KDI 정책포럼 Business Groups and Declining Allocative Efficiency in Korea 2018.04.19
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- 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 productivity. 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. Moreover, 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.
□ 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.
2. Declining Allocative Efficiency
3. Decomposition of the Declining Allocative Efficiency
4. Allocative Efficiency and Business Groups
5. Conclusion and Policy Suggestions
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