Determinants of new firm formation The case of Vietnam.Determinants of new firm formation The case of Vietnam.Determinants of new firm formation The case of Vietnam.Determinants of new firm formation The case of Vietnam.Determinants of new firm formation The case of Vietnam.Determinants of new firm formation The case of Vietnam.
INTRODUCTION
Rationale of the thesis
The theory of the firm is fundamental to economics, emphasizing the significant role of new enterprises in economic development, particularly through competition Historically, economists have recognized that the entry of new competitors drives prices toward competitive levels, enhancing both technical and allocation efficiency Research indicates a positive correlation between the formation of new firms, productivity, and economic growth New businesses often emerge from innovative ideas, serving as a vital force for technical progress and market competition, thereby facilitating the commercialization of innovations.
The establishment of new firms is crucial for structural change, as it facilitates the reallocation of resources, leading to more efficient utilization This concept, supported by Schumpeter's theories from 1934 and 1942, emphasizes the importance of entrepreneurship in driving economic progress.
In recent decades, the formation of new firms has gained significant attention from researchers and policymakers, driven by the belief that it is a key factor in economic growth and development A robust economy not only relies on a healthy stock of existing businesses but also on a steady flow of new business creation Research indicates that low levels of business ownership can negatively impact economic growth, while new businesses are often more innovative and contribute significantly to job creation.
2014) Entrepreneurship is a key element of evolutionary economics (Schumpeter1934; Witt 1998; Grebel et al 2003; Metcalfe 2004; Grebel 2007) and has been
Regional economic development is significantly influenced by the formation of new firms, as highlighted by various studies (Acs and Armington 2004; Audretsch et al 2006; Fritsch 2008) Understanding the regional variations in entrepreneurship is crucial, especially given the notable disparities in entrepreneurship rates and their underlying factors both within and between countries (Bosma and Schutjens, 2008).
Most studies on the transition from a command to a market economy have primarily concentrated on the privatization of existing firms, overlooking the importance of new firm creation as a vital growth channel New firms stimulate competition, compelling established businesses to enhance their products and production methods Those unable to adapt will ultimately fail, leading to a survival-of-the-fittest scenario that drives economic growth This dynamic underscores the ongoing interest among researchers in this field, particularly following Birch's foundational work.
In 1979, the significance of small firm formation for employment generation was acknowledged, leading to new firm formation becoming a crucial subject for researchers and policymakers Subsequently, studies have focused on evaluating the factors influencing entrepreneurship, such as the business environment, institutional frameworks, and governmental roles.
When establishing a new enterprise, investors must consider various factors that influence business creation Understanding these determinants can aid local governments in recognizing their strengths and weaknesses This is why the topic "Determinants of New Firm Formation: The Case of Vietnam" has been chosen for a master's thesis, aiming to systematically analyze the key factors influencing business formation in Vietnam using the most recent data available The research findings will subsequently provide policy recommendations to assist the government in enhancing investment attraction strategies, ultimately increasing the number of active enterprises in Vietnam.
Object and objective of the thesis
This thesis investigates the key factors influencing new firm formation in Vietnam, focusing on the critical determinants that guide potential entrepreneurs in their decision to establish businesses By providing a comprehensive analysis of these factors, the study aims to enhance understanding of the entrepreneurial landscape in Vietnam and offers recommendations for policymakers to improve the business entry rate in the country.
What is the definition of new firm formation?
Why new firm formation is important to the development of a country?
What is the current situation of new firm formation in Vietnam?
What are the key factors affecting in new firm formation in Vietnam?
Which policy implications can be suggested in order to encourage new firm formation in Vietnam?
Methodology
This study examines the factors influencing new firm formation in Vietnam from 2015 to 2018, utilizing panel data models estimated through Pooled Ordinary Least Squares (POLS), random effects model (REM), and fixed effects model (FEM) To determine the most suitable estimation method, the author employed tests such as the Breusch and Pagan Lagrangian multiplier test and Hausman tests The analysis incorporates first-order lag for time-variant independent variables to address endogeneity issues The findings from the linear regression analysis will effectively highlight the key factors impacting new business establishment in Vietnam.
This dissertation employs secondary data from 63 provinces in Vietnam, sourced from publications and reports by the General Office of Statistics (GSO) as well as official government articles and websites.
Scope of the thesis
This study analyzes the determinants of new business formation in Vietnam from 2015 to 2018, focusing on key factors such as unemployment rate, population growth, population density, urbanization, income level, exit rate, foreign direct investment (FDI), mean establishment size (MES), and the Provincial Competitiveness Index (PCI).
Structure of the thesis
In detail, this dissertation is divided into five chapters as follows:
Chapter 1 – Introduction: Giving overview of the current context, introducing the necessity of the topic as well as the overall research method of this thesis General structure of the thesis is also included in this chapter.
Chapter 2 – Theoretical framework about new firm formation and literature review:
This section will focus on the theoretical framework surrounding new firm formation It will summarize existing literature on the determinants of new firm creation, drawing on empirical findings from global studies to identify key explanatory variables for model estimation Finally, the author will outline the research hypotheses that will be tested within the model.
Chapter 3 – Situation of new firm formation in Vietnam: This chapter applies qualitative methods to analyse the current situation of new firm formation in Vietnam Basing on these actual situations, this chapter also assesses intuitively the impact of new firm formation on Vietnam’s economic development during the aforementioned period.
Chapter 4 – The model and empirical results: Insights into the research method, the model, data collection and empirical results in the examined period through quantitative analysis The last part of this chapter illustrates the empirical results from the regression estimation of different models including POLS, REM and FEM by using econometrics software STATA.
Chapter 5 – Policy implications and conclusions: In this final chapter, after summing up all essential findings of the research based on the discussed regression results in chapter 4, some recommendations shall be suggested to help VietnameseGovernment as well as policymakers to promote the formation of new businesses,thereby stimulating the positive influences of new firm formation on economic development of Vietnam.
THEORETICAL FRAMEWORK ABOUT NEW FIRM
Overview about new firm formation
2.1.1 Definition of new firm formation
Enterprise creation involves the organization of new businesses by coordinating interdependent actions into coherent sequences that lead to meaningful outcomes This process typically unfolds in five stages: identifying business opportunities, defining the business concept, mobilizing resources, forming the enterprise, and launching the business However, these stages are dynamic and may not follow a linear progression, as entrepreneurs can abandon their efforts if they determine that their business ideas are unviable.
Enterprise creation involves the establishment of new organizations by coordinating ongoing interdependent actions into logical sequences that yield meaningful results This process typically unfolds in five distinct stages.
According to Bhave (1994), opportunity recognition is a crucial initial step that can occur before or after the decision to launch a new venture It arises when aspiring entrepreneurs identify unmet needs that are not adequately addressed by existing vendors In their quest to find solutions, they often discover that these needs are widespread, leading them to recognize viable business opportunities Conversely, the decision to start a business can also be triggered by personal or environmental disruptions, prompting entrepreneurs to perceive numerous opportunities, although they may only pursue a select few This process then involves aligning their knowledge, experience, skills, and resources with market demands.
In Stage 2, entrepreneurs clarify their business concepts to align with customer needs, as highlighted by Bhave (1994) This involves developing a business model that includes setting firm objectives, determining size, creating a vision, assessing risks, and defining success criteria (Ardichvilia et al., 2003; Morris et al., 2005) Entrepreneurs often document these elements in a business plan, either out of personal initiative or due to requirements from financial institutions (Honig & Karlsson, 2001) However, the actual impact of the business plan on project realization remains uncertain (Gasse et al.).
2004) although researchers tend to advocate several advantages for making business plans (Filion et al., 2009).
In Stage 3 of business realization, entrepreneurs must effectively mobilize essential resources, including organizational, technological, human, social, financial, and physical assets (Brush et al., 2001) Research indicates that successful entrepreneurs often work in teams composed of family, friends, or colleagues (Brush et al., 2001; Ruef et al., 2003; Aldrich et al., 2004) According to Ruef et al (2003), these teams typically consist of individuals with similar characteristics, enabling them to make collective decisions and navigate the challenges and successes of the business together.
In Stage 4 of establishing a start-up, entrepreneurs typically focus on creating their organization in a location that prioritizes quality of life, proximity to home, and adequate space, often opting for areas close to their residence or even their homes (Gasse et al., 2002; Borges et al., 2005) The choice of premises is influenced more by personal convenience than by regional advantages or access to research and development (Filion et al., 2006) Additionally, founders must develop an organizational structure for their business (Gartner, 1985), and once established, they can choose to operate informally or officially register the business as an enterprise (Schneider & Enste, 2000; Bennett, 2010).
Stage 5 marks the crucial moment when the organization is ready to launch the business The activities undertaken during this phase significantly influence the firm's future success, as highlighted by McMullan & Long (1990) and supported by research from Duquette-Labrecque et al.
Research by Filion et al (2005, 2006) indicates that the duration between decision-making and execution is longest for developing the first product, followed by making the first sale, and then hiring the first employee This variability in gestation periods highlights the significance of these milestones for entrepreneurs.
As the enterprise creation process is dynamic and case-specific, the previous stages do not necessarily occur in sequence (Bhave, 1994; Bruyat & Julien, 2001).
2.1.3 Measurement of new firm formation
Measuring the absolute number of new market entrants can be misleading due to the varying sizes of markets For instance, if one market has twice the number of new entrants as another but is also twice as large, it would be incorrect to conclude that entry activity is higher in the larger market To make meaningful comparisons across different market sizes, the absolute number of entrants must be standardized Two primary approaches for measuring and comparing entry activity across markets are the ecological approach and the labor market approach, as noted by Audretsch and Fritsch (1994b) Additionally, Storey (1991) categorized the literature on this topic into two distinct groups.
The traditional industrial organization theory focuses on how industrial structure affects the establishment of new enterprises It utilizes an industrial organization method to assess whether market structure facilitates or hinders the formation of new firms by calculating entry rates relative to the existing number of firms at the beginning of the period This approach, known as the ecological approach, considers entry activity in relation to the size of the existing business population It is widely used in industrial organization literature, where empirical studies seek to explain the significant variations in entry rates across different product markets.
The second research category focuses on labor market theory, linking annual firm formation to the number of employees within the same region, sector, and year By utilizing integrated data, this approach aims to identify factors that influence new firm creation and individual entrepreneurial decisions, particularly considering changes in an individual's labor market status The goal is to standardize the number of new entrants relative to workforce size, based on the premise that new entrepreneurs emerge from the existing labor pool This method draws on the entrepreneurial choice theory by Evans and Jovanovic (1989), positing that each new firm is founded by someone within the same labor market While acknowledging cross-market worker mobility, the labor market approach assumes that entrepreneurs typically gain prior experience as employees before launching their businesses.
Most empirical studies examining the determinants and economic impacts of regional entry rates utilize a labor market approach (Van Stel and Storey, 2004) This distinction highlights the conceptual difference between independent start-ups and subsidiaries of established firms Independent entry is influenced by the local workforce, while the formation of new subsidiaries correlates with the number of existing companies in the region Essentially, independent start-ups arise from the available labor pool, whereas new subsidiaries are generated from the existing stock of firms.
This thesis adopts the labor market approach to analyze a country's attitude towards entrepreneurship, grounded in the theory of entrepreneurial choice A key assumption of this approach is that entrepreneurs operate within the same labor market as their new firms Given that most new businesses are often established at home or nearby (Stam, 2009) and that new entrepreneurs typically possess regional work experience, this assumption is deemed valid.
2.1.4 The importance of new firm formation
New businesses entering an industry can significantly influence overall economic performance through both direct and indirect effects The direct effect involves the creation of new jobs within the newly established firms, while the indirect effects pertain to the impact these new entrants have on existing companies in the market.
2.1.4.1 Direct impacts of new firm formation on economic development
New businesses play a crucial role in economic development and community well-being, as they contribute to regional economic performance by increasing firm formation and local business stocks These enterprises enhance consumer choice, foster competition, and create jobs while being locally owned and committed to their communities Moreover, high rates of new business creation are associated with innovation, the development of new products, and the generation of employment opportunities, establishing a direct link to overall economic well-being.
Literature review about determinants of new firm formation
Extensive research has been conducted on the economic impact of new firm formation and the factors influencing it Different approaches to studying these determinants have led to various research methodologies Numerous theoretical models exist to explore a range of factors that can be tested in empirical studies to identify what drives new business creation This article focuses on nine key determinants of new firm formation in Vietnam: unemployment rate, population growth, population density, urbanization, income level, exit rate, foreign direct investment (FDI), mean establishment size (MES), and the Provincial Competitiveness Index (PCI).
Research indicates a complex relationship between new firm formation and unemployment, with conflicting findings in the literature While the unemployment rate is often seen as a key factor influencing firm creation, the effects can vary The recession-push hypothesis suggests that higher unemployment leads to reduced disposable income and local demand, ultimately hindering new business entries (Mocnik, 2010; Delfmann et al., 2014; Sutaria & Hicks, 2004; Fotopoulos, 2014; Audretsch & Fritsch, 1994) Supporting this view, studies by Tervo and Niitykangas (1994), Sutaria (2001), and Sutaria and Hicks (2004) show a negative correlation between regional firm formation and unemployment levels.
The second perspective posits that higher unemployment rates can drive individuals to start their own businesses as a means of securing employment, as the potential rewards of self-employment often exceed social allowances This necessity can lead to an increase in new business formation, as unemployed individuals seek alternatives to joblessness (Okamuro & Kobayashi, 2005) Research by Reynolds et al (1995) indicates that the inability to find jobs may push individuals towards entrepreneurship out of desperation, while Storey (1991) notes that high unemployment can elevate entry rates into new ventures Hamilton (1989) argues that the relationship between unemployment and new firm creation is not straightforward and may vary based on reaching certain unemployment thresholds Most studies utilizing interviews or surveys support the notion of a positive correlation between unemployment and new business formation (Binks and Jennings, 1986; Vivarelli, 1991), although some research, including Storey (1991) and Audretsch and Fritsch (1994), presents mixed findings, with Fritsch and Falck (2002) reporting no significant relationship.
Population change significantly impacts new firm formation by creating opportunities for economic activity as larger consumer markets emerge due to growing populations This demand for goods and services fosters new business prospects and encourages start-up activity Additionally, population growth can act as a push factor for individuals to engage in self-employment, as increased competition for jobs can lower opportunity costs While some studies have shown mixed results regarding this relationship, numerous research findings indicate a positive correlation between population growth and start-up rates Notably, research by Hathaway and Litan (2014) highlights that regions with higher population growth in the 1970s saw increased firm formation rates, contrasting with areas that experienced lower growth and firm formation.
A study conducted in 2004 revealed that population growth did not have a significant positive impact on the formation of new firms Nonetheless, the researchers acknowledged the limitations of their modeling approach, which may have failed to accurately reflect the anticipated positive correlation between population growth and new business creation.
Population density significantly influences the birth of new firms, with research indicating a positive correlation between urbanization, agglomeration, and firm formation rates (Reynolds et al., 1994; Audretsch & Fritsch, 1994) Urban areas with high population density exhibit a greater percentage of entrepreneurial activity (Bosma & Schutjens, 2011) However, once a region has fully capitalized on the advantages of urbanization, excessive population density may lead to adverse effects (Delfmann et al., 2014).
Research by various scholars, including Audretsch and Fritsch (1994) and Guesnier (1994), highlights the positive correlation between population density and new business formation, suggesting that increased population drives demand for goods and services, leading to higher rates of new firm creation Regions with dense populations benefit from improved access to diverse markets for capital, labor, and services, as noted by Fritsch and Mueller (2006) Most studies confirm this trend, with Gaygisiz and Koksal (2003) identifying population density as a key factor influencing new firm formation in Turkey's manufacturing sector Similarly, Guesnier (1994) found that France experienced higher firm formation rates in areas with greater population density, a finding echoed by Audretsch and Fritsch (1994) in Germany However, Garofoli (1994) presents an exception, indicating that population density does not significantly affect new business formation in Italy.
The degree of urbanization refers to the percentage of a region's population residing in urban areas, reflecting the benefits of dense living conditions that foster new business formation Urban regions offer entrepreneurs access to a diverse labor market, enhanced information exchange, and a wider variety of goods and services This diversity not only meets varied consumer demands but also encourages innovation, as more heterogeneous cities tend to support a higher rate of start-ups Additionally, densely populated areas provide favorable market entry conditions due to their proximity to consumers and well-developed business infrastructures.
Agglomeration effects significantly enhance new firm formation by increasing local market opportunities for consumers and essential inputs Firms located in densely populated areas benefit from lower transportation costs and proximity to suppliers and customers, which helps reduce costs and improve product quality Urbanization fosters a skilled workforce and accelerates the flow of ideas and knowledge Additionally, the risk of starting a business in urban environments is lower due to abundant employment opportunities that provide a safety net if the new venture does not succeed.
The impact of urbanization on the establishment of new businesses is debated, as increased urbanization can drive firms to seek economies of scale, allowing them to operate more efficiently and potentially reducing opportunities for smaller enterprises (Verheul et al., 2001).
Agglomeration can lead to adverse outcomes such as heightened competition, which may drive up wages and input costs, ultimately deterring new entrants into the market (Nyström, 2007) Additionally, research by Van Stel and Suddle (2008) indicates that in the Netherlands, service start-ups experience negative impacts due to their lower reliance on the advantages of agglomeration.
Income plays a dual role as both a demand and supply factor in entrepreneurship, as its growth not only increases demand but also enhances access to capital for aspiring business owners Verheul et al (2001) explore conflicting hypotheses regarding the impact of wages on start-up rates, with one suggesting that higher wages create greater opportunity costs for self-employment, leading to decreased new firm formation As salaries rise, employees are less inclined to leave their jobs to start their own businesses, while high income levels also contribute to increased labor costs for companies, potentially deterring market entry in sectors sensitive to these costs (Nystrom, 2007) Research by Santarelli et al (2009), Audretsch and Fritsch (1999), and Fotopoulos and Spence (1999) indicates a negative correlation between wages and new firm formation in developed countries, with Bosma et al (2008) highlighting the adverse effects of high employee hiring costs on self-employment.
The second hypothesis posits a positive correlation between high wages and start-up rates, indicating that higher income reflects a prosperous economy with better survival rates for new businesses Increased income levels in a region lead to heightened demand for various goods and services, thereby fostering entrepreneurial activity and encouraging new business ventures Research by Gaygisiz and Koksal (2003) and Cala and Arauzo-Carod (2010) suggests that low-income markets hinder demand growth and deter new firm entry Additionally, Butler and Herring (1991) found that individuals with higher family incomes tend to have better employment opportunities Further studies by Armington and Acs (2002) and Lee et al (2004) confirm a positive link between income growth and the emergence of new firms, while Reynolds et al (1995) established a relationship between personal wealth and firm formation.
Johnson and Parker (1996) discovered no correlation between exit rates and entry rates However, our findings reveal a significant positive effect of the previous year's exit rate on the current year's new firm formation This indicates that when firms exit the market, whether voluntarily or involuntarily, they contribute to the emergence of new businesses.
The dynamics of market competitiveness are influenced by the entry and exit of firms, with new entrants often bringing innovative products and services that better meet existing demand While the exit of firms can create a less competitive environment, making it easier for new businesses to enter, research indicates that the previous year's entry rate is a more significant predictor of current entry rates than the exit rate This trend suggests a momentum effect, where regions with recent business growth are likely to see continued new firm formation, whereas a high exit rate does not necessarily lead to an influx of new businesses in the following year.
Research hypotheses
Based on the theoretical and empirical studies, the thesis entails concepts and research hypotheses as follows:
Hypothesis H1: A region’s unemployment rate is positively related to its new firm formation rate.
In Vietnam, higher unemployment levels are anticipated to lead to an increase in new business startups, as unemployed individuals often turn to entrepreneurship as a viable alternative This trend is further supported by the ease of hiring labor for startup enterprises, which enhances the motivation to launch new ventures.
Hypothesis H2: A region’s population growth is positively related to its new firm formation rate.
Population growth acts as a dual factor in supply and demand, as it not only provides potential entrepreneurs but also boosts the demand for goods and services Consequently, it is anticipated that in Vietnam, the formation of new firms will be positively impacted by this population increase.
Hypothesis H3: A region’s population density is positively related to its new firm formation rate.
Improved access to diverse markets for capital, labor, and services encourages entrepreneurs to invest more in regions with high population density and economic activity Consequently, the author anticipates a positive correlation between population density and the formation of new firms in Vietnam.
Hypothesis H4: A region’s degree of urbanization is positively related to its new firm formation rate.
In Vietnam, urbanization positively influences new firm formation by providing better business infrastructure, reduced transportation costs, and enhanced opportunities for innovation compared to rural areas Furthermore, urban environments attract a more skilled workforce and facilitate the rapid exchange of ideas and knowledge, further driving entrepreneurial growth.
Hypothesis H5: A region’s income level is positively related to its new firm formation rate.
The author posits that higher income levels in Vietnam positively influence the rate of new firm formation, as increased regional income signifies greater demand for diverse goods and services, thereby stimulating entrepreneurial activity and encouraging new business startups.
Hypothesis H6: A region’s rate of firm exit is positively related to its new firm formation rate.
This thesis posits that higher exit rates of firms in Vietnam can stimulate the formation of new businesses As firms exit a market, competition diminishes, creating opportunities for new entrants Consequently, a less competitive environment fosters a more favorable landscape for new firms to establish themselves.
Hypothesis H7: A region’s FDI inflows is positively related to its new firm formation rate.
Foreign Direct Investment (FDI) inflows are anticipated to positively impact new firm formation in Vietnam This is due to multiple channels through which FDI encourages the establishment of domestic businesses Firstly, employees from foreign firms often transition to entrepreneurship by starting their own companies in the same or related sectors, utilizing the skills and knowledge gained during their employment Secondly, the presence of foreign firms can stimulate domestic market entry, fostering a competitive environment that benefits new local enterprises.
The "demonstration effect" occurs when domestic entrepreneurs learn from the successes and failures of foreign firms Additionally, foreign direct investment (FDI) can positively influence domestic market entry through vertical linkages Foreign firms often boost the demand for local inputs and intermediate goods, creating opportunities for new inputs in upstream industries (backward linkages) Furthermore, these firms can introduce higher quality inputs to domestic customers, thereby increasing demand in downstream industries (forward linkages) Collectively, these factors represent new business opportunities that can stimulate the entry of domestic firms, known as the demand creation effect.
Hypothesis H8: A region’s mean establishment size is positively related to its new firm formation rate.
In Vietnam, the author anticipates that the presence of large firms will positively influence the establishment of new businesses This is primarily because small firms often rely on larger companies for support New enterprises are likely to be drawn to areas with significant large firms to supply goods and services, as well as to take on various jobs that the larger companies find inefficient to handle internally.
Hypothesis H9: A region’s PCI is positively related to its new firm formation rate.
Provinces with a higher Provincial Competitiveness Index (PCI) often see a surge in newly established businesses, as a strong PCI indicates a favorable business environment and effective governance The confidence in public authorities' transparency encourages firms to invest, leading to an increase in new business formations Consequently, there is an anticipated positive correlation between PCI and the number of newly established enterprises.
PCI and the rate of new firm formation in Vietnam.