Championing trade openness and investment

Over the past 25 years of membership, Korea has managed to become a true champion of trade openness. Korea has not only worked with the OECD to reform its foreign direct investment (FDI) policies and services regulations, it also went further by contributing to the development of relevant monitoring and measurement tools and contributed as a result to shaping global economic governance. Indeed, Korea was one of the most active countries in the development of the common methodology agreed upon by OECD Members for the OECD STRI (Services Trade Restrictiveness Index). The STRI has been designed to help countries understand where bottlenecks can be found at a very granular level and go into the details of regulations. Over the years, Korea became a perfect illustration of the extent to which the STRI can help strengthen domestic reforms and promote trade in services liberalisation. Ultimately, the long-term cooperation between Korea and the OECD has enabled a considerable surge in FDI flows, a sizeable increase in trade in services and a deeper integration in global value chains (GVCs) (Figure 1).

Korea’s rapid evolution from an industry-led economy to a diversified GVC powerhouse will be detailed further in this chapter, notably by reflecting on the domestic reforms undertaken by Korea since the 1990s to liberalise its economy. The Background section describes Korea’s ambitious reform process towards FDI between the end of the 1990s to today. It is followed by an analysis of the growth performance of the services sector in Korea during the same time period and highlights the regulatory reforms undertaken by the Korean government to accelerate the country’s servicification of GVCs. The final section concludes and highlights Korea’s success in leveraging the insights from the OECD toolkit on trade and investment to increase its participation in GVCs, to unleash its services sector and to become a leading reformer in the Asia-Pacific region.

Figure 1. Growth of Korea’s GVC participation rate compared to APEC average

Source: OECD TIVA database (2016).

Background

Korea has over the course of half a century advanced from a low-income agricultural economy to a high-income industrial economy with a per capita income approaching the OECD average (Figure 2), a top-ten ranking in world merchandise exports and a top-fifteen ranking in world service exports (Figure 3). The transition has progressed through light industries in the 1960s (textiles, apparels and household appliances), to heavy industries and chemicals in the 1970s and 1980s (iron and steel, non-ferrous metals, machinery, ships, electronics and chemicals) to motor vehicles and information and communication technology in the 1990s and 2000s. More than 30% of GDP has been saved and invested annually to sustain the engine of growth, supplemented with foreign investment to bring in new technologies. The policy shift from import substitution to a government-led export promotion strategy in the mid-1960s produced unprecedented growth in the four first decades. GDP grew by an average rate of 9.6% between 1965 and 1997, doubling the size of the economy every seventh year.

Figure 2. GDP Growth and Income Convergence with the Industrial Countries in the OECD

Source: Bank of Korea and OECD.

Figure 3. World Rank in Merchandise and Services Exports

Source: WTO and World Bank

On the heels of Korea’s entry into the OECD, the country was struck by the 1997-1998 financial crisis in Asia, driven by concerns over non-performing loans. A reform programme addressed weaknesses in the financial system, corporate governance and labour market regulations. Reforms also involved the liberalisation of FDI, including in the services sector. Throughout the reform process, the OECD remained a trusted partner, supporting Korea in its efforts to liberalise investment and reform the regulatory environment for services sectors. Growth did not resume to the same level as before the crisis but Korea remained on the same income convergence path, catching up with other OECD economies (Figure 2). Investment and services reforms played a key role in the integration of Korea into GVCs.

Korea now faces the same challenge as other OECD members of finding new ways to grow the economy by climbing the value chain, increasing innovations and unleashing the full potential of the services economy. Since the mid-2010s growth accounting data revealed a slower growth trend in the value added of Korean services sectors compared to the manufacturing sector and a productivity gap has been identified between large firms involved in GVCs and the rest of the economy. Addressing these challenges has been an important part of the collaboration between Korea and the OECD in the last decade.

Korean investment policy reforms and OECD accession

Korea embarked on ambitious reforms of its regime regulating FDI in the 1990s. These reforms started in the early 1990s and were further reinforced through negotiations as part of Korea’s accession to the OECD in 1996. The years leading up to the Asian Financial Crisis were marked by a two-track strategy of liberalisation of FDI restrictions. Foreign investors were allowed into a rapidly increasing number of sectors but the overall mechanism for restricting foreign investment remained in place in the form of horizontal impediments such as screening. These broader impediments were gradually dismantled beginning in 1993, a process which accelerated during the negotiations for OECD membership. As part of OECD accession, the Korean government made a number of upfront commitments to liberalise further in 1997 and 1998. The crisis was not so much a window of opportunity for reforms as a door that was already partly open.

From 1997 to 2010, in the years following OECD accession and during a period when many countries removed statutory barriers on investment, Korean reforms of investment policy exceeded those of any other country covered in the OECD FDI Regulatory Restrictiveness Index (Figure 4). In 1997, Korea ranked second after China in terms of FDI regulatory restrictiveness but by 2010 it had moved to tenth place. Based on the Index, Korea’s score fell from 0.532 in 1997 to 0.143 in 2010. By 2020, Korea was only the 23^rd most restrictive country out of 84 countries under the Index or 6^th among OECD members (Figure 4).

Figure 4. Korea was the biggest reformer under the FDI index between 1997 and 2010

Source: www.oecd.org/investment/fdiindex.htm.

Many sectors which were opened in the 1980s maintained some limits on foreign equity initially. Thus, complete liberalisation of these sectors occurred with a lag. By 2002, 27 sectors had partial restrictions on FDI, a still significant number relative to other OECD countries but a substantial improvement over only a decade earlier.

Figure 5. Despite major liberalisation in the past, there is still scope for further FDI reform in Korea

Source: www.oecd.org/investment/fdiindex.htm.

Looking at the simplified time series using the OECD FDI Regulatory Restrictiveness Index1, it shows that the Korean economy was highly restrictive for foreign investors prior to 1980 (Figure 5). A separate regime existed for certain export-oriented, labour-intensive activities which fell outside of the usual regulatory environment but which nevertheless included various performance requirements relating to local content, technology transfer and exports. The FDI Index suggests that very little broad-based liberalisation occurred until the early 1990s. Sectors may have been opened up to some extent, but investors still faced a number of important horizontal restrictions on their activities. From 1990 to 1996, the Index fell from 0.74 to 0.56, a significant change by historical standards but much less than what was to come in 1997-98.

The rapid liberalisation of FDI policies in Korea beginning in the mid-1990s had a dramatic effect on inflows of FDI. The stock of inward FDI as a share of GDP more than quadrupled between 1996 and 1999, largely on the back of rising cross-border mergers and acquisitions (Figure 6).

The second wave of post-crisis reform led to a sharp rise in inward FDI in the first few years following the crisis, as the crisis-driven slowdown in net FDI inflows was short-lived. FDI inflows more than doubled from USD 7 billion in 1997 to USD 15.7 billion in 2000 (notification basis), placing Korea as the second-most favoured investment destination in Asia and contributing significantly to overcoming the economic crisis. This performance is all the more remarkable, given that Korea had only attracted USD 8 billion in FDI from 1962 to 1990 and USD 17 billion from 1991 through 1997.

Figure 6. The greatest liberation of FDI restrictions in Korea took place in the 1990s

Source: Government of Korea and OECD FDI Regulatory Restrictiveness Index https://www.oecd.org/investment/fdiindex.htm

Before the crisis, the dominant mode of FDI in Korea was minority-stake joint ventures, an outcome clearly linked to the restrictions in place at the time. Building on liberalisation prior to the crisis, mergers and acquisitions (M&As) rose sharply during the crisis as the number of distressed firms surged. FDI peaked in 1999 and 2000 as foreign minority investors bought out their Korean partners and as new foreign investors sought to benefit from the opportunities offered by the crisis-induced decrease in the costs of acquiring assets and the increasing number of firms desperate for capital infusions.

Figure 7. Foreign investors responded eagerly to Korea’s reforms of FDI Policies

Source: OECD Data.

Following these developments, foreign multinational enterprises were found to contribute substantially to the country’s net trade surplus as well as to employment generation and manufacturing production. This is all the more positive for the Korean economy since firms and sectors with high FDI have higher than average labour productivity, wages and R&D expenditures. In the retailing, banking and life-insurance industries, for example, foreign investors introduced greater customer focus and efficiency improvements that helped to address Korea’s endemic productivity gap.

The importance of the services economy in Korea and recent regulatory reforms

Services are a major part of Korea’s economy, generating close to 60%2 of the country’s GDP, attracting more than half of FDI3 and employing the most workers (Figure 8 and Figure 9). Korea exported services worth USD 99 billion (1.7% of world services exports) and its services imports amounted to USD 129 billion (2.3% of world services imports) in 2018.4 Services also account for almost 35%5 of Korea’s value-added exports, indicating that Korea’s exports of goods rely intensively on services inputs. Services thus contribute extensively to growth and job creation in the Korean economy.

Figure 8. Services value added as percentage of GDP, 2019

Source: World Development Indicators (2020). Data for Hong Kong, Peru, Chinese Taipei and the United States is for 2019. Data for Japan, New Zealand and Papua New Guinea is for 2018. Data for Canada is for 2017, and the rest of the data is for 2020. Data for Chinese Taipei is from Directorate-General of Budget, Accounting and Statistics.

Figure 9. Services share of

Source: OECD (2019).

Korea has long recognised the importance of promoting services trade, setting ambitious goals to reduce trade barriers and promoting regional economic integration. As observed in other countries, there are still obstacles to Korea’s services trade and some sector-level regulations remain complex and can discourage trade. The OECD STRI has been a key tool to assist Korea in tackling these issues.

Launched in 2014, and updated annually, the OECD STRI regulatory database brings together information from more than 16,000 laws and regulations for 22 sectors. It is a unique, evidence-based tool that provides information on regulations affecting trade in services across all OECD member countries and selected non-member economies (Brazil, China, India, Indonesia, Kazakhstan, Malaysia, Peru, the Russian Federation, South Africa and Thailand). The STRI toolkit supports policymakers to scope out reform options, benchmark them relative to global best practice, and assess their likely effects; for trade negotiators to clarify restrictions that most impede trade, and for businesses to shed light on the requirements that traders must comply with when entering foreign markets. Eventually, OECD policy research based on the STRI has uncovered a number of stylised facts (not specific to Korea) summarised below:

• Services trade restrictions are negatively associated with both imports and exports of services;

• High restrictions reduce both the probability to begin trading and the intensity of trade once trade relations are established;

• A reduction in the regulatory heterogeneity for given levels of STRI has a significant impact on services trade in and of itself. The positive impact is larger the lower the level of trade-restricting regulation.

Growing awareness of this evidence informed efforts to reshape the regulatory framework around Korea’s services economy. Indeed, key aspects of the domestic regulatory landscape for services had proven to be at least partly responsible for the slowing down of the internationalisation of its services sector, including for instance the strict rules on foreign investment. The extensive regulatory reforms undertaken since the late 1990s were instrumental in lowering Korea’s STRI under the OECD average (Figure 10). In 2020, Korea had a lower STRI6 score than the average in 11 out of 19 sectors measured by the OECD.

Figure 10. Average STRI across countries, 2020

Note: The STRI indices take values between zero and one, one being the most restrictive. The STRI database records measures on a Most Favored Nations basis. The indices are based on laws and regulations in force on 31 October 2020.

Source: OECD STRI and TIVA databases (2020).

Most remaining restrictive regulations in Korea are now vertical ones and only few horizontal regulations persist. The exceptions are measures related to natural persons seeking to provide services in the country on a temporary basis (for instance the duration of stay limited to 24 months on their first entry permit) and the fact that procurement regulation do not explicitly prohibit discrimination of foreign suppliers. Korea also requires commercial presence to provide services in the local market, and it has relatively costly procedures to register companies. Foreign equity limits below 50% are applied in broadcasting, telecoms, air transport and maritime transport services. There are also a few sectors where the state still controls major firms and where barriers to competition contribute to higher STRI indices. In spite of those remaining barriers, Korea has made tremendous progress in recent years, which enabled the country to progressively catch up with the servicification rate of other OECD countries.

Thus, the liberalisation process undertaken by Korea since the 1990s—with a notable acceleration in recent years—is reflected in a generally declining trend of the STRI over time for most sectors of Korea’s services economy. This can be illustrated by looking at three network industries with additional policy data to cover the period before the accession of Korea to the OECD (going back to the mid-1970s).

Regulatory reforms in the air transport sector translated into a decreasing sector-specific STRI. The key reform in the air transport industry from a perspective of boosting the productivity has been to reduce public ownership, but the largest and most assured benefits were achieved when entry regulations were liberalised. Results in the air transport industry were measured through the OECD Product Market Regulation (PMR) Index7 which has been getting closer and closer to zero over the years. Reforms in the telecommunications sector produced similar benefits to those of the air transport industry with one exception. The impact on output, prices and productivity were primarily driven by entry reforms as opposed to public ownership. But then again, the strongest and most assured results were achieved when both margins were reduced at the same time. The PMR Index for the telecommunications industry has followed a similar trend as the one in the air transport industry.

Concluding remarks: Korea as a leader in the global economy and important player in the APEC region

Since becoming an OECD Member in 1996, Korea has actively and successfully engaged in discussions with other OECD Members to cement its position as a leader in the global economy. In the area of services trade, insights from the STRI have been successfully leveraged to not only unleash the Korean services sector, but to also strengthen the integration of the Korean economy in Asia-Pacific value chains in services. While Korea was already more integrated in GVCs than the average of APEC countries in 1995, its participation index increased at an even higher pace in the 2000s and 2010s. Even more importantly, the increase in GVCs income has been comparable in both manufacturing and services. The share of services within GVCs is also expected to increase further with the servitisation of manufacturing and the increasing role played by services in the digital economy.

Changes in Korea’s regulatory environment have been instrumental in narrowing the gap between Korea and other OECD members. As such, Korea has become an important partner to the OECD on sharing its experiences and the lessons learned, and helping others emulate its internationalisation path, including through the promotion of the FDI restrictiveness index and the STRI. In the APEC region, Korea became one of the driving forces behind the expansion of the OECD STRI, especially in the context of the APEC Services Competitiveness Roadmap.

The past 25 years have thus shown that, by going beyond the roadmap for reform, Korea has made sustained efforts to promote public awareness of the benefits of further openness in FDI and services trade. By taking advantage of the insights provided by OECD tools and by engaging in a rigorous reform process, Korea succeeded in establishing a friendlier climate for trade and investment. As a result of these reforms, Korea secured its position as a GVC powerhouse and a leading exporter to the world. However, reforms should not remain a one-time occurrence but rather a continuous process. While many APEC countries have reformed significantly over time, as Korea did in the 1990s and beyond, increasing regional and global economic integration, together with technological change, imply that policies will have to be continuously adjusted to ensure competitiveness in the global services economy.

References

Nicolas, F., S. Thomsen and M. Bang (2013), "Lessons from Investment Policy Reform in Korea", OECD Working Papers on International Investment, No. 2013/02, OECD Publishing, Paris, https://doi.org/10.1787/5k4376zqcpf1-en.

OECD & APEC (2020),  Pilot Program for Measuring the Regulatory Environment of Services Trade in the APEC Region, Report to the Group on Services https://issuu.com/oecd.publishing/docs/measuring-regulatory-environment-services-trade-ap

OECD (2019),  OECD Services Trade Restrictiveness Index” (STRI): Korea 2019, OECD STRI Country Notes, https://www.oecd.org/trade/topics/services-trade/documents/oecd-stri-country-note-korea.pdf

OECD (2021), Inclusive Growth Review of Korea: Creating Opportunities for All, OECD Publishing, Paris, https://doi.org/10.1787/4f713390-en.

Notes

← 1.  The historical Index score in Figure 2 is based mainly on horizontal measures and hence does not equal the overall score for Korea shown in Figure 1.

← 2.  OECD (https://www.oecd.org/trade/topics/services-trade/documents/oecd-stri-country-note-korea.pdf).

← 3.  OECD (https://data.oecd.org/fdi/inward-fdi-stocks-by-industry.htm).

← 4.  OECD (https://www.oecd.org/trade/topics/services-trade/documents/oecd-stri-country-note-korea.pdf).

← 5.  OECD (https://www.oecd.org/trade/topics/services-trade/documents/oecd-stri-country-note-korea.pdf).

← 6.  OECD (http://www.oecd.org/tad/services-trade/STRI_KOR.pdf).

← 7.  The OECD PMR Index estimates the effects on market performance of specific regulations. The more a PMR index decreases, the more efficient was the deregulation process undertaken by the country.