Download The 60-year Long March of the Korean Economy

MONTHLY FOCUS NO 8 - 2008
The 60-year Long March of the Korean Economy
By JEON Young-Jae
October 2008
I. Introduction
Korea's economy has been one of history’s most remarkable performers in the world.
Once one of the poorest countries in the world, with a per capita income of only US$67
in 1953, Korea is now the world’s 13th largest economy just 60 years after the founding
of its new government and Japan’s 36-year humiliating colonization. In the 1950’s,
Korea’s income levels were lower than those in semi-developed countries in South
America (e.g. Uruguay and Argentina), and lower still than in some African countries
(e.g. Congo, Gabon, and Ghana). Korea’s economy has now surpassed all of them
through years of rapid economic growth.
.
Per Capita Income in Representative Countries (From 1954 to 2003)
(National per capita income based on the Geary Khamis dollar in 1990)
Figure 1.
US
28500
Western Europe
& North America
26000
1990 International Geary-Khamis dollars
23500
Austria
21000
Italy
18500
Ko r e a
16000
East Asia
& Af rica
13500
11000
Western Europe
& North America
US
Central & South
America
Argentina
Uruguay
8500
6000
3500
East Asia
& Africa
1000
Central & South
America
Argentina
Uruguay
Austria
Africa
Italy
Congo
Ghana
Congo
Ghana
Korea
1954
2003
Year
Note:
Angus Maddison uses Geary-Khamis dollars, a kind of the purchasing power parity
exchange rate, for comparison with other countries based on per capita income
per nation.
Source: Maddison, Angus (2003) The World Economy: Historical Statistics, Paris: OECD
Publishing.; http://www.ggdc.net/maddison/
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But, the Republic of Korea started its history divided from North Korea and went
through the Korean war, which started with aggression from North Korea. Though the
country would face unfavorable geopolitical conditions for many decades after its
founding, it prospered nonetheless. Introduction of a free market system laid the
foundation for economic growth and the timely and wise implementation of various
policies allowed for remarkable economic growth.
II. Conditions of the Korean Economy
Unfavorable Conditions Become an Opportunity
The Korean War erupted two years after the 1948 founding of the Republic of Korea.
When an armistice was declared in 1953, 1.5 million civilians had been killed, and 40 to
50% of the ROK’s infrastructure had been destroyed. After it launched its ambitious
economic development plan in early 1960s, the nation would face several crises due to
its lack of natural resources and inefficient social systems. Despite all these obstacles,
South Korea persisted in forging ahead. Its unrelenting sense of crisis, induced by
constant North Korean threats and terrorism, actually helped the country push even
harder for economic development.
During the Cold War, South Korea made extensive use of the security, capital, and
market opportunities provided by the US to develop the economy. Constant competition
against North Korea, Japan, and China also served to stimulate national cohesion and
gave the country a sense of purpose. To be specific, “Ideological competition with North
Korea,” “Catching up with Japan through imitation and learning,” and “Alertness about
the rising Chinese economy” gave further impetus to the Korean economy. This
contributed to the economy’s robust growth.
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Major Transition Points and Growth Trends in the Korean Economy
Figure 2.
(Year-on-year
Crisis of Absolute Poverty
growth, %)
First and Second Oil Shocks
Democratization and Massive
15
1973
1983
1988
Labor Disputes
10
1954
1989
5
1962
1997
0
-5
Korean War
Asian Currency Crisis
-10
1953
1956
1959
1962
1965
1968
1971
1974
1977
1980
1983
1986
1989
1992
1995
1998
2001
2004
2007
Economic System: Creating a Free Market
The government amended the Constitution in 1954 and set up a free market system in the
country. This marked a major departure from the constitution in 1948, which expanded
the scope of nationalization and restricted rights1 to private property based on the
concept of an “egalitarian economy.”
Though the free market economy was introduced somewhat reluctantly, to attain more
aid from the US, this decision would eventually lay the foundation for the nation’s
breakthrough economic development in the 1960’s. The South and the North started off
roughly equal; depending on assistance from stronger patrons and employing an import
substitution strategy. Now the contrast between the two Koreas could hardly be starker.
South Korea is now an open, market economy and North Korea is a closed socialist
economy.
Korea maintained the basic framework of a market economy as it launched a planned
initiative to develop the economy in the 1960’s. Though the Korean government at this
1
Park Myung-Lim (2008). “Constitution, Economic Reform, and Presidential Leadership: South Korea’s
‘National Founding Constitution’ (1948) and ‘Post-Korean War Constitution’ (1954) in Comparison.”
The Korean Journal of International Relations, 48(1), 429-454
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stage was deeply engaged in plotting the overall economy, it played mostly a supporting
role, serving as a partner for private companies. This stood in contrast to countries like
India and Brazil, which attempted industrialization through state-run enterprises. From
the late 1980’s Korea tried to transit towards a private sector-led economic system from
a government-led one in accordance with increasing demand for democratization.
III. Policy Choices of Korea
Five-year Economic Development Plans
To overcome its traditional “spring hunger” (i.e. the famine period before the early
summer barley harvest), to achieve political stabilization and to fortify its national
security Korea launched the first of four 5-Year Economic Development Plans. Under
the initial plan, the economic focus shifted from a “domestically-oriented economy” to
an “export-driven economy.” In the 1950’s, Korea’s economic system was domesticallyoriented because the government had focused on recovering from the war. Korea chose
exports because it lacked natural resources and had a small and underdeveloped domestic
market. To this end, Korea would leverage its ability to provide low cost labor for light
industry, before moving on to heavy industry.
Since then, the government has striven to establish various systems and improve
institutions for industrialization. Some of these efforts included establishment of the
Economic Planning Board, downward denomination of the won, (the nation’s currency),
revision of the Bank of Korea Law, establishment of special purpose banks, reform of
the foreign currency management system, and adoption of export promotion policies.
The government placed particular emphasis on expanding SOC (Social Overhead
Capital), i.e. social infrastructure which includes basic facilities like electricity and
transportation needed for export. This economic development plan would become the
core of Korea's economic development strategy: government-led export-oriented
industrialization.
This economic development plan would prove its worth decades later. In contrast to its
numerous peers, who attempted to develop their economy through import substitution.
Korea, rapidly advanced to the “take-off” stage2 in the mid-1960’s on the back of brisk
2
Rostrow divided economic growth into five stages; the traditional society, the preconditions for
take-off, the take-off, the drive to maturity, and the age of high mass-consumption. Among them, the
take-off stage is most important because the society which successfully advanced into the take-off stage
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exports. Eventually, however, a focus on quantity over quality would result in an
imbalance between export and domestic demand; between large and small companies;
between regions; and between income classes.
Fostering Heavy and Chemical Industries and Large Conglomerates
The first oil shock in the early 1970’s presented the first non-military crisis to the Korean
economy. As the global economy slowed down, industrialized countries tightened import
regulations on labor-intensive light industrial goods, and developed countries began to
catch up with Korea. Realizing that light industrial goods would not guarantee sustained
prosperity, Korea then set out to nurture the heavy and chemical industries. The Korean
government set up its Heavy & Chemical Industry Promotion Council, under the
guidance of the Minister of the Economic Planning Board. Simultaneously, the
government raised capital and resources at home and abroad, constructed industrial bases
for key strategic sectors, and built more SOC to support heavy and chemical industries.
Companies brought in production facilities and technology from far more industrialized
countries like Japan on the back of the government’s full financial support and the
country’s cheap and abundant labor supply.
Although the emphasis on heavy and chemical industries precipitated many side effects,
including overlapping investment among companies and inflation, there is no doubt that
it contributed greatly to increasing the nation’s industries and exports in both qualitative
and quantitative terms. This is exemplified by the fact that the share of heavy and
chemical industry among the nation’s manufacturing industries surged to 53.6% in 1980
from 39.2% in 1970 while the share of heavy and chemical industries in total exports
rose from 12.8% in 1970 to 41.5% in 1980. Large conglomerates started to form as big
companies tried to achieve higher growth by diversifying their businesses, advancing
into petrochemicals, steel, cement, shipbuilding, and machinery by leveraging
government’s full-blown support. In particular, any heavy and chemical industry requires
economies of scale for its growth. Government promotion of the industries thus paved
the way for the emergence of large conglomerates.
IT Industry
In 1983 Korea entered the IT industry in earnest by entering the DRAM memory chip
can make a sustainable growth without retreating to the previous stage (Rostow, W. W. (1960). The
Stages of Economic Growth : A Non-Communist Manifesto. Cambridge: Cambridge University Press).
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market. From 1998, Korea outpaced Japan, the frontrunner of the semiconductor industry
and rose to the top of the DRAM memory chip market. In addition, the launch of the
Time Division eXchange (TDX) in 1986, which was a domestically developed full
automatic telephone connection system, laid the foundation for the development of the
IT industry.
These achievements served as an opportunity to instill greater self-confidence the hearts
of Korean companies. From this time onward, Korean companies began to believe that
they too could develop high-technologies on their own and become top players even in
cutting-edge areas. Success in the DRAM industry led to a successful entry into TFTLCD area in the 1990’s. In addition, the success in TDX led to the commercialization of
CDMA3 mobile phone technology in 1996, and the launch of DMB broadcasting in
2005, and the introduction of portable internet services in 2006, all of which were first in
the world. These cutting-edge IT technologies turned Korea into a leading IT
powerhouse. With the IT industry as a new growth engine for the economy, Korea was
able to diversify its industry in the 1990’s. As the nation progressed from light industry
in the 1960’s, to heavy and chemical industries in the 1970’s, to assembly and processing
industry in the 1980’s, it added the IT industry to the list of its mainstay industries in the
1990’s. IT, which used to account for only 4.4% of real GDP in 1996 took up 16.9% of
real GDP in 2007.
Opening the Market
From the 1980’s, however, the external environment deteriorated rapidly. Leading
countries (including the US), which experienced an economic downturn in the 1980’s,
started to impose protective measures for their declining industries while demanding that
developing countries like Korea open their markets further. In the late 1980’s the
growing trade surplus with the US put further pressure on the Korean market. In the face
of mounting pressures for market opening, Korea finally adopted an open-door policy,
which liberalized the movement of imports and capital. In the beginning, market opening
was limited to goods, but opening would expand to liberalization of capital movements
from the mid 1990’s. Korea pushed for liberalization of foreign exchange and capital
transactions in earnest from 1993 in order to meet requirements to join the Organization
for Economic Cooperation and Development (OECD). Previously, this liberalization had
proceeded in a marginal manner subsequent to the Foreign Investment and Foreign
3
CDMA (Code Division Multiple Access) is a digital cellular technology using spread-spectrum
techniques.
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Capital Inducement Law revised in 1984. The Korean government enacted liberalization
of capital transactions in three steps from 1995 to 1999. After the Asian currency crisis,
Korea opened the market even further, accelerating its incorporation into the global open
market system. After the IMF bailout began in 1998, almost every sector of the Korean
economy was opened to the world, while market opening and liberalization of capital
transactions were put on par with those of leading countries.
Despite numerous trials and errors in the process of market opening, Korea's entry into
the global open market system has improved its competitiveness. During this process,
Korea was, however, destined to experience many setbacks due to its failure to control
the speed of market-opening, resulting in the currency crisis in late 1997. However,
thanks to the enhanced competitiveness it attained for the long time from the pre-crisis
era, Korea would later advance in status to become the world’s 13th largest economy.
Korea’s export-oriented strategy and its opening of the domestic market helped spur
competition between Korean and foreign companies and improved the health of the
overall economic structure. Goods and financial markets are now as open as those of
other OECD countries. Still, some areas remain that call for wider opening, particularly
areas like law, energy, and professional services.
Fortification of the Welfare System
As the economy grew, pressure increased to distribute the benefits of growth more
equally. To address these concerns, the Korean government pushed for various measures
to strengthen its welfare system from the late 1980’s. The government launched the
National Health Insurance System nationwide and gradually introduced the National
Pension System and Employment Insurance. Initially, the National Health Insurance
system, which had been applied to companies with more than 500 employees, expanded
coverage to all citizens in 1989. The National Pension System and Employment
Insurance that had been introduced first to companies over certain sizes, later expanded
to all citizens and to companies employing a single employee, respectively.
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Figure 3.
Introduction and Expansion of Major Welfare Systems
Introduction
National Pension System
Expansion
▷ 1988: Companies with more
▷ 1999: Coverage was
than ten employees
expanded to all citizens
▷ 1977: Companies with more
▷ 1989: Coverage was
than 500 employees
expanded to all citizens
▷ 1995: Companies with more
▷ 1998: Companies with more
than 30 employees
than one employee
▷ 1964: Companies with more
▷ 2000: Companies with more
than 500 employees
than one employee
Public Assistance
▷ 1961: Livelihood Security
▷ 2000: National Basic
(Secondary Social Safety Net)
System
Livelihood Security System and
▷ 1978: Medical Aid
Medical Allowance Program
National Health System
Employment Insurance
Workers’ Compensation
* People capable of working are
* People capable of working are
excluded
included
These three systems laid the basic foundation for the country’s welfare system while
trying to minimize negative externalities, namely welfare dependency. In addition to
these measures, the government established a social insurance system to protect against
social risks from unemployment, disease, industrial accidents, and aging. Also, the
government set up public assistance system to protect the existing underprivileged. The
welfare system was expanded only gradually to avoid imposing sudden burdens on the
economy, and such gradual expansion has successfully limited moral hazard to some
degree. Nevertheless, concerns remain over whether the current system will be
sustainable in the future, as the welfare system was designed without adequate
consideration of the aging of the population.
Reforms in the Financial System
The Korean economy was engulfed by the 1997 Asian currency crisis for any number of
reasons. The economy had failed to find a new growth strategy to replace governmentled growth, while market opening was haphazard and ill-prepared. Korea also failed to
carry out critical prudential supervision and well-planned foreign exchange policies.
Nevertheless, Korea was able to use the crisis as an opportunity to push for marketcentered financial reforms. Recognizing the limits of its bank-centered financial system,
Korea tried to transform its economy into an Anglo-American one centered on financial
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markets. Efforts were made to strengthen financial intermediary functions in order to
foster new growth engines and enhance competitiveness of the weak financial industry.
In July 2007 the government adopted the Capital Market Consolidation Law, and
implemented measures to develop the capital market and foster the financial industry as
a new growth engine. As a result, the size of the capital market as of March 2008 has
grown to 1.5 times of commercial banks’ assets whereas it was just half the size of
commercial banks’ assets around the time that the currency crisis erupted.
Figure 4.
Growth in the Capital Market (Ratio of Direct Finance to Indirect Finance)
Nevertheless, the current market-centered financial system is still immature in many
respects. Hedge funds and investment banks, the major players in the mature capital
market, are still either absent or only marginally present (hedge funds will likely be
introduced in late 2009). There are no domestic investment banks that can compete
against global investment banks. In addition, there exist still restrictions on the entry into
financial industry and on the development of financial products. Furthermore,
companies’ fund-raising from the capital market declined from 2001, indicating that the
financial industry is not functioning properly as a supporter for other industries.
IV. Implications and Suggestions
Today, after many trials and errors, the Korean economy is on the verge of becoming a
leading economy. However, many obstacles still need to be overcome if Korea is to
continue moving forward. The industrial strategies of the past, namely “imitation and
learning” from leading countries, will not be effective when Korea has to compete in
industries with cutting-edge technology. Imitating advanced technologies and expanding
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the quantitative scale of investments can secure growth only for a limited time. Once
semi-developed countries succeed in catching up with more- industrialized countries and
try to advance their economies to the next level, they may fall into a “non-convergence
trap,” where imitation and investment-driven growth becomes ineffective. While the
Korean economy has a strong presence in traditional manufacturing and IT, its industry
portfolio has not yet reached the level of diversification found in the leading countries.
The latter group exhibits great strength in next generation industries like finance, energy,
environmental science, and biotech, areas where Korea still lags behind. The Korean
economy should accordingly increase R&D investment and enhance efficiency rather
than simply increase labor and capital input if it hopes to make the transition to an
innovation-driven economy.
R&D intensity4 of Korean companies was rated at 3.2% as of 2005, higher than the
2.2% average of OECD countries. But due to lack of innovative materials and
ineffectiveness in the R&D process, Korean research institutions’ results lag far behind
their peers in leading countries.
In an innovation-driven economy, there is a high degree of uncertainty about investment,
thereby discouraging any indispensable investment at all. Korea will thus need to
improve efficiency in the financial sector to encourage companies to make aggressive
investments. In the public sector, the government can relax regulations, and create new
market opportunities to foster promising next generation growth engines like finance,
biotechnology, and energy. By doing so, the Korean economy, whose mainstay
industries are traditional manufacturing and IT, can gain a more diverse and less
vulnerable industrial structure. Inducement of inbound foreign investments and
encouragement of outbound foreign direct investments will also be necessary along with
market opening.
Korea will accordingly need to find new growth engines and expand social capital to
become more of a leading economy. Needless to say, Korean society urgently needs to
resolve the persistent conflicts that impede this process. Korea’s economic momentum
has been badly stalled by a lack of adequate conflict-resolution systems and a lax attitude
towards legal compliance that pervades society. Social conflicts have worsened, and now
transcend economics to embrace ideology, welfare, environment, and culture.
Unfortunately, such conflicts continue to be expressed in a manner incompatible with the
observance of the law that is a prerequisite for being an advanced economy and society.
4
R&D intensity = {(Companies' R&D Intensity) = (Companies' R&D expense)/(the value-added of the industry) x 100}
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Korea’s index for legal compliance (Index of Law and Order) was rated at 4.6 as of 2003,
ranking 21st among 30 OECD countries (the average of OECD countries was 5.0).
Korea should accordingly establish a stronger foundation to pursue the rule of the law by
providing better conflict-resolution systems. The government will also need to get
serious about enforcement, and consistently apply the full force of the law to illegal acts.
Only through such measures, can a culture of mutual trust emerge. Francis Fukuyama, a
professor at John’s Hopkins University, famously noted the importance of trust between
members of society as a core factor in ensuring their advancement; as essential as the
physical infrastructure of transportation and telecommunication lines. Expansion of such
social capital is the next-to-none measure needed to take the Korean economy forward.
At the same time, a virtuous circle needs to be created in which wealth distribution
improves as the economy grows. Social safety nets should be strengthened to prevent the
socially-marginalized from being excluded from the benefits of economic growth.
Continuous expansion of the underprivileged class will threaten social cohesion while
reliance on trickle-down effects from economic growth will unlikely stall this trend.
Accordingly, the government should reinforce the social safety net and more importantly,
help the underprivileged to stand on their own by.
As for welfare policy, this should be better designed to stem any excessive rise in
government spending by sharing the burden with the market. Also it should be designed
to raise the social mobility. For the working poor just above the lowest-income bracket,
the government should devise measures to bolster the ability to be self-sufficient. To
maximize the effects of the government’s measures the government’s efforts should be
focused on enhancement of self-sufficiency rather than simple protection from hardship.
The author is a research fellow at the Macroeconomics Department, Samsung Economic
Research Institute. Inquiries on this article should be addressed to [email protected]
Copyright 2008 Samsung Economic Research Institute. All rights reserved.
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