South Korea’s Manufacturing: in a Funk

South Korea’s manufacturing sector has been the foundation of the economy’s impressive growth in the last half-century from its inconspicuous start with wigmaking, which developed into light industry, and then into world-class competitiveness in heavy chemical industries such as steel, ship building, automobiles and petrochemicals – in the 1980s.

More recently, South Korea has become a global leader in semiconductors, televisions, and cutting edge Information Communication Technology (ICT) such as mobile phones. Manufacturing-centered economic growth in South Korea provided high quality jobs and led to the development of a solid middle class through forward and backward linkage effects.

But today, the manufacturing sector is in crisis. The shipbuilding industry, which had led the world since the early 2000s, is suffering losses as it sees business move to offshore plants and more clients are lost to Chinese competitors, as witnessed in the cases of STX and Daewoo Shipbuilding and Marine Engineering.

Auto industry falling in ranking

The automobile industry is also falling in global rankings of production and exports, and concerns are being raised about the country’s status as a production base, as seen in the case of GM Korea. This fall is not limited to one or two sectors. The sales and exports of South Korean manufacturers decreased in 2016 compared to 2015. While it seems as though they are performing better in 2018 due to a semiconductor boom, other manufacturing sectors are suffering.

The bigger problem is that these hardships are not something that will soon pass. China has been fiercely chasing after South Korea’s steel and shipbuilding industries in recent years. Chinese companies will be tough competition in the coming years due to their cheap labor and accumulated technology. China and India’s efforts in the automobile sector are also a great challenge.

What’s worse, South Korea is not even one of the leaders in future advances in the automobile sector such as electric cars or autonomous navigating cars. The country is doing well in ICT products such as mobile phones, but Chinese companies such as Huawei and Xiaomi are encroaching on their market share. South Korea is still competitive in semiconductors, such as D-RAM, but China’s aggressive investments in this area are threatening this, resulting in the need to diversify South Korea’s portfolio from its current memory-heavy production line.

The Cause of the Crisis

What put the South Korean manufacturing sector in such a crisis, marked by an uncertain future and widespread lethargy? Every business sector has its own reasons for the current situation, but a common theme is that the “fast follower” model that enabled South Korean manufacturing to enjoy such success in the past is no longer effective. South Korea can no longer be competitive using second-mover advantages, making an efficient production process for products that first-movers succeeded in, due to the competitive threats from China and India.

South Korea also lacks its own accumulated know-how, either, leaving it sandwiched between the two groups.

This dilemma is well represented in the book Time for Creative Accumulation, co-authored by 26 professors from the College of Engineering at Seoul National University. They point out, sector by sector, the causes of the hardships facing the South Korean manufacturing sector. The common theme is “lack of creative accumulation.” High added value in manufacturing, such as conceptual design or constructing an industry as a whole, is accumulated through prolonged time and creative experiences.

Advanced industrialized countries have done this through their extended industrial history of trial and error. South Korea’s own experience of economic development is too short to have accumulated such a capacity. The book points out that this is the fundamental reason that the South Korean manufacturing sector is now going through a hard time.

Let us consider shipbuilding and offshore plants as an example. Offshore plants, in general, involve engineering, production, construction, and installation. South Korea is quite successful in construction and installation, thanks to its outstanding construction capacity. But the engineering and production phases result in more value added. In consideration of this, South Korean corporations started to bid for turn-key projects, which involve taking charge of all four stages.

But a lack of engineering and production experience has delayed the construction period in projects of this kind and resulted in huge losses, leading to the current crisis. Thus, the cause is the lack of accumulated high value-added technology. Even the semiconductor sector, said to be at its peak, is doing well because of price competitiveness thanks to production capacity. Most of the core design concepts that South Korea uses in its manufacturing, however, come from foreign companies. Manufacturing equipment is also imported from Japan or Germany. As a result, the foundation of this competitiveness is weak.

Declining population an issue

Furthermore, as South Korea’s population continues to experience a steep decline, the number of students continues to decrease, and as a consequence, the supply of a workforce with major manufacturing expertise has become unstable.

Also, creative talent capable of the kind of creative destruction the economy needs isn’t being nurtured. Instead, the country is still providing narrow-minded college educations that center on knowledge delivery and the college entrance system, forcing memorization of known knowledge. In particular, the ability to converge understanding of various areas is important in the upcoming age of fourth industrial revolution, but South Korea’s educational system is hindering the training of convergence-type talent. This is why South Korea’s future has become more insecure.

A Solution to the Crisis?

As a result, is the solution to push forward the country’s services sector and abandon manufacturing? Some might argue so, but most economists do not. The manufacturing sector is less susceptible to the influence of the business cycle, so it is stable and supplies high-quality jobs, making it difficult to give up for any country. The importance of the manufacturing sector can be witnessed by looking at Germany and Japan, where the economy is relatively stable despite the rise and fall of the global economy. Even the US, which dominates the services sector globally, has begun to adopt policies for reshoring their manufacturing sector.

So, what should be done to revive South Korea’s manufacturing sector? No silver bullet exists. However, if a variety of possible options are tried, the crisis could subside. The first task is to horizontally converge those things that South Korea does well. For example, it could combine ICT with the marine and shipbuilding industry.

The US aviation giant Boeing is making more in sales in its maintenance business than by selling aircraft. Similarly, South Korea’s marine and shipbuilding companies should not just end up with making and selling ships. If, for example, they could employ sensors to ships that monitor the condition of major parts, they could develop their maintenance business by utilizing ICT.

Back on the ‘fast follower’ track

Another task is for South Korea to use the “fast follower” strategy in industrial sectors where it is not yet a global leader, thereby joining leaders in those sectors. For example, the biomedical, energy-environment and aerospace industries are sectors that potentially have a large market, but South Korean companies are not at a leading level in those areas.

In such industrial sectors, a “fast follower” strategy should be utilized to quickly become a leader. South Korea’s KAIST Moon Soul Graduate School of Future Strategy, where Professor Kwang Hyung Lee serves as president, has suggested five new industrial and business areas that fit this strategy, called MESIA – Medical-Bio, Energy-Environment, Safety, Intellectual Service and Aerospace.

Finally, South Korea should take advantage of changing global trends related to the so-called fourth industrial revolution. Artificial intelligence, the internet of things, big data, and mobile are technologies that will lead the fourth industrial revolution. They are new to everybody. Even in advanced industrialized countries, there is as yet no “creatively accumulated” ability in these sectors.

In principle, South Korea should be able to compete with them on an equal footing. To gain global competitiveness in these areas, regulations and a labor environment that are favorable towards these new industries, and an educational system that nurtures convergence-type talent, is essential. For South Korea to prepare for the future, it is absolutely necessary to engage in developing such an infrastructure.

Se-jung Oh, a member of the 20th National Assembly in South Korea, obtained his bachelor’s degree in physics at Seoul National University, and his PhD, in physics at Stanford University. He taught and researched as a professor at Seoul National University’s Department of Physics & Astronomy from 1984 to 2016. This is reprinted with permission from the East Asia Foundation, a Seoul-based think tank.