Ebs Cohost

118
SOUTH KOREA: GOVERNMENT-LED

DEVELOPMENT AND THE DOMINANCE
OF GIANT CORPORATIONS
Leung-Chuen Chau
University of Hong Kong
I. Overview of Development Since the Early 1960s
1. Growth Performance
In macroeconomic terms the growth of the Korean economy since the
1960s has been characterized by high growth rates of incomes, high
inflation rates in the 1960s and 1970s, declining unemployment rates
and a rapid increase in exports.
Most remarkable was its growth performance. As can be seen from
Table 3.1, Rapid growth was achieved from 1963 on, right after it
switched to export-oriented industrialization in 1962. GDP growth
averaged 7.8 percent during the first five-year plan period (1962-67),
up from a level of 4 percent in the 1950s. It leapt to 9.7 percent in
the next plan period, and generally stayed at this high level, reaching
10 percent over the sixth five-year period (1987-91). The one exception
was the year 1980, when the economy was hit simultaneously by
the second oil crisis and political unrest following the assassination of
President Park. It registered the country's one and only negative growth.
As a result, growth rate decelerated to 5.7 percent in 1977-81. It is
noteworthy that Korea weathered the first energy crisis of 1973
which left most Western economies in the doldrums for many years
remarkably well. As a matter of fact, the rate of growth never fell
below 5 percent since 1963, except for 1980.
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AN: 235825 ; Kwong, Kai-Sun.; Industrial Development in Singapore, Taiwan, and South Korea
Account: s4054273
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Account: s4054273
Table 3.1: (Continued)
Year
1980
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
GNPper
capita
(US$)
1,597
2,242
2,568
3,218
4,295
5,210
5,883
6,757
7,007
7,513
8,483
10,076
10,548
GNP
(billion
US$)
60.00
91.10
105.40
133.40
179.80
220.40
251.80
292.00
305.70
330.80
376.90
448.30
484.60
GNP
Growth
Rate (%)
^1.8
5.4
12.3
12.8
12.4
6.9
9.6
9.1
5.0
5.8
8.2
9.3
6.9
Inflation
Rate (%)
25.6
4.1
2.7
3.7
5.9
5.3
9.9
10.1
6.1
5.1
5.4
4.6
5.0
Interest
Rate (%)
19.5
10.0
10.0
10.0
10.0
10.0
10.0
10.0
10.0
8.5
9.3
8.8
n.a.
Rate of
Private
Savings
(%)
18.0
23.7
27.8
30.8
31.5
28.4
27.4
28.3
27.1
26.7
26.0
26.0
n.a.
Trade
Balance
(mn US$)
(4,384)
(19)
4,206
7,659
11,445
4,597
(2,004)
(6,980)
(2,146)
1,860
(3,145)
(4,749)
(15,278)
Exports
(mn US$)
17,214
26,442
33,913
46,244
59,648
61,409
65,016
71,870
76,632
82,236
96,013
123,242
129,715
Foreign
Debt
(mn US$
27,170
46,762
44,510
35,568
31,150
29,372
31,699
39,135
42,819
43,870
56,850
54,542
n.a.
Note: GNP and GDP per capita are in current prices. The rate of inflation is based on GNP deflator. T
interest rate on time deposits for the period of one or more years.
Source: Economic Statistics Yearbook, various years, and National Accounts 1994, by National
Korea
Major Statistics of the Korean Economy, various years
The First Five Year Economic Development Plan, 1962-66
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Account: s4054273
South Korea 121
In broad terms, Korea's real GDP tripled every decade since 1962.
When combined with a rapid slowing down in population growth, it
resulted in handsome gains in per capita income. This gain was effectively
spread among the population through rising wages and rapid job creation.
There was double-digit unemployment at the start. But it declined
rapidly. Full employment was achieved in late 1960s, and was maintained
thereafter. There was an acute labour shortage from 1988 on. Unlike the
growth rate of income, the rate of unemployment has been quite stable
from 1970s on.
The high growth of early decades was accompanied by even more
rapid growth in prices. Inflation rates were almost always double-digit
before 1982. It averaged 14 percent in the 1960s, and 19 percent in the
1970s, much higher than other Asian NICs. As will be explained below,
it was a byproduct of the development policy pursued by the Government.
Thus when government switched its policy in early 1980s, inflation fell
sharply.
2. Sources of Growth
With its start as a resource-poor, agrarian economy, the source of its
post-1960 growth is quite obvious export-oriented industrialization.
Table 3.2: The Structure of Production (% distribution in current prices)
Sector
Agriculture
Industry
Mining
Manufacturing
Construction
Utilities
Services
Total (GDP)
7960
39.9
18.6
2.3
12.1
3.5
0.7
41.5
100.0
1970
31.1
28.4
1.3
19.1
6.4
1.6
40.5
100.0
1980
14.6
41.4
1.4
29.6
8.2
2.1
44.0
100.0
1990
9.0
44.7
0.5
28.9
13.2
2.1
46.3
100.0
1995
6.6
43.5
0.3
26.9
14.1
2.2
49.9
100.0
Source: Economic Statistics Yearbook 1978, 1995, National Accounts 1994
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DE MEXICO
Account: s4054273
122 Industrial Development in Asian NIEs
Reflected first in the structure of production. The share of manufacturing
went up from 12 percent in 1960 to 27 percent in 1995, while the
primary sector shrank (Table 3.2).
Most manufactured products were destined for export. Exports were
growing faster than the GDP. As sources of demand, their relative share
continued to increase, rising from 14.7 percent in 1970 to 36.2 percent
in 1985 (Table 3.3). Interestingly, imports share continued its rapid
increase until 1980.
Like other East Asian economies, Korea started out with developing
labour-intensive light manufacturing industries. In 1970, such products
accounted for some 70 percent of total exports. But all out efforts
Table 3.3: Export and Economic Growth Changes in Demand Structure
Demand Component
Consumption
Investment
Exports
Imports
Total
1970
83.7
26.4
14.7
-24.8
100.0
1975
82.0
27.5
30.3
-39.8
100.0
1980
76.6
31.2
33.7
-41.5
100.0
1985
68.9
30.6
36.2
-35.7
100.0
1990
63.7
36.8
31.0
-31.4
100.0
1995
61.3
38.3
30.6
-30.2
100.0
Source: Economic Statistics Yearbook, The Bank of Korea, various years
Table 3.4: Export and Economic Growth Demand Side Sources of Growth in
Manufacturing Output (%)
Demand Expansion
Consumption
Investment
Export
Import
Changes in input-output coefficient
Total
1970-5
54.8
15.5
27.3
-1.3
3.7
100.0
1975-80
48.1
21.1
27.3
1.7
1.8
100.0
1980-3
45.8
19.8
32.9
3.7
-2.2
100.0
1983-7
41.7
21.6
34.2
4.1
-1.6
100.0
Source: 1970-83 figures are World Bank estimates, KoreaManaging the Industrial
Transition, World Bank, 1987. Other figures are obtained from the author's estimates
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CIUDAD DE MEXICO
Account: s4054273
South Korea 123
were launched, as early as mid-1973, to develop heavy and chemical
industries producing for export. Specifically, six industries were targeted
for promotion: industrial machinery, shipbuilding, electronics, steel,
petrochemical and non-ferrous metal. By 1990, products from these
industries accounted for 40 percent of total exports.
Sources of growth are also analysed from the supply side, using the
well-known growth accounting approach pioneered by Denison. Some
results are summarized in Table 3.5. The growth of labour input was
the single most important source of growth in the 1960s and 1970s. There
was a substantive increase in labour input, taking into consideration
number of workers as well as hours worked per week.
31
By contrast,
labour input was falling in Japan during its period of most rapid
Table 3.5: Supply Side Sources of Growth (% per annum)
Korea Japan W. Germany US
1963-73 1973-86 1982-89 1953-71 1950-62 1948-90
Real GNP Growth Rate
1. Contribution of inputs
Labor
Capital
2. Total factor Productivity
Advances in knowledge
Improved resource
allocation
Economies of scale
9.5
5.4
3.2
2.2
4.1
1.4
1.0
1.7
7.8
4.1
2.2
1.9
3.7
1.6
0.6
1.5
8.1
4.4
2.5
1.9
3.7
0.9
1.0
1.8
8.8
3.9
1.8
2.1
4.9
2.0
1.0
1.9
6.3
2.8
1.4
1.4
3.5
0.9
1.0
1.6
3.2
1.8
0.6
1.2
1.4
1.0
0.4
n.a.
Source: Korea (1963-73) from Byung-Nak Song 1984; Korea (1973-86) from Byung-Nak
Song; Korea (1982-89) from Joon-Kyung Park and Jung-Ho Kim, 1995; Japan and W.
Germany from E.F. Denison and W.K. Chung, 1976; US from P. Samuelson and W. Nordhaus,
1995
31
Korea has the longest working hours of all Asian newly industrialized economies. In
1986, for example, the work week in manufacturing industries was 13 hours longer than
that of Japan, and 6 hours longer than that of Taiwan. Unlike Japan and Taiwan working
hours continued to rise until 1986, in spite of steadily rising income. (Cho, 1994, 92-3)
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growth. The stock of physical capital also increased very rapidly, as a
rising proportion of a rapidly growing income was devoted to investment.
Overall, the growth in inputs contributed considerably more to GNP
growth than did increases in productivity, while the reverse was true
for Germany and Japan. Paraphrasing Krugman, we can say that,
compared to advanced countries, Korea grew more by perspiration than
by inspiration.
However, contribution from productivity growth was by no means
negligible. A significant component of which was advances in knowledge.
This was obviously related to the emphasis on human capital formation.
Even in 1960, Korea had a relatively high level of educational attainment
among developing countries. School enrollment grew exponentially
thereafter. Enrollment ratio for secondary school went up from 27 percent
in 1960 to 82 percent in 1982. For tertiary education, the ratio increased
from 11 percent in 1977 to 37 percent in 1987. In 1990, public and
private spending on education totalled 10 percent of the GNP. Particularly,
the training of scientists, engineers and technicians was emphasized.
The remaining productivity growth, ascribed to improved resource
allocation and scale economies, was clearly related to the rapid pace of
industrial transformation referred to earlier. It resulted in a rapid increase
in the share size of high-technology products in manufacturing and
exports. To the extent that these industries became competitive in the
world market it would have resulted in improved resource allocation. At
the same time, scale economies are important for heavy and chemical
industries actively promoted.
It should be noted that growth accounting is a very uncertain art,
particularly for developing countries with incomplete data. Thus the
relative contribution of productivity growth calculated by different
researchers vary considerably.
In sum, Korea's economic development was fueled by an intensive
increase in factor input and rapid expansion of exports. Within three
decades, the economy was transformed from a backward poor agrarian
economic backwater into an industrial economy; a process which often
took industrialized economies a century to achieve. But this condensed
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South Korea 125
growth did not just evolve under the invisible hand of market forces.
Quite to the contrary, it was orchestrated, throughout, by a strong and
authoritative government with forceful policy.
II. Historical Evolution of Economic Policy and Development
1. Background
From the beginning, the Korean government took on an active and direct
role in guiding and promoting economic growth, much more so than the
governments of Japan and Taiwan. The overriding objective was growth
maximization. This was considered essential to survival, to counter the
threat of North Korea, which was stronger militarily and economically in
early 1960s. The strategy was clear-cut and simple: outward-, industry-
and growth-oriented (or "OIG-oriented").
32
To do well in export was
considered of paramount importance. The phrase "export first" was
written into the second five-year plan (1967-71), and "nation building
through exports" was President Park's favourite maxim. At the helm was
the government's strong guiding hand. Two months after Park took
control of the Country, an Economic Planning Board was established
which reported directly to the President. A monthly export promotion
conference was established way back in December 1962, and it was
always attended by President Park himself, as well as by all important
public officials and private experts concerned with trade. Explicit targets
for the growth of industrial outputs and exports were set, and the
President himself checked on the progress of exports and the performance
of exporting firms.
Three phases of industrial policy can be distinguished: (1) Industrial
takeoff (1961-73): exports were aggressively promoted. Interventions
were manifold, but were neutral with respect to the composition of
exports. (2) The Heavy and Chemical Industry Drive (1973-79):
Song, B.N. (1995), p. 85.
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promotion of specific industrial targets. (3) Functional incentive (1980s):
a return to neutral, functional intervention.
2. Industrial Takeoff
Trade, exchange, fiscal and financial policies were integrated to pursue
the primary objective of export growth. It resulted in a wide range
of incentives, administrative support and infrastructure investment for
the benefit of exporters. Exporters were supported with tax exemptions,
allocation of credits at zero or negative interest rates, multiple exchange
rates, direct cash payments, permission to retain foreign exchange
earnings for private use and the privilege to import restricted
commodities. Some of these benefits were automatic, others were at the
discretion of officials. In either case, they were tied to export perfor-
mance. The government built export industrial estates to provide export
firms with sites, utilities, transportation, communications and other
services at discounted or controlled prices. It also helped to control the
wages of workers at the exporting firms and restricted labour union
activities.
Administrative support of business also served as an effective sup-
plementary policy instrument. Businessmen operated under a maze of
laws and regulations concerning trade and industry, inherited from
the Japanese colonial regime, which were designed to control business
activities by the native Korean population. Administrative support helped
to cut through the red tape and greatly reduced the cost of doing business.
At the Monthly Export Promotion Conference, for example, businessmen
could tell their problems directly to the President. A number of quasi-
public organizations also provided valuable support for exporting firms.
The Korean Trade Promotion Corporation was established in 1962
to help with international marketing. The Korean Trade Association
(KTA) was influential in promoting contact between the government
and businesses. The Korean Institute for Science and Technology was
established in 1961 to spearhead the country's technological drive.
Finally, a system of general trading companies (GTCs) played a vital
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South Korea 127
role in speeding up export expansion, though the legal framework
was only introduced in 1975. Trading companies were designated a
GTC by meeting a number of requirements such as paid-in-capital,
public stock offerings, number of overseas branch offices, and, most
importantly, annual export sales. In addition to prestige, sanctioned
(licensed) companies enjoyed various benefits such as cash subsidies
tied to export volume and preferential access to foreign exchange. By
regularly raising the minimum export value requirement, the government
continuously pressured GTCs to expand exports. For their part trading
companies, which steadily increased their market shares, could support
and pressure producers for greater efforts.
Non-monetary rewards, such as medals, citations or presidential
awards were used extensively to mobilize commitment to development
policies. Such social recognition was believed to be very effective
motivators in a traditional society like Korea, where people value
loyalty to the President and country very highly. Clearly, such incentives
could be used in the reverse, in the form of social pressures and
practical penalties withdrawals of recognitions, privileges and supports
to ensure compliance.
The main features of industrial policy in this phase were: (a) moderate
protection of domestic markets, offset by special subsidies for exports;
(b) approximately world market pricing of inputs and outputs across
different export products; (c) great protection of the domestic market in
industries with poor export prospects; and (d) great protection of final
consumer goods, relative to industrial raw materials and capital goods.
Overall, protection did not significantly distort either the general level
or the inter-industry pattern of export incentives. Consequently, the
emerging export structure reflected comparative advantage more closely
than is generally the case in protected economies.
These efforts turned out to be phenomenally successful in the
1960s. As shown in Tables 3.6-3.8, performances repeatedly outpaced
targets. Average growth rate was targeted at 7.1 percent for the first
five-year plan (1962-66). The actual performance was 7.8 percent.
Annual growth of exports was 44 percent, some 80 percent above
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Table 3.6: Targets and Growth Performance of the First Five-Year Plan
(1962-66)
Indicator
Economic growth rate (%)
Investment as share of GNP, %
Domestic saving as share of GNP, %
Foreign saving as share of GNP, %
Current account in 1966 (mn $)
Exports in 1966 (mn $)
Annual average percentage change
Imports in 1966 (mn $)
Targets
7.1
22.6
9.2
13.4
-246.6
137.5
n.a.
492.3
n.a.
Performance
7.8
17.0
8.8
8.2
-103.4
250.4
43.7
679.9
19.1
Table 3.7: Targets and Performance of the Second Five-Year Plan
(1967-71)
Indicator
Current account in 1971 (mn $)
Exports in 1971 (mn $)
Imports in 1971 (mn $)
Targets
7.0
19.0
11.6
7.5
-95.8
550.0
894.0
Performance
9.5
26.1
16.1
10.2
-847.5
1132.3
35.2
2178.2
26.2
Source: Economic Planning Board; Bank of Korea, National Accounts 1990
target. The feat was repeated over the second five-year plan when
economic growth reached 9.5 percent, against the 7 percent target, and
exports grew at 35 percent. The success spurred the government into
more direct and comprehensive intervention for more ambitious results.
The drive for heavy and chemical industrialization was formally
declared in January 1973.
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South Korea 129
Table 3.8: Target and Performance of the Third Five-Year Plan
(1972-76)
Indicator
Current account (mn $)
Exports (mn $)
Imports (mn $)
Targets
8.6
27.6
19.5
5.4
-359.0
3510.0
3993.0
Performance
9.1
27.1
20.8
6.7
-313.6
7814.6
47.1
8405.1
31.0
Source: Same as Table 3.6
3. The Heavy and Chemical Industry Drive
The controversial Heavy and Chemical Industrialization (HCI) policy was
officially declared by President Park in January 1973. But the targeting
of the six industries concerned, namely, industrial machinery, shipbuilding,
electrical, steel, petrochemical and non-ferrous metals began a few years
earlier, during the second five-year plan. In typical Korean fashion, a law
was specifically enacted for the promotion of each of these industries.
The Industrial Machinery Promotion Act, for example, came out in 1967.
Steel, petrochemicals, and non-ferrous metals were selected primarily to
enhance self-sufficiency, as Korea's manufacturing was unusually dependent
on imports. The others were selected because they were technology-
intensive.
A number of distinctive features of HCI policies are worth noting.
Firstly, the policy was outward-looking. The targeted industries were
planned to be internationally competitive from the outset. It was
recognized that the domestic market was too small to exhaust the scale
economies of these industries. The second feature was its detailed
planning. Targets set in 1973 included physical quantities of steel, ships
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and autos to be produced by 1980. Harbour, road and water investments
were coordinated and provided as part of the social overhead capital
investment. Plans were explicit in saying that only up-to-date technology
was to be used. The third and most controversial aspect of Korean
industrialization is its financing. Public resources were directly mobilized
for HCI financing via the National Investment Fund. Banks were directed
to lend to the industry at preferential rates. In addition, there was a
plethora of tax incentives as well as subsidized public services. The true
cost of the HCI promotion will thus never really be known.
Buttressed by the six promotional laws issued during the Second FYP
(i.e., for Industrial Machinery-1967, Shipbuilding-1967, Electronics-
1969, Steel-1970, and Petrochemicals-1970), President Park's 1973
Decree mobilized Korea's bureaucracy to achieve his goals. The most
remarkable feature of these plans was that each industry designated for
support was to go through four pre-determined phases:
(i) minimum scale, when active government planning and support
accompanies protection;
(ii) optimum scale, at which time government lending and support
continues but the industry matures;
(iii) international scale, by which time industries are expected to be
self-sustaining and initiative is to come from business itself; and
(iv) international first-class scale, by which time the industry is expected
to be internationally competitive.
A Heavy and Chemical Industry Planning Council was established by
the President in 1973 to take charge of the planning and implementation
of the heavy and chemical industry buildup. The Industrial Base
Development Promotion Act was enacted in the same year, which decreed
the establishment of 13 heavy chemical industry complexes throughout
the country to accommodate plants of the targeted industries. To mobilize
resources, the National Investment Fund Act was legislated, also in
1973. According to this law, each and every type of savings was to be
mobilized, on a compulsory basis, to invest in essential that is, heavy
and chemical, and export industries. They did so through the purchase
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South Korea 131
of the National Investment Bond, or deposited their money with the
National Investment Fund (NIF). The big push was also accompanied
by a rapid increase in external debt. An early emphasis on drawing foreign
direct investment was not successful. Almost all important investments
were made by local entrepreneurs, who relied principally on borrowing.
Targeted industries received heavily subsidized loans from NIF.
Indeed, real bank interest rates were negative during most of the 1970s.
HCI projects were heavily favoured. About two-thirds of NIF loans went
to HCI projects. Similarly, bank credits also favoured such projects.
Policy loans, the directed credit instrument of Government, reached 41
percent of domestic credit in 1975, and 51 percent in 1978. In contrast,
light industries such as textiles faced fierce discrimination in getting
access to credit. They had to resort to more expensive sources. The HCI
sector also received more favourable tax treatment. Marginal tax rates
for non-HCI corporations were 2 to 3 times higher.
Intervention did not stop with credit allocation. Almost every price
even the prices of fast food items was under government control.
There was a complete control on wages. The Government set guidelines
for wage rates, taking into consideration their impact on the price level
and on exports. Labour movement was practically outlawed. Similarly,
a guideline for determining dividend rates was set by the Government,
which was concerned with their impacts both on interest rates and on
the development of the stock market.
During the third five-year plan period (1972-6), when most of the
rest of the world was plagued by the energy crisis and stagflation, the
Korean economy performed brilliantly. At 9.1 percent, the growth rate
was ahead of target (Table 3.8), and was also the highest among non-
oil-producing countries. Unemployment rate fell to 3.9 percent. The very
ambitious investment target was achieved. Exports were growing at an
unprecedented 47 percent per annum.
However, the HCI drive had little to do with this success. It would
have taken another ten years before their products became competitive
in world markets. Instead, it was due primarily to some fortuitous
external events. First, the 1973 international exchange-rate adjustment
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CIUDAD DE MEXICO
Account: s4054273
Table 3.9: Target and Performance of the Fourth Five-Year Plan (197
Indicator
Current account (mn $)
Exports (mn $)
Imports (mn $)
average
9
26
24
2
1977
10
27
22
5
-634
9700
10133
Targets
1978
9
26
23
3
-237
11970
11925
1979
9
26
24
2
235
14519
14043
1980
9
26
25
1
679
1981 i
9
26
26
0
1172
17292 20242
16435 18872
iverage
6
31
24
6
22
24
1977
10
27
25
1
12
10047
29
10523
25
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Account: s4054273
South Korea 133
brought about an appreciation of both the Japanese Yen and the German
Mark, providing the Korean exporters with great competitive advantage.
Second, the OPEC countries in Middle East lavished their bloating
oil revenue on massive infrastructure projects. Korean construction
firms were heavily involved in these activities. But the policy of heavy
industrialization was clearly responsible for fueling inflation. While
most other countries tried to contain their inflation, Korea persisted in
maintaining a growth-oriented expansionary policy. The rate of inflation
topped 20 percent for the years 1974-76, despite extensive price
controls.
With economic success, policymakers became more confident, and
pursued the HCI drive with greater vigour. More ambitious targets were
set for the fourth five-year plan (1977-81). The plan also aimed at
cutting its reliance on foreign capital, while raising the proportion of
heavy and chemical industries to almost 50 percent. As detailed in
Table 6b, growth targets were achieved in 1977 and 1978, but it slipped
behind in 1979. The following year, Korea experienced its first and
only negative growth. Average growth was substantively below the target
rate. Investment target, however, was exceeded for every year. Indeed,
total investment in exports and heavy and chemical industries during
the first three years surpassed that planned for the entire period. This
was partly at the expense of light industries investment, which fell far
short of the plan's goal. On the other hand, the targeted rate of saving
was not achieved. The result was a large-scale foreign capital inflow. It
was noteworthy from Table 6b that, year after year, the export target
was fulfilled with hairsbreadth accuracy. It reflected overriding
importance accorded by all parties concerned to the export goal. On the
other hand, actual imports far exceeded planned levels.
Behind the facade of rapid growth and industrialization, economic and
social problems were mounting. Inflation averaged more than 20 percent,
it reached 26 percent in 1980, the year of negative growth. It was
widely believed that the actual inflation exceeded official figures. With
multiple prices for the same goods official prices, announced prices,
and market prices the rate of inflation was hard to ascertain. High
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inflation brought about widespread speculation on buildings, land and
durable goods. There was also widespread excess capacity and financial
losses in HCI. The balance of payment worsened, and foreign debts
snowballed. As the HCI drive favoured large enterprises, engineers and
highly skilled labour, distribution of income and wealth became more
unequal. High inflation and a real estate boom further aggravated
the problem. At the same time heavy investment in HCI crowded out
expenditure on social services and infrastructure.
Substantial adjustments were therefore necessary. As most of the
woes mentioned above were related to the HCI drive forced from
above, a shift in strategy would have been a natural response.
4. A Shift Towards Functional Incentives
The assassination of President Park in October 1979 was followed by a
prolonged crisis in political, economic and social spheres, which were,
to some extent, reactions to the distortions and imbalance brought about
by forced growth. General Chun Doo Hwan seized power in May 1980,
and was inaugurated as President in March 1981.
In the early 1980s, the Korean economy was characterized by very
slow growth, high inflation, and rapidly expanding foreign debts. The
new government had simultaneously to stabilize the macroeconomy,
solve the mounting financial problems in major industries, and establish
new directions for industrial policy. The new approach to industrial
policy, written into the fifth five-year plan, represented a shift to
indicative planning, and an aim to rely more on market forces and
private enterprise. This was eventually translated to a range of financial
and trade liberalizations.
Trade liberalization started in 1981 and progressed steadily, gathering
momentum after the 1985 Plaza Agreement. In the area of industrial
finance, the government sold its bank stocks to the public between 1981
and 1983, and it abolished numerous regulations and control on the
management of banks. It reduced its role on specific credit allocation,
and abandoned policies which favoured the HCI sector. Interest rates
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CIUDAD DE MEXICO
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South Korea 135
were increased to reduce the gap between the organized and unorganized
sectors of the financial market. New financial institutions were established
for participations by foreign banks. In all, the scope of interest rate
subsidies for particular borrowers was substantially reduced.
The privatization of commercial banks was the most notable part of
the drive for promoting the "private initiative economy". The Monopoly
Regulation and Fair Trade Law was introduced in 1980, which created
a Fair Trade Commission. The purpose was "...encouraging fair and
free competition and thereby stimulating creative business activities
and protecting consumers as well as promoting a balanced development
of the national economy" (Song, 1990, 116). Promotion of small and
medium enterprises (SMEs) was high on the agenda. In 1982, the Small
and Medium Industry Promotion Act was enacted, which created a
fund to build industrial complexes for small enterprises and to furnish
managing and technical skills for them. In 1986, the Small and Medium
Industry Startup Promotion Act was introduced to help entrepreneurs
start SMEs through tax incentives and financial support.
Despite this general thrust towards neutrality, the government
continued to play an active role in several areas of policy. Intervention
since 1979 has focused on the restructuring of distressed industries,
support for the development of technology, and the promotion of
competition. Restructuring operations became frequent in the wake of
sharp reversals in world markets and the overambitious investment
programs of the 1970s. The firms and industries involved were large
and highly leveraged, with their loans representing a significant share
of commercial bank assets. These factors, coupled with the relative
thinness of Korean capital markets, drew the government deeply into
the restructuring process. The plans it helped orchestrate involved
mergers, capacity reduction and special financial rescheduling with
commercial banks. Although the government was no longer involved in
picking winners, it did occasionally block industrial entry (such as
when Samsung wanted to enter the automobile market), possibly for
strategic economic reasons.
Export expansion remained the corner stone of growth policy. With
slow growth, mounting foreign debt and high inflation, to speed up
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export-led growth became more urgent. As a result, export promotion
was given the highest priority again. This was done through intensive
promotion of export goods and market diversification, reform of the
export support system, lowering of tariff rates to expand importation of
goods used in manufacturing, and expansion of loans associated with
the exportation of durable goods such as machinery and ships.
The decade of the 1980s was marked by spectacular economic success,
surpassing even the performance in the 1960s and 1970s. Rapid growth
was accompanied with price stability, debt reduction, improved social
justice and democracy. Macroeconomic indicators are summarised in
Table 3.10. During the fifth plan period (1982-6), growth averaged 9.8
percent, against the targeted 7.6 percent. Both investment and saving
targets were fulfilled. Though both exports and imports were below
target, the current account deficit was steadily narrowing. In 1986, a
sizeable surplus was registered, the first in the history of the Republic.
Even more remarkable was the drop in the rate of inflation. Wholesale
price inflation fell from 39 percent in 1980 and 20.4 percent in 1981 to
4.6 percent in 1982, and was below 1 percent in the following years.
Favourable global events, like the appreciation of Japanese Yen from
1985 on and falling commodity prices explain part of the success, but
policies of stabilization and liberalization must have made an important
contribution, too.
High growth was sustained during much of the sixth five-year plan
(1987-91) (Table 3.11). Average growth was is double-digits, much
higher than the 7.2 percent targeted. Both investment and saving rates
overshot their targets. Contrary to the earlier period, both exports and
imports exceeded their targets in every year, but import was growing
much faster. And the balance of payment swung from a sizeable surplus
in 1988 to a hefty deficit in 1991. Export growth also tumbled from
1989 on, due to appreciation of the Korean Won and rapidly rising
wages. Inflation shot up. The economy was entering into a more difficult
period.
The HCI sector was promoted with export in mind. The government
embarked on the project on the belief that the comparative advantage of
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Account: s4054273
Table 3.10: Targets and Performance of the Fifth Five-Year Plan (1982-8
Indicator
Current account (bn $)
Exports (bn $)
Imports (bn $)
average
8
32
27
4
1982
8
31
24
7
-5
24
-29
Targets
1983
8
31
26
5
-4
31
34
1984
8
31
27
4
-4
37
40
1985
8
32
28
3
-4
44
47
1986
8
"33
30
3
-4
53
56
average
10
30
37
3
11
4
1982
7
30
22
7
-3
21
1
24
-3
Perfo
1983
13
30
26
4
-2
23
11
25
6
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Account: s4054273
Table 3.11: Targets and Performance of the Sixth Five-Year Plan (198
Targets
Indicator
Current account (bn $)
Exports (bn $)
Imports (bn $)
average
7
31
32
-2
1987
8
30
31
-1
2
36
33
1988
8
31
32
-1
3
40
36
1989
7
31
32
-2
3
44
40
1990
1
31
33
-2
4
49
45
1991
1
31
33
-2
4
54
50
average
10
35
36
-2
16
21
1987
13
30
36
-7
10
46
36
39
30
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South Korea 139
Table 3.12: Korea Trade by Principal Commodities (US$bn)
Total mechandise exports
% agriculture-intensive
% labour-intensive
% capital-intensive
% minerals-intensive
Agriculture
% merchandise exports
% annual growth
Manufactures
clothing
telecommunications equipment
road motor vehicles
electrical machinery
footwear
woven textiles, non-cotton
sound recorders
office machines
toys, sporting goods
ships and boats
travel goods
domestic electric equipment
iron, steel, plate, sheet
rubber articles
textile yarn and thread
machines, non-electric
others
Total
% merchandise exports
% annual growth
Mining and other
% exports
% annual growth
HCI sector (industries in italics)
Total
% manufacturing exports
% total exports
1980
17445
11.4
43.9
41.3
3.4
8.8
2.4
2854
942
118
151
873
1004
215
86
326
135
262
63
555
496
623
121
6861
15685
89.9
17.9
1.3
44.3
2294
14.4
13.1
7955
30283
5.3
50.1
40
4.5
4.9
2.9
4291
1572
646
1370
1543
1326
706
582
662
5040
470
311
529
470
600
264
7287
27669
91.4
3.6
3.8
11.4
11685
40.6
38.6
1990
60420
5.4
38.6
53.4
2.5
5.1
3.3
7994
4616
2178
6104
4164
3813
2795
2658
154
2801
1097
839
1613
961
867
1230
11373
56257
93.1
4.4
1.8
8.8
24243
42.3
40.1
1991
71672
5.4
36.9
53.2
3.4
4.5
4.0
7507
4663
2593
7387
3679
4733
3002
2855
1093
4129
1036
1029
1714
989
971
1398
17822
66600
92.9
18.4
2.6
71.7
28815
42.1
40.2
1992
76394
5.4
33.6
57.4
3.6
4.2
0.4
6857
4756
3172
8579
3034
5362
2884
3047
923
4113
895
1096
2079
1142
1042
1738
10247
70966
92.9
6.6
2.9
18.2
31398
42.9
41.1
1993
81937
5.3
29.9
61.2
3.6
3.8
2.4
6172
5100
4941
9941
2128
6062
3125
3414
710
4061
796
1217
2269
1240
944
2064
22187
76371
93.2
7.6
3.0
9.6
35859
45.5
43.8
1994
95440
5.6
27.3
63.8
3.3
3.8
16.8
5689
5977
5857
15272
1557
7380
3456
3498
657
4945
706
1486
2142
1345
1055
2698
25432
89154
93.4
16.7
2.8
7.8
44311
48.3
46.4
Source: Economic Statistics Yearbook, The Bank of Korea
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Korea was shifting away from labour-intensive to capital-intensive
industries. The capacity envisaged for these industries far exceeded
domestic demand. The competitiveness of these industries in overseas
markets and their contribution to the outstanding success of the 1980s
is thus a key issue consideration in assessing the success of HCI drive.
The change in export composition is presented in Table 3.12. Between
1975 and 1987, export shares of chemical products, electrical machinery
and transport equipment increased most rapidly. They were among
the six industries promoted in the HCI drive. If manufacturing exports
are dichotomized into light industry and heavy industry, then the
share of heavy industry increased steadily from 14.2 percent in 1971 to
41.5 percent in 1980, and 60.4 percent in 1992. From mid-1980s on,
manufactured exports shifted decisively to skill-intensive goods such as
computers, semi-conductors, colour television sets, and automobiles. By
and large, the planned schedule was met: HCI exports reached world
class scale in the mid-1980s, and successfully entered Western markets
by late 1980s. Most heavy industries were operating at full capacity
from 1986 on.
III. Working of the Outward-, Industry- and
Growth-Oriented Growth Strategy
1. Growth Strategy: An Overview
The outstanding economic growth of Korea over the past three decades
documented earlier has come out from a single development strategy:
promotion of merchandise exports. When labour was abundant and wages
were low, they rapidly built up their export-oriented light industry. When
it was perceived that they were losing their competitiveness to newly
industrializing economies with even lower wages, they moved into heavy
and chemical industries in the early 1970s. Many of these industries
became competitive in world market after mid-1980s. By this time they
began to channel their efforts to upgrade their technology for the
production and development of sophisticated high-tech products. Once
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South Korea 141
again, impressive success was achieved. In 1995, Korea became the fifth
largest producer of automobiles, the second largest shipbuilder in the
world and the leading producer of semiconductors. All these were
achieved by indigenous efforts.
This single-minded emphasis on commodity production for export
purpose is reflected in its economic structure, in comparison with other
NICs, as shown in the following table:
Table 3.13: Structural Change: Sectoral Share of GDP (%)
Agriculture Industry Services
Economy 1970 1983 1993 1970 1980 1993 1970 1980 1993
Korea 29.8 14.2 6.4 23.8 37.8 46.1 46.4 48.1 47.6
Taiwan 7.9 3.4 46.0 41.8 46.1 54.8
Hong Kong 0.9 0.2 32.0 22.6 67.2 77.2
Singapore 2.2 1.1 36.4 38.8 36.5 60.0 63.3
Source: Asian Development Outlook 1994, ADB, p. 236
In other economies, the share of industry turned downward after
1980, but it continued to rise sharply in Korea. Concomitantly, the
share of services was much smaller than the case for Taiwan (situations
in Hong Kong and Singapore are less comparable as they are urban
economies).
Public policy was at the centre of development. The government set
the targets, decided on the strategy, and controlled the allocation of
strategic inputs. It even inspired and harnessed national effort, through
campaigns and exhortation, to attain growth objectives. Private enterprises
were relied upon to do the production. But the government was the
premier entrepreneur, able, through incentives and licensing, to determine
what, when and how much to produce in milestone investment projects.
Particularly, it initiated new industries and orchestrated structural
changes. State enterprises were created when needed. The trade regime
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was schizophrenic, with a pro-export bias, as reflected in trade preferences
and an aggressive real effective exchange rate policy, combined with
import protection.
Korea is credited with excellent policy making and implementation.
Its policy effectiveness is not in dispute. But evidence is mixed as
to whether particular industrial policies were necessary or efficient.
In this section we focus on the interaction of industrial development,
industrialization, industrial policy and its implementation. Costs and
benefits in a wider context are noted.
2. Sources of Technology
Technological advancement of the Korean industry went through three
phases: duplicative imitations in the 1960s and 1970s, creative imitations
from 1980s on and innovations since 1990. This evolution paralleled
the three key sequences in the flow of technology from advanced indus-
trialized economies to catching-up countries, namely, transfer of foreign
technology, diffusion of imported technology, and indigenous R&D
to improve foreign technology and to generate its own technology.
(Kim L., 1997, 23)
The government played an active role in technology development
from the very beginning. There was a Bureau of Technologies under the
Economic Planning Board. In 1967 it was upgraded into a Ministry of
Science and Technology (MOST), the first country to have a full-fledged
Ministry of this kind.
Foreign technology is transferred through three main channels: foreign
licenses (FLs), foreign direct investment (FDI) and the purchase of
turnkey plants and machinery. Korea's policies on foreign licenses was
quite restrictive in the 1960s, restricting the kinds of licenses and the
terms of payments to licensers. Policies were progressively relaxed from
the 1970s on to attract sophisticated technologies. Royalty payments
began to soar. (See Table 3.14.)
Policies on FDI followed a somewhat different course. There was
little restriction in the 1960s, but few foreign investments were made
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South Korea 143
Table 3.14: Foreign Technology Transfer to Korea, 1962-93 (mn dollars)
Foreign Licensing
Foreign Direct Investment
Capital-Goods Imp.
1962-66
0.8
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316
1967-71
16
219
2541
1977-81
451
721
27978
1987-91
4539
3636
120952
1992-93
1797
1939
67152
Source: Kim, L. 1997 Imitation to Innovation, p. 40-1
due to political instability and the uncertain economic outlook. In the
1970s, foreign direct investment was placed under tight control. As a
result, the relative size of FDI was much smaller than that of Singapore,
Taiwan and Hong Kong. Again, policy restriction on FDI was gradually
relaxed from the mid-1980s. But FDI in manufacturing has declined
steadily in recent years due to rising wages. More importantly, technology
was imported through the procurement of turnkey plants and capital
goods. Such imports were favoured by tariff exemptions, overvaluation of
the local currency, and the financing of purchases by suppliers' credit.
For example, chemical, cement, steel and paper industries established
in the 1960s and early 1970s were all started on imported plants and
capital goods. We can see from the table below that capital goods imports
far surpassed other means of technological transfers in value terms.
Korea relied heavily on Japan and United States for technology.
During the first two decades of industrialization, they accounted for 80
percent of FDI and 70 percent of FLs and capital imports. Japan took a
strong lead in those years. In the 1990s, however, the U.S. share of
technology transfer increased significantly.
The effective diffusion of technology acquired abroad across firms
and industries is as important as technology import in upgrading the
overall technological level of the economy. Public diffusion agents for
such purpose were established in the 1960s, but demand for their
services were limited, as matured products were easily imitated through
reverse-engineering without the need to consult technical literature. With
the stock of technology accumulating, and products becoming more
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sophisticated in the 1970s, such efforts intensified. In the 1980s, an
intensive network of government, public and non-profit technical
support systems to promote technological diffusion within the economy,
particularly among small and median enterprises, came into being. There
were industrial technology institutes and SMI production corporations
at the national and regional level to provide technical extension services.
The Korean Academy of Industrial Technology, together with other
government R&D institutes and industry specific R&D institutes,
comprise core of an R&D network for technological diffusion. Training
programs on quality control, value engineering, physical distribution
and factory automation were provided by the Korean Productivity
Center and the Korean Standard Association. All these functions were
coordinated by the Industrial Advancement Administration. In addition,
an on-line network for scientific and technical information dissemination
has also been introduced.
As Korean industries became progressively more technology-intensive,
the government focused more attention on indigenous R&D activities.
This was done through two major mechanisms: direct R&D investment
and indirect incentive packages. With the former, the government
developed the science and technology infrastructure and promoted R&D
at universities and government research institutes. Its indirect incentive
packages, including preferential finance and tax concessions, were aimed
at stimulating industry R&D. In early 1980s, preferential R&D loans
became the most important means for financing private R&D activities.
Public financing, mostly loans, accounted for 64 percent of the nation's
total R&D expenditure in manufacturing in 1987. The cost advantage of
such loans was, however, relatively modest. There are five categories of
tax incentives for corporate R&D: tax advantage for corporate R&D
investment, reduced tariffs on import of R&D equipment and supplies,
tax deduction of noncapital R&D expenditures and human resource
development costs, and exemption from real estate tax on R&D related
properties.
There has been a sharp increase in R&D investment in the past
decades, both absolutely and in relation to national income. The trend
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South Korea 145
and distribution of research and development expenditures are presented
in Table 3.15. R&D increased its share of GNP from 0.32% to 2.61%
in 1971-1994, surpassing that of the United Kingdom. Korea's R&D
growth rate is the highest in the world. For instance, the highest average
annual growth rate of a nation's R&D investment per GNP in 1981
1991 was that of Korea at 24.4%, compared with 22.3% in Singapore and
15.8% in Taiwan.
Of interest is the structural change in R&D investment displayed in
Table 3.15. Until 1980, the government played a major role in R&D
activities. Then, responding to incentives and increasing competition in
the international market, the number of corporate R&D laboratories shot
up from 12 in 1975 to 2,272 in 1995, reflecting the seriousness with
which Korean firms were pursuing high-technology development. R&D
Table 3.15: Research and Development Expenditure, 1965-93 (in billions of won)
R&D expenditures
Government
Private Sector
Government (% total)
R&D/GNP
Manufacturing Sector
R&D expenditure
% of sales
Number of researchers (total)
Government/Public institution
Universities
Private Sector
R&D expenditure/Researcher (xlOOO)
Researcher/10,000 population
Number of corporate R&D centers
1975
43
30
12
71
0.32
17
0.4
10275
3086
4534
2655
4152
2.9
12
1980
283
180
103
64
0.77
76
0.5
18434
4598
8695
5141
15325
4.8
54
1985
1237
307
930
25
1.58
689
1.5
41473
7542
14935
18996
27853
10.1
183
1990
3350
651
2699
19
1.95
2135
2.0
70503
10434
21332
38737
47514
16.4
966
1994
7895
1257
6635
16
2.61
4851
2.6
117446
15465
42700
59281
67220
26.4
1980
Source: 1994 Report on the Survey of Research and Development in Science and Technology,
Ministry of Science and Technology (Korea), December 1994
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spending in manufacturing sector has outstripped sales. The machinery
and electronics industry spent more than 4 percent of sales on R&D
since the mid-1980s. Consequently, the private sector had assumed an
increasingly larger role in the country's R&D efforts, accounting for
84 percent of such expenditure in 1994.
These efforts produced a rapid rise in patent registrations, a sure
sign that the country is able to develop its own technology. The number
of Korean patents have risen significantly in the past two decades
compared to the previous two, increasing a mere 48% in 1965-1978
but almost tripling in 1979-1989 and almost tripling again in 1989-
1993. This reflects the expanding importance of intellectual property
rights in the face of declining reverse-engineering. Furthermore, the
Korean share of local patent registration also swelled from 11.4% in
1980 to 39.7% in 1993, indicating increasing R&D activities. Korea
was fifth in the world in 1993 in the number of industrial property
applications, following Japan, the United States, China and Germany. For
industrial property applications by local residents per population, Korea
ranked second after Japan.
Patents registered in the U.S. are often used as a surrogate measure
of international competitiveness. The number of U.S. patents held by
Koreans is far below that of the Taiwanese, let alone those of advanced
countries. The cumulative number of U.S. patents granted to Koreans
between 1969 and 1992 is only 1751, compared with 4978 to Taiwanese.
But Korea jumped from thirty-fifth in rank among the thirty-six countries
listed in a National Technical Information Service report, with five
patents in 1969, to eleventh, with 538 patents, in 1992, for an average
annual growth rate of 43.32%, the highest among the countries in the
report. This indicates once again that Korea has been gaining rapidly in
international technological competitiveness. The number of Korean
scientific publications cited by the Science Citation Index increased
slowly from 27 in 1973 to 171 in 1980, but rapidly to 1227 in 1988 and
3910 in 1994, climbing from thirty-seventh in the world in 1988 to
twenty-fourth in 1994. Korea achieved the highest annual growth rate
(28.97%) in 1973-1994.
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South Korea 147
All these represented the output of a rapidly expanding workforce of
R&D personnel. The number of R&D scientists and engineers rose more
than fivefold, from 18434 to 98764, between 1980 and 1993. The annual
growth rate of 14 percent was again the highest in the world.
3. The Sources of Manpower
Emphasis on education and respect for scholarship is a hallmark of
Korean culture. With an acute lack of natural resources, Korea must
develop its abundant human resources to sustain economic growth.
Korea started its expansion of education right from the beginning.
The budget share on education rose from 2.5 percent in 1951 to more
than 17 percent by 1996, and peaked at 23 percent in early the 1980s.
Yet, government disbursement accounted for only one-third of total
expenditure on education. As a result, enrollment rate at various levels
of schooling rose rapidly, as shown in Table 3.16. What distinguished
Korea among development countries was a well-balanced expansion of
all levels of education at an early stage of development to support
subsequent industrialization. Korea consistently achieved the highest level
of educational attainment among countries of comparable income.
Special emphasis was given to science and technology. A Vocational
Training Law was enacted in 1966 to complement the formal education
system. In 1974, in-plant training was made compulsory for all industrial
enterprises with 300 or more workers. The number of graduates from
vocational training centres and junior colleges was large and increased
rapidly after 1970. (Table 3.16) In 1980, 70 percent of junior college
students were enrolled in technical programs.
University enrollment also expanded rapidly, from 38400 in 1953 to
1.15 million in 1994. And the proportion of those majoring in science
and engineering also went up from 35 percent in 1965 to 44 percent in
1994. The number of scientists and engineers per 10000 population
reached 22 in 1993, the highest among developing countries and
comparable to France and the United Kingdom. In addition, overseas
training and observation were widespread. In 1993, for example, the
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59.6
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184.4
128.4
183.4
Table 3.16: Indicators of Human Resource Development in Korea
1953 I960 1970 1980 1990 1994
Illiteracy rate (%) 78 27.9 10.6 0 0 0
Enrollment as % of corresponding age group
elementary school (age 6-11)
middle school (age 12-14)
high school (age 15-17)
tertiary schools
Graduates of vocational training centres
Number of junior college graduates
Number of university graduates (1000)
Number of graduates from tertiary schools
(per 10000 population) 6.6 11.4 27.7 59.4 69.5
Source: Kim, Limit (1997) Imitation to Innovation, p. 61
31,076 Koreans studying in American universities ranked fifth after
China, Japan, Taiwan and India, and it was second only to Taiwan only
in term of population ratio.
But there are problems behind these figures of impressive progress.
According to Kim, there has been an underinvestment at all levels
of education since 1970, as the government was preoccupied with
maximizing short-term production and exports. The result was that:
"Progress has been very impressive in terms of quantity but
dreadful in terms of quality. ... The problems of underinvestment
in education is most critical in higher education. ...
Consequently, all universities have remained primarily
undergraduate-teaching-oriented rather than research-oriented
institutions." (1997, 64, 65)
The short supply of highly trained human resources has become a
major bottleneck in Korea's innovation drive.
Kim's observation seems to be consistent with a recent assessment
by the World Competition Report on human capital of countries in the
Region. Some of the findings are presented in Table 3.17. Korea excelled
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Table 3.17: Manpower, R&D in Selected Countries
US Japan Australia HK Korea Singapore
% 20-24-year old in tertiary education
Public spending on education,
US$ per capita in 1992
R&D personnel per 1000 in the labour
force in 1993
Ranking among 48 Asian nations:
on adequate supply of engineers
on science and technology
R&D expenditure as % of
GNP (GDP*)
76
172
>.6*
31
1113
14.3
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2
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Source: World Competitiveness Report 1995
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on quantitative terms: the highest enrollment rate in tertiary education,
surpassing Japan and Australia, the number of R&D personnel per 1000
labour force was second only to Japan. But public spending on education
was quite low. Most significant, its ranking in science and technology
and in supply adequacy of engineers was far behind that of Taiwan and
Singapore, but on a par with Hong Kong, which did not boast any
science and technology policy.
An effective way to remedy the shortage is by overseas recruitment,
particularly among the large number of Korean scientists and engineers
working and teaching in the United States. The government initiated
this move a long time ago. In the early stage of Korean development, it
suffered from a severe shortage of researchers with doctoral or master's
degrees. In order to address this problem, the Korean government built
up KAIS (Korea Advanced Institute of Science) in 1971, a research-
oriented graduate school to produce high quality scientists and engineers.
KAIS offered salaries four times greater than those of other Korean
universities to attract top-quality faculty members from overseas. Students
were offered generous scholarship and exemption from obligatory military
services. The institution was immediately successful in recruiting faculty
members as well as top graduate students. From 1975 to 1993, KAIST
(KAIS was renamed KAIST in 1981) produced 7,577 M.Sc and 1,693
Ph.Ds. In 1986, another educational institution called KIT (Korea Institute
Of Technology) was established. This is an undergraduate school for
those with scientific and technological talent. In 1990 the two institutes
were merged to form the Korea Advanced Institute of Science and
Technology (KAIST).
A large number of Korean students studied overseas, mostly in the
United States and Japan. In early years, most of them chose to remain
overseas after graduating.
33
This resulted in a serious brain drain problem.
33
In 1967, 97% of Korean scientists and 88% of Korean engineers educated abroad
remained overseas compared with world figures of 35% and 30% for all countries (Kim,
1997, p. 66).
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South Korea 151
KIST started an attempt to draw back Korean scientists and engineers
employed overseas the so-called "reverse brain drain". The reverse
brain drain was successful, and its impact on the national R&D systems
was enormous in several ways. First, the recruiting team, supported
by Battelle Memorial Institute, sent recruiting letters to around 800
institutions in the world and received around 500 applications. Almost
all Korean scientists and engineers abroad were informed, and KIST had
the opportunity to select the most appropriate researchers. Second, since
all the key members were hired from abroad, there was no damage to
existing institutions. Instead, since a large part of the initial members
moved to academic circles later after having had research experience in
Korea, education institutions benefited from these talented new professors.
The program also set a model for the private sector, which assertively
recruited high-calibre scientists and engineers in the 1980s and 1990s to
expedite their advance into state-of-the-art technologies. In 1992 alone,
427 were lured from abroad, many from leading high-tech corporations
in the U.S. The best among them joined the leading chaebols.
4. The Role of Foreign Investment
To developing economies, foreign direct investment brings in much-
needed capital, know-how, as well as access to the international market.
As such, it is ardently courted by most governments. Korea was an
important exception. There was little restriction in the 1960s, only
because few investors came knocking at the door. In the 1970s, FDI
was tightly controlled. Only 44 percent of three-digit industrial subsectors
were open to foreign direct investment. In addition, Korea was
considered to be the most unattractive country in which to invest due to
extremely cumbersome bureaucratic red tape. (Seong, 56)
34
Generally,
34
Language barriers could have been another deterrent, in a recent visit to Seoul, I
experienced much frustration due to the low English proficiency of the local people.
Personnel in banks and in bookstores selling English books could not handle simple
English. The situation could only be worse in early years. C
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foreign investors were barred from investing in import-substitution sectors
such as pharmaceuticals and heavy industry. During 1965-85, FDI
amounted to much less than one percent of GNP, and below 5 percent
of total capital inflow. While it depended heavily on foreign loans,
Korea has entertained almost no foreign direct investment outside the
labour-intensive sectors. (Amsden, 89, p. 9)
As a result, FDI had a minimal effect on the Korean economy.
Its contribution to GDP growth in 1972-80, for example, was only
1.3 percent. The restrictive policy was designed to preserve Korea's
management independent from foreign multinationals, particularly the
Japanese. Korean firms were forced to acquire and assimilate foreign
technology primarily through imitative reverse engineering of imported
foreign goods.
Over the 1980s and 1990s the government gradually relaxed the
controls of foreign direct investment. Restrictions on repatriation of
capital and foreign ownership ratio was abolished in 1984. The proportion
of three-digit industrial subsectors open to foreign investors increased
from 44% in 1970s to 66% in 1984 and 91% in 1994. In 1995, the
government introduced an automatic approval system, expanded tax and
other incentives for investments in strategic high technology sectors,
and created a "one-stop" service centre. The primary objective was to
acquire more sophisticated foreign technologies to sustain its international
competitiveness in high value-added industries. The outcome was not
very successful. New FDI in manufacturing has declined steadily since
1991. Most foreign investment in recent years went to service sectors.
With cheap labour costs a thing of the past, foreign companies are not
willing to collaborate with Korean companies in technology-intensive
production. (Kim, 1997, p. 44)
5. Planning for Growth
Korea was a highly regulated society with an authoritative and inter-
ventionist government. For much of the period under consideration, the
government could be characterized as a military dictatorship. It was
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South Korea 153
only in 1993 that a civilian politician was elected president. In economic
affairs in particular, market mechanism played second fiddle to planners
and regulators.
5.1. Organization of Economic Planning
The first five-year plan started in 1962. A New Economy Five-Year
Plan, which displaced the 7th plan (1992-6), is now in progress. Even
before that, the government was engaged in various economic plans
and policies. As soon as Park Chung Hee took power he created the
Economic Planning Board (EPB) in July 1962 by combining the Bureau
of the Budget in the Ministry of Finance, the Bureau of Statistics in the
Ministry of Home Affairs and the planning functions of the Ministry of
Reconstruction. It has since played a central role in economic planning,
national budgeting, foreign capital management and statistics. In 1963,
the minister of EPB was designated deputy prime minister and authorized
to control, coordinate and adjudicate among other ministries on economic
matters. Also in 1961, an Office of Planning and Coordination was
established under the prime minister to evaluate and monitor project
and program performance. Planning and management units were set up
under the vice minister in every ministry to superintend and monitor
tasks.
Besides the economic planning organizations, many specialized policy
research institutes were sponsored by the government to strengthen public
policy planning by various ministries. The better known ones are the
Korean Development Institute (KDI) under the EPB, the Korea Institute
for Industrial Economics and Technology (KIET), the Korea Research
Institute for Human Settlement (KRIHS) and the Korea Education
Development Institute (KEDI). In the field of science and technology,
many other research institutes were fully sponsored by the government.
In addition, specific administrative apparatus were often established
to take charge of particular programs. In 1973, a Heavy and Chemical
Industry Planning Council was established by the President for the
planning and implementation of the HCI drive, resulting in a dual
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structure in economic planning. To promote industrial technology, a host
of institutes, corporations and centres were created, under the umbrella
of the Industrial Advancement Administration, to import, diffuse or
generate technology.
5.2. Planning Procedure
For a five-year development plan, the EPB first prepares preliminary
guidelines on policy targets and directions, together with macroeconomic
projections. Economists from government-sponsored research institutes
are widely consulted at this stage. Individual ministries then formulate
their own sectoral plans in accordance with the guidelines, with inputs
from a large number of working committees associating with government
ministries, industrial organizations, financial institutions, universities and
research institutes. The preliminary guidelines and individual sectoral
plans will then be consolidated into a draft plan and will be presented
at a series of public policy forums. Experts and representatives from
business organizations, labour unions, and consumer groups are invited
to make their comments. A consolidated plan will then be formulated,
to be reviewed first by the Plan Working Committee, consisting of vice
ministers of economic affairs, and then by the Plan Deliberation Com-
mittee which comprises the prime minister and other cabinet members.
Eventually, the plan will be presented to the President for approval.
To implement mid-term plans, government used the annual rolling
Economic Management Plan to translate its policy targets and strategies
into specific, annual action programs, and to make policy adjustments in
response to unforeseen changes in domestic and international economic
environment. The Economic Management Plan was also intended to
review and evaluate performance in the preceding year and to provide
guidelines for the government's annual budget.
5.3. Scope of Industrial Policy
The development of export-led manufacturing industry was to be the
engine of economic growth. Industrial policy can be considered the
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South Korea 155
centrepiece of these plans, with other segments playing a supplementary
role. Until 1992, industrial policy was not confined to indicating the
direction of growth and providing incentives. It was involved directly in
deciding what industry to expand or to initiate, the scale of the project,
the timing and speed of investment, even deciding the number of entrants
and choosing when to launch the enterprise. Most new manufacturing
branches were initiated by the government. They included the early
import-substitution projects in cement, fertilizers, oil refining and
synthetic fibres. The state also took the driver's seat in the transformation
from light to heavy industry, like steel mills in early 1960s, shipyards
in later 1960s, and heavy machinery and chemicals in the late 1970s.
In recent years, the government continued to play a key role in the
development of the electronics industry, as will be detailed in the case
study to follow. After deciding what to produce, how much, and who
will do it, it is only natural for the government to arrange all necessary
inputs for these projects. In this way, the state is largely taking over the
entrepreneurial role of industrial diversification the selection, planning
and resources mobilization involved in the penetration of new industries.
Such involvement placed the government in the position of an implicit
risk partner, and to assume financial responsibility for business failures.
6. Government Incentives and Industrial Development
6.1. Taxes, Foreign Exchange and Loans
Targeted HCI industries were favoured with a host of incentives. Most
overt were various tax concessions, like tax holidays, special investment
tax credits and accelerated depreciation of fixed capital. At the same
time other business faced higher taxes due to the withdrawal of several
kinds of subsidies to exporters. The result was that the effective tax
rates on the marginal return of capital for 1975-80 averaged 17 percent
for industries favoured by HCI policy, compared with 50 percent for
other industries (Yoo, 90, 34-5). Higher tariffs sheltered HCI products
from foreign competition. Trade policy became more restrictive, reversing
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the liberalizing trend since the middle of the 1960s. As a result, effective
protection rates became widely dispersed by the 1980s among various
industries. Another important instrument was the exchange rate policy.
The nominal exchange rate was held constant during 1974-1979 in the
face of rampant inflation at home. The result was an over-valued currency.
Access to foreign exchange granted to targeted industries then represented
a significant subsidy. But the most powerful tool was the allocation of
investment funds. Targeted industries received loans from the National
Investment Fund and from commercial banks, which were owned and
controlled by the government. The real interest rates charged on such
loans were often negative due to high inflation. On top of that, heavy
and chemical industries also paid preferentially low interest rates.
Between 1973 and 1977, the share of credit allocated to the six priority
sectors virtually doubled from one third to about 60 percent. They also
faced much lower borrowing costs. At the same time, investment in
light manufacturing plummeted.
Private firms in Korea contributed very little of their own capital to
most investment projects. Internal financing in 1963-1973 accounted for
only 20 percent of total financing, much lower than the case in Japan
and the United States (Amsden, 85). They borrowed as much as they
could from the banks, often in excess of the amount needed to finance
planned investment, so as to take advantage of interest subsidies. The
excess borrowing frequently found its way into land speculation. As
banks were owned and controlled by the state, such heavy borrowing
put businessmen under tight government control, making credit allocation
an effective key instrument.
6.2. Price Control and Labour Policy
The government also maintained tight control of wage rates, and through
its industrial estates development policy, also controlled land prices and
user fees for electricity, water, transport, communications and other
services. The result was lower cost and less uncertainty for favoured
industries. Of particular interest was its effort to maintain industrial peace.
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South Korea 157
Through the late 1980s, the government pursued a consistent policy of
repressing labour movements. Though the ban on unions was lifted in
early 1960s, the restrictive legal framework made it virtually impossible
to organize independent unions. National security consideration vis-a-
vis North Korea offered a convenient pretext to spy on and repress
labour unions through the 1970s. As a result, workers became exceedingly
docile. For example, between 1979 and 1984, only half a working day
per 100 workers per year was lost to industrial dispute, compared with
two days in Japan and fifty in the United States (Kim, L. 1997, p. 33).
6.3. Impact on Industrial Development
To assess the impact of the HCI drive on the evolution of manufac-turing
industries, Yoo (1990) divided manufacturing industries into two groups:
the seven industries favoured by the HCI policy, namely, industrial
chemicals, iron and steel, non-ferrous metal, metal products, non-
electrical machinery, electrical machinery, and transport equipment and
17 other industries. The two groups are referred to, respectively as HC
group and light industry group. As the HCI drive lasted from 1972 to
1979, development from 1966 to 1985 will be considered.
As expected, growth of the HC group accelerated during the era of
the HCI drive. Throughout the period, the HC group grew faster than
the light industry group in value-added and in employment. As shown
in Table 3.18, it grew twice as fast in value-added during 1970-78,
compared with a 30 percent difference in late 1960s. The same pattern
existed for employment, but to a more moderate extent. The result was
a big structural change. In 1966, light industry accounted for 70 percent
of total value-added in the manufacturing sector. It fell to 60 percent in
1975, and 49 percent in 1985. Its employment share for the 3 benchmark
years was 83, 78 and 68 percent respectively.
As credit was made more available and less costly to the HC industry,
capital accumulation is expected to be faster in these favoured industries.
This is borne out sharply by the data. From Table 3.14, we note that the
rate of capital accumulation was about the same for the two groups
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Table 3.18: Evolution of Korean Manufacturing Industries
Average annual growth of value-added
1966-70
1970-73
1970-78
1978-85
Annual employment growth
1966-70 '
1970-73
1970-78
1978-85
Annual growth in capital stock
1966-70
1970-73
1970-78
1978-85
Annual growth in capital intensity*
1966-70
1970-73
1973-75
1975-78
1978-85
All Manufacturing
21.0
20.2
18.5
7.4
8.8
9.6
10.6
1.4
11.6
21.7
18.3
9.5
2.5
11.1
2.8
5.7
7.9
Heavy &
Chemical
23.3
32.2
30.0
10.3
11.8
15.5
15.4
5.7
11.0
23.6
24.9
11.0
-0.7
7.0
11.9
7.1
5.0
Light
17.8
19.2
15.9
6.1
8.2
8.2
9.4
-0.1
11.8
20.2
15.4
8.3
3.3
11.1
-0.7
4.2
8.4
*Measured in millions of won per worker
Source: Yoo Jung-ho (1990), p. 48, 51, 54, and 57
during 1966-70. The HC group started to edge ahead during 1970-73.
It took off during 1973-78, a period when the HCI drive was in
full steam. At the same time, capital accumulation in light industry
decelerated. The working of discriminatory policy came out even more
strongly when we look at the trend of capital intensity for the two
groups of industries. Capital intensity is measured here as the capital-
labour ratio. Whereas with the three indexes of growth just considered,
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South Korea 159
the two groups followed a broadly similar trend over the two decades,
here the trend went separate ways during the period of our concern. From
the Table we see that during the second half of 1960s, capital intensity
was rising for light industry but falling for the HC group. During the
next three years, capital intensity was still increasing much faster for
light industry. Then in the next five years, following the enactment of
HCI drive, the situation reversed abruptly. Capital intensity was stagnant
for light industries, while it rose sharply for HCI. The trend diversion
between the two groups of industries during the first phase can be
ascribed to aggregation and change in external demand. This was not
the case for the 1970s, when capital intensity increased in HCI. It was
the result from price distortions imposed by HCI policy. The two industry
groups faced different wage-rental ratio. The situation reversed once
more after the termination of HCI policy in 1979, capital intensity again
rose faster for light industries.
6.4. Price Distortion and Capital Efficiency
Industry policy related to the HCI drive worked mainly through the
allocation of capital. There was little intervention in the issue of labour
supply. If we assume that wage rates are competitively determined,
then the existence and effect of factor market distortion can be clearly
ascertained. In the period 1973-75, capital intensity was falling in light
industries, but rising sharply for the HC industry. The immediate cause
was a sharp rise in light industry employment. Hence, the wage-rental
ratio must have been falling for this industry group. Falling wage rate
could have brought this about. Actually, wages were rising sharply. The
rental rate must have been rising still faster for the light industry group,
depressing the wage-rental ratio. By the same token, sharply rising
capital intensity for the HC group reflects rising wage-rental ratio.
Assuming that wage rate was rising at the same pace for this group, the
increase in its capital cost must have been lower. In short, for the period
under consideration, light industries were confronted with a higher and
more rapidly rising capital cost.
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With factor price distortions, economic analysis predicts that resource
allocation will not be efficient. In particular, the marginal return to a
unit of resource (capital in this case) will not be equal in different uses.
To check this out, Yoo made a comprehensive study on capital efficiency
for various industry groups over the years 1966 to 1986. He calculated the
return to capital as the value-added minus the compensation for labour,
and capital efficiency as the return to a unit of capital. His results show
that, before 1980, capital efficiency was higher for light industry than
for heavy and chemical industries. The difference was more pronounced
when valued at international prices. He argued that the efficiency gap
in the second half of the 1960s was a transitory phenomenon related to
the surge of light industry exports. Adjustment was in progress for the
capital efficiency of the HC group to catch up. But the process was
upset by the HCI policy, and the efficiency gap persisted in the latter
half of the 1970s.
Under the assumption that production functions of manufacturing
industries were linear homogenous, and that compensation labour was
equal to its marginal value product per unit of capital. It follows that
"marginal product of capital was lower in the heavy and chemical
industries that were favoured by the HCI policy than the light industries
during the 1970s." (p. 83). There was an overinvestment in HC
industries in the 1970s.
7. Formulation and Implementation of Plans and Policies
Economic decision-making was very much a top-down process, parti-
cularly in the 1960s when many government offices were headed by
retired generals. It was a nation-wide apparatus headed by the President.
In the drawing up of five-year plans, for example, policy proposals
prepared by a ministry were seldom available to the public for discussion
and did not represent public opinion. They were processed secretly among
a small group of elite officials. Emergency policy proposals, in particular,
tended to be prepared quickly by a small group of confidents. Observers
likened this decision-making process to a "General Head-Quarters" style,
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South Korea 161
in which the President himself made all the major decisions and
settled policy disputes among his senior officials. This concentration of
decision-making power allowed the government bureaucracy to make
speedy decisions and policy adjustments.
It was said that President Park despised or ignored politicians,
so they had little influence under his regime. Instead, he relied on a
handful of capable technocrats and bureaucrats to manage the economy
(Song, 1995, p. 141). The capability, integrity and dedication of this
group were crucial. For effective policy implementation, a competent
and strong civil service was also necessary. The condition was largely
fulfilled. From early 1960s on, civil servants were recruited through open
competitive examinations. It is a two-tier system similar to that used
in Japan. Those who pass the high civil service examination will start
at a higher level and enjoy better prospects for advancement. Competition
for passing this examination has been intense. Between 1963 and 1985,
2600 succeeded, representing 1.7 percent of those who attempted.
This rigorous selection process has earned high regard from the public
for senior civil servants. This respect also reflects the long Confucian
tradition of honouring scholar-bureaucrats. The same tradition also
instills into civil service a sense of mission and loyalty to the state and
to their superiors. Promotions are based on evaluations of performance.
All civil servants are given job security.
Korean civil servants are not well rewarded financially. Until recently,
they earned only 50-60 percent of what their civilian counterparts could
get. But they have job security and pensions, which is rare in Korea.
The strongest incentive for higher level civil servants is the social respect,
which increases with their rank and stays with them after they have left
office. Then there is the prospect of special recognition in the form of
citation, honour and personal appreciation by the heads of state. In the
Confucian tradition, this honour is regarded as something shared by the
entire family or clan. By the same token, dismissal from a government
post for wrongdoing will be considered a social disgrace. Thanks to
such Confucian values, the civil service in Korea is well staffed with
able and dedicated personnel.
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Korea's development-oriented state was at the wheel of its indus-
trialization drive, at least for the 1960s and 1970s. Private firms,
particularly chaebols, served as engines. A chaebol is a business group
of varied corporate enterprises operating in diversified areas, and typically
owned and managed by one or two related family groups. They were
intentionally created by the government to marshall the scale economies
inherent in mature technologies, to compete in export markets, and to
engage in technological learning. It is also easier for the state to direct
and control a small number of large enterprises which have long-term
association with the government. The rise of this relationship was
somewhat theatrical. Some Korean businessmen managed to become
rich during the period of reconstruction following the Korean war.
Under the reign of an interventive and venal regime, it was inevitable
that many of them made their fortunes through illegal means, like bribery.
There was widespread popular prejudice against them. Shortly after
coming to power, President Park arrested a large number of them on the
charge of alleged accumulation of wealth through illegal means. But he
soon realized that he would need a large business class to perform
entrepreneurial functions to fulfil his development goals. And business
entrepreneurs were in short supply in those days.
35
The government
therefore exempted most of them from criminal prosecution. Instead
of going to jail, they were to invest in new industrial firms in basic
industries. They were supposed to donate the shares representing their
assessed obligation (for illicit wealth accumulation) to the state. But
this condition was rarely fulfilled. (Amsden, 1989, p. 72) Thus an
alliance was formed between business and the government that laid the
basis for subsequent industrialization, an alliance in which business
clearly played a subordinate role.
From that day on, the survival and prosperity of Korean enterprises
were largely in the hands of government officials. All commercial banks
35
Due to Confucian influence, merchants and businessmen were placed near the
bottom of the social hierarchy. This tradition survived the period of Japanese occupation
(1910-45).
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South Korea 163
were nationalized, so the government controlled the access and costs of
credits. It also rationed and guaranteed foreign loans, granted access to
imported raw materials, intermediate inputs and capital goods. Tariffs and
licensing protected their markets from foreign and domestic competition.
Fortunate for Korean growth, this support was granted, by and large, on
grounds of good performance. Poorly managed firms were penalised.
The government refused to bail out bankrupt firms in otherwise healthy
industries. Instead, it appointed better managed chaebols to take over
them. Good performers were rewarded with further licenses to expand,
or were invited to venture into new lines of promoted activities. In this
way, well-managed firms were guaranteed growth and diversification.
In addition, firms that had been around for a longer time and had
built up a good working relationship with the government had an edge
over their rivals. More diversified firms are also better positioned to
withstand cyclical and demand shocks. The result is that there is a
higher concentration of large firms in Korea than any other developing
countries. In 1993, 6 chaebols ranked among the top 100 global industrial
enterprises, compared with one each for Taiwan and Mexico. Internally,
the ten largest chaebols accounted for 48% of GNP in 1980. By 1977,
93 percent of all commodities were produced under monopoly, duopoly
or oligopoly conditions, with the top three accounting for more than 60
percent of the market.
The government exercised effective discipline over the chaebols, to
secure their cooperation and to avoid any abuse of power. These
companies were highly geared. In 1993, they depended on commercial
banks and Korea Development Bank for 90 percent of their facility
investment funds. (Hyung-koo Lee, 126) The government had complete
control over these credits. There were scores of laws and regulations to
be used for administrative control. A particularly handy and effective
"stick" was the discretionary use of tax audits. To curb monopoly power,
market-dominating enterprises were subject to yearly negotiated price
controls. At the end of 1986, 110 major commodities were under price
control. (Amsden, 1989, p. 17) Finally, the remittance of liquid capital
overseas was tightly controlled. In all, policy makers and bureaucrats
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could count on the support and cooperation of businessmen to carry
out their policy. As one observer put it: "In relation to the government,
virtually all businessmen are highly cooperative, sometimes even
subservient." (Kim and Leipziger, p. 35)
This strategy of forced growth imposed heavy costs, both tangible and
intangible, on the general public. Important economic costs were high
inflation, widespread price distortions, high costs or unavailability of
many foreign goods. The poor, in particular, were disadvantaged by
inflation, negative interest rates on savings, wage suppression and an
inadequate supply of social services. Also, Korean workers are noted
for their long work weeks. In all, the rise in general living standards
probably lagged considerably behind the rapid GDP growth achieved.
Finally, entry restriction and domination of chaebols meant that most
people could not start their own enterprises. It is remarkable that until
recent years, dissent was minimal. The underlying national identity and
social consensus was an important ingredient to the Korean success.
IV. Appraisal
The industrial policy of selective intervention which underlined Korea's
development strategy will be evaluated at two levels. First, we assess
its overall impact on the general efficiency and competitiveness of
the Korean manufacturing industry. We shall also speculate on the
hypothetical question of whether some of the promoted industries would
not have come into being in the absence of government initiation and
assistance. Secondly, its broader impact on fiscal, political, social, as
well as economic spheres will be considered.
1. Industrial Development and Performance
1.1. Evaluation of some Key Industries
Four major heavy industries were reviewed by Stern, Kim, Perkins and
Yoo (1995). They are aluminum, shipbuilding, automobiles and steel
industries. (Case studies for the last three industries are in the Appendix.)
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South Korea 165
Aluminum
The Korea Aluminum Company was started in 1969 as an import
substitution project. It was not a commercial success throughout its
history. The production scale was well below 100 000-ton level considered
necessary to achieve reasonable economy of scale. The smelting
technology it used was outmoded. Lack of raw materials and high energy
costs added to its woes. Domestic price of aluminum was one-third
higher than the world price. Due to a lack of technology, it turned out
only low-end, unsophisticated products. The government ceased to
subsidize the Company in 1989, and it went out of business.
Shipbuilding
The industry had an early start in 1960s, with the enactment of the
Shipbuilding Industry Encouragement Act of 1962. It expanded rapidly
in the 1970s. By 1979, Korea established itself as the second-largest
shipbuilding nation in terms of orders, and seventh in terms of tonnage
constructed. It became the fifth largest in 1996. But it was not successful
financially, and rarely turned in any profits. It suffered from excessive
expansion. Shipyards worked far below capacity throughout much of
the 1970s and 1980s. The situation deteriorated further after the mid-
1980s, when the industry was plagued by rising wages and labour disputes
at home, and change in the demand pattern for ships abroad. From 1985
to 1988, the four largest shipyards lost 765 billion Won ($US1 was
worth about 859 Won). Shipbuilders are debt ridden from past expansions
and losses. Despite its size, the industry still depends on Japan for
technology and intermediate goods. This notwithstanding, the industry
is usually held up as the pride of Korea's industrial might.
Automobiles
The industry was judged to be a mixed success. Like shipbuilding,
it was promoted by the government well before the HCI drive, in the
mid-1960s. Progress was made by stages: from the assembly of parts in
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the 1960s, through gradually increasing domestic contents, to rolling out
the first Korean car in 1974. Throughout, the number of producers was
restricted to four. Export to Europe started in 1982, and to the
U.S. in 1985. Korea remains the only developing country to have
achieved international status as an exporter of domestically built cars.
In 1996, Daewoo Motors started building cars in Poland to sell in
Eastern Europe.
The most important factor contributing to the success of the Korean
auto industry was the Voluntary Export Restraints imposed by the
United States on the sales of Japanese cars, which made room for
Korean cars in the low end, subcompact market. The depreciation of
the Won in early 1980s, and sharp appreciation of the Yen after 1985
also yielded a great competitive advantage to Korean car makers. In
view of this fortuitous circumstances, the industry is judged to be a
mixed success.
Steel
This industry is an unqualified success. The Pohang Iron and Steel
Company Ltd. (POSCO) was established in 1968. Construction of
facilities commenced in April 1970 and was completed in record time.
Blessed with superb planning and management, rapid development of
downstream industries due to the HCI drive and a high level of
construction activities, the firm continued to expand rapidly, and became
a showcase of financial and technologies success. For six consecutive
years from 1982, Pohang Steel Works had the lowest unit production
costs for steel worldwide. Cost of hot-rolled steel in 1987, for example,
was 80% of U.S. and 60% of Japanese costs.
There is overwhelming evidence that Korea managed to create a
successful, competitive steel industry out of nothing, and that the creation
involved a very rapid expansion of capacity and output. More impressive
yet, all this took place at a time when the steel industry in the rest of
the world was in depression. It is without doubt, one of the more
remarkable achievements of Korea in its industrialization drive.
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South Korea 167
1.2. Impact on Export Competitiveness
Discriminatory policy may be expected to have differential impact on
the competitiveness of the two groups of industries in the world market.
The changes in marker shares of Korean exports from 1970 to 1985 are
summarized in Table 3.19. The market share of HCI products increased
consistently and sharply, a 10-fold increase between 1970 and 1978, and
doubling again by 1983. By contrast, the share of light industry products
increased sharply until mid-1970s, then stagnated and fell between 1978
and 1980. As light industry products accounted for roughly 70 percent
of Korea's exports, the country's share of world exports fell during these
years. To see if this decline was caused by a shift in world demand, the
performance of six other countries with similar manufacturing exports
Table 3.19: Korea' s and Its Competitors' Market Shares in World Exports
Korea's Heavy and Korea's "Light" Korea's Share in Competitors'Share
Chemical Products Products World Exports in World Exports
1970
1973
1975
1978
1980
1983
1986
[1]
0.07
0.33
0.33
0.7
0.8
1.6
[21
1.5
3.52
4.13
5.92
5.27
6.23
[3]
0.315
0.669
0.745
1.206
1.121
1.637
1.856
[percent]
3.682
4.327
3.935
4.658
5.183
5.776
6.611
[1]: Included in "Heavy and Chemical" products are (2 or 3-digit SITC codes in parentheses):
chemical elements and compounds (51), petroleum products (332), iron and steel (67),
non-ferrous metals (68), non-electric machinery (71), electric machinery (72), transport
equipment (73).
[2]: Included in "Light" products are: rubber products (62), plywood (631), textiles (65),
travel goods (83), clothing (84), footwear (85), miscellaneous mfr. (89)
[3]: The sum of all countries' exports, excluding the exports of OPEC
Source: Yoo Jung-ho (1990), p. 90, 92
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is also shown in the Table
36
. Their combined share of world exports
continued to increase rapidly during 1978-80. The falling share of
Korean exports reflected therefore a deterioration of its competitiveness.
Yoo ascribes this to the discrimination of the HCI policy against light
industries. But it is more than a little unfair to assess on basis of a short
downturn. During the next three years, for example, Korea's export share
shot up to 46 percent, compared with a 15 percent gain for the other six
competitors. More appropriately, we can compare the gain in export
share between 1975-76, when the HCI policy began to show its impact,
and 1985-86, the last years of data in Table 3.19 (we use a two-year
average to iron out cyclical influence). Korea's share in world exports
rose by 112 percent, compared with 57 percent for its competitors. Thus,
contrary to Yoo's interpretation, over the decade following the adoption
of the HCI drive, Korea gained in export competitiveness, as measured
by market share.
But the question remains: How would the HC group have performed
in the absence of HCI policy? It is not possible to give a definitive
answer to this counterfactual question. To shed light on this issue, Yoo
compares export performance between Korea and Taiwan. He notes
that Taiwan's export mix was very similar to Korea's. They are also
comparable in population density, factor endowment, cultural background
and the stage of development. The one important difference was that
Taiwan did not employ an industrial policy similar to Korea's HCI policy.
Yoo argues that, in the absence of HCI policy, the export competitiveness
of these industries would be similar to their counterparts in Taiwan.
With all those supports and subsidies from HCI policy, one would expect
a substantially faster rise in export competitiveness of Korea's heavy
and chemical industries. Using market shares in OECD imports as an
index of competitiveness, Yoo finds that the growth in market share of
all heavy and chemical products over 1974-1987 was essentially the
same for Korea and Taiwan. Among subgroups, Korea made more
The countries were Hong Kong, Israel, Portugal, Spain, Taiwan, and Yugoslavia.
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South Korea 169
progress with chemical and basic metal, but lagged behind in electric and
other machinery. Yoo concluded,
"... the HCI policy had a net negative effect on the export
competitiveness of the manufacturing sector as a whole, since
the light industry group's competitiveness suffered while there
were either no effects or negative effects on the heavy and
chemical industry group's competitiveness." (1990, p. 101)
1.3. Impact on Industrial Structure
An important issue is how many of the HCI projects would have
been undertaken in the absence of government subsidy. Aside from the
obvious negative connotation of inefficient and unprofitable projects
being bankrolled by public funds, there is also a positive side. Some
projects may yield unattractive private return but confer important
external benefits, so that they can be justified on basis of social rate of
return. Secondly, some projects may not be profitable at their inception.
But their prospects or potentials are such that, with subsequent changes
in demand, input and output prices, they become successful. Empirically,
this calls for project- or firm-specific approach. Some initial attempts
were made by Stern et al. using a cost-benefit analysis.
The cost-benefit calculations were done using both base-year prices
(the price estimates when the projects was undertaken) and current prices
(later-year prices), at a point after the project was completed and in
production. By traditional economic theory, if the economic rate of
return on a project exceeds the opportunity cost of capital, the project
is worth implementing and is in line with the economy's long run
comparative advantage. If, for a variety of reasons, the financial rate of
return for this project is below the market cost of capital, private agents
will not undertake the activity. In this case, government measures can
serve to bring the private returns in line with economic returns and
ensure that economically desirable activities are undertaken or that the
government can undertake the activity itself.
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The result can be summarised schematically as follows:
Base Year Prices
Current Prices
ERR>Pk
ERR<Pk
ERR>Pk
Quadrant 1:
Successful
Quadrant 4:
Successful
ERR<Pk
Quadrant 2:
Unsuccessful
Quadrant 3:
Unsuccessful
ERR=economic rate of return; Pk=opportunity cost of capital
Industries that fall into Quadrant 1 would have been selected using the
standard neoclassical selection criteria and would remain successful at
current prices, either because there has been little change in relative
prices affecting the activity or because the project is so robust that
it remains economically attractive even when prices have changed.
Quadrant 2 activities are projects that would have been selected under a
market-conforming industrial policy but are nevertheless considered
unsuccessful.
Quadrant 4 activities are of greatest interest. That are projects that
would not have been selected if the neoclassical acceptance criteria had
been applied. If they were nonetheless implemented, they may have
become economically successful for one of two reasons. The first is that
changes in input and output prices were favourable. Second, quadrant 4
projects may have become successful for reasons other than exogenous
price changes. Only such projects provide evidence for non-market-
conforming industrial targeting. Industries in Quadrant 3 are activities
that should have been rejected: They did not pass the cost-benefit test
at the time they were proposed, and nothing has changed to make them
successful.
Data to carry out the required cost-benefit analysis, using both
pre- and post-project implementation information, are difficult to obtain,
so the cost-benefit analysis was limited to six projects. Because of the
small number of projects studied and because they were selected
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South Korea 171
primarily on the basis of data availability, the projects obviously do not
represent a random sample of HCI projects promoted. The projects
included and years of initiation and completion are:
Samsung Electronic Company (1971-2)
Korea Heavy Machinery (1976-78)
Dong Yang Steel (1979-81)
Hyundai Pipe Company (1979
Korea Steel and Chemical Company (1981-83)
Boo-Koo Steel (1982-84)
The results are presented in the following diagram.
Base Year Prices
Current Prices
ERR>Pk
ERR<Pk
ERR>Pk
Quadrant 1:
Successful
Dong Yang
Steel Company
Hyundai Pipe
Samsung
Electronics
Quadrant 4:
Successful
ERR<Pk
Quadrant 2:
Unsuccessful
Korea Heavy
Machinery
Korea Steel and
Chemical
Boo-Koo Steel
Quadrant 3:
Unsuccessful
Of the six projects discussed using the cost-benefit analysis, all had
internal rates of return that exceeded the opportunity cost of capital.
But most had low, even negative, internal rates of return at market
prices. In fact, each was a legitimate candidate for government support.
It follows that none of the projects fall into quadrants 3 and 4.
A review of the ex-post rates of return leads to the conclusion that
only three projects Hyundai Pipe, Dong Yang Steel and Samsung
Electronics can be classified as successful in the sense that after
the passage of some time they exhibited internal rates of return that
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exceeded the current opportunity cost of capital.
37
However, none of the
six cases would fall into quadrant 4 projects having a low internal
rate of return at base-year economic prices and a rate of return exceeding
the opportunity cost of capital at current prices. Thus Korean planners
were not picking winners.
2. General Economic EfficiencyStatic and Dynamic
We have considered evidences of inefficient investment which can be
ascribed to distorted input prices. Soft-budget constraints also contributed
to overinvestment in favoured projects. As noted, entrepreneurs com-
mitted very little of their own money in such investments. It is
understandable that investors tend to be less cautious with other people's
money, particularly when there is an asymmetrical system of rewards
and penalties. Only overt mismanagement was penalized. When failures
were caused by changes in external demand, technology, or rising
competition (which a prudent investor should have taken into considera-
tion if he was bearing the risk) the government could be counted on to
bail them out. Similar asymmetry extended to policy makers in the
government. In Korean bureaucracy, achievement is openly recognized,
failure seldom seems to be penalized. (Kim and Leipziger, 1993, p. 320)
It is then not surprising that unsound ventures, over-expansions and
financial losses were quite common among HCI projects.
Price distortions were not confined to inputs. Controls on other prices
were extensive. The government relied heavily on price controls to
combat inflation, to countervail monopolistic power, or to hold down
cost of living. With import control, prices for all imports are distorted.
According to basic economic analysis, allocative efficiency in consump-
tion and production cannot be maintained under such extensive price
distortions.
37
The inferred economic opportunity cost of capital were: 1975-77 = 10.18%, 1978-80
= 8.1%, and 1981-83 = 9.39%.
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South Korea 173
On the macroeconomic front, condensed growth and ambitious
investment targets led to repeated bouts of high inflation, persistent
external deficits, and mounting debts. In the second half of 1970s,
inflation averaged to more than 20 percent (Table 3.1). Income policies,
price regulations and budget freezes were used to combat inflation,
causing other problems. The single-minded pursuit of export growth
created various sectoral imbalances. We noted how the HCI drive
retarded the growth of light industries. Development of the agricultural
sector was similarly neglected. The growth of labour productivity in
agriculture was much lower than that in Taiwan: 2.8% per annum
over 1952-80, compared with 4.2%. This, according to Oshima (1987,
pp. 160-1), was at the root of its macroeconomic woes. When farm
output was low, food had to be imported, and the farm sector could
save little. Both contributed to larger foreign debts. Lower farm income
means slower spread of mechanization, which tied down more labour in
agriculture. Less labour was released to the industrial sector, resulting
in labour shortage, rising labour costs and higher inflation. In 1988, for
example, agriculture accounted for 21% of total employment (Song,
1990, p. 109), compared with 4.5% for Taiwan.
The dynamic efficiency of the strategy was also called into question.
The condensed growth of Korea over 1960s to 1980s was a variant of
an extensive growth model: by using existing domestic and imported
resources and technologies. The potential for such growth was obviously
limited. To sustain vigorous growth, a country must cultivate sources of
intensive growth: those that enhance the productivity of existing resources
through indigenous innovation and reforms. But the preoccupation with
maximizing short-run growth rate that characterized the condensed
growth strategy often undermined those human and institutional factors
conducive to intensive growth. Important examples are a competitive
market system, a vigorous sector of small and medium-size enterprises
and a high quality of education.
3. Social and Welfare Consequences
The ordinary worker, who may be likened to the foot soldier of "Korea,
Inc.", paid the price for growth maximization. Korean workers had the
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longest work week: at 54.7 hours in 1994, the average manufacturing
work week was 10 percent higher than Taiwan's, 31 percent above
Japan's and 34 percent above that of the U.S. There was little improve-
ment in housing, perhaps the most important determinant of welfare for
Koreans, in view of the high value put on family life. The ratio of
housing units to total households deteriorated until 1991. In general,
international comparisons indicate that Korea lags behind Taiwan and
the industrialized countries in most aspects of welfare.
From the 1980s on, many of these ill consequences began to surface.
The public also expected more in return for their efforts. It is to the
credit of the Korean government that appropriate policy responses were
quickly implemented.
V. Present Challenges and Policy Responses
1. Rapidly Rising Wages
Wage rate increased so much more rapidly than productivity growth that
Korea is no longer a country of low labour costs.
Solutions:
(1) Control wage increases: since 1993, the government has encouraged
the Federation of Korea Trade Unions (FKTU), the only legally
established national labour union, and its management counterpart,
the Korea Employer' Federation, to set target ranges for pay
increases. The "Central Labour-Management Wage Negotiation",
which includes the government, as well as the employers, and trade
union federations, has played a limited role in the deceleration of
wages.
(2) Reduction or abolition of the minimum wage rate: In March 1997,
an amendment was made to the Labour Management Act to promote
the flexibility of the labour market and a stabilized environment for
wages, along with systems of flex time, arbitrary dismissal and no-
labour no-wage.
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South Korea 175
(3) Increase labour market flexibility: minimum wage and employment
security policies have to be reviewed in order to promote the labour
market flexibility needed to accommodate the rapid pace of structural
change in Korea.
(4) Outward processing in some developing countries: For example,
Korean firms started to invest in the Shandong and Liaoning
provinces in China which were adjacent to the Korean peninsula. In
1992-1994, Korean investment in China grew at an annual rate of
114%.
2. Labour Shortage
Korea is now facing a labour shortage problem. In a March 1995 survey,
there is a shortage of 183 000 workers, equivalent to 3.7% of the labour
force.
Solutions:
In July 1995, the government implemented the "Employment Insurance
System" (EIS), which includes employment promotion measures to
counter the shortage, as well as active labour market programs to
improve the quality of the work force.
(1) Promotion of female labour force participation: the EIS provides
subsidies to encourage employers to re-integrate their female
employees into their work force after taking child-care leave. Also,
firms which maintain day-care centers on their premises can be
subsidized. The government has also decided to make child-care
expenses deductible from income taxes and to develop training
courses for women in public vocational training centers. The Equal
Employment Act was strengthened in August 1995 to narrow the
wage differential between men and women.
(2) Increase the employment of workers above 55: Because of the
increase in life expectancy in Korea, the government adopted
the "Employment Promotion Act for the Aged" in 1991 which
recommended that older workers should account for at least
3 percent of employees at firms with more than 300 workers. The
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EIS also provides a subsidy to firms where employees over 55
account for more than 5% of the workforce.
(3) Imported labour in Korea; In 1992 and 1993, 8000 foreign workers,
primarily from other Asian countries, were allowed to enter Korea
for a short time period. In 1995, the government has approved the
import of a further 20 000 foreign workers to help ease labour
shortages.
(4) EIS also aims to improve the job placement service.
3. Labour Disputes
The decline in labour disputes since 1987 has continued, reducing the
number of working days lost due to such conflicts and the resulting
economic costs.
Solutions:
Labour law prevents the establishment of a second union within an
enterprise that is already unionized. This rule is designed to prevent
internal labour disputes. Third party intervention in labour disputes is
prohibited, thus preventing enterprise-level unions from receiving
assistance from organizations which are not officially recognized.
4. Protectionism, Increased Competition from
ASEAN Countries
Korean exporters will have trouble finding their niche in the world
market, as the newly developing nations, namely China and the ASEAN,
are all competing in price with Korea.
Solution:
Korea can invest in other developing countries to capture their low
labour costs. For example, between 1991 and 1994, Korean companies
doubled their overseas investment from US$3.4 billion to US$7.7 billion.
Outward investment totaled US$4.9 billion in 1995, a rise of 37%.
Around half of Korean investment is within East Asia. China topped the
list with US$41.2 billion or 25%.
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South Korea 177
5. Falling Prices of Yen
The Japanese yen depreciated against the US dollar by 15.2 percent
between July 1995 and April 1997, which dulled the shipment activities
of Korea whose main export items are in the semiconductor, automobile
and shipbuilding industries. Actually, a strong yen is a mixed blessing,
given that a quarter of Korea's imports come from Japan.
Solutions:
(1) Reduction of interest rates: Exchange rate pressure can be moderated
to some extent by allowing interest rates to fall if the currency
appreciates, thereby lessening the risk that the competitiveness of
Korean exports would be unduly undermined.
(2) Sporadic rounds of intervention by the central bank will stop the
currency from being pushed much higher.
6. Vicissitudes of High-Tech Industry
Korea no longer has a lower labour cost than other developing countries.
However, the technological level of Korea still cannot catch up with the
advanced countries, such as U.S.A. and Japan. This brings a problem to
Korea.
Solutions:
(1) Increase R&D development: R&D is very important for Korea to
continue its development of high-tech industry. R&D expenditure
increased from 0.8 percent of GDP in 1980 to 2.6 percent in 1994,
a figure close to the OECD average. Despite the rapid increase, the
size of Korean R&D spending remains small in absolute terms
relative to the major OECD countries. To reduce the gap, the
government plans to raise total R&D expenditure to 4 percent of
GDP by the year 2000.
(2) Attract foreign direct investment: In order to attract foreign
investment, the liberalization ratio of foreign investments was raised
from 95.1% in May 1996 to 97.4% in May 1997. For investment
in highly advanced technologies, exemption benefit for a five-year
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118

SOUTH KOREA: GOVERNMENT-LED

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