Case Study

The Payoffs and Perils of IT Industry Policy

Policymakers are widely credited with making South Korea an IT powerhouse and one of the world's most connected countries. It ranks a respectable 19th in the 2011 IT Industry Competitive Index. But government efforts to foster a competitive IT sector have come in for plenty of criticism, too.

No doubt, the IT industry is the driver of South Korea's economic success. The Asian country is today the world' biggest producer of memory semiconductors and display panels and the second-biggest maker of mobile phones. According to the Ministry of the Knowledge Economy (MKE), IT exports increased from US$5m in 1970 to US$154bn in 2010 and now represent 33% of total exports. The IT sector accounts for about 11% of GDP, compared with just 0.01% 40 years ago.

MKE officials stress that the key to this success is effective collaboration between the government and the private sector. A good example is in the rollout of super-fast broadband networks, which will be crucial in the era of cloud computing. By establishing firm targets for speed and coverage, and providing incentives such as a favourable tax regime, the government has encouraged the private sector to invest the bulk of the funds needed while ensuring competition does not suffer.

The government's efforts in the educational area are also laudable. One initiative is to promote cooperation between businesses, universities and research institutions. An "IT mentoring" program gives students the opportunity to gain experience in a commercial environment. At the same time, the government tries to ensure that businesspeople are involved in shaping university curricula. All of this is aimed at matching the needs of the IT sector with the educational system.

Nevertheless, South Korea has acquired a reputation over the years for protectionist policies that favour chaebols, like Samsung, and discourage foreign direct investment. In 2009—the last year for which actual data were available—South Korea ranked lower than any regional peer apart from Japan in terms of inward direct investment as a percentage of GDP (see chart; although not industry-specific, this statistic is almost certainly reflective of foreign investment in the technology industry, which in South Korea accounts for a large share of economic output). The MKE puts its hand up for "causing controversy over discrimination against foreign enterprises", but insists it has recently expanded the scope of sectors open to foreign investment and is trying to create an environment of fair competition for foreign companies.

Inward FDI as a % of GDP, 2009
Inward FDI Chart
Source: Economist Intelligence Unit

A related criticism is that policymakers have promoted technologies with limited commercial appeal simply to bolster the chaebols. The classic example—albeit from the telecoms industry—is of WiBro, a mobile broadband technology developed largely by Samsung. The government essentially forced Korea Telecom and SK Telecom, the country's two biggest operators, to launch WiBro despite their own preference for more established 3G standards. As both operators now start migrating from 3G to LTE, a so-called '4G' technology, the money spent on WiBro appears largely to have been wasted.

Perhaps the biggest problem the government has created is a cultural one. Chaebols like Samsung have become so powerful that smaller domestic firms have been squeezed out of the picture almost entirely. As a result, South Korea's brightest students have seen little incentive in becoming entrepreneurs. The government now says it is pursuing policies to nurture creative IT talent and provide greater support to small and medium-sized firms. Supporting alternative sources of innovation to ageing technology giants seems eminently sensible.