Industrial Policy in Export-Oriented Economies: Lessons from the Experiences of Japan, South Korea and Taiwan

The industrial policy of Japan is comprised of three stages: the reconstruction phase, rapid economic phase and post-oil-crisis phase.

During the first phase of industrial policy, direct government regulatory measures were employed. Key industries were developed by directly channelling into government funds and at the same time allocating raw materials, foreign exchange and foreign technology. Publicly-owned financial corporations were also created to support priority industries. Fiscal incentives were utilized and big businesses were divided. This yielded a competitive market structure as well as decision-making autonomy for corporate managers. In the 1950s, international competitiveness was pursued using tools like low interest loans, special depreciation, and tax exemption of raw materials and real property. Moreover, tariff and non-tariff barriers were used to protect specific industries from foreign producers.

In the second phase, the economy underwent a transformation from agriculture to manufacturing and from light to heavy industries. Exports in heavy industries accelerated and real GDP grew. The promotion of specific industries continued while foreign exchange and trade liberalization were implemented. The government also discouraged excessive competition by promoting specialization for certain goods.

During the post-oil-crisis phase, industrial policy shifted its focus from giving priority to maximum economic growth to the improvement of social and economic performance. In response to structural change in the economy, two important adjustment mechanisms were used: the establishment of joint credit funds to purchase scrapped facilities with bank loan guarantee and the establishment of capacity-reduction cartel. Industrial policy relied in market-conforming mechanism and less on active protection and direct regulatory tools. It also encouraged knowledge-intensive and energy-saving industrial structure. Furthermore, the government focused on its role as the coordinator of consultation and consensus formation.

South Korea went through several adjustments in response to the dislocations that were caused by partition and the Korean War. In the 1950s, the country followed an import-substitution industrialization strategy; import controls and a multiple exchange rate system protected the domestic market. In 1964, South Korea adopted an export-oriented industrialization strategy. Reforms included devaluation, expansion of export incentives, trade control relaxation, and import liberalization. Exports were promoted through specific incentives like conversion of export earnings into foreign exchange certificates, privilege to import prohibited items through export earnings, loans at preferential rates, direct cash subsidies, tax exemption of imported goods used for exports, and others. These incentives were given to producers of indirect exports starting 1965. Also, the promotion of infant industries led to the creation of huge conglomerates, known as chaebols.

A new market structure evolved by controlling the inflows of foreign investments and foreign technology and by constraining new industry entrants. Vertical integration and local content regulations were imposed on different industries. However, Korea’s success can be largely attributed to selective intervention, especially in its export performance.

Like South Korea, The Republic of China or Taiwan followed an import-substitution industrialization strategy after the War and then moved to export promotion strategy in the 1950s. Before the turn to the next decade, Taiwan relied on tariffs and quantitative restrictions. It was in 1959 when the export oriented strategy started. Taiwan employed a series of reforms, incentives, and selective intervention policies. Support services were also given by the government as well as industrial estates and duty-free economic zones.

Comparison of Japan, South Korea and Taiwan

Japan, South Korea and Taiwan all faced natural-resource constraints. All of them enjoyed successful land reforms, as well as social and political stability. Their governments provided an environment that is conducive for investment. They all adopted consistent policies and formulated supportive measures. Their governments did not compete with the private sector. Vested interest in import substitution was not deemed important. Lastly, all countries shifted from import-substitution to export-promotion.

Japan became a role model for South Korea. Their strong business relations created a highly concentrated industrial structure. On the other hand, Taiwan’s income distribution was more equitable during the period of rapid growth. This was brought by policies that ease small and medium enterprise entry. Meanwhile, Japan and South Korea also set preferential rates, while Taiwan employed interest rates that are close to market-clearing rates. Unlike Japan and South Korea, it promoted export-oriented industrialization by setting the exchange rate close to market-clearing rate.  Japan and Taiwan both had stable output and inflation rates; South Korea, on the other hand, experienced less stable prices and inputs due to its monetary policies. In terms of the role played by the government, Japan and South Korea’s governments were very active in controlling private enterprises, while the government of Taiwan provided an environment that is both conducive to growth and the propagation of small and medium enterprises.

Lessons

The performances of Japan, South Korea and Taiwan proves that trade restrictions are not inferior to free trade. Their economic success are explained by their reliance on private enterprises, the establishment of the rule of law, domestic and international competition,  and the creation of institutions to improve technological import capabilities. Japan and South Korea influenced the market by controlling how many firms should there be through rationalization and structural adjustment programs.

One of the most important lessons from South Korea is the involvement of the private sector in the promotion of export. In addition, it efficiently used foreign capital and kept it as a response to favorable export performance. It showed that a successful export promotion policy needs export incentives and a system of export targets. Tariff exemption incentives were administered in such a way that tariffs on import and export production were paid at the same time and then rebated at the time of export. In addition, South Korea effectively used local content regulations.

The fact that South Korea’s development of its heavy industry was not successful yielded the following lessons: 1) the objective must be to meet international competitiveness in the medium-term; 2) information regarding comparative advantage must be continuously sought; 3) detailed industry-specific strategy should be reformulated as needed; 4) a small number of industries must be targeted; and 5) government intervention should not constrain the exploitation of comparative advantage in established industries.

 Taiwan’s experience, on the other hand, proved that in an environment that does not encourage large enterprises, growth and equity can be pursued at the same time. The environment must be one where the government lets market forces work after laying down measures which promote economic take-off. In sum, the three economies that were observed indicate that availment of incentives must be subjected to a definite time horizon and must be based on performance.

Source:

Patalinghug, Epictetus, “Industrial Policy in Export-Oriented Economies: Lessons from the Experiences of Japan, South Korea and Taiwan” Philippine Review of Economics and Business, VolumeXXIX, No. 2 (December 1992), pp. 264-276.