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The Political Economy of Development in South Korea

Permanent Link: http://ncf.sobek.ufl.edu/NCFE004100/00001

Material Information

Title: The Political Economy of Development in South Korea
Physical Description: Book
Language: English
Creator: Gordon, Geoffrey
Publisher: New College of Florida
Place of Publication: Sarasota, Fla.
Creation Date: 2009
Publication Date: 2009

Subjects

Subjects / Keywords: International Political Economy
Development Economics
Comparative Politics
Genre: bibliography   ( marcgt )
theses   ( marcgt )
government publication (state, provincial, terriorial, dependent)   ( marcgt )
born-digital   ( sobekcm )
Electronic Thesis or Dissertation

Notes

Abstract: A common explanation for South Korea's vulnerability to contagion in the East Asian Financial Crisis in 1997-98 has been the close relationship between capitalism." Since the crisis, a number of scholars have sought to revise the history of development in business elites and the government � so-called "crony South Korea, attempting to explain how corruption could exist alongside development. They attribute the success of the developmental state to systemic vulnerabilities that forced politicians to enact developmentfriendly policies, or to private initiative in the face of self-seeking behavior by politicians. This thesis reexamines both the history of the developmental state in South Korea and the conditions that made South Korea vulnerable to crisis in 1997-98. It argues that the state played a vital role in promoting development by coercing reluctant economic elites to invest in export promotion and technological upgrading. Furthermore, the conditions that made South Korea vulnerable to financial contagion were created not by crony capitalism but by financial liberalization, which allowed firms to build up unsustainable levels of debt and to over-invest in financial services and off-the-shelf technologies.
Statement of Responsibility: by Geoffrey Gordon
Thesis: Thesis (B.A.) -- New College of Florida, 2009
Electronic Access: RESTRICTED TO NCF STUDENTS, STAFF, FACULTY, AND ON-CAMPUS USE
Bibliography: Includes bibliographical references.
Source of Description: This bibliographic record is available under the Creative Commons CC0 public domain dedication. The New College of Florida, as creator of this bibliographic record, has waived all rights to it worldwide under copyright law, including all related and neighboring rights, to the extent allowed by law.
Local: Faculty Sponsor: Hicks, Barbara; Khemraj, Tarron

Record Information

Source Institution: New College of Florida
Holding Location: New College of Florida
Rights Management: Applicable rights reserved.
Classification: local - S.T. 2009 G66
System ID: NCFE004100:00001

Permanent Link: http://ncf.sobek.ufl.edu/NCFE004100/00001

Material Information

Title: The Political Economy of Development in South Korea
Physical Description: Book
Language: English
Creator: Gordon, Geoffrey
Publisher: New College of Florida
Place of Publication: Sarasota, Fla.
Creation Date: 2009
Publication Date: 2009

Subjects

Subjects / Keywords: International Political Economy
Development Economics
Comparative Politics
Genre: bibliography   ( marcgt )
theses   ( marcgt )
government publication (state, provincial, terriorial, dependent)   ( marcgt )
born-digital   ( sobekcm )
Electronic Thesis or Dissertation

Notes

Abstract: A common explanation for South Korea's vulnerability to contagion in the East Asian Financial Crisis in 1997-98 has been the close relationship between capitalism." Since the crisis, a number of scholars have sought to revise the history of development in business elites and the government � so-called "crony South Korea, attempting to explain how corruption could exist alongside development. They attribute the success of the developmental state to systemic vulnerabilities that forced politicians to enact developmentfriendly policies, or to private initiative in the face of self-seeking behavior by politicians. This thesis reexamines both the history of the developmental state in South Korea and the conditions that made South Korea vulnerable to crisis in 1997-98. It argues that the state played a vital role in promoting development by coercing reluctant economic elites to invest in export promotion and technological upgrading. Furthermore, the conditions that made South Korea vulnerable to financial contagion were created not by crony capitalism but by financial liberalization, which allowed firms to build up unsustainable levels of debt and to over-invest in financial services and off-the-shelf technologies.
Statement of Responsibility: by Geoffrey Gordon
Thesis: Thesis (B.A.) -- New College of Florida, 2009
Electronic Access: RESTRICTED TO NCF STUDENTS, STAFF, FACULTY, AND ON-CAMPUS USE
Bibliography: Includes bibliographical references.
Source of Description: This bibliographic record is available under the Creative Commons CC0 public domain dedication. The New College of Florida, as creator of this bibliographic record, has waived all rights to it worldwide under copyright law, including all related and neighboring rights, to the extent allowed by law.
Local: Faculty Sponsor: Hicks, Barbara; Khemraj, Tarron

Record Information

Source Institution: New College of Florida
Holding Location: New College of Florida
Rights Management: Applicable rights reserved.
Classification: local - S.T. 2009 G66
System ID: NCFE004100:00001


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THE POLITICAL ECONOMY OF DEVELOPMENT IN SOUTH KOREA BY GEOFFREY GORDON A Thesis Submitted to the Divisions of Political Science and Economics New College of Florida in partial fulfillment of the requirements for the degree Bachelor of Arts Under the sponsorship of Barbara Hicks and Tarron K hemraj Sarasota, Florida May, 2009

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THE POLITICAL ECONOMY OF DEVELOPMENT IN SOUTH KOREA Geoffrey Gordon New College of Florida, 2008 ABSTRACT A common explanation for South Korea's vulnerabilit y to contagion in the East Asian Financial Crisis in 1997-98 has been the close relationship between business elites and the government – so-called “cro ny capitalism.” Since the crisis, a number of scholars have sought to revise the histor y of development in South Korea, attempting to explain how corruption could exist al ongside development. They attribute the success of the developmental state to systemic vulnerabilities that forced politicians to enact development-friendly policies, or to private initiative in the face of self-seeking behavior by politicians. This thesi s re-examines both the history of the developmental state in South Korea and the conditio ns that made South Korea vulnerable to crisis in 1997-98. It argues that the state played a vital role in promoting development by coercing reluctant economic elites t o invest in export promotion and technological upgrading. Furthermore, the condition s that made South Korea vulnerable to financial contagion were created not by crony capitalism but by financial liberalization, which allowed firms to bu ild up unsustainable levels of debt and to over-invest in financial services and off-th e-shelf technologies. Barbara Hicks Tarron Khemraj Political Science Economics

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iii Table of Contents I. Introduction....................................... ...............................................1 II. Political Economy of the Developmental State....... ........................9 A. States, Markets, and Economic Development....... .....................9 B. The History of the Developmental State in South Korea..........23 III. Financial Liberalization and Financial Crisis in S outh Korea......76 A. Finance and Economic Growth..................... ............................77 B. South Korea and the Asian Financial Crisis, 1997 -98..............92 IV. Conclusion........................................ ..........................................107 Bibliography....................................... ..........................................113

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1 I. Introduction According to Hall (1997), political economy seeks t o answer three sets of questions. First, whose interests are being served by a particular set of economic arrangements, and how do these arrangements distrib ute power across groups? Second, what are the institutional arrangements tha t underpin the operation of market mechanisms? And third, how do our conceptions about how the economy works influence economic and political behavior, and wher e do these conceptions come from? Rationalistic models of political economy tha t assume self-interested maximizing behavior by politicians imply that polit icians are primarily motivated by material gain and maintaining power, not altruistic ideals about how society should be ordered. They concentrate on explaining how interes ts determine and institutions constrain political decisions while neglecting or o utright rejecting the role of ideas. Such approaches tend to privilege laissez-faire ins titutional arrangements that limit the influence of the state on the economy because t hey predict that politicians will use the state's economic power to create rents, reward cronies, and make economic decisions based on popular opinion rather than econ omic necessity (Kang 2002). Rational choice models represent the mainstream in American political economy research, reflecting the greater influence of neo-c lassical economic theory on the American school of international political economy than the more critical, multidisciplinary British school (Cohen 2008). Although early studies of South Korea's rapid econo mic development attributed the country's success to private sector initiative and government restraint, revisionist studies that came out in the 1980s and 1990s argued that South Korea

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2 challenges the very premises on which reductionist approaches to political economy are based. Whereas modernization theory and neo-cla ssical theories of economic growth assume that self-interested private entrepre neurs provide the impetus for industrialization, the revisionist wave argued that the Korean state was vital in coercing the private sector to compete for market s hare and upgrade technology (Amsden 1989, Woo-Cumings, ed. 1999). In contrast t o the predatory rent-seeking state actors anticipated by rational choice models and experienced by many developing countries, the South Korean government w as strongly developmental. Some political scientists began to search for possi ble non-material explanations for the seemingly altruistic behavior of Korean politic ians, pointing to the influence of Japanese colonialism on Korean institutions as well as shared Confucian values among Koreans and other economically successful cou ntries in the region (Kohli 1996, Huntington 1996). As Western social scientists searched for an explan ation as to why Korean politicians were seemingly less greedy than others in the developing world, the East Asian Financial Crisis of 1997-98 turned perception s about the Korean economy and political system on their heads. What had seemed to be a close-but-productive relationship between business and state turned out to be something far less sanguine in the eyes of mainstream American economists. “Ten years ago, finance experts called [close relations between firms, financial in stitutions, and the state] relationship banking, and thought it might help to minimize 'pro blems of asymmetric information and incentive incompatibility,' today we call it 'c rony capitalism.'” (Frankel 1998, 2). Influential analyses of the crisis from Western soc ial scientists blamed implicit government guarantees on bank loans linked to indus trial policy and corrupt links

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3 between chaebol (industrial conglomerates) and financial institutio ns for bad investments that caused over-capacity and over-inde btedness. While there were notable exceptions that blamed the crisis on financ ial liberalization (for example, Chang 1998), the international financial community had satisfied itself that, one way or another, bad government was to blame for the cri sis. The Washington Consensus institutions had been uneasy with the idea that pol iticians could promote industrialization, as the 1993 World Bank report on East Asian development illustrated. The general gist of the report was tha t, while the government did not get in the way of development, South Korea and the other E ast Asian tigers would have been better off had the state not intervened as muc h as it did. Thus, the 1997-98 crisis was an “I told you so” moment for mainstream econom ists. Since the crisis, another round of revisionist scho larship has emerged challenging the arguments established by the previo us revisionists, the developmental state theorists. The motivation behind many of the new works has been attempting to reconcile the pre-crisis vision of a seemingly altr uistic developmental regime with the crony capitalism narrative that became the mainstre am explanation for the 1997-98 crisis. While Kang (2002) and Doner et al (2005) acknowledge that the state played a positive role in promoting industrialization, they both argue that economic growth was largely an unintended consequence of self-seeki ng behavior by politicians. Kang (2002) argued that the image of the Korean state as an autonomous social actor was misleading. In reality, corruption was an important feature of the developmental regime even during the high-growth years, and polit ical – not economic – considerations dominated policymaking. The fact tha t Park Chung Hee, the military leader who was president during the first 19 years of the developmental regime

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4 (1961-1979), took bribes from many of the firms tha t received directed funding is enough evidence for Kang to conclude that greed rat her than idealism was driving politics. Doner et al (2005) adopt the same rational choice assumptions about the motives for political activity, but focus on the ro le of geopolitics and potential political instability in driving the state to promo te industrialization. They argue that systemic vulnerability – the confluence of geopolit ical and social factors that challenged the military regime's grip on power – fo rced inherently self-seeking politicians to adopt rational, growth-enhancing pol icies. In other words, without a hostile military on its northern border and continu ous student and worker unrest, Korean politicians would have been able to follow t heir natural inclinations to leach off of productive activity rather than promote it. Both the crony capitalism explanation of the financ ial crisis and the counterrevisionist rational choice models that followed ov erlook inconvenient facts that weaken their cases. Heterodox critiques of the main stream explanations for the financial crisis pointed out that the Korean govern ment had disassembled most of the tools of industrial policy and liberalized the fina ncial sector in the decade leading up to the crisis (Chang and Yoo 1999). The crisis had a lot more to do with perverse incentives and de-stabilizing capital inflows creat ed by the transition from the developmental regime to a neo-liberal model. Just a s neo-liberal economists and bureaucrats may have jumped to ideology-supporting conclusions in the midst of the financial crisis, the revisionist models of the dev elopmental regime overlooked important facts that undermined rationalistic hypot heses. If systemic vulnerability was sufficient to force politicians to adopt growth -enhancing policies, then the Syngman Rhee regime that preceded the Park governme nt and faced many of the

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5 same challenges should have been far less predatory Also, the governments of many other developing countries that have faced acute ge opolitical crises and domestic unrest would have industrialized by now as well, bu t instead they have been more likely to collapse under the pressure. If systemic vulnerability were necessary, then the emergence of India and China during times of re lative geopolitical and internal stability would have been impossible. While it is t rue that money was an important political lubricant during the developmental presid ency of Park Chung Hee, Kang's (2002) model fails to account for why Park was will ing to undertake policies that were unpopular with Korea's inexperienced and reluc tant entrepreneurial class during the 1960s or why, when there was a coherent state a nd disbursed business community at the beginning of his term, the state did not bec ome predatory (Amsden 1989). The money politics model fails to explain why the South Korean government would ever enforce its rules against Korean corporations, a tr ait that set it apart from other developing world governments. If incentives provided by money politics and constr aints created by systemic vulnerability are not sufficient to explain why Sou th Korea's government enacted growth-enhancing policies, what other explanations are there? And if the economic crisis was preceded by free market reforms, what ac counts for the difference between the theoretical benefits of economic regime change and the historical results? Together, these questions constitute the heart of S outh Korea's challenge to neoliberal orthodoxy. This study seeks to explain how the developmental regime emerged in South Korea, why there was a shift to a neo-libe ral model despite the apparent success of the developmental regime, and how libera lization created the conditions that led to the crisis of 1997-98. In contrast to r ational choice explanations that

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6 substitute what the author thinks motivates politic ians in the place of revealed preferences, this study seeks to take the ideas tha t prominent politicians have about the economy seriously as a factor that explains why the developmental regime was so effective, and why it met its demise. Park Chung He e was a more effective leader than his predatory predecessor Syngman Rhee in no s mall part because of their different world views stemming from their different social and educational backgrounds, which influenced their policy prioriti es in office. President Rhee did not even create an economic development bureau until hi s tenth year in office, whereas Park was the brains behind the textile export push and the heavy and chemical industrialization of the 1970s (Robinson 2007). Als o, the developmental state was made possible by the weakening of the landed aristo cracy, which allowed the military to transform the social order. Liberalization was d riven by the changing balance of power between business and the state, which coincid ed with the rising influence of American-trained economists, who were more free-mar ket friendly. The financial crisis was caused by speculative bubbles in manufac turing and risky financial services that resulted from capital account liberal ization, the emergence of a largely de-regulated secondary market for financial assets (bonds, stocks, insurance, etc.), and the declining profitability of Korean firms. South Korea's experience also provides some interes ting insights into the relationship between capitalist development and dem ocracy in the developing world. High rates of economic growth corresponded in Korea with increasing calls for democratization, culminating in the return of civil rights and presidential elections in 1986 and 1987. Interestingly, although South Korea was one of the most successful developing countries in the latter half of the 20th century, and even though it has a

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7 reputation for being relatively egalitarian, the di visions between those who benefited from industrialization and those who were exploited the most or left out completely were important driving factors behind the push for democratization. The movement for democracy in the 1980s is an example of what Po lanyi (1964 [1944]) referred to as the double movement. As the commodification of K orea's human and natural resources intensified, the movement for democracy ( which was steeped in the language of self-reliance [Lee 2007]) began as soci ety's way of protecting itself from further damage. Middle class students and white col lar workers joined in solidarity with the blue collar class in demanding civil right s and better working conditions. However, once civil rights were restored, the diver ging economic interests of the middle and working classes broke up the coalition t hat brought down the military regime. Therefore, it could be said that the downsi des of capitalist development had as much to do with democratization in South Korea a s did the good aspects of it. The movement for democracy was also a response to the a nti-democratic pressures of the Cold War international system, which at times subju gated South Korean selfdetermination to the political and economic interes ts of the United States and Japan. South Korea's experience with capitalist developmen t defies conventional wisdom and easy answers. The next two chapters will take a two-pronged approach to studying how the Korean case compares with prevaili ng theories about the roles of the state and private finance in economic developme nt. Chapter Two will begin with a review of the literature on the concept of the deve lopmental state, with an emphasis on the role of ideology in promoting economic devel opment. Then, the history of the rise and fall of the developmental regime will be e xamined. The causes of the financial crisis in Korea in 1997-98 will be examin ed in Chapter Three. The first

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8 sections will review the literature on the relation ship between finance and economic growth and evaluate the theoretical case for financ ial liberalization. The second section will examine in detail how financial libera lization contributed to the vulnerability of the Korean economy to economic cri sis. Finally, the last chapter will summarize the conclusions of the study and possible avenues for future research. Although the author is American, the preference in the following chapters for holistic, theoretically promiscuous explanation over parsimon ious, theoretically rigorous modeling is positively British.

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9 II. The Political Economy of the Developmental State Part A: States, Markets, and Economic development The question of the proper role of the state in eco nomic development is as old as the study of political economy itself. During th e last three decades or so of neoliberal hegemony in economic policymaking, the answ er one would be likely to hear would be “little or none.” While the respondent mig ht mumble something about fixing market failures or compensating globalizatio n's losers, the emphasis would be placed on the need to establish sound market instit utions and refrain from industrial policy, protectionism, and other such sins. However a look at the history of countries that are developed today reveals that the governmen t has traditionally played a much stronger role in economic development than neo-libe ralism lets on (Chang 2003). In the United States, for example, state support for i ndustrial expansion that took the forms of infant industry protection and subsidizati on of railroad construction and other key internal improvements were vital in promo ting American manufacturing. The problem is that for every success of government -led industrialization, there have been multiple cases of governments leeching off of private economic activity. In the worst cases, such as the Democratic Republic of Con go, private economic activity of any scale is smothered by predatory state activity like confiscation of property or extortion. More frequent are intermediate cases lik e Argentina, Brazil, and India during their periods of import-substitution industr ialization, where pervasive corruption and clientelism created bloated bureaucr acies and private monopolies that were horrendously inefficient.

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10 Why is it that some states are developmental, while others are predatory or intermediate? Through what mechanisms have successf ul developmental states in the past delivered economic growth? Rationalistic model s of political economy are particularly ill-suited to answer these questions b ecause their assumption of selfseeking maximizing behavior by politicians would le ad them to expect every state to be predatory, or at best intermediate. They cannot explain why some politicians pass up opportunities to distribute rents to politically -connected individuals but others do not, or why self-interest takes so many different f orms across different societies and time periods. A better analysis of developmental st ates would begin by examining how politicians and bureaucrats interact in develop mental regimes, and how that compares to intermediate and predatory regimes. Two of the distinguishing features of developmental states are the presence of an effe ctive economic bureaucracy that formulates policy prescriptions appropriate to the facts on the ground, and the willingness of politicians to enact the recommendat ions of the bureaucrats. Additionally, the structure of the international di vision of labor is important to look at because it shapes the unique economic challenges th at every country faces. Developmental regimes seek to overcome obstacles cr eated by a country's place in the global political economy such as lack of domestic t echnological capabilities, lack of foreign market access, and instability caused by fo reign financial flows. Just as importantly, the role of developmental ideologies i n encouraging reluctant entrepreneurs to take risks on capacity expansion a nd production for export must also be studied.

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11 Embedded Autonomy Bureaucracy has become a bad word in American polit ics. However, without effective bureaucracies politicians are prone to ma ke poorly informed policy decisions, and their ability to execute those polic ies are severely limited because they would lack a critical layer between governments and society. By relieving asymmetries of information between government and t he private sector, bureaucrats can send the government strong signals about approp riate policies to pursue. It gives one pause to consider what governing the American e conomy would be like without all of the data and analysis provided by the Treasu ry Department and the Federal Reserve, yet many developing countries lack even ba sic sector-level economic data (Evans 1995, 74-99). At the same time, government b ureaucracies must be distant enough from those they govern that they are actuall y willing to enforce the rules that they create. The Securities and Exchange Commission 's willingness to look the other way as banks accumulated risky assets in the U.S. w as an example of an asylum that was run by prisoners, or an embedded bureaucracy th at lacked autonomy. In order for bureaucracies to be effective at making sound devel opment policy, they must have a corps of well-trained employees and a meritocratic hiring process with opportunities for promotion based on quality of work. These quali ties foster a corporate coherence that gives the bureaucracy autonomy from the social actors they seek to govern and the politicians whom the interests can more easily influence. At the same time, in order for the bureaucracy to be legitimate, it must be “ embedded in a concrete set of social ties that binds the state and society and pr ovides institutionalized channels for the continual negotiation and re-negotiation of goa ls and policies” (Evans 1995, 12). Whereas neo-classical economics and rational choice theory view all states as

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12 fundamentally similar and self-interested, the embe dded autonomy argument is based on the premise that states “vary drastically in the ir internal structures and relations to society” (Evans 1995, 12). Evans constructs two ide al-types of states that illustrate how internal structures and state-society relations influence the preferences and actions of state actors. Predator states are charac terized by lack of bureaucracy. Ties to society are limited to ties to individual incumb ents, not connections between constituents and the state as an organization (Evan s 1995). Therefore, incumbents are able to pursue their own goals, usually related to amassing their own fortunes and those of their close connections. At the other extr eme, developmental states are characterized by embedded autonomy, allowing their bureaucracies to make longterm plans that they can expect economic actors to follow, and that benefit broader constituencies than those with individual links to the leaders. While there are examples of both ideal-typical states in the real w orld (the Democratic Republic of Congo is a good example of the predator state, whil e Japan's post-war government can be viewed as an example of a developmental stat e), most states fall somewhere in-between. Intermediate states are characterized b y some organizational characteristics of a developmental state, such as h aving a planning ministry, but also have personalistic or rentier-like characteristics as well, often pitting one institution of the state against another. Theoretical perspectives that overlook the complexity of motives behind state action oversimplify the proces ses associated with politics. Neoclassical economists, in particular, tend to the vi ew the state as a unitary actor with objectively defined interests and preferences, of w hich all actors are aware. Evans, on the other hand, views the state as a socially and h istorically constructed organization comprised of institutions with different roles, int ernal structures, and relationships to

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13 society, giving these institutions varying interest s and policy preferences. These differences across state institutions create room f or conflict and contradiction within the state itself. Another important difference between Evans' embedde d autonomy argument, as well as other institutionalists, and economistic theories of politics is the relationship between politics and economic activity Neo-classical economics and rational choice theory conceive of the market-syste m as an autonomous, naturallyforming system separable from political institution s, which are governed by marketlike motives. These theories assert the primacy of economics over politics. Evans, on the other hand, follows in the tradition of Polanyi (1964 [1944]) and others in asserting the primacy of politics over economics. W hile markets have indeed existed on varying scales over the course of history, the m arket system characterized by commodification of the world's human and natural re sources only dates back to the Industrial Revolution in England in the 19th Century (Polanyi 1964 [1944]). Actions taken by the state created economic institutions su ch as private property and the labor market and provided the legal and physical infrastr ucture necessary for competitive markets to be created. Thus, talk of how much or ho w little state intervention there should be in the economy is misleading. Strong stat es are essential prerequisites for the formation of market economies, not simply helpf ul adjuncts (Evans 1995, 29). The question, rather, is what types of state action facilitate economic growth. The conceptual supremacy of politics over economics can be taken further by understanding economic decisions of firms as politi cal decisions based on socially and politically constructed preferences and expecta tions, rather than self-interest based on objectively given preferences. The critica l difference is that economic

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14 decisions are based on what firms perceive to be in their self-interest, which is open to interpretation based not only on purely economic factors such as market structure and interest rate levels but also based on politica l factors such as ideology and relationships with other social actors. One manifestation of the primacy of politics over e conomics is the political struggle over the creation of state autonomy throug h land reform. The most underdeveloped countries tend to be dominated by fe udalistic social relations, which inhibit modernization because they remove incentive s to invest in better agricultural practices or in industrialization. In these countri es, the state depends on the rentier class for revenue and human resources, making it be holden to their interests. Political, and often military, struggle is necessary to induce fundamental change in the system of accumulation, as higher potential returns from i ndustrial activity are offset by the amount of risk involved with such drastic change. T he politics of land reform are strongly influenced by international relations, as similar struggles in neighboring countries or regions can provide the impetus for cl ass struggle, and foreign powers can tip the scales one way or another. Patterns of dependency induce international pressures that can fortify domestic power structure s, especially when the prices of staple commodities are at risk or when the multinat ional corporations that dominate the economy use political weight in their home coun tries to provoke foreign intervention. The CIA's involvement in the Guatemal an coup of 1953 on behalf of United Fruit Company is an example of the latter. I n South Korea, the land reforms during the 1940s and 1950s ended the system of labo r-repressive tenant agriculture that had created radical inequality, but reform lik ely would not have been possible without peasant mobilization demanding change or th e shift from Japanese

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15 colonization to American influence (Shin 1998). The supremacy of politics over economics also has i mportant implications for understanding the international economy. Neo-libera lism, the political philosophy based on the supremacy of economics over politics, argues that the creation of a global common market that levels the (legal) playin g field for poorer countries would be beneficial for human welfare. Yet the world's bi ggest proponents of neo-liberalism (the United States, Europe, and the international f inancial institutions they dominate) do not practice what they preach. In theory, a bila teral free trade agreement should lower all barriers to trade between two countries; in reality, “free” trade agreements include loopholes that protect and privileged acces s that promotes the comparative advantages of developed countries, while developing countries are forced to open even the markets they specialize in to competition from developed countries. Furthermore, international financial institutions f orce policies on developing countries such as fiscal austerity, privatization a nd rationalization of state enterprises, and curtailment of rights of unions to organize tha t would never be allowed in developed countries, but that reflect the ideologie s of the institutions as well as the business interests of developed countries. These po licies would never pass muster in developed countries because their voting citizens w ould perceive that such policies would be against their preferences and interests, s o their politicians, who retain discretion because of the primacy of developed coun tries over other political entities, respond by passing laws that benefit citizens, such as agricultural subsidies. Therefore, when a country liberalizes its interest rate regime, it is not “letting the market decide,” but is transferring discretion over policy to other actors, who are usually from the developed world and always have th eir own interests at heart.

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16 Thus, the global economy more closely reflects the world of classical political economist Friedrich List, who is associated with me rcantilism, than that of prominent neo-liberal commentator Thomas Friedman. Whereas Fr iedman asserts that the differences between countries are increasingly insi gnificant in the eyes of the businessman who is looking for the lowest input pri ces and highest factor productivity he can find (hence the title of a rece nt book of his, The World is Flat ), and so it is in the self-interest of nations to cat er to the needs of businessmen or else the latter will take their capital elsewhere, List argues that a conceptual framework that leaves economic policy aside from other matter s of the state, such as war or tending to the welfare of citizens, creates a “flat ,” frictionless world that, simply put, does not exist, and that countries should focus on promoting their own domestic industry (List 1997 [1885]). Even in 1885, List cou ld say that “under the existing conditions of the world, the result of general free trade would not be a universal republic, but, on the contrary, a universal subject ion of the less advanced nations to the supremacy of the predominant manufacturing, com mercial, and naval power, is a conclusion for which the reasons are very strong” ( List 1997, 51). The advantages that the most powerful states enjoy from already be ing advanced in industry and having military and economic power will allow them to dominate weaker countries in an open trading system. This conclusion led List to recommend for the backwards countries of his day what Chang (2003) and Evans (1 995) call for today: infant industry protection and constructing comparative ad vantage. “In order for the freedom of trade to operate naturally, the less adv anced nations must first be raised by artificial measures to that stage of cultivation to which the English nation has been artificially elevated” (List 1997, 54). Mercantilis t policy is not as much what should

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17 be as what must be in order for developing countries to catch up b ecause otherwise developed countries will always stand in the way. The Political Imperatives of the Developmental Stat e While the embedded autonomy argument is a good plac e to start for understanding why some states are more developmenta l than others, the narrow focus on particular bureaucracies needs to be expanded in order to fully understand the political challenges of developmental states. In ad dition to the purely economic aspects of industrial policy, successful developmen tal states must provide a “vision” for the country's future that shapes the preference s of economic actors in favor of, for example, long-term investment (over short-term rent -seeking) (Chang and Rowthorn 1995). In his comparative historical study of late industrialization in Europe in the late 19th and early 20th Centuries, Gerschenkron (1966, 24) highlighted the importance of the creation of a developmental ideol ogy for inducing investment: To break through the barriers of stagnation in a ba ckward country, to ignite the imaginations of men, and to place their energies in the service of economic development, a stronger medicine is nee ded than the promise of better allocation of resources or even o f the lower price of bread. Under such conditions even the businessman, even the classical daring and innovating entrepreneur, needs a more po werful stimulus than the prospect of high profits. What is needed t o remove the mountains of routine and prejudice is faith – faith in the words of SaintSimon, that the golden age lies not behind but ahea d of mankind. Negotiation of the vision for the future can lead t o political instability because it necessarily brings up issues related to class, ethn icity, and geography. Furthermore, because different political institutions within the state can have different ideological influences, the task of articulating a vision of th e future requires conflict and compromise within the state.

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18 Another factor to consider is the importance of civ il society in the ideational process because the organizations, institutions, an d media of civil society are responsible for communicating the vision for future development to the public and providing feedback to politicians. However, civil s ociety is not composed of passive intermediaries that simply foster communication and understanding between citizen and state; instead, civil society consists of organ izations with their own often conflicting visions for the future of society. The process of articulating a vision for the future is also influenced by international economic political, and cultural linkages, as ideas about what policies are most effective and, m oreover, normative values defining what the good life can have a powerful impact on th e preferences of economic and political actors. Whereas developmental states are able to articulate a reasonably coherent (if not without contradiction) vision for the future, less powerful intermediate states are prone to conflict between p olitical institutions (say, representative institutions and the military) and b etween polity and civil society, as in the cases of many Latin American countries in the 1 960s that faced the prospect of guerrilla warfare. Democracy's effect on developmen tal states is ambiguous because, on the one hand, it can weaken entrenched interests and let off steam associated with social discontent over the rising inequality that c omes with low-but-rising levels of industrial activity, but, on the other hand, democr acy can provoke entrenched interests to end the developmental project if they become con vinced that the future will not be brighter than the past (witness, for example, the C hilean coup of 1973) and can lead to greater oppression of minority groups. States that seek to be agents of economic change mu st also tend to their relationship with civil society. In Gramsci's conce ptualization, civil society is the

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19 arena in which “political and economic hegemony are maintained through mediating institutions which represent and express in their a ctions the dominant normative claims of the ruling class” (Woods 1992, 83). Civil society is the arena for the struggle for hegemony over the terms of political d ebate. While civil society is usually considered a realm separate from the state, some institutions such as schools, universities, and (in many developing countries) th e media are operated or directly influenced by the state itself. Many developing cou ntries attempt to suppress civil society autocratically, and thereby limit the chall enges to the hegemony of their vision of the future. This strategy could be politi cally expedient in the short-run as the state is able to carry out important structural cha nges that would be highly controversial in a more open government. However, o ver time, this strategy could be quite risky. Economic transformation involves creat ive as well as destructive processes that leave very distinct winners and lose rs (Chang and Rowthorn 1995). Industrialization involves shifting resources away from traditional sectors towards new ones, which creates a segmented labor force and increasing prosperity for those in the new industries, while workers from older sec tors either continue toiling away at their traditional jobs or move to the cities to fin d work. Rising inequality with industrial development, as insiders reap the benefi ts of new industries while outsiders are left behind, threatens the hegemony of the stat e's vision for future development, and an economic downturn could re-open controversy over first principles. Democracy can make this process smoother by providi ng an institutional outlet for renegotiation of the dominant ideology, or it can pro voke greater conflict or a radical re-envisioning of the state's role in society. A notable common feature of the countries that have industrialized is the

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20 presence of a strong national identity that can soo th divisions along the lines of class, ethnicity, and geography, which are identity constr ucts that threaten to tear societies apart, particularly when they are negotiating the f irst principles on which state action is based. Social cohesiveness is critical for creat ion of a vision for future development because it is on the sense of mutual responsibility among various social actors that the effectiveness of a developmental ideology is based. While radical income inequality by itself may not hinder the creation of a vision f or future development, class consciousness, particularly in countries with histo ries of armed struggle between workers and capitalists, can undermine any sense of trust or of mutual responsibility between the two. Likewise, the presence of multiple ethnic identity constructs can undermine a sense of shared responsibility because then politics is more likely to resemble a competition for the spoils of state or c ontinual renegotiation of the state's first principles rather than policy debate that tak es place within a mutually agreed normative framework. Even in ethnically homogeneous populations, geographical region can have an important effect on feelings of shared responsibility, especially in countries with uneven geographical distribution of natural resources. In South Korea, regionalism has been an important defining factor o f their politics (even without any natural resources to speak of), as presidents have traditionally tried to funnel investment projects into their home cities and prov inces. It should come as no surprise that the protests that are arguably most r esponsible for the de-legitimation of South Korea's developmental regime took place in Gw angju, a part of the country that was discriminated against by politicians from other more populous regions, and that did not receive nearly as much investment as some o ther parts of the country (Lee 2007, 49).

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21 In addition to national cohesion, building a succes sful developmental state requires that different political institutions and bureaucracies are able to work together without undercutting or coming into confli ct with one another. One of the drawbacks of the comparative institutional approach taken by Evans (1995) is that, by focusing on one bureaucracy in each different count ry, he does not take into account the relationships among representative institutions (where they exist), militaries, planning agencies, and other state actors with resp onsibility for economic policymaking. Different political institutions and bureaucracies can have different policy preferences because of differences of their relationships with other social actors. Argentina, for example, has been plagued by political and economic instability for much of its independent history largely as a re sult of conflict among different government actors. The military has traditionally b een aligned with societal elites, and has had a much more conservative world view tha n most representative governments, which has been a source of often viole nt conflict. On strictly economic issues, relationships among the President, the Mini stry of Finance, and the Central Bank have been strained on a number of occasions in Argentina, especially during the 1990s, a period characterized by constant in-fighti ng between President Carlos Menem and Finance Minister Domingo Cavallo. Menem c ame from the populist Peronist Party, whose base of support consisted of workers in the country's largest cities, while Cavallo was an American-trained econo mist with no party affiliation and no patience for politics, so they frequently and pu blicly clashed over economic issues, but usually compromised behind closed doors (Mosley 2003). They needed to maintain their respective faces in public because o f their connections to different, conflicting social groups – Menem had to show loyal ty to workers, while Cavallo was

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22 loyal to domestic capitalists and international inv estors. Furthermore, federal systems can undermine developmental states if lower levels of government are predatory, as in the case of rural provincial governments in Argenti na, which are run as private fiefdoms by low-level autocrats (Gibson 2005). Rent ier behavior by lower-level governments detracts from the efficiency of the sta te's scarce funds. International linkages can have a strong influence on the ideological vision of the developmental state. This influence can be tran smitted directly through diplomatic or military pressure to change important industrial policies, but it can also take the form of ideological and cultural influences that ca n shape the preferences of economic actors within the developing country. Glob al powers and the international organizations they dominate can directly affect the policy choices of developing countries through attaching conditionalities to loa ns, signing bilateral trade agreements that favor the stronger country, locatin g military bases inside of developing countries, and establishing conditions f or entering international organizations such as the Organization for Economic Cooperation and Development (OECD), which requires that its members liberalize their capital accounts. Additionally, a developing country's culture is sha ped by relationships with economically and militarily stronger countries, and its dominant developmental ideology can be shaped by other developing countrie s with cultural, economic, or geographical ties that are able to create economic growth. For example, U.S. hegemony after World War II witnessed the rise of A merican economic ideas in all corners of the world, even where it was not the res ult of direct intervention by the U.S. government or the international financial inst itutions that it dominates. This phenomena can be the result of the attractiveness o f the American lifestyle to people

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23 in developing countries, the influence of American ideas on the way economics is taught in other countries, and training of military officers from around the world in American schools, which leaves a strong ideological influence on people who become politically influential in many developing countrie s. It could be argued that American media dominance shapes the preferences of newly aff luent workers in developing countries in favor of conspicuous consumption (Barb er 1995). In East Asia, the strategies of developmental states such as South Ko rea and Taiwan were similar to that of Japan following the Meiji Restoration, whic h should be seen as a lasting ideological influence the country had on its former colonies, even when Japan itself was widely unpopular following decolonization (Amsd en 1989). The ability of the state to establish a vision that shapes the preferences of economic actors comes back to the embedded autonomy argument. On the one hand, the state needs to be embedded enough in the social fabric that it can institutionalize negotiation and re-negotiation of state policy with out causing important social actors to turn against the regime entirely. At the same ti me, the state must be sufficiently autonomous from domestic and international power st ructures to instill and enforce its vision for economic development. Part B: The History of the Developmental State in S outh Korea With an outline established of what developmental s tates do that set them apart from other regime types, it is time to examin e a successful but somewhat puzzling case: South Korea. The case study historic izes the theoretical construct of the developmental regime by examining the processes that brought about its rise, success, and fall. By adding historical context, th e case study contributes to our

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24 understanding of the underlying social interactions that make the developmental state work. Although the embedded autonomy explanation ha s more merit than rationalistic attempts to model the developmental state as the un intended consequence of the actions of self-interested actors, it leaves out wh at factors created state autonomy in South Korea. Indeed, many efforts at explaining wha t set South Korea apart from other developing countries tend to ignore the Ameri can occupation (1945-1948) and the First Republic (1948-1960) altogether for the s ake of parsimony and to facilitate comparison with other cases. Kohli (1999), taking a different tack, argued that the developmental state was a direct descendant of the Japanese colonial state that controlled the country from 1910-1945. According to this argument, Japan bequeathed to Korea a strong but autonomous state t hat improved revenue collection, built infrastructure, and, during the lead-up to Wo rld War II, introduced industrial activity into the peninsula. However, continuity fr om the Japanese occupation to the developmental state regime (which lasted from the m ilitary coup of 1961 until the assassination of Park Chung Hee in 1979) was limite d by occupation and division by competing foreign powers, a greatly destructive war from 1950-1953, and the establishment of a strong and socially autonomous m ilitary. State autonomy and capacity were much more limited during the period o f state formation than under the colonial government or the developmental regime, an d the politics of the Rhee government closely resembled models of predatory st ate behavior. In order to explain why the developmental regime emerged in South Korea it is necessary to examine ideological and institutional differences between t he Rhee government and the Park government. In addition, explanations of the developmental stat e often fail to adequately

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25 explain its decline. The gist of most economistic m odels of the developmental state is that politicians offer businessmen finance on easy terms and protection from foreign competition, and workers are promised higher-than-m arket wages in exchange for continued political support (for example, Kang 2002 Doner et al 2005). Big business and labor, therefore, both stand to lose in the sho rt-term from neo-liberal reforms, which remove state intervention in the market in fa vor of allowing the impersonal forces of the market to allocate resources efficien tly. However, South Korea differs from this story drastically. Although trade and fin ancial liberalization threatened the chaebols' interests in theory, they were among the loudest v oices advocating neoliberal reforms (Minns 2001). Also, even though neo -liberal reforms threatened labor's protection against lower-cost competition i n other countries by allowing capital to enter and exit the country at will, and even though labor mobilization was a critical factor in the democratization movement, th e biggest push for economic liberalization came during the first civilian presi dency in 30 years. Explaining these puzzles requires a historical perspective on how th e societal transformation caused by industrialization, changes in military leadership, and changes in South Korea's relationship with the international system (especia lly relations with the United States) transformed the strategic calculations of important social actors, leading to fundamental changes in the structure and behavior o f the state. This chapter seeks to answer two separate but relat ed questions. First, why did the developmental state emerge in South Korea? Kore a's place in the Cold War system was a necessary condition for the emergence and success of the developmental state because industrialization would not have been possible without American investments in institution-building (Brazi nsky 2007), preferential access to

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26 American markets (Amsden 1989), and participation i n the Vietnam War, which provided the military government with the hard curr ency necessary to begin the push for heavy industrialization in the early 1970s (Woo -Cumings 1998). However, if American advisers had had their way in the 1960s an d 1970s, South Korea never would have undertaken the reforms that laid the gro undwork for economic success (Amsden 1989, 139-156). Furthermore, the behavior o f the private sector during the 1940s and 1950s illustrated that societal elites we re more interested in preserving privileges than in modernizing economic activity in the country, as most private investment went to speculative and low-return econo mic activity (Amsden 1989, 3852). The key turning point that sent South Korea al ong a different historical trajectory from that of most other post-colonial states was th e military coup of 1961. The coup brought to power a cadre of young soldiers, led by General Park Chung Hee, who imposed on the country an industrial program based on a Gerschenkronian developmental ideology rooted in nationalism and in study of the experiences of previous late developers, especially Japan. Whereas Syngman Rhee represented exclusively the interests and outlook of the tradit ional elite, General Park and his cadres represented a major break with the past beca use their experiences gave them sharply different perspectives than their predecess ors on Korea's place in the world and on the normal workings of a modern society. Par k and many of his most important cadres spent time in the Japanese militar y during World War II, and Park was one of few Koreans to attend the elite Japanese military academies, where he was educated in the workings of the Japanese system and the history of the Meiji Restoration (Kim 1971). This experience was critica l in shaping the policy priorities and political strategies adopted by the Park admini stration during the high-growth

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27 years of the 1960s and 1970s. If the developmental state was so successful during the 1960s and 1970s, then what led to its transformation in the 1980s and 199 0s into a neo-liberal state? The decline and transformation of the developmental sta te can be explained by three separate-but-related trends that changed social act ors' political priorities and strategies dramatically over the course of the 1980s, leading to (semi-)democratization in 1987 and the liberalization program of 1993-1997, and cu lminating in the dismantling of the final vestiges of the developmental state follo wing the financial crisis of 1997-98. First, developments in the late 1970s and early 198 0s dramatically weakened the chaebols' confidence in the ability of the state to guide ec onomic development. The global economic crisis caused by the second oil sho ck in 1979 hit South Korea particularly hard because it drastically reduced de mand for Korean exports and it dried up foreign capital markets, resulting in a sh arp economic contraction. Also in 1979, Park Chung Hee was assassinated by the head o f the country's intelligence agency over dinner one night, causing the political crisis surrounding the economic downturn to worsen dramatically. Park's replacement as president, General Chun Doo-Hwan, was much more corrupt and much less compe tent than Park was in the eyes of the business elite (Kang 2002, Robinson 200 7). With confidence in the state's ability to guide economic development on the declin e, chaebol managers began to push for reform. The second trend was rising discontent over the une qual distribution of the benefits from industrialization and in response to the highly authoritarian politics of the Korean government. Although statistical methods of calculating inequality score Korea well below many other industrialized or semiindustrialized countries, leading

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28 many Western social scientists to classify Korea as relatively egalitarian, such measures do not capture the degree of inequality in standards of living accurately. These measures are based on income reports, which d o not include gifts that managers receive from their companies and other for ms of non-salary benefits that are common in South Korea (Amsden 1989). Exclusion from the benefits of industrialization was based on differences in class gender, region of origin, ideology, and other important factors (Amsden 1989, Lee 2007, Robinson 2007). Repression of labor, which was often violent, was necessary for c apitalist development in Korea because it kept wages down, but it sowed the seed o f the regime's demise because of the growing popular backlash against rising inequal ity and growing materialism (Lee 2007). Third, political developments in South Korea's bene factor, the United States, had a number of important impacts on the ideologies and strategic calculations of major social actors. Changing American national sec urity priorities in East Asia also had a major impact on the path to industrialization that South Korea took. During the 1960s, South Korea's support for the war in Vietnam provided Korea with an opportunity to produce manufactured goods to supply both militaries with, and also provided the government with hard currency and mark et access that it could use to promote industrialization. Cuts in American militar y support for South Korea in the early 1970s led the Korean military government to c onclude that it needed to produce its own weaponry, which sparked the heavy and chemi cal industrialization drive during that decade (Horikane 2005). The rise of lai ssez-faire ideology in the United States with the election of Ronald Reagan had a str ong influence on the policy preferences of business leaders in South Korea, who were losing confidence in the

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29 ability of the state to provide effective entrepren eurial leadership. Furthermore, shifting attitudes towards third-world democracy in the United States changed the way American diplomats handled episodes of popular uprisings (Fowler 1999). The next section of this chapter examines the creat ion of a strong, but not autonomous, state during the American occupation an d First Republic (1945-1960). Then, the second section will discuss how the milit ary's autonomy from society (especially the elite landowning and entrepreneuria l classes), the ideological leadership of Park Chung Hee, and the weakness of t he chaebol created a clearly hierarchical relationship between state and busines s that enabled the government to promote higher-risk, higher-return investments that the private sector would not otherwise have undertaken. Section three will analy ze the breakdown and reversal of that relationship between business and state during the 1980s and 1990s. Particular attention will be paid to the ways in which the wea kening of the military government and democratization actually strengthened the chaebols' influence over Korean politics, despite the role of labor organization an d socialist ideology in the democratization movement. Finally, section four will tie the main points of t his chapter to the theory review in the previous sectio n. The Politics of State Formation: 1945-1960 Korea ceased to be a formal colony when Japan was f orced to give up its colonial possessions at the end of World War II in 1945. Although Japan did establish a sophisticated bureaucracy to manage taxation and to control the native population, racist policies prevented most Koreans from receivi ng an education beyond the primary level, and Koreans were not allowed to be i nvolved in colonial

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30 administration except at the lowest level of author ity in the security forces (Cumings 1987, Robinson 2007). Furthermore, the colonial exp erience, especially during the lead-up to World War II, deeply traumatized Korean society (Cumings 1987). Thousands of Koreans were enrolled in the Japanese military or sent to Japan to work as low-cost laborers in the factories, and the incr eased demand for food caused by the war mobilization created the practice of famine exp orting, whereby Koreans would grow rice and export a vast majority of it to the m etropole despite high levels of starvation on the peninsula (Cumings 1987, Shin 199 8). Thus, when Americans arrived in the southern half of the peninsula, they found little capacity for administration or conflict resolution amidst consid erable social upheaval resulting from a peasant backlash against the traditional lan dlord class ( yangban ), which had collaborated heavily with the Japanese (Cumings 198 7, Robinson 2007). Because of the total lack of state capacity, the Am ericans put off establishing a formally independent Republic of Korea until the tu multuous year of 1948, when independence was one among many fundamental reforms demanded by rebellious peasants. In the place of an independent state duri ng the first three years of their presence, and continuing after the establishment of the First Republic, the United States government invested in developing government and civil society institutions. The most important institution they established was the military. After the Korean War, American efforts to develop institutions creat ed a functioning state and land reforms weakened the domestic elite However, the lo gic of Korean politics stayed the same during the duration of the Rhee regime despite weakening of the social status quo. The clientelistic administration of President Rhee was culled from the elite class of society and was primarily accountable to the ric h landowners and entrepreneurs

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31 that financed political parties and had close infor mal ties to the president. While their economic base may have been weakened, their politic al influence was not. Tensions developed between the political elites, who were cl osely aligned to the underdeveloped status quo, and military officers wi th experience in the Japanese military who sought to transform Korean society. Land Reform and the Legacy of Colonial Exploitation Prior to Japanese colonialism, Korea had a feudalis tic class structure ruled by a weak monarchy for thousands of years, with strong ties to the neighboring Chinese monarchies because of shared Confucian traditions ( Robinson 2007, 8-34). When Japan annexed Korea in 1910, it sought to establish a settler colony on the peninsula, but the mission changed when Japanese officials rea lized that Korea was not as empty as they thought (Robinson 2007, 37-43). Instead of establishing a settler colony, their strategy became strengthening the already-existing social order and re-directing Korea's output to fit the needs of the metropole. T hey undertook a land census during the first decade of colonial rule which established land titles, created a penetrating security apparatus that kept nationalist movements at bay, and invested in bureaucratic infrastructure to make taxation more e ffective (Robinson 2007, Shin 1998). In this set-up, Korean landlords cooperated with the Japanese in exchange for payment for output and security against peasant agg ression. In response to Japanese occupation and landlord collaboration, a nationalis t movement with strong socialist overtones emerged in the 1920s to oppose the exploi tation of peasants. Because the war mobilization effort made increased exploitation of Korea's human and natural resources imperative for the metropole, and because war mobilization made it more

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32 difficult to put down peasant rebellions, the Japan ese colonialists made a number of concessions to the tenants to try to ease landlordpeasant tensions that undercut the relative economic power of landlords vis-a-vis peas ants (Shin 1998). For example, the Japanese introduced multi-year tenancy contract s that made it difficult for landlords to kick unruly peasants off of their land thereby forcing landlords to give tenants a greater share of the land's output and gi ving landlords the incentive to treat tenants more humanely in general. The dominant soci al order was further weakened by the introduction of industrial activity onto the peninsula and by the use of Korean labor in Japanese factories, both of which contribu ted to the changing world views of many Koreans. In a largely sedentary society where peasants were tied to the land for generations, the introduction of new forms of econo mic activity and experience in a more developed country produced extreme dislocation and instilled in many ordinary Koreans a vision for the future that was much diffe rent from the one offered by the traditional order (Cumings 1987). Nationalism and class grievances that built up as a result of the colonial experience developed into the movement for land ref orm that pushed reluctant South Korean political elites and American advisors into breaking up the economic base of the traditional social order. Although the end of J apanese colonization left the landlord class weak in the face of the mobilized pe asantry, comprehensive land reform was far from assured. When the Americans arr ived, a vast majority of land was still in the hands of a few families (Robinson 2007, Shin 1998). Grassroots peoples' committees, that had socialist tendencies sprung up throughout the peninsula following the Japanese withdrawal, which threatened the landholdings of collaborator landlords. However, the American military governmen t sought to put an end to the

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33 potentially revolutionary committees, and with the establishment of the First Republic essentially handed the keys to the car over to trad itional social elites, who in 1948 chose former nationalist symbol Syngman Rhee, an op position figure from the 1920s who had been living in America in exile, as their p resident (Brazinsky 2007, Cumings 1981, Shin 1998). However, continued peasant mobili zation in opposition to the attempts to restore the power of the collaborators and in response to the much faster pace of land reform in the communist-controlled nor th led American and Korean officials to the conclusion that some form of land reform was necessary to stave off revolution in the south (Cumings 1981, 255-258). While land reform sewed the seeds of industrial tra nsformation by destroying the economic base of the traditional social order, it was not sufficient to bring about industrialization because elites were more willing to invest in speculation and rentseeking than in new productive activity. As part of compensation for giving up large landholdings, the yangban were given incentives to invest in industrial acti vity. However, the yangban were generally inept as entrepreneurs because they lacked the experience, skills, and willingness to take risks t hat are at the heart of the process of creative destruction. The results were rampant spec ulation and overinvestment in the few industries that Korea had experience with, most prominently the textile sector (Amsden 1989, 38-42). With the traditional feudalistic model of accumulat ion in shambles due to land reforms, and with little willingness or ability to invest in modernizing Korean industry, the new entrepreneurial class turned to c ronyism as a means of accumulating wealth. In exchange for bribes to President Rhee an d donations to his political party, business elites were given access to American aid m oney. Rhee, for his part, was very

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34 content to accept bribes in exchange for access to funds without using the state's control of resources as leverage to promote investm ent in productive activity. After being elected as Korea's first president in 1948 on the basis of name recognition (he was a nationalist hero and Kim [1971, 15] suggests that he was a direct descendant of the Yi dynasty that ruled Korea until Japanese occu pation), Rhee used the state security apparatus against leftists and political r ivals to consolidate power during and after the Korean War. Cronyism was part of a broade r strategy for Rhee to consolidate power against potential competitors; as long as he was willing to do them favors, wealthy elites did not have the incentive to suppor t rivals. Predatory politics during the period in question ca n be attributed to business and political elites being more interested in conso lidating power and creating and protecting privilege than in investing in the highrisk, high-reward process of industrial modernization. South Korea needed a soci al force that was autonomous from backwards, privileged elites and that provided a strategic vision for modernization that went beyond narrow anti-communis m. The military and civil society, both developed by American investment and both shaped by the experience of Japanese colonialism, offered competing visions for Korean modernization, creating a tension that would define Korean politic s for decades. The Military and Civil Society: Competing Visions With the state and the economy under the power of w ealthy but structurally weakened conservative traditional elites, the impet us for transformation had to come from elsewhere in society. In response to the bruta lity, greed, and corruption of the traditional elites, two competing visions of Korean modernity emerged during the

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35 1950s, one from the universities and one from the b arracks. Although they were tied together by a common tragic view of Korean history, the students and the military were divided by the contradictions of Cold War poli tics and capitalist development. What united the opposition to the Rhee government i n the streets and in the barracks as the 1950s progressed was the view that tradition al elites were more concerned with their own privileges than they were in either natio nal independence (as their collaboration with the Japanese showed) or in devel opment. The divisions in the opposition reflected the duality of American Cold W ar foreign policy. The vision put forth by the students in response to the corruption of elites was of a democratic, independent, united Korea, along the lines of the l ines of the democratic government they were promised by their constitution as well as by the values taught in the schools and other civil society institutions developed by A merican aid money (Brazinsky 2007). They represented the vision of liberal democ racy America tried to promote to the post-colonial world. The military, however, had different priorities, reflecting the challenges of depending on a strong benefactor with its own economic and security priorities for protection against hostile neighbors as well as evincing a deeper suspicion of democracy. The three-way division betw een students, the military, and the economic elite came to define South Korean poli tics during the eras of state formation and state transformation. Building an indigenous military was the first prior ity of the Americans as soon as they took over from the Japanese (Kim 1971, Cumi ngs 1987, Brazinsky 2007). The end of World War II and Japanese colonialism brough t the return of Korean soldiers of different ideologies and generations from throug hout the region. From China came the old nationalist forces that fought the Japanese in the northern hills and across the

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36 border in Manchuria, and from Japan and throughout East Asia came the troops Japan conscripted into its military during the war mobili zation. The older nationalist resistance fighters were less skilled and less trai nable, and therefore less useful, to the American military advisers who were putting togethe r the first group of Korean military leaders (Kim 1971, Brazinsky 2007). Instea d, the American advisers promoted officers who had experience in the Japanes e military, especially the ones who had been trained in Japanese military academies because they were much more sophisticated than other classes of Korean soldiers However, many Japanese-trained soldiers were unwilling to drop Japanese customs, s uch as martial prayer exercises, symbolic of a deeper suspicion of and resistance to American ideas. This would create a constant source of tension between the American m ilitary advisers and the Korean soldiers (Kim 1971, 48-51). Although the South Kore an constitution made the military subservient to the President by allowing h im significant control over promotions, the military retained an autonomous cul ture because of the professional training soldiers received from the Japanese milita ry during World War II and from the American military during the lead-up to the Kor ean War. Thus, as the corruption and authoritarianism of the Syngman Rhee presidency escalated after the war, a fissure developed between senior officers, who were forced to continuously show their personal loyalty to President Rhee, and junio r officers, who came to believe that only the military had the discipline, administrativ e capacity, and vision to modernize the country (Kim 1971, 68-69). The escalation of authoritarianism and corruption i n the years following the Korean War elicited a different response from civil society. By the end of the Korean War, most traditional leftist elements, such as lab or organizers or leftist intellectuals,

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37 had either fled north or been captured by the South Korean security apparatus. Fierce anti-communism and intolerance for dissent made the appearance of free speech farcical. Resistance to the increasing authoritaria nism was led by a generation of students who had been educated in Korean schools si nce the end of Japanese colonialism. American influence on the Korean schoo l and university systems led to changes in the curriculum that undercut support for the traditional Confucian system and that promised students a constitutional democra cy along the lines of that which exists in the United States: “By the late 1950s [an] elite tier of youth, more t han almost any other group in South Korean society, understood political liberty and was willing to challenge authority. Its increasingly defiant attitude toward the government was a product of the new opportunities that had been open ed to students, the liberated atmosphere that prevailed at institutions of higher learning, and a more enduring ideal in Korean culture that placed t he responsibility for advising and criticizing the government on intellec tual elites” (Brazinsky 2007, 48-49). The student protesters had fundamentally different priorities than did the military leaders. Whereas the military leaders wer e no less anti-communist than the civilian regime, and therefore were willing to re-u nite with the north only if the communist regime fell, the students prioritized reunification of the peninsula over a division that was a result of a global power strugg le that they felt Korea had nothing to do with (Lee 2007). Although both the junior off icers in the military and the students were skeptical of U.S. motives, the milita ry leaders saw close cooperation with the United States as a necessary evil in the n ame of national development, whereas the students saw the United States as a new colonial power (Lee 2007, Robinson 2007). Therefore, when student protesters took to the streets of Seoul and forced Syngman Rhee's resignation following a stole n election in the spring of 1960,

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38 the military saw itself as the last defender of the South Korean social order against revolution or re-unification under the communist No rth Korean government. The period of state formation cleared the way for a transformation of society because it weakened the traditional agrarian elites and because it brought about the emergence of social actors with alternative visions for modernization. State formation in South Korea poses an interesting contrast to pat terns of state formation in other parts of the world. In contrast to many Latin Ameri can countries, where military struggles for land and natural resources during the period of state formation brought the interests of military leaders and large landown ers together, creating a lasting partnership, the South Korean military was financia lly and ideologically autonomous from other parts of society, and the leadership of the first military government was not as involved in informal networks with social el ites as their Latin American counterparts often were. Therefore, the South Korea n military had more autonomy with which they were able to dictate to social elit es how to invest their money. Furthermore, the absence of natural resources meant that elites did not have a natural source of rents with which to maintain their politi cal and economic power and co-opt potential sources of opposition. Therefore, they we re vulnerable to transformational pressures from the students and the military. The Developmental State, 1961-1979 The military coup of 1961 fundamentally changed the direction of influence between business and the state. Park Chung Hee and his cadres were Weberian social carriers of entrepreneurial spirit, as they used th eir control over the state to force tradition-minded yangban elites to take calculated risks and pursue profit

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39 maximization. However, the military government did not have total autonomy to dictate the substance and pace of reforms. Korea's American benefactors, as well as the international financial institution it controls used their leverage to promote liberalizing reforms that the Korean government was reluctant to enact, such as an experiment with interest rate liberalization that l asted from 1965 until a crisis in 1969-70 (Amsden 1989, Chang and Yoo 1999). Also, se curity concerns were an important factor in determining the timing of the h eavy industrialization push of the early 1970s. Participation in the Vietnam War promp ted Korean companies such as Hyundai to gain experience in new industries while allowing the government to build up hard currency reserves, both of which made heavy industrialization possible. Shifting U.S. policy priorities after Vietnam made investments in military-relevant industries particularly important, as the opening t owards China signaled a lessening of American attentiveness to South Korean concerns (Woo-Cumings 1998). Despite the fact that industrialization dramatically raised the living standards of most South Koreans, there was nonetheless an undercurrent of s ocial unrest, particularly coming from the universities and low-level manufacturing w orkers. Export-oriented industrialization inevitably created segmentation o f the workforce, sharpening lines of inequality in Korean society. The need to keep wage s low, as well as suspicion of the (potentially Communist) motives of labor organizers and a general intolerance of dissent, led to harsh repression of labor organizat ion and political mobilization, especially at the hands of the feared Korean Centra l Intelligence Agency (KCIA). Furthermore, division of the peninsula by foreign p owers and continued American support for repressive Korean governments seemed to contradict the promises of freedom and self-determination made to Koreans when they became independent

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40 from Japan. Continued economic growth kept simmerin g tensions among the business, the state, and labor (and labor's allies on the campuses) under a lid, but that lid was lifted in 1979 by the economic crisis cause d by the Second Oil Shock and by the political crisis caused by the assassination of Park Chung Hee that fall. Cornerstones of the Developmental State After the military coup, General Park and his cadre s wasted little time in showing the public and the traditional elites that things were going to be different. A month after the coup, the biggest beneficiaries of the Rhee regime's spoils were detained by the military, and General Park threaten ed to confiscate their property. Kang (2002) suggests that the fact that Park did no t confiscate their property was a sign that he had no intentions of making the elites change their ways, and that he was only trying to appease popular pressure for retribu tion. If one assumes that all political actors are out to maximize their individu al material self-interest, then the fact that Park did not confiscate the property of more t han a very small number of traditional elites, combined with the fact that he received bribes from major businessmen (Kang 2002), looks like a continuation of the same clientelistic politics of the Rhee government. However, such a view overlo oks how the military government used the leverage it gained over the tra ditional elites with the threat of confiscation of property and the nationalization of the banks to transform the approach to management that owners of capital in So uth Korea took. By attaching export requirements to loans to businesses, the mil itary government forced previously reluctant entrepreneurs to rationalize production, invest in labor-saving (and efficiency-enhancing) technologies, and to increase output.

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41 In order to understand better why Park Chung Hee an d the other leaders of the military government behaved differently from the Rh ee regime, it is important to examine how his training in the Japanese military i nfluenced Park's vision for Korean modernization. As mentioned before, Japanese-traine d officers were given priority for promotion over older, more anachronistic soldiers w ith experience fighting against the colonialists, and General Park was foremost amo ng those officers with Japanese experience. He was one of a handful of Koreans that were allowed to enter Japan's most prestigious military academy, where he was tra ined in the Japanese method of warfare and received education in history and polit ics. He was known to have a keen interest in world history (Robinson 2007, Amsden 19 89). In contrast to the United States, where the intellectual hegemony of Englishstyle liberalism led advisors to recommend a minimal role for the state in economic development, the Japanese tradition of economic thought, influenced by the Ge rman Historical School, considers state leadership of entrepreneurship to be a critic al aspect of the success of developed countries (Yong 2008). The idea that state interven tion is normal for economically successful countries is one of the most important p oints of Park's vision for Korean modernity, as his 1963 book The Country, The Revolution, and I illustrates (Amsden 1989, 14). The book is an analysis of how four revo lutionaries (nationalist China's Sun Yat Sen, Turkey's Kemal Pasha, Egypt's Nasser, and Japan's Meiji rulers) attempted to modernize their countries in the face of hostile foreign imperialism and economic backwardness. “From the Meiji, the only un reservedly successful of the revolutionaries, Park learned the importance of ind igenizing foreign ideas, of crowning a political hierarchy with an emperor (the I of the Revolution), and of allowing 'millionaires who promoted the reform' to enter central stage, 'thus

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42 encouraging national capitalism'” (Amsden 1989, 14) Faced with the prospect of having their property confiscated or of being cut o ff from finance if they did not modernize their business practices, the millionaire s joined the program, as was evident by the 76% increase in gross investment fro m 1962 to 1963 (Amsden 1989, 57). While Park's vision set the contours of economic po licymaking, the responsibility for planning and coordination of inv estment was delegated to the Economic Planning Board (EPB). The Board was respon sible for budgeting, development and implementation of five-year plans, and it scoured the world for needed markets, capital, and technology (Cumings 19 87, 73). Unlike government bureaucracies in many other parts of the developing world, the EPB was characterized by embedded autonomy (Evans 1995, 5154). As was the case with Japan's Ministry of International Trade and Industr y (MITI), the EPB was able to draw on the best and brightest from Korean universi ties, but unlike the MITI, foreign advisors (mostly from the US and Japan) also played an important role in the EPB's activities (Evans 1995, 51; Cumings 1987, 73). Beca use the EPB drew most of its members from the same three elite Korean universiti es, and because it offered its members a stable career track with rewards for qual ity work and longevity, it was said to have an autonomous corporate culture that made i t impervious to the type of pernicious, widespread self-seeking behavior that c haracterizes bureaucracies in countries like Brazil and India (Evans 1995). While bureaucratic autonomy certainly helped make the EPB an effective body, its ability to do its job ultimately rested on Park's willingness to discipline the millionaires. If Park were as self-serving as Kang (2002) argued, it would be possible for millionaire s to, for example, get export

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43 requirements reduced or eliminated altogether for t he right price, but there is little evidence of such activity. Two Distinct Periods of Rapid Growth When the military took over and began pushing firms to invest in greater output capacity and export orientation, it focused primarily on light industry, especially textiles. South Korea, after all, had li ttle hard currency to invest in heavier industries, and its entrepreneurs had little experi ence with industries other than textile production. Within a decade, exports reached $1 bil lion, up from $55 million in 1962 (Horikame 2005, 380). Export-orientation was more t han just industrial policy, it was the object of much publicity from the government, a nd business leaders and bureaucrats were rewarded handsomely for meeting ta rgets (Horikame 2005). Politically, although the military coup did not lea d to the suspension of direct elections for the presidency, authoritarianism incr eased with the creation of the KCIA, the notoriously brutal intelligence agency, i n 1962. While successful economic growth created popular acquiescence to the regime, there were nonetheless a few acute political crises during the first decade of t he developmental regime. The controversy over normalization of relations with Ja pan in 1964, which led to widespread concern that South Korea was becoming re -colonized (Lee 2007). Financially, American aid ran dry at the end of the 1950s, and pressure from the International Monetary Fund and other financial age ncies prompted an experiment with liberalizing reforms, beginning with interest rate liberalization in 1965 (Amsden 1989, Chang and Yoo 1999). Although the savings rat e jumped significantly during

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44 1965, the reforms nonetheless failed when a build-u p of curb-market1 debt by private firms led the Korean government to suspend repaymen ts on curb market loans for three years (Chang and Yoo 1999). At the end of the 1960s and the beginning of the 19 70s, however, the geopolitical landscape of East Asia was shaken by a number of events, leading President Park and his top assistants to believe in the need for drastic improvements in heavy industrial capability. The push for heavy and chemical industrialization (HCI) began as a response to a perceived national s ecurity crisis. First, North Korean leader Kim Il-Sung announced at a party congress in October 1966 that he was no longer content to achieve unification through peace ful means, saying that he would be willing to use force if necessary (Horikane 2005, 3 71). The United Nations Command in Korea reported a drastic increase in North Korea n violence in 1967, and on January 21, 1968 North Korean commandos raided the Blue Hou se, South Korea's presidential residence, in an attempt to assassinat e Park Chung Hee (Horikane 2005, 370-371). Second, while North Korea appeared to be getting more belligerent, the United States military's commitment to defending So uth Korea was wavering. Korea was a participant in the Vietnam War, which allowed the government to collect precious hard currency and gave chaebol such as Hyundai the opportunity to move into new lines of business in industries like const ruction (Woo-Cumings 1998). However, the war's toll on the American military le d to changes in political and military strategy in the region. First, in 1971, th e US pulled thousands of troops out of the peninsula to be re-stationed elsewhere or to go straight into Vietnam. Second, 1 When a country represses financial flows, informa l institutions like the curb market emerge to provide illicit hard currency loans to borrowers at high interest rates.

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45 Nixon's decision to talk to China, who was an arden t supporter of North Korea and who refused to accept investment from firms that in vested in South Korea or Taiwan, made it clear to Park and his cadres that South Kor ea was caught in the middle of bigpower politics over which they had little control ( Horikane 2005). Therefore, the only solution that Park could see was developing South K orea's ability to produce military equipment domestically. Initially, the plan to produce munitions domestical ly in South Korea was limited to renovating already-built plants to produ ce weapons and ammunition for the military's reserves. However, weapons for the regul ar military required a degree of precision that re-configured factories could not ac hieve, thus requiring substantial investments in building new ones (Horikane 2005). B efore they were ready to build plants for weapons and ammunition, however, the Kor ean government's priority was one step upstream in the chain of production: steel Rather than depend on imports for steel that would be used to make weapons, the Korea n government wanted to establish a domestic source that could provide chea p steel. Although they had tried three times previously to raise international fundi ng for an integrated steel mill, all of these efforts failed because investors, having prev ious negative experiences with building steel industries in developing countries, were not ready to support a project anywhere near the scale that the government wanted (Amsden 1989, 295). However, the worsening security situation created a new sens e of urgency. In 1968, the Pohong Iron and Steel Company (POSCO) was founded as one o f Korea's few state-owned enterprises, and, after two years of haggling with Japan over funding, construction on the plant began in 1970 (Horikane 2005). Japan was reluctant to provide financial and technical assistance to POSCO because the country's constitution prevented it from

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46 providing assistance to projects that they knew wou ld be used for military purposes. However, Japan succumbed to pressure by the United States government, who by the early 1970s was planning on a redeployment of troop s in the region and thus had an interest in helping South Korea develop its own mil itary capabilities. The POSCO plant in the southwestern city of Pohang opened in 1973, coinciding with the official announcement of the he avy and chemical industrialization push. Within three years of opening, exports would take up to 40% of POSCO's production, a solid feat for a firm with little exp erience (Amsden 1989, 301). POSCO helped promote other industries in South Korea not only by providing a domestic source of cheap steel, but also by setting an examp le of a well-managed industrial firm for other Korean businesses to follow, and man y POSCO managers would go on to work for other chaebols such as Hyundai and Samsung in following years. Ot her major industries that received promotion from the g overnment as part of the HCI push were automobiles, shipbuilding, and constructi on. Hyundai's story provides an interesting example of how Korean chaebol were able to diversify into heavier industries during this time period. Hyundai receive d a major boost in hard currency reserves and experience by servicing US military co nstruction contracts during the Vietnam War, and it sent construction teams to vari ous locations in the Middle East during the 1970s to work on oil and construction pr ojects there. As part of the HCI push, Hyundai began to diversify into shipbuilding. By 1984, Hyundai Heavy Industries (HHI) became the world's largest shipbui lder. Amsden (1989, 280-87) argued that HHI was successful because of governmen t financial support through establishing low-interest financing abroad (the gov ernment maintained control over capital flows in and out of the country), foreign t echnical assistance in developing the

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47 shipyard and designs for ships and motors, and memb ership in an already large and diversified business group (the chaebol ). Chaebol membership allowed HHI to benefit from managerial experience in Hyundai's con struction and automobile divisions by bringing experienced managers, enginee rs, and quality control professionals from other branches of the company to work directly on construction of the shipyard and on making the assembly line more e fficient. Both POSCO and HHI benefited from constant pressure to make the production process more efficient and precise and t o improve technological capabilities, pressure that was supplied by both th e market and the government. While it is true that “systemic vulnerability” (Doner et al 2005, 328) provided the impetus for the heavy and chemical industrialization drive, the successful expansion of Korean chaebol into non-military industries is attributable, in p art, to the Gerschenkronian vision and Weberian entrepreneurial ethic that President Park and the economic bureaucracies instilled in these busin ess groups. The government played a strong proactive role in finding markets for new Korean goods, acquiring financial and technical assistance for Korean firms expanding into unfamiliar industries, providing chaebol with incentives to compete on international market s, and helping them shoulder risks associated with major fixed inv estments in new industrial capacity. In all of these regards, Korean state lea dership of the industrialization drive bore a strong resemblance to Japan's industrializat ion efforts in the late 19th and early 20th centuries. Government intervention complemented th e pressure that international markets for steel, ships, automobiles, and other in dustrial goods put on chaebol to continually invest in process innovation and in dev eloping better technological capabilities. Without visionary leadership from the government, such projects as the

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48 steel plant in Pohang and HHI's very modern main sh ipyard never would have gotten off the ground. The Yushin Constitution and the loss of legitimacy While Park's leadership was critical in creating ec onomic growth, his economic heroics are offset in the Korean memory by the brutality and personalization of politics during his presidency. Immediately following the coup, Park established the KCIA and sent members to infil trate the universities, which were the bases of the protests that brought down the Rhe e government in 1960. Also, the National Security Law put strict limits on what the press could say. Although the military set about curtailing civil rights as soon as it took power, it left the constitution in place, leaving formal limitations o n the president's power, particularly direct election of the president and the need to ha ve a majority in the legislature pass his initiatives. As the 1960s went on, popular frus tration with the regime continued to grow, especially in the cities, which had more high ly educated populations and where the inequalities of industrialization were most app arent. In 1968, President Park was re-elected by a fairly close margin and his party n arrowly maintained a majority in the legislature on the strength of rural support and th e support of staunchly anticommunist North Korean expatriates (Robinson 2007). The 1971 presidential election was the closest in Korean history, as opposition le ader (and later President) Kim Dae Jung won 56% more votes in urban areas than Preside nt Park, who once again depended on the staunch anti-communism and traditio nalism of older rural voters (Robinson 2007, 137). At the heart of the opposition to President Park wa s the widening gap between the living standards of white-collar workers and th ose of low wage blue-collar

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49 workers. One of the biggest myths about South Korea n industrialization was that it was egalitarian in any way. Companies that depended on exports for profits chafed at the idea of raising wages or cutting hours for lowlevel employees. Because labor unions were outlawed and because employers could al ways count on the national police to support them during periods of labor stri fe, employees had little way to push back against rising inequality and exploitation. So uth Korea also lacked any sort of social safety net for individuals who were laid off or injured at work (Robinson 2007). Changes in gender roles also contributed to the opposition to Park. In 1970, a young male textile worker immolated himself publicl y in Seoul's textile district in protest over the effects of gendered segmentation o f the workforce (a practice that is advocated by some Western development economists, s uch as Rodrik [2007]) on young women working in sweatshops, galvanizing the opposition movement (Robinson 2007, 138). In addition to class and gend er issues, industrialization was highly uneven regionally, as politicians attempted to funnel projects back to their hometowns, a practice whose origins are unclear but stretch back beyond the beginning of the military government. It is very si gnificant to note that Kim Dae Jung was from the Cholla region, which had been largely left out of the spoils from development and would be the site of a major showdo wn between the military and protesters in 1980 (Lee 2007). Combined with South Korea's precarious geopolitical situation in the early 1970s, the increasing unrest over the unequal distr ibution of the benefits from development put immense pressure on President Park, who was overseeing the nascent development of the HCI intiative. In July 1 972, Park met with North Korean leader Kim Il-Sung, ostensibly to discuss avenues f or possible reunification of the

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50 peninsula. Shortly after the summit, however, the S outh Korean government declared martial law, during which time an emergency council put together a new, much more authoritarian constitution. The Yushin (“restoratio n”) Constitution replaced direct election of the president with election by the Nati onal Council for Unification, which featured over 2,000 members. Because the president appointed one-third of the council, he was virtually assured continuous re-ele ction (Robinson 2007). Furthermore, the new constitution gave Park the pow er to take whatever emergency measures were necessary during times when “the nati onal security or the public safety and order is seriously threatened or anticipated to be threatened” (Lee 2007, 34). The period of 1974 until Park's death in 1979 is known as the Era of Emergency Decrees, the most severe of which, Emergency Decree Number N ine enacted after the fall of Saigon in 1975, prohibited “any kind of antigovernm ent activity, including any criticism of the constitution” (Lee 2007, 35). Thus although the new constitution was sold as a means for facilitating re-unification, in reality it was a way for Park to consolidate power in the face of tremendous uncerta inty caused by threats to the government both domestic and from beyond its border s. As escalating authoritarianism alienated the Korean middle class more and more, especially at the universities, the governmen t's record of delivering economic growth became its last pillar of legitimacy. Thus, the Second Oil Shock in 1978 and 1979 was the straw that broke the camel's back, as it brought the Korean economy to a standstill. Anger over the new constitution and r ising inequality spilled into the streets. An important event that contributed to the downfall of the regime was police brutality towards young women workers at the YH Tra ding factory, who were having a sit-in strike because their factory owner closed the shop without prior notification.

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51 During the brawl with police, the protest spilled o ver into the headquarters of the opposition New Democratic Party, and one young woma n was killed in the melee (Lee 2007, 226). The incident sparked outrage again st the government nationwide, and labor unrest continued in the Masan and Pusan f ree-trade zones (Robinson 2007, 138-139). If the death of the developmental regime can be traced to a single event, it was a dinner at the presidential Blue House on Octo ber 26, 1979. The protests in Masan had already provoked the government to declar e martial law, and Park and his aides were discussing whether or not to send in par atroopers. KCIA Director Kim Jae Kyu urged Park to show restraint, but Park, under t he influence of his chief bodyguard, was preparing to call in the paratrooper s when Kim decided to take matters into his own hands, assassinating Park and his bodyguard during the dinner (Robinson 2007, 138-139). The nation was shocked, r elieved that the horrors of the Yushin years were over, but concerned over what cam e next. Dual Liberalization, 1980-present By 1980, South Korea had industrialized to an exten t that nobody would have anticipated when the military took over in 1961. Ho wever, capitalist development came at a large social cost. For low-wage workers w ho toiled away in miserable working conditions for measly wages, who had no cha nce of sending their children to the elite high schools and colleges that trained th e privileged white-collar workers and professionals, and who sent their daughters to work in sweatshops, the country's development felt like a false promise. The Gwangju Uprising of 1980 was the ultimate articulation of the frustration of people who worked very hard and contributed to the country's economic success yet w ere denied the opportunity to

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52 share in that success. The Minjung (“people”) Movem ent gave voice to their concerns. For the chaebol on the other hand, the Second Oil Shock and the assassination of Park Chung Hee signaled that the o ld state-led model of development was no longer going to work. The coup that brought Chun Doo Hwan to power in the winter of 1980 further undermined confidence in the state's ability to maintain its lead role because Chun was less disciplined and enjoyed the spoils of office more than his predecessor, and he lacked Park's vision as well (K ang 2002, Robinson 2007). Increasing labor unrest and pressure to democratize also undermined business confidence because they posed a direct threat to th e low-cost export-led model the chaebol depended on in order to stay competitive. While th e chaebol were worried about political threats to their cost structure, th ey were gaining confidence in their ability to compete on international markets for bot h market share and financial capital. A major factor behind the chaebols' support for liberalization was the fact that they no longer needed state tutelage in order to ra ise capital or compete globally because they had gained experience and built succes sful international business relationships (Chang and Yoo 1999). As the military's influence over society began to r ecede, two social forces competed to re-orient the Korean political economy in very different directions. On the one hand, the Minjung Movement, which was led b y students and blue collar workers, pushed for social democracy, reunification with the North, and meaningful economic and military sovereignty (Lee 2007). On th e other hand, the chaebol pushed for neo-liberal reforms that would give them access to international capital, more control over the domestic banking sector, and conti nued repression of labor. Paradoxically, the dueling movements produced democ ratization followed by

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53 liberalizing economic reforms. The paradox can be e xplained, at least in part, by the direct and indirect influences of a third actor, th e United States. In terms of direct influence on Korea's movement for democracy, both s ides of American foreign policy came out during the 1980s. At the beginning of the decade, America's experience with the Iran hostage crisis made both the government an d the public weary of a movement in an allied country with strong socialist and nationalist overtones. However, as the decade progressed and “people power ” movements took power in places like the Philippines, support for the milita ry dictatorship became harder to square with the country's vocal support for democra cy (Fowler 1999). On economic policy, the US and the international financial inst itution it dominates had a direct impact in shaping the early liberalizing reforms of the 1980s, but its indirect ideological impact was perhaps even stronger. Most Korean economists held doctorates from American universities, and were thu s strongly influenced by the free market ideology sweeping through the country's econ omics departments, media, and polity during the 1980s. By the end of the decade, even employees of the EPB were calling for the Board to be dismantled (Chang and Y oo 1999). The chaebol also played an important role in bringing free market id eology to Korea by establishing think tanks, similar to those in America, which, in addition to providing the government with prochaebol policy prescriptions, had a tangible influence on public opinion. Another reason for the paradox was changes in middl e class attitudes toward the social goals of the Minjung Movement in the lat e 1980s and the phenomenon Weyland (1999) called “neo-liberal populism.” The r estoration of civil rights brought about a huge increase in labor unrest, causing some segments of the middle class,

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54 such as shopkeepers and small business owners, to v iew unionists as selfish, troublemakers, or as communist subversives (Koo 199 1). In addition, politicians, the state-owned media, and organizations representing t he interests of chaebol and of the business community more broadly actively campaigned against the union movement, arguing that it would undermine the export-led mode l by changing the cost structure of manufacturing firms (Koo 1991). By the time of t he 1993 presidential elections, middle class South Koreans wanted a government that would break the economic and political power of the chaebol without fundamentally transforming the social orde r, as some Minjung leaders called for. In this context, t he power of the neo-liberal populism communication strategy becomes clear. It p romised to force the chaebol to compete with other firms for funds, rather than rec eiving policy loans based on personal connections between chaebol leaders and the president, while also forcing them to compete to maintain their market share in d omestic markets by removing barriers to domestic and foreign competition. Howev er, the increased political power of the chaebol undermined the efficacy of free market reforms bec ause, through bribery, trickery (such as having family members of chaebol owners purchase large amounts of shares in new financial institutions), a nd influence peddling, they sabotaged the market reforms, leading to strengthen ing of the chaebol Ultimately, it would take a massive financial crisis in 1997-98 an d subsequent IMF intervention to break the power of the chaebol over the civilian government. The Minjung Movement and the Gwangju Massacre While the universities had been a site of protest a gainst authoritarianism and inequality in Korea since they were established and developed during the period of

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55 state formation, the influence of intellectuals and student movements increased dramatically during the late 1970s and throughout t he 1980s in response to escalating authoritarianism and concentration of power in the hands of the president. Student and worker unrest exploded in 1978-1979 as the econ omy ground to a halt, and the assassination of Park Chung Hee in 1979 led many to believe that the military would have to give up power. However, high level authorit ies in the government and the military showed little interest in allowing greater civil rights because of concerns over the country's stability and the potential for anticapitalist and subversive forces to come to power. Opposition to the government festere d. The critical turning point that marked, once and for all, the decline of the milita ry's influence in Korean society was the Gwangju (also spelled Kwangju) Uprising. Gwangj u, in North Cholla province, was a government-planned satellite city for Seoul t hat had experienced unrest in the early 1970s as a result of the failure of the gover nment to provide basic services they promised the citizens of the town when they moved t here (Lee 2007). In May 1980, students at the local university held a protest aga inst the authoritarianism of the government, which was brutally squashed by the mili tary. In response, the citizens of Gwangju rose up en masse to take the city back from the military, driving o ut the special forces. For a week, the government negotiat ed with the citizens of Gwangju over a truce, but on May 27 the military sent in sp ecial forces and paratroopers. The bloody siege claimed the lives of over 2000 student s and townspeople, leading to widespread popular outrage over the level of cruelt y the government was willing to use against its own citizens (Robinson 2007, 140-14 2). Though popular opposition to the military regime ha d been escalating during the Yushin period, and the Minjung Movement had alr eady begun on campuses of

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56 major universities, the Gwangju Massacre created a dramatic shift in popular attitudes towards students, intellectuals, workers, and Ameri can power, and it made the Minjung leaders change their strategy. Rabid anti-c ommunism created widespread suspicion of the motives of regime critics, but suc h concerns gave way to sympathy for students and ordinary townspeople who were will ing to put their lives on the line for democracy (Han 2001). For the students in the M injung Movement, the Gwangju Massacre represented something of a failure because many intellectual leaders of the movement felt that the students and intellectuals a bandoned the ordinary working people by the time the military laid siege to the c ity. The repression caused a change in the movement's focus from simply articulating cr iticisms of the Korean system to actively organizing and building solidarity with or dinary working people, a shift in strategy that would have major consequences on Kore an politics throughout the decade (Lee 2007, 52-53). Furthermore, the Gwangju Massacre did serious damage to the United States' reputation amongst ordinary Kore ans. Although the United States government has denied involvement in the incident, the fact that the Korean special forces are responsible in many circumstances to the United Nations commander, usually an American, created the widespread percept ion that the United States military could have put a stop to troop movements t o Gwangju, but refused to out of complicity with the military government (Lee 2007, Robinson 2007). Many Koreans remained grateful to the United States for their su pport against the communist North and for their contributions to Korean development. However, America's influence on Korean culture and its efforts to undermine the eco nomic strategy of the developmental state, as well as American support fo r partition of the peninsula, led many intellectuals and students to criticize the re lationship between Korea and

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57 America as neo-colonial. Perceived complicity in th e Gwangju Massacre led to widespread disillusionment with American power and made the Minjung criticism much more salient for middle class Koreans (Lee 200 7, 50-51). Indeed, the Minjung Movement can be seen as a respo nse to the antidemocratic features of the international system. A major theme in the speeches and writings of the movement's intellectual leaders is the crisis of historical subjectivity (Lee 2007). Throughout their history, the people of the Korean peninsula have been objects over which larger, more powerful neighbors and foreign empires have struggled for control. During the years of dynastic rule that preceded Japanese colonialism, Korean monarchs were politically, econ omically, and intellectually subservient to the neighboring Chinese monarchy (Ro binson 2007). The brutal years of Japanese occupation witnessed the marginalizatio n of Korean culture and traditions, as well as redirection of economic acti vity in the interests of the colonial power at great social cost to Koreans. While indepe ndence promised Koreans command over their own affairs, the occupation and division of the peninsula between the two post-war superpowers quickly put to rest the illusion of control over their own affairs. The Japan-Korea Normalization Tr eaty of 1964, which re-opened political and economic ties between the former colo nial superpower and subject, was seen by many Koreans as an attempt by the Americans to once again make Korea a colony by forcing it to once again become economica lly subservient to Japanese interests (Lee 2007, 30-32). President Park was mot ivated by the Japanese example because they successfully fought off attempts by fo reign colonial powers to impose unequal exchange on them, and, through savvy statec raft and business management, were able to grow into an autonomous power in its o wn right (Lee 2007).

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58 For the Minjung Movement, the crisis of historical subjectivity manifested itself in the contradictions of the Cold War intern ational system. The students and intellectuals that led the movement were, for the m ost part, born after the Korean War and after the turbulence of the 1940s and 1950s. Th us, they tended to be less staunchly anti-communist and pro-American than the older generations. They saw the national security crises of the 1970s and the Gwang ju Massacre as results of foreign meddling in the affairs of Koreans. Both Koreas wer e just pawns in a larger imperial chess game, basically fighting other peoples' wars (Lee 2007). This is why reunification was such an important goal for the Minj ung Movement. Furthermore, American leaders spoke often about spreading democr acy and free market capitalism around the world, but when push came to shove, they did not hesitate to support proAmerican dictators for the sake of economic and mil itary stability, and when the American economy suffered downturns, the United Sta tes government (at the urging of voters) adopted mercantilistic policies such as “voluntary export restrictions,” constantly shifting the playing field to give their firms an advantage. Also, American influence on Korean culture was very strong, as the Armed Forces Network was one of three broadcast television networks available th roughout South Korea (Robinson 2007). Therefore, younger intellectually active Kor eans began to view their country as a new American colony, and the perception of com plicity in Gwangju strengthened anti-imperial sentiments. In addition to nationalism, social democracy was a vital element of the Minjung Movement, but this would prove to be contro versial as the decade progressed. Attention to the plight of average Kore an workers who were left out of the gains from development, such as the citizens th at stayed behind in Gwangju to

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59 fight to the very end, became widespread during the 1980s (Lee 2007). The independent labor movement picked up steam after Gw angju as graduates began to pass up jobs as managers or professionals in order to work as wage workers in factories so that they could organize Korean worker s into independent unions (Han 2001, Robinson 2007). Clergy of Christian churches, who in South Korea were heavily influenced by liberation theology, began to step up efforts to help and advocate for the poor and for the workers (Han 2001 Lee 2007). Koo (1991) argued that the Minjung Movement was driven by the desire for democracy in three spheres: political democracy, economic democracy, and socia l democracy. The movement for democracy was aimed at correcting the inequalities of the development model, but to do so, the leaders argued, the development model ne eded to be transformed fundamentally so that labor would no longer be thro wn under the bus in order for the chaebol to succeed. While middle class support for politic al democracy was strong, its support for social and economic democracy was m uch weaker and more contingent because of the benefits that capitalism had delivered South Korea and because of strong skepticism of socialist ideas. The Chaebols' Brave New World At the same time that the legitimacy of the state-l ed development model was diminishing among the working and middle classes, t he model's credibility was also under attack from Washington, the international fin ancial community, and, eventually, the Korean polity and business community. Because t he HCI drive was largely funded through foreign borrowing, the economic crisis resu lting from the Second Oil Shock in 1979 forced the country into the arms of the IMF in 1981. Liberalizing

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60 conditionalities attached to the IMF agreement were only the beginning of a decade and a half long process of transforming the develop mental state into one conforming more with the neo-liberal model. Although Korean po litical and business leaders were initially somewhat reluctant to abandon the mercant ilistic policies on which the developmental state's success was based, a fundamen tal transformation of the Gerschenkronian ideology within the Korean governme nt and business community led to economic liberalization. The growing hegemon y of free market ideas in the United States during the 1970s and 1980s had a huge influence in bringing the transformation about, as did constant pressure from the Washington Consensus institutions. However, the road to liberalization w as long and winding because of the perilous domestic political environment, in which t he Minjung Movement and the labor movement that was its offspring threatened bo th the country's political stability and the cost structure of the chaebol Ultimately, successful transformation of the Korean political economy depended upon the ability of Korean politicians and business leaders to sell the neo-liberal reforms to Korean citizens in the 1993 elections. The 1979 economic crisis came at a turning point in the American worldsystem. American advisors had always been skeptical of South Korea's state-led development system, but as long as South Korea was a security priority and continued to record solid economic growth numbers they were a ble to keep reformers at bay. However, America's withdrawal from Vietnam and enga gement with China meant that the United States had reduced security tension s in the region. Also during the 1970s, skepticism of the state's role in wealth cre ation began to increase within American economics departments, and the election of Ronald Reagan in 1980

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61 signaled an increased effort by the American govern ment to push liberalizing reforms in the world. The debt crisis that hit the developi ng world in 1981-82 fueled the rising anti-state sentiment, as governments were blamed fo r the collapse of importsubstitution regimes in Latin America as well as th e crisis in South Korea. The antistate revolution also spread to international finan cial institutions such as the World Bank and the IMF. The World Bank, in particular, be came an important source of anti-state, free market economic thought, which hea vily influenced its policies as well as the thinking of developing world politicians and economists, who looked to the institution for advice. In 1981, the World Bank app ointed conservative economist Anne Krueger (now at the IMF) to head the Bank's Ec onomics and Research Department, where she purged the 31 economists from the staff, leaving 7 loyalists. “The World Bank's Personnel Department warned senio r management that Krueger had adopted an 'intelligence' system to detect her staff's divergences from politically correct views. The Bank's official history called t his 'thought control.'” (Amsden 2007, 128) Because of close cultural ties between the US and S outh Korea forged by educational exchange and business and political con nections, trends in American politics have tended to refract onto South Korea (C umings 1989). Many Korean political and business leaders and economists recei ved advanced degrees in the United States during the 1960s and 1970s, around th e time that neo-classical economics and neo-liberalism more generally were ga ining ideological hegemony in American universities. Thus, like the Japanese-trai ned officers who brought the nationalist mercantile model to South Korea in the 1960s, these intellectuals were social carriers of neo-liberalism. With the ideas o f Friedman and Hayek gaining

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62 currency in the United States, the same trend could be observed in the Korean economics bureaucracies, as American-trained econom ists saw state efforts to “pick winners” as being corrupt and less efficient than a llowing a private financial sector to allocate resources. In addition, they saw re-struct uring of the chaebol to be an essential element of the reform program. The 1979 c risis created overcapacity in Korean industry, which was seen to be a result of a llowing multiple chaebol to enter the same industry at the same time, even though som e chaebol were significantly less competitive than others. The goals of neo-liberal r eforms, for the bureaucrats, were to try to induce the chaebol to be more efficient by increasing competition for domestic market share and access to capital. Although some within the bureaucracies supported re forms during the early 1980s, pressure for meaningful reforms did not begi n in earnest until the later part of the decade. The reason for the timing was that the chaebol did not come around to reforms until the revival of export growth from 198 4-1987. Along with recovering liquidity in the international financial system, st rong export performance gave the chaebol confidence that they could access capital on inter national markets without requiring government guarantees. The Korean governm ent kept tight control on capital flows coming into and out of the country fr om the 1960s as a way of ensuring that speculation did not get out of control (Chang and Yoo 1999). In light of improving performance, and with liquidity in the gl obal financial system recovering from the debt crisis, the chaebol began to view tight regulation of capital flows as more of a nuisance than a safeguard. In addition, g reater international capital mobility meant that chaebol could outsource production, thereby giving them a means of cutting production costs in the face of rising labo r strife. As chaebol policy

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63 preferences were changing, the process of policymak ing within the government itself was changing, giving the chaebol more say over the policies imposed on them. During the Park years, economic policymaking in the Korean government was characterized by an “information up, policy down” a pproach in which business associations would send economic information up thr ough the bureaucracy to the president, who would review and sign off on the bur eaucrats' policy recommendations before sending the command back down to the busines ses (Fields 1997, 138). In the 1980s, by contrast, the business organizations, lar gely dominated by the chaebol started making policy recommendations of their own and creating think tanks. During the 1980s, it is estimated that 70% of recommendati ons from the largest Korean business association, the Federation of Korean Indu stry (FKI), were enacted within three years of initially being recommended, with th e number going up to around 90% during the 1990s (Fields 1997, 138). Prior to the 1 980s, FKI did not have a public policy branch. Despite increasing support for liberalization from the chaebol there was also tension between them and reformers within the gover nment and middle class opposition. While capital account liberalization pr omised to allow the chaebol to become truly international, reforms that increased transparency and competition threatened the chaebol business model. Thus, numerous reform efforts duri ng the 1980s and early 1990s were sabotaged by the chaebol (Gills 1996, Chang and Yoo 1999). For example, the government attempted to pri vatize the banks during the 1980s, only for the banks to fall under direct chaebol control because family members of chaebol executives purchased controlling shares in them (C hang and Yoo 1999). Additional reforms that would have consolidated ind ustries under the leadership of

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64 the most successful firms, which would have lowered the risk of overcapacity, and corporate governance reforms were scrapped because of lack of chaebol support. The failure of early efforts to liberalize the economy during the 1980s was the result of a decline in the state's ability to discipline capita l. Kang (2002) reported that bribery at the presidential level was more severe under Chun t han it was under Park, and Robinson (2007) observed that Chun enjoyed the spoi ls of office more and was significantly less disciplined than his predecessor In a system such as the South Korean one, where the president serves as arbiter b etween interest groups and the bureaucracy, greater corruptibility of the presiden t threatens the autonomy of the entire government. Furthermore, the chaebol were able to resist reforms because their large size and influence in the economy made imposi ng fundamental reforms that would hurt the chaebol in the short run prohibitively costly to society. Democratization and Liberalization As South Korean political and business elites warme d to the idea of economic liberalization, tensions between the democracy move ment and the government were running ever higher. The Gwangju Massacre, together with the bloody coup that took place later in 1980, tainted the military regime to such an extent that it would never recover (Robinson 2007). Although the government an d the media attempted to portray student demonstrators and labor leaders as Communist subversives, middle class support for the demonstrators and the workers continued to build (Lee 2007). A critical factor was the continued use of heavy-hand ed tactics to put down student demonstrations, which continued to chip away at the legitimacy of the government. Tensions between the government and the workers and students reached a peak in

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65 1987. The catalyst was increasing exploitation, as well as international attention, generated by the build-up to the Olympic Games, hel d in Seoul in 1988. In preparation for the games, the government built fre eways, airport facilities, subways, and other projects that disrupted life in Seoul for years, serving to unite the opposition (Robinson 2007, 144). In contrast to 1980, when a w ar-weary American public, political class, and military leadership had little patience for a student revolt with socialist overtones taking place in a strategically important country, the zeitgeist was much friendlier to democratic movements in 1986-198 8. People power in places like the Philippines and the Soviet bloc provided encour agement to Koreans that their voices could be heard, and it also excited America' s imagination (Robinson 2007, Fowler 1999). The prospect of a violent clash with students shooting around the world via CNN seemed disastrous for a regime that d id everything it could not to alienate the United States government or potential foreign investors, especially on the eve of what was supposed to be South Korea's coming -out party (Robinson 2007). On June 29, 1987, after a month of particularly fie rce demonstrations, the government announced that it would restore civil ri ghts. The announcement came weeks after General Roh Tae Woo was selected as lea der of the government's civilian arm, the Democratic Justice Party, a move that was seen by many Koreans as a selection of a successor by President Chun (Robinso n 2007). The June 29 Declaration, as it came to be known, restored freed om of speech and association, including the right to organize labor unions. The w orkers and the intellectual leaders of the Minjung Movement immediately set about tryin g to organize independent labor unions. Within three months of restoration of civil rights, more than three thousand labor disputes occurred in South Korea (Koo 1991, 4 94-495). The spike in labor

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66 unrest rattled the democratic opposition because mo re conservative middle class Koreans were ambivalent about making fundamental ch anges to the development model (Cumings 1989, Koo 1991). Although white-coll ar workers such as educators and journalists were very interested in unionizing because of the notoriously authoritarian atmosphere in their workplaces, shopk eepers and small businessmen were more likely to be ambivalent about the greater bargaining power of workers (Koo 1991). Despite the unpopularity of the militar y regime, divisions within the opposition allowed Roh Tae Woo to win the president ial election later in 1987. Between Rho's election in 1987 and the presidential election of 1993, a struggle took place in civil society, both domestic and global, over the direction of economic and social policies. Continued labor strif e despite a downturn in economic performance in 1988 and 1989 further alienated the social democratic movement from the middle class. In particular, the “old midd le class” of shopkeepers and small businessmen, whose profit margins suffered from dou ble-digit wage increases that blueand white-collar workers received during thos e two years, increasingly came to view the labor movement as a threat to continued ec onomic progress (Koo 1991). The middle class and the elites found their interests c onverging more and more in the face of labor militancy. In 1990, the middle class oppos ition Peaceful Party, led by Kim Young Sam, merged with the ruling Democratic Justic e Party (DJP), formalizing the convergence between the bureaucracies, the chaebol and the old middle class. At the same time that the increasing acrimony in labor rel ations was alienating elements of the Korean middle class from the social democracy m ovement, elite support for economic reforms was growing, particularly for refo rms that would open the economy to foreign trade and investment. Internatio nal pressure on developing

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67 economies to globalize rose dramatically at the end of the Cold War, as advanced industrial countries shifted their foreign policy p riorities to increasing market access for goods and capital. Pressure to liberalize the K orean economy came through bilateral relations with the United States as well as multilateral international organizations and commitments, such as the IMF, the General Agreement on Tariffs and Trade (GATT), and the Organization for Economic Cooperation and Development (OECD) (Gills 1996). Domestically, pres sure continued to build from American-trained economists in the bureaucracy (esp ecially the EPB, paradoxically) and from the chaebol (Chang and Yoo 1999). Although the chaebol found some corporate governance and financial transparency ref orms advocated by liberalizing bureaucrats and pro-small business reformers worris ome, they fully supported globalizing reforms because they felt the increasin g need to shift production to cheaper locations in order to stay competitive (Gil ls 1996, 670). Despite stiff competition from Kim Dae Jung, who wa s perceived as more social justice oriented, Kim Young Sam's middle cla ss-elite coalition emerged victorious in the December 1992 elections. Although he had the support of the governing party and received campaign donations fro m the chaebol Kim Young Sam nonetheless ran on an antichaebol neo-liberal populist platform (Gills 1996, Weyland 1999). Even more conservative elements of t he middle class were dismayed at the amount of influence that the chaebol had in Korean society, so reforms that would limit their control over finance by enhancing transparency in bank ownership and introduce internal competition by lowering trad e barriers were popular, especially with the shopkeepers and small businessmen. Kim You ng Sam was seen as the “economics president” because he promised a package of reforms that would bring

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68 South Korea to first-world living standards, making consumer goods more plentiful and of higher quality while reducing the influence of the chaebol and creating an even playing field for domestic competition (Gills 1996, 676). While antichaebol rhetoric made Kim more popular with the middle class during the campaign, it made governing very difficult. There was constant tensio n between the interests of the chaebol and the interests of the nation as perceived by th e reformers in the government. During the first phase of Kim's preside ncy, when the government attempted to enact real name banking reforms2 and other reforms aimed at removing privileges for chaebol and military elites, the chaebol responded with a capital strike (Gills 1996, 681-683). While the government was having a difficult time tr ying to reduce chaebol influence over the economy, it was under pressure f rom both domestic and international sources to liberalize the capital acc ount. As the United States government and multilateral organizations were tryi ng to get foreign investors into the Korean economy, the chaebol wanted capital account liberalization so that they could get out. South Korea, increasingly seeing its elf as a first-world nation, was interested in joining the OECD, but capital account liberalization was a membership prerequisite. Within the government, there had been a significant amount of debate over whether capital account liberalization was rea lly a good thing. During the Roh administration, influential members of the EPB and other parts of the economic bureaucracy were becoming increasingly concerned ab out the de-coupling of finance from production, and they worried that the Korean e conomy was showing early signs 2 Real name banking reforms ended the elite practic e of opening multiple bank accounts under aliases, a practice that made illicit transactions easier to perform

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69 of de-industrialization (Gills 1996, 681-682). Chaebol were choosing to invest in subsidiaries in new industries rather than investin g in producing new technology through research and development, and speculation i n real estate and other nontradables was rife (Gills 1996, Smith 1997). As the next chapter discusses, the Korean economy was suffering from a lack of investment dem and due to technological dependence and human capital deficiency. In this co ntext, some leading economists within the bureaucracies warned that opening the ca pital account would lead to the chaebol outsourcing production to Southeast Asia, and that the influx of foreign portfolio capital could lead to macro-instability ( Gills 1996). Their warnings were not heeded, and the inflow of foreign portfolio capital sent the real exchange rate skyrocketing, creating a massive trade imbalance an d leaving the chaebol unable to service their debts because of unprofitability. Thu s, the banks that lent to them were vulnerable when a banking crisis in Thailand in Jun e 1997 sent foreign investors fleeing from emerging markets around the world. In the midst of the crisis, with IMF negotiations l ooming overhead, the Korean citizens elected former resistance hero Kim Dae Jung as their next president. Although this Kim had been a hero to many elements of the Minjung Movement, and the fact that he was South Korea's first leader fro m Cholla was very significant, his hands were nonetheless tied politically by the hars h program that the IMF sought to impose. Some accounts of the time period argue that Kim supported, and even advocated for, some of the planned IMF reforms (suc h restrictions on labor organization), even though Kim spoke out against th e IMF agreement's threat to Korea's economic sovereignty during the campaign (C umings 1998). Regardless, the IMF agreement succeeded in accomplishing what neo-l iberal reformers had wanted to

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70 do to the chaebol by forcing them to close inefficient subsidiaries and by introducing more transparency into the financial system. Outsid e intervention was required to execute reforms that the state had become too behol den to the chaebol to accomplish. The next chapter will investigate more closely the causes of the Korean financial crisis and will evaluate whether the IMF based its reforms on the right diagnosis of the problem. Conclusion The history of the developmental state in South Kor ea illustrates that the government can have a positive role in development, and that the socially constructed world views (that is to say, identities) of politic al and economic actors affect their behavior. In neo-liberal conceptions of economic gr owth, individual entrepreneurs and the financial intermediaries that fund them pro vide the impetus for economic development, with the state interfering out of eith er predatory self-interest or the need to repair market failures in the name of maintainin g legitimacy. In South Korea, by contrast, it was the state that took the initiative in development, dragging the timid, inexperienced Korean entrepreneurs into modern capi talism by forcing them to compete on export markets, rationalize production t echniques, and invest in technological upgrades. Models that assume that act ors are driven by narrow selfinterest miss the enormous differences between, for example, Park Chung Hee and his predecessor, Syngman Rhee. Whereas Rhee was content to focus on consolidating his power and building his political party, Park active ly sought, from day one, to transform Korean society, and the difference in out look affected their policy preferences and priorities.

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71 Although actors' identities inform their preference s and thus shape their behavior, they are nonetheless constrained by domes tic and international social structures. While Presidents Rhee and Park definite ly had different ideas about what they wanted Korean society to look like, they also faced different domestic political constraints based on the balance of power between g overnment and other elements of society. Even if Rhee were to have had a more expan sive vision for transforming Korean society, it is unclear if he would have been able to implement it given his dependence on wealthy landowners and entrepreneurs for political support. If he were to have stopped distributing foreign aid to support ers, they could have turned around and supported another person who was willing to dol e out the money to them. Therefore, the rise of the developmental state duri ng Park's presidency is not only attributable to his vision, but also the balance of power between the military and the wealthy elite at the beginning of his term. Park wo uld not have been able to impose his vision on Korean entrepreneurs without the cred ible threat that he would confiscate their property or cut them off from fina ncing unless they were willing to change their ways. Also, the wealthy elite he was i mposing on were still reeling, in many ways, from the upheaval of the Japanese war mo bilization, land reform, and the Korean War. Thus, they were not able to mount an op position to him. The failure of neo-liberal reforms to increase financial transpare ncy and reduce chaebol influence on the economy, by contrast, can be seen as a situa tion where visionary leaders (liberal reformers within the bureaucracies and the middle class opposition) were thwarted by oligopolistic business interests whose control over the economy gave them tremendous direct and indirect influence over the government. Despite the fact that Park's vision and discipline were critical in making South

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72 Korea the modern industrialized country it is today he was far from altruistic or benevolent, as the frequent protests that marred hi s tenure showed. Development in South Korea was far from egalitarian and was anythi ng but democratic. There were clear differences between the lifestyles of those w ho benefited from integration into the global capitalist system, and those who worked hard but earned very little. The inequality of capitalist development and the countr y's precarious place in the Cold War system were the two biggest causes of unrest du ring the developmental regime, and unrest was met with an iron fist. Response to u nrest was driven by a desire to stay in power, an authoritarian developmental ideology, and the inflexibility of development model itself. Continued investment duri ng the 1960s and 1970s was facilitated by the fact that chaebol and other businesses could count on the police to support them against unruly workers. The movement f or democratization can be seen as an outgrowth of the process Polanyi (1964 [1944] 130) called the “double movement”: as industrialization rapidly increased t he commodification of workers, women, and youths, the Minjung Movement arose as an organic social attempt to reduce the disparities between the winners and lose rs from development and to reunite the peninsula. Ultimately, the goals of the M injung Movement were not realized because of the contradictions of global capitalism that trap middle income countries. As labor became stronger over the course of the 198 0s, it began to threaten the livelihood of the white-collar workers who had join ed with the movement in opposing the military dictatorship because the firms they wo rked for stood to lose competitiveness if labor costs continued to increas e. Because Korean firms lacked confidence in local human capital capabilities, the y invested more in making products with off-the-shelf technologies that were subject t o diminishing returns, especially

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73 with emerging lower cost competition elsewhere in t he region. Social democracy would have threatened the development model because of the stratifying effects of the international division of labor, and thus became an unattractive option for middleclass voters. While the president's office was the spark of indus trialization during the 1960s and 1970s, Park did not formulate industrial policy on his own. An important aspect of Korea's success was the army of bureaucra ts and managers. The “information up, policy down” approach that charact erized business-government relations in the 1960s and 1970s was a textbook exa mple of embedded autonomy (Fields 1997, Evans 1995). However, embedded autono my broke down during the 1980s as the oligopolistic chaebol began to lobby actively for their own agenda and against reforms that would reduce their influence o ver the economy. Although some elements of the neo-liberal program, such as capita l account liberalization, were in the chaebols' interests, many of the reforms advocated by Korean bureaucrats during the 1980s and 1990s sought to curtail their strength. T hose reforms that would have hurt the chaebol were sidelined because the behavior of the preside ncy changed after Park was assassinated, and because the chaebol were able to carry out investment strikes that crippled the economy if reforms made productio ns or finance costs more expensive (Gills 1996). Chun Doo Hwan was less disc iplined and had more of a taste for the spoils of office than his predecessor, thus inviting more corruption and cronyism, and Kim Young Sam depended on chaebol support to fund his party (and not fund his opponents). In addition to the breakdown of state autonomy, ide ology also played an important role in transforming the developmental st ate. The neo-liberal wave that

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74 swept through the capitalist world system during th e 1980s and 1990s had a strong effect on Korean politics. Intellectuals, economist s, businessmen, and politicians who received college educations in the West, especially in the United States, brought the neo-liberal world view to Korean politics through t he business associations, the bureaucracies, the media, and in the presidential e lections of 1992. Kim Young Sam's antichaebol pro-globalization rhetoric during the 1992 campai gn reflected his roots in the moderate-to-conservative element of the midd le class and his American education, and had much in common with similar neoliberal populist leaders vying for power elsewhere in the world during the time pe riod (Koo 1991, Weyland 1999). However, intellectual commitment to reforms ran up against the structural power of the chaebol, creating a situation in which liberalizing reforms that the chaebol liked, such as capital account liberalization, were enacte d relatively quickly while reforms that would have made life more difficult for them, such as new financial regulations that would enhance transparency and slow down specu lative investment, were held up by investment strikes or through corrupt practices (Gills 1996). Thus, it can be said that one of the reasons neo-liberal reforms failed in South Korea was because the state did not have the autonomy to transform the bu siness sector until economic catastrophe followed by foreign intervention cleare d out the status quo economic powers, similar to how land reform and the Korean W ar weakened the traditional elites enough to allow the military to drag them in to modernity. Since the IMF agreement, the contradictions of demo cracy in a semiperipheral economy have continued to create simmeri ng political tensions between those who want to secure greater compensation for t hose marginalized by capitalist development and those who want South Korea to stay competitive in the global

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75 economy. Tensions bubbled to the surface in 2004 wh en conservative politicians tried to impeach the relatively progressive president, fo rmer human rights lawyer Roh Moo Hyun, amidst widespread protests over a controversi al free trade agreement with Chile and over the continued presence of American s oldiers in South Korea, as well as the presence of Korean troops in Iraq. New tensi ons created by increasing foreign direct investment have also emerged. In February, w orkers for the South Korean automotive firm Ssangyong that was bought by China' s Shanghai Automotive Industry Corporation protested the Chinese company' s decision to lay off workers in the South Korean plants, and have accused the Chine se firm of stealing the Korean company's proprietary technology ( New York Times 2/23/09, A6). The situation illustrated popular concerns that Korean efforts ov er the years to develop their own products using their own technologies, which were a critical aspect of their economic success, would be wasted by allowing foreign firms to take control of Korean firms. With the current economic crisis hitting South Kore a particularly hard, elite commitment to democracy will almost certainly be te sted again in the future.

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76 III. Financial Liberalization and Financial Crisis in South Korea A core tenant of the Washington Consensus over the last three decades has been the idea that developing countries need to lib eralize their financial sectors. Financial liberalization and internationalization a re supposed to help countries raise the capital they need in order to develop by attrac ting foreign investors, who are drawn by potentially higher rates of return in lowcost countries. However, after two decade of increasing global financial integration, the data would seem to suggest that the experiment has failed. Prasad, Rajan, and Subra manian (2007) have shown that financial globalization has actually led to net cap ital flows from south to north, directly contradicting the theoretical expectations Rodrik and Subramanian (2009) have argued that financial globalization has done m ore harm than good to the developing world, as financial liberalization has b een more likely to lead to financial crisis than to sustained increases in growth in dev eloping countries. Because developing countries lack the capabilities necessar y to earn high returns on investment, capital inflows created by financial gl obalization will not necessarily lead to sustainable economic growth. If you give an entr epreneur in a developing country $50 million to invest, and then ask that person abo ut investment ideas for his or her country, “your question will be met by a long silen ce, followed by the riposte: 'do I have to invest the $50 million here?'” (Rodrik and Subramanian 2009, 17). Furthermore, there is a long list of countries like Argentina, Mexico, and South Korea that have experienced currency crises within a few years of liberalizing their financial sectors.

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77 Have the developing countries that have attempted f inancial liberalization during the last 20 years been too politically inept to carry out reforms effectively, or is there a deeper theoretical problem with the notion of financial liberalization itself? In other words, is the problem political or theoretica l in nature? This chapter takes a two-pronged approach to analyzing financial liberal ization. First, the arguments in favor of financial liberalization and their underly ing assumptions will be interrogated. In particular, since unleashing the animal spirits of international finance is supposed to create economic growth, the theoretical linkages between financial liberalization and economic growth will be a major subject of foc us. Then, the history of economic development in South Korea begun in the previous ch apter will be extended to cover Korea's experience with financial liberalization an d financial crisis during the 1990s. Although Korea's political system received much of the blame for encouraging speculative over-investment, in reality it was the market that created overcapacity, non-performing loans, and the eventual bank run tha t forced South Korea into IMF receivership in the winter of 1997. The economy was vulnerable to crisis because financial liberalization worked the way it was supp osed to in some important ways. By facilitating acquisition of off-the-shelf techno logies and creating massive capital inflows without creating incentives or capabilities for innovation, liberalization created massive speculative bubbles in manufacturin g and offshore financial services. Part A: Finance and Economic Growth The Neoclassical Story In the financial liberalization literature, the dev elopment of financial intermediaries are a first-order cause of economic growth because developing

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78 countries are seen as savings constrained, and ther efore investment constrained (Levine 1996, Fry 1997). Well-functioning systems o f financial intermediation facilitate the trading, hedging, diversifying, and pooling of risk; allocate scarce capital efficiently; monitor managers and exert corporate c ontrol; mobilize savings; and facilitate the exchange of goods and services acros s greater distances of time and space through futures contracts and commercial pape r (Levine 1996, 6). Financial liberalization is necessary because it deepens the reach of the financial system and creates a competitive market of financial intermedi aries that keeps lending rates low and deposit rates and return on investment high, th erefore increasing the supply of loanable funds (Shaw 1973). Through the inflation t ax, caps on interest rates, directed credits, deficit spending, and other forms of indus trial policy, developing countries are seen as repressing financial markets (Fry 1997) Opportunities to invest are plentiful, but perverse incentives created by gover nment intervention into the economy encourage investment in low-return activity The solution is to allow the market to set interest rates, which will weed out t he high-return activities by selfselection (Fry 1997). “Growth in the financially re pressed economy is constrained by saving; investment opportunities abound here” (Fry 1997, 755-756). By focusing their attention solely on the financial market, and keeping all else static, neoclassical theory completely misses the c hallenge of development in the 21st century. The problem is precisely that high-return investment opportunities that are subject to increasing returns do not abound in developing countries. Levine's (1996, 26-28) parable about a hypothetical entrepreneur's interaction with financial intermediaries is a wonderful example of how econom ists can create well reasoned analytical models that have nothing to do with real ity. Engaging with Levine's parable

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79 can be illustrative of some of the problems faced b y late developers. “Consider Fred, who has just developed a design for a new truck tha t extracts rocks from a quarry better than existing trucks.” This first sentence i s the most problematic sentence in the thought experiment, and the one that makes it irrel evant for developing countries because, in most developing countries, Fred does not exist! The problem of financing development is that before Fred has an idea about m aking a better truck, he needs to learn how to make a truck to begin with. That impli es high fixed costs associated with educating engineers, educating managers, finding wa ys to produce component products (or importing them) at competitive prices, and learning-by-doing for a period of time, which implies low profits or losses And he needs to know how to market it in other countries, or develop relationsh ips with those who do, so that he can convince consumers to buy his truck, even thoug h they have never heard the name of it before. In Fred's absence, financial int ermediaries in developing countries have more incentives to invest in low-return, low-r isk activities unless there is a coordinating mechanism, such as industrial policy. Unlike the Industrial Revolution in Britain (Levine 1996, 8), developing countries are not in a situation where there are a bunch of inventors sitting around with designs for products that they have no money to produce themselves; rather, the problem is that they need to learn, not just how to produce, but how to innovate. In addition to the absence of Freds in developing c ountries, there are other problems with theories of financial liberalization. In particular, the efficacy of stock markets for financing development has been question ed because of the large information asymmetries that exist between firms an d investors (Stiglitz 1989). Screening investors is made difficult by the fact t hat the entrepreneurs who are most

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80 willing to sell shares in their firms include those who believe, or know, that the market has overvalued their shares (Stiglitz 1989, 57). Managers have a pecking order of finance, preferring retained earnings over bank debt over equity because investors in equity markets tend to have shorter-term prefere nces than banks, and retained earnings do not require any sacrifice of managerial autonomy at all (Singh 1997, 773). Developing country stock markets also suffer from a lack of transparency. Outside of a few blue-chip stocks that dominate mos t of the market capitalization, most stocks are low-yielding and these stocks suffe r from information and disclosure deficiencies (Singh 1997, 772). Thus, “the disadvan tages of equity seem, in most cases, to outweigh the advantages” (Stiglitz 1989, 58). With liberalized capital accounts, the large influx of foreign portfolio cap ital into developing country stock markets can exacerbate information asymmetries, mak ing instability much more likely. In addition to the already present informat ion asymmetries, international investors must ration information about investment choices, meaning that they may look at fewer indicators or the wrong indicators to judge an investment's worthiness (Mosley 2003). Financial liberalization theory has significant sho rtcomings, and has not been particularly successful in many of the places it ha s been tried. In response to the empirical challenges, an advocate of financial libe ralization, Fry (1997, 759), listed five prerequisites countries must meet before they liberalize their financial sectors: adequate prudential regulation and supervision of b anks, price stability, fiscal discipline, profit-maximizing competitive behavior by commercial banks, and a tax system that does not impose discriminatory or impli cit taxes on financial intermediation. It is unrealistic to expect a devel oping country to meet some of these

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81 expectations. In fact, recent events have provoked doubt about regulation and supervision of banks within the core of global fina nce. Furthermore, countries that have low levels of capital accumulation are more li kely to have oligopolistic or monopolistic rather than competitive banking sector s. However, the deeper problem with financial liberalization theory is that it doe s not take into account asymmetries in productive capabilities. Simply put, you can struct ure a financial system any way you want, but it will not make a difference if you do n othing to improve productive capabilities. A liberalized financial sector in a t echnologically dependent country will not create movement up the technological ladder bec ause the risk of failure is too great and the rewards, great as they may be, are no t guaranteed to be appropriable by those who finance research. Technology and Economic Growth Developing countries are capability -constrained at least as much as they are savings constrained. Differences in technological c apabilities across firms create market power within industries, and differences in technological capabilities across countries create patterns of dependency. In order t o understand the relationship between technological capabilities and financing de velopment, a brief review of the role of technology in prominent theories of growth is helpful because technology's impact on developing countries' market structures s hapes the incentives of economic actors. Early models of economic growth held techno logy constant, which led them to the conclusion that free capital flows across borde rs would, ceteris paribus lead to income convergence between rich and poor countries. In this world, price-taking firms compete to produce at the lowest cost possibl e, earning profits by undercutting

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82 the competition. New growth theory has tried to inc orporate innovative capabilities into the equation by introducing technology and hum an capital, with the implication that income convergence is conditional upon capabil ity convergence. The new models suggest imperfectly competitive market structures w ith increasing returns to scale resulting from continuous innovation. The unequal d istribution of innovative capabilities structures the international division of labor, as some regions of the world (the core) reap the rents from the design, marketin g, and provision of vital capital inputs for products that are assembled in countries on the semi-periphery and periphery (Smith 1997, Bernard and Ravenhill 1995). Differences in technological capabilities explain, at least partially, why incre asing international capital mobility has not resulted in income convergence, but has ins tead been correlated with income divergence (Prasad, Rajan and Subramanian 2007). Fu rthermore, differences in technological capability, as well as global trade a nd financial liberalization, have created regional production networks that string to gether factories, laboratories, and design centers across multiple countries under the heading of a multinational firm (Bernard and Ravenhill 1995). These regional produc tion networks are the empires Frankel (1998) was talking about, in terms of their behavior, market power, and political power. A country's relationship with regi onal production networks has a major influence on the behavior of the country's fi nancial system because it structures the investment opportunities that are available for financial intermediaries and foreign investors. Because the Solow growth model (1956) leaves techno logy out of the equation, it conceals the advantages that firms in developed countries have in global markets. Exogenous technology and innovation mean t hat firms do not benefit from

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83 experience or learning, so there are no natural3 barriers to entry and competition for new firms from other parts of the world, making mar kets perfectly competitive. The Solow model's assumption of diminishing marginal re turns to capital reflect this underlying assumption of perfect competition betwee n firms. Because firms do not benefit from experience, each additional unit of ca pital will yield a smaller increase in output than the previous unit. Developed countries, which have higher capital-tolabor ratios (indicating that they specialize in mo re capital-intensive production), are expected to have lower marginal productivity of cap ital than developing countries, which are relatively capital scarce. Therefore, in an open global economy, capital will flow from developed countries to developing countri es until the marginal productivity of capital is equalized. The assumption of constant returns to scale also feeds the perception of a perfectly competitive market econom y. Because firms do not receive decreasing per-unit costs as output expands in the model, larger firms do not have any advantages over smaller firms. Since innovation and invention are exogenous, the only way firms can maximize profits in the model is through cutting costs and maximizing output as much as possible, and this dri ves capital to roam the world searching for the lowest input costs and highest re turns on capital, which are found in labor-abundant, capital-scarce developing countries New growth theory attempts to overcome the shortcom ings of the neoclassical growth model by incorporating technologic al change and imperfect competition into the equation (Romer 1994). Instead of technology being a public good that is equally available across firms, new gr owth theory sought to take into 3 By “natural” I mean those barriers to entry and c ompetition that are not the result of government intervention; rather, they are informal barriers, p articularly to competition, that are created by vastly superior knowledge or experience

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84 account the fact that firms seeking short-term rent s from monopolistic competition invest in technological innovation. Romer (1990) co nceives of technology as a nonrival, partially excludable good. While legal in stitutions such as patents, as well as the specialized nature of most technological innova tion, create temporary rents from innovation, the nonrival nature of knowledge means that other firms will be able to learn-by-doing, competing away profits over time. “ A firm incurs fixed design or research and development costs when it creates a ne w good. It recovers those costs by selling the new good for a price that is higher tha n its constant cost of production. Since there is free entry into this activity, firms earn zero profits in a present value sense” (Romer 1990, S73). Since not all research is specialized innovation by profitmaximizing firms, the technological component is di vided into two sectors: the finaloutput research sector, and the basic research sect or, which is usually general research funded by governments and universities (Romer 1990) To illustrate how the two work together, Romer (1990) uses the example of the video cassette: governmentfunded basic research established the principles of optics that were used by the private firm that created the particular instructio n for putting together raw materials to produce the desired effect. For present purposes, the issue raised by the endog enous growth literature is under what conditions do firms in an economy undert ake research that goes beyond learning-by-doing and that allows firms to capture rents from product innovation? Say a firm in a developing country that has investe d significantly in all levels of education (thereby creating a solid pool of human c apital) decides to manufacture cars. It hires researchers to take apart cars from more advanced companies, put them back together, and infer how they work. Then, it hi res more engineers to figure out

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85 how to mass-produce the cars and the inputs. Assume the firm has a captive domestic market (protected by tariffs) and that, over the co urse of several years, becomes more efficient at making cars, and seeks to market the c ars for export (for example, because of directed credits with incentives to export attac hed to them). Because of low labor costs, the firm is able to compete on international markets on the basis of price, but its product does not work as well as more advanced cars designed in more advanced countries. Now say that a real appreciation in the exchange rate and demands for higher wages by workers causes the cars to be less competitive in export markets, and the firm's profitability is squeezed. Furthermore, a foreign hegemonic power is pressuring the firm's government to lower trade bar riers while at the same time insisting on the imposition of “voluntary” export r estraints in the automotive industry. The normal case for free trade is that competition will give this firm an incentive to invest in improving their product or production pro cesses. Theoretically, this firm will shift its investment from “learning” to “innovating ,” creating new information that would allow the company to capture rents by either undercutting or offering a better product than their competitors. Regional Production Networks and Technological Depe ndence However, this firm will choose to outsource product ion to lower cost suppliers elsewhere in the region, and adding some context wi ll help explain why. When the firm was planning to manufacture cars, suppose that it entered an agreement with a more advanced firm from a wealthier country to impo rt more complicated aspects of the car as well as design schemes, so that it makes better cars earlier than if it invested for years in reverse engineering. While this agreem ent allows them to bring better

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86 products to market sooner, it creates a dependence on the advanced country firm that impedes the transfer of technology. This firm is no w renting another firm's expertise at the expense of developing its own. Thus, after a few years of learning to work with the imported technology, this hypothetical firm bec omes very good at assembling cars, not designing or marketing them. Faced with r ising labor costs, it will export its comparative advantage in knowing how to put things together to firms in lower cost countries that are starting to enter the industry b y sending factory managers and equipment to these locales. This scenario more accu rately captures the challenges face by newly industrialized countries who, after a spurt of rapid growth stemming from investments in “catching up,” are stratified i n their place in the international division of labor by technological dependence. Regi onal production networks are manifestations of technological dependence. In contrast to the atomistic national economies lin ked by exchange of final goods depicted by neoclassical models, the global e conomy is increasingly characterized by regional production networks in wh ich design, production of critical inputs, final assembly, and marketing of products o ccur in different countries, linked together under the umbrella of a single multination al entity (Bernard and Ravenhill 1995, Smith 1997). Rents from innovation accrue to the countries that source the branding and designing of products, as well as manu facture of critical inputs, while the countries that produce standardized components and assemble imported inputs into final products according to imported instructi ons compete on the basis of comparative labor costs and productivity. While fir ms in developing countries may derive rents from process innovations gained from e xperience in product assembly, this knowledge acquired from learning-by-doing and using “off-the-shelf”

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87 technologies (Levine 1996, 25) is subject to dimini shing returns in the face of constant wage competition. In theory this should sp ur them to invest in creating their own technology, but in reality increasing investmen t in innovation requires access to higher education resources and specialized research to which, for legal and historical reasons, developing countries do not have access. F irms do not have the incentive to invest in developing human capital capabilities and basic scientific research that are prerequisites for advanced technological innovation because innovation is not guaranteed to happen, and if it does, it will only be partially appropriable at best. Therefore, middle-income countries that can no long er compete on the basis of labor costs, but at the same time do not have the capabil ities to improve technology, are caught between a rock and a hard place, as the prof itability of their firms declines and as firms in advanced countries continue to pull awa y on the strength of product innovation. Technological Dependence, Financial Liberalization, and Currency Crisis Advocates of financial liberalization argue that th e competitive financial intermediaries that liberalization creates will lea d to investment in technological innovation by lowering transaction and information costs. Government intervention in the market for loanable funds through directed cred its and caps on interest rates creates adverse selection by encouraging intermedia ries to invest in lower-return activities that would not be profitable at higher i nterest rates, and by basing investment choices on political rather than strictl y economic criteria. By allowing credit markets to set the real interest rate, finan cial liberalization leads to a higher level of investment (by increasing savings) and act s as a rationing device to greater

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88 investment efficiency because only entrepreneurs wi th high-return projects will be profitable, so they will be the only ones who apply for loans (Fry 1997, 755-576). Well-functioning financial intermediaries “boost th e rate of technological innovation by identifying those entrepreneurs with the best ch anges of successfully initiating new goods and production processes” (Levine 1996, 1 4). The problem with this line of argument is that, in newly industrialized econom ies that cannot compete with core countries on the basis of technological innovation, the better entrepreneurs do not exist, and liberalized financial sectors do not cre ate the incentives to undertake the illiquid, long-term, and extremely high-risk invest ments in developing innovative capabilities that may take a very long time to turn profitable. Instead, liberalization of domestic loan markets and increasing the opportunit ies for foreign direct investment are more likely to worsen technological dependence and increase the vulnerability of the economy as a whole. First, opening the capital account will lead to an inflow of foreign portfolio capital, which can lead to destab ilization for a number of reasons. Second, unimpeded foreign direct investment allows foreign firms to source production in a country without even bothering with technology transfer. Third, financial liberalization comes with a number of pre requisites (see Fry 1997) that many developed countries have trouble meeting, much less developing countries characterized by imperfect competition (and therefo re the presence of market power, that naturally comes with political power). Financi al liberalization is more likely to sharpen boom and bust cycles rather than create the long-term boom that advocates often promise to countries that leave themselves to the whims of the global market. Newly industrialized countries that are capabilityconstrained are dominated by diminishing marginal returns activity, so a rush of capital into the system is likely

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89 to create bubbles in liquid, low-risk, low-return a ctivities. Liberalization of capital inflows tends to create an influx of short-term por tfolio capital, which worsens already-existing bubble situations and creates new ones in activities such as real estate development and consumer finance. These infl ows worsen the current account by causing the real exchange rate to appreciate. Fu rthermore, portfolio capital flows are strongly pro-cyclical, meaning a country is lik ely to attract them when it needs them the least (such as when a real estate market i s booming from domestic investment) and they are the first ones to leave at the sign of trouble (Mosley 2003). Information rationing and portfolio diversification across countries create the risk of contagion, as problems in one developing country ca n lead worried advanced-country investors to withdraw funding from all emerging mar ket assets in their portfolio (Mosley 2003). Palma (1998, 790) argues persuasivel y that the 1982 debt crisis, 1994 Mexican “Tequila Crisis,” and the 1997-98 East Asia n crisis were all caused, at least in part, by an over-willingness on the part of the international financiers to overlook the problems of developing countries and invest in them because of the pressures caused by a “buyers' market” for international fund s. In short, opening the capital account creates the risk of far too much investment capital chasing too few opportunities and not creating any new ones. While foreign direct investment is not as unstable as portfolio flows, it comes with its own risks for newly industrialized countri es. Foreign direct investment can help a country's firms gain experience in producing for export markets, but allowing complete foreign ownership of productive capabiliti es will stifle technology transfer rather than create it (Evans 1979). Foreign ownersh ip of productive capacity makes an economy more vulnerable to cost pressure and pol itical risk. A multinational firm

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90 will choose where to source its production units ba sed on relative costs and politically designed incentives, such as preferential market ac cess. Thus, not only does a firm in a newly industrialized country that depends on mult inationals sourced in advanced industrial countries for technology face competitio n from cheaper neighbors, but it is also vulnerable to changes in the real exchange rat e with major trade partners as well as protectionist swings in the policies of major tr ade partners. A major difference in the pattern of industrialization in South Korea fro m the experiences of Latin American countries is that the Korean government re stricted foreign ownership of Korean assets to under 50%, which created more tech nology transfer and better opportunities for domestic firms to build their own capabilities (Evans 1987, Koo 1987). Therefore, while foreign investment can be a good thing if it builds capabilities, the wrong kind of foreign investment could leave a country vulnerable to exogenous politically constructed shocks on its cos t structure. Inflows of foreign capital require that a country's financial system be capable of allocating capital efficiently, but, as argued e arlier, developing countries lack the regulatory framework required to make this possible and this fact is often blamed for the presence of currency crises in the developing w orld. Kaminsky and Reinhart (1999) did a cross-national study of a number of cu rrency crises, and concluded that financial crises are the result of financial libera lization amidst weak regulation and poor banking supervision. In their parable of finan cial crisis (1999, 494-496), a country enjoys an economic boom, but weak banking r egulations lead to a build-up of bad loans. When the economy enters a downturn (for whatever reason), the banks become insolvent, and then all hell breaks loose. T hey conclude that “among the lessons that emerge from this analysis is the obvio us case for strong banking

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91 regulation and supervision to allow countries to sa il smoothly through the perilous waters of financial liberalization” (1999, 496). Ho wever, given the effects of technological dependence on newly industrialized co untries, this may be too limited of a conclusion to draw from emerging market financ ial crises because it does not take into account the deeper causes of currency cri ses. Conclusion Middle-income countries like South Korea suffer fro m constraints on technological capabilities that prevent them from t ruly competing with advanced industrialized countries, yet their higher wage rat es and standards of living make them unattractive locations for low-cost production Therefore, the risk is that massive investment inflows will create precisely th e situation that Rodrik and Subramanian (2009) brought up, where entrepreneurs receive large sums of money and ask themselves “must we invest it here?” While the risk of political failure in implementing financial liberalization is high, that is as much a theoretical failure as it is a problem with political systems in developing c ountries. One can hear echoes of Friedrich List in Rodrik's (2007) criticism that ec onomists tend to advocate policies that would work in an ideal, frictionless world eco nomy, but these policies are not realistic in a world of national governments that h ave their own interests and responsibilities to which to respond. In the theore tical world economy, financial liberalization along with reforms to make the banki ng sector competitive, investments in human capital and basic science research, and re gulations that prevent the rise of asset bubbles can create economic growth. In the re al world, where capability and political constraints prevent all of these cognate policies from passing, financial

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92 liberalization can be dangerous, as South Korea lea rned in the 1990s. Part B: South Korea in the Asian Financial Crisis, 1997-98 The East Asian Financial Crisis took the financial world by surprise because it occurred in the region that the World Bank hailed a s 'miraculous' just a few years before (World Bank, 1993). In June 1997, a banking crisis in Thailand forced the government to draw down its hard currency reserves trying to bail out banks. When the government revealed that it was running out of foreign reserves, international portfolio investors scrambled to get their money ou t of the Thai baht. In following weeks, international investors began the flight to safety out of potentially hazardous emerging markets, causing currency devaluations and debt defaults around the world. Other East Asian countries were particularly hard h it, especially South Korea and Indonesia, who joined Thailand in IMF receivership by the end of 1998. The crisis was surprising from an intellectual perspective bec ause it followed a different pattern from the developing country financial crises of the 1980s, for which the first generation of financial crisis models was developed (see, for example, Krugman 1992, chapter 4). The Latin American Debt Crises of the 1980s were sparked, in most cases, by balance of payment crises. High-priced te chnology imports were used to make products that could not compete on internation al markets, leading to persistent high trade deficits which were funded by borrowing in dollars from foreign banks. At the same time, governments ran budget deficits in o rder to subsidize state-owned firms as part of their import-substitution industri alization plans. Thus, when interest rates on adjustable-rate dollar loans skyrocketed i n the early 1980s, as the United States tried to fight domestic inflation, the Latin American countries did not have

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93 enough hard currency to pay off their loans, creati ng currency crises and hyperinflation. The state became the prime culprit in these crises because, through state ownership of important industries and protect ionism, it prevented firms from being forced by market competition to improve outpu t efficiency and quality, making them uncompetitive in international markets. Reform efforts focused on withdrawing the state from the economy and re-structuring the s tate-owned firms. In contrast to the Latin American cases of the 1980 s, it appeared that the private sector was the culprit in East Asia. Wherea s states accumulated excessive debts in Latin America, private sector financial in stitutions and business conglomerates accumulated the vast majority of debt in the East Asian cases (Radelet and Sachs 2000). Asset bubbles in regional stock an d real estate markets and nonperforming loans issued by private banks to private firms created badly overleveraged business conglomerates that were vulnerab le to sudden changes in external economic conditions. Some early, influential explan ations for the East Asian crisis focused on how close ties between business elites a nd government officials created perverse incentives that led banks to continue maki ng bad loans to uncompetitive firms. In South Korea's case, close ties among bure aucrats, politicians, and businessmen prevented the state from having the aut onomy to force insolvent banks and uncompetitive firms to shut down. Continued wil lingness on the part of government to keep bailing out insolvent banks, as well as heavy chaebol influence over the financial sector, created moral hazard. Th e banks thought they could continue to keep uncompetitive firms alive by pumpi ng capital into them as long as the state would be there to bail the banks out (Kru gman 1998, Frankel 1998, Krueger and Yoo 2000). Thus, the accumulation of non-perfor ming loans in the private sector

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94 was the result of government unwillingness to let t he market run its course. However, in their haste to blame the state for making Korea vulnerable to contagion, economists who advanced the moral hazard story failed to expla in why the massive build-up of private sector debt in the years leading up to the crisis coincided with sound macroeconomic fundamentals as well as the state's w ithdrawal from the financial sector. A more accurate account of the financial crisis beg ins with the withdrawal of the state from the economy. While financial liberal ization did lead to financial deepening and made capital more available to firms of all sizes, the policies had the unintended effects of creating speculative bubbles in financial services and industries in which South Korea had an established comparative advantage. Before internationalization of the financial sector began in 1991, there were already concerns that financial liberalization was de-coupling finan ce from productive activity (Gills 1996). By the end of the 1980s, non-bank financial institutions had begun to supplant more heavily regulated commercial banks as the domi nant sources of finance capital for the chaebol (Chang et al 1998). The large industrial conglomerates displayed a stronger preference for expanding financial service s offered by chaebol -dominated financial institutions and opening subsidiaries to compete with other chaebol than investing in new sectors or research and developmen t to improve existing technologies (Gills 1996). By making off-the-shelf technologies more available, financial liberalization induced the formation of b ubbles in industries in which South Korea had developed comparative advantages. Interna tionalization of the financial sector also led to the creation of bubbles in finan cial services, particularly the offshore financial centers that emerged in the earl y 1990s to arbitrate between

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95 American, Japanese, and other Asian interest rates (Kregel 1998). Merchant banks would borrow short-term on international currency m arkets and lend long-term to firms in South Korea and elsewhere in Asia at highe r interest rates. Reforms in 19941996 made it easier for foreigners to buy debt liab ilities from South Korean banks and firms, much of which was short-duration (Chang et al 1998). The ratio of short-term debt to foreign exchange reserves began to increase rapidly during 1996 and 1997 as export receipts fell and firms and banks alike cont inued to borrow heavily from international capital markets. The country was push ed into insolvency in 1998 after IMF conditionalities imposed in the winter of 1997 that were aimed at restoring the health of the financial sector by raising interest rates pushed already teetering firms and banks over the edge, causing a sharp contractio n in output and rise in unemployment and diminishing what remained of the c ountry's hard currency reserves (Radelet and Sachs 2000, Kregel 1998). Therefore, while political failure to guard against chaebol takeover of the financial system contributed to the weakness of the Korean economy in 1997, ultimately the economic failure can be linked to fl aws in the underlying reasoning behind liberalizing reforms. Financial liberalizati on destroyed an institutional arrangement that, while not without its flaws, was nonetheless well-suited for South Korea's place in the global economy, and replaced i t with institutions that were more appropriate for an idealized world. South Korea is on the semi-periphery of global production processes, so it depends on access to te chnology from and export markets in more advanced (and politically powerful) countri es while facing constant competition from lower-cost labor markets. Thus, it s current account balance is constantly in flux, as adjustments in exchange rate s, protectionist changes in trade and

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96 intellectual property laws in advanced countries, f luctuations in consumer demand in economies of trade partners, and the entrance of lo wer cost competitors create the risk of rapid and drastic changes in trade flows. Furthe rmore, the country must borrow abroad in order to finance economic expansion, addi ng to the precariousness of its position. Persistent balance of payments deficits c an draw down hard currency reserves. While international investors are always willing to finance expansion when economic prospects are good, they are often unwilli ng to lend and anxious to exit when the country needs capital the most during econ omic downturns (Mosley 2003). The developmental regime ameliorated some of the ri sks created by the structural features of the international division of labor by tempering pro-cyclical international capital movements. Also, through infant industry pr otection and industrial policy, the previous regime provided domestic firms with a sign ificant margin of error in the event of sudden balance of payments reversals creat ed by exogenous demand shocks (Kregel 1998). Furthermore, the 'information up, po licy down' model of investment decision-making under the developmental regime reli eved information asymmetries inherent to financial markets that can lead to the creation of overcapacity. Financial liberalization in South Korea eliminated institutions that created some semblance of balance in an economy with an unb alanced, structurally leveraged development model. Allowing firms to borrow at will while stripping state planning agencies of their responsibilities increased compet ition, as advertised. However, increased competition created overcapacity in indus tries in which South Korea was already competitive. Although increased competition was supposed to make firms more profitable by forcing them to compete for mark et share, in reality increased competition withered away the profitability of alre ady-existing firms by removing

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97 domestic monopolies and creating additional pressur e on foreign market shares. Competition did not give firms sufficient incentive to invest in research and development, as lack of confidence in domestic huma n capital capabilities and decreasing margins of error on future investments f rom increasing competition made firms reluctant to invest in innovation (Gills 1996 Smith 1997). As multiple firms began pouring into the same industries, the profita bility of each firm fell and the risk of failure rose, but the massive inflow of foreign capital and the optimism of each individual firm overwhelmed concerns about economywide overcapacity. Without the coordinating mechanism of the Economic Planning Board (EPB), there was no way of guarding against over-investment. Even in th e late 1980s, when the EPB was gradually stripped of its authority before being di smantled in 1993, overcapacity began to emerge in the petrochemical industry becau se of a refusal to rationalize production in the name of letting the market work ( Chang et al 1998). In order to better understand the mechanisms at wor k in the 1997-98 crisis, a contrast with a previous economic crisis in 1979-19 80. As discussed in the previous chapter, the 1970s witnessed a major effort by the government to invest in heavy industry not just as a means to increase the countr y's wealth, but primarily as a means of providing the military with sufficient weaponry and ammunition. While the selection of firms to work with may have been subje ct to some amount of cronyism, the government's investments in the POSCO steel mil l and other projects were closely supervised by the president and top economic offici als, who insured that the project was completed on time and that products were of suf ficient quality (Amsden 1989). Economic growth hit a major stumbling block when th e Second Oil Shock provided a simultaneous supply and demand shock. On the supply side, important inputs became

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98 more expensive and the cost of transporting finishe d products spiked, while on the demand side, growth in the economies of major tradi ng partners dropped off significantly. While government pet projects suffer ed during 1979 and 1980, success of companies like Pohang Steel and Hyundai's shipbu ilding arm, both of which began during the heavy industrialization program and went on to be world leaders during the 1980s in their respective industries, would seem to vindicate the development model, despite its exposure to the crisis (Chang and Yoo 1 999). Whereas the 1979 crisis was driven by national secu rity needs and exogenous shocks, the 1990s crisis was driven by speculation. The trends in manufacturing growth, current account, and exchange rates in Tabl e 1 illustrate that after high manufacturing growth in the late 1980s related to s trong export performance, manufacturing growth slowed down during the 1990s a nd Korea returned to running annual small current account deficits. The spikes i n manufacturing growth in 19901991 and 1994-1995 occurred during years when the K orean government took significant steps to internationalize the financial sector. Liberalization of foreign exchange transactions and rules for foreign investm ent in the first period and internationalization of the market for corporate de bt liabilities in the second period created a rush of foreign investment into the count ry. Chaebols opened subsidiaries in new industries to compete with other chaebols – the effect of off-the-shelf technology being made more available (Gills 1996). Whereas the manufacturing boom of the late 1980s coincided with current account surpluses and strong export performance, the manufacturing expansion in 1994 and 1995 was associ ated with stagnating high-tech export growth, rising current account deficits and appreciation of the won against the dollar. These data suggest two trends were occurrin g: increasing international

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99 overcapacity in industries that chaebol were entering into, and appreciation of the won driven by inflows of foreign capital into the K orean financial sector. In addition to speculative over-investment in the p roductive sector, liberalizing reforms eliminated institutional safeg uards against de-stabilizing growth and internationalization of the financial sector. R estrictions on foreign investment were meant to assure that the capital account alway s supports the current account so that the exchange rate remains stable. Rapid capita l inflows can lead to an appreciation of the currency, which can be deadly f or a country that depends on lowcost exports for economic growth. Furthermore, hard currency reserves are scarce in developing countries because of their need for debt to finance expensive foreign capital inputs, and because of the threat of exogen ous shocks to export demand. In South Korea, the developmental regime restricted th e use of foreign exchange and monitored all incoming foreign investment to preven t speculative overcapacity. Financial liberalization eliminated these instituti ons because they were seen as protecting inefficient firms from having to compete for financing, but in reality these institutional arrangements were in place because th ey protected the economy from exactly the kind of speculative financial activity that occurred in the years following the liberalizing reforms. As soon as restrictions w ere lifted on financial institutions' uses of foreign exchange and international lenders no longer needed to prove that investments were filling real market demand in 1990 and 1991, the chaebol rushed to open merchant banks and offshore financial centers that speculated heavily in South Korea, Thailand, Indonesia, and other parts of Asia (Chang and Yoo 1999, Kregel 1998). Despite growing systemic risk, macroeconomic indica tors did not show signs

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100 of serious trouble, and the international financial markets continued to show confidence in the South Korean economy. In hindsigh t, 1996 was a year of foreboding. The current account deficit rose sharpl y, the won appreciated against other major currencies, real interest rates rose fr om 2% to 4%, manufacturing growth plummeted, the share of high-tech exports among all other manufacturing exports fell 2%, the ratio of short-term external liabilities to foreign exchange reserves reached 279%, and, most alarmingly, excess inventories skyr ocketed (IMF and World Bank data, see Table 2). The source of the appreciation of the won is somewhat unclear. While there is a good chance that increasing foreig n capital inflows contributed to it, the decision by Japan to allow the yen to depreciat e in 1995 also contributed to the rise in the real effective exchange rate (Johnson 1 998). However, macroeconomic fundamentals did not look worse than if the country was entering a relatively mild downturn. Furthermore, the country joined the Organ ization for Economic Cooperation and Development (OECD) in 1996, raising its investment profile. Corporate external debt liabilities skyrocketed fro m $26.1 billion to $41.8 billion from 1995 to 1996, while the external liabilities o f financial institutions rose from $90.5 billion to $116.5 billion in the same time pe riod (You 2006, 214). Thus, it appears that Korean firms were continuing to pile u p external debt, much of it shortterm, despite declining export performance. As the manufacturing bubble began to burst in 1996, Korea entered a cycle of debt-deflation that ravaged the financial sector. P rior to the crisis, Korean firms had become far more leveraged than their American or Ja panese counterparts, reaching debt-to-asset ratios upwards of 300% (Jang 1999). A s export sales fluttered, excess inventories began to accumulate. Firms had to begin selling products at fire-sale

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101 prices, causing the export price index to drop to 6 0 in early 1997 (Kregel 1998). Because firms were selling output at lower prices, they were not able to pay off their debt, leading to a string of major chaebol bankruptcies in 1997, starting with the Hanbo group (You 2006). Insolvency of major Korean firms undermined the stability of financial institutions, as the rising number of non-performing loans in Korea and elsewhere in Southeast Asia meant that they would n ot be able to support their shortterm external liabilities. The bank run in Thailand in May 1997 triggered an exit of portfolio capital from South Korea, worsening the f oreign exchange situation, but it was not until November of 1997 that an internationa l run on Korean banks, stemming from increasing fears of insolvency, sent the Korea n government to the IMF with hat in hand (You 2006). While the bursting of the manufacturing bubble and the ensuing run on the banks would certainly have led to negative economic growth, the IMF's response increased the output loss and the human costs creat ed by the crisis. By forcing the Korean government to enact contractionary fiscal an d monetary policies, the IMF conditionalities that were imposed in November 1997 increased interest payments and reduced aggregate demand, pushing teetering firms o ver the edge into insolvency (Radelet and Sachs 2000, Chang et al 1998, Kregel 1998). Whereas in developed countries the central bank has the authority and th e means to act as a lender of last resort to troubled domestic banks, the Korean centr al bank was in no position to do so by itself because of the run on hard currency reser ves. The IMF could have provided the means for the Korean government to keep some of the banks alive, even while firing management and taking other steps to prevent moral hazard, which could have allowed the banks to continue functioning. Instead, the IMF forced the Korean

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102 government to allow banks to fail, which dragged do wn other healthier institutions that may have been able to weather the storm otherw ise. Higher interest rates set by the central bank under the conditionalities essenti ally punished anybody in the Korean economy who held debts, whether they contrib uted to the manufacturing bubble and over-investment in risky financial servi ces or not. As a result, an otherwise normal correction of over-investment beca me a broader catastrophe that pushed otherwise healthy smaller firms into insolve ncy because they could not afford their debt payments. Even more puzzling than the ov erly punitive monetary policy conditionalities was the push for fiscal austerity. As unemployment was rising due to insolvency caused in part by IMF reforms, the IMF w as forcing the government to trim its already minimal welfare state, leading to an increase in human suffering and a drop in aggregate demand (Radelet and Sachs 2000, C hang et al 1998). It seemed that the IMF was imposing a package more apt for the Teq uila crisis, in which excessive government and consumer spending played a much larg er role in causing the crisis, than for South Korea's conditions. On top of it all the IMF imposed an ideologically influenced radical restructuring of corporate gover nance, but these reforms had more political support because many neo-liberal reformer s had been wanting to reduce the chaebol influence in the economy but lacked the political ability to do so (Chang and Yoo 1999). An interesting question to bring up here is whether or not the Korean financial crisis represented a broader crisis in Korea's mode l of export-driven accumulation. You (2006) argues that the profitability of Korean firms had been steadily declining for over a decade leading up to the financial crisi s because of rising labor costs, increasing low-cost competition in neighboring coun tries, and the lack of domestic

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103 research and development capacity. South Korea was caught in a sort of middle income trap: too rich to continue exporting low-cos t finished and intermediate goods, but not yet well developed enough to compete at the cutting edge of technology with advanced industrial countries like Japan and the Un ited States. While South Korea had specialized in industrialization through learni ng, which in practice meant reverse engineering of final products and capital inputs fr om advanced countries, it still had yet to develop the capacity to produce its own nove l technologies that would allow it to acquire a larger share of profits in the industr ies in which it participated (Smith 1997). There is a large difference between learning and innovation, and the transition from one to the other is far from natural or assure d. A major shortcoming of the case for financial liberalization is that while it does make off-the-shelf technologies more available, it does so at the expense of incentivizi ng innovation. While it increases the supply of funds than can be used for investment, fi nancial liberalization does not provide incentives for firms to invest in unpredict able and potentially nonappropriable research and development, nor does it help increase the supply of highly educated human capital necessary for advanced scien tific research. The preference of chaebol to open subsidiaries in industries that other firm s were already successful in (thus creating bubbles) rather than invest in makin g better products that could potentially be more profitable was a manifestation of the underlying crisis of accumulation (Gills 1996, Smith 1997, You 2006). South Korea has recovered well from the economic cr isis, returning to high economic growth (see Table 3), but its experience w ith financial liberalization during the 1990s should give pause to advocates of one-siz e-fits-all neo-liberal reforms. In contrast to earlier studies that blamed government impropriety for the frenzy of

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104 overinvestment in the Korean economy, it is now cle ar that the private firms and financial institutions following their own interest s created an unsustainable level of speculative investment activity. Without the coordi nating mechanism of the developmental regime, private firms, acting in thei r own self-interests, overinvested in activities for which embodied technology and kno wledge was easily available. Additionally, without regulations on the uses of fo reign exchange and inward investment, the financial sector was allowed to bec ome de-coupled in important ways from productive activity, de-stabilizing the exchan ge rate. Moral hazard was not created by government intervention in the economy; it was created by government withdrawal from the economy. While financial libera lization made it easy for firms to invest in products in which other domestic firms we re already competitive, it failed to create incentives or capabilities for firms to upgr ade technologically, and liberalization of capital outflows made it easier f or Korean firms to outsource production. Thus, financial liberalization ended up making constraints on sustainable economic growth stemming from South Korea's place i n the international division of labor more severe by increasing low-end competition without alleviating capability constraints that prevent Korean firms from competin g with advanced countries.

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105 Table 1: Manufacturing Growth and the Balance of Pa yments, 1986-1998 Year 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 Manufacturing Growth (annual % growth rate) 20 19 12 3 9 9 4 5 11 12 6 5 -8 Export Growth (annual % growth) 27 22 12 -4 4 11 12 12 16 24 12 22 13 Current account balance (% GDP) 4 7 8 2 -1 -3 -1 0 -1 -2 -4 -2 12 Official exchange rate (won/dollar) 881 823 731 671 708 733 781 803 803 771 804 951 140 1 High-tech exports (% of manufactured exports) N/A N/A 16 18 18 19 20 20 23 26 24 26 27 Source: World Bank World Development Indicators Table 2: Debt Build-Up, 1993-1998 Year 1993 1994 1995 1996 1997 1998 GDP growth (2000 dollars) 5.5 8.3 8.9 6.8 5.0 -6.7 Current account/GDP 0.29 -0.96 -1.74 -4.42 -1.71 12.46 Effective Exchange Rate 100.9 98.3 98.0 96.0 104.6 131.1 External liabilities/GDP 19.38 22.04 24.46 31.60 33.16 46.48 Short-term external liabilities/FX reserves 198.89 227.48 240.58 279.75 309.82 59.24 Source: You (2006, 215-216)

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106 Table 3: Post-Crisis Data Year 1997 1998 1999 2000 2001 2002 2003 2004 2005 2 006 2007 GDP per capita growth 4 -8 9 8 3 6 3 4 4 5 5 Current account/GDP -2 12 6 2 2 1 2 4 2 1 1 Manufacturing growth/GDP 5 -8 22 17 2 8 6 11 7 8 6 High-tech exports/all manufactured exports 26 27 32 35 30 31 32 33 32 32 33 R&D funding/GDP 2 2 2 2 3 3 3 3 3 3 -Official exchange rate (won/dollar) 951 1401 1189 1131 1291 1251 1192 1145 1024 955 929 Export growth/GDP 22 13 15 19 -3 13 16 20 9 12 12 Sources: World Bank World Development Indicators, IMF Inter national Financial Statistics

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107 IV. Conclusion South Korea developed not because it unleashed the forces of the market, but because it tamed them. The developmental regime was able to curb excessive competition while guarding against rent-seeking, pr otecting against de-stabilizing capital flows into and out of the country, and, mos t importantly, providing entrepreneurs with the impetus to compete on export markets and upgrade technology. Because of the success of the developme ntal regime, South Korea went from a level of economic backwardness on par with t he poorest post-colonial nations to a prosperous middle-class country with a strong high-technology sector within one generation. When the military took over the country in 1961, such progress would have been unthinkable. The First Republic (1948-196 0) was characterized by predatory state behavior similar to political syste ms in the world's least developed countries. Autonomy from the given social order and a vision for how to achieve consistently high levels of economic growth allowed the military regime under Park Chung Hee to transform Korean society. When the Kor ean government dismantled the institutional arrangements of the developmental regime, replacing them with market institutions, the result was an economic cri sis brought on by speculation. The lack of coordinating mechanisms that could guard ag ainst overcapacity and elimination of safeguards against excessive growth of the financial sector caused the chaebol to become highly indebted without improving the pr ofitability of the companies. At the same time, de-coupling of finance from production and the emergence of financial institutions that specialize d in risky forms of financial speculation de-stabilized the balance of payments, a result that checks on foreign

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108 capital flows had been designed to prevent. The res ult was a financial crisis driven by the private sector, not by excessive state interven tion in the economy. South Korea's experience with the developmental sta te should lay waste to the false dichotomy between self-interest and altruism. An implicit notion underlying models of political economy that assume self-seekin g politicians is that politicians can either be motivated by incentives or ideals, bu t certainly not both at the same time. Since thinking that all politicians act on th eir ideals would be nave, it is generally assumed that they do not have principles at all, and that the only way for state intervention in the economy to work is if pol iticians have the incentive to enact development-friendly policies. Political incentives typically lead neither to shar ed goals of national economic transformation, nor to the creation of mon itoring devices and incentive structures through which political leader s (principals) control the bureaucrats (agents) who implement such goals. We thus cannot explain developmental states as a result of either benign motivations or “state autonomy” (Doner et al 2005, 329). However, it is impossible to explain the developmen tal state strictly in terms of incentives. There have been numerous occasions in u nderdeveloped countries where the military takes over the government promis ing to clean things up and foster development, only to revert to the predatory behavior of its predecessors. Park Chung Hee was different because, although he c ertainly took bribes from industrialists, and thus had the incentive to back off of them, he nonetheless undertook the effort to transform the behavior of t he hesitant, inexperienced entrepreneurs. While some may view his empty threat s to confiscate property from wealthy landowners and entrepreneurs as a sign of capitulation, seen in the context of the Meiji-like program he was trying to create, his actions can be

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109 interpreted differently. Rather than backing down f rom a genuine interest in redistributing property or just making threats to p acify the population, it seems that the threat of confiscation was a means of gain ing leverage over entrepreneurs so that he could impose his vision. F urthermore, the fact that Park was willing to crush dissent and take bribes should dispel the notion that idealism is necessarily altruistic and in tension w ith self-interest. Ideology can also be teleological. One could view Korean moderni zation as a giant prestige project for Park driven by his conceptions of how t he economy works. In short, self-interest can accompany and even complement ide alism, and vice-versa. The assumption that all politicians, or all develop ing world politicians, are cravenly self interested and have no principles is strongly ideological and misleading. In addition to challenging the dichotomy between se lfishness and idealism, South Korea's experience with development also disp utes common assumptions about the relationship between development and democracy. Although the two were correlated in South Korea, the amount of coercion a nd violence involved in development should give pause to the those who beli eve that all good things go together. Development is about more than just incre asing productivity of existing structures of production; it involves fundamentally transforming economic activity within a country, with broader social and political implications. In order to jump-start development, the military government needed to coer ce social elites into higher levels of investment and productivity, which in practice meant transforming their habits and business practices. If Park were a democratically e lected leader who depended on social elites for political contributions and for n ot supporting opponents, he would

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110 have had far less autonomy with which to impose his vision on them. In addition, the ability to mass produce cheap exports depended on t he willingness of the military government to coerce workers into accepting low wag es, long hours, and horrendous working conditions. In a democracy with an active l abor movement and a vibrant civil society, the level of exploitation that devel opment required in South Korea would have been difficult to sustain. Although demo cratization coincided with higher levels of industrialization, it was driven in large part by opposition to increasing inequality of living standards created by the expor t-led development model. Although there was a positive relationship between developme nt and democracy, it was not because of connections between political liberty an d economic liberty. Just the opposite, democratization was a response to the inc reasing commodification of Korea's human resources. South Korea's example also dispels misconceptions r egarding the relationship between institutions and economic growth. It has be come trendy in economics to talk about institutions. Most of these discussions revol ve around the question of what institutional arrangements will yield the optimal r esults given neo-classical conceptions of economic growth (Chang 2003). It is not controversial that neoclassical economics shows a strong bias towards see ing the market as self-regulating. Neo-classical models have built into them the idea that each individual entrepreneur or financier acting in his or her own self interest will make efficient economic decisions. One of the central claims of new institu tional economics is that strong property rights free the entrepreneur from constrai nts on his or her self-interest, thereby generating desirable economic results. Thus new institutionalist economics places an inordinate amount of emphasis on the appr opriate institutions for an

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111 idealized world. In the real world, information asy mmetries among economic actors can create inefficient results, even in the absence of government regulation (Stiglitz 1994). Therefore, the role of institutions in creat ing economic growth should not necessarily be limited to facilitating the emergenc e of free markets. Institutions must also correct pervasive market failures created by i mperfect information. In South Korea, the planning bureaucracies ensured that over capacity did not result from too many competing firms entering the same market. They also ensured that informationrationing foreign investors had to provide compelli ng evidence that their investments would yield positive results, and not just create u nnecessary debt in the private sector that could destabilize the balance of payments. Whe n Korea replaced institutions designed for the real world with institutions desig ned for an ideal world where private investors always know best, they ended up with over -investment in manufacturing and excessively indebted speculative financial firm s, a combination that led to crisis. Although financial liberalization intensified South Korea's vulnerability to contagion, its strong recovery suggests that there may be steps that countries can take to limit the risk of such reforms. Corporate govern ance reforms eliminated institutional features of the economy that encourag ed the rapid build-up of corporate debt, such as the subsidization of poorly performin g subsidiaries by more successful ones within the same business conglomerate. Critica lly, the role of commercial banking in corporate finance has grown dramatically since the economic crisis, driving out poorly regulated non-bank financial ins titutions that were too closely related to the chaebol to be able to provide adequate screening and monit oring. Inflows of short-term portfolio capital have also b een curtailed, while regulation of offshore financial centers and merchant banks has i mproved. Nonetheless, a

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112 significant cause of both the 1997 and 1979 economi c crises was negative demand shock for Korean exports. The downside to an export -led growth model is that the country becomes vulnerable to sudden drops in exter nal demand stemming from exogenous changes in the exchange rates of export m arkets and competitors or poor performance in the economies of major trading partn ers. South Korea's recovery from the crisis of 10 years ago has been stopped by the current global economic crisis, which started in the United States and whose origin s have little to do with Korea. While it would be foolish to suggest that internal policies do not have anything to do with economic crises like those which South Korea h as experienced, deeper structural features of the global political economy put middle -income exporters at risk of crisis no matter what financial policies they pursue.

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