South Korea's transition from imitator to innovator: The role of external demand shocks

South Korean manufacturing firms have rapidly increased research and development (R&D) expenditure and the number of patent applications since the 1980s. This paper empirically argues that the increase in external market demand resulting from exchange rate changes had significant impacts on R&D expenditure of manufacturing firms in South Korea. Empirical analyses using South Korean firm-level panel data from 1981 to 1995 show that the exchange rate change was a significant driver of increased R&D expenditure. The South Korean firms whose exporting goods were similar to those produced in Japan were more sensitive to the exchange rate changes (especially Japanese yen's appreciation) than the firms whose exporting goods were less similar to Japanese exports. The result suggests a causal relationship between external demand and R&D expenditure.