Academic journal article Contemporary Economic Policy

Identifying and Estimating Sources of Technical Inefficiency in Korean Manufacturing Industries

Academic journal article Contemporary Economic Policy

Identifying and Estimating Sources of Technical Inefficiency in Korean Manufacturing Industries

Article excerpt

I. INTRODUCTION

The South Korean government has continuously pursued an industrial policy that promotes strategic manufacturing industries, although the target of the policy shifted from light industries in the 1960s to heavy and chemical industries in the 1970s and 1980s. Under this policy, the government directed subsidized credit to strategically chosen firms and industries by operating an internal capital market. The industrial policy contributed to building Korean manufacturing firms that are owned and controlled by large business groups known as chaebols. Once large manufacturing firms that could compete in the world market were established, the government repeatedly intervened to save them from bankruptcy. Despite the government's gradual adoption of free market mechanisms in the 1980s, the tradition of regulatory industrial policy remained strong. For example, from 1984 to 1988, the government rescued many firms in the construction, shipping, and machinery industries when they became insolvent. The government's repe ated bailouts encouraged Korean manufacturing firms to expand without proper consideration of profitability and of their mismanagement. (1)

This inherent problem in Korean manufacturing industries continued to develop but was hidden by economic growth for an extended period. However, from the late 1980s until the early 1990s, when the Korean economy was growing quickly and recorded an unprecedented surplus in the balance of payments, there was a heated debate about the sustainability of the economic growth and the fundamental strength of the Korean manufacturing sector. In that debate, academics widely believed that the economic boom had more to do with the temporary economic environment, including such factors as a strong Japanese yen and low oil prices, than with the strength of the Korean manufacturing industry. Thus, many Korean economists insisted that the Korean manufacturing sector should be restructured to sustain the growth. However, restructuring had not been fully implemented before the financial crisis struck the Korean economy in late 1997. After the crisis, restructuring was reemphasized and implemented as a key to revitalizing the Korean economy. (2)

The financial crisis resulted directly from short-term defaults in the Korean financial sector and was also associated with the failure of the Korean manufacturing sector, which was plagued by weak corporate governance and resulting poor firm performance. Joh (1999) indicated that several factors were responsible for the failure of corporate governance in Korea, such as the lack of a credible threat, disparity between control and ownership and the ensuing management problems, and lack of monitoring by financial institutions. (3)

First, the lack of a credible threat for large firms in Korea--which resulted from frequent government bailouts, lengthy bankruptcy procedures, and an underdeveloped corporate control market--provided no incentive for firms to maximize their performance. Second, financial institutions had not developed adequate techniques to evaluate firms and failed to monitor firms that relied heavily on debt for their financing. The control of nonbank financial institutions by chaebols and poor accounting standards in Korea aggravated the problem. Third, the controlling shareholders of the 30 largest chaebols exploited the interlocking ownership among firms and managed the groups of firms, although their direct ownership was less than 10%. This disparity between control and ownership gave controlling shareholders an incentive to divert firms' resources to their own interests. The boards of directors were picked by the controlling shareholders and played no internal monitoring or disciplinary role; minority shareholders had few legal rights to prevent the controlling shareholders and managers from pursuing wasteful projects.

Manufacturing inefficiency in Korea originated not only from environmental factors, such as a poor business environment and a lagging financial sector as discussed, but also from firm-specific factors, such as inadequate size, lack of research and development (R&D) investment, inefficient managerial practices, and lack of international competition. …

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