Jordan Kim
Prof. David Coates
April 10, 2018
The Economy of the Republic of Korea
Abstract: South Korea, or the Republic of Korea, has rose from being one of the world’s poorest nations following its liberation from Japan in 1945, to becoming a wealthy, prosperous nation today. This “Miracle on the Han River” is thanks to generous US aid in the first stages of its development, promoting exports, and its neoliberal model. Although South Korea has faced disaster during the 1997 Asian Financial crisis, and to a lesser extent, the 2008 crisis, it has been able to rebound in miraculous ways. This paper aims to examine the progress of economic growth and occasional fall in South Korea, and its strengths and weaknesses.
I. The Korean Economy
South Korea obtains much of its imports from the People’s Republic of China, Japan, and the USA
Company Structure
Industry is generally dominated by the chaebol, large, family-owned business conglomerates
After 1997, are increasingly acting out of the reigns of the Government
Criticisms of the Chaebol
Corruption
Samsung leader Lee Kun-Hee and Hyundai Motor leader Chung Mong-Koo have been convicted for financial malpractice.
President Park Guen-Hye was impeached for arranging to receive bribes from big businesses such as Samsung
Recklessness
Chaebols often recklessly expand into industries where their intentions or even ability to collaborate are unclear
Samsung expanded into car manufacturing, then quickly abandoned to Renault
SK Group, one of the largest chaebols, owns S. Korea’s largest oil refinery and bought Hynix, a memory chip provider
Decline of the labor force
Sharp decrease in employment of both white and blue-collar workers, due to technological advancements in machinery and operation.
Manufacturing employment has decreased, from 31% in the 1990s to only 17% during 2010-16
Suppression of competition
Often crowd-out smaller businesses and smother innovation and competition by either destroying or buying-out start-ups.
Banking System
The Financial Supervisory Service manages the activities of the commercial banks and the financial services sector.
Bank of Korea (BOK), the central bank of South Korea
Was not a legitimate policy-making institution, rather it ensured that the policies made by the Ministry of Finance and Economy (MOFE) were carried out
The 1997 BOK Act changed all of this, as it created a completely autonomous bank that worked to stabilize prices and to ensure market neutrality. (Pirie, 2005)
Increased the autonomy of the MPC (Monetary Policy Committee). However, the Governor of the BOK acted as the head of the MPC, and most of the members of the MPC are nominated by the economic bureaucracy. This ensures that the MPC acts in the “general, not the particular, interests of capital” (Pirie, 2005)
II. South Korea’s Economic Growth
1945 Japanese Liberation – the Division of Korea into North and South
For the most part, the industrial base of Korea was located in the material-rich North Korea (Looney, 2017)
The agricultural South faced poor farming conditions, and production declined
The 1950-1953 Korean War Halts Attempts to Rebuild the Economy
Exports, main drivers of South Korean economic prosperity, were reduced to only 1% of GDP in 1954
South Korea turned to the United States of America for aid
US aid accounted for nearly half of the South Korean budget
1948-1960 President Dr. Syngman Rhee Fails to Jumpstart the Economy
Used import substitution to protect domestic firms from foreign competition through high tariffs
Companies were unable to become properly efficient and could not prosper for long
Inflation and a fixed and overvalued exchange rate for the South Korean won
South Korean goods could not compete in foreign markets
Imports shortages arose out of reductions in US aid
1972: Park Chung-Hee’s Authoritarian Regime Brings About the Change Needed
The Three Plagues of the South Korean Economy
A lasting recession since 1956 and strikes and demonstrations plagued the economy
South Korea’s economy paled in comparison to the North Korean command economy
US withdrew much of its aid after Park’s coup d’état
Park Chung-Hee Introduces New Economic Reforms for a Developmental State Model
Indicative planning: guidelines and goals for economic growth are created by consulting businesses (Looney, 2017)
Incentivized exporting companies, aiming to promote exports rather than substituting imports
Exporting companies benefited from tax advantages, government subsidies, priority in credit allocation, and access to foreign currency
Support of the Chaebol
Export promotion demanded low production costs to compete overseas
Meant high levels of production were met to reach lower costs
The government began to support chaebols, which were able to reach this economy of scale
Support of the chaebol eventually came to a disastrous end in the crisis of 1997
Chaebol bought out and restructured bankrupt companies, leading to the belief that turning over was more important than profits
Chaebol began to irrationally acquire businesses through politically allocated credit and extend into industries where they do not belong
Normalized relations with Japan
South Korea began to access Japanese technology
Park Chung-Hee’s success
Average annual GDP growth rate was 8%, inflation and unemployment rates were low, exports increased in both quantity and quality (from raw materials to industrial goods to technology)
This rapid growth necessitated an increase of imports
Improved standard of living and sparked the rise of a new large middle class
Danger Forthcoming: Foreshadowing the 1997 Asian Financial Crisis
Irrational use of short-term capital by the chaebol led to increased debt
The 30 largest chaebol had an average debt-to-equity ratio of 330%, and amongst efforts to manage these debts, profits took a significant hit
Internal cross-subsidization reduced economy’s efficiency
Chaebol stepped into many industries without a strategy, and most of their subsidiaries were unprofitable.
The Fall and Eventual Rise of the South Korean Economy
The progression of economic downturn and the spark of recovery in 1997
Starts with Hanbo and Sammi Steel bankruptcy in the first quarter of the year, sparking fear of a corporate debt crisis.
August: Credit ratings are downgraded for banks that are exposed to distressed corporations such as Hanbo and Kia.
November: Government turns down IMF bail-out as the Won drops below 1,000 to the dollar. Seoul initiates a stabilization package to lift spirts overseas, and asks the IMF to prepare loans of $20 billion
December: South Korea agrees for $57 billion IMF bailout and reform package. Short term debt is twice as much as projected, at $100 billion. Reduces status of state and corporate bonds to junk-bond status, seeking to quickly raise capital. IMF and other nations advance $10 billion to South Korea, spurring an increase in the value of the Won of 23%. Foreign banks agree to give loans to South Korea.
Attempts to Alleviate the Trauma 1997 Crash
At the onset of the 1997 Asian financial crisis, South Korea maintained the exchange rate of the won to US dollar at one that was much higher than what was realistic
However, this caused people to become suspicious, and the won’s value eventually fell
Kim Dae-Jung’s 1998-2003 Term Begins to Truly Reform the South Korean Economy
“four plus one” policy reforms the labor market, and financial, public and private sectors, alongside exposing South Korean markets to foreign competition
In the labor sector, tripartite negations were instituted, involving the government, business, and labor.
Strikes were still frequent and the negations fell apart in some instances, the labor status improved after the crisis
In the financial sector, the IMF (International Monetary Fund) ordered that stakes in two of South Korea’s largest banks were sold to investors overseas to free the market and introduce more competition
Korea Asset Management Corporation bought and restructured debt, but the investment trust and credit card businesses found trouble, and the taxpayer suffered
Kim deregulated and privatized the public sector, reducing the risk for corruption in the chaebol-influenced bureaucracy, and started an anti-corruption commission to rid the public office of corruption.
Efforts in the private sector were largely effective
Attempted to rid the chaebol of their debt and tendency of cross-subsidization
Cross-subsidies were mostly removed and debt-to-equity ratios were improved, but nepotism in the chaebol is still very much prevalent.
Opening the market to overseas competitors and short-lived success
Removed regulations that blocked trade
1999 saw double-digit GDP growth rates, but those fell sharply in the years following
South Korea’s Seemingly Miraculous Growth and Recovery After the 1997 Crisis
Propelled by an increasing demand for Asian exports in the US (Landler, 2000)
Salomon Smith Barney investment bank increased full-year forecast for growth from 6.7% to 6.9% to 7.1%
“The longer the US keeps booming, the faster Asia will grow” – Simon L. Ogus
Asian economies are incredibly affected by expectations regarding future US interest rates demand for Asian goods
Weaker currencies compared to the dollar help with growth because their goods are cheaper overseas in US
This increased rate of growth was good, but made Asian governments more relaxed about reforming the economy to ensure growth
Ridding country of debt-encumbered banks and corporations
South Korea experienced double-digit gains in growth for two years, and has started to reform
Recovering from the 2008 Crisis
South Korea was not as affected by the 2008 crisis as other countries, given its substantial amount of reserve holdings, which allows it to somewhat effectively maintain the strength of the won.
Growth was initially strong, thanks to South Korea’s export-driven economy (Looney, 2017)
Unfortunately, poor demand at home and dealing productivity reduced growth rates to 3.5%, nearly half the rate South Korea experienced post-1997 crisis
2012 output gap was 0.8% (gap between actual and potential output as a percentage of potential output), only increasing to 1.4% in 2016
South Korea has also suffered from a decreasing potential to produce goods and services
From 10.9% in the 1980s to only 2.9% in 2016
To combat this, in 2013, President Park Geun-Hye began a fiscally-focused recovery plans, emphasizing job creation, increasing the number of small and medium-sized businesses to offset the dominance of the chaebol (large business conglomerates), and reduction of household debt.
2016 was a strong year for recovery: GDP expansion rate of 2.8%. Declining net exports were counteracted by strong performance in the residential construction and investment sectors. More heavy taxation of households led to increased tax revenues, cutting away at the chunk of debt that South Korea accumulated during the 2008 crisis. A $17 billion dollar fiscal stimulus package introduced by the US in June helped to restructure the South Korean shipbuilding and shipping industries.
2017 budget adjustments moved to allocated 33% of spending to social welfare, mainly addressing youth unemployment, which was at 9.8% in 2016.
III. South Korea as a Neoliberal State
By the 1997 crisis, South Korea abandoned the dirigiste (state-led) model of economics and began to adopt a neoliberal model of regulation.
The Fall of the Dirigiste Model
1990s: under the dirigiste model, the state attempted and failed to regulate the private sector investment, and eventually withdrew much of its influence in the financial system (Pirie, 2005)
The third industrial revolution has drastically improved communication and global transportation, and have brought about a “unified real-time global financial system”, which undermines the “axiomatic belief that strong national firms equal a strong national economy” (Pirie, 2005)
Increasing research and development put a toll on the dirigiste state, as the state and domestic institutions are unable to fund investment in the capital requirements of larger and larger firms.
A need is realized for global capital and market investment.
This adoption of the neoliberal model is rationalized as a response to overseas competition
Thanks to the 1997 crisis and IMF intervention, the balance of power was shifted form the conservative members of the South Korean bureaucracy to the pro-reform members.
Making the financial regulator more autonomous, alongside an independent central bank, helps solidify South Korea in neoliberalism, preventing backtracking to the dirigiste model.
IV. The Strengths and Weaknesses of the South Korean Economy
Perhaps the greatest strength of South Korea’s economy is its export-driven quality
So long as overseas demand for South Korean exports is substantial, South Korea will continue to see either respectable GDP growth rates (as seen under Park Chung-He), or quick recovery after crisis (after the 1997 and 2008 crises).
The export-driven economy can also be South Korea’s greatest weakness
decreasing potential to produce goods and services after the 2008 crises
only 2.9% in 2016
The output gap between actual and potential output has grown
As South Korea’s ability to produce goods and services falls, its GDP will be greatly affected
Its neoliberal model has allowed it to properly reform after the 1997 crisis
Able to obtain global capital for its larger corporations, rather than having to fund them domestically
Able to take part in the global financial system, and do open-market trade internationally
The FSC (Financial Services Commission), an autonomous financial regulator, allows the bureaucracy, not the politicians, to effectively and fairly dictate the policies of the financial sector
However, the nepotist chaebol is a burden that has held down much of South Korea’s potential advancement
Although much of cross-subsidization and corruption was removed, larger chaebols such as Samsung and SK Group have their grasp in many industries, and nepotism is prevalent
Bibliography
Landler, Mark. “Asian Region Rides a Wave of Growth Linked to Exports.” The New York Times, 27 May 2000, pp. A1–B2.
Looney, Robert E.. Economy (The Republic of Korea), in Europa World online. London, Routledge. Wake Forest University. Retrieved 5 April 2018
Pirie, Iain. “The New Korean State.” New Political Economy, vol. 10, no. 1, Mar. 2005, pp. 25– 42., doi:10.1080/13563460500031172.