5

The South Korean Political

Economy Since 1945

5.1 The Cold War, US hegemony and the South Korean

political economy

After Japan was defeated by the Allied powers in 1945, the Korean
peninsula came under the joint occupation of the Soviet forces in the
north and the US forces in the south with the 38th parallel as the
demarcation line, as agreed between the United States and the Soviet
Union before the end of the war. The Allied occupation was seen at
the time as a temporary measure for the Koreans to prepare for election
of their own government and regain independence. However, with the
spread of the Cold War from Europe to the Far East, it gradually became
clear that a peninsular-wide election was no longer possible. Eventu-
ally, the Korean peninsula was formally divided into two separate states
along the 38th parallel in 1948 with the establishment of the Repub-
lic of Korea (hereafter referred to as South Korea) and the Democratic
People’s Republic of Korea (hereafter referred to as North Korea). With
the breakout of the Korean War (1950–53), the United States and South
Korea formally formed an alliance. In 1954, the two allies signed the
Mutual Security Treaty, by which Seoul was officially incorporated into
Washington-led anti-communist security framework in the Far East. The
US–South Korean Mutual Security Treaty thereafter became the corner-
stone of America’s military commitment to South Korea, while South
Korea took a development path that was vastly different from that of
North Korea.
Like that of the Japanese political economy, the transformation of the
South Korean political economy in the postwar years was substantially
influenced by Washington’s geopolitical strategy in the region. Follow-
ing the communist victory in mainland China in 1949 and the outbreak

83
84 The Political Economy of East Asia

of the Korean War in 1950, the strategic importance of South Korea

became all the more evident for Washington. Therefore, soon after the
end of the Korean War in 1953, South Korea was formally incorpor-
ated into America’s strategy of containing communism and isolating
China and the other socialist countries in the Far East. This policy was
clearly reflected in Washington’s National Security Council (NSC) policy
document, NSC 154, approved by the President on 3 July 1953, which
laid out various interim courses of action designed to maintain eco-
nomic and political pressures on China and North Korea and to support
South Korea’s defense and security.1 As an integral part of this policy,
Washington decided to substantially boost its aid to help South Korea
with its economic reconstruction and development, a policy that was
specified in the NSC policy document on postwar economic and mil-
itary aid for South Korea (NSC 156).2 The US aid was crucial for the
very survival of South Korea at the time, a country that had been totally
devastated by the war.
As such, the United States provided huge amounts of military and eco-
nomic aid for South Korea in the postwar years.3 In August 1953, 1 month
after the end of the Korean War, Washington established the US Office of
Economic Coordinator for Korea to coordinate US economic and military
aid so that the aid funds were used efficiently. From 1946 through 1976,
South Korea received $12.6 billion in US military and economic aid.4
Including $1.9 billion from the international financial institutions and
about $0.8 billion from Japan, South Korea received a total of over $15
billion in aid during this period, equivalent to $600 per capita, a per cap-
ita aid figure that was only surpassed by South Vietnam and Israel.5 Par-
ticularly in the period 1953–61, the US aid, which accounted for 95% of
total foreign aid the nation received, helped South Korea finance the gov-
ernment budget and capital formation, ease balance of payments deficits,
and reduce the inflationary pressure. The US economic aid amounted to
100% of the South Korean government budget in the 1950s,6 80% of the
fixed capital formation, 8% of GNP, and 70% of total imports from 1953
through 1962. Moreover, the US military aid programs not only helped
the construction of roads, bridges, and other infrastructure but also con-
tributed to the formation of valuable human capital through the training
of South Korean military personnel in organization, management and
technical skills, who, after leaving military service, went to work in indus-
trial and service sectors, especially in government-owned enterprises.7
Consequently, for the two decades from the mid-1940s to the mid-1960s
the US economic and military aid constituted a critical factor not only for
South Korea’s survival as an independent state but also for its economic
 The South Korean Political Economy Since 1945 85

recovery and early industrialization, which in turn laid the foundation

for the nation’s rapid economic growth in the subsequent years.
After the mid-1960s, while its direct aid reduced in significance, the
United States played a crucial role in absorbing South Korean goods.8
While tolerating South Korea’s highly protective policies and prac-
tices, Washington adopted liberal and benevolent trade policies toward
South Korea and brought it into the liberal international trade regime.
America’s huge open market and relatively liberal markets in other
industrial countries made it possible for South Korea to successfully
switch to implement an export-oriented development strategy from the
early 1960s onward.
The US investment and technology transfer also played an import-
ant role in South Korea’s economic development. Particularly, after the
United States shifted its economic aid from grant aid to loan aid in the
mid-1960s, the South Korean government switched to rely on huge for-
eign borrowings (governmental loans as well as commercial loans) to
finance its series of economic development plans and maintain a vig-
orous pace of investment activities. Moreover, supported by the United
States, South Korea joined the IMF and the World Bank on 26 August
1955, which further facilitated the flow of foreign capital into the coun-
try. From 1962, when the first FDI project was approved by the South
Korean government to the end of 1976, South Korea received a total of
$950 million in FDI. The FDI inflows in South Korea were dominated
by US companies until 1968, and thereafter they became predominantly
Japanese.9 The foreign investment, together with foreign aid and loans,
contributed to the expansion of the export manufacturing industries.
By the 1970s, exports and foreign private capital had replaced US aid
to become the major sources of foreign exchange earnings to finance
the country’s industrialization. Equally significant, the US aid made a
considerable contribution to the transfer of technology through project
financing, development loans, and the provision of large numbers of
technical experts. In the meantime, South Korea also acquired modern
industrial technology through US investment and technological licens-
ing agreements with US companies. To help South Korean industry with
the adoption and adaptation of modern technology, the United States
aided the creation of the Korean Institute of Science and Technology
(KIST) in 1966.
The United States also provided South Korea with technical assistance
through being heavily involved in government economic decision-
making regarding the allocation of aid sources. After the mid-1960s, the
United States showed more concerns for research, economic planning
86 The Political Economy of East Asia

and policy, and export programs. It financially supported a series of

economic and social studies of problem areas in the South Korean eco-
nomy, such as the financial system, grain marketing, and land tenure
conditions.10 In 1971, Washington used its aid to support the creation
of the Korea Development Institute (KDI), which was to assist the South
Korean government with research and analysis of critical economic
policy and planning problems.
Given the high degree of hostility between the north and the south,
the US military protection not only provided South Korea with a secure
external environment for its economic development, but also helped
the country reduce the burden of its military expenditures so that South
Korea could use more resources on economic development. On the other
hand, South Korea also earned huge amounts of foreign exchange from
South Korean troops’ participation in the Vietnam War and from local
procurement by US forces stationed on its soil, which were then used to
pay for imports needed for the country’s industrialization. According to
Edward Mason et al., the foreign exchange earnings from these sources
were even larger than regular export earnings in the period before 1962.11
Using its influence, Washington pressured South Korea for a series of
reforms and policy adjustment, which later proved conducive to the
country’s economic recovery and subsequent rapid growth. The land
reform in South Korea was initiated by the US occupation authorities
after 1945 and was later completed by the South Korean government
under America’s strong pressure after the country’s independence. More
significantly, to push the South Koreans to increase their ability of earn-
ing foreign exchange to finance the nation’s development, Washington
pressured Seoul to switch its import-substitution development strategy
of the 1950s to the export-oriented development strategy after the 1960s.
The US influence was also reflected in a high proportion of the senior per-
sonnel in the government, business, and academics who were exposed
to US training under either the economic or military aid programs.
While the United States most substantially influenced the trajectory
and pace of South Korea’s postwar political economy in the context of the
Cold War, Japan, encouraged by Washington, also played an important
role in providing capital and technology for South Korea in its economic
development after the normalization of diplomatic relations between
the two countries in 1965. In the meantime, Japan also became the
second largest market for South Korean exports after the United States
for decades, contributing to the success of South Korea’s export-oriented
development strategy. It is important to note that from the very begin-
ning South Korea’s economic ties with Japan were built into a pattern of
 The South Korean Political Economy Since 1945 87

triangle economic relationship that involved the United States, Japan,

and South Korea, within which the United States functioned as a major
market to absorb South Korean products, Japan provided South Korea
with capital and technology, and South Korea produced goods aimed at
the US market. This pattern of trilateral economic relationship continued
thereafter.
Obviously, America’s military and economic support for South Korea
in the context of the Cold War provided crucial external conditions for
South Korea to achieve economic recovery and fast economic growth. By
the end of the 1980s, however, the external conditions had substantially
transformed. Particularly, with the end of the Cold War and the relative
decline of the US economic power, Washington modified its previous
Cold War foreign policy that subordinated its economic interests to its
geopolitical objective to a new approach that pursues both economic and
geopolitical interests. On its side, South Korea, with the achievement of
industrialization and economic boom, had substantially improved its
position and confidence as a nation by the end of the 1980s. Under such
circumstances, the US–South Korean relationship gradually transformed
in the period 1980s–90s. While the two countries continued to maintain
their political and strategic alliance, there was the emergence of conflict
over a range of economic issues. Especially, the economic success that
had its roots in the early 1960s continued throughout the 1980s and
culminated in the rapid expansion of South Korean exports to the US
market in the late 1980s and resultant South Korea’s swelling trade sur-
pluses with the United States. As a result, economic frictions and tensions
emerged between the two allies. In defense of its own economic interests,
Washington growingly treated South Korea as an economic competitor
and exerted increasing pressure upon the nation.
Despite the rising economic power, however, South Korea continued
to have a high stake in its relationship with the United States. This is not
only because South Korea continued to need its alliance with the United
States for protection of its security and for maintenance of regional sta-
bility, but also because the United States remained the largest export
market for South Korean products until very recently and the nation’s
largest source of FDI. As such, South Korea’s relationship with the United
States remained the top priority in Seoul’s policy agenda.

5.2 The South Korean state and economic development

When the Korean peninsula was formally divided into two states in
1948 with the establishment of the Republic of Korea in the south
88 The Political Economy of East Asia

and the Democratic People’s Republic of Korea in the north, nearly all
the power-generating capacity and almost two-thirds of heavy industry
was left in the north. The subsequent Korean War of 1950–53 further
destroyed the tiny industrial base that had been newly created in the
south. Consequently, South Korea faced mounting social, economic, and
political problems in the immediate postwar years, including a flood of
penniless refugees from the north, a high unemployment rate, a severe
housing shortage, a completely destroyed administrative and economic
infrastructure, and political instability.
Despite the immediate huge task of the nation’s reconstruction and
rehabilitation in the aftermath of the war, however, President Syngman
Rhee was preoccupied with the consolidation of his political power and
the reunification of the peninsula on his own terms. Although efforts
were made for the reconstruction of the nation’s industrial base and
infrastructure and for the promotion of domestic import-substitution
production, little attention was given to the country’s long-term eco-
nomic development. Moreover, with almost no domestic savings, South
Korea relied heavily on foreign aid, US aid in particular, for all its recon-
struction needs. As a result, the economic growth remained stagnant
until the military coup in 1961.
The real transformation of the South Korean economy started only
after the 1961 military coup led by Park Chung-hee, which brought
in a military-controlled authoritarian government in 1962. While the
new government resorted to authoritarian rule by declaring martial law,
dissolving the National Assembly, imposing press censorship, and sus-
pending party political activities, it initiated a major shift in policy focus
toward economic growth. This major policy shift was based on Pres-
ident Park Chung-hee’s belief that building of a strong economy and
improvement of people’s living standard would best enable the coun-
try to withstand the threat from the north and protect it from domestic
communist insurgence. But to build such a strong nation, according to
Park, a strong authoritarian government was essential. Consequently,
the Park government concentrated on the promotion of rapid economic
growth at the expense of development of a democratic political system.
The new political leaders were therefore highly committed to eco-
nomic development and initiated a series of organizational reforms that
aimed at the construction of a capable institutional structure for eco-
nomic planning and management. Particularly important under these
initiatives was the establishment of the Economic Planning Board (EPB)
in 1961, a key body that was to be responsible for economic plan-
ning, central budgeting, foreign capital management and statistics and
 The South Korean Political Economy Since 1945 89

that was to have the authority to coordinate policies and programs

among all the functional ministries involved in economic affairs. The
role of the EPB was particularly strengthened through an institution-
alized arrangement under which the minister of the EPB concurrently
served as the deputy prime minister, who oversaw relevant ministries
involved in economic matters.12 In the meantime, the Office of Planning
and Coordination was also established under the prime minister in 1961,
which was to assist the prime minister in monitoring the performance
of major projects and policies. This framework of planning and policy-
making was highly centralized and streamlined. It is important to note
that in South Korea the actual policymaking process usually involved
only a small number of government officials, although policies were dis-
cussed at the Economic Ministers Consultation Meeting. As such, policy
decisions could be made quite rapidly in South Korea.
With a sound institutional structure in place, the South Korean gov-
ernment played a very significant role in the course of the nation’s
economic development through formulating economic development
plans, designing and implementing appropriate development strategies,
allocating budgetary and financial resources in support of economic
development, and providing leadership and guidance for the private sec-
tor with respect to the direction of industrialization. In the meantime,
the government also formed a cooperative alliance with the business in
pursuing industrialization.
It was under such circumstances that in 1962 South Korea started
to implement the first (1962–66) of its series of five-year economic
development plans that were to transform the nation’s economy in the
subsequent years. These five-year plans set out the government’s policies
and objectives and played a significant role in guiding and coordinating
the direction of industrialization. As South Korean leaders were very prag-
matic, these economic plans were designed in a way that responded to
changing domestic and external conditions at the time. It is important to
point out that while economic planning exerted a substantial influence
on the private sector by providing a framework of guidance and direction
of industrialization, the South Korean government still primarily relied
on the market mechanism for its economic policymaking and was com-
mitted to maintaining an economy in which the private sector played a
central role. What the government mainly did was to offer incentives to
those companies that complied with economic plans, while final cooper-
ate decisions were still left in the hand of private companies. Since 1962,
the series of government five-year plans has substantially contributed to
the country’s rapid industrialization and economic growth.
90 The Political Economy of East Asia

As South Korea had scant natural resources, a small domestic market

and weak capability of earning foreign exchange, the Park government,
soon after coming to power, switched from the import-substitution
development strategy of the 1950s to an export-oriented development
strategy that was designed to achieve industrialization by focusing on
the production and export of labor-intensive manufactured goods, of
which South Korea had comparative advantage at the time. This devel-
opment strategy would not only help increase employment and income
but also help provide much needed foreign exchange earnings and a
sound base for further economic development. In pursuing this develop-
ment strategy, the South Korean government followed Japan’s footsteps
by vigorously adopting industrial policy to identify the priority indus-
tries that the government saw most important for the private sector to
develop. Although the government did not always dictate policies to the
private sector, it exerted substantial influence on private firms through
various policy measures. As such, throughout the process of industrializ-
ation, the South Korean government played a significant role in shaping
the nation’s industrial structure.
In response to changes in both domestic and external conditions,
South Korea’s industrial policy was timely adjusted and redesigned.
During the take-off period 1962–72, the focus of South Korea’s indus-
trial policy was to promote exports and to construct basic industries
and social infrastructure. To achieve these objectives, the government
adopted a series of policy measures, including an exchange rate system
under which the Korean won was pegged to the US dollar, drastically
raised interest rate to increase domestic savings, anti-inflation fiscal and
monetary stabilization policies, various incentives to promote exports,
and high tariff and a negative list system that imposed restrictions on
imports. These policy measures brought rapid export increase, economic
growth, and the establishment of basic industries such as steel, fertilizer,
cement, oil refining, and electricity and the social and economic infra-
structure such as highways, harbors, and irrigations facilities, which had
basically transformed South Korea from an agricultural economy into a
manufacturing-centered economy by the early 1970s.
The South Korean government timely moved to a new industrial policy
in 1973, issuing the Heavy and Chemical Industry Declaration. The
new industrial policy was intended to promote such strategic heavy
and chemical industries as iron and steel, nonferrous metals, shipbuild-
ing, industrial machinery, electronics, and petrochemical processing
industries. To support the development of these heavy and chem-
ical industries, the government provided not only direct and indirect
 The South Korean Political Economy Since 1945 91

administrative assistance but also preferential financial resources in

support of the construction of plants and facilities. A National Invest-
ment Fund was created to provide low-interest loans for investment in
the heavy and chemical industries. The proportion of financial resources
allocated to the heavy and chemical industries much exceeded those
to light industries. In the meantime, preferential tax policies, such as
exemptions and reductions of corporate taxes, were also employed to
support the heavy and chemical industries. Furthermore, the heavy and
chemical industries were protected by the government as “infant indus-
tries’’ from international competition through prohibitive tariffs and
import restrictions. Particularly, the South Korean government encour-
aged monopolistic production in certain of these industries on the
ground that this would strengthen their competitiveness through eco-
nomies of scale. Consequently, chaebol grew rapidly at the expense of
small- and medium-sized companies. With the aid of these policy meas-
ures, the heavy and petrochemical industries had been solidly established
by the end of the 1970s with their share in the manufacturing sec-
tor increasing from 38% in terms of value added in 1973 to 54.5%
in 1980, and exports exceeding 50% of total exports by 1983. The
heavy industrialization in turn helped promote the nation’s economic
growth.13
During the 1970s, the South Korean government also attempted to
modernize the rural sector, which had fallen behind the urban sector
during the process of rapid industrialization. In order to promote the
development of the rural sector, the government launched the Saemaul
(New Community) Movement in 1971, which aimed to boost agricul-
tural production and productivity and to raise the income of farmers
and fishing workers. While the government’s efforts to boost rural pro-
ductivity and income were quite successful, the policy of price support
for agricultural produce greatly contributed to the government’s chronic
budget deficits and the nation’s inflation in the 1970s.
By the end of the 1970s, there had been changed domestic and
external conditions. Domestically, there was rising domestic inflation
due to the government’s inflationary policy to finance the nation’s
industrialization over the 1970s. In the meantime, there was lack of
economic rationale of the heavy industrialization, as it was pursued
for national-security as well as economic reasons rather than based on
comparative advantage, over-concentration of economic power among
several major corporations and subsequent economic inequality. There
was also political instability following President Park’s assassination
in 1979. Externally, the worldwide recession following the oil crises
92 The Political Economy of East Asia

of the 1970s dealt a heavy blow to the South Korean economy. The
development of the heavy and chemical industries was based on the con-
sumption of huge amounts of energy, which was 100% imported from
abroad. As a result, with ever-growing heavy and chemical industries
South Korea became increasingly vulnerable to fluctuations in global
energy prices. Consequently, the impact of the oil crises of the 1970s
on the South Korean economy was devastating. The nation’s crude oil
import bill increased to the equivalent of 9.2% of GNP in 1980 from 2.2%
in 1972.14 In the meantime, South Korea was facing mounting pressure
of the developed countries from above and developing countries from
below. Whereas industrialized countries became increasingly protection-
ist against foreign products, including South Korean products, as a result
of their loss of comparative advantage in many traditional manufactur-
ing industries, developing countries, such as China and Southeast Asian
countries, began their rapid industrialization by specializing in the pro-
duction of low-skilled, labor-intensive goods, which challenged South
Korean products in these sectors.
Facing the new challenges under such concurrent changes in domestic
and external conditions, the government adjusted its economic policy
in the early 1980s to focus on price stability, balanced economic growth,
and market liberalization. In the meantime, the government conducted
structural readjustment of the heavy and chemical industries through
mergers, cancellation of some investment projects, and promotion
of product specialization in power-generating equipment, automobile
assembly, heavy electrical motors, electronic switchboard systems, diesel
engines for marine use, and copper smelting. To improve the compet-
itiveness of South Korea’s companies, the government started to retreat
from its previous practice of providing heavy and chemical industries
with preferential loans as a direct policy measure of support. While con-
tinuing to provide directions of growth, the government allowed market
forces to play a growingly important role. Investment was still encour-
aged in the heavy and chemical industries, but these industries were
no longer protected by the government’s import restrictions and tariffs.
As part of the government’s commitment to liberalization and interna-
tionalization, domestic markets were opened up to foreign goods and
services, and in 1986 the regulations that prohibited foreign invest-
ment in South Korea were removed. The tax exemption enjoyed by
these industries was ceased. In order to improve efficiency, the gov-
ernment promoted market competition and established a competitive
environment by enacting the Anti-Monopoly and Fair Trade Act in 1981,
which was aimed at eliminating market monopoly and preventing the
 The South Korean Political Economy Since 1945 93

concentration of economic power in a handful of large conglomerates.

An important measure to promote competition was to start the pro-
cess of liberalization during this period and reduction of tariffs. In the
meantime, the government began to encourage growth of small- and
medium-sized companies by offering them incentives to increase their
investment and marketing activities. In a similar fashion, the govern-
ment also made efforts to move industrial facilities into rural areas
to promote more equitable distribution of wealth between the urban
and the rural areas. The result of these policy measures was an overall
improvement in economic performance over the 1980s.
Entering the 1990s, the government’s policies aimed to transform
the nation’s economy and lay the groundwork for the reunification
of the Korean peninsula by stimulating technological and managerial
innovation, boosting R&D spending, increasing expenditure on social
infrastructure, and easing labor shortages. In the meantime, the gov-
ernment also promoted social development, which involved develop-
ing rural areas, improving social welfare, enhancing socio-economic
equity, expanding the nation’s housing stock, and curbing real estate
speculation.
In the process of industrialization, the South Korean government was
actively engaged in fiscal management to pursue its industrial policy.
The most important reform in fiscal management seemed to be the
establishment of the Office of National Tax Administration in 1966,
which thereafter became a powerful government body that supervised
business performance and steered businesses toward objectives of the
government’s industrial policy. In general, South Korea adopted a fiscal
policy that was characterized by restrained government expenditure, a
small public sector, a balanced budget, comparatively low taxes, liberal
use of tax incentives for investments, heavy reliance on indirect taxes,
increased public savings, small expenditures on social services (but rising
sharply in recent years), high expenditures on education, and the use of
significant resources for industrial development. The government adop-
ted various short-term policies to address such areas as aggregate demand
management, taxes, exchange rates, interest rates, preferential credit,
farm prices, and industrial promotion. These policies were usually ini-
tiated or designed by various relevant ministries, such as the Ministry of
Finance, the Central Bank, the Ministry of Agriculture and Fisheries, and
so on.
The South Korean government’s tax policy was designed not only
to mobilize resources for capital formation in the public sector but
also to encourage investments in the private sector. The South Korean
94 The Political Economy of East Asia

government applied various tax incentives to promote industrial

development and export growth. These tax incentives were particu-
larly provided for those heavy and chemical industries and export
industries. In general, investment-incentive policies were employed to
affect the sectoral allocation of investment resources. Through numer-
ous tax reforms in the process of industrialization, the government
provided businesses with increasingly favorable tax treatment, includ-
ing tax exemptions, investment tax credit, accelerated depreciation, and
continuously lowered tax rates.
Since the adoption of its first economic plan in 1962, the South Korean
government has pursued a systematic economic policy of export-led
growth. This was a highly logical policy for a country that lacked natural
resources and sizable domestic market. To promote exports, the govern-
ment set export targets for each sector and provided those companies
engaged in exports with various policy incentives including tax exemp-
tions, reduced public utility charges, low interest loans, tariff rebates
on imports for re-export, and simplified customs procedures for import
of raw materials to be processed for re-export. Companies that met or
exceeded the government-set targets would receive even more favorable
treatment, whereas companies that failed to meet their quotas would
face sanctions and tax investigations. Consequently, exports functioned
as the engine of South Korea’s economic growth and industrialization.
At the same time, the export structure of South Korea also substantially
transformed alongside its industrialization. During the 1960s, as the only
available resource South Korea possessed was huge, cheap, and skilled
labor force, the government adopted a strategy of promoting export of
labor-intensive light manufactured goods, which provided a sound eco-
nomic base from which South Korea could start to develop heavy and
chemical industries in the 1970s. Entering the 1980s and 1990s, South
Korea’s exports switched from labor-intensive products to capital- and
technology-intensive products.
South Korea’s trade policy was quite systematic. Its basic trade policy
was characterized by balanced expansion of external trade, diversific-
ation of foreign markets, development of brand names and product
image, and expansion of multilateral cooperation. As a nation that heav-
ily relied on foreign trade, South Korea pursued active trade diplomacy,
participating in multilateral trade negotiations under the framework of
GATT/WTO and holding regular talks with major trading partners such
as the United States, Japan, and more recently China.
A unique feature of the South Korean political economy was a long-
time mutually profitable relationship between the government and big
 The South Korean Political Economy Since 1945 95

business. As in Japan, the South Korean government dominated its

relationship with business, encouraged the development of a handful of
conglomerates, chaebol, through various policy incentives, and provided
a favorable environment for business. Especially, the government exerted
extensive influence on business activities by owning financial interme-
diaries and controlling access to foreign capital. But before and after
the government made decisions regarding policies and targets, busi-
ness leaders were usually consulted. On the other hand, the chaebol
gave their support to the government in return and seized the oppor-
tunities provided by the government. So it was the combined efforts
of the government and the private sector that produced South Korea’s
economic success. This government–business relationship was well sup-
ported by the cultural orientation of the Korean people, who have long
been psychologically oriented toward powerful leadership by an elite and
a centralized hierarchical bureaucracy. Under such an arrangement, the
South Korean economy was dominated by a handful of powerful chaebol,
which produced a wide range of goods for both export and domestic sale.
The chaebol therefore played a vital role in South Korea’s industrialization
and economic growth.
In summary, the South Korean government played a crucial role in
helping achieve the country’s economic success through adoption of an
outward-oriented development strategy, providing various incentives by
resorting to the market mechanism, supporting the big business groups,
and providing social and political stability through authoritarian rule.
Although the process of democratization, which started in 1987 with the
restoration of the multiparty political system following rising popular
demonstrations and pressure for democracy since the early 1980s, even-
tually led to the nation’s successful transition to democracy by 1992 with
the election of Kim Young-sam as the nation’s first civilian president fol-
lowing 32 years of military rule, the South Korean government, as a fully
functioning modern democracy, still maintains an active role in promot-
ing the national economy as was during the authoritarian period. In a
final analysis, such persistent influence of the state in the nation’s eco-
nomic development might probably be explained by some unique social
and cultural conditions of South Korea like a strong sense of national
identity, loyalty, collectivism, paternalism, and acceptance of authority.

5.3 The rise of the South Korean economy

At the end of the Korean War in 1953, South Korea inherited an eco-
nomy that had been devastated by the war, an impoverished population,
96 The Political Economy of East Asia

and a country that lacked resources. Furthermore, the division of the

peninsula along the 38th parallel had left most of the nation’s industry
and natural resources in the North, while the South possessed a backward
agrarian economy with agriculture, forestry, and fishing accounting for
47% of GNP and manufacturing for less than 9%.15 With such unfavor-
able economic and social conditions, together with a constant security
threat from the north, it seemed to be an extremely difficult task at the
time for South Korea to bring economic recovery and build a sound eco-
nomy. After over five decades of development, however, South Korea
has transformed dramatically from a small, stagnant agricultural subsist-
ence economy into a modern industrialized economy, achieving what is
called the “Miracle on the Han River.’’
In retrospect, there has been a clear trajectory of the rise of the South
Korean economy over the past five decades. During the first postwar
decade, South Korea remained locked in the so-called “vicious cycle’’ of
poverty. Although the reconstruction of the infrastructure and factor-
ies that had been destroyed in the war was completed by mid-1957,
the South Korean leaders failed to take effective measures timely to pro-
mote economic growth. In the meantime, the government adopted an
import-substitution industrial policy and made limited attempts to pro-
mote exports. As a result, the economic growth during 1953–61 was
quite modest with the average annual growth rate being 3.7% and the
average annual per capita GNP growth rate being 0.7%.16 Exports were
stagnant during this period, rising only from $39.6 million in 1953 to
$40.9 million in 1961, which was equivalent to no more than 1% of
GNP.17 Consequently, by 1962 the South Korean economy remained
largely agrarian, with about two-thirds of the population working in the
primary sector, per capita GNP being only $87, virtually no exports and
domestic savings, and a population growing at a faster rate than the eco-
nomy.18 As a result, South Korea lagged behind North Korea in terms of
per capita income and industrial production capacity.
The nation was put on the right track of fast economic growth only
after the establishment of a development-oriented military-influenced
authoritarian government under Park Chung-hee in 1962. Seeing the fail-
ure of the import-substitution development strategy adopted in the pre-
vious decade, the Park government switched to an export-oriented devel-
opment strategy that would promote such labor-intensive industries as
textiles, toys, footwear, and plywood for exports in which the nation
enjoyed comparative advantage. As a result, South Korea achieved rapid
economic growth after 1962 with the real growth rate rising from 2.1%
in 1962 to 13.8% in 1969, an average annual growth rate of 8.7%.
 The South Korean Political Economy Since 1945 97

The performance was even more impressive in terms of per capita GNP
growth, which rose from $87 in 1962 to $210 in 1969, an average annual
growth rate of 12.5%.19 The result of this rapid growth was the doubling
of the nation’s GNP. More significantly, the rapid economic growth was
accompanied by steady structural changes of the economy with the share
of the manufacturing sector rising from 16% of GNP in 1962 to 21% in
1970 while that of the primary sector declining from 37% to 26%.20 By
the early 1970s, the construction of the basic industries such as steel, fer-
tilizer, cement, oil refining, and electricity and the infrastructure such as
highways, harbors, and irrigations facilities had been either completed or
underway. As a result, South Korea had been well on the way from a tradi-
tional agriculture-based economy to a modern manufacturing-centered
economy.
It is particularly important to point out that much of the high eco-
nomic growth rate was attributed to the rapid growth of exports, which
increased from $54.8 million in 1962 to $658.3 million in 1969, an
average annual rate of 41.5%. In the meantime, imports also grew at
an average annual rate of 24.7%, rising from $390.1 million in 1962 to
$1650.0 million in 1969.21 Notably, there was a changing structure of
exports, which represented the resonance of the transformation of the
nation’s economic structure. Initially, South Korea’s exports consisted
only of low-skilled, labor-intensive products such as wigs, plywood, foot-
wear, toys, and low-quality textiles. By the end of the 1960s, however,
they diversified into higher-skilled, labor-intensive goods such as electric
products. The remarkable performance in export growth brought huge
amount of foreign exchange earnings, contributed to the high economic
growth and helped accelerate industrialization.
Moreover, the rapid economic growth during this period also benefited
from huge investment, most of which was financed by foreign capital,
as the domestic savings rate remained well below the investment rate. As
such, the government encouraged private companies to borrow foreign
loans from international commercial banks and provided guarantees on
foreign borrowings under the Foreign Capital Inducement Act of 1966.
In the early 1970s, South Korea experienced changed domestic and
international economic conditions. Domestically, the rapid economic
expansion of the 1960s led to a growing shortage of skilled workers,
which, together with soaring inflation, caused a rapid rise of real wages.
While its competitive advantage was eroding in many labor-intensive
export industries as a result of the rising labor costs, South Korea faced
growing competition from a number of other East and Southeast Asian
developing economies, particularly Taiwan and Singapore. Moreover,
98 The Political Economy of East Asia

South Korean exports also encountered a worsening market condition

resulted from rising protectionism in the world economy and the world-
wide stagflation triggered by the first oil crisis. Facing the loss of its
competitive advantage in export-oriented light industries, the South
Korean government timely pushed for strategic restructuring of its eco-
nomy and establishing a new niche in the world economy by promoting
heavy and chemical industries, including shipbuilding, iron and steel,
automobiles, machinery, petrochemicals, and electronics.22 As a result,
the share of heavy and chemical products expanded from 12.8% of total
exports in 1970 to 38.5% in 1979, while the share of primary products
dropping from 17.5% to 10.1%, and light industry products from 69.7%
to 51.4%. With the successful transformation of heavy and chemical
industries into new export sectors, South Korea continued to maintain
rapid export growth at an annual rate of about 40% throughout the
1970s with the total amount of exports rising from less than $1 bil-
lion in 1970 to $15 billion in 1979. In the meantime, South Korea also
promoted construction and manufacturing exports to the oil produ-
cing countries in the Middle East. Particularly, the construction orders
from the Middle East amounted to $3.4 billion in 1977, $8 billion in
1978, and $6 billion in 1979 respectively, as compared to $0.8 billion
in 1975, which not only helped improve the domestic employment but
also brought a new source of foreign exchange earnings. The rapid export
growth in turn contributed to a continuing high economic growth rate,
which was averaged at 8.6% per year throughout the 1970s. Equally
impressive, per capital GNP jumped from $243 in 1970 to $1636 in
1979.23 As a result, South Korea emerged by the end of the 1970s as
one of the four NIEs in the region, along with Taiwan, Singapore, and
Hong Kong.
However, the process of South Korea’s industrialization during the
1960s–70s was accompanied by chronic inflation, piling-up of foreign
debt, and persistent huge trade and current account deficits. These prob-
lems, together with the effects of the assassination of President Park
Chung-hee (October 1979), the second oil crisis and a disastrous harvest,
finally brought a heavy blow on the South Korean economy, turning its
growth rate into the first ever-negative figure of 2.1% in 1980. Under such
circumstances, the post-Park Chun-hee government undertook a series
of structural adjustment measures to streamline the economy. The policy
adjustment measures, added by low oil prices, low international interest
rates and low exchange rates of the won, paved the way for resumed rapid
economic growth in the 1980s, averaging at 7.5% per year. Especially,
economic growth was accelerated at a spectacular rate after 1986 with
 The South Korean Political Economy Since 1945 99

the growth rate of 1987 reaching 13.0%, one of the highest growth rates
in the world. Accordingly, per capita GNP increased from $1598 in 1980
to $5185 in 1989, an average annual increase rate of 12.2%. Particularly
significant, in 1986 South Korea achieved its first substantial trade and
current account surpluses in its 38-year history of the Republic.24 In the
meantime, the domestic savings rate also increased from 24.4% in 1980
to 37.6% in 1989, exceeding the domestic investment rate. As a result,
investment was increasingly financed by domestic funds.25
Starting in the early 1990s, South Korea entered a new stage of devel-
opment through improving product quality, upgrading technology, and
producing high-tech, high value-added goods. Propelled by export of
high-tech, high value-added products, such as semiconductors, electron-
ics, and automobiles, South Korea’s economic growth continued in the
1990s. During the period 1990–96, the nation maintained an average
annual growth rate of 7.6%, which helped increase per capita GNP from
$5886 in 1990 to $12,197 in 1996. After experiencing the worst con-
sequences of the financial crisis in 1997–98, during which the economy
grew at a reduced rate of 4.7% in 1997 but shrank by 6.9% in 1998, the
nation soon recovered and regained economic growth by 9.5% in 1999
and 8.5% in 2000 respectively.26 As a result, South Korea still achieved
an average annual growth rate of 5.7% between 1990 and 2000.27
As in the previous two decades, the remarkable performance of the
South Korean economy during the 1980s–90s was well reflected in the
nation’s export performance. South Korean exports rose tenfold from
$17.4 billion in 1980 to $171.8 billion in 2000.28 According to United
Nations Conference on Trade and Development (UNCTAD), the nation’s
overall world market share increased from 1.5% to 2.5% between 1985
and 2000. Most importantly, South Korea’s export success during this
period was largely based on high- and medium-technology exports with
the exports of high-tech products jumping from 14% to 38% and the
exports of medium-tech products rising from 22% to 29%. Its five
high-tech exports (semiconductors, computers and parts and accessories,
telecom equipment, and electrical machinery and apparatus) accounted
for over one-third of all exports. Moreover, passenger cars represen-
ted another significant export item. In the meantime, South Korea also
improved its market share in products based on natural resources. Con-
sequently, South Korea increased its market share in all ten of the
principal export products, seven of which are dynamic in world trade
(Table 5.1).29
The rapid economic growth of the 1980s–90s also benefited from accel-
erating FDI inflows during these two decades, which helped bring foreign
100 The Political Economy of East Asia

capital, technology, know-how and access to the global market. FDI

inflows remained insignificant until the mid-1980s due to the restrictive
foreign investment policy imposed by the government. After the liberal-
ization of foreign investment was initiated in the mid-1980s, there was
rapid rise of FDI inflows into the country. The average annual FDI inflows

Table 5.1 The Republic of Korea’s Competitiveness in the World Market,

1985–2000

Product Category 1985 1990 1995 2000

Market shares 1.5 1.9 2.2 2.5

Primary productsa 0.3 0.5 0.5 0.4
Manufactures based on natural 0.7 0.8 1.2 2.0
resourcesb
Manufactures not based on 2.3 2.6 2.9 3.2
natural resourcesc
Low technologyd 5.0 4.7 3.0 2.8
Medium technologye 1.1 1.6 2.2 2.5
High technologyf 1.8 2.5 3.8 4.2
Othersg 0.5 0.7 1.4 1.2
Export structure 100.0 100.0 100.0 100.0
Primary productsa 4.8 3.2 1.9 1.7
Manufactures based on natural 9.3 7.4 9.1 12.0
resourcesb
Manufactures not based on 84.7 88.0 86.7 84.4
natural resourcesc
Low technologyd 48.7 41.7 22.5 16.9
Medium technologye 21.7 25.9 31.3 29.2
High technologyf 14.4 20.5 32.9 38.4
Othersg 1.1 1.3 2.2 1.8
10 Principal exports (SITC A (h) B (i) 21.6 28.0 47.0 54.3
Rev.2)
776 Thermionic valves ∗ + 4.8 7.3 16.7 16.4
and tubes and other
semiconductors, n.e.s.
752 Automatic data processing ∗ + 0.9 3.4 3.4 6.8
machines, units thereof
781 Passenger motor cars (excl. ∗ + 1.4 3.1 5.1 6.8
public service type)
764 Telecommunications ∗ + 3.2 3.4 3.8 6.6
equipment, n.e.s.
334 Petroleum products, + 2.1 0.5 1.8 4.3
refined
759 Parts, n.e.s., of and ∗ + 0.7 1.1 3.4 3.7
accessories for 751 and 752j
 The South Korean Political Economy Since 1945 101

583 Polymerization and ∗ + 0.7 1.2 2.9 3.1

copolymerization products
653 Fabrics, woven, of man-made + 4.0 4.4 5.0 2.5
fibers
674 Universals, plates and sheets, + 2.7 2.3 2.3 2.5
of iron or steel
778 Electrical machinery and ∗ + 1.2 1.3 2.4 1.7
apparatus, n.e.s.

Source: UNCTAD, World Investment Report 2002: Transnational Corporations and Export Compet-
itiveness (New York: United Nations, 2002), Table VI.16, p. 177.
Notes: a Contains 45 basic products that are simple to process, includes concentrates.
b Contains 65 items: 35 agricultural/forestry groups and 30 others (mainly metals, excluding

steel, plus petroleum products, cement, glass, etc.)

c Contains 120 groups representing the sum of low, medium, and high technology.
d Contains 44 items: 20 groups from the textile and garment category, plus 24 others (paper

products, glass and steel, jewellery).

e Contains 58 items: 5 groups from the automotive industry, 22 from the processing industry,

and 31 from the engineering industry.

f Contains 18 items: 11 groups from the electronics category, plus another 7 (pharmaceutical

products, turbines, aircraft, optical and measuring instruments).

g Contains 9 unclassified groups.
h Groups (∗ ) belonging to the 50 most dynamic in world imports, 1985–2000.
i Groups in which South Korea gained (+) world market share, 1985–2000.
j 751 refers to office machines; 752 refers to automatic data processing machines and units

thereof.

increased from $105 million in the 1970s and $133 million in 1981–85
to $676 million in 1986–90. Entering the 1990s, FDI inflows increased
even more rapidly, particularly after the mid-1990s. By 1999, the nation
received $9.4 billion FDI, which was followed by $8.6 billion in 2000.
While the annual FDI inflows dropped to around $3.0–$3.8 billion in
2001–03, it jumped again to $7.7 billion in 2004 (Table 5.2). Accord-
ingly, the stock of FDI inflows increased from $1.3 billion in 1980 to
$5.2 billion in 1990, $37.2 billion in 2000, and $55.3 billion in 2004.30
These FDI inflows helped to contribute to the country’s export growth,

Table 5.2 South Korea: FDI Inflows, 1971–2004 ($ millions)

1971–75 1976–80 1981–85 1986–90 1991 1992 1993 1994 1995

550 495 665 3382 1130 563 539 788 1250
1996 1997 1998 1999 2000 2001 2002 2003 2004
2012 2640 5040 9448 8591 3692 2975 3785 7687

Source: UNCTAD, Key Data from WIR (World Investment Report)

t Annex Tables,
http://www.unctad.org, accessed on 18 February 2006.
102 The Political Economy of East Asia

particularly in the 1990s, although South Korean chaebol are responsible

for the bulk of the country’s exports.
The economic success of South Korea is indeed very remarkable.
While the nation’s GDP expanded from about $2 billion to $688 bil-
lion between 1962 and 2004, per capita GNI rose from $87 to $14,162
during the same period.31 Especially noticeable, today South Korea has
far surpassed North Korea in every aspect of the economy with its GDP
almost 40 times and per capita GNP almost 20 times those of North
Korea.32 More significantly, South Korea has followed a clear path of
upward movement along the ladder of economic development with the
nation’s economic structure undergoing a dramatic transformation. For
the past four decades, the manufacturing sector has been the focus of
development and the primary source of growth. During the 1960s, the
government promoted the development of export-oriented light indus-
tries such as textiles, toys, and footwear. Entering the 1970s, due to
increasing labor costs and competition from other developing coun-
tries, the South Korean government shifted its attention to the growth
of heavy and chemical industries such as shipbuilding, iron and steel,
automobiles, machinery, petrochemicals, and electronics. During the
1980s–90s, the government focused on the development of technology-
and capital-intensive industries, including electronics, semiconductors,
automobiles, and machines. As a result, between 1960 and 2003 the share
of the manufacturing sector in the economy rose from 14% to 23%, while
the agricultural sector falling from 37% to 3%.33 In this process, South
Korea has transformed from a mere assembler of a range of manufactur-
ing products under contract with Western and Japanese transnational
corporations (TNCs) to a major player in its own right that designs and
develops its indigenous brands and models.
By the early 21st century, South Korea has emerged as an economic
power in the world economy. In 2003, for example, with 0.8% of the
world population, South Korea produced 1.7% of world GDP and ranked
11th in the world in terms of the economic size, ahead of Australia,
Netherlands, and Russia. In the meantime, South Korea was the 12th
largest export nation as well as the 12th largest trading nation.34 Fur-
thermore, the nation established a strong presence in a range of key
industrial sectors, including automobiles, shipbuilding, iron and steel,
electronics, petrochemicals, machinery, and construction. By the early
21st century, South Korea was the fifth largest producer of passenger
cars after the United States, Japan, Germany, and France (2001); the
second largest shipbuilding nation next only to Japan (2001), includ-
ing both tankers and other sea-going merchant vessels; the ninth
 The South Korean Political Economy Since 1945 103

largest iron and steel producing country (2001); the third largest TV
set producer after China and Malaysia (2001); the fifth largest cement
producer (2000); the fourth largest producer of household-use refriger-
ators (2000); and the fifth largest producer of household-use washing
machines (2000).35 Moreover, South Korea was also the second largest
memory chip and the third largest semiconductor producer in the
world.36
In projecting the nation’s growing economic might, South Korean
chaebol have played a crucial role. These large business conglomerates,
supported by the government, are involved in a variety of business
activities, ranging from heavy and chemical industries to high-tech
and services industries. Leading chaebol include Samsung, LG, Hyundai,
Daiwoo, and SK. They are actively engaged in the production and export
of a wide range of products through their affiliated companies. Accord-
ing to UNCTAD, three South Korean companies were among the top
50 nonfinancial TNCs from developing countries in 2003, of which
Samsung Electronics Co., Ltd. ranked the 4th, LG Electronics Inc. the
9th, and Hyundai Motor Company the 35th. Samsung Electronics Co.,
Ltd. was also among the world’s top 100 TNCs.37 Actually, chaebol are the
driving force behind the rapid export-led growth of the South Korean
economy.
In parallel with the growing economic power of South Korea and the
rise of chaebol is the acceleration of South Korea’s outward FDI. South
Korean FDI did not become important until the mid-1980s. After South
Korea achieved its first significant current account surplus in 1986, its
outward FDI began to accelerate, jumping from $124 million in the
period 1971–80, $972 million in 1981–85 to $4.0 billion in 1986–90.
Entering the 1990s, there was a surge of South Korean FDI outflows,
reaching its annual peak of $5.0 billion in 2000 (Table 5.3). Accordingly,
the nation’s accumulated FDI outflows rose from $127 million in 1980 to
$2.3 billion in 1990, $26.8 billion in 2000, $39.3 billion in 2004.38 Today,

Table 5.3 South Korea: FDI Outflows, 1971–2004 ($ millions)

1971–80 1981–85 1986 1987 1988 1989 1990 1991 1992 1993 1994
124 972 1227 515 643 598 1052 1489 1162 1340 2461
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004
3552 4670 4449 4740 4198 4999 2420 2617 3426 4792

Source: UNCTAD, Key Data from WIR (World Investment Report)

t Annex Tables,
http://www.unctad.org, accessed on 18 February 2006.
104 The Political Economy of East Asia

South Korea is the fourth largest outward FDI nation among developing
economies, after Hong Kong, Singapore, and Taiwan.
In terms of sectoral distribution, the share of South Korean FDI that
went to exploit natural resources in developing countries decreased from
the mid-1980s onwards, while manufacturing FDI increased in import-
ance. By the end of 1998, 52.0% of South Korea’s total accumulated FDI
outflows had been in the secondary sector, 6.9% in the primary sector,
and 41.1% in the tertiary sector. In terms of geographical destination,
45.9% of the South Korean outward FDI had been in Asia, 28.3% in North
America, 10.0% in Western Europe, and 15.8% in the rest of the world.
By 1998, South Korean TNCs had established a total of 8450 overseas
affiliates, of which 66.6% (5631) was in the secondary sector, 3.2% (266)
in the primary sector, and 30.2% (2553) in the tertiary sector. In terms of
geographical distribution, 1243 South Korean overseas affiliates (14.7%)
were in North America, 278 (3.3%) in Western Europe, 6027 (71.3%)
in Asia, and the remaining 902 (10.7%) were in the rest of the world.39
By investing abroad, South Korean companies are primarily motivated
by obtaining cost advantages through relocating industries, overcoming
trade barriers in other countries, gaining access to new markets and high
technology, and obtain competitiveness over domestic rivals.40
Probably, the rise of the South Korean economy is most illustrat-
ively reflected in Seoul’s accession to OECD in 1996, by which the
economic might of South Korea was formally recognized by Western
powers. Hence, South Korea, following the steps of Japan ahead of it,
became the second Asian country that was admitted to this rich coun-
tries’ club. In 2004, South Korea joined the trillion-dollar club of world
economies.
As economic development continued, there were increasing calls for
political reform and democratic developments to match the economic
gains. The 1987 presidential election, a direct popular election, was a big
step toward a more democratic system of government, which led to the
first peaceful transfer of power in the history of the Republic in 1988.
The presidential election of 1992 saw the election of the first civilian
leader in three decades in South Korea, which led to the nation’s success-
ful transition to democracy. Since then, democracy has been gradually
consolidated in South Korea.

5.4 South Korea’s transformed regional economic relations

In the process of the rise of the South Korean economy, the nation’s eco-
nomic relations with major neighboring countries evolved in the postwar
 The South Korean Political Economy Since 1945 105

years, reflecting changing international, regional, and domestic condi-

tions. For over a decade after the Korean War, South Korea’s economic
exchanges with the neighboring economies in East Asia were quite lim-
ited. Particularly, the Cold War prevented South Korea from establishing
economic as well as political contact with China and other communist
states in the region. On the other hand, Seoul’s historical animosity and
political distrust of the Japanese blocked development of economic ties
with Japan. It was the normalization of South Korean–Japanese diplo-
matic relations in 1965 that finally paved the way for the reestablishment
of economic ties between these two countries. Thereafter, South Korea’s
regional economic relations primarily focused on Japan. Although the
bilateral political relations between Seoul and Tokyo continued to be
shadowed by the Koreans’ persisting bitterness and bad feeling against
the Japanese harsh colonial rule in 1910–45, the bilateral economic rela-
tions experienced very rapid development. Mimicking the structure of
bilateral economic relationship during the Japanese colonial era, the
post-1965 economic ties between South Korea and Japan assumed a sim-
ilar one-sided pattern, under which Japan provided South Korea with
ODA, investment and technology while South Korea exported their
products to the Japanese market. As a consequence, the Japanese ODA,
investment, technology and market played an important role in the
economic success of South Korea.
The close economic ties between South Korea and Japan in the post-
war years were initially reestablished on the basis of Japanese aid to
South Korea. As part of the deal for normalization of bilateral relations
in 1965, Japan paid South Korea $300 million as an indemnity for the
harm incurred on the Koreans under Japan’s 35 years of colonial rule
before World War II. In the meantime, Japan further provided $200 mil-
lion in long-term low interest government loans and $300 million in
commercial loans in assistance of South Korea’s economic development
over a period of 10 years. The result of this arrangement was sizable
financial flows from Japan to South Korea after 1965. The Japanese
grants were used by South Korea to purchase Japanese equipment for
developing marine and agricultural sectors, textile, steel, and machinery
industries, while the Japanese government loans were used for the con-
struction of railways, motorways, and dams. In 1971, Japan extended
new aid to South Korea, which amounted to 107 billion yen in grants
and 317 billion yen in loans over a period up to 1980. In a 1983 agree-
ment on aid, Japan further promised to provide $4 billion for the period
1982–89, which was divided into $1.85 billion yen-denominated ODA
loans, $350 million yen bank loans, and $1.8 billion Export-Import Bank
106 The Political Economy of East Asia

dollar-denominated loans. Japanese ODA loans were used by South Korea

for the construction of modern urban infrastructure and for programs of
agricultural and marine research. By the early 1990s, as a well-established
mature economy, South Korea had ceased to receive Japanese aid. There-
after, the focus of bilateral interest shifted to investment and technology
transfer.41
Alongside Japanese aid was the rising Japanese investment in South
Korea after the mid-1960s, which led Japan to become a major investor
in the country. During the period 1965–70, the Japanese FDI accounted
for 33.3% of total amount of FDI inflows in South Korea. The Japan-
ese share rose to 61.6% in the period 1971–80 but dropped slightly to
49.5% in 1981–85. After the mid-1980s when the South Korean govern-
ment relaxed its FDI policy and the appreciation of the yen as a result of
the Plaza Accord, the Japanese share remained high until 1989, when it
began to decline. According to South Korean statistics, Japanese invest-
ment in South Korea mainly focused on the production of components
and intermediate goods and on export production for third markets.
With rising labor costs and deteriorating labor relations in South Korea,
however, Japanese companies began to look elsewhere for production
sites in the late 1980s, particularly in China and Southeast Asia. Con-
sequently, entering the 1990s, Japanese FDI to South Korea began to
decline (Table 5.4).
As South Korea’s major investor and source of imports, Japan also
quickly became a principal supplier of foreign technology and capital
goods to South Korea. From 1962 to June 1991, for example, South
Korea imported 3683 Japanese technologies (51% of the total imported
technologies), which were valued at $1.5 billion (31% of the total).42
Trade played a most important role in South Korean–Japanese eco-
nomic relations after 1965. Before the normalization of diplomatic
relations, bilateral trade was extremely limited between the two countries
with the total trade volume standing at only $211 million in 1965. By
1970, however, the volume of South Korean–Japanese trade had grown
to $1.4 billion. By 1980, the figure had jumped to $8.9 billion.43 Despite
some stagnation in the early 1980s, trade between the two countries rose
rapidly again after the mid-1980s, which reached $31.2 billion in 1990,
$49.7 billion in 1995, $52.3 billion in 2000, and $67.8 billion in 2004.44
Especially, it is important to note that South Korean–Japanese trade rela-
tions after 1965 were part of a trade triangle among the United States,
Japan, and South Korea. Over time, Japan replaced the United States as
South Korea’s main source of imports and the United States replaced
Japan as its main export market. Consequently, with the exception of
 The South Korean Political Economy Since 1945 107

Table 5.4 South Korea’s FDI Inflows by Geographical Origin, 1965–2003 (% of

Total)

Japan USA Western Europe-5∗ Others

1965–70 33.3 46.1 8.7 11.9

1971–80 61.6 21.7 7.4 9.3
1981–85 49.5 32.9 8.8 8.8
1986 39.1 35.3 16.1 9.5
1987 46.7 23.4 19.6 10.3
1988 54.3 22.2 17.1 6.4
1989 42.7 29.3 18.4 9.6
1990 29.3 39.6 23.0 8.1
1991 16.2 21.2 56.5 6.1
1992 17.3 42.4 28.4 11.9
1993 27.4 32.6 27.3 12.7
1994 32.5 23.6 16.7 27.2
1995 21.8 33.0 17.8 27.4
1996 8.0 27.3 19.7 45.0
1997 3.8 45.8 28.7 21.7
1998 5.7 33.6 29.5 31.2
1999 11.3 24.1 36.4 28.2
2000 16.1 19.2 26.8 37.9
2001 6.9 34.4 23.0 35.7
2002 15.4 49.4 10.9 24.3
2003 8.4 19.2 24.3 48.1

Source: Calculated from National Statistical Office (Republic of Korea), statistical database
(KOSIS), http://www.nso.go.kr, accessed on 19 February 2006.
∗ Western Europe-5 refers to UK, Germany, France, Netherlands, and Switzerland.

1983, the United States was South Korea’s largest export market until
2003, when it was replaced by China, while Japan often well behind the
United States. On the other hand, with the exception of 1982–83, Japan
maintained its position as South Korea’s leading source of imports while
the United States in the second place until 2004, when China overtook
it as the second largest source of South Korea’s imports.
A significant feature of South Korean–Japanese trade is a bilateral trade
structure that produced substantial bilateral trade imbalance that was
constantly in favor of Japan. Under this trade structure, South Korea
predominantly exported low value-added and labor-intensive industrial
products such as textiles, and agricultural and fishery products to Japan,
but imported high value-added Japanese capital goods and technology.
Although the specific goods that flowed between the two countries
changed over time, this structure remained basically unchanged. For
example, during the 1960s–70s, South Korea imported textile machinery
108 The Political Economy of East Asia

and synthetic fibers from Japan and exported textiles mostly to the
United States and secondly to Japan. After South Korea moved into ship-
building in the 1970s–80s, the nation began to import steel, engines,
and heavy electrical machinery from Japan. During the 1980s–90s, South
Korea’s electrical and electronic consumer goods and chemical goods
relied heavily on Japanese components and assembly-line equipment.
Consequently, the process of upward movement of South Korea’s indus-
tries along the technological ladder was accompanied by the import
of relevant equipment and components from Japan. This trade pattern
reflected South Korea’s heavy dependence on Japanese components and
intermediate parts as well as Japanese technology and know-how for the
nation’s industrial development. In many sectors, the introduction of
technology from Japan brought in complete Japanese factory lines and
production systems that relied on imported Japanese components and
intermediate materials. Although the South Korean government attemp-
ted to reduce their trade deficit with and their import dependence on
Japan, their concerted efforts to obtain Japanese technology (by implica-
tion, creating their technological dependence on Japan) actually helped
to aggravate rather than improve trade balance and increase rather than
reduce dependence on Japanese technology.
South Korea’s trade dependence on Japan was reflected not only in the
trade structure but also in the share of its trade with Japan. For example,
trade with Japan accounted for 19.7% of South Korea’s total trade in
1985. By comparison, trade with South Korea represented only 3.7% of
Japan’s total trade for the same year. South Korea’s trade with Japan
remained around 20–25% of its total trade until the mid-1990s before
it began to decrease to around 15%. On the other hand, Japan’s trade
with South Korea maintained about 4–6% of its total trade during the
1990s through the early 21st century.45 South Korea’s trade dependence
on Japan was even more pronounced with respect to imports, which
accounted to 34.3% of South Korea’s imports in 1986. Although this
dependence decreased in the following years due to South Korea’s efforts
to reduce its trade deficits with Japan, it still stood at 20.6% of its total
imports for 2004.46
The trade deficit with Japan has regularly accounted for the lion’s share
of South Korea’s total trade deficits. In 1991, for example, South Korea’s
trade deficit with Japan reached 8.8 billion, equivalent to 91.7% of South
Korea’s total trade deficit of $9.6 billion for that year. In 1995 and 1996,
South Korea’s trade deficit with Japan reached $15.5 billion and $15.7 bil-
lion respectively, which were even larger than the nation’s overall trade
deficits for these 2 years ($9.8 billion for 1995 and $12.7 billion for 1996).
 The South Korean Political Economy Since 1945 109

By 2004, South Korea’s trade deficit with Japan reached a peak of $24.4
billion.47 The persistent trade imbalance with Japan and Tokyo’s reluct-
ance to further open its markets to South Korean goods or to provide the
advanced technology needed by South Korean manufacturers turned to
be a constant source of frictions between the two countries.
On the other hand, however, with successful industrialization, which
was greatly based on Japanese technology and components, South
Korea also became increasingly in competition with Japan in global
markets for significant market shares for its ever-growing industrial capa-
cities. Over time, the South Koreans followed the Japanese into the
US market and other markets by offering a similar mix of products
and trying to undercut Japanese products. This competition started in
cutlery and textile goods in the 1960s and thereafter involved an ever-
increasing list of products such as ocean vessels, steel, electronics, and
cars.
In the course of rising economic power, South Korea achieved remark-
able success in exporting to overseas markets and significant trade
surpluses. This led to increasing economic frictions with major developed
countries, the United States in particular. As a result, South Korean
exports increasingly faced trade barriers and protectionist measures in
the United States and other Western developed countries. Particularly,
Washington criticized South Korea for not making enough progress in
economic liberalization, lack of enforcement of copyright and patent
protection, the existence of a number of non-tariff barriers (such as
overstrict testing and quarantine procedures for imported goods), and
restrictions on foreign access to South Korea’s financial, telecommunic-
ations, distribution, and service industries. On the other hand, there was
also mounting economic conflict with Japan. Under such circumstances,
South Korea began to seek diversification of its foreign economic rela-
tions so as to rectify its dependence on the United States and Japan. It
was within this context that Seoul modified its foreign policy by adopting
the “northern policy’’ in the late 1980s and early 1990s. While political
considerations of reaching rapprochement with communist giants and
stabilizing its relations with North Korea were well behind this policy
change, Seoul’s intention to diversify its economic relations was appar-
ently an important factor for the adoption of the new foreign policy. As
a result, the early 1990s saw a dramatic change in Seoul’s foreign policy
from a strong anti-communist posture in the 1960s to the normaliza-
tion of diplomatic relations with the Soviet Union in 1990 and with
China in 1992. The improved relations with the two communist giants
not only helped greatly increase Seoul’s status in the international arena,
110 The Political Economy of East Asia

but also broadened its external economic space. In this process, China
was especially an important target of Seoul’s efforts to diversify its foreign
economic relations.
For political reasons, South Korea and China were completely closed
of each other both politically and economically for over four decades
during the Cold War era. However, the establishment of diplomatic
relations in 1992 paved the way for rapid expansion of economic ties
between the two countries. The highly complementary economic struc-
tures of the two countries provided a strong impetus for accelerating
bilateral economic relations. Moreover, the geographic proximity, shared
cultural background, similar security and trade interests and common
experience with the Japanese provided additional favorable conditions
for the rapid development of bilateral economic relations. Especially,
the huge Chinese market as a result of China’s rapid economic growth
became increasingly important for South Korea’s economic growth and
future.
The rapid expansion of South Korean–Chinese economic ties since
1992 was most phenomenally illustrated by the rapid growth of bilat-
eral trade, which jumped by 18 times from $4.4 billion in 1991 to
$79.3 billion in 2004. By 2004, China had surpassed the United States
as South Korea’s largest trading partner. In this process, the share of
South Korean exports to China out of the nation’s total exports increased
from 1.4% in 1991 to 19.7% in 2004, while the share of South Korea’s
imports from China rose from 4.2% of the country’s total imports to
13.2% during the same period. Particularly significant, China surpassed
Japan to become South Korea’s second largest export market in 2001,
and subsequently overtook the United States in 2003 to become the
largest market for South Korean exports and remained so in 2004. Most
importantly for the South Korean economy, the nation has enjoyed per-
sistently expanding trade surplus with China since 1993. In 2004, South
Korea’s trade surplus with China reached a record of $20.2 billion, which
accounted for 70.4% of the nation’s total trade surplus ($28.7 billion) for
the year.48
The pattern of South Korean–Chinese trade reflected the complement-
arity of economic structures of the two countries. On the one hand, South
Korea mainly exported to China such industrial intermediate goods as
electrical machinery, nuclear reactors and boilers, plastics, petrochem-
ical products, and iron and steel. On the other hand, South Korea’s
imports from China underwent structural change over time, reflecting
the rapid industrialization of the Chinese economy. As a result, the share
of South Korea’s import of raw materials from China decreased from
 The South Korean Political Economy Since 1945 111

67.8% to 37.4% in the period 1995–2003, while the share of capital

goods increased significantly from 8.1% to 33.4%, and the share of
consumption goods increased slightly from 24.2% to 29.2%.49
The rapid expansion of South Korean–Chinese economic ties was also
reflected in the rising flows of FDI from South Korea to China. South
Korean companies began to invest in China in the late 1980s. However,
the initial South Korean investment in China was small and explorat-
ory in nature. It was only after the establishment of diplomatic relations
between the two countries in 1992 that there was rapid rise of South
Korean investment in China. Notably, the investment protection treaty
that was signed between Seoul and Beijing soon after the establish-
ment of diplomatic relations in 1992 paved the way for the subsequent
mounting of South Korean investment in China. According to South
Korean statistics, South Korean FDI to China experienced the first wave
of rapid increase in the period 1992–96, from $6.4 million in 1989 to
$141.1 million in 1992 and $901.2 million in 1996. As a result, after
1994 China became the second favorite investment destination of South
Korean companies after the United States. South Korean FDI to China
subsided significantly after 1997 due to the devastating financial crisis.
As the South Korean economy began to recover from the financial crisis,
South Korean FDI to China started to show resurgence in 2000, increas-
ing by 75.8% from the previous year. In 2003, China overtook the United
States as the largest destination of South Korean FDI, receiving an annual
amount of $1.3 billion, which accounted for 37.1% of total South Korean
FDI for the year. In the meantime, the number of South Korean projects
in China reached 1757 in 2003, which accounted for 59.7% of the total
number of South Korean foreign investment projects for the year. As a
result, the cumulative South Korean FDI in China reached $8.0 billion
by the end of 2003, which represented 18.0% of total South Korean FDI
outflows, while the cumulative number of South Korean FDI projects
in China rose to 9075, which was equivalent to 46.0% of the total num-
ber of South Korea’s overseas investment projects.50 In the process, South
Korea’s giant companies such as LG, SK, Hyundai, and Samsung, together
with small- and medium-sized enterprises (SMEs), increased their invest-
ment, taking advantage of low labor costs in China. According to Lee
Chang-kyu, South Korean FDI to China contributed to increasing South
Korean exports to China because South Korean affiliates in China impor-
ted large amounts of intermediate goods and components from the
home country. According to a survey study conducted by the Korea
International Trade Association (KITA), South Korean FDI in China was
estimated to create a trade surplus of $3.46 billion, which accounted for
112 The Political Economy of East Asia

54.5% of South Korea’s actual trade surplus with China in 2002. Cheap
goods manufactured by South Korean (or joint venture) companies in
China were mostly exported to third countries such as the United States
and Japan, while some of these goods were also exported to and take a
sizeable market share back in South Korea. As such, South Korean FDI
in China served as a main channel for bilateral trade between the two
countries.51
As a result of expanding economic ties with China for over a decade,
South Korea’s previous excessive partner concentration in the United
States and Japan substantially transformed by the early 21st century.
While the relative share of US and Japanese markets was on the decline,
China became a significant market for South Korean exports. Dur-
ing the period 1986–2004, while the US share of South Korea’s total
exports drastically decreased from 40.0% to 17.0% and the Japanese
share dropped from 15.6% to 8.6%, the Chinese share rose from almost
none to 19.7%, which made China the largest market for South Korea.52
In the meantime, South Korean FDI flows to China helped restructur-
ing of the South Korean economy into a more technology-intensive and
high value-added industries. The growing importance of China for the
South Korean economy was also reflected in a “China boom’’ that South
Korea is currently experiencing. A growing number of South Koreans are
studying the Chinese language and traveling to China, and public opin-
ion polls show that a growing number of South Koreans have favorable
views of China, which is in contrast of a sharp decline in favorable views
of the United States and Japan. These developments will inevitably bring
substantial impact on the political economy of East Asia.

5.5 The South Korean economy rebounding from the Asian

financial crisis

Entering the 1990s, while continuing to achieve rapid, although reduced,

economic growth, the South Korean economy suffered major setbacks
again as a result of rising production costs, increasing protectionism in
key export markets, and fierce competition from developing countries.
Domestically, the democratic reform in 1987 led to the free formation
of autonomous trade unions for the first time in the nation’s history.
As a result, the increased collective bargaining power of South Korean
workers led to rapid wage increases that far exceeded the increase in
productivity. In the meantime, the prolonged and sometimes violent
labor disputes affected both South Korea’s production and exports. On
 The South Korean Political Economy Since 1945 113

the other hand, the rapid appreciation of the won against major cur-
rencies further weakened the competitiveness of South Korean exports.
Consequently, under the combined effect of wage increases and cur-
rency appreciation, South Korean exports lost their competitiveness in
the global market. While South Korean products became unable to com-
pete with the products of other East and Southeast Asian economies on
price in the lower end of the market, they were not yet in a position
to challenge Japanese products on quality at the top end of the market.
In the meantime, the liberalization of domestic markets in the 1980s
brought a surge in imports of both capital and consumer goods.
As a consequence, the nation’s current account balance turned into
deficit from 1990 onward. Especially, the 1996 current account deficit
reached $23.1 billion, equivalent to 4.1% of GDP. Total foreign debt also
widened from $29.4 billion at the end of 1989 to $104.7 billion at the end
of 1996.53 On the eve of the Asian financial crisis in June 1997, the total
foreign debt amounted to $116.7 billion, of which $67.8 billion (58.1%
of the total debt) was short-term debt.54 Notably, from the beginning of
1997, NPLs of South Korean banks had rapidly accumulated as a result
of a string of large corporate insolvencies.
Behind the mounting problems were the fundamental structural weak-
nesses characterized by an excessively indebted corporate sector and a
poorly supervised, fragile financial system. These weaknesses derived
from the close ties between the government, banks, and corporations,
which had formed a web of implicit guarantees and a mentality of “too
big to fail.’’ This so-called “crony capitalism’’ resulted in excessive fin-
ancial borrowings and high risky over-investment without sufficient
attention to credit and exchange rate risks. Finally, the shaky financial
system was unable to sustain the shocks of the Asian financial crisis that
started in Thailand on 2 July 1997.
Characterized by large-scale capital flight, the plummeting exchange
rate of the won (dropping from about 1150 won to the dollar at the
beginning of December 1997 to almost 2000 won at the end of the year)
and sharply falling stock and property markets, the financial crisis of
1997–98 soon evolved into an overall economic and social crisis, bring-
ing a most severe blow to the South Korean economy in the Republic’s
history. As a result of the crisis, economic growth dropped from 7.0%
in 1996 to 4.7% in 1997 and finally shrank by 6.9% in 1998. Per capital
GNP dropped substantially from $12,197 in 1996 to $7355 in 1998.55
In the meantime, with the loss of 1.2 million jobs the unemployment
rate climbed from 2.2% to 7.0% between the summer of 1997 and June
1998.56
114 The Political Economy of East Asia

On the verge of defaulting on its debts as a result of the financial

crisis, South Korea turned to the IMF for emergency aid in Novem-
ber 1997. In the following month, Seoul signed an agreement with
the IMF, which promised to provide a record standby of $57 billion
loan under the condition that the South Korean government would
adopt a series of tight macroeconomic policies – including monetary
and fiscal policies – to restore economic stability and confidence. In
the meantime, as part of the agreement with the IMF, South Korea
also undertook a wide range of painful structural reforms to further
liberalize the economy and to create a more effective governance struc-
ture to supervise and regulate financial institutions and the corporate
sector. The programs of restructuring the financial sector and cor-
porate sector aimed at enhancing the soundness and profitability of
the two sectors by adopting measures to rejuvenate troubled financial
institutions and companies, improve the financial structure of viable
financial institutions and companies, and strengthen management
transparency.
The restructuring of the financial sector was conducted through two
stages, during which the financial sector was reorganized through mar-
ket competition and financial companies shrank by about 30% in terms
of both the number of companies and the number of employees with a
number of insolvent financial institutions cleaned up. The result was the
substantial improvement in the soundness, profitability, and efficiency
of financial companies, which was reflected in various productivity
indices, including assets per capita, net profit per year, and return on
assets. Moreover, the government poured huge amounts of public funds
into banks to help eliminate bad loans, facilitate capital expansion,
and secure profitability, which helped South Korean banks substantially
improve their Bank for International Settlements (BIS) ratios and bad-
debt rations from 12.9 in 1999 to 2.4 by June 2002, approaching the level
of advanced countries. In the meantime, all 15 commercial banks and
5 noncommercial banks turned from the red to the black and achieved
a net profit of 4.1 trillion won during the period, which indicated that
South Korean banks acquired the ability to absorb by themselves NPLs
that could arise in the future.57 The recuperated financial system in turn
set the stage for economic recovery.
The restructuring of the corporate sector involved the early disposal
of insolvent companies, improvement of companies’ financial struc-
ture, and adoption of an ongoing evaluation system for corporate credit
risk. These measures helped improve the financial soundness, efficiency,
management transparency, and corporate governance of companies. As
 The South Korean Political Economy Since 1945 115

a result, the ratio of ordinary profits to sales increased from 2.2% to 7.6%
between the first 9 months of 2001 and those of 2002, which marked the
highest recorded profit. At the same time, the financial structure of com-
panies greatly improved with debt and cross shareholdings reduced. The
debt ratio of the manufacturing sector dropped from 396% in 1997 to
130% by the end of September 2002. By 2003, the restructuring of the
corporate sector was successfully completed.58
As a result of the sound macroeconomic policies and restructuring
of financial and corporate sectors, the South Korean economy soon
achieved an impressive recovery from the financial crisis and the severe
recession of 1997–98 with most of its macroeconomic indices recovering
to pre-crisis levels. By the end of 1998, the economy had stabilized, set-
ting the stage for a resumption of growth in the following years. In 1999,
the nation achieved economic growth by 9.5%, which was followed by
a growth rate of 8.5% in 2000. Although the growth rate reduced to
3.8% in 2001 in the midst of a global recession, the South Korean eco-
nomy posted a rebounded growth rate of 7.0% in 2002. Thereafter, South
Korea’s growth rates remained around 4% (3.1% for 2003, 4.6% for 2004
and 4.0% for 2005).59 In the process of economic recovery, the corpor-
ate sector slashed employment and wages, reduced its debt burden, and
recorded profit gains, leading to a rise in fixed investment. Export growth
also picked up, reflecting the increased competitiveness of South Korea
following the depreciation of the won. Particularly noteworthy was the
information technology industry, which was the fastest growing industry
sector in recent years, accounting for some 10% of GDP and 30% of
total exports in 2002.60 As the economy continued its rapid recovery, the
unemployment rate declined each year after 1998, hanging around 3.3–
4.0% in 2001–05.61 In the meantime, South Korea reversed its chronic
current account deficit in 1998 and maintained a surplus thereafter. Most
significantly, the nation turned itself around from a net debtor country
to a net creditor country in 1999 and has remained this net creditor
position ever since. With all this success, South Korea had its IMF debts
completely cleared in 2002.
While the post-crisis economic recovery of South Korea was impress-
ive, however, there were still some apparent problems. Most not-
ably, some of the troubled financial institutions and large compan-
ies were not sufficiently restructured, and state financial institutions
still did not enjoy managerial autonomy. Moreover, judged by inter-
national standards, South Korea’s financial sector remained fragile
in terms of soundness, profitability, software level, market transpar-
ency, fairness, and corporate financial soundness.62 On the other
116 The Political Economy of East Asia

hand, despite successful cooperate reorganization, a small number of

chaebol continued to dominate the corporate environment, with the
top 30 of them accounting for about 40% of manufacturing output
and 50% of exports.63 Moreover, the nation’s external dependence
increased as a result of market liberalization and securing of for-
eign capital in the process of economic reforms. Besides, the tight
macroeconomic policies and restructuring programs brought about
adverse social effects like the deepening gap between the rich and the
poor.
Despite the problems that continued to exist, however, the remark-
able recovery of the South Korean economy from the financial crisis of
1997–98 was indeed primarily due to the supportive fiscal and monet-
ary policies and economic restructuring programs. More fundamentally,
South Korea’s quick recovery reflected the underlying dynamism of
the South Korean economy. The sound macroeconomic policies and
reform efforts simply helped capitalize this very dynamism of the South
Korean economy by strengthening the mechanisms for resource alloc-
ation through market forces and altering the legal and institutional
settings to improve governance.