Contribution of productivity and firm size to value-added: Evidence from Vietnam Thi Bich Tran, Quentin Grafton à , Tom Kompas Crawford School of Economics and Government, The Australian National University, J.G. Crawford Building (Bldg 13), Ellery Crescent, Canberra, ACT 0200, Australia article info Article history: Received 4 May 2007 Accepted 21 May 2009 Available online 18 June 2009 JEL classification: C43 D24 R38 Keywords: Total factor productivity Indexing decomposition method Value-added abstract A new indexing method is developed to decompose the contributions of productivity, prices and firm size to a firm’s value-added. The method introduces an error term into the decomposition equation to capture measurement biases which are caused by using the deflator instead of the observed price and all other sorts of measurement error. An application of the method is given using private small and medium manufacturing firm level data in Vietnam from 1996 and 2001. The error index decomposition method provides a comparison of performance of all firms to the hypothetical representative firm. The analysis allows firms and policy makers to realize the key factors contributing to the success or failure of a firm and suggest strategies to improve firm economic performance. & 2009 Elsevier B.V. All rights reserved. 1. Introduction An understanding of the factors contributing to a firm’s profit and value-added, and also at the industry level, is important to both firm owners and policy makers. In this paper an index-number profit decomposition method is extended to account for the nature of manufacturing industrial data, i.e., firms produce different outputs and use different inputs, to evaluate firm and industry performance. This different dimensionality results in difficult problems of aggregating and decomposing sepa- rate price effects with the profit decomposition method. To overcome the problem of decomposing profit and value-added given the data characteristics, a new indexing decomposition method called the error index decomposi- tion method (EIDM) is developed using the value-added total factor productivity (TFP) measurement. The EIDM allows for differences in a firm’s value-added to be decomposed into separate effects due to variations in productivity and firm size in both labor and capital. It also helps resolve the dimensionality problem by using the industry deflator instead of the observed price. This approximation introduces biases into TFP measurement (Coelli et al., 2003; Diewert, 2005) and, thus, an error term is added into the decomposition equation to capture measurement biases and white noise. The method is applied to domestic private small and medium manufac- turing enterprises in Vietnam over the period 1996–2001 and shows that productivity is a core contributor to the success of a firm. The remainder of the paper is organized as follows. Section 2 describes the profit decomposition and the EIDM. Details of data and variable measurement are presented in Section 3 while Section 4 discusses the value- added TFP index for private small and medium manufac- turing enterprises (SMEs) in Vietnam. The decomposition of factors contributing to a firm’s value-added is analyzed in Section 5. Section 6 concludes with suggestions as to how to promote firm and industry performance in Vietnam. Contents lists available at ScienceDirect journal homepage: www.elsevier.com/locate/ijpe Int. J. Production Economics ARTICLE IN PRESS 0925-5273/$ - see front matter & 2009 Elsevier B.V. All rights reserved. doi:10.1016/j.ijpe.2009.05.025 à Corresponding author. Tel.: +612 6125 6558; fax: +612 6125 5570. E-mail address: quentin.grafton@anu.edu.au (Q. Grafton). Int. J. Production Economics 121 (2009) 274–285