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Financial Economics

KDI Policy Forum

Business Groups and Declining Allocative Efficiency in Korea

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  • Author Cho. Duksang
  • Date 2018/04/19
  • Series No. KDI Policy Forum No. 270 (2018-03), eng.
  • Language English
SUMMARY □ The allocative efficiency in Korea is on a rapid downturn.

- Based on Statistics Korea’s Survey of Business Activities, an analysis was conducted on firms with over 50 regular employees and 300 million won in equity during 2006-2015 to find that allocative efficiency has continued to decline since 2008 (labor productivity from 2008, TFP from 2011).

- Using the methodology proposed by Melitz and Polanec (2015), allocative efficiency was measured through the covariance between firms’ productivity and market share―a decline in allocative efficiency means that resources are being excessively allocated to low-productivity firms while the opposite is true for high-productivity firms.

□ Since 2011, the decline in allocative efficiency has been observed mostly among affiliates of large business groups that are designated by the Korea Fair Trade Commission (KFTC) for limitations on cross-shareholding.

- Considering large business groups’ immense share of inputs (labor and capital), their diminishing efficiency in resource allocation accounts for much of the recent productivity slowdown in Korea.

□ To improve overall economic growth, efforts must be made to offset the declining allocative efficiency engendered by large business groups.

- The holding company system needs an overhaul to prevent the growth of business-group firms from eroding allocative efficiency.

- Actions need to be taken so that any problems incurred from the misconduct of controlling shareholders do not lead to misallocation within business groups.
KDI VOD Report
The sharp downward trajectory in productivity since 2011
has prompted many to voice their concerns over the slowdown in
Korea’s economic growth.

So, why is the productivity growth rate declining?

To find out,
an analysis was conducted on the growth in the aggregate
productivity of Korean firms from 2006 to 2016
based on the increase in average productivity, allocative efficiency,
and the entry and exit effect.

The results revealed that from 2011,
allocative efficiency has rapidly fallen,
which has, in turn, diminished overall productivity.

A decline in allocative efficiency implies that resources are being
excessively allocated to low-productivity firms while being inadequately
allocated to high-productivity firms.

Then, who has primarily contributed to the decline in
allocative efficiency?

The changes in allocative efficiency were decomposed into
the contribution of stand-alone firms and
that of the affiliates of large business groups designated by
the Korea Fair trade Commission for limitations on cross-shareholding.

A visible downturn was discovered in the allocative efficiency of
large business-group firms from 2011,
which has consequently curtailed the firms’ overall growth in aggregate

On the other hand,
no notable trends were found for stand-alone firms.

Why is the decline mainly found in business-group firms?

Compared to stand-alone firms,
the increased output of business-group firms on an additional one unit
of capital is lower.

This is because the excessive amounts of capital used by business
groups distort the allocation of resources,
and not because their technological competence is inferior.

the market exit rate of large firms with over 300 employees
depends on the ownership structure.

Compared to stand-alone firms, business-group firms are less likely to
exit and also show lower productivity at the point of exit.

As a result,
the prolonged presence of business-group firms with low capital
productivity in the market is exacerbating the decline in allocative
efficiency within the Korean economy.

[저자 인터뷰]
The problems associated with the economic concentration of business groups are vital not only in terms of fairness but also efficiency in the market economy and growth.

This study shows that the recent slowdown in Korea’s economic growth can derive from the declining allocative efficiency brought about by business groups.

Accordingly, the holding company system needs to be reorganized so that business-groups’ excessive capital holdings do not impede the growth of stand-alone firms and to reverse the decline in allocative efficiency. Also, measures should be established to prevent the misconduct of controlling shareholders from leading to the misallocation of resources.
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