Government-led restructuring of firms' excess capacity and its limits: Korean "Big Deal" case

Since the early 1980s, the South Korean government has repeatedly attempted to address what it has seen as structural excess capacity in the country’s economy. In particular, it identified excessive business diversification and over-investment by the country’s “chaebols” (large business groups) as major factors in the country’s 1997 financial crisis. In response, the government implemented the "Big Deal" programme, under which the five largest chaebols were asked to swap businesses in which chronic excess capacity was identified.

In an attempt to assess the usefulness of programmes like the Big Deal, this papers examine the factors that determine the excess capacity of South Korean firms. It uses statistical (panel data) analysis of financial information for 26 firms affected by the Big Deal during 1988-98.

The paper’s findings include that:

• the statistical evidence suggests that structural excess capacity affected these industries because investment continually exceeded the levels justified by the level of demand
• after controlling for other explanatory variables, the level of excess capacity appears to have closely reflected unpredictable changes (shocks) in the level of demand
• however, reckless investment in new facilities due to overly optimistic forecasting during 1994-98 was also observed.

Drawing on both theoretical analysis and the statistical results, the paper concludes that it is not feasible to achieve industrial restructuring through governmental intervention since the government cannot control the strategic behaviours of competing firms in an oligopolistic industry. It argues that business swaps and mergers and acquisitions such as those demanded by the Big Deal can deepen market concentration and impair fair competition; and that it might be more desirable to allow firms to form a temporary cartel.

However, the paper contends that in the long run, the most effective solution to the problem of excess capacity is to bring about institutional improvements in the corporate governance of firms and in the credit assessment system of the finance industry.

To read this report, click on the link below, open the ZIP file and extract the file named 15-2-6.PDF.