Republic of Korea: Selected Issues

International Monetary Fund

doi:10.5089/9781451822229.002.A002

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Republic of Korea: Selected Issues

Author: International Monetary Fund

Publication Date:: 11 Oct 2007

eISBN:: 9781451822229

Language:: English

Keywords:: ISCR; CR; rate; China; mortgage market; won; firm; mortgage; market share; trade surplus; shipbuilding performance; export success; parent firm; Foreign direct investment; Manufacturing; Export performance; Competition; Global; Asia and Pacific; overseas affiliate; exports of electronics

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This Selected Issues paper on the Republic of Korea reviews near-term economic prospects and risks. Korea experiences solid growth with low inflation, and vulnerabilities to potential shocks appear low. With Korea aging at an almost unprecedented rate, spending on pensions, health, and long-term care could rise by as much as 11 percent of GDP over the long term, threatening fiscal sustainability. Although risks facing financial institutions appear quite manageable, the authorities have focused on risks to the highly indebted household sector.

Abstract

II. Korea’s Competitiveness in the Global Marketplace¹

A. Introduction

1. Despite continued strong export performance, concerns have been raised recently about Korea’s competitiveness. Exports have recorded double-digit growth for the past four years, benefiting from Asia’s growing trade and production links. At the same time, the won has appreciated by 20 percent in real effective terms since end-2004, among the highest in emerging Asia. Coupled with rising oil prices, this is squeezing the profit margins of some Korean companies, including those in key export sectors. In addition, competition with China and other low-cost countries is eroding Korea’s industrial base, as companies are moving some of their operations overseas, resulting in stagnant investment and lower employment in manufacturing. Korea is perceived by some as being “sandwiched” between China, its key trading partner, which is catching up rapidly in terms of product technology, and Japan, its major export competitor, which is still technologically more advanced. This paper provides an assessment of Korea’s external competitiveness, focusing in particular on challenges posed by China and Japan, and offers some policy recommendations.

B. Exchange Rate and Competitiveness

2. Despite a steady appreciation of the won in recent years, Korea’s external competitiveness has remained strong. Since end-2004, the won has strengthened significantly against major currencies and in real effective terms. Nevertheless, exports reached $332 billion in 2006, making Korea the world’s 11^th largest exporter, while the nation’s share of world exports has remained steady at about 3 percent over the same period. CGER-type analysis suggests that the exchange rate remains broadly in line with fundamentals, with estimates of the deviation of the won from its equilibrium ranging between -4 and +14 percent, depending on the methodology for exchange rate assessment. The won appreciation is also consistent with Korea’s strong labor productivity growth in manufacturing, averaging 10 percent during 2002–06, mainly driven by technological innovation and labor-shedding as part of corporate restructuring efforts.

3. Korea has maintained its export growth by specializing in higher value-added products, while remaining relatively diversified. Over the past fifteen years, there has been a clear shift in the production of low value-added goods to high value-added goods, as well as a marked improvement in the quality of Korean products. This can be largely attributed to the high level of R&D investment in product development and design. Indeed, Korea’s R&D spending as a share of GDP is among the highest in the OECD, at close to 3 percent of GDP. High value-added products such as automobiles, consumer electronics, and ships now make up more than one-half of Korea’s exports, up from just one-fourth in 1990, at the expense of light industry products such as textiles. Korea is currently home to the world’s three largest shipbuilding companies, third largest steel producer, sixth largest carmaker, and leading producers of memory chips (including the biggest maker of NAND flash and the top two makers of DRAM chips), mobile handsets, and LCDs. The Herfindahl index, which measures the degree of trade specialization, increased from 0.03 in 1990 to 0.05 in 2005, suggesting that Korea has become more specialized over this period.² While the low values of the Herfindahl indices for Korea, Japan, and China indicate that exports of these countries are relatively diversified, Korea turns out to be the least diversified of the three.

4. A good example of Korea’s export success is its shipbuilding industry which has become a dominant global player over the past few years. Exports of vessels have increased by 25 percent per year on average since 2004, and now account for 7 percent of Korea’s total exports. Korea overtook Japan as the world’s largest shipbuilding nation in 2000. By 2006, Korea’s share in the global shipbuilding market was 40 percent in terms of new orders, followed by China and Japan at around 25 percent each. Korea has gained a competitive edge in shipbuilding through its high productivity, strong infrastructure and labor skills, advanced technology, and improved design and construction capabilities. Major shipbuilding exports include large tankers, liquefied natural gas (LNG) carriers, and mega-container ships. Korea’s shipbuilders are benefiting greatly from the surge in global trade, oil prices and energy demand, as well as strong demand for offshore oil facilities, machinery, and construction equipment.

5. The strong won appreciation is, however, having an impact on corporate profits. Profits at large companies—many of which are export-oriented—have remained at healthy, albeit reduced levels, as foreign exchange hedging and the shift of operations overseas as well as other cost-cutting measures have helped them mitigate the impact of the currency appreciation. However, Korean SMEs are coping with difficulty, partly due to increased competitive pressures from China and other low-wage countries and slow progress on some structural reforms. Some large Korean companies have pressured local SME suppliers to reduce prices, while other have switched to lower-cost foreign suppliers altogether. In response to heightened competition, some SMEs have either gone out of business or relocated all or part of their production facilities overseas. As a result, investment in the manufacturing sector has been modest and manufacturing employment has declined. In addition, SMEs have not been able to benefit fully from the country’s rapid technological advancement as R&D activities have been concentrated in a few large enterprises and in the manufacturing sector, notably in information and communication technology (ICT) and automobiles.³ Thus SMEs faced difficulties in upgrading their products and technologies to remain competitive. This is worrying because SMEs—which account for about one-half of manufacturing output, one-third of exports, and 90 percent of total employment—are an important source of jobs and spending for the economy.

6. In particular, the strengthening of the won vis-à-vis the Japanese yen is hurting Korea’s competitiveness in some sectors. The won has appreciated by 60 percent in real terms against the yen since end-2003, reaching a ten-year high recently. Partly as a result, Korea’s trade deficit with Japan has continued to widen, reflecting the won’s higher purchasing power as well as Korea’s strong dependence upon Japan for imports of high-tech capital goods as well as parts and materials for its manufactured products. Japan is Korea’s closest competitor in major export industries, including electronics and automobiles.⁴ Various measures of export competition in third markets, including the export similarity index and the index of trade competition, suggest that the degree of competition between Korea and Japan is the most intense and has increased significantly during the past two decades.⁵ Thus the won appreciation relative to the yen is squeezing profit margins of some Korean companies, notably automakers. For example, Korea’s export growth of passenger cars in unit terms decelerated sharply between 2004 and 2006, while that of Japan surged over the same period. The share of Japanese automobiles in the U.S. market rose from 29 percent in 2003 to 37 percent in 2007, while the share of Korean cars increased only slightly from 4 percent to 5 percent. Consequently, Korean automakers have recorded a fall in profit margin from 7 percent to 4½ percent since 2003, while profit margins at Japanese car companies have remained stable at about 5 percent.⁶

C. China: Trading Partner or Competitor?⁷

7. China has been a key factor driving Korea’s export growth during the past decade. Korea’s exports to and bilateral trade with China have increased by sixfold in value since 1998, reaching $70 billion and $120 billion in 2006, respectively. Through its booming economy and emergence as a regional production hub, China has become the most important destination for Korean exports, surpassing the United States in 2003 and accounting for one-fifth of total goods exports. Korea has its highest bilateral trade surplus with China, on the order of $20 billion on average during the past four years, exceeding even the surplus with the EU as a whole. At the same time, Korea’s imports from China are rising, particularly in intermediate goods and, as a result, Korea’s trade surplus with China began to narrow in 2006.

8. Korea’s trade with China has been driven by the expansion of production networks and the rapid growth of processing trade. The fragmentation of production processes, prompted by low input costs and high labor productivity in China, has led to the development of production networks in Asia. This is reflected in the rise in China’s role in Korea’s trade in parts and components since the early 1990s. According to Kim and others (2006), China’s share in Korea’s total parts exports increased sharply from 1 percent in 1992 to 27 percent in 2004, notably in the electronics sector, replacing the United States as the major export market for parts.⁸ The share of China in Korea’s total parts imports also rose significantly from ½ percent to 12 percent, with Korea importing less from Japan and the United States. Similarly, Korea’s share of parts imports by China grew from 2 percent to 12 percent over the same period. These highlight the role of China as a major assembler of parts and components into final goods as well as the strengthening of production linkages between China and Korea. Kim and Park (2006) note that on the whole China has thus far had a positive impact on Korean exports, due to the surge in China’s processing trade and Korea’s direct investment in China, both of which increased the demand for parts and materials from Korea.

9. But China is also posing challenges for Korea. On the domestic front, Korean firms are facing stiffer competition at home from the sustained rapid growth of low-price Chinese imports, for both raw materials and consumer goods. At the same time, China has also become a key competitor in the global markets, by catching up with other countries in terms of product technology, while offering lower prices for its goods. Over the last decade, China’s rapid export expansion has displaced Korea’s exports in major markets, notably in the United States and Japan. Korea’s share in the U.S. market dropped slightly from 3 percent in 1996 to 2½ percent in 2006, while China’s share rose from 7 percent to 16 percent over the same period. Similarly, Korea’s market share in Japan remained at around 4½ percent during this period, although China’s share doubled to 21 percent. Kim and others (2006) find that China’s displacement of Korean exports in Japan and the United States between 1992 and 2004 occurred mostly in the low-tech and medium-low tech industries.⁹ Nevertheless, Korea has been able to raise its market share in the high-tech and medium-high tech industries in the world’s major markets, even as China was also increasing its own market shares in these industries. This more than offset the loss of Korea’s export market share to China in the low-tech and medium-low tech sectors in world markets.

10. China is quickly moving up the value chain in many sectors. China’s export structure more closely resembles that of Korea today than it did a decade ago, with electronics comprising nearly 40 percent of total exports. Over the last decade, the share of China’s IT exports in the world market has risen by more than fivefold. While a majority of high-tech products are still manufactured by foreign companies operating in China and the most sophisticated parts and components continue to be imported, China has made considerable effort in moving up the product ladder.¹⁰ This has been aided by the strengthening of R&D by major multinationals in China’s IT sector, especially consumer electronics. In a study by Samsung Economic Research Institute (2007), the number of overlapping exports among the top 100 items of Korea and China rose from 21 in 1995 to 29 in 2005, with half of these belonging in the medium-tech category and the rest in the high-tech category. In addition, the export similarity index indicates that China is beginning to compete with Korea in similar export products, particularly during the past decade.¹¹ Kang (2007) also shows that while Korea’s manufacturing exports remain more sophisticated than those of China’s, the gap between the levels of sophistication (proxied by relative export prices) of the two countries has narrowed sharply since 2001.¹² Moreover, Kim (2007) reports that China has already surpassed Korea in industrial competitiveness (based on price, quality, production, organization, and labor skills) in clothing and MP3 players, and is catching up rapidly in telecom equipment, digital TVs, and steel. However, Korea remains far ahead of China in the areas of auto parts, shipbuilding and petrochemicals.

11. The shipbuilding industry in China is emerging rapidly. According to Lim (2007), Chinese shipbuilders have now reached the world’s top position in terms of new orders, which have accelerated in the past two years, with the strong support of the government. China has 31 shipbuilding companies among the world’s top 100, compared with Japan’s 30 and Korea’s 15. Nevertheless, Korea is still ahead of China in key areas such as the production of high value-added ships. More than one-half of new orders at Chinese shipyards in 2007 were for low value-added bulk carriers, whereas orders placed in Korea were mostly for high-end LNG carriers and container ships. China also trails behind Korea when it comes to the level of productivity, technology, and domestic content of ships. For example, China produces only 40 percent of required inputs for its ships domestically, compared with Korea’s domestic content of 90 percent.

12. China’s level of export sophistication in the IT sector has increased markedly, but mainly at the lower end.¹³ While the expansion of IT exports over the past decade is evident across the entire technology spectrum, most of the increase has been concentrated at the lower end. Japan has lost market share across all groups, presumably to China and other low-cost countries where production has been outsourced. At the same time, Korea has managed to move up the value chain by raising its share of medium- to high-end IT products in world markets, although not at the highest end. As mentioned above, one plausible reason could be that Korean companies in China are producing and exporting these types of products, which along with other foreign companies has helped to lift China’s export share at the higher end groups. These observations are consistent with the “flying geese” model, where innovation and the transfer of technology through production networks enable developing economies to catch up with more advanced ones.¹⁴

13. China has also become more self-reliant, importing less from Korea. Korea’s export growth to China has dropped dramatically since 2003. The slowdown in exports to China has been particularly severe for intermediate goods, and to a lesser extent for capital goods, reflecting China’s increasing production capacity and ability to produce these goods domestically.¹⁵ Within intermediate goods, the slowdown has been mainly in the low-tech categories such as home electrical appliances and office and communication, while exports of automobile parts have held up well. In terms of sectors, Korea’s exports of electronics to China have taken the biggest hit in the last few years, while exports of electrical machinery and manufactured goods (mostly iron and steel) have become stagnant more recently. But this is not a phenomenon unique to Korea. Indeed, China’s total import growth has slowed in recent years, with the largest contribution to the slowdown coming from intermediate goods. These observations are not surprising, given that China has invested heavily in the production of steel and chemicals and has also benefited from substantial inflows of foreign direct investment in the electronics sector, both of which have enabled it produce domestically most of its raw materials as well as some intermediate goods in the more advanced sectors.¹⁶

14. Korea’s substantial investment in China had initially boosted its exports. Korean companies have been establishing a manufacturing base in China, to take advantage of its low production costs and to gain access to the rapidly expanding domestic consumer market, supported by China’s openness to foreign investment.¹⁷ Korea’s direct investment in China has increased rapidly over the past several years, with FDI amounting to $10 billion during 2002-06. Since 2002, China has replaced the United States as Korea’s largest destination for overseas investment, accounting for 45 percent of Korea’s total outward FDI on average, more than twice the share in the 1990s. The setting up of Korean overseas affiliates, including through joint ventures with domestic Chinese firms, and the ensuing flows of FDI to China have fostered the transfer of technology and created a platform for the production of goods, mostly in the manufacturing sector.¹⁸ These goods are sold domestically, exported back to Korea (i.e., reverse imports), or exported to third markets, the last of these bypassing some of Korea’s direct trade with these countries. The initial stage of the investment cycle involved significant intra-firm trade, whereby parent firms supplied parts and components to their overseas affiliates for final assembly. This led to an increase in Korea’s exports of intermediate goods to China.

15. But China’s improved production capabilities may be contributing to Korea’s recent export slowdown. As Chinese firms have become more technologically advanced and domestic supply chains have been developed, Korea’s overseas affiliates in China have been able to partially substitute domestically produced intermediate inputs for similar imports from Korea.¹⁹ A survey of affiliates of Korean manufacturing companies in China, covering both large firms and SMEs, conducted jointly by Korea Institute for Industrial Economics and Trade and Ministry of Commerce, Industry and Energy, indicated that the share of local procurement of parts and components rose from 27 percent in 1996 to 46 percent in 2003, while the share of parts and components imported from Korea in total procurement fell from 65 percent to 37 percent, notably in electronics and telecom equipment where Korea’s FDI in China has been concentrated.²⁰ The survey also revealed that the share of domestic sales in total sales of overseas affiliates increased from 23 percent in 1996 to 34 percent in 2003, signaling the rise in the spending power of China’s emerging middle class, which represents a substantial opportunity for Korean exporters.²¹ Meanwhile, the share of reverse imports dropped from 26 percent to 18 percent, which seems to suggest that Korean firms have increasingly moved the final assembly stages of production to China, rather than sending goods back to Korea for the “finishing touches”. Finally, although on the whole the share of manufacturing exports to third markets by Korean firms in China remained unchanged at around 50 percent, exports of machinery and equipment and electronics and telecom equipment to third markets increased substantially, an indication that the rise of China as a major production and export platform has indirectly contributed to the growth of Korea’s high value-added industries.

D. Policy Implications

16. Looking ahead, Korea will face a number of challenges to its external competitiveness. Korea has been successful in moving rapidly up the value-added chain and staying ahead of the competition in many key export sectors, spurred by its high productivity in manufacturing, intensive investment in R&D and education, and its role as a major supplier of intermediate goods in the regional production network. But a declining labor force, low service sector productivity, and increasing competition from low-cost countries are putting pressure on Korea’s competitive position. The government recognizes these challenges and has taken some steps to address them. Nevertheless, more needs to be done to ensure that Korea maintains its competitiveness in the global marketplace.

17. To remain competitive, Korea should continue to move its manufacturing sector up the value chain. To achieve this, following OECD (2005) recommendations, the R&D framework could be improved to promote private sector R&D and greater diffusion of technology, especially to the lagging sectors of the economy. Specific policies include maintaining flexibility in setting priorities for R&D spending and avoiding concentration of R&D in a few targeted sectors; strengthening R&D linkages among businesses, universities, and the government; upgrading the R&D role of universities; promoting international technological collaboration, in part through FDI; and improving the quality of human capital, including by restructuring the education system, especially at the tertiary level.

18. A more conducive business environment would help attract foreign investment. FDI inflows to Korea have been low compared to those of other OECD countries, totaling just $34 billion (1 percent of GDP on average) over the period 2000-05. Moreover, the share of the service sector in the stock of inward FDI is the lowest in the OECD at 27 percent (OECD, 2007). Korea ranks 14^th among OECD countries in terms of inward FDI potential, but ranks 24^th in terms of FDI performance, which compares actual inflows relative to economic size. Creating better business conditions, including through a less complex and more transparent regulatory framework and a more flexible labor market, would help encourage domestic and foreign investment, which would not only increase innovation through greater competition and the transfer of technology and management skills, but also generate more and better jobs.

19. Korea also needs to raise its services productivity. The Korean economy is shifting further from manufacturing toward services, and this trend is expected to continue as has been witnessed in other advanced countries. Boosting productivity in the service sector is therefore essential to ensure a smooth transition and sustain growth. Key steps include opening and deregulating the service sector, improving access to market financing for small and knowledge-based enterprises, and easing the burden imposed on those using bankruptcy laws. The government is taking a piecemeal approach by targeting specific sectors, such as the elimination of the value-added tax for hotels and the provision of tax and other financial incentives to promote the development of golf and maritime leisure facilities. These measures could introduce market distortions and erode the tax base. More comprehensive reforms to relax product market regulations and open the service sector—including in the knowledge-based industries such as legal and accounting services—to competition would be a better policy option. In addition, the government is pursuing free trade agreements as an impetus to deregulate the service sector, including with the United States and the European Union. However, the recently signed FTA between Korea and the United States excludes the education and health sectors, where competition is still limited and where strong demand for healthcare services is envisaged given Korea’s rapid population aging.

20. Efforts to enhance labor market flexibility and upgrade the safety net should be strengthened. Policies should be aimed at reducing employment protection of regular workers while expanding and strengthening the social safety net. A new labor law, intended to provide job security for nonregular workers, recently came into force. Effectively, workers who have been employed by a firm for more than two years will be granted the status of regular workers. However, this raises the cost of hiring nonregular workers, who are likely to face higher job turnover as firms allow their contracts to expire, and provides less incentive for firms to invest in the upgrading of skills. While this law will help reduce the duality in the labor market, it needs to be complemented with measures to increase employment flexibility for regular workers. In this regard, dismissal conditions for regular workers have been eased, for example through shorter consultation periods, but severance costs remain high. Most workers are eligible for unemployment benefits, but actual coverage remains low due to weak compliance.

E. Conclusion

21. Korea has been able to maintain its competitive edge in the global economy and stands to benefit from further structural reforms. The exchange rate has appreciated steadily in recent years, but overall export performance has remained strong. At the same time, Korea is facing increasing competition from Japan and China and other low-cost countries, while a shrinking labor force and stagnant service sector productivity threaten to limit its potential growth. To cope with these challenges and achieve sustainable growth over the long term, Korea will need to continue to bolster its competitiveness by moving its manufacturing sector further up the value chain and accelerating reforms aimed at improving the investment climate, opening and deregulating the service sector, and enhancing labor market flexibility.

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Prepared by Varapat Chensavasdijai.

The Herfindahl index is derived from the sum of squares of the share of a commodity in a country’s total exports, across all industry subgroups. The index ranges from 0 to 1 and a higher value indicates that the country is more specialized in the production of a few goods.

According to the OECD (2005), the ICT and automobile sectors accounted for 60 percent of business R&D expenditures in Korea in 2003, with the top five companies in these two industries accounting for 37 percent of total business R&D. In contrast, the service sector only made up 13 percent of business R&D.

Kang (2007) finds that the gap between the levels of sophistication of manufacturing exports for Korea and Japan has remained relatively unchanged (with the ratio of Korea-Japan export prices below one) since the mid-1990s, which means that Korea still lags Japan in the level of technological progress.

The export similarity index measures the extent to which two countries compete by exporting the same products in world markets and is derived from the cosine of the vectors of the shares of each commodity in total exports for Korea against its trading partner, calculated using Standard International Trade Classification (SITC) 3 -digit trade data. The index ranges from 0 to 1 and a higher value denotes that the composition of exports between the countries is more similar. The index of trade competition, another variant of the export similarity index, between Korea and Japan rose from 0.42 in 1985 to 0.64 in 2005, while that between Korea and China increased from 0.41 to 0.48 during the same period. See Cerra and others (2005) for details of the index.

Profitability is measured by the ratio of ordinary income to sales for Korea (Financial Statement Analysis, Bank of Korea) and the ratio of operating profits to sales for Japan (Business Accounts of Corporations, Ministry of Public Management, Home Affairs, Posts and Telecommunications).

The author is grateful to Murtaza Syed and Masahiro Hori for providing data for the analysis in this section.

Estimates of the share of parts and components in Korea’s total exports to China range from 50 percent (Kim and Park, 2006) to 70 percent (Ahmed and others, 2007). In China’s manufacturing sector, parts and components account for 30 percent of total exports and 40 percent of total imports in 2005 (Ahmed and others, 2007).

Kim and others (2006) follow the OECD classification of technology groups (low, medium-low, medium-high, and high) based on the International Standard Industrial Classification (ISIC).

SERI (2007) finds that foreign firms contributed around 80 percent of China’s high-tech exports in 2005. Kim and Park (2006) also note that in 2005, 13 of the 100 largest exporters in China were Korean, constituting 9 percent of total exports. Fifty-nine enterprises were foreign, accounting for 55 percent of total exports.

Schott’s (2007) version of the export similarity index indicates that China’s manufacturing exports have become more similar with those of the OECD as a whole, although prices of Chinese exports remain below those in the OECD, which suggests that they are of lower quality.

Using a weighted index of per capita GDP associated with a country’s exports to measure the level of sophistication, Rodrik (2006) also reaches a similar conclusion.

Using SITC 5-digit trade data, the definition of IT products comprises a total of 129 goods within categories 75, 76, 771, 772, 773, and 776. The ordering of each product by level of technology is based on the weighted average of per capita GDP of the countries that export this product, where the weights are determined by the country’s share of world exports of the product.

See Hiratsuka (2005) for an application of the flying geese model in manufacturing in East Asia, with Japan identified as a frontrunner in the product cycle, followed by the NIEs (Hong Kong SAR, Korea, Singapore, and Taiwan Province of China), and finally China and four ASEAN countries (Indonesia, Malaysia, Philippines, and Thailand).

Cui and Syed (2007), find that the domestic content of China’s exports has increased. This is supported by the observation that the domestic production capacity of a number of raw materials has risen sharply, while exports of final goods have grown faster than their associated imported components, especially for low-tech products.

Cui and Syed (2007) assess that while the sophistication levels of China’s electronics exports and imports have increased over time, imports continue to have higher levels of sophistication than exports and the gap between the two remains significant. This suggests that China still relies on imports of high-tech intermediate inputs for the production of its more sophisticated final goods.

Kim and others (2006) note that according to a survey of 706 Korean manufacturing companies conducted in 2003 by Korea Institute for Industrial Economics and Trade (KIET) and Ministry of Commerce, Industry and Energy (MOCIE), 43 percent of firms cited low labor costs as the primary factor for investing in China, while 33 percent pointed to market access.

Data from the Export-Import Bank of Korea indicates that 80 percent of Korea’s FDI in China takes place in the manufacturing sector, with the rest in services and construction. Within manufacturing, the electronics and telecom equipment industries account for the biggest share of the total stock of Korea’s FDI in China at 27 percent, followed by transport equipment (13 percent), petroleum and chemicals (11 percent), and textiles and apparel (11 percent). Kim and Mah (2006) also point out that there has been a shift in Korea’s FDI from consumption goods (such as textiles, leather and footwear) to capital goods in China’s manufacturing sector since the 1990s.

Indeed, Chinese firms have also been able to increase their parts exports as a share of total exports from 13 percent in 2000 to 17 percent in 2005 (Samsung Economic Research Institute, 2007).

According to Kim and others (2006) in the electronics and telecom equipment sector, the share of local procurement by Korean affiliates increased from 14 percent in 1996 to 57 percent in 2003, while imports from Korea fell from 86 percent to 36 percent. It is not possible to ascertain from the survey whether Korean firms operating in China are procuring locally from other Korean affiliates, in which case earnings remain within the corporate group and may be repatriated back to Korea, or from Chinese firms, some of which could also still be importing intermediate goods from Korea.

The share of domestic sales in total sales may be biased upward since the firms surveyed also include Korean suppliers selling intermediate goods to other Korean affiliates in China and do not represent exclusively the Chinese local market.

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