Which are determinants of firm innovation in vietnam a micro analysis

A Micro Analysis LE THI NGOC BICHPost and Telecommunication Institute of Technology - bichltn@ptit.edu.vn VU TRONG PHONGPost and Telecommunication Institute of Technology LE THI NGOC DIE

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Which are Determinants of Firm Innovation

in Vietnam? A Micro Analysis

LE THI NGOC BICHPost and Telecommunication Institute of Technology - bichltn@ptit.edu.vn

VU TRONG PHONGPost and Telecommunication Institute of Technology

LE THI NGOC DIEPPost and Telecommunication Institute of Technology

Abstract

This study sets out to investigate factors influencing Vietnam firms’ innovation

in various sectors by using World Bank (2015) enterprise survey for 996 firms across the country We employ simple ordinary least squares (OLS), probit model, and marginal effect to estimate the impact of firm characteristics, industry characteristics, and business climate on different facets of innovation, including technology and non-technology Quantitatively, we find that direct exporters, firm size, state ownership, email using, and competition increase the probability

of technology innovation Meanwhile, foreign ownership impacts negatively on innovation in all aspects, technology and non-technology innovation Firm age and bribery are not influential factors in innovation in all cases From the findings

of analysis, a few policy implications regarding the studied factors are drawn for better environment for firm innovation.

Keyword: determinants of innovation; direct export; foreign ownership;

technology innovation;

non-technology innovation

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1 Introduction

Vietnam, according to World Bank, is assessed as a developmentsuccess story After the reforms launched in 1986, Vietnam has maderemarkable progress, transformed from one of the poorest countries to alower middle income country with per capita income of $1960 by the end

of 2013 Vietnam’s growth rate has been around 6.4% per year onaverage for the last decade Besides that, Vietnam has been successful inreducing poverty, the people living in poverty decreased fromapproximately 60% in 1990s to below 10% recently However, theeconomic growth remains moderate, below its potentials and relies mostly

on physical capital, natural resources and cheap labor The power of thesesources is diminishing and Vietnam is likely to face the so-called middleincome trap To boost its economy and develop sustainably, it is time forVietnam to make innovation become the drive for productivity gains,especially when the nation is facing fierce competition in globalizingmarkets

The nation has recently accomplished certain improvements in innovativefield, yet it still lagged far behind developed countries According to GlobalInnovation Index (GII), which is annually co - published by the WorldIntellectual Property Organisation, US- based Cornell University and France

– based INSEAD business school, the country ranked 71st and 76th out of

141 countries in 2013 and 2014, respectively In 2015, Vietnam wasamong a group of countries that upgraded their innovation performanceranking compared to 2014, stood at 52nd out of 141 economiesworldwide, improved 19 places from 2014

The improvement in GII can be a good sign for the upgrade ofinnovation in Vietnam; nevertheless, it reflects only a part of the wholepicture for Vietnam situation It is undeniable that innovation in bothprivate and public sectors in Vietnam is only emerging and still has a lot ofroom for improvement Capability of innovation is weak and the nationalinnovation system is uncoordinated and fragmented In the businesssector, research and development is not aware properly and facesresistant obstacles, while in the public sector it seems to work inefficientlyalthough receiving specific privileges

World Bank (2014), in its analysis on Vietnam’ science, technology andinnovation (STI) system, highlights strengths and weaknesses of thecountry Accordingly, there are some advantages for STI such as strongeconomic performance, geographical location, sizeable labor force orcertain achievement in basic education However, like many otherdeveloping countries, there are still many existing problems deterringVietnam from the development of STI The resistant weaknesses includeinfrastructure deficiencies, inefficient education system, limited access tofinance for enterprises, and inadequate STI government arrangements andpolicy implementation

To have further understanding about these strengths and weaknesses,this study aims to investigate empirically the factors influencinginnovative activities of Vietnam enterprises from different aspects,technological and non – technological innovation Using firm – level data

set, the findings was intended to draw insights into the deterrents ofinnovation in order to find possible

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suggestions for policies The paper will point out impacts of each element

on innovation with empirical evidences, which will be persuasive clues forfurther implication to help government and other stakeholders know where

to target their efforts in an attempt to provide favorable condition forinnovation

The remainder of the paper is structured as follows Section 2 reviewsliterature on innovation Section 3 describes methodology and data used

in the study Section 4 presents the findings and discussion of the results,while Section 5 gives implication and conclusion

2 Literature review

Literature presents different views on measurement of innovation andinnovation determinants In general, innovation is still an ambiguousconcept with different definition and there are many controversial opinions

on its determinants

Schumpeter (1942) shaped the theoretical framework for innovation,divided innovation into five types: (1) launch of a new product or a newspecies of existing product; (2) application of new methods in production orsales of a product; (3) opening of a new market (the market for which abranch of the industry was not yet represented); (4) acquiring of new sources

of supply of raw material or semi- finished goods; (5) new industry structuresuch as the creation or destruction of a monopoly position He claimed thatthere is a trade-off between innovation and market power of large firms Inother words, to have a rapid technology progress, we must be willing toaccept imperfectly competitive markets for the reason that in perfectcompetitive market, where firms produce and sell the same products, there is

no incentive to innovate In contrast, innovative activity is more likely to befavored by large firms and high concentration in imperfectly competitivemarkets

To examine Schumpeter’ hypothesis, Symeonidis and George (1996)reviewed many empirical works on the relationship between innovation,market structure and firm size and sum up: the idea that market powerand large firms stimulate innovation is found inconsistent Precisely, thispositive relationship can occur when certain conditions are met, such assunk cost per individual project, economies of scale and scope in theproduction of innovation rent

More recently, Wan et al (2005) employed data from 71 companies inSingapore and study innovation in more complex and broad context, as aprocess of generation, adoption and implementation of new ideas orpractices The findings show the positive linkage between innovation andfive elements, namely decentralized structure, presence of organizationalresources, belief that innovation is important, willingness to take risks andwillingness to exchange ideas

Almeida and Fernandes (2007) studied the corelation between opennessand technological innovation by employing firm- level data in developingcountries They considered technological innovation in terms of whetherfirms introduce new technology that substantially improves the production

of its main product in the last three years to the surveyed time The resultsshowed that firms involving in international trade, export and import, aremore likely to adopt new technology.

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Moreover, it found that majority foreign – owned firms tend to involved ininnovative activity more than minority foreign – owned firms or domesticfirms

Defining innovation as activities related to improvement of productionand/or process, Lee (2004) examineed linkage of innovation withcharacteristics of firms and industry in Malaysian manufacturing sector.The findings suggested that firm size is positively related to innovationbecause large firms have more chance to access to substantial resourcesand have greater capacity to innovate Furthermore, ownership structurealso impacts innovative activity due to its determination on financeresource through equity market Accordingly, sole proprietorship firms areless innovative than private limited and public limited firms Unlike RitaAlmeida and Ana Margaria Fernandes (2007), this study found the lessinnovative tendency in firms exporting, explained by the overwhelmingpresence of firms with no exports in data

For Vietnam, there are also studies on innovation, but they are stilllimited in quantity and detailed analysis For instance, Nguyen et al.(2013) give a diagnostic overall review on national innovation systems,analyzing strengths and weaknesses of the institutions, policies andlinkages that characterize the country’s national innovation systems.When it comes to empirical research, there are few papers giving insights

on innovative activities of Vietnam enterprises on the whole anddeterminants of innovation in particular Therefore, this paper will takeinitiatives in giving empirical evidences for the case of Vietnam firms,which is likely to imply meaningful advices for government and enterprises

to act and change situation positively

In order to analyze innovation in various facets, we take a clear andbroad view of World Bank (2004) as the main reference for theunderstanding of innovation This study suggests that innovation shouldcover not only “technology innovation” which is defined as the diffusion ofnew products and services, but also non – technological forms ofinnovation The latter can be the introduction of new management ormarketing techniques, the adoption of new supply or logisticarrangements, or improved approaches to internal or externalcommunication and positions Accordingly, this study will examine variousaspects of innovation, namely (1) whether firms have new or significantlyimproved products or services; (2) whether firms have new or significantimproved method of manufacturing or offering services and (3) whetherfirms have new organizational structure or management practice

Regarding innovation atmosphere in developing countries like Vietnam,aforementioned study pointed out that firms are deterred from innovation byweakness of three important elements, including levels of educationalattainment, the business environment and infrastructure Different phases ofindustrialization require different educational needs, from basic literacy totertiary education and these economies fail in matching education and labordemand The quality of business environment can be measured bygovernance conditions, values and cultural specificities which can causeobstacles for business operation in these countries Finally, the issue of

infrastructure in developing world relates to the troubles in telephoneinfrastructure, transport infrastructure and

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other primary components such as sanitation, water or electricity Thesecommon deterrents, nevertheless, seem to be neglected in previousstudies, probably due to the fact that they are not problems for operation

of enterprises in those countries

In an attempt to deal with shortcomings in previous studies and depictprecisely the case of Vietnam, this study will capture not only impact ofconventional elements on firm and industry characteristics, but alsoinnovation – climate - factors which are highly likely to be obstacles forfirm innovative activities in three mentioned aspects Our study takes onvarious problems of this issue and hence represents a real value addition

in this are of literature as well as imply valuable suggestions to relatedactors

3 Methodology and data

3.1 Empirical strategy

This study uses quantitative statistical techniques to examine the WorldBank Enterprise Survey (2015) for Vietnam using the Stata software Theempirical estimation employs probit model with marginal effect in order toanalyse the factors that may influence engagement of firms to innovativeactivity, with the assumption on the normal distribution of error terms.The dependent variable for innovation is binary, equal to 1 if firmsinnovate and 0 otherwise As mentioned in section 2, innovation isconsidered in three perspectives in three respective models: new orsignificantly improved product or service (model 1), new or significantlyimproved method of manufacturing product or offering services (model 2)and new or significantly improved organizational structures ormanagement practices (model 3) Precisely, in model 1 for the aspect ofinnovation in product/ services, dependent variable for innovation is equal

to 1 if firms have new or significantly improved product or service in lastthree years and equal to 0 otherwise Similarly, in model 2 which considersinnovation as improvement in method or process, dependent variable isequal to 1 if firms have new or significantly improved method ofmanufacturing or offering of services in last three years Finally, whenexamining innovation in terms of changes in organization or management

in model 3, dependent value for firms having new or significantly improvedorganizational structures or management practices is equal to 1 and 0otherwise

Explanatory variables are divided into three groups, firm characteristics,industry features and business climate of country, equivalent to threeestimation steps for each measurement of technological and non-technological innovation The propensity of innovation in three aspects isexplained by independent variables indicating firm characteristics in thefirst step, supplementary industry features in the second and businessclimate in the third

Following findings from previous papers on the relation of openness andinnovative activity, this study considers the difference in the innovationpattern between firms engaging in direct export and the counterparts that are

firms selling domestically or exporting indirectly Variable for openness isequal to 1 if firm exports directly and 0 if not The results will check oncommon expectation that

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firms exporting directly are more likely to be engaged in innovativeactivity comparing with firms selling products domestically

Firm age, presenting by the number of year firms operated up to 2015,

is deemed to be an element affecting innovation since the operating timemay influence firms in many ways such as competence of employees,managerial skills of managers or relation with government officials Firmsexisting longer may have better conditions for innovation, but it could beanother way around if new entrants tend to be more creative to penetratemarket

Another element is firm size which is added to see the different pattern

in innovation of small, medium and large firms Those having less than 20employees are classified as small firms while medium firms are thosehaving from 20 to 99 employees and firms with 100 employees or moreare seen as large ones The number of workers can reflect humanresource of firms and potentially cause specific patterns in organization ormanagement of firms Small and large firms may have no difference intechnological innovative activities, but the difference in number ofemployees requires different improvement in non – technologicalinnovation

Additionally, three models consider foreign ownership of firms sincephysical capital from oversea investors is more likely to cause certainadvantages in technology and availability of physical capital, compared todomestic firms More precise, the former tends to have financial sourceand up – to – date technology from outside border, which is favorable forinnovative performance in comparison with the later In the survey, firmsreported the percentage of capital owned by foreign privates,organizations or companies and concrete values will be used to show thedifference in propensity of innovation for each percent increase of foreigncapital

In addition, government ownership is also considered in the model for thereason that state - owned companies in Vietnam may have more privileges infinance or legal procedures than private ones Like foreign ownership, firmswere asked the percentage of capital owned by state organization andconcrete values of state owned capital are employed to see the discrepancy

in innovation probability in company with one percent change of government

- owned physical capital

The final element for firm characteristics should be taken into account isthe role of internet to innovation of firms Normally, firms employinginternet in operation is more likely to be active and innovative than non -users To see the effect of internet on innovative activity, the model willcompare the innovative pattern of firms using email and firms not.Similarly, internet users are expected to be engaged in innovative activitymore than non – users The variable for email using is represented bydummy variable, equal 1 if firms use email and 0 otherwise Thecoefficient is expected to be positive, implying advantages of internet toinnovative activity

In the second step, independent variables of industry characteristics isadded to the model together with firm characteristics, presenting by

dummy variables for group of industries in which firms are operating sincedifferent industries have different features in technology and innovation.For example, low – technology sectors such as food or textiles is less likely

to innovate than high –

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technology ones such as machinery because the later has moresophisticated products and needs continuous improvement to compete inthe market Nevertheless, opposite tendency can be true that the low –technology industries are more likely to innovate since theirunsophisticated products such as flavor of foods or design of textileproducts may be easier to improve The answer for the difference ofindustries will be investigated among 3 groups of sectors, namely low -technology sectors, medium -technology sectors and services which areclassified based on R&D intensities of OECD Directorate for Science,Technology and Industry (2011) Accordingly, low technology sectorinclude firms operating in the industries of food, textiles and garments,wood and furniture Meidum – technology sector includes firms ofmachinery and chemicals, metal, and some of wood and furniture Servicesectors are the remaining industries, including services in construction,sales, hospitality, transport, etc

Moreover, when considering industry characteristics, this study intends

to investigate the role of market competition in boosting innovation offirms with the hypothesis that firms will have more incentives to innovatewhen they have to compete with others Due to the lack of data formeasuring the degree of competition, this study employs availableinformation from survey in which firms were asked whether they competeagainst unregistered or informal firms The variable value is 1 for “yes”answers and 0 for “no” The positive value of estimator impliesadvantageous role of competition to innovation

In the third step, to find out the impact of business climate on innovation,variable relating to governance is added to the model In fact, weakgorvernmenternance, especially beaucratical system and legal regulations,causes many obstacles for Vietnam enterprises Corruption can be used as ameasurement for this weakness due to the fact that whengorvernmenternance is inefficient, firms are more likely to be forced to paybribe to get things done In the survey, firms were asked to evaluatesubjectively how much obstacles caused by corruption they have, usingscales from 0 to 4, equivalent respectively to no obstacle, minor obstacle,moderate obstacle, major obstacle and very severe obstacle In order tocompare the difference in innovation of firms facing obstacles in bribery andfirms without, dummy variable for corruption will be used in the model, equals

to 1 if firms have any obstacle from minor to very severe scales and equals to

0 if firms reported without obstacle It is expected that firm reported havingobstacle with corruption is likely to have less innovative activity, i.e, thevariable for corruption is anticipated to be negative and significantstatistically

In conclusion, the equation used in empirical study for firm i in sector j isdepicted as:

Step 1:

Innov ij = X ij ’ β + ε ij

Innovij is dummy variable to measure innovation of firms in threeaspects, equivalent to three models: new or significantly improved product

or services (model 1); new or significantly improved method ofmanufacturing or offering services (model 2); new or significantlyimproved organizational structure or management practices (model3).

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X’ is the vector of independent variables representing firm characteristics,including export, foreign factor, gorvernmenternment factor, firm age, firmsize and the use of email

εij is the error term which is assumed to be distributed normally withmean zero and constant variance

to yield data that are comparable across the world’s economies Thequestionnaire was divided into two parts: the first one comprising of 7sections covers firm characteristics on the business and the investmentclimate such as sales and supplies, infrastructure and services, degree ofcompetition, business government relations, investment climateconstraints; the second with 3 sections deals with facts and figures related

to finance, labor and productivity Additionally, information about capacitysuch as use of production capacity and hours of operation was surveyed inmanufacturing enterprises

Table 1

Variables and summary statistic description

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Source: own calculation from World Bank Enterprise Surveys for Vietnam; 2015

The 2015 data is the most up – to – date collection which had theparticipation of 996 enterprises from various industries in Vietnam Thesurvey was implemented between November 2014 and April 2016 withmore improved questionnaires than ones used in 2009 and 2011 Thenumber of observations of some variables used in this study may be lessthan the total sample due to the lack of data of some enterprises (Table1)

The numbers of firms by key background characteristics are generatedfor qualitative analysis in attempt to draw insights into the interactionbetween different characteristics (Table 2) Table 2 shows that amongfirms reported on innovation in three aspects, there are 304 firms changedtheir in products/ services (equivalent to approximately 30.8% of totalfirms), 319 firms improved method of manufacturing or offering services(equal to 32.3%) and 306 firms innovated in organizational structures ormanagement practices (equal to 30.9%)

Each aspect of innovation is classified by different characteristics Fordirect export, number of non – exporters overwhelms the counterpartsthat are exporters Amongst exporting firms, around 40% are innovativefor each innovation aspects, while innovative firms in non – export groupaccounts for only about 28% This preliminary descriptive finding mayimply positive relationship between direct export and probability ofinnovation

Table 2 does not show any significant difference in distribution of firmsamong size groups, small, medium, and large firms

The analysis of firms by foreign ownership and state ownership revealsthat the proportions of foreign firms and state firms overpass that ofdomestic and private ones In addition, among studied foreign companies,the percentage of innovative firms is less than that of firms withoutinnovation, comprising of about 26% Meanwhile, the proportion ofinnovative firms fluctuates in different aspects of state – owned