Report No. 20346-KO Republic of Korea Transition to a Knowledge-Based Economy June 29, 2000 East Asia and Pacific Region World Bank u Document of the World Bank CURRENCY EQUIVALENTS (As of June 21, 2000) Currency Unit = Won (W) $1.00 = W1,119.20 W1.00 = $0.000893 ABBREVIATIONS ADSL Asymmetric Digital Subscriber Line KEPCO Korea Electric Power Company ANVAR Agence nationale de valorisation de la KFTC Korea Fair Trade Commission recherche (French Innovation Agency) KIET Korea Institute for Industrial Economics and Trade CDMA Code Division Multiple Access KINITI Korea Institute of Industry and Technology Chaebol Conglomerate Information CNRS Centre national de la recherche scientifique KIS Korea's Innovation System (National Center for Scientific Research) KITA Korea Industrial Technology Association DDSA Door-to-Door Sales Act KOSDAQ Korea Securities Dealers Automated Quotation EPCC Economic Policy Coordinating Committee - A NASDAQ-like Stock Exchange in Korea ERC Engineering Research Center KOTRA Korea Trade Promotion Corporation FDI Foreign Direct Investment KSE Korea Stock Exchange FSC Financial Supervisory Commission KSMBA Korea Small and Medium Business Administration FTA Fair Trade Act KT Korea Telecom GDI Gender-related Development Index LCD Liquid Crystal Display GDP Gross Domestic Product MPB Ministry of Planning and Budget GEM Gender Empowerment Measure Nil National Information Infrastructure GNP Gross National Product NIS National Innovation System GRI Government Research Institute NPL Non-Performing Loan GSM Global System for Mobile Communications OECD Organization for Economic Co-operation and MIC Ministry of Information and Communications Development MNC Multinational Corporation PC Personal Computer MOCIE Ministry of Commerce, Industry, and Energy PCER Presidential Commission on Education Reforrn MOE Ministry of Education POSTECH Pohang Science and Technology Institute MOFE Ministry of Finance and Economy R&D Research and Development MPB Ministry of Planning and Budget RRC Regional Research Center NEAC National Economic Advisory Council SAT Scholastic Achievement Test NRDP National R&D Programme SCI Science Citation Index ICT Information and Communication Technology SME Small and Medium Enterprise IMD International Institute for Management SNU Seoul National University Development SRC Science Research Center IMTS-2000 International Mobile Telecommunication STEPI Science and Technology Policy Institute Standard 2000 STI Science Technology and Innovation ISDN Integrated Services Digital Network STSP Specialized Telecom Service Provider ISO International Standards Organization TFP Total Factor Productivity KAIST Korean Advanced Institute for Science and TMA Trademark Act Technology TRIPS Trade-Related Aspects of Intellectual Property Rights KAMCO Korea Asset Management Corporation Ul Unemployment Insurance KBE Knowledge-based Economy UNCPC United Nations Central Products Classification Scheme KCC Korean Communications Comrnission VolP Voice over Internet Protocol KDI Korea Development Institute WIPO World Intellectual Property Organization KEDI Korea Education Development Institute WTO World Trade Organization Vice President: Jemal-ud-din Kassum, EAPVP Country Director: Sri-Ram Aiyer, EACKF Sector Manager: Homi Kharas, EASPR Task Manager: Carl Dahlman, WBIKP ACKNOWLEDGEMENTS This report is the result of collaborative effort between the World Bank and the OECD. Most of the work on this report was financed from the World Bank's Korea country program budget. The OECD also contributed staff and resources towards the development of the report. Additional funds were provided by the World Bank Institute. The World Bank team was headed by Carl Dahlman, and included Saha Dhevan Meyanathan, Anuja Adhar Utz, Jean-Eric Aubert (on secondment from the OECD), Moon Kyu Bang, Xiaonan Cao, Swati Ghosh, Denis Gilhooly, Charles Kenny, and Eul Yong Park (consultant). The OECD team was headed by Thomas Andersson, and included Peter Avery, Jean Guinet, Abrar Hasan, Daniel Malkin, and Joonghae Suh and Zhang Gang (consultants). Carl Dahlman was responsible for the overall co-ordination of the report. Valuable contributions and comments were received from World Bank colleagues including Charles Abelmann, Sri-Ram Aiyer, Jacqueline Baptist, Gillian Brown, Bruce Harris, Emma Hooper, Masahiro Kawai, Homi Kharas, Eun Jeong Kim, Bruno Laporte, Katherine Marshall, John Middleton, Richard Newfarmer, Zia Qureshi, Christopher Thomas, and Shahid Yusuf, as well as from Randall Jones and Dimitri Ypsilanti of the OECD. Research assistance was provided by Sean White and Zhihua Zeng. Administrative assistance was provided by Megan Breece. We are grateful to our Korean counterparts for their many insightful comments, notably those received from Mr. Kun-Kyung Lee, Deputy Minister, Ministry of Finance and Economy, Mr.Yong Lin Moon, Minister of Education, Mr. Nyum Jin, Minister of Planning and Budget, Mr. Oh Seok Hyun, Managing Director of the National Economic Advisory Council to the President of Korea, Mr. Jin Soon Lee, President, Korea Development Institute, Mr. Jungho Yoo, Vice President, Korea Development Institute, and Mr. Cheonsik Woo, Korea Development Institute. PREFACE This report was prepared by the World Bank and the OECD at the request of the Ministry of Finance and Economy (MOFE) of the Government of Korea, as an input to its strategy for becoming an advanced knowledge-based economy. During the course of the preparation of this report over the past year, several missions made up of World Bank and OECD staff visited Korea and held discussions with various government counterparts, representatives from think tanks, the private sector, and civil society, to obtain a better understanding of the issues confronting Korea in its transition to a knowledge-based economy. During these meetings, the team gained valuable insights on the process, timeline, and details of the Korean vision and strategy. At the request of Deputy Minister of Finance and Economy, Mr. Kun Kyong Lee, the team first visited Korea from 12-21 September 1999 to discuss the comments sent to MOFE on its preliminary strategy. A second mission visited Korea from 14-21 October 1999 and worked with the relevant ministries, think tanks, and representatives from the private sector to gather relevant data and information for the report. The team followed up in December 1999 and delivered a presentation on the report to relevant stakeholders in Korea. The team visited Korea again from 10-15 March 2000 to present the preliminary synthesis of the overall report to key counterparts in the Korean Government. The mission was very timely as the governnent was in the final stages of preparation of its three-year Master Plan, following the announcement by President Kim in January 2000. The team presented a concept note on this work at a review meeting at the World Bank on 12 October, 1999. The Bank review of the report took place on 3 May 2000. The OECD participated in both meetings and in the revisions of the report. Comments from the Government on the revised draft were received at meetings in Seoul on June 15 and 17, 2000. These meetings were organized by MOFE, and included representatives from various ministries and two think tanks. These comments were taken into consideration in the preparation of the final revision of the report. This process of collaboration and joint work on the report with Korea and the OECD contributed immensely to the overall development of the report. TABLE OF CONTENTS Page No. EXECUTIVE SUMMARY A. Challenge of the Knowledge Revolution to Korea's Development i Strategy B. Framework of the Knowledge-based Economy iv C. Issues in the Four Key Areas v D. Implementation of the Reforms viii E. Executive Summary Matrix: Main Findings and Remaining Issues x THE KNOWLEDGE REVOLUTION: A CHALLENGE TO KOREA'S DEVELOPMENT STRATEGY A. The Current Context I B. The Knowledge and Information Revolution 2 C. Challenges to Korea's Future Development 5 D. Korea's New Development Strategy 9 E. The Concept of a Knowledge-Based Economy 10 F. Definition and Framework 11 HI. UPDATING THE ECONOMIC INCENTIVE AND INSTITUTIONAL REGIME A. Introduction 19 B. Redefining the Role of Government 19 C. Opening Up the Economy and Promoting Competition 21 D. Increasing the Soundness and Efficiency of Financial Markets 25 E. Enhancing Labour Flexibility and Strengthening Social Safety Nets 26 F. Addressing the Risks of the "Digital Divide" 28 G. Updating the Institutional Regime 32 H. Conclusion 36 III. DEVELOPING HUMAN RESOURCES FOR THE KNOWLEDGE-. BASED ECONOMY A. Introduction 38 B. Educational Achievements and Recent Education Reforms in Korea 38 C. Paradigm Shift in Education 41 D. Challenges and Possible Responses to the Korean Education System 43 E. Conclusions 58 IV. ENSURING A DYNAMIC INFORMATION INFRASTRUCTURE A. Background 63 B. Recent Sector Growth 64 C. Remaining Challenges 67 D. Cyber Korea 21: Targets and Initiatives 68 E. Next Generation Policy and Regulatory Role for Government 69 F. Ensuring Access and Overcoming the Digital Divide 76 G. Using ICTs to Improve the Performance of Government 78 H. Conclusions 79 V. IMPROVING THE KOREAN INNOVATION SYSTEM A. Introduction 82 B. Profile of Science, Technology, and Innovation Activities 83 C. Korean Innovation System: Main Features and Weaknesses 86 D. The New Policy Agenda 92 E. Conclusions 102 VI. PROMOTING KNOWLEDGE-BASED ACTIVITIES A. Introduction 105 B. Reforming the Chaebol 107 C. Improving Conditions for Small and Medium-sized Enterprises 111 (SMEs) D. Strengthening the Contribution of Foreign Firms 115 E. Promotion of High Value-added Services 117 F. Promoting Investment in Intangible Assets 119 G. Conclusion 121 VII. IMPLEMENTING KOREA'S STRATEGY FOR A KNOWLEDGE- BASED ECONOMY A. Introduction 125 B. Broadening and Deepening the Consultations 126 C. Working Out the Implementation Details 129 ANNEXES Annex 1: Preliminary Assessment of the Knowledge Economy in Korea 135 Annex 2: Closing the Digital Divide: Some Country Examples 140 Annex 3: Some Reflections on the Challenges of Policy Implementation 144 1 - EXECUTIVE SUMMARY 1. This executive summary provides an overview of the report. The first section summarizes the challenge of the knowledge revolution to Korea's development strategy. Section B summarizes the analytical and policy framework for a knowledge-based economy used in this report. Section C highlights the main issues in the four key areas of the framework: the economic incentive and institutional regime; education, training, and human resource management; information infrastructure; and the innovation system. Section D makes some observations on the implementation of these reforms in Korea, based on the experience of other countries. Details on the specific findings and recommendations are presented in the matrix in Section E.' A. Challenge of the Knowledge Revolution to Korea's Development Strategy 2. Korea's Achievements. Korea has achieved one of the fastest rates of economic development of any country in the world. Between 1966 and 1996, its per capita income grew by an average of 6.8% per annum,2 and it became an OECD Member in 1996. Towards the end of 1997, however, Korea experienced its worst economic crisis since the Korean War. Nonetheless, Korea made a remarkable recovery from the crisis, and grew at 10.7% in 1999. The government expects the economy to grow at about 8% in 2000, and around 6% in the following few years. 3. Irrespective of the crisis, Korea is expected to face a much more difficult and competitive global environment. Its wages have risen and it is facing increasing competition from lower- wage countries in East Asia. Although its manufactured exports have been expanding rapidly, it is being squeezed between the developed OECD countries at the higher end, and China and other East Asian developing countries at the lower end. As a result of these developments and the increasing importance of knowledge, Korea is facing the unprecedented challenge of transforming itself into a knowledge-based economy. 4. The Global Knowledge Revolution. Increasing scientific understanding and very rapid advances in information and communication technologies (ICTs) are making knowledge and information one of the most important factors for competitiveness. Reductions in transportation and communications costs, as well as technical progress, are leading to a more interdependent and competitive world. Investors are increasingly seeking first-mover advantages, new products and services which can respond to customers' diverse and rapidly changing demands, speed to the market, and first-rate access to key customers and sources of information. The rapid development of ICTs and the Internet are exposing inefficiencies in the functioning of markets, firms, and institutions, putting downward pressure on prices, and accelerating the need to restructure and adapt to changing conditions. They are also improving the efficiency of interaction among government agencies and the delivery of government services, as well as facilitating consultation with the public. The new forms and means of networking are altering social pattems of work, shopping, education, leisure, and communications. These changes are ' The matrix distinguishes the situation prior to the crisis in Korea, the ongoing reformns, and identifies the additional issues that need to be addressed. 2 In constant 1995 USD. - ii - creating three key, overarching challenges for Korea's future development strategy. 5. The first challenge is that Korea needs to increase its overall productivity. In the past, Korea's growth was based on high capital investments and growth in labor inputs. However, the development model predicated on input-driven growth and the rapid expansion of the large chaebol had begun to reach its limits by the early 1 990s. Although the measured rate of total factor productivity growth over the past 30 years has been respectable, it has been small relative to the rapid growth of output. Most of Korea's economic growth over the past decades has been underpinned by strong capital accumulation, made possible by a high savings rate and increases in labor input. Total factor productivity growth declined both in manufacturing and services during the 1990s. In sectors such as finance, insurance and business services, and wholesale and retail trades, total factor productivity growth actually turned negative. Growth in the future will need to be more productivity-based by increasing the efficiency of investments in physical capital and knowledge. 6. In Korea, investments in education, information infrastructure, and research and development (R&D) as a percentage of GDP are among the highest in OECD economies. However, the country is not getting the full benefit of these investments because of problems with the overall economic incentive and institutional regime, as well as due to issues specific to the policies and structure in each of the three areas. Some of the reasons for this relative inefficiency include: - inadequate conditions for generation and exploitation of knowledge and information (e.g. intellectual property rights and the regulatory framework in IT); * insufficient competition, flexibility, and diversity (e.g. the chaebol, the financial system, and the education system); and - misallocation of investments (e.g. duplication of public investment in R&D, not enough public investment in basic R&D, and too much investment in education for just passing exams). 7. These problems are serious as they cast doubt on Korea's capability to sustain its development process in the long term, despite the resources invested. Korea now has to move to a strategy of achieving greater productivity across the board. The specifics are summarized in Section C, and developed in more detail in the attached matrix, and in the subsequent chapters of the report. 8. The second challenge is that, in the context of an increasingly globalized and interdependent world, Korea needs to become more internationalized. This includes not only opening up to trade and foreign investment, but actually trying to become more integrated into the global system. This involves: * More active participation and leadership in international forums and institutions, especially those that are setting the rules and practices for the new economy, such as the WTO, the World Intellectual Property Organization (WIPO), the International Standards Association (ISO), the OECD etc. * Developing alliances with world-class universities, fostering the exchange of professors and students, and enhancing knowledge of foreign languages and culture. - iii - * Tapping more effectively into global knowledge systems through joint research, joint submissions to international journals, strategic alliances, inward and outward FDI, and more contracting of foreign research institutes. * Harmonization with evolving international standards, more active participation in the International Telecommunications Union, etc. 9. The third challenge is that, in the dynamic context of the knowledge revolution and the networked economy, the role of the Korean Government will need to be redefined. The Korean Government has played a key role in the country's rapid development, and will indeed need to play an important role in the transition to the knowledge-based economy. However, its role must change from the interventionist policies of a government-led strategy based on the growth of large-scale industry, especially the chaebol. The Korean system has been over- regulated in the sense that the behaviors of a number of actors have been constrained by "dirigiste" procedures and rigid and detailed rules. At the same time, the "rules of the game" for a competitive, transparent, equitable economy are not sufficiently developed or enforced. Meeting the requirements of the knowledge-based economy means making markets function more effectively so that they can facilitate the constant redeployment of resources. This simply cannot be done through heavy government intervention in the economy. The key elements of the changed role of government in this context are: * unleashing the creative power of markets; - providing legal and regulatory underpinnings for freer and more competitive markets-rule of law, standards for transparency and accountability, modern regulatory institutions; e building modern legal infrastructure for the knowledge-based economy; intellectual property rights; cyber laws covering privacy, security, and digital transactions; - continuing to provide public goods (education, basic research) as well as address missing or underdeveloped markets (information networks); * fostering policies and institutions conducive to entrepreneurship and enterprise development (facilitating entry and exit in a number of areas, including removing onerous regulations for start-up of new businesses especially in the service sector, promotion of high value-added services, valuation of intangibles). 10. A new and important role for govermment will be to address the risks of the "digital divide". The new ICT revolution brings with it not only opportunities, but also risks of creating a "digital divide" between those who have access to the potential benefits of the ICTs and knowledge and those who do not. To offset the risks of a growing digital and knowledge divide, the Korean Government needs to adopt proactive policies to foster the availability of information and knowledge services, and widely spread entrepreneurial activity. It should pay special attention to the use of ICTs and new technologies to provide opportunities for rural and poor urban communities and the disabled. In addition, the government must modernize itself in order to capture efficiency gains by improving the quality and effectiveness of public services and strengthening government information flows. Since the crisis, the Korean Government has made a very impressive start in this direction. The next step will be for it to become a facilitator of change, fostering broad participation consistent with the distributed power arrangements of the networked economy. - iv - 11. Korea's New Vision. The Asian financial crisis has brought about a re-examination of Korea's structural problems and a new willingness and social energy to change the Korean economy and society. At the beginning of this year, the government articulated a long-term vision to transform Korea into an advanced knowledge-based nation. The goals include: * making Korea into one of the world's top-ten information and knowledge superpowers; * developing the next generation Internet and the information superhighway by 2005; * promoting the use of computers by students, teachers, and the military; * conducting radical reforms in education to arm the country for its drive to transform itself into a knowledge-based economy; * envisioning the dawning of an Internet society, where people will participate in the governance process though ICT, in a democracy based on human rights; and * closing the development divide through productive welfare and balanced regional development. B. Framework of the Knowledge-Based Economy 12. This report does not focus narrowly on high-technology industries or ICTs, but on the broader context of the extent to which an economy is effectively tapping and using the potential of the growing stock of knowledge and advances in ICT for its overall development. A knowledge-based economy is therefore defined as one where knowledge (codified and tacit) is created, acquired, transmitted, and used more effectively by enterprises, organizations, individuals, and communities for greater economic and social development. A knowledge-based economy thus requires: • an economic and institutional regime that provides incentives for the efficient use of existing knowledge, for the creation of new knowledge, and for the dismantling of obsolete activities and the start-up of more efficient new ones; - an educated and entrepreneurial population that can both create and use new knowledge; - a dynamic information infrastructure that can facilitate effective communication, dissemination, and processing of information; and i an efficient innovation system comprising firms, science and research centers, universities, think tanks, consultants, and other organizations that can interact and tap into the growing stock of global knowledge; assimilate and adapt it to local needs; and use it to create new knowledge and technology. 13. The economic incentive and institutional regime is explicitly included in this definition because it is central to the overall ability of the economy to make effective use of knowledge and critical to the effectiveness of other three key areas. For example, pressing on with the reforms of the economic incentive regime will induce the chaebol to become leaner, more competitive, and more knowledge-based. It will force the exit of non-viable economic activities while providing opportunities for entry by newcomers, open up demand in the education and information infrastructure sectors, and unleash the innovation, creativity, and entrepreneurship of the Korean people. 14. This framework is used in the report to take stock of where Korea currently stands, and to suggest further measures which would be helpful to facilitate its transition to an advanced knowledge-based economy. C. Issues in the Four Key Areas 15. The challenges identified above are systemic in nature. A key task for the government is to move towards a more comprehensive and consistent approach which encompasses all the relevant policy domains. As an essential component of such an approach, reforms are necessary in the four areas discussed below, each of which contain deficiencies which have implications for Korea's ability to benefit from the knowledge-based economy. 16. Economic Incentive and Institutional Regime. The main challenge is to move away from direct intervention and to create a flexible, adaptive, market-based economy and a creative society, compatible with the knowledge-based networked economy. This means placing high priority on reforms that will enhance competition and flexibility in the economy and unleash efficiency gains and innovation. It will require measures which can bring about a fundamental upgrading of the economy's capacity for spontaneous adjustment to changing competitive pressures and opportunities and for using and creating knowledge effectively. Some traditional areas will have to be deregulated, while there is a need for establishing modem regulatory oversight in certain new areas to strengthen markets. While the government has already started on a series of important reforms, it needs to embark on a systemic agenda for reform across a number of areas, including: * Product markets: strengthen foreign and domestic competition, consumer protection, and standards. * Financial markets: ensure greater transparency and disclosure, strengthen corporate governance, accounting rules, prudential supervision, improve equity and venture capital markets. * Labor markets: improve labor relations, make worker benefits portable, and remove employment biases against women. * Knowledge market: strengthen intellectual property rights, their enforcement, and the promotion and valuation of intangible assets. * Industrial restructuring and entrepreneurship: put in place policies and institutions for spontaneous industrial restructuring and development, including the fostering of entrepreneurship and a more favorable performance of small and medium-sized enterprises. * Social issues: mitigate the risks of the "digital divide" by upgrading social safety nets, strengthening opportunities for retraining, and extending access to education and information infrastructure to the poor and displaced. 17. Education, Training, and Human Resource Management. During its industrialization drive, the Korean educational system served the country well with its emphasis on primary and secondary education and equal access to education opportunities, which produced students of fairly high average quality. One of the main strengths of the Korean education system is the high investment in education. A weakness, however, is that these investments have not been put to the most efficient use. Currently, the share of public financing in education is roughly 4.4% of GDP, - vi - which is lower than the OECD average of 4.9% in 1995. But this is supplemented by a much larger investment in education by the private sector. Parents contribute an additional 2.3% of GDP to tuition and other expenses at both public and private schools, from the primary to the tertiary level. In addition, lack of choice and large class size in the public sector, combined with a very strict national university admissions examination system, have led parents to invest another 3.2% of GDP on private tutoring for their children. An estimated additional 3.4% consists of general expenses, including the purchase of study materials, books and stationary, uniforms, transportation fees, lodging, food, and other costs. As a result, Korea actually spends 13.3% of GDP on education-probably the highest share for any country at its level of development. The current environment of greater competition and rapid technical change requires that such investments be put to better use in the future, so that people learn and upgrade their skills to function more effectively in the new knowledge-based economy. 18. The time is thus ripe to switch to a new model of education in Korea that promotes quality, creativity, and lifelong learning, and that emphasizes not just formal schooling, but overall human resource development. This will entail major deregulation, decentralization, and diversification of the Korean education system and enhancement of competition. The urgency of this task also calls for closer and more effective co-operation between the relevant Ministries, notably the Ministries of Education, Labor, Health and Welfare, Industry, Science and Technology, and Information and Communications. President Kim's recent decision to reform and reorganize the human resource development sector by setting up the post of a Deputy Prime Minister for Education is a move in the right direction. In addition, the task requires an expansion of the focus beyond the Ministry of Education to that of Human Resource Development or a Ministry of Knowledge. Some areas of the government's reform agenda that are critical to responding to the needs of the knowledge-based economy include: * Deregulating the education system and increasing autonomy for private secondary and higher education, involving changes in curriculum, tuition, and permitting universities to set their own admission requirements, number of places, etc. * Integrating the current formal, vocational, adult, and distance education systems and training of people to meet the growing needs of lifelong learning. * Reorienting the use of public and private resources to emphasize improvements in the quality of education at all levels. In addition, more scholarships should be made available for poor students to address the equity issues that will result from the growth and improvement of private education. Furthermore, special efforts should be made by the government to encourage more women to go into higher education and into technical and scientific fields. This should be coupled with special initiatives to open up more professional employment opportunities for women. * Introducing outcome-driven governance systems in education with clearly defined autonomy and accountability at the institutional levels and decentralization to enhance local decision making at schools and universities. * Strengthening Korea's links to the global educational system. Universities should be encouraged to develop strategic alliances with world-class universities and encourage faculty exchange and joint courses, as has been done in Singapore. In addition, the curriculum in English and ICTs should be strengthened to facilitate global communications and international links in order to better prepare Korean students for the increasingly globalized world. - vii - 19. Information Infrastructure. The ICT revolution will increasingly affect the efficiency and functioning of all economic and social activities. While Korea has moved a long way toward liberalizing the ICT sector and is thereby capturing many of the benefits of advancing technologies, and there has been a very rapid uptake of new information technologies such as mobile phones and the Internet, it has a regulatory regime that may constrain continued fast development. The Ministry of Information and Communications (MIC) still tries to orchestrate much of the sector's development when, in reality, the market is moving much faster than regulator can successfully anticipate. Thus, the MIC should move further toward facilitating private provision of services and addressing areas of market failures. 20. In particular, it should: * liberalize the telecoms service industry, unbundle local loop services, set up an independent regulatory agency, and open up to more foreign investment; * develop a modem regulatory oversight for telecoms that includes interconnection standards, service quality, auctioning of spectrum; and . develop legislation on regulation of e-commerce that is harmonized with evolving international standards. 21. Innovation System. Korea reportedly spends more on R&D as a percentage of GDP (2.8%) than most other OECD countries. However, the productivity of this effort is questionable on the basis of various indicators of industrial competitiveness, technical creativity, and scientific production. There are some inherent weaknesses in the innovation system that need to be addressed. The government has perceived the challenge and has announced that it plans to increase R&D expenditures to 5% of the national budget, which is an ambitious target and signals the seriousness of its resolve. However, it is not so much a matter of the amount of money which is spent as the way it is spent. The key issues in this area include: Encouraging greater interaction among firmns, universities, government research programs and GRIs. Clearly justifying the rationale for public intervention, and providing subsidies in a transparent and non-discriminatory manner. - Providing support to R&D in large companies on stricter conditions, assisting only when they would not have undertaken the concerned projects, and stimulating partnership with other actors (enterprises, university and public laboratories), etc. * Increasing the effort in basic research; this should be done principally in universities, which should receive larger resources. This also implies changing various forms of regulations and practices that discourage research activities. * Reorienting the Government Research Institutes (GRIs) as their activities tend to duplicate those of industry. The GRIs have to be re-positioned to do more upstream research or to become more focused on research of collective interest (e.g. health, transport, etc). A larger part of their budget has to be secured in the form of institutional funding. * Developing better formns of support to innovation in SMEs with emphasis on effective networking and clustering, and the involvement of local authorities. * Strongly encouraging contacts of all actors with foreign counterparts-academic and research exchanges, technological co-operation, industrial joint ventures, participation in international regulatory bodies, etc. * Enforcing co-ordination procedures involving key ministries. - viii - Implementing evaluation exercises, including an international review of the basic research capacities of the country. D. Implementation of the Reforms 22. The reform strategy outlined above has to be systemic and must involve the design and implementation of measures which are consistent across different, traditionally disparate areas of policy making. While piecemeal reform of individual elements can yield some improvements, the results will not be as promising as if a series of reforms are jointly undertaken. This is particularly relevant in the knowledge-based economy because of the greater importance of networking and horizontal interactions among policies as well as actors. The government has a significant role to play in making sure that all groups are well informed about trends and forces affecting them and therefore the need for change. 23. We do not underestimate the challenges-short, medium and long-term-that developing and effectively implementing such a systemic strategy would entail. Based on the experience of other countries that have crafted and implemented broad strategies, such as Canada, the United Kingdom, Ireland, and Finland, it is clear that the development of the strategy must be undertaken in consultation with the private sector and civil society. This is particularly relevant for Korea, given the current social and political change that is taking place and the vision for the country in the 21st century enunciated by the govenment. The public hearings and consultations with think tanks and the private sector on national policies and reforms that have taken place so far represent an encouraging trend. 24. However, building consensus and buy-in from stakeholders on the desired measures requires a greater effort of dissemination, explanation, and consultation with a wider range of the public, including civil society. To illustrate, the education sector must implement major reforms-many of which have already also been formulated by Korean think tanks and concerned groups. However, much initial resistance to reforms is likely to come from the education agencies and from teachers, as both would lose some degree of power and control. It will be important to convince these groups of the benefits of the reforms. 25. Implementation of the strategies should also focus on whether the infrastructure to implement reforms is in place. Too often, across countries, strategies and initiatives are announced without the adequate evaluation systems and staff in place. Because of the dynamic nature of the knowledge and information revolution and the global economy, it is important to set up a monitoring and evaluation system as an integral part of the implementation process. It would also be necessary to have built-in provisions for adjusting plans and actions in light of on- going developments, including the findings of impact evaluations. 26. There is also a tension between the need for some centralized locus of responsibility for overall co-ordination of the strategy and its implementation, on the one hand, and the distributed power arrangements of a networked economy, on the other. An appropriate balance has to be found in the Korean context. -ix - 27. These are preliminary suggestions and should be treated as points for more intensive discussions. This report represents a review of what appear to be some of the key issues of a very dynamic system, seen from the perspective of two international institutions who have the advantage of a broader perspective of cross-country experiences, but are not as knowlegeable about the specifics and details of the Korean context as the Koreans themselves. It should thus be interpreted as a first step in a broader process which Korea has to set up for itself, to analyze where it currently stands, where it wants to go, and how it is going to get there. Such a process has to be owned not only by the Korean Government, but by the Korean people. - x - E. Executive Summary Matrix: Main Findings and Remaining Issues Redefining the Role of Government * The Government tended to be highly * Since the crisis, the Government has * The Government should change its role from centralized, interventionist, and dirigiste, announced that it is moving more towards direct intervention to the provision of an especially in regard to the financial and market-based principles. It has opted for more incentive and regulatory framework that industrial sectors. openness and competition, encouraged buttresses well functioning markets, while participation of selected groups in policy addressing market failures, missing markets, discussions, and paid attention to social sector promoting public goods, and dealing with and safety net issues. Greater market inequities that may result. discipline forms the core of the new policy * It should foster greater entrepreneurship and paradigms. Some industrial targeting remains spontaneous industrial restructuring and in the telecommunications manufacturing enterprise development. sector. * The Government should participate more actively in international forums and institutions, especially those that are setting rules for the new economy such as WTO, WIPO, ISO, the OECD, etc. Opening Up the Economy and Promoting Competition * A number of policy measures constrained the * The Government has been reducing tariff and * The Government should continue with competitive environment including controls non-tariff barriers. liberalization, especially with further on the price and quantity of credit; entry * It has also strengthened anti-trust actions deregulation in services, like barriers and investment restrictions; tariff and through the Fair Trade Commission (FTC). telecommunications, financial news, and legal non-tariff barriers; restrictions on FDI; and * Deregulation efforts came with the Regulatory services. weak mechanisms for exit. Reform Committee in 1998 which has a broad * Antitrust actions and enforcement of mandate across sectors. competition policies in general should be * In the area of insolvency and creditors' rights, strengthened by giving more analytic and the Government has taken steps to improve enforcement power to FTC. the handling of bankruptcy cases in the court * The bankruptcy regime should be further system. improved, and capacity needs to be increased in the bankruptcy division of the Seoul District Court to handle its caseload. Foreign Direct Investment * Historically, foreign direct investment (FDI) * FDI restrictions have been considerably * There should be greater liberalization of FDI has been highly restricted. liberalized through the Foreign Investment into services sector to increase domestic - xi - * Restrictions on FDI were gradually liberalized Promotion Act of 1998. Foreign investment competition and provide better management during the 1980's, including the adoption of has increased from an average of US$1.2 models. the negative list, abolishing performance billion in 1991-95, to US$8 billion in 1998 * Accompanying reforms in corporate requirements, and easing friendly cross border and US$ 15.5 billion in 1999. governance and innovation policy, including M&A. * Restrictions on foreign land ownership were intellectual property rights, will help attract lifted in 1998. FDI that can generate positive linkages and spillovers to the economy. Improving the Soundness and Efficiency of Financial Markets * Financial policies towards the chaebols, plus * Since the financial crisis, Korea has made * Korea still has to resolve the overhang of non- lack of investment alternatives channeled steady progress in restructuring and reforming perforning loans (NPLs), adequately considerable private household savings into the financial system, reestablishing solvency, recapitalize banking institutions, improve the banks, that internediated this capital into bank and setting up mechanisms for monitoring and credit culture of banks, and systematize the loans to chaebols and large firms. Banks had supervision. regulatory oversight for the financial sector. little incentive to develop their institutional * Accounting and auditing standards and * It should further open the financial sector to capacity to analyze credit and risks. practices have been upgraded and the FDI to provide more competition to domestic * The non-bank sector was also compromised institutions responsible for setting standards banks, and to benefit from global banking and when chaebols gained control of many and ensuring compliance have been management expertise. intermediaries. Capital market development strengthened. * It has to implement the new financial was hindered by pervasive explicit or implicit transparency and accountability standards, and guaranteeing of banking system instruments modify restrictive regulations on the auditing and weaknesses in regulatory and institutional profession. framework for capital markets. * Financial transparency and accountability was weak. Corporate Governance * The system of corporate governance in Korea * Since the financial crisis, Korea has * Korea should adopt a mandatory code of led to massive investment and industrial strengthened corporate transparency through corporate governance consistent with expansion, resulting in over-diversification improved accounting and auditing norms, international best practice (OECD Principles and over-leveraging, making Korea vulnerable strengthened minority shareholder rights, and of Corporate Governance), issued by the to the financial crisis. accountability of boards of directors. Korea Stock Exchange (KSE). * It should require listed companies to report regularly to shareholders, and remove obstacles to class action suits by shareholders against directors. * It should implement a system of secured transactions including a national system of registration to facilitate credit to SMEs. - xii - Venture Capital Emphasis in Korea's financial system was on * Korea established KOSDAQ in 1996, and as * Korea needs to strengthen regulatory collateral-based debt rather than equity. This of 3/7/2000, 473 firms have been listed, oversight and information disclosure, reduce practice presented a bias against small start-up including 155 new venture based firms. Value restriction on capital funds, and open full firms in knowledge-based sectors which can of KOSDAQ transactions is now greater than participation of foreign investors. incur high costs for knowledge gathering but that of the KSE. have little physical capital that can be used as collateral. Listing in capital market was available only to well established companies. Risk taking is constrained by strong cultural stigma associated with failure. Enhancing Flexibility in the Labor Market * Labor legislation, labor relations, and * Since the crisis, Korea has revised labor laws * Korea needs to develop better industrial industrial and market structures contributed to to legalize layoffs and increase flexibility of relations, make worker benefits fully portable, rigidity in the Korean labor market, which labor market. reorient training schemes to meet demands of reduced the speed with which Korea could * The Government has begun to focus on the more flexible economy, and ease restrictions adapt to changing competitive pressures. need to provide more labor retraining. on temporary workers. This requires greater * There has been insufficient emphasis on firm- awareness raising and buy-in from labor. based training and labor retraining. * It also needs to redress the inequality of access * There has been a significant employment in job opportunities and pay for women. discrimination against women. Social Safety Nets * Korea made substantial progress in reducing * Since the crisis, the Government has begun to * Korea should build on reforms through better poverty during the 1990's. However, with the strengthen social safety nets and tripled enforcement of labor market regulations, onset of the crisis poverty rose dramatically in expenditures on social protection, which also better targeting of programs for the poor and 1998. included public works and livelihood vulnerable, improvement of employment protection. opportunities through retraining and enhanced * It began to reform its pension system in 1998, labor market flexibility, and reform of the and private management and funded pensions pension system. will be given a larger role in the new system. Addressing the Risks of the Digital Divide * The new information and communication * As a result of the crisis, the Korean * The government needs to strengthen the social technology (ICT) revolution brings with it not government has become aware of the risks of safety nets to help those who are negatively only opportunities, but also risks of creating a increasing social inequality, and going beyond affected by economic restructuring and its "digital divide" between those who have the immediate impact of the crisis to the risks associated job displacement. There is a case sufficient access to the potential benefits of of the digital divide. for broadening and further strengthening its the ICTs and knowledge and those who do * President Kim's January 2000 vision 'productive welfare' system to provide not. This is likely to be even more serious in statement includes narrowing the digital opportunities for retraining and productive developing economies because of greater employment, and foster access to new - xii - disparities and weaker social safety nets. divide through a 'productive welfare' strategy technologies, especially for the poor, women, and balanced regional development. and the disabled. * In the area of education, the government has * It should also put in place efficient new plans such as providing free PCs and five programs which will provide access to new years of free Internet access to 50,000 students technologies, computers, and the Internet to from poor families. low-income families. * In the area of the information infrastructure, * It should design appropriate regulatory the Cyber Korea White Paper has initiatives incentives to further encourage the provision such as connecting 10,400 schools; teaching of telecommunications on a commercial basis civil servants, students and military personnel to low-income groups in rural as well as in on how to use computers; building Internet poor urban areas. plazas; and facilitating Internet PC purchases. Strengthening Intellectual Property Rights and Enforcement Sizeable portion of the public had little * Intellectual Property Right (IPR) law has been * Korea needs to create greater awareness and understanding of the criminal nature of actions strengthened in 1998, but its enforcement is mount advocacy campaigns of the importance which amount to infringement of intellectual still weak. of IPRs among the general public, produce property rights. * Much of the public still considers knowledge better documentation and knowledge to be available freely, which creates a databases, and upgrade KINITI. disincentive for the private producers of * It must further improve IPR laws, their knowledge. administration, and enforcement. Ii. EDUCATION AND SKILLS Educational Achievements and Recent Education Reforms in Korea * Korea has high educational achievements * The Presidential Commission on Education * A systemic and profound reform of the current among OECD countries. But, the system has Reforms 1995 (PCER) made many education system is necessary to spur the constrained entrepreneurial behavior, and recommendations, but the implementation has development of more creative people with the lacks flexibility and the incentives for further not reached a desired level. Programs like skills to underpin the knowledge-based improvements. Brain Korea 21 have started to address this economy. * The public share of education financing in issue. * There is a need for adequate campaigns to Korea was 4.4% of GDP in 1998, lower than * The Government plans to increase the public inform the public on the benefits of proposed the OECD average of 4.9% in 1995. Parents share of education to 5% of GDP. changes in education. also spend 3.2% on tutoring their children. * The Government has begun efforts to * The educational environment should be * Korea has been insular, with few strong strengthen foreign language education in the improved to the level of OECD countries (for associations with the outside world. country. example, in class size, public expenditures, * The recent announcement by President Kim to and participation of women in science and set up the position of a Deputy Prime Minister technology areas). The government should for Education to coordinate all human reduce the burden on parents for quality resource development policies more closely is education, while maintaining equity in the system. It should also examine the efficiency - XIv - a positive move. and allocation of resources by both the public and the private sector. Deregulation and Decentralization * Rigid Government control over of the * PCER proposes the creation of "autonomous * The Government should implement further education system includes curriculum, school community," including creating school major deregulation of the system at various examination system, tuition fees, and the councils and open recruitment of principals levels and encourage competition. number of students by discipline, for both and teachers. * It should implement an outcome-driven public and private institutions. * PCER intends to establish curriculum and governance system with clearly defined * There is ineffective and inefficient use of assessment centers for schools. autonomy and accountability at the resources and lack of accountability of the * PCER aims to link financial support to institutional level. system. universities with performance evaluation. * It should increase institutional autonomy to * At the primary and secondary levels, enhance local decision making at schools and responsibilities have been divided among the universities. central and provincial governments and * The Government should ensure equity in the schools in designing and implementing the system by investing in appropriate schemes to national curriculum. To a certain degree, help students from poorer families. colleges outside Seoul are allowed to * It should establish sound accreditation system; determine their tuition fees, student quotas, undertake benchmarking assessments to judge and curriculum. the quality of teachers and programs; track and monitor quality over time; and make this information available to the public. Diversification * There has been an over-emphasis on * The government intends to give greater * Korea needs to promote diversity and homogeneity of university types and autonomy to universities in admissions specialization in the system through a few curriculum. (student quotas) and academic affairs. It has universities that provide comprehensive * There has also been a geographical begun approving new specialized colleges. programs in a broad range of subjects, and concentration of Universities around Seoul. * It has started changing the college entrance other universities that provide specialized * All students are subject to the same curriculum examination to expand student choice. programs to meet different learning needs of in both private and public schools, and there * Brain Korea 21 plans to nurture leading students. It needs to ensure greater has been no grouping according to ability in regional universities to meet the needs of possibilities for students of self-determination the general secondary school system. local industry by allocating 350 billion Won and choice of subject areas, as well as from 1999 to 2005; and changing the mobility within the system to fulfill the goals requirements for entry into universities; and of lifelong learning, equity, and efficiency. recruiting more professors. * It should develop 'double qualifying * The government has started to experiment educational pathways' that can lead to the with ability-based grouping at the primary university, tertiary level vocational education, level, and is planning to start this at the or the labor market. secondary level in 2002. - xv - Relevance, Quality, and Gender * There has been a shortage of training in new * According to the 7th curricular revision that * Korea should integrate the curriculum to skills and too much emphasis on quantitative came into practice at the beginning of this include training in new skills such as reasoning. year, some curriculum reform is currently communication skills, capability to utilize * The educational output has been inadequately underway, for example, in decreasing the ICTs, as well as increase possibilities for related to industrial needs. number of required subjects, and in increasing gaining field experience. * There have been insufficient linkages between the number of elective courses. * It should enhance pedagogical training with the Ministry of Education and other relevant * Reforms of textbooks, teaching methods, and emphasis on new knowledge and ICT; provide ministries. the use of a variety of educational incentives for teachers including outcome and * There is also a deeply-embedded gender bias technologies are also proposed. performance-based pay schemes; and develop against women in Korean culture and society. * Brain Korea 21 aims to give more research knowledge sharing systems. focus to universities by nurturing world class * It should implement strategies to increase the graduate schools. An allocation of 1.4 trillion number of women who can participate in the Won has been made for 1999-2005. To economy, and change the entrenched mind-set participate in this program, universities will against greater labor force participation of be required to reform the student admission women in Korean society. system, reduce undergraduate student ratio in * It should encourage university and industry return for financial support, and develop partnership. In addition to industry providing curriculum and research programs with financial support, industry representatives world's leading universities. Performance should be on university boards and participate based promotion for professors will be also be in curriculum development. introduced. * It should encourage the expansion of exchange programs between Korean and foreign educational institutions; encourage entry of foreign university branches; and allow twinning arrangements. It should strengthen the link between the Ministry of Education and the Ministry of Labor, the Ministry of Commerce, Industry, and Energy, and the Ministry of Science and Technology to provide better coordination between needs of the labor market and industry, and the supply of education. - xvi - Lifelong Learning * Too much emphasis was placed on formal * The Education Credit Bank system has been * The Government should establish the lifelong over informal education and lifelong learning. introduced which makes it possible to have learning system by integrating the formal * There was also insufficient job-related training credits earned through the open educational education system with distance education, for the working-age population. system recognized as the equivalent of a adult education, and vocational educational formal degree. systems. * Korea has increased efforts to promote adult * It should strengthen the informal lifelong education attached to universities. education programs and provide incentives * It is also focusing on ICTs, for example, by and opportunities for those who have left wiring schools. school to come back whenever needed. It * PCER intends to provide greater opportunities should fully implement the Education Credit for job training for women and the elderly. Bank proposal. The Ministry of Education will also establish * It should assist education institutions to build and run a Lifelong Center for Education. up their ICT infrastructure to deliver educational training on demand. The Current Situation * Until the crisis, Korea was significantly * Korea has had very rapid investment in * Korea has tremendous potential to be a leader lagging in the information related certain telecommunication service areas in in information infrastructure. If it can infrastructure for an economy at its level of last few years. In 1999, mobile phones introduce the necessary institutional and GNP per capita. surpassed fixed lines. Internet prices are low regulatory reforms to enhance competition in for off-peak times and Internet use has been the telecommunications sector and implement growing fast. Public access to the Internet is the recommendations below it will be able to high. leverage itself into a world leader in this area. * Cyber Korea 21 and related initiatives However, it needs to make a sharper (including President Kim's New Year Policy distinction between the advantages of the Speech) lay out an ambitious set of targets to production of ICT hardware and technologies be met by 2002, including: and those of its effective use and application. - providing universal service access at There appears to be too much emphasis on the speeds of 2Mbps; former and not enough on exploring the - connecting 10,400 schools to the Internet; potential of the latter. and * In general, more open competition and - teaching 900,000 civil servants, 10 investment policies are required. Korea has million students and 600,000 military the potential to be a regional logistics hub, as personnel how to use computers. a complement to expansion of ICT services. Regulation * Korea and Japan are the only countries in the * The Ministry of Information and * Korea needs to set up an independent OECD that do not have an independent Communications (MIC) has been trying to regulatory agency outside the MIC. Priorities regulatory agency. This creates real and regulate markets and provide greater for improved regulation are: - xvii - perceived problems of unfair treatment among competition, but competition is still limited - move to long run average incremental industry operators. and there are concerns about preferential costs to calculate interconnection costs; treatment. - create universal service fund; - simplify licensing regime and processes; - price caps for dominant local loop provision; leased line and long distance provision; and arrangement for unbundling of services; and - move to a more open system of allocating the radio frequency. Competition and Foreign Investment * There were very strong limits to foreign * Korea has been liberalizing its * Eliminate restrictions on foreign investment in investment in the telecommunications sector. telecommunication sector by moving toward the telecommunications services and complete removal of limitations on resale manufacturing sectors to enhance investment services. Up to 49% foreign ownership is now levels to gain from globalization of ICTs and allowed. ICT services. Local Loop Services * Korea Telecom was the only telephone service * In 1997, Korea opened up the local loop * Local loop services should be unbundled to provider until 1990 (duopoly in long distance). market to competition, however, competitors stimulate competition and the introduction of to Korea Telecom must replicate all fixed line new technologies such as ADSL. investments which constrains real competition. Legislation and Regulation for Electronic Commerce * Prior to the crisis, there were no legislative * Korea passed the Electronic Signature Law in * Korea needs to move to new system of provisions for electronic commerce, as this July 1999. Outstanding issues still include taxation and commercial regulation that was still an incipient sector. restrictions on number of Internet financial provides for harmonization with evolving services, and a requirement for Internet firms international rules including prevention of tax to have a physical presence in Korea. avoidance/double taxation, ensuring privacy, * The Govermment has announced Door to Door and limiting transactions costs. sales law to be repealed or amended. * It also needs to reduce restrictions on Internet financial services. Electronic Government * No major provision for electronic Government * In the area of re-engineering and innovation * Korea should pay more attention to innovation was made before the crisis, as this is a in Government through ICT, Cyber Korea 21 in government, policy issues that cut across relatively recent phenomenon. lays out impressive targets for using ICTs to ministerial boundaries consistent with the new improve performance of Government (e.g., role of Government, and improve capacity at providing e-mail accounts to all public the local levels. servants, digitizing public procurement, - xviii - document circulation). . It has increased provision and delivery of social services on-line; helped the disadvantaged and disabled with on-line connections, I. _NOATO SSE Profile of Science, Technology and Innovation Activities * Korea's innovation system (KIS) is based on * Funding for R&D has been increased from 3.7 * While still exploiting the strengths of its the catch-up model rather than a KBE model to 4.1% of the budget with emphasis on R&D catch-up model, Korea needs to move toward that emphasizes innovation and building in telecommunications, bio-technology and a new model with stronger university research capabilities and linkages among key actors. new materials. capabilities, deepening basic R&D effort by * The country reportedly spends 2.8% of GDP * President Kim has announced that Korea will the private sector, greater emphasis on on R&D, but efficiency of such investment is increase R&D's share in the national budget diffusion efforts by the Government, and more low as measured by scientific and technical to 5% by 2003. linkages among domestic actors and between articles produced per unit of GDP. * Government has begun some evaluation of the them and international actors. Many of these * Other issues include: effectiveness of its R&D policy and to make steps are included in a new science and - little spent on effective basic research; some changes. technology strategy vision for the year 2025 and * The Government has designated strategic presented in May 2000. - little use of FDI and weak global linkages. fields for R&D support, especially in the ICT * The key challenge is going to be in the areas, such as next generation Internet, fiber- implementation, particularly inmaking the optic technology, digital broadcasting, system more efficient, effective, and wireless communications, software, and interactive by strengthening linkages among computers. participating institutions and actors, including * The President established a National Science those from abroad. and Technology Council to coordinate the * There should be an international review of various ministries active in S&T policy. basic research capabilities in Korea in all scientific fields, according to international standards. Universities * Universities do not carry out much science * Brain Korea 21 program aims at strengthening * There needs to be increased government research, although research resources per research capability of premier Korean funding and more emphasis on basic research researcher are above EU average. The problem universities. at universities, as well as the creation of is lack of incentives for research and lack of centers of excellence. appreciation of research. Little emphasis is * University regulations concerning teaching placed on basic research due to low public obligations, professors' evaluation and funding and dependence on private enterprise promotion, etc. that create obstacles to funding. research work and contact with industry should be removed or changed. - xix - Private Sector R&D * In Korea, two-thirds of R&D is undertaken by * Chaebols have been- downsizing their R&D as * Korea needs to increase domestic and foreign the private sector, and the bulk of this is by a result of the crisis and are beginning to competition through improvements in the large vertically integrated chaebols that tend focus their R&D on core areas. overall economic incentive regime which will to internalize these activities and have little * Some technology based SMEs are investing in force the chaebols to reorient research toward mutually reinforcing linkages with SMEs. R&D, but they are still a very small minority. greater specialization and focus on their core * Most of R&D by large chaebols is for competencies. widening the focus rather than deepening and * Financial and technical support to SMEs need little is done on basic research. Industrial to be strengthened to stimulate their R&D spending is concentrated in a small investment in R&D and technological number of sectors. interactions with the chaebols, foreign firms and GRIs. SME technology, training, and research policies should be better coordinated through the establishment of regional networks involving the regional and local authorities. Government Policies * The Korean Govemment has promoted R&D * The 1999 Law for Establishment, * The Government should complement market through various policies including tax and Administration and Promotion of GRIs has forces where R&D will yield highest social financial incentives, procurement, technical taken many of the GRI from the direct control returns. information, human resources, cooperative of their ministries and made them accountable * The Government's R&D programs should put research, SME support, R&D to the National Research Council Boards. more emphasis on diffusion and strengthening commercialization support, and public R&D * Nevertheless, the processes for allocating systemic linkages. It should: labs. funding on more competitive basis and on - give incentives to GRI to diffuse and * There has been little objective evaluation. making institutes more accountable for results commercialize; and Despite some success stories, most national are not sufficiently developed. - develop bridging institutions, such as R&D programs and government research * The Government has begun to think about university-industry interface, specialized institutes have suffered from problems of redefining the role of the GRIs. research firm spin-offs. duplication with the private sector. * The Government should redefine the role of * Overlap in R&D support and R&D programs GRIs by among different ministries has been pervasive. - Redirecting GRIs toward more basic and long term research through secure public funding; and - repositioning GRIs with respect to universities and private sector to reduce overlaps. * The Government should move from sectoral promotion to the cluster approach, as found in - xx - OECD countries, and improve coordination between national and regional policies. * It should increase the mobility of human resources in S&T through removal of regulatory obstacles that impair mobility of researchers between public and private sectors; and encourage foreign research and management talent (as found in Singapore). Weak Global Linkages * Korea has had both formal and informal * Chaebols have been setting up research * It is necessary to examine what policy barriers against inward FDI, and there have centers abroad as a way of tapping foreign measures should be taken to encourage: been few linkages with foreign public or knowledge directly. - firms to tap effectively into the global private research. * Chaebols have also developed some strategic knowledge base through FDI, * Korea has not participated actively in alliances with foreign firms, but they need to international business alliances, and joint international public research programs. develop strategic alliances with research programs; and technologically strong foreign firms more - foreign scholars at research universities aggressively. and institutes through scholarships and * Korea is beginning to develop more grants. cooperative and public research programs * Government should use technological with other countries. forecasting to obtain a stronger appreciation of trends for policies in science and technology. V. STRATEGYlDiZl FOR KNWEGEBSJ DEVELOPMENT 00 Implementing the Strategy * Prior to the crisis, a number of initiatives were * A new vision for transforming Korea into a * In crafting the strategy and action plans, a taken by the Government on issues affecting knowledge-based economy was announced by number of issues should be taken into account, education, science and technology, etc. the President on January 3, 2000. such as: However these were not integrated into a a The task to map out the details of the strategy - role of government as facilitator and knowledge-based development strategy. was given to the National Economic Advisory coordinator; Council (NEAC) which was formed towards - reform should be systemic and involve the end of 1999. design and implementation of measures * There is an encouraging trend of building which are consistent across different areas consensus through public hearings, of policy making; consultations with wide ranging think tanks, - building consensus and buy-in from key and the private sector in the process of stakeholders; designing polices. - opening up traditionalist attitudes for critical reflection among the public at large (e.g., education reforms, entrepreneurship, and risk taking); - addressing implementation concerns such - xxi - as respective responsibilities of agencies, institutions and private sector; - addressing coordination issues with adequate resources and a clear focal point; - making provisions for monitoring and evaluation (by, for example, the NEAC); and - establishing an institutional set-up and a process which can adequately balance stability with the need for continuous adjustment of the strategy. CHAPTER I: THE KNOWLEDGE REVOLUTION: A CHALLENGE TO KOREA'S DEVELOPMENT STRATEGY A. The Current Context 1.1 Korea has achieved one of the fastest rates of economic development in the world. Between 1966 and 1996, its per capita income grew by an average of 6.8% annually,l and the country became a member of the OECD in 1996. Its per capita income grew from under USD 100 in the 1950s to USD 10 550 by 1997. Life expectancy has risen to 72 years, just short of the OECD average of 76. Primary and secondary education were universal by the 1990s, and by 1996, Korea's tertiary enrollment rate was higher than for most OECD countries. 1.2 Towards the end of 1997, however, Korea experienced its worst economic crisis since the Korean War. As a result of the East Asian financial crisis, GDP contracted by almost 6% in 1998. Unemployment, which was less than 2.5% in the second quarter of 1997, rose to a peak of 8.6% in February 1999, and foreign exchange reserves fell to less than USD 5 billion in December 1997. Nonetheless, Korea made a remarkable recovery, and the economy grew by 10.7% in 1999. The Korean Govermment expects the economy to grow by about 8% in 2000, and by around 6% in the following few years. 1.3 The recovery has its roots in many factors, including improving investor confidence in East Asia, and corrections to initial overshooting by the international capital markets. The government's macroeconomic adjustment policies and the accompanying structural reforms have been at the core of the recovery process: as a result of the crisis, the Korean Government began a series of significant reforms in the financial, industrial, labor, business environment and social sectors. Those that are most relevant for this report are summarized in the policy matrix attached to the executive summary, and are covered in respective chapters. 1.4 Despite the very rapid recovery, there is concern about its sustainability and the prospects for sustained future growth. The 1997 economic shocks and 1998 crisis revealed fundamental structural weaknesses in the Korean economy. The input-driven growth strategy had already led to declining total factor productivity growth from the beginning of the decade.2 In the financial sector, rapid credit growth based on weak credit evaluation and inadequate prudential regulation and supervision had made the banking system vulnerable to shocks. Conglomerates had become greatly overextended because of extensive diversification, based on excessive leveraging. The concern over future growth also stems from an increasing awareness that the global marketplace is becoming more competitive, and that radical changes are taking place in the production, exchange, and use of goods and services, driven by what can be described as a knowledge revolution. 1 In constant 1995 US$. 2 See World Bank, 1999b, and Section C for details. B. The Knowledge and Information Revolution 1.5 Awareness that knowledge is a critical element of economic growth and increased welfare is not new. What is new is the speed of changes in the production and dissemination of knowledge made possible by increasing scientific understanding and very rapid advances in information and communications technologies (ICT.) Advances in scientific understanding and in the codification of knowledge are facilitating the rapid development of new technologies. We are now at the stage where we can begin to engineer materials at the molecular level and even life forms and are in the middle of a revolution in information, computing, and communication technologies. The cost of voice transmission circuits has dropped by a factor of 10 000 over the last 20 years and computing power per dollar invested has risen by a factor of 10 000 over that same period. The ICT revolution, in turn, is increasing the speed and decreasing the cost of developing tools and instruments for basic research (proto-types, demonstrators, simulation techniques), as well as extending the power of electronic networks as research tools, permitting the generation of a larger set of new technologies. 1.6 At the same time, investment in ICTs has expanded.3 Growth in connectivity has fueled the revolution of the Internet. As more suppliers and customers go on line, the benefits of participating expand, and the penalties for non-participation also increase. The direct linkages between producers and customers imply a reduced role for interrnediaries in many markets, including consumer goods, food, manufactured components and primary products. Entirely new markets are being created from new networking (e.g. personalized information services, online securities trading). In addition, the impact of networking in the public sector has become enormous, with the potential for dramatic reductions in the cost of delivering services such as health and education, and on governance through the reorganization of administrative and political institutions. The Internet is also likely to fimdamentally alter social trends through its impacts on day-to-day activities, including working, shopping, communicating, and even leisure. The pervasiveness of these changes and their impact even at the macroeconomic level has given rise to the concept of the "new economy" (see Box 1.1). 1.7 The ICT revolution involves significant reallocation ofjobs across industries and changes in the skill and occupational composition of the workforce. In OECD countries, low technology manufacturing jobs have declined, while jobs in high technology manufacturing have been mixed. Overall employment in the OECD countries has been shifting away from manufacturing and into services. Within services, there has been strong growth in high-value-added service sectors such as finance, insurance, real estate, and business services, which tend to be the most skill- and infornation-intensive. The overall occupational structure of the workforce in OECD ' In a recent study of 60 major telecommunications markets worldwide (covering 90% of the telecom market), Pyramid Research estimated that in the 1991-94 period, communication service providers in those countries connected 118 million telephone lines, 40 million mobile subscribers and 6 million leased lines. Between 1995-98, these figures increased to 171 million new telephone lines, 238 million mobile subscribers and 8 million leased lines. Cumulative investments in ICT infrastructure in all the countries examined for the Pyramid study totaled USD 327 billion between 1991-94. Between 1995-98, such investments nearly doubled, to USD 572 billion. Pyramid Research also forecast a number of technological advances over the next ten years that will fuel rapid expansion in the virtual economy and its impact on the world. As an example, the worldwide e-commerce market is forecast to expand from USD 26 billion in 1997 to USD 1 trillion by 2002. And Cyber Korea 21 predicts that the size of the e-commerce market will expand from KRW 55 billion to KRW 3.8 trillion between 1998 and 2002. -3 - countries is changing towards higher skills in both industry and services as demand for low- skilled workers has declined. High-skilled, white-collar workers make up an increasing proportion of the workforce, and account for between 25% and 35% of total employment. Box 1.1: The New Economy In parallel with these developments, substantial changes in economic growth have fuelled the notion of a "new economy". First, there are observed changes in the pattern of economic growth. Most attention has focused on the United States, which is currently experiencing its most prolonged boom ever. Although productivity performance continues to be exceptionally strong and unemployment has gone way below what used to be viewed as compatible with price stability, there is little sign of inflationary pressure. In a number of other countries there is similarly surprisingly little evidence of inflationary pressures. At the same time, comparing across countries, it appears that the forces pushing towards convergence in growth rates have given way to increasing divergence. Broadly speaking, countries which are doing well seem to be gaining ground relative to the followers. There are signs of growing income differences within as well between countries.4 Second, there appear to be important changes in the sources of growth. Traditional determinants of growth, such as macroeconomic policies and the functioning of labor markets, continue to affect the performance rates observed in the late 1990s. In parallel, however, there is a pervasive influence of "new factors". This applies most notably to investment in ICTs, which was long observed to show up "everywhere but in productivity figures". Today, the contribution of ICTs to output and productivity growth is visible, significant and rising in many OECD countries. In Canada, the United Kingdom and the United States, the growth contribution of ICT equipment amounts to about half of the entire growth contribution of fixed capital. In France, Germany and Japan, the contribution of ICTs to output growth has been somewhat smaller, but is still significant.5 A number of smaller OECD countries are witnessing similarly strong benefits. These developments appear to play an important role in changing price behavior, since improved access to information is accompanied by stronger competitive pressures at the micro level and reduced prices across a broad spectrum of industrial activities. At the same time, investment in ICTs is not the whole story. On the contrary, it appears that "the new economy" has brought about a more complex interplay between different factors, with, at its core, the diffusion and use of knowledge. Among all OECD countries, those which have strong growth rates tend to demonstrate an upsurge in multi-factor productivity. While it is difficult to determine the underlying sources and mechanisms, the evidence points to the crucial interplay between investment in ICTs, changes in innovation processes, organizational changes, and upgrading of human skills (OECD, 2000). 1.8 There are also significant investments in training aimed at helping workers make use of 6 the new technologies and perform new functions. There are also important investments in other intangibles: expenditures on R&D in the OECD countries account for 2.2% of GDP on average, meaning that R&D investment makes up more than 10% of gross domestic investment. When other investments in intangibles, such as in patents and licensing, design, marketing, education, training, and software are added, investment in intangibles may represent as much as gross domestic investment (see Chapter 6 for a discussion of these issues). 1.9 The rapid development and spread of knowledge facilitated by technical progress and the ICT revolution is creating a more competitive and interdependent world. The share of world 4 See Wilson, E. & Rodriguez. 1999. "Are Poor Countries losing the Internet Revolution?" report prepared for infoDev, University of Maryland, College Park and Analysys Inc. 2000,"The Networked Revolution and the Developing World." Report prepared for InfoDev, World Bank. 5 "The Contribution of Information of Conimunication Technology to Output Growth: A Study of the G7 Countries", STI Working Papers, 2000/2, OECD: Paris, Paul Schreyer. 6 OECD 1998a, pp. 42-45. -4 - trade (exports and imports) in world GDP increased from 28% in 1970 to 45% in 1997,7 indicating increased globalization and competition in the global economy. Beyond trade, there is greater interdependency through more foreign direct investments and international sourcing of production inputs and inter-firm alliances, including the internationalization of R&D and technology licensing activities. Increased availability of ICTs; deregulation of financial and product markets; and the liberalization of trade, investment, and capital movements are accelerating this process Increased international competition in turn spurs firms to create new products and more efficient production processes. The expansion of international trade and production provides firms with the resources to finance innovative efforts, especially in countries with small domestic markets. 1.10 The direct role of technology in this process is reflected in the changing patterns of international trade . Between 1976 and 1996, the share of high- and medium-technology products increased from 33% to 54% of total goods traded (Figure 1.1). On the other hand, the share of other primary commodities fell from 34% to just 13%, while that of resource-based products remained constant. These trends have major implications for developing countries, which are primarily exporters of primary commodities. Not only the volume, but also the prices of their exports, have been falling over the last five decades. 1.11 These figures, however, highlight only the most visible aspect of the relationship between technology and globalization. Technological change combines with increased economic interdependency to intensify and alter the nature of global competition across a widening spectrum of industries. In industries characterized as low or medium technology, the increase in technical knowledge and associated organizational changes increasingly provide an edge in productivity and enable product differentiation, significantly shaping competitiveness and value added. At the same time, globalization adds to pressures for adjustment and restructuring, which can adversely affect unskilled workers as well as firms in industries vulnerable to foreign competition. 1.12 While, in principle, the globalization of trade, finance, and information flows may make it easier to narrow knowledge gaps across countries, the accelerating pace of change and the difficulties of many developing countries in getting started, may in effect, bring about the opposite - a widening knowledge gap or a "knowledge divide". If the knowledge gap were to widen, the world would be split even further, not just by disparities in capital and other resources, but also by disparity in knowledge. Increasingly, capital and other resources might flow to those countries with stronger knowledge bases, reinforcing inequality in a vicious circle.8 1.13 There is also the danger of widening knowledge gaps within countries. The OECD economies are seriously concerned that the rapid advances in knowledge may be adversely affecting unskilled workers and increasing unemployment. In a number of countries, there is evidence to show that technology and technology-related organizational change is widening wage disparities between skilled and unskilled workers (OECD, 1998b). Such impacts are likely to be felt even more stronger in developing countries, where access to education and ICT infrastructure is far more differentiated and where formal safety nets are less prevalent. The rural 7World Bank, 2000 World Development Indicators. 8World Bank, World Development Reportl998/99: Knowledge for Development, Washington DC, 1999. - 5 - areas and the poor are being left behind, and thus run the risk of being increasingly marginalized in the new knowledge-based economy (see Chapter 2 for a description of the situation relating to Korea). Figure 1.1: International Trade by Type of Good, 1976 vs. 1996 1976 1996 Miscellaneous g High TechTology Other Pno Misc ella ne o.us producs/ | A O1he,Pvney eonloighyTechnolgy / 1 / ttediwTeTechnology TV olneoloyReso C./li Chlee to Koe' Fuur Deelpmn .°.esource-base;~~~~~~~ Technog il Tcnby T,chn.logy Note: The technology intensity of rnanufactured products is determined by the share of R&D to sales, where high technology products are those widh the highest shares. Source: Based on figure 2.2, p.28 World Bank 1999a, based on World Bank Comtrade database. C. Challenges to Korea's Future Development 1.14 Korea's rapid economic growth has been largely the result of high savings and high investment rates. Studies of total factor productivity (TFP) growth indicate that although Korea's TFP has been respectable compared to that of other countries, it has been low compared to overall growth in outputs and inputs.9 A recent study, for example, shows that of the 7.5% per capita growth between 1970 and 1995, 55% was due to growth in capital inputs, 20% to growth in labor inputs, and 25% - or nearly two percentage points - was due to TFP growth (Table 1.1). 9 Total factor productivity (TFP) growth is a methodology for decomposing growth in value added into the contribution of growth in capital and labor inputs and a residual that is attributed to technical change. The results of the decomposition depend on the type of production function assumed and on the degree of adjustments made to the quality of inputs (for example education of labor) or the quality and utilization rate of capital. For estimates of TFP for Korea see Young (1993), McKinsey (1998), World Bank, 1999b. - 6 - Table 1.1: Total Factor Productivity Growth Estimates for Korea Contribution to GDP growth per capita per annum of 7.5% for 1970-1995 (assuming constant returns to scale and competitive markets) Labor inputs/capita 20.5% Capital inputs/capita 54.5% Measured TFP 25.0% GDP/Capita 100% Dissagregation of TFP growth of 3.6% per annum for period 1975-1995 (when adjustments are made for increasing returns and imperfect competition) Mark-ups 60.0% Scale effects 17.9% Technical change 17.3% Other 4.8% Source: World Bank, 1999b, p. 47. 1.15 Estimates of TFP depend very much on the methodology used for the calculations and most do not adjust for increasing returns to scale or to price mark-ups which are characteristic of markets with imperfect competition (such as those in Korea). When these adjustments are made, the contribution of TFP falls to less than 1%. Moreover, there is concern that per capita income growth will slow down as the contribution to growth due to increases in the working age population and rising labor force participation, as well as from rapid increases in educational attainment, reaches its limits.10 1.16 A theme that will be developed throughout this report is that Korea needs to achieve higher productivity from its considerable investments in physical and human capital. This also includes obtaining higher returns on the substantial resources that are being invested in information infrastructure and in research and development (R&D). In the context of the rapid changes taking place as a result of the knowledge revolution and a very dynamic and interdependent global economy, achieving these higher returns depend on redefining the role of the Korean Government and re-orienting its overall development strategy. 1.17 Korea's development model has largely relied on a government-led strategy based on the growth of large-scale industry. This model started in the early 1960's with the nationalization of key industries and banks. Control over the allocation of credit and a strong licensing and permit system allowed the government to influence the industrial structure. The key focus in the 1960s was a strong export drive, which was successful in making Korea an export-oriented economy. This was followed by the Heavy and Chemicals Industry drive in the 1970s. During this period, there was an increasing concentration of economic activity in the chaebol as it was easier for the government to implement its policies through a smaller number of firms. These firms, however, grew larger and became more diversified, benefiting from privileged access to subsidized state finance and favorable regulatory and administrative interventions from the government. 1.18 In the 1 980s, a series of policy measures were taken which aimed at strengthening market mechanisms. These included some trade liberalization, passing of the competition law, 10 One factor that still has strong potential is increasing labor force participation by women, an issue which will be developed in Chapter 2. - 7 - deregulation, and some privatization. Nevertheless, the role of the state and the reliance on the chaebol remained strong. Access to low-cost loans allowed the chaebol to continue their rapid expansion and to diversify into numerous industries - at the expense of profitability."1 This is corroborated by the declining rate of return on corporate assets in the 1990s.12 In addition, despite declining profitability, the chaebol steadily increased their leverage ratios during the 1990s as they continued to have access to cheap government-controlled credit. 1.19 Korea's development paradigm is now at a crossroads. The development model predicated on input-driven growth and the rapid expansion of the chaebol had played its role and had begun to falter by the early 1990s.While the financial crisis in Korea was triggered by the regional contagion, capital flight from the local currency, and a weak financial system with poor prudential regulation and supervision, it was in large part also a corporate crisis, driven by excessive corporate debt and associated structural problems (OECD, 1999b). 1.20 Beyond its revival from the crisis, Korea is confronted with serious structural issues. According to the IMD World Competitiveness Yearbook ranking, Korea fell from 26th place in 1995 to 38th in 1999 as a result of weakening structural factors that culminated in the 1997/98 crisis.13 For the year 2000, it moved back up to 28th place due to the many structural reforms that have been undertaken. It continued to rank lower in finance, management, infrastructure, and internationalization. Meanwhile, there will be increasingly fierce international competition, from advancing low-cost countries as well as in the advanced, knowledge-intensive areas. 1.21 The changing composition of manufactured exports from the East Asian economies points to the strong challenges facing Korea. Over the period 1980 through 1997, Korea's share of world manufactured exports roughly doubled to about 3%. However China increased it share of exports from about 0.5% of world manufactured exports in 1985 to nearly 4% in 1997, surpassing Korea, Singapore, Chinese Taipei, and Hong Kong, the former developing country leaders (Figure 1.2)'4. Meanwhile, China shows a dramatic fall in resource-based exports and a very significant increase in medium- and high-technology industries (Figure 1.3). 15 China's very rapid upward shift is exerting significant pressure, not only on developing economy exporters of labor-intensive manufactures, but also on developing and advanced country exporters of medium- and high-technology products. All the other East Asian economies also show a significant expansion of medium- and high-technology exports, with the exception of Hong " Claessens et. al. 1998. 12 World Bank 1999b, pp. 46-47 and figure 4.5. 13 The IMD methodology ranks a country based on structural factors and annual surveys of entrepreneurs. These are grouped into eight factors: domestic economy, internationalization, government, finance, infrastructure, management, science and technology, and people. 14 It is also striking that Hong Kong's share in world manufactured exports has actually fallen by half to only about 0.6%, while all the other East Asian economies have increased their shares. This reflects its falling competitiveness in manufacturing as well as its shift towards a service economy. However, Singapore has also shifted towards a knowledge-intensive service economy, while at the same time increasing its share of manufactured exports. 15 Technology intensity is defined by the share of R&D to sales in each sector, as determined by an average R&D to sales ratios for OECD countries. Although Korea has a stronger technological base than all other East Asian economies (with the exception of Japan), many other East Asian economies appear to show higher technological intensity in their exports because they rely on imported inputs with high technological components that are assembled locally and re-exported. Much of this is carried out by foreign firms using these countries as export platforms. There are also differences in product mix between Korea and the other countries. -8 - Kong, which has the largest share of low-technology exports. Singapore, Malaysia and the Philippines stand out due to their dramatic changes in export structures towards medium- and high-technology industries. These developments were largely enabled by export-oriented foreign investment, a strategy which, until recently, Korea had shunned because of its restrictions on direct foreign investment. Figure 1.2: East Asian Countries Share of World Manufactured Exports 4.50 so / ... .. _ ..... . _ _ . . . ... . . . ... ......... .......... ..... .. . . .. . .. ... .. 4.500% 3.00% - __ _ _ _ . _ _ .-_._ _ -_ 3.00% - ~ ~ ~ -- -~~~- ~ -~~ - --- ~~--~ 4 - -j ~~ i --_-.China a -| --Hong Kong 2.50% _ __ _ _ __ ____ _ +Singapore Korea 2.00% ->--E-_ Taiwan .01~~ ~~~~~~ = Malaysia --.--Indones'a / t t - Philippines Thailand too%--I '''' 0.50% …----- = - - - - 0.00% 1980 1985 1990 1995 1997 Source: UN COM1RADE Database Figure 1.3: Changing Composition of East Asian Manufactured Exports, 1985 vs. 1995 100% 80% 60% 40% 20% 0% 1985 1995 1985 1995 1985 1995 1995 995 1985 1995 1985 1995 1985 I995 1995 1995 1985 1995 China Hong Kong Singapore __Korea Taiwan Malaysia Philippines _Thailand [ndonesia 0 Resource based Low Techno logy_ MMedium Technology OHfigh_Technology- Source: Lail et. al. 1999 - 9 - D. Korea's New Development Strategy 1.22 Caught between the rapid advance of the export-oriented developing countries in the region, and especially China, on the one hand and the G7 countries on the other, Korea is currently under strong pressure to shift its development strategy towards becoming an advanced knowledge-based economy. Pnror to the crisis, some analysts were already predicting that the growth of the Korean economy and indeed that of the rest of the East Asian economies was not sustainable.16 The Korean press highlighted the n'sks facing the nation in a series of reports centered on the theme of change, the need for productivity-based growth, and a vision for the future based on knowledge.'7 The press also initiated discussions and dialogue with civil society and business groups on these issues. The govemment for its part, has intensified its efforts to develop an overall knowledge-based development strategy. This has included consultations with leading think tanks (the Korea Development Institute and others), as well as public hearings. 1.23 The task of mapping out the details of the strategy and the new vision, including that for the knowledge-based economy, was given to the National Economic Advisory Council (NEAC), which was fonned towards the end of 1999.18 During its second meeting on 19 January 2000, the NEAC unveiled a proposal for a three-year master plan that serve as the blueprint for turning Korea into a knowledge-based economy. The meeting, which was chaired by the- President, presented three goals: i) to make Korea one of the top- 10 knowledge and information powers through a massive upgrading of the National Information Infrastructure; ii) to improve education to meet OECD standards; and iii) to enhance the Korean science and technology base to the level of the G7 nations.'9 1.24 With Korea emerging from the crisis, now is the ideal time to take stock of where the country is, and what needs to be done to maintain a robust and sustainable recovery, remain competitive and increase the quality of life and welfare of its citizens in the 21't century. The remainder of this chapter develops the concept of the KBE and sets out a framework for analyzing the four main pillars that need to be addressed by Korea in its transition to an advanced knowledge-based economy. The four subsequent chapters summarize the key issues in each of these pillars. Chapter 6 sets out a programme for the promotion of knowledge-based activities. Chapter 7 concludes with the importance of developing a consultative process for building national consensus to address the outstanding issues, and suggests elements for an integrated implementation strategy. 16 See Paul Krugman, "The Myth of Asia's Miracle", Foreign Affairs, Nov. 1994. 17 The Maeil Economic Daily, for example, has sponsored three reports: Revitalizing the Korean Economy Toward the 21" Century 1997 by Booz Allen Hamilton; Productivity-led Growth in Korea 1998 by McKinsey; and Knowledge for Action 1998 by the Monitor Company. 18 The NEAC was legally created in November 1999 to focus mainly on future-oriented policy directions, in contrast to the more short-term policies that come under the purview of the Economic Policy Coordination Committee in the Prime Minister's Office. A further round of consultations took place within government agencies and research institutions to chart out the various action plans as part of the implementation strategy. This part of the process is expected to be completed in March 2000 to chart out the various action plans and implementation strategy. Preliminary details of the plan were announced at the beginning of April 2000. 19 See Chapter 7 for the most recent developments in the institutional responsibilities surrounding implementation of the knowledge based development strategy. - 10- E. The Concept of a Knowledge-Based Economy 1.25 The OECD defines knowledge-based economies as "economies which are directly based on the production, distribution, and use of knowledge and information." Actually, by that definition, all economies are knowledge-based. What is different, today, however, is that our rapidly growing economies are becoming increasingly dependent on the effective creation, acquisition, distribution, and use of knowledge which is, to a large extent, enabled by the rapid advances of the science base and the ICT revolution. In fact, it now appears that the effective use of knowledge and information is becoming the most important factor for international competitiveness, as well as for the creation of wealth and the improvement of social welfare.20 1.26 There are many ways of trying to measure the increasing spread of the "knowledge" sector in an economy. The pioneering attempt on this issue was made by Fritz Machlup in 1962. Machlup distinguished five broad categories of information activity: education, communications media, information machines, information services, and other information activities. He calculated that, in 1958, the knowledge sector accounted for about 29% of GDP in the United States, and about 32% of the labor force. Following the same methodology, Rubin and Taylor (1984) found that, by 1980, the share of the knowledge sector in GDP had increased to 32%. The OECD has also undertaken various studies of the knowledge economy, concluding that in the post-war period there has been a clear trend towards an economy where the share of the labor force engaged in the production, distribution, and use of information is much greater than the share handling tangible goods.21 1.27 Another way to trace the rise of the knowledge sector is to look at the share of various knowledge-based industries. The OECD defines knowledge-based industries and services as those which are relatively intensive in their inputs of technology and human capital. The narrowest category is high-technology manufacturing, that is, manufacturing where R&D accounts for a high percentage of sales. Its share of value added in the business sector in OECD countries averages 3% to 5% . A broader measure includes ICT manufacture and services. Using this measure, the share ranges from 5% in the United States to 10% in Japan, and has remained more or less constant, or fallen slightly, over the period 1985 to 1994, reflecting in part the falling share of manufacturing in value added and a decrease in defense spending." A still broader approach, which has been used most recently by the OECD, is to add communication services; finance, insurance, real estate and business services; and community, social, and personal services23 (see Chapter 6). 1.28 Over the past several years, Korea has been developing a foundation for its knowledge- based or "new" economy by developing inforrnation and communications-related technologies, and by promoting computer literacy and the use of the Internet. Knowledge-based industries have played a leading role in Korea's economic growth. According to the Ministry of Finance 20 See Lester C. Thurow, Building Wealth, 1999. 21 Foray and Lundvall, "The Knowledge Based Economy: From the Economics of Knowledge to the Learning Economy", 1996, pp. 15-16. 22OECD, 1998a. 23 The financial sector is perhaps the most information-intensive sector in the economy. It aggregates information on the use of resources in order to allocate capital to the most efficient uses. It is also the most intensive user of ICTs and has been the first to operate on a global dimension in real time, thanks to advances in ICTs. - 11 - and Economy, between 1991 and 1999, the average annual real growth rate of Korea's knowledge-based industries was 13.7%, 9.6 percentage points higher than the 4.1% recorded by other industries.24 In 1999, knowledge-based industries accounted for 45.6% of the nation's annual GDP growth rate. From 1991 to 1999, Korea's knowledge-based exports increased by an average of 26.4% annually, higher than the 11.3% recorded by other industries. These indicators reveal the increasing importance of knowledge-based industries. In recognition of this, the govermnent is taking additional measures to optimize conditions for the knowledge-based economy. These measures are set out in the recently released "Three-year Information Technology Plan" and include: the continuous expansion of investment in R&D and human capital; the development of a high-speed communications network infrastructure; and the encouragement of foreign direct investment from technology-intensive companies.25 F. Definition and Framework 1.29 Because of rapid technical progress, the development and application of ICTs and globalization, the acquisition and use of knowledge is becoming more central than ever to economic and social development. A knowledge-based economy is one that promotes its organizations and people to acquire, create, disseminate, and use (codified and tacit) knowledge more effectively for greater economic and social development. 26The KBE requires: 3 An economic and institutional regime that provides incentives for the efficient use of existing knowledge, the creation of new knowledge and entrepreneurship.27 - An educated and skilled population that can create and use knowledge. D A dynamic information infrastructure that can facilitate the effective communication, dissemination, and processing of information. * A system of research centers, universities, think tanks, consultants, firms, and other organizations that can tap into the growing stock of global knowledge, assimilate and adapt it to local needs; and create new knowledge. 24 The definition used by the MOFE appears to be based on the OECD's 1998 definition which includes high technology manufacturing, communication services, and finance, insurance and business services, but excludes the two other categories - medium-high-technology manufacturing and community, social and personal services, which the OECD added in 1999 By this definition, according to the MOFE, knowledge-based industries in Korea increased from 14.7% of GDP in 1991 to 20.5% in 1999 (compared to 34% in the United States for the latter year). 25 Korea Economic Update (Newsletter of Korean Ministry of Finance), April 20, 2000 (Volume 30 No.5, p.1). 26 The terms "new economy", "digital economy", and "knowledge economy" are currently used interchangeably, and usually focus on the creation and use of ICTs. In this report, we have chosen a broader definition of the knowledge-based economy that includes not only ICTs and industries dependent on high and medium R&D, but on the effective use of technical, policy, and social knowledge for economic activities. However, this not as broad as other definitions, for example, that of the knowledge society, which includes spiritual, social, intellectual and philosophical knowledge. 27 The economic institutional regime allows organizations, people, and institutions to adjust to changing opportunities and demands in flexible and innovative ways. In a sense, it is the fundamental pillar of the knowledge- based economy, since in the absence of a strong economic incentive and institutional regime that deploys these resources to productive uses, it is possible to have a strong educational base and/or a highly developed R&D infrastructure (as is the case in Russia, for example), but to miss out on the full benefits of these achievements. Thus, it is the nature and quality of interactions among the four pillars of the framework that are important for the knowledge-based economy, as broadly defined in this report. - 12 - 1.30 These are the necessary conditions for increasing the efficiency, flexibility, and resilience of the economy and its ability to restructure, respond to new challenges, permit the emergence of new firns, and take advantage of new opportunities to ensure that the benefits of growth are broadly shared by society. The rationale for the focus on each of these factors is discussed below. The following four chapters will evaluate Korea's position in each and identify the key issues that need to be addressed in the transition to an advanced knowledge-based economy. Annex I benchmarks Korea against a group 61 countries (28 developed and 33 developing countries) using a scorecard of basic indicators for each of the four areas. The highlights are summarized at the end of each of these sections. Chapter 6 takes note of the outcomes of the interactions of these four pillars in terms of industrial structure and examines five structural policy areas that need to be addressed in promoting knowledge-based activities. 1. A New Economic Incentive and Institutional Regime 1.31 Whether the vast and rapidly growing stock of global knowledge is tapped and used efficiently by a country depends to a large extent on the economic incentive regime and institutional set up in place. The incentive regime depends on the structural and market and non- market institutional arrangements within an economy. A competitive environment induces firms and individuals to seek out knowledge on how to produce goods or services more efficiently or to produce new goods and services. The general competitive environment and the pressures for more efficient firms to expand and for less efficient ones to shrink or disappear have a direct bearing on the diffusion of knowledge in an economy. 1.32 Taking advantage of the potential offered by the knowledge revolution will require a flexible society and economy, able to successfully cope with the need for constant change. This will continue to hinge on effective economic incentive regimes and institutions that promote and facilitate the constant redeployment of resources from less efficient to more efficient uses. This, in turn, means good macroeconomic, competition, and regulatory policies and the existence of financial systems that can allocate resources to promising new opportunities (including venture capital) as well as re-deploy assets from failed enterprises to more productive uses. It also requires conditions that are conducive to entrepreneurship and risk-taking, the expansion of small enterprises, an adequate exchange of information between science and industry, as well as a sufficiently flexible labor markets that can facilitate the redeployment of labor. It also implies the development of appropriate social safety nets to facilitate the constant relocation and retraining of people for new jobs, and help those people who are adversely affected by constant restructuring. 1.33 The ways in which people access relevant knowledge and the incentives for them to gather, provide and use it are also affected by the institutional structure of a society. This involves relationships between legal rules and procedures, social conventions, organizations such as firms, and government and non-government organizations and markets. Equally important are the institutions that govern the rules and procedures in a society, which in turn determine how decisions are made and actions taken. A key feature is the quality of government, as its integrity and effectiveness determine the basic rules of a society. Another important element is the extent to which the legal system supports basic rules and property rights. The creation and dissemination of knowledge, for example, is strongly affected by the degree to which intellectual property is valued and its rights, protected and enforced. - 13 - 1.34 Finally, the ICT revolution will also have implications for governance systems which need to cope with the many demands that such constant restructuring and redeployment will put on the rules of the game both at the international and the national level. Globalization and the trend towards a global innovation system is intensifying pressure for harmonization in in the treatment of intellectual property protection, competition policy, and taxation. At the same time, the moves towards greater democratization, transparency, accountability and decentralization in government, which are in part facilitated by the ICT revolution, will raise new challenges related to coping with local needs in an increasingly globalized environment. Compared to the most advanced countries, Korea still has some way to go on many aspects of the economic and institutional regime (see Annex 1). However, Korea is using the pressure of its recent financial crisis to undertake a major overhaul of its economic incentive and institutional regime to move towards a new knowledge-based development strategy. In Chapter 2, we analyze the progress made to date in the economic incentive and institutional regime, and highlight areas that still need attention. In Chapter 6, we analyze some of the key issues that need to be addressed to further promote knowledge-based activities. 2. Skilled and Creative Human Resources for the Knowledge Economy 1.35 Skilled and adaptive people play a crucial role in taking advantage of the potential offered by the explosion of new knowledge and accelerating technical change. Ensuring that expenditures on education are allocated efficiently, and that the entire population has the knowledge and skills necessary to participate in the knowledge-based economy requires particular attention. Education is the basis for creating, acquiring, adapting, disseminating, sharing, and using knowledge. Basic education increases peoples' capacity to learn and to use information. But this is just the beginning. Increasingly, it is also necessary to have technical secondary education, as well as higher education in engineering and scientific areas to monitor technological trends, assess what is relevant for the firm or the economy, and to use the new technologies. The production of new knowledge and its adaptation to a particular economic setting is generally associated with higher-level teaching and research. In industrial economies, university research accounts for a large share of domestic R&D; in Korea, however, universities produce very little research. 1.36 In the context of rapid development and dissemination of new knowledge, opportunities for lifelong learning are essential. Creating a culture of continuous learning and openness to new ideas is critical for a knowledge-based economy. This should not only be limited to learning on the job, but to learning in multiple environments: at home, at school, and at work through both structured continuing education courses, self learning through the Internet, or computer-assisted instruction. In addition, to be able to use the new technologies, in particular the very rapidly changing ICTs, workers and firms need new skills. Firms are investing heavily in training their employees. In Korea, firms complain that they have to invest in retraining new college graduates who are just entering the workforce - indicating that despite high levels of educational attainment, the educational system is failing to meet the needs of the new knowledge-based economy. - 14 - 1.37 In Chapter 3, we take a critical look at the education and skills issues facing Korea from the perspective of the needs of the knowledge-based economy. Korea ranks favorably in educational attainment, even when compared to advanced countries (see Annex 1). However, the surprising conclusion is that, despite the very high levels of investment in education and skills, this is the area that requires the most fundamental reform and restructuring to position Korea to take full advantage of the knowledge economy. 3. A Dynamic Information Infrastructure 1.38 The rapid advances in ICTs are dramatically affecting economic and social activities, as well as the acquisition, creation, dissemination and use of knowledge. These advances affect the way in which manufacturers, service providers, and governments are organized, and how they perform their functions. Increased access to ICTs is affecting the way people work, learn, play, and communicate. As knowledge becomes an increasingly important element of competitiveness, use of ICTs is reducing transaction costs, time and space barriers, allowing the mass production of customized goods and services, and substituting for limited factors of production .With ICT use becoming all-pervasive and its impacts transformational, they have become an essential backbone of the knowledge-based economy. To support Internet-based economic activities, countries need to ensure competitive pricing of Internet services and provide an appropriate legal infrastructure to deal with online transactions. 1.39 The National Information Infrastructure (NII) consists of telecommunications networks, strategic information systems, the policy and legal frameworks affecting their deployment , as well as the skilled human resources needed to develop and use it. To develop a strong NII, it is necessary to mobilize the many stakeholders that are involved in its deployment and use - government, business, individual users, the telecommunication and information service providers, and so on. The formulation of a NII strategy involves identifying the opportunities and needs for information and communications infrastructure in the economy. It also involves assessing the existing information systems in the economy to identify common constraints and difficulties, and formulating goals and visions for the NII. The latter are political roles around which to rally the resources of society. As such, the government has a very important role in the articulation of that vision, although this should be done in a consultative process with other stakeholders. 1.40 It is also essential to assess the knowledge and skills required in the workforce to design, implement, and use the new ICTs. This requires researchers and technicians across a spectrum of information technologies, a workforce that can use the new production technologies, and a general population that can use electronic products, computers, and software, and information services effectively. Addressing these needs will require developing education and training policies, institutions, and programmes to prepare the appropriate human resources. While the government does not need to provide any of these services, it can play a critical co-ordination role in identifying needs and weaknesses, ensuring that the necessary skills are developed, and setting in motion mechanisms to accomplish this. 1.41 In Chapter 4, we analyze Korea's information infrastructure. In the scorecard indicators (see Annex 1) we found tPat, based on data for 1997, Korea did not rank very well compared to - 15 - advanced countries. However, the goverrnment has developed a comprehensive and ambitious plan with high investments in this area, and much progress has been made to date. Nevertheless, there are still some major issues to be addressed in the regulatory and legal regime, which, if properly dealt with, could speed up progress in this critical area. 4. An Effective Innovation System 1.42 An innovation system consists of the network of institutions, rules, and procedures that affect how a country acquires, creates, disseminates, and uses knowledge (see Box 1.2). Currently, the bulk of technical knowledge is produced in the developed countries. Estimates show that roughly 88% of total R&D expenditures are undertaken by developed countries and that these countries also account for roughly the same percentage of patenting or the production of scientific and technical papers. On a per capita basis, the disparity in the production of technical knowledge is greater than the disparity of income between developed and developing countries. Fortunately, developing countries do not have to reinvent everything. There are many ways in which they can tap into and use the knowledge created in developed countries. Box 1.2: National Innovation System There is no single accepted definition of a national innovation system; what is important is the web of interaction or the system as a whole. The concept of national innovation systems rests on the premise that understanding of the linkages among the actors involved in innovation is key to improving a country's technology performance. Innovation and technical progress are the result of a complex set of relationships among actors producing, disseminating, acquiring and applying various kinds of knowledge. The innovative performance of a country depends to a large extent on how these actors relate to each other as elements of a collective system of knowledge acquisition, creation, and use. These actors are primarily private enterprises, universities and public research institutes and the people within them. Linkages can take the form of joint research, personnel exchanges, cross- patenting, licensing of technology, purchase of equipment and a variety of other channels. Expanded definition of that used in OECD, National Innovation Systems, 1997. 1.43 Developing countries need to establish effective institutions to create, adopt, and disseminate knowledge locally. Some of the key organizations for the creation of knowledge include universities, public and private research centers, and policy think tanks. And to the extent that they also produce new knowledge, non-government organizations, private firms, and the government are also part of the innovation system. Some of the key institutions for the dissemination of knowledge include agricultural and industrial extension services, engineering consulting firms, economic and management consulting firms and, in the case of Korea, the GRIs. However, the mere existence of these organizations is not sufficient. What is important is the extent to which they are effective in creating, adapting, and disseminating knowledge to the firms, government, other organizations or people who put it to use. Therefore, networking and interactions among the different organizations, firms, and individuals are critically important. The intensity of these networks as well as the incentives for acquiring, creating, and sharing knowledge are also influenced by the economic incentive regime in general. They are also affected by specific policies relating, for example, to the importation of foreign technology through technology licensing, direct foreign investment, foreign collaboration, and policies on the protection of intellectual property. - 16- 1.44 In Chapter 5, we analyze these issues in the Korean context. According to official Korean data, the country actually spends more on R&D as a share of GDP than most other OECD countries (2.8% of GDP during 1985-95). However, the scorecard indicators (Annex 1) suggest that it does not appear to be getting full value for its money. Its broader innovation system must therefore be improved to take advantage, not only of the creation of new knowledge at home, but also for the acquisition of knowledge from abroad, and for the dissemination and effective use of knowledge regardless of where it is created. 1.45 Given its high educational attainment, heavy investments in R&D, and very rapid progress in developing its information infrastructure, Korea is on its way to becoming a knowledge-based economy. Chapters 2-6 show that much work remains to be done to provide adequate conditions for this. Chapter 7 highlights some of the issues that need to be addressed in order to implement a successful development strategy. - 17 - REFERENCES Analysis Inc. 2000. The Networked Revolution and the Developing World. Report prepared for infoDev, World Bank, Washington, D.C. Booz Allen Hamilton. 1997. Revitalizing the Korean Economy Toward the 215 Century. Claessens, Stijn, S. Djankov. J. Fan, and L. Langet. al. 1998. Resolution of Corporate Distress: Evidence from East Asia's Financial Crisis. World Bank. Policy Research Working Paper No. 2017. World Bank, Washington, D.C. Foray, Dominique, and Bengt Ake Lundvall. 1996. "The Knowledge Based Economy: From the Economics of Knowledge to the Learning Economy". In OECD, Employment and Growth in the Knowledge-based Economy, pp.1 5-16. Korea Economic Update (Newsletter of Korean Ministry of Finance), April 20, 2000 (Volume 30, No.5, p.1). Krugman, Paul. 1994. The Myth of Asia 's Miracle. Foreign Affairs, November. Lall, Sanjaya, Manuel Albadejo, and Enrique Aldaz. 1999. "East Asian Exports: Competitiveness, Technological Structure and Strategies." Paper prepared for ASEM (Asia Europe Meeting) Regional Economist's Workshop: From Recovery to Sustainable Development. Machlup, Fritz. 1984. Knowledge: Its Creation, Distribution and Economic Significance, Vols. 1, 2, 3. Princeton: Princeton University Press. McKinsey. 1998. Productivity-led Growth in Korea. Monitor Company. 1998. Knowledge for Action. OECD. 1998a. Science Technology and Industry Outlook. OECD. 1998b. Technology, Productivity and Job Creation - Best Policy Practice. Paris. OECD. 1999a. 1999 "Science, Technology and Industry Scoreboard, Benchmarking Knowledge- Based Economies." Paris. OECD. 1999b. "Asia and the Global Crisis. The Industrial Dimension." Paris. OECD. 2000. "Is There a New Economy? First Report on the OECD Growth Project." Forthcoming. Paris. Shreyer, Paul. The Contribution of Information of Communication Technology to Output Growth: A Study of the G7 Countries. STI Working Papers, 2000/2, OECD: Paris. - 18 - Thurow, Lester. 1999. Building Wealth. Wilson, E. & Rodriguez. 1999. Are Poor Countries Losing the Internet Revolution? Report prepared for infoDev, University of Maryland, College Park. World Bank. 1 999a. World Development Reportl998/99: Knowledge for Development, Washington D.C. World Bank. 1999b. Korea, Establishing a New and Sustained Foundation for Sustained Growth, Washington D.C. World Bank. 2000. 2000 World Development Indicators. Washington D.C. Young, Alwyn. 1993. Lessons from East Asian NICs: A Contrarian View, NBER Working Paper No 4482. October, Cambridge. - 19- CHAPTER II: UPDATING THE ECONOMIC INCENTIVE AND INSTITUTIONAL REGIME A. Introduction 2.1 The 1997 crisis clearly demonstrated the need to re-examine the economic incentive and institutional regime in Korea. The main challenge facing Korea is to move away from past direct interventionist policies to create a flexible, adaptable, market-based networked economy and creative society. 2.2 The broad agenda presented in this chapter includes completing the structural reforms started in the wake of the crisis and putting these into practice, including redefining the role of government, creating conditions that support the entry of more new players in the economy, improving the soundness and efficiency of the financial system, increasing the flexibility of the labor market and preventing the potential "knowledge and digital divide", and strengthening the basic institutional infrastructure and fortifying the rule of law. B. Redefining the Role of Government 2.3 The Korean Government has played a key role in the country's rapid development, and will indeed play a critical role in the transition to the knowledge-based economy. However, this new role must abandon the interventionist policies of the past. Meeting the requirements of the knowledge-based economy means making markets work more effectively. This will facilitate the constant redeployment of the resources that enter into the creation and implementation of new and better ways of doing things and the rejection of outmoded methods, but cannot be done through heavy government intervention in the economy. The key elements of the changed role of government in this context are: * Promoting competition, entrepreneurship, and deregulating the market to unleash the creative energy of individuals and the private sector, while at the same time providing a modem regulatory framework to support the efficient and equitable functioning of markets. * Securing the rule of law and providing greater transparency, disclosure of information, and accountability for market players, as well as for government. * Building up and harnessing a modern legal and institutional infrastructure relevant for the knowledge economy, in such areas as intellectual property rights, valuation of intangible assets, cyber laws covering privacy, security, and digital transactions. * Addressing the access and equity issues that may result from greater reliance on stronger market forces, from continuous restructuring, and from the risk of a growing digital divide. * Providing public goods such as basic education and basic research. - 20 - * Addressing missing or underdeveloped markets and networks, including acting as a catalyzor for a high-speed Internet backbone,1 promoting new technologies,2 facilitating networking (e.g. between universities, researchers, and firmns), while being careful to foster market-led mechanisms rather than impede them. 2.4 In addition, the government must modernize and restructure itself in order to capture efficiency gains by: improving the quality, efficiency and delivery of public services; strengthening government information flows; and building strategic information systems.3 Since the crisis, the Korean Government has already made a very impressive start in this direction. Reforms in the corporate, financial, and labor markets are being supported by a restructured public sector consisting of a "small, efficient and service-oriented government" which will be achieved through improved public sector management, including the tax system and administration; more transparency in expenditures and budgeting processes and human resources management; and greater outsourcing to the private sector. Over the coming years Korea will need to address a number of issues in this area. The program will entail completing govermnent reforms to achieve a civil service that is knowledgeable and compatible with the information age through: an appropriate level of salaries; new modalities for policy making in the context of greater globalization; the creation of a knowledge based government through extensive training, the building of government informnation networks and better methods of knowledge sharing;4 and the definition of the role of government in knowledge based activities. In addition, there is a need for privatization of state-owned enterprises, especially in the information infrastructure sector, to provide reliable, efficient and low-cost services through the effects of competition underpinned by the modern regulatory oversight found in other OECD countries. There is still a strong sentiment in the private sector that the government sector has not changed enough - it is primarily perceived as a regulating institution rather than one that is supportive of individual creativity, and fully engaged in encouraging the growth of the private sector. The government will have to become a facilitator of change, fostering broad participation consistent with the distributed power arrangements of the networked, knowledge-based economy. 2.5 While the government plays a critical role in creating the appropriate incentive regime and in strengthening the education and informnation base, entrepreneurship and innovation are central to the knowledge-based economy. These activities are carried out primarily by ' In large infrastructure such as the high speed internet backbone, profits depend on scale and scope economies and on complex arrangements influenced by laws and regulations, and benefits may consist of public goods that are not captured as profits. 2 Including, for example, acculturation policies for the use of computers and internet among the population. 3 This includes sector-wide information systems for education, health, public sector management, transport, electronic payments, university and science network, trade facilitation, property and business registries, disaster prevention and national statistics. 4 Some of detailed measures contemplated by the government are: a) strengthening cooperation between government ministries by raising the positions of ministers of Finance and Economy, and Education to that of deputy Prime Minister level in charge of coordinating other Ministries, a development committee for human resources and a ministers meeting on welfare policies, voluntary reengineering of each ministry; b)accomplishing e-government in the short-term, through a knowledge management system and the introduction of e-administration (e-mail reports, electronic approval systems and electronic data interchange and Laining; civil affairs office to provide service for 24 hours through the internet) c)improving the budget management institutions (by finding ways to increase the efficiency of public spending including those of local governments) d) proceeding with deregulation and e) reformn of state owned enterprises and privatization (MOFE, February 28, 2000, Korea Economic Update). - 21 - individuals, firms, and non-governrment organizations. An essential element concerns spurring greater technopreneurship, i.e. entrepreneurship combined with the use and development of modem information and communications technologies in a broad span of sectors, including services. There are still fiscal and other barriers to entrepreneurship, however, and despite a rapid development of venture capital markets in recent years, challenges remain as regards the performance of new and small firms more generally and the degrce of entrepreneurship among people (see further Chapter 6). A culture of entrepreneurship also involves a change in the mind- set of people as regards failure. One reason for the high level of innovativeness and dynamism in the United States is that honest failure is socially acceptable. Many successful entrepreneurs have failed several times in trying to bring innovative ideas to the market before they succeeded . For Korea to achieve such a change in mind-set change and foster a greater more entrepreneurial culture5 will require joint action on the part of the educational system, the media, and the society at large. C. Opening Up the Economy and Promoting Competition 2.6 Greater Opening to Trade: Reducing Tariff and Non-tariff Barriers. During the 1980s and 1990s, Korea embarked on selective liberalization and deregulation of the economy. This resulted in a decline in the percentage of product markets in which the top-three firms together accounted for more than half of total sales: from 88% in 1981 to 76% in 1994. However, the degree of competition was relatively limited prior to the crisis, as evidenced by measures of the mark-up of prices over costs: relative to other countries, mark-ups were significantly higher in Korea in a large number of manufacturing sectors. Moreover, these mark-ups were found to be negatively correlated with Total Factor Productivity growth, suggesting that the lack of import competition had significant negative impacts on productive efficiency.6 2.7 Since the crisis, however, there has been a further liberalization of the Korean trade regime. The simple effective tariff rate which had declined from 6.8% in 1988 to about 4.5% in 1996 was brought down further in 1998 and, by 1999, 90% of the rates were under 10% and the effective tariff rate had fallen to 2.8%. Progress had also been made on non-tariff barriers, and further deregulation is planned. 2.8 Opening up Foreign Investment. After joining the OECD in 1996, Korea streamlined previously restrictive regulations and brought them up to internationally accepted levels. Since the crisis, it has undertaken major liberalization of foreign investment through the New Foreign Investment Promotion Act (1998 and revised in 1999). As of May 2000, of a total 1 148 classified sectors, only four remained closed to FDI. The 14 partially closed sectors and three of the closed sectors are expected to be further liberalized in 2000. Market access has been expanded through the liberalization of sectoral restrictions and the facilitation of cross-border mergers and acquisitions. As a result of the liberalization and the requirement that over- leveraged domestic firms reduce debt equity ratios to 200% by the end of 1997, FDI more than 5 This point is central to the United Kingdom's 1998 White Paper "Our Competitive Future: Building the Knowledge Driven Economy", prepared by the Departmnent of Trade and Industry after extensive consultation with business and civil society. 6See World Bank, "Korea: Establishing a New Foundation for Sustained Growth", 1999. - 22 - doubled between 1997 and 1999 as many domestic firms sold assets (Figure 2.1). Most of the restricted sectors are in the service industries.7 Some of the affected sectors that directly relate to knowledge diffusion are broadcasting, television and cable broadcasting, news agency activities, publishing of newspapers, periodicals, and telecommunications. Figure 2.1: Korea: FDI by Sectors (US$, Million) I 6100 - - + M a.u fa-c luring 14000 ~~~~~~~~~~~~~~~~~~~~-' -S e reXicecy --- Other- 2000 -- ----~~~~~~~~~~Totll/ 6 0 0 0()- -/ 4 000 - 2000-- ---- - , 1962- 1991 1992 1993 1994 1999 1996 9997 1999 1999 2.9 Korea now needs to focus on how to be more proactive in attracting the FDI that can contribute most to its present stage of development and on maximizing the positive spillovers from such investments in the economy, especially the knowledge-intensive industries and the service sectors.8 Much will depend on the extent to which the industrial structures, workforce competencies and institutional conditions, such as intellectual property rights, induce foreign firms to transfer skills, technologies and management practices, and allow domestic enterprises and individuals to capture spillover effects. The experience of countries such as Ireland and Singapore are particularly relevant in this area. Chapter 6 further develops some of these issues. Appendix 1 presents a case study of the Irish experience. 2.10 Deregulation. The first important step towards domestic regulation came with the passage of the Basic Act on Administrative Regulations in 1997. In 1998, the Regulatory Reform Committee was established under the Office of the Prime Minister. By July 1999, a total of 5 480 regulations had been eliminated, 5 695 had been streamlined, and 7 707 regulations emanating from 934 subordinate laws had been revised. In addition, 1 466 out of 1 840 informal regulations had been abolished. Although much progress has been made in liberalizing the trade and foreign investment regime, Korean markets are still encumbered with vague and complicated regulations, especially in the service sectors. Excessive regulation is one of the reasons why the 7 The 14 partially restricted sectors are: cereal grains production, publishing of newspapers, publishing periodicals, coastal water passenger transport, coastal water freight transport, scheduled air transport, non-scheduled air transport, wire telecommunications, wireless telecommunications, domestic banking, trust companies, cable broadcasting, and electric power generation. (Ministry of Commerce, Industry and Energy, ROK, "Shaping a New Investment Environment: Korea prepares for the 21 5 Century, September 1999). 8Ambiguous tax laws as well as cumbersome regulations on customs and import procedures have been regarded as the most serious impediment to foreign investment (discussions with KOTRA). - 23 - service sector remains relatively underdeveloped compared to countries such as Singapore, the United Kingdom, the United States and Japan (Figure 2. 1).9 Figure 2.1: 9o ---- SerC-e-as-% of-GDP (195196 - - --- HongeKong 80 - - -- '52S06---- -y ~i-~-26--- ---- - USA--- R2 =0.2249 Sngapore 60 - - - * t *opan 60~ ~~~Ic ----- ----------* **.21an aIndia af_ ianland Vietnam _ 30 --- - azil China * V 20 ----_ - ------- -_-----------\- ----- Maysi I\Eaysia U ~ ~ ~T____ ___ 0 1 2 3 4 S Per capita GDP (US$ 1995, Log) 2.11 Maintaining the momentum of deregulation will be crucial in order to ensure the more competitive environment that would facilitate greater knowledge acquisition, diffusion and use. Deregulation should also focus on other areas central to the knowledge economy-education and human resources, information infrastructure, and the science, technology and innovation system, as will be developed in subsequent chapters. While each Ministry is empowered to carry out its own deregulation mandate, overlapping areas have not yet been successfully resolved. Also, "informal guidance" should be underpinned by legal foundation and the regulatory oversight of infrastructure sectors should be brought up to the level of the OECD models. The strengthening of skills in the area of regulatory reform and modem regulatory oversight will be necessary as the country moves into the next phase of its transition to a knowledge-based economy. 2.12 Increasing Domestic Competition and Entry. The recent trade and FDI liberalization and many of the regulatory reforms currently being undertaken should improve the competitive structure of the economy. Korea's liberalization effort has in fact significantly increased the 9 In retail trade, retail banking, telecommunications, and construction sectors, for example, product market regulations appear to have limited the degree of competition (McKinsey Global Institute, Productivity-led Growth for Korea, 1998). In the telecommunications sector, although long distance and the international services were deregulated, Government interventions on pricing decisions have limited the ability of new entrants to compete against the incumbent on price, and a lack of equal access to subscribers has further impeded their efforts to compete. The deregulation of the services sector is particularly important, given the large productivity gains that can be reaped through deregulation (in the US communications sector, for example, deregulation has brought productivity gains that have exceeded the economy-wide average by two thirds over the last 20 years) and the important synergies between manufacturing and services sectors that can be exploited. Many such anti-competitive regulations are now being eliminated. The Government has also announced a privatization program, the first phase of which includes Korea Electric Power (KEPCO) and Korea Telecom (KT). The intention is to introduce effective competition, and the Ministry of Budget and Planning recognizes that regulatory oversight would have to be developed before any significant privatization transaction takes place. - 24 - potential for foreign competition across the board. These actions will discipline industrial behavior, provide a more level playing field for new entrants and thus usher a new industrial structure consistent with the development of the market economy, in contrast to past directive measures. The challenge is to ensure that the reform effort is sustained and that continued progress is made in promoting a more competitive environment. The next step is to build capacity among regulatory institutions to shape a fair and efficient market system. The Korean Fair Trade Commission (KFTC) established in 1980 - which is in charge of enforcing the Monopoly Regulation and Fair Trade Act (FTA) - has been strengthened over the past few years.10 In terms of overall competencies, the KFTC ranks well with other OECD and developed countries. However, to effectively fulfil its competition objectives, the KFTC needs certain strengthened capabilities, particularly with respect to investigative skills and enforcement capabilities. I 1 2.13 Korea's industrial development and present structure has been much influenced by government support for the chaebol, and the impediments confronting foreign competitors as well as small and young companies in Korea. The govemment has implemented a range of measures to create a more favorable business environment, but there is still a strong element of command policies rather than measures which can put in place mechanisms for spontaneous change. Also, much remains to be done with respect to implementation and consolidation of existing policies. These issues are returned to in Chapter 6. 2.14 Bankruptcy and Reorganization. The Korean Govermment has reviewed measures to remove impediments to the effective implementation of bankruptcy and reorganization laws. A New Bankruptcy Act has been passed and 99 companies from 21 chaebol have been placed under court supervision since 1997. Of these, 59 were placed under court receivership, which entailed a loss of ownership and management control, and 40 are in the process of reorganization. Some asset transfers have also been completed, including the sale of Kia to Hyundai, or are under final negotiation. The Korean government has been encouraging market led workout programs. To improve the efficiency of restructuring under court supervision, in December 1999 the National Assembly passed amendments to the Korean insolvency laws, including the Corporate Reorganization Act and Composition Act. Some important changes are: i) a shortening of the maximum period for courts to decide whether to accept a reorganization petition, from five months to one month; ii) a reduction in the requirement for the approval of a reorganization plan from 80% to 75% of the secured creditors; and iii) automatic application of the liquidation process in cases where a reorganization plan fails. The amendment will be effective three months after its promulgation. The remaining issue here is the more effective implementation of the procedures and over time, the move towards an increased reliance on market-based remedies through the legal system. '0 So far the KFTC has focussed largely on unfair trade practices, which include predatory pricing and cross- subsidization of subsidiaries, false advertising, and refusal to sell. It has done less in the areas of abuse of dominant position, and resale price maintenance, which require more analytical skills. Also, monitoring of mergers and acquisition (M&A) has been generally limited to responding to pre-notifications. Capacity needs to be built to assess more complex M&A cases where enhanced efficiencies of M&A outweigh the effects of competition restriction. 1 1 For more detail, see World Bank, 'Korea: Establishing the Foundations for Sustained Growth," 1999 and OECD, Regulatory Reform, Korea, 2000. - 25 - D. Increasing the Soundness and Efficiency of Financial Markets 2.15 Bank and non-banking institutions. Since the beginning of the crisis in November 1997, Korea has made significant progress in restructuring its financial system and reestablishing the solvency of banking institutions and begun to lay the foundations for a sound and efficient financial system. Distressed banks are in the process of being restructured, viable banking institutions have been recapitalized, non-performing loans (NPLs) acquired from distressed institutions are being sold and a new regulatory and supervisory framework is being established. A major turnaround was made in terms of phasing out all policy loans, a cornerstone of the previous development strategy.12 While these achievements are remarkable, the agenda for financial sector reformn over the short term remains unfinished. The success of the financial sector restructuring program will depend upon the reduction of the still high leverage of domestic enterprises. A lack of significant progress in corporate sector restructuring will undermine any improvement in the health of financial institutions. Amnong the most important issues faced by the govermnent in the short term are: resolution of NPLs; asset disposal by KAMCO (Korea Asset Management Company), recapitalization of banking institutions; resolution and restructuring of Non Bank Financial Institutions (NBFIs), especially the merchant banks, finance companies, insurance and investment trust companies; and privatization of nationalized banks. 2.16 Despite significant improvements in the framework, additional changes are necessary to ensure that the financial sector promotes efficient mobilization and (re)allocation of funds to new and emerging knowledge intensive sectors and that markets and institutions exercise due diligence over Table 2.2: Total outstanding venture corporations including improved corporate governance capital investments in Korea practices. Moreover, improving accounting and (Won Dec 97 Dec 98 Dec 99 disclosure standards, and minimizing moral hazard billion) Total fund 2,501 2,606 4,691 through the use of public funds for financial sector Investment 1,833 1 ,511 2,188 restructuring, remain a medium term issue on the agenda. outstanding % of GDP 0.40 0.34 0.44 2.17 While these actions would be necessary to Source: MOFE improve the financial markets, the longer-termn challenge is the creation of a sophisticated market-based financial system that will fundamentally alter the incentives and institutional framework influencing the behavior of banks and other financial institutions, enterprises and policy makers. Four sets of policies appear to hold the key to promoting a broader, more efficient and adaptable financial sector over time: continued strengthening of the incentive framework for the governance of financial institutions; promotion of securities markets (especially through good corporate governance, accounting and legal frameworks);13 further 12 Policy loans were given under the directives of the Ministry of finance to selected sectors especially to the heavy and chemical industry sectors. 13 Financial-and in particular capital market-development appears to be positively affected by good corporate govemance. Korea has made great strides in this strengthening corporate govemance since the crisis. These fall in the broad categories of: a) shareholders' rights, particularly those of minority shareholders b) institutional and strategic investors' rights c) creditors' rights d) accountability and functioning of corporate Board of Directors e) improving the legal system, including better insolvency procedures and f) improving the transparency of financial information and ensuring accountability (see Chapter 6 and World Bank (1999) for a more detailed discussion). As - 26 - opening of the financial sector and strengthening of legal codes and prudential regulation (see World Bank 1999 for more details). 2.18 Venture Capital. In Korea, the emphasis is placed on collateral-based debt rather than on equity. This practice presents a bias against small start-up firms in knowledge-based industries which can incur high costs for knowledge gathering, but which generate little physical collateral. Improving access to equity capital is important to the success of knowledge-based businesses.14 Total venture capital investments outstanding amounted to KRW 2 188 billion at the end of 1999, or about 0.4% of GDP (Table 2.2). 5 In contrast, in the United States, outstanding venture capital investments amount to about USD 95 billion, or over 1% of GDP. 2.19 To improve the venture capital market, Korea should strengthen regulatory oversight and information disclosure, reduce restrictions on capital funds, and open up to full participation of foreign investors. It is also important to further encourage a culture of entrepreneurship and technopreneurship and overcome the social stigma associated with business failure. Policies that promote the development of the public (stock) market may also provide an impetus for the (private) venture capital markets. E. Enhancing Labor Flexibility and Strengthening Social Safety Nets 2.20 Enhancing Labor Market Flexibility. The Korean labor market has been excessively rigid in the past, as measured by layoffs. Labor legislation, labor relations, and industrial and market structures have all contributed to labor market rigidities. Such rigidities hamper the ability of the country to respond rapidly to the changing market needs and opportunities which result from restructuring pressures and those brought about by the knowledge revolution. 2.21 A number of initiatives have been implemented since the crisis to create a more flexible labor market. The government has revised the labor law to legalize layoffs; introduced a legal framework for manpower leasing services; relaxed restrictions on private employment agencies; extended unemployment insurance to cover workers in all firms including temporary and part time workers; and introduced measures to improve the efficiency of active labor market policies. However, more work still needs to be done in this area. The issues include overcoming labor's resistance to reform; revising employee benefits to make them fully portable; reorienting training these reforns take hold and are deepened, they should provide further impetus to the development of Korea's stock markets. 14 Venture capital has made possible the growth of new knowledge-based industries in sectors ranging from computer technology, pharmaceuticals, and biotechnology. The explosion in the Internet and teleconmmunications in the US is facilitated by the presence of robust venture capital. Venture capital provides the fmnancial foundation for innovation that is driving knowledge-based economies. 15 Even in larger industrial countries the importance of venture capital varies significantly. In the USA, Canada, and the UK where venture capital markets are the largest, new venture capital investments averaged 0. 15-0.185 of GDP. In many other countries such as Germany, France or Italy, however, annual venture capital investments have been at the order of 0.04-0.06% of GDP. 16 Some countries, such as the U.K., have explicitly made an effort to teach entrepreneurship in schools. See "Our Competitive Future: Building the Knowledge Driven Economy" DTI, UK, December 1998. Singapore has since the early 1990's engaged in the teaching of technopreneurship at the National University of Singapore. See http://www.ec.gov.sg for initiatives in this area. - 27 - schemes to meet the demands of the flexible economy of the 21 S' century (including the services sector) and multi-skilling of school-leavers and university graduates (see Chapter 3). Focusing on these issues will certainly lead to high payoffs in the knowledge based economy through the creation of a continuously adaptable labor force to new skill needs and life long learning. More recently, following the recovery Korean labor unions have stepped up their opposition to further labor adjustments. Changing the outlook of the labor unions to issues such as productivity, reskilling, and retraining as found in countries such as Singapore remain a challenge. 2.22 Strengthening social safety nets. Korea has also begun to strengthen its social safety nets - an important factor in enhancing labor market flexibility. As labor markets become more flexible, the risk of employment and income loss for individual workers increases. The government has an important role in providing credible insurance against these risks, not only for reasons of equity but also to encourage appropriate risk-taking by individuals, thereby promoting labor market flexibility. Unemployment insurance, well-functioning pension systems, and targeted poverty programs all form part of the overall insurance package. Since the crisis, the coverage of the Unemployment Insurance (UI) program and the benefits structure have been significantly improved. Coverage of UI now extends to all firms; the duration of benefits has been increased by two months for all categories of eligibility and the minimum replacement rate has been raised from 50 to 70% of the minimum wage. 2.23 Korea has also embarked on a reform of its pension system. This has been motivated by several objectives: the social goal of securing adequate income support for the elderly, the fiscal need to ensure financial viability of the pension schemes, and the broader economic objectives of supporting capital market development and an efficient labor market. 2.24 Enhancing labor market flexibility is contingent on continued reform. Building on important steps that have been taken since the crisis, labor flexibility needs to be increased through better enforcement of existing legislation, further easing of legal restrictions, improvements in active labor market policies, and the strengthening of social protection. In particular: * Legislation on firing should be fully enforced to allow firmns the flexibility to restructure and respond to changing conditions. * Restrictions that still apply to temporary workers should be removed to allow for a lower cost structure and the outsourcing of non-core activities. Besides the economic efficiency argument, there is an equity argument for removing these labor market rigidities which protect the interests of a minority of the workforce that is unionized at the expense of interests of the vast majority of the workers who are not unionized and who typically earn much less. * Strengthening the social safety net will go some way to protecting workers from the higher frictional unemployment associated with more flexible markets. Although the payroll contribution rate of the UI was increased from 0.6 to 1% in 1998, it needs to be re-evaluated to ensure its financial viability over the longer term. Similarly, the financial viability of the pension system needs to be ensured. Ensuring the portability of different pension schemes to allow workers to maintain their benefits when switching jobs is also crucial. One of the constraints to portability is the difference in the benefit formula applied to the NPS and the - 28 - three occupational schemes. Thus, a comprehensive reform strategy needs to integrate the private and public pension schemes within a coherent framework. F. Addressing the Risks of the "Digital Divide" 2.25 The knowledge-based economy brings with it the risk that social inequality will increase due to rapid technological change, as a bias may be created towards specific production factors and because workers' preparedness for change differs. Accordingly, Korea needs to pay more attention to the (re)training of workers, an area in which it has no significant institutional public program. The government needs to establish a comprehensive training/retraining plan to meet the requirements of the knowledge-based economy.18 Sound industrial relations are also a prerequisite for productivity improvement. 2.26 Korea has rightly been hailed for its success in reducing poverty levels over the past three and more decades. Between 1965 and 1995, the absolute poverty rate declined from 41% to approximately 7%. With the economic and social crisis, which spread to the country in late 1997, poverty rates increased substantially, but the latest evidence'9 is that these rates are once again on the decline. 2.27 As a result of the crisis, however, unemployment, poverty and inequality increased in Korea. The percentage of the population living in poverty increased from 8.5% in 1997 to 22.9% in the third quarter of 1998. Due to government income programs and the economic recovery, the rate came down sharply to 14.7% by the first quarter of 1999. Unemployment fell from a peak of 8.7% in February 1999 to 4.4% in November 1999 . However, real wages, which fell by 12.5% from mid 1997 to the end of 1998, are still below their pre-crisis levels, despite substantial recovery in 1999. The Gini coefficient for urban incomes increased from .27 in 1997 to .30 in 1998. The National Statistical Office also reports that the ratio of incomes between the top and the bottom deciles of urban households widened 8.5 fold compared to 6.9 fold in 1997. There is also concern that many of the new jobs that have contributed to the falling unemployment rates are temporary and therefore less secure and less well paid. Women were significantly affected (see Section F) as they tended to be laid off before their male counterparts and, when they are rehired, their contracts tended to be short term. 2.28 Continued income disparities in Korea mean that the knowledge economy could create a "digital divide" such as that identified by the US Department of Commerce: a gap between those who have sufficient income and education to gain access to the potential benefits from IT and those who do not.20 During most of the period between 1965-95, the primary strategy for poverty reduction has been the maintenance of macroeconomic stability in the context of steady 17 This is also the case for Korea. During the 1980s, technological change widened the educational wage differential across industries. (Kang-Shik Choi, "Technological change and educational wage differentials in Korea", Econornic Growth Center Discussion Paper No. 698, Yale University, 1993). 18 For example, in collaboration with universities, government could introduce study courses for workers. Austria utilizes the Fachhochschulen system across each province to this end. Finland also uses public/private partnership programs to enhance professional education. 19 Kakwani and Prescott, 1999. 20 Other factors that can lead to the gap are geographical location and language barriers and outmoded mindsets. - 29 - economic growth. This approach has proven to be very successful in reducing the overall levels of poverty. However, even as overall levels of poverty continue to shrink, the hard-core poor are left in poverty21. This group faces challenges that cannot be overcome through the somewhat indirect expedient of steady economic growth. The Korean Government recently recognized the limitations of the existing welfare system and is now developing a new "productive" welfare system which stresses the provision of basic education, medical and housing support. The rationale for the new system is to help the poor pull themselves out of the poverty trap by supporting their basic needs and implementing programs to develop their ability to work. New legislation, such as the Civil Basic Livelihood Secure Act, will become effective in October 2000. 2.29 Directions for Future Poverty Reduction. A major question to be addressed is the potential impact of a knowledge-based economy on groups which are socially and economically vulnerable - the poor, particularly the rural poor; the disabled, and the uneducated - and the potential of ICT as a component of a poverty reduction strategy. Such an analysis will make it possible to design better strategic approaches for assisting vulnerable groups to benefit from the knowledge-based economy and reduce their social and economic exclusion. The challenge today for Korea in terms of poverty reduction is therefore to understand the dimensions and nature of hard-core poverty, how this population is changing over time as a result of the economic and social transforrnations in Korea, and how best to design programs and interventions which can improve their lot in the context of these transformations. 2.30 Use of ICTs to Assist Targeted Poverty Reduction. The relationship between access to information and level of income is strong and becoming stronger at both the national and the international levels.22 The ICT revolution threatens to increase inequity, but it also provides tools to reduce poverty. Rural and poor urban communities can be integrated into economic life and their income levels raised through information services and electronic transactions. Appropriate regulatory incentives can be designed to encourage provision of rural telecommunications on a commercial basis. Satellite networks, wireless communications, public telephones, and community inforrnation centers are effective arrangements. Public access "telecenters" can provide employment, training for school-children in basic computing skills, assistance in local govenment planning and co-ordination, support for maintenance of local ICT equipment, support for farmers (both price information, and extension support), and outlets for the sale and production of electronic goods.23 Information and communications technologies can also be used to monitor the poor, and evaluate the extent to which such programs are affecting their lives. 21 The percentage of the Korean population that is below the international poverty gap of $1 per day is less than 2%. See World Bank, World Development Indicators 2000. 22 See for instance, US Department of Commerce, "Falling through the Net: Defining the Digital Divide", 1999; and Lester C. Thurow, Building Wealth: "New Rules for Individuals, Companies, Nations in a Knowledge Based Economy", Harper Collins, 1999. 23 There are also some inherent poverty and income inequality issues in relation to access: computer technology is expensive, with the result that unless specific action is taken to redress the imbalance, the rich will be in a better position to take up opportunities than the poor. To increase alternatives available to poor and vulnerable groups, parallel initiatives will need to be undertaken in the areas of small and medium enterprise development, access to credit, service and tourist industries, and cottage industry development and marketing. - 30 - 2.31 Community information centers can extend the reach of information services to under- served rural and urban areas.24 In the United States, a report on the "Digital Divide" recommended the extension of Internet access centers which provide ICT facilities for those who lack access at home and work. Other outreach measures being explored in the United States include: low-cost basic telephone service, cable connections for public institutions at little or no charge, regulatory mechanisms to enhance the availability of advanced telecommunications services to all educational and health-care institutions and libraries through mechanisms such as preferential rates for telecommunications services, and adoption of communications reform legislation which increases competition to make low-cost, high-quality services and equipment widely available, and to advance both rapid infrastructure modernization and expanded universal services for disadvantaged users, high cost or rural areas (see Annex 2). Such options could also be examined in the Korean context.25 2.32 Addressing Employment Biases Against Women. Despite considerable progress in the quantitative expansion of women's economic opportunities, including their increased access to education and training, improved health conditions as reflected in significant declines in mortality rates and increased life expectancy, and advances in legal status, Korean women still lag behind men as regards opportunities for higher education and better employment. They continue to be discriminated against in recruitment and wage levels.26 In addition to the moral argument against the inequity of access of women to economic opportunities, there is also an economic argument. By not addressing such discrimination and by continuing to misallocate human capital resources that are vital for its competitiveness and sustained growth, Korea is missing out on the potential contribution of women to the workforce and hence to the nation's productivity. As noted in Chapter 1, the rate of growth is likely to be lower in Korea because the earlier contributions to productivity growth from increased educational attainment and increased labor force participation will essentially be exhausted unless there is an increase in educational attainment and labor force participation by Korean women. Korea ranks 24th out of 29 countries on the UN Gender related Development Index (GDI) and 78th out of 102 countries in the Gender Empowerment Measure (GEM). 24 In Amsterdam in 1994, a government sponsored project created De Digitale Stad (The Digital City) as a virtual market and town center to facilitate community participation in government. In the first few weeks, 100,000 people joined. In North America, Freenets with similar purposes have been created in about 50 cities. With government support, the effort is being extended to the rural USA. The Nordic telecottages provide isolated village communities with access to information resources for distance working, distance education, and other capabilities. The Cornmunity Learning Utility project provides distance learning in Europe; similar initiatives have started for some developing countries. Volunteers in Technical Assistance (VITA), 1995. 25 On March 2000, the Korean govenmment launched a nationwide campaign to teach Internet to one million housewives over a period of 18 months. In Seoul and nearby cities nearly 70% of private computer institutes joined this program and are fully booked through July 2000. The program provides 20 hours of Internet courses per month for just Won 30,000, much lower than the going market rate of Won 100,000. 26 While the average male life expectancy in the Korea increased to 67.2 years in 1990-1995, nonetheless, Korean men live less than men in OECD countries, and an average of 8 years less than Japanese imen. Meanwhile Korean (and Japanese) women have similar life expectancies, currently 74.8 years, that are among the highest in the world, rivaling and sometimes exceeding those in OECD countries. - 31 - 2.33 Overall, women are concentrated in services (60% of the total), agricultural and clerical occupations (47%), and constitute about one-third of professionals (32%).27 Women's labor force participation rate in Korea was 47.4% at the end of 1999, down 2.1% from 1997. By comparison, men's labor force participation was 75.6%, down 0.4% over the previous year. In absolute numbers, more men than women lost their jobs due to the crisis. However, the percentage of the female labor force that was negatively affected by the crisis is higher than that of the male labor force. Women enter the labor market and become employed earlier in life than men but there is a tendency for employed women to withdraw from the labor force immediately after marriage, presumably for socio-cultural reasons.28 Support services for working women are also limited. There are few childcare facilities and those that exist are expensive. Many women, especially the educated, leave work after having children and choose to stay at home. 2.34 President Kim Dae Jung's Government is actively promoting greater participation of women in the workforce and in politics. The legal framework has been established in the form of the Equal Employment Opportunity Act of 1987, which has been amended three times, the last time in 1999 when the Anti-Discrimination Bill was introduced.29 He also announced a new women's cabinet position in January 2000. However, despite the firmn legal background and positive policies, women make up only 3% of national and local government, and discrimination against women in the workforce is still widespread. 2.35 Strategies for Gender-related Access to the Benefits of the Knowledge Economy. Given that the gender equity problems that exist in Korea could potentially be exacerbated by the transition to a knowledge-based economy, affirmative measures in the workplace could include:30 * Flexible working arrangements: ICTs have the potential to open up alternative and more flexible working arrangements that would help women juggle their dual roles, and reduce work stress on men. Introducing this flexibility into such a rigid work culture will be challenging, and should be done in such a way to ensure that the benefits are felt by men as well as women. * Opportunities for entrepreneurship through the Internet, which is used by women in other countries to enable them to work from their homes, should be explored. Linkages with international networks of women in business should be developed, and training provided for women entrepreneurs in Internet-based commerce. International linkages should also be developed through NGO networks such as the Women's Information Network for Asia and the Pacific. 27 Annual Report on the Economically Active Population Survey, 1999, National Statistical Office, Table 9 The status and occupation of a worker is also gender-differentiated. Fewer women than men are self-employed (20% compared to 34% of men), and many more are unpaid family workers (22% of women compared with 2% of men). The distribution of employees is similarly gender-differentiated: a much higher proportion of women (43%) are in temporary employment than men (21%). 28 Annual Report on Economically Active Population Survey, 1999, National Statistical Office, Table 2.1 and 2.2. 29 Women's wages are lower than men's, despite the Equal Opportunity Act enacted in 1987, which guarantees equality between men and women in employment, and its 1989 revisions to include provisions of equal pay for equal work regardless of sex. In 1992, the average monthly wage of female workers was only about 56% of those of males, though this figure represents a 12 percentage point increase since 1972. 30 Initiatives that can be taken at the school and university level are addressed in Chapter 4. - 32 - * Provision of improved, less costly childcare facilities including those in private sector enterprises. * Consensus-building between the public and private sectors, labor unions and women's organizations on enhancing Korean women's contribution to the economy and society. * Developing consensus-based measures to eliminate discrimination in personnel management systems including promotion and wages, using the example of efforts made in this area by leading private and public sector industries in developed economies. * Giving public recognition to firms and government agencies employing substantial numbers of women in professional and managerial positions. * Supporting policy initiatives on new ways of doing business including telecommuting and other flexible arrangements such as working from home, part-time work and job-sharing, global sourcing arrangements, new training and education capabilities.31 In a survey conducted by the Small and Medium Business Administration between October and November 1999 on women-owned enterprises, it was found that over 70%of women-owned enterprises had personal computers (PCs)and on average each enterprise had 4.4. computers; 11.1% of women-owned enterprises managed their own homepage. However, the same survey showed that 64% of women business owners used PCs only for simple office work, 21.4 of them used the computer for Internet search, while 44.4 % of women entrepreneurs are computer illiterate.32 * Promoting the utilisation of such innovations, particularly amongst women, the poor and other vulnerable groups, through outreach efforts involving a wide range of stakeholder organizations and networks, particularly targeting rural areas. G. Updating the Institutional Regime 2.36 The increasing importance of knowledge and the greater ease of acquiring, processing, and disseminating information are creating pressures to update many areas of the legal and regulatory structures in order to facilitate the flexibility of markets and provide incentives for the creation, diffusion and use of knowledge. An area in need of immediate attention is intellectual property. However, more generally, it also includes the institutional regime pertaining to information disclosure; transparency; accountability; rule of law, as well as the structure and functioning of government, including issues of governance and the reduction of corruption. 2.37 Strengthening Intellectual Property Rights Laws and their Enforcement. The protection of intellectual property rights (IPRs) is becoming increasingly important in knowledge-based economies. This is being driven by the mounting costs of R&D for new products or processes, 3' In much of the industrialized world and specifically in the US, it is largely the private sector which creates the information, develops applications and services, constructs facilities, and trains others to tap its potential. All these areas offer opportunities for flexible employment for Korean women. The need for adequate technical support offers considerable opportunities for women trainees, including flexible working hours which could accommodate their dual roles. The involvement of women's networks in the non-governmental sector, in academia and among students should be actively sought to promote take-up of such training. 32 See, SMBA survey, Oct27, 1999 to Nov.30, 1999. 33 Intellectual property consists of creative works, inventions, trade secrets, and business goodwill. The scope and nature of intellectual property rights vary depending upon the rights concemed. Some of the rights protect ideas, some, the expression of the idea, some rights give the limited form of monopoly right, while others merely give a - 33 - the shortening of the product life cycle, the rapid growth in international trade in high-tech products, and the internationalization of the research process.34 This trend presents a major challenge for Korea as it moves from the knowledge acquisition and adaptation phase of the past, to becoming a generator and user of new knowledge and technologies. In the 1999 World Competitiveness Index produced annually by IMD, Korea ranked 41't out of 47 countries in terrns of patent and copyright protection. 2.38 Quite apart from the obligations of global treaties that deal with IPRs (TRIPs), the incentive to develop knowledge is weakened if that knowledge is not protected. Patents and copyrights are a compromise between the need to provide an incentive for the creation of new knowledge and the social goal of disseminating knowledge at little or no cost. Giving property rights for a specified period of time provides the incentive to create the new knowledge. Requiring the publication of the knowledge in question partially fulfills the objective of announcing to the public that the knowledge has been created. 2.39 IPRs are important because: i) they provide incentives for innovation that cover the costs of creation; ii) they are an essential vehicle for transferring technologies and investment in high- technology industries, if the correct price is paid for sharing technologies; and iii) they help to attract funding for innovation and knowledge creation - sharing the risks and costs of R&D and encouraging collaborative research between domestic firms, universities, research institutions, and between domestic and foreign research consortia.35 All of these factors are very relevant for Korea, given its strong R&D capability, its advanced industrial structure, and its strong desire to become a knowledge-based economy. Intellectual property rights create bundles of rights that lend themselves to efficient exploitation through the market - production responsibilities can be divided among large and small firms and businesses - which is essential for the competitive development of Korea's high-tech small and medium businesses. 2.40 It used to be a generally held belief among the Korean population that information and knowledge are public goods, thereby constraining the incentives for knowledge creation and provision. This thinking has been changing recently with strong support given to IPR issues. Korea is classified as "Priority watch list" status under the special 301 provision of the US Office of the Special Trade Representative, which does an annual classification of intellectual property rights regimes as they affect US trade and investment. Advocacy and education in IPR issues has been advancing. The Korean Government recently took the stance of valuing intellectual properties -technologies, knowledge, intellectual assets, and so on - and using them as materials right to prevent copying, and so on. In general there are 7 types of rights-patent, copyright, registered trademarks, registered designs, plant variety rights, confidential information, and circuit layouts. 34 At the conclusion of the 1994 Uruguay Round of multilateral trade negotiations that led to the creation of the World Trade Organization (WTO) a new agreement on trade-related aspects of intellectual property rights (TRIPs) strengthened IPRs in WTO member countries and gave developing countries a transition period to make the adjustment. 35 A study of Brazil and Mexico showed that in both countries, prior to the strengthening of the IPRs, researchers tended to leave their countries as soon as research results became promising and took out patents in developed countries which had adequate IPR protection. Venture capital start-up was slow to develop as small start up businesses feared that the venture capital firms might appropriate their knowledge; and knowledge interchange among researchers and technicians was constrained as researchers had no way of protecting their findings (Dong- Hyun Park, 1998). - 34 - for evaluating companies (and their viability),36 and for new ways of calculating GNP. The government is also cognizant of the fact that with globalization and the spread of ICTs, technical disputes in high-value technologies have emerged between domestic firms and between domestic and foreign firms, and that these disputes are likely to rise even among other OECD countries. 2.41 Recent amendments in legislation should improve the overall protection and enforcement of IPRs in Korea. In particular, the Patent Court and the amendments to the Trademark Act (TMA) have been established, and both took effect in March 1998. These have already yielded positive changes.37 The media is also playing a positive role in publicizing the enforcement efforts and in reinforcing governmental efforts. The bankruptcy of Hangul & Computer Co. (HCC) gave a valuable lesson that if intellectual property is not respected and protected, knowledge-creating activities will not be sustained. HCC had been the leader in Korea's word- processing software market until its bankruptcy in 1998. Even Microsoft, with its aggressive marketing campaign, could not outpace the HCC. One of the reasons for HCC's bankruptcy was the frequency of pirated copies. Following the news of HCC's bankruptcy, the Korean public initiated voluntary campaigns to buy original products, and these have helped to resuscitate the Hangul software. 2.42 Despite the efforts that have been undertaken so far in this area, a number of issues remain: * A sizeable portion of the public does not understand the criminal nature of actions which amount to infringement. Advocacy of IPRs to demonstrate their value to firms and their role in the stimulation of intellectual creation therefore needs to be strengthened. This has to be done jointly through co-ordinated efforts among government agencies, and through collaboration between government and private and research institutes and the media. * The Korean Government should increase public information services to enable better use of and access to new knowledge, whether patented or not. It should increase its efforts to produce more effective documentation and to compile knowledge in such areas through databases. The quality of institutions providing information services, such as the Korea Institute of Industry and Technology Information (KINITI), should be upgraded. D There is need to further extend the IPR laws and the administration of the new IPR laws- copyright protection-to pre-existing works and sound recordings (as part of TRIPS Agreement); patent protection for pharmaceuticals and the protection of data for pharmaceuticals; protection of famous marks; software protection (there is a need to amend the Computer Program Protection Act); improved implementation of the Patent Act and Utility Model Act to streamline the examination and appellate process; and protection of trade secrets that are produced by foreign businesses in business plans or on products to government as part of the entry requirements. 36 In 1977, the Korea Technology Guarantee Fund (KOTEC) created the Technology Appraisal Centers in Seoul, Pusan, Taejon, and Suwon to evaluate technologies owned by venture start-up companies. Made up of teams that consist of experts in engineering, business and accountanting, the Centers evaluate technologies owned by companies in terms of monetary value and business prospects that are used to provide credit guarantees by KOTEC or as collateral for loans from financial institutions. Patent rights, design rights, IPRs as well as commercialized technologies are appraised. 37 The amendments to the TMA were intended to streamline registration and various recording procedures and also to meet the necessary intemational standards for Korea's accession to the Trademark Law Treaty adopted by the WIPO. KIPO has mounted its advocacy function through education and training. - 35 - * Current administrative structures for protecting IPRs need to be streamlined. The Korean Intellectual Property Office (formerly the Korean Patent Office) is in charge of patents, utilities and trademarks; the Ministry of Culture is responsible for copyright; the Ministry of Information and Communication (MOIC) is in charge of computer programs; and the Ministry of Agriculture is responsible for plant seeds. * The courts, prosecutors, police, and other government agencies have increased enforcement of IPR laws and are maintaining or increasing funding and resources to abate the problem. Enforcement of IPRs can be improved through progressively oriented judicial activism in the interpretation of the laws, through enforcement of the laws, and through the proactive involvement of the prosecutor's office and other government agencies. 2.43 Rule of Law, Fairness, Anti-corruption Campaign, Equal Opportunity. Following the election in February 1998, the present government embarked on an ambitious program to reduce corruption in the public sector. On 17 August 1999, the government announced a comprehensive package of anti-corruption measures. The package includes specific targets or measures such as increasing the salaries of public servants so they can match those of private industries within five years, compensating those who report corruption with cash rewards amounting to 5 to 15% of the government's recovered revenues, launching inspections of large local governments such as those in metropolitan cities and provinces upon the request of 1 000 or more citizens, and making it obligatory provide inform on the contents and use of political funds. As an indicator of a just and fair society, the government aims to become "transparent" by year 2003, which implies a considerable improvement from the 43rd position to the 20th position in the ranking of 38 Transparency International. Progress is also indicated by the growth of many new non- government organizations (NGOs) which are pushing for greater transparency and accountability for government and society at large. The issue here is the timely implementation of the measures, including the announcement of the scorecard of success. In addition, upholding the rule of law to protect the poor, women, and the disabled would be important. 2.44 Norms, Standards, Consumer Protection. A knowledge-based economy is predicated on nonns and standards that facilitate production and transactions while protecting consumers. This is an area where Korea needs to build further strengths. As in many other East Asian economies, the regime was tilted in favor of production compared to transactions and consumption. The typical sequence in the industrial sector was to buy standard hardware technologies from abroad, 38 In recent years there has been a surge of interest in the consequences of govemance for development. In a recent paper, Kaufmann, Kraay, and Zoido-Lobaton construct six aggregate indicators corresponding to six fundamental governance concepts. The authors define governance broadly as the traditions and institutions by which authority in a country is exercised. This includes: (1) the process by which governments are selected, monitored, and replaced- the two clusters of indicators used as indices for this are labeled "Voice and Accountability", and "Political Instability and Violence"; (2) the capacity of the government to effectively formulate and implement sound policies, reflected by two clusters referred to as "Government Effectiveness" and "Regulatory Burden"; and (3) the respect of citizens and the state for the institutions that govern economic and social interactions among them-the two clusters labeled "Rule of Law" and "Graft". A preliminary examination of the data in these six clusters shows that Korea does relatively well (when compared to the US and Japan) in the "Voice and Accountability" and the "Rule of Law" clusters. It is comparable to Japan in "Regulatory Burden", but has some way to go in the clusters relating to "Government Effectiveness", "Political Instability and Violence", and "Graft". Daniel Kaufmann, Aart Kraay, and Pablo Zoido-Lobaton, "Governance Matters," The World Bank, August 1999. - 36 - use and adapt these technologies, and then follow-up with standardized production and exports. The scope and domestic development of (product) standards, certification, codification, accreditation were limited. Building such capabilities in public and private sectors and moving towards international benchmarks in these areas would be crucial for Korea's next phase of quality- and innovation-based competitiveness. This would also assist in the greater diffusion and commercialization of technologies. The role, functions, and actions of the Consumer Protection Bureau should be better understood, including its legal and institutional framework. Although the Consumer Protection Act was passed in 1980, it was only after it was revised in 1987 with the establishment of the Consumer Protection Board that attention was paid to the issue. While the Board has investigative powers its capacity needs to be strengthened for advocacy, testing for consumer safety and investigative functions. Product information disclosures have been made mandatory. 2.45 In 1999, more than 300 cases of unfair advertising were filed with the Board and more cases are surfacing in the services sector such as finance, e-commerce, and cellular phones. The generic issue here is one of asymmetric information between consumers and sellers. A related issue is co-ordination of the functions that are now shared between the FTC, MOFE and MOCIE. The formation of National Consumer Policy Review Committee, headed by the MOFE and composed of ministers, representatives of consumer groups and professors is a step in the right direction. H. Conclusion 2.46 To achieve a significant shift towards the knowledge-based economy, it is necessary for Korea to undertake a broad-based and interlinked reform package that covers the four pillars developed in Chapter 1. However, it is suggested that the highest priority be accorded to updating the incentive and institutional regime as this is critical to enable Korea to position itself on a new and sustainable growth path. These reforms are central to the overall functioning and flexibility required of the knowledge based econom and the other three components of the framework. For example, pressing on with the reform of the incentive regime will induce the chaebol to become leaner, transform themselves into knowledge-based entities, make them more competitive in terms of innovation and encourage them to increase the productivity of their R&D efforts. This will promote Korean technopreneurship and at the same time create a market for the valuation of intangible assets. The incentive and institutional regime changes discussed in this chapter would also open up the education, training and informnation infrastructure markets. The education and human resource needs for Korea's transition to the knowledge-based economy are discussed next. - 37 - REFERENCES Annual Report on the Economically Active Population Survey, 1999, National Statistical Office. Seoul, Korea. Daniel Kaufmann, Aart Kraay, and Pablo Zoido-Lobaton, "Governance Matters," The World Bank, August 1999. Department of Trade and Industry, "Our Competitive Future: Building the Knowledge Driven Economy", UK, December 1998. Dong-Hyun Park, "Intellectual Property Regime and the Developing Countries", STEPI, November 1998. Kakwani Nanak and N. Prescott, 1999, "Impact of Economic Crisis on Poverty and Inequality in Korea", Background paper prepared for the World Bank. Kang-Shik Choi, "Technological change and educational wage differentials in Korea", Economic Growth Center Discussion Paper No. 698, Yale University, 1993. Lester C. Thurow, Building Wealth: New Rules for Individuals, Companies, Nations in a Knowledge Based Economy, Harper Collins, 1999. McKinsey Global Institute, Productivity-led Growth for Korea, 1998. Ministry of Commerce, Industry and Energy, ROK, Shaping a New Investment Environment: Korea prepares for the 21st Century, September 1999. MOFE, February 28, 2000, Korea Economic Update. OECD, Regulatory Reform, Korea, 2000. Small and Medium Business Administration, Survey on SMBs, Oct. 27, 1999 to Nov.30, 1999, Seoul, Korea. US Department of Commerce, "Falling through the Net: Defining the Digital Divide", 1999. Volunteers in Technical Assistance (VITA), 1995. World Bank "Korea: Establishing a New Foundation for Sustained Growth", 1999. World Bank, World Development Indicators 2000. - 38 - CHAPTER III: DEVELOPING HUMAN RESOURCES FOR THE KNOWLEDGE-BASED ECONOMY A. Introduction 3.1 Increasing overall productivity and adaptability will be fundamental for Korea's transition to an advanced knowledge-based economy. Developing the appropriate human resources will indeed be the linchpin of such a transformation. Ensuring the flexibility of the education system, both formal and informal, will thus be critical for developing creative, knowledgeable, and better skilled human resources for the 21 St century. 3.2 Korea has attained remarkable achievements in education over the past three decades, and the quality of its basic education has been internationally acclaimed. In recent years, Korea has embarked upon a series of reforms in education. The challenge is whether the well- established Korean education system will be able to maintain its excellence, make the necessary changes, and provide the needed human resources for its transition to an advanced knowledge- based economy. To meet this challenge, Korea needs to make its education system more flexible and relevant to the new global environment by focusing on learning rather than on schooling, creating an enabling environment for promoting creativity, improving the quality of higher education and providing opportunities for lifelong learning. The over-regulation and continued emphasis on homogeneity of the system are observed to be the main obstacles, making a profound and systemic education reform focusing on deregulation and diversification and a new role for government in the education system a central requirement. A reformed education system would integrate and update the existing education and training systems, and facilitate individual learning by anyone, anywhere and at any time. 3.3 This chapter provides a brief review of Korea's achievements and recent reforms in education. It then discusses the paradigm shift in education and learning brought about by the new global economy, as well as the challenges facing the Korean education system and proposes possible responses. B. Educational Achievements and Recent Education Reforms in Korea 3.4 Korea has a unique education system characterized by much larger private sector Flum 3.1: EdonIndcatotsforthe PuxIcofKom representation and investment, and a 120 relatively small publicly financed sector 100 - compared to other industrialized nations. In 80 - the past three decades, the government has, 0. through its highly regulated and centralized 40 governing system, attained remarkable a) X educational achievements. Since 1970, Korea o 0 1970 1975 1930 1935 1990 1995 1996 1997 - 39 - has maintained full enrolment in primary education (see Figure 3.1). Illiteracy also declined from above 10% in 1970 to virtually nil in 1997.1 Gross enrolments in secondary education increased from 40% in 1970 to become almost universal by 1997. At the tertiary level, Korea ranks third among OECD countries in the educational attainment of its population, and 84% of its high school graduates entered a university or a 7 college in 1998.2 Schools around the country Figure 3.2: Student-Teacher Ratio (Secondary) have very low drop-out rates: 0.8% for 50 - - - - - 'I_middle school, 2.1% for high school, and 40 - Aal"ia -j 2.5% for higher education. Due to this rapid 30 1 __ __ _. IFiand E 1expansion in schooling, gender disparities 20 - _=~ -+KoRp X have been eliminated at both the primary and 2 7- u Uitgbm secondary levels, although they still exist at I0 _ _ UiW KfiVdm Jthe tertiary level (see section D.3). At the 10 1975 - 101-985 1-0-9 --9-- same time, class sizes have fallen for all 1970 1975 19_0 19_5 1990_1995 19961997 __ _ levels of education and pupil teacher ratios have become smaller, although they remain considerably higher than the average in certain OECD and other advanced countries (see Figure 3.2 for this ratio in secondary education). 3.5 Korea also shows remarkable achievements in other international comparisons. According to the TIMSS study, Korean students at the 4th and 8th grades performed significantly better than the OECD average. In mathematics, for example, Korean students obtained the highest scores among all participating countries, followed by Japan. The transition from school to work is also relatively smooth in Korea - the unemployment rate for young adults (20-24 year-olds) is in the low range among OECD countries. And in tertiary education, although countries like the United States, Australia, and Finland are ahead of Korea with enrolment rates close to 84%, Korea has overtaken Japan and the United Kingdom which had higher tertiary education rates in 1970 but have now fallen behind. Korea's female tertiary enrolment has also surpassed that of Japan and Singapore. In addition, Korea has the highest growth rate in scientific publications among the OECD countries. 3.6 Over the past three decades, public expenditure per student as a percentage of GNP per capita in Korea has fallen significantly for tertiary education and increased for primary and secondary education. The total education expenditure increased from 8.8% of GDP in 1966 to 13.3% in 1998,3 the highest share for any country at this level of development. Of this, however, only 4.4% was the share of public financing, which is even lower than the OECD average of 4.9% in 1995 (Table 3. 1).4 Such relatively low public investment in education has led parents to spend more on education and, to certain degree, has reduced the strength of the public education system in Korean society. i World Bank. 1999. EdStats (Education Statistics Database). 2Ministry of Education: Educational Yearbook of 1998, Seoul. 3Korea Education Development Institute: Study on Education Expenditures in Korea. December 1998. 4In 1995, in terms of public expenditure on education as a percentage of GDP, Korea was in the lowest group among all OECD countries, together with Turkey and Greece. Korea's expenditures were only about half of those of the Scandinavian countries. (OECD: Education at Glance, 1998). - 40 - Table 3.1: Public Expenditure on Education as Percentage of GDP, 19955 Australia 4.5 Greece 3.7 Finland 6.6 Korea 3.6 Norway 6.8 Sweden 6.6 Turkey 2.2 United States 5.0 OECD average 4.9 3.7 Parents spend 2.3% of GDP on tuition and school supporting association fees for formal education in both public and private schools from the primary to the tertiary level. In Korea, more than 35% of secondary schools and almost 90% of institutions at the tertiary level are private. In percentage terms, Korean households contribute almost 84% of the costs of tertiary education, significantly more than in any other OECD country. However, lack of choice and large class size in the public sector, combined with a very strict national university admissions examination system, have led parents to invest another 3.2% of GDP on private tutoring for their children. The remaining 3.4% consists of general expenses, including the purchase of study materials, books and stationary, uniforms, transportation fees, lodging, food, and other costs). 3.8 The Korean Government has embarked upon a series of reforms in education since the early 1990s; these were enumerated in detail in the Presidential Commission on Education Reform (PCER) initiative of 1995, as well as in subsequent revisions.6 Some 120 tasks for reform have been proposed. Some examples of the reform agenda include greater autonomy for universities in admissions and academic affairs, including deregulating student admission and enrollment quota; nurturing leading regional universities to meet the needs of local industry; establishing education and research networks with leading world universities to stimulate research at Korean universities; and realizing the vision of an open educational system through a new Education Credit Bank system. For various reasons, especially the lack of consensus- building in this process, these reforms have not been fully implemented as envisaged.7 3.9 Given its national zeal for education, Korea has great potential and is well positioned to forge ahead in today's world where knowledge and information are becoming the most critical factors in creating value added. However, it must address serious questions such as: how can both the quality of learning and opportunity for lifelong learning be improved when the government invests only one-third of the total expenditure on education, and yet controls almost every aspect of its operation? How can educational institutions be more responsive to the needs of the knowledge-based economy while at the same time being constrained by regulations 5OECD: Investing in Education: Analysis of the 1999 World Education Indicators, EdStats, The World Bank. 6 Even through the PCER has now been dissolved, the proposals highlighted are in various stages of implementation. 7 In 1998, the Korean Ministry of Education launched a new campaign to create a "Five Year Education Development Action Plan (draft)". The latest reform package, entitled "Vision for Education beyond 2002: Creation of a New School Culture", comprises five components: creating an autonomous school community; implementing a student-centered curriculum; cherishing the value of students' life experiences; diversifying the methods used for evaluating students; and emphasizing the professionalization of teachers. Detailed programs for each of these components are under development. - 41 - affecting student admission quotas, curriculum, teacher hiring, and tuition? How can creativity be developed in both teaching and learning when the incentives are such that they overwhelmingly encourage students to pass rigid college entrance exams to obtain admission into the elite schools? Without a massive deregulation and diversification of the existing education system, Korea will be unable to bring about the kinds of changes in the quality of learning required by the knowledge-based economy or the opportunities for lifelong learning that are fundamental for enhancing creativity and productivity in the new economy. The current reform programs do not seem to go far enough in this regard. C. Paradigm Shift in Education 3.10 Korea's present education system has responded well to the basic education needs of the population and delivered the manpower needed for its industrialization efforts. However, the system was developed to serve the needs of the organization of production in industrial societies which featured rule-driven, routine production processes controlled by management with little requirement for creativity on the part of workers. The new knowledge-based economy requires a different type of organization of production, which calls for changes in the relationship of worker to work, worker to worker, and worker to consumer, and seeks to stimulate continuous improvements in productivity by giving workers greater control over production.8 Technological improvements made by workers during the production process are as significant as those resulting from design changes by engineers and scientists. Thus, the knowledge-based economy requires an education system which not only permits learning throughout the lifetime of its citizens and encourages their creativity, but more importantly, is sufficiently flexible to adapt to the changing demands of a knowledge-based economy. This has to be based on continuous learning - from providing basic skills, to developing core skills that encourage creative and critical thinking for problem-solving, to developing specialized skills for specific professional careers and tasks, and should take place in multiple environments: at home, at school, and at work. This new environment requires a different approach to work and a different mind-set, including not only formal education and the ability to acquire and apply theoretical and analytical knowledge, but above all, a continuous upgrading of skills.9 3.11 The concept of "lifelong learning for all", adopted by OECD Education Ministers in January 1996, provides a framework to guide education and training policy in the knowledge- based economy.10 Successful implementation of this "cradle-to-grave" approach displays four characteristics: individuals are motivated to learn on a continuing basis; they are equipped with cognitive and other skills to engage in self-directed learning; they have access to opportunities for learning throughout life; and they have financial and cultural incentives to participate in lifelong learning. 8 Peter Drucker: 'Knowledge Worker Productivity: The Biggest Challenge" in California Management Review, Winter 1999. 9 Merrill Lynch & Co.: "The Book of Knowledge - Investing in the Growing Education and Training Industry", April 1999. 10 A. Hasan: "Lifelong Learning: A Monitoring Framework and Trends in Participation", in OECD: 1998 Education Policy Analysis. - 42 - 3.12 The lifelong learning approach is based on the centrality of the learner - defined to include both the individual and collective entities, such as the enterprise, the economy, and society at large. The objectives of education policy in this new environment need to be defined in the broader social and economic context and take into account individual objectives as they change over the lifecycle. The economic argument is that the knowledge-based economy requires a skilled, flexible, and adaptable labor force. New developments in the labor market include: rising skill thresholds; falling demand for low-skilled workers in relative terms and rising growth rates for so-called knowledge workers. Micro-level studies indicate increasing use of flexible management practices,'1 stemming, in part, from more frequent and volatile changes in the demand for products and services. These developments contribute to reducing the shelf life of skills and multiple careers through one's working life are becoming more common. All these factors place a high premium on frequent updating of skills, increasing demand for problem solving, teamwork, communication, and ICT skills. 3.13 In general, based on the accumulated knowledge of international best practices as well as changes in production processes and relationships, the new paradigm in education proposes a new set of elements: 12 * Primary attention is given to different methods of learning. - Teachers provide some direction to bodies of knowledge but place greater emphasis on applications. D Teachers spend little time on instruction and devote the greater part of their effort to the facilitation of learning. - Students spend most time on experiential learning: learning while working, and working while learning. * Group learning is emphasized over individual learning. * Emphasis is on the diversity of perspectives that can be brought to solve problems, rather than on the identification of a single concept or best approach. * Non-cognitive methods of expression are encouraged to stimulate creativity in finding solutions to "messy" and complex problems, and in facilitating communication. * Changes in student assessment are required, with a shift away from measurement of knowledge towards the evaluation of performance. * Attention to the application of knowledge increases inter-disciplinary work and, over time, leads to a blurring of disciplinary lines and the creation of new disciplines. * Emphasis in both teaching and learning is on the construction of knowledge through action rather than the (re)discovery of existing facts. * Different expressions of human intelligence are valued in co-operative efforts at home, in the work place, in society, and in government. 3.14 Whether or not everyone agrees with the above set of elements, the emerging evidence from recent education reforms around the world seems to indicate that they are indeed the key drivers of changes in the content, delivery, and operation of education systems. 1 OECD 1998: Technology, Productivity and Job Creation: Best Policy Practices, The OECD Jobs Strategy, Paris, and OECD 1999: "New Enterprise Work Practices and Their Labour Market Implications", Employment Outlook 1999, Chapter 4, June, Paris. 12 Noel McGinn: "Globalization, Education, and Knowledge for Development", 1999. - 43 - D. Challenges and Possible Responses to the Korean Education System 3.15 The new paradigm for education described above, which is characterized by opportunity, creativity, and quality of learning, provides us with a broad context to discuss some of the major challenges facing the Korean education system in relation to the knowledge-based economy. Some features of the new paradigm can be identified in the PCER reform programs since 1995 and in subsequent revisions. However, interviews and site-visits in Korea seem to suggest that the main problems identified in the PCER report still persist to a large extent, and that the implementation of the government's reform agenda has not gone as far as originally planned. More assertive reforms in governmnent deregulation and administration are needed to create the appropriate enabling environment for educational change. The central government has a very important role to play in the continuous improvements that are needed in the country's education system. However, in the future its role will be different from its traditional one. In this section, the discussion is focused on four inter-linked areas which present major challenges to the government and society in the reform of its education and training system: deregulation and decentralization; diversification; gender, relevance, and quality; and the provision of lifelong learning. 1. Deregulation and Decentralization 3.16 As mentioned above, Korea currently spends about 13.3% of its GDP on education, and parents spend 3.2% on private tutoring for their children. Such heavy investment in education should, in theory, lead to a satisfactory national education system which provides quality education and meets the demands of the labor market. However, discussions with various stakeholders point to the opposite view: students are less and less content with what they learn and what they are taught at school; parents are not satisfied with the education their children receive, as is evidenced by the amount they spend on extra tutoring; companies complain about the lack of specialty and skills of their newly recruited workers and graduates. The country as a whole is not confident that its education system will enhance its competitiveness in the global economy which is increasingly driven by knowledge. Why then have the heavy investmnents in education not provided the results expected by Korean society? Why do Korean parents have to spend so much on private tutoring? In addition to Korean parents' strong sense of wanting their children to get into elite universities in Seoul, the over-regulated private provision, combined with lack of institutional autonomy and insufficient public funding in the Korean education system, have led to this outcome. The time is therefore ripe for a shift in the government's as well as the public's focus from increasing quantity to enhancing the flexibility of the education system to promote creativity and effectively use all available educational resources to improve learning outcomes in Korea. 3.17 Deregulation. Over the years, the Korean education system, like the country's other economic sectors, has been heavily subjected to government regulation. On the one hand, such intervention has played a major role in universalizing basic education and providing skilled labor for the industrialization of the country. 13 On the other hand, government intervention has 13 Although it has been argued that the educational policies pursued by the government have artificially stimulated the public's demand to seek higher education, one cannot ignore the positive role played by the Korean Government - 44 - generated a range of regulations regarding the provision of educational services. Although it provides only 4.4% of GDP public spending on education, with two-thirds of its education expenditure coming from private sources and with private education institutions constituting 35% and 90% of schools at the secondary and the tertiary levels respectively, the government's control over the entire operation of the education system has rendered the system highly centralized and inflexible to market needs. The central government regulates matters such as type of schools, student admission, curriculum, textbooks, and teacher hiring; these regulations are also applied to all education institutions, with no distinction between private and public education institutions in the content or type of education services provided. In the absence of deregulation, it will be hard to carry out the educational reforms needed for Korea's transition to the advanced knowledge-based economy. 3.18 The most illustrative example of over-regulation comes from the tertiary education sector. Both the private and public universities lack autonomy in their management and academic affairs, with government regulations constraining them in the recruitment and payment of staff, student enrollments and admissions, fee levels, and so on. Although the universities do not receive direct government instructions on curriculum content, the curricula that they actually provide are fairly uniforrn and many universities simply copy the programs of the top-ranking university. Consequently, the students coming out of this system tend to have the same knowledge structure and skills.14 Such a heavily regulated system does not have the flexibility to fulfil the country's growing demand for new types of knowledge workers. 3.19 Until very recently, the university entrance examination system was open to the criticism of being both inequitable and inefficient as a means of selecting students and making the entire education system exam-driven. Examinations rank students according to a total score in a limited range of subjects, pointing to a lack of diversity; and the adoption of multiple choice questions does not encourage critical thinking or analysis. It is inequitable because it stimulates a high level of spending on tutoring in order to prepare for the entrance examination, putting significant financial pressure on lower income families.'5 In 1998, the govermnent introduced performance- based evaluation, that is, cumulative school perfornance in addition to the test scores and reformed the college entrance system by allowing universities to develop their own admission in the quantitative expansion of schooling in the country. (Ki Su Kim: "A Statist Political Economy and High Demand for Education in South Korea" in Education Policy Analysis Archives, v. 7, n. 19, 1999). 14 Woo & Lee (1999). The PCER reform proposals include increasing institutional autonomy, and implementation has already started, for example, in the regulation of student admissions to universities, but reforms have not gone far enough. 15 Parents spend large amounts on private tutoring, some to make up for poor quality schooling, and to provide greater diversity. More than 53% of Korean households with school-age children pay for private tutoring for their children (KEDI survey). More than 50% of students receive tutoring from the for-profit Private Leaming Institutes (PLI) or Hak-Won. Total expenditures on private tutoring amounted to 3.2% of GDP in 1998. There are two kinds of private tutoring (PT): one for improving talents and the other for academic achievement. Typically, pre-school children and elementary school students engage in private tutoring for the purpose of acquiring specific talents, such as learning drawing or music, and for improving the 3Rs (reading, writing, arithmetic). This may be called PTI. This type of tuition is demanded because Kindergarten or primary schools do not meet parents' expectations of quality and variety in education. Secondary school students, on the other hand, focus on academic achievement in such subjects as English, Korean and Math in order to improve their chances for college entrance. Expenditure on PT2, therefore, does not so much compensate for poor school quality but is geared largely towards the college-entrance exam, which is highly competitive because of the limited university entrance quota. - 45 - criteria and select students based on perfonnance rather than on pure test scores. However, this has not yet resulted in substantial changes in the system due to the lack of institutional capacity in the universities to implement such wide-ranging reforms. 3.20 The Korean Government has recognized the problems which arise from its tight control over the education system and has embarked on a number of deregulation efforts. Deregulation should focus on: developing an education market with healthy competition; creating flexibility; and promoting synergy in the system to maximize its outcome. Granting greater autonomy to education providers, especially the private institutions, will certainly increase their responsiveness to the needs of the labor market. However, deregulation alone is not sufficient to bring the required improvements. Changing the traditional mind-set of the Korean public concerning the pursuit of education, especially at elite universities, is equally important, because such elitism not only dictates the secondary school curricula and the entrance examination system, but also increases the financial burden on parents from private tutoring. Chapter 7 elaborates on how to effectuate the mind-set change. 3.21 Decentralization. While deregulation may bring the needed flexibility to private institutions, it is not sufficient for public education, which has been subject to a very centralized administrative control by the central government. Increased productivity in the new knowledge- based economy will require that decisions be made at the local level, meaning that greater autonomy is devolved to knowledge workers, thus improving their overall performance.16 Although efforts in the area of decentralization have started, the expertise, knowledge base, and supporting infrastructures for effective decision making at the local levels are not yet strong enough to permit the needed decentralization. 3.22 Elsewhere in the world, experience shows that the role of central governments in education is changing. This is reflected in the shift of managerial responsibilities and resources away from central government (i.e. the Ministry of Education) to lower levels of authority, and often directly to schools, with corresponding accountability. It is hoped that bringing decision- making power and accountability closer to those who teach and manage schools will make them more effective in helping students learn, more efficient in utilizing limited resources, and more directly accountable to students, parents, and local communities, leading to reduced need for central control and supervision. 3.23 Effective school improvement cannot be brought about by schools alone, but the school must see itself as~ a central part of the solution.17 In Korea, the 1995 PCER reform introduced a new type of governing body in schools, although its roles were not clearly defined. A new autonomous school approach was proposed to improve the quality, competition, and diversity of educational services. 8 Still, so far, insufficient important administrative and financial decision- making power has been delegated from the provincial educational authorities to individual 16 Peter Drucker, 1999 and Noel McGinn, 1999. " Michael Fullan, "The Retum of Large-Scale Reform," Journal of Educational Change, October, 1999. IR This approach advocates, for example, freedom to charge tuition at private schools and freedom to set curricula at all schools. - 46 - schools. 19 Further decentralization is therefore needed to enable school-based management and to make the Korean education system more responsive to local needs. Experiences of decentralization in countries like Australia, New Zealand, Spain, and the United States can be useful references (see the example of New Zealand in Box 3.1). However, the autonomous school approach is likely to encounter serious opposition as it may be viewed as going against the ethos of Korean culture and perceived as catering only to the higher income families. The issue of equity that will arise through greater market orientation will also need to be addressed. 3.24 Changing Role for Government. The required efforts in both deregulation and decentralization in the public sector will not entail reduced responsibility for central government in the nation's educational development. Rather, the role of central government will be strengthened, although not in the traditional sense of maintaining control. The central government's new role in education is in macro-level strategic decision making, securing resources, ensuring overall co-ordination and evaluation, setting standards, assuring equity and quality, and providing support services. These new requirements and responsibilities have been recognized in Korea.20 The role of government in ensuring equity is paramount, particularly in light of the envisaged deregulation of the education system. As the govemrnment deregulates and the private sector expands, new demands are placed on government to ensure that poorer students are adequately taken care of by means of scholarships at the secondary and tertiary level. The Korean Governnent has set up a number of programs to help children from poor families avoid the poverty trap: i) their school attendance is well protected through a subsidy program; ii) the school lunch program provides meal for those who cannot afford to pay for them. 3.25 The Korean Government's share of the education expenditure is considerably below the OECD average, and only about 70% of what is the level in most western industrialized countries. However, as noted above, total educational expenditures in Korea as a share of GDP are probably the highest in the world. Greater deregulation will help the private sector to respond to parents' demand to improve the quality and diversity of private education. But, this is likely to be accompanied by rising tuitions. For children whose parents cannot afford the higher costs of private education, this raises the issue of equity. Therefore, a crucial role for government will be to find ways to reduce the burden on parents for quality education, while maintaining equity in the system through the use of instruments such as scholarships, vouchers, tax deductions, low interest loans for private education, and improvements in the quality of public education. It should closely examine the efficiency of the allocation of public and private resources to education. In addition, the government needs to provide substantial support to help individual For example, an examination of the percentage of decisions taken at each level of government in public lower secondary education in Korea in 1998 shows that 37% of decisions were taken at the central level; 31% at the provincial/regional level; 7% at the sub-regional level; none at the local level; and 25% at the school level. In contrast, in some Scandinavian countries (Finland and Norway) and the US, more than 50% of decisions were taken at the local level. (Education at a Glance, OECD Indicators, 1998). 20 The Korean government provides the framework for the curriculum, qualifications, quality assurance procedures and standards for teacher training, within which schools have substantial responsibility for managing their own affairs, including budgets and staffing. This has been the trend in many countries around the world (for example, Australia), informed by research from organization theory and school effectiveness. It reflects developments in other sectors, including business, and is likely to be sustained. The school remains accountable to a central authority for the manner in which resources are allocated, usually judged to be effective (or not) by student outcomes. - 47 - institutions build their capacities. To promote quality and accountability, the central government should make the system more transparent and increase the availability of educational policy information and statistics to the public. Without this, deregulation and decentralization efforts will not succeed. 3.26 Possible Responses: . As mentioned, continued deregulation of the education system is needed to further educational reform in Korea. This includes deregulation not only of the tertiary, but also of the secondary education system. * Greater efforts should be made to introduce a market-oriented and stakeholder-driven governing system in education in Korea, with clearly defined autonomy as well as accountabilities at the institutional level. * Responsibilities should be decentralized, with corresponding resource allocations, and with each level being held accountable for results, especially to the local level. Institutional autonomy needs to be increased to enhance the decision making of schools21 and universities22 in areas such as staff administration (hiring, firing, salaries and benefits), teaching loads, admissions policies, enrollment quotas, and budgeting and financing.23 * The government should continue to increase the public expenditure and investments in education, enabling the system to provide high-quality services and reduce the burden on parents of private tutoring. It must ensure equity in the system by investing in appropriate schemes, for example, providing scholarships to students from poorer families. * With the increasing diversity in the supply of education, it will be important to develop a transparent mechanism for the accreditation of different types of institutions and for undertaking benchmarking assessments to judge the quality of teachers and programs and to track and monitor quality over time. A national body with clearly defined criteria and standards could be established to undertake this task. The government has taken a number of steps in this area in recent years, such as the establishment of an educational credit bank system which allows individuals to accumulate course credits from accredited institutions towards certification throughout their lifetime. Further efforts need to be made along this path to set up a national framework that encompasses all educational and vocational qualifications, whether obtained formally or informally. - The newly conceived college entrance system, which allows each university or college to develop its own criteria to admit students, needs to be firmly implemented. This will improve equity of access to university education, and help to shift the learning culture in high schools away from learning by rote towards the development of critical-thinking and problem- 21 As regards the autonomous school approach, one way may be to introduce such a scheme on a pilot basis, while addressing the equity issue by giving access to all students within an area (or through a lottery approach), their tuition being paid through some form of income-based subsidies, e.g. a combination of scholarships and vouchers. The purpose of such a pilot would be to demonstrate that school-level initiatives could improve quality. 22 Management capacity at the schools and university level should be strengthened. Increasing autonomy might require changes in the basis of allocating public funds to universities, by for example, moving towards block grants to take account of the need for local decision making and management, and to increase effectiveness and efficiency. 23 The aim would be to permit institutions to attract quality staff in a competitive market, provide them with competitive employment conditions (academic as well as financial), adjust staffing and resources in line with changing demand for courses, allocate resources between teaching and research, etc. The corollary of most grants of autonomy is that institutions become more financially self-sufficient. - 48 - solving capacities. The government needs to develop instruments such as scholarship and voucher schemes to guarantee equal leaming opportunities to all Koreans. Box 3.1: Decentralization Experience in New Zealand From 1987 to 1997, New Zealand undertook a major restructuring of its public education system with the primary objective of decentralizing authority to the school level. With the social pressure (no economic growth, high unemployment yet a lack of skilled people, huge foreign debt, and few intemational trading partners) and political pressure (against the backdrop of broader, sweeping changes in the public sector) in the country, this reform was created by building inter- ministerial co-operation, by employing personal commitment from the Prime Minister to enlist public support, and by providing a clear, "pre-negotiated" roadmap for reform implementation (the Picot Commission Report). The reformn plan was to produce a publicly funded self-managing education system where authority and delivery was decentralized to the local level including: appropriate, well-defined accountability systems; targeting for those with specific needs; and, offering choice to all as to where and how to get education throughout their lives. Three key issues were central to this decentralization reform: school-level self-management and decision making; central government setting of clear frameworks, guidelines, standards, and requirements; and parental choice by offering more options, greater diversity, enhanced access. The central government was also committed to targeting resources to needy areas of and ensuring equity throughout the system. While there was a devolution of power to schools, the central government created several intermediary agencies which were accountable to the government, e.g. the Education Review Agency, responsible for conducting school-level evaluations; the New Zealand Quality Authority, responsible for quality promotion and assurance; the Implementation/Training Unit, responsible for advising and supporting administrators to deal with the financial management and budget skills; and Education Service Centers for consulting with and supporting schools. Central offices at each level maintained the following roles: policy advisory, managing property, moving funds, and developing personnel, administrative, governance guidelines. In short, their main focus was on equity, support services, and results. In 1989-90, almost ovemight, most school-level tasks originally controlled by the central government went to 2 800 parent elected and controlled boards. This transition was preceded by the establishment at each school of a Board of Trustees with elected members. These boards signed charters with schools to set guidelines for school self-management and reflect local needs. Many observers feel that they have strengthened the role of the parents, but not necessarily of the teachers. Some lessons learned from this reform experience are: i) change is catalyzed by a general reform climate, broad public support, and requisite infrastructure; ii) consistent, strong, committed political leadership is essential; iii) legislating change demonstrates serious intent and reduces the temptation of reversal by fiat; iv) political leaders must have confidence in the commitment and ability of their public officials; v) allies in the planning and financial arenas of government are critical, along with other option leaders; vi) use the communications media; vii) change quickly - more quickly than comfortable; viii) appoint a specialist change manager with authority to act; ix) take action to gain the co-operation of existing staff who must implement the transition; x) deliberately engage or isolate pressure groups - never ignore them; xi) be prepared to inject extra funding to "sweeten the pill" for reform losers; xii) allow for mistakes and create incentives for transparency and learning; and xiii) remember exit, transition, and entry arrangements. This decentralization reform has provided more choices for parents and has improved effectiveness and efficiency of the public education system in the country. Although there are some indications of the increased learning outcome of students, thorough evaluations are currently under way. Lyall Perris: Implementing Education Reforms in New Zealand: 1987-97, The World Bank: Human Development Network. 1998. 2. Diversification 3.27 As the knowledge-based economy evolves and the Korean education system is further deregulated, there will be increasing demand for diversified learning opportunities and increasing - 49 - competition among providers to provide a varied menu of offerngs.24 A diversified system would consist of centers of excellence, providing leadership for the nation's education and training system, and of a variety of quality institutions which fonn the needed critical mass to serve the needs of both local economy and individual learning. This would involve not only universities and vocational institutions, but general secondary schools as well. Consequently, their programs would allow some possibilities for diversification, while maintaining some common core standards by the Ministry of Education. In addition, increased possibilities for self- paced and directed leaming - brought about by the utilization of ICTs, and by a blurring of the distinction between formal and informal institutions in terms of provided services - demand greater diversification in both the content and the providers of education and training. 3.28 Diversification of the education system has already started in Korea, as for example, in the government's Seventh Curriculum Reform25 and Brain Korea 21 initiative which aims at establishing a few centers of excellence in higher education with substantial public investment. However, investing in centers of excellence alone will not satisfy the demand for human resources with the diverse skills that are needed for a knowledge-based economy. Some structural adjustments are also needed. For instance, the scale of junior colleges is currently only about the half of the formal colleges and universities, even though junior colleges produce the middle-level technicians that are increasingly in demand in the new economy. At both the college and at the school level, very few programs are challenging enough for gifted students whose talents are important assets for the development of the knowledge-based economy in Korea. Thus, the kind of diversification in education and training needed in Korea is not limited to any particular level of education or institution; rather it calls for a systematic effort. 3.29 Currently in Korea, the high-school vocational and academic streams are completely separate, and opportunities for constructing individual pathways combining elements of academic and work-related experience are limited. This implies that the most important educational decision in a child's educational history is made at age 15, at the end of the junior school, and is based mainly on examination scores. Such early streaming constrains individual learning opportunities. Recently, several academic high schools have begun to offer the vocational program to their senior students, although this has met with considerable resistance from students and parents who worry that it might lower their Scholastic Achievement Test 24 In addition to having people who are creative and sufficiently flexible to meet a variety of demands, there will be an increasing need for a very large number of knowledge workers called "technologists" in the knowledge-based economy. These workers-who may constitute the fastest-growing group of all workers-do both knowledge work and manual work, and, for example, include health-care workers and automobile mechanics. In the transition to a knowledge-based economy, more and more manual workers will be technologists. To increase knowledge-worker productivity, augmenting the productivity of technologists deserves to be given high priority (Peter Drucker, 1999). The training of technologists is weak in the current Korean education system. For example, a recent firm-level survey for Korea indicated that the quality and supply of technicians and high-skill personnel poses a problem in production and for technological improvement (Corporate Survey of the Asian Financial Crisis," World Bank, PREM, 1999). However, educating technologists is expensive and calls for partnerships with all sectors of the economy. Another issue is that in Korean culture and social structure, educated people look down on people who work with their hands. 25 The Seventh Curriculum Reform offers a number of reforms, including a reduction in core subjects and a greater degree of choice. At present only limited changes in majors (20%) is permitted. Special admissions are allowed only to a total of 10%. This type of diversity is linked to the freedom of universities in controlling the size and nature of their enrolment. - 50 - (SAT) score that is administered nation-wide by the government each year.26 In addition to the diversification in curriculum, other efforts should include, for instance, magnet schools in technical areas or in the arts, as well as specialized training institutions outside the formal school system. 3.30 Korea should promote diversity in its tertiary education system since tertiary education is the main provider of highly-skilled personnel. Although the nearly universal participation in tertiary education seemingly provides enough knowledge workers for the Korean economy, there is a growing need for a more diverse body of knowledge workers. Under the government's rigid regulations, all Korean universities operate in a "department store" style, offering similar disciplines rather than concentrating on selected areas in which they have a competitive advantage. Recently, the government has started to expand the autonomy of universities, particularly in creating their own curriculum. However, this has been slow to take place due to the lack of institutional capacity in many universities and the lack of competition among them. A stronger competitive environment for all universities thus needs to be cultivated, as this will help to create greater diversification and responsiveness to student needs. 3.31 The current higher education system in Korea is highly concentrated around Seoul and its vicinity, and among universities, there is a strong concentration of the "best" institutions in Seoul. This has given rise to a strong sense of elitism centered on Seoul National University (SNU). It also inspires high-school graduates to disproportionately apply for entry to SNU and other elite universities in Seoul at the expense of provincial universities. Provincial universities, in turn, tend to follow and copy the trends in SNU, often without regard to their ability to afford them. The result is a tendency towards homogeneity in public universities that reduces the flexibility and relevance of provincial universities in addressing local development needs. There is a need to further develop local universities outside Seoul. Graduate schools in different regions need to become specialized to meet local needs. It is important to note that diversification of the tertiary education system will involve complementary changes at the secondary level. The strong belief of the Korean people in education, and especially in elite education, means that diversifying the national educational system will present quite a challenge, as citizens may be reluctant to experiment in these areas. 3.32 Possible Responses: * Measures to increase institutional and curricular diversification should be combined to promote interdisciplinary studies and advance broader qualification profiles and flexibility, including overlap between academic and vocational streams. It is important to ensure students' individual choice and to provide for mobility within the system to fulfill the goals of lifelong learning, equity, and efficiency. This could, for example, be done by institutionalizing the credit transfer system; accepting double majors; providing more information on other universities and colleges; providing economic incentives for mobility; and facilitating exchange programs with national and foreign universities. * Greater emphasis should be given to developing "double qualifying educational pathways" that can lead students to university or to tertiary-level vocational education or directly to the labor market. The axis of vocational education should move to the post-secondary level to 26 The number of students in vocational high schools was about 42% in 1995, the remainder being in academic high schools. This percentage is among the middle-ranks of OECD countries. - 51 - meet the demands of the knowledge-based economy. Vocational colleges should be authorized to teach and award degrees and their degree programs should be given proper recognition in the tertiary education system. * Efforts should be made to develop a diverse tertiary education system with a few comprehensive universities that cover all disciplinary areas and others that provide more specialized programs. Each institution needs to develop its own programs in light of its institutional strengths and local industry needs. As virtual universities are mushrooming around the world, diversifying institutions could be achieved by using the new technologies. In addition to the emphasis on universities, efforts should be made to upgrade and expand junior colleges. The education system at the secondary level should be diversified through the deregulation of the education system. 3. Gender, Relevance, and Quality 3.33 Gender. The transition to the knowledge-based economy in Korea requires a shift in the mind-set of its citizens toward reform and development, especially in the area of education. One important issue in this area is the gender bias against women which is deeply embedded in the Korean culture and tradition. For example, although female students make up approximately 38% of total enrollment in tertiary education, they are mostly concentrated in the arts and social sciences. Only 4% of the graduates in science and technology are women. Female university professors are rare, particularly in the science and technology fields. Lesser participation of women in science and technology limits the pool of women suitable for recruitment in the technology industries. Gender biases in textbooks, prevailing social norms, and a strongly gender-differentiated workforce make it difficult to change deeply entrenched attitudes to women's employment. 3.34 Changing the mind-set towards the gender issue needs to start at early stage. The curriculum at schools needs to be reexamined to remove gender bias and to take account of gender issues. In addition, women should be encouraged and given the opportunities to assume leadership roles in the education system. This mind-set change towards women in society will be a long-term process, but is crucial to allow each Korean citizen to fully participate in and contribute his/her full potential to the nation's transition to a knowledge-based economy. 3.35 Relevance. According to Robert Reich, the three jobs of the future include routine production services (perforning repetitive tasks); in-person services (providing person-to-person services); and symbolic analytical services (problem-solving, problem-identifying, and strategic brokering activities).27 In Korea, the overarching need is to develop critical thinking skills, communication skills, computer skills, quantitative reasoning, social interaction among students so that they can become successful knowledge workers for the future.28 These new skills are very 27 Examples of routine production services include traditional blue-collar jobs and low- and mid-level managers (25% in the US); examples of in-person services include waiters and flight attendants (30% in the US); and examples of symbolic analytic services include scientists and lawyers (20% in the US). Robert B. Reich: "The Work of Nations" 1991, Chapter 4. 28 For example, it has been said that the new, minimum skills that people now need to get a middle-class job include the ability to: read at the 9th-grade level or higher; do math at the 9th-grade level or higher; solve semi-structured problems where hypotheses must be formed and tested; work in groups with persons of various backgrounds; communicate effectively, both orally and in writing; and use personal computers to carry out simple tasks like word - 52 - different from the traditional ones taught at schools. Although the quality of Korean education at the primary and secondary levels has been praised around the world, how well can Korean schools perform and how good will be the quality of Korean education when measured against these new skills requirements? Until now, the main purpose of secondary education in Korea has been to enable students enter prestigious colleges and universities. Even though a number of reforms have been embarked upon in this area,29 the college entrance examination system still tends to give priority to students who do better in all fields on average, rather than to those who possess creativity and problem-solving capabilities. The gap between what currently exists and what is required for the future needs to be bridged for Korea's transition to a knowledge-based economy. There are distortions in the labor market in Korea with respect to wage premiums for different types of education/degrees, partly fueled by the traditional sense of elitism for education. In its transition to an advanced knowledge-based economy, Korea must analyse its education system not only from the supply side, but also from the demand side. 3.36 Korea has been attempting to achieve the right balance between quantitative expansion and quality promotion of its university education system. A shift in Korean education policy in 1980 increased the number of university entrants by 30%, and reduced the wages of young college graduates relative to the wages of young high-school graduates between 1982-88.3° Firms complain that they now have to invest in re-training newly-recruited college graduates, although Korean firms spend much less on such training than do enterprises in other OECD countries. The Korean public needs to realize that, even in the new knowledge-based economy, there is a need to increase the technical skills of students, and that this does not necessarily require a university-level education.31 This links back to the issue of the diversification of the system. 3.37 Korean universities do not maintain close linkages with industry, and there are no mechanisms for systematic feedback from industry to indicate the kind of knowledge that should be taught and the skills that should be gained in universities. As a result, the university curriculum does not reflect the needs of industry, and graduates are not well prepared to perform their jobs without further training. If Korea wants to truly transform itself into a knowledge- based economy, a better mechanism for integrating the demands of the market into the education system needs to be developed. The knowledge-based economy also requires that university processing. Richard Murnane and Frank Levy: "Teaching the New Basic Skills: Principles for Educating Children to Thrive in a Changing Economy", 1997. 29 Some significant liberalization has taken place in the area of college admissions. Starting in 2002, universities will have complete freedom to select students with their own criteria. 30 Kang-Shik Choi: "The Impact of Shifts in Supply of College Graduates: Repercussion of Educational Reform in Korea" in Economics of Education Review, v. 15, n. 1, 1999. 31 For example, in the State of Massachusetts, more than 70% of high school graduates receive some form of tertiary education. There is constant pressure on schools to increase offerings in science and mathematics, and there is declining support for vocational education and training. This one-sided approach to education ignores the reality of how economies and labor markets function. According to the State's estimate, between 1996 and 2006, the economy will create through job replacement and growth about 1.1 million job openings. Only 3% of these openings will require schooling beyond university; 31% will require at least a university education; more than 54 % of the jobs will be in occupations that require high school or less; and 36% will be in occupations that require no more than one month of training. Division of Employment and Training, MA: "Employment Projections for Industries and Occupations 1996-2006", 1998. - 53 - faculty become "learning facilitators" and "knowledge utilization coordinators" who help to train students and to transform research results into marketable products.32 3.38 Quality. The quality of the basic education system in Korea has been globally recognized and Korean students do remarkably well in international comparisons. The question is whether the system is of is sufficiently high quality to ensure the development of the Korean knowledge- based economy, especially in terms of the new skills required.3 3.39 Teachers play an essential role in ensuring the quality of education, but the lack of a sound incentive system for teachers is a major problem facing Korean schools. The salary rates of beginner teachers may not be sufficiently competitive with starting rates for graduates recruited to other occupations. In the area of teacher education, dated curricula and pedagogy are some of the other major problems and have contributed to the difficulties encountered in recruiting high-caliber people to the teaching profession. This is a problem as teachers are increasingly seen as fundamental agents for change and quality assurance in many countries which are undertaking major education reforms.34 It is particularly true that while decentralization has brought decision-making and resources closer to those who teach and manage schools, it simultaneously demands schools and teachers to be more accountable to their students, parents, and local communities. The increased accountability and requirements for new teaching skills call for a strengthening of the teaching profession; but the teaching profession must also become more active about its professionalism.35 3.40 Korea lags behind in this area: in 1995, 55% of all secondary teachers came from universities that are not specialised in teacher education. Teachers are recruited at the local level on the basis of selection tests administered by district education authorities, and undergraduate students focus narrowly on preparing for these quite mechanistic tests, rather than securing a broad knowledge and pedagogical basis for teaching. Teaching practice (in all 8 weeks for primary and 4 weeks for secondary) and pedagogical training play a remarkably minor and insufficient role in teacher education and training. The curricula for teachers' education gives far too much weight to subject content and too little to cross-subject themes such as those emphasized in the knowledge-based economy - communication, problem-solving, critical thinking, etc. The curricula is also dominated by university academics who do not promote teaching methods that focus on the acquisition of knowledge through practical experience. In addition, in-service education and training seems to be restricted to teachers at certain promotion points in their careers, instead of being related functionally to the changing requirements of the teaching profession as a whole. Insufficient skills and training in technology have discouraged teachers from integrating ICT with curriculum and teaching. Experience and lessons can be learned from countries such as Singapore where, based on the national ICT strategy, a teacher training plan has been developed with different approaches (e.g. a formal support system, informal network of teachers, and self-directed independent training) focusing on IT integration at the academic subject level. In short, to improve the quality of its education system, Korea must establish the right incentives and mechanisms for the professional development of teachers. 32 Michael Gibbons: "Higher Education Relevance in the 21st Century", 1998. 3 See Murmane and Levy (1997). 34 Fullan, 1999; Darling-Hanmmond, 1997; Elmore, 1996. 35 Chase, 1998. - 54 - The government has an important role to play in this area, not only in terms of providing the needed supporting services, including both financial and non-financial, but also in making the current system more transparent to enhance its quality. 3.41 Quality is a more challenging issue in Korea's higher education system. Korean universities tend to focus on teaching students subject matter content ("know-what" knowledge) rather than teaching or coaching them on how to apply or utilize knowledge ("know-how" knowledge)36. Lack of a sound incentive structure, including unsophisticated evaluation measures for tenured professors (i.e. which are not performance and outcome based, but seniority based) and hiring own graduates, has been a major contributor to the low quality of faculty. This, in turn, makes it more difficult to address quality issues at the institutional level. Once hired, professors have lifetime tenure irrespective of research/teaching performance, their pay is linked with the civil service scale and promotions are based on seniority and length of tenure. Universities typically also hire their own graduates rather than searching out the best performners 37 irrespective of the candidates' alma mater. Unless the incentive structure is reformed, no more than minimal gains may be expected. Thus, unlike its basic education system with its highly recognized quality, Korea has neglected to promote quality education in its university system, which is vital today in building a strong knowledge-based economy. 3.42 In addition, Korean universities have weak linkages with the international educational community. Students do go abroad for education, but foreign teaching institutions have not been given incentives to provide educational services in Korea due to government-mandated criteria for setting up campuses in the country , as they have in, say, Malaysia and Singapore. These criteria include size of the campus lot, quantity and quality of various facilities, size of buildings, number of professors, etc. Foreign schools have difficulty meeting these regulations due to the very high cost of space and facilities in Korea, particularly in Seoul. There are also informal pressures by students and the government to keep the tuitions low for all Korean universities. This is a missed opportunity in terms of raising the quality level of Korea's higher education. The government could, for example, start by creating incentives to encourage joint offering of degrees by foreign universities with local ones. Under this format, foreign universities would maintain linkages to operations in their home countries. For example, students could study for part of the time in Korea and part of the time at their home campuses. 3.43 One of the main barriers for foreign faculty teaching in Korean universities is the low English language proficiency of the students. The current government has introduced several measures to improve the quality of university education in Korea. In the Brain Korea 21 Project, the government plans to invest USD 1.2 billion during the next seven years to prepare the Korean workforce for the coming century. However, to reach standards in higher education comparable to those of leading countries is not simply a matter of resources. Many fundamental 36 Dominique Foray and Bengt-Ake Lundvall: "The Knowledge Based Economy: From the Economics of Knowledge to the Learning Economy" in OECD, 1996, Employment and Growth in the Knowledge-based Economy. 37 The Ministry of Education has recognized these problems and revised the rules of the Public Educational Personnel and Staff Act. Contract-based faculty hiring is promoted, quotas are set up to limit universities to recruit their own graduates, and universities will have to decide their own standards for evaluating their faculty. - 55 - changes have to be made at the institutional level regarding organizational structure, curriculum, and pedagogy to match the requirements imposed by globalization and competition. 3.44 Possible Responses: * Strategies to increase the number of women who can participate fully in the new knowledge- based economy should include the removal of socio-cultural obstacles to women who are skilled and have technical expertise. This should include desegregation of academic fields by gender, provision of support, networks, and incentives to encourage women to enter, remain in, and succeed in areas of study that will enable them to work in any field. At school level, teachers should be educated about gender biases and expectations; curricula and textbooks should be adapted to remove gender biases; and increased career guidance should be available for girls. At tertiary level, women should be encouraged to take up science and technology courses through outreach measures such as grants, scholarships; providing support networks for women who are in large minorities on courses; setting quotas for women for lectureships, post-graduate courses, research positions; and ensuring equal opportunities for overseas training. * There is a need to reform the existing curriculum and teaching pedagogy to make learning experience gained at school more relevant to society's expectations. The integrated curriculum should include training in the new skills, e.g. communication skills, capability to utilize ICTs, good problem-solving, social skills to co-operate and share with others, etc. * Efforts should be made to revise the curricula to improve the balance between practical and theoretical subjects, and incorporate new technologies. New technologies will need to be an integrated part of teaching methods in most subjects in order to secure skilled and up-to-date graduates. This will require general access to computers, the use of computer-based training, access to the use of electronic mailing, distance education, and so on. * Greater importance should be given to developing more extensive and varied forms of university-industry partnership.3 Such improvements would lead to a more effective, efficient university system - one which is more relevant to the needs of industry and which prepares students to be more productive on entry to employment. Measures which foster the establishment of exchange arrangements between universities and enterprises should also be encouraged. * To improve their educational services, universities could consider the adoption of new instruments including: i) accepting double majors; ii) adopting more open-ended evaluation and testing methods; iii) facilitating student and teacher mobility both nationally and internationally; iv) integrating field experience in the curricula, such as compulsory trainee periods in private enterprises; and v) formalizing credit transfers among institutions. * There is need to reform the incentive system for teachers, at both the school as well as the university level, by designing pay schemes that are not based on seniority, but rather on performance and outcomes. 38 Close links between university and enterprises will often be very profitable for universities, since they can secure up-to-date and relevant teaching at the universities. On the other hand, industry will often also be able to profit from research results generated by universities. Empirically it seems that a close co-operation between universities and enterprises facilitates development and innovation. - 56 - It is also important to adopt effective mechanisms to encourage healthy competition among professors and teachers.39 A knowledge management system could be introduced to develop communities of practice to upgrade the skills of teachers to teach with new technologies and pedagogy, through sharing of experience and best practice. * Another important step to improving the quality of education in the country will be to encourage the expansion of exchange programs between Korean and foreign universities in OECD countries. Foreign professors could be appointed in Korean universities in order to help them keep up with the latest developments in their subject areas. To stimulate competition among Korean institutions, the government could consider gradually opening the education market to foreign accredited providers in tertiary education. 4. Lifelong Learning 3.45 In the context of the rapid development and dissemination of new knowledge, it is particularly important to facilitate opportunities for lifelong learning. It should be emphasized that lifelong learning is a "cradle-to-grave" concept and is not limited to adult learning only. In advanced countries, there is currently a proliferation of institutions and mechanisms which focus on lifelong learning at work and at home. New forms of learning are becoming available, such as the Internet, increased use of TV, distance learning, virtual universities, and others. These trends can only intensify in the knowledge-based economy. 3.46 The lifelong education system is not well developed in Korea. ICTs are not fully exploited in areas such as distance learning and virtual universities, and Korea lags its OECD peers in the provision of learning opportunities for adults. While the training opportunities provided by the private sector are limited in comparison to other advanced countries, those that are available could lead to a risk of social polarization, as those who are better qualificd may have the most opportunities for further training. However, there will be no incentive and motivation for lifelong learning if the improved or newly-learned skills are not appreciated in the workplace. Such recognition and reward are important because in Korean culture, rewards are often based on seniority rather than on increased productivity derived from improvements in workers' skills. 3.47 Since learning needs and motivations change over the lifetime, the knowledge-based economy needs to cater to the growing diversity of learning needs, both formal and infornal. This is important for developing informed citizenship, strengthening the foundations of democracy, and developing a consensus for the knowledge-based economy. Thus, the issue of access to knowledge and information for all, and especially for the poor, needs to be stressed. 3.48 The Korean Govemment has recognized the importance of this issue and has begun to expand the high-speed Internet network, offer free public access to computers, provide training in informatics, and promote English proficiency. With regard to the digital divide for the children of poor families, the government has set up a special program to teach Internet and basic PC skills to nearly half million students from poor families. It will also give free PCs and five years 39 In the past, the government emphasized equality in the access to education; as a result, competition was not given much importance, and school and professors and teachers were treated equally regardless of the difference in their performance. This distorted attitude influenced the adoption of fair evaluation of teaching staff. - 57 - of free Internet access to about 50 000 children from low-income families (see also Chapter 4).4° These measures are important, but not sufficient. For example, teaching children how to use the Internet is only the first step. The Korean Government should adopt some of the more efficient solutions that have been adopted by many countries, both developed and developing ones. The United Kingdom plans to set up 700 local Internet access centers around the country to increase access to knowledge and information. Canada has already connected all its libraries and schools. However, current programs to help poor students and other programs such as IT-related local government programs to build the information society in local areas, are not closely integrated in Korea as the main agencies dealing with these issues are different and effective co-ordination between them is lacking. 3.49 Another important issue is the development of content for self-learning students. For example, Canada (SchoolNET) has put in place incentive programs to encourage teachers, professors and students to develop content that can be shared. Korea needs to develop suitable content for students at primary and secondary schools, and to make use of content developed by other countries. 3.50 Possible Responses: a Korea needs to fully integrate its current adult, informal, vocational, and distance education systems with its formal education system, and to develop a lifelong learning system. The Education Credit Bank system is one initiative that can help to ensure such integration. * The government should invest more resources into helping schools build up their information 42 infrastructures, and facilitating greater inter-university networking through ICTs to improve teaching and research. X The development and expansion of early childhood educational services should be given a higher priority in the government's educational agenda (including funding). A closer integration of early childhood educational services with the first year of primary education should be undertaken. • Women should be targeted in policies for enabling lifelong learning. Sites for early childhood education can help women to access second-chance educational opportunities. The government should provide guidance and informnation services about educational programs, training, introduce support groups (as in the case of Singapore), and provide access to open education programs and learning networks. * ICT-supported network learning should be utilized more in the education system to overcome the limits of distance and time. 43 Special attention needs to be given to the integration of ICTs with curriculum and pedagogy. The govenmment's efforts towards equal access should gradually enable every citizen to learn whenever and wherever he/she wants in a convenient way and at low cost. 40 Eun Jeong Kim, The World Bank. E-mail received on April 6, 2000. 4' For further information, see http://www.schoolnet.ca. 42 The average number of students per computers was 16 in 1998. Vocational schools showed the highest PC distribution (5.5), whereas academnic high schools showed the lowest PC availability rate (19.6). 43 For example, the UK's National Grid for Learning scheme highlights the Government's commitment to lifelong learning and the creation of a learning society. The main aim of this scheme is to help create a "connected society", to improve the quality and availability of educational materials, and to widen access to learning. - 58 - E. Conclusions 3.51 The planned transition to a knowledge-based economy requires that Korea undertake systemic reforms in education. These reforms will involve profound changes in all aspects of its current education system, i.e. not only in the inputs and their content and composition, but also in the institutional and govemance infrastructures that deliver them. Deregulation and diversification of the existing education system is fundamental, as without this, the system would remain inflexible, lack competition, and be less relevant to the needs of a changing society. At the same time, the education system should be relevant to the needs of the population and should emphasize lifelong learning. It should also be noted that the education reform process will be complex and will take time - there is no instant solution guaranteeing quick results. 3.52 Global experience and research on education reform show that factors such as shared vision, clear goals, strong leadership, broad consensus building, the ability to make adjustment along the process, measurable indicators, and the availability of a support infrastructure are critical to ensunrng that the reforms take place and achieve the desired results. The role of the govenment will be very central in this process for overseeing the whole education system, particularly in maintaining minimum standards, setting up a system of national qualification structure, providing information on outcomes and quality, improving teacher training, encouraging industry-university partnerships, dealing with issues of equity, and investing more in public education. 3.53 In short, the systemic reform in education required in Korea will be a long-tenn process.44 The challenge is how to maintain the good practices within the existing system, such as relatively high average quality and low dispersion of student performance, while trying to reform and create a new system that would serve the country's human resource needs in the new global economy. 44 For a summary of lessons learnt from the Korean education reform effort, see Se-Il Park: "Managing Educational Reform: Lessons from the Korean Experience: 1995-97, The Brookings Institution, 1999. The main points are (i) for the success of any reform, close cooperation as well as a system of checks and balances between the Cornmission (designing body) and the Ministry of Education (implementing body) is important; (ii) sufficient budgets should be allocated for the reform; (iii) in dealing with vested interest groups, more refined, sophisticated, and flexible strategies should be developed as merely appealing to the moral conscience, civic virtue, or public-mindedness of the interest group will not work; (iv) providing the appropriate incentive system to bureaucrats should be sought after; (v) a special pay system and promotion policy could be designed to motivate them to be more proactive for reform; (vi) for effective deregulation, the establishrnent of a "Conmmittee for Deregulation" composed only of non- bureaucrats is recommended; (vii) close cooperation with the mass media is indispensable for reform success; (viii) for reform to succeed, a top-down (government-led) approach should be accompanied by a bottom-up movement; (ix) the participation of teachers and parents in the reform-designing and implementing process is of pivotal importance, as is institutionalizing their permanent participation into educational policy making and in the implementation process; (x) as education reform usually takes a long time to consolidate, the reform group should prepare a series of small victories or reforms that are "felt by skin" that people can celebrate during the road to reform. By doing this people will maintain a high level of enthusiasm for reform; and (xi) the best way to successfully consolidate reform is to set up a reform body that outlives the current government or regime. This will ensure greater consistency and continuity in the reform management process that is politically and institutionally guaranteed, thus leading to successful consolidation of the reforms. - 59 - 3.54 It is suggested that Korea study how other countries, especially the OECD countries and neighboring countries like Singapore and Hong Kong (China), are undertaking systemic reforms in education, with special attention to process-related issues. Above all, a change is needed in the mind-set of major players involved in decision making on the acquisition and value of education, training, and skills. The required changes need the championship of the government, and extensive participation of all stakeholders: parents, teachers, unions, private sector, professors, and others in civil society and the media. The Korean Government has demonstrated its willingness and commitment to education reforn. Given the capacity and the political will to carry out such unprecedented reforms, Korea will have a new generation of education citizens and will be on its way to making the transition to an advanced knowledge-based economy. Chapter 7 elaborates on the implementation of the reforns in education Korea. - 60 - REFERENCES "A Comprehensive Plan for Knowledge-based Development of Korea (Draft)," An Interim Report, Ministry of Finance and Economy, Korea, June 1999. A. Hasan: "Lifelong Learning: A Monitoring Framework and Trends in Participation", in OECD: 1998 Education Policy Analysis. "Brain Korea 21," Ministry of Education, Korea. Cheonsik Woo and Ju-Ho Lee: "Efficiency of Korean Education: Myth and Mission," Korea Development Institute, Working Paper #9906, April 1999. Christopher Thomas: Back to Office Report and Aide Memoire: Korea Structural Reform in Higher Education, The World Bank, August 17, 1998. Dominique Foray and Bengt-Ake Lundvall: "The Knowledge Based Economy: From the Economics of Knowledge to the Learning Economy" in OECD, 1996, Employment and Growth in the Knowledge-based Economy. "Education Reform for the 21't Century," The Presidential Commission on Education Reform, Korea, November 1997. "Employment Projections for Industries and Occupations 1996-2006," Division of Employment and Training, MA, 1998. Eun Jeong Kim: "Closing the Digital Divide in Korea", E-mail received on April 6, 2000. George Cole: "Great Leap Forward", Times Education Supplement, October 15, 1999. "Human Development Report 1999," UNDP: Oxford University Press, 1999. "Implementing Education Reforms in New Zealand: 1987-97", by Lyall Perris, The World Bank: Human Development Network. 1998. Kang-Shik Choi: "The Impact of Shifts in Supply of College graduates: Repercussion of Educational Reform in Korea" in Economics of Education Review, v. 15, n. 1, 1999. Ki Su Kim: "A Statist Political Economy and High Demand for Education in South Korea" in Education Policy Analysis Archives, v. 7, n. 19, 1999. Merrill Lynch & Co.: "The Book of Knowledge: Investing in the Growing Education and Training Industry", April 1999. - 61 - Linda Darling-Hammond: "Reward and Reform: Creating Educational Incentives That Work" in S. Fuhrman & J. O'Day (eds.), Restructuring Schools for High Performance. San Francisco: Jossey-Bass. 1997. Marrakesh Seminar on Teacher Unions and Ministers, Morocco, April 26-27, 1999. Merrill Lynch & Co.: "The Book of Knowledge - Investing in the Growing Education and Training Industry", April 1999. Michael Fullan: "The Return of Large-Scale Reform," Journal of Educational Change, October, 1999. Michael Gibbons: "Higher Education Relevance in the 21st Century", 1998. Ministry of Education: Educational Yearbook of 1998, Seoul. Noel McGinn: "Globalization, Education and knowledge for Development", Speech given at the "Using Knowledge for Development" Workshop, Helsinki, Finland, May 25, 1999. OECD 1998: Technology, Productivity and Job Creation: Best Policy Practices, The OECD Jobs Strategy, Paris. OECD, 1998: "Education at a Glance," OECD Indicators. OECD, 1999: "New Enterprise Work Practices and Their Labour Market Implications", Employment Outlook 1999, Chapter 4, June, Paris. Peter Drucker, "The Age of Social Transformation" in the Atlantic Monthly, Nov. 1994. Peter Drucker: "Knowledge Worker Productivity: The Biggest Challenge" in California Management Review, Winter 1999. R. Chase (1998): "NEA's Role: Cultivating Teacher Professionalism", Educational Leadership, v. 55, February. "Reviews of National Policies for Education: Korea," OECD: Paris, 1998. Richard Elmore: "Getting to Scale with Good Educational Practice", Harvard Educational Review, v. 66, n. 1, 1996. Richard Mumane & Frank Levy: "Teaching the New Basic Skills: Principles for Educating Children to Thrive in a Changing Economy", 1997. Robert B. Reich: "The Work of Nations" 1991, Chapter 4. Se-Il Park: "Managing Educational Reforrn: Lessons from the Korean Experience: 1995-97, The Brookings Institution, 1999. - 62 - Sungteak Kim: "Policy Suggestions for the Development of Knowledge-Based Industry in Korea," KIET, June, 1999. World Bank: EdStats (Education Statistics Database). World Bank,1999: "World Development Indictors 1999". - 63 - CHAPTER IV: ENSURING A DYNAMIC INFORMATION INFRASTRUCTURE A. Background 4.1 The Korean Government and people have been quick to recognize the importance of the global networking revolution and to formulate a strategy to ensure that the country moves ahead to gain all possible benefits from that revolution. Korea has performed impressively in the information infrastructure sector in many areas - especially Internet access and mobile telecommunications. It has a well-educated workforce, a strong ICT manufacturing sector and a number of other advantages. However, to preserve this strong record, the country needs to move towards a more efficient model of ICT provision and services. 4.2 The 1999 White Paper Cyber Korea 21 notes that levels of information and the size of the knowledge gap greatly influence the productivity of individuals, businesses and economies as a whole. Cyber Korea 21 and related initiatives (including President Kim's New Year Policy Speech) lay out an ambitious set of targets to be met by 2002 to ensure that Korea becomes one of the top-ten nations in terms of information infrastructure and industry. Cyber Korea 21 highlights the importance that the country's leaders attribute to information infrastructure and sets out a number of significant policy goals. However, it suggests a role for the government that may be beyond what is appropriate in such a dynamic sector where technology and the speed and flexibility of the private sector may make strong government orchestration a hindrance rather than an asset. 4.3 This chapter provides a picture of recent growth in the ICT sector in Korea - in both infrastructure and manufacturing - before turning to some of the problems facing the sector. It discusses the legal, regulatory and investment environment in Korea, arguing for a change in focus in regulation and support. It builds on the ideas laid out in Cyber Korea 21, but suggests a different focus in terms of regulatory and investment priorities. Broadly, it argues that Korea's high level of investment in information infrastructure has achieved impressive results. But, in common with the country's education sector, reform of the laws and regulations governing the sector could bring even higher returns to investment. Moving from micro-management of research and investment with direct control of regulation towards a more hands-off model might help support an even more rapid roll-out of ICTs and ensure even higher growth of the sector in the future. - 64 - B. Recent Sector Growth Recent growth in telecoms and Internet 4.4 In 1980, telephone penetration in Korea was 7.3 lines per 100 people. By 1997, it was 44.4, almost reaching the OECD average of 48.9 telephones per 100 people.' Between 1994 and 1998, the number of mobile phone subscribers grew from under 1 million to 14 million (see Figure 4.1)2, which, at 30.2 mobile phones per 100 people, was higher than the OECD average of 25. By end-1999 it is estimated that there were nearly 23 million mobile phones in Korea. Quality and cost of basic services is good, with the percentage of faults repaired within 24 hours the highest in the OECD area, and rental charges well below the OECD average.3 Now, one out of every two persons owns a mobile phone. Figure 4.1: Past and Predicted Growth in Mobile Phones 0 400 o 00 0.30 0 200 6 2 100 0 1988 1990 1992 1994 1996 1996 2000 2002 2004 2006 2008 2010 2012 Kong Kor _ea_ ' Mayla. ngire Lknted States 4.5 The number of Intemet hosts is also increasing rapidly, with the country adding nearly 100 000 host sites between January 1999 and January 2000 (an increase of over 50%)4. Estimates suggest there were already nearly 13 million Internet users in Korea in February of this year, up from just 3.1 million at the end of 1998 and only 1.6 million in 1997. At the end of 1999, 23.6% of Korea's population used the Internet -about the same proportion as the UK and Taiwan, and a significantly higher percentage than in countries including Japan and Germany (both at around 15%). In 1999 alone, an estimated 2 million Intemet-capable PCs were sold. The number of women Internet users in Korea is also growing (although not fast enough). Women users made up 16% of all Internet users in 1998, reaching 20% in 1999.5 Korean advanced services are mostly supplied at low cost and with good public access: ' OECD, 2000, Regulatory Reform Korea, OECD, Paris. 2 Source: Pyramid Research. 3 Korea has not done as well in increasing the number of personal computers per 1 000 persons between 1994 and 1998. By 1998, the number was 157 per 100 persons, compared to 458 in Singapore and an OECD average of 256. 4 In 1998, Korea had 38 Internet hosts per 10 000 people, compared to 188 in Singapore and an OECD average of 254. 5 This figure is clearly too low, and points to one of the costs arising from discrimination mentioned elsewhere in the report. The recently announced initiative on subsidizing training for home-makers should help to solve this problem. - 65 - * For consumers and small businesses using the Intemet for less than 20 hours a month at off- peak times, a recent study by the OECD suggests that Korea's rates are the lowest among Member countnes. * Public access is also high in Korea. A recent survey of Web users worldwide found that Korea had one of the highest rates of access from school (at 29% of respondents) among the OECD countries (in Japan, the figure was 7%). Access from kiosks, libraries and cyber cafes accounted for over 20% of users -compared to less than 10% in Japan. This is in part thanks to a network of cyber cafes offering service for less than USD 1 an hour. * An information superhighway has been installed in 94 major areas of the nation, with a capacity of 2.5 gigabytes per second. * In terms of use, a recent survey indicated that 56% of Korean users had purchased goods over the Internet from home (compared to a high of 72% in the United States, but only 37% in Spain). * There are 400 domestic online shopping malls, with monthly average sales of some KRW 50 million to KRW 60 million (USD 41 700 to USD 50 000) as of January 1999. 4.6 Employment in information and telecommunication companies has climbed from 318 000 to 507 000 1994-98, and public telecommunications revenue reached around USD 9.1 billion in 1997. Turnover in the information and communications sector as a whole in 1999 is estimated to have increased by 20.0% to KRW 71 trillion. A strong private telecom manufacturing sector 4.7 Korea is currently one of the world leaders in CDMA technology, with SK Telecom the world's largest CDMA operator and numerous local vendors exporting CDMA equipment, especially handsets. In 1998, Korean companies exported USD 660 million worth of CDMA- based phone sets and the nation's three biggest mobile telecom firms - Samsung Electronics, LGIC and HEI - planned to ship USD 1.62 billion of CDMA mobile phone equipment in 1999. Exports from the information and communications sector constituted 67% of the nation's trade surplus in the first quarter of 1999 (i.e. USD 4.77 billion). 4.8 With nearly 40% of the global CDMA market, Samsung is expected to remain the world's largest supplier for the third consecutive year. The company has established a firmn footing in the US market and recently concluded a USD 100 million contract with AirTouch Communications to provide its CDMA commercial system through 2003. In mid-July, Samsung won a three-year USD 160 million contract for its Internet phones from the Norwegian state-run telecommunications firm Telenor. 4.9 Arguably, government intervention enabled the benefits of scale with CDMA to be realized so quickly. The MIC has focused on the development of an infornation infrastructure through local technologies, rather than relying on foreign vendors. Recognizing the potential of CDMA technology, the govemment pushed the industry to adopt that technology as the standard 6 Although in the case of a "basket" encompassing PSTN connection and usage fees plus ISP charges for users staying on line for 40 hours or more a month, Canada and the United States are still the cheapest markets at peak times. 7Cyber Korea 21. - 66 - for mobile communications and to develop a local technology base. The lack of worldwide development of CDMA technology presented lower entry barriers for local companies to gain expertise with foreign companies through public and private research and development. 4.10 The Korean Government's interventionist approach to guiding the development of the industry has a parallel in Europe where governments adopted the GSM standard (although this was not part of an industrial policy, merely to ensure service integration). In contrast, wireless information infrastructure development in the United States has been hampered by multiple standards, resulting in an inability to interoperate among different carriers in the country as well as with the rest of the world. Nonetheless, despite the fact that it paid off, the choice to enforce a CDMA standard was a risky gamble. And it has involved costs - including the need to make significant payments to US patent owners. In Section E, we further discuss the limited applicability of this experience to other efforts at central planning at the micro level. Heavy investments in ICT infrastructure 4.11 As Table 4.1 suggests, Korea invested heavily in its infornation infrastructure over the course of the 1990s. As a percentage of GDP, Korean investment was 0.8% in the first half of the decade, and more than doubled to 1.85% of GDP in the second half. Compared with a number of other countries, this performance is very impressive. In percentage terms, in the second half of the 1 990s Korea's investment rate was nearly twice that of Hong Kong, and more than five times that of Japan. 4.12 Another distinguishing feature of Korean investment s that a high percentage came from government. In many OECD countries, the public share in investment was zero in the late 1 990s, while for Malaysia, Singapore and the United Kingdom, the public share was 5% or less. In Korea, 25% of investment came from the public sector (although this was down from 48% in the early 1990s). As a percentage of GDP, public investment in information infrastructure in Korea was higher than total investment in information infrastructure in Japan and the United Kingdom, and about similar to US total investment. As a percentage of GDP, public investment in the sector actually rose over the course of the 1990s. Table 4.1: Korean Investment in Information Infrastructure, 1991-99 Investment/GDP (%) Public investment (% of total) Average 1991- Average 1996- Average 1991- Average 1996- 95 99 95 99 Hong Kong 0.58 0.98 0 0 Japan 0.14 0.34 0 0 Korea 0.80 1.85 48 25 Malaysia 1.12 1.04 6 5 Singapore 0.35 0.57 38 4 UK 0.23 0.35 2 2 US 0.58 0.52 0 0 Source: Pyramid Research. 4.13 Public investment in Korea has a fairly distinguished record compared to such investment elsewhere. Nonetheless, these figures raise the question of the returns to this investment. Does - 67 - the performance of the ICT sector suggest that this investment has collected the returns that might have been possible? While the country's performance has been notable, international comparisons suggest that the answer to this question is at best unclear. C. Remaining Challenges 4.14 While growth in service provision and the ICT sector has been striking in recent years, there is still some way to go. Perhaps most important in the future is the roll out of more advanced equipment and services. The network digitalization rate in 1997 was 66.7% of fixed access lines, compared to an OECD average of 89.2%. In ISDN, as of May 1999, Korea Telecom had only 90 000 customers (although there were a total of 829 000 high-speed Internet subscribers in February, 2000, about half of whom accessed using ADSL).8 Continued advance in the quality of fixed service provision is central to further expansion of Internet use in the country, especially as consumers and businesses start to demand an "always on" Internet environment (the ability to stay on line for extended periods). 4.15 Indeed, while we have witnessed impressive performance in the growth of the Internet over the last two years, this performance is less astounding from the perspective of a global revolution in Internet provision. Figure 4.29 shows that future growth in Internet use is predicted to be reasonably strong - but this is from a low base, with 0.03 Internet subscribers per capita in 1997, compared to 0.11 in Hong Kong, RgJe42 TdilrEartR1aiJN&, for example. And, although we have seen that advanced Internet services are developing, once again this is frorm a very low base. In August 1999, only two 10fl scoD ,Korean banks had started offering Internet banking - and then only a limited range of services (although, again, there has been rapid progress over a 10 the last year).10 We have seen that Korea a11 F vhas 400 (rather small) cyber malls - J ,l X - ----------i__ compare this to Japan's 7 000 and the 19e5 19o 1595 zm 2c5 zno 5_i United States' 450 000.11 4.16 Further, in common with the rest of the world, Korea has seen the emergence of a 'digital divide' between rich and poor, more and less educated, men and women, rural and urban. For example, the usage rate amongst those with incomes above KRW4 million is more than double 8 OECD, 2000, Regulatory Reform Korea. OECD, Paris, and Ministry of Information and Communication, Paris. 9Source: Pyramid Research. 10 HSBC Securities Sector Report: Korean Intemet Plays August 1999. Local banks are adopting the Internet banking system, however, turning it into one of their main business objectives this year, by offering diverse services including loan applications. Kookmin Bank has seen the number of its Web banking customers top 100 000 and I 000 new ones registering every day. Shinhan Bank has received 1 000 loan applications online daily as opposed to just 400 at bank counters. 1 Korea Ministry of Commerce, Maximizing the Benefits of Electronic Commnerce: Korea's Initiatives, 1999. - 68 - that amongst people earning less than KRW1 million. For farmers and fishernen, a usage rate of 7.3 percent compares to a usage rate of 64 percent amongst office workers. 4.17 Broadly, the picture is mixed for past returns to very significant levels of investment in the sector, and future estimates suggest that, in the absence of reform, returns to investment will remain lower than might have been the case. In mobile telephony, where competition prevails, returns appear to have been substantial. In other sectors with less competition, the evidence is less reassuring. How can better performance be ensured, especially in the provision of next generation ICTs? Given the revolutionary nature of the sector, this report suggests that there is a vital role for government - especially in rolling out services to the disadvantaged - but that that role is different from that traditionally followed, involving more open competition and investment policies. D. Cyber Korea 21: Targets and Initiatives 4.18 Responding to both the need to increase returns to investment and to keep Korea on the cutting edge of information and technology roll-out, in 1999 the Korean Government launched Cyber Korea, together with a range of linked initiatives. Targets were laid out, including: * Designating six strategic fields in which Korean firms will compete on the global stage: next- generation Internet, fiber-optic telecommunications, digital broadcasting, wireless communications, software and computers. * Creating 1 million jobs and KRW 118 trillion of new production. * Providing universal service access speeds of 2 Mbps. * Nurturing more than 5 000 venture enterprises while doubling the proportion of Korean parts in IT equipment from today's 40%. * Increasing the number of Internet users to 10 million by 2001. 4.19 In order to meet these ambitious targets, a range of government initiatives have been put forward: * Reducing government ownership of Korea Telecom to 34% by the year 2000. * Providing KRW 500 billion for the development of info-tech core technologies in a bid to end dependence on foreign technologies. * Setting up a venture firm in information and communications and a venture co-operative to expand infrastructure for venture firms. * Investing KRW 10.4 trillion in advanced information infrastructure and information technology by 2002. * Removing impediments to e-commerce, including the Door-to-door Sales Act, and ensuring the validity and security of digital signatures. * Connecting more than 10 000 schools to the Internet, providing computers free of charge to over 230 000 teachers and 200 000 classrooms and providing free access to 50 000 poor children. * Facilitating Internet PC purchases through a lump-sum payment at computer shops or through fixed installment savings accounts at the country's 2 800 post offices, with a target of 9 million new PCs, priced between USD 731 and USD 830. - 69 - * Building Internet Plazas in public facilities, including libraries and post offices, and providing kiosk access to certificate issuance services. * Teaching 900 000 civil servants, 10 million students and 600 000 military personnel how to use computers. * Providing subsidized or free Internet training for groups including housewives, juvenile delinquents and the disabled. * Providing e-mail accounts to all public servants and moving to a digital documentation and authorization system that will decrease work process times by up to 30% and digitize 80% of circulated documents. * Digitizing the public procurement operations of 26 000 institutions (up from 556 in 1998). 4.20 The rest of this chapter explores the reform agenda in the light of Cyber Korea, and commends many of the recommendations of the report while suggesting a slightly different focus in terms of priorities and programmes in specific areas. E. Next Generation Policy and Regulatory Role for Government 4.21 Korea has been moving towards a more liberal ICT sector. Excluding Korea Telecom, the last few years have seen the launching of initiatives to remove limitations on resale services, individual ownership and mergers and acquisitions, increase aggregate foreign ownership restrictions to 49% and allow the largest shareholder be foreign. The liberalization of the local loop market in 1998 means that all parts of telecommunications services are now legally open to competition. There is an important role for oversight of dominant operators to ensure fair competition. However, as we will see below, other restrictions remain, both on the incumbent operator and on the freedom to compete with it. Further, many domestic players are concerned that the government's continued interventionist approach, which appears to favour large players, will reduce the creativity and vibrancy of the industry. Opening up domestic andforeign competition12 4.22 Where more open and fair competition and less regulatory intervention has been allowed for significant periods, the results have been noteworthy - not least in the mobile sector and in third-party resellers for VoIP services. In 1995-98, mobile revenues increased nearly six-fold. With the removal of the government-imposed compulsory subscription period of two years for mobile in April 1999, the number of mobile customers shot up by 3 million in just one month. Low prices for Internet access are in part the result of fierce and relatively unencumbered competition between some 24 commercial and five non-profit ISPs, some of which offer free PCs in return for a three year subscription. 4.23 Conversely, competition has been slow to deliver in fixed services. There have been only three new entrants in the fixed telecommunication infrastructure market (compared to 29 operators in Ireland). In the national long-distance market, Korea Telecom had a 91% market share in mid-1999, and held close to 100% of the local market. As a result, prices have remained 12 This and the following four sections draw heavily on OECD, 2000, Regulatory Reform Korea, OECD, Paris. - 70 - high and service provision is weak. Between February 1996-1999, the highest long- distance telephone charge in Korea dropped by 22%, compared to 50% in Japan or 46% in France. In addition, many advanced infrastructures (including ISDN) have been slow to roll out (although ADSL, for example, has grown more rapidly). 4.24 Independent regulation (discussed below) will be part of the solution to overcome these problems (by offering better support for competition). Another will be to lower the barriers to entry posed by very high licence, annual and research fees levied on operators. At present, the MIC has the authority to recommend the level of investment required by each telecom provider to fund the research and development of telecom technology and other related projects. This is set by law at 3% of revenue (although the major operators did not meet this target in 1998 and it should be noted that the MIC plans to reduce these fees). A third method to overcome barriers to fixed competition would be to unbundle services. Presently, local loop network elements may not be unbundled, which means in effect that Korea Telecom's competitor in this market (Hanaro), must replicate all existing sunk plant at prohibitive cost. If unbundling remains prohibited, real competition will be unable to blossom in this market. A regulatory reform agenda to encourage stronger competition is laid out below. Accessing international investment 4.25 Another important measure to ensure international competitiveness and improve domestic service provision is opening up access to international investment. As noted above, t Korea has implemented WTO agreements on foreign ownership - and did so 18 months earlier than scheduled. However, remaining limits - including those on ownership of Korea Telecom itself - are a wasted opportunity to attract investment to a sector where there is clearly foreign interest. For examnple, British Telecom is expected to invest USD 500 million in LG, while Bell Canada Intemational Inc. recently announced that it has agreed to invest USD 159 million to acquire about 23.6% of Hansol PCS Co. Ltd, one of three new Korean CDMA-based PCS operators. 1 3 4.26 Thus, while Korea Telecom is extending its overseas reach (it recently acquired a stake in a Vladivostok telephone company), overseas investment in domestic ICT markets should also be encouraged. If the government is concerned about international control of the incumbent, other OECD countries have found that "golden share" approach to be more efficient than maintaining majority ownership. 4.27 Encouraging a greater role for private investment should allow for a reduction in government expenditure on service roll-out, which is also likely to increase efficiencies. Looking at the Internet backbone, government use of ICTs and universal access to advanced services, " The global rush to invest in Korean Internet companies has also increased since last spring, when Web giants began to forge strategic ties with Korean companies. Amazon.com, one of the largest U.S. online music and book retailers, formed a partnership with Samsung Corp., which recently announced that it would transform into an Internet-oriented finm through a strategic alliance with America Online. Microsoft launched a Korean version of msn.com, its Web search and content aggregation service, in March, while Lycos Inc. will open a Korean-language portal in July through a joint venture with Mirae Corp., investing US$3 million for Net services. A U.S. online brokerage, E*Trade plans to team up with LG Securities to offer a joint stock trading service here. These foreign investors will bring needed talent and expertise to the Republic of Korea's nascent advanced Internet services. - 71 - there remains a role for government support. However, this support should at the least be flexible and open to adjustment given changing circumstances. For example, capacity on the Korea Electric Power Corporation (KEPCO)'s dual-capacity fiber optic 2.5 gigabyte backbone was previously leased to 43 (out of 78) regional cable TV system operators purely for cable TV use. Recently, the backbone was spun off and new regulatory conditions will allow the cable companies to provide services including Internet over the network. Despite this "windfall" in backbone capacity, MIC is yet to account for this change in its backbone investment plans. 14 Reducing micro-regulation and control 4.28 The advantages of open competition suggest what could be gained by rolling back a range of micro-regulations in the sector. While government intervention to impose the CDMA standard suggests that early standardization is of benefit to consumers, balancing this effect is the risk of "locking in" the wrong standard.15 Therefore, any technology standards ought to be widely canvassed with the private sector before introduction and should remain as flexible and limited as possible. 4.29 Less defensible than standards from an economic standpoint are price regulations, except those designed to control monopoly rents. For example, the government's decision to forcibly abolish company subsidies on cellular phones seems an unnecessary intrusion into business practices. Cyber Korea 21 also suggests a continued government role in the pricinv policies of Internet Service Providers, which appears unjustifiable in a very competitive market. 4.30 Finally, it should be noted that, despite the need for a more market-friendly approach to regulation and restrictions, many areas will continue to need oversight and (possibly) a greater level of regulation. For example, entry into the specialized telecom service provider (STSP) market has been simplified, and this sub-sector is now very competitive. Recently, an STSP company went bankrupt, raising concerns about compensation of consumers - here, there is clearly a need for regulation. Also, at the moment, there is a degree of cross-ownership between competing telecommunications providers - for example, DACOM owns 11% of Hanaro in the local telecom market. This should be discouraged, perhaps through regulation. Independent Regulation 4.31 Perhaps the most important change that might be made to the regulatory environment is the creation of an independent regulatory agency. Korea is one of only two countries in the OECD without one. The Korean Communications Commission (KCC) is charged with ensuring fair competition in the sector through arbitration of disputes, fact finding on unfair practices, 14 Although it should be noted that in the wake of the Asian crisis, the MIC has already scaled back its planned investment from 63 trillion to 10.4 trillion won by 2002. 15 A commonly cited example of suboptimal 'locking in' is the VHS standard of video systems, visually inferior to the Betamax system, but which more quickly achieved a critical mass of users. Although this example was a private sector failure, government enforcement of standards can increase the risk, especially in a rapidly developing sector such as telecommunications. 16 Increased competition is likely to produce losers as well as winners - and might even increase the rate of bankruptcies in the sector. If these are the result of fair competition, however, they are an important part of the market process. - 72 - examination of competition-related rules and regulations and proposing corrective measures against unfair practices. This body is nominally neutral, and can under limited circumstances over-rule the Minister of Information and Communications. For example, when it arbitrates between companies, its decisions cannot be overturned by the Minister. However, the KCC lacks independent legal status (coming under the supervision of the MIC) and has but 20 employees who remain part of the MIC's management structure. Its powers are largely indirect and advisory; its role reactive rather than proactive. 4.32 The problems created by this lack of independence are illustrated by the history of STSP competition. Since the government liberalized the international call market, STSPs have mushroomed and their share of the market is now estimated at 15% to 20%. In the wake of broader competition, international calls now cost one-half or one-third of previous prices. However, the STSPs claim that KT is demanding that newcomers pay three to five times more for using KT equipment than do existing carriers such as Dacom and Onse Telecom, while the nation's public network operators, who once enjoyed an oligopoly in the international call market, complain in turn about the new competitors. They charge that STSPs are getting a free ride, demanding to use facilities in which backbone network operators have made huge investments. Without an independent regulator, at the very least it will be hard to convince all sides that rules are being enforced fairly.17 4.33 Only with an independent regulator are all sides likely to feel equally treated - a vital step in encouraging investment and competition in the sector. An independent KCC, separated from the MIC and with its own staff and budget, would more effectively achieve market confidence and transparency. The KCC would need powers of licensing, price controls and interconnection, overseeing policies on universal service and the implementation of other regulatory safeguards. A Telecommunications Regulatory Reform Agenda 4.34 A recent OECD report'8 laid out a broad agenda for regulatory reform in the telecommunications sector. Beyond independent regulation, and fewer price controls in competitive markets, it suggests that priorities for improved independent regulation in this area should include: * A shift to the long-run average incremental cost methodology (away from the fully distributed cost methodology) in calculating interconnection costs, to avoid manipulation of distribution of common costs and to penalize inefficiencies in the former monopoly carrier. Currently, while KT interconnection charges are in the mid-range of OECD countries, they are high relative to retail prices and revenues. * Creating a universal service costing methodology and moving towards a technologically neutral universal service fund as the vehicle for supporting roll-out. 17 Other problems include that Korea Telecom is frequently competing against private operators such as SK Telecom, or Samsung Electronics for research funds, licenses or services - and complaints also surface here of unfair treatment. Another example is the selection process of the broadband wireless local loop spectrum. Newly- selected corporations were charged a fee for the right to bid while Korea Telecom and Hanaro Telecom were selected with no charge six months earlier. Korea Telecom and Hanaro were thus given preferential access to a valuable spectrum resource at no cost. 18 OECD, 2000, Regulatory Reform Korea, OECD, Paris. - 73 - * Simplifying the licensing regime by removing existing distinctions between fixed provision of local and long-distance services and perhaps moving towards a class-licensing system. * Simplifying the registration process for licences: moving to ex post examination of licensee standards and agreements rather than a priori examination wherever possible; allowing for rolling applications rather than offering a twice-yearly application window; reducing data requirements for licensees; and removing R&D requirements on licensees. * Rolling out IMTS-2000 mobile licences (MIC is considering an auction process as one of the options in selecting service providers). Pre-qualification for this process might enhance competitive conditions in the market. * Price caps for dominant local loop, leased line and long-distance provision (this is already being reviewed by the MIC), and removal of price restrictions in the competitive mobile market. * Arrangements for unbundling. * Number portability to encourage competition by allowing users to change service providers without changing numbers (pledged by the MIC for this year). * Reducing government involvement in accounting rate negotiations with foreign operators based in a competitive market. Currently, the MIC approves a single accounting rate for all carriers operating between Korea and a second country. This is one reason for very high accounting rates (leading to expensive international calls) in Korea. The US accounting rate with Korea is 71 cents, compared to the US-France rate of 20 cents or the US-Japan rate of 28 cents. * Minimizing overlapping roles of the KCC and the Korea Free Trade Commission which enforces the Fair Trade Act on all sectors including telecommunications (for which there are no exemptions). * Increasing the transparency of the policy formulation process. Progress has already been made here, with the government holding public hearings on some regulatory proposals and providing notice of changes to the telecommunications Business Act. Major telecom legislation is now reviewed by the Information and Communication Policy Deliberation Committee made up of outside experts. Nonetheless, user groups including the Federation of Korean Industries could be encouraged to play a more active role in the policy formulation process. * Moving towards joint independent operation with broadcasting regulators (the MIC has suggested that such an approach be implemented over the next year). Legislation and Support for Research and the Manufacturing Sector 4.35 We have seen that the government mandates research expenditures for telecommunications services suppliers. Cyber Korea plans to step up govermnent support for investment in technology and manpower to small venture firms in the information and telecommunications industry. 4.36 There are particular concerns about the Ministry having the joint roles of consumer protection and industry promotion - most regulatory bodies in the OECD are solely concerned with consumer interests. This problem would be reduced with the granting of greater independence to the KCC. However, it should be noted that promoting the domestic telecommunications manufacturing industry does not necessarily have a positive effect on the - 74 - service quality of domestic telecommunications. Indeed, if domestic promotion involves discriminating against superior imports, the opposite effect might be achieved. For example, Cisco Systems has already captured 80% of the domestic Internet equipment market. It might be a mistake to encourage a domestic competitor under these circumstances. 4.37 Instead, the manufacturing sector ought to be opened up, creating a framework in which manufacturing and services can develop in a competitive environment. This is especially true in the case of trade. Korean telecommunications manufacturers have greatly benefited from healthy export markets and the capability to exploit them. At the same time, however, European mobile telecommunications conglomerates have begun building CDMA handsets. In response, Korea should liberalize its own telecom manufacturing industry both to ensure that manufacturers remain internationally competitive at least on the easier home market, and to put itself in a position to argue for the elimination of trade barriers in telecom fields elsewhere in Asia, Latin America and Africa. 4.38 Where a role remains for support through targeted investment, the Scottish model of venture capital support (rather than direct intervention in management decisions) might provide a good model of a relatively hands-off approach to industry promotion. Further, foreign investors are showing great interest in Korean manufacturing operations. The recent investment by Philips in LG-LCD, one of the world's largest liquid crystal display manufacturers, came about partly because of the high level of manufacturing technology of the Korean counterpart. Korean companies have abundant skilled labour, and development costs could be much cheaper in Korea because the wages of Korean engineers are lower than those of other OECD countries. Where it is available, tapping foreign investment and expertise is likely to be a more efficient mechanism for promoting a strong ICT services sector than widespread government investment and closing off the manufacturing sector from foreign competition. Legislation and regulation for electronic commerce 4.39 There is also the need for wider reforn to prepare businesses for the digital age. Venture capital has an important role to play in supporting entrepreneurs who typify Web development - small and relatively inexperienced in business and financial management. Governnents in other countries (such as Scotland), as mentioned earlier, have supported venture capital funds to develop the ICT industry, similar in some respects to the funds to be set up in Korea. More important to further development of ICT industries, however, is the broader legislative and regulatory environment. Full competition in telecommunications and Internet service provision is perhaps the first step. Beyond that, the Ministry of Finance and Economy's decision to streamline laws that negatively impact upon SME operations is a significant move, as is the government's overhaul of 106 laws and regulations that will impact the growth of the knowledge-based economy. More narrowly, a number of considerations related particularly to e- commerce are already being addressed through Korea's Basic Act on E-Commerce, the Electronic Signature Act and the Act on Telecommunication Infrastructure Protection. Some steps remain to be taken, however. 4.40 As we have noted , Korea's electronic commerce is expected to grow from KRW 150 billion (USD 125 million) in 2000 to KRW 3.7 trillion (USD 3 billion) in 2002, so the - 75 - government needs to prepare for rapidly expanding Internet transactions. Tax incentives for online transactions are not necessary, but a different approach to taxation might well be required - for example, modifying the VAT system. It is also important to study ways of protecting consumers and ensuring the privacy of information, with a need for electronic signatures and certification systems - especially at public terminals. 4.41 A number of national initiatives from around the world suggest a range of activities for governrment in this sector:19 * Encouraging the foundation of a digital economy, including: the mapping of emerging clusters of e-commerce and examining whether their development can be facilitated; encouraging training, supporting industry mentoring and partnering - especially for and with SMEs, as with Korea's Electronic Commerce Resource Centers; ensuring the equivalence between digital and written documents; supporting electronic signatures, payment systems and certification systems (a measure supported in Cyber Korea); and ensuring widespread broadband access. * Enhancing trust, including: the provision of a secure Public Key Infrastructure (an adaptable and secure form of encryption), especially for govermment-private sector and government- citizen relations; allowing users free choice of cryptographic methods (and using them to protect critical infrastructure); guaranteeing the rapid and widespread prosecution of electronic fraud and other electronic crimes; supporting "parents' Web sites" and content- filtering software; and ensuring that government itself adopts "best practice" information and privacy policies. * Ensuring sustainability, including: adapting tax laws to the new commercial environment; promoting widespread access both within and outside government (a key part of the Cyber Korea initiative); and preserving the value of intellectual property through enforcement of the 1996 World Intellectual Property Organization treaties. 4.42 While the passage of the Electronic Signature Law in July 1999 was a step in the right direction for e-commerce in Korea, a number of barriers remain. For example, under current laws, only the Korean Fund Transfer Center and the Korean Fund Transfer Company are allowed to execute foreign exchange business, inhibiting a number of key Internet financial services. Similarly Internet brokerage operations are not allowed outside of the insurance business. The Door-to-door Sales Act (DDSA), which requires all firns conducting business over the Internet to have a business presence in Korea and to comply with Korean law, also acts as a bottleneck. It is a commendable part of the plans laid out in Cyber Korea to repeal this law. In general, a broad survey of laws governing commerce should be conducted, and those laws which would unintentionally or unnecessarily restrict e-comrnmerce should be amended so that Internet firms can do business freely. Foreign standards on e-commerce transactions should be mutually recognized, while ensuring the protection of the Korean consumer. 19 See for example: UK Government e-commerce@its.best.uk A performance and Innovation Unit Report, September 1999; Computer Systems Policy Project: Advancing Global Electronic Commerce: Technology solutions to Public Policy Challenges, July 1999; Ireland Advisory Committee on Telecommunications Report to the Minister for Public Enterprise, November, 1998; OECD Working Party on Telecomrnunications and Information Services Policies The Role of Telecommunications and Information Infrastructure in Advancing Electronic Commerce, October, 1998. - 76 - 4.43 The issue of taxation of e-commnerce is a particularly complex one which is still being worked out worldwide. Now is the time, however, to move towards novel taxation systems that account for the growth of e-commerce - expected to equal 7.2% of GDP in the United States by 2001, for example. A second consideration is international harmonization of rules regarding the taxation of e-commerce, although this issue is slightly less urgent as the WTO predicted in 1998 that only USD 60 million in international trade would be conducted over the Internet in 2001.20 Korean tax administrators face a number of challenges in an environment where it is difficult to establish the place of residence of both the seller and buyer (or consumer) of a product: * Preventing tax avoidance (for example, with mail-order goods) and double taxation (on some services). * Discouraging new forms of tax fraud and evasion - both intentional and accidental. This would involve enhanced capabilities in tax and police departments as well as information campaigns for (in particular) SMEs. * Ensuring consistent treatment of cross-border transactions. * Ensuring privacy. * Limiting transaction costs - this could be achieved in part through the use of advanced software and database technologies. 4.44 Some solutions being examined worldwide include licensing suppliers to support (supplier) residence-based taxation. This, in turn, might be streamlined through automated transaction reporting systems embedded in software - perhaps browsers - and tax forms redesigned to obtain data on electronic trading. These solutions raise a number of privacy and economic efficiency concerns, however. The OECD has convened a number of discussions on e-commerce issues and has concluded that VAT should be taxed according to the point of consumption. These discussions are ongoing. 4.45 One further important element will be to move towards a common global standard of classification of services similar to that for goods maintained by the World Customs Organization (the Harmonized Commodity Description and Coding System). The United Nations Central Products Classification Scheme might be a system on which to build (the United States Census Bureau appears ready to use a classification system based on UNCPC, for example).21 It will also be important over the medium term for Korea to take a significant role in international discussions on the direct tax treatment of international e-commerce transactions, especially relating to VAT and customs duties on small consignments of imports. F. Ensuring Access and Overcoming the Digital Divide 4.46 While much of this chapter has discussed the need for a lighter government hand - less regulation, greater distance between bureaucrat and entrepreneur - there are a number of vital roles that the government retains in the information economy. Some of these roles will require an even greater level of activism. Perhaps most importantly, in order to ensure that the digital 20 Boyle, Pweterson, Sample, Schottenstein and Sprague, The Emerging International Tax Environment for Electronic Commerce, Tax Management International Journal, June 11, 1999. 21 National Tax Association, Communications and Electronic commerce Tax Project, Final Report, September 7, 1999, Washington, DC. - 77 - revolution benefits all rather than being reserved for an elite, it is vital to ensure access to the new information technologies - both for the individual and for small companies wishing to bid for government contracts on line, for example. 4.47 A first step toward universal access to information infrastructure is the universal service obligation for basic telephone services - although Korea, with telephone penetration rates above the OECD average, should find this challenge easy to address. At least in the short term, it is likely that the incumbent could shoulder the responsibility at limited cost. In the longer term, as mentioned above, its universal service compensation fund should be competitively and technologically neutral. However, beyond basic services, universal access to more advanced equipment is likely to be better funded directly through general government revenues rather than by imposing requirements on telecommunications operators. 4.48 Improving the equity of access to the Internet will involve the widespread training and access policies outlined in the Cyber Korea White Paper - initiatives such as connecting 10 400 schools; teaching civil servants, housewives, students and military personnel how to use computers; building Internet Plazas; and facilitating Internet PC purchases. 4.49 There are a number of models from around the world of training programmes to ensure ICT technological literacy. In Singapore, there are computerized community clubs, staffed by volunteer trainers, near every public housing complex (where more than 80% of the population lives). The city-state has also encouraged private companies to sponsor mass training exercises. It is important that such exercises reach out and are flexible to the needs of the disadvantaged - the poor, the elderly and the disabled. 4.50 Technological literacy is only the first step, however, and there is a large role for government to support more advanced training. Ireland has introduced training programmes for future Net entrepreneurs in the business skills that they will need to run their own Internet start-up. Finally, although English is losing its position as the monopoly language of the Internet, it is likely to remain dominant. While there might be a role for government to support Korean- language content in some sectors (for example, public health), the networked economy also increases the importance of foreign language skills. 4.51 Training is clearly only useful if people have access to networked computers. A model for the provision of access, used in this case for the provision of public telephones but adaptable to public Internet provision, is the Chilean subsidy auction system. In 1994, Chile set up a limited-life fund to support the provision of the first payphones to remote and rural areas. Companies were asked to bid for the lowest subsidy that they would accept to provide service. Within two years, the fund had achieved 90% of its roll-out objectives, using only about half of its USD 4.3 million budget - largely because it received bids to provide service with no subsidy to about half of the chosen locations. Just over USD 2 million in public funds had leveraged USD 40 million in private investment to install telephones in 1 000 localities at about 10% of the costs of direct public provision.22 Such methods, supporting public provision through tapping private entrepreneurialism, are likely to achieve more than direct government provision as suggested in the CyberKorea report and at lesser cost. 22 Wellenius, 1997. - 78 - G. Using ICTs to Improve the Performance of Government 4.52 Another unique role for government in the new information economy is to introduce ICTs into the 21% of GDP that it is directly responsible for. Cyber Korea also lays out some impressive targets for using ICTs to improve the performance of government - for example, providing e-mail accounts to all public servants and digitizing public procurement operations and document circulation. 4.53 The range of ICT applications in govemment suggested by international experience is huge: * In Ireland, the Department of Social Welfare supported decentralization efforts through more than a dozen computer applications that improved information transfer and co-ordination. * In the United States, "collusion detection software" is being used to root out impropriety in public bids. * In Spain, smart cards are used to collect unemployment benefits at kiosks, check on job vacancies and job opportunities. * In Malaysia, govemment departments have collaborated on a networked system to facilitate land resource management.2 - Thirty million people a month access New York City's Web site, where they will soon be able to pay local taxes, municipal bills and parking tickets, as well as secure permits, look for govemment jobs, bid on government auctions, and obtain govemment and community information and news.24 * The Estonian Association of Telecottages is preparing to exploit IT to increase governance, planning a pilot project of virtual municipalities, based on Kuusamo in Finland. There, villagers are able to access information about local government budgets, contacts, laws, transport, health and counseling services. They will also be able to access forms and documents. 4.54 International experience also suggests some important lessons, however. First, ICTs can only play a part in reform of govermment processes. While they allow for greatly increased information processing and flow, only with broader institutional reform will the full benefits of ICT introduction be felt. Second, it is important to walk before running. Bringing ICTs into any workplace is a complex, time- and resource-intensive activity. Moving from no computerization to full government on line in a single stage is a difficult proposition. Third, and perhaps most significant, it is important not to leave clients behind. Govemment on line can only be equitable if all citizens are on line. If ICT access does not reach the vulnerable -groups such as the old, the poor or the disabled - the very people who need govemment services the most are likely to be denied them. This only emphasizes the importance of overcoming the digital divide. 4.55 Seattle might provide a model here. The city is bolstering its public access network with remote wireless Internet connections at eight storefront "little city halls" and installing Intemet gateways for 85 PCs at five community centres throughout the city. Officials have also hired a 23 Richard Heeks, "Information Age Reform of the Public Sector: The Potential and the Problems of IT for India."Information Systems for Public Sector Management working Paper Series No. 6 IDPM, University of Manchester. 24 See the website at on http://www.ci.nyc. ny.us/html/dot/html/ssss/home.html. - 79 - consultant to draw a technology map that will tell residents where they can find public Web connections from locations as diverse as senior centres and neighborhood convenience stores. 4.56 Finally, there is need for greater co-ordination within government. The proliferation of government initiatives on the knowledge economy and society within individual government departments in Korea will further slow progress on implementation of the Cyber Korea program unless increased co-ordination can be ensured (see Chapter 7). In the United States, co- ordination between the White House, the Department of State, the Department of Commerce and the FCC, among others, has been a vital element in fostering the benefits of the Internet and electronic commerce for businesses and consumers. H. Conclusions 4.57 Korea has made impressive strides in rolling out and updating its information infrastructure. This has involved not only the infrastructure itself, but also the manufacturing sector that creates it. However, in such a fast-moving field, strides are not enough - worldwide, the sector is changing and expanding by leaps and bounds. A number of Cyber Korea 's goals - creating new jobs and production, increasing the bandwidth of universal service, nurturing venture enterprises, increasing the number of Internet users - are admirable. However, the sector's progress is constrained by an unwieldy, outdated regulatory and legal structure which will have to be streamlined. Without reform, the goals of Cyber Korea will be unachievable -or will be achieved at great cost. Moving towards independently regulated competition will allow for the more efficient upgrading of technology and provision of services. At the same time, to ensure that all parts of Korean society move forward together, the country's plans for inclusion and the use of ICTs in governance must be given the highest priority. Revisiting Cyber2l and related targets, what does this mean for the country? * Government ownership and control: Reducing government ownership of Korea Telecom is an important step, but one that could be taken further. It is only the first of many needed stepss to reduce the role of government in this sector. There is a need to revisit regulations on foreign ownership and licensing, to reduce direction of research and pricing, , to push forward on unbundling and a range of other issues. * Investing in advanced information infrastructure: There is a role for government in this sector - although major support should be limited to the backing of private provision of services to government agencies and departments. These plans should be highly flexible, taking into account, for example, the "windfall" of the KEPCO network. * Providing support to end dependence on foreign technologies, setting up a venture firm in information and communications and a co-operative to expand infrastructure for venture firms are all complex undertakings. In particular, the goal of "ending dependence on foreign technologies" is likely to be overly ambitious. It is unlikely that Korea will have a strategic comparative advantage across the entirety of the ICT sector. While there might be a small government role in encouraging the growth of SMEs in the Internet sector, a hands-off approach is likely to produce better results than detailed targeting of firms and technologies. The governnent's primary role in creating a dynamic information infrastructure is to ensure that the market conditions and incentives are in place to allow for private sector competition and investment. - 80 - Removing impediments to e-commerce and ensuring the validity and security of digital signatures are important first steps. The Korean Government will need to examine a range of other issues - such as taxation of e-commerce and the provision of public key infrastructure - in order to enhance its ability to move transactions on line. * Connecting schools, providing computers free of charge to teachers, facilitating Internet PC purchases, and building Internet Plazas in public facilities are valuable steps towards the goal of expanding access. For the roll-out of ICT infrastructure, a market-conforming measure such as the Chilean auction scheme might provide a model mechanism for efficient provision, and might be a more responsive and targeted mechanism than blanket subsidies. * Teaching civil servants, housewives, students and military personnel to use computers are also laudable goals. The Singapore model might further expand access to training. * Providing e-mail accounts to all public servants and moving toward a digital documentation and authorization system, along with digitizing public procurement operations, should greatly increase the efficiency of government. However, they also make it all the more important to ensure that the disadvantaged are not excluded from services or SMEs from bidding for contracts - again, this emphasizes the need to ensure equality of access and training. 4.58 With the help of such reforns, Korea can put itself in a leading-edge position in the OECD in terms of public and government access and use of ICTs. - 81 - REFERENCES Boyle, Pweterson, Sample, Schottenstein and Sprague, "The Emerging International Tax Environment for Electronic Commerce," Tax Management International Journal, June 11, 1999. City of New York, 2000, http://www.ci.nyc.ny.us/html/dot/html/ssss/home.html. Computer Systems Policy Project, Advancing Global Electronic Commerce: Technology Solutions to Public Policy Challenges, Computer Systems Policy Project, Washington, D.C., 1999. Government of Korea, Cyber Korea 21, Government of Korea, Seoul, 1998. Heeks, Richard, "Information Age Reforn of the Public Sector: The Potential and the Problems of IT for India Infornation Systems for Public Sector Management" (Working Paper Series No, 6) IDPM, University of Manchester, 1998. HSBC, Securities Sector Report: Korean Internet Plays (August), HSBC, London, 1999. Ireland Advisory Committee on Telecommunications, Report to the Minister for Public Enterprise, Government of Ireland, Dublin, 1998. Korea Ministry of Commerce, "Maximizing the Benefits of Electronic Commerce: Korea's Initiatives," Korea Ministry of Commerce, processed, 1999. National Tax Association, Communications and Electronic Commerce Tax Project, Final Report, National Tax Association, Washington, D.C., 1997. OECD Working Party on Telecommunications and Information Services Policies, The Role of Telecommunications and Information Infrastructure in Advancing Electronic Commerce, OECD, Paris, 1998. OECD, Regulatory Reform Korea, OECD, Paris, 2000. UK Government, e-commerce(gits. best. uk: A Performance and Innovation Unit Report, HMG, London, 1999. Wellenius, Bjorn, "Extending Telecommunications Service to Rural Areas --the Chilean Experience (World Bank Viewpoint Note No. 105)," Processed, World Bank, Washington, D.C., 1997. - 82 - CHAPTER V: IMPROVING THE KOREAN INNOVATION SYSTEM A. Introduction 5.1 Korea's innovation system (KIS) remains largely based on the catch-up model. In the past, this model was quite effective in achieving Korea's development goals in a short period of time and the country rapidly mastered a wide range of industrial and technological activities. However, this model has its limitations. The private sector R&D, the lion's share of gross R&D spending, remains mainly oriented towards short-term technological development. Most public sector R&D programs are highly mission-oriented but weak in terms of diffusion. Overall, Korea's development strategy in the S&T area has strongly favoured the rapid exploitation of mature and advanced technologies for market expansion in selected sectors, over a broader strengthening of its knowledge base. The KIS has had relatively weak global linkages, except through arms length ways of acquiring foreign knowledge such as technology embedded in equipment goods and components and formal technology licensing contracts. Until recently Korea has made little effective use of technology acquisition through foreign direct investment (FDI), strategic alliances, or joint research programs. 5.2 Today, Korea is facing the limitations of this strategy. In a world where trade, investment, and production are increasingly globalized, the capacity to develop, acquire, diffuse, and commercialise knowledge is becoming the major source of competitiveness and growth. In the knowledge-based economy, production and innovation increasingly require complementarity between "partners" at national and international levels. The holistic concept of the national innovation system (NIS) makes this requirement clear'. 5.3 In many respects, the potential research capability compares well with that of many other OECD countries. High R&D spending and relatively well educated human resources are among its assets. But the KIS is weak in terms of systemic linkages and interfaces among innovation actors. Korea's transition to the knowledge-based economy will therefore require a reorientation of its innovation system. Questions that need to be examined are: is the current research orientation appropriate for supplying the knowledge-based economy with the necessary knowledge base? Is its current configuration adequate for making efficient use of available resources? Is its current incentive structure suitable to effectively respond to changes in technology, market, and social conditions? In the wake of the recent financial turbulence, the country has recognised the importance and urgency of this issue, and has introduced several important policy measures. While some are very positive, others need to be more carefully designed from a systemic perspective. See Box 1.2 in Chapter 1 for a definition of a national innovation system. - 83 - B. Profile of Science, Technology, and Innovation Activities 1. R&D expenditure and output 5.4 Korea ranks very high among OECD countries in terms of R&D intensity (R&D as a share of GDP), along with Finland, Japan, Sweden, Switzerland, and the United States. It has the lowest government share of R&D financing, followed by Japan, pointing to the prominent role of the private sector in R&D financing and performance. R&D intensity in the business sector is very high, with only Finland and Sweden showing higher intensities. In contrast, the share of R&D performed by the Korean higher education sector is very low and, in terms of researchers per 10,000 labor force, the country ranks close to the EU average. 5.5 Korean R&D spending is high and in 1998, its total R&D budget in current PPP USD ranked seventh in the OECD, roughly equivalent to that of all Nordic countries (Denmark, Finland, Norway and Sweden) taken together. However, Korea's R&D activities can be characterised as being "high input" with a "biased composition of output", the generation of codified knowledge (eg. in the form of patents and publications) is relatively low compared to that of knowledge embodied in traded goods (Table 5.1). The number of scientific and technical articles per unit of GDP is quite low. Other patent-related "output" indicators shown in Table 5.1, such as technological strength and technological intensity, confirm that Korean R&D efforts contribute less to the generation of codified knowledge. 5.6 This can be seen from the pattern of Korean patenting in the United States. Patenting has nsen indicating the increased innovative capability of Korea and Korean patents represented 2% of all utility patents granted. However, of all patents of foreign origin, Korea ranked fifth, with 5% of the total. Patenting is mainly concentrated in the chaebols, with Samsung playing the dominant role. Samsung Electronics Co. Ltd. patented the most (40%), followed by Daewoo electronics (9.7%), LG Semiconductor Co. Ltd (7.2%), LG Electronics Inc. (6.6%), and by Hyundai Electronics Industries Co. Ltd. (6.5%). Patenting by Samsung almost exclusively concerns electronics, with little breadth to the patenting either by company or by sector.2 2 U.S. Patent and Trademark Office, 1998. - 84 - Table 5.1: Income and Technological Performance, 19981 Income level, Indicators of scientific and tt-cbnological activities 1996 GlDP per Gross Researchers Government Government Business Scientific & Technological Technological capita as % of domestic per 10 000 financed financing of expenditure technical strength per S of Intensity, 0OECD) expenditure labour force, R&D as a % R&D as a % on R&D as a articles per R&D, average on R&D as a 1997! of GDP, of total % of unit of GDP2 %ofGDP, 1998' R&D, 1998' business 1998' GDP, 1998' United States 140 2.8 74 0.8 30.6 2.3 20 410 10.4 Norway 128 1.7 76 0.7 42.9 1.3 21 Switzerland 126 2.7 55 0.7 26.9 2.3 37 Japan 121 2.9 92 0.5 18.1 2.3 15 354 10.6 Iceland 118 2.0 91 1.1 55.9 1.2 23 Denmark 117 1.9 61 0.7 35.7 1.9 31 87 1.6 Canada 114 1.6 54 0.5 31.9 1.3 25 203 3.3 Belgium 112 1.6 53 0.4 26.4 1.4 20 111 1.8 Austria 111 1.6 34 0.7 44.6 1.1 18 125 1.9 Australia 107 1.7 67 0.8 46.0 0.8 24 Germany 107 2.3 59 0.8 35.6 2.0 21 215 5 Netherlands 106 2.1 50 0.8 39.1 1.4 31 170 3.5 France 103 2.2 60 0.9 40.2 1.8 20 115 2.7 Italy 102 1.0 32 0.5 51.1 0.7 13 101 I Sweden 100 3.9 86 1.0 25.2 4.4 41 147 5.3 United Kingdom 98 1.9 51 0.6 30.8 1.6 29 160 3.2 Finland 96 2.9 83 0.9 30.9 2.9 35 114 2.7 Ireland 92 1.4 51 0.3 22.2 1.3 16 69 New Zealand 88 1.1 45 0.6 52.3 0.4 29 Spain 77 0.9 33 0.4 43.6 0.5 16 21 0.2 Portugal 70 0.7 27 0.4 68.2 0.2 7 8 0 Greece 67 0.5 20 0.2 46.9 0.2 16 Czech Republic 64 1.3 24 0.5 36.8 1.0 15 Hungary 47 0.7 28 0.4 56.2 0.3 20 115 0.7 Mexico 36 0.3 6 0.2 71.1 0.1 2 15 0 Poland 35 0.8 32 0.5 59.0 0.4 17 Turkey 30 0.5 8 0.3 53.7 0.2 4 . Or latest available year. 2 Scientific and technological articles per billion US$ of GDP. See National Science Foundation (1998). 3 Technological strength is determined by multiplying the number of patents with an index of their impact. This index measures how frequently a country's recent patents are cited by all of a current year's patents, The patents refer those granted at the US patent office. Data are from CHI research. 4Technology intensity compares the technological strength of a country with its GDP expressed in PPP$. See Science. Technology and Indusiry Outlook 1998 for details. Source. OECD Secretariat calculations on the basis of MSTI database, CHI research, National Science Foundation (1998), and Science, Technology and Industry Outlook 1998. - 85 - 2. Flows of R&Dfunds 5.7 Flows of R&D funds in Korea show some peculiarities. First, shares of self-financing are very high in both the public and the private sectors. Government is the main financier of government research institutes (GRIs), at more than 80%. Industry also shows a very high share of self-financing, at more than 90%. The higher education sector shows the most diversified sources of funding, although this is mainly the result of weak public support for university research. 5.8 Table 5.2 also shows that private enterprises account for the lion's share of both R&D investment and spending, the government sector's share is moderate, and that of the university sector is very small. Roughly two-thirds of total R&D funds are spent by private enterprises. The shares of GRIs and universities are 15% and 10%, respectively. National/public universities rely mostly on government funds, while the private universities tend to be self-financing. Table 5.2: Flows of R&D Funds in Korea, 1997 (Unit: 100 million won) Performed by National Other Nat'I & Private Gov't- Private Total & public GRIs non-p. Pub. Univ. invested Encerprises Financed by Re. Inst. org. Univ. org. Govemment 99.67 82.87 19.85 64.47 30.86 1.21 4.67 25,897.88 (21.25) Government-funded 0.08 4.47 0.90 6.58 5.24 0.12 0.47 1,808.43 institutes (1.48) Other non-profit 0.01 0.13 40.87 2.57 1.57 0.63 0.36 1,326.81 Organizations (1.09) National & public 0.00 0.01 0.07 8.42 0.13 0.00 0.02 393.73 Universities (0.32) Private universities 0.00 0.01 0.03 0.18 47.99 0.00 0.00 4,021.29 (3.30) Govemment-invested 0.05 8.38 31.37 3.25 1.31 97.90 0.11 10,355.34 organizations (8.50) Private enterpnses 0.17 4.13 6.90 14.45 12.14 0.09 94.31 77,936.62 (63.96) Foreign sources 0.01 0.01 0.01 0.09 0.76 0.05 0.06 117.96 (0. 10) Total 3,805.4 15,106.2 1,777.3 4,361.5 8,354.4 8,363.4 80,089.5 121,858.1 _______ __ (3.12) (12.40) (1.46) (3.58) (6.86) (6.86) (65.72) (100.00) Note: Numbers except total are percentage shares out of each column. Numbers in parenthesis under totals are percentage shares out of total. Source: MOST, Report on the Survey of R&D in Science and Technology, 1998. 3. R&D activities and international competitiveness 5.9 R&D resources tend to be concentrated in a small number of industries, especially the ICT (e.g. communications equipment, semiconductors, computers and electrical and electronic products) and automobile sectors, while the sources of international competitiveness are spread over a diverse set of industries, including some with low research intensities. Some R&D- intensive industries (e.g. precision instruments and pharmaceuticals) have been lagging in improving their international competitiveness, in contrast with some scale-intensive sectors - 86 - (e.g. plastic and rubber, shipbuilding and iron and steel) and labour-intensive sectors (e.g. textiles and leather). 5.10 This implies that Korean industry has not yet fully harnessed the potential of R&D to add greater value to their products. While Korea is a major exporter of high-tech products, the value content of its exports, including high-tech products, remains low. For instance, its up-market share in exports to EU-15 countries is below the OECD average, while its down-market share comes fourth, after Turkey, the Czech Republic and Poland.3 C. Korean Innovation System: Main Features and Weaknesses 1. Weakness of the basic knowledge effort 5.11 In terms of basic research, Korea shows two contrasting features: it ranks in sixth place among the OECD countries in overall spending on basic research as a percentage of GDP; but it has one of the lowest shares of basic research in all R&D activities (Figure 5.1). The favourable position in terms of spending on basic research reflects the fact that Korean business enterprises perform more basic research as a share of GDP than do firms in any other OECD country with the exception of Switzerland. However, the low overall basic research share indicates that public research sectors, including the GRIs and the universities, spend relatively less on basic research than in most other OECD countries.4 Figure 5.1: Basic rserch as a prcrntage oT CDP by eector of performance. 1997 27.9 Sizrad(96 22.0 France (199) 21.2 Datrny (I 993) 26.1 ,.. i ..lr .,==g A,ostraliS (19963) (196.0 Unitecl States 13.3 Korea 12.0 - Japan (adJustad) 21.3 A9stra (1993) 16 1 r.____ o,eqy (19ss) 22.1 i taly 19.0 1-4191-cr.erdocatir,.f Coach FMOpubi IC 35.5 LVf OOovrhmrant Polt~.. 7and c::N.Ft.ia o protit 9.6 Ro=3sineSs entetrprise, Netherlands (1995) 2208 - Spain 2409 CG- i (ortugal (1995) 17.0 ~ BSi researc7 aI. Ie1land (1993) 35.8 all iRED aSIivltis NVlexico (1995) O.tl0 o. 0.6 0.5 0.4 0.3 0.2 0.1 0 Up-markets are where the unit value of exports are 15% above average, whereas down-markets are those where unit value of exports are 15 % below average. For more information, see Science, Technology and Industry Scoreboard 1999-Benchmarking the Knowledge-based Economy, OECD, 1999. 4For comparison with OECD countries, see OECD STI Scoreboard 1999, section 3.3 and appended tables. - 87 - 5.12 Korea's universities are characterised as being weak in research and are mainly oriented towards general education. Their share in total R&D expenditures is one of the lowest in the OECD area (Figure 5.2). To a large extent, this is due to high student-teacher ratios and heavy teaching loads, inadequate research infrastructure (e.g. a lack of experimental facilities), and a lack of qualified research manpower and support staff. However, the shortage of human resources is not sufficient to explain Korea's poor performance as measured in terms of scientific publications and patents. The ratio of R&D expenditures to researchers, a proxy for research infrastructure, is almost equivalent to that of most OECD countries. This points to the existence of institutional problems and a lack of incentives for research in the higher education. Until very recently, research had not been a primary concern in most Korean universities and quality of research is not given much weight in recruitment and promotion. Figure 5.2: Higher Education Expenditure on R&D per Researcher HERD per researcher 2- 2L 200 1 50 2 100 50 j3: g;i tt! 0 Source: Calculated from OECD, Main Science and Technology Indicators, 1999. 5.13 In addition, universities do not specialise in basic research. Their participation in wider R&D activities may suggest better relationships with other innovation actors. However, this creates a serious bias in the orientation of university research and weakens the domestic knowledge base. The problem is closely related to flows of R&D funds. Compared with GRIs, public funding for university research in general is low, and there is a sharp contrast between national and public universities and private universities. Public research funding for the latter stands at half the level of national and public universities. Consequently, universities tend to seek other funding sources, notably from private enterprises, which may also bias university research away from enhancing the knowledge base. 2. Private sector R&D system The limitations of internalization in large companies 5.14 Private enterprises have endeavoured to upgrade their technological capabilities by establishing in-house research labs; they have rapidly increased R&D expenditures since the early 1980s, and large companies, notably the chaebol, have taken the lead in this process. This required intensive efforts of assimilation and adaptation and led to the successful development of capacities for the production of standardised products using mature technologies. Until recently, most R&D laboratories were organised and managed in the same way as other areas of business, i.e. in the framework of centralised and hierarchical structures that facilitate the mobilisation of - 88 - existing financial and human resources into new business lines while utilising the know-how and production inputs of existing ones. Combined with lower labour costs, these management strategies, including in the R&D area, contributed to the strength of the Korean conglomerates' compared to their foreign competitors. 5.15 The weakness of current R&D system is that large research labs with centralised and hierarchical structures are inherently lacking in flexibility and the cost of dismantling existing organisational structures to meet the needs of the knowledge-based economy could be prohibitive. A further limitation of excessive internalisation is that it weakens the need for closer co-operation with other actors in the innovation system. A vicious circle of self-fulfilling internal ties is therefore blocking the further development of the K1S. The structural imbalance between large companies and SMEs 5.16 Over the last decade, the share of the top-20 companies' in total business enterprise R&D has increased steadily. In contrast, there has been no substantial increase in the R&D intensity of SMEs. This imbalance between the large internal R&D effort by large companies and the lack of R&D spending by technologically weak SMEs, raises a serious problem for the KIS. As of 1995, only 0.7% of manufacturing enterprises with fewer than 100 employees performed R&D, compared to 19.1% of enterprises with between 100 and 299 employees and two-thirds of enterprises with more than 299 employees. In the knowledge-based economy, industrial and production activities become technologically more demanding and complex, and the existence of supporting industries - where SMEs play a critical role - is a key factor in a company's international competitiveness as well as in the development of the producer-user interactions that are an essential source of innovation and technology diffusion. 3. Government policies and programs The effectiveness of government R&D support policy 5.17 Korea has implemented a number of policy measures targeted at promoting technological innovation by private enterprises. The government's R&D support system includes: i) tax incentives; ii) financial incentives; iii) procurement; iv) technical information support; v) human resource support; vi) promotion of co-operative research; vii) technology support for SMEs; viii) support for the commercialisation of new technologies; and ix) promotion of the establishment of research labs. Each of these categories contains detailed policy measures.5 5.18 Given the patchiness of the evidence, the effectiveness of these policy categories and measures is hard to assess objectively, but recent policy measures to increase government funding for basic R&D and to enhance policy co-ordination by the Science and Technology Council are cited as good policy practices.6 However, there some important issues that merit consideration. KITA's (Korea Industrial Technology Association) Industrial Technology White Paper 1998 points out that the absolute amount of financial support measures is too low to have a substantial effect on innovation by private enterprises. Other reports express the need for 5Review of National Science and Technology Policy: Republic of Korea, OECD, 1996. 6 Managing National Innovation Systems, OECD, 1999. - 89 - increased government support.7 The appropriate scale of government R&D support is an issue that deserves an in-depth and comprehensive study. Yet, prior to increasing government support, it is important to evaluate the effectiveness of current policy measures and thereby allocate resources more efficiently.8 A recent STEPI report covering seven tax incentive measures and six other measures concludes that these measures are only marginally helpful in stimulating business enterprises' innovation activities. The report emphasises the need for streamlining and restructuring support measures as they are too complex.9 5.19 Notwithstanding numerous government policy measures, the technological capabilities of Korean SMEs are still lagging. Among OECD countries, Korea has the lowest share of SMEs engaged in R&D activities, despite the fact that the share of these enterprises in total government funding of business R&D is relatively high.10 This raises questions concerning the appropriateness of policy measures to foster R&D-related innovations in Korean SMEs. 5.20 The STEPI report mentioned above indicates that many technology support measures, including the technology reserve fund system, are not very effective for increasing innovativeness among SMEs. In contrast, some technology support measures, such as the government procurement system and the technology transfer system from public research institutes and universities, appear to be quite effective in enhancing new product development by SMEs. Nonetheless, proportionally greater government funding is allocated to relatively ineffective measures. National R&D programs (NRDP) and the role of GRIs" 5.21 Korea's national R&D programmes (NRDPs) were launched by MOST in 1982 as the "Special R&D Programme (SRDP)". The implementation of the NRDPs is closely related to the role of the GRIs.'2 NRDPs provided a momentous opportunity for revitalising GRI research, i.e. to complement research areas that would not be covered by the private sector. There have been substantial achievements'3. However, although the Korean Government has tried to balance the 7For instance, according to Lee (1998), Korea is utilising only one-tenth of possible public support measures allowed under the WTO subsidy rule. 8 KITA's White Paper sunmuarises the problems associated with goverrnent support: 1)mismatches between the objectives of government support measures and industrial needs; 2)1ack of complementarity between financial measures and tax incentives; 3)difficulty for SMEs in obtaining loans; 4)limitations on the mobilisation of funds through capital markets; 5)high interest rates on bank loans; 6)underdevelopment of the venture capital system; 7)inadequate banking regulations and practices. In particular, the White Paper points to the problem of overlapping policy measures of various ministries. 9 Wi-Chin Song and Taeyoung Shin, Determinants of Success of New Technology Based Firms and Innovation Policy, STEPI, 1998. 1° For a comparison with other OECD countries, see OECD STI Scoreboard 1999, section 5.4. 11 For a general explanation of national R&D programs, see OECD (1996), Part I, Chapter VI. 12 Before 1982, a substantial part of the GRI budget relied on contract research from industry. But, as industries began to establish in-house research laboratories, industry's needs decreased. Responding to this and other changes, the government restructured the GRIs. 13 For instance, the successful development of successive generations of DRAM was made possible by NRDPs co- ordinated by the government research institute ETRI, with active participation by private enterprises such as Samsung, Hyundai and Gold Star. Also as "output", it is reported that, until 1997, 687 items were successfully commercialised; 482 patents were granted in foreign countries; and 4,126 scientific papers were published in intemational journals. - 90 - NRDPs' mission-oriented and diffusion-oriented efforts, NRDPs remain biased towards mission- oriented R&D. Strategic targeting is also popular in programs of other OECD countries and in EU framework programs. The issue is how to use public resources more efficiently and how to build diffusion mechanisms into the programs. Korea has tried to use NRDP to also support diffusion programs, as well as created separate diffusion programmes, but this strategy has not proved very- effective so far. 5.22 The rationale for the NRDPs and the raison d'etre of the GRIs are to support and complement industry research by conducting upstream research that would not be performed by industry alone. However, most GRIs perform downstrearn research and experimental development, with several implications: i) the lack of long-term basic research, which weakens the basic science/knowledge base of the KIS; and ii) research overlaps with that of the private sector, leading to duplication and the crowding out of resources. 5.23 The weakness of the science/knowledge base of the KIS is clearly related to the general orientation of the NRDPs. Owing to the concentration of public R&D resources on GRIs, the universities play a minor role in the national innovation system. In 1998, 65% of NRDP resources went to the GRIs as main contractors, compared with only 9% and 2% to the universities and industry, respectively. University researchers participate in most NRDPs but, generally, to a minor extent. Given that universities have 58% of PhDs in full-time equivalent terms or 75% in absolute numbers, the contract pattern and budget allocation of the NRDPs are strongly biased against the universities. 5.24 The problem of overlap with the private sector is severe. A STEPI report, based on a 1995 survey, noted that more than half of the companies participating in NRDPs would have undertake the project even in the absence of government support.'4 The reasons for this include: i) the NRDPs are not sufficiently clearly planned, do not reflect industry needs and do not identify elements lacking in private research; and ii) the majority of the private partners of NRDPs are large companies, notably chaebol, which are sufficiently mature to implement the most commercially oriented NRDP research topics themselves. The Government has recently planned a new R&D program, based on long term technology forecasting and industry needs survey. 5.25 The NRDPs as a whole have been unsatisfactory in terms of utilising national R&D results (see Box 5.1). There are several causes, including the lack of policy co-ordination. Several measures, including the establishment of the NSTC (National S&T Council), that aimed at harmonising individual ministries' R&D programs, have been implemented to improve results. Other recent measures include the enactment of the Special Law for S&T Innovation and programs to improve technology transfer and establishment of venture business for helping in the commercialisation of research results and setting up technology business incubators in GRIs. 14 Hwang et al. (1997), An Assessment of Government R&D Programs, STEPI. Based on the survey to researchers who participated in NRDPs, the report also points out other problems: the lack of programmatic differences among the programs; the significant bias towards commercial technology; short-sighted time horizon for R&D; discrepancy between R&D objectives and R&D performance/impacts; and inconsistencies of R&D policies and ineffective program management. - 91 - Box 5.1: Under-utilisation of National R&D Results - STEPI Report Based on surveys and interviews with 947 principal researchers who had participated in NRDPs in the past three years, including those of MOST and other ministries, the report analyses how effectively R&D results from NRDPs are utilised. Diffusion from GRIs to private enterprises is moderately successful, whereas diffusion from universities is less satisfactory. Second, bottlenecks impede diffusion: 42% of GRI and university respondents pointed out the lack of technological capability of private enterprises; in contrast, 40% of private enterprise respondents point out the lack of GRI and university technological know-how and knowledge for solving private firms' technical problems. Third, public R&D institutions, including universities, responded that private firms are not interested in technology diffusion from them; they also pointed out the lack of absorptive capacity in private firms. Private firms responded that public R&D institutions have not made enough effort to increase public awareness of national R&D projects. Fourth, the best way to diffuse new technological knowledge generated by GRIs is to transfer technical personnel trained in GRIs to private firms. University professors are not actively involved in technology diffusion due to their heavy teaching load. GRI researchers have not efficiently extended their R&D results to commercialization. Moreover, there is no professional organization that effectively links universities and GRIs to private firms. The report concludes that all these factors cause the under-utilization of national R&D results in Korea. Chai Kon Oh (1997), A Study on the Promotion of the Effective Diffusion of National R&D Results, STEPI. 5.26 Several NRDPs have been targeted at SMEs, but with disappointing results. From 1983 to 1997, when MOST introduced the "New Technology Commercialisation Programme" for SMEs, the total amount spent for the "SME Support Programme", one of ten NRDP categories, represented only 2.4% of the overall budget for NRDPs. In most other NRDPs, SME participation has been negligible. 4. Weak global linkages 5.27 Knowledge and technology flow across borders through various channels. Korea's traditional ways of acquiring global knowledge and technology sources were through arm's- length licensing and "brain gain" - the return of Korean scientists and engineers from abroad. Although useful, these two methods have limitations. Licensed technologies are protected and tend to be mature, meaning that the potential for further innovation is relatively low. According to a report by the Korean Development Bank, most technologies licensed to Korea are in the mature stages of their life cycle." Moreover in recent years, the number of Korean students studying abroad has decreased markedly, 6 suggesting that the benefits from "brain gain" will decrease as time goes on. 5.28 Other means of knowledge and technology transfer have not been used extensively; for instance, until the financial crisis FDI played a very minor role and joint ventures were not popular. Consequently, Korea did not take advantage of knowledge and technology inflows from multinational activities.'7 In the areas of science and technology research, Korea has weak global 15 Korea Development Bank, Analysis of the Effects of Technology Imports, Seoul, 1991. 16 According to the National Science Foundation, Science and Engineering Indicators, 1999, the number of Korean science and engineering PhDs awarded in US universities peaked at 1143 in 1994, and has since rapidly decreased. '7 Some OECD countries show positive evidence on the role of FDI in upgrading indigenous technological capability. (Aidan Meyler, "Technology and foreign direct investment in Ireland", Technical Paper No. 98/10, Economics Department, Trinity College, 1998). Djankov and Hoekman (1999) show that FDI in the Czech Republic had a great positive impact on total factor productivity in Czech enterprises (Simeon Djankov and Djankov and - 92 - linkages: compared to other OECD countries, the country ranks very low in cross-border ownership of inventions and cross-border co-authorship of scientific articles and co-invention of patents. D. The New Policy Agenda'8 The need to adapt the STI Policy 5.29 It is clear from the above that Korean science, technology and innovation policy needs to be reoriented. A number of issues were identified in the 1995 OECD Policy Review, and some policy measures have been taken. But the weaknesses of the innovation system have become more apparent in the wake of the recent financial crisis and refonns can no longer be put off. 5.30 Korea needs to reorient its R&D efforts, including the way in which they are managed and implemented by the public and private sectors. University research should be strengthened and the private sector, and particularly the chaebol, should be encouraged to work in partnership with other actors in the innovation process. The technological and organisational capabilities of SMEs need upgrading. The role of the GRIs needs to be redefined to place greater emphasis on basic research to meet future demand, in addition to perforning research on technologies that serve the public interest such as environment, space, and nuclear energy and which do not receive enough attention by the private sector. 5.31 Box 5.2 presents a summary overview of the changes required of the different actors in the transition from the "catch-up" model to the knowledge-based economy model. Considering Korea's current level of development, it can still benefit from many elements of the catch-up model, but it needs to actively begin the transition to the new knowledge-based economy model. This chapter provides a detailed overview of the actions that will be required of govermnent. 5.32 The Korean governnent has elaborated a "Long term Vision for S&T Development towards the Year 2025" which sets new guidelines for its S&T strategy; based on the transitions: 1) from a government-led, development-centred domestically networked R&D system to a private-led, distribution-centred, globally networked R&D system; 2) from a supply expansion policy to an efficient utilisation policy; and 3) from a policy meeting short term demands to a policy with longer term perspectives that creates new markets.'9 These broad guidelines provide a framework for the new policy approaches needed for the transition from the "catch-up model' to the "KBE model". Bernard Hoekman, "Foreign investment and productivity growth in Czech enterprises", Policy Research Working Paper 2115, World Bank, 1999). The same can be said of the experience of Singapore and Ireland. 1 In collaboration with the Korean government, the OECD published the Review of National Science and Technology Policy: Republic of Korea in 1996. Its main (policy) recommendations have been widely circulated and referred to in Korea. On the whole these recommendations remain largely valid, and the Korean government has recently initiated several policy changes based upon them. This section tries to derive a more specific policy agenda in the context of knowledge-based economy from an NIS perspective. 19 See MOST 2000. - 93 - Box 5.2: KIS for the Transition to Knowledge-based Economy Catch-up model KBE model Requirements System as a * Compartmentalized * New engine of growth * Building up indigenous whole * Centralized * Integrated knowledge base * Participatory * Strengthening linkages * Decentralized domestically and internationally * Promoting regional innovation system Government * Developmental * Catalytic * Defining a new role * Client-oriented * Collaborative * Inter-ministerial co- * Mission-oriented * Diffusion oriented ordination and partnership * Sectoral promotion * Cluster approach with industry * Build diffusion mechanism in government R&D programs * Improvement in framework copditions University * General education * Higher research * Adapting the education orientation orientation system to needs of market * Minor role as knowledge * Primary source of new * Strengthening research producer knowledge in domestic capability, especially basic context research * Main producer of both graduates and knowledge GRI * Targeted technology * Higher contribution to * Redefine the role of GRI development knowledge base * Realigning GRI * Whole spectrum of R&D * Clear division of labor with university and industry Industry * Rapid market expansion * Secure market * New business strategy * Volume/cost advantage specialization * Capitalizing on R&D * Industrial/technological * Higher value-addition and resources widening economic rents via * Redefine the role of * Hierarchical production innovation chaebol system * Industrial/technological * Strengthening SMEs' deepening technological capability * More horizontal * Strengthening linkages and relationships clusters 5.33 The nature of the innovation process, including its linkages with more basic research activities, calls for its modification. Competitive markets stimulate innovation and allow firms and individuals to derive the benefits from knowledge accumulation. At the same time, firms are not simply production organisation but also learning organisations,20 whose efficiency depends on often country-specific institutional, infrastructural and cultural conditions. In addition to correcting market failures (provision of public goods, intellectual property rights (IPRs), subsidisation of R&D), governments have a responsibility to improve the institutional framework 20 Footnote paper by Matthews in Singapore. - 94 - for knowledge interactions among finns and between market and non-market organisations. In particular, most OECD countries are introducing new policy and institutional measures aimed at stimulating the diffusion of public R&D results across the economy (the Danish and Dutch programmes are good examples of such measures). 5.34 The private sector can improve its R&D efficiency by reorganising its R&D activities. Many companies have begun to move in this direction, particularly since the financial crisis, by: downsizing R&D labs, adopting more horizontal structures to create networked R&D units within and outside the company, encouraging spin-offs, introducing performance-based remuneration systems for R&D personnel, etc. A very positive recent phenomenon is that specialised R&D laboratories are emerging as spin-offs from firnms that are downsizing and from universities. 5.35 The efforts of private enterprises to reorganise their R&D activities have been triggered by the changes in the business environment that have come about in the afterrnath of the crisis, especially those affecting corporate governance structures. Macroeconomic and competition policies will also have significant effects on R&D activities (see Chapter 2). This is why the OECD calls for government initiatives to ensure "framework conditions" (incentive and institutional regimes) that are conducive to innovation.21 Such conditions include the tax environment and accounting practices that affect firms' strategies with respect to technological and organisational assets and human resources, as well as regulations and public procurement practices that affect forms of organisation, for example, for co-operation among finns. 5.36 A key feature of a knowledge-based economy is that agglomeration economies at the regional level, network externalities and dynamic economies of scale in clusters of technologically related activities are important sources of increasing returns to private and public investment in R&D. As a consequence, most OECD countries are shifting their STI policy away from conventional sectoral promotion towards a cluster approach. Finally, the experiences of the most successful OECD countries demonstrate that increasing the efficiency of STI policy requires improved policy co-ordination and evaluation mechanisms (see Chapter 7). 1. Enhancing basic research capabilities 5.37 The extent to which a country should devote and allocate resources to basic research is always difficult to estimate. There are trade-offs as well as complementarities between basic research and applied research. The challenge for Korea is to make strategic use of existing knowledge bases, both domestic and foreign. This will require comprehensively reviewing it's the nation's basic and applied research capabilities in all scientific fields vis d vis international standards. The evaluation should be made by teams made of recognised foreign and Korean experts in concerned disciplines, and best practices should be adopted: this is key for ensuring sound judgements on the strengths and weaknesses and for defining an overall research strategy, encompassing both the universities and the public research institutes.22 21 OECD, Technology, Productivity and Job Creation, 1996 and 1998. 22 Sweden is very instructive in this respect and more particularly the experience of the Natural Sciences Research Council which conducts periodic international reviews of the research activities it supports in all different fields - 95 - 5.38 A central issue in enhancing Korea's knowledge base is the upgrading of university research. Korean universities have grown massively in recent years, with the number of doctoral degrees awarded in science and engineering by Korean universities increasing more than eleven- fold, from 160 in 1980 to 1 920 in 1995. Yet, the quality and quantity of research is insufficient. The government should play a catalytic role in improving this situation by: i) increasing public support in order to encourage basic research; and ii) making better use of the "centres of excellence" framework under which universities compete and specialise on the basis of research quality (Brain Korea 21 is a step in the right direction and should perhaps be expanded);23 iii) designing a system whereby the universities would supply qualified graduates to industry. * Increasedfundingfor the research base: In most OECD countries, science policy is evolving towards greater emphasis on the technological and industrial applicability of scientific research. Underlying this change is a strong domestic science base based on the research capabilities of universities or national research centres. Korea needs to focus on upgrading its basic science and research base. Some relevant policy measures have been adopted: for instance, the MOST's ERC/SRC/RRC programnmes and the Ministry of Education's Academic Promotion Fund. However, further secure public funding for more basic and long- term research is recommended. * Promoting centers of excellence: Based on transparent reviews (with the participation of foreign experts), a small number of universities should strongly focus on research (for example, as has been done by the Australians and the Canadians). To date, KAIST and POSTECH have achieved this goal. OECD (1996) concluded that MOST's SRC/ERC programmes were successful in promoting research in universities, mainly due to the following factors: funding was dependent on research excellence; regular evaluations were performed; public support was based on long-term research; and management autonomy was secured. These factors, together with a relatively clearer mechanism of competition, have provided the "framework" for research in universities. This framework should be applied more generally to the allocation of research funds to universities. * Provision of specialists: The supply of qualified technical and scientific graduates to industry represents the most direct contribution of the universities to the KIS. In most successful education systems in OECD countries, university research and training are fundamental to (regional) innovation clusters. Some European countries have developed excellent technical school systems (e.g. Austria's Fachhochschulen) or university curricula adapted to respond to business needs (e.g. University Colleges in Ireland). Some Korean universities are moving in this direction but, as noted in Chapter 3, the government needs to further deregulate the university sector in such a way as to promote greater adjustment by the universities to changing market needs. (physics, chemistry, earth sciences, etc). The system is remarkably expedient, efficient in terms of cost/quality ratio and also transparent. For more details see "Evaluation of scientific research: selected experiences" (OECD, 1997). 23 The "Brain Korea 21 Project" introduced in June 1999, aims to create world class graduate schools, leading regional universities; improve graduate school infrastructure; enhance research of graduate schools, balance the focus of academic studies; and enhance intemational co-operation through short-and long term training of students and the invitation of foreign professors. - 96 - 2. Redefining the role of GRIs and their funding 5.39 The Law for Establishment, Administration and Promotion of Government-funded Research Institutes (hereafter, GRI Law) was enacted in January 1999. Based on this law, the GRIs depending on each ministry were transferred to five Research Councils under the responsibility of the Prime Minister's Office. Science and Technology research institutes were transferred to three S&T Research Councils: Fundamental, Industrial and Public. The GRI Law and restructuring process aim to induce administrative innovation, effective human resource management, and enhanced productivity in research projects, although it is too early to assess the results of the measures. As part of this restructuring process, the Korean Government needs to address a number of fundamental issues: * Redirecting GRI research towards more basic and long-term research through secure public funding. When restructuring the GRIs in 1980, the Korean Government clearly defined their role and this definition remains valid (see footnote 10). Rapid increases in both university and private sector research capabilities have occurred over the years. In response, the government has introduced several policy measures aimed at renewing the GRIs, but the task is not yet complete. For effective restructuring, the research orientation of GRIs should also change. This implies that secure government funding for more basic and long-terrn research by GRIs be ensured. Based on the experiences of OECD countries with similar laboratories, the ratio of outside funding to secure funds ranges from 35%-65% to 55%-45%, depending on the nature of disciplines or technologies in which they operate. * Redesigning funding mechanisms. In addition to increasing public funding for GRI's basic and long-term research, the funding mechanism needs to be strengthened. Criteria for allocation of public funding (including clear guidelines on the economic rationale for such funding) as well as the process (e.g. peer review of competing proposals) should be strengthened. The government has instituted the principle of contractual research, through which industry's participation and linkages will be increased. 24 In 1996, the Project Base System was introduced as a national R&D management system to enhance research performance and competitiveness. The policy making government funding conditional on matching funds from the business sector for all R&D projects in which it is involved is also a step in the right direction and should be pursued actively. * Repositioning the GRIs vis-ai-vis other actors in the innovation process. The current role of the GRIs overlaps with that of other innovation actors in universities and the private sector. In particular, it appears that the government uses the GRIs as agencies to undertake ministries' R&D programmes. This strategy has serious drawbacks. For instance, the GRIs do not educate R&D personnel, a key function of public research institutions in many European countries. In a longer-term perspective, the Korean Government should consider how best to integrate the research capability of the GRIs with the universities' main education mission. The establishment of joint research teams or laboratories - with similar rules relating to evaluation, remuneration and promotion for all researchers involved - could be an efficient way of achieving the necessary integration [see the French experience with the "associated CNRS/university laboratories"]. 24 European countries are extensively using contractual research for public research system. For instance, in the case of TNO in the Netherlands, the share of government funding out of total turnover in 1997 is about 43%, and the rest is mostly from contractual research. - 97 - * Ensuiring long-term consistent policy design. The GRIs play a pivotal role in orchestrating nation-wide innovation activities. The govermment needs to establish a long-term plan for the GRIs in the KIS; this could involve creating a GRI Realignmnent Commission, composed equally of representatives from government, industry, university and GRIs. It would be desirable for such a Commission to have an advisory board composed of eminent foreign experts, including Korean expatriates. Critical institutional redesign factors would include greater autonomy, mission rationalisation, institutionalisation of co-ordinating mechanisms and job retraining and relocation programmes for displaced employees. 3. Strengthening knowledge diffusion and system linkages 5.40 Technology policies in OECD countries are converging towards two overriding objectives: i) complementing market forces where this would yield the highest social return (rather than allocating public support according to predefined sectoral or political priorities); and ii) fostering the development of linkages among all actors in the innovation system and providing these actors with market-compatible incentives. In particular, policy measures are shifting away from conventional subsidisation towards public-private partnerships in which co-operation at the design stage, and risk/cost sharing at the implementation stage ensure that the economic value of R&D activities is improved. For "mission-oriented" programmes to be effective, a systemic approach is needed that provides a framework for a more market-driven, bottom-up definition of objectives and more decentralised implementation.25 Policy implications for Korea follow: - Greater emphasis on the diffusion of NRDPs. As mentioned above, the R&D results of both mission- and diffusion-oriented NRDPs are poorly diffused and utilised. The governtment should, in consultation with all the parties concerned, promote the commercialisation of NRDPs' R&D results through public-private partnerships. Korean Government policies tend to target direct support measures, with other measures attracting less attention. In contrast, many other OECD countries tend to direct their support to other areas, such as promoting networking and clustering (e.g. Dutch Clustering policies and German BioRegio Initiative), expanding SME access to the public research system (e.g.the United State's Small Business Technology Transfer program) etc.26 - Bridging institutions. In addition to placing greater emphasis on the diffusion of NRDPs, it is very important to institutionalise the diffusion mechanisms. This can be done in two ways: i) provide incentives for existing research institutions to induce them to increase their diffusion efforts; and ii) establish intermediary bridging institutions. Korea is already moving in the first direction, but the second also deserves consideration. For instance, despite its many achievements, Taeduck Science Town has been often criticised as being weak on industrial linkages. Government can induce its GRIs in the town to increase their efforts or can establish a new specialised institution with that specific objective. A good examples is Taiwan's Hsinchu Science-Based Industrial Park. * Intermediary institutions in the private sector. Various kinds of intermediary institutions can strengthen the linkages between public and higher-education research and industry. Korea lacks the university-industry interface units and technology centres which are popular in other OECD countries. The high concentration of private R&D in the chaebol has prevented the development of independent service firmns which play a large role in the diffusion of 25 For more detailed explanations, see OECD, Technology, Productivity and Job Creation, 1998. 26 See OECD, Managing National Innovation Systems, 1999. - 98 - knowledge in advanced countries and allow more efficient outsourcing of technological, management and organisational services. The growth of specialised research labs spun off from large firms since the financial crisis offers a welcome opportunity to fill some of the gaps in the KIS's system linkages. Government should encourage their growth, for instance by allowing them access to the public research system and results. Strengthening global linkages. Korea's scientific and technological activities need to be better integrated into global networks. As of 1998, nineteen Korean journals featured among in the 5600 journals covered by the Science Citation Index (SCI). The Korean Government should seek to create a more internationalised science community, for instance by encouraging the presence of capable foreign scholars in Korean universities and public research institutes through grants and fellowships. Government and public research institutes could establish an Advisory Board composed of eminent foreign scholars and Korean expatriates. The restructuring of the chaebol and the surge of foreign investment provide an opportunity to diversify the sources of knowledge acquisition. Government should seek to link recent inflows of foreign investment to domestic R&D activities. The integration of Korea into international innovation networks will require initiatives in other areas, such as international technology co-operation, including international business alliances, scholarships, etc. 4. Increasing mobility of human resources in science and technology 5.41 Technical progress and the move towards the knowledge-based economy are increasing the demand for skilled labour and spurring an upgrading of skills. This raises several important policy challenges for governments, one of which is increasing human mobility. The movement of science and technology personnel between sectors, large and small firms, and across national borders is an important conduit for technology transfer. The government should develop policy initiatives to increase human mobility in the KIS. * Removal of (regulatory) obstacles that impair the mobility of researchers between the public and private sectors. At a general level, the barriers and obstacles to labour market mobility for S&T personnel relate to regulations on employment (hiring and firing), pension rules and wage bargaining arrangements. Regulations such as employment protection legislation could *act as barrier to flexibility and mobility. In the public sector, researchers may not be willing to abandon permanent employment for employment in industry, even at a higher wage. Other factors that hinder mobility include age limits on junior faculty or research posts. In all these areas, government needs to make further efforts. * More open recruitment is needed in high-level government positions with responsibilities in policy making and implementation. The current official recruitment system creates an invisible wall between government and business. Government should encourage much wider participation of business in NRDPs, not only as research partners but also as key players in program design and evaluation. 5. Stimulating innovation in SMEs 5.42 In line with streamlining its R&D support system, government should make greater efforts to identify what SMEs need most. First, awareness of the importance of innovation is still low among SMEs, particularly among the smaller ones. Government should increase information - 99 - provision services for SMEs. Second, SME policies should aim at enhancing the absorptive capacity of SMEs through the provision of qualified R&D personnel and promotion of technology transfer from public research institutions. Third, government should comprehensively review support measures and reallocate government funds in consequence. In accordance with this comprehensive review and reallocation, implementation procedures need to be re-examined in light of international best practices for example, the US Small Business Innovation Research Programme and Small Business Technology Transfer Programme. 5.43 The system for supporting innovation in SMEs needs: i) increased resources (both financial and human); and ii) a regional/local base, in line with successful OECD experiences. The experiences of the European countries may provide useful insights. For example, the French Innovation Agency (ANVAR) provides support to R&D and innovation in SMEs, with a total yearly budget of USD 200 million, and with the assistance of 24 regional offices which enjoy full decision-making power of up to USD 20 000 per project. Aids include direct support to innovation - reimbursable in case of success, subsidies to employment of scientists by SMEs, support for collaborative projects with a university or a public laboratory, seed money for enterprise creation, etc. 5.44 A network of local service points providing technical information and assistance to SMEs needs to be set up. From this viewpoint, the Korean system, based on the "Technical Academy", is rather undeveloped, with very limited resources and practically no local "antennas". Korea does not have the capacity to build up a large infrastructure, such as the Japanese prefectural laboratories network, but should aim for lighter and efficient structures, similar to the Danish system.27 5.45 The Korean Government should strive to expand SME access to the public research system. To date, large enterprises have been the main partners of the NRDPs and SME participation should be encouraged. The government should also earmark a set percentage (up to 10%) of the R&D procurement of each ministry to SMEs, in line with the successful US experience. Further, knowledge diffusion should be facilitated through networks, which can be both horizontal (e.g. with SMEs setting up a research consortium with public research institutes, including universities) and vertical (e.g. with the chaebol acting as the main organiser through their SME subcontractors). 5.46 In recognition of the importance of venture capital in creating economic and employment benefits and supporting the start-up of technology-based SMEs, the Korean Government has recently initiated several policy measures. In 1997, the Venture Business Promotion Law28 was enacted, and financial support for venture business has been substantially increased over the last two years. These policy initiatives appear to be contributing significantly to the creation of an entrepreneurial environment that favours risk-taking. The government now needs to focus more 27 See OECD: Science Technology and Innovation Policies, Denmark, 1995. 28 The law (Special Law for the promotion of Venture Business) was revised several times since then and the latest change was made in January 2000. Some of the new provisions include: support for financing, location, technology development, human resource development, collaboration with research centres, and access to the technology guarantee fund. - 100- on the overall regulatory and supervisory environment for venture capital to ensure that there is proper discipline and transparency in this booming market.29 6. Shifting from sectoral support to cluster promotion 5.47 Cluster-based innovation and technology policy offers many advantages and the cluster approach has become a key policy tool in a number of OECD countries. Clusters can systematically enhance linkages among innovation activities, thereby maximising the value added of production activities. Private enterprises, and in particular SMEs, can efficiently draw upon the knowledge-creating institutions, such as universities and research labs which form the hub of the cluster. Governments can promote clusters in several direct and indirect ways: their cluster policies are closely related to regional development policies and can help to reduce regional imbalances (see Box 5.3). The cluster approach has several implications for Korea. Box 5.3: From a Sectoral to a Cluster Approach: Innovation and Technology Policy in the Knowledge-based Economy Clusters are networks of interdependent firms, knowledge-producing institutions (universities, research institutes, technology-providing firms), bridging institutions (e.g. providers of technical or consultancy services) and customers, linked in a value-added creating production chain. The concept of clusters goes beyond that of firm networks, and captures all forms of knowledge sharing and exchange. The analysis of clusters also goes beyond traditional sectoral analysis, as it accounts for the interconnection of firms outside their traditional sectoral boundaries. In many OECD countries, clusters are seen as the drivers of growth and employment. Governments can nurture the development of innovative clusters primarily through regional and local policies and development programmes, and by providing the appropriate policy frameworks in areas such as education, finance, competition and regulation. Some best practices include: * Creating a platform for government's dialogue with the business sector (Netherlands); * Focusing R&D schemes, innovative public procurement, investment incentives and the creation of " centres of excellence" (Sweden); * Competing for government funding to provide incentives for firm networks to organise themselves on a regional basis (Germany). OECD, Managing National Innovation Systems, 1999. 5.48 Traditionally, the chaebol have played the role of clustering institutions through subsidiary and subcontracting companies, while government has pursued a sectoral support policy. This division of labour is becoming less and less viable; it has led to an over-expansion of the chaebol system, while impeding the exploitation of intersectoral synergies in the innovation process. The Korean Government should facilitate networking and clustering, in particular by: i) establishing a more competitive environment through competition policy; ii) providing appropriate infrastructures and incentives, in particular for SMEs; and iii) improving co- ordination of regional and national policies. 29 As noted by the European Venture Capital Association, "The most desirable government programs are those that strengthen the private venture capital sector and then, as private markets mature, are phased out. The economic and social benefits of such programs continue long after the government's direct role has ended "White Paper: Priorities for Private Equity - Realising Europe's Entrepreneurial Potential", 1998. p. 11. - 101 - 7. Stimulating regional and local innovation initiatives 5.49 As clearly shown by the above considerations and abundantly illustrated by the experiences of the OECD countries', the regional and local dimension is key to the development of efficient innovation policies. Korea suffers from an administrative framework that does not facilitate spontaneous initiatives by regional and municipal authorities. The lack of financial autonomy of these authorities, their budget being fed by limited local taxes and funds provided by the central ministries, serves to exacerbate this inflexibility. However, some opportunities exist that could usefully be exploited by some of the entities - the six metropolises (including Seoul, Pusan, Kwangju) and the nine provincial govermments - which do have a significant budget. Central government can stimulate this move by providing matching funds for the establishment and the overheads of the infrastructures required for supporting innovation in SMEs and constituting regional clusters. The experiences of some Nordic countries (e.g. Denmark and Finland) could be useful in this respect, as well as that of France (although the regional innovation initiatives benefited from an overall decentralisation policy since the early 1 980s which significantly increased the financial autonomy of the regions). 8. Improving coordination and evaluation at the central level 5.50 To be successful, innovation policy requires strong co-ordination between the various ministries and agencies involved in the innovation process. There is a real need for co-ordination between education policy (MOE), S&T policy (MOST) and industrial policy (MOCIE). The recent creation of the National Science and Technology Council will allow for a more co- operative approach, and, if appropriately managed, could become an efficient instrument of change, facilitating the implementation of the necessary reforms. A good example in this area is the Finnish S&T Policy Council, which brings together government bodies and high-level industry representatives under the chairmanship of the Prime Minister, and has been instrumental in stimulating change in the Finnish innovation system. 5.51 In order to conduct their task efficiently, the central authorities as well as the above- mentioned Council, should commission and make use of appropriate evaluations. Some organisations, such as KISTEP (Korea Institute for S&T Evaluation and Planning), have conducted rigorous and critical evaluations of government programmes (see section B), and good use should be made of such monitoring capabilities. We would suggest that an international review of Korea's basic research competencies be performed. As a complement to such a review, a technology foresight study would be instrumental in helping to place Korea's efforts in the broader international context. To date, Korea has not made much use of such benchmarking techniques, although they provide a useful tool for assessing global trends, and highlighting areas where Korea should concentrate its efforts. The exercise should draw on the experiences of the scientific and business communities. 30 30 Some OECD countries, for instance Ireland and UK's Scotland, are more frequently including foreign companies in their industry-academia-government forum. - 102 - E. Conclusions 5.52 The challenges facing the KIS require important changes. As a number of changes concern, directly or indirectly, the wider economic context, the adaptation of the KIS requires initiative from the various innovation actors. This is particularly so as since the financial crisis, the Government, industry, and the research community has been engaged in undertaking painful reforms. Some are positive, others need to be more carefully designed. The Government, however, also has to redefine more carefully the mechanisms and means through which it can most effectively support the role of different actors in the innovation system and the rationale for its subsidy and grant programs. This includes budgetary measures (increased funding, reallocation of resources, changes in funding methods, etc.), as well as introducing new forms of incentives (particularly to facilitate linkages). This also requires institutional initiatives, such as the removal of regulations which are obstacles to innovation (e.g. in universities), the creation of appropriate commissions (e.g. to 'realign' the GRI), or the implementation of targeted reviews and foresights. The implementation and coordination of the necessary reforms is principally a matter of political will, not a matter of lack of understanding, resources, or administrative tools, as will be elaborated in the last chapter. - 103 - REFERENCES Djankov, Simeon and Bernard Hoekman, "Foreign investment and productivity growth in Czech enterprises," Policy Research Working Paper 2115, World Bank, 1999. European Venture Capital Association, 1998, "White Paper: Priorities for Private Equity - Realising Europe's Entrepreneurial Potential," Brussels: EVCA. Hwang, Yongsoo, et al., "An Assessment of Government R&D Programs," Seoul: Science and Technology Policy Institute, (In Korean), 1997. Korea Development Bank, "Analysis of the Effects of Technology Imports," Seoul: KDB, (In Korean), 1991. Korea Industrial Technology Association, "Industrial Technology White Paper," Seoul: KITA, (In Korean), 1998. Lee, Won-Young, "Proposal for improving tax and financial incentive systems," Seoul: Science and Technology Policy Institute, (In Korean), 1998. Meyler, Aidan, "Technology and foreign direct investment in Ireland", Technical Paper No,98/10, Economics Department, Trinity College, Dublin, Ireland, 1998. Ministry of Science and Technology, Korea, "Dream, Opportunity and Challenge of S&T Toward the Year 2025," (In Korean), Gwachon, Korea: MOST, 2000. Ministry of Science and Technology, Korea, "R&D Budget Statistics," Gwachon, Korea: MOST, 1999. Ministry of Science and Technology, Korea, "Thirty Year History of Science and Technology," Seoul: MOST, (In Korean), 1997. Ministry of Science and Technology, Korea, "Report on the Survey of R&D in Science and Technology," Seoul: MOST, 1998. National Science Board, "Science and Engineering Indicators," Arlington, Virginia: National Science Foundation, 1999. OECD, 1995, "Science Technology and Innovation Policies, Denmark," Paris. OECD, 1996, "Reviews of National Science and Technology Policy: Republic of Korea," Paris. OECD, 1996, "Technology, Productivity and Job Creation, Vol, 2 Analytical Report," Paris. OECD, 1997, "National Innovation Systems," Paris. OECD, 1998, "Technology, Productivity and Job Creation," Paris. - 104- OECD, 1999, "Main Science and Technology Indicators," Paris. OECD, 1999, "OECD Science, Technology and Industry Scoreboard 1999 - Benchmarking the Knowledge-Based Economy," Paris. OECD, 1999, "Managing National Innovation Systems," Paris. OECD, 2000 (forthcoming), "Mobilising Human Resources for Innovation," Paris. Oh, Chai Kon, "A Study on the Promotion of the Effective Diffusion of National R&D Results," Seoul: Science and Technology Policy Institute, (In Korean), 1997. Song, Wi-Chin and Taeyoung Shin, 1998, "Determinants of Success of New Technology Based Firms and Innovation Policy," Seoul: Science and Technology Policy Institute, (In Korean). - 105 - CHAPTER VI: PROMOTING KNOWLEDGE-BASED ACTIVITIES A. Introduction 6.1 The level of development now attained by Korea, coupled with rising competition in high-volume, standard products and intemational technological and economic developments, make it essential for Korea to exploit knowledge effectively in economic activity. Part of the challenge is to raise its competitiveness in knowledge-based activities and industries - areas where a genuine capacity to innovate is vital. Over the past decades, Korea's industrial profile has moved towards what can be viewed as typical for an OECD country. Currently, knowledge- based industries, as estimated by the OECD, account for 50.4% of value added in the business sector,' ranging from a low of 31.4 % in Iceland to a high of 58.6% in Germany (former West Germany) (Figure 6. 1.).2 These industries have in fact grown more rapidly than the average for the total business sector in practically all OECD countries (Figure 6.2). In Korea, knowledge- based industries account for 40.3% of business sector value added. Whereas knowledge-based manufacturing accounts for a relatively large share of GDP, the share of knowledge-based services is unusually small. On average, services now account for over 70% of economic activity in the OECD economies, compared to less than 20% for manufacturing.3 6.2 Furthermore, based on productivity and trade statistics, many knowledge-based industries seem to exhibit a quality gap relative to other industrialized countries [Woo, 1999]. Table 6.1 summarizes Korea's position in a few knowledge-based industries, and indicates some key weaknesses and challenges.4 As can be seen, Korea is well-placed intemationally in several of these industries, despite problems with respect to innovation capability, access to skilled personnel and value-added content. This situation reflects the Korean emphasis on mass production and price competition as means to expand market share, rather than on innovation and product differentiation to increase profitability through enhanced productivity and value added. ' Total business sector is defined as ISIC Rev. 2 Divisions I to 9. 2High technology manufacturing includes computers, aerospace, pharmaceutical, and communications equipment. Information and communication manufacturing includes office and computing equipment, radio, TV and conrmunications equipment; services includes comnmunications services. Knowledge-based industries also includes finance, insurance, and business services. Note that for Japan and the OECD, the category of 'Finance, Insurance, and Other Business Services' includes 'Community, Social, and Personal Services'. ' OECD, 1999a. 4 The table seeks to illustrate the structural strengths and weaknesses of Korean knowledge-based industry. The industries chosen belong to the high-tech category, as defined by the OECD, and are viewed either as strongholds of Korean industry or as "future industries". - 106- Figure 6.1: Share of Total Business-Sector Figure 6.2: Real Value-Added Growth Value-Added by Knowledge-Based by the Total Business Sector and by Industries (1996 or latest available year) Knowledge-Based Industries (Compound average 1985-96 1996 or closest years) Germany K.- . -inm.im.mininm ' lJUnited States * [: i.RYYS,rir _ S ,: ;, Japan Austrata i ' i _ i l _ |i ';~~ ~~~~~i0 nited Kingdom- -<#-1 E = S R0;I Canada O rECD ap p ..IUIEIE ' '#Sweden Finland *III*I * ' Netherlands Mexi; ! ~ iimi *[__ France Austria } 1 g-, S :: ~~~~~~~~~~~~EU Gennanyi ia. -i:iiX A i, . Australia OECD i | jBieo Belgium Canada \ 3_ ~~~~~~~~~~~~~~~Austria Unfted Statesij\r>::iii'R;iSCi Finland EU E[zEmiIE. Denmark U5 I .... . .. .i.i. gMexico .. r7777" -,777FW ~ Italy il~ g *l ' 1 Korea i ~ *fl 0 New Zealand Netherlands Greece Italy Spain France Norway Sweden Portugal hni --- i Iceland Denmark 60 50 40 30 20 10 0 M % 0 1 2 3 4 5 6 7 EOCommunity, social & personal services O3Total business sector * Finance, insurance and other business services []Knowledge-based industries and services *Communication services I High-technology manufactures O Medium-high-technology manufactures Source: OECD 1999a. 6.3 The government seeks to champion a triangular relationship in the Korean economy - one in which: i) the reformed chaebol would focus on their core competencies, becoming world- class, competitive conglomerates, and ii) knowledge-based high-tech SMEs and suppliers of parts would form a supporting pillar, while iii) foreign companies would invest in Korea, contributing with advanced manufacturing and management skills. These three functions are likely to be important for maintaining or developing competitiveness in the knowledge-based economy. More fundamental, however, is the task of strengthening the mechanisms for spontaneous development and use of knowledge in the economy. Throughout the OECD area, there is a similar ongoing shift in industrial policies away from defensive support of specific firms and industries towards building institutional conditions and policies which strengthen the - 107 - capacity of industry to do so in response to changing consumer demands and market opportunities. 6.4 It should be stressed that there is no static or absolute definition of knowledge-based industries or activities. Some tend to be more intensive in their use of knowledge than others, but the development and use of knowledge can be decisive for competitiveness in any economic activity. At the same time, historical circumstances along with social and economic forces shape industrial activities, which in turn influence risks and opportunities for the future. Along with the policy areas presented in the previous chapters, there area at least five key sets of industry- related issues require special government action in Korea as the country seeks to strengthen a knowledge-based economy. Unless they are properly addressed, the presence of these issues will limit the pressures for change and the responsiveness of the private sector to new opportunities, and thus serve to preserve outdated industrial structures at the expense of knowledge-based activities: i) the dominating position and limited responsiveness of the chaebol; ii) the untapped potential of SMEs; iii) remaining barriers to contributions by foreign firms, including inward FDI; iv) impediments to high-value-added services; and v) inadequate incentives for firms to invest in intangible assets. The following sections discuss the policy issues that characterize these areas. B. Reforming the Chaebol 6.5 The prevailing industrial structure in Korea has been much influenced by the family- controlled conglomerates - the chaebol. Their investment, and exploitation of scale economies, has been critical for establishing internationally competitive production in a number of capital- intensive industries: * The conglomerates have effectively exploited economies to scale and devoted considerable resources to research. * They have gained considerable experience in international markets, and have established strong competitive positions in many product areas. 6.6 The rise of the chaebol during the 1960s and 1970s was supported by the Korean Government through preferential access to credit and protection from foreign competition. In a situation of weak financial markets and dependence on foreign technologies, the chaebol assumed the role of financial intermediaries. The diversity and size of their portfolios permitted them to spread and underwrite risk for investment in new or expanding areas. Their room for discretion provided them with the ability to act quickly - a factor that proved critical in a number of instances. Samsung, for example, became the world market leader in metal oxide semiconductors and the DRAM segment by the early 1990s, climbing from a market share of virtually zero in 1984. Hyundai and LG Semicon likewise emerged as the fourth and fifth largest producers of DRAMs in 1996. In shipbuilding, following an impressive campaign to increase capacity and sales, Korea now ranks number one, a position previously held by Japan. - 108 - Table 6.1: Main Characteristics of Selected Knowledge-intensive Industries in Korea Industry Strengths and position as of today Weaknesses and challenges for further development Semiconductor * Korean industry accounts for one- * Heavy dependence on a single product i.e. memory industry (SI), mainly third of world production chips, for nearly 90 % of SI revenue semiconductor chips for * The industry accounts for 10% of * Heavy reliance on export markets for 90 % of total a wide array of Korea's total exports (1997) production (1997) electronic devices. * Risk of losing competitiveness due to reduced investment in new product development and production capacity for future generations of products Telecom equipment * Production value USD 6 484 * Increased competition in Korean market following industry (TEI), million Telecom and Information Technology Agreement including wire and radio * 58 % of product sold in Korea, (1997) communication accounting for 63% of domestic * Competitiveness lags behind that of advanced equipment. market share (1997) countries * TEI production is anticipated to * Insufficient innovation capability surge from 2000 * Problems as regards core technology of TEI industry * Insufficient supply of high-quality human resource Computer software & * CSS business tumover USD 5 904 * Reliance on imports for system software services (CSS), mainly million (1997) * Low export capability of the CSS industry, package software * High (94%) market share in accounting for 1.6% of turnover (1997) industry and computer domestic market (1997) * An estimated 10-20 years behind the United States service industry. in technological development * Insufficient supply of highly qualified software engineers * Difficulty for software industries to raise capital * Development of CSS is hampered by weak protection of intellectual property rights Fine chemicals * Production value USD 17.4 billion * A high degree of reliance on imports for high-tech industry (FCI), * High (85%) market share in and high value-added core inputs, e.g. 60-70% of including domestic market (1996) intermediate input from abroad pharmaceuticals, * Pharmaceuticals and cosmetics are * Industry-related trade deficit for USD 2.9 billion in pesticides, cosmetics, twin engines of growth 1997 dyestuffs and organic * Final products are mostly low value-added pigments, paints and common products printing inks, and other * Lack of own technology, 56% of firms rely on high value-added technology imports (1997) chemicals. * Low innovation capacity, eg. ability to invent new drugs lags 50% below that of US firms Biotech industry (BI), * Production value USD 892 million * Korean firms possess some basic technology of BI including the production (1997) thanks to the R&D investment of engineered biological * 150 companies, of which two- * Production technology mainly at the stage of products and all thirds are side-line business imitation of advanced countries supporting businesses, subsidiaries to large firms * Considerable gaps remain between scientific * National biotechnology research, application research and technological development program (Biotech commercialization 2000) led by the govemment since * Anticipated difficulty in imitating advanced 1993 technology due to improved protection of * Large govemment budget awarded intellectual property rights in the future for R&D in biotechnology for USD 170 billion (1997) Environmental * 11 700 firms with sales revenue of * Insufficient technology capacity compared with industry (El), including USD 8.9 billion in 1996 firms from advanced countries, especially in the many diverse sectors, * Fast growth by 15% per year, medium- and high-end product segments with environmental between 1990-97 * The opening up of the Korean environmental protection equipment * Large govemment environmental protection market for equipment and services to production being the spending, at I% of GDP during foreign countries will be a major challenge to the main component of the 1990s Korean El industry in Korea. * Policy environment conducive to El, including the Environmental Vision 21 Policy, and Green country construction plan * Govemment R&D support for the El Source: Compiled based on Profile of Korean Industries, Korea Institute for Industrial Economics and Trade (1998). - 109 - 6.7 The extensive diversification of the chaebol involved intense competition among them in numerous markets. In 1990, for example, Korea had 21 semiconductor producers, four shipbuilders, and 14 television makers. Samsung chose to enter the automobile industry despite the fact that four other producers (Hyundai, Daewoo, Kia and Sangyong) were already supplying the relatively small domestic market. At the same time, the chaebol accumulated power and established modes of governance based on tight control by few actors, limited transparency, weak protection of minority shareholders, and heavy dependence on bank lending rather than on equity. Despite reduced government support from the 1980s, the conglomerates have continued to account for a large proportion of economic activity. 6.8 The position, brand names, reputation, and resources of the chaebol represent assets that can potentially be deployed to increase the production of knowledge-intensive goods and services. For instance, their strong competitive positions can be exploited to enable them to forge strategic alliances with foreign partners. On the other hand, the chaebol have generally lacked effective mechanisms for identifying - and disclosing - when operations go astray. There are "lock-in" effects along the trajectories of existing markets, products and technologies, and reduced incentives for innovation (see Chapter 5). This has contributed to excess capacity, extensive misallocation of resources and low profitability. Meanwhile, the reliance of the chaebol on imported technology and inputs to support expansion has often been paralleled by weak linkages with other parts of the Korean economy, including SMEs [OECD, 1 999b; OECD, 2000a]. 6.9 In the wake of the crisis, the government introduced measures to improve the global competitiveness of the chaebol. This has been done through: i) enhancement of market transparency; ii) elimination of cross debt guarantees; iii) capital structure improvement; iv) business consolidation into core competence areas; and v) improved management accountability. Additional supportive measures were: i) changes in the corporate governance of non-bank finance companies, many of which were controlled by chaebol and provided excessive funding to their affiliates; ii) curbing circulating investment and unfair intra-group transactions; and iii) blocking irregular means of inheritance. Some of the reforms are highlighted in Table 6.2. 6.10 The government's efforts towards restructuring have so far consisted in a mixture of market-oriented measures designed to liberalize and stimulate competition, and interventionist measures designed to force the chaebol to restructure, contract in areas of overcapacity, and focus on their core competencies. Nevertheless, and despite increasing foreign competition, a web of vertically integrated structures and entrenched relationships continues to limit market contestability even in the face of extensive regulatory reform and apparent market openness. This raises a demand for continued actions to enforce restructuring. At the same time, it must be clearly understood that the chaebol are strongly heterogeneous. In practice, these company groups display a variety of strengths and weaknesses, and there is no panacea for improved performance which can be universally applied by any public or private actor. The most effective instrument for the government to push for restructuring probably emanates from its role as owner of a number of the major commercial banks - the government can and should ensure that they do not lend money unwisely. In addition, the Financial Supervisory Commission (FSC), as regulator of the banks, can take more affirmative action to ensure the health of financial institutions. - 110- 6.11 Beyond this, competition policy has an important role to play in ensuring effective competition. Indeed, as discussed in Chapter 2, the government has recently strengthened the position of the Korean Fair Trade Commission (KFTC). At the same time, the KFTC has been charged with regulating the activities of the chaebol since the amendment of the Fair Trade Act of 1986. Restructuring the chaebol does not equate with antitrust. Monitoring the activities of the chaebol -700 companies in all - is clearly a huge task. Since 1986, the main chaebol have grown and experience shows that those that, at least until recently, have attracted the very highest level of competence, have in effect been able to evade the spirit, if not the letter, of the regulations enforced by the KFTC. Table 6.2: Measures to Improve the General Policy Environment for Business in Korea Are i:tio takej X Transparency The chaebol are required to prepare consolidated financial statements beginning in 1999, and quarterly reporting in 2000, that must include line-of-business reports as well as disclosure on intra- group transactions. Measures to increase the role and independence of external auditors have been introduced. The amendment of financial accounting standards in December 1998 has brought Korean practice into line with international standards. Shareholder The reform of the Commercial Code in December 1998 has enhanced the rights of minority rights shareholders by lowering ownership thresholds for initiating various types of adverse actions. The removal of "shadow-voting" in September 1998 permits investors to vote freely on such matters as mergers, business transfers and the election of directors and auditors. Company Listed companies are required to fill one-quarter of their boards of directors with outsiders directors beginning in 1999. The responsibilities and obligations of directors have been clarified, while the definition of directors has been expanded to include any person who exercises a direct decision-making function in a corporation. Cumulative voting (which enhances minority shareholders' rights) for directors is now possible (but not required). Intra-group New debt guarantees between chaebol subsidiaries were prohibited in 1998; existing guarantees are relations to be eliminated by March 2000. The 25% ceiling on equity investments by chaebol subsidiaries in third companies (which had been intended to limit chaebol expansion) was lifted, with a view to facilitating restructuring. Holding companies are allowed, subject to restrictive conditions on debt and the structure of such companies. Insolvency Re-organization procedures (applicable to large enterprises that are deemed viable) have been procedures strengthened through the introduction of economic criteria in evaluating applications, and through the establishment of time limits. Investment The ceiling on foreign shareholding in individual companies was abolished in 1998. All forms of mergers and acquisitions, including hostile take-overs by foreigners, are permitted. The number of business lines where foreign direct investment is restricted was reduced from 53 to 24. Other The ceiling on banks' equity investments in individual companies was temporarily boosted from 10 to 15%. As from 2000, the corporate tax system will not allow deductions for interest payments on any debt exceeding five times equity capital. A Corporate Restructuring Fund of KRW 16 trillion was created in October 1998 to assist SMEs. Source: OECD 1999c. 6.12 It is important that the KFTC does not mix up competition aspects with policies for industrial restructuring (OECD, 2000e). The government has invested considerable effort and - 111 - resources in creating market institutions, notably a reformed financial system and a new corporate governance framework. While serious structural issues remain to be tackled and require short-term remedies, market institutions will not be fully activated and are unlikely to play their intended roles as long as the government relies on direct control of the chaebol. For example, "non-market" transactions to assist affiliated companies have a direct impact on shareholders, who should use their powers under the new corporate governance framework to defend their position. Meanwhile, the KFTC should have a strengthened role in ensuring that markets are contestable by removing remaining barriers to entry and by establishing more open and competitive structures in vertically integrated industries. For this to happen, there would need to be a strengthening and redirecting of its analytical competencies, so as to enable the KFTC to serve as a true champion and guardian of contestable markets. 6.13 In addition, there is a need for careful follow-up on the implementation of corporate governance reform. Further measures should be taken to ensure accountability of business leaders to stockholders and financial institutions, and to loosen the uncontested hold of business leaders on corporate control. Further attention should be paid to: * Corporate restructuring. The procedures for dealing with firms in trouble should be improved by providing incentives for debtors and creditors to initiate re-organization or composition proceedings prior to the closure of an enterprise and giving a greater role to creditors in the governance of the debtor. * Shareholders' rights. Rules expanding the use of cumulative voting could be established and companies should be required to schedule shareholder meetings in ways that would encourage, rather than limit, participation. * Corporate directors. A clearer statement of the responsibilities and liabilities of corporate directors should be established; outside directors should be given greater responsibility. a Holding companies. The restrictive conditions, which, in practice, prevent the formation of holding companies should be eased in order to enhance transparency and accountability, while promoting the sale of non-core companies. 6.14 Progress in these areas is vital for improving risk management and for moving away from a dependence on debt towards widespread equity financing, and for advancing new formns of co- operation and alliances between firms which have become a significant instrument in knowledge and technology flows. C. Improving Conditions for Small and Medium-sized Enterprises (SMEs) 6.15 In the OECD as a whole, SMEs make up over 95% of all enterprises (99% for Korea) and account for 60-70% of jobs (74% for Korea in 1997) [OECD, 1997; OECD, 2000c].5 The share of SMEs in employment tends to be somewhat lower in manufacturing, ranging from 40 to 80% (69% for Korea). See Table 6.3 for some basic characteristics of industrial enterprises in Korea. 5 Definitional differences complicate comparisons. While usually defined to include firms with less than 500 employees, a number of countries use a lower cut-off point of 250 (300 in the case of Korea). - 112- 6.16 Korean SMEs fared particularly badly during the financial crisis. Average value added fell and some 20 000 small firms went bankrupt when the chaebol delayed payments to their SME suppliers. The problems confronting big parts of the SME-sector in Korea, however, are of a more long-term nature, go beyond the role of the chaebol and are related to the knowledge- based economy. While productivity differentials between large firms and SMEs have narrowed in some low-tech traditional industries - e.g. textiles, clothing and footwear, and food processing - they have increased in industries where technological competitiveness matters most - e.g. machinery, electronics, and transportation equipment. On average, value added per employee in SMEs relative to large firms fell from 55% in 1980 to 39% in 1997 [Woo, 1999]. Table 6.3: Basic Characteristics of Manufacturing Establishments by Size in Korea Number of establishments in manufacturing industry 1991 1993 1995 1997 Total 72 213 88 864 96 202 92 138 Percentage break-down by size of enterprises SMEs 98.5 98.9 99 99.1 Large enterprises 1.5 1.1 1.0 0.9 Percentage break-down by number of employees SMEs | 63.5 | 68.9 1 68.9 69.3 Large enterprises 36.5 31.1I j 31.1 30.7 Percentage break-down by value added SMEs 45.8 50.3 46.3 46.5 Large enterprises 54.2 49.7 53.7 53.5 Source: NSO, Report on Mining and Manufacturing Survey. 6.17 Some important developments have started to alter the picture. In July 1996, KOSDAQ (a NASDAQ-like stock exchange) was established to facilitate equity funding of emerging businesses. In the wake of the crisis, special measures were also put in place, e.g. many more Korean SMEs obtained access to trade finance facilities and a discount window of the commercial banks. A separate program for SMEs was started to focus on firms "in the middle" - those that were potentially viable but which needed support. Today, large banks are operating separate internal workout units for SMEs. With the chaebol in the process of reducing their debt exposure, the SME share in financing provided by the banking system improved markedly in 1999. 6.18 Following the easing of restriction to entry and other accompanying structural and policy changes, there has been a surge of start-ups. About 3 000 start-up companies are established each month, compared to the exit of some 600 firms (Table 6.4). The entrepreneurs behind these start- ups are generally college graduates, a fair proportion of whom have strong engineering backgrounds. Women are also emerging as owners of venture businesses, with 2 546 start-ups in 1999, up from 1 447 in 1998. Virtualtek in the Internet business (recently listed on the KOSDAQ), and CardKorea provide examples. - 113 - Table 6.4: Trend of Start-ups and Bankruptcies by Year Year Seven metropolitan areas No. of A/B Start-up corp. (A) Bankruptcy corp (B) bankruptcies (Multiple) (C) 1993 11938 2669 9502 3.5 1995 17245 4559 13992 2.9 1996 19264 3879 11589 5.0 1997 21057 6132 17168 3.4 1998 19277 7538 22828 2.6 1999 2286 196 672 11.7 Source: The Bank of Korea. 6.19 Of the 3 000 start-ups per month, about 50 are new high-tech start-ups. From less than 100 in 1995, there were more than 3 500 high tech start-ups in 1999. The prospects for technologically oriented, knowledge-based SMEs now appear exceptionally favorable. Not only does the government expect to support the growth of some 10 000 such start-ups though venture funds worth KRW 1 trillion (MOFE), but the changes in the chaebol and the economy at large bring new opportunities and particularly help to attract entrepreneurial resources and skilled labor, notably in knowledge-intensive service industries. High-tech start-ups have recently featured prominently on the list of venture enterprises maintained by the Small and Medium Business Administration. 6.20 At the same time, there has been an obvious overshooting in the evaluations of such enterprises, and an associated misallocation of resources and unwanted distribution effects (see section below on intangible assets). While the conditions for high-tech start-ups appear to have improved, the general conditions for start-ups and for SMEs remain much less favorable. Although the SME sector has expanded since the mid-1980s, there has been little upgrading as regards technological capabilities and competitiveness.6 The majority of SMEs remain engaged in low-tech industrial production. The sector remains thinly layered, with insufficient growth of firms capable of producing highly sophisticated parts, resulting in a weak foundation of firm- level technical training and technology development [Woo, 1999; Park, 1998]. 6.21 Several factors interact to hamper the development of SMEs, including; product market competition, including subcontractor systems; public procurement practices; formal and informal business practices, and access to skilled labor and technology.7 For instance, there are serious shortages in technical competence and accounting and marketing skills, and these gaps are being 6 A KOTRA survey on SMEs undertaken in November 1999 showed that out of 200 buyers the principal problems of SMEs in order of importance were 1) price competitiveness; 2) observance of shipment deadlines; 3) after sales service; and 4) complaints from European and US buyers that Korean SMEs lagged in new product development. Other problems identified included late invoice payments; lack of aggressive long term marketing strategy and quality control (the Japanese complained of defective products) [Korea Herald, Nov. 16, 1999]. 7 See a survey of five industries that represented the largest sectors in terms of Korean value added and exports. Given that the survey was undertaken in the middle of the financial crisis, it is not surprising that high interests and access to credit were a major problem. That red tape and corruption are still important bottlenecks for Korean firms, substantiates that problems remain in the broader institutional regime, as does the relatively high average for protection of intellectual property rights. The high problem rating for quality and supply of technicians and high skilled personnel substantiates the problems highlighted in Chapter 4. See Annex 1, which includes a table on the most important bottlenecks in production and technological improvement in Korea. - 114- filled only slowly. Although the number of R&D labs in SME reportedly increased from about 500 in 1990 to some 3 000 in 1998, most SMEs remain mired in product adaptation rather than innovation. With respect to technology, there are serious gaps relative to internationally acceptable levels [KIET, 1999]. At the same time, competitive pressures are set to increase, following from greater openness in the domestic market and because the chaebol are likely to become far more demanding customers. 6.22 Improved SME performance matters not only in its own right, but also because small firms are less likely to suffer "lock-in" with respect to existing plants, technologies and organizational structures, making them important for innovation and commercial experimentation with new technologies. At the same time, SME operations are typically characterized by high turbulence and churning, and the social benefits of their commercial experimentation tend to exceed the private ones. In the knowledge-based economy, policy intervention must crucially be conducive to entrepreneurship and risk-taking, but should not shelter SMEs from change. Today, information and communication technologies open up new opportunities for combining the advantages of small scale with those from networking among SMEs (and/or between SMEs and larger firms, or between firms and other actors such as research institutes). Networks can also serve as an instrument to enable government policy to reach out more effectively. It is essential that networks are driven by the identification of market opportunities, however, and policies should be conducive to such "demand-led" approaches. The available experience suggests that successful network development requires a combination of measures facilitating the provision of venture capital, public procurement, technology diffusion, programs and incentives conducive to training, regulatory reform, etc. [UNIDO 1995ab; UNIDO 1999; Schmitz and Nadvi, 1999]. 6.23 So far, the Korean Government has tried to balance market openness with selective support through a number of measures [KSMBA, 1999]. A number of good programs have been introduced, aiming at, e.g. the promotion of competitiveness through technological upgrading, deregulation and enforcement of competition law, promotion of venture business through "business-angel" capital, assistance to entrepreneurs establishing new firrns using their own technology, and the encouragement of technological innovation as discussed in Chapter 5. In effect, however, much of the government support provided to SMEs so far has served to protect them from normal business pressures, leading to a dependence on government programs that has diminished competitiveness and innovation. The Government needs to develop a comprehensive strategy for encouraging improved competitiveness while scaling back on direct intervention. In particular, it should replace protection by measures to help viable SMEs grow. It would be desirable to consolidate the presently huge number of SME programs, by evaluating not only their cost efficiency but also their economic outcomes, partly as a means to ensure complementarity and avoid duplication. There is also a need for an effective mechanism for feeding the results of evaluations back into policy design [OECD, 1998]. 6.24 In short, there is a case for consolidating present programs and increase consistency among different policies, phasing out those that aim directly at protecting SMEs; enhance markets and programs to strengthen the diffusion of technology and skills; and improve the broader entrepreneurial climate through the creation of a social and economic environment - including government institutions - which is more friendly to small business development. -115 - D. Strengthening the Contribution of Foreign Firms 6.25 Another feature of the Korean set-up until recently has been the limited presence of FDI, especially in the form of mergers and acquisitions, which has impeded foreign knowledge transfers. The ratio of FDI to gross fixed capital formation has averaged less than 1% over the past three decades (for China, this ratio has grown from virtually nil during the late 1970s, to close to 14% during 1992-96) [UNCTAD, 1998]. The very high rate of output growth indicates that Korea has been able to compensate for this deficiency in other ways, e.g. through very effective application of imported technologies and large capital investments. However, there have been downsides. By relying on short-term bank loans rather than on long-term capital, Korea became susceptible to turbulent foreign exchange markets. In addition, the absence of foreign firms reduced competitive pressures, stifling one of the stimuli for innovative activity. 6.26 In recent years, Korea has taken major steps to formally liberalize its inward investment regime and reform bankruptcy regulations, etc. (see Chapter 2). Together with the decline in asset prices and a more welcoming attitude to foreign investors following the Asian crisis of 1997-98, this has led to a substantial increase in inward FDI (Figure 2.1). There has also been a shift towards foreign investment in business services, especially securities firms, insurance companies, and commercial banks as part of the financial sector restructuring efforts. For 1999, foreign investment reached USD 15 billion, and the surge has continued into the first quarter of 2000 when it was up 36% on a year-on year basis. EU companies have become the largest investors, taking over from the United States and Japan, and signaling a diversification of investment sources. 6.27 This development has helped to reinvigorate the economy by bringing in capital, technology, and a package of soft core assets in accordance with global management standards. It has increased the potential for Korean actors to link into international networks and alliances. Increased competition and links to international systems of knowledge generation, together with growing FDI and other forms of collaboration with foreign multinationals, e.g. in the form of strategic alliances, will greatly influence the progress that can be made in knowledge-based activities. Foreign investments in companies have brought about changes in corporate culture, with traditional hierarchical management structures being increasingly discarded in favor of more transparent and efficient management. Mergers such as that of Hansol PCS with Bell Canada International have brought transparency to management and boosted efficiency. Doosan Seagram, and Oracle Korea appear to be creating flexible, ability-oriented and specialist organizations. 8 Foreign companies have also been aggressive in hiring Korean women professionals and this is having a demonstration effect on Korean companies. Samsung, for instance, is reportedly hiring a greater number of women professionals partly as a result of the successful experience of foreign firms. 6.28 Nevertheless, a combination of formal and informal barriers continues to hamper the role that could be played by foreign firms in lifting the overall competitiveness of the economy, and has prevented them from helping provide a countermeasure to the power exercised by the 8 English is a survival means for Korean staff in foreign invested companies. LG telecom with BT of UK sponsor 6 months language training for its employees in the UK. Other companies are changing the corporate landscape- Volvo Korea, Korea Fuji Xerox operate in-house language classes. (Business Korea, October 1999). - 116- chaebol. The Korean policy set-up retains features which limit the extent to which foreign investors are prepared to engage in extensive transfer of technology and skills [OECD, 1998]. It is true that technology from abroad has played an important role in Korea's rapid development, but this applies primarily to technology embodied in imports of capital and goods, and licensing arrangements. Following the liberalization of licensing arrangements in 1978, royalty payments rose from an annual average of less than USD 100 million to USD I billion by 1990 and to almost USD 2 billion by 1995. 6.29 Participation by Korean businesses in joint ventures with MNCs for the purpose of acquiring access to technology from foreign firms has been much more problematic. As Korean firms have become strong competitors in many fields, foreign companies become uneasy about technology transfers. Contributing to this problem is the weak enforcement of intellectual property rights which undercuts the basis for orderly exchange [OECD, 1998, KIET, 1998]. For example, in the biotechnology industry, Korean firms have mainly imitated foreign technologies in their production of antibiotics and vaccines. In the case of software industry, the poor protection of IPR made it difficult for the industry to develop in Korea in the first place [KIET, 1998]). 6.30 High-skilled human resources and capable suppliers with technological and research capability are other weak spots. In contrast to countries that successfully attract foreign technology and know-how through inward investment, including the United States - but also small countries such as Singapore and Ireland - Korea has severe barriers to imports of foreign expertise and talent: foreign managerial positions are few and there is a range of limitations to mobility between science and research institutions and industry. Together with the small number of SMEs with satisfactory research and innovation potential, the inadequate pool - and mobility - of human resources as well as capable supporting firms, risks hampering the country's ability to continually attract world-class MNEs. 6.31 The attraction of large inward FDI is not necessarily an indication of favorable economic prospects. Rather than the capital flows involved, the impacts on economic and social development crucially depend on how firms reorganize their operations, and on the new skills and technologies made available through these changes in corporate behavior. Studies of foreign investment decisions point to inadequate intellectual property rights and conditions for genuine innovative activity, limiting the willingness of foreign investors to move beyond mere marketing activity and engage in production and sizable technology transfers [Mansfield, 1995; Maskus and Yang, 2000].9 Without improvements in these respects, even sizable inward investment flows might end up making modest contributions to the performance of the Korean economy, including to its advance into the knowledge-based industries and activities. 6.32 The Government of Korea should complement its extensive liberalization of foreign business activity with measures that can strengthen the incentives of foreign firns to transfer 9 The impact is the strongest in activities such as drugs, chemicals, machinery and equipment and electrical equipment. However, it appears that foreign investors perceive the intellectual property rights regime as an important indication of the real attitude of the host country regime towards foreign investors, which is important for their general willingness to make long-term commitments of the sort that is required for, e.g., setting up of local R&D facilities. - 117- technologies and skills. This agenda includes the implementation of corporate governance reform, the strengthening of national innovation systems and intellectual property rights protection, and the upgrading of human capital and measures to enhance its mobility, including the dismantling the barriers to mobility between foreign and domestic firms. Improving the level of English-language knowledge and skills, already discussed in Chapter 3, would enable Koreans to work in FDI firms and gain higher positions in foreign-owned entities, and would enhance the learning effects to be gained from serving in such positions. In addition, the following measures should be considered: * Improved inforrnation to potential or actual foreign investors about the risks and opportunities associated with ventures in Korea ("invest-in-Korea-services"), and particularly with respect to opportunities in knowledge-intensive areas. * Measures to catalyze a more effective domestic market for business services. * Strengthened co-operation between domestic and foreign firms in research and development through the expansion of foreign participation in government-supported R&D projects. * Examination of how other economies, including Ireland, Singapore and Chinese Taipei, have spurred foreign firms to develop backward linkages in order to strengthen the technological capability and competitiveness of domestic suppliers. E. Promotion of High Value-added Services 6.33 Services represent a rapidly growing share of knowledge-based activities, although this development has taken place at a slower rate Korea than in most other OECD countries (Chapter 1). As regards knowledge-based services,'0 a review indicates that their share of business sector value added amounted to some 30.6% in 1996, compared to an OECD average of 41% [OECD, 1999d]. Communications services (at 2.4%) were comparable to the OECD average, while financial, insurance and business services (at 19.5%) trailed many other OECD countries by 5 to 10 percentage points. The last years have seen a certain catching up, as there has been high overall growth in knowledge-based services in Korea, averaging 10.6% during 1987-96 compared to 3.2% for the OECD area as a whole. 6.34 The knowledge-based economy is highly dependent on a competitive services sector. The more interlinked the provision of goods and services, the more sophisticated the products and the greater the capacity to satisfy increasing consumer demand. Furthernore, as incomes rise, the demand for services tends to increase faster than the demand for goods. The production of services is less standardized and less capital-intensive (but typically not less knowledge- intensive) than the production of goods. Meanwhile, technical progress, in particular in ICTs, partly by facilitating storage and trade, is exerting a major impact on the functioning and organization of many services. "Knowledge-based services" now account for a larger and more rapidly growing share of the economy than "knowledge-based manufacturing" in practically all OECD countries [OECD, 2000b]. 6.35 Another set of factors influencing the role of services relates to industrial organization. In many OECD countries, there has been a pronounced shift in the way that businesses organize to For analytical purposes, knowledge-based services are defined to include communications services, finance, insurance and other business services, and community, social and personal services. -118- service-related functions. To a growing extent, manufacturing firms tend to outsource what they perceive as their non-core functions - thereby fuelling an apparent growth in the services sector. The trend towards greater outsourcing is typically driven by: * Competence. The increasing sophistication of information, financial, computer, research, and training needs by business, and the rapid evolution of new techniques and products in these fields has made it difficult for firms to maintain competitive competence in these areas. To do so would require the accumulation and maintenance of a knowledge base in diverse disciplines which, in most instances, firms would be hard-pressed to justify. * Cost and efficiency. Firms specializing in support functions are often able to provide their services at lower cost, while offering a wider choice of innovative products, reflecting the positive effects of competition (in-house services were likely to be shielded from such competition, a condition which lowered the need to maximize efficiency and to innovate). * Specialization. The trend in industry in recent years has been towards consolidation and concentration on core competencies, providing increased opportunities for independent suppliers of goods and services. 6.36 Outsourcing by large and small firmns alike is set to grow in Korea in tandem with the emergence of innovative, knowledge-based service providers. However, in Korea and, to a lesser extent, Japan, this trend has so far been weaker than in most other OECD countries; companies have preferred to retain control of many service-related functions in-house. The obstacles to outsourcing in Korea include the emphasis on vertical hierarchical structures, and barriers to the mobility of workers. In addition, as noted in Chapter 2, a number of regulations continue to constrain the service sector's ability to innovate, adjust and grow. There is no panacea for stimulating greater competitiveness and higher growth in business services. However, several areas require reform: * Continued removal of regulatory barriers to market entry and exit. • Initiating creation and expansion of new service markets by promoting outsourcing of services in the public sector. - Reforming financial support to innovation and government-supported research programs to make them more applicable to the services sector. Current incentives are primarily geared to the needs and opportunities of manufacturing operations. * Reviewing education and training policies to support the development of the human resource skills needed to support knowledge-based industries, most of which are service-oriented. * Exploring ways to adapt intellectual property rights to more effectively meet the needs of services industries. * Improving data on services industries; this will benefit services providers, users and investors alike, while providing the basic information required by governments to fornulate policy. * Continuing work in the WTO-GATS framework to identify effective strategies for liberalizing trade in services on a multilateral basis. * Fostering a better functioning market for knowledge-based consultancy services, without resorting to public consultancy services as these can impede the development of private consultancy services. * Improving conditions for investment in intangible assets (see below). - 119- F. Promoting Investment in Intangible Assets 6.37 Traditionally, the private sector and the government have focused their attention on investment in physical assets, such as machinery and equipment. In the knowledge economy, however, the source of value has shifted from physical content to knowledge content. The development of knowledge-based activities is critically dependent on conditions conducive to investment in so-called intangible assets (e.g. innovations, worker skills, patents, brand names). The weak state of services in Korea, for instance, is related to a bias in favor of investment in plant and equipment relative to investment in intangible assets. 6.38 Today, corporate investment in intangible assets is growing faster than tangible investment throughout the OECD. Investment in knowledge (defined as R&D, software, public spending on education) now represents an estimated 8% of OECD-wide GDP, a figure similar to investment in physical equipment. Investment in intangibles ranges from between 9-10% of GDP in Nordic countries and France to 6-7 % in Italy and Japan." The OECD average exceeds 10% when private spending on education and training is included [OECD, 1999a]. Yet, this is only a partial picture. For a list of possible components of investment in intangible assets, see Box 6.2. Box 6.2: Components of Investment in Intangible Assets 1. Computer-related * Software * Large database * Other computer service 2. Production and technology * R&D * Design and engineering * New quality control systems * Patents & licenses * Know-how 3. Human resources * Organized training * Learning by doing * Activities which improve the health and motivation of the workforce (including labor relations, physical check- ups, and other sport and fitness programs) 4. Organization of the firm * New methods of organization of the firm as a whole * Establishment of networks * New working methods 5. External: marketing and sales * Market research * Advertising * Brands * Firm name and logo * Lists of customers, subscribers and potential customers * Product certification, quality certificates 6. Industry-specific * Quotas (which may not be traded and thus lack a market price), e.g. in mineral exploration * Entertainment, literary and artistic originals Source: OECD ' Korea is not included in this ranking, due to lack of comparable data. - 120 - 6.39 Problems arise partly because investments in intangibles tend to assume characteristics of public goods, making it difficult for private investors to capture the full benefits of their investments and leading to under-investment. Such market failure arguments have long been the rationale for government intervention in areas such as science, research, education and training. In addition, the inability of enterprises to effectively report to capital markets on the extent, importance and utilization of intangible assets reduces their incentives to improve internal management systems [OECD, 1998]. 6.40 Venture capital is important for enabling investment in intangible assets, especially in new, explorative firms and industries. Risk-taking is a key element in venture capital, and excessive government guarantees regarding the financing of intangibles can counteract the innovativeness that it aims to encourage. The problems with measuring and disclosing intangible assets are particularly severe in a debt-oriented economic system such as Korea, since intangibles cannot generally be taken as collateral for bank loans. This is especially troublesome for new firms without a track record, and in services where tangible assets tend to be limited. The prevailing situation in Korea in this regard may appear paradoxical, since some new enterprises within these categories recently have found themselves drowning in equity funding. However, where systematic information on intangible assets is difficult to come by, it is particularly difficult for the market to evaluate which new firms are viable and which are not. 12 Although a similar situation is observable in other OECD countries, there are special complications in Korea. These are partly rooted in "cultural factors", such as the lack of preparedness to adopt new ideas. They are also a result of the weak Korean tradition in providing information about business operations, which has brought about a habit of reliance on inadequate information in investment decisions, providing little shelter from overly high expectations in new growth areas. Whereas any excesses in that respect should be expected to correct themselves sooner or later - although inevitably resulting in painful lessons and unwanted distribution effects - the current situation should lead to a strengthening of the demand for better transparency in business operations. 6.41 For the majority of companies which have been unable to turn limitations in information management into an advantage, the prevailing situation is hampering service sector development and entry by newcomers. In response, the government has developed a system of valuing technology assets for the purpose of strengthening access to finance particularly for new entrepreneurs. A financing institution has been set up to provide technology warrants or guarantees for banks that use these warrants as collateral for loans. Loan conditions have been eased for SMEs with weak credit ratings and little collateral, with credit guarantees for SMEs which are unable to provide collateral. It is not only start-up and survival that matters, however. The effectiveness of public funding for high-technology start-ups needs to be better assessed and benchmarked against other countries. 6.42 There is also a need for other initiatives to increase the understanding of intangible assets. Most important among these is to promote initiatives by firms themselves. While individual firms in several OECD countries have recently taken steps to improve their measurement and 12 On March lth , 2000, for instance, the Wall Street Journal reported how mere advertising on the Internet enabled unexperienced Korean entrepreneurs to attract millions of dollars. On April 3rd, Maeil Business News reported that 27 KOSDAQ companies were temporarily suspended for failing to meet trading rules. - 121 - reporting of intangibles, this tends to be anecdotal and is performed in a way that allows for little systematic comparison and analysis. The challenge for the Korean Government is to stimulate the adoption of comparable and relevant practices without stifling creativity and differentiation in reporting -crucial because of the inherently idiosyncratic nature of intangible assets. 6.43 The valuation of intangible assets is influenced by attitudes. The government can exert a certain influence in this respect as well. The following are a few concrete initiatives that may be considered for building a more hospitable policy set-up for investment in intangibles in Korea: * Publicizing and broadly disseminating cases of successful development of intangible assets by Korean citizens and companies, such as the patenting in the semi-conductor area; the successful development of Korean software, such as the Hangol word-processing, and Korean game software; and cultural and literary achievements. * Broadening the support for innovative efforts away from traditional R&D support. * Examining options for introducing tax incentives to stimulate training (e.g. exempting profit tax on profits used for paying for personnel training). * Reviewing and correcting government policy bias in favor of physical investment. * Promoting research and evaluation to document successful cases (best practice) of foreign- Korean co-operation, and developing the means to diffuse such information effectively. - Improving enforcement of intellectual property rights protection. G. Conclusion 6.44 The dominance of the chaebol, the weaknesses of the SME sector, barriers to contributions by foreign investors, the weaknesses in knowledge-base services, and inadequate conditions for investment in intangible assets combine to weaken the mechanisms for the development of knowledge-based activities and industries in Korea. This chapter has emphasized that the Korean Government should continue to press for efficient resource allocation and higher profitability in the chaebol, but should do so primarily through the financial channel and through corporate governance reform. Meanwhile, competition policy should be clearly separated from structural, or interventionist, policy. Conditions for start-up and growth of SMEs should be improved through a consolidation of existing support programs backed by more critical evaluations and an increased emphasis on the diffusion of technology and the upgrading of workforce skills. Furthermore, the government should follow-up on the liberalization of inward FDI with measures that can induce foreign firms to transfer more skills and technologies to Korea, including improved intellectual property rights and the removal of barriers to labor mobility. It should dismount the remaining barriers to service-sector development, e.g. through continued regulatory reform, and develop a comprehensive strategy for improving the conditions for investment in intangible assets. - 122 - Annex 6.1: Most Important Bottlenecks in Production and Technological Improvement (Ranked from 1=no problem, 5=major problem) Average Standard No. of Deviation responses a. Lack of high quality local suppliers 2.96 1.22 809 b. Lack of machinery and equipment supplier 2.66 1.12 807 and service companies c. Infrastructure service (water, electricity, 12.18 1.03 804 telecommunications, transportation) d. Quality and supply of technicians and high- 3.23 Il.15 821 skilled personnel e. Quality and supply of production workers 3.09 1.11 817 f Labor costs 3.29 1.07 822 g. Minimum wage laws 2.28 1.06 805 h. Restrictions on hiring or firing of workers 2.56 12 805 I. Labor unrest/strikes 2.24 1.22 806 l j. Access to finance for working capital 3.37 1.26 829 |k. High interest rates make loans too costly 3.84 11.19 828 1. Customs administration 3.09 1.21 792 m. Red tape/bureaucracy x3. * .I5 81 n. Corruption 3.58 l l15 818 o. Protection of intellectual property rights 3.09 1.26 799 p. Import tariffs and quotas on inputs, raw material and 2.69 _ I _ 792 equipment q. System of import duty exemption/reduction 2.88 1.19 788 Source: World Bank Supported Survey of Korean Enterprises. Note: The survey was distributed to 2 500 enterprises, of which 863 responded. It was initiated in November 1998 and completed in February 1999. SMEs (20-300 employees) made up approximately 85% of the sample; about 13% were firms with more than 10% foreign ownership. The differences in the average scores between the large and small sub-segments was not very significant - except for corruption which was a bigger problem for SMEs. - 123 - REFERENCES KIET (Korean Institute for Industrial Economics and Trade), "Profile of Korean Industry," Seoul, 1999. Korean Small and Medium Business Administration (KSMBA), "Small and Medium Business Administration," 1999. Edwin Mansfield, "Intellectual Property Protection, Foreign Direct Investment, and Technology Transfer," International Finance Corporation, Discussion Paper 19, 1994. Joon Kyung Park, "Creating Extra firm Infrastructure of Institutions for small and medium sized businesses," Korea's Choices in Emerging Global Competition and Cooperation, KDI, 1998, Ed. by Lee Jay Cho and Yoon Hyung Kim. Keith E. Maskus, and Guifang Yang, "Intellectual Property Rights, Foreign Direct Investment and Competition Issues in Developing Countries," International Journal of Technology Management, Vol. 19. Nos. 1/2, pp. 22-35, 2000. OECD, 1997: "Small Business, Job Creation and Growth" OECD, Paris. OECD, 1998: "Technology, Productivity, Job Creation - Best Policy Practices," Paris. OECD, 1999a: "OECD Science, Technology and Industry Scoreboard -- 1999: Benchmarking Knowledge-based Industries," Paris. OECD, 1999b: "Asia and the Global Crisis: The Industrial Dimension," Paris. OECD, 1999c: "OECD Economic Surveys 1999: Korea," Paris. OECD, 1999d: "Strategic Business Services," Paris. OECD, 2000a: "OECD Economic Surveys: Korea," Paris (forthcoming). OECD, 2000b: "Realising the Potential of the Service Economy: Facilitating Growth, Innovation and Competition," Paris (forthcoming). OECD, 2000c: "SME Policy Outlook," Paris (forthcoming). OECD, 2000d: "Knowledge-based industries in Asia: Present Development and Policy Issues," Paris (forthcoming). OECD, 2000e: "Regulatory Reform in Korea, OECD Reviews of Regulatory Reform", Paris. Schmitz, Hubert, and Khalid Nadvi, "Clustering and Industrialisation: Introduction," World Development, 1999, 27(9): 1503-1514. - 124 - SIM, S-T, "Number of start-up companies expected to surpass 30,000 in 1999," Korean Herald. December 15, 1999. United Nations Conference on Trade and Development (UJNCTAD), "World Investment Report," 1998, Geneva. United Nations Industrial Development Organisation (UNIDO), "Principles of Promoting Clusters and Networks of Small and Medium Enterprises," 1995a. http://www.unido.org/doc/Publications.htmls. United Nations Industrial Development Organisation (UNIDO), "Industrial Clusters and Networks: Case Studies of SME Growth and Innovation," 1995b. http://www.unido.org/doc/Publications.htmls. United Nations Industrial Development Organisation (UNIDO), "SME Cluster and Network Development in Developing Countries," 1999. http://www.unido.org/doc/Publications.htmls. Woo, Cheonsik, "Inbound FDI and Industrial Upgrading of Korea: Prospect and Challenges," Korea Development Institute, 1999, Seoul. - 125 - CHAPTER VII: IMPLEMENTING KOREA'S STRATEGY FOR A KNOWLEDGE-BASED ECONOMY A. Introduction 7.1 Since early 1999, the Government has been developing its vision for making Korea an advanced knowledge-based economy, as announced by President Kim in January 2000. The Ministry of Finance and Economy (MOFE), in conjunction with thirteen think tanks led by KDI, prepared a series of background papers, which were discussed at a public hearing in October 1999. This was followed by further work on the overall strategy, and presented to the subsequently created National Economic Advisory Council (NEAC) and the President. 7.2 In January 2000, following the Presidential announcement, the NEAC unveiled a three- year master plan focusing on five key themes: i) developing the national information infrastructure; ii) improving the national science and technology innovation capabilities; iii) developing new knowledge industries and digitizing older industries; iv) developing the human resource system to respond to the knowledge-based economy; and v) addressing the "digital and knowledge divide". In the first quarter of 2000, five task forces (of 14-18 members each) from the responsible ministries, agencies, and research institutes were created around these broad strategies and began preparing detailed action plans for each of these themes. Another public hearing was held in April 2000 on the draft Action Plan. The details were then approved by the Cabinet and put into effect in May 2000.1 7.3 The Economic Policy Coordinating Committee (EPCC) in the Prime Minister's Office is expected to be made responsible for the overall implementation of the Action Plan, including the co-ordination of policies and measures and the updating of procedures. Implementation is expected to be carried out through the same type of multi-agency framework as is found in other countries, by all the respective agencies participating in the task forces. In early May 2000, a co-ordinating Task Force was established, made up of MOFE and the Ministry of Planning and Budget (MPB), some civilian experts, and the heads of the five above-mentioned task forces. The Director General of MOFE's Economic Policy Bureau was designated as the head for the co-ordination of the task force, and will be responsible for all practical matters.2 7.4 These are important steps. We elaborate below on two issues which in our view will strongly influence to what extent this action plan can be implemented successfully. The first relates to the process of consultation in Korea which, given the social and political changes taking place, needs to be broadened and deepened. The wider consultations with society which take place in many other OECD countries are not yet the norm in Korea's mode of govemment. ' See KIET, "Theory and Practice of the Knowledge Based Economy," 2000. 2 See Cheonsik Woo, "Road To KBE: Case of Korea", Background Note, paper presented at "International Brainstorming on the K-Economy," organized by ISIS Malaysia, May 27-28, 2000, Kuala Lumpur. - 126 - The second issue concerns the practical workings of the implementation plan, which need to be further refined. B. Broadening and Deepening the Consultations Overcoming resistance and changing mind-sets 7.5 The very nature of the knowledge-based economy and societies implies distributed power, with knowledge and technologies empowering the student, worker, researcher, government employee and communities. It is therefore important that the agenda for reform is also owned by the private sector and civil society to ensure that they not only understand the key trends and forces affecting them and therefore the need for change; but also what the implementation of that agenda will require of individuals, firms, organizations and the government. In this regard, the chosen implementation strategy should fit closely the country's institutional realities. This will involve policy reforms, government initiatives, institutional reorganization, and actions by firms and social groups. 7.6 Some elements of the reform package can be implemented by modifying regulations or procedures. Others may require changes in legislation (e.g. regulatory framework for telecoms). Such legislative reforms would require lobbying in order to convince legislators of the need for such reforms. There may also be resistance to many of the proposed changes, some of which may come from interest groups who stand to lose power or authority as a result of the changes; or it may stem from a misunderstanding of the rationale for change. Other forms of opposition may be based in tradition or the beliefs (e.g. that the educational system should be supply- oriented or that knowledge is a free good). 7.7 Developing and effectively implementing the strategy will entail challenges in the short, medium and long terms; and these should not be underestimated. Based on the experience of other countries that have crafted and implemented such broad strategies (Ireland, Finland, and Canada), we emphasize that the development of the strategy must be undertaken in consultation with the private sector and civil society.3 This is particularly relevant to Korea given the current social and political change that is taking place and in light of the country's vision for the 21st century. The public hearings4 and consultations that have taken place with a number of think tanks and private sector bodies on national policies and reforms, are an encouraging sign. However, building consensus and getting stakeholders to "buy" the proposed measures will require greater efforts in termns of dissemination, explanation, and consultation with a wider range of experts and other actors in society. This will require highlighting the broader societal and public interest aspects of the proposed changes as being necessary to help Korea continue to improve the income and welfare of its citizens in an increasingly complex and competitive 3Although the three countries are all implementing knowledge-based plans, they are not as comprehensive as that proposed in this report by us or that proposed by the Korean authorities. The core of the plan in these three countries has focused primarily on the national information infrastructure pillar. However, they are expanding their focus to include R&D, innovation and education. 4 In the case of the knowledge-based development strategy, the Korean authorities have held two public hearing sessions, one in October 1999 and the other in March 2000. - 127 - world, where more effective use of knowledge is critical to enable it to remain competitive as well as to deal with the constant restructuring caused by increasingly rapid advances in knowledge. 7.8 In addtion to stakeholder involvement, a key element in any reform is opening up established attitudes to critical reflection. This can only be accomplished through dialogue and persuasion. As the Irish and Finnish experiences have shown, it is not possible to steer the development of the knowledge-based economy in a centralized manner. Some examples of attitudes requiring re-examination include: the fear of taking entrepreneurial risk, the preference for university vs. business jobs among the highly qualified, the low self esteem of vocational degree holders, etc. Some of these attitudes might change slowly through the impact of a greater openness to market forces but a conscious effort to promote change can be made through wider dissemination of information (e.g. on returns to different types of jobs) and in collaboration with the media. Again, as Finland has demonstrated (see Box 7.1) a broader consultation of sectoral interests (education, science and technology, ICT access, women, labor, etc.) can go a long way in ensuring an enduring vision and plan of action. Box 7.1: Finland's Broad Consultations Broad consultations were conducted by Finland's Steering Group for Strategy Updating (SGSU) with the National Council for Information Society (NCIS) and the Information Society Forum (ISF). Relevant institutions were invited to take part in the discussions, background reports produced, experts interviewed, several brainstorming events and seminars held, relevant ideas received through 5 000 e-mails, and the first draft proposal was circulated to 150 experts for commnents and feedback. The project had a full-time secretariat, with a project manager. All these inputs were used by the Steering Group in formulating Finland's implementation strategy. Consultation in Korea's educational reforms: someproposals 7.9 To illustrate the consultation process, we use the example of reforms in the education sector, and human resource management more broadly. Many of the proposed changes have been formulated by Korean think tanks and concerned groups. However, much of the resistance to reform is likely to come from the education agencies and from teachers, as both groups stand to lose some power and control. An important task is therefore to convince them of the benefits of the proposed reforms. Likewise, without the active support of teachers, it will not be possible to implement the move to a student-centered education system. Therefore, it will be essential to raise awareness and invest in retraining teachers as part of the reform process. 7.10 Complex process. At the same time, the education reform process is complex and will take time; there is no instant solution guaranteeing quick results. And policies alone are not sufficient for change, what counts is their implementation. Global experience and research in education reform show that factors such as a shared vision, clear goals, strong leadership, broad consensus building, the ability to make adjustments throughout the process, measurable indicators, and the availability of a support infrastructure are critical to ensuring that the reforms are implemented and achieve the desired results. In short, the systemic reform in education - 128- required in Korea will be a long-term process. The challenge is how to maintain the good practices within the existing system, such as relatively high average quality and low dispersion of student performance, while trying to reform and create a new system that will serve the country's human resource needs in the new global economy. 7.11 Lessons from earlier reforms. Korea has been engaged in a series of education reforms since the early 1990s. Lessons from these reformns suggest that the current reforn process requires substantial adjustment. The complexity of the agenda and the need for support, co- ordination, and integration of such reforms in Korean society at large, will require that the government build up greater public awareness of what is at stake. It may also be necessary to reconfigure some of the government ministries, for example, labor, education, and science and technology, that are involved in education and training. The Korean Government should adopt a more integrated approach to reform in education and human resource management, and appoint a unified national governing body to be responsible for these reforms and their implementation. This body should comprise representatives from the key, relevant stakeholder groups, and should not be perceived as being controlled or steered by the government. As a start, it should review the PCER-proposed reform programs and their implementation in the light of a clearly articulated conceptual framework involving education, human development, the changes in the global economy, and the requirements of the knowledge-based economy. Special attention should be paid to the vision, goals, appropriate timeframe, and content of the reform, as well as to the lessons learned, in order to make the necessary policy adjustments.5 7.12 Negotiations with stakeholders. Based on the outcome of such a review, a process of negotiation with key stakeholders-from industry, local government, teacher's unions, school administration associations, parents, and representatives from civil society-on reform-related matters should take place in order to share the new vision and build the necessary consensus on the reforms. In particular, parties opposed to the reform should be included in this process. Constructive inputs from all involved stakeholders should be taken into account in policy adjustments to make the reform policies more legitimate and ensure broad ownership. This is not an easy process. However, experiences from reforms around the world (from the Netherlands, New Zealand, Australia, and Singapore) indicate that managing this process will be critical in determining the ultimate success of the reform of the Korean system for education and human resource management. 7.13 Awareness campaigns. Once consensus has been built, the government should launch a well-designed and massive campaign to build public awareness on the need for such a profound education reform for the future development of Korea; what needs to be changed, how the proposed changes will take place, who will be involved, and what are the expected outcomes. Such a campaign will require more than simply publishing brochures, posters, and advertisements on TV or on other media. The campaign should aim to "sell" the reforms to the 5 The establishment of a higher education council could be considered as a means of providing guidance on how to adapt the colleges and universities to world-class levels. Such a council would be made up of all the important stakeholders in the education system-parents, the private sector, education specialists, professors, and government-to set guidelines and monitoring and evaluation procedures for the allocation and effective use of public resources. A separate review board can also be set up to examine quality and accGuntability issues, and to promote more transparent and timely information on the performance of graduates from different types of public and private education facilities. - 129 - public. The communication strategy for the recent public campaign for the large-scale reform initiative of the National Literacy and Numeracy Strategy in the United Kingdom provides a good example in this regard.6 7.14 Lifelong Learning. To fully achieve the goal of the education reform, the scope should cover not only the formal education sector but also lifelong leaming. Importance of lifelong learning should be emphasized because of the need to address the learning needs of individuals throughout their life time and to complement the weaknesses of formal education. Lifelong learning involves both formal and informal learning. The importance of informal learning, especially at the enterprise level, is on the rise. New forms of learning are becoming available, such as through the Intemet, increased use of TV based instructions, distance learning, virtual universities etc. These trends will only intensify in knowledge-based economies. Therefore, an integration of the current fornal, vocational, adult, and distance education systems with instruments such as the Education Credit Bank system should be undertaken.7 7.15 To open Korean education to the world, an intemnational expert panel should be created to bnrng in knowledge on global best practice and reform experiences, and to provide objective and comparative studies to Korean educators and policy makers. Internally, the curriculum on English teaching and learning should be strengthened and exchange programs with international education institutions should be expanded. In addition, women's education in scientific and technical areas, as well as in overall economic activity should be fostered. These, plus the necessary resources, will provide a sound infrastructure for the reform effort. With this foundation and overarching framework in place, educational institutions will be able to reconfigure and re-structure themselves within the appropriate regulatory framework to make the relevant changes in crucial matters such as the curriculum, teaching practice, instruction matenals, and administration, with appropriate incentives and the involvement of teachers, parents, students, and the community at large. C. Working Out the Implementation Details 7.16 Implementing major reforms and actions that are interlinked as proposed in this report requires defining specific roles and responsibilities, co-ordinating implementation efforts, and setting monitorable goals through action plans.8 We have already noted the rapid progress made 6George Cole: "Great Leap Forward", Times Education Supplement, October 15, 1999. 7Increasingly, policy issues for lifelong learning go beyond the traditional confines of education ministries and involve others, including the Ministry of Labor and the Ministry of Information and Communications. In some areas, such as the Internet, it is not even clear where the major responsibility lies So, it is imperative that policy development is done in consultation with the relevant agencies in government and between the government and segments of the private sector and civil society that have a direct bearing on the sectoral strategies being formulated. s We say this based on our experiences in other countries. This is supported by a recent survey of 200 key opinion makers in government, the private sector, and civil society in the Republic of Korea. The survey examined the Korea's preparedness for the knowledge-based economy. The main recommendation of the survey, and one that we fully endorse, is that it is not useful to discuss a plan for making the Republic of Korea into a knowledge based society without a specific implementation plan. Such a plan must include not only what will be implemented, but how and why it will be implemented and by whom. It should also include how the degree of success of the implementation will be measured and evaluated (Survey by Maeil Business Newspaper, September 1999). In a number of countries many good plans and programs were wasted for they were not well implemented. The - 130 - to implement the Action Plan. However, three critical remaining questions need to be addressed in order to facilitate successful implementation: i) Who will coordinate, and participate in, the implementation of the plan? ii) How to allocate needed resources? iii) How to monitor, evaluate and adjust the plan? 1) Who will coordinate the strategy? 7.17 In the case of govemment initiatives, it is natural that government agencies be called upon to implement and co-ordinate activities using existing mechanisms within each ministry or through Councils (e.g. National Science and Technology Council), and the Ministry of Planning and Budget on the allocation of resources. For the private and voluntary sectors, the issue would be: which organization or organizations can best represent developments in their respective sectors? 7.18 An important issue here is the role of government and that of other actors. While the government has a critical leadership role in the implementation of the strategy, it needs the participation of other actors. Finland, Ireland and Canada used the shared responsibility principle as an overarching theme in their strategies. Co-operation between sectors and administrative fields and within the international context was highlighted. Public sector, industry and other organizations were invited to initiate, participate in the decision making and commit themselves to promoting the defined objectives. The stated principles should also be applied to decision making concerning the allocation of resources, reflected in the strategies and decisions in the different sectors and parties, in the ongoing projects and in the preparation of "spearhead" or "flagship" projects.9 In addition, these strategies should focus on promoting the functioning of markets where possible through de-regulation and competition, while building up modern regulatory oversight. 2) How to allocate the needed resources? 7.19 Implementation of the strategies should also focus on whether the infrastructure to implement reforrns and measures are in place, especially in terms of staff and resources. In the Irish case, resources needed to ensure successful implementation was assessed by concerned departments and agencies in consultation with the Prime Ministers Department, Ministry of Finance and the Implementation Group in accordance with normal financial planningl' (see Box 7.2). 7.20 Co-ordination of efforts is equally fundamental as there are many overlapping initiatives taken by related agencies in Korea that address a particular objective (e.g. developing science opportunity cost of the failure of good implementation would be extremely high for the Republic of Korea given the mounting pressures for shifting to higher productivity driven growth. 9 In Finland and Ireland and other developed countries have recently also embarked on "flagship" or "spearhead" projects. These are considered to have large spillover effects for the acquisition, creation, dissemination or use of knowledge by society. 10 See "Progress Implementing the Information Society: Second Report of the Inter-Departrnental Implementation Group," July 1999, Ireland. - 131 - and technology, digital divide, development of venture firms, SME development)."1 The Finnish strategy explicitly aims to overcome overlapping mandates, promote synergy among projects with the aim of reducing costs. It has created development networks between existing and new projects in order to enhance knowledge and information transfer and for the congruence of services being developed to meet the desired needs, and to evaluate measures against the broader goals of the country's vision.12 7.21 Another fundamental issue for the successful implementation of overall development strategy of knowledge based economy is to secure enough financial resources and to allocate them efficiently among the various elements of the strategy. Some elements of the strategy will require reallocating investments or changing approaches rather than higher expenditures. Others, however, will. Any additional expenditures must be decided upon within the overall taxation and expenditure regime, including the effects on incentives, efficiency, equity and with consideration to macroeconomic stability. Box 7.2: Implementing and Financing: The Irish case In the case of Ireland, at the time of the adoption of the Action Plan in January 1999, the Interdepartmental Implementation Group was directed by the Irish Government to access the resources needed to implement the plan. This was the primary focus of the group for the first few months. In its first review in July 1999, the Group concluded that substantial additional staff and funding needed to be made available if rapid progress was to be made and the objectives of the Action Plan met. The resources needed to implement the Plan are very substantial and most cases an intense period of up to three years is envisaged. An evaluation team was established as a fast-track mechanism to approve projects for funding. The policy development team was established to co-ordinate the implementation of the Action Plan. The department of finance approved a staffing envelope to facilitate the implementation of projects. A high-level cross departmental implementation Group was set up to co- ordinate and drive the process with a set of guidelines during project preparation and project approval and implementation. 7.22 For the efficient allocation of financial resources, adjustments should be made in the budget process.'3 Recently, new actions has been introduced to increase the efficiency of " There are many measures aimed at the development of SMEs, high-tech start-ups, new venture firms, etc. administered by various agencies (MOCIE, MOST, MOIC, Ministry of Culture and Tourism, etc.). In place of the current focus on providing financial and other support through institutions, targeting specific services relevant to the needs of the various enterprises might be warranted. Despite the measures, the bulk of the SMEs are generally weak in terms of their technological competitiveness (see Chapter 6). 12 See SITRA, " Quality of Life, Knowledge and Competitiveness: Premises and Objectives for Strategic Development of the Finnish Information Society", Helsinki, 1998. The Spearhead Network Service disseminates information and transfers knowledge and expertise among the spearhead projects. At the same time, this Internet service also serves those interested in the development of the Finnish information society by providing them with information about the progress of the Spearhead Projects. 13 For the year 2000 budget, major plans are: to increase R&D investment from 3.7% of the national budget in 1999, to 4.1% in 2000, to 5% by 2002. The plan for R&D in 2000 is to spend KRW 200 billion under Brain Korea 21 to promote graduate level research. Other plans also include increasing access nodes to the High Speed Telecommunications Network from the current 107 to 144; increasing spending for information technology in the government from KRW 537 billion to KRW 671 billion; tuition support for kindergarten and secondary education pupils to cover 230 000 and 400 000 pupils respectively; college tuition loans to cover 300 000 students; KRW 50 billion to be allocated annually to the Cultural Industry Promotion Fund; spending to foster SME sector to be - 132 - government expenditure; the medium-term fiscal plan, preliminary appraisal system for the major social overhead capital (SOC) projects, attraction of private funds for the SOC investments etc. There should be continuous monitoring and feedback in the implementation process. For example, the multi-year approach adopted by the Korean Ministry of Planning and Budget (MPB) serves as a step towards facilitating the necessary monitoring and adjustment in a co- ordinated and participatory manner (see Box 7.3). Box 7.3: Korea's Medium-Term Fiscal Plan In order to overcome the limitation of annual budgeting, Korea's Ministry of Planning and Budget adopted a multi- annual budgeting process in 1998. This is the medium-term fiscal plan, which lays out the indicative targets for fiscal investment, sources of revenue, budget balance, etc. The plan is revised annually and adjusted to accommodate the rapidly changing environment. In the planning process, the MPB assesses competing budget demands among agencies and projects by evaluating the effectiveness of long-term programs, policies and procedures, which entails in improving efficiency and flexibility of an annual fiscal policy. The plan also has contributed to enhancing the soundness of Korean public finance through managing the co-ordination of national policies requiring a large government expenditure. Ministry of Planning and Budget, 1999. 3) How to mfonitor, evaluate, and adjust the plan? 7.23 Because of the dynamism of the knowledge and information revolution and changes in the global economy, it is important to set up a monitoring and evaluation system for each of the broad policy goals and strategies in the functional areas, and to create procedures for adjusting plans and actions according to the findings of the impact evaluations. In some cases, the broad goals might have to be refined, in others, policies and policy instruments might need adjustment. Yet in others, better use of resources or co-ordination efforts might be required. 7.24 Who will do the monitoring and evaluation? Monitoring and review is expected to be carried out by the EPCC, NEAC, National Science and Technology Committee, Infornatization Promotion Committee, and Informatization Strategy Committee. The five task forces are expected to support the workings of the EPCC in the implementation phase. It will be important to consider how to incorporate the views of key stakeholders, including the private sector and civil society. 7.25 Evaluation will be needed at the project, intermediate and the broader macro level. There is a need to obtain the industry perspective of specific sectors and the regional perspective. It is essential for evaluations to go beyond narrow efficiency aspects to address economic impacts, and to do so at a level which enables economy-wide outcomes and linkages between measures in increased by 16% to KRW 2 294 billion; funds totaling KRW 120 billion to be earmarked for supporting regional clusters, e.g shoe manufacturing in Pusan. (Source: The Budget of the Republic of Korea: Fiscal Year 2000, December 1999). The rationale for these specific goals should be discussed and made explicit; and evaluations should be made of the outcomes, impacts and progress in attaining these goals so that they can be adjusted and maximum impact obtained at least cost. - 133 - different areas to be addressed (i.e. avoiding a piecemeal approach)'4. It is important to evaluate productivity- and innovation-based competition, transformation of SMEs into knowledge-based entities in addition to measunrng numbers of start-ups, evaluation of "flagship projects" (e.g. e- government, the NII). Program evaluation should cast light on the types of activities that are more or less successful and how programs can be better designed and managed. Also necessary would be the evaluation of education reforms and the digital divide. It would be useful for the MPB to be included in monitoring and for a program audit and evaluation to be conducted. In this regard, use of external experts would bring best practices found elsewhere into Korean practice. 7.26 What will constitute the monitoring indicators? How will the relevant statistics be obtained? This implies that the National Statistical Office should be included to organize data specific to the Knowledge Economy initiatives (and later to publish them from a holistic perspective). Other data inputs might also be useful, such as project and program surveys and assessments e.g. computers in schools, lifelong learning indicators, monitoring of overall goals and comparing them with G7 countries (e.g. in educational standards, performance in science and technology etc). Other indicators might also be necessary, e.g. on the impacts of programs and instruments on the disabled, on the creation of local knowledge communities, etc. The private sector might be able to provide indicators on knowledge management by firms. 7.27 What is involved in continuous adjustment? Given rapid changes and new emerging issues, some anticipation of changes (e.g. technological forecasting; broader foresight studies)'5 and how they will affect the chosen strategy should be undertaken. It will also be important to work out how the findings from the monitoring and evaluation are to be fed back into the implementation plans of the different actors. Again, Finland provides a possible approach in this area (see Box 7.4). Box 7.4: Finland's Rolling Strategy Process in the development of Finland's "information society" is a decision-making process with the support of different actors in society. The process seeks to identify and anticipate opportunities and threats as the country develops its information society. It is based on the belief that it is not possible to steer the development of the information society in a centralized manner given the rapid environmental changes. The strategy process focuses on monitoring changes in the environment and adapting the strategy accordingly. It uses extensive information society statistics and, with the help of a wide range of experts, reviews and revises the priorities. It assesses the social and societal effects of ICT and the need for new procedures and services as an important element of the strategy review process. It also disseminates information concerning the monitoring and the achievement of objectives of programs and projects on a short-term basis and with a more comprehensive annual review. This review is placed in the purview of Sitra, the Finnish National Fund for Research and Development which is expected to report to parliament annually. SITRA, Quality of Life, Knowledge and Competitiveness, 1998. 14 Both Ireland and Finland have also carried out surveys on impacts of the general strategy and specific initiatives. See for instance "Challenges of ICT in Finnish Education, SITRA,1999; "Ireland's Progress as an Information Society", Information Society Commission, October 1999. 1s See the New Zealand's exercise on this which included the following: establishing the context; setting up the strategies; decisions made; and implementation of new strategies. Rick Christie, "Steps towards a Knowledge Economy: The New Zealand Experience", paper presented at " International Brainstorming on the K-Economy organized by ISIS Malaysia", May 27-28, 2000, Kuala Lumpur. - 134 - 7.28 These are preliminary suggestions and should be treated as input to an ongoing process. This report addresses what has been identified as key aspects of a very dynamic system, by two international institutions which have the advantage of a broader perspective of cross-country experiences but not insights into all the specifics of the Korean context. It should thus be interpreted as merely one contribution to a process which has to be locally owned, not only by the Korean Government, but more importantly, by the Korean people. What we have attempted to do is to provide a broad framework against which to lay out the issues that appear to be relevant. Given Korea's own strong capacities, the country must set up its own process, draw on global experience, and adapt it to its specific situation. - 135 - ANNEX 1: Preliminary Assessment of the Knowledge Economy in Korea 1. The World Bank has developed a methodology to compare how economies rank in terms of a set of 200 indicators that serve as proxies for the four areas discussed above. This methodology consists of a set of structural and qualitative variables that serve to benchmark how an economy compares to its neighbors or competitors or to countries it may want to emulate.' It helps to identify where a country may be weak and where, depending on its specific conditions and its development strategy, it may need to focus policy attention or future investments. This is the first step in a process of making a more detailed assessment based on in-depth work, analysis, and interviewing to develop a more coherent national strategy for the more effective use of knowledge for development. 2. As a large set of variables is unwieldy, we have developed a simplified 'knowledge assessment scorecard' which consists of twenty variables that attempt to capture the essence of some of the key parameters of a country's preparedness for the knowledge economy. Each of the variables has been normalized on a scale from 0 to 10, so that the highest value is rated 10 and the lowest is rated 0. The comparison is undertaken for a group of 60 economies which includes most of the developed economies and about 30 developing economies. An economy does not necessarily have to have a score of 10 on all variables. Some reflect performance; others reflect trade-offs, as will be seen below, which characterize different development strategies. Still others reflect particular structural characteristics of an economy. The normalized variables are put on star diagrams which helps to graphically illustrate and facilitate comparisons among countries. The scorecard for Korea is presented in Figure 2.1. 3. As indicators of the overall performance of a country we use two indicators: annual GDP growth 1990-1997, and the human development index 1997. The human development index is a composite measure of three components: longevity (measured by life expectancy); knowledge (adult literacy rate and mean years of schooling); and standard of living (real GDP/capita in purchasing power parity). On these two measures, Korea is ranked relatively close to the top perforrners. 4. For proxies of the economic regime we use two indicators. For an index of the robustness of the financial system and country risk, we use the composite ICRG risk rating. For a measure of the degree of competition we use tariff and non-tariff barriers, which is a composite of the rating on tariff and non-tariff barriers and customs corruption from the Heritage Foundation and the Wall Street Joumal's economic freedom rankings. On both these measures, Korea rates just ' The quantitative variables are based on official statistics compiled by the respective country governments and vetted by international statistical organizations. Most are reported in the World Bank's 1999World Development Indicators. The qualitative indicators come primarily from surveys of businessmen done annually by the IMD and the World Economic Forum, although some also come from specialized organizations such as Transparency International or the Heritage Foundation. The sources for each of the variable on the scorecard are in the annex to this chapter. - 136 - above and at the mid range respectively, suggesting that the country still has a way to go to be among the top ranking countries. 5. For the institutional regime we use four measures. As a proxy for government quality we use the corruption perceptions index, since the government is a key institution in setting the institutional and regulatory regime. On this measure, Korea ranks in the bottom third. For the general legal regime we use compliance with court rulings. Because adequate protection of intellectual property is a critical issue in the incentive regime we also use the businessmen's assessment of intellectual property protection. On both these legal/institutional issues, Korea ranks only in the middle. Finally as a measure of the free exchange of ideas we use press freedom, where it ranks roughly at 75%. Taken together these measures also suggest that Korea still has a ways to go on the institutional side. Chapter 2 will undertake a broader and more detailed analysis of some of the critical issues that need to be addressed in this area. 6. For education and human resources we use three variables. The literacy rate gives a very broad stock measure. Secondary and tertiary enrollment rates give us a flow rate. On literacy Korea ranks very near the top, and on the enrollment rates it ranks in the top 20%. These measures reflect the very impressive gains the country has made in educational attainrment. However, on the third variable, which is on a qualitative ranking on the flexibility of people Korean ranks in the bottom third. This foreshadows a point which will be developed further in Chapter 3, that despite the very high educational attainment, there is significant concern among the business community about the quality of education and the creativity of Korean students. 7. For the innovation system we use six variables as this area is of special relevance to a knowledge-based economy. As proxies for the extent to which an economy taps into the growing stock of global knowledge we use foreign direct investment as a share of GDP and royalty and licensing fees paid abroad as % of GDP. On both these measures Korea ranks at the bottom, suggesting that it is not well integrated into global knowledge. As indicators for R&D we use two measures. For effort we use scientists and engineers in R&D per million population, while for domestic R&D output we use patents granted by different ciountries in the US per million of their population.2 On scientists and engineers, it ranks below the middle range, while on patenting it ranks in the bottom third--which is of concern for a country that aims to become a knowledge-based economy. Finally, to get some sense about the actions of some of the critical actors in the innovation system we use qualitative rankings about the closeness of research collaboration between universities and industry and how well companies absorb new technology. On these indicators Korea ranks in the middle range, suggesting that in this area too it has a significant way to go. These issues are analyzed extensively in Chapter 5. 8. For the infornation infrastructure we have three variables. Telephones per 1000 population is the sum of telephone mainlines and mobile phones which is better indicator of connectivity than either in isolation. Computers per 1000 population is an indicator of personal computer penetration. Internet hosts per 10,000 measures use computers and communications. On 2 Because countries have different patenting procedures, rather than using patenting in their home countries, we have used patenting in the United States, which is the largest market for patenting. This biases the ranking in favor of the US, but the US is anyway recognized as the world leader in innovation, and the measure does give a good indication of the relative performance of other countries. Japan, for example, scores very near to the US. - 137 - telephones, Korea does slightly better than mid range; on computers, it ranks lower than mid range, and on Internet hosts it lags seriously. However, the use of Internet has exploded recently so the current situation is much better than this data suggests. This is analyzed in more detail in Chapter 4. 9. To give some perspective on how Korea compares to other economies, Figures 2.2-2.4 present the knowledge assessment scorecards for the US, Japan, and Singapore. These countries have been chosen to illustrate different strategies. The US, which is arguably the most advanced knowledge-based economy overall shows a relatively full circle. However, it is not fully open to international competition as can be seen from it ranking on the tariff and non-tariff indicator. Also, it does not rely very much on direct foreign investment, in large part because it has such a strong domestic R&D infrastructure. 10. Singapore, on the other hand, is very open to the world and gets most of its technology by relying very heavily on foreign investment and on technology transfer. It is not so strong in its R&D efforts (although that includes R&D undertaken by multinationals located in Singapore) and is very weak in terms of patenting. However, it does very well on the extent to which companies absorb foreign technology and on research collaboration between university and industry. Singapore does not do well on press freedom, which reflects the still very strong role of the state in economic and social activities. On the other hand, it does quite well on all the indicators of the information infrastructure as it is one of the economies that has most systematically used ICTs as part of its development strategy. 11. Japan, looks like a more advanced version of Korea, which is not surprising since Korea tried to follow the Japanese development model in many respects. However, given the decade long slump that Japan has been experiencing, Korea has begun to look at the way in which other economies, particularly the US and some of the dynamic European countries are structuring their economies to make more effective use of knowledge. We will analyze these issues in the following chapters. Figure 2.1: Korea Annual GDP growth Intemet hosts -s-I -_t .Human Devt Index Computers Composite ICRG Risk Rating Telephones Tarnff & nontanff barriers Companies absorb new tech. Corruption Perception Index Research collaboration bet. Univ and - - - C , C R Industry Compliance wdh Court Rulings Patent Applications Granted - Intellectual Property is well protected Scientists & Engineers in R&D Press Freedom Royafty and License Fees Literacy Rate Foreign Direct Investmenf ------ Secondary x Tertiary Enroll. Flexibility ot people - 138 - Figure 2.2: Japan Annual GDP growth Internet hosts 10-.- Human Devt. Index Computers Composite [CRG Risk Rating Telephones Tanff & nontariff bamers Companies absorb new tech. Comuption Perception Index Research collaboration bet. Univ. and Industry - ---- -Compliance with Court RZulings Patent Applications Granted Intellectual Property is well pretected Sdentists & Engineers in R&D Press Freedom Royalty and License Fees . Literacy Rate Foreign Direct Irvestment --Secondary + Tertary Enroll. Flexibility of people Figure 2.3: United States Annual GDP growth Internet hosts ID-10--- Human Devt. Index Computers Composite ICRG Risk Rating Telephones Tanff & nontariff barriers Companies absorb new tech. . Corruption Perception Index Research collaboration bet. Univ. .... - Co and Industry _ o +. -, ~~~Compliance with Court Rulings and Industry Patent Applications Granted . Intellectual Property is well protected Scientists & Engineers in R&D Press Freedom Royalty and License Fees Literacy Rate Foreign Direct Investment Secondary + Tertiary Enroll. Flexibility of people Figure 2.4: Singapore Annual GDP growth Internet hosts - ---- .Human Devt. Index Computers Composite ICRG Risk Rating Telephones Tariff & nontariff barriers Companies absorb new tech .- Corruption Perception Index Research collaboration bet. Univ. and Industry U -- . Compliance with Court Rulings Patent Applications Granted Intellectual Property is well protected Scientists & Engineers in R&D Press Freedom Royalty and License Fees Literacy Rate Foreign Direct Investment- Secondary I Tertiary Enroll. Flexibility of people - 139 - Knowledge Assessment Scorecard Indicators: Performance Indicators 1. Average Annual GDP growth 1990-97 (%) (World Development Indicators, 1999) 2. Human Development Index 1997 (Human Development Report 1999, UNDP) Economic Incentive 3. Composite ICRG risk rating (December 98, World Development Indicators): This is the Composite International Country Risk Guide: An overall index, ranging from 0-100, based on 22 components of risk. 4. Tariff & Non-tariff barriers (Heritage Foundation, 1999) Institutional Regime 5. Corruption Perception Index (Transparency International, 1999) 6. Compliance with Court Rulings (World Economic Forum, 1999) 7. Intellectual Property is well protected (World Economic Forum, 1999) 8. Press freedom 1999 (Freedom House, 1999) Human Resources 9. Literacy rate as % of population (IMD, 1999) 10. Secondary + tertiary enrollment, 1996 (World Development Indicators, 1999) 11. People are flexible to adapt to new challenges (IMD, 1999) Innovation System 12. FDI as % of GDP 1997 (World Development Indicators, 1999) 13. Royalty and License fees as % of GDP, 1997 (World Development Indicators, 1999) 14. Scientists and engineers in R&D per million population, 1985-95 (World Development Indicators, 1999) 15. Patent Applications granted by different countries in the US per million of their population (US Patent Office, 1998) 16. Research collaboration is very close between universities and industry (World Economic Forum, 1999) 17. Companies are aggressive in absorbing new technology (World Economic Forum, 1999) Information Infrastructure 18. Telephone per 1000 persons, 1997 (telephone mainlines + mobile phones) (World Development Indicators, 1999) 19. Computers per 1,000 persons, 1997 (World Development Indicators, 1999) 20. Internet hosts per 10,000 persons, July 1998 (World Development Indicators, 1999) - 140 - ANNEX 2: Closing the Digital Divide: Some Country Exampleg With the growth of the internet revolution, an emerging policy concem is the growing digital divide within and among countries. In general, this new inequality is due to factors such as geographic location, gender, income and, education. Rural communities, women, the poor and the illiterate are most likely to be excluded from the opportunities to learn and adapt to new technologies. Several governments (described below) have developed the strategies and programs aimed at closing the divide. Country Strategies Programs/ Projects Denmark * Promoting gender equality in IT use, * The government asked the universities research, education. to prepare a " Plan of Action for Equality" to improve female enrollments and to promote a more equal distribution of the sexes among scientific personnel. * Also, the universities were encouraged to recruit more women students and researchers in research & IT based study programs. * Introduce special training programs, targeting unemployed and unskilled female workers. * Develop new training program in close cooperation with the larger social community. Ireland * Promote the general access to Library Projects: information and communication * Maximize the number of public internet technology across the community. access in libraries by escalating the * Promote "access" as awareness, investment. Libraries must extend open physical accessibility, usability and hours and provide training program for user-friendliness of information the general public and staff. Further technology and availability of tuition initiatives to promote accessibility of IT and technical support. equipment for people with disability. * Promote training for the general public, School Projects: target disadvantaged and marginalized * Schools act as central facilitators of groups. community access to ICT. Upon receiving government IT funding, schools need to provide greater community use of their IT equipment. IT 2000 program targets at least 50% of schools with IT access. Community and Voluntary Sector: * The department of social, community Sources: (I) Eun Jeong Kim, EASES, World Bank "Summary of Strategies for the Digital Divide in a Knowledge- based Economy: Denmark, Ireland, Singapore, and USA", 2000. (2) David Johnston, "Canada Life- Long Learning in the Knowledge Based Economy", paper prepared for GKII, Malaysia, March 2000. (3) "IT access for All - Report of the Information Society Commission", http//:www.isc.ie, March 2000. (4) "Our Competitive Future: Building the Knowledge Driven Economy", Department of Trade and Industry, United Kingdom. - 141 - and family affairs will rapidly increase the level of funding to the community and voluntary sectors. * The information Society Conimission is establishing focus groups on Connected Communities, to especially overcome the technical barriers to late adopters and people with special needs. * With the cooperation of the private sector, the Ennis Information Age Town project, resulted in a total of 49 towns throughout the country developing strategies for improved the use of information and communications technology in their own community. Citizen Information Centers: * 28 Citizens Information Centers and additional outreach locations around the country provide access to Citizens' Information Database for the provision of information on social services and job search. Raise the Awareness of ICT: * The information Society Commission has invited the Internet Service Providers (ISP) to develop the simple, easy to use web-based email services directed to late adopters. Canada * Develop a national access strategy to National Access: ensure the affordable access by all * The federal government has established Canadians to essential communication working group on access and is services. undertaking a study of social aspects * Emphasize on convenient, less expensive and barriers to access to the Information and just-in-time life-long learning to Highway esp. the influence of social improve the ability of labor force. factors (age, disability, ethnicity, education and income). * Government has added additional budget to the Community Access Program to expand the targeted number by the Federal Youth Employee Strategy. Community Access: * Industry Canada's Community Access program enables people in rural and remote communities to access to the Internet. Electronic government service and information is being delivered to these communities and to help them develop skills. * SchoolNet, LibraryNet programs facilitate the connectivity of Canadian by equipment donation from government, corporations and individuals. In 2000 Canada will establish up to 10,000 public access sites to connect all Canadians. - 142 - Preferential Tariffs for Education and Health Entities: * In September 1996, the Canada allowed preferential tariffs on telecommunications services for non- profit educational and health service entities. The new preferential tariffs apply to competitively provided services only and must cover the costs of providing the service. Singapore * Extend the use of PCs and Internet to * Provide a free used PC and basic low income households. training to 30,000 low income * Address also language and mindset households. issues besides the income and gender * Provide free broadband Internet access issues. at community centers and locally relevant web content in other Asia languages with the help of the private sector and tax incentives. * Develop national Chinese Internet programs for different population segments to bridge the language gap. * Extend "e-Ambassador" program, i.e. early internet users to voluntarily teach late comers. To extend around 2,500 new e-ambassadors. United * Lower the prices of both hardware and * Universal Service Program: In 1998, the States software to make them affordable to Federal Communication Commission's consumers by adapting pro- (FCC's) Universal Service Fund was competition policies. established to help low-income * Provide tax incentives to encourage the households pay monthly service bills private sector to donate computers to and the installation costs required to communities and to stimulate training initiate services. and education programs. * US. Department of Agriculture's rural * Improve information infrastructure in service provides lending and technical the rural area, consulting in rural area. * Encourage women seeking technical * Media dissemination: Showing female education and to pursue technical role models through media in order to career. improve the image of women scientists and technologies. * Developing science encouragement programs in order to increase female students' interest in technical careers. * Using influential colleagues, mentors and sponsors in both schools and business communities to develop women's interest in IT. * Using the alliance between business, government, and education communities in order to expand technical training and job opportunities for women. United * Develop strong regional partnership * New regional venture capital funds will Kingdom and strengthen the roles of the regional specialize in providing small-scale development agencies (RDAs). equity to business with growth potential, * Communities access with small drawing in local enterprise. enterprise strategies. * Business-led RDAs will be lead bodies at regional levels for coordinating - 143 - inward investrnent, raising skills, encouraging links business and higher and future education. * The government works with business in the communities to extend "IT for All" to the "information-have- nots". * All public libraries will be linked electronically by 2002 to provide the community access to digital technology. - 144 - ANNEX 3: Some Reflections on the Challenges of Policy Implementation 1. There is considerable information available to governments on what need to be done to strengthen the basis for development and use of knowledge. What is more tricky is how to actually implement action. Doing so typically includes overcoming political resistance, and to reduce the risk - and expectations - of unmotivated deviations in future policy decisions. A policy which looks good on paper can in fact be detrimental if market actors anticipate it soon to be overturned. 2. For policy to be consistent and credible, broad support within (and outside) governments for long-term objectives is important, not least as it can help to underpin long-term commitment to these objectives. Policy packages spanning a number of areas can also strengthen political backing by increasing the number of winners and weakening the position of groups that have to pay for the reforms by giving up their previous privileges. In order to obtain better policy co- ordination, however, it is often necessary to improve co-ordination and decision-making across different policy areas and traditional delineation of administrative competence. For this to be possible, new institutional arrangements are often required. 3. Appropriate incentive systems are needed to engineer policy co-ordination. Financial pressures can be used creatively to spur change in governance, and to adopt assessment mechanisms designed to induce innovative behavior. Checks must be put in place against government failure, such as institutions furthering their own special interests, and adopting a partial rather than an economy-wide perspective. 4. In a number of countries (Finland, Netherlands, Norway), the setting among ministries of a common goal for developing the information society demonstrates what progress can be made once common objectives have been identified. On the other hand, experience also shows that rapid progress may require sanctioning of the highest level of authority. In the knowledge-based economy, where the challenge partly is about providing adequate room for initiative and creativity from bottom-up, the need for the top to embrace this principle is particularly important in relatively autocratic societies. 5. How can policies in individual areas be made part of a broader package developed in consultation with the social partners to ease transition problems? One strategy is to begin with those measures which appear to be the most feasible, universally supported and whose effects are likely to be the most evident. Once these measures have been in existence for some time and their effects have been evaluated, necessary corrections can be implemented and more difficult decisions can be pushed through. Policies conducive to improve knowledge creation and use in Finland, Iceland, Japan and the Netherlands have been able to evolve along these lines. Even when "big bang" policies have been introduced, some key knowledge-related policies - 145 - (technology, education, etc.) have generally evolved gradually over a period of decades (e.g. New Zealand). On the other hand, the ability to advance may hinge on the political will to push through difficult decisions, handle the associated transition costs and demonstrate positive outcomes. In some countries, a crisis situation has helped muster support for reform (e.g. Finland, Japan, Korea). It is important that policy makers exploit such opportunities as they arise. 6. Many governments in the OECD are increasingly making use also of other methods as instruments to facilitate or strengthen policy implementation. These include: * Decentralisation of responsibilities, which can be a crucial instrument for bringing policies sufficiently close to their constituents. It is not least important for allowing adaptation and specialisation, e.g., in education policy or mechanisms for establishing science-university linkages. On the other hand, in areas where wider regional and social concerns are critical, decisions must not be left to the local level as it would result in compartmentalisation and bring new problems with consistency and co-ordination. * Private-public partnership can be very important for making policies more susceptible to customer needs and to strengthen political support. * Large-scale information campaigns can help to anchor policies more broadly in society and enable policy design and implementation which is in line with real needs. * "Audits" and international benchmarking, e.g., of how policy organization and formulation relate to economic behavior and performance, can help to raise general awareness and also induce a critical process of self-examination in governments. * Special large-scale initiatives to involve society in policy formulation and the establishment of new priorities in science and innovation. For instance, both the United States and Australia have recently held major summits on innovation policy. In the United States, the National Science and Technology Council hosted a Summit on Innovation on 30 November and I December 1999, aiming to explore the future direction and properties for federal support of innovation. The summit brought together business, government, the research community and non-profit organisations, to examine both obstacles and opportunities for greater innovation. 7. Regarding important linkages between areas, measures that promote broad-based upskilling and lifelong learning can help to raise the mobility and employability of workers and mitigate the costs of job displacement. Social security programmes and transfers protecting social cohesion will continue to play an important role in preserving a social fabric conducive to trust; itself a major building block for risk-taking, innovation and creativity in a broader sense. At the same time, it is crucial that policies be designed in such a way that they do not undermine incentives for work, upskilling, organisational change or restructuring. OECD countries face a major challenge in putting into place, and successfully communicating to the general public, a comprehensive policy framework which allows for a mutual strengthening of social cohesion, on the one hand, and technological progress and change on the other. 8. There can be a mutually reinforcing interplay between reforms and economic performance. In recent years, regulatory reform and intensified competition have been powerful engines of - 146 - change in many countries. They have enabled strong performance improvements in sectors such as electricity, gas and water, transport and communication, wholesale and retail trade, finance and many other services. In some cases, notably telecommunications and electricity, it is technological change that has permitted regulatory reform, however, since it has eroded the natural monopoly character of these industries.