Excelsior: The Korean Innovation Story

When Korea launched its industrialization drive in the early 1960s, it was a typical developing country, with poor resource and production bases, a small domestic market, and a large population dependent on foreign powers for national security. The economic situation was more than bleak: Korea’s gross domestic product (GDP) in 1961 was only $2.3 billion or $82 dollars per capita. It was a mostly agrarian economy, with manufacturing accounting for just 15% of GDP. International economic interactions were very limited. In 1961, Korea’s exports totaled $55 million, and imports $390 million.

The science and technology (S&T) situation was even worse. There were only two public S&T institutions: the National Defence R&D Institute, created immediately after the end of the Korean War, and the Korea Atomic Energy Research Institute, founded in 1959. On such a base, Korea invested $5 million on R&D in 1964, which enabled the employment of fewer than 5,000 scientists and engineers. As far as S&T was concerned, Korea was no more than a barren land.

It was under such a setting that Korea started its drive for S&T development and transformed itself into one of the world’s most dynamic economies. Korea has succeeded largely because it invested heavily in human resource development and because it forced companies to compete in global markets. In the process, however, scientific research capability played second fiddle to industrial development. Today, Korea recognizes that it must bolster the basic system for innovation in order to sustain and build on its prosperity.

In 1962, Korea launched its first five-year economic development plan, aimed at developing an industrial base that could support both import substitution and export promotion. Lacking in technological capability, Korea had to rely almost completely on imported foreign technologies. Early on, Korea pursued two objectives: promoting the inward transfer of foreign technologies and developing the domestic absorptive capacity to digest, assimilate, and improve on the transferred technologies. Because of concerns about becoming dependent on multinational firms, Korea, unlike other developing countries, chose to largely forgo foreign direct investment (FDI) and instead focused on arm’s-length methods such as reverse engineering, original equipment manufacturing (OEM), and foreign licensing. These methods had the benefit of providing a substantial amount of worker training.

Korea resorted to long-term foreign loans to finance industrial investments. The money was invested in selected industries, which led to massive imports of foreign capital goods and turnkey plants. In order to acquire necessary technologies, industry later reverse-engineered imported capital goods. Korean firms benefited most from OEM production arrangements because they offered opportunities to work with foreign buyers who provided everything from product designs and materials to quality control at the end of the production process. This was especially the case in the garment and electronic industries. Workers gained valuable experience.

During the 1970s, Korea made massive investments in machinery and chemicals. In chemicals, Korea relied largely on turnkey plants, which included technical training programs as part of the packages. In heavy machinery, foreign licensing was an important channel for technology acquisition. To help the two nascent industries further, the government created government R&D institutes, which worked with private industries to build the technological foundation for industrial development.

In short, Korean industries relied more on informal rather than formal channels for technology acquisition. The Korean approach resulted in both positive and negative effects. On the plus side, the policy enabled Korea to acquire technologies at lower costs and precluded the constraints often imposed by multinationals on local firms’ efforts to develop their own capabilities. The downside is that Korea had to forgo access to technologies that might have been available through direct equity links with foreign firms. By restricting FDI, Korea failed to meet global standards in domestic business operations. Much worse, the reliance on large-scale foreign loans contributed to a major financial crisis in 1997. Yet in the end, Korea was able to succeed largely because the informal modes of technology transfer that it emphasized contributed in a major way to building a well-educated work force. The need for such a work force cannot be underestimated.

Building an indigenous R&D capacity

As industrial development continued into the 1980s, the technological requirements of Korean industries became more complex and sophisticated. At the same time, developed countries began to view Korea as a potential competitor in international markets, and foreign companies became increasingly reluctant to transfer new technologies to their Korean counterparts. The government responded by loosening its FDI regulations and liberalizing foreign licensing, but the moves did not lead to significant increases in either area.

Consequently, the government concluded that to sustain development, it needed to build indigenous R&D capability. The National R&D Program was launched in 1982, and various actions were taken to promote and facilitate private R&D activities, including tax credits for R&D investments and worker development. Some of the key steps taken were designed to implement the overall government strategy of exposing firms to international competition. The government provided companies with financial and other incentives based on export performance. Companies with better performance were given better business opportunities as well as better access to financial resources. Korean firms recognized that to keep pace with technological change and survive in this export-driven world, they would have to invest heavily in R&D. The government’s export drive also favored large firms, giving birth to a unique business organization in Korea called the chaebol (similar to the zaibatsu in Japan before World War II). Chaebols enjoy greater financial affluence because of greater economies of scale and the greater scope of their business operations. Chaebol companies are thus able to engage in risky and expensive R&D projects that are unthinkable for small- and medium-sized firms. Today, the top 20 firms account for about 57% of the total industrial R&D investments in Korea.

The results of the government’s actions were dramatic. The turn toward indigenous R&D for technology acquisition can be seen in the sharp decline in the ratio of technology imports to business R&D from about 40% in 1981, to 20% in the mid1980s, and to 10% in the early 1990s. Korea’s R&D investment, which stood at only $526 million or 0.81% of GDP in 1981, rose to $13.5 billion or 2.6% of GDP in 1996, and to $26.3 billion dollars or 2.9% of GDP in 2005. During a period of 24 years, R&D investment increased almost 50 times, with an average annual growth rate of almost 20%. Korea now is the sixth largest R&D spender among Organization for Economic Cooperation and Development countries.

As private-sector R&D spending rose, government spending declined. In 1981, the government accounted for 53.5% of total R&D investment, but that share declined to 19.4% in 1990 and 16% in 1994, before heading up again to 24.3% in 2005. Now the private sector accounts for 75.6% of the total. With industry leading the way, R&D activities in Korea are focused largely on applied research and technology development, reflecting shorter-term commercialization concerns. In the 1980s, about 83% of R&D funds were used for applied research and technology development; in 2005, the share was 84.7%.

A key reason why Korea was able to increase R&D investment so rapidly was because it had an abundant pool of highly educated workers that could meet the increasing demand for R&D services in both private and public sectors. Korea recognized that R&D investment is more constrained by the lack of human resources than by financial limitations, and thus prepared itself well for development by investing heavily in education and human resource development.

R&D investment grew rapidly and continuously until Korea was hit by the 1997 financial crisis. R&D was one of the most damaged victims. In a survey undertaken in early 1998, many companies responded that they would cut R&D investments and personnel by almost 20% in response to the crisis. Actually, industrial R&D expenditures decreased by 10% in nominal terms from 884.4 billion Won in 1997 to 797.2 billion Won in 1998, but in dollar terms, the decline was even sharper (38.5%) because the value of the Korean currency relative to the dollar plummeted in 1998. R&D personnel also decreased by 15% from 102,000 in 1997 to 87,000 in 1998. This was a serious blow to the innovation system. If the crisis had continued for several more years, the system might have collapsed.

Fortunately, however, Korea recovered from the crisis in a relatively short period of time. It took only two years for industrial R&D to recover and rise above the level before the crisis. Korea was able to do this because of two things. First, government made up for the decrease in industrial R&D by increasing its own R&D expenditures. The government’s share of gross R&D expenditures increased from less than 20% before the crisis to 27% afterward. Government R&D funds were directed in particular at small technology-based firms, which helped them maintain and expand their innovative activities. Second, government promotion of information technology (IT) and IT-related ventures led to an IT boom in the early 2000s. The share of IT in government R&D expenditures rose from 13% in 1997 to 33.5% in 2002. The pro-IT policy also positively influenced innovative activities in other sectors.

Although there has been some criticism of Korean R&D policy—the major one being that public investments have not been efficient enough to be economically justified—one cannot deny the positive contributions that the efforts have made. Rapid growth in R&D investment has led to a remarkable increase in patent registrations. The number of patents granted by the Korea Industrial Property Office increased from 1,808 in 1981 to 73,512 in 2005, an average annual growth rate of about 15%. More encouraging still is the growth of patents granted to Koreans, which rose from 12.8% of the total (or 232) in 1981 to 72.7% of the total in 2005, an average annual growth rate of more than over 24%. The number of U.S. patents granted to Koreans rose from just 5 in 1969, to 543 in 1992, and to 3,538 in 2001, putting Korea in seventh place in the world. According to a patent analysis by the U.S. Department of Commerce, Korea has established world prominence in areas such as information and telecommunications, pharmaceuticals, advanced materials, and auto manufacturing. These statistics indicate that Korea is gaining rapidly in technological competitiveness.

Another important development is the remarkable increase in the number of scientific publications in internationally recognized academic journals. The number of publications by Koreans reported by the Science Citation Index increased from 27 in 1973, to 171 in 1980, to 1,227 in 1988, to 9,124 in 1997, and to 23,048 in 2005, raising Korea from 37th in the world in 1988 to 14th in 2005. Although Korea still lags far behind advanced countries in scientific publications, it recorded the highest growth (24.2% per year from 1973 to 2005).

Finally, R&D efforts have contributed to the development of high-tech industries in Korea. Based on in-house R&D, Korean industries have recently emerged as world leaders in semiconductor memory chips, cellular phones, and liquid crystal displays, as well as establishing themselves in the world market in shipbuilding, home appliances, auto manufacturing, telecommunications, and other areas.

Government’s evolving role

As industry has developed and grown more mature in Korea, the government’s role in fostering economic development has evolved as well. In the early 1960s, the government assumed a key role in Korea’s development, setting specific policy goals and leading industry in pursuing the goals. It acted as a rule- and target-setter as well as a financier. S&T was an integral part of the national economic development plan. But as industrial development proceeded, it became increasingly difficult for the government to intervene effectively in economic as well as R&D activities because of the increased scale and complexity of industrial activities. Consequently, government began to use more indirect means for promoting development, serving largely as a facilitator and promoter.

Currently, the National Science and Technology Council (NSTC), presided over by the president, is the top body responsible for setting the direction of S&T policy and priorities for government R&D investment. The Office of Science and Technology Innovation (OSTI), created in 2004 within the Ministry of Science and Technology (MOST), allocates S&T budgets based on the priorities set by the NSTC. Until 1987, MOST was the sole player in public-sector research, but late in what is considered the takeoff stage of Korean’s development (the late 1980s and early 1990s), other ministries began to establish their own R&D programs in order to solve problems in the areas of their purview. For example, the Ministry of Commerce, Industry and Energy launched the Industrial Base Technology Development Program in 1987 and the Alternative Energy Development Program in 1988, and the Ministry of Information and Communication created the Information and Communications Technology Development Program in 1989. Consequently, MOST’s role has been reduced; in 2003, its share of government R&D expenditures was only 20.6%.

A new issue resulted from the increased participation of ministries in R&D: how to allocate limited resources. The question is not only technological but also economic and political in that government R&D is justified only if taxpayers consent. To deal with the issue, the government in the mid-1980s adopted the concept of technology planning and evaluation in implementing R&D programs. Yet it was not until 1992 that a Korean system of public-sector R&D management took form. In that year, the government launched the Highly Advanced National (HAN) Project, a 10-year interministerial R&D program aimed at developing core technologies for 21st-century industrial development. The HAN project is the first government R&D program developed through a full cycle of planning processes: technology foresight activities, interministerial consultation, and so forth. It also marked an even further transformation of MOST from the major R&D funder into the S&T policy and R&D coordinator.

Into the future

Korea has made enormous strides in S&T during the past four decades. By making continuous and massive investments in human resource development and R&D, Korea has succeeded in building a unique innovation system. Yet there are problems, too. First, even though Korea spends a larger share of GDP on R&D than most other countries, R&D activities are highly concentrated in a small number of large enterprises, causing a serious imbalance in the system. Indeed, industrial R&D is skewed in favor of industries such as electronics. If this high concentration persists for long, it will dichotomize Korean industries into technologically advanced and retarded firms and sectors. In addition, the high concentration means that the R&D system is vulnerable to changes in economic and business environments. For instance, large Korean enterprises responded to the financial crisis of 1997 by cutting their R&D spending by about 14%, hurting the entire system. Second, although Korea has reached nearly the level of advanced countries in terms of S&T inputs, it still has a long way to go in terms of R&D productivity. The most important source of inefficiency is the lack of interaction and exchanges among the major actors of innovation: universities, research institutes, and industry. Intersector mobility of scientists and engineers is extremely low. Third, a weakness in basic sciences poses a fundamental problem, because scientific capability determines a nation’s technological potential. As Korea has emphasized industrial technology development, scientific research has been more or less neglected. Strengthening university research is a key to the future.

The Korean experience offer lessons for policymakers in developing countries. First, there is no doubt that education builds a nation’s ability to absorb new knowledge and technology. Thus, government should assume full responsibility for taking the necessary measures to promote human resource development. Investing in education in advance, as Korea did in the 1960s and 1970s, is essential in laying a foundation for industrial development. To help workers cope with technological change, the government should provide vocational and technical training or take measures to promote such training at work places. Later, as the economy becomes more advanced, technological competence becomes a critical factor, and the nurturing of high-caliber scientists and engineers capable of dealing with developments at the scientific and technological frontiers becomes necessary. In short, advanced education in S&T should come first in preparing for entrance into a developed world. In the case of Korea, education and industrialization helped each other in sustaining and accelerating development. Education made technological learning and therefore industrialization possible, while industrialization enhanced the rate of return on investment in education, promoting further demand for education.

Korea’s industrialization evolved from imitation to innovation. In the initial stage, Korean industries attained technological capability through informal channels for technology transfer, such as OEM production arrangements, reverse engineering of imported machines, technical training as part of turnkey plant importation, and so on. To lay the initial technological foundation, many Korean industries resorted to nonmarket processes, relying on the absorptive capacity of their workers for technology acquisition. This approach enabled them to acquire technology at a lower cost and maintain independence in business operations. But this strategy came at great cost: Korea had to abandon many of the technological opportunities that foreign direct investors might have offered.

By adopting an outward-looking development strategy, the government drove Korean industries into the competitive international market, putting them under great pressure for technological learning and/or development. Korean industries responded by investing heavily in technology development. By developing technological competence, they have been able to survive internationally and establish prominence in key areas. Protectionist policy may be effective in creating initial market opportunities for domestic industries, but if such a policy is prolonged, industries will develop immunity against market pressure for innovation. It may be for this reason that export-oriented firms achieved technological learning more rapidly than import-substituting firms.

In sum, Korea owes its technological development and industrialization to the development of a strong human resource base and an outward-looking development strategy. Two major lessons form the Korean experiences are that human resources are the key to S&T development and thus to economic growth, and that nothing can better motivate private businesses to invest in technology development than market competition. But for Korea to sustain past development into the future, it has to further strengthen basic scientific research capability and improve framework conditions for innovation.