What’s Wrong with South Korea’s Services?
Samsung, Hyundai, LG – all of them are world leaders in their respective industries. They are the exponents of the Korean economic miracle driven by a dynamic state-of-the-art export-oriented manufacturing sector.
But now, the manufacturing sector is at such a high level, there’s hardly any room left for further growth.
South Korea has arrived at a pivotal moment where it will eventually leave its manufacturing past behind and will need to rely more on the service sector to keep its economy growing into the future.
The Service Sector is not keeping up with Economic Growth
Compared to other major members of the Organization for Economic Cooperation and Development (OECD), South Korea’s service sector’s contribution to its GDP is rather low.
This becomes clear when you look at the graph below.
The country’s service sector is not growing in line with its income levels. Labor productivity in the service sector is also problematic when compared to the manufacturing sector.
The poor performance of South Korea’s service sector therefore casts serious doubts on whether or not it can effectively contribute to the country’s future growth.
Lack of Foreign Direct Investment (FDI)
Shielding domestic firms and industries from FDIs can help domestic companies grow, unhindered by foreign competition.
But the downside is that the lack of competitive pressure takes away any incentive for these companies to stay ahead and raise their game. This ultimately puts a damper on overall productivity.
Another explanation for the lagging service sector is that South Korea’s research and development (R&D) expenditures and ICT investments have been lacking until recently.
This curbed innovation in the sector and has slowed the country’s ascent up the value chain towards higher value-added service activities.
R&D through Chaebols
But all is not lost for South Korea’s service sector.
You see, high value-added service activities require high levels of human capital. And the country’s world-class manufacturing sector has left it with a highly educated workforce.
That workforce is the key to improving the service sector in such a way that it becomes productive, adds higher value, and ultimately becomes a driver of economic growth.
Over the past few years, the South Korean government has committed to spending more on R&D. In 2016 it became the world’s second largest spender by devoting 4.23 percent of its GDP to R&D.
Even though public spending on R&D is high, almost three quarters of South Korea’s R&D is driven by the private sector.
That’s because the government heavily supports business R&D by giving its chaebols or family-run conglomerates, like Samsung and LG, cheap loans and tax incentives.
The graph below shows how huge the impact of South Korea’s government support actually is.
This strategy allows chaebols to in engage in riskier and more expensive R&D projects. It’s this system that created world-renowned companies like Samsung and LG and made the country a world leader in memory chips, displays and smartphones.
However, critics of the system say that there’s an overall lack of innovative ideas, particularly in software and services. They say it’s because R&D is mainly focused on big companies and state-run research institutes, and because the chaebols’ dominance blocks new entrants.
Nonetheless, the South Korean government seems to have placed its bets on its chaebols to help the country move up the value chain and upgrade its service sector.