The role of the government in the development of the automobile industry in Korea

Abstract

This article addresses the effect of government R&D policies on the development of Korea’s automobile industry, particularly in relation to technological upgrading. The automobile industry is a highly value-added, technology-intensive industry that generates many good job opportunities. In addition, it is linked to various industries. Korea developed its own car model in the mid-1970s and since then Korea’s automobile industry has continued to develop. Effective government policies have played a significant role in its remarkable success. This article provides policy suggestions for developing countries intending to develop their own automobile industries.

Keywords

automobile industry R&D government Korea

I Introduction

Korea has recorded rapid economic growth since the early 1960s and there has also been a remarkable structural transformation in the Korean economy. The share of the agricultural sector has dropped, while that of the manufacturing sector has risen. Even within the manufacturing sector, the share of low value-added, light industries has continued to fall and that of heavy and chemical industries (HCIs) and higher value-added, technology-intensive industries has risen. Currently, Korea’s exports are led by two technology-intensive industries, that is, the electronics and automobile industries. The latter warrants particular attention because it generates employment and has links to many other industries.

According to Forbes (2013), the Hyundai Motor Company and Kia Motors Corporation in Korea ranked the ninth in the world automobile industry with an annual revenue of US$75 billion and a market value of approximately US$40 billion as of 2013. Since 2010, the production of these two companies has exceeded four million units and the number of exports has generally been increasing by greater than three million units each year. One major domestic automobile component company, Hyundai Mobis, showed an annual revenue exceeding US$16 billion in 2012. These outcomes for Korea’s automobile industry since the latter half of the 1970s are astonishing compared with the meagre performance of the 1960s and the early 1970s.

The government intervened significantly in the development process of the automobile industry. It pursued the HCI Promotion Plan aggressively in the 1970s, which built the foundations for HCIs, including the automobile industry (Mah, 2007). The role of government intervention in the development of HCIs has been a controversial issue. The endogenous economic growth theory supports the significance of government R&D policies in stimulating innovative activities and thus economic growth (Jones, 1995). Also, regarding the automobile industry specifically, Jenkins (1985) has argued that government policies, such as export subsidies and protection for domestic producers, have been the major sources of development in semi-industrialized countries.

In the 1960s, Korea’s automobile industry was in the very initial stages of development. There was neither indigenous technology nor a car model based on the country’s own technology. In the process of pursuing the HCI promotion policy, the government tried to develop technology to the level needed for automobile production and ensured a supply of skilled/educated workers, as it grasped the potential impact of developing the automobile industry. The development of all-Korean car models was undertaken despite poor conditions in relation to domestic consumption and technology (Cho, 1997).

This article focuses on the effect of government R&D policies on the development of the automobile industry, particularly in relation to technological upgrading. It also presents policy suggestions for developing countries which intend to develop their own automobile industries. The structure of the current article is as follows: Section II describes the overall evolution of Korea’s automobile industry. Section III explains the government policy measures in relation to the automobile industry. The performance of Korea’s automobile industry is analyzed in Section IV. Section V provides policy implications for developing countries trying to develop their own automobile industries drawing on Korea’s experience. Conclusions are provided in Section VI.

II Evolution of Korea’s Automobile Industry

Around the time of the Korean War in 1950–53, Korea’s small-scale automobile companies developed from supplying components to satisfying the demands of the military forces (Ryu, 1990: 17). Experience built in this period was a ‘breeding ground for experienced technicians’, although the skills they possessed were limited to serving military vehicles (Korea Automobile Manufacturers Association [KAMA], 1990: 107). During the 1960s, automobile companies were unable to improve their technological level and were limited to importing knock-down (KD) components under an import substitution strategy (Ryu, 1990: 19–20). However, in this period, the government realized that economic gains from assembling imported components could not be sustainable, as it was likely to discourage Korean automobile companies from producing their own models. The government considered that the key to the development of the automobile industry was for it to design its own models, and thus it introduced a government plan for the automobile industry in 1964 (KAMA, 2001: 111–12). Under the Second Five-Year Economic Development Plan covering the period 1967–71, the machinery industry was selected as one of the three goals, leading to an increase in governmental financial support to 2.4 billion Korean won in 1968 (Korea Finance Consortium, 1971: 60).

To develop more value-added industries, the government announced the HCI Promotion Plan in 1973. The automobile industry was one of the six core industries to be promoted.¹ As part of the HCI Promotion Plan, the government announced the Automobile Industry Long-Term Promotion Plan in 1974, a very ambitious development plan for the automobile industry. Table 1 shows the basic principles and targets announced in the Plan, as well as the needs for and advantages of domestic production of small cars. It articulated a need for the mass production of domestically produced small cars and contained seven principles to achieve the objective of matching domestic demand. Starting from 1975, the government set the goal of developing a domestically produced, economical car without frequent model changes and a local content ratio of over 95 per cent. The Plan set the target of producing 50,000 cars each year and lowering production costs through economies of scale. In view of the importance of components in the automobile industry, the government required the automobile producers to establish factories producing important automotive parts.

Table 1.
Automobile Industry Long-term Promotion Plan of 1974

Targets 1. Totally new, economical model
2. Local content ratio: over 95%
3. Production starts from 1975
4. More than 50,000 cars every year
5. Production cost below US$2000

Basic principles 1. Extension of factories for producing complete cars
2. Introduction of new passenger cars
3. Mass production of domestic cars
4. Requirement of building a factory producing important car components
5. International scaling of component factories
6. Production companies
7. Designate the small-sized car as the ‘Nationals Car’

Source: Adapted by the authors from Oh (1996).

To implement the Automobile Industry Long-Term Promotion Plan, the government began to provide financial support to domestic automobile producers. The government policy of promoting the automobile industry worked as an effective stimulus in companies in developing domestic car models. The failure of a collaboration between Hyundai and Ford due to government disapproval also motivated Hyundai to develop its own model (Ryu, 1990). Around that time, the then leader of the Hyundai Motor Company contended that it was desperate to develop its own car model to achieve further growth and to compete with the other multinational car companies in the international market. He also considered that domestic demand for cars was too limited to satisfy its supply. In 1975, Hyundai became the first domestic automobile company to produce its own car model, ‘Pony’, thanks to which Korea became the 16th country producing a domestic car model (KAMA, 2005: 209, 212). With the successful development of Pony, Korea’s automobile industry was able to progress further in technology and began to compete with the leading car manufacturers in the global market.

Behind the successful story of the car manufacturers in the 1970s was the contribution of the automotive parts manufacturers, which was critical to the overall growth of Korea’s automobile industry. ‘Systematization’ between car manufacturers and automotive parts manufacturers, encouraged by the government from 1975, helped the Korean automobile industry take one step further towards greater competence.

Korea’s automobile industry developed rapidly and Hyundai began to export the Pony in the second half of the 1970s. However, due to excessive investment in the HCIs and the occurrence of the second oil crisis with a consequent decline in demand for automobiles, the automobile industry faced hardship in the late 1970s and the early 1980s. To overcome the difficulties confronting the industry, the government implemented the HCI Rationalization Scheme in the 1970s, which sought to reduce overlapping investments. The government supported this through policy loans at lending interest rates much lower than the commercial rates and through tax incentives (Mah, 2007). The Investment Adjustment Act for the HCI Sector in 1982 reduced government support, offering fewer tax incentives, focusing rather on government-led integration attempts to achieve economies of scale in production through merging car manufacturers (Cho, 1997; KAMA, 2005).

Economic growth and the so-called ‘three lows’² boom, a phenomenon which started in the mid-1980s, increased both domestic consumption and foreign demand for Korean automobiles. For instance, domestic car ownership began to exceed one million in 1985. The strength of the yen against the US dollar also contributed to the Korean automobile companies’ attaining price competitiveness in the US market. Together with this favourable external condition, government policy also contributed to the development of the automobile industry in the second half of the 1980s. For instance, the government’s withdrawal of the Rationalization Scheme in 1987 lowered the entry barrier and fuelled competition among the domestic car manufacturers (KAMA, 2005: 602–03). Private companies increased their R&D expenditures and put greater effort into technology development. With favourable external and internal conditions, three major car manufacturers in Korea, that is, Hyundai, Kia and Daewoo, performed well in the US market in the mid- to late 1980s (KAMA, 2005: 332–33).

Table 2 shows the trend of automobile production in Korea. Whereas only some 37,000 cars were produced in 1975, production increased ten-fold to over 378,000 cars in 1985. It then increased seven-fold to 2,526,400 cars in 1995. In 1995, Korea became the fifth largest producer in the world (KAMA, 2005: 402). Thus, Korea became one of the major players in this market in the 1990s. The number of cars produced in Korea continued to rise to over 4.5 million cars in 2012.

Table 2.

Automobiles produced in Korea (unit: number)

Year	1975	1985	1995	2005	2012
Passenger car	18,398	264,458	2,003,146	3,357,094	4,167,089
Bus	3,808	29,090	210,549	115,015	121,257
Truck	14,973	78,171	288,541	216,656	259,094
Special vehicles	–	6,443	24,164	10,585	14,326
Total	37,179	378,162	2,526,400	3,699,350	4,561,766

Source: KAMA (2005, 2013: 15).

III Government Policy Measures in Relation to the Automobile Industry

Regulations

In the 1960s, the Korean automobile industry lacked technology and was thus confined to assembling components. It was also short of scientists, engineers and skilled technicians. In order to develop technology and increase efficiency in the automobile industry, the government offered incentives and imposed regulations at the same time. The regulations essentially pursued the maximization of benefits arising from economies of scale in production.

As the economic development of Korea in the 1970s and 1980s was led primarily by large enterprises, the transition that took place in Korea could be regarded as being one based on a neo-Shumpeterian model formed by economies of scale (Wang and Tsai, 2010). This also applies to the development of Korea’s automobile industry. The potential benefits from economies of scale in the automobile industry are vast. The costs of developing domestic car models are considerable, including R&D, production facilities, marketing and so on. For that reason, under the Long-Term Automobile Promotion Plan of 1974, the government required a production capacity of over 50,000 cars per year (Ahn, 2007: 61).

Table 3 shows the changes in market structure and production technologies from the 1960s. Essentially, the oligopoly situation persisted through the 1970s, which was possible under the Long-Term Automobile Industry Promotion Plan. Hyundai, Kia and Daewoo continued to lead automobile production in Korea. Export subsidies and extensive financial supports worked as incentives, but, at the same time, they led to overcapacity and over-investment problems in the late 1970s. Under the Automobile Industry Rationalization Act of 1981, the government tried to reduce the overlap in investments in the automobile industry, pursuing economies of scale (Kim, 1997: 116).

Table 3.
Production structure and technologies

Period Automobile companies Development of component companies Technology development

1960s Passenger cars (since 1967):
Shinjin, Hyundai, Asia
Commercial vehicle: Kia – 1962~1963: semi-knock-down
1966~ onwards:
complete knock-down (KD)

1970s Passenger car: Kia, Hyundai, Daewoo
Commercial car: Asia,
Dong-Ah 1973: Cooperation with complete car company strengthened 1974: domestic model developed; technology for design
of car body

1980s Passenger car: Kia, Hyundai, Daewoo
Commercial car: Kia, Daewoo, Hyundai, Asia, Ssangyong Vertical cooperation strengthened
Improved price
competitiveness 1988: Hyundai Sonata; sash, engine, gearbox, design technique improved gradually; beginning of R&D on engine and gearbox.

1990s New entries:
Samsung in 1994 Increased foreign investment 1994:
Hyundai Accent;
diversified models;
infra for sash, and
engine built up

2000s~to date Hyundai, Kia, GM Korea (since 2002), Renaults Samsung (since 2000), Ssangyong Private company-
oriented improvements;
development of
Hyundai Mobis Efficiency improvement via
component modularity;
eco-friendly technologies
emphasized

Period	Automobile companies	Development of component companies	Technology development
1960s	Passenger cars (since 1967): Shinjin, Hyundai, Asia Commercial vehicle: Kia	–	1962~1963: semi-knock-down 1966~ onwards: complete knock-down (KD)
1970s	Passenger car: Kia, Hyundai, Daewoo Commercial car: Asia, Dong-Ah	1973: Cooperation with complete car company strengthened	1974: domestic model developed; technology for design of car body
1980s	Passenger car: Kia, Hyundai, Daewoo Commercial car: Kia, Daewoo, Hyundai, Asia, Ssangyong	Vertical cooperation strengthened Improved price competitiveness	1988: Hyundai Sonata; sash, engine, gearbox, design technique improved gradually; beginning of R&D on engine and gearbox.
1990s	New entries: Samsung in 1994	Increased foreign investment	1994: Hyundai Accent; diversified models; infra for sash, and engine built up
2000s~to date	Hyundai, Kia, GM Korea (since 2002), Renaults Samsung (since 2000), Ssangyong	Private company- oriented improvements; development of Hyundai Mobis	Efficiency improvement via component modularity; eco-friendly technologies emphasized

Source: Adapted by the authors from KAMA (2005) and Han (2007).

In 1987, the government undertook the ‘internal’ liberalization measures to strengthen the market mechanism in the automobile market. That is, the Automobile Industry Rationalization Act of 1987 was the beginning of ‘internal liberalization’, which meant free competition within the domestic automobile industry. Free competition among the car manufacturers drove them to strengthen their high-tech bases to cope with the stronger competition (KAMA, 2005: 603).

In addition to focusing on the production of cars, starting from the mid-1960s, the government tried to strengthen the ties between car manufacturers and automotive parts manufacturers. As a car is composed of approximately 20,000 components and two-thirds of the total production costs of a car derives from automotive parts (Ahn, 2007: 68), strengthening the relationship between car manufacturers and automotive parts manufacturers is critical to improvement of competitiveness, not only in quality but also in price. The government encouraged the automotive parts manufacturers to improve their productivity and quality of supplies so as to enhance the overall quality of Korean cars. As a means of achieving this, the government initiated the Promotion Act for Collaboration of Small- and Medium-sized Automotive Parts Makers with Car Makers’³ in 1993 (KAMA, 2005: 446–48). The growth in exports in the automotive parts industry was accompanied by that of automobiles.⁴

Together with the emphasis on economies of scale in production and consolidation between car manufacturers and automotive parts manufacturers, the government’s regulations on concessions for automobile production factories in 1967 also contributed to improvements in technology. Under the regulation, a company could build car factories only when it possessed more than US$7 million for production facilities and had a contract for licensing technology with foreign automobile companies (Shin, 1990: 164). The government imposed these conditions to promote technological learning from advanced countries. After the announcement, domestic car manufacturers made more contracts with foreign companies to obtain technologies and capital.⁵ The government’s promotion of technological collaboration with foreign car manufacturers acted as an important source in the successful development of domestic car models from 1975 (Cho, 1997: 50; Kim, 1997: 112–13). The decision of the government that foreign shares in the HCI sector cannot exceed 50 per cent drove domestic car manufacturers to rely on technology licensing rather than inward foreign direct investment in acquiring technologies (Park, 2012: 98).

Import Protection and Tax Incentives

Under the Automobile Industry Protection Act of 1962, imports of foreign cars and automotive parts were restricted until 1967 to protect the domestic industry in the initial stages of development. While restricting imports of foreign parts, the government tried to increase the local content ratios of domestic cars to develop the automotive parts industry, although this was not successful until the early 1970s. The major problem underlying the failure to raise the local content ratio was the low level of technology. In 1974, the government abolished quantitative restraints on imports and instead raised the tariff rates imposed on passenger cars from 150 per cent to 250 per cent, as shown in Table 4. Under the protection from foreign competition, the local content ratio gradually increased through the development of domestic automotive parts manufacturers. That is, the local content ratio of the Kia Brisa and the Hyundai Pony rose from 63 per cent and 85 per cent, respectively, in 1975 to 92 per cent in 1979 (Korea Industrial Economy Technology Research Institute [KIETRI], 1982).

Table 4.

Changes in import policy in 1974

	Tariffs before 1974	Tariffs since 1974	Effect
Passenger car	150 per cent	250 per cent	Demand for domestic car increased
KD Component	No tariffs on imported KD components	Limit on the import amount of foreign KD components, imposition of tariffs	Growth of domestic component industry; limited success in localization

Source: Adapted by the authors from KAMA (2005: 201–03).

Under the HCI Promotion Plan in 1974, the government lowered overall tax rates⁶ on the consumption of domestically produced cars, which contributed to promoting consumption (Cho, 1997). In 1977, to expand the domestic consumption further, the government modified the tax rates for the automobile industry. Special consumption taxes on cars were cut by more than half. For example, the tax rate for cars below 1,500cc decreased from 40 per cent to 15 per cent in 1977 (Cho, 1997). That for cars between 1,500 cc and 2,000 cc (above 2,000 cc) also fell from 50 (100) per cent to 20 (40) per cent in the same year. In addition, car acquisition tax, registration and license taxes were also lowered. The number of cars per 1,000 people almost doubled from 2.7 in 1976 to 5.0 in 1978 (The Ministry of Land, Infrastructure and Transport [MOLIT], https://stat.molit.go.kr/portal/cate/engStatListPopup.do).

The tariff wall, local content requirement and tax incentives for domestic consumers all worked as stimuli to develop technology in the automobile industry. Even though financial incentives for foreign investors existed (Shin, 1990: 183), the impact was limited until the early 1980s. With the increasing demand for cars, the automobile industry could derive greater economic benefits by expanding production facilities. The amount of investment by domestic car manufacturers increased during the latter half of the 1970s. For instance, it increased from 24 billion Korean won in 1977 to 107 billion Korean won in 1979 and 77 billion Korean won in 1980, which was a source of technological development but also a cause of the over-capacity problem from the late 1970s to the early 1980s (KAMA, 2005: 254–55; Ryu, 1990: 40).

In the early 1980s, Korea was one of several countries with domestic car models and exports reached nearly 30,000 cars each year. As the Korean car manufacturers’ exports to the USA rose and the trade deficits of the USA began to increase during the 1980s, the USA started to request changes to Korea’s import protection measures. To mollify the USA and keep up with the global market trend, the government gradually undertook import liberalization measures in the automobile market. During the 1980s, import tariff reduction continued and tariff rates on passenger cars and trucks fell to 25 per cent in the late 1980s. Tariff rates continued to decrease until the mid-1990s as a result of the Uruguay Round multilateral trade negotiation. Tariff rates on passenger cars decreased to 10 per cent in 1993 and then to 8 per cent in 1998. As of February 2014, the import tariff rate with respect to passenger cars equalled 8 per cent (Hankuk Economy Newspaper, 2012; Korea Customs Office, http://www.customs.go.kr, retrieved 12 February 2014). Defence tax also affected the total price of imported cars. For instance, in 1990, defence tax amounted to 30 per cent of the total special consumption tax, 20 per cent of the registration tax and 30 per cent of the car ownership tax. The defence tax was eliminated in 1991 (KAMA, 1990: 46).

Education and Research Institutes

Human capital leads a society to achieve innovation and sustainable economic growth (Temple, 2002: 8). The Korean government built educational institutions to improve human resources and established research institutes to advance technology. In the 1950s and 1960s, the short-term vocational training institutes and technical high schools had played a role in providing workers with basic skills for the labour-intensive industries. With the beginning of the HCI promotion policy in the 1970s, demand for skilled workers and research institutes leaped. The government effort to generate quality workers through the vocational training institutes and technical high schools met the rising demand for skilled workers in the HCI sector (Jung and Mah, 2013b). As of 1974, for instance, approximately 18,000 high school students entered technical high schools to major in machinery (Park, 2012: 191). In addition, the vocational training institute established and run by the government in the 1970s and 1980s included Automobile Repair Departments. Currently, as of January 2014, there are three leading technical high schools fully devoted to educating technicians dealing with automobile production and repair (Korea Research Institute for Vocational Education and Training [KRIVET], 2014).

In 1966, the government established the Korea Institute of Science and Technology (KIST) to provide an intensive boost to the science and technology (S&T) sector. KIST played a pivotal role in implementing the HCI Promotion Plan, particularly in the automobile industry. It contributed to technological development in the automobile industry by inventing automobile-related technologies such as light-weight automobile materials and special plastics used in automobiles. In 1998, the government established the Korea Automotive Technology Institute with a contribution of as much as 2 trillion Korean won (KIST, 2006).

The Korea Advanced Institute of Science and Technology (KAIST), established in 1971, is another major government-built educational institution, educating bright college and graduate students majoring in the natural sciences and engineering. The government has granted it a vast amount of financial support. It has also been accorded the privilege of exemption from mandatory military service (Jung and Mah, 2013a). The government’s support of S&T education and related research institutes has increased the number of engineers majoring in automobile-related fields.

Building Infrastructure

Starting with the first national motorway, the Seoul-Incheon motorway, which was completed in 1969, the government constructed further motorways to build infrastructure for economic growth and the total length of motorway provision was 551 km in 1970. Due to the construction of other motorways during the 1970s, this was further extended to 1,225 km in 1980 and then to 1,551 km in 1990 (Hyundai Motor Company, 1996). The expansion of the motorways and the rising per capita income level due to rapid economic growth increased domestic demand for passenger cars, which contributed to increased automobile production capacity during the 1970s and 1980s.

Together with the construction of motorways, the government built an industrial estate to house the factories producing cars. That is, in 1973, the government decided to establish the Changwon National Machinery Industrial Estate as part of the HCI Promotion Plan. It houses, for instance, the production facilities of the Hyundai Motor Company (Park, 2012: 21, 541).

IV Performance of Korea’s Automobile Industry

Production

In Korea, the capability of producing automobiles was quite limited until the mid-1960s. The production capacity increased significantly after the government announcement of the Automobile Industry Promotion Plan of 1964. From 1962 to 1968, the production capacity increased ten-fold. Thus, the beginning of governmental support for the domestic automobile industry coincided with the starting point of the rapid growth in production capacity, although the automobile industry was still at the KD level.

The HCI Promotion Plan, announced in 1973, with the aim of producing 500,000 cars by the early 1980s, was an effective measure for supporting the development of the domestic automobile industry. Hyundai’s development of the first domestic car model in 1974, for instance, enabled the sudden increase in the production capacity from approximately 70,000 units in 1974 to 194,000 in 1976. In 1975, the government announced the Long-Term Automobile Industry Promotion Plan and the production capacity of the automobile industry rose to 366,000 units in 1980.

The artificial restructuring of the automobile industry by the government-led car manufacturers to suffer massive losses⁷ and a reduction in production capacity during the first half of the 1980s. For instance, the losses incurred by the Hyundai Motor Company alone reached 19 billion Korean won. Due to favourable foreign market conditions, the government policy of stimulating domestic consumption and rapid economic growth, the production capacity regained its former position in the mid-1980s.

In the period 1984–92, the production capacity increased by 7.5 times. Although the gradual liberalization of imports and tax reductions initiated from the 1980s onwards provided more room for foreign companies to penetrate into the domestic market, they also made the domestic automobile industry more competitive as domestic producers coped with the changing environment by developing more advanced technologies. During the 1980s, core production techniques, such as those used in producing chassis, engines, gearboxes and designs were developed in Korea (KAMA, 2005: 596). Hyundai successfully developed another own car model, ‘Sonata’, in 1988, the later versions of which were a huge success in the international market (Ahn, 2007: 94–96). The production of passenger cars in Korea reached 4.5 million units in 2012, as shown in Table 5. Considering that the world production of automobiles was recorded as 84.1 million in 2012 (Shim and Choo, 2014: 21), production in Korea had a share of global production of much higher than 5 per cent.

Production capacity kept growing through the 1990s. An interesting phenomenon is observed in the outward foreign direct investment (OFDI) of the automobile industry in the 1990s. That is, to overcome the trade protection wall, Korean companies began to establish subsidiaries abroad. For instance, during 1989–97, Hyundai established factories in 11 countries with a production capacity of 170,000 cars; Kia did the same in eight countries, with a capacity of 158,000 cars. Daewoo aggressively undertook OFDI, establishing its factories in 10 countries in the same period with a production capacity of 831,000 cars. The subsidiaries of Daewoo established in Poland and Uzbekistan were able to produce up to 290,000 and 200,000 cars, respectively, in 1996 (KAMA, 2005: 416).

Table 5.
Production capacity

Year Passenger car Bus Truck Total

1962 2,000 – 500 2,500

1968 15,000 1,500 8,000 24,500

1974 38,200 7,200 24,900 70,300

1976 130,000 9,400 54,600 194,000

1980 238,000 23,000 105,000 366,000

1984 192,000 41,000 104,000 337,000

1988 1,273,000 124,000 210,000 1,607,000

1992 1,840,000 252,000 420,000 2,512,000

1996 2,735,000 269,000 449,000 3,453,000

2000 3,542,000 – 790,000 4,332,000

2004 4,355,000 – 450,000 4,805,000

2008 4,392,000 – 496,000 4,886,000

2012 4,518,000 – 466,000 4,984,000

Year	Passenger car	Bus	Truck	Total
1962	2,000	–	500	2,500
1968	15,000	1,500	8,000	24,500
1974	38,200	7,200	24,900	70,300
1976	130,000	9,400	54,600	194,000
1980	238,000	23,000	105,000	366,000
1984	192,000	41,000	104,000	337,000
1988	1,273,000	124,000	210,000	1,607,000
1992	1,840,000	252,000	420,000	2,512,000
1996	2,735,000	269,000	449,000	3,453,000
2000	3,542,000	–	790,000	4,332,000
2004	4,355,000	–	450,000	4,805,000
2008	4,392,000	–	496,000	4,886,000
2012	4,518,000	–	466,000	4,984,000

Source: KAMA (2005, 2013).

Note: From 2000, the production capacity of bus is included in that of truck.

In 1996 and 1997, the production capacity of Korean car manufacturers’ subsidiaries abroad reached between a third and a quarter of that within Korea. With the balance of payments crisis in 1998, Korea’s OFDI in the automobile industry shrank for a while. After overcoming the balance of payments crisis in around 2000, Korean car manufacturers’ OFDI again continued to increase. For instance, in 2013, Hyundai and Kia exported 2.3 million cars, whereas they produced 4.1 million cars in their subsidiaries in the rest of the world (Han-Gyu-Re Newspaper, 27 January 2014).

Exports

With the introduction of the Hyundai Pony, exports of automobiles continued to increase. Fuelled by the successful story of Hyundai,⁸ other Korean car manufacturers put more effort into developing their own models. Technological collaboration with foreign companies⁹ was the predominant source for building up technologies which contributed to improvements in the overall export performance of the automobile industry. The experience of technology licensing built up during the 1970s was a critical resource for the development of technologies which helped domestic exporting companies to cope effectively with competition abroad in the coming years (Ryu, 1990: 55). In September 1975, the Ministry of Commerce and Industry designated the automobile industry as an export industry and during the Fourth Five Year Economic Development Plan, covering the period 1977–81, and began to provide various export subsidies (Park, 2012: 75). As Table 6 shows, exports of automobiles increased to over 26,000 cars in 1979.

Although exports of automobiles rose in the late 1970s, they stagnated from 1979 primarily due to the second oil crisis in the world economy. As Table 6 shows, car exports began to rise again in the late 1980s, which was due to the so-called ‘three lows’ boom and the favourable exchange rate compared with Japan. As Korean and Japanese car manufacturers produced and exported mainly small-sized cars, they began to compete fiercely in the US market. As price competitiveness improved, the Korean car manufacturers’ exports rose sharply from 25,356 in 1983 to well over 300,000 in the late 1980s. In addition to the favourable global market conditions, government policy also contributed to the expansion of exports.

The ‘three lows’ boom phenomenon ended in 1989 and the export boom also came to an end. Complaints about the quality of Korean cars and negative images in the eyes of foreign consumers hit the Korean car manufacturers. This, together with the rising crude oil price, resulted in a fall in exports of automobiles in the early 1990s. The reluctant attitude of foreign car manufacturers towards technology licensing was another major cause of hardships experienced by Korean car manufacturers in this period (Kim, 1997: 119). However, the Korean automobile industry continued to make technological improvement.

Government policy measures, supporting institutions such as KAMA and the Korea Automotive Technology Institute (KATECH) and providing R&D funding and tax incentives, enabled Korea’s car exports to rise again from around 1993. Hyundai’s development of another model, ‘Sonata’, also contributed to a leap in Korea’s car exports during the 1990s, which increased from less than 0.4 million units in 1991 to over 1.5 million units in 1999. The accumulated experience of producing cars also enabled a rise in labour productivity. For instance, Levitt, Lyst and Syverson (2013) showed that in automobile assembly, the average man hours required to assemble a car and the average number of defects per car decreased sharply with production experience due to learning-by-doing in the case of the USA.

Table 6.

Exports of automobiles by companies

Year	Hyundai	Kia	Asia	Daewoo	Ssangyong	Total
1975	0	10	0	21	5	31
1977	7,527	117	0	177	1	9,136
1979	19,540	6,647	0	5,013	72	26,337
1981	19,504	2,345	1,220	2,389	1,128	26,283
1983	18,500	600	5,816	357	81	25,356
1985	120,041	1,322	733	879	132	123,110
1987	407,924	63,410	2,785	71,533	658	546,310
1989	215,101	95,018	1,277	43,497	599	356,040
1991	254,555	80,020	3,116	51,253	1,179	390,362
1993	349,580	158,419	14,753	102,133	9,533	638,557
1995	472,813	200,477	27,212	247,510	14,731	978,688
1997	565,235	281,501	23,401	333,004	90,675	1,316,891
1999	617,429	397,796	5,154	463,533	17,515	1,509,660
2001	801,076	464,989	0	220,356	14,317	1,501,213
2003	1,012,134	528,750	0	256,147	15,406	1,814,938
2005	1,131,211	838,513	0	544,809	65,521	2,586,088
2007	1,076,086	840,822	0	807,729	64,073	2,847,138
2009	911,088	736,024	0	429,259	12,747	2,148,862
2011	1,204,155	1,075,871	0	656,425	73,630	3,151,708
2012	1,242,083	1,102,004	0	655,878	71,553	3,170,634

Source: KAMA (2005, 2013).

Note: Total exports also include exports from the other domestic automobile companies.

Except for a few years, car exports tended to increase throughout the 2000s. Due to the global financial crisis which broke out in 2008, exports decreased significantly in 2009 (KAMA, 2013). Since then, they have recovered, reaching 3.2 million cars in 2012. In the same year, Hyundai and Kia shared approximately three quarters of Korean car exports. In 2013, Korea exported 3.1 million cars and the export values of cars (including components) reached US$74.7 billion (The Ministry of Trade, Industry and Energy, http://www.motie.go.kr, retrieved 12 February 2014).

Patents

Korea’s automobile industry evolved from an imitator to an innovator during the 1970s–1990s. As a technology-intensive industry, innovation is critical to the continued development of the automobile industry. Since the early 1980s, the number of patents in the automobile industry has grown overall. Although the number of patents granted in the automobile industry in Korea continued to be fewer than 10 each year until 1982, it has jumped to over 40 each year since 1983 (Ryu, 1999).

With the active role of the government in R&D promotion, the technology level improved consistently during the 1990s and 2000s. For instance, as Table 7 shows, the number of patents for which applications were made in the machinery industry (in which the automobile industry is an important component) increased from 3,662 in 1990 to 22,007 in 1995 and then to 27,132 in 2008. This increasing trend in patent applications follows the development of government R&D activities in the machinery industry, indicating that these activities have been effective in improving the overall technology level.

Table 7.

Patent application and government R&D expenditure in Korea’s machinery industry, 1990–2008 (unit: number, billion Korean won)

	1990	1995	2000	2002	2004	2006	2008
Patent applications	3,662	22,007	16,464	17,150	20,844	24,662	27,132
Government R&D expenditure	n.a.	n.a.	n.a.	345	443	792	700

Sources: Korea Patents Office (2011) and National Science and Technology Council (2010).

Note: n.a.—not available.

V Policy Implications for Developing Countries

Korea’s automobile industry remained at the KD level until the first half of the 1970s due to lack of capital and technology. As part of the HCI promotion policy, the Korean government actively implemented various policy measures to promote the automobile industry, particularly from the mid-1970s. Its performance since then has been remarkable. The technological level of Korea’s automobile industry has notably progressed. Together with other technology-intensive industries, that is, the electronics industry, the development of a value-added automobile industry has enabled the Korean economy to leapfrog from a low-income developing country to an OECD member within a few decades. Korea’s experience in developing its automobile industry and the role of the government in this process has important policy implications for developing countries which wish to develop their own automobile industries, not to mention many other industries linked to it.

Infrastructure

Building the supporting infrastructure is necessary for the development of the automobile industry. The Korean government began to build motorways in the late 1960s. Following that time, several motorways which connect the largest city in Korea, Seoul and the main industrial estates, seaports and other large cities were constructed in the 1970s, which expedited delivery of automotive parts to the car manufacturers and also stimulated the consumers’ demand for cars. The Korean government constructed a large-scale national industrial estate and allocated it to car manufacturers, thus reducing their production costs.

Government Regulation

The Korean government regulated the automobile market, particularly in the early stages of development. That is, the government aimed to regulate the number of car manufacturers, considering economies of scale. It played an important role in helping domestic car manufacturers to overcome issues with domestic consumption during the 1970s and 1980s. This can be considered a factor which enabled Korea’s automobile industry to achieve remarkable growth, in contrast to the situation in other developing countries during the 1970s (Cho, 1997).

Utilizing Foreign Technologies

Providing proper incentives to promote the introduction of advanced technologies from foreign major car manufacturers has also contributed to technological development. The technological improvement of Korea’s automobile industry arising from foreign sources can be seen in technology licensing in particular. The Korean government offered financial incentives and also employed administrative restrictions, such as restrictive conditions for building factories, as tools to encourage domestic car manufacturers to build technology tie-ups with foreign companies.

Tax and Import Policies

Tax and import policies played an important role in the development of the automobile industry, especially in the early stages of development. The Korean government imposed high tariff rates, as high as 150 to 250 per cent during the 1970s, which succeeded in protecting domestic car manufacturers. As the production capacity exceeded one million cars in the second half of the 1980s and exports increased, the government reduced the tariff rates. Protection in the first decade of the development of domestic car models enabled the car manufacturers to survive in the early stages.

Gradual import liberalization in the next stage encouraged those producers to try to improve the quality of their cars to cope with competition in the domestic market. The reduction in consumption taxes and import tariff rates during the 1980s and 1990s contributed to the expansion of domestic consumption of automobiles, which was of considerable help to domestic car manufacturers when they faced a slowdown in exports. Although the current World Trade Organization (WTO) system regulates subsidies targeting selected industries, import tariff rates are allowed to a certain extent. Therefore, in light of Korea’s experience, developing countries may consider such measures when trying to develop their own automobile industries, using import tariff policies and domestic tax policies appropriately within the bounds of the current WTO regulations.

Relationship between Car Manufacturers and Automotive Parts Manufacturers

Strengthening the relationship between car manufacturers and automotive parts manufacturers is essential in increasing the value-added component in the automobile industry. In the case of Korea, cooperation and consolidation between these two industries were critical in boosting the quality of products as well as lowering production costs (Jung et al., 2000).¹⁰ Synergies from efficient resource sharing promoted by the government led to development in Korea’s automobile industry. From the 1970s, the Korean government encouraged this through regulation, such as requiring a high local content ratio in production, which facilitated resource exchanges between the two, leading to development of the automotive parts industry. Considering that development of car manufacturers without that of automotive parts industry is groundless and results in low value-added, it is essential for the government to design the measures of developing the automotive parts industry and consolidating the relationship between those two.

Human Capital

Improvement in the level of human capital is a critical building block in the development of the automobile industry due to its technology-intensive nature. The Korean government contributed significantly to building up the human capital needed in the automobile industry by establishing and maintaining government research institutes and educational institutions. KIST, established by the government in 1966, was a pivotal research institute, providing cutting-edge technologies to the automobile industry. Furthermore, the Korean government established the Korea Automotive Technology Institute in 1998 as a research institute fully devoted to developing technologies regarding automobiles. In relation to educational institutions, the government has maintained and financially supported the short-term vocational training institutes and the technical high schools to provide technicians, in addition to those provided by the tertiary-level educational institutions such as KAIST and the mechanical engineering departments in universities. Likewise, developing countries can promote the development of domestic technologies by supporting research institutes and educational institutions related to the automobile industry.

VI Conclusion

The automobile industry is a highly value-added, technology-intensive industry generating a large number of good job opportunities. In addition, it is linked to various other industries. Therefore, many developing countries have tried to develop their own automobile industries. However, most have not succeeded in developing their own car models or acquiring a significant proportion of the share of production and exports. Korea can be regarded as the only exception in the past half century among developing countries as a whole. Although the domestic situation in the 1950s and 1960s was devastating, Korea managed to develop its own car model in the mid-1970s and since then Korea’s automobile industry has continued to develop. Korea is currently one of the major car producers in the world. In addition to entrepreneurship and public diligence, effective government policies have played a significant role in its remarkable success.

As part of the HCI Promotion Plan during the 1970s, the government protected and provided incentives to develop the country’s domestic automobile industry. Initially, the government played a major role as the private sector was unable to ensure growth on its own in the industry’s infancy. Tax and financial incentives, import protection policies and R&D policy measures enabled private companies to develop their own car models, improve quality and increase production capacities. As the domestic car manufacturers grew their core competency in production technologies and price competitiveness, the government gradually moved aside and became ‘small’ government after the mid-1980s.

The performance records of Korea’s automobile industry have been remarkable, demonstrating an expansion in production and exports as well as improvement in the quality of cars produced. In 2013, Korea’s major car manufacturers, Hyundai and Kia, shared 9.2 per cent of exports to the US market and were the fifth largest sellers of automobiles in the global market in terms of quantity (Fn-news, 2014; Sky-E-Daily, 2012).

The effective role of government policy in the development of Korea’s automobile industry suggests several policy implications for developing countries: the importance of building appropriate infrastructure such as motorways and the industrial estates; the need to form the market structure in the sense of pursuing economies of scale; ensuring efficient technological learning from foreign sources; the use of tax and import tariff measures to strengthen production capability and price competitiveness, particularly in the early stages of development; taking measures to strengthen the relationship between the automobile and automotive parts industries; the provision of human capital by establishing and maintaining government research institutes and educational institutions. It is a combination of such measures that needs to be considered to establish an automobile industry that is successful both in domestic and international markets.

Footnotes

Notes

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Targets	1. Totally new, economical model 2. Local content ratio: over 95% 3. Production starts from 1975 4. More than 50,000 cars every year 5. Production cost below US$2000
Basic principles	1. Extension of factories for producing complete cars 2. Introduction of new passenger cars 3. Mass production of domestic cars 4. Requirement of building a factory producing important car components 5. International scaling of component factories 6. Production companies 7. Designate the small-sized car as the ‘Nationals Car’