Impact of R&D on the productivity growth of manufacturing firms in Vietnam

~· ~ ' - UNIVERSITY OF ECONOMICS HO CHI MINH CITY VIETNAM ! INSTITUTE OF SOCIAL STUDIES THE HAGUE THE NETHERLANDS VIETNAM- NETHERLANDS PROJECT ON DEVELOPMENT ECONOMICS IMPACT OF R&D ON THE PRODUCTIVITY GROWTH OF MANUFACTURING FIRMS IN VIETNAM ?· ' By Duong Thi Phuong Ngoc Academic supervisor: Dr Vo Van Huy TRUONG £),b,l HOC I"INH TE TP.HCM ' CHUONG TRINH HQ~ 1A~ £)~O }~ CAO HQC KINH TE PHAT TRIEN VI~T NAM- Hf> LAN (UEH-ISS! Ho Chi Minh City, November, 2008 CERTIFICATION I certify that the substance of this thesis has not already been submitted for any degree and is not being currently submitted for any other degrees I also certify that, to the best of my knowledge, any help received in preparing this thesis, and all sources used, have been acknowledged in the thesis Signature Duong Thi Phuong Ngoc i ACKNOWLEDGMENT In completing this thesis, I am indebted to numerous individuals but I cannot name them all here First of all, I would like to thank all the staff and teachers of the Project for their valuable lessons, good learning facilities and warm attitudes during my school time My deepest gratitude goes to my supervisors, Dr Vo Van Huy, and Dr Nguyen Trong Hoai for their valuable comments and instructions concerning my thesis I am also very grateful to Mr Luong Vinh Quoc Duy, a teacher of the Project, for his support and lectures in econometrics Finally, I would like to thank my friends, my family who have been always behind me, given me moral support, encouragement, and sympathy that have helped me gain more strength to complete this work ABSTRACT This study exammes the relationship between R&D expenditure and productivity growth of manufacturing firms in Vietnam Data on 264 manufacturing firms having positive R&D, which was drawn from the data set of Vietnam Enterprise Survey conducted by the General Statistics Office in 2004, is used for analysis A regression model is estimated based on the Cobb-Douglas production function and the R&D capital model with three main independent variables: physical capital, labor and R&D capital, and dummy variables reflecting type of ownership and size of labor R&D capital is measured in a simple way by using available R&D expenditure in the survey and ignoring the accumulation of R&D expenditure in the past, its deflation and obsolescence However, a positive and significant impact of R&D expenditure on i productivity is found with the elasticity of productivity with respect to R&D expenditure per labor is about 0.1 Moreover, the effects of physical capital and labor on productivity are also positively and statistically significant The elasticities of productivity with respect to physical capital per labor and total labor are around 0.35 and 0.15, respectively TABLE OF CONTENT i CHAPTER!: INTRODUCTION 1.1 RATIONALE OF THE RESEARCH 1.2 OBJECTIVE OF THE RESEARCH 1.3 RESEARCH METHODOLOGY 1.4 THESIS STRUCTURE CHATPER 2: LITERATURE REVIEW 2.1 INTRODUCTION 2.2 CONCEPTS 2.2.1 Research and experimental development (R&D) 2.2.2 Productivity 2.2.3 Manufacturing sector 2.3 ECONOMIC THEORIES Production theories 2.3.1 2.3.1.1 Cobb-Douglas Production Function 2.3 1.2 The Law of Diminishing Returns 11 2.3.2 R&D Capital Model 12 2.3 Suggested research model from economic theories 14 2.4 EMPIRICAL STUDIES 15 2.4.1 Overview 15 2.4.2 R&D and Productivity in French manufacturing firms 16 2.4.3 R&D and Productivity Growth in Japanese manufacturing firms 18 2.4.4 The effect of R&D Capital on Danish Firm Productivity 19 2.5 SUMMARY 20 CHAPTER 3: OVERVIEW OF R&D AND FIRM PERFORMANCE IN VIETNAM 22 3.1 INTRODUCTION 22 3.2 R&D ACTIVITIES IN VIETNAM 22 3.3 STRUCTURE OF THE R&D SYSTEM IN VIETNAM 25 LINKAGE BETWEEN THE PRODUCTIVE SECTOR AND R&D INSTITUTIONS 27 3.5 SUMMARY 29 CHAPTER 4: RESEARCH METHODOLOGY 30 4.1 INTRODUCTION 30 4.2 MODEL SPECIFICATION 30 4.3 DATA TRANSFORMATION 34 4.3.1 Labor productivity based on output (Y/L) 34 4.3.2 Physical capital per labor (K/L) 35 4.3.3 R&D expenditures per labor (RIL) 35 4.3.4 Firm sizes (LARGESCL, MEDIUMSCL) 35 4.3.5 Types of ownership (STATE, FOREIGN) 36 4.4 SUMMARY 36 CHAPTER 5: RESULT ANALYSIS 37 5.1 INTRODUCTION 37 5.2 FIRMS CHARACTERISTICS 37 5.3 REGRESSION ANALYSIS 43 5.3 SUMMARY 47 CHAPTER 6: CONCLUSIONS AND RECOMMENDATIONS 48 6.1 CONCLUSION 48 6.2 POLICY RECOMMENDATIONS 50 6.2.1 Experience of Korea 50 6.2.2 Policy Recommendations 51 6.3 LIMITATIONS OF THE RESEARCH 52 REFERENCE 54 APPEND IX 57 Appendix 1: A System Model for Technological Innovation 58 Appendix 2: Regression results 59 Appendix 3: White Heteroskedasticity Test 59 j • LIST OF TABLES Table 2.1: Overview of main productivity measures Table 3.1: Science & Technology Organizations in Vietnam by 31 Dec 2003 26 Table 3.2: Ranking of most wanted services (for firms) and most capable activities (for academic institutions) of enterprises 28 Table 5.1: Industrial Classification of the Sample 39 Table 5.2: Statistics Summary 41 Table 5.3: Correlation matrix from the variables in the function 43 Table 5.4: Coefficients and statistics for the productivity model 45 LIST OF FIGURES • Figure 2.1: The effect oftechnology improvement 12 Figure 3.1: Percentage ofGDP spent on R&D in 1996 23 Figure 3.2: Expenditure on R&D by Government and Business sector in 2002 23 Figure 3.3: Sector-wise R&D Expenditure in Vietnam in 2002 24 Figure 3.4: R&D Personnel per Thousand of Total employees in 2002 25 Figure 5.1: R&D firms by ownership 38 Figure 5.1: Structure of firms by size 38 Figure 5.3: Total cost for research & development of technology by resources 42 Figure 5.4: Total cost for research & development of technology by purposes 42 • ACRONYMS CBO Congressional Budget Office EU European Union GDP Gross Domestic Product MFP Multifactor Productivity MOST Ministry of Science and Technology NACE Classification of Economic Activities in the European Community NISTPASS National Institute for Science and Technology Policy & Strategy Studies OECD Organization for Economic Cooperation and Development OSTP Office of Science and Technology Policy R&D Research & Development SME Small and Medium Enterprise VES Vietnam Enterprise Survey VND Vietnamese Dong CHAPTER! INTRODUCTION 1.1 RATIONALE OF THE RESEARCH In the modem economy today, technological progress has a quite central role It contributes importantly to growth of economy and is a key factor to determine the competitiveness of firms in both national and international marketplace Research and Development (R&D) is widely regarded as the core of technological advance, and innovative capacity of firms are reliably indicated by levels and rates of R&D expenditures growth Countries belonging to the Organization for Economic Cooperation and Development (OECD) spend significant amounts on R&D activities On average, OECD countries have spent more than percent of GDP on annual public and private R&D investments during the last two decades (OSTP , 1997) In a traditional way, firms have paid attention to R&D because the technical advances resulting from innovation may allow them to improve productivity, succeed in competitive markets, and meet environmental and regulatory requirements Besides, R&D has also had contribution to the development of new products and, in many cases, the creation of new markets Within firms, economic returns are always taken into consideration on deciding the importance and nature of R&D performance Firms usually take part in R&D activities only when the results are appropriate and offer higher rates of return than that of other available investment alternatives such as acquisition of new machinery, advertising, or purchase of speculative assets There are many sources for productivity improvements, but one strategy for enhancing productivity growth which is widely acknowledged is increasing the stock of knowledge This stock of knowledge can be increased by formal investment in OSTP is Office of Science and Technology Policy R&D activities In the private and public sectors, the allocation of resources toward the investment to generate new knowledge must be decided carefully In spite of the importance of R&D in firms' productivity, R&D activities have not been taken into consideration for much investment in Vietnam, especially in business sector While most OECD countries and China devoted around 2% of their GDP to R&D activities, Vietnam spent only 0.5% of its GDP for this purpose (Nguyen and Tran, n.d.) R&D expenditure of Vietnamese enterprises accounted for only about 20% of the total R&D expenditure of the country in 2002 (Nguyen, n.d.) Whereas, according to OSTP (1997), companies in OECD countries finance more than 50% of all R&D expenditure and they conduct two-thirds of all R&D activities SMEs make up the vast majority of registered companies in Vietnam, namely 96.5% Nevertheless, the technology level across the SME sector in Vietnam is generally assessed as being two, three or even more times lower than both world and regional levels (Bezanson et al., 2000) One of main reasons under the assessment of the Ministry of Industry is that the labor currently lack of necessary skills to support technological upgrading and there are very little R&D activities appropriate for such upgrading Indeed, only a small fraction of the country's R&D scientists and engineers are working in industrial enterprises The rest are working in national centers for R&D, ministries and government agencies, universities or other institutions that perform research Another reason is that there is little market-oriented relationship between firms, R&D institutions and universities (Bezanson et al., 2000) Moreover, the most important reason for a little investment in R&D activities of Vietnamese enterprises may be their limitations in financial resources The case of Vietnam raises a doubt if R&D has any relationship with productivity of manufacturing firms Practically, there are many empirical studies at firm level that has emphasized the role of technological or knowledge capital in productivity growth Early studies focused on R&D investment and found that in most countries, R&D has - number means that a 1% increase in R&D expenditure per labor leads to only 0.1% increase in productivity This number is acceptable because Griliches (1995) demonstrated in a cross-sectional study that the output elasticity of R&D capital was around 0.09-0.14 (cited in Wang and Tsai, 2003) Thus, physical capital and labor have more effects on productivity than R&D expenditure This can be explained that Vietnamese enterprises not care much about investing for R&D while labor is a cheap and easily-accessed input Even though the result that R&D expenditure has positive effect on productivity in this case, there are some points needed to be discussed Wang and Tsai (2003) said that the conclusion that R&D investment has a positively significant impact on productivity in most studies may be overoptimistic due to the problems of 'filedrawer' and measurement of R&D capital As mentioned before, due to limitation of the data, this study fails to measure R&D capital in a way other studies often It neglected the accumulation of R&D expenditure in the past, its lag, deflation and obsolescence However, the regression result is a surprise to the author It may be explained that because most R&D activities of Vietnamese enterprises are problemsolving, not science-based; and most of R&D expenditure are for developing technology, not for research (Figure 5.4) Such technology-developing activities have direct effects on technology and therefore on productivity more quickly than research activities 5.3.2.3 Statistical validity of the model In this model, the hypothesis of constant return to scale with respect to three inputs (K, L, R) is tested The coefficient of natural log of total labor or a (see model4.2) is a scale parameter This coefficient is statistically significant and around 0.15, which implies that the assumption of constant returns to scale is rejected at the significant level of 1% and increasing returns to scale is accepted 46 There are two important tests in this model: multicollinearity and heteroscedasticity These tests are to make sure the statistic validity of the model It is unnecessary to test multicollinearity problem for the model because most of the correlation coefficients between regressors did not exceed 0.5, except some correlation coefficients relating to dummy variables (Table 5.3) Moreover, independent variables included in the model were statistically significant at 1% and R square of the model were lower than 0.8 (Table 5.4 and Appendix 2) Regarding heteroscedasticity, the model was handled to be free of it Detailed results of White Test are shown in the Appendix 5.3 SUMMARY This chapter analyzed characteristics of firms in the sample and regression results of the productivity model The main research question that whether R&D expenditure has positive impact on labor productivity growth in Vietnamese manufacturing firms is answered The elasticity of labor productivity with respect to R&D expenditure per labor is positively and statistically significant with the value of about 0.1 Moreover, physical capital per labor and total labor variables also have positive and significant effects on labor productivity growth with elasticities of around 0.35 and 0.15, respectively ; If multicollinearity occurs, the model will have few t-ratio significant ratios and R squared of the model is very high (Gujarati, 2003) 47 ,[CHAPTER6 CONCLUSIONS AND RECOMMENDATIONS 6.1 CONCLUSION In this study, the relationship between R&D expenditure and productivity of manufacturing firms has been analyzed based on a sample of 264 manufacturing firms reporting positive R&D The sample was drawn from the data set including 91,755 observations in all sectors of the Vietnam Enterprise Survey in 2004 In the sample, state-owned firms account for 59.47% while foreign firms account for only 11.74% Large scale firms (>249 employees) make up more than 60% of the sample, the medium (50 - 249 employees) and small (1- 49 employees) make up 25.38% and 13.26%, respectively With reference to the industrial classification, firms manufacturing Chemicals and Chemical Products account for the largest share of the sample (17.08%) The second largest share belongs to firms operating in the Food Products and Beverage manufacturing (17.05%) The statistic summary indicates that state-owned enterprises seem to perform in a le~s efficient way than foreign ones on average Furthermore, foreign firms seem to be stronger in capital resource and invest more in innovation, R&D activities than stateowned firms and the others Regarding the structure of total cost for research and development of science & technology of manufacturing firms in the sample, 82% of the cost is financed by firms themselves Nevertheless, 81% of such cost is used for developing technology and just 17% is used for research In relation to the analytical framework of the research, the regression equation was estimated mainly on the basis of the Cobb-Douglas production function and the R&D capital model It was formulated in a logarithmic form and had statistical validity The regression model can be written as follows: 48 Log(y) L = 2.24 + 0.351og(K) + O.IOlog(R) + 0.15log L + 0.26LARGESCL + L L 0.28MEDIUMSCL + 0.53STATE + 1.34FOREIGN + u (6.1) The most important finding of the research is that R&D investment was a significant determinant of growth of firm productivity Holding other variables constant, I% increase in R&D expenditure per labor leads to about 0.1% of labor productivity growth Even though R&D capital was measured in a much si"mpler way than most related studies usually by using available R&D expenditure in the survey, the result is so surprised It is due to the statistical significance and positive sign of R&D elasticity coefficient The reasons may be that most R&D activities of Vietnamese enterprises are problem-solving, not science-based and most of R&D expenditure are for developing technology, not for research In addition to R&D capital, other independent variables are also statistically significant The elasticities of productivity with respect to physical capital per labor and total labor were around 0.35 and 0.15, respectively Physical capital per labor and labor have more effects on productivity growth than R&D expenditure per labor Moreover, ownership and firm size also have impacts on productivity growth rate If other variables are held constant, it is found that the productivity growth rate in foreign firms is higher than in state-owned and other firms There is no difference between state-owned firms and others due to the insignificance of STATE variable Similar to foreign firms, productivity growth rate of medium-sized firms (50-249 labors) is a little bit higher than that of large-sized firms (>249 labors) and much higher than small-sized firms In conclusion, besides usual production inputs such as physical capital and labor, R&D activities also plays an important role in productivity growth of manufacturing firms in Vietnamese case Hence, the first research question as mentioned in the first chapter is answered Regarding the second research question, manufacturing firms should pay more attention on investment in R&D activities in order to increase their 49 productivity The section below will discuss some policy recommendations to support firms 6.2 POLICY RECOMMENDATIONS 6.2.1 Experience of Korea In order to stimulate R&D activities in the industry sector, the Korean Government used a variety of methods and policies which were flexible to different periods and national development strategies In 1960s and 1970s, polices mainly focused on tax motivation and preferential treatment to R&D activities However, these policies' results were below expected level because firms in the industry sector lacked of clear demand for investment in R&D and they thought that it was easy to access prevailing technology from many sources In 1980s, there were other motivation methods such as: decreasing tax rate applied for importing R&D equipment; spending for R&D and development of R&D human resources were considered as activities deducted from tax; or exempting fixed assets relating to R&D from taxes, and so on Moreover, the Korean Government launched some indirect programs stimulating R&D activities such as International Standard Korean Products Program; or the Government built a list of 21 products relating to 59 manufacturers in the industry sector to provide supports Besides tax motivation methods, the Government also had financial supporting policies to encourage enterprises in investment for R&D activities Small enterprises, which were unable to establish their own R&D centers, were encouraged to cooperate with other firms Thanks to such solutions, the number ofR&D institutes and associations increased sharply, especially in 1980s- 1990s In September 1999, Korean Industrial Property Office launched a campaign to support SMEs This program aimed at encouraging all SMEs to invent new technologies and use them as their key business assets In order to achieve the target, the program was conducted in such steps as strengthening the community's awareness of intellectual 50 ; property; connecting R&D activities with intellectual property; improving patentissuing procedure; and supporting the usage, transaction of patent technologies Furthermore, in order to support financial resources for the commercialization of new technologies, the Government stimulated the development of private venture capital and initiated by establishing government venture funds The Government also enhanced capital market for newly-established firms, science and technology firms; and developed a secondary stock market for them 6.2.2 Policy Recommendations Majority of Vietnamese firms now are small or medium in scale, weak in financial resources; therefore, investment for R&D activities is limited Besides, the domestic market for technology services has not developed, firms not have information about researches, inventories conducted in the country Therefore, many firms just take into consideration the acquisition and development of new equipment, and ignore research or technology transfer SME enterprises often rely on external sources for their R&D because local R&D institutions have not well connected with enterprises For many reasons, R&D activities have not been invested at a proper level However, in the context of international integration today, enterprises have no choice to survive and develop by investing for R&D activities and technology innovation as well These activities may help firms improve production capabilities, which lead to productivity growth, production costs saving, lower price of products and higher competition ability Even though these activities may take times, require a large amount of capital, and suffer high risks, firms must be determined to conduct these activities because it is a long-term investment In addition to firms' own attempts, supports from the authority are necessary to stimulate their R&D investment Thus, in this research, some policy recommendations are drawn based on the experience of Korea and the actual context of Vietnam to encourage firms to invest in R&D activities as follows: 51 Equitizing R&D institutions so that they can be more active, creative and responsible in their activities to meet demand of the productive sector As mentioned before, the research infrastructure of Vietnam is lower than international standards, the link between the productive sector and research institutions is weak Local enterprises depend on external sources for R&D and foreign ones rely on their parent companies in home countries In general, the support of R&D institutions and universities to firms is under desirable level Equitization may enable them to operate in a more market-oriented and efficient way Through this, R&D institutions may have better contribution in supporting enterprises Focus on tax motivation and preferential treatment to R&D activities such as decreasing tax rate applied for importing R&D equipment; spending for R&D and development of R&D human resources are considered as activities deducted from tax; exempting fixed assets relating to R&D or Technology Development Fund from taxes, etc Establishing R&D venture funds of the government to support financial resources for firms and stimulate the development of private venture capital These funds must be managed and supervised strictly to make sure that the capital is used in right places, at right time and for right purposes Stimulating firms to establish their own R&D departments or cooperate with other firms This policy should be specified by programs or campaigns, which are conducted in many years and at the national level 6.3 LIMITATIONS OF THE RESEARCH The research does of course have some limitations First of all, most studies regarding the contribution of R&D to productivity growth suffer the double counting of R&D labor and physical capital, which are counted once in measuring labor and physical 52 capital and once agam m measurmg R&D capital (Cuneo and Mairesse, 1983) However, the research subtracted only R&D labor from the total labor and failed to correct the double counting of physical capital In reality, the task is impossible because the limitation of the data Secondly, due to the availability of data in only one year 2004, the research failed to measure R&D in a way it should have been done R&D capital was measured by available R&D expenditure in the data The research ignored the accumulation of past R&D spending, its lag, deflation and depreciation Moreover, the relationship between R&D expenditure and productivity growth was examined for only year, therefore, the result of R&D elasticity is still skeptical This fact is the suggestion for another research in the future, which use panel data or time-series data, instead of crosssectional data Measurement of R&D expenditure in many years may bring a more reliable result than the recent study does 53 REFERENCE Bezanson et al (2000) A Science Technology and Industry Strategy for Vietnam [online] Available: http://www.unido.org/fileadminlimport/20398_kbfin.pdf Congressional Budget Office (2005) R&D and Productivity Growth [online] Available: http://www.cbo.gov/ftpdocs/64xx/doc6482/06-17-R-D.pdf Cuneo, P and Mairesse, J (1983), Productivity and R&D at the firm level in French manufacturing [online] Available: http://www.nber.org/papers/w1068.pdf Eris, E D and Saatcioglu, Y (2006) A System Look For Technological Innovation: Firm Based Perspective [online] Available: http://www iseing.org/emcis/EMCIS2006/Proceedings/Contributions/C52/CRC/eris% 20&%20saatcioglu%20CRC.pdf Graversen, E K and Mark, M (2005) The Effect ofR&D Capital on Firm Productivity [online] Available: http://www.cfa.au.dk/Publikationer/Working_papers/WP2005 _3.pdf Griliches, Z (2000) R&D, Education and Productivity, London: Harvard University Press Gujarati, D N (2003) Basic Econometrics, Fourth Edition, International: McGraw- Hill Kwon, H U and Inui, T (2003) R&D and Productivity Growth in Japanese Manufacturing Firms [online] Available: http://www.esri.go.jp/jp/archive/e_ dis/e_ dis050/e_ dis044a.pdf I -I Mairesse, J and Sassenou, M (1991) 'R&D and Productivity: A Survey of Econometric Studies at the Firm Level', NBER Working Paper No 3666 • Matteucci, N and Sterlacchini, A (2004) ICT, R&D and Productivity Growth: 54 Evidence from Italian Manufacturing Firms [online] Available: http://www.isae.it/Matteucci Sterlacchini ICT.pdf Nguyen, M.Q (n.d.), The Role of Technology Upgrading to Enhance Growth and Competition: The Case of Vietnam Available: http://info worldbank.org/etools/docs/library/23 8724/8%20AIF-Vietnam-Quan.pdf Nguyen, V.H., and Tran, N.C (n.d.) 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Vietnam's Innovation System: Toward a Product Innovation Ecosystem [online] Available: http://crds.jst.go.jp/GIES/archive/GIES2006/participants/abstract/33 _ ca-ngoctran.pdf US Census Bureau 'NAICS Sector: 31-33 Manufacturing' [online] Available: http://www.census.gov/epcd/ec97/def/31-33.HTM 55 f Wang, J C and Tsai, K H (2003) Productivity Growth And R&D Expenditure In Taiwan's Manufacturing Firms [online] Available: http://www.nber.org/papers/w9724 http://www.ic.gc.ca/canadian industry statistics/cis.nsf/IDE/cis31-33defe.html European Commission (n.d.) The new SME definition: User guide and model declaration [online] Available: http://ec.europa.eu/enterprise/enterprise_policy/sme_definition/sme_user_guide.pdf ' 56 ' APPENDIX 57 • Appendix 1: A System Model for Technological Innovation lmpl•m•ntation I N p u T De