The Service Industry in Korea: Productivity and Competitiveness

1. APO Study Meeting on Expansion and Development of the Service Industry in Asia The Service Industry in Korea: Productivity and Competitiveness 17 June, 2008 Hyun Jeong Kim (The Bank of Korea)

2. <Contents> • Introduction • The Service Industry in Korea • Characteristics of the Korean Service Industry: An International Comparison • Issues • Concluding Remarks

3. Introduction

4. 1. Introduction □ Shift to the service economy (“tertiarization”) has been widely seen including Korea. [1/2] — Definition: increase in the service sector’s share in the whole economy, in terms of production, employment, trade, consumption, etc.

5. 1. Introduction □ Shift to the service economy (“tertiarization”) has been widely seen. [2/2] Share of the Service Sector in Total Value Added in Major Countries

6. 1. Introduction □ Drivers of the tertiarization — Three factors (or hypotheses) • Traditional View: Income growth and consumption shift from goods to services (Fisher 1935, Clark 1940) • Cost Disease Hypothesis: Productivity gap between goods producing sectors and the service sector (Baumol 1967, Baumol et al. 1985) • Exogenous Demand Shock Hypothesis: Structural changes such as increase in service outsourcing, or in female participation in economic activity

7. 1. Introduction □ Effects of the tertiarization — Two views on the relationship between economic growth and the tertiarization • Pessimistic View: Economic growth will inevitably slow down with tertiarization. (Baumol et al. 1985) • Optimistic View: Service sector can lead productivity growth and thus income growth. (Kendrick 1985, Bailey and Gordon 1988, Fixler and Siegel 1999, Triplett and Bosworth 2002)

8. 1. Introduction □ In reality, two tendencies coexist. — In developed countries, convergence in per capita (or per hour worked) GDP of the EU to the US seems to stop or to be reversed after the mid-1990s. • This is diagnosed as being caused mainly by differential performance in the service sector. — In Korea, performance gap between the manufacturing and service sectors became wider after the 1997 crisis than before.

9. 1. Introduction □ Grouping of industries within of the service sector to more specifically locate driving or dragging factors with regard to economic growth   ④ — 4 subgroups • Distributive S: Wholesale and retail trade, transport, and storage • Producer S: Communication, finance, insurance, real estate, renting of machinery and equipment, advertising, business services, and broadcasting • Personal S: Hotels and restaurants, movie and entertainment, other recreational services, cultural services, repairs, and other personal services • Social S: Public administration and defense, education, health care, and social welfare

10. 2. Service Industries in Korea

11. 2. The Service Industry in Korea <1> Production [1/2] — As a whole, the share in terms of nominal value added rose from 44.7% in 1970 to 56.3% in 2005. Share of the Service Sector in Total Value Added in Korea (in current prices) .

12. 2. The Service Industry in Korea <1>Production [2/2] — By subgroup, producer S was the main driver in the shift to the service economy in Korea. Change in the Shares of 4 Subgroups of the Service Sector in Korea .

13. 2. The Service Industry in Korea <2> Employment [1/2] — As a whole, the share in terms of employment increased from 34.3% in 1970 to 65.2% in 2005. Share of the Service Sector in Total Employment in Korea .

14. 2. The Service Industry in Korea <2> Employment [2/2] — By subgroup, personal S and producer S were the main driver. Change in Employment By Sector in Korea(1992~2004) (10 thousand people) .

15. 2. The Service Industry in Korea <3> Intermediate Consumption — The share of services in intermediate inputs for the production in the manufacturing sector increased from 10.1% in 1980 to 14.2% in 2000. • Especially, the share of producer S rose from 2.8% to 7.3. Change in Input Structure of Korea’s Manufacturing Sector .

16. 2. The Service Industry in Korea <4> Final Consumption — The ratio of expenditure on services to total household consumption expenditure increased from 35% to 57% in nominal terms and from 48% to 56% in real terms. . Share of Services in Total Household Consumption Expenditure in Korea

17. 2. The Service Industry in Korea <5> Trade [1/2] — Trade volume in services and its share in total trade on the rise in Korea. Share of Services in Korea • The tendency is more prominent on import side than on export side in Korea. . • Import: 12.9% in 1980 18.3% in 2004 • Export: 12.8%14%

18. 2. The Service Industry in Korea <5> Trade [2/2] — Reflecting the above mentioned feature in trade as a whole, deficits on the services account increased: especially, quite rapidly after 2000. Services Account Balance by Subgroup in Korea . • Producer S and Personal S are the main culprit.

19. 3. Characteristics of the Korean Service Industry : An International Comparison

20. 3. Characteristics of the Korean Service Industry <1> Production: Tertiarization has been progressing relatively very slowly. Share of the Service Sector in Total Value Added in Major Countries • Share : about 20%p lower than the US • Speed : 12.5%p up in Korea vs. • 20%p up in advanced countries

21. 3. Characteristics of the Korean Service Industry <1> Production: By subgroup, the share of producer S is still very low compared to advanced countries. Share of Producer S in Total Value Added in Major Countries • The share of producer S has increased most rapidly in Korea, • but the gap between Korea and advanced countries is still very wide; • 15%p lower than in the US.

22. 3. Characteristics of the Korean Service Industry <2> Employment: Tertiarization has been progressing quite rapidly. Employment Share of the Service and Manufacturing Sectors in Major Countries

23. 3. Characteristics of the Korean Service Industry <2> Employment: employment growth rate in the Korean service sector has been higher than most of OECD countries and the trend continues. Employment Growth Rate in OECD Countries (1980~1990) (1990~2003) 23

24. 3. Characteristics of the Korean Service Industry <2> Employment: high employment growth rate took place mainly in traditional services (distributive S or personal S) rather than in knowledge-based S (KBS) like in producer S. International Comparison of Employment Structure in the Service Sector

25. 3. Characteristics of the Korean Service Industry <3> Intermediate consumption: Tertiarization has progressed only very slowly. — The extent of inter-industry linkage is still very weak in Korea. Share of Service Input for the Production in the Manufacturing Sector in Major Countries

26. Total manufacturing High-tech manufacturing Korea US Finland Norway Japan Germany UK France 3. Characteristics of the Korean Service Industry <3> Intermediate consumption: the share of producer S in total inputs in manufacturing is very low. Share of Producer S in Total Inputs in the Manufacturing Sector (Major Countries) 26

27. 3. Characteristics of the Korean Service Industry <4> Productivity: Labor productivity is 1/3 of the US. Labor Productivity By Sector in Major Countries (VA per working hour, US=1, PPP, as of 2005) Source: EU KLEMS Dataset (2008 March release)

28. 3. Characteristics of the Korean Service Industry <4> Productivity: LP growth rate has been slowed down significantly since the early the 1990s although it is not very low compared to other countries. Labor Productivity Growth Rate in OECD Countries (Manufacturing sector vs. service sector, per person) (1980~1990) (1990~2003) Source: OECD STAN Dataset

29. 3. Characteristics of the Korean Service Industry <4> Productivity: Inter-industry productivity gap is widest, however. Inter-industry Labor Productivity Gap in Major Countries Source: OECD STAN Dataset

30. 3. Characteristics of the Korean Service Industry <4> Productivity: Total factor productivity level is also very low, 1/2 of that in the US. Total Factor Productivity By Sector in Major Countries(as of 2005)

31. 3. Characteristics of the Korean Service Industry <4> Productivity: the gap in TFP with the US has widened rather than narrowed in the last 20 years. TFP of Korean Manufacturing and Service sectors (US=100)

32. 3. Characteristics of the Korean Service Industry <5> Consumption: tertiarization took place most dramatically. Share of Services in Household Consumption Expenditure in Korea and the US 32

33. 3. Characteristics of the Korean Service Industry <6> Trade: Korea suffers from chronic service account deficit while the US, UK and France maintaining surpluses in services trade for several decades, especially in producer S. Service Account Balances in Major Countries (Total services) (Producer S) 33

34. 3. Characteristics of the Korean Service Industry <6> Trade: exporting capacity of producer S is very weak in case of Korea. Export Specialization Index* (1991~2003) Ratio of Export of Producer S to Total Service Export (991~2003) (Total services) (Producer S) 34 * (X – IM)/(X + IM)

35. 3. Characteristics of the Korean Service Industry <Summary [1/2]> — Tertiarization in employment has been more pronounced than in production in Korea. — Tertiarization on demand side, intermediate and final, has been more pronounced than on supply side in the country. (Producer S) • Low contribution to economic growth in case of Korea • Low productivity • Increasing trade deficits, esp. in KBS 35

36. 3. Characteristics of the Korean Service Industry <Summary [2/2]> — Korean service sector’s contribution to economic growth is 35~50% in contrast with 76~80% in advanced economies. (Producer S) * US, UK, France and Japan SOURCE: OECD STAN Database , the Bank of Korea 36

37. 4. Issues

38. 4. Issues □ Causes for low productivity and competitiveness • Weak regulatory reform • Insufficient openness • Weak innovation • Low utilization of high-quality human resources

39. 4. Issues <1> Weak regulatory reform Ranking of Product Market Regulation Index of OECD countries(2003) * Lower ranking means more regulated product market. Source: Conway et al.(2005)

40. 4. Issues <2> Insufficient openness Index of Barrier to Foreign Ownership in OECD Countries (2003) OECD average: 1.8 * High index means more barrier. Source: Conway et al.(2005)

41. OECD average: 17.4% OECD average: 2.7% 4. Issues <3> Weak innovation [1/2] Share of ICT in Gross Fixed Capital Formation and GDP (period average for 1995~2004) Source: OECD Productivity Database

42. 4. Issues <3> Weak innovation [2/2] — Service R&D / Total R&D Source: OECD in Figures 2006~2007

43. Servi-ces share (%) Female employment rate (%) 4. Issues <4>Low utilization of high-quality human resources [1/2] — In particular, low employment rate of high-quality female population Correlation between Services’ Share in Employment and Female Employment Rate (in 2003) 43

44. Japan Korea France UK US 4. Issues <4>Low utilization of high-quality human resources [2/2] — Differences between total employment rate and female employment rate reduced only slightly from the 1980s in Korea. 44

45. 5. Concluding Remarks

46. 5. Concluding Remarks □ The shift to the service economy has gradually taken place in Korea, and it has certain amount of positive aspects in terms of economic growth such as the increasing share of the knowledge-based services, including producer S. □ While the demand side of the service sector in Korea is quite rapidly catching up with the advanced countries, its supply side seems not to be able to meet the surging demand in terms both of quality and of quantity, resulting snowballing deficits on the services account .

47. 5. Concluding Remarks □ For the sustainable long-term growth of the Korean economy, its service sector has to grow and develop further. — To do this, various efficiency-boosting measures should be applied to Korea’s service sector just as those kind of measures were applied, quite successfully, to its manufacturing counterpart in the past. — Above all, more competition from abroad and from within, deregulation, innovation-supporting infra- structure including appropriate financial system are most urgently needed for the purpose.

48. Thank you for your attention !