Due to industrialization that had put priorities to manufacturing at the expense of services, the service sector in Korea was grossly underdeveloped up to the early 1990s. Numerous sector specific regulations and restrictions on FDI prevented competition and impeded the offering of higher value services. In 1990, the labor productivity of the Korean service subsectors was much lower than that of the advanced countries. The labor productivity of 'distribution services, etc.', in particular, was less than one-fifth that of the U.S. in 1990.

Since the mid-1990s, the Uruguay Round negotiations and the OECD accession enabled the Korean government to gradually open its service sector to foreign suppliers. As a result, distribution services, business services, entertainment and recreational services and other personal services, in particular, have been almost completely liberalized.
The financial crisis of 1997 also gave momentum to the elimination of horizontal and sector-specific market access restrictions in the service sectors beyond the commitments made in the WTO and the OECD. The Korean government has accelerated its liberalization schedules for transportation services, financial services and telecommunication services since 1998. As of July 2000, the degree of liberalization of the Korean service sector is comparable to that of the developed countries, with almost all the service subsectors open, with the exception of a few areas sensitive to national security, culture, and political stability.

Thanks to the accelerated liberalization, Korea's trade in services increased rapidly in the 1990s. Trade in services, by the three modes of supply (cross-border supply, consumption abroad and movement of natural persons), except commercial presence, increased from $22.8 billion in 1991 to $49 billion in 1998. More significant increase in trade in services occurred through commercial presence. FDI inflows in services increased from $1.6 billion in 1982-90 to $6.3 billion in 1998-99. In particular, FDI in distribution services and transportation services increased remarkably in 1996-97. FDI in financial services and other services experienced a sharp increase after the financial crisis.

The liberalization of services is presumed to bring productivity gains in the service sector and also in the manufacturing sector which use liberalized services as inputs. By examining the changes in productivity of the service subsectors in 1970-97, we find that liberalization may have positively contributed to the productivity of the liberalized service subsectors. 'transport and communications', which was partially liberalized in the 1990s, showed a gain in total factor productivity growth in the late 1990s, from 2.2 percent in 1990-95 to 4.12 percent in 1995-97. The total factor productivity in 'distribution, etc.', which was almost completely liberalized in 1996, also improved in the late 1990s, from 0.41 percent in 1990-95 to 0.02 percent in 1995-97. Whereas, 'finance, etc.', which had been nearly closed until the late 1990s, showed negative total factor productivity growth rates throughout the periods studied.

The hypothesis that liberalization in services may increase the productivity of the manufacturing subsectors which use liberalized services as inputs is also tested by comparing the growth rates of productivity by manufacturing subsectors and the input coefficients of services to those manufacturing subsectors. However, it seems to be difficult to extract any consistent pattern, possibly due to the relatively small input coefficients of services in the manufacturing subsectors.
Considering the positive impacts of the liberalization of trade in services on domestic economy, it is in the interest of the Korean economy to continue the liberalization process and refrain from retreating. As entry barriers have been widely removed, most remaining obstacles are the internal barriers faced by both foreign and domestic suppliers. These barriers are more difficult to remove because they are part operating practices, part regulation and part cultural.

In particular, the ambiguous tax laws as well as cumbersome regulations are regarded as the most serious impediment to foreign investors. This implies that deregulation should focus not only on reducing the number of regulations but also on enhancing its transparent enforcement. In the process of deregulation, the government should also be attentive to reducing excessive regulations for fulfilling their objectives.

Another important area which has not been adequately addressed is labor market inflexibility. The limitations on layoffs may discourage foreign service suppliers from establishing local subsidiaries, which otherwise can create employment. Establishing an adequate social safety net and effective retraining programs is thus needed not only because it enhances labor market flexibility but also because it enables the government to liberalize mode 4---temporary entry of service providers.

Dr. Jong-Il Kim, a professor of economics at the Dongguk University, earned his Ph.D. at Stanford University. He specializes in productivity and economic growth. Address: Department of Economics, Dongguk University, Pil-Dong, Jung-Gu, Seoul 100-715, Korea: (Tel) 82-2-2260-3274; (Fax) 82-2-2260-3684; (E-mail) jongil@dgu.ac.kr
Dr. June-Dong Kim, a research fellow at the Korea Institute for International Economic Policy (KIEP), earned his Ph.D. in Economics at the University of Chicago. He specializes in international trade policy and direct investment. Address: 300-4 Yomgok-Dong, Seocho-Gu, Seoul 137-747, Korea; (Tel) 82-2-3460-1129; (Fax) 82-2-3460-1077; (E-mail) jdkim@kiep.go.kr

Executive Summary

Ⅰ. Introduction

Ⅱ. Evolution of Services Liberalization and Recent Trends of Trade in Services
1. Evolution of services liberalization
2. Recent trends of trade in services

Ⅲ. The Experience of Liberalization in Distribution Services

Ⅳ. Changes in Productivity Growth Rates
1. Sectoral labor productivity: an international comparison
2. Productivity growth in services
3. Contribution of services liberalization to manufacturing

Ⅴ. Concluding Remarks

References
Appendix: Sources of Data
Appendix Tables