ASIA KLEMS HSI 2017 July 31 Tokyo, Japan Estimates of Total Factor Productivity and Ex-post Rates of Return by Industries in Korea (1980-2014) Hak K. Pyo, Hyunbae Chun and Keun Hee Rhee* Hak K. Pyo, Hyunbae Chun and Keun Hee Rhee Estimates of Total Factor Productivity and Ex-post Rates of Return by Industries in Korea (1980-2014)

Part 1: Sources of productivity growth in Korea Introduction Part 1: Sources of productivity growth in Korea We examine the sources of aggregate productivity growth in Korea for the period of 1996-2014 using Korea Industrial Productivity (KIP) database The sources of productivity growth have shifted (1) from capital deepening to TFP growth (TFP-led growth) and (2) from manufacturing to non-manufacturing (industrial transformation) Hak K. Pyo, Hyunbae Chun and Keun Hee Rhee Estimates of Total Factor Productivity and Ex-post Rates of Return by Industries in Korea (1980-2014)

Part 2: Rate of returns estimates Introduction Part 2: Rate of returns estimates We also estimate the ex-post rates of return by industries and compare it with ex-ante rate of return such as corporate bond rate. Both estimates of rates of return have co-moved together since early 1980s and have shown a distinctive downward trend as the Korean economy moves from higher-growth regime to lower-growth regime due to industrial maturity and aging following up the Japanese experience of two lost decades. Hak K. Pyo, Hyunbae Chun and Keun Hee Rhee Estimates of Total Factor Productivity and Ex-post Rates of Return by Industries in Korea (1980-2014)

Part 1: Sources of Growth in Korea Slowdown in real GDP growth rate since the mid-1990s 1981-1995: 9.4%, 1996-2005, 5.2%, 2006-2016: 3.5% Industrial transformation GDP share of manufacturing has little changed since the 1990s, while GDP share of service has steadily increased until the mid-2000s. Hak K. Pyo, Hyunbae Chun and Keun Hee Rhee Estimates of Total Factor Productivity and Ex-post Rates of Return by Industries in Korea (1980-2014)

Slowdown in Economic Growth: Real GDP Growth Rate, 1981-2016 1981-1995: 9.4%, 1996-2005, 5.2%, 2006-2016: 3.5% Hak K. Pyo, Hyunbae Chun and Keun Hee Rhee Estimates of Total Factor Productivity and Ex-post Rates of Return by Industries in Korea (1980-2014)

Sectoral Transformation of the Korean Economy Hak K. Pyo, Hyunbae Chun and Keun Hee Rhee Estimates of Total Factor Productivity and Ex-post Rates of Return by Industries in Korea (1980-2014)

Changing Industrial Sources of Productivity Growth Following Stiroh (2002), we decompose aggregate (value-added) labor productivity (ALP) growth into The sum of industry value-added LP growth The sum of industry gross output productivity growth and material reallocation (OR) Capital deepening, labor quality and TFP growth Hours (labor) reallocation (toward more productive industries) Hak K. Pyo, Hyunbae Chun and Keun Hee Rhee Estimates of Total Factor Productivity and Ex-post Rates of Return by Industries in Korea (1980-2014)

Korea Industrial Productivity (KIP) DB 38 Industries (2 Agr-Min; 19 Mfg; 3 Utl-Con, 14 Ser) Period: 1996-2014 2008 SNA and ISIC Rev. 4 Note: ASIA KLEMS 30 industries (ISIC Rev. 3) Period: 1980-2010(4) Countries: India, Japan, Korea, Taiwan Hak K. Pyo, Hyunbae Chun and Keun Hee Rhee Estimates of Total Factor Productivity and Ex-post Rates of Return by Industries in Korea (1980-2014)

ALP Decomposition Using Industry Gross Output Productivity ALP growth decomposition Real value-added (Y), labor hours (H), gross output (G), materials (M), industry VA and material weights (w, m), industry(i) The first term: The direct productivity effect The sum of industry gross output productivity Hak K. Pyo, Hyunbae Chun and Keun Hee Rhee Estimates of Total Factor Productivity and Ex-post Rates of Return by Industries in Korea (1980-2014)

ALP Decomposition Using Industry Gross Output Productivity The second term: The material reallocation effect (RM) RM has a negative effect on ALP if more intermediate input (M) raises gross output (G) The third term: Hours reallocation (RH) ALP rises if industries with VA shares above labor shares experiences growth in hours In Korea, ALP falls because MFG industries (VA shares with VA shares above labor shares) reduce hours Hak K. Pyo, Hyunbae Chun and Keun Hee Rhee Estimates of Total Factor Productivity and Ex-post Rates of Return by Industries in Korea (1980-2014)

ALP Decomposition Using Industry Gross Output Productivity 1996-2014 (A) 1996-2005 (B) 2006-2014 (B) – (A) Aggregate labor productivity growth (value-added) = (1) + (2) +(3) 4.3 4.9 3.6 -1.3 Decomposition using industry gross output productivity (1) Weighted ALP (gross output) 4.4 4.6 4.2 -0.4 (1A) Manufacturing 2.2 2.7 1.6 -1.0 (1B) Non-manufacturing 1.9 2.5 0.6 (2) Material reallocation (-RM) -0.7 -0.8 -0.6 0.2 (3) Hours reallocation (RH) 1.2 0.1 -1.1 Hak K. Pyo, Hyunbae Chun and Keun Hee Rhee Estimates of Total Factor Productivity and Ex-post Rates of Return by Industries in Korea (1980-2014)

ALP Decomposition Using Industry Gross Output Productivity Hak K. Pyo, Hyunbae Chun and Keun Hee Rhee Estimates of Total Factor Productivity and Ex-post Rates of Return by Industries in Korea (1980-2014)

Findings ALP growth slowdown (-1.3%) from 1996-2005 to 2006-2014 is attributable to Slowdown in MFG industry GO productivity (-1.0%) and worsened hours reallocation (-1.1%) BUT, both NMFG industry GO productivity (0.6%) and material reallocation (0.2%) raise ALP Hak K. Pyo, Hyunbae Chun and Keun Hee Rhee Estimates of Total Factor Productivity and Ex-post Rates of Return by Industries in Korea (1980-2014)

ALP Decomposition Using Industry Value-added Productivity ALP growth decomposition The first term: the sum of industry VA productivity The second term: hours reallocation Further decomposition of Industry VA LP growth Capital deepening, labor quality, and TFP growth Two groups of industries: MFG & NMFG Hak K. Pyo, Hyunbae Chun and Keun Hee Rhee Estimates of Total Factor Productivity and Ex-post Rates of Return by Industries in Korea (1980-2014)

ALP Decomposition Using Industry Value-added Productivity 1996-2014 (A) 1996-2005 (B) 2006-2014 (B) – (A) Aggregate labor productivity growth (value-added) = (1) + (2) 4.3 4.9 3.6 -1.3 Decomposition using industry value-added productivity 3.7 3.8 -0.2 (1) Weighted ALP (value-added) (1A) ALP (VA) Manufacturing 1.9 2.3 1.5 -0.8 (1A1) capital deepening 1.3 1.6 0.9 -0.7 (1A2) labor quality 0.1 0.0 (1A3) TFP 0.5 -0.1 (1B) ALP (VA) Non-manufacturing 1.8 2.1 0.6 (1B1) capital deepening 1.4 (1B2) labor quality 0.2 0.3 (1B3) TFP (2) Hours reallocation (RH) 1.2 -1.1 Hak K. Pyo, Hyunbae Chun and Keun Hee Rhee Estimates of Total Factor Productivity and Ex-post Rates of Return by Industries in Korea (1980-2014)

ALP Decomposition Using Industry Value-added Productivity Hak K. Pyo, Hyunbae Chun and Keun Hee Rhee Estimates of Total Factor Productivity and Ex-post Rates of Return by Industries in Korea (1980-2014)

Industry VA LP Contributions to ALP, 1996-2005 vs. 2006-2014 Hak K. Pyo, Hyunbae Chun and Keun Hee Rhee Estimates of Total Factor Productivity and Ex-post Rates of Return by Industries in Korea (1980-2014)

Industry VA LP Contributions to ALP, 2006-2014 Hak K. Pyo, Hyunbae Chun and Keun Hee Rhee Estimates of Total Factor Productivity and Ex-post Rates of Return by Industries in Korea (1980-2014)

Findings ALP growth slowdown (-1.3%) from 1996-2005 to 2006-2014 is attributable to Fall in capital deepening in MFG (-0.7%) and Worsened hours reallocation (-1.1%) due to a sharp decrease in hours in MFG But, NMFG industry VA TFP (0.6%) raises ALP Little changes in MFG TFP Hak K. Pyo, Hyunbae Chun and Keun Hee Rhee Estimates of Total Factor Productivity and Ex-post Rates of Return by Industries in Korea (1980-2014)

Part 1. Summary Changing sources of productivity growth in Korea, 1996-2005 to 2006-2014 The sources of productivity growth have shifted from capital deepening to TFP growth (TFP-led growth), especially due to rise in TFP in non-manufacturing (industrial transformation) Moreover, ALP slowdown is attributable to (1) the worsened hours reallocation due to a rapid decrease in MFG hours as well as (2) a large fall in capital investments in MFG Hak K. Pyo, Hyunbae Chun and Keun Hee Rhee Estimates of Total Factor Productivity and Ex-post Rates of Return by Industries in Korea (1980-2014)

Part 2. Estimates of Ex-post Rates of Return to Capital by Industries There are two methods of estimating rates of return to capital. Following OECD Productivity Manual and EU KLEMS Manual we use the following formula for Ex-post Rates of Return. Hak K. Pyo, Hyunbae Chun and Keun Hee Rhee Estimates of Total Factor Productivity and Ex-post Rates of Return by Industries in Korea (1980-2014)

Estimation Formula of Ex-post Rates of Return by Industries in EU KLEMS Manual 𝑖 𝑗,𝑡 : ex-post rate of return to industry j’s capital at time t 𝑃 : price of capital or price of asset 𝛿 : depreciation 𝐾 𝑗,𝑡 : real capital stock of industry j at time t 𝐴 𝑘,𝑗,𝑡 : Kth real asset of industry j at time t Hak K. Pyo, Hyunbae Chun and Keun Hee Rhee Estimates of Total Factor Productivity and Ex-post Rates of Return by Industries in Korea (1980-2014)

Estimates of Ex-post Rates of Return to Capital: Korea (1981-2014) Primary Industry Secondary Industry Tertiary Industry Economy-wide 1981~1990 0.3696 0.4943 0.6081 0.4086 1991~2000 0.2797 0.1813 0.1764 0.1479 2001~2010 0.2609 0.0640 0.0790 0.0664 2011 0.2658 0.0470 0.0615 0.0511 2012 0.2196 0.0292 0.0332 0.0304 2013 0.2341 0.0012 0.0155 0.0085 2014 0.2488 -0.0099 0.0293 0.0119 Hak K. Pyo, Hyunbae Chun and Keun Hee Rhee Estimates of Total Factor Productivity and Ex-post Rates of Return by Industries in Korea (1980-2014)

Estimates of Ex-post Rates of Return to Capital: Korea (1981-2014) Hak K. Pyo, Hyunbae Chun and Keun Hee Rhee Estimates of Total Factor Productivity and Ex-post Rates of Return by Industries in Korea (1980-2014)

Comparative Profile of Economy-wide Ex-post Rates of Return and Ex-ante Rates* of Return to Capital: Korea (1987-2014) * 3-year Corporate Bond Rate (AA- rating) Hak K. Pyo, Hyunbae Chun and Keun Hee Rhee Estimates of Total Factor Productivity and Ex-post Rates of Return by Industries in Korea (1980-2014)

A Double-Koyck Type Acceleration Model of Investment by Industries 𝐾 : capital stock 𝑋 : output 𝑋 ∗ : desired output (1) (2) (3) Hak K. Pyo, Hyunbae Chun and Keun Hee Rhee Estimates of Total Factor Productivity and Ex-post Rates of Return by Industries in Korea (1980-2014)

A Double-Koyck Type Acceleration Model of Investment by Industries (4) (5) Hak K. Pyo, Hyunbae Chun and Keun Hee Rhee Estimates of Total Factor Productivity and Ex-post Rates of Return by Industries in Korea (1980-2014)

A Double-Koyck Type Acceleration Model of Investment by Industries (6) (7) (8) (9) Hak K. Pyo, Hyunbae Chun and Keun Hee Rhee Estimates of Total Factor Productivity and Ex-post Rates of Return by Industries in Korea (1980-2014)

A Double-Koyck Type Acceleration Model of Investment by Industries (10) (11) (12) (13) Hak K. Pyo, Hyunbae Chun and Keun Hee Rhee Estimates of Total Factor Productivity and Ex-post Rates of Return by Industries in Korea (1980-2014)

A Double-Koyck Type Acceleration Model of Investment by Industries (14) (15) (16) Hak K. Pyo, Hyunbae Chun and Keun Hee Rhee Estimates of Total Factor Productivity and Ex-post Rates of Return by Industries in Korea (1980-2014)

A Double-Koyck Type Acceleration Model of Investment by Industries (17) Hak K. Pyo, Hyunbae Chun and Keun Hee Rhee Estimates of Total Factor Productivity and Ex-post Rates of Return by Industries in Korea (1980-2014)

A Double-Koyck Type Acceleration Model of Investment by Industries (18) Hak K. Pyo, Hyunbae Chun and Keun Hee Rhee Estimates of Total Factor Productivity and Ex-post Rates of Return by Industries in Korea (1980-2014)

Estimation Results of Investment Functions with Real GDP and Investment 𝐼 𝑡 𝑗 𝐼 𝑡−1 𝐼 𝑡−2 𝐺𝐷𝑃 𝑡 𝑅 𝑡 𝑒𝑥𝑎𝑛𝑡𝑒 𝑅 2 Economy-wide 0.629743*** -0.18271 0.515764*** 0.825332* 0.972739 Primary 0.593074*** 0.041071 0.296149*** 1.950715 0.647721 Secondary 0.269725 -0.251295* 0.895729*** 0.651737 0.958927 Tertiary 0.995454*** -0.24128 0.225240*** 0.618589* 0.980208 𝑅 𝑡 𝑒𝑥𝑝𝑜𝑠𝑡 1.015200*** -0.425953*** 0.387177*** -0.087075*** 0.994358*** 0.684459*** 0.099944 0.187429** -0.1213 0.888842 0.578109*** -0.16355 0.538891*** -0.131869*** 0.985034 1.216427*** -0.472896*** 0.238366*** -0.028272** 0.995658 ● 𝑅 𝑡 𝑒𝑥𝑎𝑛𝑡𝑒 : 3-year Corporate Bond Rate (AA- rating) Hak K. Pyo, Hyunbae Chun and Keun Hee Rhee Estimates of Total Factor Productivity and Ex-post Rates of Return by Industries in Korea (1980-2014)

Estimation Results of Investment Functions with Nominal GDP and Investment 𝐼 𝑡 𝑗 𝐼 𝑡−1 𝐼 𝑡−2 𝐺𝐷𝑃 𝑡 𝑅 𝑡 𝑒𝑥𝑎𝑛𝑡𝑒 𝑅 2 Economy-wide 0.646296*** -0.312387** 0.621411*** 0.252564 0.993967 Primary 1.010074*** -0.38779 0.346005*** 0.580520* 0.995295 Secondary 0.452060** -0.273616* 0.753118*** -0.51791 0.983233 Tertiary -0.387788** 𝑅 𝑡 𝑒𝑥𝑝𝑜𝑠𝑡 0.864412*** -0.377962*** 0.480904*** -0.086513** 0.998492 0.549811*** 0.133348 0.267620*** -0.12694 0.97564 0.553575*** -0.17041 0.564905*** -0.122673*** 0.994865 1.096801*** -0.556601*** 0.424105*** -0.026089* 0.999001 ● 𝑅 𝑡 𝑒𝑥𝑎𝑛𝑡𝑒 : 3-year Corporate Bond Rate (AA- rating) Hak K. Pyo, Hyunbae Chun and Keun Hee Rhee Estimates of Total Factor Productivity and Ex-post Rates of Return by Industries in Korea (1980-2014)

Estimation Results of Investment Functions with Real GDP and Investment and Rates of Return Differential Variable 𝐼 𝑡 𝑗 𝐼 𝑡−1 𝐼 𝑡−2 𝐺𝐷𝑃 𝑡 𝑅 𝑡 𝑒𝑥𝑝𝑜𝑠𝑡 − 𝑅 𝑡 𝑒𝑥𝑎𝑛𝑡𝑒 𝑅 2 Economy-wide 0.900647*** 0.002817 0.093209 0.820542** 0.963453 Primary 0.667906*** 0.014427 0.304295** -1.761911* 0.614035 Secondary 0.263343 -0.131163 0.799757*** 0.516493** 0.928514 Tertiary 1.289021*** -0.340854** 0.049115 0.276949** 0.976167 ● 𝑅 𝑡 𝑒𝑥𝑎𝑛𝑡𝑒 : 3-year Corporate Bond Rate (AA- rating) Hak K. Pyo, Hyunbae Chun and Keun Hee Rhee Estimates of Total Factor Productivity and Ex-post Rates of Return by Industries in Korea (1980-2014)

Estimation Results of Investment Functions with Nominal GDP and Investment and Rates of Return Differential Variable 𝐼 𝑡 𝑗 𝐼 𝑡−1 𝐼 𝑡−2 𝐺𝐷𝑃 𝑡 𝑅 𝑡 𝑒𝑥𝑝𝑜𝑠𝑡 − 𝑅 𝑡 𝑒𝑥𝑎𝑛𝑡𝑒 𝑅 2 Economy-wide 1.019509*** -0.195395 0.168356 0.780156** 0.990000 Primary 0.299009 -0.082411 0.687466*** -1.919959** 0.795794 Secondary 0.396415** -0.176354 0.716806*** 0.363390 0.977533 Tertiary 1.447974*** -0.581310*** 0.124628 0.261757* 0.993051 ● 𝑅 𝑡 𝑒𝑥𝑎𝑛𝑡𝑒 : 3-year Corporate Bond Rate (AA- rating) Hak K. Pyo, Hyunbae Chun and Keun Hee Rhee Estimates of Total Factor Productivity and Ex-post Rates of Return by Industries in Korea (1980-2014)

Interpretations and Conclusion The rates of Return in both Manufacturing and Service industries declined significantly over time in three decades. This must have been main factor behind sluggish investment demand and lower growth rates. Our estimates of capital income does not include mixed income which is accrued to capital from proprietors’(self employed) income. Hak K. Pyo, Hyunbae Chun and Keun Hee Rhee Estimates of Total Factor Productivity and Ex-post Rates of Return by Industries in Korea (1980-2014)

Interpretations and Conclusion Therefore, our estimates of ex-post return to capital tend to overestimate true rates of return to capital because capital income includes proprietors’ implicit wages and salaries. It is particularly over-estimated in Primary and Tertiary sector where a large pool of self-employed exists. The Primary sector’s ex-post rates of return are higher than Secondary sector’s and Tertiary sectors because land is excluded from the coverage of capital. Hak K. Pyo, Hyunbae Chun and Keun Hee Rhee Estimates of Total Factor Productivity and Ex-post Rates of Return by Industries in Korea (1980-2014)

Interpretations and Conclusion The regression results of acceleration model of investment function based on double-Koyck adjustment specifications indicates that instead of either ex-post or ex-ante rate of return, the interest differential between the two has more explanatory power. It is found that GDP has a positive acceleration effect on investment. Hak K. Pyo, Hyunbae Chun and Keun Hee Rhee Estimates of Total Factor Productivity and Ex-post Rates of Return by Industries in Korea (1980-2014)

Interpretations and Conclusion The interest rate differential (Ex-post Rate – Ex-ante Rate) has positive effect in Secondary and Tertiary industry’s investments but negative effect in Primary industry’s investment. In other words, at given-level of ex-ante interest rate, the higher the ex-post rate of return is associated with higher investment in both Secondary and Tertiary industry. Since in Agriculture most of loans are subsidy-based preferential policy loans, they are less sensitive to ex-post rates of return. Hak K. Pyo, Hyunbae Chun and Keun Hee Rhee Estimates of Total Factor Productivity and Ex-post Rates of Return by Industries in Korea (1980-2014)