Chapter 3. Economic and institutional environment in Korea

This chapter gives an overview of the performance of the overall economy, macroeconomic developments and challenges, governance and institutions, and general incentives in Korea for investments by firms, including farms, input suppliers and food companies. It discusses basic conditions for investment established by the overall regulatory environment; trade and investment policy, which influences the flow of goods, capital, technology, knowledge and people needed to innovate; and access to credit needed to innovate. The general fiscal policy and the treatment of agriculture are then discussed. Specific obstacles and incentives for investment in the agricultural sector are dealt with in later chapters of this report.

    

3.1. Macroeconomic policy environment and governance

At the broadest level, stable and sound macroeconomic policies, leading to high growth and low and stable inflation rates, play an important role in setting a favourable environment for investment in farms or agri-food firms seeking to introduce new products, to adopt new production methods, or to undertake organisational changes that can lead to higher productivity growth and more sustainable use of natural resources. Assessment of the country’s overall growth and growth potential in the short- to medium-term has implications for sector-specific prospects as well. In some circumstances, macroeconomic policies and their impacts can contribute to implicit and perhaps unintended biases for or against the food and agriculture system.

Macroeconomic environment

Over the long-term, macroeconomic indicators show that Korea’s economy is improving in various aspects. It has had the fastest growing per capita income among other OECD economies over the past 25 years, sustaining double-digit export growth in volume, which helped it become the 6th largest exporter and 11th largest economy in the world by 2015 (OECD, 2016a). The per capita GDP gap narrowed from 65% of the OECD average in 2000 to 93% in 2015. Labour productivity has risen sharply over the last two decades to nearly three times the OECD average. However, the productivity gap between the manufacturing and service sectors is still a concern. Productivity in services, which is around 90% of that in manufacturing in the average OECD economies, was 45% in Korea.

Korea is an export-oriented economy. The trade share in Gross National Income (GNI) increased from 35% in 1970 to 81% in 2016 and peaked at 114% in 2011. The contribution of net exports to economic growth averaged 45%, which is compatible with the contribution made by domestic consumption and investment of 55% (Jung et al., 2013). Major trading partners are the People’s Republic of China (hereafter “China”), Japan, the United States, the European Union and ASEAN. Studies find that a rapid expansion of FTA with major economies has led to greater volumes of trade and varieties of products (Bae et al., 2012; Civic Consulting & Ifo Institute, 2017; USITC, 2016). China accounts for a quarter of Korean exports and is a key source of demand, along with other countries in Asia.

According to the United Nations (UN), the inward foreign direct investment stock of Korea expanded nearly ten times to USD 179.5 billion in 2015 from USD 18.2 billion in 1995. However, the outflow expanded more than 20 times over the same period, from USD 13.3 billion to USD 306.1 billion. Despite a recent slowdown in export growth, the current account surplus has risen to nearly 6% of GDP, reflecting weak domestic demand, falling oil prices and transitory demographic trends (Table 3.1). High household debt, which rose to KRW 1 296 trillion (USD 1.1 trillion) as of 2016, has tended to exert a drag on private consumption. Despite the government’s efforts to reduce the household debt, its growth rate accelerated to 11% in 2016 compared to 5% before 2010.

Table 3.1. Key indicators of Korea’s economic performance, 1990 to 2017

 

1990

1995

2000

2005

2010

2011

2012

2013

2014

2015

2016e

2017e

Real GDP growth, %

9.8

9.6

8.9

3.9

6.5

3.7

2.3

2.9

3.3

2.6

2.7

2.6

General government financial balance1

2.4

3.1

4.4

1.6

1.0

1.0

1.0

1.3

1.3

1.4

1.9

2.5

General government gross debt2

13.0

8.9

26.2

35.8

33.5

36.1

38.5

40.5

43.7

44.2

44.2

43.3

Current account balance1

-0.9

-1.8

1.9

1.4

2.7

1.6

4.1

6.2

6.0

7.7

7.1

6.4

Exchange rate, (Won per USD)3

708

771

1 130

1 024

1 155

1 107

1 125

1 094

1 052

1 130

1 158

0

Inflation, annual %, CPI all items

8.6

4.5

2.3

2.8

2.9

4.0

2.2

1.3

1.3

0.7

0.9

1.5

Unemployment rate, %4

2.4

2.1

4.4

3.7

3.7

3.4

3.2

3.1

3.5

3.6

3.8

3.8

Notes: e: OECD Economic Outlook estimate.

1. As a percentage of GDP.

2. As a percentage of GDP at market value.

3. Period average.

4. End year, as a percentage of total labour force.

Source: OECD (2016b), OECD Economic Outlook, Vol. 2016/1, OECD Publishing, Paris. Last updated June 2016, http://dx.doi.org/10.1787/eco_outlook-v2016-1-en.

 StatLink https://doi.org/10.1787/888933852331

The World Economic Forum (WEF) Global Competitiveness Indicators for 2016-17 rank Korea at 26th place out of 138 (Figure 3.1). This stable overall position conceals some notable improvements in several pillars:

  • The macroeconomic environment is performing well. Building on a healthy financial situation, Korea moved up two places to rank third in the macroeconomic environment pillar, scoring higher than the average of the top five OECD countries.

  • Institutions have conspicuously improved. Improved public-sector performance, security and corporate accountability have led to an advance in the institutions pillar to 63rd position.

  • The infrastructure is considered excellent. Korea has joined the top 10 performers in this pillar for the first time due to the high quality of its transportation, electricity and communication infrastructure.

  • The labour market is improving, but from a low base (77th position): it notably ranks 113th for the ease of firing and hiring workers, 112th for the average cost of redundancy, and 135th for the quality of social dialogue. Labour market efficiency is one of the areas where Korea has struggled the most.

  • Financial development (80th position) has improved markedly after several years, although credit access conditions and low confidence in the banking system remain a concern.

  • Innovation is considered as highly reliable (20th rank).

Figure 3.1. Global Competitiveness Index: Macroeconomic environment, 2016-17
Scale from 1 (worst) to 7 (best)
picture

Note: OECD top 5 refers to the average of the scores for the top 5 performers among OECD countries (Switzerland, Finland, Luxembourg, Netherlands and New Zealand). Indices for EU28 and OECD are the simple average of member-country indices.

Source: World Economic Forum (2016), The Global Competitiveness Report 2016-2017: Full data Edition, Geneva 2016. www.weforum.org/reports/the-global-competitiveness-report-2016-2017-1.

 StatLink https://doi.org/10.1787/888933851609

Governance and Institutions

Central government

The country has a unicameral Parliament, the National Assembly, 253 of whose 300 members are elected by a simple majority rule from the same number of local constituencies; the rest are elected from national lists of political parties. In addition to legislative power, the National Assembly has the right to consent to the appointment of Prime Minister by the President, to open a hearing to assess the appropriateness of nominees for an office of a minister in the government, to amend the government’s budget proposals and to approve them.

The President of Korea is directly elected by popular vote. The President and the Executive Body have considerable power in both legislative and budgetary processes. Subject to the government’s consent, the National Assembly can increase the number of individual items in the government’s annual budget proposal.1 Because it is equipped with relatively richer budget and personnel resources than the Legislature, and with strong discretionary powers in the execution of laws, the Executive has flexibility in policy design and implementation.

Local government

The Constitution stipulates that the local governments are responsible for matters pertaining to the welfare of local residents and management of properties. The Law on Local Autonomy adds the promotion of industry to their responsibilities, which include agriculture, regional development and environmental facilities, promotion of education, sports, culture, and arts, and regional civil defence and firefighting.

Currently there are 17 units of larger local governments (Provinces and Special Cities) and 226 basic local governments (Cities, Counties, and Gu). Each local government has a Governor or Mayor, who is elected by a popular vote, and Councils whose members are directly elected from constituencies. The local governments play an important role in the implementation of some agricultural policies such as the processing of applications for direct payment programmes and disbursing those payments.

Quality of governance

Korea has developed well-functioning public institutions to secure transparent and inclusive governance. For example, Korea is among the few countries that oblige the inclusion of advisory or expert groups in the policy process, and to have whistle-blower protection legislation for all public sector employees and suppliers (OECD, 2015a). In 2015, Korea scored above the OECD average in stakeholder engagement for developing regulations and regulatory impact assessment in the OECD indicators of regulatory policy and governance. It scored around the average for ex post evaluation of regulations (OECD, 2015b).

However, public perceptions of government performance indicate considerable room for improvement. Opinion surveys carried out in the business community database suggest that Korea ranks among the lower group of OECD countries in terms of the overall index of quality of public institutions (Figure 3.2.A). In comparison to other OECD countries, it performs weakly in “ethics and corruption” and “undue influence” (Figure 3.2.B). A closer look at the sub-indices of the quality of public institutions reveals that Korea’s weak point lies especially in public trust in politicians, favouritism in decisions of government officials, the burden of government regulation, and the transparency of government policy making.

Figure 3.2. Global Competitiveness Index: Quality of public institutions, 2016-17
Scale from 1 (worst) 1 to 7 (best)
picture

Notes: Indices for EU28 and OECD are the simple average of member-country indices. OECD top 5 refers to the average of the scores for the top 5 performers among OECD countries (Finland, Switzerland, New Zealand, Sweden and Norway).

Property rights refers to the average of the indices: Property rights and Intellectual property rights. Ethics and corruption refers to the average of the indices: Diversion of public funds, Public trust in politicians and Irregular payments. Undue influence refers to the average of the indices: Judicial independence and Favoritism in decisions of governmental officials. Government efficiency refers to the average of the indices: Wastefulness of government spending, Burden of government regulation, Efficiency of legal framework in settling disputes, Efficiency of legal framework in challenging regulations and Transparency of government policymaking. Security refers to the average of the indices: Business costs of terrorism, Business costs of crime and violence, Organized crime and Reliability of police services.

Source: World Economic Forum (2016), The Global Competitiveness Report 2016-2017: Full data Edition, Geneva 2016, www.weforum.org/reports/the-global-competitiveness-report-2016-2017-1.

 StatLink https://doi.org/10.1787/888933851628

3.2. Regulatory environment

The overall regulatory environment establishes basic conditions within which all firms, including farms, input suppliers and food companies, operate and make investment decisions. Competitive conditions in domestic markets, including low barriers to entry and exit, can encourage innovation and productivity growth, including through their impact on structural change. Regulations may also enable or impede knowledge and technology transfer directly, contributing to more or to less innovation, including in sustainability-enhancing technologies.

Regulatory environment for entrepreneurship

Korea ranks fifth out of 189 countries in the World Bank’s “Ease of doing business” index (World Bank, 2017). Korea led in two categories – Getting Electricity and Enforcing Contracts – and 11th in Starting a Business, but some areas need further improvement, such as Dealing with Construction Permits, Registering Property, and Getting Credit. In 2014, the Government launched the “cost-in, cost-out” approach to avoid introducing unnecessary new regulations. From January 2014 to January 2015, the number of economic regulations was cut by 10% (WTO, 2016).

The Korea Fair Trade Commission (KFTC) is an independent agency that is mandated to prevent anti-competitive market structures through merger enforcement, to remove regulations that hinder competition, to deter cartels and vertical restraints, to improve conglomerate ownership structure and transparency, to promote fairness in transactions with consumers, and to strengthen private enforcement against unfair practices. KFTC also applies laws to protect SMEs and is involved in regulating the chaebol conglomerate business groups. While enforcing laws about cartels and mergers and eliminating regulations that constrain market competition are important, the KFTC has placed equal importance on reforming the ownership and investment structures of the chaebol (OECD, 2007).2

Box 3.1. Agricultural co-operatives in Korea

Korea’s primary agricultural co-operatives are comprised of 1 052 regional agricultural co-operatives and 79 commodity specialised agricultural co-operatives. Regional agricultural co-operatives are composed of 936 regional crop farming co-operatives and 116 regional livestock co-operatives. Commodity specialised co-operatives are comprised of 45 crop co-operatives, 23 livestock co-operatives of specific livestock, and 11 ginseng co-operatives. Primary co-operatives have been continuously merged to improve operational efficiency, decreasing their number from 1 277 in 2006 to 1 131 in 2017. The primary co-operatives compose the National Agricultural Co-operative Federation (NACF). In Korea, both NACF and primary co-operatives conduct banking and insurance business, and input supply and marketing business.

The majority of profits of primary agricultural co-operatives are accrued to the banking and insurance business and the primary co-operatives have been relying on profits from financial business to continue their input supply and marketing business. NACF provided financial support to primary co-operatives to support their input supply and marketing business based on its earnings from financial business (KREI, 2015a). In 2012, the financial and other business operation of NACF was separated to two holding companies (NH financial holding company and NH business holding companies). The regional co-operatives also separate the accounting for the financial and other business activities to distinguish profit and loss for each account, but the settlement of assets, debt, capital, costs and revenue are based on a single account.

As of April 2017, the total membership of primary agricultural co-operatives is 2.25 million. Any farmer that satisfies specific conditions is eligible for membership; conditions include cultivating or managing more than 0.1 ha of farmland and working more than 90 days per year in farming. Farms can join their regional agricultural co-operatives while simultaneously being members of product co-operatives. Non-farmers are also allowed to be associated members if they pay a membership fee. However, associate members do not have voting rights in the management of the co-operative.

Because the basic objective of agricultural co-operatives is to provide mutual aid among small-scale farmers, the co-operatives have been exempted from certain provisions of the Monopoly Regulation and Fair Trade Act, conditional on this arrangement not undermining the basic principles of economic order. Legitimate joint purchase and sale activities of agricultural co-operatives are subject to tax reduction or exemption in: value-added tax applied to agricultural inputs and equipment; sales tax; interest income and dividend income on deposits and contributions of members; and corporate income tax. Moreover, government programmes such as subsidised credit have been channelled through primary agricultural co-operatives.

As of 2016, NH’s marketing share of total agricultural products is 49.2%, and average marketing share by major item is as follows: horticultural products 60.2%, grains 50.6% and livestock products 39.2%. NH dominates fertiliser supply in Korea: it supplies nearly 100% of fertilisers for rice farming, 80% of fertilisers for horticulture and 97% of other fertilisers. NH business holding company established a subsidiary company to produce fertilisers (Namhae Chemical), which account for approximately one-third of the fertiliser production in Korea. NH’s volume-based share of fertiliser marketing is around 97.2% and its value-based share is about 95.9% as of 2013 (KREI, 2015a). NH supplies its members with farming materials such as pesticides and feeds to increase their income by reducing the cost of farming. The NH’s share of the pesticide and feed markets was about 15% and 18% respectively in 2016. As a stable supply of agricultural materials such as fertilisers and pesticides at appropriate prices has been the most important task of agricultural co-operatives since the 1960s, NH has concentrated on the fertiliser industry with the support of the Korean government; the original purpose was to allow farmers to obtain fertilisers at a low cost and increase yields.

Regulations on natural resources

Regulations on natural resources are central to ensuring their long term sustainable use and in large part determine access to and use of land, water and biodiversity resources.3 They also impose limits on the impact of industrial and agricultural activities on the state of natural resources (e.g. water pollution, soil degradation, greenhouse gas emissions). The design of natural resource and environmental policies is important in terms of the incentives they generate for innovation and sustainable productivity growth.

Framework of environmental regulation

The first national level legal step for environmental and natural resource conservation policies in Korea was the introduction of the Act on the Prevention of Pollution in 1963. The law itself did not contain regulations in detail, and the emission standards were introduced only when the Act on the Prevention of Pollution was amended in 1971. Technology standards for polluting firms were introduced in 1978. The Environmental Office, which has become the Ministry of Environment of Korea (ME), was established in 1980 as an independent government agency (Korea Environment Institute, 2004).

Until the late 1980s, most environmental regulations in Korea were direct controls or command-and-controls. The importance of reforming environmental regulations by introducing incentive systems was much emphasised in the early 1990s. The current environmental regulatory system in Korea comprises direct controls and incentive systems. Direct controls include emission standards, ambient standards, and technology standards. Technology standards are imposed mostly on sources emitting highly intensive pollutants and involve the installation and operation of preventive facilities. ME sets ambient standards of air, water, noise, and soil, and imposes emission limits or standards on emission sources in order to achieve them (Kwon, 2013).

The incentive system in environmental conservation has become an important source of government budgets for environmental policy, providing 14.1% of the ME budget in 2016 (ME, 2016a). Several types of emission fees or charges apply to types of pollutants and amounts of emissions, varying to account for regional differences. A deposit-refund system promotes collection and recycling of waste. Product charges are imposed on products with high environmental burden at the stage of production or consumption. Fees are imposed on specific natural resource developers such as bottled water producers. Water Use Charges are imposed on consumers drinking tap water if its source is one of four major rivers. Economic activities of pollution sources located upstream of rivers are strictly regulated (Kwon, 2013).

In 2007 the National Strategy for Green Growth and the Five-Year Plan for Green Growth were launched. Both aimed at reducing CO2 emissions and escaping from the global economic crises by boosting green industries. The three growth strategies of the Plan were: 1) adapting to climate change and improving energy self-sufficiency; 2) creating a new growth momentum; and 3) improving the quality of life and enhancing national status. The national target level of CO2 emissions was unveiled for the first time as a policy goal, and a nationwide CO2 emission trading scheme was introduced in 2015 as a result. The policies were followed through by the establishment of the Presidential Committee on Green Growth.

For the agricultural sector, the National Strategy for Green Growth emphasised the following: 1) reducing emission of nitrous oxide and methane from agricultural production; 2) building a carbon circular society by reducing food waste, planting woody crops on idle lands, introducing minimum tillage and crop residue management, and constructing bio-gas production systems; 3) adapting to climate change by R&D investment in breeding, integrated management of soil and nutrition, and improved pest and disease control; 4) developing new growth areas such as biological pesticides and organic fertilisers, high valued-added seed industries, and new material and new crops based on biotechnology and nanotechnology; and 5) developing food industries by developing food technology, globalising Korean traditional foods, and constructing a national food industry cluster (Kim, 2009).

According to the OECD indicator, environmental policy in Korea is slightly more stringent than the OECD average in 2012 (Figure 3.3). Measures are focused on energy sector regulations but complemented by information on other types of environmental policies.

Most of the regulations introduced and controlled by ME are applied to non-agricultural sectors. However, there are specific environmental regulations affecting agricultural activities as well, such as regulations on livestock manure management, pesticide containers, soil quality management, land conversion, forest management, and groundwater and watershed management. MAFRA is in charge of some of those regulations. Some of the regulations affecting agricultural activities take the form of subsidies. For instance, the Water Use Charges (or River Basin Fund) paid by downstream urban residents are used to assist the upstream rural residents whose economic activities are regulated for river water quality preservation.

Figure 3.3. Stringency of environmental policy in selected OECD countries, 1990-95 and 2012
picture

Note: For Korea, Poland and the Slovak Republic, 1990-95 average is not available.

Source: Botta, E. and T. Koźluk (2014), “Measuring Environmental Policy Stringency in OECD Countries: A Composite Index Approach”, OECD Economics Department Working Papers, No. 1177, http://dx.doi.org/10.1787/5jxrjnc45gvg-en.

 StatLink https://doi.org/10.1787/888933851647

Regulation on soil preservation

Uncontaminated land, water, and air are the three fundamental environmental resources required for agricultural production. The Soil Environment Conservation Law introduced in 1995 pursues both the prevention of human and ecosystem damage caused by soil contamination and the purification of contaminated soils. The law regulates 21 polluting substances and imposes two contamination standards: the worrisome level and the countermeasure standards. The worrisome level is the level of contamination that merits concern about damage to humans and the ecosystem. The countermeasure standards set out levels of contamination requiring countermeasures (ME, 2016a).

The Soil Environment Conservation Law is strictly based on the “polluter pays” principle (PPP). Not only are the owners and operators of polluting facilities legally responsible for contamination, but so too are future owners of the facilities. The liability of polluters includes soil purification as well as compensation for the damage incurred (Choi, 2007). Because the owners of the facilities are responsible for the damage, the Law creates an incentive for a voluntary soil environment assessment when a site which may be contaminated is traded. Currently there are 2 000 soil environment monitoring sites. For the agricultural sites, the soil monitoring system monitors 188 sites of forestry areas, 247 sites of paddy fields, 20 sites of pastures, 146 sites of non-paddy fields, and 24 sites of orchards. In 2011, the contamination levels of even the most seriously contaminated agricultural sites did not reach the worrisome levels (Kwon et al., 2013).

Korea also has a system of designating and preserving Natural Environment Protection Areas. The main purpose is to conserve and manage ecosystems and biodiversity in the designated areas. Periodic surveys on the natural environment are conducted, and an information network on the resources is constructed. There are long-run projects of building and managing databases of the natural environment, drawing up ecosystem and nature maps, and conducting researches for biological diversity protection (ME, 2016a).

Regulation on fertiliser and pesticides

Because of their potential to contaminate soil, chemical fertilisers and pesticides can be registered, sold and used only if they satisfy ingredient standards and pass safety tests. Additionally, safety and pesticide residue regulations on crops induce producers to use an appropriate level of chemicals voluntarily. However, the uses of chemical fertilisers and pesticides are declining mostly due to the decline in cropping land area and elimination of subsidies.

The Fertiliser Control Act manages the quality and safety of fertiliser via the “legal standards” of the Rural Development Administration (RDA). These standards indicate the minimum quantity of main ingredients, the maximum allowable content of harmful ingredients, and the content of additional ingredients. The regulation on pesticide has been converted from a negative list system to a positive one. The purpose of managing the list of permissible pesticides is to prevent their overuse or misuse and to control unregistered pesticides used on imported agricultural products. Pesticides being used domestically or on imported products are required to be registered. Maximum residue limits are applied to registered pesticides, while a residue limit of 0.01 mg/kg is applied to every non-registered pesticide. The RDA manages the registration system.

The Ministry of Environment is considering introducing a Total Maximum Nutrient Loading System to control overuse of inorganic fertilisers, as is already being implemented in the United States and the European Union. Under this system, nutrient inputs and outputs of each region will be investigated and use of nutrient inputs will be controlled at the level that the absorptive capacity of soils can accommodate. Moreover, the government supports developing nutrient-reducing practices such as improved fertilisation and the rotation system, and inducing producers’ adoption of new practices in pilot study areas. A bottleneck for introducing the Total Maximum Nutrient Loading System is the large amount of livestock manure. Although not chemical, manure compost contains large nitrogen compounds; imposing the System standards on manure compost may limit the size of breeding herds, and possibly damage livestock farms (KREI, 2015b).

Regulation on livestock manure

Livestock manure has become the main agricultural source of water and soil pollution in Korea. Regulations on livestock manure are stipulated under the Act on the Management and Use of Livestock Excreta. The Act was amended in 2006 to emphasise converting manure into resources by composting and liquid fertilisation. The central government financially and technically supports R&D in manure treatment technology. Each province has to establish a 10-year plan of livestock manure management and report it to the Minister of Environment (ME, 2011).

Depending on the size of breeding herds or barns (breeding facilities), animal farms are classified as Facilities subject to Permission, Facilities subject to Reporting, and Facilities without Reporting. Farms with hog barns larger than 1 000 m2 or cattle barns larger than 900 m2 are subject to permission. Facilities subject to permission and reporting must install and operate livestock manure treatment facilities which recycle manure by composting or liquid fertilisation; otherwise, manure has to be purified before being discharged. For regions where special steps are required for water pollution prevention, additional regulations are imposed: the barn size criteria requiring permission are reduced to 500m2 for hogs and 450m2 for cattle, and treating manure inside the barns as much as possible is required.

A multi-dimensional approach is important to tackle the growing livestock manure management problem (Box 3.2). In Korea, the government has been subsidizing, installing, and operating public manure treatment facilities to reduce the burden of manure treatment on small-scale farms’ since 1991. MAFRA and local government provide subsidies and loans to develop composting, liquid fertilising, and energy production by farm households, farmer’s organisation, or agricultural companies. Furthermore, the government is investing in constructing large-scale public facilities for converting manure into agricultural resources. Because the size of the livestock industry keeps growing while the total area of crop land is declining, there will be an excess supply of manure composts or liquid fertilisers. The government is running an inspection system of manure treatment and is considering introducing a manure traceability system.

Box 3.2. Comprehensive policy framework for livestock manure management in the Netherlands

The livestock sector in the Netherlands is important to the nation's economy, competitive in international markets and very intensive. The sector produces three to four times more manure than is needed for fertiliser use in the country. A single 500-sow farm producing 20 piglets per sow each year produces the same effluent as a town of 25 000 people, but on a much smaller land area. 80% of manure production (around 70 million tonnes per year) is from cattle, 18% from pigs and 2% from poultry.

The manure management approach adopted in the Netherlands is based on the premise that manure is a valuable product rather than waste and its valorisation can be a key driver of the circular economy. The Dutch manure policy focuses on both the production and the application of manure with the objective of optimising the use of manure through balanced fertilisation and suitable application techniques. The government supports this process through penalising polluters and rewarding innovators and farmers who find ways to export manure. Their multi-dimensional approach entails: i) regulating the use of manure; ii) market-based instruments to facilitate innovation and investment in new techniques, including financing R&D for innovative processing and manure management, and subsidies and tax reductions; iii) capacity building for farmers through farmer networks; iv) partnerships between government, industry, NGOs and R&D institutions; v) international co-operation through multi-stakeholder platforms such as the “Global Agenda for Sustainable Livestock”, the “Global Research Alliance on Agricultural Greenhouse Gases” and the “Global Partnership on Nutrient management”.

The cornerstone of the Dutch manure policy is a system of application standards for both nitrogen and phosphate on agricultural land. The legislation for using manure on land imposes: i) Application rates: low maximum use of manure per ha land based on phosphate and nitrogen; application in growing season; low emission application techniques, such as obligatory injection of liquid manure; ii) Enforcement: registration of production (livestock, crop and manure); compulsory processing of excess manure into products with high nutrient levels and a low moisture; iii) Obligation to reduce nutrient losses: build low-emission housing and provide emission-free storage. Failure to comply results in an economic offence, which can be investigated and prosecuted under criminal law. All farmers with a manure surplus must develop a disposal plan. Farmers who exceed permitted production levels face fines, and there is an escalating level of tax on commercial feed. A “Manure Board” regulates manure flows, provides manure for use in arable areas, and helps find new manure users. It also conducts research, assists in the processing of manure and establishes treatment plants.

Another essential element of the Dutch manure management system is manure distribution from livestock farms with a nutrient surplus to arable farms that can use the nutrients in crop production. The most common use of animal manure is its application as fertiliser on agricultural land (90% of all manure). Manure application is only allowed when using low-emission technology like manure injection on grassland and immediate covering with soil on arable land. The manure application period is limited to the early growing season of crops. By using animal manure as a nutrient source for crops, more than 90% of synthetic phosphate fertilisers and more than 60% of synthetic nitrogen fertilisers have been replaced by phosphate and nitrogen from animal manure.

As of 2014, farmers with a phosphate surplus are obliged to process and export a percentage of it. These percentages increase annually until the desired balance between manure phosphate production and available agricultural land or crop uptake in the Netherlands is reached. The percentages are higher for farms in the livestock concentration areas (south and east) than for farms elsewhere in the Netherlands. Large manure surpluses are produced mainly from pig and poultry farms, as they cover little land, while most dairy farms have more land (50 ha per farm on average) and can apply part of the manure to it. Transport is expensive because manure consists largely of water: livestock farmers have to pay the transport companies approximately EUR 10 to EUR 23 per tonne. Transport companies will pay approximately EUR 3 to EUR 10 per tonne to manure-receiving arable farmers; the difference must cover the costs of transportation. Reducing the water content and processing manure to increase organic matter and nutrient content makes distribution more efficient.

The evaluation of the Manure and Fertiliser Act 2016 concludes that the current manure and fertiliser policy reduces environmental problems. Agricultural production is economically and ecologically very efficient per unit of product, but because of its volume, environmental pressure remains high: although balanced fertilisation for phosphate was reached in 2014 and nitrate surpluses have decreased, in southern sandy regions, nitrate concentration exceeds the target, partly due to manure separation and manure fraud.

Over the coming years the focus of manure management policy in the Netherlands will be on three areas:

  • Manure processing to increase the export potential of animal manure. In addition, to reduce veterinary health risks, the exported manure must comply with the requirements for animal by-products. Processing methods to improve export opportunities comprise mechanical separation (the initial stage of the processing of liquid manure), manure processing and anaerobic digestion.

  • Animal feed agreements with farmers and feed industry: i) to decrease the concentration of phosphate in the feed; and ii) to develop innovations to create more cost-effective feed.

  • Fertiliser replacement: upgrading animal manure to products with properties comparable to synthetic fertiliser; increased use of renewable resources; improving the efficiency of fertilisers.

A key lesson from the Dutch approach to manure management is the importance of a coherent system of clear and realistic regulatory standards (e.g. nutrient application standards for agricultural land) which can be adapted as required by local circumstances. An efficient logistics system for manure storage and distribution is also indispensable, as well as accurate records, monitoring, administration and enforcement.

Regulation on air

Korea introduced air quality standards on sulphur dioxide gas for the first time in 1978, since which time the standards have been extended to cover more substances. Air quality standards are reported to be satisfactory for most substances in most regions, but there is a growing concern on fine particulate matters PM10 and PM2.5, whose standards are often not satisfied. Unlike other domestic source substances, emission of VOC (volatile organic compounds) from automobiles keeps increasing and makes it difficult to control ozone content (ME, 2016c).

All facilities emitting air pollutants are subject to permission or reporting. Facilities are subject to permission if the proportion of a specific air pollutant in emission exceeds a certain level or the facilities are located in a special countermeasure area (the industrial complexes in Ulsan and Yeosu). Facilities are classified into five groups depending on operation scale. Using coal and other types of solid fuels is prohibited in densely populated regions. Restrictions apply to locating facilities in areas with more than 20 000 residents within a 1 km radius, with a high level of specific air pollutant emission, or with a large scale of emission located in a special countermeasure area (ME, 2016c).

Regulation on waste

Waste affects the qualities of soils, water, and air when it is landfilled or incinerated and is classified into municipal waste and industrial waste. Municipal waste is mostly controlled by the pay-as-you-go garbage collection system, while industrial waste is mostly controlled by the deposit-refund system. Food waste is controlled more strictly than other municipal wastes.

Agricultural waste is classified as municipal waste subject to the pay-as-you-go system. The cost of discharge for farm households can be substantial as they have to buy authorised garbage bags to dispose of their waste. Used agricultural plastics and pesticide bottles are collected by designated collectors. Because the number of collectors is limited in remote rural areas, those two forms of waste are not controlled very well in those areas. Incineration or landfill of the waste generates soil and air pollution in rural areas (MAFRA, 2014a). While used agricultural plastics and recyclable bottles are compensated when they are appropriately collected, the per-unit payment is not large enough to induce voluntary collections (MAFRA, 2014a).

Regulation on greenhouse gas

Korea aims to reduce GHG emissions by 37% by 2030 relative to a “business-as-usual” (BAU) baseline. To this end, a GHG emission trading scheme (ETS) was launched in 2015 as the main policy instrument. The ETS covers approximately 525 of the country’s largest emitters, which account for around 68% of national GHG emissions (International Carbon Action Partnership, 2017). The ETS allowances are currently allocated for free, thus the government does not collect any revenue from selling them, but they are scheduled to be auctioned in the future. The ETS does not affect agricultural production directly: only a few large agricultural marketing firms participate in the system. However, the system may have indirect effects on agricultural production, particularly if it results in a change in energy prices.

The main strategies of mitigation of GHG emissions from the agricultural sector are: 1) adopting mitigation practices such as altering paddy management practices and improving feed qualities; 2) increasing livestock manure treatment facilities; 3) increasing the share of renewable energies and extending energy saving facilities; 4) undertaking R&D for low carbon agriculture; 5) establishing institutional arrangements that encourage producers’ participation in mitigation activities; 6) promoting consumption of low carbon agricultural products; and 7) constructing reliable databases (MAFRA, 2014b).4

To encourage producers’ participation in GHG reduction, the government monitors and measures farm households’ voluntary GHG reduction and buys their certificates. In 2014, 179 farm households participated in the programme (MAFRA, 2014b). The number of public facilities producing composts, liquid fertilisers, and energy with livestock manure is expected to increase up to 150 by 2017, with the central and local governments covering 70% of their total cost (MAFRA, 2016a). The government assists farm households when they install renewable energy or energy-saving facilities (ME, 2016b). It has supported the installation of geothermal pumps, solar power, and wood pallet heaters for greenhouses, barns, and nurseries. A project also exists for the construction of small hydropower generators in agricultural reservoirs (MAFRA, 2012).

Regulations on products and processes

Regulations on products and processes aim to protect human, animal and plant health and can also impact natural resource use. Environmental and health-related regulations can boost innovation by building consumer and societal trust in the safety and sustainability of new products of processes, but unnecessary or disproportionate regulations can stifle innovation and technological development. Food safety and quality standards are also important in developing the food value chain: standardisation of the quality and safety of products reduces the transaction costs of organising vertical co-ordination along the value chain to meet consumers’ demand.

Food safety management

Food safety is managed during the process of agricultural production and the process of marketing, processing, and sales. In the process of production, the National Agricultural Products Quality Management Service (NAQS) and the Rural Development Administration (RDA) control the safety of agricultural products based on the Agricultural Products Quality Control Act and the Pesticide Control Act. In the stages of marketing, processing, and sales, the Ministry of Food and Drug Safety (MFDS) manages food safety based on the Food Sanitation Act, although NAQS is also involved in safety control at these stages.

The three main programmes of NAQS are food safety inspection and regulation, country of origin labelling management, and certification of environment-friendly products and good agricultural practices (GAP). The food safety inspection and regulation programme of NAQS investigate residues of pesticides and other noxious substances at the stages of production and marketing as well as agricultural soils, water, and other inputs used for agricultural production. The purpose of the origin of labelling management is to prevent illegal sales of imported products with domestic product labelling, and to provide exact information on the origin to consumers. The system is applied to 220 agricultural products, 257 domestically processed products, 161 foreign processed products, and 20 products used by restaurants.

Regulations on animal and plant quarantine and inspection

Korea’s Animal and Plant Quarantine Agency deals with both quarantine and inspection. It runs a situation room for animal disease control and takes preventive measures against food-and-mouth disease (FMD) and avian influenza. The agency quarantines imported animals and plants, monitors imports of living modified organisms (LMOs) and inspects medicine for animals. Since the outbreak of FMD in 2010-11, a livestock farming permission system has been introduced (Box 3.3) for all animal farms with a breeding facility larger than 50m2. The permitted farms have to be equipped with certain levels of breeding facilities, ventilation, and a disinfection facility for humans and cars. A limit on the number of breeding herds per square meter is also applied (Ji et al., 2016).

Animal product traceability is applied to swine and cattle. Information from the birth of an animal to the slaughter and sale of meat is collected and provided to consumers. Consumers can trace the information using smart phone applications or the internet. This system contributes to enhancing the reliability of meat products.

Box 3.3. Livestock disease management in Korea

The rapid intensification of livestock production in Korea over the past two decades has substantially increased the risks of occurrence and spread of disease. Since the mid-2000s, the country has experienced serious reoccurrences of highly infectious diseases, such as avian influenza, FMD, brucellosis, bovine tuberculosis and classical swine fever. The highly pathogenic avian influenza (HPAI) was notified to the OIE (World Organisation for Animal Health) in 2003, 2006, 2008, 2010, 2014 and 2015. Occurrences of FMD have caused considerable financial damage: in 2010-11, 153 outbreaks over 145 days prompted the destruction of 3.3 million pigs and 150 000 cattle. The estimated impact on the national budget was KRW 2.7 trillion (USD 2.5 billion), which included the cost of compensation for destroyed animals, the cost of vaccination and of disease control measures. Although the government adopted a policy of nationwide vaccination for all cloven-hoofed animals in 2011, FMD has reoccurred every year since 2014.

Regulation for livestock operations has been significantly tightened, with stringent criteria introduced for production facilities, their location and livestock densities. The legal responsibility of farmers to report disease was increased, with non-compliance leading to large financial penalties and criminal responsibility. Mandatory training for persons involved in breeding and handling livestock was introduced, majority-funded by the state.

Compensation under the disease control and prevention programmes, applied to nationally notifiable diseases, includes: (i) indemnity for direct disease losses, such as dead or destroyed animals; (ii) compensation for consequential losses, such as those from business interruption; and (iii) payments for farmer’s ex ante actions, such as subsidising biosecurity investments and operations. The indemnity for direct disease loss is discounted to discourage producer misbehaviour. For example, for those tested positively for FMD, HPAI, classical swine fever or brucellosis, the indemnity is discounted by 20% of the market price. A reduction in indemnity rates is also foreseen in the event of violation of rules for preventive vaccination or failure to comply with disease outbreak control orders as well as delays in reporting. Consequential loss assistance has so far been provided discretionally and only in the cases of large epidemics of FMD and HPAI. Currently, subsidised livestock insurance covers nearly all insurable livestock, but it does not cover the risk related to nationally notifiable diseases (further description of the programme in Section 5.2).

Despite a structural adjustment in livestock sector leading to a concentration of production in larger units, the sector continues to be dominated by small-scale and often non-professional farmers. Substantial farming segments may be facing constraints to undertake adequate investments in biosecurity and in better production technologies to reduce disease risks. The current livestock disease policy seems to be driven mainly by a veterinary and sanitary rationale. However, the improvement of the livestock disease situation in Korea is also a matter of structural policy insofar as it facilitates the establishment of enterprises with adequate investment-generating capacity and higher human capital.

Source: OECD (2017c).

Regulations on GMO

Korea has enacted a law to implement the Cartagena Protocol on Biosafety. The law requires Living Modified Organisms (LMOs) to pass human safety testing and environmental risk assessment. For example, importers of LMOs have to pass the relevant administrative agency’s human and environmental risk review. The human safety testing is conducted by the Ministry of Food and Drug Safety (MFDS) and the Korea Centres for Disease Control & Prevention (KCDC). The environmental risk assessment is conducted by the RDA for the crop cultivation environment test, by the National Institute of Environmental Research for the natural ecosystem test, and the National Fisheries Research and Development Institute for the fisheries environmental and marine ecosystem test (Consumer Safety Centre, 2014).

The labelling of GM agricultural products is regulated by the Agricultural Products Quality Control Act, while that of GM food and food additives is regulated by the Food Sanitation Act. Seven agricultural products must indicate LMO content: soybeans, corn, cotton, canola, beet, and alfalfa. The threshold level for labelling of GM ingredients is 3%. Depending on the share of LMOs in the products, the labels have to be written as ‘genetically modified [ingredient name]’ ‘genetically modified [ingredient name] is included,’ or ‘possibility of including genetically modified [ingredient name]’. For food and food additives, it must be indicated whether GM agricultural products are used as raw materials. The labelling requirement does not apply if genetically modified DNA or exogenous protein has disappeared in the process of manufacturing and processing.

3.3. Trade and investment policy

Trade policy

Trade can facilitate the flow of goods, capital, technology, knowledge and people needed to innovate. Openness to trade and capital flows is conducive to innovation as it provides a larger market for innovators, reinforces competition, increases access to new technologies, ideas and processes, including from foreign direct investment (FDI) and related technological spill-overs, and facilitates cross-country collaboration. Trade and investment openness can influence innovation throughout the food supply chain, from input suppliers to food service and retail firms. Input and output markets that operate effectively can foster productivity growth. Trade and investment openness can also facilitate the development of market mechanisms to foster more environmentally sustainable production.

Tariffs remain one of Korea's main trade policy instruments. The average applied Most Favored Nation (MFN) tariff rate was 14.1% in 2016, which is high by OECD country standards. Tariff concessions or drawbacks to ensure that tariffs on intermediate inputs do not become taxes on exports are adding to the complexity of border taxation (WTO, 2016). The OECD Product Market Regulation Database shows that Korea is more restrictive than most OECD countries, in particular in tariff protection (Figure 3.4). This is largely due to relatively high tariffs on agricultural goods. The simple average MFN applied tariff on agricultural goods is 53%, which is the highest among the OECD and large emerging countries.

Figure 3.4. Index of regulatory restrictions to trade
Scale from 0 (least) to 6 (most) restrictive
picture

Notes: Indices for EU28 and OECD are the simple average of member-country indices. OECD top 5 refers to the average of the scores for the top five performers among OECD countries (Netherlands, Belgium, Australia, United Kingdom and Finland). For Indonesia and the United States, 2013 data are not available. For Indonesia and the United States, 2013 data are not available.

The tariff index is based on an average of effectively applied tariffs, scaled within a range between 0 and 6 points, whereby a tariff below 3% is attributed zero points and a tariff above 19.6% is attributed 6 points. Barriers to trade facilitation refer to the extent to which the country uses internationally harmonised standards and certification procedures, and Mutual Recognition Agreements (MRAs) with at least one other country.

The statistical data for Israel are supplied by and under the responsibility of the relevant Israeli authorities. The use of such data by the OECD is without prejudice to the status of the Golan Heights, East Jerusalem and Israeli settlements in the West Bank under the terms of international law.

Source: OECD (2014), OECD Product Market Regulation Database, http://www.oecd.org/eco/reform/indicatorsofproductmarketregulationhomepage.htm.

 StatLink https://doi.org/10.1787/888933851666

The barriers to trade facilitation index shows Korea is below the OECD average in the areas of internationally harmonised standards, certification procedures and mutual recognition agreements, but its overall trade facilitation performance is comparable with other OECD countries (Figure 3.5). Existing measures on advance rulings can be improved by extending accredited dates of rulings, shortening the ruling periods, and increasing the application rate through active publicity activities.

Growing volumes of trade and increasing number of trading partners oblige Korea to develop a more IT-based, integrated, and automated customs administration. For instance, the Korea Customs e-Clearing System (UNI-PASS) – part of the Korea Customs Service – is the culmination of the past 20 years of experience and know-how in customs administration. The system allows one-stop paperless service operation through an integrated portal; single-window, real-time cargo tracking; and control and facilitation of passenger clearance. The UNI-PASS system is also connected to a server of the Animal and Plant Quarantine Agency, through which applications for quarantine can be made.

Figure 3.5. Trade Facilitation Indicators: Korean’s performance, 2015
Scale from 0 (worst) to 2 (best) performance
picture

Note: Indices for OECD and OECD top 5 are the simple average of country indices. OECD top 5 refers to the average of the scores for the top five performers among OECD countries (Australia, the Netherlands, Ireland, Austria and Canada).

Source: OECD (2015c), Trade Facilitation Indicators, http://www.oecd.org/trade/facilitation/indicators.htm.

 StatLink https://doi.org/10.1787/888933851685

Restrictiveness of FDI

The Korean government enacted the Foreign Investment Promotion Act (FIPA) in 1998 to attract FDI in the aftermath of the Asian financial crisis. A series of the amendments of FIPA improved the FDI environment by liberalizing additional sectors, rationalizing the control and management service, removing restrictive measures, strengthening investment incentives, and streamlining the application and report procedures. The government provides a range of incentives for foreign investors comprising tax abatement and exemption for corporate tax, income tax, acquisition tax, registration tax and aggregate land tax. Cash grants are also available from the central and local governments in the event that foreigners purchase land or lease factory facilities and manage employment, education or training of workers. Industrial site support comprises leasing land to foreign firms at a lower rate or for free. However, the cost effectiveness of these incentives remains questionable (WTO, 2016).

FDI caps are in place in several sub-sectors. For example, foreign investors are not allowed in the cultivation of grains and other food crops. Foreign ownership cannot exceed 50% of beef cattle breeding and the wholesale meat businesses. Foreign investors cannot own financial services provided by agricultural co-operatives. Official approval is required for foreign investment in financial services, while prior notification by foreigners is needed in various other subsectors (WTO, 2016).

According to the OECD FDI regulatory restrictiveness index, Korea has more restrictive regulation than the OECD average, with agriculture one of the most restrictive sectors (Figure 3.6). Although Korea achieved the largest improvement in the FDI index between 1997 and 2010 among 40 OECD and emerging economies, the improvement has slowed down in more recent periods. Similarly, the agricultural FDI index was halved from 1.0 in 1997 to 0.5 in 2003 but remained at the same level until 2016.

Figure 3.6. Foreign Direct Investment (FDI) Regulatory Restrictiveness Index by sector, 2003 and 2016
Scale from 0 (least) to 1 (most) restrictive
picture

Notes: Countries are ranked according to "All sectors" 2016 levels.

Indices for OECD are the simple average of member-country indices. Four types of measures are covered by the FDI Restrictiveness Index: 1) foreign equity restrictions, 2) screening and prior approval requirements, 3) rules for key personnel, and 4) other restrictions on the operation of foreign enterprises.

Source: OECD (2017a), “OECD FDI Regulatory Restrictiveness Index”, OECD FDI Statistics (database), http://www.oecd.org/investment/fdiindex.htm.

 StatLink https://doi.org/10.1787/888933851704

3.4. Financial market policy

Access to financial services can be limited or unequal across regions and firms when financial markets fail or when risks are too high. Policies that improve the functioning of financial markets can facilitate productivity enhancing investments in agriculture and farm size growth. Policies may also facilitate access to funding for sustainability-enhancing investments. Low cost loans and venture capital can also be an important source of funding for innovative firms with high growth potential.

Korea ranks lower for financial market development than most OECD member countries on the Global Competitiveness Index and below the OECD averages for all financial market development components (Figure 3.7). While rising household debt and large corporate loans to weak sectors, such as shipbuilding, boosted the banking sector’s risk-weighted assets, the ratio of regulatory tier 1 capital to risk-weighted assets was the lowest in the OECD, at 11.7% in 2015 (OECD, 2016a).

Figure 3.7. Global Competitiveness Index: Index of financial market development, 2015-16
Scale from 1 (worst) to7 (best)
picture

Notes: Indices for EU28 and OECD are the simple average of indices. OECD top 5 refers to the average of the scores for the top five performers among OECD countries (New Zealand, United States, Finland, Australia and Canada).

The Legal rights index is scored on a scale from 1 to 10 based on calculations by the WEF from the World Bank–International Finance Corporation’s Doing Business 2013 and then rescaled to 1 to 7 scale by the OECD.

Source: World Economic Forum (2016), The Global Competitiveness Report 2016-2017: Full data Edition, Geneva 2016, www.weforum.org/reports/the-global-competitiveness-report-2016-2017-1.

 StatLink https://doi.org/10.1787/888933851723

Korea’s household debt was 163% of household disposable income in 2014, well above the OECD average of 137% (OECD, 2016a). Older persons, the self-employed and low-income workers in particular face high debt burdens, raising social cohesion concerns, as financial institutions have become increasingly reluctant to lend to such persons (Jones and Kim, 2014). The high level of household debt has also been a policy issue in agriculture, particularly in capital-intensive sectors (Box 3.4).

Mutual finance institutions are the main player in rural finance. They include NH, regional credit unions (CU), community credit co-operatives and regional fisheries co-operatives. Among the four institutions, the market share of NH was 58.1% in deposits and 57.6% in loans in 2015, according to the National Credit Union Federation. However, the majority of NH loans are provided to the non-farm sector. Total liabilities of farm households and agricultural corporations accounted for 31% of total loans in 2015.

The Korean government plays a dominant role in assisting farmers to finance their investment though grants, subsidised loans and credit guarantees. NH and private operators also provide advance payment as a part of co-operative marketing for short-term credit needs during the production period. The government loan programme often compensates banks for the difference between commercial and subsidised interest rates. In the agricultural sector, NH is the main financial institution for delivering government loan programmes. While commercial banks have recently been allowed to participate in the government programmes, they accounted for only 0.8% of their value in 2015. The Agriculture, Forestry and Fisheries Credit Guarantee Fund (Nongshinbo) guarantees credit for bank loans of farmers and agricultural corporations. Nongshinbo can guarantee bank loans up to 20 times the value of underlying assets; this is financed by a guarantee fee charged to borrowers and contributions from government and financial institutions.5

Box 3.4. Farm debt issue in Korea

A foreign-exchange crisis in 1997 followed by an economic depression caused debt problems for capital-intensive farming. A Special Act was implemented to postpone due dates for repayment, to lower interest rates and to replace existing loans with cheaper ones. The Act alleviated the problems but revealed some limitations in resolving them fundamentally. For example, the Act was only applied to impending repayment schedules, thus requiring additional revision for subsequent schedules. From 2003, the government introduced a Business Revitalization Fund programme, operated by the NH, to help farmers with temporary crisis management, which provided low cost loans to qualified farmers all year around. However, the loans made by the fund showed a high default rate compared with other loans made by policy funds and/or mutual finance (Park et al., 2015).

In 2006, a Farmland Purchase Program to revitalise business (FPP) was established, whereby the Farmland Bank provides credit to farmers by purchasing their farmland, allowing the farmers repay the outstanding debts. Commercial banks (including NH Bank) cannot join this programme as only farmers or legally designated agricultural corporations can own farmland. Farmers have the right to rent the farmland for up to 10 years and to repurchase it at any time during the contract period.

Although subsidised loans and credit guarantees have been the main financial instruments in Korean agriculture to date, a direct financing channel is emerging. For example, in 2010, the investment partnership between the government and fund management companies established a fund of funds that invests in the agricultural sector. In 2016, licensed brokers with online platforms launched crowd funding for agriculture. The government also developed the legal framework to provide loans based on movable property such as livestock. In 2012, an act on security over movable property and receivables was enacted to resolve capital rationing pertaining to small and medium-sized businesses with a lack of real property. This allowed agricultural inventory, livestock and livestock products to be used as collateral for loans. For example, to help livestock farms 2015, NH expanded the types of collateral to include Korean native cattle, beef cattle, dairy cattle, broiler chickens and ducks. JB bank also provides loan secured by agricultural products, such as livestock, livestock products and rice within 80% of market valuation.

3.5. Tax policy

Tax policy affects innovation, productivity and sustainability in many ways: it affects the decision of firms and households to save or invest in physical and human capital, and thus the adoption of innovation; it raises government revenues, which can then finance public services, including those enabling innovation such as education and skills, R&D, and strategic infrastructure; it can also be used to provide direct incentives, for example preferential tax treatment to investments in private R&D or to young innovative companies. In addition to its economy-wide impacts, tax policy influences the conduct, structure and behaviour of farm, input suppliers and food companies. Taxes on income, property and land and capital transfer, including land, may affect structural change, while differential tax rates on specific activities (polluting or environmentally friendly), resources, or input use may affect sustainability.

In Korea, the ratio of tax revenue to GDP, including social security contribution is around 25% as of 2015, which is below the OECD average of 34%. As of 2017, there are 14 national taxes and 11 local taxes. Income tax, VAT, and corporate income tax are by far the most important in terms of revenue. The total tax rate on enterprise in Korea was 33% in 2016, which is lower than that of most OECD countries (World Bank Group and PwC, 2017). Taxes on consumption account for 29% of tax revenue, which is lower than the OECD average of 34%. The share of local government in total tax revenue was 20.1%, excluding social security contributions, whereas its share in expenditure was much higher, at 63% in 2014 (Box 3.5). Expanding the tax base is another important policy agenda for Korea, including lowering the minimum income taxation threshold and decreasing – or in some cases eliminating – special tax treatments. This issue has significant relevance for agriculture, a sector that has enjoyed a considerable number of special tax treatments.

Box 3.5. The fiscal relationship between central and local government in Korea

Local governments depend heavily on grants from the central government. Their financial resources come mainly from local taxes, shared taxes, and earmarked grants. Revenue from local taxes accrues directly to the local government. The revenue of the shared taxes, which is 19.2% of all national taxes except customs tariffs, is allocated by a predesigned formula to provide the financial resources necessary to deliver basic public services. The discretionary powers of the central government over local and shared taxes are limited. In 2016, the combined share of local taxes and shared taxes in local government revenue was 74.2%.

Earmarked grants, which flow from the central to local governments, target political objectives considered important by the central government. Earmarked grants for many expenditure programmes are conditional on co-financing by the local governments. For example, 34 of MAFRA’s 70 expenditure programmes of 2016 entailed co-financing for which local governments provided 40% of the total budget, or KRW 1.26 trillion (USD 1.09 billion) (MAFRA, 2016b).

A Special Tax for Rural Areas (STRD), whose revenue goes directly to a pre-designated government programme on rural development, was introduced in 1994. It is a surtax levied on the exempted amount of corporation tax, individual income tax, customs duty, individual consumption tax, and securities transaction tax. A special account for regional development (SARD) was established based on the STRD’s revenue to allow the local governments more fiscal resources for their own policy initiatives. Unlike the subsidies which are linked to expenditure programmes designed by the central government, a part of the SARD resources can be utilised by the local governments as ‘block grants’ with more discretion so long as their expenditures conform to guidelines set by the central government. The principle of co-financing by the local government is also applied to all categories of SARD block grants, with co-financing ratios varying between 0% and 70%. As of 2016, there were five categories of block grants (for which the MAFRA set the guidelines in 2015), supporting the development of rural tourism, infrastructure for upland farming, regional industry, and basic living infrastructure (Ko, 2015).

Tax expenditure

The State Finance Act caps tax expenditure to 15% of the sum of central government tax revenue and tax expenditure, but the actual ratio of tax expenditure was 14.1% in 2015. In terms of revenue foregone, the VAT tax deduction for the purchase of agricultural products by the food processing businesses or restaurants is the largest tax expenditure programme. Tax expenditure on agriculture accounts for 13.4% of total expenditure in 2017, which is higher than the share of agriculture in budget expenditure (Table 3.2).6 Tax expenditures account for 20% of total expenditure on agriculture, which is higher than for other policy areas, indicating the importance of tax relief as a policy measure to support the sector.

Table 3.2. Budget and tax expenditures in Korea, 2017
Trillion KRW, %

 

Amount (A)

Share (%)

Amount (B)

Share (%)

A+B

Share (%)

B/(A+B) (%)

Agriculture1

19.6

4.9

4.9

13.4

24.5

5.6

20.0

Education

56.4

14.1

1.3

3.4

57.7

13.2

2.3

Social welfare

119.7

29.9

10.3

27.9

130.0

29.7

7.9

Others

205.0

51.1

20.5

55.3

225.5

51.5

9.1

Total

400.7

100.0

37.0

100.0

437.7

100.0

8.5

1. Forestry and fisheries included.

Source: National Assembly Budget Office (2016).

 StatLink https://doi.org/10.1787/888933852350

Taxes on agricultural products and inputs

In Korea, the supply of unprocessed edible food is categorically exempted from VAT. The rationale for this exemption is to free the consumers from a tax burden on necessity goods. The same principle applies to water supply, briquettes, and women’s sanitary pads. However, the exemption has positive production and income effects on agricultural producers as the benefit of non-taxation is shared between consumers and produces.7 The special VAT treatments function as a means of supporting their income.

As the supply of unprocessed edible food is not taxable in the Korean VAT system, agricultural producers cannot get an input VAT deduction. Most inputs to agricultural production have a special treatment in the VAT system to remove this “unwanted” side-effect. Two important forms of the special treatment are the (ex ante) zero tax rate and the (ex post) VAT payment refund. The zero rate is applied to input items which are used exclusively for agricultural production such as fertilisers, chemicals for plant protection, agricultural machines, equipment and materials for livestock farming, and feed. For some specific equipment and materials that can be used for purposes other than agricultural production, a VAT refund is available when they have been used for agricultural production.

Another important tax treatment for agricultural inputs is the exemption of the taxes on oil fuels used for agricultural machines. In the Korean tax system, oil fuels used for agricultural machines, including tractors and heaters, are exempted from all fuel taxes; transportation-energy-environment tax, auto tax, individual consumption tax, education tax, and VAT.

Tax incentives to encourage innovation

Income tax or corporate income tax credit is given for a portion of expenses for R&D and human resource development. This tax credit is the third largest item in terms of foregone revenue. These expenses encompass salaries for R&D personnel, material costs for R&D, costs of outsourced training, and job capability development costs (Jeong, 2015). The credit ratio is higher if the taxpayer is a small or medium-sized enterprise or the expenses are made in specific businesses designated by the government as new growth-propelling sectors. Tax credit is also available for investment in facilities needed for R&D and human resource development. In terms of the relative importance of tax incentives in government funds for R&D, Korea has been in the higher ranking group among OECD countries (Figure 3.8).

Figure 3.8. Government support for business R&D through direct funding and tax incentives, 2006 and 2014
Tax incentive share of government funds for R&D
picture

Note: For Turkey, 2006 is replaced by 2008.

Source: OECD (2017d), R&D Tax Incentive Indicators, http://oe.cd/rdtax; OECD (2017e), Main Science and Technology Indicators, www.oecd.org/sti/msti.htm.

 StatLink https://doi.org/10.1787/888933851742

Tax credit is available for a firm’s capital investment on condition that the number of permanent employees does not decrease. The credit to investment ratio is differentiated by sector, size of the firm, and the location of the investment (favouring SMEs and regions outside of the metropolitan area around Seoul). SMEs can claim special tax credit for investment in specific equipment or facilities essential to their business or computer software programmes. The credit-to-investment ratio of this treatment is 3%. Besides tax credit for investment, a partial tax exemption is available for SMEs. The exemption rate is differentiated from 5% to 30% by the size of the firm and its location. With foregone revenue of KRW 1.9 trillion (USD 1.64 billion), this credit is the fourth largest tax expenditure item.

Tax credit is also used as an incentive to encourage companies to adopt new technologies. It is available for investment in productivity-enhancing facilities, energy-saving facilities, and environment-preserving facilities. Another category of tax incentive to encourage the adoption of innovation is special treatment for start-ups or investment in venture enterprises, e.g. tax credit or reduction, special treatments in collection procedures. Examples of such incentives include a tax reduction for new SMEs and venture enterprises for five years (50%) (KRW 145.4 billion - USD 125.2 million), tax incentives for investments in start-up investment companies, and tax exemption on gains from exercising the stock options of such companies.

Tax incentives to enhance sustainability

Korea provides tax credit for investment in environment-preserving facilities and energy-saving facilities, as well as zero-rating in VAT of equipment and materials for environment-friendly farming. Afforestation is promoted by a special treatment that reduces the personal or corporate income tax amount by 50% for income that is generated at least 10 years after afforestation. However, Korea’s energy taxes do not sufficiently consider the environmental and other external costs of energy production and use across sector activities. For instance, in terms of both energy content and carbon content, the gap between the taxation of transport fuels and that of non-transport fuels is above the OECD average (OECD, 2013). Payment for energy also varies by user group, with tax rates highest for households, followed by industry, and agriculture enjoying exemptions. Environmental tax and charge rates on air pollution, water pollution and use, and land development are too low to cover environmental and social externalities or to encourage pollution reduction and efficient resource use. Furthermore, nitrogen oxide emissions from industry are not subject to the air pollution tax despite the fact that they are increasing (OECD, 2017b).

Unlike some OECD countries, Korea is not adopting an explicit carbon tax system. OECD (2016c) calculated ‘effective carbon rates’, in the determination of which tax systems play an important role. Korea is in the middle-low range among 41 OECD and selected partner countries in both road and non-road sectors. Except for residential and commercial uses, its proportion of CO2 emissions priced above EUR 30 per tonne is lower in comparison to other larger OECD countries.

3.6. Summary

Korea has one of the most favourable macroeconomic environments among the OECD countries, with the fastest growth rate of per capita income over the past 25 years. The Korean economy is highly dependent on exports, which account for more than half of GDP. Reflecting the critical role of trade, Korea maintains a relatively open trade environment and has been actively pursuing bilateral and regional trade agreements. It also took a number of steps to liberalise foreign direct investment. However, agriculture is one of the few sectors receiving border protection, and foreign direct investment in some of the agricultural sectors is still restricted.

Enforcement of fair competition has been a policy issue in Korea, particularly because the economy is dominated by a small number of conglomerate business groups. Ensuring fair competition in input and output markets is a key area of policy to improve the agricultural sector’s competitiveness. Korea’s agricultural co-operative (NH) has been playing a major role in supplying farm inputs and finance, particularly for small scale producers. The government has been providing preferential tax and regulatory treatments to NH and used them as a channel of subsidised credit. However, as farm structure has diversified, high market shares of NH in supply of certain inputs (e.g. fertiliser) and financial services may hinder the entry of other players who can address the diverse needs of commercial farms.

Korea has developed relatively well-functioning financial markets and farmers can have access to various sources of finance, including through emerging direct financing. The government has also been providing low cost loans through NH. Although a government programme allowed small-scale producers to invest in farm equipment and land, it may have led to over-investment, constraining productivity improvement at the farm level and causing a structural farm debt problem after the financial crisis of the late 1990s.

Korea imposes a relatively low tax rate on enterprise, which has proved a favourable environment for corporate activity. It also provides tax incentives to encourage investment, in particular in R&D. The tax incentive for R&D in Korea is higher than in the majority of OECD countries. Preferential tax treatment plays a larger role in agriculture. For example, primary agricultural products are categorically exempted from VAT, and agricultural inputs including fertiliser, plant protection, farm machine and feed receive either a zero VAT tax rate or a VAT refund. Fuel taxes are exempted for farm machines. However, such special treatments may encourage the use of potentially environmentally harmful inputs such inorganic fertiliser, chemicals and fuels. The consistency with other policies to promote sustainability of agriculture, such as support to energy-efficient facilities, can be improved. Moreover, it may discourage appropriate financial management to record revenue and expenditure.

Korea has strengthened its environmental regulations and the stringency of its environmental policy is above the OECD average. The general environmental regulation system in Korea evolved from direct controls or command-and-controls in the 1980s to a combination of direct control and incentive systems since the early 1990s. Currently there is no environmental regulation imposed specifically on agricultural production, except for the regulations on livestock manure. Most of the regulations in the agricultural sector are on products and processes such as food safety, labelling of origin, and traceability. A comprehensive approach including regulation, incentives to invest in developing new technology, capacity-building and building partnerships between stakeholders is necessary to tackle growing livestock manure and disease management.

Designing agri-environmental policy requires the definition of reference levels and environmental targets, which play a crucial role in choosing policy instruments. Reference levels are the minimum levels of environmental quality that farmers are required to provide at their own expense, while environmental targets are a voluntary (desired) level of environmental quality. To establish a solid framework of agri-environmental policies, Korea should clarify the reference environmental quality as well as environmental targets which are well adapted to the local ecological conditions.

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Notes

← 1. The National Assembly can of course “create” new budget items or increase budget expenditure by enacting laws. However, once the budget proposal is submitted by the government to the National Assembly, the stipulation of the Article of 57 of the Constitution binds.

← 2. The food industry is not an exception. Both the Lotte Group and CJ Group can be considered as chaebol and the sum of their market share in the Korean food industry is about 26.4%.

← 3. The regulations on water resources and land use are reviewed in Chapter 4.

← 4. Kwon et al. (2017) estimated the impacts of introducing mitigating steps of improving irrigation method, feed quality, and livestock manure treatment using a large scale applied general equilibrium model. They found that the marginal abatement cost of agricultural source GHG is about KRW 10 000 (USD 8.6) per tonne of CO2 when those strategies are introduced, which is almost half of the average trading price of Korean ETS.

← 5. Nongshinbo reported a guarantee balance of KRW 11 120 billion (USD 9 829 million) with underlying assets of KRW 2 250 billion (USD 1 988 million) in 2015.

← 6. Important special tax treatments for agriculture are: the zero VAT rate for agricultural inputs (KRW 2.5 trillion USD 2.16 billion), the tax exemption for fuel oil used for agricultural production (KRW 0.9 trillion USD 0.78 billion), special treatment of capital gains tax on self-cultivated agricultural land (KRW 0.8 trillion USD 0.69 billion), and a tax favour on agricultural cooperatives’ investments and deposits (KRW 0.7 trillion USD 0.6 billion).

← 7. As a consequence, food processing businesses or restaurants are allowed the aforementioned estimated input VAT deduction for the purchase of agricultural products. Without the estimated input VAT deduction, they would be unable to get the input VAT deduction because agricultural producers are not VAT-registered.

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