Taejong Kim

Korea’s Economic Transformation- Challenges and Policy Responses -

KDI School of

Public Policy and Management

November , 2006

1. History of Economic Development

2. Reform and Restructuring

3. Transition to a Knowledge Economy

4. New Challenges

5. Policy Response

6. Summary and Conclusion

Contents

Transformation of the Korean Economy (1945~2003)

A. Growth Trend

6 Five-Year Economic Development Plans

2003P19801962 1970 1995

5,000

10,000

67 87

11,432

7,355

1953

Per Capita GNI(US$)

19901945

12,646

100(1964)1,000(1977)

1998

Big PushLiberation(1945)

Korean War(1950~53)

OECD(1996)

F. Crisis(1997)

History of Economic Development

Changes in Employment Structure

B. Changes in Industrial Structure

Changes in GDP Structure

Manufacturing

63.07.9

28.3

1960

Service Sector

19.2

71.5

9.3

Service Sector

Agriculture / Fisheries

Manufacturing

Agriculture / Fisheries

200232.5

63.2

4.3

Service Sector

Agriculture /Fisheries

Manufacturing

36.8

15.9

47.3

Manufacturing

Agriculture /FisheriesService Sector

Economic Take-off with Outward-looking Development Strategy(1960~80)

CapitalShortage

WeakTechnology Base

UnderdevelopedPrivate Sector

AbundantLabor

StrongEconomic will

High Level ofEducation?

A. Economic Conditions of the early 1960s

Economic Growth

Reproduction

SExport

PromotionManufacturingProcessing

PrivateEnterprises

Government

TechnologyDevelopment

Financial Tax Support

Well-educated Labor force

Foreign TechnologyImports

Capital Good Imports

Raw Material Imports

Foreign Capital Inducement(Economic Aids External Debt)

S

B. Working Mechanism of Outward-looking Development Strategy

E P B Office of the President Economic Ministries

Government Think-tankEconomic Policy Design

Strong export promotionsupports high Growth

(Export Growth of 30%per annum)

Efficient Economic Policy making

Financial Support Marketing SupportTax Support

DiligentWorkers Overseas Marketing and

Economic GrowthStrong

Entrepreneurship

Private Enterprises

C. Continued High Growth Based on Strong Entrepreneurshipand Government Support

Policy Change toward Heavy and Chemical Industry Development

Iron and SteelElectronics Petro-Chemical Products

AutomobilesShip-buildingMachinery

D. Heavy and Chemical Industry Development during 1970s

Mobilizing Financial Resources

Selecting National Champions(Chaebol)

Accelerating Competition

ExportCommodity

Profile

1960 1970 1990 19991980

HCI Product

Agricultural Product

Light Industry Product

50%

Wig Automobile SemiconductorTextile

2003

Semiconductor, Mobile Phone, DTV, Display, Automobile, Ship-building, etc.

79.8%

14.1%

6.1%

E. From Agriculture to Manufacturing/ From Light Industry to Heavy Industry

Changes in Export Commodity Profile

Increased Production CostEfficiency LossWeakened Export Competitiveness

Limitations of Government-led Development and Changes in Development Strategy(1980~2000)

Financial SuppressionDue to Prolonged

Government Intervention

Inefficient Resource Allocation

Over-investment in HCI

1979 : Negative Export Growth for the first time since 19601980 : Negative Economic Growth(-3.9%)

A. Pitfalls of Government-led Economic Development

Stabilization Policy in the early 1980s

Budget Freeze/CutZero-Base-Budgeting

Phasing-out of PolicyLoans and InterestRate Deregulation

Investment Adjustment in HCI

Results

Inflation at around 3%

Inflation at around 3%DisinflationDisinflation

Current AccountSurpluses

Current AccountSurplusesStrong ExportsStrong Exports

GDP Growth of8% per annum

GDP Growth of8% per annum

High Economic Growth

High Economic Growth

B. Recovering Growth Potential with Economic Stability

Increased Corporate

Failure

Heavy CorporateDebt Leverage

Labor MarketRigidity

IMFRescue Package

Delayed Economic Reform and Financial Crisis in 1997

• Massive Capital Outflow• Denied Rollover of

Short-term external Debt

Continued GovernmentIntervention

DeterioratedFinancialSoundness

South East AsianCrisis

Establishing marketdisciplines

Establishing marketdisciplines

MarketOpeningand FDI

MarketOpeningand FDI

Expanding socialsafety net

Expanding socialsafety net

Financialsector

restructuring

Financialsector

restructuring

Corporatesector

restructuring

Corporatesector

restructuring

Labormarket

restructuring

Labormarket

restructuring

Public sectorrestructuring

andfiscal support

Public sectorrestructuring

andfiscal support

Reform and Restructuring

Customer-orientedservices

Customer-orientedservices

ReorganizingGovernment

Administrativestructure

• Consolidatingoverlappingfunctions

• Expanding newlydemanded sectors

• Entrusting certainfunctions to theprivate sector

•Transferring centralgovernment functions to localgovernments

InnovatingGovernment

Operating system

• Organizing a results-oriented administration system

• Creating openpersonnel management

• Introducing an annual salary

• Expandingout-sourcing

• Introducingresponsibleadministrativeinstitution

• Introducingcharter ofadministrative service

Reforming publicCorporations &Gov’t-affiliated

agencies

• Reforming publiccorporations- Privatization- Enhancing

managementefficiency

• Reforminggovernment-affiliated agencies- Reducing

unnecessaryfunctions

- Consolidatingoverlappingfunctions

- Transferring toprivate sector

- Enhancingmanagementefficiency

Reform in the Public Sector

Five Major Principles of Corporate Restructuring

1. Transparency of corporate management

2. Dismantling cross-debt guarantees

3. Significantly improving capital structure

4. Identifying core businesses and strengthening cooperative relationships with small and medium-sized companies

5. Enhancing accountability of controlling shareholders and enhancing their management accountability

Reform in the Corporate Sector

Abolishing government influencesAbolishing government influences

BankManagement on a

Fully commercial basis

• Improve ownership &Governance structure

• Remove line-of-business restrictions& high entry barriers

• Strengthen prudentialregulation & supervision

Establish a financialinfrastructure

• Enhance credit analysis

• Broadening creditinformation management system

• Upgrade accounting,auditing & disclosurestandards tointernational bestpractice

Enhance stabilityOf financial system

• Strengthen independent & efficient central banksystem

• Establish effectivefinancial supervisionsystem

• Consolidate financialsupervisory functions

Enhancing competitiveness &Efficiency of financial

industry

Enhancing competitiveness &Efficiency of financial

industry

Reform in the Financial Sector

InvigoratingThe labor market

InvigoratingThe labor market

• Diversifyingemployment patterns

• Flexible wages

• Diversifyingemployment patterns

• Flexible wages

• Strengthening jobplacement services

• Strengthening jobplacement services

• Increasing laborsupplies

• Effective vocational training

• Increasing laborsupplies

• Effective vocational training

Enhancing competitiveness andCreating jobs

Enhancing competitiveness andCreating jobs

Building sound and strong social safety netsBuilding sound and strong social safety nets

Reform in the Labor Market

Fostering futureindustries

• Building technologyInfrastructure

• Linking S& T withindustry/market

• Long-term planning forStrategic areas

• Cluster approach

Promoting services industry

• Enhancing Productivity through innovation

• Stimulating competition by liberalization

• Introducing advanced expertise and management skills

Linking Leading IndustriesLinking Leading Industries Creating jobsand absorbing workers

Creating jobsand absorbing workers

Realizing the 21st century

industrial structure

Realizing the 21st century

industrial structure

Strategy for Industrial Restructuring

Informatization

• Home banking,telecommuting

• Using IT ineducation, healthand welfare distribution sector

• Electroniccommerce

Development of ITindustry

• More supports forbasic research

• Deregulation andFDI promotion

Higher nationalWelfare and

Quality of life

Higher nationalWelfare and

Quality of life

Realization of the 21st

Century informationsociety

Realization of the 21st

Century informationsociety

HigherCompetitivenessOf the industry

HigherCompetitivenessOf the industry

Strategy for Informatization

Swift Crisis Resolution and Economic Recovery

CrisisResolution Measures

Cleaning up Nonperforming Loans

Expanding Social Safety Net

Reducing Moral Hazard

Improving Corporate Governance

AcceleratingLiberalization

Results

Early Graduation from the IMF Program- Foreign Reserves of more than

US$100bn

Early Graduation from the IMF Program- Foreign Reserves of more than

US$100bn

11

Rapid Economic Recovery- GDP Growth: 1998 -.67%

1999 10.7%

Rapid Economic Recovery- GDP Growth: 1998 -.67%

1999 10.7%22

Social Stability with ProductiveWelfare SystemSocial Stability with ProductiveWelfare System33

1960s1960s 1970s1970s 1980s1980s 1990s1990s 2000s2000s

DevelopmentStage

DevelopmentStage

Factor-Driven StageFactor-Driven Stage

Investment-Driven StageInvestment-Driven Stage

Innovation-Driven StageInnovation-Driven Stage

Major Direction of

Industrial Policy

Major Direction of

Industrial Policy

Expand export-orient light industries

Expand export-orient light industries

Expand heavyand chemical

industries

Expand heavyand chemical

industries

Expandtechnology-intensive

industries

Expandtechnology-intensive

industries

Promotehigh-technology

innovation

Promotehigh-technology

innovation

Transition toknowledge-based

economy

Transition toknowledge-based

economy

S&T Role of

Government

S&T Role of

Government

ScientificInstitutionBuilding

- MOST/KIST- S&T promotion act - 5-year economic

plan includesS&T

ScientificInstitutionBuilding

- MOST/KIST- S&T promotion act - 5-year economic

plan includesS&T

Scientific InfrastructureSetting

-GRI-Daeduck sci. town-R&D promotion act -KSIST:highly

qualified personnel

Scientific InfrastructureSetting

-GRI-Daeduck sci. town-R&D promotion act -KSIST:highly

qualified personnel

R&D and PrivateResearch LabPromotion

- NRDP - Promoting privateresearch labs- Promotion of industrial R&D

R&D and PrivateResearch LabPromotion

- NRDP - Promoting privateresearch labs- Promotion of industrial R&D

Leading Role inStrategic Area

- HAN - Enhancing univ. reseach capability- Promoting co-op research - Policy coordination- GRI restructuring

Leading Role inStrategic Area

- HAN - Enhancing univ. reseach capability- Promoting co-op research - Policy coordination- GRI restructuring

<New Challenges><New Challenges>

InnovativeCapability of

Private Sector

InnovativeCapability of

Private Sector

Sources of Competition

cheap labormanufacturing capability

innovative capability

Korea’s Development Stages

The technological capability building process in Korea’s machinery industry

The process of development Technology imports Production and R&D

1960s– 1970s

Policy goal: establishmentof production base

Characteristics: heavy dependenceon imported technologies

Packaged technology:turn-key based plants

Assembling technology

Knock-down typeproduction system

OEM-dominated

Almost no in-houseR&D

Early1980s

Policy goal: promotion ofself-reliance

Characteristics: Import-substitution,localisation of parts/componentsproduction

Unpackaged technology:parts/components-relatedtechnology

Operation technology

OEM/own brand:high ratio

Product development

In-house R&D begons

Late1980s– 1990s

Policy goal: export-promotion bymeans of expansion ofdomestic market

Characteristics: beginning of plantexports, learning advanced andcore technologies

Materials-related technology

Control technology

Design technology

High-quality product tech.

OEM/own brand:low ratio

Product innovation

Process improvement

2002

2000

1998

1996

1994

1992 1990

1988

1976

1978

1980

1982

1984

1986

0.0

0.5

1.0

1.5

2.0

2.5

0 20 40 60 80 100 120

Royalty Payment/BERD

BER

D/S

ale

s

Changing Relationship between TI and R&D

Korea’s Industrial Policy

1960-1970s- Direct Intervention Nurturing Specific Industries

Export industries in 1960s, Heavy chemical industries in 1970s- Support & Protection Measures

Financial/Tax Incentives, Import Regulations, Entry Barriers1980s

- Government intervention gradually reduced- Emphasis on enhancing competition 1990s

- Further Liberalization & Market Opening- Further emphasis on investment in tech. development

Korea’s S&T Policy

1960-1970s- Building institutions

KIST (1966); MOST(1967); KAIST(1973)Technology Development Promotion Act (1967)

1980s- National R&D Programs (NRDP, 1982)- Private enterprises began to act1990s

- Mission-oriented R&D by line ministriesTargeted, and top-down approach

- Private/public partnership in technology development

Improving the Quality of LifeImproving the Quality of Life

Creativity &Autonomy

Creativity &Autonomy

Respect & Rewardfor Knowledge

Respect & Rewardfor Knowledge

Upgrading Economic Structure

Upgrading Economic Structure

Building National Innovation SystemBuilding National Innovation System

GovernmentLaw & Institution

GovernmentLaw & Institution

IndustryGrowth engine

IndustryGrowth engine People

Life-long learning

PeopleLife-long learning

CreativeHuman Resource

InnovativeR&D system

World-frontierInformation Infra

Knowledge-intensiveIndustrial Structure

Changes in World Economic Environment : The Advent of KBEChanges in World Economic Environment : The Advent of KBE

Transition to a Knowledge Economy

0

5

10Econ. Incentive Regime

Innovation

Education

Information Infrastructure

most recent 1995

INFORMATION INF/RE.:-Tel. Lines per 1000 people- Computers per 1000 people- Internet hosts per 10,000 people

EDUCATION:- Adult literacy rate- Secondary Enrollment- Tertiary Enrollment

ECON. INCENTIVE REGIME:-Tariff & Non-tariff barriers-Property Rights-Regulation

INNOVATION:-Researchers in R&D- Manuf. Trade as % of GDP- Scient. & Tech. Pub.

per million people

Changes in Korea - Indicators

Restoring Economic Vitality Improving Welfare of the Needy

Partnership between labor & managementProvide employment opportunities for the youth

& the disadvantagedEnhance the role of the public sector in job creation

Creating Jobs

Lower private educational costs

Reduce credit delinquencies

Continue to contain inflation

Curb speculation in the real estatemarket

Expand the social safety net

Encourage active investments• Promote foreign direct investment

and SOC investment • Ease investment-related regulations,

and expand tax/financial incentives

Reduce financial market uncertainties

• Resolve the insolvency issue of the financially-vulnerable institutions

Maintain flexible fiscal policy.stance

New Challenges

SourceSource: KDI* Employment Growth Rate / Economic Growth Rate

1975 1980 1985 1990 1995 20000

0.1

0.2

0.3

0.4

0.5

0.6

0.7 Employment Elasticity* (2 Year Moving Average)

Trend Line

Strong Concern over Job Creation

Korea’s Productivity Gap

Denmark

Finland

CanadaNetherlandsAustria

Ireland

ItalyIceland

Greece

New ZealandSpain

Australia

BelgiumUKFrance

US Korea

Sweden

JapanSwitzerland

Germany

0.00

0.50

1.00

1.50

2.00

2.50

3.00

3.50

6 7 8 9 10 11 12 13 14

machinery & equipment investment

business R&D investment

(1) 1993-1997 average

Investment and Physical Capital and R&D

Sweden

FinlandJapan

USSwitzerland

KoreaGermany

Denmark

AustraliaItaly

SpainNew Zealand

Greece

Ireland

CanadaNetherlands

Belgium

Austria

Iceland

UK

France

0.00

0.50

1.00

1.50

2.00

2.50

3.00

3.50

6 7 8 9 10 11 12 13 14

machinery & equipment investment

busi

ness

R&D i

nvestm

ent

(2) 1998-2002 average

0

2

4

6

8

10

12

14

16

Ger

man

y

Neth

erla

nds

OEC

D

Kore

a

Swed

en

USA

Japa

n

(% a

s o

f G

DP)

1993-1997 1998-2002

Changes in M&E Investment

0

0.5

1

1.5

2

2.5

3

3.5

Neth

erla

nds

OEC

D

Ger

man

y

Kore

a

USA

Japa

n

Swed

en

(% a

s o

f G

DP)

1993-1997 1998-2002

Changes in Business R&D Investment

Innovation Integration

AcceleratingInnovation

• Synergistic Interaction

• Enhancing productivity• Reducing social conflicts• Increasing economic stability

• Enhancing productivity• Reducing social conflicts• Increasing economic stability

Inducing Integration

• Creating jobs• Developing human capital• Securing welfare resources

• Creating jobs• Developing human capital• Securing welfare resources

Policy Response

University Graduates as Portion of Total Population

(IMD 2001)

Japan

47%

Internet Accessibility

(IMD 2003)

Korea* Taiwan

3rd

7th

Korea*

40%

* 3rd among 30 countries with population of more than 20 million

* 3rd among 30 countries withpopulation of more than 20 million

US

39%

Taiwan

38%

Highly skilled human

resources

Highly Highly skilled skilled human human

resourcesresources

• Highly educated population- 40% of population aged 25∼34 are university graduates

(Ranked 3rd globally as of 2001)

• Abundance of highly educated female workforce

• Highly educated population- 40% of population aged 25∼34 are university graduates

(Ranked 3rd globally as of 2001)

• Abundance of highly educated female workforce

World-class IT

infrastructure

WorldWorld--class class IT IT

infrastructureinfrastructure

• Rapid buildup of world class IT infrastructure - Internet accessibility (Ranked 3rd globally) - Proportion of Internet Users (Ranked 2nd globally)- High-speed Internet (Ranked 1st globally)- Share of mobile users is approx. 70%

• Rapid buildup of world class IT infrastructure - Internet accessibility (Ranked 3rd globally) - Proportion of Internet Users (Ranked 2nd globally)- High-speed Internet (Ranked 1st globally)- Share of mobile users is approx. 70%

Broad industrial

base and Hi-tech

leading companies

Broad Broad industrial industrial

base base and Hiand Hi--techtech

leading leading companiescompanies

US Malaysia

1st

6th

* High-end technology and mid-upper end technology manufacturers

Proportion of Knowledge Intensive Manufactures

(OECD 2000)

Ireland

11.7%

Korea

14.0%

Germany

19.0%

OECD Avg.

8.4%

• High proportion of knowledge-intensive manufacturing: - Ranked 2nd among OECD countries - Global leader in IT home appliances, mobile phones,

semiconductors, etc.

• Broad industrial base with global leading firms - Semiconductor (DRAM) : Samsung (1st), Hynix (3rd) - L C D : LG Phillips (1st), Samsung (2nd) - Automobiles : Hyundai-Kia (9th)- Shipbuilding : Hyundai (1st), Samsung (2nd), Daewoo (3rd) - Steel : POSCO (4th)

• High proportion of knowledge-intensive manufacturing: - Ranked 2nd among OECD countries - Global leader in IT home appliances, mobile phones,

semiconductors, etc.

• Broad industrial base with global leading firms - Semiconductor (DRAM) : Samsung (1st), Hynix (3rd) - L C D : LG Phillips (1st), Samsung (2nd) - Automobiles : Hyundai-Kia (9th)- Shipbuilding : Hyundai (1st), Samsung (2nd), Daewoo (3rd) - Steel : POSCO (4th)

Capabilities to Achieve the Vision

FlexibilityFlexibilityFlexibility

Sound Government

Budget

Sound Sound Government Government

BudgetBudget

• Relatively flexible to reform and change- Evidenced by the extensive reform efforts and innovative policies

following the financial crisis of 1997

• Relatively flexible to reform and change- Evidenced by the extensive reform efforts and innovative policies

following the financial crisis of 1997

• Balanced and sound government budgeting - Accumulated Budget Deficit/GDP(%) = 22.1 (OECD Average = 73.0)

• Balanced and sound government budgeting - Accumulated Budget Deficit/GDP(%) = 22.1 (OECD Average = 73.0)

2001 National Debt/GDP Ratio

Korea USFinland OECDAverage

SourceSource: OECD

22.1%

51.5%59.7%

73.0%

LocationalAdvantage

LocationalLocationalAdvantageAdvantage

• Strategically located at the center of Northeast Asia, one of thethree largest economic zones in the world

- Accounting for nearly 20% of world GDP• Gateway to major markets- Proximity to China, Japan, Southeast Asia, Central Asia

• Strategically located at the center of Northeast Asia, one of thethree largest economic zones in the world

- Accounting for nearly 20% of world GDP• Gateway to major markets- Proximity to China, Japan, Southeast Asia, Central Asia

World GDP share of 3 economic zones

4 Northeast Asian Economies

20.0

EU NAFTA

25.5

36.7

SourceSource: DRI-WEFA

19.825.1

33.320012016 ~ 2020

3.5

Russia

Japan

USAustraliaDenmark

CanadaUK

NetherlandsKorea

SpainItalyPoland

Austria

Switzerland

FinlandFrance

Germany

Turkey

China

IndiaBrazil

0

1000

2000

3000

4000

5000

6000

0 0.5 1 1.5 2 2.5 3R&D expenditure as % of GNP

Res

earc

hers

(per

mill

ion

popu

latio

n)

Gross R&D Investment

• Strengthening upstream sectors- Innovation Capabilities

• Strengthening Linkages- Innovation networks and clusters

• Need to do more to tap into global knowledge and to combine it effectively with domestic R&D effort

• Innovativeness of SME- Positive sign, but majority of SME is weak in their readiness to cope with rapid changes, e.g., globalization, IT revolution

Making Innovation System more effective

Period of inception-beginning(1960-1970)

Period of inception-beginning(1960-1970)

Period of Structural Adjustment(1980s)

Period of Structural Adjustment(1980s)

Period of Take-off(1990s)

Period of Take-off(1990s)

Weak research capability ofprivate enterprises and Universities

• Goal-oriented research in linewith technology demands fromthe government and industry

• GRI’s leading role in industrialtechnology development

Imitation of simple technology ingrowing industry

Weak research capability ofprivate enterprises and Universities

• Goal-oriented research in linewith technology demands fromthe government and industry

• GRI’s leading role in industrialtechnology development

Imitation of simple technology ingrowing industry

Partial improvement in researchcapability of private enterprises and universities

• Adjusting the role and characteras an agency for implementing thegovernment’s R&D programmes

• Big R&D projects which requirenation-wide drive; central role in cooperative research amongindustry-university-researchinstitutes

Improvement of mature technologyImitation of future advancedtechnology

Partial improvement in researchcapability of private enterprises and universities

• Adjusting the role and characteras an agency for implementing thegovernment’s R&D programmes

• Big R&D projects which requirenation-wide drive; central role in cooperative research amongindustry-university-researchinstitutes

Improvement of mature technologyImitation of future advancedtechnology

Industry-led innovation systemIncreased research capabilityof universities

• More emphasis on future-oriented large complexdevelopment

• Rising necessity of redefiningGRI role and preparing new take-off basis

Development of future advancedtechnology through creativeresearch

Industry-led innovation systemIncreased research capabilityof universities

• More emphasis on future-oriented large complexdevelopment

• Rising necessity of redefiningGRI role and preparing new take-off basis

Development of future advancedtechnology through creativeresearch

Domesticcondition

Mission & Role

Researcharea

Domesticcondition

Mission & Role

Researcharea

• New Role of Government Research InstitutesMaking Innovation System more effective

Active exporting (21.6%)

All manufacturing SME (80,636 firms)

R&D spending(7.6%)

Venture (3.0%)

year 1998

Active exporting (11.6%)

All manufacturing SME (99,754 firms)

R&D spending(18.1%)

Venture (8.8%)

year 2002

• SMEs in Korea

Educational Attainment in OECD: Adult Population

OECD: percentage of the population that has attained upper secondary or tertiary education (1998)

42 38 30

2319

14

47

25

0102030405060708090

100

25-34 35-44 45-54 55-64Age group

%

TertiaryUpper secondary

Education & Training System

• Korea has high assets in educational investment and attainment

• Improving quality of formal education and developing effective lifelong learning are critical.

• Should put more emphasis on excellency and creativity

• Reshuffle vocational training system to meet the need of rapid changes in industry and technology

• Korea has achieved high growth through the partnership between government and business.

• Old strategy had limitations; delayed reform brought the financial crisis.

• Crisis offered an opportunity to make economy-wide reform and restructuring.

• Transition to a knowledge economy was the vision and strategy.

• The process is continuing and rolling over as new challenges are coming.

Summary and Conclusion

Thank you !!!