A second important source of efficiency improvement is the reallocation of resources from less productive toward more productive sectors. A notable example is the migration of labor and capital from agriculture to manufacturing, from light industries to HCIs, and from rural to urban areas. The economy-wide productivity improves when such migration proceeds without much difficulty. On the other hand, productivity improvement is constrained when such migration is hindered by an inflexible labor market, geographic immobility of factor inputs, government protection of declining industries and unprofitable businesses, inefficient financial intermediation, or inadequate supply of infrastructure to support the growth of cities.
In Korea, the rapid structural changes recorded in the past decades (Figures 3-1, 3-2, 3-3) indicate that resources have been reallocated quite flexibly across sectors. According to Jong-il Kim (1998), the TFP growth in 1970-1986 was 1.45 percent per year, of which 0.74 percent was attributable to technological progress and 0.71 percent to resource reallocation, implying that the latter was as important as the former in productivity improvement.
In the labor market, Kim and Topel (1995) report that labor mobility was high not only between rural and urban areas but also within manufacturing during the period of rapid economic growth (the 1970s and the early 1980s). In the 1990s, the flexibility in employment and sectoral mobility somewhat declined as the supply of young workers from rural areas fell off (Ju Ho Lee and Dae-Il Kim, 1997).
Geographic mobility has been also high as can be inferred from the rapid urbanization trend (Figure 3-10). The Korean government has made consistent efforts to expand urban infrastructure to accommodate the increasing population. As a percentage of GDP, the current level of government capital stock across the country compares favorably with those in major economies (Joonook Choi, DeokHyun Ryu and Hyungsoo Park, 2005). 1)
Figure 3-10. Urbanization trend
At the same time, however, the Korean government impeded the market-based resource reallocation with directed credits, the promotion of HCIs, repeated bailouts of insolvent firms, and the protection of SMEs. Perhaps more importantly, the long period of financial repression stunted the development of an efficient system of financial intermediation and weakened the competitiveness of the financial sector. It is still being debated whether these interventions accelerated or hampered the economic growth and structural changes.
In understanding the nature of resource reallocation, one question remains. Other than government influences (intentional or unintentional), what drives the reallocation? An immediate answer would be the high profitability in high-productivity sectors that lures capital and labor into these sectors. But when the market size is limited, the extent of reallocation will also be limited. 2) International trade in this regard enables a country to overcome the limited size of its domestic market, and stimulates a further reallocation of resources toward its areas of comparative advantage. Korea would not have been able to expand its manufacturing sector to the present degree without the opportunities offered by international trade.
The meaning of comparative advantage needs some elaboration. Traditionally, factor endowments were believed to determine the comparative advantage of a country. But they cannot explain the recent increase in intra-industry trade, and economies of scale is now receiving greater attention as a determinant of comparative advantage (Gill and Kharas, 2007, p.13). Products with small differences still fall under the same broad industrial classification, yet may be made in different countries and traded for each other. With increasing returns to scale, trade allows the exploitation of technological advantages by increasing the market size, and encourages specialization in production. Specialization in turn promotes innovation and reinforces the comparative advantage. The Korean economic growth in the past decades is well described by such a dynamic development of comparative advantages.
Source : SaKong, Il and Koh, Youngsun, 2010. The Korean Economy Six Decades of Growth and Development. Seoul: Korea Development Institute.
1) Infrastructure investment is discussed in Chapter 5 of this book.
2) It should also be noted that productivity growth can reduce rather than increase employment as in the case of retail services.
Again the critical question is the market size.
· Kim, Jong-il,“ The Sources of Growth of Korean Industries and their Productive Efficiency,”Kyong Je Hak Yon Gu, Vol. 4, No. 3, March 1998, pp.3-24 (in Korean).
· Kim, Dae-Il and Robet H. Topel, “Labor Markets and Economic Growth: Lessons from Korea’s Industrialization, 1997-1990,”in Richard B. Freeman and Lawrence F. Katz (eds.), Differences and Changes in Wage Structure, The University of Chicago Press, 1995, pp.227-264.
· Lee, Ju Ho and Dae-Il Kim, “Labor Market Developments and Reforms in Korea,”KDI Working Paper, No. 9703, March 1997.
· Choi, Joonook, Deockhyun Ryu and Hyungsoo Park, The Sectoral Allocation of Government Functional Expenditure, Korea Institute of Public Finance, 2005 (in Korean).
· Gill, Indermit and Homi Kharas, An East Asian Renaissance: Ideas for Economic Growth, World Bank, 2007.