Innovation and exports of vietnamese SMEs evidence from firm level data

The influence of subcontracting activities on the innovation UNIVERSITY OF ECONOMICS December 5, 2017 ERASMUS UNVERSITY ROTTERDAM HO CHI MINH CITY INSTITUTE OF SOCIAL STUDIES VIETNAM NETHERLANDSTHE VIETNAM – THE NETHERLANDS PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS THE INFLUENCE OF SUBCONTRACTING ACTIVITIES ON THE INNOVATION IN VIETNAMESE SMALL AND MEDIUM-SIZED ENTERPRISES A thesis submitted in partial fulfillment of the requirements for the degree of MASTER OF ARTS IN DEVELOPMENT ECONOMICS By NGUYEN QUANG HUNG Academic Supervisor: LE VAN CHON PhD HO CHI MINH CITY, December 2017 ABSTRACT This study investigates the impact of subcontracting activities on the innovativeness of Vietnamese subcontractors in Small and Medium-Sized Enterprise (SME) sector The study approached two main theories of transaction cost (TCE) and knowledge-based theory The data was drawn from the rich data set of Vietnamese SMEs in 2015 The empirical test used the probit model to examine 271 subcontractors to give the evidence that subcontracting activities with the foreign-invested contractor are likely to innovate rather than with domestic contractors In addition, the results have suggested that the absorptive capacity is very important for innovation of a small firm In this thesis, based on the paper of Cohen and Levinthal (1990), the formation of the absorptive capacity is generated by skilled staffs and training activities in the firm The findings showed that the innovative probability of subcontractors is positively affected by subcontracting activities in foreign-invested sectors and the absorptive capacity Key words: knowledge, innovation, subcontracting activity, Vietnamese SME ABBREVIATION FDI Foreign direct investment LEs Large firms MNCs Multinational Corporations OECD Organization for Economic Co-operation and Development R&D Research and Development SOEs State-owned enterprises SME Small and Medium-sized Enterprise TCE Transaction cost economics TFP Total factor productivity CHAPTER INTRODUCTION 1.1 Research context 1.2 Problem statement 1.3 Research objective 1.4 Research question 1.5 Scope of the study 1.6 Structure of thesis CHAPTER LITERATURE REVIEW 10 2.1 Theoretical framework 10 2.2 Innovation in subcontracting 12 2.3 The role of the subcontractor in the supply chain and its innovative capability 15 2.4 Transaction cost theory (TCE) 20 2.5 Knowledge-based theory 23 2.6 Empirical review 32 CHAPTER 3.1 DATA AND RESEARCH METHODOLOGY 34 Data and sample 34 3.1.1 Small Medium – sized Enterprises (SMEs) .34 3.1.2 Data of Vietnamese Small and medium-sized enterprises 35 3.1.3 Sampling 36 3.2 Definition and classification 37 3.2.1 Definition of Innovation 37 3.2.2 Definition of Subcontracting 39 3.3 Research methodology 41 3.3.1 Transaction cost approach 42 3.3.2 Knowledge-based approach 43 3.4 Analytical frmework 48 3.5 Variables and measurement 48 3.5.1 Data description 48 3.5.2 Dependent variable 50 3.5.3 Independent variables 51 3.5.4 3.6 Description of variables and expected sign 55 Analytical method 58 3.6.1 Empirical model, estimation method 58 3.6.2 The identification strategy 60 CHAPTER EMPIRICAL RESULT 61 4.1 Descriptive statistics 61 4.2 Regression Results 62 4.3 Results interpretation 63 CHAPTER CONCLUSION AND POLICY IMPLICATION 72 5.1 Conclusion 72 5.2 Implications 74 5.2.1 Policy implication 74 5.2.2 Managing implication 75 5.3 Limitations 75 5.4 Future research 76 REFERENCES 77 APPENDIX 87 List of Figure Figure Theoretical framework 12 Figure The mutual benefit relationships between contractors and subcontractors 16 Figure Structure of subcontracting system 17 Figure Knowledge-creation process - SECI model 29 Figure The level of subcontractor in chain structure .41 Figure Analytical frmework 48 List of Table Table Summary of advantages of star- and tier-shaped structure .18 Table Classification of Small-, and Medium-sized enterprises 35 Table Sample of Vietnamese subcontractors 37 Table The rate of innovation of subcontractors 49 Table The rate of innovation of subcontractors of foreign-invest enterprises of the sample 49 Table Statistic of number of innovators of the sample by type of enterprise 50 Table Statistic of enterprises of the sample classification by total labor force 50 Table Independent variables 55 Table Summarizing the variables 61 Table 10 Regression Results 62 CHAPTER INTRODUCTION 1.1 Research context After nearly three decades, Vietnam officially began to adopt ‘Doi Moi’ (renovation) policy under the pressure in economic reform but until the year of 1989 Vietnam implement indeed a comprehensive and radical reforming program; Vietnam has shifted from centrally planned economy to socialistoriented market economy, aims to stabilization and openness As a result, the economy experienced rapid growth during the period of the 1990s, Vietnam became one of the fastest-growing countries in the world with the annual average growth rate of this period was up to 7.76%1 Vietnam has attained impressive achievements and succeeded to process of international economic integration Since launching the renovation programme in the early 1990s, small and medium-sized enterprises (SMEs) emerge as a dynamic force, they account for a large proportion of Vietnamese enterprises In line with renovation policy, they are on top of structured transformation In the meaning of development, the reform of economic environment has positively affected entire Vietnam economy in general and on the development of small and medium-sized enterprises in particular Vietnamese small and medium-sized enterprises and the private sector are continuously the main engines of contribution to growth in Vietnam economy With the dominant force in the economy, small and medium-sized enterprises are playing a critical role, which has overwhelmed Vietnam economy’s development At end of 2015, the number of small and mediumsized enterprises accounts for 98%2 of entire enterprises in nationwide; the velocity of the number of small and medium-sized enterprises in the period 2000 - 2015 is averagely 18.1% They are a prime source of job creation, Statistic from Work bank data (2016) 45th Small and Medium Enterprises Working Group Meeting organized 13 September 2017 in Ho Chi Minh City (link: https://apecceosummit2017.com.vn/45th-small-and-medium-enterprisesworking-group-meeting-104.html) wealth distribution, poverty alleviation, and innovation as well Therefore, they become an important part of the national development and have been viewed as the backbone of the economy In the early stage of transition, Vietnamese small and medium-sized enterprises were facing many inherent constraints on an underdeveloped country, such as lack of production land, capital for business activities, market information, skilled labor force, modern technology, and investment, etc Thanks to the open-door policy, traditional barriers were gradually detached Vietnamese enterprises have approached opportunities for integrating with the rest of the world In the globalization and technological information era, the challenge also increases the threat from their counterparts in international play-fields These are public issues debating in many literatures and it is also concerns of many researchers and policymakers Theorists and scholars have shown that the innovation is an appropriate solution for firms to create and maintain the competitive advantage So, studying in innovation is necessary for Vietnamese Small and medium-sized enterprises in the context of globalization 1.2 Problem statement In Vietnam, Small and medium-sized enterprises account for a large portion of total enterprises The major roles of Small and medium-sized enterprises in the economic development of a country are job creation, nurturing the growth of the labor market, and reducing the development gap among localities, and countries In their evolution progress, small and medium-sized enterprises have faced almost constraints and significant challenges such as high production costs, poor quality of products and services, low degree of innovation, many difficulties in access finance, weak management skills and expertise, lack of market information, and so forth Competitive abilities of Small and medium-sized enterprises in local and global markets are also weak due to obstacles of information, domestic and international regulations, absorbing and accessing technological advantage, and so on The globalization process has dramatically changed This process increases abilities of countries to access new information and markets in both domestic and international Vietnamese economy has integrated into the international economy that has opened a great opportunity for Vietnamese small and medium-sized enterprises to take part in the production chains However, they did not develop full awareness and did not pay adequate attention to the participation in and appreciate the benefits of participation in production chains nor take into account it as a tool, a means of survival, of adding value and of improving the efficiency of their production process Moreover, the globalization process gives rise to the capital flows move in the developing countries, and thus it also increases the opportunities for foreign countries to take part in the exploitation of the domestic market size, as a result, the competitive degree becomes larger in the host countries However, the globalization and competition commonly not always create the threat for enterprises in the host countries In a certain aspect, the challenges from the globalization produce motivation for firms to development by enhancing operational effectiveness and productivity For this reason, the ideal ways for the firm to survive are the innovation and participation in regional and/or global production chains (Harvie, Narjoko, & Oum, 2010) The innovation is extremely important for development and sustaining the productivity, growth, and development of a country in general as well as a firm in particular In the macro level, the innovation is the shortest way to fill the development gap between countries For firm level, the recognition of innovation is a vital factor A large number of studies have documented that innovation is a key driver to lead an increase in competitive advantages In the last decades, most studies of creativeness and/or innovativeness in enterprises concentrate on exploiting the relationships between innovation and trade, innovation and productivity, or finding the determinants effect on innovation In fact, studies of the relationship between the innovation and subcontractor are a little, especially in the developing world Subcontracting activities are becoming a key factor of industrialization in most countries in the world In the Organization for Economic Co-Operation and Development (OECD) countries, subcontractors are crucial elements for establishing production value chains The integration companies require their subcontractors having the innovativeness to contribute to value chains Contractors and subcontractors together set up an ecosystem, which is formed industrial clusters for development and enhancing competencies In which, innovative activities are a primary concern In Vietnam, subcontractors are firms that almost take part in the processing, assembling, or manufacturing peripheral products for large companies (e.g multinational corporations), or foreign direct investment (FDI) enterprises Excluding several industries that involved the foreigninvested sector, most domestic manufacturing enterprises have operated in the low added-value industries In addition, most subcontractors lack the cohesion or it is very weak Accordingly, their competitive and innovative capabilities are low (even in cognition) Due to low innovative ability, Vietnamese small and medium-sized enterprises concentrate on low laborcost or labor-intensive production activities that they have the competitive advantage compared to regional counterparts Many papers focus on analyzing the role of the subcontractor in developed countries (e.g OECD countries) where the development and the technological degree are very high, and they involve into global value chains from the initial stages (e.g design stage) to ultimate stages (e.g end-used product stage) Studies of the manufacturing subcontractors in Vietnamese small and medium-sized enterprises sector are virtually rare Most research of Vietnamese small and medium-sized enterprises accrue to the subcontracting activities in supporting industries (automobile, electronics, and electricity) In these industries, enterprises are relatively mature and larger than small and medium-sized enterprises Besides, some existing theories cannot be applied to examine the innovativeness of the Vietnamese small enterprises due to the knowledge and technology gap Therefore, this study will contribute significant findings and open the new direction to attract policy-makers, scholars for deeply study in this field in order to enhance competencies of Vietnamese small and medium-sized enterprises in general and the subcontractor in particular 1.3 Research objective Since the innovation plays the important role in the survival and maintains the competitive advantage for the subcontractor, so the main objective is to explain the innovativeness of them through subcontracting activities For that reason, the thesis will discuss the issue involved the subcontracting activities of Vietnamese subcontractor in the SME sector through subcontracting agreements and investigate their knowledge-creation abilities through the absorptive capacity that enhance the innovation likelihood of the firm Firstly, the thesis will examine the innovativeness in subcontracting activities of the subcontractor through subcontracting agreements In which, the subcontracting relationships, with contractors in the domestic and foreigninvest sectors, are separated into two groups Based on that, the thesis specifically assesses the subcontracting activities at which sector are more likely to innovate Secondly, the thesis will investigate the innovation of subcontractors across building the knowledge base that will form the absorptive capacity of the firm More specifically, the thesis examines the elements of quality management, education, and training activities will contribute to the absorptive capacity Based on the literature, the thesis will conduct other determinant factors that affected the innovation of the firm Next, a regression model will be built Secondly, the branches of state-owned bank support Small and medium-sized enterprises to approach financial sources and the local government assists experts to evaluate the innovation projects of Small and medium-sized enterprises In fact, Small and medium-sized enterprises are too hard to approach the loans due to lack of collateral The long-term loans thus are very important for Small and medium-sized enterprises to invest in innovation Besides, the local government proposes supporting programs to help Small and medium-sized enterprises enhance their perceptions of business and trade laws, training managing skills, giving legal, technological advice, and so on 5.2.2 Managing implication The entrepreneurs, who managing the subcontracting firms in this study, should plan a strategy to invest more in human capital and training activities to improve their employees’ skills and knowledge it, in turn, will build the absorptive capacity for the firm The innovative cognition of the staffs is also critical for firms Those are a premise to innovative activities that is the key for successful subcontractors The results suggest that entrepreneur should involve deeply and empowers more for middle-managers in the innovation process Participating in the industry forums and constructing the learning-sharing networks are the sources to create knowledge for narrowing the gap of technology and serving the innovation In addition, recognizing the information technology is seen as an inevitable trend of international economic integration make the motivation for the firm to change outdated working modes in order to take part in the global value chains 5.3 Limitations Although this study has achieved the insightful objetive of the nature of the manufacturing subcontractors in the Vietnamese Small and medium- sized enterprises sector to contribute the literature There have much works to be done to understand deeply on this subject Firstly, the observations drawing from the SME dataset and omitting information of the respondents reduce the number of observations in the regression model Yet, the characteristics of these firms are relatively homogeneous comparing to the dataset Secondly, due to the number of observations and omitting information of the respondents, the thesis cannot evaluate the impact of subcontracting activities on each kind of innovation to give the subcontractor a more specific strategy for improving their competitive advantage Thirdly, since the dataset is not specifically designed for Vietnamese subcontractors, this study does not comprehend all aspects of Vietnamese enterprises It thus does not show completely the information of innovation operating and managing processes as well as cannot evaluate the innovation efficiencies 5.4 Future research Future research is needed to evaluate the impact of activities on each kind of innovations in order to consider which kind of innovation strongly affects the competitive advantage of the subcontractor REFERENCES Abernathy, W J (1982) Competitive decline in U S innovation : the management factor Research management, 25(5), 34-41 Abraham, K G., & Taylor, S K (1993) Firms' use outside contractors: Theory and Evidence National Bureau of Economic Research Acemoglu, D., Aghion, P., Griffith, R., & Zilibotti, F (2004) Vertical integration and Technology: Theory and Evidence NBER working paper series Acs, Z J., & 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Classification of Small-, and Medium-sized enterprises 35 Table Sample of Vietnamese subcontractors 37 Table The rate of innovation of subcontractors 49 Table The rate of innovation of subcontractors