The Republic of Korea, Generally Known As South Korea, Has Shown One of the Most Impressive

13South Korea

INTRODUCTION

The Republic of Korea, generally known as South Korea, has shown one of the most impressive records of economic growth over the past 35 years. In 1961 the economy was largely agrarian (65 percent of the workforce was in agriculture), the state was weak, labor unrest was frequent, and industrial growth was slow. In that year, a group of army ofﬁcers seized control of the country, initiating a series of events that resulted ultimately in the elevation of General Park Chung Hee to the presidency. Park ruled as an authoritarian dictator for the next 25 years, during which Korea was transformed from an agrarian state to a modern industrial society.

Korean development has strong parallels to that of Japan, including the dominance of large diversiﬁed industrial groups (in Japan prewar zaibatsu and postwar keiretsu, in Koreachaebol, or jaebul), the powerful role of the bureaucracy, the rapid import and implementation of foreign technology, the low levels of direct foreign investment, and the export-orientation of growth. Nevertheless, it would be an oversimpliﬁcation to consider Korea merely a new application of the “Japanese model.” Korea offers lessons in its own right, not the least in how it will resolve the economic and political difﬁculties pressing on it in the early 21st century.

HISTORICAL BACKGROUND

The Colonial Legacy

For about 600 years (between the 13th and 19th centuries), Korea was ruled as a feudal state by the Yi dynasty. Power was held by an elite (the yangban) composed of the monarchy, the landowners, and the scholars. The conservative interests of these groups effectively blocked economic and political reform. The vast majority of the population were peasants living in subsistence conditions. Any agricultural surplus was used either to support the consumption of the elite groups, or went as tribute to Imperial China, which maintained a sleepy suzerainty over the peninsula.

In the late 19th century, this stability was disturbed by two forces. First, rapid population growth increased the demands on the fragile agricultural resources of the mountainous Korean peninsula, leading to peasant unrest. Second, following the Meiji reformation (see chapter 10), Japan embarked on an outward-oriented policy, trying to augment its limited resource base by acquiring territory in China’s waning sphere of inﬂuence. The Treaty of Khangwa in 1876 established Japanese commerce through Korean ports, and by 1910 Japan’s military muscle allowed the establishment of formal colonial status.

There is a lively debate about the role of Japanese colonialism on Korean development. Some authorities see it as “modernizing,” because it swept away the feudal barriers to economic progress; Japanese occupation destroyed the class system, abolished slavery, broke up the great estates, and paved the way for land reform. The colonial period led to increased education for the average Korean, the transfer of managerial skills in industry and commerce to Koreans, and the creation of an urban industrial workforce.

While admitting the elimination of barriers to change, another view emphasizes the distortionary nature of Japanese colonialism and the negative effects of subsuming Korean development to Japanese needs. Certainly the Japanese occupation did not result in Korean-controlled industrialization or create a large Korean business community. The vast majority of industrial investment in Korea was Japanese. By 1938 Koreans held only 12 percent of the total capital of Korean industry, and just six Japanese zaibatsu accounted for fully 70 percent of Korean industrialcapital. During the 1920s, after a decade of intense discrimination against Koreans, the Japanese did allow the evolution of what economist Alice Amsden calls a “wafer-thin stratum” of indigenous capitalists. Among these were some of the families that would in the postwar period develop the great Korean industrial groups,1 but who in the interwar years were allowed only to serve Japanese interests. Korea produced food, raw materials, and semiﬁnished goods for Japanese industry. As war approached, the Japanese created a Korean heavy industrial base using the peninsula’s mineral wealth, which remained nevertheless completely under Japanese control. Table 13.1 shows some indices of Korean growth for the start of Japanese colonial rule until 1941.

The Postwar Period

By the end of World War II in 1945 Korea’s economy had been shattered. The industrial base built in the interwar and early war years had been stripped toward the end of the war. Moreover, Korea’s economy had been part of an integrated Japanese trading system involving close links with Japan, North Korea, and Manchukuo (the Japanese-controlled puppet state in Manchuria). As these links dissolved, the economy collapsed. Half of the manufacturing establishments operating under the Japanese closed during the immediate postwar period, and many others drastically reduced employment and production. In addition, the U.S. occupying forces dismantled and removed most of the Japanese facilities that had been producing war material. Industrial output fell by 85 percent in less than two years.2

Agriculture was little better. Neglect during the war years, a shortage of inputs, and an inadequate distribution system put Korean agriculture in difﬁculty. For several years following the war there was a general shortage of food and some localized cases of famine. The food crisis was exacerbated by the repatriation to South Korea of about two million Koreans who had been working in Japan or who had ﬂed to China to avoid Japanese occupation. On top of this, two to three million refugees had ﬂed from the communist north as the country was partitioned. Finally, the outbreak of the Korean War not only hampered economic reconstruction but also resulted in the destruction of 40 percent of industrial capacity and 20 percent of the housing stock.

Extensive U.S. aid got Korea through the 1950s. In 1960, exports amounted to only 3 percent of Korean gross domestic product (GDP), while imports amounted to about 13 percent. However, ﬁnancial inﬂows from the United States, consisting of “development aid” (in excess of $200 million annually) and substantial expenditure by the U.S. military, represented 10 percent of GDP. Like Japanese rule, U.S. presence in Korea had a modernizing function, but it was also highly distortionary, since U.S. military needs warped industrial growth and led to bias toward the service sector. Simultaneously, the generous economic development aid enriched a new entrepreneurial class, whose prosperity depended on close political links to the government and military.

Corruption was pervasive during the FirstRepublic (1948–1960) and great fortunes were amassed by a new capitalist class. The gravy train started with sales of Japanese property at below-market prices to friends of the government, and subsequently favored ﬁrms were allocated hard currency to import scarce materials—grains and fertilizers—to be resold on the domestic market at monopoly prices. Some ﬁrms were also given access to loans at subsidized interest rates, granted tax exemptions, and awarded preferential contracts for large-scale government projects.3 Despite their shady origins, these entrepreneurs had certain advantages in promoting economic development. First, they came without preconceptions; they were less conservative in style than Korea’s older textile industry chiefs and were far more growth oriented. Second, although these businessmen came from a wide range of industries, they were not wedded to any particular sector, but were business generalists, specializing in making money by whatever means. Third, steering aid in their direction gave them substantial funds for investment and solved the problem of initial capital accumulation. Finally, their corrupt past gave the Park administration a hold over them that could be used as a lever to ensure complicit behavior. These men were the founders of many of the diversiﬁed business groups, or chaebol, that remain so important in Korea today.

The Policies of Park Chung Hee

The FirstRepublic ended in 1960 with the death of Syngman Rhee, and a brief experiment with democracy ended when General Park Chung Hee led an army coup, unopposed by the United States. Two years later Park resigned from the military and was elected president of the Republic, though his close military links persisted through the 25 years of his presidency. Park was an ascetic individual who expected and demanded that all Koreans should make sacriﬁces to further his vision of the new Korea. His views were highly inﬂuenced by South Korea’s security problems and the need to develop a strong industrial base to support the military establishment. In particular, it was clear that North Korea (The People’s Republic of Korea), by pursuing a program of Stalinist industrialization, was outgrowingSouth Korea and worsening the strategic position of the south. Park’s pursuit
of industrial growth was oriented to furthering the creation of military power ratherthan toward the economic well-being of the population. In that sense, Park’s policies may be viewed as being purely mercantilist, “the pursuit of power over plenty.”

Park was able to centralize power because there was little to oppose him. Japanese colonization, World War II, and the Korean War had transformed the class structure of Korean society, leveling landlord and scholar classes. The communist threat tended to solidify society, and also silenced U.S. criticism of the regime’s excesses. Plentiful labor and high unemployment initially made the unions powerless. Park was also able to call on Korea’s heritage of Confucianism to enrich his rhetoric on the relation of the individual to the state, and by extension to his or her employer.4

In addition to these political advantages, Park had two important levers by which to control business: access to imports and access to ﬁnance. In the early 1960s Korea’s international trade was governed by a complex system of licensing and tariffs. To receive a license, a ﬁrm had to show both the absence of a domestic substitute and the necessity of the imports for the production of goods that were either to be exported or vital to the domestic economy. In addition, protective tariffs averaged over 40 percent in 1962 and a complex system of multiple exchange rates put further restraint on trade. By giving favored ﬁrms import licenses, hard currency at discounted rates, and tariff wavers, the government allowed the appropriation of economic rents by selected industrial leaders.

Park further tightened control of the economy by the nationalization of the commercial banks,5 which made about one-third of all loans in Korea and provided most industrial ﬁnance. The four specialized banks,6 which together made about 12 percent of loans, were also taken under public control. This gave the government the ability to control credit and the power to discipline any ﬁrm that displeased it by blocking any reﬁnancing of its debt.

PHASES OF KOREAN GROWTH

Export Promotion, 1961–1973

The early years of the Park regime saw a heavy emphasis on exporting. Initially
exports consisted mostly of textiles and light manufactured goods because Korea’s cheap labor gave it comparative advantage in these industries. Policy changes in 1961, including a 50 percent devaluation of the Korean currency (the won) and the elimination of multiple exchange rates, did a lot to boost exports. The government also used more direct action. Successful exporters were assured import licenses, ﬁnance for expansion, tariff relief, and direct subsidies. The government also imposed a 1 percent surcharge on imports and used the proceeds to ﬁnance specialized institutions7 to promote exports. Export targets were established for individual ﬁrms, and although there were no direct penalties for failing to achieve these goals, ﬁnance was more likely given to those who had succeeded in such competition, an early example of the “market-augmenting” competitions used by Asian economies to allocate credit.

The results of the export promotion campaign were staggeringly successful. Between 1963 and 1973, exports grew at an annual rate of 44 percent, and increased from about 1 percent of gross national product (GNP) in 1963 to over 25 percentin1973. The commodity composition of exports also changed, from a heavy concentration in textiles in the early years, to more diversiﬁed light manufacturing in the later ones. Imports increased as well, although at a slightly lower rate. Imports also rose because of the need for raw materials and capital goods. Investment rose from 11.5 percent of GNP in 1964 to 27 percent in 1969 before moderating to 23 percent in 1973 as global economic conditions worsened.

The Heavy and Chemical Industries Drive,
1973–1979

Despite the economic success of the late 1960s, the Park government decided that the future of the Korean economy lay in heavy industry and in 1973 inaugurated the Heavy and Chemical Industries Development Plan (HCI). This shift was motivated by three factors. First, the belief that military self-sufﬁciency, necessary in an era of a reduced U.S. presence, required the development of a heavy industrial base. Second, increased globalization of production and accelerating integration of Asian countries into the global economy was eroding Korea’s comparative advantage in light industry, which was based on cheap labor. Wage costs in Indonesia, the Philippines, and Malaysia were much lower than in Korea, and higher Korean wages, and living standards, could only be sustained by higher labor productivity and that required more capital-intensive industry. Third, despite rapid export growth, the Korean balance of payments remained in deﬁcit and a greater production of heavy industrial materials and chemicals would reduce import dependence. The HCI initiative was opposed by most of Korea’s economic advisors, particularly the World Bank and the United States on the grounds that it ran counter to the established pattern of comparative advantage.

Iron and steel, nonferrous metals, shipbuilding, machinery, and chemical industries were chosen as growth sectors. The HCI drive illustrates the ﬁnancial leverage wielded by the Korean government. Large ﬁrms, selected on the basis of their past performance and connections, were “invited” to expand production into speciﬁc industries. They were guaranteed generous access to ﬁnance at favorable rates from the nationalized banking sector, priority access to imports, assistance with technology and frequently direct subsidies, tax holidays, accelerated depreciation, and investment tax credits. By the end of the 1970s, the effective marginal corporate tax rate on heavy industry was 30 percent less than the comparable rate on light industry. The level of import protection in these industries also rose during this time, reversing the global trend toward freer trade.

Directed credit, however, was the most powerful tool. At the outset of the HCI drive in 1973–1974, heavy industry accounted for just one-third of total bank loans to industry; just two years later in 1975–1976, heavy industry received over 60 percent of such loans. Increased government involvement in the credit allocation process occurred at the same time. The share of “policy loans” from the commercial banks (that is, those loans made at the behest of the government) rose from less than 50 percent in 1970 to more than 60 percent in 1978.

There is still controversy about the effect of the HCI campaign. It did succeed in sustaining expansion during a period of severe global stagnation; GNP growth in the 1970s averaged 9.6 percent per year, on a pace with the 1960s. Exports, too, continued their rapid expansion at a rate of 31 percent per annum, slower than the 44 percent managed in the 1960s but still remarkable by most standards. The structure of output in Korean industry was certainly changed. In 1971 light industry represented 56 percent of the total, and heavy industry 44 percent, but by 1980 this proportion had reversed.

However, the drive also represented a distortion of the economy, and even afterallowing for all of the material incentives enjoyed by ﬁrms to induce them to enter heavy industry, there was still considerable short-term economic sacriﬁce. Amsden presents evidence that throughout the 1970s, proﬁtability remained highest in labor-intensive industry; was greater in light, rather than heavy, industry; and was higher in the older established industries as opposed to the new ones.8

The HCI drive probably went against the short-term interests of Korean industrialists, who participated because of government pressure. That in itself does not mean it was misguided, because it is possible that dynamic and short-term efﬁciency are not coincident. One way to view the HCI drive is as a massive infant-industry protection scheme in which ﬁrms were induced to follow long-term national interests by both the carrot and the stick. The result was technological inﬂow, learning-by-doing, the grasping of economies of scale, and the establishment of an entirely new basis for the Korean economy. Adherence to strictly market logic (a market-conforming approach) would not have led to the rapid development of a heavy industrial sector in Korea. The alternate market-augmenting approach forced industrialists to accept a lower rate of return on capital in the short-run, but it may well have ensured the continuation of the “miracle” into the 1990s. That said, there is also much evidence to suggest that the HCI drive was carried too far, and that the extirpation of criticism or open-thinking by the government was counterproductive.