Inefficient Resource Allocation Hampers Economic Growth: Productivity and Innovation Should Guide Funding

BOK Issue Note - Inefficiency of Resource Allocation by Industry and Productivity
Smooth Funding Needed for Highly Productive Companies and Innovative Startups
Conditions for Financing, Including Financial System and Capital Market Access, Must Be Improved

An analysis has indicated that, in order to achieve sustainable growth through improved productivity across the economy, it is essential to fundamentally reform the structure of 'inefficient resource allocation.' It was pointed out that conditions for financing?such as the financial system and access to capital markets?should be improved so that highly productive companies and innovative startups can smoothly secure funding and grow.

According to the "BOK Issue Note ? Inefficiency of Resource Allocation by Industry and Productivity" (authored by Lee Eunkyung, Jung Wonseok, Kim Jungwook, and Lee Solbin), published by the Bank of Korea on July 29, the slowdown in the growth of total factor productivity (TFP) in the Korean economy is closely related not only to the deceleration of technological progress but also to the increase in inefficiency of resource allocation. Total factor productivity is a concept that indicates how efficiently production factors such as labor and capital are utilized. It can be measured not only at the level of the entire economy but also at the industry and individual company levels. Lee Eunkyung, Deputy Head of the Model Forecasting Team at the Bank of Korea’s Economic Modeling Office, explained, "The efficiency of resource allocation is a key factor that can enhance economic growth even under the same level of technology and total production factors. It refers to the extent to which resources are allocated in proportion to the productivity of companies."

The report analyzed that, based on estimates of the degree of inefficient allocation of production factors among domestic companies, the inefficiency of resource allocation in the Korean economy has expanded significantly over the past 30 years. In particular, the inefficiency of resource allocation in the service sector has grown more rapidly than in the manufacturing sector. Lee noted, "This phenomenon became even more pronounced during and after the financial crisis and the COVID-19 pandemic."

The inefficiency of resource allocation has expanded mainly among 'high-productivity, under-resourced' companies. Lee stated, "While relatively fewer resources were allocated to highly productive firms, relatively more resources were allocated to less productive firms," adding, "The inefficiency of resource allocation has expanded mainly among 'high-productivity, under-resourced' companies rather than 'low-productivity, over-resourced' companies."

Additionally, the proportion of companies that are under-resourced in terms of 'capital' rather than 'labor' has increased markedly, especially among service sector firms and startups. The proportion of 'low-productivity, over-resourced' companies has not decreased over the past 30 years and has remained at a certain level, failing to contribute to the improvement of resource allocation efficiency. Lee pointed out, "As a result, the inefficient utilization of resources that could be invested in productive sectors has persisted."

The report emphasized that, for sustainable growth through improved productivity across the entire economy, it is necessary to fundamentally reform the structure of inefficient resource allocation. Lee stressed, "It is important to improve the financial system and access to capital markets so that highly productive companies and innovative startups can smoothly secure funding and grow," adding, "It is also necessary to ease excessive protection for low-productivity companies to induce the efficient reallocation of resources to high-productivity firms." The report explained that, if an efficient resource allocation structure is established, the total factor productivity of the entire Korean economy will improve, thereby strengthening the foundation for long-term sustainable growth and competitiveness.