The ‘underdog’ informal Vietnamese enterprises: R&D, innovation and productivity performances

Abstract This paper analyzes the different performances of formal vs. informal firms in terms of R&D, Innovation, and Productivity. Using data from the 2011, 2013, and 2015 results of the Micro, Small, and Medium Enterprise Survey in Vietnam, we also evaluate the effects of the transition from an informal to a formal status on firms’ innovativeness and productivity. By accounting for the under-reporting of R&D investments, we show that (i) informal firms invest less in R&D, and (ii) those who switch to a formal status have a higher probability of introducing innovations. However, our study provides evidence of hump-shaped R&D-innovation and innovation-productivity relationships. Also, it identifies the existence of an innovation probability threshold, beyond which informal firms outperform formal ones in productivity. Although the transition to formal status exerts a positive direct effect on productivity, the formalization’s benefits diminish as innovation probability intensifies. Hence, these findings underscore an interesting and hidden trade-off in the linkage between firms’ flexibility and productivity. Even though formal firms have a higher probability of introducing innovations, our results also reveal that—against all odds—(iii) the’underdog’ informal Vietnamese firms may have a higher level of productivity, the more likely they are to introduce radical or incremental innovations. Results also hold when we control for a reverse causality effect of firms’ productivity that may result in a driven factor of their formalizations. Thus, our outcomes challenge one-size-fits-all approaches to formalization, and policymakers should recognize that formalization’s benefits also depend on the innovative profile of firms.