The Tortuous Path of South Korean Economic Development 9781009419321, 1009419323

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The Tortuous Path of South Korean Economic Development This book explains how South Korea has uniquely transformed itself from a developing to a developed country by combining economic analysis with historical perspective, an approach badly needed but rarely taken by previous studies. The book shows that the country has done so through a tortuous process. It first explains how Korea failed earlier in history to emerge as a developing rather than a developed country after the Second World War but South Korea began to grow rapidly in the 1960s. It then explains that the country has sustained growth while undergoing recurring crises, examining three conditions for sustaining growth: macroeconomic management, structural transformation, and social conflict management. While doing so, the book interprets some important subjects differently from the previous studies; it also explains some other important subjects they have not covered sufficiently. The book finally discusses questions for the future briefly. Jaymin Lee,  PhD (Harvard), is Professor Emeritus of Economics at Yonsei University, Seoul, South Korea. He was Vice Chairman of the National Economic Advisory Council of the Republic of Korea (2019–21), president of the Korea Development Economics Association (2006–7) and president of the Korean Economic History Society (2001–3). Jaymin also served as Editor of the International Economic Journal for 2002–15. As an economist, he combines theoretical analysis with historical perspectives and policy insights to explain South Korea’s economic development.

The Tortuous Path of South Korean Economic Development Jaymin Lee Yonsei University

Shaftesbury Road, Cambridge CB2 8EA, United Kingdom One Liberty Plaza, 20th Floor, New York, NY 10006, USA 477 Williamstown Road, Port Melbourne, VIC 3207, Australia 314–321, 3rd Floor, Plot 3, Splendor Forum, Jasola District Centre, New Delhi – 110025, India 103 Penang Road, #05–06/07, Visioncrest Commercial, Singapore 238467 Cambridge University Press is part of Cambridge University Press & Assessment, a department of the University of Cambridge. We share the University’s mission to contribute to society through the pursuit of education, learning and research at the highest international levels of excellence. www.cambridge.org Information on this title: www.cambridge.org/9781009419321 DOI: 10.1017/9781009419352 © Jaymin Lee 2024 This publication is in copyright. Subject to statutory exception and to the provisions of relevant collective licensing agreements, no reproduction of any part may take place without the written permission of Cambridge University Press & Assessment. First published 2024 A catalogue record for this publication is available from the British Library Library of Congress Cataloging-in-Publication Data Names: Lee, Jaymin, author. Title: The tortuous path of South Korean economic development / Jaymin Lee, Yonsei University, Seoul. Description: Cambridge, United Kingdom ; New York, NY : Cambridge University Press, [2023] | Includes bibliographical references and index. Identifiers: LCCN 2023025909 | ISBN 9781009419321 (hardback) | ISBN 9781009419352 (ebook) Subjects: LCSH: Korea (South) – Economic conditions. | Korea (South) – Economic policy. | Korea (South) – History. Classification: LCC HC467 .L44 2023 | DDC 338.95195–dc23/eng/20230725 LC record available at https://lccn.loc.gov/2023025909 ISBN 978-1-009-41932-1 Hardback ISBN 978-1-009-41931-4 Paperback Cambridge University Press & Assessment has no responsibility for the persistence or accuracy of URLs for external or third-party internet websites referred to in this publication and does not guarantee that any content on such websites is, or will remain, accurate or appropriate.

Contents

List of Figures

page viii

List of Tables

x

Preface and Acknowledgments Notes on the Romanization of the Korean Language List of Abbreviations

xi xiii xv

1 South Korean Economic Development in Perspective

1



1.1 A Unique Case

4



1.2 A Tortuous Path

9



1.3 The Great Divergence and the Great Convergence

13



1.4 Sustained but Crisis-Ridden Growth

15



1.5 Questions for the Future

20

2 The Great Tradition That Failed

21



2.1 Traditional Korea

21



2.2 The Failure

28



2.3 The Colonial Economy

38

3 Some Lights in the Dark

48



3.1 Division, War, and the Consequences

48



3.2 The Exception to Work

56



3.3 Growth with Aid

67



3.4 The Long-Run Growth and the Short-Run Crisis

76

4 Kicking Off the Miracle

83



4.1 Explaining the Kickoff

83



4.2 The Contours of Economic Policy



4.3 Trade Policies and Export-Oriented Industrialization

104



4.4 Overcoming the Bottleneck and Beyond

115

91

v

vi Contents

5 Contours of the High Economic Growth

122



5.1 An Aggressive but Vulnerable System

122



5.2 Crisis, Stabilization, and Boom

131



5.3 Macroeconomic Performance after the Boom

140



5.4 A Crisis-Bound Economy?

149

6 Industrial Policy and Chaebol

158



6.1 Structural Transformation and Industrial Policy

158



6.2 The Role of Chaebol

171



6.3 Liberalization and New Industrial Policy

178



6.4 Chaebol in Transition

188

7 Growth with Equity?

198



7.1 Jobs, Poverty, and Inequality

198



7.2 Slowing Inequality, More Oppression, and Beyond

210



7.3 Sustaining Growth with Democratization

218



7.4 Inequality and Reform after the Democratization

228

8 Crisis and Reform

239



8.1 The Nature of the Crisis

239



8.2 Understanding the Resolution Process

247



8.3 The Response

254



8.4 The Reforms and Their Consequences

262

9 The Slowing Engine of Growth

9.1 The Slowdown and the New System



9.2 Current Account, International Investment Position, and Self-insurance

272 272 282



9.3 The 2008 Crisis and After

292



9.4 New Challenges

301

10 Industrial Policy and Firms

315



10.1 Industrial Policy and Structural Transformation

315



10.2 Whither Chaebol?

329

Contents vii

10.3 Venture Business and Foreign Direct Investment

337



10.4 The Plight of Small and Medium-Sized Enterprises

345

11 Inequality, Jobs, and Welfare

357



11.1 The Changing Inequality

357



11.2 Labor Market Problems

364



11.3 Capital, Labor, and Industrial Relations

378



11.4 The Welfare System

389

12 Questions for the Future

400



12.1 The Changing International Environment

403



12.2 The New International Political Economy

409



12.3 South Korea and the Great Powers

412



12.4 Does History Help?

416



12.5 Domestic Politics Matters

418

Appendices References Index

423 446 465

Figures

4.1

Export ratio and import ratio, 1953–2022

4.2

Unemployment rates, 1963–2022 (percent)

5.1

Gross investment rate and gross saving rate,

(percent)page 112

1953–2022 (percent) 5.2

135

The composition of gross investment rate, 1970–2022 (percent)

6.1

126

The composition of government expenditure, 1970–2020 (percent of GDP)

5.4

124

Debt-equity ratio and interest coverage ratio, manufacturing sector, 1962–2021 (percent)

5.3

120

144

R&D expenditure by fund sources as a percentage of GDP, 1970–2020

182

6.2

School attendance ratios, 1980–2022 (percent)

185

6.3

Top chaebol’s shares in value added, 1973–1995 (percent)191

7.1

Top income shares, 1958–2021 (percent)

7.2

Capital gains on land as a percentage of GDP,

200

1965–2021205 7.3

Unionization rate, 1963–2021 (percent)

208

7.4

Propensity to strike, 1965–2021

236

8.1

Short-term foreign debt and international reserves as a percentage of GDP, 1964–2022

9.1

The shares in lending by general banks, 1989–2021 (percent)

9.2

243 280

The composition of gross saving rate, 1975–2021 (percent)284

9.3 viii

Real effective exchange rate (2010=100), 1964–2022

287

list of Figures ix 9.4

Financial account and the changes in net international investment position as a percentage of GDP,

9.5 10.1

1980–2022 (three-year average)

289

Fiscal balances as a percentage of GDP, 1970–2021

303

Relative labor productivity and employment share by industries, 1980–2021 (percent)

10.2

324

The share of venture business in employment and venture capital investment in GDP, 1998–2021 (percent)341

10.3

Foreign direct investment on report basis as a percentage of GDP, 1980–2022

10.4

343

Foreign direct investment and direct investment overseas on balance of payments basis as a percentage of GDP, 1980–2022

10.5

345

Relative debt-equity ratio and profitability: Small and medium-sized enterprises to large enterprises, manufacturing sector, 1970–2021 (percent)

10.6

347

Productivity-related indices, small and medium-sized enterprises relative to large enterprises, 1983–2020 (percent)

10.7

351

Employment share, small and medium-sized enterprises relative to large enterprises, 1982–2020 (percent)354

11.1

Gini coefficients, 1990–2021

359

11.2

Employment rates, 1989–2022 (percent)

369

11.3

Labor share of income, 1975–2021 (percent)

379

11.4

The composition of capital share of income, 1975–2021 (percent)

11.5 11.6

384

The sources of government debt as a percentage of GDP, 1997–2021

394

Dependency ratios, 1960–2070 (percent)

398

Tables

4.1

Fiscal expenditure and revenue as a percentage of GDP, 1953–1970page 93

4.2

Interest rates on major loans and inflation rate, 1961–1988 (percent)

101

4.3

Exchange rates for exports, 1955−1990

105

4.4

Exchange rates for imports, 1955−1990

110

6.1

Protection and subsidies for targeted and untargeted manufacturing industries, 1963–1995 (percent)

11.1

Employment shares by enterprise size and worker status, 2002−2021 (percent)

x

166 373

Preface and Acknowledgments

This book explains the economic development of South Korea as it has unfolded, from the beginning of Korean history to the present, mainly focusing on the period following the 1960s when the economy began to grow rapidly. The title Tortuous Path has been chosen to highlight the fact that, while the country’s economic development is a great success story, it has not been a smooth process, but one accompanied by twists and turns. I have written this book thinking that, though much ink has been spilled over the subject, it can still make some scholarly contribution. The book tries to interpret economic development in historical perspective; it tries to explain the development process from the 1960s with a consistent framework about growth and crises. The book also tries to explain some important subjects differently from the existing studies and discuss some subjects they have not covered sufficiently. I have tried to keep the economic analysis in the book as nontechnical as possible. There is only one simple equation presented in the book. I have mainly used narratives, citing the statistical numbers for economic variables when necessary. In cases where showing the trend of economic variables is important, I have used more figures than tables because figures show summary trends better, especially when the data have long time series. I have benefited from the discussions and comments of many of my colleagues made in the conferences and seminars where the ideas for the book were presented. I thank those who helped me obtain unpublished data, including the researchers at the Bank of Korea and the Korea Institute for Industrial Economics & Trade. I especially thank the anonymous readers of the manuscript during the review process of the book, who read it carefully and made constructive xi

xii Preface and Acknowledgments comments. My assistants during my days of teaching and research at Yonsei University also helped to write the book. My family also aided me in writing the book through giving me peace of mind and by making some helpful comments. I also appreciate the financial support provided by the National Research Foundation of Korea to write the book.1 I finally thank Cambridge University Press for publishing the book.



1

This work was supported by the Ministry of Education of the Republic of Korea and the National Research Foundation of Korea (NRF-2017S1A6A4A01022143).

Notes on the Romanization of the Korean Language

The romanization of the Korean language does not conform to a single, uniform system. In the past, the McCune–Reischauer system was widely used, and many authors still follow it. However, the National Institute of Korean Language has formulated the official guideline for romanization. This book follows the guideline as the first reference. It thus places, for example, the family name before the given name in writing personal names in the text. However, some exceptions are inevitable, mainly because the official guideline fails to consider the possibility that the same English vowel can be read in different ways. This book revises the official guideline taking this possibility into account, when it seems necessary. The book thus retains, for example, the conventional spelling of the Korean family name Lee rather than changing it to Li following the official guideline. A related problem is how to spell internationally known Korean words. This book retains the well-known words like chaebol, and the spelling of the brand names of Korean firms like Hyundai and Samsung, which would have to be spelled in a different way according to the official guideline. It also retains the spelling of Korean authors’ English names appearing in the referenced scholarly journals and books, regardless of whether they are in line with the official guideline. The book also does not follow the official guideline in writing the personal names of internationally known Koreans. The alternative guideline here is the spelling from Wikipedia, if the personal names appear there. It is arbitrary, but may help the readers to identify the referenced persons. Furthermore, for the purpose of consistency, the book follows Wikipedia and places a hyphen between xiii

xiv Notes on the Romanization of the Korean Language the syllables of the given names for the persons who do not appear on Wikipedia. In the end, the exceptions outnumber the regular cases that follow the official guideline, but this is more or less inevitable given the current changing state of the romanization of the Korean language in the globalized world.

Abbreviations

BOK

Bank of Korea

CPI

Consumer price Index

DTI Debt-to-Income ERP

Effective Rate of Protection

FDI

Foreign Direct Investment

FKTU

Federation of Korean Trade Unions

HCI

Heavy and Chemical Industry

HEG

High Economic Growth

ICT

Information and Communication Technology

KCTU

Korean Confederation of Trade Unions

KOSDAQ

Korea Securities Dealers Automated Quotation

LTV Loan-to-Value NBFIs

Non-Banking Financial Institutions

NIIP

Net International Investment Position

NPLs

Non-Performing Loans

NPS

National Pension Service

NSO

National Statistical Office

PPP

Purchasing Power Parity

REER

Real Effective Exchange Rate

SMEs

Small and Medium-Sized Enterprises

TIs

Targeted Industries

TFR

Total Fertility Rate

UIs

Untargeted Industries

xv

South Korean Economic Development in Perspective

1

On January 1, 2010, South Korea became the twenty-fourth member of the Development Assistance Committee (DAC) of the Organization for Economic Cooperation and Development (OECD). The DAC is a forum for discussing issues related to development and poverty reduction in developing countries. When the decision to admit the country to the DAC was made on November 25, 2009, the South Korean government made much fanfare, emphasizing that the country had become the first to turn into an aid donor after being an aid recipient. In a national radio broadcast on November 30, the then-president Lee Myung-bak defined the event as “a miracle that our great people have accomplished and an amazing success story in world history.” He further stated that the Republic of Korea (the official name of South Korea) was “a success model of international aid and cooperation and a beacon for developing countries in the twenty first century.”1 To those who remembered the country’s past, Lee’s words were not an overstatement. Up to the early 1960s, the South Korean economy was virtually propped up by foreign grants-in-aid, mostly from the United States. From 1953 to 1962 – the first decade for which data are available – grants-in-aid accounted for about 14.3 percent of GDP; this represents even a higher proportion than in many recent “failed states” of Sub-Saharan Africa.2 South Korea’s transformation into a donor nation within less than 50 years was certainly a remarkable accomplishment. 1

2

http://world.kbs.co.kr/service/contents_view.htm?lang=k&menu_cate=&id=&​board_​ seq=256434. Grants-in-aid as a percentage of GDP were calculated from the Bank of Korea, Economic Statistics Yearbook, various issues.

1

2 The Tortuous Path of South Korean Economic Development Lee Myung-bak was not the first person to use the term “miracle” to describe South Korea’s economic rise. In fact, the term was not popularized by any politician’s political rhetoric: Its origins were academic, as it became commonly used around the world after the World Bank published a book titled The East Asian Miracle in 1993. As China was not covered in the book, South Korea was described as the leading county behind the East Asian Miracle. Owing to the “miracle” that it had accomplished, South Korea joined the OECD, the “rich countries’ club,” in 1996; its admission to the DAC in 2009 represented a further step in the country’s OECD membership. The country also became a member of the Group of 20 (G20) summit formed in the wake of the 2008 crisis and was supposed to host the fifth G20 summit in Seoul in November 2010. The summit would deal with the “development agenda,” whereby the South Korean government would share its own development experience as an example for the world. Of course, one could observe that, by 2009, the South Korean economic “miracle” was a thing of the past. After the 1997 crisis, the country’s growth rate almost halved: In the 11 years following the crisis (from 1998 to 2008), it grew by 5.0 percent on average annually, while it had grown by 9.2 percent on average in the 11 years before the crisis (from 1986 to 1996).3 However, a 5.0 percent of average growth rate in the 11 years after the crisis was not a low number in the international context, belonging to the higher end of the average growth rates for OECD countries over the same period. The country was also doing relatively well in 2009: While most OECD countries were recording negative growth rates by a significant margin in the aftermath of the 2008 crisis, it recorded a positive 0.8 percent growth rate. This fact provided some ground for the Lee government to make fanfare about the admission to the DAC. On the other hand, many South Koreans did not feel comfortable with the admission to the DAC and the fanfare made by the Lee

3

Growth rates in this book are in 2015 prices unless specifically noted (data source: ecos.bok.or.kr).

South Korean Economic Development in Perspective 3 government. They knew that their country was not ready to become a substantial aid donor. More importantly, joining the DAC reminded them of the pains of the 1997 currency crisis, as they believed that the decision to join the OECD in 1996 had been an underlying cause of the crisis. When it broke out, the crisis had been – rightly – called the “biggest disaster next only to the Korean War.” In 1998, the economy contracted by 5.1 percent. Economists were (and still are) divided about the reasons for the fall of the growth rate after the crisis: Some claimed that the growth slowdown reflected the normalization from the “overgrowth” before the crisis; others held that the slowdown represented the “undergrowth” created by the crisis. Whatever the explanation from economists was, the common people, who had been accustomed to a high growth rate for decades, did not take the sudden fall in the growth rate easily. In fact, the fall of the growth rate was painful to them, as it meant not only a slow growth in income but also an increasing scarcity of jobs. Politicians tried to accommodate common people’s sentiments by promising to boost the growth rate in electoral campaigns. In this regard, Lee was best placed to make people believe in his promise of growth, as they remembered him as one of the heroes behind the economic miracle of the 1960s and 1970s. He had been the boss of the Hyundai Construction Corporation, a powerhouse of the South Korean overseas construction drive in the 1970s. In the presidential election campaign of 2007, Lee promised that he would achieve an average growth rate of seven percent in the five years of his tenure as president. By November 2009, it was clear that this was an impossible mission, whether Lee had believed in it or not when he had promised it in 2007. Instead, Lee emphasized the great achievement that had been made before, to which he had contributed as a businessman. This made many people uncomfortable, although presumably only a minority regarded the affair as a ploy from Lee to divert public attention from his failure to meet his promise.

4 The Tortuous Path of South Korean Economic Development Furthermore, on closer examination, one could easily identify the country’s relatively better growth performance in 2009 as deeply ironic, given that it stemmed from the weakness rather than the strength of the economy. When the global financial crisis broke out following the bankruptcy of Lehman Brothers in September 2008, the country underwent another currency crisis, as foreign capital started to flow out in droves. The exchange rate skyrocketed, and the country could barely resolve the crisis with the conclusion of currency swap agreements with the United States, Japan, and China. Subsequently, the exchange rate fell only slowly and was maintained at a high level in 2009. Although the South Korean economy recorded a 0.8 percent positive growth rate in 2009, this was due mainly to the fact that the rise in the exchange rate increased the net exports (exports minus imports), which accounted for 3.1 percentage points of the economic growth, while the domestic demand (consumption and investment) accounted for −2.3 percent points of the economic growth.4 Thus, South Korea’s relatively good growth performance in 2009 was – at least partially– a result of the failure to prevent another currency crisis after undergoing the 1997 crisis; more generally, it reflected the country’s high vulnerability to crises. This book will discuss how South Korea accomplished an economic “miracle” and therefore stands as an “amazing success story in world history.” At the same time, it will explain how this miracle has been a tortuous process, ridden with crises such as the 1997 currency crisis and another one in 2008.

1.1  A Unique Case What makes South Korea’s economic development an “amazing success story in world history”? Lee Myung-bak is likely to have pronounced that statement as a form of political rhetoric, without giving extensive thought to the reasons. The economic development of South Korea should nevertheless have its place in the world history,

4

The figures are from ecos.bok.or.kr.

South Korean Economic Development in Perspective 5 as it is the only country to have made the transition from a developing country to a developed country in the last 70-plus years. One can easily realize this by taking a look at the world history. The most important aspect of human history over the last few hundred years has been the Industrial Revolution. Just like that of all other countries, the economic development of South Korea is inscribed within the Industrial Revolution. The term Industrial Revolution is controversial, as its relevance varies according to the context. Economists rarely use it to describe today’s economic development.5 However, over the long term, there is no doubt that today’s economic development forms part of the Industrial Revolution, which indeed represents the largest change undergone by human beings since they settled down as agrarian people after the Neolithic Revolution about 10,000 years ago. The Industrial Revolution started in Britain in the late-​ eighteenth century and spread to continental Europe and the colonial offshoots of Europe in the nineteenth century. Of course, it did not suddenly spring out of a vacuum in Britain; it occurred within the broader conditions whereby Europe had forged ahead of the rest of the world. Europe’s head start led to Western imperialism around the world. Although Western imperialism had started before the Industrial Revolution, the latter nevertheless made it more intense and pervasive. The “first globalization,” which took place from the nineteenth century until the outbreak of the First World War in 1914, meant the expansion of trade, investment, and migration on a voluntary basis among the equal partners of the Western world, but it meant coercion to the rest of the world  – coercion first through gunboat diplomacy and then colonization. A very small number of non-Western countries avoided colonization; even those that avoided it often became semi-colonies, experiencing severe infringement on their sovereignty as they found themselves having to cede territories and concede privileges to Western powers. Only Japan survived and

5

See Lucas (1998) and Acemoglu and Robinson (2012) for the exception.

6 The Tortuous Path of South Korean Economic Development succeeded in starting an industrial revolution of its own. Japan then joined the West in the pursuit of imperialism, colonizing Korea and Taiwan. The first globalization was interrupted by the crisis of the first half of the twentieth century – or more precisely, from 1914 to 1945 – when two great wars and the Great Depression ravaged the West. The nature of the imperialism changed, as the tight control on the colonies was loosened and the imperialist powers redistributed the colonies among themselves. Nevertheless, imperialism persisted. Imperialism invoked national liberation movements in the countries that had fallen victim to it. National liberation movements and the changing international political economy led to their independence after the Second World War. After gaining political independence, the next goal for those newly independent countries was to achieve economic development, that is, to pursue an industrial revolution of their own. This is how “development economics” was born. Development economics emerged as a distinct subfield of economics when newly independent countries emerged with the decolonization following the Second World War. In an overview article on development economics in the New Palgrave: A Dictionary of Economics, Clive Bell uses “pioneers” and “latecomers” as an organizing framework, based on the fact that newly independent countries started out from a state of poverty in a world where there were already rich countries.6 Although Bell used the more gentle expressions “pioneers” and “latecomers,” the harsh underlying reality was that the distinction was in fact between the former imperialist powers and their ex-colonies or ex-semi-colonies. If one excludes gray areas such as Latin America, the dichotomy between developed and developing countries in the last 70-plus years comes from this historical legacy. Over the last 70-plus years, the ensuing global question has been: Can those newly independent developing countries become

6

Bell (1987).

South Korean Economic Development in Perspective 7 developed countries just like their former masters? If so, which countries will? The answer to this question is that, after so many “success stories” achieved by different countries at different times, South Korea has now emerged as the only “country” (if not “economy,” as explained later) to have transformed itself from a developing to a developed country. To be able to claim that South Korea has emerged as the only country to have transformed itself from a developing to a developed country, one must first check that the country is really a developed country. It is defined as such according to the criteria of various international organizations. One of those criteria is membership in the OECD, as the organization is regarded as the “rich countries’ club.” OECD membership is limited to a small subset of countries (It currently totals 38 members, up from 20 when it was established in 1961), designating about 80–85 percent of the world’s countries as developing and about 15–20 percent as developed. Within the OECD, membership in the DAC can be considered a further step in the acknowledgment of a country as developed. International organizations such as the United Nations Development Program (UNDP), the World Bank, and the International Monetary Fund (IMF) also classify countries into developed and developing ones, employing different methods of classification and using different names to define developed countries’ status: “developed countries” (UNDP), “high-income countries” (World Bank), and “advanced countries” (IMF). These organizations all classify South Korea as a developed country. Then, one must check that no other former colonies are featured on the list of developed countries. Three other ex-colonies  – Hong Kong, Singapore, and Taiwan  – also seem to qualify for the list in some way. However, one has to consider politics here, as democracy, according to the OECD and UNDP classifications, is one of the criteria for achieving developed country status. It is natural to classify only democratic countries as developed ones considering the importance of democracy in modern world history. Along with the Industrial Revolution, democratization has been one of the most

8 The Tortuous Path of South Korean Economic Development pivotal changes in human society over the last few hundred years. The significance of democratization along with the Industrial Revolution has best been explained by the idea of the “dual revolution” espoused by Eric Hobsbawm, who saw the economic revolution that started in Britain (the Industrial Revolution) and the political revolution that broke out in France (the French Revolution) as the two forces that brought about the most profound changes in the world since the invention of agriculture, cities, and states.7 What Hobsbawm meant by democracy was liberal democracy, with the rule of law and civil liberties as major components. Democracy took a long time to take root even in Western European countries, with some of them democratizing only in the 1970s. Today’s developing countries learned the idea of democracy from their Western imperial aggressors or colonial masters. The idea of democracy subsequently received a boost as national liberation movements turned into mass movements. After they obtained independence, the majority of developing countries declared democracy as their governing principle. Though they learned the idea of democracy from the West, their democracies often took non-Western, nonliberal forms. Over the years, however, it has become clear that there is nothing like non-Western, nonliberal forms of democracy. South Korea declared liberal democracy as the governing principle of the country; the country underwent authoritarian rules that violated the principle, but it eventually managed to move to liberal democracy. Hong Kong and Singapore do not qualify as liberal democracies. Hong Kong is part of China, which is not a liberal democracy, and Singapore’s democracy may be considered only nominal. In contrast, South Korea and Taiwan have established substantial liberal democracies, meeting, for example, the criteria proposed by Samuel Huntington to measure the consolidation of democracy: two peaceful turnovers of power through elections between political parties or

7

Hobsbawm (1996).

South Korean Economic Development in Perspective 9 groups.8 Hong Kong and Singapore’s economies are also exceptional in the global context, as both developed from serving as enclaves for Western countries in the colonial era. They started from a higher base, and thus their growth rates of per capita GDP over the last 70 years have been lower than those of South Korea and Taiwan. Thus, only South Korea and Taiwan are left on the list of the countries that pass the rigorous test for the transformation from a developing to a developed country. What distinguishes South Korea from Taiwan is its political status on the international stage. Although both belong to divided nations, their political statuses are very different from each other’s: South Korea is treated as a country, whereas Taiwan is regarded as an “economy.” Thus, while South Korea joined the OECD, became a member of the DAC, hosted the G20 summit at which it shared its experience of economic development with the world, the same was out of the question for Taiwan. Whether that kind of activity, together with events such as hosting the Olympics in 1988 and 2018 and the World Cup in 2002, helped South Korea’s economic development is highly questionable; it may well have been the opposite. Hosting the Olympics and the World Cup was expensive, and joining OECD was an underlying, if not a direct, cause of the 1997 crisis.9 However, if this is true, one may paradoxically say that South Korea has managed to become a developed country even after paying all these costs. South Korea is also larger in size than Taiwan with more than twice the population.

1.2  A Tortuous Path South Korea’s achievement in economic development has been unique, but its process has been a tortuous one. Korea’s emergence as a developing country in 1945 in itself indicates the turbulent nature of its history. Being originally part of the “Great Tradition” of East Asia, as defined by the now-classic study by Edwin Reischauer and



8 9

Huntington (1993, Chapter 5). This will be discussed in Chapters 5 and 8.

10 The Tortuous Path of South Korean Economic Development John King Fairbank, Korea failed somewhere in its history, eventually becoming a colony.10 Korea’s history after 1945 also started with a series of disasters. Following a period of chaos, the country was divided into the North and the South, and the Korean War broke out in 1950, killing millions. Although the war ended in 1953, South Korea stagnated for another ten years, being virtually propped up by grants-in-aid from the United States. By the end of the 1950s, Washington officials wondered whether the country was a “basket case.”11 A student-led revolution broke out in 1960 and a military coup followed in 1961. Unexpectedly, the South Korean economy began to grow rapidly in the mid-1960s. This economic growth was sustained longer than in any other developing country. The records for developing countries’ growth in the last 70-plus years show that sustained growth has been rare, with abundant cases of years of high growth followed by long periods of stagnation. Many countries experienced years or even decades of growth but fell into a long stagnation at middle-income levels, failing to graduate to the ranks of developed countries. In the recent economic development literature, this phenomenon has been called the “middle-income trap.” This book does not address whether this phenomenon exists worldwide. However, the concept helps with understanding South Korean economic development by indicating that sustaining growth is at least as difficult as, or often more difficult than, starting growth itself.12 The fact that South Korean economic growth was sustained, and thus enabled the country to avoid a middle-income trap, really speaks to the uniqueness of its economic development process. South Korea seemingly ran through a turnpike since the mid1960s, judging from the fact that high economic growth (HEG) was sustained longer than in any other developing country; however, the growth was actually accompanied by recurring crises. Aside from

10 11 12

Reischauer and Fairbank (1960). See also Fairbank et al. (1965). Mason et al. (1980: 7). See the literature listed in footnote 20.

South Korean Economic Development in Perspective 11 the current crisis caused by the pandemic and Russia’s invasion of Ukraine, four crises stand out. In the early 1970s, the firms that had incurred domestic and foreign debts in the late 1960s found themselves unable to pay the debts back. The country resolved this crisis through an emergency decree to reduce their debt burden in August 1972. In 1979, a bigger crisis broke out, contracting the economy in 1980 for the first time since the end of the Korean War. This crisis took years to recover from and led to a drastic switch in economic policies. Then, in 1997, the East Asian financial crisis  – the severest and most widely known one – hit the country. South Korea was forced to seek assistance from the IMF to resolve the crisis and carried out a thoroughgoing reform following the IMF demand. In 2008, the country was drawn into another crisis with the outbreak of the global financial crisis. It resolved the crisis through currency swap agreements with the United States, Japan, and China. There were also many other smaller crises. Barry Eichengreen and his colleagues compared the crises South Korea had undergone in the four-plus decades before the 2008 crisis on the international scale and found that the country was on the crisis-prone end of the spectrum.13 Thus, while South Korea showed an outstanding performance in sustaining growth, it showed at best a mediocre performance when it came to avoiding economic crises. In addition, there were a number of political crises that had implications for the economy. HEG began under the authoritarian rule of Park Chung Hee, who had waged a military coup to topple the elected government in 1961. The subsequent economic growth was accompanied by an incessant movement to restore democracy, until that goal was achieved in 1987. South Korea provides a typical example of a developing country that grew rapidly under an authoritarian political regime and then democratized. The country thereby managed to become the only country to eventually transform itself from a developing to a developed one. However, this process was

13

Eichengreen et al. (2012, 277–278).

12 The Tortuous Path of South Korean Economic Development not a smooth one, involving political crises, which were often intertwined with economic ones. The economic crisis that broke out in 1979, for instance, was coupled with a major political crisis whereby Park Chung Hee was assassinated and succeeded by another military strongman, Chun Doo-hwan. During Chun’s rule, the economy flourished, but a political crisis developed to potentially jeopardize the very foundations of the Korean economic miracle. This crisis could be diffused, this book will argue, only through the democratization of 1987. After democratization, South Korea’s economic growth did not slow down. According to Lant Prichett and Lawrence Summers, South Korea is the only country to have experienced a rise in growth rate following democratization.14 However, democratization may have worked in one way or another as a cause of the 1997 crisis. The country continued to face problems after the 1997 crisis. Growth slowed down remarkably, more than the natural slowdown expected with the maturation of the economy. The meaning of the slowdown differs depending on whether it represents the normalization from overgrowth before the crisis or the newly emerging undergrowth after the crisis. This book will argue that the slowdown represents undergrowth, as the radical reform after the crisis, while trying to make the economy less crisis-prone, undermined growth by making the economic system less aggressive. It is also questionable whether the economy really became less crisis-prone, as illustrated by the outbreak of another crisis in 2008, after which growth slowed down further. Income inequality also widened after the 1997 crisis, so one may say that the economy moved from “growth with equity,” as characterized by the World Bank, to “slowdown with inequality.”15 Though the enhanced welfare system has offset the widened inequality of market income, the welfare system has its own problems, especially because of the rapid aging of the population.

14 15

Prichett and Summers (2014). See World Bank (1993: Chapter 1) for characterizing the East Asian economic performance before the 1997 crisis as “growth with equity.” Chapter 11 will discuss “slowdown with inequality.”

South Korean Economic Development in Perspective 13 Finally, the country is facing the changes in the international environment more fundamental than anyone it has encountered in the last 70-plus years. Beginning with the 2008 crisis, advanced countries’ economy has been undergoing a stagnation not seen since the end of the Second World War. Developing countries are doing better, but globalization has slowed or reversed. The rise of China is posing a challenge to the US hegemony, the political base of the postwar international economic order. The country is thus facing a tectonic shift of the international environment that it has no experience in dealing with. This book explains how South Korea’s economic development unfolded through a tortuous path to become a unique case globally. It first shows how it historically emerged as a developing rather than a developed country but launched the economic miracle in the 1960s, defining the process as “the great divergence” and “the great convergence.” The book next describes how economic development proceeded after the HEG began, summarizing the pattern as “sustained but crisis-ridden growth.” Finally, it briefly discusses the problem of coping with the changes in the international environment.

1.3  The Great Divergence and the Great Convergence To see how South Korea historically emerged as a developing country in 1945, but launched the economic miracle in the 1960s, one first has to explore how Korea failed earlier in history. The country failed first because East Asia lagged behind Europe in the modern era. Why this happened is a seminal question on which a substantial amount of ink has been spilled; this book uses the term “the great divergence” to describe this lag, following Kenneth Pomeranz.16 Within East Asia, China, Japan, and Korea took different paths in the nineteenth century, the explanation of which being another seminal historical question. One also has to examine what happened to Korea under



16

Pomeranz (2000). See also, among others, Landes (1998) and Morris (2011) for the comprehensive account of Europe’s forging ahead in the modern era.

14 The Tortuous Path of South Korean Economic Development the Japanese colonial rule (1910–1945), as many observers think this affected the future economic development of South Korea.17 It is also important to understand what happened from the liberation in 1945 to the beginning of the HEG in the 1960s. Korea went through disorder, division, and the Korean War in 1945–1953, and the South Korean economy stagnated after the war in spite of the massive amount of US aid. However, many conditions that would help future economic growth formed during this period. According to Daren Acemoglu and James A. Robinson, the two Koreas are the model examples of successful and failed states where a difference in institutions introduced at the time of the division made a critical impact.18 South Korea actually differed not only from North Korea but also from the majority of the ex-colonies at the time, which may have contributed to future growth. Finally, one needs to explain how HEG began in the 1960s, which more or less remains an unsettled issue. Earlier explanations emphasized the working of the market, emphasizing the pursuit of export-oriented industrialization, which became the mainstream view among economists. Later, some political economists presented a revisionist view, focusing on the role of the government. Some compromise was made as the mainstream view recognized the presence of heavy government intervention, but a difference remains as the mainstream view newly named itself the “market-friendly view.” The market-friendly view holds that it was market forces rather than government intervention that drove the economy to high growth.19 The three chapters following this introductory chapter explain what occurred during the three aforementioned periods, respectively: Chapter 2, “The Great Tradition That Failed,” explains how Korea emerged as a developing rather than a developed country in

17 18 19

Eckert (1991), Woo (1991: Chapter 2), Kohli (1994). Acemoglu and Robinson (2012: Chapter 3). See Keesing (1967), Krueger (1979, 1997b), Amsden (1989), Wade (1990), and World Bank (1993: Chapter 2). They will be discussed in Chapter 4.

South Korean Economic Development in Perspective 15 1945. After describing the traditional Korean state and economy briefly, the chapter explains how the country failed, by discussing the great divergence between Europe and East Asia and the different paths taken by China, Japan, and Korea in the nineteenth century. It then examines the economic changes made during the colonial period. Chapter 3, “Some Lights in the Dark,” discusses what happened from 1945 to 1960. This chapter describes the mixture of the darker aspects of the time and the brighter aspects of the succeeding period. The division and the Korean War made South Korea’s economic system a big exception among the ex-colonies, which would help growth later. After the war, growth was not impressive in spite of massive US aid, but some additional conditions for future growth were formed. Chapter 4, “Kicking Off the Miracle,” explains the achievement of the great convergence, beginning with the HEG in the 1960s, as the leadership change enhanced state capacity with the exportoriented industrialization already in place. The chapter then examines how the fiscal, monetary, and financial policies worked. It next investigates trade and exchange rate policies and the role of exports in the economy. It finally examines how South Korea overcame the bottleneck to the incipient HEG.

1.4  Sustained but Crisis-Ridden Growth The book next discusses how South Korea sustained growth, but the process was crisis-ridden. It does so by referring to studies that have tried to explain the sustainment of growth worldwide. They have identified a wide range of conditions for sustaining growth, but three conditions stand out: macroeconomic management, structural transformation, and the management of social conflict.20

20

See, among others, Aiyar et al. (2013), Benhabib and Rustichini (1996), Berg et al. (2012), Doner and Schneider (2016), Eichengreen et al. (2012), Eichengreen et al. (2013), Hausman et al. (2005), Jankowska et al. (2012), Im and Rosenblatt (2013), Lee (2019), Lin and Wang (2020), Rodrik (1999), and Vivarelli (2014).

16 The Tortuous Path of South Korean Economic Development Macroeconomic management is vital for sustaining growth. A country may initiate growth with price stability, but it may lose control over prices later. A high rate of inflation is detrimental to growth; a moderately high rate of inflation may not undermine growth much, but, depending on the circumstances, it may also be incompatible with growth in the longer run. The business cycle is inherent to the market economy, but a big boom, which is often accompanied by overinvestment or an asset price bubble (or both), involves domestic spending based on borrowing and drives the economy above its potential output. The subsequent overcapacity and bursting of the asset price bubble may cause a credit crunch and so cause many of the loans to stop performing. Moreover, inflows of foreign capital are sometimes followed by a sudden reversal, precipitating a currency crisis, which is far more difficult to deal with than domestic financial crises. Structural transformation is also critical for sustaining growth. A country may begin to grow by exporting commodities, but it needs to diversify its industrial structure to insure against idiosyncratic shocks in the form of sudden export collapses or a sudden deterioration of the terms of trade of the exported commodities. In the initial phase of development, a developing country can compete in the international markets by producing labor-intensive, low-cost manufacturing products, using technologies imported from abroad. However, over the years, wages rise, making the labor-intensive exports less competitive in the world markets. Thus, the country needs to move up the value chain to avoid finding itself stuck in the middle, between rich and poor countries. The third condition for sustaining growth is the management of social conflict. Although social conflict is ubiquitous in human society, it may become more remarkable in the process of economic development, as dislocations and strains accompany industrialization and urbanization. Conflict may develop among various social groups such as workers, industrial and business people, the military, bureaucrats, landlords, and peasants; conflict may also arise among

South Korean Economic Development in Perspective 17 ethnic, tribal, and regional groups. If the conflict intensifies and takes a violent form, such as a civil war, economic growth will collapse. Even if the conflict does not become violent, it may create uncertainties large enough to discourage investment. Social conflict also undermines growth by diverting people’s activities from the productive to the redistributive sphere as they aim to capture a larger share of the output through political means. Meeting these conditions is a recurring challenge in the process of economic development. The nature of the challenges changes over the years, as domestic and external situations change. The problems faced by a country at the middle-income stage differ from those faced at the low-income stage. The international environment may also change as, for example, the international economic order, which is beyond the control of a developing country, changes. If a country fails to respond to these challenges well, it will undergo a crisis. Responding to these challenges in an impeccable way is of course impossible, so it is inevitable to undergo crises, large or small, in the process of economic development. However, if a country makes a serious mistake in dealing with any of these crises, a crisis that could otherwise be short-lived will evolve into a longer one, leading to long-term stagnation. South Korea’s economic growth was sustained but crisis-ridden because, while the country did not respond to the aforementioned challenges well, it managed to make the ensuing downturns relatively short-lived. Yet, the 1997 crisis became a watershed event in this regard. Before the 1997 crisis, the country sustained HEG, recovering the same growth dynamism after going through crises; after the 1997 crisis, the economy recovered quickly and continued to grow, but the growth momentum weakened remarkably. It is also questionable whether the economy became less crisis-prone after the crisis, and inequality widened. This book examines the three aforementioned conditions for sustaining growth by classifying the period from the beginning of HEG into two sub-periods, with the 1997 crisis as the dividing line.

18 The Tortuous Path of South Korean Economic Development It explains in separate chapters how each of the three conditions for sustaining growth worked itself out respectively in each of the two sub-periods. There are thus six chapters altogether assigned to showing how South Korea’s economic development was characterized as sustained but crisis-ridden growth. In addition, one chapter is inserted before the three chapters covering the period after the crisis to explain the nature of the 1997 crisis and the ensuing reform. Thus, Chapters 5–7 respectively discuss macroeconomic management, structural transformation, and social conflict management before the 1997 crisis; Chapter 8 discusses the nature of the 1997 crisis and the ensuing reform; Chapters 9–11 respectively explore macroeconomic management, structural transformation, and social conflict management after the 1997 crisis. The contents of the seven chapters from Chapter 5 to Chapter 11 can be summarized as follows: Chapter 5, “Contours of the High Economic Growth,” deals with the macroeconomic management before the 1997 crisis. The economic system supporting the HEG tended to precipitate crises, which led to a big crisis in 1979. The country implemented a strong disinflation policy after the crisis, bringing about the recovery and boom in the 1980s. It then sustained HEG by boosting construction investment and riding the emerging global boom, but vulnerabilities to crisis remained. Chapter 6, “Industrial Policy and Chaebol,” is about the structural transformation before the 1997 crisis. The government initially implemented both vertical and horizontal industrial policies, and chaebol played a major role in structural transformation while emerging in a full-fledged form. Industrial policy then moved weight to horizontal policy while chaebol firms became global players in higher-technology industries. Yet the vulnerabilities surrounding chaebol were ready to precipitate a crisis. Chapter 7, “Growth with Equity?” deals with the management of social conflict before the 1997 crisis. HEG created jobs, reducing inequality, but there were also factors increasing inequality, which weakened over the years. South Korea sustained HEG through

South Korean Economic Development in Perspective 19 democratization mainly because it was limited in scope. Inequality did not narrow after democratization, but it led to reforms to enhance the transparency of the economy and allowed the emergence of independent unions. Chapter 8, “Crisis and Reform,” discusses the nature of the 1997 crisis and the subsequent reform. The causes and resolution process of the crisis reflected South Korea’s failure to adapt to the changing international environment of the 1990s. Yet, South Koreans tried to utilize the IMF conditionality as a momentum to carry out thoroughgoing reforms, which left many questions unanswered. The chapter then briefly surveys the contents of the reforms and their immediate consequences. Chapter 9, “The Slowing Engine of Growth,” deals with macroeconomic management after the 1997 crisis. Growth slowed down as the reform purged the previous system supporting the HEG while trying to make it less vulnerable to crises. However, the new system could not prevent another crisis in 2008. South Korea subsequently faced a deflation threat, and fiscal policy became a major issue. The country fought the coronavirus crisis from 2020 well, but risks in the financial markets remain. Chapter 10, “Industrial Policy and Firms,” is about the structural transformation after the 1997 crisis. Industrial policy remains alive, while services have become more important. Chaebol firms became true global players with less vulnerabilities but have many downsides unsolved. Venture business and foreign direct investment (FDI) failed to replace the role of chaebol, but their role is not the same as before. Small- and medium-sized enterprises (SMEs) continued their plight. Chapter 11, “Inequality, Jobs, and Welfare,” deals with the management of social conflict after the 1997 crisis. The chapter first shows that inequality widened after the crisis. It then explains how inequality widened as jobs became scarcer, labor market dualism deepened, the labor share of income fell, and unions often failed to represent the interest of the entire working class. The rise in welfare

20 The Tortuous Path of South Korean Economic Development expenditure reduced inequality, but the welfare system has faced its own problems in coverage and sustainability.

1.5  Questions for the Future Finally, there are the questions for the future. The future of the South Korean economy will depend first on how the country deals with the problems discussed in Chapters 9–11. Furthermore, the country is facing a tectonic shift in the international environment. This makes it helpful to go back to the longer span of history, and the book assigns another chapter to deal with the question briefly: Chapter 12, “Questions for the Future,” first explains that South Korea is facing a tectonic shift in the international environment that is not seen in the last 70-plus years. The chapter then discusses the country’s relationships with the great powers, seeking hints from what happened in the nineteenth century. The chapter finally discusses the country’s ability to manage the international relations with domestic cohesion.

The Great Tradition That Failed

2

Korea is an old country that comprised part of the Great Tradition of East Asia. However, when the Second World War ended in 1945, Korea emerged as a developing, rather than a developed, country due to the country’s failure somewhere in its history. This chapter briefly charts Korean history from the very beginning through to 1945. After describing traditional Korea, the chapter explains how the country fell behind not only Europe but also neighboring China and Japan and how it was colonized. It then examines what happened to the country under Japanese colonial rule.

2.1  Traditional Korea The Korean peninsula is a pleasant place to live as it is located in a temperate part of the Eurasian continent. Evidence of humans living in the peninsula can be traced back to the Paleolithic age. These people, like all humans in the Paleolithic age, were hunters and gatherers. Human life was transformed from hunting and gathering to farming sometime during the ensuing Neolithic age. Humans settled in villages rather than moving around. The Agricultural Revolution is one of the two great revolutions in human history, together with the Industrial Revolution. The Agricultural Revolution is important for the Industrial Revolution as regions that experienced the Agricultural Revolution before others tend to perform better in the Industrial Revolution.1 Agriculture began in Korea in around 4000 BCE, after the start of the Neolithic age in approximately 6000 BCE. Korean soil is good for farming, even though a large share of the total land area comprises

1

Putterman (2008).

21

22 The Tortuous Path of South Korean Economic Development mountains. Little is known about the people who started agriculture in the Korean peninsula around 4000 BCE. They are unlikely to be the ancestors of the majority of today’s Koreans; the majority of Koreans probably moved onto the peninsula after agriculture had already begun. The exact origin of current Koreans’ ancestors remains unknown, but the founding myths of Korea’s early kingdoms generally suggest that the ruling classes migrated from the northern Eurasia, leaving a lasting cultural legacy. However, over the period, China came to have an increasing amount of influence on the Korean peninsula. Therefore, traditional Korea was largely a mixture of the northern legacy and the Chinese influence, with the latter becoming stronger over the years.

The Korean State The development of agriculture led to the formation of states. The early Korean states were founded as walled town states that subsequently evolved into confederated kingdoms. This process was quickened by the inflow of iron culture from China around the fourth century BCE. In favorable areas, such as the Taedong River near Pyongyang (now the capital of North Korea), the first confederated kingdom called Joseon (called “Old Joseon” in Korea to distinguish it from the Joseon that would appear later) was instituted in approximately the fourth century BCE. Emperor Wu of China’s Han Dynasty conquered Joseon in 108 BCE. The Han Dynasty established a total of four commanderies in the northern part of the peninsula and the southern part of Manchuria. During the second century, the commanderies weakened along with the Han Dynasty. Throughout the period of Chinese domination, Korean confederated kingdoms once again emerged. The emergence of the confederated kingdoms led to the Three Kingdoms period (?-676), with the kingdom of Goguryeo emerging in the area where the Han commanderies were weakening and the Baekje and Silla kingdoms emerging in the south of the peninsula. These three kingdoms were constantly at war.

The Great Tradition That Failed 23 Over the years, an important factor arose that affected the relationship between China and these three kingdoms. China was rebuilt as a unified empire by the new Sui Dynasty (581–618) and Tang Dynasty (618–907) after being invaded by northern nomads in the early fourth century. The emperors of the new dynasties had to subjugate the peripheral areas of the empire, with Goguryeo being considered the most important. Goguryeo beat back the Chinese invasion many times, even when it was attacked by the Sui army of over a million soldiers led by the emperor himself and the Tang army led by emperor Taizong, a most capable emperor in Chinese history. If Goguryeo had failed to hold off the Sui and Tang armies, Baekje and Silla would not have been safe either. Korea may have been colonized again by China, this time perhaps permanently. The unification of the peninsula occurred in the context of the scramble for diplomacy in East Asia. Silla made an alliance with Tang, which triumphed over Baekje and Goguryeo. However, after that, Silla fought the Tang army for eight years, helped by the people of the regions previously belonging to Goguryeo and Baekje. By that time, Tang was weaker than it had been during the Taizong era. Silla eventually achieved independence after negotiating a tributary relationship with Tang in 676. In the north of the Unified Silla, the Balhae kingdom was founded in 698, claiming to succeed Goguryeo. It survived until 926, when it was conquered by the Kithans. When Balhae fell, many of the ruling class moved to Goryeo (918–1392), which succeeded the Unified Silla. The name Korea comes from Goryeo, which was named after Goguryeo, which it claimed to succeed. Korea has continuously existed as an independent country longer than most countries around the world. Its tributary relationship with China basically continued until the end of nineteenth century. It was a strategy to maintain independence in the face of the unequal balance of power, which worked as China did not invade Korea after the seventh century. The tributary relationship involved cultural as well as political relationships, with Korea importing advanced technologies and institutions from China. Therefore, Korea produced

24 The Tortuous Path of South Korean Economic Development items, such as china, almost as soon as China produced them (Korea probably started producing china in the tenth century), and Korea also introduced metal movable types in the thirteenth century, which was the first of its kind outside of China.2 Koreans differed from other peoples in East Asia in many respects. The majority of nomadic peoples in the north, who used to be the epicenter of the military turmoil in the Eurasian continent, invaded China and were subsequently absorbed into the Chinese population. The weaker peoples were simply conquered by China and became part of the Chinese. The Southeast Asians survived, some of them with the Sinicization of their cultures. However, they were farther from the center of China’s power, which was mostly located in North China; they were also farther from the northern nomads’ raids, which were frequent occurrences in Korea. Japan mainly kept to itself owing to its geographical location, and it evolved into a warrior state. Korea was raided by Japanese pirates when the Japanese islands’ central authorities failed to control them, but Japan under the control of a central authority invaded Korea in 1592 and devastated the country for six years. In Korea, for reasons that cannot be provided here, dynasties had unusual longevity. Silla existed for hundreds of years before unifying the peninsula in 676, after which it survived until 935. Goryeo was founded in 918 and ruled until 1392. The succeeding Joseon was founded in 1392 and survived until 1910. However, the political system constantly evolved over the years, with many twists and turns. It could be summarized as a process of building a bureaucratic state that aligned with the Chinese model. Silla was initially ruled by aristocrats, who were determined based on their bloodlines, but this was later challenged by a reformist idea that was based on Confucianism. The reformist idea from Confucianism continued to challenge the aristocracy during the Goryeo dynasty. Joseon finally completed the transition to a bureaucratic state in line with the Chinese model by

2

Jeon (2020); Kim (2012).

The Great Tradition That Failed 25 instituting a system in which the country was ruled by a king assisted by neo-Confucian literati officials who were selected through meritbased examinations. The completion of the transition to a bureaucratic state brought about the pinnacle of traditional Korea’s cultural creativity in the fifteenth century, most notably during the era of King Sejong’s rule (1418–1450). King Sejong could be regarded as a model “philosopher king.” During his rule, Korea invented its own alphabet, Hangeul, and carried out many scientific inventions. Joseon subsequently produced a few more kings who deserved the title of “philosopher king,” but Korea’s history from the sixteenth century onward was marked by a long anticlimax. The longevity of Joseon meant that its decline was protracted. Joseon was also becoming the Hermit Kingdom due to a limited amount of interaction with the outside world. Most importantly, Korea’s relationships with China and Japan were limited as China and Japan also isolated themselves from the outside world.

Agriculture and Commerce After agriculture began, agricultural technology advanced sporadically. First of all, the staple crops changed over time. Initially, the staple crop was millet, but in time it was replaced by rice. Major technological changes that occurred subsequently included the spread of iron tools and the use of cows in cultivation from the fourth to the eighth century. As elsewhere in the world, agriculture in Korea had fallow system, but it disappeared sometime between the tenth to the fifteenth century  – earlier than in Europe where the system existed into the nineteenth century. Another important technological advance was the introduction of transplanting rice seedlings in the sixteenth and seventeenth centuries. There were other technological changes as well, such as improvements in fertilizers, irrigation, and tools. State and Confucian literati were interested in increasing agricultural productivity, which was manifested, among other things, by the publication of many agricultural books. In the mid-eighteenth century, the ratio of planting to cropping was one to 40–50, whereas

26 The Tortuous Path of South Korean Economic Development the ratio in Europe was about one to six in the seventeenth century.3 Technological progress went side by side with the reclamation of land to increase production. As a result, population increased. It is difficult to trace the precise population, but estimates suggest that the Korean population increased more than threefold during the Joseon era, sparking a very high population density, like in other parts of East Asia.4 Little is known about the trends of per capita product in traditional Korea. The trend of per capita product before the Industrial Revolution seems to be an unsettled issue even for Europe. For example, Gregory Clark shows that per capita product fluctuated in a negative correlation with population, as the law of diminishing returns in agriculture was in action. In contrast, Angus Maddison holds that Europe in the early modern era underwent a slow but consistent growth of per capita product.5 In China, from which Korea borrowed much, per capita product increased for quite a long period of time during the Song Dynasty (960–1279).6 But no study has identified the increase in Korea’s per capita product for a significant period of time. Slavery was widely practiced in the Three Kingdoms period, as the kingdoms were constantly at war. Yet it is questionable whether slavery was the dominant class relationship in the Three Kingdoms period. One may remember that, even in ancient Greece and Rome, slavery was a complex system difficult to define monolithically.7 It is also questionable whether the unfree laborers in Korea could be called slaves in the Western sense; they may better be called “servants.” Servant labor in agriculture declined over the years. Until the fifteenth century, large farms using servant labor proliferated along with sharecropping; however, sharecropping came to dominate from the sixteenth century on. Peasants were no longer personally subservient to landlords, though economically they had little bargaining

3 4 5 6 7

Lee (2018: 59). Lee (2018: 51–61). Clark (2007: Part 1); Maddison (2001: Chapter 1). Jones (1988: Chapter 4); Maddison (2001: Chapter 1). Finley (1973: Chapter 3).

The Great Tradition That Failed 27 power in relation to landlords, as they had no alternative to cultivating land. The widespread practice of sharecropping can be identified by the fact that 50.4 percent of all cultivable land was under sharecropping tenancy in 1918, when the Japanese colonial government completed the cadastral survey.8 Aristocrats originally owned land and servants, but bureaucrats and ex-bureaucrats replaced them over the years. By the Joseon Dynasty, bureaucrats and ex-bureaucrats owned all land and servants. The majority of them lived in the countryside without any political or military base. The state was typically on the side of aristocrats earlier and bureaucrats later but was often interested in protecting peasants and servants, as the king had to worry about the tax base and long-term viability of the system. In the Joseon period, neo-​ Confucian ideology may also have worked as a check on the unlimited exploitation of peasants and servants. To understand Korea’s commerce in traditional society, it may be useful to classify commerce into “local trade” and “long-distance trade,” referring to the types of commerce in medieval Europe. Local trade catered to the demands of villagers’ daily necessities in the markets to which they could travel within a day; long-distance and international trade mainly met the luxury demands of the ruling classes by exchanging goods in farther fairs or cities.9 In Korea, local trade developed with agricultural development and population increase. By the late Joseon period, village markets that opened every five days densely populated the country. On the other hand, long-distance trade was stagnant. The state of long-distance trade depended much on the state of international trade, given the limited size of the country. International trade stagnated, first of all, because of state control. In the late Unified Silla period, the loosening of state control led to the active participation of Koreans in international trade. But the rise of the Goryeo Dynasty, even though its founder had commercial interests, led to the decline of international trade as the state came

8 9

Lee (2018: 331). Bernard (1975).

28 The Tortuous Path of South Korean Economic Development to control it more tightly. International trade also depended much on what happened in China. The Tang Dynasty chose a more open system, and Unified Silla was at the eastern end of the Silk Road. The Song Dynasty and Yuan Dynasty (1271–1368) also chose an open system. However, the Ming Dynasty (1368–1644) and Qing Dynasty (1644–1912), which roughly overlapped with the Joseon Dynasty in timing, chose a closed system. Korea’s international trade got a further blow when Japan’s Tokugawa Shogunate (1603–1868) also adopted a closed system in the seventeenth century.

2.2  The Failure While Korea survived for a long time as an independent country, it ultimately failed to join the early comers to the Industrial Revolution. This was mainly due to two reasons: East Asia lagged behind Europe, and Korea lagged behind neighboring China and Japan.

The Great Divergence and the Turning Point The failure of East Asia in relation to Europe has recently become known as “the great divergence,” a term coined by Kenneth Pomeranz.10 The great divergence did occur not because East Asia stagnated in particular, but because Europe forged ahead of the rest of the world. There was thus the “European Miracle” before the “East Asian Miracle,” as Eric Jones argued.11 Explaining the great divergence has an old but still-unsettled history. The term the great divergence itself is not neutral, as Pomeranz belongs to the “historical accident school” as opposed to the older “lock-in school,” according to Ian Morris.12 The historical accident school finds the causes of the great divergence in historical contingencies like the existence of coal and the American colonies, while the old lock-in school emphasizes the differences in socio-economic systems. Yet both schools have many variations within themselves.

10 11 12

Pomeranz (2000). Jones (1987); see also Landes (1998: Chapters 2–15). Morris (2011).

The Great Tradition That Failed 29 This is not the place to go through the vast literature about the great divergence. However, the explanation based on the evolution of the political system seems persuasive. In the ancient world, two colossal empires, Han China and Rome, dominated the East and the West, respectively. While China reemerged as a unified empire with the founding of the Sui and Tang dynasties, Rome was broken to pieces permanently. Although some rulers came close to rebuilding an empire in Europe, in the end, no one succeeded. Europe thus came to have a decentralized political system from the medieval era on. While other regions of the world at that time had similar decentralized political systems, Europe maintained this system for the longest. One may question whether this was a sufficient condition for the European Miracle in a global context, as so many observers have mentioned so many other factors. However, it surely seems to have been a necessary condition when Europe is compared with East Asia.13 There were benefits of an empire for economic development. The large size of the economy provided a favorable condition for innovations when the pace of innovations was random. It is apparently no exaggeration that most major innovations until the early modern era came out of China, leaving one to wonder why China failed to lead the world subsequently (the “Needham Puzzle”). The benefits of an empire indeed seem to account for China’s lead in the long medieval era. There is no agreement over when this primacy ended, but China no doubt lost its edge somewhere in the modern era. Europe’s “navigation revolution” in the fifteenth and sixteenth centuries likely marked a watershed event in which its decentralized system manifested the advantage. China had its own navigation revolution led by Zheng He in the early Ming Dynasty. Zheng He’s fleet was beyond comparison in scale with any European fleet at the time. Yet it was Europe that sustained its navigation revolution. Zheng He was ordered by the Yongle emperor to navigate mainly for

13

See Hall (1988), Wickham (1988), and Mo (1995), among others.

30 The Tortuous Path of South Korean Economic Development the purpose of searching for the former emperor, Yongle’s nephew, whom Yongle had deposed by coup. When it became clear that the deposed emperor would not come back, the Ming court lost its main interest in the expedition. This is in stark contrast to the case of Christopher Columbus. Columbus initially tried to persuade many sovereigns of Europe with his idea, but to no avail. He eventually persuaded Queen Isabella of Spain, who was then happy with her (and her husband’s) army’s triumph over the Muslims. Columbus’s expedition was a pygmy in size when compared with Zheng He’s first sail 87 years prior. However, after less than a century since Zheng He’s last expedition, China had forgotten its project while Ferdinand Magellan was rounding the globe. The subsequent succession of Europe’s navigation revolution also owed much to the decentralized system, as Holland replaced Spain in the seventeenth century and England replaced Holland in the eighteenth century as the leader. In the modern era, Europe’s decentralized political system led to the chronic warfare among nation states, which raised their state capacity. Wars placed a premium on the sources of taxation and created incentives for governments to invest in revenue-raising institutions.14 The enhanced state capacity was combined with the expansion of commerce as the navigation revolution extended the long-distance trade of the medieval era to a global scale. This provided the groundwork for the mercantilist system, where the influence of merchants rose. Merchants were the cronies of the political rulers initially, but they came to demand freedom from state intervention over the years. The ensuing events eventually led to the Industrial Revolution. A detailed exploration of the events in Europe leading to the Industrial Revolution is beyond the scope of this book. Yet Europe’s warfare states would soon dominate the world, and this dominance accelerated as Europe was on the road to the Industrial Revolution. It began with gunboat diplomacy and then moved to formal imperialism

14

Tilly (1990); Hoffman (2017).

The Great Tradition That Failed 31 to build colonies all over the world. In the end, a very small number of non-European countries avoided colonization; even those that managed to avoid colonization often experienced severe infringement on their sovereignty as they had to cede territories or concede privileges to the Europeans. Northeast Asia, composed of China, Japan, and Korea, was last affected by the advance of the West. It was now the advance of the West rather than Europe because the United States joined Europe in the advance to East Asia. With the emergence of the West, China, Japan, and Korea each faced a turning point. Japan eventually succeeded in building a state after the Western model to embark on economic growth and then joined the West in the pursuit of imperialism. Japan became a notable exception throughout the world by becoming an imperialist power of non-European origin. China failed to adapt to the new situation and became a semi-colony, managing to avoid full colonization only due to its size. Korea also failed to adapt and became a bone of imperialist contention, to be eventually colonized by Japan. Explaining such divergence for the three countries is another seminal question in history. The explanations have mostly focused on the difference between China and Japan. The old lock-in school version asserted that the Chinese economy and society stagnated and were not ripe enough for autonomous industrialization, while Japan was.15 However, for latecomer countries in economic development, what is critical is the “reform from above” initiated by the state. This was true even in Europe. Once Western European countries forged ahead, countries like Prussia or Russia had to carry out reforms in order not to fall behind. Enlightened monarchs and bureaucrats rather than the bourgeois (not to mention peasants) initiated the reforms. Of course, such reforms hardly worked when a country lacked the economic and social base to absorb advanced countries’ technology and institutions. However, few would think that China lacked such

15

Moulder (1977: 12–23).

32 The Tortuous Path of South Korean Economic Development a base or Japan had a far better base than China so as to make the observed difference in consequences. A far more important difference between China and Japan lay in their ability to carry out reform from above through state initiatives. In this regard, the attitude of the elites most likely mattered. Chinese elites were unable to see the seriousness of the Western challenge until it was too late because they thought China was the center of human civilization, surrounded by barbarians from whom they had little to learn. The Chinese elites’ mentality was illustrated by the Qing court’s response to the McCartney Mission of Britain in 1793. Japan, in contrast, had been on the fringe of civilization and had the experience of learning from greater civilizations, so it adjusted quickly to succeed in the Meiji Restoration.16 Another important factor may be the difference in political systems. Japan had a decentralized political system, which made it similar to Europe, as Marc Bloch observed earlier.17 Japan evolved into a warfare state with a stronger capacity resembling European ones. Japan’s stronger state capacity was revealed in the war of East Asia that Japan started by invading Korea in 1592. Japan mobilized about 158,000 soldiers when it launched the first attack, but Ming China could send only an approximately 43,000-man army to counter it. Though the nature of Japan’s warfare state weakened during the era of peace under the Tokugawa Shogunate (1603–1868), the legacy survived. Of course, Ming China may well have done differently in 1592 if it had been in the early phase of the dynasty. The Chinese empires had dynastic cycles. Their state capacity rose in the early phases but declined in the late phases. Thus, China in the nineteenth century could have countered the European offensive far better if the Qing Dynasty had been in its early phase. Then, the ensuing question is: If the Qing dynasty was in its declining phase, was it impossible to



16 17

Fairbank et al. (1965: Chapters 1–5). Bloch (2016: Chapter 3).

The Great Tradition That Failed 33 change dynasties? Indeed, the Taiping Rebellion (1850–1864) resembled typical peasant revolts in the late phase of Chinese dynasties, leading to their changes. Yet the Qing Dynasty managed to survive with the help of the Western powers, which found preserving the decaying Qing Dynasty better for imperialist encroachment. Indeed, the Western imperialist powers consistently intervened in China’s domestic affairs, while there was no such intervention in Japan. The imperialist intervention in domestic affairs was far stronger for China than Japan because China was the main target of the Western aggression; Japan was just important to countries like the United States as the stopover en route to China.18

Korea’s Plight Why did Korea fail? The first explanation came from Japanese scholars belonging to the lock-in school, who insisted that traditional Korea stagnated because of the backwardness of its socio-economic system. Korean scholars refuted the theme from the colonial era on, trying to find some “sprout of capitalism” in traditional Korea. Later empirical studies show a mixed picture. The population increased more than threefold from the fifteenth to the nineteenth century, supported by advances in agricultural technology and the reclamation of land. Local trade developed and market density rose. On the other hand, long-distance and international trade stagnated, and by the nineteenth century, Korea was lagging behind China and Japan, not to mention Europe, in terms of indices like per capita product, urbanization, and commercialization.19 More importantly, Joseon’s state capacity weakened contin­ uously from its peak in the fifteenth century, though with some back and forth. The bureaucratic state of Joseon, dominated by neo-​ Confucian literati in a long period of peace since its founding in 1392, evolved into a state most remote from the warfare states of Europe.



18 19

Moulder (1977: Chapters 4–7). See Maddison project and Mason et al. (1980: 66–70).

34 The Tortuous Path of South Korean Economic Development Joseon’s weak state capacity was revealed when it met the unexpected contingencies of war. When Japan invaded Korea in 1592, the Joseon court depended heavily on volunteer militias called the “righteous armies,” as well as aid from Ming China. The navy did well, but the court did little to support the navy. Weak state capacity was further revealed when Joseon could do little against Jurchen invasions in 1627 and 1636. The Joseon dynasty nevertheless did not collapse because, after the Jurchen invasions, there was another spell of peace that was better and longer than the previous one. Qing China eliminated the possibility of invasion by the northern nomads; the Tokugawa Shogunate exterminated the Japanese pirates. Joseon underwent a significant expansion of its economy during the first half of the peace period, which coincided with the expansions of the Chinese and Japanese economies. However, state capacity continued to weaken, which made it difficult to cope with the challenges posed by the advance of the West in the nineteenth century. Koreans also had a more limited opportunity to learn from overseas during the Joseon era. Koreans had a strong tradition of learning from advanced countries, notably China. During the times of the Three Kingdoms, Unified Silla, and Goryeo, Korean students, scholars, and Buddhist monks went to China and even India for study. Korean elites were aware of the world beyond East Asia. In 1402, three years before Zheng He’s first navigation, Joseon made a map of the world that included Europe and Africa.20 However, unlike the previous Chinese dynasties, Ming and Qing did not admit Koreans for study, so no Koreans went to China for study during the Joseon period.21 The problem worsened as Joseon’s ruling elites turned to fundamentalist neo-Confucianism to maintain their hegemony domestically after the Japanese and Jurchen invasions. Their mentality even turned against learning from China, which was ruled by the Qing Dynasty of the barbarian Jurchen origin.



20 21

m.khan.co.kr/opinion/column/article/202107200300075#c2b. Kim Duksoo (2020).

The Great Tradition That Failed 35 Regardless of their mental disobedience to the barbarian-​origin Qing, Joseon elites maintained a Sino-centered world view, all the more so as they became fundamentalist neo-Confucians. The tributary system was originally a strategy for survival and access to advanced civilization, but it became a rigid ideology in the late Joseon period. The continued isolation and the Sino-centered elite mentality undermined the country’s ability to adapt to the advance of the West in the nineteenth century. Thus, when Britain defeated China in the Opium War (1839–1842), Japan’s Tokugawa Shogunate carried out significant studies, but the Joseon court did little.22 Later, when the United States demanded Joseon open its borders, the Joseon court responded that such a thing was up to China. The United States got the answer from China that Joseon was its tributary state but independent in diplomacy as well as internal affairs, so it was in no position to tell Joseon to open its borders or not.23 Yet, it was clear that, when the Joseon court behaved that way, its ruling elites lacked the perspective beyond East Asia they had had earlier. Korea, in the long run, was indeed a survivor, which was possible because Koreans knew their position in the broader world. It was unfortunate that the Joseon’s ruling elites had lost such perspective before facing the tectonic shift of the international environment in the nineteenth century.

The Opening and Beyond Korea opened the door in 1876 after resisting a few invasion attempts by the West. The opening was dangerously late, as Western imperialism was moving from gunboat diplomacy to official colonization. Korea was far away from Western imperialist powers, which did not have much interest in the Hermit Kingdom of the Far East. Korea was even less of a target of the Western advance than Japan. However, to Korea’s neighbors  – China and Japan  – Korea was of vital interest,



22 23

Kang (1985: 18). Rhee (2006).

36 The Tortuous Path of South Korean Economic Development all the more so because they were themselves under the threat of Western imperialism. China was attacked on its peripheries, notably with France’s colonization of Indochina. China gave up the previous pattern of tributary relationship and began to directly intervene in Korea’s internal affairs. To Japan, Korea was the first country to be neutralized and eventually conquered, with the Korean peninsula being perceived as “a dagger thrust at the heart of Japan.”24 As in most latecomer countries, the ability to carry out reform from above through state initiative was critical. It is difficult to imagine that Korea lacked an economic and a social base on which to launch economic development even with a successful state initiative. There were indeed reform efforts initiated by elites. Once the door was opened, many Korean elites quickly began to learn from the outside world, as illustrated by the name attached to the period following the opening: “The Period of Enlightenment.” The mercantilist idea “Enrich the Nation, Strengthen the Military” spread rather quickly among elites. Yet it was difficult for the reformists to overcome the opposition of the conservatives. The critical difficulty was Joseon’s inability to build a significant modern armed forces. The weak state capacity and late start made it difficult to build modern armed forces after opening the door. Joseon thus had far weaker armed forces than neighboring China and Japan, not to mention the Western powers, which made it impossible to counter foreign invasions or stop foreign powers from fighting on its own soil. To make matters worse, Joseon elites did not hesitate to call foreign intervention into domestic affairs. Thus, in 1882, when the revolt of the old-style army threatened the incumbent elites’ position, they invited Qing troops to maintain power. In 1884, some radical reformers staged a court coup against the incumbents with the support of the Japanese troops stationed in Seoul, but it failed as the Qing army waged a counterattack. In 1894, when a peasant revolt – now called the “Donghak (Eastern Learning) Peasant

24

Peattie (1984: 15).

The Great Tradition That Failed 37 War” – broke out, the Joseon court called in the Qing troops again, which precipitated the war between Qing and Japan. After Japan triumphed in the war with Qing, it severed Korea’s long-standing tributary relationship with China, but that was a step towards colonization. In 1904, Japan fought another war with Russia, which came to have an interest in the Korean peninsula by that time. Japan won the war in 1905, not least with the help of Britain, which had forged an alliance with Japan in 1902 to counter the Russian advance in the Far East. Japan turned Korea into a protectorate in 1905, and formally annexed the country in 1910. There was fierce resistance to the colonization, led, as in the Japanese invasion in 1592, by righteous armies, but it could not stop the colonization. Though Korea failed to reform on its own and eventually lost sovereignty, there were some important institutional changes during this period. In 1894, Joseon carried out a significant reform, though under the pressure of the Japanese troops advancing to Seoul in the war with Qing. The reform included, among other things, an introduction of the principle of equality before the law, that is, the abolition of the formal class distinction of the traditional society. Western technologies and institutions were also introduced. Capitalist institutions such as corporations and banks emerged. Even some industrial policies were implemented, including the establishment of state-run factories, which suffered many difficulties in the beginning, but did better later. The construction of infrastructure proceeded, including the building of the turnpike railroad from Seoul to Busan. The market economy expanded as the country ended its isolation and lifted the state control of international trade. Trade items changed from luxuries to necessities. The opening led to the activation of long-​distance trade within Korea, which is evidenced, for example, by the rising degree of the integration of the rice markets across the regions.25 According to the Maddison project tracing the long-run trend of population and per capita product all over the world, succeeding the

25

Cha (2000).

38 The Tortuous Path of South Korean Economic Development job Angus Maddison started, the Korean population in the area that would later become South Korea was stagnant during this period, with about 9.8 million people in 1870 and 10.1 million in 1910. However, per capita product increased by about 35.1 percent from 1870 to 1911.26 If converted into the annual average growth rate, it is slightly higher than 0.3 percent. The trend in the area that would become North Korea is unlikely to be different. Korea differed from Japan and China in terms of the trend of population and per capita product after opening the country. Japan’s per capita product increased alongside the population. According to the Maddison project, China’s population shrank with the Taiping Rebellion and failed to recover to the previous level through the rest of the nineteenth century. The Maddison project does not show the decline of China’s per capita product, but Maddison himself earlier showed that China suffered a drastic fall in per capita product after opening the country.27 Korea fared worse than Japan but better than China in terms of the trend of population and per capita product. Politically, however, Korea was more doomed than China, not to mention Japan. China managed to avoid colonization, but Korea could not. This was the first time that Korea completely lost its sovereignty.

2.3  The Colonial Economy Under the Japanese colonial rule, Korea underwent a big economic transformation. Japanese colonial rule in Korea differed from most colonial rules in other parts of the world at the time. The two countries were geographically and ethnically close, and the Japanese colonial government replaced an existing government ruling a very homogeneous population, who subjectively considered themselves culturally superior to the Japanese (from a Confucian viewpoint).28 Japanese colonialism in Korea was similar to British colonialism in Ireland or Russian colonialism in Poland rather than the Western

26 27 28

www.rug.nl/ggdc/historicaldevelopment/maddison/?lang=en. Maddison (2001: Chapter 1). Cumings (1984: 486).

The Great Tradition That Failed 39 colonialism in other parts of the world. Japan tried to abolish the identity of the Korean people ultimately, prohibiting them from using their own language and alphabet. This kind of colonialism tended to be especially repressive and create intense resentment on the part of the colonized. However, Japanese colonialism was even more unique, as it tried to transform the colonial economy drastically.

The State and the Economy When Japan turned Korea into its protectorate in 1905 and colonized it in 1910, the world economy was still in the “good old days,” according to the chronology of the “phases” of capitalist development. The good old days were entailed by a crisis period, precipitated by the outbreak of the First World War and later the Great Depression, which would be followed by the Second World War.29 However, Japan did not suffer much from that crisis until the late 1930s. Japan got a bonanza from the First World War, and it suffered less from the Great Depression by implementing an expansionary macroeconomic policy ahead of most Western countries.30 Japan, with its relatively well-performing economy, transformed the Korean economy drastically. The changes in the nature of the state were most important in this regard. The Japanese colonial government had a far stronger state capacity than the Joseon dynasty in its last phase. The strengthening of state capacity was manifested in tax collection. As Japan imposed protectorate status on Korea, the total government revenue increased more than threefold from 1905 to 1911.31 Of course, without foreign intervention and colonization, Koreans may have by themselves enhanced state capacity through reform from above, or a revolution from below, such as the peasant war in 1894, may have overthrown the Joseon dynasty, founding a new state with a stronger capacity. Answering such counterfactual questions is always difficult.

29 30 31

Maddison (1982). Bairoch (1993: Chapter 1–2). Kohli (1994: 1276).

40 The Tortuous Path of South Korean Economic Development The Japanese colonial government had a particularly strong capacity compared with other colonial governments at the time. While colonial powers in other parts of the world also created a competent civil service, the Japanese colonial government was unique in both the extent and the intensity of bureaucratic penetration. There were some 52,270 Japanese officials in the Japanese-Korean government in 1937 for a population of about 22.7 million. Compare this with the French in Vietnam (where the presence of the French was already more significant than that of the British in Africa), who ruled a nearly similar-sized colony with some 3,000 French.32 The Japanese colonial government had the police machine penetrating every corner of the society. The police force was highly centralized, well-​ disciplined, and exerted extensive control throughout society. At the height of the colonial rule, there were enough police that the lowestlevel policeman knew every man in their village.33 Of course, this was possible because the Japanese employed Koreans as policemen and spies to aid them. The colonial government not only had a police force for control but also bureaucrats for economic growth. Japanese bureaucrats, selected by merit-based examinations, working in the colonial government were competent, devoted, and incorrupt. They were doing in Korea what they had done in Japan not long before. Japanese colonial policies also fit the conditions already in place before colonization. The Korean traditional society was similar to the Japanese one in many respects, if not in the state capacity. In addition, Korea had undergone many changes in its opening period, which the Japanese colonial government just needed to accelerate. Koreans yet had no representation at all in the colonial government, so economic policies were entirely decided by the Japanese, reflecting their own interests. In the 1910s, Japan consolidated the institutional settings by establishing modern property rights and



32 33

Eckert et al. (1990: 257). Chen (1984: 225).

The Great Tradition That Failed 41 carrying out an extensive cadastral survey to facilitate land transactions and establish the taxation base. The Oriental Development Company, a large real estate company established in 1908, began to promote the immigration of the Japanese into Korea. Japan also established a modern monetary system by establishing the central bank of the colonial Korea. It further built infrastructure, including branch railroad lines supplementing the turnpike lines. At the same time, the Japanese colonial government enacted the Corporation Law (1911) that empowered itself to control and dissolve both new and established enterprises in order to preserve Korea as a place for its own investment in the future, as Japan could not afford much investment in Korea immediately. In the 1920s, Japan, facing the shortage of rice supply at home, transformed its colonies Korea and Taiwan into the suppliers of rice to Japan proper. The colonial government launched a campaign to increase rice production by applying the technologies developed in Japan during the Meiji era. At the same time, the Corporation Law was rescinded because Japanese firms could now afford to invest in Korea, as they had accumulated the capability through the boom of 1915–1920, mainly as a result of the First World War. Japanese firms began to invest in Korea’s manufacturing and service industries. The rescinding of the law also gave a chance for Korean enterprises. In the 1930s, Japan promoted heavy and chemical industries (HCIs), state-of-the-art industries at that time, in Korea. Japan launched its aggression into China with the Manchurian Incident in 1931 and tried to build the Great Asian Co-Prosperity Sphere in the global environment where the great powers were building bloc economies under the impact of the Great Depression. Japan found Korea, especially its northern part, fit for the HCIs, given the endowment of raw materials and the favorable conditions for electricity generation. Japanese zaibatsu firms found Korean wages low in relation to productivity, rent low, and infrastructure well provided by the colonial government. There was also no factory act in Korea, in contrast to Japan. Korean-owned firms also increased activities, though they were

42 The Tortuous Path of South Korean Economic Development marginal in weight, concentrated in light industries, and composed of smaller firms.

Growth, Distribution, and Divide Under colonial rule, Korea’s population grew consistently. According to estimations by Korean economic historians at the Naksungdae Institute of Economic Research, who have traced the historical statistics for Korea, Korea’s population grew by 1.3 percent on average from 1911 to 1944. The population grew for the same reason as in other colonies: The death rate fell with the introduction of modern medicine, while the birth rate did not fall. Per capita GDP increased by 2.1 percent on average from 1911 to 1943. Structural change accompanied the increase of per capita GDP. Agriculture (including animal husbandry) and forestry accounted for 66.5 percent of GDP in 1911 but only accounted for 38.4 percent in 1940. Mining and manufacturing accounted for 5.0 percent of GDP in 1911 but accounted for 17.2 percent of GDP in 1940.34 The GDP data have the critical problem of representing the production “within Korea” and thus fail to present Koreans’ production and income. One could, however, surmise that Koreans’ per capita product increased during the colonial era. The GDP in 1943 was approximately 2.74 times the GDP in 1911 in constant prices (2010 prices). There is also an estimate indicating that the Japanese probably accounted for more than 20 percent but less than 30 percent of income within Korea in the 1930s.35 One could assume the extreme case that Koreans accounted for 70 percent of GDP in 1943 and 100 percent of GDP in 1911 (This is a grave overestimation because foreigners accounted for about 1.6 percent of the population in Korea in 1911; the share rose to 3.1 percent in 1943). Even with such an extreme assumption, the GDP accounted for by Koreans in 1943 was about 1.92 times the GDP accounted for by Koreans in 1911. Considering



34 35

The numbers are from naksung.re.kr. Lee (2018: 404).

The Great Tradition That Failed 43 that the Korean population in 1943 was approximately 1.50 times the population in 1911, one can conclude that the per capita GDP accounted for by Koreans in 1943 was at least 1.28 times that in 1911. The living standard, however, did not improve for the majority of Koreans. The living standard of the common people often failed to improve in the early phase of industrialization in advanced countries as well, but Korea as a colony displayed some peculiar features. Notably, the per capita consumption of food grains as a whole declined substantially after the early years of the colonial period. This was mainly because, in spite of the increase of production, about half of the rice products ended up as exports to Japan, while imported crops were not as good food as rice for Koreans. Korean workers’ living standards also did not rise. Real wages rose for a small number of skilled Korean workers but failed to rise for the majority of unskilled workers from the 1910s to the 1930s.36 If Koreans’ per capita product increased while the living standard of the majority of the population failed to rise, some Koreans must have benefited disproportionally. In this regard, landlords stood out. Japan modernized land ownership through cadastral survey but left the traditional landlord-tenant relationship intact. Landlords’ fortunes improved under the colonial rule, which is illustrated by the increase of the weight of tenanted farmland in the cultivated acreage. The weight was 50.4 percent in 1918, when the cadastral survey was completed, but rose to 63.4 percent in 1945.37 The majority of land was owned by Korean landlords, in spite of the penetration of the Japanese ownership through the Oriental Development Company (By the end of the colonial rule, about 13.1 percent of total cultivated land was owned by the Japanese).38 Landlords did well exactly because the living standards of the majority of the population stagnated. Peasants’ bargaining power in

36



37 38

See Suh (1978: 82–90) and Huh (2005) for Koreans’ living standard during the colonial period. Lee (2018: 331). encykorea.aks.ac.kr/Contents/Item/E0013191.

44 The Tortuous Path of South Korean Economic Development relation to landlords weakened or continued to be low. While the population grew in numbers, peasants did not have many opportunities for nonagricultural activities. Though Korea underwent industrialization, in 1940, only 4.8 percent of Korean workers were engaged in manufacturing, whereas 72.7 percent worked in agriculture.39 There were occasions when Koreans worked outside the country. By 1944, about 16 percent of the population had moved from the Korean peninsula to live in places like Japan and Manchuria.40 However, they were working as unskilled workers or were mobilized by the Japanese for war efforts, so their moving out of their rural hometown rarely represented a move to seize remunerable opportunities. The inequality between the industrialists and workers was less of a source of inequality among the Koreans because the industrial sector was relatively small and the ownership was overwhelmingly Japanese, but that of course did not mean the absence of an inequality problem among the Koreans. Inequality badly divided Koreans. The majority of landlords became the de facto allies of the Japanese colonial rule, particularly after Japan began to promote rice production in the 1920s. Japan promoted rice production for political as well as economic purposes. After the harsh military rule in the 1910s precipitated the March First Movement in 1919 – the massive national liberation movement that led to the establishment of the Korean Provisional Government in Shanghai, China – Japan switched to “cultural rule” in an attempt to court some groups of Koreans to collaborate with, or at least not to actively resist, the colonial rule. Landlords were the natural candidates to court. Indeed, the low per capita food consumption was the result of the landlord-tenant relationship combined with the Japanese policy to export rice. Korea could export about half of the rice product to Japan because of the harsh landlord-tenant relationship. Landlords had a large



39 40

Lee (2018: 405). Eckert et al. (1990: 322).

The Great Tradition That Failed 45 amount of surplus rice to sell, while peasants had to pay about half of their products as rent even when their consumption level was low. The harsh landlord-tenant relationship led to sporadic peasant protests, but the Japanese colonial government quickly squelched them. The colonial state also repressed any protest by workers or their attempts to form labor unions. The Japanese of course utilized Korean collaborators in the repression, mainly those who joined the police force, who were often more cruel to their own people than the Japanese masters. The divide appeared in the national liberation movement. The plight of peasants and workers went side by side with the radicalization of the intellectuals who led the national liberation movement. From the late 1920s, it became increasingly difficult to separate social revolutionaries from nationalists because most Korean intellectuals studied radical ideas as patriots, intensely concerned with overthrowing the Japanese colonial rule.41 The Korean national liberation movement was accordingly divided into moderate and radical factions. While the former retained some nationally known elderly figures, the latter, composed of younger ones, became the major target of the police and comprised the overwhelming majority of the political offenders who were arrested, tortured, and imprisoned, especially in the southern part of the peninsula.

Sustainability and After Dwight H. Perkins and his colleagues differentiate development and growth, and say that there are cases where growth cannot be called development. First, the government may pursue growth not to improve the welfare of their citizens but to augment the glory of the state and its rulers. Second, consumption may not rise while the investment for the future increases, as in the former Soviet Union. Third, income and consumption may increase, but those who are already well off may reap most or all of the benefits.42 According



41 42

Eckert et al. (1990: 297). Perkins et al. (2012: 39).

46 The Tortuous Path of South Korean Economic Development to those criteria, the economic growth under the Japanese colonial rule is disqualified as development even without considering that Koreans had little voice in designing the growth. However, the real limitation was that the growth was unsustainable, for political rather than economic reasons. The Japanese economy itself most likely contracted due to the strains of the Second World War somewhere in the 1940s. Korea’s GDP and per capita GDP peaked in 1941 and then fell.43 Not only the overall size of the economy contracted, but also the civilian consumption was reduced as the Japanese colonial government contracted the industries meeting civilian demands in favor of the industries catering to military needs. Japan also mobilized millions of Koreans to support the war, which undermined the growth of the economy as well as their living standards and often threatened their physical lives. Eventually, the Japanese Empire itself became unsustainable. The unsustainability of the Japanese Empire was more or less builtin. After the initial success, the obsession of successive Japanese governments with the strategic security of the empire’s borders played a pernicious role in sustaining the empire itself. The initial rationale for Japan’s imperial expansion – the need to control adjacent territories on the way to a near-at-hand formal empire – made it impossible to give finite limits to Japan’s imperial ambition. Each new imperial acquisition required the control of a buffer territory adjacent to it.44 Japan first regarded the Korean peninsula as a dagger thrust at its heart. Once Korea was colonized, Manchuria became the buffer territory to be brought under control. After Japan came to control Manchuria, China proper became the next target. The war with China was extended to the unwinnable war with the United States and allied powers. When the Japanese Empire collapsed with the defeat in the Second World War, Korea was liberated from its colonial rule, but the



43 44

See naksung.re.kr. Peattie (1984: 9).

The Great Tradition That Failed 47 Korean economy was in shambles. Korea’s per capita GDP in 1946 was most likely smaller than in 1909. Then, what legacy did the colonial rule leave for Korea’s future development? There would not be much industrial production capacity left for the future South Korea. The larger amount of the industrial capacity was located in the northern part of the peninsula, and much of the smaller amount located in the South would be destroyed in the Korean War or decayed due to neglect through the turbulent years after the liberation. Yet an economy with an experience of rapid industrialization behind it may be different from a tradition-bound, nearly stagnant, agrarian economy, which was common for other ex-colonies. Korea inherited infrastructure that was among the finest that an ex-colony had inherited. The colonial experience may have helped Korea to have a stronger state capacity than other ex-colonies after their liberations. Koreans also got the experience of living with modern market institutions like corporations, factories, and banks, even though their opportunity to acquire important skills was limited. The experience of living outside the Korean peninsula made the workers different from the peasants who lived in their home villages their entire lifetime. However, the colonial rule left a critical negative legacy. As Edward S. Mason and his colleagues suggest, the most serious negative feature of Japanese colonial rule was the continued isolation of Koreans from experience in the international arena and in running their own country.45 In August 1945, Korean people would gain their liberation without such experience while being severely divided among themselves, with bitter memories of the colonial rule shared by the majority of the population.



45

Mason et al. (1980: 91).

3

Some Lights in the Dark

Korea was liberated from Japanese colonial rule on August 15, 1945 when Japan was defeated in the Second World War. The country subsequently went through a disastrous phase until 1953. The separate occupation by the United States and the Soviet Union led to the division of the country; this was followed by the Korean War, which broke out in June 1950 and continued until July 1953. After the Korean War, the South Korean economy failed to grow rapidly even though the country received massive foreign aid. In 1960, a student-​ led revolution broke out. However, many of the conditions that laid the groundwork for the high economic growth of the future were established during this period. This chapter briefly surveys what happened to the country in 1945–1960, focusing on the darker aspects of the time and the brighter aspects of the succeeding period.

3.1  Division, War, and the Consequences In 1945, the United States and Soviet Union separately occupied the Korean peninsula. Though the occupation was temporary, it led to the division of the country. The country was divided mainly because the United States and the Soviet Union failed to agree on the terms of their withdrawal from Korea. The only way to avoid division was to build a diplomatically neutral state with a mixed economy, similar to what was done in Austria. Austria was probably too far removed to be an example given the different historical backgrounds of the two countries. However, many contemporary ex-colonies became neutral states with mixed economies, a remarkable example and the largest of them, being India. Why was that kind of settlement impossible? Lee Chong-Sik, a well-known expert on this matter, says that Joseph Stalin ordered 48

Some Lights in the Dark 49 the setting up of a separate regime in the North as early as September 1945.1 However, Lee does not clearly explain why Stalin agreed to the US proposal for the imposition of a five-year trusteeship in Korea at the Moscow Conference of Foreign Ministers of the United States, the Soviet Union, and Britain in December 1945. Meanwhile, the US position was ambivalent; its only consistent objective was to block the communists from taking power. Regardless of the positions of the United States and the Soviet Union, the country could have avoided division if Koreans had an idea about how to avoid division and rallied behind it. Koreans, however, lacked such an ability. They lacked such an ability mainly because of their isolation from experience in the international arena and in running their own country during the colonial period. They had also been badly divided within. Some political leaders tried hard to avoid division, but others found that their interests lay in solidifying their positions in the divided halves of the country. These leaders seized power with the ascendancy of the Cold War.

The Politics of Conflict What happened to the South? The United States was unprepared for occupation and initially planned to rule through the Japanese colonial government that was in place. However, by the time US troops arrived in September 1945, the Japanese colonial government could not function due to upheavals. In its place, there emerged “people’s committees,” which were self-governing bodies.2 A nationwide organization related to the people’s committees – the Committee for the Preparation of Korean Independence – also emerged. However, it had a weakness. The organizer of this committee, Lyuh Woon-hyung, commanded widespread support, particularly among the youths, but he lacked the overwhelming charisma of successful leaders of national liberation movements that some ex-colonies had. He was



1 2

Lee (1998). Cumings (1981: Chapter 3).

50 The Tortuous Path of South Korean Economic Development also a moderate leftist without full control over radical leftists, who, together with the communist leaders in the North, had little sense of how to avoid division. The United States did not recognize the people’s committees and instead imposed military rule, relying on the Koreans who approached it quickly, many of whom had collaborated during Japanese colonial rule. The military government notably came to have the machine of the revived Japanese imperial police, now composed of Koreans. This led to fierce resistance from the leftists. The suppression of the leftist resistance involved the terrorization and massacre of innocent people. At the same time, right-wing leaders gained some advantage by leading a movement to oppose the Moscow agreement on trusteeship. Oddly enough, the movement was precipitated by false reports by leading newspapers that insisted that Moscow rather than Washington had proposed the trusteeship while failing to explain that it was an arrangement for a transition to independence with Korean participation. Two prominent right-wing leaders, Rhee Syngman and Kim Gu, led the anti-trusteeship movement. Rhee Syngman, a Princeton PhD in international politics who had been in exile in the United States for more than 40 years where he was seeking Korean independence through diplomatic means, knew very well that scuttling the Moscow agreement would lead to the division of the country. On the other hand, Kim Gu, who had come back from exile in China where he was the chairman of the Korean Provisional Government in Chongqing, led the movement without knowing that it would lead to division. Rhee then supported the US decision to move the agenda to the United Nations, while Kim Gu regarded that move as a road to division and belatedly sought a compromise with the communist leaders in the North, who actually used his efforts for their propaganda that they did not seek division. In 1948, Korea became independent as a divided nation. In the South, the Republic of Korea (the official name of South Korea) was established with liberal democracy (henceforth “democracy”) as the

Some Lights in the Dark 51 founding ideology. Rhee Syngman seized power as the first president. Many commentators say that Rhee was a leader with foresight and that he understood the impossibility of a compromise with communists and, thus, the inevitability of the division, ahead of other leaders.3 It is impossible to answer a counterfactual question such as whether a compromise with communists was possible in Korea in the mid-twentieth century. However, it is also true that Rhee knew from the beginning he could seize power only through the division of the country because the Korean peninsula under his rule would be unacceptable to the Soviet Union (just as the Korean peninsula under communist rule would be unacceptable to the United States). Rhee lacked a political base within Korea and seized power with the help of, to a significant degree, collaborators with Japanese colonial rule. The collaborators had their own interest in division because an undivided country would punish them, however lightly, for their ill doings during the colonial period. Rhee’s seizure of power, together with the US occupation policy, resulted in not punishing a single person for collaborating with Japanese colonial rule. Instead, the collaborators became elites in the new republic. This caused the South to suffer an inferiority complex toward the North, which routed the collaborators, in the following decades.4 The collaborators were naturally authoritarian in disposition and, with Rhee’s consent, often violated the principle of democracy. When the division happened, many people, including some foreign observers, worried that it might lead to a war.5 The division indeed led to the outbreak of the Korean War, which the North started, on June 25, 1950. It is now known that Stalin said he approved and aided the North’s attack in order to reduce the pressure from the West in Eastern Europe.6 At the same time, Rhee’s government did

3



6

4 5

Kim (2010: Chapters 1–2) is one good example. See, for example, The Economist Survey on South Korea, June 3, 1995. For example, Australia’s UN representative said that the decision to divide the country might lead to a war, which would put the United Nations in a dilemma between intervention and neglect (Oliver 2008: 164). https://digitalarchive.wilsoncenter.org/document/112225.

52 The Tortuous Path of South Korean Economic Development not lack its own rhetoric about emancipating the North through war. The critical difference between the North and the South was that the United States, unlike the Soviet Union, did not give enough arms to the South to start a war. When the North attacked, Rhee fled to the southern part of South Korea while telling the people that he was in Seoul and ready to fight to the end there. His main action was calling back the US troops that had left Korea. After China joined the war, the conflict continued for three years until the signing of an armistice on July 27, 1953. The armistice merely imposed a stop to the war. No peace treaty has been signed yet.

The Economy, 1945–1953 The power vacuum left by the Japanese, the unpreparedness of the US occupation, and political turmoil left the Korean economy in shambles immediately after the country’s liberation in 1945. In addition to those political factors, economic factors played a hand in the economic disruption. First, the unrestricted monetary expansion by the Japanese colonial government immediately before and after the liberation caused high inflation. The inflation rate, measured as the increase rate of the consumer price index (CPI) for the Seoul area (The index for the whole country would be available only in 1965), was 918.4 percent in 1946 and 158.7 percent in 1947 (See Appendix 1). This impeded production activities, while fostering only speculative activities. Second, the sudden severing of the Korean economy from the Japanese economic bloc brought about complications. Most of the Japanese business people, managers, engineers, and technicians returned home, leaving many firms bereft of management or technical expertise. Cutting the closely-knit ties with the Japanese economy also meant a sudden interruption of the supply of intermediate goods and the loss of product markets. Third, with the partition of the country, the complementary economic structure between the northern and southern regions of the country was lost. All these factors reduced production drastically. According to the unofficial statistics compiled by the Naksungdae Institute of

Some Lights in the Dark 53 Economic Research (Official statistics began to be compiled in 1953), GDP in South Korea (in 2010 prices) in 1946 was 51.1 percent of the peak figure in 1941. Even by 1949, GDP was only 72.9 percent of the 1941 level. Per capita GDP underwent a similar descent.7 Then came the Korean War. The number of civilian war casualties, including those missing, was approximately 1.5 million – about 7.3 percent of the South Korean population in 1950. The physical damage the war inflicted upon the civilian economy was equivalent to about 85 percent of GDP for 1953.8 The growth rate of GDP and per capita GDP was negative in 1950 and 1951, making them fall below the 1949 level for three consecutive years from 1950 (See Appendix 1). The war also destroyed price stability. By 1949, inflation had more or less been stabilized, with the inflation rate coming down to 32.5 percent. In 1950, Korea established its central bank, the Bank of Korea (BOK), under the advice of US economists who recommended the establishment of an independent central bank resembling the US Federal Reserve Board. Although the Bank of Korea Act failed to actually bestow full independence on the central bank, the country gained an organization whose main mission was to stabilize prices. However, the outbreak of the Korean War immediately afterward led to galloping inflation. The inflation rate averaged 164.6 percent during the four years from 1950 to 1953 (See Appendix 1).

A Big Exception After the Korean War, South Korea emerged as a country very different from other ex-colonies. By the time the Korean War ended, the world was being roughly divided into three groups: the free (capitalist) world, the communist world, and the Third World. Most excolonies belonged to the Third World, though there were overlapping cases like China or North Vietnam, which became communist countries as the previous victims of imperialism. In contrast, South Korea became a vanguard of the free world in the Cold War with limited

7 8

See naksung.re.kr. Kim and Kim (1997: 11).

54 The Tortuous Path of South Korean Economic Development sovereignty. In 1953, it signed the Mutual Defense Treaty with the United States, which maintained the military bases in South Korea while China withdrew its troops from North Korea in 1958. South Korea kept its own armed forces of about 600,000 men  – a great contrast to the late Joseon period. This military, however, was far beyond South Korea’s own economic capabilities, with US aid funding a major part of the cost of maintaining it. Military aid amounted to approximately nine billion dollars in total from 1945 to 1972. The US military headquarters was stationed in the very heart of Seoul, in the same place where the Japanese army headquarters had been located. The commander of the US forces had operational control of the Korean armed forces. Rhee Syngman had handed it over temporarily during the war; however, it continued after the war ended. The United States wanted to maintain the operational control, fearing Rhee’s rhetoric that South Korea would ignore the armistice and continue fighting the war. Anticommunism became the foremost de facto principle of governing. Although the constitution was still defining the country as a democracy, the pursuit of anticommunism could often overrule the constitution. Thus, the government could persecute socialism of any kind, insisting it as communism or sympathy with communism. Rhee could not push anticommunism over democracy to the extreme, as he had to play an electoral game under US pressure, but it would be generous to consider the political system of the country at that time democratic, except for in a formal sense.9 The political situation was reflected in people’s use of words. For instance, South Koreans became reluctant to use words like “people” or “class,” so the Korean equivalents virtually disappeared. Thus, South Koreans (not to mention North Koreans) could not think about social science subjects in the usual fashion. Third World nationalism was also anathema. The Rhee government was putatively nationalist, but the personal record of having

9

See Henderson (1968), for example.

Some Lights in the Dark 55 joined a national liberation movement could invoke suspicion from the government of being a communist or communist sympathizer. The term “national liberation movement” suffered a fate similar to words the “people” and “class.” Espousing the peaceful unification of the country meant sympathizing with the North. Third World nationalism as anathema was more or less consistent with extreme anti-socialism, considering that Third World nationalism and socialism often overlapped with each other in contemporary ex-colonies. Many national liberation movement leaders had become socialists in the process of freedom fighting. One can see the ascendancy of socialism in the immediate post-colonial era by checking the list of leaders attending the Bandung Conference in 1955: Sukarno of Indonesia, Jawaharlal Nehru of India, Ho Chi Minh of Vietnam, and Zhou Enlai of China. One may say that they were particularly leftist, not representing the overall political spectrum in the Third World.10 However, when China, India, and Indonesia participated, it is hard to say that the leftist trend revealed at Bandung Conference failed to represent the contemporary mood in the Third World. Korea, particularly its southern region, was originally no exception in that regard. One could expect that from what had happened during its colonial era. It was no surprise that colonial rule in its later years provided a basis for belief in the story of “the brave men leading the jump in history.” Socialism was indeed strong in people’s committees and the Committee for the Preparation of Korean Independence. The Korean Provisional Government in Chongqing, China, regarded as the collection of right-wing leaders at that time, had economic doctrines more leftist than the British Labor Party’s.11 According to one opinion poll conducted by the US military government in 1946, 70 percent of Koreans in the South favored socialism, with another ten percent favoring communism.12 However,

10



11 12

See Escobar (1995: 31) for the view that there was a left-leaning bias in the Bandung Conference. Han (2014). Park (2006: 108).

56 The Tortuous Path of South Korean Economic Development the division of the country and the Korean War wiped out socialism together with Third World nationalism, making South Korea a real exception among ex-colonies at the time. This exceptionalism would turn out to be a favorable condition for future economic growth.

3.2  The Exception to Work The wiping out of socialism together with Third World nationalism would help the economy grow because socialism and Third World nationalism did not work in the ex-colonies. South Korea succeeded by escaping from such common failures. The country established institutions for private enterprises that faced poor labor rights. In addition, the country became another exception by carrying out a thoroughgoing land reform.

Escape from the Common Failures The escape from socialism would turn out to be a favorable condition first because capitalism came to prosper in advanced countries. As briefly mentioned in Chapter 2, the good old days of capitalism were entailed by a crisis period, involving two world wars and the Great Depression. In addition, two great revolutions broke out, first in Russia during the First World War and then in China after the Second World War. In contrast, from the 1950s, advanced countries underwent the “golden age of capitalism.”13 The performance of their economy was better than not only in the crisis period but also in the good old days preceding it. This classification of the “phases” of capitalist development may be too European and US-centered, but helpful nonetheless. Europe and the United States have been the center of the world since the nineteenth century. From the 1950s, not only the frontier economy  – the US economy  – performed better, but also, more importantly, the European and Japanese economies went through a rapid catch-up growth. During the preceding crisis period, a big gap had

13

Marglin and Shor (1992); see Maddison (1982) for statistical evidence.

Some Lights in the Dark 57 opened up between the United States on the one hand and Europe and Japan on the other. That gap narrowed from the 1950s; the US economy in turn enjoyed the stimulus provided by the rapid growth of the European and Japanese economies. The golden age of capitalism went side by side with the second globalization. Globalization had reversed during the crisis period but was now resuming. The second globalization was supported by the establishment of international organizations such as the International Monetary Fund (IMF) and the General Agreement on Tariffs and Trade (GATT). The political base underlying the second globalization was the establishment of US hegemony. The theme “hegemonic stability,” conceived by Charles Kindleberger and then elaborated upon by other authors, seems a persuasive scheme in this regard.14 In a strict sense, the golden age of “capitalism” is a misnomer. Most Western countries introduced a mixed economy or welfare state by the 1950s. The system accommodated the working class’s revolutionary energy by institutionalizing modern industrial relations through independent labor unions. New Dealers in the United States and social democrats in Europe, who were not strictly capitalist, seized power through elections. The emergence of this new system owed, not to a small degree, to the threat of communism.15 It was still a capitalist market economy, and globalization proceeded with the deepening integration of the world market. The failure of the communist variety of socialism needs no elaboration here. Indeed, Karl Wittfogel had insight when he observed that communism in the Eurasian continent was a variant of “oriental despotism” (though his idea of the hydraulic society as its origin is not so persuasive).16 In fact, as a modern totalitarianism, communism was worse than oriental despotism as it left less room for pluralism, private property, and the protection of tradition. The mid-twentieth

14 15 16

See Kindleberger (1973) and Keohane (1984), among others. See Obinger and Schmitt (2011), for example. Wittfogel (1957). See also Fukuyama (2011: 83).

58 The Tortuous Path of South Korean Economic Development century saw the proliferation of various ideologies, including totalitarianism, on both the right and left. While fascism – a most flagrant form of totalitarianism – collapsed with the Second World War, communism – which was in fact just as flagrant – was on ascendancy. Communism was on ascendancy because of the crisis of capitalism in the first half of the twentieth century. In the colonies, the belief that capitalism was inseparably intertwined with imperialism was also responsible. Thus, some conscientious national liberation movement leaders like Ho Chi Minh became communists, overlooking what was really happening in the Soviet Union.17 However, their belief was becoming an anachronism in the second half of the twentieth century, as the golden age of capitalism was unfolding itself and colonialism was ending, while the miseries of communism persisted. Thus, the big question for South Korea was whether there was no other way to avoid communism than division and war. South Korea not only avoided communism but also benefited from the consolidation of the communist regime in the North, which drove hundreds of thousands of educated and talented people to the South. Some of them had to move to the South because of their collaboration record under the Japanese colonial rule, but most were just fleeing the communist tyranny. By driving these people to the South, North Korean communist leaders were not only creating a condition for the division of the country but also losing talents to the South. Such an effect was most visible in Taiwan and Hong Kong at the time, but the effect was surely present in South Korea on a smaller scale. The two Koreas have thereby become model examples of successful and failed states where a difference in institutions introduced at the time of the division made a critical impact. However, South Korea actually differed not only from North Korea but also from most of the ex-colonies at the time, where other varieties of socialism prevailed and then failed. A most illustrative example is Nehru’s Fabian

17

Duiker (2000).

Some Lights in the Dark 59 Socialism in India, which brought about the “License Raj.” The License Raj bound Indians’ individual initiatives and entrepreneurship with omnipresent red tape; consumers faced sellers’ markets, where they had to buy poor-quality consumer goods, and thus had not much incentive to work.18 There is no way to know how socialism worked in all other ex-colonies. The taxonomy of economic system is complex, and many other factors interacted with the influence of socialism to determine the economic system of the ex-colonies. However, according to Jeffrey Sachs, South Korea, together with Hong Kong, Singapore, and Taiwan, became clearly an exception among the ex-colonies in belonging to the capitalist system.19 The division laid the foundation of future growth because Korea undivided would most likely have had an economic system common to other ex-colonies. In fact, even the division did not introduce the capitalist system de jure. South Korea’s first constitution resembled the constitution of the Weimar Republic of Germany, reflecting the influence of socialist ideas even among the right-wing leaders at that time; it introduced the principle of the mixed economy. However, political realities differed from the constitution, for which the Korean War was critically responsible. The war also led to the introduction of the principle of private enterprise for major industries through the revision of the constitution (explained below). Furthermore, the war moved millions of people out of their hometowns and disrupted the existing social structure, helping the future economic growth. It destroyed the wealth of the rich, thereby reducing inequality, which would help economic growth later by stabilizing politics. Thus, to a large degree, the division laid the foundation of future economic growth as an unintended consequence by ending up with a war. Third World nationalism failed mainly because of the reluctance to integrate economically with advanced countries. It is now self-evident that developing countries need the market, technology,



18 19

Rodrik and Subramanian (2004); Aghion et al (2008); Rajan (2010: Chapter 2). Sachs (2000: 38–39).

60 The Tortuous Path of South Korean Economic Development and capital provided by advanced countries. However, most national liberation movement leaders did not like the integration with advanced countries. They remembered history: The integration with the West had eventually meant colonization at worst or political subjugation at best. An extreme case in this regard was Maoist China, which experienced the disaster of the Great Leap Forward. However, Mahatma Gandhi had an idea not very far from Mao’s when he led the Swadeshi movement, aspiring to build a new India by resorting to her great tradition, as suggested by his image in older days – a man rowing the spinner’s wheel of India’s indigenous cotton textile industry. He even refused Western medicine in the late years of his life. Jawaharlal Nehru, his protégé, had a better sense of modern industries, but he aspired to build the Indian economy (if not its polity) after the model of the Soviet Union, which provided the then-“recent success story” by growing fast after severing ties to advanced capitalist countries.20 Kwame Nkrumah of Ghana, Black Africa’s first head of state, said that integration would create a “neocolonialism.”21 Critical here was the fact that the age of colonialism was over. Now, economic integration did not mean colonization or political subjugation. Underlying this was the replacement of the old colonialism by US hegemony. The two world wars in the twentieth century led to the collapse of the old colonialism led by Europe. Now, Europe and Japan gave up – voluntarily or involuntarily – their prewar imperial ambitions. The ex-colonies now faced the new capitalist world with the United States as the hegemon and Europe and Japan as its minor partners. It is beyond the scope of this book to define the nature of the US behavior toward developing countries. It is yet worth noting that the ending of territorial ambition was a big thing. The United States surely showed nasty behaviors toward developing countries, including wars, assassinations, and coup manipulations.22 However, in no

20 21 22

Bhagwati and Panagariya (2013: Part I). Bhagwati (2004: 9). See, for example, Perkins (2005) and Bevins (2020).

Some Lights in the Dark 61 case did the US action involve territorial ambitions. The result of the integration of the ex-colonies with advanced countries would thus not be the same as under the old imperialism. Moreover, the Cold War acted as an important check on the abuse of power. In fact, the United States was a “benevolent” hegemon in many parts of the world, which was particularly true for South Korea, a vanguard in the Cold War. South Korea’s integration with advanced capitalist countries was a big source of benefit for the country. Initially, the overwhelming mechanism of integration was the grants-in-aid, which South Korea received disproportionately more of than other developing countries. The mechanism of integration would later move to trade, which would critically contribute to the HEG. In addition, the integration with advanced countries laid the groundwork for active learning from overseas. To find a comparable period in Korean history, one has to go back to the late Goryeo era when the Yuan Dynasty of China admitted Koreans for study. During the Joseon period, no Koreans went to China for study. Then, after a brief period of opening in the late nineteenth century, Koreans were under the Japanese colonial rule that virtually confined their source of learning to Japan, itself a latecomer to Europe and the United States. Now, South Koreans were in a position to learn from all over the world except the communist bloc. Particularly, they came to have vast opportunities to learn from the United States, by far the largest source of advanced learning after the Second World War.

Private Enterprise with Poor Labor Rights Private property right was left intact during the turbulent years from 1945 to 1953, with the major exception of land reform (explained below). Koreans’ private property was not just kept intact; it was expanded with the privatization of the “vested properties,” mainly composed of the enterprises left by the Japanese. The larger amount of the Japanese industrial capacity was located in the northern part of the peninsula, and much of the smaller amount located in the South was destroyed in the Korean War or decayed due to neglect during

62 The Tortuous Path of South Korean Economic Development the turbulent years after the liberation. Still, they comprised by far the largest portion of the industrial properties existing at that time. The US military government confiscated them and then decided to privatize them. It thereby denied not only the previous ownership of the Japanese but also the ownership of the Korean workers, who were self-managing some of the enterprises. Korean workers were doing so mainly to preserve the facilities and maintain jobs, but they were also often associated with people’s committees. The US military government sent managers to those firms, chosen mainly through the connections to the Korean personnel in the military government. It then began to sell the vested properties to Koreans. When the sales involved disorder, fraud, and corruption, Korean political leaders called for stopping the privatization regardless of their ideological inclinations. The realized sales during the three-year US military rule thus accounted for only 0.5 percent of the values of the vested properties.23 Divesture was also not initially active under the newly established South Korean government. The country’s first constitution stipulated the nationalization of major industries. In 1949, the National Assembly passed a law limiting the sale of vested properties by excluding major industries like mining, iron and steel, and banks. The government privatized only smaller firms not belonging to those industries. The Korean War changed that. The United States demanded the amendment of the constitution as a condition for aid. The Korean government had its own need to raise revenues to carry out the war. The Rhee government also thought that privatization would create a new capitalist class as a social force, helping to fight the war. The National Assembly eventually revised the constitution in 1954, to replace the principle of nationalization of major industries with the principle of private enterprise. The government privatized large enterprises in major industries and banks. Among the companies with 300 or more employees, the share of privatized ones reached

23

Lee (2018: 444).

Some Lights in the Dark 63 approximately 40 percent by the late 1950s.24 The government still owned a large proportion of enterprises, but the principle of private enterprise was firmly entrenched. The privatization of the vested properties provided the pattern of Korean business for many years to come – the cronyism between the government and big business. The price of sale was far below the market price, and new owners paid the prices by spreading out the payment under the inflationary conditions. The buyers of the vested properties had various backgrounds, but managers previously sent by the US military government accounted for the largest proportion in terms of cases. They accounted for 51.9 percent, followed by the buyers that had begun to do business during the US military rule, who accounted for 14.5 percent. Third were buyers who had been doing business since the colonial era and accounted for 13.3 percent.25 They were shrewd people who captured the new opportunity quickly, utilizing the connection with politicians and government officials. The newly emerging business people would face workers with poor labor rights, given the country’s political situation. The labor movement under the Japanese colonial rule had existed in a sporadic and eventually an underground form. The leadership of the labor movement emerging after the liberation was naturally in leftists’ hands, but they immediately faced conflict with the US military government. Under such a circumstance, the right-wing forces formed nationwide organizations to introduce modern industrial relations based on independent unions, but their real aim was to destroy the leftist-led unions.26 Eventually, the division of the country and the Korean War led to a very unfavorable condition for labor rights. Labor rights were poor not because the laws were especially repressive. South Korea’s constitution, resembling as it did the Weimar Republic’s constitution, had favorable labor clauses. In 1953,

24 25 26

Koh (2010: 11). Calculated from Lee (2018: 446–447). Park (2006: 132–133).

64 The Tortuous Path of South Korean Economic Development the country enacted modern labor legislation at the urging of the US advisers, defining the protection of individual workers through the Labor Standard Act and allowing the collective voice of workers through the laws on the union rights. Actually, the Labor Standard Act legislated the conditions favorable to workers that most employers found hard to abide by at that time, including 48 working hours per week, annual paid leave, severance pay, and so on. However, the government was not really interested in enforcing the laws. At the bottom line was the political atmosphere that allowed anticommunism to overrule the constitution, and repressing labor rights was often regarded as the top priority in the anticommunist agenda. The Labor Standard Act remained virtually a dead letter. With the benefit of the laws on union rights, workers could officially organize unions, though employers tried to block them by every means, often with the acquiescence or even the assistance of government officials. Yet even when workers managed to organize unions, unions lacked independence. The anticommunist organizations that had fought the leftist-led unions transformed themselves into nationwide unions, but their leadership was subjugated to Rhee’s ruling party. The union leaders were not so much interested in improving workers’ conditions as they were in improving their political fortune. At the enterprise level, some union officials tried to represent the workers’ voice, but they counted little. The government responded quickly to any labor unrest, with physical force if necessary. This provided a favorable business environment that would contribute to the HEG later.

Land Reform South Korea escaped socialism, preserving the principle of private property rights. However, the country could not push it too far. It had to carry out land reform, which was a serious infringement on private property rights. In a sense, the land reform was actually a logical conclusion of the principle of private property rights. The classical defense of private property was proposed by John Locke, who

Some Lights in the Dark 65 defended private property as the product of human labor.27 However, owning land not produced by humans is another matter. Locke justified the private ownership of land by assuming that land was unlimited, but land is of course limited. Moreover, as John Stuart Mill, an eminent nineteenth century liberal, recognized, land ownership was the product of conquest and violence rather than the fruit of Locke’s honest labor.28 That was no doubt true for Korea. Landlords had ruled for millennia, their property rights indeed being the legacy of the old regime originally founded on violence. Landlords had also benefited much from the Japanese colonial rule, which was illegitimate to most Koreans. Once the Japanese colonial rule collapsed, the demand for land reform exploded. A thoroughgoing land reform in the North also made land reform an urgent task for the South. South Korea’s land reform was part of a broader move in East Asia in the mid-twentieth century, when China, Japan, the two Koreas, and Taiwan carried out land reform. As a whole, it was probably the largest single change of land ownership in history. The prime catalyst was the communist revolution or its threat. In China, Mao Zedong was winning the civil war on the platform of land reform. In Japan, the United States carried out land reform mainly to weaken the influence of the radical left that had become influential after the defeat in the Second World War. The context was similar for Taiwan. Initially, many observers regarded South Korea’s land reform as a failure. Official land reform was carried out as late as in early 1950, five years after liberation, as the influence of the landlords in the US military government and the subsequent Rhee Syngman government led to the procrastination of the reform bills. During those five years, landlords sold about half of their lands directly to peasants. However, later studies reveal that direct sales were at bargain prices, often by a wide margin.29 Also, the redistribution through the government

27 28 29

Locke (1988: 265–428). Mill (1987: 208). Jang (1984: 262–272).

66 The Tortuous Path of South Korean Economic Development mediation resulted in fatally eroding landlords’ interests as the delay in payments with the Korean War, combined with high inflation, drastically reduced the real value of “land compensation securities” the government had distributed to landlords in exchange for their land. The landlords’ losses were not matched by peasants’ equivalent gains because peasants had to pay the price of redistributed land in kind rather than in cash. However, landlord as a class was wiped out when the reform was over. After the land reform, rent payment fell to a mere two percent of rural household income.30 Land reform turned out to be critical for the survival of the state of South Korea. When the North Korean army occupied the South briefly in the war, they met not so many landless peasants hailing them. Instead, their atrocities and hard-heartedness (They often counted the number of individual gains) were more visible to the majority of the rural population. Land reform also critically contributed to political stability internally because, as Samuel Huntington observed, while peasants without land were most radical, peasants with land were most conservative.31 The majority of the rural population, who could now be called self-proprietor “farmers” rather than peasants, became part of the propertied class, however petty their property may be. The resultant political stability would help economic development. Economically, the land reform improved the living standard of peasants and thus most likely contributed to the subsequent spread of education. Land reform was part of the drastic changes in the income and wealth distribution after the liberation. The Japanese, who had occupied the highest bracket of distribution during the colonial era, were gone, and land reform equalized distribution among Koreans. Then the Korean War devastated much of the remaining wealth. Korea indeed became a typical case to realize equality owing to violence such as war, civil war, and revolution (or the threat thereof), in the



30 31

Ban et al. (1982: 301). Huntington (1968: Chapter 5).

Some Lights in the Dark 67 mid-twentieth century, as Walter Scheidel observes.32 In 1958, the earliest year for which income distribution data are available, the top one percent income share and top ten percent income share were a mere 4.5 percent and 14.7 percent, respectively. It is not clear whether the figures were derived by using exactly the same method as those figures appearing in the World Inequality Database. However, if one just looks at the figures presented, South Korea belonged to the countries with the lowest top one percent and top ten percent shares listed there. In fact, South Korea was comparable to the contemporary communist countries in this regard.33 It was ironic that the country became a classless society while class became a taboo word.

3.3  Growth with Aid From 1953, South Korea implemented its postwar reconstruction. Then, the emphasis shifted to price stabilization in the middle of 1957. Both the reconstruction and stabilization programs were supported by massive grants-in-aid, mostly from the United States. As a vanguard of the Cold War, South Korea received 4.4 billion dollars of economic aid in addition to approximately nine billion dollars of military aid. It was one of the largest recipients of aid per capita alongside South Vietnam, Taiwan, and Israel. Economic aid was concentrated in the 1953–1960 period. During this period, aid financed 78.1 percent of fixed investments and 71.8 percent of imports on average.34 The government budget heavily depended on aid money. In spite of the massive aid, the economy grew at not-so-​ impressive rates. GDP grew by 5.4 percent on average in 1953–1960 (in 2015 prices). Per capita GDP rose more slowly due to the rapid increase of the population. After the liberation, those who had moved out of the country to Japan or Manchuria during the colonial rule came back in droves. In addition, probably over a million people

32



34

33

Scheidel (2017: Part I–Part IV). wid.world/data/. Korea’s figures come from Hong (2015), which will be explained in Chapter 7. The figures are calculated from Mason et al. (1980: 206–208).

68 The Tortuous Path of South Korean Economic Development sought refuge from the North in the South between 1945 and 1953. Per capita GDP grew by 2.7 percent on average in 1953–1960 (See Appendix 1). Considering the country was recovering from the chaos after the liberation and the devastation caused by the war, the growth rate was not impressive. The US aid authority was unhappy with the Rhee Syngman government (August 1948–April 1960), which was eager to extort aid without making serious efforts to mobilize domestic resources. They came to see South Korea as a “basket case” over the years. However, South Korea carried out import-substituting industrialization (producing domestically the previously imported manufactured goods) during this period. This period also saw the formation of chaebol, a major player in South Korean economic development.

Market Failure, Government Failure The growth rate was low during this period because the investment rate was low. Gross investment averaged only 11.4 percent of GDP from 1953 to 1960. The investment rate was low because, while market failure was ubiquitous, the government failed to address it properly. Markets often fail in developed countries, but they fail far more seriously in developing countries. The capital market is imperfect. Entrepreneurs with new business ideas have to finance investments with their own resources, so they may be unable to sustain the losses until the investment eventually becomes profitable. Financial institutions may find it easier to lend to households, taking real estates as collateral, than lending to enterprises, which requires knowledge about their financial situation and technological potential. There are also spillover problems. Private firms first investing in the acquisition of knowledge may find it difficult to appropriate the returns from the knowledge acquired. There is also labor market externality as the firm entering an industry first may be shouldered with training workers with the skills that latecomer firms can then use without paying the training cost. Lastly, there is coordination failure. Investment

Some Lights in the Dark 69 may be possible only with the simultaneous development of downstream and upstream activities. In some cases, imports could solve the problem, but the simultaneous development often requires either the geographic proximity of the supplier to the final user or the availability of complementary local inputs.35 Market failure was probably less serious in South Korea than in other developing countries owing to the colonial legacy. Many market institutions survived, though only after going through disruptions, setbacks, and reorganizations. People’s experience of having lived with market institutions also helped. Still, market failure was ubiquitous, so government intervention was a necessity. However, for successful government intervention, state capacity was essential. Without due state capacity, government intervention to correct market failure may lead to government failure that harms the economy more than the market failure itself. This has indeed happened in many developing countries. South Korea in the 1950s was not plagued with the symptoms of very weak state capacity, such as teachers and doctors not showing up in the schools and hospitals officially employing them. South Korea had a higher ability to collect direct taxes than other countries with a similar level of per capita income (Collecting direct taxes requires stronger state capacity because it is difficult to assess and tax income and wealth).36 What accounted for such a not-so-weak state capacity? The legacy of the Japanese colonial rule likely mattered. Many government institutions of the colonial era survived, again after going through disruptions, setbacks, and reorganizations. The experience of living under the strong state capacity of the Japanese colonial government lingered on, though only a small minority of South Koreans had participated in the rule itself. South Korea’s state capacity in this period, however, was not strong enough to launch a high economic growth. Most of all, Rhee Syngman was not in a position to lead economic

35



36

See Rodrik (1995) and Stiglitz (1996) for detailed explanations of the sources of market failure in developing countries. Jones and Sakong (1980: 111–115).

70 The Tortuous Path of South Korean Economic Development growth. He turned 78 in 1953. Rhee was a man of charisma and expertise in political intrigues, but he was not good at grasping the downto-earth realities of the economy. Rhee was not much interested in building an effective government bureaucracy. Higher civil servants were recruited politically with only perfunctory screening rather than based on merit. A relatively small portion of the bureaucracy was open to foreign models, innovation, and planning. The bureaucracy could thus at best be described as “dualistic,” being composed of mixed elements.37 Rhee’s government was corrupt. Unlike many leaders of the ex-colonies, Rhee was not personally corrupt, but Rhee and his party had to play an electoral game. One obvious way to mobilize funds to finance elections and other party activities was to forge cronyism with emerging big business. Big business arose after the liberation through the purchase of vested properties; now they were accessing the foreign aid distributed by the government. The cronyism-​ generated rents were recycled back to government officials, the party, and individual legislators. Indeed, South Korea provided one of the earliest cases mentioned by the proponents of the idea of rent-seeking activity. Gordon Tullock’s narration, based on his own experience as a US Foreign Service officer in Seoul during the 1950s, illustrates such activity: In the years after the Korean War, President Rhee drove around the streets of Seoul in an old Packard automobile originally imported into South Korea as the personal car of the American ambassador; it was sold to Rhee when the American ambassador got a newer car. The most important single businessman in Korea visited the United States and then returned to Korea, not by air or passenger ship, but on a freighter. The freighter docked at Inchon, about twenty miles from Seoul, and there were on the deck of the freighter two Buicks, one green and one blue. Also, in the hold of the freighter there was a very large quantity of various things the businessman wanted to

37

Lee (1968: Chapter 8).

Some Lights in the Dark 71 bring into Korea. When he arrived at Inchon, the customs inspectors promptly informed him that substantially everything he had with him was illegal for import. The businessman, however, was a very good businessman, and he had planned for this contingency in advance. There was no reason why he could not land, and he went from the ship directly to the Kyung mu Dai (Korean White House). There, he told President Rhee that he had been concerned about the Korean president’s driving around in an elderly car and had brought back a Buick for the president. In fact, he said that he had brought back two Buicks, so that the president could have his choice; he himself would use whichever one the president did not want. President Rhee was pleased and asked where the Buicks were. The businessman said, “Well, all my personal effects are currently being held up in customs in Inchon, but if you would like to see them immediately, I’m sure that you can arrange to get them released.” President Rhee accordingly ordered that the businessman’s personal luggage, including large items, be released. The businessman arrived the following day at Kyung mu Dai with two Buicks, and President Rhee chose the blue one.38 Given this kind of behavior at the top, similar behaviors prevailed throughout the country. In such an atmosphere, the economy could not grow rapidly.

Import-Substituting Industrialization While the economy as a whole failed to grow rapidly, the manufacturing sector grew by a respectable 11.8 percent on average in 1953– 1960. The share of manufacturing in total value added rose from 7.9 percent in 1953 to 12.3 percent in 1960, while the share of agriculture-​ forestry-fishery sector declined from 48.6 percent in 1953 to 39.3 percent in 1960.39 South Korea carried out import-substituting

38



39

Tullock (1980: 28–29). Reprinted from Toward a Theory of Rent−Seeking Society, by James M. Buchanan, Robert D. Tollison, and Gordon Tullock (eds.) by permission of Texas A&M University Press. The data are from ecos.or.kr.

72 The Tortuous Path of South Korean Economic Development industrialization during this period. South Korea did not differ from other developing countries in that respect, except that the country was relying on the massive foreign aid. Carrying out industrialization with aid had constraints im­­ posed by the United States as the major donor country. Economic policy was determined only after consulting the US aid authority, which did not necessarily agree with the South Korean government concerning policy priorities. The South Korean government wanted to prioritize rebuilding the production capacity destroyed by the war and raising it further, that is, boosting investment. The US aid authority prioritized keeping the postwar inflation in check and providing a minimum standard of living for the South Korean people.40 The United States provided the bulk of the aid according to its priority, such as supplying food crops, while assigning a small proportion to financing investment.41 However, even the low ratio of the aid allotted to financing investment was the result of Rhee’s maneuvering against the US intention in the postwar reconstruction of the division of labor in East Asia, designed to make South Korea a mere backyard of Japan, supplying primary goods in exchange for manufactured goods.42 The main method to carry out import-substituting industrialization with aid was to set the exchange rate at an artificially low level. The low exchange rate applied to imports had its origin in the wartime arrangement. During the Korean War, American and other military forces needed a means of payment for local goods and services they purchased. To facilitate this, the South Korean government turned over to the United Nations Command a large amount of won in advance with the understanding that the terms of repayment in dollars would be negotiated later. In the negotiations, the South Korean government tried to keep the won-dollar exchange rate low to maximize dollar receipts. The policy continued after the war

40 41 42

Cole and Lyman (1971: 164–165). Krueger (1979: 69). Woo (1991: Chapter 3).

Some Lights in the Dark 73 to maximize dollar receipts through aid. At the same time, to prevent the low exchange rate from undermining the competitiveness of domestic producers, the government imposed high tariffs and strict quantitative restrictions on imports not financed by aid. Thus, the foreign exchange provided by aid generated a large amount of rent for the business people who managed to get it. Though they had to share the rent with the politicians and government officials they lobbied and bribed, they retained enough share of their own, which made the investment profitable. The South Korean government also employed domestic policy measures to promote industrialization, though they were relatively smaller sources of rent than access to foreign aid. The government offered fiscal incentives through tax deductions and exemptions on preferred industrial activities. The more important means was financial policy. The government rationed credit through banks. Banks were state-owned enterprises until February 1957, when the government finalized the privatization of banks that had begun in 1954. Yet credit rationing continued after the privatization. The government regulated the banks to ration the credit according to the priority it set. The first priority was allocating credit to enterprises rather than households. This was natural because, given the financial market imperfections, banks, if left alone, would prefer lending to households with real estate as collateral, creating bubbles and encouraging speculations in real estate markets.43 Credit rationing to firms prioritized the industries deemed important or productive. In January 1954, the government launched the Korea Development Bank with the mission to provide key industries with long-term loans at interest rates lower than those on ordinary loans. Yet commercial banks also rationed credit to firms according to the government priority. Such a practice was strengthened over the years as the BOK implemented selective rediscount for bank loans. The policy had some industrial policy element by giving

43

Studwell (2013: Part III).

74 The Tortuous Path of South Korean Economic Development priority to chemicals, textiles, machinery, and food over other industries like beverages, finished textile goods, furniture, cosmetics, and service industries like retail trade.44 The credit rationing involved subsidies as well as availability. Not only the Korea Development Bank loans but also commercial bank loans carried interest rates lower than the market-clearing rates. The government capped the official lending rates by commercial banks at 20 percent, while the inflation rate was well over 20 percent until 1957. The real interest rate thus remained negative, often by a wide margin. Meanwhile, there emerged a “curb market,” an unorganized financial market to meet the demand for credit not met by the official bank loans. The curb market naturally carried an interest rate higher than the market-clearing rate. The monthly interest rate in the curb market fluctuated around as much as 15 percent to 20 percent in the early 1950s and four percent to six percent thereafter.45

The Emergence of Chaebol The aid-financed import-substituting industrialization gave South Korean business another boost in addition to the distribution of the vested properties. Given the heavy intervention of the government, the success of business depended much on how shrewdly business people forged cronyism with politicians and government officials. However, this cronyism was not the only necessary condition for success; entrepreneurial talent also counted. Indeed, not all the business people who got access to the government’s favor succeeded. Many of them failed, while a small number enjoyed enormous success and grew into chaebol, South Korea’s familycontrolled business conglomerate. Chaebol would lead South Korea’s industrial development during the Rhee government’s period and beyond.

44 45

Woo (1991: 62–63). Woo (1991: 61–62).

Some Lights in the Dark 75 Family-controlled business conglomerates like chaebol are found in other developing countries. They emerge because of ubiquitous market failure. They can overcome the coordination failure by simultaneously investing in upstream and downstream activities. Indeed, early-starting South Korean firms often had to produce most of the complementary inputs by themselves because they could not find appropriate suppliers.46 When they established separate firms for that purpose, they would form conglomerates through related diversification. Chaebol was also formed through unrelated diversification. In developing countries, the ability to run modern business enterprises does not emerge easily, which is another source of market failure. The “generic capability” of firms doing business in the existing lines of industries can thus count more in starting business in new industries than the skills specific to them.47 When the firms enter the new industries utilizing the generic capability but do not divest from the previous lines of business, they become conglomerates through unrelated diversification. Once chaebol were established, a cumulative process set in. The formation of the “internal capital market” across the member firms could mitigate the capital market imperfections. The size and stability of chaebol-affiliated firms (stability coming from diversification) made them attractive borrowers to banks. Moreover, by 1958, chaebol came to own banks as a result of the privatization, so banks were incorporated into the internal capital market of chaebol. Chaebol could also cope better with the labor market externality. Owing to their size and stability, chaebol could train their employees and recoup the cost of the training by retaining them within the same firm or group. Chaebol could recruit high-quality employees by providing them with training opportunities and promising careers through promotion within the same firm or group; some employees could expect to work for the same firm or group for life.

46 47

Amsden (1989: 126). Amsden and Hikino (1994); Kim et al. (2004).

76 The Tortuous Path of South Korean Economic Development

3.4  The Long-Run Growth and the Short-Run Crisis The political economy in 1945–1960 was a mixture of the darker aspects of the time and the brighter aspects of the succeeding period. The institutional framework established through the division and war produced favorable conditions for future growth. The importsubstituting industrialization supported by massive foreign aid failed to initiate a HEG, but it would contribute to the HEG later. There were other factors failing to help the economy grow or even contributing to the outbreak of a crisis in the short run that would help the economy grow in the longer run. The disinflation policy implemented from late 1957 was such a factor. It brought about short-run stagnation, but it was necessary for long-run growth. The promotion of exports was another factor. It could not initiate HEG immediately but would work as a condition for the HEG later. Educational achievement was yet another factor. Education skyrocketed at all levels, providing a favorable condition for future growth, but it was dangerous politically without the concomitant growth of jobs. Of course, the story of the darker aspects of the time and the brighter aspects of the succeeding period is no more than the postfactum description of what actually happened. Nobody planned the “dynamic path” over the present and future. The brighter aspects of the succeeding period would be realized only when other conditions were added in the 1960s, which few people foresaw in the 1950s. The immediate result was the revelation of the darker aspects of the time, as the student-led revolution broke out in 1960.

Stabilization and Stagnation In the middle of 1957, upon completing the urgent reconstruction of war damage, the focus of policy shifted to stabilization. The high inflation during the Korean War had stabilized quickly, but the inflation rate was still 23.0 percent in 1956 (See Appendix 1). The US aid authority pressed the South Korean government to reduce the

Some Lights in the Dark 77 inflation rate further, emphasizing that, without controlling the inflation, the country would not maintain ordinary economic activity, not to mention long-term development. The Rhee government agreed and implemented a strong stabilization program beginning in late 1957. The stabilization program initially depended mainly on the shrinking of the BOK credit to banks. In 1958, the BOK loans to banking institutions shrank by 37.0 percent.48 The contractionary fiscal policy followed, with fiscal balance turning from deficit in 1958 to surplus in 1959 (See Table 4.1). The stabilization policy worked, helped by the bumper crop in 1958. The inflation rate fell to −3.6 percent in 1958 and 3.2 percent in 1959. With the stabilization policy, the economy fell into relative stagnation from 1958. The growth rate of GDP, which peaked at 9.4 percent in 1957, fell to 6.6 percent in 1958 and 5.6 percent in 1959. Per capita GDP grew by 5.8 percent, 4.4 percent, and 2.8 percent in 1957, 1958, and 1959, respectively (See Appendix 1). The disinflation policy provided a favorable condition for future growth. The country would see the resumption of double-digit inflation in the 1960s (explained in Chapter 4), but it would begin on the base of the price stability achieved in the 1950s. Without such a base, inflation might have become far more unruly in the 1960s, undermining longer-run growth. On the other hand, in the short run, the stagnation ensuing from the disinflation policy contributed to the outbreak of a political crisis in 1960.

Promoting Exports South Korea began to promote exports in the 1950s. Many observers think that the country began to promote exports in the 1960s, with the exchange rate reform in 1964 as the critical moment, but that is not true, as will be explained in Chapter 4. In the 1950s, South Korea was being flooded with foreign aid, but it was clear that aid would wind down over the years, so the country had to develop the ability to earn foreign exchange by itself. South Koreans were also

48

The figures are from the Bank of Korea, Economic Statistics Yearbook, 1960.

78 The Tortuous Path of South Korean Economic Development seeing what was happening in neighboring Japan, which was exporting labor-intensive manufactured goods, mainly to the United States. The main policy measure to promote exports was the multiple exchange rate system, which applied a higher exchange rate to exports by adding “export dollar premiums” to the official exchange rate. The government introduced export dollar premiums in November 1954 and increased them subsequently. By 1959, the export dollar premiums averaged about 1.7 times the official exchange rate. Another method to promote exports was to allow exporters automatic access to duty-free imports of raw materials and intermediate inputs up to a limit. Exporters could also retain a share of their export earnings to import certain items for home consumption, a system that translated into a large export subsidy given the low exchange rate applied to imports and the large price discrepancy caused by heavy protection of the domestic market. The government also employed fiscal and financial policies to promote exports. Financial policy was particularly important, given the large gap between the official interest rate and market-clearing interest rate. The BOK gave priority to commercial bank loans for exports in its rediscount facility. The disinflation policy implemented from 1957 also raised the price the producers got in the export markets relative to the price they got in the domestic market. The incentive for exports rose sharply in the late 1950s (more on this in Chapter 4). The rise of the export incentive would work only when coupled with the expansion of supply capacity. When the reconstruction from the war was going on, supply capacity was falling short of domestic demand, so producers had little incentive to export. Producers found domestic sales more profitable in spite of the higher exchange rate applied to exports. Yet the domestic market became saturated over the years, so producers began to seek an outlet in exports.49 Thus, South Korea’s exports were stagnant until 1958, but grew by 25.0 percent in 1959; it grew by 65.7 percent in 1960 in spite of the

49

Choe (2003).

Some Lights in the Dark 79 political turmoil. Previously, exports had greatly fluctuated as they were composed of commodities; now exports, mainly composed of manufactured goods, began to increase steadily. Exports of manufactured goods increased by as much as 173.2 percent in 1960.50 Exports could not lead growth as they accounted for no more than 1.7 percent of GDP in 1960, but the increase of exports would work as a necessary condition for the HEG later on.

Educational Achievement After the liberation, South Korea experienced an education boom. The literacy ratio stood at 22 percent in 1945 but rose to 72 percent in 1960. Total school enrollments rose from 5.7 percent of the population in 1945 to 18.5 percent in 1960.51 There is no study comparing South Korea’s level of education with that of other ex-colonies’ at the time of the liberation, but by 1960, the country was an extreme deviant on the high side in a correlation of the index of human resource development with per capita product among developing countries.52 There were two main reasons why the country managed to achieve such educational improvement in a short span of time. First, education was supplied at a low unit cost. That was possible because teachers were willing to work for wages lower than those paid to people of equivalent training in other developing countries. They did so because the teaching profession was respected in the country and thus provided some psychic benefit because of the Confucian legacy of the traditional society. The government also supplied a large number of teachers through the teacher training programs for high school and college graduates that were of relatively short duration and low cost. The use of teachers trained quickly at low cost was facilitated by the tradition of respect for teachers



50



51 52

The growth rates of exports are from the Bank of Korea, Economic Statistics Yearbook, 1961. The growth rate of manufacturing exports was calculated from the data in Hong (1976: 151–157). McGinn et al. (1980: 47–48). Cole and Lyman (1971: 138, 295–296).

80 The Tortuous Path of South Korean Economic Development and strict discipline in classrooms. The official use of Hangeul, the Korean alphabet that is very easy to learn, also facilitated education. Second, the private contribution to public education was high. Public expenditure per student on education in South Korea was lower than in most developing countries with similar levels of per capita income even if low unit cost was taken into account; however, high parental demand for educating children resulted in private contributions to the public education, sometimes amounting to almost 50 percent of the total educational expenditure.53 Such parental willingness to contribute to the public education apparently came from the fact that, in a “classless society,” education became the new rule to define classes. The traditional Confucian legacy also contributed to making education the new rule to define classes. The incentive for education became stronger than in the colonial era now that educated Koreans could rise to top positions in society. Moreover, given the equality in distribution, more people, including those in rural areas, could afford to bear the cost of education. The improvement in education helped the country prepare for economic take-off, by raising the latent return on investment in physical capital. However, in the short-run, it could just breed political instability unless accompanied by job growth. Indeed, the 1960 revolution broke out partly because of the shortage of jobs for the educated youths.

The Crisis of 1960 The revolution in 1960 was directly precipitated by the rigged election in which Rhee’s incumbent party tried to get his successor-to-be elected as vice president. The revolution was also facilitated by the attitude of the United States, which had been “ever ready” to eliminate Rhee because of his recalcitrance on many issues, including the normalization of the diplomatic relationship with Japan, which the



53

See McGinn et al. (1980: 60–80) for the low unit cost of education and the private contribution to public education.

Some Lights in the Dark 81 United States strongly pushed in order to strengthen the Cold War alliance in East Asia.54 However, like most revolutions, South Korea’s 1960 revolution had an economic background, with the jobs problem being particularly important. The shortage of jobs was breeding the political instability that helped precipitate the revolution. The mediocre performance of the economy under the Rhee government failed to create sufficient jobs even before it implemented the disinflation policy; from 1958 on, the disinflation policy aggravated the problem. The shortage of urban jobs was more problematic. Given the resource endowment of the country, the country had to create non-farm jobs to solve the jobs problem. Moreover, South Korea had a disproportionately large urban population compared with other countries with the same level of per capita income and population.55 By 1960, South Korea had experienced more rural–urban migration than other developing countries because the country had experienced more urbanization during the colonial period. Diaspora during the colonial era also helped to increase urban population, as many of those people who had left their homes in the countryside came back to live in urban areas after the liberation. In addition, those people who sought refuge from the North in 1945–1953 preferred to live in urban areas. There are no official statistics about the job situation in the 1950s (The government began to compile job statistics from 1963). Yet some partial evidence indicates that the country was failing to create non-farm jobs. From 1955 to 1960, workers in firms with five or more employees decreased from 255 thousand to 235 thousand, while the population aged 14 years or older grew from 12.63 million to 15.04 million.56 As the country failed to create sufficient non-farm jobs, cities abounded with unemployed or underemployed people, including the jobless, part-time workers such as servants

54



56

55

Oliber (2008: 566). In 1966, Korea’s share of non-agricultural employment was 45 percent, well above the level predicted by cross-country estimations based on per capita income and the size of the population, which was about 30 percent (Lindauer 1997: 36). The situation in 1960 is unlikely to have been very different from the situation in 1966. The Committee for Editing the Sixty Years of the Korean Economy (2010c: 650).

82 The Tortuous Path of South Korean Economic Development and shoeshine boys, dingy-shop owners, outright beggars, and, more detrimental to society, criminals like pickpockets, prostitutes, and thieves. However, the immediate threat to political stability was the shortage of jobs for educated youths. One should not overestimate the effect of this factor because, as Chalmers Johnson observed, Korea’s student activism tended to be independent of economic conditions, at least since the March First Movement in 1919.57 Yet the shortage of jobs was surely an important condition for the revolution in 1960. This was all the more so because the parents of those youths had often educated them through extreme austerity. The problem was especially visible when the parents resided in the countryside. People cynically called colleges and universities “Cow-Bone Towers.” The term originated from the reality that the parents in the rural area often sold cows – the first item on their property list – to finance their sons’ college education (They rarely sent their daughters to college; college fees were very high because the government little subsidized college education), but their sons could not find jobs after graduation. As the country failed to create non-farm jobs, the rural population continued to suffer from unemployment and underemployment, with their chances of finding jobs in the urban area remaining thin. This would eventually destroy the effect of the land reform. The land reform had reduced social tension in the rural area, but it would not solve the poverty and inequality problem by itself. If left alone, the rural area would see the reemergence of the landlord-tenant relationship, as the poor peasants would have to sell their lands to kulaks out of desperation. No study has rigorously investigated the return of tenant farming, but there was a sign that tenant farming was reemerging, with tenant farmers accounting for about 26 percent of farm households in 1960. The plight of the rural poor was also manifesting itself in the widespread practice of usury in the countryside.58

57



58

See Johnson (1989:76). It would be the same after 1960, as will be discussed in Chapter 7. Lee (2018: 457).

4

Kicking Off the Miracle

After the 1960 revolution, the democratically elected Chang Myon government took office, but in 1961, General Park Chung Hee waged a coup to topple the Chang government. Park’s military junta justified the coup by referring to the task of economic development. The economy continued to stagnate initially, but Park held power through the junta period and was elected president in 1963. The South Korean economy then began the HEG. This chapter explains how South Korea kicked off the HEG in the 1960s.

4.1  Explaining the Kickoff The growth rate of the GDP suddenly jumped from 3.9 percent in 1962 to 9.0 percent in 1963. This was mainly due to the bounce back from the extraordinarily bad harvest in 1962, but the economy continued to grow rapidly in the ensuing years. The gross investment rate (gross investment as a percentage of the GDP), which stood at 9.7 percent in 1960, rose steeply, passing the 20 percent mark in 1966. Once the investment rate rose, a virtuous circle of investment and growth set in. High investment rate led to high economic growth, which led firms to expect high growth in sales and invest accordingly, which in turn led to high economic growth. The growth rate of GDP would average 10.6 percent from 1963 to 1979, the last year of Park’s rule when the country met a big crisis; the growth rate of per capita GDP would average 8.5 percent during the same period. The HEG was accompanied by a rapid structural change. The share of manufacturing in total valued added rose from 13.6 percent in 1963 to 24.2 percent in 1979, while the share of agriculture-forestryfishery sector declined from 45.6 percent in 1963 to 20.8 percent in 1979. The country would recover from the 1979 crisis and resume 83

84 The Tortuous Path of South Korean Economic Development the HEG in the 1980s, which would be accompanied by equally rapid structural transformation.1 The HEG brought about convergence with advanced countries’ economies. South Korea’s per capita GDP began to converge to the level of advanced countries, including the United States, the world’s productivity leader. As mentioned in Chapter 2, South Korea’s per capita GDP grew somewhat during the opening period (1876–1910), but the growth rate was far lower than that of the United States. It is impossible to determine the growth rate of South Koreans’ per capita GDP during the colonial period (It is only possible to estimate the per capita GDP within the Korean peninsula). Moreover, economic growth collapsed with colonial rule itself, which was followed by the disaster in 1945–1953 and ensuing mediocre growth. To see whether there was a convergence of per capita GDP from the opening of the country to the eve of the HEG, it may be helpful to examine the changes in the per capita GDPs of South Korea and the United States from 1870 to 1962. 1870 is the year closest to 1876, the year of the opening, among the years for which per capita GDP data are available; 1962 is the year just before South Korea’s HEG began. According to the Maddison project, South Korea’s per capita GDP in 1962 was 197.6 percent of what it was in 1870, while the United States’ per capita GDP in 1962 was 395.1 percent of the 1870 per capita GDP. It was thus the beginning of the HEG that put the country on the road to convergence. South Korea was finally on the road to the “great convergence” after undergoing the “great divergence” explained in Chapter 2. The earlier explanation of the beginning of the HEG emphasized the pursuit of export-oriented industrialization, with the exchange rate reform of 1964 as the critical moment.2 Later, some political economists presented a revisionist view, emphasizing the role of the government.3 The mainstream view later recognized the heavy

1 2 3

See Appendix 1 for the growth rates and ecos.or.kr for the share of value-added. Keesing (1967); Krueger (1979); Krueger (1997b). Amsden (1989); Wade (1990).

Kicking Off the Miracle 85 government intervention but held that it made little difference or even undermined growth.4 Export-oriented industrialization most clearly differentiated South Korea (together with Taiwan, Hong Kong, and Singapore) from other developing countries in the 1960s. The majority of developing countries stuck to import-substituting industrialization without promoting exports much, which is unsurprising, considering that the 1960s were the heyday of Third World nationalism. South Korea’s export-oriented industrialization in fact represented the manifestation of the “exception to work” discussed in Chapter 3. Unlike most developing countries, the country actively integrated itself with advanced capitalist countries. The integration began with receiving massive aid but moved to increasing exports. The domestic boom of advanced capitalist countries, together with the second globalization, provided a favorable condition for export-oriented industrialization. Moreover, it helped significantly that only a small number of developing economies pursued export-oriented industrialization contemporaneously alongside South Korea. If the majority of developing countries, including giants like China and India, had also pursued export-oriented industrialization, advanced countries would have had far greater difficulty absorbing developing countries’ exports. However, the pursuit of export-oriented industrialization did not initiate the HEG. Korea began promoting exports in the late 1950s, and exports of manufacturing goods increased drastically in 1960. Exports also accounted for only a small share of the GDP (3.1 percent in 1963). The HEG began as aggregate demand increased drastically across the board, as domestic demand and import substitution as well as exports grew rapidly. In fact, the expansion of domestic demand accounted for a far larger portion of the growth of aggregate demand than the expansion of exports in the 1960s.5 Production



4 5

World Bank (1993); Lee (1996). Kim and Roemer (1979: Chapter 5).

86 The Tortuous Path of South Korean Economic Development was also increasing across-the-board in industrial sectors  – that is, in terms of the sources of aggregate supply. The growth rate rose in agriculture, fishery, infrastructure, construction, and services, while manufacturing was the main export industry. South Korea’s HEG began as state capacity was enhanced to make the government’s role more effective. Export-oriented industrialization was surely a necessary condition for the HEG; without export-oriented industrialization, enhancing state capacity would have resulted in an economy like that of North Korea or Maoist China. However, without enhancing state capacity, export-oriented industrialization may have just switched the destination of products from the domestic to overseas markets, as would actually happen later in many other developing countries.6 The HEG began as state capacity was enhanced, with export-oriented industrialization already in place as a necessary condition.

Enhancing State Capacity The change in leadership was critical to enhancing state capacity. Park Chung Hee was far younger than Rhee Syngman and was committed to economic growth. Unlike Rhee, who maintained an aloofness toward the people and government bureaucracy, Park grasped the down-to-earth realities of the economy and actively managed it. While Rhee had lived in the United States in exile for more than 40 years and was engaged in the national liberation movement, Park grew up under Japanese colonial rule and served as an officer in the Japanese imperial army. Immediately after liberation, he briefly joined the communists. He personally respected Yoshida Shoin, the patron of Japan’s Meiji Restoration, and aspired to emulate Japanese institutions and policies before and after the Second World War. However, one should not emphasize Japanese influence too much. South Korea was under the overwhelming influence of the United States in the 1950s and 1960s. Park’s military colleagues were mixing up with US

6

See Rodrik (1995).

Kicking Off the Miracle 87 officers and often had experience of studying in the United States. Park was also willing to employ personnel trained in Western universities, notably the United States. Park joined the contemporary leaders of East Asia similarly committed to economic development, such as Taiwan’s Chiang Kaishek and Singapore’s’ Lee Kuan Yew, though Park’s leadership quality fell short of Chiang’s or Lee’s. When top leadership really cared about growth, finding ways for economic development was not an insurmountable obstacle. Park made efforts to enhance state capacity since the junta period. The junta launched a series of institutional reforms, including the restructuring of the economic bureaucracy. The Economic Planning Board was launched as the pilot agency, combining planning powers with control over the budget and allocation of foreign capital. The Economic Planning Board minister was given the title of deputy prime minister. The junta also launched a number of reforms designed to improve bureaucratic performance. It applied the standard briefing procedure it had developed to the government bureaucracy. Park monitored progress on specific projects on a daily basis through the organization of the Presidential Secretariat within the presidential mansion, now known as the Blue House. Park thereby maintained close contact with, and control over, the bureaucracy, in contrast with Rhee’s aloofness from the details of economic management.7 Park reinforced the reconstruction of the government bureaucracy after he was elected president in 1963. He expanded and populated it with younger-generation officers selected by meritocratic examinations, eliminating the dual nature of bureaucracy in the 1950s. South Korea had a favorable legacy in building such government bureaucracy. It had a long history of running a Chinese-style merit-based bureaucracy. Koreans had also experienced merit-based bureaucracy through Japanese colonial rule, even though few had

7

Haggard et al. (1991: 860–862).

88 The Tortuous Path of South Korean Economic Development served in top positions. The country also had a large number of qualified personnel to fill the government bureaucracy as a result of the educational achievements made after liberation. State capacity rose sharply. Good evidence of this is the opinions expressed in the entrepreneurship survey conducted by Leroy Jones and Sakong Il on how effective the government was in ensuring compliance with its instructions. Under Park, 78 percent said that it was impossible to avoid complying with government decisions, as opposed to only three percent under Rhee.8 This did not mean that Park’s government was incorrupt. Corruption scandals erupted from the very beginning of Park’s rule. One remarkable case was the stock market scandal. In the process of founding Park’s ruling party, the Korean Central Intelligence Agency (Korean CIA), the secret police Park’s junta established in 1962, apparently manipulated the stock market to collect political funds. Many other scandals followed, involving the highest government elites who had waged the coup. They took the lion’s share, but the lower-ranking officers also had their share of spoils. Corruption was bred by authoritarianism. The Park government was far more authoritarian than the Rhee government, not to mention the shortlived Chang government. One may thus ask a counterfactual question, a question like the one asked about the division of the country in Chapter 3: Could South Korea have achieved the HEG while maintaining democracy?

Democracy and Development There is vast literature on democracy and economic development, but the old modernization view may still have some validity for South Korea. According to thinkers like Seymour M. Lipset, economic growth generates an increasingly more educated middle class, which fosters the values of political toleration, trust, satisfaction, and competence, making democracy more likely.9 Thus, the pattern

8 9

Jones and Sakong (1980: 136–137). Lipset (1959).

Kicking Off the Miracle 89 of political and economic changes in developing countries may often be characterized by seeking order first, then economic development, and only later democracy.10 It is easy to guess why enlightened authoritarianism may do better than democracy for economic growth. Democracy may have difficulty maintaining order when a country is fraught with class struggles or ethnic conflicts. Authoritarianism, when it is pro-​business, can boost investment by better protecting the property rights of capitalists from workers’ redistribution demands. Authoritarianism can raise state capacity by quickening decision making, while democracy, with its checks and balances, often slows or even blocks important decision making. The downside of authoritarian regimes is that, lacking the rule of law and thus without any checks and balances provided by opposing parties, judiciary, or press, they tend to degenerate into “kleptocracy,” which naturally undermines growth. This has happened to many authoritarian regimes in developing countries. The relationship between democracy and growth may thus be non-linear: Authoritarian regimes are associated with high and low growth rates, and democratic regimes with intermediate growth rates.11 South Korea was, of course, the case of an authoritarian regime with a high growth rate. However, the economic growth achieved under authoritarian rule did not automatically lead to democratization. It needed a democratization process, which was painful and costly. The country could have saved such pains and costs if it had achieved the HEG while preserving the young democracy in place by 1960. Here, a dissenting view to the sequencing view of the modernization school, such as Adam Przeworski’s, may provide a clue: Economic growth only stabilizes democracy once it comes into place for reasons exogenous to income.12 South Korea, after the 1960 revolution, thus needed economic growth to stabilize democracy.

10 11 12

Huntington (1968); Zakaria (2003). Seim and Parente (2013). See Przeworski and Limongi (1997).

90 The Tortuous Path of South Korean Economic Development The critical question was whether the democratically elected Chang Myon government could have initiated high economic growth. Chang Myon and his colleagues knew the importance of economic growth and set it as the first priority of their government. Chang was far younger than Rhee. His government would have almost certainly modernized economic bureaucracy. Redistributionist pressure was not strong, given the extraordinarily equal distribution of income and wealth. One problem was the activation of unions, which increased labor disputes. However, how strong the unions could become remained questionable, given the legacy of the 1945–1953 period. Despite the flood of demonstrations, there was no evidence that the Chang government failed to maintain order. The growth rate of GDP continued to be low, and the hard-won price stability was shaken as the inflation rate rose to 8.1 percent in 1960 and 1961. However, it remained in the single digits, and the fiscal balance was in surplus in 1960 (See Table 4.1); exports continued to grow rapidly. There were some stalemates in the National Assembly, but it is difficult to judge how critical they were. Moreover, Park and his colleagues initially had no idea about economic policies. Park’s junta actually stole the Chang government’s blueprint of economic planning and presented it to the public as if it were of its own making. Park’s junta also made blunders like reviving double-digit inflation, as will be explained below. Park’s later policies were not necessarily optimal either, leaving one to wonder how well Park’s government used the enhanced state capacity. The Park government was also far more corrupt than the Chang government, which would undermine growth, as illustrated by the stock market scandal. There is again no answer to this kind of counterfactual question, but the possibility that the country could have launched the HEG without Park’s coup may have been higher than conventionally thought.

Kicking Off the Miracle 91

4.2  The Contours of Economic Policy Utilizing enhanced state capacity, Park’s government actively intervened in the economy for the single purpose of growth. Government intervention went far beyond the commonly recognized role of the government. The government often regulated the entry, investment, pricing, and sales of firms, particularly large firms; it took almost total control over the allocation of investable funds. The government implemented economic plans, launching the First Five-Year Economic Development Plan in 1962, which would be succeeded by six more five-year plans. They were “indicative plans” designed to gather consensus among politicians, government officials, and private sector actors. They were goal oriented and had no inter-temporal prescriptions, so they did not replace the market mechanism by government bureaucracy at the implementation level. The government took a pragmatic approach to implementing policies. It left the markets to work where it thought they worked; it intervened where it thought markets did not work. It assumed a direct role in the areas where it was regarded as necessary; in other areas, it provided private sector actors with incentives to behave according to its priority. The key here was that the government did not give away favors but verified whether the favors were used properly. This was first noticed by revisionist authors like Alice Amsden and Robert Wade and was later recognized by mainstream thinkers like the World Bank.13 Many economic policies were continuities from the 1950s, although there were of course changes. The changes did not necessarily represent improvement over the previous policies. The main difference between the 1950s and the 1960s was the enhancement of state capacity, which enabled the policies to be implemented more effectively, rather than improving the policy portfolios themselves.

13

See World Bank (1993: Overview and Chapter 6) in addition to Amsden (1989) and Wade (1990).

92 The Tortuous Path of South Korean Economic Development This section will briefly discuss fiscal and financial policies, which were, as in the 1950s, intertwined with the monetary policy. Section 3 will discuss exchange rate and trade policies.

Small Government Geared to Growth While the government intervened pervasively, the size of the government itself was “small,” geared toward the single purpose of economic growth. The Park government implemented such a fiscal policy while achieving fiscal independence by reducing dependence on aid. The statistics for fiscal policy in the 1950s and 1960s are not so good. The best data are the unofficial data compiled by Roy Bahl and his colleagues.14 They depend on the old national account data and use different classifications from the official data, which are available from 1970. However, they can help to see the trend of fiscal policy in the 1950s and 1960s. Table 4.1 presents major fiscal policy indicators excerpted from those data as a percentage of GDP from 1953 to 1970. It first gives total government expenditure and its components by functional classification – defense, economic service, social service, and the other. It then gives total government revenue and its components – domestic revenue and the revenue from foreign aid. It finally gives fiscal balance. The share of total government expenditure in GDP rose with postwar recovery and reconstruction but fell in the ensuing disinflation process. The changes in the share of expenditure on economic services mainly accounted for the rise and fall in the share of total government expenditure. The government depended heavily on the foreign – mainly the US – aid for the revenue, and the United States complained that the Rhee government was making few efforts to raise domestic revenue while trying to extort as much aid as possible. However, the share of domestic revenue in the GDP rose from 1955, though with fluctuations; by 1960, it reached 17.8 percent of GDP,

14

Bahl et al. (1986).

12.5 14.3 13.1 15.1 20.4 23.2 21.0 19.8 22.2 27.6 19.1 13.9 15.3 19.3 22.1 23.0 26.1 23.5

1953 1954 1955 1956 1957 1958 1959 1960 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970

6.6 6.8 5.1 4.5 6.6 6.8 6.7 6.3 5.7 5.9 4.2 3.5 3.7 3.9 3.8 4.1 4.1 3.8

Defense 2.2 3.2 3.3 4.5 6.7 7.5 4.5 3.7 6.4 10.7 6.2 3.9 4.3 6.9 9.6 8.6 12.0 9.0

Economic service 1.3 1.8 1.9 2.5 3.2 4.7 5.3 5.0 6.1 6.3 5.3 4.0 4.4 5.2 5.5 7.0 6.4 7.0

Social service 2.5 2.6 2.7 3.7 3.8 4.2 4.5 4.8 4.1 4.7 3.4 2.5 2.9 3.3 3.1 3.4 3.6 3.6

Other 11.0 10.8 11.3 15.2 22.6 20.4 21.8 22.7 21.9 24.0 19.1 14.3 16.4 13.9 19.3 21.8 22.0 21.9

Total 10.6 6.1 7.2 10.5 14.9 11.4 15.7 17.8 14.4 15.8 14.0 10.7 12.9 10.8 17.0 20.2 21.0 21.3

Domestic revenue 0.4 4.7 4.2 4.7 7.8 9.0 6.2 4.9 7.5 8.2 5.1 3.6 3.5 3.1 2.3 1.7 1.0 0.6

Aid

Revenue

−1.5 −3.5 −1.7 0.1 2.3 −2.7 0.8 2.9 −0.2 −3.5 0.0 0.3 1.1 −5.4 −2.8 −1.2 −4.1 −1.7

Fiscal balance

Sources: Bahl et al. (1986: 257–267). The data were provided as a percentage of GNP, but they have been revised as percentage of GDP using the ratio between GNP and GDP in the Bank of Korea, National Income Accounts 1984.

Total

Year

Expenditure

Table 4.1  Fiscal expenditure and revenue as a percentage of GDP, 1953–1970

94 The Tortuous Path of South Korean Economic Development equivalent to 89.9 percent of the total expenditure, which stood at 19.8 percent of GDP. Meanwhile, the share of government revenue coming from foreign aid in the GDP rose until 1958 but fell drastically thereafter. Fiscal balance was more often in deficit than in surplus in the 1950s, but in 1960, it was in surplus by 2.9 percent of GDP. Fiscal policy took a drastic expansionary turn with Park’s coup. Park’s junta raised salaries for civil servants by 50 percent and even more for military personnel; it increased credit to SMEs, canceled much of the outstanding indebtedness of low-income farmers, and initiated an expanded agricultural credit program, most of which were backed by fiscal expansion. It launched the ambitious First Five-Year Economic Development Plan in 1962, which involved the rapid expansion of government expenditure. Total government expenditure shot up from 19.8 percent of GDP in 1960 to 27.6 percent of GDP in 1962. Meanwhile, Park’s junta failed to raise the share of domestic revenue in GDP. The rise in the share of the revenue coming from foreign aid somewhat offset that, but the fiscal balance turned from a surplus of 2.9 percent of GDP in 1960 to a deficit of 3.5 percent of GDP in 1962. This threatened price stability because the budget deficit was monetized. Price stability had already been shaken by political turmoil in 1960 and 1961, but the expansionary fiscal policy of Park’s junta could critically undermine it. Being worried about price stability and unwilling to foot the bill for the expansionary fiscal policy anymore, the United States again pressed for a disinflation policy. Park’s junta, and the succeeding Park government, had to comply, given the country’s still-heavy dependence on US aid. Park pursued the disinflation policy by drastically retrenching government expenditure. From 1962 to 1964, the share of total government expenditure in GDP fell by almost half, from 27.6 percent to 13.9 percent. Though the share of total government revenue in GDP also fell, the fiscal balance turned into a small surplus by 1964. Fiscal policy took another expansionary turn from 1965, although the share of total government expenditure in GDP did not

Kicking Off the Miracle 95 return to the previous peak in 1962. The rising share of the expenditure on economic services led the expansion. Park put some restraint on defense spending, and the share of the expenditure on social services in GDP rose less drastically than the share of economic service in GDP. Meanwhile, the government began to collect taxes actively, so the share of domestic revenue in GDP rose consistently, while the share of aid fell further, to a mere 0.6 percent of GDP by 1970. The country thereby achieved fiscal independence. In the end, South Korea’s fiscal policy came to have some peculiar characteristics by international comparisons. The country had a small government, with total government expenditure accounting for a lower share of the GDP, even compared with other developing countries. The government could be small mainly because the share of the expenditure on social services in GDP was low. Moreover, education accounted for more than 60 percent of government expenditure on social services.15 The share of health and social protection, often used as the proxy of the expenditure on social welfare, was minimal, standing at a mere 0.9 percent of GDP in 1970 according to the official data, which report separate figures on health and social protection (See Figure 5.3). One obvious reason for the minimal share of welfare expenditure was the routing of socialism and organized labor – the political base of the welfare state in the West. At the same time, the exceptional equality of income and wealth achieved in the 1950s may have reduced the pressure for redistribution and enabled the government to concentrate on growth. Park’s development strategy indeed prioritized growth to redistribution. Accordingly, the country had comparatively lower tax rates.16 The neglect of redistribution was also revealed by the composition of taxes. While raising more taxes to achieve fiscal independence, the government made no noticeable shift toward direct taxes in the 1960s, emphasizing the taxation of urban consumption.17

15 16 17

Mason et al. (1980: 303). Bahl et al. (1986: Chapter 2). Mason et al. (1980: 322–326).

96 The Tortuous Path of South Korean Economic Development The fiscal policy focused on the single purpose of growth. The government not only assumed the role of investor by itself but also provided the private sector with tax incentives and preferential public loans to build infrastructure, such as railroads, turnpikes, and power plants. The government also built industrial complexes for the collective accommodation of related industrial plants, thereby addressing the coordination failure of the market. Notably, the government built the Ulsan Industrial Complex in 1962, the first of such projects, followed by the construction of other complexes later. The government also widely offered tax deductions and exemptions to promote the private economic activities that it prioritized. However, with the expansionary turn of the fiscal policy, total government revenue failed to keep up with total expenditure, so the fiscal balance turned into a deficit again from 1966, creating inflationary pressure. The pressure was added to a situation where the country was already undergoing double-digit inflation.

The Resumption of Inflation Double-digit inflation resumed in the mid-1960s. Price stability had already been shaken by the political turmoil in 1960 and 1961. Park’s junta aggravated the situation critically by pursuing the expansionary fiscal policy backed by expansionary monetary policy. The monetary base (high-powered money) changed little from January 1960 (the first month with official data) to May 1961, but it increased by 89.7 percent from May 1961 to November 1962. The increase in lending by the BOK to the government accounted for 68.2 percent of the increase in the monetary base during this period.18 There were also policy blunders. In 1962, Park’s junta changed the denomination of the currency and froze all bank deposits, expecting that the move would help mobilize domestic savings. The

18

The figures are from the Bank of Korea, Economic Statistics Yearbook, 1963. The BOK provides the consistent data for the sources of the monetary base only from 1970, so the figures may be inconsistent with the figures presented in the current database ecos.bok.or.kr.

Kicking Off the Miracle 97 freezing was lifted within days under US pressure, but it undermined confidence in the financial system, triggering a shift from holding financial assets to holding real estate. The stock market crash of 1962 had similar effects. Park’s junta also critically weakened the independence of the central bank. It revised the Bank of Korea Act to give the Ministry of Finance the right to recommend the BOK governor to the president. The Ministry of Finance also had the authority to request reconsideration of the resolutions adopted by the Monetary Board, the BOK’s policymaking body. The Ministry of Finance assumed administrative power to supervise the BOK’s business and control its budget and expenses. The Ministry of Finance could direct the BOK to purchase securities issued by government agencies with redemption guarantees. The inflation rate shot up to 20.7 percent in 1963 and 29.5 percent in 1964. The disinflation policy led by the fiscal retrenchment from the end of 1962 reduced the inflation rate to a more moderate 13.6 percent in 1965 and 11.5 percent in 1966 (From 1966, the inflation rate was measured as the increase rate of the CPI in the whole country). The country did not pursue disinflation policy further, contrary to the last years of the 1950s. The US aid authority could not push the disinflation policy further because it was losing influence on South Korea’s economic policy as the country came to depend less on aid. Financial policy also took an expansionary turn in the late 1960s. BOK lending to financial institutions expanded consistently. The government obliged the BOK to rediscount bank loans to firms. The most pronounced case was loans for exports. Banks supplied low-interest loans in the short term without limit against any letter of credit, and then the BOK discounted the bank loans without limit. The BOK also financed other policy loans. In 1968, the government abolished the ceiling on the BOK rediscount facility and entitled banks to an automatic rediscount of a fixed proportion of their directed credits. While running an expansionary monetary policy, the government strengthened price controls that had been implemented since

98 The Tortuous Path of South Korean Economic Development the 1950s, but that just delayed inflation. From 1965 to 1972 (before the government repressed inflation severely through price controls in 1973, as will be explained in Chapter 5), the inflation rate stayed between 10 percent and 20 percent. The rate was high by all but contemporary Latin American standards. Although the resumption of double-digit inflation in 1963 coincided with the beginning of the HEG, it was by no means responsible for the beginning of the HEG. Japan, Taiwan, and other successful economies in the postwar period kicked off high economic growth without aggravating price stability. Double-digit inflation would be a big source of trouble in many ways, but the immediate impact was on the workings of the financial policy, the most important policy instrument of the Park government.

Working of the Financial Policy The Park government utilized financial policy as the most important instrument to provide incentives to the priority activities. Park’s junta renationalized commercial banks in 1962. The government also had the Korea Development Bank to support key sectors such as infrastructure and priority manufacturing industries. In addition, the government established various specialized banks to support specific sectors. The government also allocated foreign capital. Now, the country’s current account turned into deficit as the gross investment rate shot up ahead of the gross saving rate (gross saving as a percentage of GDP) while foreign aid was winding down. The country began to borrow abroad to finance the current account deficit, and the government had to play a role in the borrowing because the private sector could not borrow on its own credit. The government not only borrowed directly but also enabled the private sector to borrow by guaranteeing payback. Meanwhile, the direct finance through the stock and bond markets was difficult to build in the initial phase of economic development, and the stock market crash of 1962 made it even more difficult. The government also kept the scope for FDI and the purchase of

Kicking Off the Miracle 99 other equity capital by foreign investors minimal. As a result, the government took almost total control over the allocation of investable funds. The only viable alternative for firms was the curb market loans, which carried a far higher interest rate. There was chronic excess demand for credits, so the government rationed them according to its priority. A large proportion of the credits were policy loans the government earmarked for particular purposes, but ordinary loans were also greatly affected by government priority. The practice was basically the same as in the 1950s, but the role of financial policy drastically expanded in the 1960s. Access to the government-controlled credits became the largest source of rent enjoyed by firms, replacing access to the foreign aid in the 1950s. As in the 1950s, the corruption of the Park government forced firms to share the rent with political elites. However, the enhanced state capacity of the Park government ensured that firms enjoyed enough rent to act according to the government priority. The government allocated credits flexibly according to the performance of firms. Firms using funds appropriately received continued or expanded support; those using the funds inappropriately faced a reduction or even termination of support. The resumption of inflation affected the workings of the financial policy. Credit rationing became less intensive with the disinflation policy in the last years of the 1950s, which made the real interest rates on all bank loans positive from 1958. In the early 1960s, the real interest rates on bank loans remained positive despite the rise of the inflation rate. However, credit rationing became more intensive with the resumption of double-digit inflation in 1963, which drove the real interest rates on all loans into negative territory by a wide margin.19 The negative real interest rates drove savers from banks to the curb market. Firms unable to access bank loans also had to go to the curb market. Firms’ reliance on the curb market deepened as the



19

Real interest rate can be calculated by subtracting the inflation rate from the nominal interest rates presented in Table 4.2.

100 The Tortuous Path of South Korean Economic Development disinflation policy from the end of 1962 made access to bank loans difficult. As a result, the lending by banks shrank, while the size of the curb market expanded. The lending by deposit money banks fell from 11.8 percent of GDP in 1962 to 7.2 percent of GDP in 1964.20 The government was thereby losing control over investable fund. The real interest rates on bank deposits began to rise in 1965 as the inflation rate fell; further disinflation would increase bank deposits by raising their real interest rates further, enabling the government to regain control over investable fund. However, instead of implementing the disinflation policy further, the government drastically raised the nominal interest rates on bank deposits in September 1965. This led to a drastic increase in bank deposits, mostly by drawing funds away from the curb market. Banks increased lending accordingly. The lending by deposit money banks rose to 13.6 percent of GDP by 1967, a higher level than the previous peak at 11.8 percent in 1962; it continued to rise rapidly as a percentage of GDP subsequently, though with some fluctuations. The government thereby regained control over investable fund. The government not only got control over the investable fund but also subsidized priority activities by setting low interest rates on policy loans. It supplied policy loans through deposit money banks as well as specialized banks. Table 4.2 presents the interest rates on the major loans for which data are available: the discount of commercial bills, loans for trade, Loans for Machine Industry Promotion, Loans with the National Investment Fund, Korea Development Bank loans, and curb market loans. The discount of commercial bills was the main channel to provide short-term liquidity to firms, which was closely linked to interest on bank deposits. Other loans were policy loans. Loans for trade were overwhelmingly the policy loans used to promote exports, allocated by deposit money banks. The Loans for Machine Industry Promotion and the Loans with the National Investment Fund were the main policy loans allocated through

20

These figures were calculated from ecos.bok.or.kr.

Discount on commercial bills

13.9 13.9 13.9 14.0 16.5 24.0 24.0 24.3 25.2 24.3 22.9 17.7 15.5 15.5 15.3 16.3

Year

1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976

13.9 12.7 9.1 6.8 6.5 6.5 6.3 6.0 6.0 6.0 6.0 6.0 6.6 8.9 7.6 7.4

Loans for trade

12.0 12.0 12.0 12.0 10.1 10.0 11.1 12.0 12.4

Loans for Machine Industry Promotion

Depository money bank loans

9.2 12.0 12.8

8.4 8.3 8.4 9.6 13.0 13.1 13.1 14.7 14.5 14.4 13.1 12.8 12.7 12.9 13.1

Korea Loans with National Development Investment Fund Bank loans

Table 4.2  Interest rates on major loans and inflation rate, 1961–1988 (percent)

52.6 61.8 58.9 58.7 56.7 56.0 51.4 50.2 46.4 39.0 33.2 40.6 47.6 40.5

Curb market loans

8.1 6.6 20.7 29.5 13.6 11.5 10.7 10.9 12.3 16.0 13.5 11.7 3.2 24.1 25.3 15.4

Inflation rate 

16.7 17.8 18.8 24.1 19.4 12.3 10.0 10.3 10.8 10.8 10.8

Discount on commercial bills 8.0 8.5 9.0 14.8 15.0 10.8 10.0 10.0 10.0 10.0 10.0

Loans for trade 13.0 14.1 15.0 20.2 17.9 12.1 10.0 10.0

Loans for Machine Industry Promotion

Depository money bank loans

14.0 15.1 14.7 18.2 16.4 12.2 10.0 10.7 10.8 10.5

13.6 13.9 13.9 18.7 17.1 12.7

Korea Loans with National Development Investment Fund Bank loans 38.1 41.7 42.4 44.9 35.3 33.1 25.8 24.8 24.0 23.1 23.0 22.7

Curb market loans

10.1 14.5 18.3 28.7 21.3 7.2 3.4 2.3 2.5 2.7 3.0 7.2

Inflation rate 

Note: Inflation rate is the increase rate of the consumer price index. The inflation rate to 1965 is for the Seoul area, and the Inflation rate from 1966 is for the country. Sources: Interest rates are from Krueger and Yoo (2002: 176). Inflation rate is from Appendix 1.

1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988

Year

Table 4.2  (cont.)

Kicking Off the Miracle 103 depository money banks as the instrument of industrial policy (more on this in Chapter 6). The Korea Development Bank loans were the loans to promote key industries, such as infrastructure and the priority industries in the manufacturing sector. The table also presents the inflation rate, measured as the increase rate of CPI, to help give an idea of the real interest rates. Table 4.2 shows that the largest leverage the government had over firms was the control of the investable fund itself. The government not only decided the availability of the fund for firms but also offered them a large amount of rent coming from the difference between the bank lending rates and the curb market rate. With the raise in the nominal interest rate in 1965, the real interest rate on the discount of commercial bills, the highest of all interest rates on bank loans, became positive; however, it stayed far lower than the curb market rate, the only viable source of fund for firms to replace the role of bank loans. Policy loans offered additional rent. Loans for trade had the largest rent element as the Park government reinforced the export promotion policy. In 1961, their interest rate was 13.9 percent, the same level as that on the discount of commercial bills, but by 1968, it fell to 6.0 percent while the interest rate on the discount of commercial bills rose to 24.3 percent. The real interest rate on the loans for trade stayed negative until 1972. Loans for industrial policy purposes offered less but substantial amount of rent. The interest rate on the Korea Development Bank loans was initially lower than that on the loans for trade but became higher as the government raised the interest rate on Korea Development Bank loans along with other interest rates in 1965. The interest rate on the Korea Development Bank loans yet rose less than the interest rate on the discount of commercial bills, so the difference between the two rates became double digit from 1966 to 1969. Loans for Machine Industry Promotion, launched in 1968, also carried an interest rate lower than the interest rate on the discount of commercial bills by a double-digit margin until 1971. The Loans with the National Investment Fund, launched

104 The Tortuous Path of South Korean Economic Development later in 1974, carried an interest rate lower than the interest rate on the discount of commercial bills by a far smaller margin, which was also the case for the Korea Development Bank loans and the Loans for Machine Industry Promotion by that time. However, the margin was surely present.

4.3  Trade Policies and Export-Oriented Industrialization Trade policies were also an important element of the Park government’s policy portfolio. Its importance is beyond doubt, as exportoriented industrialization was a necessary condition for the HEG. In the late 1950s, South Korea had a multiple exchange rate system. The government set the official exchange rate at an artificially low level and applied it to imports, while applying a higher exchange rate to exports by adding export dollar premiums to the official exchange rate. At the same time, to prevent the low official exchange rate from undermining the competitiveness of domestic production, the government imposed high tariffs and strict quantitative restrictions on imports. The 1964 exchange rate reform consolidated the multiple exchange rates into a single rate by drastically raising the official exchange rate while eliminating the export dollar premiums. The government also intended to reduce the high tariffs and strict quantitative restrictions on imports on the premise that a higher official exchange rate would replace them as an incentive for domestic production in relation to imports. The rest of this section first examines the effect of the exchange rate reform and other policy changes on exports and imports, and then discusses how the export-oriented industrialization worked as a necessary condition for the HEG.

Promoting Exports Export promotion policies can be summarized by the “real effective exchange rate (REER).” Table 4.3 shows how the REER for exports is calculated. There are three steps to this calculation. First, the official

Official Exchange Rate

30 50 50 50 50 63 128 130 130 214 265 271 271 277 288 311 348 392

Year

1955 1956 1957 1958 1959 1960 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 1971 1972 39.8 39.7

46.3 52.9 58.9 64.0 84.7 83.9 14.6

Export dollar premiums 76.3 102.9 108.9 114.0 134.7 146.9 142.6 130.0 169.8 253.7 265.0 271.0 271.0 277.0 288.0 311.0 348.0 392.0

Export exchange rate

Table 4.3  Exchange rates for exports, 1955–1990

0.0 0.1 0.1 1.0 1.3 1.1 8.4 22.0 8.2 10.3 10.0 13.0 20.0 17.0 19.0 20.0 22.0 12.0

Export subsidies 76 103 109 115 136 148 151 152 178 264 275 284 291 294 307 331 370 404

Effective exchange rate 0.341 0.384 0.433 0.411 0.418 0.463 0.522 0.576 0.645 0.923 1.000 1.060 1.115 1.181 1.233 1.293 1.370 1.428

PPP index

224 268 252 280 325 320 289 264 276 286 275 268 261 249 249 256 270 283

REER 

398 407 484 484 484 484 484 619 686 738 781 806 870 881 823 731 672 709

1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990

Export dollar premiums 398.0 407.0 484.0 484.0 484.0 484.0 484.0 619.0 686.0 738.0 781.0 806.0 870.0 881.0 823.0 731.0 672.0 709.0

Export exchange rate 9.0 8.0 13.0 12.0 9.0 11.0 11.0 20.0 15.0 3.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0

Export subsidies 407 415 497 496 493 495 495 639 701 741 781 806 870 881 823 731 672 709

Effective exchange rate

Sources: Krueger (1979: 48–49, 87) for 1955–1964, and Krueger (1997a: 301) for 1965–1990.

Official Exchange Rate

Year

Table 4.3  (cont.)

1.241 1.456 1.762 1.886 1.875 1.781 1.980 2.411 2.771 2.988 2.958 2.942 3.000 2.607 2.421 2.292 2.350 2.453

PPP index

328 285 282 263 263 278 250 265 253 248 264 274 290 338 340 319 286 289

REER 

Kicking Off the Miracle 107 exchange rate is revised by adding average export dollar premiums to get the export exchange rate, the exchange rate applied to exports. Second, the amount of subsides per dollar exports is added to the export exchange rate to determine the effective exchange rate for exports. Third, the REER for exports is calculated by dividing the effective exchange rate for exports by the purchasing power parity (PPP) index for exports, which represents the domestic price level relative to the weighted average of the price level of the economies South Korea exports to. The REER for exports rose sharply in the late 1950s, from 224 in 1955 to 325 in 1959. It rose sharply as official exchange rates, export dollar premiums, and export subsidies all rose, while the PPP index, after rising from 1955 to 1957, fell from 1957 to 1959. Subsequently, however, the REER fell from 325 in 1959 to 275 in 1965. It fell as a result of the interaction of various forces. Official exchange rate more than quintupled: The Rhee government raised it in 1960, and the Chang government raised it again in 1961; the 1964 reform raised it further. Meanwhile, export dollar premiums, which averaged 169.4 percent of the official exchange rate in 1959, were phased out in the 1964 reform. The exchange rate applied to exports rose because the rise of the official exchange rate more than offset the abolition of export dollar premiums. In addition, export subsidies rose. The government increased export subsidies through fiscal and financial policies, with export loans with a negative real interest rate being the main component. As a result, the effective exchange rate for exports rose. However, the PPP index rose so drastically that the REER actually fell. The PPP index rose drastically because of the resumption of inflation. The exchange rate reform in 1964 fell short of offsetting the effect of resumed inflation. Put another way, the government failed to raise the official rate large enough or it eliminated export dollar premiums prematurely in the face of resumed inflation. Furthermore, given the double-digit inflation, maintaining the REER at the 1965 level was difficult. The exchange rate would have to rise continuously to maintain the REER, but the rise of exchange

108 The Tortuous Path of South Korean Economic Development rate failed to keep up with the inflation rate, so the REER continued to fall after 1965. It was impossible to offset the effect of inflation by increasing fiscal and financial subsides as long as the subsidies per dollar exports did not increase exponentially, which was practically impossible. Increasing export subsidies to offset the effect of inflation was also self-defeating because they were interlocked with inflation through monetization. Fiscal subsidies were indirectly monetized through fiscal deficit, and financial subsidies were directly monetized  through the BOK rediscount of the bank loans for exports. Increasing export subsidies would thus lead to further inflation and would raise the PPP index to lower the REER. Meanwhile, the Park government employed non-price measures to promote exports. The first of them was the Monthly Export Promotion Conference, later renamed the Monthly Trade Promotion Conference, presided over by the president himself, which brought the public and private sectors together and served to disseminate the government’s emphasis on export promotion and quickly resolve problems encountered by exporters through the final decision of the president. The second was the export targeting system, under which the government set annual export targets by major commodity groups and destination and assigned quotas to individual firms; the government then monitored the export performance of those firms against the quotas. It worked because the government set quotas considering the economic conditions, but also because firms recognized meeting the quotas as instrumental in maintaining goodwill with the government. In fact, maintaining goodwill with the government worked as an incentive for exports not just for those firms to which the government assigned quotas; all firms felt that export performance would affect the rigor of tax collection and the facility and speed in their dealings with the government.21 Thus, the Park government strengthened the non-price incentives for exports while weakening the price incentives. Non-price

21

See Rhee et al. (1984).

Kicking Off the Miracle 109 incentives were personalized and thus more costly than price incentives, diverting the energy of government officials, including the president himself, to micromanagement. It also provided far more room for bureaucratic and political discretion, which could breed cronyism. Thus, what actually happened in the 1960s was the degeneration of export promotion policies rather than the initiation of export-oriented industrialization. The main culprit was the resumption of double-digit inflation.

Exchange Rates and Protection While failing to enhance the REER for exports, the government managed to raise the REER for imports. Table 4.4 shows how the REER for imports is calculated. The official exchange is revised by adding the “tariff equivalent” to determine the effective exchange rate for imports. Tariff equivalent is the summary price measure of the effect of tariffs, non-tariff charges, and quantitative restrictions per unit of imports – in reality, it is calculated as the difference in prices between domestic and world markets. The REER for imports is calculated by dividing the effective exchange rate for imports by the PPP index for imports, which represents the domestic price level relative to the weighted average of the price level of the economies South Korea imports from. The REER for imports rose from 198 in 1959 to 293 in 1965. In the 1950s, the government set the official exchange rate (applied to imports directly, in contrast to exports) low while imposing high tariffs and wide-ranging quantitative restrictions. From 1959 to 1965, the tariff equivalent fell, but the official exchange rate rose more, raising the effective exchange rate for imports. The effective exchange rate rose large enough to offset the rise in the PPP index, raising the REER for imports. Thus, the exchange rate reform of the 1960s affected imports more than exports. This was natural because there had been no equivalent of the export dollar premiums for imports. Still, double-digit inflation threatened to lower the REER for imports as well. The country thus had to continue imposing tariffs

Table 4.4  Exchange rates for imports, 1955–1990

Year

Official Tariff Effective Exchange rate equivalent exchange rate PPP index REER

1955 1956 1957 1958 1959 1960 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990

30 50 50 50 50 63 128 130 130 214 265 271 271 277 288 311 348 392 398 407 484 484 484 484 484 619 686 738 781 806 870 881 823 731 672 709

12 7 8 14 33 37 19 16 18 33 28 25 25 26 25 25 21 23 20 18 25 31 36 43 36 34 34 41 56 52 50 62 65 49 34 39

42 57 58 64 83 100 147 146 148 247 293 296 296 303 313 336 369 415 418 425 509 515 520 527 520 653 720 779 837 858 920 943 888 780 706 748

0.321 0.380 0.430 0.410 0.419 0.461 0.521 0.573 0.685 0.922 1.000 1.057 1.113 1.188 1.232 1.292 1.372 1.421 1.244 1.460 1.767 1.880 1.871 1.780 1.977 2.419 2.738 3.031 2.886 2.938 2.997 2.605 2.407 2.287 2.346 2.452

131 150 135 156 198 217 282 255 216 268 293 280 266 255 254 260 269 292 336 291 288 274 278 296 263 270 263 257 290 292 307 362 369 341 301 305

Sources: Krueger (1979: 48–49, 87) for 1955–1964, and Krueger (1997a: 301) for 1965–1990.

Kicking Off the Miracle 111 and quantitative restrictions on imports, although some quantitative restrictions were eased, particularly with the switch from a positive to a negative list system in 1967. The maintenance of tariffs and quantitative restrictions on imports could not yet offset the effect of inflation in the longer run, so the REER for imports also began to fall after 1965. It was thus uncertain whether South Korea could improve its trade balance. This would be a source of trouble throughout the Park era. Meanwhile, the government completely liberalized the imports of the intermediate inputs  – machinery, components, parts, and materials  – used for export production. The structure of protection thus became dualistic. Since exporters could import intermediate inputs free of tariffs or quantitative restrictions and export products free of any taxes or levies, the “effective rate of protection (ERP),” taking the protection of intermediate inputs as well as final products into account, was zero for exports. At the same time, the structure of protection for domestic sales did not change much, leaving the stake of existing firms catering to domestic demand virtually intact. This made it easier to pursue export-oriented industrialization politically. South Korea could maintain such a dualistic system of protecting the domestic market while exporting to advanced countries because the GATT system allowed it. However, the dualistic system also reflected the inability to lift tariffs and quantitative restrictions, mainly because of double-digit inflation.

Export-Oriented Industrialization in Action Despite the problems in trade and exchange rate policies, exports grew rapidly; exports grew more rapidly than production, so the export ratio (exports of goods and services as a percentage of the GDP) shot up. The rise in the export ratio was accompanied by a rise in the import ratio (imports of goods and services as a percentage of the GDP). Figure 4.1 shows the export and import ratios from 1953. The figure also shows aid import ratio, the imports by aid as a percentage of the GDP. The export ratio fell and rose in the 1950s, but the rise

112 The Tortuous Path of South Korean Economic Development 60.0

50.0

40.0

30.0

20.0

10.0

19 53 19 56 19 59 19 62 19 65 19 68 19 71 19 74 19 77 19 80 19 83 19 86 19 89 19 92 19 95 19 98 20 01 20 04 20 07 20 10 20 13 20 16 20 19

0.0 Export ratio

Import ratio

Aid import ratio

Figure 4.1  Export ratio and import ratio, 1953–2022 (percent) Notes: Export ratio is total exports (exports of goods and services) as a percentage of GDP. Import ratio is total imports (imports of goods and services) as a percentage of GDP. Aid import ratio is total imports financed by foreign aid as a percentage of GDP. Sources: Export ratio and import ratio are from Appendix 1. Aid import ratio is calculated from Mason et al. (1980: 206-208) and the Bank of Korea, National Income Accounts 1984.

accelerated in the 1960s. The import ratio was far higher than the export ratio in the 1950s, as imports were mainly financed by aid. It fluctuated with the variations of the aid inflow but began to rise rapidly with the onset of the HEG in the 1960s, to stay still higher than export ratio. The export and import ratios would reach a level far higher than the international “norms” predicted by the population size and per capita product by the 1970s.22 South Korea was thus becoming much more closely integrated with the world economy than other developing countries. Why did the export ratio shoot up in the 1960s? The export ratio rose first because existing firms in the manufacturing industries

22

Kim and Roemer (1979: Chapter 6).

Kicking Off the Miracle 113 increased exports with the saturation of the domestic market. Newly founded firms also saw the possibility of expanding their business horizons beyond the domestic market. Given such changes, the export ratio rose rapidly while the export incentives did not necessarily rise, with the fall of the REER and the introduction of non-price incentives. Exports did not “lead” growth, as the increase in exports did not account for a large share of the increase in aggregate demand. Exports rather “balanced” growth by financing imports that increased with the HEG. The HEG began with an increase in investment, which increased the imports of machinery and other inputs. The rise of income with the HEG increased consumption, which also increased the imports of consumer goods or – more commonly – the imports of the capital and intermediate goods for their domestic production. South Korea’s growth strategy could be called export-oriented industrialization because the country was much more interested in promoting exports than the majority of developing countries at the contemporary time. They stuck to import-substituting industrialization without developing much export capacity and faced a chronic balance of payments problem, which made growth assume a “stopgo” pattern.23 Of course, South Korea had its own balance of payments problem, as shown in Figure 4.1, where the export ratio fell short of the import ratio by a wide margin. Previously, foreign aid offset the margin, so the current account was more or less in balance; now, the current account turned into a large deficit as the margin remained wide while aid wound down. Current account deficit would persist until the mid-1980s, to cause many troubles for the economy, the first one being the bottleneck for the just-beginning HEG, as discussed later. However, an economy growing rapidly with even more rapidly growing exports was not the same as economy stagnating with slow or no growth of exports. Exports did more than balancing growth. Exports raised the overall productivity of the economy by enabling firms to realize

23

Diaz Alejandro (1973)

114 The Tortuous Path of South Korean Economic Development economies of scale and driving them to face effective competition not offered by the narrow domestic market. That unleashed entrepreneurial dynamism and reduced the room for rent-seeking and cronyism. Exports also promoted learning. Exporters had to learn how to meet the tastes of foreign customers. Foreign buyers offered the necessary technical assistance to South Korean firms to ensure that South Korean-made products met their technical specifications. The learning effect of exports was particularly strong because the partners were advanced capitalist countries. In 1965, the United States, Japan, and Western Europe together accounted for 74.4 percent of South Korea’s exports.24 Exports not only promoted learning but also changed people’s behavior. As John Stuart Mill observed in the mid-nineteenth century, a major benefit of trade in developing countries is placing human beings in contact with persons dissimilar to themselves and with modes of thought and action unlike those with which they are familiar.25 Trade enlightens people’s behavior. South Korea provides an interesting example in this regard. Most adult Koreans know what the “Korean Time” meant in the past. It was a term coined by Westerners to signify the fact that Koreans used to fail to be on time for appointments and feel that there was nothing wrong with being one or two hours late. However, the Korean Time disappeared over time, and South Korean people came to keep time like people in advanced countries. Nobody has studied how Korean Time disappeared, but the following anecdote is suggestive: When South Korea’s export drive was in full swing in the late 1960s, a foreign buyer who visited a South Korean shoe manufacturer told the president of the company that he would purchase shoes in large quantity if the sample he requested met the quality standards of his company. He said he needed the sample in one month by mail, as he had to return to his office

24 25

The data arte from kosis.kr. See Mill (1987: 581).

Kicking Off the Miracle 115 next day. The president worked all night long to make the sample and presented it to the foreign buyer before he left the airport. The buyer, who was flabbergasted but impressed by his efficiency, became the company’s best client.26

All of a sudden, Korean Time was becoming −30 days rather than one or two hours. One can easily expect that the manufacturer would have demanded similar behavioral changes to the suppliers of inputs to his firm. That kind of change would spread nationwide eventually.

4.4  Overcoming the Bottleneck and Beyond South Korea had to overcome a bottleneck to sustain the justbeginning HEG. This was the emerging balance of payments problem caused by the current account deficit. The country began to borrow abroad to finance the current account deficit, but the borrowing depended on the current account situation itself. The country had to find extra sources of foreign exchange other than exports and borrowing. The Park government found two such sources: normalization of the diplomatic relationship with Japan and sending troops to Vietnam.

Normalizing the Relationship with Japan With liberation, South Korea’s diplomatic relationship with Japan was severed. That was not natural, but normalization was not easy. The normalization of the relationship was an issue involving the United States as well as Japan and South Korea. South Korea’s rapprochement with Japan was on the US policy agenda dating back to the late 1940s. The United States wanted to strengthen the Cold War alliance in Northeast Asia, and once the Japanese economy recovered from the devastation of the war and began to grow rapidly in the 1950s, the United States wanted to let Japan share the burden of supporting South Korea. However, South Koreans did not like the idea.

26

A businessman recounted this to me in a private conversation.

116 The Tortuous Path of South Korean Economic Development Rhee Syngman adamantly opposed the normalization of the diplomatic relationship with Japan. He set a hurdle difficult to cross by refusing reparations of any figure lower than two billion dollars. Under the Rhee government, imports from Japan had to be balanced by exports to Japan, which severely limited trade. Rhee’s recalcitrant position toward Japan was one reason why he was ousted by the 1960 revolution, where the South Korean armed forces under US influence stayed neutral. Chang, succeeding Rhee, thought that 1.25 billon dollars was the rock bottom figure. Park was in a weaker position than Chang, not to mention Rhee, given his shaky political ground after waging the coup, as well as his record of communist involvement. He had to obtain US support by normalizing the relationship with Japan; indeed, the United States supported Park on this issue, threatening his opponents that failing to agree on the normalization would jeopardize the continued US support for the country.27 In the negotiations, South Korea demanded indemnities for the pains of colonial rule. Japan refused to pay the indemnities and rather insisted that it was Japan that needed compensation for the properties left behind in Korea. Japan had recognized US action to confiscate those properties in the San Francisco Peace Conference in 1951 but raised the issue in the normalization talks. In the end, the two sides agreed on the amount totaling 800 million dollars, composed of a direct grant of 300 million dollars, loans of 200 million dollars, and private firms’ investments of another 300 million dollars. 800 million dollars was equivalent to 25.8 percent of South Korea’s GDP in 1965. Japan put the name tag of “congratulatory money” for the newly independent South Korea on the money, adamantly refusing to define it as compensation for the ill-doings in the colonial period. On the other hand, the Park government explained to the South Korean public that it was “claim right money,” with the connotation that the money represented compensation for the ill-doings during

27

Woo (1991: 86).

Kicking Off the Miracle 117 colonial rule. The Park government and the Japanese government agreed to settle “all claims,” including those to be made by individuals. While the Japanese government published the entire agreement to the Japanese public, the Park government published the agreement to the South Korean public omitting the clause on the cancelation of all claims. Within South Korea, there was strong opposition to Park’s actions. The reasons varied, but the fundamental concern was that the country would again become dependent on Japan politically and economically. The political reason was not groundless. With the “reverse course” in the US occupation policy of Japan in the late 1940s, the prewar Japanese leaders, many of them war criminals, came back and joined the mainstream of postwar political elites. In South Korea, the collaborators of colonial rule preserved their status and power after liberation. They could easily become cronies. Democracy could be a purifying power against that legacy, but under Park’s rule, democracy was severely limited. Park had connections to the old guards of the Japanese Empire, such as Kishi Nobusuke, who had run the puppet state of Manchukuo, where Park had been its junior army officer. After the Second World War, the United States imprisoned Kishi for three years as a suspected Class A war criminal, but then released him in the reverse course; he eventually became a prime minister of Japan. The relationship between Park and Kishi was only a salient example; there were many connections between Park’s colleagues and the old elites of the Japanese Empire.28 The cronyism was unacceptable to the majority of South Koreans, not to mention the still-surviving national liberation fighters. Their opposition had clear and present ground: The connection was having an impact on domestic politics. Japanese firms provided two-thirds of Park’s ruling party’s 1961–1965 budget.29 Japanese firms wanting to do business with the country were composed mainly of



28 29

Jeong (1991). Woo (1991: 86).

118 The Tortuous Path of South Korean Economic Development those with prewar connections to the Korean colony. The broader context of international politics was also reminiscent of the structure of colonization in the early 1900s, when Japan had allied with Britain to counter Russia; here, Japan was allied with the United States to counter the Soviet Union and China. However, there were also realities different from those in the early 1900s. Old colonialism was gone. In the postwar arrangement of East Asia, Japan itself looked like a US “protectorate” under the Pacifist Constitution and would remain as such, at least for a while. The Japanese elites with a strong connection with Park were only part (though important) of the broader ruling coalition of postwar Japan. Economically, normalization meant lifting the restrictions on the relationship with the country that would be a natural partner in trade and investment. The immediate result for South Korea was getting a helping hand in breaking through the bottleneck in the justbeginning HEG. The Japanese money helped South Korea to resolve the balance of payments problem it faced. The Park government put the money into building the steel complex, which the United States and World Bank refused to finance, and infrastructures such as turnpikes, power plants, railroads, irrigation networks, and communication facilities. The 300 million dollars of commercial loans went to financing plant imports from Japan, such as power facilities, textile production machinery, and transportation equipment. South Korea came to depend on Japan for machinery, components, parts, and materials. South Korean firms would combine them with cheap domestic labor and export the products, with the largest destination being the US market. The country thereby entered a vertical division of labor with Japan, importing intermediate goods from Japan that were far more technologically sophisticated than its exports to Japan. Such a division of labor was natural, given the resource endowment of the two countries. South Korea was actually benefiting from its heavy dependence on Japan for imports because of the rising productivity of the Japanese economy, which was the most dynamic of the advanced countries at that time. The critical

Kicking Off the Miracle 119 question here was whether the vertical division of labor would persist. It would depend on how successfully South Korea would transform its industrial and trade structures in the future.

Sending Troops to Vietnam Another source of foreign exchange was sending troops to Vietnam. The United States escalated the war in Vietnam and sought to get an allied commitment like that which had accompanied its involvement in the Korean War. South Korea was the natural candidate for such a commitment, and Park had already offered several times to send South Korean troops to Vietnam before the United States asked him. Nearly 50,000 South Korean soldiers went to fight in Vietnam, and as many as 300,000 South Koreans served cumulatively from 1964 to 1973, by far the largest number among US allies. South Korea received 7.5 million dollars per division. From 1965 to 1970, about one billion dollars in American payments went to South Korea. As Japan had found momentum from the Korean War on which to rebuild the economy after the devastation of the Second World War, South Korea found the Vietnamese War enormously helpful in maintaining the burgeoning momentum for the HEG. Unlike the normalization of the diplomatic relationship with Japan, sending troops to Vietnam invoked little domestic dissent. After the Korean War, anticommunism was so firmly entrenched that sending troops as a crusade against communism was something to be taken for granted. Third World nationalism also had no place in South Korean politics, so sending troops to fight against the national liberation movement of other people met little opposition. Sending troops to Vietnam on a large scale – for money, especially – was squarely against the tide of Third World nationalism riding high in the 1960s. Atrocities South Korean troops committed to the Vietnamese civilian population were also a subject of sensation. However, the fact remained that the foreign exchange so earned was used to break through the bottleneck in the HEG, among the first of such things occurring in the ex-colonies.

120 The Tortuous Path of South Korean Economic Development 18.0 16.0 14.0 12.0 10.0 8.0 6.0 4.0 2.0

19 63 19 66 19 69 19 72 19 75 19 78 19 81 19 84 19 87 19 90 19 93 19 96 19 99 20 02 20 05 20 08 20 11 20 14 20 17 20 20

0.0

Total

Non -farm

Youth

Figure 4.2  Unemployment rates, 1963–2022 (percent) Notes: Unemployment rate before 1999 is based on the workers who actively sought jobs in the last one week, while unemployment rate from 1999 is based on the workers who actively sought jobs in the last four weeks. Source: kosis.kr.

The Crisis Dissolved South Korea’s balance of payments remained a chronic problem, but the immediate bottleneck was removed with the normalization of the diplomatic relationship with Japan and the sending of troops to Vietnam. The country could thereby sustain the HEG. The HEG resolved the jobs problem that helped precipitate the crisis of 1960, as unemployment and underemployment shrank drastically. As shown in Figure 4.2, unemployment rate was 8.1 percent in 1963 (the first year the data are available), but it fell to 3.9 percent by 1973. The unemployment rate for non-farm households fell more drastically, from 16.3 percent in 1963 to 6.8 percent in 1973. The unemployment rate for the youths (15–29 years old) fell from 11.1 percent in 1965 to 6.6 percent in 1973.

Kicking Off the Miracle 121 Changes in unemployment rates underestimated job growth because they excluded underemployment, as one or more hours of work a week was classified as employment. Many of the workers classified as employed in 1963 were underemployed and working less than full time. On the other hand, by 1973, far fewer people classified as employed were underemployed; they may well have worked too long, as will be discussed in Chapter 7. The HEG dissolved the job crisis, epitomized as the “Cow-Bone Tower” syndrome. Education had provided the potential for growth in the 1950s, but the rising level of education unaccompanied by job creation contributed to the outbreak of the 1960 crisis. Now, the HEG created jobs, helping to realize the growth potential provided by the rise of education level. Less-educated workers also came to have jobs. Their jobs were not high-paying ones, but they were far better than the unemployment or underemployment they had suffered previously. As people got jobs and their incomes increased, they were able to educate their children better. Thus, a virtuous circle of growth, jobs, and education set in. Jobs were created mainly in urban areas, but they also had an impact in rural areas. As urban jobs increased, rural unemployment and underemployment fell rapidly as workers migrated to urban areas. Rural populations had the option of moving to urban areas rather than continuing to struggle with the poor endowments of cultivated land. The migration alleviated the plight of the remaining rural population, as it raised the chance to cultivate more land. The migration thus eliminated the rural land tenure problem eventually. As the income of the rural population rose, the practice of usury became less prevalent. At the same time, being a landlord living on rent payments from the ownership of cultivated land came to mean little as a method of fortune making. If land ownership mattered as such, it was through the rise of land prices coming from rapid industrialization and urbanization.

5

Contours of the High Economic Growth

After the HEG began in the mid-1960s, it was sustained but accompanied by recurring crises. As mentioned in Chapter 1, this chapter and the two that follow explain such “sustained but crisis-ridden growth” from its beginning to the 1997 crisis. They discuss three subjects: macroeconomic management, structural transformation, and the management of social conflict. This chapter deals with macroeconomic management, leaving the other two subjects to Chapters 6 and 7, respectively.

5.1  An Aggressive but Vulnerable System The HEG began with the rise in the investment rate. The gross investment rate rose over 20 percent in 1966 and over 30 percent in 1974; it fell below 30 percent in 1975 and 1976, but rebounded to 30.0 percent in 1977, staying well over 30 percent until 1997. This was one of the highest levels in the contemporary world. Once the investment rate rose, a virtuous circle of investment and growth set in. The workforce expanded rapidly to help sustain the HEG. Baby boomers (The birth rate had shot up after the Korean War) joined the workforce, and migration from rural to urban areas skyrocketed. The workers were ever better educated. However, the HEG was based on an “aggressive but vulnerable system” that made the high gross investment rate possible but also made the economy undergo frequent crises. A crisis broke out in 1972, which the government resolved through an emergency decree. Then, a far bigger crisis broke out in 1979, which was accompanied by a political crisis. The country recovered from the crisis and created a big boom in the late 1980s. The HEG continued after the boom, but the system remained vulnerable to crises. 122

Contours of the High Economic Growth 123 This section discusses how the aggressive but vulnerable system formed and worked in the 1960s and 1970s, postponing the discussion of what happened in the 1980s and 1990s to the rest of the chapter.

Current Account and the Firm-Finance Nexus There were two main factors comprising the aggressive but vulnerable system: current account and the firm-finance nexus; the two often interacted with each other. Current account was in large deficit as the gross investment rate shot up ahead of the gross saving rate while the foreign aid wound down. Normalizing the diplomatic relationship with Japan and sending troops to Vietnam helped to reduce the current account deficit, but not entirely. Figure 5.1 presents the gross investment rate and gross saving rate together with the gross aid investment rate (gross investment financed by aid as a percentage of the GDP). This is the corollary of Figure 4.1 because the difference between gross saving and gross investment is equivalent to the difference between total exports and total imports. The figure confirms that the gross investment rate shot up ahead of the gross saving rate while the foreign aid wound down, producing a large current account deficit. The country borrowed heavily from abroad to finance its current account deficit, accumulating foreign debt. That would pose no problem in the end, as long as the interest rate on foreign debt was lower than the growth rate of the economy, which was the case. However, for foreign lenders, the shorter-term ability to service the debt was also important. If South Korea failed to assure them of its ability to service the debt, the country would be unable to roll the debt over and face a currency crisis. Double-digit inflation aggravated the problem. It threatened the sustainability of growth in various ways (more on this later), but its adverse effect on the current account was important. The REER for exports and imports continued to fall, which non-price incentives could not offset in the longer run. The government had to raise the

124 The Tortuous Path of South Korean Economic Development 45.0 40.0 35.0 30.0 25.0 20.0 15.0 10.0 5.0

Gross investment rate

Gross saving rate

20 21

20 17

20 13

20 09

20 05

20 01

19 97

19 93

19 89

19 85

19 81

19 77

19 73

19 69

19 65

19 61

19 57

19 53

0.0 Aid invetment rate

Figure 5.1  Gross investment rate and gross saving rate, 1953–2022 (percent) Notes: Aid investment rate is gross investment financed by foreign aid as a percentage of GDP. Sources: Investment rate and import rate are from ecos.bok.or. Aid investment rate is calculated from Mason et al. (1980: 206–208) and the Bank of Korea, National Income Accounts 1984.

exchange rate to prevent the REER from falling. Under the Bretton Woods system in place at that time, changing the exchange rate required the permission of the IMF. The IMF maintained an office in Seoul from 1965 to 1987, as the country concluded a standby agreement with the IMF. Another element of the aggressive but vulnerable system was the firm-finance nexus, which kept the debt-equity ratio of firms high but their profitability low. The debt-equity ratio of firms rose with the beginning of the HEG as they increased investment by borrowing rather than raising equity capital. Equity capital was difficult to raise because of the underdevelopment of the stock market; the lingering memory of the stock market crash in 1962 was another obstacle, and corporate tax discouraged equity financing. Firms borrowed from

Contours of the High Economic Growth 125 banks, overseas, and the curb market. A high debt-equity ratio would pose no problem if firms were profitable enough. However, firms were not profitable enough, as they pursued long-term growth ignoring short-term profitability. It has not been clearly explained why South Korean firms pursued long-term growth ignoring short-term profitability as the HEG began. The best-known explanation is that the government implicitly guaranteed the bailout for firms – chaebol firms in particular – if investment went wrong (more on this in Chapter 6). More generally, the government, which took almost total control over the allocation of investable funds, encouraged firms to invest actively while failing to impose adequate financial market discipline on them. Banks, which were state enterprises, had inadequate incentives to lend according to market principles. Their first goal was to comply with government objectives rather than the efficient management of their portfolios. Banks could not ignore portfolio management completely as long as they had to compile their own financial statements, but government ownership bred the belief that banks could survive regardless of their business performance. Under such circumstances, firm owners may have expected that growing fast and ignoring shortterm profitability would bring more profit or other benefits to them in the end. Aggressive investment financed by heavy borrowing without caring much about profitability made the HEG possible, but it was a source of vulnerability because the ability of firms to pay the debt back was questioned. This can be identified empirically. A best measure to represent the ability to pay debt back is the “interest coverage ratio,” the percentage of operating profit to interest payments. If a firm cannot earn enough profit from its business activities to cover interest payments, its ability to pay debt back is questioned. Figure  5.2 presents the debt-equity ratio and the interest coverage ratio for the manufacturing sector. Consistent data are only available for the manufacturing sector, but the situation in other sectors is unlikely to have been different.

126 The Tortuous Path of South Korean Economic Development 1,200.0

1,000.0

800.0

600.0

400.0

200.0

19

16

20

13

20

20

07

10

20

04

20

20

98

01

20

95

19

92

19

89

19

86

Debt-equity ratio

19

83

19

80

19

77

19

19

71

74

19

68

19

65

19

19

19

62

0.0 Interest coverage ratio

Figure 5.2  Debt-equity ratio and interest coverage ratio, manufacturing sector, 1962–2021 (percent) Source: Appendix 3.

As the HEG began, the debt-equity ratio shot up toward around 400 percent, while the interest coverage ratio dived toward around 100 percent. Firms became barely able to pay interest with operating profit, while their debt-equity ratio soared. Operating income barely covering interest payments was inconsistent with the principle of market economy because firms had debts with no obligation to pay interest, such as commercial credit. Such debt accounted for about 40 percent of the total debt from 1962 to 1997, though with some variations over the years. Moreover, given the diversity of financial situations among firms, the fact that firms barely covered interest payments with operating profit on average suggests that a large proportion of firms were unable to pay the debt back. They were producing non-performing loans (NPLs) for the banks. One has to consider the capital gains on fixed assets as well as operating profit in assessing the ability of firms to pay debt back. Firms reaped the capital gains on the fixed assets they held as the

Contours of the High Economic Growth 127 economy grew rapidly and the inflation rate stayed in the double digits. Firms could use fixed assets as collateral for loans, which banks mostly required when lending. The capital gains raised the collateral value and enhanced the ability to pay the loans back. No data are available for the exact size of the capital gains reaped by firms; however, the available data on the capital gains on land suggest that the capital gains were huge. The capital gains on privately owned land averaged as high as 84.9 percent of GDP from 1965 to 1979 (See Appendix 5). There are no data about how much of those capital gains accrued to firms rather than households, but the capital gains reaped by firms in the real estate market are likely to have substantially enhanced their ability to pay the loans back beyond what Figure 5.2 indicates. It is impossible to know exactly how much the capital gains on fixed assets reduced NPLs. However, aside from the ability to pay debt back eventually, firms’ practice of heavy borrowing without caring much about profitability made the economy vulnerable to shocks. Indeed, a crisis broke out in the early 1970s as macroeconomic conditions soured.

The 1972 Crisis As foreign debt accumulated with the current account deficit, debt service became a problem. Debt service ratio, the sum of the interest and repayment of principal as a share of total exports, rose from six percent in 1965 to 31 percent in 1970.1 The IMF recommended that South Korea devalue its currency (raise the exchange rate); it also demanded tightening monetary control and ending export subsidies and import restrictions. The South Korean government agreed to the IMF program in 1970, with the exception of the demand to end export subsidies and import restrictions. South Korea devalued its currency by 11.9 percent in 1971 and another 13.0 percent in 1972. The government implemented a contractionary monetary policy and tight credit

1

Eichengreen et al. (2012: 272).

128 The Tortuous Path of South Korean Economic Development control, bringing relative stagnation. The worldwide economic recession made things worse. The growth rate of the GDP, which stood at 14.6 percent in 1969, fell to 10.1 percent in 1970 and 10.5 percent in 1971. The falling growth rate hit firms hard, given their high indebtedness and low profitability. In addition, the short-term adverse effect of devaluation hit the economy before a favorable longer-term effect was realized. The firms that had borrowed from abroad were in trouble, as they had to pay more in won per the debt owed in foreign currency, but under tight credit control, they could not borrow from banks. Firms, including chaebol firms, turned to the curb market as the last resort, with its high interest rate and short-term maturity. When firms could not pay the curb market loans back, they faced bankruptcy. After consulting leading business people, the government concluded that some extraordinary measures were in order. On August 3, 1972, a presidential emergency decree was issued to bail out debtridden firms. It imposed an immediate three-year moratorium on the payment of all debt owed by firms to the curb lenders, after which all curb loans had to be turned into five-year loans at the maximum annual interest rate of 16.2 percent – this at a time when the prevailing market rate was well over 40 percent. The total amount of curb market loans registered with the government amounted to 42 percent of the total bank loans.2 The emergency decree also included extensive rescheduling of bank loans at reduced interest rates. The bank interest rate on loans for up to one year was reduced from 19 percent to 15.5 percent. Furthermore, approximately 30 percent of the shortterm commercial bank loans were converted into long-term loans to be repaid on an installment basis over five years at an eight percent annual interest rate, with a three-year grace period. The BOK ultimately backed the conversion by accepting the special debentures issued by commercial banks. These measures shifted the burden of the corporate sector to curb lenders and banks, and, ultimately, to the

2

Cho and Kim (1997: 84).

Contours of the High Economic Growth 129 public, on a tremendous scale. The emergency decree was a serious violation of the principle of private property, which may well have been unconstitutional in normal times. It was possible, however, as Park strengthened his authoritarian rule by August 1972, two months before he waged the self-coup to install himself as lifetime president. With the reduction of interest payments to domestic debt, firms successfully maintained foreign debt service. They could also drastically improve international competitiveness, as the devaluation in 1971 and 1972 took effect with a lag. The government severely regulated prices, as the emergency decree had promised to reduce the inflation rate to three percent or lower, as the low inflation rate would compensate for the reduced nominal interest rate to the curb lenders. A heavy regulation of prices managed to reduce the inflation rate to 3.2 percent in 1973. As a result, in 1973, the REER for exports shot up above the previous peak in 1959 (shown in Table 4.3). This led to an almost doubling of exports when combined with the global boom in 1973 – the last year of the golden age of capitalism. The REER for imports also rose drastically, encouraging domestic production instead of importation. The current account deficit, which stood at 7.6 percent of GDP in 1970, fell to 2.2 percent in 1973. The growth rate of GDP, which plunged to 7.2 percent in 1972, shot up to 14.9 percent in 1973. High growth, on top of the effects of the emergency decree, drastically improved the financial situation of firms. The debt-equity ratio of the manufacturing sector fell below 300 percent and the interest coverage ratio rose above 200 percent in 1973.

Industrial Policy and the First Oil Shock The government promised to reduce the inflation rate to three percent or lower when implementing the emergency decree in 1972. It had, however, no intention to carry out a disinflation policy, except for strengthening the price regulation, which could be no more than a temporary measure. From 1973, the government implemented a strong industrial policy supported by an expansionary macroeconomic policy. In addition, at the end of 1973, the First Oil Shock

130 The Tortuous Path of South Korean Economic Development hit the country hard. Implementing an expansionary macroeconomic policy in the face of rising oil prices helped to sustain the HEG, but at the expense of price stability and current account. The economy grew by 9.5 percent in 1974 and by 7.8 percent in 1975, while the inflation rate jumped to 24.1 percent in 1974 and 25.3 percent in 1975. The current account deficit widened to 10.4 percent of GDP in 1974 and 8.7 percent of GDP in 1975. In December 1974, South Korea devalued its currency by 21.3 percent. The growth rate jumped to 13.2 percent in 1976, and the doubledigit growth continued until 1978 as the government pushed ahead with the industrial policy while the effect of the First Oil Shock tapered off. The Vietnam War experience allowed South Korean firms to explore the Middle East construction market, helping to maintain growth and reduce the current account deficit. The stabilization of oil prices lowered the inflation rate and reduced the current account deficit; the devaluation in December 1974 also reduced the current account deficit with a lag. The inflation rate fell to 15.4 percent in 1976 and 10.1 percent in 1977; the current account deficit shrank to 1.0 percent of GDP in 1976 and turned to a small surplus in 1977. However, double-digit inflation continued while the government kept the exchange rate fixed since December 1974, so the current account turned to a deficit of 2.0 percent of GDP in 1978. All of these led to the rapid accumulation of foreign debt. Foreign lenders began to question the country’s credibility and shortened the terms of lending. Short-term foreign debt became larger than international reserves held by the government as early as the end of 1974 (See Appendix 2). In 1975, South Korea had to tap into the IMF Oil Facility, temporarily arranged as a separate program from the ordinary credit quota. The amount received was more than twice the ordinary credit quota assigned to South Korea. The country continued to borrow, notably from advanced countries’ banks that were recycling the petrodollars. International reserves increased to outnumber short-term foreign debt in 1977, but the margin remained slim.

Contours of the High Economic Growth 131 The financial situation of firms deteriorated again, as firms invested actively by borrowing without caring for short-term profitability. The emergency decree made firms believe that they could rely on the government for support when they faced trouble. In addition, the industrial policy of 1973 pushed many firms – chaebol firms in particular – to invest massively by borrowing without consideration for short-term profitability. The government often assured, though implicitly, chaebol investing in the promoted industries that it would come to their aid when they faced difficulties in the future (more on this in Chapter 6). Banks still prioritized complying with government objectives over managing their portfolios efficiently. In fact, the government drove banks harder than before to supply credit to firms investing in priority industries. As a result, after 1973, the debt-equity ratio of the manufacturing sector rose again while its interest coverage ratio fell, as shown in Figure 5.2.

5.2  Crisis, Stabilization, and Boom In 1979, South Korea faced a crisis far bigger than the one in 1972. It was a political as well as economic crisis, during which Park Chung Hee was assassinated. The crisis was resolved after another military strongman, Chun Doo-hwan, seized power in 1980. Chun carried out a successful disinflation policy, which put the country on the road to recovery and a subsequent boom, with a low inflation rate and current account surplus.

The 1979 Crisis The 1979 crisis was precipitated by the contractionary macroeconomic policy to cope with the high inflation. By 1978, inflation was becoming intolerable to the majority of the population. Most painful was the rise of real estate prices caused by the loose monetary policy. In 1978, land prices rose by 49 percent on average in the country and 79 percent on average in the major cities.3 Capital gains accruing to

3

www.reb.or.kr/r-one/statistics/statisticsViewer.do?menuId=LFR_12100

132 The Tortuous Path of South Korean Economic Development the private sector through the rise of land prices amounted to 144.1 percent of GDP (See Appendix 5). They mostly represented the transfer of wealth to the rich from the economy as a whole, so the threat of a breakdown of social cohesion loomed due to both the real and perceived widening of inequality (more on this in Chapter 7). By the end of 1978, Park recognized the gravity of the problem and ordered his staff to implement a disinflation policy. In April 1979, the government announced a comprehensive stabilization program, whereby fiscal and monetary policies took a contractionary turn, the interest rate was raised for some categories of deposits to increase savings, and government regulation of prices was to be reduced. Unfortunately, the timing of this contractionary macroeconomic policy coincided with the Second Oil Shock, dealing a major blow to the economy, particularly given the high indebtedness and low profitability of firms. The growth rate of GDP, which stood at 4.5 percent in the first quarter of 1979 (seasonally adjusted rate compared with the previous quarter), dropped to 0.8 percent in the second quarter. In the third quarter, the growth rate dropped to −2.8 percent, which was the largest quarterly contraction of GDP since 1960 (the first year the quarterly data were compiled). In the fourth quarter, GDP contracted further by 1.5 percent.4 Such economic downturn interacted with political crisis. The legitimacy of Park’s government was substantially tied to sustaining the HEG; thus, the falling growth rate was highly detrimental to this legitimacy. Park was assassinated in October 26, 1979, though the deteriorating economic situation was by no means the main reason for the assassination. To make matters worse, the world economy was spiraling toward the deepest recession it had experienced in the post-war period up until then, triggered by the implementation of the Volker Disinflation in the United States from the autumn of 1979 on top

4

These quarterly growth rates are inconsistent with the annual growth rate of 8.7 percent appearing in Appendix 1. The Bank of Korea has not offered any explanation about the inconsistency. It yet seems that the quarterly data are intuitively more appealing.

Contours of the High Economic Growth 133 of the conditions created by the Second Oil Shock. The recession hit the export-oriented South Korean economy hard. The high US interest rate raised the value of the US dollar, to which the Korean won was pegged; therefore, South Korean exports began to lose their competitiveness in the world market. Meanwhile, the inflation rate rose from 14.5 percent in 1978 to 18.3 percent in 1979 because of the rising oil prices. The rising oil prices also bloated the current account deficit, which shot up to 6.4 percent of GDP in 1979. The crisis culminated in 1980. The combination of the global recession, high oil prices, and domestic political uncertainty following Park’s assassination all wreaked havoc to discourage investment. An unusually long cold spell throughout the summer months resulted in a crop loss amounting to a quarter of the expected yield. The economy shrank by 1.6 percent in 1980, the first contraction on annual base since the Korean War. The inflation rate rose to 28.7 percent, and the current account deficit jumped to 10.6 percent of GDP, the highest level ever.

The Disinflation Policy After Park’s assassination, the interim government led by Choi Gyu-ha (October 1979–August 1980) took charge. It raised interest rates by approximately five to six percentage points for all organized financial markets, showing the intention to continue Park’s disinflation policy. Monetary policy remained tight. South Korea negotiated with the IMF and devalued its currency by 19.8 percent in January 1980 to reduce the current account deficit. To increase flexibility in the exchange rate, the government introduced a new exchange rate system of multiple basket peg system, pegging the currency – the Korean won – to a basket of major currencies rather than US dollar. Politically, the hope for democratization ran high after Park’s assassination. However, another military strongman, Chun Doohwan, took power through a bloody coup in two stages: the purge of his rivals in the army in December 1979 and the clampdown during the Kwangju Uprising in May 1980. While Park’s coup in 1961 was bloodless, Chun’s coups involved not only the deaths of numerous

134 The Tortuous Path of South Korean Economic Development soldiers but also a massacre in Kwangju. Chun then elevated himself to president through an electoral college organized by himself. Chun suffered from a well-known reputation for dullness, obstinacy, and arrogance. His family, including his wife and his younger brother, was continuously implicated in scandals. However, fortunately for the economy, Chun acknowledged that he had no knowledge or experience in economic management. He employed competent economists, who were mostly trained in the United States and marketoriented, and delegated them great authority over economic policy. While abstaining from micromanagement, he asked his staff to pursue an unwavering disinflation policy.5 To carry out the disinflation policy, the Chun government pursued contractionary fiscal and financial policies. The contractionary fiscal policy began in 1982, as the Chun government had to implement an expansionary fiscal policy in 1981 after undergoing a negative growth rate in 1980. The growth rate recovered from −1.6 percent in 1980 to 7.2 percent in 1981, not least owing to the expansionary fiscal policy. In 1982, the Chun government began to implement a contractionary fiscal policy through the retrenchment of expenditure, as the Park government had done in 1962. In January 1982, it introduced zero-based budgeting that would be implemented immediately. The subsequent budgets were prepared with great restraint. This led to the real retrenchment of government expenditure. Figure 5.3 presents the government expenditure and its components as a percentage of GDP from 1970, the first year the official data are available. Government expenditure fell from 24.7 percent of GDP in 1981 to 18.4 percent in 1987, the last year of the Chun government. Two components mainly accounted for the fall of the share of government expenditure in GDP: defense and economic affairs. The share of defense spending in GDP had risen in the 1970s as the Park government pursued independent defense in response to the

5

Sakong (1993: 68).

Contours of the High Economic Growth 135 45.0 40.0 35.0 30.0 25.0 20.0 15.0 10.0 5.0

Economic affairs

Welfare

18

15

20

12

20

09

20

06

Educaon

20

03

20

00

20

97

20

94

19

91

19

88

19

85

19

82

Defense

19

79

19

76

19

73

19

19

19

70

0.0 Others

Figure 5.3  The composition of government expenditure, 1970–2020 (percent of GDP) Source: ecos.bok.or.kr.

US position from the Nixon to Carter administrations to withdraw troops from South Korea. With the launch of a renewed Cold War against the Soviet Union, the Chun government was able to put the brakes on defense spending as the Reagan administration decided to maintain American troops in South Korea. Thus, the share of defense spending in GDP fell from 4.6 percent in 1981 to 3.2 percent in 1987. The share of the expenditure on economic affairs in GDP had fluctuated in the 1970s, reflecting the need to boost the economy after the First Oil Shock as well as the building of infrastructures and promoting of priority activities. It stood at 7.0 percent in 1981 after undergoing an expansion to cope with the negative growth rate in 1980. The Chun government cut its share to 3.4 percent of GDP in 1987, the lowest figure since 1970. The government not only cut its own investment but also reduced tax deductions and exemptions

136 The Tortuous Path of South Korean Economic Development for export promotion and industrial policy, the most sacred policy agenda of the 1970s. Though the Chun government’s retrenchment in 1981–1987 was less drastic than the Park government’s retrenchment in 1962– 1964, it managed to transform the fiscal balance into a surplus. Fiscal balance turned from a deficit of 4.3 percent of GDP in 1981 to a surplus of 0.2 percent of GDP in 1987. The Chun government also pursued a contractionary financial policy. It initially found it difficult to pursue the policy, as it would mean suddenly taking away funds from firms. It also introduced new credit programs for SMEs. In addition, the BOK had to make special low-interest loans to banks to compensate their losses after the government obliged them to write off the NPLs of firms accumulated in the 1970s (more on this in Section 4). The BOK offset the effect of the loans by selling Monetary Stabilization Bonds (bonds issued as the debt of the BOK itself, which was introduced in 1961 and became the major instrument of the BOK’s open market operation), but did not do so thoroughly. The contractionary financial policy thus proceeded relatively slowly. Meanwhile, the Chun government implemented a kind of “incomes policy” by waging a strong campaign for burden sharing in real income loss. The government restrained the salaries of civil servants and state enterprise employees. It was part of the fiscal retrenchment, but the government used the restraint to induce private-sector restraint, especially from higher-income workers. The government urged workers not to demand wage hikes while urging firms to refrain from price hikes or even to cut prices. It asked households to spend less and save more. The government propagated the long-run benefit of price stability through various channels such as mass communication and booklets. Of course, the ultimate underlying factor was fear: If someone disagreed openly with the government, he or she would be punished immediately with the violence the government commanded. The Chun government intensified the oppression of labor unions established in the Park era (See Chapter 7).

Contours of the High Economic Growth 137 There was, of course, a double standard in action. While pushing burden-sharing campaigns, Chun collected a tremendous amount of slush funds and his family members were continuously implicated in scandals. Overall, however, Chun-style incomes policy worked as an effective disinflation policy.

Turnaround and Boom South Korea managed to reduce its inflation rate from 21.3 percent in 1981 to 7.2 percent in 1982, the first single-digit figure since 1973. The growth rate of GDP rose from 7.2 percent in 1981 to 8.3 percent in 1982, in spite of the fiscal retrenchment. South Korea’s private sector was buoyant, so the economy did not need fiscal stimulus except in crisis times. The world economy was also recovering from the recession caused by the Second Oil Shock and Volker Disinflation. However, balance of payments was again a bottleneck. South Korea devalued its currency further several times, but current account deficit, which had risen to 10.6 percent of GDP in 1980, fell only slowly, to 8.9 percent of GDP in 1981 and 7.2 percent of GDP in 1982. South Korea drew 498.8 million Special Drawing Rights from the IMF in 1980, which were about three times the credit quota for the country, but international reserves came to fall short of short-term foreign debt again, and the gap widened in 1981 and 1982 (See Appendix 2). The country had to do something special about the balance of payments. The Chun government decided to resolve the problem through a diplomatic maneuver. In April 1981, it demanded Japan lend South Korea 10 billion dollars on the grounds of burden sharing in the collective defense of East Asia. When Japan was reluctant to respond, the Chun government appealed to the Reagan administration of the United States. Chun had a friendly relationship with the Reagan administration, which was illustrated by the fact that as soon as Reagan entered office, he chose Chun as the first foreign head of state to visit Washington. The Reagan administration agreed with Chun’s idea of burden sharing. In the end, in January 1983, South Korea managed to borrow four billion dollars – equivalent to 5.1

138 The Tortuous Path of South Korean Economic Development percent of the 1982 GDP – from Japan, which critically helped the country avoid a currency crisis. The growth rate of GDP rose further, averaging 10.6 percent from 1983 to 1985. This time, the HEG was accompanied by a low inflation rate and shrinking current account deficit. The inflation rate fell to 3.4 percent in 1983, then to 2.3 percent in 1984, and 2.5 percent in 1985; South Korea thus managed to achieve price stability close to that of advanced countries. The country continued to devalue the currency, and the current account deficit fell to 4.1 percent of GDP in 1983 and 1.9 percent of GDP in 1984. Then, in late 1985, favorable external shocks occurred. In the Plaza Agreement in September, G7 countries agreed to devalue the US dollar drastically in relation to other major currencies, the Japanese yen in particular. Because the Korean won was mainly linked to the US dollar, it also fell drastically in relation to other currencies, particularly the Japanese yen (Though South Korea had moved to the multiple basket peg system in 1980, the dollar still had the largest weight in the basket). This devaluation of the won helped South Korean exports because South Korean export goods were close substitutes of the now more expensive Japanese ones. In addition, the pricing of oil by the Organization of Petroleum Exporting Countries (OPEC), which had brought about the Second Oil Shock in 1979, was collapsing. By the end of 1985, the adverse shocks of 1979 had reversed themselves. This happened while the country had devalued its currency (raised the nominal exchange rate) substantially while implementing a strong disinflation policy. By 1986, the REER for exports shot up to surpass its previous peak in 1973, in spite of the contractionary fiscal and financial policy phasing out export subsidies, as shown in Table 4.3. REER for imports also rose above its previous peak in 1973, as shown in Table 4.4. As a result, from 1986 to 1988, the country went through a boom, with the growth rate of GDP averaging 12.0 percent. Inflation rate remained low until 1987, before it began to rise again in 1988 (discussed below). The current account turned into a surplus of 2.2 percent of GDP in 1986, and the surplus

Contours of the High Economic Growth 139 expanded to 5.8 percent of GDP in 1987 and 6.4 percent of GDP in 1988. The current account surplus during those three years virtually wiped out the foreign debt accumulated in the preceding years. The gross foreign debt stood at 46.2 percent of GDP at the end of 1985 but shrank to 15.6 percent of GDP at the end of 1988; the net foreign debt fell from 35.1 percent of GDP to 3.6 percent of GDP during the same period (See Appendix 2). The emergence of a substantial current account surplus meant that the gross saving rate eventually caught up with the gross investment rate, as shown in Figure 5.1. The gross saving rate rose to one of the highest levels in the contemporary world. Most remarkable was the rise of the household saving rate – the net household saving as a percentage of household disposable income. It was 3.1 percent in 1970 but rose steeply to reach its peak of 23.9 percent in 1988.6 Economists have tried to explain the high household saving rate of East Asian countries, including South Korea, during certain stages of economic development. Demography is a powerful explanation. South Korea’s birth rate fell quickly as industrialization and urbanization proceeded; the government also waged a vigorous campaign to reduce the birth rate. The total fertility rate (TFR), defined as the number of live births to 1,000 women aged 15 to 49 years, stood at 4.53 in 1970, but it fell to 2.06 by 1983, a level lower than the reproduction rate of about 2.1. TFR fell further subsequently. The falling TFR reduced the young-age dependency ratio, the percentage of the young-age population (0–14 years old) to the working-age population (15–64 years old). Meanwhile, old-age dependency ratio, the percentage of the elderly population (65 years or older) to the working-age population, rose only slowly with the lengthening of life expectancy. As a result, total dependency ratio (the sum of the young-age dependency ratio and the old-age dependency ratio) fell from 83.8 percent in 1970 to 47.1 percent in 1988.7 This enabled households to save more.

6 7

The numbers are from ecos.bok.or.kr. The numbers are from kosis.kr; see Figure 11.6.

140 The Tortuous Path of South Korean Economic Development The country also had a larger proportion of the self-employed by international comparison, who saved more because of the uncertainty about the future. The poor social security system drove workers to save more in order to take care of their own retirement. The financial policy of prioritizing lending to firms over lending to households also made households save more. The Chun government continued the policy even though it began to liberalize the interest rates and privatized the banks (more on this below). The policy imposed a “liquidity constraint” on household consumption, raising the household saving rate.8 In June 1987, when the economy was in the midst of the boom, South Korea democratized politically. South Koreans enjoyed political democratization while the economy was undergoing a stellar performance. The 1988 Summer Olympic Games in Seoul were the coming-out party for the “Miracle on the Han” (Han is the river flowing through Seoul). It would have great political implications for the world as well as South Korea, as will be discussed in Chapter 7. However, problems were forming behind the scenes of the boom.

5.3  Macroeconomic Performance after the Boom South Korea moved from a great boom to a relative recession in 1989. It failed to maintain the low inflation rate achieved in the mid-1980s, and the current account turned to deficit in the 1990s. Yet the country sustained the HEG with single-digit inflation and a moderate current account deficit until the 1997 crisis.

The Return of Inflation and Current Account Deficit In 1989, the economy grew by 7.1 percent, which was almost a five percentage point drop from 12.0 percent in 1988. This was accompanied by the return of inflation and current account deficit. The inflation rate, which had jumped to 7.2 percent in 1988, fell to 5.7



8

These explanations were first offered for Japan; see Horioka (1990) and Ito (1992: 268–276). Explanations for other East Asian countries are basically the same.

Contours of the High Economic Growth 141 percent in 1989, but it failed to return to the low rates of the mid1980s subsequently. Current account surplus shrank to 1.5 percent of GDP in 1989, and disappeared in the 1990s (with a brief exception in 1993). The source of the problem was the increase of money supply coming from the large current account surplus during the 1986–1988 boom. The large current account surplus bloated the net foreign assets of the BOK, which would increase monetary base. To cope with this problem, the public sector stopped borrowing from abroad and started to repay foreign debts. The government relaxed restrictions on the direct investment overseas while restricting the inflow of foreign capital. The government paid back the BOK loans, being helped by the fiscal surplus achieved in 1987 and 1988. The BOK, for its part, tried to sterilize the increase of net foreign assets by reducing the net loans to banks and selling Monetary Stabilization Bonds. However, all those efforts failed to offset the effect of the large current account surplus. Monetary base increased by 16.2 percent in 1986, 48.9 percent in 1987, and 30.2 percent in 1988, in contrast with 3.7 percent in 1984 and 1.7 percent in 1985.9 The failure to restrain the increase of money supply interacted with the effect of democratization in 1987. Democratization reversed the Chun-style incomes policy, as the government could no longer wield the threat of using violence. Democratization made independent union activity possible for the first time (explained in Chapter 7). Nominal wages of full-time employees of the manufacturing sector rose by 11.6 percent in 1987, 19.6 percent in 1988, and 25.1 percent in 1989.10 South Korea could have mitigated such a situation if it had revalued its currency (lowered its exchange rate) earlier to reduce the size of current account surplus to a manageable level. Yet the government delayed the revaluation because government officials, together



9 10

The numbers are from ecos.bok.or.kr. Kim (1999: 374).

142 The Tortuous Path of South Korean Economic Development with the public, were preoccupied with reducing the foreign debt immediately through maximum current account surplus. The government revalued the currency slowly, only as the United States put pressure on the charges of manipulating the exchange rate. However, once the government began to revalue the currency, it did so drastically. The won–dollar exchange rate (annual average) was 881.3 in 1986, but fell to 671.4 in 1989. When combined with the renewed inflation, the revaluation led to the fall of the REER. The REER for both exports and imports was lower in 1989 than in 1985, as shown in Tables 4.3 and 4.4. The South Korean economy underwent an “overgrowth” during the 1986–1988 boom and then experienced a sudden cooldown in 1989. The overgrowth undermined the hard-won price stability, which would not be easy to regain. Current account surplus disappeared. However, one should not emphasize the deterioration of the macroeconomic performance after the 1986–1988 boom too much. The country could have revalued its currency earlier lest the economy overheat and then suddenly cool down. It could have thereby maintained the low inflation rate and spread the growth rate and current account surplus more evenly over a longer period. Aside from the comparison with such an alternative situation, macroeconomic performance after the 1986–1988 boom was not so poor. The country sustained the HEG while maintaining the inflation rate at a single digit and current account deficit at a moderate level.

Sustaining the High Economic Growth To cope with the cooldown the falling REER brought about, the government turned to boosting domestic demand. The best way to boost domestic demand was to promote construction investment. The country was facing a shortage of housing and infrastructure because the disinflation policy of the Chun government had discouraged construction investment. Especially troublesome was the shortage of housing. In 1980–1987, housing (residential buildings) investment increased only by 6.5 percent in real terms on average, producing

Contours of the High Economic Growth 143 a shortage of housing, especially in the Seoul metropolitan area.11 When combined with the loose monetary policy in the 1986–1988 boom, it led to the drastic rise of housing and land prices, a major mechanism in widening inequality (more on this in Chapter 7). With democratization, the voice to stabilize the housing prices was stronger than ever. Stabilizing housing market was the foremost challenge for the Roh Tae-woo government (February 1988–February 1993), which succeeded the Chun Doo-hwan government after the democratization in 1987. Roh was a colleague of Chun, elected with 36.6 percent of the vote due to the split of the opposition. His political position was naturally weak, which reinforced the necessity to stabilize the housing prices. The Roh government sought to expand the housing supply drastically as well as restricting the speculative activities in the real estate market through regulation and taxation. Investment in non-housing construction, such as non-residential buildings, roads, subways, dams and water supplies also increased dramatically. Figure 5.4 shows the share of various forms of investment in GDP. The share of construction investment rose sharply from 14.1 percent in 1987 to 22.5 percent in 1991. The share of housing investment rose more drastically from 3.9 percent in 1987 to 8.1 percent in 1991 (Housing investment in real terms increased by 28.5 percent on average during the four years from 1988 to 1991). In 1991, the shares of housing investment, construction investment, and gross investment in GDP all peaked; subsequently, all of them fell. The share of housing investment and construction investment fell as the need to build housing and to boost domestic demand had been more or less met. Yet the share of gross investment did not fall as much due to the rising share of the intellectual property investment. In the 1990s, South Korea was not only intensifying the research and development (R&D) efforts geared toward catching up with advanced countries, but also those geared toward the jump into the newly emerging

11

The increase rate of investment is from ecos.bok.or.kr.

144 The Tortuous Path of South Korean Economic Development 45.0 40.0 35.0 30.0 25.0 20.0 15.0 10.0 5.0

18

15

20

09

12

20

20

06

Facility

20

03

20

00

Other construction

20

97

20

94

19

91

19

88

Housing

19

85

19

82

79

Inventory changes

19

19

76

19

73

19

–5.0

19

19

70

0.0

Intellectual property

Figure 5.4  The composition of gross investment rate, 1970–2022 (percent) Source: ecos.bok.or.kr.

technologies globally, especially the information and communication technology (ICT; see Chapter 6). Meanwhile, the share of facility investment did not fall much in spite of the waning of the 1986–1988 boom. It did so because firms saw the opportunities provided by the emerging global boom. Facility investment was occurring mainly in manufacturing sector, which comprised the mainstay of export industries, and the export opportunity was rising owing to an emerging global boom. After the golden age of capitalism ended in 1973, the word economy relatively stagnated. Then, in the 1990s, the ICT industry boom in the United States was providing a new momentum for a global boom. More importantly, there was the catch-up growth of developing countries. China was sustaining the high economic growth begun in the 1980s. With the end of the Cold War, former Soviet bloc countries began the catch-up growth, riding the tide of globalization. Many Third World countries, including the big ones like India, also switched policy to launch catch-up growth by joining globalization. South Korea, with

Contours of the High Economic Growth 145 the recent development experience, often had an edge in meeting those countries’ needs. The country was in an especially favorable position to take advantage of the rapid growth of the Chinese economy, owing to the geographic and cultural closeness. South Korea normalized the diplomatic relationship with China in 1992, which facilitated the trade and investment. The growth rate of GDP rose from 7.1 percent in 1989 to 9.9 percent in 1990 and 10.8 percent in 1991. Yet the inflation rate rose from 5.7 percent in 1989 to 8.6 percent in 1990 and 9.3 percent in 1991. In 1992, the Roh Tae-woo government implemented a stabilization policy. The growth rate fell to 6.2 percent in 1992 and 6.9 percent in 1993. In 1993, the inflation rate fell to 4.8 percent, the lowest level since 1987, and the current account turned into a surplus for the first time since 1989. However, macroeconomic policy took another turn with the coming of the Kim Young-sam government (February 1993–February 1998). A long-time opposition leader, Kim was the first civilian president in 32 years, though he seized power by merging his party with the party of Chun and Roh in 1990 and winning the presidential election in 1992 with the help of Roh and his colleagues. Many observers regarded him as a politician of “feeling” rather than reasoning. He once said, “You can borrow someone else’s brain, but not his body.” His politics of feeling worked wonders for South Korea’s democracy when he purged the personal legacy of the military government with a blitzkrieg tactic as soon as he seized power. He also successfully enhanced the transparency of the economy (explained in Chapter 7). Yet he was probably the least aware of the economy of all South Korean presidents, and delegated economic policy to his staff. His staff pursued expansionary macroeconomic policy rather than continuing the Roh government’s stabilization policy. With the expansionary macroeconomic policy, the gross investment rate rose again. This time, the share of construction investment in GDP did not rise. Instead, the share of facility investment alongside the intellectual property investment in GDP rose. The share of

146 The Tortuous Path of South Korean Economic Development facility investment in GDP rose from 12.2 percent in 1993 to the average of 13.4 percent from 1994 to 1996; the share of the intellectual property investment in GDP rose from 2.6 percent in 1993 to the average of 3.1 percent from 1994 to 1996. The gross investment rate averaged 39.1 percent of GDP from 1994 to 1996. As the gross investment rate continued to be high, the country sustained the HEG. The growth rate of GDP averaged 8.9 percent from 1994 to 1996. Inflation and current account deficit persisted, but they were unlikely to make growth unsustainable. The inflation rate was moderate, averaging 5.2 percent from 1994 to 1996. Current account deficit rose from 1.0 percent of GDP in 1994 to 4.0 percent of GDP in 1996, but it started declining in early 1997. The country borrowed to finance the current account deficit, but the growth rate of the economy was far higher than the interest rate on foreign borrowing, so the country was no doubt able to pay the foreign debt back; foreign debt was of course far smaller as a percentage of the GDP than in the 1960s and 1970s (See Appendix 2).

Macroeconomic Populism? The macroeconomic performance during this period was inevitably intertwined with democratization. Chapter 7 will examine the relationship between democratization and the economy, but the topic of macroeconomic populism needs some elaboration here. Democratization in developing countries may lead to macroeconomic populism by opening the floodgates for demands upon the government by allowing the previously excluded members of society to represent themselves through various channels. Politicians may respond to this demand with shortsighted expansionary macroeconomic policy to win elections.12 South Korea seemingly resembled this picture when Chun government’s incomes policy was reversed after the democratization. Inflation and current account deficit came back. The Roh

12

Dornbush and Edwards (1990).

Contours of the High Economic Growth 147 Tae-woo government boosted the economy through construction investment. Some observers indeed assert that the South Korean government practiced macroeconomic populism after its democratization. For example, Mo Jongrin and Barry Weingast say that the Roh government’s housing project represented macroeconomic populism, with the implication that it was responsible for the 1997 crisis.13 The South Korean government hardly practiced macroeconomic populism. The Roh government boosted construction investment to cope with the waning of the 1986–1988 boom and the shortage of housing and infrastructure. The housing project surely included subsidized housing for the poor, but the project addressed the general shortage of housing, including housing for the urban middle class. The housing project ended in the early 1990s, making it unlikely to be responsible for the 1997 crisis. True, the size of the government grew after 1987, as shown in Figure 5.3. Government expenditure rose from 18.4 percent of GDP in 1987 to 22.3 percent of GDP in 1997. Yet the government’s size did not increase because of macroeconomic populism. Economic affairs and welfare led the rise of the share of government expenditure in GDP. The expenditure on economic affairs rose from 3.4 percent of GDP in 1987 to 5.3 percent of GDP in 1997; welfare expenditure (defined as health and social protection) rose from 2.5 percent of GDP in 1987 to 4.0 percent of GDP in 1997. The increase in the share of the expenditure on economic affairs represented more or less the recovery from the previous fall under Chun’s fiscal retrenchment in which it had borne the major burden. On the other hand, the share of welfare expenditure in GDP represented a monotonically rising trend that had been in place before. It had crawled up from 0.9 percent in 1970 to 2.2 percent in 1981; it rose even during Chun’s fiscal retrenchment, though with some fluctuations, reaching 2.5 percent in 1987. It then rose to 4.0 percent in 1997.

13

Mo and Weingast (2013: 125–138).

148 The Tortuous Path of South Korean Economic Development The share of welfare expenditure in GDP rose as the government completed the introduction of a formal social insurance system, by adding the national pension in 1988 and unemployment insurance in 1995 to the industrial accident insurance and health insurance already in place. In addition, the government extended the coverage of national health insurance to all South Koreans in 1989 and reinforced the industrial accident insurance (more on this in Chapter 7). However, the rise of the welfare expenditure was not entirely the result of democratization. The Chun government had already included those programs in the Sixth Five-Year Economic and Social Development Plan (From 1982, the five-year plan was named the Economic and Social Development Plan rather than the Economic Development Plan) launched in 1987. After the democratization of the country, the then-officials of the Economic Planning Board, the ministry responsible for the budget, said that they had “made an effective defense against welfare demands by making a preemptive move.”14 The limited nature of democratization, as explained in Chapter 7, was also responsible for the moderate increase of welfare expenditure. Moreover, the country maintained fiscal soundness – contrary to the common practice in macroeconomic populism. The government financed the rising expenditure with rising revenue rather than increasing debt. From 1988 to 1997, the country maintained the fiscal balance at −0.1 percent of GDP on average (See Figure 9.5). One limitation here was the pensions planned in an unsustainable way, but it could not be a cause of the 1997 crisis (explained in Chapter 8). Monetary policy did not represent macroeconomic populism either. The BOK increased money supply not to support fiscal deficit nor to accommodate the cost-push factor coming from the reversal of Chun’s incomes policy; it did so because it could not offset the effect of the increase of the net foreign assets coming from the large current account surplus during the 1986–1988 boom.

14

Kim (1999: 377–378).

Contours of the High Economic Growth 149 If South Korea had implemented macroeconomic populism after the democratization, it would not have sustained the HEG as long as ten years. The country met the crisis in 1997 for other reasons than practicing macroeconomic populism.

5.4  A Crisis-Bound Economy? The South Korean economy continued the HEG until the eve of the 1997 crisis. However, the causes of the crisis were lurking below the HEG. This section examines the macroeconomic background of the  crisis. It first examines a well-known view that South Korea’s HEG was the input-driven growth that eventually hit the wall. It then discusses the problems coming from the aggressive but vulnerable system that had been in place from the 1960s. It finally investigates the capital market opening as a cause of the currency crisis.

Input-Driven Growth? Some economists insisted that East Asia’s economic growth was input-driven, like the former Soviet Union’s, with the implication that it was responsible for the 1997 crisis. If the HEG had been driven by factor inputs rather than productivity growth, it would have been unsustainable because of diminishing returns: As capital accumulated relative to labor, further investment would produce progressively less output per capita. Those economists based their argument on the empirical evidence that the growth rate of total factor productivity, defined as the growth rate of output subtracted by the weighted average of the growth rates of inputs, was very low.15 This explanation is problematic. First, even if the growth rate of total factor productivity were very low, one cannot conclude that the growth was without technological progress. Unlike the former Soviet Union, East Asian countries invested through installing imported foreign equipment. The imported equipment was expensive as it embodied the technological progress in advanced countries, making the

15

Krugman (1994); Young (1995).

150 The Tortuous Path of South Korean Economic Development growth rate of total factor productivity low. East Asian countries thus grew by “purchasing” technological progress from advanced countries. Such a growth was sustainable.16 One may see this by just contrasting the images of the hamlets and rickshaws in South Korea at the time of the Korean War with the skyscrapers in Seoul at the time of the World Cup games in 2002, which had been built no doubt with the latest cranes.17 Moreover, it is hardly plausible that the miracle based on factor inputs would have vanished suddenly in 1997. East Asian economies crashed almost simultaneously, within a matter of months, regardless of the difference in the accumulation of capital in relation to labor across the countries. Last, there is what empirical studies reveal about South Korea. All empirical studies, though with variations across them, show that the growth rate of total factor productivity in the country before 1997 was not only positive but also consistently higher than in advanced countries.18

Non-Performing Loans The aggressive but vulnerable system that had been in place from the 1960s remained a potential cause of crises. One major component of the aggressive but vulnerable system – current account deficit – was no serious problem by the 1990s. On the other hand, the other major component – the firm-finance nexus that produced NPLs – remained troublesome. Firms’ pursuit of long-run growth by borrowing while ignoring short-term profitability accelerated with the industrial policy in the 1970s, which made the 1979 crisis more severe. Debtequity ratio of the manufacturing sector shot up to 487.9 percent in 1980, the highest level ever, and interest coverage ratio fell to 94.6 percent in 1981, the lowest level ever. Many firms, including chaebol firms, were on the verge of bankruptcy. The Chun Doo-hwan government carried out structural adjustment to reduce the NPLs. It initiated three rounds of “investment

16 17 18

Stiglitz (2001: 512). Bhagwati (2004: 200). Han and Shin (2007); Eichengreen et al. (2012: Chapter 2).

Contours of the High Economic Growth 151 coordination,” by providing fiscal subsidies and bank loans to restructured firms, and coordinating merger and acquisition among chaebol. It urged banks to write off debt to firms and offer new long-term lending at bargain interest rates. To compensate for the losses incurred by the banks, the BOK granted them special loans at an interest rate of three percent when the discount on commercial bills was doubledigit (This was one reason why the BOK could not reduce the credit to banks easily in the disinflation process). The restructuring efforts produced results. As shown in Figure 5.2, the debt-equity ratio fell and interest coverage ratio rose. Meanwhile, Chun’s disinflation policy reduced the capital gains on real estate. From 1980 to 1986, the capital gains accruing to privately owned land averaged 34.0 percent of GDP – still a large figure but falling far short of the average of 84.9 percent from 1965 to 1979 (See Appendix 5). The smaller capital gains helped to reduce the NPLs less than before. Yet the structural adjustment was effective overall, so firms were largely coming out of the bankruptcy situation. However, as firms were coming out of the bankruptcy situation, they resumed investing with borrowed money while not caring much about short-term profitability. Debt-equity ratio of the manufacturing sector rose again from 1990 after falling to 254.3 percent in 1989; interest coverage ratio fell again from 1987 after rising to 162.2 percent in 1986. By the mid-1990s, the debt-equity ratio of the manufacturing sector was around 300 percent, averaging 302.1 percent from 1994 to 1996. This was lower than the debt-equity ratio in the late 1970s leading to the 1979 crisis, which averaged 360.7 percent from 1976 to 1978. Yet interest coverage ratio averaged 132.4 percent from 1994 to 1996, while it had averaged 151.4 from 1976 to 1978. Meanwhile, the capital gains in real estate changed to deteriorate the financial situation of firms by the mid-1990s. Another round of the rise in real estate prices from 1987 (which went side by side with the rise of housing prices mentioned above) helped firms to improve their financial soundness. During the five years

152 The Tortuous Path of South Korean Economic Development from 1987 to 1991, the capital gains on the privately owned land amounted to 89.6 percent of GDP on average. Subsequently, however, real estate prices stabilized for the first time since the HEG began, with the capital gains on privately owned land averaging no more than 13.9 percent of GDP from 1994 to 1996 (See Appendix 5). It thus became more probable that the high debt-equity ratio and low interest coverage ratio in the mid-1990s could produce a large amount of NPLs. The NPLs problem in the mid-1990s was worse than before the 1979 crisis. This happened while the country was trying to transform the firm-finance nexus. The Park Chung Hee government nationalized banks and put them under its strict control, rationing credit to priority activities. The Chun Doo-hwan government embarked on the privatization of banks and the liberalization of interest rates. Liberalization of interest rates was initially part of the stabilization policy, but soon became part of the broader liberalization drive of the economy. The liberalization drive was inevitable because, as the size of the economy grew, government intervention had to give way to the more decentralized decision-making through the market (though the government continued intervening in a different way to cope with the still-present market failure; more on this in Chapter 6). Financial liberalization was a main component of the liberalization drive because financial policy had been the most important policy instrument previously. The government privatized banks and liberalized interest rates so that banks would stop rationing credit and allocate it through the interaction of the supply of and demand for investable funds. With privatization and liberalization, banks were expected to pay more attention to efficient portfolio management. Banks would lend to firms after evaluating their ability to pay the loans back more rigorously. If firms were unable to pay them back, banks would force them to exit. If banks had too many NPLs, they themselves would have to be forced to exit. The government would not direct banks to allocate credit but “supervise” them so that they stay sound

Contours of the High Economic Growth 153 financially.19 Building such a governance structure is difficult even in advanced countries, as evidenced by the sporadic eruption of financial crises. South Korea could not build such a structure overnight. Though the Chun government privatized banks, individual owners could own at most eight percent of banks, so the government still exerted a strong influence over the management of banks. For the banks, government control implicitly guaranteed their survival regardless of their business performance. Banks thus failed to develop the ability to impose a discipline on the firms not to produce NPLs. The country also failed to develop an effective financial supervision system. The BOK supervised banks while the Ministry of Finance (Ministry of Finance and Economy from 1994) supervised non-​ banking financial institutions (NBFIs; NBFIs outweighed banks in lending by the mid-1990s, as will be explained in Chapter 6). This division made cross monitoring difficult, but the turf war between the BOK and the Ministry of Finance made consolidating the supervision system impossible. However, the immediate obstacle was the existence of a large amount of NPLs itself. To be able to impose proper discipline on firms, banks would have to write off the NPLs first, but they were unable to absorb the cost of writing off the NPLs with their weak financial position. It was up to the government to resolve the NPLs problem, but the government was unwilling to address the problem in earnest. The Chun government’s structural adjustment fell short of liquidating the NPLs. It did not liquidate the NPLs because doing so was not an immediately binding constraint on growth. Once some degree of restructuring was completed, the HEG resumed; the further structural adjustment might stall the HEG. Democratization made the NPLs problem more difficult to address. While Chun had no sense of limited tenure, democratically elected presidents had a single five-year term. They naturally had a shorter time horizon for economic policy. The emergence of independent unions after the

19

See Lee (2001) for a more detailed explanation.

154 The Tortuous Path of South Korean Economic Development democratization also aggravated the NPLs problem (explained in Chapter 7). The NPLs had a clear potential to precipitate a crisis if things went badly.

Capital Market Opening By the 1990s, current account deficit was no serious problem in terms of size. However, it was becoming a serious source of vulnerability as it was financed by short-term capital inflow. Capital inflow and outflow had been under strict government control previously, with the government inducing foreign capital to make up for the chronic current account deficit. In the wake of the 1986–1988 boom, the government completed the liberalization of current account and embarked on the liberalization of financial account. To prepare for the forthcoming liberalization of financial account, the government changed the exchange rate system from the multiple basket peg system to the “market average exchange rate” system in March 1990. Under  the new system, the exchange rate was to be determined by demand for and supply of the South Korean won vis-à-vis foreign currencies, and the government could affect the exchange rate only indirectly through the market. In January 1992, the stock market was opened to foreigners, who could now invest in listed firms up to a certain limit. The major obstacle to the capital market opening was the large discrepancy between domestic and foreign interest rates. The discrepancy was especially visible because the neighboring Japan had close to zero interest rates while South Korea had double-digit interest rates. Given the interest rate differential, there was incessant demand for borrowing from overseas; now, the private sector could borrow from overseas without the (explicit) government guarantee. The incentive to borrow from overseas became all the stronger because, by the mid-1990s, the liberalization drive had phased out most subsides and protection, leaving foreign borrowing as by far the largest source of rent (more on this in Chapter 6). On the part of the government, the major concern was that capital inflow would deteriorate current account by lowering exchange rate. If the capital inflow

Contours of the High Economic Growth 155 were composed of short-term capital inflow, the reversal could precipitate a currency crisis. Capital market opening became a more complicated problem as the Kim Young-sam government decided to join the OECD. The decision was made on a political ground rather than through the deliberation of economic conditions, as Kim had promised joining the OECD in the presidential election campaign in 1992. South Korea became the twenty-ninth member of the OECD in December 1996. To join the OECD, the country had to open the capital market to its member countries. In the negotiation for the membership, South Korea managed to get some reservations so that it could open capital market gradually, following a positive list approach. Thus, joining the OECD was not a direct cause of the 1997 crisis; however, the possibility of a currency crisis would not be the same as when the country did not join it. Meanwhile, the Ministry of Finance opened a backdoor for capital inflow from 1993. Even before fully liberalizing FDI, the government allowed banks to borrow in the short-term from foreign banks through trade-related and inter-bank financing. That led to the massive borrowing by South Korean banks from foreign banks, particularly the Japanese banks. The official account of prioritizing short-term borrowing by banks was that the government kept guard against the risk of opening capital market: Because banks were under its control, the government could quickly withdraw the privilege given to banks at any sign of trouble. The government also thought that by giving priority to banks, it could help them improve their international competitiveness.20 It is questionable whether the government prioritized shortterm borrowing by banks solely for policy reasons. Foreign borrowing was led by merchant banks, which had been formerly investment and finance companies. In 1994–1996, the government allowed 24 investment and finance companies to transform themselves into merchant

20

The Committee for Editing the Sixty Years of the Korean Economy (2010a: 50).

156 The Tortuous Path of South Korean Economic Development banks with the license to do business overseas. Many of them were chaebol affiliates, so the transformation may have been the result of chaebol lobbies. As merchant banks increased borrowing from overseas, commercial banks demanded leveling the playing field, so the government allowed them to increase the weight of short-term liabilities, which facilitated their short-term borrowing from abroad.21 On the part of the Ministry of Finance officials, by allowing the inflow of short-term capital, they could exercise their right to license overseas borrowing more frequently. Contrary to the initial expectation by the government, once banks began to borrow in the short-term, it was difficult to stop, as it became fait accompli. The government found it impossible to allow long-term capital inflow because it would further lower the exchange rate. The short-term borrowing by banks backed the expansionary macroeconomic policy of the Kim Young-sam government. Much of the money banks borrowed from overseas eventually landed in the hands of chaebol, which put it into long-term investment. They thus came to rely on short-term foreign borrowing to finance long-term domestic investment. Though the size of current account deficit was moderate, the country financed it in a perilous way. By 1996, the government recognized the widening current account deficit as a problem. However, it failed to identify its causes. Rather than finding them in the falling exchange rate brought about by the capital inflow, it pointed to the export structure. Rha Woongbae, the then-Minister of Finance and Economy (the Deputy Prime Minister of Economic Affairs), thought that the current account deficit was coming from the export structure heavily skewed to dynamic random-access memory (DRAM) chips, which had become South Korea’s major export item by the mid-1990s.22 Indeed, the current account deficit widened in 1996 because DRAM chip producers were encountering the depreciation of the Japanese yen (The Japanese



21 22

Cho (2003: 89–90). Chosun Ilbo, May 26, 1996.

Contours of the High Economic Growth 157 producers were the main competitors of the South Korean DRAM chip manufacturers) as well as the drastic fall of the DRAM prices in the world market. However, Rha overlooked the fact that, in 1995, South Korean DRAM chip producers had a bonanza due to the appreciation of the Japanese yen and the high DRAM price in the world market, but the country had recorded current account deficit equivalent to 1.8 percent of GDP. To make matters worse, the government had to meet the obligation of the OECD membership. To meet the OECD membership requirement, the government raised the limit on the foreign ownership of stocks in 1996, putting further downward pressure on the exchange rate as foreigners bought South Korean stocks. However, the more important problem of the OECD membership was its effect on the atmosphere among government officials. Though the country negotiated a gradual opening of the capital market, joining the OECD made the opening of the capital market an established policy direction, so few government officials, including the Ministry of Finance and Economy officials in charge of the capital control, thought about checking the dangers in the banks’ overseas borrowing in the short term. The government officials yet felt that it had to do something about the falling exchange rate. Instead of controlling capital inflow, however, it encouraged capital outflow. As a result, banks borrowed from overseas markets and lent there directly. A large part of the money went to Southeast Asia and became NPLs as those countries were heading to a crisis. With the swelling short-term foreign debt, the country was becoming ever more vulnerable to a currency crisis, but the government officials did not know it.

Industrial Policy and Chaebol

6

This chapter deals with the structural transformation of the economy after the HEG began – the second condition for sustaining growth – until the 1997 crisis. The chapter will focus on industrial policy and chaebol, both of which played key roles in the structural transformation during this period. It will first discuss the roles of the industrial policy and chaebol in the 1960s and 1970s, and then examine how they changed in the 1980s and 1990s.

6.1  Structural Transformation and Industrial Policy The HEG began with an increase of production across-the-board in industrial sectors, so the growth rate rose for virtually all sectors, including agriculture, manufacturing, construction, and services.1 However, growth rate varied much across the industries, which meant that the HEG was accompanied by a rapid structural transformation. Growth naturally occurs side by side with structural transformation as labor moves from low-productivity to high-productivity sectors. In a country like South Korea, the shift of labor from the primary industries like agriculture, the reservoir of low-productivity workers, to the more dynamic industries like manufacturing mainly accounted for the structural transformation. The structural transformation was especially pronounced  for South Korea as the role of agriculture in economic development differed from the stylized pattern observed in most countries. Agriculture usually plays an active role in economic development by providing capital (saving) for the non-agricultural sector, serving

158

1

One exception was mining, whose growth rate fell as the HEG began.

Industrial Policy and Chaebol 159 as a market for  the manufacturing sector, and providing foreign exchange through exports.2 In South Korea, such a role of agriculture was broadly missing. Rural saving was minimal, and manufacturing sector mainly found its market overseas under the export-oriented industrialization.3 Urban consumption was far more important than rural consumption for domestic demand, and the investment in urban area was creating demand as well as supply capacity. Agricultural products like raw silk were an export item in the 1950s and early 1960s, but its weight in earning foreign exchange was minimal.4 The most salient role of agriculture was the passive one of releasing labor to the non-agricultural sectors through the rural-urban migration of population. All this meant that South Korea’s HEG was accompanied by a more rapid structural transformation from agriculture to manufacturing and services than in the stylized pattern. South Korea made efforts to increase agricultural production in the 1960s as the US aid for food grains was winding down. In the 1970s, the government raised the incentives for agriculture to increase production and reduce the income gap between rural and urban households (more on this in Chapter 7). However, the growth rate of agriculture rose far less than that of other sectors with the beginning of the HEG; it was also far lower than the growth rate of other sectors after the HEG began. The growth rate of agriculture-​ forestry-fishery averaged 3.4 percent from 1954 to 1962 and 4.7 percent from 1963 to 1979, while the growth rate of manufacturing averaged 11.5 percent from 1954 to 1962 and 18.3 percent from 1963 to 1979. The growth rate of the tertiary sector averaged 5.3 percent from 1954 to 1962 and 10.7 percent from 1963 to 1979. The HEG indeed proceeded with rapid structural transformation across the sectors. However, it was accompanied by the structural change within the secondary and tertiary sectors as well. The structural

2



3 4

Perkins et al. (2012: Chapter 6). See also Bairoch (1973) and Ohkawa and Rosovsky (1973: 13–15) for the earlier experience of advanced countries. Ban et al. (1982: Chapter 2). See Hong (1976: 142).

160 The Tortuous Path of South Korean Economic Development transformation within the secondary – that is, manufacturing – sector was most important.

Industrial Policy to Sustain Growth The structural transformation within manufacturing was most important because manufacturing was South Korea’s main export industry. It was most necessary for sustaining growth. The country began the HEG mainly exporting labor-intensive low-cost manufacturing products such as garments, wigs, plywood, toys, and low-cost textiles, using technologies imported from abroad. Over the years, wages rose, making the labor-intensive exports less competitive in the world market. The country had to move up the value chain to avoid finding itself stuck in the middle, between the advanced and latecomer countries (The structural transformation within the tertiary sector, which can best be represented by the rising share of “modern” service industries at the expense of “traditional” service industries, would become a major source of growth later, as will be discussed in Chapter 10). South Korea implemented an industrial policy to move up the value chain in manufacturing. Was it necessary? Structural transformation in manufacturing may be achieved without government intervention. In market economies, firms make investment decisions taking the future trend of the economy, including rising wages, into account. The room for industrial policy thus lies in market failures such as capital market imperfections, labor market externality, and coordination failure, as discussed in Chapter 3. In addition, “strategic trade” may provide a ground for industrial policy. The world market is rarely competitive for the higher-technology industries. Government intervention, if well implemented, may shift rents across countries when the world market is organized as an oligopoly.5 Industrial policy is composed of “vertical” and “horizontal” policies. Vertical policy consists of protecting and subsidizing

5

Brander and Spencer (1985).

Industrial Policy and Chaebol 161 particular industries, while horizontal policy supports industries across-the-board by keeping currency undervalued, building infrastructure, providing education, promoting R&D, and so on. However, the line between the two is blurry because, in reality, horizontal policy is rarely neutral across industries. Any stance on exchange rates may affect industries differently. Infrastructure development at any given place and time may be associated with the development of particular industries. The same is true for promoting education, training, and R&D.6 It is thus a matter of degree that distinguishes the two policies. South Korea implemented both vertical and horizontal industrial policies. The country laid much emphasis on vertical policy in the 1960s and 1970s but shifted the weight to horizontal policy in the 1980s. This section discusses the industrial policy of the 1960s and 1970s, deferring the discussion of the industrial policy from the 1980s on to Section 3. South Korea’s import-substituting industrialization policy in the 1950s had some industrial policy elements, as mentioned in Chapter 3. In the 1960s and 1970s, the country implemented a strong industrial policy. It emulated Japan’s industrial policy, but implemented its policy more decidedly. The Japanese industrial policy, beginning with the publication of Chalmers Johnson’s book on the role of the MITI (Ministry of International Trade and Industry), drew worldwide attention.7 However, contrary to the stated objectives, the Japanese government in reality tended to protect and subsidize mature industries rather than infant industries.8 South Korea, in contrast, clearly promoted infant industries. The First Five-Year Economic Development Plan (1962–1966) announced by Park’s junta emphasized the import substitution of industries such as cement, fertilizer, petroleum refining, chemicals, and synthetic textiles, which were relatively higher-technology

6 7 8

Stiglitz et al. (2013). Johnson (1982). Beeson and Weinstein (1996).

162 The Tortuous Path of South Korean Economic Development industries at that time. The policy helped to kick off the HEG through an across-the-board increase of production. Industrial policy continued in the Second Five-Year Economic Development Plan (1967–1971). The government promoted seven industries – machinery, shipbuilding, textiles, electronics, petrochemicals, iron and steel, and nonferrous metal – by promulgating promotional laws for each of them. Then, in 1973, the government launched the “Heavy and Chemical Industry Drive” (henceforth HCI drive) a comprehensive plan to promote six industries: iron and steel, nonferrous metal, machinery, electronics, shipbuilding, and chemicals. After pushing the HCI drive hard for six years, the government began to scale it down in April 1979, as part of the stabilization policy. The government targeted higher-technology industries, whether they were producer goods industries or consumer goods indus­­­tries. Yet the emphasis was laid on producer goods industries as they tended to be more technology intensive. Producer goods industries also got priority as the government promoted the domestic production of components, parts, and materials. The HCI drive targeted many producer goods industries, but they themselves needed the imports of components, parts, and materials, so the government pursued the domestic production of those products. The main background here was the evolution of the trilateral relationship that had taken shape with the normalization of the diplomatic relationship with Japan in 1965. South Korea imported machinery, components, parts, and materials from Japan and exported most of the processed goods to the United States and Europe. As a result, the country incurred a large trade deficit with Japan, which accounted for a high share of the current account deficit. Industrial policy usually began with the efforts to substitute imports with domestic production, though it promoted some industries as export industries from the beginning, with shipbuilding as an example. Overall, however, the industrial policy was part of the export-oriented industrialization, at least from the Second Five-Year Economic Development Plan. It had a clear objective of building the

Industrial Policy and Chaebol 163 targeted industries (TIs) into future export industries rather than the industries just catering to domestic demand. The government ensured that firms would realize economies of scale and increase productivity in order to become competitive in the world market eventually, and the firms understood this well. The producers of components, parts, and materials supplied to the producers of final products were only indirectly linked to the export-oriented industrialization, but they were under the broader policy line to make the final products competitive in the world market; this meant that they themselves had to become internationally competitive. Some producers of components, parts, and materials aimed at becoming exporters by themselves. South Korea implemented industrial policy while exporting to the rest of the world, mainly to advanced countries. Industrial policy thus needed an asymmetric trade relationship whereby the country could export freely while protecting and subsidizing domestic industries. In the 1960s and 1970s, advanced countries allowed such asymmetric relationships under the GATT system, which had the built-in infant industry clause.9 It was an exception in history: Advanced countries had never allowed such a relationship with developing countries before the Second World War, and it would be discontinued from the mid-1980s (discussed later).

The Policy Portfolios The government laid much emphasis on the vertical policy of protecting and subsidizing particular industries. The government also employed horizontal policy, but its line with the vertical policy was indeed blurry. The first vertical policy was protection, the oldest means of industrial policy. As the first step to promote an industry was usually import substitution, protecting the TIs from overseas competition was natural. Of course, the protection had the dualistic system explained in Chapter 4. The government protected only the

9

Hudec (1987: Chapters 1–4).

164 The Tortuous Path of South Korean Economic Development production catering to domestic demand because it could not protect the producer goods industries catering to export goods. Second, the government used fiscal and financial policies to subsidize the TIs. Fiscal policy mainly took the form of tax deductions and exemptions (Cash subsidies were rarely used). More important than fiscal policy was financial policy. The government directed banks to prioritize lending to TIs to subsidize them. The policy was strengthened with the presidential emergency decree in August 1972, which reversed the high interest rate policy implemented from 1965, providing more rent to the firms getting access to bank loans. The rent increased as the rise of the inflation rate with the First Oil Shock plunged the real interest rates on all bank loans to large negative figures in 1974 and 1975. The government also employed Korea Development Bank loans to promote the TIs. In addition, the government introduced policy loans earmarked to promoting TIs, such as the Loans for Machine Industry Promotion and the Loans with National Investment Fund, which carried interest rates artificially set low, as shown in Table 4.2. The government also allocated foreign capital preferentially to the TIs. The first horizontal policy was education. The government designed the education plans to supply the human resources needed for industrial development, tightening the control over the schools and universities. To cater to the industrial policy, it drastically increased the total enrollments in various levels of engineering and technical schools and expanded their facilities. Second, the government established government research institutes whose mission was to import advanced foreign technologies, modify them to suit local needs, and disseminate the results to firms. Last, the government constructed industrial complexes to accommodate the plants of the TIs. In addition to the Ulsan Complex already launched, the government built the Changweon Machinery Complex, the Yeocheon Petrochemical Complex, the Gumi Electronics Complex, and so forth.10 Those

10

See Kim and Kim (1997: 21–22).

Industrial Policy and Chaebol 165 horizontal policies had blurred lines with the vertical policy because they were geared to meeting the requirements of particular TIs. Among those measures of industrial policy, protection and subsidies – that is, vertical policies – are quantifiable. Table 6.1 gives the figures representing the protection and subsidies, classifying the manufacturing sector into the TIs and the untargeted industries (UIs). TIs include basic metals, fabricated metal products, electrical equipment, machinery, and transportation equipment, which roughly correspond to the industries the Second Five-Year Economic Development Plan and the HCI drive promoted. Untargeted industries are those they did not promote: food and beverages, textile and leather, wood and paper products, printing and publishing, non-metallic minerals, and other manufacturing. As the measures of protection and subsidies, Table 6.1 presents the effective rate of protection (ERP), effective corporate tax rate, and average cost of borrowing. The data for the ERP are available from 1963, though only for the years that the Input-Output tables were compiled. The reliable data for the effective corporate tax rate and average cost of borrowing are available from 1970. ERP rather than nominal rate of protection is used considering that South Korean industries imported a large amount of intermediate inputs (This was the reason why the ERP was calculated for the years that the Input-Output tables were compiled). The ERP is calculated by comparing domestic market price and world market price rather than using nominal tariff rate because there were so many quantitative restrictions. Fiscal incentives are represented by the effective corporate tax rate – the tax rate after taking tax deductions and exemptions into account. There are no satisfactory data that summarize the amount of financial subsidies given for industrial policy purpose. Yet the average cost of borrowing can be a proxy because TIs were prioritized in credit rationing and received policy loans with lower interest rates. What matters for the effect of the vertical industrial policy is the difference in those policy measures rather than their absolute levels. In 1963, UIs were receiving higher ERP than TIs, reflecting

266.8

8.7

−15.1

−5.7 10.7

158.7

25.5

6.8

37.4

44.2

1963 1964 1965 1966 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980

UIs (B)

TIs (A)

Year

33.5

43.1

21.9

16.8

−108.1

A – B

Effective rate of protection

39.2 34.9 27.7 33.5 29.9 15.9 18.0 17.5 16.9 18.3 18.3

TIs (C)

39.4 34.7 29.8 38.6 37.7 52.1 51.0 49.5 48.4 48.5 48.8

UIs (D)

−0.2 0.2 −2.1 −5.1 −7.8 −36.2 −33.0 −32.0 −31.5 −30.2 −30.5

C – D

Effective corporate tax rate

17.7 12.9 10.5 8.7 10.4 10.2 10.1 11.5 10.1 12.5 17.6

TIs (E)

15.5 14.4 13.3 10.9 10.6 12.2 13.7 14.3 15.9 16.6 20.1

UIs (F)

2.2 −1.5 −2.8 −2.3 −0.2 −1.9 −3.6 −2.8 −5.8 −4.1 −2.5

E – F

Average cost of borrowing

Table 6.1  Protection and subsidies for targeted and untargeted manufacturing industries, 1963–1995 (percent)

8.7 −2.5

−13.5 −5.8

−0.9 −1.3

26.2

15.2

9.9

12.9

6.6

3.9

5.2

7.5

18.7

23.4

17.7

17.5

20.6 47.1 40.4

51.1 48.2 42.2

−30.5 −1.1 −1.8

17.5 15.3 12.9 14.4 12.7 12.0 12.1 12.7 13.5 12.5 12.7 11.9 10.9 11.1 11.3

19.6 16.9 14.6 14.5 14.8 13.5 13.4 13.6 13.8 13.1 13.5 13.2 12.0 12.3 12.8

−2.2 −1.6 −1.7 −0.1 −2.0 −1.6 −1.3 −0.9 −0.2 −0.5 −0.8 −1.4 −1.2 −1.2 −1.5

Sources: Effective rate of protection is calculated from Kim and Hong (1982) and Hong (1997). Effective corporate tax rate is from Kwack (1985). Average cost of borrowing is from the Bank of Korea, Financial Statements Analysis, various issues

1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995

168 The Tortuous Path of South Korean Economic Development the legacy of the import-substituting industrialization of the 1950s, which mainly promoted the development of lower-technology industries that would later comprise the UIs.11 However, the government changed the structure of protection in favor of TIs in the late 1960s, though, when TIs were producer goods industries, the government raised the ERP only for the inputs to the production catering to domestic demand because it allowed the inputs to the production for exports to be freely imported. By 1970, the TIs were receiving higher ERP than the UIs. The difference in ERP between the two industries widened subsequently, peaking at 43.1 percentage points in 1978, and narrowed thereafter. The difference in the effective corporate tax rate widened from 1972. It jumped to a peak of 36.2 percentage points in 1975 and stayed at more than 30 percentage points until 1981, before falling drastically to 1.1 percentage points in 1982. The difference in the average cost of borrowing shows a less drastic but similar trend. It rose from 1971, to reach a peak of 5.8 percentage points in 1978, and then fell gradually from 1979. Table 6.1 roughly shows that South Korea implemented vertical industrial policy, making all-out efforts during the HCI drive from 1973 to 1978, and then phased the policy out.

Performance of the Industrial Policy South Korea’s industrial policy performed better than most developing countries’. It performed better, first, because it was part of the export-oriented industrialization. It had a clear objective of building the TIs into future export industries. Firms thus invested while taking economies of scale and productivity growth into account from the beginning. The overall growth of exports also helped by providing the foreign exchange needed to support production and investment in the TIs. The country thereby managed to avoid the “stop-go” pattern of economic growth observed in the import-substituting industrialization pursued by the majority of developing countries. TIs also



11

Though the import-substituting industrialization of the 1950s had some industrial policy element, its overall weight lay in the lower-technology industries.

Industrial Policy and Chaebol 169 improved productivity through their own exports. They exported their products at the infant stage owing to the export subsidies and the ability to practice price discrimination, the latter coming from their market power in the protected domestic market. Such exports provided a ground for intensive learning.12 Second, South Korea’s industrial policy performed better because of the competition among the few in the protected domestic market. Though the government restricted entry into the TIs and imposed many regulations, it rarely allowed monopolies in those industries. A few oligopolistic firms effectively competed with one another in the domestic market by introducing new products, improving the quality of existing products, and enhancing marketing efforts such as advertising. Such competition helped to increase the productivity of the protected industries, which would make them competitive in the world market eventually. This kind of mechanism had worked in Japan earlier, and Korea was following suit, though to a lesser extent than Japan because of the smaller size of its domestic market (It seems that China is currently doing it in a far larger scale due to the massive size of its domestic market).13 Last, but most importantly, there was the state capacity. Many observers of industrial policy in East Asia have concluded that industrial policy works only for countries with strong state capacity.14 Park added his personal commitment to the strong state capacity, devoting 30 percent to 40 percent of his time to HCI drive from 1973.15 This probably accounts for why South Korea typically targeted infant industries while even Japan failed to do so. The strong state capacity enabled the government to link its favors to the performance of firms. However, South Korea’s industrial policy had its own problems. It was excessive, with the cost outweighing the benefit.

12 13 14 15

Westphal (1990). See Amsden and Singh (1994) for the Japanese and Korean cases. See, for example, Levy and Fukuyama (2010). Stern et al. (1995: 17).

170 The Tortuous Path of South Korean Economic Development This was mainly because the premature attempt to promote the TIs slowed their productivity growth while getting their output to grow rapidly, creating a large cost for consumers and taxpayers. When an economy enters new industries, their productivity growth depends on the economy’s accumulated learning experience. Thus, an attempt to move up the technology ladder at a pace beyond its level of industrial maturity slows productivity growth in the new industries.16 South Korea in the 1970s apparently faced such a situation. Critical here was the technological capability of firms. South Korean firms built technological capability initially through simple learning by doing, reverse engineering, and licensing of outdated technology from overseas (especially from Japan). By the time the government promoted the TIs intensively, firms had not built up their technological capability enough for the mass production in those industries. Firms were particularly ill-equipped in R&D capability. The manpower policy concentrated on training technicians rather than R&D personnel. There were surely efforts, led by government research institutes, to modify imported technologies to fit local situations, but they were not sufficient. As late as 1979, the total amount of R&D spending was no more than 0.54 percent of GDP (See Figure 6.1). The hasty promotion of the TIs on a gigantic scale without the appropriate technological capability slowed their productivity growth and raised their unit cost drastically in relation to UIs. This combined with the rapidly growing output of the TIs to inflict a dear cost to consumers and taxpayers. The cost was too great to recover later because, when the TIs finally gained international competitiveness, their growth would slow down and the margin of benefit would be far smaller than the initial difference in the unit costs.17 This calculation does not include the cost incurred by producing NPLs mentioned in Chapter 5 (more on this later).

16 17

Young (1993). See Lee (2011) for the cost-benefit analysis. See also Noland and Pack (2003) for the evaluation of the vertical industrial policy.

Industrial Policy and Chaebol 171

6.2  The Role of Chaebol Together with the industrial policy implemented by the government, chaebol played an important role in the structural transformation of the economy. Chaebol’s role interacted with industrial policy, and industrial policy was thereby closely associated with the emergence of chaebol in full-fledged form. In developing countries, different kinds of big businesses can lead industrial development and structural transformation. They could be foreign multinational corporations, state enterprises, or domestic private enterprises like chaebol. Foreign multinational corporations played a minor role in South Korea. The Park government briefly flirted with the idea of actively inducing FDI in the late 1960s but gave up the idea quickly. State enterprises played a far more important role than foreign multinational corporations. The Park government, while continuing the privatization of the state enterprises which had begun in the 1950s, established new state enterprises. State enterprises particularly covered the industries characterized by a high degree of linkages and scale economies.18 However, the most important agents for investment were chaebol. Immediately after the coup in 1961, Park’s junta arrested major chaebol leaders on charges of corruption during the Rhee Syngman era, but quickly released them on the condition that they would cooperate with the economic development efforts. The junta recognized that it had no alternative to cooperating with chaebol, though it seized all outstanding shares of commercial bank stocks. Chaebol assumed the leading role in investing in the TIs. Chaebol could cope with market failure better than ordinary firms owing to their generic capability and internal capital market, as discussed in Chapter 3. Chaebol wanted to diversify into higher-​ technology industries, utilizing such competitive advantages. Chaebol



18

Jones and Sakong (1980: 148–155).

172 The Tortuous Path of South Korean Economic Development of course could not cope with all sources of market failure, leaving room for government role. In fact, the structural transformation of the economy occurred as chaebol’s actions interacted with the government’s industrial policy. Chaebol also interacted with the government policy to promote the domestic production of components, parts, and materials, by developing a subcontracting relationship with SMEs.

Chaebol and the Structural Transformation The entry into TIs was determined by the interaction between the government and chaebol leaders. For example, Samsung chaebol’s entry into the electronics industry in 1969 was initiated by its founder, Lee Byung-chul. He had been doing business in woolen textiles and sugar refinery, but now he wanted to diversify into the electronics industry, one of the TIs. Samsung entered the industry in spite of the objection by many government officials and the public opinion. Lee overcame the opposition through his lobbying ability; he also promised that the newly founded company would export all its products (He immediately reneged on the promise after the production began).19 In most cases, however, the government selected the chaebol to enter a particular industry. A salient example was Hyundai’s entry into shipbuilding. Park Chung Hee urged Chung Ju-yung, the founder of Hyundai chaebol, whose main business was construction, to enter the industry. When Park heard the news that no international finance could be found for the Hyundai shipyard, and the project would have to be abandoned, his response was a thinly veiled threat: “If you only want to do what’s easy, then you’ll get no more help from us.”20 Later, as it launched the full HCI drive in 1973, the government called on all major chaebol to take part in the drive. Chaebol diversified mainly by founding new firms. Chaebol then utilized internal capital markets to support them. Much of the



19 20

Kim (1998: 122–123). Jones and Sakong (1980: 119–120).

Industrial Policy and Chaebol 173 equity capital came from existing member firms. In turn, the newly founded firms assumed equity ownership of other member firms, expanding the equity capital of the chaebol group through interlocking ownership.21 The existing member firms could also support the newly founded firms through lending and borrowing. The NBFIs played a particularly important role in this regard. The Park government had nationalized banks but allowed chaebol to own insurance companies, security companies, investment and finance companies, and so on. The majority of these companies were created in the 1970s mainly to siphon off the curb market funds into the organized market. They not only provided flexible day-to-day cash flow to existing member firms but also supported the new member firms. Existing member firms could also support the new member firms outright through “related transaction,” often selling cheap and buying dear (In fact, the distinction between internal capital market and related transaction was blurred because the support through the internal capital market was a kind of related transaction, broadly defined). The new chaebol firms also had advantages in obtaining funds in external capital markets. Banks regarded them as attractive borrowers because of the availability of debt repayment guarantee from other group members that were financially stronger. Chaebol combined the equity capital created through interlocking ownership with the bank loans acquired through the repayment guarantee of member firms. New chaebol firms could thereby mobilize a large amount of investment funds to realize economies of scale, which was important in the TIs. Chaebol also utilized internal labor markets by dispatching employees of existing member firms to new member firms. Chaebol acquired talented manpower by recruiting high-quality personnel and training them; some of their employees enjoyed not only higher wages and salaries but also expected to work in the same chaebol group for their life. They were high-quality personnel, well-trained

21

Kim et al (2004).

174 The Tortuous Path of South Korean Economic Development in running businesses, representing the generic capability of chaebol. When dispatched to new member firms, they could manage them effectively and efficiently. Chaebol thereby emerged in full-fledged form by the end of the 1970s. This of course increased the influence of chaebol in the economy. Available evidence shows that chaebol’s shares in the economy rose drastically through the HCI drive. According to Sakong Il, the value added accounted for by the top five chaebol rose from 3.6 percent of GDP in 1973 to 8.1 percent of GDP in 1978; the share of the top ten chaebol rose from 5.1 percent of GDP to 10.9 percent of GDP. In 1978, the 46 largest chaebol accounted for 17.1 percent of GDP and 43.0 percent of manufacturing value added (See Appendix 4).

Chaebol, Small and Medium-Sized Enterprises, and Subcontracting While chaebol were forging ahead in tandem with the industrial policy, SMEs were in plight as they had no way to compete with chaebol firms. Large single firms could squeeze SMEs through various means, but chaebol had the additional weapons of internal markets and related transactions. The government recognized this problem and began to promote SMEs systematically, enacting the Framework Act on Small and Medium-Sized Enterprises in 1966. The country thus came to have an odd policy regime that extended favors to chaebol while promoting SMEs at the same time. It could not yet level the playing field between chaebol firms and SMEs. Under this situation, SMEs survived by finding niches in the products that chaebol were not interested in, mostly lower-technology and less capital-intensive ones. They also found an outlet in exports. The government helped SMEs to export by various means, including assistance by the Korea Trade Promotion Agency (KOTRA) established in 1962. However, the most meaningful new business opportunity for SMEs was the subcontracting relationship with large enterprises, mostly chaebol firms, supplying them with various inputs on a repeat sale basis. Chaebol developed subcontracting relationships with

Industrial Policy and Chaebol 175 SMEs, both existing and newly founded. It represented advancement from the 1950s when chaebol mostly had to establish their own affiliates to resolve the coordination failure of the market, as mentioned in Chapter 3. Chaebol firms now tried to organize the upstream of the value chains into a subcontracting system. Subcontracting, based on repeat purchase and sale, was the transaction method lying between the open market and vertical integration. On the part of the chaebol firms, it reduced the rigidity of vertical integration that could involve bureaucratic over-stretching, while, at the same time, helped to overcome the information failure ubiquitous in the open market. On the part of SMEs, subcontracting provided a stable marketing outlet, and sometimes technological and financial assistance. In the postwar period, Japanese firms notably developed a subcontracting system, and South Korean firms were emulating them.22 The government promoted subcontracting as new business opportunities for SMEs. It tried to combine the subcontracting relationship with the efforts to substitute the imports of components, parts, and materials by domestic production. Subcontracting SMEs could thus enjoy the benefit of the government policies to promote the import substitution of those products. The government helped chaebol firms and SMEs to overcome the coordination failure by locating them together in the same industrial complexes. The government also tried to coordinate the disputes in the subcontracting relationship. Subcontracting increased the influence of chaebol in the economy further. Chaebol were in control of a higher share of the economy than the official figures suggested by commanding the alliance with SMEs through subcontracting.

Chaebol and the Financial Market By the end of the 1970s, chaebol came to dominate the South Korean economy. While helping to sustain the HEG through structural transformation, the chaebol domination had many downsides. An obvious

22

See Kimura (2001) for the case of Japan.

176 The Tortuous Path of South Korean Economic Development one was the plight of independent SMEs in individual markets. Yet just as important was the overall concentration of economic power. The government recognized the problem as early as 1974 and introduced a basket control of credit on chaebol. However, the basket control was inconsistent with the contemporary industrial policy and was soon neglected. The concentration of economic power proceeded as the cronyism between the authoritarian government and chaebol deepened. They were essentially unchecked by the rest of the society. Meanwhile, between themselves, the government had the upper hand as it had many leverages over chaebol. The government regulated almost all activities of chaebol, including entry, investment, pricing, and financing. The government could wield various carrots and sticks over chaebol. Carrots were of course various favors the government allocated, credit being the most important of them. The government could wield big sticks by, first of all, cutting off the credit; it could also utilize, among others, tax monitoring as a big stick because virtually all chaebol evaded taxes. Under the authoritarian regime, chaebol could not influence politics much through providing campaign funds in the elections. At the same time, however, both the government and chaebol knew that chaebol as a group could sabotage the government policy if they were pushed too far. Chaebol also had a serious corporate governance problem. Chaebol were composed of legally independent firms, with chaebol families controlling far more assets than their ownership share through the interlocking ownership. Such a situation expanded as chaebol came to raise more money from the stock market as they grew in size, which the government also encouraged. Thus, the related transactions included not only the well-intended ones to subsidize the newly founded member firms in the TIs, but also the ill-intended ones to benefit the chaebol families at the expense of minority shareholders. Member firms with a higher ownership share of a chaebol family could sell dear to and buy cheap from the other member firms with a lower ownership share of the family.

Industrial Policy and Chaebol 177 As such, these downsides of chaebol would not immediately threaten the sustaining of the HEG. However, in the financial market, chaebol generated problems that could immediately threaten the HEG itself. Chaebol were at the core of the aggressive but vulnerable system discussed in Chapter 5. Chaebol firms led the aggressive investment with borrowed money, ignoring short-term profitability, but that meant they could become more unsound financially. They were larger in size and could expect that the government would come to their help if they were in trouble, considering the large shock their bankruptcy would deal to the economy – a phenomenon called “too big to fail.” Too big to fail is not a sure phenomenon because chaebol went bankrupt frequently; South Korean business history is fraught with the bankruptcy of major chaebol.23 Frequent chaebol bankruptcy is not surprising because, even though bankrupting chaebol firms is more difficult than bankrupting ordinary firms, some chaebol could go too far in the pursuit of long-run growth while ignoring short-term profitability to cross the redline. The sporadic bankruptcy of individual chaebol would not undermine the HEG much. South Korea had a well-defined legal procedure to deal with firm bankruptcies. The bankrupt chaebol firms would be put under the procedure, whereby the share ownership would be written off and the management would change hands. The firms themselves would be preserved and then usually taken over by other chaebol. On the other hand, mass bankruptcy of chaebol would precipitate an economy-wide crisis, undermining the HEG. Indeed, such a possibility emerged in the early 1970s, which the Park government aborted through the presidential emergency decree on August 3, 1972. The Federation of Korean Industries, the organization representing chaebol, strongly demanded the implementation of the emergency decree. The emergency decree made chaebol believe that they could rely on the government support if they faced trouble. Then, as it launched the HCI drive in 1973, the Park government pushed chaebol to invest

23

Eatwell and Taylor (2000: 46–49); Shin and Chang (2003: Chapter 3).

178 The Tortuous Path of South Korean Economic Development massively without caring about short-term profitability, implicitly assuring them of help when they faced trouble in the future. This led to the new accumulation of NPLs by chaebol. As shown in Figure 5.2, the debt-equity ratio rose and the interest coverage ratio fell after 1973, the year the presidential emergency decree took effect and the HCI drive was launched. No study has identified to what extent chaebol were responsible for the increase of NPLs after 1973. However, considering all the circumstances after the launch of the HCI drive, it is imperative to conclude that chaebol firms were far more likely to be responsible for the production of NPLs than ordinary firms. Their financial weakness made the 1979 crisis more severe.

6.3  Liberalization and New Industrial Policy Over the years, liberalization became inevitable because the decentralized decision-making through the market had to play more role as the economy grew in size. The country indeed carried out liberalization from the 1980s. While liberalization proceeded in all areas of the economy, it affected the industrial policy in particular because the industrial policy had involved pervasive government intervention. Yet the government lifted only the vertical policy, while reinforcing the horizontal policy. At the same time, the government promoted SMEs in earnest.

Liberalization Drive The immediate reason for the liberalization was the necessity of disinflation, as mentioned in Chapter 5. The tax deductions and exemptions for the TIs were phased out quickly as part of the fiscal retrenchment. The government lifted its financial policy more slowly to avoid dealing shocks to firms. The government then pursued liberalization as an objective by itself. Those policies had more impact on TIs than UIs, as shown in Table 6.1. The difference in effective corporate tax rates narrowed quickly; the difference in interest rates also shrank, though more gradually. The government also narrowed the difference in ERP.

Industrial Policy and Chaebol 179 Then, in the mid-1980s, the United States began to press South Korea to liberalize on the grounds of “fair trade.” Now, the United States was no longer willing to allow the asymmetric relationship in trade, whereby other countries protected and subsidized domestic industries while freely exporting to the United States. The United States was in fact demanding the due course under the GATT system to be realized. The United States had allowed its asymmetric relationships with Europe and Japan on a temporary basis until they recovered from the devastation caused by the Second World War. As the temporary circumstances ended with their recovery, the United States returned to the original principle of the GATT to look for reciprocity.24 Japan became a major target in the move, but South Korea was perceived as “a Second Japan.” Actually, putting pressure on South Korea was illegitimate because it was still a developing country qualified to enjoy the benefit defined by the infant industry clauses of the GATT. The United States nevertheless put pressure on South Korea because the country was recording a persistent trade surplus with the United States by the mid-1980s. It reflected the consolidation of the trilateral relationship between South Korea, Japan, and the United States introduced with the normalization of the diplomatic relationship between South Korea and Japan in 1965. South Korea imported machinery, components, parts, and materials from Japan and then exported the processed final products to the United States. The unilateral pressure by the United States tended to complicate the liberalization process. South Koreans not only saw it as illegitimate but also thought that they had better wait until they were pushed or retain something to yield when they were pushed. Overall, however, they knew well that they had no choice but to liberalize. Moreover, the government officials committed to liberalization often found the US pressure to be helpful in overcoming the resistance by domestic interest groups. In 1986, the government declared that it would no longer target particular industries; instead, industrial

24

Bhagwati and Irwin (1987).

180 The Tortuous Path of South Korean Economic Development policy would move to “functional” measures  – that is, horizontal policy  – affecting all industries across-the-board. The government did not declare that it would no longer pursue the import substitution of components, parts, and materials, but that policy would also be affected by the overall shift of the focus to horizontal policy. In January 1990, South Korea moved into the status of a GATT Article XI nation, so it could no longer impose trade restrictions for balanceof-payments reasons. The government cut protection across-the-board. From 1981 to 1995, average statutory tariffs declined from 34.4 percent to 9.8 percent, while the import liberalization from quantitative restrictions rose from 60.7 percent to 92.0 percent.25 Such a move did not narrow the difference in ERP between the TIs and UIs for several years from 1983, but narrowed it eventually, as shown in Table 6.1. South Korea also cut subsidies to a level comparable to OECD countries. By the early 1990s, its subsidies to the manufacturing industries were 2.8 percent of the manufacturing value added, not far above the OECD average of 2.5 percent. They were mainly composed of financial subsidies, which were subsequently phased out with the financial liberalization.26 Such a fall in the overall subsidies affected the TIs more than the UIs, accounting for the narrowing difference in the average cost of borrowing shown in Table 6.1. Did the liberalization hurt the international competitiveness of the TIs? There is little evidence suggesting so. For one thing, the government lifted the protection and financial subsidies gradually, though it lifted the fiscal subsidies quickly. It phased out protection gradually to expose the industries to international competition rather than to improve consumer welfare immediately. In addition, the government continued protecting most sensitive products through the “import-source diversification policy” introduced in 1977. The policy designated several industries, including electronic goods and



25 26

Koh (2010: 51). The figures were collected from Son et al. (1994).

Industrial Policy and Chaebol 181 automobiles, as areas that favored imports from any country other than Japan, on the ground that South Korea was recording a chronic trade deficit with Japan. The real purpose of the policy was protecting those industries from competition with the then-mighty Japanese firms. The government also lifted the financial subsidies slowly to avoid dealing shocks to firms. Second, the competition in the domestic market through introducing new products, improving the quality of existing products and enhancing marketing efforts such as advertising, which had been in place from the 1960s and 1970s, persisted. It became, in fact, more effective as the domestic market expanded in size. Last, but probably most importantly, while lifting the vertical policy, the government reinforced the horizontal policy. Most of all, there was the effect of the disinflation and devaluation, which made the Korean won less overvalued. As shown in Tables 4.3 and 4.4, the REER for exports and imports rose in the 1980s compared with the 1960s and 1970s. According to the Bank for International Settlements data, South Korea’s REER on average from 1980 to 1996 was 20.0 percent higher than the REER on average from 1964 to 1979 (See Figure 9.3).27 Though the higher REER affected industries acrossthe-board, it benefited the TIs more as long as they were less competitive. Another horizontal policy that the government reinforced was enhancing technological capability.

Enhancing Technological Capability Previously, industrial policy was pushed without enhancing technological capability sufficiently. Now, the government moved the weight of industrial policy toward enhancing the technological capability. The first way to enhance the technological capability was promoting R&D efforts. The government granted tax deductions and exemptions and preferential loans to encourage R&D efforts. It also established many research institutes in specific fields, in addition to those established in

27

Calculated from www.bis.org/statistics/eer.htm.

182 The Tortuous Path of South Korean Economic Development 6.0

5.0

4.0

3.0

2.0

1.0

18

15

20

12

20

09

20

06

20

20

03

00

20

97

Private

20

94

19

91

Public

19

88

19

85

19

19

82

79

19

76

19

73

19

19

19

70

0.0

Foreign

Figure 6.1  R&D expenditure by fund sources as a percentage of GDP, 1970–2020 Sources: R&D expenditures are from kosis.kr. GDP is from ecos.bok​ .or.kr.

the 1960s and 1970s. The changing government policy coincided with the changing competitive strategy of firms. Firms – particularly chaebol firms – paid more attention to R&D efforts as they recognized that foreigners were less and less willing to provide technology while the South Korean wage level was rising. Firms began to establish in-house R&D institutes. Government research institutes and firms’ in-house R&D institutes were emerging as two major pillars of R&D efforts. The government built science parks to accommodate government research institutes and firms’ in-house R&D institutes. They often collaborated with each other in developing technology. R&D expenditure rose sharply. Figure 6.1 presents R&D expenditure and its composition by fund sources as a percentage of GDP. R&D expenditure was a meager 0.38 percent of GDP in 1970; it was still no more than 0.53 percent of GDP in 1980. But it shot up to 1.60

Industrial Policy and Chaebol 183 percent of GDP in 1990 and 2.25 percent of GDP in 1997. There was also a reversal in the composition of funds between the public and private sectors over the years. In 1970, the R&D expenditure by public and private sectors accounted for 0.27 percent and 0.11 percent of GDP, respectively; in 1997, they accounted for 0.62 percent and 1.63 percent of GDP, respectively. The higher weight of the private sector meant that R&D efforts were directly contributing to the industrial competitiveness of firms. Through this process, the country managed to reverse brain drain, as those who had gone abroad for studies – especially to the United States  – came back in droves. This can be seen from the “world talent ranking” compiled by the International Institute for Management Development in Switzerland.28 The rank represents how a country draws talent from all over the world. South Korea ranked fourth in 1995, the first year the statistics were compiled, and seventh in 1996. Since the country was not in a position to draw foreign talent, the ranking mostly represented the reversal of the brain drain. As a result, at least in quantitative terms, Seoul and the science park areas became major intellectual centers of the world. Promoting R&D efforts was a horizontal policy, with firms being able to obtain subsidies regardless of the industries they did business in. However, in reality, the line between the vertical and horizontal policies was indeed blurry. Now, “technology targeting” through the collaboration of government research institutes and firms’ in-house R&D institutes became the main form of R&D efforts.29 Though it had a different name tag, the policy in fact aimed at enhancing the competitiveness of particular industries. Technology targeting benefited firms doing business in higher-​technology industries more, as they had more technologies to target. The rising R&D efforts went side by side with the increase of the supply of skilled labor to industries. South Korea’s human

28 29

www.imd.org/wcc/world-competitiveness-center-rankings/talent-rankings/. Kim and Seong (1997: 389).

184 The Tortuous Path of South Korean Economic Development resources were consistently upgraded as education rose sharply in all levels. Parents wanted to educate their children ever more, and they could afford to do so with the rising income and falling number of children. The government met the demand by increasing the supply of education in all levels; however, raising the share of the collegeeducated labor in the workforce was most important in supporting the high-technology industries. The government thus raised college attendance ratio. The Chun Doo-hwan government raised the college attendance ratio in an odd way. In 1981, it more than doubled college enrollment quotas, which it controlled. It was basically a political move to weaken the student activism, which bore the brunt of the burden for the democratization movement (explained in Chapter 7). The Chun government stipulated that it could weaken the student activism by admitting more students to universities and making the graduation difficult. The tactic failed because universities did not cooperate to making the graduation difficult. South Korea raised the college attendance ratio again in the 1990s, now to cope with the rising demand for skilled labor more explicitly. The Roh Tae-woo government (February 1988–February 1993) raised college enrollment quotas and the succeeding Kim Young-sam government (February 1993–February 1998) raised the college attendance ratio by liberalizing the enrollment. Figure 6.2 presents the college attendance ratio (the number of college students as a percentage of the age cohort) together with the high school and junior high school attendance ratios from 1980, the first year the consistent data are available. The college attendance ratio doubled from 11.4 percent in 1980 to 22.9 percent in 1985; it leveled off in the late 1980s, but doubled again from 22.6 percent in 1989 to 45.3 percent in 1997. The attendance ratio of high school and junior high school began to rise earlier and continued to rise steadily, reaching 85.5 percent and 92.8 percent, respectively, by 1997 (The attendance ratio of elementary school was already close to 100 percent in 1980). Such a rise in education in all levels supported the

Industrial Policy and Chaebol 185 120.0

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Figure 6.2  School attendance ratios, 1980–2022 (percent) Source: index.go.kr. Numbers from 1980 to 1999 are from the previous post and the numbers from 2000 are from the current post.

structural transformation of the economy into high-technology industries; however, the sharp rise in the share of college-educated labor in the workforce was most important in supporting the transformation. South Korea initially concentrated on catching up with advanced countries’ technologies. However, in some areas, the country was completing the catch-up process and moving into the newly emerging global frontiers by the 1990s. Information and communications technology (ICT) was the salient case. ICT was “short cycle” technology that did not impose a high barrier to entry. The country could achieve rapid progress in the ICT field as the outgrowth of the electronics industry promoted from the 1960s. It shortened the length of time needed for the catch-up in the electronics industry. For example, International Business Machines (IBM) first introduced the personal computer in 1978, beginning its mass distribution in

186 The Tortuous Path of South Korean Economic Development the United States  in 1981.  It  was only two years later in 1983 that Samsung Electronics was distributing its own personal computers in South Korea. In December 1983, Samsung succeeded in producing 64-megabit DRAM chips. After that, Samsung invested aggressively in R&D efforts, so that in 1994 it became the first company to develop 256-megabit DRAM chips. Hyundai and LG were closely following Samsung’s heels. In the 1990s, South Korea waged all-out efforts to jump into the newly emerging ICT industries. The government promoted them by subsidizing R&D efforts, providing skilled labor, and assisting exports. The government also sought to create an efficient national telecommunications infrastructure by building, for example, the “national information super-highway” based on high-speed broadband internet access. The government, together with the press, waged a campaign to create an information-based society; the slogan “Latecomer in Industrial Society, but Leader in Information Society!” was widely heard. The government, the business community, and the society in general thereby came to share the vision that ICT industries were a new source of growth for the country. These endeavors enabled the country to forge ahead in some areas of the ICT industries. It surpassed the United States, the global champion of ICT, in terms of establishing a more extensive broadband internet network. The country found itself on the cutting edge in developing and adopting other ICTs such as the Time Division Exchange (TDX) telephone switching technology and the CodeDivision Multiple Access (CDMA) wireless system.

Promoting Small and Medium-Sized Enterprises Another aspect of new industrial policy from the 1980s was the promotion of SMEs. First, the liberalization leveled the playing field between large enterprises and SMEs as large chaebol firms had been the major beneficiaries of the vertical industrial policy previously. The Chun Doo-hwan government also promoted SMEs in a more devoted way than the Park Chung Hee government. It increased tax

Industrial Policy and Chaebol 187 deductions and exemptions to SMEs, while phasing them out for large enterprises. The Chun government introduced new credit programs for SMEs, and the BOK began to provide a rediscount facility for various types of bank loans to SMEs, while phasing out the rediscount of the bank loans to large enterprises. The Chun government widened the business opportunities for SMEs further by strengthening the subcontracting relationship with large  – mainly chaebol  – firms by designating particular industries and items as areas to develop subcontracting relationships and inducing large enterprises to entrust their production to SMEs. The policy to promote subcontracting went side by side with the continued efforts to substitute the imports of components, parts, and materials with domestic production. The Chun government introduced fair trade policies. It legislated the Monopoly Regulation and Fair Trade Act, which became effective in 1981. The act regulated the unfair trade in individual markets by restricting anticompetitive merger and acquisitions, undue collaborative activities, resale price maintenances, and anticompetitive international contracts. The law defined the sanctuaries for SMEs. The Chun government also enacted the Fair Transactions in Subcontracting Act in 1983 to address the problem of the disparity in bargaining power in subcontracting relationships. Subcontracting relationships inherently involved the asymmetries in bargaining power as the subcontractor could not find alternative buyers once it made an investment specifically geared to a particular large enterprise. The law demanded the codification of subcontracting contracts, set the code of conduct between the subcontracting partners, and assumed that the government would coordinate the disputes between them. In addition, the Chun government began to address the concentration of economic power by various means (discussed below). To implement these policies, the government established the Fair Trade Commission within the Economic Planning Board in 1981. Fair trade policies got further momentum with democratization in

188 The Tortuous Path of South Korean Economic Development 1987. The Fair Trade Commission became an independent agency in 1994, and the Chairman of the Commission was accorded a ministerlevel position in 1996. The Chun government even began to promote the founding of high-technology startups. Yet the emergence of startups in earnest began in the mid-1990s, as the development of ICT industries provided a favorable ground for high-technology startups. Even though all of them did not belong to ICT industries, startups in other areas could also benefit from the development of ICT, especially the Internet. In 1996, the Kim Young-sam government launched the Korea Securities Dealers Automated Quotation (KOSDAQ) market as a separate body from the existing Korea Composite Stock Price Index (KOSPI) market. In 1997, it enacted the Act on the Special Measures for the Promotion of Venture Businesses as a framework to promote startups. The Kim Young-sam government expected that venture businesses would become an alternative to chaebol in leading the country’s industrial development in the future.

6.4  Chaebol in Transition Chaebol continued leading the structural transformation of the economy in the 1980s and 1990s, emerging as global players. This meant that the concentration of economic power persisted. Chaebol also came to face a new political and economic environment with liberalization and democratization, which seemingly increased their influence while weakening the state capacity. However, whether this was true requires closer examination. Meanwhile, chaebol still had many problems, including the financial market problem, which provided a ground for the 1997 crisis.

Global Players and the Concentration of Economic Power As liberalization proceeded, the initiative of private enterprises became more important than the government policy in leading the structural transformation. The natural candidate to take the initiative was chaebol, owing to their ability to cope with market failure.

Industrial Policy and Chaebol 189 Liberalization lifted the regulations on entry, investment, and pricing for chaebol firms together with subsidies and protection. Under this situation, chaebol led the investment in high-technology industries and products, especially when it was a large lump-sum investment. Notably, Samsung initiated the production of DRAM chips, and Hyundai and LG followed on Samsung’s heels. Chaebol firms anticipated the acceleration of digitalization and the growth of wireless communication services, which led them to focus intensively on the development of liquid crystal displays (LCDs) and mobile phones, and so on. Chaebol financed investment in large scale projects using the internal and external capital markets that had been in place. Chaebol also made use of their internal labor markets. Chaebol continued to expand subcontracting relationships with SMEs. By the mid-1990s, about 60 percent of manufacturing SMEs were engaged in subcontracting, if the second vendors selling to the first vendors and the third vendors selling to the second vendors were included.30 Chaebol cooperated with subcontractors to substitute the imports of components, parts, and materials with domestic production. Such a picture represented the successful conclusion of the policies implemented since the 1960s. Chaebol were graduating from the government subsidies and protection offered by the vertical policies on a temporary basis. Infant industries promoted by the vertical policy of the 1960s and 1970s were finally maturing.31 On the basis of that success, chaebol were jumping into newly emerging industries on their own initiatives. Chaebol firms managed to become global players with their own brand names and R&D capabilities in industries like DRAMs, household appliances, automobiles, iron and steel, shipbuilding, and petro-chemicals. Moreover, international environment was changing favorably for chaebol in relation to SMEs. As China and other newly



30 31

Ju et al. (2009: 2). Lee (1997); Lee (2011).

190 The Tortuous Path of South Korean Economic Development industrializing countries underwent catch-up growth, riding the tide of globalization, their weight in South Korea’s trade rose. This gave more opportunity to chaebol firms doing business in high-technology industries employing high-skilled workers, while the competition from those countries undermined the position of the SMEs employing low-skilled workers. All of this meant that the concentration of economic power persisted. The concentration of economic power came to be the corollary of having chaebol firms as global players in spite of the relatively small size of the economy. Data on the concentration of economic power are patchy. There are two data sets about the share of chaebol’s value added in GDP before the 1997 crisis: one by Sakong Il from 1973 to 1978 and the other by Choi Sung-No from 1985 to 1995.32 There are no data for the years from 1979 to 1984; however, Sakong provides chaebol’s share in the value added in the manufacturing sector from 1973 to 1989 (with some missing observations). Figure 6.3 presents the share of the top five chaebol’s value added and the top ten chaebol’s value added in GDP, excerpted from Sakong’s and Choi’s data, denoting them as “Top 5” and “Top 10,” respectively. It also presents the share of the top ten chaebol and top 20 chaebol in manufacturing value added from 1973 to 1989, excerpted from Sakong’s data, denoting them as “Top 10 M” and “Top 20 M.” The trend of the Top 5 and Top 10 shows that the concentration of economic power soared from 1973 to 1978, when the HCI drive was in full swing. The Top 5 and Top 10 were lower in 1985 than in 1978, suggesting that the concentration of economic power was reversed in the early 1980s. The trend of the Top 10 M and Top 20 M also shows a steeply rising concentration of economic power from 1973 to 1978 and then a reversal of the trend thereafter. The trend of the Top 5 and Top 10 diverged from the trend of the Top 10 M and Top 20 M in the last years of 1980s, which cannot be analyzed

32

Sakong (1993); Choi (1996).

Industrial Policy and Chaebol 191 35.0

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Figure 6.3  Top chaebol’s shares in value added, 1973–1995 (percent) Source: Appendix 4.

here. However, the trend of the Top 5 and Top 10 shows that the concentration of economic power rose again in the 1990s. The trend of the concentration of economic power appearing in Figure 6.3 is basically the result of the interaction of two forces, one cyclical and the other irreversible. The cyclical force was the working of the “aggressive but vulnerable system,” where chaebol lay at the core, with the increase and decrease of NPLs being repeated over the period. The concentration of economic power had risen drastically in the 1970s as chaebol invested aggressively while ignoring short-term profitability during the HCI drive. Their financial vulnerability exacerbated the 1979 crisis, and many chaebol were on the verge of bankruptcy by the early 1980s. The Chun Doo-hwan government carried out a massive restructuring of chaebol through the three rounds of investment coordination mentioned in Chapter 5, which involved mergers and acquisitions among chaebol firms. Through the process of restructuring, which chaebol would survive and which would perish was decided by no

192 The Tortuous Path of South Korean Economic Development means in a transparent way, as it went side by side with Chun’s collection of slush funds.33 Overall, however, the restructuring of chaebol managed to reduce their NPLs. This mainly accounted for the fall of the debt-equity ratio and the rise of the interest coverage ratio during Chun’s rule (1980–1987), as shown in Figure 5.2. The restructuring is likely to have put the brakes on the trend of the concentration of economic power in chaebol. The Chun government’s structural adjustment fell short of liquidating the NPLs because it was not a necessary condition for resuming the HEG. Chaebol resumed their aggressive investment as the restructuring had pulled them out of their mass bankruptcy situation. The democratically elected governments of Roh Tae-woo and Kim Young-sam were even less interested in liquidating NPLs because of their shorter time horizon. Chaebol’s investment accelerated in the 1990s, which apparently accounts for the rising concentration of economic power shown in Figure 6.3. The irreversible force was liberalization and democratization. Chaebols were facing a new political and economic environment with liberalization and democratization. Many observers have argued that liberalization and democratization caused the South Korean government to lose control over chaebol, allowing chaebol’s economic power to communicate itself to the equivalent political power. It weakened the state capacity as chaebol captured the government, transforming the country into a “chaebol republic,” which would lead to the outbreak of the 1997 crisis.34 However, the reality was more complex than such a picture. The bottom line was that the government control over chaebol was limited even before liberalization and democratization, which had been revealed as early as Park’s junta period. Of course, above the bottom line, there could be a difference in degree in chaebol’s influence, and it may have risen so



33



34

Later, Kukje chaebol (the seventh largest chaebol at the time) claimed that it had been forced to go bankrupt because it had failed to contribute to Chun’s slush fund in a generous enough way. In 1993, the constitutional court ruled that the dissolution process of Kukje chaebol had been unconstitutional. See Lee (2000), Yeung (2017), and Mo and Weingast (2013: 138–141), among others.

Industrial Policy and Chaebol 193 drastically with liberalization and democratization that the country may have become something like a chaebol republic. However, it is unlikely that liberalization and democratization just weakened state capacity and allowed chaebol to capture the government. The causes of the 1997 crisis may also be more complex.

The New Political Economy of Chaebol Liberalization did not represent the weakening of state capacity or the chaebol’s capture of the government. It was basically a due course following the economic logic. The government regulations of entry, investment, pricing, and financing of firms had to go as the size of the economy grew and decentralized decision-making was in order. Vertical industrial policy was a temporary measure to promote infant industries. The government phased out the vertical policy even though chaebol lost from it doing so (The loss was somewhat compensated by the reinforced horizontal policy, but not completely). The government did so because state capacity was maintained; the government captured by chaebol would have preserved the status quo of sharing rent between the government elites and chaebol. Chaebol also did not benefit from the government policies to promote SMEs through fiscal, financial, and fair-trade policies implemented alongside the liberalization. In 1986, the Chun Doohwan government revised the Monopoly Regulation and Fair Trade Act to address the concentration of economic power directly. The revised law prohibited the bilateral shareholding between member firms, restricted the cross-shareholding by imposing a ceiling on the amount that a member firm could hold other members’ shares (The ceiling was defined by the amount of the net capital of the firm). It restricted the voting rights held by the NBFIs that were the members of the same chaebol. The Fair Trade Commission began to designate the 30 largest chaebol to monitor and regulate from 1987. Democratization weakened the government control over chaebol as the elected governments, unlike the authoritarian ones, could not wield arbitrary power over chaebol. Chaebol could now influence the political process through providing campaign funds. On the

194 The Tortuous Path of South Korean Economic Development other hand, democratization brought chaebol and government elites into check by the general public. While, between themselves, the government elites had lost the upper hand they had over chaebol in the authoritarian era, both of them were now put in check by the public. As the military dictators were ousted, politicians got out of their control and vied for the election through popular vote, where they began to raise their voices against chaebol. Public opinion became important, and the voice for reform was loud after the painful process of democratization, which could have led to a social revolution if things went badly (See Chapter 7). This may well have enhanced state capacity. Democratically elected governments continued the liberalization initiated by the Chun government. In October 1987, the National Assembly inserted the “economic democratization” clause when it revised the constitution. Its main objective was establishing the constitutional grounds for applying the Monopoly Regulation and Fair Trade Act to the concentration of economic power by chaebol. In the 1990s, reducing the concentration of economic power in chaebol became a major policy agenda. The ceiling on cross-shareholding was lowered. The restriction on the cross-guarantee of loans was introduced; the basket control of bank credit was applied to the largest 50 chaebol, regulating the total flow of credit from each bank into each chaebol and its subsidiaries. The government also employed other regulations on intra-group transactions, business diversification, and ownership structure. Democratization also opened the door for reforms to enhance the transparency of the economy, which the Kim Young-sam government carried out. Those reforms caused chaebol as well as political elites to suffer by making it difficult to evade taxes and circumvent regulations. Chaebol could not block the reforms, even though they tried hard. The Kim government also revised the political fund law to reduce the influence of money on politics (See Chapter 7). It is impossible to know how all these interacted with the cyclical force to determine the concentration of economic power presented in Figure 6.3. However, they do not suggest that liberalization

Industrial Policy and Chaebol 195 and democratization weakened state capacity and enabled chaebol to capture the government. Of course, this does not mean that liberalization and democratization really took care of the downsides of chaebol. Chaebol came to have new problems in addition to the ones they had already had from the 1970s. Liberalization and democratization made it difficult to address those problems in some cases, which contributed to the outbreak of the 1997 crisis.

Financial Market Problems Over the years, chaebol would reveal a fundamental problem. As the economy grew, markets would become less imperfect, thereby making industry-specific skills and knowledge more valuable than the generic capability of chaebol in leading the structural transformation of the economy. The advantage of internal markets would weaken as external markets developed. Of course, it was difficult to know when the “crossover” from the advantages to the disadvantages of chaebol would come. However, it was clear that chaebol were losing entrepreneurial dynamism as they were entrenched in family control over the generations. With the aging of the founders, they wanted to bequeath the managerial control of their empires to their sons (if not daughters), who rarely had the entrepreneurial talents of the founders. Chaebol accomplished this by exploiting poor corporate governance. The typical method was the related transactions  – selling cheap and buying dear – to the member firms in which chaebol families held majority shares. Chaebol families got ever more money to steal from minority shareholders this way because, as chaebol firm went public, the chaebol family’s share of the total equity capital was diluted. Thus, the ill-intended related transactions came to dominate the well-intended ones to subsidize the newly founded member firms in high-technology industries. The government did little to check such behavior. Still, poor corporate governance was not a factor threatening the sustaining of the HEG itself. As in the 1970s, it was chaebol’s financial market problems that posed an immediate threat. The

196 The Tortuous Path of South Korean Economic Development Chun government’s restructuring fell short of liquidating the NPLs, and the democratically elected Roh and Kim governments were even more reluctant to address the NPLs problem. After the restructuring and boom of the late 1980s, the country was returning to the earlier pattern of the HEG with sporadic bankruptcy of chaebol. From 1989 to 1996, three chaebol, two of them belonging to the 30 largest chaebol under the surveillance of the Fair Trade Commission, went bankrupt. There is again no study about how much chaebol firms accounted for the NPLs in the mid-1990s mentioned in Chapter 5. However, they were less profitable than ordinary firms, which suggests that they continued to lead investing aggressively with borrowed money ignoring short-term profitability.35 In addition, a new – and more immediate – threat was forming. Chaebol came to face a serious liquidity problem as a result of the Kim Young-sam government’s policy to reduce the concentration of economic power. It drastically strengthened the restrictions on chaebol’s conventional way of borrowing from banks such as the cross-guarantee of loans. The amount of the cross-guarantee of bank loans for the 30 largest chaebol amounted to 469.8 percent of equity capital in 1993, but it fell to 91.3 percent of equity capital in 1997. Restrictions on other methods of borrowing such as issuing bonds in the capital market and procuring commercial loans from abroad were similarly strengthened.36 Oddly, the Kim government allowed chaebol to circumvent these restrictions by issuing commercial papers to NBFIs. The 1980s and 1990s witnessed the expansion of many NBFIs such as finance companies and merchant banking corporations that had been in place since the 1970s. A host of other NBFIs such as venture capital companies and lease companies also sprang up. They managed to replace the previous role of the curb market to a large extent, being helped by the disinflation and liberalization policies that reduced the difference in the interest rates they offered from the interest rates prevailing in the curb market.

35 36

Joh (2003); Lee (2014). Choi (2006).

Industrial Policy and Chaebol 197 NBFIs were subject to lighter regulations than banks. Owing to the lighter regulations, their lending and deposit rates were higher than bank rates, restrictions on asset portfolio were fewer, market entry was easier, and directed credit was not an obligation. Many of them were owned by chaebol. Chaebol lobbied, often successfully, for further deregulation. This enabled NBFIs to grow rapidly.37 By 1996, the lending by NBFIs was 1.8 times the lending by banks.38 As banks continuously lost their market share to NBFIs, they demanded a leveling of the playing field. The government thus allowed banks to undertake more trust business. The trust accounts of banks subsequently grew rapidly in volume, with their share in the total domestic liabilities of banks rising from five percent in 1984 to over 40 percent in 1993.39 To manage their trust account, banks purchased a large amount of the commercial papers issued by chaebol. As a result, chaebol borrowed in the short term from NBFIs and trust accounts of banks and then invested in long-term projects, creating a serious term mismatch in assets and liabilities. This could cause a liquidity crisis, which would be added to the solvency crisis coming from the NPLs. Chaebol’s financial market problems represented a mixed picture of chaebol influence and state capacity changing with liberalization and democratization. Democratization made the NPLs problem more difficult to address. Yet the Kim Young-sam government’s drastic tightening of the restrictions on chaebol’s conventional way of borrowing did not represent the weakening of state capacity; it was rather a policy blunder committed by a strong state. On the other hand, chaebol lobbies enabled NBFIs to grow rapidly. Chaebol lobbies may also have been responsible for the opening of the backdoor for foreign capital inflow, as mentioned in Chapter 5. Chaebol would thus be responsible for the 1997 crisis, though the overall picture of the chaebol influence is more complex than conventionally thought.



37 38 39

Cho (2003: 94). ecos.bok.or.kr. Koh (2010: 49).

7

Growth with Equity?

This chapter examines the management of social conflict – the third condition for sustaining growth – from the beginning of the HEG to the 1997 crisis. It does not delve into all the subjects related to social conflict, which is beyond the scope of this book. The chapter will focus on equity, believing that it is a key to managing social conflict. It is easier to deal with, employing the quantitative data of the distribution of income and wealth. Of course, economic factors interact with non-economic factors to determine social conflict. Particularly important in this regard is democratization, which South Korea achieved in the process of the HEG. That brings up the questions about how the country sustained the HEG with the democratization, and what the consequences of the democratization were for growth and equity.

7.1  Jobs, Poverty, and Inequality Social conflict arises in the process of economic development because of the dislocations and strains of industrialization and urbanization. The higher the growth rate, the more intense the conflict may be, so South Korea’s HEG provided ample room for social conflict. At the same time, the HEG itself was a strong mechanism to manage social conflict by creating jobs and reducing poverty. That indeed resolved the crisis of the early 1960s and continued to ease social conflict later. However, maintaining equity was also important because widening inequality would breed relative deprivation that would potentially undermine social peace. That was indeed true for South Korea throughout the HEG period, but especially so in the 1960s and 1970s. 198

Growth with Equity? 199

Growth with Equity? As the HEG began, demand for labor increased rapidly for all categories of work. The supply of labor was quite elastic initially, as there were a large number of unemployed or underemployed workers in the urban as well as rural areas. Urban workers were hired first, but rural workers migrated to urban areas en masse. Over the period, while the demand continued to increase, the supply became less elastic as the number of unemployed or underemployed workers fell. The labor market became tighter, as shown by the falling unemployment rate in Figure 4.2. This reduced poverty drastically as poverty in developing countries came mainly from a large number of the unemployed or underemployed. South Korea managed to lift those people out of poverty en masse by giving them jobs. Lifting people out of poverty reduced social tension. In addition, South Korea was regarded as having done well on the distribution of income as well, so its development process was characterized as “growth with equity,” according to the World Bank.1 The main problem with this observation was that the income distribution statistics were compiled by the household surveys that understated the income of the richest strata of people who were reluctant to reveal their income. In the 2010s, taxation data became available for research purposes, and economists began to study income distribution by utilizing the taxation data and the national account data. Hong Minki and Kim Nak Nyeon used such a method to estimate a long-run series of the top one percent and top ten percent income shares. Hong reports the numbers from 1958 to 2013, and Kim reports the series from 1976 to 2021.2 Figure 7.1 shows their estimation results, denoting Hong’s as (1) and Kim’s as (2) respectably. According to Hong’s estimation, in 1958, South Korea’s income distribution was very equal, with the top



1 2

World Bank (1993: Chapter 1). Hong (2015); Kim reports the numbers in the World Inequality Database (wid.world/ data/).

200 The Tortuous Path of South Korean Economic Development 60.0

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Figure 7.1  Top income shares, 1958–2021 (percent) Source: Appendix 5.

one percent and top ten percent accounting for as low as 4.5 percent and 14.7 percent of total income, respectively. This was the historical legacy discussed in Chapter 3. Both the top one percent and top ten percent income shares began to rise subsequently, so by 1963, the year the HEG began, they amounted to 5.9 percent and 19.4 percent, respectively. They were still very low by international comparison, according to the World Inequality Database.3 However, top income shares rose rather sharply through the HEG in the 1960s and 1970s. By 1979, the Top one percent (1) estimated by Hong rose to 8.3 percent and Top one percent (2) estimated by Kim rose to 8.9 percent; Top ten percent (1) rose to 35.1 percent and Top ten percent (2) rose to 31.0 percent. For international

3

wid.world.

Growth with Equity? 201 comparison, Top one percent (2) and Top ten percent (2) estimated by Kim may be more useful, considering that they appear in the World Inequality database alongside the estimations for other countries. By 1979, both top one percent (2) and top ten percent (2) were lower than in the United States and Japan, but they were higher than in the majority of the rest of the advanced countries in Europe, North America, and Oceania. Meanwhile, both Top one percent (2) and Top ten percent (2) in 1979 were lower than in most developing countries (Most of them have data from 1980 in the World Inequality Database, but comparing South Korea’s 1979 or 1980 figures with their 1980 figures gives the relative magnitude). This calls for a more rigorous interpretation of the idea of the growth with equity. South Korea failed to achieve growth with equity if it were understood as “growth with rising equality” or even as “growth with maintaining the existing level of equality.” The country only achieved growth with equity by international comparison due to its historical legacy of exceptional equality. By the end of the 1970s, the reference for the international comparison changed: The country had unquestionably lower inequality only in comparison with most of the developing countries. What made inequality widen in the 1960s and 1970s? Creating jobs through the HEG narrowed inequality as well as reduced poverty because unemployment was the largest source of inequality: The unemployed had no income at all, with a wide gap in relation to the employed. Reducing the number of the underemployed by creating jobs had a similar effect. Inequality rose because other factors more than offset such effects. As Simon Kuznets suggested, inequality widens in the initial phase of industrialization.4 Urban income tends to be more unequal than rural income, which was particularly true for South Korea, which had carried out a thoroughgoing land reform. The income gap between rural and urban households widened as the labor productivity rose faster in the secondary and tertiary

4

Kuznets (1955).

202 The Tortuous Path of South Korean Economic Development sectors than in the primary sector. The younger and more educated rural population moved to urban areas, reinforcing the widening of the income gap. Though the migration enabled the remaining rural population to cultivate more land, it could not offset the effect of the rising gap as long as the migration was occurring due to the productivity difference. In the early 1970s, the Park Chung Hee government launched the “New Community Movement” to raise the productivity and living conditions of the rural population by improving infrastructure and housing, among others.5 It also upheld the income of rural households through the “dual price system,” whereby the government purchased rice and barley at a price higher than the sale price to urban residents.6 Those moves narrowed the income gap, and by 1975, the rural households on average were earning more income than urban households. However, the trend was reversed after 1975 as the labor productivity in the urban areas rose rapidly with the HCI drive.7 Inequality also widened in the urban sector itself. Inequality of urban income widened first because firms were being organized into a hierarchy. A strong differentiation between white-collar and blue-collar workers, based on educational background, was forming. Gender was also an important factor in determining workers’ places in the hierarchy, with unmarried young women, who were usually expected to leave at the time of marriage or their first pregnancy, being placed at the lowest rung. Building the hierarchy interacted with market forces. The supply of college graduates fit for the managerial and technological jobs was relatively limited, while the supply of blue-collar workers was abundant. Weak union power also contributed to the differentiation. The wage gap between the college graduates and other workers was wide by international comparison and increased in the 1970s.8

5 6 7 8

Ban et al. (1982: 275–280). Ban et al. (1982: Chapter 8). The Committee for Editing the Sixty Years of the Korean Economy (2010b: 64–67). Lee and Lindauer (1997a: 59–62).

Growth with Equity? 203 Inequality also widened as labor market dualism emerged with the consolidation of different employment practices. Some workers – mostly male – of large private enterprises, the public sector, and the semi-public sector such as banks and private schools, tended to stay a long time with the same employers, some of them for their lifetime. They were provided the opportunity for training to enhance their productivity. Such conditions, in turn, enabled those employers to recruit high-quality workers. Meanwhile, other workers, the majority of whom joined SMEs, changed employers often as their labor market was very flexible.9 These workers received lower wages than those who stayed a long time in large private enterprises, the public sector, and the semi-public sector. They received relatively less opportunity to get training, so their relative productivity was lower. However, to understand the distribution problem accurately, one has to consider the transfer problem. The idea of growth with equity is almost completely subverted if one takes this into account.

The Transfer Problem There were two major channels of transfer: the real estate market and the welfare system. The real estate market transferred wealth to the rich, while the welfare system transferred income to the poor. While the former was huge, the latter was minimal. The transfer through the real estate market has been common to the high-growth economies of East Asia, which have undergone rapid industrialization and urbanization after the turbulence of war, revolution, and chaos. The price of real estate rose sharply, generating a large amount of capital gains, which were unearned income, that is, the transfer from the economy as a whole to the owners. Real estate prices rose often directly as a result of government action in urban development and infrastructure construction. There was thus a strong case for the government to minimize the capital gains accruing to the owners themselves. In this regard, South Korea differed

9

Vogel and Lindauer (1997: 100).

204 The Tortuous Path of South Korean Economic Development from the contemporary newly industrializing economies of Taiwan, Hong Kong, and Singapore. Those economies had some concept of public ownership of land, but South Korea had little. South Korea particularly compared unfavorably with Taiwan, where Chiang Kaishek tried to practice Sun Wen’s idea borrowed from Henry George.10 The Park Chung Hee government’s loose monetary policy also provided a favorable condition for the rise of real estate prices. Moreover, on some occasions like the development of the Gangnam area of Seoul, the Park government made use of the rise of real estate prices to create political funds.11 No data are available for the total amount of the capital gains accruing to the real estate during this period, yet the data for the capital gains accruing to land are available. Land price may actually help to capture the amount of transfer better because, while the price of housing and buildings may have risen due to the owners’ investment as well as the growth of the whole economy and urbanization, the price of land rose almost entirely with the growth of the whole economy and urbanization. Figure 7.2 presents the amount of capital gains accruing to privately owned land and publicly owned land as a percentage of GDP. The capital gains accruing to privately owned land are more relevant to the transfer problem. During the 15 years from 1965 to 1979 (1979 was the last year of Park’s rule), capital gains on privately owned land averaged an astounding 84.9 percent of GDP. Of course, the capital gains would widen inequality only when the ownership was unequal. There are no data about the distribution of real estate ownership for the 1960s and 1970s, but the capital gains most likely accrued disproportionately to the rich. They did so first because the rich lived in their own houses while the poor rented. Furthermore, many people bought real estate purely for speculation purposes. The game was definitely favorable to the rich because they could better afford the cost. Even among the rich, the game was



10 11

Sun (1972: 216, 284). Jeon (2019: Chapter 3).

Growth with Equity? 205 200.0

150.0

100.0

50.0

19

16

13

20

20

10

20

07

20

04

20

01

20

98

20

95

19

92

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89

19

86

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83

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80

19

77

19

74

19

71

19

68

19

19

19

65

0.0

–50.0 Private Public

Figure 7.2  Capital gains on land as a percentage of GDP, 1965–2021 Source: Appendix 5.

unfair as the differences in their dispositions mattered: Shrewd people who joined the tide of the speculation gained much while those who devoted themselves to daily business gained little. Firms, especially chaebol firms, heavily speculated in the real estate market. They had a better sense of speculation than most households. They also had better information about urban and infrastructure development projects and better access to bank credit. The access to bank credit and the rise of real estate prices reinforced each other. Real estate – especially land – was used as collateral for bank loans. The rise of real estate prices raised its collateral value, enhancing the ability to gain access to bank loans, which could in turn be used to purchase more real estate. High-ranking government officials were in a similar position as chaebol, with better access to information and bank credit. Thus, rising real estate prices, credit rationing, the concentration of economic power, and government corruption interacted with

206 The Tortuous Path of South Korean Economic Development one another to generate a huge transfer of wealth to the rich. That intensified social conflict, threatening the sustainability of growth. Indeed, as mentioned in Chapter 5, Park Chung Hee ordered the disinflation policy at the end of 1978 out of the concern, to not a small degree, about the rampant real estate speculation. In 1978, the capital gains on privately owned land amounted to 144.1 percent of GDP, the highest figure ever. The ensuing disinflation policy in the face of the Second Oil Shock precipitated the 1979 crisis. There was little transfer of income to the poor, mainly because of the poor social welfare system. South Korea’s social welfare during this period was less developed even compared with other developing countries’. The government expenditure on health and social protection, often used as the proxy for welfare expenditure, was a mere 0.9 percent of GDP in 1970 and 1.7 percent of GDP in 1979.12 The Park government introduced social insurance programs in a rudimentary form, but in a different way from the European countries that had introduced them earlier. Those countries had started with the lowerincome workers, but South Korea began with higher-income workers, in the particular occupations able to afford the contribution, in order to minimize fiscal burden. The country’s first pension program was introduced for government employees in 1960. That was followed by the pensions for military personnel in 1963 and for private school teachers in 1975. The national health insurance on compulsory base was introduced in 1977, with the coverage limited to the employees of the firms with 500 or more workers, public sector employees, and private school teachers. The social insurance programs thus left the majority of the population uncovered, including the poor that needed them most. The poor were also little covered by public assistance programs because the government kept them minimal. People had to make their own ends meet whatever their income level was. Those people unable to work, including the elderly and the disabled, were put under their

12

Calculated from ecos.bok.or.kr; see Figure 5.3.

Growth with Equity? 207 family’s care while the extended family was collapsing rapidly. The agony of these people has not been well documented. However, they were not the largest source of social conflict. The largest source of social conflict lay in the industrial relations among those who were able to work and get jobs, as their voice was repressed.

Repressing the Workers’ Voice The 1960 revolution somewhat activated the workers’ voice. The old anticommunist nationwide union was dissolved, and independent unions were formed. However, after the coup in 1961, Park dissolved all existing political organizations, including unions. Park then formed a new nationwide union, the Federation of Korean Trade Unions (FKTU), which became heir to the old anticommunist union. Park, like Lee, was preoccupied with anticommunism and repressed independent unions. Park also thought it a luxury to allow them. Park’s junta revised labor laws. It barely revised the Labor Standard Act, in spite of employers’ demands to lower the standard, thus leaving a large gap between the law and reality intact. The junta, on the other hand, limited union rights by introducing the virtual licensing for organizing unions and prohibiting multiple unions. Park encouraged industrial unions instead of the enterprise unions that the Rhee government had preferred. Park did so thinking that industrial unions would make the control of workers easier. Though the laws limited union rights, they did not block the organization of unions itself. The leaders of FKTU as the sole nationwide union had little interest in building independent unions, but at least officially they had to behave as the spokesman of the workers. At the enterprise level, some union officials came into close contact with workers and represented their interest. At the same time, the number of wageworkers increased rapidly, with the desire to have their voices heard. Thus, not only the number of union members increased but also the unionization rate rose. Figure 7.3 shows the unionization rate measured as the number of union members as a percentage of wageworkers. The unionization rate rose steadily in the 1960s and 1970s.

208 The Tortuous Path of South Korean Economic Development 25.0

20.0

15.0

10.0

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93 19 96 19 99 20 02 20 05 20 08 20 11 20 14 20 17 20 20

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Unionization rate

Figure 7.3  Unionization rate, 1963–2021 (percent) Source: Appendix 6.

Employers did not like to see unions organized even with the limited rights and tried to block unionization by various means; once unions were organized, they tried to undermine their normal operations. They employed illegal as well as legal tactics. Many of them formed “company unions” to obstruct independent unions. They often used threats and sometimes resorted to violence against union activists, including beating, confinement, stabbings, and, though rarely, gang raping if they were female. Employers mobilized thugs, gangsters, and co-opted workers in exerting the violence.13 The large discrepancy of the Labor Standard Act from reality and the prevalence of the illegal actions by employers provided a large room for discretion for the administrative officials. Their attitude was critically influenced by Park’s attitude, which was best revealed by the fact that seven out of the first ten heads of the Labor Agency

13

Shin (2004).

Growth with Equity? 209 (established in 1963 and promoted to a ministry in 1981, and currently the Ministry of Employment and Labor) were ex-policemen.14 There was also the surveillance by the police and the secret police – the Korean CIA. The court was more independent than the administration, but it was also greatly influenced by the political atmosphere under Park’s rule. The bottom line was the condition inherited from the 1950s that the pursuit of anticommunism could overrule the constitution that defined union rights. Unions felt relatively less pressure from the government until the mid-1960s when the size of the working class was small and wages did not rise rapidly. Subsequently, the Park government intensified the pressure on unions. Park also briefly looked abroad to encourage foreign direct investment and tried to assure foreign investors that they could count on labor peace. In the early 1970s, Park strengthened his authoritarian grip on the country, declaring himself as lifetime president in 1972. The government revised the labor laws in 1973 and 1974 to further restrict union rights. In addition, the rule of law fatally weakened after 1972 so the administration could intervene without much regard to laws. Park switched from the previous control of the workers through industrial unions to the direct control of individual workers through enterprise unions, police, secret police, and the military.15 As a result, from the late 1970s, the private violence wielded by the employers relatively declined, being replaced by police and military actions.16 In spite of such repression, an average of a hundred cases of virtually illegal disputes occurred every year. They were largely wildcat strikes, often sparked by incidents such as the failure of employers to pay wages, the closing of a plant, or the efforts of the employers to create company unions. Eventually, a wildcat strike dealt a blow to Park’s government. In the summer of 1979, young female workers of YH Trading Company, a moderately sized wig-manufacturing firm,

14 15 16

Lee (2002: 381). Lee Yung Chul (2004). Shin (2004: 237–238).

210 The Tortuous Path of South Korean Economic Development were protesting its closure, on the ground that the closure was due to their boss’s absconding with the money he had stolen from the company. As the police beat them ruthlessly, they escaped to the opposition party’s headquarter building. When the police stormed the building, a young female worker was killed; she turned out to have saved money to send it home so that her younger brothers could afford higher education. The accident invoked bitter criticisms, including that of the Carter administration of the United States, contributing to the downfall of the Park government.17

7.2  Slowing Inequality, More Oppression, and Beyond In the 1980s, inequality stopped rising or rose more slowly, as shown in Figure 7.1, where the top one percent income share curve flattened and the top ten percent share curve slowed its rising trend. South Korea was now undergoing “growth with maintaining the existing level of inequality” or “growth with more slowly rising inequality.” The rise of real estate prices also slowed. This happened while the Chun Doo-hwan government intensified repressing the workers’ voices. It was becoming clear that the repression could not persist, as workers wanted to have their voices heard and the democratization movement was on the way.

Slowing Inequality with More Oppression There is no explanation why the top one percent share curve flattened while the top ten percent share curve only slowed to rise in the 1980s; however, the two curves together show that inequality at least slowed its widening. This happened basically because jobs continued to grow while the factors offsetting its effect weakened. The unemployment rate soared with the 1979 crisis and the ensuing recession, widening inequality. However, the effect of rising unemployment was somewhat offset by Chun’s incomes policy that

17

Cumings (1997: 373–374).

Growth with Equity? 211 froze the salaries of the higher-income workers of chaebol firms, the public sector, and the semi-public sector. Unemployment rate fell again with the resumption of the HEG, as shown in Figure 4.2. It had soared from 3.2 percent in 1978 to 5.2 percent in 1980 but fell consistently thereafter. Real wages rose quickly again. David Lindauer compared the Korean experience in the rise of employment and real wages from 1965 to 1986 (the year before democratization) with that of other large, rapidly growing non-oil exporting middle-income countries and found that South Korea ranked first in terms of the rise of both employment and real wages among the compared countries.18 This helped to reduce inequality as well as pull people out of poverty. The rural–urban income gap continued to grow, but its contribution to overall inequality fell over the years. The disinflation policy widened inequality between rural and urban households as it weakened the dual price system for rice and barley (The dual price system, upholding rural households’ income while keeping the urban households’ living cost down, produced a large fiscal deficit, so it was a main target of the fiscal retrenchment by Chun government). The dual price system persisted in a weakened form, particularly for rice; the Korean government stuck to rice self-sufficiency even when it got the US pressure to open up the agricultural market from the mid1980s on. Still, the policy could not keep the income gap between rural and urban households from widening. However, the rural–urban income gap came to account for less of the overall inequality as the agricultural population shrank rapidly in weight. By 1987, the last year of Chun’s rule, the primary sector’s share in total employment fell to 23.0 percent (See Appendix 9). The factors offsetting the effect of job creation also weakened with the changes in the structure of supply and demand for labor in the urban area. The demand for skilled labor continued to increase, but its supply came to surpass its demand in relative terms. The supply of skilled labor continued to grow rapidly as education rose

18

Lindauer (1997)

212 The Tortuous Path of South Korean Economic Development sharply in all levels, while the supply of unskilled labor slowed down as the unemployed or underemployed workers dried up. Particularly important was the Chun Doo-hwan government’s more than doubling of the college enrollment quotas in 1981, which increased the relative supply of college graduates drastically while the relative demand for college graduates did not increase as much. As a result, the wage gap between college graduates and high school graduates narrowed in the 1980s.19 In addition, firms and other institutions were probably nearing the completion of building a hierarchy by the 1980s. Export-oriented industrialization also reduced inequality. South Korea traded mainly with advanced countries such as the United States and Japan, exporting unskilled labor-intensive goods and importing skilled labor-intensive goods. That benefited unskilled workers at the expense of skilled workers through “factorprice equalization.” During Chun’s rule, real estate speculation became less rampant mainly owing to the disinflation policy. From 1980 to 1986, the capital gains accruing to privately owned lands averaged 34.0 percent of GDP – still a large figure but falling far short of the 84.9 percent from 1965 to 1979. The transfer to the poor remained minimal with the government expenditure on welfare (health and social protection) rising slightly from 2.1 percent of GDP in 1980 to 2.5 percent of GDP in 1987. Yet it is notable that the share of welfare expenditure in GDP rose even through Chun’s fiscal retrenchment from 1982 to 1987, though with some ups and downs (See Figure 5.3). The Chun government then included the extension of welfare programs in the Sixth Five-Year Economic and Social Development Plan launched in 1987 (mentioned in Chapter 5). On the other hand, the Chun government repressed the workers’ voice more severely than the Park government had. Independent unions were briefly activated after Park’s assassination, but Chun quickly snuffed them out. His government revised labor laws to

19

Park (2014); Koh (2019).

Growth with Equity? 213 further weaken unions. The new laws made enterprise unions mandatory. Chun was completing the direct control of individual workers that Park had started in the 1970s, so now he forcefully imposed enterprise unions to weaken the overall union power. The new laws prohibited the involvement of third parties, including trade union federations, in workplace industrial relations as well as activity outside the workplace. A long cooling-off period for strikes was imposed. Government officials exerted wide-ranging discretionary power, including the rights to order the dissolution of particular unions, limit the qualifications of union officers, demand the re-​election of particular union officers and inspect the daily operations of unions. FKTU officials were put under the direct control of the government. The government intervention was more intensive for large enterprises, notably chaebol firms, where the strong government surveillance made it difficult to organize unions themselves. However, SMEs could also count on government officials, who were ready to intervene whenever labor unrest arose. More generally, Chun further undermined the rule of law, forming an atmosphere of terror and arbitrariness, which affected the behavior of the court as well as the administration. Chun’s direct control over individual workers made South Korea differ from other newly industrializing East Asian economies at the time, where the governments abstained from directly intervening in the industrial relations of workplaces.20 As the government assumed the role of repressing independent unions directly, employers wielded relatively less violence privately, a continuity from the late 1970s.21 At the same time, they came to have little incentive to develop cooperative industrial relations by themselves; they were accustomed to solving the conflict easily by relying on government intervention.



20 21

Fields (1994). Shin (2004: 237–238).

214 The Tortuous Path of South Korean Economic Development The repression inflicted by the Chun government led to the decline of the unionization rate, as shown in Figure 7.3. However, the heavy government intervention in industrial relations led to their politicization. Industrial relations had already been politicized, but it intensified under Chun’s rule. The Chun government tried to control unions as an effort to eliminate the base for political opposition to his rule. Industrial relations were thus closely associated with the democratization movement.

Changes in Order The South Korean case showed that growth mattered. The economy grew rapidly with minimal welfare system and the repression of workers’ voice, but such growth created jobs massively to reduce poverty and eventually inequality. Jobs were indeed the best form of welfare. In this respect, the country apparently stood in contrast to the majority of developing countries. They often had a better welfare system but failed to help the poor much because of the poor delivery systems. Their unions often undermined growth by interrupting firms’ investment decisions and reducing investable funds; they tended to breed inequality by representing the interests of a small number of privileged “insiders” who already had good jobs at the expense of the “outsiders” who did not.22 However, it was highly questionable whether South Korea could continue with the system. Without changes, growth itself could become unsustainable because of the rising conflict. The conflict had been there during Park’s rule, but it intensified greatly under Chun’s rule. The conflict was still coming mainly from the discontent of the workers rather than the poor unable to work. Notwithstanding the rising real wages, workers were not happy with their situation. They were suffering the relative deprivation caused, among others, by the rising real estate prices (which continued under Chun’s rule, though on a smaller scale).

22

See, for example, Bhagwati and Panagariya (2013).

Growth with Equity? 215 The workplace situation was also painful. Working hours were long. Long working hours represented improvement over the unemployment or underemployment the workers had escaped from. Yet long working hours were still painful; workers often worked to physical exhaustion. Without any significant social safety net, workers had to prepare for the retirement all by themselves. In addition, with less government expenditure on higher education, older workers had to pay the education cost of their children. Average working hours per week increased to more than 50 hours a week in the 1970s, to peak at 52.5 hours in 1983 and 1986 (See Appendix 6). The length of the South Korea’s workweek stood out when placed alongside the experience of other economies, no other country reporting a workweek longer than South Korea’s, including the contemporary newly industrializing economies of Taiwan, Hong Kong, and Singapore.23 The working environment was usually poor and sometimes terrible, with poor air quality, exposure to toxic materials, high risk of injury, and so on. This environment together with long working hours often threatened the health of workers, leading to a high industrial accident ratio, though it fell consistently after initially rising shortly with the beginning of the HEG (See Appendix 6). There is no study to systematically compare South Korea’s industrial accident ratio during the HEG period with other countries’, given the admittedly questionable accuracy of the data all over the world, but it was surely one of the highest in the world.24 Industrial accident insurance was first introduced in 1963 for workplaces with 500 workers or more, and was later extended to smaller units. Employers bore 100 percent of the cost, in contrast to the pensions and health insurance where they contributed half. However, that could only partially offset the agony coming from the high industrial accident ratio.



23 24

Lee and Lindauer (1997b: 80–81). Vogel and Lindauer (1997: 159–160).

216 The Tortuous Path of South Korean Economic Development The social approval for the working class was low. The middle class and upper class looked down on them, as illustrated by the widespread use of the terms gongdori and gongsuni, which can be translated roughly as “lowly factory guy” and “lowly factory girl,” respectively. Within workplaces, workers operated under a strict hierarchy determined by their educational background and gender. Threats, abuse, beating, sexual harassment, and (more rarely) rape, which tended to be inflicted on union activists, were often part of the daily lives of many workers, though in a milder form. The composition of industrial workers initially helped to make them compliant. They were mostly composed of young, unmarried, and relatively less educated female workers with rural backgrounds. Traditional attitudes of subservience to male authority also made them compliant. Male workers were similarly compliant. Since 1950, almost all young Korean males served two or more years in the military, where they became accustomed to high levels of discipline. By international standards, South Korea’s industrial work was much regimented, but to the vast majority of male workers who were returning servicemen, it was, if anything, far less regimented than the life they knew. Over the years, however, the nature of the workforce changed. By the late 1970s, the new recruits into the HCIs were less rural and better educated than previous industrial recruits, with a majority having at least a junior high school education. They were young: In 1986, the median age of the workers in manufacturing was 30.25 These young people often had no personal memory of escaping from the hunger and poverty that the older generation had. Those workers wanted to have their voices heard. Repressing the workers’ voice was becoming ever more difficult to continue, making change inevitable. The change would largely depend on political change, not least because industrial relations were politicized. The overwhelming political change in the

25

Lindauer (1997: 47).

Growth with Equity? 217 1980s was of course democratization. There are few significant studies about the role working class played in South Korea’s democratization. It was students, not workers, who bore the brunt of the burden in the democratization movement. However, if workers’ discontent was combined with student activism, it would be a serious threat to the establishment, not to mention the military government. The threat was indeed forming as intellectuals, including university students, were entering the labor movement. In the 1970s, some church workers came to give refuge to suffering workers. Then, student activists leading the democratization movement were coming to factories as blue-collar workers, concealing their educational background. They were called “disguised workers.” Nobody knows the exact number of disguised workers; only very broad guesses can be made that they may have numbered 1,000 to 10,000. They provided leadership to dissatisfied workers, providing a voice for groups that lacked an outlet not provided by co-opted union officials. They organized strikes illegally. These strikes were no longer wildcat strikes but strikes with a political agenda against the “forces of oppression.”26 The emergence of disguised workers represented the depth of the crisis the country was undergoing in the 1980s. Few systematic studies have analyzed the ideological orientation of the disguised workers and their objectives. It would certainly be inaccurate to guess that all of them were leftist revolutionaries. It is yet certain that most of them aimed at more than introducing mere “bourgeois democracy,” whereby people would just elect their leaders while leaving the edifice of the economy and society intact. Thus, the decades-long repression of the workers’ voice was providing a ground for touching off a social revolution. Of course, how things would really unfold depended on the broader politics of democratization involving various forces of the society, including the elites and the middle class.

26

Vogel and Lindauer (1997: 105).

218 The Tortuous Path of South Korean Economic Development

7.3  Sustaining Growth with Democratization South Korea democratized after more than two decades of HEG under authoritarian rule. The critical moment was the June 29 Declaration in 1987 by the presidential candidate Roh Tae-woo of Chun Doohwan’s ruling party. The country sustained the HEG through the process of democratization. According to the old modernization school, economic growth provides the conditions for democratization, by generating an increasingly more educated middle class, which then fosters the values of political toleration, trust, satisfaction, and competence, making democratization more likely. More recently, economists and political scientists have tried to analyze democratization making use of game theory. The essence of the idea is that democratization is easier if wealthy elites expect that a democratic transition will not undermine their privileged position. The two ideas in fact coincide with each other because the existence of a large middle class will make wealthy elites believe that democratic transition will not undermine their privileged position through the expropriation of or heavy taxation on their wealth and income. In such a case, wealthy elites accept democratization instead of spending their resources to block it. It is also likely that, when the elites think that they have the effective means to counter the move for expropriation or taxation, they tend to accept democratization. Thus, democratization is easier when the elites’ wealth is composed of mobile assets that could be moved overseas rather than immobile assets such as land that cannot be moved overseas. However, inequality and democratization are likely to have a nonlinear rather than linear relationship because, while the high level of inequality makes the elites fear the result of democratization, the low level of inequality makes the people not aspire for democratization. Democratic transition is thus the likeliest in countries with the middle level of inequality.27 This may explain South Korea’s democratic transition well.

27

Acemoglu and Robinson (2006: Parts I–III).

Growth with Equity? 219

Chaebol, Middle Class, and Students To make the game theoretic explanation operational, one has to define who are elites and who are middle class. Nobody has done that for South Korea, but chaebol were no doubt elites. Chaebol could rely on the thick layer of the middle class, including their own employees, who would not want to change the status quo radically. Chaebol could also drive any democratically elected government into dysfunction by sabotaging investment, even though they could not easily move their assets overseas. Moreover, by the 1980s, chaebol were tired of the extortion by the military governments. They were ambivalent in this regard. They had benefited, and were still benefiting, enormously from the cronyism with the military governments, but they were increasingly feeling unhappy with the extortion. Chaebol in this regard resembled the European bourgeois in earlier times, who had benefited from the mercantilist policy but, as the rising new economic elite, wanted to achieve independence from the old political elites expropriating their income and assets.28 Chaebol were more unhappy with Chun than Park because, whereas Park had extorted them while increasing government favors, Chun extorted them while reducing the favors. It is not easy to define who were middle class. In purely economic terms, one could define the middle class as the group of people belonging to certain cohorts of distribution. According to this criterion, the South Korean middle class may well have shrunk after the HEG began as income and wealth distribution became more unequal. However, one needs to define middle class in the historical context. Industrialization produces the old middle class (small business owners) and the new middle class (white-collar workers). South Korea’s HEG produced the old middle class as many new firms sprang up or existing small firms expanded in size. The new middle class also grew rapidly in size with the growth of large private enterprises, the public sector, and the semi-public sector. The new middle class, in

28

See Ansell and Samuels (2010) for this motivation as a ground for democratization.

220 The Tortuous Path of South Korean Economic Development particular, became ever better educated. The emergence of a large middle class was reflected in people’s perceptions. A survey shows that, by 1984, 74.9 percent of the population regarded themselves as belonging to the middle class.29 One may raise a question about the figure on the ground that “class” was a taboo word under the fearsome anticommunist atmosphere. Indeed, the survey used a variant term that could be translated into “middle-propertied stratum,” the term that had earlier replaced the term middle class. The point was that so many people subjectively regarded themselves as belonging to the middle strata of the society. And yet they were not necessarily satisfied with the distribution of income and wealth. Distribution was still equal compared with other developing countries, but inequality had expanded rapidly and was still expanding, though more slowly. The relative deprivation coming from the transfer of wealth through the real estate market was serious. The high figure of 74.9 percent suggests that some blue-collar workers regarded themselves as belonging to the middle strata of the society, but their feelings of relative deprivation and humiliation were also there. Thus, South Korea fit the case of a democratic transition with the middle level of inequality. However, the position of chaebol and the middle class was no more than a necessary condition for democratization. There were political elites comprising the military government, who, unlike chaebol, had much to lose from democratization and a strong reason to fear its results. They would not release power unless they were forced to. Only the democratization movement could force them to release power. Chaebol and the middle class were yet unwilling to fight for democracy through beating, torture, and imprisonment by the military government. It was student activists that dared to do so. Their behavior was independent of economic conditions, at least from the March First Movement in 1919. In

29

Hong (2005: 112).

Growth with Equity? 221 1960, the shortage of jobs for the educated youths provided a condition for the revolution; in the 1980s, the abundance of jobs for college graduates could not stop student activists from fighting for democracy. At its core, the democratization process was the headon clash between the Chun clique leading the military government and the student activists. Such a confrontation would inevitably occur in the international context. International context is always important for democratization, but in South Korea, it was far more important than in other developing countries because of the presence of the United States.

The Confrontation and the Consequences Over the years, with the ever-intensifying repression by the military governments, student activists became ever more radical. It inevitably involved the reflections on the country’s relationship with the United States. Park Chung Hee was assassinated by the chief of his secret police – Korean CIA – while his relationship with Carter administration was going from bad to worse. Nobody knows whether the assassin received some signal from Washington before acting, but some concerned US officials said that he had acted after “misreading” them.30 Chun’s bloody coups, first through purging his opponents in the army in December 1979 and then clamping down on the Kwangju Uprising in May 1980, occurred while the United States maintained operational control of the South Korean armed forces. Immediately after the bloody clampdown on Kwangju Uprising, the commander of the US forces in South Korea, General John A. Wickham, suggested in an interview with the Los Angeles Times that the United States had, in effect, decided to support Chun as the country’s next president and that all the South Korean people were lining up behind Chun like “lemmings.”31 Several months later, in February 1981, Ronald Reagan himself accorded



30 31

Oberdorfer and Carlin (2014: 91). Eckert et al. (1990: 380).

222 The Tortuous Path of South Korean Economic Development Chun the honor of being the first head of state to visit the White House. Domestically, Chun was trying to boost his legitimacy by boasting the intimacy with the United States, which badly backfired, confirming the suspicion that Chun was no more than a US lackey. Student activists’ perception got support from intellectual circles, themselves undergoing similar radicalization from the late 1970s. Opposition intellectuals began to reinterpret the Korean history from just before and immediately after the liberation, claiming that the majority of the country’s ruling elites had been the collaborators of the Japanese colonial rule who then transformed themselves into the collaborators of the US occupation. Their belief was supported by the surge of the revisionist school overseas, led by the publication of Bruce Cumings’s book in 1981 on the origins of the Korean War. To the student activists and opposition intellectuals, the beatings and torture by the police and secret police were the déjà vu of what had happened under the Japanese colonial rule. The bloody clampdown on Kwangju Uprising was reminiscent of what had happened to people’s committees after the liberation. The Chun government avoided a currency crisis making use of its close relationship with the Reagan administration to enlist the assistance of Japan, as mentioned in Chapter 5. However, to student activists and opposition intellectuals, such a thing, if they had noticed it at all, merely revealed South Korea’s dual dependence on the United States and Japan. Even some scholars of the Western learning who paid attention to the arrangement, such as Carter Eckert and Woo Jung-en, had a cynical view about that.32 Their views were not groundless because, viewed from a different angle, it was part of Japan’s intervention in South Korea’s domestic politics. The deal came to be realized with the coming of the Nakasone Yasuhiro cabinet, the most right-leaning of the Japanese cabinets until that time. The mediator of the deal was the old guard of the Japanese Empire

32

Eckert et al. (1990: 393); Woo (1991: 182–187).

Growth with Equity? 223 who had served as a military officer in Manchukuo; he advised Chun to host the 1998 Olympic Games to weaken the resistance to his illegal seizure of power in 1980.33 In the process of radicalization, quite a few student activists became pro-North Korea. The emergence of the disguised workers mentioned above also represented such radicalization. Their ideas were anachronism to most observers aware of what was happening outside the country, particularly in China, the Soviet Union, and Eastern Europe, not to mention North Korea. There were a large number of Western-educated university professors, many of whom knew that well, but those professors and student activists were like aliens to each other. Radicals were surely a minority among the population, but they were the ones willing to fight to the teeth under the extreme oppression. The majority of South Koreans supported them simply because there was no alternative force to fight for democracy to the end. The country was in a deep political crisis by the mid-1980s. The Reagan administration was now worried that a social revolution may break out in South Korea. It dispatched a career CIA officer, James R. Lilley, to be the US ambassador in Seoul. During normal times, he would have been overqualified for the job, which can be read from the assignment of his next job: ambassador to Beijing. Lilley supported, almost to the last moment, the indirect election of the president that Chun attempted to impose on the people in order to extend the military dictatorship. However, when Chun decided to clamp down on the protests with military force on June 19, Reagan sent a personal letter to Chun via Lilley. Chun decided not to challenge Reagan, trying to make a breakthrough by accepting the direct election of the president.34 Chun was also not sure of the loyalty of the army, with some of the officers reluctant to see further bloodshed. All these led to the June 29 Declaration on Democratization in 1987.



33 34

www.joongang.co.kr/article/3133239#home Lilley (2004: Chapter 17).

224 The Tortuous Path of South Korean Economic Development What would have happened had the head-on clash between Chun and student activists gone on? The counterfactual assumption is again troublesome, but the clash would probably have led to another terrible bloodshed like the one in Kwangju in 1980, now at the center of Seoul. The situation may have become uncontrollable, precipitating a social revolution. At least, the ensuing political instability could have seriously undermined economic growth. In this sense, democratization was indispensable for sustaining growth; South Korea was to sustain economic growth owing to, not in spite of, democratization. The 1988 Summer Olympic Games in Seoul were the comingout party of South Korea’s democratization as well as its economic miracle. In fact, it was more than that. In the games, East Germany did spectacularly well together with the Soviet Union. The United States showed a relatively lackluster performance; more distressingly, in the games, South Korean crowds hailed whoever were the opponents of the US teams or players. However, underlying the surface was a different current. South Korea’s democratization process was probably the last battle of the Cold War, fought on its domestic front, only a few years before it ended. More significantly, it was probably the last significant fight for Third World nationalism, also domestically fought. Outside the country, Third World nationalism had been waning, not least due to South Korea’s economic development. South Korean economic development, together with the Taiwanese one, played a critical role in China’s decision for reform and opening in 1978. Chinese leaders like Deng Xiaoping had seen what was happening in South Korea and Taiwan, though that kind of influence leaves few formal records. Vietnam, which had won the national liberation war against the United States just three years before China switched policy, followed on the heels of China from 1986 on. India would join the move later, but it was becoming ever clearer in the 1980s that the economic policies of the old Third World nationalism were not working in view of the performance of the East Asian Tigers.35

35

Bhagwati (2004: Chapter 5).

Growth with Equity? 225 South Korea also transformed its posture in the world over the years. Still being a vanguard of the Cold War, the country had to become more pragmatic out of the logic of economic development. After the First Oil Shock, the country sent a massive number of construction workers to the oil producing Muslim countries, making use of the experience of the construction work in the Vietnam War. The Muslim countries included not only the pro-US ones like Saudi Arabia and Shah’s Iran, but also Muammar Gaddafi’s Libya. South Korea continued the efforts to court the Third World countries subsequently. In 1983, Chun Doo-hwan visited Yangon, Myanmar, an early champion of Third World nationalism that came to have a positive view about South Korea’s economic development by that time. Chun was almost killed by North Korea’s terror at the Martyrs’ Mausoleum of Yangon. The incident signified the changing position of South Korea and North Korea in the Third World. The Chun government then secretly prepared for the rapprochement with China and the Soviet Union, which the succeeding Roh Tae-woo government (February 1988–February 1993) formally launched. To the radical student activists and intellectuals who had borne the brunt of the burden in the democratization movement, this was the last phase of the illusion and disillusion in modern Korean history. It finally transpired that the story of “the brave men leading the jump in history” was incorrect. However, it is also true that, without their belief in the jump in history, democratization would have been impossible.

Growth after Democratization What was the effect of democratization on economic growth? As mentioned in Chapter 4, democracy and economic growth are likely to have a nonlinear relationship with each other. Authoritarian regimes have high- and low-growth rates; democratic regimes have intermediate growth rates. In the low-growth authoritarian regimes, democratization enhances growth rate by ending the kleptocracy. On the other hand, in the high-growth authoritarian regimes,

226 The Tortuous Path of South Korean Economic Development democratization may well reduce growth rate by eliminating the authoritarian government that has single-mindedly pursued growth. South Korea had no doubt belonged to the high-growth authoritarian regime, but there was no slowdown of growth after democratization. In fact, as mentioned in Chapter 1, South Korea is the only country to have experienced a rise in growth rate following democratization. How did South Korea manage to maintain the HEG after the democratization? Chapter 5 examined the macroeconomic policies that sustained the HEG after the 1986–1988 boom ended. The government boosted domestic demand, but there was no macroeconomic populism. Such a situation must be explained by political conditions. The country was able to sustain the HEG after the democratization because, once the head-on clash between the Chun clique and the student activists was over, the conditions for democratization worked themselves out. Chaebol and the middle class saw their expectations met. Democratization indeed did not lead to the expropriation of or heavy taxation on their income and wealth. Democratization remained limited. The leaders of the democratization movement could not form independent political forces, such as a progressive party. Instead, existing politicians and parties took over the politics, recruiting some leaders of the democratization movement individually. Those existing politicians and parties were far from being leftist by global standards, though there were some nuanced differences among them. Politics took the form of “boss politics,” centered on the presidential candidates, who had their voter bases in regions rather than classes. Moreover, the split of the opposition led to the election of Roh Tae-woo, a colleague of Chun Doo-hwan, as the first president after the democratization in December 1987. The next president, Kim Young-sam, the first civilian president in 32 years, was elected in 1992 after having merged his party with Chun and Roh’s in 1990.36

36

See Kong (2000: Chapter 4) for a detailed account of Korea’s limited democratization.

Growth with Equity? 227 Democratization did not leave the elites’ interests completely intact. Most of all, democratization activated independent unions for the first time in Korean history. Strikes erupted on a gigantic scale across the country immediately after the June 29 Declaration. There were approximately 3,500 labor disputes in July and August of 1987 alone and 3,749 in total during the year, a huge jump from 289 in 1986. They were mostly wildcat strikes, displaying the spontaneous explosion of workers’ mass grievances. The issues were about wage increases in most cases, but they also included the longer-run task of organizing new unions if there had been none or ousting the existing company unions. However, the government basically retained control over the labor movement. Strikes erupted on an enormous scale in 1987 because the government suddenly withdrew from the intervention, being concerned about the upcoming elections and about incidents that might interfere with the 1988 Seoul Olympics. The general public accepted the situation recognizing the workers’ suffering under the severe repression of their voice during the authoritarian era. Yet by the end of 1988, the government surmised that the general public had grown weary of the labor protests. In January 1989, the government arrested strikers, called in masses of unionized workers for questioning, and jailed about 200 to 300 strike leaders.37 Union rights also remained limited in global standard. After the massive eruption of strikes, the National Assembly passed a liberal bill despite strong opposition from businesses in 1987; however, Roh Tae-woo vetoed the bill in 1988, accommodating the demand of businesses. The new labor laws enacted subsequently still prohibited multiple unions both at the enterprise and national levels, allowing the monopoly of FKTU as nationwide union. The laws limited the involvement of third parties in workplace industrial relations, and banned teachers’ unions and government employees’ unions. They also prohibited the political activity by unions.

37

Vogel and Lindauer (1997: 110).

228 The Tortuous Path of South Korean Economic Development

7.4  Inequality and Reform after the Democratization The limited nature of the democratization enabled the country to sustain the HEG. It thereby maintained the ability to create jobs, which had been the main mechanism to manage social conflict by reducing inequality as well as poverty. Democratization yet had some effect on inequality by itself. Of course, democratization interacted with other changing conditions of the economy to affect inequality. At the same time, democratization led to the reforms to enhance the transparency of the economy and institute independent unions, which would affect the management of social conflict.

The Trend of Inequality Figure 7.1 suggests that democratization did not lead to the reduction of inequality. Both Top one percent (1) and Top one percent (2) continued the flat trend begun earlier. Top ten percent (1) and Top ten percent (2) show somewhat different trends from each other after the democratization. Top ten percent (1) continued the rising trend begun earlier for several years but fell in the mid-1990s, while Top ten percent (2) continued the crawling up trend begun earlier. However, neither shows that the top ten percent share fell after the democratization on net basis. The foremost reason that democratization failed to lead to the reduction of inequality should be the limited nature of the democratization. However, other factors affecting the trend of inequality interacted with democratization to produce the result appearing in Figure 7.1. The first such factor was technological change and globalization. In the 1990s, South Korea underwent “skill-biased technological change” as it was graduating from the catch-up stage and jumping into the newly emerging industries, as explained in Chapter 6. Skillbiased technological change increased the demand for skilled labor. The country traded mainly with the countries richer than itself, such as the United States and Japan, but in the 1990s, it began to trade

Growth with Equity? 229 more with the countries poorer than itself, particularly China. As a result, the demand for skilled labor increased in relative terms. The government tried to cope with the changing structure of labor demand mainly by raising the college attendance ratio. College attendance ratio doubled again from 1989 to 1997, but the college wage premium rose in the 1990s because the supply of skilled labor lagged behind the demand.38 Second, there was the effect of independent unions, which was the result of democratization. Independent unions, in spite of the limitation of their rights, raised wages at the expense of firm profitability.39 This reduced inequality because wages were more equally distributed than profits (more on this in Chapter 11). Independent unions also reduced the wage gap within individual enterprises. The effect was especially strong with large enterprises, many of which were newly unionized as the government lifted surveillance over them after the democratization. However, the unionization of large enterprises had uncertain effects on the inequality of wages. While it reduced the wage gap within individual large enterprises, it widened the wage gap between large enterprises’ workers and SMEs’ workers. Particularly, it widened the wage gap between large enterprises’ workers and their subcontractors’ workers, as large enterprises put pressure on the subcontractors to offset the burden of the rising wages for their own workers.40 Third, the share of large enterprises in employment fell while their workers’ productivity rose faster than SME workers’ (See Appendix 10). The share of large enterprises in employment fell first because subcontracting continued to increase. Large enterprises also increased automation to save labor more than SMEs. Automation was easier for large enterprises because they could better mobilize the funds needed and realize economies of scale with more fixed investment. The government policy also reduced the share of large

38 39 40

Park (2014); Koh (2019). See Lee (2012) for the effect of unions on firm profitability after the democratization. Kim (2019) elaborates upon this possibility.

230 The Tortuous Path of South Korean Economic Development enterprises in employment. Since the Chun Doo-hwan government had begun to promote SMEs, they received ever more favors from the government. Over the years, more than 100 favors came to be decided by the threshold defining the status of large enterprises and SMEs, which was usually set at 300 workers. Thus, large enterprises not far from the threshold had the incentive to move to the status of SMEs by reducing the number of workers. Likewise, SMEs were unwilling to cross the threshold; the owner of a successful SME preferred partitioning it before crossing the threshold. Of course, firms raised automation and reduced employment size to avoid unionization or weaken the existing unions. Meanwhile, the productivity of large enterprises’ workers rose faster due to the better training and automation. When large enterprises employed a smaller share of workers whose productivity rose faster, it could widen inequality by producing a smaller group of workers receiving higher wages than other workers. The examination of these factors tells that probably Top ten percent (2) in Figure 7.1 is more accurate than Top ten percent (1), as none of the three factors is likely to have raised the top ten percent share immediately after the democratization and then lowered it in the mid-1990s. It also provides reasons to believe that top ten percent share rather than top one percent share rose in the 1990s. The skillbiased technological change that raised the college wage premium is likely to have raised top ten percent share. When large enterprises employed a smaller share of workers whose productivity rose faster, it probably raised top ten percent share more than top one percent share. Thus, the trend of inequality after the democratization basically continued the existing trend that top one percent share stayed flat and top ten percent share slowly rose. Democratization led to such results when it interacted with the factors discussed above on the condition of its limited nature.

Changes in the Transfer The effect of democratization on the transfer mechanism was not straightforward. Democratization coincided with another bout of

Growth with Equity? 231 real estate speculation, the main mechanism to transfer wealth to the rich. As mentioned in Chapter 5, the loose monetary policy in the 1986–1988 boom together with the shortage of housing raised real estate prices, which can be read from Figure 7.2. During the five years from 1987 to 1991, the capital gains on privately owned land averaged 89.6 percent of GDP. With democratization, the voice to address the problem was louder than ever. Now, the government carried out the survey of land ownership for the first time. The survey revealed that city land was very unevenly owned. As of June 1988, top five percent owned 65.2 percent of the land in major cities. The Gini coefficient for land ownership in the Seoul area was as high as 0.911.41 The Roh Tae-woo government, while expanding the housing supply, strengthened regulations on transactions of real estate, raised taxes on the ownership, and urged chaebol firms to sell idle land. These policies worked. The capital gains on privately owned land fell to 12.1 percent of GDP by 1992. In 1993, they fell to −19.9 percent of GDP, the first negative figure since 1965. The capital gains on privately owned land averaged no more than 6.8 percent of GDP during the five years from 1992 to 1996. This reduced inequality. Thus, during this period, South Korea was undergoing an economic performance closer to “growth with equity” than ever. Meanwhile, the welfare system, the mechanism to transfer income to the poor, saw some progress. It was not necessarily the result of democratization because the Chun Doo-hwan government had made the pre-emptive move. The limited nature of the democratization also restricted the expansion of the welfare system. Regardless of the causes, however, there was surely an expansion of the welfare system after democratization. National health insurance, which was first introduced in 1977 to workers in the firms with 500 or more employees, together with the public sector workers and private school teachers, extended the coverage to

41

Choi and Kwon (1997: 568).

232 The Tortuous Path of South Korean Economic Development the entire population in 1989. It was still a low-contribution, lowbenefit system, unable to cover the really costly diseases, but the expansion was clearly an important step forward. National Pension Service (NPS) was introduced in 1988 for workplaces with ten or more workers. In 1992, it was extended to workplaces with five or more workers. The unemployment insurance was introduced in 1995 for workplaces with 30 or more employees (The government named it “employment insurance”). Industrial accident insurance was extended to workplaces with ten or more workers in 1991 and five or more workers in 1992. South Korea thus more or less completed the edifice of a social insurance system by 1995. The share of welfare expenditure, measured as spending on health and social protection, rose from 2.5 percent of GDP in 1987 to 4.0 percent of GDP in 1997. Still, the effect of the welfare system on income distribution was minimal. Welfare expenditure of 4.0 percent of GDP in 1997 was minuscule compared with advanced countries’ 20 percent or more. Available evidence for income distribution shows that the redistribution through the social welfare was minimal. According to an estimation taking the taxation data into consideration, in 1996, the Gini coefficient was 0.303 for market income and 0.302 for disposable income, respectively; relative quintile share (top 20 percent income divided by bottom 80 percent share) was 4.57 and 4.51 for market income and disposable income, respectively.42 Two factors were responsible for the minimal redistribution through social insurance. First, it was incomplete, leaving a large proportion of the population still uncovered. Even those who were covered received small amount of benefit because of the immaturity of the system: They had contributed a small amount during a relatively short period of time so their benefit was small. The second reason was the demography: South Koreans were still young and the old-age dependency ratio was low (See Figure 11.6).

42

Kim and Kim (2013). Chapter 11 discusses other data about the redistribution.

Growth with Equity? 233

Enhancing Transparency While democratization affected inequality in an ambiguous way, it led to enhancing the transparency of the economy in a straightforward way. With the democratization, there was an ever louder voice to improve the transparency of the economy. Compiling the statistics on land ownership would thus have been impossible without democratization. Yet the foremost issue was the reinstallation of the “real name financial transaction system.” In the 1960s, the Park Chung Hee government repealed the system on the grounds of the necessity to mobilize domestic saving. South Koreans could make deposits in financial institutions under false names. This allowed the rich to own assets without revealing their identities, allowing them to evade taxes, to circumvent real estate regulations and corporate shareholder limits. The Chun Doo-hwan government flirted with the idea of introducing the real name financial transaction system in the early 1980s but quickly gave it up. After the democratization, a newly emerging “citizens’ move­­­ ment” played a leading role in the efforts to reinstall the real name financial transaction system. The Roh Tae-woo government acknowledged the necessity, some high-ranking government officials thinking that the country badly needed reforms after narrowly avoiding – it seemed to them – a social revolution.43 The Roh government, nevertheless, procrastinated. Vested interest groups, led by chaebol, made strenuous efforts to block the reform. Finally, Kim Young-sam introduced the system in August 1993, employing a blitzkrieg tactic, five months after he had purged the personal legacy of the military government with the same tactic. It represented his “politics of feeling” that had driven him to merge his party with the party of Chun Doo-hwan and Roh Tae-woo, describing himself as a “Trojan horse” that would conquer state power from the inside and reform it. The Ministry of Finance estimated that in 1993 over one million false

43

For example, Moon Hi-gap, Chief Economic Secretary of Roh Tae-woo, said that economic reform was necessary to stave off revolution (Moon 1992: 5).

234 The Tortuous Path of South Korean Economic Development names were used, corresponding to 30 trillion won – equivalent of 9.5 percent of GDP – in assets.44 When the reform was announced with the blitzkrieg tactic, a horrific outcry came out of the business community, but there is no evidence that the reform undermined growth. In addition to the real name financial transaction system, the Kim Young-sam government introduced the real name transaction system in real estate in 1995. Previously, real estate could be owned under the names of other people, making taxation and regulation impotent. The Kim government also legislated the disclosure of assets for high-ranking government officials. It also revised the political fund law to reduce the influence of money on politics. Kim finally arrested and tried former military leaders, including Chun Doo-hwan and Roh Tae-woo, on charges of corruption as well as rebellion, the corruption charge mainly being the creation of huge amounts of slush funds. This was ironic because Kim himself was a typical boss politician relying on slush funds (though he did not personally benefit from them, unlike Chun and Roh); it also later turned out that Roh had provided Kim with a huge amount of slush fund to be used in the presidential election in December 1992. However, Kim’s reform survived his incumbency and was reinforced subsequently. Though it is unclear whether enhancing transparency reduced inequality immediately, elites clearly lost in the long run as the transparency of the economy was enhanced. It helped to ease social conflict by reducing corruption and thereby making the existing distribution of income and wealth more legitimate.

Independent Unions Though the government basically retained control over the labor movement immediately after democratization, the democratization paved the road to institutionalizing modern industrial relations through independent unions, following what major advanced capitalist countries had done by the mid-twentieth century. With

44

Kang (2002: 167).

Growth with Equity? 235 democratization, the old industrial relations, involving repression, politicization, and the possibility of a social revolution – imagined or real – were coming to an end. Most disguised workers left the labor movement after democratization, leaving it to the union leaders coming out of the workers themselves, who were far less ideologically oriented. Of course, the process was not a smooth one. As the employers could no longer rely on the quick repression of unions by the government, they again resorted to private violence by mobilizing thugs, gangsters, and co-opted workers to tame unions. Government officials often acquiesced in such a behavior. However, the resort to violence invoked far more criticism than before the democratization, and gradually declined over the period as the rule of law was consolidated. Union membership rose by 34.7 percent for the six-month period from July to December in 1987. The unionization rate, after falling during the Chun era, rose from 12.3 percent in 1986 to 18.6 percent in 1989. The most significant development was the unionization of large enterprises, especially chaebol firms. Notable here was Hyundai chaebol, whose firms, none of which had been unionized before 1987, were all unionized after democratization. Hyundai chaebol could not help but recognize the unions as counterparts after several attempts to abolish them failed. The unions of Hyundai firms later became leading unions nationwide. Surprisingly, as shown in Figure 7.3, the unionization rate began to fall in the 1990s. The unionization rate fell in many advanced countries in the 1990s, but they were not the same as South Korea where independent unions were just emerging. The changes in industrial structure, that is, the falling share of manufacturing in employment, which peaked at 27.8 percent in 1989 (See Appendix 9), were not a reason because the unionization rate fell in the manufacturing sector itself. Few studies have clearly explained why the unionization rate fell in the 1990s. Yet the falling share of large enterprises in employment was one obvious reason because SME workers were

236 The Tortuous Path of South Korean Economic Development 800.0 700.0 600.0 500.0 400.0 300.0 200.0 100.0

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Figure 7.4  Propensity to strike, 1965–2021 Source: Appendix 6.

more difficult to organize. Of course, enterprises often reduced the size of employment to avoid unionization or to weaken the existing unions. Public opinion also turned less favorable to unions. The public was initially sympathetic to unions, remembering the pains of the workers in the previous era. However, they were sensitive to the disruptions caused by strikes. Over the period, many of them, alongside many economists, came to think that unions were representing the relatively well-to-do workers of large enterprises, which was not entirely groundless, as explained above. Still, there was no way back to the previous era. The country was learning to live with independent unions. Figure 7.4 presents the propensity to strike, calculated as the number of days lost in labor disputes per thousand wageworkers. The propensity fell drastically after skyrocketing in 1987. All concerned parties of industrial relations – workers, employers, and government officials – knew that the revision of the labor laws in 1988 was a temporary arrangement. Labor leaders demanded

Growth with Equity? 237 the reform of the labor laws to match the global standard. They organized an independent nationwide union, violating the existing laws and risking arrests. Finally, in 1995, they established the Korean Confederation of Trade Unions (KCTU), a new nationwide union alternative to the FKTU. The government also had to change the labor laws because of the OECD membership, which required the country to bring the labor laws up to par with the OECD rules gradually. Meanwhile, employers demanded an enhancement of labor market flexibility by revising the Labor Standard Act, which defines the individual protection of workers. Previously, there had been a large discrepancy between the law and the reality, but the law had tended to be treated as dead clauses under the authoritarian governments. Now, the law became more binding with democratization, so they wanted to see it revised. Employers particularly demanded to make it easier to hire and fire workers. The government formed a presidential committee for the reform, composed of the representatives of workers, employers, the government, and the public, in May 1996. The committee transferred the draft of the revised laws to the National Assembly. On December 26, the ruling party rushed the bill through at dawn, effectively keeping out the opposition party from the meeting. The ruling party’s revised labor laws were far more unfriendly to workers than the government’s draft. Such a move provoked a public outcry, reminiscent of the ruling party’s tactics during military rule. Immediately, the KCTU declared a nationwide general strike as a protest. Church leaders, writers, professors, and artists declared support for the general strike. The OECD and the International Labor Organization (ILO) also criticized the move. Humiliated, the ruling party withdrew the bill. The success of the general strike elevated the KCTU, still an illegal organization, to the position of the de facto national center for the labor movement. Though the FKTU eventually joined the strike, it did so too late to take a leading role.45

45

See Shin (2010) for the description of the unfolding of the process.

238 The Tortuous Path of South Korean Economic Development Independent unions did not undermine the HEG immediately. However, they aggravated the NPLs problem mentioned in Chapters 5 and 6. Union rights still fell short of the global standard, but they were strong enough to erode the profitability of individual firms. They eroded firm profitability even when firms were already producing NPLs. If the NPLs had worked as an immediate threat of firm bankruptcy, unions would not have eroded the profitability of such firms because the bankruptcy might threaten the job security of their members, which was as important as their wages. However, there was no such threat, especially to chaebol firms, as financial institutions, the NBFIs in particular, continued lending them (mentioned in Chapter 6).46 Moreover, the memory of the extraordinary wage gains granted from 1987 to 1989 made workers believe that firms could afford to pay higher and higher wages. Leadership in those unions gravitated toward the more radical members – those most willing to make huge demands and take part in militant action. Unions would thus be responsible for the 1997 crisis by aggravating the NPLs problem.



46

See Lee (2014).

Crisis and Reform

8

In 1997, South Korea underwent its largest-ever economic crisis, widely regarded as the worst disaster since the Korean War. It went to the IMF, cap in hand, to obtain liquidity. The sharp economic downturn the IMF conditionality brought about was painful for the majority of the population. They created new phrases like “I Am Fired” or “I Am Finished” for the acronym IMF. In contrast, Michel Camdessus, the then-Managing Director of the IMF, said that the crisis could be a “blessing in disguise” for crisis-hit countries like South Korea.1 Many South Korean leaders agreed with Camdessus, including Kim Dae-jung, who was elected president at the height of the crisis in December 1997. The majority of South Koreans also agreed with Camdessus and Kim, in spite of the pains of the downturn. The country carried out a thoroughgoing reform, adding many “pluses” to the IMF conditionality. This happened while many observers outside the country criticized the IMF’s handling of the crisis. How to view the nature of the crisis and the ensuing reform is still a controversial issue. This chapter tries to address the problem.

8.1  The Nature of the Crisis The 1997 crisis began with the outbreak of the liquidity crisis as a result of the policy enacted by the Kim Young-sam government mentioned at the end of Chapter 6. It had restricted the conventional ways of borrowing for chaebol, which chaebol circumvented by issuing commercial papers to NBFIs and trust accounts of banks. This happened while many chaebol were already producing NPLs. In such a situation, the bankruptcy of one chaebol would lead to the chain

1

www.imf.org/en/News/Articles/2015/09/28/04/53/spmds9717

239

240 The Tortuous Path of South Korean Economic Development bankruptcies of other chaebol and financial institutions. Six out of the 34 largest chaebol that had been included in the Fair Trade Commission’s list of the 30 largest chaebol at least once from 1993 to 1997 but surviving until the beginning of 1997 went bankrupt before the country went to the IMF on November 21 (There were 36 chaebol included in the list, but two had gone bankrupt before 1997).2 The mass chaebol bankruptcies precipitated a serious financial crisis. It was not, however, unmanageable. South Korea had welldefined legal procedures to deal with firm bankruptcies. Owners and managers of the bankrupt firms would lose their ownership and control, but the firms themselves would usually survive after restructuring, with the majority of the employees retaining their jobs. Putting a large number of chaebol through the bankruptcy procedure would slow down growth, but the government could offset it by expansionary macroeconomic policies. The government would need to create a large amount of public funds to shore up the financial system, but the fiscal situation was sound enough to make it possible. However, before the country embarked on the efforts to deal with the financial crisis, a currency crisis broke out. A currency crisis was far more difficult to cope with than a domestic financial crisis because it involved the debt denominated in foreign currencies. While the government could handle a domestic financial crisis mobilizing its own fiscal, financial, and monetary policies, it could not deal with a currency crisis in such a way. This was the first time that South Korea was drawn into a currency crisis; before 1997, the country underwent recurring domestic financial crises, but they were not accompanied by currency crises.

Causes of the Currency Crisis The cause of the currency crisis was the short-term debt banks had incurred with foreign banks, mainly Japanese banks, as explained

2

Lee and Eo (2000).

Crisis and Reform 241 in Chapter 5. Japanese banks began to pull out of South Korea in the summer of 1997. Why did they pull out? The seemingly straightforward reason was the mass chaebol bankruptcies, which deteriorated the balance sheets of the banks. However, Japanese banks were pulling out of other East Asian countries as well, and were even withdrawing money from domestic borrowers. Japanese banks were doing so as, being prompted by the bankruptcy of some major insurance companies at home, they wanted to reduce the ratio of riskier assets in order to meet the Bank for International Settlements ratio.3 As the Japanese banks pulled out, South Korean banks were in trouble: They had to pay back the foreign debt when they were already facing the mass chaebol bankruptcy domestically. However, such trouble of banks was not supposed to precipitate a currency crisis. On August 25, fearing that the banks’ trouble would critically harm the economy, the government guaranteed the payback of all foreign debt owed by banks. Given that guarantee, the government’s ability to bail the banks out, rather than the banks’ ability to pay their debt back, would critically determine whether a currency crisis would break out. Indeed, the currency crisis broke out exactly because the government was unable to bail the banks out. Why was the government unable to bail the banks out? Some economists pointed to the fiscal situation. Despite the country’s seemingly sound fiscal position, there were large hidden contingent liabilities, notably pension commitments.4 A subsequent study found that, although the official data failed to fully represent contingent liabilities, the discrepancy was not as large as those studies had claimed.5 Moreover, in 2008, in spite of a fiscal situation far worse than in 1997, the country resolved another currency crisis with the bailout guarantee by the government, as will be discussed

3 4 5

Kaminsky and Reinhart (2001); King (2001); Willet et al. (2004). Burnside et al. (2001); Corsetti and Mackowiak (2005). Lee et al. (2006).

242 The Tortuous Path of South Korean Economic Development in Chapter 9. In 1997, not only the fiscal situation but also all other macroeconomic indicators were sound enough. Current account deficit was at a manageable level and shrinking, and inflation was essentially under control. Few economists point to the macroeconomic situation as responsible for the currency crisis. The South Korean government’s trouble was not the fiscal position or any other macroeconomic conditions but the lack of international reserves large enough to make creditors believe in its bailout guarantee. In other words, South Korea’s currency crisis in 1997 was not a solvency crisis but a liquidity crisis. Why did the government fail to have enough international reserves? The government officials in charge of managing international reserves did not know that banks’ short-term foreign debt was swelling. Nor did they realize the need to maintain international reserves to prepare for the contingency of a sudden reversal of capital flow. Figure 8.1 presents the amount of short-term foreign debt and international reserves as percentages of GDP. The country began its HEG in the 1960s with the international reserves far larger than short-term debt, but soon short-term foreign debt caught up with the international reserves in size. The international reserves fell short of short-term foreign debt as early as from 1974 to 1976. International reserves surpassed short-term foreign debt in 1977, but became smaller than short-term foreign debt again in the early 1980s. South Korea managed to avoid a currency crisis by borrowing four billion dollars from Japan through the US mediation in January 1983. The international reserves caught up with short-term foreign debt in 1988 and then fluctuated at a level not too far from short-term foreign debt until 1993. The liquidity position in relation to the outside world did not improve much even though the large current account surplus from 1986 to 1988 virtually wiped out net foreign debt, drastically improving the country’s solvency position. International reserves fell short of short-term foreign debt significantly again from 1994, as the government allowed banks to borrow abroad in the short-term. International reserves fell to the

Crisis and Reform 243 35.0

30.0

25.0

20.0

15.0

10.0

5.0

21

18

20

15

20

09

12

20

20

06

20

03

20

00

20

97

20

94

19

91

Short-term foreign debt

19

88

19

85

19

82

19

79

19

76

19

73

19

70

19

67

19

19

19

64

0.0

Interantional reserves

Figure 8.1  Short-term foreign debt and international reserves as a percentage of GDP, 1964–2022 Source: Appendix 2.

dangerously low level of 40.9 percent of short-term foreign debt by the end of September 1997. This was not only the result of swelling foreign debt; the government used up 12.2 billion dollars of international reserves from July 1996 to the October 1997. There was a rumor that the Kim Young-sam government used international reserves to hold down the exchange rate in order to maintain the per capita gross national income (GNI) above 10,000 dollars. In 1996, the Kim government made fanfare about reaching per capita GNI of 10,000 dollars in 1995. Together with joining the OECD, reaching per capita GNI of 10,000 dollars was sold to the public as the symbol of the success of the incumbent government (The claim was only partially true because Kim had stayed out of the government until 1990, when he merged his party with the party of Chun and Roh). Though there is no written evidence concerning this rumor, it was quite likely.

244 The Tortuous Path of South Korean Economic Development

Resolving the Crisis Clearly, South Korea could not resolve the foreign debt problem by itself; it needed outside help. The first source of help was Japan. Kang Gyeong-sik, the then-Minister of Finance and Economy, asked Mitsuzuka Hiroshi, the Japanese Minister of Finance, to carry out “administrative guidance” on the Japanese banks, so that they would not pull out of South Korea. However, the Japanese Ministry of Finance could not do so because Japanese banks were withdrawing money from the Japanese borrowers as well. Also, at that time, the Japanese Ministry of Finance was facing an investigation of the prosecutors about its cronyism with banks.6 Japan then proposed the Asian Monetary Fund (AMF) at the Annual Meeting of the World Bank and the IMF in Hong Kong on September 21, 1997. The AMF would be launched with 100 billion dollars of regional funds to be financed and run by Asian countries to help regional economies facing the currency crises. The proposal met China’s opposition, which feared the rise of Japanese influence in East Asia. However, it was yet not a critical factor, given China’s weak international position at that time. The overwhelming obstacle was the vehement opposition by the United States. The US opposition began even before Japan formally proposed the AMF, with Deputy Secretary of Treasury Lawrence Summers’s midnight call to Sakakibara Eisuke, the main architect of the AMF as the Vice Minister of the Japanese Ministry of Finance, on September 14.7 The United States then acted swiftly and decisively to scuttle the AMF proposal, and, after two months, Japan retracted it.8 The United States opposed not only the AMF but any other form of assistance, including the bilateral provision of liquidity. In early November 1997, President Bill Clinton sent a letter to the Japanese prime minster telling him that the crisis should be handled through the IMF mediation rather than bilateral or other

6 7 8

Kang (1999: 273). Blustein (2001: 162). Higgott (1998); Lee Yongwook (2006).

Crisis and Reform 245 arrangements.9 Thus, when the South Korean government made the last-minute effort in November to obtain some assistance from Japan before going to the IMF, the Japanese government answered that it could act only in coordination with the United States.10 With the assistance from Japan blocked, South Korea went to the IMF on November 21. The IMF provided a bailout package, amounting to 58.35 billion dollars in total. The IMF attached three conditions to the rescue package: a high interest rate policy, thoroughgoing domestic reform, and the immediate opening up of all capital markets. Yet the IMF rescue package failed to reverse the capital flow because of two fatal problems. First, the 21 billion dollars the IMF was supposed to supply were not disbursed in time because the IMF would disburse the money only after verifying the conditionality was met. The IMF money was thus “money with strings attached.” Second, the money for the second line of defense assigned to the United States was not clearly committed. The United States promised to provide the money, hoping that it would actually not need to disburse the money. Meanwhile, what mattered to the creditor banks was the amount of international reserves South Korea had at the moment in relation to the amount of foreign debt immediately due.11 As South Korea was heading toward national default, the United States decided to organize a “bail-in” by persuading the creditor banks to rollover the loans to the South Korean banks on Christmas Eve 1997. This coordination was possible because the creditors were composed of a small number of global banks.12 In the process of organizing the bail-in, however, South Korea promised the United States that it would carry out “IMF-Plus” reform, that is, the country would carry out a reform more thoroughgoing than the conditionality originally brought forth by the IMF.13

9 10 11 12 13

Chung (2008: 37). Kang (2005: 448–449). Radelet and Sachs (1998: 66). Roubini and Setser (2004: 152). Blustein (2001: 191–205).

246 The Tortuous Path of South Korean Economic Development The IMF conditionality was controversial. A high interest rate policy would be necessary to reverse capital flow because, without the high interest rate, South Koreans as well as foreigners may want to move capital out of the country. Alternatively, the high interest rate would drive highly leveraged South Korean firms further into trouble, hastening the flight of capital. Later empirical studies show that high interest policy had a positive effect – though moderate – on reversing capital flow.14 The demand for the domestic reform was more controversial. The prospect of domestic reform could reverse capital flow by assuring foreign investors that South Korean assets would become more profitable. On the other hand, it would distract attention from the core issue of the currency crisis, which was the liquidity problem. The demand could also make it more difficult to reverse capital flow by implying that the currency crisis was caused by the deep-rooted flaws in the domestic economic system so it could not be resolved until those flaws were eliminated, which was a difficult and time-consuming process. The South Korean currency crisis was resolved in an ironic way. The high interest rate policy and radical structural adjustment combined with the high debt-equity ratio and low profitability of firms wreaked havoc upon the economy. The economy shrank by 5.1 percent in 1998, leading to a steep decline of imports, given the country’s high import ratio (total imports as a percentage of GDP).15 As a result, in 1998, the country recorded current account surplus equivalent to 10.4 percent of GDP, the highest level ever. International reserves, which stood at 35.3 percent of the short-term foreign debt at the end of 1997, shot up to 149.5 percent of the short-term debt by the end of 1998. Once the foreign exchange market was stabilized, the government quickly pursued expansionary monetary and fiscal policies to boost the economy. In 1999, the growth rate of GDP bounced back to 11.5 percent. Current account recorded a surplus equivalent to 4.4 percent of GDP, as the exchange rate that had soared in the

14 15

See Cho (2004: 101), for example. Cho and Rhee (1999).

Crisis and Reform 247 crisis fell but settled at a level significantly above the pre-crisis level. International reserves rose further to 201.4 percent of the short-term foreign debt by the end of 1999.

8.2  Understanding the Resolution Process The resolution process of the crisis left many questions to be answered. If the Japanese government had managed to launch the AMF or lent liquidity bilaterally, the crisis may have ended up as a domestic one alone, which would have been far easier to deal with. It is thus imperative to examine how such a resolution process could not come into fruition.

The Logic The logic for launching the AMF or bilateral lending by Japan was clear enough. Japanese banks were pulling out of South Korea, so the Japanese government would come to the assistance of South Korea. However, the United States objected to such a move on two grounds: duplicity and moral hazard.16 Both were shaky. According to the duplicity argument, the creation of the AMF would add little to the pre-existing system centered on the IMF. This was, however, inconsistent with the status of the IMF as the lender of last resort. Why should the lender of last resort intervene when the creditor and debtor countries were ready to settle between themselves? This position was also inconsistent with the rule of the US domestic politics. The US government should get the IMF to abstain from being involved in currency crises that could be solved otherwise because the money the IMF puts toward the risky rescue package may end up as the US taxpayers’ burden, given that the United States is the largest shareholder of the IMF. It certainly is the reason why the US Congress scrutinizes the rescue packages of the IMF. The validity of the duplicity argument is also questionable considering that any currency crisis is highly contagious, rendering the timing

16

Lipscy (2003: 96); Kawai (2005: 38).

248 The Tortuous Path of South Korean Economic Development of action critical. In 1997, Japan had the incentives to act quickly because of its high exposure to East Asia through trade and investment. In this regard, there was a precedent of the US action in the Mexican crisis in 1994. According to the moral hazard argument, Japan would wrongly provide liquidity without imposing strict conditions. Money should not be given away to crisis-hit countries without making sure that the moral hazard problem be resolved first. If those countries could circumvent the IMF by tapping into a separate source of money with few strings attached, they would have little incentive to make the adjustments necessary to prevent a larger crisis precipitated by continuing their irresponsible policies. South Korea certainly had moral hazard problems. It had, most of all, the NPLs problem. The IMF indeed demanded structural reform on the ground that the domestic economic structure encouraging the excessive borrowing by chaebol caused the currency crisis.17 However, chaebol’s NPLs were not the cause of the currency crisis. It was the cause of the domestic financial crisis, so the South Korean government, not the IMF, was in a position to address the moral hazard problem. Moreover, chaebol were already suffering severely from mass bankruptcy. The bankruptcy would make chaebol families lose their ownership and control and professional managers lose their jobs. On the other hand, South Korea had no moral hazard problem in terms of macroeconomic indicators. From a macroeconomic viewpoint, a moral hazard problem implies that a country lives beyond its means, disregarding the results of such behavior or expecting to get some debt relief eventually. In such a case, crisis-hit countries deserve the austerity resulting from the contractionary policies prescribed by the IMF. However, South Koreans had not lived beyond their means before the crisis, as all macroeconomic indicators were sound enough. Current account was in deficit, but high

17

Fisher (1998).

Crisis and Reform 249 investment rate rather than high consumption rate was responsible for the deficit. The deficit was shrinking in 1997. The cause of the currency crisis was short-term foreign debt banks came to owe in the liberalization process. In this regard, some authors pointed out that the South Korean government had given banks the priority to borrow from abroad because of the economic system that put banks under the government control.18 Also, it is likely lobbies worked in allowing banks to incur the short-term foreign debt, as mentioned in Chapter 5. However, that does not change the fact that the crisis was no more than a liquidity crisis. Fairness also mattered. For every debtor, there was a creditor. If the debtor had a moral hazard problem, the creditor had the same one. When foreign banks lent money to South Korean banks, they apparently did so for two reasons. They may have failed to pay attention to the financial soundness of South Korean banks, blindly believing that the country’s economic miracle ensured the creditworthiness of its banks. Alternatively, they may have assumed that there was an implicit government guarantee for the payback of the debt.19 In either case, there were moral hazard problems with the creditors as well, and it would have been fair for them to share responsibility. Making the creditors share responsibility would help prevent another crisis in the future because, if they could keep their money intact, they may well repeat their reckless lending behavior. However, while trying to root out the debtors’ reckless borrowing habits, the United States and IMF overlooked the creditors’ equally reckless lending habits. In the end, the United States recognized the de facto responsibility of creditors when it organized the bail-in, which restricted their portfolio choice. Thus, economists like John Eatwell and Lance Taylor held that a bail-in was fairer than a bailout, providing a model to the resolution process for future currency crises.20 However,

18 19 20

Chung and Eichengreen (2004: 4–9); Wolf (2004: Chapter 13). Dooley and Shin (2000) say that this was indeed true. Eatwell and Taylor (2000: 232).

250 The Tortuous Path of South Korean Economic Development the United States arranged the bail-in not because it was fairer but because, by December 24, it was the only way to avoid South Korea’s national default that might precipitate a global storm. Foreign banks did not lose much with the arrangement either, because there was no “haircut”; rather, they enjoyed a big hike in interest rates in exchange for rolling the loans over. The moral hazard argument was eventually thrown out by the US government’s handling of the 2008 crisis. It gave away hundreds of billions of dollars to its own banks without attaching any strings, an action Simon Johnson called “The Quiet Coup,” and Joseph Stiglitz named “The Great American Robbery.”21 Indeed, what the United States did to itself in the 2008 crisis did not remotely resemble what it had done to East Asia in 1997. The US government did so even though, in contrast to its position in the 1997 East Asian crisis, it was in a direct position to punish the banks on behalf of the US taxpayers. Surprisingly, in 2009, the same people who had handled the East Asian crisis in the Clinton administration in 1997 were handling the US crisis in such a way in the Obama administration.

The Interests What caused the inconsistency of the US actions between 1997 and 2008? The first explanation is the cronyism between Wall Street and the US Treasury Department; their interests were consistently underlying the logical inconsistency in the handling of the two crises. In 1997, they wanted to open up South Korea’s capital markets. South Korea was beginning to open its capital market, but it was too slow for them. They demanded South Korea to proceed quicker, but the country responded only reluctantly. Even when it joined the OECD, the country promised to open capital markets only gradually with the positive list approach. They thus made use of South Korea’s liquidity problem as an opportunity to open up its capital markets immediately. They employed the IMF as the agency to realize their

21

Johnson (2009); Stiglitz (2010: Chapter 5).

Crisis and Reform 251 goals, so the cronyism extended to the “Wall Street–Treasury– IMF Complex.”22 The emergence of the Wall Street–Treasury–IMF Complex was the product of the changes in the US domestic political economy. In the wake of the Great Depression, the government regulated the financial sector on the ground that the speculators were responsible for the outbreak of the Great Depression. Banking became a boring job under the government regulations. From the 1970s, however, the government deregulated the financial sector and financial firms increased size and diversified business lines. The financial sector came to account for an ever-larger share of the economy. As a result, not only the economy but also the whole society underwent “financialization.”23 Ironically, the deregulation did not mean real liberalization; it led to the development of the cronyism between the large financial firms and the Treasury Department. It would be a mistake to think that the cronyism with Wall Street solely decided the behavior of the US Treasury Department in 1997. It also acted out of its perception of broader national interest. The domestic deregulation of the financial sector naturally interacted with the changes in the international economic order. The Bretton Woods system, founded in 1944, sought to reconcile an open multilateral financial system with the more interventionist policies after the Great Depression. Governments of developed as well as developing countries were allowed to impose capital controls as they saw fit.24 However, with the deregulation drive in the domestic market from the 1970s, the United States began to demand other countries to open their capital markets as it opened its own. The US demand was intertwined with the efforts to establish a new form of hegemony based on the superior competitiveness of its financial sector. After finding the Bretton Woods system unmanageable in the early 1970s, the United States decided to support international capital movement. This move reflected an attempt to develop a kind of

22 23 24

Bhagwati (1998); Wade (1998). Dore (2008), Wray (2009). Helleiner (2010); Rodrik (2011: Chapter 4).

252 The Tortuous Path of South Korean Economic Development market-based “structural power” that would replace the old system of the US hegemony. It represented a departure from the previous “benevolent” hegemony. The opening of the financial market was subsequently backed by European countries, such as France under a socialist government in the 1980s, out of their experiences of capital controls not working well.25 The US endeavor to open capital markets was in line with its broader global policy framework. As discussed in Chapter 6, from the mid-1980s, the United States was no longer willing to allow the asymmetric relationship with developing countries, not to mention developed countries. The United States had begun to apply pressure for trade liberalization before financial liberalization. It may have thought that South Korea had not liberalized trade sufficiently. In fact, the country had liberalized trade quite significantly by 1997, but the perception of protecting domestic market persisted. Thus, Mickey Kantor, the then-US Secretary of Commerce, said in his interview with the London Times that the United States should use the IMF as the “battering ram” to open up the East Asian countries’ market.26 The US motivation apparently went beyond collapsing the protection of South Korea’s domestic market. The US multinational corporations may have felt uneasy about the aggressive posture of chaebol. Chaebol were, it seemed to them, “disrupting the world market” with the government support in industries such as automobiles, semiconductors, consumer durables, and petrochemicals, most of which were dominated by a small number of large multinational corporations.27 Last, but probably most importantly, the ending of the Cold War mattered. This is best illustrated by comparing what happened in 1997 with what had happened in 1983. In January 1983, the Chun Doo-hwan government managed to borrow four billion dollars from an initially reluctant Japan through the US mediation, making use of

25 26 27

Helleiner (1994: 114); Konings (2008); Abdelal (2006). Weisbrot (2016:349). Crotty and Lee (2001: 157); Shin (2014: 143).

Crisis and Reform 253 South Korea’s position in the renewed Cold War the Reagan administration was waging. In 1997, in contrast, Japan was willing to provide liquidity, but the United States adamantly blocked it. Such a move reflected the wider conceptualization of the post-Cold War order. Though the Cold War was over, the US hegemony in East Asia had to be left intact. Thus, the United States opposed launching the AMF because it meant the exclusion of the United States in Asia-Pacific affairs. The AMF proposal broke the rule of Japan’s postwar foreign policy by proposing an “Only Asian” solution to Asia-Pacific affairs for the first time.28 The resolution process of the South Korean currency crisis confirmed that the US hegemony was alive and well. Japan could not withstand the US objection to the AMF. The US power was further revealed when it organized the bail-in on December 24. The bailin was actually no more than administrative guidance that South Korean government had asked the Japanese government to do earlier. While the Japanese government could not do administrative guidance to its own banks, the US government did it to the creditor banks from all over the world, including Japan. Japan eventually showed that it was not ready to replace the US hegemony in East Asia to even a moderate degree. Japan not only backed off in response to US pressure, but also turned utterly opportunistic, making use of its influence in the IMF to insert its demand to abolish South Korea’s import-source diversification policy (mentioned in Chapter 6) into the conditionality of the IMF rescue package.29 South Korea’s 1997 currency crisis was essentially the result of the failure to adapt to the changing world political economy of the 1990s, such as financial globalization and the ending of the Cold War. In this sense, the 1997 crisis stands in contrast to the launching of the export-oriented industrialization discussed in Chapters 3 and 4. South Korea’s export-oriented industrialization meant taking



28 29

Blustein (2001: 166); Lee Yongwook (2006). Kapur (1998: 123).

254 The Tortuous Path of South Korean Economic Development advantage of the new world political economy of the 1950s and the 1960s. The 1997 currency crisis represented South Korea’s failure to adapt to the new world political economy of the 1990s.

8.3  The Response What was South Korea’s response to the resolution process of the currency crisis? Surprisingly, there were few dissenting voices within the country – not only from the government but also from the society as a whole. This happened while many observers outside the country criticized the IMF’s handling of the crisis; they included conservatives like Martin Feldstein and liberals like Joseph Stiglitz, who usually rarely found issues to agree upon between themselves.30

Few Dissenting Voices There were few dissenting voices among South Koreans first because many government officials in the key positions had no clear idea about the exact causes of the currency crisis. They failed to recognize that the causes of the domestic financial crisis and currency crisis were separate from each other. They thus thought that the government’s commitment to domestic structural reform would persuade foreign banks not to pull out of the country. The commitment included letting chaebol go bankrupt and legislating financial reforms.31 Such commitment could induce capital inflow to improve the country’s liquidity situation, which would in turn reduce the creditor banks’ incentive to pull out of the country. However, such a possibility was slim. In truth, without first solving the immediate liquidity problem, even the existing foreign investors would most likely pull out, prompting the creditor banks to pull out further. When the government officials were confused, they could not provide a clear voice about the resolution process. However, even if the officials had an understanding of the causes of the currency crisis



30 31

Feldstein (1998); Stiglitz (2002: Chapter 4). Kang (1999: 255–272); Kang (2005: 558–588).

Crisis and Reform 255 and the problems of the resolution process, they may have thought it difficult to voice dissent because they saw no alternative. The alternative would be playing an endgame against the United States and the IMF, which might lead to a severe downturn of the economy and alienate the country from global capital markets in the near future. South Koreans had no experience in facing such a situation. Government officials were so scared about what was happening that they were unable to disagree openly, as Joseph Stiglitz observed as the then-Vice President of the World Bank.32 Some government officials also perceived themselves as a buffer between the United States and the “excitable” South Korean public. For example, a high-ranking official said at the time of the crisis: “If the US Treasury’s role in the IMF negotiations becomes widely known to the public, anti-American sentiment will explode out of control.”33 The South Korean public was apt to be excited by antiAmerican agitation because of the lingering memory of the image of the US cronyism with the military dictatorship in the 1980s. However, sentiment was not the real problem. There were fatal interests involved, as many people would lose jobs and income with the implementation of the IMF conditionality. Indeed, all around the world, there tended to be fierce resistance to IMF conditionality as it would hit ordinary people’s lives hard. Thus, the “IMF riots” broke out in many countries, including Argentina, Brazil, Bolivia, Columbia, Costa Rica, Ecuador, Nigeria, Zambia, and so on.34 Did the resistance have legitimate grounds? It first depended on whether the currency crisis was a solvency or liquidity crisis. If it was a solvency crisis, the resistance had legitimate but limited grounds. It had legitimate grounds because the IMF was always unilaterally on the side of the creditors. Domestically, the poor and middle class usually had to bear the brunt of the burden, while the



32 33 34

Stiglitz (2002: 42). Steil and Litan (2006: 86). Easterly (2006: 217–218).

256 The Tortuous Path of South Korean Economic Development rich elites had mainly benefited earlier from the spending spree with the borrowed money. However, the resistance had limited grounds because the middle class and the poor may also have benefited from the spending spree with the borrowed money, however small their share may have been. On the other hand, if the currency crisis was a liquidity crisis, the resistance to the IMF conditions was completely legitimate because there had been no spending spree. As previously stated, South Korea’s currency crisis was no doubt a liquidity crisis. Moreover, the liquidity crisis could have been resolved between South Korea and Japan as the debtor and creditor if the United States had not intervened. The grounds for the IMF intervention lacked logic, and, upon deeper investigation, South Koreans could have detected the US national interest underlying the IMF conditionality. South Korea in 1997 was thus a natural case for an IMF riot to break out. No riot broke out, however, because the public was not sufficiently informed; the government officials that were privy to the nature of the crisis did not reveal this information to the public, indeed out of their fear of potential riots. However, more important than the behavior of government officials was the attitude of political leaders. The response eventually depended on politics. The endgame to resist the IMF conditionality would require a tremendous political resolve because it would mean resisting the US hegemony. It would involve telling the public what the United States had actually done in the resolution process. Such political resolve was difficult to form in South Korea, given its relationship with the United States. How to respond to the resolution process was largely up to Kim Dae-jung, who was elected president on December 18, 1997, at the height of the crisis. Kim Dae-jung was not in a strong enough position to lead the political resolve against the IMF conditions. Initially the most respected and unwavering democracy fighter persecuted most by the Park and Jeon governments, he had fallen from the rank of angels after leading the split of the opposition in the 1987 presidential election. The regional divide strategy of the Park and Chun

Crisis and Reform 257 governments had driven his status down to the leader of the weaker minority region. He got elected by forming an alliance with Park’s former colleagues while one important member of the incumbent party defected to run as an independent, getting 19.2 percent of total votes cast. Last, but most importantly, his political opponents were ever ready to exploit any schism between his government and the United States, employing their old tactic of McCarthyism. During the election campaign, Kim Dae-jung said that he would renegotiate terms with the IMF, invoking severe criticism from his opponents. However, after being elected, he accepted the IMF conditionality without hesitation. He repeatedly said the crisis would be “remembered as a blessing” to the country because it would bring about vital reforms, echoing the assertion by Michel Camdessus.35 Subsequently, few dissenting voices were coming out of the county – not only from politicians or government officials but also from the society as a whole. Rather than rioting or even trying to weaken the IMF conditionality, they were accepting it in a wholehearted way.

Political Economy of the Reform It is still unknown why Kim Dae-jung suddenly changed his position after being elected. He may have recognized that he was not in a position to lead the political resolve against the United States and the IMF. However, it is likely that he really thought implementing the IMF conditionality would benefit the country. His attitude was a surprise to those who remembered him as a populist with antiforeign capital rhetoric. He presented some anti-foreign capital views in a book published when he first ran for the presidency in 1971. However, he changed views in his later book, written during his exile in the United States. In that book, he called for reforms analogous to those of the IMF conditionality, emphasizing the need to correct the vice of cronyism between the big business and the authoritarian government, and called for liberalization, market opening, and the

35

New York Times, on February 18, 1998 (quoted from Crotty and Lee 2001: 188).

258 The Tortuous Path of South Korean Economic Development inducement of foreign capital.36 After being elected, he coined the slogan “the simultaneous promulgation of democracy and market economy,” which was in line with the ideas in his later book and the IMF conditionality. Public opinion supported his position. To the majority of the “opinion leaders,” the IMF-mandated reforms were in many ways similar to what the country had tried to carry out by itself earlier. Now, the IMF was demanding the implementation of those reforms in one stroke. According to Lee Gyu-seong, Kim Dae-jung’s first Minister of Finance and Economy, the South Korean people, first shocked and humiliated by the crisis, began to forge a consensus to turn the crisis into an opportunity. He cites an editorial in the Chosun Ilbo (November 25, 1997), South Korea’s most influential and conservative newspaper, which proposed to use the IMF demand “not as a one-time solution of the imminent crisis but as a natural turning point to rearm the economy with a new orientation and development strategy.”37 Another newspaper, Hankyoreh, the most liberal and opposed to Chosun Ilbo on virtually every issue, carried an economist’s opinion that the IMF conditionality represented no more than the reforms the country itself had tried to carry out before, and it had to accept the IMF “trusteeship” to thoroughly carry out those badly needed reforms (November 25, 1997). The reform received strong support from the citizens’ movements, which had emerged influential after the 1987 democratization but became more so under the Kim Dae-jung government (February 1998–February 2003). The leaders of the citizens’ movements hailed the IMF conditionality as it demanded enhancing the transparency of the economy. The conditionality was particularly appealing to them because it had chaebol reform at the top of the list. They had played an important role in instituting the real name system for financial transaction and real estate ownership. In contrast, they had been



36 37

See Kim (1971: Chapter 2) and Kim (1985: Chapter 4). Lee Gyu-seong (2006: 129).

Crisis and Reform 259 unable to do much about chaebol reform. After the crisis, the minority shareholder movement to reform the corporate governance of chaebol emerged as a leading citizens’ movement. Likely influenced by the government and opinion leaders, the public perceived the IMF-driven reforms favorably. An analysis of survey data collected in 1998 and 1999 revealed that South Koreans did not place much blame on the IMF conditionality for the worsening of the economic conditions, nor did they endorse refusing the conditionality as the effective method to deal with them. Instead, they blamed their own system of crony capitalism to the greatest extent, and endorsed the fixing of the malfunctioning system as the most effective solution to their economic problems.38 The IMF’s intervention in South Korea’s economic policies was also not new. The IMF had maintained a resident representative office from 1965 to 1987, and carried out a surveillance function on South Korea’s economic policies. The IMF not only provided direct financial assistance but also energized serious discussions on a macroeconomic policy framework and financial discipline. The government often used those discussions to garner support for its policies from both politicians and the business community in general. The planning and finance ministries used IMF discussions to sway other economic ministries with conflicting interests. The government often found the IMF discussions useful in selling painful adjustment programs to the public.39 The country thus decided to carry out a thoroughgoing reform, taking advantage of the IMF conditionality. The Kim Dae-jung government designated four areas of reform  – firms, finance, public sector, and labor – which in fact covered the whole economy. It added many “pluses” to the IMF conditionality, indeed keeping the promise it had made with the United States at the time of the bailin arrangement. Such a wide-ranging reform was carried out with



38 39

Hayo and Shin (2002). Sakong (1993: 134–135).

260 The Tortuous Path of South Korean Economic Development exceptional momentum created by the extraordinary situation of the crisis and the IMF “trusteeship.” The momentum was reinforced by the widespread belief, often prompted by the government, that, without immediately implementing a thoroughgoing reform, the country could not overcome the currency crisis. As a result, in a short span of time, the country carried out the most consummate economic reform ever. However, such a reform left many questions unanswered.

A Reform with Unanswered Questions Most of all, the reform failed to address the causes of the currency crisis, as it concentrated on the domestic economic structure. The immediate cause of the currency crisis was the opening of the backdoor for capital inflow. The correct way to address the causes of the currency crisis was to close the backdoor and reexamine the market opening process. Instead, the country opened up all capital markets, both short- and long-term, immediately. That could precipitate another currency crisis in the future. The domestic reforms included policies to prevent future currency crisis, notably, enhancing the risk-management ability of financial institutions and the supervision ability of the government over them. However, as Dani Rodrik and Arvind Subramanian observe, if an emerging market country tries to prevent a currency crisis through such endeavors while keeping capital markets thrown open, the list of complementary measures to be taken tends to become almost infinite in length.40 The IMF’s demand for complete capital market opening was actually inconsistent with its own position in 1997. The IMF, a Bretton Woods institution, changed its position towards capital market opening from the 1970s, which peaked in 1997, the year of the East Asian crisis. However, even in 1997, the IMF acknowledged the existence of “preconditions” for the smooth working of capital market opening.41 Demanding an immediate opening of capital



40 41

Rodrik and Subramanian (2009: 125). Ocampo et al. (2008: 28).

Crisis and Reform 261 markets in full for a country like South Korea hit by a currency crisis was inconsistent with that position, as the country was hit by the currency crisis exactly because it had lacked those preconditions. Opening the short-term capital market while failing to provide the preconditions was the real cause of the crisis, but the reform institutionalized such an arrangement. The reform of the domestic economic system addressed the causes of domestic financial crisis. Yet some reforms went beyond that purpose as the government tried to carry out the reforms of its own choice taking advantage of the momentum the IMF provided. Many of those reforms as well as the IMF conditionality were desirable per se, representing the agenda that the country would have to address in one way or another in the future. However, to be successful, reforms should consider the complementarities between the existing institutions and the new institutions they introduce; they need sequencing and pacing based on those complementarities, making a distinction between the long-run objectives and short-run tasks.42 In 1997, the IMF and the United States did not allow South Korea to do that, and South Koreans gave up doing that in order to carry out a thoroughgoing reform immediately, utilizing their demand as momentum. The reform was thus carried out like “shock therapy.”43 As a result, the reform overlooked the multi-faceted nature of the economic system in place before the crisis. The system surely had many problems, including those that precipitated the crisis, but it had positive aspects as well, which were often intertwined with those problems. Purging the system by the reform carried out like shock therapy could undermine its positive aspects as well as the problems. Those positive aspects included, first and foremost, the HEG; they also included equality, as the country was showing an economic performance closer to “growth with equity” than ever by the mid-1990s.



42 43

Rodrik (2007). Stiglitz (2002: 73).

262 The Tortuous Path of South Korean Economic Development

8.4  The Reforms and Their Consequences This section briefly surveys the reforms in the four areas – firms, finance, labor, and public sector – and discusses their consequences. As it is impossible to discuss the longer-run consequences, this section will discuss only the immediate results of the reform. It will then discuss the sale of South Korean assets to foreigners after the crisis.

Chaebol Reform Reform of firms was reform of chaebol. The Kim Dae-jung government touched upon all the measures of chaebol reform that had been tried before the crisis and added some new ones. It strengthened fair trade policy by regulating the related transaction more strictly. The government initially abolished the restrictions on interlocking ownership, but soon reintroduced them to check the concentration of economic power. It urged leading chaebol to carry out business swaps, asserting that unrelated diversification, another mechanism of the concentration of economic power, was the source of the mass bankruptcy  – a claim difficult to defend because unrelated diversification in fact contributed to spreading the risk and was thus not responsible for the chaebol bankruptcies.44 Business swap received criticism and was carried out on a limited scale. In 2000, the government banned the cross-guarantee of loans among chaebol affiliates to reduce the concentration of economic power as well as to make them financially sounder. The Kim Dae-jung government greatly emphasized corporate governance reform. It strengthened minority shareholders’ rights by making it easier to litigate against managers, to ask for the inspection of the books, and to demand the dismissal of directors and auditors. The reform allowed voting rights for the shares held by institutional investors like trust funds of banks. The reform also strengthened the



44

Lee and Eo (2000).

Crisis and Reform 263 role of the board of directors and audit committee, and made it mandatory to appoint a quarter or more of the directors as outside (nonexecutive) directors. The reform rationalized and internationalized the accounting system to enhance transparency, and required chaebol to compile consolidated balance sheets. The government allowed holding companies, with strict limitations, believing that the holding company system was more transparent than the complicated interlocking ownership. The reform made the hostile merger and acquisition (M&A) possible. Before the crisis, even the friendly M&A was strictly limited; now, the reform allowed the hostile M&A. If chaebol undermined shareholder value, they would face hostile M&A and may lose control. Last, the reform improved chaebol’s financial situation, which had been the main source of NPLs and repeated crises. The government demanded chaebol firms to reduce their debt-equity ratios to 200 percent or lower by the end of 1999. Banning the crossguarantee of loans among chaebol affiliates was also an attempt to make chaebol financially sounder by reducing debt-equity ratio. The government urged chaebol to raise more capital in the stock market instead of borrowing from financial institutions. The reform intended to strengthen the discipline exerted by financial institutions on chaebol so that chaebol would no longer pursue long-run growth with borrowed money while ignoring short-term profitability. Those reforms fell far short of meeting the standard of advanced countries, particularly the United States, whose system they tried to introduce. Yet the reforms were surely a big step towards the system that the country had to head eventually. On the other hand, the reform proceeded ignoring the multi-faceted nature of the chaebol system before the crisis. The system allowed virtually free stealing of the minority shareholders’ money by chaebol family, and was responsible for the NPLs leading to recurring crises. At the same time, chaebol’s internal capital and labor markets and their pursuit of long-run growth with borrowed money enabled them to play the

264 The Tortuous Path of South Korean Economic Development leading role in HEG accompanied by rapid structural transformation. Chaebol were at the core of the “aggressive but vulnerable system” in place before the crisis, so the reform, carried out like shock therapy aiming at purging the vulnerable part of the system, could purge the aggressive part as well.

Financial Sector Reform The Kim Dae-jung government was determined to reform the financial sector. It thereby tried to complete the liberalization begun in the 1980s. Liberalization meant building a new system in which financial institutions would make loans to firms after evaluating the borrowers’ ability to pay them back. They then had to check continuously whether the borrowers had such an ability. If they failed to do so and accumulated NPLs, financial institutions themselves would be forced to exit. The government role would not lie in allocating credit but in supervising financial institutions to ensure that they stayed financially sound. The first obstacle to building such a system was the existence of the large amount of NPLs. It was up to the government to purge the NPLs, but the governments before the crisis had been unwilling to tackle the task to the end. The Kim Dae-jung government finally tackled the task in earnest by thoroughly restructuring financial institutions. It mobilized the public fund by about 25 percent of GDP to recapitalize them, to take over their NPLs, and pay for the deposits if they were banks. The government then sold the overtaken financial institutions mainly to foreign investors, who carried out further restructuring. In the end, about one-third of financial institutions existing as of the end of 1997 were liquidated, suspended, or merged with other institutions. The surviving financial institutions, on the other hand, became far sounder. The government not only purged the existing NPLs but also tried to improve the future banking ability of financial institutions. It introduced more rigorous rules to classify the asset portfolios, including the “forward-looking criteria” to consider the borrowers’ future

Crisis and Reform 265 ability to pay loans back. A deposit insurance system was introduced to reduce moral hazard. Previously, the government guaranteed all bank deposits regardless of the amount, but now, a limit of 50 million won per person was set. With the limit, banks would face the possibility of a run if their financial situation deteriorated because depositors with more than 50 million won would rush for cash. The government then urged financial institutions to enhance their ability to manage risk. The reform did not create a majority shareholder of banks, the surest way to establish their independent business entity. Yet the government carried out the governance reform for banks similar to those for firms: strengthening shareholders’ rights, systemizing the managerial and auditing function, and rationalizing and internationalizing the accounting system. The reform would help to prevent the arbitrary intervention by government officials in the management of banks. The reform also failed to force chaebol to divest from NBFIs; however, the governance reforms similar to banks were carried out for NBFIs, with the expectation that the improved governance system would reduce the arbitrary intervention by chaebol families in their management. The government also reformed the financial supervision system. The Financial Supervisory Service was established by consolidating supervision agencies across banking, securities, and insurance, removing the right to supervise banks from the BOK and the right to supervise NBFIs from the Ministry of Finance and Economy. The reform produced results. As shown in Figure 5.2, the debtequity ratio fell and the interest coverage ratio rose drastically for the manufacturing sector. Purging the NPLs was indeed the most salient achievement of the reform. On the other hand, this was the corollary of correcting the behavior of firms, chaebol firms in particular, to pursue long-run growth with borrowed money while ignoring shortterm profitability through a reform carried out like shock therapy. It represented purging the aggressive as well as the vulnerable part of the system in place before the crisis.

266 The Tortuous Path of South Korean Economic Development

Labor Reform The IMF demanded labor reform, and the Kim Dae-jung government carried out the reform, emphasizing that it was necessary to overcome the currency crisis by persuading foreign investors to reverse the capital flow.45 In fact, how the labor reform would help to resolve the currency crisis was unclear, considering that the causes of the currency crisis were not the same as the causes of the domestic financial crisis. The labor reform had a ground because unions of chaebol firms were responsible for the domestic financial crisis, by helping them to produce NPLs, as mentioned in Chapter 7. However, unions were changing their behavior with the crisis, which made them worry about their members’ job security. The government carried out the labor reform anyway, making use of the IMF demand as a momentum for the reform it had regarded as pending since the 1987 democratization. The Kim Dae-jung government launched the “Tripartite Commission” after the Northern European model of the dialogue and compromise between workers and employers through government mediation. The commission drew a social compact on February 6, 1998 (henceforth the “2.6 Compact”), the first its kind in South Korean history. The 2.6 Compact was a compromise of the previous moves to revise the labor laws after the 1987 democratization. It accommodated workers’ demand by lifting the restrictions on union activity such as the prohibition of multiple unions at the national level (albeit not the firm level) and the limitation of the involvement of the third parties in firm-level industrial relations. It also legalized teachers’ unions and government employees’ unions, allowed unions’ political activity, and provided a way to improve the financial independence of unions. At the same time, it accommodated employers’ demands by allowing them to lay off workers on the ground of the poor financial performance of firms. It allowed them to employ workers on short-term contracts as “non-regular” workers. It

45

Ji (2011: 237–238).

Crisis and Reform 267 also legalized “labor dispatching,” whereby dispatch work agencies would receive requests from businesses to have them hire workers on the businesses’ behalf. Dispatching would involve no direct contract between dispatched workers and the businesses using the agency’s services. The 2.6 Compact brought about intense dissent within the KCTU, which had established the de facto leadership of the labor movement by leading the general strike in early 1997. The KCTU leaders had actually proposed the need of a social compact in December 1997 and were thus a major partner in the 2.6 Compact. The compact legalized the KCTU by allowing multiple unions at the national level. However, the member unions vehemently opposed it because of the layoff clause. KCTU suffered internal divide and a leadership change. The National Assembly passed the labor laws based on the 2.6 Compact. Being worried about the massive layoffs, however, the new Labor Standard Act limited the ground for layoffs to “urgent managerial necessity,” required “sincere consultation” between labor and management before layoffs, and obliged employers to “exhaust all means” to avoid layoffs. The laws nevertheless cleared the way for immediate structural adjustment by defining transfer, merger, and acquisition as urgent managerial necessities. The KCTU was responsible for the collapse of the 2.6 Compact. However, the compact left unanswered the critical question of whether February 1998 was the right time to introduce layoffs. It would lead to massive job losses for workers with little protection by the still-poor social safety net. Of course, to avoid layoffs, the country needed wage concessions by workers, that is, “price flexibility” instead of “quantity flexibility.” Indeed, unions tended to offer wage concessions to preserve their members’ jobs, as could be expected from the union behavior elsewhere in the world.46 The government also made some efforts for job sharing. However, layoffs were carried



46

See Freeman and Kleiner (1999) and Kuhn (1998) for the general cases. The Korean case will be discussed in Chapter 11.

268 The Tortuous Path of South Korean Economic Development out on a gigantic scale under the new laws. Altogether, hundreds of thousands of workers, including one-third of financial sector employees, were laid off.

Public Sector Reform The public sector reform addressed the causes of the domestic financial crisis by tackling the NPLs problem in earnest and by developing the ability to supervise financial institutions. However, it went beyond that. It aimed at accelerating the liberalization process going on from the 1980s. The Kim Dae-jung government also tried to make the public sector reform lead the private sector reform. The first move of the public sector reform was a massive deregulation drive, which reduced the overall number of regulations drastically. The reform also tried to raise the public sector’s productivity and save budget by, for example, scaling down the government bureaucracy and outsourcing government jobs to the private sector. It introduced performance-based wages to replace seniority-based wages for the high-ranking public sector workers. The government privatized state enterprises on a large scale. The state enterprises not privatized went through downsizing and rationalization. As a result, the number of the government employees fell by 8.5 percent from 1997 to 2001. The number of employees of state enterprises fell by as much as 61.8 percent from May 1998 to November 2002.47 These figures do not tell how many workers lost jobs through the public sector reform because the government employees may have moved to other jobs and the privatization of state enterprises did not necessarily mean shedding workers. It was yet clear that the layoffs of the public sector workers went far beyond firing the government officials responsible for the crisis. Moreover, the public sector laid off workers while the private sector was laying off workers, so it magnified the effect of the private sector layoffs rather than offsetting it.

47

Yang (2004: 124).

Crisis and Reform 269 It was clear that the country had to strengthen the social safety net. In 1999, the Kim Dae-jung government introduced the slogan of “productive welfare” to reinforce the welfare system. Industrial accident insurance and employment insurance were extended to cover all workplaces in 2000. The government also reformed the national health insurance. National health insurance had been extended to cover the whole population in 1989, but there were hundreds of separate insurance programs based on jobs and regions. In 2000, the government consolidated them into a single program, which had a strong equalizing effect by pooling the resources across rich and poor groups of people. In 1999, the NPS was extended to all urban residents. In 2000, the government strengthened the public assistance program that had existed nominally, by enacting the National Basic Living Security Act. The law aimed at providing a minimum standard of living for all people, mainly targeting the aged, families with children, disabled, and single-parent families. The government expenditure on welfare, measured as the expenditure on health and social protection, shot up from 4.0 percent of GDP in 1997 to 5.4 percent of GDP in 1998, the largest jump in one year until then. It rose further to 6.1 percent in 1999, and then fell to 5.2 percent in 2000. These changes mainly reflected the rise and fall of the unemployment rate, which shot up to 7.0 percent in 1998 and then fell as the economy recovered. However, the weight of welfare in government expenditure crawled up subsequently, though with some fluctuations, reflecting the strengthening of the social safety net (See Figure 5.3).

Asset Sales The crisis and reform led to a massive sale of South Korean assets to foreigners. The financial distress that began with the outbreak of the domestic financial crisis led to the precipitated drop of asset prices. Then, the high interest rate policy and radical structural reforms imposed by the IMF deepened the financial distress, further pressing down the asset prices. Firms and financial institutions had to sell

270 The Tortuous Path of South Korean Economic Development off their assets at bargain prices to foreign investors. The immediate opening of the capital market in full facilitated the foreign takeover. Mark Aguiar and Gita Gopinath empirically confirm that there was a wide-ranging fire sale in the crisis-hit East Asian countries such as South Korea through 1997 and 1998.48 Foreign investors inclined toward high-risk, high-return investments such as hedge funds and investment banks bought up those assets (Some of these investment banks were part of the universal banks that had pulled their loans out to precipitate the 1997 currency crisis). Asset sales continued after the financial distress was over. South Korea had to meet the IMF conditionality to sell two commercial banks to foreigners. More importantly, continued inducement of foreign capital was regarded as a necessity to overcome the currency crisis, even after the financial distress was over. “Restoring foreigners’ trust” became an obsession for the government and public for many years after the crisis. In addition, asset sales seemed a sure way to achieve the purpose of the reform. Foreign ownership and control would provide a managerial entity independent of the chaebol and government, and bring in transparent and advanced managerial skills. The Kim Dae-jung government set inducing foreign capital the first national priority agenda. Almost every economic activity was judged by its effect on foreign capital inducement. Asset sales to foreigners in whatever condition became an activity to be highly appreciated. In this context, for example, the government required chaebol to present detailed plans specifying the amount of their asset sales to foreigners by the end of 1999. When the four largest chaebol reported their results at the end of 1999, 10.8 billion dollars of assets were handed over to foreign capital.49 Throughout this process, domestic capital could not play any significant role. Previously, the main player in any new economic activity were chaebol. However, this time chaebol were the target of



48 49

Aguiar and Gopinath (2005). Shin and Chang (2003: Chapter 4).

Crisis and Reform 271 reform. There were institutional investors such as pension funds, but they could not take part in the purchase of the assets on sale because they were not ready to make high-risk, high-return investments (In fact, they were often legally prohibited from doing so). The country had no private equity fund or investment bank to do high-risk, highreturn investments. By 2004, 42 percent of stocks of listed companies were owned by foreigners. Before the crisis, South Korea had one of the lowest foreign ownership share of assets in the world; after the crisis, it came to have one of the highest. All major banks except one came to be majority-owned (though mostly dispersed) by foreign capital.

9

The Slowing Engine of Growth

As mentioned in Chapter 1, three chapters beginning with this one explain the pattern of economic development characterized as sustained but crises-ridden growth for the period after the 1997 crisis. They discuss three subjects: macroeconomic management, structural transformation, and the management of social conflict. This chapter deals with the first of the three subjects. The South Korean economy recovered from the 1997 crisis and continued to grow subsequently; however, growth slowed down, and the economy became, not necessarily, less crises-prone, as evidenced by the outbreak of another currency crisis in 2008. Growth slowed down further after the 2008 crisis, and the economy faced another crisis with the pandemic in the 2020s.

9.1  The Slowdown and the New System The South Korean economy bounced back quickly from the 1997 crisis. The growth rate jumped from −5.1 percent in 1998 to 11.5 percent in 1999. Subsequently, the growth rate was not low by the international standards, helping the country evolve into an advanced country. The country joined the OECD in 1996 but came to be classified as a developed country by the World Bank and UNDP after 1997. Thus, the crisis did not act as a middle-income trap. Still, economic growth slowed down. There were basically two moments of the slowdown: the first was the 1997 crisis and the ensuing reform; the second was the 2008 crisis and the Great Recession following it. This section focuses on the first slowdown, leaving the further slowdown to Sections 3 and 4. During the ten years from 1998 to 2007, the growth rate of GDP averaged 5.2 percent. This was quite 272

The Slowing Engine of Growth 273 high by international comparison but represented a drastic drop from the average of 9.2 percent from 1987 and 1996, ten years before the 1997 crisis broke out. The growth rate of per capita GDP averaged 4.6 percent from 1998 to 2007, down from 8.2 percent from 1987 to 1996. The growth rate of GDP fell as the gross investment rate fell. The gross investment rate averaged 37.8 percent from 1987 to 1996; it averaged 32.0 percent from 1998 to 2007. Once the investment rate fell, a relatively vicious circle of investment and growth set in. A lower investment rate led to a lower growth rate, causing firms to expect slower growth of sales and thereby invest less vigorously; this, in turn, led to a lower growth rate. The gross investment rate fell as the reform after the crisis purged the “aggressive but vulnerable system” in place before the crisis. It did so first by eliminating the firm-finance nexus that supported aggressive investment but produced NPLs chronically; second, it made the current account turn from deficit into surplus. This section deals with the first aspect, postponing the second to the next section.

Explaining the Slowdown Growth slows down with the maturation of the economy. Borrowing technology from more advanced countries becomes difficult. Labor supply becomes less elastic as population growth slows; relocating labor from lower-productivity sectors like agriculture to higherproductivity sectors like manufacturing becomes more difficult. As a result, firms find less opportunity for profitable investment. However, such a natural slowdown cannot explain the drastic fall of the growth rate after the crisis. As noted in Chapter 1, economists are divided over the explanation of such a slowdown: Some say that the growth slowdown reflects the normalization from the “overgrowth” before the crisis; others hold that the slowdown represents the “undergrowth” after the crisis. Between the two opposing views, the “overgrowth” view is more sophisticated, being based on econometric analysis. Barry Eichengreen and his colleagues analyze the trend of South Korea’s

274 The Tortuous Path of South Korean Economic Development growth rate using time-series data to conclude that the discontinuity in growth was less remarkable in 1998 than in 1989. They imply that, in the mid-1990s, the South Korean economy underwent an overgrowth similar to the 1986–1988 boom.1 However, the comparison is misplaced. The 1986–1988 boom was clearly an overgrowth caused by the especially favorable international conditions that could not persist. In contrast, in the mid-1990s, South Korea was facing the global boom that was more likely to persist, caused mainly by the catch-up growth of latecomer countries such as China. The overgrowth view also explains South Korea’s growth slowdown by referring to other countries’ experiences. According to crosscountry econometric analysis, the growth slowdown in Europe and Japan in the postwar period was characterized by a sudden drop rather than the gradual convergence to the United States – the productivity leadership country. South Korea is no exception to this pattern. The way the country joined the common pattern, the argument goes, was the adjustment from the overinvestment before the 1997 crisis. In the 1990s, the investment rate should have fallen as the economy matured, but it did not. South Korea’s investment rate before the 1997 crisis was thus higher than in other countries with similar characteristics. After the 1997 crisis, South Korea’s investment rate converged toward the level observed in countries with similar characteristics.2 However, the rise of the investment rate in the mid-1990s mainly reflected the move to capture the opportunity offered by the newly emerging global boom. There is no evidence that, after the crisis, South Korea suffered from massive idle capacity brought about by the overinvestment made before the crisis. Rather, the opposite was true. The country was able to get out of the currency crisis by exporting the products of the industries that had made heavy investments before the crisis (Even though the immediate cause of the large



1 2

Eichengreen et al. (2012: Chapters 1 and 2). Eichengreen et al. (2012: Chapters 1 and 2); Kim and Lee (2013).

The Slowing Engine of Growth 275 current account surplus in 1998 was shrinking imports, the eventual ability to overcome the crisis came from the export capacity). The cross-country empirical analysis is useful for analyzing the different performances at different “stages” of development. At the early stage of development, an economy sharing the same characteristics with other poor economies cannot grow rapidly as those same characteristics may well be the obstacle to growth. South Korea historically had characteristics distinct from other developing countries, mainly composed of ex-colonies, as discussed in Chapters 2 and 3. The distinct characteristic continued to exist in the early phase of the HEG. For example, in the 1970s, South Korea had a far higher weight of manufacturing production and exports as a percentage of GDP compared with countries with similar levels of per capita income and population.3 Those distinct characteristics helped the country forge ahead of other developing countries. Then, when an economy approaches the advanced country status, does it help for a country to share the same characteristics with other advanced countries? This is not necessarily true. At the heart of the problem lies the fact that there are quite a few advanced economies that did well for a significant period of time and then stagnated and failed to catch up with the United States, the productivity leadership country. They include, for instance, Japan, Italy, Spain, and Greece. The cross-country econometric analysis includes these countries in the samples. If South Korea’s investment rate converged with these countries’ at a similar level of development, the country would also be unable to catch up with the United States. What the cross-country analysis actually shows is that, after the 1997 crisis, South Korea may have converged with the other advanced countries that failed to catch up with the United States. All these suggest that “undergrowth” after the crisis rather than “overgrowth” before the crisis is responsible for the slowdown. What then caused the undergrowth after the crisis?

3

Kim and Romer (1979: Chapter 6).

276 The Tortuous Path of South Korean Economic Development

A Less Aggressive System Undergrowth occurred because the investment rate fell. Why did the investment rate fall? External conditions did not turn unfavorable to investment as the new global boom that began in the 1990s continued until the global financial crisis in 2008. Domestic macroeconomic policies also turned more favorable to investment. The real interest rate fell as a result of the capital market opening. The effective corporate tax rate was cut, though with some twists and turns.4 The business environment turned more favorable due to massive deregulation and the weakening of union power (See Chapter 11 for the weakening of union power). The investment rate fell as the reform after the 1997 crisis, while purging the vulnerable part of the existing system, purged its aggressive part as well. Some empirical studies confirm this. Hong Gi-Seok has shown that investment rates fell with the drastic reduction of the debt-equity ratio of chaebol firms in a short span of time after the crisis.5 Lee Sangwoo and his colleagues have shown that the reform after the crisis made the internal capital market of chaebol, a mechanism that had activated investment previously, difficult to function.6 The government made efforts to offset such an effect by introducing alternative mechanisms of investment. The most salient endeavor was promoting venture business. The Kim Dae-jung government (February 1998–February 2003) mobilized every method to promote venture business, reinforcing the move initiated by the Kim Young-sam government (February 1993–February 1998), which had indeed tried to promote venture business as an alternative engine of growth to chaebol. From 1998 to 2000, there was a big venture boom. However, it led to the formation of a huge bubble in the KOSDAQ market, a channel to recuperate the capital invested in venture



4 5 6

Kim (2013). Hong (2007). Lee et al. (2009).

The Slowing Engine of Growth 277 businesses. When the bubble burst in 2000, the venture boom could no longer offset the effect of the reform, though venture business would not be the same as before (See Chapter 10). Another candidate to replace the role of chaebol was FDI. In 1997, FDI inflow shot up as the government had liberalized it to meet the conditionality of the OECD membership, enabling the pent-up demand of foreign investors to be realized. After the crisis, the government induced FDI actively, by providing various incentives and establishing the Foreign Investment Committee to administer the policy to induce FDI. FDI inflow rose further for a few years from 1998 as the pent-up demand continued to be realized and the government’s efforts took effect; asset sales also increased FDI inflow. However, such inflow was temporary, and FDI inflow fell quickly after the initial surge, though it was also not the same as before (more on this in Chapter 10). The last but most relevant candidate to replace chaebol was conventional SMEs, which accounted for a far larger share of investment than venture business or FDI. However, SMEs failed to do so, as they could not suddenly increase investment. They rather faced a deteriorating investment environment as financial institutions reduced the share of lending to them while raising the share of lending to households dramatically. From the 1950s on, South Korea implemented financial policy to ration credit to enterprises rather than households, thinking, rightly so, that banks, if left alone, would not lend enough to enterprises. They would prefer lending to households, mainly with real estate as collateral, because it was easier than lending to enterprises, which needed the ability to evaluate their financial soundness and business potential. The government also used financial policy to subsidize exports and priority industries. In the 1960s and 1970s, the policy favored large enterprises, especially chaebol firms. Banks also preferred lending to large enterprises because of their higher creditworthiness. In the 1980s and 1990s, while pursuing the overall liberalization of the financial sector, the government moved the focus

278 The Tortuous Path of South Korean Economic Development of financial policy to supporting SMEs. Banks also became better able to process information about SMEs. Banks increased lending to SMEs accordingly. In the mid-1990s, banks reduced lending to chaebol as regulations on the concentration of economic power proliferated. Chaebol tapped NBFIs as an alternative source of credit, which caused the liquidity crisis in 1997. Chaebol firms and other large enterprises also moved to direct financing by issuing more stocks and bonds. Banks thus had more incentives to lend to SMEs. Meanwhile, the government lifted the restrictions on household loans gradually as part of the liberalization drive. Banks increased household loans accordingly. In fact, they had incentives to increase household loans on a larger scale because lending to households was still easier than lending to SMEs. Yet they could not do so because the government lifted the restrictions on household loans only gradually. However, the 1997 crisis and the ensuing reforms changed the situation dramatically. Chaebol reduced borrowing by lowering the debt-equity ratio after the crisis. However, this did not result in a rise in the share of SME loans. The share of SMEs rather fell. The share of SME loans fell initially because the crisis drove many SMEs into financial distress, making financial institutions avert lending to them. Then, radical structural adjustments after the crisis aggravated their ability to lend to SMEs, based on their long-term relationship with SMEs that provided the information about them. It damaged the relationship by massively closing financial institutions and laying off their personnel; particularly, it closed many local banks that had ongoing relationships with local SMEs. At the same time, the government suddenly lifted the restrictions on household loans almost completely as part of the reforms after the crisis. In addition, the Kim Dae-jung government activated real estate transactions to boost the economy. It lifted the policies that had been introduced to discourage real estate speculation previously, including capital gains tax and the regulations on the sale price of apartments and the sale of the ownership of a lot for the purchase of apartments

The Slowing Engine of Growth 279 without moving in, and so on.7 The resultant rise of housing prices interacted with the increase of household loans. As people expected the rise of housing prices, they borrowed from banks to purchase housing, raising housing prices further, which in turn raised the collateral value of the housing. All these led to the explosion of household loans. There are no data about the comprehensive picture of the allocation of loans to different categories of borrowers over the longer run. The available data are those the BOK and the Financial Supervisory Service compiled for loans made by general banks (nationwide and local), which account for about 60 percent of total assets in the financial sector. The data give the amount of their loans made in domestic currency won to large enterprises, SMEs, and households from 1989 (There are no separate data for loans to chaebol; they are mostly included in the loans to large enterprises). Figure 9.1 presents the share of large enterprises, SMEs, and households, respectively, in the loans. The share of large enterprises fell consistently from 1989. The share of SMEs shot up to fill the room left by large enterprises. Households then joined SMEs to fill the room, but the share of SMEs continued to rise, standing far above the share of households. Then, the 1997 crisis changed the picture dramatically. The share of large enterprises continued to fall, but this time, the share of SMEs also fell. It stood at 54.3 percent in 1996 but suddenly fell to 43.9 percent in 1997 and fell further subsequently. It stabilized later but never recovered to its 1996 level. Meanwhile, the share of household loans was no more than 19.5 percent in 1996, but it skyrocketed with the crisis, reaching the peak of 56.3 percent in 2005; it stayed higher than the share of SME loans afterwards. The explosion of household loans undermined growth by channeling money into consumption rather than investment. The increase in household loans had its own benefit: It improved consumer

7

Lee (2007).

280 The Tortuous Path of South Korean Economic Development 60.0

50.0

40.0

30.0

20.0

10.0

Large enterprises

SMEs

19 20

16 20

13 20

10 20

07 20

04 20

01 20

98 19

95 19

92 19

19

89

0.0

Households

Figure 9.1  The shares in lending by general banks, 1989–2021 (percent) Notes: Lending in Korean won. Source: Appendix 7.

welfare by lifting liquidity constraints on households, enabling them to consume according to their lifetime income and wealth. However, household loans were suddenly liberalized without carefully weighing the benefit against the cost in a balanced way. Thus, the shocks of the crisis and the ensuing reforms, which were carried out like shock therapy, reduced the growth rate through the explosion of household loans. Furthermore, the explosion of household loans would create new vulnerabilities.

New Vulnerabilities The explosion of household loans became the source of new vulnerabilities as they were combined with the government policy to boost the economy in the short term. The Kim Dae-jung government

The Slowing Engine of Growth 281 implemented short-term policies to boost the economy in addition to long-term policies like the promotion of venture business and FDI. The first such policy was the promotion of the use of credit cards. The Kim government promoted the use of credit cards not only to enhance the transparency of the economy but also to boost it by encouraging households to consume more. It gave tax deductions for purchases made with credit cards and loosened the regulations on issuing them. Despite the liberalization of household loans, banks were initially not inclined to lend to households that lacked collateral and proper credit records. However, once the government promoted the credit card business, banks and chaebol moved into the credit card business in droves, setting off a credit card lending boom. The competition among credit card firms led them to make loans even to those who had questionable ability to pay them back. The regulatory authority did little to stop the reckless lending until it was too late. The credit card boom helped boost the economy, but by 2003, many of the credit card companies had been pushed to the edge of insolvency. The crisis was brought under control relatively quickly by an injection of BOK liquidity into the banking system and other regulatory interventions. Another short-term policy to boost the economy was activating the real estate transactions mentioned above. It led to a real estate boom and temporarily boosted the economy. However, it had a devastating effect on equity, as it had earlier. The succeeding Roh Moo-hyun government (February 2003–February 2008) tackled the real estate problem in earnest. As a civil rights lawyer-turned-​ politician, Roh Moo-hyun was probably the most reform-oriented, though not so experienced, of all South Korean presidents. His government tried hard to control the rising real estate prices by raising taxes, re-imposing regulations, and introducing the prudential measures like the loan-to-value ratio (LTV ratio) and the debt-to-income ratio (DTI ratio) for household loans. However, those policies failed to cool down the speculative boom easily once it set in. The real estate boom cooled off eventually, as the Roh Moohyun government’s policy finally took effect and the 2008 crisis dealt

282 The Tortuous Path of South Korean Economic Development a further blow, but it precipitated another crisis as many savings banks’ financial situations deteriorated drastically. Savings banks, previously named mutual savings banks, had been community banks established to provide financial services to low-income households, the self-employed, and SMEs with limited access to commercial banks, replacing the previous role played by the curb market. However, as commercial banks and credit card firms moved into household lending on a large scale after the crisis, mutual savings banks mounted intensive lobbying efforts to revise the regulations to give them more leeway to diversify their loan portfolios into property lending to firms. The lobbying efforts succeeded. Savings banks lent massively to construction firms and real estate rental companies benefiting from the real estate boom. They did well as long as the real estate boom persisted, but it did not. By 2011, many savings banks were on the verge of bankruptcy. The government resolved this crisis in a way similar to the credit card crisis.8 The credit card and savings bank loan crises did not pose any serious systemic risk because the amount of lending accounted for a small share of the total credit. There was also no sign that household loans were chronically becoming NPLs like the loans to firms before the 1997 crisis. Overall, the economic system became less vulnerable than before the 1997 crisis by purging the firm-finance nexus that had chronically produced NPLs. The system thereby became less aggressive, but it also became less vulnerable. However, a far more significant source of vulnerability for a country like South Korea was the foreign exchange market rather than the domestic financial market.

9.2  Current Account, International Investment Position, and Self-insurance The vulnerability in the foreign exchange market apparently fell as the current account turned from deficit into surplus after the 1997 crisis. Current account turned into a chronic surplus as the gross

8

See Park et al. (2021: Chapter 12) for the credit card and savings banks crises.

The Slowing Engine of Growth 283 investment rate fell. The fall of the gross investment rate made the economy less aggressive, while the resultant current account surplus made the economy less vulnerable to currency crisis. However, the current account surplus did not lead to the equivalent improvement of the net international investment position (NIIP), failing to reduce the possibility of a currency crisis to the extent that NIIP represented the net foreign assets of the country. Moreover, the current account surplus itself was mainly the result of efforts to hold more international reserves to insure the economy against the enhanced possibility of a currency crisis after opening up the capital market. All this would be true for the whole period after the 1997 crisis, but it was particularly true for the years from 1998 to 2007, before another currency crisis broke out in 2008. This section examines what happened in those years.

Current Account Surplus After the 1997 crisis, the current account turned into a chronic surplus, averaging 2.5 percent of GDP from 1998 to 2007. The current account turned into a surplus because the gross saving rate did not fall as much as the gross investment rate, as shown in Figure 5.1. The gross saving rate fell less than the gross investment rate as its composition changed: The weight of household saving fell steeply, but the weight of corporate saving rose to partially offset it. Figure 9.2 shows the composition of the gross saving rate. Household saving came to account for less of the gross saving rate, while corporate saving accounted for more of the gross saving rate after the crisis. Household saving accounted for 12.9 percent of GDP in 1996 but only 4.2 percent of GDP in 2007; corporate saving was 13.3 percent of GDP in 1996 but rose to 19.0 percent of GDP in 2007. Household saving came to account for a lower share of GDP as the household saving rate fell drastically after the crisis. The net household saving rate, measured as net household saving as a percentage of household disposable income, nosedived. It stood at 15.1 percent in 1996, rose to 20.4 percent in 1998, but fell to a mere

284 The Tortuous Path of South Korean Economic Development 45.0 40.0 35.0 30.0 25.0 20.0 15.0 10.0 5.0

20

17

14

20

20

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08

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20

05 20

02

99

Corporation

20

19

96

93

Household

19

90

19

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84

87 19

81

19

19

78 19

19

75

0.0 Government

Figure 9.2  The composition of gross saving rate, 1975–2021 (percent) Source: ecos.bok.or.kr.

1.8 percent in 2007.9 Such a drastic fall in household saving rate is without parallel in other OECD countries. Why did the household saving rate nosedive? The explanation of the high household saving rate before the crisis (discussed in Chapter 5) provides the answer. The household saving rate was high because of the demography, poor social security system, restrictions on household loans, and the high proportion of the self-employed. Among them, changing demography was not responsible for the fall of the household saving rate because the total dependency ratio changed little: It stood at 40.8 percent in 1996 and 40.4 percent in 2007 (See Figure 11.6). The social security system was strengthened after the crisis, but it still had a long way to go. The proportion of the self-employed did not change much. Thus, the household saving rate nosedived mainly because household loans skyrocketed, lifting the liquidity constraint on households, which interacted with the rise of real estate prices. Meanwhile, corporate saving came to account for a higher share of GDP as firms and financial institutions became more profitable

9

The numbers are from ecos.bok.or.kr.

The Slowing Engine of Growth 285 and retained the major portion of the increased profits. The less aggressive system after the crisis meant that firms, chaebol firms in particular, paid relatively more attention to short-term profitability than long-term growth, and they indeed became more profitable.10 They retained the major portion of the increased profits rather than distributing them to households as dividends (See Chapter 11). Yet the share of corporate saving in GDP failed to rise enough to offset the falling share of household saving in GDP, so the gross saving rate fell after the crisis. Though the gross saving rate fell, the gross investment rate fell more, so the current account turned into a surplus. Underlying this shift was the macro-economic policy to maintain the inflation rate at a lower level and the exchange rate at a higher level than before the crisis. The inflation rate, measured as the annual increase rate of the CPI, averaged 3.2 percent from 1998 to 2007, down from 6.0 percent from 1987 to 1996. The inflation rate finally approached that of advanced countries. The exchange rate skyrocketed during the crisis and then stabilized, but at a level higher than the pre-crisis level. The country could maintain a lower inflation rate owing, not to a small degree, to instituting the independence of the central bank. The government enacted a new Bank of Korea Act, bestowing the BOK independence for the first time since Park’s junta had subjugated it to the executive branch of the government in 1962. According to the new law, the BOK governor, instead of the Minister of Finance and Economy, became the chairman of the Monetary Policy Committee. The Minister of Finance and Economy lost the power to overrule decisions by the Monetary Policy Committee, and all requests by the Minister of Finance and Economy to the Monetary Policy Committee were made public. The Monetary Policy Committee then practiced inflation targeting, setting the target at three percent ±0.5 percent (Previously, it targeted monetary aggregate, M2).

10

Lee (2014).

286 The Tortuous Path of South Korean Economic Development Meanwhile, the government maintained the exchange rate at a level higher than before the crisis by intervening in the foreign exchange market. After the crisis, South Korea officially chose a floating exchange rate, but in reality, the government intervened to maintain the exchange rate at a level high enough to generate a current account surplus. The country thus chose a heavily managed floating exchange rate system. Of course, the country could not maintain the exchange rate at a higher level just by intervening in the foreign exchange market. It had to offset the effect of the current account surplus on inflation. The current account surplus increased the BOK’s net foreign assets, which, if left alone, would lead to an increase of monetary base. The resultant increase of money supply would raise the inflation rate and erode the current account surplus. This had indeed happened in 1986–1988 boom, as explained in Chapter 5. Now, the BOK was better able to offset the effect of the current account surplus on the monetary base. The size of the current account surplus as a percentage of GDP in each year was not as large as in 1987 or 1988. The bond market was substantially deepened and widened, so the BOK found it easier to sell Monetary Stabilization Bonds. As the inflation rate fell and exchange rate rose, the REER rose. Figure 9.3 presents the REER from 1964 calculated by the Bank for International Settlements (These REER figures do not include the subsidies and tariff equivalent appearing in Tables 4.3 and 4.4, so they are not directly comparable to the REER figures in those tables). The REER averaged from 1998 to 2007 at a level 12.0 percent higher than the level from 1987 to 1996. The increase of the REER switched the expenditure to net exports (exports minus imports) away from domestic absorption (investment and consumption). Since the difference between domestic absorption and domestic production is the difference between gross investment and gross saving, the switch in expenditure due to the rise of REER drove the gross saving rate above the gross investment rate, to generate the current account surplus.

The Slowing Engine of Growth 287 140.0

120.0

100.0

80.0

60.0

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21

18

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94

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85

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82

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76

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70

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67

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64

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Real effective exchange rate

Figure 9.3  Real effective exchange rate (2010=100), 1964–2022 Source: Calculated from the monthly data of the Bank for International Settlements (www.bis.org/statistics/eer.htm?m=2676).

Net International Investment Position Unfortunately, the current account surplus did not lead to the equivalent increase in NIIP, the total assets held abroad minus the total liabilities to foreigners. The current account surplus amounted to 145.0 billion dollars from the fourth quarter of 1997 to the end of 2007, but NIIP decreased by 110.6 billion dollars during the same period. The difference, 255.6 billion dollars, was equivalent to the reduction of national income.11 South Korea thus suffered not only a decline in the growth rate measured in terms of GDP but also a decrease of national income through international investment after the crisis. Moreover, the deterioration of the NIIP made the economy more vulnerable to currency crisis, as long as the NIIP represented the net foreign assets of the country.

11

Obstfeld (2012: 4).

288 The Tortuous Path of South Korean Economic Development The current account surplus failed to increase NIIP because the country suffered negative net capital gains or “net capital losses” from international investment. The following relationship shows the point: NIIP  CA  KA  E  NKG , where ∆NIIP, CA, KA, E, and NKG represent changes in NIIP, current account, capital account, errors and omissions, and net capital gains from international investment, respectively. The sum of the current account, capital account, and errors and omissions makes up the “financial account,” representing the net acquisition of foreign assets. The equation shows that the increase in NIIP is equal to the net acquisition of foreign assets plus the net capital gains accruing to existing foreign assets and liabilities. Capital account KA is almost negligible in amount as it is composed of minor elements such as liquidation of debt; errors and omissions E are equally negligible in amount. Thus, ∆NIIP being negative while current account CA being positive means large negative net capital gains or net capital losses. Figure 9.4 presents the trend of financial account and changes in NIIP as a percentage of GDP to help see the amount of net capital losses. The figure confirms that South Korea came to suffer large net capital losses in international investment after the crisis. Changes in NIIP did not diverge much from financial account before the crisis, but they widely diverged from each other after the crisis. Net capital losses averaged 0.2 percent of GDP from 1980 to the third quarter of 1997, but they averaged 3.6 percent of GDP from the fourth quarter of 1997 to the end of 2007. Economists typically explain that such capital losses are caused by risk sharing. Because assets of emerging market countries (EMCs) like South Korea are riskier than assets of advanced countries like the United States, the rate of return on the former should be higher than that on the latter, and the difference in net capital gains is part of the difference in the rate of returns. Moreover, a large part of EMCs’ foreign assets are international reserves, which are composed of low-risk

The Slowing Engine of Growth 289 8.0 6.0 4.0 2.0 0.0 –2.0 –4.0 –6.0 –8.0

Financial account

20 20

17 20

14 20

11 20

08 20

05 20

02 20

99 19

96 19

93 19

90 19

87 19

84 19

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–10.0 Change in NIIP

Figure 9.4  Financial account and the changes in net international investment position as a percentage of GDP, 1980–2022 (three-year average) Source: ecos.bok.or.kr.

assets such as US Treasury Bills. Thus, the current account deficit of advanced countries, notably the United States, is not accompanied by an equivalent reduction in their NIIP, while the current account surplus of EMCs, like South Korea, fails to produce an equivalent increase in their NIIP.12 However, risk sharing alone cannot explain why net capital losses increased drastically with the 1997 crisis. One obvious reason for the drastic increase was the capital market opening and asset sales made immediately after the crisis. As mentioned in Chapter 8, after the crisis, South Korea suddenly opened up the capital market in full and sold a massive amount of assets to foreigners, many of them through fire sale. The prices of those assets shot up as the economy recovered. The structural reform also raised asset prices by improving the financial situation of firms and financial institutions. The fall of the exchange rate, which had skyrocketed during the crisis, additionally raised the asset prices in dollar terms. Asset sales

12

Obstfeld (2012, 2013); Gourinchas et al. (2013).

290 The Tortuous Path of South Korean Economic Development also explain why the net capital losses as a percentage of GDP fell after rising dramatically until 2007, as shown in Figure 9.4. The asset sale was basically a one-shot event, so the effect had to taper off over the years, with ups and downs caused by events like the 2008 crisis. As a result, the NIIP deteriorated in spite of the current account surplus after the crisis. The deterioration of the NIIP made the economy more vulnerable to currency crisis, as long as the NIIP represented the net foreign assets, representing the “solvency” of the country in relation to the outside world. Thus, the emergence of the current account surplus after the 1997 crisis failed to mean the exchange between slower growth and lower risk of currency crisis. The economy became less aggressive by recording current account surplus with the lowered gross investment rate, but it failed to become less vulnerable to currency crises as the NIIP deteriorated. However, more significant for the possibility of a currency crisis than the NIIP is the liquidity position in relation to the outside world.

Liquidity Position and Self-insurance The liquidity position in relation to the outside world is determined mainly by the amount of internationally liquid assets in relation to short-term liabilities. For policy purposes, the amount of international reserves held by the government in relation to short-term foreign debt is critical. After the 1997 crisis, South Korea accumulated international reserves while opening up the capital market, including the liberalization of short-term borrowing. One can go back to Figure 8.1 to identify the improvement of the liquidity position. After the crisis, the amount of international reserves shot up above the amount of short-term foreign debt to a degree never seen since 1970. The country became far better prepared for the possibility of a currency crisis. However, the problem is more complex than it first appears. After the crisis, South Korea, like most EMCs, held international reserves for self-insurance against the possibility of a sudden reversal of capital flow. This was a great improvement over the

The Slowing Engine of Growth 291 situation before the crisis, when the country had little sense of selfinsurance while incurring short-term foreign debt. The risk of currency crisis clearly fell if one compares the realities before and after the crisis. However, one could also make a comparison between the realities after the crisis with what would have happened if the resolution process of the 1997 crisis had followed what a sensible economic logic would have dictated. Instead of demanding South Korea to throw open the capital market in full, the IMF should have demanded it to recalibrate the capital market opening, which would have been in line with the IMF’s own position, as discussed in Chapter 8. When compared with such a counterfactual scenario, whether the economy became less vulnerable to currency crisis is unclear. The country was holding more international reserves out of precautionary motives to prepare for the contingency of a sudden reversal of capital flow after throwing open all capital markets. In other words, the country was self-insuring against the risk that “rose” with the capital market opening. It was by no means clear whether the net risk of a currency crisis fell. The domestic reforms included policies to prevent future currency crisis, notably enhancing the riskmanagement ability of financial institutions and the supervision ability of the government. However, it is very difficult for an EMC to prevent a currency crisis with such policies while keeping its capital market thrown open, as the list of complementary measures to be taken may become almost infinite in length.13 A country can reduce the possibility of a currency crisis to almost zero by holding an infinitely large amount of international reserves, even when it keeps its capital market open. However, holding international reserves is costly, so there should be an optimal amount of international reserves. There is a rule of thumb like the “Guidotti–Greenspan Rule” in this regard, requiring the international reserves to be larger than short-term foreign debt in amount.14



13 14

See Rodrik and Subramanian (2009: 125) cited in Chapter 8. Rodrik (2006).

292 The Tortuous Path of South Korean Economic Development However, abiding by the Guidotti–Greenspan Rule did not spare South Korea another currency crisis when a global financial crisis broke out in 2008.

9.3  The 2008 Crisis and After South Korea underwent another currency crisis in 2008. What caused it? Many observers, including the US government, regard it as selfmade – at least partially – on the grounds that the global imbalance played a major role in precipitating the global financial crisis. East Asian countries, including South Korea, recorded a large current account surplus with the United States, providing the bulk of foreign savings that lowered the US interest rates by plowing the money back into the US capital market through purchasing liquid assets such as Treasury Bills.15 The global imbalance surely helped to keep the US interest rates low, encouraging more borrowing within the United States. However, that does not mean that the creditor countries were responsible for the crisis. To be responsible for the crisis, they would have had to have suddenly pulled money out of the United States, for example, by selling off the Treasury Bills. In reality, as the crisis broke out in the United States, money quickly flew back to the United States and other advanced countries, leaving EMCs like South Korea to face currency crises. Finding the causes of the 2008 crisis in the global imbalance is also inconsistent with the US position on the 1997 East Asian crisis. At that time, the United States never regarded the creditors, mostly advanced countries’ banks, as responsible for the crisis even though they had indeed pulled money out of the debtor countries. In contrast, this time around, the United States claimed that creditors were responsible for the crisis even though they had not pulled money out of the country. Moreover, to a large degree, East Asian countries such as South Korea had bought the liquid US assets like Treasury Bills to

15

Dunaway (2009: 3).

The Slowing Engine of Growth 293 accumulate international reserves for self-insurance purposes after opening up the capital market. They wanted to self-insure by accumulating more international reserves after suffering from the harsh treatment by the IMF in the 1997 crisis; they expected the same treatment if they faced another currency crisis and went to the IMF.

Causes of the Crisis The 2008 crisis was not a self-made one for South Korea. Instead, the country was hit by the crisis that originated in the United States. The global financial crisis hit South Korea particularly hard, as it had become a “global automated teller machine (ATM)” after the 1997 crisis, as South Koreans called their country cynically.16 However, the critical problem was again the pullout by the banks that had lent to South Korean banks in the short term rather than the pullout by hedge funds or mutual funds. South Korean banks had again borrowed in short term from foreign banks and then found themselves unable to roll the debt over when the creditor banks pulled out of the country to meet an urgent need at home. The trap that caught the banks was the transaction of foreign exchange derivatives. As South Korea moved to a floating, though heavily managed, exchange rate system, hedging against exchange rate risk became a critical task for traders and investors. The largest demanders of the hedging were shipbuilders. When they concluded shipbuilding contracts with buyers, they wanted to sell forward exchange at a specified rate in order to make sure that they would receive a pre-determined price in South Korean won when they handed over ships after years (about three years on average) of construction. Asset management firms also had considerable demand for hedging exchange risk. After the crisis, South Koreans made portfolio investments overseas on a large scale. The government encouraged portfolio investment overseas as capital inflow lowered exchange rate to threaten the current account surplus. Many South Koreans

16

www.mk.co.kr/news/economy/view/2018/07/470371/

294 The Tortuous Path of South Korean Economic Development made portfolio investments through asset management firms, which wanted to hedge the exchange rate risk for their clients. Banks bought the forward exchange shipbuilders and asset management firms sold. When banks bought the forward exchange, they had to meet the position requirements of the supervisory authority. Before the 1997 crisis, the financial supervision rule required that, when banks bought forward exchange, they had to sell equivalent amount of forward exchange at the same date in the future. However, after the crisis, the supervisory rule was revised to allow banks to meet position requirements just by incurring foreign debt. As the banks still had difficulties with long-term borrowing, given their low credibility abroad, they borrowed in the short term. As a result, banks developed a serious term mismatch in their foreign assets and debts. In contrast to 1997, they now had only term mismatch (without any currency mismatch), but it was enough to precipitate a currency crisis when external conditions soured. Why was the position requirement on banks relaxed? The government officially strengthened financial supervision by creating the Financial Supervisory Service, but the supervision ability actually deteriorated in the critical areas like the position requirement. There is no study about why this happened, but some guesses can be made. First, the financial authority, including the Financial Supervisory Service, may have been swayed by the overall deregulation drive, the general policy atmosphere after the crisis. Second, the government thought deregulation of banks was necessary to promote the financial sector as an industry in itself rather than the supporter of other industries like manufacturing; it was part of the efforts to cope with the sagging growth momentum after the crisis. Third, the reform after the crisis failed to dismantle the firmly entrenched interests of the financial bureaucracy; the reform rather strengthened them. The Financial Supervisory Service was quickly put under the control of the personnel from the Minister of Finance and Economy (previously the Minister of Finance), who used to be called “MOFIA.” They completely triumphed over the BOK in the turf war for the right of

The Slowing Engine of Growth 295 financial supervision, even though they had been far more responsible for the 1997 crisis. Such a result could actually be foreseen from the resolution process of the 1997 crisis. The currency crisis had been caused by ill-sequencing in the capital market opening  – allowing banks to borrow in short term without the proper development of their riskmanagement ability or supervision ability of the financial authority. The IMF nevertheless demanded South Korea to open up all capital markets immediately, and the country willingly complied. It was thus no wonder that the same mistake was repeated.

Resolving the Crisis The government had to do the same as in 1997. On October 19, it guaranteed the payback of the foreign debts owed by the banks, making use of the international reserves. The government also lent banks international reserves. However, the government action did not work. In 2008, South Korea’s fiscal situation was far worse than in 1997, but it was not the reason why the government action did not work. The problem was again the shortage of liquidity. The government had far more international reserves than in 1997, and they exceeded short-term foreign debt in amount. As of the end of September 2008, international reserves amounted to 239.7 billion dollars while shortterm foreign debt was 190.1 billion dollars. However, the trend illustrated a different picture. As shown in Figure 8.1, the difference between international reserves and shortterm foreign debt as a percentage of GDP peaked in 2004 and fell thereafter. The rapid increase of foreign debt accounted for the narrowing difference, but the fall of the international reserves as a percentage of GDP was also responsible. In 2008, the amount of international reserves itself decreased. This came from the confusion in the macro-economic policy of the Lee Myung-bak government (February 2008–February 2013), which was the conservative government in ten years. As mentioned in Chapter 1, Lee was elected president promising to achieve an average growth rate of seven percent

296 The Tortuous Path of South Korean Economic Development in the five years of his tenure. His government initially emphasized keeping the exchange rate high to maintain current account surplus that would help to keep the growth rate high. However, it changed the policy as the inflation rate rose due to the rising oil price. In December 2007, the annual inflation rate, measured as the increase rate of CPI over the same month a year earlier, rose above the upper limit of 3.5 percent set by the BOK. As the inflation rate rose further in 2008, the Lee government decided to spend international reserves to offset the effect of rising oil price by bringing down the exchange rate. International reserves decreased from the peak at 264.3 billion dollars in March 2008 to 239.7 billion dollars in September 2008. This happened while short-term foreign debt, which had already swollen rapidly, increased from 178.2 billion dollars to 190.1 billion dollars during the same period. Moreover, the current account was turning into deficit with the soaring oil price. One could thus expect that short-term foreign debt might soon exceed international reserves in amount. The Lee Myung-bak government spent international reserves to stabilize inflation even though the world economy was already showing signs of distress with the US subprime mortgage crisis. When the subprime mortgage crisis evolved into the global financial crisis in the autumn of 2008, the government lacked international reserves large enough to bail the banks out. To resolve the crisis, the country had to borrow liquidity from abroad. This time around, the IMF was willing to lend liquidity to EMCs like South Korea with sound fiscal and current account situations without attaching conditions. However, when the rumor spread that the government was considering taking the IMF money, financial markets collapsed immediately, apparently out of the memory of what had happened under the IMF conditionality after the 1997 crisis. The government hurriedly denied that it was seeking the IMF money.17 Finally, on October 30, the BOK signed a currency swap accord worth 30 billion dollars with the US

17

Korea Economic Daily, October 30, 2008.

The Slowing Engine of Growth 297 Federal Reserve Board, critically stabilizing the market. The United States attached no conditions this time. In December, South Korea signed additional swap accords with Japan and China, each worth 30 billion dollars, also without any conditions attached. Once the currency swap agreements stabilized the foreign exchange market, other steps were relatively easy. The BOK slashed its policy rate from 5.25 percent to 2.00 percent between September 2008 and February 2009. Fiscal policy also turned expansionary. The country implemented expansionary fiscal policy to abide by the agreement at the G20 meeting, where it became a member (It hosted the G20 summit in 2010). The G20 decided that the countries able to afford expansionary fiscal policy should implement it, and South Korea was no doubt one of them. The Lee Myung-bak government was in fact implementing expansionary fiscal policy even before the crisis broke out, not by increasing the government expenditure but by cutting taxes. It cut the corporate tax rate and slashed the taxation on real estate, which the Roh Mu-hyun government had raised.18 It did so on the ground of the “Laffer Curve,” but it was highly questionable whether those tax cuts would increase tax revenue. With the outbreak of the crisis, the Lee government increased the government expenditure as well. The expansionary fiscal policy played an important role in coping with the crisis, which was manifested by the fact that, in 2009, the government contributed 2.3 percentage points of the economic growth while the private sector contributed −1.5 percentage points of the economic growth. At the same time, the outbreak of the currency crisis ironically helped the recovery, as mentioned in Chapter 1. With the crisis, the exchange rate skyrocketed and then fell, but only slowly. The REER in 2009 was higher than the REER in 2007 by 38.4 percent. The rise of the REER increased net exports (exports minus imports), which accounted for 3.1 percentage points of the economic growth, while

18

m.khan.co.kr/politics/president/article/200912070125055#c2b

298 The Tortuous Path of South Korean Economic Development the domestic demand (consumption and investment) accounted for −2.3 percentage points of the economic growth in 2009.19 Owing to the expansionary macroeconomic policy and the drastic rise of REER, South Korea recorded a positive growth rate of 0.8 percent in 2009, while most OECD countries recorded negative growth rates by a wide margin. The current account surplus amounted to 3.5 percent of GDP in 2009. International reserves, which stood at 137.0 percent of the short-term foreign debt at the end of 2008, shot up to 185.1 percent of the short-term debt by the end of 2009. The country overcame the 2008 crisis far more easily than it did the 1997 crisis because it was able to procure the necessary liquidity without any conditions attached. Especially helpful was the currency swap agreement with the United States. The United States did not attach any conditions to the swap agreement at that time, which was in sharp contrast to 1997. The underlying reason was obvious: In 1997, the United States wanted to open up South Korea’s capital market and to realize other national interests; in 2008, the United States wanted to stop an impending global meltdown. However, the swap agreements were not an institutionalized process, depending on the partner countries’ ad hoc judgment on their national interests. South Korea could not be sure of the same assistance when it faced the next currency crisis. South Korea finally recognized that opening the capital market in full after the 1997 crisis was a mistake. In 2010, the Lee Myung-bak government introduced the “macro-prudential measures” to regulate the short-term capital flow. They were composed of taxing the shortterm debt of banks, limiting the derivative transactions in the foreign exchange market, and taxing foreigners’ transactions of bonds. The move was in line with the global trend after the 2008 crisis. The international community, including the IMF, recognized that some

19

The figures for contribution of the government, private sector, domestic demand, and net exports to the economic growth are provided by the national account in ecos.bok. or.kr.

The Slowing Engine of Growth 299 capital control might be legitimate in EMCs.20 At the same time, the country accumulated more international reserves by recording current account surplus.

The Great Recession and Deflation Threat South Korea’s economic growth slowed down further after the 2008 crisis. The 2008 crisis evolved into the Great Recession in advanced countries, the longest stagnation since the Great Depression of the 1930s. With the onset of the Great Recession, globalization slowed or even reversed. The rise of China also led to the disruption of the international economic order. The Great Recession and the setback in globalization hit open economies like South Korea particularly hard. The growth rate of its GDP averaged 3.1 percent from 2008 to 2019 (the year before the pandemic hit), while it had averaged 5.2 percent from 1998 to 2007. The growth rate of GDP per capita averaged 2.6 percent from 2008 to 2019, while it had averaged 4.6 percent from 1998 to 2007. The growth rate of its GDP and per capita GDP was still high among the OECD countries, but it indeed represented a drastic fall from the HEG before 1997. The country came to face a chronic shortage of aggregate demand for the first time, which manifested itself as a deflation threat, making another sharp contrast with the period before 1997. The inflation rate fell beow the BOK’s targeting band in 2013. The BOK originally set the band at three percent ±0.5 percent and widened it to three percent ±1.0 percent in 2010. However, the inflation rate fell to 1.3 percent in 2013 and 2014 and fell further to 0.7 percent in 2015. The BOK lowered the target to two percent with no band from 2016, but the inflation rate consistently fell short of two percent. With the deflation threat looming, boosting the economy became an important policy agenda. In 2013, the Park Geun-hye government (February 2013–May 2017), another conservative government succeeding the Lee Myung-bak government, came to power. As

20

Ostroy et al. (2011); Group of Twenty (2012).

300 The Tortuous Path of South Korean Economic Development the daughter of Park Chung Hee, she was also expected to raise the growth rate. However, instead of using fiscal policy, a most effective policy to fight the deflation threat, her government tried to boost the economy again by activating real estate transactions from 2014. It lifted the regulations on housing transactions and loosened the LTV ratio and DTI ratio for household loans. To support the policy, the BOK cut its base interest rate from 2.50 percent in July 2014 to 1.25 percent in June 2016. The Park government also introduced taxation on the retained profits of corporations to encourage the distribution of dividends in order to increase household income and consumption. The policy failed to boost the economy much while sparking up another bout of real estate speculation. The Park Geun-hye government did not use fiscal policy because of the fiscal conservatism. Its top policy makers, together with the members of the economic bureaucracy, were more or less preoccupied with the previous experience of achieving the HEG with a balanced budget since the Chun Doo-hwan government. South Korea had no experience of using fiscal policy except in crisis situations like the ones in 1998 and 2009. It also did not help that the majority of the economists were educated in the United States from the 1980s to the 2000s, when fiscal policy lost its position as the instrument to fight recessions. They were concerned more with long-run fiscal soundness, for a reason that was not entirely groundless, as discussed in the next section. Yet they tended to overlook the fact that the fiscal deficit incurred to boost the economy was temporary, while once the deflation really set in, it would destroy long-run fiscal soundness as well as economic growth. The Park government rather increased taxation, mainly by reducing tax deductions and exemptions. The Park Geun-hye government was soon embroiled in a big corruption scandal and then collapsed with the “Candlelight Revolution” in early 2017. The Moon Jae-in government (May 2017– May 2022) took over as the first liberal government in more than nine years. Another civil rights lawyer-turned-politician and a close

The Slowing Engine of Growth 301 friend of Roh Moo-hyun, Moon Jae-in was elected on the platform of enhancing the welfare state and reducing inequality. Meanwhile, the deflation threat worsened as the drawn-out recession produced the worldwide populist backlash against globalization, leading to the election of Donald Trump as the US president in 2016. The need to boost the economy became ever more urgent.

9.4  New Challenges The Moon Jae-in government took a peculiar approach to boost the economy. Rather than increasing government investment, such as infrastructure construction, it tried to boost private consumption through changing income distribution. To accomplish this, it drastically raised the minimum wage while offsetting its effect on small businesses by subsidizing them. The minimum wage was raised by 16.4 percent in 2018. The Moon government also increased welfare expenditures. In 2018, the first year it compiled the budget, government expenditure rose to 31.1 percent of GDP from 30.3 percent of GDP in 2017; welfare expenditure rose to 11.6 percent of GDP from 11.1 percent of GDP in 2017. Meanwhile, the Moon government raised the corporate tax rate for the most profitable corporations and set a new income tax bracket for the highest income earners. It also raised the taxation on real estate ownership and transactions. Such a policy produced results. GDP grew by 2.9 percent in 2018, a good performance among the OECD countries. Private consumption contributed 1.5 percentage points of the 2.9 percent growth. Apparently, raising the minimum wage increased private consumption not only by raising the wages of the least skilled workers but also by pushing up the wages of the next-tier workers. The increase of welfare expenditure may have also helped to raise private consumption by increasing the transfer to the poor. This happened while the fiscal situation improved. The consolidated fiscal account, taking all government revenues and expenditures into account, recorded a surplus of 1.6 percent of GDP in 2018 – a rise from 1.3 percent of GDP in 2017.

302 The Tortuous Path of South Korean Economic Development

The Fiscal Question The Moon Jae-in government wanted to pursue expansionary fiscal policy, but met resistance by the economic bureaucracy, notably the Ministry of Economy and Finance, the government agency in charge of fiscal policy, which was backed by the conservative press. They were concerned more with long-run fiscal soundness, for a reason that was not entirely groundless. South Korea’s fiscal situation was seemingly sound enough, with the consolidated fiscal balance in chronic surplus. However, it was coming from the surplus in social insurance programs, taking a fully funded system with defined benefits. They were in surplus because they were still immature, with the working-age population contributing more than the elderly population was receiving; however, the surplus would soon turn into a deficit as the programs matured and the population aged. To take such effect of social insurance into account, the government began to compile “management fiscal account,” excluding the contribution and payment for social insurance from 1990. The management fiscal account was mostly in deficit. Such a situation made it difficult to pursue an expansionary fiscal policy. Increasing the government expenditure while collecting more revenue could stimulate the economy through the “balanced budget multiplier” effect, but it was unclear whether that would be enough. To stimulate the economy surely, the consolidated fiscal account had to be in deficit, or more accurately, the “structural fiscal account,” which represents the “discretionary” fiscal policy, taking the improvement of the fiscal balance in booms and its deterioration in recessions (mainly due to the progressive taxation and welfare expenditure) into account, should be in deficit. However, a deficit in the consolidated fiscal account or structural fiscal account would mean a larger deficit in the management fiscal account, which the government officials disliked much. Figure 9.5 presents the balance of the consolidated, management, and structural fiscal accounts. The consolidated fiscal account

The Slowing Engine of Growth 303 4.0

2.0

0.0

-2.0

-4.0

-6.0

18

15

20

12

20

09

20

06

20

03

20

00

97

Management

20

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94

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91

Consolidated

19

88

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85

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82

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79

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76

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73

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70

-8.0 Structural

Figure 9.5  Fiscal balances as a percentage of GDP, 1970–2021 Sources: Consolidated and management fiscal balances are from index. go.kr. Structural fiscal balance is from stats.oecd.org. GDP is from ecos​ .bok.or.kr.

was in deficit in the 1970s but improved with the Chun Doo-hwan government’s fiscal retrenchment in the 1980s and remained roughly in balance subsequently until the 1997 crisis. It turned into a big deficit with the crisis but came to be mostly in surplus from the 2000s. On the other hand, the management fiscal account was mostly in deficit from 1990. The discrepancy between the two measures expanded over the years as the weight of the social insurance programs in the budget rose. The balance of the structural account did not diverge much from the balance of consolidated account for several years from 2007, the first year it was compiled. However, it began to diverge in the mid-2010s, suggesting that the country failed to tackle the deflation threat with discretionary fiscal policy. In 2018, the consolidated fiscal account was in surplus by 1.6 percent of GDP, but the management fiscal account was in deficit by 0.6 percent of GDP. The structural fiscal balance was in surplus

304 The Tortuous Path of South Korean Economic Development by 3.1 percent of GDP, the highest level since 2007. Meanwhile, the inflation rate was 1.5 percent, still falling short of two percent target of the BOK. Given the large surplus in structural account and the low inflation rate, an expansionary fiscal policy was clearly in order. However, for those who were just concerned with the long-run fiscal soundness, the deficit in the management account was the first thing to be considered. In 2019, the Moon government raised the minimum wage by 10.9 percent while continuing to subsidize small businesses and increasing welfare expenditure further to 12.8 percent of GDP. It met stiffer resistance, which was not groundless: It meant fighting the deflation threat, which was temporary, with an increase of government expenditure that might become permanent. Though the Moon government increased taxation, it failed to raise the contributions to social insurance, most notably the NPS, which was a major source of the long-run fiscal problem (more on this in Chapter 11). A more persuasive fiscal policy to boost the economy lay in government investment in productive projects. Such investment could be financed by the fiscal deficit because it was not only temporary but also self-paying as long as the growth rate was higher than the interest rate. The Moon government now added some government investment projects. In 2019, the consolidated fiscal account turned into a deficit by 0.6 percent of GDP, and the deficit of the management fiscal account rose to 2.8 percent of GDP, the largest deficit since 2009. Still, the structural fiscal account was in surplus by 1.2 percent of GDP. The economy grew by 2.2 percent, with the government contributing 1.6 percentage points, out of which government investment accounted for 0.5 percentage points. Owing to the expansionary fiscal policy, the economy grew in 2019 faster than other advanced economies depending heavily on international trade, which suffered a significant blow from the drastic deterioration of the trade environment due to the aggravating US–China conflict. Germany grew by a mere 0.6 percent, Singapore by 0.7 percent, and Hong Kong by −1.2 percent. Only Taiwan grew by 2.7 percent, mainly as Taiwanese manufacturers

The Slowing Engine of Growth 305 moved their production home from China to avoid punitive US tariffs.21 However, the composition of the government contribution was still problematic, as government investment accounted for only 0.5 percentage points while government consumption accounted for 1.1 percentage points. Moreover, in spite of the efforts to boost the economy, the deflation threat did not go away. The inflation rate was as low as 0.4 percent in 2019. Then, in 2020, the outbreak of the coronavirus crisis radically changed the conditions for the macro-economic policy.

Fighting the Coronavirus Crisis South Korea dealt with the coronavirus crisis better than most countries. In 2020, the country’s economy grew by −0.7 percent, one of the highest rates among OECD countries. However, it is questionable how well its economic policies factored into this. The country’s growth rate was higher than most OECD countries’ in 2020 because it fought the pandemic better, not because it implemented economic policies better. The country fought the pandemic better, first, due to the openness of its politics. They were the fruit of the Candlelight Revolution that collapsed the Park Geun-hye government, which had dealt with the Middle East Respiratory Syndrome (MERS) terribly in 2015. Yet the experience of dealing with MERS helped to enhance the medical staff’s ability to deal with the coronavirus crisis in 2020. It also helped that the country retained the manufacturing capacity for medical instruments like diagnosis kits and masks. By fighting the pandemic better, the country avoided lockdowns, and thus the economy contracted less. Like other OECD countries, South Korea mobilized various policies to reduce the impact of the pandemic on the economy. The BOK slashed the policy rate from 1.25 percent in February to 0.50 percent

21

asia.nikkei.com/Economy/Taiwan-outperforms-other-Asian-tigers-to-notch-2.7growth-in-2019

306 The Tortuous Path of South Korean Economic Development in May 2020. The BOK launched “quantitative easing,” by expanding the trading items of open market operation from government bonds, Monetary Stabilization Bonds, and government-guaranteed bonds to other bonds issued by public enterprises. The BOK also expanded the list of the transaction partners in open market operation. The government compiled four rounds of special budgets amounting to 3.5 percent of the 2020 GDP in total. It made use of the BOK money and fiscal sources as leverage to establish funds to prevent the bankruptcy of firms, help the self-employed, stabilize the financial market, subsidize laid-off workers, and so on. The government distributed helicopter money, naming it “disaster support money.” The Moon Jae-in government then launched the “Korean New Deal” policy in July 2020. It was composed of three elements: the Digital New Deal, the Green New Deal, and the Human New Deal. The Digital New Deal was basically an industrial policy to jump into the newly emerging artificial intelligence and data technologies. The Green New Deal comprised policies to cope with climate change. The Human New Deal aimed at strengthening the social safety net and enabling people to adapt to the changing environment. The Digital New Deal and the Green New Deal were implemented in an attempt to boost the economy through government investment (Though the private sector would do the major chunk of investment, the government would lead with its own investment). The consolidated fiscal deficit amounted to 3.7 percent of GDP in 2020, the highest figure since 1970. The management fiscal deficit was 5.8 percent of GDP, also the highest figure since 1990. Even the structural fiscal balance turned to a deficit of 2.3 percent of GDP. However, the deficit was smaller than other OECD countries’. The government debt rose from 37.6 percent of GDP in 2019 to 43.8 percent of GDP in 2020, also a smaller increase than in other OECD countries (See Figure 11.5). The smaller deficit reflected the country’s better performance in fighting the pandemic, but it also meant that the government did not do enough to boost the economy. The government contributed 1.1 percentage points of growth

The Slowing Engine of Growth 307 while the private sector contributed −1.8 percentage points, making the growth rate −0.7 percent. This compared unfavorably with the government contribution of 2.3 percentage points in 2009, which made the growth rate positive. The government contribution of 1.1 percentage points in 2020 was even smaller than the 1.6 percentage points in 2019. In 2021, the economy bounced back, with the growth rate rising to 4.1 percent. South Korea recovered to the 2019 GDP level as early as in the first quarter of 2021. However, it was again due to its better performance in fighting the pandemic rather than its economic policy. The government contributed no more than 0.7 percentage points out of the 4.1 percent of growth.22 These figures call into question whether the Korean New Deal policies were really implemented. Fiscal policy failed to boost the economy enough apparently because the Moon Jae-in government could not fully control the Ministry of Economy and Finance officials, who were backed by the conservative press. In 2020, South Korea could not escape the deflation threat while the economy contracted, so the inflation rate was no more than 0.5 percent. However, in 2021, the country came to undergo an inflation problem, like most countries in the world. The annual inflation rate, measured as the increase rate of CPI over the same month a year earlier, shot up above the BOK target of two percent from April 2021 and accelerated subsequently. The BOK reacted quickly, and raised the base interest rate ten times from August 2021 to 3.50 percent by January 2023, a level higher than the pre-pandemic level by 2.25 percentage points. As the deflation threat suddenly turned into inflation threat, the need to boost the economy through fiscal policy disappeared. However, politicians wanted to continue the expansionary policy, particularly to help small businesses that had suffered during the pandemic. The coming of the new conservative government of Yoon

22

The calculations are based on the data in ecos.bok.or.kr.

308 The Tortuous Path of South Korean Economic Development Suk Yeol (May 2022−present) did not stop the move. Yoon was the Moon government’s prosecutor general who ran for the presidency as the opposition candidate to win the election in March 2022. He is the first president after democratization with no experience in politics before deciding to run for the presidency. He also had no experience other than serving as prosecutor. He declared that he did not know much about the economy and would entrust the economic affairs to specialists. However, the first action taken by his government was compiling a special budget with shaky economic logic. In May 2022, just before the local elections in the midst of an intensifying inflation, it compiled a special budget equivalent to 3.0 percent of the 2021 GDP. This was the largest single special budget as a percentage of the previous year’s GDP since the data about the special budget were compiled from 1992.23 The Ministry of Economy and Finance willingly complied this time, insisting that the special budget would not undermine fiscal soundness because there would be enough excess tax revenue, in spite of the upcoming slowdown of growth due to the restrictive monetary policy. Meanwhile the Yoon government cut back corporate taxes for the most profitable corporations and slashed taxation on real estate, repeating what the Lee Myung-bak government had done earlier. It tried to offset the resultant shortage of revenue by fiscal retrenchment. Though it has cut some welfare expenditure, it has not implemented fiscal retrenchment enough to offset the shortage of the revenue. Thus, fiscal policy has been expansionary while monetary policy has been restrictive. The expansionary fiscal policy in the face of contractionary monetary policy helped the growth rate to fall less but made it difficult to reduce the inflation rate. In 2022, the economy grew by 2.6 percent, but the inflation rate was 5.1 percent, well beyond the BOK target of two percent. The annual inflation rate in February 2023 (the

23

The data are from index.go.kr and ecos.bok.or.kr.

The Slowing Engine of Growth 309 increase rate of the CPI from February 2022 to February 2023), the latest monthly figure at the time of this writing on March 29, 2023, stood at 4.8 percent – a slight improvement over 2022. The country thus has a long way to go to bring the inflation under control; however, the disinflation policy is raising the risks in the financial markets, as elsewhere in the world.

The Perils of Household Debt While there have always been risks in the financial market, the drastic rise of interest rates enhances the possibility of systemic risk as the indebted firms, financial institutions, government, and households may find it difficult to repay debts. The overall firm-finance nexus is less a source of risk as firms have continued to improve their financial soundness after the 1997 crisis, as shown in Figure 5.2. Of course, the average figures appearing in Figure 5.2 cannot capture the situation of the marginal firms that produce NPLs. The BOK has traced the firms with an interest coverage ratio lower than one since 2008, and reports that about 30 percent or more of firms had interest coverage ratio lower than one for a decade or so. The ratio climbed in the last years of the 2010s and reached 35.7 percent in the first half of 2022. However, in contrast to the period before the 1997 crisis, it is mainly the SMEs that account for the firms with a low interest coverage ratio, so the impact on the overall stability of the financial system is relatively weak (See Appendix 8). Government debt is also not a serious source of risk. South Korea has a long-term fiscal soundness problem, with government debt crawling up with the deficit in the management account (more on this in Chapter 11). The Moon Jae-in government did not deal with the problem squarely when it failed to raise social insurance contributions. The Yoon Suk Yeol government is cutting taxes without devising a systematic way to retrench government expenditure. Still, fiscal soundness is a long-term challenge rather than an imminent threat.

310 The Tortuous Path of South Korean Economic Development The source of a far heavier risk is household debt. The rapid increase of household loans precipitated the credit card crisis in 2003 and the savings bank crisis in 2011. However, household loans continued to increase subsequently. The activation of real estate transactions by the Park Geun-hye government from 2014, backed by loose monetary policy by the BOK, accelerated it. In anticipation of a rise in housing prices, people borrowed from financial institutions to purchase housing, thereby raising housing prices further and bloating the collateral value of housing. The Moon Jae-in government tried hard to stabilize housing prices, restoring housing transaction regulations lifted by the Park government and tightening LTV and DTI ratios. It also raised taxation on housing ownership and capital gains reaped by housing transactions. Eventually, the Moon government turned to the policy of increasing housing supply in the Seoul metropolitan area. None of this worked well. Once the public expected a rising trend in housing prices, it was very difficult to reverse the expectation, which had been the case for the Roh Moo-hyun government in the mid-2000s. In 2020, the expansionary monetary policy to cope with the coronavirus crisis further accelerated the purchase of housing with borrowed money. Housing speculation and loose monetary policy increased household loans dramatically. Household credit, which had risen to 67.9 percent of GDP in 2013 from 59.2 percent of GDP in 2002 (the first year data are available), jumped to 89.9 percent of GDP in 2021.24 The increase of household loans slowed down as the government began to tighten controls and the BOK began to raise the base interest rate in 2021. Housing market finally cooled off in 2022, and housing prices are expected to drop by a significant margin. With rising interest rates and falling housing prices, it is a big question whether household loans will perform. Household credit as a percentage of GDP fell slightly to 86.8 percent in 2022. However, the interest payments on the credit are rising rapidly because household

24

Calculated from ecos.bok.or.kr.

The Slowing Engine of Growth 311 loans have been made mainly with floating interest rates. As of January 2023, household loans with floating interest rates accounted for 75.8 percent of household loans made by deposit money banks.25 The immediate threat so far has been the financial distress of the construction companies that built housing and the financial institutions that lent them money. Major banks have not been heavily involved in lending to those construction companies. After suffering through the 1997 and 2008 crises and the 2011 savings banks crisis, they became more prudent in lending. The tightening of LTV and DTI ratios during the Moon government may help their household loans to perform. They have also become more profitable to better absorb NPLs shocks. It is mostly NBFIs that have lent to the construction companies and thus are currently undergoing financial distress. Yoon Suk Yeol government is massively lifting the regulations on housing transactions and household loans as well as cutting taxes on housing on the ground of inducing the soft landing of housing prices to ease the financial distress of the construction companies and the NBFIs. However, it remains to be seen whether those measures can induce the soft landing of housing prices. Moreover, South Korea has an additional household debt that is mostly absent in other countries: the debt owed by housing owners to their tenants. The country has a peculiar housing rental system whereby tenants make deposits with owners without being paid interest, which replaces the monthly rent. If the deposits owed by housing owners are added, total household debt amounts to more than 130 percent of GDP, by far the highest ratio among OECD countries.26 The owners usually roll over the deposits by finding new tenants willing to make the same or more amount of deposits. However, the amount of deposits is rapidly falling with the rise of interest rates, so housing owners are forced to find alternative sources of money when the lease term ends.



25 26

The data are from ecos.bok.or.kr>interest rate>lending rate. www.joongang.co.kr/article/25068292#home.

312 The Tortuous Path of South Korean Economic Development Carrying out the disinflation policy without incurring systemic risk is thus a formidable task. However, South Korea cannot carry out disinflation policy solely based on the possibility of systemic risks in the domestic financial market; they must also consider foreign exchange market instability. This is especially true as a currency crisis is still far more difficult to deal with than a domestic financial crisis.

Lingering Risks in the Foreign Exchange Market South Korea became less vulnerable in the foreign exchange market after the 2008 crisis. The country continued to record current account surplus after the 2008 crisis. From 2008 to 2022, current account surplus averaged 4.0 percent of GDP. Meanwhile, the effects of the asset sale after the 1997 crisis waned and the country recorded net capital gains equivalent to 0.08 percent of GDP on average from 2008 to 2022. How the country came to record net capital gains rather than net capital losses after 2008 crisis remains to be analyzed. Yet the chronic current account surplus combined with the net capital gains improved the NIIP remarkably. In 2022, the NIIP stood at 44.9 percent of GDP, a drastic increase from −16.1 percent of GDP in 2007 (See Appendix 2). The country’s solvency in relation to the outside world rose accordingly. The country’s liquidity position also improved. After undergoing the 2008 crisis, private agencies like banks paid more attention to managing risk coming from the foreign exchange market. The introduction of the macro-prudential measures in 2010 helped to check the increase of short-term foreign debt. Meanwhile, the country accumulated more international reserves making use of the current account surplus. As shown in Figure 8.1, the amount of international reserves rose again in relation to short-term foreign debt after the 2008 crisis. Still, there are lingering risks in the foreign exchange market. The country is unlikely to immediately face a currency crisis because of the inability to pay back foreign debt as in 1997 or 2008. However,

The Slowing Engine of Growth 313 a sudden reversal of capital flow may disrupt the financial markets, which are intertwined with one another often by many derivatives, accelerating capital flow further. The outbreak of the coronavirus crisis in 2020 showed that. With the outbreak of the crisis, the country was threatened by sudden capital outflows. In March 2020, the United States again extended 60 billion dollars of currency swap, helping to stabilize the foreign exchange market. The United States also allowed Treasury Bill swapping for cash. Now, the disinflation policy has revealed another risk in the foreign exchange market. In raising base interest rate for disinflation, the BOK cannot just consider systemic risk in the domestic financial market; it must also consider foreign exchange market stability. To prevent the sudden outflow or inflow of capital, the BOK cannot set the base interest rate far from the federal fund rate of the United States, the key currency country and often the epicenter of global capital flows. The BOK cannot do so even though, due to its high household debt vulnerability, South Korea’s domestic financial situation differs from the US’. The BOK began to raise interest rate earlier than the US Federal Reserve Board, but raised it less dramatically. The BOK base interest rate became lower than the US federal fund rate, and the gap was expected to widen over time. This raised the exchange rate, which undermined disinflation efforts by raising import prices. To prevent the exchange rate from rising too fast, the government intervened in the foreign exchange market using international reserves. The amount of international reserves fell for 12 consecutive months from November 2021 to October 2022 before increasing slightly subsequently. In February 2023, international reserves stood at 90.6 percent of its peak in October 2021. At the time of this writing on March 29, 2023, the BOK base interest rate of 3.50 percent is lower than the US federal fund rate by a maximum of 1.5 percentage points. Whether it will lead to a massive capital outflow is uncertain because there are other factors than interest rate differentials that affect capital flows. However, if it occurs, the South Korean government will have to make a difficult

314 The Tortuous Path of South Korean Economic Development choice between tolerating a drastic rise in the exchange rate and intervening in the foreign exchange market using a large amount of international reserves. The former would aggravate inflation and disrupt financial markets; the latter would weaken the country’s ability to cope with another sudden capital outflow later, which could raise the possibility of a currency crisis eventually. Having a source of outside help would enhance the ability to cope with such a contingency. South Korea hopes it could rely on another currency swap agreement with the United States, but it is, of course, not an institutionalized arrangement.

10 Industrial Policy and Firms

This chapter examines the problem of structural transformation after the 1997 crisis. South Korea essentially continued the industrial policy in place from before the crisis, while the development of service industries came to comprise the main part of the structural transformation. The chapter then examines the behavior of firms as agents of investment. While Chapter 6, which dealt with the structural transformation before the 1997 crisis, focused on chaebol, this chapter gives attention to other agents as well, considering that the reform after the 1997 crisis tried to purge the system led by chaebol.

10.1  Industrial Policy and Structural Transformation After the 1997 crisis, the Kim Dae-jung government (February 1998– February 2003) declared that it would promulgate a market economy, as mentioned in Chapter 8. Since industrial policy was a typical government intervention in the market, it seemed to be the first policy to be abandoned. However, the reality was different. From the 1980s, the country lifted the vertical policy while reinforcing the horizontal policy; but, as mentioned before, the distinction between them was blurry. This style of industrial policy continued after the crisis. Major changes lay not in the type of industrial policy but in the contents of the structural transformation that occurred. The structural transformation gained a new dimension as service industries became important as the source of growth. Growth increasingly depended more on moving resources from low-productivity services to highproductivity services. 315

316 The Tortuous Path of South Korean Economic Development

Industrial Policy Alive The liberalization of the 1980s moved the weight of the industrial policy to horizontal policy. After the 1997 crisis, the government phased out the remaining elements of the vertical policy, notably the “import-source diversification policy,” in compliance with the IMF demand. Those measures did not undermine the competiveness of South Korean industries much. The rise of the REER, mentioned in Chapter 9, helped to offset the effect of ending the policy. In addition, in the 2000s, the once-mighty competitiveness of Japanese firms was waning. Aside from that, the country continued the industrial policy in place from before the crisis, that is, targeting newly emerging dynamic industries and enhancing the technological capability in those industries. Of course, in a market economy like South Korea, private enterprises make investment decisions by anticipating the future trends of the economy, including structural change. Industrial policy can achieve its goal only through affecting their investment decisions. In fact, the government and business interact with each other to develop and share a vision for future industrial development. There has been not so much difference between the opinions of the government and business in this regard. Thus, the Kim Dae-jung government actively promoted ICT indus­ tries, succeeding the Kim Young-sam government’s policy. Later, as growth slowed down, industrial policy to find “the new growth momentum” became an important agenda. The succeeding governments of Roh Moo-hyun (February 2003–February 2008), Lee Myung-bak (February 2008–February 2013), Park Geun-hye (February 2013–May 2017), and Moon Jae-in (May 2017–May 2022) all designated several industries to promote. They were composed of high-​technology manufacturing and service industries; they also included some “fusion” industries, mixing high-technology manufacturing and service industries. Though different governments designated different industries, they overlapped with one another because government

Industrial Policy and Firms 317 officials and business leaders essentially shared the list of the industries to lead future economic growth. The international environment has also made industrial policy a living agenda. In 2015, China launched the “Made in China” policy  – an industrial targeting plan. A glance over the list of the industries that China intends to promote to a globally leading position by 2025 reveals that many of them are the industries in which South Korea currently has international competitiveness (though China formally says that Germany is the first target to catch up). Surprisingly, industrial targeting also appeared in the United States in 2021 as the Biden administration promoted the domestic production of strategic industries such as semiconductors and batteries. South Korea continued the policy of import substitution of parts, components, and materials. In quantitative terms, the country had almost completed the import substitution of those products before the crisis. In 1994, the first year data are available, production was 96.8 percent of domestic demand. The ratio rose to 102.0 percent by 1997, indicating the country became a net exporter of those products by the time of the crisis. The ratio rose further after the crisis, to reach 120.8 percent in 2020.1 The country now exported components, parts, and materials mainly to China and other newly industrializing Asian countries. A trilateral relationship similar to the one between South Korea, Japan, and the United States in the previous era came into place among South Korea, China (and other newly industrializing Asian countries), and the United States. South Korea has continued to upgrade the technological sophistication of the components, parts, and materials they produce. Still, it depends on Japan and other advanced countries for some high-technology items. In July 2019, Japan’s Abe Shinzo cabinet imposed an embargo on Japanese exports of some chemicals essential for the production of DRAMs in retaliation to the South Korean Supreme Court’s ruling that the Japanese firms that had used forcefully mobilized Korean

1

index.go.kr/potal/main/EachDtlPageDetail.do?idx_cd=1159

318 The Tortuous Path of South Korean Economic Development workers during the Second World War should compensate them. It was a surprising move, as the Japanese government was violating the rule-based order of international trade on political ground, a rare action taken by an advanced capitalist country in the postwar period. If Abe’s purpose had been to hurt South Korea’s DRAM industry, the move was a failure. South Korea managed to quickly substitute the imports from Japan through domestic production or imports from a third country. Yet, the move created substantial uncertainty for the South Korean business, while reinforcing the reason to pursue the import substitution of those products. In addition, at the time of this writing in March 2023, the combination of the disruption of the global supply chains caused by the US–China trade war, the coronavirus crisis, and the Russian invasion of Ukraine is proving to be a big challenge for an open economy like South Korea. All these suggest that the country will have to reinforce industrial policy.

Changing Features of Technological Capability Enhancing the technological capability is still at the core of industrial policy. Promoting R&D continues to be the main means. It is compatible with the World Trade Organization (WTO; launched in 1995) rule, which allows a government to subsidize up to 75 percent of R&D expenditure of firms. Though the private sector has taken ever more initiatives in R&D efforts, they are, as elsewhere in the world, a product of the interaction between the government and business, where other actors like universities are also involved. By the mid-1990s, the country was making significant R&D efforts, with R&D expenditure amounting to 2.25 percent of GDP in 1997. The ratio fell immediately after the 1997 crisis, but began to climb again, reaching 4.81 percent of GDP in 2020, the second highest in the world next to Israel. The number of R&D personnel as a percentage of the population also climbed to a similar level. The private sector accounted for the major proportion of the expenditure. The weight of the private sector fell somewhat after the 1997 crisis, but rose again subsequently, accounting for 76.7 percent of total R&D expenditures

Industrial Policy and Firms 319 in 2020 (See Figure 6.1). The substantial weight of the private sector means that R&D efforts are directly contributing to industrial competiveness. It is yet questionable whether this quantitative expansion has led to an equivalent improvement in industrial competitiveness. For one thing, the role of universities has been weak. Before the crisis, South Korea successfully established the R&D system centered on the cooperation of the government research institutes and firms. To upgrade R&D capability, the country needs more role of universities, which employ the majority of high-quality personnel. From the 1990s, the government has encouraged R&D activity at universities by providing various national projects and supporting the establishment of university research centers. However, the linkage of universities with industries has remained weak, the main reason being the rule of competition for the university professors. The government, joined by the press, evaluates them mainly by their publication records in globally renowned journals rather than their contribution to domestic industrial development. The evaluation affects the government support of universities as well as individual professors. Thus, engineering professor often find it more paying, economically and psychologically, to publish an article in the Nature or Science than obtaining major patents enhancing industrial competiveness in their specialized areas. In 2020, universities spent about 8.9 percent of the total R&D expenditure, while in most OECD countries the ratio was well over 10 percent. This happened while universities employed 56.6 percent of all PhDs in 2020.2 The country thus fails to mobilize its most qualified personnel for R&D efforts to enhance industrial competitiveness. As before the 1997 crisis, the main role of the university lies in education. The role of universities in education became more important as the demand for skilled labor increased faster in relative terms. It did so as skill-biased technological change continued and trade

2

The data are from kosis.kr.

320 The Tortuous Path of South Korean Economic Development partners came to be composed more of the poorer countries, China in particular. To meet the increasing demand, college attendance ratio rose further, from 45.3 percent in 1997 to 70.5 percent in 2008. The ratio fell slightly subsequently, but rose again to 71.5 percent in 2021 (See Figure 6.2). Over the years, however, the supply of college graduates apparently overshot the demand. The increase of the demand for skilled workers slowed down. The skill-biased technological change became more difficult after the near-completion of the catchup and the initial jump into the new technologies.3 The increase of the weight of the trade partners poorer than South Korea more or less came to a halt. As a result, students and parents came to recognize that attending college did not pay, which led to the fall of the college attendance ratio. The college attendance ratio has risen again in the 2020s, but whether this represents a reversal of trend remains to be seen. Currently, South Korea’s college attendance ratio is the highest in the world. The highest college attendance ratio, together with the second highest ratio of the R&D expenditure to GDP, suggest that the country is investing most heavily in acquiring skills and knowledge. However, the overshooting of the supply of college graduates, together with the general shortage of jobs with the slowdown of growth, leads to the unemployment of educated youths (more on this in Chapter 11). At the same time, in some areas, like the production of semiconductors, skilled labor is in short supply. It mainly comes from the rigidity of the education system. However, it also comes from the deterioration of the ability to supply the highestskilled labor to industries after the 1997 crisis. Such ability deteriorated as the quality of science and engineering students fell dramatically. After the crisis, leading high school graduates came to no longer choose the science and engineering departments of universities. For example, before the crisis, the Department of Electrical Engineering (currently the Department of

3

Koh (2019).

Industrial Policy and Firms 321 Electrical and Computer Engineering) at Seoul National University, the country’s leading university, recruited better high school graduates than the College of Medicine at the same university. Soon after the crisis, however, the department of medical studies at any university came to recruit higher caliber students than the Department of Electrical Engineering at Seoul National University. This happened as the structural adjustment after the crisis led to a massive layoff of the personnel with science and engineering background.4 The government also reduced scientists’ and engineers’ income relative to doctors’ income by raising the amount of rent doctors enjoyed through freezing the admission quota to the departments of medical studies in universities, as discussed below. The falling quality of the science and engineering students not only reduced the supply of the best-skilled labor to industries but also deteriorated the quality of R&D personnel; the quality of the R&D personnel deteriorated significantly in spite of their quantitative increase. Moreover, the quality of the R&D personnel deteriorated as brain drain resumed after the crisis. South Korea had managed to reverse the brain drain before the crisis, but it resumed after the 1997 crisis. It resumed, first, as the structural adjustment led to a massive layoff of personnel with science and engineering background. The rise of the exchange rate after the crisis also lowered the salaries paid to returning scientists and engineers in dollar terms. In addition, the rising income for talented people in the United States and other advanced countries has made it difficult to lure them back. One can identify the brain drain from the world talent ranking compiled by the International Institute for Management Development in Switzerland, mentioned in Chapter 6. South Korea ranked fourth in 1995 and seventh in 1996, but it fell to thirty-eighth in 1999. The country remained in a similar ranking subsequently, placed at thirtyeighth again in 2022.5

4 5

Jo and Jeong (2001). www.imd.org/centers/wcc/world-competitiveness-center/rankings/world-talentranking/.

322 The Tortuous Path of South Korean Economic Development

The Development of Service Industries The development of service industries became an important source of growth after the 1997 crisis. Growth occurs side by side with structural transformation as labor moves from low-productivity to high-productivity sectors. In a country like South Korea, initially the shift of labor from the primary industries like agriculture to the more dynamic industries like manufacturing accounted for the structural transformation and growth. Over the years, however, the country had to develop service industries, as the potential for further growth lay in services. According to the Korea Productivity Center, in 2019, South Korea’s labor productivity of the manufacturing sector (based on PPP) was 88.6 percent of the United States’, but labor productivity of the service sector was 53.0 percent of the United States’, leaving a large amount of room for catch-up growth.6 Service industries can also create jobs better than manufacturing. Manufacturing is increasingly unable to create jobs due to the pursuit of automation. The share of manufacturing in employment fell from its peak 27.8 percent in 1989 to 16.0 percent in 2021, while its share in value added fell only slightly from 29.2 percent to 27.9 percent during the same period (See Appendix 9).7 Labor productivity of manufacturing rose in relation to other industries, but it also meant that manufacturing was unable to lead job creation any more. Services, in contrast, remained more labor intensive. The share of services in employment rose consistently, to account for 70.0 percent of total employment by 2021. Service industries can also play a role in increasing the productivity of other sectors by supplying software, finance, design, legal service, human resource recruitment, and marketing. However, the problem is more complex because there are many different kinds of services. There are basically two kinds of

6 7

Korea Productivity Center (2021: 10). The share in value added can be calculated by multiplying the share in employment with the relative productivity shown in Appendix 9. Alternatively, it can be obtained directly from ecos.bok.or.kr.

Industrial Policy and Firms 323 service industries: traditional and modern. Traditional service industries include wholesale and retail trade, accommodation and food services, real estate transactions, regional, social and personal services, and so on. Modern service industries comprise sectors such as software, information and communication, healthcare, law, finance, business services, etc. It is the latter that provides the new potential for growth. Meanwhile, the former, rather than providing the potential for growth, becomes the new reservoir of low-productivity labor. As a result, raising the share of modern services in relation to the traditional services as well as the primary industries in employment becomes the new mechanism for growth and structural transformation. There are no data neatly classifying services into traditional and modern ones. The available data classify services into four groups: (1) wholesale and retail trade, accommodation, and food services; (2) transportation, storage, and communication; (3) finance, real estate, and business service; and (4) public administration, defense, social insurance, education, health and social service, and cultural service. Yet one can see the difference between the traditional and modern services by comparing the first group, virtually completely composed of traditional services, with the other three groups that are the mixture of traditional and modern services. Figure 10.1 presents the “relative labor productivity” and the employment share of the primary industries and the two groups of service industries named “service (A)” and “service (B).” Service (A) denotes the first group services and service (B) denotes the other group services (the sum of the second, third, and fourth groups). The relative labor productivity is calculated by dividing the share of value added by the share in employment for each group of industries. Figure 10.1 also presents the employment share of primary industries and the two groups of service industries. As expected, primary industries were the reservoir of lowproductivity labor initially. As late as 1980, primary industries accounted for 34.9 percent of total employment while its relative

324 The Tortuous Path of South Korean Economic Development 200.0

60

180.0 50

160.0 140.0

40

120.0 30

100.0 80.0

20

60.0 40.0

10

20.0 0 Relative productivity, Primary

19 20

16 20

13 20

10 20

20 07

04 20

01 20

98 19

2

95 19

19 9

89 19

19 86

83 19

19

80

0.0 Relative productivity, Service (A)

Employment share, Primary

Employment share, Service (A)

Relative productivity, Service (B)

Employment share, Service (B)

Figure 10.1  Relative labor productivity and employment share by industries, 1980–2021 (percent) Source: Appendix 9.

productivity was the lowest. Service (A) also became the reservoir of low-productivity labor over the years. It had higher relative labor productivity than the primary sector initially, but its relative labor productivity more or less converged toward the primary industries’ relative productivity subsequently. Meanwhile, its share in employment rose from 19.2 percent in 1980, reaching the peak of 28.3 percent in 1999, making a contrast with the primary industries, whose share in employment fell to 11.4 percent by 1999. Figure 10.1 shows that the move to service (B) out of service (A) as well as the primary industries mainly comprised the structural change from the 2000s. The share of service (B) in employment continued to rise, reaching 50.0 percent in 2021, while the share of service (A) as well as primary industries fell continuously. The relative productivity of service (B) itself fell mainly because the relative productivity of manufacturing rose consistently, but it continued to be higher than the relative productivity of service (A) as well as the

Industrial Policy and Firms 325 primary industries. Growth and structural transformation from the 2000s have thus depended greatly on the development of modern service industries. It is impossible to know how much the government policy and autonomous decisions by the private sector are responsible for the development of modern service industries. There are so many different kinds of modern services, and the role of the government and the private sector varies among them. However, a few remarks are in order about two special cases of interest. One is cultural industries, which have risen dramatically, bringing about the global “Korean Waves (Hallew).” Another is regulated industries, including, typically, finance, law, and medicine.

The Rise of Cultural Industries What accounts for the rise of South Korea’s cultural industries? The basic underlying condition is the country’s exposure and openness to the influence of foreign cultures. Hallew is the hybrid of Korea’s traditional culture, which was heavily influenced by China and blended with the Japanese, American, and (to a lesser extent) European cultures in the modern era. Of course, this was no more than a necessary condition. Some observers regard the rise of Hallew as a “success without design,” the result of timely coincidence of many factors, none of which was planned by the government.8 There was indeed no consistent government plan to develop the industries. Firms made decisions about doing business taking the market conditions into account; the competition among firms for survival in domestic and then global market was very intense; and a few talented entrepreneurs played a crucial role in globalizing the industries. However, industrial policy, which took a new approach and was applied to other industries like ICT industries from the 1990s, also played its share of roles. A critical condition for the development of cultural industries was the freedom of expression, so the promotion of cultural

8

See Kim (2016), for example.

326 The Tortuous Path of South Korean Economic Development industries began only with the coming of the Kim Young-sam government (February 1993–February 1998), the first civilian government in 32 years. It eliminated censorship of most cultural activities, while beginning to regard cultural industries as a new source of growth. The Kim Young-sam government, together with business community and society in general, shared the vision that cultural industries could be a new source of growth. Then, following the 1997 crisis, the Kim Dae-jung government (February 1998–February 2003) promoted cultural industries aggressively. The policy was succeeded by all the ensuing governments. The government increased support through providing tax benefits and technological assistance, developing skilled workforce, building infrastructure, and assisting exports. The Kim Young-sam government allowed chaebol to enter cultural industries, which led to the entry of major chaebol into multiple sectors of them. Chaebol’s business in cultural industries underwent some reshuffling as they partitioned themselves (discussed later) and carried out structural adjustment after the 1997 crisis. Chaebol yet continued to do business in cultural industries. Chaebol played a particularly important role where lump-sum investment was necessary, such as the production of blockbuster movies. Venture businesses sprang up, together with venture capital specializing in cultural industries. In addition, a number of new small- and medium-sized enterprises (SMEs) entered cultural industries. Those firms entering cultural industries actively utilized the innovations in ICT. The government encouraged the integration of cultural industries with ICT industries. Cultural industry firms utilized the ICT infrastructure such as broadband internet highways built by the government initiative to improve their competitiveness in global as well as domestic markets. This created a virtuous circle of growth between the cultural and ICT industries.9



9

See Kwon and Kim (2014) and Chung (2019) for the description of the government policies and the evolution of cultural industries in South Korea.

Industrial Policy and Firms 327 The government employed the “arms’ length principle” of “supporting but not intervening” in promoting cultural industries, in order to ensure that the freedom of expression would not be endangered. It delegated the authority to select the recipient of the government support to independent councils and committees composed of the personnel not only from the cultural industries themselves but also from the government, business, and non-profit organizations. More broadly, the country tried to build, with some success, a governance structure based on autonomy, decentralization, and participation to support cultural industries.10 The development of civil society independent of the state after democratization played an important role in building such a governance structure.

Political Economy of the Regulated Industries The picture for the “regulated industries” is less positive. A notable case of regulated industries is the financial industry. The reform after the 1997 crisis tried to promote the financial industry by establishing an independent managerial entity for financial institutions. The government then organized the majority of the financial institutions into a holding company system centered on banks, though some of the NBFIs were still under chaebol ownership and control. In the 2000s, the government tried to promote finance as an industry in its own right rather than as the supporter of other industries. The Roh Moo-hyun government even tried to make the country the financial “hub” of Northeast Asia. The move was stalled after the 2008 crisis, as South Koreans recognized that further “financialization” of the economy and society was not desirable. However, over the subsequent years, the chief executive officers and managers of financial holding companies developed a practice of repeatedly appointing themselves to the same positions that received very high salaries, if not in Wall Street standard. The Yoon Suk Yeol government is saying that it will reform such governance structure, but its first move has

10

See Han et al. (2012) for the support system.

328 The Tortuous Path of South Korean Economic Development been appointing an ex-officer of the old Ministry of Finance as the chairman of one the four major financial holding companies. South Korea has peculiar problems with legal and medical services, the two services whose employees enjoy especially large amounts of rent and privilege worldwide. The country managed to increase its number of lawyers, which improved the access to legal services for the common people. However, it was accompanied by the rise of dualism in legal services. South Korea’s prosecutors exceptionally monopolized the right to indict as well as to investigate until very recently; judges are out of democratic control, forming an elite group responsible only for themselves. Prosecutors and judges become practicing lawyers immediately after leaving office, and they receive the “honorable treatment” of ex-officers by incumbent prosecutors and judges. Thus, the rich and powerful employ ex-officers, while the poor and weak resort to other lawyers. The Moon Jae-in government embarked on the task of checking the ascendancy of the prosecutors by establishing a government agency able to investigate them and by assigning some investigation rights to the police. However, it was met by strong resistance of the prosecutors, and Yoon Suk Yeol, the prosecutor general who led the move, ran for the presidency as the opposition candidate to win the election in March 2022. The medical services revealed a more straightforward problem, as doctors collectively resisted increasing their supply. When the Kim Dae-jung government introduced the separation of prescription and dispensing of drugs (both monopolized by doctors previously) in 2000, it encountered a fierce strike by doctors. The government settled the strike by promising to freeze the admission quota to the departments of medical studies in universities. In 2020, as the Moon Jae-in government planned to establish “public medical schools” to take care of people with poor access to medical services, it was met with a strike by doctors in the midst of the pandemic. The government postponed the discussion of the policy until the end of the pandemic. This happened while South Korea had 2.5 doctors per 1,000 people in 2020, the lowest among the OECD countries except

Industrial Policy and Firms 329 Mexico.11 If one excludes the doctors in Chinese medicine (whom the striking doctors do not recognize as doctors), the number falls to 2.1, by far the lowest among the OECD countries.12

10.2  Whither Chaebol? Chaebol went bankrupt massively with the 1997 crisis, and the reform after the crisis tried to purge the system led by chaebol. In addition to the six chaebol that had gone bankrupt before the country went to IMF, 12 additional chaebol out of the 34 largest that had been included in the Fair Trade Commission’s list of the 30 largest chaebol at least once from 1993 to 1997 and survived until the beginning of 1997 went bankrupt after the country went to the IMF. Thus, altogether, more than half of those chaebol went bankrupt. Then, the reform after the crisis tried to purge the system led by chaebol – at least nominally  – so the surviving chaebol underwent a drastic reform, as explained in Chapter 8. However, chaebol continued dominating the economy after the crisis and reform. Four out of the five largest chaebol before the crisis – Samsung, Hyundai, SK, and LG – survived, though with some restructuring (The exception was Daewoo, which was the second largest when it went bust in 1999). Many smaller chaebol also survived. Moreover, after restructuring the bankrupt chaebol firms, the government sold them to the highest bidders, which were mostly the surviving chaebol, in order to recuperate the public funds spent to shore up the financial system after the crisis. Nobody has traced the share of chaebol in the economy through the turbulent period just before and after the 1997 crisis. However, there is a study showing that the concentration of economic power in the chaebol rose again in the 2000s and beyond. The value added by the four largest chaebol accounted for 3.9 percent of GDP in 2001, but the share rose to 7.5 percent of GDP in 2012. The value added by the ten largest chaebol

11 12

stats.oecd.org/. The number 2.1 was obtained by using the data on the composition of doctors appearing in kosis.kr (kosis.kr/statHtml/statHtml.do?orgId=101&tblId=DT_1ZGAB2).

330 The Tortuous Path of South Korean Economic Development accounted for 5.4 percent of GDP in 2001 but 9.6 percent in 2012 (See Appendix 4; these numbers are not comparable to those in Figure 6.3 because they exclude the financial sector).

Chaebol and Industrial Dynamism The increase in the chaebol’s concentration of economic power in  the 2000s and beyond resembled what happened in the 1990s before the crisis, when their concentration of economic power grew after the restructuring in the 1980s. Now, the increase was not accompanied by the chronic production of NPLs because chaebol became financially sounder. Chaebol became financially sounder as they ceased to lead the investment with borrowed money for longrun growth ignoring short-term profitability. Chaebol firms should account for the improvement in the overall financial soundness of firms shown in Figure 5.2 more than ordinary firms, as they became more profitable than ordinary firms, making a contrast with the pre-crisis period.13 Some chaebol have shown poor profitability, as a big gap has developed between the four largest chaebol and the rest, but chaebol’s overall financial situation has been far sounder than before the crisis. Thus, the rise in the concentration of economic power in chaebol is more likely to be sustained than before the crisis. Chaebol firms have continued leading structural transformation by investing in new industries, technologies, and products. They are major spenders as well as suppliers of R&D money. In 2019, the five largest firms in terms of sales, all of them affiliated with the four largest chaebol, accounted for 33.8 percent of R&D expenditure and 23.9 percent of the employment of PhDs by private firms.14 Some chaebol firms managed to emerge as leading global players; one salient case is Samsung Electronics, which is one of the largest spenders on R&D globally.



13 14

Lee (2014). KISTEP Statistics Brief, 2020.19, page 7 (in Korean).

Industrial Policy and Firms 331 What is questionable is whether the “chaebol system” still helps investment and structural transformation. It did so until 1997, as evidenced by the fact that the sudden disruption of the system led to the fall of the gross investment rate after the crisis, as mentioned in Chapter 9. However, over the years, it has become ever more questionable whether chaebol’s generic capability and internal markets work as a source of competitive advantage. As market institutions develop, competitiveness of firms is determined more and more by industry-specific skills and knowledge rather than generic capability. The benefit of internal markets has declined with the development of external markets. Chaebol firms are often sitting on a large amount of retained earnings accumulated through enhanced profitability because they do not see sufficient investment opportunities; internal capital market is meaningless when capital is no longer a binding constraint on investment. Chaebol’s own behavior reveals such changes. Chaebol have often behaved against the logic of generic capability and internal markets. Several chaebol partitioned their empires with intergenerational succession, against the logic of generic capability and internal markets.15 Of course, chaebol also acquired new members, including the firms of the bankrupt chaebol graduating the bankruptcy procedure. Yet it is often questionable whether the acquisitions are in line with the old logic of leading structural transformation. A notable case in this regard is the takeover of the Hyundai Engineering & Construction Company  – the former Hyundai Construction Corporation  – by Hyundai Motors Group in 2011. Hyundai Construction Corporation, established by Chung Ju-yung, founder of the Hyundai chaebol, went bankrupt in 2000 and was put under the bankruptcy procedure. When Hyundai Construction completed the bankruptcy procedure and the government sought a new owner, an intense takeover competition broke out between Hyundai Motors Group and Hyundai Group, the former led by Chung Ju-yung’s oldest surviving son and the latter

15

Choi (2011).

332 The Tortuous Path of South Korean Economic Development led by the widow of the fifth son. The two groups competed for the status of the legitimate heir to the old Hyundai chaebol rather than according to economic rationale. Hyundai Motors Group triumphed eventually, but it was against the logic of chaebol leading structural transformation. The old Hyundai chaebol had diversified from the lower-technology construction industry to the higher-technology automobile industry, but now Hyundai Motors Group was moving the other way around. Chaebol also often entered traditional service industries like the restaurant business. Chaebol tend to undermine entrepreneurial dynamism as they are entrenched in family control. As the intergenerational succession of ownership and control proceeds, the entrepreneurial talent of the founders is becoming a thing of the past. The second generation may have helped their fathers found the empires or may have at least witnessed the toils of doing so, but the third generation and beyond have no such experience. They often have to compete in the world market with the founders of large enterprises elsewhere. According to the study by Peterson Institute for International Economics based on the Forbes list of billionaires from 1996 to 2015, 74.1 percent of South Korea’s billionaires in 2014 were inheritor businessmen; the ratio was 2.0 percent for China, 18.5 percent for Japan, 28.9 percent for the United States, and 35.8 percent for 25 European countries.16 The structure has not changed much in spite of the growth of some venture businesses into large enterprises (discussed later).

Corporate Governance and Cronyism Family ownership and control is transferred to the next generation mainly by exploiting poor corporate governance. Corporate governance surely improved after the crisis. In addition to the initial reforms made following the IMF demand, some further reforms were made until 2007 under the Kim Dae-jung and Roh Moo-hyun governments. They introduced the class action suit against stock price

16

www.yna.co.kr/view/AKR20160311168500009

Industrial Policy and Firms 333 manipulation, all-encompassing inheritance tax, and the limitation of interlocking ownership. Still, minority shareholders did not have effective leverage to protect their rights against chaebol family controlling the management. The commercial law allowed a minority shareholder holding at least one percent of the total shares, which was too high, to sue the executive that inflicted irrecoverable damage to the firm. Outside directors, usually comprised of university professors and ex-bureaucrats appointed by the chaebol family, rarely worked as a check on their misbehavior. The all-encompassing inheritance tax law was not so effective without the cooperation of the court. Thus, even after those reforms, South Korea’s corporate governance was poorer than that of China or Indonesia.17 Then, the Lee Myung-bak government, the first conservative government after the 1997 crisis, eliminated the restrictions on the interlocking ownership and loosened the regulations on holding companies while introducing no alternative measures to improve the corporate governance. The typical method of transferring to the next generation continues to be the related transaction – selling cheap and buying dear – to the member firms in which the heirs held majority shares. In some cases, merger and division of affiliated firms are also used. A big scandal involving the merger of two Samsung firms broke out in 2016. Samsung chaebol bribed President Park Geun-hye’s mentor to make the NPS – which came to own more stocks of private enterprises after the crisis, including Samsung firms’  – vote on the side of Lee Jaeyong, the third-generation heir of the Samsung family, in the merger decision. This brought down the Park Geun-hye government through the Candlelight Revolution. The Moon Jae-in government promised to do three things to improve corporate governance: make it easier to sue managers; introduce “cumulative voting” whereby shareholders could vote for multiple candidates of directors instead of a single one (The former method gives minority shareholders some influence in electing

17

Claessens and Kang (2007).

334 The Tortuous Path of South Korean Economic Development directors while the latter allows majority shareholders to elect all directors); and elect some members of the audit committee independently of the majority shareholders by limiting their voting right to a certain limit. However, the Moon government postponed those reform agendas, though it quickly provided the stewardship code for the NPS. In 2020, it eventually proposed a law limiting the voting rights of majority shareholders in the election of one of the two members of the audit committee to three percent, dropping the other two agendas. Still, the National Assembly watered down the proposal and passed a law effectively expanding the limit well beyond three percent in December 2020. The Moon government apparently behaved that way not because of cronyism but in consideration of the economic reality. It had to court chaebol as it faced the challenges of activating investment. No South Korean government, however liberal, can alienate chaebol, who control investment and thus can wage a “strike of capital.” In that respect, the country has changed little from the time of Park Chung Hee’s junta. Eventually, the Moon government released Lee Jae-yong from prison on parole in August 2021. One years later, in August 2022, Yoon Suk Yeol pardoned Lee Jae-yong. Chaebol’s leverage to influence politics through providing campaign funds weakened with the introduction of the public management of elections in 2000 and 2004 during the Kim Dae-jung and Roh Moo-hyun governments (in addition to the revision of the political fund law during the Kim Young-sam government). Also, boss politics, where the presidential candidates wielded the influence with slush funds collected mainly from chaebol, came to an end with the coming of the Roh Moo-hyun government in February 2003, as the president of the country ceased to be the president of the ruling government party at the same time. With the consolidation of democracy, public opinion became more important and the rule of law was strengthened. However, the country has had a long way to go in this regard. Chaebol can influence public opinion strongly by affecting the behavior of the press, whose influence rose drastically with

Industrial Policy and Firms 335 democratization. Chaebol have had various ways to influence the press, the allocation of advertising expenditure being the major means. Without the chaebol support, few media organizations can survive. This has become all the more remarkable as the new forms of media have threatened the survival of conventional forms of media. The press people working in the conventional media know well who are feeding them. Such cronyism is usually tacit and rarely reveals itself, so systematic studies are rare. However, the cronyism may well be one main reason why poll after poll show that South Koreans’ trust in their press ranks the lowest among the polled countries.18 The main obstacle to the rule of law is the cronyism between chaebol and the legal profession. While chaebol’s cronyism with executive branch officials weakened with liberalization, chaebol’s cronyism with prosecutors and judges strengthened as laws became more binding with democratization. The rights of prosecutors and judges were also strengthened with democratization, which got them to come out of the influence of the military government. In fact, many of the corporate governance reforms following the 1997 crisis would have been redundant if the existing laws had been strictly implemented, as South Korea had laws on the books regarding breach of trust and misappropriation. It is thus natural that, given the legal reality, the reform after the crisis did not improve the corporate governance much. Chaebol have especially taken full advantage of the honorable treatment of ex-officers.

Chaebol and Foreign Capital When the domestic governance structure is poor, foreign investors, who came to own a large share of South Korean firms, could do something about that. Immediately after the 1997 crisis, South Koreans welcomed the foreign ownership, expecting that it would improve corporate governance, as mentioned in Chapter 8. However, the expectations failed to materialize. Most foreign investors remained

18

www.seoul.co.kr/news/newsView.php?id=20200617500048

336 The Tortuous Path of South Korean Economic Development portfolio investors. Though they sometimes collectively owned more than half of major chaebol firms, individually they remained minority shareholders. They were unhappy with the stealing of their money by chaebol families, but they retained their ownership of chaebol stocks as long as they were profitable enough in relation to the risks. Many foreign investors bought the South Korean shares through the fire sale immediately after the crisis. Later, they bought the shares with the “Korea discount” coming from the poor corporate governance; thus, without an additional deterioration of the corporate governance after the purchase of shares, they do not lose money. If foreign investors were to check chaebol families’ behavior effectively, somebody had to organize the collective action. That somebody tended to be “finance capital” such as hedge funds doing high-risk, high-return investments. The IMF demanded South Korea make hostile takeover possible on those grounds (Corporate raiders are the best fiends of minority shareholders). There were two hedge fund attempts for hostile takeovers of large South Korean firms. In 2003, Sovereign Asset Management attempted the hostile takeover of the SK Corporation; in 2006, Carl Icahn tried another hostile takeover on KT&G. Both Sovereign and Icahn failed in the takeover bid itself, but managed to reap hundreds of millions of dollars of capital gains by reselling the shares quickly. Hostile takeover bids became impossible thereafter because the Lee Myung-bak government eliminated the restrictions on interlocking ownership and loosened the regulations on holding companies. The public also soured against hostile takeover bids, changing the attitude immediately after the 1997 crisis. They increasingly questioned whether the takeover of South Korean firms and financial institutions by foreign capital would benefit the economy. The change in perception initially came from the experience of the friendly acquisition of assets on a large scale by foreign private equity funds after the 1997 crisis. They took over South Korean firms and financial institutions, often at fire sale prices, and carried out radical structural adjustments, the main method being massive layoffs

Industrial Policy and Firms 337 of workers. They then quickly resold them as the share prices rose, reaping huge capital gains, which partly accounted for the net capital losses South Korea suffered after the crisis, as discussed in Chapter 9. Private equity funds also lacked transparency, just like chaebol. Most Koreans had no idea who their real owners were. In the case of bank takeovers, they rarely met US regulations on bank ownership, so they closed the bank’s US branches. Lone Star Funds, which took over Korea Exchange Bank, manipulated the stock price to maintain control. Many South Koreans thus came to think that modern finance capital like hedge funds were no more than what Rana Foroohar called the “barbarians at the gate.”19 They coined the term “Eat and Run Foreign Capital” for them. That, in fact, was the manifestation of the contradictions in the 1997 crisis. The IMF demanded the country to allow hostile takeover bids even though the currency crisis had nothing to do with the prohibition of such activities. South Koreans tried to utilize such an illegitimate demand to carry out the domestic reforms. However, they came to recognize that the crisis and reform had brought about results very different from their expectations at the time of the crisis. Chaebol utilized the threat of the foreign finance capital as a shield against the demand for the governance reform. Thus, in 2020, when the Moon Jae-in government proposed the corporate governance reform bill (that was already much weaker than the original plan), the business community raised the takeover bid by hedge funds as the main grounds for the opposition. That likely helped the watering down of the reform bill in the National Assembly.

10.3  Venture Business and Foreign Direct Investment After the 1997 crisis, the government made efforts to introduce alternative mechanisms of investment into the system led by chaebol. The most important of such endeavors were promoting venture business and inducing FDI. They could not offset the fall of the gross

19

Foroohar (2016: Chapter 4).

338 The Tortuous Path of South Korean Economic Development investment rate coming from the reform. However, in the longer-run, venture business and FDI would not be the same as before.

Promoting Venture Business The Kim Dae-jung government made all-out efforts to promote venture business. It wanted to promote venture business to cope with the unemployment problem that was suddenly becoming serious with the crisis, as well as foster a new business model to replace chaebol, reinforcing the move initiated by the Kim Young-sam government. The policy seemed inconsistent with the Kim Dae-jung government’s position to promulgate a market economy. However, market fails to support highly innovative startups, even in the most advanced countries. The returns to innovative activities are highly uncertain and often skewed; entrepreneurs may possess more information about the nature of their business than potential investors; innovative activities are usually intangible so that it is difficult to assess their monetary value before they become commercially successful; furthermore, innovative startups create the knowledge that can be freely used by other firms.20 They thus suffer from basically the same market failure problems as those discussed in Chapter 3. The main difference is that, while the market failure problems discussed in Chapter 3 prevail in virtually all modern industrial activities at the initial stage of development with the poor state of the market institutions, market failures persist for innovative startups even in advanced market economies. Thus, advanced countries promote venture business in one way or another, including the United States, widely known for its spontaneous venture hub, Silicon Valley, far away from the federal government.21 The Kim Dae-jung government introduced the “venture certification system” in 1998. It certified venture businesses employing



20



21

Mansfield, et al. (1977); Stiglitz and Weiss (1981); Myers and Majluf (1984); OECD (2004: 17–18). Murray (2007); Lerner (2000).

Industrial Policy and Firms 339 various criteria, including R&D efforts, technological potential, acquisition of venture capital investment, export performance, and so on. Venture business was thus defined more broadly than in other countries, especially the United States, where venture business refers to the startups financed by venture capital or angel investors. South Korea’s market institutions for venture business, including the venture capital market, had a long way to go, so the government selected the venture businesses not only to support them directly but also to send signals to financial institutions and other market participants. The government offered various favors to venture businesses. They included tax deductions and exemptions, supplying startup funds, preferential treatment in credit guarantees, and preferential allocation of policy loans. To facilitate the supply of human resources, university professors and researchers were allowed to found businesses and could take leave for that purpose. The government allowed laboratory factories, urban type factories, and venture clusters as the locations of venture business. The government made it possible to take part in investment through industrial property rights. Venture businesses could apply for a fast examination to obtain patent rights. Venture businesses also got preferential treatment in founding limited liability companies, share exchanges, and stock options. The Kim Dae-jung government’s policy to promote venture business was the most active industrial policy since the Park Chung Hee government’s HCI drive in the 1970s. Like the HCI drive in the 1970s, it contributed to the structural transformation of the economy but involved government failure. Government intervention was not as intensive as in the 1970s, and there was less room for cronyism due to democratization. On the other hand, there was more room for government failure because of the information problem. In the 1970s, chaebol firms receiving government favors were small in number, making it relatively easy for the government to verify their performance. Promoting venture business had no such condition because of the sheer number of venture businesses.

340 The Tortuous Path of South Korean Economic Development As a result, venture policy became a breeding ground for widespread cronyism and corruption, which led to a series of scandals involving various power elites. A big bubble formed in the KOSDAQ market, a channel to recuperate the capital invested in venture businesses, as innocent people swarmed into the market. The bubble burst with vengeance in 2000. After the bubble burst, the government policy shifted its focus to making venture business financially sound, which led to favoring older firms rather than startups. The promotion of venture business thus failed to offset the decline of the gross investment rate after the 1997 crisis. However, venture business began to gain momentum again in the late 2000s, this time more consistently. Venture business indeed became a major player in the economy over the years. The Park Geun-hye government again emphasized venture business, which the Moon Jae-in government accelerated. The Moon government established the Ministry of SMEs and Startups to promote venture business as well as SMEs in 2017. As a result, venture business got a renewed boost. Figure 10.2 presents the number of venture business workers as a percentage of the total employment and the amount of venture capital investment as a percentage of GDP. The share of venture business workers in total employment rose rapidly after the 1997 crisis and then fell; it rose again from the late 2000s, accounting for 3.1 percent of total employment by 2021. In 2021, venture business employed 15.9 percent more workers than the four largest chaebol.22 There may well be no comparison in job quality between venture business and chaebol, but in quantitative terms at least, venture business managed to create more jobs than the four largest chaebol. Venture capital investment as a percentage of GDP shows a more drastic change but a similar pattern. It shot up drastically initially and then fell as drastically, but began to crawl up slowly later, to accelerate from 2018 under the Moon government. By 2021, venture

22

www.hani.co.kr/arti/economy/startup/1073624.html

Industrial Policy and Firms 341 3.5

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Figure 10.2  The share of venture business in employment and venture capital investment in GDP, 1998–2021 (percent) Sources: Employment of venture business is from idex.go.kr. Total employment is from kosis.kr.Venture capital investment is from index. go.kr. GDP is from ecos.bok.or.kr.

capital investment amounted to 0.37 percent of GDP, which was the fourth highest in the world after Israel, the United States, and China.23 The venture policy produced results. Some venture businesses grew into large corporations. At the time of this writing on March 29, 2023, two of the portal firms founded as venture businesses in the late 1990s rank ninth and twelfth in market capitalization, respectively. They are making South Korea a global exception in the sense that, at least in the domestic market, those portal firms are outperforming the US portal firms dominating the world. At the end of 2022, South

23

The data for international comparison are from stats.OECD.org. For South Korea, there is some discrepancy between the government data and the OECD data. Figure 10.2 is based on the government data.

342 The Tortuous Path of South Korean Economic Development Korea had 22 “unicorns,” unlisted startups ten years old or younger but worth one billion dollars or more, which was the tenth largest in the world in numbers.24

Foreign Direct Investment In South Korea, FDI played a minimal role, contrary to most newly industrializing economies. In the mid-1990s, FDI was supposed to increase as the country began to open the service industries to meet the requirements of WTO clauses. The country also deregulated FDI as it joined the OECD in 1996. After the 1997 crisis, the government reinforced its efforts to induce FDI as it regarded FDI as a new momentum for industrial development together with venture business. The Kim Dae-jung government further offered deregulation and tax incentives to FDI; it also established the Foreign Investment Committee to administer the policy to induce FDI. Figure 10.3 shows the inflow of FDI reported to the Ministry of Trade, Industry and Energy as a percentage of GDP. FDI is classified into Greenfield FDI and M&A FDI, the latter being FDI made through mergers and acquisitions. FDI inflow averaged no more than 0.38 percent of GDP from 1980 to 1996, but it rose above one percent of GDP in 1997. It shot up to its peak of 3.13 percent of GDP in 1999 and then fell, but still to a level higher than the level before 1997. The ratio showed some upward trends in the 2010s and 2020s. Greenfield FDI is more important than M&A FDI in raising the gross investment rate. Greenfield FDI showed a pattern similar to total FDI. Greenfield FDI rose for a few years from 1997 first because the pent-up demand, which had been formed by the restrictions imposed before 1997, was realized. The enhanced efforts to induce FDI after the crisis also helped. The inflow of Greenfield FDI peaked at 2.15 percent of GDP in 2000. If such a pace had continued, it could have played a substantial role in boosting the gross investment rate.

24

www.korea.kr/news/pressReleaseView.do?newsId=156551649

Industrial Policy and Firms 343 3.5

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Figure 10.3  Foreign direct investment on report basis as a percentage of GDP, 1980–2022 Notes: Based on the amount reported to the Ministry of Trade, Industry and Energy. Sources: www.motie.go.kr/motie/py/sa/investstatse/investstats. GDP is from ecos.bok.or.kr.

Yet the inflow of Greenfield FDI lost its initial momentum as the pent-up demand was realized. M&A FDI was negligible until 1996. South Korea prohibited hostile M&A until it embarked on liberalizing it in order to join the OECD. Even friendly M&A was exceptional. M&A FDI rose to 0.12 percent of GDP in 1997, and shot up above one percent of GDP in 1998 and 1999, but fell below one percent from 2000. M&A FDI did not increase investment in South Korea, but it could have raised productivity by improving the managerial practice, which could have in turn led to Greenfield FDI. However, the bulk of the M&A FDI made immediately after the crisis was not for such purposes. It was part of the massive asset sale to foreigners, often through fire sale. M&A FDI fell below one percent of GDP in 2000 as the asset sale peaked out.

344 The Tortuous Path of South Korean Economic Development In 2003, with the sagging growth momentum, the Roh Moohyun government established Free Economic Zones, offering special tax incentives and deregulation to FDI. However, they did not work well. The central government set up an agency to administer the zones, but its officials had difficulties in coordinating the tasks with local officials, who had little sense of globalization. Officials also changed their positions so frequently that tasks could not be carried out consistently.25 The government could not recruit or train enough experts in FDI. Most of all, the zones had formidable competitors like mainland Chinese cities, Hong Kong, and Singapore that had far longer histories of inducing FDI. FDI as a percentage of GDP shot up after the crisis and then fell, so it did not play a significant role in filling the gap left by the reform of the previous mechanism of investment; yet FDI, like venture business, was not the same as before, now accounting for a higher percentage of GDP. Over the years, however, South Korean firms increased their direct investment overseas. Figure 10.4 shows FDI and direct investment overseas as a percentage of GDP. The numbers are from the balance of payments data compiled by the BOK based on the actual transactions (The inflow figures are thus different from the amounts appearing in Figure 10.3). The BOK does not present the Greenfield investment and M&A investment separately, but the figures may help to understand the overall trend of FDI and direct investment overseas. Both FDI and direct investment overseas started at a very low percentage of GDP and gradually rose until the mid-1990s. Then, FDI rose above direct investment overseas in 1998 and stayed there until 2005. Direct investment overseas then shot above FDI subsequently, and the gap remained large in the 2010s and 2020s. Thus, though FDI has played a greater role than before the 1997 crisis, the country has basically failed to make direct investment on a net basis a new source of growth.

25

Song (2014).

Industrial Policy and Firms 345 4.5

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Figure 10.4  Foreign direct investment and direct investment overseas on balance of payments basis as a percentage of GDP, 1980–2022 Source: ecos.bok.org.kr.

10.4  The Plight of Small and Medium-Sized Enterprises While venture business and FDI came to play a more important role after the crisis (even though the role of FDI was much limited), conventional SMEs failed to do so. As mentioned in Chapter 9, the single most important reason why the gross investment rate fell after the 1997 crisis was the failure of SMEs to play their role. They did so as banks increased loans to households rather than to them. This first happened because the financial distress during the crisis and the ensuing structural adjustment damaged the ongoing relationship between banks and SMEs while the reform liberalized household loans. Over the years, however, the causation also went the other way. Banks preferred lending to households because they could not

346 The Tortuous Path of South Korean Economic Development find enough SMEs that were financially sound or technologically promising. Such SMEs failed to emerge in large numbers after the crisis. SMEs were actually facing a plight after the 1997 crisis as their financial soundness worsened and the productivity of their workers, which was closely related to their technological capability, fell in relation to large enterprises. While large enterprises had their own problems, most notably the aforementioned chaebol problem, SMEs were lagging behind large enterprises with worsening relative financial soundness and falling relative productivity of workers. This happened while SMEs came to account for a larger share of employment, which deepened the labor market dualism.

Financial Soundness One can judge the financial soundness of enterprises by their debtequity ratio and interest coverage ratio, as shown in Figure 5.2. Unfortunately, the interest coverage ratio is unavailable for large enterprises and SMEs separately. Instead, one can use the profitability figures themselves. There are basically two profitability figures: return on assets (ROA) and return on equity (ROE). ROA better represents profitability when one considers that large enterprises invested more aggressively, ignoring profitability, with borrowed money, and then often received relief for the interest payments, as in the case of the emergency decree in August 1972 and the structural adjustments in the 1980s and after the 1997 crisis. ROA is less affected by such government action than ROE, representing how efficiently enterprises use capital regardless of its sources.26 In South Korea’s financial statement analysis, the figure that best approximates ROA is “gross profit to total assets,” calculated by dividing the sum of profit before income taxes and interest expenses by the value of total assets. The financial statement analysis does not treat venture businesses or firms established by FDI separately from



26

In fact, there is no significant difference in the conclusion whether one uses ROA or ROE.

Industrial Policy and Firms 347 250.0

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Figure 10.5  Relative debt-equity ratio and profitability: Small and medium-sized enterprises to large enterprises, manufacturing sector, 1970–2021 (percent) Source: Calculated from Appendix 3.

conventional SMEs, so it provides the debt-equity ratio and ROA figures for all large enterprises and SMEs. However, considering that venture businesses and FDI firms are a small proportion of firms, the figures mainly represent the situation of conventional large enterprises and SMEs. The figures are only available for the manufacturing sector, but they may help to see the trend in all sectors over the years. To see the financial soundness of SMEs in relation to large enterprises, one could calculate SMEs’ relative debt-equity ratio by dividing the SMEs’ debt-equity ratio by large enterprises’ debt-equity ratio; their relative profitability can be calculated by dividing SMEs’ ROA by large enterprises’ ROA. Figure 10.5 presents SMEs’ relative debt-equity ratio and relative profitability for the manufacturing sector. Initially, SMEs were financially sounder with a relative debt-equity ratio lower than 100

348 The Tortuous Path of South Korean Economic Development percent and a relative profitability higher than 100 percent, in spite of their weaker market power. This suggests that large enterprises, including chaebol firms, led the HEG by investing aggressively with borrowed money while ignoring profitability. Then, SMEs’ relative debt-equity ratio rose, apparently as they joined large enterprises in investing with borrowed money, but their relative profitability stayed above 100 percent. In the 1990s, there were signs that SMEs’ relative financial soundness was weakening. Their relative profitability fell while their relative debt-equity ratio stayed above 100 percent; from 1990 to 1996, their relative profitability averaged no more than 103.2 percent while their relative debt-equity ratio averaged 136.7 percent. This happened probably because, as discussed in Chapter 6, some chaebol firms were graduating from the government subsidies and emerging as global players. On the other hand, SMEs, which were doing business in lower-technology industries employing lower-skilled workers, likely had more difficulty with adjusting to the new ICT. The changing composition of trade partners also worked unfavorably for SMEs, as the competition from China and other developing countries began to undermine their position while improving the opportunities for large enterprises. Still, the relative profitability fell short of being reversed because large enterprises, which included most chaebol firms, continued to lead investing aggressively, ignoring shortterm profitability. The deteriorating trend of SMEs’ relative financial situation was reversed with the 1997 crisis and the following structural adjustment, as they affected mainly large enterprises. However, as the structural adjustment was completed, SMEs’ relative financial soundness deteriorated drastically. From 2002 to 2021, SMEs’ relative debt-equity ratio and relative profitability averaged 175.7 percent and 75.4 percent, respectively. Of course, averages fail to reveal the diversity among enterprises. Yet, there is evidence that SMEs are composed relatively more of financially unsound firms. According to the BOK data, for the 12 years from 2008 to 2019, on average, 40.2

Industrial Policy and Firms 349 percent of SMEs had the interest coverage ratio lower than one, while 24.0 percent of large enterprises had the interest coverage ratio lower than one. Those figures shot up with the pandemic in 2020; however, while the percentage for the large enterprises fell to 23.4 in the first half of 2022, the percentage for SMEs stayed at 49.7 in the same period (See Appendix 8). SMEs’ relative financial soundness deteriorated first because the structural adjustment following the 1997 crisis improved chaebol’s financial soundness drastically. In addition, the forces that had worked in the 1990s continued to work. Skill-biased technological change continued, and the share of poorer countries, such as China, in trade kept rising. The subcontracting system also came to work less favorably for SMEs after the crisis. Most subcontractors have little bargaining power in relation to the particular large enterprise they sell products to because it is the sole buyer of their products. There is always the possibility that large enterprises use their superior bargaining power to squeeze the subcontracting SMEs. No formal study has analyzed how large enterprises changed the use of such power after the 1997 crisis. However, it is quite likely that large enterprises came to squeeze subcontracting SMEs harder as they became more profit-oriented after the crisis. Large enterprises often slashed prices after a contract was signed; they also often forced SMEs to hand over technology or poached the personnel that had led SMEs’ successful R&D. Under such a situation, the government’s measures to help SMEs tended to end up serving the large enterprises as they imbibed the benefits of the support. There are signs that the forces that deteriorated SMEs’ relative soundness have weakened. The influence of the new technologies may have weakened or spread more evenly among firms, and the share of poorer countries in trade has leveled off. The National Assembly revised the Fair Transactions in Subcontracting Act several times to enhance the bargaining power of subcontracting SMEs, notably by introducing the punitive indemnification for the damages inflicted in 2010. The Moon Jae-in government implemented policies

350 The Tortuous Path of South Korean Economic Development to enhance fair trade at the administrative level, and increased the government procurement from innovative SMEs. However, it is unclear how much those changes raised relative profitability. Meanwhile, Figure 10.5 suggests that there may have been some turnaround in SMEs’ relative debt-equity ratio in the late 2010s. Nobody has rigorously analyzed the causes, but it may be due to the fact that SMEs are following large enterprises in reducing the debtequity ratio. After the 1997 crisis, large enterprises, led by chaebol, reduced the debt-equity ratio more drastically than SMEs, raising the relative debt-equity ratio. By the late 2010s, large enterprises’ debtequity ratio apparently leveled off while SMEs continued to reduce their debt-equity ratio (See Appendix 3).

The Trend of Productivity Intertwined with the relative financial soundness is the relative labor productivity of workers. The relative labor productivity of SMEs’ workers continued the trend in place before the crisis. As mentioned in Chapter 7, the relative labor productivity of SMEs’ workers fell before the crisis due to poorer training and slower automation. SMEs may have also been less innovative. The 1997 crisis is likely to have accelerated the trend as the ensuing structural adjustment concentrated on chaebol firms. There are no data on the relative labor productivity of SMEs’ workers over the longer run. The National Statistical Office (NSO) compiled the data for production and employment by the size of establishments (business units) rather than enterprises. The data underestimate the share of large enterprises because one large enterprise can have more than one establishment. One can thus just examine the data on establishments, assuming that there is a close correlation between the size of establishments and the size of enterprises. Most studies on large enterprises and SMEs have done so, defining establishments with 300 or more workers as proxies for large enterprises and establishments with less than 300 workers as proxies for SMEs. Kim Won-gyu has calculated the relative productivity of SMEs for

Industrial Policy and Firms 351 90.0

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Total factor productivity

Figure 10.6  Productivity-related indices, small and medium-sized enterprises relative to large enterprises, 1983–2020 (percent) Source: Appendix 10.

the manufacturing and mining sectors from 1983 to 2017 using such a method.27 His estimation covers only the establishments with ten or more workers due to the limitation of the data. It also fails to treat venture businesses or FDI firms separately from conventional firms. However, his estimation may help reveal the trend of relative labor productivity of SMEs’ workers over the years. Labor productivity can be decomposed into capital intensity (capital-labor ratio) and total factor productivity. Total factor productivity is an elusive concept, as mentioned in Chapter 5. Yet it is likely to be determined mainly by innovative activities. Innovative activities are not easy to measure, but R&D efforts could be a first proxy. Figure 10.6 presents SMEs’ relative labor productivity, relative

27

They are the background data of Kim Won-gyu (2020).

352 The Tortuous Path of South Korean Economic Development capital intensity, relative total factor productivity, and relative R&D intensity calculated by Kim. The figure also presents SMEs’ relative wage level, which is compiled for all industries from 1998 to 2020. Though the relative wage level does not exactly coincide with relative labor productivity, its trend may tell something about the trend of relative labor productivity. Relative wage level data are available only from 1998, so they reveal little about the changes through the 1997 crisis and the subsequent structural adjustment; however, they give more updated information, being compiled to 2020. SMEs’ relative labor productivity fell consistently until the 2000s, but the reasons varied over the years. Before the 1997 crisis, it fell mainly because the relative capital intensity fell, probably as automation proceeded faster in large enterprises than in SMEs. Large enterprises better handled the automation process because they did business in more capital-intensive industries. They were better able to raise the capital needed for the automation. They may also have pursued automation to weaken labor unions. SMEs’ relative capital intensity fell drastically with the 1997 crisis, probably as large enterprises shed more workers through the structural adjustment. Yet the fall more or less stabilized in the 2000s. No study has been conducted regarding why the SMEs’ relative capital intensity stopped falling in the 2000s, but it is probable that by then, large enterprises were approaching the limit to carry out automation and layoffs in relation to SMEs. After the 1997 crisis, SMEs’ relative labor productivity fell mainly because their relative total factor productivity fell. SMEs’ relative total productivity fell even though their relative R&D intensity rose. R&D intensity rose both in large enterprises and SMEs, but it rose more in SMEs than in large enterprises, not least because of the rising weight of venture business (See Appendix 10 for the R&D intensity of large enterprises and SMEs). SMEs’ rising relative R&D intensity failed to raise their relative total factor productivity because SMEs, including venture businesses, were organizing their R&D less efficiently. SMEs were not good at developing an open system of innovation connected to the outside world. Their collaboration with

Industrial Policy and Firms 353 government research institutes as well as universities was not easy to establish. SMEs also had fewer networks to cooperate with to realize the economies of scale in R&D. SMEs were also weak at “non-technology” innovations such as developing workplace ideas to improve productivity. SMEs continued to have a poorer ability to attract talented workers and improve their labor productivity through training. Poor corporate governance was also an obstacle to improving productivity. While large enterprises, particularly chaebol firms, improved corporate governance after the 1997 crisis, SMEs have had a far worse sense of governance or transparency. The owner-managers of SMEs often intertwine their own interests with the enterprises’ interests, discouraging talented workers from joining them.28 Figure 10.6 shows that SMEs’ relative total factor productivity may have bottomed out in the 2010s. If it did, it would probably be because SMEs have made some progress in organizing innovations. Many of the difficulties in SMEs’ innovation efforts were transitory, which they may have begun to overcome. The bottoming out of relative total factor productivity led to the bottoming out of realtive labor productivity. SMEs’ relative wage level, compiled to 2020, also bottomed out. It fell from 66.6 percent in 1998 to 53.2 percent in 2014 but rose subsequently; though it fell again and hit a low at 53.1 percent in 2018, it quickly bounced back thereafter, to reach 57.8 percent in 2020. It remains to be seen whether the bottoming out is a longer-run trend.

The Changing Employment Share As mentioned in Chapter 7, before the 1997 crisis, SMEs’ share in employment rose as large enterprises pursued subcontracting and automation. The activation of unions also gave firms the incentive not to increase their size, so did the government policy. The 1997 crisis provided a momentum to accelerate this trend. Large enterprises,



28

The problems of SMEs’ innovation ability are from National Research Council for Economics, Humanities, and Social Sciences (2021: 29–53).

354 The Tortuous Path of South Korean Economic Development led by chaebol firms, laid off workers massively. Most workers laid off from large enterprises could not return to similar workplaces subsequently; they exited from the labor market or joined SMEs (See Chapter 11). Over the years, however, SMEs’ share in employment could not continue rising as their relative financial soundness deteriorated and relative labor productivity fell. There are two data sources for the SMEs’ relative share in employment, both defining them as establishments with less than 300 workers. One is Kim Won-gyu’s data on the manufacturing and mining industries; the other is the NSO data on all industries. Both data fail to cover the establishments with less than ten workers; however, they may again help to see the trend. Figure 10.7 presents the SMEs’ relative share in employment calculated by dividing the number of SMEs’ workers by the number of large enterprises’ workers. Relative Share (1) is from Kim’s data, and 400.0 350.0 300.0 250.0 200.0 150.0 100.0 50.0

Share  (1)

18 20

15 20

12 20

09 20

20

06

03 20

00 20

97 19

94 19

91 19

88 19

85 19

19

82

0.0

Share   (2)

Figure 10.7  Employment share, small and medium-sized enterprises relative to large enterprises, 1982–2020 (percent) Note: Share (1) is for manufacturing and mining sectors and share (2) is for all industries. Source: Appendix 10.

Industrial Policy and Firms 355 Relative Share (2) is from the NSO data. As expected, both Relative Share (1) and Relative Share (2) rose sharply after the crisis. There is some difference between Relative Share (1) and Relative Share (2) in the subsequent trend. While it is uncertain whether Relative Share (1) peaked out, Relative Share (2) clearly peaked out in the 2000s. It is impossible to explain the difference, but they concur in showing that SMEs’ relative share in employment at least slowed down the rising trend over the years, probably as their relative financial soundness deteriorated and their relative labor productivity fell. There were other factors that affected the trend of SMEs’ relative employment share. One is the peaking out of the subcontracting system. SMEs increasingly found the subcontracting relationship limiting their business opportunities rather than enhancing them, as they could not develop independent business capability. The enhanced pressure from large enterprises was also likely to have reduced the incentives for subcontracting. The proportion of subcontracting SMEs out of the total SMEs in the manufacturing sector peaked at slightly over 60 percent just before the 1997 crisis; it decreased gradually after the crisis, falling below 50 percent by the late 2000s.29 Another is the persistence of “zombie firms,” which helps to keep SMEs’ relative employment share from falling. SMEs have a higher ratio of financially unsound firms with slower productivity growth, so, proportionately, they have comprised more of zombie firms. Zombie firms have nevertheless survived for extended periods due to “ever greening” by financial institutions, which is implicitly supported by the government. The government cannot force zombie firms to exit out of the concern for the resultant job losses under the still weak social safety net. SMEs’ relative employment share leveled off or peaked out as the aforementioned factors interacted with one another. There is no evidence that the turnaround in the relative debt-equity ratio and

29

Ju et al. (2009: 2).

356 The Tortuous Path of South Korean Economic Development relative labor productivity in the 2010s led to a rise in SMEs’ relative employment share. What is clear is the difference between before and after the 1997 crisis: SMEs’ relative employment share is higher while their relative productivity is lower after the crisis than they were before the crisis. Whether this has raised or reduced the overall productivity of the economy is unclear, as the higher relative productivity of large enterprises’ workers may offset the effect of their lower weight in employment. However, it is clear that the existing labor market dualism has deepened after the 1997 crisis, as a smaller number of large enterprise’s workers have higher relative productivity than a larger number of SMEs’ workers than before the crisis. It has naturally widened inequality, as will be discussed in Chapter 11.

11 Inequality, Jobs, and Welfare

This chapter deals with the management of social conflict after the 1997 crisis. Though South Korea evolved into an advanced country, managing social conflict has remained a challenge. Democracy was consolidated, as illustrated by four peaceful turnovers of the government in 1997, 2007, 2017, and 2022. However, inequality widened badly after the crisis, first with the massive layoff of workers and then with the slowdown of growth that weakened the ability to create jobs subsequently. Deepening labor market dualism and falling labor share of income also widened inequality. Over the years, the inequality of market income more or less leveled off while the government increased redistribution through the welfare system. However, the welfare system has had its own problems.

11.1  The Changing Inequality By the mid-1990s, the South Korean economy was approximating “growth with equity” more than ever, as explained in Chapter 7. The top ten percent income share rose slowly at most while the top one percent income share flattened; the capital gains on real estate transactions, the major mechanism of transfer to the rich, was under control while the welfare system, the mechanism of transfer to the poor, made a significant progress. Reforms were made to make the economy more transparent. After the 1997 crisis, the reform enhanced the transparency of the economy further, but inequality widened while growth slowed down. South Korea moved from “growth with equity” to “slowdown with inequality,” though inequality more or less leveled off and the government redistribution narrowed the inequality of the disposable income over the years. This section will first sketch the changes in inequality after the crisis and then try to explain them. 357

358 The Tortuous Path of South Korean Economic Development

The Trend of Inequality South Korea’s income distribution data were inaccurate, being compiled by the surveys based on the answers to questionnaires distributed to households. After the 1997 crisis, the NSO tried to compile income distribution data in a more systematic way by launching the Survey of Household Conditions. However, it was still based on answers to questionnaires distributed to households, so it seriously underestimated inequality. In the 2010s, taxation data became available for research purposes, and economists began to study income distribution by cross-checking the taxation data with the national account data. Figure 7.1 is based on the estimation using such a method. As accurate statistics on income distribution were increasingly in demand, the NSO cooperated with the BOK (compiling the national account), the National Tax Service, and the Financial Supervisory Service to compile the Survey of Household Finances and Living Conditions from 2011. The survey added the administrative data of the National Health Insurance Service from 2017. These data are now the official income distribution data (The NSO ceased to compile the Survey of Household Conditions in 2017). Survey of Household Finances and Living Conditions data are more accurate than those previously compiled, but the time series are too short to show the longer-run trend involving the periods before and after the 1997 crisis. The Survey of Household Conditions data, while underestimating inequality, may help to see the longerrun trend, as they present the Gini coefficients from 1990 to 2016, though only for urban households with two or more members. Figure 11.1 presents the Gini coefficients of market income and disposable income in the data, denoting them as Market Income (1) and Disposable Income (1), respectively. Figure 11.1 also presents the Gini coefficients of market income and disposable income in the Survey of Household Finances and Living Conditions data, denoting them as Market Income (2) and Disposable Income (2), respectively. They help to see the trend of inequality from 2011 onward.

Inequality, Jobs, and Welfare 359 0.50 0.45 0.40 0.35 0.30 0.25 0.20

Market income  (1) 

Disposable  income (1)

Market  income (2)

Disposable income   (2) 

20 20

17 20

14 20

11 20

08 20

20

05

02 20

99 19

96 19

93 19

19

90

0.15

Figure 11.1  Gini coefficients, 1990–2021 Source: kosis.kr.

One can combine the trend of the top income shares in Figure 7.1 and the trend of the Gini coefficients of Market Income (1) in Figure 11.1 to analyze the changes in inequality through the 1997 crisis. Both of them suggest that inequality of market income widened with the crisis. Other studies comparing particular years before and after the crisis using the taxation and national account data also report a similar result. For example, Kim Nak Nyeon and Kim Jong-il found that the Gini coefficient of market income rose from 0.303 in 1996 to 0.411 in 2006.1 Yet there is a room for different interpretations about the widening of inequality. Top one percent shares, as shown in Figure 7.1, began to rise after the crisis, suggesting that inequality newly widened with the crisis. Top ten percent (1), as shown in Figure 7.1, which had fallen somewhat for a few years before the crisis, shot up after the crisis, also suggesting that inequality newly widened with the crisis. On the other hand, Top ten percent (2), as shown in Figure 7.1, more or less continued the rising trend in place from before the crisis. The Gini coefficient of Market Income

1

Kim and Kim (2013).

360 The Tortuous Path of South Korean Economic Development (1) in Figure 11.1 also suggests the possibility that inequality continued the rising trend that had begun in the mid-1990s. There is thus no unanimous evidence that the 1997 crisis newly widened inequality. However, the evidence overall suggests that the 1997 crisis more likely widened inequality newly than not. Moreover, inequality is most likely to have newly widened if the income not distributed to households is also considered, as will be discussed below. Both Figure 7.1 and Figure 11.1 show that inequality of market income peaked out or leveled off eventually. Yet by international comparison of the present state of inequality, the top income shares in Figure 7.1 and Gini coefficients in Figure 11.1 differ from each other. Top income shares appearing in Figure 7.1 are presently high when compared with other advanced countries’. In 2021, the top ten percent income share, at 45.8 percent, was even higher than 45.7 percent in the United States, the country that has had the highest inequality among advanced countries. The top one percent share, at 14.5 percent, was lower than 19.1 percent in the United States, but higher than in most other advanced countries, including Japan.2 On the other hand, Market Income (2), as shown in Figure 11.1, the Gini coefficient in the Survey of Household Finances and Living Conditions data, stood at 0.405 in 2020 and 2021, which was lower than major advanced countries’.3 Nobody has yet explained the discrepancy between the two sets of data. However, the trend of top income shares in Figure 7.1 tells an interesting picture by international comparison. The inequality in income distribution measured by top income shares has more dramatically risen in South Korea than in any original advanced countries, composed of the Western countries and Japan. In the 1950s, income distribution was most likely more equal in South Korea than in any of them; by 2021, income distribution became more unequal in South Korea than in most of them. South Korea has become the only

2 3

See Appendix 5 and World Inequality Database. The distribution data of OECD countries are from https://stats.oecd.org/Social Protection and Well-being.

Inequality, Jobs, and Welfare 361 country to transform itself from a developing country to an advanced one in the last 70 years or so, as explained in Chapter 1. However, the transformation has been accompanied by the widening of income inequality not observed in any of the original advanced countries. Figure 11.1 shows that the redistribution by the government came to have more impact after the 1997 crisis. Over the years, the redistribution continued to increase while the inequality of market income peaked out or leveled off, so the inequality of disposable income narrowed. Yet the inequality of disposable income is still higher than in other advanced countries, mainly because the redistribution by the government is smaller. The Gini coefficient for disposable income was 0.333 in 2021, which placed the country at the higher end of OECD countries, slightly below the United States and the United Kingdom. The income distribution data have limitations because they are based on household income and thus are unable to capture the portion of national income that does not flow to households. While firms distribute part of their profits to households as dividends, they also retain them within themselves. To understand income distribution more comprehensively, one has to take the distribution of those retained profits as well as the income distributed to households into account. This is all the more important because the share of retained profits most likely rose after the crisis, as they comprise corporate saving, which rose as a percentage of GDP after the crisis, as shown in Figure 9.2. If the retained profits are taken into account, inequality of household income would widen with the 1997 crisis more than what Figure 7.1 and Figure 11.1 reveals because corporate profit is most unevenly distributed of all incomes distributed to households (The distribution of dividends shows this, as explained in Section 3). This makes it most likely that inequality newly widened with the 1997 crisis. One also has to consider the transfer of wealth through the real estate market. While the government increased the transfer to the poor through redistribution, the rise in real estate prices resumed

362 The Tortuous Path of South Korean Economic Development after the 1997 crisis to increase the transfer to the rich, as shown in Figure 7.2. The country managed to reduce the capital gains on privately owned land to 6.8 percent of GDP on average during the five years from 1992 to 1996. However, after the crisis, the Kim Daejung government (February 1998–February 2003) activated real estate transactions to boost the economy, raising the real estate prices. The Roh Moo-hyun government (February 2003–February 2008) tried hard to control the rising real estate prices, but it was difficult to do once the speculative boom set in. The capital gains on privately owned land fell to −20.9 percent of GDP in 1998 but rose to 29.5 percent of GDP on average from 1999 to 2007, the year before the 2008 crisis. Real estate prices stabilized as the Roh Moo-hyun government’s policy took effect and the 2008 crisis dealt a further blow. However, in 2014, the Park Geun-hye government (February 2013– May 2017) again tried to boost the economy by activating real estate transactions. The Moon Jae-in government (May 2017–May 2022) once again tried to control real estate prices, but it was again very difficult. Capital gains on privately owned land amounted to 25.5 percent of GDP on average during the eight years from 2014 to 2021. The size of the capital gains is now smaller as a percentage of GDP than in the previous bouts of price rises from the 1960s to the 1980s (shown in Figure 7.2), which is natural given the slowdown of growth and urbanization. The rule of the game has also become fairer as the liberalization of household loans has broadened the access to the borrowing from financial institutions. Still, it has had a devastating effect on inequality.

Understanding the Changing Inequality What accounted for the changes in inequality after the crisis? The redistribution by the government is the result of policy, or, more accurately, the result of the welfare system built by the government policy, as will be discussed in Section 4. The transfer of wealth through real estate transactions is also the result of government policy, though, to some degree, it was a consequence of the 1997 crisis

Inequality, Jobs, and Welfare 363 because Kim Dae-jung government’s policy may have been spared without the crisis. On the other hand, inequality of market income has changed for more complex reasons. The first reason for the widening inequality of market income is the technological change and globalization that affected the structure of the demand for labor from before the crisis. As mentioned in Chapters 6, 7, and 10, the demand for skilled labor increased relatively from somewhere in the 1990s as South Korea underwent skill-biased technological change and traded more with the countries poorer than itself, particularly China. To cope with the rising demand for skilled labor, the government raised college attendance ratio, but the college wage premium rose because the supply of skilled labor lagged behind the demand. This trend continued after the 1997 crisis, accounting for the continuing rise in inequality. Over the years, however, skillbiased technological change became more difficult and the weight of the trade partners poorer than South Korea stopped rising. The resultant overshooting of the supply of college graduates reduced the wage gap, which may have contributed to the peaking out or leveling off of the inequality in market income shown in Figure 7.1 and Figure 11.1. There are also sociological factors that affect the trend of inequality, such as the increase of the one-person households, which tend to be poorer than multi-person households. The aging of the population has produced more elderly people without income. However, the longer-run changes in technology, globalization, and sociological factors cannot explain why inequality newly widened after the crisis. The eventual peaking out or leveling off of inequality may also be due to the tapering off of the impact of the crisis and reform as well as the slowdown of the skill-biased technological change and the leveling off of the share of poorer trade partners. The 1997 crisis newly widened the inequality of market income in three interrelated ways. First, it led to the layoff of hundreds of thousands of workers immediately after the crisis. Second, jobs became scarcer as growth slowed down, and the wage gap widened as labor market dualism deepened. Third, the labor share of income fell

364 The Tortuous Path of South Korean Economic Development or, equivalently, the capital share of income rose. In the rest of this chapter, Section 2 deals with the first and the second reasons, while Section 3 deals with the third.

11.2  Labor Market Problems Inequality widened after the crisis as the labor market situation deteriorated. The labor market situation deteriorated first as hundreds of thousands of workers were laid off, and then as the ability to create jobs weakened with the slowdown of growth. South Korea came to suffer a serious job shortage for the first time since the beginning of the HEG. Previously, creating jobs worked as the main mechanism of the growth with equity, but after the crisis, the scarcity of jobs became the ground for the slowdown with inequality. Moreover, inequality widened with the deepening of the labor market dualism, as employers hired more non-regular workers and dispatched workers, which were allowed by the reform after the crisis.

Laying Off Workers Inequality widened after the crisis first as the massive layoffs raised the unemployment rate. The unemployment rate, which stood at 2.0 percent in 1996, rose to 2.6 percent in 1997 and then shot up to 7.0 percent in 1998 and 6.3 percent in 1999, mainly because of the layoffs. This widened inequality because the unemployed had no income at all, differentiating them from the employed. The unemployment rate fell as the economy recovered, falling below four percent by 2002. It hovered between three percent and four percent subsequently, as shown in Figure 4.2. This happened while the government changed the way to define the unemployment rate in 1999: It changed the denominator from the number of the workers who had actively sought jobs for the last one week to those who had actively sought jobs for the last four weeks. The change is likely to have raised the unemployment rate by reducing the denominator. In spite of the revision, the unemployment rate eventually did not rise much from the pre-crisis level. Unfortunately, this failed

Inequality, Jobs, and Welfare 365 to restore inequality to a level before the crisis because the laid-off workers could not return to the jobs similar to those they had before the crisis. Many of them dropped out of the workforce entirely, not to be classified as unemployed but to contribute to the widening of inequality. The laid off workers could not return to the jobs similar to those they had before the crisis because of the nature of the layoff combined with the labor market dualism. As explained in Chapter 7, South Korea had labor market dualism already before the crisis. Some workers – mostly male – of large private enterprises, the public sector, and semi-public sectors tended to stay a long time with the same employers, some of them for their lifetime. They were more skilled workers; part of their skills were acquired through the training in workplaces. Their labor market was inflexible, and they mostly received seniority-based wages and salaries. Meanwhile, other workers, the majority of whom were employed by SMEs, were less skilled and changed employers often as their labor market was very flexible. Before 1997, crises did not lead to much layoff of the first category workers. The public and semi-public sectors’ workers were not laid off during crises. Large private enterprises’ workers were also not laid off much, the majority of them keeping jobs even when their firms went bankrupt.4 This was rational because the firms had invested much in their skills. Crises mainly led to the layoff of the second category workers because SMEs were more vulnerable to crises and the employers had not invested much in their skills. However, these workers, after being laid off, could return to jobs similar to the previous ones rather easily with the recovery of the economy because their job market was very flexible. The layoff after the 1997 crisis took a different pattern. Employers laid off the first category as well as the second category workers massively. They did so because the country tried to carry out a fundamental reform of the system rather than coping with a

4

Lee Deog Ro (2004).

366 The Tortuous Path of South Korean Economic Development short-term crisis. The government made some efforts to reduce layoffs through job-sharing measures such as cutting work hours and setting special holidays, leaves of absences, training, reassignments, and so on. However, the basic policy line was laying off workers to pursue “quantity flexibility” rather than “price flexibility,” as explained in Chapter 8. Unions were often willing to make wage concessions for price flexibility – a common behavior expected of them when they faced a threat to the job security of their members. Before the crisis, unions had eroded firm profitability even when firms were already producing NPLs because NPLs would not immediately bankrupt the firms (explained in Chapter 7). However, with the outbreak of the 1997 crisis, firms were facing mass bankruptcy, threatening the job security of the union members. Financial institutions were also facing bankruptcy, and other semi-public sectors and the public sector were carrying out a strong structural adjustment. Thus, the unions, with many first category workers as their members, were willing to make concessions. Those workers were also better able to make concessions because they had been sharing rents with their employers. However, the employers and the government did not accommodate the unions’ willingness to make concessions. Hyundai Motors provided a remarkable example in this regard. Hyundai Motors’ Union was a key member of the KCTU and thus was responsible for the breakdown of the 2.6 Compact, mentioned in Chapter 8. In 1998, Hyundai Motors’ management tried to carry out massive layoffs, the first of such a move after the new Labor Standard Act allowed layoff. Hyundai Motors’ Union proposed a job-sharing program by offering 250 billion won of wage concessions in exchange for reducing work hours per week from 56 to 35 hours, manpower rotation, and so on. The wage concession of 250 billion won was more than five times Hyundai Motor’s net profit in 1997. Hyundai Motors’ management nevertheless refused the union’s proposal and went ahead with the layoffs; it also tried to utilize the layoffs as an opportunity to fire the union activists. The latter endeavor failed as

Inequality, Jobs, and Welfare 367 the union waged a long strike and politicians intervened, but Hyundai Motors eventually laid off about ten thousand workers.5 Among the laid-off workers, the first category workers would find it hard to return to similar jobs, given the inflexibility of their labor market. This was all the more so because all sectors employing them were carrying out the layoffs simultaneously. Moreover, employers mainly laid off the workers in their forties and fifties. It served the purpose of improving the financial soundness of the employers well because those workers were earning higher wages and salaries than their productivity under the seniority-based wage system. It was yet unfair because those workers were earning wages and salaries higher than their productivity at that time as they had earned less than their productivity when they had been young. However, the critical problem was that they were far less likely to move to jobs similar to the previous ones than younger workers, not to mention the second category workers. How the laid-off workers fared was illustrated by a case study of the 945 workers who left Chungcheong Bank, a provincial bank that merged with another bank in 1998. The majority of them had apparently belonged to the first category workers as they had earned about 1.5 times the average urban workers. As of 2007, nine years after being laid off, only 22 workers (2.3 percent of the total laid-off workers) managed to move to similar jobs in the financial sector. Five workers – equivalent to 0.53 percent – committed suicide. The ratio was about 27 times the average nationwide suicide ratio during the same period. About 200 severed ties with their former colleagues and secluded themselves from society. Out of the 465 respondents to the survey, 111 (23.9 percent) had no jobs. More than half of the rest changed jobs three times or more, suffering persistent job insecurity. The laid-off workers now earned only about half of the average urban workers, if they had jobs at all. Few received help from the social safety net. All of this led to the disruption and collapse of

5

Lee Byoung-Hoon (2004).

368 The Tortuous Path of South Korean Economic Development their families through divorce, separation, and abortion.6 More formal empirical studies confirm the story of such a case study. Workers who lost jobs in the post-crisis restructuring but managed to find other jobs suffered large wage losses; the workers who once lost jobs underwent repeated unemployment through job losses.7 No study has analyzed the position of the laid-off workers in the scale of income distribution before the crisis. However, the majority of the first category workers laid off probably belonged to the higher middle-income strata, as can be guessed from the Chungcheong Bank case. They lost such status and were driven into the lower strata. The situation of the second category workers worsened as those newly laid-off workers put pressure on their already-worse-off situation. They were better able to return to workplaces similar to their previous ones as the economy recovered. However, they also had more difficulty in finding similar jobs than in the previous recoveries as the former first category workers, newly laid off, came to compete with them. Furthermore, the job situation worsened for all workers as jobs became scarcer after the crisis.

The Jobs Problem Jobs became scarcer after the crisis. The unemployment rate fails to capture job market situation accurately because it does not take the workers who have given up seeking jobs actively into account. Many workers laid off immediately after the 1997 crisis did so, as shown by the Chungcheong Bank case. Over the years, however, youths came to account for the majority of such workers. To take such a situation into account, South Korea came to pay attention to the “employment rate,” the percentage of the employed to working-age population. The NSO has compiled the employment rate for the working-age population, defined as 15 to 64 years old, from 1989. It has also compiled the employment rate for the youths, defined as 15 to 29 years



6 7

Ryu (2008). See Cho and Keum (2002) and Park (2010).

Inequality, Jobs, and Welfare 369 70.0 65.0 60.0 55.0 50.0 45.0 40.0 35.0 30.0

Working-age population

22 20

19 20

16 20

13 20

10 20

07 20

04 20

01 20

98 19

95 19

92 19

19

89

25.0

Youths

Figure 11.2  Employment rates, 1989–2022 (percent) Source: calculated from the data in kosis.kr.

old. Figure 11.2 presents the employment rates for the working-age population and youths. The employment rate for the working-age population rose rapidly before the 1997 crisis but fell drastically thereafter. It rose again subsequently, but more slowly than before the crisis. It stood at 67.7 percent in 2022, a level far lower than in advanced countries such as the United States, Japan, and major European countries. The employment rate for the youths is affected much by school attendance ratio. Before the 1997 crisis, it rose from 38.2 percent in 1989 to 43.2 percent in 1996, even as the college attendance ratio jumped from 22.6 percent to 41.1 percent and high school attendance ratio rose from 69.8 percent to 83.1 percent during the same period. Youth employment rate fell drastically with the 1997 crisis and then recovered as growth came back. However, it fell again in 2005. As growth slowed down, the growth of the demand for labor also slowed down, and employers found it easier to reduce the demand for the new entrants

370 The Tortuous Path of South Korean Economic Development to the labor market, mainly comprised of youths, than laying off existing workers, which was still difficult. Youth employment rate bottomed out after hitting the low at 37.1 percent in 2013. There is no explanation about this bottoming out of youth employment rate in the face of the continuously weakening growth momentum. One could yet speculate that employers began to hire younger workers as the age structure of employment was being normalized with the retirement of older age workers. Youth employment shot up particularly in 2021 and 2022 after a dip in 2020 with the pandemic, to reach 44.4 percent in 2022, the highest level ever. Whether this will continue remains to be seen. The low youth employment rate is the result of the high youth unemployment rate as well as low labor force participation rate. Youths are not only failing to seek jobs actively; they are failing to get jobs even when they seek them actively. This is manifested by the high youth unemployment rate. While the overall unemployment rate eventually rose only slightly from the pre-crisis level, youth unemployment rate rose more. Youth unemployment rate is always higher than overall unemployment rate as youths search for jobs longer than older workers (With incomplete information, they commit trial and errors in the job search process, and they are willing to pay the cost incurred in the process because they can expect larger benefit from successful job searches). South Korea’s youth unemployment rate was higher than overall unemployment rate from before the 1997 crisis. Then, the gap between youth unemployment rate and overall unemployment rate widened after the crisis, as shown in Figure 4.2. The gap narrowed from the late 2010s; by 2022, the gap almost came back to the level before the crisis. To grasp the jobs problem for youths more accurately, the NSO began to compile a new statistic from 2015 at the recommendation of the ILO, naming it the “extended youth unemployment rate.” It takes into account the number of youths who have given up seeking jobs, postponed graduating colleges, attended the private institutes assisting the job search, worked part-time while preparing the application

Inequality, Jobs, and Welfare 371 to aspired jobs, and so on. The rate was as high as 21.9 percent in 2015 and stayed well over 20 percent subsequently. It stood at 23.1 percent in 2021 but fell to 19.0 percent in 2022, which was the lowest level since 2015.8 It remains to be seen whether this represents the falling trend or cyclical change, but the fact yet remains that the scarcity of jobs for the youths is a big problem. The scarcer jobs widen inequality as long as joblessness is a large source of inequality. Job creation as a mechanism to manage social conflict has weakened accordingly. To make things worse, jobless youths are more highly educated. As college attendance ratio has risen while the economy is unable to create enough jobs, more jobless youths have come to be composed of college graduates. South Korea’s job situation has thus more or less returned to the situation of the late 1950s, epitomized as the “Cow-Bone Towers” mentioned in Chapter 3. Now, far fewer students have rural origin, so their parents rarely sell their cows to send their children (now daughters as well as sons) to colleges. It does not change the fact, however, that the joblessness of educated youths undermines political stability. The jobs problem for youths deteriorated further as labor market dualism deepened after the 1997 crisis.

Labor Market Dualism South Korea had labor market dualism between the first category and second category workers mentioned above (dualism whereby some workers in large private enterprises, the public sector, and semipublic sectors were differentiated from the other workers mainly employed by SMEs) before the 1997 crisis. The reform after the crisis deepened the dualism by allowing the hiring of non-regular workers and dispatched workers while strictly limiting the conditions for laying off regular workers, as explained in Chapter 8. Employers thereby came to have a strong incentive to hire non-regular and dispatched workers. Their shares in employment skyrocketed accordingly.

8

kosis.kr/statHtml/statHtml.do?orgId=101&tblId=DT_1DA7300AS

372 The Tortuous Path of South Korean Economic Development The increase of non-regular workers deepens dualism, as they earn lower wages as well as suffer from weaker job security than regular workers. Their status is rarely a stepping stone to the regular worker status; rather, once youths become non-regular workers, they are likely to stay as such permanently. Labor dispatching also deepens dualism because the dispatched workers receive lower wages as they have far weaker bargaining power in their workplaces compared with the directly employed workers. Their job security is also weaker than that of directly employed workers’. The use of non-regular and dispatched workers interacted with the existing dualism to produce four categories of workers: regular workers of large private enterprises, the public sector, and semipublic sectors; non-regular and dispatched workers in large private enterprises, the public sector, and semi-public sectors; regular workers in other sectors; and non-regular and dispatched workers in other sectors. The first category workers enjoy better job security as well as higher wages and salaries compared with the rest of the workers. All job seekers naturally want to join the first category workers. However, their share in employment fell after the crisis as the share of large enterprises fell and the share of non-regular and dispatched workers shot up. Thus, “good” jobs as well as jobs in general became scarcer after the crisis. The statistics on labor market dualism are in disarray. The NSO started compiling the number of regular workers and nonregular workers in 2002, as the skyrocketing number of non-regular workers became a social issue. The NSO then started compiling the numbers of non-regular workers in large enterprises and SMEs in 2004. However, it classifies large enterprises and SMEs by the size of the establishments (business units), which underestimates the true share of large enterprises. Meanwhile, the NSO overestimates the share of regular workers by classifying the dispatched workers as regular workers of the enterprises where they work. To make things worse, the statistics giving the data on the regular and non-regular workers alongside the large enterprise and SME workers are inconsistent with those on the workers in large enterprises

Inequality, Jobs, and Welfare 373 and SME appearing in Figure 10.7 (This happens frequently with the NSO data). However, one could combine the NSO statistics on labor market dualism with other helpful information to see some trends over the years. Table 11.1 presents the employment share of large enterprises’ workers, regular workers, and the four categories of workers combining the two: regular workers in large enterprises, non-regular Table 11.1  Employment shares by enterprise size and worker status, 2002–2021 (percent) Large enterprises

SMEs

Year

Large Regular enterprises workers

Regular workers

Nonregular workers

Regular workers

Nonregular workers

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021

12.2 12.2 12.3 12.6 12.0 11.6 11.5 12.2 11.3 11.2 11.8 12.0 12.3 12.3 12.4 12.3 12.6 12.9 13.2 13.3

9.8 10.1 9.6 9.3 9.5 10.1 9.6 9.3 10.0 10.2 10.4 10.6 10.7 10.7 10.8 10.9 11.1 11.0

2.5 2.5 2.4 2.3 2.0 2.1 1.7 1.9 1.7 1.8 1.9 1.7 1.7 1.7 1.9 2.0 2.1 2.3

53.2 53.3 55.0 54.9 56.7 55.1 57.2 56.5 56.8 57.3 57.4 57.0 56.5 56.5 56.2 52.7 52.5 50.6

34.4 34.1 33.0 33.5 31.7 32.7 31.5 32.2 31.5 30.7 30.3 30.7 31.1 31.2 31.1 34.3 34.3 36.2

72.6 67.4 63.0 63.4 64.6 64.2 66.2 65.2 66.8 65.8 66.8 67.5 67.8 67.6 67.2 67.1 67.0 63.6 63.7 61.6

Notes: Large enterprises are defined as establishments with 300 or more workers. Source: kosis.kr.

374 The Tortuous Path of South Korean Economic Development workers in large enterprises, regular workers in SMEs, and non-​ regular workers in SMEs. Large enterprises and SMEs are defined in a conventional way, using the establishments with 300 or more workers as proxies for large enterprises and the establishments with fewer than 300 workers as proxies for SMEs. The employment share of large enterprises was as low as 12.2 percent in 2002 but did not fall further subsequently, apparently because it mainly fell before 2002. It is not easy to reconcile this exactly with the peaking out of the SMEs’ relative employment share (2) in Figure 10.7, but one could conclude from the two data that large enterprises’ share fell in the 1990s through the 1997 crisis but stopped falling somewhere in the 2000s. Meanwhile, the share of regular workers fell sharply from 72.6 percent in 2002 to 63.0 percent in 2004, apparently representing the last phase of the skyrocketing rise of non-regular workers since 1998 with the reform that allowed hiring them. The share of regular workers rose somewhat subsequently, but fell again in the late 2010s. After the 1997 crisis, the falling shares of large enterprises’ workers and regular workers interacted with each other to reduce the share of large enterprises’ regular workers in employment. Table 11.1 suggests that such a change mainly occurred before 2004, the first year the statistics for the four categories of workers were compiled. From 2004 to 2021, the share of large enterprises’ regular workers did not change much, hovering between 9.3 percent and 11.1 percent, suggesting that about ten percent of wageworkers have “good” jobs. Of course, this number has serious limits as it is calculated for establishments rather than enterprises and the regular workers include dispatched workers. To know the situation of large enterprises more accurately, the Ministry of Employment and Labor asked the enterprises – private, public, and semi-public – employing 300 or more workers to disclose their employment situation from 2014. By 2021, all the enterprises disclosed them. In 2021, those employers employed 23.7 percent of total wageworkers, which is far higher than 13.3 percent in 2021

Inequality, Jobs, and Welfare 375 appearing in Table 11.1. There is no explanation about why the two figures diverge from each other so widely (though one may guess that it is mainly because many large enterprises have more than one establishment). However, the share of full-time regular workers in the Ministry of Employment and Labor data was no more than 57.8 percent.9 Thus, the share of full-time regular workers in large enterprises was 13.7 percent of total wageworkers, a little higher than the 11.0 percent in 2021 shown in Table 11.1. Yet this does not change the fact that good jobs are gravely in short supply. One could consider here government employees, who accounted for about 5.5% of wageworkers in 2021. There are no data about the exact composition of the government employees, but the share of non-regular and dispatched workers in government employees is most likely lower than ten percent.10 The regular government employees enjoy far better job security than private sector employees, if not higher salaries, so the majority of them comprise those who have good jobs. However, even if all government employees were counted as having goods jobs, only 19.2 percent of wageworkers can be regarded as having good jobs. The labor market dualism is probably responsible for the especially high top ten percent share of income by international comparison mentioned above. It may also be responsible for the high extended youth unemployment rate. Youths compete intensely to join the limited number of regular workers in large enterprises and the government. College students often postpone graduation to prepare themselves for those jobs; youths also quit frequently to seek better jobs. In the end, only a small proportion of youths get the jobs they yearn for, leaving the rest with frustration and dissatisfaction. The country has tried to weaken the labor market dualism. As mentioned in Chapter 10, the government implemented policies to reduce the gap between large enterprises and SMEs, which would

9 10

eiec.kdi.re.kr/policy/materialView.do?num=217179. One could infer this from the government data about its non-regular and dispatched workers. See www.moel.go.kr/info/publict/publictDataView.do?bbs_seq=​ 20220900317.

376 The Tortuous Path of South Korean Economic Development weaken the dualism between their workers. At the same time, the government has tried to reduce the dualism between regular workers and non-regular and dispatched workers regardless of the size of the enterprises. The Roh Moo-hyun government began the efforts to reduce the share of non-regular and dispatched workers. It started with the public sector under its control, by converting those workers engaged in “continuous all-time jobs” into regular workers, to make a model for the private sector. It is unclear whether such a switch of the government policy brought about the leveling off of the share of non-regular workers from 2004 appearing in Table 11.1, because the Roh government could not do much about the private sector. Business leaders disagreed with the Roh government’s position, arguing that, to reduce non-regular and dispatched workers, employers should be able to fire regular workers more easily because the difficulty in firing regular workers made them hire non-regular and dispatched workers (It thus remains to be explained why the share of non-regular workers leveled off from 2004). Business leaders had a strong influence over the conservative Lee Myung-bak government, but the Lee government quickly met the contingency of the 2008 crisis. In the wake of the 2008 crisis, the Tripartite Commission drew up a new social compact on February 23, 2009, now only with the FKTU as the party to represent the labor (the KCTU boycotted the commission). The compact stipulated that employers would refrain from laying off workers while workers would curb their demand for wage hikes. This time, business leaders recognized that laying off workers in a crisis would not help because it may cause the loss of skills that would become necessary when the economy recovered. Workers, of course, preferred wage concessions to layoffs. Over the years, however, business leaders once again came to want to make it easy to fire regular workers. At the end of 2014, the Park Geun-hye government accommodated their requests, declaring that the “excessive protection” of regular workers was the fundamental

Inequality, Jobs, and Welfare 377 cause of the labor market dualism.11 However, the Park government could not put the policy into practice because of the strong resistance by workers. It was also difficult to implement because the country’s social safety net was still poor. South Korea’s expenditure on labor market programs such as employment insurance and retraining programs accounted for about 0.63 percent of GDP in 2014. The ratio was higher than the US’ or Japan’s, but fell far short of Western European countries’.12 Making the firing of regular workers easier could thus lead to the repetition of what had happened after the 1997 crisis. The Moon Jae-in government, following the Roh Moo-hyun government, again tried to restrict the hiring of non-regular and dispatched workers. As with the Roh government, it began with the public sector by converting those workers engaged in continuous alltime jobs into regular workers. The Moon government managed to convert 195.7 thousand of such workers – equivalent to 0.93 percent of the total wageworkers in 2021 – from June 2017 to June 2021.13 It could yet again do little to the private sector. Table 11.1 shows that the share of regular workers began to fall again in the late 2010s. The fall accelerated during the Moon government in spite of the efforts to check it. It is still unknown exactly what caused the fall, but the demographic trend may be largely responsible. The workforce is increasingly comprised more of elderly workers due to the rapid aging of the population and incomplete social safety net. From 2017 to 2021, the share of the workers 60 years or older in the workforce shot up by 4.5 percentage points from 15.3 percent to 19.8 percent, an acceleration from the rise by 2.4 percentage points from 12.9 percent in 2013 to 15.3 percent in 2017.14 Elderly workers can rarely become or remain regular workers. The increase of female workers and social service workers, many of them non-regular workers, may also be responsible.

11 12 13 14

www.news.donga.com (2014.11.26). See stats.oecd.org/Labor/Labor Market Programs. public.moel.go.kr/pub_home/board/docs_list.do?curr_menu_id=95. Calculated from the data in kosis.kr/stat.

378 The Tortuous Path of South Korean Economic Development Currently, the new conservative government of Yoon Suk Yeol (May 2022−present) has declared to raise the “flexibility” of labor market, accommodating the business leaders’ demand. It yet remains to be seen whether the Yoon government will try to make firing regular workers easier.

11.3  Capital, Labor, and Industrial Relations Inequality widened after the 1997 crisis also as the labor share of income fell, or, equivalently, the capital share of income rose. The labor share of income fell in many advanced countries from the 1980s, widening the inequality among households and individuals.15 However, the labor share of income fell suddenly in South Korea with the 1997 crisis, while it fell gradually in those advanced countries. The changing labor share of income is not captured fully in the household income data because corporations retain part of their profits. This section first examines the fall in the labor share income after the 1997 crisis and discusses how it has affected the changes in the overall distribution of income, taking the effect of the retention of profits into account. It also discusses what has happened to industrial relations, which is not only an important determinant of the labor share of income but also affects the distribution of labor income itself.

The Labor Share of Income National account data do not give the labor share of income. They provide only the share of employee compensation in the national income at factor cost. This figure treats the income of the selfemployed as solely capital income, though it is actually mixed income of capital and labor. Various methods have been proposed to calculate the labor share of income with such limited data, but a relatively good method for South Korea is assuming that the labor



15

Piketty (2014); Karabarbounis and Neiman (2014); ILO, IMF, OECD, World Bank (2015).

Inequality, Jobs, and Welfare 379 100.0 90.0 80.0 70.0 60.0 50.0 40.0 30.0 20.0 10.0

20

17

20

20

14

11

20

20

08

05

20

20

02

99

20

96

Employee compensation

19

93

19

90

19

19

87

84

19

19

81

78

19

19

19

75

0.0

Labor income of the self-employed

Figure 11.3  Labor share of income, 1975–2021 (percent) Source: Calculated from the data in ecos.bok.or.kr.

share of the mixed income of the self-employed is the same as the labor share of the income in the rest of the economy. Considering that the self-employed use more labor-intensive methods of production, the assumption may lead to underestimation of the labor share of income; however, this method may not be so flawed for the purpose of reading the trend. Figure 11.3 presents the labor income of the self-employed calculated in this way as a percentage of the national income at factor cost; it also presents employee compensation as a percentage of the national income at factor cost. The two, added together, give the labor share of income. The labor share of income fell drastically with the 1997 crisis and took many years to bottom out. It fell as the share of employee compensation in the national income at factor cost, which had risen consistently before the crisis, fell with the crisis and then leveled

380 The Tortuous Path of South Korean Economic Development off. Labor income increasingly became composed more of employee compensation, though with some fluctuations, which is natural as wageworkers accounted for more of the workforce over the years. Thus, the fall and subsequent leveling off of the share of employee compensation in the national income at factor cost naturally meant fall in the labor share of income. After shooting up briefly in 1998, apparently due to the profit squeeze with the contraction of the economy, the labor share of income fell drastically; it fell from the precrisis peak of 80.8 percent in 1996 and bottomed at 67.4 percent in 2010. The labor share of income rose subsequently, though with dips in 2016 and 2017; it then rose for four consecutive years from 2018. The labor share of income fell drastically after the 1997 crisis as, first of all, the structural adjustment raised firm profitability through the massive firing of workers and (less often) through wage concessions. In addition, changes in the labor laws after the 1997 crisis weakened labor’s bargaining power. They lifted the remaining major restrictions on union rights while allowing employers to lay off existing workers and hire non-regular and dispatched workers. This “exchange” worked unfavorably for labor. The massive layoff caused workers to suffer substantial employment dislocation, and the newly increased non-regular and dispatched workers had far weaker bargaining power compared with the past when they had been employed as regular workers. The subsequent relative scarcity of jobs also reduced workers’ bargaining power. Firms became more profit-oriented, making managers resist workers’ demands for wage hikes more strongly. The increase of direct investment overseas, which tended to involve the movement of jobs offshore, also weakened labor’s bargaining power. The unionization rate fell, weakening labor’s bargaining power. It had already fallen from its peak at 18.6 percent in 1989 to 12.1 percent in 1996, the year before the 1997 crisis, as shown in Figure 7.3. The unionization rate continued to fall after the crisis, even though teachers’ unions and government employees’ unions were legalized. It fell just below ten percent by 2005 and hovered around ten percent

Inequality, Jobs, and Welfare 381 for more than a decade subsequently. The unionization rate fell first because large enterprises’ share in employment fell with the massive layoff; the increase of non-regular and dispatched workers also reduced the unionization rate because they were more difficult to organize. Not only the unionization rate fell but also existing unions’ bargaining power weakened, reducing the union effect on profitability.16 Now, preserving jobs for their members became a major task for unions, and resisting layoffs became a relatively more important reason for labor disputes than wage hikes, compared with the period before the crisis.17 This is reflected in the propensity to strike in Figure 7.4. The propensity fell after the explosion in 1987, but rose again after the 1997 crisis, as employers laid off workers massively. It fell subsequently but rose in 2016, when the Park Geun-hye government tried to extend the performance-based wage system to the lower-level employees of the public sector, which the employees regarded as a threat to their job security.18 The labor share of income began to rise in the 2010s. It rose first because some of the forces that lowered it after the 1997 crisis waned. The massive layoff after the 1997 crisis became a thing of the past and the share of non-regular workers stopped rising, at least drastically. The court judged some of the dispatch contracts illegal, checking the increase of dispatched workers.19 However, the most important reason was probably the changes in the political atmosphere after the Candlelight Revolution from late 2016 to early 2017 that collapsed the Park Geun-hye government. It was precipitated by the scandal that Samsung chaebol bribed Park’s mentor. Samsung happened to be the chaebol that consistently blocked the unionization of its firms, employing every means possible, mostly illegal, even



16



18

17

19

Lee (2012). See the Ministry of Employment and Labor’s Labor White Paper (2003: 89; 2017: 245–246). wspaper.org/article/16779. www.joongang.co.kr/article/25025663#home.

382 The Tortuous Path of South Korean Economic Development after the democratization in 1987. The revolution brought into light other chaebol’s misbehavior and their cronyism with other elites of the country, which put chaebol and capital in general on the defensive in relation to labor. Labor’s bargaining power also rose as the Moon Jai-in government, coming after the Candlelight Revolution, tried to make the labor laws consistent with the standard of advanced countries, which South Korea had promised earlier. The country joined the ILO in 1991, promising to meet the standard over the years. The country made the same promise when it joined the OECD in 1996 and again when it concluded the free trade agreement with the European Union in 2011. In 2021, the National Assembly ratified the ILO core conventions. Though the legislation was made in 2021, the political atmosphere leading to it most likely raised labor’s bargaining power from 2017. The unionization rate bottomed out and rose for four consecutive years from 2017, reaching 14.1 percent in 2021, a level higher than in 1996 (See Appendix 6). The unionization rate bottomed out, apparently because the forces that had led to the fall had hit their lows. Large enterprises’ employment share bottomed out for the whole industry, as shown in Figure 10.7. The Moon Jae-in government’s policy to transform non-regular and dispatched workers in the public sector into regular workers raised the unionization rate as the new regular workers joined unions. However, the turnaround of the political atmosphere with the Candlelight Revolution may again have been most responsible. These changes contributed to the bottoming out of the labor share of income. However, the labor share of income in 2021, at 73.6 percent, still fell far short of the pre-crisis peak of 80.8 percent in 1996. The pro-labor legislation passed in 2021 may raise labor’s bargaining power further. However, the labor share of income may fall again under the new conservative government of Yoon Suk Yeol (May 2022–present), which has taken an unfriendly position towards unions thus far.

Inequality, Jobs, and Welfare 383

Capital Income and Inequality The effect of the falling labor share of income on inequality depends on two conditions: first, whether capital income is more unevenly distributed than labor income; second, whether capital income is more closely correlated with total income than labor income. Empirical studies based on household income reveal that capital income is far more unequally distributed than labor income, but it is less closely correlated with total income because some people with a low total income live on capital income. Overall, the former effect dominates the latter effect. Lee Byung-hee has investigated the Survey of Household Finances and Living Conditions data for 2013 and reports that a one percentage point fall in the labor share of income leads to a 0.12 percentage point rise in the Gini coefficient.20 Thus, the falling labor share of income after the 1997 crisis most likely widened overall inequality. However, household income data have serious limitations. They do not classify the mixed income of the self-employed into labor and capital incomes. More importantly, the data fail to cover the capital income not distributed to households. A large proportion of profits does not flow to households as dividends but is retained by firms, and the share of retained profits rose after the 1997 crisis. To analyze the changes of inequality comprehensively, one has to take these factors into account. To take the aforementioned factors into account, one can examine the composition of capital income. Capital income can first be classified into the income distributed to households and the income not distributed to households. The capital income distributed to households is composed of the capital income of the self-employed, rents, interests, dividends, and “other investment income” (such as incomes received from pensions, insurance, and so on). Rents and interests should be calculated as net figures because households also pay rents and interests to other sectors. Capital income not flowing

20

Lee (2016: 96–97).

384 The Tortuous Path of South Korean Economic Development 35.0

30.0

25.0

20.0

15.0

10.0

5.0

Net interest to household Other capital income of household

20 20

17

14

20

20

11

08

20

05

20

20

02

99

20

19

96

93

19

90

Capital income of the self-employed Net rent to household Retained profits

19

19

87

84

19

19

81

78

19

19

19

75

0.0

Dividend to household Net capital income of the government 

Figure 11.4  The composition of capital share of income, 1975–2021 (percent) Source: Calculated from the data in ecos.bok.or.kr.

to households is distributed to the government or withheld by firms as retained profits. Figure 11.4 presents each category of these capital incomes as a percentage of the national income at factor cost. Figure 11.4 shows an interesting picture regarding the changes in the factor share of income that occurred with the 1997 crisis. The total capital share of income rose, as a corollary of the falling labor share of income. However, the share of the capital income distributed to households fell after surging briefly because of the high interest rate policy imposed by the IMF. The share of the capital income distributed to households averaged 12.7 percent from 1975 to 1996 and 11.1 percent from 1998 to 2021. It fell because the share of the capital income of the self-employed fell, which was natural as the share of the self-employed in the workforce fell over the years. The share of the rest of the capital income distributed to households rose, but only marginally; it averaged 7.5 percent from 1975 to 1996 and 8.4 percent from 1998 to 2021. The rising total share of capital income with the

Inequality, Jobs, and Welfare 385 falling share of the capital income distributed to households meant the rising share of retained profits. It stood at 7.1 percent in 1996 but shot up after the crisis to peak at 21.2 percent in 2010 before falling to 15.6 percent in 2021. It averaged 9.7 percent from 1975 to 1996 and 16.2 percent from 1998 to 2021. The falling share of the capital income of the self-employed is unlikely to have changed the distribution among individuals or households much. The share of the rest of the capital income distributed to households changed only marginally after the crisis, but its composition changed significantly, with the most salient change being the falling share of net interests and the rising share of dividends. This raised inequality because dividends are more unequally distributed than interests. According to the taxation data reported by the National Tax Service, from 2016 to 2019, the top one percent of individual shareholders accounted for 71.5 percent of dividends, while the top one percent of individual creditors accounted for 45.8 percent of the interests paid by corporations to households. Thus, the falling share of interests and rising share of dividends contributed to the rising top one percent share of household income after the 1997 crisis, shown in Figure 7.1, as long as individual income and household income are closely correlated with each other. Meanwhile, the top ten percent of individual shareholders accounted for 93.9 percent of the dividends, while the top ten percent of individual creditors accounted for 90.9 percent of the interests.21 Thus, the falling share of net interests and the rising share of dividends contributed little to the rising top ten percent share of household income after the 1997 crisis (Unfortunately, there is no study about the difference between net interests and dividends in their correlation with total income). The rising share of retained profits is likely to have widened inequality, considering that the ownership of retained profits is as unequally distributed as dividends. Of course, the reality is more



21

www.hani.co.kr/arti/economy/economy_general/997804.html provides the data for dividends and interests.

386 The Tortuous Path of South Korean Economic Development complex than what the data for the individuals reveal because not only individuals but also institutional investors own corporate shares, and firms and financial institutions cross-own one another. In addition, foreigners came to own a higher share of corporations and financial institutions after the 1997 crisis. Calculating the distribution of the retained profits by tracing such an ownership structure to the individual shareholder level is out of the question. However, it is certain that, if the retained profits directly owned by individuals were added to the household capital income, the inequality of household income would be higher than what the household data show in Figure 7.1 or Figure 11.1, considering that dividends are more unequally distributed than any income flowing to households. The inequality of household income would also turn out to widen with the 1997 crisis more than what Figure 7.1 or Figure 11.1 reveals. The rising capital share of income widened inequality after the 1997 crisis. Likewise, the peaking out of the capital share of income in the 2010s is likely to have reduced inequality, although it was not large enough to offset the effect of the initial rise.

Whither Unions? The labor share of income changed as the bargaining power of labor changed. At the core of the bargaining power of labor was the strength of unions. Unions reduce inequality by raising the labor share of income. However, it is uncertain whether unions reduce the inequality of labor income itself, especially given the labor market dualism. While unions are likely to reduce the inequality of labor income among workers belonging to the same category, they may rather widen the inequality between the different categories of workers. Unions tend to pursue the interest of their members, who are mainly regular workers at large enterprises, at the expense of other workers. The lingering legacy of enterprise unions encourages such behavior. This practice existed before the 1997 crisis but has worsened since. There is no empirical study regarding whether unions narrow or widen the inequality of labor income overall. However, there are

Inequality, Jobs, and Welfare 387 ample cases showing that unions act in the narrow interest of their members rather than in the broader interest of the working class. Unions of large enterprises have often acquiesced in using non-regular workers as buffers to ensure job security and high wages for regular workers. For example, Hyundai Motors’ union, which had fiercely resisted the layoff attempt by the management in 1998, agreed with the management’s decision to hire 16.9 percent of workers as non-​ regular workers in 2000.22 In 2017, Kia Motors’ union conducted a referendum asking its members whether they agreed with the “one union per one company” principle, which was in reality an attempt to block the formation of non-regular workers’ unions.23 In 2021, the union of the National Health Insurance Service opposed the conversion of the dispatched workers in the call center into directly employed regular workers, based on poll results where 75.6 percent of the union members opposed the move.24 Union members opposed the move out of concern that their own benefits would be undermined by the conversion. The country tried to address the problems of labor market dualism as well as the factor share of income by creating a new social compact. In spite of the collapse of the 2.6 Compact in 1998, the Tripartite Commission survived. Even the conservative governments of Lee Myung-bak and Park Geun-hye tried to utilize it as a channel to draw a consensus between employers and workers. In the wake of the 2008 crisis, the Tripartite Commission drew up a new social compact on February 23, 2009. However, the Tripartite Commission could do little about labor market dualism. The Tripartite Commission made efforts to draw up another social compact during the Park government period, but they proved unfruitful as the Park government unilaterally tried to make it easier to fire regular workers. The Moon Jae-in government devoted many efforts to create a new social compact. It restructured the Tripartite Commission by extending the participants to include representatives of non-regular

22 23 24

www.laborplus.co.kr/news/articleView.html?idxno=4322. Hankyoreh April 12, 2017. www.hani.co.kr/arti/society/labor/993675.html.

388 The Tortuous Path of South Korean Economic Development workers, youths, and women, renaming the commission the Economic, Social, and Labor Council. Its success depended much on the participation of the KCTU, which had the legitimacy of having led the independent union movement and controlled more of the larger workplaces of chaebol firms and the public sector. KCTU’s membership rose with the Moon government’s conversion of non-regular and dispatched workers of the public sector into regular workers. The KCTU briefly joined the council but walked away quickly after disputes developed with the government over the issues like minimum wages. The KCTU has an inherent problem in that its decentralized decision-making system makes it virtually impossible for the leaders to agree on behalf of the member unions. In 2020, the KCTU refused to join the social dialogue in the council to cope with the coronavirus crisis. It then waged mass demonstrations, ignoring the quarantine rules created in response to the pandemic, almost completely alienating itself from the public. Given such an attitude of the KCTU, even the Moon Jae-in government had to go with only the FKTU as a partner. The FKTU now is not the same as it was in the authoritarian era and the early days of democratization. Over the years, the leadership of the FKTU and most of its member unions, partially in a bid to compete with the KCTU, have become far better defenders of workers’ interests. Still, whether it has completely shed its past legacy is questionable. Overall, a social compact drawn up with the FKTU alone as a partner is unlikely to work. In the end, the Moon government failed to draw up a social compact. The Yoon Suk Yeol government (May 2022–present) has been far less friendly to unions. It appointed an extreme-right politician as chairman of the Economic, Social, and Labor Council. The FKTU complained that the council set agendas for labor reform without its participation. In February 2023, the FKTU and the KCTU agreed to jointly resist the Yoon government’s anti-labor policies.25

25

news.mt.co.kr/mtview.php?no=2023021510404738713

Inequality, Jobs, and Welfare 389

11.4  The Welfare System After the 1997 crisis, while inequality widened and jobs became scarcer, the welfare system was strengthened to bear the brunt of the burden of reducing inequality and easing social conflict. The government expenditure on welfare, defined as health and social protection, shot up from 4.0 percent in 1997 to 6.1 percent in 1999 and fell to 5.2 percent in 2000. However, it crawled up subsequently, as shown in Figure 5.3. South Korea began its HEG with a low share of its expenditure on welfare and a high share of its expenditure on economic affairs, but now the former has come to outnumber the latter. The expenditure on welfare began to clearly outnumber the expenditure on economic affairs in 2006, and the gap between the two widened subsequently, as shown in Figure 5.3. In 2020, welfare expenditure amounted to 14.9 percent of GDP, dominating the expenditure on economic affairs that stood at 5.8 percent of GDP. Welfare expenditure rose first because the social insurance programs installed earlier matured. The 1997 crisis also provided momentum to strengthen the welfare system, as explained in Chapter 8. South Korea continued to reinforce the welfare system after the crisis was over. As shown in Figure 11.1, the rising redistribution through welfare expenditure offset the rising inequality of market income after the crisis; then, the rising redistribution through welfare led to the falling inequality in disposable income as the inequality in market income peaked out or leveled off. Yet South Korea’s welfare expenditure still falls short of the OECD average, which stands at about 21 percent of GDP. The shortage reflects the poor coverage coming from the short history and incompleteness of the welfare system. At the same time, the welfare system has a longrun sustainability problem, especially because of the aging of the population.

Coverage The poor coverage is a historical legacy. The social insurance programs began with large private enterprises, public sector, and

390 The Tortuous Path of South Korean Economic Development semi-public sector, and then were gradually extended to other sectors. The 1997 crisis provided momentum to extend the coverage, but it could not solve the problem overnight. The deepening of the labor market dualism has made it difficult to extend the coverage subsequently. It is not easy to bring SMEs’ workers, non-regular and dispatched workers, the self-employed, and the newly emerging platform workers under the coverage of the social insurance programs. Many of them are too poor to afford the fees; they are also often out of the government executive power. The government began to subsidize the insurance fees for such people in 2012, but there are still many people without coverage. The coverage of employment insurance rose consistently, and by 2021, 75.9 percent of wageworkers were contributing to the employment insurance. However, while 90.9 percent of regular workers were contributing, only 52.6 percent of non-regular workers were contributing. The self-employed and platform workers rarely contributed. The coverage of pensions also rose consistently, but they also have a coverage problem stemming from the labor market dualism. In 2021, 69.4 percent of wageworkers eligible for the national pension, handled by the NPS, through the workplace were contributing to the NPS; however, while 88.4 percent of regular workers were contributing to the NPS, only 37.9 percent of non-regular workers were contributing to the NPS.26 The ratio was much lower for those who were ineligible through the workplace and thus had to buy membership to NPS regionally. Pensions have the additional problem of the benefits being too small. Retired government employees, military personnel, and private school teachers receive sufficient benefits due to their longer history of pensions (They were launched in the 1960s and 1970s). However, they account for only approximately five percent of retired workers. The history of NPS is shorter, which means that the period of contribution is also shorter, so the payment received is insufficient



26

kosis.kr/statisticsList/statisticsListIndex.do?vwcd=MT_ZTITLE&menuId=M_01_01

Inequality, Jobs, and Welfare 391 to cover the living costs of retirees. In 2021, the average payment to the recipients of the NPS was a mere 15.7 percent of the average wage of the working population.27 As it turned out to be difficult to extend the coverage of the NPS, in 2008, the government introduced the Basic Old-Age Pension to distribute benefits to the elderly regardless of contribution to the NPS. In 2021, it provided about 9.2 percent of the average wage to around 70 percent of the people aged 65 or more. The NPS and the Basic Old-Age Pension thus spread resources very thinly over a large segment of the older population. The result is a very high rate of poverty among the elderly, though it is gradually falling. In 2020, 38.9 percent of the population aged 65 and over lived in relative poverty (defined as having disposable income lower than 50 percent of median income per capita). The ratio was by far the highest among the OECD countries.28 Health insurance has suffered from a different kind of coverage problem. It covered the whole population, but the coverage of expenses was limited as it had been launched as a low-contribution, low-benefit program unable to cover diseases that were costly to treat. The coverage ratio then rose gradually to reach 65.0 percent by 2007. However, the Lee Myung-bak government reduced the ratio to 62.0 percent by 2013, and it more or less leveled off under the Park Geun-hye government. The ratio rose again during the Moon Jae-in government, reaching 64.5 percent in 2021.29 But it has a long way to go to catch up with other advanced countries’ coverage ratios, which stand at well over 80 percent. When the coverage was retrogressing under the Lee and Park governments, some health insurance for the well-to-do was privatized. The new conservative government of Yoon Suk Yeol has declared that it will roll back the Moon government’s policy to raise the coverage ratio. The weak role of social insurance for those who truly need it makes the public assistance programs more important. The Kim

27 28 29

The NPS statistics are from kosis.kr, and the wage data are from idex.go.kr. stats.oecd.org/Social Protection/Income Distribution and Poverty. index.go.kr/unity/potal/main/EachDtlPageDetail.do?idx_cd=2763

392 The Tortuous Path of South Korean Economic Development Dae-jung government drastically reinforced these programs by enacting the National Basic Living Security Act in 2000. The aged, disabled, and single-parent families mainly receive assistance from this program. After the initial surge, however, the coverage of the program stagnated. The main obstacle was the eligibility criteria based on the “family support obligation rule.” Those people with family members (which was defined too broadly) with income beyond a certain threshold could not receive the payment. The recipients of the program stood at 3.1 percent of the population in 2017, a slight fall from 3.2 percent in 2001. Then, the Moon Jae-in government made efforts to abolish the eligibility condition in earnest to raise the number of recipients to 4.6 percent of the population by 2021.30 Another public assistance program is the Earned Income Tax Credit system to help the working poor. The Roh Moo-hyun government introduced the system for the first time among Asian countries. It went into effect from 2008 and was then gradually expanded. The Moon Jae-in government greatly strengthened the program, with the subsidies to the working poor amounting to 0.21 percent of GDP in 2021.31 Overall, the coverage of welfare system has been extended consistently, but it still falls short of the coverage in other advanced countries, and those who need social protection most often lie outside of the coverage.

Sustainability South Korea’s welfare system has also a serious sustainability problem. The main source of the problem is the long-term insolvency of pensions. Pensions except for the Basic Old-Age Pension (financed by current government revenue) have a fully funded system with defined benefits. They were initially planned in an unsustainable way and became more so after the crisis due to the slowdown of growth and the aging of the population.



30 31

index.go.kr/unity/potal/main/EachDtlPageDetail.do?idx_cd=2760. index.go.kr/potal/main/EachDtlPageDetail.do?idx_cd=2826.

Inequality, Jobs, and Welfare 393 Pension programs with longer histories faced insolvency problems earlier. The pension funds for military personnel and government employees have been exhausted, with the benefit now being supported by the general account of the government budget. Pensions for government employees and private school teachers have gone through some reforms, but they have fallen short of ensuring longrun sustainability. A far bigger problem lies with the NPS, which is beyond comparison with other pensions in size. The NPS was also planned in an unsustainable way originally, setting contribution at three percent of income and benefit at 70 percent of average lifetime income. The government raised the contribution rate to nine percent in 1998 but further attempts to raise it has been frustrated so far. Promised benefits were scaled down to 60 percent in 1999; in 2007, the government decided to gradually reduce the rate to 40 percent by 2028. The eligibility age has also been planned to be gradually raised from 60 to 65 in 2033. NPS will become insolvent in the long run with the current rate of contribution and benefit. Even with the cut in the income replacement rate to 40 percent and the planned hike in the pension eligibility age to 65, NPS expenditure is set to rise faster than revenue. However, reforming the NPS has been politically difficult. Without reforms, pension expenditures have to be supported by the general account of the government budget, which is already being done for the pensions for military personnel and government employees. It will be unfair because the beneficiaries of pensions are relatively well-to-do people. In the case of the NPS, it is also practically impossible to finance its expenditure by general account because of its sheer size. Moreover, the general account is already in deficit, accounting for the major part of the deficit in the “management account” mentioned in Chapter 9. The deficit in general account mainly comes from the increase in government welfare expenditure. The general account took care of the depletion of the pension funds for military personnel and government employees. Many welfare programs introduced after the 1997 crisis, including the assistance by

394 The Tortuous Path of South Korean Economic Development the National Basic Living Security Act (2000), Earned Income Tax Credit (2008), Basic Old-Age Pension (2008), and subsidizing social insurance fees for the poor (2012), were designed to be financed by the general account. Meanwhile, no consistent efforts have been made to raise taxes. The Roh Moo-hyun government raised taxes, but the Lee Myung-bak government cut them; the Park Geun-hye and Moon Jae-in governments raised taxes, but the Yoon Suk Yeol government is cutting them. The deficit in general account is thus the main source of the rising government debt. This can be identified by the trend and composition of government debt. Figure 11.5 presents government debt and the composition of its sources as a percentage of GDP. Government debt is classified into deficit-originated and financeoriginated, depending on whether the debt has a counterpart asset. The first source of deficit-originated debt is the general account. The 50.0 45.0 40.0 35.0 30.0 25.0 20.0 15.0 10.0 5.0

General   account   deficit

Public  fund   converted Foreign exchange     stabilization

20 21

20 19

20 17

20 15

20 13

20 11

09 20

20 07

20 05

03 20

20 01

19 99

19

97

0.0

Housing   stabilization

Figure 11.5  The sources of government debt as a percentage of GDP, 1997–2021 Source: Index.go.kr.

Inequality, Jobs, and Welfare 395 second source is “the public funds converted,” representing the debt incurred through the public funds mobilized to cope with crises. The first source of finance-originated debt is “foreign exchange stabilization,” representing the fund borrowed to intervene in the foreign exchange market. The second source of finance-originated debt is “housing stabilization,” representing borrowing for the purpose of building housing for the poor. South Korea still has one of the lowest government debt ratios among the OECD countries, but the ratio is rising. It stood at as low as 11.1 percent of GDP in 1997 but rose to 47.3 percent of GDP in 2021. Among the four major sources of the government debt, two – the public funds converted and housing stabilization – are shrinking as a percentage of GDP after rising earlier, so they are not seriously undermining the long-run fiscal soundness. South Korea spent about 25 percent of its GDP as public funds (raised through the bonds issued by agencies like the Korea Asset Management Corporation with the government’s guarantee) to shore up the financial sector after the 1997 crisis. The government also put public fund about two percent of GDP into the savings bank loan crisis in 2011. The government converted the public funds into its own debt later. By the end of 2021, the converted public funds accounted for 3.4 percent of GDP. The eventual impact of the public funds on government debt was far smaller than the original size of the public funds because of some recuperation of the funds; more importantly, they were one-shot measures whose impact tapered off as the interest rate on the public debt was lower than the growth rate of the economy. The weight of the debt originating from supplying housing for the poor also fell, as the pace of urbanization slowed. The other two sources – deficit in the general account and foreign exchange stabilization  – are rising as percentages of GDP, so they are the real threat to long-run fiscal soundness. Between the two, foreign exchange stabilization is an inevitable source of government debt as South Korea has to continue intervening in the foreign exchange market. The government issues the “foreign exchange

396 The Tortuous Path of South Korean Economic Development stabilization bond” for that purpose. The debt has the international reserves as a counterpart asset. This leaves the deficit in the general account as the most problematic source of the government debt. It was 0.0 percent of GDP in 1997 but rose to 26.4 percent of GDP by 2021. Overall, South Korea’s welfare system is facing a big fiscal challenge. Extending the coverage to those who need social protection most will need more government revenue. To make the social insurance programs sustainable, the government has to collect more contributions or cut benefits. If it fails to reform the social insurance system, the general account, already under strain, will have to bear the burden. The challenge is becoming ever more serious because the population is aging rapidly.

The Challenge of the Demography Population aging is a serious threat to the welfare system as it means fewer and fewer working people to support more and more elderly people. The population is aging because the fertility rate is low. Low fertility rate is common in high-income East Asian economies, but South Korea has a particularly low fertility rate. The country can cope with the problem by prolonging the retirement age, raising women’s labor force participation rate, and easing immigration, but those measures will have only limited effects. South Korea had a high fertility rate earlier, like most developing countries. The fertility rate fell quickly subsequently. Total fertility rate (TFR), which had fallen below the reproduction rate of about 2.1 by 1983, fell further to 1.53 in 1987; it rose to 1.76 in 1992, but fell again to 1.54 in 1997. Then, the TFR nosedived with the 1997 crisis. The massive layoffs under the poor social safety net lowered the TFR, as did the rising share of non-regular and dispatched workers.32 In 2005, the TFR hit 1.08, the lowest among the OECD countries.33 The



32 33

Chung (2013). data.oecd.org/pop/fertility-rates.htm.

Inequality, Jobs, and Welfare 397 TFR then recovered somewhat, apparently as the shock of the 1997 crisis subsided. However, the rate fell again from 2016 to reach 0.98 in 2018, making South Korea the only OECD country with a TFR below 1.0. It fell further to scaring 0.78 in 2022.34 The government failed to recognize the low fertility rate as a problem for two decades after the TFR fell below the reproduction rate. Only in the mid-2000s did it recognize low fertility rate as a problem and try to raise it. The closest measure representing the government’s efforts to raise TFR is the “total public expenditure on families.” South Korea’s total public expenditure on families rose from 0.2 percent of GDP in 2001 to 1.4 percent of GDP in 2018 – the steepest among the 32 OECD countries providing the data. In 2018, 1.4 percent for South Korea was higher than the figures for the United States, Mexico, Greece, and Turkey but lower than the figures for most European countries (France led with 3.7 percent).35 The Moon Jae-in government tried to raise the expenditure, but it managed to do so only marginally after meeting the stiff resistance of the bureaucracy that prioritized fiscal soundness. It is unclear how much the government’s efforts contributed to the reversal of the declining trend of the TFR after 2005. It is clear, however, that the efforts failed to prevent the renewed fall of the TFR from 2016. There are few studies explaining the renewed fall of the TFR from 2016. One may speculate that the female population born in the mid-1980s, when the TFR dropped below 2.1, was entering the age cohort of the early thirties that is most productive. The rise of housing prices may also be responsible. If the current trend continues, the South Korean population will be aging the fastest among the East Asian countries. As a result, the  old-age dependency ratio will rise sharply. Figure 11.6 presents the old-age dependency ratio, the young-age dependency ratio, and  the total dependency ratio projected by the NSO to 2070. The



34 35

index.go.kr/unify/idx-info.do?idxCd=5061. stats.oecd.or/Social Protection and Well-being/Family Database.

398 The Tortuous Path of South Korean Economic Development 180.0 160.0 140.0 120.0 100.0 80.0 60.0 40.0 20.0

Young age

Old age

70 20

60 20

50 20

40 20

30 20

20 20

10 20

00 20

90 19

80 19

70 19

19

60

0.0

Total

Figure 11.6  Dependency ratios, 1960–2070 (percent) Source: Calculated from the data in kosis.kr.

total dependency ratio fell drastically into the 1990s mainly due to the falling young-age dependency ratio; it more or less leveled off in the 2000s and 2010s, but it is rising sharply from the 2020s because of the rising old-age dependency ratio. The rising total dependency ratio will undermine fiscal soundness by reducing the tax base relative to welfare expenditure. The difficulty is that the low TFR is the result of the whole economic and social system, which produces job scarcity, labor market dualism, high education costs and housing prices, intense competition through educational credentials and merit-based examinations, and the weakness of the social safety net. Gender problems are also responsible. Having children works as a disadvantage for the career of female workers; long working hours and high work intensity for pregnant female workers often cause miscarriage; wives have to bear the major burden of housekeeping even when both spouses work while the childcare services are in short supply. The low TFR is also the result of the changes in social atmosphere that make

Inequality, Jobs, and Welfare 399 the youths feel less necessity of marriage, while the social norms still do not approve out-of-wedlock births. Unless such conditions change simultaneously, increasing the family benefit in piecemeal will have only a marginal effect on the TFR while undermining fiscal soundness. This indeed seems to have happened in the last two decades or so.

12 Questions for the Future

What is the future prospect of the South Korean economy? It will first depend on how the country deals with the problems it is currently facing, mentioned in the previous three chapters. The immediate future will be decided first by how well the country carries out the disinflation policy without incurring systemic risk in the financial market. If things go badly, it may repeat the Japanese experience of the sudden burst of an asset bubble and the ensuing stagnation of the economy. It is also possible that the deflation threat may come back after inflation is brought under control. The country has to cope with foreign exchange market risk as well. Even if the country avoids a sudden capital outflow in the disinflation process, it will still face inherent uncertainty regarding capital flows without an institutionalized lender of last resort. The coronavirus crisis and the ensuing disinflation process showed that the macro-prudential measures introduced in 2010 were not enough to stave off sudden capital outflows. The country may pursue financial globalization further, but striking a balance between liberalization and regulation will continue to remain an issue. Even if it wards off those threats successfully, the country will still have a long way to go to catch up with the world’s most advanced countries, like the United States. The most important threat in this regard is the aging of the population. The aging of the population threatens not only the growth of the whole economy but also per capita product by reducing the ratio of working-age population. It will further slow growth if it undermines fiscal soundness. Painful structural adjustment will follow with the hollowing out of towns and cities, not to mention villages; schools and colleges will have to restructure themselves as they face a shortage of students. These 400

Questions for the Future 401 changes are already occurring in a large scale but will accelerate in the future. The TFR, the prime source of population aging, is not easy to raise. To raise the TFR, the country needs to tackle all the conditions leading to a low TFR simultaneously, which is a daunting task. It would have to undergo thoroughgoing reform because the whole economic and social system is responsible for low TFR. The country would be able to offset the effect of population aging by raising the productivity of the working-age population, which will mainly depend on whether it can transform the structure of the technology economy through investment in future-oriented, high-​ industries. In this regard, the new technologies, centered on artificial intelligence, big data, 3D printing, fully automated vehicles, robotics, the Internet of Things, and so on, provide both an opportunity and a challenge. As long as the new technologies are the outgrowth of the ICT, South Korea, having made a head start with ICT, is in a good position to capture the opportunities offered by them. However, some developing countries may jump into newly emerging industries, enjoying the latecomers’ advantage, as South Korea did with the ICT industries in the 1990s. China has indeed done so, already surpassing South Korea in some areas, particularly where the availability of big data and economies of scale determine competitiveness. At the same time, the United States maintains leadership in producing source technologies. South Korea will have to work hard to find niches in a world dominated by the United States and China. Private enterprises will be largely responsible for the innovations in the new technologies, but industrial policy will also matter. The government needs to engage more university professors in R&D efforts to enhance industrial competitiveness and upgrade the quality of science and engineering students. It should make efforts to reverse the brain drain again. Sustaining the rise of cultural industries and reforming the regulated service industries are also important. The government should reform chaebol, encourage the growth of startups, raise the productivity of SMEs, and induce more FDI in hightechnology industries.

402 The Tortuous Path of South Korean Economic Development New technologies are likely to widen inequality as they tend to be skill-biased and capital-intensive. They are also likely to create an extensive jobs problem, as existing jobs will disappear and new jobs will appear massively, creating insecurity for the majority of the population. Rising inequality and insecurity will pose a major challenge to the country, particularly since, after the 1997 crisis, inequality widened significantly (though they peaked out later) and insecurity skyrocketed due to the increase of non-regular workers. It is important to resolve labor market dualism. The falling gap in the labor productivity between large enterprises and SMEs, going on from the mid-2010s, must continue. Labor market policies will also matter. In the long run, the country will have to make it easier to fire regular workers in the face of rapidly changing technologies. However, it will be difficult to do so without strengthening the social safety net, which will quickly invoke the fiscal question. In the near future, the rise of the labor share of income made during the Moon Jae-in government may be reversed under the Yoon Suk Yeol government, widening inequality, while the weakening of union power may help to narrow the wage gap between regular workers of large enterprises and other workers. The country must bring real estate speculation, the main mechanism to transfer wealth to the rich, under control. The country needs to expand the coverage of the welfare system but it will invoke fiscal sustainability question. The Yoon government is trying to retrench welfare expenditures that rose during the Moon government, while cutting taxes for the rich and large corporations. The National Assembly, under the control of the more liberal opposition, is putting some brakes on the move, so the stalemate or compromise is the likely picture in the near future. The Yoon government says it will reform the pension system, without proposing a detailed plan until the time of this writing on March 29, 2023. In the longer run, the country will have to address the need to expand the social safety net in the face of the rising uncertainties and insecurities the new technologies will bring about, while

Questions for the Future 403 addressing the fiscal sustainability problem that will interact with the low TFR. These are indeed a daunting task to deal with. However, it is about how to sustain the HEG that began in the mid-1960s, though growth has greatly decelerated over the years. Meanwhile, the country is facing a fundamental change in the international environment that made the HEG possible, discussed in Chapters 3 and 4. Such a “tectonic shift” of the environment is a challenge South Korea has not faced so far. It may thus be necessary to hark back to the long-run history discussed in Chapter 2.

12.1  The Changing International Environment South Korea has incessantly faced changes in international environment since the HEG began. In the mid-1980s, the country had to adapt to US demand to open up the domestic market and reduce subsidies. In the 1990s, it failed to adapt to the new conditions formed by financial globalization and the ending of the Cold War and underwent the 1997 currency crisis. Since the 2000s, the country has faced the deterioration of the multilateral trade order, represented by the stalling of the Doha Round. To cope with the situation, the country began to aggressively conclude free trade agreements. At the time of this writing on March 29, 2023, South Korea has 21 effectuated free trade agreements with 59 economies, including the United States, China, and the European Union, the three largest economies in the world. The country has signed or is currently negotiating free trade agreements with more than 20 economies.1 It was quick in negotiating its free trade agreement with Britain after the Brexit decision was made. It is also active in joining regional integration organizations. However, the country is now facing changes more fundamental than ever since the HEG began. The first of such changes is associated with climate change. This book did not discuss environmental issues, despite the fact that sustainability was its main subject. The

1

www.fta.go.kr/main/situation/kfta/ov/

404 The Tortuous Path of South Korean Economic Development country experienced serious environmental degradation in the initial phase of the HEG, but the environmental problem improved as the HEG continued. Environmental problems have not constrained growth; they are unlikely to do so in the future for South Korea as an individual country. However, climate change appears to pose an existential threat to humanity in the long run, which the country cannot escape. More realistically, the country may face international actions beyond its control to combat the negative effects of climate change. The signal about international actions, especially from the United States, has been inconsistent and confusing; however, international actions led by private as well as public initiatives are being taken and are likely to be strengthened in the near future. South Korea will have a particularly hard time adjusting to such actions because the country significantly lags behind other advanced countries in “green growth.” This is because its industrial structure is energy-intensive. South Korea’s GDP per unit of energyrelated CO2 emissions (2015 US dollars per kilogram) was 3.84 in 2021, lower than Japan’s 5.15 and the United States’ 5.46, which were themselves lower than European countries’. The country also lags behind in green energy supplies. Renewable energy supply as a percentage of total energy supply was a mere 2.13 percent in 2021, far lower than Japan’s 7.07 percent and the United States’ 8.00 percent, not to mention the European countries’.2 The Moon Jae-in government’s Green New Deal policy was a belated effort to move to green growth, which apparently produced not-so-meaningful results. The Yoon Suk Yeol government has not shown much interest in green growth thus far. Green growth is a real challenge for South Korea in the future, which is beyond the scope of this book. However, the conditions that have been discussed in the book are also changing in a more fundamental way than ever since the HEG began. The first of such changes is the stagnation in the “center” of the world economy,

2

The numbers are from stats.oecd.org.

Questions for the Future 405 composed of the original advanced countries from 1945. They went through the golden age of capitalism after experiencing the crisis in the first half of the twentieth century, which involved two great wars and the Great Depression. The golden age of capitalism was one basic underlying condition for South Korea’s head start in the HEG, as mentioned in Chapters 3 and 4. The growth of those original advanced countries slowed down with the end of the golden age of capitalism around 1973, but it slowed down further with the 2008 crisis. According to the Maddison project, the per capita GDP in PPP (based on 2011 prices) of the United States, the productivity leadership country, averaged 0.78 percent during the 11 years from 2008 to 2018, the last year data are available. To find the latest 11 years with an average growth rate of per capita GDP lower than 0.78 percent, one has to go back to the period from 1930 to 1940, composed mainly of the years of the Great Depression. In the case of Japan, one has to go back to the average for the 11 years from 1945 to 1955, which includes the −23.6 percent in 1945, the last year of the Second World War. The same is true for most other original advanced countries: To find the 11 years that recorded a lower average growth rate of per capita GDP than the 11 years from 2008 to 2018, one has to go back to the period including at least one year from the First World War to the Second World War. Thus, the original advanced countries are in a phase of stagnation never seen after the crisis period in the first half of the twentieth century. This would become more pronounced if one compared the 15 years from 2008 to 2022 with the previous 15 years, considering that the pandemic from 2020 and Russia’s invasion of Ukraine in 2022 have had a significant negative effect on the growth rates per capita GDP from 2020 to 2022. If the stagnation in the center economies continues, it will not help South Korea sustain growth, not only because it will provide less market, capital, and technologies but also because it will interact with the deterioration of the international economic order (more on this below).

406 The Tortuous Path of South Korean Economic Development The world economy shows a somewhat different picture, owing to the catch-up growth of developing countries. The growth rate of the per capita world GDP compiled by the World Bank averaged 1.50 percent during the 12 years from 2008 to 2019, the year before the pandemic. To find the latest 12 years with an average growth rate of per capita GDP lower than 1.50 percent, one has to go back only to the period from 1991 to 2002.3 This mainly reflects the massive contribution China has made to the growth of the world economy in the last quarter century or so. The growth of other developing economies, such as India and the ASEAN countries, has also helped. The rise of the Chinese economy provided a great opportunity for South Korea, as China was close geographically and culturally. It provided a new market for exports and was responsible for the surge in the investment rate in the mid-1990s. Exports to China helped the country to recover from the 1997 crisis. China became South Korea’s largest trade partner in 2004, and China’s massive boosting of the economy helped the country to cope with the 2008 crisis better. Yet the most remarkable benefit from China’s rise has been a trade surplus. A trilateral relationship involving South Korea, China, and the United States, similar to the one involving South Korea, Japan, and the United States formed in the 1960s, came into place. South Korea exported machinery, components, parts, and materials to China, which China used to manufacture goods for export, mainly to the United States. Exports to China’s domestic market became more significant later, but the structure remained unchanged. As a result, South Korea consistently recorded a trade surplus with China, just as Japan had done with South Korea since the 1960s. From 1998 to 2022, China accounted for 84.9 percent of Korea’s trade surplus (measuring exports in free on board and imports in cost, insurance, and freight), which was equivalent to 67.2 percent of the current account surplus during the same period.4



3 4

data.worldbank.org/indicator/NY.GDP.PCAP.KD.ZG. Calculated from kosis.kr.

Questions for the Future 407 China may continue to contribute to the growth of the world economy, from which South Korea may continue to benefit. However, China is becoming a formidable competitor in the world market. China is rapidly catching up in technological capability and has surpassed South Korea in some areas. This has recently manifested itself in a sharply shrinking trade surplus. As late as 2018, the ratio of imports from China to exports to China was 65.7 percent, which was not particularly high or low compared with previous years. However, the ratio rose to 78.7 percent in 2019, 82.1 percent in 2020, 85.1 percent in 2021, and 99.2 percent in 2022. The jump in the ratio in 2022 may reflect the relative stagnation of the Chinese economy due to the coronavirus lockdown. However, the continuously shrinking trade surplus reflects China’s catch-up in technological capability, which is revealed in the changing composition of trade items. South Korea’s exports to China are increasingly concentrated within a narrow range of high-technology products like semiconductors as lowertechnology products lose competitiveness. At the same time, China’s exports to South Korea are increasingly composed of high-technology products, particularly components, parts, and materials.5 A shrinking trade surplus with China is distressing, as it contrasts with the persistent trade deficit with Japan. South Korea’s imports from Japan were 178.6 percent of exports in 2022, which was little improvement over the 2010s; especially, it was virtually no improvement over the 178.9 percent in 2018, the year before the Abe cabinet imposed sanctions on chemicals for semiconductor production and South Korea accelerated the efforts to substitute those chemicals and similar import items from Japan. Nobody has explained exactly why the trade surplus with China is rapidly shrinking while the trade deficit with Japan persists. However, it is likely the result of the weakness of South Korea’s SMEs in producing components, parts, and materials. Improving their productivity remains a big question for the country’s economy.

5

Kim and Cheon (2022).

408 The Tortuous Path of South Korean Economic Development ASEAN countries and India may provide a new source of growth and trade surplus for South Korea; the government and business community are fully aware of that. However, it will be far more difficult to take advantage of those countries’ growth than China’s because they are farther away geographically and culturally. South Korea is offsetting the shrinking trade surplus with China by expanding its trade surplus with some ASEAN countries. In 2022, the country recorded its largest trade surplus with Vietnam. It also recorded a trade surplus with India. Yet it remains questionable whether these countries can fully replace China as the source of South Korea’s growth and trade surplus. The overall trade balance turned into a deficit in 2022, the second time since 1998 (There was a small deficit in 2008). At the time of this writing in March 2023, trade deficit is expanding rapidly. Whether this is a temporary phenomenon or represents a structural change remains a question. It may be a temporary phenomenon brought about by the rise of energy and food prices with the war in Ukraine, the coronavirus lockdown of the Chinese economy, and the adverse market condition for semiconductors, South Korea’s major export item. On the other hand, the shrinking trade surplus with China is most likely structural, affected not only by changing technological conditions but also by changing political  – international and domestic – conditions (discussed below). If the trade deficit persists, South Korea will find it difficult to maintain its current account surplus. The current account surplus shrank drastically in 2022: it had hovered around three to seven percent of GDP for ten years from 2012 to 2021 but fell to 1.8 percent of GDP in 2022 (See Appendix 1). The main factor to offset the trade deficit now is the surplus in investment income. Net investment income turned positive in 2010 and increased to 1.4 percent of GDP in 2022.6 However, the offsetting role of net investment income is limited. The NIIP in 2022 was no more than 44.9 percent

6

Net investment income is from ecos.bok.or and trade deficit is from kosis.kr.

Questions for the Future 409 of GDP; moreover, international reserves, composed of low-risk, low-return assets such as US Treasury Bills, accounted for 25.4 percent of GDP (See Appendix 2). If the country’s current account goes into deficit, the NIIP will deteriorate accordingly. When the capital market is fully open, the expectation that such a thing may happen in the near future can threaten the stability of the foreign exchange market.

12.2  The New International Political Economy South Korea is also facing the slowdown of globalization and the deterioration of the international economic order, which are intertwined with the stagnation of the center economies and the rise of China. Globalization slowed or reversed with the Great Recession; the volume of world trade as a percentage of world GDP, compiled by the World Bank from 1970, peaked at 61.0 percent in 2008 but fell to 56.5 percent in 2021, after several fluctuations. Other postwar slowdowns pale in comparison with this slowdown, as the previous longest slowdown was a dip between 1981 and 1989.7 The slowdown of globalization in the 1980s may be related to the United States’ trade disputes with Japan and European countries. In those disputes, the United States used unilateral measures. However, as mentioned in Chapter 6, the United States did so mainly on the ground of restoring the original reciprocity principle of the GATT. The consequences of the unilateral measures also turned out to be the strengthening of the multilateral trade order, with the launch of the WTO in the end. However, this time around, the United States is taking unilateral actions that are most likely to lead to the breakdown of the rulebased order. It began with the Trump administration’s protection of smokestack industries, as imports, mainly from China, depressed rust belt workers’ living conditions. However, the Biden administration is accelerating the unilateral actions by implementing an aggressive

7

data.worldbank.org/indicator/NE.TRD.GNFS.ZS.

410 The Tortuous Path of South Korean Economic Development industrial policy to subsidize domestic production of high-​technology manufacturing industries. Biden’s policy is far more threatening to South Korea, as the production of semiconductors, batteries, and electronic vehicles may move to the United States. The United States also demands Korean semiconductor producers not to export high-technology products to China, and not to invest in the production of high-technology products in China. If Europe follows suit, the country may face hollowing out of high-technology manufacturing industries. Populism is rising in the center countries, interacting with their stagnant economies to undermine the rule-based order. Though China and other developing countries are offsetting the stagnation of their economies globally, it is not helping to keep the rule-based order from deteriorating. Just the opposite is true, as shown by the rise of populism in the rust belt of the United States. However, more critical is that China’s rise poses a challenge to US hegemony, the very foundation of the capitalist world order after the Second World War. In fact, the United States’ demand for semiconductor producers stems from China’s challenge to the US hegemony. China grew rapidly by integrating itself with the world capitalist economy since the 1970s, accepting the existing international economic order based on the US hegemony. It benefited much from the second globalization, as Japan and South Korea had done earlier. However, China now wants to change the rule itself, challenging the US hegemony. In the last 70 years or so, the challenge to the US hegemony has been repeatedly talked about. The challengers or potential challengers, including the Soviet Union, Japan, and the European Union, have all failed; now China is emerging as a new candidate. China is still a developing country with per capita product far smaller than the United States’, but hegemony is a political phenomenon involving “national power,” for which total product rather than per capita product matters. China also has developed technological capability far stronger than what its per capita product suggests. China is thus the most formidable challenger so far.

Questions for the Future 411 The rise of China is having an impact all over the world, but it is the greatest in East Asia. The change in East Asia is comparable to the one that occurred with the emergence of the West earlier in history. In the long-run perspective, the “great convergence,” that is, the reversal of the great divergence discussed in Chapter 2, is now occurring. Japan and South Korea went through the convergence with the West earlier, but the rise of China signals the real great convergence, considering that China had led the world before the great divergence; China also dominates Japan and South Korea in size. As the great divergence created a tectonic shift of the international order in East Asia in the nineteenth century, the great convergence is creating another tectonic shift in the twenty-first century. One major difference is that, while the declining Qing Dynasty ruled China then, the People’s Republic of China is a rising power now. Another major difference is the involvement of the United States in East Asia as the incumbent hegemon, making East Asia the frontier of the hegemony contest between the United States and China. The hegemony contest is unlikely to employ the same imperialist tactic as in the nineteenth century, but that does not change the fact that East Asian countries face another tectonic shift. All of East Asia is the arena of the hegemony contest, with the Taiwan Strait and South China Sea being the focus of current tension. However, Northeast Asia, where the heart of Chinese politics lies and the United States has two military allies in Japan and South Korea, may be the real center of the contest. The US strategy toward the region has lacked consistency, as Donald Trump showed more interest in extorting money from Japan and South Korea as a price for protecting them. However, a more consistent strategy by mainstream political forces of the United States has been consolidating an alliance to counter China. China will seek its own allies or try to neutralize the alliance. South Korea’s position is especially perilous in such a situation as it critically depends on the United States for defense, while it heavily depends on China economically. It has the additional task

412 The Tortuous Path of South Korean Economic Development of dealing with North Korea, the sole Stalinist regime to survive the end of the Cold War, which has now developed nuclear weapons. The essence of coping with the new challenge for South Korea is managing its relationships with the great powers. It has always been important, but this time, it seems critical. This subject needs many more books to cover it, but it is imperative to discuss the subject here, however briefly.

12.3  South Korea and the Great Powers The relationship with the United States has dominated South Korea’s international relations since 1945. Overall, it has been a great success story, in spite of many unhappy incidents. The international order under the US hegemony has been the best one for the country historically – far better than the tributary relationship with China, not to mention the imperialist scramble led by Europe or the harsh colonial rule by Japan. Under the US hegemony, South Korea has achieved independence, economic development, and democratization. The basic underlying condition for the success story is the position of the United States as the global hegemon with no territorial interest in East Asia. South Korea is a country that greatly needs US involvement in the region, given its relative weakness compared to its far stronger neighbors. Another important condition is the sharing of values, notably democracy, which South Koreans value dearly. A fundamental change is thus unlikely in the near future, as long as the United States sees South Korea as a valuable ally in checking China’s ascendancy. South Korean people also support the alliance with the United States. Poll after poll show that the majority of South Koreans support the continued presence of US troops on their soil, not to mention the Mutual Defense Treaty.8 Still, there are lingering questions. The first is the sovereignty problem. Sovereignty is limited for all countries under the asymmetric alliance with the United States, but the US operational

8

www.seoul.co.kr/news/newsView.php?id=20180510005003.

Questions for the Future 413 control of the armed forces makes South Korea a distinct case (The US military headquarters was moved out of central Seoul at South Korea’s expense). Regaining control has been repeatedly talked about and tried, but it is unlikely to be realized in the near future, keeping the country a big exception all over the world. Another important problem is that the United States wants to create a trilateral military alliance against China involving Japan, South Korea, and itself. Joining the alliance may threaten the South Korean economy by angering China. It also means forming a military alliance with Japan, which many South Koreans fear would lead to the subjugation to Japan again. There could be many other areas where the national interests of South Korea may not coincide with those of the United States, which may increase in the future with the tectonic shift of the environment. The relationship with China is more or less just the opposite of the relationship with the United States. The basic underlying condition is that China is a neighboring giant with a worrying historical legacy and the potential for a territorial dispute. The Chinese memory of its great past involves the tributary relationship with Korea.9 The humiliation China suffered from the nineteenth century on may make it more assertive than in the old tributary system, if not than in the last decades of the nineteenth century. China shares no democratic value with South Korea, as there now seems little hope that China will democratize with economic development. Meanwhile, China became South Korea’s largest trade partner and has been so since as early as 2004. In 2022, China accounted for 22.8 percent of South Korea’s exports; if Hong Kong is added, the share rises to 26.8 percent, far surpassing the 16.1 percent of the United States. Korea also needs China’s cooperation in coping with North Korea’s nuclear threat. The difficulty in managing the relationship with China was manifested in 2016, when South Korea agreed with the United States

9

Roland, Gerard (2023: 6).

414 The Tortuous Path of South Korean Economic Development to introduce the Terminal High Altitude Area Defense (THAAD) antiballistic missile system to counter North Korea’s nuclear missiles. China said that the THAAD system targeted China and retaliated economically, violating WTO rules. The Moon Jae-in government (May 2017–May 2022) installed the THAAD while saying it would take a “Three Nos” policy: no additional deployment of the US-made THAAD anti-missile system in Korea, no participation in a US-led missile defense network, and no involvement in a trilateral military alliance with the United States and Japan. China did not retaliate further and agreed to UN sanctions on North Korea for developing nuclear weapons and missiles in 2017. The coming of the Yoon Suk Yeol government (May 2022–present) has changed the country’s attitudes toward China. It declared that it would not continue the Moon government’s Three Nos policy; it particularly sent many signals that South Korea would join the trilateral military alliance with the United States and Japan. Its highranking officials openly said South Korea would cut economic ties with China. However, in February 2023, facing decreasing exports and an expanding trade deficit, the Yoon government’s Minister of Economy and Finance said that the situation would improve with the recovery of the Chinese economy after the coronavirus lockdown in 2022.10 South Korea’s relationship with Japan is closer to its relationship with China than that with the United States. Japan is a neighboring country with a present territorial dispute and a bitter historical legacy. The two countries normalized diplomatic relations without solving those problems in 1965, which produced a fundamental concern that South Korea could again be subjugated to Japan. The main ground of the concern was the vertical division of labor and the intervention in domestic politics. Subsequently, South Korea made efforts to overcome the vertical division of labor, with considerable success. Though the bilateral trade balance is still in deficit, South Korea’s

10

news.einfomax.co.kr/news/articleView.html?idxno=4254722.

Questions for the Future 415 technological capability has no doubt improved relative to Japan’s since 1965. Japan could not do much about that when it had to live in the postwar international economic order. Japan’s intervention in domestic politics also could not stay the same, as South Korea sustained the HEG, underwent generational transition, and, most importantly, consolidated democracy. However, Japan did not stay the same either. Japan consistently moved toward the right, though with some back and forth, not least because of the failure to liquidate the legacy of the empire after the Second World War. The move became steeper in the 2010s under the Abe Shinzo cabinet. Abe Shinzo, the grandson of Kishi Nobusuke mentioned in Chapter 4, tried hard to revise the Pacifist Constitution with US support. This objective seems to be achieved de facto now with the plan for military build-up. Japan being able to wage a war and allied with the United States to counter China would resemble what happened in the early 1900s, when Japan allied with Britain to counter Russia, far more closely than in the early 1960s, when there was a big dissent within South Korea to the normalization of the diplomatic relationship. Thus, joining the trilateral military alliance against China invokes worrisome questions about the repetition of history as well as the retaliation by China. In 2019, the Abe Shinzo cabinet imposed an embargo on the Japanese exports of some chemicals necessary for the production of DRAMs in South Korea in retaliation to the South Korean Supreme Court’s ruling that the Japanese firms that had used forcefully mobilized Korean workers during the Second World War should compensate them. The source of the conflict was the difference in the interpretation of the terms of the diplomatic normalization in 1965. Japan held that the agreement in 1965 settled all claims, including those by individuals. The South Korean Supreme Court’s position was that the agreement between states could not nullify individuals’ claims. What was surprising was that Japan’s action was a rare case of an advanced capitalist country violating the rule-based order on political grounds. South Korea’s relationship with Japan sunk to

416 The Tortuous Path of South Korean Economic Development a low point, accordingly. The new Yoon Suk Yeol government (May 2022–present) declared that it would improve the relationship with Japan. In March 2023, he promised that South Korea would follow the Japanese interpretation of the terms of the normalization, ignoring the Supreme Court’s ruling. Japan’s Kishida Fumio cabinet lifted the embargo on chemicals exports subsequently.

12.4  Does History Help? Managing relations with the great powers is a difficult task for South Korea because the country has no experience in dealing with a tectonic shift of international environment. The last time Korea faced such a great change as an independent country was in the nineteenth century, when the country faced the emergence of the West. It may thus help to hark back to that era. At that time, Joseon miserably failed to adapt to the great change for several reasons. First, the country lagged behind economically, not only compared to Europe and the United States but also to neighboring China and Japan. That may not have been a critical problem if the elites had carried out a reform from above in time. However, Joseon’s elites had little sense of the changing world order before it was too late. Second, Joseon had a particularly weak state capacity, which was composed mainly of military capability until the nineteenth century. Finally, Joseon lacked domestic cohesion, with elites inviting foreign intervention in domestic conflicts. Today’s South Korea is far from such a picture, more or less making the comparison with Joseon in the nineteenth century nonsense. According to the United Nations, South Korea’s per capita GDP in PPP surpassed Japan’s in 2017.11 The people of a former colony becoming more productive than the people of their former colonizer is a globally meaningful fact, one related to the origin of development economics, as mentioned in Chapter 1 (One may again remember that Taiwan did it earlier, but Taiwan is not treated as

11

data.un.org/Data.aspx?d=WDI&f=Indicator_Code percent3ANY.GDP.PCAP.PP.CD

Questions for the Future 417 a country). South Koreans – the public as well as the elites – know the world well after running an independent country under an open system for more than 70 years. They have learned intensively from the world, traded with economies all over the world, and experienced setbacks like the 1997 currency crisis. The country has a respectable state capacity, as demonstrated, among others, by its military capability. It ranks sixth in the 2023 Military Strength Ranking by Global Firepower, a civilian organization. Japan ranks eighth, two ranks below South Korea; the United Kingdom, the successor state of the old British Empire, stands fifth, just one rank above South Korea; and France, another prominent old European imperialist power, is in ninth, three ranks below South Korea.12 One may wonder how accurate this kind of information, seemingly just based on statistical numbers, is; however, it is enough to show that South Korea’s state capacity today really differs from Joseon’s in the nineteenth century. Of course, military capability may now be a far smaller part of state capacity. However, South Korea also showed leading state capacity to fight the pandemic in 2020. However, similarity remains, notably, in the ability to form domestic cohesion. This ability is important because, while polarized politics is bad at any time in any country, it would be especially perilous for a country like today’s South Korea, facing the tectonic shift of its environment while being surrounded by great powers. The most dangerous possibility is the polarization of politics that may lead to inviting foreign intervention in domestic conflict, as Joseon elites did in the nineteenth century. There is again a fundamental difference in this regard. The power struggle among Joseon elites and the peasant war of 1894 was a matter of life or death. Now, democracy provides a different rule of the game. Under democracy, different political forces with different views can compete with one another under the rule of law, which is completely healthy. However, some similarities to the nineteenth century linger, as the rule of law has a long way to go.

12

www.globalfirepower.com/countries-listing.php.

418 The Tortuous Path of South Korean Economic Development The rule of law has a long way to go despite the consolidation of democracy. The institutional arrangement to ensure the independence of government agencies like the prosecution and the police is still incomplete. Meanwhile, politics continues to be corrupt, though the level of corruption has fallen remarkably with the reforms to enhance the transparency of the economy and reduce the influence of money on politics. Moreover, electoral and political laws are often so binding that even uncorrupt politicians find it difficult to abide by them. Laws can also be interpreted in a variety of ways, often arbitrarily. Thus, the prosecution and the police can virtually target any politician or politically influential person on corruption or other charges to cater to the taste of the incumbent government. Under such conditions, elections become a survival game. The presidential election is the most pronounced in this regard because the control over the prosecution and the police is at stake in the election. The winner becomes president, but the loser may go to prison. Political forces, therefore, have the incentive to use “whatever means necessary” to undermine their opponents, including attacking their position toward the country’s relationship with the great powers. This makes it difficult to manage the relationship with domestic cohesion.

12.5  Domestic Politics Matters The problem of domestic cohesion is most pronounced in the relationship with the United States. Using the relationship with the United States for domestic politics is almost taken for granted. The United States influences other countries’ domestic politics elsewhere in the world, but South Korea may be an exceptional case. Before the 1987 democratization, the government treated antiAmericanism just like communism, while democratization leaders hoped that the United States would restrain the military governments’ abuses. After the democratization, political forces have always been ready to exploit any schism between their opponents and the United States to gain an advantage in domestic politics. Thus, as mentioned in Chapter 8, Kim Dae-jung practically had no

Questions for the Future 419 option other than accepting the IMF conditionality because of the domestic political situation, even though he is likely to have acted mainly out of his own ideas about the economy. The problem has persisted subsequently. During the Moon Jae-in government, for example, his opponents repeatedly tried to frame his government as anti-American, while its officials said that the relationship with the United States was as good as ever. The dispute continued when the presidential transition committee of the Yoon Suk Yeol government declared that it would “restore” the alliance with the United States, while the Moon government officials said that the alliance was as solid as ever. All this leaves the question of how the country will make a decision in future contingencies where its national interests critically diverge from the United States’. South Korea’s domestic politics in relation to Japan has made a sharp contrast with that in relation to the United States. Politicians have tended to use “Japan bashing” to gain popularity domestically, often trying to frame their opponents as pro-Japanese (They did so even while sometimes asking Japan for help when the country faced troubles, as illustrated by what happened in the early 1980s and 1997).13 At the same time, it is questionable whether the country has the ability to manage its relationship with Japan on the basis of domestic cohesion. A remarkable example is what happened when the Abe cabinet imposed an embargo on chemical exports in response to the South Korean Supreme Court’s ruling in 2019. Conservatives, rather than standing behind the Supreme Court’s ruling, which was consistent with the principle of liberal democracy, the founding ideology of the country, concentrated on attacking the Moon Jae-in government, which had had little influence on the Supreme Court ruling, insisting that its poor diplomacy invited Japanese retaliation. After nominally pointing out the violation of the rule-based order by Japan, they single-mindedly denounced the

13

See Chapters 5 and 8.

420 The Tortuous Path of South Korean Economic Development Moon government.14 The Japanese edition of South Korea’s leading newspaper catered to the tastes of Japanese readers by unilaterally blaming its own country for the issue.15 Now, under the Yoon Suk Yeol government, his opponents blame him for ignoring the Supreme Court’s ruling and showing a subservient attitude toward Japan. One could ask what will happen to all those behaviors when South Korea faces a more critical conflict with Japan in the future. The relationship with China had no place in domestic politics initially but gained one over the years. It became particularly visible during the Moon Jae-in government after it adopted the Three Nos policy. His opponents attacked the posture as subservient to China, which went along with framing his government as anti-American.16 On the other hand, his policy defenders say it was a practical one with no alternative; they also criticize the Yoon Suk Yeol government’s anti-Chinese posture as undermining South Korea’s economy and making it difficult to get China’s cooperation in dealing with North Korea’s nuclear ambition.17 Unfortunately, the position toward North Korea, if not the economy, is the source of a deep domestic divide. Until the 1987 democratization, the relationship with North Korea could not be a source of domestic divide, at least not openly, as any conciliatory move taken by actors other than the authoritarian leaders themselves was treated like communism. It was not a source of domestic divide either when the Roh Tae-woo government (February 1988–February 1993) first launched the rapprochement with North Korea. The Roh government established the Basic North– South Agreement that defined peaceful coexistence in 1991. In 1992, the United States withdrew nuclear warheads that had been in South Korea since 1958. However, when the Kim Dae-jung government (February 1998–February 2003) relaunched the rapprochement after

14 15 16 17

Hankyoreh editorial, July 6, 2019. July 17, 2019, Pd Journal. weekly.chosun.com/news/articleView.html?idxno=19077. youtube.com/watch?app=desktop&v=VyRXI__-c6c.

Questions for the Future 421 North Korea’s nuclear ambition surfaced as an issue, the relationship with North Korea became a source of deep divide in South Korea. Kim Dae-jung’s opponents resorted to the old tactic of McCarthyism; the Kim government had its own problems, including, for example, announcing the agreement on the first summit between Kim Daejung and the North Korean leader Kim Jong-il in June 2000 just three days before the general election for the National Assembly. The domestic divide persisted when the Roh Moo-hyun government (February 2003–February 2008) succeeded the Kim Daejung government’s rapprochement policy. Then, the Lee Myung-bak government (February 2008–February 2013) and Park Geun-hye government (February 2013–May 2017) almost completely reversed the policies of Kim and Roh governments, which widened the domestic divide. The domestic divide concerning North Korea naturally led to the polarization of ideas in foreign policy among the political parties.18 The Moon Jae-in government launched the rapprochement policy again. The Moon government did not intentionally use it for domestic politics, but it helped his government party secure a landslide victory in the local elections in 2018. In 2022, the Yoon Suk Yeol government arrested and indicted the Moon government’s highranking officials on the charges of manipulating the treatment of some accidents involving North Korea in North Korea’s favor, which the Moon government’s officials deny as a groundless ploy designed for domestic politics. South Korea’s future will depend on whether it can live up to the favorite slogan of Rhee Syngman, the country’s first president: “United we stand, divided we fall.” The phrase originated in Aesop’s Fables, but Zhuangzhou in ancient China said something similar. Rhee cited the phrase repeatedly after the liberation and during his tenure as president (1948–1960). Whether Rhee himself lived up to the phrase is highly questionable. He was a divisive figure in the national

18

Jaung (2019).

422 The Tortuous Path of South Korean Economic Development liberation movement and was responsible  – at least partially  – for the division of the country after its liberation. His main tactics after seizing power were to divide and rule, before being expelled by the student-led revolution. However, aside from Rhee’s own behavior, the country’s future will depend greatly upon whether it can form the domestic cohesion that Rhee emphasized by citing the phrase so frequently.

Appendices

Notes on the Appendices Appendices provide the data mentioned in the text or used as the base of the figures in the text but are not easily accessible from publicly known sources. They also provide the longer-run time series of the data for which recent ones are available from publicly known sources but older ones are obtained from other sources.

Appendix 1  Macroeconomic variables, 1946–2022 (percent) Growth rates1 GDP 1946 1947 1948 1949 1950 1951 1952 1953 1954 1955 1956 1957 1958 1959 1960 1961 1962

7.1 21.1 10.1 −15.1 −3.6 6.5 29.1 7.5 5.6 0.6 9.4 6.6 5.6 2.3 6.9 3.9

Per capita GDP

Inflation rate2

Export ratio3

Import ratio3

Current account / GDP

2.3 17.2 8.2 −16.1 −0.7 4.8 26.8 4.5 4.8 -2.8 5.8 4.4 2.8 −0.7 3.7 1.1

918.4 158.7 67.8 32.5 73.0 414.1 124.1 47.1 45.6 74.0 23.0 23.2 −3.6 3.2 8.1 8.1 6.6

2.9 1.7 1.3 1.7 1.3 0.9 1.0 1.7 1.9 2.3

25.6 16.7 24.5 26.6 26.4 19.9 15.4 17.3 14.7 17.7

−6.4 −2.0 −0.7 −0.7 −0.1 2.0 0.8 0.7 1.5 −2.3

423

424 Appendices Appendix 1  (cont.) Growth rates

1963 1964 1965 1966 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995

GDP

Per capita GDP

Inflation rate

Export ratio

Import ratio

Current account / GDP

9.0 9.5 7.3 12.0 9.1 13.2 14.6 10.1 10.5 7.2 14.9 9.5 7.8 13.2 12.3 11.0 8.7 −1.6 7.2 8.3 13.4 10.6 7.8 11.3 12.7 12.0 7.1 9.9 10.8 6.2 6.9 9.3 9.6

6.1 6.8 5.0 9.3 6.8 10.9 12.2 8.3 8.6 4.6 13.4 7.9 6.1 11.6 10.6 9.4 7.2 −3.1 5.7 6.7 11.9 9.3 6.8 10.3 11.7 11.0 6.1 8.9 9.8 5.1 5.9 8.3 8.6

20.7 29.5 13.6 11.5 10.7 10.9 12.3 16.0 13.5 11.7 3.2 24.1 25.3 15.4 10.1 14.5 18.3 28.7 21.3 7.2 3.4 2.3 2.5 2.7 3.0 7.2 5.7 8.6 9.3 6.2 4.8 6.3 4.5

3.1 4.0 5.6 6.6 7.3 8.5 9.2 10.2 11.2 15.0 23.2 22.8 23.3 25.8 26.1 23.6 23.3 32.1 34.2 31.8 31.3 32.2 29.4 34.2 36.6 33.7 28.5 26.1 24.7 24.9 24.4 24.7 26.4

20.0 13.6 14.9 19.0 22.7 27.3 26.8 24.3 25.1 23.2 30.5 35.1 33.4 29.3 28.1 27.8 31.4 41.7 43 38.3 34.5 33.2 30.5 32.5 31.1 28.1 27 26.9 27.1 25.6 24.1 25.5 27.8

−5.1 −0.9 0.3 −2.7 −4.4 −8.2 −8.1 −7.6 −8.9 −3.4 −2.2 −10.4 −8.7 −1.0 0.0 −2.0 −6.4 −10.6 −8.9 −7.2 −4.1 −1.9 −2.2 2.2 5.8 6.4 1.5 −1.0 −2.4 −0.8 0.4 −1.0 −1.8

Appendices Appendix 1  (cont.) Growth rates

1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022

GDP

Per capita GDP

Inflation rate

Export ratio

Import ratio

Current account / GDP

7.9 6.2 −5.1 11.5 9.1 4.9 7.7 3.1 5.2 4.3 5.3 5.8 3.0 0.8 6.8 3.7 2.4 3.2 3.2 2.8 2.9 3.2 2.9 2.2 −0.7 4.1 2.6

6.9 5.3 −5.8 10.8 8.3 4.1 7.1 2.6 4.8 4.1 4.8 5.3 2.2 0.3 6.3 2.9 1.9 2.7 2.6 2.3 2.5 2.9 2.4 2.0 −0.8 4.0 2.6

4.9 4.4 7.5 0.8 2.3 4.1 2.8 3.5 3.6 2.7 2.2 2.5 4.7 2.8 2.9 4.0 2.2 1.3 1.3 0.7 1.0 2.0 1.5 0.4 0.5 2.5 5.1

25.5 29.2 41.1 33.9 35.4 33.3 31.1 32.7 38.2 36.9 37.3 39.4 49.8 47.1 49.2 55.3 56 53.2 49.6 44.6 41.8 42.7 43.7 41.5 38.4 44.3 50.8

29 30.6 31.7 29.5 34.3 32.7 30.3 31.4 34.9 35.4 37 38.7 50 43 46.2 53.6 52.3 47.9 44.1 37.4 34.8 37.5 38.9 37.9 33.9 39.6 49.7

−4.0 −1.9 10.4 4.4 1.8 0.4 0.6 1.6 3.7 1.3 0.2 0.9 0.2 3.5 2.4 1.3 3.8 5.6 5.6 7.2 6.5 4.6 4.5 3.6 4.6 4.7 1.8

Notes: 1 Growth rates are in 2010 prices until 1953 and in 2015 prices from 1954. 2 Inflation rate until 1965 is the increase rate of the consumer price index in the Seoul area. Inflation rate from 1966 is the increase rate of the consumer price index in the country.

425

426 Appendices Appendix 1  (cont.) 3

 xport ratio is total exports (exports of goods and services) as a E percentage of GDP. Import ratio is total imports (imports of goods and services) as a percentage of GDP. Sources: Growth rates until 1953 and inflation rate until 1965 are from naksung.re.kr. Growth rates from 1954 and inflation rate from 1966 are from ecos.bok.or.kr. Exports, imports, and current account until 1979 are from the Bank of Korea, Economic Statistics Yearbook, various issues. All others are from ecos.bok.or.kr.

Appendix 2  Foreign debts and foreign assets as a percentage of GDP, 1964–2022 Gross foreign debt1 1964 1965 1966 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984

6.0 6.6 10.4 14.7 22.4 26.5 27.5 30.6 33.0 30.7 30.4 38.8 35.2 32.9 27.5 31.4 41.6 44.5 47.3 46.0 44.2

Net foreign debt1

19.2

19.9 31.0 19.8 17.7 21.6 30.0 33.6 36.1 35.2 33.8

Short-term foreign debt1

International reserves

NIIP

0.3 0.1 0.2 1.5 1.6 2.9 4.6 5.0 5.9 5.1 6.3 11.1 10.2 9.7 5.8 8.4 14.3 14.0 15.9 13.8 11.7

4.5 4.7 6.5 8.1 7.2 8.1 7.5 6.0 6.8 7.9 5.4 7.1 9.9 11.2 9.2 8.8 10.1 9.5 8.9 7.9 7.8

−28.8 −33.2 −34.2 −31.4 −30.9 −32.4 −26.7 −26.1 −24.7 −28.4 −36.8 −37.8 −39.6 −43.9 −40.3

Appendices Appendix 2  (cont.)

1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Gross foreign debt

Net foreign debt

Short-term foreign debt

International reserves

NIIP

46.2 38.1 24.0 15.6 11.9 11.2 11.8 12.0 11.2 17.5 19.2 23.8 28.4 39.3 27.8 23.2 20.9 20.3 19.5 18.5 17.2 21.6 28.7 29.9 36.2 31.0 31.8 31.9 30.8 28.5 27.0 25.5 25.4

35.1 27.8 15.1 3.6 1.2 1.7 3.6 3.1 2.0 3.6 4.1 6.8 11.2 7.8 0.0 −4.6 −7.7 −8.4 −12.7 −17.6 −16.7 −14.3 −6.6 −2.6 −7.7 −8.4 −7.9 −10.1 −13.5 −17.1 −22.1 −26.6 −28.7

10.6 7.9 6.3 4.9 4.4 5.1 5.2 5.2 4.9 7.8 9.1 11.5 10.2 9.1 7.4 7.3 6.2 6.8 6.6 6.7 7.0 11.0 13.9 14.0 15.4 11.8 11.1 9.9 8.0 7.7 7.1 7.0 7.1

7.7 6.8 6.2 6.2 6.2 5.2 4.2 4.8 5.2 5.5 5.8 5.4 3.6 13.6 14.9 16.7 18.8 19.4 22.1 25.1 22.5 22.7 22.4 19.2 28.6 25.5 24.4 25.6 25.3 24.5 25.1 24.7 24.0

−44.4 −35.3 −23.7 −10.2 −6.0 −5.4 −6.1 −5.4 −6.2 −8.0 −8.1 −10.4 −11.3 −13.5 −17.2 −6.3 −10.5 −9.7 −9.0 −7.6 −15.4 −14.9 −16.1 −6.7 −10.7 −11.6 −6.6 −7.6 −2.9 5.5 14.0 18.7 16.1

427

428 Appendices Appendix 2  (cont.)

2018 2019 2020 2021 2022

Gross foreign debt

Net foreign debt

Short-term foreign debt

International reserves

NIIP

25.6 28.5 33.5 34.9 39.9

−27.7 −29.5 −29.4 −24.7 −21.7

7.3 8.2 9.7 9.1 10.0

23.4 24.8 26.9 25.6 25.4

25.3 31.4 29.6 36.4 44.9

Notes: Foreign debt data before 1994 and those from 1994 lack consistency because the government revised the way to compile the data from 1994. Sources: Foreign debts before 1994 are from Lee (2018: 731). NIIP before 1994 are from the Committee for Editing the Sixty Years of the Korean Economy (2010a: 82). Others are from ecos.bok.or.kr.

1

Appendix 3  Indices for the financial soundness of firms, manufacturing sector, 1962–2021 (percent) All enterprises

1962 1963 1964 1965 1966 1967 1968 1969 1970 1971 1972 1973

Large enterprises

SMEs

Debtequity ratio

Interest coverage ratio

Debtequity ratio

Return on assets

Debtequity ratio

Return on assets

153.5 92.2 100.5 93.7 117.7 151.2 201.3 270.0 328.4 394.2 313.4 272.7

314.4 405.6 273.7 320.9 236.9 227.2 212.7 133.5 113.4 90.8 135.3 224.4

331.8 402.1 319.1 276.5

9.4 8.3 10.6 12.8

206.8 161.3 138.8 148.8

10.3 11.2 10.4 13.6

Appendices Appendix 3  (cont.) All enterprises

1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

Large enterprises

SMEs

Debtequity ratio

Interest coverage ratio

Debtequity ratio

Return on assets

Debtequity ratio

Return on assets

316.0 339.5 364.6 350.7 366.8 377.1 487.9 451.5 385.8 360.3 342.7 348.4 350.9 340.1 296.0 254.3 285.5 306.7 318.7 294.9 302.5 286.8 317.1 396.3 303.0 214.7 210.6 182.2 135.4 123.4 104.2 100.9

173.5 149.1 153.3 142.0 158.7 125.0 98.5 94.6 113.0 147.6 147.4 146.9 162.2 157.4 148.4 118.4 127.5 116.7 105.2 118.7 135.6 149.6 112.1 129.1 68.3 96.1 157.2 132.6 260.3 367.1 575.8 525.4

322.4 351.5 372.4 349.3 363.3 377.5 504.7 451.1 377.6 360.6 339.5 344.7 355.7 331.1 283.9 239.9 273.8 288.1 302.5 273.5 282.9 268.3 301.6 390.0 295.4 208.9 224.6 201.6 128.9 113.5 91.7 86.1

10.9 9.4 10.4 10.1 10.8 10.6 8.8 9.7 8.8 9.5 9.6 9.1 10.2 9.8 10.3 8.0 7.3 7.3 7.6 7.1 8.1 9.6 6.3 5.1 5.5 6.7 5.1 4.0 12.9 8.5 13.4 10.1

140.9 185.9 272.2 358.6 388.1 374.3 394.9 453.2 433.0 357.8 366.0 369.6 326.0 375.0 357.7 347.0 338.6 413.2 418.5 388.1 394.2 380.6 387.4 418.4 334.4 232.4 179.7 144.7 152.1 147.6 138.7 140.9

12.8 10.9 11.2 12.3 12.2 11.8 11.1 11.4 8.7 10.3 10.2 10.7 12.2 11.8 11.9 9.7 9.5 8.1 6.8 7.4 8.1 7.5 6.9 6.4 7.1 8.0 7.7 5.5 7.2 6.2 6.8 7.4

429

430 Appendices Appendix 3  (cont.) All enterprises

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021

Large enterprises

SMEs

Debtequity ratio

Interest coverage ratio

Debtequity ratio

Return on assets

Debtequity ratio

Return on assets

98.9 97.8 123.2 116.8 108.3 109.2 101.0 93.0 89.2 85.3 80.2 77.0 73.6 73.5 76.3 78.6

439.3 435.3 415.8 404.1 558.0 486.0 455.4 513.6 412.3 539.8 640.8 914.3 848.3 496.7 541.4 958.3

85.5 88.8 111.5 101.4 92.5 94.4 86.4 76.4 71.1 69.7 64.2 61.5 58.7 58.3 61.5 65.2

9.0 9.7 5.5 8.3 10.7 7.9 7.7 6.2 5.3 5.7 6.7 9.4 8.7 4.5 4.4 8.5

132.6 147.0 147.0 159.7 155.4 153.8 146.6 146.7 145.3 142.0 138.2 132.9 125.7 122.0 122.3 121.7

6.6 6.8 5.4 5.1 6.2 6.1 6.0 5.8 5.4 5.5 5.4 5.0 4.6 4.3 4.6 5.1

Sources: Data before 1990 are from the Bank of Korea, Financial Statement Analysis, various issues. Data from 1990 are from ecos.bok​ .or.kr.

1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989

Top 4 5.1 5.6 7.1 7.2 10.6 10.9

8.8 8.4 8 8.9 9.9

6.6 6.2 6.1 6.4 7.4

Top 10

3.6 3.8 4.7 5.1 8.2 8.1

Top 5 7.1 7.8 9.8 9.4 13.3 14

Top 20

All industries1

9.8 10.3 12.3 12.3 16.3 17.1 16.6 19.5 24

Top 46

33.2

29.3 27.6 29.6 29.5 28.9 28.5 27.3 26.7

23.4

23 21.9 24.2 24.1 23.6 23.4 23.3 22.7

18.4

28.9

18.9

12.6

21.8

Top 20

13.9

Top 10

Manufacturing2

8.8

Top 5

Appendix 4  Top chaebol’s shares in value added, 1973–2012 (percent)

43.0

36.5

31.8

Top 46

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 20013 2002 2003 2004 2005 2006

3.9 4.7 4.8 5.9 5.1 4.9

Top 4

Appendix 4  (cont.)

7.2 7.2 7.6 7.8 8.3 10.1

Top 5

5.4 6.8 6.6 7.7 7.8 7.3

9.5 9.6 10 10.3 11 12.9

Top 10

6.0 7.6 7.3 8.7 9.2 8.9

Top 20

All industries Top 46

Top 5

Top 10

Top 20

Manufacturing Top 46

7.9 8.2 8.2

9.6

5.1 5.6 5.9

7.5

11.2

9.4 9.8 9.8

1

Notes: Top chaebol’s value added as a percentage of GDP. 2 Top chaebol’s manufacturing value added as a percentage of manufacturing value added. 3 The data from 2001 exclude the financial sector. Sources: The data for all industries from 1973 to 1978 and the data for manufacturing from 1973 to 1989 are from Sakong (1993: 247). The data for all industries from 1985 to 1995 are from Choi (1996: 41). The data for all industries from 2001 to 2012 are from Hwang et al. (2014: 29).

2007 2008 2009 2010 2011 2012

434 Appendices Appendix 5  Top income shares and capital gains on land, 1958–2021 (percent) Top one percent income share (1) 1958 1959 1960 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990

4.5 5.6 5.4 5.1 4.4 5.9 5.3 6.0 6.2 6.2 6.1 8.1 7.9 7.8 7.8 8.5 8.8 10.8 8.3 9.4 7.5 8.3 9.6 8.2 8.4 8.5 8.2 8.2 9.1 9.2 9.0 8.9 9.3

Top ten percent income share

(2)

(1)

8.4 8.8 9.0 8.9 9.4 8.8 9.0 9.6 9.6 9.4 9.3 9.5 9.6 9.4 9.3

14.7 18.6 16.7 16.7 17.8 19.4 18.6 19.8 20.6 20.9 19.7 26.1 26.3 30.9 29.1 28.0 27.9 28.7 25.1 27.6 31.0 35.1 35.7 33.7 35.0 35.5 33.9 34.0 35.4 35.5 35.7 35.7 37.1

Capital gains on land / GDP

(2)

Private

Public

28.1 28.7 31.5 31.0 32.3 32.1 32.7 33.5 33.4 32.7 32.8 33.3 33.6 33.6 33.7

65.1 78.3 94.4 137.3 137.1 118.9 63.6 35.4 65.5 82.4 61.8 46.6 89.4 144.1 53.4 21.3 22.4 23.3 59.3 35.0 34.3 42.3 53.4 82.7 108.8 110.7

18.0 14.6 16.4 29.2 23.7 19.6 7.8 1.6 7.9 14.3 4.7 7.5 15.0 28.7 9.5 7.9 4.5 5.3 13.2 16.0 10.7 12.0 17.5 22.9 31.5 37.2

Appendices Appendix 5  (cont.) Top one percent income share

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021

Top ten percent income share

Capital gains on land / GDP

(1)

(2)

(1)

(2)

Private

Public

8.6 9.2 9.3 9.1 8.2 8.4 8.5 7.4 8.5 9.0 9.5 9.7 9.4 10.4 11.3 12.2 13.0 12.3 12.2 12.8 13.4 13.6 13.7

9.1 8.9 9.0 9.1 9.2 9.2 9.5 7.7 9.2 10.0 10.4 11.3 11.4 12.0 12.0 12.8 13.6 13.9 13.7 14.5 14.7 14.4 14.2 14.3 14.5 14.6 14.7 14.7 14.5 14.5 14.5

35.6 37.1 37.9 36.6 34.7 34.0 35.0 33.1 32.9 36.4 38.7 37.1 36.3 40.7 44.1 46.7 46.3 46.2 45.8 46.7 47.8 48.1 48.5

33.7 33.7 34.1 34.4 34.7 37.0 37.8 35.1 37.1 38.2 39.1 40.5 41.1 41.5 40.1 44.2 44.9 45.4 45.0 45.8 45.8 45.4 45.2 45.3 45.7 45.9 46.0 45.9 45.8 45.8 45.8

92.5 12.1 −19.9 12.3 13.4 16.0 9.9 −20.9 14.2 9.9 11.6 36.3 29.5 33.2 40.3 48.3 41.9 14.8 16.1 13.4 15.9 9.4 7.1 16.5 16.5 17.9 22.6 24.8 22.3 42.6 40.4

32.2 4.3 −7.6 5.6 3.0 1.2 2.7 −8.9 5.8 4.7 5.9 7.2 6.4 8.4 10.3 12.9 12.8 1.0 3.5 3.5 5.2 4.2 2.0 5.6 6.0 5.0 4.4 6.2 5.8 6.1 6.8

Sources: Top income shares (1) are from Hong (2015), and top income shares (2) are from World Inequality Database. Capital gains on land are from the Bank of Korea.

435

436 Appendices Appendix 6  Indicators of labor market and industrial relations, 1963–2021

1963 1964 1965 1966 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995

Weekly working hours

Industrial accident ratio1

Unionization Propensity to rate2 strike3

51.6 50.6 50.9 50.7 49.6 50.0 50.7 51.4 51.3 50.5 51.6 51.9 52.1 52.5 52.4 51.9 52.5 51.9 51.1 49.2 48.2 47.9 47.5 47.5 47.4 47.7

1.82 5.91 5.85 5.42 4.70 4.72 4.85 5.34 4.32 4.50 4.62 4.39 4.20 4.60 4.48 3.61 3.02 3.41 3.98 3.98 3.60 3.15 2.99 2.66 2.48 2.01 1.76 1.62 1.52 1.30 1.18 0.99

9.4 11.5 11.5 11.7 12.4 12.1 12.5 12.6 12.7 12.9 13.2 14.8 15.8 16.5 16.7 16.9 16.8 14.7 14.6 14.4 14.1 13.2 12.4 12.3 13.8 17.8 18.6 17.2 15.4 14.6 14.0 13.3 12.5

7.2 14.6 3.3 19.2 46.1 2.4 2.9

2.9 3.3 2.3 0.0 2.6 9.4 4.7 1.7 1.2 2.6 7.9 8.5 755.8 562.0 611.3 409.8 279.6 128.3 109.5 118.9 30.5

Appendices Appendix 6  (cont.)

1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021

Weekly working hours

Industrial accident ratio

47.3 46.7 45.9 47.9 47.5 47.0 46.2 45.9 45.7 45.1 44.2 43.5 42.4 42.3 42.5 41.9 41.4 41.0 40.8 41.1 40.8 40.0 39.6 39.4 38.7 38.8

0.88 0.81 0.68 0.74 0.73 0.77 0.77 0.90 0.85 0.71 0.77 0.72 0.71 0.70 0.69 0.65 0.59 0.59 0.53 0.50 0.49 0.48 0.54 0.58 0.57

Unionization Propensity to rate strike 12.1 11.1 11.4 11.7 11.4 11.5 11.3 10.7 10.3 9.9 10.0 10.5 10.2 9.9 9.6 9.8 9.9 10.1 10.0 10.0 10.1 10.5 11.6 12.4 13.8 14.1

67.7 33.2 118.1 107.9 141.8 79.3 111.4 90.2 80.5 55.8 77.2 33.6 49.9 38.1 30.1 24.7 52.7 35.1 34.7 23.2 104.1 43.2 27.5 19.7 27.2 22.7

Notes: Industrial accident ratio is the number of the victims as a percentage of the workers in the workplaces covered by industrial accident insurance. 2 Unionization rate is the number of union members as a percentage of wageworkers. 3 Propensity to strike is the number of days lost in labor disputes per thousand wageworkers. 1

437

438 Appendices Appendix 6  (cont.) Sources: Weekly working hours before 1980 are from Lee (2018: 733). Weekly working hours from 1980 are from KLI labor statistics, 2022, Table 4.2. Industrial accident ratio to 1988 is from Lee (2018: 733). Industrial accident ratio from 1989 is from KLI labor statistics, 2022, Table 4.28. The number of union members to calculate unionization rate and the days lost in labor disputes are from the Ministry of Employment and Labor, Labor White Paper, various issues. The number of wageworkers is from kosis.kr. Appendix 7  The shares in lending by general banks, 1989–2021 (percent)

1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Large enterprises

SMEs

Households

47.3 37.1 36.5 37.1 33.3 27.5 21.1 20.7 19.9 18.8 18.6 16.4 10.8 7.6 5.9 5.4 5.7 4.4 5.4 8.1 7.2 8.6 10.5 11.8 11.3

40.2 49.8 52.0 52.4 54.8 54.9 55.9 54.3 43.9 40.6 42.7 39.7 37.9 38.0 39.7 38.2 36.4 38.1 41.9 41.8 41.9 39.9 38.2 37.4 38.1

8.5 8.3 7.7 7.0 8.7 14.7 17.5 19.5 20.0 18.2 26.2 28.0 38.4 52.9 53.0 55.0 56.3 55.8 50.9 47.9 48.8 49.4 48.9 48.8 48.3

Appendices Appendix 7  (cont.)

2014 2015 2016 2017 2018 2019 2020 2021

Large enterprises

SMEs

Households

10.8 9.7 8.1 7.2 6.9 6.2 6.0 4.0

38.0 38.8 38.8 39.5 39.5 39.7 40.0 43.0

49.1 49.8 51.6 51.9 52.2 52.6 52.7 53.0

Notes: Lending in Korean won. Source: Bank Management Statistics, compiled by the Bank of Korea before 1999 and by the Financial Supervisory Service from 1999. Appendix 8  The percentage of enterprises with interest coverage ratio less than one, 2008–2022

2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 20221

All enterprises

Large enterprises

SMEs

32.7 31.4 28.8 29.5 33.1 32.4 32.6 30.2 30.9 32.3 35.7 35.1 39.7 35.5 35.7

21.1 20.1 20.6 28.1 28.7 28.4 28.5 22.8 20.1 20.9 24.5 23.6 28.8 22.5 23.4

43.6 42.4 34.3 30.2 37.0 38.3 38.2 38.7 41.6 44.1 47.2 47.0 50.9 48.4 49.7

Notes: 1The 2022 figures are for the first half. Source: The Bank of Korea, Financial Stability Report, various issues.

439

1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996

49.7 51.9 51.9 50.6 51.5 55.0 51.4 49.3 51.6 50.3 49.8 54.6 54.4 50.3 52.8 52.8 52.4

Primary

114.1 119.8 115.9 115.2 118.4 115.2 114.3 109.6 110.0 105.1 101.7 100.2 102.4 110.2 115.8 120.0 120.0

Manufacturing 76.7 76.0 68.4 66.3 68.5 66.3 69.5 72.6 70.7 68.8 65.4 62.2 57.2 51.7 48.0 47.1 43.9

Service (A)1 187.1 182.0 187.4 179.6 163.2 157.1 154.6 153.3 149.1 150.9 149.3 143.7 149.6 150.2 151.2 147.0 150.0

Service (B)2

Relative labor productivity

153.4 142.3 161.3 173.3 150.9 150.7 154.8 155.8 141.7 144.0 151.3 140.2 130.0 132.8 121.2 116.5 115.7

Other 34.9 35.2 32.8 30.6 28.0 25.9 24.8 23.0 21.4 20.1 18.3 14.9 14.3 13.8 12.7 11.9 11.2

21.6 20.4 21.1 22.5 23.2 23.4 24.7 27.0 27.7 27.8 27.2 27.6 26.2 24.5 24.0 23.6 22.7

19.2 19.8 22.1 22.3 21.9 22.5 22.4 22.0 21.6 21.3 21.8 22.2 23.6 25.4 26.5 26.5 27.2

Service Primary Manufacturing (A)1

Share of employment

Appendix 9  Relative labor productivity and employment share by industries, 1980–2021 (percent)

17.8 18.2 18.0 18.8 20.3 21.8 22.1 22.1 22.9 24.0 24.9 26.4 26.6 27.1 27.3 28.3 29.0

Service (B)2

6.5 6.4 6.0 5.8 6.6 6.4 6.0 5.9 6.4 6.8 7.8 8.9 9.3 9.2 9.5 9.7 9.9

Other

1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

49.2 40.5 43.8 42.5 41.8 40.2 39.5 41.2 39.0 38.5 36.9 35.7 37.7 38.1 40.4 41.3 40.3 42.4 45.1 44.7 44.5 40.1

127.2 141.6 143.2 144.4 139.8 142.3 141.2 155.6 156.9 158.8 163.3 167.2 172.6 177.6 182.4 182.1 177.9 171.1 164.9 165.9 172.4 173.1

40.4 37.5 41.2 46.0 45.2 44.4 43.0 42.1 42.5 43.6 44.0 45.7 46.4 47.9 49.2 49.6 49.5 46.3 45.9 46.4 45.8 46.7

148.9 144.6 137.9 131.2 132.9 131.9 130.7 122.6 120.8 118.8 116.5 116.1 111.5 107.4 104.8 104.4 104.9 107.6 107.6 105.9 105.1 106.2

114.7 126.8 126.7 114.5 117.3 111.8 115.0 110.6 109.7 107.1 103.7 91.4 98.7 93.3 88.1 89.8 92.4 97.5 103.9 109.3 103.3 96.0

10.8 12.2 11.4 10.7 10.1 9.5 8.9 8.4 8.0 7.7 7.3 7.1 7.0 6.6 6.4 6.1 6.1 5.6 5.2 4.9 4.9 5.1

21.4 19.6 19.8 20.3 19.8 19.2 19.0 18.5 18.1 17.6 17.2 16.9 16.4 17.0 17.0 16.7 17.0 17.2 17.6 17.4 17.1 16.8

27.7 27.9 28.3 27.1 27.2 26.9 26.5 25.9 25.4 24.9 24.4 24.1 23.6 23.0 22.7 22.7 22.4 23.0 23.0 22.9 22.8 22.2

30.1 32.1 32.9 34.1 35.2 36.3 37.1 38.8 40.3 41.6 42.8 43.8 45.3 45.8 46.5 46.9 46.8 46.4 46.5 47.1 47.2 47.6

10.0 8.2 7.6 7.8 7.7 8.1 8.5 8.4 8.3 8.3 8.3 8.1 7.7 7.7 7.5 7.5 7.7 7.7 7.8 7.8 8.1 8.3

37.9 37.8 38.9

168.9 166.5 174.5

Manufacturing 47.6 46.3 47.8

Service (A) 107.7 107.6 105.8

Service (B)

Relative labor productivity

99.1 101.1 87.9

Other 5.1 5.4 5.3

16.3 16.3 16.0

22.0 21.0 20.0

Service Primary Manufacturing (A)

Share of employment

48.3 49.0 50.0

Service (B)

8.1 8.3 8.6

Other

Notes: 1 Service (A) is composed of wholesale and retail trade industries and accommodation and food service industries. 2 Service (B) is composed of service industries other than Service (A). Sources: The value-added data are from ecos.bok.or.kr, and the employment data are from KLI labor statistics, various years.

2019 2020 2021

Primary

Appendix 9  (cont.)

1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997

110.5 111.6 117.7 125.6 124.3 126.5 143.5 147.5 157.9 173.4 193.3 196.2 191.3 192.8 192.0

Share (1)

1

2

124.4 130.7 168.7 142.7 167.3 156.8 150.8 137.6 167.9 166.2 184.0 191.2 203.4 237.5 226.3 228.6

Share (2)

Employment share

51.0 49.1 49.3 49.0 50.4 55.8 54.5 51.5 51.0 49.7 48.7 45.9 41.5 42.5 41.4

79.6 80.7 80.2 79.3 76.8 72.8 72.9 72.8 73.9 70.0 66.2 65.9 66.1 64.2 60.4

Capital Labor 1 productivity intensity1 64.1 60.9 61.4 61.9 65.6 76.7 74.8 70.7 69.1 70.9 73.6 69.6 62.8 66.3 68.5

Total factor productivity1

Wage level2

4.0 4.6 5.3 4.8 4.8 5.2 5.9 6.7 6.2 6.7 6.9

Large enterprises

0.7 0.8 0.8 0.7 0.7 0.9 0.8 0.8 0.7 0.8 0.9

SMEs

17.2 14.9 14.9 14.6 17.4 12.7 11.6 11.2 17.9 12.3 14.4

Relative

R&D intensity1

Appendix 10  Productivity-related indicators of small and medium-sized enterprises relative to large enterprises, 1982–2020 (percent)

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

204.2 230.4 241.6 262.0 275.7 280.3 260.4 267.6 262.4 277.6 270.3 277.7 287.9 280.7 276.0 288.2 293.0

Share (1)

248.4 246.1 287.7 314.1 293.8 280.8 342.9 345.5 333.9 360.1 320.4 329.4 272.3 303.0 312.6 303.4 331.4

Share (2)

Employment share

Appendix 10  (cont.)

41.9 37.3 38.1 37.1 35.0 36.0 34.0 35.9 35.9 33.7 32.8 33.4 28.7 29.3 30.1 30.3 32.6

Labor productivity 51.5 48.8 49.3 48.9 50.0 50.7 53.1 53.7 54.0 52.5 53.5 54.6 52.6 51.8 52.2 51.4 53.1

Capital intensity 81.2 76.5 77.4 75.9 69.9 71.1 64.1 66.8 66.5 64.1 61.2 61.2 54.6 56.5 57.7 59.1 61.5

Total factor productivity 66.6 64.5 65.0 65.9 62.2 60.9 57.2 57.6 59.9 58.4 55.4 57.6 54.8 53.8 54.1 53.8 53.2

Wage level 6.3 6.0 6.8 7.4 7.4 8.5 8.4 9.3 9.9 9.8 9.0 9.6 9.6 10.0 11.4 13.0 14.5

Large enterprises 0.9 0.9 1.3 2.3 2.3 2.0 1.8 1.8 2.4 2.9 3.1 3.1 3.0 3.2 3.6 3.5 3.5

SMEs

15.7 19.7 30.6 30.8 22.9 21.8 19.7 23.9 29.4 34.6 32.4 30.9 32.2 32.0 27.2 24.1 24.0

Relative

R&D intensity

287.4 293.0 289.9

324.2 303.2 302.3 303.1 291.2 283.5

35.9 35.6 33.5

55.6 55.5 54.5

64.7 64.1 61.5

54.5 54.9 56.2 53.1 55.5 57.8

15.0 15.5 16.5

3.6 3.7 3.8

23.6 23.3

Notes: 1 The numbers are for manufacturing and mining sectors. 2 The numbers are for all industries. Sources: Employment share (2) is from kosis.kr. Wage is from index.go.kr. Others are from Kim Won-gyu (2020).

2015 2016 2017 2018 2019 2020

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Index

Abe cabinet, 407, 419 Abe Shinzo, 317, 415 Acemoglu, Daren, 14 Act on the Special Measures for the Promotion of Venture Businesses, 188 administrative guidance, 244, 253 Africa, 34 aging, 12, 195, 363, 377, 389, 392, 396, 397 Agricultural Revolution, 21 Aguiar, Mark, 270 aid, 14, 62, 72, 77, 92, 94, 111, 113, 123, 159 authority, 68, 72, 76, 97 donor, 1, 3 economic, 67 grants-in, 1, 61, 67 military, 54 recipient, 1 AMF, 244, 247, 253 anachronism, 58, 223 anticommunism, 54, 64, 119, 207, 209 anticommunist, 64, 207, 220 aristocrats, 24 armistice, 52, 54 ASEAN, 406 Asian Monetary Fund. See AMF Asia-Pacific affairs, 253 assassination, 60, 132, 133, 212 asymmetric relationship, 163, 179, 252 automation, 229, 322, 350, 352, 353 Baekje, 22 Bahl, Roy, 92 bail-in, 245, 249, 253, 259 bailout, 125, 241, 245, 249 balance of payments, 113, 115, 118, 120, 137, 180 balanced budget, 300 balanced budget multiplier, 302 Balhae, 23 Bandung Conference, 55

Bank for International Settlements, 181, 241, 286 Bank of Korea. See BOK Bank of Korea Act, 53, 97, 285 bankruptcy procedure, 240, 331 bargaining power, 26, 27, 43, 187, 349, 372, 380, 382, 386 Basic North–South Agreement, 420 Basic Old-Age Pension, 391, 392, 394 basket case, 10, 68 basket control, 176, 194 Beijing, 223 Bell, Clive, 6 Biden administration, 317 big business, 63, 70, 171, 257 Bloch, Marc, 32 blue-collar workers, 202, 217, 220 BOK, 53, 77, 97, 136, 141, 148, 151, 153, 187, 265, 285, 296, 299, 305, 307 boss politics, 226, 334 bottleneck, 15, 113, 115, 118, 120, 137 bourgeois, 31, 217, 219 brain drain, 183, 321, 401 brand names, 189 breach of trust and misappropriation, 335 Bretton Woods system, 124, 251 Brexit, 403 Britain, 5, 8, 32, 35, 37, 118, 403, 415 broadband internet network, 186 bubble, 16, 276, 340, 400 bureaucratic state, 24, 33 bureaucrats, 16, 27, 31, 40 business cycle, 16 business swaps, 262 cadastral survey, 27, 41, 43 Camdessus, Michel, 239, 257 Candlelight Revolution, 300, 305, 333, 381, 382 capital control, 157, 251, 299

465

466 Index capital gains, 126, 131, 151, 203, 204, 206, 212, 231, 278, 288, 336, 337, 357, 362 capital inflow, 154–157, 197, 254, 260 capital losses, 288, 289, 337 capital market imperfections, 75, 160 capital market opening, 149, 154, 155, 260, 276, 289, 291, 295 capital outflow, 157, 313, 314 capital share of income, 364, 378, 384, 386 capitalism, 8, 56, 58 crony, 259 golden age, 56–58, 129, 144, 405 sprout, 33 Carter administration, 135, 210, 221 catch-up, 56, 144, 185, 190, 228, 274, 322, 406 chaebol, 18, 19, 68, 125, 131, 151, 171–178, 187–197, 205, 213, 219–221, 226, 233, 235, 248, 252, 259, 262–264, 270, 326, 329–337 bankruptcy, 177, 196, 240, 241, 262 basket control, 176 concentration of economic power, 176, 188, 190–194, 196, 205, 262, 330 cross-guarantee of loans, 194, 196, 262, 263 cross-shareholding, 193, 194 external capital market, 173, 189 generic capability, 75, 171, 174, 195, 331 global players, 188, 189, 330 interlocking ownership, 173, 176, 262, 333, 336 internal capital market, 75, 171, 172, 189, 263, 276, 331 internal labor market, 173, 189, 263 related diversification, 75 related transaction, 173, 174, 176, 195, 262, 333 republic, 192 unrelated diversification, 75, 262 Chang Myon, 83, 90 Changweon Machinery Complex, 164 charisma, 49, 70 Chiang Kai-shek, 87, 204 China, 4, 11, 24, 28–38, 55, 85, 144, 224, 225, 229, 274, 299, 341, 401, 406, 410, 411, 413 Choi Gyu-ha, 133 Choi Sung-No, 190 Chun Doo-hwan, 12, 131, 133, 150, 152, 184, 186, 191, 212, 225, 231, 252

Chung Ju-yung, 172, 331 Chungcheong Bank, 367 citizens’ movement, 233, 258 claim right money, 116 Clark, Gregory, 26 climate change, 306, 403, 404 Clinton, Bill, 244 Clinton administration, 250 Cold War, 49, 53, 61, 67, 135, 144, 224, 225, 253, 403, 412 alliance, 81, 115 collaborators, 45, 51, 117, 222 collateral, 68, 73, 127, 205, 279, 281 college attendance ratio, 184, 229, 320, 363, 369, 371 college wage premium, 229, 230, 363 colonial government, 38, 45, 49, 69 colonies, 6, 7, 28, 31, 58 colonization, 5, 31, 35, 37, 60, 118 Columbus, Christopher, 30 commanderies, 22 commerce, 27, 30 commercial bank, 73, 74, 78, 98, 128, 156, 171, 270 commercial papers, 196, 197, 239 commercialization, 33 Committee for the Preparation of Korean Independence, 49 commodities, 16, 79 communism, 54, 55, 57, 58, 119, 418 communist, 49, 50, 53, 57, 58, 65 confederated kingdoms, 22 Confucian legacy, 80 Confucianism, 24 constitution, 54, 59, 62, 64, 194, 209 construction investment, 18, 142, 143, 145, 147 consumer goods industries, 162 consumer price index. See CPI continuous all-time jobs, 376, 377 coordination failure, 68, 75, 96, 160, 175 coronavirus, 19, 305, 388 corporate governance, 176, 195, 259, 262, 332, 333, 335, 337, 353 Corporation Law, 41 coup, 10, 36, 60, 83, 90, 94, 129, 133, 171, 207, 221, 250 Cow-Bone Towers, 82, 371 CPI, 97, 103, 285, 296, 307 credit cards, 281 credit rationing, 73, 99, 165

Index 467 cronyism, 63, 70, 74, 109, 114, 117, 176, 219, 244, 250, 251, 255, 257, 334, 335, 339, 382 cultural industries, 325, 327, 401 cultural rule, 44 Cumings, Bruce, 222 curb market, 74, 99, 100, 103, 125, 128, 173, 196, 282 currency crisis, 3, 4, 16, 123, 138, 149, 155, 157, 222, 240, 241, 246–248, 253, 254, 256, 260, 261, 266, 270, 272, 274, 283, 287, 290, 291, 293, 294, 298, 337, 403, 417 currency mismatch, 294 currency swap, 4, 11, 296, 298 current account, 98, 113, 115, 123, 130, 138, 145, 248 deficit, 98, 113, 115, 123, 127, 129, 130, 133, 137, 138, 140, 142, 150, 154, 156m 162, 242, 289 surplus, 131, 139, 141, 142, 148, 243, 246, 283, 286, 289, 292, 293, 296, 299, 312 Daewoo, 329 debt service ratio, 127 debt-equity ratio, 124, 125, 126, 129, 131, 151, 152, 178, 192, 246, 263, 265, 276, 346–348, 350, 355 debt-to-income ratio. See DTI ratio decentralized decision-making, 152, 178, 193, 388 decolonization, 6 deflation, 19, 299, 300, 303–305, 307, 400 democracy, 7, 54, 88, 145, 220, 223, 225, 258, 412 consolidation, 8, 334, 357, 415 liberal, 8, 50, 419 democratization, 7, 12, 19, 89, 140, 141, 146, 149, 184, 187, 188, 192, 194, 195, 197, 198, 210, 214, 216–238, 266, 308, 327, 335, 339, 382, 412, 418, 420 economic, 194 Deng Xiaoping, 224 dependency ratio, 139, 284, 398 old-age, 139, 232, 397 young-age, 139, 397 deposit insurance system, 265 deregulation, 197, 251, 268, 276, 294, 342, 344 development economics, 6, 416 Digital New Deal, 306

direct investment overseas, 141, 344, 380 directed credit, 97, 197 disguised workers, 217, 223, 235 disinflation, 18, 76–78, 81, 92, 94, 97, 99, 100, 132, 134, 137, 138, 151, 178, 181, 196, 206, 211, 212, 400 dispatched workers, 267, 364, 371, 372, 374–377, 381, 387, 388 disposable income, 139, 283, 357, 358, 391 dividends, 285, 300, 361, 383, 385 Doha Round, 403 domestic cohesion, 20, 416, 417, 419, 422 domestic demand, 4, 78, 85, 111, 142, 143, 159, 163, 164, 168, 226, 298, 317 domestic financial crisis, 240, 248, 254, 261, 266, 268, 269 domestic market, 78, 111, 113, 114, 165, 169, 181, 251, 252, 341, 403 downstream activities, 69, 75 DRAM, 156, 186, 189, 317, 415 DTI ratio, 281, 300 dual price system, 202, 211 duplicity argument, 247 dynastic cycles, 32 Earned Income Tax Credit, 392, 394 East Asia, 13, 28, 31, 32, 35, 81, 137, 203, 244, 248, 250, 253, 411, 412 East Asian Miracle, 2, 28 East Germany, 224 Eat and Run Foreign Capital, 337 Eatwell, John, 249 Eckert, Carter, 222 economic bureaucracy, 87, 90, 300, 302 Economic Planning Board, 87, 187 Economic, Social, and Labor Council, 388 economies of scale, 114, 163, 168, 173, 229, 353, 401 education, 66, 76, 79, 80, 82, 88, 95, 121, 161, 164, 184, 210, 211, 216, 319, 320, 398 college, 82 effective competition, 114 effective rate of protection. See ERP Eichengreen, Barry, 11, 273 elites, 32, 34–36, 51, 88, 99, 117, 118, 193, 194, 217–220, 222, 227, 234, 256, 340, 382, 416, 417 EMCs, 288, 290, 292, 296, 299 emergency decree, 11, 122, 128, 129, 131, 164, 177, 346 emerging market countries. See EMCs

468 Index employment insurance, 232, 269, 377, 390 employment rate, 368 youth, 370 entrepreneurs, 68, 325, 338 entrepreneurship, 59, 88 equity capital, 99, 124, 173, 195, 196 ERP, 111, 165, 178, 180 Eurasian continent, 21, 24, 57 Europe, 5, 13, 26, 31, 34, 56, 60, 162 Eastern, 51 medieval, 27 European Miracle, 28, 29 European Union, 382 exchange rate, 4, 15, 73, 78, 124, 130, 133, 142, 157, 161, 243, 246, 285, 289, 293, 296 effective, 107, 109 floating, 286, 293 manipulating, 142 market average, 154 multiple, 78, 104 multiple basket peg system, 133, 138, 154 official, 78, 104, 107 real effective. See REER reform of 1964, 84 ex-colonies, 6, 14, 15, 47–49, 53, 55, 56, 58, 59, 61, 70, 119 export dollar premiums, 78, 104, 107 export promotion, 77, 103, 104, 108, 109 export ratio, 111 export subsidies, 78, 107, 127, 138, 169 export targeting system, 108 export-oriented industrialization, 14, 84, 85, 104, 109, 111, 113, 159, 162, 168, 212, 253 Fabian Socialism, 58 facility investment, 144, 145 factor-price equalization, 212 failed states, 1, 14, 58 fair trade, 179, 187, 262, 350 Fair Trade Commission, 187, 193, 196, 240, 329 Fair Transactions in Subcontracting Act, 187, 349 Fairbank, John King, 10 fallow system, 25 Far East, 35, 37 Foroohar, Rana, 337 fascism, 58

FDI, 19, 98, 155, 171, 277, 281, 337, 342, 344, 346, 401 Greenfield, 342 M&A, 342 Federal Reserve Board, 53, 297, 337 Federation of Korean Industries, 177 Federation of Korean Trade Unions. See FKTU Feldstein, Martin, 254 financial account, 154, 288 financial distress, 269, 345 financial industry, 327 financial policy, 15, 73, 78, 97, 98, 99, 136, 140, 152, 164, 178 financial supervision, 153, 265, 294 Financial Supervisory Service, 265, 294, 358 financialization, 251, 327 fire sale, 270, 289, 336, 343 firm-finance nexus, 123, 124, 150, 152, 273, 282, 309 First Oil Shock, 129, 135, 164, 225 First World War, 5, 39, 41, 56, 405 fiscal account consolidated, 301–304 management, 302–304, 393 structural, 302 fiscal balance, 77, 90, 92, 94, 96, 136, 148, 302, 306 fiscal deficit, 108, 148, 211, 300, 304, 306 fiscal independence, 92, 95 fiscal policy, 15, 19, 77, 92–96, 134, 164, 297, 300, 302–304, 307, 308 fiscal retrenchment, 97, 136, 147, 178, 212, 303, 308 fiscal situation, 240, 241, 295, 301, 302 fiscal soundness, 148, 300, 302, 308, 395, 397–399 Five-Year Economic and Social Development Plan Sixth, 148, 212 Five-Year Economic Development Plan First, 91, 94, 161 Second, 162, 165 FKTU, 207, 213, 227, 237, 376, 388 foreign debt, 11, 123, 127, 129, 130, 139, 141, 142, 146, 241, 245, 294, 295 short-term, 130, 137, 157, 242, 243, 246, 249, 290, 291, 295, 298, 312 foreign direct investment. See FDI foreign exchange market, 246, 282, 286, 297, 298, 312, 395

Index 469 foreign exchange stabilization bond, 396 foreign intervention, 36, 39, 416 Foreign Investment Committee, 277, 342 forward exchange, 293 Framework Act on Small and Medium-Sized Enterprises, 174 France, 8, 252, 417 Free Economic Zones, 344 free trade agreement, 382, 403 French Revolution, 8 friendly M&A, 263, 343 Gaddafi, Muammar, 225 Gandhi, Mahatma, 60 Gangnam, 204 GATT, 57, 111, 163, 179, 179 Article XI nation, 180 general account, 393, 395 General Agreement on Tariffs and Trade. See GATT George, Henry, 204 Germany, 59, 304, 317 Gini coefficient, 231, 232, 358–361, 383 global financial crisis, 4, 11, 276, 292, 293, 296 global imbalance, 292 global supply chains, 318 globalization, 13, 57, 144, 190, 228, 299, 301, 344, 363 financial, 253, 403 first, 5, 6 second, 57, 85, 410 Goguryeo, 22, 23 good old days, 39, 56 Gopinath, Gita, 270 Goryeo, 23, 24, 27, 34, 61 governance structure, 153, 327, 335 government bureaucracy, 70, 87, 91, 268 government debt, 306, 394, 395 government expenditure, 92, 94, 147, 297, 301, 302 economic affairs, 135, 147, 389 economic services, 92 health and social protection, 206, 269, 389 retrenchment, 134 social services, 95 welfare, 147, 269 government failure, 69, 339 government intervention, 14, 69, 85, 91, 152, 160, 178, 213, 339

government research institutes, 164, 170, 182, 183, 319, 353 government revenue, 39, 92 Great Asian Co-Prosperity Sphere, 41 great convergence, 13, 15, 84, 411 Great Depression, 6, 39, 41, 56, 251, 299, 405 great divergence, 13, 15, 28, 411 Great Leap Forward, 60 Great Recession, 272, 299 Greece, 275, 397 green growth, 404 Green New Deal, 306, 404 Group of 20. See G20 growth momentum, 17, 294, 316, 344, 370 growth with equity, 12, 199, 201, 203, 261, 357, 364 G20, 2, 297 summit, 2, 9, 297 Guidotti–Greenspan Rule, 291 Gumi Electronics Complex, 164 gunboat diplomacy, 5, 30, 35 haircut, 250 Han Dynasty, 22 Hangeul, 25, 80 Heavy and Chemical Industry (HCI), 41, 162, 165, 169, 174, 177, 202, 216, 339 hedge funds, 270, 293, 336, 337 hegemonic stability, 57 hegemony, 13, 34, 57, 60, 251–253, 256, 411 helicopter money, 306 Hermit Kingdom, 25, 35 hierarchy, 202, 212, 216 historical legacy, 6, 200, 201, 389, 413, 414 Ho Chi Minh, 55, 58 Hobsbawm, Eric, 8 holding company, 263, 327, 333, 336 Holland, 30 Hong Gi-Seok, 276 Hong Kong, 7, 8, 58, 85, 204, 215, 244, 344, 413 Hong Minki, 199 hostile M&A, 263, 343 hostile takeover, 336, 337 household debt, 309–311, 313 household loans, 281, 282, 284, 300, 345, 362 housing, 142, 143, 147, 151, 202, 204, 231, 279, 300, 395, 397 Human New Deal, 306 human resource, 79, 164, 183, 184, 322, 339

470 Index Huntington, Samuel, 8, 66 Hyundai, 3, 172, 186, 189, 235, 329 Hyundai Construction Corporation, 3, 331 Hyundai Engineering & Construction Company, 331 Hyundai Motors, 332, 366, 387 Icahn, Carl, 336 ICT, 144, 185, 186, 188, 325, 401 ILO, 237, 370, 382 core conventions, 382 IMF, 7, 11, 57, 124, 127, 133, 240, 244, 247, 249, 266, 269, 291, 293, 296 conditionality, 19, 239, 245, 253, 255–259, 261, 270, 296, 419 Oil Facility, 130 standby agreement, 124 IMF-Plus, 245 imperialism, 5, 6, 8, 30, 35, 58, 61 import ratio, 111, 246 import-source diversification policy, 180, 253, 316 import-substituting industrialization, 68, 72, 74, 76, 85, 113, 161, 168 incomes policy, 136, 141, 146, 148, 210 India, 34, 48, 55, 59, 60, 85, 144, 224, 406 indicative plans, 91 Indochina, 36 industrial accident insurance, 148, 215, 232, 269 industrial accident ratio, 215 industrial complexes, 96, 164, 175 industrial policy, 18, 19, 37, 73, 103, 129, 131, 158–171, 178, 186, 306, 325, 339, 401 cost, 170 horizontal, 161, 163, 164, 178–181, 183, 193, 315 vertical, 160, 163, 165, 178, 189, 193, 315 industrial relations, 57, 63, 207, 213, 227, 234, 236, 266, 378 politicization, 214, 216, 235 Industrial Revolution, 5, 7, 21, 30 industrialization, 16, 31, 43, 44, 47, 73, 121, 139, 198, 201, 203, 219 industry-specific skills and knowledge, 195, 331 inequality, 17, 18, 19, 44, 59, 82, 132, 143, 198, 201, 204, 210–214, 218, 220, 228–231, 233, 234, 301, 356–358, 361–364, 371, 378, 383, 385, 386, 389 disposable income, 361, 389

market income, 12, 357, 359, 360, 361, 363, 389 infant industry, 161, 163, 169, 179, 189, 193 inflation, 16, 72 double-digit, 90, 96, 98, 99, 107, 109, 123, 130 galloping, 53 resumption, 96, 98, 99, 107, 109 return, 140 inflation rate, 52, 53, 74, 76, 77, 90, 97–100, 103, 108, 127, 129–131, 133, 137, 138, 140, 142, 145, 146, 164, 285, 286, 296, 299, 304, 305, 307, 308 inflation targeting, 285 information and communication technology. See ICT in-house R&D institutes, 182, 183 input-driven growth, 149 insolvency, 281, 392 intellectual property investment, 143, 146 interest coverage ratio, 125, 126, 129, 131, 150–152, 178, 192, 265, 309, 346, 349 interest rate, 103, 123, 128, 132, 133, 146, 151, 196, 246, 269, 304, 395 base, 300, 307, 310, 313 double-digit, 154 liberalization, 140, 152 market-clearing, 74, 78 official, 78 real, 74, 99, 100, 103, 107, 164, 276 international economic order, 13, 17, 251, 299, 405, 410 International Institute for Management Development, 183, 321 International Labor Organization. See ILO International Monetary Fund. See IMF international organizations, 7, 57 international reserves, 130, 137, 242, 243, 245, 283, 288, 290, 291, 293, 295, 299, 312, 396 investable fund, 91, 99, 100, 103, 125, 152, 214 investment bank, 270, 271 investment coordination, 150, 151, 191 investment income, 383, 408 investment rate, 68, 83, 98, 122, 123, 139, 145, 146, 249, 273–276, 283, 285, 286, 290, 331, 338, 340, 342, 345 Iran, 225 Israel, 67, 318, 341 Italy, 275

Index 471 Japan, 4, 5, 11, 24, 32, 36, 38–47, 60, 72, 98, 115, 116, 118, 137, 154, 161, 162, 169, 175, 179, 181, 222, 244, 247, 252, 253, 275, 317, 405, 413, 414, 419 Japan bashing, 419 Japanese Empire, 46, 117, 222 job-sharing, 366 Johnson, Chalmers, 82, 161 Johnson, Simon, 250 Jones, Leroy, 88 Joseon, 22, 24, 27, 33–36, 39, 416 June 29 Declaration, 218, 223, 227 junta, 83, 87, 88, 90, 94, 96–98, 171, 192, 207, 285, 334 Kang Gyeong-sik, 244 Kantor, Mickey, 252 KCTU, 237, 267, 366, 388 Kia Motors, 387 Kim Dae-jung, 239, 256–259, 262, 264, 266, 268–270, 276, 278, 280, 281, 315, 316, 326, 328, 332, 334, 338, 342, 362, 363, 391, 392, 418, 420, 421 Kim Gu, 50 Kim Jong-il, 359, 421 Kim Nak Nyeon, 199, 359 Kim Won-gyu, 350, 354 Kim Young-sam, 145, 155, 156, 184, 188, 192, 194, 196, 197, 226, 233, 239, 243, 316, 326, 334, 338 Kindleberger, Charles, 57 Kishi Nobusuke, 117, 415 Kishida Fumio cabinet, 416 Korea Asset Management Corporation, 395 Korea Development Bank, 73, 98, 100, 103, 164 Korea discount, 336 Korea Exchange Bank, 337 Korea Securities Dealers Automated Quotation. See KOSDAQ Korean CIA, 88, 209, 221 Korean Confederation of Trade Unions. See KCTU Korean New Deal, 306 Korean Provisional Government, 44, 50, 55 Korean Time, 114 Korean War, 3, 10, 14, 47, 48, 51, 53, 56, 59, 61–63, 66, 222 Korean Waves, 325 KOSDAQ, 188, 276, 340 KT&G, 336

Kuznets, Simon, 201 Kwangju Uprising, 133, 221, 222 Labor Agency, 208 labor market dualism, 19, 203, 357, 363–365, 371–373, 375, 377, 386, 387, 390, 398, 402 labor market externality, 68, 75, 160 labor market flexibility, 237 labor movement, 63, 217, 227, 234, 237, 267 labor rights, 56, 61, 63 labor share of income, 19, 357, 363, 378, 380–383, 386 Labor Standard Act, 64, 207, 208, 237, 267, 366 Laffer Curve, 297 land reform, 56, 64, 65, 67, 82 landlords, 16, 26, 43, 44, 65 large enterprises, 62, 174, 186, 187, 213, 229, 230, 235, 236, 346–348, 350, 352, 353, 355, 372, 374, 375, 381, 386, 402 Latin America, 6 layoffs, 267, 268, 336, 352, 366, 367, 376, 381, 396 Lee Byung-chul, 172 Lee Byung-hee, 383 Lee Chong-Sik, 48 Lee Gyu-seong, 258 Lee Jae-yong, 333, 334 Lee Kuan Yew, 87 Lee Myung-bak, 1, 4, 295, 298, 333, 376, 391, 421 Lee Sangwoo, 276 legal profession, 335 legal services, 328 lender of last resort, 247 LG, 186, 189, 329 liberalization, 152, 154, 178, 179, 186, 188, 192–194, 196, 197, 249, 251, 252, 257, 264, 268, 290, 316, 335, 362 liberation, 14, 47, 52, 62, 63, 66, 67, 79 Libya, 225 License Raj, 59 Lilley, James R., 223 Lindauer, David, 211 Lipset, Seymour M., 88 liquidity, 100, 140, 196, 197, 239, 242, 244, 246–250, 253–256, 281, 290, 295, 296, 298, 312 liquidity constraint, 140, 284 literacy ratio, 79

472 Index loan-to-value ratio. See LTV ratio lobbies, 156, 197, 249 local trade, 27, 33 Locke, John, 65 Lone Star Funds, 337 long-distance trade, 27, 30, 37 LTV ratio, 281, 300 lump-sum investment, 189, 326 Lyuh Woon-hyung, 49 macroeconomic populism, 146–148, 226 macro-prudential measures, 298, 312 Maddison project, 37, 38, 84, 405 Maddison, Angus, 26 Made in China policy, 317 Manchukuo, 117, 223 Manchuria, 22, 46 Manchurian Incident, 41 Mao Zedong, 65 March First Movement, 44, 82, 220 market failure, 68, 69, 75, 152, 160, 171, 188, 338 market-friendly view, 14 market institutions, 47, 69, 331, 338 Mason, Edward S., 47 McCarthyism, 257, 421 McCartney Mission, 32 medical services, 328 Meiji Restoration, 32, 86 mercantilist system, 30 merchant banks, 155, 156 mergers and acquisitions, 191, 342 merit-based examinations, 25, 40, 398 metal movable types, 24 Mexican crisis, 248 Mexico, 397 middle class, 88, 147, 216–221, 226, 256 middle-income trap, 10, 272 Mill, John Stuart, 65, 114 Ming Dynasty, 28, 29 minimum wage, 301, 304, 388 Minister of Finance and Economy, 156, 244, 258, 285, 294 Ministry of Economy and Finance, 302, 307, 308 Ministry of Employment and Labor, 209, 374 Ministry of Finance, 97, 153, 155, 156, 233, 328 Japanese, 244

Ministry of Finance and Economy, 153, 157, 265 Ministry of SMEs and Startups, 340 Ministry of Trade, Industry and Energy, 342 minority shareholders, 176, 195, 262, 333, 336 Miracle on the Han, 140 MITI, 161 Mitsuzuka Hiroshi, 244 modernization school, 89, 218 monetary base, 96, 141, 286 monetary policy, 15, 96, 127, 131, 143, 148, 204, 308 Monetary Policy Committee, 285 Monetary Stabilization Bond, 136, 141, 286 Monopoly Regulation and Fair Trade Act, 187, 193, 194 Monthly Export Promotion Conference, 108 Moon Jae-in, 300–302, 307, 328, 333, 349, 362, 377, 382, 387, 391, 392, 394, 397, 419, 421 moral hazard, 247–249, 265 multilateral trade order, 403, 409 multinational corporations, 171, 252 Mutual Defense Treaty, 54, 412 Myanmar, 225 Nakasone Yasuhiro cabinet, 222 Naksungdae Institute of Economic Research, 42 national account, 92, 199, 358, 359 National Assembly, 62, 90, 194, 227, 237, 267, 334, 349, 382, 402, 421 National Basic Living Security Act, 269, 392, 394 national health insurance, 148, 206, 231, 269 National Health Insurance Service, 358, 387 national information super-highway, 186 national liberation movement, 6, 8, 45, 55, 60, 119, 421, 422 National Pension Service. See NPS National Statistical Office. See NSO National Tax Service, 358, 385 nationalization, 62 navigation revolution, 29 NBFIs, 153, 173, 196, 197, 239, 265 Nehru, Jawaharlal, 55, 60 neo-Confucian literati, 33 neo-Confucianism, 27, 34

Index 473 Neolithic Revolution, 5 net capital gains, 288, 312 net foreign assets, 141, 148, 283, 286, 287 net international investment position. See NIIP New Community Movement, 202 New Dealers, 57 newly industrializing countries, 190 NIIP, 283, 287–289, 312 Nixon administration, 135 Nkrumah, Kwame, 60 non-banking financial institutions. See NBFIs non-performing loans. See NPLs non-regular workers, 266, 364, 371–374, 376, 377, 381, 387, 388, 390 North Korea, 14, 38, 66, 86, 223, 225, 412, 421 Northeast Asia, 31, 115, 327, 411 NPLs, 126, 136, 150–154, 157, 178, 192, 195–197, 238, 248, 263, 264, 266, 268, 273, 282, 309, 330 NPS, 232, 269, 333, 334, 390, 393 NSO, 350, 355, 358, 368, 372, 373, 397 Obama administration, 250 OECD, 1, 2, 7, 9, 155, 180, 237, 243, 250, 272, 284, 299, 301, 306, 319, 343, 361, 382, 389, 391, 397 Development Assistance Committee (DAC), 1, 3, 7 South Korea’s membership, 3, 9, 155, 157, 237, 277, 342 Olympic, 9, 140, 223, 224 opinion leaders, 258, 259 Opium War, 35 Organization for Economic Cooperation and Development. See OECD Organization of Petroleum Exporting Countries, 138 oriental despotism, 57 Oriental Development Company, 41, 43 overgrowth, 3, 12, 142, 273, 274, 275 overinvestment, 16, 274 pandemic, 11, 272, 299, 305–307, 328, 349, 388, 405, 406 Park Chung Hee, 11, 83, 86, 131, 152, 172, 186, 202, 204, 206, 221, 233, 300, 339 Park Geun-hye, 299, 305, 333, 340, 362, 376, 381, 394, 421

peasant revolt, 33, 36 peasant war, 36, 37, 39 peasants, 16, 26, 27, 31, 44, 45, 47, 65, 66, 82 pension eligibility age, 393 people’s committees, 49, 55, 62, 222 The Period of Enlightenment, 36 Perkins, Dwight H., 45 Peterson Institute for International Economics, 332 platform workers, 390 Plaza Agreement, 138 policy loans, 97, 99, 100, 164, 165, 339 political crisis, 12, 77, 122, 132, 223 political economists, 84 political fund law, 194, 234, 334 Pomeranz, Kenneth, 13, 28 population density, 26 populism, 146–149, 226, 410 portal firms, 341 portfolio investments, 293 position requirement, 294 poverty, 1, 6, 82, 198, 199, 201, 211, 214, 216, 228, 391 PPP, 107, 108, 109 price discrimination, 169 price flexibility, 267, 366 Prichett, Lant, 12 private enterprises, 56, 171, 188, 203, 219, 316, 333, 365, 372, 401 private equity fund, 271, 336 private violence, 209, 235 privatization, 61–63, 73, 75, 152, 171, 268 producer goods industries, 162, 164, 168 property right, 40, 61, 64, 89, 339 protectorate, 37, 39, 118 Przeworski, Adam, 89 public assistance, 206, 269, 391 public expenditure on families, 397 public fund, 240, 264, 329, 395 public opinion, 172, 194, 236, 258, 334 purchasing power parity. See PPP Qing Dynasty, 28, 32, 34, 411 quantitative easing, 306 quantitative restrictions, 73, 104, 109, 111, 180 quantity flexibility, 267, 366 R&D, 143, 161, 170, 181, 183, 186, 189, 318–321, 330, 339, 349, 351, 352, 401 radicalization, 45, 222, 223

474 Index rapprochement, 115, 225, 420, 421 Reagan, Ronald, 221, 223 Reagan administration, 135, 137, 222, 223, 253 real estate, 41, 73, 97, 127, 203, 220, 234, 300, 361 prices, 131, 151, 152, 204, 205, 210, 214, 231, 281, 284, 361, 362 regulation, 143, 231, 233 speculation, 204, 206, 212, 231, 300 real name financial transaction system, 233 rediscount, 73, 78, 97, 108, 187 redistribution, 89, 95, 232, 357, 361, 362, 389 REER, 104, 107, 109, 113, 123, 129, 138, 142, 181, 286, 316 reform from above, 31, 36, 416 regulated industries, 325, 327 regulation, 129, 169, 189, 194, 197, 234, 251, 281, 333, 336 Reischauer, Edwin, 9 relative deprivation, 198, 214, 220 rent-seeking, 70, 114 research and development. See R&D retained profits, 300, 361, 383, 385 return on assets, 346 reverse course, 117 revisionist school, 222 revisionist view, 14, 84 revolution, 8, 10, 21, 29, 30, 39, 48, 56, 57, 65, 66, 76, 80, 82, 89, 116, 194, 203, 207, 217, 221, 223, 224, 233, 235, 382, 422 Rha Woong-bae, 156 Rhee Syngman, 50, 51, 54, 65, 68, 69, 86, 116, 171, 421 righteous army, 34, 37 right-wing leaders, 50, 55, 59 risk-management ability, 260, 291, 295 Robinson, James A., 14 Rodrik, Dani, 260 Roh Moo-hyun, 281, 327, 332, 334, 344, 362, 376, 392, 394 Roh Tae-woo, 143, 145, 147, 184, 192, 218, 225–227, 231, 233, 420 Rome, 29 rule of law, 8, 89, 209, 213, 235, 334, 335 rule-based order, 318, 415, 419 rural–urban income gap, 211 rural–urban migration, 81, 159 Russia, 11, 37, 56, 118, 415

Russian Revolution, 8 rust belt, 409, 410 Sachs, Jeffrey, 59 Sakakibara Eisuke, 244 Sakong Il, 88, 174, 190 Samsung, 172, 189, 329, 333, 381 Samsung Electronics, 186, 330 San Francisco Peace Conference, 116 Saudi Arabia, 225 saving rate, 98, 123, 139, 283, 286 corporate, 283 household, 139, 140 net household, 283 savings banks, 282 Scheidel, Walter, 67 science and engineering, 320, 321, 401 science park, 182, 183 Second Oil Shock, 132, 133, 137, 138, 206 Second World War, 6, 21, 39, 46, 48, 58, 61, 163, 318, 405, 415 Sejong, King, 25 self-employed, 140, 282, 284, 306, 378, 383, 384, 390 self-insurance, 290, 293 semi-colonies, 5, 31 seniority-based wage, 268, 365, 367 Seoul, 2, 36, 37, 52, 54, 70, 140, 143, 150, 183, 204, 223, 224, 231, 413 Seoul National University, 321 service industries, 41, 74, 160, 315, 316, 322, 323, 325, 332, 342, 401 shock therapy, 261, 264, 265, 280 short-term profitability, 125, 131, 150, 151, 177, 178, 191, 196, 263, 265, 285, 330, 348 Silk Road, 28 Silla, 22, 24 Unified, 23, 27, 34 Singapore, 7, 8, 59, 85, 87, 204, 215, 304, 344 SK, 329, 336 skill-biased technological change, 228, 230, 319, 320, 363 slush funds, 137, 192, 234, 334 small and medium-sized enterprises (SMEs), 19, 94, 136, 172, 174, 175, 178, 186, 187, 189, 193, 203, 213, 229, 230, 282, 309, 326, 354, 345–356, 365, 371, 372, 374, 375, 390, 401, 402 social compact, 266, 376, 387 social democrats, 57

Index 475 social insurance, 148, 206, 232, 302–304, 389, 391, 396 social safety net, 215, 267, 269, 306, 355, 367, 377, 396, 398 socialism, 54–56, 95 socio-economic system, 28, 33 solvency, 197, 242, 243, 255, 290, 312 Song Dynasty, 26, 28 South China Sea, 411 Southeast Asia, 157 Sovereign Asset Management, 336 sovereignty, 5, 37, 38, 54, 412 Soviet Union, 45, 48, 51, 58, 60, 149, 224, 225 Spain, 275 special budget, 306, 308 speculation, 73, 278 Stalin, Joseph, 48, 51 startup, 188, 338–340, 342, 401 state capacity, 15, 30, 32–34, 39, 47, 69, 86, 89, 99, 169, 192–195, 197, 416 state enterprise, 125, 136, 171, 268 Stiglitz, Joseph, 250, 254, 255 strategic trade, 160 strike, 213, 217, 227, 236, 328, 367, 381 of capital, 334 general, 237, 267 wildcat, 209, 217, 227 structural adjustment, 150, 153, 192, 246, 267, 321, 326, 336, 345, 346, 348, 350, 352, 366, 380, 400 structural power, 252 student activism, 82, 184, 217 student activists, 217, 220–223, 225, 226 subcontracting, 172, 174, 175, 187, 189, 229, 349, 353, 355 subprime mortgage, 296 Subramanian, Arvind, 260 sudden reversal, 16, 242, 290 Sui Dynasty, 23 Summers, Lawrence, 12, 244 Sun Wen, 204 Supreme Court, 317, 415 Survey of Household Conditions, 358 Survey of Household Finances and Living Conditions, 358, 383, 360 Swadeshi movement, 60 systemic risk, 282, 400

Taiwan Strait, 411 Taizong, 23 Tang Dynasty, 23, 28 targeted industries. See TIs tariffs, 73, 104, 109, 180, 305 tax collection, 39, 108 corporate, 124, 165, 168, 178, 276, 297, 301, 308 deductions and exemptions, 73, 96, 135, 164, 165, 178, 181, 187, 300, 339 direct, 69 monitoring, 176 taxation data, 199, 232, 358, 385 Taylor, Lance, 249 technological capability, 170, 181, 316, 318, 346, 410, 415 technology targeting, 183 term mismatch, 197, 294 territorial ambition, 60 territorial dispute, 413, 414 TFR, 139, 396–399, 401, 403 Third World, 53–56, 144, 225 nationalism, 54, 56, 59, 85, 119, 224 Three Kingdoms, 22, 34 TIs, 162–171, 173, 176, 178, 180, 181 Tokugawa Shogunate, 28, 32, 34, 35 too big to fail, 177 top income shares, 200, 359, 360 total factor productivity, 149, 351–353 total fertility rate. See TFR trade balance, 111, 408, 414 trade deficit, 162, 181, 407, 408, 414 trade surplus, 179, 406–408 transparency, 19, 145, 194, 228, 233, 234, 258, 263, 281, 337, 353, 357 Treasury Bills, 289, 292, 409 tributary relationship, 23, 36, 37, 412, 413 trilateral military alliance, 413, 415 trilateral relationship, 162, 179, 317, 406 Tripartite Commission, 266, 376, 387 Trump, Donald, 301, 411 Trump administration, 409 trust account, 197, 239 trusteeship, 49, 50, 258, 260 Tullock, Gordon, 70 Turkey, 397

Taiping Rebellion, 33 Taiwan, 6–9, 41, 58, 59, 65, 67, 85, 87, 98, 204, 215, 304, 416

UIs, 165, 168, 170, 180 Ukraine, 11, 405 Ulsan Industrial Complex, 96

476 Index underemployment, 82, 120, 121, 215 undergrowth, 3, 12, 273, 275 UNDP, 7, 272 unemployment insurance, 148, 232 unemployment rate, 121, 199, 210, 211, 269, 364, 368 extended youth, 370, 375 non-farm households, 120 youth, 120, 370 unicorns, 342 unilateral measures, 409 unintended consequence, 59 union activists, 208, 216, 366 union rights, 64, 207, 209, 227, 238, 380 unionization rate, 207, 214, 235, 380, 382 unions, 45, 57, 90, 136, 202, 267, 352, 353, 366, 382, 386 company, 208, 209, 227 enterprise, 207, 209, 213, 386 government surveillance, 213 independent, 19, 63, 153, 207, 208, 212, 227–229, 234–238 industrial, 207, 209 multiple, 207, 227, 266, 267 United Nations, 50, 72, 416 United States, 1, 4, 10, 31, 35, 48–52, 57, 60–62, 67, 72, 80, 84, 94, 115, 118, 119, 132, 134, 137, 142, 162, 179, 183, 186, 210, 221, 222, 224, 244, 245, 249, 252, 255, 256, 263, 275, 288, 292, 298, 300, 317, 338, 341, 360, 397, 401, 411, 413, 418 untargeted industries. See UIs upstream activities, 69, 75 urbanization, 16, 33, 81, 121, 139, 198, 204, 362 US Treasury Department, 250, 251 usury, 82, 121 value chain, 16, 160, 175 venture business, 19, 188, 276, 326, 337, 339, 340 venture capital, 196, 326, 339, 340 venture certification system, 338 vertical division of labor, 119, 414 vested properties, 61, 62 vicious circle, 273 Vietnam, 40, 53, 55, 67, 115, 119, 120, 123, 224, 225 village markets, 27

virtuous circle, 83, 121, 122, 326 Volker Disinflation, 132 wage gap, 202, 212, 229, 363 wageworkers, 207, 236, 374, 377, 380, 390 Wall Street, 250, 251, 327 Wall Street−Treasury−IMF Complex, 251 walled town states, 22 warfare state, 30, 32, 33 Washington, 10, 50, 137, 221 Weimar Republic, 59 welfare expenditure, 20, 95, 147, 148, 206, 212, 232, 301, 302, 304, 308, 389, 393, 398 welfare state, 57, 95, 301 welfare system, 12, 20, 203, 206, 214, 231, 232, 269, 357, 362, 389, 392, 396 coverage, 389–392 sustainability, 389, 392, 393 white-collar workers, 202, 219 Wickham, John A., 221 Wittfogel, Karl, 57 Woo Jung-en, 222 working class, 19, 57, 209, 216, 217, 387 working hours, 64, 215, 398 World Bank, 2, 7, 12, 91, 118, 199, 244, 255, 272, 406 World Cup, 9, 150 world economy, 39, 112, 132, 137, 296, 404, 406 world history, 1, 4, 7 World Inequality Database, 67, 200 world market, 16, 57, 109, 133, 157, 160, 163, 165, 169, 252, 332 world talent ranking, 183, 321 World Trade Organization (WTO), 318, 342, 409, 414 Yangon, 225 Yeocheon Petrochemical Complex, 164 YH Trading Company, 209 Yoon Suk yeol, 307, 308, 327, 328, 334, 378, 382, 391, 394, 404, 419, 421 Yoshida Shoin, 86 Yuan Dynasty, 28, 61 zaibatsu, 41 Zheng He, 29, 34 Zhou Enlai, 55 zombie firms, 355