Sector Switching: An Unexplored Dimension of Firm Dynamics in Developing Countries



In this paper we explore (i) efficiency levels among different types of manufacturing
firms in Vietnam, and (ii) the firm and sector level factors which determine firm exit
and switching decisions. Vietnam represents an illustrative case of economies in
transition for exploring these issues. Wide ranging reforms to enterprise, commercial
and investment laws have been carried out in recent years; and economic growth in the
last five years has been impressive. The industrial sector has played a key role in this
process,2 and industrial value added is set to grow at around 10 percent per year from
2006 to 2010 according to the Socio-Economic Development Plan (MPI, 2006). At the
same time, accession to the World Trade Organisation (WTO) in January 2007 presents
a new set of challenges to the sector.

The industry dynamics literature has recently evolved to consider the impact of trade
liberalisation and other policy reforms on productivity, primarily through firm exit and
entry. Melitz (2003), Pavcnik (2002) and Eslava
et al. (2004) are all relevant in pointing
to a variety of mechanisms through which trade liberalisation can impact positively on
growth. It transpires as well that these effects will depend on the ability and willingness
of firms to reallocate activity across sub-sectors and whether or not this reallocation is
productivity enhancing. We argue that (i) firm turnover and sector switching are likely
to play an important role in determining the overall productivity performance of the
manufacturing sector both now and in the future, and (ii) in order to inform policy we
need to understand whether and how manufacturing sub-sectors differ in terms of the
factors that impact on firm decisions to reallocate resources.

Our data come from the Vietnamese Census of Production for 2001-2004 provided by
the General Statistics Office (GSO), and we analyse firm switching and exit in the run
up to WTO accession in two steps. In the first step, stochastic frontier production
functions are estimated for sub-sectors of the manufacturing sector and relative
efficiency measures are calculated for each firm for the period 2001 to 2004. This firm-
specific efficiency measure allows us to establish the extent to which the efficiency of
incumbent firms differs from that of new entrants, real exits and switching firms that
reallocate resources across sectors. In the second analytical step, we formally explore

2 Between 2001 and 2005 growth in GDP averaged around 7 percent annually with growth in 2005
reaching 8.1 percent. The industry share of GDP reached 41 per cent in 2005, with growth in the sector
driven by private sector expansion.



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