INTRODUCTION

I. THE RELEVANCE OF THE THESIS

Private sector development has really moved to center of economic development strategies in transition and developing countries since early 1980s. The increased attention given to the private sector reflects growing recognition of the inefficiency of many state-owned enterprises and the cost of government failures. The need to reduce the size of the state sector and to foster private sector development as the engine of economic growth now receives increasingly substantive attention by many national leaders.

Vietnam has started the transition from a central planned economy to a market oriented one during the mid-1980s. A major objective of the transition is to reactivate and develop the private sector within a multi-sector structure economy. Government has issued several new laws and policies to create the enabling environment for the private sector to engage in business. The successes of the private sector in agriculture, trade and services, as well as some light industry sub-sectors, in the initial period of reform are indicative of the considerable potential for rapid growth. However, the output growth rate of the private sector has lagged behind that of the state sector. In addition, the development of this sector in recent years has tended to worsen. The crucial factors to this situation are inefficiency of enabling macroeconomic environment and distortions of incentive structures due to institutional constraints. In fact, the private sector has not received the same encouragement given by the government to the state and foreign invested sector. This suggests that improving incentives or at least reducing disincentives is necessary for Vietnamese private sector to develop. 

II. OBJECTIVES, SCOPE AND FOCUS OR THE THESIS

This thesis is an attempt to identify the factors of government policy and institutional structure that affect the performance of the private sector, and to analyze policy implications for improvement of incentives to Vietnamese private sector during period 1986-1998.  

In practice, several studies in recent years have restricted attention to performance of private manufacturing enterprises. Others have been interested in the impacts of institutional weakness on private sector development. However, with limited data, short concerning period, and limited scope, the former authors have not reflected the performance and trend of the private sector and examined fully the impacts of policy at present period. To analyze deeply the impacts and implications of government policies on incentives of private sector in Vietnam, the thesis not only deals with the problems of the macroeconomic policies and legal framework but also includes the problems of informal constraints. With more update data and more concerned aspects, the author hopes to provide a deeper analysis on policy implications to improve incentives to private sector in Vietnam. However, the informal business activities are out of the focus of the thesis. The thesis only focus on external incentives which related to government policies, thus internal incentives which originated from structure of the enterprises are not concerned. 

III. RESEARCH QUESTIONS

1.     The necessity of private sector development in Vietnam?

2.      Has the growth of Vietnamese private sector been below the potential?

3.     Does the state sector “crowd out” the private sector? If so, how?

4.     What institutional weakness and distortions deter private sector development?

5.     How to improve incentives to Vietnamese private sector development?

IV. DATA AND RESEARCH METHODS

The thesis employs comparative, logical, inferential and econometric methods to deal with the research questions. For quantitative analysis, some regression equations are introduced to test the statistical significance of concerning policy variables on private investment. The thesis collected data from official sources of GSO, WB, UNDP, CIEM, and MPI.

V. THE STRUCTURE OF THE THESIS

The thesis consists of an introduction and four chapters

Chapter 1 discusses various theories, which concerned with private sector development over the world and incentives to private sector development in transiting and developing countries.  This chapter justifies the use of the neoclassical theory and the institutional theory as analytical framework of Vietnam.

Chapter 2 presents private sector performance to demonstrate its role and potential in economic growth; reviews the macroeconomic and regulatory policies which Vietnamese government has done to create enable environment for private sector engage in business. This chapter tests the crowding out effects of the state sector on the private sector to identify the importance of further reform.

Chapter 3 suggests some present obstacles to the development of Vietnamese private sector. This chapter interested in institutional weaknesses and distortions of the private sector in both aspects of formal and informal constraints.  

Chapter 4 reviews the main findings of the previous chapters and presents some policy recommendations for further promote Vietnamese private sector development.

 

CHAPTER 1: THEORETICAL FRAMEWORK OF PRIVATE SECTOR DEVELOPMENT

 

I. PRIVATE SECTOR IN ECONOMICS OF DEVELOPMENT

1.     Free market- classical viewpoints

It is argued that in a competitive market, the private sector has incentives to innovate and take advantage of new profitable opportunities. The private individuals and firms are both owners and managers of their property, and the owners-managers hire labor and enjoy powerfully autonomy. The threat of competition forces private enterprises to be efficient in both dimensions of allocative efficiency and productive efficiency. However, free market goes along with the market failure such as: asymmetric information, monopoly, and social cost, which provide some economic justification for political intervention in the market place.

 

2.     Statist viewpoints

These viewpoints founded on public ownership and central planned mechanism. With the objects of correcting market failures, the governments control market place fully by macroeconomic policies and participate directly in economic activities in the form of nationalized industries, public enterprises, and public investment programs. However, this theory is criticized due to governmental failures and public enterprise inefficiencies.  

3.     Neoclassical- minimal government viewpoints

Three crucial features of this theory are: (1) a free or neutral trade regime is governed by (2) a market-determined price environment in which (3) the state rejects the directive mantle for that of the stagehand, the state should primarily rely on market base, private sector drives initiatives in the mobilization and allocation of resources to growth promoting activities. The state should provide a stable and predictable macroeconomic environment through appropriate coordination of fiscal, monetary and exchange rate policies. Moreover, the state should provide pure public goods such as law and order, national defense, and public infrastructure. This viewpoint has strongly influenced many countries over the world since 1980s. However, the empirical evidences of the East Asian countries suggest that private sector’s success has been associated with governmental regulations, which somewhere felled out the neoclassical claims. In Vietnam, private sector developed dramatically in early reform but tended to decline even deeper decentralization and liberalization. This suggested neoclassical theory could not explain the economic performance of all countries fully.

4.     Neostatist viewpoints

It is argued that a developmental state (1) is able to resist the myopic interests and rent-seeking activities by various social groups, and to overcome the problems of collective actions; (2) is able to develop and to implement a program of national development; (3) can mobilize necessary physical and human resources for economic progress; (4) is able to manage the external environment, controlling foreign access to domestic political and economic arenas.

However, to satisfy the claims of developmental state is impossible for transitional countries. In these countries, the problems of bureaucracy, corruption, and adverse selections, shortage legal framework, weak contract enforcement, and poor legal acknowledgement may exclude good effects from the state intervention but retain government failures.

5.     Institutional viewpoints

This theory argues that the market is itself an institution, comprising a host of subsidiary institution, and interactive with other institutions in society. Market transactions involve costs of research, information, negotiation, contracting, policing and enforcement. Market exchange and governing costs are generally characterized as a transaction costs. If transaction costs are high, market failures or government failures-generally characterized as institutional failures-may results. Thus, institutional development characterized by declining costs of transactions.

Institutional theory may be useful for transition economies to analyze the economic performance. In these countries, the elements of both the central planned and market economy are existing; the old institutions and property relationship are being absorbed by the new economic system. Thus, the effects of institutional structure on private sector are inevitable tension.

II. THE DEVELOPMENTAL IMPACTS OF THE PRIVATE SECTOR

Encouraging private sector development in developing countries aims a number of goals namely: promoting efficient economic growth; creating jobs and incomes; raising accountability of political systems and labor standards; using better of both human and physical resources; expanding private investment, allowing public investment resources gradually to focus on social areas and infrastructure; and promoting foreign capital inflows and technology transfer.

In Vietnam, private sector development is further significance. First, it allows exploiting and using the nation’s potential resources by operation of small-medium enterprises. Second, it absorbs labor from reformed state-owned enterprises and generates employment for new entry labor force. Third, it fulfills in the business sector that requires small capital and low return. The last, it encourages traditional handicraft activities, which invest mainly in rural areas, reduces imbalance between rural and urban and meanwhile maintains traditional jobs as cultural features.

III. THE INCENTIVE FACTORS OF PRIVATE SECTOR DEVELOPMENT

There are at least six conditions for private sector development in transition economies. First, the private sector must be wholly and truly liberalized. It means that the freedom to establish new firms and to enter new areas of production; prices must be freely contracted between buyer and seller; and private sector must be unrestricted right to entry and act in all markets namely real estate market, labor market, capital market, foreign trade market, foreign exchange market and so on. Second, the enforcement of private contracts must be guaranteed by law. Third, the absolute security of private property should be emphatically declared. Fourth, the tax system should not restrain private investment. Fifth, private investment as well as the formation and growth of private capital must be promoted through credit. And the sixth, social respect must be developed toward the private sector.

In practice, many transition and developing countries have been undertaking structural reforms to encourage private sector development. These efforts focus on macroeconomic policies, institutional policies, and supporting policies.

1.     Macroeconomic policies

1.1  Fiscal policy

a)    Budget deficit:

The fiscal deficit can be financed by sources of either domestic private saving or foreign saving. Large fiscal deficit pressures on real interest rates and thus reduces private investment and outputs. Reduction of budget deficit will relax capital from private saving and transfer to private investment.

b)    Public investment:

Public investment can crowd out or crowd in private investment. The concept crowding out can be defined as: “ A situation in which large increases in government spending and the resultant deficit financing are likely to reduce personal consumption and business investment spending. Private incentives to work and invest may be diminished, thereby dampening the economy. The reasons for this are: 1) financial resources that may otherwise be used by the consumers and business sector are diverted to public use. 2) Interest rates may be pushed up due to competition between private and public sector, which increase the costs of borrowing by the private sector and dives it out of the financial market.”

c)     Tax policies

Tax affects private investment through the impact on the aggregate demand then declines incentives to private investment decision.

The criteria for ‘good tax structure’ consist of at least four requirements. First is equality that people’s tax payments should be in proportion to their income. Second is certainty that tax liabilities should be clear and certain, rather than arbitrary. Third is convenience of payment that taxes should be collected at a time and in a manner that convenient for the taxpayer. Fourth is economic that taxes should not be expensive to collect and should not discourage business.

1.2  Monetary policy

a)    Interest rate and credit regulation

Interest rate and credit regulations are two instruments that affect directly on private sector. An increase in official interest rates would lead to contractionary effects on output and employment. An increase in central bank credit to commercial banks would bring about a positive effect on the private sector. As credit expands, output and prices rise, the parallel exchange rate depreciates, and the informal interest rate falls. These effects stimulate increasing private output and investment.

b)    Inflation control and capital market development

It is argued that inflation would affect negatively to private investment, bring about risk and uncertainty, and reduce income of private sector. 

Capital market development would create opportunities for private sector mobilizing fund following different forms to develop their business activities. In most developing countries, the virtual absence of organized markets for equity capital and debt finance thus limits private sector access to fund resources.

c)     Exchange rate control

Exchange rate devaluation affects private investment through several channels as followings:

·       Alters the real supply price of capital goods;

·       Alters the real price of import inputs;

·       Impacts on the real product wage and affects profitability and investment;

·       Changes in real income, which affects the demand for domestically produced goods;

·       Affects nominal and real interest rates which in turn have an impact on investment.

1.3  Trade policy

Trade policy has had a powerful effect on private sector. Heavy tariffs and quota controls prevent private sector entering international trade. Trade reform through reducing both tariff and non-tariff protection and eliminating the traditional anti-export bias could expand international integration. As trade is expansion, size or growth of domestic market no longer limits the output. Consequently, the private sector undertakes new investment in the tradable sector, establishes and re-establishes connections with the international market and boost export activities. Trade liberalization enhances productivity by allowing the economy to absorb new technology from abroad and to increase specialization.

1.4  Deregulation

The deregulatory policy involves in an attempting to reduce the burden of regulation. It includes legalizing private ownership, liberalizing prices, reducing public sector monopoly, and removing the constraints imposed on private sector activities, encouraging competition, reducing administration, and using financial incentives.

2.     Institutional  policy

2.1  Laws:

In societies where an unstable legal and policy environment makes it sensible to conceal one’s activities and assets from the government, people will make extensive use of currency to carry out their transactions. When people prefer to hold assets in the form of currency than financial claims it means that capital mobilization for investment is very difficult.

2.2  Property rights

Insecure private property rights and contract enforcement are likely harmful to the incentive to invest. It threatens the investor with the loss of assets. The risk of such loss is greatest in doing business. Inversely, secure private property rights are crucial to economic efficiency and progress.

2.3  Other regulations:

Government intervention in the operation of private market could forbid private parties from making a transaction that both parties want and impose burdensome regulations on business, these rules create strongly incentives for bribe of government officials. Thus, setting discretionary regulations on business add transaction costs to investors.

2.4  Organizations

The organizations as purposive entities are designed to maximize wealth, income, or other objectives are defined by the opportunities, which afforded by the institutional structure of the society. With existence of certain formal and informal rules, different organizations induce different outcome performance.

3.     Supporting policy

Supporting policies consist of the efforts to improve the ability of the public sector in provision of essential public goods such as administration, physical infrastructure, health care, and educational services. In most transition countries, input markets are still underdevelopment particularly capital market thus private enterprises in these are handicapped by shortages of medium and long term credit. So, easily credit access is the most significant supporting policy in developing countries.

CHAPTER 2: OVERVIEW OF PRIVATE SECTOR AND GOVERNMENT EFFORTS TO IMPROVE INCENTIVES TO THE PRIVATE SECTOR DEVELOPMENT IN VIETNAM

 

I. THE EMERGENCE OF PRIVATE SECTOR IN VIETNAM

Vietnamese private sector had experienced since early 1950s and existed implicitly in many years ago until the government carried out macroeconomic and regulatory policies to legalize and make it restores since late of the 1980s.

Although the private sector was tolerated since 1980s, economic liberalization did not mean active encouragement this sector. It is not surprising that the private sector continues to view policy statements with some skepticism, and has adopted a wait-and-see attitude.

II. OVERALL PRIVATE SECTOR DURING 1986-1998

1.     The role of the private sector in economic development

Vietnamese private sector’s contributions to national economic development during period 1986-1998 were significant. The most impressive contribution is employment generation. The labor force employed in non-state sector account for 85%- 90% total employed labor force during 1986-1998. Private sector has created job and income for majority of population in the country. It has contributed to poverty elimination in the country, which has reduced from more than 70% of total households in the mid-1980s to somewhere closer to 30% in 1992 and 17% in 1998.

The output of private sector in this period accounted for over a half of GDP. In spite of declining sharply, about 12.4% in comparison with in 1986, the private share of GDP in 1998 has still stood at over 50% of total GDP. The private investment share in total national investment in Vietnam was around 40% in the late 1980s but has decreased dramatically since 1990s and has been standing at 21% in 1998. The private sector’s contribution to government revenue has increased lightly over time and has reached at 18.5% of total government revenue in 1998.

In detail, Vietnamese private sector has carried out a considerable role in all fields of production.  The industrial output of this sector accounted for 31.1% and 22% of industrial output total in 1991, 1998. Private sector has created major agricultural output that used to be 41% of GDP in 1991 and accounted for nearly 26% GDP in 1998. Moreover, in the aspect of national retail sales, private sector also took major proportion about 76.9% in 1995 and increased continuously to 77.4% in 1996, 78.6% in 1997 and 78.4% in 1998. In which, households and individuals accounted for 74-75% national retail sales. These proved that Vietnamese private sector has been an important component of the economy.

2.     Scope and structure of Vietnamese private sector

Since renovation of 1986, the scope of Vietnamese private sector has developed strongly in absolute term. It is defined in terms of number of entities, labors, and capital investment.

The number of household businesses has increased from about 0.32 million in 1989 to 2.2 million by 1996. The number of non-agriculture cooperatives declines significantly from 42,995 in 1989 to 1,867 in 1995 because of cutting off government subsidies and converting into private ownership form. However, it seems to have a brightly sign since 1996 and stands at number of 4,259 in 1998. The number of private enterprises and limited companies increases impressively but it is far below the increase of business households. The numbers of entities in these two forms in 1998 have established more than three hundred times compared with 1991. The number of joint stock companies is the slowest increase. These figures suggest that at present private enterprises and limited liability companies have illuminated as favorite forms of private corporate sector. The type of household businesses dominates private sector in Vietnam

Although, there have trend to transform into more complex ownership form, the small-and medium-scale productions have been dominant in the private sector. Document 681/CP-KTN issued by the Government on June 20, 1998, stipulates that small or medium enterprises should have a maximum registered capital of VND 5 billion and employ less than 200 persons. The average registered capital of new enterprises by ownership form states that private firms are mostly small and medium scales. Capital formation of non-state manufacturing enterprises is mostly from their own capital. It accounts for 90-91% of the total capital formation while capital from banking loan is around 3-4% only, and from credit cooperatives is very few, 0-1%.

In aspect of labor, private sector has employed approximately 90% of total labor force. However there is a difference of educational level in the labor force among areas as well as forms of business.

3.     Development trend of Vietnamese private sector

From 1986 to 1998, private sector has grown continuously but its growth rate still lagged behind that of the state and foreign-invested sector except for two years of 1989 and 1990. In these two years, nearly all-direct subsidies to the state-owned enterprises were removed, many state-owned enterprises had broken-down. It created opportunities for private sector develops quickly. The growth rate of the private sector reached 7.2% in 1989 and 6.2% in 1990. Since 1991, the resumption of the state sector together with the strong growth of foreign invested sector by priority of the government has affected private sector. There has the slowdown trend of growth in the private sector of all ownership forms in recent years. The growth rate of collective forms is the slowest. The mixed form had the highest of 12.7% in 1995 but decreased dramatically to 4% in 1998. The private and individual forms were slow trend but retained at high growth level at 7.03% and 4.06% in 1998. This exposes that private enterprise is the most pre-eminent. It explains why the number of private enterprises has grown much stronger than other forms of the private corporate sector.

Contribution of the Private corporate sector to GDP also decreased. The output contribution of collective, private and mixed enterprises accounted for 17.5% of GDP in 1995 and decreased to 16% in 1998.

Industrial output of domestic private sector reduced dramatically from over 40% of national industrial output in the late 1980s to 22% in 1998. The industrial output of cooperatives declined substantially from 28% of industrial output total in 1986 to less than 1% in 1998. The share of private enterprises in industrial output is low, at 2.3% in 1998, while more than 13% of total industrial output accounted for over 60% of industrial output of private sector comes from household activities.

 

 

III. GOVERNMENT EFFORTS CREATE INCENTIVES TO THE PRIVATE SECTOR

1.     Macroeconomic policy

1.1  Fiscal policy

The fiscal deficit has reduced from 7% in 1989 to 2% in 1991 and remains at 3-4% in next years through a combination of tax reform, elimination of subsidies to cooperatives and SOEs, and restriction of expenditure. Fiscal deficit reduction has restored government accountability from investors. However, tax policy, public investment programs seem to be insignificant positive effects.

1.2  Monetary policy

By 1989, the State Bank has raised real interest rate to positive level. The interest rate reform has encouraged domestic saving as well as private saving. Interest rate reform has abolished specific lending interest rate in favor of differentiated lending rates by term of structure. Inflation has declined from over 67.5% in 1991 to fewer than 5.3% in 1993 and stayed at one digital in many following years.

Since 1991, Vietnam had expanded financial sector to include joint stock banks, foreign banks, joint venture banks, and representative offices of foreign banks and credit cooperatives. However, the amount of credits has been around 20% of GDP only. There has a trend toward small loans for individuals, households and small businesses, particularly in rural areas. Thus, the balance between lending to the private sector and lending to the state sector has improved.

The exchange rate was re-aligned and adopted by market-oriented policy since 1989. The large devaluation has eliminated serious overvaluation of official rates. However, after 1992 nominal exchange rate is still above the real one.

1.3  Trade policy

Since 1989 the government efforts to liberalize trade has brought an increase of trade volume from 35.5% of GDP in 1989 to 71% in 1998. However, private sector engaged in international trade was still limited.

2.     Institutional policy

The Vietnamese government has carried out institutional changes to shift the central planned economy to the market-oriented one and to establish favorable environment for private sector development. Major reforms since renovation are followings:

 

Year	Major reforms
1986	-       VI Party Congress declared beginning doimoi
1987	-       Law on Foreign investment introduced “Open door” policy -       Land law establishes private use of allocated land in agriculture -       The central treasury created to manage the budget
1988	-       The two-tier banking system established -       Decree on foreign exchange control liberalize the retention of foreign exchange, the opening of foreign current accounts, and the use of foreign exchange transfer to pay for import or repay foreign debts. -       Law on Import and Export Duties -       Decree  No 27, 28/ HDBT dated 9 March 1988 formally recognized private sector
1989	-       Removed nearly all direct subsidies and price control – end of “two price system” -       Domestic trading in gold legally allowed, foreign exchange system unified -        Bank interest rates made positive in real terms -       Ordinance on Economic Contract established rights for legal entities to enter contracts.
1990	-       Tax reform introduce special sales, turnover and profit tax -       Law on foreign investment revised -       Law on private enterprise, law on companies established -       Ordinance on State Bank, ordinance on Banks, Credit Cooperatives and financial institutions enacted
1991	-       Foreign exchange trading windows opened at the State Bank -       Agriculture Bank of Vietnam allowed lending to farming households -       Private companies allowed to direct engage in international trade
1992	-       New Constitution allowed individuals to exercise ownership rights over income producing assets and personal property. -       Foreign investment law amended -       Pilot equitization program for SOEs introduced
1993	-       New land law introduced -       Law on bankruptcy and environmental protection promulgated -       The system of 90-day suspension of import duties for intermediate input into export production introduced -       Law on Agriculture land- use tax promulgated
1994	-       Economic courts established -       Law on promotion of Domestic investment -       Ordinance on Income Tax of high-income earners promulgated
1995	-       New regulation on land restricts the nature of land use rights for private sector and limits the rights to mortgage land use rights held by domestic organizations -       The general department for managing state capital and assets in SOEs created in MOF -       Number of export tax rates increased to 11 products -       Number of turnover tax rates reduced from 18 to 11 -       Law on State Enterprises
1996	-       Credit activities exempted from turnover tax -       Law on Sate budget promulgated -       Law on Minerals -       Regulations elaborate regime under civil code for protection of industrial property rights. -       Decree No 75/CP dated 28 November 1996 allowed establishing State Stock committee.
1997	-       Law on State Bank of Vietnam introduced -       Law on credit institutions established -       Law on Value Added Tax promulgated -       Law on Corporate income tax -       Commercial law introduced
1998	-       Private sector enterprises allocated quota to import fertilizer and export rice -       Domestic enterprises authorized to directly export production without an export/import license -       Land law amended -       Law on promotion of Domestic investment amended -       Decree  No 48/CP (1998) on Securities and Stock Market

In general, the efforts of government in changing institutions have consisted of reforms of property rights, legal framework, regulations, and institutional structure, which have affected strongly market entry, input access, and development of private sector.

3.     Supporting policy

Vietnamese government still has not established a particular supporting policy for private sector from government. Although the law on promotion of Domestic investment has introduced in 1994, it mainly supported to the state sector. The number of private investment projects and amount of received priority capital are too small. The number of private projects, which are provided and leased land in over thirty provinces (up to 31 December 1997) only have been 1 and 16 while number of state projects respectably are 23 and 44. In the fact, there are some foreign organizations and capital funds (namely Beta Mekong Fund, Beta Vietnam Fund, Vietnam Enterprises Investment Ltd.…) have carried out supporting activities to the private sector. However, the number of enterprises, which receives capital from financial funds, is very small. Most Funds have rejected the local investment projects due to their feasibility weakness and non-profitability.

IV. ECONOMETRIC EVIDENCE:

1.     Theoretical basis for the regressed equations:

The theoretical basis, which discussed in chapter 1, postulated that public investment could crowd out or crowd in private investment. Khan and Reinhat (1989) found that public investment in infrastructure crowds in private sector whereas public investment in manufacturing is less productive than comparable private investment.  The study of Jayaraman (1996) showed that private investment share of GDP responded strongly to fluctuations of GDP growth and is inversely related to public investment share of GDP. Thus, public investment is an important factor that relates to private investment 

Because private disposal income is only either to consume or to save (YD = C +S) thus, as private consumption increases, private saving has to decrease. When private saving decreases the private investment would decrease. The empirical evidence of Rodriguez (1991) from time series analysis of Argentina through two periods of (1914-1984) and (1960-1984) showed that government investment has no significant effect on private investment while government expenditure and private consumption has negative effect. Therefore, the private consumption is a factor that determines private investment.

Tax affects private investment through the impact on the aggregate demand then declines incentives to private investment decision. The study of Ahmed and Miller (1997) postulated that tax-financed government expenditure crowds out investment more than debt-financed expenditure. Thus, tax is a factor that crowds out private investment.

An increase in central bank credit to commercial banks would bring a positive effect to the private sector. As credit expand, output and prices rise, the parallel exchange rate depreciates, and the interest rate falls. These effects stimulate increasingly private output and investment. Dailami and Giugale (1991) found that private investment respected positively to credit rate to GDP and real GDP growth. Therefore, credit is one of the determinants of private investment. 

Heavy tariffs and quota controls prevent private sector to entry into international trade. Trade reform through reducing both tariff and non-tariff protection and eliminating the traditional anti-export bias could expand international integration. As trade expansion increases, output is no longer limited by size and growth rate of domestic market but by exports prospects. Consequently, the private sector undertakes new investment in the tradable sector, establishes and re-establishes connections with the international market and boost export activities. In addition, trade liberalization enhances productivity by allowing the economy to absorb new technology from abroad and to increase specialization. Levine and Renelt (1992) found that only trade variables (such as the import plus export share to GDP) and other measures of openness explain investment robustly. Thus, trade volume is one of determinants of private investment.

2.     Case study of Vietnam

Vietnam’s renovation during period of 1986-1998 through macroeconomic policy reform such as tax, public investment, credit, trade policies (section 2 of chapter 2), have brought about effects on economic growth, private investment and consumption. According to theoretical base, the expansion of tax, public investment, government credit and private consumption would be negatively effect on private investment. In contrast, the growth of national output, the expansion of private credit and trade volume would be positively impacts on private investment. By graphically intuitive observation of data series, it shows that Vietnamese private investment seems to be negatively relation to the state investment and public investment. Private investment ratio of GDP has been the same direction as the growth rate except year 1992, and inverse direction with private tax ratio of budget revenue. The correlation of private investment with the private expenditure and volume of trade during period 1986-1998 is unclear. The variation of private investment respectably to private credit, and government credit is also unclear. However, to examine the effects of consumption, state investment, credit, growth rate, tax, government investment, and trade on Vietnamese private sector, it needs to establish the models for regression.

2.1  The regression models:

To shed sharply light does the state sector crowd out the private sector especially private investment five regression models are constructed as following

Model 1:        PI = A₀ + A₁STIS + A₂ PEX + A₃ VOLTR + Ui

Model 2:                 PI = A₀+ A₁STIS + A₂GCR + Ui

Model 3:                 PI = A₀ + A₁STIS + A₂PCR + Ui

Model 4:                 PI = A₀+ A₁GR +A₂TAX + Ui

Model 5:                 PI =A₀+ A₁GIS +A₂TAX +Ui

Where:

GCR = government credit/ GDP

GIS = government investment from budget/ total investment

GR = growth rate of real GDP

PCR= private credit/ GDP.

PEX= (final consumption- current expenditure from government budget)/GDP

PI = (total investment - budget investment- government credit investment - investment of SOEs - foreign investment)/GDP

TAX= private tax/ budget revenue

STIS= (budget investment + investment of SOEs + government credit investment)/ total investment.

VOLTR        = [(import + export) × annual average exchange rate] /GDP

 

All independent and dependent variables in the regressive models are measured by percentage and at current price.

2.2  The results of regressions:

Results of the regression models confirm the significance of all variables. In other words, Vietnamese private sector is crowded out by the state sector.

The determinants of the private investment for Vietnam

Dependent variable: private investment (PI)

 

Note: n.a.: Not applicable. All variables are in percent form. Numbers of t-statistic are in parentheses. Degrees of freedom for F-statistic are given in the parentheses. The coefficient for the constant term is not report in the regressions.

*** Significant at the 99 percent level, ** significant at 95 percent level, * significant at 90 percent level.

 

Generally, within the factors, which affected negatively the private investment, the private tax rate, state sector investment and government investment are larger impacts. Thus to reduce disincentives to private investment, policy implications should focus further on taxation, public investment and SOEs reforming. The increase of private consumption brings about a negative impact on private investment thus it should be considered when policy implications are made to foster aggregate demand. In addition, government credit ratio of GDP discourages while private credit ratio of GDP encourages private investment thus it need to reduce government credit rate and increase private credit rate to promote private sector development. Moreover, encouraging economic growth and import-export is necessary to improve private investment in Vietnam.

 

CHAPTER 3: PRESENT CONSTRAINTS OF VIETNAMESE PRIVATE SECTOR

I. FORMAL CONSTRAINTS

1.     Macroeconomic policy constraints

1.1  Disincentive tax policy

At present cooperate income tax and value added tax are typically claimed for disincentive of tax policy in Vietnam.

The profit tax rate is 45% on commercial activities, 35% on light industry and 25% on heavy industry. The tax rate of domestic enterprises accounts for 25-45%, while that of foreign invested enterprises are much lower at 10-25% to attract foreign investment. The tax holiday period of newly established domestic entities is two years from first year of taxable income while those of foreign invested enterprises and foreign partners in business cooperation contract is from 2 up to 8 years. Within two first years of business, almost business entities can not make profit but most of them have loss. Thus, tax holiday in reality is less incentive. This tax structure discriminates against domestic investors. For this profit tax structure, private corporate sector is the most sufferers because it is doing businesses mainly in commerce and light industry.

The implementation of VAT has brought several complaints of tax rate, tax discount rate of inputs, classification of tax code, tax invoice, and enacted scope. Different rates charged on the same machinery of production in the same sector. Different tax codes labeled on the same kind of goods. A great majority of businesses and household enterprises does not keep detail accounts of VAT requires; most of them have used inputs purchasing directly from suppliers without invoices, therefore, it is difficult to calculate “value added” figure. Taxation collected from individuals and small firms mostly bases on ‘negotiated tribute’ between taxpayers and tax authorities. It creates collusion for tax evasion. It creates incentive for firms to stay small or under the form of business households to avoid a tax contribution.

In addition, the law, setting on State owned general corporations, states that transactions among member enterprises of corporations are exempted from the tax. Such selective exemption excludes private sector from transacting with member enterprises of corporations, makes obstacles of backward and forward linkages for private sector, and adds to distortions of tax system.

1.2  Public expenditure

Public investment in Vietnam remains at low level. Public expenditure allocation is very imbalance. Inefficiency of public investment projects, capital allocations, and project management, induce a result that public investment is competitive rather than complementary to private investment. Lack of master plans with prudent analysis and discretion of project selection have brought about numerously wasteful projects. Public investment on transport, communication, and irrigation although has increased, it is still not enough, inefficient. Most of them are operating around 60% of the designed capacity and many others are too old, decaying conditions. The small operation and maintenance expenditure of 0.6% of GDP during 1990-1998 has led quickly downgraded investment projects. Thus, it makes capital wastes increase.

 

1.3  Credit policy

Credit policy and banking system in Vietnam are weak and do not fulfill the demand of private investment. Main reasons include mistrust in banking system and cash oriented business practice, unclear and insufficient legal framework in collateral. In addition, the state banks must bailout SOEs; private firms lack of planning, accounting and managerial skills to meet the requirements of the bank.

1.4  Trade policy

High protection, large scatter, and incentive imbalance characterize the import tax structure in Vietnam. High protections of capital intensive industries, which belong mainly to the state or foreign invested sectors, make them have high return without efficiency. High tariff and import restrictions encourage smuggling, illegal trading, and corruption. These bring disadvantages to the private producers.

2.     Legal constraints for market entry and production factor access

2.1  Market entry

Differential treatment based on different legislation for different categories of owners have stifled incentive of private investors. Complicated registration- procedure leads slow establishment of new business thus slow mobilization of domestic resources, fewer opportunities of employment for workers and slow economic growth.  That discourages not only the transition of individual and household businesses into formal system but also the formation and expansion of private enterprises. The new Enterprise Law has made a significant improvement to eliminate the barriers of market entry. However, the bias against private firms would not go to the end if tax, credit regulations and exchange rate control as well as land use rights continued to discriminate private sector.

2.2  Land access

Individuals and private firms in Vietnam face many difficulties in carrying out their land use rights.  These difficulties include burden of administrative procedures, taxes on land-use right transfer, and discriminative regulations. The Land Law (1998) allows all economic organizations, which are allocated land by the state, subject to payment of land use right fee, have the right to contribute capital in the form of land use right together with assets attached thereto to joint ventures with domestic and foreign organizations and individuals. However, private Vietnamese entities can only have such land use right if they pay their rent in advance for the entire term of the lease. This is a discrimination against private sector. 

2.3  Capital access

Although amount of banking loans of private sector has improved in recent years and some foreign financial funds have supported to private sector, but the number of private firms, which had received credit or supporting fund, is small. It is difficult for private firms generally obtain credit as well as medium and long-term loans for investment. To obtain credit, private sector has to provide their pledge or mortgage and locate nearly to the credit organizations but the state sector has not to do that. The legislative decision of Prime Minister on credit activities in early 1999, No 13/1999/ QD-TTg (dated 4 February 1999) Article 4 states that investors who are SOEs do not have to provide collateral when borrowing capital.

2.4  Technology and information access

The imported inputs licensing system in Vietnam tends to deter the development of more advanced technology in existing firms in the market. To get imported input licenses, such firms must have approval to change their product mixture or increase their capital. Most private firms have no chance to establish joint ventures with foreign investors thus technology access is limited. Capital shortage leads to a lack of modern machines so induces low quality products, high prices and as a result, weak competitiveness.

The high costs of communication and Internet usage have made it difficult for Vietnamese businessmen to access international information thus it is difficult to expand their market share.

2.5  Skilled Labor access

Lack of skilled labor is one obstacle to the development of private firms in rural areas that produce products for export.

 

I. INFORMAL CONSTRAINTS

1.     Traditional norms

Household business is dominance in the private sector. It is easily to see that storefronts, shops, mini hotels, and restaurants are growing like mushroom together with many street vendors in any lager towns and cities in Vietnam. That is not to say a tradition of small-scale production is not evident in Vietnam. However, these are not major causes of dominant of small-scale production form in Vietnam but ones originated from officials’ attitudes and government policies.

2.     Ideology

Vietnamese private sector suffered greatly during the period of “hard” socialization. A large part of the private sector continues to view policy statements with suspicion, and adopts a wait-and–see attitude. While private sector has not yet really believed in government policy statement the state continue to affirm and try to remain the leading role of the state sector through its protections and discriminations against private sector.

3.     Consumption custom

While infrastructure investment in rural that can support private investment development is very inadequate, wastes of administrative expenses in the state agencies are prevalent. The redundant of cars and office-equipment (namely computers, photocopier, and air conditioners) is easily to found in most of state administrative offices from central to local level. The perception of saving and anti-waste has not been widely disseminated among people and state agencies, a lack of detailed rules and standard norms have made it difficult for implementation.

 

 

 

 

CHAPTER 4: CONCLUSIONS AND IMPLICATIONS

 

1.     The Vietnamese private sector have existed and experienced before the reform, thus they were experienced and traditional entrepreneurs

2.     The domestic private sector is playing an important role in Vietnam’s economic development since innovation.  Private sector has created nearly 90% of employment, contributed more than 50% of total national domestic products and higher 20% of total investment. In addition, it has contributed approximately 20% of government revenue, undertaken nearly 80% of total retail sales in the economy and more than 20% of national industrial output. Thus, encouragement of private sector development is necessary for economic development.

3.     In recent years, the growth of Vietnamese private sector has slowed. The private corporate sector potentials for economic development are untapped. From 1986 to 1998, domestic private sector’s output has declined from nearly 70% to 50% of GDP. In which, industrial output share fell out from 44% to 22% of total industrial output. Private investment has also decreased from 62% of total national investment to 21%. The growth rate of the private sector has lagged behind the growth of state sector and foreign invested sector. The existence and development of numerous business households, which have done their business successfully, postulated that they have powerful potentials to grow into private corporate forms. The trend of households to develop into private corporate sector has occurred in reality but it is very slow and insignificant. Thus, it needs more incentives from government to restore growth rate of the private sector and to make its potentials come true.

4.     In reality, Vietnam’s state and government have carried out many efforts to create enable environment for private sector engaging in business. However, these efforts only tolerate and recognize but are not enough to encourage actively private sector development. There have not yet supporting policy from government to the private sector. Thus, it needs more active attitude and policy toward private sector.

5.     The domination of the SOEs with support and bailout from government has crowded out private sector investment. The Empirical analysis in chapter 2 shows that within the factors, which affected negatively the private investment, the private tax rate, state sector investment and government investment are larger impacts. Thus to reduce disincentives to private investment, policy implications should focus further on taxation, public investment and SOEs reforming. The increase of private consumption brings about a negative impact on private investment thus it should be considered when policy implications are made to foster aggregate demand. In addition, government credit ratio of GDP discourages while private credit ratio of GDP encourages private investment thus it need to reduce government credit rate and increase private credit rate to promote private sector development. Moreover, encouraging economic growth and import-export is necessary to improve private investment in Vietnam.

6.     Many constraints are obstacles to private sector at present. Macroeconomic policies are still carrying out problems that have discussed in chapter 3. Tax system is still distorting; public investment is very inefficient; banking system and credit controls are weak. Trade policy still restricted private sector entering international trade. Institutional framework is being inconsistent, discretion and discriminative against private sector. It includes market entry, land, capital, technology, and skilled labor access. Informal constraints also are large obstacles to private corporate sector. Aside from the traditional norms and consumption behaviors, the ideology is an important obstacle. It prevents household and individual businesses developing into private corporate sector, and encourages private sector stay at small-scale production. Thus, reforming seriously is important for private sector to become engine of economic growth in Vietnam. The Tax reform should be completed and eliminated differential tax rate. Enhancing efficiency of public investment program is urgent need. Banking improvement, and trade liberalization need to do more seriously. Institutional framework particularly regulation on production factor access should be equal treatment for all economic entities. The elimination of enmity against private sector and improvement of consumption custom as well as saving behavior must be widely disseminated.