South Korea: Miracle on the Han River

As a result of its almost unparalleled economic growth, today South Korea is one of the leading players in the global marketplace and one of the wealthiest countries in the world. The Republic of South Korea is one of the economic success stories of the first wave of newly industrialized countries. Barely a few decades ago the country’s economy was essentially at the level of a third world country. In 1948, at the time of the founding of the Republic, it was one of the poorest countries in the world. In 2010 the per capita GDP was $29,791, and according to data of the Bank or Korea the pace of economic growth was 6.1 per cent (ITD Hungary, 2011).

In 1970 the per capita GDP was $2,500, calculated according to the current value of the US dollar. By 1995 it had reached $12,600, an increase of 500 per cent. It took the United States almost a century, from 1857 to 1954, to attain comparably dramatic growth. Japan was able to achieve similar results in just over two decades, from 1952 to 1973. The key to the transformation of the South Korean economy was an ambitious strategy of economic development that focused on the use of exports as the engine of growth.

HISTORICAL PRECEDENTS

In the middle of the 20th century the future did not seem to hold much promise for South Korea. At the end of the Second World War the Korean peninsula was politically divided at the 38th parallel. The occupying Japanese forces were replaced by Soviet soldiers in the North and American troops in the South. In the South, with the active support of the American military, Li Sin Man came to power, the leader of the Korean right wing and a radical nationalist and anti- communist. In the North the communist government of Kim Ir Sen enjoyed the support of the Soviets. Since each of the two regimes considered itself as the sole heir to the national past, demands were soon made for unification of the peninsula into a single country. The government of Kim Ir Sen resolved to bring the entire peninsula under its control. When it was unable to do so using political means, preparations were made for war.

At the time, both countries were among the poorest states in the world, and the war that was launched by the North in the summer of 1950 only worsened conditions. When the devastating hostilities came to an end three years later, the frontlines remained exactly where they had been at the outset of the conflict. But while the war may have done nothing to change the borders, it made the political and economic circumstances all the more precarious.

At the time no one would have thought that in the space of a few decades South Korea would perform a veritable economic miracle, showing record growth, and its neighbour to the North would find itself confronted with a crushing economic crisis and increasingly dire poverty. This was all the more striking, given that during the period of Japanese occupation the majority of industrial, metallurgic, and electrical factories had been established in the Northern part of the peninsula. Thus for instance a significant chemical industrial centre had been built near the city of Hamhung with the cooperation of the German conglomerate I. G. Farben, and the Suphun hydroelectric plant was constructed along the Amnok river. The hydroelectric plants in the North provided electricity for the cities in the South for decades.

In the wake of the devastating war the recovery began much more slowly in the South than in the North. Li Sin Man, who was extremely unpopular, was unable to prevail in the economic crisis. Year in, year out South Korea was dependent on imported foodstuffs, and it was only thanks to American assistance that the government was able to ensure sustenance for the population. The country was in a state of economic chaos, and the failure to implement radical land reform led to an agricultural crisis.

In contrast, by the end of the 1950s North Korea was able, with the help of the communist countries (including Hungary, and of course mainly the USSR) in the form of financial aid and loans made on favourable terms, to rebuild the country and ensure a more or less stable standard of living for the population. Given the relative growth of the North, it is hardly surprising that in the course of an uprising against Li Sin Man and his government (both of which had lost all credibility) in the spring of 1960 and the later student protests slogans and rallying cries expressing sympathies with the North were heard with increasing frequency.

Today South Korea is the fifteenth largest economy in the world and the fourth largest economy in Asia. The country had to travel a long road in order to reach its current position of prominence, but today it is the fifth most important producer of automobiles and the foremost producer of ships and steel structures. Furthermore, it is a significant player in the market for consumer electronics and replacement parts. The rise in the country’s GDP (figure 1) clearly illustrates its dramatic economic growth.

The secret to economic success lies in the close cooperation between the state and private enterprise. As a consequence, South Korea has emerged as one of the fastest growing economies over the course of the past decades. In addition, in 2009 South Korea enjoyed a trade surplus of 41 billion USD. This rapid economic rise, which began in the 1960s, is referred to as the Miracle on the Han River, and it has been compared to the rapid economic growth of West Germany following the Second World War, the so-called Miracle on the Rhine.

The industrialization of the country began with the export-oriented development of certain branches of light industry, which demand considerable labour. This was followed by the creation of branches of heavy industry. In the 1950s and 1960s this served to meet the demands of the domestic market. The focus was on the production of textiles, leather and shoes, sports and recreation equipment, machines used in the chemical industry, and the necessary primary materials for these industries. With the rapid growth in production, however, emphasis soon shifted to exports to other countries in the region. The most important elements of the South Korean system of enterprise, the so-called Chaebols (roughly equivalent to the concept of a business conglomerate), developed quickly. Several of the companies known today throughout the world began as small undertakings that enjoyed generous state subsidies and created separate industrial plants to produce the necessary machinery and basic materials.

Like the old Japanese conglomerates (so-called Zaibatsus), the Chaebols were diversified, with the understanding that the Chaebols did not have their own banks, as earlier banks were not allowed to be held in private hands. Like the Japanese, the South Korean enterprises strove to create their own brand names. The high quality and competitive prices of their goods soon made their influence felt. Daewoo, Samsung, LG, KIA, and Hyundai enjoy the same broad recognition and popularity among consumers worldwide as Japanese, American, and West European products. In addition, the most modern techniques are used in South Korea for the production of basic materials (one thinks of metallurgy). At the time of the steel crisis in the 1970s the largest steel plant in the country was built in Pohang, the Pohang Iron and Steel Company (POSCO), which produced materials of the highest quality. Due to its partnership with the Japanese company Nippon Steel, POSCO became the foremost steel manufacturer in the world.

At the beginning of the 1970s, South Korea responded to the changes that were taking place across the world by modifying its economic strategy. The fluctuations in currency rates that came in the wake of the collapse of the Bretton Woods financial system had a negative effect on account balances in South Korea too. Because of the oil crisis in 1973, inflation rose the world over, economies stagnated, and protectionist policies were established everywhere. South Korea responded to the various challenges by shifting its economy towards exports, thereby attempting to address increasingly dire imbalances in foreign trade. Changes were made in the export structure to favour high value-added goods. The state strove to nurture various trade partnerships and increase agricultural exports. In the course of the transformation of the economy, emphasis shifted from branches of industry that demanded a large labour force to branches of industry that required significant capital. The primary role was given to chemical and heavy industry. The large investments in the new branches of industry (including the construction of ships, the iron and steel industries, automobile manufacturing, production of machinery, and the petrochemical industry) were made largely by implementing financial and tax incentives. The government supported developments in heavy industry and the chemical industry with low interest rate loans. The efforts paid off. In the space of nine years chemical and heavy industry products came to play a considerably more prominent role in the export market, growing from 13 per cent of exports overall to 39 per cent. The emergence of the new branches of industry in South Korea created a greater need for skilled labour as well, which contributed to an increase in wages. In the meantime light industry in South Korea gradually lost its competitive edge, putting those who had invested capital and labour in light industry in a difficult position.

Thanks to the calculated adaptation of its flexible economy, South Korea was able to maintain the pace of economic growth it had attained in the 1960s. Average yearly growth in the period between 1970 and 1979 hovered around 9 per cent, and between 1976 and 1978 it even reached 11.2 per cent. Exports grew annually by 40 per cent on average, and by 1979 had reached 15 billion dollars in total value. The per capita GDP grew from 249 USD in 1970 to 1,636 USD in 1979. But the transformation had negative consequences as well. Growth in capital led to lasting high inflation, which went as high as 18 per cent. Strong state intervention distorted prices and created competitive imbalances. Wages grew more rapidly than labour productivity, and this had a negative effect on competitiveness. These tendencies compelled the government to devise a strategy for economic development that allowed for continued growth but also created some measure of stability.

At the beginning of the 1980s, as a consequence of the global oil crisis and the domestic political crisis caused by the assassination of president Park Chung- Hee, the South Korean economy again found itself confronted with significant challenges. For the first time since the launch of the various five-year programs economic growth came to a halt, and soon indicators began to show negative values. Inflation shot up to 28 per cent, and the current account balance also indicated a dire trend. Any enterprise that had additional capacity had to accept tasks allotted by the government, and numerous mergers took place. The Chaebols bought up many smaller enterprises that found themselves unable to cope with the new circumstances, thereby acquiring a larger share of economic power. In the 1970s and 1980s these conglomerates, which were essentially based on family enterprises, acquired a leading role in the South Korean economy.

Commercial banks were privatized at the beginning of the 1980s, and by 1982 there was almost no difference whatsoever between the interest rates of state banks and private banks. The strict monetary and fiscal policy, the fall in the price of oil, and low international interest rates helped stabilize the South Korean economy. Restrictions on the influx of foreign investment capital were relaxed. Inflation again became single-digit, and the average yearly growth of the GNP hovered around 10 per cent in the 1980s. Since 1986 the trade balance has been positive and savings accounts among citizens have gradually risen reaching 37.6 per cent of the GDP in 1989.

At the beginning of the 1990s, Korean enterprises had to address new challenges. New competitors had emerged in the domestic and international marketplace in the form of the enterprises of a second wave of newly industrializing countries. Furthermore, the World Trade Organization exerted influence on the country by pressuring it to open its economy, in particular the agricultural sector and financial services sector, which until then had been strongly protected. Korea strove to become an integral part of the global economy, liberalizing its international financial transactions, actively taking part in the World Trade Organization Uruguay Round [extended negotiations regarding international trade in which 123 countries took place], and becoming a member of the Asia-Pacific Economic Cooperation (APEC). In 1996 South Korea became part of the OECD as well. The stabilization of political relations with China in 1992 constituted a significant breakthrough, and the two countries resumed diplomatic ties. This gave new momentum to the already existing economic cooperation between the two countries, and also gave South Korea greater prestige in the international arena. Today China is South Korea’s most important trade partner. In 2004 the Chinese share of Korea’s exports was 19.6 per cent, while imports from China were only 13.2 per cent. The country is an important trade partner for Hungary as well. Indeed South Korea is Hungary’s third largest foreign trade partner in Asia, after Japan and China, and Budapest occupies a place of no small prominence in Seoul’s business interests in East Central Europe.

POLITICS OF INNOVATION

Deliberate promotion of the sciences and scholarship played an indispensable role in economic development, first and foremost with the transformation of the institutional system for research and development. Ever since the period of industrialization, South Korea placed considerable emphasis on the reform of the educational system and scientific institutions. In order to achieve this, it was necessary both to transform the system of funding for the existing institutions and scientific institutes and to form modern institutions (for example ministries and universities). The institutions created their own plans for growth and development, in which the development of research infrastructure was given the primary role, and they themselves were responsible for monitoring the implementation of these plans. New research institutes came into being alongside the existing scholarly and scientific research programs. The Korea Institute of Science and Technology, a state institution, directed several research institutes, each of which had its own specialty and focused on the technological development of a different branch of industry. These included ship construction, electronics, telecommunications, engineering, chemical industry, etc. And while the various plans were being implemented, the government always kept a watchful eye on the results.

Education was given a prominent role in the process of growth, as were research and development and the expansion and improvement of the related institutional systems. The creation of a layer of skilled workers was an indispensable precondition of success in the leading industries that helped sustain the economy. In the initial stages, the developmental states focused on the creation of the necessary human resources component of technology, while later, having crossed this threshold, they placed greater emphasis on research.

As in the case of Japan, in South Korea with every passing year increasingly large sums were spent on the purchase of licences, but proportionally these sums were decreasing in comparison with the billions of dollars invested in innovation. The economic strategy adopted by the country thus could be characterized as a transition from growth led by investment to growth led by innovation. Venture capital played a significant role in the funding for research.

The American practice of supporting cooperation between industry and research universities was broadly adopted in order to facilitate the social and practical application of the sciences. Universities created private enterprises, and were thereby able to turn the results of research to practical use. The transition to a strategy driven by innovation took form in the growth of government sources for research and development. Furthermore, larger sums were devoted to the development of technological infrastructures, investment in necessary equipment for universities and laboratories, and the educational institutional infrastructure.

CONCLUSIONS

The rise of the countries of the Far East offers an unambiguous sign that the structure and development of the new global economy is taking shape according to a new set of rules, rules that these countries have clearly learned more quickly and to which they have been better able to adapt than countries of the West that had become industrialized earlier, not to mention the countries of Eastern Europe. The comparatively rapid development of these countries has thrown into question the conventional assumptions of neo-classical economics regarding theories of growth. The developmental state played an active and decisive role in this success, in the emergence of these countries as globally competitive economies.

Selective industrial policies were given significant emphasis in these countries, as was the defence of domestic agriculture. In the interests of promoting development, financial policy and trade policy were subordinated to industrial policy. Initially, foreign currency reserves were very tight because of the closed capital account, but the branches of industry that enjoyed state support were able to obtain funds at favourable terms. However, as far as the policy regarding property is concerned, the principle of private property prevailed, though in the interest of securing long term advantages the state played a proprietary role in the financial markets as well.

In the hopes of promoting growth, the governments emphasized the accumulation of capital, since in order to make investments in the future it was necessary first to set aside savings. The state offered unusual stimulus for both investments and savings. Paired with methodical policies promoting development, general frugality ensured remarkably high levels of investment. Revenues from exports were put back into new investments. The state motivated investment in part by offering low interest rates and in part by involving itself in the private sphere and instilling confidence in the promise of a more prosperous future. Two of the guarantees of this prosperous future were the series of repeatedly emphasized protectionist steps and the assurance that the enterprises that enjoyed state support would have access to the export market.

As in the case of other successful states of the Far East, in South Korea and later in Malaysia, strivings were made to industrialize at a pace that corresponded to the life cycles of the various products. It was essential, in the case of products with large value added, that they have comparative advantage. While at the outset of the process of industrialization enterprises producing textiles and clothing for export had played a decisive role, later emphasis shifted to the chemical industry, followed by the increasing prominence of the steel industry, the automobile industry, and electronics. It is important to underscore that these countries created their comparative advantages themselves with deliberate industrial and educational policies, not simply adjusting their production to their own natural resources, but creating and nurturing human resources. The governments gave a very prominent role to the development of human resources and raising the level of education. By the 1960s educational indicators in the country had surpassed the averages in countries at a comparable stage of developmen. One should add that in the case of South Korea the government only began to encourage direct foreign investment in the 1970s, by which time the domestic economy based on the Chaebols rested on solid ground.

In the case of both countries macro-economic stability was an important precondition of the development of a competitive economy. Until the 1990s indebtedness was uncharacteristic of the developmental states of Asia, which kept inflation down and pinned their currency rates to the US dollar.

For some time the governments did not have to confront opposition among the citizenry. Economic growth and the continuous rise in living standards gave the dictatorship of a narrow ruling elite a kind of sanction. In Malaysia, the compromise between the Malay, Chinese, and Indian elites represents a masterpiece of shrewd political prescience that ensured the foundations of long-term economic development. The leaders of the two countries were always cautious to share the benefits of economic growth with the population. This is why one does not find the same pronounced social inequalities in Asia that one finds, for instance, in Latin America. While there are fourfold or even fivefold differences in income in South Korea, in Latin America these differences reach a factor of 28. This tendency is strengthened in Asia by the characteristic practice of life-long employment, whereby the company giving employment ensures balances in income. By placing the responsibility for social benefits on the private sphere, the state is able to create further sources for development. Alongside all of these factors, the educational strategy has also had a role in reducing social inequalities, as have the strivings to draw the so-called “Bumiputera”, the Malay people, into economic life.

(Supported by TÁMOP-4.2.1.B-11/2/KMR-2011-0002)

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Translation by Thomas Cooper