Do better institutions boost firm performance the case of manufacturing firms in vietnam

ABSTRACT This paper explores how institutional reforms in Vietnam affect the performance of manufacturing enterprises across 63 provinces by utilizing a unique dataset which includes the

UNIVERSITY OF ECONOMICS INSTITUTE OF SOCIAL STUDIES

VIETNAMTHE NETHERLANDS

VIETNAM - NETHERLANDS PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS

DO BETTER INSTITUTIONS BOOST FIRM PERFROMANCE?

THE CASE OF MANUFACTURING FIRMS IN VIETNAM

BY

NGUYEN THI NHA TRANG

MASTER OF ARTS IN DEVELOPMENT ECONOMICS

UNIVERSITY OF ECONOMICS INSTITUTE OF SOCIAL STUDIES

VIETNAMTHE NETHERLANDS

VIETNAM - NETHERLANDS PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS

DO BETTER INSTITUTIONS BOOST FIRM PERFROMANCE?

THE CASE OF MANUFACTURING FIRMS IN VIETNAM

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

MASTER OF ARTS IN DEVELOPMENT ECONOMICS

First and foremost, I would like to express my deepest gratitude to my supervisor, Professor Nguyen Trong Hoai, who was always available to answer any questions of mine and helped me stay focused on the research Extremely busy, he never failed to answer my calls or send me a text back His knowledge, patience and encouragement were the emotional and intellectual fuel that I needed to stand up and step forward whenever I felt discouraged and wanted to stop halfway

I would also like to extend my most sincere thanks to Dr Tran Tien Khai, Dr Pham Khanh Nam, Dr Pham Hoang Van, and Dr Truong Dang Thuy for their valuable suggestions and comments on my TRD, which kept me from straying away from “the main road” Without their support, I could never reach the finish line of this journey My special thanks also go to all the VNP teachers and support staff Not only did they assist

me with my study and thesis drafting process, they also made me truly feel to be a part

of this wonderful community, to relive a beautiful and unforgettable college life

I wish to thank, from the bottom of my heart, my wonderful classmates: Khanh Vu, for guiding me through the complicated Vietnam Enterprise Survey and Stata techniques, friends from my mini-group: Thien, Nhung, Hung, Ly, Viet for constantly reminding me of not giving up so that we can proudly celebrate together as VNPers, and other classmates for co-building a warm and bright C19 family Finally, I thank you my family, my husband and my little son for their unconditional love and support I always hope I can make them proud

ABBREVIATIONS

AEC : The ASEAN Economic Community

ASEAN-6 : Brunei, Indonesia, Malaysia,

the Philippines, Singapore, Thailand ASEAN-4 : Malaysia, the Philippines, Singapore, Thailand

GSO : General statistics office of Vietnam GVN : Government of Vietnam

OECD : Organization for Economic Cooperation and Development

VCCI : Vietnam Chamber of Commerce and Industry

ABSTRACT

This paper explores how institutional reforms in Vietnam affect the performance of manufacturing enterprises across 63 provinces by utilizing a unique dataset which includes the 2007-2012 Provincial Competitiveness Index merged with a set of data on firm-level performance extracted from the annual Vietnam Enterprise Survey The results show that provincial competitiveness significantly and economically explains the performance of firms located in different provinces Out of the nine subsets of institutional reforms, at least four sub-indices significantly and positively associate with the economic performance of the firms observed, which are Labor and Training, Legal Institutions, Transparency and Business Support Services

Keywords: provincial competitiveness index, firm performance, labor productivity, ROA, ROE

TABLE OF CONTENTS

DECLARATION 3

ACKNOWLEDGMENTS 4

ABBREVIATIONS 5

ABSTRACT 6

TABLE OF CONTENTS 7

LIST OF FIGURES 9

LIST OF TABLES 9

LIST OF APPENDIX 10

CHAPTER 1 INTRODUCTION 11

1.1 Problem statement 11

1.2 Research objectives 14

1.3 Research questions 15

1.4 Scope of the study 15

1.5 The structure of the study 15

CHAPTER 2 LITERATURE REVIEW 17

2.1 Institutions 17

2.1.1 Definitions 17

2.1.2 From institutions to governance 18

2.2 Institutions and economic performance: 19

2.2.1 More definitions and clarifications 19

2.2.2 Institutions and economic performance: theoretical views 20

2.2.3 Institutions and economic performance: empirical studies 25

2.3 Measurement of institutions: 28

2.4 Firm Performance 28

2.4.1 Definitions: 28

2.4.2 Measurement of firm performance: 29

2.5 Analytical framework for the study 30

CHAPTER 3 RESEARCH METHODOLOGY 32

3.1 Data sources: 32

3.1.1 Vietnam Enterprise Survey: 32

3.1.2 Provincial Competitiveness Index (PCI) 34

3.2 Model and variable construction 37

3.2.1 The Model: 37

3.2.2 Variables 3.2.2.1 Dependent Variables (Proxies of Firm Performance) 37

3.2.3 Descriptive (Initial Relationship) 42

3.2.4 Analytical Approach 48

CHAPTER 4 FINDINGS AND DISCUSSIONS 50

4.1 Overview of the business sector performance in Vietnam during the observed period:50 4.2 Overview of Basic Institutional Reforms and Their Impacts on Business Formance 52 4.3 Empirical results 54

CHAPTER 5 CONCLUSION 62

5.1 Main findings 62

5.2 Policy implications 63

5.3 Limitations and directions for further research 67

REFERENCES 69

APPENDIX 73

LIST OF FIGURES

Figure 1: Institutions……… 18

Figure 2: A visual explanation of institutions and economic performance (Ugur, 2010): 24

Figure 3: Analytical Framework 3030

Figure 4: Number of Firms Surveyed from 2007-2012 (VES) 32

Figure 5: Collection, Construction and Calibration of PCI Data 35

Figure 6: Number of Issued Legal Documents, 2010-2014 ……… 54

Figure 7: Example of an eRegulations Portal……….63

LIST OF TABLES Table 1: Number of Firms and Observations in the Sample 33

Table 2: Number of Firms Surveyed by the PCI Research Team from 2007-2012 34

Table 3: Sub-Index Weights 35

Table 4:Explanation of PCI Ranking 37

Table 5 : Firm level variable definitions ………….39

Table 6: Descriptive Statistics of Key Variables 43

Table 7: Mean Values by Types of Ownership 44

Table 8: Mean Values by Years 44

Table 9: Statistics of Institutional Variables and Economic Environment 45

Table 10: Mean Values by Manufacturing Industries 46

Table 11: Correlation Matrix 48

Table 12: Results of Regression No 1 (DV: Labor Productivity)……….58

Table 13: Results of Regression No 2 (DV: Capital Productivity)……… 59

Table 14: Results of Regression No 3 (DV: ROA)……… 59

Table 15: Results of Regression No 4 (DV: ROE)………60

LIST OF APPENDIX

Appendix 1 : Summarized Description of PCI Sub-indices

Appendix 2 : Full 2012 PCI Rankings

Appendix 3 : PCI Map

Appendix 4 : 2014 PCI Rankings

Appendix 5 : Boxplot Chart for each Variable (VAL, KL, ROA, ROE)

Appendix 6 : Regression Results

Therefore, there is a real need for further research on how institutions and institutional changes influence economic performance at the micro level A few typical researches studying this relationship focused more on the enforcement issues and quality

of administrative procedures, for example, Berkowitz and DeJong (2003) obversved that businesses tended to choose to operate in regions believed to receive more political support from local governments in Russia, whereas Laeven and Woodruff (2007) founded that larger companies were attracted more to effective jurisdictions in Mexico Obviously, the success of the business sector in any country would lead to rising employment rate, better trade, investment and national competitiveness as well as greater tax revenues These factors eventually contribute to the national socio-economic development Therefore, many countries have been considering and applying appropriate policies to catalyze

positive institutional changes in order to improve the business climate and facilitate the operations of the business sector

In Vietnam, since the adoption of Doi Moi policy starting in 1986, “institutional

reform” has always been of great concern to the Government of Vietnam Most of recent important political documents consistently emphasized the key objectives of improving market economy institutions and the efficiency of state management and enhancing the effectiveness of the rule of law More specifically, “institutional reform” is set as a priority

in the Governments administrative reform program for the 2011-2020 period and the 13thCongress legislative agenda until 2016 The Government of Vietnam has, of late, issued important resolutions reflecting their strong determination to improve the business environment, specifically Resolution No 19/NĐ-CP dated March 18, 2014 and Resolution

No 19/2015/NĐ-CP dated March 12, 2015, aiming to advance the business environment (reaching the ASEAN-6’s average level by the end of 2015 and ASEAN-4’s by the end of 2016) and strengthen national competitivess These are the two “decisive factors” for Vietnam’s socio-economic development as stressed by the Prime Minister at a meeting in April, 2014

And while the results of the implementation of Resolution No 19/2015 have not been announced, the encouraging outcome from the implemention of Resolution No 19/2014 was highlighted at the 2014 Vietnam Development Partnership Forum (VDPF) with the theme “Institutional reform economy, enhanced autonomy and competitivness of Vietnam’s economy” organized on December 5, 2014 in Hanoi Some specific results include the starting-a-business ranking of Vietnam in Doing a Business 2014 jumped from

109 to 60 and the ratio of enterprises adopting e-tax declarations amazingly increasing to 95% from 65% Additionally, the Government of Vietnam issued Decree 78/2015/NĐ-P providing guidance on the implementation of the new Enterprise Law on Setempber 14,

2015 This decree is considered a step forward in the goverment’s determination and

committment to faciliate the ease of doing business in Vietnam and enhance the transparency in the area of business registration Therefore, researches on in what way institutional reforms should be designed and governance should be executed to help boost the performance of the business sector by improving the business climate and regulatory framework seem to attract greater attention.

Vietnam entered several important trade deals in 2015 including the European Union Free Trade Agreement, and more importantly, participated in the recently-concluded negotiations of the Trans-Pacific Partnership Agreement (TPP) TPP, which is expected to liberalize 40 percent of the world’s economy, is forecast to bring big benefits

Vietnam-to its members with Vietnam being expected Vietnam-to be one of the biggest gainers The benefits here for Vietnam do not lie only in the number of tariff lines cut but its most profound and positive effect on Vietnam is the strong requirement for institutional reforms as commented

by both overseas and local economists

Moreover, the ASEAN Economic Community (AEC) is coming into being by the end of this year with the objective of making this region a single production base with free movement of capital, investment and labor However, it seems that Vietnamese enterprises are still very passive in learning about and self-adjusting to be more competitive faced with both challenges and opportunities brought about by the AEC Recent surveys by the Vietnam Chamber of Commerce and Industry (VCCI) revealed that more than 30 percent

of Vietnamese enterprises surveyed admitted not knowing about Vietnam’s entry to TPP negotiations, 76 percent having no idea of the AEC , 94 percent not having AEC’s negotiation contents and 63 percent completely in the dark about opportunities and challenges awaiting them once AEC is officially launched This stresses the need for better information-sharing mechanism accessible to businesses and further research into institutions and their effects on economic performance to equip economic actors with good information and advices necessary for them to design appropriate strategies and thus

benefit from these trade deals and integration initiatives as well as successfully integrate deeper into the global economy

For developing countries like Vietnam, the quality of institutions and regulatory frameworks and their implementation may differ among regions and provinces (Viet (2013)) Therefore, sub-national studies may have more advantages due to certain similarities in terms of political and legal framework and other aspects such as culture and language within a particular region (McCulloch, Malesky, & Duc, 2013), which may enable the studies to produce more relevant analytical results and policy recommendations therewith local governments can select and effectively implement the most efficient reform packages Following the footsteps of “giants” in the area of development economics such

as the recently named Nobel laureate, Angus Deaton, who proved that high-quality micro data can shed light on important development issues, this paper attempts to find answers to the question whether or not better institutions can improve economic performance at the firm-level by looking closely at how companies respond to changes in the Provincial Competitiveness Index (PCI) and their sub-indices

1.2 Research objectives

This study aims to:

(a) investigate the relationship between institutions and the performance of

manufacturing enterprises in 63 cities and provinces in Vietnam

(b) recommend appropriate institutional reforms to improve the business

environment based on findings from the research

1.3 Research questions

This study observes the impact of institutions on firm performance Applying quantitative research on a panel data of firms in the manufacturing sector in Vietnam and the PCI data, the thesis attempts to answer these two questions:

1 Do better institutions boost firm performance?

2 Which aspects of institutions, if improved, will serve as drivers for better economic performance at the firm-level?

1.4 Scope of the study

This study attempts to examine the impact of institutions on the economic performance of manufacturing companies in 63 cities and provinces in Vietnam Firm data

is taken from the Vietnam Enterprise Survey (VES) from 2007 to 2012 and the data on provincial institutions is garnered from the Provincial Competitiveness Index Surveys (PCI) Other macro data is extracted from the General Statistics Office’s reports

The study focuses on labor productivity as the main proxy of firm performance Capital productivity and two firm profitability ratios (ROA, ROE) are also used to reconfirm the results

1.5 The structure of the study

This study is presented in five main chapters, constructed as follows:

Chapter 1 briefly introduces the problem statement, research objectives and

research scope and data

Chapter 2 reviews the relevant literature and empirical studies on the relationship

between institutions and economic performance It introduces definitions of some key concepts and lists out main findings of prominent studies on this relationship by both foreign and local researchers

Chapter 3 presents the research methodology with discussions on data collection,

analysis and regression techniques to be used This chapter also provides details on the

conceptual framework, explains the variables and how they are measured

Chapter 4 briefly presents an overview of the business sector performance in

Vietnam, basic institutional reforms and their impacts on business performance and the

results with statistical descriptions of the data Findings are discussed here

Chapter 5 summarizes the main findings, recommend policy implementations and

outlines limitations as well as suggests directions for future researches

CHAPTER 2 LITERATURE REVIEW

2.1 Institutions

2.1.1 Definitions

Institutions, as defined by North (1981, p.201), are “a set of rules, compliance procedures and moral and ethical behavioral norms designed to constrain the behavior of individuals in the interests of maximizing the wealth or utility of principles” Also according to North (1990, p.3), institutions are “the rules of the game in a society or, more formally, are the humanly devised constraints that shape human interaction” Concurring with North’s view, Lin and Nugent (1995, p.2306) described institutions as “a set of humanly devised behavioral rules that govern and shape the interactions of human beings

in part by helping them to form expectations of what other people will do” There still remain different opinions on the definition of “institutions”; however, according to Chang (2006), most of the arguments support the important role of institutions on economic performance

It is necessary to distinguish between institutions and organizations Institutions are generally viewed to have a broader sense, being those which determine the environment in which organizations are established and operate Organizations such as firms and banks are more inclined to be goal-oriented economic actors (Ugur, 2010) Institutions may guide or constraint the choices and actions of organizations Focus on institutions means focus on governance quality and they have an impact on not only the economy as a whole but also individual organizations operating in it

North (1990a) distinguished between informal institutions and formal institutions and the new institutional economics focused largely on formal institutions; however, recent interest in the relationship between informal institutions and economic development has

been spotted Lauth (2005) obversed that there are three types of relationship between informal and formal institutions They can be complementary (coexisting and supporting each other), conflicting, or subsitutive (informal institutions do work while the other do not and vice versa)

Figure 1: Institutions

2.1.2 From institutions to governance

Governance is defined by the World Bank (1992) as “the manner in which power

is exercised in the management of a country’s economic and social resources for deveopment” and by the OECD as “the exercise of authority in government and the political arena” Linking the notions of governance and institutions, Huther and Shah (2005) defined governance as the “aspects of the exercise of authority through formal and informal institutions in the management of the resource endowment of a state.” Obviously, having good institutions are not enough Good institutions need to go in line with good governance to achieve expected outcomes of boosting development or growth Good governance can be assessed through various aspects: accountability (government officials’

www.gsdrc.org 8

Box 5 Examples of inclusive institutions

Universal: universal age-related state

pension; universal access to justice or services

Non-discriminatory: meritocratic

recruitment in the civil service; inheritance laws that protect widows’ land rights

Targeted: affirmative action to increase the

proportion of women political representatives; budget rules that prioritise investment in disadvantaged areas

Formal and informal institutions structure the distribution of opportunities, assets and resources in society For example, political settlements (usually an agreement among elites) establish the formal rules for managing political and economic relations (such as electoral processes, constitutions, and market regulations), as well as the informal division of power and resources (DFID, 2010a: 22) Powerful people and groups can shape institutions, making them inclusive or exclusive, for their own benefit and to maintain power (Jones, 2009: 11; World Bank, 2013a: 13; Goetz, 1997: 14; Leftwich & Sen, 2010: 24) In this way, institutions are both shaped by power relations and in turn act as ‘bottlenecks’ on acceptable forms of governance and the exercise of power (Wilson, 1997: 17)

Communities, families, economic relations and political governance are key institutional domains influencing development outcomes (see Figure 1) Together, these institutions determine the degree to which social relations are inclusive

Figure 1 Institutions governing development outcomes

Sources: Acemoglu & Robinson, 2012; Jones, 2009; Jütting et al., 2007;

Kabeer, 1994; Leftwich & Sen, 2010; Unsworth, 2010; World Bank, 2013a.

1.4 What do inclusive/exclusive institutions look like?

Inclusive institutions:

Bestow equal rights and entitlements, and

enable equal opportunities, voice and access

to resources and services

Are typically based on principles of universality, non-discrimination, or targeted action (see Box 5) Targeted action is needed where some people and groups are particularly disadvantaged, and therefore require differential treatment to achieve the equivalent outcomes

Communities and families

Rules and norms structuring the distribution of authority, assets and labour within the community and family, including rules on marriage, procreation, inheritance and parenting, and local decision-making and

Economic relations

Rules and norms determining the degree of regulation, rent-seeking and corruption in economic relations, shaping access to assets, property, employment and credit

actions must be subject to oversight to ensure they act with honesty and integrity), government effectiveness (good quality of policy formulation, capable civil servants and effective public services), regulatory quality (ability to create and enforce good policies and regulations that can promote the development of the private sector), rule of law (agents’ confidence in the legal system and abide by the laws and regulations), and others

2.2 Institutions and economic performance:

2.2.1 More definitions and clarifications

Nelson and Sampat (2001) pointed out three approaches explaining the impact of institutions on economic performance:

First, the “rule of the game” approach, as first put by Coase (1960) and later North (1990b), focuses on institutions’ impact on transactions among economic actors These

“rules of the game” enable predictability of behaviors of individuals or companies either from the angle of their likely actions or the probability of their compliance due to well-defined and enforced sanction rules, which facilitate contracting between these economic actors Transaction costs are significant and institutions can significantly influence economic performance in two main ways: first, reducing costs per transaction, and second, increasing the number of transactions (Wallis & North, 1986)

Second, the “governance structures” approach, as put forward first by Coase (1937) and later by Williamson (1975), emphasizes institutions’ role in enabling economic actors

to stay away from prisoners’ dilemma situations, for instance by guaranteeing property rights, and alleviating agency problems with well-defined governance standards

Third, institutions may promote cooperation among self-interested actors either businesses or individuals, by a decentralized way of resolving problems related to information and sanctioning (Axelrod & Reisine, 1984)

From the perspective of industries and firms, better institutions mean less uncertainty, lower transaction costs and higher volume of transactions Transaction costs include, but are not limited to, information costs, negotiating costs, contract-writing costs and others Better institutions also mean more effective and less costly enforcement of contracts and settlement of disputes as well as more secure property rights All these factors build companies’ confidence in the business environment and encourage them to invest or engage more in economic activities, offer more incentives to employ and efficiently exploit their resources

2.2.2 Institutions and economic performance: theoretical views

The impact of institutions on economic performance has long been mentioned by

well-known economists Adam (1776), in his highly acclaimed book Wealth of Nations,

commented “Commerce and manufacturers, in short, can seldom flourish in any state in which there is not a certain degree of confidence in the justice of government” Obviously, according to Smith, institutions are an important factor leading to better trade and industrial development This economist further explained that higher security level and lower expropriation risks are positively related with higher level of investment thus growth

The important role of institutions was somehow underestimated by neo-classical economics, which used a technical production function with two factors (capital and labor) and utility functions to explain economic growth However, this view faced certain challenges trying to explain the co-existence and interaction of non-market institutions and market institutions Moreover, this technical view was found unable to explain the reduction of economic activity due to unclear definition of property rights or weak contract enforcement rather than due to technical production function (Rodrik, 2000) This view also failed to explain the development gap between developing and developed countries as people, based on neoclassical view, may argue that scarcity means higher rates of return

on capital in developing countries and consequently attracts more capital which leads to

higher output and helps narrow the above-mentioned gap In reality, the “yet right” policies

in developing countries have somehow hindered the incoming inflow and mobilization of both foreign and domestic capital

Institutional perspective-guided researches were quite modest until the middle of 1980s, when Scully (1988) and Kormendi and Meguire (1985) published their papers on the relationship between institutions and cross-country investment and growth The liberalization reforms in late 1980s and 1990s painted a clearer picture of the role of institutions and proved that all countries, regardless of developing or developed, were both sensitive to price signals and price signal-related incentives could lead to increased welfare only when there were institutions in place that ensure the predictability of property rights, high contract enforceability and effective measures to reduce risks, resolve conflicts and solve moral hazard problems (Rodrik, 2000)

Which and how institutions impact on economic performance can be summarized

as follows (Aron, 2000; Rodrik, 2000):

i) Property rights institutions: These include norms and rules such as rule of law,

quality of law enforcement, risk of expropriation, and others These institutions lay the foundation for trust-building that will reduce the risks related to investment and contracting

as well as influence on economic actors’ decisions including those on savings and investment Johnson, McMillan, and Woodruff (2002) could obsserve that better property rights-related institutions increase the possibility of firms reinvesting their profits in the business Moreover, Yasar, Paul, and Ward (2011), using firm data in 52 countries to anyalyze the relationship between institutional quality and property rights institutions, concluded that better property rights institutions have a significantly positive impact on firm productivity

ii) Regulatory institutions: these are norms and regulations that can affect

economic performance by increasing the efficiency of public policies and preventing corporate actors from being involved in anti-competition, rent-seeking and free-riding activities These norms, rules and regulations manifest the level of independence of civil services from politicians and the accountability of policy makers and corporate actors towards the public and other stakeholders According to Krueger (1974), political rent-seeking, for example, is quite popular and defined as a process that involves activities including lobbying, cultivating and influencing government officials and judges to obtain better treatment such as winning huge government contracts or being given certain flexibility when it comes the enforcement of rules or standards These kinds of activities can create a rent for the businesses being favored and, at the same time, place more barriers for the others Without higher level of independence and accountability of government officials and policy makers, the unfair competition among economic factors, including firms and industries, remains and negatively hinders those who don’t have good political

connections

iii) Macroeconomic stabilization institutions: These institutions have an impact

on economic performance by way of reducing uncertainty and promoting sustainable growth By minimizing the probability of macroeconomic volatility and improving the economy’s resilience to external shocks, these institutions are believed to help reduce macroeconomic instability The efficiency of these institutions are reflected in the level of independence of the central bank, the budgetary process’s credibility and transparency The macroeconomic factors are beyond what corporate managers can do and this is the area where macroeconomic stabilization institutions should lend a helping hand The macroeconomic factors that may affect the economy, the industry and the firm include fluctuations in the inflation rate, interest rate, exchange rate, level of foreign direct

investment and many more These can only be fixed or adjusted through wise and sound fiscal and monetary policies and solutions by the government and its agencies

iv) Conflict resolution institutions: These norms and regulations affect the

economic performance in that they ensure internal security These are institutions that serve

to resolve conflicts, regardless of political, social or economic conflicts These address failures or disputes in the areas of coordination, distribution, violence, personal security,

and others These institutions, if well–enforced, can address the issue of distribution

failures, cooperation problems or the inclusion or exclusion of firms in the formal economy

In summary, institutions have two main effects on economic performance: market creating effect and market deepening effect

a) Market creating effect: the institutions can encourage and facilitate the growth

of markets where economic actors can engage in beneficial activities The high quality of institutions, as discussed above, will lower transaction costs and increase the volume of transactions and encourage economic actors to explore and engage in new areas

b) Market deepening effect: this effect reflects enhanced efficiency of the current

markets Once economic actors can feel the improvement in the quality of institutions and governance, they are more confident in good returns on the volume of contracts they engage in as this institutional improvement can minimize the risks of agency problems, market failures and coordination failures as well as reduce macroeconomic instability and the economy will be less likely to suffer from losses due to misallocation or distortion of scarce resources

The distinction between these two effects is useful in analyzing the impact of institutions; however, it should be well indicated that these two effects are not totally

separate They can co-exist within each channel described in the diagram below In the other direction, economic performance has also feedback effect on institutions For example, Dang (2013), using a dataset from the PCI survey and flow of FDI into Vietnam since the country joined the WTO, found that economic institutions across Vietnam are associated with the flow of FDI

This diagram visualizes the two above-mentioned types of institutions and their effects on economic performance Type 1 instutitions (including property rights institutions and conflict solving institutions) boost economic performance by enabling the creation of incentives that lead to a higher volume of contracts between economic actors This effect

is named market-creating effect Type 2 institutions (including macro stabilization institutions andn regulatory institutions), has a market-deeping effect These institutions faciliate economic actors to obtain better returns on the economic activities they engage in

Figure 2: A visual explanation of institutions and economic performance (Ugur, 2010):

2.2.3 Institutions and economic performance: empirical studies

The relationship between institutions and economic performance has been analyzed

in a growing empirical literature The bulk of the research, however, focuses more on proxy indicators of the business environment at the country level including, but not limited to, the level of economic freedom in a certain country (such as the Heritage Foundations’ Annual Report); competitiveness (the World Economic Forum’s Global Competitiveness Report); transparency (Transparency International’s country ratings); governance (Kaufmann, Kraay, & Zoido-Lobatón, 2000); and regulatory constraints (Botero, Djankov,

La Porta, & Lopez)

There is also a good number of empirical researches which used industry or firm level data to observe the links between institutions and economic performance Klapper and Love (2004), using firm-level corporate governance rankings of 14 new markets, found that the firm-level governance is lower in markets where the legal systems are weaker and that there is a high correlation between high corporate governance and operating performance as well as market valuation

A good number of studies, using firm-level data collected through well-designed surveys, mostly those conducted by the World Bank, confirmed the strong relationship between performance and institutional constraints: Maksimovic, Demirgüç-Kunt, and Ayyagari (2006), using firm-level survey data collected from 80 countries to observe which aspects of business environment that constraint firm growth, applying regressions and Directed Acyclic Graph methodology, found that political instability, crime and finance directly affect firm growth; Hallward‐Driemeier, Wallsten, and Xu (2006), using a large dataset of 1,500 firms in five Chinese cities to look at the links between ownership, regional investment climate and firm performance, highlighted the effect of investment climate on firm performance and stressed the necessity of using firm-level data to explore these

effects However, these empirical papers also called attention to the possibility of biased estimates because of omitted variables or errors in variables as well as the endogeneity of independent variables

Not few researchers directed their attention to the effect of institutional quality on firm performance, particularly firm’s productivity The operating environment, or institutions, can affect firm’s productivity through various channels: i) through incentive mechanisms that encourage more investment in R&D (Griffith, Harrison, & Van Reenen, 2004), speed up the process of convergence to leading economic actors’ productivity levels

in the domestic market (Bartelsman, Haskel, & Martin, 2008) and narrow the technology gap (Bloom, Schankerman, & Van Reenen, 2007); ii) through greater competition which enables good companies to acquire larger market shares (Eslava, Haltiwanger, Kugler, & Kugler, 2004; Foster, Haltiwanger, & Krizan, 2001), creates more opportunities for company owners to monitor managers by comparing their performances (Nalebuff & Stiglitz, 1983); moreover, a competitive environment is also where productivity improvement tends to generate higher profits and revenues (Aghion & Howitt, 1998) and competition may lead to more incentives for workers (Haskel & Sanchis, 1995); iii) through improved quality of market regulation: poor regulations may create unreasonable incentives that lower productivity (Bridgman, Qi, & Schmitz, 2009)

According to Aron (2000), Rodrik (2000), Loayza, Oviedo, and Serven (2005), and Bowen and De Clercq (2008), good institutions tend to associate with higher accumulation

of capital, both physical and human, encourage the adoption of good technologies and investment in the creation and transfer of knowledge and expertise

In Vietnam, since the introduction of the Provincial Competitiveness Index (PCI), which offers a good measurement of institutions at the provincial level, there have been a number of studies trying to explain the links between institutions and economic

performance, both at the macro and micro level, by utilizing this PCI To begin with, Malesky and Taussig (2009), using PCI and its sub-indices to examine the links between provincial institutions and business formalization, proved that better institutions enable entrepreneurs to be more confident in government policies and select the growth-oriented way of formality and also, better protection of property rights encourages the formalization

of businesses as they perceive less risks for their investment In another study, McCulloch

et al (2013), using the PCI to explain the relationship between provincial institutions, governance and the level of private investment in Vietnam, found that there is a strong correlation between the transparency and information access index and the level of investment, commenting that entrepreneurs are unlikely to decide to invest or expand their business if they cannot access to information about legal procedures and business opportunities Anh, Thai, and Thang (2007), analyzing the importance of legal local incentives in attracting FDI in 64 provinces between 2000 and 2005, concluded that there was a positive relationship between the investment environment and level of FDI attraction Tran, Grafton, and Kompas (2009), using the PCI and firm-level data (the Vietnam Enterprise Survey) in 2005 to examine the impact of institutional reforms on firm-level economic performance with labor productivity employed as a proxy for firm performance, found that the PCI can significantly explain the differences in firm-level performance across provinces and that “a 1% point improvement in government practice could increase the daily value-added of an average firm by an amount equivalent to nearly three times per capital GDP per day” T V Nguyen, Le, and Bryant (2013), also using the PCI and data from the Small and Medium Enterprises (SME) to examine the relationship between the institutions and firm performance, found that better institutions not only positively impact firm performance but also increase their competitiveness by pushing them towards effective developing strategies

However, there were also some studies investigating the relationship between institutions and economic performance which failed to find significant links between these factors, for example, Nguyen and Nguyen (2007), using the PCI to investigate the determinants of FDI inflows to Vietnam, found no significant correlation between institutions and FDI inflows McCulloch et al (2013) suggested that big amount of noise

in the firm-level data from the then surveys might be a reason for the insignificant results

2.3 Measurement of institutions:

As partly discussed above, institutions are usually measured through designed surveys, most popular are the World Bank’s Worldwide Governance Indicators (WGIs), World Bank’s Doing Business survey, World Economic Forums’ Global Competitiveness Report, Transparency International’s country ratings, and other regional and national surveys

In Vietnam, many researchers have used the Provincial Competitiveness Index, jointly produced by the U.S Agency for International Development (USAID)-funded Vietnam Competitiveness Initiative (VNCI) and Vietnam Chamber of Commerce and Industry; the Vietnam Provincial Governance and Public Administration Performance Index (PAPI), jointly surveyed and reported by the United National Development Program (UNDP) and the Center for Community Support Development Studies (CECODES); and the UNDP-supported Public Administration Reform Index (PARI)

2.4 Firm Performance

2.4.1 Definitions:

There is yet an all-agreed definition of firm performance even though this is a major theme in a large number of management researches and its status of being a common dependent variable (Richard, Devinney, Yip, & Johnson, 2009) Studies on firm

performance usually face challenges such as the lack of consensus, convenience-driven selection of indicators and ignorance of the multidimensionality of firm performance Based on the availability of data, many researchers chose to measure this performance with

a single indicator (Glick, Washburn, & Miller, 2005)

According to Venkatraman and Ramanujam (1987), corporate performance or, as used in this paper, firm performance is a multidimensional construct viewed from three categories: business performance, financial performance, and organizational effectiveness Business performance is a market or value-based measure and covers both operational and financial performance Indicators measuring business performance include market share, sales growth, product development, diversification, and others Financial performance is analyzed from the accounting perspective It measures firm profitability through indicators such as ROA (return on assets), ROE (return on equity), and ROS (return on sales) Organizational effectiveness measures performance through indicators such as quality, social responsibility and employee satisfaction

2.4.2 Measurement of firm performance:

This paper examines the relationship between institutions and firm performance with the latter being viewed from the productivity angle and profitability angle

Firm productivity: “productivity” reflects the efficiency of physical inputs being

converted into useful outputs Depending on the treatment of inputs and outputs, researchers can choose to utilize single-factor productivity ratios or multi-factor and total factor productivity ratios (Lieberman & Kang, 2008) In this study, the value added concept-based productivity measure is used, which means the difference between firm’s sales and its purchases of raw materials and outside services Due to the availability of data, labor productivity (output per unit of labor input) is calculated here Another single-factor productivity ratio, capital productivity (through the proxy of value added per unit of

capital) is also employed to reconfirm the relationship between institutions and firm performance

Firm profitability: ROA and ROE are calculated and serve as tools to reconfirm

results of the investigation of between institutions and firm performance with labor productivity being the main proxy

2.5 Analytical framework for the study

Figure 3: Analytical framework for the study

Source: Author’s self-summarized from literature review

From the literature review, a framework is summarized as above to paint a clearer picture of the relations to be examined in this paper On the left-hand side are Type 1 institutions, “the rules of the game”, which, within the PCI index, include sub-indices such

as Entry Costs, Land Access and Security of Tenure, Informal Charges, Legal Institutions, and Time Costs and Regulatory Compliance These institutions lay out the incentive and sanction framework based on which economic actors will know which actions are encouraged and which are not as well as the costs and benefits associated with these actions And this understanding will delineate the extent of economic actors’ investment and contract intensity These institutions have a “market-creating impact” on the firm performance

On the right-hand side are Type 2 institutions, “the governance structures”, which, within the PCI, are composed of Transparency and Access to Information, Proactivity of Provincial Leadership, Business Support Services, and Labor and Training These are supposed to enhance the “market creating” effect created by Type 1 institutions These help ensure economic actors will achieve higher returns on their economic operations, partly due to the high predictability of the governance mechanisms and better quality of public policies, which are believed to minimize uncertainties and risks

CHAPTER 3 RESEARCH METHODOLOGY

This chapter displays the theoretical framework to develop the model and discusses the data sources and filtering mechanism, data analysis and regression techniques

3.1 Data sources:

This paper utilizes two sets of data: the first one is a set of firm-level panel from the Vietnam Enterprise Survey (VES) between 2007 and 2012 and the second is the set of subnational institutional scores collected from the PCI surveys during the same period

3.1.1 Vietnam Enterprise Survey and Manufacturing Firms:

Vietnam Enterprise Survey (VES)

Conducted by the General Statistics Office of Vietnam (GSO) since 2000 on a yearly basis, VES is a fairly comprehensive survey covering all state and non-state enterprises and foreign invested enterprises in 63 provinces and cities in Vietnam The dataset contains information reflecting firm performance, ownership, employment, production situations, job training, and other details This survey is frequently employed to study about the business sector in Vietnam with its increasingly better quality and expanding samples

Figure 4: Number of firms surveyed from 2007-2012- Source: Vietnam Enterprise Survey

155.771 205.689 248.555 286.541 343.215

358.557

Number of observations

Manufacturing Firms

In 2011 and 2012, the survey recorded necessary indicators twice a year, on the first day of January and last day of December This study uses the indicators recorded at the year end Moreover, as mentioned in the research objective, the study observes the relationship between institutions and the performance of manufacturing firms in Vietnam, only data of manufacturing firms, which was fairly rich and categorized into 33 industries,

is used To have a fairly consistent panel data, much time has been spent on the filtering

process In this study, a unique code was created by adding four codes (id): madn + macs + nganh kd + year to eliminate overlapping data Box-plot rule was also applied to drop

outliers from the sample The final sample has 4,118 manufacturing firms with 14,242 observations

Table 1: Number of Firms and Observations in the sample

Source: Author’s self-calculation

It should be mentioned that when calculating the firm-level value added, which equals total sales minus intermediate inputs measured here as the cost of goods sold, the latter value (cost of goods sold) was not available in the surveyed data for the years 2007,

2008 and 2009 Therefore, I had to calculate the average ratio of value added over total sales of the following years with better data (2010, 2011, 2012) then multifly this ratio with

total sales of the years 2007, 2008 and 2009 to obtain estimated value added of these years each Data extracted from the VES is used to calculate dependent variables including labor productivity, capital productivity, return on assets and return on equity and a number of control variables such as the capital/labor ratio, firm size and firm types

3.1.2 Provincial Competitiveness Index (PCI)

First developed in 2005, the Provincial Competitiveness Index (PCI) was jointly produced by VNCI and VCCI in an effort to provide objective assessment of the quality of provincial institutions and governance Appraised by Oxford Policy Management’s Director for Economic Policy Neil McCulloch as “the single best sub-national governance index in the world”, the survey is conducted by mailing out questionaires to samples of firms, selected randomly, in each province The questions are designed to obtain firms perceptions of the quality of economic performance in their province as well as their specific experience of governance (See the tables and figures below, and appendices 1,2,3 more details)

Table 2: Number of Firms Surveyed by the PCI Research Team from 2007-2012

The PCI is constructed following three steps as described in the chart below with sub-indices standardized to a 10-point scale and the composite index estimated by weighting the mean of all sub-indices with a 100-point score

Figure 5: Collection, Construction and Calibration of PCI Data

Source: PCI’s Official Website

The sub-index weights slightly change over years and a typical sub-index weight table is as follows:

Table 3: Sub-Index Weights

Source: Provincial Competitiveness Index

By common perceptions, a well-performing province is one that has lower entry costs and informal charges, easier land acccess, better regulatory compliance, and so on, the PCI index has made it easier for researchers by calculating scores in ways that any province scores better on an index means it performs better in that area Here is a typical example:

Table 4: Explanation of PCI Rankings

Top and Bottom-Ranked Provinces in Each Sub-Index of PCI 2012

Source: The 2012 PCI Report

Data for the institutional variables of this study’s model was extracted from the PCI Index Other data characterizing two groups of control variables including firm-specific group such as firm size and firm ownership and provincial initial endowment group including GDP per capita, annual GDP growth rate, provincial industrial production index,

infrastructure index, educational level, population are extracted from the VES and the GSO’s statistical yearbooks

3.2 Model and variable construction

3.2.1 The Model:

This study employs a basic panel data model to analyse the relationship between institutions and firm performance with hypotheses that better institutions (higher PCI and sub-indices scores) are posilively related with better firm performance:

Yipt = β 0 + βXpt + δFipt + γPpt + εt

where:

Yipt is the firm performance (productivity/profitability) of firm i in province p in year t

Xpt is the explanatory variables (here are institutional variables) of province p in year t

Fipt is a vector of firm specific characteristics in province p in year t

Ppt is a vector of the provincial initial endowment in year t

εt is the error term

as proxy for firm performance is labor productivity, or value added per worker It is assumed that better institutions will catalyze higher labor productivity The capital productivity is at the same time measured to double check the results obtained from the

analysis of the institutions-labor productivity relationship Binswanger (1980) argued that institutions may have a substantial influence on the share of factors of production, particularly labor, in the output and distribution of income

& Kraemer, 2003) Firms are assumed to achieve higher returns on assets and equity once the business environment improves

Table 5: Firm-level Variable Definitions

ROAipt Income/Assets Assets = ½ (year beginning assets +

year-end assets) of firm i in province p in year t

Independent variables

Explanatory variables

LCpt PCI Sub-index: Land Access & Security of Tenure +

Control variables

SOEipt, Priipt,

Foript

Firm ownership: State-owned enterprises, Private, FDI

of province p in year t

+

Infra1pt

Number of fix phones to provincial population (%), a

proxy for provincial infrastructure quality (in year t)

the values of these variables (scores) are higher, this means institutions and governance are perceived to be better and thus firm performance is expected to improve (See appendix 1 and 2 for more details about these institutional variables)

3.2.2.3 Control Variables:

Capital to Labor Ratio

The fluctuation of this ratio may have a certain impact on firm performance This ratio is expectedly positively correlated with labor productivity (value added per worker) while negatively correlated with ROA and ROE (higher ratio means larger total assets)

Firm Size

This indicator is very often interpreted as the source of organization costs (Shepherd, 1972) This is also considered an indicator of diverification and was found to negatively affect performance (Rumelt & Wensley, 1981; Wernerfelt & Montgomery, 1988) The firm size here is measured by the average number of workers following Decree

No 56/2009/NĐ-CP dated June 30, 2009, which divides firms into three categories: Small (employing between 10 and 200 workers), Medium (200-300 workers) and Large (over

300 workers)

Firm Ownership

Firms here are divived into three groups by types of ownership: Private, Owned Entprises (SOE), and Foreign Invested Enterprises (FIE) Views of the relationship between firm ownership and firm performance are quite controversial among economists Boycko, Shleifer, and Vishny (1996) and Krueger (1990) argued that SOEs are less efficient than private enterprises because they are under pressure to employ more labor inputs than needed, and tend to employ politically-connected instead of truly qualified and capable people and these are also believed to pursue social and political objectives rather