Korea has been famous for being a successful export-oriented economy. Since its government policy shift from import substitution to export promotion, it has shown remarkable performance and its economy has grown by more than eight percent a year, making it one of the most rapidly-growing economies. Because of its success, the Korean experience has been the subject of many studies. A general consensus was that the Korean trade regime was far from a laissez-faire regime. Instead, the government used a combination of industrial policies and protection measures to favour the export sector.
Government intervention was indeed present throughout the industrialization period; however, the extent and role of government policies on Korea’s success is unclear. The view of neutral and market-friendly interventions with respect to the Korean economy has been popular among many development economists. On the other hand, some analysts point out that the Korean government played a more positive role in the country’s success and it was not neutral in its incentive policies. Amsden (1989) even claimed that the Korean government intervened to get the relative price “wrong” to overcome the consequences of industrialization[1].
In spite of Korea’s distinction, empirical investigations remained to be few. Some studies used macroeconomic data or an isolated industry. However, these data are subjective and they often reinforce an author’s ideology. Some analysts have attempted to describe the links between trade strategies and total factor productivity of Korean industries using change in sectoral export demand and import propensity. However, these measures do not fully capture the degree of government intervention.
To fill the information gap, direct measures of government intervention like tariffs, import restrictions, credit allocation, and tax incentives were observed. Panel data from 38 Korean manufacturing industries from 1963 to 1983 were used to test the relationship of government intervention and sectoral productivity.
A Brief History on Korea’s Government Intervention Policies
Trade Protection. The average level of tariffs has been gradually declining[2], but has remained high during the period from 1952 to 1962 and the tariff schedule changed a little. Due to tariff exemptions on imported materials for export firms and key industries, actual tariff rates have been substantially lower than official rates.
Import Restrictions. Direct restrictions were used to reduce balance-of-payments deficits and to protect domestic industries. With the introduction of the negative list system[3] in 1967, import restrictions dropped dramatically as compared to the earlier positive list system. Nevertheless, discretionary import licensing still prevailed when a substantial liberalization of import restrictions was implemented for the first time. To develop the heavy and chemical (HC) industries, the government enforced various incentive programs including quantitative import restrictions.
Tax incentives. After it started export-oriented industrialization, the tax system was modified a number of times to give incentives to vital import-substituting and export industries. Inputs for export production and export sales received exemptions and rebates. Imports of raw materials and capital equipment for export industries were also exempted from tariffs. According to Collins and Park (1989) exemptions from indirect tax and tariffs were the two most significant export incentive schemes. After 1975, however, domestic tax incentives became more important when incentives were given to HC industries. Tax incentives increased significantly, especially in the machinery and chemical industries, with the initiation of the HC promotion.
Financial Incentives. Until 1982, the Korean government controlled the country’s financial institutions. Nominal interest rates were kept low relative to inflation rates to create demand for credit. Allocation of cheap credit to targeted industries became one the most powerful government schemes. In the industrialization period, financial incentives were used to support export firms through preferential access to loans that bear low interest rates.
Framework of the Empirical Analysis
The conventional growth accounting framework suggests that the growth rate of value added in a sector can be decomposed into the contribution of increase in factor inputs and a residual. The original equation that was used for this paper was decomposed into a neutral technological progress and the accumulation of physical and human capital stock. The empirical implementation of such equation is problematic because human capital cannot be adequately measured because of limited data. Hence, the equation was modified where the sum of variables technology level and human capital was put into a residual, growth of total factor productivity (TFP).
Empirical Implementation
The dependent variable that was used was labor productivity growth (or one of its components: growth of capital stock or growth of TFP). The independent variables included a set of initial levels of state variables and a set of government policy variables. Initial state variable include the natural logarithm of value added per workhour in the initial period and the logarithm of the capital stock per workhour in the initial period. They are assumed to describe the effects of initial differences of capital stocks and output per worker across industries on the consequent sectoral productivity growth. Government policy variables include measures of nontariff barriers (measured by the coverage ratio), average tariff rate (nominal ad valorem rate for total import charge), tax incentives (difference between the legal and effective marginal corporate rate tax), and financial incentives (ratio of bank loans to total assets in each sector). The intercept was assumed to vary over time and across industries.
The equation is estimated using weighted least squares method, which corrects for heteroskedasticity. The three-stage least squares technique (using one-period lagged policy variables) was also applied to overcome the possible presence of endogeneity of policy variables.
Estimation Results
The regression results reveal interesting results for the effects of government policy variables and sectoral labor productivity growth. Trade protection had a strong negative effect on the growth rate of value added. A ten percent increase in nontariff barriers was associated on average by a 1.4 to 2.5 percent decrease in growth rate of value added per year. Tariff rates were also negatively correlated with labor productivity growth at the sectoral level (although they were insignificant under WLS). Tax incentives showed a positive effect on the growth rate of value added, where a ten percent increase in tax incentive was associated with a 2.4 to 3.1 growth rate of real per worker value added per year. Financial incentives were only insignificantly correlated with the sectoral growth rates of value added.
The growth accounting framework suggests that any correlation between a policy variable and output growth could come from two effects:
· The government policy may influence capital accumulation and output growth
· The government policy could affect the output growth by influencing TFP growth.
In regression runs that included the growth rate of capital stock, the estimated coefficients on tax incentives became insignificant, while the coefficients on nontariff barriers are still significant.
Regression results on the test on independent effects of government policy variables on growth rates of capital stock and the growth of TFP indicate that nontariff barriers had a significant negative effect on the accumulation of physical capital, while tax incentives had a positive effect. The test for the interaction between policy measures and TFP growth shows that the nontariff barrier variable is negative and highly significant, while tax and financial incentive variables were not significant.
Conclusions
The empirical results show that trade protections like tariffs and import restrictions are negatively related with the growth rates of value added, capital stock and total factor productivity. These suggest that too much trade protection have never brought about higher productivity growth in protected industries. Government interventions in foreign trade did not prevent the economy’s underlying comparative advantage from coming through.
On the other hand, government policies in tax incentives are positively correlated with output and capital growth. They had an effect on the allocation of resources in the manufacturing sector. However, since total factor productivity growth were not correlated with incentives, the policy did not accelerate overall growth of the economy (it may have even retarded it). Industrial policies helped the economy’s structural formation, but they did not promote productivity growth.
Evidence of negative links between protection and productivity growth show that implementation difficulty of infant industry protection. Infant industry protection aims to yield productivity gains. However, in reality, it has brought about a loss in productivity and a slowdown in technological progress for Korea. Economists have recognized how difficult it is to protect the right infant industry.
Young (1993) has derived a theoretical model in which government intervention policies decrease productivity growth. This happens when policies target premature industries and the government tries to develop technology at a faster rate than what its level of industrial maturity can handle. Another explanation of the negative relationship of protection and productivity growth is the inefficiency of firms in the protected industry that results when excessive protection decreases competition and makes firms lazy. Young (1992) supported this analysis when he found out that Korean import-competing firms developed the quality of their products and increased their productivity after the government liberalized the imports of the products that are same as theirs.
Therefore, empirical results go against the popular view on government interventions. There is no significant evidence showing that government interventions have positive contributions on productivity growth. In fact, Korea’s success could have been stronger without government intervention. It would be more appropriate to say that Korea succeeded “in spite of” not “because of” interventions. Although free trade is not a sufficient condition, less government intervention in foreign trade is better for growth.
Source:
Lee, Jong-Wha, “Government Interventions and Productivity Growth.” Journal of Economic Growth (September 1996), Volume 1, Number 3, pp.391-414.
[1] According to Amsden, the wrong prices worked for Korea because government discipline over business enabled subsidies and protection to be more effective.
[2] Tariffs on some selected products were raised. The Korean government imposed special import duties on specific (nonessential) items.
[3] In the negative list system, only prohibited or restricted import items were listed. In the positive list system, only listed items were approved for importation.
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