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Economic Outlook

KDI Economic Outlook 2017-1st Half

Recent Equipment Investment Trends: Focusing on the Manufacturing Capacity Utilization Rate

SUMMARY ■ Equipment investment showed improvements thanks to the recent boom in a few sectors such as semiconductors. But, the average capacity utilization rate of manufacturing sectors stagnated at a low level, limiting additional growth momentum in equipment investment.

■ Therefore, efforts to eliminate obstacles to equipment investment are needed. In this regard, enhancing the dynamism of the Korean economy by revitalizing firm’s entry and exit is desirable to be considered.
Report VOD
Korea’s equipment investment is drawing broad attention,
thanks to the recent high growth rates on the back of improvements
in certain industries including semiconductors.

the average capacity utilization rate of manufacturing sectors
remains on a downward trajectory since the 2008 global financial crisis,
raising concerns that this could hinder equipment investment.

As such,
this study analyzes the relationship between equipment investment
and the manufacturing utilization rate to draw on the implications of future trends.

Let us start by examining the utilization rate by sector.

An examination into the distribution of the utilization rate
among the top 10 manufacturing sectors uncovers a sizable gap.
From 2010 to 2016, those at the bottom of the spectrum posted steep declines in their utilization rate, from approximately 76% to just 40%.

This, in turn, has acted to drag down the overall average utilization rate in the manufacturing industry.
Exacerbating the problem is that certain sectors at the bottom,
including other transport equipment, for example shipbuilding, and electronic parts expanded their capacity despite the decline in production.

And it was found that the share of zombie firms,
i.e. those receiving financial support and are potentially insolvent, in these sectors is growing.

This suggests an ongoing need for restructuring, because a large share of zombie firms indicates excess capacity.

So, how does low utilization rates affect equipment investment?

An empirical analysis reveals that on a 1%p improvement in operating profits, the investment rate will increase by 0.24%.

However, this does not hold true for those with a utilization rate of below 60%.

Ultimately, what this implies is that,
because sectors with a low utilization rate have a high tendency to withhold investment,
the recent improvement trend in equipment invest will not expand across all sectors.

Next, an analysis was conducted on the source of the falling average utilization rate, from a macroeconomic perspective.

The results show that projections for demand have a meaningful impact
on the average utilization rate of manufacturing sectors.

For example,
positive projections for private consumption and exports increases
production, and therefore, the utilization rate while the opposite lowers the utilization rate and impedes equipment investment.

Indeed, the results suggest that,
as expectations for exports and private consumption declined following
the global financial crisis, demand conditions worsened,
which drove down the average utilization rate in the manufacturing industry.

In addition,
a regression analysis found that on a 1%p drop in the average utilization rate,
the growth rate in equipment investment will fall by 1.26%p during the following quarter.

In sum,
the outcome of this study confirms that if internal and external demand
conditions do not improve in the near future,
the average utilization rate in the manufacturing industry will continue
to remain low for the time being, limiting equipment investment.

In all, the failure of Korean companies to implement the appropriate restructuring measures in response to the decline in production, as overall demand wanes, will serve to diminish future equipment investment.

To resolve this problem, efforts must be made to boost Korea’s economic dynamism, including revitalizing the entrance and exit of firms.

Reducing excess capacity via restructuring will not only help to rally the current low utilization rates of certain sectors but it will also positively impact the entrance and growth of new firms who can create new demand.
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