By Lee Byoung-ki

The health of Korea’s domestic economy is largely dependent on the soundness of Korea’s small- and medium-sized enterprises (SMEs). As of 2009, Korea’s SMEs accounted for 99.9 percent of all business establishments, and they hired 87.7 percent of domestic workers as a whole. Thus, it is pivotal to strengthen the competitiveness of SMEs in order to ensure Korea’s solid and sustainable economic growth in the future. Despite the enhancing importance of SMEs, the productivity of SMEs is lower compared to large enterprises and widespread insolvency is an additional symptom. Moreover, exports and outward foreign direct investment (FDI) of SMEs are decreasing. Overall, it could be said that overall competitiveness of SMEs is deteriorating.

To establish a vibrant small- and medium-sized enterprise sector, related systems and policies regarding policy loans, tax incentives, and technology innovations must be amended. Support policies for SMEs should be propelled in a way that government provides aid to more efficient companies. In reality, the policy is not functioning properly ― the actual efficiency and productivity among SMEs are rapidly declining in spite of government’s recent extended support policies as technological development stagnated and movement of resources from low to high productivity sectors were restricted.

Against this backdrop, the Korean government dramatically changed their policy direction after the local election held on June 2010, to the stance creating a win-win situation for both large- and small-sized companies. In contrast to the previous passive policies, the proposed “shared growth” policy agenda included a number of key reforms, such as establishing a shared growth index, designating SMEs-suitable business areas, and introducing a profit sharing system. The intention of this policy initiative was to more tightly regulate large enterprises and better protect small and medium sized enterprises. For instance, designating SME-suitable business areas is a policy assuming that there are certain business sectors only suitable for SMEs. Moreover, the prototype of the SME-only business system was abolished only few years ago. That policy already showed us that the policy does not breed competitiveness of the firms but rather wanes it by letting them maintain the inefficiency as there are entry barriers installed by the government.

From this point forward, policies must focus on continuous growth and enhancing competitiveness of SMEs ― the government should alter their policies and systems into the direction that SMEs can grow larger with efficiency. The government should launch policies fostering small enterprises to grow into medium-sized companies and medium-sized companies into larger conglomerates. Yet, such corporate growth was rarely witnessed in Korean corporate history

The government’s financial loans and public investments for SMEs exceed 10 trillion won in 2012. However, the financial investment programs for SMEs carried out by each ministry lack organic connection, and the plans are duplicated, which could result in inefficient investments. Furthermore, there are rumblings about poorly allocated policy funds and that the increased policy loan and fiscal support on SMEs after the 1998 and 2008 financial crises have contributed to greater insolvencies among them, leading to the double whammy of reduced investment and suppressed employment creation for normal companies. In this context, the government’s financial investment and policy loans must focus on small- and medium-sized enterprises that lack funds but possess innovative technologies.

Currently, an enterprise becomes eligible for SME incentives when it satisfies a specific scale irrespective of business history or quality. This policy promotes SMEs to be content with their scale and forgo any attempt at growth into medium-sized enterprises. Institutional restraints and regulations should be relaxed for SMEs to expand into medium or large enterprises. One of the most restrictive areas SMEs face today is fund raising for expansion. It is better for medium-sized enterprises to raise money from commercial banks and capital markets. And yet, the percentage of Korean SMEs that raise funds through capital markets including stocks and bonds is extremely low. To facilitate financing of small- and medium-sized enterprises, it is necessary to revitalize and boost Korea’s stock and corporate bond markets for direct financing.

Lee Byoung-ki is a senior research fellow in Korea Economic Research Institute(KERI).