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1 Policy, Trade, and Development: A Case Study of 40 Years of South Korean Growth The primary goal of this thesis is to assess the relationship between international trade in goods, policies relating to trade and the development of so calle thesis approaches the question through a case study method, utilizing data collected over the course of 40 years. The country of note, South Korea, has been the focus of much research in the past. The general conclusions of the thesis are that trade can be a strong driver for growth, and that policies, when properly calculated and implemented, can also strongly drive growth.
2 Policy, Trade, and Develo pment: A Case Study of 40 Years of South Korean Growth Table of Contents Chapter 1: Introduction 2 Chapter 2: Theory and Previous Works 15 Chapter 3: 1960 1979 34 Chapter 4: 1980 1999 57 Chapter 5: Conclusions 71 Bibliography 91 Appendix A 96 Appendix B 98
3 Chapter 1: Introduction International economic theory at the present is heavily predisposed towards trade liberalization between economies. Considerable empirical work has been done to develop measures for openness to trade This has in turn provided support for trade liberalization policies. Several approaches have arisen, each with issues. (Rodriguez & Rodrik, 2000) These measures of openness are important because trade liberalization, as with almost any theory in econom ics, is not universally successful. There are conditions in which a nation will see Pareto inefficient results from normal prescriptions of economics. Under these conditions, nations should implement one of a variety of trade adjustments and policy prescr iptions that are often referred to as industrial policy. Attention has, in recent years, been given to methods of implementing industrial policy in successful developing economies, such as Japan, the Four Asian Tigers, and Latin American economies. (Wa cziarg & Welch, 2003) Trade theory and industrial policy are not theoretically exclusive. In fact, much of industrial policy is rooted in trade theory. International trade organizations such as the World Trade Organization (WTO) have exceptions written i nto their articles for industrial policy implementation. In spite of this, there has been a decline of industrial policy in the past few decades. This may not be a Pareto efficient situation for developing economies. In this thesis, I will approach the subject of how one such developing economy grew. In this case, the economy in question is South Korea. The question I wish to answer is simple: was South Korea's economic development export led, or not? My expectations are that I will find South Korea's growth to have been lead by their exports. A secondary question is whether or not
4 South Korea's policy positions helped in their development. Here, I expect to find that economic theory is correct, and that their policy positions were not effective in a ssisting their development. (Harrison & Rodriguez Claire, 2009) Before beginning on the discussions briefly mentioned above, it is worthwhile to review the basics of trade theory. Specialization is the basic underpinning of economics in general, and tra Wealth of Nations Unfortunately, due to reasons often political, the situation does not perfectly follow standard pricing theories when applied to international trade. Since Adam Smith economists have debated the existence of a correlation between trade openness and growth. The premise that underlies any idea of a correlation between these is the idea of specialization. As the number of workers in an economy increases, each one is able to special ize in the production of a single product, product to be created more rapidly and at a lower price than could otherwise occur. The situation is a little more complex when involving trade and national borders. A defining quality of nations is sovereignty. This means that a nation has both the final responsibility and the final authority regarding activities that occur within or across its borders. For reasons that ar e outside the scope of this thesis governments choose to institute taxes and restrictions on the transfer of goods and/or services across their borders. This creates a distortion effect in prices. (Pugel, Chapter 8 Analysis of a Tariff, 2009) A distortion is nothing more than a generic category of cause to an equally generic category of effect. As such, it must have an effect. The effect category, in this
5 case, is economic inefficiency. Economic theory states that such inefficiencies impede markets from properly distributing resources. In this case, the distortion is more specifically defined as the tariff, which will later be discussed as a tax on goods being produced in a foreign nation. The economic inefficiency that results is an increase in prices, offsetting some or all of the resource and efficiency benefits that may have resulted from foreign production of a good or service. Ideally, this would not occur. Unfortunately, the real world does not much care for ideal situations. In the real world, we are faced with circumstances under which governments implement taxes and trade barriers which artificially inflate prices. The only time in which a government implemented tax or policy is not a distortion to some degree or another is when the policy or tax is implemented for the purpose of countermanding a previously existing distortion, known as an externality. In the absence of such an externality, the artificial inflation of the price causes imports to claim a smaller portion of the market. This gap between where imports would have begun to fill market demand without the tax or distortion, and where imports actually begin to fill market demand with the tax or distortion is filled by less efficient domestic production. This encouragement of less effi cient production causes a sub optimal allocation of resources. All of this leads to the discussion of the point of what connection exists between trade and growth. Several answers have been proposed. The first is that trade allows for a more efficient al location of resources. By allowing foreign producers, who may be better suited to produce goods that consumers demand, to go ahead and fulfill those demands, domestic resources can be put to more efficient uses. This more efficient use of resources allow s a greater quantity of goods to be produced and consumed than would be possible without trade, where the less efficient allocation
6 would consume greater quantities of resources to meet the same levels of demand. Thus trade produces growth by allowing act ors to find the minimum amount of resources that can be dedicated to the fulfilling of market demands. A second answer that has been proposed is the theory of technological migration. Under this theory, domestic producers learn by doing. In this theory, as factories are established and goods are produced, producers will learn to recreate the same techniques and technology that was implemented in local factories by foreign producers. This will allow local producers to implement the same technology in thei r own factories, inspiring increased levels of growth capability for the national economy. In either case, the connection between trade and growth inspires questions about the optimal approach to maximize growth. It is this aspect of both trade theory and policy that has been contested. There are two dominant schools of thought on this subject, liberalization and protectionism. The camp of liberalization favored by most economists and theories, argues that the optimal level of growth occurs when there ar e little to no trade barriers between economies. Protectionism argues that completely open economies are too inherently unstable, and that optimal growth comes from reducing the amount of instability that an economy faces from foreign economic actors. At present liberalization is the dominant trade policy. It is the economic policy that underwrites the entire structure of the WTO. The International Monetary Fund (IMF) and, occasionally, the World Bank are so in favor of liberalization that it is one of t heir primary policy prescriptions to any nation that applies for their aid. Since the 1940s there has been a significant reduction of tariffs, nearly 40% across a variety of
7 goods (WTO, 1998). Developing economies see more trade as they produce goods th at they would not otherwise have been able to trade. There are questions about the validity of liberalization as a development strategy. Many development economists question the ability of liberalization to close the gap between less developed countries ( LDCs) and their developed counterparts. Some accuse developed economies of trying to prevent developing economies from being able to develop. Leaders of developing economies, unhappy with their minimal relative gains, constantly demand special considerat ions from the developed Beyond its nature as a general sentiment that free trade is inherently biased against developing nations, fair trade has very little in the way o f a unified meaning or intention (Bhagwati, 2002) Some theorists and leaders believe that the freedom to implement industrial policy decisions without pressure from international economic agencies such as the IMF and World Bank would be sufficient to mak e free trade fairer. Others believe that there should be a set of preferential tariffs, subsidies and products of developed nations (Stiglitz & Charlton, Chapter 6: Spec ial Treatment for Developing Countries, 2005) again, beyond this thesis's scope. Some argue that these weightings should give heavy preference to developing nations, in effect artificially underc utting developed nations in favor of developing nations. No matter their proposal, those who argue for fair trade claim that free trade as it stands is neither satisfactory nor sufficient for the purposes of allowing a developing economy to become a develo ped economy. The problem with such a weighting system as is often called for by fair traders
8 is that, although it may create short term growth, it is not a long run efficient system. In the short term, the nation may be able to produce a sufficient quant ity of goods to see economic gains, as the weighting makes options more profitable. However the weighting of the international economy towards their goods serves to create a distortion which encourages overproduction. This overproduction takes resources away from other uses that might generate greater long run gains. If the economy develops expecting this weighting, and does not actually develop into production sectors that are more profitable in a non weighted world, then there is an incentive for rent seeking. Producers have incentive to spend up to their expected losses from the removal of weighting to pursue the maintaining of the weighted international economy. This sort of pattern is what supporters of liberalization fear with the implementation of any sort of protectionist measure. Because of this, liberalization supporters often view fair traders and protectionists as much the same thing. While true that they often advocate the same policy positions, protectionism and fair trade are not mutually inclusive. Protectionism is a theoretical approach that is focused on gains from the domestic economy rather than the international one. Under protectionism the goal is to maximize the domestic economy, and the best way to do that is to implement polici es that minimize the ability of foreign actors to influence the domestic economy. Protectionism may range from attempts to preserve jobs to propping up entire industries, to simply implementing a 30 60% tariff on all foreign goods and services. Protection ism, in one sense, is a variation on the hammer problem. When all that you have is a hammer, all problems begin to look rather like nails in wood.
9 Similarly, protectionism looks at problems as diverse as unemployment, decline of an industry, or a falteri ng economy and, immediately deciding that the problem must be foreign actors, goes to prevent these foreign actors from influencing the economy. The lengths that protectionists go to prevent foreign influence are impressive, such as the development of the Voluntary Export Restraint (VER) by the Reagan administration. While there are undoubtedly circumstances under which way to stabilize the situation and allow for domest ic recovery, these circumstances are only policy that must be accounted for. Industrial policy is another major section of international economic policy. The term industrial policy is wide ranging, but the intention of actions that fall into it is to assist domestic industries in their growth to international competitors. Where trade policy deals with a nati towards foreign producers and their products entering the nation, industrial policy deals with the development of domestic producers into internationally competitive firms. (Pack H. 2000) In general, there are two aspects to industria l policy, each of which has two an intervention might include a tax on environmen tal damages. Additionally, hard interventions deal with information issues such as learning from foreign direct investment (FDI). Soft interventions are designed to address the inefficient allocations and coordination failures that may result from these externalities without
10 necessarily acting against the externality directly. Such an intervention may include preferential lending policies implemented by the government for producers. (Harrison & Rodriguez Claire, 2009) The second aspect of industrial pol icy regime is whether it is export or import led. An import led policy is where a nation discourages exporting to encourage the production of domestic substitutes. This results that any industry that can remain competitive under this climate will, in the ory, be more productive once the discouraging policies are removed. Export led policies are designed to encourage domestic producers to actively seek out industries where they are able to compete in foreign markets. These policies include subsidizing the production of goods for exporting, and tax exemptions for businesses that export their products. There are many commonly advocated industrial policies. One is to encourage domestic investment, keeping earnings in the domestic market rather than allowing actors to invest into foreign opportunities. A second is to subsidize the domestic producers while encouraging them to develop the facilities, techniques and capacities to compete with foreign producers. A third is to erect barriers against foreign compe tition in a given sector, shielding the domestic producer until it is able to compete with foreign producers. There are several ways to encourage domestic investment In Getting Interventions Right: How South Korea and Taiwan Grew Rich Rodrik argues th at an effect of gains in investment levels (1995) Investment policies Rodrik discusses include government actions to improve the investing climate. In one particularly extre me example, South Korea's government arrested every businessman who was involved in rent seeking. Additional approaches Rodrik discusses include direct
11 government involvement in the coordination of investment, substantial subsidies aimed at domestic inves tment, and developing public enterprises and investment companies. These policies, according to Rodrik, were key to both South Korea and Encouraging domestic investment is part of industrial policy. Subsidization and protectin g domestic markets from foreign competition is not so clear cut. prevent a national governm ent from artificially making it more profitable to export a product than it is to sell the same product domestically. Thus one of the intentions of the governing articles of the WTO is to try and maintain a single uniform marginal revenue for the product, rather than to create a situation in which a producer has two separate marginal revenue (MR) curves; one MR curve that represents domestic consumption, and a separate, much more profitable MR curve that represents gains from selling abroad and collecting o n the subsidy. It is important to note that this article does not bar subsidization completely. Subsidies are allowed under the WTO when they do not require the recipient to distort international trade, such as having a minimum export target or requireme nts to use domestic inputs as opposed to imported inputs. (WTO Articles) Protectionists have long favored barriers against foreign competition. The most common of such barriers is the tariff. A tariff is a tax imposed on foreign goods for crossing the bo rder of a nation. Under taxation theory, the purpose of a tax is to correct for or compensate for some imperfection or distortion in the market. Thus a tariff can be viewed as a tax on a good for having not been produced domestically.
12 The distortion be ing compensated for here is the harm done to domestic industries by reducing their share of the market by one unit. Under the protectionist goal of supporting and encouraging the domestic economy as opposed to the international economy, this is a normativ ely desirable tax. Since the signing of the General Agreement on Tariffs and Trade (GATT) tariffs have been on the decline. With this reduction of tariff levels, protectionists have become more creative in their construction of mechanisms to insulate the economy. These mechanisms are non include domestic input requirements, import quotas, VERs, inspection requirements, and customs requirements. (Pugel, Chapter 9: Nontariff Barriers to Trade, 2009) Domestic input requirements produce an illegal subsidy under the rules of the WTO. A domestic input requirement states that a certain percentage of inputs must cheaper imported inputs causes a distortion, and results in an inefficient allocation of resources both domestically and internationally. Import quotas are the inverse of an export quota. Under an import quota, there is an absolute quantitative cap on the amount of a good or s ervice that a nation can import. This means that less efficient domestic producers will produce until they reach the quantity demanded less the import quota. This both artificially inflates prices above where they would have otherwise been, and results i n an inefficient resource allocation. A VER is one of the sneakier NTBs that exist. The purpose of a VER is to force a foreign government to limit the quantity of a product sent abroad. In spite of it being a voluntary action by the foreign government, th ey nearly always are coerced
13 into taking such an action by the government on the importing end of the VER set prices as they choose. This combination of ability to choos e production levels, and then set prices higher than they would be normally, is rather similar to the power of a monopoly. Another form of NTB is requirements that must be met for a product to be sold legally. This comes in two variations; customs require ments and inspection requirements. Customs requirements are certain procedures, documentations, or economy. Such inspections are often accompanied by rigorous requiremen ts in regards to when or where they can occur. Inspection requirements involve either a detailed inspection of the quality of the product itself, or the facility in which the product is produced, prior to its sale in the market. It can take years for a government to get around to inspect foreign facilities, in which case the producers must wait until the inspection is completed before they can begin to sell. This section has served as an overview of the issues of trade and industrial policy. Neither the particulars of individual types of policies, nor their criticisms or supporting arguments, have been given any full or detailed accounting. In the second chapter, the literature of trade and its connection to growth will be discussed in terms of pros and cons. The third and fourth chapters will begin a detailed case study of South Korea's growth. The third chapter will cover the 1960s and 1970s, broken further down into five year segments, so as to create a better long run assessment of the situation du ring these years. The fourth chapter will utilize the same procedures
14 for the 1980s and 1990s. The fifth chapter will present the final conclusions of this thesis regarding the previous thesis question and its corollary: Was South Korea's growth export l ed, and were industrial policy positions beneficial to this growth? The reasons for choosing South Korea are many. The nation demonstrated considerable economic growth over a relatively short period of time. This growth has been the subject of much discus sion, and has generated contradicting theories, creating an interesting puzzle. It does not have complex and deep economic ties to other large or dominant economies such as China or the U.S. as some of the other developing economies of the world possess. Additionally South Korea does not generate gross distortion effects due to issues such as population size. In the years after the Korean War, the South Korean economy was one of the worst in the world. As noted by various economists, a slew of import su bstitution economic woes. Between the 1960s and 2000 South Korea moved from being one of the worst economies in the world to being the 31 st economy in the world in terms of GDP per capita (CIA, 2009) This growth has been the subject of several contradicting claims, which serves as a convincing reason to choose South Korea. Another reason for choosing South Korea, and the Asian Tigers more generally, is that they each demonstra ted explosive growth during the period from the 1960s through the financial crisis of 1997. In theory, the claims applied to South Korea could probably be applied to the other Four Asian Tigers. However, Singapore has been the focus of considerably less research than South Korea, and given the scope of this paper, Singapore is not a viable option. This leaves Taiwan and Hong Kong as alternatives. Hong Kong is technically part of China in everything except its
15 economic situation, and this creates policy c omplexities that are, again, beyond this for its growth to those demonstrated by South Korea. The problem with choosing Taiwan is its quite complex relationship with Chi with China is so complex, choosing Taiwan as a possible case study would require a considerable amount of effort dedicated specifically to unravelling the interactions between the two nations. South Korea has no such rela tionship with China, and this removes an unnecessary exogenous variable. Other options include China, India, or developing countries from Latin America. The problem with Latin America is quite similar to the problem that comes from choosing Taiwan. Altho ugh none of these countries have the same politically complex situation, all of the Latin American countries have distinctly complex powerful economy makes for greater difficulty in analyzing the results of policies implemented by these individual governments. There are policy complications that come from the sheer size of the Chinese and Indian populations that can cause problems for some trade theories and policies. Although it is not wise to reject every populations are sufficiently large to give them some form of monopsony. This sort of distortion is a complication that this analysis does n ot need.
16 Chapter 2: Theory and Previous Works There are many benefits, and many failings, of free trade. These have been The Wealth of Nations. These strengths underwrite the propositions and approaches adopted by the IMF, Worl d Bank, and World Trade Organization. The weaknesses presage and explain where these propositions and approaches fail. These three organizations have enormous influence on the course of growth and development of developing nations. Strengths of Trade Li beralization Strengths of the theory of trade liberalization are many. First, the theory is robust. Even in cases where the pure theoretical propositions are not fulfilled, trade liberalization demonstrates results. Liberalization of trade presents posi tive externalities such as the migration of technology. As to the strengths of trade liberalization, the most obvious one is the increase in growth rates that accompany a more liberal trade policy. Hand in hand with this increase in growth is an increase in productivity. To discuss any point, basic assumptions must be drawn out and explored. In the proposition of trade liberalization, there are a couple of assumptions. The first is that trade barriers are reduced to zero. Honesty is another assumption of trade liberalization. This assumption states that nations will not implement economic actions, such as subsidies, that are designed to give domestic competitors a competitive advantage based upon their ability to seek rents from the government, rather than their ability to produce and leverage their resource endowments. Subsidies and dumping are two separate issues that have been of great
17 importance in the trade liberalization process. Subsidies, particularly export s ubsidies, are a case of the government paying producers to send products overseas, or simply to produce products that they would not otherwise. This is, as discussed earlier, a distortion. Dumping, on the other hand, falls into the category of predatory trading, the practice of actively seeking to destabilize or weaken a competing foreign industry share. (Destler, 2005) To achieve this, producers must find a way to elimina ability to remain in the market. Economically speaking, the easiest way to do this is to drive the market price so low that they cannot produce at that price level and remain in business. Should the market price reach such a point, the only rational option left to a producer in the long run is to shut down and withdraw from the market, putting their resources to more effective use in another industry. (Case & Fair, 2007) Driving prices down so low is not an easy proposition. Price reductions normally occur only when the average cost of production decreases. Most commonly this occurs with the development of a more efficient method of production. As later discussed, the technological diffusion effect of trade liberalization makes it more difficult to keep more efficient production techniques from spreading to competitors than it otherwise would be. (Pugel T. 2009) By driving the competitor out of the market, the producer gains at least a part of their market share. However, this n ew situation is not the optimal efficiency situation that is set out in the normal trade liberalization theory; by cheating, the foreign producer has shifted away from the Pareto optimal position. (Case & Fair, 2007)
18 In some cases, subsidies are considered another form of cheating the system. In theory, a subsidy is designed to correct distortions in the incentives of individuals or producers. These distortions are usually explained as a misjudging of the cost or benefit of a product or activity to societ y. When these subsidies are designed to compensate for a 'misjudging' that results in too little of a product being produced and exported, then the subsidy is an export subsidy. Export subsidies are intended to promote a greater level of output in regard s to a single product, while simultaneously directing production into the export market. This is achieved through the effect of subsidies on the price expected by producers for their goods and services. As producers can expect to acquire revenue equal t o the sales price plus the value of the subsidy for exporting their goods, they are unwilling to sell in the domestic market for less than that price. This results in a higher level of revenue for the producers. It is also inefficient, as the higher pric e drives consumers out of the market, and diverts resources from other uses. On the other hand export subsidies have been implemented to great effect by developing nations in the past. A portion of this thesis, for example, will discuss the export sub sidization strategy of South Korea. Nations can utilize these export subsidization strategies to leverage the much larger international market for goods and services. The subsidy encourages producers to begin selling more heavily to the international mar ket. By doing so, their demand curve shifts outward, increasing the quantity demanded. This change in quantity demand further increases the producers willingness to move into the international market. Perhaps because of its potential utility to a devel oping nation, export subsidization is not explicitly banned by the rules of the WTO. Due to its ability to
19 distort the market, it is regulated under those same rules. As subsidies are created through the implementation of law by a nation, they can have a number of preconditions worked into their text. In these cases, an exporter must fulfill the preconditions to qualify for these subsidies. Preconditions are the cause of much of the trouble regarding subsidies. When subsidies are designed to help nativ e producers achieve international competitiveness, there is an incentive to instigate preconditions that are designed to further bolster the domestic economy. These preconditions usually range from composition requirements to export requirements. These t wo subsidies fall into the category of prohibited subsidies by the WTO, and can draw retaliatory measures. Composition requirements are also known as domestic input requirements. As the name implies, these requirements are implemented regarding the compos ition of goods. More specifically, for a producer to earn the subsidy, a certain percentage of the inputs must come from domestic sources. These subsidies can be put into place regarding either specific goods, or entire stores. In the case of a store, a certain percentage of its sales product must come from a domestic source. Export requirements will be considerably more important to our study. Export requirements are, quite simply, export targeting. For a producer to earn the subsidy, the producer mu st export a certain amount of product, either in total or percentage terms. This prohibition on export requirement subsidies will be important because, as discussion in the following policy sections will make clear, our case study nation of South Korea re lied heavily upon export targeting to monitor its infant industry producers. Infant industry protection and development is a major focus of Ha Joon
20 Chang's book Kicking Away the Ladder (2005). The book approaches development through the lens of economic h istory, analysing the development of the world's points which are useful for discussion of South Korean growth. The first is that infant industry protection has been a key part of the development of most of the world's developed economies. The second point is that, above and beyond the tariffs of infant industry protections, infant industry promotion policies have been equally important. Chang argues that protection of inf ant industries through tariffs and other measures were key to the development of the modern developed world. Looking at nations that range from Britain and the U.S. to Japan and South Korea, Chang finds that protection of manufacturing industries was the norm up until after World War II. He finds two categories of tariffs to have been used. The first is blanket tariffs, where tariffs are levied upon all foreign production, no matter the nature or industry in question. The second category is targeted tar iffs. Targeted tariffs, as Chang calls them, are tariffs that cover specific industries and goods. This can be argued as a way to protect developing industries from foreign competition (Chang, 2005). Tariffs encourage the production of a domestic indust ry by artificially raising the price of goods. By raising prices, producers who previously could not enter into an industry due to costs find it possible to earn profits. Sometimes, this is an artificial space, as the resources needed to compete in this industry do not exist domestically. An example of this is the U.S. textile industry, which is rapidly becoming uncompetitive without tariffs (Destler, 2005). On the other hand, tariffs can encourage producers to enter into fields where factor endowments exist, thus the possibility for a competitive industry. Such encouragement might be necessary in the case of large
21 foreign competitors, whose ability to produce at much lower costs, due to economies of scale, may make it difficult or impossible for domest ic producers to establish themselves without assistance (Chang, 2005) Infant industry promotion, as Chang calls it, is simply a rephrasing of infant industry policy. Infant industry policy, or promotion, is focused on assisting industries that heavily emp hasize the use of readily available production factor advantages. Although this category of policy includes infant industry protection, protection is not the only method of encouraging infant industry growth, as protection is merely focused on preventing foreign competitors from driving the product out of the market before it can develop any real competitive ability or market share. Promotion, on the other hand, is focused on allowing growth of the producer overall (Chang, 2005). One method for this is th rough export encouraging policies such as export subsidization and export targets. This method encourages producers to enter foreign markets, increasing the population exposed to its products, and thus increasing demand commensurately. Additionally, the u se of export subsidies and export targets enables and encourages producers to take advantage of increasingly greater economies of scale as they must produce more and more goods to meet their export targets (Chang, 2005). An additional policy for infant ind ustry promotion is control of competition. There are two ways to go about controlling competition, depending on whether competition needs to be encouraged or discouraged. In some industries, competition needs to be encouraged, as is the case with service industries, electronics, transportation and telecommunications. In these cases, national governments can set up a public or private corporation to compete with previously existing corporations.
22 By increasing the number of firms in a market, firms are fo rced to innovate, improving the overall quality of the industry. On the other hand, some fields do not operate well with an excess of competition, such as aircraft and automotive manufacturing. In these cases, the government can discourage competition th rough licensing and other controls on how and when firms may enter the market, and the quantity of goods that they can produce and sell (Chang, 2005). Trade liberalization has several theoretical benefits which have been discussed. An additional theoretic al benefit to liberalized trade is the benefit of technology diffusion. Trade liberalization leads to technological diffusion through several possible mechanisms. This point is what's at the heart of debates over the functioning of technological diffusio n in trade. The central problem with discussing technological diffusion in trade liberalization is that, as with so much of the situation of trade liberalization, no one really agrees on how it works. Some authors argue that technology diffusion is rapid and costless (Mankiw, Phelps, & Romer, 1995) Other authors argue that technology only begins to impact a nation when it is adopted by that nation, a process that takes considerable time and resource investment (Parente & Prescott, 1994) As is also comm on in discussion about the effects of trade liberalization, these two divergent opinions on the process of technological diffusion still come to similar conclusions. This conclusion is that technological diffusion is what allows nations to see long run gr owth from trade liberalization. In The Growth of Nations article, an orthodox approach to technology diffusion is adopted and developed (Mankiw, Phelps, & Romer, 1995) This approach
23 international experience. Their goal is to assess the value of an orthodox growth model. The basic question that the authors put forth is whether or not the orthodox growth model can be at all useful for dealing with the realities of internatio nal economics. The question is inspired by the real world difficulties developing nations seem to encounter in implementing growth. If the Solow model is found to be viable be all that is needed to achieve growth in developing nations. If it was not found to be viable, then more serious adjustments might be necessary in regards to the suggestions made to developing nations by developed nations. To handle this question, they examine, in turn, three separate issues; differences in international incomes, convergence rates, and rates of return. Throughout all three, they determine that the basic growth formula is insufficient as a tool for quantitative analysis. The persistent difference in international income levels is one of the more function, they derive a descriptive equation that should describe the long state of an economy. Thei r conclusion is that incomes in these stable states are dependent upon population and investment levels, and that higher values in either category should increase income levels. As the authors point out, this is inconsistent with real world data; developi ng nations have considerably higher populations, and yet do not see the same income levels more developed nations do. Although some of this is explained by investment levels the authors find that, even with investment accounted for, the difference is no t fully explained. With this information they conclude that the most likely explanation is that of a difference in production
24 functions. They attribute this difference in production functions to a difference in capital shares. These capital shares are readily defined as the level of technological investment and human capital; the technological investment aspect of these capital shares, in the case of most developing countries, is the result of technological diffusion. (Mankiw, Phelps, & Romer, 1995) On the issue of convergence the authors feel the need to revert to the basic assumptions of the theory before they turn to actually handling the convergence issue. will con verge towards each other, but rather that incomes will converge towards their own stable states. This is to say that, except for a special case of a single universal stable state, orthodox growth models do not predict that all nations will converge toward s a single income level. (Mankiw, Phelps, & Romer, 1995) In large part, freer trade can be said to help equalize nations in the long run due to a higher rate of return. As developing nations would have a lower capital endowment than more developed nations these developing nations should show a higher marginal product for capital, making investment more profitable in developing nations than in developed nations. This higher profit margin should make it more attractive to invest in developing nations, prom pting a sort of capital flight from the capital rich developed nations into the capital poor developing nations. This is not the case. As the authors go on to derive, unless the capital shares of developed economies are twice the size of those in develo ping economies, then the profit maximizing decision is to move capital into the developing economies. Real world experience dictates that, although there is some movement of capital from developed to developing economies, it is not as large as more traditi onal
25 model would predict under a Cobb Douglas production function equal to 1 an assumption that is commonly made. A point is made that a Cobb Douglas of 1 is considered reasonable because it has applied for the U.S. for some time. Although it might app ly in the U.S., which is reasonably close to a stable state, the authors point out that it might not hold as well in the developing world, which has not approached a stable state yet. Therefore the authors turn to look at the elasticity of substitution be tween labor and capital for a possible answer to why the capital flight that is predicted under the normal usage of the orthodox growth models does not occur. Their conclusion is that the value of elasticity of substitution is considerably higher in the d eveloping world than in the developed world. (Mankiw, Phelps, & Romer, 1995) These three points are important because they help illustrate one dominant approach to technology diffusion. The adjustments made in this article show the robust nature of trade liberalization as a theory. Their final conclusion is that as capital share accumulates, either due to externality benefits or in the form of human capital, the incomes across nations equalizes, resulting in long term growth. Orthodox economists are not the only people to present a view on technology diffusion from trade liberalization, however. As in the previous example, the authors of Barriers to Technology Adoption and Development attempt to develop a model designed to encompass both the widely dispar ate income levels demonstrated by the various nations of the world, and the Tigers, with a particular focus on Japan. Their basic hypothesis is that technology diffusion occurs when an entrepreneur decides to invest time and capital on adopting the technology. The price of adoption is a function of two elements, the level of
26 (Parente & Prescott, 1994) Under the assumptions of th is article, barriers to adoption are manifold. Included in the category are legal restrictions and inspection issues. Similarly the category includes more visceral issues, such as the threat of violence. In addition the category includes the possibility of labor strikes and other similar issues. Each of these impedes the ability of an entrepreneur to adopt technology into a nation by increasing the costs that they face. The level of world knowledge is the other determinant. This is the general level of development technologically that is seen worldwide. Technological advances are seen to increase this level. Increases in this level of knowledge reduce the costs of technology adaptation. This is somewhat straightforward. The more technology advances, the further away from the cutting edge previous technological advancements get. The further away from the cutting edge that those advancements get, the less specialized training an individual needs to implement those advancements, reducing the cost of imp lementation. (Parente & Prescott, 1994) The model developed by the authors of Barriers to Technology Adoption and Development is applied to two separate possible causes for income differences across nations. The first one is the level of taxation within a nation. The second possibility is barriers to technological diffusion. Taxation is a popular option, as it implements a direct distortion to the economic model, rather than the indirect one that is implied by technological diffusion barrier theory. The authors of the article find that it is possible, in theory, for taxation to explain the income differential that is seen in the real world in their model. However it is not practical. Under their model, the income differential can only be explained if
27 tw o conditions are previously met. The first: taxation levels near 100% in developing nations. The second: taxation levels are at or near 0% in developed nations. As neither is the case, it can be assumed that the theoretically possible explanation of ta xation is not a viable candidate utilizing their model. (Parente & Prescott, 1994) ch is defined as the difference in income growth that can be associated with technology barriers. This value is quite poorly explained, and the authors do not go into much depth about how the variable is arrived at. Still, at a value specified as hey determine that the income disparity found between the U.S. and post war Japan during the time ranging from 1950 1988 is as the model would predict. Thus at barriers to technology adoption off of their relative income level to the U.S. at the time, or vice versa. Par aguay, Columbia and Pakistan. The model predicts technology adoption barriers ranging from 1.6 times those of the U.S. for the U.K. to barriers that are 3.5 times as difficult to overcome for Pakistan. The values found for barriers increase as the distan authors hold this to be evidence in favor of their proposition. The authors then put their article to the test of explaining why one set of
28 identical miracle (the Philippines) failed. They also look at reconstruction through the same matrix. Their chosen reconstruction proj ects are Germany and France. In a study that seems to cross into both categories, they also focus heavily upon Japan's growth. Although the Philippines are mentioned in passing, they are utilized more as a tool to draw conclusions from their study of su ccessful cases of development, rather than serving as the base for their analysis of development. Their conclusion is that the problem rooted from technological barriers. Technological barriers, in the case of Parente and Prescott, is referent to barriers restricting the adoption of new technology. These barriers minimize the ability for nations to achieve balanced growth. The precise technology adoption barrier levels that lead them to this conclusion are not given unfortunately, making any assessment of this claim difficult. (Parente & Prescott, 1994) Barriers could be implemented through laws that make reverse engineering difficult. Alternatively barriers could be caused by restrictions regarding the importation of foreign technology. Finally a techn ological barrier can be constructed through ignorance; if there is a lack of understanding in how technology functions, then it is difficult for technology to be adopted. As mentioned, one proposition regarding the growth seen by trade liberalization poli cies is that, at least initially, the growth rate increases come from reversal of the inefficiencies produced by an inwardly oriented trade policy. In this assumption, trade policies that are inwardly oriented are import substitution policies. The goal o f such policies is to minimize imports by replacing commonly imported products with domestic equivalents. The problem is that products that are import substituted are not necessarily comparative advantage products. By implementing
29 heavily distorting imp ort substitution policies, excessive resources are spent on products that are unlikely to ever be viable for general production. Through the removal of these policies, the economy can normalize back to a more efficient position. This results in a sudden spike in growth, as competitive advantage reasserts itself and competitive products that were not previously produced are now produced, causing growth in the economy. Two additional effects of technology barriers are worth noting. The first is that, when a new technology is adopted, an economy finds itself stuck in a given short run position until it can adapt to a position that can more favorably take advantage of the new technology. A second is the effect of trade policy in relation to factor endowment s. These two effects are integrally linked. Trade policy can help or hinder the transition to a long run position through altering the legal ways in which producers can utilize production factors. Counterarguments to Trade Liberalization and Growth As th e previous two articles have lead up to, there is a strong connection between trade liberalization and growth. One of the major arguments in favor of trade liberalization is the increased rate of growth that nations see when they liberalize their trade p olicies. Whether or not this is necessarily true has been a point of discussion for quite some time. The ability of trade liberalization to drive economic growth has several major criticisms. One criticism is the stagnation that many nations who have followed liberalization approaches to growth have encountered. A second criticism is the difficulties in meeting the theoretical requirements for growth from trade. Jamaica is a geographically local example of a nation that has seen sporadic
30 effectiveness from liberalization as a growth policy. Suzette Hudson highlights this in her Trade Liberalization and the Jamaican Economy: Prospects and Effects of Tariff Adjustments a work produced for the Bank of Jamaica. Her conclusions highlight the vulnerabilit y of small economies like Jamaica in the face of rapid liberalization of their economies. This highlighting occurs in three elements. First, she points out that Jamaica's economy is heavily impacted by the shifts in their tariff rates due to the necessit y to import many goods. The second point is that Jamaica's balance of payments deficit is heavily based upon their tariff adjustments. The third is that, in their present situation, Jamaica must take advantage of GATT (now WTO) rules involving infant ind ustries and emergency situations. As Hudson points out, the Jamaican economy is both small and open (Hudson, 2003). Their population is limited by geographic concerns, resulting in a limitation in regards to labor intensive products. On the other hand, t hey have a low relative level of capital, limiting their ability to produce in capital intensive products. Due to these two elements, Jamaica's economy is limited in size regarding its exports. To improve export position, Jamaica needs to expand its capit al base to enter into capital intensive industries. This wouldn't be problematic, if it wasn't open as well. The open aspect of the economy is the result of low tariffs and the freedom of foreign investment. Foreign investment into the Jamaican economy a llows foreign producers and economic actors to benefit from the production and resources of the Jamaican economy. Although this is somewhat beneficial to the domestic economy through the wage earnings of domestic labor, much of the profit is not in the d omestic economy. This is a contrast to when a business is domestically owned. Further, direct foreign investment is often
3 1 fickle, unlikely to remain in an economy for an extend period of time. Smaller economies in particular, with their limited supplies of labor and capital, have a greater need to develop a capital base to compensate their low labor supplies. This is difficult in the fickle flows of an open economy. Hudson directly ties the balance of payments deficit in Jamaica to their liberalization o f import tariffs. As noted above, Jamaica lacks much of the production ability of a larger economy. With the reduction of tariffs, the Jamaican economy began to import products that cannot be produced domestically. As there are many products that are un able to be produced, and a relatively small domestic production sector to help pay for those products, Jamaica is faced with a demand for imports that far exceed their ability to pay. This creates a balance of payments deficit that is detrimental to their overall economic development and performance. (Hudson, 2003) In response to their present situation, Hudson proposes that Jamaica falls back on the infant industry and emergency clauses of the WTO. The WTO rules allow nations to implement protective tari ffs in two cases. The first is the protection of an infant industry. The second is in response to a balance of payments emergency where nations are consistently unable to cover their imports with their exports. (Hudson, 2003) Infant industries are indust ries that a national government or agency believes can, with some encouragement and assistance, become an international competitor. Industries that benefit from infant industry protection are often capital intensive industries that will require years to r each a point where they can survive without some sort of assistance or protection, with a similar amount of time being necessary until they are able to reach a point where they can reliably draw in financial capital
32 investments. Tariffs can allow these na tions to develop a larger percentage of domestic demand by limiting international competition. Limiting this international competition and developing a larger percentage of domestic demand lets the producer become more competitive. The emergency clause is effectively for cases where a national economy has such a huge balance of payments deficit that they cannot function due to the minimized value of their currency. Because their currency has such little value, their products are of similarly minimal value In the emergency situation, this reaches a point where they cannot reverse the spiral. The implementation of the emergency clause allows a national government to implement tariffs to slow or stop this spiralling balance of payments problem, and hopeful ly be able to reverse the trend (WTO Articles). Hudson's observations lead her to the conclusion that Jamaica should begin to liberally utilize these clauses to improve their economic position. Her conclusion about the size and openness of the economy is applicable to many similar economies. Additionally her point about the need for Jamaica to utilize the clauses to grow is in keeping with the growth experiences of several other national economies. Hudson's general position is that, until Jamaica is able to improve its economic situation, they cannot afford to liberalize their trade any more than they already have, and they may have been mistaken to liberalize to their present point. (Hudson, 2003) Todaro and Smith's introductory development economics tex t, fittingly labelled Economic Development has something of a heterodox slant. However they do a thorough job in highlighting the theoretical weaknesses of the various forms of neoclassical trade theories that underwrites the normal position of growth a s a path to
33 development. In particular they highlight six major theoretical requirements that they believe to be inaccurate, or difficult to achieve in real world settings. (Todaro and Smith, 2009) The first assumption is that the full utilization of reso urces with in an economy. This includes a state of full employment, fixed resources, and immobility for financial capital and labor regarding their movement between nations. The first two are chronically untrue in developing nations, according to Todaro and Smith. This chronic imbalance leaves a space for improvement. It is, however, also hobbling for development. (Todaro and Smith, 2009) The second assumption relates to shifts in the system. Technology is argued to be fixed, freely available to all co untries, and universally beneficial. Additionally this assumption states that consumer preferences do not change. Consumer preferences are known to change in the long run, although not necessarily in the short run. Technology, as discussed in the techno logical migration section, is not fixed. (Todaro and Smith, 2009) The third assumption is that nations are able and willing to reform their economies rapidly to changes in world prices and markets. This assumption is based upon the assumption that nationa l economies function like businesses. According to Todaro and Smith, this is not plausible in national economies, where the costs and risks for moving inputs are high. This is particularly true of developing countries. (Todaro and Smith, 2009) The four th assumption is the complete laissez faire position of the national governments in regards to economic relations. This is patently untrue. National governments are prone to implement tariffs and barriers to trade, as discussed earlier.
34 Furthermore, nat ional governments are also prone to support industries. The fifth assumption is that trade is balanced at all times. The final assumption is that nationals of a country are the ones who benefit from gains accrued by a country. As the Jamaica case abov e demonstrates, these assumptions are not always accurate. (Todaro and Smith, 2009) In the face of these criticisms, trade liberalization cannot always be said to be the most effective growth encouraging policy. On the other hand, trade liberalization has assisted many nations in their development. Furthermore, its criticisms aside, trade liberalization has still proven quite serviceable as a theory of growth and development. Because of this plethora of positions both for and against trade liberalization the next two chapters will consist of a case study on the issue. As previously discussed at length, the case study is focused upon South Korea.
35 Chapter 3: 1960 to 1979 Beginning with this chapter, and continuing into chapter 4, we'll begin analyzing th e export performance of South Korea from 1960 through 1999. Because most trade led growth theories tend to be concerned with the long term benefits of trade, rather than the short term costs, the analysis will be broken into a series of 8 five year averag es. These averages are further split into two sets of 4. One of these sets is the focus of this chapter, namely the set ranging from 1960 through to 1979. the other set, ranging from 1980 to 1999, is the focus of chapter 4. Following the analysis of the variables, attention will be paid to the secondary question; what benefits, if any, policy positions had on the growth of the South Korean economy. This analysis will look into specific policies for their long run effects. In the short run, the analysis of policies and positions will be looked at with a mind towards how they could have shifted the averages from one five year average to the next. Additionally, considering South Korea's implementation of the five year plan model, the various five year pla ns will be looked at with a mind to how they could have shaped the next five year average. This will hopefully create both context for the shifting of averages, and provide some insight into the value of the five year plan model as it was implemented in South Korea. The first variable is total GDP. This variable is rather self explanatory. That being said, there are two important questions that need to be answered about GDP. The first is in what terms is GDP measured, and the second; are those terms co nsistent. The answer to the first is that GDP is measured in terms of U.S. Dollars as of the year 2000. As all years in this analysis are in the year 2000, the values are consistent. The final question is whether this value has purchasing power parity. As
36 all values are converted to the U.S. dollar from the year 2000, all currencies are by definition the same. This makes for a de facto purchasing power parity. Second is the growth rate of GDP. This value is presented in the percentage of GDP. The question that arises is whether this value is presented as a real GDP growth rate, or whether it is unadjusted. It is expected that the GDP growth rate figures are calculated from the GDP figures given in the data set. As these GDP figures are all conver ted to a single year from a single country, they are all in the same terms, and thus have no inflation or deflation. That would incline me to believe that the GDP growth rate is a real growth rate, rather than an unadjusted one. Unfortunately it is not e xplicitly stated anywhere in the World Development Indicators database whether or not the growth rate is real or unadjusted. GDP Per Capita is drawn from the Groningen Growth and Development Center's Maddison Historical Statistics database. GDP per capita is simply the GDP of a nation, divided by its total population during a given year. This gives an insight into the value of production per person in an economy. It similarly can serve as a measure of standard of living. It is not an optimal tool, but i t is widely available and reliable in its measurement. As several sources have pointed out that there is a sometimes depressing lack of data available regarding the South Korean economy, a reliable and available measurement is preferable to a more obscure one. This data is presented in a different monetary format from the other values, due to its difference in source. More specifically, this data is presented in 1990 International Geary Kharmis dollars. These dollars are calculated from a an estimated s et of uniform international prices. There are some flaws for the Geary Kharmis method that are worth pointing
37 out, particularly in the early period of South Korean development. Geary Kharmis dollars tend to more closely follow the patterns of richer devel oped countries. Because of this, they tend to overstate the volume of activity in poorer countries that are further away from their estimated price values. Although it is possible to calculate my own GDP per capita data, I found that the attempt, utilizin g the GDP and population figures provided by the World Bank's World Development Indicators index, produced GDP values far below the expected values. In one example, South Korea returned a GDP per capita of approximately $100. Seeing this, it seems more a dvisable to utilize an externally calculated value. The third variable is the F.O.B. value of exports in goods. This value is collected as the exports are leaving a country, making it uniquely suited to determining the true value of overall exports. Bec ause it is collected before transportation to another country, neither the cost of transport, nor the various customs and border fees are calculated into the value. Complementary to the F.O.B. value of exports in goods, is the F.O.B. value of imports in go ods. This is the value of imports sent to South Korea, with their values calculated at the time the good is shipped from the country of origin. As with exports F.O.B., this value avoids adding transportation and customs costs to the value of the good, pr oviding a closer representation of the actual value of a good. The trade balance variable is the result of the F.O.B. value of exports in goods less the F.O.B. value of imports in goods. This is valuable partially because it is these values we are using t o discuss imports and exports. The other reason that the trade balance is useful, and by extension the two F.O.B. values used to calculate it, is that it focuses on goods. South Korea, for the most part, was not a service producing
38 economy for quite some time. Although in the 1970s and 80s the nation did develop a robust export of construction services, much of the economy was still built around goods, and the goods sectors were where South Korean trade policy focused heavily. The disadvantage to using the F.O.B. data is that it is not available for any time before 1976. Because of this, discussion of export performance before the mid 1970s becomes problematic. Nonetheless the growth of the South Korean economy in the 1960s is worth discussing, as much of the policy that would shape the South Korean economy was begun in this time period, What follows is the 5 year data for the first half of the study, ranging from 1960 to, but not including, 1980. The data is presented in terms of millions of dollars, with all values being calculated in year 2000 dollars. The exception is, of course, average GDP growth rate. The GDP growth rate is given in percentage of GDP. Table 1 Variable 1960 1964 1965 1969 1970 1974 1975 1979 Average GDP $3,243.3 $4,991.5 $12, 481.5 $41,125.4 Average GDP growth rate 6.12% 14.17% 8.05% 8.52% Average GDP Per Capita $1,284.67 $1,700.48 $2,559.13 $3,754.13 Average Goods Exports F.O.B. N/A N/A N/A $11,319 Average Trade Balance N/A N/A N/A $18.10.50 Average Goods Imports F.O.B N/A N/A N/A $13.129.50
39 1960 1964 GDP Growth At the beginning of the 1960s, Korea was a mostly agricultural economy. When General Park Chung hee took office, as one source put it, one of his major goals agricultural nation into a modern this ambition, the overall GDP of South Korea during this time period was fairly low, averaging to $3 billion. For comparison, the U.S GDP at the time averaged over demonstrations of the relatively weak South Korean economy of the time, the growth rates of the first half of the 1960s average to 6.12 per cent. The GDP per capita averages at $1,284.67 for the first half of the 1960s. As previously stated, this per capita figure is a different dollar value from that of the other figures. For comparison's sake, the U.S. GDP per capita, from the same databa se, averages to $11,930 for this time period. This relative level shows that South Korea's GDP per capita, while not abysmal, is low. In fact, South Korea's GDP per capita, at this time, fits amongst the higher performing economies of Africa, and is well below the world average of $2,925.20 for the time period. Trade and Industrial Policy South Korean policy at the beginning of the 1960 undergoes a serious change. This is because of the rise of General Park Chung The ould institute the Five Year Plan model into South Korea, which would shape much of the policy of South Korea until the mid 1990s. What follows is
40 first a presentation of facts; the policies that were implemented during the 1960s, both independent of and included in the 5 year plans. After that will come some analysis of the policies. As the focus of this thesis is a long run consideration of variables and policies, the focus of the analysis will be to look at the major policies implemented, and determin e their predicted economic effects. During the time period from the 1950s through to the 1970s, South Korea's primary economic contributor was U.S. aid. Although in theory an economy should develop industries of its own, this did not manifest due to the p rimary financial policies of the time. More specifically, for the first half of the 1960s, the central bank of South Korea maintained a policy of negative interest rates. This was coupled with the directing of loans to the politically influential, neglec ting high return business opportunities (Institute for International Economics, 2003) In 1961, shortly after taking control of the government, Chung hee infused heavy amounts of government intervention into various domestic markets. Ranging from governme nt control over the banks to the merging and running of agricultural cooperatives as part of the agricultural bank, South Korea's government took an active role in the forming of their national economy. The bank encouraged increases in savings, which was nearly non existent previously. This newly developed capital was then directed by an Economic Planning Board, headed by bureaucrats with experience in business and economics, into sectors and producers who were believed to be potentially competitive inter Park Chung hee implemented a variety of changes. One of the largest was a shift in the state's policy regarding the financial and banking sectors. Prior to his
41 coup, South Korea's government had maintained a virtual stranglehold on the South Korean banking system. This is apparent in the negative interest rates and direction of lending to politically influential figures, rather than lending to high rate of return investments. Chung hee did not release the government's control over the banking system. In fact, where banks had previously had the semblance of freedom, Chung The other m ajor change under Chung hee was the implementation of the Economic Planning Board in 1961. This board was populated by bureaucrats hand chosen for their intelligence and their experience in business and economics. Run by one of his ministers, this board was ultimately responsible for directing the economy through controlling the allocation of capital and resources. The board was further These t wo steps were among a series of actions undertaken by the Chung hee government to consolidate government control over businesses and the economy. These steps were the result of the government's belief that there was not sufficient entrepreneurial experien ce in international business and finance to effectively direct over the level of corruption tha t was present in the already developed entrepreneurs. In spite of these concerns, if the South Korean government was to achieve any sort of rapid industrialization, they needed the entrepreneurs and their chaebol Government and Public and Private Co
42 control over the business sector, Chung hee both could more effectively observe and curtail the potential for corruption, and direct capital and business development until they were sufficiently capable. In the 1960s, South Korea was mainly an agricultural economy. Due to relatively low rainfalls, little incentive for mechanization, and mountainous terrain, South Korean agriculture was inefficient. Better than 60 percent of South Koreans were rural farmers at this point in time, making agriculture the major production activity of South Korea. The inefficiency of agriculture meant that only minor portions of their agricultural products were exported. That being said, the two primary agricultural products of So uth Korea, and thus their primary exports, were rice and barley. In 1962, the first 5 year plan was implemented by General Chung hee. This plan focused on the development of a competitive industrial sector in South Korea. This plan also focused on ensuri ng that this newly competitive industrial sector would not be reliant upon oil in its production. The dual focus was intended to help South Korea become a more competitive international presence in the long run.(South Korea The Economy). The developme nt of a competitive industrial sector was focused on shifting from the rural economy present in South Korea in the 1960s towards a more industrialized and urbanized economy. Manufacturing, energy production, and construction were all major parts of this p that this new industrial sector would not be reliant upon oil, South Korea heavily Having covered South Korea's trade policies, its now worth while to make
43 some economic estimates about their longer run effects. There are three points of policy to review in this period. The first is direction of loanable funds and the moral hazard problem that accompanies it, as pointed out by Yung Chul Park ( 1990). The second is the Economic Planning Board's direction of resources, and the orthodox predictions regarding interventions in resource allocation. Finally some attention must be directed to the 5 year plan and its focus on industrializing South Kore a; the intent here being to establish what direction that this plan's implementation would take the economy. This analysis of the 5 year plan will give us a guideline to measure following successes or failures by. Through the guiding of capital and loans the South Korean government possessed considerable leverage over the businesses and industrial sector of their nation during the 1960s. One of the problems that arises from this is the issue of moral hazard. Moral hazard is a problem that arises where a party is insulated from risks. When an economic actor is guaranteed a bailout or a loan, they are insulated from at least some of the fallout of poor economic decisions. This insulation means that economic actors may take risks that they otherwise woul d not, as they have the assurance of readily available funds if or when they need them. As Yung Chul Park points out, some degree of moral hazard is inherent in the directed and preferential lending system of South Korea (Park 1990). Industries and produc ers targeted as potential international competitors were extended lower interest rates, and were more likely to be granted loans. It would be expected that this would encourage borrowers to be less careful in their economic activities, as they could reaso nably expect a loan if needed. In theory, lenders would not be aware of this increased tendency towards risk taking activities provoked by the availability of
44 capital. In practice, given that the Economic Planning Board was responsible for both coordinati on of capital and resources, as well as being populated by those experienced with economics and business practices, it is unlikely that the thought of moral hazard did not cross their minds. Although export targeting was not a part of the South Korean tra de policy until the second half of the 1960s, the immediate linkage of export targets to loanable funds, among other benefits, is likely a result of the possibility of moral hazard. As both Dani Rodrik and the Institute for International Economics point ou t, South Korea was in possession of a not insignificant supply of human capital at the end 1950s. One guess for the cause is population migration due to the Korean War (Institute for International Economics, 2003). Both present the argument that this cap ital was useful to the South Korean economy, whose physical capital had been demolished in the war. Rodrik takes this prediction one step further, arguing that South Korea's development success came from an increased level of returns to investment and phy sical capital, brought about by the prevalence of human capital. In Rodrik's estimation exports were not the cause of growth, but a positive externality of their improved capital earnings (Rodrik, 1995). Whether or not Rodrik's argument will hold is a poi nt for future analysis sections. South Korea's first 5 year plan was intended to produce a more industrialized economy. To that end, certain shifts and results would be expected from economic theory. Industrialization requires capital, as the previous discussion demonstrates. Similarly, industrialization results in shifts in population earnings and activities, as farmers become factory workers and begin earning higher wages. The first prediction, therefore, would be an increase in investment due to in creased capitalization by firms.
45 This increased investment should present itself as increases in GDP. Additionally, increased earnings by the population should present itself as an increase in GDP per capita. 1965 1969 GDP Growth At this point, we ca n begin to make comparisons, back to the previous 5 year period. Total GDP from 1965 1969 averages to $5 billion. This is a goodly sized jump from $3.2 billion, but not the spectacular increases that would be expected from an explosion of industrial ex pansion. GDP growth rates jump dramatically during this period when compared to the 1960 1964 average growth rate. The average growth rate increases from 6.12 percent to an astounding 14.17 percent. Such an increase in the growth rate shows an economy t hat has begun to rapidly expand. This is in keeping with the expectations that are established by the previous 5 year plan. Oddly enough, this growth is not as obvious in the GDP figures. Based upon this percentage growth rate, we would expect considera ble growth in the next 5 year time period. The GDP per capita figures improve heading into this time period, rising to an average of $1,700.48. While a notable improvement in a self contained context, this growth in GDP per capita is barely sufficient to keep up with the gains in world average GDP per capita, which grew to $3,416.40 for this time period. U.S. GDP per capita increased to an average of $14,384.92 for this time period. This shows relatively low gains for South Korea's economy, and implies r elatively little benefit from policies up to this point.
46 Trade and Industrial Policy During the 1960s, South Korea began moving from its previous economic position to a more heavily export oriented policy. The government began to more heavily implement interventionist policies. Simultaneously, the government seized upon exports as the variable of choice for determining the performance of any given company, particularly those that were already receiving aid (Institute for International Economics, 2003) This decision was made, quite simply, because it was the only variable that producers could not fake or manipulate (Institute for International Economics, 2003) Starting at some point in 1964, South Korea began to implement a variety of export and impor t related policies, designed at encouraging export growth. Given that such policies are most likely to have their effects apparent in this time period, rather than in the time period that they occurred at the end of, the discussion of these policies is he re. South Korea's trade policies were a mixture of subsidization for infant industries through both direct and indirect means and tariffs. Tariffs were put into place to discourage the importation of competing goods, thus helping infant industries claim a larger market share than they otherwise would (Harrison & Rodriguez Clare, 2009). This improved the ability of infant industry producers to produce by allowing both them to capitalize upon larger economies of scale, and to produce at higher prices, allow ing firms that might not have been competitive to be competitive while they developed the techniques, technology, and capital base to reduce their prices. On the other hand, South Korean industrial policy also had a large array of
47 export related benefits, ranging from wastage allowances and loosened import restrictions, to tax benefits. Of these, the wastage allowances and looser import restrictions are perhaps the most noteworthy, as they constituted a large portion of South Korean subsidization (Institut e for International Economics, 2003). South Korea's import restrictions were such that many products were expensive to import for anyone outside of the nation's targeted infant industries. Rather than subsidizing their producers directly, South Korea put their infant industry producers into a separate category of import regulations so long as they met their performance requirements. These separate regulations included reduced customs fees, and allowances to import products that were otherwise restricted. This was all done under the pretext of allowing producers import products that were necessary for their operations, a fact that was usually true (Rodrik, 1995). All of this would be useless without the wastage allowances that were a key part of this syst em. Wastage allowances consist of a certain percentage of extra imports, above and beyond the necessary quantity, that a producer was allowed to import to compensate for inefficiencies in their production methods (Institute for International Economics, 20 03). This was a legitimate use. However, these producers were also allowed to sell any of this extra product that was not necessary at market restricted supply from import re strictions, and the high customs duties, this created a source of economic rent (Institute for International Economics, 2003). It also constituted a major source of subsidization for South Korea. The above combination constituted one of South Korea's ma jor subsidization techniques. As mentioned in the discussion of moral hazard, the Economic Planning
48 Board noted the potential for these incentive policies to be detrimental to growth. To offset this, these policies were connected directly to a producer's primary measure of performance. As mentioned earlier, in South Korea this measure was exports. More specifically, the South Korean government implemented a comprehensive set of negotiated export targets for producers. Infant industries were afforded a wide array of benefits and advantages over their competitors. These were not carte blanche benefits, however. These benefits were earned every year. To earn these benefits, producers had to meet their export targets. These targets were not arbitrarily set values, but a heavily negotiated, precisely calibrated network of targets. Targets were set at the level of industries, firms, and individual products. Failure to meet targets did not invoke a direct punishment, but rather resulted in the retraction of the rent generating benefits that infant industry producers were afforded. The problem with export targeting is its distortion effects. By requiring that a certain quantity of exports be produced to earn the benefits afforded to infant industry exporte rs, the incentive is created for rent seeking activities. Without this incentive, production of goods would stop at the point where marginal costs equal marginal revenue. With the offering of benefits for meeting export targets, an artificially larger re venue is created, as the revenue for meeting export targets consists of both the revenue gained from the sale of goods, and the revenue gained from the various benefits and subsidies offered to exporters. This can create production at levels well above the natural equilibrium, diverting resources from their normal optimal distribution. On a different note, the second five year plan was implemented during this
49 time period. The first plan focused on developing the industries that South Korea could compete i n at the time of its implementation. This produced a somewhat reliable export based income for the South Korean economy. The second plan focused on further enhancing the achievements of the first plan by reducing South Korea's reliance upon foreign produ cers for inputs necessary for its increasing industrialization. As an additional focus, the second five year plan put an emphasis on modernization of industries. This modernization focus thus continued the focus of the South Korean plan and government o n improving South Korea's economic The composition of South Korean exports at this time is consistent mostly with those from the first half of the 1960s. Although there were shifts towards the ma nufacturing production that would mark the 1970s, relatively little was in place by the end of the 1960s. 1970 1974 GDP Growth This 5 year period's GDP presents both confirmation of our expectations developed during the previous time period, and further expectations for the next 5 year period. Previously South Korea presented an average GDP of $4.9 billion. In this time period that GDP has nearly tripled to $12.4 billion. The growth rate has, in this five year period, settled to a value somewhere betwee n those of the previous two periods, at 8.05 percent, With this smaller growth rate, we should not expect the same explosive increase in GDP that occurred heading into this five year period. Still a somewhat greater level of growth than that seen
50 heading from the 1960 1964 period into the 1965 1969 should be expected heading into the latter half of the 1970s. For the first half of the 1970s, South Korea's GDP per capita averages to $2,559.13. This is fantastic growth, an almost $1,000 increase from the p revious half decade. Again, it's worth nothing that the GDP per capita data is in a different value format. As with previous sections, the world average for the time period can produce some context. For this time period the world average has grown by t his point to $3,923.76. This implies that South Korea has seen considerable growth relative to both itself, and the world average, which it is slowly catching up on by this time period. The U.S. average appears to be holding the same relative distance b etween itself and South Korea. This seems indicative of global growth, which could explain some of their explosive gains in total GDP. The growth rate seen in the period from 1965 1969, and the growth rate seen in this five year period are both impressive That being said, they are not sufficient to explain the explosive growth of South Korea during this 10 year period. It is impossible to make any sort of explanations before looking at the data. That being said, it is a useful question to keep in mind, and one that will be returned to after the analysis of the data. Trade and Industrial Policy As the 1970s began, South Korea's economic policies shifted. After nearly a decade of impressive growth based on labor intensive outputs, South Korea began to f rural areas began to face ever increasing income disparities with the more
51 industrialized urban areas. It was to both of these problems that South Korea turned its attent ion throughout the 1970s. Intending to not only move into sectors with less competition, but to reduce its reliance upon foreign producers for armaments (always a concern, as North and South Korea were, and are still technically at war), South Korea began in the 1970s to move into the heavy manufacturing sector (citation). Heavy manufacturing includes less consumer products and more projects requiring specialized training and design skills, such as shipbuilding and engineering projects. This shift in focu s was encouraged by a continuation of South Korean policy from the 1960s; namely the government direction of finances and investment. (Institute for International Economics, 2003) Simultaneously, South Korea implemented the third five year plan. This pla n focused heavily upon the movement towards heavy industries and chemical industries. In addition to the financial direction mentioned above, this plan implemented two additional elements. The first was a set of incentives and funding for students to go to universities if they focused on engineering and the sciences. This would not only lay the groundwork for future growth in the South Korean economy, but also provided domestic labor (Institute for International Economics, 2003). By encouraging these st udents to study in fields that were growing in South Korea, the nation also avoided the "brain drain" problem quite admirably (Amsden, 1994). The brain drain problem, as noted by Todaro and Smith, is an issue that most developing economies must deal with a t some point. Quite simply, this is a problem where many of the most well educated, or most ambitious, members of a society, having received training or education in a specialized field, leave the country to pursue work in the field that they were trained in. The problem is that this leaves the
52 country berift of innovators, or skilled workers to help develop higher performance industries that could help with growth (Todaro and Smith, 2009) To offset the problems with income disparities, as well as minimiz e exposure of these new industries to possible damages by North Korea, South Korea offered heavy incentives to producers to move these new operations further south on the pinensula. Such incentivization was intended to offer jobs to the rural workers who had been thus far left out of the growth in earnings for South Korea. ("South Korea The Economy") South Korea's economy, as a result of the 5 year plans and the development of various new industries, achieved a markedly different export composition for the beginning of the 1970s than that which it possessed in the 1960s. The previously agricultural economy moved towards a heavy manufacturing economy. Heavy manufacturing, in this case, consists less of end consumer products, such as electronics, and more of industrial goods and products of interest to governments and corporations. More specifically, beginning towards the end of the 1960s and heading through to the 1980s, South Korea's exports were built mostly around chemicals, shipbuilding, armaments, a nd steel. Additionally, South Korean construction firms did the vast majority of their work overseas, constituting another major export for the nation ("South Korea Industry"). Having gone through the data, its now possible to discuss why South Korea's economy grew as rapidly as it did from the 1965 1969 time period to the 1970 1974 time period. Three individual options come to mind for the possibility. First, industrialization due to the 5 year plans of South Korea. Second, a pattern of global growth as implied in the steady increases in global GDP per capita that kept South
53 Korea's GDP per capita, in spite of gains, in the same relative position. Finally, export growth due to South Korea's export targeted expanison policies. Domestic causes for the increase in the South Korean GDP include the industrialization that accompanied South Korea's 5 year plan, and gains in investment and production from the same sources. Industrialization allows firms to create larger quantities of goods for lower costs t han they could otherwise achieve. This would induce an increase in the overall activity level of the South Korean economy. There is evidence that South Korea undertook actions to improve their rate of savings during F are generally believed to cause increases in investment. Such increases would lead to higher GDP, as investment is a direct contributor to GDP. The problem with this proposition is what happened to the increa sed production of goods. South Korea's GDP per capita increased during this time period, this is true. However it did not increase sufficiently to produce a 250 percent increase in their GDP from solely domestic consumption. The other option is for such an increase in production to be directed to exports. This ties into the option of the South Korean economy's growth being explained through gains in exports. South Korea did demonstrate increase gains from their exports, with exports F.O.B. valuing close to $2 billion. As noted above, however, exports were only 1/6 th of the South Korean economy's GDP. Some of this gain in exports can be explained from the changes in their export profile, moving to the more profitable manufacturing exports from the agric ultural exports of the 1960s. Some of this gain can also be explained through increases in volume no doubt brought about by the implementation of industrialization. Even with both of these factors, however,
54 exports that consist of 1/6 th of the South Kore an GDP cannot explain a 250 percent increase in the economy on their own. A third option is presented in the data from the GDP per capita information. Even though South Korea's economy made great gains in comparison to itself, South Korea's overall positi on in relation to the rest of the world's economies does not appear to have drastically changed during the first half of the 1970s. This implies that there has been considerable economic growth globally. The problem with this proposition is that South Kor ea's economic growth is a considerable percentage of their annual GDP. Such a percentage growth is not reflected in the growths of other nations. Although it is not impossible for there to have been an international pattern of increased growth, it is unl ikely that such a pattern of growth can explain a 250 percent GDP gain over a period of 5 years. I would argue that none of these three points are sufficient to explain the gains in South Korea's GDP by themselves. Although the proposition of an internati onal pattern of growth is tenuous, I would contend that, if nothing else, increases in domestic production and investment, as well as industrialization, contributed to South Korea's growth. Additionally the gains that South Korea's exports produced liekly also contributed to growth. 1975 1979 GDP Growth This five year period's growth surpasses any reasonable expectations built by the growth rate data from 1970 1974. The total GDP averages to $41 billion dollars. This represents more than a tripling of the $12 billion average from the previous five
55 years. Growth rates in these five years are about the same as the previous five year period. At an average of 8.5 percent, I expect that, given the jump from the previous 5 years to these 5 years, that the 1 980s will begin with a similarly large economic jump. South Korea's GDP per capita at the end of the 1970s jumped to an average of $3,754.13. The world average for this time period has also grown, climbing to $4,306.39 for the end of the 1970s. This re presents a continuation of South Korea's gains on the world average GDP per capita. Additionally, it demonstrates another gain of over $1,000 dollars for the South Korean GDP per capita. Export Performance As of the mid 1970s, South Korea's goods exports and goods imports F.O.B. data, as well as the trade balance calculated from it, are available. The exports F.O.B. in goods begins at a value of $11,319. This is indicative of a robust export sector, with exports constituting nearly of the South Korean GDP. As imports are, by definition, a deficit value, their negative value is not a surprise. What is a surprise is the magnitude of this deficit, a value of just over $13 billion. It is not outside the realm of possibility, based on this size deficit, that South Korea's imports have been of a large scale for some time. As the composite values are now available, it stands to reason that the trade balance is now an available statistic.. The balance at the end of the 1970s is an average deficit, coming ou t to $18,105 in millions of year 2000 U.S. dollars. With this data in mind, it makes it questionable whether exports can justify the massive growth of the South Korean economy heading into this 5 year time period.
56 Trade and Industrial Policy Heading int o the end of the 1970s, South Korea could be said to be in a calm between economic storms. In the previous 5 year time period, the first OPEC oil shock occurred. In the following five years, the second OPEC oil shock would occur, as would the assassinati on of their long time president. 1975 1979 was fairly quiet until 1979 itself. In addition to the major policy shift of 1979, this time period saw the implementation of the 4 th five year plan. Export composition during the end of the 1970s remains simila r to that at the beginning. Armaments manufacturing and shipbuilding are major industries, as South Korea by the 1970s became one of the world's top producers in both. Steel manufacturing is similarly growing, as is chemical work. The major addition at this point in time is the entry of South Korea's automotive industry, regarding both cars in South Korea did not implement much in the way of major policy shifts in the second half of the 197 0s. The 1970s were a period that altered future economic decisions for South Korea. The later half of the 1970s were a period of global recession. In such a time period, the heavy industries that South Korea had so heavily invested in were faced with re duced demand, as consumers are less able to afford goods. The fourth five year plan saw the culmination of much of the incentives for producers to move into various industries, and for the population of South Korea to move towards education in certain sect ors over other sectors. This is because the 4 th five year plan saw South Korea begin to actively encourage its producers to move into internationally competitive industries. As with previous time periods, South Korea
57 utilized heavy quantities of governme nt aid to assist their chosen industries. At this point, the chosen industries were heavy industrial and heavy chemical sectors. Additional sectors that received government support were skilled labor sectors such as shipbuilding. These industries, heavi ly reliant upon skilled labor or technology, are such that other nations could not move into these industries without years of developing the capacity. This helped ensure that there would be a minimum of new competition for years to come. In 1979, South K orea implemented a Comprehensive Stabilization Plan (Institute for International Economics, 2003). This plan, in fact, was the retraction by the South Korean government of much of their directed aid to producers. Funding was shifted from targeted loans a nd factor import subsidization to improvement to the overall economy. This included improvements to telecommunications and transportation systems. Although some directed funding was still present in the South Korean economy, the end of the 1970s brought the end of such lending activities.
58 Chapter 4: 1980 1999 This chapter picks up where the previous chapter left off. In the previous chapter, the analysis was ended at the end of the 1970s. This chapter's analysis begins with the 1980s. In the 1980s a nd 1990s, there are two points that are worth observing. The first is the shift in South Korean policy away from their previous interventions. The second is the questionable nature of ascribing benefits to policy, due to this shift. There is considerably less scholarly work done about the South Korean policies regarding trade and industry in the 1980s and 1990s. This can be explained by the nature of policy in the 1980s and 1990s. In the previous two decades, South Korean policy was at odds with the ort hodox economic opinion regarding trade and development. Where the general prescription of the discipline was liberalization and interventions aimed at improving structural and distribution issues, South Korea had implemented very strong trade intervention and industrial policy measures. In the 1980s and 1990s, South Korea's policy increasingly reverted to those policies generally prescribed by orthodox economics. As noted in several locations, it is difficult to ascribe benefits to any one trade policy si mply because it is difficult to parse out what would have happened in counterfactual regarding any policy (Institute for International Economics, 2003). That being said, it is similarly difficult to ascribe South Korea's growth in the 1980s and 1990s to their non intervention policies. It is similarly difficult to state that this growth is a delayed benefit of their prior interventionist policies. To ascribe cause requires answering the question of would South Korean industries have developed as they di d, or indeed, would certain industries have developed at all, without such interventions. This question is outside of the scope of this thesis.
59 What follows is the data table for the time period ranging from 1980 through 1999, broken down once again into 5 year averages for purposes of analyzing data in a long run consideration, rather than in the short run year by year analysis. As with the previous chapter, all variables are given in terms of year 2000 dollars, in millions. Again, the exception is GDP growth rate, which is given in terms of a percentage value. Table 2 Variable 1980 1985 1985 1989 1990 1994 1995 1999 Average Total GDP $77,848.7 $153,170.1 $337,483.6 $476,375.3 Average Growth Rate 6.18% 9.18% 7.82% 4.69% Average GDP Per Capita $4,67 0.97 $6,899.43 $9,823.56 $12,625.36 Average Goods Exports F.O.B. $21,736.94 $45,825.16 $77,499.18 $134,265.8 Average Trade Balance $2,845.36 $5,487.38 $2,427.8 $9,486.12 Average Goods Imports F.O.B. $24582.3 $40337.78 $79926.98 $124779.44 1980 1984 GDP Growth At the beginning of the 1980s there was a single year of slightly negative growth. Due mostly to external factors, this does not seem to have detrimentally affected their long run GDP growth. Total GDP during this time period averaged t o $77 billion. As the 1970s ended with a GDP total at $41 billion, this total growth is
60 impressive. GDP growth rate, during the 1980s, averaged to 6.18 percent. Given the negative growth rate that opened the 1980s, at least one year must have had a mor e significant growth rate than is average. That being said, this implies a slowing of South Korea's growth, not surprising given the manifold growth of the 1970s, In the first half of the 1980s, South Korea's GDP per capita once again grew by nearly $1, 000, reaching a value of $4,670.97. For the entirety of the 3 rd chapter, South Korea's GDP per capita was slowly catching up to the global average for the various time periods. In the time period spanning the fist half of the 1980s, South Korea's GDP per capita surpassed the world average of $4,549.12. Export Performance Exports F.O.B. tells a story somewhat different from that of the GDP growth figures. At the end of the 1970s, the export F.O.B. averaged to $10 billion. The beginning of the 1980s, in spite of the slowed international economy, saw the export F.O.B. value more than double, to $21,736.94 million. This indicates a heavy increase in either the production quantity or the price of goods. Additionally, for exports F.O.B. to improve that much with the average GDP growth, both in percentage and actual terms, having been so low, indicates that exports were more than likely a major part of the GDP gains. For the first half of the 1980s South Korea's imports F.O.B. average to about $24.5 billion. This figure is a massive growth from the previous half decade.. This increase, averaging over 11 billion dollars, obviously indicates heavy imports. What these imports are is up for debate. Some sources argue that South Korea relied
61 heavily upon forei gn producers for the capital to produce its end products, without developing the skills to maintain this capital (Westphal, 2010). Such an argument would seem contrary to the concept of technological migration. This is a point for further discussion. Hea ding into the 1980s, South Korea's trade balance continued to sink into deficit, reaching over 2 billion dollars in deficit. This implies that, in spite of the massive gains in exports F.O.B., a significantly larger quantity of imports were heading into t he South Korean economy. The increasing deficit of trade balance could explain some of the slowing in the South Korean economy. Trade and Industrial Policy Several major economic changes were put into place by South Korea during the 1980s. Due to the OPEC oil shocks, South Korea's 4 th five year plan was implemented during a world wide period of economic recession. The OPEC oil shock of 1979 put many of the industrialized countries that would be able to purchase South Korean goods into recessions. The se recessions reduced the abilities of these countries to purchase much in the way of higher value industrial goods. South Korea did not demonstrate any of the economic slowing that was associated with the increases in oil prices. This is due to elements of the 5 year plans implemented in the 1960s and 1970s. More specifically, those plans held elements to reduce the reliance of South Korea upon foreign oil. This was achieved through the En power plants allowed South Korea to continue functioning with less interruption of production due to oil shock.
62 As noted at the end of chapter 3, South Korea ended the 1970s with inflationary pressures on the rise. The response of their gov ernment was to adjust monetary policy in an attempt to reign in the rate of inflation. Monetary policy was tightened considerably in response to the inflationary pressures facing the South Korean economy. The growth of the money supply was capped at a 15 percent growth rate. This cap cut heavily into the money supply growth of the 1970s, which routinely of money slows the economy, decreasing investment by banks in new ventur es, and forcing them to withdraw from their riskiest business ventures. The Comprehensive Stabilization Plan, mentioned at the end of Chapter 3, was put into full effect in the 1980s. This plan consisted of a series of shifts in South Korean policy, parti cularly as it regarded exports, imports, and the handling of infant industries. Considering that much of the South Korean policy of interest during the 1960s and 1970s focused on these areas, this plan is of significant importance. The primary effects of the Comprehensive Stabilization Plan were the withdrawal of the South Korean government's import regulations and export targeting, as well as the direction of funding to structural enhancement projects and assistance to struggling agricultural areas. Perh aps the most important part of the Comprehensive Stabilization Plan was that it was the first policy to remove the state subsidization industries and producers. This was achieved through the elimination of export targeting and import based reward systems (Institute for International Economics, 2003). In later years, although the exact timing is not available, restrictions on imports and exports would be loosened. The loans that were directed so routinely to infant industries were
63 redirected for use in co nstructing roadways and electrical systems in the rural areas of South Korea, as well as attempting to prop up an agricultural sector that was slowly Korea As the 1980s began, South Korea's export industries only marginally changed from their focus in the 1970s. Chemicals, shipbuilding, armaments, and construction were still major contributors. However these industries were joined by electronics manufactur ing, an increasingly active automotive manufacturing sector, and some Additional to the implementation of export and import liberalization policies, South Korea implemented the 5 th five year plan in the first half of the 1980s. This plan initiated the shift of the South Korean economy towards technologically intensive production sectors, further capitalizing upon previously instituted education incentives by focusing on technology and telecommuni Additionally, the 5 th five year introduced a capital market into the South Korean economy. This was perhaps the only point where the South Korean government continued with its interventionist policies, as it offered a wide range of tax benefits and subsidies to incite investment of funding into this new capital market. As this section has shown, in the 1980s South Korea's policy positions shifted rather decisively towards those of an orthodox trade position, with int erventions reserved to addressing distortions, and handling large projects that are generally beneficial to the economy, such as infrastructural development. The general assumption of orthodox economics, at this point, is that the markets will dictate pri ces and performance, and that as long as industries react in profit maximizing methods,
64 there will be growth. This orthodox assumption is based upon a perfectly competitive market, which does not necessarily exist in South Korea during the 1980s, and even to some degree in the 1990s. In South Korea, the chaebol routinely operate under monopolistic or oligopolistic conditions. This constitutes a distortion. I can find no evidence, however, that South Korea undertook any action to address this distortion w ith policy. With the retraction of the stick and carrot of export targets that are linked to economic incentives, it is difficult to find any real check on the monopolistic and oligopolistic abilities of the chaebol 1985 1989 GDP Growth The ending half of the 1980s evidence significant growth in the South Korean economy. This is shown throughout the GDP section of the analysis, but it is first evidenced in the average total GDP figure of $153.17 billion. Given the first half of the decade's average GDP figure of $77.85, this represents a near doubling of the South Korean economy during the course of the 1980s. This growth is reflected in the average GDP growth rate of 9.18% for the second half of the 1980s. With steadily consistent growth at such a lev el, the South Korean economy which slowed to approximately 6 percent growth for the first half of the decade must have seen dramatic improvement. As noted previously, the South Korean average GDP per capita overtook the world average per capita at the begi nning of the 1980s. During this time period, South Korea's GDP per capita actually grew more rapidly than in previous time periods,
65 reaching $6,899.43. This is a growth of almost $2,000 from the previous time period, and is indicative of considerable impr ovements in the standard of living. Export Performance During the second half of the 1980s, South Korea's exports F.O.B. jumped to $45,825.16 million. This growth more than doubles the exports F.O.B. at the beginning of the 1980s, where exports F.O.B. va lued at just over $22 billion. Such an increase in the value of exports implies that the South Korean economy has by this point rebounded from the slowing of the 1980s and begun to improve significantly. Heading into the second half of the 1980s, South Ko rea's imports F.O.B. nearly double, reaching $40.3 billion on average. This represents spectacular growth over a fairly short time period. On one hand, this could be indicative of growing tendency towards consumer usage, as the rising GDP per capita woul d imply that private consumption should soon be increasing. On the other hand, this could also be in keeping with previously touched upon arguments regarding South Korea's reliance upon foreign capital for production. For the later half of the 1980s, indi cators of an accelerating South Korean economy continue into the trade balance, which rises from its previous deficit to an average surplus of $5.4 billion for the time period in question. That this surplus is achieved in spite of the increases in import s implies a robust economy. Although it does little to dispense with the possible argument of South Korea's reliance upon foreign capital production it does indicate that, even should this prove true, the approach generates results.
66 Trade and Industrial Policy As would be expected from the increases in GDP per capita, South Korea's domestic economy began to increase in its rate of consumption during the later half of con sumer goods that had been exported until this time period were diverted to use with the domestic economy. This increasing consumption slowed down South Korea's export sector, although it did not slow down South Korean growth overall. Around the middle of the 1980s, South Korea undertook to liberalize their banking industry. The industry, which had been tightly regulated and mostly nationalized through the 1960s and 1970s, began to see looser regulations as several banks were released from their nationaliz ed status. This being said, the banking system was still overseen quite stringently by the central bank's Office of Bank Supervision and Examination. Additionally rules remained in place regarding ownership of banks. More specifically, it was illegal f or chaebol to own banks, or vice versa. This is perhaps the single greatest control over the chaebol that exists Money and At the end of the 1980s, South Korean exports shifted not in nature but in relative compositions. The major shift was away from shipbuilding and into automotive projects. A secondary shift was a decrease in overseas construction projects being contracted to South Korean companies. Electronics, armaments, and chemicals all continued to grow, with chemicals seeing particular growth due to the large number of South Korean refineries for petrochemicals. South Korea implemented the 6 th five year pl an during this time period. This
67 five year plan was basically a continuation of the previous five year plan, with some adjustments. With the continued reduction of support to specific industries, as begun in the previous 5 year plan and the Comprehensive Stabilization Plan, South Korea also began to put more funding into government funded R&D programs that were likely to aid wider base of industries. Previous R&D efforts had been focused on a few specific industries, with all other industries that receiv ed assistance being a 1990 1994 GDP Growth Heading into the 1990s, South Korea's growth continued unabated by any and all problems. Total GDP again grew, averaging to $337.5 billion for the first half of the decade. This GDP figure implies considerable growth in the economy overall. Given trends demonstrated in the 1980s, however, I would expect that we're going to find South Korea's exports to have slowed somewhat, with consumption making up the dif ference in GDP performance. GDP growth rates found a rate somewhere between the slowing of the first half of the 1980s, and the higher speed of the second half of the 1980s. Averaging to 7.82 percent growth in the first half of the 1990s, South Korea's slo wer growth could have a number of causes. As would be expected, South Korea's GDP per capita once again exceeds the world average of $5,191.20 for the beginning half of the 1990s. More specifically, South Korea's GDP per capita works out to $9,823.56 for the time period. This per capita GDP is a gain of almost $2,000 from the previous period. Based upon the
68 previous increases in South Korea's domestic consumption, it would be expected to see an even greater increase in consumption during this period. Ex port Performance Continuing with the theme of growth in the South Korean economy during the first half of the 1990s, the export F.O.B. for the first half of the 1990s averages to $77,499.18 million. This is not a doubling from the previous period, althoug h it is a considerable amount of growth from that seen in the second half of the 1980s, at $47.1 billion. However compared to the average exports F.O.B. of $22 billion, found at the beginning of the 1980s before the implementation of the shift towards hig h technology requirement sectors begun in the 5 th five year plan, it represents an impressive amount of growth. This would indicate that there has been considerable growth in the South Korean economy during the 1980s as a whole. This could be attributed to either the shift towards higher technology sectors begun in the first half of the 1980s, and the liberalization that occurred in the second half of the 1980s, or it could be attributed to both of the above causes. Once again, imports F.O.B. have grown s ignificantly from the previous time period. Reaching a value of $79.92 billion, this is nearly double the value of the previous time period, representing the 3 rd time in as many time periods that the total value of imports F.O.B. has doubled. Some of thi s growth can be attributed to increases in the consumer sector, although not all. South Korea, at the beginning of the 1990s, once again resumed its deficit trade balance, sinking to approximately $2.4 billion deficits. This deficit can largely be pointe d towards the massive gains in imports F.O.B., which have once again nearly
69 doubled heading into the 1990s. The general cycle that is beginning to take shape, where imports F.O.B. overtake exports F.O.B., only for the reverse to happen in the next 5 year period, seem to be in keeping with Westphal's argument. Trade and Industrial Policy The first half of the 1990s was a period of non intervention by the South Korean government in regards to the economy. Outside of the implementation of the 7 th five year plan, few policies of note were implemented. This combined with the increasing demand that results from increasing per capita income resulted in a South Korea with growth that was less export reliant. The 7 th and final, five year plan was implemented in the first half of the 1990s. This plan was a final shift towards high technology reliant industries, such as microprocessors. This shift was implemented with government assistance in the construction of facilities. Whether this was the final plan by de sign or by chance is uncertain. (U.S. Library of Congress, accessed 2010) The composition of exports in the 1990s is fairly similar to that of previous time periods. Electronics continued to see growing influence as a major Korean export during the 1990s. In previous periods, South Korea had been a major producer of consumer electronics, a position that they began to lose to newer producers in the 1990s. Even as newer producers began to out price South Korea in consumer electronics, South Korea grew into a major exporter of electronic components for 1995 1 999
70 GDP Growth The average total GDP during the second half of the 1990s is $476.4 billion. This growth is a much slower rel ative growth than seen in between previous time periods, although it does represent an average total gains of more than $100 billion. The average GDP growth rate supports the point that the growth during the second half of the 1990s is lower than previous time periods, averaging to 4.69 percent. The slower growth rate could have multiple causes, particularly considering the time period. The previous time periods saw GDP per capita grow by increasing quantities, and in spite of the financial crisis that str uck South Korea in the middle of this time period, the GDP per capita increases by nearly $3,000, reaching $12,625.36 for the term. The world average, for comparison, comes out to $5,649.97 for this time period, putting the South Korean GDP per capita at nearly 2 times the world average. Export Performance The average exports F.O.B. increased heading into the second half of the 1990s, reaching $134,265.8 million overall. This growth in exports F.O.B., even as the economy slows heading into the second h alf of the 1990s, indicate that South Korea's export industries have remained strong even heading into a period of slower growth. This indicates a robustness of performance not necessarily expected of industries that developed under protection. For the fi rst time since the start of this section of the analysis, South Korea's imports F.O.B. do not double from the previous time period. Reaching a value of $125.8 billion, this is still significant growth, even if it is not a true doubling. Such a
71 growth is difficult to explain, as it is unlikely that consumer usage will have grown so spectacularly, and imports F.O.B. is a goods only data point. Thus, a good portion of this value must be for use in industry. This again seems to be in keeping with Westphal's argument. Trade balance once again swings into a positive balance, reaching $9.4 billion for the time period. Given the implications of financial crisis for the 'real' sector of the economy, this is a respectable surplus, although not the most spectacula r. Still, in the face of the rapidly growing imports F.O.B. values faced by South Korea, it is indicative of a still robust and effective export sector. Trade and Industrial Policy In the second half of the 1990s, no new 5 year policy was implemented by the South Korean government. This coincides with a serious economic crisis for South Korea in the form of the Asian Financial Crisis. Although much can be said regarding the financial crisis, South Korea's major policy shifts were mainly a response to s aid crisis. These responses consisted mostly of reforms and further liberalization of the national economy of South Korea. Reforms included attempts to avoid a repetition of the Asian Financial Crisis by reducing the ability of speculators to invest and r emove funding quickly (Pugel, 2009). As previously noted, the composition of exports at the end of the 1990s were much the same as that during the 1990s. Electronics, automotive, chemicals and some steel were the major exports. There are some indications that the South Korean shipbuilding industry improved as orders were put in to replace older ships, but there is no hard data available for this time period.
72 Chapter 5: Conclusions The conclusions section of this thesis will be broken into several subjects Primarily conclusions will be drawn about the relation of trade, particularly exports, to Secondary conclusions will be drawn about the role of policy in this growth. These concl usions will focus both on the individual subjects, trade and policy, and on their interaction; in other words were South Korean policies effective in inciting growth overall. To put it succinctly, there were two questions posed at the beginning of this the sis. The first was whether or not South Korean development was based upon their export performance. The second, as a sub topic, was the relation of policy to their development. It was proposed that their export performance would serve as a key element of their growth, while their policy decisions would not. I find that South Korean development was, in keeping with expectations, based heavily upon their export performance at the beginning of the study, with its importance becoming more muddled as the study moved into the 1980s and 1990s. In the 1960s and 1970s South Korea, from at least a policy perspective, heavily emphasized growth through exports. As the 1980s and 1990s came, and the South Korean economy began to reap the benefits of its growth, it bec ame less and less reliant upon exports, although it still demonstrated robust exports. On the front of policy, I find the results to be mixed, again divided between the 1960s and 70s on one hand, and the 1980s and 90s on the other. In the 1960s and 1970s, South Korean policy was a vital part of their development, as the South Korean government actively directed the flow of capital and resources, while carefully
73 controlling the level of competition that firms faced from both foreign and domestic rival firms In the 1980s and 1990s, South Korea's government reverted rapidly towards an laissez faire ideal, removing themselves from the functioning of their economy, and retracting to a laissez faire position. Trade and Growth The discussion of trade and growth is simply too large a conversation to have in one shot. Discussing the growth patterns of a nation over the course of 40 years with any sort of value requires a certain degree of specificity, which cannot occur by looking at the time period as a whole. Thus, although I will make a few brief comments about the overall growth patterns demonstrated by South Korea, I will focus mostly on one decade at a time. The overall results, however, are positive for the relationship of growth and economy grew massively during the time from 1960 to 2000. During this time period they moved from exporting $32 million a year, to over $172 billion by 2000. This surge of exports ebbs and flows with some variation, but for the most part continues to gro w, and with it the South Korean economy. Some sources suggest that South Korean growth was heavily reliant upon imports. This argument, for the time periods for which data is available, has some truth to it. Imports, in terms of a percentage of GDP, grow rapidly from 1960 to 2000. In 1960 imports consumed about 12 percent of a South Korean GDP equalling $ 3 billion a year. In 2000, this figure had climbed to 35 percent of a GDP over $500 billion annually. Imports did not spike like this at any point in time. Rather there is a gradual annual increase in the percentage of imports. Even as the overall size of
74 or even grows from year to year. This indicates at least some re liance upon imports to fuel their growth. Were imports being substituted out or less heavily drawn upon, we would expect to find imports as a percentage of GDP decreasing over time. What follows is a decade by decade breakdown of conclusions regarding trad e and its relevance to the growth of the South Korean economy. Although these sectional breakdowns will support the general conclusions of this work, they will point in time. These sections will also return to theories discussed previously, ranging from technological transfer, to growth theories such as neoclassical growth and infant industry arguments. 1960s od. This decade was a decade in which South Korea took several bold risks; risks not entirely endorsed by standard theories in economics. Still, the results are difficult to argue with; South he end of the decade. Four of those years saw growth rates of better than 10 percent from the previous year, and one of those years saw a staggering 26 percent growth rate. By focusing on exports, simply because they could not be lied about, South Korea e ncouraged two events simultaneously. The first was locally targeted; producers, by being forced to meet certain export values to maintain their benefits as exporters, practically ensured a certain degree of contribution to the South Korean GDP. The secon d was foreign funding. By sending goods overseas, South Korea was
75 able to defray some of the cost of their import heavy economic build up. Neoclassical growth theory states that a nation can best grow by taking advantage of its resource endowments that ar e most available to earn profits. These profits are then reinvested into production fields that take advantage of resource endowments, but require a greater degree of capital development. At the end of the 1950s, and heading into the case study of this t hesis, South Korea's primary products were rice and barley. These products, however, were not advantageous for South Korean factor endowments. South Korea is a mountainous country, with th Korea terrain, discouraging the use of more modern mechanical equipment, as few farmers or collectives found it cost effective to purchase machinery for their farms. This kept South Korean farming output low and inefficient. As this was the primary industry, it had the additional effect of impeding South Korean growth in the orthodox method. South Korean infant industry policy in the 1960s focused on resolving this pr oblem. Given the choice between improving the efficiency of presently active industries, or encouraging the production of new industries, South Korea's government instituted policies focused on encouraging the growth of new industries. This runs directly counter to more extreme orthodox theories, which advocates that governments focus their attention on structural improvement, maintaining a laissez faire stance on the economy although it is in keeping with Chang's argument. Although the institution of in fant industry policy is counter to the propositions of some versions of neoclassical economics, the industries which benefited from these policies are strongly in keeping with the propositions of factor endowment and
76 neoclassical theory. Due to the delays inherent in shifting from short run positions to long run positions, the benefits would not be seen until the next decade. However, South Korea's movement into manufacturing took advantage of its relatively well educated population (Rodrik, 2003), while minimizing reliance upon large tracts of land. 1970s The 1970s are an equally strong period of growth. For the period from 1970 to 1979, there are two years with growth rates of 5 percent or less. Of the 8 remaining years, four demonstrate growth rates of 10 percent or greater. Along with this growth is a steady increase in exports, again as discussed in Chapter 3. Infant industry promotion techniques, implemented initially in the 1960s, began to produce notable effects at this point in time. One point mentioned in previous chapters is the growth rate of South Korea during the first oil shock of 1973. The previous point was that South Korea, a fairly heavy exporter and importer, demonstrated considerable economic growth during a time period when the in dustrialized countries that it was trading with were seeing drastic price increases due to the energy crisis. Infant industry policy, as noted earlier, is multifaceted. The facets that are of interest at the moment are trade related. Although it would be useful to discuss imports, there is little data available on South Korean tariffs and import related policies. Export policies, such as export subsidization and export targeting, are another story, as discussed in the previous chapters. Heading into the 1970s, South Korea began to demonstrate spectacular growth.
77 This point is well covered in the previous chapters. Policy could be related to some of this growth, but some of this growth is the result of trade. More specifically, technological migration i s a likely source for some of the growth demonstrated through the 1970s. Technological migration, as discussed in chapter 2, is a externality of trade. It is not the place of this thesis to discuss which of the sundry technological migration theories is a ccurate, but rather to discuss how technological migration relates to South Korea, and contributed to South Korean growth. Technological migration contributes to growth through several methods. First, it helps increase the quality of labor through supple mentation with capital. Second, it enables access to higher economies of scale. Third, it can drive growth in new industries. It is difficult to make claims relating to technological migration in regards to the 1970s. This is because there is a lack of i mport data available for this time period, and a key part of technological migration is reverse engineering from importation of capital (Parente and Prescott 1994). However, in spite of the lack of data, the spectacular growth of South Korea during the 19 70s would fit with gains from technological migration, in addition to the gains from other aspects discussed in Chapter 3. 1980s Although growth is impressive throughout the decade, with only 1 year demonstrating less than 5 percent growth, and 4 years demonstrating growth rates around 10 percent, these values are less impressive than those of the 1970s, and less
78 still than those seen in the 1960s. An interesting conclusion for this chapter is the connection between international economic position (trade balance, balance on goods and services, current account balance) and GDP growth rates. It would be expected that gains in these three measures of economic position would accompany pe riods of increasing growth, as these gains would indicate stronger net export positions, thus directly increasing GDP. The data, while supportive, is not conclusive for this point. In this decade, the first for which the above mentioned data points are av ailable from beginning to end, the decade sees a general trend of gains in the ratio of exports to imports, coupled with a growth rate lower than that of the previous year. This is useful for highlighting the fact that an economy is not made solely of its strong emphasis on exporting as a measure of economic performance, it cannot avoid domestic economic considerations. In the 1980s, South Korea demonstrated a shift towards orthodox policies. Previously active export prom otion policies were dismantled over the course of the decade. Economic theory would predict that these incentives would have encouraged overproduction. Their removal would thus be predicted to coincide with a decrease in production in some sectors, as th e overproduction reverts to the natural market equilibrium (Pugel, 2009). Such a reversion would have a temporarily negative effect on the economy, as it shifted from one short run state to another. No such decrease is notable during the 1980s. Whether this is because there was not a large enough level of overproduction to affect the South Korean economy, or because the gradual removal of promotions reduced the shock, is difficult to say. However, it is worth noting that there is no evidence of South K orea's major export industries receding,
79 with the exception of shipbuilding. The decrease in shipbuilding, as previously noted, is believed to be linked to the oil shocks. 1990s The 1990s are by far the slowest decade of this study. While their growth i s lofty heights of 10 percent or better that made up large swaths of the years from 1960 be tween 5 and 9 percent growth. Conclusions for this decade, strictly from economic data, are somewhat scarce. This decade, however, does offer one point. Although the 1980s did demonstrate that foreign account balances are not sufficient to doom or guaran tee growth, they can have significant negative impact on an economy. For much of this decade, South Korea demonstrates significant foreign account deficits. These deficits are both more persistent than those seen during the 1980s, and of far greater size In 1996, the year before the financial crisis, these deficits hit over $20 billion each. This allows for a twin set of conclusions to be drawn. The first is more generally about the decade, the second about the situation in 1996 1998. The second concl usion is relevant for 1996 1998. The massive deficits of 1996 could be argued to be a precursor to the crash of late 1997. In the face of a sudden account deficit, speculation became even more likely, and with South Korea having liberalized their currenc y only a few years previously, speculation was almost inevitable.
80 Policy and Growth At this point, focus shifts over to the policies of South Korea during this study. Focus will break down across decades, as in the previous section. My general conclusio n regarding policy is positive. However, the devil is in the details, and the details of policy discussions are what make this section important. 1960s Policy in the 1960s was both aggressively export targeted and strongly beneficial. Policies were de signed to encourage exportation, demand competitiveness, and be reasonably possible for producers. At the same time, this industrial policy was accompanied by certain practices in the banking and financial sector that were far less encouraging, and potent ially less beneficial. Export policies in this decade are an example of possible approaches to be that they would, as a nation, like to be competitive in, but upon indus tries which South Korea possessed favorable factor endowments. South Korea put export encouraging policies into place with their labor intensive industries in keeping with the Hecksher tries were thus encouraged to grow strongly throughout the decade, allowing South Korea to reap the benefits normally spoken of in conjunction with comparative advantage. The financial policies are far less promising. South Korean policy throughout the 19 60s, in terms of finance, consists of state control of banks to maintain negative interest rates, and extension of loans to wealthy and powerful private individuals rather than high return projects. These policies would be reversed in later decades, but
81 s till, it demonstrates the problem of giving politicians control over economic projects. The 1960s therefore stand out as both a strong example and a cautionary tale. Although South Korea demonstrated a strong growth in real sectors of production, they als o demonstrated considerable harmful bias in financial sector. The effectiveness encouraging of loans and resources to input advantageous products indicates a tendency to improperly allocate in the domestic economy, one which the South Korean government ac ted to correct, quite well, using export targeting to ensure that the corrections were bearing fruit. As funds were directed consistently away from higher return private productions, it is worth wondering if the 1960s might have seen even greater growth w ithout such interference. Unfortunately, as the Institute for International Economics notes, it is difficult to connect portions of growth with any single policy (2003). Infant industry policy was key for South Korea during the first half of this study. As one of two theories explaining how a nation can go about achieving growth, South Korea's infant industry policy is a key issue. The purpose of infant industry policy is explicitly to encourage growth of the economy through enabling the development of k ey future industries. As previously noted, Chang argues that infant industry promotion is key for the development of an economy. As infant industry policy advocates, this is a necessity because of the problems that new firms face in certain fields. These problems could come from capital requirements, or managerial and production techniques that must be developed over time. By promoting infant industries, national governments pursue a policy that maximizes resource endowments that otherwise might be left unexploited. This is in keeping with the position of South Korea, which possessed a fairly well educated
82 work force, but lacked the industries to put this highly developed human capital to effective use (Rodrik, 2003). 1970s Policy in the 1970s is a much more interesting discussion than the economic data of the 1970s. At this point, South Korean policy became quite targeted, intent on moving the focus and direction of South Korean growth towards higher value industries such as heavy manufacturing and che micals. This effort was three pronged. The first step was that South Korea encouraged the growth of these industries by shifting its exporter preferential policies away from labor intensive projects and into heavy manufactures. The second technique was a shift in financial policy. The third was an active effort to encourage the development of the skilled labor and technology needed to actively compete in these industries. As noted, South Korea encouraged these exporters with their pro export policies. In the previous decade, these targets were relatively loose in nature, with a sophisticated enough to target individual products, with targets negotiated between the gover nment and the producers. This sort of system is a double edged sword. On one hand, the involvement of producers ensures that targets, while still requiring work to reach, will not be unreachable. On the other hand, by setting targets at the level of ind ividual products, the South Korean government could readily be encouraging resources to be moved from far more productive uses to fulfill these targets. Thus, while export targeting could be considered good, particularly at the level of individual firms, it is possibly detrimental at the level of individual products.
83 The shift of financial policy demonstrated by South Korea is of note. At this financial system, began direc ting loans towards their targeted producers. Negative interest rates, while not completely eliminated, were severely curtailed. Preferential lending status, having been extended to targeted producers, practically ensured that preferential producers would be able to produce any product that they found it advantageous to move into. Additionally, public banks were established, with the explicit purpose of financing the endeavors of certain industries, firms, or even specific projects. This shift in the fina ncial sector is, while no doubt better than the outright inefficiency of the previous decade, still somewhat questionable. This policy of preferential lending status ensures that industries considered high potential will be able to grow. The argument bei inexperienced and under trained at this point, and thus unable to reliably lend money to the proper individuals, it served as justification both for government control of the industry, and the targeted lending. If could be argued to be correcting for an inefficient distribution of resources. Whether or not it is true is questionable, as at least some of the ineffective lending of the previous higher return projects that could benefit from the money. Finally, South Korea began actively en couraging the development of skilled labor. It achieved this through subsidization of college education, particularly
84 engineering and science degrees. These young people were similarly encouraged, and compensated, for taking domestic jobs. The result wa s that South Korea mitigated brain drain and encouraged continued growth in skilled labor fields. This feeds a more general conclusion that, as skilled labor will move where it can most readily take advantage of its higher earning potential, even if this requires moving to another nation, nations are well served by combining policies; encouraging growth in certain sectors, and then simultaneously encouraging the development of skilled labor for those sectors, avoiding brain drain and improving the producti vity of those sectors. Technological migration is as relevant to the relationship between policy and growth as it is to the relationship between trade and growth. As previously noted, technological migration draws strongly on the ability of the economy to reverse engineer techniques and capital from foreign producers. The ability of the South Korean economy to do this in the 1970s was hampered by policy. As discussed in earlier sections, South Korea in the 1960s and 1970s implemented policies that restric ted the ability of firms and individuals to import certain products. Only targeted industries and producers could get around these restrictions, and only if they met export targets. This limitation on the quantity and types of products that could be brou ght into the economy limited the chances for reverse engineering. With the ability to reverse engineer products being indirectly restricted, the rate of technological migration was impeded. This, based upon Parente and Prescott's predictions regarding tec hnological migration, reduced the ability of South Korean producers to adapt new strategies and machines, as well as their ability to learn to repair their current equipment. With every piece of equipment being valuable either to
85 use or sell due to restri ctions, the ability to disassemble and study a piece of equipment to learn how it works and how to repair it was impeded. This point, by Parente and Prescott, is one of the key reasons for the argument that South Korea might have developed a dependence on foreign producers for replacement capital (1994). 1980s The policies of the 1980s were combination of reaction to inflation and retraction of government support. The inflationary responses were standard; tight fiscal policy and conservative monetary pos itions. Government support was shifted from targeting large industrial competitors to developing the national infrastructure. This is a reversal of the normal approach advocated, which is to develop the national infrastructure through government, allowing producers to take advantage of the new infrastructure to improve productivity. South Korea instead developed robust economic competitors first, and then moved into developing public goods once the economy was moving on its own. This approach has proven beneficial to South Korea, and has some interesting implications. One of the noteworthy problems with public goods is that they are almost guaranteed losses in financial terms. Without exclusivity, there is no way to recoup the losses. Some branches of n eoclassical growth suggestions thus encourage governments in developing nations to take on massive losses to improve public goods. economy. This not only makes for more de veloped urban centers, as well as a greater concentration and accessibility to modern equipment and skilled labor for developing
86 such public goods, but also increases the tax base available. By increasing the tax base available, the debt taken on by produ cers is reduced. In the 1980s, South Korea's policies reverted to an orthodox policy position. This is a potentially beneficial reversion, as if it is well timed it can help avoid the issues of rent that arise from infant industry protection. Additionall y, by liberalizing their economy, and thus moving to an orthodox position, South Korea placed a greater degree of competition on their protected industries, and improved the rate of technological migration. The problem with infant industry promotion polici es is that they can result in rent seeking. If industries are receiving profits from infant industry promotion, then they have incentive to spend up to their earnings to keep these promotions in place. As these producers grow and become more capable, thi s becomes a retarding effect. Having reached a point where the firm can survive without these promotions, the pressure to remain competitive is gone. By moving towards an idealized orthodox, laissez faire position, these promotions are repealed. This pu ts firms at the mercy of the market, requiring that they remain competitive to earn profits. Having developed the resources, capital, and techniques under infant industry promotions, firms now exposed to the orthodox economic environment are forced to inn ovate. This innovation creates further profit, and thus further growth, but developing the techniques, resources, and capital necessary for competing in such an environment is, according to Chang, very difficult outside of infant industry promotion. By re verting to the orthodox policy position, thus removing infant industry promoting policies, South Korea placed its producers under increased competition.
87 By allowing foreign competitors into the market, domestic competitors were directly challenged by fore ign competitors in a market that had previously been exclusively, or nearly exclusively, theirs. This further creates pressure for innovation, and adoption of new techniques and technology. Additionally this increases the prevalence of foreign products a nd capital. This increased prevalence allows for more products to be used for reverse engineering. This allows for faster adoption of new techniques and technology, further allowing firms to remain competitive. 1990s The 1990s are a period where policy causes some problems for South Korea. South Korea continued to remove import barriers, and engaged in a nearly cold turkey liberalization of their financial system. The useful conclusion from the 1990s is the importance of a gradual transition from barri ers to no barriers, as in the case of the South Korean productive sector, rather than the sudden transition of the financial sector. 1990s illustrates the problem that all prote cted industries face. When their protections and benefits are removed, protected industries must adapt quickly or go out of business. This results in poor growth or even losses for these industries. A gradual approach allows for adjustments to be made to wards a different long term position, rather than forcing a producer with a given short run position into a completely revised economic environment, one that requires a drastically different short run position to survive. Thus they actually saw benefit fr om a gradual transition, as it minimized the economic losses from reduced barriers.
88 On the other hand, a sudden transition results in a short run position that cannot handle the new economic environment. The financial system, with its vulnerability to for eign shocks and speculation, demonstrates this admirably. Sudden removal of financial restrictions caused, at least in part, a sudden shock. This shock forced the financial system to transition from one short run position to another. In the process of t ransition, considerable economic loss was garnered. Trade and Policy Trade and policy is less of a decade by decade approach and more of a points of interest. The five yea r plan model implemented by South Korea was intended to help direct the overall economy, ensuring growth. South Korea demonstrated the ability of an economy to develop advantages that it did not previously have, developing the capital necessary to move fr om labor intensive to high technology intensive sectors in 30 40 years. One of the problems that face all economic endeavours is rate of return. In an economy this problem results in slowing growth rates as their comparative advantages are worn out. Addi tionally, once a nation is demonstrating growth from a given industry, other nations seeking to grow, and with similar resource endowments, are likely to follow into the sector in question, seeking to take advantage of an economic profit. This reduces fur ther the ability of a nation to grow, as their earnings are cut by competitors. The five year plans of South Korea helped to avert this problem by moving and developing resources, while shifting the focus of the economy through policy. On
89 one hand, the fi ve year plans encouraged the development of skilled labor, the importation of heavy machinery, and research and development efforts. On the other hand, the five year plans provided consistency, ensuring that resources were utilized to their best effective ness. This requires heavy planning from the government, and considerable understanding of resource endowments. It also requires long term planning, as the present five year plan must set the stage for the next five year plan, or even the plan for five yea rs after that. When achieved, however, it circumvents both problems mentioned above. South Korea managed to quite nicely avoid the problem highlighted at the end of Chapter 2 by the work of the Jamaican national bank. This problem, a lack of capacity for capital intensive industries, coupled with an open economy reliant upon foreign production for many key goods, was easily possible in the case of South Korea, who to this day imports more than 50 percent of its foodstuffs. This problem was circumvented by the use of the 5 year plan model in combination with the infant industry model. The 5 year plan model encouraged the development of capital in infant industries, as well as directing the development of human capital for use in future target industries. The 5 year plan model was further used to respond to societal issues, such as the agricultural problems that arose in the 1980s, the income disparity between the rural and urban portions of the population, and the development of the national infrastructure The infant industry model was meanwhile utilized to encourage the development of skilled labor and capital in the target industries. Although the centralized directing of funding is less efficient, due to its consideration of other
90 factors in addition to the rate of return for an investment, it did ensure that the protected industries received the capital that they needed. Of course, once the industry was settled into place and capable of competing, maintaining its support from the government is ineffi cient. At this point, the South Koreans reverted to a orthodox position regarding their economy. When assessed in relation to the results that were earned from their protection of industries, it might have been more beneficial to revert to the orthodox p osition in regards to certain sectors of the economy, focusing attention on developing future competitors. Although there will always be the problem of rates of return, by developing the resources needed to shift into new sectors of production through gove rnment policy, there is insurance that the nation will continue to grow rapidly. For example, South footwear. While their economy developed along those lines, policies wer e put into place to develop the skilled labor and capital requirements to move towards heavier industries. This transition occurred, and policy shifted to encourage the development of the technology and skilled labor required for high tech industries such as electronics manufacture and communications. By creating conditions where they would continuously be adding in new industries with different rates of return, while moving out of low earning industries whose rates of return had become quite poor, South Korea ensured its ability to continuously grow. These same actions allowed South Korea to minimize competition from other move into sectors, South Korea would soon be prepared to move out of that sector into another area of productivity, utilizing resources that their erstwhile competitors would
91 be unable to develop for some time to come. All of this is reliant upon the ability of a developing nation to develop comparative adva ntages that it did not initially possess. South Korea achieved just to a lesser extent, the 1980s, these industries were reliant upon some skilled labor, and a heavy e ndowment of physical capital. From the 1980s through to the 1990s, South Korea began to produce more and more products in technology intensive industries. major exports are electronic goods, cars, and ships. To make this transition required the development of capital and skilled labor, as outlined in the discussion of the five year plan. That being s aid, exports were not the only tool that South Korea relied upon. South Korea utilized targeted exports, with generally beneficial results. Its financial mishaps not withstanding, South Korea also realized that no nation in the world can grow superconduc tors. With this acknowledgement, South Korea, while developing their present competitors, laid the groundwork for future competitive industries, producing 4 decades of continuous growth and improvement in the economy. Thus, while there is benefit in caut ioning developing nations to be wary of government interventions, it is irresponsible to simply write them off when, as in the case of South Korea, their proper utilization can be so beneficial to an economy
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97 Appendix A: Annual Data GDP, GDP Growth Rate, GDP Per Capita GDP presented in terms of U.S. dollars as of the year 2000. GDP per capita presente d as 1990 International Geary Kharmis dollars Year GDP Annual Growth Rate GDP Per Capita 1960 $3,891,849,047.98 N/A $1,226.38 1961 $ 2,357,059,044.85 4.94% $ 1,246.59 1962 $ 2,745,939,978.76 2.46% $ 1,245.17 1963 $ 3,863,726,949.36 9.53% $ 1,315.51 1964 $ 3,358,134,142.76 7.56% $ 1,315.51 1965 $ 3,017,614,366.40 26.27% $ 1,436.33 1966 $ 3,806,043,708.69 12.70% $ 1,569.33 1967 $ 4,702,747,059.38 6.10% $ 1,644.65 1968 $ 5,955,336,766.30 11.70% $ 1,812.05 1969 $ 7,475,692,343.91 14.10% $ 2,040.00 1970 $ 8,899,729,520.86 8.34% $ 2,167.33 1971 $ 9,851,361,083.10 8.24% $ 2,332.36 1972 $ 10,735,574,842.83 4.47% $ 2,456.46 1973 $ 13,691,504,318.13 12.03% $ 2,824.25 1974 $ 19,229,361,880.98 7.12% $ 3,015.24 1975 $ 21,458,884,297.52 5.95% $ 3,161.70 1976 $ 29,554,752,066.11 10.57% $ 3,476.40 1977 $ 37,926,239,669.42 9.99% $ 3,774.59 1978 $ 51,125,206,611.57 9.30% $ 4,063.91 1979 $ 65,561,776,859.50 6.78% $ 4,294.02 1980 $ 63,834,351,283.27 1.49% $ 4,114.10
98 1981 $ 71,469,245,114.01 6.16% $ 4,301 .86 1982 $ 76,218,197,734.85 7.33% $ 4,557.29 1983 $ 84,510,602,642.60 10.77% $ 5,006.96 1984 $ 93,210,997,791.50 8.10% $ 5,374.62 1985 $ 96,619,732,879.70 6.80% $ 5,670.39 1986 $ 111,305,576,039.48 10.62% $ 6,262.96 1987 $ 140,005,592,229.23 11.10% $ 6,915.90 1988 $ 187,446,511,818.66 10.64% $ 7,620.58 1989 $ 230,473,148,065.41 6.74% $ 8,027.30 1990 $ 263,776,986,549.11 9.16% $ 8,704.42 1991 $ 308,185,041,249.06 9.39% $ 9,404.30 1992 $ 329,885,864,343.81 5.88% $ 9,803.20 1993 $ 362,135,746,944. 57 6.13% $ 10,231.86 1994 $ 423,434,190,055.38 8.54% $ 10,973.99 1995 $ 517,118,129,837.80 9.17% $ 11,850.48 1996 $ 557,643,607,433.65 7.00% $ 12,578.66 1997 $ 516,282,942,110.18 4.65% $ 13,066.02 1998 $ 345,432,412,375.84 6.85% $ 12,281.61 1999 $ 4 45,399,303,511.04 9.49% $ 13,350.03
99 Appendix B: Exports F.O.B., Imports F.O.B., Trade Balance All values presented in terms of millions of year 2000 U.S. dollars Year Goods Exports F.O.B. Goods Imports F.O.B. Trade Balance 1960 N/A N/A N/A 1961 N /A N/A N/A 1962 N/A N/A N/A 1963 N/A N/A N/A 1964 N/A N/A N/A 1965 N/A N/A N/A 1966 N/A N/A N/A 1967 N/A N/A N/A 1968 N/A N/A N/A 1969 N/A N/A N/A 1970 N/A N/A N/A 1971 N/A N/A N/A 1972 N/A N/A N/A 1973 N/A N/A N/A 1974 N/A N/A N/A 1975 N/A N /A N/A 1976 $7,814.0 $8,404.0 $590.0 1977 $10,046.0 $10,523.0 $477.0 1978 $12711.0 $14,491.0 $1,780.0 1979 $14.705.0 $19,100.0 $4,395.0 1980 $17,245.3 $21,858.5 $4,613.2 1981 $20,747.3 $24,596.1 $3,848.8 1982 $20,934.4 $24,596.1 $2,827 .2 1983 $23,271.6 $25,120.1 $1,848.5 1984 $26,486.1 $27,575.0 $1,670.1 1985 $26,632.6 $26,652.8 $20.2 1986 $34,128.3 $29,829.2 $4,299.1 1987 $46,559.9 $39,030.5 $7,529.0 1988 $59,973.0 $48,689.7 $11,283.3 1989 $61,832.0 $57,486.7 $4,345.3
100 1990 $63,659.7 $66,121.0 $2461.3 1991 $70,549.6 $77,450.0 $6,903.6 1992 $76,209.5 $78,116.5 $1,907.0 1993 $82,097.8 $79,947.7 $2,150.1 1994 $94,982.5 $97,999.7 $3,017.2 1995 $124,934.0 $129,298.0 $4,364.6 1996 $130,038.0 $145,115.0 $15, 077.1 1997 $138,731.0 $141,986.0 $3,255.7 1998 $132,251.0 $90,586.2 $41,665.0 1999 $145,375.0 $116,912.0 $28,563.0