South Korea flexing its considerable

South Korea flexing its considerableTHE ECONOMIC, POLITICAL, and social transformations that have occurred in South Korea in recent decades have been remarkable. That nation now is one of the most vibrant and thriving democracies in Asia. At the same time, it has become a regional as well as global economic powerhouse. The implications for U.S.-Korean relationships are profound.

Korea is in the midst of perhaps its most fundamental economic adjustment in modern times. It is taking on the key characteristics of the most advanced industrial economies. Its extraordinary economic development, especially over the past half century, has been based heavily on the growth of manufacturing centered on the chaebol, which is a conglomerate of many companies clustered around one parent firm. However, Korea currently is witnessing much of its traditional manufacturing activity moving to lower cost areas, notably China. That should be viewed as neither surprising nor undesirable.

The concerns expressed in some business quarters of Korea about the "hollowing out" of its manufacturing base ring a clear bell with Americans. That has been a much discussed topic in numerous U.S. industries for some decades now. A great many nations have seen their manufacturing workforces shrink in recent years (including China). In the typical case, the main agent of change has not been from overseas, but rather the rise in the productivity of domestic business operations due, in large measure, to technological advances. For example, American industry literally is producing more goods (the current Index of Industrial Production is 13% above 1997) with fewer people (14,000,000 as compared to 17,000,000 in 1997). Economic trends rarely move in the same direction for long periods of time. New factories in some high-tech industries tend to be so capital intensive that there is little advantage to locating them in areas of low-cost labor.

Understandably, employees who are displaced have been hearing bad news--at least until they get new jobs. Yet, as a practical matter, were it not for rapid technological progress and resultant rising productivity, most Americans still would be doing harsh physical labor working on farms in order to raise enough food to feed the population. Living standards, as a result, would be much lower than they are today. The same is true for advanced industrial nations generally.

In the 21st century, there is a different, but fundamental, justification for the expansion of productivity, it is the basis for successful competition in world markets. Were the productivity of our workers stagnant over the years, there would be no economic basis for raising compensation or even maintaining employment. The business would have gone to more competitive firms in other countries.

In highly developed economies such as in the U.S., outsourcing often is part of a broader effort of private companies to focus on their core competence. In the process, major business farms subcontract out many of their activities to other firms, mainly domestic. Despite the vehement criticism by various interest groups, overseas sourcing can best be seen as a part of that more basic trend to more efficient and effective business management. For instance, as companies upgrade their software systems, there is less need for locally based programmers and--simultaneously--more domestic demand for higher paid systems integrators. Corporate information technology departments are changing their mix of in-house talent. They are emphasizing such relatively high-paid skills as managerial experience, business process knowledge, and understanding the domestic customer.

Many advanced economies have seen their domestic industries do much of their current expansion in China and elsewhere in East Asia. In fact, over the course of global economic history, taking on production for wealthier regions is a way in which poorer countries accelerate their economic development cycles.

The U.S. perhaps is the most conspicuous example of this phenomenon. American companies have moved a substantial portion of their new production facilities offshore. For the generation of domestic income and employment, they are relying much more on the development and marketing of high-tech products as well as those services that embody substantial degrees of technological sophistication. Just as in the case of the earlier shift from agriculture to manufacturing, the adjustments experienced have been necessary and painful. Certainly, a willingness to adjust to a changing economic environment is how the U.S. has maintained and benefited from a flexible economic structure.

Lessons from U.S. experience

There are some lessons from the American experience that may be useful for Korean planners. For example, 'although the U.S. has an imposing array of extremely large and successful business enterprises, it has learned that so much of the motivation for innovation, as well as the growth of employment, have occurred in new and smaller companies. Hewlett and Packard started their venture in David Packard's garage. The genesis of General Electric was the genius of Thomas Edison. William Gates and Microsoft had equally modest beginnings. This points to a future potential challenge to the role of the chaebol. Of course, huge corporations are essential in a modern economy. It takes an extremely large organization to manage the complicated task of designing and producing a modern aerospace system, be it military or commercial. Numerous small, medium, and large companies are involved as suppliers and subcontractors in such a cooperative effort.

This, however, leads to a second point. In those mammoth aerospace corporations producing supersonic aircraft, intercontinental missiles, and space exploration vehicles, the largest department no longer is manufacturing--it is engineering. The most successful American industries today are very high-tech. They finance, as well as perform, the major share of all research and development (R&D) that takes place in the U.S. These massive private investments in new science and technology have been undertaken for good business reasons. To succeed, companies need to utilize the results of new R&D. That combination of science and business has enabled many modest-size firms to become huge giants of industry, although not all succeeded in that effort. Surely, there was no national decision to rely primarily on high technology and new and smaller firms to pace economic growth. The success resulted from the workings of a highly competitive and decentralized marketplace.

Nevertheless, actions by government--both negative and positive--were extremely important in that process of economic development. On the positive side, government is in a special position to finance research, especially the basic type which is drawn upon by a variety of firms. No one company has the incentive to pay for such a common good. However, the subsequent development stage for a new product is fat more expensive than the research on which it is based. For a variety of reasons, the developmental effort is most effective when it is paid for, not by the citizenry at large, but by the company that will use the results.

Governments and universities have important roles in educating future scientists and engineers. In this regard, Korea seems to be doing rather well. The proportion of science and engineering majors among students of college age (specifically 24-year-olds) is much higher than in the U.S.--nine percent versus 5.5%.

The most vital role for government is rather indirect--to help create an economic environment conducive to private investment, capital formation, and risk bearing. Securing private property rights is fundamental to that process. In the terms of current public policy debates, an important accompanying feature is a tax system that encourages the savings necessary to finance new investments. That often requires stripping out numerous special provisions that shield segments of the economy from marketplace competition. Keep in mind, though, that the public sector can interfere with entrepreneurship and business growth by maintaining a wide array of extensive and burdensome bureaucratic regulations.

That situation hardly is unique to any one country. For example, a company in the Republic of Korea has to visit more than 10 central and local government agencies to obtain a building permit. It takes a determined effort to clear away much of the underbrush of such regulatory barriers. However, judging from a variety of national experiences, a major effort at regulatory reform can be quite worthwhile.