Determinants of Country Competitiveness and Shifts: the Importance of Regulatory Reform.

Determinants of Country Competitiveness 1

Determinants of Country Competitiveness and Shifts:

the Importance of Regulatory Reform.

Dr. P. M. M. De Faria b, Dr. J. D. Van der Bij c a

S2405172, Master student MSc BA Strategic Innovation Management b

Supervisor c

Co-assessor

Abstract – This paper examines country competitiveness and the factors that compromise this phenomenon. The determinants of a country’s competitiveness remain unclear to a certain extent. The literature describes several reasons that lead to a country’s competitiveness, however, these have turned out to be outdated and are based on obsolete measures for today’s fast-moving and globalized marketplace. In this research we found that regulatory reform and policy changes implemented by the nation are one of the main determinants for long-term growth. Korea and the United States have been investigated based on their increase and decline in competitiveness, respectively. The regulatory reforms in the fields of market openness, innovation, and international trade have had considerable influence in determining country competitiveness. This paper provides evidence that factor endowments are not main determinants of competitiveness but rather shift towards the combined influence of the government and industry.

06/2014

Word count: 17.379 University of Groningen

Faculty of Economics and Business P.O. Box 800

Nettelbosje 2

Determinants of Country Competitiveness 2 INTRODUCTION

It is a recognized fact that countries enhance their competitiveness and go through stages of economic development where, using the traditional perspective, a nation moves from producing primary products, to manufacturing goods, and finally to service activities (Brakman et al., 2011). However, it is less known what factors contribute to this country competitiveness. Country competitiveness is defined as a nation possessing a competitive advantage relative to the best global competitors (countries) (Porter, 1990b) which determines their ability to attract business activity to their nation. This has been considerably influenced by globalization which resulted in faster competitive shifts between countries. These competitive shifts, in turn, cause industries to migrate between countries based on their relative competitiveness (Dunning, 1992; Griffiths & Zammuto, 2005).

Historical cases have shown us that there have been many fluctuations in relative country competitiveness leading to industry migration between nations. This was the case for the United States (US) which accounted over 65% of the world’s business in 10 of the 15 industries in 1960 in a research on global corporate competition. This number decreased to 9 in 1970, and only 3 industries by 1980. The US decline in market position was ascribed to European as well as Japanese increases in competitiveness whose sales increased gradually during 1960-1970 and showed increased growth between 1980 and 1986. In these years there were also significant advances from new industrialized economies (NIEs) such as South Korea, which begun obtaining notable shares of world markets during this period (Franko, 1989). These country competitiveness shifts can be attributed to changes in the location-bound resources of a nation. However, this might not be the only influencing factor to country competitiveness. Other factors include R&D spending and intensity (Franko, 1989; Griffith et al., 2004; Guellec & De la Potterie, 2001), industry and innovation activity (Dunning, 1992), and national/industry regulations and policies (Bassanini & Scarpetta, 2001; Brakman et al., 2011).

Determinants of Country Competitiveness 3 (Fagerberg, 1988; Porter, 1990a; Dunning, 1993; Malerba & Orsenigo, 1996). Finally, many studies on country competitiveness and shifts are aimed at developing countries and to a lesser extent the advanced economies. This research will provide more comprehensive theory on country competitiveness using adequate measures for advanced economies that determine this phenomenon instead of the obsolete export figures. Furthermore, this paper will use cases that provide evidence post 2000 that will supplement the current theory on country competitiveness.

The goal of this study is to refine our current understanding of the determinants of country competitiveness which influence the migration of industries between nations. The objective is to identify how the technological leadership has shifted between countries and to furthermore identify the competitive advantages of these nations. The results of the paper will provide the reader with up-to-date knowledge on country competitiveness which might have considerable influence on managerial and policy decision making in today’s globalized market.

This paper will consist of two parts in which different research questions will be answered. The first part of the research will consist of a pattern identification analysis where the R&D intensity of 17 OECD countries will be identified and compared. R&D intensity has been proven to be a reliable measure of the position of a nation’s industries in technological space since R&D activity in itself has a significant positive effect on economic growth and is positively associated to productivity increases (Chung & Alcácer, 2002; Bassanini & Scarpetta, 2001). Therefore the Analytical Business Enterprise Research and Development (ANBERD) database will be used. Based on the R&D intensity, patterns will be identified for selecting relevant countries and industries to conduct qualitative research. This first part of the research will take a quantitative approach and describe the evolution of the technological leadership of several countries. Therefore, in this first section the research will answer the question: Which countries have increased, or decreased, their R&D intensity most among the OECD countries and their industries? The results from this research will provide input for the second part of the research which will take a qualitative approach. In this part of the research, countries will be selected which will serve as case studies to country competitiveness. Additional industries will be selected that provide support for the evidence from the selected countries. These countries and supporting industries will provide evidence on the determinants of country competitiveness. Therefore, in this second section the following questions will be answered: Why did competitiveness shift between country A and B? And what are the determinants of country competitiveness?

Determinants of Country Competitiveness 4 in order to apply objective selection for the cases used. These calculations indicate the evidence for the extreme cases and polar types. Therefore the cases selected were not based on whether they would replicate previous cases or relevant theory, but rather based on facts that resulted from the R&D intensity calculations.

Korea and the United states (US) have shown the highest increase and decrease in competitiveness based on R&D intensity, respectively. It was found that an important determinant for country competitiveness was the industry activity and competitiveness within a nation. The governmental and institutional influence on competitiveness through fostering competitive capabilities of industries and firms through their policies enables industries to improve their competitiveness. This industry competitiveness, in turn, positively influences the competitiveness of a country. For both countries, regulatory reform has been the main driver of these shift in competitiveness and is directed to making sure that regulations remain fully responsive to changes in economic, social, and technical conditions surrounding them (OECD, 1997). These regulatory reforms have contributed significantly to the competitive shift away from the US and towards Korea. The policy changes that Korea has implemented, and which the US has neglected, have considerably influenced the competitiveness increase of Korea in terms of market openness, innovativeness, and international trade level compared to the US.

The paper will proceed with the theory section in which the topic and phenomenon of country competitiveness will be further elaborated. The next section will proceed with the methodology in which both the quantitative and qualitative process will be explained. In this section, the results of the quantitative analysis, which will serve as input for the qualitative analysis, will also be given. After this, the paper will proceed with the results section of the qualitative analysis. The paper will finalize with a discussion section which will provide several propositions for country competitiveness. The paper will end with a conclusion with relevant policy and managerial implications and suggestions for future research.

THEORY

Country competitiveness is the ability to produce goods and services that meet the test of international competition while citizens of the country enjoy a standard of living that is both rising and sustainable (Krugman, 1994). This also entails the ability of a nation to sell their products in world markets and at the same time create an attractive market for business activity, for domestic as well as foreign enterprises. The following sections will examine the current literature on country competitiveness but also industry competitiveness which, in turn, is an important determinant for country competitiveness.

Determinants of Country Competitiveness 5 develop international policy (OECD, 2014a). These countries are mostly advanced countries and show a high degree of international involvement and globalization of their countries and their industries (OECD, WTO, UNCTAD, 2013).

Brakman et al. (2011) suggest that the 1980s was a period of rudimentary change for OECD countries in which significant structural change took place causing many competitive increases and decreases of nations. Brakman et al. (2011) analyze the evolution of comparative advantage which, according to Rugman and Verbeke (1992) can be referred to as the country specific advantages provided to enterprises. These benefits originate from the lower factor costs (i.e. direct and indirect labor) that countries charge to businesses which in turn will attract more business activity to that country. In their research, Brakman et al. (2011) identify waves of structural change in OECD countries and provide several general causes for these waves. These structural changes have been possibly caused by, first, competition from low-wage nations: new entrants in the world market with different factor prices than incumbent trading partners might capture a share of world exports. This explanation will especially affect unspecialized labor since nations that are able to provide this type of labor will be abundant. Therefore lower factor cost will be a main reason for relocating business activity which is provided by new industrialized economies (NIEs). Second, deregulation in OECD countries may cause structural change; some governments have a favorable attitude towards market mechanisms while others avoid implementing market-oriented policies. These market mechanisms positively influence competitiveness since increased competition requires increasing productivity and may possible enhance a country’s comparative advantage. This possible cause of structural change will most likely affect advanced countries that perform more specialized stages of the value chain because these are less subjected to factor endowments and are more affected by long-term implication such as the future business environment which will be highly influenced by the regulatory setting of a country. These causes, however, were not considered to be the main causes and further reasons for trade patterns were beyond the scope of their paper.

Country Competitiveness

Determinants of Country Competitiveness 6 patent share which has dropped 20.6% in the same period. Furthermore, the UK patenting performance has also experienced a considerable downturn of 1.4% (Amendola et al., 1993). This downturn in the US and UK has been caused, according to Amendola et a. (1993) by ineffective managerial practices, nearsighted financial institutions, and policy failures. This would suggest that the US and UK have undertook short-term measures to enhance its competitiveness at the long-term cost such as giving licenses to NIEs to generate revenue leading to knowledge leaving the nation and deteriorating its innovativeness. These competitiveness changes identified by Amendola et al. should be interpreted with caution since these shifts were based on export shares. This measure of competitiveness has not been able to correctly identify a nation´s competitiveness since it only represents which nations export the highest relative amount or value of goods or services. Therefore traditional measures, such as shares in gross world export, are becoming less informative for policy making since later stages of the industry will export more value than earlier stages because of the cumulative added value within each stage (Timmer et al., 2013).

The competitiveness changes among the former three countries can be further elaborated by technological competitiveness and the ability to compete on delivery rather than relative unit labor costs (location-bound aspect) which is considered to be too simplistic. Economic growth may influence technological competitiveness which is achieved through investment in physical production that should be seen as complementary to the growth of other resources such as the number of scientists and engineers, R&D facilities, and advanced electronic equipment etc. (Fagerberg, 1998). This indicates that countries, and their industries, should invest in both their physical and non-physical assets to secure their long-term growth; this growth, in turn, will result in increased competitiveness by becoming more attractive for importing and exporting to other nations. This explanation complements the findings of Amendola et al. (1993) in that ineffective managerial practices and policy measures might result in countries and industries to forego on making investments to stimulate long-term growth. These explanation, however, are again based on export market shares as competitiveness measures which may not be sufficient in determining the competitiveness of a nation or firm. Furthermore, the study of Fagerberg (1998) was conducted more than two decades ago which may result in different explanation for nation and industry competitiveness and industry migration.

Determinants of country competitiveness

Determinants of Country Competitiveness 7 Factor endowments have been an important competitiveness driver from 1975 to 1996, when the US was the most competitive economy among the OECD countries, especially in the manufacturing sector because of higher productivity and lower costs. However, Asian emerging economies experienced much lower unit labor costs than advanced countries in the same period during which it also experienced massive exchange rate depreciation leading to reinforcement of their cost advantage. This would result in an apparent emergence among two groups of Asian non-OECD countries (some of these countries have entered the OECD since the study was conducted). A distinction can be made between, on the one hand, export in products with relatively low technological content (textiles, footwear, consumer goods etc.), and on the other hand exports in medium- and high- technology goods (computers, electrical equipment, communication etc.) (Durand et al., 1998). This entry in new markets by Asian countries has directly resulted in the declining competitiveness of advanced nations in the same markets. In this case, factor endowments were the most important determinants of competitive changes among countries, however, these factor endowments have a greater impact on unspecialized than on specialized labor and may thus fail to come to a reliable conclusion about country competitiveness for advanced countries. Also, the use of export measures may again be considered a flawed measurement method to determine country competitiveness.

Determinants of Country Competitiveness 8 of globalization and MultiNational Enterprise (MNE) activity which significantly influence the competitive advantage of nations (Dunning, 1993).

Globalization has significantly changed competitiveness for countries. Globalization was driven by a decrease in transportation costs which has resulted in the production of goods near to the point of consumption to become unnecessary. This has resulted in the outsourcing and offshoring of plants to lower-waged countries that could perform the production at lower cost. Subsequently, globalization was driven by rapidly decreasing communication and coordination costs. This resulted in the fragmentation of value chains and the opportunity to offshore different tasks in the chain to other nations and firms (Baldwin, 2006). This globalization has led to the obsolescence of ‘natural’ assets such as land and untrained labor which is emphasized by Porter (1990a) since globalization has resulted in the easy availability of these resources through cross-border transfer. Therefore, globalization has led to the importance of ‘created’ assets (human capital, knowledge, technological capacity, transport and communications infrastructure, organizational systems, and government policy) (Dunning, 1993). These latter assets require both physical and non-physical investments from governments and enterprises to enhance their development as stated by Fagerberg (1998). Therefore, governments, in establishing strategies, need to take the strategies of other governments into account to invest in policy changes etc. (Dunning, 1993)

Increased MNE activity is another factor influencing the theoretical approach discussed by Porter and highly influences competitiveness. Growing cross-border networking of firms through strategic alliances, international subcontracting and other cooperative arrangements is further undermining any concept of national firm specific “diamonds” (Dunning, 1993). Thus, through MNE activity, business activity becomes more globalized which leads to factor endowments becoming less important for competitiveness determination. Because of economic integration driven by MNEs, national diamonds have to be replaced by supranational diamonds because national border’s importance decreases (Dunning, 1993).

Competitiveness of countries thus relies on a large set of factors which differ between whether a country is advanced or a NIE and what type of business activity is involved. Due to globalization and MNE activity, some of these factors have become obsolete and require research for new, present-day determinants of competitiveness.

Industry Competitiveness

Determinants of Country Competitiveness 9 innovation models (Malerba & Orsenigo, 1996). The Schumpeter Mark I model is characterized by easy entry in an industry, innovative roles for newcomers, and erosion of the competitive and technological advantages of the established firms in an industry. This model is further characterized by high opportunity, low appropriability conditions, and low cumulativeness conditions of knowledge. Mechanical industries are an example of the Schumpeter Mark I model. (Malerba & Orsenigo, 1996). The Schumpeter Mark II model is characterized by higher entry barriers, a hierarchy of large established firms in innovative activities, and the dominance of a few firms that are mainly active in innovation due to their cumulative innovative capabilities. High opportunity, high appropriability, and high cumulativeness conditions are additional conditions of the model. This model is thus in favor of established firms at the cost of new firms and can mostly be found in chemical and electronics industries (Malerba & Orsenigo, 1996). This would suggest that the Mark I industries, being more dynamic, are more subjected to within industry fluctuation between firms than Mark II industries. Due to a higher dynamic level, the industries characterized by the Mark I model will also be subjected to globalization and MNE activity earlier than Mark II industries. Therefore, countries including a high degree of Mark I industries have a higher risk of losing their competitiveness since these industries are more accessible to other countries. However, the fact that the study was conducted approximately two decades ago may require caution when interpreting the results. Today, Mark I and II models may not be distinguished so clearly and may actually be complementary than distinctive.

Determinants of industry competitiveness

Determinants of Country Competitiveness 10 When taking the political economy perspective, state involvement in industries through the development of institutions that coordinate economic activity and furthermore change environmental circumstances in favor of those industries is a key variable related to economic competitiveness. The political economy theory thus argues that coordinated relationships between state and industry gives the state the competence to maintain national competitiveness by dealing with conditions of economic and industrial change (Griffiths & Zammuto, 2005). This is in line with Dunning (1992) stating that governments are able to directly affect the supply and demand of resources and capabilities affecting competitiveness and they have the ability to motivate firms in pursuing competitiveness. When combining the literature of strategic management and political economy, Griffiths and Zammuto (2005) found that “joint governance”, in which the government is involved in industry decision-making and industries value chains are integrated, is the best state for achieving industry competitiveness; especially when industry competitiveness relies on achieving value-added outcomes and innovation. Considering that long-term competitiveness is related to investing in innovative learning (Amendola et al., 1993), than this type of governance will have the highest probability of achieving industry competitiveness in dynamic industries. This joint governance can also be interpreted as a vicious circle in which the government provides for policies from which the firms in that country gain benefits. This, in turn, leads to an advantageous industry structure from which firms are better able to create competitiveness. This will ultimately contribute to a nation’s competitiveness derived from superior enterprise activity in the country. In other words, country competitiveness and industry competitiveness are enablers of one another.

This study, however, provided less attention to the governmental institutions and their influence as compared to firm-level influences, thereby not providing a comprehensive understanding of the earlier mentioned relationship between the country- and industry-level. This requires additional research in the governmental role of enhancing competitiveness. Also, the study related to the period between the 1960s and 1990s which again can be considered outdated and not providing present-day explanations for country competitiveness.

Determinants of Country Competitiveness 11 spillovers are able to cross borders and enhance the innovative level of industries in other nations (Castellacci, 2008).

However, these previous literature treats industries on a similar bases whereas their development differs significantly; the competitiveness of industries may be considerably influenced by sectoral differences. These sectoral differences can be explained by using the evolutionary view as discussed earlier and provides additional innovative aspects that influence international competitiveness. These sectoral differences are determined by first, the innovative activity taking place in a sector which confirms the mainstream economics view that higher R&D intensity positively influences competitiveness. Second, vertical linkages and inter-sectoral knowledge flows enhance industry integration leading to extensive knowledge flows which confirms the work of Griffiths and Zammuto (2005) that a higher level of integration provides a basis for international competitiveness. And third, the technological regimes that set up the framework conditions in which firm’s innovative activities take place (the nature of the knowledge base, appropriability conditions, cumulativeness conditions, and the technological opportunity) have significant influence in determining the innovative level of an industry which confirms the Schumpeterian models (Castellacci, 2008). Higher levels of these three factors thus positively influences an industry’s competitiveness which eventually will improve country competitiveness. This relationship between industry and country competitiveness elaborated by Griffiths and Zammuto (2005) is further supported by the evolutionary view; sectoral innovation is greatly shaped by the characteristics of the national system of innovation and the latter, in turn, is affected by the former (Castellacci, 2008). Also regional systems co-evolve with sectoral patterns of innovation, therefore the competitiveness of industries relies on the dynamic interaction between regional and sectoral systems (Castellacci, 2008). These findings strengthen the theory that a country’s government influences industry competitiveness which, in turn, stimulates country competitiveness. However, this research requires further determinant in how governments shape competitiveness which ultimately leads to country competitiveness.

Determinants of Country Competitiveness 12 complementary research which takes into account the globalization effect, fragmentation of value chains, governmental influence, and other possible phenomena for the migration of industries between countries which will influence the final competitiveness of countries and industries.

METHODOLOGY

Selection of the Cases

In order to determine country competitiveness and fluctuations between them, cases needed to be selected that have experienced competitive increases or decreases. To select these cases, the selection process has taken a quantitative form in which country data on R&D expenditures was subjected to calculations in order to apply objective selection. Thus, the cases were selected based on facts and not only on whether the cases would replicate or extend emergent theory (Eisenhardt, 1989). However, there is still the notion of theoretical sampling because the cases selected will most likely provide evidence for emergent theory.

The quantitative research section of this paper has identified structural changes in R&D intensity patterns. R&D intensity of 17 OECD countries were calculated relative to the other OECD countries in the sample. As we have seen in the introduction and theory section, relative R&D expenditures are a reliable measure for a country’s and industry’s position in technological space (Chung & Alcácer, 2002; Bassanini & Scarpetta, 2001). Because of this, the ANBERD database has been used to identify patterns of R&D intensity among OECD countries (OECD, 2013a). The ANBERD database presents annual data on R&D expenditures by industry and currently includes 25 OECD countries and 3 non-member economies concerning 100 manufacturing and service sectors. The International Standard Industrial Classification (ISIC) Revision 4 ANBERD database has been used to provide for the most recent data. Within the ISIC Rev. 4 database, several currency options could be selected to display the R&D expenditures by country and industry. 2005 dollars – constant prices and Purchasing Power Parity (PPP) has been selected because this would yield comparable results for all countries and industries of the OECD. The time period for which the research was conducted was 2003 to 2011. The reason for this is that whereas previous research mainly focused on structural patterns that took place before 2000, this paper aims to identify structural changes in R&D intensity and phenomena that took place more recently. This time period was also selected because it provided the highest availability of data and this time period connected well with the OECD GDP database needed for the calculation of R&D intensity thereby minimizing information gaps in the database.

Determinants of Country Competitiveness 13 4 database with the ISIC Rev. 3 was not possible due to a different classification of the industries and a high degree of interconnectedness between the figures; many classifications contained sub-classifications whereby manually complementing the database would affect and disorder the other data. Because of this, a primary selection was made that included the industries with a significant amount of data from 2003 to 2011. The criteria that were set were based on the number of years from which data was available and were composed as follows: a ‘0’ was given if no annual information was available; ‘1’ was given if there was between 1 till 4 years of data available; ‘2’ included the 5 till 8 years of available data; ‘3’ included 9 and 10 years of available data; and ‘4’was given if 11 or total availability of data was present. After this categorization, many countries and industries were entirely characterized by ‘0’, ‘1’, or ‘2’ categories which has led to the removal of these countries and from the sample since this would not contribute to the R&D intensity calculations and would result in calculation errors. Furthermore, 48 industries and 17 countries remained which were selected based on ‘3’ and ‘4’ categories. The countries that were included in the final sample are: Australia, Austria, Belgium, Canada, Czech Republic, Finland, Germany, Hungary, Israel, Italy, Japan, Korea, Norway, Portugal, Slovenia, Spain, and the US.

The identify patterns of country competitiveness, a formula was used among the sample countries and industries that provided an index which compared the R&D expenditures in an industry to the other OECD countries’ industries. The index is calculated through the subtraction of the R&D intensity of an industry in the country under consideration “h” from the average R&D intensity of all other OECD countries (Salomon & Jin, 2008). Positive values can be interpreted as relative technological leadership in an industry, whereas negative values indicate a lagging status. The formula is the following:

Where j entails the industry, h stands for the country under consideration, k stands for the OECD country in the sample under consideration, t stands for time, and n stands for the number of OECD countries excluding the country under consideration. This, in the formula, translates to RDIhjt being the R&D intensity index of country h for industry j in year t; Rhjtis

the R&D expenditure in country h for industry j in year t; GDPht is the GDPof country h in

year t; Rkjt is the R&D expenditure for country k in year t; and GDPkt is the GDP of country k

in year t (Salomon & Jin, 2008). Because the formula calculates RDI relative to other countries, a sharp increase in the RDI of a particular country will be countered by a sharp decrease in other countries.

Determinants of Country Competitiveness 14 country competitiveness changes. This was based on whether countries and industries showed significant fluctuations in their RDIs and went from a negative to a positive index in the period of 2003 till 2011. These tables and graphs are displayed in appendix A. The industry classification “Total Business Enterprise” included most relevant information to identify structural changes in national RDI intensity. The countries and industries that were selected were most likely to serve as the best cases to yield information about industry migration and country/industry competitiveness.

The calculations of the 17 OECD countries’ and 48 industries’ R&D intensity indexes yielded some significant patterns to be identified. The absolute indexes are all small number fluctuating around 3 decimal places. This is because the R&D expenditures are measured relative to the GDP of the country under consideration which is a significant large number. In the previous section, it was stated that the industry “Total Business Enterprise” was a useful classification to see whether countries in their total business activity experienced a competitiveness increase or decrease. From this classification, most nations had a stable position with slight decreases or increases in their RDI. However, the US has experienced the highest downturn in its R&D intensity compared with other nations in the period of 2003 to 2011. The US dropped from a RDI index of 0.0021 in 2003 to a RDI index of -0.0181 in 2011. This decrease in RDI would initially indicate a decrease in competitiveness for the US based on the innovative level that would result in a decreased relative ability to compete in international markets. For the 17 OECD countries researched it seems that the loss in R&D intensity by the US has been gained by Korea which in 2003 had a RDI index of 0.0027 in 2003 to a RDI index of 0.0224 in 2011. This indicates the increased relative ability to compete in international markets for Korea. These patterns have resulted in Korea and the US being the countries selected for the case studies of country competitiveness. Korea and the US will serve as polar types in the cross case analysis since these cases will represent determinants of both competitiveness increases and decreases (table 1 & figure 1, appendix A).

To confirm whether Korea and the US have indeed experienced significant increases/decreases in their R&D intensity, and that indeed a pattern can be distinguished, two industries have been selected to provide supportive data for the Korea and US cases which enhanced our understanding about the changing competitiveness of the two nations. Several of the 48 industries have experienced significant fluctuations in leading and lagging nations while other industries have experienced a more balanced development where the different nations did not show high fluctuations in their R&D intensity indexes. This can be explained by the dynamic level of the industry where a highly dynamic industry will be more subjected to fluctuations in leading firms and nations than stable industries.

Determinants of Country Competitiveness 15 competitiveness and industry migration than the more stable sectors and industries characterized by the Mark II model (Malerba & Orsenigo, 1996) and will thus have a higher likelihood to support the evidence about country competitiveness. A further criterion for the industry selection was the presence of both Korea and the US in that particular industry; seeing as some countries were not included in particular industry RDI calculations because of the lack of data from that particular country. From the 48 industries, 2 have been selected which would provide supportive evidence for the US’ and Korea’s competitiveness by providing relevant information for the qualitative research based on the dynamic level of the industry.

The results from the RDI calculations have demonstrated evidence for the presence of both more dynamic and more static industries. The first industry selected was the “Computer, Electronic, and Optical Products” industry. In 2003, Korea enjoyed a RDI of 0,0021 which it was able to increase to 0,0145 in 2011 thereby experiencing the highest RDI in the industry. This shift was coupled by the US’ decrease from a RDI of 0,0080 in 2003 to the lowest RDI in the industry of -0,0031 in 2011. The second selected industry also displayed the highest increase for Korea and highest decrease for the US. This was the “Chemicals and Chemical Products” industry. Although the differences in RDIs were not as significant as in the previous selected industries, the pattern of Korea’s increase versus the US’ decrease was clearly identified. Korea has increased its RDI from -0,0049 to 0,0016 over the years between 2003 and 2011 thereby becoming the industry leader based on RDI among the 17 OECD countries. In contrast, the US went from a RDI of 0,0095 to the lowest RDI of -0,0010 from 2003 to 2011. Appendix A displays the tables and graphs as a result from the RDI calculations for the selected 2 supporting industries.

Case Studies

Whereas the quantitative evidence has indicated the patterns of the 17 OECD countries and their industries, the qualitative data has been useful for understanding the theory and explanations underlying these patterns. In this sense, the qualitative data will provide anecdotal evidence for the quantitative data (Eisenhardt, 1989).

Determinants of Country Competitiveness 16 sources for archival data on country competitiveness. A requisite of these publications were that they related to factors, policy changes, and regulatory reforms relating to the two selected nations and their competitiveness. The databases were subjected to a set of keywords to finds relevant publications. Some of these keywords, to name a few, were: country competitiveness, industry competitiveness, regulatory reform, industry migration, industry evolution, policy changes Korea, and policy changes US.

To measure the effect that policy changes, regulatory reform, and R&D intensity has had on the period under consideration, additional OECD databases were used such as the Structural Analysis (STAN) and additional bases on value added, patents, and foreign direct investment (FDI) which provided for further evidence of country competitiveness and changes herein.

Within case analysis has been applied for Korea and the US to become familiar with each case as a stand-alone entity (Eisenhardt, 1989). The two cases have been supported by the 2 selected industries to provide further evidence of decreasing or increasing competitiveness of the particular country in that industry. After the within case analysis of Korea and the US, cross case analysis was used by comparing the two polar type cases of Korea and the US to enhance the probability that novel findings would be captured. Considering that these countries show contrary patterns of RDI, changes in national and industry policy in one country may affect the competitiveness in another country’s and vice versa.

RESULTS

In this section, the cases for Korea and the US will be further analyzed in terms of their competitiveness that may have resulted in industry migration. To explain for changes in competitiveness, this section will start with a reflection of both countries’ competitiveness leading up to approximately 2000. Based on this period, the OECD and WTO formulate challenges and recommendations for economic growth and improving competitiveness for the coming years. These challenges and recommendations together with the country reflections before 2000 will form the starting point for both countries from which policy changes and regulatory reforms will be identified that have changed the competitive positions of Korea and the US in the period of 2000 to 2011. To support the evidence, the Computer, Electronic, and Optical Products, and Chemicals and Chemical Products industry will provide additional data on industry migration for the two countries.

Korea

Determinants of Country Competitiveness 17 the world centers of innovation and thus lagged in engineering, technical skills and R&D. And (2) Korean firms were also dislocated from the international markets it wished to supply thereby lacking user-producer linkages essential to innovation and industrial development (Hobday, 1995). However, in the period of 1985 to the mid 1990s, Korea has been able to “catch up” with the advanced countries, meaning closing the technological gap between the two types of nations. In order to overcome their traditional dependency on advanced nations, Korean latecomer firms stepped up in their in-house R&D spending, acquired overseas high-technology firms, and formed high-technology partnerships with leading foreign companies (Hobday, 1995). From as early as the 1960s, Korean latecomer firms, in most industries, used a high degree of reverse engineering to start with the assembly production of imported parts, then developed low- to high-tech parts, and learned to design the existing products with modifications, which ultimately led to the ability to create new product concepts (Lee & Lim, 2001).

The article of Lee and Lim (2001) identified three patterns of catching-up by latecomer firms. First, latecomer firms may follow the same path as their predecessors in a shorter period of time. Second, firms can follow the path to an extent but skip some stage, and thus, save time. This is referred to as stage-skipping or leapfrogging catching-up. Third, latecomer firms may explore their own path of technological development and thereby catch-up by path-creation. These latter two approaches have been successful for Korean latecomer firms in catching up. The stage-skipping approach was mainly successful in the automobile and the dynamic random-access memory (D-Ram) industries. Because of a clear technological trajectory in both industries which made the catching-up “target” more clearly, latecomer firms had a high incentive to invest in in-house R&D. This, combined with Korean firms already being very experienced in process innovation and scale-intensive R&D and production, which were important determinants of competitiveness, led to the growing competitiveness of Korean firms (Hyundai, Samsung) in these industries (Lee & Lim, 2001).

The path-creation approach has especially been successful in the industry of telecommunications. Korean firms disregarded the TDMA technology in order to pay attention to the emerging CDMA technology being more efficient in frequency utilization and had a higher quality in voice transmission. This approach has led Korean firms to become world leaders in CDMA phone technology. These two approaches have been successful due to acquiring external knowledge though licensing agreements, collaboration with advanced nation firms, and Korean government support in R&D (Lee & Lim, 2001).

Determinants of Country Competitiveness 18 major setback in market share. Also, because their technological capabilities had not grown sufficiently, they were not able to stand alone (Lee & Lim, 2001).

Summing up, in many industries, Korean firms were able to learn from advanced country firms leading to process innovations to improve productivity and quality. This learning process transformed many Korean firms from original equipment manufacturers (OEMs) to original design manufacturers (ODMs), thereby internalizing system design skills and complex production technologies leading to more value added without the risk of launching own brand and incurring investment costs. Korean firms eventually transformed to original brand manufacturers (OBMs) that sold goods under their own brand name, capturing more of the post-production value added (Hobday, 1995).

Korean challenges and recommendations in 2000

From the regulatory reform review of Korea (OECD, 2000a) the main recommendation was to further enhance market openness and fair trade in Korea. This was mainly due to the dominant position that Korean conglomerates possessed; these ‘Chaebols’ were known for stifling competition and limiting transparency of the market. In order to enhance market openness, policies needed to be altered that improved corporate governance, regulations, and institutions in the financial sector that lead to a higher degree of transparency and accountability of the market and its firms. By ensuring that the government is not involved in supporting firms occupied with anti-competitive practices and lowering government support as a whole, Korea aimed to move from a direct intervention to a market-based system since a market-based system would result in fair trade and less control from a central authority (OECD, 2000a). Here pressures from stockholders, together with competition, both domestic and international, and the threat for bankruptcy, would discipline Chaebols’ behavior (OECD, 2000b).

By altering the competition policy, Korea wanted to achieve improvements in corporate structuring. The elimination of import restrictions, leading to lower trade barriers, would further open up the Korean market, thus increase flows of foreign investments and activity, and thereby increase competition (OECD, 2000b). The increased participation by foreign firms would also lead to a business climate better corresponding to global standards (OECD, 2000a).

In order to realize these goals and reform regulations, political support over a multi-year period was essential for Korea. Korea further needed to strengthen the efforts of market-oriented institutions in exerting competitive disciplines and improving the legal and administrative environment of Korea. Strengthening the role of the Korean Fair Trade Commission (KFTC), where the KFTC would gain more control to enforce regulations and standards, improve fair trade and prevent competition issues (OECD, 2000a).

Determinants of Country Competitiveness 19 would be able to enhance the openness of the Korean market and improve the competitiveness of the country as a whole as proposed by the OECD in 2000.

Regulatory reform and policy changes in Korea

In the globalization literature, Korea is a well-known case for successfully catching-up with advanced countries due to industrialization and the shift from light to heavy and chemical industries which resulted in increased growth and their integration into foreign markets (OECD, 2012a). This successful catching-up, leading to rising GDP per capita and industrial structural change, was achieved through a deliberate national development strategy with a high degree of intervention in policy development. This was launched in the 1980s when the government started carrying out R&D and providing the private sector with incentives to invest in R&D. During the 1990s, Chaebols invested heavily in R&D to which the government responded by expanding R&D policy to include support to venture business. This was necessary due to a rising demand from the private sector (OECD, 2012a). However, R&D policy was not the only factor contributing to the Korean economy; regulatory reforms, competition policy, the innovative system, and market openness also had significant influence.

Interesting about Korea is that it was able to make a quick recovery from both the Asian financial crisis in 1997 and the global economic crisis in 2007/2008. Korea´s recovery was enhanced through regulatory reform (improvement in the quality of government regulation), a consistent macroeconomic policy, and the introduction of many institutions enhancing regulatory reform. After the first crisis, the newly-created Regulatory Reform Committee has minimized the existing regulation by a half resulting in quick recovery from the Asian Crisis. By 2003, Korea was totally recovered from the crisis until the global economic crisis in 2007/2008. To recover from this crisis, the Korean government initiated the Temporary Regulatory Relief (TRR) and the Presidential Council on National Competitiveness (PCNC) which were closely linked to Korean industries and aimed to overcome the crisis and protecting jobs by reinforcing investment and consumption in the private sector and taking regulatory burden off the shoulders of enterprises and citizens (OECD, 2010a). The TRR suspended 280 regulations for two years with the aim of stabilizing the economy.

Determinants of Country Competitiveness 20 several other policy changes to ensure the elimination of any antitrust activities such as monopoly positions and cartels, because without fair competition there cannot be competitiveness (OECD, 2010a). This has led to the abolishment of some uncommon business regulations resulting in a similar competition policy as advanced countries. Thus, the Korean government, by abolishing many regulations and promoting competition, relied on putting market discipline at work which led to the Korean Economy becoming highly dynamic (OECD, 2010a).

Since the first economic crisis, the Korean government has continuously reformed the foreign trade and investment regime aiming for smooth adjustment of the Korean economy to global market forces. Because of low market openness and transparency, the International Monetary Fund’s (IMF) Stand-By Agreement of 1997 imposed requirements on the Korean government to abolish export-related subsidies, the import licensing system, the import diversification program, and had to improve transparency in import certification procedures. The compliance to these demands over time facilitated foreign business entrance in the Korean market, thereby enhancing customer benefit and competition in the Korean market. The increased market openness, in combination with a rise of foreign exchange rate, resulted in the increasing share of imports and exports to 45,4% and 46,8% in 2008 respectively (OECD, 2010a). Furthermore, substantial evidence of market openness can be found in the extent to which Korea participated in foreign direct investment (FDI). Both inward and outward FDI flows are a good output measure to determine market openness and eventual competitiveness growth since open markets will attract more FDI and will also perform more FDI than markets that are tight. Increased FDI also enhances the economic growth in terms of technology transfer which contributes more to growth than domestic investment (Borensztein, De Gregorio, & Lee, 1998). Table 5 in appendix B displays the FDI data for Korea. There is clear evidence that Korea has considerably increased its FDI compared with other countries by looking at the growth figures; the inward flows of FDI activity has increased by 2.8% annually, and outward flows of FDI activity have increased significantly by 22.2% annually over the period between 2002 and 2012, thereby signaling an increased opening up of the Korean market (OECD, 2014c).

Determinants of Country Competitiveness 21 this industry. The ‘Chemical and Chemical Products’ industry (table 8, appendix C) was not able to replicate this evidence based on value added since growth rates were similar with those of the US. Korea was again smaller in terms of value added compared with the average OECD country at the beginning of the 2000s but was able to attract more industry and create industrial growth with an average of 7.9% annually between 2000 and 2010 (OECD, 2012d). Although this would not indicate any difference in competitiveness between Korea and the US (since growth rates are similar), Korea does seem to overtake the US in this industry. Korea has increased its labor productivity faster than the US in the heavy and chemical industry; Korea has experienced and index change in labor productivity of 80 in 2000 to 116 in 2009 whereas the US experienced more modest growth of 90 in 2000 to 107 in 2009 (year 2005 = 0). This illustrates the more rapid growth of Korea with respect to the US in the heavy and chemical industry (OECD, 2012e).

Determinants of Country Competitiveness 22 2% to 3% over ten years. This opened up the Korean service market enabling entrepreneurial activity and enhancing innovation in this sector (Jones, 2009).

Further contributing to market openness and the innovative level of Korea was the Korea-Chile Free Trade Agreement (FTA) in 2004. Chile was chosen as potential partner because of the possible benefits from Chile’s complementary industrial structure. The successful Korea-Chile FTA lay a strong foundation for Korea’s FTA policy (Hae-kwan, 2003). Korea altered its trade strategy to become a ‘FTA hub’, ensuring that Korea could access other key markets in the global economy. This strategy led to effective FTAs with 46 countries (i.a. Chile, ASEAN, Singapore, India, the EU, the US, EFTA, Peru, and Turkey), and negotiated with 17 other countries (FTA Portal Information Service, 2014). These developments have led the Korean market becoming more open and transparent and resulted in lower tariff and non-tariff barriers to trade making Korea more attractive to foreign firms’ business activities.

In addition to FTAs which supply a nation with external technology transfer, improving its innovative level (Borensztein, De Gregorio, & Lee, 1998), Korea also undertook nation-wide, regional developments to improve the nation’s overall innovative level and competitiveness. The Korean catching-up process until the mid 1990s has mainly benefitted the large metropolitan areas such as Seoul and Gyeonggi resulting in a lower growth rate of the other provinces. This has been one of the major policy priorities for the Korean government which required these regions to obtain more education and business opportunities. In 1994, reforms were introduced that resulted in enhanced power and responsibilities for local governments. Furthermore, advanced democratization during this period resulted in a more bottom-up approach in policy making instead of a highly centralized approach. This was coupled by a expansion of the industrial policy to incorporate innovation as a result of the rising of the knowledge and information economy (OECD, 2012a). Since the end of the 1990s, Korea selected regions to introduce specific program targeting activities which were extended to all provinces by targeting balanced growth in Korea. Since 2008, Korea´s priority shifted from balanced growth (as compensation for regions outside the metropolitan areas) to regional competitiveness and has introduced a more sophisticated policy package for supporting regional development (OECD, 2012a).

Determinants of Country Competitiveness 23 Special Account consisted of approximately USD 5,2 billion in 2005 and increased to USD 9,6 billion in 2011. The third phase (2008-2011), growth in regions was enhanced through regional development policy where the government increased the resources for regional development, designed new programs enabling cross-regional collaboration, and created Economic Regional Committees to support bottom-up initiatives and development planning in regions. Since 2008, the Ministry of Knowledge Economy introduced 3 programs for supporting industrial development of the regions: (1) The Leading Industry Program, supporting R&D activities and industrial development of 7 economic regions; (2) The Strategic Industries Program, supporting industrial development in 13 provinces through targeting R&D in universities, companies and techno parks; and (3) The Region Specific Industries Program, supporting local area industrial development and projects which address specific local development challenges (OECD, 2012a).

Another area in which Korea has aimed to improve its innovative levels were investments in human capital. Human capital policies influence the extent to which workers acquire the analytical skills required to adapt to technological change. Increasing these skills enhance the resource flow to more productive uses and eventually promoting investments in intangible assets and innovation (OECD, 2012c). Korea has placed significant focus on its people and how they can enhance future economic performance. In the levels of education, Korea is ranked highest on the global scale of high-education attainment among 25 to 34 year olds in 2012; tertiary education attainment levels have risen an average of 5.2% annually from 2000 to 2010 being considerable higher than the OECD average growth of 3.7% (OECD, 2012b). These policy changes over the period of 1997 to 2012 have had significant influence on the competitiveness of Korea in which the Korean government has been responsible to a considerable extent.

These regulatory reforms in the innovation policy have been highly visible in the share of triadic patent families of Korea which also indicates the innovativeness of a country (Table 9, appendix D). A patent family refers to a set of patent registered in various countries to protect the same invention. Triadic patent families are a set of patents filed at three of the major patent offices (i.a. Europe, Japan, and the US) and are easily compared internationally; triadic patent families are expressed per million inhabitants (OECD, 2013). Among the OECD countries, the most spectacular growth came from Korea which in 2000 had a patent family share of 1.6% (732), to a patent family share of 4.6% (2 182) in 2010 representing a 11.5% annual increase in patent family quantity and a 10.9% average annual increase in patent family share (OECD, 2012f; OECD, 2013b).

Determinants of Country Competitiveness 24

United States

From the mid 1980s, the US has rapidly changed from the world’s largest creditor to the world’s largest debtor nation (Mutsune, 2008). According to Amin and Hagen (1998), US’ global competitiveness in international markets has declined because of the following factors: productivity, investment, international trade, the political-legal environment, the educational system, technology development, and product quality.

The productivity advances that the US enjoyed were largely eroded during the 1990s when production possibilities per person became similar between the US and Japan. Productivity could be increased by investments in plant and equipment modernization since this leads to flexibility in responding to changing consumer demands and generation of economies of scale. However, the R&D intensity of the US in many categories of manufactured goods was considerably lower than that of countries like Japan and Germany that invested a significant larger part of their GDP in R&D during the mid 1990s. In terms of international trade, the market share of the US in global markets has declined approximately 1 percent per year to 16,5 percent in 1991 where, again, countries as Japan and Germany were able to gain global market shares. However, the US did preserve a leading global position in several technology fields such as aircraft, large computers, and industrial chemicals. These markets, however, were at risk because of other countries’ catching-up processes. As the above has shown in the case of Korea, latecomer firms were able to acquire knowledge through licensing agreements or by the procurement of foreign technology. This technology was supplied by advanced nations including one in specific; the US. Wanting to achieve short-term revenues, US companies sold and licensed important technologies to these latecomer firms, not bearing in mind the possible long-term foreign competitive dangers. This led to an increase of technological development of these latecomer firms at the cost of US technological development capability. Although, during the 1990s, the US mostly developed new basic technologies first in the world, foreign nations created new products using these new technologies faster than the US. This decline in technological development has resulted in a decline of relative quality of US products that resulted in a growing trade problem through the 1980s and 1990s. Furthermore, deterioration of the US education system and a political-legal environment that focused on protecting national business rather than achieving success in international markets has led to the decreasing competitiveness of the US (Amin & Hagen, 1998).

Determinants of Country Competitiveness 25

United States challenges and recommendations in 2000

The US had been a leader in the field of regulatory reform during the end of the 1990s. However, other countries were catching up in areas such as efficiency-enhancing regulation and flexible regulatory alternatives. Therefore, the US needed to give continuing attention to regulatory quality if it was to enjoy its traditional competitive advantages from good regulatory practices. The US also needed to make changes considering the fact that reform has long-term, large-sale implications and because US responsiveness to unexpected impacts has declined (OECD, 2000c).

The US needed more systematic monitoring and evaluation in the aftermath of reform as well as a higher degree of flexibility and capacity for regulatory adaptation. Flexibility and capacity to adapt was also essential in the increasing globalization and rapid technological change. This required the US to implement more dynamic regulatory efficiency in which regulation adapts over time to changing conditions instead of regulation that is optimal at a certain point in time. The US further needed to improve the policy responsiveness of its regulatory system by streamlining the inefficiencies in the slow and troublesome processes at the time. These inefficient processes have also been a result from not creating any close linkages between the government and US industries leading to the development of more appropriate policy changes. Thus, the regulatory system’s processes needed to be accelerated including faster issuing new regulations and more frequent updating of existing regulations (OECD, 2000c).

Because the US failed to use more flexible and market-oriented policy instruments in social policy areas, they missed the opportunity to exploit the nation’s innovative culture. During the end of the 1990s, the US regulatory system was mainly characterized as a rigid and judicial system which entailed high hidden costs in the innovative and entrepreneurial economy. Therefore, the US needed to pay more attention to result-oriented regulations in the public sector that would transform the rigid system into a more flexible regulatory system which encouraged innovation (OECD, 2000c).

Considering social policies, the US can achieve better long-term economic prospects through government policies with respect to education and health. Increasing the quality of the nation´s schools is essential to maintaining the supply of highly skilled workers essential in high-technology sectors (OECD, 1999; OECD, 2000c).

Another important recommendation for the US was increasing the coordination and review to improve efficiency and coherence of regulations at the federal and state level interface. States can better adapt regulatory reform to local conditions, however, this was under-utilized by federal regulators that preferred standardized reforms. Improved coherence between federal and state systems would reduce costs and speed up the process of regulatory reforms (OECD, 2000c).

Determinants of Country Competitiveness 26 recognition of regulations. This would intensify the use of existing international standards leading to harmonized standards among the partners (OECD, 1999; OECD, 2000c). These policy changes at the time should have had positive influence on the US competitiveness and lower the degree to which the US would be caught up with by other countries.

Regulatory reform and policy changes in the United States

As an advanced country of the OECD, the US was the world’s largest single importer and a main engine of growth for its trading partners during most of the 2000s (WTO, 2008). But the US was also able to grow and recover from the 2001 recession because of the modest economic performance of several US key trade partners (WTO, 2004). The US economy has supported its own and global growth by maintaining its market largely open for imports, and to a lesser extent for exports. This market openness and market liberation was pursued by mainly using a multilateral trading system in its international trade policy. A multilateral trade system involves multiple countries that regulate trade between the nations without discrimination. This system aims to lower trade barriers and enhance economic integration between the nations and, together with bilateral trade systems, was further enhanced through the implementation of 15 concluded and/or effective FTAs by the end of 2005 (i.a. NAFTA, Singapore, Chile, Israel) (WTO, 2004; WTO, 2006).

However, before 2007, the US economy was mainly concerned with its domestic trade instead of export related trade. Being the largest global importer while exporting to a lesser extent has increased the US trade deficit, where mainly the US’ trading partners benefitted instead of the US itself. The further trade liberation and market openness for imports also contributed to the growing trade deficit because of open trade and investment regimes resulting in low barriers to the US market access leading to high import levels. Responding to this disadvantaged position, the US acted protective of its market which required domestic firms to supply the local US market thereby importing from its trade partners to a lesser extent. This was realized by maintaining export restrictions and controls for national security to ensure sufficient domestic supply. The Federal government further realized this goal by maintaining ‘Buy American’ restrictions for government agencies which required them to only purchase supplies and construction materials manufactured in the US with more than 50% of US components (WTO, 2004).

Determinants of Country Competitiveness 27 contributing heavily to the slow recovery of the US was the protective stance towards its national market leading to minimized attention to international trade. Therefore, the US was actually closing instead of opening the market which may have led to the decreasing competitiveness of the US. This protective stance led to a decrease in FDI activity. Although the US accounted for approximately double the FDI activity compared to Korea, the growth pattern of the US is less positive and may remain at the same level or even decline. The US has experienced stable inward and outward flows of FDI activity where its inward FDI flow grew by 1.4% annually over the period between 2004 and 2012. The outward FDI flows increased by 4.6% annually over that same period (OECD, 2014c). Table 5 in appendix B displays the FDI data for the US. This stable, and sometimes even decreasing numbers in FDI has led to less technological knowledge from other countries entering the US (OECD, 2008).

Another reason for the decreased relative competitiveness was the inability of the US regulatory system to adapt to market changes. The US regulatory system included many gaps that were caused by the fragmented structure of regulation between the federal- and state-level and therefore lacked oversight to conduct effective regulatory reforms (OECD, 2008). The regulatory system of the US also lacked timely response and did not make policy changes on a continuing basis which has been one of the recommendations for the US regulatory system. Therefore, by not becoming more flexible in the regulatory system, the US neglected this recommendation and remained fairly rigid (OECD, 2010). This was the case after the 2001 and 2007/2008 crises where the US retained and even sharpened many of its regulations as a protective effort for the domestic market aiming for survival of US firms instead of strengthening US competitiveness by reducing the restrictive influence of regulations on businesses and industries. This lack of responsiveness can also be found in the similarity of the general recommendations for economic growth in the years 2000 to 2006. This similarity can be explained because the US did not attempt to make any policy changes recommended by the OECD or WTO. This could have been due to the crises putting more emphasis on regulations, or due to the US’s highly developed position which did not necessitate for rapid economic growth.