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Stanford Report, September 27, 2000
In lawless frontier, Vietnamese entrepreneurs thrive

Business people rely on trust, reputation and the fear of losing deals, economist discovers

BY BARBARA BUELL

Look around the world, and you will find that not every thriving economy exists in a land of commercial law and order. Vietnam, for example, currently has a booming private sector fueled by eager entrepreneurs but virtually no commercial code to regulate transactions or settle disputes between companies. That paradox drew Stanford Business School economist John McMillan and University of California-San Diego economist Christopher Woodruff to find out what makes commercial agreements work in such an uncertain, scrappy environment.

McMillan, who is a professor of international management and economics, has spent eight years examining emerging markets in transition. "It's the biggest economic policy issue of our lifetime," he says. "It impacts a huge part of the world's population." Vietnam, for one, is still officially a planned economy. In the unreformed financial sector, for example, there are state-operated monopoly banks that serve state-run manufacturing entities but few small banks for entrepreneurs. There also are no sources of market information, such as trade associations or credit bureaus, as well as no contract laws -- things Americans take for granted. Yet, what McMillan and Woodruff found so compelling is that the dynamism in the Vietnamese economy has come from the start-up sector, not the privileged government-operated sector. Says McMillan: "This is a gigantic experiment in how markets work."

McMillan has looked at other fledgling economies in Russia and Eastern Europe where there are some legal systems in place, but in Vietnam he found no such thing. He and Woodruff used a 1995-97 survey of 259 privately owned manufacturing firms in Hanoi and Ho Chi Minh City to decipher how firms use ongoing relationships to maintain agreements. While central planning remains in place, the real way business gets done is through an ad hoc strategy devised by entrepreneurs at ground level. The researchers found bottom-up substitutes in place of the law of contracts.

In Vietnam, business people can easily cheat each other because there are no contracts. More than 90 percent of the managers surveyed said the courts are of no use to them in resolving disputes. In a series of interviews, entrepreneurs told the researchers they rely on reputation and gossip to select partners. They try to avoid disputes by checking their customers' financial backgrounds and personalities with others who have done business with them. In fact, managers meet each other regularly in teahouses and bars to exchange information and discuss market opportunities. Indirectly, these exchanges create a business ethic that supports the market. And if a debt is not paid, it gets negotiated patiently.

McMillan and Woodruff used principles of game theory to figure the conditions under which relationships are or are not enough to sustain contracting. They found that agreements in Vietnam rest on a subtle mix of formal and informal sanctions. "What is striking about Vietnam is that the entrepreneur's incentive not to cheat a contract partner is not that the partner will sue but that he'll stop dealing altogether," McMillan says.

Certain aspects of this, the researchers say, are as relevant in New York as they are in Ho Chi Minh City. Contracting everywhere rests on reputation and goodwill. For example, a New York cable television company, Paragon Cable, has a novel strategy for getting its customers to pay overdue bills. Rather than unhook the cable, it runs C-Span's droning political hearings on all of its 77 channels until the subscriber pays up. A debt collection agency for fish wholesalers in Portland, Maine, began using the Internet to sell wholesalers credit information about deadbeat buyers, much as Vietnamese business people swap such information in teahouses.

McMillan and Woodruff's findings have implications for policy reform in planned economies. Building a modern legal system takes a long time. In the early stages of reform, fostering market players such as trade associations and intermediaries that disseminate information could promote extra-legal means of contract enforcement by keeping records of contract violations and by serving as quality watchdogs. In Vietnam, trade associations do not yet perform such a role, but public policy could help promote them.

Market-oriented legal reform should be written so as to legitimize current business practices, says McMillan. Introducing commercial laws insensitively in Vietnam could actually harm trade by disrupting traditional commercial relationships built on trust.