3. The future of doing business

Abstract

To keep up with its outstanding past economic performance while promoting more inclusive growth, Korea should address key challenges to its business environment, namely unbalanced growth across sectors and firm size, unequal distribution of productivity gains across population groups and slowdown in globalisation. Based on new internationally comparable OECD data on productivity, business dynamism and global value chains, this chapter presents a set of product market, industry, innovation, trade and investment policies that can lead to a virtuous circle between growth and inclusiveness, complementing and supporting the labour market reforms discussed in Chapter 2. Five key policy insights are discussed in detail: i) rebalancing productivity growth towards services; ii) creating a better environment for SMEs to work with large firms; iii) unleashing the growth of SMEs; iv) assessing, evaluating and streamlining SME support programmes; and v) designing a more inclusive global value chain strategy.

Summary and key policy insights

Korea has achieved remarkable growth in the past, closing the per capita GDP gap with G7 economies. Thanks to its innovative economy, strong institutions and capacity to engage in reforms, Korea has shown resilience during economic downturns and an ability to swiftly recover after the 1997 Asian crisis and the 2008 global financial crisis. The country can build on this ability to navigate difficult times and grow to deal with the challenges of the digital revolution and the slowdown in globalisation, while ensuring that productivity gains are shared by all.

In order to keep up with its outstanding past economic performance while promoting a more inclusive growth, Korea should address the key challenges to its business environment that are also found in other OECD economies, such as unbalanced growth across sectors and firm size, the unequal distribution of productivity gains across population groups and an increasingly uncertain international environment. Appropriately tailored reforms can lead to a virtuous circle between growth and inclusiveness.

To look at how Korea can reconcile growth and inclusiveness, this chapter combines for the first time new OECD data on productivity, business dynamism and global value chains (GVCs) that highlight the main issues to be addressed for the future of doing business. It presents a set of product market, industry, innovation, trade and investment policies that can be used to complement and support the labour market reforms discussed in Chapter 2. The analysis relies on internationally comparable evidence from a distributed micro-data approach (MultiProd and DynEmp) with first-time results for Korea and from the latest release of the OECD Trade in Value-Added (TiVA) database (see Box 3.1).

With respect to productivity, the chapter highlights the important disparities between firms in Korea, leading to a relatively low aggregate productivity average and large wage inequalities across workers. The two main productivity gaps are between the manufacturing sector and services industries, and between large and small firms. In Korea, labour productivity is 40% lower in service SMEs than in large manufacturing firms, as compared to 20% in other countries. These productivity gaps come with equally important wage gaps. Action can be taken to create a more inclusive economy while promoting productivity growth. This involves a shift towards service activities as well as helping SMEs to work with large firms and grow.

A key factor is the slow diffusion of technology, especially digital, to small firms. For example, less than 7% of Korean SMEs perform big data analysis, versus almost 20% in the OECD on average. Beyond supporting the development and adoption of new technologies, innovation policy can contribute to inclusiveness by ensuring a broad-based diffusion of existing digital technologies among all Korean firms. As digitalisation requires complementary skills, Korea needs to make the most of its human capital, which entails increasing the participation of women in the economy. Higher female participation can help overcome skill shortages and contribute to increase inclusiveness of the digital transformation without impairing productivity growth.

Regarding business dynamism, the chapter finds that Korea is characterised by low survival and scale-up rates amongst the many small start-ups and young firms, despite the large number of schemes supporting SMEs (more than 1 300). In the market services sector, only 2.5% of entrants with less than 10 employees grow, versus 6% in other OECD countries on average. The low rate of scale-ups is partly the consequence of thresholds in policies, which indirectly discourage small firms from growing.

Many support schemes targeting different types of firms and activities have introduced complexity and information costs in the SME business environment. The wealth of options might discourage entrepreneurs from applying for support, while at the same time it may entail rent-seeking by some businesses. To unleash the growth of small firms in a cost-effective way, existing policies should be reviewed to address any size contingency issue and to assess, evaluate and streamline support to SMEs.

The productivity gaps can also be partly explained by the focus of the former export-led growth strategies on key manufacturing industries and targeted support to a small set of IT sectors. Policies intended to help close these gaps might require reconsidering the GVC strategy of Korea, which is also needed in the context of rising protectionism and trade tensions.

Diversifying exports can allow a broader set of firms to benefit from gains from trade and can improve the resilience of the Korean economy to external shocks. To do so, the country needs to improve the connectivity of Korean firms and in particular their ability to access and share data across borders. All firms willing to go global should be supported – and not only firms in specific activities identified by the government. Inclusiveness can be improved by encouraging SMEs to participate in GVCs and through the diversification of exports towards services activities, which are less exposed to trade tensions. The consolidation of the network of free trade agreements to which Korea is a party can also help to mitigate the impact of protectionism and create a more GVC-friendly environment for Korean firms to grow.

To maintain Korea’s position in global trade, promote business dynamism and address the productivity gaps – while promoting inclusive growth – this chapter provides five key policy insights. Each policy insight is summarised here and discussed in detail in the relevant section, where different policy options are reviewed. The suggested policies should be seen as a full package of reforms to be implemented together, as they are complementary and mutually reinforcing. Sequencing is discussed at the end of the chapter.

Encouraging a rebalancing of productivity growth towards services
- Create a level playing field between manufacturing and services for tax policy, incentives and support to firms, as announced by the Korean government in July 2019.
- Introduce product market reforms in lagging service sectors, starting with horizontal measures (i.e. not sector-specific) before moving to sector-specific regulatory reforms.
- Reduce barriers to international trade and inward foreign direct investment to create more competition and promote international productivity spillovers towards service firms.
Creating a better environment for SMEs to work with large firms and be more productive
- Prevent large firms from capturing the productivity gains of smaller firms through competition policy but also through trade and investment reforms and measures aimed at protecting the intellectual property rights of SMEs; encourage the co-operation between large and small firms and start-ups through incubators, and science and technology parks.
- Strengthen business-academia ecosystems and support the development of start-ups within universities.
- Address the skill mismatch of SMEs and facilitate the adoption of technologies that can lift up their productivity, reinforcing not only support aimed at hardware, software and use of technology, but also skills development across the whole workforce.
- Review and assess existing programmes and support aimed at fostering women’s entrepreneurship and participation in managerial jobs; encourage the acquisition of STEM skills through the development of gender-neutral learning environments and by addressing stereotypes and discrimination that lead women to feel uneasy in technology-rich environments.
Unleashing the growth of SMEs
- Address size contingency and transfer of ownership in schemes supporting firms, labour laws, tax policy and in the credit market.
- Support the scaling up of small firms by redesigning R&D tax credits so that they benefit small (manufacturing) firms and by helping service SMEs to invest in intangible assets and knowledge-based capital.
- Reduce the cost of experimenting and venturing in new activities by promoting competition through regulatory reforms and by strengthening market selection through better insolvency regimes.
Assessing, evaluating and streamlining existing SME support programmes
- Help start-ups and SMEs navigate a complex and potentially confusing landscape by providing a single “one-stop” shop for SME support.
- Assess, evaluate and streamline existing programmes by focusing on their rationale and effectiveness and by avoiding duplication and overlap.
- Provide support to all SMEs rather than cherry-picking specific activities or types of firms, which could lead to misallocating resources and unintentionally creating disincentives for non-targeted firms.
Designing a more inclusive GVC strategy
- Improve the connectivity of Korean firms in order to give opportunities to different categories of workers to interact with global firms and diversify exports, by both encouraging strategic partnerships between Korean and foreign firms and adjusting cross-border data regulations to facilitate the transfer of information and promote e-commerce.
- Promote inclusiveness in GVCs by increasing the participation of SMEs through streamlined support but also policies aimed at boosting their productivity (as described under points 2, 3 and 4 above) and by encouraging the rebalancing of GVCs towards service industries.
- Mitigate the impact of protectionism to maintain Korea’s position in GVCs by using mega-regional agreements to lock in trade preferences and make free trade agreements more GVC-friendly, while facilitating the consolidation of value chains and their re-organisation in the new trade environment.

Box 3.1. New evidence based on MultiProd, DynEmp and TiVA

This chapter combines novel evidence from two distributed micro-data projects (MultiProd and DynEmp) with first-time results for Korea and incorporates findings from the latest release of the OECD Trade in Value-Added (TiVA) database.

MultiProd

The MultiProd project gathers new evidence on productivity patterns based on firm-level micro-data. It extends productivity analyses beyond aggregate industry performance and focuses on the underlying dynamics and developments within industries. For example, MultiProd offers new insights on the evolution of “inequality in corporate performance” (measured by productivity dispersion within industries), and its structural and policy drivers. The MultiProd database relies on representative data and is harmonised across countries and over time, thus facilitating international comparisons with a cross-country benchmark and providing policymakers with detailed insights into the relative strengths and weaknesses of the economy in terms of productivity.

The MultiProd project relies on collaboration between the OECD and experts from National Statistical Offices within the MultiProd network. The project utilises a distributed micro-data approach that respects the confidentiality of the underlying data sources. See Berlingieri et al. (2017[1]) for a methodological presentation of the MultiProd project.

There are two data sources for Korea: the Survey of Manufacturing, which covers establishments in the manufacturing sector with at least 10 workers over the period 1994-2017, and the Survey of Business Activities, which covers enterprises with at least 50 employees in the entire business sector over the period 2006-17.

The analysis focuses on manufacturing and non-financial market services (“services” for brevity) in order to enhance cross-country comparability, even though MultiProd covers most sectors of the economy. Macro-sectors (“sectors” for brevity, i.e. manufacturing and non-financial market services) are defined according to a customised 7-sector aggregation of ISIC Rev.4/NACE Rev.2 industrial classification. Detailed industries (“industries” for brevity) follow the SNA A38 classification. Coke and refined petroleum and real estate are excluded from the analysis. See Desnoyer-James et al. (2019[2]) for details on industry coverage and classification.

When relevant, the analysis compares Korea with a set of reference countries referred to as “Other OECD countries”. This benchmark comprises Australia, Austria, Belgium, Canada, Chile, Denmark, Finland, France, Germany, Hungary, Ireland, Italy, Japan, the Netherlands, Norway, Portugal and Switzerland. Figures do not include benchmark statistics after 2012 due to limited data availability.

The size thresholds for inclusion in the surveys imply that the analysis of the manufacturing sector relies on the population of manufacturing establishments with at least ten workers (“10+”), while the analysis of the market services sector relies on the population of market service providers with at least 50 employees (“50+”), for both Korea and the set of reference countries. In some instances, the analysis of the service sector also shows the statistics for the population of firms with at least 10 workers for the benchmark countries.

DynEmp

The DynEmp project provides a comprehensive overview of employment and business dynamics across countries over the last two decades. The main contribution of the project is the creation of a harmonised micro-aggregated database with which business and employment dynamics can be analysed across countries in a comparable way. The data are based on administrative records with quasi-universal coverage (such as business registers or social security records). Assessing employment and business dynamics in comparison to those of an appropriately defined benchmark group of countries can further inform and orient policy intervention.

The DynEmp projects relies on collaboration between the OECD and experts from National Statistical Offices and other institutions within the DynEmp network. The project utilises a distributed micro-data approach that respects the confidentiality of the underlying data sources. See Criscuolo, Gal and Menon (2015[3]) for a methodological presentation of the DynEmp project.

The DynEmp database generally covers most sectors of the economy, but in order to enhance cross-country comparability the analysis focuses on manufacturing and non-financial market services (or “services” for brevity). The data source for Korea is the Statistical Business Register. See (Desnoyers-James, Calligaris and Calvino, 2019[2]) for more details on the metadata across countries.

Unless indicated otherwise, all presented numbers rely on averages for the period for which data are available; for Korea, this is 2010-15. To allow an evaluation of Korea’s performance relative to that of other countries, the Korean results on employment and business dynamics are compared to a “benchmark” group of countries for which DynEmp data are available: Austria, Belgium, Brazil, Canada, Costa Rica, Finland, France, Hungary, Italy, Japan, the Netherlands, Norway, Portugal, Spain, Sweden and Turkey. Owing to methodological differences, figures may deviate from officially published national statistics.

TiVA

The OECD Trade in Value-Added (TiVA) database is a set of indicators designed to better inform policy makers by providing a value-added decomposition of international trade flows. The goods and services we buy are composed of inputs from various countries around the world. However, the flows of goods and services within these global production chains are not always reflected in conventional measures of international trade. The development of TiVA addresses this issue by considering the value added by each country in the production of goods and services that are consumed worldwide. The data presented in the TiVA database can provide insights into the domestic and foreign content of gross exports, on the participation in GVCs via intermediate inputs embodied in exports (backward linkages) or domestic value-added embodied in partners’ exports (forward linkages) or on the country and industry of origin of value-added in final demand.

The latest release of TiVA (2018 edition) covers 64 economies, including all OECD, EU28 and G20 countries, most East and Southeast Asian economies and a selection of South American countries. 36 unique industrial sectors are represented. This edition covers the period 2005 to 2015, with preliminary projections to 2016 for some indicators. The underlying Inter-Country Input-Output (ICIO) tables are based on statistics compiled according to the 2008 System of National Accounts (SNA 2008) from national, regional and international sources and uses an industry list based on the International Standard Industrial Classification (ISIC) Revision 4. For more information on TiVA see: http://oe.cd/tiva.

Reconciling growth and inclusiveness in Korea: main challenges

The strong growth of Korea from the 1960s to the 1990s has been described as a miracle.1 Through an export-led growth strategy, Korea achieved a remarkable macroeconomic transition from an agricultural economy to a major industrial hub and became an OECD Member. Per capita GDP increased from 10% of the United States level in 1970 to 65% in 2018, rapidly closing the gap with the average of G7 economies (Figure 3.1). The growth miracle was characterised by a low degree of income inequality and the alleviation of absolute poverty. Korea also successfully integrated into GVCs and became the world’s sixth largest exporter.

Since the 1997-98 crisis, the pace of income gains has been slowing down. Despite the convergence observed, aggregate labour productivity is low by OECD standards. In 2017, GDP per hour worked in Korea was 37% of the productivity level of the United States, below the OECD average of 55% (see Figure 1.5 in Chapter 1). But aggregate productivity hides important disparities across sectors and across firms. In some industries, Korea has some of the most productive global companies. If similar productivity levels are reached by a wider set of firms, Korea could not only create a more inclusive society but also further increase its aggregate productivity and resume its income convergence with G7 economies.

Figure 3.1. High growth rates in the past led to fast income convergence

Imbalances in the Korean business environment

Korea’s export-led development relied on light industries in the 1960s (such as textiles), heavy industries and chemicals in the 1970s and 1980s (such as shipbuilding), and motor vehicles and information and communication technology in the 1990s and 2000s. Today, the semiconductor industry plays a significant role in the Korean economy, accounting for more than 17% of total exports in 2017.

A few industries contributed to most of aggregate productivity growth in the recent period (Figure 3.2). In manufacturing, the lion’s share of productivity growth between 2012 and 2017 was driven by the computer, electrical and machinery equipment industries (which include semiconductors). In services, the finance industry contributed the most to productivity growth.

Figure 3.2. Productivity growth is unbalanced across sectors

Korea’s reliance on manufacturing exports by chaebols also led to contrasted productivity outcomes between manufacturing and services. The sector-productivity gap in Korea is among the highest in the OECD (Figure 3.3). Productivity in market services was on average only 43% of the productivity level in manufacturing in 2016. This is less than the gap observed in the US (61%) or in the UK (78%). Low productivity in services is ultimately detrimental to all industries that use service inputs.

Figure 3.3. Korea has one of the largest productivity gaps between manufacturing and services

Moreover, Korea has one of the highest size-productivity gaps in the OECD (Figure 3.4). Korean SMEs are more than 70% less productive than large firms, while this gap is only 30% in Germany and 13% in the United Kingdom. This is a concern as small businesses are generally key contributors to productivity and job creation and drive business dynamism.

Figure 3.4. There is a large gap in productivity between large firms and SMEs

The inclusion challenge

The link between disparities in productivity and inclusiveness was already highlighted in Chapter 2. The sectoral- and size-productivity gaps imply that productivity gains are not shared with all workers. For example, women and elderly workers are mostly employed in small service firms. In 2017, women accounted for 41% of the active population, with 23 percentage points corresponding to employment in small services firms and only 1 percentage point in large manufacturing firms (Figure 3.5, panel A). The pattern is the same for elderly workers, whose participation rate was 37% in 2017 with 21 percentage points corresponding to employment in small services firms and only 1 percentage point in large manufacturing firms (Figure 3.5, panel B).

Figure 3.5. Women and elder workers mostly work in small firms in the service sector

An uncertain international environment

In addition to the inclusion challenge, the growth model of Korea is impacted by two important trends that are currently transforming the world economy. First, since the 2008 financial crisis, protectionism has increased, starting with non-tariff measures and contingent protection in selected industries under pressure during the crisis. However, it has now turned into tariff wars between major exporters. Korea is exposed to some of the current trade tensions, both directly and indirectly. Since a large share of GDP relies on exports, some policy answers are needed to mitigate the impact of protectionism and ensure that GVCs can still contribute to growth.

The second challenge is related to the digital transformation and how Korea can maintain its technological leadership. The Korean government plans to continue to support key industries, in particular the “big 3” sectors: semiconductors, bio-health and future cars. Support will also go to the so-called “DNA” sectors that are data, networks (5G) and artificial intelligence. The question is how Korea can redefine its industrial policy in the digital age. The digital transformation will provide opportunities but also challenges as competition heats up at the global level and leading firms can quickly scale up their operations through investment in intangible assets such as data, proprietary software, and human and organisational capital. The focus on inclusiveness does not mean that only small firms should receive the attention of the government as large Korean firms are also facing a new challenging international environment. But a more market- and demand-driven industrial policy means that future successful activities in Korea may come from a broader set of sectors and this is where inclusiveness can be part of a new growth model relying on business dynamism.

Towards a virtuous circle between productivity, business dynamism and inclusiveness

The policy recommendations in this chapter are based on the idea that there are strong complementarities between productivity, business dynamism and inclusiveness (OECD, 2018[4]). As summarised in Figure 3.6, reforms aimed at promoting business dynamism, helping small firms to scale up and accelerating technology diffusion between frontier firms and laggards can increase productivity and reduce the sector and size productivity gaps. This higher productivity benefitting a wider set of firms will enable Korea to participate in new GVC activities and allow productivity gains to be shared across more workers with a reduction in wage dispersion. This will in turn allow more workers to participate in the dynamic part of the economy and encourage new entrepreneurs to start businesses, thus contributing further to business dynamism.

To reach the desired level of granularity in the analysis of productivity and business dynamism and to provide international comparisons, this chapter relies on the MultiProd and DynEmp projects, which are distributed micro-data approaches (Box 3.1). To include a GVC perspective, the chapter also uses the latest release of the OECD Trade in Value-Added (TiVA) database. The combination of these datasets offers a new perspective on the strengths and weaknesses of the Korean economy and provides clues as to what the best policy course might be to reconcile growth and inclusiveness.

Figure 3.6. Virtuous circle between growth and inclusiveness

Addressing the productivity gaps

This section relies on novel data to document the productivity-inclusiveness nexus in Korea by looking at the productivity performance between and within industries, and linking it to patterns of wage disparities. The analysis suggests avenues for creating a more inclusive economy while still promoting productivity growth. This includes rebalancing productivity gains towards services and creating a better environment for SMEs to work with large firms and be more productive.

The global productivity slowdown and the concomitant rise in income inequalities have brought the importance of understanding the nature of firm-level productivity development to the forefront of the policy debate. Recent OECD work has documented a significant increase in the productivity gap between the most successful firms and those lagging behind since the 2000s, even within countries and narrowly defined industries. As there is a tight link between firm-level productivity and wages, the dispersion of firms’ productivity matters for inclusiveness. Wage dispersion is linked to increasing differences between high and low productivity firms (Berlingieri, Blanchenay and Criscuolo, 2017[5]). Moreover, rising productivity gaps are linked to the global productivity slowdown, as they appear to weigh on aggregate productivity growth (Andrews, Criscuolo and Gal, 2016[6]).

A caveat applies regarding the productivity analysis for Korea based on the MultiProd data. The Korean data do not cover manufacturing firms with fewer than 10 workers. Moreover, no data for market services firms with fewer than 50 employees are available either. The productivity analysis takes this limitation into account, in particular when comparing data with other countries (see Box 3.1). Complementary sources were also used to check the robustness of results for the whole population of firms.

Different types of productivity gaps

At the aggregate level, the sector and size productivity gaps in Korea are among the largest in the OECD, as emphasised in the previous section. At a more disaggregated level, three main productivity gaps are identified: (i) between firms in different industries; (ii) between large firms and SMEs within industries and (iii) between top firms and laggards within industries. Overall, these gaps are large by OECD standards. Finally, productivity disparities also exist at the regional level. Regional disparities are relatively high and have been on the rise in Korea (OECD, 2018[7]). However, the present analysis does not address the regional dimension of productivity due to data limitations.

Productivity disparities between industries

Productivity disparities between industries are larger in Korea than in other OECD economies (Figure 3.7). Within-industry average labour productivity relative to the average in the manufacturing sector is highly heterogeneous across industries, and more so than in the benchmark set of other OECD countries. For example, the textile industry – the least productive industry in both Korea and in other OECD countries – is about 40% less productive than the average manufacturing industry, while it is only 30% less productive in other OECD countries. At the other end of the industry productivity distribution in manufacturing, labour productivity in the pharmaceutical industry is more than two times higher than the manufacturing average, while it is only about 50% higher in other OECD countries. Productivity disparities across industries do not necessarily imply economic inefficiency. In Korea, however, their magnitude and the legacy of the former development model that championed a few industries suggest that they may reflect resource misallocation.

The heterogeneity in industry productivity is even more marked in non-financial market services, where labour productivity in such activities as administrative and support services industries is relatively low, while it is very high in the telecommunications industry. Moreover, the productivity gap relative to the average manufacturing industry is larger for most market services industries in Korea than in the benchmark.

Figure 3.7. Productivity disparities between industries are larger in Korea than in other OECD countries

Productivity disparities between SMEs and large firms

Size productivity gaps are larger in Korea than in other OECD countries within most industries (Figure 3.8). However, there is a difference between manufacturing and services. On the one hand, SMEs – defined as firms with fewer than 250 workers – are less productive than large firms (more than 250 employees) in all manufacturing industries. While this is generally the case across OECD economies, the productivity gap between SMEs and large firms in manufacturing is substantially larger in Korea.

In non-financial market services, on the other hand, there is no clear-cut pattern regarding the size productivity gaps across industries. While in some industries, such as media or telecommunications, large firms are substantially more productive than SMEs, it is not the case in industries like advertising and market research. The absence of a robust positive correlation between size and productivity in non-financial market services is consistent with international evidence showing that large employers are generally more productive in manufacturing, but not in services (Berlingieri, Calligaris and Criscuolo, 2018[8]).

Figure 3.8. Size productivity gaps are larger than in other OECD countries in most industries

The existence of persistent size productivity gaps may be related to the digital economy. The cost of information and communication technologies (ICT) and of investment in complementary intangible assets, the skill mismatch or the lack of absorptive capacity can explain a lower diffusion of technology and knowledge between large high-productivity firms and low-productivity SMEs.

However, not all low-productivity SMEs are firms that should go out of business but survive due to weak market selection. In a recent study, (Berlingieri et al., 2020[9]) show that the least productive firms are on average smaller and younger than other firms. It suggests that some of the low-productivity SMEs are young businesses with a high productivity growth potential.

In the case of Korea, the question is whether the different schemes supporting SMEs have not created disincentives for them to become more productive. Moreover, the difference in size between large chaebols and small firms that are often suppliers or sub-contractors also raises the question of unfair practices or market power that could lead to productivity gains being captured by large firms (Jones, 2018[10]).

Productivity disparities between laggards and frontier firms

The productivity gap between the least and the most productive firms within industries – a measure of inequality in corporate performance – is large in OECD countries, even within narrowly defined industries.2 This productivity gap tends to be larger in Korea than in other OECD countries (Figure 3.9). Defined here as firms in the 10th percentile of the labour productivity distribution, laggards are substantially less productive than frontier firms (i.e. firms in the 90th percentile of the productivity distribution). For example, the productivity of laggard pharmaceutical manufacturers is only 8% of the productivity of frontier firms in that industry, while it amounts to about 15% in other OECD countries. In services, the productivity of laggard firms in the Korean transportation and storage industry is only about 12% of that of frontier firms, while it reaches 23% on average in the OECD.

Within-industry productivity disparities matter at the aggregate level. Heterogeneity in firm performance within industries is associated with cross-country differences in aggregate productivity (Bartelsman, Haltiwanger and Scarpetta, 2013[11]; Hsieh and Klenow, 2009[12]). Moreover, the increase in productivity gaps between top firms and the others are correlated with slower aggregate productivity growth within industries across OECD economies (Andrews, Criscuolo and Gal, 2016[6]).

The rise in the productivity gap observed within-industry is less pronounced in sectors where the pace of product market reform was faster, both in OECD countries in general and in Korea in particular (Andrews, Criscuolo and Gal, 2016[6]; Choi, 2018[13]). Pro-competitive product market reforms promote the productivity catch-up of laggards by strengthening the process of creative destruction, which forces inefficient businesses out of the market and creates strong incentives for incumbent laggards to adapt better technologies and management practices. It also promotes technological diffusion by spurring entry, to the extent that young firms possess a comparative advantage in commercialising radical innovations. Moreover, pro-competitive reforms in upstream services sectors spill over to downstream sectors, thereby promoting productivity across the entire economy.

Figure 3.9. Productivity gaps between laggards and frontier firms are large by OECD standards

Productivity gains are not shared equally among workers

There exists a robust productivity-wage premium in OECD economies (Berlingieri, Calligaris and Criscuolo, 2018[8]). Higher wages are paid by firms that are more productive and there is a tight link between productivity and wages. Therefore, the three types of productivity gaps identified in the Korean economy come with equally pervasive wage gaps. Addressing the productivity gaps can contribute to reducing wage dispersion and creating a more inclusive society, since marginalised workers are over-represented in sectors and firms that lag behind in terms of productivity.

Wage gap between large manufacturing firms and services SMEs

The picture that emerges from Korea opposes large manufacturing firms to SMEs in the service sector. Combining the size and sectoral dimensions from the within-industry analysis and linking them to wages, it appears that productivity gains overwhelmingly accrue to large manufacturing firms. Productivity in small manufacturing firms and in service firms of all size is low compared to large manufacturing firms, and the gap is larger in Korea than in other OECD countries on average (Figure 3.10, panel A). Wage gaps largely reflect the productivity gaps (Figure 3.10, panel B).

Figure 3.10. Wage gaps relative to large manufacturing firms reflect the productivity gaps

Figure 3.10 offers three main takeaways regarding the distribution of productivity and wage levels across size and macro-sectors in Korea. First, it shows that productivity and wages are the highest in large manufacturing firms with more than 500 employees, both in Korea and in other OECD countries. Second, it indicates that both the productivity gap and the wage gap between large manufacturing firms and the rest is larger in Korea than in other countries. Third, it confirms the positive correlation between productivity and wages in manufacturing and the absence thereof in services, as mentioned above.

Rising wage gap between top firms and laggards in manufacturing

Earnings inequality has increased over the past two decades in Korea (OECD, 2018[14]). One aspect is related to differences in wages between firms within the same industry, which is found to be positively correlated with rising earnings inequality in OECD economies. Most of the observed divergence in wages between firms is driven by differences in pay across firms within industries rather than by differences across industries (Berlingieri, Blanchenay and Criscuolo, 2017[5]).

Another aspect of earnings inequality arises from the productivity distribution of wages, i.e. differences in average wages paid by firms at different parts of the productivity distribution. Indeed, economic policies that shape wage distribution may have a heterogeneous impact across different segments of productivity distribution. For example, in OECD economies, high minimum wages are associated with reduced wage dispersion (and hence overall inequality) and tend to weaken the correlation between wages and productivity in the bottom and the middle part of the productivity distribution, but not at the top (Berlingieri, Blanchenay and Criscuolo, 2017[5]).

In the Korean manufacturing sector, the firms at the top and those at the bottom decile of the productivity distribution have experienced the same cumulative growth in labour productivity since 2000. Indeed, while Figure 3.9 shows a high level of within-industry productivity dispersion between the top and the bottom, Panel A of Figure 3.11 indicates that the gaps have not grown larger. This absence of within-industry divergence in productivity contrasts with the experience of most OECD countries.3 There was no divergence in within-industry wage growth between the top and the bottom of the productivity distribution either, which is reminiscent of the link between wages and productivity within manufacturing industries described above (Figure 3.11, panel B). However, the level of wage dispersion is very high in Korea compared to other OECD countries (OECD, 2018[14]). Therefore, the cumulative wage differential in monetary value between the top and the bottom of the productivity distribution is sizeable, even though wages grew at the same pace at the top and the bottom (Figure 3.11, panel C).4 Consequently, Korea is one of the countries with the highest average yearly increase in the wage differential between firms at the top and firms at the bottom (Figure 3.11, panel D).

Figure 3.11. Large wage differentials between frontier firms and laggards in manufacturing

The challenge of digital adoption for small firms in Korea

Insufficient development and adoption of new technologies, particularly those related to the digital transformation, is one of the reasons why large productivity gaps are observed between frontier firms and laggards (Andrews, Criscuolo and Gal, 2016[15]). This is true for Korea as well, where the uneven diffusion of technologies is contributing to the productivity gap (Choi, 2018[13]).

On the one hand, Korea generally scores well on digital economy-related indicators when it comes to key enabling infrastructure. For example, Korea has one the highest penetration rates for high-speed broadband internet observed worldwide and is the leading country in terms of the deployment of the fifth generation of cellular network technology (5G). Korea is also well advanced in the automation of its flagship industries, such as the automotive and electronics sectors. Korean firms further account for a large share of artificial intelligence (AI) patents filed worldwide (OECD, 2017[16]) and the country hosts the headquarters of some of the key world players in the field. Through programmes such as the “big 3” and “DNA”, Korea is trying to maintain such technological leadership.

On the other hand, evidence shows that technology diffusion has been uneven, especially when different types of ICT tools are considered (Figure 3.12). For example, while virtually all Korean companies have broadband access, and many of them use basic ICT tools such as website and enterprise resource planning (ERP) software, they tend to lag behind in terms of other key tools, such as consumer relationship management (CRM) support, cloud computing, e-sales or big data.5

Figure 3.12. Uneven diffusion for key ICT tools

When it comes to cloud computing, big data analysis and e-commerce, lower adoption rates are especially observed for small firms (Figure 3.13), whose growth and efficiency would benefit most from adopting such technologies. Cloud computing, for example, may allow young firms to rapidly scale up, by reducing the need to purchase costly servers and ICT computing devices ahead of scaling up, thus exchanging ICT sunk capital for pay-on-demand services, and allowing SMEs to only pay for what they really need (DeStefano, Kneller and Timmis, 2019[17]). In turn, big data analysis (performed or not using cloud computing) can help support the decision-making and marketing strategies of SMEs at a more accessible cost as compared to traditional marketing tools, while e-commerce helps them tap into larger and different (including international) markets and to customise the offer, to be able to better adjust prices and mark-ups.

As shown in Figure 3.13 (panel C), Korean firms have low rates of participation in e-commerce (11% in 2017), as compared to shares of more than 40% in New Zealand or Australia and an average of more than 20% across OECD countries.

Moreover, as mentioned, Korea hosts the headquarters of some of the most important innovators worldwide, companies that rank high among the corporations that invest the most in R&D activities worldwide, the so-called “top corporate R&D investors” (see (Dernis et al., 2019[18]) for details). However, this stylised fact is to some extent the bright side of a coin that sees on the other side the concentration of Korea’s innovative ability in just a few large companies, such as Samsung Electronics or LG Electronics (Figure 3.14). The productivity gap between large and small firms also reflects these disparities in innovative activity.

Figure 3.14 further shows that leading Korean innovators focus relatively more on patenting and trademarking than on publishing scientific research. This may hinder knowledge spillovers and the ability of other companies, including SMEs, to pursue cumulative innovation strategies by building on the shoulders of the giants.

Figure 3.13. Low adoption of productivity-enhancing ICTs that are well suited to SMEs

Figure 3.14. Korea’s innovative ability is very concentrated and not oriented towards publishing scientific research

Finally, a gap emerges in terms of innovation between manufacturing and services firms, similar to the productivity gap previously identified. R&D spending and government support for R&D are very high in Korea, but the share that is accounted for by the service sector is the lowest in the OECD (Figure 3.15).6 In 2015, services accounted for only 8% of Korea’s business expenditure on R&D, as opposed to 15% in Germany and 30% in the US. For public R&D spending (not shown in the Figure), the share of services was only 3.5% in 2017. This gap in R&D between services and manufacturing partly reflects the size composition of the two macro-sectors, and the fact that the services sectors in Korea mainly features SMEs, which in turn are reluctant to invest in R&D (OECD, 2018[14]).

Figure 3.15. The gap between R&D in services and in manufacturing is the largest in the OECD

Leveraging the full potential of technology, human capital and skills for inclusion

Human capital is crucial to reap the benefits of the digital transformation. According to the 2015 OECD Skills Strategy Diagnostic Report of Korea, Korean students are among the top performers in reading, mathematics and science and a high share of them continues to tertiary education, while Korean workers display close to OECD average numeracy and problem-solving skills. However, Koreans use these skills at work less than the OECD average, which points to a possible skills mismatch. This suggests that, at present, there is a potential for the working population of Korea to both upskill and contribute more to improving the productivity performance of Korean firms (OECD, 2017[21]).

As discussed in Chapters 1 and 2, evidence shows that the participation of Korean women in the labour market is relatively low compared to other OECD countries. As female students have tended to outperform male students in recent years, women’s limited participation in the labour market may curb the country’s economic performance, as the best talent available remains untapped. Promoting women’s participation in the labour market thus appears like a necessary precondition for and an enabler of Korea’s enhanced economic performance.

In what follows, the analysis highlights how important it is to couple technology development and adoption with human capital development. This would help enhance Korea’s economic performance and growth while at the same time fostering societal inclusiveness and well-being. As the digital transformation unfolds – with Korea playing a key role in shaping the future of digital technologies and of artificial intelligence – it is important to add to the elements discussed in Chapter 2 some insights that are specific to digital economies and societies (including e.g. how to narrow the digital gender divide).

Young Korean women have a high potential to harness the possibilities offered by the digital transformation. Solid cognitive skills coupled with the ability to solve problems and think creatively are key to adapting to the scale, speed and scope of digital transformations. In Korea, top-performing young female workers have better problem-solving skills in a technology-rich environment than their male counterparts (Figure 3.16). While this may to some extent be a result of selection (i.e. that only few and the best performing women enter the labour market), it nevertheless points to untapped growth potential, as women are amongst the best skilled part of the Korean population. Another factor holding back Korea’s economic performance is wide gap between the skill level and spectrum of young people in the workforce versus their older counterparts. For instance, Korea has one of the largest age gaps in skills related to problem-solving in technology environments, which is a problem for older workers in the digital economy. As shown in the OECD Skills Outlook 2017, a country’s dispersion of skills influences what industry it specialises in, as well as its competitiveness patterns (OECD, 2017[22]). Even if two countries have identical average skills endowments, they will trade with each other depending on the properties of their human capital dispersion.

Figure 3.16. Young Korean women have a high potential to harness digitalisation

Human capital and skills need to be acquired but, perhaps more importantly, maintained. Evidence shows this to be only marginally the case in Korea, as firm-based training is relatively low in the country, especially for low-skilled workers. (Figure 3.17). Training helps technology diffusion as it provides workers with the skills they need to navigate the digital transformation. It also contributes to fostering inclusiveness, as workers become more productive, and may thus be compensated with higher wages. Recognition increases the sense of belonging to a company and a worker’s willingness to contribute to its performance and success – see e.g. Khan (2012[23]) and Elnaga and Imran (2013[24]).

In Korea, less than 60% of workers receive any type of firm-based training, versus more than 70% in the United States. Moreover, low-skilled workers receiving firm-based training account for about 4% of the total number of workers, while high-skilled workers account for more than 30%. Low skilled workers mostly receive informal training, and less than 5% of national gross value added is invested in training, as opposed to more than 8% in the United States (Squicciarini, Marcolin and Horvath, 2015[25]).

Figure 3.17. Firm-based training lags behind, especially for Koreans with low skill levels

Finally, gender-related differences are large in the Korean business environment. While women hold more than 30% of the seats on the boards of the largest publicly listed companies in Germany, in Korea this share is a mere 3.6%, the lowest proportion among OECD countries (Figure 3.18). Making boards more diverse would be important not only for the inclusion of women in Korea’s economy and society, but also to enhance companies’ economic performance. According to data, there is a positive correlation between firm performance and board gender diversity, e.g. Conyon and He (2017[26]). Christiansen et al. (2016[27]) further show that corporate returns on assets and the share of women in senior positions are also positively associated. Such correlation is more pronounced in sectors where women tend to account for a larger share of the labour force (e.g. service sector) and where complementarities in skills and critical thinking are in high demand (e.g. high-tech and knowledge-intensive sectors).

Korean women are not only prevented from fully contributing to a successful business performance, but are also left at the margins of professional and scientific networks. For example, the share of co-inventions that include a woman inventor as a percentage of IP5 patent family is the second lowest in the OECD (OECD, 2017[28]). Across the OECD, women entrepreneurs have greater difficulty accessing finance than men (Lassébie et al., 2019[29]). In Korea, only 10.6% of loans and 5.9% of guarantees were available to women entrepreneurs in 2018.

Figure 3.18. Gender differences are sizeable in Korean businesses

Policy insights

The above analysis has highlighted various explanations as to why the sector and size productivity gaps are so wide. Not all countries have a lower productivity in services as compared to manufacturing. In the case of Korea, it seems that both past policies, which pushed manufacturing exports, and missed opportunities for regulatory reforms in services have exacerbated productivity differences across the two sectors. Encouraging a rebalancing of productivity growth towards services will require further strategic thinking on how to implement services reforms as well as creating a level playing field between manufacturing and services.

To address the productivity gap between large and small firms, a different set of policies might be required, in particular to enhance the capacity of small firms to work with large firms and to facilitate the diffusion and adoption of technologies that can boost their productivity. In addition to the need of concerted policy actions aimed at facilitating the diffusion and adoption (and performance-enhancing) technologies, especially by SMEs, upskilling and making full use of human capital in the Korean economy is key. Both types of measures would contribute to improving the economic growth and performance of Korea while making the country more inclusive. As most policies related to skills and the participation of women in the labour market were addressed in Chapter 2, the policy insights focus on some complementary policy measures that are aimed more at businesses.

Policy insight #1: Encouraging a rebalancing of productivity growth towards services

There is robust evidence across OECD countries that high regulatory barriers in the service sector shelter incumbent companies and create costs for production, with a detrimental impact on productivity (Conway et al., 2007[30]; Bouis, Duval and Eugster, 2016[31]). However, service reforms are complex to design and to implement. Since 2001, Korea has announced every year a strategy for the development of services. Between 2003 and 2013, some studies reported an improvement in the ease of doing business in services (Park et al., 2014[32]). However, the pace of reforms has been slower than in other countries, with Korea becoming the fifth OECD country with the highest overall Product Market Regulation (PMR) index in 2018 – i.e. with the highest regulatory barriers-, as opposed to being the sixth ten years before (out of 34 countries). The Ministry of Economy and Finance acknowledges that reforms have been limited and that many of the services strategies have not been implemented (MOEF, 2019[33]). The adoption of the Framework Act on the Service Industry Development has been pending in the National Assembly since 2011. Services reforms are still seen as a controversial issue and there is a persistent negative perception of the service sector, particularly when it comes to productivity. Yet, long-term structural trends requiring urgent policy action, such as ageing and climate change, provide service industries with opportunities to develop productivity-enhancing innovations, in particular related to health care and well-being applications.

Create a level playing field between manufacturing and services

A strategy aimed at reforming services industries in Korea should start with a strong signal from the government that services matter as much as manufacturing industries. Firms in the manufacturing and service sectors do not benefit from the same support or operate under the same tax rules, which might partly explain the productivity gap. In July 2019, the government announced a plan to provide the service sector with the same level of fiscal and financial support as the manufacturing sector, in order to promote R&D, service standardisation and service-manufacturing convergence (MOEF, 2019[33]).

Creating a level playing field between the manufacturing and service sectors is a policy objective that should be less controversial and can bring about key reforms without opening difficult discussions on the regulation of specific industries. It should however be accompanied by a more consistent strategy to promote services industries. The “big 3” and “DNA” programmes of the current government, for example, remain rather focused on manufacturing, even if some services are included under the bio-health industry and as part of digital activities under DNA (e.g. the development of the fintech market).

There were also announcements by the government that four service sectors would be promoted, including health, tourism, content and logistics. This is a step in the right direction if support does not lead to a misallocation of resources and, instead, complements a market-driven expansion, as can be seen in the case of the content industries (e.g. animation, broadcasting, gaming, music), providing firms with a better regulatory environment. The practice in the past has been to select specific sectors in an export-led growth strategy. While successful when catching-up with industries in other countries, this strategy is less relevant when the country is close to the technology frontier and when there is a digital transformation, as it is difficult for the government to identify the best industries to allocate resources. In this case, a level playing field that allows young firms to emerge in any sector is preferable.

Introduce product market reforms in lagging service sectors

There is currently no plan to further introduce product market reforms in service sectors where the productivity gap with manufacturing is the highest. In order to identify areas where reforms are needed, several OECD tools can be used. The PMR highlights that there is scope for reforms with respect to government’s involvement in business operations, barriers in network industries as well as trade and investment barriers (see below). Priorities can be set based on the feasibility of each type of reform and the expected benefits. In particular, some horizontal restrictions affect manufacturing as much as services and their removal would, therefore, also benefit the manufacturing sector. The fact that they are horizontal could avoid moving directly into sector-specific discussions where stakeholders may have different views and oppose reforms. When the political environment is more favourable, some sectoral reforms could then be considered. Removing barriers to investment and foreign entry in sectors such as IT and other information services, professional services and transport services could create a more competitive environment increasing the productivity of Korean firms and allowing them to compete on global markets. Box 3.2 provides examples of successful reforms in the service sector and their impact on productivity.

Finally, it should be noted that with the servitisation of manufacturing and digital transformation, services are increasingly important for the future of the manufacturing sector. Therefore, reforms aimed at enhancing the productivity of services will also benefit downstream manufacturing industries, which is just one more reason why service reforms are needed and could help convince those who may still have negative perceptions about services or do not consider them as big of a priority.

Box 3.2. The challenge of reforming the service sector

While there is a consensus about the benefits of service reforms, it is often challenging to design and implement them. On the one hand, the regulation of services involves different ministries, regulatory agencies and government bodies that may have diverging views. On the other hand, incumbent firms that benefit from the status quo will tend to block reforms. Three examples of successful service reforms are described below with some explanations of how countries have overcome the challenges related to their adoption.

Mexico’s reform of telecommunications

The telecommunications market in Mexico was very concentrated in 2012. After the privatisation of the former state company, the market was dominated by incumbent firms in the fixed-line and mobile markets. Mexico had some of the highest telecommunications prices in the OECD. In 2012, at the request of the Mexican government, the OECD conducted a Review of Telecommunication Policy and Regulation in Mexico. The report recommended key measures to make telecommunication services more efficient. In 2015, a new telecommunications and broadcasting law (Ley Federal de Telecomunicaciones y Radiodifusión) entered into force removing foreign equity restrictions in the fixed-line and internet services segments of the sector. The law also introduced a new independent regulator and a series of pro-competitive measures to challenge the dominant position of incumbent firms. Before changing its telecommunications law, Mexico introduced in its constitution a new amendment with the main principles of the reform, in order to give to the government enough power to deal with private monopolies in the sector. The three main political parties also agreed on a “pact for Mexico” that included the reform of the telecommunications sector, thus building a national consensus. After the reform, not only important productivity gains were reported but they were also passed on to consumers through lower prices. The reform thus contributed to inclusiveness by giving access to affordable telecommunication services to poor households.

The reform of professional services and other regulated professions in Portugal

In 2008, Portugal ranked 26th out of 34 countries in the OECD PMR (overall indicator). In the aftermath of the financial crisis, growth was slow and the country engaged in a series of structural reforms in order to increase productivity and competition. Many professional services are self-regulated by professional bodies that tend to reduce competition and exclude foreign providers. Portugal introduced a horizontal framework covering all self-regulated professions. In 2011, 174 professions were deregulated. In 2012 and 2013, all regulated professions were reviewed to check for any unjustified or unnecessary requirements in the regulations and compliance with the constitutional principle of freedom of choice of profession. This process led to further policy recommendations and 14 more professions were deregulated. In 2018, Portugal ranked 16th in the OECD PMR. Using firm-level data, Monteiro et al. (2017[34]) highlight the positive impact on total factor productivity of product market reforms in Portugal, including for companies downstream using services inputs. Moreover, the reforms had a larger impact on laggards, i.e. firms that are farther away from the technological frontier, and contributed to a more efficient allocation of resources as it encouraged the exit of less productive companies. The use of a horizontal framework with the same process of review applying to all regulated professions helped to overcome the resistance to reforms.

Reforms in the road freight industry in Central and Eastern Europe

The transport industry is one of the most challenging to regulate due to network effects and specificities inherited from the past. The air transport industry, for example, has a specific international regulatory regime and very strict rules on the entry of firms, pricing and business operations. Rail freight is a sector where there are still many domestic monopolies and where there is no consensus on the best way to implement pro-competitive reforms. In the road freight market, however, some reforms have been successful in promoting competition and improving productivity. When eight central and eastern European countries joined the European Union in 2004, their road freight market had already been substantially reformed and aligned with EU regulations as part of their accession process, begun in the early 1990s. These economies in transition were starting from a very different economic system and the liberalisation of the road freight market was one of the first major product market reforms they implemented. In order to foster reform acceptance, the first step taken by governments was to re-organise the profession and to group the various associations and syndicates into a single federation of the road transport sector. This way, a single organisation could be the counterpart of the ministry in charge of road transport when designing and implementing reforms. Ownership of the process by the profession was an important element in the success of the liberalisation. Following the deregulation of prices and the removal of barriers to entry, there was an important increase in road haulage and in the number of road transport companies. International traffic increased more than domestic traffic with stiffer international competition. Poland became particularly competitive and had the largest market share of EU road freight traffic in 2018. While the advantage of central and eastern European countries was first based on lower labour costs for drivers, it shifted to a higher productivity based on scale, reduced maintenance costs and better financing of trucks when wages increased in these countries.

Source: Monteiro et al. (2017[34]), OECD (2017[35]; 2017[36]), World Bank and IRU (2017[37]).

Reduce barriers to international trade and inward foreign direct investment

Korea’s relatively high trade and investment barriers may partly explain the productivity gaps between industries. Product market competition is one of the main engines of productivity growth through its impact on efficiency and on innovation (Aghion and Griffith, 2005[38]). Barriers to trade and investment typically reduce competitive pressures and hinder the creative destruction that forces inefficient businesses to exit. As of 2018, trade and investment barriers in Korea are among the highest in the OECD, second only to Mexico according to the OECD PMR database. Many of the key barriers affect industries in the service sector.

Moreover, there are productivity spillovers through trade and foreign direct investment (Saia, Andrews and Albrizio, 2015[39]; Keller and Yeaple, 2009[40]). Domestic firms can learn from foreign suppliers and even more when selling their products to global buyers. High trade and investment barriers can also hinder such productivity spillovers.

In addition to the PMR, OECD has detailed information on trade and investment barriers in its Services Trade Restrictiveness Index (STRI) and Foreign Direct Investment (FDI) Restrictiveness Index. For Korea, these indices report barriers related to market entry, the movement of business people and regulatory transparency. Horizontal measures could be first targeted for reforms. For example, Korea could consider facilitating the entry of foreign service providers through “Mode 4” in the language of the WTO General Agreement on Trade in Services (GATS). Procedures to set up companies could also be simplified for foreign firms. Foreign firms and service suppliers can improve the “connectedness” of the Korean economy (see policy insight #5).

Policy insight #2: Creating a better environment for SMEs to work with large firms and be more productive

While product market reforms and the removal of trade and investment barriers can also increase the productivity of small services firms and reduce the gap with large manufacturing firms, the size-productivity gap is not limited to services firms and requires additional policy answers. Helping SMEs to be more productive should start with policies addressing their relationship with large firms with a priority for measures related to the prevention of unfair business practices.

Prevent large firms from capturing the productivity gains of smaller firms and encourage co-operation between large and small firms

A potential driver of the productivity gap between large manufacturing firms and small service businesses is the fact that large chaebols may be the only buyers of some intermediate inputs. This creates a monopsony or oligopoly where efficiency gains from small firms are captured by large firms through market power. The Korea Fair Trade Commission (KFTC) is monitoring such cases and has legal tools to enforce competition but small firms may not always co-operate with the Commission, as they fear losing markets.7 Some large companies are also exempted from investigations when they receive an A or B grade from the Korea Commission for Corporate Partnership (KCCP) based on KFTC and KCCP assessment. In principle, this exemption comes from their good practices with respect to co-operation with small firms but the result is that some large firms are no longer under scrutiny for unfair trade practices. With respect to co-operation between large and small firms, KCCP promotes “win-win” partnerships but is also restricting certain activities to SMEs, which might not be the best option for productivity.

In addition to strengthening KFTC rules, the entry of foreign firms (both as suppliers and as buyers) could be an effective way to reduce the market power of large domestic incumbent firms. Curbing their dominant position could be done by lowering barriers to trade and FDI that, as mentioned above, are still high in Korea. Foreign firms themselves can be involved in unfair business practices, this is why such policy should be carried out at the same time as reinforcing the tools of KFTC to address such practices. If foreign firms, however, were to enter the domestic economy, SMEs would no longer be left facing only potentially dominant large Korean firms.

Finally, it could be useful to reinforce the capacity of SMEs to protect their intellectual property. Their ability to deal with IP disputes is generally weak (Sohn, 2017[41]). Korea enacted a Framework Act on Intellectual Property in 2011 and established the Industrial Property Protection Cooperation Bureau to support SMEs, a policy which could be reinforced.

Guaranteeing a level playing field is important, as it is through the co-operation between small and large businesses that technologies and know-how can be shared and that productivity can trickle down. To encourage co-operation between large companies and small firms, particularly start-ups, several countries have been successful in creating incubators and Science or Technology Parks – see e.g. Squicciarini (2008[42]; 2009[43]) and Link and Scott (2015[44]). For example, in the area of bio-health, which is part of the “big 3”, Luxembourg opened in 2015 a new incubator for firms working in biotechnology and ICTs. Through co-location on a common site, it is expected to create synergies and opportunities at the intersection of biomedical research and big data. Beyond large firms, incubators and Science and Technology Parks also establish co-operation networks among SMEs, helping them to overcome the lack of management skills and organisational capital. In Korea, the “Accelerator Investment-Driven Tech Incubator Program for Startup” (TIPS) was recently launched and is supported by government funds combined with angel investment and business mentoring. Previously, start-up incubators and accelerators relied on private initiatives.

Strengthen business-academia ecosystems and support the development of start-ups within universities

The productivity of small firms can then be enhanced through business-academia linkages, which are also avenues for large firms and small firms to work together in programmes involving also universities. Korea already has such programmes. For example, the Leaders in Industry-University Co-operation Plus (LINC+) programme aims to create an ecosystem where small firms have access to universities’ research outcomes, advanced machinery and research facilities, as well as young talents. There is also an Integrated Industry-Academia Co-operation platform created by the Ministry of Education and the National Research Foundation of Korea as well as a Programme for Specialized College of Korea (SCK) and a Programme for Industrial Needs-Matched Education (PRIME).8 Korea could strengthen this academic-industrial co-operation system aimed at SMEs.

European OECD countries offer relevant examples of well-functioning co-operation between businesses and universities. Universities can require (or at least strongly encourage) that graduation thesis research (e.g. in engineering sciences, management studies) be conducted in direct project-based collaboration with industry. This requires professors to prepare for and accept thesis themes relevant to industrial innovators. It has worked in bringing graduates closer to companies (OECD, 2014[45]). In Korea, particular emphasis should be placed on collaboration with SMEs. In that respect, the KU Leuven Research and Development (LRD) in Belgium is an example of best practice in terms of technology transfer to society in a broad sense. LRD is a separate entity within the university and an active partner in planning and setting up the broader infrastructure for innovation in the region, such as clusters, science parks and incubators. Seed financing is another key ingredient of its success (OECD, 2016[46]).

The mission and financial setup of some Korean research institutes could be re-considered to incentivise collaboration with the industry, in particular with SMEs. The funding mode of the institutes of the Fraunhofer Society (FhG) in Germany may serve as an interesting example. The typical FhG institute receives 40% of its income from industry, 30% from participation in public competitive funding programmes for collaboration between the public sector and industry, and 30% from government funding. If the income from industry is lower, government funding is reduced so that the institute has to increase its collaboration efforts with industry. If industrial income rises above a certain ceiling, government funding is reduced as well, to avoid subsidising private research efforts that would have happened in the absence of support (OECD, 2014[45]).

This could be complemented with measures facilitating the mobility of researchers abroad as well as facilitating the entry of foreign researchers. Aiming to achieve a similar goal, the Finnish Government is exploring new measures to facilitate the entry of more international students and to get them to work in the country once they have completed their training. A co-operation group was set up between the Ministry of Education and Culture and the Ministry of Interior in order to streamline entry and residence practices for foreign students.9

Finally, university entrepreneurship can help nurture innovative start-ups and create links between universities and the private sector. In 2017, the Korean Ministry of Education launched the University Entrepreneurship Fund to invest in university start-ups. With this Fund, students receive an equity investment and not a loan to start a business, so that they can restart in case of failure.

Address the skill shortage of SMEs and facilitate the diffusion of technologies that can boost their productivity

Skill shortages create upwards pressures on wages, so that less productive firms (“laggards”) are unable to afford the cost of high-skill workers. The government partly addressed the issue by reforming the curricula at vocational schools and expanding the Meister School and Work-Study Dual Systems, as discussed in Chapter 2. Further actions could be taken, e.g. by increasing public training opportunities, which help relax such tensions and foster laggards’ productivity growth. Institutional public training is a particularly good policy lever to help SMEs, as they often lack the resources to organise in-house training and rely on outside training institutions.

Product market reforms – already emphasised in policy insight #1 – can help close the gap between leaders and laggards, especially in the service sectors, which are generally more sheltered from international markets. This would also create better conditions for growth-enhancing reallocation through the entry of more productive businesses and the exit of less successful ones, which would sharpen the incentives for technological adoption. Cross-country analysis shows that the productivity gap between frontier and laggards is much smaller in sectors where pro-competition market reforms were the fastest (Andrews, Criscuolo and Gal, 2016[15]). This has been confirmed also for Korea (Choi, 2018[13]).

When it comes to promoting innovation and facilitating the diffusion of new technologies, especially to SMEs, several mechanisms are already in place in Korea. The government grants R&D support of KRW 3 trillion a year to SMEs, placing Korea second among OECD countries (Jones and Lee, 2018[47]). But there is an issue with the efficiency of such support and the selection of recipients, as the current system leads to grant support to recipients whose performance is lower than that of non-recipients (Lee, 2018[48]). Given the low diffusion rates observed for technologies that are particularly important for SMEs and the role of complementary assets in adopting such digital technologies, support should not only be directed to technology development but also technology adoption. Support could target infrastructure and acquisition of hardware and software and, more importantly, investment in skill development, management and organisational capital. Recent measures go into this direction, in particular subsidies to SMEs to access cloud services. However, investment in organisational capital accounts for only 1.7% of total value added in Korea, lower than the OECD average, which is 2.2% (OECD, 2015[49]). It is important for these measures to encompass the development of skills and organisational capital to have the expected impact, as technologies alone would not lead to the performance improvement sought.

But more generally, policies that can have an impact on the productivity gap between frontier firms and laggards and accelerate the diffusion and adoption of technologies are those promoting business dynamism. They are reviewed more in detail in the next section with further policy insights.

Review and assess existing programmes and support aimed at fostering women’s entrepreneurship and encourage the acquisition of STEM skills

Despite some progress, the gap between women and men in Korean society remains large. While this is related to culture, and thus requires a sustained long-term approach aimed at addressing engrained social norms and stereotypes, many short- and medium-term policies can allow women to contribute fully to growth, innovation and entrepreneurship. As part of such an integrated policy approach aimed at leveraging the untapped potential of women in the Korean society (see Chapter 1), the following measures related to the future of doing business could be included.10

First, to stimulate women’s entrepreneurship and participation in management jobs, it would be important to review and assess existing programmes and support aimed at fostering women’s participation in the labour market and in entrepreneurship. The objective would be to identify key bottlenecks and define clear priorities, while promoting and implementing actions to address sources of discrimination. Among the possible actions that can be envisaged include: fostering blind applications, affirmative action, and (voluntary or compulsory) reporting by firms on positive actions implemented to prevent or at least address discrimination. In Korea, affirmative action is envisaged only for firms with more than 500 workers.11 Yet the share of women accounts only for 37% of total employees of such firms. Female entrepreneurship could also be supported by connecting female and male entrepreneurs, through small business initiatives or by fostering links between large and small businesses. While targeted actions are needed, it should be noted that women’s entrepreneurship and participation should be encouraged by transparent and stable regulations for all entrepreneurs, including easy access to public information on starting a business. A culture of non-discrimination is better achieved by not singling out women. This is why affirmative action and support to firms based on gender would need to be carefully conceived and enacted. The Ministry of Gender Equality and Family has taken steps to advance gender equality in the business sector, e.g. by helping companies set and implement gender balance objectives. In addition, it promotes gender equality throughout society through consensus-building strategies, e.g. by publicizing the gender of listed corporations’ executives.

To remove obstacles to the career development of women, it is also important to address stereotypes and socio-cultural norms that discourage women’s participation in environments considered “masculine”. Promoting the development of women-friendly environments can further be achieved through role models, mentors and “ambassadors”, which would make women feel more comfortable in unwelcoming environments. In addition, better networking among female professionals could enhance the career development of women. A country that has implemented such a policy is Sweden. In 2008, the government funded an ambassador’s project to highlight successful women in different business activities who could inspire others to become entrepreneurs. These women could share their stories and experiences in networks, encouraging more women to view entrepreneurship as a possibility for their career while also addressing the challenges they face. Between 2008 and 2014, about 2 000 women were selected to become ambassadors and participated in about 11 000 activities, reaching 170 000 people at the national and regional level (OECD/EU, 2016[50]). Similar programmes have been introduced in many countries, including Germany and Scotland. As a first step in this direction, the Ministry of Gender Equality and Family has set up the Women’s Talent Academy to foster young women’s careers through mentoring and networking.

Finally, young Korean women often display relatively higher skills and better educational outcomes than their male counterparts. However, when looking more broadly at STEM skills (science, technology, engineering and mathematics), there is still a significant gender gap in Korea. This could be addressed by encouraging the acquisition of STEM skills amongst women through the development of gender-neutral learning environments and addressing stereotypes and socio-cultural biases that lead women to feel uncomfortable in STEM environments. Gender-neutral textbooks and methodological approaches in education and training can help to create such a gender-neutral environment. One can also provide targeted advice, especially related to the career prospects of different educational choices and support such STEM- and technology-related choices, through e.g. loans or grants, or quotas in educational institutions: 27% of researchers in public research institutions are women, 32% in universities and 16% in firms.12 Greater participation of women in innovative activities (including software development) can also be fostered by means of designing incentives and supporting mechanisms that favour or reward to a greater extent the scientific and inventive output of women or of mixed teams of researchers and inventors that include women.

Promoting business dynamism

There are many start-ups and young firms in Korea, and a variety of schemes supporting SMEs. Yet, Korea is characterised by low survival rates of entrants and a difficulty for firms to scale up. This section uses novel data to characterise business dynamism in Korea and compare it to other OECD economies. It provides insights into policies that could unleash the growth of SMEs by addressing size contingency issues in support policies, re-designing R&D support to accelerate technology diffusion, and reducing the cost of experimentation. Moreover, this section recommends the assessment, evaluation and streamlining of existing SME support programmes.

A dynamic business environment is key to enable new productive firms to enter the market, grow and replace old and unproductive ones. This Schumpeterian process of “creative destruction” leading to productivity-enhancing resource reallocation is a major driver of aggregate productivity growth (Decker et al., 2017[51]). Business dynamism is also of primary importance for labour market outcomes, as young firms and start-ups disproportionately contribute to job creation in OECD countries (Criscuolo, Gal and Menon, 2014[52]). Moreover, fast-growing young firms are more likely to recruit workers who are marginalised on the labour market, thereby contributing to sharing productivity gains with larger segments of the population (Coad et al., 2014[53]). Therefore, when young firms perform well it improves the business environment while creating opportunities for all.

Analysing the specific contribution of firms of different sizes to employment growth requires detailed data on job creation and destruction. The evidence base in this section relies on DynEmp (see Box 3.1), an OECD distributed micro-data project that collects different aggregations of annual job flows at the industry level for different types of firms (young and old, small and large) and according to their transition dynamics (growing, stable, shrinking) and their demographic status (entrants, exiting, incumbent). The resulting database is comparable across countries and over time.

Heterogeneity in the SME landscape

SMEs play a prominent role in Korea. Their share of employment is higher than in any other OECD economy and they occupy a central place in the government’s new paradigm, in which they replace large firms as the drivers of innovation (OECD, 2018[14]). The development of SMEs promotes inclusiveness by creating broad-based income gains across regions and industries in OECD economies (OECD, 2017[54]). However, the existence of pervasive size productivity gaps suggests that achieving inclusive growth requires improvements in the business environment of SMEs, especially in the service sector.

The size distribution in Korea is skewed towards small establishments, both in manufacturing and non-financial market services. While micro-businesses with fewer than 10 workers are more prevalent in Korea than in the reference set of countries, the opposite holds true for businesses with more than 10 workers, both SMEs with 10 to 250 workers and large establishments with more than 250 workers (Figure 3.19, panel A).13 The relatively large discrepancy in the size distribution of firms in Korea and the significant differences with other countries points to the existence of firm-level barriers to growth.

A very large share of employment in the Korean manufacturing and non-financial market services is found in SMEs. Large Korean enterprises only account for about 20% of employment in both macro-sectors, versus respectively 40% and 30% in the manufacturing and services sectors of other countries (Figure 3.19, panel B).14 As it indicates where the typical worker in the economy works, the distribution of employment shows that Korean workers are less likely than others to be active in large businesses.

Analyses of the size distribution at the macro-sector level hide important heterogeneity across industries within the manufacturing and service sectors (Figure 3.20, panel A). The share of micro-businesses in manufacturing industries such as textiles or wood and paper is almost 80%, while it is only 60% in the computer and electronics industry, and about 45% in the transport equipment industry. The cross-industry heterogeneity is large in the service sector as well, with 90% of micro-businesses in the retail and wholesale industry and in the hotel and restaurant industry, versus only 60% in the IT industry. This confirms previous studies highlighting that one issue with services in Korea is related to the many small firms in the retail sector and in the hospitality sector (Kim, 2018[55]).

Figure 3.19. The size distribution is skewed towards micro-businesses and SMEs in Korea

The distribution of employment shares is very heterogeneous across industries as well (Figure 3.20, panel B). Cross-industry heterogeneity largely reflects the former development strategy that championed a few selected sectors. Indeed, while large firms account for a low share of employment in most industries, they account for a very large share in the computer and electronics industry, in the transport equipment industry, in the IT industry and in the scientific and R&D industry.

Figure 3.20. The size distribution is heterogeneous across industries

Barriers to scaling-up

The Korean business environment appears very dynamic at first sight. The share of start-ups and young establishments is significantly larger in Korea than in other OECD countries across all size classes (Figure 3.21, panel A). The share of start-ups is particularly high among small enterprises.15 Consistent with this, other evidence shows that the difference in the birth rate 16 of employer enterprises and non-employer enterprises is higher in Korea than in any other OECD country (OECD, 2017[54]).17 This points to the coexistence of very different types of entrepreneurship in Korea, including subsistence entrepreneurship 18 as a key element of the social safety net (OECD, 2018[14]). Moreover, the Korean business environment is characterised by relatively high flows of job creation and destruction, in particular for establishments of small size (Figure 3.21, panel B). Job flows appear larger than in other OECD economies. According to Cho et al. (2017[56]), small businesses are the driving force of aggregate employment growth in Korea, but growth is mostly driven by the entry of very small firms, which is offset by job destructions of a similar magnitude.

Figure 3.21. The Korean business environment appears very dynamic at first sight

Yet, this apparent dynamism hides the very low scaling-up and survival rate of entrants, which suggests large impediments to SME scaling up. Small entrants, which account for most job creation, grow much less and shrink more than in other OECD countries, especially in non-financial market services (Figure 3.22, panel A). Moreover, the survival share of entrants is very low by OECD standards (Figure 3.22, panel B). Over the period 2010-15, only about 50% of entrants in manufacturing and 40% in services had survived three years after entry, versus about 70% in manufacturing and 65% in services in the benchmark set of countries.

Such characterisation of business dynamics in Korea (high share of start-ups but little scaling up) points to an environment that is not conducive to sustainable entrepreneurship and growth. This contributes to perpetuating productivity and wage gaps between large conglomerates and the rest of the economy, and hence to the concentration of wage gains in a small part of the workforce.

Figure 3.22. Most micro-entrants do not scale up…if they survive at all

Scaling-up patterns are heterogeneous across industries in both manufacturing and non-financial market services (Figure 3.23). While both survival and post-entry growth rates of entrants are generally lower in Korea than in other countries across all industries, some industries stand out. At one end of the spectrum, the hotels and restaurants industry is characterised by the lowest rate of post-entry growth and the second lowest survival rate across manufacturing and non-financial market services. At the other end of the spectrum, entrants in the chemical industry have both a relatively high survival rate and more robust post-entry growth.

Figure 3.23. Survival and post-entry growth are heterogeneous across industries

Policy insights

Korea has a very developed set of policies aimed at helping SMEs and young firms. In 2016, Korea provided financial support to SMEs through public funds and credit guarantees amounting to 3.8% of GDP, the second largest share in the OECD (Jones and Lee, 2018[47]). The current government has reinforced this support (Box 3.3). The above analysis suggests possible explanations of why these firms do not manage to scale up despite the support they receive.

Box 3.3. Financial support for SMEs and start-ups

Many of the policies of the current administration are aimed at SMEs and start-ups. In 2019-2020, this includes:

Loans amounting to KRW 10 trillion to SMEs in key industries (motor vehicles, shipbuilding, display and oil & gas), future industries (future cars, drones, bio-health, smart cities) and “DNA” and KRW 5 trillion to SMEs investing in facilities for the environment and safety.
Extension of the Growth Support Fund amounting to KRW 8 trillion, with 40% of funding provided by the government and the rest by the private sector.
Additional loans and guarantees by financial institutions and credit guarantee organisations for firms’ facility investment and restructuring (MOEF, 2017[57]).
Plan for a new “Scale-Up Fund” focused on scale-up of firms with innovative technologies. The fund will raise KRW 12 trillion by 2020. (MOEF, 2019[58]).
New Capital Market Innovation Plan to ease the access of SMEs to capital markets by reducing the threshold for crowdfunding (FSS, 2018[59]).

New rules for financial institutions providing loans and credit guarantees, such as using movable assets (IP collateral and half-finished goods) as collateral and abolition of joint sureties for corporate owners, which posed a heavy burden on entrepreneurs. Private institutions will phase it out gradually.

Policy insight #3: Unleashing the growth of SMEs

The policy environment is key in unleashing the growth potential of SMEs. One important question is whether regulations are not to some extent discouraging firms in Korea from growing. There are many policies in place aimed at enabling SMEs to overcome their disadvantage in accessing credit, dealing with red tape and bearing fixed operation costs. However, such policies can create disincentives to grow and cross the size threshold beyond which the policy no longer applies. Size-contingent policies may therefore partly explain size gaps (Box 3.4). Moreover, such policies reduce aggregate productivity because they distort the allocation of resources, both labour (e.g. in the case of size-contingent labour laws) and capital (e.g. in the case of size-contingent corporate income tax provisions).

Box 3.4. Size contingencies and disincentives to grow

The business environment of advanced and developing economies alike is characterised by the existence of size-contingent policies, i.e. policies that seek to ease the regulations on small businesses with employees or turnover below a certain threshold. The typical regulatory sources of size contingencies include labour laws, rules governing the provision of healthcare and other benefits to workers, and the corporate tax system.

Market failures vs. disincentives to grow

The rationale for size-contingent policies stems from market imperfections that disproportionately affect small businesses. Size-contingent support or exclusion from regulations aim at levelling the playing field by addressing the competitive disadvantage of small firms in terms of access to credit, red tape and other fixed operating costs (OECD, 2019[60]).

However, size-contingent policies have adverse effects because support is cut off beyond a given threshold. Efficient businesses with growth potential may choose to remain small in order to avoid the additional costs associated with crossing the threshold – the so-called “Peter Pan syndrome”. Such disincentive to mature and grow distorts the allocation of labour and capital inputs, which is detrimental to aggregate productivity.

The welfare and policy implications of trade-offs associated with size-contingent policy interventions are the subject of debates and require empirical assessment. Academic research regarding the case of labour legislation in France recently attracted policymakers’ attention. The regulatory burden that French firms face increases substantially when they employ 50 workers or more. Among others, they must create a works council (comité d’entreprise), establish a health and safety committee, report detailed information on all employees to the administration and appoint a union representative. In fact, some firms choose to remain below the threshold to avoid the extra burden.

The case of French labour legislation

The hypothesis was formally tested based on micro-data covering the population of French firms (Fichier de Comptabilité Unifiée – FICUS) – see Garicano, Lelarge and Van Reenen (2016[61]). The research identifies departures from the theoretical firm size distribution, namely a bulge before the 50 worker threshold and a valley after the threshold (Figure 3.24). The size-contingent regulation distorts resource allocation, and thus reduces aggregate productivity, as some firms with fewer than 50 employees would be larger if the threshold were not in place, while the extra cost associated with the regulation makes firms with more than 50 employees smaller than they would be in an unregulated economy. The associated welfare loss depends on the degree of wage flexibility in the labour market. In France, a country with relatively high minimum wages and powerful unions, it is estimated to be 3.5% of GDP.

Figure 3.24. Size-contingent labour laws create disincentives to grow in France

Address size contingency and transfer of ownership in schemes supporting firms, labour laws, tax policy and in the credit market

The relative lack of medium-sized companies in Korea is often blamed on the abrupt discontinuation of support schemes for companies that graduate from the SMEs category. Companies that have annual revenue in excess of KRW 150 billion on average for three years are excluded or benefit less from a range of support schemes, including below-market interest on bank loans, finance from the technical guarantee fund, and tax benefits (OECD, 2014[45]).19 Beyond the discontinuation of government financial support, the following regulations kick in at various size thresholds:

Labour laws:
- 5 workers: cap on working hours and minimum additional pay for supplementary hours; minimum paid leave; obligatory security and health training; limits on temporary employment; restrictions regarding retirement age
- 10 workers: employment handbook required
- 30 workers: compulsory consultations with labour unions
- 50 workers: security and health managers required; quotas of disabled workers
Healthcare and benefits
- 5 workers: restrictions regarding retirement age
- 500 workers: childcare system
Tax system
- 300 workers/KRW 150 billion revenue: lower R&D investment credit and R&D tax credit; lower tax credit for job creation; no longer income tax deduction for young workers; no longer reduced CIT rate (actually several threshold; further contingency on industry – wholesale, retail, medical industry – and location – in or outside metropolitan area)

The Korean government is aware of the phenomenon and has experimented with policy responses. Korea should monitor and evaluate these policies, in order to ensure that they do not create any new distortive size threshold. In particular, it established the Growth Ladder for Medium-Sized Companies programme in September 2013. Participating companies can keep benefiting from enhanced access to public procurement and from preferential R&D tax credit. The World Class 300 Project specifically aims at developing 300 competitive medium-sized companies by 2020 by supporting their R&D, human resources, finance and global marketing.

Other mechanisms that might indirectly hinder firms’ growth come from the taxation of transfers of ownership in private (family-owned) businesses, such as a reduction in the inheritance tax liability. In Korea, there are inheritance tax reductions when the new generation of owners also manages the company for at least ten straight years after inheriting it. This type of family ownership and management transfer across generations might be detrimental to the firm’s performance and prevent income redistribution (Bloom and Van Reenen, 2010[62]). Finally, the government involvement in the credit market could be reviewed and evaluated to check that loan guarantees benefiting small firms are not creating disincentives to grow. For example, the Korean Credit Guarantee Fund and the Korea Technology Credit Guarantee Fund provide credit guarantees to SMEs that are otherwise ineligible for regular bank loans. Regulations that request commercial, regional, and foreign banks to devote a specific proportion of their loans to SMEs could also be included in this evaluation exercise.

Support scale up of small firms

Supporting the scaling up of small firms and accelerating technology diffusion from the most productive firms to laggards may also involve redesigning R&D tax credits so that they benefit small (manufacturing) firms and helping service SMEs to invest in intangible assets and knowledge-based capital. Korea is among the top performers in terms of government support for R&D, both direct and indirect through tax incentives. Direct and indirect support each account for about half of total support. However, R&D tax credits that are not refundable may not be the most adapted to small firms as they might be in a loss position and not be tax liable. Korea could use the experience of other OECD countries with cash refunds or exemptions from the payroll withholding tax that are found to be more favourable to SMEs. R&D support could also be re-balanced towards direct funding, as the latter was shown to increase the catch-up of laggards across European OECD countries (OECD, 2019[63]). Moreover, R&D support mainly benefits R&D performers, and thus sectors that are more R&D intensive, i.e. the manufacturing sector and knowledge-intensive services, such as computer services firms.20 Helping SMEs in the service sector also requires supporting investment in intangible assets, beyond R&D and innovative property, such as organisational capital and economic competencies.

Reduce the cost of experimenting and venturing in new activities

The last area of policy action to unleash the growth of SMEs deals with reducing the cost of experimenting and venturing in new activities. It can be achieved by promoting competition through regulatory reforms and by strengthening market selection through better insolvency regimes. Market selection through entry and exit is the key feature of the process of “creative destruction” that leads to technological change and productivity growth as is the inherent risk that entrepreneurs face when investing in innovative activities. Regulatory reforms can help promote competition. Overly stringent regulations increase the cost of experimenting, of expanding a product range or venturing into different activities. Korea’s positive-type regulatory system, which prohibits everything except what is specifically allowed, may be an obstacle to experimentation. Reforms have started in 2018 to reverse the system towards a negative-type regulatory regime, which allows everything except what is specifically prohibited. These reforms should be extended to a broader set of regulations. Moreover, Korea has started to use “regulatory sandboxes” to test new regulations in selected industries, particularly in the area of digital technologies (e.g. new ICT convergence technology). Moreover, the Regulation-free Special Zone Act from April 2019 has enabled the government to ease regulations in 14 special zones regarding specific innovative technologies, including blockchain (Busan), autonomous driving (Sejong) and biomedical technologies (Daejeon). These are also steps in the right direction.

Finally, insolvency costs and barriers to restructuring are associated with lower productivity growth of laggard firms across the OECD (Adalet McGowan, Andrews and Millot, 2017[64]). Reforms should reduce the relatively long time to discharge bankrupt entrepreneurs from pre-bankruptcy indebtedness, which is three years in Korea as opposed to less than one year in Japan or the US (OECD, 2018[65]).

Policy insight #4: Assessing, evaluating and streamlining existing SME support programmes

The Korean government has been implementing a large number of support measures for start-ups and SMEs (OECD, 2014[45]). More than 1 300 programmes are in place, managed by different institutions at the central and local level in 2017 (Baek, 2017[66]). Helping small businesses as they face relatively high fixed operating costs due to administrative processes, credit market imperfections and other information asymmetries is good policy. However, the multiplication of support programmes can be counter-productive, as it creates a complex and potentially confusing landscape for small businesses. Moreover, the existence of too many programmes could add to information asymmetry and eventually help inefficient businesses escape the market’s selection.

Help start-ups and SMEs navigate a complex and potentially confusing landscape

A first step to helping start-ups and SMEs navigate a complex and potentially confusing landscape could be to provide a single “one-stop” shop for SME support. There are currently several places that provide information and guidance to SMEs while it is recommended to have a “one-stop” shop (KIET, 2014[67]; MOTIE, 2019[68]). But on the government side as well, the complexity and overlap between the different programmes must be better understood. In 2015, Korea introduced an “Integrated Management System for SMEs” (SIMS) that can be seen as a first effort to link and integrate existing programmes. SIMS built a database and provides information to policymakers about the overlapping schemes. The system could also be used to identify SMEs participating in multiple programmes, so as to prevent firms from accumulating benefits from different subsidy schemes and reduce the disincentive to grow.

However, addressing the issue requires more fundamental policy action. Research indicates that Korean SMEs accessing government support are on average less productive than SMEs that did not receive public financing (Chang, 2016[69]).

Assess, evaluate and streamline

The performance of supported firms should be carefully monitored and be based on their productivity performance, not on survival. The introduction of a system of graduation from government financing would redirect support to young firms, which face market failures in credit, and would avoid extending the life of inefficient SMEs. SME support should not interfere with incentives to scaling up but be conducive to building a complete ecosystem of small, medium and large firms.

When there is some overlap or duplication in support schemes, streamlining can help improve the efficiency of support. For example, between 2006 and 2010, the UK government reduced the number of support schemes from 3 000 to 100 (Box 3.5). Evaluation of support policy program is also important. Ex-post evaluation and ex-ante strategies for ex-post evaluation should become part of the policy cycle and inform policy decisions. Piloting and randomised experiments could also be valuable tools for estimating the causal impact of policies.

Box 3.5. Streamlining public support for SMEs and start-ups

In most OECD countries, governments have set up schemes to support entrepreneurship and SMEs. The rationale lies both in the idea that start-ups and young (small) firms create most private sector jobs (Birch, 1979[70]; Davis, Haltiwanger and Schuh, 1996[71]; Haltiwanger, Jarmin and Miranda, 2013[72]), and in the fact that small businesses face proportionally high fixed operating costs due to administrative processes, credit market imperfections and other information asymmetries.

Over time, however, support schemes and other policy initiatives typically pile up, possibly overlapping or even duplicating. The proliferation of support schemes eventually decreases overall efficiency, either because it creates a complex and potentially confusing landscape for start-ups and SMEs, or because it adds an extra layer of information asymmetry that entails inefficient, low-productivity businesses to escape market selection and survive.

While there exists no one-size-fits-all criterion with which to assess whether the number of support programmes is excessive, an evaluation and possibly a streamlining of existing schemes is beneficial to achieve coherence in public support. The creation of an inventory that maps businesses to the different programmes from which they benefit can uncover overlaps and inform the streamlining process.

In the United Kingdom, the Business Support Simplification Programme provides an example of such policy. Prior to the launch of the Programme in 2006, the existence of more than 3 000 publicly-funded support schemes reportedly overwhelmed businesses. Often, they found it both too complex and too costly to apply. The government then set about reducing the number of schemes to 100 and simplifying delivery channels. By 2007, it made a single programme, called Business Link, the primary access route for individuals and businesses seeking support, and started reviewing existing schemes based on the following criteria:

Rationale: is there a market failure in provision that justifies the intervention?
Effectiveness: is the intervention likely to reach its objective?
Need: is there a business demand for the intervention?

Selected programmes were then grouped around a number of common business themes, including finance access, innovation, R&D, training and skills, exporting and overseas trade, and efficient use of natural resources. The process that led to the final “Solutions for Business” package was carried out in collaboration with businesses, and an independently chaired board was set up to maintain the coherence of the package.

By 2010, substantial streamlining was achieved. Finally, an online tool for guidance was set up, the business support and finance finder (https://www.gov.uk/business-finance-support-finder). For details, see OECD (2014[45]) and references therein.

Provide support to all SMEs rather than cherry-picking specific activities or types of firms

A last point, already made with respect to other policy insights, is that past Korean winner-picking and specialisation policies may have weakened competition and protected incumbents, contributing to productivity gaps and low aggregate productivity. Instead of selectively supporting SMEs based on their industry, activity or region, reforms should enhance competition across all industries and provide the same support to all firms.

Re-thinking the global value chain strategy of Korea

The former strategy of export-led growth in key manufacturing industries and targeted support to a small set of IT sectors can partly explain the observed productivity gaps. This section suggests reconsidering the GVC strategy of Korea, which is also needed in the context of rising protectionism and trade tensions, as well as the digital transformation. The trade policy of Korea can contribute to the policy objectives previously highlighted, in particular the rebalancing of the economy towards services and the growth of SMEs. Participation in GVCs can help firms to scale up and be more productive, particularly service firms, which are also less exposed to tariff wars.

Global value chains in the midst of rising protectionism

In the last three decades, Korea has increased its productivity and income through greater participation in GVCs. The concept of GVCs describes the increasing fragmentation and internationalisation of production and the fact that economic integration now takes place at a more granular level with a specialisation in specific tasks in the value chain rather than in specific industries. In GVCs, companies organise their supply chains across different countries and serve global markets. Among G20 economies, Korea is the country with the highest index of participation in GVCs (Figure 3.25).

Figure 3.25. Korea has the highest GVC participation among G20 economies

Korea has a very high backward participation in GVCs (32.6% in 2015) indicating that Korean firms source a significant share of their inputs abroad. These inputs come either from foreign affiliates of Korean firms or from foreign firms. International sourcing ensures competitiveness and lower costs of production. Korea also exports inputs used in GVCs of other countries (19.1% of gross exports in 2015) as measured by the forward participation index, highlighting the integration of the country in “factory Asia” and the dependence of part of the economy on exports.

Korea was already more integrated in GVCs than the average of G20 countries in 1995 but has increased its participation index at a higher pace in the 2000s (Figure 3.26). Participation in GVCs reached a peak in 2008 just before the global financial crisis (60%). Although it recovered after the crisis, the index remained below its 2008 level and has declined since 2011. The same trend is observed in the rest of G20 countries. It can be explained by changes in prices of intermediate inputs (in particular the price of oil)21, new business models that rely less on offshoring (with wages catching up in the developing world), the re-centring of the Chinese economy on its domestic markets and more recently by the rise in protectionism. For Korea, it means that expansion through GVCs might be more limited in the coming years and trade tensions within Asia and in the rest of the world might further reduce exports (Box 3.6). Nevertheless, through its network of free trade agreements (FTAs) and assuming trade tensions are temporary, Korea can still expect productivity gains and opportunities for increased income through its participation in GVCs. What we should see in the coming years is a reorganisation of GVCs rather than a “de-globalisation”. The rest of this section looks at such opportunities and the impact on inclusive growth.

Figure 3.26. Korea has the highest GVC participation among G20 economies

Box 3.6. The exposure of Korea to protectionism

Current trade tensions between China and the United States indirectly affect Korea through GVCs. Chinese firms source many inputs from Korea and to the extent that tariffs on Chinese products in the United States reduce demand for these products, there are fewer exports from Korea to China. The same happens when US firms exporting to China or producing in China rely on Korean inputs, this time affecting Korean exports to the US or to US firms established in China. Korea then also needs inputs that may be dependent on the US-China trade relationship more upstream in its GVCs.

Table 3.1. Trade exposure to US-China bilateral trade relationship
Trade exposure to US-China bilateral trade relationship
Country	Share of GDP exposed
World	1.0%
China	3.8%
United States	1.2%
Chinese Taipei	1.7%
Korea	0.8%
Malaysia	0.8%
Singapore	0.8%
Thailand	0.5%
Chile	0.5%
Viet Nam	0.5%
Japan	0.2%
EU	0.1%
Note: Hypothetical extraction for the year 2015.
Source: Authors’ calculations based on the OECD Inter-Country Input-Output (ICIO) Tables, https://oe.cd/icio.

Using the OECD Inter-Country Input-Output (ICIO) tables, one can calculate the share of Korean GDP exposed to US-China trade tensions (Table 3.1). Through an hypothetical extraction where bilateral trade between the US and China is set to zero, GDP can be recalculated in a world where there is no trade between the two countries, thus providing an estimate of the share of GDP exposed to protectionist tensions. When doing this exercise, the two countries the most affected are China and the United States. But with 0.8% of its GDP at risk, Korea is the second country the most indirectly impacted. Japan and the EU are less affected than other countries, as their GVCs are less dependent on China.

While 0.8% of GDP may seem to be a small figure, the impact is concentrated in a few industries (Figure 3.27). In addition, the calculations do not take into account how the extra costs to re-organise value chains would further affect trade with third countries.

Figure 3.27. Most exposed Korean industries to bilateral US-China trade

Maintaining the central position of Korea in GVCs

When it comes to manufacturing, Korea is one of the main hubs in international production networks. Based on the calculation of a centrality index (see Box 3.7), Korea is ranked 7th among the top 10 manufacturing hubs in GVCs (Figure 3.28). In Asia, it has the third place behind China and Japan. Between 2005 and 2016, centrality has slightly decreased but less than what is observed in Japan or the United States. Since centrality is a relative concept and China became the main hub in Asia during this period, one can interpret this result as Korea maintaining its competitiveness and leading role in manufacturing GVCs.

However, as it was observed in terms of productivity, there is an important gap when looking at the position of Korea in services GVCs (right panel in Figure 3.28). Korea is not among the top 10 hubs and ranked only 21st. Unlike China or the United States, it has not increased its centrality between 2005 and 2016. There are fewer and bigger hubs for service GVCs, as indicated by the higher values for centrality in the top 10 countries. With the servitisation of manufacturing (Vandermerwe and Rada, 1988[73]) and the increasing role played by services in the digital economy, the future of manufacturing activities may depend more on services. Therefore, rebalancing the participation of Korea in GVCs from manufacturing to service activities may not only be good for inclusiveness but also for productivity growth and for preserving the position of Korea as one of the main manufacturing hubs.

Figure 3.28. Korea is among the main hubs in GVCs for manufacturing

Box 3.7. GVC centrality

There are different metrics that can be used to analyse GVCs and characterise the position of countries in production networks. The participation index is based on the size of trade in intermediate inputs. It refers to the use of foreign inputs by domestic firms or the use of domestic inputs in exports of third countries downstream in the value chain. However, a high participation index can be achieved by having a single foreign supplier or customer in a very short value chain (but with high value transactions). It does not reflect the number of partners or the complexity and length of the value chain.

Based on techniques coming from network analysis, the centrality index complements traditional GVC indicators – such as the participation index – by adding information on the complexity of the network and the connectivity and position of countries (Criscuolo and Timmis, 2018[74]). A high centrality is achieved by countries that are connected (directly or indirectly) to many countries and are influential in the value chain. Centrality is a relative concept and can be measured backward (with suppliers) or forward (with customers), with total centrality being the average of the two. Only foreign centrality is taken into account when analysing GVCs. A high centrality indicates that a country is a hub in the value chain, importing inputs from many places that are themselves well connected to other countries, but also supplying these inputs to a large network downstream. These countries downstream form the spokes. A low centrality index means that a country is at the periphery and not well connected to GVCs.

Centrality matters for productivity. A high centrality is associated with faster productivity growth, particularly for small firms and firms that are not on the productivity frontier (Criscuolo and Timmis, 2018[75]). As such, it should be regarded as a useful indicator for policymaking. Connectivity does not only depend on trade and investment liberalisation but also on contract enforcement, access to finance and labour market policies. Participating in GVCs is not only about opening markets but also having the tools to connect to foreign partners and identify business opportunities.

Centrality can also be calculated for industries at the country level, distinguishing backward centrality (i.e. being connected to many suppliers) from forward centrality (i.e. being connected to many customers). Figure 3.29 reveals contrasted outcomes across Korean manufacturing industries (which are ordered from left to right based on their contribution to exports). In the ICT & electronics industry, the centrality of Korea significantly decreased between 2005 and 2016 due to the rise of China. But it is almost exclusively explained by forward centrality, meaning that the output of Korean firms goes to a reduced number of spokes and that there are fewer customers for Korean products. This consolidation in the network may affect productivity, as knowledge is often shared between suppliers of inputs and their customers. Fewer customers translate into a lower level of interactions and opportunities to learn. This concentration can also lead to a higher dependency on key spokes and a higher risk when trade tensions affect those spokes.

Figure 3.29. Contrasted outcomes when looking at the change in GVC centrality for Korean industries

In other manufacturing GVCs where Korea is strong, centrality has however increased, generally both in terms of backward and forward centrality. For some industries, such as motor vehicles, it is the result of further fragmentation of production within Asia with more partners among ASEAN economies. This trend was encouraged by the conclusion of FTAs in the region (such as the ASEAN-Korea FTA signed in 2005 at the beginning of the period considered in Figure 3.29).

When it comes to services, Figure 3.29 highlights that for “other business services”, Korea has achieved a higher centrality between 2005 and 2016. This industry includes services such as professional services, management and consulting activities, as well as scientific research and development, advertising and market research. These services are essentially knowledge-based activities that play an important role in productivity growth and the digital transformation. A higher centrality for these activities is a positive outcome but Korea is still ranked only 31st (out of the 64 countries included in the TiVA database) in 2016, suggesting that through services reforms and measures in favour of small services firms the centrality of Korea could be improved.

Increasing income derived from GVCs

The size of economic gains derived from participation in GVCs also matters when looking at inclusiveness and how income can be more equally shared. The best way to analyse the income generated in GVCs is to look at “GVC income” which is all the income generated by sales of final products in a given industry (Timmer et al., 2013[76]). For example, the GVC income of Korea in ICT & electronics is the value-added created by all Korean firms (from any industry) involved in the production of ICT and electronic goods sold anywhere in the world (including in Korea).

Figure 3.30 shows the change in Korean GVC income for manufacturing and services industries between 2005 and 2016. Using input-output techniques, the change is further broken down to see the effect of technological changes (the structure of economies), a change in domestic demand and a change in foreign demand.22

GVC income in Korea increased in all industries (in current prices) between 2005 and 2016 but the size of the increase is not the same across sectors. Industries are ranked again according to their share in exports (from top to bottom). As already seen when looking at centrality, the ICT & electronics sector has moved towards an organisation of production where Korea is less influential and we can see from Figure 3.30 that fewer value-added is created within Korea. However, due to increased demand for ICT & electronics goods, particularly outside Korea, GVC income has continued to increase. Nevertheless, it suggests that the over-dependence of Korea on the ICT & electronics is a risk for the future if the industry continues to move to business models where Korea is less central and generates lower levels of value-added.

A similar pattern is observed in other GVCs, such as chemicals (including pharmaceuticals, an industry that is currently expanding in Korea), other transport (including shipbuilding), machinery and electrical machinery. The contribution of structural change (technology) tends to be negative, although less than in ICT & electronics, while demand has increased (driven by foreign demand). The situation is however different in the motor vehicles industry, which is the industry where GVC income has increased the most. Here, technology had a small but positive contribution.

Interestingly, GVC income has also substantially increased in most service GVCs (right panel in Figure 3.30). But the main difference with manufacturing is that it was mostly driven by domestic demand. A very small share of GVC income comes from sales of services abroad and these services are those mostly associated with sales of goods such as wholesale & retail or transport & storage. Increased GVC income from foreign sales can also be seen in other business services and hotels & restaurants (in relation to tourism). As in the manufacturing sector, technology and the structure of the Korean economy have rather negatively contributed to income growth, with the exception of transport & storage.

Figure 3.30. Korea has generally increased its income in GVCs because of a higher domestic and foreign demand

Overall, Korea has increased its income derived from GVCs, but results suggest that it is mostly demand-driven. As discussed in relation to productivity, key reforms could allow technology (the structure and organisation of production) to also become a driver of increased GVC income. It would be particularly needed if current international trade tensions dampen foreign demand.

The previous analysis can be complemented by looking at the change in GVC income in Korea relative to other countries. The same way that a “revealed comparative advantage” (RCA) index can be calculated based on trade flows (Balassa, 1965[77]), GVC income can be used to look at industries where Korea has a GVC comparative advantage. The GVC RCA index is the share of Korea in world GVC income of a given industry divided by the share of Korea in world GVC income (Timmer et al., 2013[76]). A RCA above 1 indicates that Korea has a comparative advantage, as it derives relatively more income from this GVC than on average from all GVCs.

Figure 3.31. Korea has a strong GVC comparative advantage in five manufacturing industries

Korea still had, in 2016, a strong comparative advantage in the ICT & electronics GVC and it has only slightly decreased as compared to 2005 (Figure 3.31). Korea has increased its comparative advantage in the other transport, motor vehicles and electrical machinery industries. Comparative advantage has on the contrary almost disappeared (value close to 1) in the textiles & apparel GVC.

Figure 3.31 confirms that Korea has improved its position in other business services. It is now a GVC where there is a significant comparative advantage. With IT services and construction (but construction is mostly for domestic demand), these industries are the only services with a value above 1. In other important service activities, such as finance & insurance or telecoms, not only Korea has no GVC comparative advantage, but also the RCA index decreased between 2005 and 2016. This provides clear evidence that service sector reforms would boost not only productivity but international competitiveness, as well.

If one looks at the OECD Services Trade Restrictiveness Index (STRI) – which summarises all the barriers to trade and investment in services industries –, sectors where Korea has no GVC comparative advantage are also the ones where barriers are relatively higher compared to other countries (Figure 3.32). For example, Korea scores above the average (i.e. is more trade-restrictive) in the telecoms sector or the banking sector (part of financial services). The same is observed in transport services (air, maritime and rail freight with the exception of road freight). Conversely, Korea has a STRI value below the average in computer services (part of IT services) or in engineering services (part of other business services). The type of barriers reported in Figure 3.32 provides further information on the reforms that can improve competitiveness, which are measures aimed at improving foreign entry and the movement of business people, as well as competition reforms.

Figure 3.32. Some service sectors are shielded by high trade restrictions

Addressing the impact of GVCs on inclusiveness

The increased participation of Korea in GVCs can also be seen as a factor that has contributed to the wage dispersion and duality of the Korean economy. In particular, the literature discusses the impact of offshoring (i.e. backward participation) on the skill premium and on job polarisation (Feenstra and Hanson, 1996[78]; Geishecker et al., 2008[79]; Goos, Manning and Salomons, 2014[80]). In the context of Korea, it was pointed out that GVC participation had a positive impact on the wages of high-skilled workers and a negative impact on the wages of low-skilled workers (Choi, 2016[81]). However, the impact measured was small, confirming that GVC participation tends to have a limited effect on the distribution of wages (Lopez Gonzalez, Kowalski and Achard, 2015[82]).

The difficulty in such analysis if to disentangle the impact of trade and technology. We can observe within GVCs a change in occupations and wages of workers but this change is generally more related to technical progress than to the fact that production has become more international. The relationship between trade and technology then becomes endogenous as trade and participation in GVCs facilitate technology diffusion.

Going beyond the dichotomy between high-skilled and low-skilled workers, Figure 3.33 focuses on the tasks performed by workers within GVCs and provides a breakdown of Korean GVC income in manufacturing industries by business function (Timmer, Miroudot and de Vries, 2019[83]). Within a given industry, the fragmentation of production results in the specialisation of firms in different functions. They are grouped in Figure 3.33 into four generic business functions: management, marketing & sales, operations (i.e. core manufacturing activities) and research & development.

Over time, there are more workers in manufacturing firms in activities related to R&D and fewer directly involved in the manufacturing process. With wages for R&D workers increasing faster than wages for workers in operations, the share of R&D activities in Korean GVC income has significantly increased while the share of GVC income in operations has decreased. We also observe that the share of GVC income in marketing & sales has slightly decreased and the share of GVC income in management remained relatively stable between 1998 and 2016. Figure 3.33 highlights that the shift in employment and wages in the Korean manufacturing sector is mainly a process where Korea remains competitive by being more innovative and devoting more resources to R&D, while relying more on offshoring or robotisation to compress costs related to operations.

Figure 3.33. Within manufacturing GVCs, Korea specialises in R&D tasks

Policy insights

The current global environment is characterised by uncertainties and a persistent trade slowdown. For a medium-sized country like Korea with a large share of GDP relying on exports, domestic demand cannot fully compensate for a decrease in foreign demand. Korea will have to re-design its GVC strategy to mitigate the impact of rising protectionism and maintain its position in global trade. This is also an opportunity to use GVCs to support other efforts aimed at reducing the productivity gaps and promote business dynamism.

Policy insight #5: Designing a more inclusive GVC strategy

To support a diversification of exports and allow a broader set of firms in different industries to join GVCs, the first objective of a new GVC strategy would be to improve the connectivity of Korean firms. This can be done by unilateral reforms in Korea as opposed to trade negotiations that take time and depend also on the willingness of trade partners to co-operate. A second set of reforms can be seen as complementary to what has been described in previous policy insights: improving the capacity of SMEs to participate in GVCs and encouraging a rebalancing of GVCs towards services. To mitigate the impact of protectionism and facilitate the restructuring of GVCs in the context of the digital transformation, the third part of the new GVC strategy involves a consolidation and extension of current trade agreements to which Korea is a party. Consequently, this third part can be regarded as a more long-term and challenging policy objective.

Improve the connectivity of Korean firms to diversify exports

A diversification of exports can make GVCs more inclusive but also more resilient in the context of trade tensions. This diversification can be expected from policies previously discussed, in particular product market reforms and a level playing field between manufacturing and services, as well as an industrial policy less focused on the promotion of a narrow set of activities but, instead, aimed at helping firms from all sectors to seize opportunities to become global. Removing barriers to FDI and allowing more foreign multinational enterprises (MNEs) to operate in Korea can play an important role in creating networks between domestic firms and global buyers and suppliers. But strategic partnerships are also increasingly used by firms to co-operate and achieve common goals and do not involve FDI. These partnerships can be used for R&D, the launch of joint products or the use of intellectual property. They require an effective system of contract enforcement and international investment rules covering this type of non-equity relationship among firms. Korea could review the legal regime for these partnerships and ensure that firms benefit from the support of the Korea Trade-Investment Promotion Agency (KOTRA) to identify partners and engage in such partnerships.

In the digital age, working with foreign firms also involves sharing data. Cross-border data regulations are needed to protect privacy and particularly the personal information of consumers. Korea should ensure that its regulations are not too burdensome and do not discourage firms from doing business with foreign partners. In 2018, the IT Networks Act was amended with more constraints on firms seeking to engage in cross-border data exchanges. Korea has also implemented strict data localisation requirements motivated in particular by national security. The low diffusion of cloud computing technologies and e-commerce, particularly in relation to online payments, can be related to such data regulations and can be a substantial obstacle for Korean firms and discourage them from working with foreign partners or serving foreign consumers. There is a need for continuous attention, in order to strike a balance between the benefits of cross-border data flows and privacy and security.

Promote inclusiveness in GVCs by increasing the participation of SMEs and encouraging a rebalancing of GVCs towards services

The second objective of the new GVC strategy would be to complement other policy efforts aimed at boosting the productivity of SMEs and encouraging a rebalancing of productivity growth towards services. There is a very low share of exporters among SMEs in Korea (2.6% according to the Korea International Trade Association) and SMEs account for only 15% of Korean exports (OECD, 2018[84]). The Ministry of SMEs and Startups has already put in place measures aimed at improving the participation of SMEs in GVCs. This includes offering support for education, information on global markets and brand development. Efforts could be extended to provide targeted support and financing to SMEs that do not directly export but supply exporters (particularly in the service sector) and could later become direct exporters or work as suppliers for foreign firms. This support would have to be assessed, evaluated and streamlined as suggested in policy insight #4. Use of digital tools are also means through which SMEs could more easily serve global markets. Another area where support could be reinforced is certification and compliance with foreign regulations. Firms trying to meet the standards of foreign markets are faced with steep costs and it is often seen as one of the main barriers to exports of SMEs.

GVCs can also help services industries to become more productive through internationalisation, complementing efforts to improve the productivity of business in the services industry and the rebalancing of the Korean economy towards services (policy insight #1). This strategy could also play a positive role for the resilience of the economy: service sectors are less affected by the current trade wars (as there are no tariffs on services) and are generally more resilient to macro-economic fluctuations (Borchert and Mattoo, 2010[85]). Moreover, the rebalancing of GVCs towards the export of services would contribute to inclusiveness. In Korea, the participation of women in GVCs is relatively low, even when considering indirect participation (i.e. through services firms supplying inputs to manufacturing exporters). This is the result of the employment of a significant share of working women in the service sector and of the Korean export specialisation in manufacturing industries. Current measures aimed at helping SMEs in the service sector to become exporters could target female entrepreneurs, as well as firms with a higher share of women in their employment.

Mitigate the impact of protectionism and facilitate the reorganisation of GVCs

The third objective of a new GVC strategy would be to mitigate the impact of protectionism and facilitate the reorganisation of GVCs. Korea has a dense network of FTAs but most of them are bilateral and with different sets of rules, including rules of origin. This prevents products manufactured in GVCs using inputs from different countries from benefiting from trade preferences or common standards. Through mega-regional agreements, such as the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP) – that includes 11 economies in the Asia-Pacific area –, other countries in the region have secured more favourable trade regimes and advanced rules benefitting GVCs. FTAs can be used to secure and expand trade preferences. They are not a perfect guarantee against trade restrictions imposed on the basis of the safeguards they include. But they can offer a framework for solving trade conflicts.

The consolidation of the network of FTAs to which Korea is a signatory and the inclusion of new partners could improve the centrality of Korea in GVCs. The conclusion of the Regional Comprehensive Economic Partnership (RCEP) with ASEAN countries, as well as China, Japan, Australia and New Zealand, or Korea joining the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP) would positively affect the capacity of Korean firms to join and upgrade in GVCs. These mega-regional agreements facilitate the creation of a network, as opposed to bilateral deals.

With rising protectionism and new trade barriers, Korean manufacturing firms may have to rely even more on high-skilled jobs and tasks in the value chain related to R&D, marketing and sales, rather than core manufacturing activities, in order to remain competitive in foreign markets. This can potentially aggravate job polarisation but there would be no gain in preventing the adjustment of Korean firms to new barriers on foreign markets. Preventing the reorganisation and consolidation of GVCs would not reverse the trend in favour of workers within the core manufacturing activities. Protectionist measures making Korean firms less competitive would on the contrary reduce income and further exacerbate structural change aimed at reducing costs. Policies directly addressing the needs of workers impacted by the transition to new activities in GVCs are preferable.

As Korean GVCs adjust to lower labour costs in China and other emerging economies, the impact of offshoring is for now skill-biased. But over time, as wages catch up in competing economies, offshoring will become unskill-biased by increasing the demand for unskilled workers in Korea as a result of the complementarity between skilled and unskilled labour, a lower differential in wages and a higher demand for manufacturing goods (Acemoglu, Gancia and Zilibotti, 2015[86]). GVCs could then contribute to inclusiveness, suggesting that the main issue to address is what happens to workers during this transition.

Conclusion and priorities

Based on the premise of strong complementarities between productivity, business dynamism and inclusiveness, this chapter provided five complementary and mutually reinforcing policy insights to reconcile growth and inclusiveness in Korea. The suggested policies constitute a full package of reforms to be implemented together in order to address productivity gaps, promote business dynamism and maintain the country’s position in global trade.

Successful structural reforms typically take time, as they require a whole-of-government approach with co-ordination of different ministries and parts of the administration. Moreover, numerous political and economic factors can facilitate or hinder economic reform. Acknowledging the constraints faced by the Korean government, this concluding section identifies priority reform actions that can be implemented in the short run.

The three main priorities for Korea in the next two years could be:

1. to create a level playing field between manufacturing and services for tax policy and government support;
2. to address size contingencies in schemes supporting firms and in labour laws and start the process of evaluating and streamlining existing SME programmes; and
3. to promote competition through trade and investment liberalisation and by addressing unfair business practices faced by small firms.

The first priority can be seen as a first step towards more ambitious services regulatory reforms but starting with a reasonable objective that could send the signal that services matter as much as manufacturing activities for the government. This process was already initiated in July 2019 with the announcement of such a reform.

The second priority requires looking at some of the laws already discussed in the context of labour market reforms, such as support for young workers, limits on temporary employment or working hours. Since these laws are already under review, the additional action would only be to take into account the role of size thresholds and how they can discourage small firms from growing and graduating from the SME category. Complementary policy action would consist in starting a review of existing SME support schemes to assess and evaluate their effectiveness and whether they are needed or not. Such evaluation would then lead in the medium term to the consolidation and streamlining of these schemes.

The third priority is more challenging in a short-term policy agenda but is essential to improve business dynamism and to have a significant impact on productivity. Foreign competition can not only help to boost the productivity of domestic firms but will also allow small firms to no longer operate in an environment with only dominant Korean firms. In addition, measures could directly address unfair business practices involving large firms, which are also necessary to discipline foreign companies that will enter the Korean market.

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Notes

← 1. The expression “the Miracle on the Han River” comes from Korea’s Prime Minister Chang Myon who used it in a speech in 1961, referring to the rapid recovery of West Germany after the Second World War, which was described as “the Miracle on the Rhine River”. It was later used to describe the rapid growth of Korea between the 1960s and 1990s (Lucas, 1993[88]; Connolly and Yi, 2015[89]).

← 2. Productivity analyses typically use the 90-10 productivity ratio to describe the overall productivity dispersion, defined as the ratio of the productivity level of firms located at the 90th percentile of the productivity distribution to the productivity level of firms located at the 10th percentile. However, this chapter uses the inverse of the 90-10 productivity ratio for the sake of consistency with the measurement of other productivity gaps. In all cases, a low ratio is indicative of a large gap between low and high productivity performance.

← 3. The observed dispersion of productivity across Korean firms tends to be underestimated since the Korean data do not include firms with fewer than 10 employees. However, robustness checks based on comparable samples of firms with at least 10 employees in both Korea and in other countries confirm that productivity dispersion has increased substantially more in Korea than elsewhere.

← 4. For example, suppose that the average worker at top firms makes USD 100k PPP per year, whereas the average worker at bottom firms makes USD 20k PPP. If wages grow at the same yearly rate of 2% at both top and bottom firms, the average worker at top firms gets an earnings increase of USD 2k PPP after one year, while the average worker at bottom firms only gets an increase of USD 0.4k PPP.

← 5. Cloud computingand big data figures for Korea are based on 2016 and 2017 data, respectively 2018 data, unavailable at the time of drafting, may show that diffusion has increased.

← 6. While it is a well-known fact that it is relatively harder to measure R&D investment in services than in manufacturing industries, such a problem would concern all countries considered and would not affect rankings.

← 7. Even the introduction in 2013 of treble damages against firms that violate subcontracting laws is insufficient to incentivise small firms to co-operate with the KFTC.

← 8. Both SCK and PRIME were recently consolidated into a Junior College Innovation Support Project and a University Innovation Support Project, respectively.

← 9. See https://www.foreigner.fi/articulo/work-and-study/finland-prepares-new-strategy-to-attract-talented-foreign-students/20190409163338001660.html.

← 10. The recent OECD report on The Role of Education and Skills in Bridging the Digital Gender Divide further discusses successful gender policy initiatives implemented in APEC economies (OECD, 2020[91]).

← 11. Affirmative action also applies to regional state-owned enterprises and public corporations under 300 workers.

← 12. Development in Korea, Key Figures of Korea R&D Activities (Ministry of Science and ICT, KISTEP, 2018) https://www.kistep.re.kr/c3/sub2_5.jsp?brdType=R&bbIdx=12801.

← 13. The difference between Korea and other countries may partly arise from the fact that the Korean data is at the establishment level, while it is at the firm level for other countries. However, the general picture of a skewed size distribution is confirmed in studies that aggregated establishment data at the firm level (Cho et al., 2017[56]).

← 14. Large businesses indirectly account for a larger share of jobs because of input-output linkages.

← 15. As previously mentioned, the difference between Korea and other countries in the reference group may partly arise from the fact that Korean data is at the establishment level, while it is at the firm level for other countries.

← 16. The employer enterprise birth rate corresponds to the number of births of employer enterprises as a percentage of the population of active enterprises with at least one employee (OECD, 2017, p. 72[54]).

← 17. The DynEmp data exclude firms with one worker in order to improve cross-country comparability and abstract from issues related to legal definitions of employer and non-employer businesses.

← 18. Subsistence entrepreneurship refers to entrepreneurship as a means of providing subsistence income, as opposed to transformational entrepreneurship, which refers to the creation of large, vibrant businesses that grow much beyond the scope of an individual’s subsistence needs and provide jobs and income for others (Schoar, 2010[90]).

← 19. Until 2015, companies with more than 300 regular workers did not qualify as SME either, irrespective of their revenue, hence were excluded from support as well.

← 20. Eurostat aggregates services into knowledge-intensive services (KIS) and less knowledge-intensive services (LKIS) based on the share of tertiary educated persons at NACE 2-digit level. For a list, see https://ec.europa.eu/eurostat/statistics-explained/index.php/Glossary:Knowledge-intensive_services_(KIS).

← 21. TiVA statistics are in current prices. In the absence of detailed price information for traded inputs, there is no robust methodology to convert data into constant prices.

← 22. The contribution of these different factors is calculated using a structural breakdown analysis. See Miller and Blair (2009[87]), Chapter 13, for the methodology. Data are in millions of USD in current prices. As previously emphasised, a limitation when using the TiVA database is that data are not in constant prices and the change over time also reflects fluctuating prices.

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