Business Groups and Declining Allocative Efficiency in Korea

- 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.