Vertical Integration, Firms’ Entry, Exit, Strategic Shifts, Age, and The Productivity Growth in Korea's Core Growth‐Leading Industries
| Author | Mi Kyung Pai |
| Date | 01 October 2019 |
| DOI | http://doi.org/10.1111/1468-0106.12182 |
| Published date | 01 October 2019 |
VERTICAL INTEGRATION, FIRMS’ENTRY, EXIT,
STRATEGIC SHIFTS, AGE, AND THE PRODUCTIVITY
GROWTH IN KOREA’S CORE GROWTH-LEADING
INDUSTRIES
MIKYUNG PAI*Kyungpook National University
Abstract. This study attempts to measure the impact of firms’entry, exit, strategic shifts, and age on
the productivity growth of Korea’s three core growth-leading industries and their vertical integration
with capital share (VI) firms and non-VI (NVI) firms in view of the 2008 global financial crisis and
the institutional push by the Korean Government. A stochastic frontier production model was ap-
plied to firm-level panel data from 2006 to 2011 for Korea’s automobile, electronics and general ma-
chinery industries. The results show that exogenous shocks to the market triggered large-scale
resource reallocations from firms with declining productivity to firms with less declining or rising
productivity, and market share reallocation between VI firms and NVI firms. The Korean Govern-
ment’s institutional push led the productivity growth of NVI firms to reach their highest levels in
2010. In a VI structure, a structure comprising VI firms only, the agency problem dominated the syn-
ergies of secure supply chains and saving on transaction costs, while NVI firms endeavoured to raise
their productivity to step into a VI structure to secure stable supply chains, only to find their R&D
initiatives stagnated once they took on the VI structure. Therefore, efficient resource reallocation is
hindered by the agency problem within the bounds of vertically integrated industrial structures.
1. INTRODUCTION
Korea’s automobile, electronics and general machinery industries have been the
main driving force behind the country’s export-driven economic growth. In
2014, automobile exports comprised 13.6% of Korea’s total manufacturing ex-
ports, while the respective exports shares of general machinery, IT products
and IT parts and components were 8.5%, 8.6%, and 17.3%. In 2014, the elec-
tronics, automobile and general machinery industries accounted for the largest,
second-largest and fifth-largest shares of Korea’s exports, respectively.
The Korean automobile industry retains a strong vertically integrated indus-
trial structure that comprises manufacturers of assembled vehicles and suppliers
of automobile parts and components. A couple of assembled-vehicle manufac-
turers are locked into monopolistic competition, while a large number of small
and medium-sized automobile parts and components suppliers form a
subcontracting hierarchy of first, second and third-level suppliers. The Korean
electronics industry, in comparison, exhibits a less vertically integrated and more
*Address for correspondence: Department of Economics and Trade, Kyungpook National Univer-
sity, 41566, Daegu, Korea. E‐mail: mkpai@knu.ac.kr. I would like to express my sincere gratitude
for the support I have received from Professor Jeffrey Bishop Nugent at USC. Without his keen
insight into Korean manufacturing industries, this work would not have been possible. I am also
deeply thankful for the substantial micro panel data set provided by the Statistics Korea and Korea
Statistics Promotion Institute, the valuable comments from Dr Hang Koo Lee on the fieldwork of
key manufacturing industries at the Korea Institute for Industrial Economics and Trade, and the
thoughtful support from Min Ji Kim at Oxford University and Christine Kim at Simprints, especially
the anonymous referees without whose input I would not have clarified the content of my paper.
Pacific Economic Review,••:•• (2016)
doi: 10.1111/1468-0106.12182
© 2016 John Wiley & Sons Australia, Ltd
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© 2016 John Wiley & Sons Australia, Ltd
Pacific Economic Review
, 24: 4 (2019) pp. 511–549
doi:10.1111/1468-0106.12182
open industrial structure relative to the Korean automobile industry, given its
products’relatively short life cycle and consequent various and changing parts
and components. Finally, among Korea’s three core growth-leading industries,
the general machinery industry shows the least strong vertically integrated in-
dustrial structure. However, the vertically integrated industrial structures of
these three industries are acknowledged as being both unparalleled and unprec-
edented relative to those seen in comparable industries in other countries.
In practice, at the pinnacle of the vertical integration, original equipment
manufacturers (OEMs), namely, Jaebol, partner subcontracting firms, operated
under the mutual understanding that both had incentives to sustain a long-term
stable business environment, to maximize their respective profits and ensure
market survival.
However, these long-term business partnerships become tainted over time,
due to the excessive bargaining power of Jaebol in business dealings that result
in the minimization of small and medium-sized subcontracting firms’profits to
sometimes one-third of those of the Jaebol.
This alarming profit gap demands the urgent attention of Korea’s policy-
makers, who must look to create a more balanced profit-sharing system between
these two currently unequal business parties, and they also need to revamp the
overall institutional system to ensure fair trade and competition.
Therefore, within the bounds of a vertically integrated industrial structure,
firms can be split into two groups. One is of firms that conduct business
transactions with parent firms, subsidiaries or associated firms, and are de-
fined as vertically integrated with capital-share (VI) firms. The other group
comprises firms that are non-VI (NVI) firms. Accordingly, the VI structure
comprises VI firms only, and the NVI structure comprises NVI firms only,
in a hierarchy of vertical integration within an industrial structure. Within
such a business environment, firms in Korea’s three core growth-leading
industries face a strategic choice; they can be VI firms and, therefore, secure
more stable supply chains that eventually generate more profits, or they can
concentrate more on technological innovation and increase productivity so
as to survive as NVI firms.
Upon facing such dichotomous conditions, firms’strategic entry to and exit
from the industry and its VI or NVI structure, and firms’strategic shifts between
VI and NVI structure are decided, and the consequent resource reallocation and
market share reallocation between VI and NVI firms follows. Accordingly,
those firm dynamics have an impact on productivity growth: not only their
own VI structure or NVI structure, but also their individual industry and the en-
tire Korean manufacturing, and which dynamics are more progressive under
conditions of macroeconomic turbulence triggered by exogenous market shock.
In particular, the extent to which exogenous market shocks (such as the recent
2008 global financial crisis) prompt or promote changes in productivity growth
and resilience are measured.
In the literature, Hahn (2000) uses a 1990–1998 plant-level panel data set of
Korean manufacturers and finds evidence that the combined effect of the entry
and exit and the market share reallocation effect help to explain aggregate
M. K. PAI2
© 2016 John Wiley & Sons Australia, Ltd
© 2016 John Wiley & Sons Australia, Ltd
M. K. PAI
512
open industrial structure relative to the Korean automobile industry, given its
products’relatively short life cycle and consequent various and changing parts
and components. Finally, among Korea’s three core growth-leading industries,
the general machinery industry shows the least strong vertically integrated in-
dustrial structure. However, the vertically integrated industrial structures of
these three industries are acknowledged as being both unparalleled and unprec-
edented relative to those seen in comparable industries in other countries.
In practice, at the pinnacle of the vertical integration, original equipment
manufacturers (OEMs), namely, Jaebol, partner subcontracting firms, operated
under the mutual understanding that both had incentives to sustain a long-term
stable business environment, to maximize their respective profits and ensure
market survival.
However, these long-term business partnerships become tainted over time,
due to the excessive bargaining power of Jaebol in business dealings that result
in the minimization of small and medium-sized subcontracting firms’profits to
sometimes one-third of those of the Jaebol.
This alarming profit gap demands the urgent attention of Korea’s policy-
makers, who must look to create a more balanced profit-sharing system between
these two currently unequal business parties, and they also need to revamp the
overall institutional system to ensure fair trade and competition.
Therefore, within the bounds of a vertically integrated industrial structure,
firms can be split into two groups. One is of firms that conduct business
transactions with parent firms, subsidiaries or associated firms, and are de-
fined as vertically integrated with capital-share (VI) firms. The other group
comprises firms that are non-VI (NVI) firms. Accordingly, the VI structure
comprises VI firms only, and the NVI structure comprises NVI firms only,
in a hierarchy of vertical integration within an industrial structure. Within
such a business environment, firms in Korea’s three core growth-leading
industries face a strategic choice; they can be VI firms and, therefore, secure
more stable supply chains that eventually generate more profits, or they can
concentrate more on technological innovation and increase productivity so
as to survive as NVI firms.
Upon facing such dichotomous conditions, firms’strategic entry to and exit
from the industry and its VI or NVI structure, and firms’strategic shifts between
VI and NVI structure are decided, and the consequent resource reallocation and
market share reallocation between VI and NVI firms follows. Accordingly,
those firm dynamics have an impact on productivity growth: not only their
own VI structure or NVI structure, but also their individual industry and the en-
tire Korean manufacturing, and which dynamics are more progressive under
conditions of macroeconomic turbulence triggered by exogenous market shock.
In particular, the extent to which exogenous market shocks (such as the recent
2008 global financial crisis) prompt or promote changes in productivity growth
and resilience are measured.
In the literature, Hahn (2000) uses a 1990–1998 plant-level panel data set of
Korean manufacturers and finds evidence that the combined effect of the entry
and exit and the market share reallocation effect help to explain aggregate
M. K. PAI2
© 2016 John Wiley & Sons Australia, Ltd
productivity growth in manufacturing during the 1995–1998 period: a time dur-
ing which the 1997 Asian financial crisis occurred. Likewise, Foster et al. (1998)
find, using establishment-level data for US manufacturing establishments, that
the effects of the reallocation of outputs and inputs from less productive to more
productive establishments has played a significant role in accounting for aggre-
gate productivity growth. As such, the literature mainly addresses plant entry to
and exit from an industry or market, and resulting resource reallocation; these
studies touch upon their impacts on aggregate productivity growth, without
due consideration for specific industrial-structure features or business dealings
in individual industries.
However, D’Aveni and Ravenscraft (1994) note that prioritizing a secure sup-
ply chain may cause principal–agent problems, and thus infringe upon fair trade
as well as competition in the market, which leads to higher production costs.
For this study, a Cobb–Douglas stochastic frontier production function (C-D
SFPF) model based on Kumbhakar (2000), Battese and Coelli (1992) and Coelli
(1996) was applied to firm-level data from Korea’s three core growth-leading in-
dustries. Ever since Solow (1956) introduced a growth accounting theory to
measure total factor productivity (TFP) growth as an engine of output growth
not explained by input growth, and described technical change as its unique
source, there have been plenty of theoretical extensions.
The stochastic frontier production function (SFPF) was introduced by
Aigner et al. (1977) and Meeusen and van den Broeck (1977). Nishimizu
and Page (1982) decompose TFP growth into efficiency changes and techni-
cal changes, and Kumbhakar (2000) proposes a method of decomposing
TFP growth into four components; technical progress (TP), changes in tech-
nical efficiency (TE•), changes in allocative efficiency (AE) and scale compo-
nents (SC).
Extending the work of Kumbhakar (2000), the current study adds a fifth com-
ponent, the respective impact of firms’entry to and exit from an industry and a
VI or NVI structure, firms’strategic shift between VI and NVI structure, and
firms’age differential on TFP growth of an industry and its VI and NVI struc-
ture (FC).
Pai (2016a) applies a translog SFPF model to a plant-level data set of Korea’s
37 key industries from 1995 to 2012 to determine the effectiveness of the Korean
Government’s“selection and concentration”policy, as it was brought to bear on
technical progress and productivity growth in the targeted industries. That study
found that in IT manufacturing, both figures were around 15%; those of assem-
bled vehicles were both around 14%; those of automobile parts and components
were 8% and 5%, respectively; and those of general machinery were 5% and 3%,
respectively.
The remainder of this paper is organized as follows. Section 2 presents actual
patterns in firms’strategic shifts and entry to and exit from Korea’s three core
growth-leading industries and their VI and NVI structure. Section 3 explains
the estimation model used herein, Section 4 describes the data used and
Section 5 discusses the empirical results. Then, Section 6 presents summary
and concluding remarks with policy implications. The Appendix elaborates on
VERTICAL INTEGRATION, ENTRY, EXIT, STRATEGIC SHIFTS, AGE, AND PRODUCTIVITY GROWTH 3
© 2016 John Wiley & Sons Australia, Ltd
© 2016 John Wiley & Sons Australia, Ltd
VERTICAL INTEGRATION, ENTRY, EXIT, STRATEGIC SHIFTS, AGE, AND PRODUCTIVITY GROWTH 513
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