The Korean Economy 1945 - 1995 : Performance and Vision for the 21st Century Edited by Dong-Se Cha Kwang Suk Kim Dwight H. Perkins Korea Development InstituteThe Korea Development Institute (KDI) is an autonomous policy-oriented research organization founded in 1971. KDI was established by the Korean government as an economic think tank to provide a rigorous academic perspective on the various economic policy issues that had arisen during Korea's rapid growth and development in the 1960s. Since then, the scope of KDI's activities has grown, and it is now called upon to provide expert analysis and advice on all as- pects of long- and short-term government policies in areas ranging from domestic economic policy to international trade and investment. In addition, KDI has played an increasingly important role in promoting international economic cooperation. By spon- soring international forums on development and maintain- ing close links with research organizations and individual scholars all over the globe, KDI helps to strengthen ties be- tween Korea and the rest of the world. © April 1997 Korea Development Institute 207-41, Chongnyangni-dong, Tongdaemun-gu PO. Box 113, Chongnyang Seoul, Korea http:/ /kdiux-kdi.re.kr ISBN 89-8063-032-8Preface The fifty years since the independence of Korea from the Japanese occupation marks the most turbulent period in Korean history politically, socially and economically, but at the same time, it was a period in which the Korean economy achieved the most remarkable economic success. After the liberation, the Korean economy was devastated by the effects of the exploitation by the Japanese and their sudden depar- ture, the division of the nation and the subsequent civil war, making it difficult to survive without foreign aid. In the 1960s, the Korean government initiated an ambitious economic development plan hoping to end the prolonged poverty and provide a foundation for the nation’s industrialization. To make the best use of limited resources, the Korean government adopted an export-oriented indus- trialization strategy and prioritized the building of social infrastruc- ture such as roads and ports. In the 1970s, the major policy effort was placed on upgrading the industrial structure for sustained export and economic growth. Strong incentives were provided to a wide range of heavy and chem- ical industries together with continued efforts to improve such infra- structure as transportation and communication networks and to build industrial complexes. By the end of the 1970s, however, it be- came evident that extensive government intervention in resource al- location could be counter productive by resulting in investment inefficiencies and macroeconomic complications. Thus, in the 1980s, policy priorities were given to fighting infla- tion and liberalizing the economy. Industrial incentives were re- formed, regulations on the financial sector were relaxed, and competition was promoted with reduced import restrictions and fair trade enforcement. Since the late 1980s, the Korean economy has met new challenges. In the course of rapid economic growth, there has been the growing itiperception among people that distributive equity had been aggra- vated and basic needs of people were not adequately met. Invest- ment in social infrastructure also turned out to be inadequate to support continuous economic growth. Furthermore, as the competi- tiveness of Korean exports weakened substantially due to rapid in- creases in wages and the appreciation of the won industrial restructuring became an urgent task. Rapid development of information and communications technol- ogy and the birth of the World Trade Organization (WTO) have brought about unlimited global competition and deepening integra- tion of the world economy. In order to survive and prosper in this environment, Korea should step up its self-motivated globalization efforts with deregulation geared to promote competition and harmonize domestic institutions with international rules and regula- tions as well as the acceleration of industrial restructuring. As a part of the commemorative work of 50th Anniversary of the Independence from Japanese colonization, the Korea Development Institute (KDI) takes great pride in publishing this volume on the Korean economy’s development process and accomplishments over the past 50 years. We hope that the careful evaluation of the prob- lems, policy responses and performances of the past will help over- come new challenges ahead and make the best use of our potential. Korean economic growth and accomplishments, unprecedented in the history of the world economy, have drawn a lot of attention from policymakers and scholars worldwide. We hope this book will also contribute to meeting their demands for information with its com- prehensive coverage of subjects and time periods. KDI sincerely ap- preciates the authors who participated in this project with enthusiasm and those who offered valuable comments and encour- agement. A number of books and papers are available on Korean economic development. However, most of them are limited either in the time span covered or subject areas. This report covers all the sectors deemed important in Korea’s economic development processes, and includes chapters on North Korea as well as the vision and strategies for the 21st century. Authors for each subject were carefully selected to successfully carry out this important task. A total of twenty-nine authors have been involved for seventeen papers including foreignscholars and many KDI fellows. Part One comprises two papers and serves as the introduction to this book. Chapter 1 attempts a comprehensive historical review and evaluation of the past 50 years of Korean economic development. Dividing the half century into three distinct periods, the authors present and assess the development strategies and patterns. Chapter 2 complements the first one by analyzing and discussing the sources of economic growth, the transformation of the economic structure, and the key factors contributing to Korea’s economic success includ- ing the roles played by the government and the market in the process of structural transformation of the economy. Part Two deals with broad macroeconomic performances and policies. The first paper, Chapter 3, presents an overview of the macroeconomy by investigating, among other things, the role of political leadership and provides some international comparisons. Chapter 4 analyzes the macroeconomic policies and performances in a narrower sense: the evolution of monetary, fiscal and exchange rate policies as well as the impact of these policies and other environm- ental factors on growth, employment, inflation, and the balance of payments. Chapters 5 and 6, respectively, deal with financial and tax- ation/ fiscal policies, with emphases on tracing the evolution of finan- cial policies and systems and assessing the shifts in major objectives and role of government budgetary management. Part Three discusses Korea’s trade and industrial policies and their roles in overall economic growth. The first two papers, Chap- ters 7 and 8, are both concerned with assessing the efficacy of the trade and industrial policies. While Chapter 7 analyzes the process of structural transformation and the efficiency of the heavy and chemical industry drive of the 1970s, Chapter 8 provides a detailed account of how trade and industrial policies have been shaped to meet the challenges of domestic and external origins. Chapter 9 dis- cusses government policies toward technology development, interac- tion between the government and the private sector in this process, and related corporate behaviors. Chapter 10 describes the evolution of Korea’s industrial organization and the government's policy response including those toward large business groups (chaebols). Ag- ricultural policy and the role of agriculture in the process of economic development are discussed in Chapter 11.Part Four deals with the issues of welfare, distribution and broader social development together with those of labor and regional development. Chapter 12 evaluates Korea’s social development in re- lation to its economic growth by examining various social develop- ment indicators including those of income distribution. Chapter 13 provides a historical overview of welfare policies and an evaluation of budgetary expenditures on welfare, the social welfare system and social security policies, as well as the distribution of income and wealth. Chapter 14 assesses the shifts in labor movement and labor policy, followed by a discussion on the labor market and employ- ment situations and policies on human resource development. Chap- ter 15 describes and assesses the government's regional development plans and provision of social infrastructure. Part Five (Chapter 16) presents a historical review of North Korea's economic system and policies together with its performances. Analyzing the causes of its economic plight in the 1990s, the authors also suggest a direction for the reforms required to improve its eco- nomic situation. Finally Part Six (Chapter 17) offers a vision and strategies of the Korean economy for the 21st century on the basis of the anticipated changes in domestic and external environment and the challenges. In completing this volume, we are grateful to a number of people including those who participated in the conference in December 1995 and offered valuable comments on the earlier draft. However, the au- thors are responsible for the contents and any remaining errors in this book. We would also like to thank Dr. Sang-Woo Nam and Mr. Seong Yun Kang for offering their invaluable support throughout the process of planning, administrating and publishing this book. April 1997 Dong-Se Cha, Kwang Suk Kim and Dwight H. Perkins viContributors Irma Adelman, FRSA is Thomas Forsyth Hunt Chair and Professor in Graduate School, University of California, Berkeley Choong Yong Ahn is Professor of Economics, Chung-Ang, University, Seoul Dong-Se Cha is President, Korea Development Institute, Seoul Kwang Choi is President, Korea Institute of Public Finance and Pro- fessor of Economics, Hankuk University of Foreign Studies, Seoul Hong-Tack Chun is Senior Fellow, Korea Development Institute, Seoul Sung-woong Hong is President, Construction & Economy Research Institute of Korea, Seoul Dong Kun Kim is Professor of Graduate School of Public Adminis- tration, Seoul National University, Seoul Jay-hyung Kim is Fellow, Korea Development Institute, Seoul Joo-Hoon Kim is Fellow, Korea Development Institute, Seoul Joon-Kyung Kim is Fellow, Korea Development Institute, Seoul Jun-Il Kim is Fellow, Korea Development Institute, Seoul Kwang Suk Kim is Advisor of Institute for Global Economics and Former Professor of Economics, Kyung Hee University, Seoul Linsu Kim is President, Science & Technology Policy Institute and Professor of Management, Korea University, Seoul Pyung-Joo Kim is Professor of Economics, Sogang University, Seoul Sookon Kim is Professor of Management and Industrial Relations, Kyung Hee University, Seoul Young Sun Koh is Fellow, Korea Development Institute, Seoul Lawrence B. Krause is Professor of Pacific Economic Cooperation and Director, Korea Pacific Program, Graduate School of International Relations and Pacific Studies, University of California, San DiegoAnne O. Krueger is Professor of Economics, Stanford University Soonwon Kwon is Professor of Economics, Duksung Woman’s Univer- sity, Seoul Ju-Ho Lee, Fellow, Korea Development Institute, Seoul Sung Soon Lee is Professor of Economics, Sung Kyun Kwan Univer- sity, Seoul Pal Yong Moon is Professor of Economics, Kon Kuk University, Seoul Sang-Woo Nam is Senior Fellow, Korea Development Institute, Seoul Jin Park is Fellow, Korea Development Institute, Seoul Dwight H. Perkins is Harold Hitchings Burbank Professor of Political Economy, Harvard University and Faculty Fellow, Harvard Insti- tute for International Development So-Mi Seong is Fellow, Korea Development Institute, Seoul Kwang-Eon Sul is Fellow, Korea Development Institute, Seoul Seong Hyeon Whang is Fellow, Korea Development Institute, Seoul Seong Min Yoo, Fellow, Korea Development Institute, Seoul viiiContents Preface iii Contributors vii PartI. Overview Chapter 1. “Korean Economic Development: An Overview,” Kwang Suk Kim and Joon-Kyung Kim 3 Chapter 2. “Structural Transformation and the Role of the State: Korea, 1945-1995,” Dwight H. Perkins 57 Part II. Macroeconomy Chapter 3. “The Political Economy of South Korea: Fifty Years of Macroeconomic Management, 1945-1995,” Lawrence B. Krause 101 Chapter 4. “Macroeconomic Policies and Evolution,” Sang-Woo Nam and Jun-Il Kim 143 Chapter 5. “Financial Policies and Institutional Innovation,” Pyung-Joo Kim 186 Chapter 6. “The Role of Tax and Fiscal Policies,” Dong Kun Kim and Seong Hyeon Whang 238 Part Il. Industry, Trade and Technology Chapter 7. “Korean Industry and Trade over Fifty Years,” Anne O. Krueger 293 Chapter 8, “The Outward-Looking Trade Policy and the Industrial Development of South Korea,” Choong Yong Ahn and Joo-Hoon Kim 339 Chapter 9. “Science and Technology: Public Policy and Private Strategy,” Linsu Kim and So-Mi Seong 383Chapter 10. Chapter 11. “Evolution of Industrial Organization and Policy Response in Korea: 1945-1995,” Seong Min Yoo and Sung Soon Lee “Agricultural Policies and Development,” Pal Yong Moon and Kwang-Eon Sul Part IV. Social Development Chapter 12. Chapter 13. Chapter 14. Chapter 15. “Social Development in Korea, 1953-1993,” Irma Adelman, FRSA “Social Welfare and Distribution Policies,” Kwang Choi and Soonwon Kwon “Industrial Relations and Human Resource Development,” Sookon Kim and Ju-Ho Lee “Regional Development and Infrastructure Construction,” Sung-woong Hong and Jay-hyung Kim Part V. North Korean Economy Chapter 16. “North Korean Economy: A Historical Assessment,” Hong-Tack Chun and Jin Park Part VI. Future Prospects of the Korean Economy Chapter 17. Index “Vision and Strategy of the Korean Economy for the 21st Century,” Dong-Se Cha and Young Sun Koh 426 468 509 541 586 623 665 733 756PART I Overview2XO) FO a1 KOREAN ECONOMIC DEVELOPMEN AN OVERVIEW Kwang Suk Kim Kyung Hee University Institute for Global Economics Joon-Kyung Kim Korea Development Institute Introduction The Korean economy has developed quite rapidly over the last half century since its liberation from Japanese colonial rule. The economy, however, experienced serious disruptions and stagnation from liberation in August 1945 to the signing of the armistice in July 1953. The main reason was that the liberation accompanied an un- expected partition of the country between South and North Korea, and the sudden severing of the country from the Japanese economic bloc. The Korean war that broke out at the time when the country was about to end its chaos and economic disruption prolonged the economic instability and stagnation by causing a tremendous de- struction of industrial facilities and heavy human casualties. The country could begin its economic reconstruction and development only after the cease-fire in 1953, with the help of massive economic assistance from the United States and the United Nations (UN). During the post-Korean war reconstruction period (1953-1960), the rate of economic growth was relatively low despite the massive inflow of foreign aid. Beginning in this period, however, the econ- omy achieved a sustained growth except for two unusual years, 1956 and 1980. In other words, Korea’s GNP grew at an average annual rate of 7.6 percent during the 41 years (1953-1994), thus resulting in4 Kwang Suk Kim & Joon-Kyung Kim about a 21-fold increase in the level of GNP. Since the population in- creased by 2.2 percent annually during this period, per capita GNP in real terms grew at the annual rate of 5.6 percent, or increased about 9.3 times. Per capita GNP in 1990 constant U.S. dollar terms rose from about $760 in 1953 to $7,500 by 1994. Thus even though the country had experienced severe economic disruption and stagnation for nearly a decade immediately following its liberation, it was able to achieve a gradual acceleration in its GNP growth rate after the cease-fire, thereby considerably improving the people’s living standards. The country’s economic growth has been led by a policy of industrialization throughout this period. Economic development was promoted by an industrialization strategy empha- sizing reconstruction of war-damaged industrial plants and import substitution until the early 1960s, and by an export-oriented indus- trialization strategy after that. Reflecting this shift in industrialization strategy, export expansion accelerated and became an engine of in- dustrial growth beginning around the mid-1960s. This growth was accompanied by a substantial change or improvement in the eco- nomic structure. This chapter presents a comprehensive overview and evaluation of the last half century’s developments in the Korean economy, in- cluding those aspects that are dealt with more intensively in the sectoral studies included in this volume. For this purpose, the last half century is broken down into three sub-periods in view of the economic policy characteristics of each period and also for the sake of convenience in our presentation. The three sub-periods are: 1945- 1960, 1961-1979, and 1980-1995. The first sub-period that starts from liberation and continues through the post-Korean war reconstruction period may be characterized as the period of politico-social chaos and economic disruption. The second sub-period covering the lifespan of the Park regime, including the military government im- mediately following the coup in May 1961, is characterized by rapid economic growth through export-oriented industrialization. Finally, in the third sub-period the economy attained growth with price sta- bility by carrying out structural adjustment programs to remove the after-effects of the growth maximization policy of the earlier period. After discussing the country’s economic development in each of the three sub-periods, an overall evaluation of the developments forKorean Economic Development: An Overview 5 the entire period is then attempted based on the discussions made for each sub-period. Following this introductory section, the country’s economic devel- opment during the above three sub-periods is dealt with in Sections U1, 10 and IV in that order. Each section mainly describes economic conditions and major policy changes in the respective periods and evaluates their economic performance. Finally, Section V presents an overall evaluation of the characteristics of Korea’s development strat- egy with consequent development patterns for the entire period, and some concluding remarks. Economic Disruption and Recovery: 1945-1960 Legacy of Japanese Colonialism The Korean economy was managed by a totalitarian Japanese Government General for about 36 years until the country was liber- ated at the end of World War Il. During colonial rule, all economic policies were actually prepared and implemented entirely for the benefit of Japan, not Korea. In view of changes in the colonial government's policies, the period of colonial rule may be broken down into three different phases: 1910-1919, 1920-1929, and 1930- 1945. The first phase may be characterized by the establishment of an institutional base for Japanese colonial rule and agricultural de- velopment in Korea. The second phase saw the alleviation of restric- tions on non-agricultural investment which had been imposed in the previous period, in addition to the continuous promotion of in- creased agricultural production by the colonial government. In the third phase during which the Sino-Japanese War and World War II occurred, emphasis was placed on the construction of heavy and chemical industries required for supplying military goods to Japan (Kim and Roemer, 1979, pp. 2-6). For the period of Japanese colonial rule neither national account data nor time series industrial production indices are available; only commodity production data are available. Total net commodity prod- uct (value-added in the commodity producing sector) showed an av- erage annual growth rate of a little over 3 percent in all the three6 Kwang Suk Kim & Joon-Kyung Kim phases without many fluctuations (Suh, 1978, pp. 170-171). Since the population of the whole of Korea (including both North and South Korea) increased at an average annual rate of 1.6 percent from 1910/12 to 1938/40, the country’s per capita net commodity product also grew by about the same rate of 1.6 percent in real terms. This growth of net commodity product was accompanied by some osten- sible improvement in the structure of manufacturing. In other words, the light manufacturing sector which had accounted for about 68 percent of total manufacturing production in 1931 occupied a much lower share of 49 percent by 1940, while the share of heavy and chemical industries in manufacturing production rose from 32 to 51 percent during the same period (Kim and Roemer, 1979, p. 11). This shows that Korea’s industrial growth and structural change under Japanese colonial rule was quite substantial. It should, how- ever, be made clear that the growth and structural change recorded in this period were not related to the traditional sectors of the Korean economy and not of much help to self-sustaining economic growth. Growth was made possible almost entirely by Japanese capital, tech- nology and management. Korean participation was limited to small and medium industries. As of the end of 1939, for instance, the amount of paid-in capital of industrial establishments owned by Ko- reans accounted for only about 11 percent of total paid-in capital for all industrial establishments within the country, although the number of industrial establishments owned by Koreans accounted for about 42 percent of the total (Cho, 1973, p. 447). The Japanese domination of industries within Korea is also high- lighted by the predominance of Japanese technical manpower. In 1944 the number of Korean technical workers in manufacturing, con- struction and public utility sectors accounted for only 18 percent of the total, while Japanese technical workers accounted for the remain- ing 82 percent. Especially in technology-intensive industrial branches such as metal and chemical industries, Korean technical workers ac- counted for a lower share of 11 percent (Bank of Chosun, 1948, pp. 1-100). Reflecting the Japanese domination of industries in Korea during the colonial period, average living standards for Koreans declined despite the 1.6 percent annual growth of per-capita GNP recorded for that period. The decline in average living standards for KoreansKorean Economic Development: An Overview 7 may be deduced from two factors. First, per capita consumption of rice, the most important staple food for Koreans, declined signifi- cantly during colonial rule. Second, real wages in Seoul also declined during the same period (Kim and Roemer, 1979, p. 20). This indicates that Korean economic growth during the colonial period did not con- tribute to improving the people's living standards. The Korean economy achieved substantial growth and structural change in quantitative terms during the period of Japanese colonial rule. But the unexpected partition of the country, as well as its severing from the Japanese economic bloc, brought about politico- economic disruptions and stagnation in the period immediately fol- lowing liberation. The severe war damage to the economy followed thereafter. For those reasons, the legacy of industrial growth achieved during Japanese colonial rule was almost negligible. Mason et al., (1980, p. 91) suggest that “the most serious negative features of Japanese colonial rule were the continued isolation of Koreans from experience in the international arena and from expe- rience in running their own country,” in the sense that such isolation was, in effect, a major contributing factor to the tragic partition of the country and also to a considerable period of political instability after the Japanese evacuation in 1945. In view of the fact that the par- tition later became the source of the Korean war, the heritage of Jap- anese colonial rule in the country was only one of a long period of hardship left to the Korean people. Whatever significant develop- ments were achieved in the industrial sectors in aggregate terms dur- ing the colonial period did not remain to be inherited after the Korean war by Koreans themselves. Politico-social Chaos and Economic Disruption, 1945-1952 Although Korea was liberated from Japanese colonial rule at the conclusion of World War II, it experienced extreme political, social, and economic disruptions until the armistice was signed in 1953. Dis- regarding politico-social factors, we may say that economic disrup- tion and stagnation were mainly caused by the following three factors: (1) the country’s partition between South and North Korea, (2) the sudden severing of the Korean economy from the Japanese economic bloc, and (3) hyper-inflation caused by the rapid expansion8 Kwang Suk Kim & Joon-Kyung Kim of the money supply before and after liberation. First, the partition along the 38th parallel struck a critical blow to the South Korean economy because it resulted in severing the two parts of the country that had a quite complementary structure of production. The partition gave the South a land area of a little less than half of the Korean peninsula. But since the South’s population accounted for about 66 percent of the total, its population density was much higher than that in the North. As of 1940, total net com- modity product in the South was slightly higher than that in the North, but per capita net commodity product in the South was only a little over a half of the North’s (Suh, 1978, pp. 160-166). Although the South’s net commodity product for the agriculture-forestry-fish- ery sector was higher than the North’s, its commodity products for the mining and manufacturing sectors were lower than the North’s. The North’s mineral production, in particular, was substantially higher than the South’s (Bank of Chosun, 1949, p. 6). In the manu- facturing sector South Korea produced a greater proportion of light industrial products than in the North while the North produced a greater proportion of heavy and chemical industrial products than in the South. The partition also brought a serious shortage of electric power in the South because about 92 percent of total power gener- ating capacity was located in the North. Second, the sudden withdrawal of Japanese entrepreneurs, engi- neers and technicians, and managers from Korea, as well as the severing of the economy from the Japanese economic bloc simulta- neously with the partition, were another major factor for causing economic disorganization in South Korea. Since the industrial growth and structural change that took place during the colonial period were mainly led by the Japanese, their withdrawals meant the unexpected loss of entrepreneurs, managers and technical manpower from var- ious industrial plants in South Korea. In addition, because of Korea's high trade dependency on Japan (ranging from 80 to 90 percent dur- ing the colonial period) the unprepared severing of the economy from the Japanese economic bloc meant a sudden interruption of the supply of intermediate goods and also the loss of product markets. Although the liberation and the consequent withdrawal of Japanese residents from Korea implied a realization of the Korean people’s long-cherished desire, they also brought a disastrous shock to theKorean Economic Development: An Overview 9 South Korean economy. Lastly, the unrestricted, rapid monetary expansion before and im- mediately following liberation, and the resulting hyper-inflation im- peded industrial investment and production activities while fostering only speculative activities. From the end of 1941 to the time of lib- eration in 1945, the currency in circulation expanded about 6.7 times. In the following four years and four months period from August 1945 to the end of 1949, it again expanded by about 15 times. Re- flecting this rapid monetary expansion, Seoul’s wholesale price index rose about 16 times during the five month period from July to De- cember 1945, and again rose 18 times during the period from the fourth quarter of 1945 to the same period in 1949 (Kim, 1973, pp. 19-21). All these factors contributed to reducing manufacturing produc- tion drastically in the period immediately following liberation. Even the production of food grains declined in this period, meaning the increasing population encountered food shortages (Bank of Chosun, 1949, p. 5, IV. pp. 18-19). Despite the fact that the country suspended its rice exports to Japan after liberation, the reduced domestic pro- duction combined with the increased population brought a serious food shortage to the South, thus making it inevitable for the country to increase its dependance on food relief provided by the U. S. mil- itary government. Table 1-1 presents the average production index of major com- modities for the period of 1946-1953 which was originally prepared by Kim and Westphal (1976).’ The production index, although it is an unweighted geometric average index, seems to explain a general trend in the movement of production, starting out from the ex- Table 1-1. Average Production Index of Major Commodities, 1946-1953 (simple geometric average index) 1946 1947 194819491950 1951 1952 1953 ‘Average index for 18commodities 100 115 149 209 132 106 184 241 Average index, excluding tungsten 100 108 141,201,133, 99165210 Source: Kim and Westphal (1976, p. 47).10 Kwang Suk Kim & Joon-Kyung Kim tremely low level of 1946. As shown in the table, industrial production started to recover be- ginning in 1947, and by 1948 it was more than 40 percent higher than the low level of 1946, despite the economic disruption experienced in the period immediately following liberation. But it should be noted that manufacturing output in 1948 was only about 16 percent of the level of South Korean manufacturing output achieved in 1939. With the exception of the metal industry whose production declined only 4 percent, the products of all manufacturing branches declined by about 66-90 percent during the 1930-1948 period (Bank of Chosun, 1949, IV. pp. 158-159). The average production index of major commodities rose steadily from the low level of 1946 to double the base year level by 1949. The outbreak of the Korean war in 1950, however, resulted in a sharp re- duction to South Korean production again so that the production index for 1951 returned to the level of 1946. But as the war stale- mated along the present demilitarized zone in 1952, production started to recover and continued to increase until 1953 when the ar- mistice was signed. As a result, the production index for 1953 be- came slightly higher than the 1949 level. South Korean trade volume (excluding U.S. aid), which had de- clined to less than 1 percent of the level achieved during Japanese colonial rule in the period immediately following liberation, showed a trend of gradual increase thereafter. But South Korean exports in 1953 were still less than 15 percent of the 1940 level (Kim and Roe- mer, 1979, p. 31). Korea continued to receive a considerable amount of assistance from the U.S. and the UN during the war period (Kim and Roemer, 1979, p. 34). U.S. assistance came in the form of relief goods and other daily necessities, equivalent to approximately $530 million, financed by the Government Appropriation for Relief in Oc- cupied Area (GARIOA) and the Economic Cooperation Administra- tion (ECA) during 1945-1949. Economic Policy in the Reconstruction Period, 1953-1960 The Korean war that had begun with the North’s aggression con- tinued for over three years until the armistice was signed on July 27, 1953. The number of civilian war casualties, including those missing,Korean Economic Development: An Overview 11 ‘was approximately 1.5 million, and the non-military war damage in- curred to buildings, structures, equipment, facilities and other mov- able assets was estimated to be about 41.2 billion won (equivalent to $3.1 billion) at constant mid-1953 prices. The physical war damage made to the civilian economy was equivalent to about 85 percent of GNP for 1953. Of the non-military war damage, private housing damage was the most severe, accounting for 43 percent of all build- ing damage (Bank of Korea, 1955). The war damage to industrial plants was equivalent to 42-43 percent of the pre-war facilities (Hwang, 1971, p. 71). South Korean GNP for 1953 was at the level of 47.9 billion won in current market prices; per capita GNP was $67 at current prices (or $757 in 1990 constant dollars). Since Korea’s national account data are available beginning in 1953, it is not possible to compare that year’s GNP or per capita GNP with the earlier years. So, total net commodity product for that year is compared with that for 1940. The result indicates about a 27 percent reduction in total net commodity product between 1940 and 1953. Except for the manufacturing sector that showed only a minor reduction in output, all sectors’ products declined substantially. As a result, per capita net commodity product in South Korea declined by about 44 percent during the period 1940- 1953 (Kim and Roemer, 1979, p. 35)? In 1953, when the postwar reconstruction began, total consump- tion expenditures accounted for 91 percent of GNP, implying an av- erage saving propensity of about 9 percent. The average saving rate was unusually high in that year compared with the late 1950s or even the early 1960s, since the large increase in agricultural inven- tories caused by a bumper rice crop in that year increased the gross saving figures. Gross domestic investment in 1953 was about 15 per- cent of GNP, but gross fixed investment, excluding changes in stocks, was only 7 percent of GNP, barely enough to cover depreciation costs of the existing capital stock. Because gross domestic saving, exclud- ing the saving in the form of inventory increase, was merely 0.6 per- cent of GNP in that year, about 90 percent of gross fixed capital formation had to be financed by foreign saving, equivalent to 6.6 per- cent of GNP (Bank of Korea, 1984, pp. 78-79). Starting out from this meager situation in 1953, the country began its postwar reconstruction and economic development. It emphasized12 Kwang Suk Kim & Joon-Kyung Kim reconstruction of the industrial plants and infrastructure that had been destroyed by the war for the first few years. Upon completing the urgent reconstruction of industrial plants and social overhead fa- cilities, emphasis shifted from the reconstruction of war damage to economic stabilization beginning in the middle of 1957. Both the re- construction and the stabilization programs undertaken during this period could not be carried out if there had not been massive aid from the U.S. and the UN. During this reconstruction period (1953-1960), Korea’s net trade balance on goods and services was always in large deficit, but its current account was generally in equilibrium although it varied by year, owing to the large receipt of unrequited transfers from abroad. However, since domestic inflation was considerably higher than that of major trading partners, the U.S. and Japan, the official exchange rate was almost always overvalued during this period despite fre- quent large devaluations of the won. A complicated system of mul- tiple exchange rates therefore developed and was applied in commercial foreign exchange transactions, making the official rate al- most irrelevant to foreign trade (Kim and Westphal, 1976, p. 53). Under the system of multiple exchange rates, the rates varied by source of foreign exchange (that is, a higher rate on dollars earned by exporting to Japan than those earned by exporting to other coun- tries) and by purpose of foreign exchange uses. This complicated sys- tem was maintained until the early 1960s. While maintaining the complicated system of multiple exchange rates, the government at- tempted to restrict imports by maintaining high tariffs and the var- ious tools of quantitative restrictions (QRs). These government measures contributed to promoting the reconstruction and develop- ment of such consumer goods industries as processed food and tex- tiles, thereby accelerating import substitution in those industries. On the other hand, total commodity exports declined from about $40 million to $32 million between 1953 and 1960, despite the fact that the multiple exchange rates were somewhat favorable to exporting activities and that the government took some ad hoc measures to promote exports. This decline in exports may be explained by two reasons. One is that domestic production capacity during this period was still not large enough to increase exports. The other is that pri- vate enterprises could capture better profit-making opportunities inKorean Economic Development: An Overview 13 the allocation of US. aid dollars than in exporting. Despite high inflation during this period, interest rates in organ- ized financial markets were kept at low levels. In the war-torn econ- omy it was not expected that domestic voluntary savings might be increased by offering a higher rate of interest. The low interest rate policy was aimed at reducing the capital costs of investors but could not help increase domestic investment. Gross fixed investment was only around 10 percent of GNP despite the massive inflow of foreign aid during this period. Because of the low investment rate, the economy grew by an average annual rate of about 4 percent. Beginning in this period, however, economic growth was led by the rapid growth of manu- facturing. Value added in manufacturing increased from 8 to 14 percent of GNP between 1953 and 1960, while the share of the ag- riculture-forestry-fishery sector in GNP declined by 10 percentage points from 47 to 37 percent. The manufacturing branches that showed rapid growth during this period were mainly light indus- tries, such as processed food and textiles. Foreign Aid and Stabilization Policy, 1953-1960 Even during the war period of 1950-1952 South Korea received grant-aid, totaling $330 million, from various organizations of the U.S. and the United Nations Korea Reconstruction Agency (UNKRA). The receipt of grant-aid actually peaked in the postwar reconstruction period (1953-1960). The assistance provided by UNKRA during the reconstruction period amounted to approxi- mately $120 million, while the U.S. official aid reached $1,745 million, including Public Law (PL) 480 funds for food assistance (Bank of Korea, 1970, pp. 322-327). The foreign aid, mostly provided in the form of grant, financed more than 70 percent of the country’s imports during this period. The country’s exports were insignificantly low, but the imports of goods and services, even if they were valued at the overvalued of- ficial exchange rate, accounted for 11 percent of GNP on average during this period. About two-thirds of such imports had to be fi- nanced by foreign assistance. In addition, the counterpart funds which represent the sale proceeds of grant-aid dollars provided an14 Kwang Suk Kim & Joon-Kyung Kim important non-inflationary source of local currency financing for both defense support and reconstruction programs. These funds ac- tually financed over half of the total general government expendi- tures during this period. The USS. assistance provided during the reconstruction period may be classified into four categories: (1) the non-project assistance that provided financing for commodity imports other than U.S. sur- plus agricultural commodities; (2) the project assistance which could generally be used for investment projects; (3) technical support; in- viting U.S. experts and technicians to Korea and overseas training of Koreans; and (4) PL 480 funds for importing US. surplus agricultural commodities. Krueger (1979, p. 69) shows that a bulk of the US. aid was provided in the forms of nonproject assistance and PL 480 funds, while a small proportion was provided as project assistance relating to investment activities. There were some disagreements between the Korean government and the U.S. aid mission in Seoul regarding the allocation of aid funds by category or usage. In general, the U.S. aid authorities placed their policy priority upon checking postwar inflation and pro- viding a minimum standard of living for the Korean people. They held the view that as long as domestic inflation prevented improve- ment of the people’s living conditions, the domestic saving mobili- zation which was required for reducing the country’s dependence on foreign aid and ultimately achieving a base for a self-supporting growth of the economy would not be forthcoming. As a means to remove the inflationary pressures, they emphasized the increasing supply of final products such as consumer goods and some inter- mediate goods that do not require much additional processing within the country (Krueger, 1979, p. 78). On the other hand, the policy objectives of the Korean govern- ment were: (1) to rebuild the production capacity that had been de- stroyed by the war, (2) to maintain a strong military force, and (3) to raise the level of private consumption. Cole and Lyman (1971, pp. 164-165) observed that since these objectives called for high levels of investment and of government and private consumption, the attain- ment of all such objectives tended to be constrained by the available supply of resources. For this reason, the Korean government at- tempted to maximize the volume of foreign aid receipts for allevia-Korean Economic Development: An Overview 15 tion of the constraint in the short run. Although the Korean govern- ment and the U.S. aid mission might have agreed on the long-run objective of building the base for a self-sustained growth of the Korean economy, their short-run policy objectives were clearly in dis- agreement. Nevertheless, the U.S. aid expenditures by category represented the result of agreement by both sides. In fact, all major economic pol- icy measures for the country, regardless of their direct relationship to the US. assistance, were jointly determined by both the Korean government and the U.S. aid mission during this period. The Com- bined Economic Board created in accordance with the “Agreement between the Republic of Korea Government and the Unified Com- mand Concerning Economic Coordination” (signed in May 1952) provided the channel for regular policy debates between the two sides and joint decision-making. Accordingly it is really not clear which parts of the policies adopted during this period reflected the position of the Korean government. The government agreed with the US. aid mission to implement a strong financial stabilization program beginning in mid-1957. The rate of inflation measured in terms of the wholesale price index, which had peaked at 531 percent in 1951, started to decline rapidly after the armistice, but the rate in 1956 was still a high 30 percent. It was therefore considered urgent to control inflation. The high in- flation in this period was judged to have been caused mainly by an excessive monetary expansion during and immediately following the war period. The stabilization program was therefore designed to con- trol the expansion of the money supply. The implementation of the program resulted in reducing the an- nual rate of increase in the money supply from 62 percent and 29 percent, respectively, in 1955 and 1956 to a 20 percent level in 1957. Even though the monetary control was somewhat eased in 1958, the country could achieve price stability in 1958-1959 thanks to the bumper rice harvest that contributed to reducing the rice price sig- nificantly. In 1960, however, the Student Revolution and the conse- quent politico-economic instability did not allow the hard-earned, price stability to sustain itself for long.16 Kwang Suk Kim & Joon-Kyung Kim Export-Oriented, High Growth Strategy of The Park Regime: 1961-1979 Policy Reform for Export-oriented Growth The military government that managed the Korean economy for nearly three years beginning in 1961 began to shift the previous pol- icy emphasizing inward-looking industrialization toward the direc- tion of export-oriented industrialization (EOI). It could not, however, complete the policy transition of adopting an EOI strategy since it failed to undertake the necessary policy reforms. It attempted to unify the exchange rate but failed mainly because its policies con- flicted with the objective of exchange-rate unification, such as it’s the deleterious currency reform and expansionary monetary policy. As a result, the export promotion policies adopted by this government were little more than ad hoc measures to offset the disincentives of an overvalued official exchange rate on exports. In other words, they were not consistent with the EOI strategy. The system of incentives consistent with the EOI strategy were institutionalized by a new civilian government, following the ex- change rate reform of 1964-1965. Through reform of the exchange- rate system in two steps, the government devalued the won and adopted the system of a unitary floating rate that was supposed to allow flexibility in the exchange rate reflecting demand and supply conditions on the market. An excessive intervention by the monetary authorities in the exchange market, however, resulted in transform- ing the system of a unitary floating rate into a crawling peg. Nev- ertheless, the nominal exchange rate was allowed to fluctuate so that a roughly constant level of purchasing-power-parity (PPP)-adjusted, real exchange rate might be maintained beginning in 1965. Following the exchange-rate reform, the government abolished ad hoc export promotion measures, such as direct export subsidies, the export-import link system, etc., since the reform significantly im- proved the price competitiveness of Korean exports. Instead, it an- nounced comprehensive measures for export promotion, consistent with the new exchange rate system, with their enforcement begin- ning in 1965. These comprehensive measures were continuously im-Korean Economic Development: An Overview 17 plemented without changing the basic framework until the early 1980s, although some modifications were made to accommodate changing economic conditions. The exchange-rate reform of 1964-1965 and the almost concurrent implementation of comprehensive export promotion measures re- sulted in a total institutionalization of the system of incentives con- sistent with the EOI strategy. The country’s shift to the EOI strategy in the first half of the 1960s is considered a wise choice in view of its economic conditions at that time. By the early 1960s the country had almost completed “easy” import substitution in non-durable consumer goods, as well as the postwar reconstruction. But the economy’s growth rate slowed down since it was encountering a limit to growth through further progress in import substitution due to a narrow domestic market. On the other hand, the sharp decline in US. assistance at that time made it almost inevitable for the coun- try to emphasize the promotion of foreign exchange earning activities for resolving the balance-of-payments problem. In addition, it was judged that the country might have a comparative advantage in the production and export of labor-intensive goods, in view of the abun- dance of a relatively well educated, labor force within the country. The government did not, however, entirely rely on the system of incentives for implementation of the EOI strategy. It used three major administrative instruments to support that strategy. One was the government export targeting system, under which annual export tar- gets were usually set by major commodity group and by destination, and export performance was monitored against these targets. The second was the support of the government-owned, Korea Trade Pro- motion Corporation (KOTRA) for overseas marketing activities of Korean exporters through a continuous expansion of its overseas net- work. The last was the Monthly Export Promotion Conference (later renamed the Monthly Trade Promotion Conference) which essentially served to disseminate the government emphasis on export promotion and also to quickly resolve problems encountered by exporters through the final decision of the president (Rhee et al., 1984, pp. 29- 35). The exchange-rate reform which accompanied the adoption of comprehensive export promotion measures resulted in a simplifica- tion of the system of incentives for exports and also in a stabilization18 Kwang Suk Kim & Joon-Kyung Kim of the effective exchange rate for exports, since ad hoc measures for export promotion were mostly dismantled immediately following the reform. In fact, the institutional reform substantially reduced net ex- port subsidy per dollar of exports, implying that trade-distorting measures on the export side dropped significantly. In this sense, we may say that the reform of 1964-1965 contributed significantly to trade liberalization on the export side (Kim, 1991, pp. 31-34). On the import side, however, only some minor progress was made in lib- eralization through the reduction of QRs in 1965-1967, but thereafter no progress was made for about 10 years until 1978. The reason was that despite the rapid expansion of exports, the country’s trade bal- ance was in chronic deficit owing to a continuous rapid rise in im- ports. The exchange-rate reform, the comprehensive export promotion measures, and the import liberalization measures were all taken as part of a policy reform package designed for the promotion of the EOI strategy. How did this reform package affect the relative incen- tives to export versus import substitution? This question may be ap- proached by two different methods. First, the annual time series of real effective exchange rates for ex- ports and imports, which were obtained by adjusting the nominal ef- fective exchange rates for exports and imports’ by the index of purchasing power parity between Korea and its major trading part- ners, remained largely stable during the period 1965-1979 (K. Kim, 1994, p. 325). In many of the years covered, the real effective rate for exports turned out to be a little lower than that for imports. But the lower rate for exports is mainly attributable to the statistical er- rors and omissions involved in the estimation of net subsidies im- plicit in various export promotion measures. In any case, the anti-export bias, which is measured by the ratio of real effective rates for exports to that for imports, remained stable at the range of 0.94- 1.00 throughout the whole period. This reflects the fact that after the policy reforms, the level of incentives to export was roughly equiv- alent to those incentives for import substitution. Second, a comparison of effective incentives to export with those to import substitute will require some explanation on the terms of the effective protection rate (EPR) and the effective subsidy rate (ESR). The EPR is measured by the percentage difference betweenKorean Economic Development: An Overview 19 domestic value added under protection and the value added in world market prices. It is designed to show the degree of protection afforded to value adding processes. It cannot, however, take into ac- count the subsidies in the form of income tax exemptions and pref- erential low-interest loans to specific activities. Since such subsidies provided substantial incentives to exporting activities in Korea, es- pecially in the 1960s and the 1970s, it is necessary to introduce the concept of ESR, in addition to EPR. To obtain ESR, the value added in domestic prices should be adjusted by adding total direct tax and interest-rate subsidies before dividing it by value added in world market prices (Balassa and Associates, 1982, pp. 17-18). Estimates by Westphal and Kim (1982, pp. 230-231) indicate that an average ESR for manufacturing exports in 1968 was about 12 percent, substan- tially higher than the average EPR for that sector’s domestic sales which stood at only 1 percent. Another study also shows that the average ESR for manufacturing exports in 1978 was 23 percent, sig- nificantly higher than the average EPR of 5 percent for that sector’s domestic sales (Nam, 1981). We may say therefore that the reform program carried out in the first half of the 1960s created the base upon which export expansion might be sustained by assuring a relatively higher and more stable level of incentives for exporters than in the past. Korea’s merchan- dise exports started to increase rapidly from a meager, $41 million, or 2 percent of GNP, in 1960 to $175 million, or 5.8 percent of GNP, in 1965. This increase may, however, be taken as a catch-up to a nor- mal level from the unusually low level of the early 1960s. Beginning in the mid-1960s, the country’s exports maintained a rapid rate of expansion to reach $15.1 billion, or 14.5 percent of GNP, by 1979. During the period of 1965-1979 the nominal value of exports in- creased by the average annual rate of 37.5 percent. Discounting for the rise in export unit prices, the volume of exports grew by the av- erage annual rate of about 30 percent. As a result, the merchandise exports which had accounted for a mere 0.1 percent of world exports in 1965 increased to about 1 percent by 1979. This increase in exports was accompanied by a considerable di- versification in both the commodity structure of exports and export markets. In the early 1960s manufactured exports had accounted for only about 15 percent of total exports, but increased to nearly 90 per-20 Kwang Suk Kim & Joon-Kyung Kim cent by the late 1970s. The country’s export markets which had been concentrated in two countries, the U.S. and Japan, were diversified considerably by increasing the market shares of the Middle East, Eu- rope and other Asian regions. The sustained expansion of exports that was accompanied by the diversification of export commodities and markets was almost entirely the result of Korean business en- deavors. As already suggested, the rapid expansion of exports contributed to an acceleration in the growth of value added in manufacturing, thereby enabling rapid growth of GNP. In other words, the export expansion made it possible for the manufacturing sector to grow by an average annual rate of about 19 percent during 1965-1979, signif- icantly higher than the same sector’s growth rates of 13 percent and 15 percent, respectively, for the two previous periods, 1953-1960 and 1961-1965. It also contributed substantially to employment creation. Since Korean exports in the 1960s and the 1970s were mainly in labor-intensive goods for which it had a comparative advantage in view of its factor endowments, the effect of exports on employment creation was substantial. Despite the rapid expansion of exports, however, the country’s current account balance could not be improved during the 1960s and the 1970s, mainly owing to the rapid growth of imports. The rapid growth of imports during this period was not attributable to import liberalization but mainly to the expansionary demand management policy which was continued as a means to promote rapid industri- alization. In particular, the Korean producer’s price index rose by the average annual rate of 14 percent, substantially higher than in major trading partners, during 1965-1979, due mainly to the excessive mon- etary expansion.’ Nevertheless, the country’s export competitiveness was not seriously hurt because stability in the PPP-adjusted, real ef- fective exchange rate could be maintained by the currency devalua- tion that took place from time to time and by the adjustment of indirect export subsidies. Policy for Heavy Industrialization Although the policy reforms of 1964-1965 started to accelerate the speed of export-oriented industrialization, the government did notKorean Economic Development: An Overview 21 totally depend upon the system of incentives for resource allocation, but made selective intervention for promotion of major industries. While promoting the exports of labor-intensive, light industrial prod- ucts by using the system of incentives, it resorted to selective inter- vention for promotion of major import-substitution industries. It placed emphasis on substituting the imports of intermediate and capital goods by domestic products beginning in the early 1960s. During the first five-year plan period (1962-1966) the government emphasized the construction of such import-substitution industries as cement, fertilizer, petroleum refining, chemicals, and synthetic tex- tiles. For promotion of private investment in such import-substitu- tion industries, the government not only encouraged the introduction of foreign capital by providing repayment guarantees for foreign loans, but also made available preferential loans from domestic bank- ing institutions to those enterprises investing in the selected indus- tries. In order to make the financing from both domestic and foreign sources possible, it had to supplement the existing law for promotion of foreign capital inflows in 1962 by enacting two additional laws.° It also had to re-nationalize in the early 1960s all the commercial banks that had been privatized in the 1950s, thus making possible its direct intervention in the allocation of bank credit. The selective promotion of import substitution industries contin- ued during the second five-year plan period (1967-1971). It was in- stitutionally supported by seven special industry promotional laws; machinery, shipbuilding, textiles, electronics, petrochemicals, iron and steel, and nonferrous metal. Among these selected industries the gov- ernment gave particular emphasis to the promotion of two mam- moth projects; a petrochemical complex and an integrated steel mill. The selective industrial policy for the third and the fourth plan periods (1972-1976 and 1977-1981) may be represented by the ambi- tious plan for construction of heavy and chemical industries (here- after referred to as the HCI Plan). In 1973, the government an- nounced the HCI Plan that envisioned a total investment of approximately $9.6 billion for construction of six HCIs —iron and steel, nonferrous metal, machinery, electronics, and chemicals— dur- ing the period 1973-1981 (Lee, 1991). The HCI Plan enumerated all the projects to be undertaken during the plan period, together with the timetable for their construction. It also included the programs for22 Kwang Suk Kim & Joon-Kyung Kim construction of large industrial complexes for collective accommoda- tion of related HCI plants: for example, Changwon Machinery Com- plex, Yochon Petrochemical Complex, Kumi Electronics Complex, and so forth. There were three reasons for the government promotion of the HCI Plan in the 1970s (K. Kim, 1994, pp. 345-346). First, the devel- opment of HCIs was considered inevitable for the purpose of con- structing a domestic defense industry which was essential for enhancing the nation’s self-defense capability. Second, the nation’s in- dustrial policy emphasized the construction of HCIs, since she faced increasing trade barriers in advanced countries against her labor-in- tensive exports while the domestic wage-rental ratio was rising rap- idly. Lastly, the development of HCIs was considered important for improving the country’s balance of payments, since the past strategy emphasizing light industry exports tended to increase imports for both capital and intermediate goods, and thus was ineffective in re- ducing the current account deficit. Because almost all of the HCI projects had to be undertaken by the private sector, a basic problem in promoting the projects was how to mobilize and channel the necessary resources, such as capital, technology, technical manpower, industrial sites, and entrepreneur- ship, to the HCI sector. The government had to take various mea- sures to help resolve the problem. First, the government took measures to increase preferential long-term financing for the HCI sector and to provide tax incentives to those enterprises investing in HCls. Second, it took measures to drastically increase the total en- rollments in various levels of engineering and technical schools and to expand the school facilities so that manpower requirements for the HCI sector might be met smoothly. Third, it established several new research institutes to promote research and development (R&D) in the HCI fields. Lastly, it increased the construction of industrial com- plexes for the location of HCI plants. These policy measures were quite effective in attracting large business groups’ investments in the HCI projects. Investment in the HCI sector increased rapidly not only in absolute terms but also in relation to that of light industry. The HCI investment which had ac- counted for about 57 percent of total manufacturing investment in the first half of the 1970s expanded to 64 percent by the latter halfKorean Economic Development: An Overview 23 of that decade, while investment in light industry declined from 43 percent of the total to 36 percent during the same period. Separating out equipment investment from the total manufacturing investment, the share of HCls in total equipment investment was as high as 76 percent during 1973-1979. In order to facilitate the implementation of the HCI Plan, the gov- ernment consistently followed an expansionary fiscal and monetary policy despite the accumulation of inflationary pressures. However, when the second world oil shock began to cause rapid increases in both domestic oil prices and the balance-of-payments deficits in early 1979, the expansionary policy had to be shifted to a strong economic stabilization program. This sudden shift of policy did not im- mediately reduce the rate of inflation, but brought about a drastic slowdown in economic growth (even to a negative rate in 1980) and a sharp decline in the HCI sector’s capital utilization. Many of the completed HCI plants could not operate without additional govern- ment assistance, thus necessitating government intervention for “in- vestment adjustment” or bailout. The government therefore undertook three rounds of investment adjustments in the HCI sector during 1979-1983. The main purpose of the adjustment was to promote mergers among competing HCI firms or to scale down the planned capacities in some cases so that the problem of excess capacity might be resolved and at the same time economies of scale might be realized through product special- ization (see Section IV in this chapter). The HCI sector’s investment adjustments were usually accompanied by “rescue” financing from the government-controlled financial institutions. Despite the painful adjustment efforts of the government, production activities of the HCI sector remained sluggish until around the mid-1980s. Only be- ginning in 1986, when the business environment was drastically changed by the Plaza Accord of September 1985, were most of the troubled HCI firms able to increase their output and exports, thereby raising their capacity utilization rates and business profitability. The selective industrial policy that evolved from the promotion of import-substitution industries during the first plan period to the implementation of the HCI Plan after 1973 resulted in significant structural improvement in both manufacturing output and exports. Rapid progress in industrialization since the early 1960s made pos-24 Kwang Suk Kim & Joon-Kyung Kim sible a gradual rise in the share of manufacturing in GNP and also a continuous rise in the share of HCls in total manufacturing value- added (from 26 percent in 1961 to 55 percent by 1979). The HCI ex- ports which had accounted for only about 10 percent of total manufactured exports until the early 1970s increased rapidly to reach 43 percent by 1979. On the whole, the selective promotion of import-substitution in- dustries during the first two plan periods was successful in realizing import substitution in selected industrial fields without causing se- rious ill effects, although it did create some financially insolvent firms in the late 1960s and the early 1970s. The implementation of the HCI Plan during the 1973-1979 period, which resulted in over- ambitious investment in HCIs and the neglect of investment in light industry, however, raised many issues in the short-run. In particular, many of the HCI plants remained almost idle or operated at a low rate of capacity utilization in the late 1970s and the early 1980s, im- plying that the HCI plan caused a waste of resources and was there- fore not successful in the short-run. It may also be said that the Plan had a negative impact on the economy in the sense that the ne- glected investment in light industry weakened international compet- itiveness of the domestic light industry and reduced the economy's growth potential based on the continuous expansion of light indus- trial exports. In the long-run perspective, however, the plan was successful in bringing about structural improvement in both manu- facturing output and exports as envisaged in the original plan. Agricultural Policy and “Saemaul” Movement When the EOI strategy was initiated in the early 1960s, Korea was a typical farm economy with over 60 percent of the work force en- gaged in agriculture. The agriculture-forestry-fishery sector ac- counted for 39% of gross domestic product. By 1979, the terminal year of the Park regime, however, the agricultural sector’s shares in national employment and GDP declined to 36 percent and 19 per- cent, respectively, due to rapid progress in export-oriented industri- alization. Korean agriculture was rapidly declining in relative importance, but this relative decline did not mean that the sector was stagnant. In those two decades Korean agriculture recorded a nearlyKorean Economic Development: An Overview 25 4 percent rate of annual growth on average, far exceeding the aver- age growth rate of world agriculture. A major characteristic of Korean agriculture was the small size of farming, reflecting the low land endowment. Even though land own- ership was relatively equal in distribution as a result of the two land reforms carried out in 1947 and 1950, the shortage of land inevitably limited the size of each individual farm. Farm land availability de- clined a little in the 1970s and thereafter since some of it had to be converted to manufacturing plant sites or used for urban popula- tions. For this reason, Korean agriculture could not realize economies of scale in production. This lack of scale economies, in turn, contrib- uted to hindering the introduction of new technology in agriculture, which might be important for improving agricultural productivity (Moon and Sul, Chapter 11 of this volume). In addition, the low grain-price policy that had been maintained until the late 1960s to stabilize both the general price level and the living costs of urban consumers reduced the farmers’ incentives to produce more grain and caused a structural change in agricultural production. Grain production exhibited a declining share in total ag- ricultural production in the 1960s, while the production of non-grain products, such as vegetables, fruits, livestock, cocoons, etc., showed an increase in relative terms (Mason et al., 1980, p. 214). On the other hand, the issue of domestic food shortage arising from the relative decline in grain production was resolved by increasing grain im- ports, especially the imports of U.S. surplus agricultural commodities under the PL 480 program. Nevertheless, the country’s agricultural productivity was rela- tively high by international standards. Rice yields per acre in Korea were even higher than those in Taiwan and almost triple those achieved in South and Southeast Asia, although they were somewhat lower than in Japan (ibid., 1980, p. 227). This high agricultural pro- ductivity in Korea reflected the fact that its labor and capital inputs per cultivated land area were relatively high by international stan- dards. The relatively high productivity of land could be achieved by increasing labor and capital inputs to use the limited land intensively. In the 1960s and the 1970s, the government undertook many new policy measures including the following: (1) a shift from the low grain-price policy to a high grain-price policy in the late 1960s, (2)26 Kwang Suk Kim & Joon-Kyung Kim the implementation of the “Saemaul” or new community movement since 1972, and (3) the improvement of agricultural financial institu- tions. First, the shift in grain price policy in the late 1960s was consid- ered inevitable not only to increase the production of food grains but also to alleviate income disparity between urban and rural house- holds by improving the terms of trade for farmers. The new, high grain-price policy was accompanied by the adoption of a two-tier grain price system since it was expected to raise the food costs of urban consumers drastically. In other words, the government was to purchase grain from farmers at a high price and sell it to urban con- sumers at a lower price. The loss accruing from this transaction was to be borne by the government (Moon and Sul, Chapter 11 of the volume). This policy also contributed greatly to increasing rice pro- duction in the 1970s. As a result, the country’s self-sufficiency in rice was achieved by the late 1970s. In the case of all grains, however, the degree of self-sufficiency rather declined as the imports of grain, other than rice, were needed for the purposes of producing feed and processed food, as well as feeding the population. As well, the two- tier price system raised the new issue of accumulating fiscal deficits. Second, the Saemaul movement was initiated in 1972 with the full support of the President himself and his government. It was a gov- ernment-guided, community development program. A social move- ment to reform the farmers way of thinking and living, through their own enlightenment and also by enhancing their spirit of self-help and cooperation. But it was also a massive investment program for the expansion of rural infrastructure and the increased income of farm households. It helped to channel rural surplus for capital for- mation in the agriculture sector by encouraging thrifty living and voluntary savings. It also contributed to improving the rural infra- structure through the implementation of its investment program. The problem was, however, that this movement was initiated and exe- cuted by a top-down approach under government guidance. The top-down approach might have been effective in giving impetus to farmers in the initial stage, but the increasing authoritarian and bu- reaucratic ways of program implementation in the latter stages dis- couraged the farmers’ voluntary participation and contributed to creating many cases of resource waste.Korean Economic Development: An Overview 27 Third, the financial system for agriculture was reformed in the early 1960s. A new form of agricultural cooperatives was created in 1962 under the name of the National Agricultural Cooperatives Fed- eration (NACF) to undertake both the credit activities of the former Agricultural Bank and the economic activities of the former Agricul- tural Cooperatives. The new cooperatives were to undertake both the credit and economic activities in such a way that the two activities might be mutually supporting. One of the important changes made to agricultural finance after the establishment of NACF was the in- tensification of the mutual financing function of unit cooperatives, in accordance with the Law on Credit Cooperatives enacted in 1971. The credit guarantee system which was introduced in the same year was also important for the development of agricultural finance. This system was used to guarantee credit to farmers and fishermen, who lacked loan collateral, on the basis of the credit guarantee fund es- tablished at the NACE. In addition, the system of using farm land as loan collateral, effective from 1970, also contributed to easing the farmers’ procurement of necessary funds. Manpower Policy and Labor-Management Relations In 1963, the number of workers engaged in the agriculture, for- estry and fishery sectors which accounted for 63 percent of total na- tional employment included some “disguised unemployment” or underemployment.’ At that time, the urban unemployment rate was as high as 16 percent. In addition, the labor force increased rapidly after 1963, even though the growth rate of the total population grad- ually subsided. During the period 1963-1979 the productive-age population increased at the average annual rate of 3.1 percent, sig- nificantly higher than the average growth rate of total population which was 2.1 percent. Total labor force increased at the higher rate of 3.4 percent during the same period, reflecting a continuous rise in labor participation of the productive-age female population. The country was not only endowed with a considerable, idle human resource in the early 1960s when the EOI strategy was ini- tiated, but also experienced a rapid expansion of that resource there- after. What was really important was that the average educational level of the Korean labor force in the early 1960s was significantly28 Kwang Suk Kim & Joon-Kyung Kim higher than that for other countries with a similar level of per capita income, and also rose continuously thereafter (Kim and Park, 1985, pp. 17-18). Under this labor surplus condition, the adoption of an EOI strat- egy opened the way for rapid industrialization through the contin- uous expansion of labor-intensive exports. The strategic shift was also important for the use of available human resources. During the period of rapid industrialization (1963-1979), total employment in- creased at an average annual rate of 3.7 percent. The growth rate of non-agricultural employment was 7.2 percent, much higher than that of total employment. The growth rate of manufacturing employment was even higher during this period, showing nearly 11 percent. This rapid rise in employment made possible a gradual decline in the country’s unemployment rate from 7.9 percent in 1963 to 3.8 percent by 1979, despite a continuous expansion of the labor force. In fact, some Korean labor experts suggest that the country’s labor market experienced the Lewisian (W. Arthur Lewis) turning point around 1975 or 1977-1978 (Bai, 1982; S. Kim, 1994). This shift in labor market conditions is explained by rapid rises in both the vacancy ratio® and teal wages. Regardless of this change in labor market conditions, three core labor rights, that is, the right of organization, the right of collective bargaining and the right to make collective labor disputes, were con- tinuously restricted during the Park regime. Although these core labor rights were well prescribed in the Labor Union Law, the Labor Standard Law, and the Labor Dispute Adjustment Law (LDAL), all of which were enacted on 1953, actual practice was different from the legal prescriptions. After the military coup of May 1961, the unions were allowed to organize in the form of industrial unions, and the Federation of Ko- rean Trade Unions (FKTU) was established as an umbrella organi- zation for various industrial unions. The union member penetration rate (number of union members/ total number of workers) showed a trend of minor increase, from 20.3 percent in 1963 to 23.6 percent in 1979. Even though labor unions existed during this period, their collective bargaining activities were largely restricted by government intervention. In the 1960s and the early 1970s any substantial im- provement in the remuneration of labor could not be expected evenKorean Economic Development: An Overview 29 if the government did not intervene, since labor surplus conditions prevailed in the economy. When the labor market conditions changed to a direction favorable for labor in the 1970s, union rights on col- lective bargaining and strikes were strongly regulated by the Law Concerning Special Measures for National Security (LCSMNC) prom- ulgated in late 1971. Even so, there were some labor disputes during the Park regime. The number of disputes that led to strikes were low from 1962-1977, but exceeded 100 cases in 1961 and 1978-1979 (Kochan, 1994). The labor disputes were largely resolved not by the normal procedures prescribed in the LDAL but by direct government intervention. Such government intervention often limited the role of union leaders in or- ganizing labor unions and settling disputes through negotiations. In view of the broad government intervention in the country’s labor- management relations, S. Kim(1994, p. 628) declared that labor-man- agement relations did not exist, only labor-government relations existed during the Park regime. The government regulation of the labor unions’ collective actions brought stagnation to union activities during the Park regime, but could not prevent a rapid rise in wages. Rapid export expansion and industrialization during this period increased demand for workers with in various categories and levels of skill, even though the labor- intensity of Korean exports gradually declined after the early 1970s. Real wages in manufacturing rose about 10 percent a year during the 1963-1979 period: slightly higher than the annual increase rate of that sector’s labor productivity (8.9 percent) measured in terms of real value added per worker. The more rapid rise in real wages than labor productivity over this period might be explained by the fact that the economy faced a relative shortage of experienced, skilled workers in the course of rapid industrialization although there was no shortage of labor in aggregate terms. The industries therefore had to offer a higher wage than the prevailing level to those with the ex- perience and necessary skills on a competitive basis. The high wages for these experienced, skilled workers later spread to other workers. In the late 1970s both the employment separation rate and the employment accession rate in Korea were relatively high, ranging from 4-5 percent of total employment. This high mobility of labor was helpful for an efficient allocation of human resources, but re-30 Kwang Suk Kim & Joon-Kyung Kim flected the fact that the Korean workers’ sense of belonging to their jobs was not as strong as in Japan. For this reason, there were many cases of “scouting” workers with necessary skill or specific technol- ogy among business establishments. All these contributed to a rapid rise in wages, while labor union activities still remained stagnant. In the early 1980s the labor union law was amended to change the existing system of industrial unions to the system of enterprise or establishment unions, similar to the Japanese model. The LCSMNS which had been restricting the unions’ collective action was also abolished. But at least until the announcement of democratization in 1987 labor union activities continued to be restrained by the govern- ment. For a few years immediately following the democratization an- nouncement, the country experienced numerous explosions of labor disputes and violent union activities. This was really a reaction to the long repression of labor union activities since the early 1960s. Such a reaction reflected the fact that the government-guided, labor-man- agement relations under the Park regime could not cultivate the practices of peaceful dispute settlements through labor-management negotiations or through the procedures prescribed in LDAL. In this respect, we may say that the labor policy of the Park regime had more demerits than merits in a long-run perspective. Expansion of SOC and Regional Development In the early 1960s the expansion of social overhead capital (SOC) facilities was urgently required for promotion of the EOI strategy. The Park regime therefore gave considerable policy emphasis to the expansion of SOC facilities, especially electric power, transport and communications facilities. In the 1960s the expansion of SOC facilities was attempted mainly to remove bottlenecks to economic develop- ment without considering the balanced development of all regions. By launching the First National Comprehensive Physical Develop- ment Plan in 1972, the government started to show its interest in bal- anced regional development, but could not achieve much during the Park regime. First, the government implemented a very ambitious plan for electric power development during the period 1962-1979. Policy pri- ority was given to the construction of thermal power plants whichKorean Economic Development: An Overview 31 could be completed in a relatively short period of time. The construc- tion of hydro power plants generally required a much longer gesta- tion period and a higher cost than in the case of a thermal plant. After the quadrupling of world oil prices in 1973-1974 that drastically raised the fuel cost of thermal plants, however, the policy emphasis shifted to constructing more hydro power plants than before and to constructing nuclear power plants for the first time in the country (Office of Prime Minister’s Program Coordination, 1977, p. 384; OPMPC, 1980, pp. 339-346). The construction of many power plants since the early 1960s re- sulted in drastic expansion of the total installed capacity of power generation by about 22 times from only 367,000 kilowatts (kW) in 1961 to 8 million kW by 1979. Gross power generation also increased about 20 times from 1770 giga watt-hours (GWh) in 1961 to 35,000 GWh in 1979. As the rapid expansion of both installed power capac- ity and gross power generation started to create some positive power reserves (possible power generation less peak demand) in 1964, the country gradually eliminated restrictions on electricity use beginning in that year (Office of Program Coordination, 1967, pp. 578-581; OPMPC, 1980, pp. 339-346). The increase of power generation, ac- companying the expansion of power transmission, transformer and distribution facilities, made possible a rapid rise in the country’s elec- trification rates for both urban and rural areas. The electrification which had been benefiting only 21 percent of all households in the early 1960s expanded to almost all households by the end of the 1970s. Second, the total volume of domestic freight traffic and that of domestic passenger traffic expanded at the average annual rates of 13 percent and 11 percent, respectively, during the period 1961-1979. Since railway transport occupied the largest shares of both freight and passenger traffic among the various transport modes in the early 1960s, the government emphasized the expansion of railway trans- port facilities, allocating nearly a half of the total transport sector in- vestment budget for that purpose, during the first plan period (1962-1966). Policy emphasis, however, shifted to highway transport during the second plan period (1967-1971). In the later period (1972- 1979) the government began to emphasize the expansion of marine transport facilities, while continuously expanding the highway trans-32 Kwang Suk Kim & Joon-Kyung Kim port facilities (Korean Chamber of Commerce and Industry, 1984, pp. 568-569). These policy shifts resulted in a substantial reduction of the shares of railway transport in both freight and passenger traffic, while increasing the shares of other transport modes, particularly highway transport, during the 1960s and the 1970s. Third, communications facilities were expanded rapidly to meet increasing demand for various communications services during the 1961-1979 period. However, an excess demand for communications services, particularly for telephone services, could not be completely eliminated until 1979, even though communications technology was significantly improved and the use of various facilities increased. A continuous acceleration of business activities and the resulting rise in the people's living standards, coupled with an unrealistic price policy on communications services, were responsible for the economy’s ever-increasing demand for their services. During this pe- tiod, the government emphasized the expansion of major communi- cations facilities, such as post offices, intra-city telephones, long-distance telephones, and telecommunications facilities. Lastly, the government did not have any definite policy for a balanced regional development until the 1970s, although the export- oriented industrialization since the early 1960s accompanied an ac- celeration of urbanization and widened disparity in development among regions. It was the policymakers’ dominating view in the 1960s and the 1970s that the industrial complexes constructed in var- ious locations would become the base of development for the hin- terlands, ultimately leading to a balanced development of all regions. The locations of the complexes were, however, determined mainly in consideration of industrial policy and economic feasibility. The third five-year economic plan that was implemented beginning in 1972 presented its goal for a balanced regional development, reflecting the objectives of the First National Comprehensive Physical Develop- ment Plan (1972-1981) announced by the Ministry of Construction. No effective policy measures were, however, taken to achieve this goal in the course of plan implementation.