KDI - Korea Development Institute - RESEARCH - Research Areas

Summary

Policy Study KOR Analyzing the Productivity Spillovers of Foreign Direct Investment (FDI) Considering the Characteristics of Industrial Complexes

Using large-scale panel data at the business unit level in South Korea, this study analyzes how the presence of FDI firms in industrial complexes impacts the productivity of domestic firms through vertical spillovers. Due to industrial agglomeration, FDI firms in industrial complexes are expected to engage more in vertical interactions with local firms and to procure a higher proportion of inputs locally compared to those outside the complexes. Therefore, the backward linkage effects of FDI firms in industrial complexes on domestic firms are anticipated to be more significant than FDI firms not operating in these complexes. To test this hypothesis, it constructs an indicator for the backward linkage effects of FDI and analyzes its relationship with the total factor productivity (TFP) of Korean manufacturing establishments.

This study finds that FDI firms located in industrial complexes exhibit significant positive backward linkage effects on the productivity of domestic firms. In contrast, the backward linkage effects of FDI firms outside the complexes are significantly lower and sometimes negative when domestic firm productivity is measured by value added per employee. These results support the hypothesis that, at least from 2010 to 2019, clustering into industrial complexes positively affects the productivity of domestic firms through the backward linkage effects of FDI firms.

Summary

KDI FOCUS Reshoring: A Study on Firm Characteristics and Influencing Factors

Among multinational manufacturers, firms engaged in reshoring are typically smaller, laborintensive, less productive, and less experienced in overseas production. Moreover, despite receiving sizable government subsidies, the domestic investments by reshorers yield smaller employment impacts compared to similar-sized domesticonly counterparts. Therefore, incentivizing domestic investment for all firms, irrespective of their repatriation, would be more effective in meeting objectives such as stabilizing supply chains, maintaining domestic manufacturing competitiveness, and boosting employment. The solution to the challenges posed by the excessive globalization of production lies in localizing production activities rather than the firms themselves.

- Reshoring, defined as the process of multinational firms bringing their previously offshored production facilities back to their home country, is attracing increasing attention in policy circles.

- Given the lack of proper evaluation in the implementation of existing reshoring policies, this study aims to assess their effectiveness by identifying the key attributes of reshoring firms and exploring the factors that influence their decisions to repatriate.

- Korea determines whether to provide policy support based on selection criteria that embody the lexical definition of reshoring.

- Major economies including the US prioritize overall investment promotion in capacity building for strategic industries, rather than formal requirements like whether a firm is “u-turning” its operations.

- This study categorizes multinational manufacturing companies into four groups by investment type, among which are offshoring and reshoring. Reshoring is defined as investing exclusively domestically while either withdrawing or suspending overseas investments.

- In this study, reshoring hinges on whether multinational manufacturers shift their strategy of overseas expansion to domestic investment, and this concept aligns with reshoring as practiced in major countries.

- Under the definition used in this study, about 24% of the multinational manufacturing firms in Korea have undertaken investment activities that qualify as reshoring.

- The pertinent question is to identify these reshorers and assess their contributions to the Korean economy following their reshoring activities.

- Around 40% of reshorers chose to engage in reshoring again in a few years, while nearly 30% transitioned to suspend or reduce investments, prompting concerns about their mid-to-longterm competitiveness.

- Reshorers in Korea are typically characterized by their smaller size, laborintensive nature, lower productivity, and limited experience in overseas production. Consequently, their likelihood of expanding investments abroad is low, which in turn suggests a diminished potential for contributions to the economy.

- As a result of reshoring, participating companies have seen an average annual employment growth of approximately 2.3%. However, their ratio of net employment to net investment is 1.17 persons per billion won, which is lower compared to expanders (1.32) and domestic-only firms (2.48).

- An analysis of internal factors influencing the four investment choices of multinational manufacturers shows that firm characteristics depicted in Figure 1 (size, productivity, labor intensity, etc.) are indeed important.

- Labor costs, both domestic and overseas, are the most relevant external factor in investment-type decisions by multinational manufacturers, emphasizing that high domestic labor costs are a fundamental barrier to reshoring.

- It is advisable to achieve the objectives of the U-turn support policy, such as stabilizing supply chains, maintaining competitiveness in manufacturing, and employment promotion, through strengthening incentives for domestic investment, independent of whether foreign production facilities are brought back home (reshoring). If the problem is the excessive globalization of production, the solution should focus on localizing production rather than localizing firms.

Summary

Policy Study KOR Offshoring vs. Reshoring: Trend, Drivers, and Policy Implications

The discussion on the side effects of offshoring and reshoring has gained momentum since the 2010s, leading to an increasing need for related research. This study analyzed 1,200 multinational corporations in South Korea from 2008 to 2019, classifying their investment types into four categories: (i) expansion with investments in both domestic and foreign markets (expander), (ii) offshoring with reduced or withheld investments domestically while investing abroad (offshorer), (iii) reshoring with reduced or withheld investments abroad while investing domestically (reshorer), and (iv) retention or downsizing with reduced or withheld investments in both domestic and foreign markets (idler). The study examined the characteristics of firms for each investment type, factors influencing investment type decisions, and the overall investment trends.

During the sample period, the overall trends of the four investment types remained relatively stable and evenly distributed. Offshorers and reshorers accounted for approximately 20% and 24% respectively. Moreover, around 40% of reshorers repeated the same investment strategy in the following years, indicating persistence in their decision-making.

Reshorers experienced short-term growth in revenue and employment, but their productivity growth rate was the lowest. Additionally, their activities in the foreign market, such as exports and imports, also decreased. This suggests a high likelihood that the observed short-term growth may not be sustainable. On the other hand, offshorers had a faster growth rate in productivity but had a negative impact on domestic employment. Offshoring and reshoring were thus economically conflicting.

The analysis of factors influencing investment type decisions revealed that expanders showed significantly higher numbers in size, productivity, and R&D investment compared to other investment types. Following expander, offshorer, reshorer, and idler exhibited lower levels of productivity in that order, highlighting the importance of productivity in investment type decisions. Reshorers had relatively high labor intensity, limited experience in overseas production activities, and their investment destination country was closer to South Korea. This suggests that firms with lower fixed costs of foreign investment and less burden in returning to the domestic market tend to choose reshoring as their primary option.

Reshoring policies have gained popularity in major advanced countries due to reasons such as national security, supply chain stability, and promotion of domestic employment. South Korea is also pursuing related policies. However, considering the characteristics of firms engaging in reshoring, it is desirable for the policy to aim at assisting reshoring firms in increasing productivity and eventually transitioning into expansionary investment firms, rather than focusing solely on reshoring itself.

Summary

KDI FOCUS The Global Trade Environment in the Biden Era and Response Strategies for Korea

□ Many expect that the trade war between the US and China will persist, and East Asia’s global value chains will undergo a significant transformation in the mid- to long-term, as China’s contracts while that of ASEAN expands. Accordingly, to effec-tively respond to the coming changes, Korea should adopt proactive strategies to join the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP), and attract quality FDI in an effort to realize sustainable growth.

- Biden’s trade policies highlight fair trade, which indicates that the US will maintain its hardline stance toward China.

- The policies of the new administration could drive the transformation of East Asia’s GVCs.

- It is too early to tell if China’s trade will remain sluggish. But, from a midto long-term perspective, East Asia’s GVCs will likely undergo some change due to China’s trade depression and diversion.

- Statistics confirm the structural changes in China which could diminish its share of East Asia’s GVCs.

- The US strategy of remodelling GVCs around itself, particularly in future technologies like 5G and AI, will likely have a huge impact on East Asia’s GVCs, especially in the electric/ electronic industry which accounts for 25% of China’s imports and exports.

- The CPTPP’s rules of origin could change the GVCs in East Asia via the trade diversion effect.

- Concerns over sensitive issues related to the CPTPP, such as market openness, policy loans, and fisheries subsidies are largely based on weak arguments.

- The longer Korea remains a non-member of the CPTPP, the bigger the decline will be in its exports. Accordingly, Korea must at least join the agreement before China.

- Attracting prime FDIs can serve as an effective policy to raise the investment necessary for sustainable growth.

- The US-China trade war presents Korea with an opportunity to attract more high-qualtiy FDIs.

- To take advantage of this opportunity, concession schedules in the Korea-China FTA should be pushed up.

- In the Korea-China FTA, the share of products subject to a five-plus-year tariff phaseout is relatively high in most industries.

- Joining the CPTPP is another effective policy to attract quality FDIs.

- A strategy to attract quality FDI is needed to drive the success of the ‘Korean New Deal’ initiative.

- From an economic policy perspective, the ultimate goal of trade liberalization is to improve the productivity of the overall economy which can be achieved through trade agreements such as the CPTPP.

- The fallout from firms exits due to the high level of trade liberalization should be not countered with trade policy, but with welfare policy.

- The emphasis of trade adjustment assistance should be placed on supporting workers. Meanwhile, agricultural policy should focus on preserving the income of farmers and strengthening their competence through a public-purpose direct payment system.

Summary

Policy Study KOR Foreign-invested Firms in the Korean Service Industry: Current Status and Economic Effects

Despite the emergence of low productivity as a critical issue in the Korean service industry, there is still a lack of a clear solution. Accordingly, this study examines how firms that have entered the domestic service market via FDIs have affected the performance of their domestic counterparts and overall industrial productivity to present the implications of policies that attract foreign investment to bolster growth in service productivity.

Existing literature suggests that the impact of foreign-invested firms on the domestic economy can vary. For example, if a highly productive firm were to enter the market, it could either seize the market shares of local competitors (negative effect), or spillover technology and management know-how (positive effect). To answer which effect is dominant in Korea, the registry of foreign-invested firms was merged with the economic census for two critical service industries: IT and business services. Both services create relatively high value-added and have a strong complementarity with manufacturing, yet they suffer from persistent low productivity. Subsequently, an analysis was conducted on how foreign entry in these two markets affects employment, sales, and exit of domestic incumbents as well as the entry of new domestic firms. The entry-driven changes in industrial productivity are also investigated.

This study finds that the entry of foreign-invested firms has, on average, driven down the productivity, sales and wage growth of domestic firms. However, some highly productive firms have shown improvements in all three categories, indicating that foreign entry has a heterogeneous effect on local businesses. Other important findings include the fact that employment adjustment was relatively less responsive to foreign entry, and also that the exit of domestic firms was not significantly affected. In sum, the entry of foreign-invested firms did not contribute to improving the aggregate productivity of local industries as it failed to facilitate the market entry and exit of domestic firms who play a major role in the reallocation of labor.

The findings contradict perhaps the conventional view that policymakers should pursue to actively lower barriers and attract more foreign investments to boost the domestic service industry. A more accurate interpretation is that neither easing restrictions on foreign investment nor reinforcing incentives to attract foreign investors necessarily leads to strengthening competitiveness across the industry, and the effect may be heterogeneous depending on the nature of the firm or market. It is suggested that, despite the need to secure opportunities and time for local firms to respond to the opening of the service market at least, institutional reforms are implemented to lower entry and exit barriers and to make the labor market more flexible for easier reallocation.

Summary

Policy Study KOR Improving Statistics on Korea’s Overseas Direct Investment

The highly rapid expansion of Korea’s overseas direct investment has brought overseas production to the fore in research and policies pertinent to industry. However, despite the growing demand, there is insufficient statistics on overseas investment. As such, this study aims to examine various approaches to develop and improve such statistics. It emphasizes the necessity of creating an information database on the overseas affiliates of Korean firms, along with statistics on their business operations and trends. Furthermore, suggestions are presented for the development of statistics that can help map out the business activities of overseas affiliates based on the parent firms in Korea. It also recommends that micro data should be provided more broadly and a system enabling such provision should be established so that the statistics on outbound investment can be diversely utilized.

Summary

Policy Study KOR Analysis on Stock Trading by Foreign Investors

Since the liberalization of the capital market, investment restrictions against foreign investors have been lifted gradually, expanding influential powers of foreign investors over Korea’s domestic stock market. The increase in foreign stock investment has brought a number of impacts on the Korean stock market. For instance, at the initial stage in the early 1990s, foreign investors, equipped with advanced skills and techniques, invested in undervalued stocks, causing the phenomenon called a revolution of stocks with low PER, thanks to which prices of these stocks skyrocketed. Also, foreign investors gained enormous profits from long-term and concentrated investment on rigorous companies, significantly changing the investing patterns of domestic investors. Not only that, the Sovereign Asset Management triggered a dispute over the management of SK Corp. in 2004 when the company was involved in the accounting fraud scandal. The dispute attracted an increasing attention to the market for corporate control, a relatively new concept to Korea at that time.

With the growing influence of foreigners on the domestic stock market, policy authorities as well as domestic investors have increasingly paid more attention to the trading patterns of foreigners. As more Koreans learned about foreigners’ high stock returns thanks to their advanced investment techniques and strategies, their daily trading trends have come under the spotlight among stock investors. Their pattern is of great significance also in that it tends to represent the assessment of foreign investors in the case of major events at home and abroad.

Such high attention to foreigners’ stock trading was largely attributable to the foreign investor registration system, which requires a foreign investor to obtain an Investment Registration Card (IRC) prior to investing. In the case of major economic or non-economic events, it usually takes a considerable amount of time to confirm relevant information on cash flow, but thanks to this system, anyone can access information on the flow of foreign stock investment on a daily basis, which makes it easy to check overseas views on respective events.

The attention to the flow of foreign stock investment reached its peak between 2004 and 2005, when major asset management companies, like Sovereign, attempted a battle for control of Korea’s leading companies. Such attention, however, had decreased, as the stock market continued to remain bullish despite the continued net selloff by foreigners. Then, during the global financial crisis triggered in 2008, foreign investors went into a selling spree and the foreign exchange rate shot up, causing severe impacts on domestic financial markets and attracting renewed attention to the trading patterns of foreign investors.

This study analyzes the stock trading of foreign investors from two perspectives. First, it uses the principal component analysis in order to see which factors among various macroeconomic variables do foreign investors mainly depend on when deciding on net buying. The result demonstrates that the improvement in the domestic economy and the global financial market tends to increase the net buying by foreign investors, and that during a crisis, the relative decrease in the foreign reserves turns out to trigger the net selloff by foreign investors.

Second, the study analyzes foreigners’s preference by stock category, and as it was found from the preceding studies, foreign investors prefer large-sized companies or those with a high export ratio due to the asymmetry of information in Korea and they tend to carefully consider the financial stability, such as cash holdings of concerned companies before deciding to invest. The study also conducts an analysis on what impacts from such preference were made on the decision to sell at the time of the financial crisis in 2008. The result shows that they mainly sold off stocks whose shares of investment amount were among the largest almost without considering the characteristics of each stock, a similar pattern observed during the burst of IT bubble in 2002. This can be translated to mean that in the event of a macroeconomic impact, the microeconomic portfolio has almost no influence on the trading pattern.

Entering 2009, foreign investors posted a massive buying trend, considerably raising the stock holding ratio of foreigners that had been contracted for the past several years. In this regard, when foreign investors go on a selling spree depending on macroeconomic changes, such as larger risk factors in the global financial market and the slowdown in the domestic economy, it is impossible to exclude the possibility that there would be a massive outflow of foreign investment funds, just like the one in 2008, along with the outbreak of a turmoil within the domestic financial market.

Therefore, since fully recognizing the limitation that microeconomic response by the corporate sector would not be enough to handle the emerging potent risk factors at home and abroad, it is now time to focus policy efforts on securing domestic macroeconomic stability which could contribute to alleviating expanded fluctuations.

Summary

Working Paper Trade, Investment and Economic Interdependence between South Korea and China

The Korean economy has been significantly impacted by the emergence of China. It is now the largest market for Korean exports and a major supplier of its low-cost imports but has at the same time become a serious challenger of Korea in the global markets for manufacturing exports. This paper investigates changes in China's export structure and its effect on Korea and bilateral trade between the two. It also examines the motives for Korean investment in China and its effect on bilateral trade and cross-border production networks. Korean FDI in China has contributed to the growth of parts exports from Korea to China, and we provide evidence for this effect with regression analysis.

Summary

Policy Study KOR On the Inter-industry Productivity Spillover Effect of Foreign Direct Investment in Korea

Since 2000, Korea has experienced a sudden downturn in the amount of FDI
(Foreign Direct Investment) inflow which has continued ever since. Rather than
this being unique to Korea, the declining trend in the size of FDI is very much
a global phenomena. Hence, global competition to attract FDI among governments
has intensified even more. Under the policy competition for the inducement of
FDI, lies the belief that the positive benefits of FDI on the domestic economy
as a whole exceeds the overall costs of various subsidiary measures. It is natural,
therefore, for economiststo investigate scientific evidences on the existence
and content of benefits associated with the inflow of FDI, on the proposition
that the positive externalities are large enough to call for government intervention,
etc.

In general, FDI is known to be advantageous to the targeted country in various
ways. For example, improving the balance of payments, increasing production
and employment, raising productivity of the target company as well as that of
other companies in the same or related industries. While economists agree on
most, they have not reached an agreement on the issue of productivity spill-over.
Since the beneficiaries of productivity spilloversare usually different from
the direct stake-holders of the FDI, the productivity spillover effect can be
classified as one of the positive externalities of FDI. It is crucial, therefore,
to study this productivity spillover to correctly measure the economic value
of FDI, and to verify the validity of governmental support for FDI.

There exist several studies in Korea on the direct effect or indirect intra-industry
productivity spillover effect of FDI. Despite its importance, the indirect inter-industry
productivity spillover effect of FDI has never been analyzed in Korea. Given
the circumstances, this study examines the effect of FDI on the productivity
of firms in the same industry as well as firms in upstream or downstream industries.
This study uses panel data set of listed manufacturing companies in the Korea
Stock Exchange and KOSDAQ as well as companies subject to external auditsduring
1991 and 2000.

First, as indicated by the results, the dummy for foreign direct invested
firms had a coefficient that was positive and statistically significant. Therefore,
it can be concluded that the productivity of firms with FDIs is higher than
that of non FDI domestic firms with other things being equal. When the results
obtained by applying the treatment effect model to correct for the endogeneity
bias are compared to the ordinary least squares estimates, it can be shown that
the coefficient of the foreign dummy in the case of treatment effect estimation
is bigger than that of the ordinary least squares estimation. It can be concluded,
therefore, that the direct effect of FDI on productivity is not a result from
endogeneity, and that ordinary least squares methodology underestimates the
magnitude of this direct effect.

Next, when the intra- and inter-industry productivity spillovers are examined,
the coefficients of intra-industry and downstream industry FDI share are both
found to be positive and significant. The backward productivity spillovers are
especially bigger and more significant among all the variables, and are not
affected by the model specification and share calculation method employed. The
forward productivity spillover, on the contrary, appeared to be unstable depending
on the model specification and share calculation method. In some cases, it appeared
to be negative and significant. It can be concluded, therefore, that FDI has
a positive productivity spillover effect on the firms in the same industry as
well as firms in the upstream industry.

This study may be considered valuable since it is dealing with inter-industry
productivity spillover effects of FDI which has never been studied before in
Korea. The existence of such an effect provides evidence on the public good
aspects of FDI and thereby can be a rationale for governmental support for attracting
FDI. It can also be suggested that those companies that are closer to the consumers
in the value chain, i.e., companies producing final finished products are the
ones that should be the focus of governmental support to maximize the overall
benefits from FDI.

As in other cases, this study does have its shortcomings. For instance, the
analysis does not provide answers to such questions concerning the optimal amount
of subsidy and optimal choice of subsidiary measure. The study cannot separate
the enhancement of productivity due to the transfer of technology and increased
competition. The study, also, relies on high level industry classification.
For the future, overcoming these problems should be a worthwhile challenge to
those who are able.

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