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 Koreas 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 didnt 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 governments 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 Koreas 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 governments 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 governments 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. Governments 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. Governments Export Promotion Policies In the economic development, the governments 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 countrys 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 governments 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 governments 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 governments 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 he …