Development & Productivity Catch-up: Korean Model of Development & Productivity Catch-up: From Capability-building to Double Upgrading Keun LEE Professor of Economics / Seoul National University Director / Center for Economic Catch-up Member / Committee for Development Policy, UN-ECOSOC President / Int’l Schumpeter Society Council Member, World Economic Forum

Korea was similar to a typical Country in Africa: A former Colony Had a Civil War Poverty and Hunger (US food aid) *Worse: Division into North & South No mineral resources (all in North) ->Need for Human & Capability based growth with learning & building capabilities as its key element

= Closing the gap with the bench marks What is catch-up? from “Catching up, forging ahead, and falling behind” (Abramovitz, 1986 JEH) = Closing the gap with the bench marks 1) national level: per capita income, share in world GDP, 2) firm-level: market share, sales growth, productivity

Korea’s Catch-up beyond Middle income trap: Per cap GDP as % of Japan, Korea = 27% in 1960; 96% in 2015

as the essence of the Korean Model thus able to sustain growth Capability Building as the essence of the Korean Model thus able to sustain growth for a longer time

From State-Market dichotomy to 2 kinds of capability building Traditional focus: government vs. markets Dichotomy Our focus= capability-based view on Korea → fundamental barriers to sustained development **Two steps of Building Capabilities: 1st: 1960s, 70s: enhancing basic human capabilities: food supply (agricultural revolution) & primary/secondary education revolution 2nd: building technological capabilities of indigenous firms in 70’ 80s and then upgraded into high ends since the late 1980s

Learning by importing foreign technology in 70s, 80s Korean firms, investing in learning foreign technology; --- mainly operational technology through purchase of capital goods or reverse engineering (L. Kim 1997). Government policies, to stimulate the importation of foreign technology. --- There were laws on capital goods imports, foreign loans and technology imports, including the Foreign Capital Inducement Act (1966). -- In 1972, the Technology Development Act was introduced to stimulate technology imports; -- In 1973, the Foreign Capital Inducement Act was revised to relax the approval criteria and facilitate technology import procedures (OECD 1996).

Foreign Technology Licensing followed by In-house R&D (Chung and Lee 2015 World Dev’t)

Then, Critical Juncture for Upgrading: the mid to late 1980s Korean firms started to establish in-house R&D and emphasize their own indigenous technologies, given their price competitiveness being challenged by next-tier exporters and rising domestic wages; 1) surpassed R&D/GDP ratio 1%, → share of private R&D 50% 2) beginning of rapid rise of firm patents > indiv. Patents 3) first time (post-war) had trade surplus in the late 80s.

The Mid-80s : R&D/GDP soared

Accumulated no.of in-house R&D centers tax exemption by Govt) 3 (1967) → 14 (1976) → 261 (1986) → 1162 (1992)

Why Soaring of R&D since mid 80s? Big business: Competitiveness crisis with rising wages -> need to upgrade and enter into higher end segments and industries 2) Gov’t responded : tax exemption for R&D ; encouraged in-house R&D labs 3) series of private-public joint R&D to enter into high ends - telephone switches, memory chips, cell phones & digital TVs → cash cows of Korea → Now, how it is done? → G-P-G model

G-P-G: Cell Phones, Memory Chips, Digital TV (more role in R&D by private) G (gov’t agents): Joint R&D by Private & Public labs G (gov’t policy): Exclusive Stands or Procurement P (private firm): Manufacturing

Increased Tech. capabilities => Double upgrading/Diversification => Productivity Catch-up with Japan intra-sector upgrading and diversification = Continuous upgrading into higher value-added segments in the same industry 2) Inter-sector upgrading and diversification = moving into newly emerging higher value-added industries. → Gov’t facilitated upgrading by targeting and entry control (for initial rents & long term investment)

Upgrading in the same industry: Value Chain in Semiconductor Sector IC Fabrication Materials Equipment IC Wafer IC Design IC Mask IC Testing IC Packaging Value-added chain High value-added Low value-added Medium- V-added

Composition of Major Export Items in Korea, (% in total Exports): by inter-sector diversification

Successive Entries: from textiles to ITs Composition of sales Changes in Samsung Source : Chang (2003), Notes: numbers are share percentages in sales

Korea’s TFP (productivity) Catch-up with Japan Rapid catch-up (about 30%) Gap (about 10%) Note : Note TFP level of all Japanese listed firms in each year is set to be 100. We can regard the difference as % gap of TFP between two countries. 18

Convergence in IT = fast catch-up: ex) Samsung vs. Matsushita Sam. Elect.: OVER While Industry : JUST 19

But slow catch-up in auto, why. : eg: Hyundai vs But slow catch-up in auto, why?: eg: Hyundai vs. Toyota; cf) slower in machine tools H.M. : 20

1) Not all sectors are the same! What determined TFP catchup? both sector - and firm-level factors (Jung and Lee 2009 in Industrial & corporate change) Codifiable (non-tacit knowledge (+) Embodied tech. transfer(+) Oligopoly market (+) 1) Not all sectors are the same! Eg) Auto with tacit knowledge takes more time to catch up Predict the direction of Structural transformation!! 2) Oligopoly Rents + int’l market discipline worked to TFP growth Sectoral factors (Malerba 2002, 2004) Firm level learning & capability External discipline (export-orient) (+) Efficiency wage(+) Innovation (R&D, patents(+)

Innovation systems at 3 Levels: country; Sector; firm → 2014 Schumpeter Prize

Korea’s Dynamic Specialization: LIC->MIC->HIC In 1960s, 70s (LIC) = latent comparative advantage sectors (bench marking Japan) 1st in the mid 80s: to short cycle sectors in MIC 2nd in the 2000s: to long cycle sectors in HIC; ex. Samsung 2 Tech. turning point Short cycle sectors Lin’s Latent Com Advant. Long cycles

Lesson for LICs/African Countries 1 Building different capabilities at different stages ( something uncertain & not available in markets) 1) Early stage (initial conditions); build human capabilities by investing into health, food, & education 2) Lower & lower middle income stages: To build operational skills / production technologies in indigenous firms in factor (labor/resource)-intensive sectors by licensing in foreign technology with know-how contracts 3) upper mid income stage: build up innovation capabilities by involving various forms of learning (private-public, domestic-foreign R&D, inviting foreign trained engineers, setting up overseas R&D posts) - to break into higher-end segment of value chains ( to avoid Mid I trap)

2. Rents as incentive & source of funds for long term investment Lesson 2 2. Rents as incentive & source of funds for long term investment but with discipline from export markets 1) Earlier stage ( 60’, 70s, ); - Focus on labor intensive export growth by fixed investment, ‘disciplined’ rents from tariffs/loans as sources for fixed capital investment -> labor productivity growth but no TFP growth 2) later stages (since mid 80s) : - exports now led by product upgrading /innovation: - now TFP growth led by R&D investment - rents from oligopoly domestic markets subject to world market discipline 3) Both stage: Exporting to generate dollars to pay for imported capital goods; without some forms of assurance (rents or expected profits), difficult to induce long term investment, without which no long term survival & no TFP catchup.

Lesson 3: Not all sectors same in str. transformation! Faster TFP catch up in sectors with higher degree of embodied tech., and codifiable and short cycle knowledge 3. Dynamic Specialization for faster structural Changes over stages: 1) at low income stages (60s, 70s): specializes in factor-intensity (labor or resources) sectors with gov’t promotion (undervaluation/tariffs/ loans) to increase not TFP but RCA (export shares) 2) at lower middle income stage (mid 70s) to move into capital-intensive (latent comparative advantage) sectors inheriting sectors from the country above you (eg, Japan) 3) at upper middle stages ( mid 80s later) to move into emerging or short-cycle, codifiable tech based sectors, such as IT manuf. & services, To increase TFP and value-added

Three Specific Comments for Uganda

1) Issue of Trade deficits and Macro Constraint Korea also had 3 decades of trade deficits, until 1986 In the 1960s: huge saving gap: savings =9% of GDP, gross investment 15% of GDP; thus relied on foreign borrowing to fill the gap and that is why exports is important and binding factor for growth Central control on foreign exchanges : export earnings allocated for investment of foreign capital goods Try to minimize imports of non-necessaries such as luxury consumer goods, and even some foreign fruits (eg Banana ) Capital Control: esp on outbound flow of money, unless justified for imports of capital goods. Control over domestic interest rates: financial repression vs. financial restraints (Stiglitz): -> controlled interest rates OK as long as real rates are positive; -> more savings not from high int rates but from growth of incomes

2) Issue of Unregulation and supporting institutions Unregulated input supply that fails to enforce quality; unregulated trading in tea; market with counterfeit inputs Korean practices: Regulation of entry control in key sectors; only those who passed some standard (quality control) to be allowed to do business in certain sectors: => A kind of industrial policy : by limiting the no of firms, those in the sectors to be assured stable profits and thus with money for investment; return rates higher than interest rates eg) 5 firms with profits better than 10 firms with no profits Some institutional devices for export promotion: 1) General trading companies to conduct exports on behalf of SMEs 2) KOTRA (Korea Trade-Investment Promotion Agency) = trade attachees all over the world like an embassy

3) Issue of Low value-addition in exports: Korea: Double upgrading = intra and inter- sectoral First, unlocking production potentials is good but the next step is upgrading for higher-values Otherwise, into the ‘Adding-up’ problems in Africa: neighboring countries exporting the same things, flooding the market, which lead to ever lower prices of the goods. Examples: Coffees/Flower in many African countries Solution: Differentiation and Upgrading a) Coffee: from crude coffee to more processed coffee from crude oil to refined oils (eg: Korea) b) Make Flower/Coffee Higher value-added using STI eg) Make flower insects/disease free; last longer with specific flavour/smells c) Enter into distribution/marketing and also brands; rather than just production -> promote your own brand: like “Intel inside”

Functional Upgrading in a given sector into higher value segments: 3 Stages: OEM – ODM – OBM : Assembly/ Production Design (R&D) Marketing OEM (own equipment) ODM (own design) OBM (own brand) Examples: Apparel; sweat shops Foxxcon for Apple; Some Korean SMEs  Often not easy or quite difficult; Many stuck in OEM Trap (low end good production)

with 1992 the year of own brand marketing Trends of Sales by Aurora World after trying OBM (only one OBM out of 700 OEM in Korea) with 1992 the year of own brand marketing showing “U” shaped OEM trap over 1991-97: Why crisis-> attack by MNCS to cut the orders Crisis/ trap

Extension and upgrading into backward or forward linkage sectors Another Upgrading Mode: from the Resource-Curse of the resource-based industries Extension and upgrading into backward or forward linkage sectors Input suppliers (backward linkages) and Commodity processors (forward linkages). Examples in Botswana: Diamond cutting and Polishing In 2005: De Beers‟ 25 year mining license was due for renewal; => a Big deal: De Beers to to create a cutting and polishing industry. (De Beers used to say: Botswana had no comparative advantage vs. India) * World's leading cutting and polishing companies (16 in total) established factories in Botswana; to transfer cutting and polishing skills to local citizens.

‘Thank you” and References (www.keunlee.com) Lee, Keun, & BY Kim,”Both Institutions & Policies matter but differently at different income levels: long run economic growth,: World Development (2009) Chung, Moon Young and Keun Lee, "How Absorptive Capacity is Formed in a Latecomer Economy: Different Roles of Foreign Patent and Know-how Licensing in Korea", World Development Vol. 66, pp. 678–694, 2015 Jung, Moosup and Keun Lee 2010. ‘Sectoral systems of innovation and productivity catch-up: determinants of the productivity gap between Korean and Japanese firms’, Industrial and Corporate Change 19 (4): 1037–69. Lee, Keun, & C. Lim (2001), “Technological Regimes, Catching-up & Leapfrogging: the Findings from the Korean Industries”, Research Policy, 459-483. Park, K., and Keun Lee (2006), “Linking the Technological Regime to Technological Catch-up: An Empirical Analysis Using the US Patent Data,” Industrial and Corporate Change, July 2006 Shin, H. and K. Lee (2012). ‘Asymmetric Protection Leading not to Productivity but Export Share Changes: The Case of Korean Industries, 1967-1993’. Economics of Transition, 20(4): 745-85.

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