It's not You, it's Your Economic Structure

South Korea’s economic growth offers slowed significantly since the 1997 Asian financial crisis. The five-year average GDP growth rate was 7.9 percent during 1991–95, but dropped substantially to Four.5 percent for 2001–05 and then Three.8 percent in 2006–10. This slowdown closely links to that in domestic need. After the burst of the credit card lending boom from 1999–Two thousand and two, growth in domestic demand has already been close to zero and has even dropped into the negative. These facts suggest that since then, the export sector has been driving South Korea’s economic growth.

Growth in exports has been high for the past 30 years, on average more than 10 percent per year, confirming the widespread view that exports underpin South Korea’s economic development. More importantly, the contribution associated with exports to GDP growth hasn’t changed much since 1980. The five-year average of the contribution associated with exports to GDP was Three.9 percentage points through 1991–95, 3.6 percentage points during 2001–05 and 3.8 percentage points during 2006–Ten. This indicates that the slowdown in both GDP growth and domestic demand growth is because the actual spillover effects from the export sector have dampened. Why has this happened?

A clue lies in the proportion of domestic value-added components of exports, which has been trending down from around 76 % in 1995 to roughly 60 percent in 2009. This suggests the contribution of South Japanese export firms to household production has declined because those firms have been usually outsourcing to foreign supply chains. This phenomenon is not limited to South Korea. Most OECD states have reported decreasing amounts of domestic value-added components because the mid-1990s, a result of the widespread use of worldwide value chains. If domestic export firms extensively use global value chains, the actual contribution of domestic value-added components to gross exports is likely to drop.

But the decrease in the proportion of domestic value-added components of exports within South Korea is also related to some other factors, distinguishable from other OECD people, which significantly decrease the spillover effects of export growth.

First, there has been a substantial decline in the contribution associated with small and medium-sized enterprises (SMEs) to exports, relative to large-sized firms. This downward pattern is a result of the relative labour productivity of each firm dimension. The ratio of value added per worker in SMEs to those in large-sized firms during 2002–06 was about 39.4 percent, further lowering to around 34.5 percent throughout 2007–10. This implies that large-sized Southern Korean exporting firms purchase foreign intermediate inputs for his or her final export goods due to the low productivity of nearby SMEs.

Second, the relative labour efficiency of the service sector to the manufacturing sector has been decreasing, from 62 percent within 2002 to 47 % in 2012. In addition, the service value-added components of manufacturing exports are much reduced South Korea than the rest of the OECD. This particular lower productivity means firms in the service sector fail to exploit the benefits from engaging in global value chains, which dampens the spillover effects from large-sized firms’ exports.

The share of the service sector in total employment has been growing, from 62.3 percent in 1993 to 74.1 percent in 2012. SMEs account for about 80 percent of output and 90 percent of employment in the service field. This suggests that the productivity space between the two sectors closely links to the productivity gap between SMEs and large-sized firms.

The reason for this particular relative productivity gap between SMEs and large firms is in the architectural problems of the South Japanese economy. After the Asian economic crisis, large-sized firms restructured, shedding labour and investing abroad, in order to regain competitiveness. But SMEs dropped behind. And the regulatory environment discouraged the growth of new industries and the service sector.

Labour marketplace segmentation due to the widespread use of short-term contracts may have negatively impacted firms’ total factor productivity (TFP). One good reason could be that as long term workers become more costly to end, firms are less likely to transform temporary workers to permanent ones and are more likely to reduce investment in on-the-job-training for temporary employees. Knowing this, temporary workers tend to make less of an effort. This can decrease a firm’s TFP (which combines the productivity of each temporary and permanent employees). Because the share of short-term workers is larger in SMEs than in larger firms, the work market segmentation may also contribute to the productivity gap.

These structural problems have curtailed any positive spillover effects from export development — mainly driven by large-sized firms — across key dimensions of the actual South Korean economy. Although large-sized firms have substantially elevated their sales in international markets, they have also substantially increased their usage of foreign elements. This, and the productivity space between SMEs and large-sized firms, reveals the economy’s inherent weaknesses. Future policymakers must conquer this challenge in order to ensure continued as well as equitable growth across the economy.

South Korea must confront structural problems in the economy is republished along with permission from East Asian countries Forum