Jon Pareliussen

Yoonyoung Yang

Market-friendly reforms in the 1960s kicked off decades of stellar growth in Korea, but productivity has slowed since, weighed down by persistent performance gaps between the vast SME sector and large companies. Extensive reforms are needed to support Korean SMEs’ productivity catch-up by boosting fair competition on a level playing field in the domestic market for goods and services. This chapter argues for:

• A Red light to state support: Many policies are in place to protect and support SMEs, including more than 1600 subsidy schemes. Consolidating these policies would reduce the risk that the sum of support and protection in various forms lock in resources in low-productive uses and thereby end up undermining the strength of the SME sector. Korea should only allow subsidies to companies in a limited number of special cases. A reformed system should contain only a small number of programmes targeting clearly identified market imperfections with a system of centralised rules, coordination and oversight.

• A Green light to private enterprise by removing regulatory hurdles: Previous OECD Economic Surveys have recommended to move to a negative list approach of regulations, meaning that activities are generally allowed unless explicitly prohibited (Table 3.1). Lowering trade barriers can boost competition across company sizes in the domestic market and create opportunities for SMEs supplying the conglomerates to diversify their customer base and thereby reduce dependence. Competition reforms in sectors with heavy state involvement would also help provide services more cost-effectively and correct relative price distortions, notably for electricity and rail.

The following policy areas should also feature in a comprehensive reform package to promote productivity. These are mentioned here for their importance and for completeness. Some of these areas are discussed further in other parts of this Survey and the others in previous Surveys, as indicated:

• Continued efforts are needed to prevent the abuse of market power by large companies and unfair subcontracting practices, including strengthening anti-trust regulation and enforcement as well as transparency and anti-corruption policies, as argued in the 2018 OECD Economic Survey of Korea. The state of play and recent developments in transparency and anti-corruption policies are presented below.

• Labour market reforms are key to reduce duality and shift from the current seniority-based wage system to one that better reflects job performance. Thus fostering the efficient reallocation of labour will boost productivity and welfare. Labour market structures are also closely related to low fertility, and therefore covered in more detail in Chapter5 of this Survey, Yang et al. (2024) and Choi and Ham (2024).

• Strengthening the social safety net is a central enabling policy. In Korea, due to the common practice of early retirement, second careers in the SME sector are de facto part of the social safety net. Chapter 5 discusses measures to move away from this practice. Increasing coverage of unemployment insurance combined with strengthened active labour market policies are essential to prevent hardship and boost social acceptance of structural reform (Chapter 5).

• High-quality vocational education and training and life-long learning could better match skill supply with jobs. Vocational graduates from Meister schools and the Work-Learning Dual System show good labour market outcomes and escape the excessive and unnecessary competition to obtain additional educational qualifications, but weak demand from students and weak employer commitment point to room for improvement. Life-long learning is key to improve matching of older workers, and to meet structural change from the green and digital transitions These issues are discussed in the 2020 and 2022 OECD Economic Surveys of Korea.

Korea’s GDP per capita has converged to the OECD average, with average growth approaching 10% per year during the past five decades (Figure 3.1, Panel A). Growth has mainly been driven by labour efficiency and capital accumulation. Capital accumulation was particularly strong from the late 1970s to the start of the Asia crisis in 1997. A strong focus on education has boosted skills, as reflected in labour efficiency. Indeed, Korea’s 15 year-olds are among the top performers in maths, science and reading, as measured in the OECD’s PISA Survey (OECD, 2023a).

Labour supply has contributed to growth over the whole period and by as much as one third in the early 2010s and early 2020s. This reflects a combination of a rising share of the population being of working age as well as increasing employment among the working-age population. Labour force participation is set to increase further, driven by women and the elderly, while the working-age population is set to shrink due to Korea’s very low fertility rate (Chapter 5). These two forces combined will lead to a much-diminished positive contribution from labour supply in the coming decade, turning negative in the late 2030s (Figure 3.1, Panel B). Productivity per hour worked is still well below the OECD average, reflecting comparatively low total factor productivity (TFP) and long working hours (Panel C). Annual hours worked have been decreasing at the most rapid pace among OECD countries, but were still at 1901, 8.5% above the 1752 OECD average, in 2022 (OECD, 2023b).

Slowing productivity growth in Korea reflects a global trend. TFP growth in the highest-productivity countries has slowed, reducing the pull from an expanding global productivity frontier. Also, as the gap between Korea’s productivity and the frontier narrows, the process of catching up to best practices slows down. Hourly productivity growth in countries at the productivity frontier slowed from 1.4% during the 1997-2007 period to 0.5% in 2007-21. Productivity growth in Korea has been catching up in both periods, growing by more than 5% per year from 1997 to 2007 and still by over 3% from 2007 to 2021 (Figure 3.2). In other words, Korea’s productivity is steadily catching up with the frontier, and at decent rates compared to other OECD countries.

Even so, Korea needs to boost productivity further to raise living standards. Rapid ageing implies that a smaller share of the population will need to produce the goods and services consumed by all (Chapter 5), a burden that can be alleviated by boosting productivity. Furthermore, there is a need to reduce working hours to improve work-life balance and help turn around the fertility trend (Chapter 5). Hourly productivity needs to continue to increase to ensure healthy income growth. Shim and Kim (2020) found that firms affected by the first stage of a reform which was rolled out from 2018 to 2021 to limit the maximum weekly work hours (including overtime) from 68 to 52 increased the number of regular employees compared to the control group while there were no negative effects on sales or value added per employee. In other words, hourly productivity increased to fully offset the reduction in work hours.

Korea has less scope to add to productivity by increasing factor inputs and education levels than in the past (Swiston and Tam, 2022; Cho, 2023). As discussed in Chapter 5 and previous Surveys, an exaggerated focus on formal qualifications has led to a race to get into the top universities to land high-quality jobs, dubbed the “golden ticket syndrome”. Young Koreans are therefore now the highest educated in the OECD, while educational attainment in younger cohorts has levelled off. It is doubtful if further investments in education will boost productivity, although there is scope to reform the education system to improve matching to labour market needs, boost productivity and people’s well-being (Chapter 5; OECD, 2022). Accelerated capital deepening is also not a credible or desirable option to boost living standards going forward. Following Korea’s rapid capital accumulation since the 1960s, investment as a share of GDP remains among the highest in the OECD (Figure 3.3, Panel A). The return on additional investments has decreased, with the investment needed per unit of growth having already surpassed that in the United States (Panel B). Strong growth in corporate saving, which exceeds 30% of GDP (Panel C), has been accompanied by stable business investment of around 20% of GDP. This indicates that the corporate sector sees limited scope for additional productive business investments in Korea above and beyond the current trend (Panel D).

Even in R&D and advanced technologies there is a need for greater value added rather than boosting factor inputs further. Korea invests more than 5% of GDP annually on R&D (2022), a level only matched by Israel among OECD peers. Korea is a frontrunner in digital technologies and one of the top five contributors to the development of emerging digital technologies. Korea accounted for 9% of global IP5 patent family filings from 2017 to 2019 (OECD, 2023c), and it files a considerable share of patents in the top 25 fast-growing information and communication technology (ICT) fields (OECD, 2020). A national Artificial Intelligence (AI) strategy was presented in 2019. Five universities were designated as AI Engineering schools, and Korea’s leading companies are investing aggressively in the technology. Korea launched the AI Strategy High-Level Consultative Council in April 2024. The number of AI Engineering schools has expanded from 5 in 2019 to 19 in early 2024. However, also within R&D there is a case to prioritize the quality of investments over quantity and channel already substantial inputs towards uses that better contribute to broad-based productivity growth.

To properly understand Korea’s case, it is useful to see it under the lens of broadly defined technology diffusion. Total factor productivity rises through: firms at the productivity frontier expanding the possible (innovation); non-frontier firms adopting new technologies, know-how and working practices invented by frontier firms and thereby catching up to higher productivity levels (diffusion); and (re-) allocation of resources between sectors and firms with different productivity levels through firm entry and exit and reallocation of labour and capital. These three channels are interrelated, and competitive markets for products, services, capital and labour are central to their effectiveness (André and Gal, 2024).

Korea’s dynamism in digital technologies is reflected in its high share of value added and employment in ICT manufacturing sectors (Figure 3.4). Even so, economy-wide productivity is far below the OECD average. This reflects several structural features. Low-productivity sectors like trade, transportation, accommodation and catering account for a higher share of total employment than the OECD average (28% against 25%). Moreover, most jobs created in new Korean small and medium sized enterprises (SMEs) are in low-productivity activities, like in many OECD countries (OECD, 2019c): in 2017, 56% of jobs created by the birth of new SMEs were in trade, transportation, accommodation and food services. Furthermore, in high-productivity sectors like manufacturing, SMEs account for a high share of enterprises and of employment, but are less productive than large firms (2018 OECD Economic Survey of Korea). This productivity gap is observed across OECD countries but is substantially wider in Korea (OECD, 2020a).

Low productivity in services and SMEs has been found to be a main contributor to productivity dispersion in Korea (KIET, 2020), even though industry structure, with a high share of value added and employment in ICT manufacturing sectors, plays a role (Figure 3.4). The employment share of SMEs is the highest in the OECD, and SME productivity is only about one third of that of large companies, compared to around half in other OECD countries (Figure 3.5).

Korea can draw valuable lessons from its own past, when export-friendly and market-friendly reforms, skilful macroeconomic management and a commitment to education were instrumental to its stellar growth performance, while periods of more interventionalist policies created imbalances and likely held back growth (Nam, 1995; Irwin, 2021; Kim, Lee and Shin, 2021). The 2018 OECD Economic Survey of Korea discussed in detail how productivity gaps between large and small companies are rooted in both the concentration of economic power among large companies, notably the large family-controlled conglomerates (chaebol), and insufficient competition in segments of the domestic economy dominated by SMEs. Both can be traced back to past periods of interventionist industrial policy, which contributed strongly to the dominance of the chaebol in the domestic market, and a subsequent counterreaction with interventions to protect SMEs.

The business groups need to maintain high productivity to compete internationally, and typically offer highly-educated workers well-paid jobs, good working conditions, regular employment and social insurance coverage (OECD, 2022). However, their size can give them market power domestically. SMEs that supply products to large firms frequently complain that they are unfairly squeezed. Issues relating to how the chaebol are organised as conglomerates and how the interests of owner families may not align with those of other shareholders are also seen as a key explanation of the “Korea discount”, the undervaluation of Korean equity prices compared to other countries (OECD, 2018). The inheritance tax rate of up to 50% of market value is the second highest in the OECD and is seen by business owners as a cause of the Korea discount. It cannot be ruled out that the inheritance tax leads owner families to take actions that hold back the market value of their companies, but there is no definitive causal evidence of this happening. Such actions can be hard to prove empirically and even harder to separate from other causes of owner families channelling profits to companies in which they hold a higher ownership share ("tunnelling”). Taxing inheritance is in general an efficient form of taxation, and it serves the important purpose of reducing intergenerational persistence of economic power. These issues deserve further research. Reducing the tax rate should be considered against the benefits of the tax and alternative reforms, including narrowing the scope for owner families to manipulate the tax base by means of regulations, supervision and a general strengthening of competition, governance and minority shareholder rights.

The sheer size and importance to the Korean economy of the chaebol is also a macroeconomic risk, compounded by their complex ownership structures, as was clearly demonstrated during the 1997-98 Asia crisis (OECD, 2018; OECD, 2022). The traditional tight bonds between chaebol and policymakers have manifested themselves in corruption, including scandals involving former presidents during their time in office. Control of corruption as measured by the Worldwide Governance Indicators has improved considerably over the past decade, but remains below the OECD average (Figure 3.6). Korea is proactively disclosing government data, and has strong regulations on political finance, but needs to further strengthen lobbying regulations or transparency tools (OECD, 2023d). While legal amendments hampering investigation and prosecution of foreign bribery offences have represented a setback, continuous steps have been taken over time to prevent market power abuse and corruption, including measures to prevent chaebols’ use of legal loopholes to expand business and the owner families’ pursuit of benefits at the expense of minority shareholders.

In 2021, the OECD Working Group on Bribery noted that while 22 out of its 36 Phase 4- recommendations had been fully or partially implemented, there was still much to be done. It welcomed Korea’s efforts to strengthen its capacity to enforce the foreign bribery offence, but noted that Korea needed to increase its efforts to train and provide adequate guidance to officials working with foreign bribery investigations to improve detection and enforcement. Korea was also urged to step up its level of foreign bribery enforcement and to address key unimplemented recommendations concerning, among others, the false accounting offence and its anti-money laundering reporting framework (Figure 3.7).

In 2022, the Korean National Assembly adopted substantial amendments to the Prosecution Service Act and Criminal Procedure Act, hampering the Prosecution Office’s ability to investigate and prosecute foreign bribery offences, according to the OECD Working Group on Bribery. The Government has taken actions to minimise possible negative effects, including by bringing the case before the Constitutional Court (OECD Working Group on Bribery, 2022). Going forward, Korea should ensure that the Prosecution Office and the police have the appropriate powers to effectively enforce the foreign bribery offence, and increase efforts to train and provide adequate guidance to officials working with foreign bribery investigations to improve detection and enforcement.

Unfair subcontracting practices and home market dominance from large companies can hold back productivity in SMEs, but there are also other important reasons for low SME productivity in Korea. SMEs employ more than half of the work force in all OECD countries except the United States. Korea has a particularly large SME sector (Figure 3.8), partially because many who retire early from their career jobs (see Chapter 5) use their retirement allowance to set up a business. SMEs are thus a key element of the Korean social safety net (OECD, 2018). Low-productivity SMEs are often in the domestic-oriented service sector and hire a larger share of non-regular workers who earn less pay. Social insurance coverage is steadily improving but remains incomplete and considerably lower in SMEs than large companies (Figure 3.9). Many of these firms are not able to attract the skills needed to boost productivity, for example by adopting digital technologies (OECD, 2022). Indeed, firms with at least 300 employees pay young workers 50% higher wages than those with less than ten employees, and only employ 14% of their work force on non-regular contracts, compared to almost half in large companies (OECD, 2018; OECD, 2022; OECD, 2020).

The existing policy mix tilted towards subsidies and other special treatment for SMEs has not narrowed the overall productivity gap between large and small companies. This point is illustrated by Woo and Han (2017), who showed that SMEs receiving the most public support saw lower growth in productivity and value added than those receiving the least. In a similar vein, businesses receiving policy financing had lower productivity and higher survival rates than what would otherwise be the case (OECD, 2018). Recent literature on size-based regulations in France and Canada confirms that firms hold back growth to stay below size thresholds, and that such regulations hold back innovation with considerable negative effects on productivity and wages (Aghion, Bergeaud and Van Reenen, 2023; Lehoux, 2024).

Public support schemes are discussed in detail below. In addition, SMEs are assisted through preferential treatment in public procurement, lower tax rates at both central and local government levels, exemptions that lower taxable income, exclusions from the Monopoly Regulation and Fair Trade Act for associations of SMEs, the right to hire foreign workers under the low-skill time-limited work immigration scheme (Chapter 5) and discounted prices for water and electricity (OECD, 2018; OECD, 2021; Chapter 4). Many regulations contain size thresholds to reduce the regulatory burden on SMEs, while they may at the same time be entitled to support for regulatory compliance and enforcement may be lenient. One example is the Duru Nuri social insurance support programme which subsidises mandatory pension and employment insurance premiums for low-income workers in companies with fewer than ten employees (OECD, 2020). Despite this support, 8% of the work force, who should be registered in the employment insurance scheme, are not. Korea also has a tradition to support sectors deemed to be new growth engines by various means including direct support and tax measures. Even though such sectoral polices are not explicitly discussed here, they contribute to the complexity and inefficiencies discussed below. Most of the arguments to limit size-based polices would apply equally to sector-based policies. A reform programme to boost SME productivity convergence should boost fair competition on a level playing field. Consolidating SME support and removing regulatory barriers to competition are key in this respect.

Central government spending on programmes subsidising SMEs amounted to 5.1% of its total spending in 2023, up from 4.3% in 2017. Comparable data for total SME support across the OECD is not available, but Korea’s SME credit guarantees and its overall R&D support to companies of any size were the highest in the OECD in 2019, the last normal year before the pandemic. These supports remained among the most generous of the OECD during the pandemic, and they have risen over time (Figure 3.10).

The system in place to support businesses is fragmented. SMEs are under the responsibility of the Ministry of SMEs and Startups, while the Korea Fair Trade Commission, the Ministry of Justice, and others are in charge of general policies that apply to all businesses including large enterprises. A total of 1646 programmes were in place in 2023 to support SMEs, 530 run by 18 different Ministries and central government agencies and 1116 run by the 17 regions. The number of central government programmes and the amounts distributed have increased since 2014, while both the number and amounts have been relatively stable at the regional level. The amount of support peaked during the Covid-19 pandemic, as policies were put in place to help affected SMEs, micro-enterprises and self-employed. It came down somewhat in 2023, as pandemic-related supports were reversed (Figure 3.11). Considerable streamlining and budget consolidation of research and development support is underway in 2024.

State support to companies can boost productivity if it is well-designed and corrects for market imperfections such as positive externalities from research and development and credit constraints that can affect companies with good business models but little collateral. The digital and green transitions strengthen the case for some of these kinds of supports. Against this background, the Government will for example provide customised support for digital manufacturing innovation to 25 000 small and medium-sized manufacturing companies by 2027 to advance smart factories in public-private collaboration. Twelve major national innovation technologies and the New Growth 4.0 Project have been supported since 2022. Support is also provided for 100 core technologies for carbon neutrality (Chapter 4).

However, in practice the sum of support schemes may hold back competition and prevent restructuring of low-productivity SMEs. Public support not targeting market imperfections normally shifts society’s resources, notably labour and capital, from more productive to less productive uses, thereby exerting a drag on productivity and growth. Even if a market imperfection has been clearly identified, a subsidy may do more harm than good unless it is able to correct for it and it is the best policy instrument available. This is a high hurdle to pass, as information asymmetries between the recipient and the administrator create scope for rent seeking and make it hard to evaluate the effectiveness of subsidies. The high number of schemes and actors involved reduces transparency and oversight from the point of view of government and that of recipients, increasing the risks of poorly conceived and designed subsidies as well as rent-seeking behaviour.

Consolidating the public support framework into a small number of programmes with centralised rules, coordination and oversight would increase the likelihood that such supports manage to target market imperfections while minimising new distortions. If possible, remaining subsidies should have a competitive design to ensure cost efficiency, like for example the Contract for Difference Scheme to support renewable energy in the United Kingdom (Pareliussen et al., 2022). Subsidy design and application procedures should be as simple as they can be while at the same time maintaining the subsidy’s purpose and the integrity of the system. The system should be a common one for all company sizes, although this does not prevent easier access to some sub-categories of support for SMEs, or even exclusive access in the case of for example startup and seed funding, as is common practice in many OECD countries.

As a good practice example of streamlining, simplifying and professionalising subsidy administration, most state and regional aid in Norway (excluding agriculture) is administered by the innovation agency Innovation Norway, owned 51% by the Ministry of Trade, Industry and Fisheries and 49% by the county authorities. One important reason why state aid in Norway is relatively limited and consolidated is that as a member of the European Economic Area, it is obliged to follow EU state aid rules. Even though these rules were designed to facilitate cross-border trade within the European Economic Area, the principles applied are ground rules for level playing field competition, and therefore equally relevant in a single-country context. The basic framework for state aid in the European Union remains intact, even though the application of the rules has become considerably more lenient over the past few years in the face of the COVID-19 pandemic and the energy crisis caused by Russia’s invasion of Ukraine. The EU Treaty declares as a general principle that state aid is illegal, except in some specified circumstances related to market imperfections and overriding policy objectives (European Union, 2008). Other key mechanisms in the EU framework include: establishing a centralised system to assess the legality of new supports before their introduction (and as a consequence having oversight from the outset); transparency about who receives aid for what; and accountability and liability in the case of illegally conceived and awarded support. State aid is in general meant to support growth. Firms in difficulties are therefore excluded in principle (Box 3.1).

In contrast to the EU general prohibition against broadly defined state aid, Korea’s Constitution declares that the “State shall protect and foster SMEs”. This principle is operationalised through the Framework Act on Small and Medium Enterprises and a range of other laws spanning from SME promotion and establishment, market and product facilitation, regional development and local SMEs, supporting human resources for SMEs, SME business conversion, SME cooperation with large companies, fair transactions in subcontracting, venture businesses, female-owned businesses, technology innovation promotion and credit guarantees (KLRI, 2013). The Framework Act requires the government to consistently strive to expand support and investment to foster SMEs (Article 18-2). Support measures should help SMEs improve the efficiency of management, develop technology, establish markets such as procurement, encourage fair competition, protect business areas in the designated fields, and secure the workforce (Articles 6 to 15). Policy instruments to be used include legislative and fiscal support (Article 18), and financial support such as credit guarantees and tax benefits (Article 19).

A better operationalization of the State’s obligation to foster SMEs would be to limit public support by law or other centralised institutional arrangements, with exceptions as outlined above. Successive governments have taken actions in this direction. Spending on public supports is evaluated by fiscal authorities and the National Assembly as part of the budget process. A 2015 amendment to the the Framework Act (Article 20-3) sets out the government’s duty to improve the efficiency of SME support programmes using the Integrated Management System of SME Aid Programmes (SIMS). As part of its efforts to improve the efficiency of SME support programmes the government introduced graduation schemes for credit guarantees in 2018 and policy loans in 2019. It introduced an evaluation scheme supported by the SIMS in 2019. Expanding the coverage of graduation schemes could increase the efficiency of support (OECD, 2022). Aided by the SIMS, some programmes have mechanisms in place to prevent support from being skewed towards a limited number of companies. The system to set up new schemes seeks to avoid duplicate support schemes. The government is also working to expand the share of support with market-based co-funding.

In addition, Korea has a system in place for centralised oversight of SME support, but the system has room for improvement. Currently, when a ministry or municipality plans to establish or revise a SME support programme it must discuss the plan with the Ministry of SMEs and Startups in advance (Article 20-5 of Framework Act on SMEs). The Ministry will review the plan, including whether it is feasible and does not duplicate the purpose or beneficiaries of existing programmes. Based on this it will accept, conditionally approve or demand a revised plan (“re-consultation”). If the two sides do not reach an agreement on a revised plan, it will be submitted for “coordination” with the SME Policy Deliberative Council, chaired by the Minister for SMEs and Startups (Article 20-5 of Framework Act on SMEs), with the goal of reaching an agreement. The applicant should follow the Council’s decision if there is no “special reason” not to do so. There are no set sanctions for ignoring the decision but in such cases the Minister for SMEs and Startups will discuss the budget for the plan with the Ministry of Economy and Finance. This system would work better if public support was only permitted in specific cases with sanctions for non-compliance, consolidated and operationalised through one or a limited number of entities making rules-based decisions on individual cases at an arms-length distance from political decision-makers.

While with the SIMS, some programmes have mechanisms in place to prevent support from being skewed towards a limited number of companies, there is no legal cap on the maximal amount of support a single firm or project can receive from different programmes for different purposes. Examples of programmes applying limits are loans operated by the Korea SMEs and Startup Agency, SME credit guarantees operated by the Korea Credit Guarantee Fund, Technology Credit Guarantee Fund and Regional Credit Guarantee Fund, and R&D projects supported under the ministries of SMEs and Trade and Industry’s SME R&D graduation System. A rule modelled on the EU system capping support to any project to the highest amount permissible under any single scheme could help limit deadweight losses, enhance competition and reduce administrative resources wasted in “support shopping”.

The SIMS has a number of potential uses in a scenario where state aid becomes more limited by law. It can for example be used to assess and consolidate existing programmes based on new criteria, to implement caps on total support received by projects and firms and to instil accountability. The information in SIMS is currently disclosed to the public upon request in accordance with the Open Government Data Act. A revision of the Framework Act on SMEs makes anonymised microdata from SIMS available to institutions and organisations for statistical and policy purposes from July 2024. This is an important step to help evaluate programmes and improve the efficiency of the system. If public support rules were tightened in the future, it would be natural to allow public access to data about who receives what to increase transparency and accountability. Non-anonymised data is currently only available to authorized institutions and related agencies.

Considerable empirical evidence shows that reforming anticompetitive regulations in markets for goods and services, as measured by the OECD indicators of product market regulation (PMR), can boost total factor productivity (Vitale et al., 2020). Restrictive regulations reduce competition not only in the directly regulated sectors, but also distort prices for the products and services they supply to other sectors. Korea has streamlined regulations over time and performs around the OECD average on the composite PMR indicator (Figure 3.12, Panel A). Out of 15 sub-indicators of regulatory barriers to competition, Korea is at or close to OECD best practice in three, underperforming the OECD average in seven, and far behind OECD best practice in five (Panel B).

Korea’s main weaknesses in the PMR indicator revolve around tariffs, barriers to foreign direct investment, and state involvement in business operations in services and network sectors. The OECD Services Trade Restrictiveness Index (STRI) paints a similar picture, with notably high restrictions on foreign entry and competition in digital and transport network services, accounting and legal services (OECD, 2023e). These weaknesses reflect that after the Korean war and the period of import substitution in the 1950s, Korea opened to the world primarily by promoting exports. Progress on opening up the domestic market to foreign trade and investment in line with OECD best practice has been significant, but slower. Increasing foreign competition could be particularly beneficial in sectors requiring scale to compete, such as those dominated by the large conglomerates and network sectors. Opening network sectors, such as electricity (Chapter 4), rail and gas to competition, while improving governance of remaining state-owned enterprises would boost growth. State-owned companies operating in markets (even imperfect ones) should focus on delivering their core services as cheaply and efficiently as possible, while social goals should be kept separate from business operations. There is also considerable room to lower barriers to imports and foreign direct investment, as well as to improve competition in public procurement. Regulatory barriers to entry in service sectors are also above average. The regulatory burden in services sectors is high (OECD, 2018), partly related to regulations in place to protect SMEs against competition, as discussed above. A decisive move towards a negative-list approach, meaning that activities are generally allowed unless specifically prohibited could help boosting service sector dynamism.

Previous OECD Economic Surveys have argued that regulations should shift to a comprehensive green-light (“negative-list”) principle, with activities allowed unless explicitly prohibited. Legislation to prioritise the negative-list approach when creating regulations for new technology services or products was passed in 2019. The Ministry of SMEs and Startups (MSS) is easing excessive regulatory burdens on SMEs aided by the SME Regulatory Impact Assessment system. Regulation should be used to correct market imperfections, but only if it is the best tool available and its benefits outweigh its costs. In this respect, State ownership and direct control are tantamount to regulation, and should only be used in specific circumstances where market solutions are not viable or clearly inferior.

There may be valid reasons to deviate from the green-light principle in specific areas where there is a risk that consequences of new products or activities are unacceptable. In such cases, smaller scale experiments of deregulation may be a good option. Korea started implementing regulatory sandboxes in 2019, and has since built a comprehensive system of sandboxes and “regulation free zones”, geographical zones where specific regulations do not apply. At the end of 2023, 1139 projects were included in the sandbox programme, of which 487 are under the Industrial Convergence sub-programme, 293 under Financial Innovation, 200 under ICT Convergence, 51 under Smart City, 84 under Special Regional Zones and 24 under ICT Zones. Sandbox projects can receive three types of regulatory assistance. Some only need a confirmation that the envisaged activity is in line with existing regulations. For this, companies can request a rapid confirmation from the Korea Chamber of Commerce, and the applicant is notified within 30 days. When applying for exemptions from existing regulations, a thorough 90-day review is conducted. Through this process, it has been confirmed that 55 projects do not violate the law. 973 projects have been approved as special cases for demonstration and allowed to operate with exemptions from existing regulations within a limited scope (area, size, period, etc.) for safety testing and verification. A third category of the sandbox is when the sandbox application itself triggers a revision of laws and regulations. In this case the project is given a temporary permit for two years, renewable once and in any case extendable until the legal revision is concluded.

To achieve the full potential of the sandbox approach, successful trials should be quickly transposed into economy-wide and permanent deregulation. So far, 70 out of 200 sandbox projects in the ICT sector and 74 out of 487 projects in the Industrial Convergence sector have led to general deregulation. However, as more services are coming to the end of the demonstration period of up to four years, it should be a priority to speed up the regulatory overhaul.

Another key priority should be to remove regulatory size thresholds put in place to protect SMEs (OECD, 2021). These include size-based regulations in the Commercial Act and set-asides for SMEs in public procurement in accordance with the Act on Facilitation of Purchase of Small and Medium Enterprise-Manufactured Products and Support for Development of Their Markets, which allows only domestic SMEs to participate. Preferential treatment in public procurement may not apply in cases with for example specific technology, quality or performance requirements or when the qualified SME has fewer than two employees. Public officials have the discretion to not apply the act if costs outweigh benefits. Regulations should apply universally to large and small companies as well as foreign entrants, and size thresholds should be used very sparingly after careful cost-benefit analysis showing that the regulations in question introduce costs that are out of proportion to the benefits when applied to SMEs. In this case, one should carefully consider if the regulation is necessary in the first place, regardless of company size. In the same vein, regulations in place should be systematically enforced for all companies. If complying with existing well-founded regulations with a positive net benefit to society is seen as an undue burden on certain SMEs, it is in society’s interest that those SMEs either raise their productivity so they can shoulder the additional burden, scale down or exit.

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