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Where Is Credit Due? Legal Institutions, Connections, and the Efficiency of Bank Lending in Vietnam

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  • Markus Taussig
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    Abstract

    Rapid development of the domestic private sector in communist China and Vietnam has been offered as evidence against a large literature that claims a solid legal infrastructure is required for the financial sector to contribute to economic development. One component of the counterargument holds that relationship-based lending has served as an effective substitute for legal institutions. In this article, we challenge this assertion with empirical findings that show bank credit allocation that relies heavily on "connections" undermines the impact of finance on investment growth. Our data come from Vietnam, where--like China--the private sector and financial sector are expanding dramatically but rule of law has not kept pace. Although Vietnam's banking sector is in transition toward a healthier system, it still allocates a disproportionate share of credit to "connected" enterprises in less competitive regions. We find that political connections, in particular, are an ineffective tool for channeling bank credit to the most profitable investors. Using a two-stage empirical approach, we find evidence that banks place greater value on connections than performance and that the firms with greater access to bank loans are no more profitable than firms without them. By some measures, connected firms are even significantly less profitable. We conclude by demonstrating that the most profitable investors in Vietnam have forgone the formal banking system, preferring to finance their activities out of reinvested earnings or informal loans (JEL G21, G28, G30, O12, K11). The Author 2008. Published by Oxford University Press on behalf of Yale University. All rights reserved. For permissions, please email: journals.permissions@oxfordjournals.org, Oxford University Press.

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    Bibliographic Info

    Article provided by Oxford University Press in its journal The Journal of Law, Economics, & Organization.

    Volume (Year): 25 (2009)
    Issue (Month): 2 (October)
    Pages: 535-578

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    Handle: RePEc:oup:jleorg:v:25:y:2009:i:2:p:535-578

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    Cited by:
    1. Hien Thu Tran & Enrico Santarelli, 2013. "Capital Constraints and the Performance of Entrepreneurial Firms in Vietnam," Working Paper Series 32_13, The Rimini Centre for Economic Analysis.
    2. Hasan, Iftekhar & Jackowicz, Krzysztof & Kowalewski , Oskar & Kozlowski , Lukasz, 2014. "Politically connected firms in Poland and their access to bank financing," BOFIT Discussion Papers 2/2014, Bank of Finland, Institute for Economies in Transition.
    3. Phan, Diep & Coxhead, Ian, 2012. "Long-Run Costs of Piecemeal Reform: Wage Inequality and Returns to Education in Vietnam," Staff Paper Series 566, University of Wisconsin, Agricultural and Applied Economics.
    4. Bat Batjargal, 2013. "Institutional Polycentrism, Entrepreneurs’ Social Networks, And New Venture Growth," William Davidson Institute Working Papers Series wp1060, William Davidson Institute at the University of Michigan.
    5. Taussig, Markus, 2013. "The neglected need for strategic renewal in emerging markets: Lessons from Vietnam in transition," Business Horizons, Elsevier, vol. 56(4), pages 465-471.

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