The Korean government has influenced the allocation of its resources among industrial activities by selective intervention. It has used policies like taxes and subsidies, credit rationing, licensing, and the creation of public enterprises. The Korean experience shows that for a number of industries, selective industrial policies have contributed significantly in achieving international competitiveness. This conclusion is not without controversy as historical information is insufficient and there is lack of agreement about the required counterfactual. But what is critical is to specify what the Korean government has done right to succeed where many governments have failed. The differences were observed in policies and politics.
Korean Development Performance
The Korean economy in the late 1950’s has been sustained by foreign assistance, where annual inflows exceeding two-thirds of both imports and investment. Its growth had been erratic and the trend was downward. Because of this, analysts expected South Korea to remain dependent on foreign aid in the future. Policy makers also behaved in ways that reinforce this foreign dependence. Their main concern was to control inflation, manage the flow of imports, and solicit foreign aid. The need to foster foreign trade prompted policies of currency overvaluation, high tariff rates, and import restrictions. These policies discouraged exports and endorsed import substitution.
After the ouster of its first president in 1960, the Korean economy began to take off. Reforms were taken to change the country’s dependent status and shift the economy’s focus from the industrialization of the domestic market. The reforms led to rapid increases in savings and investment rates and initiated a change in development strategy.
The Korean economy experience rapid growth over the past three decades after it had adopted an export-led industrialization strategy. It became the one of the world’s fastest growing economies worldwide during this period. The economy also experienced one of the fastest structural transformations.
During the 1960’s, the Korean economy was dominated by agriculture and mining. Exports only amounted to 3 percent of GNP and it involved products like seaweed and ginseng. Today the economy was taken over by the manufacturing sector – chemicals, electronics, automobiles, and heavy electrical equipment – and exports constituted over 90 percent of GNP. Manufactured exports evolved from simple products like wigs and textiles to electronic products and now to sophisticated goods like automobiles and computers. Quantitative evidence indicates that multinational corporations played a supporting role to the evolution of Korea’s comparative advantage. Hence, the country’s export performance substantiates Korea’s speed in acquiring diverse and more sophisticated industrial capabilities.
Korean Industrial Policies
Korea’s terrific development comes from using both neutral and non-neutral policies. Neutral policies refer to the absence of differential effects on the allocation of resources among activities relative to the supposed circumstances of perfectly free trade.
Encouraging Exports through Neutral Policies
Policy reforms for export-led industrialization centred on fostering exports through neutral policies. They accomplished this by insulating export activity from the adverse consequences of policies motivated by other concerns rather than by reducing the domestic market’s insulation from import competition. A virtual free trade regime was put into place, so that capital and transitional inputs used in producing goods for export could be imported without tariffs and outside quotas. Tradeable inputs were exempt from direct taxes. The multiple exchange rate system was replaced by a unitary exchange rate to facilitate a close agreement between domestic and world prices for the output of comparatively advantageous activities.
The government assured adequate financing through its control of the banking system. In the mid-1960’s interest rates were raised; this attracted more deposits to the banking system and increased the government’s authority over domestic financial flows. This happened despite the fact that the government did not have complete control over the flow of funds. Even if the banking system is now controlled by the private sector, export financing continues to be regulated by the government through the central bank.
Real subsidies were also given in the form of direct tax reductions, preferential interest rates, and privileged access to import licenses. However, most of them were either withdrawn or greatly reduced in value. The value of these incentives has wavered that it roughly compensated for the fluctuating currency overvaluation.
The export incentives were applied uniformly across all industries. Incentives were also given to indirect export – inputs produced and sold domestically that will be used in producing goods for export. The virtual free trade regime accounted for two-thirds of total export incentives. What is good about this regime is that it does not discriminate among export activities. In addition, it does not alter the relative values of net prices and capital inputs relative to output prices. All other incentives were discriminatory, but they were administered in relation to some other base other than net price. Altogether, the export incentives have been largely neutral.
The Korean government set quarterly export targets for and with individual commodities, markets and firms. Close contact between the government and business entities was established to implement these targets. Progress toward targets is reviewed regularly at the Monthly Trade Promotion Conference. They kept the government well-informed so that necessary modifications could be made. They also encouraged firms to pursue profitable opportunities. Export achievements have brought national awards and material benefits through discretionary means – which included preferences in credit allocation under government directed bank lending and relaxed tax surveillance.
While non-uniform export incentives have been important for some periods, they did not produce a non-neutral impact and they just offset the distortions that resulted from other objectives.
Promoting Infant Industries Using Non-Neutral Policies
The South Korean government provided non-neutral policies that would help targeted industries. They did this generally by helping create large-scale establishments which were accorded temporary monopolies. They received preferential access to credit and reductions/exemptions to taxes.
Infant industries received protection for non-export sales; it has rarely been given to indirect exports. Protection has been the dominant incentive for infant industries. They were given absolute protection through import controls to ensure them enough non-export sales and a satisfactory rate of return on investment. Controls have often been in the form of quotas that set ceilings on imports. Import controls will be given only if firms could show that the good could not be acquired domestically in reasonable terms.
Infant industries were constrained to pursue sharp productivity growth through the export targeting system for infant industries to sell their output at world prices as direct or indirect exports. Infant industries were able to practice discriminatory pricing on export sales because these sales were sheltered by the government. It sanctioned a policy that gives non-competitive market arrangements, but selective subsidies followed a declining schedule over a limited period. It made the profitability of exports contingent on an industry’s efforts to slash marginal cost through fast productivity growth.
Market agents were created in the process of fostering infant industry development. Obvious products of this effort are the chaebol, Daewoo, Hyundae, Samsung and large conglomerate groups that were concentrated in manufacturing and construction. The chaebol decentralized the administration of export incentives and undertook the activities needed to strengthen Korea’s export marketing capabilities. They also helped implement government plans in the 1970’s that were focused on the heavy industry.
The Korean government controlled the inflows of foreign investment and proprietary technology to mould industrial structure at the firm level. It was able to select among the potential entrants and influence the plans and evolution of the initiating venture by controlling the emergence of other entrants and by becoming involved in decision-making. The chemical, machinery, and equipment industries have been special objects of this kind of intervention.
Vertically integrated industrial development was promoted at the national level. Local regulations were implemented, requiring them to increase their local input shares. In the 1970’s local content provisions were instituted for all investment projects.
Public enterprises played a more significant role in the industrial evolution than the private agents because:
· No private parties were willing to undertake the venture
· Direct control over the start-up and operation of the industry is preferred
· It was viewed that public agents could have better negotiations with foreign suppliers of capital and technology
Despite this, private entities were still expected to achieve rapid international competitiveness.
Policy Mix Evaluation
The neutrality of Korean export incentives for well-established industries became evident as the average effective incentive rate on exports is only 0.8 percent. Relative to free trade, export incentives are largely neutral, except among import-competing countries. There exists a pro-export bias as average effective incentive rates on exports are greater than those on non-exports sales for well-established industries. The effects of selective intervention in fostering new industries are also evident in the effective incentive rates on non-export sales.
It is important to note that incentive policies were not biased against the agricultural sector. Rather, by protecting them from imports and exempting taxes, their government subsidy actually becomes higher than the subsidy of manufacturing companies. This was not observed in other developing countries. On the other hand, it was observed that the selective intervention to promote infant industries has been narrowly focused. For well-established industries, they have been subject to only two types of control: export targeting and capital market intervention.
Government controls on the flow of funds to mature industries were not selectively exercised. Controls have been administered on a first-come, first-served basis using market criteria. Because of this, their impact on mature industries has been the result of the limited supply relative to the demand in market clearing terms.
Industrial policies were utilized within the framework of a consistent industrialization strategy, one that gives a different treatment for targeted industries to grant them comparative advantage while exploiting the comparative advantage of internationally competitive ones. Non-neutral policies were used selectively in an environment where prices have reflected relative factor scarcities. Market forces that responded to neutral policies have been used to allocate resources in internationally competitive industries. Korea’s policy toward nontargeted industries has been promotional (in relation to exports) or permissive. For activities not being promoted, its policy has been one of benign neglect.
Contribution of Korean Policies
Selective intervention played a significant role in achieving Korea’s remarkable success. The rate of growth accelerated with little compensating loss in efficiency terms. This is evidenced by the country’s export success in different industries and by its strong overall performance of its industrial sector. The Korean industry achieved international competitiveness in a wide variety of industries.
There has been huge uncertainty in selecting infant industries and setting export targets. These were resolved by using the information gathered during implementation to evaluate and revise intentions. The government paid special attention to international competitiveness; it recognized that exports are not necessarily indicative of competitiveness when non-neutral policies are in place. Because of this, the government paid attention to the magnitude of incentives, the relationship of domestic to world prices, and other information such as indicators of product quality. This monitoring process ensured that exports are privately profitable and internationally competitive, at least in the medium run.
Empirical evidence has not yet revealed the market failures that were solved by selective intervention. However, technology as a possible source of market failure has received attention in firm-level research. This appears to be a particular object of the Korean government’s selective intervention.
Market imperfections associated with technological change were not given much importance in the context of industrialization because less developed countries have an abundant supply of available technology. There exists an abundant international trade of technology, but such trading is far from being perfect as purchase is not sufficient for effective possession. Because of this, externalities related to technological development can be broad.
Problems in communication over long distances and across social differences arise making the price of importing greater than the price of exporting. The tacitness of circumstantial knowledge makes some elements non-tradeable as peculiarities cannot be understood without experiencing them in some way.
Efforts to acquire technological capability and to tailor technology often coincide. It appears that returns to technological development are very high, but this comes with a cost.
Investments in the assimilation and adaptation of industrial technology are important in the development process. Through selective intervention, a country’s ability to capture dynamic economies associated with the introduction and exploitation of modern technology will increase.
Even if externalities are huge, it does not necessarily follow that selective intervention is appropriate in ensuring their realization. According to Baldwin (1969), technological spillover problems can be dealt with direct and selective policy measures instead of unorthodox policy measures like credit rationing and import protection. These instruments can be combined with coercive interventions in decision making to encourage technological investments. Enos and Park (1988) demonstrated that such combination has been an important part of the Korean government’s handling of industrial policy.
Lessons from Korea
The government’s reliance on free market institutions to provide flexibility in resource allocation greatly affected Korea’s industrial performance. The government’s promotional policies toward exports and initiatives that target industries for development also contributed much to Korea’s success. Based on the difference between the mistakes that were committed in the heavy engineering industries in the 1970’s and the successes of other industries, the following principles were highlighted:
· The main objective of intervention must be the achievement of dynamic efficiency in the sense of attaining international competitiveness within a medium-term horizon.
· Relevant information must be sought continuously from every possible source.
· Specific industry strategy should be reformulated as needed in relation to the gathered information and acquired experience.
· Only a small number of industries should be targeted at one time so that scarce technical and entrepreneurial talent will not be spread too thinly.
· Government intervention should not constrain the exploitation of comparative advantage in well-established industries too much.
The relevance of these guidelines will not be substantial for other less developed countries if no commitment to meaningful economic development is made.
Although import liberalization does not play a significant role in export-led development, the rules of importing have still changed. Prior to the reforms, rent seeking in relation to import licensing and tariff exemptions had given much revenue for businessman and government officials.
Credit rationing has prevented companies from making independent decision-making. Also, the important role given to the chaebol has yielded a concentrated industrial structure that is unpleasant to many Koreans. Now that the Korean economy is changing – imports are now liberalized and the trend is now away from selective intervention – it remains to be seen whether the country’s economic performance will still be outstanding.
Source:
Westphal, Larry, “Industrial Policy in an Export-Propelled Economy: Lessons from South Korea’s Experience.” Journal of Economic Perspectives, (Summer 1990) Volume 4, Number 3, pp. 41-59.
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