Economic Development in South Korea Assignment

Economic Development in South Korea Assignment Words: 4256

At the end of World War II, Korea was a poor former agricultural colony of Japan. But the rapid growth of Korea’s industrial economy has been remarkable. The economy of South Korea is now the third-largest in Asia and the 13th largest in the world by GDP as of 2007. To trace back the economic development of South Korea, the former president Park Chung-Hee played a pivotal role, and was credited for shifting its focus to export-oriented favoring a few large conglomerates.

Unlike his predecessors, Park showed a strong commitment to economic development, believing good economic performance as a primary means for enhancing his political legitimacy. Under the President Park Chung-Hee’s era, the government played a dominating role in a country’s economy. It was able to do so by allocating resources, fixing prices, and owning and controlling enterprises directly. The government of Republic of Korea’s role in the economic development plan was “either direclty participate or indirectly render guidance to the basic industries and other important fields. The government actively intervened in economic development, providing financial incentives, offering industry-specific information, regulating labor force as well as entry and exit of the market, and initiating almost every major investment by the private sector. South Korean economy in 1961-1979 could be defined as the capitalist world’s most tightly supervised economy, often characterized as a state-led industrialization. The essay dealt with how the President Park Chung Hee’s government played an exact role in finance, investment, regulation, and administration to carry out the economic development plan during 1961 to 1979.

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I. Financial Incentives by the Government The Korean government had been a pervasive force in every sector of the economy, pursuing the state “shall encourage the foreign trade, and shall regulate and co-ordinate it. ” In South Korea, a policy moved toward primary-export substitution. In order to encourage export of goods, the government accomplished through a reform of the structure of financial incentives. It involved lowering of tariff barriers that had protected native industries, tax holidays, exemptions, and reductions across the board for firms willing to export.

In addition, the state allowed discounts and subsidies for transportation costs and devalued the Korean won to cheapen export goods. From 1963 a trade link system was introduced and encouraged the exporters by giving them the right to use all the profits generated by exports to import more goods. As a result, there was rapid increase in exports in 1963 which triggered by this link system. When the domestic currency was overvalued, the companies imported raw materials and sold the finished products in the domestic market, rather than in overseas markets to generate profits.

The government of Korea’s exchange rate policy took an important role in sustaining growth in exports. Especially after an amendment of the Bank of Korea Act in 1962, monetary policy authority was transferred to the Ministry of Finance. Under the amended act, the Ministry of Finance gained control of foreign exchange from the central bank, and this added crucial factor to the government’s financing strategy for development project. In 1964, Korea officially moved away from a fixed exchange rate to floating exchange rate system.

Despite the changes in exchange rate system, the actual system was not much different from the fixed rate system based on the U. S. dollar with discontinuous devaluations. According to Bank of Korea’s Monthly Economic statistics, there were devaluations of the nominal exchange rate of 64% in 1964, 12% in 1971 and 1972, 19% in 1975, and 25% in 1979. The discontinuous devaluations of Korean won to U. S. dollar had helped to remain the real exchange rate unchanged.

It was important to maintain the constancy of the real exchange rate, because the real exchange rate indicated the prices of foreign goods relative to Korean goods in the world market. So it had a significant impact on the determination of the amount of Korean exports. As a result of the fixed real exchange rate, it prevented Korean exported goods becoming more expensive relative to competing goods in the world market. The devaluations of Korean won ultimately stimulated exports further. II. Information Services: Quasi-government organizations

As a major financial control strategy, the President Park established the Economic Planning Board (EPB) in July 1961. The decision-making in the government became decentralized through granting extensive autonomy to the quasi-government organizations including the Economic Planning Board. The EPB committee was consisted of several policymaking functions of different ministries. The EPB took over the entire budgetary function from the Ministry of Finance, as well as the collection and evaluation of national statistics from the Ministry of International Affairs.

The duties included deciding which industries and firms to promote, supervising both the development and the implementation of planning of each ministry’s activities. The EPB was in charge of formulating and monitoring implementations and budget of Five Year economic development plans. Detailed information was reported to the President at the monthly economic briefings. Consequently the EPB became more influential in economic planning decisions, and their growth greatly strengthened the power of Ministry of Commerce and Industry.

As one of the export promotion strategy, the government created the Korea Trade Promotion Corporation (KOTRA) in order to provide institutional support in foreign marketing. KOTRA as one of the “quasi-governmental organizations”, it was founded in 1962 and was an important instrument in the early development of exports. They provided expert information on the potential markets for existing products while closely in touch with embassy and consular officials. At the same time, they advised domestic manufactures on products which could be developed.

Often they even provided training for salesmen, instructing them how to present samples, giving advice on foreign import laws and assisting with legal and financial aspects of trade. KOTRA’s another important duty was monitoring all tariff and non-tariff barriers on goods from Korea on a monthly basis and guiding the relevant business of their character. If any goods may soon become subject to trade barriers then the organization informed an early-warning system on those goods.

The wealth of information and ideas on policy often originated with KOTRA and were channeled to Ministry of Commerce and Industry. In case when Ministry of Commerce and Industry wishes to modify trade policy, KOTRA examines the policy and advises the impact of proposed policies on the overseas. III. Government Regulations The Korean government’s role in promoting economic growth was not confined to economic planning or to the control of financial institutions. The Republic of Korea was poor and resource-deficient country, but their major comparative advantage was low-wage labor of relatively high quality.

So the government realized the importance of maintaining competitive labor costs, and it was able to control and discipline the industrial labor force through various restrictions. Another reason the government took a harsh measure on labors was to promote a favorable investment climate for foreign capital while enhancing business confidence for domestic capital. As Kuznets argues, “because Korea regime has been authoritarian, it could hold down wages and consumption, largely ignore rural interests, and concentrate on rapid development through industrialization. For example, at POSCO, largest steel producing company in Korea, the normal workweek is seven 8 hour days and workers are allowed to only one day off per month. Due to the success of export-oriented and labor-intensive industrialization, it has further depended on sustaining low wage and unfavorable working conditions. The effective economic deployment of labor was done by a combination of corporate control of labor union activities with the government repression. After 1971 presidential elections, Park established emergency rule under which he could declare any strike illegal.

Then in 1972 a new “revitalizing constitution” claimed total prohibition of strikes altogether in the state sector, public enterprises, local government, and foreign-invested sector. If any business division is presumed to be important to the national economy, then any strikes were banned and labor unrest had been severely punished. That same year, there was an amendment to labor legislation about collective bargaining could not proceed without prior labor committee certification as to its legality. Due to the repressive controls, the workers’ working environment was poor, such as there were no minimum-wage standards in Korea.

In terms of collective bargaining power, unions were weak and existed as no more than an arm of the government. All the unions were company or state-managed in good corporate fashion. Initially, the government deregistered all existing unions and arrested many union activists. As a result of Park’s repressive measure on labor union, only 850,000 were registered as members of a union out of estimated eight million industrialized work force in Korea, This means a unionization rate was only 10. 6% in Korea, compared with Japan’s 30. 8%, the United State’s 23. %, Germany’s 41. 5%, and Great Britain’s 59. 4%. After he dissolved all existing trade union, he formed a new national trade union, Federation of Korean trade Unions (FKTU). The FKTU was strictly supervised by the government and was forced to take a moderate stance. Until the mid-1970s, the functions of the national industrial unions were mainly to moderate union demands, implement government policy, and discipline workers. By tightly controlling labors, the government was able to fulfill the objective which was to minimize the growth of any base for political opposition.

Furthermore, there were other factors that helped the Park regime to suppress the labor cost in Korea. One was the direct grain aid from the United States. Although the official direct aid from the United Stated ended in the mid 1960s, grain and other supports continued to flow to Korea. Korea alone received $8 billion worth of U. S. food shipments during the period of 1952 to 1974. This surplus American grain had been keeping price of grain low which was essential in maintaining wages low. Moreover, there was high population growth and the absence of opportunities for emigration.

The other factor was the President Park’s the national security argument that the government continued to feel threatened by possible invasion from North Korea. So the leaders made an argument that they needed to watch over the labor unions closely in order to assure that there was no dissident labor groups making secret liaison with the North. From 1961 to 1979, the Park regime depended on a marriage of cheap, disciplined labor force. They have been successful in exploitation of this important economic resource for national development.

Korean managers also enjoyed the luxury of having low paid workers of high quality willing to work long hours, without serious labor protest. The other area that the government heavily regulated was in determining who enters certain sectors of the economy. In fact, the Park regime had been lenient on regulating anti-trust and unfair business practices up until the early 1980s when a new Law of Monopoly Regulation and Fair Trade was formulated. In many sectors of industry, private firms had to get approval from the state to begin a new business.

This new barriers of entry was usually done by domestic firms through business licensing and capital controls and restricted entry of multi-national corporations by limiting on foreign direct investments. This had greatly reduced competition in domestic market and protected many big conglomerates, known as Chaebols. There were a few cases that the government even forced some companies out of certain business segments such as in the machinery and automotive industries in 1979. Many big-sized corporations exercised monopolistic activities such as cartels, collusion, and price setting.

Despite the decreasing tendency in recent years, the Korean government owned a significant portion of enterprises. It was reported that 75 public companies that were wholly owned or partly owned by the state accounted for 4. 1% of the nation’s GDP in 1972. The major biggest corporations were Pohang Steel corp. , Korea electric Power corp. , and Korea telecommunications Authority. By allowing monopoly rights for certain firms and industries, the government had acted as a strong supporter for selected business mainly exporting companies.

Exercising entry and exit regulations had been one of the most powerful tools that the government could use in influencing private businesses. IV. Investment Incentives by the Government One characteristic that distinguished the economic development of Korea to the other forms of market economy was the resource-allocation process. The government of Korea had been deeply involved in the resource-allocation process, and the economic development plans served as a mean for the government to be engaged in this procedure.

Eventually the state controlled directly a significant amount of investment funds under the national budget, and initiated almost every major investment by the private sector. The government was able to direct the flow of investment through its control of the commercial and development bank credits and determining its interest rates. Moreover, Korean government had access to use of foreign loans, and had the power to screen and monitor the activities of multi-national corporations and other foreign investors. Particularly, the government exercised discretionary lending to large-scale enterprises, known as

Chaebols, to allocate underpriced credit. Given Korea’s narrow domestic market and poor resource endowment, the government decided to support large industrial firms, Chaebols, to promote export-led growth. Especially, the President Park’s implementation of Heavy and Chemical Industry Plan (HCIP) went hand in hand with the Chaebol groups. The relationship between the Korean state and large conglomerate’s were often portrayed as a marriage of convenience, a so-called “partial mutuality. ” By 1979 the largest five Chaebol, Hyundai, Samsung, Daewoo, Hanjin and Lucky Goldstar, accounted for 17. percent of the total value added in the manufacturing sector. The HCIP policy was launched in 1972 for an outward-looking industrialization. The Park government chose these Chaebols to embrace HCIP because widely diversified and large business groups were in a better position to undertake risky projects. Also Chaebol groups could take advantage of synergies and economies of scale to achieve rapid economic growth . Finally, a small number of large firms were better able to respond to state initiative and were easier to supervise them.

These Korean business groups undertook large investment projects initiated by the government in such industries as shipbuilding, petrochemicals, steel, construction, automobile, and consumer electronics. As these industries required a large sum of investment, the government offered preferential investment support to Chaebol groups. Korea pursued debt industrial financing over equity financing as the Korean stock market was just beginning to serve as a means of raising substantial capital. Around 80 percent of assets came from loans from the banking system and other money markets such as the curb market.

The other remaining 20 percent came from equity and this was significantly low as compared to the United States where there were more than 50 percent of internal financing among firms. This brings back to the importance of the government control over the commercial banks in Korea. Excluding local banks, branches of foreign banks, life insurance companies and merchant banking organizations, every commercial bank was either partly owned by the government, or was a government agency. This was due to re-nationalizing the banks that had been privatized in the late 1950s.

According to the statistics, in 1970 the Park regime directly controlled 96. 4 percent of financial assets although the portion decreased to 84. 4 percent in 1978. Through the ownership of commercial banks, the government managed supply of bank credit. This instrument was the single most important source for the government to influence over the private sector and Chaebol’s capital accumulation. The Park government was able to set the price and quantity of bank credit and had the authority to allocate the scarce supply of funds to designated borrowers.

For example, in 1968 the government ordered 10,000 million won to be set aside for commercial loans just to promote the machinery industry. When Chaebol groups operated in heavy and chemical industries, they enjoyed preferential access to subsidized bank loans as well as the government’s own development funds. The Korean government also applied the short-term export credit system to grant further export incentives. The system allowed the automatic approval of loans by commercial banks to those with an export letter of credit. Of the loans directed toward the manufacturing sector from commercial and industrial banks, 52. % was allocated to the heavy chemical industry in 1965 and this amount increased to 54. 5% in 1970 and 56. 4% in 1975, respectively. In order to exercise the “discretional lending” towards Chaebol groups, the Korean government created General Trading Company(GTC) license which was modeled on the Japanese sogo shosha suggesting an explicit policy of promoting industrial concentration. If the firm qualified as a GTC, they received exclusive financial rights including various export incentives and lower interest rates than the ordinary loans.

Generally, the rates on the policy loans including export and equipment had been made substantially lower than rates on commercial loans. In return for offering important export promotion, the government demanded rising capital and export requirements that limited the GTC license to the largest ten to twelve Korean firms. One of the financial supports by the government included the National Investment Fund (NIF) for financing long-term investment in the heavy and chemical industries.

The National Investment Fund was managed by the state-owned banks which meant they were able to mobilize public employee pensions and a fixed portion of all bank deposits, and channeled them into designated projects and sectors. The NIF also offered radically lower interest rate on loans as compared to other financial institutions. In 1974, the NIF interest was set at 9% when the prevailing three-year interest rate on bank loans was 15. 5%. Therefore, the NIF provided loans to handful Chaebol groups at a notably negative rate.

Several foreign governments repeatedly advised the Korean government to let interest rates and competition among independent financial institutions to determine the allocation of credit. However, the government consistently kept loan interest rates below equilibrium levels and intervened pervasively in allocation decisions. British merchant banker Alan Plumb said, “[i]t made credit decisions very easy. No company would come to you if it was not a good credit. There was no credit assessment … There were no corporate collapses in those days. “

Other than the bank loans, the Park government allowed two additional financial channels for Chaebol groups to borrow capital resources to achieve the ambitious economic development program. One way was to rely on foreign loans and the other way was to borrow money through informal money market or “curb market”. The Korean government knew well that Korea lacked the domestic resources to carry out the large investment projects such as Heavy and Chemical Industry policy. Unlike Latin American countries or Southeast Asian countries in the 1980s, the state decided not to depend on foreign direct investment (FDI) to build up financial capital.

Instead, the government chose to rely heavily on foreign loans. This way the state could maintain high barriers of entry and exit of multinational corporations from influencing domestic market as well. Since many domestic firms lacked the credit in the international market to raise capital on their own at that time, the Park regime decided to permit state-owned banks to guarantee private-sector foreign borrowing. All foreign loans had to be authorized by the government, and were allocated according to the policy priority of investment projects.

So the most of huge inflow of foreign commercial loans went to big companies and it greatly contributed to their accumulation of capital. Due to the government’s effort to fuel investment, there was a surge of foreign investment inflow to Korea in the second half of the 1960s. In particular, in 1968 and 1969, investment increased at an average rate of nearly 50 percent per annum and domestic credit expanded at over 60 percent. As a result, the current account deficit expanded from $191. 9 million in 1967 to $440. 3 million in 1968 and $548. 6 million in 1969.

The uncontrolled investment boom brought cash flow difficulties to a number of firms and many of them could not meet their foreign debt obligations. So many desperate corporations turned to the last available resort which was the curb market. The curb market offered high rates of interest for short-term loans; sometimes the interest rate hovered around 50% in the 1970, when the nominal interest rate on general bank loans was around 24%. Despite of the high interest rates, Chaebol groups often used this alternative source of capital in order to meet the government expectations.

There was no question that the allocation of under-priced credit and access to foreign borrowers had been by far the most important single instrument of government economic control in Korea. However, the government’s discretionary industrial policy had negative side effects. The low-cost government funds and easy bank credit made business groups to rely on debt, producing the high ratio of debt. Chaebol owners maintained their control of business with relatively small amount of capital. Often, Chaebol groups financed new ventures with cross investment or circular investment among member companies.

Cross investment was an illegal practice involving buying, purchasing, and selling products at a higher price than the market price within their business lines. This significantly weakened financial structure among large corporations. Moreover, the bias toward heavy industries limited access of small-and medium-sized firms (SMEs) from bank credit and drained investment resources from the light manufacturing sector that remained central to exports and employment. There were inefficiencies in banking sector as loans were made even when the company’s credit standing was poor.

V. Government as an Administrator The government incentive of investment was a powerful measure in terms of disciplining business corporations in Korea. Economically, the credit instruments was used to mobilize Chaebol groups to initiate the government economic development programs such as export promotion or development of machinery and petrochemical industries. On the other hand, the supply of credit was served as a political tool to maintain government control and cooperation from the business community.

Therefore, the Park government subsidized companies that adheres to national industrial policy and punished those that did not. All Chaebol corporations were well aware of the need to stay on good terms with the President Park in order to assure continuing access to credit and avoid harassment from the tax officials. For example, a firm that did not follow the government expectations might found that its tax returns are subject to careful examination, or its application for bank credit was constantly ignored, or its outstanding bank loans were not renewed.

Due to the state’s absolute control over access to investment capital, all the Chaebol groups were structurally vulnerable with very low equity and huge debt components. Most of the companies were in technical bankruptcy at any given time. Thus, the Korean firms learned that it will “get along best by going along” with the Park government. The chairman of Daewoo, one of the Chaebol groups in Korea, Kim Woo Choong said, “[t]he government tells you it’s your duty and you have to do it, even if there’s no profit. The harsh consequence by the state was demonstrated when the Yolsan conglomerate had affiliation with the Park Chung Hee’s opposition leader Kim Dae Jung in 1979. Present Park punished the firm by cutting the supply of credit and Yolsan immediately collapsed, taking several small banks with it. Another anecdote that illustrated the close relationship between the government and business could be from Hyundai and the founder Chung Ju Yung. Hyundai group had been one of the Chaebol groups in Korea and the corporation grew larger with the President Park’s economic development ambition.

When Park decided that South Korea needed a large-scale shipyard, he chose Hyundai to build it. The government was deeply involved, even ordering a specific location to build the shipyard. Hyundai constructed the world’s largest shipyard at the eastern port of Ulsan in the early 1970 with the special government loan. Chung Ju Yung was initially refused to be financed by British, Swiss, and French bankers. At the time, Hyundai had no previous experience in shipbuilding, and no Korean firm had ever built a vessel larger than 10,000 tons.

Yet Chung Ju Yung wanted a $60 million loan to build a shipyard that could produce 260. 000 ton crude oil carriers. When Chung had trouble arranging foreign loans, the President Park told him to try harder, implicitly threatening him that Hyundai would receive no more government favors and incentives if it could not deliver what the president wanted. Eventually Hyundai got its loan from the British and simultaneously received an order from a Greek ship owner. The government-directed economic development model in South Korea had brought tremendous economic progress.

The Korean economy during 1961 to 1979 was unique, especially the relationship between the government and business corporations. The state contained relative autonomy and it was able to define developmental goals and the power to build the social coalitions to support the planned industries. The trade between the member companies of Chaebol groups could be defined as non-market trade. In 1975, each of the top four Chaebols had between 29 to 36 member companies, and they partly existed to allow member companies to have cross investments. The price of trade had no necessary relation to the market prices for the goods.

In fact, the member companies were not trading at arm’s length, which meant the trade was not governed by the price mechanism. As a result, it created inefficiencies and inherent flaws in the model, and is no longer suited to Korea as an advanced economy in globalized market. South Korea needs a new paradigm that would help to achieve the next phase of dynamic growth, the second economic miracle. This would require establishing the laws, institutions, and financial markets that would promote efficiencies and market discipline on corporations.

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