The Korean exception: service outsourcing by manufacturing firms and the role of institutions

Korea is one of the countries in which the gap in productivity growth between manufacturing and service sector is the most pronounced among OECD countries. The slow productivity growth in the service sector is associated with the increasing use of low-productivity service intermediates by Korean manufacturing firms. The share of outsourced services in terms of employment increased dramatically in Korea, while, on the contrary, its share in terms of output did not grow significantly. This implies either that the production of outsourced services became extremely labor intensive than before, or that the outsourced services became much cheaper than manufactured products or services in general. The specificity that characterizes the pattern of Korean de-industrialization occurred, because the subcontracting firms were able to impose very low prices to their subcontracted service providers. The institutional background of this practice is the combination of the strong dual labor market with the segmented product market. The findings of this paper implies that competition policies and labor market policies can play a more important role than industrial policies do, for productivity growth in the service sector in Korea.