Survey
* Your assessment is very important for improving the workof artificial intelligence, which forms the content of this project
* Your assessment is very important for improving the workof artificial intelligence, which forms the content of this project
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/ 2 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. 3 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 4 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 5 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). 6 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. 7 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. 8 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 9 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 10 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} 11 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. 12