The role of the government in promoting industrialization

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Title: The Role of the Government in Promoting Industrialization and Human Capital Accumulation in Korea
Author: Joon-Kyung Kim, Sang Dal Shim, Jun-Il Kim
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This PDF is a selection from an out-of-print volume from the National Bureau
of Economic Research
Volume Title: Growth Theories in Light of the East Asian Experience, NBER-EAS
Volume 4
Volume Author/Editor: Takatoshi Ito and Anne O. Krueger, eds.
Volume Publisher: University of Chicago Press
Volume ISBN: 0-226-38670-8
Volume URL:
Conference Date: June 17-19, 1993
Publication Date: January 1995
Chapter Title: The Role of the Government in Promoting Industrialization
and Human Capital Accumulation in Korea
Chapter Author: Joon-Kyung Kim, Sang Dal Shim, Jun-Il Kim
Chapter URL:
Chapter pages in book: (p. 181 - 200)
7 The Role of the Government
in Promoting Industrialization
and Human Capital
Accumulation in Korea
Joon-Kyung Kim, Sang Dal Shim, and Jun-I1 Kim
7.1 Introduction
Korea's economic growth performance in the past 30 years has been cited
as an exemplary model of rapid economic development and has been termed
an "economic miracle." Lucas (1993) even constructed a model for the occur-
rence of economic miracles based on the Korean growth example.
Korea started its process of economic development in the early 1960s with
a small industrial base and little accumulated capital and technology. The post-
war division of the country severed whatever industrial link existed between
the north and south, and the Korean War (1950-53) almost completely de-
stroyed the production facilities and infrastructure of the economy. In the
1950s,many foreign observers regarded the Korean economy as hopeless. Un-
til the early 1960s,the economy depended on foreign economic aid, and its per
capita income was less than $100, which lagged behind that of many African
countries (including Ghana and Kenya), not to mention most Latin American
countries. Korea, perhaps with Taiwan, is one of the few countries that grew
from poverty to industrial strength comparable to advanced OECD countries.
Identifying the factors behind Korea's fast growth is a task of paramount
interest to both policymakers and academic researchers. In academic circles,
there has been a renewal of interest in identifying the factors that determine
growth after the publication of Romer's paper (1986), which sparked a signifi-
cant amount of research on "endogenous growth." According to the theory of
endogenous growth, one of the key factors generating fast growth is human
capital accumulation through learning by doing, or on-the-job training, as well
as education. The accumulation of human capital can be accelerated through
Joon-Kyung Kim, Sang Dal Shim, and Jun-I1 Kim are research fellows at the Korea Develop-
ment Institute.
181
182 Joon-KyungKim, Sang Dal Shim, and Jun-R Kim
international trade, which expands and diversifies the production frontier and
hence provides excellent opportunities for fast learning. Grossman and Help-
man (1989, 1990) identified knowledge spillovers from advanced to devel-
oping countries as the most important gains from trade. Lucas (1993) stressed
the importance of becoming a large-scale exporter, as it allows workers and
managers to continue taking on new tasks, which enables sustained learning
on the job.
Government assistance can also affect the speed of human capital accumula-
tion. In order to maintain a high rate of learning, people need to change jobs,
which necessitates the continuous introduction of new industries and new
products, requiring different skills and technologies. But the creation of these
new industries is subject to high risks. The government's assistance can encour-
age private industrialists to undertake new projects by reducing the risk they
face. Thus, the diversification of the industrial structure with governmental
assistance enables the learning process to continue without being subject to
diminishing returns.
The role of governmental assistance has been given little attention in the
endogenous growth theory literature. In practice, the most successful econo-
mies, such as those of the East Asian countries, were not only big exporters
but were those whose governments extensively supported exports and industri-
alization. This paper attempts to identify the factors behind the rapid Korean
growth and interpret the Korean experience within this framework, while giv-
ing special attention to the contribution that Korean government policies made
in accelerating economic growth. It will also explore the negative side effects
of such policies.
The paper is organized as follows: Section 7.2 will discuss the socio-
economic factors that contributed to the Korean work ethic and heightened
educational zeal. Section 7.3 will discuss policy measures that were adopted
from the 1960s to the 1970s to promote exports and industrialization. Section
7.4 evaluates the effectiveness of these policy measures in accelerating human
capital accumulation and economic growth in Korea. It also discusses distribu-
tional issues and other side effects of such government interventions, which
need to be addressed for the formation of future developmental policies.
7.2 Socioeconomic Factors and Human Capital Accumulation
The socioeconomic environment can affect human capital accumulation.
Unlike countries like India, where there is a caste system which precludes a
person from advancing in social status, the class distinction between the noble
and ordinary people was largely destroyed in Korea during Japanese colonial
rule (1910-45). The destruction of the traditional social hierarchy played a
major role in motivating Koreans to invest in human capital.
Just before liberation in 1945, 90 percent of industrial assets were under
183 Industrialization and Human Capital Accumulation in Korea
Japanese ownership, and the rest belonged to a handful of Korean landowners.
Between 1949and 1951,land was distributedto poor farmersthrough the Land
Reform Bill and large landowners disappeared.As mentioned before, most of
the industrial and capital base was devastated during the Korean War, resulting
in the extreme poverty of all people. As a result, Korea saw an unusual equal-
ization in assets and income in the 1950s and became a rare case among devel-
oping countries.
Korea has maintained one of the world's most competitive educational sys-
tems, in which access to higher education is determinedby a uniform standard.
With few exceptions, access is determined by the applicant's score on a na-
tional exam-unlike in Western countries where multiple standards such as
family background, extracurricular activities, alumni connections, and leader-
ship skills are considered.
Such an environment of equal status with fair competition created great po-
tential for vertical mobility in society: the general public was given almost
equal opportunity and strong incentives to move up the "status ladder" by in-
vesting in human capital or by entrepreneurial activities.' Of course, human
capital accumulation and active business promotion at the individual level
would have been unlikely if the government had initiated the economic devel-
opment process within a socialist framework, rather than a capitalist one.2
7.3 Government Policies for Industrialization
7.3.1 Export Promotion
From the beginning of the first Five-Year Economic Development Plan in
1962, the Korean government has adopted an export promotion strategy rather
than an import substitution p01icy.~The government strongly supported ex-
porting firms with various incentive measures, including favorable treatment
in the allocation of credit and in the taxation system.
The system of export financing played a critical role in supporting export
industries until the mid-1980s when the Korean current account recorded a
surplus. The essence of the system was the Bank of Korea's (BOK's) automatic
rediscountingpolicy, which suppliedcredit via commercial banks to exporting
firms who received letters of credit (L/C). The central bank`s discount loans
1. This argument resembles the convergence results in neoclassical growth models in which
poor economies with lower capital-labor ratios grow faster than rich countries, converging to the
same steady state, other things being equal. In endogenous growth models, however, absolute
convergence results are not obtained because steady state growth itself depends on saving rates
and other model parameters.
2. In 1960,North Korea dominated South Korea in terms of production capacity and per capita
GNP. Such dominance, however, was reversed in the early 1970s.
3. Export promotion was largely dictated by the need to finance the imports required to build
up industrial capacity.
184 Joon-KyungKim, Sang DaI Shim, and Jun-Il Kim
Table 7.1 Export Loans by Domestic Money Banks (%)
1961-65 1966-72 1973-81 1982-86 1987-91
Export loans by BOK (as a share
of export loans by DMBs) n.a. 75.4 90.1 65.8 45.3
Export loans by DMBs (as a
share of total loans by DMBs) 4.5 7.6 13.3 10.2 3.1
Export loans by DMBs (as a
share of total policy loans' by
DMBs) n.a. n.a. 20.4 16.5 4.5
Export loan interest rate (A) 9.3 6.1 9.7 10.0 10-1 1.o
General loan interest rate (B) 18.2 23.2 17.3 10-11.5 10-1 1.5
B - A 8.9 17.1 7.6 0-1.5 0-0.5
Financial subsidy ratio for
exportsb n.a. 1.6 0.6 0.5 0.2
Annual export growth rate' 40.3 37.1 35.1 10.5 16.4
Export/GNP 3.5 9.9 26.2 32.5 30.7
Source: Bank of Korea, Economic Statistics Yearbook (Seoul, various issues).
"The size of policy loans is estimated for earmarked credit such as export credits, National Invest-
ment Fund loans, housing loans, and credit for agriculture, fisheries, and small and medium-
sized companies.
bThe financial subsidy ratio is estimated by dividing the total amount of financial subsidy for
exports by the total export value. The amount of financial subsidy is calculated by multiplying the
size of export-related loans by the interest rate differential between the average borrowing rate for
the manufacturing industry and interest rates for export-related loans.
'Annual export growth rate during 1953-60 was 8.2 percent.
were also extended to preshipment exports, as well as to imports of raw materi-
als and intermediategoods for export use and to the purchase of export content
from local ~uppliers.~
Table 7.1 shows that most of the export credit extended by domestic money
banks (DMBs) were supported by the central bank. Between 1966 and 1986,
the annual average ratio of BOK export credits to DMB export loans was 79.4
percent. In particular, the ratio reached 90.1 percent in the 1973-81 period.
Table 7.1 also shows DMB export loans as a share of total DMB loans. Be-
tween 1961and 1965,the annual average share was only 4.5 percent. The share
increased to 7.6 percent in the 1966-72 period and further, to 13.3percent, in
the 1973-81 period. The share, however, has decreased significantly since the
mid-l980s, when the current account surplus began accumulating.
The interest rate on export loans was also heavily subsidized. Until 1981,
export loans were provided at rates of 6-10 percent even though general loan
rates were 17-23 percent. After 1982, the differential disappeared (see table
4. In addition to this explicitly earmarked export credit program, the government guided the
banks through moral suasion, directives, or communication to lend to exporters to support their
fixed investment as well as working capital. See Rhee (1989) and Cho and Kim (1993) for a
detailed description of Korea's export credit policy.
185 Industrialization and Human Capital Accumulation in Korea
7.1). Given the facts that the availability of credit was what mattered and that
the curb-market rates usually exceeded 30 percent, the preferential treatment
given to exporters was far greater than that implied by the above-mentioned
differentials alone.
It is interesting to see in table 7.1 that there is some positive correlation
between export growth and export loan support, in terms of its availability and
the extent of preferential treatment. Between 1961 and 1981, exports grew
about 35-40 percent per annum and their share in GNP increased by more
than seven times. However, the growth rate has dropped to the 10 percent level
since 1982.
Such fast export growth in the 1960s and 1970s was not due solely to these
export credit programs. The government also provided substantial tax incen-
tives to exporting firms by reducing business and corporate taxes on export
income by 50 percent and exempting tariffs on materials or intermediategoods
imported as export content. Furthermore, exporters were exempted from tax
investigations, which motivated business firms to restlessly participate in ex-
porting.
In addition to these incentives, there was also a long list of governmental
measures for export activity promotion at the microlevel. Since export market-
ing has substantial fixed costs in the beginning stages, the government estab-
lished the Korea Trade Promotion Corporation (KOTRA) mainly to explore
foreign markets. To assist Korean exportersin effectivelyfilling foreign orders,
the government also subsidized projects to improve the wrapping and design
of products, the expansion of inspectionfacilitiesfor export goods, the opening
of foreign-languagetraining centers, and traveling expenses for delegationsto
overseas expositions and trade shows?
The government also initiated close consultation with the export industries
and monitored the performance of supported firms through "monthly export
promotion expansion meetings," chairedby the president.Ministers with trade-
related duties, representatives from business, banking institutions, and ship-
ping companies, and labor-union leaders participated in these meetings to re-
view export performance broken down according to product and destination,
and to discuss international market trends and emerging problems. For in-
stance, if export performance was weak, the president urged relevant govem-
ment officials and bankers to provide enhanced support to achieve a target
volume of exports as planned. Through the process of consensus building in
these meetings, export promotion policies were systemized (Kim 1990).6
Another salient feature of Korean export promotion policies was that the
5. These broad projects were financed from a sort of semitax on domestic exporter's imports,
which was operated by the Korea Trader'sAssociation (KTA).
6. The term "Korea Incorporated"was coined mainly because of this unique feature of Korea's
export promotion policy implementation: banks acted as a treasury unit, the industrial sector as
production and marketing units, and the government as a central planning and control unit (Cho
and Hellmann 1993).

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