The effects of debt subsidies on corporate investment behavior: the Korean experience

We argue that credit subsidies are ineffective in stimulating business investment in productive assets. Instead, they will lead to an increase in corporate holdings of financial assets and real estate. For empirical verification we examine corporate investment patterns in Korea between 1984 and 1988. We find a significant positive relation between corporate speculative asset holdings and access to subsidized loans. Our estimates indicate that in the absence of interest rate controls and other forms of subsidies, corporate holdings of speculative assets would have been one-sixth of observed levels. Furthermore, most corporate real estate holdings appear to be unrelated to production activities. In sum, we find little evidence that the Korean government's interest rate controls and credit allocation policy have generated increases in corporate investment; if anything, they are partly to blame for the overheated Korean stock market during the sample period.