Economic transformation: private sector and SMEs take the baton

May 23, 2017 | 15:07
With the government’s efforts to develop the private sector in a bid to foster economic growth, Dominic Mellor, senior country economist for the Asian Development Bank in Vietnam and leader of the Mekong Business Initiative, provides an in-depth analysis.
Economic transformation: private sector and SMEs take the baton
Dominic Mellor, senior economist of the Asian Development Bank and leader of the Mekong Business Initiative

Since doi moi, Vietnam has been ranking as one of the world’s most dynamic market economies. The country’s GDP has grown at an impressive seven per cent on average over the last 15 years. Yet growth has begun to slow, and the so-called “fourth industrial revolution” is forcing economists to confront structural weaknesses in the economy.

What will it take to shore up Vietnam’s economic transformation? The answer is as simple to articulate as it is complex to execute: Vietnam needs a more dynamic and innovative private sector fuelled by home-grown entrepreneurship. Foreign direct investment in manufacturing can continue to be a valuable source of jobs and investment in the short term.

In the long term, however, only home-grown small and medium-sized enterprises (SMEs) can feed the economy’s hunger for innovation and productivity. Fortunately, Vietnamese people have an entrepreneurial temperament. If given sufficient incentives to innovate, they will be up for the challenge.

The government has recognised SMEs’ importance. Resolution 35 set a goal of one million enterprises by 2020. Unfortunately, the economy is currently at risk of falling short of this benchmark. As of 2017, the total stands below 600,000.

This shortcoming is not for lack of trying. The government has compiled any number of plans and programmes to support entrepreneurship. However, in the policy dialogues between SMEs and government officials, entrepreneurs often question the efficacy of these programmes.

The government has circulated a draft Law on Supporting SMEs, and plans to implement it are under development. Municipalities, including Ho Chi Minh City and Danang, have frameworks and five-year action plans to support startups and innovation. The Mekong Business Initiative (MBI) has been working with local governments to make sure that reforms offer better targeted and higher quality support to SMEs.

The government initiatives to support the private sector yield the best results when they receive input and feedback directly from the private sector. Historically, though, SMEs have been struggling to be heard in the public-private dialogue.

MBI has worked hard to involve SMEs in policy dialogue. Last year, we helped launch Vietnam Private Sector Forum in partnership with the Vietnam Young Entrepreneurs’ Association. We have also supported the dialogue between government and women’s business associations and have involved entrepreneurs in frameworks and action plans to support entrepreneurship at the municipal level. We hope that based on private sector feedback, the government will continue to reform and modernise support for the private sector.

However, government policies cannot remove all bottlenecks to entrepreneurship and innovation. SMEs also need better access to private sources of financing.

Unlike lenders in highly developed economies, banks in Vietnam typically do not extend credit without collateral. Nor do they offer cash flows or invoice financing. Thus, Vietnamese SMEs must turn non-bank sources for funds to expand or cover short-term cash flow requirements. The current alternative financing instruments available to them are limited: mainly loans from friends, family, and community-based networks.

The recent worldwide explosion of financial technology (fintech) promises to fill the gaps in enterprise financing. Some technologies facilitate peer-to-peer lending. Other technologies, such as Blockchain, provide greater security and verifiability for invoice financing. Before these solutions can be adopted in Vietnam, the government must warm to emerging technologies and offer sandboxes for testing, verifying, and regulation.

Since last November, MBI has been facilitating workshops with officials from the Ministry of Finance and other financial regulators across the Greater Mekong Subregion. Step by step, regulators are realising fintech’s potential and are considering ways to adapt regulatory best practices in Vietnam.

If we truly want a dynamic private sector, though, Vietnamese entrepreneurs must develop their capacity for innovation. Vietnam exported $16 million worth of electronics in 2015 and is ranked 59th out of the 128 countries in the 2016 Global Innovation Index (GII). Continuing to develop Vietnam into a first-tier innovation economy will help entrepreneurs find international markets, protect their innovations from competition, and attract international investment. It will also help Vietnamese enterprises improve productivity.

For this to happen, the country must address weaknesses at the institutional level. GII ranked firm’s innovative capacity in Vietnam only at 101th, with private sector firms investing only 3 per cent of their budgets into research and development.

Vietnamese technology startups have begun to attract interest from venture capital funds. Plenty of co-working spaces, incubators, and acceleration programmes have popped up to fuel their development. Nonetheless, Vietnamese tech startups have yet to find a collective identity or to exploit a globally competitive niche. Instead, most technology startups and SMEs do small-scale, contract component manufacturing or adapt foreign software and online services for the domestic market.

MBI has identified several verticals where innovative Vietnamese firms have the potential to find both strong domestic markets and competitive niches globally. These include financial, travel, and agricultural technology as well as technological solutions for managing urban density. In these verticals, Vietnamese entrepreneurs have internationally valid insights, clear and pressing market needs at home, and the ability to use the domestic market as an incubator for solutions that might one day ‘go global.’

It is up to the private sector to innovate, but there are ways the government can help. The Vietnamese government should explore new incentives for enterprises to invest in research and development, as well as technology transfer. I should also mention government investments in education and training to increase the availability of highly-skilled labourers in science and engineering.

Finally, the government needs to do more to simplify licensing and permitting and to reduce the regulatory burdens on Vietnamese SMEs. In the face of heavy paperwork and compliance costs, many businesses would rather stay small and informal than grow big enough to pop up on the government’s radar.

Informal businesses do not operate efficiently, struggle to attract talent and innovate, and cannot participate in international value chains.

While the government has made significant strides forward in reducing licensing and permitting requirements for business, much work remains to be done.

SMEs still must navigate more than 6,000 mini permits. To help the government prioritise reforms, MBI is supporting the Central Institute for Economic Management to develop a new tool. This tool will measure the compliance cost of enterprises for every license, permit, and regulation. With this data, the government will be able to target and prioritise reforms more effectively.

The fourth industrial revolution is upon us. Startups and SMEs must pick up the baton from state-owned enterprises and foreign direct investment projects. Only SMEs have the innovative capacity to accelerate Vietnam’s long-term economic development.

Government policy, forged in dialogue with entrepreneurs, can help SMEs along by easing regulatory and compliance burdens, providing better support for business development support, facilitating access to new sources of finance, and improving their capacity for innovation.

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By By Dominic Mellor - Leader of Mekong Business Initiative

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