The Korean Economy (Six Decades of Growth and Development)

THE KOREAN
ECONOMYSix Decades of Growth and Development
The Committee for the Sixty-Year History of the Korean EconomyTHE KOREAN ECONOMY
Six Decades of Growth and Development
YEARS
THE KOREAN ECONOMY
60
년년년년년년년년년년년년년년년년년년년년년년
Editors
Il SaKong and Youngsun Koh
THEKOREANECONOMY
SixDecadesofGrowthandDevelopment
TheCommitteefortheSixty-Year
HistoryoftheKoreanEconomyEditorsIlSaKongandYoungsunKoh
60년년년년cover-print_ok:60년년년년cover-print_ok 10. 12. 21 년년 10:42 Page 1

60YEARS
THE KOREAN ECONOMY
The Korean Economy
Edited by
Il SaKong and Youngsun Koh
The Committee for the Sixty-Year History of the Korean Economy
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ⓒ 2010
Korea Development Institute
P.O.Box 113 Hoegiro 49 Dongdaemun-gu
Seoul, 130-868
Korea
www.kdi.re.kr
ISBN 978-89-8063-457-6
The Korean Economy

iiiContents
Foreword
A Note on Romanization
Abbreviations
Contributors
Chapter 1
Introduction 001
Il SaKong
Chapter 2
The Growth of Korean Economy
and the Role of Government 007
Youngsun Koh
1. Introduction 009
2. Liberation and state-building (1948-1959) 010
3. Export promotion and government-led
industrialization (1960-1979) 016
4. Stabilization and liberalization (1980-1997) 039
5. From the economic crisis to the present (1997-2009) 061
6. Challenges 073
7. Conclusion 074
Chapter 3
Korea’s Industrial Development 083
DoHoon Kim and Youngsun Koh
1. Introduction 085
2. Structural changes in the Korean economy 086
3. Historical development of Korean industry 102
4. Conclusion 118
60YEARS
THE KOREAN ECONOMY
Contents
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ivTHEKOREANECONOMY
Chapter 4
International Economic Policy 123
Junkyu Lee, Jungho Yoo, Nakgyoon Choi,
Jeong Gon Kim, June Dong Kim, Hea-Jung Hyun,
Sangkyom Kim, Jinkyo Suh, Deok Ryong Yoon,
Hongshik Lee and Yoocheul Song
1. Introduction 125
2. The early evolution of international economic policy
from the 1950s to 1970s 125
3. Expansion of economic liberalization and globalization
from 1980 to the present 137
4. Liberalization of foreign direct investment 145
5. Economic cooperation 150
6. Agricultural import liberalization 154
7. Liberalization in the service sector 161
8. Financial opening 167
9. Conclusion 173
Chapter 5
Territorial Development Policy 177
Jung Jay Joh, Young-Pyo Kim and Youngsun Koh
1. Introduction 179
2. Agrarian land reform and post-war reconstruction
from 1948 to the 1950s 183
3. Development of industrial parks and population
migration to Seoul in the 1960s 184
4. Development corridors and the Saemaul Movement
from 1970 to 1987 186
5. The pursuit of a better quality of life and globalization
from 1988 to the 1990s 195
6. Promoting regional balance and green growth in the 2000s 202
7. An assessment of Korea’s territorial policy 209
8. Conclusion 223
60YEARS
THE KOREAN ECONOMY
Contents
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vContents
Chapter 6
Social Policy 227
Youngsun Koh, Seung Kwon Kim,
Chang Whan Kim, Young Lee, Joo Seop Kim,
Sang Young Lee and Young-Ock Kim
1. Introduction 229
2. Demographic changes 230
3. Education system 234
4. Developments in the labor market 247
5. Social welfare system 268
6. Health care services 286
7. Women’s economic and social participation 299
8. Conclusion 306
Appendices
Annex tables 313
Committee members 331
Advisory group 331
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60YEARS
THE KOREAN ECONOMY
List of tables
viTHEKOREANECONOMY
Table2-1.Priceinflation 015
Table2-2.Exportcreditbybanks 018
Table2-3.Capacityutilizationinmanufacturing 025
Table2-4.Tariffrates(1957-1984) 026
Table2-5.MaincomponentsoftheAugust3rdMeasure 032
Table2-6.Centralbanklendingtodepositmoneybanks 035
Table2-7.Contributionstothereservebasegrowth 036
Table2-8.Internationalcomparisonofconsumerprice
inflation 036
Table2-9.Majormacroeconomicindicators(1975-1990) 041
Table2-10.Investmentcoordinationandindustrialrational-
izationinautomobilemanufacturing 046
Table2-11.ReformofBOKlendingprograms(March14,
1994) 048
Table2-12.MainindicatorsoftheNationalHealth
Insurance(1977-2008) 058
Table2-13.Housingsupplyratio(1960-2008) 058
Table2-14.Expansionoftransportfacilities 059
Table2-15.Majormacroeconomicindicators(1991-2000) 061
Table2-16.Averagereturnonassetsofthelargest30
chaebol 062
Table2-17.Changesinthenumberoffinancialinstitutions069
Table3-1.Annualoutputgrowthbysector 086
Table3-2.Shareingrossvalue-addedbysector 087
Table3-3.Shareofthetop10exportitemsintotalexports089
Table3-4.Distributionofemploymentbysector 090
Table3-5.Sourcesofgrowthinmajorregions(1961-2004) 093
Table3-6.Importsbycommoditygroup095
Table3-7.Fishexportsinthesecondhalfofthe1940s 103
Table3-8.Savingsandinvestment 105
Table3-9.Self-sufficiencyratioofgrains(1956-2005) 106
Table3-10.Energyconsumptionbysource 108
Table3-11.GrowthcontributionbyICTindustries 113
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viiListoftables
Table4-1.Foreignaid(1953-1960) 126
Table4-2.Theextentofwonovervaluation(1955-
1970) 128
Table4-3.Korea’simportsandexports(1955-1970)
130
Table4-4.Opennessrankingofmajorcountries 141
Table4-5.Korea’scurrentstatusoftheFTAs 144
Table4-6.Theutilizationrateofpreferentialtariffs 144
Table4-7.Trendsofinwardforeigndirectinvestment
bythe10largestinvestingcountries 147
Table4-8.Contributionbyforeign-investedcom-
paniesinmanufacturingproduction 147
Table4-9.Contributionbyforeign-invested
companiesinservicesproduction 148
Table4-10.Korea’soutwarddirectinvestmentby
region 149
Table4-11.Korea’soutwarddirectinvestmentby
sector 150
Table4-12.Korea’stradesurplus(1982-1987) 155
Table4-13.Agriculturalimportliberalizationrate 156
Table4-14.Changesinmajorindicatorsofagriculture
inKorea 157
Table4-15.ServicesectorinKorea(1960-2008) 162
Table4-16.Thechangeintravelexpenses(1988-
1992) 163
Table4-17.LevelofliberalizationintheMode3after
theUruguayRound 164
Table4-18.Theacceptanceandreservationrateof
Korea 165
Table4-19.TypeofFDIinKorea 166
Table4-20.FDIbyindustry(1990-2008) 168
Table5-1.Annualgrowthrateofpopulationbyregion
182
Table5-2.Designationofindustrialparks(1974-1984)
187
Table5-3.Changesinminingandmanufacturing
employmentbyregion 188
Table5-4.Reclamationprojects(1946-2007) 194
Table5-5.Housingstockandhousingsupplyratio
(1980-2006) 198
Table5-6.IncheonInternationalAirport’srankingin
theACIevaluation(2009) 207
Table5-7.Populationinthecapitalregion 210
Table5-8.Urbanizationtrends 210
Table5-9.Annualizedgrowthrateofthepriceindex
forapartmentsales 217
Table5-10.GRDPbyregion 219
Table5-11.PopulationofSeoulandthecapitalregion
in1981and1991 219
Table5-12.Populationgrowthinregionalgrowth
centers 220
Table5-13.Indexforeconomicandlivingconditions
222
Table6-1.PrivatetutoringinKorea(2007) 245
Table6-2.Employmentratesaftergraduationand
study-jobmatchesoftertiaryeducation 245
Table6-3.Workersbystatus 251
Table6-4.Employmentbysector 256
Table6-5.Employmentbyoccupationalgroup 257
Table6-6.FlexibilityandsecurityintheKoreanlabor
market 264
Table6-7.OECDemploymentprotectionindex(2008)
266
Table6-8.Developmentofthesocialsecuritysystem
270
Table6-9.ParticipantsintheNationalHealth
InsuranceProgram 275
Table6-10.Spendingforthecareandeducationof
pre-schoolagechildren 280
Table6-11.Averagepersonalincometaxandsocial
securitycontributionratesongrosslabor
income(2008) 284
Table6-12.MainindicatorsoftheNationalHealth
Insurance(1977-2008) 285
Table6-13.Numberofhospitalsandclinicsby
ownership(December2008) 289
Table6-14.AgreementsoftheKORUSFTAinthe
healthcaresector(December2008) 297
Table6-15.Women’sroleinKorea’seconomicand
socialdevelopment 299
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viiiTHEKOREANECONOMY
60YEARS
THE KOREAN ECONOMY
List of tables
Table6-16.Advancementrateintotertiaryeducation 302
Table6-17.Employmentratesofpersonswithtertiary
education(2008) 305
AnnexTable1.Majormacroeconomicindicators(1953-
2009) 313
AnnexTable2.NominalexchangerateofwontotheU.S.
dollar(1945-1970) 315
AnnexTable3.Shareingrossvalue-added 317
AnnexTable4.Shareintotalemployment 319
AnnexTable5.Majortradeindicators 321
AnnexTable6.Demographictrend 323
AnnexTable7.Educationalparticipationandresources
325
AnnexTable8.Labormarketindicators 326
AnnexTable9.Participantsinwork-relatedsocial
insuranceprograms 328
AnnexTable10.Healthcareindicators 330
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60YEARS
THE KOREAN ECONOMY
List of figures
ixListoffigures
Figure 2-1. Movement of real exchange rates (1945-
2009) 018
Figure 2-2. Exports and imports (1953-2009) 020
Figure 2-3. Marginal effective tax rates on corporate
income 022
Figure 2-4. Trend in R&D expenditure 023
Figure 2-5. Trend in import liberalization (1955-1999)
026
Figure 2-6. Outstanding stock of external assets and
liabilities (1962-2009) 028
Figure 2-7. Debt-to-equity ratio and interest coverage
ratio in the manufacturing sector 029
Figure 2-8. Inflows of grants, loans, and FDI 030
Figure 2-9. Trends in real interest rates (1954-2009)
034
Figure 2-10. Consolidated central government fiscal
balance (1970-2009) 042
Figure 2-11. Central government debt (1953-2008) 042
Figure 2-12. Sterilization of central bank lending (1950-
2009) 043
Figure 2-13. Sterilization of net foreign assets (1966-
2009) 044
Figure 2-14. Share of the largest 100 companies in
mining and manufacturing 056
Figure 2-15. General and central government spending
(1953-2009) 057
Figure 2-16. General government spending by function
(1970-2008) 057
Figure 2-17. Enrollment rates and the number of
enrolled students (1965-2009) 060
Figure 2-18. Output growth: Comparison of 1997-1999
and 2008-2010 071
Figure 3-1. Share in gross value-added by sector 087
Figure 3-2. Share in total employment by sector 088
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60YEARS
THE KOREAN ECONOMY
List of figures
Figure 3-3. Share in manufacturing value-added by
subsector 088
Figure 3-4. Share in exports by sector 089
Figure 3-5. Periods of industrialization 091
Figure 3-6. Trends of Hoffman ratio across countries
091
Figure 3-7. Investment and savings rates 092
Figure 3-8. R&D expenditure 094
Figure 3-9. Royalties and license fees 095
Figure 3-10. Urbanization trend 096
Figure 3-11. Labor productivity of the service sector
(1963-2008) 099
Figure 3-12. Average wages by firm size in
manufacturing (1980-2008) 100
Figure 3-13. Labor compensation per employee (2006)
100
Figure 3-14. Employment share in the service sector
101
Figure 4-1. Export composition 131
Figure 4-2. Earnings per dollar of exports 132
Figure 4-3. Import liberalization 135
Figure 4-4. Korea’s tariff rates (1978-2007) 138
Figure 4-5. Export growth and real effective exchange
rates 142
Figure 4-6. Korean outward direct investment (1981-
2008) 148
Figure 5-1. Map of the Republic of Korea 182
Figure 5-2. Changes in farm household income (1971-
1982) 192
Figure 5-3. Changes in population distribution (1960-
2005) 211
Figure 5-4. Infrastructure development (1960-2008) 213
xTHEKOREANECONOMY
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Figure 6-1. Population growth and fertility rate
(1961-2008) 230
Figure 6-2. Population pyramid in 1955 and 2005
231
Figure 6-3. Share of the elderly (65 years and over)
in total population (1950-2050) 231
Figure 6-4. Share of foreigners in registered
residents in Korea 234
Figure 6-5. Number of students 235
Figure 6-6. Enrollment rate 235
Figure 6-7. Population that has attained tertiary
education (2008) 236
Figure 6-8. Investmentineducationalresources 237
Figure 6-9. Advancement rate 237
Figure 6-10. Number of high school graduates and
university entrance quota 240
Figure 6-11. Fraction of students attending private
institutions (1965-2009) 243
Figure 6-12. Inactive youth in the 15-29 age group
with tertiary education (2004) 246
Figure 6-13. Unemployment rate 248
Figure 6-14. Growth of unit labor costs 249
Figure 6-15. Growth of wages and output per work
249
Figure 6-16. Number of labor disputes 250
Figure 6-17. Labor union participation rate 251
Figure 6-18. Share of salaried workers and
regular employees 252
Figure 6-19. Employment rate 252
Figure 6-20. Wage by worker’s educational
attainment 253
Figure 6-21. Share of temporary employees and
day laborers 254
Figure 6-22. Female labor market participation
rate by cohort 255
Figure 6-23. Employment rates in OECD countries
(2008) 256
Figure 6-24. International comparison of the
employment pattern 258
Figure 6-25. Workers by status 259
Figure 6-26. Share of the non-salaried workers 259
Figure 6-27. Share of part-time workers in total
employment 260
Figure 6-28. Incidence of part-time employment
(2008) 261
Figure 6-29. Trends in the minimum wage level
262
Figure 6-30. The level of minimum wage in OECD
countries (2008) 262
Figure 6-31. Hours worked in Korea 263
Figure 6-32. Hours worked in the OECD area
(2008) 264
Figure 6-33. Labor union participation rate in
OECD countries (2008) 265
Figure 6-34. Growth and distribution of income in
1965-1989 269
Figure 6-35. Gini coefficient (1982-2008) 270
Figure 6-36. General government welfare
spending 271
Figure 6-37. Social expenditure in Korea and other
Figure 6-38. Recipients of unemployment benefits
278
Figure 6-39. Relative poverty rate 281
Figure 6-40. Impact of taxes and transfers in
reducing poverty among the entire
population 282
Figure 6-41. Participants in work-related social
insurance programs 283
Figure 6-42. Trends in tax burden 284
Figure 6-43. Health outcomes 287
Figure 6-44. Health expenditure in Korea 287
Figure 6-45. Out-of-pocket and public health
expenditures 288
Figure 6-46. Health expenditures in OECD
Figure 6-47. Increases in health care resources
290
Figure 6-48. Labor force participation rate 301
xiListoffigures
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xiiTHEKOREANECONOMY
Foreword
Korea’s economic success has often been called a‘miracle.’There has been an
ongoing debate about the factors behind its success, which has attracted the interest
of not only academicians but also policy practitioners. Korea’s experience holds
relevance for other developing countries that want to catch up with advanced
economies in a short period of time as Korea did. A careful study of Korea’s
economic history is also essential to chart its future path in the face of new
challenges.
Two years ago, a project to compile the sixty-year history of the Korean
economy was started to contribute to the discussion. For this purpose, issues were
grouped into five areas－(1) general economic policies (macroeconomic, financial
market, fiscal, taxation and competition policies), (2) industrial growth, (3) external
economic relations, (4) territorial development, and (5) social policies. In the last
two years, many research institutions and researchers have worked on this project
to highlight Korea’s progress in the five areas, examine main issues, and draw
lessons. The result was published in five volumes in Korean. This English volume
is a condensed and revised version of the original Korean text.
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xiiiForeword
In romanizing Korean, we have used the guideline set forth by the Korean
government in 2000. In romanizing the names of Koreans, we have used their
preferred romanization. When the information was not available, we have
followed the above-mentioned guidelines and put a hyphen between the two
personal names, the second of which has not been capitalized. In ordering the
elements of persons’names, we have adopted a Western sequence?personal
name first and family name last. Exceptions are the names of Presidents of the
Republic of Korea, for whom the use of the family name first seems to be
established by custom and preference. Korean words in the plural are not
followed by the letter“s.”
Many people contributed to the publication of this book. Special thanks go to
Mr. Man-Soo Kang (Senior Economic Adviser to the President and Chairman of the
Presidential Council on National Competitiveness) who initiated the project two
years ago as Minister of Strategy and Finance. The advisory group consisting of
eminent scholars－Professors Chang Yung Jung (Yonsei University), Kwang Suk
Kim (Kyung Hee University), Heeyhon Song (Asia Development Institute), Jung Jay
Joh (former Minister of Maritime Affairs and Ficheries), Hacheong Yeon (Myongji
University), and Chong-Hyun Nam (Institute for Global Economics)－provided
many valuable suggestions to the authors throughout the two-year period to
improve the book. The Ministry of Strategy and Finance (MOSF) financed and
assisted the project under the leadership of Minister Jeung-Hyun Yoon. Messrs
Cheol-Kyu Park (MOSF) and Sang-Mok Choi (Financial Services Commission) have
played a particularly important role in this regard. President Oh-Seok Hyun of
Korea Development Institute organized the work and his staff worked very hard for
a successful completion of the project. The participants of the international
conference held in Seoul on August 30, 2010, including Professor Anne Krueger
(Johns Hopkins University), made valuable comments on the original draft. Mr.
John Burton served as the English-language editor of the book. The devoted efforts
by these people are deeply appreciated.
Il SaKong
Chairman of the Committee for the Sixty-Year History of the Korean Economy
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xivTHEKOREANECONOMY
In romanizing Korean, we have used the guideline set forth by the Korean
government in 2000. In romanizing the names of Koreans, we have used their
preferred romanization. When the information was not available, we have
followed the above-mentioned guidelines and put a hyphen between the two
personal names, the second of which has not been capitalized. In ordering the
elements of persons’names, we have adopted a Western sequence－personal
name first and family name last. Exceptions are the names of Presidents of the
Republic of Korea, for whom the use of the family name first seems to be
established by custom and preference. Korean words in the plural are not
followed by the letter“s.”
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Abbreviations
ALMP active labor market policy
APEC Asia-Pacific Economic Cooperation
ASEAN Association of Southeast Asian Nations
ASEM Asia-Europe Meeting
BOK Bank of Korea
BOP balance of payment
CD certificate of deposit
CP commercial paper
CRIK Civil Relief in Korea
DAC Development Assistance Committee
DDA Doha Development Agenda
DMB deposit money bank
ECA Economic Cooperation Administration
EFTA European Free Trade Association
EIS Employment Insurance System
EPB Economic Planning Board
EU European Union
FDI foreign direct investment
FSC Financial Supervisory Commission
FTA free trade agreement
FTC Fair Trade Commission
GATT General Agreement on Tariffs and Trade
GCC Gulf Cooperation Council
HCI heavy and chemical industry
ICA International Cooperation Administration
ICT information and communication technology
KDB Korea Development Bank
KDI Korea Development Institute
KITA Korea International Trade Association
KOTRA Korea Trade Promotion Agency
L/C letter of credit
M&A merger and acquisition
MBC merchant banking corporation
MDA Manufacturing Development Act
MFN most favored nation
MMA minimum market access
MOF Ministry of Finance
MPC military payments certificate
MRFTA Monopoly Regulation and Fair Trade Act
MSB Monetary Stabilization Bond
NAFTA North American Free Trade Agreement
NAMA non-agricultural market access
NBFI non-bank financial institution
NBLSP National Basic Livelihood Security Program
NFA net foreign asset
NHI National Health Insurance
NIF National Investment Fund
NPS National Pension Scheme
OBS Office of Bank Supervision
ODA Official Development Assistance
ODI overseas direct investment
R&D research and development
RTA regional trade agreement
SACU Southern African Customs Union
SITC Standard International Trade Classification
SME small- and medium-sized enterprise
SOE state-owned enterprise
TFP total factor productivity
TRERA Tax Reduction and Exemption Regulation
Act
TRQ tariff-rate quota
UNC United Nations Command
UNCTAD United Nations Conference on Trade
and Development
UNKRA United Nations Korean Reconstruction
Agency
UR Uruguay Round
URAA Uruguay Round Agreement on Agriculture
WTO World Trade Organization
ZBB zero-based budgeting
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Contributors
Nakgyoon Choi
Senior Research Fellow, Korea Institute for International Economic Policy
Hea-Jung Hyun
Research Fellow, Korea Institute for International Economic Policy
Jung Jay Joh
Former Minister of Maritime Affairs and Fisheries and President of Korea Maritime Institute
Chang Whan Kim
Senior Research Fellow, Korean Educational Development Institute
DoHoon Kim
Senior Research Fellow, Korea Institute for Industrial Economics and Trade
Jeong Gon Kim
Senior Researcher, Korea Institute for International Economic Policy
Joo Seop Kim
Senior Research Fellow, Korea Labor Institute
June Dong Kim
Sangkyom Kim
Seung Kwon Kim
Senior Research Fellow, Korea Institute for Health and Social Affairs
Young-Ock Kim
Senior Research Fellow, Korean Women’s Development Institute
Young-Pyo Kim
Senior Research Fellow, Korea Research Institute for Human Settlements
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Youngsun Koh
Senior Research Fellow, Korea Development Institute
Hongshik Lee
Professor of Economics, Korea University
Junkyu Lee
Research Fellow, Korea Institute for International Economic Policy
Sang Young Lee
Research Fellow, Korea Institute for Health and Social Affairs
Young Lee
Professor of Economics, Hanyang University
Il SaKong
Chairman of the Presidential Committee for the G20 Seoul Summit
Yoocheul Song
Professor of International Business, Dongduk Women’s University
Jin Kyo Suh
Director, Department of Planning and Research Coordination, Korea Institute for International Economic Policy
Jungho Yoo
Professor, Korea Development Institute School of Public Policy and Management
Deok Ryong Yoon
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60YEARS
THE KOREAN ECONOMY
Chapter 1
Introduction
IlSaKong
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In the last six decades, Korea has achieved unparalleled economic growth. Korea was
one of the poorest countries in the world in 1948 when the government was first
established. Now it has grown into a global economic player with a solid industrial base.
In the meantime, democracy and pluralism have taken firm root in Korean society. It is no
exaggeration to say that Korea is one of only a handful of countries that have combined
economic success with democratic transition in the post-World War II era.
The transformation of the Korean economy can be summarized in two words－
industrialization and globalization. The share of the industrial sector (manufacturing,
construction and public utilities) in total value-added more than doubled from 17 percent
in the 1950s to 38 percent in the 1980s, and has fluctuated around this level ever since. The
service sector has also increased its share from 41 percent in the 1950s to 60 percent in the
2000s. By contrast, the primary sector has experienced a precipitous fall in its share from
42 percent to 3 percent in the same period. Along with rapid industrialization, integration
into the global economy accelerated, as indicated by total trading volume, which rose from
about 10 percent of GDP in the 1950s to 80-90 percent in recent years. Cross-border capital
flows also increased rapidly in this period.
The industrialization of the Korean economy has been greatly affected by the
globalization trend. International trade offered a vast global market for Korean producers.
It also enabled them to import intermediate goods and advanced technologies needed for
the production of export goods. At the beginning, the international division of labor
prompted the growth of labor-intensive industries in which Korea had a comparative
advantage. These industries absorbed surplus labor from rural areas and contributed to an
increase in per capita income and savings rates. Later, as capital accumulation progressed,
the comparative advantage shifted from labor-intensive to capital-intensive industries, and
the latter began to dominate industrial production and exports. Per capita income
continued to grow rapidly as productivity improved.
In the process of industrialization and globalization, the policy stance of the government
underwent a few significant changes. In the aftermath of the Korean War, the government
focused on meeting the immediate consumption needs of the population. It was only in
the 1960s that a systematic effort to jump-start the economy was initiated. The government
actively promoted exports with pecuniary and other incentives given to exporters. Initially,
these incentives were non-discriminatory in the sense that all exporters with a good export
performance were entitled to them regardless of their business sector. In the 1970s,
however, as the government came to concentrate its efforts on promoting heavy and
chemical industries (HCIs), government intervention in the market became more selective
and discriminatory. The government also strengthened its control of the financial market to
003Introduction

direct resource allocation in favor of the HCIs.
The government-led growth strategy, as exemplified by the HCI drive, produced many
problems, including a serious misallocation of resources, chronic inflation, and greater
income inequality. In the early 1980s, the government made a radical departure from the
past by emphasizing price stability over economic growth. It also encouraged private
initiatives and began to liberalize the market. More attention was given to social policies,
with a corresponding increase in public spending on health, welfare and education.
Throughout its economic history, Korea has had its fair share of failures as well as
successes. Financial repression since the 1960s held back the financial sector from
developing into a fully competitive service industry. A number of large business
conglomerates, namely the chaebol, increased their influence on the back of government
support, and the concentration of economic power emerged as an important economic
and social issue. In addition, Korea failed to establish sound worker-management relations
until disruptive labor movements appeared in the mid-1980s.
Most importantly, the repeated interventions by the government to salvage troubled
firms from bankruptcy strengthened the so-called“too-big-to-fail”principle. Combined
with very low interest rates maintained since the 1960s, the risk partnership between the
government and private sector encouraged excessive borrowing by the latter. The average
corporate debt-to-equity ratio hovered between 300 and 400 percent between the 1970s
and 1990s. The non-performing loans of banks grew in size, and the financial sector
became increasingly vulnerable to external shocks.
The financial crisis of 1997, while inflicting extreme hardship on many Koreans, worked
as a catalyst in solving many of these problems. Many chaebol went bankrupt and the
public-private risk partnership disappeared. Government-led restructuring strengthened the
financial health of the banking sector significantly. External liberalization, especially the
opening of capital markets, accelerated Korea’s integration into the global economy. While
pursuing liberalization, the government also modernized and strengthened prudential
regulation and competition policy. A modern economic system finally came into
operation.
On the other hand, concerns have been raised in the 2000s on the growth potential of
the Korean economy. Economic growth began to slow in the 1990s with the decelerating
growth of the working-age population. Income distribution also started to deteriorate in
the early 1990s, with the expansion of the knowledge-based economy and globalization
leaving low-skilled workers at a disadvantage. At the same time, productivity gaps
between manufacturing and services, between the HCIs and light industries, and between
large and small companies are widening, and access to quality jobs is becoming more
004THEKOREANECONOMY

difficult.
Summarized in this way, the economic history of Korea poses many interesting and
important questions. For example, what are the main characteristics that distinguished
Korea from other developing countries that failed to establish an industrial base? What are
the commonalities and disparities between Korea and other East Asian countries that
achieved similar economic success? Were financial repression, the HCI drive, and
oppressive labor market policies inevitable choices for Korea? What would have a more
liberal, market-friendly policy achieved? These questions hold relevance not only for Korea
but other countries, and continue to generate discussions in academic and policy circles.
To contribute to this debate, the following chapters describe the growth of the Korean
economy from various perspectives. Chapter 2 chronicles the various market interventions
made by the Korean government, including export promotion, the HCI drive, financial
repression, the bail-out of private companies, and price controls. Some of the
interventions, notably export promotion and investment in infrastructure and education,
successfully addressed market failures and contributed to economic growth. But many
others did more harm than good to the long-term growth and stability of the Korean
economy. The author concludes that the government can and should play an important
role in a country’s economic growth, but try to avoid the errors made by the Korean
government.
Chapter 3 documents Korea’s industrialization process, and offers an explanation on its
structural changes in the growth accounting framework. The rapid capital accumulation
based on Korea’s high savings rate accounts for a large part of output growth as has been
noted in the existing literature. No less important, however, has been the rapid increase in
total factor productivity (TFP). Among other factors, international trade has made a
particularly important contribution to TFP growth by stimulating innovation and
technological progress and by encouraging the reallocation of resources from less to more
productive sectors. The authors point out that a critical task for the Korean government is
to maintain dynamism in the private sector, rather than designating certain industries as
“strategic”and providing them with subsidies in the name of industrial policy.
Chapter 4 explains the development of external economic policies in various areas－
trade, foreign direct investment, economic cooperation, agriculture, services and financial
markets. According to the authors, three rounds of devaluation in 1960 and 1961 prompted
a sudden jump in exports in the early 1960s and led to a policy switch in the mid-1960s
from import-substitution industrialization to export promotion. Various export-promotion
measures neutralized the depressing effects of the protectionist policy on exports and
cleared roadblocks to allow the growth of Korean exports in the global market. In this
005Introduction

respect, a major contribution by the Korean government to export growth in the 1960s and
thereafter lay in eliminating market distortions created by overvaluation and protectionism.
Building on past success, future efforts should be directed at pursuing external
liberalization consistently in all areas and strengthening market mechanisms.
Chapter 5 reviews Korea’s territorial development over the last sixty years. In Korea,
territorial policy has been assigned three main responsibilities: (1) supplying physical
infrastructure for economic growth, (2) stabilizing real estate prices, and (3) promoting
balanced regional growth. The first of these has achieved tremendous success thanks to
heavy government investment, while the other two goals have fallen short. Various
measures to reduce speculative real estate demand often increased price instability in the
market. More successful in curbing property prices were the measures to increase the
housing supply, such as the construction program adopted at the turn of the 1990s. The
Korean government has also made recurrent efforts to promote balanced regional growth,
but the population has continued to be concentrated in the capital region. A more market-
friendly approach to regional development is called for that focuses on building“soft”
infrastructure in regional communities while allowing the dynamic reallocation of resources
across the country.
Chapter 6 examines Korea’s social development with a focus on education, the labor
market, welfare and health care policies. Up to the early 1990s, Korea could maintain
relatively equitable income distribution due to several factors, including the explosive pace
of economic growth and the rapid creation of jobs; the promotion of mass education by
the government; and a labor market that functioned smoothly in most areas. But Korea
currently faces many new challenges. It needs to upgrade the quality of education by
decentralizing the education system and giving more power to parents and students. The
sharp contrast in the labor market between core and periphery workers should be
mitigated by relaxing legal employment protection provisions on the one hand and
strengthening social welfare and active labor market programs on the other. Welfare
policies achieved great progress, especially after the 1997 financial crisis, but further efforts
are required to improve their effectiveness, minimize their adverse impact on work
incentives, enhance long-term financial sustainability, and give a greater role to the private
sector in the provision of services.
To summarize, Korea has achieved not only tremendous economic growth but also
broad-based social development in the last sixty years. Government policies have been
broadly in line with market principles, in particular in regard to exchange rate and trade
policies. Many challenges remain, but as long as Korea maintains its economic and social
dynamism, the future will favor Korea.
006THEKOREANECONOMY

60YEARS
THE KOREAN ECONOMY
Chapter 2
The Growth of
Korean Economy
and the Role of
Government
YoungsunKoh

1. Introduction
Korea has achieved rapid economic growth and social development in the last five
decades. Per capita income grew from 1,342 dollars1
in 1960 to 19,227 dollars in 2008. In
the same period, life expectancy rose from 52.4 years to 79.6 years and infant mortality
declined from 70 deaths per 1,000 births2
to 3.4 deaths. The political structure also
switched from an authoritarian one to a fully functioning democracy.
In the 20th century, such sustained growth over decades can be found in only a handful
of developing economies, including Korea and other East Asian countries. Their socio-
economic achievements have often been described as a‘miracle.’Various interpretations
have been offered for the role that governments played in leading or supporting these
achievements (Aoki, Kim and Okuno-Fujiwara, 1997).
According to the market-friendly view, the rapid growth was made possible by the
government maintaining macroeconomic stability and heavy investments in human capital.
On the other hand, the selective promotion of particular industries by government was
either ineffective or counter-productive to overall growth since it hampered an efficient
allocation of resources. This view, as represented by the World Bank (1993), Noland and
Pack (2003), Jungho Yoo (2004) and others, emphasizes the primary role of government in
helping the market mechanism to function properly.
At the opposite end of the spectrum is the development-state view, which claims that
prevalent market failures in the early years necessitated government intervention to correct
them. East Asian countries purposefully distorted relative prices (“getting the prices
wrong,”Amsden, 1989) and boosted investment in particular sectors, attaining rapid
industrialization that would have been otherwise impossible.
In the case of Korea, the truth may lie somewhere in between these two extreme views.
Government intervention appears to have been more extensive than the World Bank
(1993) admits. The promotion of exports in the 1960s and heavy and chemical industries
(HCIs) in the 1970s was based on severe financial repression. The period up to the 1980s
was characterized by high import barriers, restrictions on capital flows, widespread price
controls, and repressive labor practices. On the other hand, a relatively stable
macroeconomic environment, well-established private property rights, and large public
spending on education (particularly primary education) and infrastructure investment were
market-friendly aspects of government policy often ignored by proponents of the
1 In 2008 constant won converted into dollars using the exchange rate in 2008.
2 This figure is for 1960-1965.
TheGrowthofKoreanEconomyandtheRoleofGovernment009

development-state view.
Some authors have noted that Asian countries did not take the same road to growth
(Perkins, 1994). Hong Kong and Singapore adopted laissez-faire attitudes from the
beginning, whereas Japan, Korea and Taiwan took more dirigiste approaches in varying
degrees. Late industrializers like Malaysia, Indonesia and Thailand, with their abundant
natural resources, relied heavily on foreign direct investment. China and India were
distinctive in their eagerness not only to invite foreign direct investment but also to go
abroad to acquire foreign firms. It would therefore be inappropriate to treat all Asian
countries in the same manner.
At any rate, few would argue that government intervention should continue in managing
the Korean economy. Past interventions produced various problems, including an
underdeveloped financial sector, excessive corporate reliance on debt financing, the
accumulation of non-performing loans by banks, the concentration of economic power in
the hands of a few large business conglomerates (the chaebol), chronic inflation, and weak
democracy. Recognizing these problems, the government began efforts in the 1980s to
liberalize the market and redefine its role. These efforts were not always successful,
however, and full-scale liberalization was postponed until after the economic crisis of 1997.
This chapter discusses the history of the Korean economy during the last six decades.
The central questions are whether various government interventions promoted or retarded
economic growth, and what kind of policy lessons we can now draw for Korea and other
developing countries. Of course, we should expect no definitive answers to such grand
questions, but only meaningful insights that may guide further research.
2. Liberationandstate-building(1948-1959)
The liberation from Japanese colonial rule in 1945 left Korea in economic chaos. The
complementary economic structure between the northern and southern parts of the
peninsula was lost. Most of the Japanese businessmen, managers and technicians returned
to Japan, leaving many firms bereft of management or technical expertise. The closely-knit
ties with the Japanese economy, a vast market for Korean goods, were broken. A
stupendous growth in money supply around the time of the liberation period generated
hyperinflation. Amid these difficulties, the newly independent Korean government was
installed in 1948, and it immediately embarked on rebuilding the nation. Any serious effort,
however, was delayed by the Korean War (1950-1953).
010THEKOREANECONOMY

011
2.1 Establishingamarketeconomybasedonprivatepropertyownership
The American military government which was in charge of South Korea between 1945
and 1948 tried to introduce a modern market economy system.3
It outlawed the so-called
“workers’self-management”of factories abandoned by Japanese owners and barred
workers from interfering with managerial responsibilities (Yong-deok Jeon, 1997a). The
military government also began to sell confiscated Japanese-owned property despite calls
for nationalization from both right- and left-wing political groups. The realized sales of
companies and farmland during the three-year U.S. military rule were not large in size, but
this was an important first step toward establishing a market economy based on private
property ownership.
Divesture continued under the newly established Korean government, and sales reached
a peak in 1951-1953. As a result, most of the Japanese-owned properties were converted
into private ownership by 1958. They accounted for a large portion of the total national
economy; for example, among the companies with 300 or more employees, the share of
privatized ones was roughly 40 percent in the 1950s. This achievement is notable given the
predisposition toward socialism even among right-wing politicians at the time.4
2.2 Agriculturallandreform
Land surveys and registration conducted by the colonial government in the 1910s
established the first modern system of property rights in Korea and reduced land
transaction costs significantly. But it was not accompanied by measures to protect small
farmers, and led to a wide disparity in agricultural land holdings (Seok-gon Cho, 2001).
The Korean government responded to the increasing demand for agricultural land reform
by enacting the Farmland Reform Act of 1949 and revising it in 1950. The reform was
based on the principle of“compensated forfeiture and non-free distribution,”whereby the
government bought farmland from landlords at forced prices and sold it to farmers at
below-market rates.
The reform had many elements that ran counter to private property rights. The
compensation to landlords was less than the market price, leading to big losses for the
landlords (Yong-deok Jeon, 1997b).5
The Farmland Reform Act also banned farmland
TheGrowthofKoreanEconomyandtheRoleofGovernment
3 The North was occupied by Soviet Union until a separate government was established in 1948.
4 In fact, the first Constitution of 1948 mandated companies of major importance to be nationalized or controlled by the government.
Following this mandate, the government designated 50 companies as state-owned enterprises in 1951. The Constitution, however,
was revised in 1954 as agreed by the Korean and American governments, and divestures gained speed to encompass all
industries except a few strategic ones.

ownership by non-farmers, stipulated the maximum amount of landholdings per farmer,
and prohibited tenant farming. Nevertheless, from the perspective of private property
rights,“compensated forfeiture and non-free distribution”was a better option than
“uncompensated forfeiture and free distribution”as espoused by left-wing groups and
“compensated forfeiture and free distribution”by centrist groups. The most pressing task
at the time was state-building, based on the support of farmers who constituted by far the
largest part of the Korean population, even if this meant some infringements on the private
property rights of landlords.
Agricultural land reform contributed not only to state-building, but also to redistributing
wealth and reducing income inequalities. Everyone was now placed on a more or less
equal footing, and individual effort and ability rather than family wealth became the most
important determinant for individual success. Many believe that the Koreans’characteristic
diligence and their emphasis on education were motivated by this perception of equal
opportunity. On the negative side, however, restrictions on farmland holdings hampered
the growth of large-scale farming and contributed to the low productivity growth of the
agricultural sector in later years.
2.3 Economicreconstructionplansandforeignaid
Rhee Syngman, the first president of the young republic, strived to rebuild the economy
with a series of reconstruction plans.6
These plans aimed to expand the economic
infrastructure, build key industries (cement, steel, etc.) and increase the productive
capacity of manufacturing (Sang-oh Choi, 2005, pp.358-359).
Rhee’s desire to construct a self-sufficient Korean economy with these plans was in
direct conflict with the American government’s intention to rebuild an East Asian economic
bloc with an industrialized Japan at its center. America urged Korea to liberalize its market,
stabilize the value of the Korean currency, and expand cooperation with Japan. To Rhee,
however, this implied nothing but the revival of the Greater East Asian Co-Prosperity
Sphere and the re-colonialization of the Korean economy. Rhee made full use of Korea’s
geopolitical value to frustrate America’s effort while promoting import-substitution
industries through reconstruction plans.7
5 The forced prices were well below market prices. In addition, the delay in payments due to the war, combined with high inflation,
significantly eroded the real value of“land compensation securities”that had been given to landlords in exchange for their lands.
6 The Five-Year Industrial Reconstruction Plan (1949), Reconstruction Plan (1951), Comprehensive Reconstruction Plan (1954),Five-
Year Economic Reconstruction Plan (1956), and Three-Year Economic Development Plan (1960). These kinds of development plans
could be found not only in socialist economies, but also in capitalist ones such as France after the Second World War (Yergin and
Stanislaw, 1998).
7 The Taiwanese government was much more cooperative than Korea was with the Americans (Jung-en Woo, 1991, p.52).
012THEKOREANECONOMY

013
The Korean government also differed with the Americans on what kind of foreign aid it
would receive. There were two types, one being project assistance and the other non-
project assistance. The former was to be used for reconstruction, while the latter was to be
distributed to private enterprises for civilian use. Korea received a large amount of foreign
aid from the United Nations and the U.S. in the 1950s and 1960s.8
The Korean government
preferred project assistance, while the American government preferred non-project
assistance. In the end, the American preference prevailed; under ICA (International
Cooperation Administration) aid, for example, project assistance made up 27 percent of the
total and non-project assistance 73 percent.
In any event, various reconstruction plans prepared by Rhee’s administration failed to
spark economic growth in Korea. They remained just that－plans.
2.4 Exchangerateandtradepolicies
Throughout the 1950s, the Korean government maintained a complicated multiple
exchange rate system (Frank, Kim and Westphal, 1975). In addition to the official rate,
there were separate rates applied to the counterpart fund9
and to military payments
certificates (MPCs).10
The overvaluation of the Korean won under these rates either
reduced the government’s burden (as in the case of the counterpart fund rate) or increased
its revenues (as in the case of the MPC rate). The government reluctantly adjusted
exchange rates from time to time when it could no longer withstand pressure from
America.
An overvalued exchange rate discouraged imports. Imports were further discouraged by
quantitative restrictions that the Korean government employed to promote import-
substitution industrialization. Trade Programs, which were published semi-annually by the
Ministry of Commerce and Industry, listed three types of goods: (1) freely-imported items,
(2) restricted items whose import required prior approval from relevant ministries, and (3)
banned items (Sang-cheol Lee, 2001, p.459). Banned items referred to those that were
produced domestically in sufficient quantity to meet all domestic demand. Restricted items
8 The amount of aid as a proportion to GDP corresponded to a low of 11 percent in 1954 and a high of 23 percent in 1957 (Sang-oh
Choi, 2005, p.362).
9 The foreign aid often took the form of the right to import from America or other countries a certain amount of goods in dollar
terms. A private importer or a government agency that was allocated these rights had to deposit Korean currencies in the
counterpart fund held by the Bank of Korea. The low won/dollar value of the counterpart fund rate meant a smaller burden for
the importer or the government agency (Younghoon Rhee, 2007, pp.302-303).
10 During the war, American and other military forces needed a means of payment for local goods and services they purchased. To
facilitate this, the Korean government turned over to the United Nations Command a large amount of won in advance with the
understanding that the terms of repayment in dollars would be negotiated later. In the negotiations, the Korean government tried
to keep the won/dollar exchange rate at low levels to maximize its dollar receipts (Krueger, 1977).

were those whose domestic production could not meet all demand.
The tariff system was also geared to protecting domestic industry. From 1945 to 1949, a
single tariff rate of 10 percent was levied on all items except for foreign aid goods. In 1950,
the government enacted the Tariff Act that imposed different rates depending on whether
the item was produced domestically or not, and whether the item was a finished good or
not. Tariff rates were generally high, ranging between 27.4 and 66.5 percent in the latter
half of the 1950s.
Export promotion was also pursued, but the focus was not on actively promoting
exports but on mitigating the impediments to exports. An example is the Foreign
Exchange Deposit System, which allowed exporters to deposit foreign currencies earned
from exports at the Bank of Korea (BOK) and to use them to pay for imports or sell the
foreign currencies to other importers at market rates. However, direct subsidies for exports
were minimal.
2.5 Financialmarketpolicies
According to Jung-en Woo (1991, p.60), Korea in the 1950s exhibited a textbook
example of financial repression. The official lending rate by banks was capped at 20
percent when the curb market rate was well above that.11
In addition, the credit priority
regulation and the credit ceiling regulation enabled the government to control bank
lending directly (Pyung-joo Kim, 1995, p.188).
In January 1954, the Korea Development Bank (KDB) was launched as a solely
government-owned bank. Its mission was to provide long-term credits to key industries. It
financed over 70 percent of total equipment loans and over 10 percent of total working
capital loans made by financial institutions (Joon-kyung Kim, 1993). It raised funds by
borrowing from the government fiscal loan program (50 percent of the funds in the 1950s)
and issuing bonds (37 percent).
The real interest rate remained negative most of the time due to low official rates and
high inflation, discouraging savings and increasing demand for credit. Credit demand
always surpassed savings despite the regulations mentioned above, and commercial banks
had to rely on the central bank rediscount facility to fill the gap. Before 1957, about half of
bank lending was financed by the central bank in this way (Jung-en Woo, 1991, p.62).
The excessive reliance on the central bank rediscount facility inevitably generated high
inflation. Money supply was increased further by central bank lending to the government
11 The curb market rate was 48-120 percent according to Sang-cheol Lee (2001, p.463) and 150-240 percent according to Jung-en
Woo (1991, p.61).
014THEKOREANECONOMY

015
to finance essential public services, such as defense and the police. Annual inflation
fluctuated between 20 and 400 percent between 1946 and 1957 (Table 2-1). The root cause
of high inflation lay in the lack of operational independence of the central bank. Arthur
Bloomfield, an economist at the New York Fed, recommended the establishment of an
independent central bank resembling the Federal Reserve Bank. Following his advice, the
Bank of Korea Act and the Banking Act were enacted in May 1950. The Bank of Korea Act,
however, failed to bestow full independence on the central bank.
Table 2-1.Price inflation
(Unit: %)
Source: Bank of Korea (2005a).
The implementation of the Banking Act was postponed until August 1954 due to the
delay in the privatization and recapitalization of banks. From 1954, the government
attempted five times to sell its shares in banks, but failed. It could finalize the sales in
February 1957 only after relaxing the eligibility conditions for bids. In the end, each major
chaebol came to own a bank, which accelerated the concentration of economic power
(Pyung-joo Kim, 1995, p.190). The military government re-nationalized the banks in 1961
shortly after seizing power.
2.6 Performanceofeconomicpoliciesinthe1950s
Throughout the 1950s, the Korean government maintained an overvalued exchange
rate, restricted imports, regulated interest rates and bank lending, and undermined central
bank independence. These market interventions created economic rents, which amounted
to 16-19 percent of GNP according to Nak-nyeon Kim (1999). Of these, the rents resulting
from exchange controls amounted to 11-15 percent of GNP and those resulting from
financial repression 3-8 percent of GNP.
The question is how much of these rents were utilized in productive activities. Sang-oh
Choi (2005) observes that rents were distributed mostly to those who put them to
productive use, and stimulated economic reconstruction at the time. He cites the case of
the cotton spinning industry, which lost 66 percent of its facilities during the war, but
recovered soon after and even encountered over-capacity in the latter half of 1956.
Younghoon Rhee (2007) also claims that the government maintained a certain degree of
1946 1947 1948 1949 1950 1951 1952 1953 1954 1955 1956 1957 1958 1959
Producer price 385.4 73.9 62.9 36.7 - - - 25.3 28.2 81.1 31.6 16.2 -6.2 2.6
Consumer price 280.4 78.9 58.4 24.9 167.5 390.5 86.6 52.5 37.1 68.3 23.0 23.1 -3.5 3.2

consistency and ethical standards in distributing dollars obtained from foreign aid and
military payment advances to civilians. In fact, real output grew by 3.8 percent annually in
1953-1960. This is about half the rate witnessed in the 1960s and afterwards, but it can
hardly be called“stagnation.”
Contrary to these views, some authors believe that the government policies at the time
encouraged zero-sum rent-seeking activities rather than positive-sum productive ones,
leading to the underperformance of the Korean economy far below its growth potential.
Jones and SaKong (1980, pp.270-274) describe the rapid growth of the chaebol after the
liberation, and declare that the major sources of accumulation were (1) non-competitive
allocation of import quotas and import licenses, (2) the bargain price acquisition of former
Japanese properties, (3) the selective allocation of aid funds and materials, (4) privileged
access to cheap bank loans, and (5) the non-competitive award of government and U.S.
military contracts for reconstruction activities. To be successful as an entrepreneur, one had
to build close ties with politicians and return their favors with cash (Jung-en Woo, 1991,
pp.65-69).
However plausible each of these contrasting views is, it is not possible to make any
quantitative judgment on this issue. We will conclude this section by looking at policy
changes taken in 1957. In the mid-1950s, the view gained wide support within America
that the best way to win the war against communism lay in promoting the economic
growth of its allies. The American government subsequently separated military and
economic aid, and began to reduce the former while increasing the latter. In addition, it
reduced unrequited transfers and introduced the Development Loan Fund in its place.
American aid to Korea peaked in 1957 and declined rapidly thereafter. At the same time,
the American government pressed the Koreans to adopt the Financial Stabilization Program
(1957-1960) to eliminate large budget deficits and curb rapid monetary expansion. Unlike
previous efforts, stabilization under the Program relied on a systematic framework
comprising annual targets for M1 growth and quarterly and monthly implementation plans.
This provided the first opportunity for Korean officials to learn the techniques of
controlling money supply (Pyung-joo Kim, 1995, p.187).　
3. Export promotion and government-led industrialization
(1960-1979)
Park Chung-hee, who came into power in 1961 through a military coup, adopted a
government-led growth strategy to build an industrial base for Korea. The strategy rested
on promoting exports and heavy and chemical industries (HCIs). For this purpose,
016THEKOREANECONOMY

financial repression was continued and imports were restricted. Below we will explore
various aspects of the growth strategy in the 1960s and 1970s.
3.1 Exportpromotion
As the new president, Park proclaimed that economic development would be the central
agenda of his administration (Soon Cho, 1991, pp.175-177). He and his aides understood
the importance of economic success in legitimizing their forceful seizure of power. Their
ideological orientation was far from a free market economic model and they made many
mistakes.12
Still, they managed to adopt active export promotion and this later turned out
to be the most important reason for their success.
Initially, export promotion was pursued in response to the rapid depletion of foreign
exchange reserves (Sang-cheol Lee, 2005, p.394). The reserves began to decline in March
1962 due to the large repayment of short-term commercial loans raised in 1961 and 1962 to
finance the first Five-Year Economic Development Plan (1962-1966).13
Faced with the
specter of a foreign exchange crisis, the government introduced various measures. In
January 1963, the export-import link system was introduced to give exporters the right to
import foreign goods equal to the full amount of exports.
In the meantime, exports began to grow rapidly following the two rounds of
devaluation in February and October of 1960.14
Starting with a 66 percent growth in 1960,
exports increased by 43 percent a year up to 1964. Bolstered by the success, the
government started more serious efforts to promote exports in 1964-1965. First, a new
exchange rate regime was announced in May 1964. Multiple fixed rates were consolidated
into a single variable rate, and the won was devalued by almost half from 130 to 255 won
per dollar. The real exchange rate has maintained a competitive and stable level since
then. Figure 2-1 shows the won/dollar real exchange rate and the won’s real effective
exchange rate over the past decades, and compares them to the dollar’s performance.
At the same time, the government phased out various ad hoc export subsidies and the
export-import link system, and established a comprehensive and consistent export
incentive mechanism (Kwang Suk Kim, 1994, p.322; Choong Yong Ahn and Joo-Hoon
Kim 1995, p.324). Key measures were (1) export credits that were automatically extended
12 They abandoned the Financial Stabilization Program and adopted expansionary fiscal and monetary policies in the first two years
of the first Five-Year Economic Development Plan (1962-1966). They carried out a currency reform in May 1962 to mobilize idle
domestic capital held by households, but it failed to disgorge the funds. The new administration also attempted unrealistic and
wasteful investments in the domestic production of cars and color TV sets, but abandoned the projects shortly thereafter.
13 The reserve fell by half (from 205 to 107 million dollars) in nine months between December 1961 and September 1962.
14 The Korean government reluctantly accepted these devaluations in accordance with the agreement with the U.S. government.
See Chapter 4 for further discussion on export promotion policies in the 1960s.

to exporters who turned in letters of credit and (2) tariff exemptions on imports of
intermediate inputs.15
Of particular importance were the export credits, whose share in
total bank credit rose from 4.5 percent in 1961-1965 to 7.6 percent in 1966-1972 and then
to 13.3 percent in 1973-1981 (Table 2-2). The interest rate on export credits was kept at
low levels, and the gap with the general interest rate reached 17 percentage points during
the high-interest rate period of 1966-1972.
Figure 2-1. Movement of real exchange rates (1945-2009)
Note: A rise in exchange rate indicates a decline in the value of domestic currency.
Source: OECD (http://stats.oecd.org); Bank of Korea (2005a).
Table 2-2. Export credit by banks
(Unit: %)
Source: Joon-kyung Kim (1993), Table 4-3; Bank of Korea (http://ecos.bok.or.kr).
These incentives were augmented by administrative measures. First, a target was set for
018THEKOREANECONOMY
1961-1965 1966-1972 1973-1981 1982-1986 1987-1991 1992-2001 2002-2008
Share of export credit in total bank credit 4.5 7.6 13.3 10.2 3.1 2.0 1.5
Interest rate on export credit (A)
General interest rate (B)
(B-A)
9.3
18.2
8.9
6.1
23.2
17.1
9.7
17.3
7.6
10.0
10-11.5
0-1.5
10-11
10-13
0-2.0
15 Other measures for export promotion included (3) indirect tax exemptions on intermediate inputs and exports, (4) direct tax
exemptions on exporters (abolished in 1973), (5) wastage allowance for imports of raw materials, (6) registration as an importer
conditional on export performance, (7) tariff and indirect tax exemptions granted to domestic suppliers of exporters, and (8)
accelerated depreciation of fixed assets in major export industries.

019
each year’s total exports by adding up the export forecasts of individual firms. This practice
was often called“export targeting.”Second, Monthly Export Promotion Meetings were
held, where government officials and business representatives gathered to monitor export
performance, compared it to export targets, identified problems, and sought solutions. The
president himself chaired the meetings. Third, the Korea Traders Association and the Korea
Trade Promotion Agency (KOTRA) were launched. KOTRA took charge of building overseas
networks, helped the marketing activities of domestic firms, and collected market information.
Exports as a proportion of GDP rose from 5 percent in 1963 to 28 percent in 1973
(Figure 2-2). International trade is known to produce multiple benefits.16
The question is
whether various schemes introduced in the mid-1960s were really helpful in promoting
exports. Kwang Suk Kim (1994, p.326) notes that they did not raise financial gains for
exporters much. Even before the exchange rate reform, exporters could convert their
foreign currency earnings into domestic currencies at market rates through the foreign
exchange deposit system. Devaluation of the won therefore did not suddenly increase
exporters’profits. The total amount of various subsidies to individual exporters was also
similar in the 1950s and 1960s. Jones and SaKong (1980, p.96) propose other reasons for
the rapid growth of exports. According to them,“the most important cause for the change
was probably the reduction of alternative higher-yielding sources of entrepreneurial
income. If you can make 100 percent in a few months with little risk, through privileged
access to foreign exchange, there is little point in devoting effort to the difficult and
complicated task of exploring export markets and putting together internationally
competitive productive combinations. The exchange rate reform closed out the zero-sum
sources of rent, reduced opportunity costs, and drove rent-seekers into productive positive-
sum activity.”They also note that other factors such as the decline in exchange rate
variability and the commitment to growth by a politically stable government must have
played an important role in creating a favorable business climate. TheGrowthofKoreanEconomyandtheRoleofGovernment
16 First, international trade enhances the division of labor as countries specialize in their areas of comparative advantage.Second,
integrated markets enable producers and consumers to reap the full benefits of economies of scale. Third, stronger competitive
pressure prompts producers to reduce inefficiencies and invest in productivity-enhancing capital goods and innovation (OECD,
2007, pp.6-7). In addition, exporters from developing countries can gain knowledge of product development,manufacturing,
marketing, and other modern practices in advanced countries (Je-min Lee, 2001, pp.493-495). The knowledge gained is
subsequently disseminated to other parts of the economy, leaving positive externalities.

Figure 2-2. Exports and imports (1953-2009)
Source: Bank of Korea (http://ecos.bok.or.kr).
3.2 Government-ledindustrialization
“Industrialization”was the central theme of the Five-Year Economic Plans that started in
1962. The initial version of the first Plan (1962-1966) assigned 34 percent of gross
investment to mining and manufacturing (Eun-bok Lee, 1986, pp.777-778). The revised
version (1964) declared the Korean government’s ambition to modernize the industrial
sector and enhance its international competitiveness by rapidly expanding key industries
(cement, fertilizer, industrial machinery, oil refinery and others), fostering related industries,
and promoting new export and import-substitution industries.
The second Plan (1967-1971) placed emphasis on HCIs, including steel, machinery and
petrochemical industries. In case of steel industry, the Steel Industry Promotion Act was
enacted in 1969 to support the construction of a large-scale integrated iron and steel mill
and other kinds of mills by granting tax exemptions to them (Ki-jun Lee, 1986, p.786). In
other industries, similar laws－the Machinery Industry Promotion Act (1967), the
Shipbuilding Industry Promotion Act (1967), the Textile Industry Modernization Act (1967),
the Electronics Industry Promotion Act (1969), the Petrochemical Industry Promotion Act
(1970), the Nonferrous Metal Producing Business Act (1971)－were introduced to provide
financial and tax incentives to these industries (Kwang Suk Kim and Joon-kyung Kim,
1995, p.49). Of particular importance to the government was the construction of a
petrochemical complex and an integrated iron and steel mill. Both projects had to rely
020THEKOREANECONOMY

021
almost entirely on foreign technology and capital, and they encountered many difficulties
at the beginning. Construction began in 1969 and 1970, respectively, after several years of
struggle.
The government also made considerable efforts to alleviate shortages in economic
infrastructure. Electric power development projects were carried out from 1962 and the
supply of electric power came to exceed demand in the mid-1960s. Road construction also
succeeded in easing transport difficulties with the completion of major expressways. The
Seoul-Incheon, Seoul-Busan and Honam Expressways were opened in 1968, 1970 and
1973, respectively.
A full-scale drive toward HCIs began in 1973. On January 1st, Park Chung-hee stated in
his New Year’s press conference that“the government is announcing the HCI project to
promote HCIs. To achieve a 10 billion dollar target of annual exports by the early 1980s,
the share of HCIs in total exports should be raised to well over 50 percent. From now on,
the government will accelerate the promotion of HCIs such as steel, shipbuilding and
petrochemical industries, and thereby increase their exports (Yeong-koo Park, 2005,
p.406).”The HCI Drive Committee was organized shortly after, and the Committee
presented the HCI Drive Plan in June. Targets were set to achieve per capita income of
1,000 dollars and annual exports of 10 billion dollars. Through industrial deepening and
export mix upgrading, the share of HCIs in total industrial production was to be raised
from 35 to 51 percent between 1972 and 1981, and their share in total exports from 27 to
65 percent. For this purpose, six strategic industries－steel, nonferrous metal, machinery,
shipbuilding, electronics, and chemical engineering－were selected. The Plan was revised
slightly in the fourth Five-Year Economic Plan (1977-1981) prepared after the first oil
shock, but in most part, it was pursued with great consistency until the Comprehensive
Economic Stabilization Program was introduced in April 1979.
Various reasons have been suggested for the adoption of the HCI drive (Choong Yong
Ahn and Joo-Hoon Kim, 1995, p.329). First, the government felt the urgent need to
strengthen its self-defense capacity by building a defense industry. Concerns about national
security grew as North Korea’s military provocations increased in frequency toward the
end of the 1960s. Furthermore, the American government announced in 1968 that its
ground troops would be gradually pulled out of Korea in 1971-1975. Second, it was
considered necessary to upgrade the industrial structure and find new export industries to
maintain a safe lead over newly industrializing countries. Policymakers thought that HCIs
would provide new sources of growth.
Government support to HCIs took various forms; (1) providing long-term credits and tax
incentives to selected industries; (2) establishing and expanding vocational schools and

training centers to supply skilled manpower; and (3) creating government-funded research
institutions to carry out R&D activities as a public good (Kwang Suk Kim, 1994, pp.347-
348; Choong Yong Ahn and Joo-Hoon Kim, 1995, p.330).
Perhaps the most important of these were the credit programs. By controlling the
financial sector, the government could supply vast amount of directed credits with low
interest rates and share investment risk with private enterprises. The National Investment
Fund (NIF), established in 1974, played an important role in this regard. Banks, insurance
companies and public funds were required to lend a certain portion of their funds to NIF.17
The NIF lent these funds in turn to financial institutions at low interest rates (5 percentage
points below the rates on general long-term bank credits on average before 1982) for very
long periods (8-10 years in some cases). In 1974-1991, 80 percent of the lending was
assigned to specialized banks (including development banks), 17 percent to commercial
banks, and 3 percent to regional banks. In 1974-1981, 62 percent of NIF lending was
assigned to KDB, and the NIF accounted for 57 percent of total equipment loans by
financial institutions. This share reached 70 percent in the late 1970s, when big industrial
complexes were being built around the country.18
Figure 2-3. Marginal effective tax rates on corporate income
Source: Tae-won Kwack (1985). Recited from Jungho Yoo (1991).
022THEKOREANECONOMY
17 To lend to NIF, banks set aside 10-30 percent of the increase in deposits, insurance companies 40-50 percent of total premium
collection, and public funds (such as pension funds for teachers and civil servants) 90 percent of their idle cash. In 1974-1979,
these sources accounted for 74, 14 and 12 percent, respectively, of NIF funding (Joon-kyung Kim, 1993, pp.162-163).
18 In 1982, interest subsidies on policy loans were abolished. At the same time, the share of KDB in NIF re-lending began to decline
while those of the Export and Import Bank and other specialized banks began to rise.

023
On top of directed credits, various tax incentives were offered to HCIs. Tae-won Kwack
(1985) estimated the marginal effective tax rates of HCIs to be 30-35 percentage points
lower than those of light industries during the height of the HCI drive (Figure 2-3).
Also notable were public-sector R&D activities. The total of public and private R&D
spending remained below 0.5 percent of GDP throughout the 1970s, far below the current
level of around 3 percent (Figure 2-4). The public sector played a leading role in those
years, accounting for 50-70 percent of total R&D spending. The government launched
many research institutions whose mission was to import advanced foreign technologies,
modify them to suit local needs, and disseminate the results.
Figure 2-4. Trend in R&D expenditure
Source: National Statistical Office (http://www.kosis.kr).
Yeong-koo Park (2005) summarizes the characteristics of the HCI drive in the following
way. First, it had a clear export orientation, going beyond import-substitution
industrialization. Its primary goal, as stated by President Park in his New Year’s press
conference, was to increase total annual exports to 10 billion dollars. Such export
orientation exposed domestic firms to international competition, forcing them to constantly
improve productivity.
Second, the government led the drive but left actual implementation to the private
sector. In most cases, the government confined its role to providing financial and tax
incentives to large private enterprises such as Samsung and Hyundai, and refrained from
direct participation in industrial production. This distinguished Korea’s strategy from those

of other developing countries at the time.19
Third, the HCI drive took demand conditions and government budget constraints into
full consideration. Priority was given to finished goods production, and then went
upstream to intermediate inputs and raw materials. Even in the case of the defense
industry, 80 percent of the capacity was allocated to the production of civilian goods in
order to maximize capacity utilization. The HCI Drive Plan specified funding requirements
for each project, and care was taken not to exceed the budget ceiling.
The HCI drive, however, was not always planned and implemented with care. Yung
Bong Kim (2003) observes that“given the haste with which the HCI Drive Plan was
prepared, it is extremely unlikely that economic benefits of individual investment projects
were carefully evaluated.”In implementing the Plan,“the detailed targets and modes of
individual projects were often determined through bargains between politicians,
bureaucrats and businessmen, with bureaucrats selecting the firms to benefit from the
projects.”If this observation was true, there must have occurred no small degree of
inefficiencies in implementing the Plan.
Different authors have expressed different views on the success or failure of the HCI
drive. On one side are those who believe that it was mostly a failure. Indeed, the HCI drive
produced excess capacity. In 1975-1980, capacity utilization in machinery, electrical
instruments and transportation equipment was around 50 percent, well below the average
capacity utilization of over 70 percent in total manufacturing (Table 2-3). This indicates the
existence of inefficiencies in resource allocation. Jungho Yoo (1991) shows that HCIs
exhibited a very low capital efficiency compared to light industries, and claims that the HCI
drive retarded overall output growth. Jong-Wha Lee (1996) finds no correlation between
industrial policies, such as tax incentives and subsidized credit, and total factor productivity
growth in the promoted sectors. He further shows that trade protection reduced growth
rates of labor productivity and total factor productivity.
The HCI drive has also been criticized for its negative impact on other aspects of the
national economy. Large amounts of policy lending led to the unhealthy accumulation of
debts by enterprises. Acting as vehicles for the HCI drive, the chaebol further increased
their economic power. Excessive monetary expansion produced chronic inflation. Most
importantly, financial repression obstructed the development of a competitive financial
sector and increased the inefficiency in financial intermediation.
024THEKOREANECONOMY
19 Since 1973, the Taiwanese government also stressed the promotion of three HCIs－steel, petrochemical and shipbuilding
industries. Unlike in Korea, however, state-owned enterprises played the main role in implementation.

025
Table 2-3. Capacity utilization in manufacturing
(Unit: %)
Source: Young-Sun Lee (1986).
On the other hand, some authors argue the HCI drive should be evaluated from the
perspective of a dynamic comparative advantage.20
According to them, Korea could make
full use of the“three lows”21
in the mid-1980s because of the industrial base built during
the HCI drive, which provided an opportunity to deepen industrial structures and upgrade
the export mix.
It is difficult to assess the impact of HCI drive on Korea’s growth path because of our
limited ability to construct counterfactuals. International comparisons, however, provide
some clues. Radelet, Sachs and Lee (1997), after reviewing the different paths taken by East
and Southeast Asian countries (Korea, Taiwan, Hong Kong, Singapore, Thailand, Malaysia,
China and Indonesia), concluded that“while the promotion of heavy industry may have
been beneficial in some identifiable cases, it surely was not the common denominator that
accounts for the rapid growth across East and Southeast Asia. Instead, the common
denominator was manufactured exports, supported by a regime best characterized as free
trade for exporters. The varied experiences of the countries of East and Southeast Asia
indicate that both an open market and a more interventionist approach that offsets other
distortions can be made to work, as long as manufacturers face the acid test of operating
on world markets, both for imported inputs and exports. East Asia’s successful industrial
policy strategy was to support labor-intensive manufactured exports, not capital-intensive
heavy industries (emphases by the original authors).”
From this perspective, Korea’s favorable growth performance was due to its export
orientation taken since the 1960s rather than the HCI drive itself. Of course, without
20 See Pack and Saggi (2006) for the discussion on dynamic comparative advantage and their criticism of this concept.
21 The“three lows”refer to low oil prices, low international interest rates, and the low value of the dollar (with which the won
moved closely) against the Japanese yen.
1975 1977 1979 1980
Total manufacturing
Steel
Nonferrous metal
Machinery
Electrical instruments
Transportation equipment
Textile
Wood and wood products
Paper and printing
70.1
67.1
67.1
52.2
62.6
42.0
70.8
74.7
84.7
81.5
80.2
85.0
66.9
71.8
37.6
58.9
94.3
96.5
81.9
81.1
69.6
60.1
69.4
35.3
82.8
84.3
93.2
71.8
74.8
62.0
42.3
58.6
44.0
79.1
52.6
57.2

definite proof for or against the effectiveness of the HCI drive, the debate will continue.
3.3 Importliberalization
The government promoted exports but maintained restrictions on imports to contain
current account deficits and protect domestic industries. Tariff rates began to decline slowly
in the early 1970s, but their levels remained very high until the early 1980s (Table 2-4).
Table 2-4. Tariff rates (1957-1984)
(Unit: %)
Note: 1) Simple average of statutory tariff rates.
Note: 2) Weighted average of statutory tariff rates with 1975 production as weights.
Note: 3) General tariff plus special tariff and foreign exchange tax.
Note: 4) = 1 / (1 + total tariff).
Note: 5) Shaded areas indicate the periods when the tariff rates rose.
Source: Kwang Suk Kim (1998), Tables 1 and 5.
Figure 2-5. Trend in import liberalization (1955-1999)
Note:‘Tariff liberalization’refers to the inverse of total tariff as defined in Table 2-4.‘Liberalization of quantitative
restrictions’refers to the number of freely-imported items divided by the number of total items.‘Total
import liberalization’is the average of these two ratios. Quantitative restrictions include those imposed not
only by the Ministry of Commerce and Industry but also by other ministries.
Source: Kwang Suk Kim (1988), Table 5; Kwang Suk Kim (2001), Table Ⅳ-1.
026THEKOREANECONOMY
1957 1962 1968 1973 1977 1979 1984
Simple average tariff1)
30.2 39.9 39.1 31.5 29.7 24.8 21.9
General tariff2)
35.4 49.5 56.7 48.1 41.3 34.4 26.7
Total tariff3)
35.4 49.6 58.9 48.2 41.3 34.4 26.7
Inverse of total tariff4)
73.9 66.8 62.9 67.5 70.8 74.4 78.9

On the other hand, quantitative restrictions were reduced significantly. The previous
positive list system whereby the Ministry of Commerce and Industry designated freely
imported, restricted and banned items was turned into a negative list system in July 1967.
In the new system, only restricted and banned items were identified, and all other items
could be imported without restriction. In Figure 2-5,‘liberalization of quantitative
restrictions’is defined as the number of freely-imported items divided by the number of
total items. This ratio jumped from 9.3 percent in 1966 to 52.4 percent in 1967.
Between 1968 and 1977, however, quantitative restrictions were strengthened, and total
import liberalization remained at around 55 percent. Compared to Japan and Taiwan,
which had already raised the liberalization ratio above 90 percent in the mid-1960s and
mid-1970s, respectively, liberalization proceeded very slowly in Korea (Young-Sun Lee,
1986, p.812). Quantitative restrictions were aimed mainly at protecting the domestic HCI
and agricultural sectors (Jungho Yoo, 1991, p.70). It was almost impossible to import the
items in these protected sectors.
Import liberalization made a fresh start in 1978 with the announcement of three separate
liberalization schedules. It was put off again due to the second oil shock that occurred in
1979, but continued after 1980. It gained full momentum in 1984 as the external balance
was restored.
3.4 Largeincreaseinforeignborrowing
Capital account opening was also pursued. In so far as its goal was to encourage foreign
capital inflow to fill the gap in domestic savings, however, liberalization remained selective
and partial. In January 1960, the Foreign Capital Inflow Inducement Act was enacted but
did not succeed in attracting much inflow. In July 1962, the new administration introduced
the Foreign Borrowing Repayment Guarantee Act to provide guarantees not only to public
but also private borrowing. These two laws were merged into the Foreign Capital Inflow
Act in August 1966 (Pyung-joo Kim 1995, p.199). At the same time, the government agreed
with Japan to normalize their diplomatic relationship in return for reparation payments of 500
million dollars22
and commercial loans of 300 million dollars (Jung-en Woo, 1991, pp.85-87).
All these efforts led to the heady growth of foreign borrowing. Access to state
guarantees was considered a privilege, and all private enterprises wanted to get a share
regardless of the viability of their business plans. The large gap between domestic and
22 Reparation was for the Japanese colonial occupation, and the payments comprised 300 million dollars in grants and 200 million
dollars in government loans.

foreign interest rates due to the interest rate reform in 1965 also encouraged foreign
borrowing. Figure 2-6 shows that the outstanding stock of external liabilities, rising from 4
percent of GDP in 1962, hovered at around 40 percent in the 1970s, and rose further to 50-60
percent in the early 1980s. This ratio went down to close to 20 percent only after the current
account experienced large surpluses in the latter half of the 1980s due to the“three lows.”23
Figure 2-6. Outstanding stock of external assets and liabilities (1962-2009)
Source: 1) Debt liability for 1962 is from Joon-kyung Kim (1993), Table 4-14, and those for 1963-1969 are from
Jung-en Woo (1991), Table 4-8. Foreign direct investment for 1962-1969 was obtained by accumulating
annual foreign direct investment from Figure 2-8. Total external liability in this period is the sum of debt
liability and FDI.
Source: 2) Figures for 1970-2004 are from Lane and Milesi-Ferretti (2006). Figures for 2005 and after are from
International Investment Position, Bank of Korea (http://ecos.bok.or.kr).
Addiction to debt financing took root in this period. The debt-to-equity ratio in the
manufacturing sector rose from 100 percent in the mid-1960s to 300-400 percent in the
1970s (Figure 2-7). Interest payments turned more onerous, as reflected in the interest
coverage ratio of 100-200 percent in the 1970s through 1990s. This implies that operating
profits could barely cover interest expenses in those years.
028THEKOREANECONOMY
23 The outstanding stock of debt liabilities corresponded to about 25 percent of M2 stock (and similarly of the bank lending stock) in
1962, rose to about 150 percent in the 1970s, and then went back to 20-30 percent after the three-low period.

029
Figure 2-7. Debt-to-equity ratio and interest coverage ratio in the manufacturing sector
Note: Interest coverage ratio = operational profit / interest expense.
Source: Bank of Korea (http://ecos.bok.or.kr).
Toward the end of the 1960s, many enterprises were no longer able to repay foreign
loans. Banks, which were in charge of providing guarantees on foreign borrowing, also
met difficulties (Jin-hyeon Kim, 1986, p.600; Eun-bok Lee, 1986, p.783). In response, the
government began to strengthen qualitative and quantitative restrictions on borrowing and
paid greater attention to attracting foreign direct investment (FDI). It launched a program
to attract FDI, designated the Masan Free Export Zone in 1970, and enacted a special law
prohibiting labor unions in foreign companies (Ki-jun Lee, 1986, pp.792-793; In-hwan
Noh, 1986, p.567). FDI inflows, however, remained meager (Figure 2-8). It was not only
because Korea was not a very attractive place for multinational corporations, but also
because there were still many restrictions on FDI inflows. Restrictions were also placed on
capital outflows as reflected in the low level of external assets in Figure 2-6. Full-fledged
market opening for both inflows and outflows came only after the economic crisis of 1997.
Since the late 1960s, widespread insolvency in the corporate sector had been a recurrent
problem. It left banks with piles of non-performing loans and threatened the stability of the
whole financial system. The government intervened frequently to stabilize the market, but
never tried to redress the root cause of the problem (i.e., excessive debt financing). In fact,
government interventions, by propping up ailing firms with public money and other
emergency measures, heightened the expectation that the government would always offer
a helping hand in times of difficulty, which encouraged further borrowing. This will be
discussed below in detail.

Figure 2-8. Inflows of grants, loans, and FDI
Sources: 1) Among grants, financial aid from U.S and international organizations are from Bank of Korea, Economic
Statistics Yearbook, 1984, p.245, and reparation payments from Japan are from Economic Planning Board,
Whitepaper on Reparation Payments, 1976, p.29.
Sources: 2) Commercial and public loans (1962-1965) are from Ministry of Finance, Thirty-Year History of Fiscal and
Financial Policies, 1978, p.97.
Sources: 3) Commercial and public loans (1966-2007), foreign direct investment and GDP are from Bank of Korea
(http://ecos.bok.or.kr).
3.5 Financialrepression
The government increased intervention in domestic financial markets to support the
government-led growth strategy, reversing the course from the 1950s (Pyung-joo Kim,
1995, p.199; Seok-mo Koo, 1986, p.127). First, commercial banks were renationalized. The
government promptly enacted the Act to Dispose of Illegally Accumulated Wealth in July
1961 and confiscated bank shares in October. The government was now in full command
of commercial as well as specialized banks.
The government also strengthened its grip on the central bank by revising the Bank of
Korea Act in May 1962. The Financial and Monetary Board was renamed as the Financial
and Monetary Operation Board to emphasize the operational, in contrast to policy-making,
role of the Board. The Minister for Finance was given the right to request the Board to
reconsider its decisions. When the Board stuck to an initial decision by a super-majority
(over two-thirds of the votes), the final decision was to be made by the cabinet. Thus the
ultimate responsibility for monetary policy came to rest clearly with the government. The
BOK was also subject to inspections by the Ministry of Finance and to audits by the Board
of Audit and Inspection, and the decision on the BOK’s annual budget was transferred
030THEKOREANECONOMY

031
from the Board to the government.
The Banking Act was revised twice, in May 1962 and January 1969, to reinforce
government control of banks. The control was often exercised through notices and
instructions from the Ministry of Finance without any clear legal basis, and affected all areas
of management. At the same time, the BOK also exercised control on commercial banks
through its rediscount facility on which banks depended heavily.
The government also established various specialized banks. The Industrial Bank of
Korea (1961), the National Agricultural Cooperative Federation (1962), the National
Federation of Fisheries Cooperatives (1962), Kookmin Bank (1963), Korea Exchange Bank
(1967), Korea Development Financing Cooperation (1967), Korea Trust Bank (1968),
Housing and Commercial Bank (1969), and the Export-Import Bank of Korea (1976) were
established in addition to KDB (1954).
This array of apparatus enabled the government to intervene in the market quite
extensively. The only incident where the government retreated from market intervention
was the decision to raise interest rates in 1965 following the recommendation by American
advisers－Hugh Patrick, Edward Shaw and John Gurley (Jung-en Woo, 1991, p.103). On
September 30, 1965, the rate on time deposits was doubled from 15 to 30 percent, and the
lending rate was increased from 15 to 26 percent. Such a steep rise in interest rates
shocked the business community that had grown accustomed to very low rates.
The interest rate reform had two purposes. The first was to encourage savings in banks
and other financial institutions. The higher rate was expected to attract financial resources
from the curb market, which offered an interest rate of over 50 percent, to the regulated
market. The second was to enhance the efficiency of resource allocation. The higher rate
would raise the opportunity costs of capital and prevent wasteful investment.
Indeed, time deposits at banks increased by half by December, and doubled each year
afterwards. Time deposits as a proportion to GDP rose from 2 percent to 21 percent
between 1964 and 1969, and total deposits from 6 percent to 29 percent. The reform,
however, entailed unintended consequences. Banks incurred losses because the lending
rate was below the deposit rate, and the BOK had to subsidize them by paying interest on
reserve requirements. More serious were the increase in foreign borrowing induced by the
large gap between domestic and foreign interest rates and a resulting increase in corporate
insolvency.
These problems led the government to revoke the interest rate reform and cut interest
rates (Seung-yun Lee, 1986, pp.196-197). The rate cut was carried out in six stages
between April 1968 and August 1972. The government also organized the Taskforce to
Restructure Insolvent Firms within the presidential office in 1969 and began closing down

or merging insolvent firms (Pyung-joo Kim, 1995, p.200; Jin-hyeon Kim, 1986, p.600; Jung-
en Woo, 1991, pp.109-110).
Entering the 1970s, output growth slowed due to the recession in major trading partner
countries and the stabilization program adopted after IMF recommendations. At the same
time, repayment of foreign loans began in full, and imposed serious burdens on indebted
firms. The large devaluation of 1971, part of the stabilization program, added to the
burden. Many firms turned to the curb market to tide over the difficulties (Chung-yum
Kim, 2006, pp.313-314).
The business community demanded government action to alleviate their financial
burden. In 1972, the government responded with a fifth and sixth interest rate cut (in
January and August, respectively) and the August 3rd Measure.24
The Measure aimed at
relieving enterprises from the burden of curb market loans and providing special financial
Table 2-5. Main components of the August 3rd Measure
Source: Pyung-joo Kim (1995), pp.202-203.
032THEKOREANECONOMY
Component Explanation
Curb market
loan
restructuring
Curb market loans as of August 2nd of 1972 should be reported and converted into long-term loans with a
three-year grace period and a five-year repayment period at a monthly interest rate of 1.35 percent (an
annual rate of 16.2 percent).
Special credit
program for
businesses
Special bonds would be issued by financial institutions and bought by the BOK in the amount of 20 billion
won and at an annual yield of 5.5 percent. The proceeds would be used for the conversion of 30 percent
of short-term credits to businesses into long-term loans with a three-year grace period and a five-year
repayment period at an annual interest rate of 8 percent.
Cuts in interest
Rates
The maximum lending and deposit rates of financial institutions and the maximum BOK lending rate
would be reduced. Lending rates of specialized banks and fiscal loans would be adjusted. The BOK would
compensate for losses incurred by financial institutions by paying interest on reserve requirements and
providing special credit subsidies.
Increased
supply of
credit guarantees
The government would provide grants to the SME Credit Guarantee Fund and the Agricultural and
Fisheries Credit Guarantee Fund to facilitate credit supply to businesses with insufficient collaterals. Each
financial institution would install a credit guarantee fund.
Industrial
rationalization
and
investment
promotion
The Committee for Industrial Rationalization would be organized within the Prime Minister’s Office and
designate industries to be rationalized. KDB would supply long-term rationalization loans to businesses at
low interest rates. Taxes would be reduced for designated industries by raising special depreciation rates
of fixed investment and increasing corporate and personal income tax investment credits.
Abolishing the
tax sharing
Central government grants to local governments and educational authorities would be reduced by
abolishing the statutory tax sharing system and instead allocating funds through the central government’s
annual budget process.
24 Its full name was the President’s Emergency Decree on Economic Stability and Growth.

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