Bank of Korea: "Corporate Productivity Slowdown Due to Decline in Innovation Quality"

Analysis and Evaluation of Innovation Activities in Korean Companies Report
Strengthening Basic Research and Venture Capital Supply Functions to Increase Corporate Productivity
Need to Increase Innovative Entrepreneurs as Well

The productivity growth of domestic companies has significantly slowed down, which is analyzed to be due to a decline in the quality of innovation within our companies. To overcome this, it is pointed out that companies need to strengthen basic research, and the government should improve the venture capital’s function of supplying innovation funds.

According to the report "Analysis and Evaluation of Innovation Activities of Korean Companies" released on the 26th by the Economic Research Institute of the Bank of Korea, innovation activity indicators of Korean companies have rapidly improved since the 2010s, but productivity growth has greatly slowed.

The scale of research and development (R&D) expenditure by Korean companies and the number of patent applications filed in the United States ranked 2nd (in 2022) and 4th (in 2020) worldwide, respectively, showing excellent performance in both input and output.

However, the productivity growth rate of companies dropped sharply from an average annual 6.1% during 2001?2010 to 0.5% during 2011?2020. The report analyzed that this was influenced by the fact that the productivity growth rate of innovative firms?companies actively engaged in innovation activities?actually slowed down even more after the 2010s.

The report classified companies with outstanding innovation performance, such as those filing patents in the U.S., as innovative firms. These companies accounted for about 72% of total corporate R&D expenditure (average from 2011 to 2020), but their productivity growth rate sharply declined from an average annual 8.2% during 2001?2010 to 1.3% during 2011?2020.

In the case of large companies (top 5% by number of employees), they led the overall increase in R&D expenditure, but productivity growth remained stagnant. This was influenced by the fact that although the quantity of innovation achievements (number of patent applications) greatly increased, the quality closely related to productivity (such as the number of patent citations, indicating the importance of innovation) declined in the mid-2000s and has not improved since.

The Decline in Basic Research Expenditure Share Worsens Quality of Innovation

It is evaluated that the lack of qualitative improvement in innovation performance of Korean companies, especially large companies, is partly due to the reduction in the share of basic research expenditure since the 2010s. Empirical analysis conducted on Korean companies showed that applied research is effective in increasing the quantity of innovation achievements, whereas basic research is closely related to the quality of innovation achievements, which forms the foundation for leading technology development.

This effect was clearly evident in large companies that operate across multiple industries and can broadly utilize basic research outcomes. However, the share of basic research expenditure by Korean companies decreased from 14% in 2010 to 11% in 2021.

For small and medium-sized enterprises (SMEs) with relatively short business histories (bottom 20% by business age), productivity growth was steep before the 2010s but significantly slowed afterward. This was influenced by increased difficulties in securing innovation funding and a decrease in the entry of startups with innovation potential.

The difficulty SMEs face in securing innovation funding is possibly due to reduced corporate access to venture capital since the 2010s and the relatively insufficient role of the private sector. The report claims that while access to venture capital has declined since the 2010s, the development of the investment exit market has been slow, and the private sector’s role remains insufficient.

The rapid aging of low-business-age SMEs, caused by the reduced entry of startups with innovation potential, was also pointed out as a problem. The decrease in the entry of startups with innovation potential is possibly due to the insufficient nurturing of innovative entrepreneurs who can lead creative destruction.

Need to Strengthen Basic Research, Supply Venture Capital Funds, and Foster Innovative Entrepreneurs

The report emphasized that to ensure that corporate innovation activities lead to productivity improvement, it is necessary to strengthen basic research, improve the venture capital’s function of supplying innovation funds, and create social conditions to actively foster innovative entrepreneurs.

To strengthen basic research, it is necessary to provide incentives for internal basic research, expand industry-academia cooperation, and revitalize innovation clusters.

It added that corporate access to venture capital, which is evaluated to be lower compared to major advanced countries, should be expanded, and conditions should be created to encourage entrepreneurial challenges by "smart misfits" and others.

Implementing various innovation policies that actively encourage corporate innovation activities has been shown to clearly contribute to economic growth and social welfare improvement.

When basic research is strengthened through research funding support and expanded industry-academia cooperation, economic growth rate and social welfare improve by 0.2 percentage points and 1.3%, respectively. When innovation firms are fostered through improved funding supply conditions and expanded entry of startups, these figures increase by 0.1 percentage points and 1.4%, respectively.