The Bank of Korea (BOK), the nation's central bank, sounded a "discouraging" note early this year regarding a comparative analysis of the export structure of Korea and Taiwan. The data indicated, among other things, that Korea has maintained a deficit in international trade since 1990 while Taiwan has gone in the black in this regard. The bank ascribed the continuing trade imbalance to the underdeveloped state of Korea's machinery industry.

During the 1990 to 1996 period, Taiwan posted an average annual trade surplus of US$10.5 billion, while Korea registered a shortfall of US$ 8.3 billion. Korea's trade imbalance reached its highest-ever point at US$20.6 billion while Taiwan marked US$14.7 billion in surplus, the highest since 1987 when it registered a surplus of US$18.7 billion. The BOK pointed to the gap in the level of development of their respective machinery industries as a significant factor in explaining the difference between the trade balances of the two nations. The report went on to elaborate that the widening trade imbalance for Korea during the same period, despite a relatively high annual export growth rate of 11.0 percent compared to 8.3 percent for Taiwan, has been due to its heavy reliance on imports to meet its needs for basic machinery equipment. Business sources share the viewpoint that Japan, despite the high appreciation of its yen, has managed to sustain strong competitiveness in international markets due to afirmly based machinery industry as the mainstay of all industries. Accordingly, they say, it is high time for Korea to focus on fortifying competitiveness in the capital goods industry, particularly in the field of machinery, in order to sustain its remarkable economic progress.

There are some 800,000 small and medium-sized companies (SMCs) in Taiwan about half of which are related to machinery production. The SMCs are responsible for 90 percent of the nation's total production and 70 percent of its exports. This sharply contrasts with Korea where more than half of domestic machinery production is undertaken by large companies known as "chaebols" or conglomerates.

The capital goods industry encompasses all activities responsible for the manufacture of machinery goods, components and material. Such is its bedrock function it determines the competitiveness of all industry. Technology-intensive industry focuses on the development of technique, progress and quality rather than on quantity and prices. It is difficult for developing nations to acquire the technology they need to remain competitive; developed nations, meanwhile, are leaders in world markets. It is often cited as an industry advantageous for Korea to develop since it will enable domestic manufacturers to gain access to other overseas markets without running up against trade barriers, and allow them to expand exports on a stable basis once the industry is competitively equipped.

The Import Trap

The structural problem that haunts the Korean economy is the fact that increases in exports and investment have also led to rises in imports. This is because the nation has depended upon imports from developed nations like Japan, in particular, to supply the bulk of its capital equipment. The nation last year exported US$62.9 billion worth of capital goods while importing US$72.7 billion worth, producing a trade shortfall of US$9.8 billion in this sector, or 48 percent of the total national trade deficit.

According to research recently conducted by the Federation of Korean Industries (FKI), a one-percent increase in facility investment will lead eventually to a 1.05 percent rise in imports of related goods. Some analysts even say the current continuing economic downturn can be traced to the structural weakness of the nation's capital goods industry. The size of trade deficit in the area of capital goods industry becomes even larger when the semiconductor industry is excluded from the reckoning, reaching in this case US$17.1 billion last year compared with US$15.4 billion and US$9.6 billion in 1995 and 1994, respectively.

Market watchers cite the need for Korea to take measures to strengthen the competitiveness of its capital goods industry especially since its admittance to the Organization for Economic Cooperation and Development (OECD). Noh Jae-min, director of industrial machinery division at the Ministry of Trade, Industry and Energy (MOTIE), took a bright view of the nation's capital equipment industry because of the expansion in the size of investments. "Imports of capital goods have increased continuously because domestic makers have failed to meet the growing demand for related goods against a background of continuing economic development," he said. "However, the nation has managed to go into black ink in the trade of capital goods to the sum of US$150 million in August this year, due mainly to a decline in investment in facilities as a result of a general economic slowdown and steady efforts since 1986 to domestically manufacture capital goods."

Avoiding the Black Ink

Industry observers, though, share the opinion that the nation will not be able to escape the current economic downturn and narrow the widening trade imbalance unless it takes steps to fortify the competitiveness of the capital goods industry. "Bolstering the capital goods industry is one of the most viable measures to resolve the current economic downturn from a mid and long-term perspective," said Song Jang-joon, researcher of the Korea Small Business Institute. "This is because the capital goods industry requires high technology and quality manpower and is no danger of being outperformed by the developing nations for a considerable time to come. Because the industry is characterized by small production runs of multiple items, nurturing the industry will also help fortify cooperation between small and medium-sized companies on the one hand, and the large ones on the other."

Han Jae-young, a researcher for the Korea Institute for Economics & Trade said: "The level of the capital goods industry reflects the level of a nation's total industry." Touching upon the measures to develop the industry, he cited the need to link technology and demand, raise the expertise of top management, so encouraging product development and mandating related institutes with the mission of monitoring industry trends at the private level.

Experts say the upgrading of the capital goods industry has become one of the most pressing national tasks in order to reinvigorate the ailing national economy and spur technological self-reliance. There do, however, remain many barriers in the forms of the necessary financing, manpower, marketing and quality certification. The Korean government has recently presented measures designed to enhance the competitiveness of the capital goods industry, focussing on increasing the ratio of domestic production of capital goods through technological development, a move which to some extent has injected some fresh air into the industry. A special feature of the measures presented by MOTIE include an arrangement under which SMCs and conglomerates cooperate to develop related technology.

The Synergy Effect

The aim is to transform the capital goods industry into the locomotive force behind an export drive calculated to last beyond the year 2000, even though it has been the main cause of the widening trade deficit so far. The ministry's decision is recognition that the development of the capital goods industry is virtually impossible without assistance at state level. The proposals the ministry submitted last May for the purpose of invigorating the capital goods industry are good examples in this respect, featuring steps designed to boost demand, introduce foreign investment, provide information, assistance on manpower exchanges and the location of production sites. The steps also aim to maximize the synergy effect by expanding assistance in all related sectors such as electronics, machinery and automobiles, and set up a systematic network linking product development and marketing.

For the purpose of acquiring needed technology at the earliest date possible, the ministry has been pressing ahead with steps to induce investment from developed nations like Japan, in particular, and bolster the SMCs as the basis of the capital goods industry. The ministry is continuing direct assistance to the industry in terms of financing the purchase of machinery from domestic and overseas suppliers. The ministry expects a successful revitalization of the capital goods industry will lead to a decrease in the trade imbalance, save production costs, create new jobs, and enhance the technological advantage of individual businesses, despite the fact such an undertaking requires a huge amount of investment, a high level of technological development and systematic state-level assistance.

Image Problems

The relatively small domestic market has sometimes been cited as a handicap to the effective development of the capital goods industry, since developers of new technology or products have failed to collect a return on their investment due to a lack of demand. Industry sources say this situation could inhibit technological development, prompt a sharp rise in foreign machinery imports and undermine the domestic production base. Most experts though express strong opposition to such gloomy prognostications. The FKI last year published the results of a survey of 55 buyers and 125 manufacturers of capital goods, showing Korea's technology level stands at 80.3 percent compared with that of Japan and its quality level at 75 percent. The prices of domestic products were found to be 75 percent those for Japanese goods but local buyers revealed intentions to buy Japanese, reflecting a serious distrust of domestic products. Experts say the distrust in part has curbed efforts toward technological development in the industry.

A small textile machine company based in Taegu experienced a major setback in early 1990 when it made a massive attempt at technological development and facility investment. The company-developed yarn machine was considered equivalent to a comparable Japanese and Italian models, which then dominated the world market. At that time, the company judged it had sufficient scope for exports with the opening of the Chinese market and the government's drive to reinvigorate light industry. Although the company embarked on production at full throttle, customers were not lining up to buy the machines. On the contrary, many textile firms were in the process of moving their production facilities, brought mostly from Japan, to overseas low-wage areas to escape high labor costs at home.

The CEO of the Company, Mr. Kim, persuaded potential buyers to purchase the company's products, offering them at lower prices and claiming they had better productivity compared with used competing Japanese models. Despite his efforts he got the cold shoulder from his prospects who explained that they could not buy his machine because they could not be assured of its quality without the appropriate certification.

The distrust of domestic machinery also exists among the conglomerates. In reference to the situation Minister of Trade, Industry and Energy Lim Chang-yeul recently commented, "It appears that the companies have severe distrust of domestic machines as evidenced by the fact that exports of general machines increased 1.7-fold during the 1993-1996 period although the orders plant exports rose 4.5-fold during the same period, indicating the accompanying machinery thus sold must have been imported. We cannot narrow the trade gap if we opt for only foreign goods, shunning those made by the local manufacturers." Technological development ,he said, must be a priority for the growth of the capital goods industry.

There is an industry consensus, though, that such development, though, should be supported by a basis of stable demand, and the first step should be a change in perception about domestic products. "The economic structure will become extremely feeble unless there be balanced development between consumption and capital goods industries," said an industry observer. "Although Korea has led the world's semiconductor market thus far, the sharp drop in product prices has prompted a serious crisis throughout the entire economy." He added: "Should the government neglect the capital equipment industry, the semiconductor industry may face a serious crisis as seen in the case of textile industry."

Kim Soon, vice president of the Korea Association of Machinery Industry commented: "The size of the nation's capital goods industry is not small by any standards. New markets can be created should the industry aim to take 30 percent of the US$150 billion domestic market, let alone take a share of the US$2 trillion world market. Assistance at the state level is urgent since the nation's industry is still at fledgling level." Experts underline the importance of joint technology development between enterprises, the standardization of components, and cooperation in production and marketing between large and small businesses. However, the situation on the ground is not encouraging.

Cooperation Needed

Despite efforts since 1990 to encourage joint technology ventures, the machine makers have failed to see tangible results so far. Competition should focus on the areas of design and function and companies need to agree on the standardization of components, initiatives through which they will be able to significantly raise their technological advantage. No company to date, though, appears ready to cooperate fully with its peers for fear company information will be leaked and technology lost to others in the process.

Problems also exist in the relation between small and large companies. Take a company based in Seoul, for instance, in the business of manufacturing parts for heavy equipment and supplying them to large companies The president of the company has lately been in trouble due to reports that a major client, inspired by the brisk sales of the product, is considering building the same type of machine as those produced by the company.

The lack of cooperation between the small and large firms has militated against concentration of efforts toward technological development, due to the extra demands of marketing and after-sales service. Most owners of small companies are those who once worked as engineers at large firms. Although equipped with high-level technology, they cannot allow themselves to focus solely on development because they also have to market their services and products. Business sources underline the need for small firms to work on technology and large ones to focus on sales through their vast marketing networks. "In order to see the growth of the capital goods industry, the close cooperation between small and large companies is essential," said director Nho Jae-min of MOTIE. "The large companies, in particular, need to buy domestic products to establish the small businesses as stable sources of supply. This is more important than the governmental assistance. The ministry will concentrate on building cooperation between enterprises,"

Within the nation's capital goods sector, the machinery industry in particular has posted a remarkable growth since the 1980s. Industry production rose 28.3-fold during the 1980-1996 period and its share in the total manufacturing sector increased from 11.7 percent to 30.2 percent. The increase in production has surpassed the growth of imports, pushing the self-sufficiency rate from 63.1 percent to 72.5 percent during the same period, greatly contributing to narrowing the trade shortfall. Automobile and shipbuilding have become representative cases of the development of Korea's machinery industry, which have emerged as the world's sixth and second largest, respectively.

In addition, the machinery industry has contributed considerably to the remarkable economic growth of the nation with annual growth rates of more than 10 percent. The contribution of the machinery industry to the gross national product increased from 3.3 percent annually in the 1980's to 13.3 percent in 1996. Since the industry began increasingly to introduce technology from developed nations in the 1970s, their production technology has reached a considerably high level. The large companies' technology in assembly and processing is almost equivalent to the level of developed nations, while technology in manufacturing material and components by small firms still lags behind major industrialized nations. Lack of expertise and investment have hampered the effective development of related technology.

Govt. Lends a Hand

The Korean government submitted a package of measures for the development of the capital goods industry in May, 1995 during a meeting on the subject of pursuing the "new economy. "The relatively weak basis of the Korea's capital goods industry stems from the nation's dependency upon imports at the start of the nation's industrialization drive in the early 1970s. Due to government efforts to increase the domestic production of machinery goods and components, some 4,202 items out of a total of 7,032 target items were successfully developed. To this end, the government extended US$785 million to 4,087 companies from the industrial assistance fund.

The initiative was credited with allowing industry to substitute imports with domestic products to the value of US$11.8 billion between 1986 and 1994. The ratio of reliance upon imports of machinery, parts, components from Japan dwindled from 57.4 percent in 1986 to 38.7 percent in 1994. Despite these efforts, the trade imbalance in the sector continued to increase amid increasing amounts of investment in the face of weak competitiveness. The trade gap which stood at US$10.1 billion in 1995 soared to US$20.6 billion in 1996. The trade imbalance in the capital goods area widened to US$ 9.8 billion last year, compared with US$2.4 billion the previous year. In particular, the shortfall in trade with Japan amounted to US$15.7 billion and US$15.6 billion in 1996 and 1995, respectively. However, the trade gap with Japan in the capital goods sector further increased to US$17.2 billion last year, up from US$16.7 billion in 1995.

The Korean government has embarked on a number of measures designed to induce foreign investment in capital goods, by for example, offering significant breaks on the cost of land in industrial complexes. The administration has also permitted exceptional imports of machinery, parts ,etc., by foreign companies operating in the industrial parks for foreigners and extended the permissible stay period for foreign workers from four to six years to a maximum of 18 years. The "one-stop service" system under which foreign companies can get enhanced service in regard to their efforts to start businesses here is part of the same initiative. And missions were dispatched to developed countries like Japan, United States, EU to induce foreign investment in the capital goods industry of Korea. The result of these efforts was that foreign investment in this sector rose to US$3.23 billion in separate 596 cases in 1996, compared with US$1.317 billion in 1994. "Currently the investment climate for Korea in the sector of the capital goods is extremely positive due to the prospects for market growth," said Noh Jae-min, director of industrial machinery division at the Ministry of Trade, Industry and Energy (MOTIE). "This is because businesses are focusing attention on the domestic capital goods industry to supply their needs, plus the government has pressed ahead with plans to revitalize what has been a lusterless industry. In addition, governmental efforts to induce foreign investment have begun to pay off." Mr. Nho said foreign companies from their base in Korea are in a position to target the Southeast Asian nations and China with their huge potential buying power, as well as the home market.

The Quest to Upgrade Technology

Market watchers share the opinion that Korea can overcome its weakening competitiveness in international markets by enhancing technological capability primarily in the area of capital goods. They say the nation's capital goods industry will continue to increase its trade surplus with the Southeast Asian countries, citing that it registered a US$13.6 billion surplus with them last year, although the industry last year posted a US$26.3 billion deficit in trade with developed nations like the United States and Japan.

The case of a small precision engineering firm presents an example of the situation faced by Korea's capital goods industry. The company, which specializes in special bearings for automobile, became disadvantaged several years ago when it failed to capitalize on its high-priced imported machines. Since the business began, its management felt it had no need to worry about operational and production strategies because of the volume of orders it had secured.

However, it failed to operate the machines because of lack of qualified manpower and the firm had to import progressively more components as its production grew since it failed to find such parts on the domestic market. Contrary to expectations, the company has not developed into a mid-sized company in the sector and still feels unstable because of the frequent shifts in industry-based technology. The number of machine-tool patents in the capital goods sector Korean companies were awarded in the United States totalled 52 from 1963 to 1994, compared with 319 acquired by Taiwanese firms over the same period. On the other hand, machine-tool patents registered by the domestic industry in Korea itself rose to 408 during 1990-1995 period although registrations amounted only to 165 from 1980 to 1989. Because 97 percent of the capital goods-related enterprises are small and medium-sized companies with less than 100 employees, they have generally failed to recruit high-quality manpower needed for sustained technological development within the industry. The proportion of total turnover devoted to research and development in the general machinery sector stood at only 3.05 percent in 1994, compared with 5.19 percent, 3.34 percent and 4.18 percent in the areas of electricity, transportation machines and precision machines, respectively.

According to research conducted by the Korea Association of Machinery Industry, the level of Korea's industrial technology in key areas such as design is only 45 to 58 percent that of advanced nations. Similar research made by the Korea Development Bank shows the nation's technology lags that of the United States, Germany and Japan by more than 10 years. The poor development in the capital goods area has been the major obstacle to the nation's bid to continue its economic progress and industrial growth. Lack of the necessary technology in the sector of machinery facilities and plant has been the main cause of increasing imports of machinery goods despite a rise in exports.

Getting the Mark

Fortunately, however, the Korean capital goods industries is now showing keen interest in the development of its related technology, as evidenced by the rush of companies to acquire the EM (Excellent Machine, Mechanism, Material) mark and NT (New Technology) mark. The Korea government began implementation of the EM mark system in 1995 under which a certificate is awarded to companies in the capital goods that succeed in developing high-quality technology and products. The procedure can take two months at the least and eight at the most to subject the products to the necessary quality checks. Certificated companies can get loans from the Korea Technology Financing Corporation of up to US$ 3.3 million without collateral and are offered various advantages by the government such as the opportunity to bid on contracts. The New Technology mark system, designed also to promote technological development by mainly small and medium industries, was introduced in May, 1993. Those acquiring the certification from the Small and Medium Business Administration also receive advantages in term of financing and marketing. The number of firms which acquired the EM mark increased in 1996 to 101 for 166 items, up from 51 firms for 70 items in 1995. As of the end of August, the number of the firms awarded the EM mark this year was 64 for 101 items. In the case of NT mark, last year, some 33 companies received the certificate in 34 items, compared to the 28 firms which received it for the same number of items the year before. As of the end of August this year, the number of firms awarded the certificate reached 29 for 31 items. A total of 491 enterprises representing 899 items have applied for the EM mark so far, of which 216 for 337 items have received it. In total, 523 firms representing 625 items have applied for the NT mark of which 157 for 165 items have been successful. The companies' rush to acquire the certification is ascribed to various kinds of incentives offered by the government in the form of financial assistance and access to its procurement system. In addition, the certification serves to enhance their image and competitiveness in overseas markets.

According to a survey conducted by the National Institute of Technology and Quality on 168 companies which had received the EM mark by the end of 1996, their turnover increased to 634.8 billion won in 1996, up by 53 percent from a year earlier, while in the same year their exports had risen to US$409 million, an increase of 68 percent from 1995. Industry observers believe bright prospects are in store for the Korean capital goods industry should the current level of governmental assistance and the efforts by the industry to strengthen its competitiveness continue. They point out, too, that foreign capital goods companies investing under the current situation through joint ventures and technological cooperation are expected to reap huge profits. In addition, an increasing amount of foreign capital is expected to flow into the country with the continuing liberalization of the domestic market, further brightening the prospects for the nation's capital goods industry. "It is very difficult for the capital goods industry in general and the machinery industry, in particular, to effect massive production because the number of items required is so varied and specialized, and machinery needed is so complicated," said Dr. Lee Kong-rae of the Science & Technology Policy Institute. "So, there are many items more suitable for development and manufacture by small and medium companies rather than the large ones. The government's emphasis on simultaneously advancing the venture businesses and the capital goods industries is accordingly expected to produce good results." He went on to say that manufacturers need to concentrate on expanding exports rather than focussing their energies to the domestic market with its attendant limited demand base. "The capital goods industry grows normally when the development of an economy reaches a certain level, so Korea's capital goods industry has experienced a rapid growth thanks, to some extent, to the development of the Korean economy," Dr. Lee said.

by Soo-Deuk Sohn