11

II. Understanding the MiracleII. Understanding the Miracle

Korean Model of DevelopmentKorean Model of Development

Strong and stable governmentStrong and stable governmentDictatorship of Chung Hee ParkDictatorship of Chung Hee ParkStable and consistent polictyStable and consistent policty

State-led developmentState-led developmentGovernment plans and private enterprise executes plansGovernment plans and private enterprise executes plans

Symbiosis between politics and businessSymbiosis between politics and business

Export-oriented growthExport-oriented growth vs. import substitutionvs. import substitution

ChaebolsChaebolsa family controlled network of big conglomeratesa family controlled network of big conglomerates

22

Market vs. StateMarket vs. State

Prosperity of the Western Europe and the US in the 19Prosperity of the Western Europe and the US in the 19 thth c centuryenturyLiberalismLiberalism : free market, free trade, small goverment : free market, free trade, small govermentRapid expansion of industry and international tradeRapid expansion of industry and international trade

World war I, the Great Depression of 1929World war I, the Great Depression of 1929Shattered belief in liberalismShattered belief in liberalismStatism Statism :: experimenting with state-led systems in less developed r experimenting with state-led systems in less developed r

egionsegionsSocialism in RussiaSocialism in RussiaFascism in Germany, Italy and SpainFascism in Germany, Italy and Spain

Newly liberated countries after World War IINewly liberated countries after World War IIStatism was a popular choiceStatism was a popular choice

33

Export Promotion vs. Import SubstitutionExport Promotion vs. Import Substitution

Developing country exports good X and import good YDeveloping country exports good X and import good YX: primary products or labor-intensive low-skill goodsX: primary products or labor-intensive low-skill goods

M: capital-intensive or high-skill goodsM: capital-intensive or high-skill goods

Export promotion (outward-looking policy)Export promotion (outward-looking policy)

develop industries producing Xdevelop industries producing X

import M with money generated by exporting Ximport M with money generated by exporting X

both X and M increase rapidly => more dependency on foreign both X and M increase rapidly => more dependency on foreign tradetrade

adopted by Asian miracle countriesadopted by Asian miracle countries

Import substitution (inward-looking policy)Import substitution (inward-looking policy)

develop industries producing Mdevelop industries producing M– decrease imports and save dollars spent on importing Mdecrease imports and save dollars spent on importing M

both X and M decreases => self-sufficiencyboth X and M decreases => self-sufficiency

adopted by Latin American countries, India and Pakistanadopted by Latin American countries, India and Pakistan

44

A BriefA Brief HistoryHistory Long tradition of centralism – Chosun Dynasty (1392-1910)Long tradition of centralism – Chosun Dynasty (1392-1910)No feudal or local powers.No feudal or local powers.King and bureaucratic scholars dominate in political power and distribution of eKing and bureaucratic scholars dominate in political power and distribution of economic resources.conomic resources.Compare Japan .Compare Japan .

Colonial rule of Japan (1910-1945)Colonial rule of Japan (1910-1945)Modernization under the Japanese colonial rule.Modernization under the Japanese colonial rule.

US Army Military Government (1945-1948) – South KoreaUS Army Military Government (1945-1948) – South KoreaSome efforts to implant democracy and capitalismSome efforts to implant democracy and capitalismPeriod of political and economic chaosPeriod of political and economic chaos

Syngman Rhee (1948-1960)Syngman Rhee (1948-1960)Korean War (1950-1953)Korean War (1950-1953)inefficient and corrupt distribution of inefficient and corrupt distribution of

Japanese enterprises, banks, US aids, imports.Japanese enterprises, banks, US aids, imports.failed to for economic development laying foundations failed to for economic development laying foundations

Korea was in a dismal state in 1960. It was as poor as sub-Saharan African countrKorea was in a dismal state in 1960. It was as poor as sub-Saharan African countries.ies.

55

Perkins (1997), in the early 60s,Perkins (1997), in the early 60s,

share of agriculture and mining – 50% (15% higher than comparable countries)share of agriculture and mining – 50% (15% higher than comparable countries)

share of manufacturing – 15%, unusually low.share of manufacturing – 15%, unusually low.

share of exports only 3% - compared with 30% under the Japanese colonial ruleshare of exports only 3% - compared with 30% under the Japanese colonial rule

Source: Lim (2000)

66

Source: Lim (2000)

77

Chung Hee Park (1961-1980)Chung Hee Park (1961-1980)

Period of authoritarian politics and rapid economic developmentPeriod of authoritarian politics and rapid economic development

Anti-communistAnti-communistThreatened by the economic success of the North KoreaThreatened by the economic success of the North KoreaEconomic development has all the prioritiesEconomic development has all the priorities

political freedom and reunification put asidepolitical freedom and reunification put aside

State-led economic developmentState-led economic developmentEconomic Planning Board created – 5 year plansEconomic Planning Board created – 5 year plansNationalized commercial banksNationalized commercial banksPut the Bank of Korea under the control of the Ministry of FinancePut the Bank of Korea under the control of the Ministry of Finance

Initial plan – import substitution development a la Latin American Initial plan – import substitution development a la Latin American countriescountriesexporting primary productsexporting primary productsdeveloping steel and machinery industriesdeveloping steel and machinery industries

88

Switch to Export-led growthSwitch to Export-led growthExport drives of labor-intensive productsExport drives of labor-intensive productsHistorical accidents - LimHistorical accidents - Lim

US tried to manipulate Park with US aids. Park, fierce nationalist, tried to be US tried to manipulate Park with US aids. Park, fierce nationalist, tried to be independent of US pressures by developing dollar-generating industries.independent of US pressures by developing dollar-generating industries.

US pressuresUS pressuresUS preferred market-oriented outward-looking growth strategy.US preferred market-oriented outward-looking growth strategy.

No FDI (foreign direct investment)No FDI (foreign direct investment)Heavily relied on foreign loansHeavily relied on foreign loansGovernment directly borrowed from the world and distributed to the Government directly borrowed from the world and distributed to the

private sectorprivate sectorGovernment guaranteed foreign loans of private businessesGovernment guaranteed foreign loans of private businesses

Development based on private entrepreneurshipDevelopment based on private entrepreneurship-backed by foreign loan guarantees and low interest rate loans-backed by foreign loan guarantees and low interest rate loans-closely monitored by the government in export performance-closely monitored by the government in export performanceLim : government - principalLim : government - principal

private sector- agentprivate sector- agent task - exportstask - exports

99

Reasons for successReasons for success

High level of educationHigh level of educationMuch higher than average developing countries’Much higher than average developing countries’

Stable and consistent policyStable and consistent policyDedication to growth and export promotionDedication to growth and export promotion

Coping with moral hazard through monitoringCoping with moral hazard through monitoringMoral hazardMoral hazard

Borrow at cheap rates and invest recklessly in unprofitable businessBorrow at cheap rates and invest recklessly in unprofitable businessMonitoringMonitoring

Government supplied low interest rate loans only to firms maintaining good export performGovernment supplied low interest rate loans only to firms maintaining good export performancesances

Firms were disciplined by competitive forces in their export marketsFirms were disciplined by competitive forces in their export markets

Concentrating on right business with right technologyConcentrating on right business with right technologyLearning from Japanese experienceLearning from Japanese experienceReliance on Japanese technologyReliance on Japanese technology

1010

HCI drives in the 1970sHCI drives in the 1970s

Promoting heavy and chemical industriesPromoting heavy and chemical industriesIndustrial upgrading: from labor-intensive consumer goods to capital-intensive intermIndustrial upgrading: from labor-intensive consumer goods to capital-intensive interm

ediated goods ediated goods US withdrawal of armed forces in AsiaUS withdrawal of armed forces in Asia

Creation of Chaebols (Creation of Chaebols ( 財閥財閥 ))Chaebol literally means “wealth clique.”Chaebol literally means “wealth clique.”Japanese Zaibatsu vs Korean ChaebolJapanese Zaibatsu vs Korean ChaebolFamily-controlled industrial conglomeratesFamily-controlled industrial conglomerates

Samsung – LeeSamsung – LeeHyundai - ChungHyundai - ChungSK - ChoiSK - ChoiLG - KooLG - KooGS - HuhGS - Huh

Diversification – controls a large number of unrelated businessDiversification – controls a large number of unrelated businessSamsung – Amusement park, electronics, insurance, credit cards, constructionSamsung – Amusement park, electronics, insurance, credit cards, constructionHyunday - automobile, ship-building, construction, securities, electronicsHyunday - automobile, ship-building, construction, securities, electronics

1111

Controls a network of companies with small holdings of equityControls a network of companies with small holdings of equity

Multi-pyramidMulti-pyramid => firm A => firm B => firm C=> firm A => firm B => firm C

Circular investmentCircular investmentfirm A => firm B => firm Cfirm A => firm B => firm C

Government –Chaebol partnershipGovernment –Chaebol partnershipGovernment select target industriesGovernment select target industriesGovernment select firms to enter target industriesGovernment select firms to enter target industriesGovernment provides low-interest loans and trade protectionGovernment provides low-interest loans and trade protection

What if a project fails?What if a project fails? Government has a moral responsibility to bail out firms without threatening governanGovernment has a moral responsibility to bail out firms without threatening governan

ce. => moral hazardce. => moral hazard

1212

Source: Lim (2000)

1313

1414

1515

Advantages of ChaebolsAdvantages of ChaebolsShortage of entrepreneurial talentsShortage of entrepreneurial talents

Inefficient legal enforcements and low level of trustInefficient legal enforcements and low level of trust– Integration saves transactions costsIntegration saves transactions costs

Diversifying heavy risks in investment in heavy industriesDiversifying heavy risks in investment in heavy industries– Large sunk costsLarge sunk costs– Long gestation periodsLong gestation periods““Without chaebols, would automobile, ship-building and semiconductor industries haWithout chaebols, would automobile, ship-building and semiconductor industries ha

ve been possible in Korea?”ve been possible in Korea?”

Inefficient labor marketsInefficient labor markets– Evaluation of employeesEvaluation of employees– Intra-firm mobility of laborIntra-firm mobility of labor

Coping with informational problems in banking industriesCoping with informational problems in banking industries– Mutual loan guaranteesMutual loan guarantees– Transfer pricingTransfer pricing

1616

III. Financial Crisis of 1997III. Financial Crisis of 1997

Growth Rate of GDP (1971 – 2006)

Bank of Korea

1717

Exchange Rate (Won/Dollar)Exchange Rate (Won/Dollar)Bank of KoreaBank of Korea

1818

The Financial Crisis of The Financial Crisis of 19971997

Foreign Debt CrisisIn 1997, Korea was fast accumulating foreign debts, mostly foreign

short-term loans to commercial and merchant banks in Korea.Questioning the ability of Korean banks to pay back these loans, for

eign banks declined to roll over the loans.Lacking foreign reserves to pay off debts, Korea turned to IMF, resul

ting in a rescue program amounting to $57 billion, the largest in IMF’s history.

Foreign Exchange CrisisForeign Exchange CrisisBecause of the dollar shortage and the speculative forces, the WonBecause of the dollar shortage and the speculative forces, the Won

/Dollar exchange rate skyrocketed from 900 to 1700 over severa/Dollar exchange rate skyrocketed from 900 to 1700 over several months.l months.

1919

The Financial Crisis of The Financial Crisis of 19971997

Banking CrisisFor most banks, the amount of non-performing loans

exceeded equity, and was in a state of bankruptcy.Left alone, bank runs would break out and paralyze the

economy.

The root cause of the The root cause of the crisiscrisis

Korean Model of Growth– Risk partnership between government and business

2020

Government select target industries and select Chaebols to develop these industries =>

Government has implicit responsibility to bail out Chaebols if they fail. =>Moral hazard of underestimating the downside risks arises.

Government subsidize Chaebols by providing loan guarantees and low-interest rate loans

=> Excessive investment

The root cause of the The root cause of the crisiscrisis

Korean Model of Growth– Risk partnership between government and business

2121

State-controlled banks channel household deposits and State-controlled banks channel household deposits and foreign loans to firms designated by the government.foreign loans to firms designated by the government.

Banks do not develop the ability to assess and Banks do not develop the ability to assess and manage risks in loan-making businessmanage risks in loan-making business

Interest rates are set by government.Interest rates are set by government.

Banks absorb losses from bail-out operations dictated by Banks absorb losses from bail-out operations dictated by the government.the government.

=> Incompetent banking industry=> Incompetent banking industry

Korean Model of Growth– Mobilizing resources through state-controlled banks

2222

Delayed ReformDelayed Reform

Lim (2000) pp. 42-55Lim (2000) pp. 42-55

Park assassinated in 1979.Park assassinated in 1979.

Chun takes power by a military coup in 1980.Chun takes power by a military coup in 1980.

A sharp recession following the second oil shock, A sharp recession following the second oil shock, political instability and the results of over-political instability and the results of over-investment in late 1970s =>investment in late 1970s =>

Korea on the verge of a major financial crisisKorea on the verge of a major financial crisis

Chun adopt the stabilization package recommended Chun adopt the stabilization package recommended by IMFby IMF

2323

Tight monetary policyTight monetary policyConsolidating industries and chaebolsConsolidating industries and chaebols

Reformatory ideasReformatory ideasOf Chun’s technocratsOf Chun’s technocrats

Korea outgrew the Korean Model of Development.Korea outgrew the Korean Model of Development.The economy became too complicated to be understood and controlled by tThe economy became too complicated to be understood and controlled by t

he government.he government.The market and the private sector should lead.The market and the private sector should lead.

– Liberalizing the banking industryLiberalizing the banking industryPrivatizing commercial banksPrivatizing commercial banksInterest rates chosen by banksInterest rates chosen by banks

Ministry of Finance keeps the lever by retaining the power to select bank Ministry of Finance keeps the lever by retaining the power to select bank presidentspresidents

From State-owed to semi-public.From State-owed to semi-public.

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– Pro-competition policyPro-competition policy

New Fair Trade LawNew Fair Trade Law

Without splitting Chaebols or opening up trade,Without splitting Chaebols or opening up trade, limited impact on competition structurelimited impact on competition structure

Government tries to regulate the behavior of Chaebols.Government tries to regulate the behavior of Chaebols.Bureaucratic control of the government remains.Bureaucratic control of the government remains.

Political resistance of vested interestesPolitical resistance of vested interestes Chaebols and bureaucratsChaebols and bureaucratsKorea democratized in 1987Korea democratized in 1987Chaebols form a new relationship with presidents and politicians thorough Chaebols form a new relationship with presidents and politicians thorough

(legal or illegal) campaign funds(legal or illegal) campaign funds