Abstract
This note is on Korea’s transition to a knowledge-based economy, the prospects and challenges ahead, and the development of its financial sector. Assessment of recent government initiatives to develop capital markets has been presented. The note discusses restrictions on Chaebol ownership of Korean banks and strategy for restructuring the small and medium-sized enterprise sector in Korea. This note describes the key fiscal challenges and discusses possible ways to address them, arguing that there is already a great need to start taking remedial action.
I. Korea’s Transition to a Knowledge-Based Economy: Prospects and Challenges Ahead1
A. Introduction
1. Korea has made huge strides in economic development over the last three and a half decades. Real GDP growth has averaged 7 percent per year over the period, increasing per capita income sevenfold. As a result, GDP per capita now stands at 70 percent of the OECD average (in purchasing power parity terms), compared with just 20 percent in 1970. The rapid accumulation of factor inputs, coupled with large productivity gains in the manufacturing sector, has been the driving force behind Korea’s impressive growth.
2. But looking forward, growth is set to decline substantially. Already, potential output growth has fallen to about 4½ percent from 8 percent before the crisis, as investment and productivity have slowed. By 2030, it could drop to just 2½ percent, mainly because Korea’s labor supply will start to fall in less than 15 years. This means that it will take longer for Korea to catch up with other advanced economies.
3. The key to reversing this trend and improving growth prospects lies in stimulating productivity, especially in the service sector. The service sector is large and growing, accounting for more than half of GDP and almost two-thirds of employment. However, productivity is low relative to other sectors and has been stagnating. The main problem lies in the retail sector, which is dominated by small mom-and-pop stores, but productivity performance in other service areas has also proved disappointing.
4. Increasing productivity in the service sector requires a three-pronged strategy. The first step would be to deregulate the service sector. The second would be to help small firms grow by increasing their access to finance. And the third would be to reform the labor market to enhance its flexibility and create a strong safety net, so that workers can move out of mom-and-pop shops to higher-quality jobs. This paper focuses on the first element of the strategy, while other studies in these Selected Issues discuss small business financing (Chapter IV) and labor market and income inequality (Chapter V) issues in depth.
5. The paper is organized as follows. Section B looks at potential output trends in Korea. It provides an update to similar studies by Ma (2001) and Zebregs (2003) in identifying the long-term determinants of growth. The key difference is that the analysis in this paper is forward-looking and potential output is evaluated at both the aggregate and sectoral levels. Section C explores the reasons why productivity is low in Korea’s service sector. Section D discusses progress in service sector reforms, especially the retail trade sector, and outlines what more can be done. Section E offers some concluding remarks.
B. Potential Output Trends in Korea
6. The drivers of growth in Korea have changed in recent periods. Based on the standard production function approach, in the 1980s employment growth accounted for half of GDP growth, while capital accumulation and productivity growth each accounted for onefourth. In recent periods, however, the growth of factor inputs has been slowing, with labor growth more than halving since the 1980s and capital accumulation decelerating sharply since the Asian crisis. In addition, productivity growth has dropped compared with the 1980s.
Contribution to GDP Growth
(average annual percent change)
Contribution to GDP Growth
(average annual percent change)
| GDP | Labor | Capital | TFP | |
|---|---|---|---|---|
| 1981–2005 | 6.4 | 2.7 | 2.0 | 1.7 |
| 1981–1990 | 8.4 | 4.1 | 2.1 | 2.1 |
| 1991–2000 | 5.3 | 1.7 | 2.4 | 1.5 |
| 2001–2005 | 4.6 | 1.7 | 1.3 | 1.6 |
Contribution to GDP Growth
(average annual percent change)
| GDP | Labor | Capital | TFP | |
|---|---|---|---|---|
| 1981–2005 | 6.4 | 2.7 | 2.0 | 1.7 |
| 1981–1990 | 8.4 | 4.1 | 2.1 | 2.1 |
| 1991–2000 | 5.3 | 1.7 | 2.4 | 1.5 |
| 2001–2005 | 4.6 | 1.7 | 1.3 | 1.6 |
7. Looking ahead, the labor supply is set to decline dramatically because Korea’s society is aging rapidly. By 2026, the elderly population (over 65 years of age) is expected to exceed 20 percent of the total population.2 The birth rate is also falling, with Korea having one of the lowest birth rates of any advanced economy. According to the U.S. Population Reference Bureau (2006), Korea’s fertility rate is at 1.1 births per woman, compared with 1.3 in Japan, 1.4 in Europe (including Eastern Europe), and 2.0 in the United States. In principle, there should be some scope to offset this low rate of birth through higher labor force participation, since Korea’s female participation rate (50 percent) is relatively low when compared with 61 percent in Japan, and 69 percent in both the United Kingdom and the United States. But over the past decade there has been no increase in the female participation rate at all. As a result, labor supply growth is slowing: based on population projections from the National Statistical Office and assuming a constant participation rate, the absolute size of the labor force is projected to decline from 2018.
Labor Force
(in millions, constant participation rate)
Citation: IMF Staff Country Reports 2006, 381; 10.5089/9781451822205.002.A001
Sources: CEIC Data Company Ltd; National Statistical Office; and Fund staff projections.Labor Force
(in millions, constant participation rate)
Citation: IMF Staff Country Reports 2006, 381; 10.5089/9781451822205.002.A001
Sources: CEIC Data Company Ltd; National Statistical Office; and Fund staff projections.Labor Force
(in millions, constant participation rate)
Citation: IMF Staff Country Reports 2006, 381; 10.5089/9781451822205.002.A001
Sources: CEIC Data Company Ltd; National Statistical Office; and Fund staff projections.
Labor Participation Rate
(In percent)
Citation: IMF Staff Country Reports 2006, 381; 10.5089/9781451822205.002.A001
Source: National Statistical Office.Labor Participation Rate
(In percent)
Citation: IMF Staff Country Reports 2006, 381; 10.5089/9781451822205.002.A001
Source: National Statistical Office.Labor Participation Rate
(In percent)
Citation: IMF Staff Country Reports 2006, 381; 10.5089/9781451822205.002.A001
Source: National Statistical Office.8. At the same time, investment growth has also been slowing due to higher perceived risk and structural impediments. Investment as a share of GDP has fallen from around 36 percent during the pre-crisis period to less than 30 percent since the crisis. While overinvestment by chaebols during the 1990s may partly explain the investment decline, there are other factors that may have restrained investment. For instance, firms are now operating in a riskier environment as production has shifted from more traditional items to advanced technology products, where tastes and technology are constantly changing.3 Moreover, corporations have limited scope for transferring risk, since cross-guarantees within business groups have been abolished and implicit government guarantees withdrawn, while banks are applying tighter risk management practices in their lending policies. Firms are also reluctant to invest due to strict labor protection for regular workers, which makes it difficult and costly to dismiss workers when projects prove unprofitable. Meanwhile, investment by small- and medium-sized enterprises (SMEs) has been held back by low profitability as a result of the growing global competition. Public credit guarantees have also increased barriers to entry and exit and delayed the much needed restructuring of SMEs, keeping many unviable firms in operation.4
Gross Fixed Capital Formation
(In percent of GDP)
Citation: IMF Staff Country Reports 2006, 381; 10.5089/9781451822205.002.A001
Source: CEIC Data Company Ltd.Gross Fixed Capital Formation
(In percent of GDP)
Citation: IMF Staff Country Reports 2006, 381; 10.5089/9781451822205.002.A001
Source: CEIC Data Company Ltd.Gross Fixed Capital Formation
(In percent of GDP)
Citation: IMF Staff Country Reports 2006, 381; 10.5089/9781451822205.002.A001
Source: CEIC Data Company Ltd.9. Meanwhile, productivity growth is now lower than it was in the 1980s. A key reason is that productivity performance in services has been poor, while the sector’s importance in the economy has been growing. Productivity in services is difficult to measure, but the available indicators consistently point to a problem. According to the OECD (2005a), labor productivity in services is only 56 percent of that in manufacturing, well below the 93 percent OECD average, the largest gap in the OECD.5 In addition, only 14 percent of Korea’s exports are related to services, compared with the OECD average of 22 percent. Pyo et al. (2006) note that labor productivity growth in Korea’s service sector was about half the rate in the manufacturing sector during 1984–2002. In addition, the study finds that total factor productivity (TFP) growth in many sub-sectors including transportation, wholesale and retail trade, and public services was negative. Similarly, Kim (2006) finds that TFP growth in services declined from an annual average of 1.7 percent in the 1980s to 0.4 percent in the 1990s, while that of other developed countries actually increased over the same period.
TFP Growth
(Average annual growth rate, In percent)
Citation: IMF Staff Country Reports 2006, 381; 10.5089/9781451822205.002.A001
Source: Staff estimates.TFP Growth
(Average annual growth rate, In percent)
Citation: IMF Staff Country Reports 2006, 381; 10.5089/9781451822205.002.A001
Source: Staff estimates.TFP Growth
(Average annual growth rate, In percent)
Citation: IMF Staff Country Reports 2006, 381; 10.5089/9781451822205.002.A001
Source: Staff estimates.10. As the Korean economy shifts further toward services, overall productivity growth could decline even more.6 The share of services in value added has been rising from 45 percent in 1970 to 50 percent in 1990 and 56 percent in 2005.7 And the share of services is likely to increase further in the future, closer to the OECD average of 69 percent. Indeed, there has been a strong shift toward services over the past two decades in OECD economies. This structural change is particularly striking in Australia, the United Kingdom, and the United States, where the service sector share rose by 15 percentage points between 1980 and 2003. This development has been driven largely by a shift in demand and increased competition in the service sector, mainly due to regulatory reform and a reduction in international barriers to trade and investment in services. Wölfl (2005) finds that the contribution of the service sector to overall productivity growth has increased in these countries.
Service Sector
(In percent)
Citation: IMF Staff Country Reports 2006, 381; 10.5089/9781451822205.002.A001
Sources: Bank of Korea and National Statistical Office.Service Sector
(In percent)
Citation: IMF Staff Country Reports 2006, 381; 10.5089/9781451822205.002.A001
Sources: Bank of Korea and National Statistical Office.Service Sector
(In percent)
Citation: IMF Staff Country Reports 2006, 381; 10.5089/9781451822205.002.A001
Sources: Bank of Korea and National Statistical Office.11. In sum, assuming current trends continue, Korea’s potential output growth would slow sharply. It is important to note that potential output estimates are subject to measurement problems and different assumptions about growth of factor inputs and productivity, and thus involve large uncertainties, especially in projections covering a time span of 50 years. Nevertheless, with assumptions about the evolution of the structure of the economy and growth of factor inputs, it is possible to make some reasonably robust estimates.
In the baseline scenario, it is assumed that the labor force grows in line with population growth projections, with a constant participation rate.8 Labor is expected to continue shifting into services, until Korea’s service sector share of employment reaches the OECD average (69 percent) within 10 years, and rising gradually thereafter to Australia’s level (74 percent) over the next 20 years.
The capital stock is assumed to grow at the average rate of the past 5 years (about 4 percent per annum) for most of the projection period, with slower accumulation once the labor shift has stabilized.9 The shares of capital stock in the service and nonservice sectors are derived from Pyo et al. (2006).
Productivity (TFP) growth in services is assumed constant at its current rate which is close to zero, while productivity growth in non-services declines over time in proportion with the shift of labor into services. This implies that Korea is close to its technological frontier in manufacturing, so that nonservice productivity growth is converging to the levels of other advanced economies.
Potential Output Growth (No Reform)
(In percent)
Citation: IMF Staff Country Reports 2006, 381; 10.5089/9781451822205.002.A001
Source: Staff projections.Potential Output Growth (No Reform)
(In percent)
Citation: IMF Staff Country Reports 2006, 381; 10.5089/9781451822205.002.A001
Source: Staff projections.Potential Output Growth (No Reform)
(In percent)
Citation: IMF Staff Country Reports 2006, 381; 10.5089/9781451822205.002.A001
Source: Staff projections.Under these assumptions, potential output growth will fall rapidly to around 2½ percent by 2030 and to 2 percent by 2050, from about 4½ percent at present. This projection is consistent with other recent estimates by the Ministry of Finance and Economy (4.8 percent for 2006–2010, and declining to 1 percent by 2050), Korea Development Institute (2003) (4.6 percent for 2003–2012), Bank of Korea (2005) (4.6 percent for 2005–2014), OECD (2005a) (4.6 percent for 2003–2012), although it is somewhat below that in Pyo and Ha (2006) (5.4 percent for 2005–2015).
12. Under this scenario, Korea will take a long time to catch up with other advanced economies in terms of per capita income. For example, Korea will continue to lag behind the United States for the next 50 years, assuming potential output growth for the United States of 3.2 percent for 2006–2011 and 2.6 percent for the remaining period.10 Based on projections from World Population Prospects of the United Nations Population Division, population growth in the United States remains positive, albeit slowing gradually, throughout the projection period.
Real GDP Per Capita
(PPP, In U.S. dollars at 2000 prices)
Citation: IMF Staff Country Reports 2006, 381; 10.5089/9781451822205.002.A001
Sources: IMF, WEO database; United Nations; and Fund staff calculations.Real GDP Per Capita
(PPP, In U.S. dollars at 2000 prices)
Citation: IMF Staff Country Reports 2006, 381; 10.5089/9781451822205.002.A001
Sources: IMF, WEO database; United Nations; and Fund staff calculations.Real GDP Per Capita
(PPP, In U.S. dollars at 2000 prices)
Citation: IMF Staff Country Reports 2006, 381; 10.5089/9781451822205.002.A001
Sources: IMF, WEO database; United Nations; and Fund staff calculations.13. However, if service sector productivity could be improved, the outlook would be much better. In the alternative scenario, we retain all the other assumptions mentioned above except that due to reforms productivity growth in the service sector now rises rapidly in the initial period and is then sustained at a higher rate (around 2 percent) for the rest of the projection period. This higher rate of service productivity growth is close to the level in Australia, the United Kingdom, and the United States during the 1990s, based on estimates in Wölfl (2005). Under these assumptions, potential output growth will increase to 5½ percent over the next decade, before gradually falling to 3 percent by 2035 and thereafter. Overall, this represents an average increase of 0.8 percentage point in potential output growth relative to the baseline scenario. This is expected to put Korea’s growth on a stronger and more sustainable path so that Korea would be able to catch up faster with other advanced economies, including the United States. The speed of catch up could be even faster if reforms result in a higher female participation rate and a better investment climate.
Potential Output Growth (Reform)
(In percent)
Citation: IMF Staff Country Reports 2006, 381; 10.5089/9781451822205.002.A001
Source: Staff projections.Potential Output Growth (Reform)
(In percent)
Citation: IMF Staff Country Reports 2006, 381; 10.5089/9781451822205.002.A001
Source: Staff projections.Potential Output Growth (Reform)
(In percent)
Citation: IMF Staff Country Reports 2006, 381; 10.5089/9781451822205.002.A001
Source: Staff projections.
Real GDP Per Capita
(PPP, In U.S. dollars at 2000 prices)
Citation: IMF Staff Country Reports 2006, 381; 10.5089/9781451822205.002.A001
Sources: IMF, WEO database; United Nations; and Fund staff calculations.Real GDP Per Capita
(PPP, In U.S. dollars at 2000 prices)
Citation: IMF Staff Country Reports 2006, 381; 10.5089/9781451822205.002.A001
Sources: IMF, WEO database; United Nations; and Fund staff calculations.Real GDP Per Capita
(PPP, In U.S. dollars at 2000 prices)
Citation: IMF Staff Country Reports 2006, 381; 10.5089/9781451822205.002.A001
Sources: IMF, WEO database; United Nations; and Fund staff calculations.C. Why Is Service Productivity So Low?11
14. Korea’s service sector productivity varies by particular sub-sectors. Finance, insurance, real estate and business services generate the highest value added per hour worked, exceeding by far the contributions from other service sectors. On the other hand, the wholesale and retail trade, and hotels and restaurants sector is the least productive subsector—and it accounts for the largest share of services, employing 40 percent of the service labor force (compared with around 20 percent in France, the United Kingdom, and the United States). According to Baek et al. (2004), labor productivity in Korea’s retail sector is the lowest among OECD economies, around 30 percent of that in the United States. Consequently, the poor performance of retail services is dragging down the productivity of the service sector as a whole.
Service Productivity
(GDP per hour worked, Won billion, 2003)
Citation: IMF Staff Country Reports 2006, 381; 10.5089/9781451822205.002.A001
Source: OECD STAN database.Service Productivity
(GDP per hour worked, Won billion, 2003)
Citation: IMF Staff Country Reports 2006, 381; 10.5089/9781451822205.002.A001
Source: OECD STAN database.Service Productivity
(GDP per hour worked, Won billion, 2003)
Citation: IMF Staff Country Reports 2006, 381; 10.5089/9781451822205.002.A001
Source: OECD STAN database.15. Performance in the retail sector would be even worse, had the sector not benefited from a series of liberalization measures.12 Deregulation in the retail sector was initiated very early on. In 1988, the government began opening the retail sector to foreign investment. The first major reform took place in 1996, when limits on the number and size of stores for both domestic and foreign retail firms were eliminated, allowing the establishment of large-scale discount stores (hypermarkets). At the same time, foreign commercial presence in department stores and shopping centers was permitted, and foreign land ownership restrictions were eased. In 1998, the government allowed the construction of hypermarkets in quasi-industrial zones and relaxed restrictions on their establishment in natural greenbelt areas.13 These reforms provided a more conducive business environment, and the number of large-scale discount stores rose from 34 in 1996 to 304 in 2005. At the same time, the reforms also attracted foreign direct investment. Three (Carrefour, Wal-Mart, and Costco) of the top twenty retailers were foreign-owned, and a partnership between Samsung and Tesco was formed in 1999. However, Carrefour and Wal-Mart have recently decided to leave the market, selling their stores to Korean retail groups.
FDI Inflows in Wholesale&Retail Trade Sector
(US$ million)
Citation: IMF Staff Country Reports 2006, 381; 10.5089/9781451822205.002.A001
Source: Ministry of Commerce, Industry and Energy.FDI Inflows in Wholesale&Retail Trade Sector
(US$ million)
Citation: IMF Staff Country Reports 2006, 381; 10.5089/9781451822205.002.A001
Source: Ministry of Commerce, Industry and Energy.FDI Inflows in Wholesale&Retail Trade Sector
(US$ million)
Citation: IMF Staff Country Reports 2006, 381; 10.5089/9781451822205.002.A001
Source: Ministry of Commerce, Industry and Energy.16. Deregulation has spurred productivity improvements in the retail industry. Enhanced competition in the retail sector brought about many benefits including lower prices, transfers of technology and management skills, and a wider selection of shopping experiences. In particular, foreign competition has reshaped the local retail market by encouraging large domestic retailers to expand and become more efficient, and by forcing small stores to increase their specialization (Kim and Kim, 2000). The Ministry of Commerce, Industry and Energy (2002) estimates the value added per employee at discount stores to be two and a half times higher than that at supermarkets. According to ACNielsen (2004), the share of discount stores in total sales value rose from 25 percent in 2001 to 29 percent in 2004, while that of small supermarkets fell from 22 percent to 17 percent.
17. But if large-scale stores are so efficient, why is the retail sector so unproductive? The answer is that the sector still remains dominated by mom-and-pop shops. More than 90 percent of Korean retail firms employed less than four employees. According to Baek et al. (2004), the number of employees per retail firm in Korea was 2.3 in 2000 compared with 5.7 in Japan and 6.3 in the European Union. In fact, around one-third of workers in Korea’s service sector as a whole are self-employed, well above the average of 19 percent in OECD countries, 11 percent in Japan, and 7 percent in the United States. In wholesale and retail trade, this number is even higher at 50 percent, compared to an average of 30 percent in the OECD area.
18. The number of small retail businesses has been growing rapidly due to lack of better job opportunities. Since the financial crisis, the manufacturing sector has been shedding permanent jobs, by around half a million jobs during the past decade. Many of these workers have entered the service sector as self-employed due to the lack of equivalent high-paying jobs in services. A survey of 3,000 retail stores by the Small and Medium Business Association (2005) indicates that more than half of stores were established for lack of better job opportunities. As a result, the proliferation of mom-and-pop stores has driven down profitability and productivity in the retail sector.
19. Meanwhile, the expansion of large-scale retail stores has been hampered by land use regulations, such as strict zoning and land development laws.14 According to Kalirajan (2000), regulations on the establishment of a business in retail services for both domestic and foreign firms are considered the most restrictive in the OECD.15 While there are no regulations on building large-scale stores in commercial zones, such zones account for only 0.2 percent of the total country. Store size is also limited in residential and industrial areas. There are no regulations on operations such as limits on shop opening hours and price controls, but large-scale stores are still subject to other regulations such as limits on buildingand volume-to-land ratios.16 The application process for opening a large-scale store remains complicated and time-consuming. Moreover, the ambiguity in laws and the difficulty in resolving conflicts between small-scale and large-scale retailers through local governments pose additional constraints.
20. In other areas of services, productivity is low for other reasons. 17
Extensive entry barriers remain across the service sector. Nguyen-Hong (2000) finds that restrictions in accountancy services in Korea are amongst the highest in the OECD.18 For example, there are residency requirements as well as restrictions on the establishment of foreign accounting firms and on investment by non-professional investors. The commercial presence of foreign law firms is also prohibited, and foreign qualifications are not recognized.19 In social services, only non-profit organizations can establish a school or hospital, and the leasing of educational buildings and land is not permitted. Meanwhile, restrictions on foreign ownership in telecommunications as well as foreign content quotas for broadcast and cable television are also in force.
Firms are faced with high startup costs. According to the World Bank (2006), Korea ranks 97th out of 155 countries in terms of the ease in starting a business. It takes on average 22 days to launch a business, at a cost of over $2,000, compared to 3 days and about $252 in Canada, which is ranked first. These factors discourage new firms from entering the market, limiting incentives for incumbent firms to increase their efficiency.
Financing is constrained. Firms in the service sector have difficulty obtaining financing to grow and become established, especially in light of high innovation costs, and therefore remain as mom-and-pop stores. This is partly a result of firms’ limited collateral for securing credit (under current collateral laws) and the underdevelopment of the venture capital industry to support innovative start-ups.20 In an OECD study (2005b), service firms identified the financing constraint as the most important barrier to innovation, which is essential for the growth of the service sector.
Exit costs are high. There is little incentive for weak firms to close due to government subsidies and the high cost of restructuring associated with an inefficient bankruptcy system. According to a survey by the Presidential Commission on Small and Medium Enterprises (2005), only 3 percent of the self-employed (businesses with less than five employees) were willing to shut down their business despite poor revenue prospects, with most intending to continue, or relocate or change the type of business activity instead. In a survey of 500 retail stores in Seoul by Korea Chamber of Commerce and Industry (2004), most retailers were relying on the government to provide tax reduction and financial support, and to impose tighter restrictions on large-scale retail stores, to improve their profits rather than trying to raise productivity by training or adopting new technology.
Time and Cost in Starting a Business (2005)
Time and Cost in Starting a Business (2005)
| Korea | OECD | |
|---|---|---|
| Procedures (number) | 12.0 | 6.5 |
| Time (days) | 22.0 | 19.5 |
| Cost (percent of income per capita) | 15.2 | 6.8 |
| Minimum capital (percent of income per capita) | 308.8 | 41.0 |
Time and Cost in Starting a Business (2005)
| Korea | OECD | |
|---|---|---|
| Procedures (number) | 12.0 | 6.5 |
| Time (days) | 22.0 | 19.5 |
| Cost (percent of income per capita) | 15.2 | 6.8 |
| Minimum capital (percent of income per capita) | 308.8 | 41.0 |
D. What Can Be Done to Improve Productivity in Services?
21. Deregulation could raise productivity in the service sector. In Korea, deregulation has generated large productivity gains in financial services, and the same principle can be applied to other services.21 Nicoletti and Scarpetta (2003) find strong negative correlations between product market regulations—particularly those related to administrative burdens for start-ups—and productivity growth in OECD countries during 1980–2000. The easing of entry restrictions in service industries is estimated to raise overall TFP growth by 0.1–0.2 percentage point in some countries. Similarly, N’Diaye (2006) estimates that product market reforms could raise TFP growth in Japan by about ¼ percentage point. The OECD (2005b) cites case studies of several international services firm to illustrate how the opening up of markets raises competition and encourages innovation, both of which contribute to improved performance in the service sector.
Service Productivity
(GDP per worker, Won million, 2000 prices)
Citation: IMF Staff Country Reports 2006, 381; 10.5089/9781451822205.002.A001
Sources: Bank of Korea and National Statistical Office.Service Productivity
(GDP per worker, Won million, 2000 prices)
Citation: IMF Staff Country Reports 2006, 381; 10.5089/9781451822205.002.A001
Sources: Bank of Korea and National Statistical Office.Service Productivity
(GDP per worker, Won million, 2000 prices)
Citation: IMF Staff Country Reports 2006, 381; 10.5089/9781451822205.002.A001
Sources: Bank of Korea and National Statistical Office.22. Australia presents a good example of the strong links between reform and productivity. According to Salgado (2000), structural reforms, including trade and product market liberalization and labor reforms, are estimated to have lifted TFP growth in Australia by 0.5–0.9 percentage points over the long run. In the service sector, Parham (2002) shows that TFP growth increased across nearly all sub-sectors, partly due to policy reforms introduced progressively from the mid-1980s through to the 1990s, which not only enhanced competition but also stimulated the adoption of advanced technologies and raised the rate of innovation. It is notable that TFP growth for the wholesale trade sector was negative in the early 1990s but turned sharply positive later in the decade.
Australia’s Service Sector TFP Growth
(Average annual growth rate, In percent)
Citation: IMF Staff Country Reports 2006, 381; 10.5089/9781451822205.002.A001
Source: Parham (2002).Australia’s Service Sector TFP Growth
(Average annual growth rate, In percent)
Citation: IMF Staff Country Reports 2006, 381; 10.5089/9781451822205.002.A001
Source: Parham (2002).Australia’s Service Sector TFP Growth
(Average annual growth rate, In percent)
Citation: IMF Staff Country Reports 2006, 381; 10.5089/9781451822205.002.A001
Source: Parham (2002).23. Australia’s relatively open retail sector was key to its productivity improvements. According to Kalirajan (2000), Australia’s retail sector is among the least restrictive in the OECD, particularly with regard to the ease of establishing a business. Johnston et al. (2000) note that the high degree of competition in the retail sector induced rationalization, a shift toward larger-scale stores, investment in technology, greater integration of the supply chain, and better management practices. Rationalization was a key factor in boosting productivity in the retail sector. For example, in motor vehicle retailing, the number of car dealerships halved from 3,650 in 1984 to 1,800 in 1999. The number of service stations also fell from 20,000 to 8,000 over this period. The emergence of specialist chain stores intensified competition and allowed economies of scale in the supply chain and the use of more advanced store management systems.
24. Some progress has been made in deregulating the service sector in Korea. Special economic zones with tax and tariff incentives for foreign investors were set up in 2002 which helped to ease entry barriers. Within these economic zones, for-profit hospitals are permitted and since 2005 foreign hospitals have been allowed to treat Korean patients. Policies to strengthen competitiveness in the service sector have been formulated and implemented since 2003, including business support services and job training. The Korea Fair Trade Commission (KFTC) abolished or reformed 56 anti-competitive regulations in 2004 and is currently reviewing 94 additional regulations, while many regulations on foreign direct investment have been reformed. The KFTC also launched a two-year review of the existing 8,000 regulations in 2005. In addition, regulations on admission into the legal and accounting services have been eased.
25. The government is continuing its efforts to promote the growth and competitiveness of service industries. It recognizes the importance of knowledge-based service industries in generating jobs through enlargement and specialization, and the need for small businesses to strengthen their competitiveness. In early 2006, the government prepared a policy package to improve competition in ten service areas, including plans to allow more foreign engagement in law and accounting. It hopes that this will encourage the consumption of services provided in Korea, and thus help narrow the trade deficit in services of recent years, including in the areas of tourism, education, and health care.22
26. But more needs to be done to raise productivity growth in Korea’s service sector. In line with OECD (2004, 2005a) recommendations, entry barriers could be reduced by further relaxing land use regulations to facilitate the development of large-scale retail stores, and easing restrictions on entry and business activity in professional services. Promoting competition in education is crucial in raising the level of human capital to support a knowledge-based economy and this can be achieved by deregulating and opening the market to foreign providers. In particular, this would encourage the restructuring and consolidation of tertiary education institutions which would help improve their quality. Regulations could be streamlined—with one-stop shops replacing multiple contact points and administrative procedures—and transparency in the regulatory framework increased. The exit of unviable firms could be facilitated with a more effective bankruptcy framework. Finally, innovation in services could be fostered, by providing firms with better access to financing so that they can invest more in R&D as well as become stronger in absorbing available technology.23
27. Trade liberalization presents another opportunity to deregulate the service sector. In line with the government’s strategy of liberalizing services, the multilateral trade liberalization under the Doha development round of negotiations could provide a stimulus to opening up the service sector, for example in the medical, educational, and business service areas. The planned free trade agreement with the United States could help this process along. According to the Korea Institute for International Economic Policy, a Korea-United States Free Trade Agreement (FTA) could increase services value added by 0.3–0.5 percent and services employment by 80,000 jobs. Overall GDP is estimated to rise by 0.4–2.0 percent. The U.S. International Trade Commission estimates that GDP could rise by 0.7 percent, with services value added increasing by 1.4 percent. Realizing the potential gains from liberalization, however, will require that the FTA (and others in negotiations) be designed in a way that will complement multilateralism. It is also important to ensure that sectoral openings under such an agreement be as nondiscriminatory as possible, so as to simplify implementation and minimize the risks of trade diversion.
E. Conclusions
28. Korea is well-positioned to make further progress in the 21st century. Compared with other OECD countries, Korea ranks fifth in R&D expenditure (about 3 percent of GDP). It has the third strongest ICT infrastructure (measured in ratio of ICT production to GDP), with the highest rate of broadband internet penetration in the world. Korea also has the highest expenditure on education (8 percent of GDP), and ranks second on international student achievement tests.
29. But the future of Korea depends critically on improving its service sector productivity performance. Deregulation of the service sector is necessary to facilitate this change, complemented by increased flexibility in the labor market and greater availability of financing for SMEs. These reforms will enhance competition and innovation, allowing the service sector to flourish, helping Korea to achieve its long-standing goal of catching up to the world’s richest nations.
References
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Prepared by Varapat Chensavasdijai.
See Chapter VI for the fiscal implications of population aging in Korea.
See IMF (2006) for a fuller discussion.
See Kang and Miniane (2004) for a detailed analysis of problems facing SMEs in Korea.
For the wholesale and retail trade, and hotels and restaurants sector, labor productivity is only 23 percent of that in manufacturing.
Wölfl (2005) finds a negative relationship between the share of services in total value added or employment and aggregate productivity growth for OECD countries during 1990–2001.
In terms of employment, the service sector accounts for 65 percent of the labor force in 2005.
Small variations in the participation rate do not affect the overall potential output trends much. See OECD (2005a) for projections of Korea’s labor force under different scenarios for the participation rates. The labor force trend is adjusted to allow for quality changes, by taking into account each employed group’s level of educational attainment and relative wages.
Capital stock estimates for Korea, along with the National Wealth Survey (NWS), were discontinued by the National Statistical Office in 1997. Thus we compute the initial capital stock in a particular year following the procedure outlined in Young (1995), and use the perpetual inventory method to estimate capital stock for the remaining years. This methodology was adopted in Zebregs (2003), but capital stock was also adjusted to allow for quality changes. The adjustment produced a similar series to the raw capital stock series. Pyo et al. (2006) estimate Korea’s capital stock with a similar methodology, linking one benchmark year for capital stock in the NWS with investment data from the national accounts, and also provide capital stock series for each economic sector.
Potential output growth estimates for the United States are based on Fund staff projections for 2006–2011 and the OECD Economic Outlook for the remainder of the projection period. Comparisons with other countries, such as Japan, are difficult given the uncertainty surrounding the path of potential output. For example, N’Diaye (2006) estimates Japan’s potential output growth to be between 1.7 and 2.3 percent, depending on the estimated magnitude of the impact of structural reforms.
This section benefited considerably from the analysis in Lee (2005).
Baek et al. (2004) and Kim and Kim (2000) provide further details of retail trade deregulation in Korea.
Natural greenbelt areas are designated development-restricted zones in urban districts, accounting for about 10 percent of total land in Korea.
Baek et al. (2004) point out that the non-manufacturing sector is subject to more and stronger entry barriers compared with the manufacturing sector. See also OECD (2000) for a comparative study of regulatory barriers in retail trade services in a number of Asian countries.
The restrictiveness index scores range from 0 to 1, with 0 being least restrictive and 1 being most restrictive. For Korea, the index is 0.59 for retail services.
For natural greenbelt areas, ceilings of 20 percent for the building-to-land ratio and 100 percent for the volume-to-land ratio apply, which makes large-scale retail outlets unprofitable. The volume-to-land ratio refers the volume of all buildings divided by the entire area of development.
OECD (2005a) also cites industrial policies favoring exports and the manufacturing sector as having had a negative impact on the growth of the service sector.
The restrictiveness index for Korea’s accountancy services is 0.72, with 0 being least restrictive and 1 being most restrictive.
Foreign lawyers can set up branch offices, form joint ventures with Korean law firms, and employ Korean and foreign lawyers, but cannot establish their own law firms.
See Chapter IV for more details.
Chapter II elaborates on financial sector deregulation in Korea.
Min (2005) considers the three key service sectors with greatest potential to be business, cultural and tourism, and medical services.
According to the OECD (2005a), Korea’s service sector accounted for only 13 percent of business R&D in 2001, compared with the OECD average of 21 percent.
