The Economic Effects of Designating Suitable Businesses for SMEs: the Case of the Korean Tofu Market

The controversy over designating suitable businesses for SMEs has been constantly raised in the last three years. Ex ante verification for selecting business was not enough to elicit agreements between firms, and ex post analysis of economic impacts of the institution has been insufficient. But still, new designation, reassignment, or rescission of businesses is repeated so that social discord over the system is likely to continue in the future. This study aims to empirically test whether the institution limiting entry or expansion of big enterprises would help improve competitiveness of SMEs. This research is significantly different from previous studies, which analyzed a number of markets at the aggregate level, in respect of empirical approach, data, and methodology. We focuse on Korean Tofu market, which fits closely with ones’ daily consumption activities, and which has been the center of controversy surrounding this system. Also, this paper uses product-level data from which we can describe consumer preference and firms’ business strategies on price and product characteristics. Using a structural model consisting of supply and demand specification, we estimate consumer preference and producers' marginal and fixed cost function, and then run counter-factual simulation to see how market equilibrium and social welfare would be today without the system. The results show that the institution possibly limits the growth of the tofu market, and that big enterprises’ reactions to the market constraints regarding product prices and characteristics can reduce profitability of SMEs as well as consumer surplus. Based on the findings, the paper recommends that the paradigm of the institution need to be changed from regulating big enterprises to setting up a fair and orderly market and to establishing a supporting policy contributing to enhancing SMEs’ product competitiveness.