1. Since the 1990s, Korea’s economic growth has experienced a structural slowdown, failing to return to its pre-crisis trend after undergoing a series of economic crises. An analysis based on macroeconomic data suggests that this resulted from negative demand shocks triggered by the said crises, which led to a persistent slowdown in the growth trend through investment hysteresis.*

* Hysteresis refers to a phenomenon in which a temporary shock has a negative effect on the long-run trajectory of economic variables (e.g., unemployment, investment).

2. To identify the causes of this investment hysteresis and explore possible solutions, an empirical analysis is conducted with firm-level microdata. An analysis of approximately 2,200 externally audited firms shows that, except for a small number of large corporations, investment among most firms stagnated or declined after the Global Financial Crisis. Furthermore, this weakness in investment appears to be more closely associated with deteriorating profitability than with tightening financial constraints.

3. Given the greater impact of deteriorating profitability on the post-crisis weakness in corporate investment than financial constraints, financial support alone may be insufficient to mitigate hysteresis. Instead, it is necessary to ensure on a fundamental level that the cleansing mechanism (cleansing effect) functions properly to allow the market exit of zombie firms, while also facilitating the smooth entry of new firms, so as to enhance the dynamism of the economy.

4. What would Korea’s investment and growth have been if the cleansing mechanism had functioned effectively? Using the characteristics of firms that actually exited the market, this paper identifies firms at high risk of exit and estimates that they accounted for 3.8 percent of the total sample between 2014 and 2019. In contrast, the actual exit rate was only 2.0 percent, roughly half the estimated share of high-exit-risk firms, indicating that the cleansing effect appears to have been limited during this period. Had these high-exit-risk firms exited the market and been replaced by viable firms within the industry, domestic investment would have been 3.3 percent higher and GDP 0.5 percent higher over the same period. During the post-pandemic period (2022–2024), the share of high-risk firms (3.8 percent) remained similar to that of the earlier period, but the actual exit rate fell further to 0.4 percent. If these firms had been replaced successfully, investment is estimated to have increased by 2.8 percent and GDP by 0.4 percent.

5. In sum, the post-crisis slowdown in Korea's economic growth stems primarily from weak investment driven by declining corporate profitability. This slowdown appears to have been further exacerbated by the impairment of the economy's cleansing mechanism, which, had it functioned effectively, could have mitigated such weakness. To mitigate and ultimately reverse the decline in the growth trend, it is essential that policy efforts prioritize the following: (1) Even when financial support is provided, it should be designed to underpin the economy’s innovativeness and dynamism by ensuring the smooth entry and exit of firms. For example, financial support should seek to enhance its effectiveness by being selective and supplementary in its application, targeting firms facing temporary liquidity difficulties or innovative early-stage firms. (2) In addition, while maintaining Korea’s technological advantage in key industries, it is important to strengthen the future growth engines of the Korean economy by stimulating investment in new industries through regulatory easing to create new demand for products and services.