[The Editors' Verdict] What the Next Government Must Do for the Defense Industry

[Ahn Young-soo, Former Director of Defense Industry Center at Korea Institute for Industrial Economics and Trade (KIET)] On the 17th, our government announced that it had secured an export contract for air defense missiles worth approximately 3.5 billion USD with the United Arab Emirates (UAE). This scale is a super-large amount, exceeding the annual export order volume of all defense materials, including aviation fuel and ammunition. Under the current administration (2017?20), defense export orders were around 2.8 to 3.2 billion USD. After five years of stagnation, defense exports have sharply shifted to an upward trend since the end of last year, significantly increasing export volume.

According to a survey by KIET, the sales of the top 10 domestic defense companies, which account for about 80% of domestic production, reached 5.46 trillion KRW in the first half of last year, a 9.7% increase compared to the same period the previous year. Therefore, production, which had faced difficulties such as an absolute decline from 2016 to 2020, turned to an upward phase last year. The Defense Acquisition Program Administration (DAPA) announced at the end of last year that export orders reached a record high of 4.6 billion USD. This figure represents a 54.9% increase compared to the previous year, resulting in significant growth in both production and export orders.

The past five years (2016?20) were the darkest period for the defense industry. The fallout from the Sewol ferry disaster spread to defense corruption, causing triple hardships for defense companies, including declines in production, exports, and operating profits. During this process, numerous companies faced debarment sanctions. Many military personnel and DAPA officials were subjected to various accusations and disciplinary actions. Moreover, the advanced aircraft (APT) export project to the United States, the original aerospace nation, worth about 10 billion USD (first phase, approximately 350 units), also failed. This is a painful case where South Korea, which had remained a developing country until the mid-1980s, missed an opportunity to leap again to the center of the global economy in the 2020s with cutting-edge aircraft products after its rapid growth to a middle-income country through the ‘Pony’ car export success to the U.S. Key experts cite low price competitiveness, government’s export indifference and strategic failures, and lack of negotiation capabilities due to appointing non-experts as CEOs as main causes.

Belatedly, the government established a defense industry officer position within the Blue House, operated the Defense Industry Development Council, and improved governance by implementing punitive measures for companies, operating a task force to promote exports, and securing budgets to encourage domestic production of parts. These efforts laid the foundation for fostering the defense industry and export industrialization. The results have led to increased production last year, a record-breaking export order at year-end, and this year’s parade of super-large orders.

However, many challenges remain to be addressed by the next government. The total production value of the defense industry is about 16 to 17 trillion KRW annually, which is insufficient to enjoy economies of scale, as it does not even reach the sales of global top 10 companies. Along with the continued trade deficit caused by the ongoing increase in imports of cutting-edge, high-performance weapons, the supply side’s domestic demand-dependent and segmented industrial structure, production centered on system integrators, and high import dependence on core components are identified as key factors lowering industrial competitiveness. The acquisition system, which is demand (military)-centered without considering supplier capabilities, the military demand, development, and project feasibility system that neglects export and international joint development, the bifurcated R&D (ADD) and production (companies) structure, and the structured gap in civil-military cooperation are major factors hindering both industrial competitiveness enhancement and the advancement to a high value-added industry typical of developed countries. The main export markets have also been criticized for being small-scale and intermittent, centered on underdeveloped countries with low purchasing power. As a result, job creation is only about 1% compared to manufacturing overall.

Therefore, the next government must aim to expand production scale by early resolution of these structural problems, pursue a growth-oriented export strategy focused on large markets such as the U.S., India, and Arab countries, and promote job creation by strengthening industrial competitiveness through fostering small and medium-sized enterprises. For effective implementation, establishing a nationwide governance system from an industrial policy perspective is essential. In particular, addressing the 2030 jobs issue is imperative.