Services Global Value Chain in Korea.

• Author: Hur, Jung

1. Introduction

   Economists have long recognized that Korea's economic growth has been driven by its export-oriented industrial policies. To promote the major exporting industries, the Korean government has selectively supported firms that can compete in the global market with cheap products. However, in order to be competitive, it is also necessary for local companies to import inputs from foreign countries at lower prices and adopt innovative technology. To achieve this, over the past few decades, the Korean economy has strongly integrated into the global manufacturing and services markets.

   Recently, however, the country has been facing challenges not only from emerging economies that were traditionally seen as mere input suppliers, but also from established multinational firms that are starting to relocate to countries with lower production costs. This trend suggests that, in the years to come, the services sector will hold the key to Korea's long-term growth. Although Korea has experienced high growth rates for a sustained period, its share of services remains quite small as compared to advanced economies. This paper, therefore, examines the role of the services sector in boosting the nation's economic growth.

   The article is organized as follows. The next section discusses the development of services in Korea. The third section focuses on the role of global production value chains in the country. The following section offers firm-level analysis of services, while the final section concludes.

2. The Services Sector in Korea

   The services sector, in the past two decades, has become an important component of Korea's economic growth. Figure 1 shows that the sector accounts for about 60 per cent of the national GDP.

   Table 1 highlights the contribution of services in terms of value-added and employment. It can be observed that the share of value-added in services has been growing in the country, from 50 per cent in the early 1990s to nearly 60 per cent in 2010s. The two largest subsectors in services in terms of value-added are: wholesale and retail trade, restaurant and hotels; and real estate and leasing. Also, activities related to business services have emerged as the third largest subsector since 2013, with the share of value-added growing from 3.5 per cent in 1990 to 7.3 per cent in 2013.

   Table 2 shows the employment diversity in the services sector. Employment in services currently stands at 14 million workers, which is about 75 per cent of the total workforce in Korea. Within services, the subsectors with the largest number of workers include: wholesale and retail trade; accommodation and food; education; human health and social work; and transportation.

   Figure 2 presents the overall picture of trade in services. It shows that, in Korea, trade in services had been quite balanced in earlier periods, but since 2000, the sector has generated deficits in international trade. In particular, Korean services trade has suffered from deficits in: other business services; travel; and manufacturing services (Table 3).

   Next, Table 4 summarizes Korea's outbound FDI flows. The majority of outbound FDI in the services sector remains concentrated in: financial and insurance activities; wholesale and retail trade; real estate; and renting and leasing activities--all related to business support. This is an important point for Korean policymakers because business support services tend to create higher value-added than manufacturing.

3. Korean Services in Global Value Chains

   According to the Trade in Value-Added (TiVA) database, the average share of foreign value-added of all major sectors in Korea is around 41.7 per cent (in 2011)--much larger than the OECD average (28.3 per cent) and the ASEAN average (32.9 per cent). This indicates that the Korean economy is deeply integrated into global value chains.

   Figure 3 plots the foreign content share of Korean exports in 1995 and 2011. It can be observed that all sectors in the country have been increasingly importing foreign inputs and using them for exporting their own goods and services. Within manufacturing, two key industries (food, beverage and tobacco; and chemicals) experienced the largest change in foreign content share; for the food industry, the foreign input stake increased from 16 per cent in 1995 to 36 per cent in 2011, while the imported foreign input share of chemicals grew from 32 per cent to 64 per cent during the same time. However, this also implies that the more integrated industries are into global value chains (GVCs), the less is their gross value-added. For example, if Korea exports chemical products worth US$1 million, domestic value-added (i.e., gross value-added less foreign value-added) is only US$0.36 million in 2011, while it was US$0.68 million in 1995.

   With respect to global value chains, services remains the least integrated sector in Korea, with the exception of the transport and storage, and post and telecommunication activities, where foreign inputs make up more than 30 per cent out of gross exports. Within services, the lowest share of foreign content is noted in financial intermediation. In fact, this share has not changed much between 1995 and 2011, suggesting that the financial sector has been very domestic-oriented and less integrated with global financial markets.

   In order to see further variation within services, Figure 4 divides the sector into twelve constituent industries. Except for financial intermediation, real estate activities and educational services, all other services industries show more than 10 per cent foreign inputs in their gross exports. Among these, hotels and restaurants, transport and storage, and post and telecommunication are the three largest sectors with 28 per cent, 34 per cent, and 22 per cent foreign content, respectively. The growing degree of integration with GVCs is also found in wholesale and retail trade, renting of machinery and equipment, and other community, social and personal services.

   3.1 Exported Domestic Value-Added

   Overall, the level of services integration with global value chains is fairly high for Korea. According to me TiVA database, me average share of foreign content in Korea's services sector was 21 per cent in 2011, while the corresponding figure for OECD was 13.4 per cent and ASEAN was 24 per cent. However, it is important to understand that Korea can benefit from tins trend only when its local firms are positioned close to the higher end of value-added activities in the global value chain. If not, such high levels of integration could actually hurt the country's economic potential growth.

   To examine this further, this study measures the share of exported domestic value-added, as well as me services content of Korea's manufacturing sector. If a rise in the share of exported domestic valueadded is observed and this dominates the proportion of foreign content of domestic value-added, that would suggest effective integration of the Korean economy into the global network of value chains. Likewise, a noticeable rise in the services content of manufacturing would mean that activities related to the services sector can produce high value-added for Korean manufacturing.

   Figure 5 shows the sectoral share of exported domestic value-added for Korea in 1995 and 2011. It can be clearly seen that within manufacturing, the shares of the constituent industries vary considerably. Five industries in particular--chemicals and non-metallic mineral products; basic metals and fabricated metal products; machinery and equipment; electrical and optical equipment; and transport equipment--exhibit increasing proportions of exported domestic value-added, indicating their improved positions in global value chains. Other industries such as food products, beverages and tobacco; textiles, textile products, leather and footwear; and wood, paper, paper products, printing and publishing, on the other hand, have experienced a decline in the export share of domestic value-added. This implies mat the valueadded generated by these industries in the global value chains is not very effective.

   The case of the services sector is highlighted in Figure 6. Wholesale and retail trade; transport and storage; and other community, social and personal services witnessed a fall in the export share of domestic value-added. Meanwhile, financial intermediation, computer and related activities, and R&D and other business activities saw an increasing trend of the export shares. It is interesting to note that only the wholesale sector enjoys high exported domestic value-added of 43 per cent, which is 16 per cent greater than the imported foreign inputs (Figure 3). It can thus be inferred mat the services sector generates high value-added in the global value chains.

   However, irrespective of the direction of change in the export share of domestic value-added in manufacturing and service, the magnitude of change continues to be small compared to foreign inputs in gross value-added of exports. The only exception here is wholesale and retail trade. This tells us that the current degree of the global integration of the Korean economy--although high--remains far from the optimal level.

   3.2 Gross Exports

   Figure 7 summarizes the domestic and foreign services content of exports in 2011. Overall, the average foreign content share of gross exports rose from 6 per cent in 1995 to 11 per cent in 2011, which means that Korean manufacturers incur high costs in terms of payments to foreign resource providers, making them less competitive in manufacturing. However, the total services content share has dropped in almost all manufacturing industries, with the exception of: food products, beverages and tobacco; and wood, paper, paper products, printing and publishing. The simultaneous trends of increasing foreign services content and decreasing share of total services content in the manufacturing industries give the impression that the so-called...