m^pz ^r
Kwong Kai-Sun Chau Leung-Chuen cis T Lui
SINGAPORE TAIWAN AND •
SOUTH KOREA
ientific
INDUSTRIAL DEVELOPMENT IN SINGAPORE, TAIWAN, AND SOUTH KOREA
INDUSTRIAL DEVELOPMENT IN SINGAPORE, TAIWAN, AND SOUTH KOREA
Kwong Kai-Sun The Chinese University of Hong Kong
Chau Leung-Chuen University of Hong Kong
Francis T Lui Hong Kong University of Science and Technology
Larry D Qiu Hong Kong University of Science and Technology
V f e World Scientific wB
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V
PREFACE
Any attempt to compare the economic development of different countries is hazardous. Every country has developed within its own confines — subject to its own endowments and structural characteristics. There is no all-encompassing framework within which the paths of different countries' development can be meaningfully compared. An attempt to learn from the development experience of other economies with a view to formulate prescriptive policies is obviously all the more inconceivable. Nevertheless, there is good reason why Singapore, Taiwan, South Korea, and Hong Kong — commonly known as Asia's Newly Industrialized Economies (NIEs) — have customarily been analyzed together under the same category. All four economies, despite their size differences, started to embark on a sustained growth path around 1960. In the last four decades, the four economies exhibited the highest growth rates in Asia. In addition, all four economies grew through substantial industrialization with a distinct bias towards export promotion. And all four economies spent heavily on education. Beneath the commonality of strong inclination toward industrialization, export, and education, there lie substantial differences among the growth experiences of the four economies. For example, Singapore relied heavily on foreign direct investment for technology transfer and job creation. Taiwan relied,'by contrast, on returned engineers from the US for quick coupling with advanced technology businesses, while South Korea depended on government direction and subsidies to quick industrialization. This book is written by four Hong Kong economists. The motivation for writing it is two fold. First, there is a relative lack of a systematic
vi
Industrial Development in Asian NIEs
study of the industrialization experiences of the Asian NIEs in the economics literature. Second, there is an on-going debate that Hong Kong needs to revive its industrial sector to maintain overall growth, and that the government ought to assume a more active role in effecting re-industrialization, particularly in the area of technology promotion. The government did concede to the call for more industrial subsidies in a broad sense, although to date there is still no guiding principle as to where to draw the line between the subsidizable and the nojisubsidizable. There is increasing pressure on the government to do more, and the government has no line of ideological defense beyond a "muddling-through" approach. If this book turns out to offer partial help in throwing the whole matter of industrialization into its proper perspective, then all of the efforts would have completely paid off.
Vll
TABLE OF CONTENTS
1. SINGAPORE: DOMINANCE OF MULTINATIONAL CORPORATIONS I. Introduction II. Historical Background m. The Role of Foreign Investors IV Sources of Technology V Sources of Manpower VI. Economic Development Board VII. Government Incentives VIII. Role of Local Enterprises IX. Technological Expertise within the Government X. Appraisal XI. How the Challenges are Being Addressed 1. Improve Skills and Knowledge 2. Promote Innovative Activities 3. Invest Abroad 4. Promote Service Industries XII. Total Factor Productivity — Why The Big Fuss? xm. The Challenge of Malaysia XIV Case Study 1. Electronics Industry 2. Biotechnology 3. Information Technology XIV Conclusion
1 1 3 13 16 20 22 27 31 33 35 39 40 41 42 42 43 45 46 46 48 50 51
viii Contents 2. TAIWAN: THRIVING HIGH-TECHNOLOGY INDUSTRIES AND SMES I. Introduction II. Historical Background and Recent Development III. Small and Medium Enterprises (SMEs) IV Sources of Manpower and Technology 1. Manpower and Education 2. Sources of Technology 2.1. Publicly Funded R&D 2.2. R&D in the Private Sector 2.3. Technology Transfer from Direct Foreign Investment V. Government Leadership 1. Government Leaders and Organisation 2. Economic Planning VI. Policies and Incentives 1. General Discussion 1.1. Widening and Deepening the Industrial Sector 1.2. General Incentives versus Industrial Targeting 1.3. The Need for Policies and Conditions for Success 2. Industrial Policies Before 1981 3. Hsin-Chu Science-Based Industrial Park (HSIP) 4. Science and Technology Program 5. Emphasis of Application in Later Stage 6. Policies in the 1990s 6.1. The ITRI: An Example of A Technology Support Institution
56 56 57 60 63 63 67 67 69 70 71 71 74 75 75 75 76 76 77 78 80 80 82 84
Contents ix 6.2. Efforts to Induce R&D Activities in the Private Sector 6.3. Financial and Fiscal Policies to Promote Industrial Development 6.4. A Brief Summary Industrial Targeting VII. 1. The Logic Behind Industrial Targeting 2. Selection of Strategic Industries 3. Policies for Strategic Industries 3.1. Preferential Loans 3.2. Tax Holiday 3.3. Technology and Management Assistance from the Government 4. Summary vra. Case Analysis 1. Automobile Industry 1.1. Early Protection and Production 1.2. Joint Ventures in the Late 1970s and Early 1980s 1.3. The New Automobile Industry Development Program 1.4. Summary Semiconductor Industry 2.1. The First Phase: 1974-79 2.2. The Second Phase: 1979-83 2.3. The Third Phase: 1984-89 2.4. The Fourth Phase: 1989-present day 2.5. Summary
85
86 86 87 87 88 90 90 91
91 92 94 94 94 96
97 98 99 99 100 102 103 104
X
Contents
3. Textile IX. The Challenge of Recent Capital Outflow X. Appraisal of Taiwan's Industrial Policy XI. Concluding Remarks Appendix 3. SOUTH KOREA: GOVERNMENT-LED DEVELOPMENT AND THE DOMINANCE OF GIANT CORPORATIONS I. Overview of Development since the Early 1960s 1. Growth Performance 2. Sources of Growth II. Historical Evolution of Economic Policy and Development 1. Background 2. Industrial Takeoff 3. The Heavy and Chemical Industry Drive 4. A Shift Towards Functional Incentives Working of the Outward-, IndustryIII. and Growth-Oriented Growth Strategy 1. Growth Strategy: An Overview 2. Sources of Technology 3. The Sources of Manpower 4. The Role of Foreign Investment 5. Planning for Growth 5.1. Organization of Economic Planning 5.2. Planning Procedure 5.3. Scope of Industrial Policy 6. Government Incentives and Industrial Development
104 106 109 112 114
118 118 118 121 125 125 126 129 134 140 140 142 147 151 152 153 154 154 155
Contents
6.1. Taxes, Foreign Exchange and Loans 6.2. Price Control and Labour Policy 6.3. Impact on Industrial Development 6.4. Price Distortion and Capital Efficiency 1. Formulation and Implementation of Plans and Policies App•raisal 182 1. Industrial Development and Performance 1.1. Evaluation of some Key Industries Aluminum Shipbuilding Automobiles Steel 1.2. Impact on Export Competitiveness 1.3. Impact on Industrial Structure 2. General Economic Efficiency-Static and Dynamic 3. Social and Welfare Consequences Present Challenges and Policy Responses 1. Rapidly Rising Wages 2. Labour Shortage 3. Labour Disputes 4. Protectionism, Increased Competition from ASEAN Countries 5. Falling Prices of Yen
xi
155 156 157 159 160
164 164 165 165 165 166 167 169 172 173 174 174 175 176
176 177
xii
Contents
6. 7. 8. 9. 10. 11.
Vicissitudes of High-Tech Industry Problems with the State Enterprises Weak SMEs Monopolistic Power of Chaebols Corruption and Scandals Financial Problems of some Large Enterprises VI. Conclusion Appendix: Case Studies of Korean Industries (I). The Shipbuilding Industry (II). Automobiles and Parts (III). The Steel Industry and POSCO Steel (IV). The Semiconductor Industry Is Korea's DRAM Industry Leading the Country to Core Status Value added Technology and skill intensity of production Market niche: DRAMs as commodity and Korea's industrial restructuring Local linkages with the electronics industry Domestic linkages of DRAM production Government Policy and the Semiconductor Industry in Korea Financial policies: cost of capital Low bankruptcy rick Institutional efficiency: economies of scope Conclusion
177 178 179 180 181 181 182 185 185 187 189 192
192 192 193
193 194 195 196 196 196 197
Contents xiii COMPARISON AMONG SINGAPORE, TAIWAN, AND SOUTH KOREA I. The System and Organization of Technological Research 1. Role of the Government in Technological Development 2. Initiation, Leadership and Institution 3. Industrial Targeting 4. Policy Instruments II. The Sources of Technology III. Sources of Manpower for Technology Development IV. Incentives Towards Industry and Technology V. The Financing of Industry and the Role of Foreign Investors VI. The Role of Private Enterprises VII. Priority of Technology and Industry Policies in State Planning VIII. The Technological Expertise in the Government IX. The Setting of Industry Targets X. Government Initiatives XI. Appraisal of Policies XII. A Common Development Paradigm: Nature, Circumstances and Applicability 1. Development Strategy and Industrial Policy 2. Policy Justifications 3. Institutional Preconditions for Success 4. Effectiveness 5. Negative Effects 6. Lessons for Hong Kong
201 201 201 202 204 205 206 208 209 210 212 214 216 217 219 220 224 224 225 225 226 227 229
xiv
Contents
Xni. Conclusion 5. STRATEGIC CONSIDERATIONS IN THE HONG KONG CONTEXT I. Introduction II. Losing Industrial Sector Amounts to Losing Growth Engine? m. Keeping Industrial Sector to Diversify Economy? IV Relocation of Services to the Mainland V. Mainland as a Source of Technology VI. High Value-Added Activities VII. Human Capital Barriers VIII. Investment Capital Barriers IX. Coordination Problems X. Science Park XI. Conclusion 6. INDEX
230 233 233 238 240 242 244 246 249 251 255 258 261 265
XV
LIST OF TABLES
Table 1.1: Gross Domestic Product at 1985 Prices, $mn
4
Table 1.2: GDP of Economy and Its Foreign Content, Current Prices, $mn
5
Table 1.3: Share of Manufacturing in GDP (at current prices)
6
Table 1.4: Decomposition of Manufacturing Output
7
Table 1.5: Share of Value Added in Output Value for Key Industries
7
Table 1.6: Output of Key Industries in the Manufacturing Sector
9
Table 1.7: The Key Components in Domestic Export, Current Prices, $mn
10
Table 1.8: Singapore Manufacturing Statistics by Capital Ownership, 1968-90
11
Table 1.9: Net Investment Commitments in Manufacturing by Country of Origin, $mn
12
Table 1.10: R&D Allocation for 1991-95 Under the New National Technology Plan
17
Table 1.11: Research and Development Expenditure and Manpower
18
Table 1.12: R&D Expenditure in 1995, $mn
18
xvi
List of Tables
Table 1.13: Research Scientists and Engineers by Qualification and Field (1987-88 average)
19
Table 1.14: Number of Technology Graduates from Local Universities and Polytechnics
21
Table 1.15: Small and Medium Enterpise Table 1.16:
Assistance Programs
32
Leaders of the EDB since 1961
34
Table 2.1: Changing Structure of the Taiwan Economy (% of GDP) Table 2.2: Share of SME Employment in the Private Manufacturing Sectors in Taiwan (%)
58
62
Table 2.3: Students Receiving Vocational Education by Discipline Table 2.4: Students Returned from Abroad Table 2.5: R&D Expenditure by Type of Research (in %) Table 2.6: R&D Expenditures As Percentage of GDP Table 2.7: R&D Expenditure by Source of Fund
64 65 66 68 69
Table 2.8: R&D Expenditure as Percentage of GNP (%) Table 2.9: Textile Industry's Contribution (%) Table 2.10: Approved Investment Outside of Taiwan (in US$ mn) Table 3.1: Major Indicators of Korean Economic Growth
83 105 107
List of Tables
xvii
Table 3.2: The Structure of Production (% distribution in current prices)
121
Table 3.3: Export and Economic Growth — Changes in Demand Structure
122
Table 3.4: Export and Economic Growth — Demand Side Sources of Growth in Manufacturing Output (%)
122
Table 3.5: Supply Side Sources of Growth (% per annum)
123
Table 3.6: Targets and Growth Performance of the First Five-Year Plan (1962-66)
128
Table 3.7: Targets and Performance of the Second Five-Year Plan (1967-71)
128
Table 3.8: Target and Performance of the Third Five-Year Plan (1972-76)
129
Table 3.9: Target and Performance of the Fourth Five-Year Plan (1977-81)
132
Table 3.10: Target and Performance of the Fifth Five-Year Plan (1982-86)
137
Table 3.11: Target and Performance of the Sixth Five-Year Plan (1987-91)
138
Table 3.12: Korea Trade by Principal Commodities (US$bn)
139
Table 3.13: Structural Change: Sectoral Share of GDP (%)
141
Table 3.14: Foreign Technology Transfer to Korea, 1962-93 (mn dollars)
143
Table 3.15: Research and Development Expenditure, 1965-93 (in billions of won)
145
xviii
List of Tables
Table 3.16: Indicators of Human Resource Development in Korea
148
Table 3.17: Manpower, R&D in Selected Countries
149
Table 3.18: Evolution of Korean Manufacturing Industries
158
Table 3.19: Korea's and Its Competitors' Market Shares in World Exports
167
Table 4.1: Major Indicators of Growth and Structural Change
227
Table 4.2: US Patents Issued
230
SINGAPORE: DOMINANCE OF MULTINATIONAL CORPORATIONS Sunny Kai-Sun Kwong The Chinese University of Hong Kong
I. Introduction The present chapter describes, drawing from materials available in a wide range of published sources, the process of industrialization in Singapore. The focus is mainly on the experiences of recent years, emphasizing the technological thrusts of recent government policy. A persistent theme that runs through a large part of the discussion is the government's emphasis on encouraging foreign direct investment, which, in the domain of manufacturing, frequently involves considerations surrounding technological advancement. Also discussed are the challenges that the government is facing, and its responses to these challenges so far. Singapore is a city state that, in terms of population, is less than half the size of Hong Kong. In mid-1996, Singapore had a population of 3.04 million. It was believed that three hundred thousand residents were non-Singaporeans. There was also a rather large population of migrant workers, in the order of around three hundred thousand. Land area was rather restricted, despite a certain amount of expansion through land reclamation. In 1996, total land area was 648 square kilometres, about half of which was built up. In the last three decades, the Singaporean economy has experienced very fast growth. For instance, the gross domestic product in 1990 was more than ten times that in 1960, in real terms. This exceedingly strong growth performance has been attributed to a number of factors. First,
2
Industrial Development in Asian NIEs
the economy in 1960 was small and significantly agricultural. Second, the savings rate has been exceptionally high. Starting at a low - 2 % in 1960, gross domestic savings over gross domestic product increased to 50% in 1996. In other words, only 50 cents out of every dollar of output were consumed. This high savings level came about mainly through the Central Provident Fund and the retained earnings of state-owned enterprises. Third, concurrent with the high savings level was the high level of investment. The government used the Central Provident Fund to finance large infrastructural projects, while large foreign companies invested directly by bringing in machinery and equipment. Fourth, wages were largely controlled by the government. Despite significant increases through the years, the manufacturing wage level at present is about one third of that in the United States. To sustain growth at its historical rate, the Singaporean economy has to face a number of challenges. First among these challenges is the severe constraint over resources. There is a shortage in many kinds of production inputs, such as land, manpower, skills, entrepreneurship, and private capital. Second, a number of economies in the region, which offer lower production costs to foreign manufacturers, are emerging quickly. These economies include Malaysia, Indonesia, Thailand, and China. Third, the manufacturing sector is dominated by electronics, which in turn is dominated by a small number of foreign companies. The economy is inevitably exposed to the vicissitudes of the global electronics industries and to the fortune of foreign companies. Fourth, because of the prevailing high level of investment, the rate of return to further investment is bound to be rather low. It is clear that future growth has to rely increasingly on amassing resources from abroad, so as to overcome the severe domestic resource constraints; and on augmenting productivity, i.e. to produce more output from a given quantity of input. As a response to the imminent challenges, the government has put forward a number of strategies. First, recruit workers from abroad. Workers at all levels, from menial workers to research scientists, have been brought into the worker population.
Singapore
3
Second, attract foreign companies to use Singapore as gateway to South East Asia. Foreign companies are encouraged to set up headquarters in Singapore and invest or operate branches in the region. Third, encourage innovation and creativity. It is believed that high value-added activities can support high wages and these activities require the ability to innovate. It is also believed that small and medium enterprises have high potential in innovative activities. These enterprises should therefore receive government support. Fourth, a crucial prerequisite to innovation in a scientific age is believed to be research and development activities. To equip the younger generation to take up research work, the education system will shift further towards scientific training. The government has also announced plans to drastically improve the scientific knowledge base by increased public funding. Fifth, recognising the limited investment potential domestically, the government has spearheaded a number of overseas investment ventures. It is also encouraging Singaporean companies to become multinational corporations. II. Historical Background Until 1959, Singapore was a British colony. In 1959, independence was declared and Singapore joined the Federation of Malaysia in 1963. In 1965, Singapore joined the United Nations and achieved full independence status. In the process of gaining independence, Singapore lost the British naval bases. The economy contracted in 1964, which turned out to be the first of two recessions in an otherwise continuous history of economic expansion. The second recession happened in 1985, when the government attempted to raise wages to force companies to phase out low valueadded activities. The attempt failed, and resulted in a recession. Table 1.1 shows the spectacular growth performance of the Singaporean economy. From the mid-1960s to the mid-1970s, the economy experienced doubledigit growth. Growth was slower afterwards, but in most years, growth rates were still in the range of 5% to 10%.
4
Industrial Development in Asian NIEs Table 1.1: Gross Domestic Product at 1985 Prices, $mn Year
GDP (1985 prices), $Mn
1960 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996
5,059 5,490 5,878 6,493 6,214 6,627 7,328 8,283 9,464 10,730 12,172 13,699 15,526 17,274 18,441 19,171 20,549 22,143 24,046 26,285 28,833 31,603 33,772 36,537 39,528 38,924 39,641 43,372 48,203 52,657 57,272 61,081 64,771 71,212 78,689 85,614 91,607
Real GDP Gr
8.5 7.1 10.5 -4.3
6.6 10.6 13.0 14.3 13.4 13.4 12.5 13.3 11.3
6.3 4.0 7.2 7.8 8.6 9.3 9.7 9.6 6.9 8.2 8.3 -1.6
1.8 9.4 11.1
9.2 8.8 6.6 6.0 9.9 10.5
8.8 7.0
Source: Peebles and Wilson (1996), Yearbook of Statistics Singapore 1996
Singapore
5
After independence, the Singaporean government decided to bring in foreign direct investment. The foreign companies manufactured goods mainly for export, and thus a long tradition of export-led growth was started. The philosophy of inducing economic growth by industrialisation and export has persisted till today. The story of industrialisation in Singapore is basically one of drawing foreign direct investment (FDI). The drive to move into high technology in recent years is also largely dependent on foreign companies. The task of attracting foreign investment is critically dependent on the Economic Development Board (EDB), which is an independent organization set up by the government in 1961. The EDB is a powerful organization that maintains substantial influence on the government. The success of Singapore, and of EDB, in attracting foreign direct investment is reflected by the exceedingly high foreign content of Singaporean output. (Table 1.2) Out of every dollar of output produced in Singapore, thirty cents accrued to foreigners. In 1996, for example, the portion of gross domestic product that accrued to foreigners amounted to 32%. These figures highlight the degree of dependency of the Singaporean economy on foreign companies.
Table 1.2: GDP of Economy and Its Foreign Content, Current Prices, $mn
GDP Portion Accruing to Foreigners As percentage
GDP Portion Accruing to Foreigners As percentage
1985
1990
1991
1992
38,924
679
75,321
80,998
9,837 25.3%
21,487 31.7%
25,423 33.8%
23,442 28.9%
1993
1994
1995
1996
94,259
108,224
120,629
132629
29,253 31.0%
34,186 31.6%
39,632 32.9%
42769 32.2%
Source: Yearbook of Statistics Singapore 1995, 1996
6
Industrial Development in Asian NIEs Table 1.3: Share of Manufacturing in GDP (at current prices) Year
Share, %
1970
20.0
1980
29.2
1990 1991 1992 1993 1994 1995 1996
28.6 28.1 27.1 26.9 27.5 27.8 26.9
Note: Excludes utilities and quarrying
Industrialization has been the key to economic growth in Singapore. Industrialization is also the source of export-led growth, as most manufactured products have been exported. This industrialization process has been fostered by multinational companies from the United States, United Kingdom, and Japan, as cost escalation in these countries led the companies to look for cheaper production sites overseas. Viewed in this perspective, the industrialization and the attraction of foreign direct investment in Singapore happened concurrently with the globalization trend of large companies. After more than thirty years of intense industrial promotion, it remains today the intention of the Singaporean government to maintain a sizeable share of industry in the economy. As shown in Table 1.3, the share of manufacturing in gross domestic product was only 20% in 1970, but it increased to almost 30% in 1980, and remained roughly at that level ever since, dropping only slightly to around 27% in the 1990s, despite rapid increases in manufacturing costs. The manufacturing sector is characterised by relatively large firms. It is also marked by its high input material content and its low labour
Singapore
1
Table 1.4: Decomposition of Manufacturing Output Year
Firm Size Materials
Labor
Value Added
Output exported
Share,% 28.1
39.1
%
Persons 69
Share,%
Share,%
1970
68.6
10.2
1980
85
67.6
8.0
26.9
60.6
1990 1991 1992 1993 1994 1995 1996
95 95 92 89 91 92 89
63.6 62.2 61.3 61.9 62.7 62.6 63.5
9.6 10.3 10.9 10.3 9.8 9.5 9.5
30.3 31.4 32.2 32.3 31.3 31.3 na
65.9 61.6 60.7 60.5 61.2 62.5 61.1
Source: Economic Survey of Singapore 1995, Yearbook of Statistics Singapore 1995, 1996
Table 1.5: Share of Value Added in Output Value for Key Industries Industry
1985
1990
Industrial Chemicals and Gases
21.2%
Petroleum Products
1992
1993
33.6%
31.1% 31.6%
32.9%
34.1% 33.8%
7.9%
14.6%
17.9%
17.0%
17.5%
17.5%
Fabricated Metal Products
37.2%
34.8%
36.4%
37.8%
37.5%
36.3% 36.0%
Machinery except Elect./ Electronic
44.6%
37.5%
38.1% 38.3% 40.9%
39.3% 39.4%
Electronic Products
31.5% 27.7%
27.7%
27.9%
27.8%
26.3% 26.6%
Transport Equipment
57.8%
42.6%
42.7%
45.2%
46.8%
45.2%
All Manufacturing
27.8%
30.3%
31.4%
32.2%
32.3%
31.3% 31.3%
Source: Yearbook of Statistics Singapore 1995
1991
1994
1995
16.8%
44.6%
8
Industrial Development in Asian NIEs
content. As shown in Table 1.4, the average firm size is around 90 persons. The share of materials in the value of output was more than 60% in each year. This means that for every dollar of output produced, 60 cents went to pay for materials. By contrast, only around 10% of output value goes to the workers. These numbers suggest that Singapore's primary role is an offshore processing centre for multinational corporations. The workers manage to capture a relatively small portion of the product value, as the core components of the product are supplied by the multinational corporations. In terms of the components of the manufacturing sector, the electronics industry is definitely the largest, followed by the petroleum industry. Because of the high import content of these two industries, the contribution of these two industries to the economy is limited, on the basis of per dollar of output produced. As suggested by Table 1.5, the share of value added in output value for the electronics industry is around 26%, and that for the petroleum industry is around 17%, somewhat lower than the sectoral average of 31%. Both electronics and petroleum industries have been actively promoted by the government. The electronics industry, in particular, is the corner stone of the sector. As shown in Table 1.6, in 1996, more than half of the manufacturing output was accounted for by the electronics industry. The petroleum industry accounted for 10% and all the other industries combined accounted for 37%. The dominating role of the electronics and petroleum industries is all the more remarkable if one looks at the composition of domestic exports. As suggested by Table 1.7, the two industries accounted for 83% of domestic exports in 1995. The dominance of the electronics and petroleum industries in manufacturing output and in domestic exports brings to the fore another remarkable feature of the manufacturing sector, namely, the dominance of foreign companies. As shown in Table 1.8, foreign companies (wholly and majority) dominated the manufacturing sector in terms of the output produced, value-added, direct exports, and capital expenditure. For instance, in 1994, which is a typical year in the last two decades,
Table 1.6: Output of Key Industries in the Manufacturing Sector 1990
1991
1992
1993
1994
1995
Industrial Chemicals and Gases 1,691 % of total 4%
3,150 4%
3,092 4%
2,643 3%
2,654 3%
3,377 3%
4,275 4%
Petroleum Refineries and Petroleum Products 11,031 % of total 29%
11,365 16%
11,288 15%
10,272 13%
11,213 13%
10,977 11%
10,603 9%
Fabricated Metal Products except Machinery 1,833 % of total 5%
3,805 5%
4,129 6%
4,363 6%
4,890 6%
5,600 6%
6,546 6%
Machinery except Electrical and Electronic 1,769 % of total 5%
3,381 5%
3,723 5%
3,861 5%
3,729 4%
4,489 4%
5,131 5%
Transport Equipment % of total
1,789 5%
3,791 5%
4,014 5%
4,397 6%
4,590 5%
5,038 5%
5,209 5%
Electronic Products and Components 9,014 % of total 23%
27,878 39%
28,958 39%
32,044 41%
39,827 45%
49,006 49%
58,170 51%
Total Manufacturing
71,333
74,575
77,276
87,639
100,622
113,109
Industry
1985
38,495
Source: Yearbook of Statistics Singapore 1995, 1996
10
Industrial Development in Asian NIEs Table 1.7: The Key Components in Domestic Export, Current Prices, $mn 1970
1980
7990
1995
Machinery and Equip.* as % of total
197.6 11%
6,566.6 25%
32,351.8 52%
67,750.7 69%
Mineral Fuels as % of total
792.2 43%
14,180.2 55%
17,136.7 27%
13,721.5 14%
Chemicals as % of total
43.3 2%
572.9 2%
3,618.6 6%
5,621.2 6%
1,832.2
25,805.2
62,754.2
98,472.7
Exported Commodity
Total Domestic Export
* "Machinery and Equipment" comprises of Office Machines (49%), Electronic Components/ Parts (22%), Radio and Television Receivers and Parts (7%), Electric Motors and Resistors (3%), etc. Percentages in brackets represent shares in 1995. Source: Economic Survey of Singapore 1995
foreign companies accounted for 76% of manufacturing output, 70% of value-added, and 85% of direct exports. Foreign companies also accounted for more than 70% of capital expenditure. And the hegemony emerged despite the fact that foreign companies accounted for only about half of the number of manufacturing workers, and less than one quarter of the number of firms. While foreign investors have come from all around the world, the bulk of foreign investment comes from American and Japanese companies. As shown in Table 1.9, the United States was the largest foreign investor in 1996, although its share was diminishing. The second largest investor was Japan, with the United Kingdom third, but by a wide margin. The three countries combined accounted for 80% of all foreign investment, and 57% of all investment. The broad picture of the manufacturing sector is thus pretty clear. The sector accounts for more than one quarter of the economy output. The sector itself is controlled by foreign companies, partly as a result of the government's deliberate effort to attract foreign direct investment.
Table 1.8: Singapore Manufacturing Statistics by Capital Ownership, 196
1968 Total Wholly Local % Majority Local % Wholly or Majority Foreign
Estab.
Workers
Output
Value-Added
%
1,586 80.5 7.8 11.7
74,833 58.7 15.1 26.2
2,176 41.1 12.8 46.1
612 40.8 15.2 44
n.a n.a. n.a. n.a.
%
2,385 66.9 11.1 22.0
191,528 32.8 15.2 52.0
12,610 18.0 10.7 71.3
3,411 24.3 13.0 62.7
7,20 8.9 7.0 84.1
%
3,355 64.2 11.0 24.8
285,250 28.2 13.4 58.4
31,658 15.6 10.7 73.7
8,522 19.1 13.5 67.4
19,17 7.1 8.2 84.7
%
3,703 67.7 8.9 23.4
351,674 29.0 12.0 59.0
71,333 15.1 9.0 75.9
21,607 16.4 10.9 72.7
47,00 7.8 6.4 85.8
%
4,013 70.5 7.9 21.5
365,588 32.7 12.3 55.1
100,622,093 16.1 8.4 75.5
31,453,946 17.9 11.7 70.4
Direct Ex
1975 Total Wholly Local % Majority Local % Wholly or Majority Foreign 1980 Total Wholly Local % Majority Local % Wholly or Majority Foreign 1990 Total Wholly Local % Majority Local % Wholly or Majority Foreign 1994 Total Wholly Local % Majority Local % Wholly or Majority Foreign
Source: Huff (1994), Yearbook of Statistics Singapore 1996
61,532, 8.7 6.6 84.7
12
Industrial Development in Asian NIEs
Table 1.9: Net Investment Commitments in Manufacturing by Country of Origin, $mn 1990
1991
1992
1,054.8 42%
969.2 33%
1,201.4 35%
Japan %ofGT
708.2 28%
713.2 24%
858.0 25%
779.4 20%
United Kingdom %ofGT
89.9 4%
186.5 6%
305.5 9%
2,217.9 89%
2,461.1 84%
Total (Local) %ofGT
269.5 11%
Grand Total
2,487.4
Country Origin United States %ofGT
Total (Foreign) %ofGT
1995
1996
2,075.8 30%
2262.0 28%
913.8 16%
1,152.5 17%
1960.4 24%
357.8 9%
525.1 9%
771.6 11%
397.6 5%
2,733.0 79%
3,177.1 81%
4,327.4 75%
4,852.4 71%
5716.2 71%
472.9 16%
748.0 21%
745.5 19%
1,437.2 25%
1,956.7 2368.9 29% 29%
2,934.0
3,481.0
3,922.6
5,764.6
6,809.1
1993
1994
1,452.2 2,451.7 37% 43%
8085.1
Source: Economic Survey of Singapore 1995, 1996
The strong influence of foreign companies amounts to a risk as the economy could be affected by the fortune of these companies. Within the sector, the role of the electronics industry is overwhelming. The consequence is, the performance of the economy is profoundly affected by the business cycle of the global electronics industry. Furthermore, the electronics industry, which exports most of its output, also imports a lot of materials. Singapore is basically an offshore processing centre. As manufacturing costs increase, the competitive pressure arising from other production sites in the region becomes increasingly apparent. To maintain the role of the manufacturing sector, the government realises the critical importance in bringing about improvements in technology, knowledge, creativity, and productivity, aspects seen to constitute the future direction of government policy.
Singapore
13
III. The Role of Foreign Investors Among the newly industrialised countries, Singapore is unique in its heavy reliance on foreign investment. By contrast, the manufacturing sector in Taiwan relies more on centrally organised research institutes and small and medium enterprises. In South Korea, the industrialisation drive is led by large Korean companies under the protection of the government. The reliance on foreign direct investment can be traced to historical and political origins. At the time of independence, the Singaporean economy was largely agricultural, and unemployment was high. Industrialisation was thought to be the way to absorb the surplus labour, and propel growth. The business sector was seen as being heavily influenced by Chinese entrepreneurs. The government feared the affinity of Chinese entrepreneurs towards Communist China. The government therefore relied on foreign investors to industrialise the economy, to the effect that on one hand, the position of the People's Action Party was strengthened, and on the other hand, the influence of local Chinese was capped. A further reason for bringing in foreign investment was the vulnerability of the country. Singapore, being a small city-state, needed to protect itself from possible foreign aggression. By giving part of the economy to the superpowers, the security of the country was better ensured. Since the 1980s, there has been a new reason for bringing in foreign manufacturers. As earlier industrialization pushed up wages, the economy needed to shift towards higher value-added activities to justify the higher wages. More advanced technology had to be acquired in order to produce products of higher value added, such as electronics. Foreign direct investment was chosen as the conduit for the transfer of advanced technology. Unlike Taiwan, Singapore did not have the advantage of a large number of returning engineers from the United States. Unlike South Korea, Singapore did not have a large domestic market and the financial power of large vertically integrated conglomerates. Foreign investment was one of the few ways by which modern technology could be acquired.
14
Industrial Development in Asian NIEs
As wage rates increased and converged to the level of the industrialised countries, the momentum of foreign direct investment in manufacturing can no longer be sustained. In the 1990s, the government shifted to encourage foreign companies to set up headquarters in Singapore, which then served as a gateway to the South East Asian region. Through Singapore, it was emphasized, foreign companies could locate low-cost manufacturing sites in the region, such as Malaysia, Indonesia and Thailand. The concept was one of regionalization and a growth triangle, encompassing Singapore, Malaysia, and Indonesia. The targeted activities that remained to be undertaken in Singapore would be research and development, distribution, and marketing. It is interesting to identify the advantages that Singapore possesses in attracting foreign investors. Schein (1996) identifies the principal advantages from interviews with foreign companies. They are summarized below. Geographic location Singapore is centrally located in a fast growing region made up of Malaysia, Thailand, Indonesia, and Vietnam. Culture English is an official language and widely used. The legal system is a legacy of the British legal system. The same applies to the accounting system commonly in use. Government The government is appreciated for its stability, efficiency, and integrity. On the business side, the government shows a strong dedication to attracting foreign investment. The rules are clear, and the government can be counted on to keep its promises and foster a real partnership relationship.
Singapore
15
Economic benefits Wages relative to labour productivity were relatively low. The government provides investment initiatives such as pioneer status, investment allowances, equity injection, subsidised loans, and training grants. Economic Development Board The EDB provides a one-stop service for foreign investors. The EDB was appreciated as being an efficient, resourceful, and accessible agency. It knows the industries and the companies well. It can help in locating suppliers, building contractors, and construction companies. It also can grant incentive schemes and participate in selected ventures as equity partners. Land Although land is scarce in Singapore, the government is willing to provide enough land for investors and allow favourable rental and leasing arrangements. The government has also built suitably designed factory buildings in industrial estates and science parks to allow a quick start in production. Infrastructure Infrastructure was generally perceived as adequate. Services related to the airport, seaport, roads, urban transport, telecommunications, banking system, housing, and environment were adequately provided and well managed. Labour conditions Workers were praised for their strict discipline and work ethics. Strikes and stoppages were unheard of. The government was willing to be flexible in immigration rules and in importing foreign labour.
16
Industrial Development in Asian NIEs
IV. Sources of Technology A prerequisite of large-scale industrialisation is the acquisition of technology. In an advanced country, the required technology may have to be derived from new scientific discoveries. For a developing country, the essential requirement for industrialisation is how mature technology in the advanced countries can be transferred and put to use locally. This certainly does not detract from the importance of a gradual progression towards indigenous research. As a country moves up the technology ladder, more and more research has to be undertaken locally. While technology may be acquired via a variety of mechanisms, in the case of Singapore, the principal source of technology is the multinational corporations which have set up operations in Singapore. The multinational corporations brought into Singapore the necessary machinery and equipment, obliterating the difficulty of deciding over the choice of manufacturing hardware. More importantly, the multinational corporations brought in the necessary software as well. This software includes the way to operate the machinery and the system of control over the production process. An important aspect is that, in the process of technology transfer, the foreign companies took part in the training of local technicians and engineers. The knowledge and experience acquired through working on-the-job constituted a great boost to the human capital of the country. Up to the 1980s, there was no science or technology policy in Singapore. A coherent science and technology initiative was first put forward in 1991, when the National Science and Technology Board (NSTB), an agency under the Ministry of Trade and Industry, was established. The government perceived that indigenous research had to take the place of technology transfer from the advanced countries. The government decided to expand rapidly the expenditure on research and development. The National Technology Plan was drawn up by the NSTB in 1991. The objectives of the Plan were to increase research and development expenditure to 2% of GDP (50% or more from private funding) by
Singapore
17
Table 1.10: R&D Allocation for 1991-1995 Under the New National Technology Plan Program
FY91-95, $m.
%
Technology Programs
806
40.3
Key strategic thrusts in tech., ad hoc projects
556
27.8
R&D Assistance Scheme
80
4.0
Manpower Development
158
7.9
Technology Infrastructure
45
2.3
Science Park Development
335
16.8
2,000
100.0
Total
Source: Wong (1995) citing Nat. Sci, and Tech. Board, National Technology Plan 1991
1995, and to increase the number of research scientists and engineers to 40 per 10,000 workers by 1995. Funding amounting to S$2 billion was set aside to attain these objectives. Of this S$2 billion, 40% was designated for technology programs, 28% for strategic projects, 17% for science park development, and 15% for manpower development, R&D assistance and technology infrastructure. (Table 1.10) The objectives of the National Technology Plan have been partially realised. Table 1.11 shows that R&D expenditure did increase sharply from S$0.6 billion in 1990 to S$1.4 billion in 1995. Nevertheless, as a ratio of GDP, the 2% target was not achieved. In 1995, R&D expenditure was only 1.13% of GDP. On other counts, the goals of the National Technology Plan were largely met. The number of research scientists and engineers doubled from 4,329 in 1990 to 8,340 in 1995. In 1995, there were thus 48 research scientists and engineers per 10,000 workers, exceeding the target of 40 per 10,000 workers. Table 1.12 shows that by 1995, the bulk of R&D was undertaken by the private sector. Of the S$1.4 billion R&D expenditure, the private sector accounted for S$881 million, or
18
Industrial Development in Asian NIEs Table 1.11: Research and Development Expenditure and Manpower
Year R&D Exp., S$Mn 1981 1987 1990 1991 1992 1993 1994 1995
81.0 374.7 571.7 756.8 949.5 998.2 1,175.0 1,366.6
R&D/GDP (%)
Res. Scientists/Engineers
Per 10,000 workers
0.26 0.86 0.84 1.00 1.17 1.06 1.09 1.13
1,193 3,361 4,329 5,218 6,454 6,629 7,086 8,340
10.6 25.3 27.7 33.6 39.8 40.5 41.9 47.7
Source: Economic Survey of Singapore 1996
Table 1.12: R&D Expenditure in 1995, $mn
Fields
Private Sector
Higher Education Sector
Government Sector
Public Research Institutes
Total
Agricultural Sciences
6.3
10.4
4.4
Biomedical Sciences
2.6
34.8
0.3
n.a.
37.6
Computer and Related
152.7
12.6
6.2
45.9
217.3
Engineering
590.8
75.2
66.7
74.6
807.3
Natural Sciences
82.4
41.1
4.7
43.6
171.8
Other Fields
46.7
19.2
28.1
12.0
106.0
881.4
193.4
110.4
181.4
1,366.6
All Fields
Source: Economic Survey of Singapore 1996
5.0
26.5
Singapore
19
some 63%, greatly exceeding the target of 50%. The majority of R&D activities have been devoted to engineering research. It is no easy task to evaluate the benefits of the government's drive towards R&D. As is the case with most technology policies around the world, the input quantities are much easier to measure than the output quantities. Likewise, in Singapore, the technology targets are in terms of R&D expenditure and R&D manpower. How the R&D funding has been used, the quality of the research personnel and the incentives that are present to motivate them are vital elements in turning the R&D drive into real economic benefits. One available piece of information that reflects the quality of R&D manpower is provided by Table 1.13. About half of the research scientists and engineers were holders of Bachelor degrees, about one quarter held master degrees, and another quarter held doctoral degrees. Most of them worked in engineering research. One commonly used measure of the performance of R&D activities in an organization is the number of patents obtained. Koh (1995) states that between 1980 and 1993, Singapore received 167 patents from the US Patent Office. Kortum and Lerner (1997) indicates that within those years, US Patent Office granted some 400,000 patents to applicants worldwide. One should be mindful that it normally takes one to two years to process a patent application, and so the figures largely reflect Table 1.13: Research Scientists and Engineers by Qualification and Field (19871988 average) Field Natural Science Engineering Computer and Related Medical Science Agricultural Science Total
Ph.D.
Master's
Bachelor's
Total
199 344 52 142 7 744
50 409 122 151 11 743
130 1254 310 43 37 1874
379 2007 484 436 55 3361
Source: Wong (1995) Appendix Table B.8
20
Industrial Development in Asian NIEs
the R&D performance up to around 1990, prior to the establishment of the National Technology Plan. It seems safe to say however, that indigenous research in Singapore, and in most other developing countries for that matter, is still at a very preliminary stage. V. Sources of Manpower In the early years of industrialisation, Singapore had an adequate supply of labour. But the manpower surplus quickly turned into a labour shortage, so that by the early 1970s, various ways had to be sought to expand the labour pool to keep up with the demand of continued industrialisation. The government had resorted to two principal means to ease labour shortage. First, by large scale education, training, and retraining programmes. Second, by importing foreign labour at all levels, from menial labourers to managers and research scientists. The manufacturing sector has a large demand for technicians and engineers. To meet this demand, the education system in Singapore is heavily biased towards technical training. The school system, in the first place, emphasises science and mathematics studies. The universities and polytechnics also put heavy emphasis on technical and vocational training programmes. Singapore has two universities, namely, the National University of Singapore and Nanyang Technological University, and four polytechnics, namely, Singapore Polytechnic, Ngee Ann Polytechnic, Temasek Polytechnic, and Nanyang Polytechnic. All six institutions are funded by the government. Table 1.14 shows the percentage of university and polytechnic graduates who specialise in technology-related studies in recent years. Technology graduates take into account graduates from engineering, science, and computer studies programmes. As shown, more than half of all graduates were technology graduates. In 1995, 53% of graduates were technology graduates. In 1990, the percentage was even higher, at 59%. In 1995, the number of technology graduates amounted to eleven thousand. (For comparison, in 1996, the seven universities in Hong Kong produced 8,770 technology graduates).
Singapore
21
Table 1.14: Number of Technology Graduates from Local Universities and Polytechnics Source
1985
1990
1991
1992
1993
1994
1995
Universities
1,623
2,339
2,547
2,916
3,271
3,376
3,580
Polytechnics
3,271
5,769
5,822
6,314
7,308
7,868
7,452
Total
4,894
8,108
8,369
9,230
10,579
11,244
11,032
as % of All Graduates
54.7%
59.1%
57.5%
56.9%
57.8%
57.3%
53.5%
Note: "Universities" comprises of the National University of Singapore and Nanyang Technological University, "Polytechnics" comprises of Singapore Polytechnic, Ngee An Polytechnic, Temasek Polytechnic (est. 1990) and Nanyang Polytechnic (est. 1992) Technology Graduates = (First Degree) graduates from engineering, science, and computer studies Source: Yearbook of Statistics Singapore 1995
In addition to the tertiary institutions, the government also subsidises training programmes run by companies. The Economic Development Board has a scheme that provides financial assistance to multinational corporations sending local employees abroad for apprenticeship training. The government also set up joint ventures with multinational corporations to set up local and overseas training institutes for workers. Workers who attend these training institutes are given allowances by the government. In addition, through a levy on firms, a skill development fund has been established to subsidise company-run training programmes. Besides education and training programmes, labour importation is another means by which the labour pool has been enlarged. The government has been flexible in allowing needed workers to enter and take up jobs in Singapore. Multinational corporations are allowed to bring in experienced managers. A large number of relatively low-skilled workers have also imported from the region to carry out menial work. It has been estimated that in 1994, as many as three hundred thousand foreign workers were taking up jobs in Singapore, although not all of them were employed in the manufacturing sector.
22
Industrial Development in Asian NIEs
In recent years, there has been an active recruitment drive for foreign research workers. The National Technology Plan required a rapid buildup of research manpower, the size of which exceeded the output capabilities of the local universities and polytechnics. The Economic Development Board has a separate division, namely, the Manpower and Capability Development Division, a principal function of which is to attract foreign talents from diverse places such as China, India, Malaysia, and the states making up the former Soviet Union. VI. Economic Development Board The Economic Development Board (EDB) is the critical agency in Singapore in charge of attracting foreign direct investment. As foreign direct investment is essentially the engine that has driven the growth of the manufacturing sector, EDB is widely regarded as the key to Singapore's industrialisation. The internal structure, the way of conducting business, the present mission, and the future challenges of EDB is therefore an important aspect towards understanding the development of industrial policy in Singapore. Schein (1996) gives an insightful account of the development and structure of EDB. According to Schein (1996), EDB was created by the government in 1961. It was governed by a board of twelve governmentappointed members. It was led by a chairman, a managing director, and a number of directors. EDB was a global organization, with branch offices in all the major cities of the world. It had 236 managers and a support staff of 183 workers. In terms of organizational structure, it had four divisions, as set out below. 1. International Operations Division 2. Operations Division a. Enterprise Development Division — in charge of the development of small and medium enterprises b. Services Development Division — in charge of the development of the service sector
Singapore
23
c. Industry Development Division — in charge of the development of strategic industries d. Manpower and Capability Development Division — in charge of worker capability development and the attraction of foreign talents e. International Business Development — in charge of promoting regionalization and the growth triangle 3. Strategic Business Units a. National Biotechnology Program b. China Focus Unit — in charge of monitoring and advising on China policy c. EDB Consulting Group — acts as consultants for companies and governments 4. Services a. Planning Division b. Human Resources Division c. Corporate Services Division d. Internal Audit Unit EDB is a highly entrepreneurial organization. Unlike a government department, EDB has its own salary scale and is flexible in its business dealings. It also has its own investment fund, which amounts to S$l billion, and it holds equity stakes in a number of joint ventures with foreign companies. One notable example is a wafer fabrication facility known as Tech Semiconductor, which was set up in 1994. The US$300 million plant was jointly owned by Hewlett-Packard, Texas Instruments, Canon and EDB, who held a share of 26%. Tech Semiconductor manufactured wafer for 16MB DRAM chips designed by Texas Instruments. EDB claims to be a non-hierarchical organization. EDB officers usually start their career working as industry specialists, under-standing a particular industry and the foreign companies of that industry. Promising officers are promoted to become officers in foreign offices. There they have to build up connections with new companies and
24
Industrial Development in Asian NIEs
reinforce relationships with the existing. They typically make 50 company visits every year. These officers know well what the government is looking for, the companies that they are interested in, and the industries that the companies are operating in. EDB emphasises timely information flow. The field officers have to file daily reports and their supervising directors have to put the reports in a standardised format, and send them back to Singapore via internet. Every company visit, or company call, requires a report, and the directors will decide who are to have access to those reports. Every month, an industry unit has to make a presentation at a meeting with the board, and every year, the board launches a strategic planning meeting involving the entire organization. To reduce bureaucracy, the managing director holds weekly meetings with some thirty-five directors and officers, to review projects in progress and to brainstorm. The chairman has to travel extensively overseas to collect first-hand information of multinational corporations, industry trends, and the progress of foreign offices. He also reviews all projects and adds his comments on "float files", which are widely circulated among senior officers. To foreign investors, EDB is a competent organization that provides a "one-stop" service. EDB can provide answers and assistance to a wide variety of problems, examples of which are construction, recruitment, immigration, labour relations, factory space, housing for employees, taxation, customs, suppliers, security and environment. EDB is generally perceived as a successful organization. Its success can be attributed to a number of factors. First, salaries are generally higher than that in the government or other statutory boards. In addition, high-powered incentive schemes are operated. Officers are paid bonuses the amount of which are determined on the basis of the amount of investment brought into Singapore. Second, EDB is able to recruit the best graduates. Most of these graduates have a science and engineering background. EDB also prefers workers with overseas experience, because they can better associate themselves with foreign companies. Third, because it is the top priority of the government to attract foreign investment, EDB has influence on the upper echelons of the government.
Singapore
25
EDB has powerful influence on such statutory boards as the Jurong Town Corporation (which runs industrial estates), Development Bank of Singapore and Public Utilities Board. Fourth, EDB has the prerogative to grant financial incentives to designated companies. The goals of EDB are continuously evolving. Its present objectives are summarised in its annual report 1995/96. There are five development programmes, as set out below. 1. Manufacturing 2000 The aim is to keep the share of manufacturing in gross domestic product at 25% and in employment at 20%. High value-added projects in the petrochemical, chemical, electronics, and precision engineering industries will be promoted. 2. International Business Hub 2000 The aim is to facilitate the setting up of 200 significant corporate headquarters to make Singapore a hub for logistics, lifestyle, information, and communications. 3. Promising Local Enterprises 2000 The aim is to nurture 100 promising local enterprises so that they can grow and each achieve a sales figure of S$100 million by year 2000. 4. Regionalisation 2000 To implement projects committed in the Riaus (Indonesia), Suzhou and Wuxi (China), Bangalore (India) and Vietnam. 5. Co-investment The fund being managed amounts to S$1.3 billion, $400 million of which has already been committed in local and overseas projects.
26
Industrial Development in Asian NIEs
It is clear that the future tasks of EDB involve much more than just attracting foreign companies to start factories in Singapore. The increased complexity of the tasks has led sceptics to doubt the future success of EDB. Schein (1996) has identified a number of challenges that EDB has to face. One concern is the ability of EDB to deal with local enterprises, which are not only more numerous in number, but also less well-organized than multinational corporations. The multinational corporations are also becoming increasingly complex. As these corporations become increasingly global, their problems may involve foreign politics and global market conditions. Some corporations have got into financial trouble. Rollei has collapsed, and Apple Computers is cutting back in payroll worldwide. Investing overseas also entails a new set of difficulties. Critics say that EDB is not very comfortable dealing in countries where rules and regulations are not well-defined. Another challenge is EDB officers have to probe into unfamiliar terrain, such as the promotion of service industries, which range from banking to tourism and movie industries. One consequence is, the pressure on the middle managers is mounting, and the turnover rate increases as a result. For the kind of tasks that EDB engages in, mistakes and failures are inevitable. The failure cases are usually not publicised and it is hard for outsiders to learn from them. A few of these cases are however mentioned in Schein (1996). One case involved a Japanese ship repairer who misled EDB into believing that a new facility would use a high percentage of local output. It turned out that the local content of output was less than 5%. Another case was one of wrong judgement — the intention to invest heavily in oil rig building facilities turned out to be a mistake as the oil industry headed into a downturn. In another case, EDB was deceived by a Hong Kong manufacturer who proposed an investment deal involving the installation of sophisticated equipment-making machinery. The machinery turned out to be value-less second hand machinery. In a final case, EDB went into a joint venture with an American with the aim to produce liquid crystal displays utilising new technology. It turned out that the production
Singapore
27
principle to be used was to "rub the glass with cat fur to make grooves that would help line up the electrons underneath appropriately." The venture failed completely. VII. Government Incentives The government has introduced a wide range of incentives to encourage foreign investment, and in recent years, research and development activities, and the development of small and medium enterprises. These incentives are granted to qualified companies only. The discretion rests with the government. The following is a catalog of some of the major incentives. Tax incentives a. Pioneer status — companies introducing new technologies may be granted tax-free status for 5 to 10 years, corporate tax rate for 1996 was 27%, for 1997 is 26% b. Post-pioneer status — tax rate at 10% for up to 10 years c. Development and expansion incentive — tax rate of 10% for up to 10 years d. Venture capital incentive — the loss on the sale of shares can be offset against other taxable income e. Investment allowance — "Up to 50% may be used towards fixed investment in R&D" (Yuan, 1990) f. Double deduction — $1 spent on R&D, excluding depreciation, counted as tax-deductible expense of $2 (therefore, an additional $1 spent on R&D saves $0.52 on taxation in 1997) g. R&D reserve — "Up to 20% of taxable income can be set aside as R&D reserve and is exempt of tax if spent within 3 years" (Yuan, 1990) h. Operational Headquarters Scheme
28
Industrial Development in Asian NIEs Research and product development grants
a. Product development assistance — matching grants for product development b. New technology initiatives — cash grants for worker training of between 30% to 90% of allowable costs c. Venture fund — managed by EDB, S$1.3 billion for equity investment in new technology companies in Singapore and overseas d. Research and Development Assistance Scheme — established in 1980 to promote medium to long term mission-oriented research projects (1980-1990 expenditure = S$75 million, mostly given to large MNCs) e. Product Development Assistant Scheme — provides grants to encourage locally owned firms to acquire new product/process design and development capabilities (1980-1990 expenditure = S$10.5 million) f. Innovation Development Scheme — the government funds up to 50% of the cost of new product or service development incurred by companies. EDB has S$500 million, of which S$119 million has been committed to 103 projects (Far Eastern Economic Review, Feb 6, 1997) Small company grants a. Local Enterprise Finance Scheme — subsidized interest rate for mechanization in local companies, in addition, EDB could underwrite part of a loan b. Local Industry Upgrading Program — started in 1985 as a scheme to upgrade local firms, to enable them to supply components, such as cables, to MNCs; or as small money to assist firms in meeting ISO9002 c. Small Industries Technical Assistance Scheme — e.g. small money to assist in computerization d. Enterprise Collaboration Forum — bring together local enterprises and hold monthly meetings to explore business collaboration opportunities
Singapore
29
Land provision In Singapore, land use is carefully controlled and land zoning is exhaustive and systematic. A great proportion of land zoned for industrial use is controlled by the Jurong Town Corporation. The Jurong Town Corporation, established in 1968, is a spin-off from EDB. Its mission is to develop and manage industrial estates. It provides building land as well as ready-to-use well-designed modern factory buildings for multinational corporations. Port and cargo handling facilities are designed to be available within close proximity. Financially, the Corporation aimed at being self-supporting. Factory space is made available to companies through either renting or leasing arrangements. Leasing usually applies to land, which is leased for thirty years usually, with the possibility of a renewal for a further thirty years, subject to government approval and rate negotiation. Renting usually applies to built units. Rental agreements are renewable every five years, with a guarantee that rental rate will not be raised by more than 50%. Land is scarce in Singapore. The Jurong Town Corporation is in a strong position in choice of tenants. This power is however subject to the influence of the Economic Development Board. The following case, documented by Schein (1996 p.130-1), concerns the wafer fab of TECH Semiconductor set up in 1994, as told by Texas Instruments. It illustrates the land shortage problem and the power of EDB. "... One of the main problems was that the new factory would need twenty acres of land, which, in that land-poor city-state, was outrageously out of proportion to what was available. Had TI gone directly to the JTC, "they would have been laughed out of the office, because even one acre is beginning to be hard to find." So the EDB had to work with all the government agencies to locate a parcel of land, to convince them of the importance of this project so that the land would be made available, clear the way for a complex leasing arrangement (because land could not be owned), provide the infrastructure such as utilities, make arrangements with suppliers of the superpure chemicals that would be needed, make sure that the needs of the chemical companies who
30
Industrial Development in Asian NIEs
would be involved as suppliers were met, clear the way for certain special imports by providing custom clearances, and so on." Science Park The science park in Singapore is actually an industrial park, one which places special emphasis on research activities. Established in 1981, the science park started operation in 1983. Resembling the industrial estates managed by the Jurong Town Corporation, tenants may lease land and construct their own buildings, or rent space within built facilities. As of 1992, around 60% of occupied space was held on a rental basis, and 40% was held on a land-lease basis (Wong et. al. (1994)). There are plans to enlarge the science park. Phase I of the science park covers 29.5 hectares, and costs S$176 million. A Phase II extension was announced in 1992, covering an area of 20.3 hectares, and costing an estimated S$150 million. Like the Jurong Town Corporation, the science park aims at being self financing, by means of rental revenue, in the long run. In the selection of tenants, heavy emphasis is placed on the expected amount of research activities to be undertaken. As of 1990, 40% of Singapore's R&D expenditure took place in the science park. The selection of tenants is the responsibility of a committee. There are five criteria, namely, fixed asset investment per unit area of floor space, value added per worker, manpower profile, R&D budget and content, and strategic value. Tenants are expected to devote at least 60% of the office space to R&D activities. In terms of technology areas, priority is placed on advanced electronics, product testing and analysis, medical and scientific instruments, R&D in biotechnology, process control and automation equipment, optical and electro-optical applications and R&D in chemicals and plastics (Wong et al. (1994)). Cheap Labour Historically, the government has attempted to control wages, although ensuing labour shortage makes the task increasingly difficult. The
Singapore
31
government is concerned that if wages increase faster than labour productivity, then the attractiveness of Singapore to foreign investors will be jeopardised. Every year, the government issues clear guidelines over the rate of increase in wages. Not only the public sector, but also the private sector is expected to follow these guidelines. Strictly speaking, it is not the government which officially determines the guidelines, but the National Wages Council, which nonetheless is controlled by the government. The National Wages Council was established in 1971. It is a tripartite body with equal representation from the government, the National Trades Union Congress, which is controlled by the ruling People's Action Party, and the employers. (Huff, 1995) Through a majority representation, the government has full control over the National Wages Council and a "consensus" over wages is easily achieved. The system of wage fixing cannot ensure efficient allocation of manpower among companies. In recent years, the National Wages Council has encouraged companies to follow a more flexible wage scheme, by introducing a variable component into total remuneration. This variable component is to be tied to company profits and individual worker performance (National Wages Council (1992)). Available evidence shows that this variable margin is not large. In 1990, the margin was about 15%. It requires detailed analysis to ascertain whether wages have been depressed by the government. According to government statistics, wages have been increasing faster than labour productivity since the late 1980s. It appears that the market has to be allowed a free play. One has to be mindful however of the one-time drop in wages of almost 10% in 1986, following a year of recession. Today, many businesses have to tolerate unfilled positions. VIII. Role of Local Enterprises The industrialisation movement of Singapore has largely ignored the local enterprises, which are mostly small and medium enterprises. There have been some government efforts devoted to developing local
32
Industrial
Development
in Asian
NIEs
Table 1.15: Small and Medium Enterprise Assistance Programs
Start-up
Growth
Expansion
(1) Local enterprise computerization program
x
x
x
(2) Local enterprise finance scheme (3)Product development
x
x
x
x
x
x
Going overseas
x
assistance sch. (4) R&D incubator program
x
(5) Skills development fund
x
x
x
(6)Venture capital
x
x
x
(7) ISO 9000 Certification (8) Local enterprise technical assistance program
x x
x x
(9) Local industry upgrading program
x
x
x
(10) Market and investment development assistance program
x
x
x
(11) Pioneer status/investment allowance
x
x
(12) Software development assistance program
x
x
(13)Automationleasing scheme
x
(14) Brand development assistance scheme
x
(15) Business development scheme
x
x
(16) Franchise development assistance scheme
x
x
(17) Total business plan
x
(18) Double deduction for overseas investment dev. Expenditure
x
(19) Overseas enterprise incentive/overseas investment incentive
x
Source: Adapted from Schein(1996), p.57 Table 3.1
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33
manufacturers to produce components for foreign companies, such as cables for computer manufacturers, but most of the components used by high technology companies remain necessarily imported. This has led to the criticism that multinational companies operate in their own enclave, and the benefits to the economy at large are limited. Another argument concerns the long-term sustainability of economic growth. The consensus is that indigenous research has to be developed, which in effect, requires local firms to substantially upgrade their technology level. By upgrading their technology level, their productivity will increase, which will then constitute the source of future growth. The government now realises the importance of local enterprises and a large range of assistance schemes is in place to foster their development. To show its dedication, the government established the Productivity and Standards Board. The major mission of this board is to enhance the development of small and medium enterprises. Table 1.15 shows the range of schemes in place to help small and medium enterprises. The long-term goal of the government is to nurture the local enterprises into multinational corporations. The development cycle is divided into four phases — start-up, growth, expanding, and going overseas. The schemes are designed to target enterprises at different phases. The financial and administrative costs of these programs are going to be substantial. Most of these programs do not involve simply financial assistance. They require vetting of individual companies, design and running of individual programs, monitoring and control. The social cost in terms of the reallocation resources is hard to estimate. IX. Technological Expertise within the Government The education system in Singapore is heavily biased towards mathematics, science and technical subjects. As pointed out in a previous section, more than half of the university and polytechnic graduates come from science and engineering programs. The consequence is that many officials in the civil service are also science and engineering graduates. To the extent that a government job is much
34
Industrial Development in Asian NIEs Table 1.16: Leaders of the EDB since 1961
Hon Sui Sen, Chairman
1961 -1968
Studied Physics at Raffles College, Singapore
E.J. Mayer, Managing Director
1961 - na
Former Director of Industrial Planning Department, Israel
I.F. Tang, Chairman
1968-1972
Born in China, Bachelor degree in science, National Central University of China, Master degree from Harvard, formerly UN official, a technical person
Chan Chin Bock, Chairman
1972-1975
Formerly teacher of an American high school in Singapore, free lance columnist, then employed by Ford public relations department, joined EDB in 1964, a deal maker
Ngiam Tong Dow, Chairman
1975-1981
Studied economics at the University of Malaya, joined EDB in 1961, went to Harvard Kennedy School in 1963, rejoined in 1964, stood for election in 1970 and became permanent secretary of the Ministry of Trade and Industry
P.Y. Hwang, Chairman
1982-1985
Biology degree from Cambridge, UK. Joined EDB in 1964, left for private business in 1965, rejoined in 1966. Singapore ambassador to EEC in 1978, a scholarly civil servant
Philip Yeo, Chairman
1986- present
Born in Singapore, obtained scholarship to University of Toronto for an applied science degree (1970), obtained master's in systems engineering from National University of Singapore (1974), MBA from Harvard (1976). Permanent secretary (defense) for logistics, research, and technology in 1979, chairman of National Computing Board in 1981, joined EDB in 1982 as Board member, an American style CEO
Tan Chin Nam, Managing Director
1986-1994
Formerly chairman of the National Computing Board
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35
sought after among university graduates, it is no accident that some of the best graduates from science and engineering programs are working for the government. The Economic Development Board, which is a high profile elitist agency in charge of implementing the foreign investment drive of the government, is rather explicit in its preference for employees with a science and engineering background. As shown in Table 1.16, almost all the chairmen in the history of the Board have a science and engineering background. The scientific expertise is clearly required in view of the fact that most of the companies that the government wants to attract are manufacturers, and in recent years, the emphasis has shifted to attracting strategic technologies rather than simply manufacturing operations. X. Appraisal In the present section, an appraisal of the industrial policy of Singapore is attempted. As manufacturing presently accounts for a quarter of economic output — somewhat higher in the 1980s — an appraisal of industrial policy cannot be conducted in complete isolation of economic policy at large. The line of enquiry will therefore first focus on the realisation of the narrow goals of industrial policy, subsequently on the impact of broad economic policy on public finance and the allocation of resources, and finally on the socioeconomic consequences of these policies. The industrialisation of Singapore has relied heavily on foreign direct investment. Singapore has been successful in attracting some of the largest industrial companies around the world to set up manufacturing operations in Singapore. In recent years, these operations have progressed to performing some research and development activities as well. These companies include: in chemicals, Dupont, Lubrizol; and in electronics and computers, Texas Instruments, Hewlett Packard, Digital Equipment Corporation, AT&T, Apple, Motorola, Seagate, Microsoft, Thompson, Siemens, Sony, Hitachi and Matsushita. As pointed out in a previous section, foreign companies account for more than half of manufacturing
36
Industrial Development in Asian NIEs
employment, and around three quarters of manufacturing output, value added, exports and capital expenditure. The large influx of foreign capital has brought with it modern technology. Many jobs have been created and fast economic growth has been accomplished. Foreign companies are hiring around 200,000 manufacturing workers, about one-eighth of the working population. Economic growth has been rapid. Between 1960 and 1996, the economy grew at a rate of 8.4% per annum, a major source of this rapid growth is derived from industrialisation. Unemployment rate has been low. Except for the recession years in 1985 and 1986, unemployment has consistently stayed below 3%. In fact, labour is in shortage and workers have to be imported from Malaysia and other countries in the region. The political situation in Singapore has been remarkably stable. Stable politics is both a consequence of fast economic growth and a reason for it, as foreign investors would not invest in a country high in political risk. The success of the economy has in fact strengthened and exalted the People's Action Party, which has dominated the government throughout Singapore's history. In terms of making a living of satisfactory standard, with reason for higher expectations for the future, the population is generally contented with what they have accomplished. Economic success and political stability came at a cost. The growth of the economy has been achieved through vast mobilisation of society resources. The Central Provident Fund (CPF) is well-known for its critical role in forcing people to save. Under the CPF scheme, which covers all workers in Singapore, every employee has to contribute 20% of his or her salary to his or her CPF account, and the employer has to contribute another 20%. The money in the CPF account cannot be withdrawn prior to retirement, except for some government-approved reasons such as the financing of public housing purchase, and the subscription of shares in newly privatised state-owned enterprises. The CPF scheme has led to a very high national savings rate. Together with contributions from the retained earnings of certain state-owned enterprises, the national savings rate in recent years has exceeded 50%.
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37
This means that of every dollar of economic output produced in Singapore, more than 50 cents go into savings, less than 50 cents is consumed. The CPF money is borrowed by the government, in the form of internal debt, to finance infrastructure building. This is the reason for the rapid build up of infrastructural facilities such as roads, airport, mass transit, and container terminals. The CPF can therefore be seen as a mechanism which directs income into the large-scale building of infrastructure. The income-earners do not have a choice over how their income is to be invested, the government makes the decision for them. It has been pointed out in a previous section that the government offers many incentives to attract foreign companies and support industries. Many incentives are fiscal in nature, offering tax holiday, investment allowance, R&D subsidies, and so on. These incentives are indirectly financed by taxes from other sectors of the economy. For salaries, the marginal tax rate varies from 5% to 30%. Profit tax is levied at 26% of taxable profits at present, used to be 27% in 1996. Starting from April 1994, a 3% Goods and Service Tax has been imposed. The GST covers almost all purchases of goods and services. After the GST was introduced, income tax was slightly reduced to alleviate the burden on low-income earners. In addition, the government also collects substantial revenue from motor vehicle taxes and the socalled Certificate of Entitlement, which is a ten-year transferable licence allowing the holder to own a motor vehicle. It should be pointed out here that the tax and subsidy system is becoming complicated and difficult to understand. Foreign investors cannot decide easily the subsidies that they are qualified for and the taxes that they need to pay, which increases the cost of doing business. On the side of the government, extra manpower is needed to implement the schemes and to ensure compliance. From an aggregate point of view, the high growth rate in Singapore must be viewed in the perspective of exceptional sacrifice over present consumption. In a nutshell, Singapore consumers consume only a small proportion of their income. They save a lot, and the government invests their saving in the building of infrastructure, which increases the capacity
38
Industrial Development in Asian NIEs
to generate higher income in future. Capital accumulation is therefore the principal source of growth. Some observers hold the opinion that Singapore cannot sustain its historical growth by capital accumulation. The return to investment is inevitably low at very high levels of investment. Future growth will have to come from improved technology and creativity, not just capital accumulation. The following remark from Krugman(1994) is representative of this line of thinking. "This (Singapore's) achievement seems to be a kind of economic miracle. But the miracle turns out to have been based on perspiration rather than inspiration: Singapore grew through a mobilization of resources that would have done Stalin proud." (italics added) The economic policies of Singapore have brought other consequences as well. One consequence is the continued subsidization of and reliance on foreign companies. Because of the power of the foreign investors and the influence that they have on the manufacturing sector, subsidization has to continue. The formulation of government initiatives, including R&D promotion and manpower training, has to take their interests into consideration. Another consequence, arguably more important, concerns the development of the local firms. The local manufacturing firms, which are mostly small and medium enterprises (SME), are relatively weak. The weakness of the SME undermines the dynamism and flexibility of the manufacturing sector. Their weakness is attributable to a number of sources. First, they have been largely neglected by the government until the 1990s, when the government began to take creativity and indigenous knowledge creation seriously. Second, the technology level of SME lags behind that of the foreign companies. There is a suspicion that the transfer of technology is in reality rather limited. The innovative and design activities have remained overseas. While local technicians and engineers do learn process technologies, these technologies are not readily transferable to SMEs. Third, despite the large volumes of manufactured exports, the brand name, the distribution channels, and the marketing plans, are owned and operated by the foreign companies.
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39
Local companies have not been able to take part in these functions. Some local companies have been quite successful in supplying parts and components to foreign companies. But the scope of forward integration into the production of end products is severely limited. Fourth, local firms cannot attract the best talents. The most respectable jobs among university graduates are jobs in the government, the statutory boards and the large foreign companies. These jobs can promise higher pay, higher prestige and more stable careers. Fifth, the pool of funds available for investment in the economy is rather limited. Most savings have gone into the Central Provident Fund and are managed by the government. These funds cannot be easily directed to fuel the growth of SMEs. Around the world, the financing of small companies is best carried out by private savings in a decentralised system. A system of this kind does not exist in Singapore. The government now recognises the strategic importance of a thriving local sector. In particular, the innovative power and the creativity of the economy are believed to stem from small companies. As the growth of Singapore in future depends on innovation and creativity, the growth of small firms becomes a matter of top priority. Both the Economic Development Board, which has been successful with foreign companies, and a newly established Productivity and Standards Board are working actively in promoting local SMEs. This is going to be a big challenge. As pointed out above, a lot needs to be done to improve the technology, the quality of manpower, entrepreneurship and the availability of investment funding. Moreover, as the number of SMEs is large, the usual targeting strategy of picking large multinational companies becomes cumbersome and tedious if applied to SMEs. XI. How the Challenges are Being Addressed Economic growth remains the overriding objective of Singapore, despite its present high per capita income. Broadly speaking, there are three ways in which an economy can grow: first, by enlarging the pool
40
Industrial Development in Asian NIEs
of manpower; second, by accumulating capital; and third, by improving knowledge, skills and technology. The first two sources of growth are facing severe limitations. The third source is expected to be the main source of future growth. The reality is almost 80% of males and 52% of females are in the workforce, and both figures have stagnated since 1991. The population is growing at a rate of 16 per thousand, a rate that has been gradually diminishing. Clearly, neither the work force participation rate nor the size of the population can grow by any significant margin. Imported short-term labour, and brain gain through overseas recruitment seem to be the only means of labour growth. Capital accumulation is also facing severe limitations. The problem here is the low rate of return to further investment. As Singapore has been investing heavily for decades, and the savings rate is standing at 50%, there are not enough profitable investment projects around locally. For this reason, the government has ventured abroad for investment projects in recent years. At present, about one-third of savings is being invested abroad. The government has launched a number of initiatives to address the challenges mentioned above. I. Improve skills and knowledge The idea here is, the quality of the workforce has to improve, since the size of the workforce cannot be easily enlarged. Workers have to acquire better skills and become more knowledgeable. If the workers can produce service of higher value, then they can justify higher wages, and the economy grows. The government sets the goal of becoming the Switzerland or the Netherlands of Asia, both Switzerland and the Netherlands being small and poor in natural resources. What is making this objective more urgent is the fact that a number of countries in the region, such as Malaysia, Indonesia, Thailand, Vietnam and China are developing fast, and are taking away the production of goods with lower value added. A number of examples will show the range of initiatives that the government has put forward in this respect.
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41
• The Design Centre was established to promote design awareness and the Design Institute was established to conduct training programmes under the National Design Council, which was established in 1991. • The government has set up training institutes as joint ventures with foreign companies, such as the Japan-Singapore Institute for Software Technology, and the Communications Institute of Singapore. The latter is a joint venture between Bell Labs and the National Computing Board. • New research institutes were set up, such as the Information Technology Institute, Institute for Molecular and Cell Biology and Institute of Manufacturing Technologies. • Introduced the R&D Assistance Scheme which helps companies, mostly multinational companies, in conducting R&D activities. The assistance is mainly in the form of research grants for designated research projects. A Product Development Assistance Scheme, on the other hand, is directed towards local firms. • An aggressive program is in place to recruit overseas talent, especially researchers in science and engineering. The major target areas are China, Hong Kong, India, and Russia. 2. Promote Innovative Activities The government recognises that future growth has to rely increasingly on innovative activities. In the past, Singapore was mainly an offshore manufacturing centre of multinational companies. Innovative activities did not figure prominently. According to the Economic Development Board, the government will address this challenge by promoting and supporting innovative projects, building innovation centres and enhancing innovation awareness. An Innovation Development Scheme was introduced in 1995 to put the initiatives in action. The Scheme will defray 50% of the costs of a qualified company, manufacturing or otherwise, in conducting innovative projects. The Scheme has an initial funding of S$500 million.
42
Industrial Development in Asian NIEs
3. Invest Abroad With abundant investment funds on hand, the government is devoting increasing attention to investment projects abroad. For example, the Economic Development Board has a joint venture with Malaysia to build an industrial park in Johor, Malaysia. There is also a joint venture with Indonesia to build industrial parks and oil storage facilities. Another joint venture involves building an industrial town in Suzhou, China. The government is also encouraging local companies to invest abroad, and become multinational companies. Under the Promising Local Enterprises 2000 programme, the government attempts to "nurture" 100 local enterprises to reach a sales turnover of $100 million by 2005. The EDB claims to have identified some 250 companies that are worthy of support. 4. Promote Service Industries While the government wants to maintain the importance of manufacturing in the economy, there are also plans to develop high value-added service activities. Many such activities are also being targeted and promoted by the government. The Economic Development Board, traditionally responsible for attracting multinational manufacturing companies, is now also working to attract multinational service companies. Services such as banking, venture capital, insurance, broadcasting, media, tourism, entertainment, and education are being actively promoted. Some definite plans have been put forward. For example, venture capitalists may be granted pioneer tax status, and capital gains arising from fund transactions may be tax-exemptible. A communication satellite is planned to be launched by 1999. To promote tourism, a cruise centre is under construction and Tang Village, a replica of a traditional Chinese village, is being planned, together with a number of other theme parks.
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43
XII. Total Factor Productivity — Why the Big Fuss? Total Factor Productivity (TFP) is an index used commonly in economics to reflect the technology level of a sector or an economy. The concept of technology level here is not the same as that used in the physical sciences. A high-tech industry, say semiconductor, may not show a rapid growth in TFP if resources are not used efficiently and effectively. In the US, the sectors that have shown large increases in TFP are transportation and telecommunications, not due to any scientific breakthrough, but rather because of government deregulation in aviation, trucking, and telephone services. TFP has caught much attention in Asia in recent years because studies have repeatedly shown that TFP in Asia experienced very little growth. The so-called "growth miracle" observed in Singapore and South Korea was largely a result of growth in capital (such as machinery, equipment, and factory space) rather than TFP. Despite all the claims made by governments that their countries are moving towards high technology, the evidence does not bear them out. Let us take a look at what TFP really measures. To start with, consider a worker sewing t-shirts. A moderately skilled worker may produce 10 t-shirts in one hour, a skilled worker may produce 15. So as a moderately skilled worker progresses to become a skilled worker, hourly output increases from 10 to 15. There is an increase in productivity of 50%. In this simple case, TFP will show an increase of 50% as well. Most production requires more than just labour hours. For a more realistic example, consider the making of potato chips. (Incidentally, this example applies equally well to the making of its high-tech counterpart — semiconductor chips.) Production requires machinery, and manpower to operate the machinery. Suppose 1 worker operating on 1 machine can produce 1 unit of chips in an hour. More can be produced if the worker has more machinery — say, 1 worker operating 2 machines can produce 1.8 units of chips in an hour. The increased output comes from added machinery, not improved technology. This is the problem
44
Industrial Development in Asian NIEs
that Singapore is feared to be facing — growth comes entirely from added machinery. TFP grows only if 1 worker operating on 1 machine can produce more than 1 unit of chips in an hour, but there is little evidence that this is happening in Singapore. On a separate note, despite the absence of TFP growth, wage rate has to increase. Labour productivity has increased from 1 unit of chips per worker hour to 1.8 units of chips per worker hour, an increase of 80%. The worker is becoming more valuable to the employer after the extra machine has been added and therefore commands higher wages. Rising wage rate is therefore an inevitable consequence of Singapore's drive for rapid capital investment. A slow growth in TFP is a symptom rather than a disease. The disease could be an inability to improve skills while the worker is on the job. Workers may be engaging in routine work which requires, or allows, little innovation. If workers keep on doing the same tasks every day without getting better at them, TFP cannot increase. Some argue that the workers in Singapore have to shift from one job to another, or from one company to another too often. The government engages continuously in worker training to suit the needs of the MNCs, and so workers may have to learn new skills all the time. Some believe the fixing of wages by the government has led to widespread job-hopping. Workers have to adapt to new working environment frequently, which may be yet another reason for slow improvement in skills. Finally, the disease could also be a general lack of ability among Singaporeans to innovate, because of a lack of entrepreneurial spirit in the private sector, a lack of private investment capital, or a lack of a domestic market of sufficient scale. Low TFP growth in Singapore could arise from many sources, and it is uncertain at the moment which are the true sources. Singapore is now working hard to increase its TFP. It is now a national target that TFP has to grow by 2% a year, in order to maintain an overall growth of 7%. Growth at this velocity is going to be a huge challenge. As Singapore is already investing roughly half of its annual output in the economy, further growth in investment is certain to bring
Singapore 45 very low return. On the labour front, there cannot be much increase in manpower. Unemployment is low and the women participation rate has not increased for years. TFP growth is therefore an importance source of growth. But the difficulty is that there is no sure way to increase TFP in any economy, Singapore notwithstanding. The Singaporean electronics industry, despite all its success in multiplying output in the 1980s, has shown very small increases in TFP. In fact, traditional industries such as clothing, tobacco, and ship repair have shown much higher increases in TFP. Whether the present schemes towards enhancing knowledge pool and innovation will be successful in raising TFP is still a question that awaits an answer. XIII. The Challenge of Malaysia The development of Malaysia poses both an opportunity and a challenge to Singapore. It is an opportunity because Singapore can invest, and help multinational companies to invest, in Malaysia. Nevertheless, many people see Malaysia as a serious competitor of Singapore in a number of ways. Malaysia has been growing rapidly. According to government statistics, since 1990, the Malaysian economy has been growing at an annual rate of 8.6%. Manufacturing has been a major driving force. The manufacturing sector has been growing at an annual rate of 13.2%. In 1996, the manufacturing sector accounts for 34.5% of economic output. As is the case in Singapore, the manufacturing sector is heavily driven by foreign companies. The major industries are electrical and electronic products; food, beverages and tobacco; and chemicals and chemical products. The Malaysia government has put in place a variety of incentives, including pioneer status, tax exemption, investment allowance, R&D allowance and tax deduction for export promotion. Penang is the centre of electronic products manufacturing. Large plants have been established by Seagate (hard disk drives), Intel (microprocessors), Motorola (chips and mobile phones), Dell (computers), Packard Bell NEC (computers) and Iomega (zip drives). The operations
46
Industrial Development in Asian NIEs
undertaken by these plants are basically assembly. Most design and research work is not undertaken here. The Malaysian government has been actively promoting a so called Multimedia Supercorridor, which is a strip of land, about 50 kilometer long, situated between Kuala Lumpur and the airport. The government plans to move the capital here from Kuala Lumpur. The area is not planned to become an industrial cluster. It is designed rather to attract research and design operations, especially companies in the telecommunications, computers and software industries. At present, the scheme is still in the planning stage. The emergence of Malaysia makes it clear that Singapore cannot remain an offshore manufacturing site for foreign companies. High wage rates and geographical limitations force Singapore to upgrade to higher value-added activities. In other words, Singapore has to aim at a niche that requires higher skill, higher technology and more knowledge. This need is well recognised and, as mentioned above, initiatives have been put forward to address it. Nevertheless, there are a few areas in which business originally based in Singapore will be drawn away by Malaysia. One example is the development of Port Klang in Malaysia. The development of this container port will make the shipment of Malaysian exports via Singapore unnecessary. The stock exchange at Kuala Lumpur is another example. It is already several times larger than that in Singapore, although there are a large number of Malaysian companies on the Singaporean stock exchange. In future, it will be harder for Singapore to act as a service provider for Malaysian businesses. XIV. Case Study 1. Electronics Industry The electronics industry is the largest industry in the manufacturing sector of Singapore. In 1996, the Electronic Products and Components industry, as it was formally known, accounted for 53% of manufacturing
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47
output. Back in 1986, its share was only 30%, reflecting its increasing importance in recent years. Annual output in 1996 amounted to S$62.7 billion. The industry is dominated by large foreign firms. Most of these firms are subsidised by the government. To illustrate, in 1996, the industry had 249 firms and employed a total of 128,033 workers. The firms that enjoyed pioneer status numbered 99, but because of their size, they employed 107,552 workers, or 84% of the total. The structure of the industry is that of a number of very large foreign firms surrounded by a fringe of small local firms the role of which is to serve the foreign firms. The industry is therefore heavily dependent on foreign firms for business, jobs, and technology. The mode of operation is still predominantly assembly and testing. The census of industrial production carried out by the government in 1994 provides some supporting evidence in this regard. In 1994, total value of output was S$49 billion, 70% of output value can be attributed to materials, 10% to operating expenses, 10% to operating surplus and only 6% to wages paid to workers. In other words, for every one dollar of output, only 6 cents went to workers, while 70 cents went to pay for materials, most of which were imported. According to this data, it may also be misleading to label the industry as capital-intensive, for only 10% of output value, namely the operating surplus, accrued to capital investment. The industry is therefore import-intensive, rather than labour-intensive or capital-intensive. Investment in the industry is largely carried out by foreign firms. In fact, foreign firms invest six times as much as local firms. Because of government subsidies, the return to investment is significantly higher among foreign firms than among local firms. From 1987 to 1994, government statistics show that the return to investment among foreign firms varied between 19.3% and 32%, which is higher than that of other industries. The return to investment among local firms was 14% in 1987, -2.9% in 1988, 1.4% in 1989, 2.7% in 1990, and 6% in 1991. The government then stepped in to subsidize the local firms, and return to local investment shot up to 43% in 1992, 51% in 1993 and 19.7% in 1994.
48
Industrial Development in Asian NIEs
Within the electronics industry, two products are of critical importance, namely, semiconductor devices and disc drives. These two products together account for more than 40% of all electronics output. Hobday(1994) observed that, in the case of semiconductors, the main operations were that of testing and assembly. In recent years, as a result of government encouragement, wafer fabrication plants have been set up by multinational corporations, such as TI, SGS-Thompson, Canon and Hewlett-Packard. In the case of disc drives, Singapore has been the world's leading exporter for a number of years. In 1994, Singapore produced S$ll billion worth of disc drives. The disc drive industry started off in the 1980s when a number of American manufacturers such as Seagate, Connor and Maxtor set up manufacturing plants there. Production volume boomed and in a few years, most disc drive manufacturers concentrated in Singapore. In sum, the electronics industry in Singapore plays a pivotal role in Singapore manufacturing. The industry was developed mainly through foreign direct investment. In the process, government subsidies play a critical role. The gains from this strategy are not easy to measure. Apparently, operations are still predominantly assembly and testing, and as a result the value that is captured by local workers is pretty small. The technology level of local firms largely falls behind that of foreign firms. Large-scale diffusion of technology to the local sector has yet to be observed. 2. Biotechnology Biotechnology is an area that has been targeted by the government for subsidy and development. The development of biotechnology in Singapore has not been easy. Without government initiative, it would not have emerged. In the first place, Singapore did not have a scientific base in chemistry and biology. University education in chemistry and biology lagged behind that of electronics and engineering. That Singapore has a small market for biotechnology products is also a handicap. There is no strong incentive that might induce foreign firms to invest there.
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Some efforts have been devoted to improve the scientific base and attract foreign investment. On the former front, the government set up the Institute of Molecular and Cell Biology. The institute is housed in a modern multi-storeyed building, with space for up to 400 staff, and is intended to be a research centre for the region. According to Yuan (1990), the three principal themes are cell regulation, infectious and genetic diseases, and plant molecular and cell biology. The institute recruits worldwide, offering competitive remuneration packages and generous research funding. It was observed however that three quarters of the workers were Asians. Yuan (1990) also suggested two deficiencies of the institute. First, there is little collaboration between the institute and the universities, and likewise with private companies. There is little sharing of information and facilities. Second, the institute is isolated from research centres in the US and Europe. A number of foreign companies are working in biotechnology related areas. Yuan (1990) divided them into two groups. The first group consists of pharmaceutical companies such as Beecham and Glaxo, and instrumentation manufacturers such as Spectramed. The second group consists of food processors such as Nestle and Kikkoman. Beecham's plant was built in 1977. It manufactures semi synthetic penicillins by chemical synthesis, with products being shipped mostly to Japan. Most R&D activities however are carried out in the UK. The government has granted the company pioneer status for five years and a subsequent tax rebate of 98% of production as incentives. Glaxo is a major British phamaceutical company. The facility in Singapore manufactures its anti-ulcer drug Zantac, which is for export to Japan and the US. No R&D is carried out in Singapore. Spectramed is an American company which makes biomedical instrumentation, especially devices for the measurement of blood pressure. The company received a grant of pioneer status for 10 years. No R&D is carried out in Singapore. In sum, the bioechnology industry of Singapore is still in its infancy. The research that is undertaken in government laboratories is not mature enough to be commercialized while the biotechnological products made in Singapore were developed overseas.
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Industrial Development in Asian NIEs
3. Information
Technology
The telecommunication infrastructure is provided by Singapore Telecom, which is a partially privatised state-owned enterprise. In 1996, Singapore had 1.5 million telephone subscribers, 404,000 mobile phone subscribers, 955,000 pager subscribers, and 129,000 internet subscribers (including those in the government, research labs, and universities). In 1992, the National Computing Board issued a report which outlined the vision of Singapore to become an intelligent island by year 2000. The report did not set out in definite terms how the goals were to be reached. It succeeded in signalling to the public the dedication of the government in developing information technology as a component of national development. IT2000, as the vision is usually known, is not a part of an industrial policy. It is basically an initiative to make use of advances in information technology to improve the quality and delivery of services. In other countries, steps in this direction have been taken by private firms without any government encouragement. In theory, government intervention is by no means essential. In broad terms, the report recognised the impact of information technology on construction and real estate, education and training, financial services, government, health care, information technology industry, manufacturing, media, publishing and information services, retail, wholesale and distribution, tourist and leisure services, and transportation. In short, information technology is regarded as having a profound impact on all facets of life and business. The goal is to, although not explicitly mentioned in the report, computerise every office desk, every home and every business, and interconnect them via fibre optics. Another goal is to provide economy-wide wireless access, so residents can communicate with each other even when they are away from home and office. If this goal is reached, then education services, entertainment, data interchange between businesses and between businesses and the government, banking services, retail services (in the handing of transactions and advertising) and so on will take on a different scenario. The reason for setting information technology at top
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priority is the recognition that the future of Singapore lies in its role as a business, service and transport hub of the ASEAN region. The small size of Singapore and the widespread use of English also makes the goal a little easier to achieve than most other countries. As of today, the goal of universal access and interconnection is still far from reality. The type of service that the government aims at requires a substantial upgrade of hard infrastructure. The telephone line network cannot support massive delivery of multimedia services. On the wireless front, access to satellite communications is inadequate. A more realistic goal is to introduce the full spectrum services in a small locality such as a university or science park. Although the development of information technology would require investment in hard infrastructure and the development of software, the impact of IT2000 on the producers of computers and software is going to be marginal. Although the demand for computers will be large, the demand will be met basically by imports. The design of software will also likely be carried out overseas. The effect of linkage on local industries is not expected to be large. In sum, IT2000 is a long-term goal which will take many years to accomplish. It is not a policy designed to increase industrial output directly, and it is not an integral part of industrial policy. It is launched to prepare Singapore to become a more service oriented economy. XIV. Conclusion The story of industrialization in Singapore is basically a story of foreign direct investment. The multinational corporations brought into Singapore technology, machinery, export markets as well as connections to a network of suppliers. Singapore was treated as an offshore production site that engaged mainly in assembly work. The products of manufacturing, most of which were exported, had high import content. This pattern led critics to claim that foreign companies were forming an enclave that had little linkage with the local sector.
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While the Economic Development Board has been credited with much of the success in attracting foreign direct investment, the source of the success lies largely in the economic parameters. In the past, the wage rate in Singapore was low, naturally in the early years, and intentionally kept so by the government in subsequent years. Now the wage rate is rapidly converging towards that of the developed economies, and the task of attracting foreign investment is becoming increasingly difficult. That is why even today, the government still attempts to determine wage rates through the National Wages Council. Investment has always been kept at a very high level and its financing comes from compulsory saving under the central provident fund scheme and from earnings of the state-owned enterprises. The massive mobilization of resources, which in the past found their way into infrastructure-building and extensive subsidization of industrial activities, made Singapore stand out as the prime location for offshore production among multinational corporations. In recent years, more investment has been directed towards overseas projects. Overseas ventures are still unfamiliar venues. Some Asian countries operate on customs and rules that are very different from those in Singapore. The rates of return to some of these investments have so far been rather low. Also of importance is the education system. The secondary school and tertiary educational institutes were, and still are, heavily biased towards the science and technical subjects. The purpose is to ensure a continuous flow of graduates that are ready for hire by foreign manufacturers. The continued emphasis of the government on maintaining the share of manufacturing in the economy also necessitates the training of a large number of science and engineering graduates. In recent years, a shortage of graduates in the other disciplines has become apparent, and the task of manpower planning is becoming increasingly difficult. There is at present much concern over the sustainability of rapid growth. The city state is running out of investment opportunities domestically and investments overseas take years to earn profits. The government is attempting to work in two directions. First, to create a knowledge base by heavily subsidizing R&D activities and recruiting
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overseas talents. Second, to assist local small and medium enterprises, making them more innovative and more technologically advanced. Work in both directions would take years to realise benefits. In the first direction, the research capability of Singapore is not yet mature. Research efforts are most conducive to success when there is a large community of researchers, each working on his own ideas in a decentralised manner. Informal linkages and a technology culture are prerequisites. This culture has yet to develop in Singapore. In the second direction, small and medium enterprises have been neglected for the better part of Singapore's history. It was only in recent years that the government began to support their growth. The challenge that the government is facing is huge. The development of small and medium enterprises requires a large and competitive domestic market (let the market choose the winner), a community of entrepreneurs who are willing to take risks (each firm has to do something different and learn from the mistakes of their own and that of others), clusters of firms with informal linkages (to build up networks of supplier user relationships, for information and risk sharing), and an adequate supply of private capital (to finance the growth of start-up firms). The existence of these prerequisites in Singapore is not readily observed. The government is assuming the responsibility of fostering the growth of small and medium enterprises. The Economic Development Board and the Productivity and Standards Board are actively pursuing the government's objectives by a wide variety of training programmes, subsidies, and tax incentives. This is a daunting task as, unlike in the case of foreign companies, there are numerous small and medium enterprises, and hundreds of them qualify for support. Whether these new directions will work for Singapore is still very much an open question. References 21 Years of the National Wages Council (1972-1992), Ministry of Labour, SNP Publishers Pte Ltd, 1992 A Vision of an Intelligent Island: IT2000 Report, National Computing Board, Singapore, 1992
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Business Week "Spotlight on Malaysia" May 5, 1997 Business Week "Don't look now, Singapore, but Malaysia is gaining on you" April 14, 1997 Economic Survey of Singapore, Ministry of Trade and Industry, Singapore, various years EDB Yearbook 1995/96, Economic Development Board, Singapore, 1996 Economic Report 1996/97 Ministry of Finance , Malaysia, 1997 Far Eastern Economic Review, "Innovate, Please" February 6, 1997 Foreign Equity Investment in Singapore 1987-1994, Department of Statistics, Ministry of Trade and Industry, Republic of Singapore, undated Hobday, Mike (1994) "Export-Led Technology Development in the Four Dragons: The Case of Electronics", Development and Change ,Vol.25, p.333-361 Huff, W.G. (1994) The Economic Growth of Singapore, Cambridge University Press (1995) "The Developmental State, Government, and Singapore's Economic Development since 1960" World Development, Vol. 23no.8, p.1421-38 Koh, Ai Tee (1995) "Technological Development and Technology Policy in East Asia: Prospects for Technological Leap-Frogging" Seoul Journal of Economics, Vol.8 no.2, p. 129-60 Kortum, Samuel and Josh Lerner (1997) "Stronger Protection or Technological Revolution: What is Behind the Recent Surge in Patenting?" mimeo. April Krugman, Paul (1994) "The Myth of Asia's Miracle", Foreign Affairs, November/December, p.63-77 Peebles, Gavin and Peter Wilson (1996) The Singapore Economy, Edward Elgar, UK Rao, Bhanoji and Christopher Lee (1996) "Sources of Growth in the Singapore Economy and its Manufacturing and Services Sectors" The Singapore Economic Review, Vol 40 no.l, p.83-115 Report on the Census of Industrial Production 1994, EDB Singapore, SNP Corporation Ltd, 1996
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Schein, Edgar H. (1996) Strategic Pragmatism — The Culture of Singapore's Economic Development Board, The MIT Press Tan, Chwee Huat (1996) Strategic Policies and Businesses in Singapore, Second Edition, McGraw-Hill Wilson, Peter (1996) "Sources of Economic Growth and Development in Asean: Closing and Summing Up" The Singapore Economic Review, Vol. 40 no.l Wong, Fot-chyi and Wee-beng Gan (1994) "Total Factor Productivity Growth in the Singapore Manufacturing Industries during the 1980s" Journal of Asian Economics, Vol.5 No.2 Wong, Poh-Kam (1995) "Singapore's Technology Strategy" in Denis Fred Simon (ed.) The Emerging Technological Trajectory of the Pacific Rim, M.E.Sharpe, New York Wong, Poh Kam and Chee Yuen Ng (1997) "Singapore's Industrial Policy to the Year 2000" in Seiichi Masuyama et.al.(ed.), Industrial Policy in East Asia, Nomura Research Institute, Institute of Southeast Asian Studies Wong, Poh Kam; Toh, Mun Heng, and Linda Low (1994) "Case Study of Singapore Science Park: Methodology Aspect and Management Strategy", Pacific Economic Cooperation Council Yearbook of Statistics Singapore, Department of Statistics, Ministry of Trade and Industry, Republic of Singapore, various years Yuan, Robert (1988) Biotechnology in Singapore, South Korea and Taiwan, MacMillan
56
TAIWAN: THRIVING HIGH-TECHNOLOGY INDUSTRIES AND SMEs Francis T. Lui and Larry D. Qiu Hong Kong University of Science and Technology
I. Introduction This chapter discusses another Asian economic miracle, Taiwan. From the theoretical perspective, an understanding of Taiwan's industrial policy is useful because it is an integral part of a development strategy that has scored already many successes. From the policy perspective, an economy like Hong Kong will also find the Taiwanese experience illuminating. The two places have many similarities. For example, the industrial sectors in both are dominated by small and medium enterprises. Both economies are export-led and scarce in natural resources. Yet Hong Kong is much less interventionist than Taiwan. If Hong Kong wants to have an industrial policy, it cannot afford to ignore the lessons from Taiwan, be they positive or negative. This chapter is divided into eleven sections. The next section reviews the history of development in Taiwan's industry. We shall then discuss a number of pertinent issues, the role of small and medium enterprises, the sources of manpower and technology, the role of government leadership and government provided incentives, the problems of industrial targeting, experiences in some specific industries and implications of the recent capital outflow. We shall also include an appraisal of the positive and negative aspects of Taiwan's experience with industrial policy. The concluding remarks are in the last section.
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II. Historical Background and Recent Development In every respect, Taiwan has become an industrialized economy. Although the manufacturing sector has shrunken in size in recent years, it is still close to 30 percent of the GDP. This has not always been the case. In 1952, it was only 12.9 percent. In fact, until recently, the industrial sector in Taiwan has outgrown its GDP. The average real growth rate of industry from 1962 to 1995 was 10.4 percent per annum, while that for real GDP was 8.8 percent. What has the Taiwan economy gone through before it reaches the current status? In this section, we outline the stages of development of its industry.1 During the Japanese occupation, the main industries were sugar, salt, camphor, textile, cement, fertilizer and other consumer basic necessities. Steel and shipbuilding were briefly developed, but destroyed by the Allies during World War II. The level of industrial production was also very low at the end of the war. After the outbreak of the Korean War in 1950, the Americans began to aid Taiwan's development. The nationalist government decided to give priority to electrical power, textile, and fertilizer. This policy is often considered to be important in laying down the foundation for future industrial and agricultural development. Industrial policy in the 1950s was dominated by import substitution. The government took an active role in promoting textile, food, cement, chemicals and a few other light industrial products by restricting import of these goods. In the sixties, when the protected light industries were big enough, further growth would require larger markets to be captured. A number of measures were used to promote exports. These included tax rebate for exported goods, low-interest loans, devaluation of the Taiwan currency and reform of the trade system. The exported goods were essentially labour-intensive products. Light industry expanded very quickly during this period. Some heavy industries, such as steel, shipbuilding, and automobile, were also developed.
1
Much of this section follows Hsiao (1994, chapter 2).
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Table 2.1: Changing Structure of the Taiwan Economy (% of GDP) Year 1952 1953 1954 1955 1956 1957 1958 1959 1960 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989
Agriculture 32.2 34.6 28.2 29.2 27.6 27.5 26.9 26.5 28.7 27.6 25.1 23.4 24.6 23.8 22.6 20.7 19.1 16.0 15.5 13.1 12.3 12.2 12.5 12.8 11.5 10.7
9.5 8.7 7.8 7.4 7.9 7.5 6.4 5.9 5.6 5.3 5.0 4.9
Industry 19.7 21.3 27.3 26.4 27.7 28.7 28.5 30.2 29.5 29.5 31.0 32.9 33.4 33.9 34.1 36.8 39.1 41.4 41.3 43.5 46.6 49.5 47.4 45.9 49.0 49.9 51.6 52.0 51.4 50.2 48.5 49.3 50.6 50.1 51.4 47.4 45.7 43.6
Manufacturing 12.9
15.6
19.1 22.0 22.9 22.3 22.5 25.0 26.5 29.1 29.2 31.5 34.3 36.8 32.8 30.9 33.8 34.2 35.6 35.9 36.0 35.6 35.2 36.0 37.6 37.6 39.7 39.5 37.8 35.6
Service 48.1 44.1 44.5 44.4 44.7 43.8 44.6 43.3 41.8 42.9 43.9 43.7 42.0 42.3 43.3 42.5 41.8 42.6 43.2 43.4 41.1 38.3 40.1 41.3 39.5 39.4 38.9 39.3 40.8 42.4 43.6 43.2 43.0 44.0 43.0 47.3 49.3 51.5
Taiwan
Table 2.1: Year 1990 1991 1992 1993 1994 1995 1996 1997
Agriculture 4.1 3.7 3.5 3.5 3.6 3.6 3.3 2.7
Industry 42.5 42.5 41.4 40.6 37.3 36.3 35.5 34.9
59
(Continued) Manufacturing 34.4 34.4 32.9 30.5 29.0 28.1 27.9 27.7
Service 53.4 53.8 55.1 55.8 59.2 60.2 61.2 62.4
Sources: Taiwan Statistical Data Book 1994, 1998; Free China Industry, various issues; Quarterly Journal of Economic Forecast, 1994; Social Indicators in Taiwan Area of the Republic of China, 1992.
In the seventies, the government decided to develop heavy industries. Taiwan shifted back to import substitution. In addition, the government launched the Ten Major Development Projects, which included a steel factory, a shipbuilding factory and building the chemical industry. The two oil crises of the 1970s and import quotas imposed by some foreign countries had induced the government to consider new industries in the 1980s. The government decided that high-value-added and high-tech industries which had good market potential should receive preferential treatment. A number of financial incentives, such as low-interest loans and matching funds, were introduced for the targeted industries. The government also set up committees to assess the relative strategic values of various industries. Tariff rates were lowered and certain trade restrictions were lifted. Expansion of industry continued, but at a slower rate. In the 1990s Taiwan has lost much of its comparative advantage in labour-intensive products. The government therefore tries to speed up the upgrading of industry. In addition, it has chosen 12 high-tech industries for development. In short, Taiwan has followed a model of active government intervention in its industrial policy. The particular choices and the
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instruments for implementation have been affected by changes in the economic and political environment, both locally and internationally. We should also note that export promotion has been an important policy since the 1960s. Taiwan has been an outward-looking and export-oriented economy for many years. III. Small and Medium Enterprises (SMEs) In Taiwan's economy, the small and medium enterprises (SMEs) play a very important role. This characteristic may have important implications for the success or failure of various government policies in general, and the industrial policies in particular. For example, one of the explanations for the different performance in the automobile industry in South Korea and Taiwan is the different average size of enterprises in the two economies, regardless of the similar government effort to promote this industry in the early years. Due to changes in the economy and industry, the term "SMEs" in Taiwan has had different definitions in different time periods. In 1967's "SMEs Assistance Guideline", the law enacted by the Executive Yuan (the cabinet in Taiwan), a manufacturing SME was defined as "a manufacturing enterprise having total assets of less than NT$5 million, with no more than 100 persons regularly employed". In 1982, it was modified as "a manufacturing, processing or handicraft enterprise having a paid-in capital of less than NT$40 million, and having total assets of no more than NT$120 million."2 A well-known characteristic of Taiwan's economic development is that SMEs played a very important role, facilitated by their flexibility and vitality. They can adjust nimbly to the rapidly changing world and hence compete successfully in the international market. SMEs contribute to Taiwan's economy in many ways such as employment, output and
2
See Small and Medium Enterprises Overview in Taiwan, 1986, p. 18 in (Chinese).
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exports. From 1961 to 1988, the ratio of the number of SMEs to total number of enterprises was over 97% in every single year, and for three years the ratio was even higher than 98%. The total number of SMEs in manufacturing increased from 51,389 in 1961 to 152,871 in 1988. SMEs in Taiwan concentrate on labour-intensive industries and therefore contribute substantially to employment in 1966. They absorbed 43 percent of the total employment in manufacturing. This figure increased to 68 percent in 1986. See Table 2.2 below for the distribution of labour employed by SMEs in various manufacturing sectors. Moreover, in the manufacturing sector, SMEs' output represent 45 percent of the total output.3 Export is often considered as an engine of rapid growth in many newly industrialising economies including Taiwan. In Taiwan the percentage of manufactured goods in total exports has risen from a mere 8% in 1953 to nearly 94% in 1985. In 1985, 65 percent of manufacturing exports came from SMEs. Moreover, Taiwan's SMEs have a higher relative export-intensity, defined as the ratio of export sales earnings to total sales earnings, than that of large firms. About 71 percent of their products are exported in 1985. That is, SMEs are more export-oriented and they are subject to more international competition, compared to large firms. This is a distinctive feature of Taiwan's economic development, and is contrary to the experience of many industrialized countries. The success of SMEs in export performance is due to the fact that Taiwan has comparative advantages in labour intensive products and SMEs just concentrate on the production in these sectors. Although SMEs' business activities are generally successful as indicated above, it is not always easy for them, especially in the later period. They often encounter some difficulties which larger enterprises are able to avoid. They lack working capital and it is hard for them to adopt a high level of technological know-how. This restricts their
3
Chou (1995).
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Table 2.2: Share of SME Employment in the Private Manufacturing Sector in Taiwan (%) Sector
Manufacturing Food Beverages & Tobacco Textiles Apparel & Accessories Leather Products Wood & Bamboo roducts Paper Products & Printing Chemincal Materials Chemical Products Petroleum & Coal Rubber Products Plastic Products Nonmetallic Minerals Basic Metals Metal Products Machinery Electrical Products & Electronics Transportation
1986 SMEs < 100 persons*
1986 SMEs < 300 persons
1991 SMEs < 100 persons
43.08 45.99 31.94 30.22 34.78 32.06 59.75
66.51 72.53 84.74 54.97 64.18 67.88 79.22
52.33 47.30 24.33 40.89 46.65 28.65 65.21
73.67 72.73 57.49 67.19 75.20 56.06 88.73
65.26
81.34
61.36
81.49
28.08 64.78 44.91 37.52 40.56 58.25 64.95 75.90 72.06 23.74
43.69 89.48 100.00 53.93 74.06 83.64 88.97 90.82 88.01 40.47
28.05 22.24 100.00 50.59 57.91 67.80 63.11 79.97 79.49 31.92
46.30 63.04 100.00 70.47 85.11 85.48 87.50 92.70 93.47 50.26
40.33
66.27
45.77
68.21
1991 SMEs < 300 persons
Precision Instruments
36.70
60.12
58.43
83.05
Miscellaneous
45.78
74.22
64.18
82.81
Source: San (1995) * The number of employees in a SME is less than 100 persons. The other columns are similarly defined.
growth. Moreover, Taiwan's SMEs are confined to labour-intensive and mature technology industries. As the economy's comparative advantages in these sectors erode, SMEs will face more difficulties. This also calls for government help.
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Government help for SMEs could take various forms. For example, the public sector indirectly supported the export-oriented SMEs and made the SMEs more successful. When Taiwan began to adopt the export expansion policy in the early 1960s, public enterprises did not get involved in the exporting business. This avoided resource competition between public enterprises and the private SMEs, which is possibly unfair competition. Instead, the public enterprises assumed the responsibility of supplying raw and intermediate materials in stable quantities and at reasonable prices to the downstream highly export-oriented SMEs. As such, there was a very natural division of labour between the governmentcontrolled public enterprises and private SMEs. Thus, the upstream public enterpirses played a very supportive role in the development of the downstream SMEs. IV. Sources of Manpower and Technology The success of an economy's technological development and industrial upgrading depends critically on the availability and continual accumulation of embzodied and disembodied human capital. In this section, we outline the basic facts about Taiwan's manpower situation and the sources of technology. 1. Manpower and Education The educated manpower necessary for the development of industry and technology in Taiwan comes from a number of sources. During the colonial period, the Japanese rulers wanted to make Taiwan a major supplier of agricultural products. To increase their productivity, farmers had to acquire some basic knowledge of modern agricultural technology. The Japanese therefore placed a lot of importance on elementary education. Schooling rate for boys aged between 6 and 11 increased from 21 percent in 1917 to 81 percent in 1943, while that for girls went up from 4 percent to 61 percent (see Lee, 1991). After Taiwan's return to the Nationalist Government, universal primary school education became an official policy. This target was achieved by 1960.
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There was also significant development in Taiwan's secondary education. Since the early 1950s, student enrollment in middle schools had been increasing at an average rate of over 15 percent. In 1968, the government changed the policy of universal education so that its length increased from 6 to 9 years. By 1986-87, the transition was complete. More than 99 percent of elementary school graduates were admitted into middle schools. There are two major types of high schools in Taiwan. The conventional schools prepare students for university education in the future. The vocational schools provide technical training in manufacturing, commerce, or related disciplines. Enrollment in both increased rapidly. In 1950, enrollment rate was below 10 percent. In 1988, more than 80 percent of middle school graduates continued their education in high schools. The government had plans on lengthening universal education to 12 years. It should be pointed out that the curriculum structure of vocational schools has been changing in response to market conditions. As is evidenced in Table 2.3 below, the proportion of students taking agriculture as their discipline has declined by 90 percent, but that for industry has almost doubled. Taiwan's tertiary institutions have been expanding rapidly in the course of Taiwan's economic growth. The number of students receiving higher education during the academic year 1997-98 was 738,500, an increase of 73 times when compared to 1952-53. The number of students in graduate schools went up from 437 in 1960-61 to 48,619 in 1997-98. The last number is quite big, given the size of Taiwan's
Table 2.3: Students Receiving Vocational Education by Discipline
1952-53 1997-98
Agricultural
Industrial
Commercial
36.8% 3.6%
22.1% 42.1%
32.1% 38.8%
Source: Taiwan Statistical Data Book, 1998.
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Table 2.4: Students Returned from Abroad 1952-61
1965
1970
1975
1980
1985
1990
1995
1996
1997
48
120
407
569
640
1350
2863
6272
2760
2968
Source: Taiwan Statistical Data Book, 1998. Note: Owing to the cancellation of government subsidy, some of the returned students were not enrolled since 1996.
population. This is important because they are the people who can play a crucial role in developing high-tech industry for Taiwan. The expansion in higher education was made possible by the willingness of the government to spend large sums of money. From 1950 to 1992, expenditure in this area had been increasing at an average annual growth rate of 21.7 percent a year.4 Students in universities also seemed to respond to market opportunities. The proportion of students majoring in engineering rose from 20 percent to 28 percent from 1960 to 1997, which was in line with the growing importance of industry in the economy.5 A very important feature of the scientific and technological manpower in Taiwan is that many university graduates go overseas to study for advanced degrees. As an illustration, the average number of students studying abroad in the 1980s was 5,894.6 Again about one third of them studied engineering and 15 percent of them did business administration. In earlier years, more than 90 percent of the students would not come back. However, in recent years, the brain drain situation has changed significantly. The number of students who have returned from abroad has increased by several times when compared to earlier years. There could be many reasons why the change
4
See Hsiao (1994, chapter 7). See Taiwan Statistical Data Book. 1998. 6 Ibid. 5
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has occurred since the early or mid 1980s. The most important ones seem to be the active promotion by the government and the narrowing of income gap between North America and Taiwan. This large pool of returnees definitely improves the technological sophistication of the manpower in Taiwan. In addition to formal schooling, there are various training programs organized by the government. The more important one is probably the 5-year plan on training industrial technicians supported by the Industry Bureau of the Ministry of Economic Affair (MOEA). The plan, which began in July 1990, had already trained more than 50,000 people during the first three years of its operation.7 Although Taiwan has put in great efforts in developing its technology manpower, the supply of high-level R&D people is still regarded to be insufficient. The government has resorted to assigning special training responsibilities to various universities and institutes. For example, Tsing Hwa University has to train traditional industrial technicians, while the Chinese Productivity Centre takes care of quality control. The Industrial Technology Research Institute (ITRI) and Biological Technology Centre provide training on strategic industries. However, there is often doubt about the scope and extent of these program (J-C Wang, 1995).
Table 2.5: R&D Expenditure by Type of Research (in %)
1984 1989 1994 1996
Basic Research
Applied Research
Technological Development
14.1 10.5 14.9 13.8
32.2 36.2 35.2 29.6
53.6 53.3 49.8 56.6
Source: Taiwan Statistical Data Book, 1998.
1
See Hsiao (1994, chapter 7).
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2. Sources of Technology New technology may be generated from domestic R&D activities or imported from foreign countries. There are two major categories of R&D activities in Taiwan, those which are publicly funded and those coming from the private sector. We shall discuss both categories and the role of foreign technology. The following table shows the distribution of funds by type of research carried out domestically. 2.1. Publicly Funded R&D In publicly funded research institutions, the division of labour is clear. The objectives of each of the major institutions are well defined. Some specialize in basic research, others in applied research, development or product commercialization. Academic departments in universities and the Academia Sinica are responsible for doing basic research. Funding comes from the Ministry of Education (MOE) and National Science Council (NSC). The MOE is responsible for basic training, while the NSC supports specific research projects. Four universities, National Taiwan, Tsing Hwa, Chiao Tung, and Cheng Kung, have each established a research institute with specialized strengths. Applied research consumes large sums of money. It also needs extensive interaction with the government. Many ministries and councils of the government have directly provided support for professional research organizations. The MOEA has established about 15 organizations for industrial and technology development. By far the most important is the ITRI, which in 1994 employed more than 6,000 people, 560 of whom held doctoral degrees.8 The main objectives of ITRI are to engage in medium and long-term strategic research and short-term product or process development. Research results are shared with the private sector.
See Lin (1996). Also see Section VI for further discussion about ITRI.
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Since research projects of these institutes are mainly funded by the government, its policy towards scientific research significantly affects the direction and speed of technology development. In 1978, the first national meeting on science and technology was held. It identified four major areas on which research in Taiwan should focus. This method of targeting research areas was followed in subsequent meetings. Eight more items were added to the list of major research areas. The meetings also made recommendations on R&D funding. In 1982, it was decided that R&D expenditure as a share of GDP should increase from 0.6 percent to 1 percent. In 1986, the target was revised. It was planned that the share should go up to 2.2 percent by 1996. It was also recommended that expenditures on basic research should increase to 12 percent of the total research expenditures. These numbers were revised again in the 1991 meeting. R&D expenditures should be 2.8 percent of the GDP by 2002. It should be reminded that these were only planned targets whose implementations were subject to the uncertainties of changes in government policy and responses from the private sector. From 1984 to 1992, actual research funding provided by the government went up at the average annual rate of 17 percent. In 1993 and 1995, the rate slowed down to 6.6 percent. By 1995 there was no real growth at all. It is clear that some of the targets decided in the meetings could not be met. Many of the long-term research plans have to be slashed or revised. The above figures do not reveal an important feature of research in Taiwan. By far the largest share of funding goes to engineering. In 1984, R&D expenditure on engineering constituted 66.3 percent of total R&D expenditures. In 1996, it had climbed up to 77.9 percent.
Table 2.6: R&D Expenditures As Percentage of GDP year
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
%
1.01
1.14
1.24
1.39
1.66
1.70
1.78
1.76
1.80
1.81
1.85
Source: Taiwan Statistical Data Book, 1998.
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The predominance of engineering-related disciplines in Taiwan is hence clear. 2.2 R&D in the Private Sector As is shown in the following table, the share of government funded R&D has been declining in Taiwan. The growing importance of R&D in the private sector seems to imply that market conditions have become more favourable to investment in technology. However, we must also look at the incentives provided by the government. The government has introduced a number of incentive schemes as the instruments to encourage investment in R&D in the private sector. More details are provided in Section VI. Here we outline the two schemes which are more closely related to technology. They are the program on Encouraging Development of New Products and the program on Development of Targeted Leading Products (DTLP). The first scheme provides matching funds for product development by private enterprises. When it was first initiated in November 1983, companies receiving the award did not have to pay back the loaned funds if their projects failed. Some companies therefore deliberately failed in order to avoid the payment. In December 1984, the MOEA launched the Development of New Industrial Products (DNIP) program as a replacement. Under the new scheme, the recipients are obliged to repay the matching funds irrespective of whether their projects are
Table 2.7: R&D Expenditure by Source of Fund Government
1984 1994 1996
Private
amount
%
amount
%
14,197 55,286 58,874
63.3 48.2 42.5
8,246 59,396 79,694
36.7 51.8 57.5
Source: Taiwan Statistical Data Book, 1998.
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successful or not. The Bureau of Industry of MOEA has also established a committee consisting of hired experts and representatives from various government agencies to review applications for the fund. A year after a product is developed and marketed, the recipient has to repay the loan by instalments. The longest repayment period is five years. The failure rate of developing new products has been low. However, the success rate of actually commercializing these products has not been very high.9 The DTLP program is aimed at increasing the incentive to apply for matching funds from the DNIP program. Essentially, it supports development of high-tech or strategic products that have great market potential. If an application is successful, the government will invest 50 percent of the cost. The other 50 percent may be obtained through the DNIP program. Because the companies have to bear very little of the costs, the program has been rather popularly received. 2.3. Technology Transfer from Direct Foreign Investment The total value of direct foreign investment in Taiwan is substantial, but not overly so. From 1952 to 1995, the combined nominal value (which has not been properly discounted to obtain the present value) is over USD 22 billion. In theory, the investment should bring new technology to Taiwan. In a survey conducted in 1972, out of 185 domestic enterprises, only 8 percent used foreign technology. However, out of the 126 foreign enterprises being surveyed, 86 percent employed foreign technology (Hsieh, 1991). The foreign technology being used can benefit the domestic enterprises. For example, Singer Company opened a sewing machine company in Taiwan in 1964. It was very active in helping Taiwanese factories to manufacture component parts for the sewing machines. This included training technicians, introducing quality control and new
9
See J-C Wang (1995).
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techniques in manufacturing and designs. These suppliers of parts later also sold their products to domestic sewing machine factories. As a result, the industry developed quickly. By the late 1970s, Taiwan had become the world's leading exporter of sewing machines. Although it is easy to find many more success stories, it is difficult to assess the overall effect quantitatively. Nevertheless, it should be safe to believe that direct foreign investment has indeed contributed to the transfer of technology in Taiwan. V. Government Leadership Government intervention is visible in Taiwan during the stage of rapid economic development. Government assistance can take many forms, such as providing leadership, commitment, incentives and protection. In this section, we would discuss the leadership and commitment made by the Taiwanese government in various periods of industrial development. Incentives are the subject of the next section. Although protection affects the development of the industries, negatively or positively, it is generally a trade policy and so is not considered in this report, which has its focus on industrial policy. 1. Government Leaders and Organisation While the government is always determinate to pursue rapid economic growth and industrialization, it also selects some particular industries and provides help to them. The semiconductor industry is one example of such targeting. Here in the discussion it serves to provide a concrete example of government leadership and initiative. In early 1970s, Y.S. Sun, who became Premier later in 1978, together with a group of overseas Chinese engineers in the United States, played the key role in launching the semiconductor industry in Taiwan. To create an organizational capacity for industrial targeting within the state, in 1973-74, Y.S. Sun established the Industrial Technology Research Institute (ITRI). With regard to semiconductors, the Electronics
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Research Service Organization (ERSO) was set up under ITRI to develop the integrated circuit (IC) project. The state initially funded ITRI and ERSO entirely. Later on, the state reduced its financial contribution to these two organizations. By 1988, ERSO received only about 20-25% from the government, with the rest coming from the private sector in the form of fees paid by companies for new product development, while in ITRI 55% of funding came from the government and 45% from the private sector. However, in the later period of time, the state mainly initiated and financed long-term projects developed by ITRI and the private sector generally supported short-term projects in ITRI.10 With the help of Y.S. Sun, in 1974-75, Taiwan's National Science Council (NSC) launched the "large scale project on microelectronics". In the early stage, the project received criticism and skepticism from every level of the economy, including some government agencies at various levels. However, due to his power and strong influence, Y.S. Sun was able to overcome all objections and obstacles in this regard and so got the project moving. The central goal of the semiconductor plan was to move technology out of the laboratory after the innovation. One effective way to achieve the goal is to form a joint state-private venture. However the private sector was reluctant to participate because of the high risk in the IC business. The Ministry of Economic Affairs (MOEA) first tried to attract local capital investment, but it was not successful. Later, MOEA had to use some influence to get contributions from some private companies. In so doing, the government reassured the private companies by creating ITIC as an IC venture. Then, ITIC became a subsidiary of banks, private investors, and the government. ITRI provided 40 percent of fund to the venture. In a similar aspect, United Microelectronics (UMC), a joint state-private sector venture, was created with 44% state ownership.
Meaney (1993).
Taiwan
73
In 1978 Y.S. Sun became Premier and he wanted more formal organizational support for high technology projects in general and semiconductors in particular. He set sup eight technical areas including IC under his economic plan. One of the developments in implementing the plan was the setting up of the Science and Technology Advisory Group (STAG) under the Executive Yuan. The idea of establishing the STAG was that Sun wanted to have an organizational capacity at a higher policy level whose members have independent ideas to function as a kind of substitute for his personal influence. The STAG consisted of foreign advisers as well as local experts. It formulated action plans for the rapid development of science and technology. In 1982, to provide a base for expanding Taiwan's R&D capacity, ITRI was considering whether or not to focus the semiconductor program on VLSI technology. The program, however, met with a lot of objections about the cost of VLSI and its ambition. Thus, the government did not go alone to start the program immediately. Instead, it conducted studies on the feasibility of the program. After a year of discussion and presentations, and because of the advancement of state-of-the-art DRAM technology, the Executive Yuan had a special review of the VLSI plan and finally approved it in 1984. In the pursuit of developing VLSI technology and moving it into the private sector, the government formed a second company, Taiwan Semiconductor Manufacturing Co. (TSMC), which was a joint venture formed by the Taiwan government (49%) Phillips (27%) and local private investors (24%). Later on in Section VIII (case study), we argue that the TSMC was successful in terms of the goals of the state's VLSI plan and the IC development program. It helped develop and distribute technology and stimulate private investments. There were many other state agencies which were created for industrial development. The Industrial Development Bureau (IDB) under the Ministry of Economic Affairs (MOEA) is one of the state agencies which are responsible for promoting industrial growth in the private sector. The Office of Science and Technology Advisors (OSTA), also under the direct control of the MOEA, administers the allocation of R&D grants to private firms.
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Thus, "states at certain moments can be (a) catalysts and (b) relatively autonomous actors in an industry's development". 11 However, it must be warned that government leadership and involvement does not always lead to success. The case study in Section VIII on Taiwan's automobile industry development is a case of a lack of government vision and policy failure. Nevertheless, the above discussion attempts to point out that without government leadership and commitment, we may not be able to achieve something which we find worth pursuing later on. One of the important lessons which we learn from the Taiwanese government's leadership which led to the successful development of semiconductor industry is that (1) there should be leadership and commitment from a core of high level individuals such as Y.S. Sun, and (2) the committees which design and implement the plans, normally consisting of experts in the area, should be able to maintain a high degree of autonomy from other branches of the bureaucracy.
2. Economic
Planning
In the next section, we will discuss various ad hoc or specific policies designed by the Taiwanese government to assist the growth of some particular industries. However, the government also designs medium and long term plans. By early 1970s, Taiwan's exports began to face more challenges than ever before. They met loud protectionist threats, especially from the United States; wages were rising faster than their competitors'; other newly industrializing countries were moving into the same markets; and the domestic physical infrastructure was over stretched. To assert its strong economic leadership, the government launched the Sixth Four-Year Plan (1973-76) which renewed the emphasis on export orientation. The plan also signaled the government support for advances in petrochemicals, electrical machinery, electronics, precision
"Meaney(1993,p. 190).
Taiwan
75
machine tools, computer terminals and peripherals, and other such products. These priorities were carried forward into the Seventh SixYear Plan (1976-81). The new plan, however, gave an even more prominent role to the state to reduce Taiwan's vulnerability to fluctuations in the prices of key intermediates. The second oil shock during 1979-80 spurred a shift in the emphasis of industrial policies toward non-energy-intensive, non-polluting and technology-intensive activities like machine tools, semiconductors, computers, telecommunications, robotics and biotechnology. The TenYear Plan of 1980-89 and the Four-Year Plan of 1982-86 reflected this change in emphasis. In addition to medium and long term plans for industrial development, the government also promoted basic research and innovation to improve the economy's growth potential. As Taiwan's predominant SMEs do not have the ability to undertake enough technology investment by themselves, the government provided incentives for investment in high-tech industries, provided other incentives for R&D activity, and offered financial aid for education and training. Moreover, the National Science Council has published a series of national Science and Technology Development plans. In line with these plans the government established and funded research and development institutes in strategic areas. VI. Policies and Incentives 1. General Discussion 1.1. Widening and Deepening the Industrial Sector "When policy-makers in developing countries concern themselves with promoting industrialization, they generally have two things in mind. First, they want to increase industry's share of total output and the industrial labour force's share of total employment; and second, they want to see a shift within industry toward higher value-added activities (meaning activities with higher average labour productivity). The former is referred to as 'widening' the industrial sector, the latter as "deepening"
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the sector. In general, widening industry is more important in the early stages of industrialization, and deepening it is more important in the later stages."12 In Taiwan, because of the healthy growth of SMEs in the industrial sector as well as in other sectors, which is encouraged by the government under the "SMEs Assistance Guideline" as discussed in Section III, the goal of widening the industrial sector has been achieved more easily and earlier, as compared to deepening the sector. In this and the next section, we will focus on the government's effort in deepening the industrial sectors in Taiwan. 1.2. General Incentives versus Industrial Targeting There are in general two types of government policies which can be adopted to promote industrialization. The first type consist of general incentives that act directly on the cause of industrialization. They attempt to encourage the accumulation of factors, without discrimination. An example of this type is the policy of promoting free trade or general education. The second type consist of government polices that focus on the end result of industrialization (structural change). They attempt to encourage the growth of particular industries. An example of this type, also called industrial targeting, are subsidies provided for a particular sector, say the automobile industry. 1.3. The Need for Policies and Conditions for Success It is economic common sense that government intervention will be better justified when there is market failure. But, the question is what defines market failure in Taiwan that calls for government policies and what conditions make the government policies possible. A situation identified in the early stage of Taiwan's economic development is "the
12
Dollar and Sokoloff (1993, p. 5).
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77
imperfect tradability of key inputs (and technologies) associated with modern-sector production, as well as some increasing returns to scale in these activities."13 Because of this, the rate of social return to R&D investments was extremely high, but expected rate of return to individual investments was low. This leaves the room for government coordination and participation. The Hsin-chu Science-based Industrial Park discussed below is an example of government assistance to overcome the coordination failure in this regard. Common measures which could coordinate private investment include credit subsidies, tax incentives, administrative guidance and public investment. However, the existence and identification of market failure and the willingness of government participation do not guarantee the success of government intervention. There are many examples of "government failure" in many economies in the world. Two important obstacles for successful intervention are rent seeking and incomplete information. Taiwan's government is able to overcome these obstacles relatively better than some other countries' governments. Strong government leadership in Taiwan helps avoid influences from various interest groups. In fact, the interest group did not have much power in the early period, partly due to the dominance of SMEs in the economy and industry. Government leadership has been discussed in the preceding section. To reduce the information problem, the government in Taiwan was able to consult experts (domestic and international) for advice and conduct studies for proposed plans. This can also be seen from some cases discussed in this chapter. 2. Industrial Policies Before 1981 The important general incentives in Taiwan in the 1960s and 1970s concerned the trade regime, interest rate and monetary policy,
13
Rodrik (1995).
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Industrial Development in Asian NIEs
and education. The policies in the 1960s were mainly general incentives which were available to all industries, while some of those in the 1970s and early 1980s were incentives used for targeting specific industries. Regarding trade policy, Taiwan maintained stable real exchange rates at levels that encouraged exports. To promote exports, a specific policy was also adopted to accord rebates on import duties for imported inputs and supply credit to exporters. Although these are export incentives, they had the effect of encouraging the accumulation of factors, particularly skills and technology, which are essential for industrial development. As for monetary policies, real deposit rates were set generally significantly positive to encourage savings. 3. Hsin-Chu Science-Based Industrial Park (HSIP) When Y.S. Sun became Premier in 1978 after the election of Chiang Ching-kuo to the presidency, the goal to develop the capital- and technology-intensive industries remained unchanged. One of the key measures proposed to achieve the goal is the promotion of cooperation between business and educational institutions in R&D activities. However, R&D involves high risk and uncertainty in returns to investment. To encourage this type of investment, the role for a government is to reduce the uncertainty and raise the profitability. This led to the establishment of the Hsin-chu Science-based Industry Park (HSIP) in December 1980. Hsin-chu by that time was a place where several graduate research institutes in science and technology were already located, such as Tsinghua and Chiaotung Universities, two of Taiwan's best educational institutions in science and technology. It was chosen for the site of the Park also because of its easy access to many major harbours, airports and the metropolitan Taipei area. The total size of the Park is 2100 hectares which includes an industrial zone, residential zone, research zone, reserve area, agricultural area and public utility area.
Taiwan
79
Also "it was the first industrial park developed exclusively for importing high-technology industries in Asia. Great emphasis is placed on development and engineering, in addition to production."14 The idea of gathering many high-technology enterprises at one place is to derive certain advantages from external economies for all the individual enterprises. The HSIP makes it easier for enterprises to recruit from a highly trained labour pool, to obtain timely and quality repair, maintenance, marketing, consulting and other services. The HSIP can be regarded as the most visible physical symbol of Taiwan's economic policy during that period of industrial and economic development. The government provided various incentives for approved investors investing in HSIP. • "Tax exemption. Central to this approach is an income tax holiday for five consecutive years. Such an approved SIP enterprise is also exempted from the business tax and the commodity tax — completely if the goods produced are for export or partially if the goods manufactured are for sale on the domestic market. A similar distinction is made in exemption from the import tariff between finished products exported and those sold domestically. • Tax ceiling. Park enterprises enjoy a 22 percent ceiling in the income tax they pay. In contrast, other business pay a maximum income tax of 25 percent. • Tax credit for stockholders. If a Park enterprise reinvests its undistributed earnings in the enterprise, the amount can be treated as a credit against the stockholders consolidated income. • Reduction of land rent. The government may reduce or even completely forgive the land rent payable by a Park enterprise if the technology of the latter is regarded as especially desirable."15 To foster the investment and R&D applications, the government also injected capital to build joint ventures with private investors. Patents 14 15
Chen (1986). Wu (1985, p. 41).
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Industrial Development in Asian NIEs
and know-how from the private sector could be counted as high as 25% of total equity contributed by private investors. However, to avoid the risk of excessive government control on joint ventures, the government agency, the National Science Council which oversees the HSIP, may only invest up to 49% of the capital of a Park joint venture. Therefore, private sectors remain as majority share holders and they only need to contribute financially no more than 26% of their own capital in order to start up an enterprise in the HSIP. 4. Science and Technology Program On August 28, 1982, the Executive Yuan promulgated the Science and Technology Program to promote knowledge-intensive industries. Under the supervision of the Executive Yuan, there are many government agencies involved in the planning and implementation of the program, which has the following main aspects: • Expansion of R&D expenditure. • An intensified program to educate, train and recruit sophisticated S&T talents. • Promotion of HSIP activities. This is probably among the most active — and incidentally most visible — part of the entire effort. • Provision of financial and tax incentives and simplification of exportimport procedures for Park enterprises. • Establishment of a cooperative research and appraisal system. • Acceleration and expansion of international technology transfer. • Expansion of equipment, library collections, data banks, international sources of information and references on international standards, industrial safety and so on at the National Science Council and in selected centres. 5. Emphasis of Application in Later Stage While investments were encouraged in technology development in the early period when the economy lacked high technology for industrial
Taiwan
81
development and growth, in later stage, they are directed more to the application of available technologies and their transfer. In December 1989, the Science and Technology Group of the Executive Yuan formulated a ten-year plan to promote industrial productivity in general and manufacturing automation in particular. This was based on the reason that the escalation of labour costs in Taiwan had gradually decreased the rate of productivity growth in the economy. Manufacturing automation included the automation of design, fabrication and assembly, packaging, transport and distribution and manufacturing management. It was hoped that it would help raise productivity. The situation at that time was that more than 45% of the enterprises did not have automated equipment of any type and even for those which had implemented automation, the equipment was more in the form of hard automation rather than advanced manufacturing technologies such as computer-aided design, computer-aided manufacturing, robotics or computer numerical control machines. In its implementation of promoting manufacturing automation, the government committed US$180 million for the four-year average funding for 1989-92. The research manpower for the same period was 1,444 man-year. This accounted for 5-10% of the total R&D expenditure in science and technology each year.16 Various R&D activities were conducted by three types of organizations, depending on their different incentives and advantages. Roughly speaking, the upstream R&D was undertaken by organizations like universities, colleges and the research institutes under Academic Sinica. The midstream R&D was undertaken by a collection of those statutory bodies engaging in R&D. And lastly, the downstream R&D was undertaken by organizations from state-owned or private enterprises in the industry. The Mechanical Industry Research Laboratories was one of the primary organizations conducting R&D in automation
16
Tan (1995).
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Industrial Development in Asian NIEs
technology. Moreover, more than two-thirds of the R&D effort was undertaken by industries, which clearly showed the orientation of application and development. To attract more people to invest in this area, the government also provided tax incentives in addition to its active participation. Basically, firms which make relevant investment would receive various deductions in their business income tax. Specifically, the tax deduction ranges between • • • •
5-20% for investing in automation equipment, 5% for acquisition of automation technology, 15-20% for investing in R&D in automation technology, and 5% for manpower training in automation.17
The government also provided financial assistance and technical assistance. The former was in the form of lower interest rates on loans which are borrowed to purchase automation equipment. The rate was generally 1.75 to 2.75% lower than basic loan rates. A form of the latter assistance was to support the firms' consultation from qualified engineers by subsidizing the consultancy fee. 6. Policies in the 1990s Throughout the 1970s and 1980s the government intensified its efforts to deepen an R&D capacity for the new growth sectors. There are two landmarks. One is the ITRI and the other is the HSIP. By 1987, ITRI had a budget of US$215 million and a staff of over 4,500, organized into six institutes (electronics, machinery, chemical engineering, energy and mining, industrial materials, and standards and measurement). In the HSIP, foreign and domestic high-tech firms operate in close proximity to ITRI laboratories and the government is willing to take up to 49% equity in each venture. The park caters
17
Tan (1995).
Taiwan
83
Table 2.8: R&D Expenditure as Percentage of GNP (%)'• Country
1984
1985
1986
1987
1988
1989
1990
1995
Japan USA Korea Taiwan
2.35 2.68 1.19 0.95
2.49 2.83 1.48 1.01
2.48 2.84 1.68 0.98
2.53 2.82 1.77 1.12
2.58 2.77 1.86 1.22
2.69 2.71 1.90 1.38
2.77 2.69 1.88 1.65
2.70 2.55 2.71 1.81
Source: Taiwan Statistical Data Book, 1998.
especially to firms in information, precision instruments, new materials and biotechnology. Despite various R&D promotion efforts made by the government, due to the dominance of SMEs in Taiwan's economy, one of the major problems of industries in Taiwan is that most firms in Taiwan are not able to become actively involved in R&D. The following table shows the growth and comparison of R&D across countries. As the above table indicates, Taiwan's R&D expenditure ratio is far lower than those of the OECD countries and considerably lower than that of Korea. The low level of R&D intensity may undermine Taiwan's international competitiveness in the future. Various policies to stimulate enterprises' R&D have been introduced in Taiwan recently. It is hoped that through more government assistance programs, firms can be induced to engage in more R&D activities. In recent years, Taiwan's R&D expenditure to GDP ratios are 1.78% in 1992, 1.76% in 1993, 1.80% in 1994 and 1.81% in 1995 (Taiwan Statistical Data Book, 1998). The Science and Technology Special R&D Projects (STP) Program under MOEA The STP was initially approved by the Executive Yuan of the government in 1982. In 1992, the Ministry of Economic Affairs (MOEA) allocated
18
San (1995).
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Industrial Development in Asian NIEs
NT$10.8 billion to strengthen the existing STP program. The main purposes of the STP are threefold: • to assist in the development of high-tech industries or high-tech industrial products; • to develop key technologies in order to increase the value-added component of major industrial products; and • to develop industrial safety and environmental control technologies to enhance environmental protection and public safety.19 To prevent abuse of the program, the STP guidelines require research proposals for assistance to be evaluated by an expert committee, which are to consist of members from tertiary institutions, industry and from government offices in charge of science and technology. In addition, to put the money in the most desirable places, each year MEOA's Office of Science and Technology Advisors (OSTA), together with industry associations, conducts surveys of all concerned industries, trying to identify the most needed research projects for each industry. Another important task in the program is to assure quality research outcome and then to make good use of the research results. To accomplish this, the OSTA is required to announce to the general public the titles and contents of all contracted research projects after they are finalized and the relevant budget has been approved by the Legislative Yuan. Furthermore, within six months after a project is completed, the relevant results are required to be publicized through seminars and in at least two nationwide newspapers. 6.1. The ITRI: An Example of A Technology Support Institution As discussed before, ITRI is an important organization established in Taiwan to promote industrial development. Within the MOEA, there are
San (1995).
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85
many important units to carry out technology development projects. Among them, the ITRI is the largest in terms of research manpower and contracted research budget. Currently, it has eleven laboratories. In 1993, ITRI employed 6,052 persons. Among them 9 percent have a Ph.D. degree, 36 percent have a master's degree, 26 percent have a bachelor's degree, and 18 percent have another college degree. In addition, it grew from NT$0.2 billion in 1974 to NT$13.1 billion in 1993.20 However, the role of ITRI has been changing significantly over the years. In the beginning, ITRI concentrated almost exclusively on advanced industrial technology development. After the middle of the 1980s, it maintained a sound balance between its basic research and applied research. In addition, it put in more effort to support the private industry's technology development. In more recent years, one of its goals is to undertake more applied research with the mission of accelerating the development of industrial technology. Moreover, it wants to keep at least 50% of the total research resources for long and medium-term projects. 6.2. Efforts to Induce R&D Activities in the Private Sector In December 1984, the MOEA obtained approval from the Executive Yuan to launch the Development of New Industrial Products (DNIP) program. The program offered low-interest loans to qualified private firms to promote their R&D activities and in particular to assist them in new product development. To enhance the existing DNIP program, on June 3, 1991, the MOEA announced the launch of the Development of Targeted Leading Products (DTLP) program. This program places more emphasis on the promotion and development of new high-tech domestic firms in order to upgrade the overall industrial structure of Taiwan. If domestic private firms meet
20
Ibid
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Industrial Development in Asian NIEs
the requirements and would like to engage in targeted leading products development, they should file an application with the government. Once their projects have been reviewed and approved, 50 percent of the development funds required for their plans will be financed, i.e., invested, by the government, while the other 50 percent may be obtained through low-interest loans. More importantly, the 50 percent of development funds invested by the government need not be repaid by the private firms as it is considered a joint development project by the government and the private firms. By mid-1993, 123 cases had been submitted to the IDB for review and 67 cases were approved by the DTLP Review Board. 6.3. Financial and Fiscal Policies to Promote Industrial Development Over the past four decades, Taiwan's government has tried various ways to promote industrial development. One of the most important regulations to assist industrial development was the Statue for the Encouragement of Investment (SEI), promulgated in 1960. It was replaced by the Statute for Upgrading Industries (SUI), promulgated in 1990. SUI has not only greatly simplified various complicated tax reduction/exemption systems in the SEI, but it has also introduced a broader and more neutral preferential system to the industry. As a result, the industrial development strategies in Taiwan have shifted from sector-oriented ones in the SEI to function-oriented ones in the SUI. Thus, policies under the SUI will at least be less distorted than those under the SEI in promoting Taiwan's industrial development. 6.4. A Brief Summary An important characteristic of Taiwan's industrial policies is that in addition to various financial incentives provided to stimulate investment in desired areas, the government is also actively involved in the investment. This is considered crucial for an economy dominated by SMEs or when investment is risky.
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87
VII. Industrial Targeting 1. The Logic Behind Industrial Targeting In the 1960s, Taiwan had comparative advantages in labour-intensive industries such as textiles and hence they were the key industries that gained general government support. However, in the 1970s, Taiwan moved away from general incentives towards industrial targeting of specific industries. The government made an effort to build up capitaland technology-intensive industries under the motive that the potential of labour-intensive industries would soon be exhausted and that there would be a need for a deepening of the industrial structure. In fact, due to the oil crises of the 1970s, the domestic wage hike and the technology backwardness of Taiwan, which resulted in a loss of comparative advantage in the production of labour-intensive products, the government became aware that it should develop capital-intensive and technology-intensive industries. In order to promote industrial development and improve the economy's industrial structure, the concept of "strategic industries" was adopted as one of the means to overcome the abovementioned problems. Promoting strategic industries, or industrial targeting, is consistent with the concept of assisting the "sunrise" or "infant" industries. The justification for industry-specific industrial policy rests on positive side-effects between firms or on economies of scale. In practice, in Taiwan, the government believes that an economy will undergo certain stages of development, and at each stage there are certain keys which through various linkage will bring about development of the entire economy. Moreover, many policy makers in Taiwan believed that the classical "price mechanism" type of resource allocation was simply too slow a process to promote industrial development. They advocated that more direct industrial policy measures be considered to speed up the development of a high-tech industry in Taiwan. Although there are theoretic justifications for targeting, we are told that successful examples of sectoral industrial policies to correct market failures are very rare. To be successful, the govern-ment officials at
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least need to know what those key industries are and what policy measures should be adopted to develop these industries. 2. Selection of Strategic Industries In February 1977, Premier Chiang Ching-kuo had a policy statement that included the vigorous promotion of capital- and technologyintensive industries. Investment policies were revised so as to offer more inducements to investors in the targeted industries through tax relief, cheaper and easier credit, and encouragement of business mergers. The establishment of the HSIP was one of the mechanisms to implement the policy and overcome some of the problems. Particularly, the following industries were given priority in the Park: • • • •
electronics and information precision instruments and machinery high-technology materials science energy science biological engineering
The U.S. and Taiwan ended their formal diplomatic ties during the 1970s. Premier Y.S. Sun in September 1978 announced a set of policy measures, aiming at assuring Taiwan of critical supplies. The machinery (including specifically the automotive), electronics, and selected chemical industries were singled out as priority or "strategic industries" to be given special preference. In March 1982, the Industrial Development Bureau (IDB) of the Ministry of Economic Affairs (MOEA) established the Executive Committee to Develop Strategic Industries, which signaled the systematic introduction of industrial targeting. In order to establish a clearer guideline as to the definition of strategic industries, the committee established six criteria for the selection of the strategic industries. The six criteria are commonly known as "two-large, two-high, and two-low", that is, large linkage effect; large market potential; high technological intensity; high degree of value added; low energy coefficient and low level of polluting emissions. Most of the selected products have been in the
Taiwan
89
mechanical products, information, and electronics sectors. The list of selected products has been changed four times and a few products in the biochemical and material industries were included after 1986.21 In 1982, there were already 151 types of industrial products classified as strategic industries. Among them, there were 87 items and 64 items listed in the machinery and electronics industries, respectively. In 1989, the list of items increased to 199 items.22 In January 1983, the government announced eight strategic industries, which were (1) energy, (2) sophisticated materials for industry, (3) information, (4) automation, (5) bio-engineering, (6) laser technology, (7) prevention and cure of hepatitis and (8) food technology. The information industry, centered on computer hardware as well as software, together with automation, had become the focal point of the government's drive toward the restructuring of Taiwan's industrial sector. In 1992, the IDB had a list of targeted leading products: • • • • • • • • • • • • • •
21 22
digital fibre loop carriers digital mobile handsets network access facilities distributed data fibre interface integrated service digital network customer premise equipment fax machines multimedia computer systems: hardware, software, applications environment back-end servers high performance CUP chip sets system software computer-aided software engineering tools advanced digital TV digital VCRs IC projection systems
Yang (1993). San (1995).
90 • • • • • • • • • • • • • • • • • • •
Industrial Development in Asian NIEs LD players digital compact cassettes music synthesizer systems home information systems 16:9 CRTs ISDN U-interface mixed mode ICs RF IC/Modules high voltage power bipolar transistors thyristors blue LEDs TFP LEDs high resolution CCD color image sensors SRAMs flash EPROMs DRAMs fluoroquinolone ACE inhibitors water-borne resins
3. Policies for Strategic Industries Generally, there are three types of preferential measures offered by the government to subsidize the strategic industries: • preferential loans, • tax holiday, and • technology and management assistance from the government. 3.1. Preferential Loans Firms belonging to the strategic industries may receive loans at preferential rates which were 1.75 to 2.75 percent lower than the prime rate offered by commercial banks. Preferential loans are administered through two channels: the pool of funds administered by the Bank of
Taiwan
91
Communications and that administered by the Medium Business Bank of Taiwan. The funds for both are partially supplied by the government's Development Fund. From 1982 to 1989, a total of NT$50 billion was put in the pool. 3.2. Tax Holiday In Taiwan, the tax code favoured the starting up of new firms in the strategic industries by allowing a five-year tax holiday for them, and by having a fairly steep, progressive corporate income tax. Also, existing firms in strategic industries are allowed a five-year tax holiday on their enterprise income tax for their new investment. Alternatively, they may choose accelerating depreciation for their new investment. Furthermore, there was an enterprise income tax ceiling of 20% for firms in strategic industries. 3.3. Technology and Management Assistance from the Government As for technology and management assistance, the Ministry of Economic Affairs asked six governmental consulting institutions to advise local firms. Normally, the government subsidizes 50% of the total expenses of the assistance program in which the task forces provide services, such as financial management, quality control, quality assurance, production management, material management, marketing, in-service training and design assistance. In 1991, a new preferential plan for strategic industries was promulgated. The total cost of the plan is NT$30 billion. This plan will be executed by the Bank of Communications (Central Development Bank). By law, the difference between the preferential interest rate and the prime rate of the Bank of Communications must be smaller than 2 percent. The selected industrial items include investments in pollution-prevention equipment, the establishment of plants, energysaving equipment, public parking lots, mass transportation equipment and automation equipment.
92
Industrial
Development
in Asian
NIEs
Figure 2.1: Allocation of Research Funds under the STP Program, 199523
•3 •4 •5
1: electrical & telecommunication (40%) 2 generic technologies (13%) 3: food & medicine (10%) 4: materials & processes (11%) 5: automated & machinery equipment (21%) 6: environment protection & resources (4%)
Generally, the government provides incentives to all firms in strategic industries. However, the distribution of budget among industries is not balanced. Here is an example of budget allocation for strategic industries. 4. Summary Scholars have different viewpoints as to the need for and the effects of industrial policy. Some people believe that all sectors should develop simultaneously under an equilibrium between demand and supply. Some others, on the other hand, recommend a "disequilibrium development strategy" requiring the government to intervene in the market and
Wang (1997).
Taiwan
93
select key industries in order to pull the growth of the whole economy along. The second group of thought mentioned above supports the idea of industrial targeting. There is also another more convincing argument for government policy, i.e., the market failure argument. However, market failure is a theoretical concept, the existence of which is very difficult to prove or disprove, and the question of market failure may be irrelevant for an industrial policy that is already implemented. Then, a natural question is whether the Taiwanese government was doing the right thing in designating certain industries as strategic ones and using the right policies. It is evident that without the government targeting and support, some targeted industries in Taiwan today might not be able to compete internationally and some of them might not even exist. However, it is also possible that government support might not affect the performance of some targeted industries. One of the studies, which takes the form of questionnaires and surveys finds that most subsidized firms would have continued with their investment projects and would still have asked for assistance from other institutions even if they had not obtained preferential support from the government. That study also shows that the government's preferential policy of lowinterest loans does not significantly reduce the interest burden, increase fixed capital formation, or improve the operational performance of firms. Those firms that took advantage of technological and management consultation showed better performance in comparison to the situation where no consultation was provided. However, the resulting improvement in performance was the same regardless of whether the consultation was provided by the government or by other institutions. Although institutions are supported by the government, these types of policies are more concerning general incentives than industry-specific ones. The above, together with some other studies on Taiwan's industrial development, seems to suggest that one general lesson from the experiences of Taiwan is that it is difficult to implement an industrial targeting policy that is not basically in line with where the private sector is planning to go anyway. However, it is difficult to evaluate whether the entire government industrial policy in a country is generally a
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success or a failure. In the case of Taiwan, there are some success stories and some flops. This leads to our case study in the next section. VIII. Case Analysis In this section, we will mainly examine a few targeted industries in Taiwan, hopefully to learn a lesson from their success and/or failure. We will analyse the automobile and semiconductor industries. The automobile and semiconductor industries represent opposite poles on the spectrum of industrial policy in Taiwan with respect to instruments of state intervention; bureaucratic agencies versus individuals involved; the nature of private sector versus business-government channels; and success versus failure. The government wanted to develop the automobile industry such that it would become competitive in the global market, but the goal failed to be realized. The semiconductor industry, on the contrary, has grown rapidly and has become an important player in the international market. Lastly, we will briefly look at another industry, namely textile, which received help from the government at the beginning but was not part of the strategic plan. 1. Automobile Industry 1.1. Early Protection and Production The automobile production history of Taiwan dates back to 1958 when the first modern assembly plant was established by Yue-Loong Co., a private firm, to produce passenger cars and trucks under a license agreement with Nissan. Yue-Loong received various protections from the government, including entry barriers. Then, under pressure from the industry, the MOEA lifted the entry barrier and granted entry to new applicants. Between 1967 and 1969, there were four new firms entering
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the automobile market, Lio-Ho, with equity participation by Toyota and competing with Yue-Loong in the small passenger car market, and SanFu, Sam-Yang and China Motors, each cooperating with a second-tier Japanese auto firm and producing pickups and vans. Initially, the government put a huge effort to help the first assembler. In 1961, the government promulgated the Measures for the Development of the Automobile Industry, which prohibited new investment in semiknockdown (SKD) assembly. It also empowered the MOEA to put import restrictions on parts, components, and finished motor vehicles. A three-tier tariff system was enacted. As a result, finished passenger cars received 60% nominal protection rate, commercial vehicles 40%, and most parts and components 15%.24 Moreover, all imports of motor vehicles for which comparable models were manufactured domestically required special approval. In particular, the government restricted all new purchases of small passenger cars for commercial use, i.e., taxis, which was to help Yue-Loong, the only domestic auto maker. Without the heavy protection from competition of imported cars, Yue-Loong could hardly survive. In 1965, being urged by Yue-Loong, the government decided to extend the existing infant industry protection arrangements for another four years. Furthermore, to enhance the incentives for higher domestic content, the tariff on auto parts and components was raised to 46% while the tariff for finished passenger cars was raised by 5% to 65%. As soon as the level of protection was raised, the government imposed a 60% local content requirement, which would be applied to all new entrants as well as existing firms. This has the effect of acting as an entry barrier to new firms. Over the 1970s, Taiwan did not have a clear and stable policy towards the automobile industry. The government was split on how to develop the industry. Some government officials saw Taiwan becoming a major automobile exporter. Others doubted that domestic demand could ever be big enough to provide the base for an export drive, given Taiwan's small domestic market. The second group thought that the emphasis should be 24
Chu (1993).
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on the development of a world-competitive auto parts and components industry, but not assembly industry. Thus, with no coherent government plan for the industry, the auto industry did not receive any assistance beyond protection. For most of the decade, the government's attention and resources had been engaged elsewhere, in the development of petrochemicals, chemicals, plastics, steel, electronics and in ten major infrastructure projects. Automobiles were squeezed out. 1.2. Joint Ventures in the Late 1970s and Early 1980s The situation started to change by the end of the 1970s. In January 1978, MOEA submitted a general proposal to the Executive Yuan to establish a large-scale automobile plant with an annual capacity of 2 million units of compact cars primarily for export. In 1979, the government announced a general proposal to establish a large-scale automobile plant and automobile industry was classified as strategic. A special task force was set up directly under the minister of MOEA. This marked the first time that the government tried to formulate a comprehensive sectoral policy for automobile production and the beginning of intensive involvement of minister-level officials in promoting the industry. There were two objectives in the development plan. First, it was to promote an export-oriented large-scale auto plant concentrated on the production of small passenger cars, and second, it was to build another plant to produce large vehicles for the domestic truck market and the military. As for the strategies adopted by the government in the plan, two joint ventures — one on small passenger cars and one on trucks — between domestic firms and foreign car-makers of world repute were encouraged. This was to bring in technology for assembling and parts and components. It was also specified that the foreign partner of the joint venture could not hold more than 45% of the equity, and would have to export no less than 50% of the production output. Several
international car-makers expressed interests and were invited to submit bids for the joint ventures.
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The choice of local partners was a surprise. In 1980, two state enterprises, China Steel and Taiwan Machinery, were chosen to be in charge of the projects. None of the six private producers mentioned above were invited or even consulted. Both local partners were allowed to select prospective foreign partners and negotiate joint-venture agreements. Taiwan Machinery picked General Motor for the production of trucks and China Steel chose Toyota for the production of small passenger cars. Both joint-venture projects, however, ran into serious problems and turned out to be failures. The truck operation under the joint venture was so uneconomical that its cost was 65% more than the imports from Japan. The China Steel-Toyota joint venture, on the other hand, was not realized. There was a dispute between Toyota and the MOEA. The government insisted on the inclusion in the plan of a strictly enforceable year-by-year schedule for reaching 90% of domestic content, 50% of export to output ratio, and substantial technology transfer. However, Toyota argued for a more flexible schedule (those should be the goals rather than targets) and an exit clause to protect "economic viability". In May 1984 Taiwan's cabinet was reshuffled. The new government called for a reassessment of the Big Auto Plant project and laid down four principles governing the joint venture. The four principles were general economic viability, local content, export requirements and provisions for technology transfer. The talks between MOEA and Toyota finally collapsed in late 1984 and the China Steel-Toyota joint venture was cancelled. 1.3. The New Automobile Industry Development Program The new wave of foreign interest in Taiwan's automobile industry in the 1980s provided the policy-makers in Taiwan a chance to reconsider their policies and remedy their two previous failed attempts. In early 1985, the government moved decisively to overhaul the existing investment guidelines and protection regime. Under the new regime, the tariff for finished cars was scheduled to be lowered to 30% in six years
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at a rate of 5% annual reductions while the domestic content requirement would be reduced to 50% in three years. Also the new investment guidelines for the first time eliminated the restriction on the foreign ownership (45% ceiling of foreign equity) and allowed wholly foreignowned subsidiaries in export-only finished-car production or parts and components manufacturing. Regarding export ratios and technology transfer requirements, they would be dealt with case by case. Eventually, under these more flexible investment guidelines, the MOEA approved Ford's first-stage expansion plan; Nissan was allowed to buy up 25% of Yue-Loong's stock; Mitsubishi to own 25% of China Motor. 1.4. Summary Regarding the state-aided development of Taiwan's automobile industry, there are generally two questions to ask. First, should automobile industry be picked as a strategic industry? Second, was the government using the measures properly? There is little doubt that the experience of Taiwan's automobile industry provides a textbook example of government failure. To understand the reason, we should pay attention to the special production and market structure of automobiles. The world automobile market is dominated by a few big multinationals which, with large production bases, could take the advantage of scale economies through a high degree of internal sourcing and oligopolizing the world's finishedcar market. The economics and dynamics of the global automobile industry impose rather restrictive constraints on Taiwan. They create an extremely high barrier preventing Taiwanese auto makers from entering the finished-car market. It may well be true that government intervention can help new firms to enter. However, the industry itself may not be justifiable for Taiwan, given that its economy is dominated by SMEs rather than big corporations that have the capability to exploit the economy of scale. The state agency responsible for promoting industrial growth in the private sector is the Industrial Development Bureau (IDB) under the Ministry of Economic Affairs (MOEA). The IDB was not strategically
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placed in the overall economic bureaucracy, nor was it empowered with effective policy instruments. Tariff policy for the automobile industry is not set by the IDB alone. The only firm- and product-specific policy instrument under the direct control of the MOEA — the allocation of R&D grants — is administered by the Office of Science and Technology Advisors (OSTA) with very limited IDB input. Also in Taiwan, the state's push for automobile industrial development was largely based on the state-enterprise sector. The private sector was not motivated to participate in the development, regardless of the size of the firms. This was not so in the case of the semiconductor industry which will be analyzed next. 2. Semiconductor Industry In the global electronics industry, Taiwan has become a "world-class player" in semiconductors. Taiwan's suppliers of semiconductors are competing aggressively in the Pacific Rim as well as supplying Taiwan's own fast-growing computer industry. As a result, it is able to eliminate the dependence on Japan for chips. Taiwan's exports of computers and related information-industry products are becoming more and more significant in the world market. This subsection will examine the growth of the industry in Taiwan and the role of the government. We will examine the birth and growth of Taiwan's semiconductor industry. 2.1. The First Phase: 1974-79 25 This period was marked by the First Five-Year Plan for developing the semiconductor industry. Former Premier Y.S. Sun together with a network of overseas Chinese engineers in the United States played the key role in launching the first
25
We follow Meaney (1993) to divide Taiwan's semiconductor industry development into four phases.
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semiconductor project in Taiwan. In 1974, Sun asked a team, formed by some experts in Taiwan and some from the United States, to study the domestic industry upgrading. The study recommended that the electronics industry should focus on semiconductor technology and that the technology be acquired from abroad. As for technology importation, a two-part strategic planning team should be formed, one part in the United States and one in Taiwan. The U.S. partner was responsible for selecting the types of technology to be transferred and training Taiwanese engineers. IC (integrated circuits) was chosen. Then, engineers from Bell Labs, IBM and various universities were invited to form the Technical Advisory Committee (TAC) to assist in selecting a particular IC technology on which to concentrate, and to recommend a list of U.S. companies to be invited to submit bids for the technology-transfer. In late 1975, RCA was chosen out of eight companies that submitted bids. One of the key reasons that RCA was selected was that RCA agreed that over five years it would provide Taiwan technicians, plus technical training in the United States. Also, it would help build up the design and production capabilities for Taiwan. On the domestic side, as discussed in Section V, the government established the ERSO (Electronics Research Service Organization) within ITRI for the IC project. Also, Taiwan's National Science Council (NSC) began a major drive to establish local IC research. They launched the "large scale project on microelectronics," which had three parts: IC process technology, personal computer applications, and automation technologies. 2.2. The Second Phase: 1979-83 If the goal of the first period was to select sectors and emphasize training as well as transfer of technology, then the second period's task was to solicit private investment and move technology into the private sector. In other words, the central goal of the state's semiconductor project was to move technology out of the laboratories into the private sector, to create commercial visibility for it, and eventually to build up Taiwan's sell-development capability and infrastructure.
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A major development occurring at the outset of the second phase was the formation of the HSBIP, which has been discussed in Section V. The objectives for the park were to establish an infrastructure needed to create and attract high value-added private enterprises to Taiwan and to establish state-of-the-art R&D capabilities. To this end, the government provided various forms of assistance for high-tech enterprises locating in the park, including tax holidays (duty-free import of key equipment, raw materials and semi-finished goods), exemption from commodity taxes on exports, low-interest loans and R&D matching funds. The greatest amount of investment in the park was for computer manufacturing, followed by IC companies. In addition to the incentive provided for private investment in the park, in 1978 the Ministry of Economic Affairs (MOEA) accepted a business proposal for a joint state-private semiconductor venture, trying to attract more local investing. The rationale behind the joint-venture is to reduce the high risk in new investment. However, the private sector was reluctant as they saw IC as a highly risky business. Eventually, the government "used its influence" to get contributions from some private investors. In return, to reassure the participating private companies, ITRI created ITIC, a subsidiary supported by banks, private investors and 40% by ITRI, to invest in the IC venture. Another joint state-private venture was also created, called United Microelectronics (UMC), with the state having 44% and private sector having 55% contribution. It proved highly successful. At the beginning, it produced "consumer" chips for Taiwan's manufacturers of "toys, telephones, watches, calculators and computers". In 1985, it went public, with the government remaining as a minority shareholder (23%). Subsequently UMC upgraded and began producing more advanced chips, including SRAM memory chips by 1989. In 1978, Y.S. Sun became the Premier, but he was still in charge of the IC project at the outset of the second phase. Sun wanted to have a more formal organizational support for high technology projects in general and semiconductors in particular and thus, he earmarked eight technical areas for prime development, including IC.
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2.3. The Third Phase: 1984-89 This phase resembled the first phase in many aspects, but it was about a new project. The outcome of this period was the adoption of the VLSI Project and formation of the Taiwan Semiconductor Manufacturing Co. (TSMC). As early as 1982, it was realized that Taiwan's R&D capacity needed further expanding and VLSI technology would provide a base for this. A decision then was made within ITRI/ERSO to focus the semiconductor program on VLSI technology. The program met with a lot of objections, however. It was said that VLSI was too expensive to develop and the program was too ambitious. Moreover, semiconductors had already been drawing too much resources, leaving not enough for other projects such as biotechnology and automation. Criticism also came from academics. On the other hand, the supporters argued that the UMC alone was still not enough for Taiwan to compete globally and the VLSI plan was a means of catching up with state-of-the-art technology. Given the diverse feeling about the program, the government moved cautiously. The plan was presented to all levels of the public and after a year of presentations, there was a special review of the VLSI plan in the Executive Yuan, which finally approved it in 1984. The next step is the investment, or the implementation of the plan. In the first few years of this phase, the plan continued to encounter reluctance and resistance. The private sector was reluctant to invest and some levels of the government were not willing to commit large amounts of capital to the program. In particular, a proposal submitted in 1984 by the MOEA for a $250 million joint venture similar to UMC met with opposition in the cabinet and was abandoned. Nevertheless, the position of those opponents within the government eventually changed due to a series of events involving the fate of some state-of-the-art DRAM technology. Pursuing its goal of developing VLSI technology and moving it into the private sector, the government formed a second company, TSMC (the first was UMC, discussed before). TSMC was a joint venture by the
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Taiwan government (49%), Phillips (27%) and local private investors (companies) (24%),26 which had successfully worked with the government before. TSMC by most accounts was regarded as a success. The goals of the VLSI plan and more generally the IC development program were achieved. Within the year after TSMC's formation, approximately forty local chip design houses were set up in the HSBIP. In addition, several private semiconductor firms were also set up, encouraged by the success of UMC and the existence of the TSMC. The TSMC venture helped garner the investments in the more costly and risky memory chip business which were needed to make Taiwan a world-class competitor independent of foreign chip manufacturers. 2.4. The Fourth Phase: 1989-present day The fourth phase is characterized by the introduction of the submicron project, the decision to produce DRAM and the rise of the private sector. To further develop and upgrade the IC industry, ERSO proposed the submicron project, based on the reason that submicron technology is necessary for producing DRAM, which was the cutting-edge technology expected by the private sector but for which private investors would not have the capacity to do the R&D by themselves. The submicron plan covered five years and involved an expenditure of NT$5.5 billion. The six existing IC companies in Taiwan as of mid-1989 were invited to participate in a consortium. The consortium would involve a fiftyfifty private sector/government contribution for ongoing expenses, with the government paying for 100% of equipment expenses. The choice of submicron technology was the result of extensive consultation and discussion with the industries, not simply a decision from the top of the government.
Meaney (1993).
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Specifically, there are many reasons for the project. As mentioned above, the submicron project involves technology necessary for producing the DRAM chip. A STAG recommendation of October 1988 argued that DRAM was a critical component for the growth of an IC industry, the world supply of DRAM at present was unpredictable, applications were expanding, the use of computers was expanding, and there were at that time no DRAM technology in Taiwan. Thus Taiwan must move into DRAM. Moreover, there was also pressure from the private sector to go into advanced technologies. The private investors were satisfied by the successes achieved by Taiwan's IC industry, IC manufacturers (in particular UMC), and computer makers (in particular the Acer corporation). Acer became a computer giant after microcomputers took off after 1980-81. It was also believed that the local market was large enough to justify a DRAM capacity. According to a recent report of Asian Wall Street Journal (1997), TSMC has become the worlds' largest contract maker of ICs. TSMC predicts that in 1997 its sales will be NT$35.22 billion (US$1.26 billion) and its pretax profit NT$8.02 billion. 2.5. Summary The above makes a strong case that the state played the leading role in the development of Taiwan's semiconductor industry. Private industry might have had interest in this sector, but would not have invested on its own. The state's role was critical at three points: launching the original IC project, creating UMC and creating TSMC. Another important factor, which accounts for the success of the semiconductor industry in Taiwan, is the contribution made by the overseas Chinese engineers in the United States, Taiwanese engineers returned from the U.S. and foreign executives. The government wisely tapped this resource pool. 3. Textile Textile has played and would continue to play an important role in Taiwan's economy, especially in employment and foreign exchange
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earnings. Table 2.9 below shows the textile industry's recent annual relative contributions which are already lower than that in the preceding two decades. Taiwan's textile industry experienced five different periods. The first period was when the industry was rebuilt after World War II. The second period, from 1951 to 1958, was characterized by import substitution, followed by export expansion in the third period (from 1959 to 1972). The industry started maturing during 1973-1981, the fourth period. 1981 was the beginning of the current (fifth) period, which represents a phase of structural change for the industry. Starting from the beginning of the last decade, Taiwan's domestic labour cost increased and the NT dollar appreciated against other major currencies, which made it more difficult for the textile industry to compete in the world market. Moreover, the government began to target strategic industries, such as electronics and machinery. The textile industry's relative contribution to the manufacturing sector in both value added and employment continued to decline in the current period, from Table 2.9: Textile Industry's Contribution (%) Year
As a percentage of manufacturing in GDP
As a percentage of manufacturing in employment
As a percentage of total exports
1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993
15.53 16.46 14.90 15.10 14.89 14.27 13.39 11.55 11.18 11.07 10.52 10.34 9.95
19.32 19.80 19.23 18.77 19.41 18.59 18.06 17.26 16.45 15.90 15.47 15.33 10.36
22.88 22.10 20.42 20.42 20.11 18.65 17.65 15.14 15.91 15.93 16.38 15.47 13.10
Source: Hsiao (1994).
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15.53% of the GDP ratio in 1981 to below 10% in 1993 and from 19.32% of employment in 1981 to about 10.36% in 1993. Its relative contribution to total exports has also dropped significantly, from 22.88% in 1981 to 13.10% in 1993 (see Table 2.9). Even more seriously, the number of workers employed by the textile has reduced by almost a half, from 1981's 417,000 workers to 1993's 268,000 workers. Textile, however, cannot be regarded as a representative case for non-targeted industries. Although it is evident that the textile industry was not classified as one of the "strategic industries" and the industry has been declining over time in the recent two decades, there are many special factors responsible for the shrinkage of the industry. In fact, as pointed out by Smith (1995), textile industrialists were still among the major recipients of government subsidies in the 1990s, despite the fact that they had not been targeted. IX. The Challenge of Recent Capital Outflow Before the 1980s, Taiwanese investment in other countries was insignificant. As is shown by some available statistics, the situation began to change around 1987. The value of investment increased rapidly. In recent years, this trend has been accompanied by rising investment in mainland China. These figures, though illuminating, must be interpreted cautiously because actual investment may differ significantly. Another way of getting some sense out of the situation is that around 10 percent of foreign direct investment (FDI) in China comes from Taiwan, while the amount from Hong Kong and Macau combined is 70 percent.27 Thus, although for political reasons, the government in Taiwan has been very concerned about capital outflow to China, the situation may have been exaggerated. What are the reasons for the capital outflow? There seem to be two major factors. First, rising labour and land costs in Taiwan have
See Kao and Wu (1995).
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Table 2.10: Approved Investment Outside of Taiwan (in US$ mn) Mainland China 1980 1985 1986 1987 1988 1989 1990 1991 1992
174.2 247.0
Countries other than China 42.1 41.3 56.9 102.8 218.7 931.0 1552.2 1656.0 887.3
Source: Chen and Chen (1995).
changed its comparative advantage in the world market. Its exports of labour-intensive consumer non-durables have met with severe competition from new entrants such as China. Economic theory tells us that under general conditions free trade and mobility of input factors (such as capital and technology) are substitutes for each other. Instead of exporting labour-intensive products, Taiwanese business people have chosen to export capital, technology and management skills to China, i.e., invest in China. Second, Taiwan has developed a competitive edge in some consumer durables such as electrical appliances and computers. One way to capture a larger share of the world market is to locate some of its production branches within close proximity to consumers. This has the advantage of improving communication between the producers and the buyers. The first reason explains the increase in investment in China, while the second is the main consideration for investing in the United States. Some surveys on the motivations behind the investment in different places confirm these conjectures.28 The most important reason for investing in the United States is to enlarge the market there or in
See Chen and Chen (1995).
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third countries. The second is to acquire new technology. The principal reason for investment in mainland China, according to the surveys, is to utilize its cheap labour. The second reason is cheap land. Thus, we should interpret the capital outflow as the result of optimizing behaviour of the private enterprises. Some people in Taiwan have been concerned about the effects of the capital outflow. Some worry that it will tighten the domestic supply of funds. This is coupled by the fact that Taiwanese investors can hardly get loans in China. Bank loans for these investments have to rely mainly on banks in Taiwan. Nevertheless, the worry is unfounded. The investments are highly profitable. More than 52 percent of the profits have flowed back to Taiwan. Moreover, trade statistics show that Taiwan has been enjoying huge trade surpluses with China since 1980. Another concern is whether investment in China will create unemployment in Taiwan. It should be reminded that if Taiwan tries to rely on its own people to produce labour-intensive goods, it cannot compete with China in the world market. That by itself will create unemployment in Taiwan. By optimizing its comparative advantage, the Taiwanese economy is more efficient. Jobs may be created as a result. In fact, labour statistics indicate that the number of blue-collar worker has declined between 1986 and 1991, but the number of white-collar staff has increased significantly in the same period.29 This can also be viewed as a result of the economic structural shift that has been occurring in Taiwan for a long time. In the long run, this may be good for the Taiwanese economy. The above conclusion ignores a priori political considerations. It is sometimes argued that because the size of the Taiwanese economy is small relative to China, the former will suffer more severely when there are drawbacks in the economic ties between the two places. While this may well be true, the conversely is also true for potential gains when the relation between the two places are normalized.
29
Ibid.
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X. Appraisal of Taiwan's Industrial Policy From what has been discussed in this chapter, it is clear that the Taiwanese government has taken a very active role in defining the direction of industry. For example, it uses preferential low-interest loans, grants, tax incentives, tariffs, trade barriers and even legal sanctions to influence the decisions of private enterprises. Some of the well-known problems associated with industry and technology targeting have emerged in Taiwan. Has the government picked the right targets? Certainly there are successful cases. For example, there is little doubt that some of the broad areas chosen by the Executive Committee To Develop Strategic Industries as the major research targets are important for Taiwan's development. The semiconductor industry, which the Taiwanese government has so heavily targeted, has been a success. Without the efforts of the government, it seems unlikely that this industry can be as well-developed as it is today. However, there are also obvious failures. The automobile industry is a classical example of government failure. The market would not have chosen this industry for Taiwan. Moreover, as pointed out by Smith (1995), the major recipients of government subsidies in the 1990s were industries in which Taiwan's comparative advantage was declining or lacking, such as textiles and apparel. Thus, the overall results of industrial targeting, as demonstrated by the experience of Taiwan, is mixed. There is no guarantee that the government's choice is socially optimal. We should examine the possible underlying causes of resource misallocation more closely. Since the payoffs for getting the subsidies are high, we should not be surprised that rent seeking activities and self-serving strategic behaviour should appear. We have already seen that some people deliberately failed in their projects in order to avoid repaying the matching fund. The government could of course come up with more restrictions to mitigate these forms of strategic behaviour. However, it is not clear whether people would not come up with even cleverer new strategies to defeat the government. Even in committees of science and technology
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experts, one might suspect that intensive lobbying would occur. The increase in the number of national "strategic" research areas from four to twelve decided in the high-powered national science and technology meetings is an indication that such meetings could become the political battleground for more influence and research funding. Although the National Science Council and the Executive Committee To Develop Strategic Industries consist of members with good reputation, it is unclear that the process itself can guarantee socially optimal outcomes. Another problem associated with the decision making-process is that too much weight seems to have been placed on the technological soundness of the projects rather than on whether they make good business sense. As pointed out earlier in this chapter, the technical success rate of product development of approved projects in Taiwan is not bad. However, it still remains to be seen how many of these can be profitably marketed eventually. There is not much evidence to suggest that the success rate is high when we use this criterion to pass judgment. In terms of efficiency in resource allocation, this is the more important criterion. Indeed if we use economic rather than technical efficiency as the yardstick, some of the apparently successful targeted industries may not yield a rate of return that is high enough to justify the investment. Even if the government has made the right choices, there is still the question of the stability of funding. It is a common misconception that government support is stable. In fact it can be subject to all the uncertainties of political changes. The Taiwanese experience is not immune from this problem. Government expenditure on R&D has suffered severe cutbacks in recent years. Many of the planned or halffinished research projects have had to be canceled. This is another source of inefficiency created by the Taiwan government's involvement in research. Sometimes wrong targeting may not be the fault of the decision makers. Good industrialists and entrepreneurs are not necessarily experts in writing proposals and applications. Since most of the enterprises in Taiwan are small, many of the industrialists find it too costly to learn the techniques and process of writing successful applications for the funds.
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Without their input, some good projects may be missed by the government. Even if we take it for granted that the government has targeted the right industries, we still need to ask whether the subsidies are really necessary. As pointed out in this chapter, a study shows that most subsidized firms in Taiwan would have continued with their investment projects even if they had not obtained preferential treatment from the government. This is not surprising. A profitable industry would in any case find its own way to survive in the absence of government subsidy. The targeting policy of Taiwan may have spent a lot of resources unnecessarily. We should not, however, conclude that sectoral targeting is the only policy employed by the government. In fact, the Taiwan government has done much more than that. As pointed out by Lee (1995), "the government's industrial policy is becoming more function-oriented and less sector-oriented, and the role of the government is shrinking while that of the private citizen is expanding." In addition to the revision of policy, Taiwan has done a number of right things. With 25 percent of the population being students, Taiwan is one of the most educated regions in the world. The government's efforts in investing human capital at all levels must have helped in building up the industrial sector. The accumulation of human capital is by itself an important engine of growth. Moreover, as the income level has gone up, Taiwan has become a more attractive place for its emigrants.30 The brain drain problem in Taiwan has almost reversed and large number of highly educated people have returned to Taiwan. Since it also has a huge pool of scientists and engineers working in leading institutions in the United States, interaction with them can bring back state-of-the-art technology.
30
It should be noted that in recent years, many "mainlanders" working in Taiwan feel that for political reasons they have been deliberately discriminated against. Some of these people, especially those who have good professional qualifications, may choose to leave Taiwan.
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One of the issues that Taiwan's research and educational system has resolved is the balance between basic research, applied research and development. As pointed out earlier in this chapter, the division of labour and specialization among the institutions in Taiwan are well defined. This is not an easy task, but an important one if we want research funding be used efficiently. Taiwan seems to have successfully built up a science and technology system that is capable of selfgenerating R&D findings continuously. A place like Hong Kong does not seem to score high marks in this regard, but Taiwan appears to have done well. Another lesson from Taiwan is that strong government is important. If an industrial policy is to be pursued, weak leadership in the government will create more rent-seeking activities. As demonstrated by the case of semiconductor industry, some of these activities could be avoided if the government has strong leadership. Although people may debate about the merits of the science-based Park in Hsin-chu, one possible advantage of a similar establishment is that it may attract foreign capital. The Taiwan experience shows that new technology beneficial to society can be brought in if more foreign firms are attracted. This does not imply that these companies should be subsidized by local investors, however. Last but not least, the export-orientation of the economy should have improved the efficiency of the enterprises because they have to compete internationally. International division of labour and specialization will also raise the efficiency in resource allocation. The outward-looking attitude of Taiwan may well be a more important reason than industrial policy for its economic success. XI. Concluding Remarks Although there is considerable controversy over whether Taiwan's high economic growth is due to improvement in total factor productivity or just a fast rate of capital accumulation, very few people would deny its success in economic development. The statistics presented in the
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appendix also indicate that industrial output has grown hand in hand with the GDP. How and why has Taiwan achieved these results? A Taiwanese expert in industrial policy (see Lee (1995)) has provided a succinct statement of the debate surrounding this question: "Some economists, mostly from the World Bank and the IMF, argue that it was the 'free market' approach, i.e., minimum government intervention plus the adaptation of an export-led development strategy, that made Taiwan successful in economic development. Others, such as Wade and Ranis, argue that it was the 'governed market' approach, i.e., the government actively promoted certain types of investments and industries in order to achieve the high rate of economic growth. In other words, proper and active industrial policy and government intervention were the keys to Taiwan's success in economic development." Which of the two models is the correct answer? This question is of great importance to the theory of economic development and policy making, but unfortunately, it does not have a simple answer. Two fundamental but related issues are raised here. First, can the government make better choices than the market? Second, is it desirable to use taxpayers' money to give preferential treatment to certain industries? Regarding the first, a standard answer is that government intervention is not necessary. If a particular industry is profitable in the long run, investors will take this into account. Driven by profit motives, they will pick it and invest in it. There is no need for the government to pay them extra money. If an industry is inefficient because it does not generate enough profits in the long run, nobody would invest in it. Profit opportunities in the free market will guide people's decision. The second issue begs another question. Is it fair for society to subsidize certain people who may already be quite rich? The answer to it unavoidably involves a value judgment, but for most people, it is likely to be a negative one. The weight of Taiwan's experience in industrial policy seems to suggest several conclusions. First, if industrial policy is narrowly defined as industrial targeting through various forms of tax-cum-subsidy, then it may often be successful in enhancing the technical sophistication of
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in Asian
NIEs
the targeted industries. However, whether it pays to do that or not is another matter. Targeting often creates many difficulties with regard to economic efficiency. On the other hand, the more function-oriented type of industrial policy, such as education, general investment in R&D and even infrastructure development, appear to have fewer negative side effects. Probably the outward-looking economy and the sophisticated manpower of Taiwan explain its economic success more than its targeting industrial policy. Appendix
Some Economic Indicators of Taiwan Year
Real GNP Annual Growth Rate (%)
1953 1954 1955 1956 1957 1958 1959 1960 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 1971 1972 1973 1974
9.3 9.6 8.1 5.5 7.3 6.6 7.7 6.5 6.8 7.8 9.4 12.3 11.0 9.0 10.6 9.1 9.0 11.3 12.9 13.3 12.8 1.02
Annual Real Growth GNP Per Capita (%)
4.2
3.1
7.9
6.1 6.6 9.0 10.7 11.3 10.7 -0.7
Growth Rate of Industrial Production (%) 25.1 5.8 13.1 3.5 12.8 8.6 11.7 14.1 15.7 7.9 9.1 21.2 16.2 15.6 16.7 22.3 19.8 20.1 23.6 21.2 16.2 -4.5
Export Growth Rate (%)
12.9
24.9 19.3 27.8 23.9 28.1 33.8 34.4 25.3 -7.3
Taiwan
115
(Continued) Year
Real GNP Annual Growth Rate (%)
1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995
4.3 13.5 10.1 13.9 8.5 7.1 5.7 3.3 7.9 10.5 5.1 11.6 12.3 7.3 7.4 4.9 7.2 6.5 6.1 6.5 6.1
Annual Real Growth GNP Per Capita (%) 2.5 11.4 8.1 11.9 6.4 5.1 3.8 2.2 6.9 10.0 4.1 11.3 11.1 7.1 6.8 4.4 6.4 5.2 5.0 5.1 5.1
Growth Rate of Industrial Production (%) 9.5 23.3 13.3 22.5 6.4 6.8 3.5 -0.6 14.1 12.2 1.4 14.9 10.7 4.4 3.7 -0.2 7.5 4.6 3.7 5.7 5.8
Export Growth Rate (%) 0.7 36.3 12.8 22.7 6.0 8.0 9.4 2.2 17.2 17.9 2.5 28.2 18.9 5.0 5.0 0.8 12.8 5.3 7.2 5.5 12.9
Sources: Taiwan Statistical Data Book, 1994, 1996.
References Chen, Li-An (1986) "Government policy on science and technology in the Republic of China", International Journal of Technology Management, vol 1 (3/4), 283-295. Chen, Tien-Chi, and Chen, Yi-Ping (1995) "The Effects of Investment in Foreign Countries on Taiwan's Industrial Development," (in Chinese), in Yang Ya-Hwei ed., Taiwan's Industrial Development and Policy, Chung-Hwa Institute of Economic Research. Chou, Tein-chen (1995) Industrial Organization in a Dichotomous Economy: The Case of Taiwan, Avebury Publishing Limited.
116
Industrial Development in Asian NIEs
Chu, Yun-han (1993) "The State and the Development of the Automobile Industry in South Korea and Taiwan", in Joel D Aberbach, David Dollar and Kenneth L Sokoloff (eds) The Role of the State in Taiwan's Development, An East Gate Book, M.E.Sharpe, Inc. Dollar, David and Kenneth L Sokoloff (1993) "Industrial Policy, Productivity Growth and Structural Change in the Manufacturing Industries: A Comparison of Taiwan and South Korea", in Joel D Aberbach, David Dollar and Kenneth L Sokoloff (eds) The Role of the State in Taiwan's Development, An East Gate Book, M.E.Sharpe, Inc. Free China Industry, various issues. Hsiao, Feng Hsiung (1994) Taiwan's Industrial Policy and Industrial Development (in Chinese). Lee, Joseph S. (1991) "Human Resources," in Kao, Charles H.C. and Joseph S. Lee, eds., The Taiwan Experience: 1949-1989, Commonwealth Publishing Company, Taiwan. Kao, Charles H.C. and Joseph S. Lee, eds. (1996) The Taiwan Experience: Past and Future. Kao, Chang, and Wu Si-Ying (1995) "The Effects of Economic and Trade Activities Across the Strait on Taiwan's Industrial Development," in Yang Ya-Hwei ed., Taiwan's Industrial Development and Policy, Chung-Hwa Institute of Economic Research. Kuznets, Paul W. (1994) "Does Taiwan's industrialisation have its own paradigm?", Journal of Asian Economics, Vol. 5, No. 4, 499-513. Lee, Joseph S. (1991) "Human Resources," in Kao, Charles H.C. and Joseph S. Lee, eds., The Taiwan Experience: 1949-1989, Commonwealth Publishing Company, Taiwan. Lee, Joseph (1995) "Policies for industrial development of Taiwan: introduction", Journal of Industry Studies, Vol. 2, No. 1, 1-5. Meaney, Constance Squires (1993) "State Policy and the Development of Taiwan's Semiconductor Industry", in Joel D Aberbach, David Dollar, and Kenneth L Sokoloff (eds) The Role of the State in Taiwan's Development, An East Gate Book, M.E.Sharpe, Inc. Quarterly Journal of Economic Forecast, 1994. Rodrik, Dani (1995) "Getting interventions right: How South Korea and Taiwan grew rich?", Economic Policy, No. 20, 55-107.
Taiwan
117
San, Gee (1995) "An overview of policy: priorities for industrial development in Taiwan", Journal of Industry Studies, Vol. 2, No. 1, 27-55. Social Indicators in Taiwan Area of the Republic of China, 1992. Tan, Raykun R. (1995) "Establishing technology transfer infrastruc-ture as a strategy for promoting manufacturing automation in Taiwan", Technovation, Vol 15 (7), 4 0 7 - 4 2 1 . Taiwan Statistical Data Book, various issues, Council for Economic Planning and Development, Republic of China. Wade, Robert (1990) Governing the Market: Economic Theory and the Role of Government in East Asian Industrialization, Princeton University Press. Wang, Jiann-Chyuan (1995) "Review of the Measures and Effects of Our Country's Industrial and Technology Policy," (in Chinese), in Yang Ya-Hwei ed., Taiwan's Industrial Development and Policy, ChungHwa Institute of Economic Research. Wang, Jiann-Chyuan and Kuen-Hong Tsai (1995) "Taiwan's Industrial Technology" policy measures and an evaluation of R&D promotion tools", Journal of Industry Studies, Vol. 2, No. 1, 6 9 - 8 2 . Wang, Lee-Rong (1995) "Taiwan's venture capital: polices and impacts", Journal of Industry Studies, Vol. 2, No. 1, 8 3 - 9 4 . Weiss, Linda and John Mathews (1994) "Innovation alliances in Taiwan," Journal of Industry Studies, Vol. 1, No. 2, 9 1 - 1 0 1 . Wu, Yuan-li (1985) Becoming An Industrialized Nation: ROC's Development on Taiwan, Prageger Publishers. Yang, Ya-Hwei (1993) "Government policy and strategic industries: The case of Taiwan", in Takatoshi Ito and Anne O. Krueger, eds, Trade and Protectionism, The University of Chicago Press. Yu, Tzong-Shian (1994) "Asian industrialisation: is there a paradigm?", Journal of Asian Economics, Vol. 5, No. 4, 491-497.
118
SOUTH KOREA: GOVERNMENT-LED DEVELOPMENT AND THE DOMINANCE OF GIANT CORPORATIONS Leung-Chuen Chau University of Hong Kong
I. Overview of Development Since the Early 1960s 1. Growth Performance In macroeconomic terms the growth of the Korean economy since the 1960s has been characterized by high growth rates of incomes, high inflation rates in the 1960s and 1970s, declining unemployment rates and a rapid increase in exports. Most remarkable was its growth performance. As can be seen from Table 3.1, Rapid growth was achieved from 1963 on, right after it switched to export-oriented industrialization in 1962. GDP growth averaged 7.8 percent during the first five-year plan period (1962-67), up from a level of 4 percent in the 1950s. It leapt to 9.7 percent in the next plan period, and generally stayed at this high level, reaching 10 percent over the sixth five-year period (1987-91). The one exception was the year 1980, when the economy was hit simultaneously by the second oil crisis and political unrest following the assassination of President Park. It registered the country's one and only negative growth. As a result, growth rate decelerated to 5.7 percent in 1977-81. It is noteworthy that Korea weathered the first energy crisis of 1973 — which left most Western economies in the doldrums for many years — remarkably well. As a matter of fact, the rate of growth never fell below 5 percent since 1963, except for 1980.
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1960
Table 3.1:
(Continued)
Rate of Trade Foreign Private GNPper GNP GNP Debt Exports capita (billion Growth Inflation Interest Savings Balance Year (US$) US$) Rate (%) Rate (%) Rate (%) (%) (mn US$) (mn US$) (mn US$ 1980
1,597
60.00
^1.8
25.6
19.5
18.0
(4,384)
17,214
27,170
1985
2,242
91.10
5.4
4.1
10.0
23.7
(19)
26,442
46,762
1986
2,568
105.40
12.3
2.7
10.0
27.8
4,206
33,913
44,510
1987
3,218
133.40
12.8
3.7
10.0
30.8
7,659
46,244
35,568
1988
4,295
179.80
12.4
5.9
10.0
31.5
11,445
59,648
31,150
1989
5,210
220.40
6.9
5.3
10.0
28.4
4,597
61,409
29,372
1990
5,883
251.80
9.6
9.9
10.0
27.4
(2,004)
65,016
31,699
1991
6,757
292.00
9.1
10.1
10.0
28.3
(6,980)
71,870
39,135
1992
7,007
305.70
5.0
6.1
10.0
27.1
(2,146)
76,632
42,819
1993
7,513
330.80
5.8
5.1
8.5
26.7
1,860
82,236
43,870
1994
8,483
376.90
8.2
5.4
9.3
26.0
(3,145)
96,013
56,850
1995 1996
10,076 10,548
448.30 484.60
9.3 6.9
4.6 5.0
8.8 n.a.
26.0 n.a.
(4,749) (15,278)
123,242 129,715
54,542 n.a.
Note: GNP and GDP per capita are in current prices. The rate of inflation is based on GNP deflator. T interest rate on time deposits for the period of one or more years. Source: Economic Statistics Yearbook, various years, and National Accounts 1994, by National Korea Major Statistics of the Korean Economy, various years The First Five Year Economic Development Plan, 1962-66
South Korea
121
In broad terms, Korea's real GDP tripled every decade since 1962. When combined with a rapid slowing down in population growth, it resulted in handsome gains in per capita income. This gain was effectively spread among the population through rising wages and rapid job creation. There was double-digit unemployment at the start. But it declined rapidly. Full employment was achieved in late 1960s, and was maintained thereafter. There was an acute labour shortage from 1988 on. Unlike the growth rate of income, the rate of unemployment has been quite stable from 1970s on. The high growth of early decades was accompanied by even more rapid growth in prices. Inflation rates were almost always double-digit before 1982. It averaged 14 percent in the 1960s, and 19 percent in the 1970s, much higher than other Asian NICs. As will be explained below, it was a byproduct of the development policy pursued by the Government. Thus when government switched its policy in early 1980s, inflation fell sharply. 2. Sources of Growth With its start as a resource-poor, agrarian economy, the source of its post-1960 growth is quite obvious — export-oriented industrialization.
Table 3.2: The Structure of Production (% distribution in current prices) Sector
7960
1970
1980
1990
1995
Agriculture Industry Mining Manufacturing Construction Utilities Services Total (GDP)
39.9 18.6 2.3 12.1 3.5 0.7 41.5 100.0
31.1 28.4 1.3 19.1 6.4 1.6 40.5 100.0
14.6 41.4 1.4 29.6 8.2 2.1 44.0 100.0
9.0 44.7 0.5 28.9 13.2 2.1 46.3 100.0
6.6 43.5 0.3 26.9 14.1 2.2 49.9 100.0
Source: Economic Statistics Yearbook 1978, 1995, National Accounts 1994
122
Industrial Development in Asian NIEs
Reflected first in the structure of production. The share of manufacturing went up from 12 percent in 1960 to 27 percent in 1995, while the primary sector shrank (Table 3.2). Most manufactured products were destined for export. Exports were growing faster than the GDP. As sources of demand, their relative share continued to increase, rising from 14.7 percent in 1970 to 36.2 percent in 1985 (Table 3.3). Interestingly, imports share continued its rapid increase until 1980. Like other East Asian economies, Korea started out with developing labour-intensive light manufacturing industries. In 1970, such products accounted for some 70 percent of total exports. But all out efforts Table 3.3: Export and Economic Growth — Changes in Demand Structure Demand Component Consumption Investment Exports Imports Total
1970
1975
1980
1985
1990
1995
83.7 26.4 14.7 -24.8 100.0
82.0 27.5 30.3 -39.8 100.0
76.6 31.2 33.7 -41.5 100.0
68.9 30.6 36.2 -35.7 100.0
63.7 36.8 31.0 -31.4 100.0
61.3 38.3 30.6 -30.2 100.0
Source: Economic Statistics Yearbook, The Bank of Korea, various years
Table 3.4: Export and Economic Growth — Demand Side Sources of Growth in Manufacturing Output (%) Demand Expansion Consumption Investment Export Import Changes in input-output coefficient Total
1970-5
1975-80
54.8 15.5 27.3 -1.3 3.7 100.0
48.1 21.1 27.3 1.7 1.8 100.0
1980-3 45.8 19.8 32.9 3.7 -2.2 100.0
1983-7 41.7 21.6 34.2 4.1 -1.6 100.0
Source: 1970-83 figures are World Bank estimates, Korea—Managing the Industrial Transition, World Bank, 1987. Other figures are obtained from the author's estimates
South Korea
123
were launched, as early as mid-1973, to develop heavy and chemical industries producing for export. Specifically, six industries were targeted for promotion: industrial machinery, shipbuilding, electronics, steel, petrochemical and non-ferrous metal. By 1990, products from these industries accounted for 40 percent of total exports. Sources of growth are also analysed from the supply side, using the well-known growth accounting approach pioneered by Denison. Some results are summarized in Table 3.5. The growth of labour input was the single most important source of growth in the 1960s and 1970s. There was a substantive increase in labour input, taking into consideration number of workers as well as hours worked per week.31 By contrast, labour input was falling in Japan during its period of most rapid
Table 3.5: Supply Side Sources of Growth (% per annum) Korea
Japan W. Germany US 1950-62
1948-90
Real GNP Growth Rate
1963-73 1973-86 1982-89 1953-71 9.5
7.8
8.1
8.8
6.3
3.2
1. Contribution of inputs
5.4
4.1
4.4
3.9
2.8
1.8
Labor
3.2
2.2
2.5
1.8
1.4
0.6
Capital
2.2
1.9
1.9
2.1
1.4
1.2
2. Total factor Productivity
4.1
3.7
3.7
4.9
3.5
1.4
Advances in knowledge Improved resource allocation Economies of scale
1.4
1.6
0.9
2.0
0.9
1.0
1.0 1.7
0.6 1.5
1.0 1.8
1.0 1.9
1.0 1.6
0.4 n.a.
Source: Korea (1963-73) from Byung-Nak Song 1984; Korea (1973-86) from Byung-Nak Song; Korea (1982-89) from Joon-Kyung Park and Jung-Ho Kim, 1995; Japan and W. Germany from E.F. Denison and W.K. Chung, 1976; US from P. Samuelson and W. Nordhaus, 1995
31
Korea has the longest working hours of all Asian newly industrialized economies. In 1986, for example, the work week in manufacturing industries was 13 hours longer than that of Japan, and 6 hours longer than that of Taiwan. Unlike Japan and Taiwan working hours continued to rise until 1986, in spite of steadily rising income. (Cho, 1994, 92-3)
124
Industrial Development in Asian NIEs
growth. The stock of physical capital also increased very rapidly, as a rising proportion of a rapidly growing income was devoted to investment. Overall, the growth in inputs contributed considerably more to GNP growth than did increases in productivity, while the reverse was true for Germany and Japan. Paraphrasing Krugman, we can say that, compared to advanced countries, Korea grew more by perspiration than by inspiration. However, contribution from productivity growth was by no means negligible. A significant component of which was advances in knowledge. This was obviously related to the emphasis on human capital formation. Even in 1960, Korea had a relatively high level of educational attainment among developing countries. School enrollment grew exponentially thereafter. Enrollment ratio for secondary school went up from 27 percent in 1960 to 82 percent in 1982. For tertiary education, the ratio increased from 11 percent in 1977 to 37 percent in 1987. In 1990, public and private spending on education totalled 10 percent of the GNP. Particularly, the training of scientists, engineers and technicians was emphasized. The remaining productivity growth, ascribed to improved resource allocation and scale economies, was clearly related to the rapid pace of industrial transformation referred to earlier. It resulted in a rapid increase in the share size of high-technology products in manufacturing and exports. To the extent that these industries became competitive in the world market it would have resulted in improved resource allocation. At the same time, scale economies are important for heavy and chemical industries actively promoted. It should be noted that growth accounting is a very uncertain art, particularly for developing countries with incomplete data. Thus the relative contribution of productivity growth calculated by different researchers vary considerably. In sum, Korea's economic development was fueled by an intensive increase in factor input and rapid expansion of exports. Within three decades, the economy was transformed from a backward poor agrarian economic backwater into an industrial economy; a process which often took industrialized economies a century to achieve. But this condensed
South Korea
125
growth did not just evolve under the invisible hand of market forces. Quite to the contrary, it was orchestrated, throughout, by a strong and authoritative government with forceful policy. II. Historical Evolution of Economic Policy and Development 1. Background From the beginning, the Korean government took on an active and direct role in guiding and promoting economic growth, much more so than the governments of Japan and Taiwan. The overriding objective was growth maximization. This was considered essential to survival, to counter the threat of North Korea, which was stronger militarily and economically in early 1960s. The strategy was clear-cut and simple: outward-, industryand growth-oriented (or "OIG-oriented").32 To do well in export was considered of paramount importance. The phrase "export first" was written into the second five-year plan (1967-71), and "nation building through exports" was President Park's favourite maxim. At the helm was the government's strong guiding hand. Two months after Park took control of the Country, an Economic Planning Board was established which reported directly to the President. A monthly export promotion conference was established way back in December 1962, and it was always attended by President Park himself, as well as by all important public officials and private experts concerned with trade. Explicit targets for the growth of industrial outputs and exports were set, and the President himself checked on the progress of exports and the performance of exporting firms. Three phases of industrial policy can be distinguished: (1) Industrial takeoff (1961-73): exports were aggressively promoted. Interventions were manifold, but were neutral with respect to the composition of exports. (2) The Heavy and Chemical Industry Drive (1973-79):
Song, B.N. (1995), p. 85.
126
Industrial Development in Asian NIEs
promotion of specific industrial targets. (3) Functional incentive (1980s): a return to neutral, functional intervention. 2. Industrial Takeoff Trade, exchange, fiscal and financial policies were integrated to pursue the primary objective of export growth. It resulted in a wide range of incentives, administrative support and infrastructure investment for the benefit of exporters. Exporters were supported with tax exemptions, allocation of credits at zero or negative interest rates, multiple exchange rates, direct cash payments, permission to retain foreign exchange earnings for private use and the privilege to import restricted commodities. Some of these benefits were automatic, others were at the discretion of officials. In either case, they were tied to export performance. The government built export industrial estates to provide export firms with sites, utilities, transportation, communications and other services at discounted or controlled prices. It also helped to control the wages of workers at the exporting firms and restricted labour union activities. Administrative support of business also served as an effective supplementary policy instrument. Businessmen operated under a maze of laws and regulations concerning trade and industry, inherited from the Japanese colonial regime, which were designed to control business activities by the native Korean population. Administrative support helped to cut through the red tape and greatly reduced the cost of doing business. At the Monthly Export Promotion Conference, for example, businessmen could tell their problems directly to the President. A number of quasipublic organizations also provided valuable support for exporting firms. The Korean Trade Promotion Corporation was established in 1962 to help with international marketing. The Korean Trade Association (KTA) was influential in promoting contact between the government and businesses. The Korean Institute for Science and Technology was established in 1961 to spearhead the country's technological drive. Finally, a system of general trading companies (GTCs) played a vital
South Korea
127
role in speeding up export expansion, though the legal framework was only introduced in 1975. Trading companies were designated a GTC by meeting a number of requirements such as paid-in-capital, public stock offerings, number of overseas branch offices, and, most importantly, annual export sales. In addition to prestige, sanctioned (licensed) companies enjoyed various benefits such as cash subsidies tied to export volume and preferential access to foreign exchange. By regularly raising the minimum export value requirement, the government continuously pressured GTCs to expand exports. For their part trading companies, which steadily increased their market shares, could support and pressure producers for greater efforts. Non-monetary rewards, such as medals, citations or presidential awards were used extensively to mobilize commitment to development policies. Such social recognition was believed to be very effective motivators in a traditional society like Korea, where people value loyalty to the President and country very highly. Clearly, such incentives could be used in the reverse, in the form of social pressures and practical penalties — withdrawals of recognitions, privileges and supports — to ensure compliance. The main features of industrial policy in this phase were: (a) moderate protection of domestic markets, offset by special subsidies for exports; (b) approximately world market pricing of inputs and outputs across different export products; (c) great protection of the domestic market in industries with poor export prospects; and (d) great protection of final consumer goods, relative to industrial raw materials and capital goods. Overall, protection did not significantly distort either the general level or the inter-industry pattern of export incentives. Consequently, the emerging export structure reflected comparative advantage more closely than is generally the case in protected economies. These efforts turned out to be phenomenally successful in the 1960s. As shown in Tables 3.6-3.8, performances repeatedly outpaced targets. Average growth rate was targeted at 7.1 percent for the first five-year plan (1962-66). The actual performance was 7.8 percent. Annual growth of exports was 44 percent, some 80 percent above
128
Industrial Development in Asian NIEs Table 3.6: Targets and Growth Performance of the First Five-Year Plan (1962-66) Indicator
Targets
Economic growth rate (%) Investment as share of GNP, % Domestic saving as share of GNP, % Foreign saving as share of GNP, % Current account in 1966 (mn $) Exports in 1966 (mn $) Annual average percentage change Imports in 1966 (mn $) Annual average percentage change
7.1 22.6 9.2 13.4 -246.6 137.5 n.a. 492.3 n.a.
Performance 7.8 17.0 8.8 8.2 -103.4 250.4 43.7 679.9 19.1
Table 3.7: Targets and Performance of the Second Five-Year Plan (1967-71) Indicator
Targets
Economic growth rate (%) Investment as share of GNP, % Domestic saving as share of GNP, % Foreign saving as share of GNP, % Current account in 1971 (mn $) Exports in 1971 (mn $) Annual average percentage change Imports in 1971 (mn $) Annual average percentage change
7.0 19.0 11.6 7.5 -95.8 550.0 894.0
Performance 9.5 26.1 16.1 10.2 -847.5 1132.3 35.2 2178.2 26.2
Source: Economic Planning Board; Bank of Korea, National Accounts 1990
target. The feat was repeated over the second five-year plan when economic growth reached 9.5 percent, against the 7 percent target, and exports grew at 35 percent. The success spurred the government into more direct and comprehensive intervention for more ambitious results. The drive for heavy and chemical industrialization was formally declared in January 1973.
South Korea
129
Table 3.8: Target and Performance of the Third Five-Year Plan (1972-76) Indicator
Targets
Economic growth rate (%) Investment as share of GNP, % Domestic saving as share of GNP, % Foreign saving as share of GNP, % Current account (mn $) Exports (mn $) Annual average percentage change Imports (mn $) Annual average percentage change
8.6 27.6 19.5 5.4 -359.0 3510.0 3993.0
Performance 9.1 27.1 20.8 6.7 -313.6 7814.6 47.1 8405.1 31.0
Source: Same as Table 3.6
3. The Heavy and Chemical Industry Drive The controversial Heavy and Chemical Industrialization (HCI) policy was officially declared by President Park in January 1973. But the targeting of the six industries concerned, namely, industrial machinery, shipbuilding, electrical, steel, petrochemical and non-ferrous metals began a few years earlier, during the second five-year plan. In typical Korean fashion, a law was specifically enacted for the promotion of each of these industries. The Industrial Machinery Promotion Act, for example, came out in 1967. Steel, petrochemicals, and non-ferrous metals were selected primarily to enhance self-sufficiency, as Korea's manufacturing was unusually dependent on imports. The others were selected because they were technologyintensive. A number of distinctive features of HCI policies are worth noting. Firstly, the policy was outward-looking. The targeted industries were planned to be internationally competitive from the outset. It was recognized that the domestic market was too small to exhaust the scale economies of these industries. The second feature was its detailed planning. Targets set in 1973 included physical quantities of steel, ships
130
Industrial Development in Asian NIEs
and autos to be produced by 1980. Harbour, road and water investments were coordinated and provided as part of the social overhead capital investment. Plans were explicit in saying that only up-to-date technology was to be used. The third and most controversial aspect of Korean industrialization is its financing. Public resources were directly mobilized for HCI financing via the National Investment Fund. Banks were directed to lend to the industry at preferential rates. In addition, there was a plethora of tax incentives as well as subsidized public services. The true cost of the HCI promotion will thus never really be known. Buttressed by the six promotional laws issued during the Second FYP (i.e., for Industrial Machinery-1967, Shipbuilding-1967, Electronics1969, Steel-1970, and Petrochemicals-1970), President Park's 1973 Decree mobilized Korea's bureaucracy to achieve his goals. The most remarkable feature of these plans was that each industry designated for support was to go through four pre-determined phases: (i) minimum scale, when active government planning and support accompanies protection; (ii) optimum scale, at which time government lending and support continues but the industry matures; (iii) international scale, by which time industries are expected to be self-sustaining and initiative is to come from business itself; and (iv) international first-class scale, by which time the industry is expected to be internationally competitive. A Heavy and Chemical Industry Planning Council was established by the President in 1973 to take charge of the planning and implementation of the heavy and chemical industry buildup. The Industrial Base Development Promotion Act was enacted in the same year, which decreed the establishment of 13 heavy chemical industry complexes throughout the country to accommodate plants of the targeted industries. To mobilize resources, the National Investment Fund Act was legislated, also in 1973. According to this law, each and every type of savings was to be mobilized, on a compulsory basis, to invest in essential — that is, heavy and chemical, and export — industries. They did so through the purchase
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131
of the National Investment Bond, or deposited their money with the National Investment Fund (NIF). The big push was also accompanied by a rapid increase in external debt. An early emphasis on drawing foreign direct investment was not successful. Almost all important investments were made by local entrepreneurs, who relied principally on borrowing. Targeted industries received heavily subsidized loans from NIF. Indeed, real bank interest rates were negative during most of the 1970s. HCI projects were heavily favoured. About two-thirds of NIF loans went to HCI projects. Similarly, bank credits also favoured such projects. Policy loans, the directed credit instrument of Government, reached 41 percent of domestic credit in 1975, and 51 percent in 1978. In contrast, light industries such as textiles faced fierce discrimination in getting access to credit. They had to resort to more expensive sources. The HCI sector also received more favourable tax treatment. Marginal tax rates for non-HCI corporations were 2 to 3 times higher. Intervention did not stop with credit allocation. Almost every price — even the prices of fast food items — was under government control. There was a complete control on wages. The Government set guidelines for wage rates, taking into consideration their impact on the price level and on exports. Labour movement was practically outlawed. Similarly, a guideline for determining dividend rates was set by the Government, which was concerned with their impacts both on interest rates and on the development of the stock market. During the third five-year plan period (1972-6), when most of the rest of the world was plagued by the energy crisis and stagflation, the Korean economy performed brilliantly. At 9.1 percent, the growth rate was ahead of target (Table 3.8), and was also the highest among nonoil-producing countries. Unemployment rate fell to 3.9 percent. The very ambitious investment target was achieved. Exports were growing at an unprecedented 47 percent per annum. However, the HCI drive had little to do with this success. It would have taken another ten years before their products became competitive in world markets. Instead, it was due primarily to some fortuitous external events. First, the 1973 international exchange-rate adjustment
Table 3.9: Target and Performance of the Fourth Five-Year Plan (197 Targets Indicator
average 1977
1978
P
1977 1 i 1979 1980 1981 •iverage
9
10
9
9
9
9
6
10
Investment as share of GNP, %
26
27
26
26
26
26
31
27
Domestic saving as share of GNP, %
24
22
23
24
25
26
24
25
Foreign saving as share of GNP, %
2
5
3
2
1
0
6
Current account (mn $)
-634
-237
235
679
1172
Exports (mn $)
9700 11970 14519 17292 20242
Economic growth rate (%)
Imports (mn $) Annual average percentage change Source: Same as Table 3.6
-
10047 1 22
Annual average percentage change
1 12
10133 11925 14043 16435 18872 24
29 10523 1 25
South Korea
133
brought about an appreciation of both the Japanese Yen and the German Mark, providing the Korean exporters with great competitive advantage. Second, the OPEC countries in Middle East lavished their bloating oil revenue on massive infrastructure projects. Korean construction firms were heavily involved in these activities. But the policy of heavy industrialization was clearly responsible for fueling inflation. While most other countries tried to contain their inflation, Korea persisted in maintaining a growth-oriented expansionary policy. The rate of inflation topped 20 percent for the years 1974-76, despite extensive price controls. With economic success, policymakers became more confident, and pursued the HCI drive with greater vigour. More ambitious targets were set for the fourth five-year plan (1977-81). The plan also aimed at cutting its reliance on foreign capital, while raising the proportion of heavy and chemical industries to almost 50 percent. As detailed in Table 6b, growth targets were achieved in 1977 and 1978, but it slipped behind in 1979. The following year, Korea experienced its first and only negative growth. Average growth was substantively below the target rate. Investment target, however, was exceeded for every year. Indeed, total investment in exports and heavy and chemical industries during the first three years surpassed that planned for the entire period. This was partly at the expense of light industries investment, which fell far short of the plan's goal. On the other hand, the targeted rate of saving was not achieved. The result was a large-scale foreign capital inflow. It was noteworthy from Table 6b that, year after year, the export target was fulfilled with hairsbreadth accuracy. It reflected overriding importance accorded by all parties concerned to the export goal. On the other hand, actual imports far exceeded planned levels. Behind the facade of rapid growth and industrialization, economic and social problems were mounting. Inflation averaged more than 20 percent, it reached 26 percent in 1980, the year of negative growth. It was widely believed that the actual inflation exceeded official figures. With multiple prices for the same goods — official prices, announced prices, and market prices — the rate of inflation was hard to ascertain. High
134
Industrial Development in Asian NIEs
inflation brought about widespread speculation on buildings, land and durable goods. There was also widespread excess capacity and financial losses in HCI. The balance of payment worsened, and foreign debts snowballed. As the HCI drive favoured large enterprises, engineers and highly skilled labour, distribution of income and wealth became more unequal. High inflation and a real estate boom further aggravated the problem. At the same time heavy investment in HCI crowded out expenditure on social services and infrastructure. Substantial adjustments were therefore necessary. As most of the woes mentioned above were related to the HCI drive forced from above, a shift in strategy would have been a natural response. 4. A Shift Towards Functional Incentives The assassination of President Park in October 1979 was followed by a prolonged crisis in political, economic and social spheres, which were, to some extent, reactions to the distortions and imbalance brought about by forced growth. General Chun Doo Hwan seized power in May 1980, and was inaugurated as President in March 1981. In the early 1980s, the Korean economy was characterized by very slow growth, high inflation, and rapidly expanding foreign debts. The new government had simultaneously to stabilize the macroeconomy, solve the mounting financial problems in major industries, and establish new directions for industrial policy. The new approach to industrial policy, written into the fifth five-year plan, represented a shift to indicative planning, and an aim to rely more on market forces and private enterprise. This was eventually translated to a range of financial and trade liberalizations. Trade liberalization started in 1981 and progressed steadily, gathering momentum after the 1985 Plaza Agreement. In the area of industrial finance, the government sold its bank stocks to the public between 1981 and 1983, and it abolished numerous regulations and control on the management of banks. It reduced its role on specific credit allocation, and abandoned policies which favoured the HCI sector. Interest rates
South Korea
135
were increased to reduce the gap between the organized and unorganized sectors of the financial market. New financial institutions were established for participations by foreign banks. In all, the scope of interest rate subsidies for particular borrowers was substantially reduced. The privatization of commercial banks was the most notable part of the drive for promoting the "private initiative economy". The Monopoly Regulation and Fair Trade Law was introduced in 1980, which created a Fair Trade Commission. The purpose was "...encouraging fair and free competition and thereby stimulating creative business activities and protecting consumers as well as promoting a balanced development of the national economy" (Song, 1990, 116). Promotion of small and medium enterprises (SMEs) was high on the agenda. In 1982, the Small and Medium Industry Promotion Act was enacted, which created a fund to build industrial complexes for small enterprises and to furnish managing and technical skills for them. In 1986, the Small and Medium Industry Startup Promotion Act was introduced to help entrepreneurs start SMEs through tax incentives and financial support. Despite this general thrust towards neutrality, the government continued to play an active role in several areas of policy. Intervention since 1979 has focused on the restructuring of distressed industries, support for the development of technology, and the promotion of competition. Restructuring operations became frequent in the wake of sharp reversals in world markets and the overambitious investment programs of the 1970s. The firms and industries involved were large and highly leveraged, with their loans representing a significant share of commercial bank assets. These factors, coupled with the relative thinness of Korean capital markets, drew the government deeply into the restructuring process. The plans it helped orchestrate involved mergers, capacity reduction and special financial rescheduling with commercial banks. Although the government was no longer involved in picking winners, it did occasionally block industrial entry (such as when Samsung wanted to enter the automobile market), possibly for strategic economic reasons. Export expansion remained the corner stone of growth policy. With slow growth, mounting foreign debt and high inflation, to speed up
136
Industrial Development in Asian NIEs
export-led growth became more urgent. As a result, export promotion was given the highest priority again. This was done through intensive promotion of export goods and market diversification, reform of the export support system, lowering of tariff rates to expand importation of goods used in manufacturing, and expansion of loans associated with the exportation of durable goods such as machinery and ships. The decade of the 1980s was marked by spectacular economic success, surpassing even the performance in the 1960s and 1970s. Rapid growth was accompanied with price stability, debt reduction, improved social justice and democracy. Macroeconomic indicators are summarised in Table 3.10. During the fifth plan period (1982-6), growth averaged 9.8 percent, against the targeted 7.6 percent. Both investment and saving targets were fulfilled. Though both exports and imports were below target, the current account deficit was steadily narrowing. In 1986, a sizeable surplus was registered, the first in the history of the Republic. Even more remarkable was the drop in the rate of inflation. Wholesale price inflation fell from 39 percent in 1980 and 20.4 percent in 1981 to 4.6 percent in 1982, and was below 1 percent in the following years. Favourable global events, like the appreciation of Japanese Yen from 1985 on and falling commodity prices explain part of the success, but policies of stabilization and liberalization must have made an important contribution, too. High growth was sustained during much of the sixth five-year plan (1987-91) (Table 3.11). Average growth was is double-digits, much higher than the 7.2 percent targeted. Both investment and saving rates overshot their targets. Contrary to the earlier period, both exports and imports exceeded their targets in every year, but import was growing much faster. And the balance of payment swung from a sizeable surplus in 1988 to a hefty deficit in 1991. Export growth also tumbled from 1989 on, due to appreciation of the Korean Won and rapidly rising wages. Inflation shot up. The economy was entering into a more difficult period. The HCI sector was promoted with export in mind. The government embarked on the project on the belief that the comparative advantage of
Table 3.10: Targets and Performance of the Fifth Five-Year Plan (1982-8 Targets Indicator
Perfo
average 1982 1983 1984 1985 1986 average 1982 1983 8
8
8
8
8
8
10
7
13
Investment as share of GNP, %
32
31
31
31
32
"33
30
30
30
Domestic saving as share of GNP, %
27
24
26
27
28
30
37
22
26
Foreign saving as share of GNP, %
4
3
Economic growth rate (%)
7
5
4
3
3
Current account (bn $)
-5
-4
-4
-4
-4
Exports (bn $)
24
31
37
44
53
Annual average percentage change Imports (bn $) Annual average percentage change Source: Same as Table 3.6
-29
34
40
47
7
4
-3
-2
21
23
11
1
11
4
24 -3
25 6
56
Table 3.11: Targets and Performance of the Sixth Five-Year Plan (198 Targets Indicator
average 1987 1988 1989 1990 1991 average 1987
Economic growth rate (%)
7
8
8
7
1
1
10
13 30
Investment as share of GNP, %
31
30
31
31
31
31
35
Domestic saving as share of GNP, %
32
31
32
32
33
33
36
36
Foreign saving as share of GNP, %
-2
-1
-1
-2
-2
-2
-2
-7
Current account (bn $)
2
3
3
4
4
10
Exports (bn $)
36
40
44
49
54
46
33
36
40
45
50
Annual average percentage change Imports (bn $) Annual average percentage change Source: Same as Table 3.6
16
36
21
39 30
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139
Table 3.12: Korea Trade by Principal Commodities (US$bn) 1980 Total mechandise exports % agriculture-intensive % labour-intensive % capital-intensive % minerals-intensive Agriculture % merchandise exports % annual growth
7955
1990
1991
1992
1993
1994
17445 30283 60420 71672 76394 81937 95440 5.6 5.4 5.3 5.4 5.4 5.3 11.4 36.9 33.6 29.9 27.3 43.9 50.1 38.6 53.2 57.4 61.2 63.8 53.4 40 41.3 3.3 3.4 3.6 3.6 2.5 4.5 3.4 8.8 2.4
Manufactures clothing telecommunications equipment road motor vehicles electrical machinery footwear woven textiles, non-cotton sound recorders office machines toys, sporting goods ships and boats travel goods domestic electric equipment iron, steel, plate, sheet rubber articles textile yarn and thread machines, non-electric others Total % merchandise exports % annual growth
2854 942 118 151 873 1004 215 86 326 135 262 63 555 496 623 121 6861 15685 89.9 17.9
Mining and other % exports % annual growth
1.3 44.3
4.9 2.9
5.1 3.3
4.5 4.0
4291 7994 7507 1572 4616 4663 2178 2593 646 1370 6104 7387 1543 4164 3679 1326 3813 4733 2795 3002 706 582 2658 2855 1093 154 662 5040 2801 4129 1097 1036 470 1029 839 311 1613 1714 529 989 961 470 971 867 600 264 1230 1398 7287 11373 17822 27669 56257 66600 91.4 93.1 92.9 4.4 18.4 3.6 3.8 11.4
1.8 8.8
2.6 71.7
4.2 0.4
3.8 2.4
3.8 16.8
6857 4756 3172 8579 3034 5362 2884 3047 923 4113 895 1096 2079 1142 1042 1738 10247 70966 92.9 6.6
6172 5100 4941 9941 2128 6062 3125 3414 710 4061 796 1217 2269 1240 944 2064 22187 76371 93.2 7.6
5689 5977 5857 15272 1557 7380 3456 3498 657 4945 706 1486 2142 1345 1055 2698 25432 89154 93.4 16.7
2.9 18.2
3.0 9.6
2.8 7.8
HCI sector (industries in italics) 2294 11685 24243 28815 31398 35859 44311 Total 42.9 45.5 48.3 % manufacturing exports 14.4 40.6 42.3 42.1 41.1 43.8 46.4 % total exports 13.1 38.6 40.1 40.2 Source: Economic Statistics Yearbook, The Bank of Korea
140
Industrial Development in Asian NIEs
Korea was shifting away from labour-intensive to capital-intensive industries. The capacity envisaged for these industries far exceeded domestic demand. The competitiveness of these industries in overseas markets and their contribution to the outstanding success of the 1980s is thus a key issue consideration in assessing the success of HCI drive. The change in export composition is presented in Table 3.12. Between 1975 and 1987, export shares of chemical products, electrical machinery and transport equipment increased most rapidly. They were among the six industries promoted in the HCI drive. If manufacturing exports are dichotomized into light industry and heavy industry, then the share of heavy industry increased steadily from 14.2 percent in 1971 to 41.5 percent in 1980, and 60.4 percent in 1992. From mid-1980s on, manufactured exports shifted decisively to skill-intensive goods such as computers, semi-conductors, colour television sets, and automobiles. By and large, the planned schedule was met: HCI exports reached world class scale in the mid-1980s, and successfully entered Western markets by late 1980s. Most heavy industries were operating at full capacity from 1986 on. III. Working of the Outward-, Industry- and Growth-Oriented Growth Strategy 1. Growth Strategy: An Overview The outstanding economic growth of Korea over the past three decades documented earlier has come out from a single development strategy: promotion of merchandise exports. When labour was abundant and wages were low, they rapidly built up their export-oriented light industry. When it was perceived that they were losing their competitiveness to newly industrializing economies with even lower wages, they moved into heavy and chemical industries in the early 1970s. Many of these industries became competitive in world market after mid-1980s. By this time they began to channel their efforts to upgrade their technology for the production and development of sophisticated high-tech products. Once
South Korea
141
again, impressive success was achieved. In 1995, Korea became the fifth largest producer of automobiles, the second largest shipbuilder in the world and the leading producer of semiconductors. All these were achieved by indigenous efforts. This single-minded emphasis on commodity production for export purpose is reflected in its economic structure, in comparison with other NICs, as shown in the following table:
Table 3.13: Structural Change: Sectoral Share of GDP (%) Agriculture Economy 1970 Korea 29.8 Taiwan Hong Kong Singapore
1983 14.2 7.9 0.9 2.2
Industry 1993 6.4 3.4 0.2 1.1
1970 1980 23.8 37.8 46.0 32.0 36.4 38.8
Services 1993 46.1 41.8 22.6 36.5
1970 1980 1993 46.4 48.1 47.6 46.1 54.8 67.2 77.2 60.0 63.3
Source: Asian Development Outlook 1994, ADB, p. 236
In other economies, the share of industry turned downward after 1980, but it continued to rise sharply in Korea. Concomitantly, the share of services was much smaller than the case for Taiwan (situations in Hong Kong and Singapore are less comparable as they are urban economies). Public policy was at the centre of development. The government set the targets, decided on the strategy, and controlled the allocation of strategic inputs. It even inspired and harnessed national effort, through campaigns and exhortation, to attain growth objectives. Private enterprises were relied upon to do the production. But the government was the premier entrepreneur, able, through incentives and licensing, to determine what, when and how much to produce in milestone investment projects. Particularly, it initiated new industries and orchestrated structural changes. State enterprises were created when needed. The trade regime
142
Industrial Development in Asian NIEs
was schizophrenic, with a pro-export bias, as reflected in trade preferences and an aggressive real effective exchange rate policy, combined with import protection. Korea is credited with excellent policy making and implementation. Its policy effectiveness is not in dispute. But evidence is mixed as to whether particular industrial policies were necessary or efficient. In this section we focus on the interaction of industrial development, industrialization, industrial policy and its implementation. Costs and benefits in a wider context are noted. 2. Sources of Technology Technological advancement of the Korean industry went through three phases: duplicative imitations in the 1960s and 1970s, creative imitations from 1980s on and innovations since 1990. This evolution paralleled the three key sequences in the flow of technology from advanced industrialized economies to catching-up countries, namely, transfer of foreign technology, diffusion of imported technology, and indigenous R&D to improve foreign technology and to generate its own technology. (Kim L., 1997, 23) The government played an active role in technology development from the very beginning. There was a Bureau of Technologies under the Economic Planning Board. In 1967 it was upgraded into a Ministry of Science and Technology (MOST), the first country to have a full-fledged Ministry of this kind. Foreign technology is transferred through three main channels: foreign licenses (FLs), foreign direct investment (FDI) and the purchase of turnkey plants and machinery. Korea's policies on foreign licenses was quite restrictive in the 1960s, restricting the kinds of licenses and the terms of payments to licensers. Policies were progressively relaxed from the 1970s on to attract sophisticated technologies. Royalty payments began to soar. (See Table 3.14.) Policies on FDI followed a somewhat different course. There was little restriction in the 1960s, but few foreign investments were made
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143
Table 3.14: Foreign Technology Transfer to Korea, 1962-93 (mn dollars)
Foreign Licensing Foreign Direct Investment Capital-Goods Imp.
1962-66
1967-71
1977-81
1987-91
1992-93
0.8 45 316
16 219 2541
451 721 27978
4539 3636 120952
1797 1939 67152
Source: Kim, L. 1997 Imitation to Innovation, p. 40-1
due to political instability and the uncertain economic outlook. In the 1970s, foreign direct investment was placed under tight control. As a result, the relative size of FDI was much smaller than that of Singapore, Taiwan and Hong Kong. Again, policy restriction on FDI was gradually relaxed from the mid-1980s. But FDI in manufacturing has declined steadily in recent years due to rising wages. More importantly, technology was imported through the procurement of turnkey plants and capital goods. Such imports were favoured by tariff exemptions, overvaluation of the local currency, and the financing of purchases by suppliers' credit. For example, chemical, cement, steel and paper industries established in the 1960s and early 1970s were all started on imported plants and capital goods. We can see from the table below that capital goods imports far surpassed other means of technological transfers in value terms. Korea relied heavily on Japan and United States for technology. During the first two decades of industrialization, they accounted for 80 percent of FDI and 70 percent of FLs and capital imports. Japan took a strong lead in those years. In the 1990s, however, the U.S. share of technology transfer increased significantly. The effective diffusion of technology acquired abroad across firms and industries is as important as technology import in upgrading the overall technological level of the economy. Public diffusion agents for such purpose were established in the 1960s, but demand for their services were limited, as matured products were easily imitated through reverse-engineering without the need to consult technical literature. With the stock of technology accumulating, and products becoming more
144
Industrial Development in Asian NIEs
sophisticated in the 1970s, such efforts intensified. In the 1980s, an intensive network of government, public and non-profit technical support systems to promote technological diffusion within the economy, particularly among small and median enterprises, came into being. There were industrial technology institutes and SMI production corporations at the national and regional level to provide technical extension services. The Korean Academy of Industrial Technology, together with other government R&D institutes and industry specific R&D institutes, comprise core of an R&D network for technological diffusion. Training programs on quality control, value engineering, physical distribution and factory automation were provided by the Korean Productivity Center and the Korean Standard Association. All these functions were coordinated by the Industrial Advancement Administration. In addition, an on-line network for scientific and technical information dissemination has also been introduced. As Korean industries became progressively more technology-intensive, the government focused more attention on indigenous R&D activities. This was done through two major mechanisms: direct R&D investment and indirect incentive packages. With the former, the government developed the science and technology infrastructure and promoted R&D at universities and government research institutes. Its indirect incentive packages, including preferential finance and tax concessions, were aimed at stimulating industry R&D. In early 1980s, preferential R&D loans became the most important means for financing private R&D activities. Public financing, mostly loans, accounted for 64 percent of the nation's total R&D expenditure in manufacturing in 1987. The cost advantage of such loans was, however, relatively modest. There are five categories of tax incentives for corporate R&D: tax advantage for corporate R&D investment, reduced tariffs on import of R&D equipment and supplies, tax deduction of noncapital R&D expenditures and human resource development costs, and exemption from real estate tax on R&D related properties. There has been a sharp increase in R&D investment in the past decades, both absolutely and in relation to national income. The trend
South Korea
145
and distribution of research and development expenditures are presented in Table 3.15. R&D increased its share of GNP from 0.32% to 2.61% in 1971-1994, surpassing that of the United Kingdom. Korea's R&D growth rate is the highest in the world. For instance, the highest average annual growth rate of a nation's R&D investment per GNP in 1981 — 1991 was that of Korea at 24.4%, compared with 22.3% in Singapore and 15.8% in Taiwan. Of interest is the structural change in R&D investment displayed in Table 3.15. Until 1980, the government played a major role in R&D activities. Then, responding to incentives and increasing competition in the international market, the number of corporate R&D laboratories shot up from 12 in 1975 to 2,272 in 1995, reflecting the seriousness with which Korean firms were pursuing high-technology development. R&D
Table 3.15: Research and Development Expenditure, 1965-93 (in billions of won)
R&D expenditures Government Private Sector Government (% total) R&D/GNP Manufacturing Sector R&D expenditure % of sales Number of researchers (total) Government/Public institution Universities Private Sector R&D expenditure/Researcher (xlOOO) Researcher/10,000 population Number of corporate R&D centers
1975
1980
1985
1990
1994
43 30 12 71 0.32
283 180 103 64 0.77
1237 307 930 25 1.58
3350 651 2699 19 1.95
7895 1257 6635 16 2.61
17 0.4 10275 3086 4534 2655 4152 2.9 12
2135 76 689 2.0 0.5 1.5 18434 41473 70503 4598 7542 10434 8695 14935 21332 5141 18996 38737 15325 27853 47514 16.4 4.8 10.1 966 54 183
4851 2.6 117446 15465 42700 59281 67220 26.4 1980
Source: 1994 Report on the Survey of Research and Development in Science and Technology, Ministry of Science and Technology (Korea), December 1994
146
Industrial Development in Asian NIEs
spending in manufacturing sector has outstripped sales. The machinery and electronics industry spent more than 4 percent of sales on R&D since the mid-1980s. Consequently, the private sector had assumed an increasingly larger role in the country's R&D efforts, accounting for 84 percent of such expenditure in 1994. These efforts produced a rapid rise in patent registrations, a sure sign that the country is able to develop its own technology. The number of Korean patents have risen significantly in the past two decades compared to the previous two, increasing a mere 48% in 1965-1978 but almost tripling in 1979-1989 and almost tripling again in 19891993. This reflects the expanding importance of intellectual property rights in the face of declining reverse-engineering. Furthermore, the Korean share of local patent registration also swelled from 11.4% in 1980 to 39.7% in 1993, indicating increasing R&D activities. Korea was fifth in the world in 1993 in the number of industrial property applications, following Japan, the United States, China and Germany. For industrial property applications by local residents per population, Korea ranked second after Japan. Patents registered in the U.S. are often used as a surrogate measure of international competitiveness. The number of U.S. patents held by Koreans is far below that of the Taiwanese, let alone those of advanced countries. The cumulative number of U.S. patents granted to Koreans between 1969 and 1992 is only 1751, compared with 4978 to Taiwanese. But Korea jumped from thirty-fifth in rank among the thirty-six countries listed in a National Technical Information Service report, with five patents in 1969, to eleventh, with 538 patents, in 1992, for an average annual growth rate of 43.32%, the highest among the countries in the report. This indicates once again that Korea has been gaining rapidly in international technological competitiveness. The number of Korean scientific publications cited by the Science Citation Index increased slowly from 27 in 1973 to 171 in 1980, but rapidly to 1227 in 1988 and 3910 in 1994, climbing from thirty-seventh in the world in 1988 to twenty-fourth in 1994. Korea achieved the highest annual growth rate (28.97%) in 1973-1994.
South Korea
147
All these represented the output of a rapidly expanding workforce of R&D personnel. The number of R&D scientists and engineers rose more than fivefold, from 18434 to 98764, between 1980 and 1993. The annual growth rate of 14 percent was again the highest in the world. 3. The Sources of Manpower Emphasis on education and respect for scholarship is a hallmark of Korean culture. With an acute lack of natural resources, Korea must develop its abundant human resources to sustain economic growth. Korea started its expansion of education right from the beginning. The budget share on education rose from 2.5 percent in 1951 to more than 17 percent by 1996, and peaked at 23 percent in early the 1980s. Yet, government disbursement accounted for only one-third of total expenditure on education. As a result, enrollment rate at various levels of schooling rose rapidly, as shown in Table 3.16. What distinguished Korea among development countries was a well-balanced expansion of all levels of education at an early stage of development to support subsequent industrialization. Korea consistently achieved the highest level of educational attainment among countries of comparable income. Special emphasis was given to science and technology. A Vocational Training Law was enacted in 1966 to complement the formal education system. In 1974, in-plant training was made compulsory for all industrial enterprises with 300 or more workers. The number of graduates from vocational training centres and junior colleges was large and increased rapidly after 1970. (Table 3.16) In 1980, 70 percent of junior college students were enrolled in technical programs. University enrollment also expanded rapidly, from 38400 in 1953 to 1.15 million in 1994. And the proportion of those majoring in science and engineering also went up from 35 percent in 1965 to 44 percent in 1994. The number of scientists and engineers per 10000 population reached 22 in 1993, the highest among developing countries and comparable to France and the United Kingdom. In addition, overseas training and observation were widespread. In 1993, for example, the
148
Industrial Development in Asian NIEs Table 3.16: Indicators of Human Resource Development in Korea
Illiteracy rate (%) Enrollment as % of corresponding age group elementary school (age 6-11) middle school (age 12-14) high school (age 15-17) tertiary schools Graduates of vocational training centres Number of junior college graduates Number of university graduates (1000) Number of graduates from tertiary schools (per 10000 population)
1953 I960
1970 1980
78
27.9
10.6
59.6 21.1 12.4 3.1
86.2 102.8 101 100.7 100.5 33.3 53.3 94.6 98.7 99.0 19.9 29.3 68.5 86.9 88.7 8.7 16.0 37.7 48.8 5.0 28.2 104.5 67.7 184.4 7,8 51.5 87.1 128.4 18.0 28.2 52.5 170.9 183.4 6.6
11.4
0
27.7
1990 1994 0
59.4
0
69.5
Source: Kim, Limit (1997) Imitation to Innovation, p. 61
31,076 Koreans studying in American universities ranked fifth after China, Japan, Taiwan and India, and it was second only to Taiwan only in term of population ratio. But there are problems behind these figures of impressive progress. According to Kim, there has been an underinvestment at all levels of education since 1970, as the government was preoccupied with maximizing short-term production and exports. The result was that: "Progress has been very impressive in terms of quantity but dreadful in terms of quality. ... The problems of underinvestment in education is most critical in higher education. ... Consequently, all universities have remained primarily undergraduate-teaching-oriented rather than research-oriented institutions." (1997, 64, 65) The short supply of highly trained human resources has become a major bottleneck in Korea's innovation drive. Kim's observation seems to be consistent with a recent assessment by the World Competition Report on human capital of countries in the Region. Some of the findings are presented in Table 3.17. Korea excelled
Table 3.17: Manpower, R&D in Selected Countries US % 20-24-year old in tertiary education Public spending on education, US$ per capita in 1992 R&D personnel per 1000 in the labour force in 1993 Ranking among 48 Asian nations: on adequate supply of engineers on science and technology R&D expenditure as % of GNP (GDP*)
Japan Australia HK Korea Singapore
39
18
40
38
172 1113
917
438
294
769
14.3
8.1
7.7
6.6
36 15
25 10
2.33
1.27*
76
31
17 2 >.6* 2.98*
Source: World Competitiveness Report 1995
35 23 1.35
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on quantitative terms: the highest enrollment rate in tertiary education, surpassing Japan and Australia, the number of R&D personnel per 1000 labour force was second only to Japan. But public spending on education was quite low. Most significant, its ranking in science and technology and in supply adequacy of engineers was far behind that of Taiwan and Singapore, but on a par with Hong Kong, which did not boast any science and technology policy. An effective way to remedy the shortage is by overseas recruitment, particularly among the large number of Korean scientists and engineers working and teaching in the United States. The government initiated this move a long time ago. In the early stage of Korean development, it suffered from a severe shortage of researchers with doctoral or master's degrees. In order to address this problem, the Korean government built up KAIS (Korea Advanced Institute of Science) in 1971, a researchoriented graduate school to produce high quality scientists and engineers. KAIS offered salaries four times greater than those of other Korean universities to attract top-quality faculty members from overseas. Students were offered generous scholarship and exemption from obligatory military services. The institution was immediately successful in recruiting faculty members as well as top graduate students. From 1975 to 1993, KAIST (KAIS was renamed KAIST in 1981) produced 7,577 M.Sc and 1,693 Ph.Ds. In 1986, another educational institution called KIT (Korea Institute Of Technology) was established. This is an undergraduate school for those with scientific and technological talent. In 1990 the two institutes were merged to form the Korea Advanced Institute of Science and Technology (KAIST). A large number of Korean students studied overseas, mostly in the United States and Japan. In early years, most of them chose to remain overseas after graduating.33 This resulted in a serious brain drain problem.
33
In 1967, 97% of Korean scientists and 88% of Korean engineers educated abroad remained overseas compared with world figures of 35% and 30% for all countries (Kim, 1997, p. 66).
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KIST started an attempt to draw back Korean scientists and engineers employed overseas — the so-called "reverse brain drain". The reverse brain drain was successful, and its impact on the national R&D systems was enormous in several ways. First, the recruiting team, supported by Battelle Memorial Institute, sent recruiting letters to around 800 institutions in the world and received around 500 applications. Almost all Korean scientists and engineers abroad were informed, and KIST had the opportunity to select the most appropriate researchers. Second, since all the key members were hired from abroad, there was no damage to existing institutions. Instead, since a large part of the initial members moved to academic circles later after having had research experience in Korea, education institutions benefited from these talented new professors. The program also set a model for the private sector, which assertively recruited high-calibre scientists and engineers in the 1980s and 1990s to expedite their advance into state-of-the-art technologies. In 1992 alone, 427 were lured from abroad, many from leading high-tech corporations in the U.S. The best among them joined the leading chaebols. 4. The Role of Foreign Investment To developing economies, foreign direct investment brings in muchneeded capital, know-how, as well as access to the international market. As such, it is ardently courted by most governments. Korea was an important exception. There was little restriction in the 1960s, only because few investors came knocking at the door. In the 1970s, FDI was tightly controlled. Only 44 percent of three-digit industrial subsectors were open to foreign direct investment. In addition, Korea was considered to be the most unattractive country in which to invest due to extremely cumbersome bureaucratic red tape. (Seong, 56)34 Generally,
34
Language barriers could have been another deterrent, in a recent visit to Seoul, I experienced much frustration due to the low English proficiency of the local people. Personnel in banks and in bookstores selling English books could not handle simple English. The situation could only be worse in early years.
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foreign investors were barred from investing in import-substitution sectors such as pharmaceuticals and heavy industry. During 1965-85, FDI amounted to much less than one percent of GNP, and below 5 percent of total capital inflow. While it depended heavily on foreign loans, Korea has entertained almost no foreign direct investment outside the labour-intensive sectors. (Amsden, 89, p. 9) As a result, FDI had a minimal effect on the Korean economy. Its contribution to GDP growth in 1972-80, for example, was only 1.3 percent. The restrictive policy was designed to preserve Korea's management independent from foreign multinationals, particularly the Japanese. Korean firms were forced to acquire and assimilate foreign technology primarily through imitative reverse engineering of imported foreign goods. Over the 1980s and 1990s the government gradually relaxed the controls of foreign direct investment. Restrictions on repatriation of capital and foreign ownership ratio was abolished in 1984. The proportion of three-digit industrial subsectors open to foreign investors increased from 44% in 1970s to 66% in 1984 and 91% in 1994. In 1995, the government introduced an automatic approval system, expanded tax and other incentives for investments in strategic high technology sectors, and created a "one-stop" service centre. The primary objective was to acquire more sophisticated foreign technologies to sustain its international competitiveness in high value-added industries. The outcome was not very successful. New FDI in manufacturing has declined steadily since 1991. Most foreign investment in recent years went to service sectors. With cheap labour costs a thing of the past, foreign companies are not willing to collaborate with Korean companies in technology-intensive production. (Kim, 1997, p. 44) 5. Planning for Growth Korea was a highly regulated society with an authoritative and interventionist government. For much of the period under consideration, the government could be characterized as a military dictatorship. It was
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only in 1993 that a civilian politician was elected president. In economic affairs in particular, market mechanism played second fiddle to planners and regulators. 5.1. Organization of Economic Planning The first five-year plan started in 1962. A New Economy Five-Year Plan, which displaced the 7th plan (1992-6), is now in progress. Even before that, the government was engaged in various economic plans and policies. As soon as Park Chung Hee took power he created the Economic Planning Board (EPB) in July 1962 by combining the Bureau of the Budget in the Ministry of Finance, the Bureau of Statistics in the Ministry of Home Affairs and the planning functions of the Ministry of Reconstruction. It has since played a central role in economic planning, national budgeting, foreign capital management and statistics. In 1963, the minister of EPB was designated deputy prime minister and authorized to control, coordinate and adjudicate among other ministries on economic matters. Also in 1961, an Office of Planning and Coordination was established under the prime minister to evaluate and monitor project and program performance. Planning and management units were set up under the vice minister in every ministry to superintend and monitor tasks. Besides the economic planning organizations, many specialized policy research institutes were sponsored by the government to strengthen public policy planning by various ministries. The better known ones are the Korean Development Institute (KDI) under the EPB, the Korea Institute for Industrial Economics and Technology (KIET), the Korea Research Institute for Human Settlement (KRIHS) and the Korea Education Development Institute (KEDI). In the field of science and technology, many other research institutes were fully sponsored by the government. In addition, specific administrative apparatus were often established to take charge of particular programs. In 1973, a Heavy and Chemical Industry Planning Council was established by the President for the planning and implementation of the HCI drive, resulting in a dual
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structure in economic planning. To promote industrial technology, a host of institutes, corporations and centres were created, under the umbrella of the Industrial Advancement Administration, to import, diffuse or generate technology. 5.2. Planning Procedure For a five-year development plan, the EPB first prepares preliminary guidelines on policy targets and directions, together with macroeconomic projections. Economists from government-sponsored research institutes are widely consulted at this stage. Individual ministries then formulate their own sectoral plans in accordance with the guidelines, with inputs from a large number of working committees associating with government ministries, industrial organizations, financial institutions, universities and research institutes. The preliminary guidelines and individual sectoral plans will then be consolidated into a draft plan and will be presented at a series of public policy forums. Experts and representatives from business organizations, labour unions, and consumer groups are invited to make their comments. A consolidated plan will then be formulated, to be reviewed first by the Plan Working Committee, consisting of vice ministers of economic affairs, and then by the Plan Deliberation Committee which comprises the prime minister and other cabinet members. Eventually, the plan will be presented to the President for approval. To implement mid-term plans, government used the annual rolling Economic Management Plan to translate its policy targets and strategies into specific, annual action programs, and to make policy adjustments in response to unforeseen changes in domestic and international economic environment. The Economic Management Plan was also intended to review and evaluate performance in the preceding year and to provide guidelines for the government's annual budget. 5.3. Scope of Industrial Policy The development of export-led manufacturing industry was to be the engine of economic growth. Industrial policy can be considered the
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centrepiece of these plans, with other segments playing a supplementary role. Until 1992, industrial policy was not confined to indicating the direction of growth and providing incentives. It was involved directly in deciding what industry to expand or to initiate, the scale of the project, the timing and speed of investment, even deciding the number of entrants and choosing when to launch the enterprise. Most new manufacturing branches were initiated by the government. They included the early import-substitution projects in cement, fertilizers, oil refining and synthetic fibres. The state also took the driver's seat in the transformation from light to heavy industry, like steel mills in early 1960s, shipyards in later 1960s, and heavy machinery and chemicals in the late 1970s. In recent years, the government continued to play a key role in the development of the electronics industry, as will be detailed in the case study to follow. After deciding what to produce, how much, and who will do it, it is only natural for the government to arrange all necessary inputs for these projects. In this way, the state is largely taking over the entrepreneurial role of industrial diversification — the selection, planning and resources mobilization involved in the penetration of new industries. Such involvement placed the government in the position of an implicit risk partner, and to assume financial responsibility for business failures.
6. Government Incentives and Industrial Development 6.1. Taxes, Foreign Exchange and Loans Targeted HCI industries were favoured with a host of incentives. Most overt were various tax concessions, like tax holidays, special investment tax credits and accelerated depreciation of fixed capital. At the same time other business faced higher taxes due to the withdrawal of several kinds of subsidies to exporters. The result was that the effective tax rates on the marginal return of capital for 1975-80 averaged 17 percent for industries favoured by HCI policy, compared with 50 percent for other industries (Yoo, 90, 34-5). Higher tariffs sheltered HCI products from foreign competition. Trade policy became more restrictive, reversing
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the liberalizing trend since the middle of the 1960s. As a result, effective protection rates became widely dispersed by the 1980s among various industries. Another important instrument was the exchange rate policy. The nominal exchange rate was held constant during 1974-1979 in the face of rampant inflation at home. The result was an over-valued currency. Access to foreign exchange granted to targeted industries then represented a significant subsidy. But the most powerful tool was the allocation of investment funds. Targeted industries received loans from the National Investment Fund and from commercial banks, which were owned and controlled by the government. The real interest rates charged on such loans were often negative due to high inflation. On top of that, heavy and chemical industries also paid preferentially low interest rates. Between 1973 and 1977, the share of credit allocated to the six priority sectors virtually doubled from one third to about 60 percent. They also faced much lower borrowing costs. At the same time, investment in light manufacturing plummeted. Private firms in Korea contributed very little of their own capital to most investment projects. Internal financing in 1963-1973 accounted for only 20 percent of total financing, much lower than the case in Japan and the United States (Amsden, 85). They borrowed as much as they could from the banks, often in excess of the amount needed to finance planned investment, so as to take advantage of interest subsidies. The excess borrowing frequently found its way into land speculation. As banks were owned and controlled by the state, such heavy borrowing put businessmen under tight government control, making credit allocation an effective key instrument. 6.2. Price Control and Labour Policy The government also maintained tight control of wage rates, and through its industrial estates development policy, also controlled land prices and user fees for electricity, water, transport, communications and other services. The result was lower cost and less uncertainty for favoured industries. Of particular interest was its effort to maintain industrial peace.
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Through the late 1980s, the government pursued a consistent policy of repressing labour movements. Though the ban on unions was lifted in early 1960s, the restrictive legal framework made it virtually impossible to organize independent unions. National security consideration vis-avis North Korea offered a convenient pretext to spy on and repress labour unions through the 1970s. As a result, workers became exceedingly docile. For example, between 1979 and 1984, only half a working day per 100 workers per year was lost to industrial dispute, compared with two days in Japan and fifty in the United States (Kim, L. 1997, p. 33). 6.3. Impact on Industrial Development To assess the impact of the HCI drive on the evolution of manufac-turing industries, Yoo (1990) divided manufacturing industries into two groups: the seven industries favoured by the HCI policy, namely, industrial chemicals, iron and steel, non-ferrous metal, metal products, nonelectrical machinery, electrical machinery, and transport equipment and 17 other industries. The two groups are referred to, respectively as HC group and light industry group. As the HCI drive lasted from 1972 to 1979, development from 1966 to 1985 will be considered. As expected, growth of the HC group accelerated during the era of the HCI drive. Throughout the period, the HC group grew faster than the light industry group in value-added and in employment. As shown in Table 3.18, it grew twice as fast in value-added during 1970-78, compared with a 30 percent difference in late 1960s. The same pattern existed for employment, but to a more moderate extent. The result was a big structural change. In 1966, light industry accounted for 70 percent of total value-added in the manufacturing sector. It fell to 60 percent in 1975, and 49 percent in 1985. Its employment share for the 3 benchmark years was 83, 78 and 68 percent respectively. As credit was made more available and less costly to the HC industry, capital accumulation is expected to be faster in these favoured industries. This is borne out sharply by the data. From Table 3.14, we note that the rate of capital accumulation was about the same for the two groups
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Industrial Development in Asian NIEs Table 3.18: Evolution of Korean Manufacturing Industries
All Manufacturing
Heavy & Chemical
Light
Average annual growth of value-added 1966-70 1970-73 1970-78 1978-85
21.0 20.2 18.5 7.4
23.3 32.2 30.0 10.3
17.8 19.2 15.9 6.1
Annual employment growth 1966-70 ' 1970-73 1970-78 1978-85
8.8 9.6 10.6 1.4
11.8 15.5 15.4 5.7
8.2 8.2 9.4 -0.1
Annual growth in capital stock 1966-70 1970-73 1970-78 1978-85
11.6 21.7 18.3 9.5
11.0 23.6 24.9 11.0
11.8 20.2 15.4 8.3
Annual growth in capital intensity* 1966-70 1970-73 1973-75 1975-78 1978-85
2.5 11.1 2.8 5.7 7.9
-0.7 7.0 11.9 7.1 5.0
3.3 11.1 -0.7 4.2 8.4
*Measured in millions of won per worker Source: Yoo Jung-ho (1990), p. 48, 51, 54, and 57
during 1966-70. The HC group started to edge ahead during 1970-73. It took off during 1973-78, a period when the HCI drive was in full steam. At the same time, capital accumulation in light industry decelerated. The working of discriminatory policy came out even more strongly when we look at the trend of capital intensity for the two groups of industries. Capital intensity is measured here as the capitallabour ratio. Whereas with the three indexes of growth just considered,
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the two groups followed a broadly similar trend over the two decades, here the trend went separate ways during the period of our concern. From the Table we see that during the second half of 1960s, capital intensity was rising for light industry but falling for the HC group. During the next three years, capital intensity was still increasing much faster for light industry. Then in the next five years, following the enactment of HCI drive, the situation reversed abruptly. Capital intensity was stagnant for light industries, while it rose sharply for HCI. The trend diversion between the two groups of industries during the first phase can be ascribed to aggregation and change in external demand. This was not the case for the 1970s, when capital intensity increased in HCI. It was the result from price distortions imposed by HCI policy. The two industry groups faced different wage-rental ratio. The situation reversed once more after the termination of HCI policy in 1979, capital intensity again rose faster for light industries. 6.4. Price Distortion and Capital Efficiency Industry policy related to the HCI drive worked mainly through the allocation of capital. There was little intervention in the issue of labour supply. If we assume that wage rates are competitively determined, then the existence and effect of factor market distortion can be clearly ascertained. In the period 1973-75, capital intensity was falling in light industries, but rising sharply for the HC industry. The immediate cause was a sharp rise in light industry employment. Hence, the wage-rental ratio must have been falling for this industry group. Falling wage rate could have brought this about. Actually, wages were rising sharply. The rental rate must have been rising still faster for the light industry group, depressing the wage-rental ratio. By the same token, sharply rising capital intensity for the HC group reflects rising wage-rental ratio. Assuming that wage rate was rising at the same pace for this group, the increase in its capital cost must have been lower. In short, for the period under consideration, light industries were confronted with a higher and more rapidly rising capital cost.
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With factor price distortions, economic analysis predicts that resource allocation will not be efficient. In particular, the marginal return to a unit of resource (capital in this case) will not be equal in different uses. To check this out, Yoo made a comprehensive study on capital efficiency for various industry groups over the years 1966 to 1986. He calculated the return to capital as the value-added minus the compensation for labour, and capital efficiency as the return to a unit of capital. His results show that, before 1980, capital efficiency was higher for light industry than for heavy and chemical industries. The difference was more pronounced when valued at international prices. He argued that the efficiency gap in the second half of the 1960s was a transitory phenomenon related to the surge of light industry exports. Adjustment was in progress for the capital efficiency of the HC group to catch up. But the process was upset by the HCI policy, and the efficiency gap persisted in the latter half of the 1970s. Under the assumption that production functions of manufacturing industries were linear homogenous, and that compensation labour was equal to its marginal value product per unit of capital. It follows that "marginal product of capital was lower in the heavy and chemical industries that were favoured by the HCI policy than the light industries during the 1970s." (p. 83). There was an overinvestment in HC industries in the 1970s. 7. Formulation and Implementation of Plans and Policies Economic decision-making was very much a top-down process, particularly in the 1960s when many government offices were headed by retired generals. It was a nation-wide apparatus headed by the President. In the drawing up of five-year plans, for example, policy proposals prepared by a ministry were seldom available to the public for discussion and did not represent public opinion. They were processed secretly among a small group of elite officials. Emergency policy proposals, in particular, tended to be prepared quickly by a small group of confidents. Observers likened this decision-making process to a "General Head-Quarters" style,
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in which the President himself made all the major decisions and settled policy disputes among his senior officials. This concentration of decision-making power allowed the government bureaucracy to make speedy decisions and policy adjustments. It was said that President Park despised or ignored politicians, so they had little influence under his regime. Instead, he relied on a handful of capable technocrats and bureaucrats to manage the economy (Song, 1995, p. 141). The capability, integrity and dedication of this group were crucial. For effective policy implementation, a competent and strong civil service was also necessary. The condition was largely fulfilled. From early 1960s on, civil servants were recruited through open competitive examinations. It is a two-tier system similar to that used in Japan. Those who pass the high civil service examination will start at a higher level and enjoy better prospects for advancement. Competition for passing this examination has been intense. Between 1963 and 1985, 2600 succeeded, representing 1.7 percent of those who attempted. This rigorous selection process has earned high regard from the public for senior civil servants. This respect also reflects the long Confucian tradition of honouring scholar-bureaucrats. The same tradition also instills into civil service a sense of mission and loyalty to the state and to their superiors. Promotions are based on evaluations of performance. All civil servants are given job security. Korean civil servants are not well rewarded financially. Until recently, they earned only 50-60 percent of what their civilian counterparts could get. But they have job security and pensions, which is rare in Korea. The strongest incentive for higher level civil servants is the social respect, which increases with their rank and stays with them after they have left office. Then there is the prospect of special recognition in the form of citation, honour and personal appreciation by the heads of state. In the Confucian tradition, this honour is regarded as something shared by the entire family or clan. By the same token, dismissal from a government post for wrongdoing will be considered a social disgrace. Thanks to such Confucian values, the civil service in Korea is well staffed with able and dedicated personnel.
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Korea's development-oriented state was at the wheel of its industrialization drive, at least for the 1960s and 1970s. Private firms, particularly chaebols, served as engines. A chaebol is a business group of varied corporate enterprises operating in diversified areas, and typically owned and managed by one or two related family groups. They were intentionally created by the government to marshall the scale economies inherent in mature technologies, to compete in export markets, and to engage in technological learning. It is also easier for the state to direct and control a small number of large enterprises which have long-term association with the government. The rise of this relationship was somewhat theatrical. Some Korean businessmen managed to become rich during the period of reconstruction following the Korean war. Under the reign of an interventive and venal regime, it was inevitable that many of them made their fortunes through illegal means, like bribery. There was widespread popular prejudice against them. Shortly after coming to power, President Park arrested a large number of them on the charge of alleged accumulation of wealth through illegal means. But he soon realized that he would need a large business class to perform entrepreneurial functions to fulfil his development goals. And business entrepreneurs were in short supply in those days.35 The government therefore exempted most of them from criminal prosecution. Instead of going to jail, they were to invest in new industrial firms in basic industries. They were supposed to donate the shares representing their assessed obligation (for illicit wealth accumulation) to the state. But this condition was rarely fulfilled. (Amsden, 1989, p. 72) Thus an alliance was formed between business and the government that laid the basis for subsequent industrialization, an alliance in which business clearly played a subordinate role. From that day on, the survival and prosperity of Korean enterprises were largely in the hands of government officials. All commercial banks
35
Due to Confucian influence, merchants and businessmen were placed near the bottom of the social hierarchy. This tradition survived the period of Japanese occupation (1910-45).
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were nationalized, so the government controlled the access and costs of credits. It also rationed and guaranteed foreign loans, granted access to imported raw materials, intermediate inputs and capital goods. Tariffs and licensing protected their markets from foreign and domestic competition. Fortunate for Korean growth, this support was granted, by and large, on grounds of good performance. Poorly managed firms were penalised. The government refused to bail out bankrupt firms in otherwise healthy industries. Instead, it appointed better managed chaebols to take over them. Good performers were rewarded with further licenses to expand, or were invited to venture into new lines of promoted activities. In this way, well-managed firms were guaranteed growth and diversification. In addition, firms that had been around for a longer time and had built up a good working relationship with the government had an edge over their rivals. More diversified firms are also better positioned to withstand cyclical and demand shocks. The result is that there is a higher concentration of large firms in Korea than any other developing countries. In 1993, 6 chaebols ranked among the top 100 global industrial enterprises, compared with one each for Taiwan and Mexico. Internally, the ten largest chaebols accounted for 48% of GNP in 1980. By 1977, 93 percent of all commodities were produced under monopoly, duopoly or oligopoly conditions, with the top three accounting for more than 60 percent of the market. The government exercised effective discipline over the chaebols, to secure their cooperation and to avoid any abuse of power. These companies were highly geared. In 1993, they depended on commercial banks and Korea Development Bank for 90 percent of their facility investment funds. (Hyung-koo Lee, 126) The government had complete control over these credits. There were scores of laws and regulations to be used for administrative control. A particularly handy and effective "stick" was the discretionary use of tax audits. To curb monopoly power, market-dominating enterprises were subject to yearly negotiated price controls. At the end of 1986, 110 major commodities were under price control. (Amsden, 1989, p. 17) Finally, the remittance of liquid capital overseas was tightly controlled. In all, policy makers and bureaucrats
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could count on the support and cooperation of businessmen to carry out their policy. As one observer put it: "In relation to the government, virtually all businessmen are highly cooperative, sometimes even subservient." (Kim and Leipziger, p. 35) This strategy of forced growth imposed heavy costs, both tangible and intangible, on the general public. Important economic costs were high inflation, widespread price distortions, high costs or unavailability of many foreign goods. The poor, in particular, were disadvantaged by inflation, negative interest rates on savings, wage suppression and an inadequate supply of social services. Also, Korean workers are noted for their long work weeks. In all, the rise in general living standards probably lagged considerably behind the rapid GDP growth achieved. Finally, entry restriction and domination of chaebols meant that most people could not start their own enterprises. It is remarkable that until recent years, dissent was minimal. The underlying national identity and social consensus was an important ingredient to the Korean success. IV. Appraisal The industrial policy of selective intervention which underlined Korea's development strategy will be evaluated at two levels. First, we assess its overall impact on the general efficiency and competitiveness of the Korean manufacturing industry. We shall also speculate on the hypothetical question of whether some of the promoted industries would not have come into being in the absence of government initiation and assistance. Secondly, its broader impact on fiscal, political, social, as well as economic spheres will be considered. 1. Industrial Development and Performance 1.1. Evaluation of some Key Industries Four major heavy industries were reviewed by Stern, Kim, Perkins and Yoo (1995). They are aluminum, shipbuilding, automobiles and steel industries. (Case studies for the last three industries are in the Appendix.)
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Aluminum The Korea Aluminum Company was started in 1969 as an import substitution project. It was not a commercial success throughout its history. The production scale was well below 100 000-ton level considered necessary to achieve reasonable economy of scale. The smelting technology it used was outmoded. Lack of raw materials and high energy costs added to its woes. Domestic price of aluminum was one-third higher than the world price. Due to a lack of technology, it turned out only low-end, unsophisticated products. The government ceased to subsidize the Company in 1989, and it went out of business. Shipbuilding The industry had an early start in 1960s, with the enactment of the Shipbuilding Industry Encouragement Act of 1962. It expanded rapidly in the 1970s. By 1979, Korea established itself as the second-largest shipbuilding nation in terms of orders, and seventh in terms of tonnage constructed. It became the fifth largest in 1996. But it was not successful financially, and rarely turned in any profits. It suffered from excessive expansion. Shipyards worked far below capacity throughout much of the 1970s and 1980s. The situation deteriorated further after the mid1980s, when the industry was plagued by rising wages and labour disputes at home, and change in the demand pattern for ships abroad. From 1985 to 1988, the four largest shipyards lost 765 billion Won ($US1 was worth about 859 Won). Shipbuilders are debt ridden from past expansions and losses. Despite its size, the industry still depends on Japan for technology and intermediate goods. This notwithstanding, the industry is usually held up as the pride of Korea's industrial might. Automobiles The industry was judged to be a mixed success. Like shipbuilding, it was promoted by the government well before the HCI drive, in the mid-1960s. Progress was made by stages: from the assembly of parts in
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the 1960s, through gradually increasing domestic contents, to rolling out the first Korean car in 1974. Throughout, the number of producers was restricted to four. Export to Europe started in 1982, and to the U.S. in 1985. Korea remains the only developing country to have achieved international status as an exporter of domestically built cars. In 1996, Daewoo Motors started building cars in Poland to sell in Eastern Europe. The most important factor contributing to the success of the Korean auto industry was the Voluntary Export Restraints imposed by the United States on the sales of Japanese cars, which made room for Korean cars in the low end, subcompact market. The depreciation of the Won in early 1980s, and sharp appreciation of the Yen after 1985 also yielded a great competitive advantage to Korean car makers. In view of this fortuitous circumstances, the industry is judged to be a mixed success. Steel This industry is an unqualified success. The Pohang Iron and Steel Company Ltd. (POSCO) was established in 1968. Construction of facilities commenced in April 1970 and was completed in record time. Blessed with superb planning and management, rapid development of downstream industries due to the HCI drive and a high level of construction activities, the firm continued to expand rapidly, and became a showcase of financial and technologies success. For six consecutive years from 1982, Pohang Steel Works had the lowest unit production costs for steel worldwide. Cost of hot-rolled steel in 1987, for example, was 80% of U.S. and 60% of Japanese costs. There is overwhelming evidence that Korea managed to create a successful, competitive steel industry out of nothing, and that the creation involved a very rapid expansion of capacity and output. More impressive yet, all this took place at a time when the steel industry in the rest of the world was in depression. It is without doubt, one of the more remarkable achievements of Korea in its industrialization drive.
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1.2. Impact on Export Competitiveness Discriminatory policy may be expected to have differential impact on the competitiveness of the two groups of industries in the world market. The changes in marker shares of Korean exports from 1970 to 1985 are summarized in Table 3.19. The market share of HCI products increased consistently and sharply, a 10-fold increase between 1970 and 1978, and doubling again by 1983. By contrast, the share of light industry products increased sharply until mid-1970s, then stagnated and fell between 1978 and 1980. As light industry products accounted for roughly 70 percent of Korea's exports, the country's share of world exports fell during these years. To see if this decline was caused by a shift in world demand, the performance of six other countries with similar manufacturing exports
Table 3.19: Korea's and Its Competitors' Market Shares in World Exports
1970 1973 1975 1978 1980 1983 1986
Korea's Heavy and Chemical Products
Korea's "Light" Products
Korea's Share in World Exports
[1] 0.07 0.33 0.33 0.7 0.8 1.6
[21 1.5 3.52 4.13 5.92 5.27 6.23
[3] 0.315 0.669 0.745 1.206 1.121 1.637 1.856
Competitors'Share in World Exports
[percent] 3.682 4.327 3.935 4.658 5.183 5.776 6.611
[1]: Included in "Heavy and Chemical" products are (2 or 3-digit SITC codes in parentheses): chemical elements and compounds (51), petroleum products (332), iron and steel (67), non-ferrous metals (68), non-electric machinery (71), electric machinery (72), transport equipment (73). [2]: Included in "Light" products are: rubber products (62), plywood (631), textiles (65), travel goods (83), clothing (84), footwear (85), miscellaneous mfr. (89) [3]: The sum of all countries' exports, excluding the exports of OPEC Source: Yoo Jung-ho (1990), p. 90, 92
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is also shown in the Table36. Their combined share of world exports continued to increase rapidly during 1978-80. The falling share of Korean exports reflected therefore a deterioration of its competitiveness. Yoo ascribes this to the discrimination of the HCI policy against light industries. But it is more than a little unfair to assess on basis of a short downturn. During the next three years, for example, Korea's export share shot up to 46 percent, compared with a 15 percent gain for the other six competitors. More appropriately, we can compare the gain in export share between 1975-76, when the HCI policy began to show its impact, and 1985-86, the last years of data in Table 3.19 (we use a two-year average to iron out cyclical influence). Korea's share in world exports rose by 112 percent, compared with 57 percent for its competitors. Thus, contrary to Yoo's interpretation, over the decade following the adoption of the HCI drive, Korea gained in export competitiveness, as measured by market share. But the question remains: How would the HC group have performed in the absence of HCI policy? It is not possible to give a definitive answer to this counterfactual question. To shed light on this issue, Yoo compares export performance between Korea and Taiwan. He notes that Taiwan's export mix was very similar to Korea's. They are also comparable in population density, factor endowment, cultural background and the stage of development. The one important difference was that Taiwan did not employ an industrial policy similar to Korea's HCI policy. Yoo argues that, in the absence of HCI policy, the export competitiveness of these industries would be similar to their counterparts in Taiwan. With all those supports and subsidies from HCI policy, one would expect a substantially faster rise in export competitiveness of Korea's heavy and chemical industries. Using market shares in OECD imports as an index of competitiveness, Yoo finds that the growth in market share of all heavy and chemical products over 1974-1987 was essentially the same for Korea and Taiwan. Among subgroups, Korea made more
The countries were Hong Kong, Israel, Portugal, Spain, Taiwan, and Yugoslavia.
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progress with chemical and basic metal, but lagged behind in electric and other machinery. Yoo concluded, "... the HCI policy had a net negative effect on the export competitiveness of the manufacturing sector as a whole, since the light industry group's competitiveness suffered while there were either no effects or negative effects on the heavy and chemical industry group's competitiveness." (1990, p. 101) 1.3. Impact on Industrial Structure An important issue is how many of the HCI projects would have been undertaken in the absence of government subsidy. Aside from the obvious negative connotation of inefficient and unprofitable projects being bankrolled by public funds, there is also a positive side. Some projects may yield unattractive private return but confer important external benefits, so that they can be justified on basis of social rate of return. Secondly, some projects may not be profitable at their inception. But their prospects or potentials are such that, with subsequent changes in demand, input and output prices, they become successful. Empirically, this calls for project- or firm-specific approach. Some initial attempts were made by Stern et al. using a cost-benefit analysis. The cost-benefit calculations were done using both base-year prices (the price estimates when the projects was undertaken) and current prices (later-year prices), at a point after the project was completed and in production. By traditional economic theory, if the economic rate of return on a project exceeds the opportunity cost of capital, the project is worth implementing and is in line with the economy's long run comparative advantage. If, for a variety of reasons, the financial rate of return for this project is below the market cost of capital, private agents will not undertake the activity. In this case, government measures can serve to bring the private returns in line with economic returns and ensure that economically desirable activities are undertaken or that the government can undertake the activity itself.
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The result can be summarised schematically as follows:
Base Year Prices
ERR>Pk ERR
Current Prices ERR>Pk Quadrant 1: Successful Quadrant 4: Successful
ERR
ERR=economic rate of return; Pk=opportunity cost of capital Industries that fall into Quadrant 1 would have been selected using the standard neoclassical selection criteria and would remain successful at current prices, either because there has been little change in relative prices affecting the activity or because the project is so robust that it remains economically attractive even when prices have changed. Quadrant 2 activities are projects that would have been selected under a market-conforming industrial policy but are nevertheless considered unsuccessful. Quadrant 4 activities are of greatest interest. That are projects that would not have been selected if the neoclassical acceptance criteria had been applied. If they were nonetheless implemented, they may have become economically successful for one of two reasons. The first is that changes in input and output prices were favourable. Second, quadrant 4 projects may have become successful for reasons other than exogenous price changes. Only such projects provide evidence for non-marketconforming industrial targeting. Industries in Quadrant 3 are activities that should have been rejected: They did not pass the cost-benefit test at the time they were proposed, and nothing has changed to make them successful. Data to carry out the required cost-benefit analysis, using both pre- and post-project implementation information, are difficult to obtain, so the cost-benefit analysis was limited to six projects. Because of the small number of projects studied and because they were selected
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primarily on the basis of data availability, the projects obviously do not represent a random sample of HCI projects promoted. The projects included and years of initiation and completion are: • • • • • •
Samsung Electronic Company (1971-2) Korea Heavy Machinery (1976-78) Dong Yang Steel (1979-81) Hyundai Pipe Company (1979— Korea Steel and Chemical Company (1981-83) Boo-Koo Steel (1982-84) The results are presented in the following diagram. Current Prices Base Year Prices
ERR>Pk
ERR
ERR>Pk
ERR
Quadrant 1: Successful
Quadrant 2: Unsuccessful
Dong Yang Steel Company Hyundai Pipe Samsung Electronics Quadrant 4: Successful
Korea Heavy Machinery Korea Steel and Chemical Boo-Koo Steel Quadrant 3: Unsuccessful
Of the six projects discussed using the cost-benefit analysis, all had internal rates of return that exceeded the opportunity cost of capital. But most had low, even negative, internal rates of return at market prices. In fact, each was a legitimate candidate for government support. It follows that none of the projects fall into quadrants 3 and 4. A review of the ex-post rates of return leads to the conclusion that only three projects — Hyundai Pipe, Dong Yang Steel and Samsung Electronics — can be classified as successful in the sense that after the passage of some time they exhibited internal rates of return that
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exceeded the current opportunity cost of capital.37 However, none of the six cases would fall into quadrant 4 — projects having a low internal rate of return at base-year economic prices and a rate of return exceeding the opportunity cost of capital at current prices. Thus Korean planners were not picking winners. 2. General Economic Efficiency—Static and Dynamic We have considered evidences of inefficient investment which can be ascribed to distorted input prices. Soft-budget constraints also contributed to overinvestment in favoured projects. As noted, entrepreneurs committed very little of their own money in such investments. It is understandable that investors tend to be less cautious with other people's money, particularly when there is an asymmetrical system of rewards and penalties. Only overt mismanagement was penalized. When failures were caused by changes in external demand, technology, or rising competition (which a prudent investor should have taken into consideration if he was bearing the risk) the government could be counted on to bail them out. Similar asymmetry extended to policy makers in the government. In Korean bureaucracy, achievement is openly recognized, failure seldom seems to be penalized. (Kim and Leipziger, 1993, p. 320) It is then not surprising that unsound ventures, over-expansions and financial losses were quite common among HCI projects. Price distortions were not confined to inputs. Controls on other prices were extensive. The government relied heavily on price controls to combat inflation, to countervail monopolistic power, or to hold down cost of living. With import control, prices for all imports are distorted. According to basic economic analysis, allocative efficiency in consumption and production cannot be maintained under such extensive price distortions.
37
The inferred economic opportunity cost of capital were: 1975-77 = 10.18%, 1978-80 = 8.1%, and 1981-83 = 9.39%.
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On the macroeconomic front, condensed growth and ambitious investment targets led to repeated bouts of high inflation, persistent external deficits, and mounting debts. In the second half of 1970s, inflation averaged to more than 20 percent (Table 3.1). Income policies, price regulations and budget freezes were used to combat inflation, causing other problems. The single-minded pursuit of export growth created various sectoral imbalances. We noted how the HCI drive retarded the growth of light industries. Development of the agricultural sector was similarly neglected. The growth of labour productivity in agriculture was much lower than that in Taiwan: 2.8% per annum over 1952-80, compared with 4.2%. This, according to Oshima (1987, pp. 160-1), was at the root of its macroeconomic woes. When farm output was low, food had to be imported, and the farm sector could save little. Both contributed to larger foreign debts. Lower farm income means slower spread of mechanization, which tied down more labour in agriculture. Less labour was released to the industrial sector, resulting in labour shortage, rising labour costs and higher inflation. In 1988, for example, agriculture accounted for 21% of total employment (Song, 1990, p. 109), compared with 4.5% for Taiwan. The dynamic efficiency of the strategy was also called into question. The condensed growth of Korea over 1960s to 1980s was a variant of an extensive growth model: by using existing domestic and imported resources and technologies. The potential for such growth was obviously limited. To sustain vigorous growth, a country must cultivate sources of intensive growth: those that enhance the productivity of existing resources through indigenous innovation and reforms. But the preoccupation with maximizing short-run growth rate that characterized the condensed growth strategy often undermined those human and institutional factors conducive to intensive growth. Important examples are a competitive market system, a vigorous sector of small and medium-size enterprises and a high quality of education. 3. Social and Welfare Consequences The ordinary worker, who may be likened to the foot soldier of "Korea, Inc.", paid the price for growth maximization. Korean workers had the
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longest work week: at 54.7 hours in 1994, the average manufacturing work week was 10 percent higher than Taiwan's, 31 percent above Japan's and 34 percent above that of the U.S. There was little improvement in housing, perhaps the most important determinant of welfare for Koreans, in view of the high value put on family life. The ratio of housing units to total households deteriorated until 1991. In general, international comparisons indicate that Korea lags behind Taiwan and the industrialized countries in most aspects of welfare. From the 1980s on, many of these ill consequences began to surface. The public also expected more in return for their efforts. It is to the credit of the Korean government that appropriate policy responses were quickly implemented. V. Present Challenges and Policy Responses 1. Rapidly Rising Wages Wage rate increased so much more rapidly than productivity growth that Korea is no longer a country of low labour costs. Solutions: (1) Control wage increases: since 1993, the government has encouraged the Federation of Korea Trade Unions (FKTU), the only legally established national labour union, and its management counterpart, the Korea Employer' Federation, to set target ranges for pay increases. The "Central Labour-Management Wage Negotiation", which includes the government, as well as the employers, and trade union federations, has played a limited role in the deceleration of wages. (2) Reduction or abolition of the minimum wage rate: In March 1997, an amendment was made to the Labour Management Act to promote the flexibility of the labour market and a stabilized environment for wages, along with systems of flex time, arbitrary dismissal and nolabour no-wage.
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(3) Increase labour market flexibility: minimum wage and employment security policies have to be reviewed in order to promote the labour market flexibility needed to accommodate the rapid pace of structural change in Korea. (4) Outward processing in some developing countries: For example, Korean firms started to invest in the Shandong and Liaoning provinces in China which were adjacent to the Korean peninsula. In 1992-1994, Korean investment in China grew at an annual rate of 114%. 2. Labour Shortage Korea is now facing a labour shortage problem. In a March 1995 survey, there is a shortage of 183 000 workers, equivalent to 3.7% of the labour force. Solutions: In July 1995, the government implemented the "Employment Insurance System" (EIS), which includes employment promotion measures to counter the shortage, as well as active labour market programs to improve the quality of the work force. (1) Promotion of female labour force participation: the EIS provides subsidies to encourage employers to re-integrate their female employees into their work force after taking child-care leave. Also, firms which maintain day-care centers on their premises can be subsidized. The government has also decided to make child-care expenses deductible from income taxes and to develop training courses for women in public vocational training centers. The Equal Employment Act was strengthened in August 1995 to narrow the wage differential between men and women. (2) Increase the employment of workers above 55: Because of the increase in life expectancy in Korea, the government adopted the "Employment Promotion Act for the Aged" in 1991 which recommended that older workers should account for at least 3 percent of employees at firms with more than 300 workers. The
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EIS also provides a subsidy to firms where employees over 55 account for more than 5% of the workforce. (3) Imported labour in Korea; In 1992 and 1993, 8000 foreign workers, primarily from other Asian countries, were allowed to enter Korea for a short time period. In 1995, the government has approved the import of a further 20 000 foreign workers to help ease labour shortages. (4) EIS also aims to improve the job placement service. 3. Labour Disputes The decline in labour disputes since 1987 has continued, reducing the number of working days lost due to such conflicts and the resulting economic costs. Solutions: Labour law prevents the establishment of a second union within an enterprise that is already unionized. This rule is designed to prevent internal labour disputes. Third party intervention in labour disputes is prohibited, thus preventing enterprise-level unions from receiving assistance from organizations which are not officially recognized. 4. Protectionism, Increased Competition from ASEAN Countries Korean exporters will have trouble finding their niche in the world market, as the newly developing nations, namely China and the ASEAN, are all competing in price with Korea. Solution: Korea can invest in other developing countries to capture their low labour costs. For example, between 1991 and 1994, Korean companies doubled their overseas investment from US$3.4 billion to US$7.7 billion. Outward investment totaled US$4.9 billion in 1995, a rise of 37%. Around half of Korean investment is within East Asia. China topped the list with US$41.2 billion or 25%.
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5. Falling Prices of Yen The Japanese yen depreciated against the US dollar by 15.2 percent between July 1995 and April 1997, which dulled the shipment activities of Korea whose main export items are in the semiconductor, automobile and shipbuilding industries. Actually, a strong yen is a mixed blessing, given that a quarter of Korea's imports come from Japan. Solutions: (1) Reduction of interest rates: Exchange rate pressure can be moderated to some extent by allowing interest rates to fall if the currency appreciates, thereby lessening the risk that the competitiveness of Korean exports would be unduly undermined. (2) Sporadic rounds of intervention by the central bank will stop the currency from being pushed much higher. 6. Vicissitudes of High-Tech Industry Korea no longer has a lower labour cost than other developing countries. However, the technological level of Korea still cannot catch up with the advanced countries, such as U.S.A. and Japan. This brings a problem to Korea. Solutions: (1) Increase R&D development: R&D is very important for Korea to continue its development of high-tech industry. R&D expenditure increased from 0.8 percent of GDP in 1980 to 2.6 percent in 1994, a figure close to the OECD average. Despite the rapid increase, the size of Korean R&D spending remains small in absolute terms relative to the major OECD countries. To reduce the gap, the government plans to raise total R&D expenditure to 4 percent of GDP by the year 2000. (2) Attract foreign direct investment: In order to attract foreign investment, the liberalization ratio of foreign investments was raised from 95.1% in May 1996 to 97.4% in May 1997. For investment in highly advanced technologies, exemption benefit for a five-year
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period and 50% exemption for another three years afterwards were provided. Industrial complexes for foreign firms were built in Kwangju and Chonan. An Investing in Korea Service Center was set up to provide a one-stop service to undertake every administrative service of the authorities. Moreover, infrastructure and necessary sites were provided to foreign firms to attract highly advanced technologies. (3) Fostering of venture firms: The new ideas and technologies that venture firms possess will be especially effective in remedying Korea's high-cost and low-efficiency problems. The government is seeking special legislation for providing financial and tax incentives to venture capital firms. The Ministry of Trade, Industry and Energy plans to funnel a total of 162 billion won ($190 million) into the development of the Kuro Industrial Estate into a major venture valley for promising venture capital companies. (4) Overseas investment in technologies: In order to acquire up-to-date technology and local marketing, an increasing amount of chaebol overseas investment is being used to either merge with, or acquire, foreign firms. Korean companies are also attempting to outflank rivals by establishing themselves in emerging markets, including the former communist states. 7. Problems with the State Enterprises In Korea, many of the state enterprises are inefficient and their existence will affect the business of the small and medium firms. Solutions: (1) Privatization of state enterprises: In 1993, Korea had 131 public enterprises. In the same year, the government announced a plan to reduce its ownership or privatize these enterprises. By mid-1995, 14 public corporations had been completely put into private hands and 4 other government-invested firms had been partially sold off. But the number fell short of the government's goal for 1995 of 24 privatizations and 4 consolidations.
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(2) Deregulation of state-own monopolies to enhance competition: For example, the reduction in the government's share in Korea Telecom is being accompanied by deregulation of the telecommunications sector. The government announced a plan in July 1995 to allow new market entrants to challenge state-own monopolies. The increased competition will help domestic firms to prepare for the eventual opening of the market to foreign companies. (3) Liberalisation of private-sector investment decisions: From 1996, the government will limit its role to providing information on longterm prospects through the Industrial Development Council and investment decisions are left to the private sector. This reduction of government interference in private-sector investment decisions should strengthen competition and weaken government-business links. 8. WeakSMEs The Korean market was dominated by big chaebols. A record number of 14,000 small businesses failed in 1995. The chaebols have monopolized bank credit, thereby forcing smaller firms to use risky and costly credit markets. Small companies complain that they abuse their monopoly positions, using their size to take advantage of suppliers. Solutions: (1) Financial assistance and government support: The government has introduced new programs to upgrade the technology and ease the financial burdens of SMEs. During 1994 and 1995, W1.5 trillion was spent in helping SMEs increase their productivity through automation, while measures to support technology-intensive business ventures have been expanded. To relieve the financial difficulties of SMEs, a W 1.75 trillion fund will be established for discounting SMEs' commercial bills at the Industrial Bank of Korea and the Kookmin Bank. (2) Korea Fair Trade Commission: The Korea Fair Trade Commission (KFTC) has increased its efforts to protect SMEs in 1994 with the revision of the Fair Subcontract Trade Act, which was introduced in
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1985. This Act, which prevents large firms from delaying or refusing to pay subcontractors, was extended to more areas. The government also established the Small Business Administration in February 1996 to assist SMEs. This agency, which has 950 employees, operates eleven regional offices that offer assistance in start-up, financing, technological development and marketing. 9. Monopolistic Power of Chaebols There is a problem of unhealthy concentration of market power in Korea. Taken together, the 4 biggest chaebols employ only 3% of the workforce but account for almost a third of total sales of all Korean companies. The top 5 accounted for 30% of the stockmarket's capitalization of US$242 billion in 1995. Solutions: (1) Change of KFTC arrangement: After this change, the KFTC is able to attend the State Council and the Economic Ministers' Meeting and put forward its independent views. In 1996, KFTC was made a ministerial agency so that it could enforce the Anti-Monopoly Act more vigorously. It was also enlarged from 265 staff in 1993 to 385 in 1996. This enabled it to expand its efforts to promote competition. (2) Reduction of the concentration of chaebol: To ensure fair competition between chaebol-affiliated firms and other enterprises, the government seeks to avoid concentration of capital amongst the large groups. This can prevent chaebols from investing in unrelated business fields. (3) Reduction of inter-firm investment of chaebol: The Government reduced the limit of chaebol investment in other firms from 40 to 25% of its net assets in April 1994, with a three-year implementation period allowed. (4) Reduction of trade barriers: In addition to preventing unfair practices by market-dominating firms, reducing trade barriers would help in this regard, since imports generally result in a significant decline in profits as well as in the degree of concentration.
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10. Corruption and Scandals There was a thriving underground economy in Korea. Endemic tax evasion and corruption were often heard as a result of governmentbusiness collusion. Solutions: (1) The real-name system: The government initiated its financial reform with a bomb-shell announcement in August 1993 that all financial transactions should be conducted in "real names" in the future. The government employed more powerful tools to remove corruption and apply sterner punishments to violators. In 1996, those who do not convert false-name accounts into real-name ones are subject to penalties of up to 30% of their deposits. (2) Financial deregulation: Greater financial deregulation is essential to eroding the culture of illicit financial transfer from companies to politicians and to bureaucrats. 11. Financial Problems of some Large Enterprises Chaebols posed a threat to financial stability. Their large debt burdens and gearing ratios are a cause for concern. The bankruptcy of a large group could bury the banking system in bad debts, dulling economic growth and triggering more bankruptcies. Also, banks have had little discretion or incentive to control risk by screening projects and monitoring corporate performance. The socialization of bankruptcy risk, combined with low interest rate ceilings, made debt financing cheap, encouraging firms to take on excessively high levels of debt. Solutions: (1) Financial reform: The 1992 financial plan contains a number of proposals in the area of prudential controls. First, the BIS capital adequacy ratios for commercial banks have been made compulsory, with banks required to reach a ratio of over 8 percent by the end of 1995 and to publish the outcome in their accounts. Second, a new reporting system was introduced for commercial banks designed
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to give early warning of problems. Finally, a new Deposit Insurance Scheme for commercial banks, with a low uniform premium was set up. (2) New guideline for banks: In 1994, the authorities issued a new guideline for banks by which the total of bad loans and 20% of the uncollaterised part of "substantard" loans will have to be kept below 2% of total loans. This will reduce the bankruptcy risk and banks will be more prudent in lending money to chaebols. (3) Decentralization of decision making process to individual banks: The government's financial program gave greater freedom to domestic banks and financial intermediaries to determine their interest rates on loans and deposits. Banks can now use it discretionary power to make loans to large chaebol. VI. Conclusion The outstanding growth performance of Korea in the three decades from early 1960s is, deservedly, labelled an economic miracle. As one observer put it: It is no exaggeration to say that the post-World-War II development of East Asia is the greatest success story of sustained economic growth in the history of humankind. (Singh, 1995, p. 4) During 1960-90, per capita GDP grew by 6.6 percent annually, which was the highest among East Asian countries. The growth rate for 1991-95 was comparable. The economy was also resilient. Since 1960, it registered negative growth only once, and it sustained high growth in the aftermath of the energy crisis of 1973, when most of the rest of the world was in recession. Inflation was high, but under control, and it served to bring about forced saving. Within three decades, Korea was transformed from a war-impoverished agrarian society to an industrial power. All these were accomplished largely by indigenous efforts. In 1996, it joined the Organization for Economic Co-operation and Development (OECD), the club of rich nations. Korea has followed consistently a clear-cut development strategy: export-led industrialization. For decades, exports were promoted as if
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they were an end in themselves. Until recently, the strategy was imposed by an authoritarian government. The planning bureau largely took over the entrepreneurial function. It dictated the direction and pace of industrial development, controlled and mobilized the required resources, and implemented its plans with an array of policy instruments which affected prices and profits. Moral suasion was also employed. To maximize growth, planners were prone to set over-ambitious development targets which called for more investment than seem feasible on the basis of expected domestic savings and foreign capital inflow. This led to excess demand. Equilibrium was restored through raising supply and involuntary financing. Supply was increased by more intensive utilisation of existing plant capacity and by lengthening the working week. (Scitovsky, pp. 178-9) Excess demand caused chronic inflation, which worsened the balance of payments and raised the rate of foreign exchange. The higher import prices that followed helped to divert resources from consumption to investment. Thus an aggressive economic policy caused the economy to perform beyond its apparent capacity. The government, through its elaborate economic planning and effective plan implementations, dominated the growth process. The chaebols were the key agents for carrying out these plans. It was said that the government played the role of chairman in Korea, Inc., while chaebols functioned as its production units. These giant conglomerates in a developing country were largely products of growth strategy and industrial policy. The Government felt that only large firms could have the scale economies to compete in the international market. The HCI drive contributed to this trend. The rationing of government-controlled bank loans by non-price mechanism favoured established large borrowers. Finally, it was the government's policy to ask successful corporations to bail out unsuccessful firms. The end result was a handful of chaebols that dominated the Korean economy. By and large, these big businesses turned out to be powerful engines for Korea's industrialization, playing a crucial role in market penetration and rapid acquisition of technological capability. Evidently, the nuclear of entrepreneurs who operated these chaebols made good use of their advantageous position. They were supported by Korea's unusually rich human resources: a labour
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force with legendary work ethics; motivated, and until recent years, exceedingly docile, plus a very high level of educational attainment from the beginning. Unlike most LDCs, foreign direct investment was not welcomed in Korea during the first two decades, though foreign technology and loans were ardently sought. There was also a regime of draconian import controls. Thus, despite its strong export orientation, the economy was far from being open or closely integrated in the world economy. As a result, relative prices in Korea were highly distorted. To a large extent, the growth of Korea was fueled by a high rate of investment, including investment in human capital. It represents an extensive growth: through the use of existing domestic and imported resources and technologies. Innovative ramification of economic activities played a relatively minor role. In Krugman's term, it was growth by perspiration instead of inspiration. The potential for such growth is inherently limited. The success of Korea's growth strategy and the effectiveness of its industrial policy is not in dispute. But there is an ongoing debate on how well the strategy has worked, on its economic efficiency, and on whether it can be socially justified. Then there is always the counterfactual issue of whether the economy could have succeeded just as well under an alternative policy regime. The assessment of economic efficiency, taking into consideration both the static and dynamic aspects, is mixed. There are those who believe that top decision makers made grave mistakes, like the premature and excessive expansion of heavy industry. Extensive price distortions did not bode well for optimal resource allocation. Directive planning, restrictions and controls stifled innovation and creativeness. Others, like Amsden, stress the virtue of having got the prices wrong in order to create dynamic comparative advantages that direct economic activity toward greater investment. Though a conclusive analysis of static efficiency was not possible due to the web of subsidies and restrictions, as well as widespread price distortions, the balance of opinions appear to be that the HCI drive failed in static efficiency. We reviewed some such evidences. We also showed that the promoted sector did not gain
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in export competitiveness, and that Korean planners were not picking winners. More generally, the strategy could have detrimental impact on long term growth. As one author pointed out, the growth first policy has nurtured an inverted sense of value: a notion that economic performance is more important than the institutions through which it is achieved: civil discipline, respect for enterprises, respect for laws and regulations, fair opportunities, and the like. (Cho, 108) Beyond doubt, the success was bought at very high social costs and lots of human sacrifice. The obvious ones were long hours of work, abstinence that produced high rate of savings, the shortage of consumer goods, particularly imports, underprovision of housing, social infrastructure, and public services, and low quality of education (reflected in a small service sector). All told, the living standards of an average Korean was considerably lower than what would be commensurate with the nation's GDP level. Obsession with an early catch-up with advanced countries through growth maximization left a peculiarly unbalanced structural pattern. Examples are strong chaebols and weak small and medium enterprises, dichotomization between heavy (HCI) and light industries in growth, profitability and productivity, relatively backward agriculture, export orientation coupled with draconian controls on imports and foreign exchange and a backward and monopolistic financial sector. More fundamental, comprehensive economic planning, controls and regulations rudely infringed on people's right to economic freedom collectively and individually. Getting the prices wrong may help to channel resources into targeted industries, but widespread price distortions made rational choice difficult with the scope of choice already greatly curtailed by controls and regulations. To a large extent, a handful of planners, at the behest of a ruler, dictated how a generation of Koreans lived and worked. Appendix: Case Studies of Korean Industries (I). The Shipbuilding Industry Well before the HCI drive of the 1970s, the government promoted the shipbuilding industry. In 1962, the government enacted the Shipbuilding
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Industry Encouragement Act to provide direct subsidies of up to 30 percent of production costs to local shipyards. During the HCI period, the government enacted the long-term Shipbuilding Industry Promotion Act which aimed to increase the self-sufficiency ratio of Korean-built ships and promoting shipbuilding as a leading industry. This called for the expansion of shipbuilding from 1 million gross tons in 1974 to 5.5 million gross tons by 1980 and to 9.2 million gross tons by 1985. During the period of 1973-1980, the government planned to invest some $570 million in this sector. By 1979, Korea produced over 6 percent of the world's total shipbuilding tonnage and established itself as the second largest shipbuilding nation in terms of orders, while ranking seventh in terms of actual tonnage constructed. In 1986, Korea was the fifth largest shipbuilding nation, with a production capacity of 6.5 million gross tons and exports valued at $2.2 billion. Generous financing for ship exports was provided through Korea's Export-Import Bank. The loan ratios were averaged around 80 percent with a nominal interest rate of about 7 percent, at a time when Korea's inflation rate was running at 18 percent in 1970s. In these periods, the Korean ships were very competitively priced because of their continued access to subsidised credits made available by the Korea Export-Import Bank, and because of the relatively low wage rates that continued to characterize the economy. Although the incentive policies enjoyed by the industry allowed it to attain its development goals, the changing world conditions and the inherent weakness of the government's program soon began to be felt, causing major difficulties for the industry. Although the industry had grown rapidly, it rarely achieved any profits, in large part because of the interest payments on the debts incurred to finance the rapid expansion. In fact, the expansion was so rapid that the shipyards worked far below capacity throughout much of the 1970s and 1980s. In spite of the rapid growth, Korea still depended on Japan for technology and intermediate goods in the 1980s. Also, the rapid appreciation of the won in 1980s and increased labour costs caused by union strikes continued to plague the industry.
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A number of other factors worsened the situation facing Korea's shipbuilders. First, since the 1981-1982 recession, Korea's shipyards faced excess capacity as prices for new ships dropped precipitously. Second, the demand pattern for ships changed. When worldwide trade in petrochemical products decreased and the trade in coal and feedstock increased, the demand for VLCC (very large cargo carriers) stagnated as the demand for container ships and specialised product ships (e.g., LPG) increased. Unfortunately, low value-added vessels, including tankers and bulk carriers, accounted for the majority of ships constructed by Korean shipbuilders. The change in marine transportation patterns had negative repercussions for Korean shipbuilders whose docks were designed for the construction of very large tankers. Labour disputes, which plagued the economy during the early 1990s, dealt a further blow to the Korean shipbuilding industry. These disputes resulted in unexpected large wage increases, and strikes delayed the delivery of ships. Adding to the unfavourable conditions at home and abroad, the Korean shipbuilding industry suffered from declining orders. Total shipbuilding orders for the first ten months of 1988 declined to 1.4 million gross tons, down about 50 percent from the same period a year earlier, while backlog orders declined to 5.1 million gross tons as of the end of October 1988, down 9.2 percent from the previous year. Moreover, Korean shipbuilders are debt-ridden from past expansions and losses. In the four years from 1985 to 1988, the four largest shipyards lost some 765 billion won, including 342 billion won in 1988 on sales of 2290 billion won. (II). Automobiles and Parts Like the shipbuilding industry, the automobile industry was started and supported by the government well before the HCI drive. In the mid1960s, Korea's policies toward the automotive industry aimed to shift it from parts production and repair to local assembly. To achieve that end, imports of fully assembled cars were effectively banned. In 1972, the government decided to concentrate auto production in the hands of
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four major companies: Hyundai, Kia, Asia Motors, and a joint venture between General motors (GM) and Daewoo. In 1977, automobile exports were only 1287 units; by 1981, they totaled 26 384 units, and from 1984 to 1987, vehicle exports increased at an annual rate of 117 percent. By 1987 the Korean auto industry accounted for 2 percent of world automobile production and 4 percent of world automobile trade. In fact, Korea remains the only developing country to have achieved international status as an exporter of domestically built cars. Korea's automobile industry began in the early 1960s with the assembly of semi-knockdown (SKD) parts imported from Japan. To assist the nascent industry, the government in 1962 banned imports of completed automobiles while allowing duty-free imports of parts for assembly plants. In 1966, in an effort to increase the local content of domestically assembled vehicles, the government established a domestic content schedule and provided for preferential allocations of scarce foreign exchange to plants producing parts. It also implemented import licenses and "administrative guidance". As part of the HCI drive, the government encouraged auto assemblers to develop their own Korean car models by adopting the Long Term Promotion Plan for the Automobile Industry. The plan limited the number of car assemblers to four: Daewoo, Hyundai, Asia Motors and Kia. In 1974, Kia manufactured the first Korean car, the Brisa, and in 1975, Hyundai introduced the well-known, and much more successful, Pony, which became the first domestically produced car to be exported. The government emphasized on joint ventures as a means of acquiring the necessary technology, while R&D expenditures were generally less than 1 percent of sales in 1970s. The number of technology licensing agreements with foreign firms increased rapidly between 1975 and 1979. Also, between 1962 and 1987, there were 183 technology licensing contracts, 48 percent of them with Japanese companies. Also, most of these licenses were for manufacturing technology. When Korean auto companies started to export in the 1980s, it became more difficult to obtain access to foreign technologies, forcing Korean companies to increase their R&D investments to about 3 to 5 percent of sales.
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In 1982, Hyundai Motor Company met the European Economic Community noise, safety and emission standards, but it was not until 1985 that the company met the more stringent U.S. standards. In 1983, Korea exported 16 405 passenger cars, 192 buses and 7852 trucks, earning $121 million. In 1986, Hyundai sold nearly 170 000 cars to U.S., while in 1987 and 1988, it sold 260 000 and 270 000 units respectively. The most important factor that contributed to the success of the automobile industry was the Voluntary Export Restraints (VER) imposed by the United States against Japanese cars, which forced Japanese companies to move up to mid-sized cars. This left the subcompact car market open and Korean firms seized this opportunity to capture the low end market of the U.S. Also, the depreciation of the won from 659 won/US$ in 1980 to its peak of 890 won/US$ in 1985 helped to enhance the competitiveness of Korean cars. One can conclude that the success of the automobile industry was not due to the adoption of Korea's industry policies. Most of the success can be accounted for by the VER imposed by the U.S. on Japan and the depreciation of the won. Like the shipbuilding industry, the appreciation of the won in the late 1980s, the labour disputes, and the rising wage rates are the problems that the automobile industry now has to face. (III). The Steel Industry and POSCO Steel The steel industry and POSCO steel can be said to be the most successful industry among the four industries. Well before the advent of the HCI drive of the 1970s, the government made several attempts to develop a large-scale integrated steel industry of sufficient capacity to meet domestic needs. In 1968, Pohang Iron and Steel Company, Ltd. (POSCO) was formally established. Construction of the Pohang facility started in April 1970, and the mill was completed on July 3, 1973, a record construction period of slightly more than three years. The plant had a production capacity of slightly over 1 million tons of crude steel a year. Construction costs totaled $304 million:
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$168 million in foreign exchange plus 54 300 million won in domestic costs. Part of the financing was in the form of loans from the Japanese Export-Import Bank ($50 million), and part ($42 million) came from the Economic Cooperation Fund, together with a $30.8 million loan from the Property and Claims Fund. POSCO was able to obtain the most modern production facilities and technologies from Japan. Ancillary technologies were obtained from the United States, Germany and England. To meet the rapidly increasing demand for steel, POSCO expanded its capacity several times. With the completion of POSCO's fourth expansion phase in May 1983, the thirteen-year project came to an end, and the company's annual total integrated capacity reached 9 million tons. For the country as a whole, annual production capacity in 1983 for ironmaking was 8.8 million tons, for steelmaking 14 million tons and for steelrolling 14.6 million tons. In the same year, Korea produced nearly 2 percent of the total world crude steel, and POSCO had become the tenth largest steel-producing company in the non-communist world. The continued increase in domestic demand for steel made necessary the construction of a second integrated steel mill. Kwangyang Bay was the chosen site and the first phase of construction commencing in November 1981. POSCO was able to purchase the most up-to-date facilities and advanced technology, further strengthening its international competitive position. To make effective use of the integrated steelmaking facilities, the construction of the second-stage project with an annual capacity of 5.4 million tons was begun in September 1986 and was completed in July 1988, bringing POSCO's total capacity to 15 million tons (9.6 million tons at Pohang). As a result, POSCO had become the third biggest steelmaker in the world, making Korea the sixth-largest steel producer among non-communist countries and the eighth largest in the entire world. In line with Korea's development policies under the HCI drive, POSCO made efforts to improve the localisation ratio of machines and equipment. POSCO insisted that foreign contractors form a consortium with Korean suppliers in order to strengthen the capacity of local
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producers to absorb the new technology. This allowed local producers to gain access to up-to-date technologies, which were, in fact, under monopoly control by a small number of advanced steel-producing countries. The successful establishment and subsequent rapid expansion of POSCO made it one of the success stories of Korea's industrialization period. There is little doubt that POSCO was financially successful, able to enter and successfully compete on the international market, while supplying reasonably high-quality products at low prices to domestic downstream consumers. The policies of the HCI period contributed to POSCO's success in two ways. First, they provided a strong rationale for the subsidies given to the sector, including the construction of the port facilities, as well as access to utilities and credits at below cost. Second and more importantly perhaps, the rapid development of the downstream industries, such as automobile and shipbuilding, as well as the continued high level of construction activities during the 1970s, provided a strong and steady market for POSCO's output. In part, POSCO's success rests on the low construction cost of its two steel mills at Pohang and at Kwangyag. The average unit construction cost was well below the level for other countries. Low construction costs reflected the reduction in construction periods, the purchase of foreign facilities through competitive international bidding, and the securing of long term, low-interest foreign loans, first through access to the Japanese reparations funds and eventually through POSCO's own high credit standing. Despite the absence of any experience in the operating of an integrated steel mill, POSCO managed to put the blast furnace of the first phase of the Pohang Steel Works into normal operation within 107 days of its initial fire-up, which is a world record. The start-up period was reduced to 80 days for the second stage, to 70 days for the third, and to a remarkably 29 days for the fourth blast furnace. The modern facilities, which POSCO has managed to operate at nearly 100 percent of their rated capacity, combined with the efficient
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siting of steel mills in coastal regions with good port facilities and access to the interior regions, have allowed Pohang Steel Works to attain the world's lowest unit production costs for steel for six consecutive years since 1982. In 1987, for example, production costs at Pohang Steel per ton of hot-rolled steel were $259.5, or 80 percent of the U.S. and 60 percent of Japanese costs. Finally, POSCO was able to maintain its independence from the government. POSCO could firmly resist outside pressures that might influence its decision-making process. (IV). The Semiconductor Industry The current success of Koreas DRAM (dynamic random access memory, commonly known as memory chips) industry has been praised as an exemplary case of a developing economy breaking into a technology intensive and high value-added industry. In the world-system theory, high value-added production activities are generally concentrated in core countries (developed countries). Thus, successful development of core activities in such high-tech areas such as semiconductors in Korea deserves careful attention in evaluating a developing economy's ability to move itself into a developed economy. Is Korea's DRAM Industry Leading the Country to Core Status Four characteristics of the DRAM industry will be evaluated: 1) whether DRAM production is high value added: 2) whether it is a technology and skill intensive production process: 3) whether DRAMs have market niche as a specialised product: 4) whether it has close local linkages and can lay the grounds for Korean industrial structure to make a transition into other high-tech industries. Value added DRAMs at the moment are definitely a high value-added product. DRAMs in Korea have an added value of roughly 50% of total production
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costs. DRAMs used as storage devices in memory-hungry new generation computers experienced soaring demand as the computer industry started to boom in the early 1990s. Samsung's net profit of US$ 3.5 billion in 1995 — which is supposedly grossly under-reported because much of the profit was used to subsidize other companies within the Samsung Group — is certainly an indication of how high the profit margins can be when demand exceeds supply. Technology and skill intensity of production All three Korean DRAM producers (Samsung, Hyundai and Lucky Start) depend on foreign equipment and materials to produce DRAMs. In this sense the DRAM industry is not that different from Korea's past industries in that imported inputs upgraded the composition of products that the country was able to develop because imported inputs embodied high technological content. Technology in the hands of the Koreans is confined to know-how in DRAM manufacturing process at the moment. DRAM production technology is increasingly accumulated in the production equipment and the production process know-how accumulated in the semiconductor producers is becoming less important in increasing the wafer yield rates. Korean semiconductor producers' advantage as incumbents with an in-depth knowledge of the DRAM production process will diminish in relative terms. Market niche: DRAMs as commodity and Korea's industrial restructuring DRAMs, unlike micro processors and ASIV chips, are not a niche market product. Rather it is a commodity that has a highly elastic demand curve and highly inelastic supply curve in the short run. Because DRAMs are not a differentiated product that can claim a premium, their prices fluctuate widely depending on the demand and supply conditions as well. As over capacity of DRAMs in the world is expected as early as the end of 1996, DRAM producers will experience a sharp decline in their profitability.
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As the capability of Korean semiconductor producers to produce logic chips is limited, plants are geared towards mass production of commodity chips, and alternative uses of production lines are quite limited. Also, the conditions for developing ASIC chips in Korea are relatively limited because the Korean electronics industry's product design and development capability is still at the infant stage. Korea's electronics industry still heavily relies on Japan for ASIC supplies and actually the dependency is increasing. There are high exit barriers associated with the DRAM business because of large sunken costs. For example, economies of scale in R&D and learning-by-doing require huge investment in the case of DRAM production. The salvage value of second-generation equipment is not very high given that there are not many alternative uses for these machines. Moreover, the emerging competition from Taiwan and other Southeast Asian countries will have serious consequences on Korea's semiconductor industry. Unless Korea can develop a technology that can diversify its chip production from commodities to specialised products such as ASICs and micro processors, Korea might have to face another round of painful industrial restructuring including mass scale fordistic plants closing down, bringing devastation to the local economy. Local linkages with the electronics industry Design of ICs — Korea is relatively weak in the design of ICs. It still must rely to a large extent on technology and materials from outside. As a result, for both Samsung and Hyundai, a large percentage of their revenues is paid in royalties for licensing different technologies that go into DRAM manufacturing, even though the know-how in the design of DRAMs and product development is their own. Raw materials used in semiconductor production — in terms of semiconductor materials, wafers comprise the largest share in the total value of semiconductor fabrication. About 80-90 percent of all wafers
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used in Korea are imported, and 100 percent of the silicon wafers used in fabrication of 4M DRAM chips (or higher) are imported. Excluding wafers, Korea's dependency on Japan for semiconductor materials is high. Assembly — The semiconductor assembly industry in Korea has a simple structure. Currently, there is only one company, Anam, which accounts for more than 40 percent of the total world market. Chaebols have begun to invest heavily in semiconductor assembly operations as part of the vertical integration of semiconductor production and Hyundai had emerged as the second-largest assembler occupying 20-25% of the total world market. Domestic linkages of DRAM production In spite of the breakthrough in DRAM production, backward linkages with local intermediate products industries are relatively weak. At the same time, an examination of the trade patterns of semiconductors reveals that most of the DRAMs produced in Korea are exported. The single most important consumer of DRAMs is the computer industry and the relative underdevelopment of the Korean computer industry means that there is not a sizable market for memory chips in the domestic market. On the other hand, the trade pattern shows that logic chips used in various consumer products are largely imported from Japan and the United States. Even with the successful development of DRAMs, Korea's dependency on Japanese semiconductor materials and parts increased from 30 percent to 56 percent between 1986 and 1992. Given that Korea's consumer electronics industry largely caters to foreign markets, it is not an exaggeration to say that Korea plays the role of a re-export station for Japanese logic chips used in consumer electronics. Even though DRAM production is a significant breakthrough in Korea's electronics industry, as a single product line, the overall effect that memory chip production has on enhancing Korea's electronics industry's structure to develop high-end products is still limited.
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Government Policy and the Semiconductor Industry in Korea Financial policies: cost of capital One of the most salient features of the Korean government's economic policy to promote development was to provide low-cost financing to export-oriented business and key industries that the Korean government encouraged. Relative to other domestic industries, Korean semiconductor producers did benefit from the policy loans since semiconductors was a key industry targeted for promotion by the Korean government. Although Korean semiconductor producers had access to cheap capital relative to other domestic industries, their cost of capital was not cheap compared to their international competitors. So the cost of capital alone is not an explanation for the success of Korea's semiconductor industry. Low bankruptcy risk The diversified business structures of the chaebol lowers business risk. Semiconductor life cycles are short and are becoming increasingly shorter as the advancement of technology accelerates. New generation chips demand high profit margins until next-generation products reach the market, causing the prices of previous-generation chips to decay exponentially. When there is excess demand, prices rise quickly. On the other hand, when there is an over-capacity, prices drop drastically. In such a high-risk business, having a diversified industrial structure helps to lower business risk. It is interesting that Samsung Semiconductor, which recently merged with Samsung Electronics, has Samsung branches that are totally unrelated to the semiconductor business as its major shareholders. Not only are chaebols able to lower their risks by branching into various business lines, but their sheer size resulting from this unrelated diversification protects them from bankruptcy. So they have a tendency to undertake high-risk projects that they would not otherwise. Also, the government will provide rescue funds for chaebols to undertake high risk projects.
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Institutional efficiency: economies of scope Korea's large business conglomerates often have an integrated industrial structure. It enabled secured markets for initially developed products. Even if the developed chips were inferior to other products available in the world market, the IC producers faced a known demand for their products in the system houses owned by the chaebol. This substantially lowered the risk of investing in the R&D of semiconductor development, and Korea's semiconductor industry developed in step with the rise of its consumer electronics industry. It is the economies of scale that allowed Korean producers cost-ofcapital advantages over others, because efficient temporal utilization of equipment must take into account the huge fixed costs in semiconductor production. The chaebol also had an advantage to improve its technology level by intra-corporate technology transfers. Pooling the knowhow within the same group for technology development is a common practice among chaebols and greatly contributed to their accumulation of production technology. Conclusion Korea's DRAM production does fit the description of a core activity in that it provides high value added. However, albeit sophisticated and high-tech, DRAMs are still a commodity with no product differentiation and only protected by the amount of the capital required for entry. It was a financial policy that made the building of a semiconductor industry in Korea possible rather than technology and skill development. The technology of DRAM production is largely embodied in the highly sophisticated equipment purchased from abroad, design know-how licensed from foreign firms and materials imported from abroad. As device sizes decrease and the specifications of tools become finer, the balance of technology accumulation is tilting even more towards equipment producers and away from semiconductor manufacturers. In case Korean producers need to reduce production capacity of DRAMs due to increasing competition from abroad, the present fordistic
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production system with little flexibility and high sunken costs will create a big exit barrier. The fact that Korea's semiconductor production lines rely solely on DRAMs and virtually no other chip production capability also makes Korea's position highly risky. The implications of weak forward and backward linkages in Korea's DRAM business are that the industry itself has not had much of an effect in deepening the country's industrial structure. Considering the inflexible manufacturing system of mass production of a single product, high exit barriers and high financial risks to tax payers, there is always the economic and ethical question of whether resources are efficiently being utilised to build the next generation of high-tech industries for the economy. References Alam, M. Shahid (1989) Government and Market in Economic Development Strategies, New York: Prager. Amsden, Alice H. (1989) Asia's Next Giant: South Korea and Late Industrialization, Oxford U. Press, New York, NY Caiden, Gerald E. and Kim, Bun Woong, eds. (1991) A Dragon' Progress, West Hartford: Kumarian Press. Cho, Soon (1994) The Dynamics of Korean Economic Development, Washington, DC: Institute of International Economics. Chon, Soohyun (1996) "Development of the Semiconductor Industry of Korea: A Stepping Stone to join the Rank of Core Countries?" Journal of Global Business and Political Economy, 1(3). Hughes, Helen (1989) "Catching up: the Asian Newly Industria-lizing Economies in the 1990s," Asian Development Review, 7(2). Kim, Ji Hong (1990) "Korea's Industrial Policy in the 1970s: The Heavy and Chemical Industry Drive," KDI working paper No. 9015, Korea Development Institute, Seoul, Korea. Kim, Kihwan and Leipziger, Danny M. (1993) "Korea: A Case of Government-Led Development", The Lessons of East Asia, World Bank.
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Kim, Linsu (1997) Imitation to Innovation, Harvard Business School Press. Krugman, P. (1994) "The Myth of Asia's Miracle," Foreign Affairs, November/December, 62-78. Kubo, Yuri and Kim, Hong-Dall (1996) "Human Capital, Imported Technology, and Economic Growth: A Comparative Study of Korea and Japan," paper presented at the Fifth Convention of East Asian Economic Association, Bangkok, Thailand, October 25-26. Lee, Hyung-Koo, (1996) The Korean Economy. State, University of New York Press. OECD, Economic Survey, 1994, 1996. OECD (1994), Industrial policy in OECD countries, pp. 173-187. Oshima, H.T (1987) Economic Growth in Monsoon Asia: A Comparative Survey, University of Tokyo Press. Science and Technology Policy Institute (STEPI), 1995, Review of Science and Technology Policy for Industrial Competitiveness in Korea, Seoul: STEPI. Scitovsky, T (1986) "Economic Development of Taiwan and South Korea," in Lau, L.J. ed., Models of Development, San Francisco: ICS Press. Seong, Somi (1997) "Industrial Policy in Korea," in Masuyama, Seiichi et al. eds., Industrial Policies in East Asia, Nomura Research Institute of Southeast Asian Studies. Singh, Ajit (1995) "How Did East Asia Grow so Fast?" UNCTAD Bulletin, No. 30-34. Song, B.N. (1995) The Rise of Korean Economy, Oxford University Press. Stern, J, J.H. Kim, D. Perkins and J.H. Yoo, (1995) Industrialization and the State: The Korean Heavy and Chemical Industry Drive, Harvard Institute for International Development and Korean Development Institute. Sung, Yeung Kwack (1986) "The Economic Development of the Republic of Korea," in Lau, L.J. ed. op cit. World Bank (1987) Vol. II, Korea: Managing the Industrial Transition, Washington, D.C. World Bank (1993) The East Asian Miracle, Washington, D.C.
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World Bank. World Development Report, various issues. Yoo, Jung-ho. (1990) "The Industrial Policy of the 1970s and The Evolution of the Manufacturing Sector in Korea." KDI working paper No. 9017. Korea Development Institute, Seoul, Korea. Yu, Seongjae (1995) "Korea's High-Technology Thrust," in Simon, D.F. ed., The Emerging Technological Trajectory of the Pacific Rim.
COMPARISON AMONG SINGAPORE, TAIWAN AND SOUTH KOREA Leung-Chuen Chau University of Hong Kong Francis T. Lui and Larry D. Qiu Hong Kong University of Science and Technology
I. The System and Organization of Technological Research In this chapter, we compare and contrast the experiences of Singapore, Taiwan, and South Korea in their drive towards industrialisation. First, we look at the system and organisation of technological research. Other aspects are taken up in turn in the ensuing sections. 1. Role of the Government in Technological Development The generation or acquisition of frontier technologies is a highly risky venture. It may also have a long gestation period. In either case, private funding may not be available, particularly in LDCs. Its viability often depends on concurrent development of upstream and downstream industries. Such activities also confer external benefits, pecuniary or technical. Government participation may be pivotal. It can coordinate related activities through initiation and publication of plans and targets, like the HCI drive of Korea. Such coordination will reduce risk and facilitate private funding. It can invest in basic research and costly technology development with long gestation periods, like the development of microelectronics in Taiwan, or subsidize R&D activities in private
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sector through fiscal incentives, preferential credits or guaranteeing of loans. Equity participation and joint ventures with domestic or foreign firms are particularly effective. 2. Initiation, Leadership and Institution The Korean government actively promoted development in technology from the very beginning of industrialization. The Korean Institute of Science and Technology (KIST) was established in 1966, and a Ministry
President Presidential Council on S&T
Economic Planning Board
General Council on S&T • S&T Budgeting • Advisory
Ministry of Education
Universities
Ministry of Science and Technology Research Insti utes National R&D Progra ms
Ministry of Commerce, Industry and Resources
• Technical Training Institutes • National R&D Programs
Ministry of Communication, Ministry of Construction, etc.
• Specific R&D Projects
Fig. 4.1: National S&L Administrative System in Korea Source: Science and Technology Institute (STEP), Review of Science and Techno-logy Policy for Industrial Competitiveness. 1995, p. 54
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of Science and Technology (MOST) was set up in 1967, the first of its kind for developing countries, and the President took a leadership role in Science and Technology policy. This has resulted in an elaborate S&T administrative system (Fig. 4.1). Over the years, a total of 24 science and technology-related pieces of legislation were enacted (Fig. 4.2). The Taiwan government also had an early start in promoting technology development, largely through the strong leadership of Y. S. Sun,
Selected Act
1960s
1970s
1980s
1990s
-Weather Act (1960) - Certified Technologist Act (1963) - Korea Institute of Science and Technology Act (1966) - S&T Promotion Act (1967) - Science Education Act (1967) - Compensation for Damage of Atomic Energy Act (1969) - Korea S&T Information Center Act (1969) - Korea Advanced Institute of Science & Technology Act (1970) - Technology Development Promotion Act (1972) - Technology Consultant Act (1973) - Technology Certification Act (1973) - Specific Research Institution Support Act (1974) - National Technology Test Corporation Act (1976) - Korea Science and Engineering Foundation Act (1976) - Korea Technical College Act (1977) - Korea Technology Development Company Act (1980) - Korea Vocational Training Corporation Act (1981) - Fostering Research Association of Industrial Technology Act (1986) - Computer Program Protection Act (1986) - R&D on Information Communication Act - Industrial Design and Packing Promotion Act - Korea Technology Bank Act - Cooperative R&D Promotion Act - Technology Assessment Act Fig. 4.2: Korea S&T Related Acts
Source: STEP, op.cit, p. 47
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who served as Economic Minister in the early 1970s and became Premier in 1978. An Industrial Technology Research Institute (ITRI) zswas set up by the Ministry of Economic Affairs (MOEA) in 1973-1974 which blossomed into an organization of 6000 people by 1994. It engaged in medium and long-term strategic research as well as short-term product and process development. There are as many as 14 other organizations under MOA engaged in industrial and technology development. Singapore was a late-comer in technology policy. A coherent science and technology initiative appeared only in 1991, with the establishment of the National Science and Technology Board (NSTB) under the Ministry of Trade and Industry. Subsequently, research institutes were established for design, information technology, molecular and cell biology, and manufacturing technologies. 3. Industrial Targeting Taiwan was most specific in identifying and promoting 'strategic' industries, with explicit criteria (technology intensity, market potential, high value added and large linkage). Eight strategic industries were chosen in 1983, and 33 targeted leading products were identified in 1992. By contrast, in its technology upgrading effort, Korea shifted from industry-specific promotion of the 1970s to functional policies of the 1980s. Policy became more favourable to individual projects rather than sectoral development. Singapore also adopted a functional approach. Objectives of the 1991 National Technology Plan were in terms of R&D expenditures and the number of scientists and engineers, and design awareness. Rather than industry- or product-specific, innovative activities in general were promoted.
Comparison among Singapore, Taiwan and South Korea 4. Policy Instruments In addition to researches undertaken by government institutes and universities, a whole array of policy tools were employed by Taiwan for promoting high-tech industries: tax incentives, preferential loans, technology and management assistance, state enterprises and joint ventures. The Hsin-chu Science-based Industry Park (HSIP) was established in 1980. Construction has started for a second HSIP in Tainan. From 1982 on, the Korean government have been heavily involved in R&D through universities and a large number of Governmentsupported Research Institutes (GRIs) under the auspices of the National R&D Program, which was periodically reviewed and revised. In 1992, there were seven categories of projects under the National Program, a key component of which is the Highly Advanced National (HAN) Project, a ten-year program of nation wide R&D investment to make Korea an industrialised countries by the early 21 st century. Under its umbrella, 14 projects were selected for implementation, equally
SEMICONDUCTOR INDUSTRY
(1) development of highly integrated semiconductor
COMMUNICATION INDUSTRY
(2) development of the integrated service and data network (ISDN)
HOME APPLIANCE INDUSTRY
(3) development of high definition TV (HDTV)
AUTOMOBILE INDUSTRY
(4) development of electrical vehicles
COMPUTER INDUSTRY
(5) development of intelligent computers
FINE CHEMICAL INDUSTRY
(6) development of new medicines and new agricultural chemicals
MECHATRONICS
(7) development of advanced production systems
Fig. 4.3a: HAN Project: Products Technology Development
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NEW MATERIALS
(1) development of new advanced-materials in information services, electronics and energy industry
MACHINERY
(2) development of next generation transportation systems, including machines and parts
BIO-TECHNOLOGY
(3) development of new functional bio-materials
ENVIRONMENTAL TECHNOLOGY
(4) technology development in environmental engineering
NEW ENERGY
(5) development of new energy resources
ATOMIC POWER INDUSTRY
(6) design of new atomic reactor and verification processes
HUMAN FACTORS
(7) human interface technology associated with electronics and robotics
Fig. 4.3b: HAN Project: Fundamental Technology Development Source: STEP, op.cit., p. 160-161
distributed between products technology development and fundamental technology development (Fig. 4.3). Special emphasis was placed on cooperative R&D among industries, universities and government research institutes. A science park was constructed in Daeduk for the co-loction of public and private research institutes to encourage exchange and coordination. The Singaporean government adopted a three-pronged approach in its technology drive: special tax incentives for R&D investment, assistance to mission-oriented research projects and the introduction of new product/process, and the construction of the science park. II. The Sources of Technology Typically, developing countries go through three successive phases of acquisition: technology transfer, diffusion of imported technologies and local efforts to assimilate, adapt, improve and eventually to generate
Comparison among Singapore, Taiwan and South Korea indigenous technology. In each case, the government, domestic enterprises and foreign investors play a role each. The transition between the three phases was most distinct in Korea, interacting with policy re-orientation: duplicative imitations in the 1960s and 1970s, technology diffusion with active government promotion in the 1980s, and innovations from 1990 on. Technology transfer was effected through foreign licensing, foreign direct investment and capital goods import. Foreign licensing was placed under strict control in the 1960s, but the restriction was progressively relaxed in the 1970s. Korea pursued an import substitution approach in technology development, and FDI was placed under tight control before the mid-1980s, greatly reducing its role as a conveyor of technology. Instead, technology transfer in the early years was mainly through turnkey plants and imported capital goods for reverse engineering. By the 1980s, an extensive network of government, publics and private agents was in place for technology diffusion, with special attention paid to small and medium enterprises. The sharp increase in R&D investment from the 1980s on has greatly enhanced endogenous innovation capability, reflected in the rapid increase of patent registrations. Taiwan chose to focus its R&D efforts on a few selected areas from the very beginning. In 1978, four major areas were targeted, and eight more were added in later years. This strategy of concentration seems to have paid off. By 1992 they had received 4978 U.S. patents, compared with 1751 for the Koreans. Technology transfer in Singapore was simple and straight forward. Both machinery and software were brought in by multinational corporations which dominate the island's manufacturing sector. To a large extent, operations are predominantly assembly and testing with imported materials and limited diffusion of technology to the local sector. Efforts to promote indigenous research are at a preliminary stage, initiated in 1991. Its impact is too early to tell.
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III. Sources of Manpower for Technology Development Conditions and policies in Korea and Taiwan closely parallel each other. There was rapid expansion at all levels of education. Korean households, in particular, spend heavily on their children's education, resulting in Korea having the highest tertiary enrollment rate in the world, as well as the highest educational attainment among NICs. Emphasis is placed on science and technology, with a high and rising proportion of college students majoring in science and engineering. Technical training is provided by a large number of junior colleges and vocational training centres in Korea. Large number of students went abroad for postgraduate study. (Taiwan had the highest ratio relative to population studying in US graduate schools in 1993, followed by Korea.) Most of them chose to stay behind after graduation, resulting in a large reservoir of highcalibre scientists and engineers for these countries to draw on in their recent technology drive. Korea made repeated efforts to attract returnees. The Korean Advanced Institute of Science (KAIS) was established in 1971 as a research-oriented graduate school to produce high quality scientists and engineers. Relative to population, Korea had the largest number of scientists and engineers in 1993 among developing countries, (on par with France and the United Kingdom), as well as the highest rate of tertiary enrollment. In spite of such efforts, supply of high level R&D people is still regarded as insufficient in both countries. Korea, in particular, suffered from a shortage of highly trained scientists and engineers due to the low quality of their tertiary training, attributable to inadequate public funding. Tertiary education in Singapore is also heavily tilted towards technical training. In recent years 57% majored in technology related studies. The government also subsidised training institutes and private training programs. Through a flexible immigration policy, needed managerial and technical personnel are readily admitted. After launching the National Technology Plan in 1991, concerted efforts were made, by
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a special division under the EDB, to attract foreign talent from neighbouring countries as well as the former Soviet Union. IV. Incentives Towards Industry and Technology Policies related to technology manpower and financing are considered separately. Functional interventions are essential for creating the preconditions for industrialisation. But they did not receive the same attention in the three economies. Korea lagged behind in the creation of market institutions, which include property rights, commercial code, accounting and commercial and investment banks. Its banking system, in particular, is suppressed and primitive. Provision of infrastructure is also considered to be inadequate. At the other extreme is Singapore. As a former trade centre and British colony, the market institutions were already in place at the outset of industrialization. Efforts were continuously made to update and upgrade them to turn Singapore into a regional financial centre. The city is also renowned for its infrastructure in transportation, communication, and urban amenities. In between was Taiwan. It was under martial law until mid-1987 which overshadowed the legal system, constrained property rights and free transactions. But price mechanism was given a free reign in the labour and credit markets (see Section V). Public works were employed, in Keynesian style, to sustain and stabilize growth, producing good infrastructure. Industrial policy to promote manufacturing industries is, by nature, a selective intervention. All three countries pursued, therefore, selective intervention. But there was a difference in the degree of selectiveness, and its resultant impact on resource allocation, industrial structure and equity was substantial. A broad array of incentives were employed in Korea to promote favoured activities: undervalued foreign exchange, import restrictions, tax concessions and subsidised loans. In the 1960s, such assistance was both moderate and broadly applied, available to all exporting firms. In the 1970s, with the HCI drive, assistance was confined to a narrow
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band of target industries, and the level of subsidies was much higher. Increasingly, large firms were favoured, and the subsidies were allocated directly and administratively, completely circumventing the market mechanism. Until the latter part of 1980s, wage control and the suppression of labour movement were used to keep down labour costs. The policy was reversed in early 1980s, and was geared towards functional incentives, trade liberalisation and market mechanism. In Taiwan, incentives for industrialisation were channelled through price and market mechanisms. They consisted of tax exemptions and accelerated depreciation for investment, tax incentives for exporters, refunds of import duties on raw materials. They were equally available to all producers and exporters. The labour market, in particular, was highly competitive, with flexible wages and high labour mobility. High interest rates were used to allocate credits (more of that below). Several export processing zones were built in the 1960s to accommodate export-oriented manufacturing, and a science park was built in Hsin-chu for the benefit of high-technology firms. In the early years, incentives in Singapore were targeted at foreign investors. They consist of a pioneering status (tax-free for 5 to 10 years), investment allowances, equity injection, subsidised loans and training grants. Flexibility, administrative support, low and stable controlled wages, and industrial peace, were added inducements. In later years, specific incentives were also offered to R&D projects and to small companies. V. The Financing of Industry and the Role of Foreign Investors All three economies achieved very high rates of investment, but with distinctive characteristics. In Korea, the household savings rate was much lower than the other two economies. Together with government and corporate savings, total savings fell considerably short of total investment. The difference was made up by capital inflows. Tight controls and the restriction of FDI
Comparison among Singapore, Taiwan and South Korea were in place until 1980s. It was less than 2% of gross capital formation in 1965-1985, or about half a percent of GDP. It depended heavily on foreign loans (about 20 times the size of FDI), half of which were public loans. From the beginning, the government allocated credits to private investors. All banks were owned by the government. In the 1960s, the allocation was based on export performance. With the drive to promote heavy and chemical industries in the 1970, loans were channelled to targeted industries. Such loans were also more heavily subsidised. Increasingly, large enterprises were favoured to reap the scale economies of heavy and chemical industries, resulting in large conglomerates, or chaebols. These companies were heavily geared with an average debt/equity ratio of 400 percent in the early 1980s. Taiwan financed a much higher proportion of its investment from domestic savings (more than 93% in 1963-1970, compared to 50-65% for Korea). The high rate of savings (a household saving rate of 17.6% in 1965-1980, compared to Korea's 7.6%) resulted from its very successful agricultural sector as well as a high interest rate policy. It was more accommodating to FDI, which in 1970-1980 accounted for about 9% of total investment. FDI is still subject to a number of conditions, such as level of domestic ownership, export performance, etc. Unlike Korea, Taiwan kept its interest rate at a very high level, unprecedented at the time, and used it to ration credit to borrowers. As there was enough demand for the large amount of savings generated, the rates chosen probably approximated the equilibrium rate and the market mechanism was at work in allocating credit. High savings rate as well as market allocation of credit (instead of that by bank or government bureaucrats) facilitated the growth of small enterprises, which dominated Taiwan's manufacturing sector. Public enterprises took over heavy industries like steel, shipbuilding and petrochemicals, whose great economies of scales rendered them natural monopolies in a small economy. Singapore's investment rate was considerably higher than that of Korea and Taiwan, the result of high rate of institutionalized savings
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and massive inflows of FDI. It is unique in its heavy reliance on foreign investment, as a matter of government policy. The manufacturing sector is dominated by multinational foreign companies which typically accounted for 70% or more of output, value added, and capital expenditure. As inducement, the Economic Development Board entered into joint ventures with foreign companies. The government also operated a large number of state-owned enterprises (later known as Government-Linked Corporations (GLCs)), which provided 18% of total employment in 1990. Until relatively recently, local SMEs were largely ignored by the industrial policy makers. VI. The Role of Private Enterprises Private enterprises are those where private agents assume business risks and make entrepreneurial decisions on investment, production and marketing. By this interpretation, whether the chaebols in Korea, which have dominated the industry from 1970s on, can be considered private enterprises is debatable. With an average gearing of over 300% since mid-1970, they operated with other people's money, usually allocated and guaranteed by the government. Policy-makers were directly involved in deciding what to produce, how much and who would do it. Our analysis here is, therefore, confined to SMEs, in the case of Korea. Small enterprises in Korea were ignored by the Government and crowded out by chaebols. Denied access to bank credits, they had to use risky and costly kerb markets, nor could they compete with chaebols for personnels. They accounted for a large share of employment in manufacturing, but their relative importance is steadily decreasing. They also had an exceptionally high rate of bankruptcy. They produced predominantly for the domestic market, exporting between 10% and 20% of their output. Due to the poor quality of their products, a subcontracting system was not developed. With the shift towards functional incentives and liberalisation in early 1980s, concerted efforts were made to promote SMEs.
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Taiwan's experience was unique. The dominant force of industrialisation was a large number of small local enterprises, producing for exports and operating in a free and competitive environment. Contrary to Korea, the relative importance of SMEs (employing less than 100 persons) increased over time. In the mid-1980s, they accounted for twothirds of manufacturing employment and output. They exported a higher proportion of their outputs than large firms. A number of factors contributed to their success, including a high rate of household savings, availability of bank credits, access to cheap rural labour — close proximity, good roads and a mild climate facilitated commuting between rural and urban areas, and the immigration of overseas Chinese. Most importantly, however, was government assistance. Forty-nine industrial parks and districts provided infrastructure facilities and generous loans. Public enterprises avoided competing with SMEs but assumed the responsibility of supplying them with raw and intermediate materials at stable prices. Singapore's industrialisation is in private hands, with government interventions affecting input prices and costs of business, but the private enterprise in question consists predominantly of foreign MNC. There was a lack of domestic entrepreneurs, and it was easier and quicker to have foreign investors fill the gap. Local SMEs were neglected by policy makers until the mid-1980s. Particularly, no efforts were made to upgrade local enterprises and to integrate them with foreign companies. Little domestic linkages resulted from FDI even from the beginning. Later on, when the government sought to upgrade the skill and technological level of industry after the mid-1970s by attracting high-technology industries, local SMEs were left further behind. The revision of incentives associated with industrial upgrading and restructuring actually discriminated against small producers. So did the high wage policy of 1980-1983. The 1985 recession highlighted the poor performance and vulnerability of domestic SMEs, when many of them closed down. Various initiatives were made after 1986 to assist SMEs and to integrate them with MNCs. A wide range of assistance is now in place.
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It is interesting that a distinct agent played the key role in industrialisation in each of the three economies: Chaebols for Korea, SMEs for Taiwan and MNCs for Singapore. VII. Priority of Technology and Industry Policies in State Planning In Korea, technology development is one of the areas that the government policies emphasize. This can be seen from its special institutional setting. In 1960s, the Korean government established a Bureau of Technologies under the powerful Economic Planning Board. In 1967, the Bureau was upgraded into the Ministry of Science and Technology. Korea was the first country to have a full-fledged ministry of this kind. Export promotion is central to Korea's economic planning and development strategy. Hence, the relative importance of technology and industry policies in the overall economic planning hinges on its relation to the country's export. We have described the Korean industry policies into three phases. In the first phase (1961-1973) and the last phase (1980—), the policies were relatively neutral. In the second phase (1973-1979), they were more targeting and biased. In the first phase, Korea's comparative advantage was in labour-intensive products and thus labour intensive industries were promoted. As a result, technology policy was not emphasised. The second phase was the well-known Heavy and Chemical Industry (HCI) Drive. The state policies favoured these industries in order to promote their exports in the future. Thus, the HCI policies and the related technology policies received the highest priority in the country's economic planning. Although the last phase returned to the neutral export promotion strategy, the capital-intensive industries still received high priority as it was believed that Korea's comparative advantage had shifted to these industries. In late 1980s and early 1990s, technology and skill-intensive goods, such as computers, semi-conductors, colour
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TVs and automobiles, were Korea's major export products and naturally received policy priority. Like Korea, export orientation is also a key component of Taiwan's state economic planning. Although there was no strong industrial policy in Taiwan such as the HCI Drive that changed the industry structure dramatically in Korea, some specific sectors were also identified by the government to provide strong support. High-tech products like petrochemicals, electrical machinery, electronics, precision machine tools and computer terminals and peripherals have been targeted since the Sixth Four-Year Plan (1973-1976). In the subsequent state economic plans, targeted sectors have been modified with the feature that they are more technology-advanced products such as information, automation and bioengineering. In the case of Singapore, there are two relevant points that can perhaps indicate the emphasis of government planning. The first is about the Economic Development Board (EDB). Although EDB is only an agency mainly in charge of attracting foreign direct investment, Singapore's industry structure is greatly affected by foreign direct investment, especially large multinational corporations, and so the EDB plays a critical role in the country's economic planning. The second point is about technology policy. The country did not have a coherent science and technology initiative until 1991, when the National Science and Technology Board (NSTB) under the Ministry of Trade and Industry was established. Since then, the state planning has paid increasing attention to technology development. For example, according to the first National Technology Plan, which was drawn up by the NSTB in 1991, the government was to increase research and development expenditure in both absolute terms (i.e., total funding) and relative terms (i.e., as a percentage of GDP). It is well recognized that all three economies have been actively pursuing outward orientation strategies. Thus, export is a high priority in economic planning. But industry has been the most important sector in exports and in all these economies industrial technologies have been upgraded rapidly. It is not difficult to infer that technology and industry
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policies have also been receiving high priority in these economies' state planning. VIII. The Technological Expertise in the Government In Singapore, the education system emphasizes mathematics, science, and technological subjects. Therefore, more and more students are attracted to these areas. As a result of this system, many officials in the civil service are science and engineering graduates. There is also evidence that some of the best graduates from science and engineering program are working for the government. The Economic Development Board, which is a high profile elitist agency in charge of implementing the foreign investment drive of the government, is a good example of this. Almost all of the chairmen of the Board in its history have a science and engineering background. Although it is almost impossible to gauge the exact impact of this bias on the country's economic structure, it is clear that industry will play a more important role in the economy in which government's guidance is important and more scientists and engineers are involved in decision making. In the case of Taiwan, in the early 1970s, Y. S. Sun authorized a team, which was formed by some engineers in Taiwan and the United States (overseas Chinese), to study and make recommendations on the path and direction of Taiwan's upgrading of its domestic industry. When IC was chosen, engineers from the Bell Labs, IBM and various universities were invited to form the Technology Advisory Committee to help the government select a particular IC technology and pick foreign partner companies. Of course, in every economy, industry development has to rely on scientists and engineers. But in Taiwan, scientists and engineers play a role not only in the implementation of the industry development strategy, but also in the planning of the strategy.
Comparison among Singapore, Taiwan and South Korea IX. The Setting of Industry Targets Normally a government needs to set up some agencies, organisations or bodies to deal with the issues of the economy's industry development. The way that such organizations are formed, and the power and autonomy that these organizations have could have a tremendous impact on the success and failure of the country's industry development. They also help to shape the industry structure of the economy. In this regard, we first briefly review the practice of industry targeting in Singapore, Taiwan and South Korea, and then point out their similarities as well as differences. Although the Economic Development Board (EDB) in Singapore is a government agency in charge of foreign direct investment, since foreign direct investment plays an important role in the economy's industrialisation, EDB is governed by a board appointed by the government and has broad economic goals. In terms of organisational structure, it has many divisions including, for example, the Industry Development Division in charge of the development of strategic industries and Enterprise Development Division in charge of the development of small and medium enterprises. EDB is a highly entrepreneurial organisation, which is reflected in two aspects. First, its officers have long experience working as industry specialists and therefore understand the industries well. Second, it holds equity stakes in many important joint ventures with foreign companies. One of the important tasks of EDB is to provide timely information, which will help identify foreign companies with good potential and formulate industry targeting. In Taiwan, the most influential government agency in industry is the Industrial Technology Research Institute (ITRI), established by Y. S. Sun in early 1970s. Under the ITRI, there is the Electronic Research Service Organisation (ERSO) that is set up with the special purpose to develop the integrated circuit (IC) project. There are other important government agencies created for industrial development, but with various functions.
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The state initially funded ITRI entirely, then reduced its share of funding. In general, the state initiated and financed long-term ITRI projects and the private sector provides financial support to ITRI's shortterm projects. On the other hand, ITRI also invests in joint ventures with private sectors. In South Korea, President Park created in 1962 the Economic Planning Board (EPB) which has played a central role in Korea's economic planning, national budgeting, foreign capital management and statistics. Besides the EPB, the government sponsors many specialised policy research institutes. Examples include the Korean Development Institute (KDI) under EPD and the Korea Institute for Industrial Economics and Technology (KTET). For industry targeting, the best-known government agency is the Heavy and Chemical Industry Planning Council established in 1973. In all three economies, there is one thing in common. That is, they all have a very powerful government agency in charge of industry planning and development. Such an agency is not subordinated to any specific ministry. A notable common practice in Singapore and Taiwan is that both the EDB of Singapore and the ITRI of Taiwan acquire some equity shares in important joint ventures. The benefit of having state-private joint ventures is, on the one hand, to show government's leadership and commitment to the development of targeted projects, and on the other hand, to allow private sector participation so as to avoid the risk of heading towards the wrong direction. We can also identify some differences among those organisations in the three economies. Singapore is the smallest economy in terms of population and area. EDB therefore has very broad business scopes covering areas like service sector, manpower, small and medium enterprise development, and others, in addition to industry development. In contrast, the ITRI in Taiwan was created as an organisational capacity for industrial targeting. Other organisations are established to take other or more specific responsibilities. In Korea, the EPB is more a planning body. Economic decision making was very much a top-down
Comparison among Singapore, Taiwan and South Korea process. Many other lower level organisations and institutions sponsored by the government are also formed with the purpose of strengthening public policy planning of various ministries. X. Government Initiatives In Singapore, the government establishes various training centres and technology institutes to improve the average skill and knowledge of the labour force. It also sets up special schemes to promote R&D activities by providing funds for innovation projects. Examples of these initiatives are the Design Centre, the Design Institute, Information Technology Institute, the Institute of Manufacturing Technologies and the Innovations Development Scheme. The kinds of government initiative in Korea that have been documented in Chapter 3 are very similar to those of Singapore. In Korea, some quasi-government organizations are established to provide public goods. They include the Korea Trade Promotion Corporation to help with international marketing, the Korea Trade Association to promote contact between government and business, and the Korea Institute for Science and Technology to spearhead the country's technological drive. In the case of Taiwan, it is recognised that in order to induce the private sector to invest in high-tech area, monetary incentives are necessary, but not sufficient. Government involvement is also an important factor. In this regard, the government of Taiwan in 1980 established the Hsin-chu Science-based Industrial Park to provide a good infrastructure and assistance for the private sector. In addition, the government also forms joint ventures with the private sector. Our case study of Taiwan's semiconductor industry has discussed two of these types of state-private joint ventures, which are regarded as a success. However, there are also examples of failure of state-private joint ventures. The case study of Taiwan's automobile industry has mentioned two such joint ventures between state owned enterprises and foreign car makers.
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What can we say about the success or failure of the kinds of government initiatives mentioned above? It is difficult to make any conclusive judgment without a careful and extensive study. But some general messages can be extracted. Government initiatives, which are more general, more neutral and closer to public goods, tend to be more useful to the economy. However, whether they can be successful are determined by many other factors, such as management. When the government initiatives are more sector-specific and targeting, their chances of success and failure also depends on the sectoral environment. XI. Appraisal of Policies An important objective of the Singapore government's industry policy is to attract foreign direct investment, especially from large multinational corporations. This distinguishes Singapore's industry policy and the resultant industrial structure from those of Taiwan and Korea. Relying on large foreign multinational corporations for industrialisation may be a good and necessary strategy for the government of small economy that aims at developing internationally competitive industries in the high-technology sectors. As a result, foreign companies in Singapore account for more than half of the manufacturing employment, and around three-quarters of manufacturing output, value added, exports and capital expenditure. Thus, the policy is successful in its narrow sense. That is, it achieves its goal. The industry policy is also successful in a broader sense. Singapore's economic growth has remained high since the 1960s and unemployment rate has been kept low for most of the time. Foreign direct investment has made a significant contribution to Singapore's economic success. However, it is inappropriate to assess a policy based only on what it has achieved. We should also look at what might be the outcome without such a policy. Many people will agree. But the problem is that nobody knows the hypothetical or counterfactual outcome, and thus it is impossible to make a comparison. Nonetheless, there are still ways, imperfect though, to evaluate a policy. One is to examine its costs and
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the other is to compare the policy outcome with the situation of another country that has most things in common except it does not implement the particular policy. In below, we make the use of the first approach for Singapore and the second for Korea. For Singapore, there are three issues relating to the costs of the industrial policy. First, the tax burden imposed on the other sectors of the economy. By providing fiscal incentives such as tax holidays and R&D subsides to a set of sectors in the economy, the government implicitly raises tax on the other sectors and particularly on consumers. Second, the policy influence of foreign companies. As foreign multinational corporations account for a large part of the economy, formulation of future government policies has to take their interests into consideration. For example, to prevent a sudden withdrawal of foreign capital, which would create large disturbances to the economy, some sort of incentive for foreign direct investment might have to continue. Third, the large inflow of foreign direct investment by large multinational corporations has adverse effects on the development of local small and medium enterprises. As a consequence, the economy might become less flexible. In both Taiwan and Korea, the governments' industrialisation approaches are somewhat different from Singapore. The industry policies are designed to promote and develop the domestic industries in the strategic, high-technology sectors. Let us examine the Taiwanese case first. There are both success stories and examples of failure. The policy to promote Taiwan's automobile industry is a failure. The major lesson that can be learnt from this case is that a government is not always able to target the right industry. The automobile sector is not the right one to be picked for Taiwan because this industry's characteristics do not match Taiwan's economic structure. Specifically, economies of scale are crucial for the automobile industry and so firms must be large in size. However, small and medium enterprises dominate Taiwan's economy. Thus, the policy is doomed to failure since there are not enough potential candidates to assume the task of building a strong domestic automobile industry.
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Even when targets have been chosen correctly, it is not guaranteed that the targeting policy will be successful. Having a strong government to support the industrial policy is very important. Any targeting policy inevitably invites rent-seeking activities, skepticism and criticism. A weak government that pursues such a policy will make the problems even worse. As demonstrated by the case of the semiconductor industry in Taiwan, some of these activities could be prevented or minimised if the government has strong leadership. The need to have strong government leadership applies also to the case of Singapore and especially Korea. It is obvious that without the incentives provided by the Economic Development Board of Singapore, the contribution by foreign investment to GDP would have been much smaller than it is now in Singapore. But as we pointed out above, this does not suffice to say that the policy is a correct one. We also need to conjecture what outcome would have turned out without such a policy. For the incentive policies in Taiwan, Chapter 2 has mentioned that most subsidised firms would have continued with their investment projects even if they had not obtained preferential treatment from the government. This needs to be interpreted carefully. It does not imply that all policy incentives and government initiatives are unnecessary. Even if the direct benefits of a policy are not crucial, sometimes the indirect benefits could be very important. In this sense, we may think that the attractiveness of the Hsin-chu Sciencebased Industrial Park in Taiwan is not necessarily the subsidies provided by the government, but more importantly the spillover effect or the network externalities associated with investment in the Park. Lastly, let us turn to the Korean industry policy appraisal. When industry policy is assessed on the basis of specific targeting policy, one can identify both success cases and failure examples in Korea's industrial development just as in the case of Taiwan. However, it seems that more failure stories are reported for Korea. With the help of the Heavy and Chemical Industry (HCI) policies, the HCI product group has performed well, in the sense that its market share in Korea's total exports increased consistently and sharply during
Comparison among Singapore, Taiwan and South Korea and after the HCI Drive. Some of the projects promoted by the HCI policies have turned a few Korean companies into big multinational corporations. This could be regarded as the successful side of the Korean industry policy. On the negative side, the growth of the HCI is built at the expense of a slowdown of the development of the light industries and agriculture. A comparison between Korea and Taiwan is interesting as it shows a possible way to answer the counterfactual question of what might be the outcome in the absence of a specific industry policy that has been implemented in an economy. Korea and Taiwan are similar in many aspects. But the Korea's HCI policy makes a difference: Korea's industry policy targets more on the heavy and chemical industry. However, the comparison shows that the growth of market share of all heavy and chemical products over 1974-1987 was essentially the same for Korea and Taiwan. This implies that the HCI policy in Korea is a failure because it has no positive effects on the targeted industry, but negative effects on the other industries. As for other targeting policies in Korea, it is easier to give failure cases than to give successes. The promotion of the automobile industry has achieved the goal, but it is only a mixed success since other unexpected factors help its growth. The target on the shipbuilding industry by the Korean government helped to push the Korean shipbuilding industry into a high ranking worldwide. But it has never been considered financially worthwhile. The government had continuously subsidised the Korea Aluminum Company to promote this industry until 1989 when the company went out of business. In summary, sometimes we can assess a specific industry policy with in-depth studies based on whether the policy has achieved its goal. However, it is never easy to examine the policy's overall economic effects, i.e., the impact on the targeted industry and the rest of the economy as well. This is more a problem if we try to evaluate a country's overall industrial policies. On policy outcome regarding the targeted industry, we can find success stories in all three economies. However, even using this narrow
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criterion, industry policies in these economies cannot be regarded as successes as many failure cases have been seen. Thus, it is obvious that sensible conclusions on these economies' industry policies are difficult to draw. XII. A Common Development Paradigm: Nature, Circumstances and Applicability 1. Development Strategy and Industrial Policy The industrialisation strategy adopted by the three economies was a variant of the so-called Japanese model, also labelled as "government capitalism" and the "guided market system". Its essential features include: (1) The government steers the economy to achieve some well-defined community goals, such as targeted income or export growth, catching up or overtaking certain more advanced nations. In the process, subjectively based decisions by government agencies override market mechanisms. (2) To control the pace and direction of development, planning, regulation, restrictions and incentives were extensively employed. For example, to start a business in Korea in the 1970s, 312 signatures from government agencies were required. (3) Cheap capital was generated through restricting foreign investment and a heavy focus on banks as the intermediaries between savers and borrowers. There was thus a heavy dependence on bank lending or indirect finance. Allocation of bank credits was tightly controlled. (4) Protectionism was employed to shield the domestic market from competition. Definitely, there were notable inter-country variations. In Taiwan higher interest rates were used to allocate credit, and there was little trade restriction in Singapore.
Comparison among Singapore, Taiwan and South Korea 2. Policy Justifications For the economies concerned, the strategy could be justified on both economic and political grounds. As for economic considerations, much more than the efficiency consideration of market failures is involved. For Korea and Taiwan, there was an acute shortage of capital and enterprise. In the 1950s, South Korea was an agrarian backwater devastated by war. Taiwan was only marginally better. Market institutions for commerce, trade and finance were primitive. Singapore lacked an industrial background, and did not have an influx of refugeeindustrialists, like Hong Kong. The government had to take the lead to mobilise internal resources, to negotiate or underwrite outside loans, to administer foreign aids, and to direct the allocation of resources to expedite industrialisation. And rapid growth was considered a political necessity. In each case, a new government had just came to power at the eve of industrial drive. It faced military threat from across the border as well as internal tension due to a large influx of refugee immigrants. Rapid growth was considered essential for survival. The people were called upon to sacrifice, through low returns on savings, high living costs, high contribution to pension funds and various restrictions on consumption and investment behaviour, to further the national cause. 3. Institutional Preconditions for Success To be effective and successful in state-led development strategy, there needed to be a strong government and a general acceptance of state guidance and authority. Korea and Taiwan had strong, authoritative military regimes. Lee Kuan Yew governed with a strong mandate, and no opposition in the Parliament. Government agencies for economic affairs were quickly established. They were highly placed in the state hierarchy, with sweeping powers and insulated from political or legislative interference. President Park, for example, took direct control on the implementation of Korea's industrialisation program.
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Culturally, the people were more receptive to group values, a strong central government, and rule by decree. Both historical background, the influence of Confucianism, and seclusion from Western influence (except for Singapore) contributed to this submission of the people. In the Confucian tradition, for example, "bureaucrats are not merely government functionaries, but leaders, intellectuals and teachers." (Song, 1997, 263). Comprehensive leadership to provide, to enrich and to educate is accepted, even expected. Initial success only reinforced this disposition, and helped to weaken the independent private sector, which could not compete with the state sector — government agencies, state enterprises and the chaebols — for professional and technical manpower. 4. Effectiveness In general, their policy succeeded in sustaining a high rate of export-led growth. As shown in Table 4.1, their growth rate over 1965-1995, which was quite similar, was the highest growth rate sustained over such a long period. The growth of merchandise exports grew much faster than income growth and was thus the leading force. Significantly, they managed to maintain the high share of manufacturing in GDP until the 1980s. This was achieved through continuous industrial upgrading. Korea and Taiwan were particularly successful in changing their leading exports from low tech, labour-intensive light industrial goods, to heavy industrial goods, then high-tech products. However, not all success can be credited to government policy. The appreciation of the yen and deutschmark, and the construction boom in OPEC countries of the Middle East contributed to Korea's high growth in the 1970s. Similarly, quantitative restrictions imposed by the US on the import of Japanese automobiles opened a niche for Korean cars. Such fortuitous developments were certainly not in the mind of planners. Secondly, it should be noted that policy was more effective in the earlier phases of industrialisation when using borrowed technology to produce mature products for established markets. Its
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Table 4.1: Major Indicators of Growth and Structural Change 5. Korea
Taiwan
Singapore
6.7 8.6 6.5
7.0 7.3 5.6
7.6 7.9 6.3
Growth of merchandise exports (%) 1960 - 1970 1970-1980 1980-1986 1987 - 1990 1991 - 1995
38.6 37.2 13.1 17.8 14.8
18.1 14.1 12.7 14.7 10.9
3.3 28.2 6.1 24.5 16.0
Share of Manufacture in GDP at current prices (%) 1970 1980 1990 1995
19.1 29.6 28.9 26.9
29.2 36.0 34.4 28.2
20.0 29.2 28.6 27.8
Average annual growth of per capita income (%) 1965 - 1986 1987 - 1990 1991 - 1995
Note: As the data are taken from a wide range of sources, inter-temporal growth rates may not be comparable.
effectiveness waned significantly in the 1980s and 1990s when rapidly changing market conditions and technology called for more specialised knowledge and timely responses (Kim, L., 1995). 5. Negative Effects We have shown how the forced growth strategy of Korea led to inflation, external deficits and sectoral and structural imbalances. (3-29, 3-38). The system also spawned massive wastes and inefficiency. This outcome is predictable when bureaucratic decision supersedes price mechanisms and market discipline, when size, market share
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and export growth were targeted instead of profitability. Underpriced credits were allocated administratively to favoured industries and firms. Banks could not play the crucial role of assessing credit risks and monitoring business practice. As a result, most chaebols were overleveraged, overextended, widely diversified ("from chips to ships", as one large chaebol advertised), took on excessive risk and underperformed in profit-making.38 This excessive and resulting vulnerability was the main cause of the recent financial crisis which led the nation to the brink of bankruptcy. On the other hand, small enterprises were at best ignored, if not discriminated against. Denied access to credits and foreign exchange, and disadvantaged in recruitment, their relative importance waned steadily. Small businesses are the breeding ground for entrepreneur ship. They can be flexible, adaptive and innovative. They support one another as well as big enterprises and render the economy more resilient. The neglect of small enterprises deprived the country of an important source of dynamism and intensive growth — the enhancement of productivity through innovation and reforms. Singapore shared with Korea this problem of weak SMEs due to neglect or discrimination by policy makers. Multinationals continue to dominate the modern sector. Compared with citizens in Hong Kong, the Singaporeans are less prone to take the initiative, innovate and take risks and are more inclined to look to the government for solutions for their problems.39 Taiwan managed to avoid most of these pitfalls. Their interventions tended to be more general and effected through market mechanisms. Small firms had access to credits which were rationed by a high rate of interest. They also benefited from other policy measures
38
Net profits of the top 49 chaebols amount to a paltry $65 million in 1996, although their sales accounted for 97% of the Korean GDP. 39
It was said that the aspiration of educated youth is to get an M.B.A. and to work for multinationals.
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which provided them with factory sites and buildings, utilities and intermediate inputs. The recent financial crisis has clearly exposed the peril of the excessive organisation, administrative resource allocation, intervention and dependence on foreign capital or enterprise. Taiwan seems to have emerged from the crisis stronger than before. To be fair, policy makers recognised the importance of free competition and small enterprises. In the early 1980s, all three economies shifted to liberalisation, privatisation and the promotion of competition and small and medium enterprises.
6. Lessons for Hong Kong The critical condition that justifies government-led industrialisation never applied to Hong Kong. There was no external threat or internal unrest. We were not short of industrial enterpreneurship among indigenous people and immigrants. We inherited a well-developed market and legal institutions as well as a stable currency and a sound banking system, which in turn attracted a steady inflow of foreign capital. By contrast, the culture and political institution for intervention that existed in our three neighbours were completely absent. Patriotism had little relevance for a transient population living in a borrowed place (as in 1950s and 1960s). Brought up in a tradition of economic freedom, citizens of Hong Kong were metropolitan, independent and self-reliant. At any rate, the colonial government of Hong Kong lacked the mandate for rallying the population to make sacrifices for a collective purpose. Therefore, even if policy makers had wanted to follow the Japanese model for economic development in the 1950s or 1960s, the pre-conditions were not there. History has revealed that we had little to lose for that. We achieved comparable economic success at much lower social and personal costs. Significantly, the other parties are making strenuous efforts to promote private enterprise, competitive market and free participation that are hallmarks of Hong Kong.
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XIII. Conclusion It may be instructive to compare the technology status of different countries at this point. There is clearly no hard and fast rule as to how technology status can be compared. One commonly used indicator is the number of registered patents that the researchers residing in a country hold. Table 4.2 illustrates one such comparison. The numbers in Table 4.2 indicate the number of patents issued in the US by the country of residence of the first-named inventor. From 1980 to 1995, the number of patents issued by the US Patent and Trademark Office per annum increased from 66,297 to 114,870. This growth is an indication of the fast pace of technological development the world has experienced in the last two decades. A breakdown of the total patents issued shows the gross disparity in technological power among countries. USA and Japan together accounted for 73% in 1980 and 77% in 1995. Besides Japan, Asia is but a small factor in the global technology business. Within Asia and setting aside Japan, only Taiwan and Korea
Table 4.2: US Patents Issued
Country/Region Malaysia Singapore China Hong Kong Korea Taiwan France Germany Japan USA Total Issued US Patents
1980
1985
1990
1995
1 3 1 49 9 71 2,150 5,895 7,401 40,847 66,297
3 10 1 66 50 199 2,516 6,906 13,351 43,481 77,361
6 16 48 151 290 861 3,093 7,861 20,743 53,205 99,452
8 61 63 248 1,240 2,087 3,010 6,874 22,871 65,425 114,870
Source: Made Bv Hong Knng. Berger, S. and Lester, R.K. (ed.) Oxford University Press, 1997, Table 14.6
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can boast some innovative power, although they together accounted for only 3,327 patents, some 3% of the total in 1995. Singapore had only 61 patents in 1995, which was already a significant growth from 16 in 1990. Hong Kong was ahead of Singapore, with 248 patents in 1995. A few major lessons stand out from our analysis of the industrialisation experience of Singapore, Taiwan and South Korea. First, the inducement of foreign direct investment does not ensure technology transfer to spur technological upgrading in local industries. The case of Singapore provides a good illustration. Second, large-scale indigenous research, as is the case in Taiwan and South Korea, was successful basically because of the abundant presence of research scientists. While the education system strongly motivated students to follow scientific studies, the large number of graduates who had gone overseas to obtain higher degrees and work experience constituted a powerful force in technology upgrading. Third, strong government direction easily led to latent problems. In the case of Singapore, the neglect of local enterprises led to an overdependence on foreign companies and a depressed entrepreneurial spirit. The unnaturally high savings rate prevented the development of markets for the financing of private ventures. In the case of Taiwan, the promotion of manufacturing led to under-development of service industries. In the case of South Korea, the most notable of all, the single-minded promotion of heavy and high-technology industries led to corruption, heavy foreign debts, low profits, a depreciating national currency and a general decline in the standard of living. Fourth, the objective to maximise economic growth has to be tempered with sustainability. In Singapore, the rate of return to pension fund investments is very low. Similarly in South Korea, despite spectacular growth figures, chaebols are on the verge of bankruptcy, as a result of continuously low profit figures. Fifth, science park development, which exists in Taiwan and Singapore, is not a primary tool in technology development. Rather, a science park is a piece of infrastructure which accommodates government policies to promote technology. If the science park development in Hong Kong is going to be successful, the accompanying policy "software" is a crucial
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consideration. Sixth, adopting a narrow objective of promoting technology alone, strong government or central targeting is probably necessary for rapid results. In the case of Singapore, Taiwan and South Korea, all three governments have well-defined target areas for technology development, although the means used differ from one economy to another. In these economies, the resources are lacking in support of technology development across a broad spectrum. This is an important consideration when Hong Kong is contemplating on its own technology policy.
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STRATEGIC CONSIDERATIONS IN THE HONG KONG CONTEXT Sunny Kai-Sun Kwong The Chinese University of Hong Kong
I. Introduction In the period from 1961 to 1997, the GDP of Hong Kong at constant prices increased by more than 13 times, while GDP per capita grew six and a half times. Unemployment stayed below 5% throughout the period, with the exception of only three years. In the same period, the government budget had an actual deficit in only seven years. By March 1998, the government had an accumulated fiscal surplus (including the land fund) of $445.6 billion. When financial crises hit Asia in the second half of 1997, affecting seriously Thailand, Malaysia, Philippines, Indonesia and South Korea, Hong Kong's economy remained stable, despite corrections in the stock market and the property market. All this is enviable performance for any economy in the world. What have frequently been overlooked are the shocks that the small economy of Hong Kong has been exposed to in the last three decades or so. The oil crisis of 1974 caused recession in almost all non-oil producing countries. Hong Kong's growth was halted for two years, but then resumed dramatically in 1976, growing by 16% in real terms. In a similar fashion, the US monetary squeeze and local political uncertainty of 1985 led to zero growth. But the economy quickly regained its growth momentum in 1986, growing by 11% in real terms. The resilience of the Hong Kong economy has been remarkable. Statistics show that the quick recovery from no-growth in both 1975 and 1985 was led by domestic exports. This is a reflection of the
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competitiveness of the export sector. The competitiveness of this sector, which comprised predominantly small- and medium-sized manufacturers, stemmed from the fact that firms could operate in an almost frictionless environment. Entrepreneurs then, as they are now, were free to set prices and compete with each other, free to source for materials to carry out the production processes and explore new markets, and were able to start up companies and hire workers with little hindrances from the government. The overall impression one gets from observing the performance of the Hong Kong economy in recent decades is that, perhaps the most important factor underlying the economy's robustness is the flexibility of the market mechanism. The market mechanism has spurred growth in the prosperous years, and promoted quick recovery in the depressed ones. The fall in wages and prices of production factors in the economic downturn of 1975 and 1985 allowed firms to regain production orders quickly as the global economy recovered. In addition to contributing to the resilience of the economy, Hong Kong's flexibility has also allowed it to make a smooth transition from a manufacturing economy to a service economy in the past decade. In 1978, when the mainland was liberalised, manufacturing accounted for 34% of GDP. In 1996, manufacturing accounted for just 9% of GDP. The speed and scale of this transition is unprecedented anywhere in the world. The scale of job changes that has been occurring in the working population of 3 million is easy to visualise. Yet remarkably, unemployment rate has remained below 4.5% throughout the transition. Evidently, the free market economy has adjusted well to this phenomenal structural change. That the free market system has given rise to great economic resilience and flexibility is by no means a new observation. In Hong Kong, the vibrant economy was fueled by the entrepreneurship and motivated efforts of millions of economic agents. The free market environment of Hong Kong has enabled them to put their energy and creativity to the best use. The observations are reiterated here mainly to put the present discussion about industrial policy in perspective.
Strategic Considerations in the Hong Kong Context Industrial policy, by definition, singles out the industrial sector of the economy for specific public support. The very nature of government action implies departure from free market principles. Unlike the other fast-growing economies in Asia, Hong Kong has never had an industrial policy. Hong Kong's economic performance so far suggests that industrial policy is not essential. In terms of economic growth, stability and people's well-being, Hong Kong is no inferior, and arguably superior, to Singapore, Taiwan and South Korea, countries that boast of having strong industrial policies. Notwithstanding Hong Kong's economic success, there have been calls in the community for fundamental changes in economic thinking. There have been active debates as to whether industrial policy has a role to play in transforming the Hong Kong economy. In a nutshell, the debates boil down to the following questions: If Hong Kong has achieved economic success so far without any industrial policy, is it really necessary to consider industrial policy at this juncture? Surely the world is changing, and today, Hong Kong is facing new challenges — high wages, slower growth, the threat of new technology, and the rapid catching-up of cities in the mainland, among others — but is industrial policy the panacea for these problems? Has the free-market principle gone obsolete in today's environment? If there is a role for the government to play, how should the government proceed? These questions are a driving force behind the present study. The basic position of the present study is that the free-market principle should remain the guiding principle of government policy. In the domain of industrial development, government attention is best directed towards eliminating barriers that impede the flow of human capital, investment capital and information. The objective should be to create a marketmediated environment in which economic agents can exercise their initiatives and creativity freely, and that everyone has an even chance of getting ahead. Of course, there may be areas in which the market fails. In particular, there are identifiable cases in which the government may have to act to enhance coordination. Nevertheless, the overall direction of government policy should be one of creating the framework and the
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pre-conditions so that industrial activities can grow autonomously. These activities should take place in a spontaneous and decentralized market system. In the process, the government should act merely as a facilitator, not as a player. Policy prescriptions for an economy are fundamentally and generally problematic, and most economists refrain from making them. Consultants easily make the mistake of equating an economy to a corporation. A corporation is a hierarchy of workers who work according to instructions in return for pay. If workers are dissatisfied with the company, they quit; and if the company is dissatisfied with the workers, the workers are fired. One can meaningfully talk about the direction that a corporation should be moving in and how that course can be changed. Not so with an economy. Each agent in an economy acts according to his/her own free will, and the market is simply the institution that mediates their actions. An economy evolves by itself, in a manner which is largely determined by available physical and human resources. The market, by providing the price signals, channels resources to those uses that generate the highest rate of return. Government intervention, to the extent that it redirects resources, almost invariably lowers the rate of return. Growth in some sectors may accelerate in the short term, but growth of the economy as a whole is rarely sustainable. It is undeniable that market failure exists, but relying on the government to correct market failure often leads to new problems. The foregoing chapters have described the industrialisation experience of Singapore, Taiwan and South Korea. Their experiences by no means suggest solutions for Hong Kong. Hong Kong's problems, advantages and weaknesses are unique and no emulation is in order. The other three economies redirected huge amounts of resources away from the market and into projects which were favoured by the government. These investments earned rates of return that were lower than the prevailing market rates. The distortion in the allocation of investment capital would eventually bring about a collapse of the economy. In the case of South Korea, the government forced local banks to extend loans to conglomerates to finance their low-return investments. These investments mostly involved high-technology or capital-intensive manufacturing.
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When the conglomerates could not repay the loans, the banks and the government had to borrow from foreigners. The result was that foreign debt increased from 6% of GDP in the early sixties to 12% by midnineties. It was clear that the situation was not sustainable. In late 1997, widespread default of loans happened which led to crises in the banking system, stock market and the value of the national currency. The case of Singapore also involved massive redirection of investment capital, although the principal intermediary was large budget surplus (high direct and indirect taxes coupled with small social welfare expenditures) and the central provident fund rather than government-controlled banks. In essence, Singapore grew by suppressing consumption. The forced savings were directed into infrastructural development, attracting foreign direct investment, and investment overseas. These investments generally yielded low rates of return. From 1995 to 1996, the Central Provident Fund investments yielded a rate of return of only 3.4%. Because of the low level of disposable savings in the economy, capital markets cannot develop. The result is a stunted development of local enterprises, and a chronic dependence on foreign direct investment. Although a crisis has not surfaced yet, the situation is clearly unsustainable. The case of Taiwan is less problematic, mainly because the scale of industrial policy has been much smaller. The industrial sector is still predominantly unsubsidized small and medium enterprises. The high-technology industries that have emerged in recent years are mainly the results of Taiwanese engineers returning to work in Taiwan after receiving training in the US. A remark about market failure. Conceptually, the market fails to allocate resources to the best uses if there exist coordination failure, natural monopoly, externalities, public goods, and information barriers. The existence of market failure gives a conceptual justification for government intervention. Where government intervention is needed in specific industries, industrial policy is called for. But the existence of market failure in a particular industry does not imply a better outcome is necessarily attained with government intervention. There are at least two sources from which problems may arise. First, the government may set the wrong objective. The government may misjudge the existence of
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market failure, market situations, technology changes, or how global affairs unfold. Second, assuming that the objective is correctly set, things may go wrong in implementation. Selective support of certain activities could lead to excessive lobbying, protection, cartelization, and corruption. In practice, the costs of industrial policy may outweigh the gains. Another problem with industrial policy concerns political economy. Industrial policies often involve subsidising certain firms or industries. In time, the subsidised firms and industries would become entrenched and the subsidisation cannot cease. In the experience of other countries, subsidisation usually increased rather than decreased over time. Furthermore, the prospect of government support encouraged firms to lobby the government. Instead of expending energy to compete against other firms in the market, firms thought of ways to lobby for more subsidies. The market has served Hong Kong well. Hong Kong has the foundation that allows free flow of resources and nurtures entrepreneurial activities. This is an important factor in sustaining growth in a fastmoving world. Industrial policy, in a form which redirects large amounts of resources and targets specific industries, is not desirable. The aim of government policy should be to identify ways to foster the flow of human resources and investment capital. The government may take steps to augment the technological resource base of the economy, create markets for the smooth flow of investment capital, and enhance coordination within and across sectors. The rationale behind this thinking is described in detail in the rest of this chapter. Also covered in this chapter are how should industry-related issues, such as the mainland factor, growth engine, high value-added activities and science park development ought to be addressed in the present perspective. II. Losing Industrial Sector Amounts to Losing Growth Engine? There is a theory which says that the economic growth in the fastgrowth economies of Asia, i.e. Hong Kong, Singapore, Taiwan, South
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Korea, Thailand, Malaysia and Indonesia, has been export-led. Since the exports comprise mainly manufactured goods, the theory implies that the relationship between the size of the industrial sector and growth is pretty strong. The reason that has been put forward is that export earns foreign exchange, which acts as a direct injection of purchasing power into the economy, which then leads to expansion in the non-traded sector. An economy which does not export would lack that initial push to stimulate economic activities, and it becomes locked in stagnancy. As firms are pessimistic, they are reluctant to hire workers, who are in turn reluctant to make purchases, which in turn confirms the pessimism of the firms. The market does not work effectively in this model because prices cannot coordinate the actions of the firms and the consumers, i.e., there is no signal which induces concurrently the firms to hire more and the consumers to spend more. In the Hong Kong context, the data confirm that the recovery of the economy from stagnancy in 1974 and 1985 was accompanied by large growth in export volume. The export-led theory thus receives some support from careful reasoning and actual data. One has to be careful however in applying the export-led growth theory to justify industrial policy. The theory implies no more than the following, namely, if one is comparing two economies, one having a large export sector and the other not, then the one with the larger export sector would grow faster. The theory does not imply that government policy which transforms the latter economy into the former economy is necessarily desirable in the cost-benefit sense. Moreover, such government policy may be hard to formulate in practice, requiring the government to possess an enormous amount of information. The fact that Hong Kong has been "fortunate" enough to have a sizable industrial sector does not imply that other developing countries should create an industrial sector, or that Hong Kong government should redirect resources to maintain the size of the industrial sector in future to keep the growth engine intact. The experience of South Korea provides a good illustration. The growth of the export sector has been spectacular, much faster than the
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growth of GNP. In 1960, export was 1.7% of GNP. In 1996, export was 26% of GNP. The exports were predominantly manufactured goods, most of which belonged to industries targeted by the government. The singleminded promotion of these industries led the government to lay down production target for large corporations, and in order to finance their production, the government provided them with low-interest loans through government-controlled banks. As the government was operating under budget deficits, funding had to come from foreign countries. The result was foreign debt amounting to US$54 billion (official figure) by 1995, 350 times of what it was in 1963. The exchange rate of the won dropped continuously from 65 won/US$ in 1960 to 844 won/US$ in 1996. The high-export-high-growth strategy evidently led to gross distortions in the economy. The financial and currency crisis that finally broke out in late 1997 was an inevitable disaster. It is inconceivable that industrial policy of the scale and depth that has been carried out in South Korea could ever be carried out in Hong Kong. Nevertheless, the South Korean experience does indicate the costs of redirecting resources away from the market and into uses that purport to maximise growth. III. Keeping Industrial Sector to Diversify Economy? An argument has been put forward which suggests that, as Hong Kong becomes a service economy, the economy is becoming less stable than before. The absence of a manufacturing sector, as the argument goes, makes the economy too susceptible to fluctuations in the financial and tourism sectors. Since the second half of 1997, both sectors in Hong Kong have been heavily hit by the financial crises that have affected Asia. The implication is that it is important to keep industrial activities in Hong Kong, and so the government has the responsibility to develop industrial activities with the aim of enhancing economic stability. The above argument is a poor justification for industrial policy. In a market economy, the output mix is a result of the menu of physical and human resources resident in the economy. The government should not
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attempt to change the output mix by distorting the utilisation of resources. Furthermore, if one compares Singapore with Hong Kong, it is not clear that Singapore, with a manufacturing sector that accounted for 27% of GDP in 1996, is inherently more stable than Hong Kong, whose manufacturing sector accounted for 8% of GDP in 1995 (although the size of the industrial sector, taking into account support services, was much larger). The manufacturing sector in Singapore is heavily biased towards electronic products. In 1996, electronic products accounted for 53% of manufacturing output, and more than 20% of electronic products belonged to a single product category, namely disk drives. The Singaporean economy is consequently highly dependent on the global demand for these electronic products. The fast growth of the Singaporean economy in the last decade was largely due to the global boom in computer demand. The coincidental emergence of the internet, Microsoft Windows and high-speed microprocessors brought about a revolution surrounding the computer. It is unlikely that the computer industry can continue growing at its present rate. Another problem is concentration. If one looks at the actual experience across industrialised economies, the indication is that the stronger is industrial policy, the more concentrated is the output mix. Government action seldom succeeded in diversifying the economy. In Singapore, the government redirected vast amount of resources to attract foreign direct investment, with the consequence that the economy is heavily dependent on a few foreign manufacturing companies and a few industries, while the development of the service sectors lagged behind. Banking, stock markets and small businesses cannot develop in Singapore because there is insufficient private capital. The Singaporean government is now actively making attempts to diversify the economy away from manufacturing by promoting such service industries as fund management, insurance, tourism, broadcasting and movie-making. In South Korea, the government's priority to develop heavy and high-technology industries has also slowed down the development of services. What has been astounding is that the scale of industrial policy has gone so far as to have damaged the foundation of the financial sector. The recent
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financial crisis in South Korea shows the damaging effect that industrial policy can have on the stability of the economy. In Taiwan, despite the widespread publicity ascribed to the electronics industry, the manufacturing sector is still predominantly traditional industries with little government intervention. Taiwan has in the past attempted to develop an automobile industry. The venture failed completely, largely because of the absence of supporting industries. The general impression is therefore that industrial policy leads to growth with heavy sectoral biases. There is little evidence that such biases can contribute towards stabilising the economy. One could look at the diversification problem from yet another angle. Make the extreme assumption that Hong Kong is in fact a risky place, and that the economy could go up and down in wide swings. Does it follow that the government should intervene to reduce risk? The answer is probably no. Since Hong Kong people can perceive the risk, they should be able to find their own ways to reduce risk. They could save in the upswing, and invest the money abroad or in long-term durables. Or workers can negotiate appointment contracts which insure them against layoffs (through large severance payments for example). Business owners could diversify their businesses outside Hong Kong. Citizens can get residence status in a foreign country, and so on. Hong Kong people learn quickly, and they can sort out ways to best protect their own interests. From this angle, the rationale that it is the government's responsibility to reduce economic fluctuations does not seem very strong. IV. Relocation of Services to the Mainland Since the liberalisation of the mainland, manufacturers have been given access to much cheaper land and labour to carry out their production. Manufacturers were driven by the profit motive to relocate labourintensive processes to the mainland. These processes were mainly pure manufacturing. The sequence of events had positive effects on the economy. Hong Kong industries became more competitive in the world market and more profits were made. Manufacturing workers in
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Hong Kong were released, and judging by the low unemployment rate, these workers were readily absorbed by the expanding service sectors. On the whole, the relocation of manufacturing did not give rise to any negative effect on the economy. Recently, some industrialists have warned that all is not well because the supporting services, such as design, sourcing and quality control, may gradually be relocated as well. The major reason, they argue, is the high cost of doing business in Hong Kong. The more far-sighted industrialists even portray a scenario in which only the headquarters of industrial companies will remain in Hong Kong. They conclude that, for the interest of the long term growth of Hong Kong, the government should try to arrest the relocation trend —- the so-called "hollowing-out" syndrome. This argument has to be taken with some reservations. First of all, it is not clear how quickly the mainland can replace Hong Kong in producing the support services. It is true that the infrastructure in the mainland (such as roads, telecommunications, ports and airports) will improve quickly. But it is not so clear that the human resources in the mainland can catch up quickly with that of Hong Kong. Skills such as design, sourcing, networking and deal-making can only be acquired after years of experience. In fact, drawing a parallel between Hong Kong and developed countries, even though Hong Kong has acted as the OEM contractor of clothing, toys and watches for overseas companies for decades, Hong Kong has not been able to take over the service activities that have been going on overseas. Buyers in developed countries have managed to stay one step ahead of Hong Kong manufacturers. The lesson is, if Hong Kong can constantly improve on its skills, then a great deal of support services will remain in Hong Kong. In fact, Hong Kong still has an advantage in being closer to the world market, more exposed to western cultures, and above all, having the ability to attract and absorb the kind of talent that is demanded by the market. Even in the unlikely scenario in which only headquarters remain, the consequence is far from worrying. The point is companies decide on the most profitable geographical configuration to run their business. If they find that the best configuration is to retain their Hong Kong
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operation as a headquarters only, then this must be the most profitable configuration to carry out their business. To the extent that the profit they earn is part of the income of Hong Kong, the economy is not hurt by the move. Surely, the workers that are released have to find new jobs because they have lost their jobs to the more price-competitive counterparts outside Hong Kong. This is how the market directs resources to new uses. To keep their wages, workers have to acquire new skills and adapt to market demand. Any attempt by the government to maintain certain business activities with an aim to protect the workers is unlikely to promote overall growth. V. Mainland as a Source of Technology The mainland does have a large pool of talent in the field of modern technology. The major weakness among mainland researchers is they lack exposure to product markets. Their sense of what constitutes a marketable product is very weak. This is a result of the long period of seclusion from the western world. Although the researchers have a basic understanding of how a technology product works, it is a long way before a marketable product can be produced in the mainland. Another weakness is the backwardness in manufacturing technology. The mainland does not have a history of free import and free competition in its product markets. The protection of local producers has slowed down the process of manufacturers acquiring better manufacturing technology from outside the country. Added to weak manufacturing technology is the inefficient management system. Incentives to produce goods cheaply and at a high quality are generally lacking among workers of all levels. While improvements are under way, the structure is still far behind that of Hong Kong. The mainland also lacks a range of linkage industries. The manufacture of a product requires the supply of many parts and components. One advantage that Hong Kong has and the mainland has not is the ready supply of these parts and components. In Hong Kong, if a component cannot be sourced locally, it can readily be sourced from
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outside. Hong Kong has a well-developed network of material sourcing. It will take many years before the mainland can achieve the same level of sourcing efficiency. Having pointed out the weaknesses of the mainland's technological infrastructure, it must be emphasised that the mainland's technological talent does present a huge advantage to Hong Kong. There are two approaches by which this resource can be tapped. First, Hong Kong manufacturers can establish research centres in the mainland. Second, Hong Kong manufacturers can import the talent to Hong Kong. Both approaches have merits. The first approach is already being pursued by some manufacturers. There is a quickly emerging high-technology sector in Shenzhen, Shanghai and Beijing, with researchers coming from the key universities in the mainland. Some Hong Kong manufacturers are also hiring mainland workers to do research in the mainland. There are reports from industrialists in Hong Kong however that this approach has met with great difficulties. One problem is the mainland researchers do not have the necessary exposure to understand what is of value in the market. They require too much supervision from the management situated in Hong Kong. For larger scale research joint ventures, there is also cultural conflict between the mainland workers and their Hong Kong counterparts. Buying research products from mainland laboratories via licensing is not a solution either. The innovators usually value their products too highly, a reflection that they do not have full understanding of the cost structure of product development. According to industrialists, hiring mainland researchers to do research in the mainland or buying research products from them have met with little success so far. While this approach will be further pursued by industrialists and success may come in future, the second approach may also be worth considering. Bringing mainland researchers into Hong Kong has the advantage of locating the design and development functions of a company close to the management. This approach also allows the researchers to gain better knowledge of the product market. They can travel frequently to overseas marketing conventions, or keep in touch with the world via the internet
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and the media. The problem with this approach in the past was it could not be pursued easily under the government's pilot importation scheme, which involved a lengthy approval procedure and a restriction over the universities from which the researcher graduated. In a 1999 revision of that scheme, many restrictions were relaxed. It is however too early to tell whether this revised scheme is appreciably affecting the size of human capital in Hong Kong. VI. High Value-Added Activities The GDP of Hong Kong is conceptually the sum of the value-added of all economic activities that take place in Hong Kong. The value-added of an activity is roughly the value of the output (whether it is a good or a service) minus the value of the materials used minus operating expenses. The value-added of an activity is also equal to the wage payments to the employees plus the compensation paid to the owners who provide the capital. The wage payment and the profit constitute the income of Hong Kong. If Hong Kong can engage in activities of higher valueadded, then the GDP of Hong Kong can grow. Three sources of growth are relevant to Hong Kong. Firstly, a growth in capital stock can increase the aggregate sum of value-added. The accumulation of capital in a free market is determined by the rate of interest and the rate of return to investment. If the equality between interest rate and rate of return is upset, as in the case of government subsidisation of investment, then there is a danger of misallocation of capital, which renders the system unsustainable in the long run. Therefore the size of capital stock must not be augmented by policy with the sole aim of inducing growth. The second source of growth is an increase in labour input. Labour input increases if the number of work hours increases or the level of education increases. There have been a number of studies which suggest that almost all the growth in GDP achieved by Singapore, South Korea, Taiwan and Hong Kong can be explained by accumulation of capital and increased labour input. An interpretation of these findings is that
Strategic Considerations in the Hong Kong Context the growth in these economies has to slow down soon, as their population level is growing slowly and their education level has already reached a high level. A third source of growth, which is particularly important in advanced economies, is an improvement in technology (known as total factor productivity). In an advanced economy, the capital stock is already rather large, and the rate of return of investing in more of the same machinery is very low. The growth of capital stock is therefore small. The growth of labour input is also small because birth rate is low and the education level attained is already rather high. For such an economy, growth has to come from a migration to high value-added activities. The migration to high value-added activities is the main source of growth in total factor productivity. While high value-added activities could take many different forms, they do share a number of characteristics. One characteristic is they involve a substantial element of creativity and innovation. If an activity does not involve innovation, then there are bound to be a large number of producers in the market. Competition among them would drive market value close to material costs and the value-added would be low. Another characteristic is the innovation must not be easily imitated by competitors. If an innovation is easily imitated, then its value-added may drop rapidly as imitators enter the business. As a consequence, high value-added activities are often knowledge-intensive activities. Knowledge is derived from experience, experimentation, formal education, research and social networks. The transfer and accumulation of such knowledge may take a long time. Knowledge-intensive activities are therefore not easily imitated. High-technology research activities are frequently equated to high value-added activities, although the two types of activities are conceptually distinct. High-technology research activities are investigations that focus on the application of those scientific results that are still in a rapidly advancing state. Research on discovering new drugs using genomics can be classified as high-technology research as genetic engineering is still a rapidly progressing science. Similarly, research
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on high-density memory chips (DRAMs used in computers) is hightechnology research as it requires the use of newly discovered materials and new photolithography techniques. This type of research activity has high value-added because of its high market value and the consequent high return on capital investment and high wage payments. This type of activity is also innovative, knowledge-intensive and difficult to imitate. High-technology research is risky. One reason is there is no guarantee that a project would turn out successful, and there are usually many researchers around the world who are working on the same problem. Competition is therefore intense. Another reason is even if a project is successful, its profitability is determined by market conditions. If a substitute product has been discovered sooner, the market value of a newly discovered product would be small. Profits of a new discovery may also be appropriated if there is inadequate or incomplete intellectual property protection. It must be emphasised that, in a free market economy, both human and physical capital are driven by market forces to activities of highest value. The fact that a job in a bank commands a higher salary than a job (requiring similar skills) in a factory is evidence that the former job has a higher value-added. Similarly, that a property agency can pay a higher rental for a retail space than a branch of a bank indicates the former runs a business that has a higher value-added (gross of rental). Closer to the present topic, if a bank can pay a higher salary to hire a programmer than a computer company, then it is in the interest of the economy at large to allocate the programmer to the bank. That the computer company may have to close down without the programmer's service is not worrisome. If the government attempts to subsidise the computer company, the programmer may be redirected and the bank may not be able to run its business effectively, which leads to higher economic loss in the aggregate. It should be pointed out that, in Hong Kong, many high value-added activities have little technological content. Examples are: design of fashion products, packaging of financial deals, restaurant services, global networking, logistics and legal services. Successful development of these
Strategic Considerations in the Hong Kong Context 249 activities could promote economic growth without heavy investment in technological research. VII. Human Capital Barriers The main spirit of the present study is that the free market system, which is the foundation underlying the flexibility and resilience of the Hong Kong economy, must be preserved. Even in the midst of new challenges, the market system remains the best system of resource allocation. In a market system, the performance of the economy ultimately depends on the amount of resources available. In an advanced economy, the most important resource is human capital. If Hong Kong is to promote growth, the policy towards human capital accumulation must be given due attention. In the realm of technological development, human capital looms even larger. The success of the US in technology can be attributed to its successful immigration policy. In the US, engineers and scientists are granted residence and work permits with relative lenience. It has been reported that the majority of workers in scientific laboratories in the US are foreigners. The abundant pool of foreign researchers, which keeps the cost of conducting research low, is a decisive factor in the profitability of technology companies in the US. In a similar vein, Israel has emerged as a vibrant research centre, mainly as a result of the influx of Jewish scientists from Eastern Europe and the former Soviet Union. Human capital is therefore the main driving force behind technological development. If Hong Kong is to become a technology centre of any discipline, the pool of human capital has to be greatly expanded. The way forward is to identify any existing barrier that may prevent the smooth flow of human capital into Hong Kong. At present, professionals from most parts of the world can obtain work permits in Hong Kong with little hindrance. The same does not apply to mainland scientists. Under the old pilot professional importation scheme, applicants had to be graduates of 36 designated universities in the mainland. The general opinion
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among industrialists was that the scheme was not very helpful. Some industrialists complained that it was easier to hire mainland scientists in Singapore than in Hong Kong. The Singaporean government had long recognised the shortage of scientists and was aggressive in recruiting scientists from the mainland and elsewhere. The government was therefore prompted to relax mainland scientists importation rules in 1999. The idea behind the revised scientist importation scheme should not be to, by itself, supply the necessary number of research workers to Hong Kong. The intention is rather to allow interaction of a small number of elite mainland scientists with Hong Kong companies. The scientists are expected to lead a larger team of researchers in the mainland. Hong Kong can leverage the imported scientists to tap the vast pool of research scientists and engineers in the mainland. Having worked in Hong Kong, the scientists will have a better understanding of the global product market. They can learn what constitutes a marketable product, and how it is to be priced. They can also travel to conventions overseas to learn new trends and what foreign companies are developing. While residing in Hong Kong, they can constantly expose themselves to the world through the media. In short, they have opportunities which do not exist in the mainland. Through them, Hong Kong can play the role of a technology bridge between the world and China. The main benefit to the economy is likely to appear only in the long term. With an expanded human capital base, foreign companies may be attracted to start research operations in Hong Kong. Because the global technology business is foreign competitive, every company is constantly looking for cheaper research sites and more economical ways to carry out research. It is hopeful that in time, when a critical mass of research activities has been built up, experienced engineers will be drawn from the US and other advanced countries to Hong Kong. This may take years, but there is no short cut to building up a self-sustaining technological base. If a viable human resource program is in place, the government can hope to boost the development of a technology sector without creating
Strategic Considerations in the Hong Kong Context a burden on taxpayers. This development also dovetails into the government's plan to build a science park. Details are discussed in a separate section. The development would also lift Hong Kong's international profile and attract the attention of financiers in the advanced countries. The presence of foreign technology companies is essential to building up confidence among venture capitalists and investment bankers to finance young technology companies in Hong Kong. The financing aspect is dealt with in greater detail in the following section. VIII. Investment Capital Barriers In a well-functioning capitalist economy, there should be a frictionless flow of investment funds from the provider of funds to the user of funds. The flow of funds can take a number of routes — through banks, stock markets, bond markets, venture capitalists, or directly from investors. The funds allow an idea or a research result to be developed into a marketable product. In reality, friction is always present. The fund users may cheat the fund providers, who in turn do not trust the fund users. As a result, banks ask for collateral to safeguard their loans, bond investors require companies to be assessed by credit rating agencies, stock exchanges require sponsorship and underwriting by prominent investment bankers, venture capitalists require a quick exit route to liquidate their investment, and direct investors require board membership and full disclosure of company records. The friction constitutes a barrier to the flow of investment capital. To overcome the investment capital barrier, some governments choose to participate directly as investors in industrial ventures, especially in technology ventures, citing the reason that technological development carries important external benefits. Thus, the Taiwanese government is a large shareholder of United Microelectronics Corporation and Taiwan Semiconductor Manufacturing Corporation. The Singapore government is a large shareholder of TECH Semiconductor. The Hong Kong government, through the Applied Research Fund, intends to be an investor in young start-up ventures, although the degree of participation is insignificant relative to that of other countries.
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As a matter of principle, the government should refrain from direct investment in any venture. If a venture has sufficient credibility, it can secure financing through one of the market channels. Only ventures that are not supported by the market would turn to the government. If the government invests in such a venture, the government is putting taxpayers' money at risk. The government should not presume that it has a better ability in assessing a venture's risk than a private investor. One can of course invoke the external benefit of a venture (especially a technology venture) to justify government investment. In practice however, the range of technologies is so wide and the frontier so volatile, that the external benefit of a venture is extremely hard for anyone to assess. Frequently, the pursuit of government investment becomes a game that industrial lobbyists play. Such lobbying is common in Singapore, Taiwan and South Korea. If Hong Kong is to develop its technology industries, human capital considerations should occupy higher priority than investment capital considerations. If there is an adequate pool of talent, some promising products will emerge. Financing for development can be obtained in a number of ways, even though friction exists. For example, a start-up company may obtain financing from private investors. If good profit can be demonstrated, the young promising company could be sold out to a large company, which can use its reputation to arrange for the financing. In the US, large companies like IBM, Cisco and Hewlett Packard buy a great deal of innovation from small firms. Alternatively, a promising company can obtain listing status from second boards around the world. NASDAQ in the US is the largest exchange for technology stocks. Besides the NASDAQ, similar exchanges can be found in Malaysia, Singapore, South Korea and Europe. Since end 1999, Hong Kong also has its own second board, called Growth Enterprise Market (GEM). The aim of GEM was to facilitate the financing of young technology firms. Opinions on launching GEM were far from being one-sided. On the positive side, advocates argued that setting up a medium for the trading of company equities cannot be a wrong move conceptually. The
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government was playing the appropriate role as a facilitator. Even if it turned out that trading was thin, the loss to the government or to society would be small. The industrialists generally welcomed the idea, for GEM offered them an extra source of financing at no extra cost. On the negative side, however, arguments came mainly from practitioners. They worried about the lack of interest and the lack of qualified candidates among Hong Kong technology companies. The trading of industrial stocks on the main board was not active, and the price earnings ratio of industrial stocks was generally lower than that of property and financial stocks. Small stocks, they argued, were also liable to be more volatile. In the US, NASDAQ was much more volatile than the New York Stock Exchange, possibly due to excessive speculation. Practitioners therefore worried that a crash in GEM might hurt the main board. As of mid-2000, there were already some thirty companies listed on GEM. Only a fraction of these were Hong Kong companies, the others being Mainland and Taiwanese companies. The Hong Kong companies were mainly dot.coms that utilise the internet to conduct e-commerce and provide portal linkages. Stock prices had been very volatile indeed. Most were worth less than half of what they were at their peak. There is a concern as to the market's continued interests in the financing circle. The financing of technological ventures is a central strategic question that is secondary only to the availability of human capital in importance, and therefore merits discussion in some detail. A start-up technology company lacks the credit-worthiness to raise outside funding through formal channels. Besides private savings, they need to rely on private investors, known as business angels in the US. Because of the large number of start-ups, a decentralised autonomous mechanism in which companies and investors can strike their own deals is the only viable approach. The government should refrain from any form of direct investment or subsidisation. If the start-up is successful, it comes up with a prototype of demonstrable potential. At this stage, the company may be sold off to a large company. Alternatively, venture capitalists may bring in new capital with a view of expanding the company further. The venture capitalists usually have a medium-term
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planning horizon. They plan to liquidate the investment within three to five years. In the US, a common form of liquidation is obtaining listing in a stock exchange. For technology companies, a common venue for listing is the NASDAQ, whose listing requirements are less stringent than the main board — an advantage to young companies which have no substantial profit records. One argument for the setting up of a second board in Hong Kong was that it provided an exit route for venture capitalists. The argument blamed the absence of a second board for an underdeveloped community of venture capital funds which supported technology companies. Without an exit route, the venture capitalists could not liquidate their investments easily, and so they were unwilling to go into this sort of investment in the first place. While this argument has its merits, one should perhaps bear in mind that getting a company listed is only one of the ways by which venture capitalists can liquidate their investment. An alternative way is to sell the company off to a large company. Instead of selling shares to the public directly via listing, the venture capitalists can exit by selling their shares to a large company. The large company can finance its purchase by borrowing or offering new shares. Either way, the funds come ultimately from the public. Instead of using a second board as an intermediary, the large company takes up the role as an intermediary. The method works without a second board because the large company pledges its future earnings and reputation in making the purchase, whereas the young company by itself cannot raise the funds because it does not have adequate credibility. The government may have a role to play in enhancing the channels of financing for large companies. One channel that is still underdeveloped in Hong Kong is the bond issue. In the US, bonds constitute a major source of financing. Why a strong bond market has failed to develop in Hong Kong is worth a detailed study. Generally speaking, a bond issue requires a rating by an independent agency. The rating indicates the default risk of the company, and the higher the rating, the lower would be interest cost of the bond issue. In the US, bonds that receive a rating are classified as investment grade, whereas those that do not are
Strategic Considerations in the Hong Kong Context classified as "junk" bonds. Because junk bonds are riskier, they have to offer higher interest rates. So long as the rating agency reflects the true degree of risk of a company, the market would determine the appropriate interest rate. At a time when the stock market is bearish, bond issue represents a useful means of corporate financing. It may therefore be worthwhile for the government to study the feasibility of boosting bond market development. The financing of start-up companies is usually the most risky type of investment. These companies usually have no record of success, no assets that qualify as collateral against loans, and no personal reputation. If the owners of the company have no personal savings, these companies can hardly grow. In some cases, business angels may be willing to invest in these companies, but usually only after securing sufficient opportunities for post-investment monitoring. What the government can do is not to act as business angels (for the government cannot have the power to monitor the companies closely) but to facilitate the matching of start-up companies with business angels. The government may study the feasibility of establishing an information clearing house whereby startup companies and business angels can seek each other out. A parallel is an employment agency which matches job-seekers to job vacancies. In the US, there are numerous informal contacts between technology startups and high net-worth investors. There are also agencies which maintain directories of start-ups and business angels. EX. Coordination Problems Under some conditions, the market fails to allocate resources efficiently. One cause of such failure, namely coordination failure, has attracted much recent attention in economics. Coordination failure refers to a situation where synergy across the action of a number of players is essential to bringing about the largest mutual benefit. For example, when a foreign company chooses a manufacturing site, the presence of a local supplier of components may be essential. On the other hand, a supplier of components would set up a distribution outlet in an area only if there
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is a manufacturing base already in existence. If the manufacturer and the component supplier fail to communicate and agree on a suitable site, no development takes place and coordination failure is the culprit. Generally speaking, the market cannot provide signals to coordinate the action of different players. Coordination failure is particularly serious when players are numerous and scattered. The possibility of coordination failure does not justify government intervention in the form of picking winners, subsidising activities or distorting prices. It does suggest that some sort of central organization is essential to facilitate synergy among players. The emergence of trade associations in many industries is one private sector's way to solve the coordination problem. Where these associations work effectively, they provide information to their members as to what other members are planning and developing. In Hong Kong, these associations do not function effectively. The large number of small firms in Hong Kong make it very hard for individual firms to discern what others are planning to do. In the past, this coordination problem was not serious, mainly because most firms were OEM sub-contractors for foreign buyers. Lack of coordination might have made some OEM industries even stronger as firms competed against each other by cutting prices. The question that is being asked today is whether this mode of operation has to be changed in the case of some major industries. One particularly intriguing question is, despite more than three decades of exporting experience, the clothing industry has failed to upgrade significantly. Few manufacturers have been able to move from the low value-added manufacturing activities to the higher value-added design activities. Today, workers in the clothing industry in Hong Kong can justify their high wages mainly because they manage effectively the production lines outside Hong Kong. The technology that they use and the quality of their products have shown otherwise little improvement. Although Hong Kong is the second largest clothing exporter in the world, it is not catching up to Italy, the largest exporter, in terms of design, materials and craftsmanship. A small number of manufacturers do have their own design teams, but they are mostly located outside
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Hong Kong. Even casual observation suggests that the price differential between imported brands and local brands is substantial. Why the markets of local and imported brands remain so segmented is intriguing. Nevertheless, as local wages increase and wages in the mainland are also on the rise, the move to design activities is by now essential to most clothing manufacturers. The role of the government is to see if there is significant coordination problems (among the large number of designers, manufacturers and consumers) in the adjustment process and if the government can work to enhance the coordination of various activities. Hong Kong has the potential to become the fashion centre of Asia. Besides being a major clothing exporter, Hong Kong also exports many fashion goods, such as spectacles, jewelry, watches and leather goods. Hong Kong also has a large retail industry for fashion goods from around the world and service industries that support the fashion business. In Hong Kong, the presence of world-class hotels, airport, shopping centres, convention and exhibition centres, multi-faceted media and efficient telecommunications are all vital aspects that support a fashion centre. Most important of all, there is in Hong Kong a large population of people who are sensitive to world fashion trends, experienced in the fashion business and appreciative of high quality fashion goods. Because of the large number of consumers, workers and firms involved, the government may investigate if there are areas in which better coordination can be achieved. Hong Kong has a definite niche to aim for in the fashion sector. Globally speaking, the centres of fashion innovation are in Milan, Paris and London. It takes a year or two for the fashion trend to diffuse to other parts of the world. While Hong Kong is not at the forefront, it is definitely ahead of most cities in Asia. Consumers in these cities look to Hong Kong for fashion ideas. Hong Kong can therefore take up the niche of translating and adapting latest trends to suit the regional tastes of Asia. In clothing, for example, a number of Hong Kong brand names have already achieved significant market shares in Singapore, Malaysia and Taiwan. These brand names aim at the mass markets.
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Their competitive advantage in combining modern styling with low prices allows them to secure a distinctive niche, separate from the high-end European brands and the low-priced ordinary varieties. As Asia grows in income, following the same strategy, many more markets will become worth exploring. X. Science Park The first science park in Hong Kong is being developed by the government. In a November 1997 report by the Planning Committee on Science Park, certain broad planning parameters concerning the site, the physical layout, the buildings, the management structure, tenant selection criteria, goals, objectives, cost and benefit estimates were laid down. According to the report, a broad picture of the science park can be described as follows. The science park will be developed in Pak Shek Kok, a reclaimed site adjacent to The Chinese University of Hong Kong. Total land area is 22 hectares. The park is going to be developed in three phases over 15 years. The first phase involves the construction of an administration building, a general R&D building, an Information Technology building and a biotechnology building. The facilities will be open for use in stages starting mid-2001. The entire phase is scheduled for completion by mid-2004. Future phases will be planned subject to the demand outcome of the first phase. Tenant companies can be accommodated by either multi-tenant buildings or purpose-built facilities developed on leased sites. The science park will be owned by a government-owned statutory corporation, Hong Kong Science Park Corporation. The mode of operation is somewhat similar to that of the Hong Kong Industrial Estates Corporation and the Hong Kong Industrial Technology Corporation. The government is to grant the land to the science park corporation at nominal premium. The corporation is responsible for developing the park, running the park, selecting the tenants, promoting the park to local and overseas industries, and maintaining linkages with local, Mainland and overseas universities, research institutions, the industries, the financial community and other science parks around the world.
Strategic Considerations in the Hong Kong Context According to the report, the science park is not going to generate high financial returns to investment. The capital cost of Phase One is estimated to amount to $3.3 billion, and operating losses of the corporation to amount to $0.3 billion by 2005, the year when the corporation is expected to begin to generate surpluses. Total cost is therefore quoted at $3.6 billion. Income of the corporation will be generated through rentals, land leases, and service charges. The take-up rate is expected to be slow in the beginning and to gradually build up as the park matures. The bottom line of these estimates is that the park is not going to be financially very profitable. Ignoring alternative uses of the site, the park can generate only a small financial return even in the long run. Taking into account the alternative uses of the site, the return to the science park development is decidedly negative. One may argue that the goal of the science park is not to generate profits, but to create a better environment to foster knowledge-intensive research activities. This point is certainly valid. The problem is it is hard to see how this goal can be achieved. Only a handful of foreign technology companies have shown an interest in moving into the Park. Companies that have shown interests are mostly local companies. They are likely to relocate their research activities to the science park from elsewhere in the territory, and so there is no real expansion. The point to be emphasised here is that the science park alone is not going to foster a research environment. There must be other fundamental changes in the human resource pool and facilities that are available in Hong Kong. The science parks in Singapore and Taiwan are successful (in the narrow sense of promoting research) as a result of a range of government initiatives. In the case of Singapore, the government subsidises the foreign companies which bring research activities to Singapore. The subsidies take the form of tax credits, subsidised rentals, and subsidised training. In the case of Taiwan, the science park provides accommodation for government-funded research institutes and a large number of start-up companies established by techno-entrepreneurs returning from the US. None of these initiatives and advantages apply to Hong Kong.
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It is not suggested here that Hong Kong should follow the footsteps of Singapore and Taiwan in introducing research subsidies. What matters is, given the absence of large-scale research subsidies, it becomes all the more important that the utilisation of the Park be mapped out strategically. The science park is best used as a facility that complements the revised mainland scientists importation scheme. It can provide a venue in which technologists from around the world interact with scientists from the mainland. Through the science park, foreign and local companies can tap the vast scientific pool of the mainland, and significantly reduce their costs of conducting research. Through the science park, mainland scientists can learn the business side of technological research and expose themselves to new product ideas and new product markets. To achieve strategic complementarity, it would be best to combine mainland scientist importation, the Science Park and the Applied Science and Technology Research Institute that was announced to be built by the government in 1999 into one coherent initiative. All three components are critical for success. The Institute will become the focal point for interaction among researchers worldwide. It will also act as the bridge to adapting advanced technologies for local commerical exploration. While leadership at the Institute will have to be foreign-trained scientists, the majority of researchers could be mainland scientists. Provided that there is sufficient scale at the Institute to bring the Science Park to attain a critical mass of scentific talents, a driving force for advanced reseach could be put in place that launches Hong Kong onto a trajectory of high-technology research. Phase One of the Park has no clear technological direction. There is a building for general R&D, one for IT and one for biotechnology. This arrangement may not build up a critical mass which is essential to attracting global attention. If the Park is to be effective, some targeting of technology areas may be desirable. At the moment, information technology is the most appropriate area for targeting. Information technology's importance has been duly recognised by the government in the setting up of the Information Technology Bureau. The role of Hong Kong as
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an international centre for business, tourism and finance would continue to induce strong demand for IT products. The development of IT applications can enhance information transmission, learning efficiency in schools, paperless trade, real-time settlement in stock market, home banking and on-line shopping and many other service functions. The Park should plan a separate IT zone for IT companies in its layout. The establishment of a few large global IT companies would also serve as an anchor which in turn attracts smaller IT companies. This targeting strategy sends out a clear signal to the technology communities around the world as to the commitment of the government, the direction of the science park and the business opportunities that can be expected to develop there. XI. Conclusion The Hong Kong economy is facing a number of challenges that tend to slow down economic growth. The foremost challenge is the high cost of doing business in Hong Kong. The cost component that is of major concern here is the cost of human resources. Rental cost is also high, but it is less of a problem because the rental market tends to adjust freely, both upwards and downwards. High business cost in Hong Kong means a low profit margin, which inevitably lowers the rate of return to investment. Investment capital would flow to places with higher rates of return. Lacking new investment, the rate of growth would have to suffer. It is true that wages can be adjusted downwards in the midst of slow growth, as there is no institutional barrier to wage adjustments. The problem here however is the rapidly increasing percentage of home ownership. Unlike tenants in public housing, home owners are committed to make mortgage payments to the bank. These payments are large because housing prices are high. Any decrease in wages therefore is going to be devastating to the household budget of home owners. In the past, high wages were supported by high value-added activities. Due credit should be given to the free market mechanism in allowing Hong Kong people to quickly capture new opportunities as they arose.
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In the last two decades however, these opportunities mainly arose from the liberalization of the mainland. The availability of vast amount of resources in the mainland enabled Hong Kong people to capture a huge amount of value-added by serving the mainland and mobilising its resources to produce goods and services for the global economy. It should be admitted that these opportunities came by luck rather than by design. The major worry here is whether Hong Kong can continue to rely on the liberalization of the mainland to generate higher valueadded activities. If it can, then Hong Kong can continue growing and the high wages and high housing prices can be supported. If it cannot, then the economy would have to go through a painful process of falling wages and asset prices, and the government will come under tremendous pressure to "save" the economy, although the menu for quick solutions is severely limited. There is no doubt that the role of the market mechanism, which has served Hong Kong well through a number of adversities in the past, must be reaffirmed. What the government should consider is, given the market foundation, whether there are ways to augment the resource base of Hong Kong. There are two aspects in this direction. First, the government should think of ways to allow the private sector to import mainland scientists. Second, the government should use the science park as a venue for the interaction between foreign and local industrialists, and the vast research pool in the mainland. Hong Kong people have been rather successful in exploring new resources in the mainland. Hong Kong has also been successful in attracting professionals from overseas, the most notable example being the large number of overseas-trained financial professionals. The emergence of Hong Kong as a financial centre is partly due to the influx of these professionals. Hong Kong has not been as successful in attracting scientists. The reason is Hong Kong does not have prospects for them. Even the Hong Kong students who are interested in science choose to study and work overseas. Moreover, Hong Kong has not been able to give leverage to the scientists in the mainland. If the barrier to the importation of mainland scientists can be removed, a process
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could be started which significantly enhances Hong Kong's status as a technology producing centre. The case for scientist importation could be further strengthened if it is considered in conjunction with the development of the science park and the Applied Science and Technology Research Institute. The Park and the Institute would have little chance of success if the pool of scientists in Hong Kong was not expanded. The local cost conditions do not make Hong Kong an economical place for foreign companies to conduct research activities. The local pool of human resources should be fostered by a liberal scheme of mainland scientist importation. The science park can then act as a focal point where mainland scientists can receive global exposure, and companies outside the mainland can tap into the scientific resources of the mainland. Another policy area concerns coordination problems. It would be desirable for the government to review areas of the economy in which better coordination can bring about substantial aggregate benefits. Within the realm of industrial development, there appears to be genuine prospect of developing Hong Kong into a centre for fashion design, as the preconditions are already in place. What the government may consider is to articulate the vision of a design centre and announce the commitment in introducing appropriate policies to facilitate the process. The impact on the government budget need not be substantial. The financing of enterprises should be left to the private sector. Relative to other countries in Asia, there is no shortage of investment capital in Hong Kong. The capital markets in Hong Kong are already working efficiently. The enterprises that are to be developed in Hong Kong will most likely be small firms in light industries, enterprises which do not require substantial capital. The capital constraint is not a major barrier to the development of enterprises in Hong Kong. What the government should consider is the facilitation of capital flow within the economy and into the economy. The government may facilitate the setting up of markets for new financial instruments. Markets for different types of bonds may be facilitated. The government may also facilitate the development of a medium which matches start-up companies to private
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investors. The potential for new capital markets and networks for startup financing is very large when one considers that they can serve not only companies and investors in Hong Kong, but also those in the mainland, and in other newly industrialised countries in Asia. Among these economies, Hong Kong is the only one which has the necessary soft and hard infrastructure in place to become a regional financing centre.
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INDEX
B biotechnology 23, 48, 55 brain drain 65, 111, 151
education 3, 20, 21, 33, 42, 48, 50, 52, 63, 64, 75, 76, 78, 114, 124, 147, 148, 150, 151, 173, 185, 208, 216, 231, 246, 247 electronics industry 8, 12, 45, 46, 48, 99, 100, 146, 155, 194, 195, 197, 242 EPB 153, 154, 218 export promotion 45, 60, 136, 214
C
F
capital accumulation 38 capital intensive industries 140, 214 Central Provident Fund (CPF) 2, 36, 37, 39 chaebol 162-164, 178, 180, 182, 196, 197, 228 chemical industry 59, 130, 160, 169, 223 China 2, 13, 22, 23, 25, 40-42, 59, 95, 97, 98, 106-108, 115-117, 146, 148, 175, 176, 250 coordination failure 77, 237, 255, 256 cost-benefit analysis 169-171
factor price distortions 160 foreign direct investment (FDD 1,5, 6, 10, 13, 14, 22, 35, 48, 51, 52, 70, 71, 106, 131, 142, 143, 151, 152, 177, 184, 207, 210-213, 215, 217, 220, 221, 231, 237, 241 functional incentives 210, 212
A automobile industry 60, 74, 76, 94, 95-99, 109, 187-189, 219, 221, 223, 242
E Economic Development Board (EDB) 5, 15, 21-26, 28, 29, 34, 35, 39, 41, 42, 52-55, 198, 199, 209, 212, 215-218, 222 economic planning 117, 125, 128, 142, 153, 214, 218
G GEM 252, 253 government leadership 56, 71, 74, 77, 222 grants 15, 28, 41, 73, 99, 109, 210 growth engine 238, 239 Growth Enterprise Market 252 H HCI 129, 131, 133, 134, 136, 140, 153, 155, 157-160, 165-169, 171-173, 183-185, 187-191, 201, 209, 214, 215, 222, 223
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heavy and chemical industries 123, 124, 133, 156, 160, 168, 211 high value-added activities 3, 238, 247, 248, 261 high-tech industries 59, 75, 84, 192, 198, 205 Hsin-chu Science-based Industrial Park 77, 219, 222 HSIP 78-80, 82, 88, 205 human capital 16, 63, 111, 124, 148, 184, 235, 246, 249, 250, 252, 253
M
I import substitution 57, 59, 105, 165, 207 Indonesia 2, 14, 25, 40, 42, 233, 239 industrial park 30, 42, 79 industrial targeting 56, 71, 76, 87, 88, 93, 109, 113, 170, 218 Industrial Technology Research Institute 66, 71, 204, 217 industrial upgrading 63, 213, 226 inflation 118, 120, 121, 133-136, 156, 164, 172, 173, 183, 186, 227 information technology 41, 50, 219, 258, 260 initiatives 15, 28, 38, 40, 41, 46, 213, 219, 220, 222, 235, 259 integrated circuit 72, 217
P petroleum industry 8 POSCO 166, 189, 190-192 preferential measures 90
J Japan 6, 10, 41, 49, 97, 99, 123, 125, 143, 146, 148, 150, 156, 157, 161, 165, 174, 177, 186, 188-190, 194, 195, 199, 230
Malaysia 2, 3, 14, 22, 36, 40, 42, 45, 46, 54, 233, 239, 252 market failure 76, 77, 93, 236, 237 matching funds 59, 69, 70, 101 Ministry of Economic Affair 66 multinational corporation 207
O offshore production oil crisis 118, 233
51, 52
R R&D activities 19, 30, 41, 67, 78, 81, 83, 85, 144-146, 201, 219 R&D expenditures 68, 144, 188, 204 relative export-intensity 6l
s science park 17, 30, 51, 206, 210, 231, 238, 251, 258-260, 262, 263 semiconductor 23, 29, 71, 73, 99, 102, 116, 192, 194, 196, 198, 251 shipbuilding 57, 59,123,129,164,165, 177, 185, 187, 189, 191, 211, 223 small and medium enterprise (SME) 38, 39, 60, 62, 218 state-owned enterprises 2, 36, 212 steel industry 166, 189
T L labour importation 21 labour productivity 15, 31, 173 labour shortage 20, 30, 121, 173, 175
technology diffusion 207 technology transfer 16, 80, 97, 98, 117, 143, 206, 207, 231 technology-intensive industries 87, 88
Index textile industry 105, 106 TFP 43, 44, 90 Thailand 2, 14, 40, 199, 233, 239 total factor productivity 112, 247
United United 100, 156,
U U.S. 100, 104, 143, 146, 151, 166, 174, 189, 192, 207 U.S. patents 146
V Vietnam
267
Kingdom 6, 10, 145, 147, 208 States 2, 6, 10, 13, 71, 74, 99, 104, 107, 111, 143, 146, 150, 157, 166, 189, 190, 195, 216
14, 25, 40
Economic analysis of the industrial experiences of the newly industrialized economies in Asia is generally lacking in the literature. This study attempts to fill that void by providing an in-depth discussion on the economic impact of the industrial policies of Singapore, Taiwan, and South Korea in the three-and-a-half decades after 1960. Throughout the study, a broad perspective of macroeconomic development is maintained. It is highly critical of the narrow-minded objective of certain governments in maximizing the pace of industrialization at the expense of general economic well-being. A comparative analysis of the industrial experiences of the three economies also shows a diversity of constraints and processes. Singapore relied on multinational corporations, Taiwan on returned engineers, and South Korea on chaebols. There appears to be no Asian formula for industrialization. In Hong Kong, there is an ongoing debate on whether some form of industrial policy should be introduced, in view of the perception that Hong Kong is lagging behind the other economies in terms of technology. Drawing on the experiences of the other economies, the concluding chapter of the book provides an informed and balanced answer to this question.
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