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 limite