This paper seeks to document Korea's inward foreign direct investment regime and some evidences of its spillover effects. Since the financial crisis of the late 1997, the Korean government started to actively promote inward foreign direct investment (FDI). In November 1998, the Korean government enacted the Foreign Investment Promotion Act. This new legislation focuses on creating an investor-oriented policy environment by streamlining foreign investment procedures, strengthening investment incentives and establishing an institutional framework for investor relations, including a one-stop service. The Korean government also undertook full-fledged liberalization in the area of hostile cross-border M&A and foreign land ownership.

As of July 1998, the government liberalized medium-term foreign loans in order to reduce the burdens on businesses seeking foreign capital. The requirement that commercial borrowing from abroad should exceed $1 million was eliminated. In April 1999, Korea abolished the restrictive Foreign Exchange Management Act and replaced it with the Foreign Exchange Transaction Act. With the Foreign Exchange Transaction Act in place, most of the restrictions on foreign exchange transactions and domestic transactions in foreign currencies have been eliminated. Remaining restrictions are now classified under a negative rather than a positive listing system.

Thanks to these policy changes, the FDI inflow has increased remarkably in 1998, reaching a record amount of US$ 5.1 billion. The pace of foreign direct investment through cross-border M&A has picked up markedly. Compared to US$ 698 million or only 10% of total foreign direct investment in 1997, foreign acquisitions of outstanding Korean stocks have increased to US$ 1,241 million or 14% of total FDI in 1998. If the acquisitions of assets were included in the statistics of cross-border M&A, the amount of cross-border M&A would be more than half of the total FDI inflow in 1998.

The case studies on some selected industries including semiconductor and chemical show that foreign invested firms raised domestic productivity by spinning out skilled workers; providing technical guidance to subcontractors; bringing in new capital goods and technology; introducing advanced management know-how; conducting in-house R&D; enhancing competition.

Considering the benefits of FDI in raising productivity through spillover effects, it is needed to attract more FDI by removing remaining barriers. As entry barriers have been almost completely ended, most remaining obstacles are the same as faced by domestic investors. Although the government is making some progress by streamlining investment procedures, Korea's markets and industries are still bogged down with regulations that are as complicated as they are vague. In particular, the ambiguous tax laws as well as cumbersome regulations on customs and import procedures are regarded as the most serious impediment to foreign investors.

Another important area which has not been adequately addressed is labor market inflexibility. Layoffs are still difficult to execute on a large scale and are allowed only in the case of emergency. Efforts to enhance labor market flexibility is limited by the lack of a social safety net.

Anti-foreign public sentiment remains at the top of lists of perceived weaknesses of the Korean culture from the point of view of foreign investors. Other weaknesses pointed out by foreign investors include a lack of rationality due to personal decision-making or emotional reactions, relationships based on school or locality, lack of flexibility or resistance to change, militant labor unions, poor dissemination of information, and the lack of internationalization.

Executive Summary

I. Historical Overview of Korea's Inward Foreign Direct Investment Policy

II. Patterns of Inward FDI
1. Greenfield vs. M&A activity
2. Sectoral distribution

III. Recent Changes in Inward FDI Policy
1. Transparency
2. Expanding market access
3. Improvement of the foreign investment support system
4. Privatization
5. Liberalizing foreign exchange transaction
6. Import liberalization

IV. Some Evidences of Spillover Effects in Selected Industries
1. Electronics
2. Chemicals
3. Machinery
4. Pharmaceuticals
5. Retailing

V. Future Agenda: Removing Remaining Impediments to Inward FDI
1. Formal barriers
2. Informal barriers

References

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