DETERMINANTS OF NEW FIRM FORMATION THE CASE OF VIETNAM. DETERMINANTS OF NEW FIRM FORMATION THE CASE OF VIETNAM. DETERMINANTS OF NEW FIRM FORMATION THE CASE OF VIETNAM. DETERMINANTS OF NEW FIRM FORMATION THE CASE OF VIETNAM. DETERMINANTS OF NEW FIRM FORMATION THE CASE OF VIETNAM.
INTRODUCTION
Rationale of the thesis
The theory of the firm is fundamental to economics, highlighting the significant role of new enterprises in economic development, often discussed in the context of competition Since Adam Smith's era, economists have recognized that new competitors drive prices toward competitive levels, enhancing technical and allocation efficiency Research indicates a long-term positive correlation between the formation of new firms, productivity, and economic growth (Van Praag and Versloot, 2007; Karlsson and Nystrom, 2008) These productivity improvements stem largely from innovations, as new firms often emerge from innovative ideas, serving as a vital force for technical progress and the commercialization of innovations (Acs et al.).
The establishment of new firms is crucial to the structural change process, as it facilitates the reallocation of resources, leading to more efficient resource utilization (Schumpeter, 1934, 1942).
In recent decades, the formation of new firms has gained significant attention from researchers and policymakers due to its crucial role in driving economic growth and development A thriving economy relies not only on a robust existing business landscape but also on a steady influx of new business ventures Studies indicate that low levels of business ownership can negatively impact economic growth, while new businesses are often more innovative and contribute significantly to job creation.
2014) Entrepreneurship is a key element of evolutionary economics (Schumpeter1934; Witt 1998; Grebel et al 2003; Metcalfe 2004; Grebel 2007) and has been
Regional economic development is significantly influenced by the formation of new firms, as highlighted by various studies (Acs and Armington 2004; Audretsch et al 2006; Fritsch 2008) Understanding the factors behind regional differences in entrepreneurship has become crucial, especially given the notable disparities in entrepreneurship rates and their determinants both within and between countries (Bosma and Schutjens, 2008).
Most studies on the transition from a command to a market economy have concentrated on the privatization of existing firms, often overlooking the importance of new firm creation as a vital growth channel New firms stimulate competition, compelling established companies to enhance their products and production methods Those unable to adapt ultimately fail, allowing only the most capable firms to thrive and drive economic growth This dynamic underscores the ongoing interest of researchers in this area, particularly following Birch's groundbreaking research.
In 1979, the significance of small firm formation for job creation was acknowledged, leading to increased interest in new firm formation among researchers and policymakers Consequently, studies began to assess the factors influencing entrepreneurship, focusing on the effects of the business environment, institutional frameworks, and government involvement.
When establishing a new enterprise, investors must consider various factors that influence business creation Understanding these determinants can aid local governments in recognizing their strengths and weaknesses This master thesis, titled "Determinants of New Firm Formation: The Case of Vietnam," aims to systematically analyze the key factors influencing new business formation in Vietnam using the most recent data Based on the research findings, the study will offer policy recommendations to assist the government in enhancing investment attraction strategies, ultimately increasing the number of active enterprises in the country.
Object and objective of the thesis
This thesis investigates the key determinants influencing new firm formation in Vietnam, identifying the most significant factors that impact potential entrepreneurs' decisions to establish businesses By providing a comprehensive understanding of these determinants, the study aims to offer valuable recommendations for policymakers to enhance the business entry rate in Vietnam.
What is the definition of new firm formation?
Why new firm formation is important to the development of a country?
What is the current situation of new firm formation in Vietnam?
What are the key factors affecting in new firm formation in Vietnam?
Which policy implications can be suggested in order to encourage new firm formation in Vietnam?
Methodology
This study examines the impact of various factors on new firm formation in Vietnam from 2015 to 2018, utilizing three estimation methods: Pooled Ordinary Least Squares (POLS), Random Effects Model (REM), and Fixed Effects Model (FEM) To determine the most suitable estimation approach, tests such as the Breusch and Pagan Lagrangian multiplier test and Hausman tests were conducted The analysis incorporates first-order lag for time-variant independent variables to address endogeneity issues The findings from the linear regression will be presented to identify the key factors influencing new business creation in Vietnam.
This dissertation employs secondary data from 63 provinces in Vietnam, sourced from publications and reports by the General Office of Statistics (GSO) as well as official government articles and websites.
Scope of the thesis
This study analyzes the determinants influencing new business formation in Vietnam from 2015 to 2018, focusing on key factors such as the unemployment rate, population growth, population density, urbanization, income levels, exit rates, foreign direct investment (FDI), mean establishment size (MES), and the Provincial Competitiveness Index (PCI).
Structure of the thesis
In detail, this dissertation is divided into five chapters as follows:
Chapter 1 – Introduction: Giving overview of the current context, introducing the necessity of the topic as well as the overall research method of this thesis General structure of the thesis is also included in this chapter.
Chapter 2 – Theoretical framework about new firm formation and literature review:
This section will focus on examining the theoretical framework surrounding new firm formation It will summarize existing literature on the determinants of new firm formation, drawing on empirical findings from studies worldwide to identify key explanatory variables for model estimation Finally, the author will outline the research hypotheses related to the model.
Chapter 3 – Situation of new firm formation in Vietnam: This chapter applies qualitative methods to analyse the current situation of new firm formation in Vietnam Basing on these actual situations, this chapter also assesses intuitively the impact of new firm formation on Vietnam’s economic development during the aforementioned period.
Chapter 4 – The model and empirical results: Insights into the research method, the model, data collection and empirical results in the examined period through quantitative analysis The last part of this chapter illustrates the empirical results from the regression estimation of different models including POLS, REM and FEM by using econometrics software STATA.
Chapter 5 – Policy implications and conclusions: In this final chapter, after summing up all essential findings of the research based on the discussed regression results in chapter 4, some recommendations shall be suggested to help VietnameseGovernment as well as policymakers to promote the formation of new businesses,thereby stimulating the positive influences of new firm formation on economic development of Vietnam.
THEORETICAL FRAMEWORK ABOUT NEW FIRM
Overview about new firm formation
2.1.1 Definition of new firm formation
Enterprise creation involves organizing new organizations by coordinating interdependent actions into effective sequences that lead to meaningful outcomes This process typically unfolds in five key stages: identifying business opportunities, defining the business concept, mobilizing resources, forming the enterprise, and launching the business However, it is important to note that these stages are dynamic and case-specific, meaning they do not always follow a linear progression Entrepreneurs may also abandon their efforts if they determine that their business ideas are not viable or promising.
Enterprise creation involves the establishment of new organizations by coordinating interdependent activities into logical sequences that produce meaningful results This process typically unfolds in five distinct stages.
Bhave (1994) posits that opportunity recognition can occur before the decision to launch a new venture, often arising when aspiring entrepreneurs encounter unmet needs that existing vendors cannot address As they seek solutions to these needs, they realize the broader market potential, identifying it as a viable business opportunity Conversely, opportunity recognition may also follow the decision to start a venture, influenced by personal or environmental disruptions In such cases, entrepreneurs may identify numerous opportunities but only pursue a select few, leading them to align their knowledge, skills, and resources with market demands.
In Stage 2, entrepreneurs must clarify their business concepts to align customer needs with their own perceptions (Bhave, 1994) This involves developing a business model by setting firm objectives, determining size, drafting a vision, assessing risks, and defining success criteria (Ardichvilia et al., 2003; Morris et al., 2005) Entrepreneurs often document these elements in a business plan, either out of personal preference or due to requirements from financial institutions (Honig & Karlsson, 2001) However, the impact of the business plan on project realization remains uncertain (Gasse et al.).
2004) although researchers tend to advocate several advantages for making business plans (Filion et al., 2009).
To successfully realize their business vision, entrepreneurs must effectively mobilize essential resources, including organizational, technological, human, social, financial, and physical assets (Brush et al., 2001) Research indicates that collaboration within teams is crucial for entrepreneurial success, with team members often being family, friends, or colleagues (Brush et al., 2001; Ruef et al., 2003; Aldrich et al., 2004) Additionally, Ruef et al (2003) highlight that team members typically share similar characteristics, which facilitates joint decision-making and mutual support through the challenges and triumphs of the business journey.
In Stage 4, entrepreneurs focus on establishing their organization, often choosing locations near their homes or even setting up in their residences (Gasse et al., 2002; Borges et al., 2005) Key factors influencing their choice of premises include quality of life, proximity to home, and available space, rather than regional advantages or access to research and development (Filion et al., 2006) Additionally, founders must develop an organizational structure for their business (Gartner, 1985) After the organization is established, they can decide to operate informally or register it as an official enterprise (Schneider & Enste, 2000; Bennett, 2010).
In Stage 5, once the organization is established, launching the business becomes essential The actions taken during this phase play a crucial role in shaping the future success of the firm, as highlighted by McMullan & Long (1990) and supported by research from Duquette-Labrecque et al.
Research by Filion et al (2005, 2006) indicates that the duration from decision-making to execution is longest for launching the first product, followed by making the first sale, and then hiring the initial employee This variation in gestation periods highlights the significance of these activities for entrepreneurs.
As the enterprise creation process is dynamic and case-specific, the previous stages do not necessarily occur in sequence (Bhave, 1994; Bruyat & Julien, 2001).
2.1.3 Measurement of new firm formation
Measuring the absolute number of new market entrants can be misleading due to the varying sizes of markets, whether by product or region For instance, if one market has twice the number of new entrants compared to another but is also twice as large, it would be incorrect to conclude that entry activity is higher in the first market To make meaningful comparisons across markets of different sizes, the absolute number of entrants must be standardized Two primary approaches for measuring and comparing entry activity across markets are the ecological approach and the labor market approach, as noted by Audretsch and Fritsch (1994b) Additionally, Storey (1991) categorized the literature into two distinct groups.
The first category of industrial organization theory focuses on how industrial structure influences the establishment of new enterprises This approach assesses whether market structure facilitates or hinders new firm formation by calculating entry rates relative to the existing stock of firms By standardizing the number of new entrants against the existing business population, this ecological approach provides insights into entry activity in relation to market size It is widely used in industrial organization literature, where empirical studies explore the varying degrees of market entry across different product markets.
The second research category focuses on labor market theory, linking annual firm formation to employee numbers within the same region, sector, and year By utilizing integrated data, the study aims to identify the factors that influence new firm creation and the decision-making process of potential entrepreneurs, particularly in relation to their labor market status This method seeks to standardize the number of new entrants in accordance with workforce size, under the premise that new entrepreneurs emerge from the existing labor pool The labor market approach, grounded in the entrepreneurial choice theory by Evans and Jovanovic (1989), posits that each new firm is initiated by an individual already within the same labor market It acknowledges the mobility of labor across different markets but assumes that prospective entrepreneurs have prior experience in the workforce before launching their businesses.
Empirical studies on regional entry rates often utilize the labor market approach, as highlighted by Van Stel and Storey (2004) This approach distinguishes between independent start-ups and those that are subsidiaries of established firms Independent entries are linked to the local workforce, whereas new subsidiaries are tied to the presence of existing businesses Essentially, independent start-ups arise from the available labor pool, while subsidiaries emerge from the existing stock of firms in the region.
This thesis adopts the labor market approach to analyze a country's attitude toward entrepreneurship, grounded in the theory of entrepreneurial choice A key assumption of this approach is that entrepreneurs operate within the same labor market as their new firms Given that most new businesses are often started at home or nearby (Stam, 2009) and that new entrepreneurs typically possess regional work experience, this assumption is deemed valid.
2.1.4 The importance of new firm formation
The entry of new businesses into an industry can significantly impact economic performance both directly and indirectly The direct impact is evident through the creation of new jobs within these businesses as they commence operations Meanwhile, the indirect effects pertain to the influence that these new entrants have on established firms within the market, shaping overall industry dynamics.
2.1.4.1 Direct impacts of new firm formation on economic development
New businesses play a crucial role in economic development and regional well-being, as their formation directly impacts uneven economic performance By fostering competition, providing employment, and promoting local ownership, new firms contribute significantly to the long-term health of the economy High rates of new business creation are associated with innovation, the development of new products, and the generation of new employment opportunities, ultimately linking them to enhanced economic well-being.
Literature review about determinants of new firm formation
Numerous studies have explored the economic impact of new firm formation and its determinants, employing various research methods based on different starting points A range of theoretical models exists to investigate the factors influencing the establishment of new firms This article focuses specifically on nine key determinants of new firm formation in Vietnam: unemployment rate, population growth, population density, urbanization, income level, exit rate, foreign direct investment (FDI), mean establishment size (MES), and the Provincial Competitiveness Index (PCI).
Research indicates a complex relationship between new firm formation and unemployment, with the unemployment rate being a significant influencing factor The literature presents conflicting views, leading to the development of two main hypotheses: the recession-push and prosperity-pull theories The recession-push hypothesis posits that higher unemployment decreases disposable income and local demand, which in turn diminishes new firm formation rates (Mocnik, 2010) Supporting this perspective, studies by Delfmann et al (2014), Sutaria and Hicks (2004), Fotopoulos (2014), and Audretsch and Fritsch (1994) show that increased unemployment correlates with reduced business entry Additionally, evidence from Tervo and Niitykangas (1994) and Sutaria (2001) reinforces the negative relationship between regional firm formation and unemployment levels.
The second perspective posits that higher unemployment rates can drive individuals to start their own businesses as a means of securing employment, as the potential benefits of self-employment often surpass social allowances Consequently, rising unemployment may lead to an increase in entrepreneurship out of necessity, with start-up enterprises more inclined to hire labor, thus enhancing the motivation to launch new ventures (Okamuro & Kobayashi, 2005) For example, Reynolds et al (1995) noted that individuals often resort to starting businesses when job opportunities are scarce, while Storey (1991) indicated that high unemployment rates can elevate entry rates into entrepreneurship Hamilton (1989) argued that the relationship between unemployment and new firm formation is not straightforward, varying based on whether a certain unemployment threshold is met Most studies utilizing interviews or surveys support the notion of a positive correlation between unemployment and new business creation (Binks and Jennings, 1986; Vivarelli, 1991), although Storey (1991) and Audretsch and Fritsch (1994) identified both positive and negative associations, and Fritsch and Falck (2002) found no significant relationship.
Population change significantly impacts new firm formation by creating opportunities for economic activity as larger consumer markets emerge due to population growth (Armington and Acs, 2002; Wennekers et al., 2005) The demand for goods and services increases, fostering prospects for new businesses and driving start-up activity (Reynolds et al., 1995) Additionally, population growth can motivate individuals to pursue self-employment as it intensifies competition for jobs and reduces opportunity costs (Verheul et al., 2001) While some studies have shown no significant effect (Audretsch and Fritsch, 1994; Garofoli, 1994), many others confirm a positive relationship between population growth and start-up rates (Armington and Acs, 2002; Bosma et al., 2008; Reynolds et al., 1995; Wennekers et al., 2005) Research by Ian Hathaway and Robert E Litan (2014) indicates a strong correlation between population growth in the 1970s and firm formation rates, suggesting that regions with higher population growth experienced greater entrepreneurial activity.
In 2004, researchers discovered that population growth did not have a significant positive impact on the formation of new firms Nonetheless, they acknowledged that the limitations of their modeling may have hindered the ability to accurately reflect the anticipated positive correlation between population growth and new business creation.
Population density significantly influences the birth of new firms, with research indicating a positive correlation between urbanization and firm formation rates (Reynolds et al., 1994) Studies by Audretsch and Fritsch (1994) further support this relationship, highlighting that higher population density fosters new entrepreneurial activities Urban areas with elevated population density exhibit greater levels of entrepreneurial activity (Bosma & Schutjens, 2011) However, it's important to note that once a region has fully leveraged the advantages of urbanization, high population density may lead to negative consequences (Delfmann et al., 2014).
Research by various scholars, including Audretsch and Fritsch (1994) and Guesnier (1994), highlights the positive correlation between population density and new business formation, suggesting that increased population drives demand for goods and services, leading to higher rates of new firm establishment High population density facilitates access to diverse markets for essential resources like capital and labor, as noted by Fritsch and Mueller (2006) Studies consistently show that population density significantly influences new firm entry, with Gaygisiz and Koksal (2003) identifying it as a key factor in Turkey's manufacturing sector Furthermore, Guesnier (1994) and Audretsch and Fritsch (1994) found similar trends in France and Germany, respectively However, Garofoli (1994) presents a contrasting view, indicating that population density does not significantly affect new business formation in Italy.
The degree of urbanization refers to the percentage of the population residing in urban areas, highlighting the benefits of dense regions for new business formation Urban environments offer labor market opportunities, enhanced information flow, and a diverse range of goods and services, making them attractive for entrepreneurs The varied demographics in urban areas lead to increased demand and stimulate innovation, as cities with higher diversity are more likely to support new firm start-ups Additionally, densely populated regions provide favorable market entry conditions due to closer consumer proximity and advanced business infrastructure.
Agglomeration effects significantly enhance new firm formation by creating increased local market opportunities for consumers and essential inputs Businesses located in densely populated areas benefit from positive externalities, such as reduced transportation costs and proximity to suppliers and customers, which help lower expenses and improve product quality Additionally, urbanization fosters a skilled workforce and accelerates the flow of ideas and knowledge The presence of abundant employment opportunities in urban settings also mitigates the risks associated with starting a business, providing a safety net in the event of a failure.
The impact of urbanization on the establishment of new firms is debated, as increased urbanization can drive economies of scale, allowing larger firms to operate more efficiently and potentially reducing opportunities for smaller enterprises (Verheul et al., 2001).
Agglomeration can lead to negative consequences such as heightened competition, which may drive up wages and input costs, ultimately deterring new entrants (Nyström, 2007) Additionally, research by Van Stel and Suddle (2008) indicates that in the Netherlands, service start-ups experience adverse effects due to their lower reliance on the advantages of agglomeration.
Income plays a dual role as both a demand and supply factor, influencing entrepreneurship While income growth boosts demand and provides access to capital for aspiring entrepreneurs, high wages can create high opportunity costs for self-employment, potentially leading to lower start-up rates Verheul et al (2001) highlight that higher salaries may deter individuals from launching their own businesses, as the opportunity cost of leaving stable employment increases Additionally, high income levels can raise labor costs, which may discourage market entry in sectors sensitive to these expenses (Nystrom, 2007) Research by Santarelli et al (2009), Audretsch and Fritsch (1999), and Fotopoulos and Spence (1999) supports the notion of a negative correlation between wages and new firm formation in developed countries, while Bosma et al (2008) note that elevated hiring costs can further inhibit self-employment.
The second hypothesis posits that high wages correlate positively with start-up rates, indicating a prosperous economy with above-average survival rates for new businesses Higher income levels in a region create increased demand for various goods and services, thereby stimulating entrepreneurial activity and encouraging new business start-ups Research by Gaygisiz and Koksal (2003) and Cala and Arauzo-Carod (2010) supports this, showing that low-income markets hinder demand and deter new firms Additionally, Butler and Herring (1991) highlight that individuals with higher family income have better employment opportunities Furthermore, studies by Armington and Acs (2002) and Lee et al (2004) reveal a positive link between income growth and new firm births, while Reynolds et al (1995) found a significant relationship between personal wealth and firm formation.
Johnson and Parker (1996) discovered no correlation between exit rates and entry rates However, our analysis reveals a significant positive impact of the previous year's exit rate on the current year's new firm formation This indicates that the departure of firms from the marketplace, whether voluntary or involuntary, contributes to the emergence of new businesses.
The dynamics of market competition are influenced by the entry of new firms that innovate to meet existing demand, while the exit of firms can create a more favorable environment for newcomers Research indicates that the entry rate of the previous year is a more significant predictor of the current year's entry rate than the exit rate This suggests a momentum effect, where ongoing trends in business entry foster further growth in new firm formation Consequently, while a region that welcomed new businesses last year is likely to see continued growth this year, the exit of firms does not necessarily trigger an equivalent response in new firm formation.
Research hypotheses
Based on the theoretical and empirical studies, the thesis entails concepts and research hypotheses as follows:
Hypothesis H1: A region’s unemployment rate is positively related to its new firm formation rate.
In Vietnam, regions with higher unemployment rates are likely to see an increase in new business formations, as unemployed individuals may turn to entrepreneurship as a viable alternative The elevated unemployment levels create a conducive environment for start-ups, making it easier for these new enterprises to hire labor and boosting the motivation to launch new ventures.
Hypothesis H2: A region’s population growth is positively related to its new firm formation rate.
Population growth serves as a dual factor in economic dynamics, acting as both a supply and demand driver As a region's population increases, it not only fosters a pool of potential entrepreneurs but also elevates the demand for various goods and services Consequently, it is anticipated that in Vietnam, the formation of new firms will be positively impacted by this population growth.
Hypothesis H3: A region’s population density is positively related to its new firm formation rate.
Improved access to diverse markets for capital, labor, and services encourages entrepreneurs to invest more in regions with high population density and economic activity Consequently, there is an anticipated positive correlation between population density and the formation of new firms in Vietnam.
Hypothesis H4: A region’s degree of urbanization is positively related to its new firm formation rate.
Urbanization in Vietnam is anticipated to positively influence new firm formation, as urban areas offer superior business infrastructure, reduced transportation costs, and greater opportunities for innovation compared to rural regions Furthermore, urbanization enhances the availability of a skilled workforce and facilitates the rapid exchange of ideas and knowledge, fostering a more dynamic business environment.
Hypothesis H5: A region’s income level is positively related to its new firm formation rate.
The author anticipates that higher income levels positively influence the rate of new firm formation in Vietnam, as increased income in a region signifies a growing demand for various goods and services, thereby stimulating entrepreneurial activity and encouraging new business start-ups.
Hypothesis H6: A region’s rate of firm exit is positively related to its new firm formation rate.
This thesis posits that higher exit rates of firms in Vietnam can stimulate the formation of new businesses As firms exit a market, competition diminishes, creating opportunities for new entrants to thrive in a less hostile environment.
Hypothesis H7: A region’s FDI inflows is positively related to its new firm formation rate.
Foreign Direct Investment (FDI) inflows are anticipated to positively influence the formation of new firms in Vietnam This relationship is evident through various channels, such as employees from foreign companies starting their own businesses in similar sectors, utilizing the skills and knowledge gained during their tenure Additionally, the presence of foreign firms can encourage domestic entrepreneurs to enter the market, further enhancing the growth of new enterprises.
The "demonstration effect" occurs when domestic entrepreneurs learn from the successes and failures of foreign firms, leading to increased local innovation Additionally, foreign direct investment (FDI) can positively influence domestic market entry through vertical linkages, where foreign firms boost demand for local inputs and intermediate goods, creating opportunities in upstream industries Furthermore, these foreign firms can introduce higher quality inputs to domestic customers, stimulating demand in downstream industries Collectively, these factors represent new business opportunities that can encourage domestic firms to enter the market, a phenomenon known as the demand creation effect.
Hypothesis H8: A region’s mean establishment size is positively related to its new firm formation rate.
In Vietnam, the author anticipates that the presence of large firms will positively influence the formation of new businesses This is primarily because small firms rely on large companies for opportunities to supply goods and services, as well as to take on jobs that large firms consider inefficient to handle internally.
Hypothesis H9: A region’s PCI is positively related to its new firm formation rate.
Provinces with higher Per Capita Income (PCI) typically experience a surge in newly established businesses, as a strong PCI indicates a favorable business environment, effective institutional quality, and successful administrative reforms The confidence in the transparency of public governance encourages firms to invest more, leading to an increase in the number of new businesses Consequently, a positive correlation between PCI and the establishment of new enterprises is anticipated.
PCI and the rate of new firm formation in Vietnam.