Bank of Korea "Backlog of Marginal Firms Pulls Down Labor Productivity... Restructuring Needed"

BOK Issue Note 'The Impact of Zombie Firms on Labor Productivity in Manufacturing'

▲Increase in labor productivity assuming the proportion of chronic marginal enterprises remains unchanged (Source: Bank of Korea BOK Issue Note)

[Asia Economy Reporter Eunbyeol Kim] It has been revealed that the proportion of marginal firms in South Korea's manufacturing sector is close to 10%, identified as a major factor lowering labor productivity. Marginal firms are defined as companies with an interest coverage ratio below 1 for three consecutive years or more and with a business history of over 10 years. These are firms that cannot even cover their financial costs with the income they generate.

According to "BOK Issue Note - The Impact of Marginal Firms on Labor Productivity in South Korea's Manufacturing Sector," published on the 20th by Sangyun Song, Associate Research Fellow at the Bank of Korea Economic Research Institute, the share of marginal firms in our manufacturing sector increased by 2.1 percentage points from 7.4% in 2010 to 9.5% in 2018. After hitting a low of 6.4% in 2011, it has shown a steady upward trend.

The quality of marginal firms was also poor. The interest coverage ratio of marginal firms, which stood at -1.03 in 2010, showed a declining trend and fell to -2.4 in 2018. The interest coverage ratio is the value obtained by dividing operating profit by interest expenses, indicating a company's ability to repay debt. A ratio below 1 means that operating profit is insufficient even to cover interest expenses. This indicates the emergence of low-profit marginal firms and the inadequate exit of existing low-profit marginal firms.

The proportion of chronically low-profit marginal firms increased from 3.9% to 5.3% during the same period. Chronically marginal firms are defined as companies with an interest coverage ratio below 1 for four years or more. New marginal firms increased only slightly from 3.2% to 3.7%, a 0.5 percentage point rise. Associate Research Fellow Song stated, "This means that a backlog of low-profit marginal firms is occurring in our manufacturing sector."

The labor productivity of marginal firms was only 48% of that of normal firms. Among marginal firms, the labor productivity of chronically marginal firms and low-profit, high-debt marginal firms was 47.7% and 41.3% of normal firms, respectively. By company size, the labor productivity of small-scale chronically marginal firms was 44.2% of that of normal firms of the same size. Associate Research Fellow Song said, "This implies that if restructuring of such marginal firms is carried out, labor productivity could improve significantly."

Examining the impact of marginal firms on the labor productivity of normal firms, it was estimated that chronically marginal firms had a negative effect on the performance of normal firms. If the proportion of chronically marginal firms had not increased during the analysis period, the annual average growth rates of fixed asset increase, employment increase, and labor productivity of normal firms would have risen by 0.5 percentage points, 0.42 percentage points, and 1.01 percentage points, respectively.

On the other hand, new marginal firms did not have a significant impact on the performance of normal firms. Associate Research Fellow Song explained, "The backlog of marginal firms caused by poor restructuring, rather than new marginal firms, is a factor lowering the labor productivity of normal firms." This means that chronically marginal firms restrict the movement of resources to highly productive normal firms (inefficient allocation of resources), negatively affecting their labor productivity.

This study was conducted using data from 76,753 companies in the manufacturing sector of the Corporate Activity Survey from 2010 to 2018.

This content was produced with the assistance of AI translation services.