing external financial resources This leads to our expectation of observing

a positive association In our equation, we use log value of firm profit A unit of this variable equals one billion VND

Firm Age: firm age reflects firm’s maturity Study shows that mature firms tend

to outperform less mature firms in term of innovation For that reason, in our study we expect a same result

Professional: professional employee, engineer and scientist, is considered essential for innovating Therefore, to measure professional level of a firm we use the ratio of educated employees to total employees In our study we expect that firm with higher educated employees ratio would innovate more

Export: we use the share of exporting to measure firm internationalization Firm that join international market may face more competitors This requires them to innovate more to meet international standard and overcome their rivals Consequently,

a positive relationship is expected

1.3) Environment factors:

Competition: a dummy variable which value is set to 1 if owner/manager believed his firm was facing competition and is set to 0 if he did not High competitive environment is believed to create pressure for firm to face which then force firm to be more creative if it wants to survive

Table 3.1: expected sign of independent variables

Independent variable Expected sign

Owner/manager characteristics

Firm’s characteristics

should react differently with low technology firms Vietnamese SME data using 4-digit ISIC classification to record firm’s main product, so we used the classification system basing on the study of (Hatzichronoglou, 1997) to separate firms into catalogs A firm can produce many various products which require different levels of technology, yet

we categorize using only its main product since firm is more intensive toward one certain level of technology that best supports its main product

Using fixed effects method allow us to control for all possible characteristics of the individuals in the study—even without measuring them—so long as those characteristics do not change over time For example, features like geography, manager’s traits which may influence innovative enterprise, yet could not be measured easily Previous study indicated that enterprises which are close to universities and academic institutions are more innovative than others Owners and managers in small firms usually are the one who make innovation decision, and a risk taker person may want to promote innovation activity more than risk averse person Yet, these factors had not been captured in our dataset, and for this reason we believed that fixed effects method on panel data is the best way of approaching for our study

manufacturing sector of 10 provinces Even though the first survey was made in 1991, our study only uses the data since 2005 up to 2011 This is because previous surveys do not capture data we need to measure enterprise innovation

This data set has many advantages which makes it useful for any SME study in Vietnam The questionnaire is well constructed and covers many aspect of Vietnamese SMEs even some rare data like informal credit The survey is divided into three modules which record not only firms’ characteristics, but also other factors that may have impacts on firm like owners’ characteristics (age, gender, education, etc.); And business environment factors (competition, economic crisis, government support, etc.) This allows a wide range of studies to be conducted One of the most advantages of this data set is it was built for panel data analysis For this reason, it supplies information of firm across many years (if it is available) which allows researchers to observe firm’s change over the years This makes the data suitable for our research

However, it also contains some certain disadvantages For example, even though the survey were trying to remain its consistency of the questions over the year, due to the need to keep the data up to date and be suitable for new methodologies, there are some slight changes in the data every time the survey questionnaire was constructed Some new variables has been added, while some other variables has been removed and some has been changed the way it was recorded This leads to the inconsistency in some variables that requires to be treated carefully The changes in name, order or unclear variable description also make it difficult to be assembled and error may occur For instance, firm’s network is changed from quantity recording to range recording “Percentage of management's working time is spent each month dealing with government regulations and officials” is removed completely in the 2011 survey We do not know the reason of removing, but we consider that variable is a good indicator of government’s effect on firms Furthermore, like any public survey,

some variables, that our study needs, are absent However, those variables are less important or can be replaced to warrant the accuracy of the final result

CHAPTER III RESULT

This section is for our conclusion and policy implication All of our study is summarized here We also discuss the advantages and disadvantages of our methodology and our data we used, as well as suggestion for future researches Policy implication is where we suggest possible policies that are influenced by this study’s findings

1 Overview of Credit and Innovation activity in Vietnamese SME

Four years after “Doi moi”, Vietnam economic reforms happened in 1986, Vietnamese government for the first time, since the union of north and south Vietnam

in 1975, introduced the Private Enterprises and Companies Law (PECL) in 1990 This action liberated private sector by giving it a legal guideline The PECL was latterly strengthened with the Law on Enterprises in 1999 and 2005 by defining more clearly about the type of enterprise and investment With the PECL, the government created Legal framework for Vietnamese private enterprises to flourish According to Enterprise Census 2000-2008 of GSO of Vietnam, up to 01 January 2009, there were 196,779 active non state enterprises in Vietnam, and they account for 95.7% of the total enterprises in Vietnam at that time Private sector also created 4.72 million jobs and accounted for 57.1% total jobs of the country Although this sector showed the lowest business efficiency with the profit before tax is only 16.6% of total revenue in

2008, comparing to state owned enterprises and FDI enterprises which account 35.3% and 48.1% respectively Still on economic aspect, it can still be considered a big success of Vietnamese economy in moving from centrally planned economy toward a free market economy

Moving along with the growth in the private sector is the increasing number of FDI enterprises and the reduction of state owned enterprises The number of active FDI enterprises was 5,625 in 2009, which was 5.3 times more than in the year 2000 And

even though the share of FDI sector was only 2.7%, it created jobs for 1.83 million workers and contributed 40.4% of the state budget The number of state owned enterprises was dropped significantly from around 7,395 in 2000 to 3,328 in 2009 This showed the effort of Vietnamese government in reforming its economic

Though there was a huge change in structure of Vietnamese economic, small and micro enterprises was still dominated the economy Based on the employment size,

on the 1st January 2009, SMEs accounted for 97.1%, while the large enterprises accounted for only 2.9% Among three types of ownership, the highest rate belongs to non state owned enterprises with 98.4%

Table 4.1 presents the share of Vietnamese SME by ownership category for the period 2000-2008 The first row indicates the rapid growth in number of SME in 9 years with the average growth rate is nearly 54% per year The reduction in the share state owner SME could be explained by 2 reasons Firstly, it is because of the reduction

of state owner SME in general, resulted from the government effort of privatizing its enterprises Secondly, it is the result of increasing in number of the non-state owner and foreign enterprise, in which the non-state owner enterprise plays a major role The fifth row shows an increasing share of non-state enterprise SMEs’ number over the years, this may explain the low level of business efficiency of this sector Because small business owners usually lack experience in doing business, producing and finding finance resources

Table 4.1: the share of Vietnamese SME by ownership category for the period

2008 The third row shows a reduction of state owner SME from 2000 to 2004, this could be the result of privatizing process Yet the increasing trend since 2005 could be the result of the government attempting to divide big state owned enterprises into smaller enterprises which for better efficiency and speeding up the privatization process

Table 4.2: the share of SMEs on total number of firms in Vietnam

Table 4.3: the share of SME by kind of economic activity

On the contrary with the remarkable growth in the number of SME, Enterprise Census 2000-2008 of GSO of Vietnam, the average growth of innovation activities within SME was declining, Vietnamese SME data 2005-2011 While there are many innovation studies (Cefis & Marsili, 2005; Geroski, 1989; Murphy, 2002) around the world has been indicated the importance of innovation and its vital role; the study of Hansen (2006) based on a panel data of Vietnamese SMEs from 1990-2000 confirmed

a positive relationship of innovation and the likelihood of SME survival For this reason, if we consider innovation as the strength of SMEs in competition market, Vietnamese SMEs were losing their power However, it should also be noticed that Vietnamese SME data has its own disadvantage Although it captures the SME innovation in quantity, it fails in capturing the quality of innovation Consequently, we could not measure the innovation in its full dimension Yet the decreasing of innovation activities still could be a warning sign

Financial Crisis and Credit access in Vietnam

Like we has mentioned in previous part, one cause for us to make this study is because of the joint report of CIEM, DoE, ILSSA and UNU-WIDER (Rand et al., 2012), where it showed the reduction of SMEs’ innovation activities in 2011 This could have been the consequence of the Vietnamese financial crisis starting in 2008 The crisis could be traced back to the end of the year 2006 when a large amount of capital inflow flew into Vietnam While the central bank tried to follow its fixed exchange rate policy but the government failed to open an efficiency bond market, money supply increased rapidly by March 2008 M2 growth rate reached 45 percent and bank credit reached 63 percent Along with the failure in sterilizing the interventions, MOF failed to control the increasing of SOEs’ loan in an attempt to stimulate their aggressive expansion in 2007 As a result, inflation reached its peak at

28 per cent by July 2008 The macroeconomic stability seems to be restored in short run after a lot of administrative intervention like set ceilings on banks’ credit growth by

increasing reserve requirements, compulsory bank purchase of treasury bills on the monetary side, and direct government limitations on SOE non-core spending on the fiscal side (Leung, 2009) Because of this, the risk of non performing loan and lack of credit histories might result difficulty in bank lending activities after 2008 Up to now there is no study supplying clear evidences proving a direct effect of credit access on innovation activities in Vietnam As a result, this is the main target of this study

Similar to other under developing financial markets, informal credit appear in Vietnam to fill the void where formal credit cannot fulfil This was caused mostly by the existence of information asymmetries and high transaction costs When it occurred, small enterprises tend to rely on their own internal resources, or informal credit source (Claessens & Tzioumis, 2006) While there is no official survey on informal credit in Vietnam at that time, Vietnamese SME Survey is still able to supply a small part of the picture In the table below we can see that in average, informal short term debt accounts for more than forty percent of the SME total debt across the year except 2007 Though informal long term debt takes a smaller share of the total debt and reducing over the years, yet it takes around ten percent This means if we want to learn about credit access and its effect, we cannot not leave out informal access

Table 4.4: SME Average share of debt

Source: Author’s elaboration based on Vietnamese SME data

2 Data description

When we only observe the average SMEs’ debt over the year and the movement

of firm innovation we see a very weak correlation This is opposite to what we learn from theory and empirical research

Table 4.5: Debt average of Vietnamese SMEs

The debt average of SMEs

Source: Author’s elaboration based on Vietnamese SME data 2005 - 2011 Table 4.5 shows a changing in the debt structure in firms It points out an increasing of firm’s total debt from 2005 to 2009 and its slight drop in 2011 However, the diminution seems to result by a huge change in the debt structure where firms’ informal long-term debt drop significantly The size of average informal long-term debt in 2011 is only 46.4% and 29.6% the size in 2009 and 2007, respectively The drop of total debt in 2011 also be caused by the drop of informal short debt however the diminution is smaller Informal short debt in 2011 only drops 13.9% On the contrary, we can see a constant growth of formal debt, both short and long term, across the years This raises a question which is outside of this study: “Does Vietnamese financial crisis affect SME at all?”, Since the data suggests that firms got better access

to credit every year, at least from formal sources Whether the financial crisis impact existed, it should have found an indirect way to affect Vietnamese SMEs may be through informal channel