Since the Doi Moi reforms in the mid-1980s, Viet Nam has been ranking as one of the world’s most dynamic market economies. The country’s GDP has grown at an impressive 7% 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.

The first industrial revolution brought us steam engines and manufacturing. The second was powered by electricity. The third revolution was digital. The fourth will see disruptive technologies further transform factory processes and global supply chains.

What will it take to shore up Viet Nam’s economic transformation? The answer is as simple to articulate as it is complex to execute: Viet Nam needs a more dynamic and innovative private sector fueled 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.

  With enough incentives, Vietnamese entrepreneurs will innovate

Fortunately, Vietnamese people have an entrepreneurial temperament. If given sufficient incentives to innovate, they will be up for the challenge.

The government has recognized 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 programs to support entrepreneurship. However, in the policy dialogues between SMEs and government officials, entrepreneurs often question the efficacy of these programs.

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 Da Nang, have frameworks and five-year action plans to support startups and innovation.

SMEs need more support

ADB 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.

Through the Australia-funded Mekong Business Initiative (MBI), ADB has worked hard to involve SMEs in policy dialogue. Last year, we helped launch the Viet Nam Private Sector Forum in partnership with the Viet Nam 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 modernize support for the private sector.

  Government cannot remove all bottlenecks to entrepreneurship, innovation

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 Viet Nam typically do not extend credit without collateral. Nor do they offer cash flows or invoice financing.

Thus, Vietnamese SMEs must turn to 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.

Entrepreneurs must learn how to innovate

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 Viet Nam, the government must warm to emerging technologies and offer sandboxes for testing, verifying, and regulation.

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

If we truly want a dynamic private sector, though, Vietnamese entrepreneurs must develop their capacity for innovation. Viet Nam 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 Viet Nam 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.

  Vietnamese firms only invest 3% of budgets in R&D

For this to happen, the country must address weaknesses at the institutional level. GII ranked firm,s innovative capacity in Viet Nam only at 101th, with private sector firms investing only 3% 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 programs 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.” MBI launched the Mekong region's first tourism startup accelerator program (MIST) to promote innovation in the tourism sector.

Government can help

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 laborers 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.

  Only SMEs have innovative capacity to accelerate long-term economic development

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 prioritize reforms, ADB 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 prioritize 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 Viet Nam’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.

This blog was originally published as an op-ed in the Vietnam Economic Review.