East Asian Economies: Transformation and Challenges 9789814379489

East Asia is regarded as growth centre in the world today, even as political tension in that region remains high. Econom

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Table of contents :
List of Tables
List of Figures
1. Introduction: East Asian economies in transformation
Part One. Studies of policy issues
2. East Asian security issues in the post -Cold War era
3. Macroeconomic performance of developing economies: A comparison of Korea, Thailand and the Philippines since 1966
4. DFI and technology transfer in East Asia: Policies and their consequences
5. Financial liberalization in Asian countries
6. East Asian trade and investment policies
7. East Asian agricultural trade and protectionism
8. International labour migration and economic development under increasing returns to scale
Part Two. Regional and country studies
9. Progress and issues in ASEAN economic integration
10. ASEAN-Indochina relations: Prospects and scope for enhanced economic co-operation
11. The Korean economy in distress: Major issues and challenges in the 1990s
12. China's open policy and its return to GATT
13. Prospects and policy options from Taiwan's perspective
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East Asian Economies: Transformation and Challenges

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The Center for Asian and Pacific Studies (CAPS) was established m 1981 at Se1ke1 Umversity m Tokyo to promote academiC research on the vanous subjects concerning the Asia-Paofic region mcludmg politics1 econom1es1 sooety1 technology and envnonment issues. CAPS promotes exchanges between experts of vanous natiOnalities and encourages InternatiOnal collaboratiOn of the studies on the above stated fields 1 which are orgamzed by members of the faculty of Seikei Umvers1ty. CAPS actiVIties mclude: sponsonng international sympos1a 1 conferences1 and semmarsj publishmg research monographs1 an academic journal entitled Revtew of Astan and Pauftc Studtes1 and discussiOn papersj and collectmg the literature on the As1a-Paofic regwn with speCial emphasis on English publicatiOns on Japan to serve the needs of researchers from abroad.

The Institute of Southeast Asian Studies (!SEAS) was established as an autonomous orgamzatiOn in 1968. It IS a regional research centre for scholars and other speoalists concerned with modern Southeast Asia 1 particularly the many-faceted problems of stability and secunty1 economiC development1 and politiCal and social change. The Institute IS governed by a twenty-two-member Board of Trustees comprismg nommees from the Smgapore Government1 the NatiOnal Umvers1ty of Smgapore 1 the vanous Chambers of Commerce 1 and professiOnal and CIVIC orgamzations. A ten-man Executive Committee oversees day-to-day operationsj It IS chaired by the Director1 the Institute's chief academic and admmistrative officer. The ASEAN Economic Research Unit (AERU) IS an mtegral part of the lnst1tute 1 commg under the overall supervisiOn of the Director who Is also the Chairperson of Its Management Committee. The Unit was formed m 1979 m response to the need to deepen understanding of economic change and political developments m ASEAN. A Regional Advisory Committee 1 consisting of a semor economist from each of the ASEAN countries1 guides the work of the Umt.





Pubhshed by Institute of Southeast Asian Studies Heng Mui Keng Terrace Pasir Pan1ang Singapore 119596 All rights reserved. No part of this pubhcation may be reproduced, stored in a retrieval system, or transmitted m any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without the pnor permission of the Institute of Southeast Asian Studies.

© 1995 Institute of Southeast Asian Studies First reprint 1997 The responsibiltty for facts and opinions expressed in this publicatiOn rests exclustvely wtth the authors and their interpretations do not necessarily reflect the views or the policy of the Instttute.

Cataloguing in Publication Data East Asian economies: transformation and challenges/ edited by Toshihiko Kawagoe and Sueo Sekiguchi. 1. East Asia - Economic pohcy. 2. Asia, Southeastern- Economic policy. 3. East Asia - Foreign economic relat10ns. 4. Asia, Southeastern - Foreign economic relations. 5. Asia, Southeastern- Economic mtegration. I. Kawagoe, Toshihiko. II. Sekiguchi, Sueo. HC412 E13 1995 sls95-94392 ISBN 981-3016-97-3 Typeset by The Fototype Business Pnnted in Smgapore by Fuisland Offset Pnntmg (S) Pte. Ltd.


List of Tables List of Figures Foreword

vii ix xi

1 Introduction: East Asian economies in transformation Sueo Sekiguchi and Toshihiko I

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Takahtleo Mutoh

the deficit sustainability This doubt 7 however7 is not so serious as it might seem. Table 3.1 shows that the average tax growth rate (16 per cent) exceeds that of government expenditure (14 per cent). The difference between the two seems to be increasing in favour of the revenue side recently Further7 although the GNP elasticity of nominal government expenditure (average 1967-89) IS approximately 1.24 (which is substantially higher than that of the elasticity of the tax revenue with respect to the nominal growth of the GNP) 7 a recent tendency IS that the former (latter) gradually decreases (mcreases). It is not necessary to exaggerate the possibility of the Thai budget deficit becoming eventually uncontrollable. Although the Thai budget deficit relative to GNP is highest among the three countries7 it does not necessarily mean that the sustainability is doubtful. How about Korea? In this country, the growth rates of government expenditure and tax revenue were more or less the same. When tax revenue and the government expenditure grow more or less at the same rate 7 and unless the interest rate on the pubhc debt is not excessively high 7 the budget deficit is basically sustainable even if government expenditure grows rather rapidly, for government revenue would also grow rather rapidly Moreover7 the difference between the two rates seems to be getting larger m favour of the revenue side recently Incidentally7 the GNP elasticity of the tax revenue and that of the government expenditure are both approximately 17 and both of them are very stable (standard deviatiOn being 0.4 to 0.5). These facts suggest that the sustainability issue is even less serious for Korea than for Thailand. In contrast7 the Filipino budget deficit is rather serious and may be unsustainable. Although the government expenditure and the tax revenue are growing more or less at the same speed (the difference of the growth rates is less than 1 per cent) 7 the GNP elasticity of the tax revenue is not very large (0.96 for 1967-89 average) 7 and its variance is very large as well as unstable (standard deviation being more than 1.5). Moreover7 the GNP elasticity of government expenditure is very large with low standard deviation (the average elasticity being 1.287 with 0.61 as the standard deviatiOn). It seems rather difficult for the Philippines to mamtain the hitherto fairly low budget

Macroeconomtc Performance of Developmg Economtes



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by 1979-81 average natiOnal producer pnces and summed for each year) whiCh was set to 100m 1961-63 average. Each figure refers to three-year average> centnng on the years shown SOURCE

FAO, i\groStat-PC (1991)

and Indonesia 7 the production per capita expanded at 10 per cent or much higher rates m the 1970s and the 1980s. Japan Is the only country in the region that showed constant decline m agncultural production throughout the penod. Planted land area in Japan decreased 34 per cent from 1960-901 which accounted for a sharp decrease of the total production. This Is caused by the conversiOn of the agricultural land to non-farm purposes and a

J:ast Astan Agncu!tuml Trade and Protectwmsm


declme of the land utilizatiOn rate/ while the land productivity was not so much improved. Although the decreasmg tendency of per capita production was also observed m Korea and Philippines in the 1980s1 this was caused by the slow production growth1 which could not keep up with the population increase. The rap1d growth of agnculture in the ASEAN countnes Is 11 attributed to the dramatiC increase in rice production. The green revolutiorr'11 diffusion of modem semi-dwarf -varieties of rice with h1gh mtrogen absorption and high yielding capaot1es (High Yielding Varieties or HYVs)1 developed in the mid-1960s by the International Rice Research Institute (IRRI\ sustamed this growth. Before the diffusion of HYVs1 yield of rice per hectare was about one to two metric tons (measured in rough nee). Recently1 the average yield reached three to four metric tons m many Asian countries. Now these countnes succeeded m attainmg self-suffioency m rice at the national level. 2 As shown m Figure 111 nee production in Asia expanded steadily during the past several decades. Above all1 Indonesia showed prominent growth of rice production from the 1970s. The diffusion of HYVs1 coupled With massive mvestments on public mfrastructure1 such as migation1 road and transport facilities1 contributed to the rapid growth m Indonesia. 9

Rice: Dietary staple in the region Rice m As1a1 Oryza sattva 1 occupies the dominant position in Asian agnculture 1 not only in developing countries m the region 1 but also m developed countries in East Asia. Even in world agnculture 1 rice IS the second largest crop1 followed by wheat1 m production volume. In 1990 world nee production was 512 million metric tons1 of which 92 per cent1 or 481 million tons1 came from Asia. China and India occupy dommant positions in world nee production1 accounting for 60 per cent of the world1s supply. Bangladesh1 Indonesia1 Thailand and Vietnam are also maJor producmg countnes of nee. However1 m order to sustain their huge population1 Chma and India are nommal exporters m the world market. Bangladesh remains one of the ma1or

7oshliuko Kawagoe

Figure 7.1 Rice production in East Asian countries, 1950-90 500~------------~--------------------.

---Asia -----Japan - - - - - Korea Malays1a -------Thailand ·················· Philippines ··· · ·· Indonesia















Year NOTE· ProductiOn rndex (1950~100) rn rough nee SOURCE

IRRI, World Rtce Stallsti(S fQ87, 1'?90 (vanow, years)

Importers of rice. Only Thailand and Vietnam are exporting rice to the world market. Most farmers in the region heavily rely on rice productiOn. They grow rice for their own consumpt10n 7 while sales of surplus nee provide them cash income to purchase other necessities. As discussed above 7 these farm producers are extremely small by Western standard7 typically two hectares or less in terms of their operational holdings of cultivated land. Even in Japan 7 there are about four million farm households whose average farm size is only 1.2 hectares7 and most of them are rice growers. The fact that many rural populations are mvolved in nee production suggests that rice could be important m the political arena.

East Astan Agncultural 1rade and Protecttomsm


Rice IS also Important m consumption as a dietary staple m the region. Annual consumptiOn of rice per person in the region ranges widely from 80-170 kg in recent years. In developing countries1 when income rises1 consumption of rice per person also rises1 then reaches saturation and begins to decrease 7 as rice IS replaced by wheat and protein nch food. For example 1 m Japan rice has remained the ma1or staple food m the diet. However1 annual per capita consumption was only 76 kg in 19901 and is still decreasing. Histoncally1 the consumption of rice in Japan increased gradually after the Meiji Restoration m 18681 when the economic system shifted from the Tokugawa feudal reign to the modern capitalist economy. In the 1870s1 annual per capita consumption was about 100 kg (milled rice)1 which mcreased to 130-150 kg by the end of the nineteenth century and reached saturation at 170 kg by the mid-1910s. Dunng the period of hunger after World War II1 consumption was depressed to only 100 kg. Although the consumption recovered to 118 kg in 19621 It never fully return to the pre-war level7 and has declined continuously since then1 owing to changes in dietary patterns. In the region many countries have reached saturation 1 and there Is decreasing rice consumption per person (Figure 7.2). In Korea and Malaysia the consumption reached saturation at around 140 kg by the mid-1970s and then began to decrease constantly to 100 kg in recent years. In Malaysia 1 a relatively high level of consumption at around 180 kg was maintamed through the 1960s and the early 1970s. By the end of the 1970s1 It had begun to decline to 150 kg. In Indonesia the consumption was only 90 kg in the early 1960s1 which rapidly increased throughout the period and reached 184 kg in 1989. Though the saturation point has not yet been observed1 judgmg from the trends in other countries1 Indonesia has nearly reached saturation. Rice consumption is increasing in the Philippmes and China 1 where only 110-120 kg are utilized per person m recent years. Judging from these trends m per capita consumption and relatively low population growth in the 1990s1 10 the demand for rice may not expand much in the coming decades in the region. Increased production and stagnant demand for rice m the region

Toslnlnko Kawagoe


Figure 7.2 Changes in annual per capita rice consumption in East Asian countries, 1961-90 kg/year per person

190 A











. ........············· ·········· ················

130 110 90 70









Year - - - Indonesia - - -Thailand - - - - - Rep. of Korea - - - Philippines

.................. Malaysia - - - - - Japan .................. China

NOTE: Per capita comumption of nee (kg/year), husked

equivalent SOURU:

FAO, AgroS'tat-PC N41.

has resulted m overproductiOn and thus depressed price in the mternational market in recent years. The latter pomt wtll be examined m the next section.

4. Changes in agricultural trade structure Agnculture is an tmportant source of foretgn currency earnmgs m most developmg countries. For the countries m the reg10n agricultural

fast Astan Agncultural Trade and Protecttamsm


commodities still play an important role in their merchandise exports. While the most dominant export commodity is petroleum m Indonesia and Malays1a 7 log 7 plywood 7 rubber and palm oil are important export commodities which occupy one-fourth or one-fifth of the total exports. Although its exports were severely depressed 7 Philippine 7s ma1or export commodities were coconut oil and sugar. Thailand Is the largest exporter of nee in the world7 and also extensively exports rubber and tapioca products. Although agricultural commodities m developing countries are still very important7 the mternatiOnal agricultural market has been unfavourable in recent periods. Export prices of the agricultural commodities have worsened since the 1980s. 11 As shown in Figure 7.37 by the end of the 1980s export prices of agricultural products have shown almost the same level of the average prices of world total merchandise exports. Import pnces of total products for developing countries also kept the same level. Since the 1980s these price indices have diverged and export pnces of agncultural products have been stagnant significantly compared to total export prices. It is obvious that the relative decline of agncultural prices has adverse effects on the exports of developmg countnes.

Regional trade structure

In the course of economiC growth in the reg10n 7 merchandise trade has expanded rapidly in recent years. Throughout the 1980s total merchandise exports and imports rose by about 12 per cent annually in Asia 7 while the world averages mcresed by only 6 per cent dunng the same period. The share of total exports of developing countries onginating from the exports of Asia increased from 29 per cent in 1960 to 56 per cent in 1990 (IMF 19937 p. 74). Among others7 the growth rates of exports of East Asian countries were especially high. Average annual growth of the exports exceeded 18 per cent during the past three decades in Thailand and Korea. The growth rates of Imports were also high at 16 per cent in Thailand 7 and more than 12 per cent in Malaysia and Korea. 12 Linkage of the economies has enhanced through interregional

Toshzhzko Kawagoe


Figure 7.3 Changes in export prices of agricultural commodities, 1966-90 500~--------------------------------~

400+--------------------+~/~--.-.----~--~ f

\ \ \



'~-- ....... .











Year _____________ ..... Export prices (world total) - - - - - Import prices (developing countnes in Asia, total) Export prices of agricultural products (world)

NOTE: Averages of 1966-68 are set equal to 100.

7rade yearbook (vanous Issue:>); IMF, lntematwnal Fznancza/ Statzsucs yearbook 1992



East Astan Agrtw!turaf Trade and Protecttomsm

trade expansion and vtce versa. As shown in Table 737 most countries in the region tend to depend more on imports and exports from inter-Asian transactions. This tendency is especially apparent in imports of the ASEAN countries. In these countries the share of inter-Asian imports increased by 10 to 20 per cent during the 1980s. Table 74 shows that in 19907 exports to the Northeast Asian region from Malaysia 7 Thailand and Philippines reached 20-26 per cent of their total exports. In the case of Indonesia7 since large amounts of petroleum and plywood are exported to Japan 7 the share exceeded 50 per cent. On the other hand 7 inter-ASEAN exports do not have such a large share and remained roughly constant at 10 per cent7 except for Malaysia that has a relatively large share with Singapore. A large share of imports from the Northeast Asian region is also observed7 which accounts for 30-40 per cent of the total imports of the ASEAN countries7 while inter-ASEAN imports account for around 10 per cent7 except for Malaysia. Although ASEAN is the only formal regional economic arrangement in Asia7 trade between member countries has remained constant and limited. Though the member countries intend to stimulate

Table 7.3 Changes in inter-Asian share of total trade for selected countries in the region, 1980 and 1990 Percentage share of trade wtthm Asta of total trade lmpons Expons

Korea Indonesia Malaysia Phrlrppines Thailand NOTE: " SOURCE





31 60 56 40 44

38 67 59 38 40

41 40 40 34 42

51 50 58 48 59

Three-year averages centnng on the years shown. ADB, Key lndtcators 1992.

1osluluko Kawagoe


Table 7.4 Trade structures of the countries in the region, 1990



Percentage dtstnbutton of exports

N.E. Asia (1) ASEAN (2) (1)+(2) USA EC

14 12 25 32 19

21 8 29 30 14





20 11 32 23 22

26 7 33 38 18

54 10 64 13 12

39 12 50 11

30 9 39 20 11

38 8 46 12 19


22 29 51 17 15

Percentage dtstnbutton of tmports from:

N.E. Asia (1) ASEAN (2) (1)+(2) USA EC

14 12 26 23 15

29 7 36 24 12

32 19 51 17 15


NOTE. ··N E Asia'' means Northeast Astan countnes (Japan, Korea, Taiwan and Chma) SOURCE. IMF,

Dt;ccttOit of lrade )learbook Nw2

interregional trade 1 considerable trade barriers still remam because of limited concessions (IMF 1993b ). 1" The Interregional trade structure IS thus characterized by growmg interdependence between two economiC zones, namely the Northeast Asian countries and the ASEAN countnes. It suggests that north-south trade withm the region m East Asia is becoming more important for the economies m the region. Trade policies adopted by the Northeast Asian countries would have more signrficant effects on the ASEAN economies.

Agricultural trade structure

Merchandise trade patterns of agncultural commodities m a country are characterized by its agricultural production structure, mdustrial structure and the level of economiC development. If agricultural

East /\stan Agncu!tural Trade and Protectwmsm


protection policres are adopted1 trade patterns are distorted. Trade balances of agricultural commodities in 1962 and 1990 (1961-63 and 1989-91 averages1 respectively) for several countries in the region are compared m Figure 74. Data in the figure depict imports1 exports and trade balances of agricultural commodi ties per capita in U.S. dollars1 deflated by world wholesale pnce index (1985 = 100). Japan is one of the largest importers of agncultural commodi ties in the world and the import per capita is also large 1 while its 1 exports are negligible. Korea s trade pattern in 1990 resembles Japarr's trade patterns. Compare d to these Import dependen t patterns in mdustrial countries1 the ASEAN countries have more export-oriented trade structures. In 1962 Thailand1 the Philippines1 and Indonesia gamed large positive trade balances1 which suggests that agriculture was an important source of foreign currency earnings. However1 in 1990 these positive trade balances per capita shrank1 owing to relatIve decline of agricultural product prices. Populatio n pressure also depressed per capita eammgs. This is especially prominen t in the Philippines1 where the economy has been stagnant and positive trade balance has almost disappeared in recent years. If we further examine components of the agricultural trade 1 changes of trade structure are more clearly observed (Figure 75). In Japan 1 during the past two decades1 imports of livestock products (meats1 dairy products1 eggs1 etc.)1 fruits and vegetables have increased1 while imports of cereals and crude materials have declined significantly. This is because the food demand diversified 1 and demand for protein rich food and various tropical fruits have expanded. A protectiomst policy1 which virtually banned imports of rice 1 depresses the import of cereals. Changes in industrial structure are attributed to the declme in import of crude matenals. Comparat ive advantage of light industries1 such as textiles1 which utilize agricultural crude materials1 has shifted to the NIEs and ASEAN countries. The Korean import structure is charactenzed by a decrease of cereals and an increase of fruits and vegetables1 just as observed in Japan. However1 we should note that imports of crude materials are still expanding in Korea. Similar situations are also observed in Malaysia1 Thailand and Indonesia. In these countries1 the Imports

Figure 7.4 Changes in agricultural trade pattern in East Asian countries, 1962 and 1990 1962






D Rep. of Korea


- Exports Tha iland


Trade balance





- 50

- 50



100 - 150 - 50 US$ per capita , 1985 prices

- 50




N OTES: Data refers to 196 1- 63 ave rage for 1962 and 1 989-~ l ave rage fo r 1990. li·ade va lues per cap ita in U.S.

do llars, defl ated by wo rld w holesale price index (198.J=i00). Imports are shown as negati ve va lues and a nega ti ve trade ba lance means the country is a net importer o f agricultura l co mmod ities. SO URC ES: FAO, AgroSI,u-PC f:·l l:·:·:·l ~>>>I l;;;l I


t, ;A I


0'' 1970 1990 I



















1970 1990

0 1111


1970 1990

E"'JC11 1970 1990





1970 1990

Indonesia Imports Exports

100 -,--,=r=-r,..,...,..,,--...,....,.,:"7"0~,.,..,


0'' 1970 1990





1970 1990



Other products


Crude materials and animal, vegetable oils


Fruits, vegetables and other food products




Livestock products and feed stuff


1970 1990

N OTES: Li vestoc k produ cts include live animals, m ea t and m eat preparati o n , dairy produ cts, a nd eggs.

Plantati on crops (food) include suga r, ho ney, coffee , tea, and cocoa. The da ta refer to 1985 constant price, deflated by w holesale price index (1 985= 100). SO URC ES: FAO,

Trade }learbool? l'l7b, 1'791; IM F, lmenuwonal F11tt111ct,d Statrstrcs }learbool? N'}2.


Toshthtko Niwagoe

of crude matenal increased1 while the exports decreased sigmficantljj which suggests that their economies have shifted from bemg traditional exporters of raw materials to being newly industrialized economies1 where the light industnes have been developed. In Thailand 1 the decrease in Imports of crude materials was compensated for by the increased imports of fruits 1 vegetables and livestock products. The share of cereals export also declined. These changes mean that the charactenstics of Thai agriculture as a traditional rice exporter has changed. Its production structure has diversified to high value added modern agricultural commodities.

International rice market

The mternational trade market for nee is characterized by its small size compared with its total productiOn. Though rice is the second most important crop in world agncultural production1 only 3-4 per cent of the produce is traded in the world market1 14 m contrast to wheat1 of which nearly 20 per cent of the produce is traded internationally. Major exporters of rice are Thailand and the United States. These two countnes accounted for more than half of the exports in 1990. On the other hand1 there is no major importer of rice. Many countries depend on rice imports to satisfy their domestic demand1 when they cannot satisfy domestic demand due to fluctuating production. Each importer orders at most several hundred thousand tons of rice and the importer exceeding one million tons were rare. In East Asia1 China1 Hong Kong 1 Singapore and Malaysia were constant importers in recent years. Though Japan and Korea are possible importers1 they virtually banned rice import under severe protectiOnist polioes. 15 After the drastic price increases arising from the oil shock of 19741 pnces of wheat and rice in the world market became stagnant and even declined in real terms in recent years (Figure 76). This tendency is especially prominent in the case of rice. Until the 1960s export pnces of rice were about twice the export pnces of wheat. However1 these price differences have almost disappeared in recent periods1


F.ttst As1an llgnwlwml Trade and Protewomsm

Figure 7.6 Changes in the international rice market, 1950-92 IUS$ per metr1c toni US$/ton

1,000 800 600 400 200 0,_---,---,----,---,---.---.----,---, 90 70 65 85 80 75 50 60 55 Year

No rES Rice pnce> refer to fob Bangkok, milled, 59(, broken nee. Wheat pnces refer to Canadian No 1 Western Red Spnng 1:1596, m store Thunder Bay. St Lawrence. The pnces are deflated by world export pnce mdex (1985=100)

SOURCES IRRI, World R/(e Stclllstlcs



due to signrfrcant declmes in the pnce of rice. This relative declme of the pnces of rice discourages rice farmers not only in exporting countries such as Thatland and Vietnam 7 but also in all other developing countnes m the region 7 smce the low export price m the world market is transferred and pushed down their farm gate prices to a low level. The depressed pnces of rice reflect stagnatwn in the world exports market. That exports have expanded signifiCantly through the 1980s7 whrle the U.S. exports have stagnated during the same period even though US. rice lobbies have pushed the US. Government to demand the liberalization of the Japanese and Korean domestiC rice markets.


Toshthtko 10Jwagoe

Rise of protectionism in East Asia Agncultural protection policies are measures to increase the income of the agricultural sector through government intervention in various stages of economic activities. Although there are nearly infinite types of protection measures7 they may be classified into three categoriesj price support of agricultural output7 subsidies to agricultural inputs and border policies on agricultural commodities. The last measure mcludes tariff and import quotas. Comprehensive treatment of agncultural protection policies Is beyond the scope of this paperj only border protection in the region is examined here. In the process of economic growth 7 East Asian countries tend to adopt protectionist polioes in their agricultural sector. This tendency in the region is clearly observed in the case of rice. As shown in Figure 7.0 the wholesale price of nee in Japan began to diverge from the world price in the mid-1950s and rose quickly throughout the 1970s and the 1980s. This was caused by government intervention in the domestic rice market7 and both consumers and producers7 prices were maintained at a very high level. The strong yen is also pushing up the domestic prices7 if measured in U.S. dollars. Although a high wholesale price does not necessarily mean a high level of agricultural protection7 it is normally highly correlated with the producer price. The high wholesale price also can be an index to measure the consumers7 burden in relation to agricultural protection policies. Similar trends of rismg prices are also observed in Korea and Taiwan. The prices began rising in Korea in the mid-1970s7 and in Taiwan in the mid-1980s. On the other hand 7 wholesale prices in the Philippines and Indonesia have remained at almost the same level of the world prices and there are no signs that the domestic pnces are raised purposely. These observations suggest that protectionist policies are adopted when the economies reach a higher income level.

5. Economic growth and protectionism in agriculture In the developed countries7 the interests of the farm sector are often disproportionally represented in internatiOnal trade policies. This is


East Aszan Agncultural Irade and Protecttomsm

Figure 7.7 Changes in domestic prices of rice for selected countries in the region, 1950-89 3,000 --.--------------,-----------., Japan Republic of Korea Taiwan Indonesia World Philippines

c:: 0

~ Cl)


::::::> QJ







1,500 ...... 0





·.:::: 0..


"'"' 0







.· ·····~····.....··








70 Year





IRRI, World Rzce Stattstzcs 1990

typrcally applied to Japanese agricultural pohcres. Japan has benefited most from the open world trade system formed after World War II under the framework of the General Agreement on Tariffs and Trade (GATT). Despite prolonged Uruguay Round negotiations, if they had failed Japan would have been most seriously affected by growing protectronrsm in the world trade system. Then why did the Japanese Government insist on protecting its agricultural sector7 while takmg a risk to collapse the open world trade system? The experiences of Japanese protectionism in agriculture give us a typical example of the failure of industrial policies7 which were caught in a trap in the process of rapid economiC growth.

Agricultural protectionism in ]apan 16

In Japan 7 when the comparative advantage of agnculture disappeared


Toshthtko Kawagoe

in the process of high economic growth in the 1960s1 vanous protectionist policies were implemented for the agricultural sector. Many agricultural commodities are under direct price support by the government. Rice 1 wheat and barley are strictly controlled by the government and their domestic prices are supported at a very high level. Meat1 dairy products1 silk1 and sugar are also under price support. Their markets are controlled by monopolistic semi-governmental institutions. Besides these protectionist policies1 imports of many agricultural commodities are restricted under various border protection measures. Most notorious among the protectiOnist measures in Japanese agricultural trade policies were Import quotas1 which violate GATT rules. In 1962 there were 81 commodities under the import quotas 7 but these were gradually reduced to 28 in 1971 and then to 22 in 19741 when oranges and beef were included. Since then 1 although several commodities under subcategories were partially freed 1 the number of commodities has remained at 22 until 1989. Both oranges and beef were critiCized by its trade partners as a symbol of unfair trade practices at that time. Under strong pressure from abroad1 the government further removed the quotas on oranges1 beef and several other commodities until 1991. In 1995 the Import quotas for the remaining 12 agricultural commodities1 excluding rice 1 were replaced by tariffs based on the agreement reached at the GATT Uruguay Round negotiations. 17 In spite of this gradual deregulation in border protection1 rice has been strictly protected in Japan. Rice policies were the basis of agricultural protection policies1 in which price support1 border protection1 subsidies and various complicated regulations are extensively integrated. As discussed in the previous sectwns1 rice occupies an overwhelmingly important position in Asian agnculture. This is also the case in Japan. Gross output from rice production occupied 47 per cent of total farm output in 1960 and 28 per cent in 1990. About 2.6 million farm households are engaging in rice production. The Farmers1 Cooperatives (JA1 Nokyo) 1 one of the strongest lobbies in Japanese politics1 are privileged to handle rice as virtually the sole marketing agent under government regulations. Thus rice policies can be a critical issue in the political arena in Japan. Before World War Il1 Japan continuously imported rice from

East Astan Agncultura! hade and Protecllomsm


Korea and Taiwan and occasionally from Southeast Asia. The rice market was basically under free competition and the government intervention to the market was limited to import tariffs. However7 due to food shortage during the war7 the Japanese Government adopted strict control of the food market under the Food Control Law. This law, enacted in 19427 strictly regulated all the marketmg processes of rice and other staple foods 7 which were under the direct control of the government. Almost all commodities were under rationing at that time. After the war7 the food shortage still continued into the early 1950s. The domestic prices of nee were set at a lower level than the import price in order to provide cheap rice to consumers7 and the producer price was depressed. The food control system under the Food Control Law by the 1950s was characterized as consumer protection policies. In the mid-1950s the Japanese economy began to grow rapidly and the agricultural production also began to recover. In the latter half of the 1950s7 technological development on rice cultivation Improved rice yield significantly7 while per capita consumption of rice began to decrease from 19627 resultmg in the decrease of domestic demand of rice. Self-sufficiency in rice was fully attained by the end of the 1960s. Throughout the 1960s7 when the Japanese economy grew very rapidly especially in the industrial sectors7 comparative disadvantage in the agricultural sector deepened and the income gap between farm and non-farm sectors widened 7 which might become a social problem and induce political instability. For the ruling Liberal Domestic Party (LDP); being a conservative party whose foundation rested solidly in rural agricultural communities7 it was critical to receive sustainable support from the rural population in order to keep the majority in the Diet and mamtain political dominance. The agricultural policies were designed to transfer income from non-farm to farm sectors7 which enabled LDP to dominate in the political arena throughout the postwar period. 18 The price policy of rice under the Food Control Law has been an important instrument for this purpose. Hence 7 the characteristic of the food control system has changed from consumer protection to producer protection. Thus producer prices were determmed politically and raised


1oshthtko fCavragoe

qutckly throughout the 1960s. HoweverJ high prices enabled small marginal farms to keep up rice productionJ and hence the modernization of Japanese agriculture was severely hampered since there were few incentives for farmers to improve production efficiency under protection. MoreoverJ under the supported producer price that was far above the market equilibrium priceJ production began to exceed demand. In order to prevent the accumulation of surplus riceJ a programme to divert land used for rice planting was introduced in 1969. The programme incurs substantial cost from payment of subsidies to farm producersJ who divert paddy fields to other crops. The heavy protection of nee in Japan is strongly criticized by Japanese consumersJ as well as by Its trade partners.

Economic growth and agricultural protectionism

After severe negotiations under the GATT Uruguay RoundJ Japanese and Korean Governments finally accepted minimum access to rice ImportsJ though both governments were faced with hard opposition from farm producers and their supporters. The oppositiOn was much stronger in Korea than in Japan. Though Japanese agriculture is still one of the most protected in the worldJ the political power of the farm lobby has gradually weakened in recent years. Producer price of riceJ raised every yearJ was frozen in 1984J and had been pushed down several times smce 1987. There may be several reasons that explain the lessening of protectiOnism. The share of farm labour decreased to less than 6 per centJ while many farmers engage in non-farm jobsJ resulting in 85 per cent of farm households being part time farmers. Only 16 per cent of the total farm household mcome comes from agriculture and only 4 per cent comes from rice. FarmersJ CooperativesJ one of the strongest political lobbiesJ cannot always represent most of the part time farmersJ interests now. On the other handJ in Korea farm employment accounts for 16 per cent of total employment. Part time farming Is relatively rare. Korean farmers heavily rely on nceJ whose receipts make up around 30 per cent of the total household income.

East Astan Agncu!tural Trade and Protectwmsm


The Japanese economy might cross the threshold of protectionIsm1 while the Korean economy has not yet reached that point. Thus protectionism may not last forever during economic growth. However, we should note these economies incurred huge social losses in the process of high economic growth. East Asian NIEs whose economies are expanding quickly, therefore 1 need to transform traditional agriculture to enable it to keep up with the changes in other sectors of the economy, before being trapped into protectionism.

6. Summary and conclusions The East Asian region enjoys one of the highest growth rates m the world economy m recent decades. In the course of rapid economic growth in the region1 interregional trade has been expandmg significantly. Above all interdependencies between the Northeast Asian developed countries and the Southeast Asian countries have been strengthened. These overall changes of the economies also brought drastic change in agricultural trade structures. High economic growth and the agricultural policy as the response to this growth m each country are important factors affecting the future of the agncultural trade in the region. In Japan imports of livestock products1 fruits and vegetables have mcreased1 owing to diverging food consumption patterns. Similar changes are also observed in Korea. On the other hand1 imports of cereals and crude materials have declined significantly in Japan. Changes in industrial structure are attributed to the decline of imports of crude materials1 since comparative advantage in hght industry has shifted to NIEs and the ASEAN countries. The latter economies have shifted from being traditional exporters of raw materials to newly industrialized economies1 where light industries have been developed. This is reflected in the mcrease in Imports of crude materials and the significant decrease in the exports of crude materials. Another condition to be noticed were the depressed prices of rice m international markets. Although the export prices of agricultural commodities have worsened since the 1980s1 this tendency was

Toshthtko KAwagoe


espeoally prominent in rice. Increased production and stagnant demand for rice in the region resulted in overproduction and thus depressed prices in the world market. Severe protection of their rice domestic markets by Japan and Korea, which virtually banned nee imports, were also due to the stagnant rice market. The depressed rice prices m the world market discouraged rice farmers not only m exportmg countries, but in all other developing countries in the region, because the low export prices push down farm gate prices. When an economy grows, the share of agricultural income in the economy inevitably declines. If the agricultural labour force has suffioently migrated to non-farm sectors, the relative decline of mcome in agriculture does not detract farm household income. However, it is not easy to reallocate human capital from the agricultural sector to non-farm sectors, and delayed adjustment results in a widened income gap between farm and non-farm sectors. This can be a possible cause of agricultural protectionism. In the process of economic growth, East Asian countries began to adopt protection pohcies in their agricultural sectors. The level of protection m Japan is the highest m the region. Korea and Tarwan also strengthened protection since the 1970s m the course of their economiC growth. The protectionism m Northeast Asia hampers efficient resource allocation and depresses agricultural trade in the region, which not only hurt consumers' welfare in the Northeast countries, but also discourage farm producers m the developing countries m the region. As shown in the Japanese experience, the protection policy Is hard to remove once it is introduced. It should be noted that there rs a threat of protectionism in agriculture in the Southeast Astan countries smce the economies are growing at a rapid pace. How to keep and enhance free trade systems m agriculture will be a key issue for the wholesome development of agriculture in East Asia.


1. Thrs paper rs a result of the East Asra study project, conducted by the Center for Asran and PaCific Studres, Serker Unrversity. The author acknowledges helpful comments from Wan-Soon Krm and other

East Astan Agncultural Ji-ade and Protecttomsm








9. 10.




project members_ The author also acknowledges finanCial support by the Masayoshr Ohrra Memonal FoundatiOn, In a recent report compiled by the World Bank (1993b) 1 these countries are called high-performmg Asran economies (HPAEs)_ Singapore1 Hong Kong, Taiwan and Korea are called the Four Trgers1 and Malaysia1 Thailand and Indonesra are categonzed as NIEs, Among the ASEAN member countnes1 Smgapore and Bruner are excluded from the analysrs smce therr domestic agncultural productron rs neglrgrble_ In 1991 current pnces Japads per caprta GNP was US$2619301 whrch was the second hrghest among the economres m the world (World Bank 1993a 1 Table 1 m World Development lndtcators)_ Data refer to the total East Asian and PaCifiC regrods low and mrddlemcome countries plus Japan1 Smgapore and Hong Kong m hrgh income countnes1 categonzed by the World Bank (IMF 1993b1 P- 74)_ The growth of agricultural GDP was much slower than other parts of the economies of ASEAN countnes dunng the latter part of the 1980s (ISEAS 19921 P- 36)_ Cultrvated land area decreased 14 per cent from 6 milliOn hectares m 1960 to 52 millron hectares m 1990, At the same trme the land utrlrzation rate dropped 32 per cent from L34 to L021 owing to drastrc increase of part trme farmmg (JMAFF 19931 PP- 32-33)_ Smce the early 1980s Indra and Indonesia have almost attamed nee self-suffroency The Phrlrppmd production mcreased srgnificantly m the 1970s_ Vietnam returned to the export market m recent years_ See Tabor (1992) for details. In major countnes m East Asra1 average annual growth of population m the 1990s rs projected to be 1.4 per cent m Indonesra1 1.3 per cent m Chma1 L9 per cent m the Phrlippmes and 1.4 per cent m Thailand_ These figures are relatrvely low1 compared to the average of low-mcome economres of 2_6 per cent (excludmg Chma and India) and 1.8 per cent in lower-mrddle mcome countnes (World Bank 1993a 1 Table 26 m World Development lndtcators). Even more long-run 1 downward trends m real pnces in mternatwnal food markets are observed throughout thrs century (Anderson and Tyers 1991 1 pp. 1-2)_ Averages of annual growth rates of export and rmport values from 1960 to 1989 are compiled from IFS CD-ROM (IMF, September 1993).


70shthtko }(au;agoe

13. At the Fourth ASEAN Summit m 19921 a plan of the ASEAN Free Trade Area (AFTA) was proposed. However7 Its reliability and future prospects are still uncertain. See Imada and Naya (1992) for details. 14. In 1990 total productiOn of nee was 337 million metnc tons (milled nee equivalent) 1 while the export quantity was only 12 million metric tons (FAO 1990). 15. In 1993 a severe crop fa1lure1 resultmg from a cool summer and a senes of typhoons 7 caused nee productiOn m Japan to decline more than 20 per cent In order to fill domestic demand 7 the Japanese Government imported 2.59 million tons of rice m the 1993/94 penods. 16. This sectiOn draws on Kawagoe (1993). 17 These 12 commodities under import quotas smce 1992 mclude dairy products7 processed rice and wheat 7 starch and other miscellaneous agncultural and fishery products. 18. LDP has been the rulmg party smce 1955. However7 in 1993 Its mner parties separated from LDP, resulting in LDP 7s loss of Its maJOnty m the Diet.

References Asian Development Bank (ADB). Key !ndtcators of Developmg Astan and Pactftc Countnes 1992. Mamla: ADB7 1992. Anderson 7 Kym and Rodney Tyers. Global Effects of Ltberaltzmg Trade m Farm Products. London: Trade Policy Research Centre (Harvester Wheatsheaf) 7 1991. Coyle 7 William T. aPacifiC Rim Agriculture and Trade: Toward the Twenty-Fust Centuryn. In Agncultural Trade m the Pactftc: Tou;ard the Tu;enty-Ftrst Century 7 edited by W.T. Coyle 1 Dermot Hayes 7 and H1rosh1 Yamauchi. Boulder: Westview Press 7 1992. Food and Agnculture Orgamzation (FAO). Trade yearbook 1990. Rome: FA0 7 1990. ___ . AgroStat-PC. Rome: FA0 1 1991. Hayami1 Yu]Iro. aThe Roots of Agncultural Protectwmsmn. In The Polwcal Economy of Agncultural Protectton 7 edited by Kym Anderson and Yu]Iro Hayami. Sydney: Allen and Unwin 7 1986. Imada1 Pearl and SeiJI Naya 7 eds. AFTA: The Way Ahead. Smgapore: Institute of Southeast Asian Stud1es 7 1992.

r-:ast Astan Agncu!tural Hade and Protectwmsm


International Monetary Fund (IMF). lnternatwnal Ftnanctal Stattsttcs )learbook 1992. Washmgton 7 D.C.: IMF7 1992a. ___ . Dtrectwn of Irade Stattsttcs )learbook 1992. Washmgton 7 D.C.: IMF7 1992b. ___ . IFS CD-ROM September 1993 versron. Washmgton 7 D.C.: IMF7 1993a. ___ .World Economtc Outlook, May 1993. Washmgton 7 D.C.: IMF7 1993b. Institute of Southeast Asian Studies (ISEAS). Southeast Astan Affatrs 1992. Singapore: ISEAS 7 1992. International Rrce Research Institute (IRRI). World Rtce Stattsttcs 1990. Los Banos7 Phrlippmes: IRRI 7 1991. Japan 7 Mmrstry of Agnculture 7 Forestry and Frshenes (JMAFF). Nogyo Hakusho Fuzoku Toket Hyo (Statrstrcal Appendix to the Agncultural White Paper). Tokyo: Norm Taker Kyokar 7 1993. Kawagoe 7 Toshihiko. ((Deregulation and Protectionism m Japanese Agnculture77. In The Japanese Expencence of Economtc Reforms7 edrted by Juro Teranishr and Yutaka Kosar. London: McMillan and New York: St. Martm's Press 7 1993. 7 Tabor7 Steven R. "Agnculture m Transrtiorr • In The Ot! Boom and Afrer: lndonestan Economtc Po!tcy and Performance m the Soeharto Era 7 edrted by Anne Booth. Oxford: Oxford Unrversrty Press 7 1992. World Bank. World Tables 1992. Baltimore and London: Johns Hopkins Universrty Press7 1992. ___ . World Development Report 1993. New York: Oxford Universrty Press7 1993a. ___ . The EAst Astan Mtrac!e: Economtc Growth and Pub!tc Po!tcy. New York: Oxford Unrversrty Press7 1993b.

8 International labour migration and economic development under increasing returns to scale HIDEKI KONISHI

1. Introductio n How does internationa l labour migratiOn affect the economies of the sendmg countries7 the host countnes7 and the world economy? This Is still one of the most controversial Issues in internationa l economics and developmen t economics7 from both theoretical and empirical pomts of view In the industnahze d nations of Northeast Asia 7 especially. in Japan 7 Taiwan and South Korea 7 the answer to this questiOn is needed urgently7 smce the pressure of the labour movement IS gettmg higher behmd the large difference m per capita gross national product (GNP) between these nations and other Asian developing nations. The larger numbers of illegal migrants are creatmg several sooal and economiC problems in these countnes. Japan and the newly mdustriahze d economies (NIEs) absorbed the outflow of workers from the developing natiOns m Asia dunng 1980s as legal or illegal migrants. For the Japanese people whose government has been taking the policy to exclude most of the foreign workers7 It was quite a shock to realize that the populatiOn of illegal migrants had mcreased enormously before they became aware of It.

lnternattonal Labour M1gratton ami Ewnom11 Develormwt

The problems caused by the increased number of foreign workers had been attracting much attention among Japanese before the economy went mto the long-term recession in the early 1990s. The controversy in Japan over immigratiOn was focused on the permission of the inflow of less skilled and unskilled workers. There were two factors m the demand and the supply side attractmg unskilled labour to Japan. On the demand side 1 there was an extreme shortage of cheap workers who are willingly to do the 11 3-D, or udirty1 dangerous and difficult 1 jobs that the native workers avoid. Meanwhile 1 on the supply s1de 1 there was the overwhelming difference in per capita mcome between Japan and other Asian developing nations. The extreme shortage of cheap workers1 prevailing especially m the construction and service mdustries at that time 1 was a pnmary reason for allowmg an inflow of labour. It was thought that without mtroducmg foreign labour1 the future economic growth of Japan might be compromised. Another reason was the lack of 11 internationahzatiod1 of the Japanese economy1 which reflects mternational ImpressiOns that the Japanese economy was not globally so open as those of other developed nations m the world. In the meantime 1 there was much opposition to the mflow of foreign workers. The researchers who were opposed to It pomted out the diffiCulties in admmistrating the volume of labour inflow and in ehmmatmg illegal Immigration. What they were worried about most was the rapid and meversible increase in the population of foreign workers and their families. A few countries that are considered to have successfully received immigration without bnnging about many sooo-econom1c problems are small countnes relative to Japan 1 like Singapore and Switzerland. They have stnct systems to monitor and control the inflow of foreign workers and ensure their return to their home countries after a certain period. In this paper1 I neither argue nor repeat the aspects on which the recent controversy in Japan has focused 1 that is from the viewpomt of a host country of labour movement. lnstead 1 I address a more fundamental problem about international migration: IS the outflow of domestic workers in Itself benef1oal for the economiC


Htdekt Komsht

development of the sending country? To answer this question; this paper focuses the analysts on the role of mcreasmg returns to scale (or non-convexities) in production; which developing nations can use to take off on to the path of economic development and industrialization. To shed light on the importance of the idea of increasing returns to scale m understanding the mechanism of economiC development; let us briefly review the textbook perspectives of the effects of international labour migration on economic development. According to the first maxim of standard international trade theory any factors hindering free international migration deteriorate the economic welfare; or efficiency of resource allocation; in both receiving and sending countries as long as there is no initial distortion caused by tariffs and domestic taxes. There arises no efficiency loss anywhere in the world when workers who would obtam relatively lower wages m developmg countries emigrate to developed countnes where they can get higher wages. This is because the global economy can exploit the htgh productivity of the workers. In this scenario; theoreticallY'; the assumptiOn of the convexity (or decreasmg returns to scale) in aggregate production function plays a central role. As for labour-exporting countries; the remittances from workers employed abroad are large enough to compensate for the loss in gross domestic product (GDP) caused by the decrease in the domestic labour force. Symmetrically. in the host countries; the gain m their GDP from receivmg foreign workers outweighs the income distributed to them. The second maxim describes the effects on income distribution m sending countries as well as in receiving countries. Since the outflow of labour brings about shortage of labour or eliminates a part of the unemployed labour force in developing countries; the wage rate rises or stops declinmg; and hence it may contnbute to more equitable distnbution of income between capital and labour there. Meanwhile; in receiving countnes; the inflow of foreign workers reduces the wage rate there by increasing the supply of labour; and hence it is harmful for the native workers while it is benefioal for the firms and the owners of capttal. This is usually

!nternattonal Labour Mtgratwn and Ewnomtc Development


the reason that trade unions in developed countries would oppose the mflow of foreign workers while the firms would welcome it. Are these theories working in practice at all? Does labour migration contribute to the reduction of the difference in per capita income between developed and developing nations? UnfortunatelY; we can find no country in history that accomplished economic development by allowing the outflow of the domestiC labour force. There is no natiOn able to take off on to the path of economic development with the sole help of the remittances sent by migrants. Why are economic development and labour outflow inconsistent in practice? Underdevelopment is drivmg down the wage rate for domestic workersi If the economy industrializes7 the wage rate will go up and labour outflow will decrease. In this answer7 emigration is regarded as one of the economic consequences brought about by the underdevelopment of the economy However7 this answer is incomplete 7 for it does not explain the reason for underdevelopment. In my opinion7 there seems to be no a priori causality between migration and mdustrialization. Does industrialization decrease the outflow of labour7 or does the outflow of labour hinder the economy from mdustrialization? In this paper7 I attempt to deny the usual one-way causality that regards emigration as a result of underdevelopment7 and instead discuss the converse of the causality As it is7 excessive outflow of labour confines the economy to the pre-industrialization stage due to the existence of increasing returns to scale in production. I address a proposition that a country loses its drive to embark on industrialization once the outflow of labour goes beyond a critical level. The larger the gap in per capita income between developed and developing countries7 the more workers are induced to emigrate from developing countries into developed ones7 and it becomes more difficult for-the labour-sending countries to industrialize. This view may upset the traditional understanding of the role of remittances that the developed countries receive from their workers emigratmg abroad. As well as direct foreign investments and official development aids 7 the importance of remittances from migrant


workers IS often emphasized as a resource that helps the economies of developing countnes industrialize. However1 the critical difference that the remittances have from the others is the fact that many domestic workers have emigrated1 led by their pessimistic expectatiOns on the possibility of future economic development of their home countries. If their expectations are rational1 the large amount of remittances labour-exporting countries receive today just Imply that their economies cannot industnalize the catch up with the economies of developed nations1 however efficiently they may use the money. This paper is organized as follows. The next section gives an overview on the recent trend of labour movement in East and South Asian nat10ns1 introducing some available data. SectiOn 3 presents a model to investigate the relationship between economic development and labour outflow under mcreasing returns to scale 1 and analyses the case of the migration of unskilled workers. I show that there exist two rational-expectation equilibna1 pre-industnahzed equilibrium and industnalized eqwlibrium1 for a fixed volume of labour outflow and that the latter disappears when it exceeds a certain critical level. I also show that both types of equilibria are possible under free migration of unskilled workers. SectiOn 4 examines the implications of the model concerning the significance of remittances1 the role of the governmenes migration policy, and the effects of the outflow of skilled workers. Section 5 concludes this paper1 makmg several remarks on subjects not discussed m the text.

2. Labour outflow in East and South Asian nations This section gives an overview on the labour migratiOn recently takmg place in East and South Asia1 making use of available data. The data on migration that I present here are based on the official statistics1 whiCh themselves depend on estimation m details. In additiOn1 illegal migrants are not taken into account in the figures. Thus1 I cannot say how precisely the data presented here reflect the reality of migration m this area1 which would be a common

fnternallonal Labour Mtgratton and Economtc Development


defect among the statistics on labour migratiOn. 1 However1 the purpose of this section is not to spell out the reahty of labour migrat10n m Asia as correctly as possible 1 but to recognize the differences m the pattern of labour outflow among the countries m this area. According to ILO (1992) 1 annual flows of workers in East and South Asia 1 moving from developmg countries such as China 1 Malaysia1 the Philippines and Thailand to developed or industrialized countries such as Japan 1 South Korea 1 Singapore and Taiwan 1 have increased from about 301000 per year in 1980 to officially around 1501000 today1 and to at least 300;DOO including illegal migrants. This rapid increase IS enough for us to imagine that the discrepancy between those countries has been expanding during recent years in per capita income or wage rates. Figure 8.1 presents the trends m per capita GNP of five nations in this area1 Thailand1 Indonesia1 Bangladesh1 the Philippines1 and Malaysia1 which are measured as a ratio to South Korea1s per capita GNP in the corresponding years. The graphs being commonly downward-sloping1 it turns out that the economies of these five countries have grown at slower rates than the economy of South Korea and the differences m the growth rates also continue to expand between these countnes and South Korea. 2 Although ncher than South Korea in per capita terms until the early 1980s1 Malaysia 1s position has been declinmg relative to South Korea since the latter caught up with it1 and in 19911 it produced less than half of South Korea 1s per capita GNP. Figure 8.2 shows the annual outflows of workers of the countries in East and South Asia1 Bangladesh1 Indonesia 1 South Korea 1 the Philippines1 and Thailand. From this figure 1 we find that these countries1 except for South Korea1 kept increasing the outflow of their domestic workers annually over the decade. The number of migrants from the Philippines is overwhelmmgly higher than the others1 while only the outflow from South Korea keeps declinmg from the early 1980s. Concernmg the trends of labour emigration in this area1 it is pointed out that the primary destinations of the Asian migrants

Htdekz Komsht


Figure 8.1 Trends in per capita GNP 120

Thailand Indonesia Bangladesh Philippines Malaysia

100 .....



'' ''




----- --20







85 86 Year






World Bank (1993).

had changed in the mid 1980s from the Middle East to developed countries in East Asia such as Japan and the NIEs. 3 Behind this change was the cessation of major construction projects m the Mrddle East. Meanwhile 7 it was noticeable that the number of migrants to the Asian developing countries continued to increase during the 1980s. It must be a reason for the change that the labour markets in the Asian developed countries became more attractive to Asian migrants than those in the Mrddle-East7 and in this respect we cannot overlook the role of Japanese corporations that embarked on direct foreign investments vigorously in this area. The change in destination from the Middle East to East Asia was quite drastiC. For the Phihppines7 which is one of the ma1or labour-exporting countries in Asia 7 the outflow of workers to the

!nternatwnal Labour M1gratton and Ewnom1c Development


Figure 8.2 Annual outflow of workers in Asian countries lin thousands) ('000) 700




Thailand Indonesia Bangladesh Philippmes Korea









/"-""" / : ' ':'-:c.C::':C··~·- ..:C.= ::-':-;.: > ~ 0.>

Wa11-Soon K11n

export expansion was shortlived7 however7 when 1 in 19897 Korea 1s exports posted a poor 2.8 per cent growth over the previous period1 more than 6 per cent decline in real terms (export volume). In spite of the steadily depreciating won and mellowing labour unrest 1 export growth rate remained at a weak 4 per cent in 19907 with the nation's trade account shifting back into deficit after four consecutive yearly surpluses. While the trade deficit on a customs clearance basis was nearly halved from US$9.7 billion in 1991 to US$5.1 billion in 19921 it was not due to rapidly growing exports but to slackened imports7 which fell sharply from 16.7 per cent in 1991 to a negligible 0.2 per cent in 1992 (Table 11.3). Reflecting the weakened competitiveness of its products in international markets7 Korea 1s ranking as an international trader dropped to thirteenth place in 1992 from its eleventh place in 1990. Korea 1s export growth rate of 6.7 per cent in 1992 was the lowest increase among the so-called four 11Asian dragonsn 1 compared with Hong Kong 1s 21.4 per cent 1 Singapore 1s 78 per cent and Taiwan's 6.9 per cent. Labour disputes1 wage hikes1 high rates of inflation7 and widening trade deficit1 which had plagued the Korean economy between 1989 and 1991 1 were substantially mitigated in 1992. These were the remarkable achievements of 1992. On the inflation front 1 consumer prices rose more rapidly in the 1988-92 period than in the previous five years. Although the trend was up through 1991 1 when consumer prices rose 9.3 per cent1 the performance in 1992 improvedi prices went up 6.2 per cent. The rate of nominal wage growth 7 the culprit in the inflation picture 1 began to decelerate in 1990 and continued to slow in 1992 to less than 16 per cent from a peak rate of 25 per cent in 1989. Also1 exports revived a little in 19921 while imports flattened 7 bringing the current account deficit down to US$4.6 billion from US$8.7 billion 1991. These improvements in the inflation and trade balance made policy makers confident about maintaining contractionary policy measures despite complaints about bankruptcies and a rapid slowdown of GNP growth to 4.7 per cent 1 the worst economic downturn since 1980 when the economy recorded a minus growth (WK. Park 19921 p. 1).


Korea11 &o11omy 111 Dtstress


Macroeconom ic prospects for 1993 and the period 1993-98

Macroeconomic prospects for 1993 The Kim Government faces what is by Korean standards an economic crisis. As indicated already, the GNP grew by 4.7 per cent in 19921 but an economic turnaround is not very likely in 1993. After a low 3.4 per cent growth in GNP in the first quarter of this year1 the rate for the second quarter was 4.2 per cent1 below the earlier forecast of 4.5 per cent1 putting the first-half growth rate at 3.8 per cent. Such lower-than-expected growth was1 as can be seen in Table 11.41 due mainly to the continued decline in corporate investment since the third quarter of 19921 lower private consumption1 and the ominous labour disputes at Hyundai between May and August 1993. The sluggish economy of 1993 did not bode well for the Kim Government1 since it enshrined high economic growth near the top of its policy priority. Thus1 it is not surprising that the government swiftly set to revive an ailing economy by prescribing short-term revival remedies in the name of the New 100-Day Economic Plan. The highlight of the Plan is to accelerate economic growth by cutting bank interest rates and easing the money supply in order to encourage business investment and to support small- and mediumsized firms. Its consequent inflationary tendencies will be held back by a freeze in public service charges and government salaries and by the voluntary restraints in wages and incomes of the business sector1 all under the cause of upain sharingn. The business-propping measures undertaken just after the inauguration to bolster the economy do not seem1 however1 to have had desired effects. As the economic performance of the first-half of 1993 shows (Table 11.4)1 investors1confidence does not seem to have recovered1 as corporate plant and equipment investments declined by 5.7 per cent. The general strike staged by the Hyundai trade 11 union seems to indicate that despite the governmenes call for pain sharingn1 the natiorr's labour unions are lukewarm in restraining their wage demands. Although the Kim Government promised to

Table 11.4 Macroeconomic prospects for 1993


Real GNP growth rate(%) Total consumpti on (private) (government) Fixed capital formation (construction) (plant and equipment ) Exports (merchandise) Imports (merchandise)

8.4 9.3 9.3 9.4 11.8 11.0 12.8 9.8 9.5 17.5 17.5


4.7 6.8 6.4 8.8 -1.8 -2.6 -0.8 9.8 9.7 2.9 1.9


BOK Pro1ecttan for 1993








7.4 8.5 8.5 8.3 6.5 4.7 8.5 14.1 14.2 11.8 11.2

5.9 7.4 7.0 10.0 -0.1 -3.5 4.5 10.2 10.2 5.2 4.2

3.3 5.9 5.2 10.4 -3.3 -3.4 -3.1 10.7 10.8 -3.2 -4.5

2.8 5.6 5.3 17.0 -8.2 -6.3 -10.2 5.3 4.9 -1.0 -2.2

3.4 5.4 5.5 5.1 -5.8 -1.7 -10.1 12.7 11.9 -0.4 -1.8

4.2 5.1 5.0 6.1 0.8 2.3 -1.5 7.0 5.5 1.8 1.7

1st-Half 2nd-Half


3.8 5.3 5.2 5.6 -2.4 0.5 -5.7 9.7 8.5 0.7 -0.1





8.5 9.4 7.7

3.6 2.8 4.5





Industry Agriculture, forestry and fishery Mining & manufacturing Manufacturing Construction Service Trade balance (customs clearance basis US$ billions) Current account balance (US$ billions) Consumer prices (%)










-1.0 8.7 8.9 11.4 10.5

5.4 4.6 4.8 -1.9 6.3

15.8 7.6 7.8 3.6 8.5

4.3 8.2 8.6 -3.0 7.3

5.3 3.1 3.3 -2.1 4.8

4.5 0.1 0.3 -4.5 5.0

1.8 1.4 1.4 -2.3 5.4

-1.0 2.0 2.2 2.7 6.6

-0.1 1.7 1.8 0.5 6.0











-8.7 9.3

-4.5 6.2

-3.2 7.2

-1.2 7.0

-0.3 6.1

-0.3 4.8

-0.7 4.6

-0.3 4.7

-1.0 4.7

-1.0 5.3

(1990=100) NOTE:

a Estimate

of the Ministry of Trade, Industry and Energy.

SOURCE: Bank of Korea.

Wan-Soon Kmz

promote economic liberalization and deregulation1 there still are continued bureaucratic intervention and proposals for change by government fiat. Along with short-term remedies for an economic revival 1 the New Government came up with some drastic measures to reform all sectors of society and1 at the same time 1 to revive a sagging economy. A real-name system1 which President Kim introduced by invoking emergency powers on 12 August is the most important reform among all the reforms pursued by the New Government. Although it was Mr Kim's major campaign pledge with strong public support1 the introduction of the real-name system was shelved because of a possible adverse short-term impact on the already weak economy, though the adoption of the real-name financial transaction system appeared necessary to achieve the anticorruption goal1 and to strengthen Korea 1s financial institution in the long run. Under the banking laws1 technically anyone could deposit an unlimited amount of money just by giving any name and a matching seal for bank deposits and withdrawals. Curb-market operators probably took advantage of this protection of anonymity and used banks as conduits for secret !endings. This has not only made assessment of individual wealth impossible, but has also hampered attempts at equitable taxation of capital income. Twice in the last 13 years1 the Korean Government tried to establish a real-name financial system. But they failed to implement it because of the concern that it would dampen the economy, of strong opposition from corporations and individuals with untraceable funds 1 and of the threat of major withdrawals of funds from banks. If the amount of monetary deposits held under financial pseudonyms is only about US$12 billion 1 or about 4 per cent of Korea 1s total deposit base (aSouth Korea: Act to Control 1Black Money 1111 Wall Street /ournal1 3 August 1993)1 that is1 if most financial transactions were actually carried out with real names1 underground funds to be channelled into the industrial sector do not seem to be very much 1 indeed. However1 businessmen complain that such a sweeping financial reform 1 for all its good intentions1 could do more harm than good for the national economy, if it is hastily driven with accusatory

The Korean &anomy m Dzstress

fever and without supplementary measures7 such as tax amnesty and/or lowering tax rates. Big corporations seem to perceive both intractable industrial relations7 confusion created by the abrupt introduction of the real-name system7 and the anticorruption drive as the most uncertain factors that would delay big investment projects. For the second half of 19931 the Korean economy shows no predictable signs of recovery. The depressed investment climate 7 aggravated further by the mandatory use of real names in financial transaction 7 and the decrease in agricultural production due to unseasonably cool weather will exert downward pressure on domestic demand. On the top of it 7 money supply (M2) 1 which had maintained a stable pace of increase until JulJ) grew by 20.3 per cent in August 1 reflecting the monetary authorities 7 desire to cope with financial stringency because of a drain of liquidity from the curb market caused by the crackdown on false-name accounts. Controlling money supply in order not to disturb price stability may be a critical test of the success of the real-name system. During the first six months of 19937 the rates of increase of both consumer prices and producer prices slowed down7 compared to those a year earlier. In the second half of 19931 however7 farm goods prices are likely to show a rather faster rise than the previous year due to the damage inflicted by unseasonably cool weather. Combined with the possible inflationary effects of the real-name system stemming from the growth of money supplJ) the economy is likely to witness mounting inflationary pressures. For the Korean economy to expect a modest recovery in the latter half of 19931 it will depend on the prospects for brisk export growth. Actually7 in the first half of 19937 the economic downturn was partially offset by a steady increase in exports. During the first six months of 19931 exports on a customs clearance basis exhibited a 6.4 per cent rise by the surge in heavy industrial and chemical products such as cars7 iron and steel7 and electronics. The continuing recovery of export industries has been mainly brought about by the rapid rise in exports to China (143 per cent\ to ASEAN (8 per cent) 1 and the South America (16 per cent) countries. Exports to the United States7 Japan and the European Community

Wcm-Soon Kun

(EC) together have decreased since the second half of 1991: 4.1 per cent in the corresponding period of 1992 and 1.5 per cent in that of 1993. Imports1 on the other hand1 turned to a mere 1.5 per cent rise in the second quarter from a 4.5 per cent fall in the first quarter1 putting the first-half import growth rate at a negative 1.5 per cent. The fall in Korea 1s imports reflected a sluggish state of the Korean economy, mainly due to a delayed recovery of plant and equipment investment. As a result1 the trade balance on a customs clearance basis accumulated a US$2.2 billion deficit during the first half of 1993. The current account thus recorded only a US$1 billion deficit1 shrinking by US$3.5 billion from the previous year1s figure. For the latter'half of 19931 the more than 20 per cent depreciation of the Korean won against the Japanese yen could be the saving grace of the depressed economy. The weakening Korean won is to aid recovery in price competitiveness of Korean products. The wondollar exchange rate is projected to rise to a level of 810 won to one dollar by the end of 1993. Thus 1 if Korea could capitalize on opportunities in the new markets in China and Vietnam1 the appreciation of the yen will be translated into immediate export gains. Taking into account these possible outcomes1 the Ministry of Trade 1 Industry and Energy revised its trade projections by raising the export target from US$83 billion to US$83.5 billion and by lowering the import target from US$86.5 to US$85.5 billion. In summary1 the mandatory use of real names in financial transactions enforced in August 1993 and the decrease in agricultural production due to unseasonably cool weather will exert downward pressure on domestic demand. In addition 1 as long as businessmen are reluctant to undertake plant and equipment investments1 a business upturn in the latter part of 1993 year is not very likely. For 1993 as a whole 1 therefore 1 the annual rate of economic growth will be less than 5 per cent1 falling short of the targeted 5.8 per cent.

Korea's five-year plan for a new economy, 1993-97 On 2 July 19931 the Kim Government issued a blueprint1 shown in Table 11.51 for economic change during the five years1 1993-90

lhe Koreu/1 hononzv uz Dzstress


which span the tenure of President Kim Young-sam. With the assumption that the world economy and trade will grow by 3.2 per cent and 5.6 per cent1 respectively1 the plan calls for attaining: (1) a sustainable average annual growth rate of 7 per centi (2) a per capita GNP of US$14p76 and US$648 billion in GNP by 1998i (3) a balance of payments surplus by 1995i and (4) economic stability with consumer prices rising by 3.7 per cent per year. The plan advocates the difficult and complex task of managing the transition to greater knowledge-based industries1 reforming the financial sector and fiscal system to ensure fair competition and abolishing 1 unnecessary regulations and restrictions inhibiting economic activity The plan recognizes the need for greater liberalization and internationalization of the Korean economy if Korea is to attain developed country status and improve its competitiveness. The introduction of the real-name system is the critical measure to rationalize the financial system in the long run 1 and demonstrates determinati on to carry out the reformist goals contained in the Five-Year Plan. The Five-Year Plan appears1 however1 to be rather too sanguine about the targeted average annual growth rate of 7 per cent1 the goal of price stabilization1 and the reversal of the deficit in the balance of payments. The 1990s face very different circumstances from the last three decades with their high growth rates. There is now widespread recognition that the rapid growth of income and wealth must be fully translated into greater wealth for the citizens. There is also greater concern with consumer rights1 welfare issues and environment1 all of which can be achieved at a high cost in growth. The latter two may be obtainable objectives when the impact of trade restrictions in Europe and North America on Korean exports will not be significanti when the protracted labour disputes and consequent wage hikes will not emerge with the projected economic growthj and when substantial resources are to be allocated to support high-technology industries in order to raise productivity and maintain price competitiveness. In order to discuss some major problems facing the Korean economy in the proper light1 Korea 1s economic performance has been evaluated so far in an aggregate context. The critical issues that may

Table 11.5 Korea's five-year plan for a new economy, 1993-97 1
















Real GNP growth rate Consumption Fixed capital formation Export (Merchandise) Imports (Merchandise)

8.4 9.3 11.8 9.8 (9.5) 17.5 (17.5)

4.7 6.8 1.8 9.8 (9.7) 2.9 (1.9)

6.0 6.1 4.2 9.2 (9.1) 5.3 (4.4)

7.1 6.5 7.0 8.1 (8.0) 6.1 (6.0)

7.2 6.5 7.3 8.3 (8.2) 7.6 (7.5)

7.1 6.4 8.7 8.1 (8.0) 8.2 (8.2)

7.0 6.4 8.9 8.0 (7.9) 8.5 (8.4)

7.0 6.4 9.2 7.8 (7.7) 8.6 (8.5)

Balance of payments (US$ billions) Exports (Export growth)

69.5 (10.2)

75.2 (7.9)

82.3 (9.5)

90.1 (9.5)

99.3 (10.2)

110.1 (10.9)

122.6 (11.3)

136.3 (11.2)

Imports (Import growth) Trade balance Current account balance Rate of inflation (%) Wholesale prices Consumer prices GNP deflator Current GNP (US$ billions) Per capita GNP ($) Domestic savings ratio (%) Cross investment ratio (%) SOURCE:

76.6 (17.5) -7.0 -8.7

77.3 (1.0) -2.2 -4.6

81.3 (5.1) 1.0 -1.4

87.6 (7.8) 2.5 0

95.8 (9.3) 3.5 0.9

105.3 (9.9) 4.8 2.1

116.1 (10.2) 6.5 3.7

128.1 (10.3) 8.2 5.3

4.7 9.3 11.2 281.7

2.2 6.2 6.3 294.5

1.8 4.9 5.3 321.9

1.8 4.3 5.3 364.3

1.7 3.7 4.8 418.9 97339 35.6 35.4

1.6 3.6 4.5 484.9

1.5 3.2 4.1 561.6 127305 36.8 36.2

1.4 2.9 3.8 648.0

67518 36.3 39.2

Government of Korea (July 1993).

6)49 34.9 361

77306 34.7 35.1

8)96 35.4 35.4

10)16 36.2 35.8

147076 37.5 36.7



influence the Korean economy in the 1990s and that are contained in the New Five Year Plan are: (1) interest deregulation and liberalization of the financial sector1 (2) labour-management relations1 (3) government-chaebol relations1 and (4) export stagnation and industrial restructuring.

4. Major issues and challenges for the Korean economy in the 1990s

Interest rate deregulation and liberalization of the financial sector Interest Rate Deregulation Over the last three decades1 the Korean Government has adhered to the notion that financial policies are the most effective tool to achieve export-led economic growth and that the financial sector should be tightly controlled to allocate scarce resources to the strategic industries. From this viewpoint1 Korean officials have maintained that the cost of capital should be kept low in order to promote rapid industrial development. ConsequentlY; institutional arrangements and practices based on the financially-repressed system have been maintained for the past thirty years. It is no surprise 1 therefore 1 to find that the ratio of financial assets to GNP, the broadest indicator of financial development1 as of the end of 1992 was at 4.487 compared with 6.91 for Japan (1991) and 5.27 for Taiwan (1991). ObviouslY; the major factor critically limiting Korea 7s financial development is a variety of heavy government intervention to which the commercial banking system has been subject. First1 it is the non-performing assets of nationwide commercial banks1 which have been caused by government-dictated bank !endings. The government has approached the restructuring of sunset industries by shifting the burden of adjustment to commercial banks1 avoiding the short-term consequences of bankruptcies. The accumulation of non-performing loans1 however7 has been found to limit the autonomy and the efficiency of the banking industry and raise the future adjustment costs to the national economy. Second 1 the share of policy loans1 a typical type of

The Korean Economy




government-directed credit1 in total domestic loans by the deposit money banks reached about 56 per cent as of the end of 1992. Until the commercial banks are freed from the obligation of extending policy loans1 the extent of financial liberalization will be limited. FinallY; a low level of Korea 1s financial development is the result of prolonged interest rates controls. Given that the debt to equity ratio of Korean companies is on average more than 300 per cent1 government and businessmen have been worried about a cost burden of high interest rates on the business sector1 cited as one of the greater disadvantages in competing internationally. Therefore 1 the government has been always ready to intervene in the financial market in order to keep the lending rates from rising too high and to avoid any financial panic for business firms. In fact 1 as the economis growth potential seemed to be seriously threatened in 19931 the new government decided to lower official interest rates by one percentage point in March as a stimulant for the sagging economy. The advocates of low interest rates have failed 1 however1 to see the crucial role of market-determined interest rates in enhancing the efficiency of investment and offering incentives to save. They have also failed to see that excess demand for funds at below-equilibrium rates of interest has required credit rationing1 usually excluding the small firms because of their inadequate collateral and credit standing. Even if the government and the central bank believe the merits of market-determined interest rates1 they have been probably concerned about losing their regulatory powers or they could not resist the strong objection by large business groups who are losing their priority access to cheap capital. The heavy intervention in1 and overregulation of1 the financial sector are major obstacles to development in the 1990s1 when large amounts of investment will be needed in new1 high-technology industries. Also1 as a result of the world-wide trend of financialmarket globalization and the inexorable increase in the complexity and market orientation of the Korean economy1 the bureaucracy becomes incapable of guiding the economy as in the past. It is not surprising1 therefore 1 that the Kim Government has rightly declared the deregulation of domestic interest rates as a critical stepping stone


Wan-Soon Ktnz

before any other financial liberalization is initiated. Furthermore 7 with the adoption of the real-name system7 a strict application of fair trade laws7 and industrial polices to reduce the business concentration7 strong resistance to reform measures by the conglomerates7 the major beneficiaries of Korea 7s repressed banking system7 will be effectively countered. In spite of the urgent need to make its financial market more competitive and efficient7 however7 the response of the Korean Government has been slow and cautious7 because it recognizes that the control of the financial sector still is one of its most potent policy instruments. As the deregulation of interest rates is feared to bring about a sudden increase in interest rates7 thereby creating financial difficulties for heavily indebted firms 7 gradual deregulation of interest rates has been favoured 7 with the rigid requirement that macroeconomic preconditions be met before the launching of substantial financial reforms. The re-emergence of a deficit in Korea 7s balance of payments in 1990 was a major factor that slowed down rapid liberalization of the financial sector. Further7 with the recent increase in inflationary pressures7 the high cost of money (the 1992 local cost of funds indicated by the three-year corporate bond yield at 16 per cent compared with foreign rivals 7 funding cost of between 4 per cent to 8 per cent\ and the persistence of excess demand for funds 7 it has been perceived by the Finance Ministry that a hasty financial liberalization including the deregulation of interest rates may cause inefficient capital flows by contracting the supply of credit to the manufacturing sector7 especially for small to medium-sized firms 7 and increase the demand for loans related to unproductive real estate investment. We are of the view that interest rate deregulation should be pushed ahead of schedule in the aftermath of the real-name system implementation. If banks were allowed to set interest rates at their own discretion 7 they would be able to lure the underground money into the organized monetary institutions by offering attractive financial packages. In response to the content and pace of Korea 7s financial liberalization7 the U.S. Government has been strongly critical of Korea 7s overly cautious approach of waiting for the elimination of internal

1he Korean honomy rn Drstress


and external macroeconomic imbalances before it considers undertaking main financial liberalization reforms. The U.S. Government holds that it is tight government control of the financial sector that has brought about the severe liquidity shortage in Korea and a high local cost of money that is approaching 16 per cent. Partly under U.S. pressure and partly for the benefit of its own economy, the Ministry of Finance introduced a revised comprehensive five-year (1993-97) 1 three-stage financial liberalization and market opening plan (Blueprint) at the end of June 1993. The revised Blueprint with no required macroeconomic preconditions is expected to accelerate or revise the previously announced four-stage interest rate deregulation plan. Effective 1 November 19931 the Korean Government implemented the second stage of its four-step interest rate deregulation programme after years of delay and vacillation. As a result1 control has been removed from the interest rates for 1 84 per cent of all loans and 57 per cent of all deposits at Korea s financial institutions. However1 the real test for the governmenfs financial liberalization programme will come when it initiates the third-stage deregulation between 1995 and 19961 when all interest rates are liberalized1 except for demand deposit rates. The ultimate step is liberalization of demand deposit rates1 planned to start in 1997 on a step-by-step basis.

Liberalization of foreign exchange Financial liberalization could bring about1 in the short-run 1 the pressure of higher interest rates1 inflow of speculative hot money from abroad 1 appreciation of domestic currency, and expansion of money stock. In order to deal effectively with these pressures1 financial liberalization in general and interest rate deregulation in particular should be implemented by adopting a more flexible exchange rate system. The liberalization of foreign exchange means abolition of the concentration system and allowing internationalization of the domestic currency. Under the multiple currency basket peg (MCBP) system 1 adopted in March 19801 the exchange rate of the Korean


Wan-Soon Ktm

won vis-a-vis the U.S. dollar was simply a weighted average between the Special Drawing Rights (SDR) basket based rate and Korea 7s own basket rate 7 plus an adjustment factor for policy purposes. The adjustment factor or policy variable was a mechanism which the Korean monetary authorities used to take account of the interest rate differentials between domestic and international 7 the prospect of trade balance 7 and other factors to achieve certain policy goals. But this was the primary reason for which Korea was accused by the U.S. Government of manipulating its exchange rate. With the shift into surplus on the current account in the period 1986-897 regulation of foreign exchange has been substantially relaxed. The government adopted the market average rate (MAR) system on March 19907 in an effort to let the exchange rate be determined by market forces and to avoid the pressure from the U.S. Government to liberalize the foreign exchange market. The MAR system sets the won/dollar exchange rate at the beginning of each business day at the weighted average of transactions in the inter-bank market on the preceding business day The market average rate thus determined becomes the basic rate of the next day This rate was allowed to fluctuate within the ±0.8 per cent band around the basic rate since July 1992. The MAR system can be regarded as being in transition to a freely floating exchange rate system in the near future. Under the Blueprint the exchange rate daily fluctuation band is to be expanded to ± 1 per cent by the year end. For the further development of Korea 7s foreign exchange market 7 two important aspects of the MAR system must be taken into consideration. First7 while the won/dollar exchange rate is determined in the Korean foreign exchange market 7 the won/yen and the won/ pound rates7 for example 7 are determined by using the dollar/yen and the dollar/pound rates determined in the international exchange market. This prevents these exchange rates from reflecting the economic conditions of Korea and Japan on the one hand and the United Kingdom on the other. Second7 with extensive controls imposed on the financial and capital markets in Korea 7 any disequilibrium in the current account cannot be fully resolved by the exchange rate movement. For instance 7 from the second quarter to the fourth quarter

The Korean &:anomy



in 19901 the Korean won in terms of the U.S. dollar remained virtually at the level of 715 won due to the surplus in the capital account 7 although Korea registered current account deficits.

Labour-management relations

The Korean labour market today is faced with structural problems. The supply of labour has been decreasing at an annual rate of 3.1 per cent since 19887 though exceeding the population growth rate of about 1 per cent per year. The labour force growth is attributable to two factors: the increase in the size of the age cohorts entering the labour-market and the rise in female labour participation rates. These changes suggest that a great deal of employment opportunities will have to be created for new entrants to the labour market. On the other hand 7 the demand for labour is likely to grow much more slowly in the future. The recent surge of wage increases originating from labour strikes and disputes has induced firms to accelerate the adaptation of automation processes7 which will contribute further to the decline of the labour-absorptive capacity of the Korean economy In the rapidly changing technological environment7 therefore 7 the Korean labour market is likely to suffer a shortage of educated and skilled manpower. Political reforms and economic liberalization that were set in motion after the 1987 presidential election have ushered in a new era for Korea 7s labour movement by strengthening basic labour rights and stressing autonomous resolution of labour disputes between labour and management. As a result 7 the number of local unions mushroomed to 0883 in 1989 from 27 263 at the end of 1986. From the viewpoint of this paper7 what draws our attention is the incipence of labour strikes7 particulary after 1987. As shown in Table 11.67 labour unions staged 3}49 work stoppages in 1980 which were about 14 times higher than the number of disputes a year earlier. Key issues of disputes include higher wages7 better working conditions7 participation in management decisions and matters related to the operation of labour unions.

Wan-Soon Ktm


Table 11.6 Trends in labour disputes


Number of labour disputes

Estimated production loss (US$ btl/ions)

Estimated exports loss (US$ millions)

1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992

407 186 88 98 113 265 276 3/49 1)873 1)616 322 234 235

NA* NA NA NA NA NA NA 3)508 4)681 6)176 2)010 1)619 2)486

NA NA NA NA NA NA NA 537 732 1)363 314 238 260

NOTE: * NA: Not Available. SOURCE: Quarterly Labor Review, 2nd Quarter, 1993 (Korea Labor Institute).

The frequency of strikes in 1989 decreased sharply to less than half of the 1987 level1 and in 1992 it was less than one-fifth of the 1989 level. Does this development mean that industrial peace has been finally restored? The substantial reductions of strikes was rather a partial reflection of the poor performance of the economy1 especially the difficulties of exporting firms. Also helpful was a tougher government stance in enforcing labour laws and regulations after several years of good experience in conducting labour negotiations. The influence of Korean labour unions on wage determination had not been strong until the late 1980s1 when unions1 bargaining power was strengthened significantly and a minimum wage law was enacted. The Federation of Korean Trade Unions (FKTU) is active today. It announces a targeted rate of wage increase at the beginning of each year and this rate usually serves as the basis for wage negotiations by labour unions. FKTU generally claims that


The Korean Economy in Dtstress

Table 11.7 Indicators of wage negotiations !Percentage per year)

1987 1988 1989 1990 1991 1992 1993

Wage increases asked by unions

Wage tncreases acceptable by management

Actual* wage tncrease

26.0-27.0 29.3 26.8 17.3-20.5 17.5 16.8 6.0-8.5

6.0-7.0 7.5-8.5 8.2-12.9 7.0 7.0 4.7-6.7-15.7 4.7-8.9

11.6 19.6 25.1 20.2 16.9


NOTE: *Nominal wage increase in the manufacturing sector. SOURCE: Korea Labor Institute.

the targeted rate of wage increase should be a minimum rate 7 incorporating the rise in the cost of living. FKTU7s counterpart7 the Korea Employers7 Federation (KEF) 7 on the other hand 7 proposes an acceptable rate of wage increase annually, suggesting that wage increases be contained within the growth rate of labour productivity. The targeted rate by FKTU7 the acceptable rate by KEF and the actual rate of wage increase are reported in Table 11.7 It can be seen that7 in the past7 the two federations 7 claims remained far apart on an appropriate ceiling for wage hikes. The combined results of successful collective bargaining and consequent wage hikes in the labour market have been the rapid rise in unit labour costs7 far outstripping productivity. As shown in Table 11.37 in the period 1987-907 nominal manufacturing wages soared at an average rate of more than 19 per cent per year7 while labour productivity rose by only 4.8 per cent per year. These meant a rise in unit labour costs of 13.8 per cent. Coupled with an appreciation of the won relative to the U.S. dollar at the same time 7 unit labour costs in U.S. dollar quivalents rose by 21.6 per cent7 undermining substantially Korea 7s international competitiveness. Korea


Wan-Soon Ktm

experienced the largest increase in the unit labour cost7 compared with 171 per cent in the Taiwan and 4.6 per cent in Japan. What does this ;rend imply for the future of the Korean labour market? Major structural changes which are taking place in the labour market lead us to seriously consider unemployment issues which have not received much public attention. As the economic growth slowed down with high wages resulting in fragile international competitiveness of Korean products and rapid hollowing of the manufacturing sector7 rising unemployment in the 15-24 year old age group will emerge as one of the most serious social concerns in the years to come. In accordance with President Kim's plea for 11 pain sharing77 for the creation of a 11 New 77 Korea 7 FKTU and KEF in February 1993 reached a rare agreement to limit annual wage increases to single digit ones in an effort to stem spiralling inflation (Table 11.7). Surprisingly enough7 they also agreed on the causes behind the declining competitiveness of Korean products in the international market: high labour and financing costs at homei poor product qualityi declining productivityj and aggressive competition from the low-wage countries of Southeast Asia and China. But there is no guarantee of how long the government campaign stressing the need for wage restraints for the national interest will have an impact on both wage demands and on the incidence of strikes. In the August 1992 case of labour dispute at Hyundai 7 there was a wide gap between the rate of wage increases the trade union demanded (12.8-20.1 per cent) and the acceptable rate of wage increases proposed by Hyundai (2.7-4.7 per cent) before they agreed on a 4.7 per cent wage increase. In the meantime 7 the Ulsan-based eight Hyundai companies estimated to have recorded a combined direct and indirect monetary loss of US$1.65 billion during the two and half months of the labour dispute. Two valuable lessons may be gleaned from the Hyundai dispute. One is that some political activists outside trade unions seem to have exercised greater influence on labour leadersi therefore 7 labour strife is not likely to subside even if the union's demands for wages and better working conditions are met. The other is that the Hyundai

The Korean &anomy m Dtstress


case is not so much the disputes in the workplace as those within the government. The root of the problem was in the Ministry of Labour Affairs7 attempt to implement a "no work1 partial paymene7 principle 7 in conflict with other Ministries7 staunch support of a 11 no work 7 no pai7 policy.

Government-chaebol relations The search for a cornpetitive 1 liberal economic order has been intensified in Korea since political democratization gained momentum in 1988. The dispersion of the concentration of economic power or the vigorous enforcement of the fair trade law is a conspicuous example of such a quest. At the heart of this issue is the chaebo/7 namely, that of conglomerate power of business groups1 the majority of whose members are big monopolistic ones in their respective markets7 and which are owned and controlled by particular individuals or their family members (Lee Kyu-Uck 1986). Under President Kim's strong reform drive 7 the chaebo!s are asked to decentralize their wealth 1 separate management from ownership and sever close relations with politics. Korea is one of the world 1s most concentrated economies. In 19907 the share of the 30 largest conglomerates in the entire manufacturing sector reached 35 per cent in shipments1 17 per cent in employment1 and 41 per cent in export. Since firms belonging to the 30 chaebo!s represent a small fraction of the total number of firms 7 real concentration of economic power was much more serious. As expected 1 the market structure is heavily concentrated. In terms of the number of commodities (122) 7 the share of industries characterized as noncompetitive remained high at 78 per cent in 1992 1 although it decreased from 84 per cent in 1977 The concentration of economic power in a developing economy like Korea is in general attributable to the scarcity of entrepreneurship7 which is vital during the initial stage of economic take-off. With the government objective of rapid economic growth continuously adhered to1 economic power was bound to be concentrated in the hands of a few entrepreneurs who entered into new markets to make


Wan-Soon Ktm

use of their excess capacity in manpower and capital. Further, given various structural and institutional barriers that protect their initial monopolistic enclaves in the market 7 this has given rise to the formation of business groups through extensive diversification by taking part in almost all areas where profit outlooks were promising. The business concentration in the context unique to Korea was really a creation of the Park era - particularly, the governmenes direct involvement during the HCI drive in the early 1970s - which justified all economic consequences of the growth first policy under the pretext of efficiency Because capital-intensive and technologically sophisticated industries such as shipbuilding7 machinery, steel products and petrochemicals favoured by the government required huge capital7 manpower7 technology, and organiz.ation7 the chaebols received special treatment7 notably in the area of industrial finance 7 with large loans at extremely favourable interest rates7 which in most cases turned out to be negative in real terms. During the 1970s7 the share of government-dictated loans in domestic credit reached 60 per cent. In contrast 7 as limited financial resources were pre-empted for the chaebols7 credit to labour-intensive industries was unduly squeezed. Given also the weak business position of small- and medium-sized firms7 they were denied access to the new HCI projects7 thus aggravating the concentration of economic power. There appear to be several major dangers with respect to heavy economic concentration. First7 there may well be efficiency losses associated with very large firms. When resource allocation is determined by a few chaebols rather than by the market mechanism7 it hampers equitable distribution. Equity is7 after all 7 a prerequisite for attaining efficiency in the long run. Second7 the pursuit of rapid economic growth on a weak domestic capital formation base made chaebols highly dependent on bank loans. Therefore 7 Korean conglomerates are highly leveraged and vulnerable to financial shocks. Third7 the concentrations of economic power in Korea has evolved into an issue with political and social dimensions beyond the simple economic sphere 7 as the relationship between the government and the key private sector entities has become more complicated. Given the concentration of economic power and its adverse impact

The Korean Economy




on the Korean economy1 the question of chaebo!s has become central in the economic and political debate. From a viewpoint of the Kim Government 1 policy towards the chaebol now seems centred on three major demands. The first is that company accounts should be more public and more easily scrutinized. The Fair Trade Commission has launched extensive investigations into illegal business practices such as raising large sums of secret funds to make contributions to politicians in return for business favours. In this regard1 the adoption of the real-name system is expected to contribute to sound financial practices of the business firms by freeing them from undue political influence. As a result1 companies will be able to focus more on their particular business interests1 including R&D and technology development. Second1 the concentration of ownership is a unique characteristic of the concentration of economic power in Korea. Because of the intercompany shareholding practice in Korea1 the ownership of large business groups has not been dispersed. In 19921 for instance 1 the average intercompany shareholding ratio for the 30 largest conglomerates was about 46 per cent. In order to dilute the power of a small number of farnilies 1 the government decided to prohibit the affiliates of the top 30 groups from holding more than a 40 per cent ownership interest in other affiliates. To this end 1 subsidiaries of the 30 conglomerates will be strictly curtailed in the amount of their cross loan guarantees to a maximum of 200 per cent of their net worth. Also suggested was a plan to convert the huge amount of bank debt of the chaebo!s into corporate shares. Third1 the government has urged the chaebo!s to slim down their weight through the divesture of peripheral holdings1 concentrate on the production of a smaller number of items1 focus research on these products1 and ensure international competitiveness. In the past1 the conglomerates took part in almost all industries whose profit outlooks were promising. Excessive diversification proved detrimental to technological innovation1 which could be carried out more efficiently by specialization in the main line of business. Some of the chaebols have already started reducing the number of their subsidiaries though sell-offs1 separation of management and mergers. A business firm


Wan-Soon Kim

should not attempt to do everything1 or diversify to different fields. It must identify its core competency. In order to eliminate the major negative effects caused by the business concentration1 more competitive pressure should be imposed on business groups by removing the barriers to entry by domestic and foreign firms 1 while the countervailing power of small- and medium-sized firms1 labour unions and consumer groups must be augmented. In addition1 the issues of the concentration of economic power and ownership must be handled through the consistent and steady implementatio n of a comprehensive policy, including not only strict enforcement of a fair trade policy, but also reformulation of other measures such as stringent tax administration1 more equitable allocation of financial resources and removal of restrictions on imports.

Export stagnation and industrial restructuring From the beginning of 19891 uncertainty has reigned over the Korean economy. The main reason for such an observation is that after the impressive export expansion between 1986 to 19881 Korea 1s exports posted a poor 2.8 per cent growth in 1989 over the previous year1 which is more than 6.4 per cent decline in real terms (Table 11.3). The trend of sagging exports continued in the following year. In spite of the steadily depreciating won and mellowing labour unrest1 export growth remained at a weak 4.2 per cent in 19901 though a slight recovery of 4.9 per cent in real terms. The trade account slid1 however1 into a deficit after four consecutive yearly surpluses. In 19911 exports emerged from their sluggishness in the previous year1 increasing at a rate of 10.5 per cent. But because imports rose to 16.7 per cent1 the trade account deficit peaked at US$9.7 billion (Table 11.3). This deficit was far above the previous high of US$5.3 billion incurred in 1979. While Korea 7s trade deficit on a customs clearance basis in 1992 was nearly halved from US$9.7 billion in 1991 to US$5.1 billion 1 it was not due to rapidly growing exports but rather to slackened imports1 which fell sharply from 16.7 per cent in 1991 to a negligible

!he Korean &anomy m Dtstress


0.2 per cent in 1992 (Table 11.3). A substantial improvement in Korea 1s trade balance in 1992 was due mainly to the explosion of exports to South American and ASEAN countries. The continuing export recovery stemmed also from the dramatic rise in exports to China. Korea 1s exports to China rose by nearly 90 per cent over the previous year to US$41493 million1 while Korea 1s imports were up by a moderate 8 per cent to US$3/25 million1 resulting in the trade balance in Korea 1s favour. Korea 1s export growth rate of 6.7 per cent in 1992 recorded1 however1 the lowest increase among the four so-called "Asian dragons111 compared with Hong Kong 1s 21.4 per cent1 Singapore 1s 18 per cent and Taiwarrs 6.9 oer cent. A£YflTe£Yate exoorts to the United States1 Japan and the 12-member EC1 Korea 1s three largest markets1 peaked at US$41.6 billion in 19881 then decreased by 6.5 per cent to US$38.9 billion in 19921 being edged out by developing countries1 chiefly China. Thus reductions in world-wide demand do not fully account for slackened Korean exports. Neither can trade barriers in industrialized countries be fully blamed for Korea 1s deteriorating export position. Obviously1 it has been the eroding export competitiveness of Korean-made products in both price and quality which accounts for Korea 1s sluggish exports to the major industrialized countries1 although it may be an achievement1 viewed from Korea 1s need to diversify its markets. The continuing price weakness of Korean products in the international market has stemmed mainly from a sharp 67 per cent increase in nominal wages in the manufacturing sector and a 21 per cent rise in the value of Korea 1s currency between 1986 and 1989. Over the same period1 labour productivity recorded a moderate growth rate of 34 per cent1 largely in response to industrial unrest coupled with the deteriorating work ethic and deficient technology development. As a result1 Korea 1s unit labour cost in terms of U.S. dollars in the manufacturing sector rose sharply by 98 per cent. The details are documented in Table 11.21 with the implications for Korea 1s international competitiveness. On top of these 1 the high cost of money and excessive user-costs to pay for infrastructure such as highways and ports that had already been utilized


beyond their capacities added to production costs. As a result 7 world consumers seem scared away by the rising prices of low quality Korean products. Against both the U.S. dollar and the Japanese yen 7 depreciation of the won since 1990 has not been enough to restore the price competitiveness of Korean products. Furthermore 7 low-priced but high-quality Japanese products7 manufactured in Southeast Asian countries7 have been eroding the share of Korean products in the world market. As a result 7 Korea 7s trade deficit with Japan 7 which had started falling a bit7 rose again by US$67 million in 1989 over the previous year7 US$1 7945 million in 19907 and US$47839 million in 1991. In 19927 Korea recorded a large trade deficit of US$7,858 million with Japan 7 about 153 per cent of its global external deficit. Measures such as cutting corporate tax rates 7 reducing interest rates 7 and increasing special loans provide only immediate relief to exporters. More fundamentally7 what is required in order to arrest Korea 7s export competitiveness from falling are well-planned industrial restructuring 7 investment in technological development and management rationalization. Korea ought to correct first those structural weaknesses that threaten its future export growth. In a certain way7 the high growth period of 1986-88 was a mixed blessing. On the one hand 7 by mopping up a sizeable balance of payments surpluses during this period7 Korea seemed to be on the verge of becoming a capital exporting nation after a heavy dependence on foreign capital. It delayed 7 on the other hand7 restructuring of Korean industries and failed to prompt their technology development efforts to keep up with ever rising competition from abroad. At the same time 7 workers7 feeling that they had been denied an adequate share of the perceived wealth 7 have insisted upon higher compensation 7 leading to severe labour disputes during this period. In the final analysis7 Korea 7s export competitiveness in the world market of the 1990s and beyond will fundamentally depend on the success of the Korean industry in upscaling its products and production lines. In most industrial sectors7 Korea can no longer rely upon low wages and labour-intensive exports to sustain its long-term export

Ihe Korean Economy




growth. The only viable alternative is for Korea to move towards a high-technology, high-productivity7 and high value-added economy as rapidly as possible through massive industrial restructuring. Thus7 the government has attempted to deal with the challenges posed to the natiorrs economy by encouraging labour-intensive producers that are no longer competitive to shift into other lines or transfer their operations overseas to lower cost countries7 such as China. Efforts are currently under way to arrest the falling productivity growth rate by establishing a new framework for technological co-operation among the government7 private enterprises7 and research institutes and universities. As these plans are put into effect7 it is expected that the share of GNP spent on R&D will increase from 0.86 per cent in 1980 to 3 per cent or 4 per cent in 19987 according to Korea 7s New Five-Year Economic Plan. Another major obstacle to restoring Korea 7s international competitiveness is the shortage of industrial manpower. The rapid expansion of the service sector in the late 1980s attracted many skilled workers away from the factories with resulting negative effects on industrial productivity. The government has adopted two basic approaches to solving this problems. First7 spending on manpower training programmes is to be substantially increased7 and the programmes will be tailored to meet specific industrial needs. Second7 macroeconomic policy will be used to restrict the excessive expansion of the consumptive service sectors so as to correct the sectoral imbalances that emerged in the late 1980s. In the short to medium-term 7 industrial recovery requires 7 above all 7 that the rise in labour costs be brought into line with productivity growth. To accomplish this7 both wage restraint and expanded investment in new plant and equipment are urgently needed. Although the new civilian government has campaigned the need for wage restraint in the national interest7 and has been doing its utmost to impress upon both employers and employees the vital importance of achieving a balance between wage increases and productivity gains7 it is not certain whether they will be successful in agreeing to contain annual wage increases within productivity growth.


Wan-Soon Ktm

In order to improve the industris international competitiveness, it will be particularly important for Korea to continue to receive substantial flows of FDI and technology from such countries as the United States, Japan and the EC in the future. On the part of Korea, it will need to make the investment climate more favourable to foreign investors. Over the last few years, there has been a serious worsening of the business climate in Korea, and Korea is falling behind other countries in the region and elsewhere in its ability to lure foreign investment into Korea. Korea also has been urged to adequately protect intellectual property rights. Also, major efforts should be made to remove investment barriers such as rapid wage increases, the shortage of social overhead capital, labour-management tension, the control-ridden financial sector, and the web of government regulations.

5. Concluding remarks Looking back on the Korean development experience over the last three decades, it seems clear that the Korean economy has been faced with endless challenges and that it has somehow properly responded and successfully adapted to them. For example, in the 1960s Korea enjoyed the dynamic gains from expanded trade by following an outward-oriented development strategy. In the 1970s, however, the Korean economy experienced economic deterioration mainly due to the excessive government intervention and the overambitious heavy and chemical industrialization drive. The 1980s have been a period of structural adjustment aimed at the promotion of continued economic growth with price stability. As the development experience of the Korean economy shows, adaptation inevitably involves much uncertainty and risks. The Korean experience seems very unique in overcoming these risks and successfully adapting to the changes in economic environment during the last three decades. Recent changes in the international environment and internal political climate have created a set of new tasks for Korea. Such a change calls for the reinvention of a national management system

The Korean Economy m Distress


that will differ drastically from the existing one (Kim L. 19937 p. 184). First7 the government and political power should no longer be the source of uncertainties for firms7 as in the past when chaebo!s colluded with political power to undertake business. Close collusion between the government and chaebo!s is a liability today. From now on 7 the Korean Government should immediately liberalize its financial markets 7 giving market mechanisms the chance to function properly in allocating resources. As business firms perceive that market and technology are the main sources of uncertainty7 not government7 they will develop the necessary strategy and organizational structures to cope with the changing environment. Second7 internationaliz ation of the Korean economy in general and Korean business in particular is the inevitable course of action for the future. As Korea 7s competitive position is constantly changing as advanced industrial countries shift into high technology sectors while latecomers among developing countries emerge as strong competitors in simple labour-intensive goods7 Korea will have to relocate low-technolog y7 labour-intensive manufacturing to low-wage countries and to continue adjusting its industrial structure. Finally, a number of structural reforms initiated by the new government should not be deterred by its political concern for the ailing economy The government should realize that the two targets of economic recovery and economic reform sought at the same time are incompatible. Adapting the behaviour and thoughts of bureaucrats and business managers to a new environment may take a long time 7 possibly six to 15 years. It is perhaps better for Korea to focus more on reform than on short-term recovery. In order for the law of the survival of the fittest to be applied in the changing environ7 ment1 external as well as internal1 Korea s search for a national management system that is compatible with the new environment is truly imperative.

Note 1. My analysis reflects the economic situation and the business mood prevailing during 1993. Things have started improving since then.


Wan-Soon Kzm

References Asian Development Bank. Astan Development Outlook 1993. New York: Oxford University Press, 1993. Bank of Korea. Current Movements and Prospects of the N:Jrean honomy. August 1993. ~~-· honomlc Statistics yearbook, various years. ~~-· "The Korean Aggregate Labor Market: Its Development and Behaviourn. Quarterly Economtc Revtew, March 1992, pp. 18-40. ~~-· 77ze Preliminary National Income Account m 1992 (in Korean), March 1993. Finance Ministry. Monthly Bulletm of Stattsttcs on Pub!tc finance and Money and Banking (in Korean). Various issues. Frankel, Jeffrey A. Uberaltzatlon of Knrea~'i Foreign Exchange Markets. Pacific Basin Working Paper Series, No. P 92-98. San Francisco, March 1992. Jwa, Sung Hee. Knrea~'i Interest Rate and Capital Controls Regulation. KDI Working Paper No. 9218. Seoul: KDI, September 1992. Kim, Choongsoo. Wage Policy and Labor Market Developmem of N:Jrea. NIESI Working Paper 9101. Seoul, Korea: National Institute for Economic System and Information, July 1991. Kim, ]in Chun. Knreas Recent Foreign Exchange Rate Systems: MCBP vs MAR System. Seoul, Korea: Korea Institute for International Economic Policy (KIEP), December 1992. Kim 7 Linsu. "Adaptation of Korean Management to Changing Global Business Environment: Toward Reinventing the National Management Systern'7 • Paper Presented at an International Conference on Strategic Responses to the Changing Global Business Environment: American 7 Japanese, and Korean Management Experience. Korea University, Seoul, Korea 7 11 October 1993. Kim, Wan-Soon. uKorea's Experience in Economic Development: Challenges and Policy Response"- Paper presented at the Symposium on Asian NIEs: Past Success and Future Challenge. Hong Kong, 30-31 May 1991. ~--·"Korea-US. Trade Relations in the GATT Frameworkn. In Knrea In a lurbulcm World, edited by I.Y. Chung. Seoul: Sejong Institute 7 1992. ~~-· uThe President's Emergency Decree for Economic Stability and Growth (1972)n. In honomtc Developmem m the Republic of N:Jrea: A Policy Perspecttve, edited by Lee-Jay Cho and Y.H. Kim. Hawaii: East-West Center7 1991.

The Korean Economy tn Distress


Korea Foreign Trade Association. Korea and the World: Key lndtcators 1993. Seoul, Korea: 1993. ___ . Major Statistics of Korean Economy. Various years since 1993. ___ . Status of International Price Compettttveness of Korean Products (in Korean), July 1993. Korea Productivity Center. Quarterly Productivity Revtew. Various issues since 1993. Lee, Duk-Hoon. 1he External Policy of Korea. Economic Division Working Papers. Canberra: Research School of Pacific Studies, Australian National University, January 1992. ___ . The Korean Economy Prospects and Ftnanctal Reforms. Economics Division Working Papers. Canberra: Research School of Pacific Studies, Australian National University, February 1992. Lee, Kyung Tae. liPolicy Measure to Reduce Industrial Concentration and Concentration of Economic Power". In F..conomic Development in the ROK: A Policy Perspecttve, edited by Lee-Jay Cho and Y.H. Kim. Hawaii: East-West Center, 1991. Lee, Kyu-Uck. liThe Concentration of Economic Power in Korea: Causes, Consequences and Polic/'. In lndustnal Development Policies and Issues, edited by Lee Kyu-Uck. Seoul: KDI, 1986. ___ . liCorporate Policies in Korea: With Special Reference to Competition Policy". Mimeographed. Seoul: KDI, 1993. Nam, Chong-Hyun. liThe Role of Trade and Exchange Rate Policy in Korea". Paper presented at the Fourth Annul NBER East Asia Seminar on Economics, San Francisco, 17-19 June 1993. Nam, Sang Woo. The Korean Economy at a Crossroads. Working Paper No. 9124. Seoul: KDI, December 1991. Park, Woo Kyu. The Korean F..conomy: Current Perfonnance and Prospects (revised). Seoul: KDI, December 1992. Park, Yung Chul. liThe Korean Economy: Where Is It Going". Paper Presented to the Symposium on Asian NIEs: Past Success and Future Challenge, Hong Kong, 30-31 May 1991. World Bank. Korea: Managing the Industrial Transition. 2 vols. Washington, D.C.: 1987. Young, Soogil. "Prospects for Investment Relations between Korea and the US in the 1990s". Paper presented at the Sixth Joint Economic Cooperation Conference between Korea and the Southeast United States, Kyongju, Korea, 10-12 October 1991.

12 China's open policy and its return to GATT* ZHANG XIAN-CHUN

1. Introduction In 1979 the Chinese Government made it a basic strategy to open and reform its economy This strategy has not changed since then1 even though there were shifts in tone between reform and regulations. Specifically, it was recognized by the government that a socialist economy should also utilize the market mechanism as capitalist economies do. This stance was strengthened as Mr Deng Xiao-ping authorized it during his trip in January-February 1992 to southern parts of the country The fourteenth general assembly of the Communist Party in 1992 decided that the goal of China was the construction of a socialist market economy This meant that the economy should utilize both the market mechanism and central planning1 and that ownership of productive assets should consist of a variety of forms: state1 collective1 individual and foreign ownership. 1 While these were guaranteed by the central government1 it may be of interest to outsiders to see how these basic strategies are implemented through specific actions. The government also maintains a strategy to promote foreign trade and investment through the Open Policy This stance has not changed since 1979. The efforts of the 374-

Chinas Open Pohcv and tts Return to CI\TT


government to 11 re-join GATT77 is the most vivid evidence of such a basic strategy. As the GATT rules require significant modification of the domestic regulations and trade practices that have been prevalent in China 7 opinions within China are split. Some argue for a larger concession but others assert a cautious approach. This paper offers a review of economic reforms and the processes for the participation of China in GATT. While controversial7 the author argues that China will and should accelerate the negotiations to promote 7 multilateral7 freer trade. This will enhance China s involvement in market integration in East Asia. To make arguments more specific 7 the paper provides the case of Dalian in reforms and promotion of external transactions. As we assume the audience of the paper comprises foreign scholars and business people 7 the paper omits some domestic details and focuses on the points that the foreign audience may be interested in.

2. Economic reforms and specific progress in policies The main characteristics of the economic reforms that the central government has pursued can be summarized in the following points: First7 economic resources should be largely allocated through the market mechanism. This means that prices should be set to clear the market demand and supply to improve efficiency in resource allocation. Second7 the macro demand management should be implemented not by direct controls but indirect inducements. TrJ.ditionallj) the Chinese Government much depended on direct regulations for the stabilization of business activities. This has created enormous distortions. Reforms aim to use indirect policy instruments in the forms of fiscal and monetary policies. Third 7 the government must make clear the legal bases for its intervention in the market when it is necessary. This implies strengthening the legal bases on which business conduct are supervised. When the government leaves resource allocation to competition among various units7 inequity and injustice occur if the legal framework remains unclear. Not only private actions but also government conduct must be subject to explicit laws so that equity under the laws can be guaranteed. 1


Zhang Xttm-Cnun

Fourth1 it is important to maintain and further elevate the Open Policy so that China can enjoy the benefits of freer and multilateral trade. While China is unique in that the state enterprise is still a main feature of ownership1 othedorms of ownership have increased their shares1 including collective 1 individual 1 and foreign ownership. To return to and participate in GAT~ the governmen t re-affirms China 1s commitme nt to the GATT rules. It is true that a large number of factories are gravely concerned about a negative impact on themselves as foreign competition forces them to adjust but China 1 will benefit more through such adjustments. Fifth1 state enterprises must be further reformed. So far the 1 number of individual enterprises has increased and has contributed to the revitalization of the Chinese economy. The efficiency of state enterprises1 however1 remain low. In July 1992 The State 1 Council1 therefore 1 published an ordinance to 11 Convert Managemen t System of State Enterprisesn. This aimed to vitalize state enterprises through expanding autonomy in managerial decisions. The fourteen points of revision included giving enterprise autonomy in personnel managemen t1 workers managemen t1 internal distribution of income 1 reform of internal structures1 foreign trade 1 and a veto against production quotas. Since the reform of state enterprises is of significant importance 1 we elaborate on the developments in this area. The governmen t aims to induce enterprises to maintain productive assets as well as to pursue profit increases1 a larger portion of which is at their disposal. Experience showed that enterprises tended to expand current profits to increase their income at the cost of productive assets. Thus1 a variety of contracts are being explored to shift from a mere 11 profit contrad1 managemen t to net asset contract1 surplus and profit sharing responsibility, and joint maintenanc e contract of state assets. Another aspect of reforms of state enterprises is securitizatio n of state enterprises. Through stock issuance and paying dividends to shareholders1 the governmen t aimed to induce state enterprises to improve efficiency. While the ownership distribution is still limited 1 as stock is mostly owned by other state enterprises the 1 number of stock-based companies reached 400 corporations by 1992.

Chmas Open Po!tcy and tts Return to CATT


The number of companies whose stock are registered at Shanghai and Shenjen Stock Markets grew to total69. In the meantime 1 takeover and merger of companies have also increased. By the end of 19921 about 101000 companies had been taken over1 and there were 45 cases of bankruptcy of state enterprises during January through October 1992. Another change is the development of horizontal co-operation among state enterprises1 which means that they form a group of enterprises to promote joint research and development (R&D) efforts1 joint imports of technology1 and joint financing. A shift from state ownership to stock ownership and increasing autonomy of management requires well-functioning factor markets in capital and labour. Naturally the goods markets must develop1 although the capital market has been grdually growing 1 which is evident from the development of stock markets. While labour markets are still constrained because of regulations on movements of registered living places1 workers have become more mobile as enterprises gain autonomy in recruiting1 and as enterprises sometimes go into bankruptcy. It is true that reforms in ownership and management autonomy have less meaning unless prices are reasonably set. If prices are arbitrarily set high1 enterprises can make profits even if management is inefficient. In contrast1 an efficient enterprise loses if the price of its output is set low by the government. In fact prices have been rapidly liberalized in recent years. As of May 1993 about 400 cities and counties (Xian) in China abolished regulated prices on foodstuff. While in 1991 there were 733 items whose prices were regulated by the central government1 including transportation fees 1 the number decreased to 89 items by the end of 1992. At the end of 19921 the state controlled prices were approximately 15 per cent of agricultural products1 10 per cent of manufactured consumption goods1 and 30 per cent of the shipment of producer goods. Another new feature is that the Chinese Government has started the preparation of social insurance because the employment practices have been changing from "permanent employment and egalitarian reward 11 to freer recruitment. Workers now have more freedom to choose their jobs but also face higher risks of unemployment.


Zhang Xtan-Chun

The past practice of "eat rice of a large bowF' is now graduall y phasing out. Under such circumstances the governm ent launched social insurance schemes for unemplo yment and retirement. It was reported that the unemployed who received unemplo yment insurance benefits reached some 300pOO during Janurary -Septem ber 1992. On the other hand, about 400,000 firms and 85 million workers joined the social insurance scheme for their pensions. Seventeen million retired Kanbu (core personnel) also joined the pension system. While we discuss the return of China to GATT in the following section, it is importan t to recognize the real situation of the nation as described above. Many foreigners may embrace the past image of China, but they must update their image taking into consideration recent changes. Changes in China are so rapid that one's image easily becomes obsolete.

3. Negotia tion for China's return to GATT The issue of China's return to GATT has been one of the keenest issues in the country as far as the nation's external policies are concerned. The negotiat ions started in 1986 and have been going on up to present. Foreigners may not distinguish ureturn td' from uparticipating in77 GATT For China, however, it is importa nt to recognize the process as areturnin g to 77 GATT China was one of the founding member s of GATT when the agreeme nt was signed by 23 nations in 1947. Howeve r China 1 could not play its role like the other founders since political struggles on the domestic front overwhe lmed all external affairs when the 1 Peoples Republic of China (PRC hereafter) was established only in 1949. Meanwh ile 1 in 1950 the Guomin tang Governm ent declared the withdrawal of 11 China'' from GATT because they considered that GATT member ship would only benefit PRC not Taiwan. It was 1 under this context that China withdrew from membership in GATT

Process of negotiations Since 1979 the Chinese Governm ent has adopted the open policy towards the outside world on one hand and promote d economi c 1

Chmas Open Po!tcy and its Return to CATT


reforms to change from the acentral planning and autarkic 11 system to 11 market-oriented11 system. Through this process1 the government has recognized that China can adapt itself to GATT rules. Thus1 the government submitted the application for returning to GATT membership in July 1986. At this time the government made clear the following points as the basic principles in joining GATT:

1. To make it clear that China 1s participation in GATT is not a new entry but a return to GATT 2. China is qualified to receive preferential treatment as a developing country in GATT and not to take the responsibility of a developed nation. 3. China is willing to undertake the obligations of GATT members mostly through implementing tariff reduction. 4. China duly requests unconditional1 most-favoured-nation (MFN) treatment from all the member countries. 5. China duly requests all GATT members to remove whatever import restrictions that discriminate against China. Based on these five principles the government submitted to the GATT secretariat the memorandum on 11 China 1s System of Foreign Trade 111 which explained the details of economic reforms1 and the workings of various institutions and business practices concerning China 1s foreign trade. In response to this1 the GATT secretariat office established in June 1987 the Working Group on China to examine China 1s participation. This Working Group is: (1) to define China 1s duty to fulfil the GATT rules1 and (2) to create the negotiation tables for China to work out tariff reductions with existing individual members1 and (3) to submit a proposal to the GATT Board of Trustees. From 1988 through 19891 the Working Group met seven times and tried to settle approximately 21000 points of issues which were made the agenda for negotiations at the outset. The major issues that the Working Group considered to hinder China 1s return to GATT were as follows:

1. In China regulations made by local governments often lack

Zlzallg XIuii-Cizun

consistency with those imposed by the central government 1 and the former often add some other regulations. This conflicts with GATT rules. 2. The legal framework concerning foreign trade is premature in China and the trading regime lacks 11 transparencyn in the eyes of foreign partners. 3. Many prices of goods are not determined by the market forces but arbitrarily set by the government. The government policies often promote dumping by cutting prices for exports even below the production cost. 4. As there are so many interventions by the government in economic activities through state planning 1 approvals by the central government1 foreign exchange controls7 and administrative screening at various levels7 tariff negotiations do not make significant sense. Non-tariff measures that distort foreign trade must be significantly reduced. The Chinese representatives promised to improve China 7s system so t}_lat it becomes compatible with GATT rules7 and hoped to accelerate the negotiation processes. The Tienanmen Square Incident of June 19897 however1 hindered progress because many Western countries implemented economic sanctions against China. The eighth meeting of the Working Group which was scheduled to open July in the same year was postponed until December. Thereafter7 the ninth meeting was held in January 1991 7 in which the Group requested the Chinese party to reconfirm that China promote economic reform and open policies after the Tienanmen Square Incident7 and asked some supplementary explanations about China 1s situation. The Chinese party replied to this request by submitting the (/Supplement Documents concerning China 1s System of Foreign Traden. This focused on disclosing internal acts and ordinances that regulate foreign trade 7 tariff reduction 7 and China 1s acceptance of the abolishment of the Regulatory Import Surcharge. After these processes7 the Working Group planned to enter a new phase in which China and GATT members deal with tariff negotiations bilaterally and multilaterally.


Open PoiiLy and tts Return to CATT


Aftermath of eleventh meeting of the Working Group While it appeared that the negotiation had reached a final stage 1 the processes have had to go through further complicated procedures. After the eleventh meeting of the Working Group1 which was held in October 19921 the group held the twelfth meeting in December of the same year and the thirteenth in March 1993. The procedures have been frustrating to the Chinese Government. 11 1 The final stages included further elaboration of China s goal 1 Con1 struction of Socialist Market Economi which was adopted at the 14th General Assembly of the Communist Party. They also included the establishment of an unofficial group to draft the protocol for China 1s return to GATT To give a few examples to explain the features of the final stages of negotiation1 the thirteenth meeting picked up the following six issues: China 1s policies towards agriculture 1 pricing practices of goods and the related policies1 allocation of foreign exchanges1 establishing a consistent national system of foreign trade 1 autonomy of enterprises in managing foreign trade 1 safety standard in regulating imports1 and inspection procedures.' It was only after these procedures that China at last entered a phase to start negotiations for tariff reduction. In fact it was in early 1993 that bilateral negotiations should start. Thereafter1 the Working Group would set a timetable 1 for multilateral negotiations. Then 1 finally the protocol for China s return to GATT would be drafted.

So-called "Taiwan issue" For China the 11Taiwan Issue 11 has never existed as an international issue because the Chinese Government regards the issue as a purely domestic one. Thus1 the government has constantly rejected any proposal or suggestions that hint at two Chinas. Since Taipei took a counter measure to represent China in returning to GAT~ the issue called attention to the other China. As the Chinese Govern1 ment has been flexible to offer aTwo Systems under One Natiorr' 1 however1 the participation of Taipei has not been totally rejected. Some elaboration is now in order. As a matter of fact 1 in January


Zhang Xtan-Chun

1990 Taipei applied to participate in GATT with the proposal that Taiwan1 Penghu1 }inma and Mazhu would join GATT as a single unit of common tariffs. In fact 1 Hong Kong Special Administrative Region (HKSAR) is allowed to participate in many international organizations such as GATT and the International Monetary Fund (IMF). As far as national security and official diplomacy are concerned1 however1 HKSAR must be subject to Beijing. Following this format 1 the Chinese Government1 instead of rejecting Taiwarr's participation1 argued that the following three principles should be maintained when Taiwan joins GATT: • The government of Peoples Republic of China is only one legitimate government that represents all China. • Taiwarr's participation can be accepted only after the return of PRC to GATT • Taiwan is permitted to join GATT as a single unit that applies common tariffs to the region in the future 1 but Taiwan must go through prior consultations with the PRC Government and it can negotiate with other countries only after a prior agreement of the PRC Government. In spite of those conditions1 the Board of Trustees of GATT decided in September 1992 to examine the participation of Taiwan to GAT~ and established the Working Group for Taiwan.

Chinese economy after returning to GAIT Debates and prospects It is obvious that China has to undertake some painful adjustment in domestic economic management and regulations on foreign trade to accommodate itself to the international rules1 while benefiting from freer multilateral trade under the most favoured nation treatment. Therefore1 hot debates occurred in the country concerning the costs and benefits of returning to GATT From a broader viewpoint1 the benefits that China gains from the GATT system1 however1 seem to be large enough to exceed the cost China must pay Major benefits for China are:

Chu1as Open Po!tcy and its Return to CATT


1. Returning to GATT enables China to participate in making the international rules concerning external trade and strengthens China 1s position in trade negotiations. It is only through the participation in GATT that China can take some initiative in trade negotiations. This is supported by the fact that China greatly benefited from participating in the International Monetary Fund and the World Bank (IBRD). 2. GATT membership guarantees China MFN treatment1 which expands trading opportunities for China that will exceed those achieved through bilateral trade arrangements1 and this is advantageous for China to correct various discriminatory treatments imposed by some countries. 4 As a matter of fact 1 roughly 85 per cent of China 1s foreign trade is with GATT member countries. It is most advantageous for China to secure the status of a developing country that enjoys some preferential treatments. 3. Efforts to adjust domestic systems to the GATT rules are compatible with the China 1s social goal to construct the 11socialist market econom/1 . Management autonomy1 which is recognized by China as an important element to vitalize the economy, will be more favourably established through the efforts to accommodate the GATT rules. Tariff reductions that require domestic adjustment also benefit China through a gain from the freer trade. In fact the number of items subject to quantity restriction of imports has rapidly declined 1 and import tariffs have also reduced significantly through the preparation of returning to GATT This has benefited China by reducing the cost of production as well as consumption.~ In 1992 the Chinese Government removed quantity restriction of imports of 16 items and decided to further abolish two-thirds of quantity restriction on imports in three years. Such import liberalization has contributed to cost reduction without significant disturbances on the domestic market and industries. 4. If China obtains the status of the GATT 12 article as a developing country1 the Chinese Government can continue to raise domestic industries. These industries will be able to catch up with the counterparts in developed countries. More severe competition

Zhang Xwn-Chun

through import liberalization will accelerate efforts for improving efficiency of management and production. Indeed7 import liberalization has significantly contributed to lowering the cost of production as the prices of imported machine and intermediate goods declined. Bankruptcy of inefficient firms in itself improves efficiency of resource allocation. On the other hand 7it is expected that China will be able to increase its exports of air transportation7 satellites7 and construction services. The picture may not be so rosy in some industrial sectors and this fact creates great anxiety in the minds of industry people. Inefficient industries and enterprises will be replaced by imported goods. China7s dependence on exports and imports (exports and imports over GNP respectively) were 20.1 per cent and 17.8 per cent respectively in 1991. The fact that foreign trade accounted for such a large share implies that import liberalization will have a significant impact on the domestic economy. Export industries may further expand but some import competing sectors may fall in a crisis. Thus7 domestic adjustment to reallocate resources from declining to growing sectors will be of crucial importance. 0 As no one is allowed to only benefit from trade liberalization of its partners without taking the adjustment burden on its own side 7 China will have to offer reciprocal treatment for foreign exporters. This is what most industry sectors are concerned about. The option for China is not to restrict foreign trade to protect import competing sectors but to encourage investment in productive equipment7 in R&D7 and in managerial skill improvement so that Chinese enterprises become internationally competitive. It is to be noted that the policies required for China to develop are not limited to investment encouragement7 but are much broader in scope. To stabilize domestic businesses7 the government must develop a set of macro policy instruments shifting from direct controls to indirect inducement. It is also essential for the government to create policy instruments to induce enterprises to achieve steadier development in the fields of foreign trade and investment. For macro control of foreign trade and foreign reserves7 the government will


Open Polley and rts Return to CATT


have to execute more indirect polices to induce domestic as well as foreign enterprises. In other words1 policy instruments should take advantage of the market mechanism and voluntary responses of individual units1 and not resort to direct dictatorship.

4. Development of the Open Policy in Dalian: A case study So far we have reviewed the evolution of the Open Policy, focusing on the processes of China 1s negotiation for returning to GATT One may want to know in a more specific manner how this policy has been changing the Chinese economy. This section focuses on the development of Dalian city1 which the governments of China and Dalian city aim to make the 11 Hong Kong of the Northern China 11 .

An overview of Dalians economy Dalian metropolitan area covers 13 million square kilometres 7 with the city area comprising 27400 square kilometres. Population is approximately 5 million in the metropolitan area and 2.4 million in the city area respectively. The most significant characteristic of Dahan is that it is the only gateway to the sea for three provinces of Northeast China7 namely Liaoning7 Jiling7 and Heilongjian provinces1 and the autonomous district of Inner Mongolia. Thus1 Dalian has a strong geographical advantage vis-a-vis Shengyan city, which is the metropolis of Liaoning Province. Shengyan has been the largest site for heavy industries1 and Dalian has developed a broader spectrum of industries and communication facilities. First we provide a geographical sketch of Dalian. The area belongs to the northern part of the North Temperate Zone. As its faces Bohai Bay and the Yellow Sea 1 the climate is mild 7 with cool summers and relatively warm winters compared with inland Northeast China. Ocean resources are rich and production of seafood in Dalian accounts for roughly 10 per cent of China 7s total production. Mineral resources are also rich 1 producing various stones and diamonds. Agriculture has a variety of products1 producing


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Table 12.1 Major features of Dalian's economy !Total GOP value RMB 232 hundred million as of 19921

industry composttton Primary Secondary Tertiary Enterprises by ownership Number of manufacturing firms State ownership (SO) Collective Ownership (CO) Joint SO and CO Joint SO and PO'' Joint with foreigners Pure foreign firms

Value or number of firms 34 116

Notes RMB 100 million

82 3,350 626 2,639 18 16

28 9

Number of firms as of 1991 Value of production RMB 34 billion N






~ ~


Size distribution of firms Large scale Medium scale Small scale Heavy and light manufacturing Heavy manufacturing firms Light manufacturing firms Affiliation of firms Central government Provincial government City government County governmenth Other local firms'

Number of firms

82 141 3,127


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