(Revised 1999 -forthcoming in Continuity and Change in Asia’s Business Systems) Linsu Kim, Korea University
D. Eleanor Westney, MIT Sloan School of Management
2. Conceptual Frameworks of Technology and Business Systems:
International market/technology environment
National technology system
Firm-level organization and management
3. Technology and Business System in Action in the Electronics Industry
The role of the government
Medison Company: A rapidly growing high-technology firm
4. The Asian Crisis and Korea’s Business System in Transition
The role of the government
The restructuring of the financial sector
The reorientation and restructuring of technology infrastructure
The restructuring of chaebol
SMEs in transition
Foreign Alliances on rise
From an economic point of view, South Korea provides one of the most dramatic cases of growth in the post-World War II era. As late as 1961, South Korea’s per capita GNP was lower than that of the Sudan and less than one-third that of Mexico. By 1995, South Korea (hereafter referred to simply as Korea) had a GNP that exceeded $10,000 per capita, placing it eleventh in the world in terms of total GNP and seventh in terms of manufacturing value added. The Asian crisis had hit Korea in November 1997, but it bounced back in one year, expecting to grow at about 7% in 1999. Korea accomplished this feat without significant natural resources (such as Mexico’s oil or Singapore’s deep-water port) and with a legacy of exploitative colonization and a devastating war.
The magnitude of Korea’s achievement can be understood even more clearly from two other indicators. The first is the number of Korean firms to rank among the world’s largest companies. In 1995, Korea had twelve firms in the Fortune Global 500, tying it with Italy for 7th place among the 24 countries represented. The only other non-Triad countries to have more than one company on the list were Brazil with four and China with two. Even after the Asian crisis, nine Korean firms remained in the Fortune Global 500 in 1999 (Fortune, 1999). The second indicator on which Korea stands out among the non-Triad countries is R&D spending: Korea is the only non-OECD country to exceed 2% of its GNP in spending on research and development.
These three patterns – Korea’s economic growth, the scale and scope of its leading firms, and its aggressive investment in technology -- are inextricably linked. Indeed, we cannot begin to understand Korea’s remarkable growth rates (nearly 9% on average from 1962 through 1994) without close attention to their underpinnings in technological change in its industries. The key actors in this process were the chaebol firms. A chaebol can be defined as a business group consisting of varied corporate enterprises engaged in diversified business areas and typically owned in significant part of one or two interrelated family groups, members of which are active in management. They drew on more advanced countries for technology, first in industries that were already seen as mature and technologically stable in the highly industrialized countries, then, as their technological capabilities grew, increasingly in industries where the technology was still evolving. In this advance from outright imitation to increasing capacity for improvement and innovation, the government also played a key role, one that has changed and evolved over time.
The challenge to Korea’s business system today is to continue upgrading its technological capabilities, which will only be possible with the continued evolution of key institutions, not only the chaebol firms themselves but also government, the universities, and Korea’s small and medium-sized firms. This paper analyses the Korea’s business system from a technological perspective and discusses the prospects for the future.
2. TECHNOLOGY AND BUSINESS SYSTEMS
The term “technology” refers both to a collection of physical processes, which transform inputs into outputs, and the knowledge and skills that structure the activities involved in carrying out these transformations. That is, technology is the practical application of knowledge and skills to the establishment, operation, improvement, and expansion of facilities for such transformation and to the designing and improving of outputs from those facilities.
The term “technological capability”, therefore, refers to the ability to make effective use of technological knowledge in efforts to assimilate, use, adapt, and change existing technologies. It also makes possible the creation of new technologies and the development of new products and processes in response to changing economic environments. Technological capability has three elements: production (capabilities for operating and maintaining production facilities), investment (capabilities involved in establishing new production facilities and expanding capacities), and innovation (capabilities involved in creating and commercializing new technological possibilities, including incremental improvements in process as well as product).
For Korea, as for many Asian countries, the challenge of catching up with the highly industrialized countries in economic terms has been seen by government policy-makers and industrial managers alike as overwhelmingly a matter of technological assimilation and learning in order to improve the technological capabilities of its own firms. We much prefer the term “catching-up countries” to the widely used terms NIEs (Newly Industrializing Economies) or NICs (Newly Industrializing Countries), which seem problematic applied to countries that have been industrializing for decades. The term “catching-up country” signals two important vectors: the focus on technological catching up and the existence of what institutional theorists (e.g., Evans 1995) call a “national project” -- a widely shared goal across government and the private sector -- to narrow the technological gap with the world’s technologically most advanced countries. In Asia, Japan was the first “catching-up country.” Its success in joining the ranks of the world’s first tier countries in terms of technology defines what is possible for other countries. Korea, Taiwan, and Singapore are today’s first-tier catching-up countries in Asia; the next tier consists of the Southeast Asian economies. Hong Kong is problematic in this context, given the virtual absence of an identifiable “project” to bring Hong Kong as an economy up to the technological level of the advanced countries.
The term “business system” refers to [Eleanor, please kindly fill this part. I remember seeing a very good definition of BS somewhere, but I cannot locate it].
The process of building technological capability at the firm level in catching-up countries requires a wide array of interactions with the government, public institutions, suppliers, buyers, and competitors at home and abroad over time. In other words, it can be an important source of dynamism in the evolution of business system in these countries. For this reason, we introduce technology as a mechanism to understand Korea’s business system in action.
Analyzing the role of technology in the evolution of the business system of “catching-up” countries involves three levels of analysis: the international technology and market environment; the national technology system; and firm-level organization and management.
The International Technology Environment:
According to a widely accepted model developed by Utterback and Abernathy, industries and firms in advanced countries develop along a technology trajectory made up of three stages: fluid, transition, and specific (Abernathy and Utterback, 1978; Utterback, 1994). The fluid stage characterizes firms in a new technology, a new industry. The rate of radical (as opposed to incremental) innovation is high and production technology is often crude, expensive, and unreliable. Technical entrepreneurs form new, small firms and new venture divisions within existing firms, competing on the basis of product innovations. Product changes are frequent, so the production system remains fluid. The organization needs a flexible structure to respond quickly and effectively. Failure rates among firms are high.
As market needs are better understood and alternative product technologies converge or drop out, a transition begins toward a dominant design and mass production methods, adding cost competition to product performance competition and giving greater importance to production capability and scale economies. Strong, large firms take advantage of their capabilities in production, marketing, and management as well as R&D. In some cases, some of the original innovating firms can build up these resources; in other cases, larger firms absorb the smaller innovators.
As the industry matures and price competition grows more intense, the production process becomes more automated, integrated, system-like, and specific -- even rigid -- to turn out a highly standardized product. The focus of innovation shifts to incremental improvements in search of greater efficiency. At this stage, firms are less likely to undertake R&D oriented to radical innovations. In some cases, radical innovations may be introduced by new entrants, challenging the dominant design or production technology and putting the industry back into an earlier stage (Utterback and Kim, 1985); in other industries, firms successfully extend the life of their product with a series of incremental innovations (Baba, 1985). It is in this specific stage that industries typically re-locate to catching-up countries (Vernon 1966).
In catching-up countries like Korea, firms usually acquire specific-stage (i.e. mature) foreign technologies from industrially more advanced countries. Often lacking local capabilities for establishing real production operations, they begin through the acquisition of “packaged” foreign technology, which included assembly processes, product specifications, production knowhow, technical personnel, and components and parts. Production at this stage is merely an assembly operation, requiring engineering effort to implement the transferred technology to turn out products whose technology and market have been tested and proved elsewhere. Foreign technical assistance is most significant in debugging the problems in the early production runs, but its utility diminishes rapidly as the local technicians acquire experience (Kim, 1980).
Once the acquisition task is accomplished, production technologies are quickly diffused within the country, especially if later entrants can hire experienced technical personnel from the early acquirers. Increased competition spurs indigenous efforts in the assimilation of foreign technologies in order to produce differentiated products. Development capabilities are added to engineering (D&E) in order to develop related products by reverse engineering. Finally, the relatively successful assimilation of general production technology and increased emphasis on export promotion, together with the growing capabilities of local scientific and engineering personnel, lead to the gradual improvement of process and product technologies through local efforts in research, development, and engineering (R,D, &E). In proceeding along this trajectory of acquisition, assimilation, and improvement, firms in catching-up countries reverse the conventional sequence of R,D, &E in advanced countries.
They also reverse the sequence of the technology trajectory. Once firms have successfully acquired, assimilated, and sometimes improved mature foreign technologies in the Specific stage, they may aim to repeat the process with higher-level technologies that are still in the Transition stage in the advanced countries. Many industries in the first tier catching-up countries (e.g. Korea and Taiwan) have arrived at this stage. As they progress, they may eventually accumulate enough indigenous technological capability to generate emerging technologies in the Fluid stage and challenge firms in the advanced countries. When a substantial number of industries reach this state, the country may be seen as having joined the ranks of the advanced countries (Lee, Choi, and Bae, 1988). So far, Japan is the only catching-up country in the twentieth century to reach this stage.
This framework provides a way to think about “international time” or period effects (Dore 1973; Cole 1976) in the technological and economic development of catching-up countries. Which industries were in the specific stage, where intensifying competition over mature products increases the willingness of firms in the advanced countries to look for lower-cost locations for production? How stable were those industries (in terms of an innovation-induced return to the transition or even the fluid stage, so that technologies acquired by the catching-up country became rapidly outmoded)? Moreover, the modes, by which technologies at various stages are transferred to catching-up countries, have often been shaped by the structure of those industries in the advanced countries and the nature of competition among the firms in those countries. But they have also been strongly influenced by the national technology system of a catching-up country and by the speed at which its firms could develop and enhance their technological capabilities.
National Technology System:
A national technology system includes those institutions that shape and constrain the stock and the flow of technology in that country. In all societies the government is a key actor in the technology system, in terms of shaping the demand and supply sides of technology development. The demand side policies allocate resources to technology development, both through industrial policy and through its role as a customer in a wide range of industries. The supply side policies shape the level and kind of technical resources available, through policies affecting technology transfer, foreign direct investment, intellectual property regimes, dissemination policies, and R&D infrastructure, including government research institutes, research programs in universities, etc. There are also policies linking demand and supply in fostering specific industries (for example, in Korea’s Heavy and Chemical Industries Program 1973-1979, discussed in more detail below). Technical education and training institutions are also a major element of the stock and flow of technology in all societies, producing technical graduates and generating new knowledge through research. In some societies, professional and industrial associations also play a key role, as has been very much the case in Korea.
Government technology policies have, deservedly, received most of the attention in analyses of national technology systems (see for example the various chapters in Nelson 1993). In Korea, there has been a notable shift over time in the kind of policies used as well as the sectors towards which they have been directed. From the 1960s (the beginning of Korea’s catching-up project), the “demand side” industrial policies took the following form:
(a) Deliberate promotion of big business (the chaebols) as an engine of technological learning, through an array of subsidies and incentives;
(b) Ambitious export-oriented industrialization programs, reinforced by a combination of “carrots” -- the provision of low-interest loans, tariff-free access to imported intermediate inputs, favorable access to bank loans (banking being a state-controlled sector), and unrestricted access to imports of foreign capital goods -- and “sticks”, such as rigorous tax audits of firms that failed to follow “administrative guidance” and denial of bank loans (Kim, 1997).
(c) The targeted promotion of technologically advanced heavy and chemical industries (for a detailed analysis, see Stern, Kim, Perkins, and Yoo 1995);
(d) Market-creating import substitution policies (particularly in the computer industry in the early 1980s).
During the same period supply-side policies included:
(a) Technology transfer policies: The government gave priority to technology imports through imports of capital goods and turnkey plants, in which control over technology remained in the hands of Korean firms. The acquisition of turnkey plants and foreign machinery was the major means of entry into the chemical, cement, steel, and paper industries in the 1960s and early 1970s. In terms of total value the import of capital goods has consistently far outweighed either foreign direct investment or foreign licensing (Kim, 1997: 40-41). The government’s intellectual property policy favored reverse engineering over licensing, and licensing over foreign direct investment, especially in the 1970s. As a result, Korea had a comparatively low level of FDI: in 1983, Korea’s stock of FDI was 23% of that of Singapore and less than half that of Taiwan and Hong Kong (KEB, 1987).
(b) Government R&D Institutes (GRIs): In 1966 the government established the Korea Institute of Science and Technology (KIST) as an integrated technical center, and over the years spun off several additional GRIs in specific areas. Given the low level of research activity at universities, GRIs have served as the backbone of advanced R&D in Korea, and accounted for a large share of the nation’s total R&D funding for many years (see Exhibit 1).
By the second half of the 1980s, as both the world economic situation and the domestic political system in Korea changed, as Korea’s technological capabilities expanded, and as Korea’s economic growth made it increasingly the target of pressures from foreign governments for liberalization of its domestic market, the government changed course in several key aspects of its policies. These changes are summarized in Exhibit 1.
[Exhibit 1 about here]
The most noteworthy from the viewpoint of technology development and the business system were the following:
(a) After two decades of very restrictive policies toward FDI and only slightly less restrictive policies toward licensing, Korea liberalized its policies toward investment and technology transfer in the 1980s and 1990s. In technology-intensive sectors Korea began to encourage foreign direct investment and foreign licensing agreements (on terms that were, in contrast to some earlier agreements, much more favorable to the foreign firms). The proportion of industrial sectors open to FDI rose from 44% in the 1970s to 66% in 1984 and to 90.6% in 1994.
(b) In the 1980s and 1990s the government introduced an extensive network of government, public, and non-profit technical support systems to promote technology diffusion in the economy among and beyond the chaebols, particularly to the SMEs (Kim and Nugent, 1999). This included the Industrial Advancement Agency, the National Industrial Technology Institute, and eleven Regional Industrial Technology Institutes, together with the Small and Medium Industry Promotion Corporation. These provided a national network of technology extension services, while the Korea Academy of Industrial Technology, together with other public R&D institutes and trade association-linked institutes, comprise a core R&D network for technology diffusion. The Korea Standards Association and the Korea Productivity Center promote technology diffusion among firms through training programs on quality control, value engineering, distribution, and factory automation.
A key element of any national technology system is the system of higher education. In Korea, these institutions have focused overwhelmingly on education and very little on research. Nevertheless, the educated human resources provided by the basic educational system and the large numbers of engineers graduated from Korean universities provided an important source of technical talent. As important was the strong tradition of overseas training, particularly in the United States, dating from the early post-Korean War assistance programs. The tradition of overseas training continues to the present: the ratio of Koreans studying in the US per population is the second highest after Taiwan. In 1993 31,076 Koreans were studying in the U.S. and 13,000 in Japan. Many of these students stayed in the United States after graduation, especially in science and engineering, joining American university faculties and top U.S. companies. In recent years, both Korean firms and Korean GRIs have targeted these individuals (and Korean-Americans) for both long-term jobs and short-tern visiting assignments, resulting in the return to Korea of a high proportion of Koreans who have work experience abroad. They bring both their expertise and their networks into the North American technological community. Moreover, over 90% of the faculty at Korean universities have PhDs from U.S. universities, and often maintain their professional networks with the North American academic community.
Not strictly part of the national technology system, but a crucially important element in the evolution of technological capabilities, is the quality of human resources, more broadly defined. These are shaped by the general educational system and by a more diffuse set of values and attitudes that for want of a better term we can call “national culture,” a particularly important concept for understanding the economic and social development of a relatively homogeneous society like Korea.
In terms of general education, Korea from the very early stages of its postwar economic development has invested an unusually high proportion of its GNP in general education (see for example, Harbison and Myers 1964). By 1980 the illiteracy rate was virtually insignificant, and by 1995 Korea had one of the highest rates of tertiary education in the world, with 54.6% of the eligible age group enrolled at junior colleges or universities. Of the university enrolment, nearly half a million students (43.5%) were in science and engineering. At a lower level of technical training, the government in 1974 enacted a law making in-plant training compulsory for all industrial enterprises with 300 or more workers.
The high levels of education are not the only labor force factor influencing the rapid development of technological capabilities in Korea. Another factor is one that both reflects and contributes to “national culture”: a strong emphasis on discipline and effort, and a willingness to work extremely hard to achieve goals. Even the Japanese, who are regarded as chronic workaholics by Americans and Europeans, marvel at the long work hours and dedicated effort of Koreans (Vogel, 1991: 48). There are several explanations for this work ethic, and until we see some major changes in it we cannot begin to weigh their relative importance. One set of explanations stresses the combination of a harsh physical environment (with a scarcity of natural resources, a severe climate, and a large population in a relatively small area, only one-third of which is arable) with the recent historical experience of hardship and deprivation. The emphasis of the school system on discipline and effort is another explanatory factor, reinforced for every male Korean by three years of compulsory military service in a context where the threat of invasion is by no means illusory. And there is a strong national sense of wanting to beat the Japanese, the former (and much-resented) colonial power. Japan provides both an example of what can be accomplished and a target for Korean competitiveness. Finally, and most elusive, Korean scholars have identified what they call the “han psyche”. Literally this means “resentment” or “grudges.” It is rooted in a Confucian-based status system requiring children in the family, employees in the company, and people in society generally to behave with outward respect towards fathers, superiors, and rulers, regardless of any feelings of unfairness or frustration. This inability to change the context of action, and the need to excel in order to win approval from authority figures, produces enormous energy that is directed towards tenacious efforts to strive for the betterment of one’s family and one’s country. The image of the tenacious, almost driven Korean, is grounded in reality, as we shall see when we turn to Section 3 below.
National technology systems, of course, also include the technology development organization at the level of the business enterprise, to which we now turn.
Firm-level organization and management:
At the firm level, two organizational subsystems are of critical importance in the development of technology: the production site (the factory or plant), and the R&D laboratory. In catching-up countries, the enhancement of technology capabilities usually focuses at first on the production site, as mature technologies are adopted from more advanced countries and the development of capabilities focuses on production technology (the assimilation stage). Formal in-house training programs and on-the-job training are of critical importance in expanding capabilities at this level.
As capabilities expand, larger firms often build up substantial engineering departments in their production sites, whose growing technological strength leads to the gradual improvement of the assimilated technology. Over time, firms invest in full-scale R&D laboratories that have the mandate of original technology development.
In Korea’s technological development the firms in the large diversified enterprises, the chaebols, have been the most significant actors in technology development at the level of the business enterprise.
The government played a key role in their early development, because large organizations were considered necessary to marshal the scale economies inherent in the “mature technologies” which were the target of the government’s plans for economic growth. In the early postwar years, the government sold Japanese colonial properties and state-owned enterprises to selected local entrepreneurs on favorable terms. The government then provided these entrepreneurs with scarce foreign exchange and preferential access to financial capital; it also handed them the responsibility for large import-substitution projects, for which these entrepreneurs imported production technology on a turnkey basis, using foreign loans guaranteed by the government. As a result of government support and their own efforts in building on this base to expand their competitive capabilities, the chaebols have come to dominate Korea’s industrial scene and to stand out as world class multinational companies. By 1995, Korea stood alone among Third World countries in having privately-owned, non-petroleum industrial corporations listed in the Fortune Global 500. All six of the largest chaebols had firms on the list: Daewoo, Samsung (3 firms – Samsung Inc., Samsung Electronics, and Samsung Life), Ssangyong, Sunkyong, Hyundai (with 2 firms, Hyundai International and Hyundai Motor), and LG (2 firms -- LG International and LG Electronics).
The government has managed the chaebols relatively effectively compared with other catching-up countries: good performers were rewarded by further opportunities for expansion, and poor performers were allowed to flounder and even go under, being taken over by better-managed groups. As a result, only three of the ten largest chaebols in 1965 -- Samsung, LG, Ssangyong -- remained on the same list ten years later; in 1985, 3 of the 1975 list were no longer among the top ten.
The chaebols played a crucial role in the rapid enhancement of technological capability in Korea. They were well positioned to attract the best university graduates; they had the resources to identify, negotiate, and finance the acquisition of foreign technology and its subsequent improvement. And they played a major role in expanding and deepening R&D activities in Korea in the 1980s and 1990s, setting up R&D laboratories and luring some of the best Korean and Korean-American scientists and engineers from the U.S. back to Korea. As late as 1980, government expenditures on R&D dwarfed those of Korean industrial firms, accounting for 64% of the country’s R&D spending. By 1993, 83% of R&D expenditures were coming from the private sector, and Korean R&D spending had reached 2.33% of GNP, putting it into the ranks of the highly industrialized countries in terms of R&D spending. For this rapid evolution, the chaebols were largely responsible.
[Exhibit 2 about here]
The chaebols played a key role in the technical labor markets in Korea, especially in their willingness to hire technical experts from each other. This is a marked contrast to the Japanese firms, whose unwillingness to hire mid-career personnel with experience at competing firms remains one of the major sources of immobility in Japanese technical labor markets. Particularly in fast-moving arenas of technology, the chaebol firms showed no compunction about poaching technical talent from their competitors in order to speed up their absorption of externally developed technology.
An abstract description of these different levels of analysis has much less immediacy than a detailed examination of the interplay across the levels in the context of technology development over time in a specific sector. The following section looks at technological change in one of the sectors in which Korean firms have become major international competitors, the electronics industry.
3. TECHNOLOGICAL EVOLUTION IN THE ELECTRONICS INDUSTRY
The first electronics product actually made in Korea was a vacuum tube AM radio assembled in 1958 from imported components for the domestic market. Just over three decades later, by 1990, Korea had become the world’s second largest producer of consumer electronics after Japan, and by 1994 it ranked fourth in the world as a producer of electronics more broadly defined, after the U.S., Japan, and Germany. Although small and medium sized firms have grown enormously in numbers in recent years, the industry’s growth has been driven by the leading Korean chaebols, four of which -- LG, Samsung, Daewoo, and Hyundai -- have dominated production and exports.
Korea’s first electronics producer was GoldStar (now LG Electronics, the name that will be used somewhat anachronistically throughout this narrative, to avoid confusion). The owner of Lucky GoldStar, a small face cream and plastic houseware company, sensed an attractive business opportunity in this sector, which was protected from foreign-built imports. He took an observation tour of several leading electronics firms in Japan, Europe, and the United States, and virtually simultaneously hired an experienced German engineer to provide the technical knowhow to begin production. The initial operation was the small-scale assembly of foreign components into the country’s first vacuum tube AM radio, largely through imitative reverse engineering of a Japanese model. The German engineer played a key role in this early stage, ordering the necessary production equipment and training Korean technicians and assembly line workers. Within a year, relatively well-educated Korean engineers were able to replace the German, in part because assimilating the product design and assembly operations was relatively simple (Goldstar, 1993). Goldstar, as the company was then known, followed the same pattern of reverse engineering and gradual accumulation of knowhow to produce other home appliances, such as electric fans and refrigerators, without foreign assistance or formal technology transfer processes.