South Korea's traditional industrial policy is dead and the nation needs a new industrial development paradigm. Top-down sectoral policies based on cheap bank credit and tax-breaks allowed a remarkable economic growth in the past 25 years and gave birth to large industrial sectors in record time.
However, they produced numerous negative structural side effects that precipitated the 1997 recession and imposed a huge clean-up burden on the country (still to be completed). Also, this model slowed down the emergence of a strong entrepreneurial and service sector in Korea.
Since the recession, economic policy triggered a large wave of structural reforms and has produced so far mixed results. These reforms have until now mainly focused on emergency financial restructuring rather than long-term industrial competitiveness.
In this post-recovery era, Korea's industrial competitiveness has not improved and export numbers have recently started to deteriorate.
Korea clearly needs a new paradigm of industrial policy. The traditional model is ill adapted to the new size and level and development of the Korean economy and hardly compatible with the rules of the game in an open market-driven economy.
Simultaneously, the required changes are too big and the market mechanisms not robust enough yet to guarantee progress without a clear industrial strategy.
Updating Traditional Competitiveness Map
To determine where Korea should play on the economic battlefield, the "traditional" map of Korea's industry portfolio along two axes is essential: attractiveness and competitiveness. Competitiveness can be defined in terms of market share, profitability, technology and attractiveness in terms of market size, profit pool, market growth and employment.
This analysis shows that Korea participates in mid- to highly-attractive industries, but that its competitiveness is relatively low.
Korea tends to be strong in several low to medium growth industries such as shipbuilding or chemical fibers and relatively weak in several high growth industries, such as biotechnology, IT software and services.
There exist, however, noteworthy exceptions where Korea has managed to build a highly competitive position in attractive industries, such as DRAM chips, display devices, and steel.
A closer look shows that these changes in competitiveness follow a relatively erratic pattern. Some industries have gained competitiveness like steel or DRAM, while other have lost competitiveness such as automotive, chemical or automotive.
New map for Korea's Economic Portfolio
To make sense of this economic portfolio, it is crucial to take a new approach and group Korea's industry in accordance with their knowledge and service intensity.
After boundaries around these industries based on knowledge and service intensity created, a clear pattern appears.
Korea is least competitive in the knowledge-based service industries such as information technology, business service, finance, life insurance, retail, and communication service.
Its competitiveness is very variable within knowledge intensive manufacturing industries such as bio technology, pharmaceutical, computer network, automobile, optical device, communication device, chemical, D-RAM and displays.
Korea should increasingly move toward knowledge intensive industries to maximize growth in the coming years.
According to our study of Organization for Economic Cooperation and Development (OECD) countries, growth of the best performing OECD countries is overwhelmingly driven by knowledge.
About 65 percent of the growth over the past 10 years has been fueled by knowledge-intensive industries.
Unfortunately, Korea's industrial structure is still lacking in knowledge.
Relative to those of OECD countries, knowledge-based industries in Korea still make up a smaller portion of Korea's gross domestic product (GDP).
Knowledge-based industries in manufacturing and service make up about 40 percent of Korea's economy compared with about 50 percent for OECD countries. Knowledge-based services alone represent 25 percent of Korea's GDP, lower than more than 40 percent for OECD countries.
Knowledge industries are important for Korea not only because they are growing fast but also because they are becoming increasingly tradable.
Global trends indicate that knowledge-based trade is growing faster than all other trade. The implication for Korea is that knowledge intensity will boost exports.
New Vision of Korean Industry
One of the solutions is to make Korea a knowledge-exporting nation by increasing the knowledge and service intensity of its industry's portfolio.
The first imperative is for Korea to upgrade its traditional manufacturing sector into exporting knowledge areas.
This can be done through increasing the knowledge intensity or service intensity in each industry, or the combination of both.
Petrochemical companies using their knowledge of operations to sell facilities consulting are one good example. Another is the Business-to- Business (B2B) exchange of steel companies, exporting their knowledge of distribution networks.
The second imperative for Korea is to upgrade the service sector. Much like upgrading manufacturing, adding more elements of knowledge to Korea's service industries will allow them to be upgraded for export.
Many examples of service industries exist which can be upgraded. From music, movies, education, Korean medicine and IT services to tourism, there exist a number of service industries that are either currently exporting their knowledge or have big export potential.
A bottoms-up Bain analysis of different scenarios of industrial structure and growth revealed that in the best-case scenario, a $27,000 GDP per capita is possible.
For reference, on a real basis, the $27,000 nominal value translates to about $17,500 in 2000. The best-case scenario is based on Korea's ability to quickly change its industrial structure and drive its growth as fast as the best OECD countries.
The implementation time horizon is much shorter than most people realize.
Many people talk about $20,000 or even $30,000 GDP per capita country in the near future, but in our scenario analysis, it is nearly impossible to achieve any real GDP growth per capita without quickly upgrading Korea's structure into knowledge. There has to be a major paradigm shift in thinking about how Korea will grow till the year 2010.