Strategies for Development: Export Promotion in South Korea
Introduction
South Korea is one of the Asian Tigers, a group of four countries whose economies have had consistent growth throughout the 1960s due to the modernization of export policies and increased industrialization. Through its success in capital-intensive industries such as shipbuilding and car manufacturing, its economy has seen significant growth. After the Korean War, the economy was characterized by subsistence farming, however, by 1996 it began producing high-value goods and was a global leader in technological innovation. South Korea has managed to transform from a low-income country to a high-income country with the 10th largest economy in the world and the 4th largest in Asia. This huge growth can be seen in the changes in GDP which in 1960 was $3.96 billion compared to 1996, where it was $610.17 billion. Korea's success can be attributed to thorough economic planning and successful export promotion industrialization from the 60s to the 90s. The country set itself up for success with land reform acts, the promotion of national conglomerates, and heavy investment in human capital. The government played a crucial role in the success of export promotion by implementing support structures, such as the creation of Free Trade Zones (FTZs), the establishment of trade promoting agencies and favourable lending terms to export-centric corporations. These structures laid the groundwork for export promotion industrialization, beginning with the development of Light Industry (LI). The success of its LI allowed the economy to expand into heavy industry and eventually into high-value-added goods in line with the global market demand.
This paper will focus on the Republic of Korea's (ROK) economy from 1953 at the end of the Korean War until the late 1990s. The first section will explain the state of the economy at the end of the Korean War and will explain the importance of substitution as well as other foundational policies that set the stage for rapid growth. The second will break down export promotion industrialization policies created throughout the 1970s to the 90s.
1953-1961: Setting the Stage and Import Substitution
Land Reform
In 1950, Korea created the Land Reform Law which limited property holdings to 7.5 acres. This reform transformed the lower class from peasants to entrepreneurial farmers and allowed landlords to redirect their resources toward industry. In 1944, 3 percent of landowners owned 64 percent, but in 1956 the top 6 percent owned only 18 percent. The land reform policy allowed the economy to shift from subsistence farming, which is not inherently profit-making, to a modern model that is supportive of advanced, high-value industries. Land reform led to structural changes in the economy as former landlords and peasant farmers became important actors in this newly capitalist society.
Education
At the conclusion of the Korean War in 1953, the GDP of South Korea was $40.9 million. With North Korea inheriting the majority of the manufacturing plants and natural resources, South Korea had few prospects and very little to offer the international market. At the time, the economy was primarily agrarian and lacked capital, meaning its capacity for mobility between sectors was extremely low. Further, it was heavily dependent on foreign aid, especially from the United States. Despite South Korea having few natural resources, it did have an abundance of labour on which it capitalized during the 1960s by focusing on education policies to develop a skilled workforce which would later become a strong economic driver (Seth, 2017). The high public expenditure on education had a profound impact on the workforce as it transformed the population, which was majority illiterate, into highly skilled workers. In 1945 the adult literacy rate was estimated at 22%; by 1970 it was 87.6% and, by the late 1980s, sources estimated it at around 93% (Glavin). Further, from 1945 to 1960, enrolment in primary schools tripled, secondary school enrolment increased more than eight-fold, and ten times in higher education. By 1960, 96% of all children of primary school age were attending school (Seth, 2017). The education system in South Korea is concentrated in maths, sciences and trades, generating a specialized workforce that fuelled the high-tech industry in the 1980s and led to Korea being a global pioneer in innovation. Investing in social capital and creating an educated and highly skilled labour force is an integral policy in export promotion and laid the foundations for the development of advanced industries in Korea later on.
Foreign Aid
To support the funding of export promoting industrialization and the building of capital-intensive infrastructure, South Korea relied on foreign aid from the United States and in exchange for their support in the Vietnam War, the US obliged. South Korea earned a lot in official development assistance (ODA) from the US which is evident when looking at how ODA increased throughout these years(Seth, 2017). South Korea entered the war in 1964 under the Park administration and received substantial foreign aid up until 1973 when the peace agreement was signed, and US troops withdrew (Seth, 2017). It is estimated that the total worth of South Korean earnings from 1965 to 1972 for its Vietnam commitment was over $1 billion. Moreover, war revenues made up nearly 40% of exchange earnings and it was estimated that, with US assistance, the government secured $2.7 billion in foreign loans by 1971. After South Korea withdrew from Vietnam in 1973, the aid payments from the US decreased drastically from about $800 million USD in 1972 to $150 million USD in 1974 (Figure 3). The foreign aid received from the United States was crucial to Korea's economic development as it was used to fund the investment into education and import substitution (Seth, 2017).
Import Substitution
As many countries did post world war, South Korea promoted import substitution industrialization (ISI) where an overvalued currency made imports cheap and exports uncompetitive. (Kirk) Import substitution was not a successful long-term solution as Korea needed to import plenty of intermediate goods necessary for the production of final goods; this left them with a deficit filled by US aid (Seth, 2017). In 1956, exports totalled $25 million USD against the import products which amounted to $389 million USD. The US aid payments made up for this deficit and accounted for nearly 80% of all government revenues and the majority of Korea's national foreign exchange earnings came from this American aid.
Promotion of Chaebols
Chaebols are large business conglomerates that play a major role in the development of the economy in South Korea, they also receive subsidies, loans, and tax incentives. Much of the ODA after the Korean War was given to chaebols as subsidies to help them to grow. The government insulated the domestic market through these heavy subsidies and significant favouritism towards chaebols to foster the production of exports. This government backing was an essential policy to export promotion as it made these industrial leaders virtually bulletproof.
These policies were the bedrock for export promotion as land reform allowed a modern economy to develop, while foreign aid supported investment in education and created a skilled labour force. Government subsidies allowed chaebols to develop in key industries, fuelling future development. In 1961, a successful coup led by General Park Chung-hee would mark the start of export promotion industrialization. The next part of this paper will investigate some of the policies that promoted export promotion and led to South Korea's rapid economic growth.
1962-1997: Sustained Growth Under Export Promotion
Under the Park administration, export promotion policies were pursued through a series of stages. The ODA funds from the US were first used to fund light industry (LI) and education, representing the forefront of export promotion strategies in Korea. The success of these policies paved the way for the development of the heavy and chemical industry, complemented by financial deregulation and the establishment of organizations that encouraged free trade. The highly skilled workforce and financially backed industries facilitated the expansion of the economy into high-value-added products. The next section of this paper will explore each of these phases and how they have resulted in steady economic growth.
1962-1971: The Development of Primary Products
The government created a favourable environment to induce economic growth via the establishment of economic policies and the support of certain organizations in the 1960s. In 1962, the first Five Year Economic Development Plan (1962-66) was created with a focus on creating an industry that was self-sufficient (Fed). The education policies paid off greatly as Korea had the comparative advantage in labour over most countries as it was abundant, cheap and its people well educated. Park capitalized on this by promoting the development of labour-intensive LI in the first five-year plan which called for 7.1% economic growth (Seth, 2017). To reach this target, the government started by increasing export subsidies on these LI such as the food, textile and garment industries (Seth, 2017). This was massively successful as they surpassed their target, reaching a growth rate of 8.9%. In 1965, the LI made up 59.5% of total exports whereas heavy industry was a mere 2.9%, by comparison (Figure 4). Commodity exports in 1960 were 32.8 million USD compared to 1969, where exports were 622.5 million USD (Figure 5). This substantial increase can be attributed to effective economic planning from the government. Throughout the 1960s, the manufacturing sector and primary product sector both saw growth, with the manufacturing sector dominating in the middle of the decade (Figure 6).
Vietnam War Economic Benefits
The benefits of South Korea's assistance in the Vietnam War were widespread. The country not only received aid payments that allowed the government to fund Chaebols but were also awarded military contracts. South Korean firms such as Hyundai were given contracts from the US during the war that gave South Korean companies experience and set them up to win future construction contracts from the Middle East.
Deregulation and Incentives
In 1960, the Foreign Capital Inducement Promotion Act (FCIPA) was created, marking the start of foreign direct investment (FDI) liberalization (OECD). FCIPA was eventually allowed tax holidays for foreign firms, generous tax concessions, 100% foreign ownership, and equal treatment with national firms. The domestic government has made it extremely easy for foreign firms to invest in South Korea which has encouraged FDI inflows into the country, driving their export-based economy (Figure 7). This influx of investment has also allowed Korea to expand their trade markets and gain access to foreign firms’ techniques, leading to an increase in overall productivity (Kim).
Trade Agencies and Policies
The government further supported export promotion by creating organizations that promote international trade. The Korea Trade-Investment Promotion Agency (KOTRA) was created in 1962 and is a government-funded organization that promotes international trade. Through trade promotion activities, KOTRA helped firms export their goods and contribute to the economic growth that was seen throughout the 70s and 80s (Mah, 2011). Another key factor in the success of Korea's export market came in 1967 when it joined the General Agreement on Tariffs and Trade (GATT) (WTO). GATT reduced barriers to international trade such as quotas and tariffs which played a crucial role in increasing South Korea’s export capacity. Further, GATT provided Korea access to cheaper imports and intermediate goods that allowed the domestic manufacturing sector to compete with the global market.
The establishment of trade zones was another important factor in the expansion of export promotion. Free Trade Zones (FTZs) offer preferential tax and customs regulations, and fees which encourage import, export, and manufacturing activities (Tetra). The first FTZ was established in 1970 in Masan, Korea to encourage FDI inflows and exports. It was the first foreign-exclusive industrial complex and focused on manufacturing (Mah, 2011). In 1972, foreign capital inflows to the Masan FTZ totalled 34.9 million USD and by 1984, inflows more than tripled to 137.3 million USD (Figure 8). Moreover, FTZ increased national employment; in 1972, the Masan FTZ employed around 7 thousand people and by 1987 employed around 36 thousand.
Other Factors
The restriction on importing consumer goods was still omnipresent in Korean society as hard currency was scarce. The government chose to funnel these limited funds to the export industry for the import of raw materials, intermediate goods and capital goods (WTO). The promotion of private savings played a large role in the ability of the industrial sector to develop as it had access to a large number of investment funds. The creation of the economic planning board was essential to the success of these export promotion measures as it was staffed by experts in their respective fields (MEF). The board was founded in 1961 under Park's administration and worked to create multiple Five Year Plans that played a major role in the economy’s success. Additionally, constant devaluations of the Won ensured that Korean goods stayed competitive in the global market. In 1963 the Won went from 190 Won (per 1 USD) to 225 Won (per 1 USD) and in 1970, the value dropped to 317 Won (per 1 USD) (Mah, 2011). The manipulation of currency was another important policy in the success of export promotion.
1971-1982: The Launch of Heavy and Chemical Industries
Under President Park, the economy thrived with exports being 12.7% of GDP in 1971 and growing to 27.4% in 1982 (Figure 1). This period marked a transition from a focus on labour-intensive light industry to capital-intensive heavy and chemical industries which required skilled labour. The year 1972 saw another devaluation of the currency from 317 Won (per 1 USD) to 399 Won (per 1 USD), keeping exports competitive (Mah, 2011). In 1973 US aid slowed, however, Korea had built a strong industrial base with a specialized workforce and did not need further assistance (Figure 3). Conversely, rising wages in the 1970s eroded the large profit margins that Korean chaebols were used to and set in motion the shift from labour-intensive industries toward high-value-added, capital-intensive industries (Mah, 2011). The highly skilled and dedicated workforce paid off in that the government could now develop higher-value goods, signalling the end of US dependence.
The second and third Five Year Plans focused on the development of heavy and chemical industry and the development of infrastructure(Fed). Industries in the forefront at this time included: iron and steel, transport machinery, household electronics, shipbuilding, and petrochemicals. These industries were developed away from the capital, Seoul, on the southern part of the peninsula so as to provide employment opportunities and encourage economic development in rural areas (Fed). There was a steady increase in the exports of non-electrical machinery, electrical machinery, chemicals and pharmaceuticals, computer and office equipment and communications equipment (Figure 9). Between 1972 and 1976, export values were 22 billion (USD) compared to 1977-1981 where they were 77 billion (USD) (Figure 10).
In 1980, Korea adopted a fixed exchange rate system to a multi-basket peg which allowed for more stability in the market (BoK) In 1990, this system was replaced by the Market Average Exchange Rate System where the exchange rate (ER) was allowed to fluctuate between a band, this allowed for more freedom so that the ER reflected the supply and demand of foreign exchange.
1982-1996: The Emphasis on Research and Development
The Fifth Five-Year Plan shifted its targets in line with world demand and saw a greater emphasis on technology-intensive industries (Fed). This time period marked the transition from a direct subsidization program for industry into a function-oriented support program. The government promoted research and development (R&D) so that the economy could keep up with global innovation and focus on high-value goods (Mah, 2011). In 1991, the percentage of GDP spent on R&D was 1.71% compared to 1997 when it totalled 2.248% (Figure 11). South Korea's spending on R&D was relatively high as the average OECD spending on R&D in 1997 was 1.965%. The emphasis on R&D is a key component of export promotion as it drives innovation, maintains growth, and keeps industries relevant. From 1985 to 1994 there was a decline in the exports of light industries such as food and textile, while there was a massive increase in the electrical machinery industry (Figure 4). The shift in export composition from 1965 to 1994 shows a decrease in the exportation of light industry and an increase in heavy industry and high-value-added goods which reflects the later stages of export promotion (Figure 6). In 1996, Korea became a member of the Organisation for Economic Co-operation and Development (OECD), representing a huge milestone as it now serves as a world leader in economic progress and world trade.
Conclusion
Export promotion industrialization in Korea was extremely successful. The increase in exports led to an increase in GDP, a decrease in unemployment, and an increase in labour force participation and has led Korea to have a strong diverse economy that is a power player in the global market. Exports in 1960 comprised 2.6% of GDP compared to 1996 when they totalled 28.3% (Figure 12). Exports were valued at 1 billion dollars (USD) in 1962 compared to 510 billion (USD) in 1996 (Figure 10). Furthermore, GDP has had steady growth over these years and increased from $3.96 billion in 1960 to $610.17 billion in 1996. Subsequently, GNI per capita in 1962 was $120 USD compared to 1996 where it was $13,320 (WB). Moreover, the unemployment rate dropped from 11.7% in 1960 to 2.6% in 1997 meanwhile the labour force participation rate was 30.8% in 1960 but by 1997 it reached 62.2% (Figure 13). These macroeconomic indicators show the success of the export promotion policies which were the product of rigorous planning and these foundational policies. The land reform acts, investment in education, foreign aid, and government-supported chaebols created favourable conditions for this rapid economic growth. Complementary policies such as the creation of organizations that promote free trade, Free Trade Zones (FTZs), financial deregulation and subsidies for export-oriented businesses were also essential in increasing exports. Korea continued to see economic growth until the 1997 Asian financial crisis when the economy slowed significantly. Since then, however, it has rebounded and continues to serve as an example of a successful export promotion policy (Figure 1).
By Alexandra Douglas for ECON 314: Economic Development II
Edited by Viktor Biquet, Estella Lamarche-Dykeman, & Tahsin Kabir
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