History Of Asian Economies
Korea was one of the poorest countries in world
after experiencing two wars.
World War II and Korean war (1950 ~ 1953).
The country even experienced a food
shortage so that it had to heavily rely
on the foreign aid. Yearly per capita
consumption was a mere $88 as late as
1965. However, since 1965, Korea has been
transformed from its underdeveloped
agricultural economy to a leading Newly
Industrializing Country. Between
1965 and 1981, its gross national product GNP
multiplied twenty times from $3
billion to $63 billion and per capita GNP
increased sixteen times from $88 to
$1,554. There have been many explanations
for Korea’s successful story. Among
those, the strong role of government would
be probably the most important
one. At the same time, this would be also
responsible for current recession.
After Koran war, the government in fact had
no sense of direction and also
due to the unstable political situation, the
country didn’t have specific
economic policy until 1961 when military
government came to power and
established the major institution guiding its
economic planning called
Economic Planing Board (EPB). This government set
economic development as the
top national priority and recognized the financial
system in support of
economic development plan. To achieve this purpose, it
focused its policies
mainly on export expansion moving its emphasis from import
substitution. The
result was considered quite successful for economic growth.
Between 1965
and 1973, exports grew at average annual rate of 45%, from $175
million to
$3,271 million. The success of the expansion was due primary to three
factors
(Kwack, 72). The first was a favorable international economic
environment,
which saw total world imports expand from $175 billion in 1965 to
$536
billion by 1973. This boom in imports of the world reflected the fact
that
the industrialized had not yet erected import barriers against exports
from
developing countries and were, on the contrary, quite active importers
of
cheaper goods from Newly Industrializing Countries such as Korea. A
second
significant factor was the Korean government’s policy of promoting
exports,
which was set in motion in 1965. Initially, the government
introduced a number
of fiscal and financial incentives, which I will discuss
more later. A third
factor was Korea’s abundant and highly productive labor
force. This gave Korea
a strong comparative advantage in producing labor
intensive products and
provided the impetus for the notable expansion for
exports. In order to expand
total exports over time periods, however, Korea
turned to new export industries
that were expected to have a comparative
advantage with abundant labor, but
skilled labor at this time, such as
shipbuilding, electronics, and steel
industries. This attempt was viewed as a
manufacturing shifting of its emphasis
from light industries to heavy
industries which later started to produce
intermediary goods as substitutes
for imports (Kwack, 77). However, this
government’s promotion of heavy
industries for large-scale economies led to
under-investment in light
manufacturing industries causing productive gap
between small and large
firms. Actually, the large firm that runs heavy
industries has been given
priorities, and small and medium firms relatively
disregarded in government’s
allocation of loanable funds and other
administrative preference. As a
result, conglomerates later known as chaebol
(family owned conglomerate) have
been formed through this expansion of heavy
industries. Government’s Policy
Before 1961 As seen above, the Korean
government has been focused on import
substitution for economic growth during
1953 ~ 65 period and followed by
export expansion policy after 1965. However, to
progress its policy
efficiently, the government had to face to one of serious
problem, poverty.
After two major wars, the country even with a food shortage
experienced lack
of capital. There was no source for savings and investment to
finance
economic growth domestically, so it depended heavily on foreign capital
which
inflow in a form of mostly aid and loan in the early stage of
economic
growth. The proportion of foreign capital to total capital formation
in 1965 was
approximately 40 percent. In addition to inflow of foreign
capital, the
government faced allocation of capital with using its financial
system. Before
the military government in 1961, the loan decisions of
commercial banks were
heavily influenced by political interference (Haggard,
26). Well, in fact the
loan decisions in Korea mostly were affected by
political interference rather
than bank themselves until recent time, but
during the 1948 ~ 1961 period, the
rent generated by low interest rate was
used for its political activities rather
than economic growth. Government’s
Export Promotion Policies In the economic
development, the government’s
creation of economic rent for certain segments
of business takes critical
role. It can be either a source of political and
bureaucratic corruption, but
if wisely used, it can be a useful or powerful
policy instrument in
supporting business operation and government policies.
Furthermore, it
can increase capital formation in the country if it effects a
redistribution
of income from consumption to investment activities (Haggard,
23). Since
the mid 1960s, the military government used regulated finance as one
of tool
to create rent and achieve exports expansion. What it did were
nationalizing
commercial banks and amending the Bank of Korea so that it can
control
financial systems directly. In general, the Bank of Korea, in its role
as the
country’s central bank, determines the allocation of loans, interest
rate
level and the supply of money but the decision making in these area
is
controlled by the Minister of Finance. In other words, it was
government’s
responsibility generating monetary and fiscal policy, not by the
central bank.
Since foreign aid started to decline later 1960s, the
government reformed
interest rate. It raised the interest rate on (one-year)
time deposits from 15%
per year to 30% per year and general loan rate from
16% to 26%. The reform
successfully attracted private saving. In the first
three months after reform,
saving deposits increased by 50%. More
importantly, this meant more rent, in
other words, more capital to be
distributed under government influence. In
addition, the financial reform
contributed to a massive inflow of foreign loans
due to the existence of gap
between domestic and international interest rate and
since the Korea
Development Bank guaranteed to pay back to foreign lender, the
inflow of the
loans were accelerated. Also this gap of interest rate was used to
promote
export expansion which was the most economic priority. For example,
while
domestic interest rate was so high comparing with international rates,
the
exporters, mostly big business in heavy industry, were able to get loan
at
little interest rate. They were not only able to get low interest rates,
but
variety of supports that the government could do such as tax break and
easy
approval of the loans for exporters. For example, profits earned on
exports have
been exempt from corporate or individual income tax and the
short-term export
credit system gave borrowers holding export letters of
credit (L/C) "automatic
approval". As a result, an increase in domestic
savings and huge inflow of
foreign borrowings had positive effect on economic
growth in Korea due to an
increase in capital accumulation. Controlling
exchange rate is another good
example to describe the effect of government’s
role on Korean economic
development. After switching its economic policy from
import substitution to
export expansion in the mid-1960s, the Korean
government officially moved from a
fixed parity to a unitary floating
exchange rate system. Although the exchange
rate system has been "floating",
its actual (real) rate was managed by
government’s market control and Korean
currency "won" was undervalued
mostly against the U.S. dollar so that the
price of exports remain cheap.
Followings are the plans that the Korean
government set over time period as a
guide for economic growth. They are
quite helpful to understand how major
government’s policies on financial
sector have been varied with given the
world economic situations like oil
crisis and its own economic recession. The
First Five Year plan (1962 –
1966) The first plan was prepared in a hurry by
the military government that
took power in 1961. The major contents of fiscal
and financial policies as
stated in the plan document were largely about the
tax, budget, and monetary
system, financial market and foreign exchange system.
During this period,
its main purpose was, however, to expand exports as much as
possible by
providing export firm with cheap loans, tax benefits, export
compensation
schemes, and various administrative support. Economic growth in
this period
was result by an increase in export and output and as well as price
level
(since output and price level are positively correlated), so there
was
inflationary pressure at the end of the first plan- actually the
inflation rate
exceeded 23 percent in 1964. The Second Five-Year Plan (1967
–1971) During
this period, the major reforms include a financial reform
assuring positive
interest rate in 1965, and exchange rate reform normalizing
highly overvalued
exchange rate, and trade reform allowing wide imports of
parts and machinery
used for the production of export goods. These reforms
were reflected in the
second plan and carried further throughout the second
plan period. In addition,
there was an increase in domestic savings and a
decrease in foreign borrowing.
The Third Five-Year Plan ( 1972 –1976) The
third five-year plan put its major
emphasis on the promotion of heavy and
chemical industries. The government made
great effort to raise domestic
savings to finance the heavy and chemical
industries, but the amount of
domestic savings fell far short of investment
requirement. As a result,
foreign borrowing expanded enormously, and management
of foreign borrowing
and debt became a major policy issue. In addition, due to
different emphasis
on light and heavy industries, the growth gap increased
substantially.
Inflation caused by the first oil shock in 1973 also takes a part
of unstable
situation of economy. Inflation rate exceeded 40 percent in 1974.
The
Fourth Five-Year Plan (1977 – 1981) Because of high inflation cause by
the
first oil crisis, stability was given relatively high policy priority.
The
government adopted monetary rule of fixing money supply growth at a
prescribed
constant rate of 20 percent per annual to stabilize price level
and overall
economy. He major change in trade policy during the fourth plan
period included
the expansion of imports related to exports, maintenance of
effective exchange
rate, expansion of export subsidies, tax benefits and
foreign loans to export
firms. In addition, the government improved the
number of industrial estates for
export firms by creating industrial export
estates and free export zones. The
fifth Five – Year Plan (1982- 1986) In the
early 1980s, the Korean economy was
characterized by very slow growth rapidly
expanding foreign debt, and high
inflation. Consequently, export promotion
was given the highest policy priority
again, so the major change in trade
policy included intensive promotion of
export goods and market
diversification, reform of the export support system,
lowing tariff rates to
expand importation of good used in manufacturing. The
Sixth Five year
Plan (1987 – 1991) As of 1986 the Korean economy realized high
economic
growth, stable price, and a trade surplus and thus faced a new phase
of
growth with enhancing the efficiency and strengthen the
international
competitiveness of the Korean economy in general by reforming
the free
enterprise market system. Thus the major contents of policy reforms
included the
dramatic reduction of various government regulations
constraining growth of
enterprises plus extensive promotion of liberalization
of finance, imports and
foreign exchange. The Seventh Five – Year Plan (1992
– 1996) This plan was
formulated after Korea became a member of the United
Nations and emphasized the
role of private sector in preparation and
implementation of the plan. The Eighth
Five – Year Plan (1993-1997) The
preparation of this plan started with the
beginning of the Seventh Republic
and the plan emphasized that management of the
economy will no longer be
government led or government controlled, as in the
past, but will be based on
the participation and innovative spirit of the Korean
people. It also
stresses the importance of reform of finance, government
administration,
budgets, ethics, etc. Even though the government on each period
recognized
the problems it was facing and made five-year plans, they were not
always
successful. Throughout the plans above, we will be able to find a
common
policy used without difficulty. That is the government’s massive
supports
toward export firms. It must work during the early stage of
development when the
country had little capital accumulation. However, the
government’s unbalanced
incentives on big businesses which are mostly in
heavy and chemical industries,
later known as chaebol, actually led them to
depend too long on protection and
debt financing. This policy wasn’t a
serious problem when the economy boomed,
but when it slowed, most debt ridden
firms fell back on the government for
relief causing the issue whether the
policy and the industry are efficient or
not. (Haggrd, 24). For example, the
combined sale of the five largest big
companies, chaebol, take 37percent of
Korea’s gross out, and their exports
were 44 percent of total exports in
1997. If there is a little slow down of the
one of the largest business, then
it is obvious the economy is not in quite safe
situation. Since chaebol’s
share of Korean economy is already huge, if they
are allowed to fail or banks
are to write off their debt, then the whole banking
system would be pushed
into collapse. This is real problem, nor chaebol or their
associated
companies, be easily shut down (Economist). As a example, the price
of a 16
MB dynamic random access memory (DRAM) chip fell from more than US $40
in
January 1996 to less than US $10 by the end of 1997. The dollar export
price
index for Korea’s electronic components fell by 50 percent over the
same time
period. Another example is current collapse of Daewoo, a second
largest chaebol,
which had huge debt to equity ratio (over 400 percent), went
to a bankruptcy
this year. This company was well known with a very close
relationship with the
governments in the past. It was ironic to see that
Daewoo was expanding its size
when the country was in recession and other
chaebols tried to reduce their size
and increase efficiency. Actually, this
is not the first time Daewoo asked for
the government’s help. Every time the
company went into a trouble, the
government didn’t let the company to fail
and put more capital available into
the company. However, this time it
doesn’t seem happening that way. Actually,
the government is trying to solve
the problem under the market operation, so
this inefficient and insolvent
chaebol can be sold. Chaebols may not be the only
one to be blamed, even
though they were blamed as a major cause of Asian
financial crisis happened
in Korea brining the country to the brink of
insolvency, as well as weak
banking system, in fact, they could be victims of
misleading government
policy. The long term close relationship between
government and big business
creating rent and using them with unbalanced support
between industries had
worked well in the early stage of development, but as
stated early, rent can
bring corruption of bureaucracy or industries also, since
it is caused by
inefficiency. Allocation of financial resources is not an easy
job, but this
would be best time for Korea to consider again about the
efficiency of closed
relationship between the government and businesses while
the country is
restructuring its economy system.
Bibliography
Blinder, Alan S..
The Economics of Finance. Washington D.C.: the Brooking
institution, 1974.
Haggard, Stephan, et al. The politics of Finance in
Developing Countries.
London: Cornell Univ. P, 1993. Lau, Lawrence J.. Models of
Development.
San Francisco: ICS Press, 1986.