Under Japan's colonial administration, agriculture was developed in the Southern half of the Korean peninsula, while industrial development was limited to the establishment of a small "modern" manufacturing sector that produces light consumer goods. After the creation of the Republic of Korea (South Korea) at the end of World War II, economic activity in the south was dominated by adjustments to the partition and to the dislocations caused by the Korean War. In 1955, the manufacturing sector accounted for only eight percent of GNP, while primary sectors composed nearly half of GNP. Because of the war, exports accounted for only 1.4 percent of GNP, while manufactured exports were virtually zero.
Industrial Incentive Policies
At the last leg of the 1960’s, Korea adopted an industrial strategy that was led by import substitution. Protection was given through a complicated system of multiple exchange rates, and widespread restrictions on imports and tariffs. The bias against exports was not as great as might appear, because export earnings were convertible in a free market and demanded substantial premium. Direct cash subsidies to exporters were also given. The economy responded to these incentives and the prevailing situation before the Korean War returned. Exports grew at an average annual rate of 16 percent between 1955 and 1960. In real terms, exports in 1960 were about 16 percent greater than in 1950, just prior to the Korean War.
Industrial output grew rapidly in response to the prevailing import substitution for non-durable consumer goods. However, industrial growth slowed down as opportunities for "easy" import substitution were reduced in the early sixties. This was coupled by political and social instability due to several changes of government. A number of policy reform and economic liberalization attempts were made starting in 1961 when a unified exchange rate was temporarily instituted. These culminated in the mid 1960’s when a number of fiscal and monetary reforms were successfully implemented. The goals of these reforms were to increase both public and private savings by expanding direct tax revenues and raising the real interest rate in commercial banks by about 10 percent. Because of them, domestic savings increased from less than eight percent of GNP in 1965 to an average of more than 17 percent in the early 1970’s.
The government realized that economic development was subject to an export oriented industrialization strategy. This view was founded on the small size of the domestic market. This meant that extending import substitution further into new lines would increase inefficiency if it is carried out immediately on Korea's very poor natural resource base. A major policy change was the institution of a uniform exchange rate in 1964. The steady adoption of explicit export incentives had started earlier in 1959. By 1966, exporters functioned under a virtual free trade regime. They received indirect tax and tariff exemptions, free access to imported inputs, reduced charges on overhead inputs, and interest rate and direct tax preferences. Incentive policies favoured exporting over domestic market sales to a small degree.
Real Effective Exchange Rates
To offset inflation, devaluations and changes in export incentive rates between devaluations were needed to maintain the real effective exchange rate for exports at constant level since 1961. The rate for exports was kept nearly equal to that for imports, while import restrictions have been gradually lenient. Export and import effective exchange rates were very close to the optimal free trade exchange rate. The relative uniformity of export incentives across industries has also been important as this led to the expansion of exports that are in line with Korea's comparative advantage and has avoided stimulus to inefficient exports. At the same time, protection on the domestic market has been quite low by international standards, and has offered few opportunities for profitable investment in inefficient import substituting activities.
Export Performance
The export incentive policies implemented in the first half of the 1960’s stimulated exportation; however, the main objective was to replace an ad hoc system based on multiple exchange rates and direct cash subsidies and require modifications with a stable system. Exports had increased rapidly between 1960 and 1965, at an annual compound rate of 24 percent. The export policy reforms laid the foundations for growth once a larger base had been established. Because of this, export growth stepped up for several years and has continued to be rapid in spite of a continually expanding base. In constant prices, the annual compound growth rate of exports between 1965 and 1975 reached 31 percent.
Manufactured exports[1] increased to 82 percent in 1975. They also became diversified; in 1975, Korea became a major exporter of electrical machinery and appliances, transport equipment, various manufactures of metal and non-metallic minerals, footwear, textiles, clothing, and plywood. This led the initial growth of exports. The concentration of exports by destination was lessened. In 1975, Japan and the U.S. became the market for 56 percent of Korea's exports, while Japan alone had received 63 percent of the total in 1960. There is little evidence suggesting that Korea's special relationship with Japan and the U.S. were responsible for this superb performance. In particular, direct foreign investment has played a very small part in Korea's industrial growth. Direct foreign investment accounted for less than five percent of the capital stock in the manufacturing sector in 1970.
Due to the growth of manufactured exports, Korea experienced rapid industrialization. Manufacturing output increased at an annual rate of 19 percent starting 1960, while manufacturing value added grew at 17 percent per annum. With real GNP rising at nine percent annually, manufacturing has risen from 11 percent of GNP in 1960 to 32 percent in 1975. Real per capita income over this period increased at 6.6 percent per annum; in 1975, Korea's population of over 34 million enjoyed a per capita income of at least $400.
The growth of manufactured exports over the past 15 years contributed to Korea's industrial development. Export expansion[2] accounted for more than a quarter of the growth of manufactured output and for a significant fraction of manufacturing employment growth. The manufacturing sector has accounted for about 40 percent of GNP growth and 38 percent of employment growth. But these figures belittle the contribution of export growth, because they do not reflect the multiplier effect from increased consumption and investment from the additional income earned or the increase in economic efficiency that results when the resource cost of exports is less than the value of the foreign exchange earned.
The Role of Trade Expansion in Industrial Development
Evidence suggests that factor utilization and allocative efficiency as a result of export growth both increased. One indicator is the decline in the open unemployment rate from 8.3 percent in 1962 to 4.1 percent. Also, the aggregate capacity utilization rate within manufacturing increased[3]. Studies show that Korea's industrial growth has utilized its comparative advantage; it lied in labor intensive as opposed to capital intensive activities. Over the 1960’s, manufactured exports were more labor intensive than manufactured imports. They became progressively more labor intensive over time even as shifts in the composition of output caused manufacturing production for the domestic market to become more capital intensive. The labor-capital ratio in the manufacturing sector generally increased between 1960 and 1973. Total factor productivity also doubled.
Resource allocation in comparative advantage caused labor intensive exports to pay for capital intensive imports. Due to a very poor natural resource endowment an increase in the share of trade in total economic activity transpired. Because of this, import substitution contributed very little in the aggregate to the growth of manufacturing, although it has been very important in some other sectors. These included the cement, fertilizer, chemicals, metals, and, machinery sectors. As such, Korea's industrial structure cannot be characterized as overly concentrated in the light manufacturing sectors; the heavy industrial sectors are relatively large and rapidly expanding. Selective import substitution has allowed the concentration of scarce investment resources in one or a few sectors and enabled greater exploitation of scale economies and of linkages among closely related activities.
Summary
Korea's development performance since the policy reforms in 1964 and 1965 has been outstanding. The role of monetary and fiscal policy in increasing public and private savings has been an important factor. In addition, exports have proven to be a powerful source of growth. Due to labor intensity, they have contributed significantly to the rapid expansion of productive employment. This has been an important factor in maintaining an even distribution of income. The most important lesson from Korea's experience is that “exports respond to incentives while efficiency in resource allocation can be assured by operating close to a free trade regime”.
The modifications of export incentive policies during the first half of the 1960’s assured constant profits on exports and were affiliated to the government's decision to adopt a strategy of export expansion. Simultaneously, the government assisted in marketing and established detailed annual export targets broken down by commodity, market, and domestic exporter. However, it would be hasty to conclude that targets independently set by the government determined actual export levels via a command-type system, because the targets were set jointly by the government and the exporting enterprises and were often exceeded. The targets complemented incentives to exporters. Without them, rapid export growth would not have been possible. The most important function filled by the export targeting system was to advertise the importance attached by the government to exports. Export incentives were well advertised and access to them was immediate. Questions whether exports would have grown as rapidly without the additional motivation provided by the targeting system still remain.
Policy reforms affecting prices, however, should not be interpreted as the only condition leading to Korea's remarkable performance, especially to the level of the growth rate or the even distribution of the results of growth. Korea has received large foreign capital inflows over the past 20 years, and only in the past five to ten years could these be considered as a synergistic response to its performance. Events that happened before 1955 led to a relatively unrestricted distribution of assets and a social and political structure that lack an aristocratic or oligarchic class. Large, privately financed expenditures on education have not only permitted the formation of a highly skilled labor force, it also made it possible for the mass of the labor force to participate in jobs of higher productivity. Nevertheless, though the evidence is presumptive and inconclusive, there is little doubt that government policies affecting prices have contributed much to the rapid growth of its exports and to Korea's overall development performance.
Source:
Westphal, Larry, “The Republic of Korea's Experience with Export-Led Industrial Development.” World Development (March 1978), Volume 6, Issue 3, pages 347-382.
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