The Koreas | Economy | East Asia
The chaebol spearheaded the country’s rapid industrialization, but it is the SMEs that will drive South Korea’s economy forward in the digital age.
The Organization for Economic Co-operation and Development (OECD) anticipates a decrease of 0.5% South Korea’s potential growth rate between the 2017-20 and 2021-23 periods. This is not a slowdown that can simply be explained as a natural part of the wider convergence with other advanced economies. On the contrary, it signals structural handicaps in the market. And while South Korea faces a number of internal headwinds, one in particular has implications for many other economies in the digital age: the productivity gap between large companies and their larger counterparts. small.
Casual international observers don’t often hear about small and medium-sized enterprises (SMEs) in discussions of the South Korean economy. The players receiving the most attention are the large conglomerates – the chaebol – which carry the mantle of having spearheaded the country’s rapid industrialization that began in the 1960s.
But whether these conglomerates still play a positive role in the economy has been a subject of debate in recent years. During the early stages of South Korea’s economic development, policymakers believed that scarce resources needed to be concentrated in the hands of a few market players to enable capital-intensive investment in productive industries. However, as the economy matured, the dominant market share of these state-sanctioned behemoths prevented more entrepreneurial start-ups from competing in the market.
Affirming the deleterious role of conglomerates in promoting competition and innovation, a recent paper in Economic policy claimed that the collapse of several indebted giants during the 1997 Asian financial crisis had an unexpected positive impact on firm-level performance. The research found that since the crisis, non-conglomerate firms in industries that were previously dominated by conglomerates have benefited from both an increase in patenting activity and labor productivity.
These estimates reinforce the view of many competition advocates in South Korea today, who believe the government needs to more actively prevent the concentration of market share in the hands of a few players. And with conglomerates still controlling significant shares of industrial sectors like automotive (Hyundai-Kia controls more than 75% of South Korea’s domestic automotive industry) and plastics (Hanwha Group produces nearly half of all PVC in the country), the economy may be ripe for more regulatory intervention.
However, the transition to the digital economy adds an additional wrinkle to South Korea’s efforts to rebalance the market. Here, the problem is no longer conglomerates constraining competition, but rather the slow adoption of new technologies by SMEs. This poses a significant challenge to South Korea’s ability to enjoy long-term growth, as these small businesses not only employ the majority of the workforce (over 80%), but are also concentrated in sectors that promise the greatest potential for growth in the digital age.
OECD economist Mathilde Pak and the co-authors of a recent report found that South Korean SMEs use digital tools at much lower rates than large enterprises. Although the country’s flagship companies are strong adopters of services such as cloud storage at the same level or above other OECD countries, South Korea overall lags far behind its global peers as smaller players countries have been slow to adopt these tools. For example, only 23% of Korean companies use cloud computing, compared to more than 50% of companies in the Nordic countries. It also goes without saying that South Korean SMEs also lag behind the productivity of their counterparts in other industrialized economies.
Besides the drop in productivity, the slow adoption of digital tools by SMEs could mean that South Korea concedes major market space created by the emerging digital landscape. The service sector is expected to experience the strongest growth in demand in the coming years. This makes perfect sense considering that a smartphone, for example, is mostly useful as a tool to access other offers. From this point of view, the productivity lag of Korean SMEs is a major handicap because they are mainly concentrated in the service sector. This means that even in the information and communications technology (ICT) sector where conglomerate Samsung has built a successful global brand through its manufacturing prowess, South Korea’s long-term competitiveness is far from be guaranteed.
Pak and his co-authors recommend that the public sector more aggressively support both the training of a cutting-edge workforce and the adoption of digital tools by SMEs. In addition, Seoul could more consciously avoid public policies that stifle new market entrants and actively crack down on business practices that have anticompetitive results. For example, large e-commerce companies employ gig workers (instead of full-time workers) to reduce labor costs. This makes it harder for start-ups to compete with established players in the delivery space on the basis of having developed a better digital platform.
The broader conclusion is that to ensure a competitive market space, government needs to be more proactive in its response. This applies to adopting necessary regulations when times are “good” and not passively waiting for recessionary environments like the 1997 financial crisis to spur change. At the same time, the public sector can be essential in ensuring that the labor market and “the rules of the game” facilitate the efforts of entrepreneurs to create new SMEs capable of supplying competitive goods and services.
As agencies in other countries also strive to build a fairer digital economy alongside tech giants like Meta and Amazon, South Korea’s headwinds offer a thoughtful case study for regulators to take. into account when adopting their own appropriate responses.