The second is what could be called the “incentive mechanism.” In a market economy the profit of each economic actor depends on its behavior. Thus, the market economy motivates people to act in an economically rational fashion. Furthermore, as Schumpeter pointed out, in a market economy people have incentives not only to act in an economically rational way but also to innovate, since it brings “entrepreneur’s profit” to the innovator.

In other words, stagnation in the planned economies was caused firstly by the inefficiency of the resource allocation, and secondly by the lack of incentives.

Thus, the ultimate objectives of the reform should be to establish conditions which give full scope to these two mechanisms of the market economy. However, these two mechanisms are difficult to synchronize, since the “market mechanism” requires “perfect competition,” or that innumerable small firms -- each of which does not have any power to influence to the prices (the “price takers”) -- act in the market based on economic rationality. Meanwhile the “incentive mechanism” causes dynamic and oligopolistic competition towards innovation, which is essentially different from the concept of “perfect competition”.

Accordingly, it is of strategic importance to strike a balance between these two merits. To foreshadow conclusion, in catch-up economies like Vietnam, greater importance should be given to the latter (the “incentive mechanism”), since for those economies innovation could be a good source of economic growth and those economies have several favorable conditions to make good use of the “incentive mechanism.”

In the following part, we will evaluate the market economy in Vietnam from the viewpoint of these two mechanisms of the market economy, further dividing the former mechanism into two; static market mechanism, or resource allocation among sectors, and dynamic market mechanism, or resource allocation among different points in time. The role of the government in a market economy is also discussed from the same viewpoint later.

## 4 -1-1 Static Market Mechanism

To give full scope to the static “market mechanism,” or to achieve optimal resource allocation among sectors, several prerequisites are required. “Structural adjustment” from the World Bank can be regarded as the series of measures to establish such prerequisites. We can evaluate the function of static resource allocation of the Vietnamese market economy by assessing whether those prerequisites have been fulfilled.

## (1) Competitive Microeconomy

Competitiveness of the economy is essential for the “market mechanism” to work. However, the concept of “(perfect) competition” in economic terms is rather unique; it is somewhat different from the ordinary concept of competition. It simply refers to a situation in which numberless small firms -- each of which does not have power over prices (“price takers”) -- are acting in the market trying to maximize their profits under the given price (“market price”). It does not include certain kinds of competition which are widely observable in a market economy, e.g. price competition, cost reduction, development of new products, R&D investment, etc. The concept of “perfect competition” must be distinguished from the “innovation competition” which is mentioned later.

In some sectors such as agriculture, service and trade, quite a number of small private farming households or traders are emerging as rational economic agents. It can be said that