In contemporary economics, the term “capital” implies not only physical capital, but human capital as well — in the form of knowledge, skills, health, and administrative capabilities. There is also social capital, reflecting social ties and interpersonal relations and trust. Human and social capital, much like physical, can accrue and bring profits to a firm.
Social networks, communication and familiarity facilitate the conducting of business for entrepreneurs, and grant them access to necessary resources and reduce transaction costs. In addition, they simplify the exchange of useful information and bring down the costs of decision-making. Firms owned by entrepreneurs with a wide range of social ties are growing faster. Examples of investments in networking can be advertising, event management, top managers meetings to discuss various issues, and even bribery.
The study conducted by Le Van allowed him to analyze the effect rendered by social connections on production and entrepreneurial activities. The mathematical model built on the basis of the Ramses model describes a simple economy containing one consumer good. A consumer maximizes his utility at some point in time and sets aside part of his income for the future. He may invest these savings in physical capital and in the creation of social ties. Part of the capital is amortized, and new capital is bought at a price expressed in units of consumer goods.
The significance of social capital in this model is that it reduces the acquisition price of physical capital, thereby reducing production costs and increasing profits. Another interpretation of the relationship is a facilitated access to credit: the more connections a firm has, the less its loan rates will be.
An important characteristic of the model is the presence of a savings effectiveness threshold (and consequently, an investment threshold). At a level of investment below a certain value, returns are equal to zero. The more efficient the technology of production and the smaller the investment thresholds are in an investment, the fewer the savings that are needed, allowing more to be spent on consumption. Another output of the model is an inverse relationship between the size of a firm’s income and the return on connections: firms with large incomes need fewer business connections.
An econometric test of the model was performed on data from the Vietnamese economy, where returns were gathered from local small and medium scale manufacturing enterprises from 2005-2011. In the final assessment, data from 5300 firms were used. The dependence of a firm’s revenue on its total assets and property (characteristic of physical capital), the number of employees and skilled workers (characteristic of human capital), and the number of contacts held by the firm (characteristic of social capital), was evaluated. A simple method of least squares and quantile regression was used for analysis. In addition to the aggregate business population, private firms were also considered separately (excluding shares owned by the government, foreign firms, as well as non-cooperative and non-collective firms), as were firms in small towns and villages.
Based on an overall assessment, the significance of social ties was evident only for businesses in small towns. In other cases, the coefficients were insignificant. Quantile regression confirms the assumption of a “corridor” for levels of profit where investments in social networks pay off. For 29% of organizations with the lowest income and 11% of firms with the highest income, investment in establishing networks is not reflected in profit. For businesses in the private sector, the effectiveness threshold is lower; it constitutes 24% of the total number of firms. Additionally, the impact of connections on these firms is greater, but the dependence is clearly not linear: up to a certain point profits do grow, and there is payoff from social connections.
More importantly, there is the presence of a wide “circle of friends” for businesses in small towns — their returns from social networks are two times higher than for other firms. This can be explained by the fact that in villages there are generally not many companies, and finding suppliers and customers is much more difficult. Here the effectiveness threshold is lower, around 19%.
From Le Van’s work we can draw the following important conclusions. First, social capital certainly impacts a firm’s profits, although it cannot generate revenue by itself, without the presence of physical and human capital. Second, empirical data confirm the notion that there is some minimal profit value that must be reached before investment in communications becomes advantageous. Third, for businesses with large revenues, returns from investments in a “circle of friends” are insignificant at a certain level.
Ilia Vasiliev
