An Analysis of Factors Discouraging SME Growth
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Writer
CFE
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1. Problem Statement: SMEs’ Voluntary Refusal to Grow
Since the 1997 Asian financial crisis, Korea’s SME policy has consistently maintained a stance of support and protection. Yet the resulting outcome is paradoxical. The productivity and wage gaps between large firms and SMEs have widened to among the highest levels in the OECD, while the layer of mid-sized firms remains shallow. This report identifies the cause of this stagnation in the Peter Pan syndrome—that is, the phenomenon in which firms deliberately avoid growth because institutionally induced distortions in incentives lead them to do so even when they are capable of growing. This is not the result of a lack of entrepreneurship, but of rational choices made under the given institutional framework.
The first mechanism creating incentives to avoid growth is a subsidy structure unrelated to productivity. According to an analysis by the Bank of Korea, a regressive structure has formed in which firms with lower profitability, growth potential, and productivity receive more government support. Through the signaling effects of soft budget constraints and forbearance lending, this structure keeps marginal firms alive while generating a crowding-out effect that absorbs credit and capital that should flow to sound firms. At the same time, high-performing firms are excluded from support programs, structurally lowering the marginal benefit of efforts to grow.
The second mechanism is the discontinuity in stepwise regulation and support based on asset size. According to the Korea Enterprises Federation, entry into mid-sized firm status triggers 126 new regulations at once, and according to Bank of Korea data, about 40% of firms just below the mid-sized firm threshold (0.9–1.0 times the benchmark) receive government support, but the moment they cross the threshold, that share drops sharply. In other words, a so-called “cliff” structure emerges, in which costs rise while benefits are cut off.
These concerns are directly confirmed in Korean data. According to an analysis by KDB Industrial Bank, the number of marginal firms subject to external audit rose about 3.3 times from 1,353 in 2011 to 4,478 in 2021, while among small and medium-sized marginal firms alone, the number increased 3.5 times from 1,225 to 4,288. The share of chronically marginal firms also rose during the same period from 13.3% to 23.1%, approaching one in five externally audited firms. Conditions in the middle tier are no different. According to the Ministry of Trade, Industry and Energy’s 2023 Basic Statistics on Mid-sized Enterprises, of the 744 firms that exited mid-sized firm status that year, as many as 574 (77.2%) reverted to SME status rather than advancing into large-firm status. The share of mid-sized firms considering such reversion also rose from 5.3% (2022) to 6.1% (2023). The leading reason for reversion was the reduction in tax support (60.8%), and more than 75% of all reasons for reversion were found to be directly related to the “loss of support.” In short, Korea’s corporate ecosystem is trapped in a dual stagnation in which firms neither grow upward nor are sorted out downward. Accordingly, the direction of policy should be neither simply to expand nor reduce support, but to redesign the linkage structure between support and regulation itself.
2. The Concept of the Peter Pan Syndrome and Its Economic Significance
The Peter Pan syndrome originally refers in child psychology to a child’s refusal to become an adult. When applied to firms, the term should be limited to cases where incentives exist to avoid growth. It is distinct from structural constraints that prevent firms from growing—such as lack of capital, insufficient technological capability, or limited market demand—and instead refers to cases in which non-market institutions such as regulation or subsidies distort growth incentives so that firms choose not to grow. This distinction is important for policy. Constraints on growth arising from market failure provide grounds for intervention through support, whereas growth avoidance arising from institutional failure instead calls for reducing and redesigning intervention.
In a market economy, firm growth is a core mechanism that improves the efficiency of resource allocation, realizes economies of scale, and promotes innovation and productivity gains. As Schumpeter pointed out, the process in which high-productivity firms grow and low-productivity firms exit raises overall economic productivity. However, Korea’s SME support system operates in a way that weakens this selection function. Low-productivity firms remain in the market by relying on subsidies, while even high-productivity firms avoid mid-sized firm status, reducing the dynamic efficiency of the entire corporate ecosystem.
Its macroeconomic implications are threefold. First, it distorts resource allocation. When firms with growth potential deliberately limit their scale, capital remains in less productive uses and labor becomes stuck in workplaces that fail to realize economies of scale. Second, it entrenches the dual structure. The divide between a small number of large firms and a large number of small-scale SMEs becomes institutionally fixed. As of 2024, the number of mid-sized firms stood at 6,474, showing apparent growth in headline terms, but within that total, hundreds of firms each year are reverting to SME status and even more are considering doing so. This stagnation cannot be captured by static indicators alone. Third, it weakens incentives for innovation. When subsidies and tax benefits function as rewards for “staying small,” firms choose to preserve the status quo rather than innovate through expansion, weakening the mechanism of development through creative destruction and lowering potential growth in the long run.
3. Mechanisms of Growth Avoidance
The first mechanism creating incentives to avoid growth is a subsidy structure unrelated to productivity. According to the Bank of Korea’s Current Status of SMEs in Korea and Measures to Improve the Support System, a regressive structure has formed in which firms with lower profitability, growth potential, and productivity receive more direct and indirect government support. The share of support funds thus shows a negative correlation with productivity, profitability, and growth.
This distortion operates through two channels. One is that it discourages marginal firms from exiting the market. Subsidies provided irrespective of productivity function as a soft budget constraint for marginal firms, making them less sensitive to debt levels, asset soundness, and interest-rate changes, while weakening their incentive to generate self-sustaining profits. In addition, subsidies serve as a positive signal in external financing, inducing banks to continue forbearance lending that bypasses normal credit evaluation, thereby creating a vicious cycle of “moral hazard → government subsidies → bank lending → moral hazard” (Peek and Rosengren, 2005; Qiao and Fei, 2022). The other channel is a decline in the marginal benefit of growth efforts. Because high-performing firms are excluded from support, the rewards for trying to grow are structurally reduced.
Source: Qiao & Fei (2022); Chang et al. (2021); Peek & Rosengren (2005)
These concerns are supported empirically. The OECD’s The Market Implications of Industrial Subsidies shows that subsidy provision itself contributes little to productivity improvement, suggesting that subsidies to low-productivity firms do not generate a virtuous cycle of “support → productivity improvement → self-sustaining growth.” Qiao and Fei (2022), using data on Chinese industrial firms, are more specific. In an analysis of approximately 1.42 million firm-year observations from 1998 to 2013, government subsidies improved both operating efficiency and real rates of return for ordinary firms, whereas for zombie firms, although operating efficiency improved somewhat, real rates of return actually declined significantly, revealing an asymmetric effect. In other words, subsidies make the short-term survival of marginal firms possible but do not lead to a fundamental recovery in competitiveness, instead locking them into a state of being “alive but unable to recover.” The authors identified moral hazard as the key mechanism: subsidies reduced moral hazard among ordinary firms but increased moral hazard among zombie firms, and this negative effect was stronger for small zombie firms with lower market share.
Performance Indicator
Zombie Firms
Normal Firms
Operating Efficiency
+0.0122
+0.0806
Real Profitability
−0.0083
+0.0169
Note: All coefficients are statistically significant at the 1% level (**). Sample: approximately 50,000 zombie firm observations and approximately 1.37 million normal firm-year observations.*
Source: Qiao and Fei (2022)
The same structure is unfolding in Korea. According to an analysis of externally audited corporations by the KDB Future Strategy Research Institute (2022), the number of marginal firms with an interest coverage ratio below 1 for three consecutive years rose about 3.3 times from 1,353 in 2011 to 4,478 in 2021, and during the same period, the share of marginal firms among those analyzed rose from 10.2% to 18.3%. In particular, small and medium-sized marginal firms increased 3.5 times from 1,225 to 4,288, driving the quantitative expansion. Even more concerning is the chronic nature of the problem. Firms classified as marginal at least twice during the analysis period accounted for 23.1% of the total, up 9.8 percentage points from 13.3% in 2016. Firms reporting operating losses for three consecutive years also increased more than fourfold from 615 (2011) to 2,519 (2021). The median borrowing dependence ratio of marginal firms was 48.3%, far above that of non-marginal firms (29.7%), and the time required to repay borrowings relative to EBITDA was about 9 years, three times that of non-marginal firms (about 3 years). This means that repayment is effectively impossible through internally generated operating capacity alone, and that such firms are surviving by relying on external financing—direct evidence that the mechanism of “discouraging market exit through soft budget constraints” is in fact operating.
The second mechanism is the stepwise increase in regulation and the cutoff of support according to asset size. In Korea, corporate regulation increases step by step as asset size grows (SME → mid-sized firm → quasi-large firm → large firm). According to the Korea Enterprises Federation’s 2023 Survey on the Status of Discriminatory Regulations Against Large Firms, the marginal rate of increase in regulation is highest when an SME grows into a mid-sized firm, with newly designated mid-sized firms becoming subject to 126 new regulations at once.
At the same time as regulation increases, support is sharply cut off. According to Bank of Korea research, about 40% of firms in the range just below the mid-sized firm threshold (0.9–1.0 times the threshold revenue) receive government support, but the moment they exceed that threshold even slightly and are recognized as mid-sized firms, the beneficiary ratio drops substantially. This creates the so-called “cliff” structure, in which costs rise while benefits are discontinued. As a result, the increase in costs and the loss of benefits that firms must bear simply for slightly exceeding the threshold become so large that there emerges a range in which the marginal benefit of growth is smaller than its marginal cost. In other words, firms face a powerful incentive to deliberately suppress growth below the threshold.
4. Empirical Consequence: Mid-sized Firms Reverting to SME Status
The consequences of these two mechanisms can be directly observed in the Ministry of Trade, Industry and Energy’s 2023 Basic Statistics on Mid-sized Enterprises. As of the 2023 fiscal closing, the number of mid-sized firms stood at 5,868. Of the 744 firms that exited mid-sized firm status that year, however, as many as 574 (77.2%) did not grow into large firms but instead reverted to SME status. The fact that reversion to SME status exceeded the combined total of temporary suspension or closure (65 firms) and entry into large-firm status (105 firms) suggests that mid-sized firm status itself is not attractive to many firms.
Note: Government support includes tax benefits, financial support, public procurement support, support for securing skilled personnel, and R&D support.
Source: Ministry of Trade, Industry and Energy, Results of the 2023 Basic Statistics on Mid-sized Enterprises
The share of firms actively considering reversion has also been rising over time. The proportion of mid-sized firms considering reversion to SME status rose from 5.3% in 2022 to 6.1% in 2023. The top reason for considering reversion was reduced tax support (60.8%), followed by SME-suitable business sectors (14.9%), reduced financial support (14.2%), and restrictions on market access such as public procurement markets (6.3%). The fact that more than 75% of the reasons for reversion are directly related to the “loss of support” shows that the cost-benefit structure associated with becoming a mid-sized firm is so unfavorable that it can lead firms to reverse their growth decisions after the fact. In the same survey, the areas in which mid-sized firms most wanted expanded support were also taxation (36.6%) and finance (34.3%), with the two categories accounting for 70% of responses. This means that under the current system, tax and financial support at the mid-sized firm stage are effectively cut off in cliff-like fashion, and even firms that have already grown lack the capacity to absorb that discontinuity.
In short, Korea’s corporate ecosystem is caught in dual stagnation, in which firms neither grow upward nor are sorted out downward. At the lower end of the market, marginal firms are expanding in number and becoming chronic, paralyzing the natural mechanism of market exit. In the middle tier, hundreds of firms voluntarily revert to SME status every year. The Peter Pan syndrome is not a hypothetical concern, but a measurable phenomenon that is updated every year in Korea’s corporate statistics.
5. Policy Recommendations and Conclusion
Accordingly, the direction of policy should not be to choose either more support or less support, but to redesign the linkage structure between support and regulation itself. This report offers five recommendations.
1) Shift support criteria from size to performance. Support criteria should be changed from firm size to performance indicators such as productivity, innovation, and growth potential. This would allow the natural exit of marginal firms while concentrating support on firms that have both the willingness and the capability to grow.
2) Introduce a gradual graduation system. Instead of the current cliff structure, in which all support is cut off and regulations are imposed at once when a firm enters mid-sized status, support should be reduced gradually and regulations applied step by step over a certain period (e.g., 5–7 years). There are international benchmarks for such buffer-zone systems in the EU and Japan, among others. Given that the top reason for considering reversion is reduced tax support (60.8%), phased relief on the tax side is the most urgent priority.
3) Manage the total regulatory burden. For the 126 regulations that are automatically applied based on asset size, individual Regulatory Impact Analyses (RIA) should be conducted so that only those whose substantive necessity is verified are retained.
4) Improve the design of tax benefits. The eligibility criteria for tax benefits should be linked not to the “maintenance of SME status,” but directly to growth-oriented corporate behavior such as R&D investment, job creation, and innovation activities. The goal is to select beneficiaries based on firm behavior rather than firm size.
5) Improve exit pathways for marginal firms. For the market’s selection function to operate properly, orderly exit for marginal firms must be possible. Safety nets should accompany this process to reduce the social costs associated with exit—such as simplified bankruptcy and rehabilitation procedures, support for re-startups, and worker retraining—so that market dynamism is restored instead of prolonged survival through subsidy dependence.
Korean SMEs’ refusal to grow—that is, the Peter Pan syndrome—is not the result of moral hazard or a lack of entrepreneurship on the part of firms, but the outcome of rational choices created by the institutional framework. In a structure where subsidies and tax benefits are concentrated on low-productivity firms, and where the rewards for growth are offset by increased regulatory burdens and the loss of benefits, it is economically rational for firms to avoid growth. The empirical materials reviewed in this report—the KDB analysis of marginal firms, the Ministry of Trade, Industry and Energy’s statistics on mid-sized firms reverting to SME status, and Qiao and Fei’s study of zombie firms—consistently support this conclusion.
Accordingly, the solution lies not in moral persuasion directed at firms, but in building an institutional environment in which growth becomes the rational choice. This cannot be achieved simply by reducing support or strengthening regulation alone; it requires a fundamental approach that redesigns the linkage structure between support and regulation itself. If the essence of the market economy lies in the dynamic process by which resources move to their most productive uses, then the current SME support system operates not to complement that self-correcting function, but rather to obstruct it. The Peter Pan syndrome is the clearest evidence of this problem and suggests that the time has come for a fundamental reexamination of SME policy.
◩ References
∙ National Tax Service and Ministry of SMEs and Startups, 2025 SME Tax Support Administration System
∙ Chanwoo Park (2022), “Current Status of Marginal Firms and Implications,” KDB Monthly Bulletin No. 800, KDB Future Strategy Research Institute
∙ Ministry of Trade, Industry and Energy, “Results of the 2023 Basic Statistics on Mid-sized Enterprises,” 2024.12
∙ Korea Enterprises Federation, “2023 Survey on the Status of Discriminatory Regulations Against Large Firms”
∙ Bank of Korea, “Current Status of SMEs in Korea and Measures to Improve the Support System”
∙ Bank of Korea, Financial Stability Report (2015.6, 2015.12, 2021.6)
∙ OECD, The Market Implications of Industrial Subsidies
∙ Caballero, R. J., Hoshi, T., and Kashyap, A. K. (2008). Zombie lending and depressed restructuring in Japan. American Economic Review, 98(5), 1943–1977.
∙ Chang, Q., Zhou, Y., Liu, G., Wang, D., and Zhang, X. (2021). How does government intervention affect the formation of zombie firms? Economic Modelling, 94, 768–779.
∙ Peek, J., and Rosengren, E. S. (2005). Unnatural selection: Perverse incentives and the misallocation of credit in Japan. American Economic Review, 95(4), 1144–1166.
∙ Qiao, L., and Fei, J. (2022). Government subsidies, enterprise operating efficiency, and “stiff but deathless” zombie firms. Economic Modelling, 107, 105728.
∙ Tan, Y., Tan, Z., Huang, Y., and Woo, W. T. (2017). The crowding-out effect of zombie firms: Evidence from China’s industrial firms. Economic Research Journal, (5), 175–188.
∙ Zmijewski, M. E. (1984). Methodological issues related to the estimation of financial distress prediction models. Journal of Accounting Research, 22, 59–82.
Original title: 중소기업 성장 거부 요인 분석
Author: Center for Free Enterprise (CFE)
Date: 2026-06-19
Source: https://www.cfe.org/bbs/bbsDetail.php?cid=issue&pn=1&idx=29180