A slower Korea after successive crises
South Korea’s long run growth engine has cooled since the 1990s. The Bank of Korea points to a central cause, the prolonged survival of marginal firms through successive crises. Companies that would normally exit have stayed alive, reducing corporate dynamism and blocking the efficient reallocation of capital and labor. Growth downshifted after the 1997 Asian financial crisis, the 2008 global financial crisis, and the 2020 pandemic. The pattern contrasts with the post oil shock rebound of the 1970s, when output exceeded its prior trend.
Firm exits stayed unusually low across those shocks. Emergency credit lines, regulatory forbearance, and public programs extended support to distressed companies with little chance of recovery. Policymakers sought to avoid mass bankruptcies, job losses, and financial instability. The short term pain was softer, but the economy’s capacity to refresh itself weakened.
The numbers show the bind. From 2014 to 2019, about 4 percent of Korean firms were in the high risk category, yet only 2 percent exited, roughly half the expected rate. The central bank estimates that replacing weak companies with healthier ones would have lifted domestic investment by 3.3 percent and raised GDP by 0.5 percentage point. The pattern persisted after the pandemic. Between 2022 and 2024, 3.8 percent of firms were high risk, but only 0.4 percent exited. The Bank of Korea calculates that investment would have been about 2.8 percent higher and GDP 0.4 percentage point higher if market exit had worked normally. That underlines an economy where capital and skilled workers are tied up in low productivity activities while new entrants struggle to scale.
Korea and the United States both saw fewer new businesses during the 2008 crisis and the 2020 shock. Exits rose in the United States, which cleared space for new firms during the recovery. Exits stayed muted in Korea and even declined in the pandemic period.
What counts as a zombie firm
Zombie firms are companies that have lost economic viability but continue operating because they receive lifelines from creditors or the state. A common benchmark is an interest coverage ratio below one for three consecutive years, which means operating profits cannot cover interest expense. Many zombies are highly leveraged, chronically unprofitable, or reliant on subsidized credit, guarantees, or tax relief.
Two mechanisms keep them alive. First, banks with weak balance sheets roll over loans to avoid recognizing losses, a practice known as forbearance. Second, very low interest rates and a flood of credit make it easier to refinance, turning projects that should be shut down into going concerns. Research across the OECD links zombie congestion to fragile banks and slow insolvency procedures. A recent global dataset also finds higher zombie shares where macroprudential rules are weak, insolvency regimes are ineffective, and credit is cheap.
How this hurts productivity
When zombies persist, market signals get distorted. Credit, talent, and management time flow to incumbents with low returns rather than to challengers. The diffusion of new methods slows because weak firms hang on to market share while stronger firms wait for capacity to free up. Investment by healthy companies falls and the rate of job creation declines. Over time, potential growth drops because the process economists call creative destruction is interrupted.
The data behind Korea’s slowdown
The Bank of Korea examined about 2,200 firms subject to external audits to estimate exit probabilities. Large corporations in the top 0.1 percent, roughly two dozen companies, kept investing through the global financial crisis. Most others stagnated or pulled back. The central bank concludes the investment slowdown is better explained by weak profitability than by credit shortages. Liquidity was often supplemented through public programs and lender support.
The high risk cohort looked worse on profitability and debt ratios than firms that actually exited, yet they had better liquidity. That is consistent with banks extending credit to keep borrowers afloat and with broad based policies that prioritized survival over restructuring. The price is lower investment and productivity across the corporate sector.
Entry down, exits muted
During the global crisis and the pandemic, firm creation slowed both in Korea and in the United States. The two countries diverged on exit. Many unviable firms left the market in the United States. In Korea, exit rates stayed low and even fell in 2020. The gap matters because new firms are a major source of innovation and job growth. When entry slows and exits do not clear capacity, the pipeline of challengers gets thinner.
Why exits stayed muted
Korean authorities have often prioritized stability during shocks by extending loans, guarantees, and regulatory protections. That can be a valid choice in a crisis. Thousands of sudden bankruptcies can trigger a credit crunch and mass layoffs. The trade off appears later. Firms that needed to restructure or liquidate are still operating, competing for resources with younger and more productive rivals.
Bank forbearance and easy money
International evidence shows how policy settings shape zombification. Studies of quantitative easing and prolonged low rates describe how easy refinancing encourages malinvestment. Banks sometimes refinance weak borrowers to avoid admitting non performing loans. Research on China after the 2008 stimulus finds that politically connected firms were more likely to become zombies when targeted industries received large support. While Korea’s institutions differ, the mechanism is clear. Generous and untargeted lifelines can keep weak firms alive and slow reallocation.
The pandemic added another layer. Emergency support around the world prevented a wave of failures. Where insolvency systems were slow and bank balance sheets were fragile, survival continued long after the emergency had passed. Korea’s post pandemic exit rate of 0.4 percent among high risk firms suggests that the clean up phase has not fully started.
Lessons from Japan and global evidence
The Bank of Korea has warned that Korea risks replicating parts of Japan’s experience after its asset bubble burst. Private sector debt in Korea reached about 207 percent of GDP in 2023, which is close to Japan’s peak in the early 1990s. Korea’s population is aging faster, and the working age population has been shrinking since 2017. When debt is high and demographics are adverse, lenders and policymakers can be tempted to keep credit flowing to maintain stability. Japan’s banks and regulators did that in the 1990s, and many unproductive firms stayed alive through the 2000s.
The central bank calls for tighter control of leverage through macroprudential rules, quicker corporate restructuring, and a stronger insolvency framework. Global research supports that approach. Countries with healthier banks and faster restructuring see fewer zombie firms and smaller congestion effects on healthy companies.
The urgency is also cultural and strategic. The central bank urged an industrial policy that protects the ecosystem rather than individual firms. It cited Swedish economist Johan Norberg to capture the choice ahead.
‘A nations rise or fall is not a matter of fate, but of choice.’
Innovation, SMEs, and a nuanced picture
Not all firms tagged as zombies fail to innovate. A study of R and D active small and medium sized enterprises in Korea found that firms with zombie status invested more in research and were more likely to secure patents than peers. The effect was strongest in industries with a lower share of zombies, a pattern the authors call zombie congestion. These firms did not show better commercialization rates, but their research effort and technical outputs were real. The takeaway is that financial filters alone can misclassify some innovators.
At the same time, stress is intensifying among smaller companies. Loan delinquency rates at banks that focus on SMEs rose to the highest level since 2010. Many small exporters have been hit by weak demand, higher costs, and tariff extensions on steel related products. Bankruptcies have increased, and surveys show sentiment well below neutral. Sector gains from the semiconductor cycle have yet to reach many suppliers. As of last year, about 18 percent of SMEs were classified as zombies by the interest coverage rule.
Where to draw the line
Policy needs a triage that separates firms with temporary liquidity problems from firms that lack a viable path back to profitability. The first group can benefit from bridge finance and targeted relief tied to restructuring plans. The second group should be wound down so that people, machines, and credit can move to businesses with better prospects. Innovation programs should assess the quality of research pipelines in addition to financial scores, especially for early stage companies.
Policy choices that revive dynamism
Reforms that speed up exit and restructuring are central. Insolvency procedures should resolve cases faster, reduce the personal cost of business failure, and support asset transfers to stronger owners. Where listed companies have failed audits or met chronic loss and governance triggers, delisting and restructuring should be timely. The Korea Exchange has begun to tighten delisting rules, and the Financial Supervisory Service has signaled tougher accounting reviews. Even so, the share of listed zombies remains high, which suggests enforcement must be quicker and more consistent.
Bank health is the other pillar. Regulators can push banks to recognize losses and clear non performing loans, then replenish capital. Reducing the tax bias toward debt and expanding equity and venture funding would give young firms better alternatives to bank loans. Market based finance helps new entrants scale without being squeezed by incumbent friendly credit channels.
On the growth side, the state can focus on public goods and clear bottlenecks rather than shielding specific firms. Easing regulatory barriers can help new industries emerge while keeping Korea’s edge in semiconductors and autos. Investments in digital infrastructure, data portability, and testing and certification speed can lower the cost of innovation. Competition policy that opens markets to new players will make it easier for challengers to take share from incumbents.
What would change for workers and investors
A faster exit process means more churn. The social cost is real if workers are left behind. Active labor market programs, including job search help, retraining tied to in demand skills, and relocation assistance, can shorten unemployment spells. Wage insurance and portable benefits can protect incomes during transitions. These tools are essential if the economy is going to recycle capital and labor at a faster pace.
Investor behavior matters too. Retail investors have shifted toward foreign equities as confidence in domestic listings has waned. A credible clean up of chronically weak listings, stronger disclosure, and consistent enforcement can help rebuild trust and shrink the Korea discount. Financial Supervisory Service Governor Lee Bok hyun told an open forum on revitalizing the stock market that culture must also change.
‘There needs to be a broader culture that recognizes and practices the value of long term investing.’
That message aligns with the central bank’s call for an ecosystem that rewards innovation and patient capital rather than the survival of incumbents at any cost.
Key Points
- The Bank of Korea links Korea’s slower growth since the 1990s to the prolonged survival of marginal firms after major crises.
- From 2014 to 2019, about 4 percent of firms were high risk, yet only 2 percent exited. After the pandemic, high risk firms were 3.8 percent and exits just 0.4 percent.
- The central bank estimates investment would have been 3.3 percent higher in 2014 to 2019 and 2.8 percent higher in 2022 to 2024 if exit had functioned normally.
- GDP would have been 0.5 percentage point higher before the pandemic and 0.4 percentage point higher after, had weak firms been replaced.
- Korea and the United States both saw fewer new firms in the 2008 crisis and in 2020, but exits rose in the United States and stayed low in Korea.
- Zombie firms persist where banks are weak, credit is cheap, and insolvency regimes are slow, reducing investment and productivity in healthy firms.
- The BOK warns of risks similar to Japan, highlighting high private sector debt and rapid aging as additional pressures.
- Evidence on R and D active SMEs shows a nuanced picture, some zombie labeled firms invest more in research and secure more patents in less congested industries.
- Regulators are tightening delisting rules and audits, but listed zombie shares remain high, signaling the need for faster restructuring.
- Policy priorities include stronger insolvency and bank cleanups, targeted support for viable firms, regulatory easing to spur new industries, and robust worker transition programs.
