Korea's transition to digital economy calls for massive investment in IT

2000/05/22

    Based on rapid development of information technology (IT), the digital economy is rising as the new economic paradigm, promising to change the structure and framework of the existing economy.

    In the U.S. the digital economy is already being acknowledged as the new economic system. A digital economy is an economic system where the IT industry is centrally located and IT functions as a catalyst.

    In a digital economy, IT development leads economic growth, which in turn stimulates IT development, thereby forming a virtuous cycle.

    More specifically, IT development causes changes in the production and trade structure of the economy as IT is applied to the production, marketing, and distribution of companies. These changes then lead to a rise in productivity and employment, which make high economic growth possible.

    IT development also leads to a fall in prices. While the rise in productivity caused by IT brings about price falls, fiercer competition due to IT applications such as e-commerce leads to even more price falls despite high economic growth.

    Under this environment of high growth and low prices, economic growth leads to the development of technologies, including IT, again as companies expand investment in R&D.

    Meanwhile, the stock market links IT with investment funds, thereby functioning as a catalyst for economic growth.

    Companies owning IT can raise capital easily by their listing on the stock market. Those companies can then possibly lead the rise of the entire market, giving investors decent returns, thereby attracting more investors into the market.

    As a result, investor wealth increases and effective demand of the whole economy expands, which in turn leads IT development and production expansion. We can currently observe these phenomena in the U.S. economy. Since the early 1990s, the longest expansion phase of the U.S. business cycle since World War II has been continuing. In addition, a new economic phenomenon of decline in both inflation and unemployment rates is occurring.

    Real economic growth rates for 1997 and 1998 were over 4 percent, and even though the weight of the IT industry to the GDP was only 8 percent, it has contributed almost one-third of the economic growth.

    Particularly, computer and telecom services have made a significant contribution to the growth. Computer sales, whose yearly average increase rate recorded almost 60 percent since 1995, have augmented the yearly average GDP growth rate by 0.4-0.6 of a percentage point.

    Growth prospectsIn Korea, the IT industry is expected to grow by an average of 13.8 percent for the next 10 years as the use of the Internet spreads, companies increase their investments in IT infrastructure such as the Intranet, and e-commerce expands.

    For the next five years from 2001 to 2005, the production of IT-related hardware and software is expected to lead the growth, which is forecasted to grow 13.8 percent annually.

    Specifically, software production is expected to keep a high growth rate of an average of 32 percent for the next five years due to the increase of companies' investments in IT-related outsourcing and the expansion of software and IT consulting markets.

    In contrast, the IT service sector will not grow as rapidly since the e-commerce market has not yet fully matured. The IT service sector is expected to increase by an average of 12 percent.

    However, when e-commerce goes into stride after 2006, the service sector of the IT industry is expected to lead the growth of the entire industry.

    As the online information-provider market and data network service market expand due to the spread of e-commerce, the IT service sector is expected to increase by an average of 25 percent a year from 2006 to 2010.

    This will substantially help balance the current disproportionate weight of IT hardware such as semiconductors in the IT industry. Accordingly, the weight of the service sector in the IT industry is expected to increase to 47.1 percent in 2010 from 26.8 percent in 1999, while that of the manufacturing sector is expected to decrease from 73.2 percent to 52.9 percent during the same period.

    IT: driving forceRapid growth in the IT industry is expected to be the driving force of future growth in the Korean economy.

    As the IT industry is forecast to sustain an increase rate of 13.8 percent each year, the weight of the industry in the overall economy will continue to increase, marking up to 15 percent of the nominal GDP in 2005 and 20 percent in the year 2010.

    As the weight goes up, the IT industry will make more contributions to growth so that its contribution to the GDP growth rate is expected to reach 23 percent in 2005 and 30 percent in 2010, which is on par with the U.S. current level.

    Moreover, the development of IT creates a positive influence on the development of other industries.

    Enhanced income level due to IT industry growth will cause an increased production in other industries as it creates new demands.

    Due to this, non-IT industries are expected to maintain an average growth rate of 7 percent for the next 10 years, although the weight of those industries in the nation's GDP is forecasted to gradually decline from 90 percent in 2000 to 80 percent in 2010. Their contribution to the economic growth rate is expected to decrease from 80 percent in 2000 to 70 percent in 2010.

    The scale of the Korean economy is also forecasted to increase rapidly, aided by the high growth rate of the IT and other industries. Korea's nominal GDP is forecasted to increase by an average of 8.4 percent every year for the next 10 years. This means that the nominal GDP, which amounts to 528 trillion won in 2000, is expected to reach 1,185 trillion won in 2010.

    Real GDP is expected to increase to 874 trillion won in 2010 from 472 trillion won in 2000. The annual real economic growth rate until 2010 will likely mark an average of 6.3 percent if the GDP deflator is assumed at 2.0 percent, considering the stable price movement under a digital economy. This means that the economic growth rate can maintain the level of the mid-1990s.

    Preconditions for transitionSeveral conditions should be met beforehand to allow smooth transition towards a digital economy. First, large-scale investment is required for the transition from an economy based on the traditional manufacturing industry to a digital economy.

    In the U.S., steady IT investment has been made since the 1970s over a long period of time as seen in IT-related capital stock increases of 10 percent every year since 1970.

    However, Korea cannot help but depend upon foreign investment for IT investment funds. To attract foreign investment, the transparency of corporate management needs to be enhanced and the sophistication of domestic financial institutions is necessary. These measures are to help enable the market to distinguish between the good and bad IT-related companies, including venture companies, thereby improving returns and reducing risk on investment capital. Otherwise, there will be difficulty in continuous expansion of investment resources through foreign investment.

    However, if foreign capital attraction is accomplished, the problem of a current account deficit may arise as a side effect since foreign capital inflow may overvalue the won, hurting the price competitiveness of domestic exporters.

    The U.S. could withstand a sizable current account deficit over a long period of time by resorting to the advantage of issuing dollars (known as 'seniorage'), the hard currency of the world. However, it is impossible to endure a current account deficit for too long in a small, open economy such as that of Korea.

    If the present trend continues without a systematic transition to a digital economy due to problems of large-scale investment maintenance and current account deficit accumulation, the production growth rate of the IT industry might slow down to 7 percent in 2010 from 14.5 percent in 2002.

    In this case, the real growth rate of the Korean economy could possibly drop to an average of 4.8 percent for the next 10 years, which is hardly a rosy picture.

The writer is a senior researcher of Samsung Economic Research Institute. - Ed.