|Industrial Policy and Financing
Korean government industrial strategy in the 1970s had three major thrusts: the promotion of exports, attainment of self-sufficiency in staple grains, and the development of heavy industries. The phenomenal growth of exports is too well known to require a lengthy discussion. The government achieved self-sufficiency in the two principal grains, rice and barley, toward the middle of the last decade, only to meet with external pressure today to allow imports of much lower priced foreign grains. The development of heavy industry has followed the most tortuous path, attracting both positive and negative comments at home and abroad. In view of the differing views on the efficacy of the heavy industry program, I will explain briefly how it started and how it fared.
A highly ambitious development program for the petrochemical and heavy industries, prepared in the Blue House, was announced in 1970 by President Park to the surprise of many cabinet members. To my knowledge, he was motivated by his belief that the real economic strength of a country derives from the strength of its heavy industry, as was well illustrated by the Japanese experience before and after the Second World War. His belief was later buttressed by the need he felt to develop the defense industry in the wake of changing U.S. policy toward South Korea following the fall of Vietnam, signaled by the withdrawal of the U.S. Seventh Division from Korea in 1971. He thought it was imperative for him to create a self-reliant defense posture on the basis of enhanced industrial capability.
One of the major weaknesses in the blueprint was that it was not backed by a workable financial program, the responsibility for which later fell upon me in my position as finance minister. Given the firm determination of President Park, my job was simply to formulate a plan to mobilize financial resources to the maximum extent possible in support of the program, which will be discussed in more detail in the next section.
Incidentally, I was not without my own perspective on heavy industry. To my way of thinking, Japan, with a population of more than 110 million at the time, had a domestic market base sufficient for heavy industry, while Taiwan, with less than 17 million people, did not. On the other hand, Korea stood between Japan and Taiwan in terms of population and had demonstrated its capacity to export. Thus the prospect of a shift of comparative advantage in light industries toward the less developed countries provided, I thought, good reason to take a chance on heavy industry.
Unfortunately, the heavy industry program encountered the unexpected oil crisis of 1973-a blow to the program in terms of external financing, prospective markets, and surging inflation at home. The job of carrying out the necessary adjustment again fell upon me as I was moved from my position of finance minister to that of minister of Economic Planning and deputy prime minister in September 1974. What I could do was to postpone or scale down the projects wherever possible and push forward the remaining projects whose construction was already well under way. A few years later some of the shiny new plants went into operation, and in 1976 they made a sizable contribution to eliminating the balance of payments deficit for the first time in Korea's history. However, the second oil crisis in 1978 hit the Korean economy once again, and the ensuing underutilization of the finished plants took a heavy toll on the economy as well as the banking system as the 1970s ended.
After many twists and turns and at much greater cost than originally expected, especially in terms of the adverse impact on the economy, Korea was able to complete such heavy industries as automobiles, steel making, metal refining, machine fabrication, and petrochemicals, making South Korea an economic powerhouse in the world today. At the time, the program was criticized by many as a glaring example of overinvestment, misallocation of resources, and a pernicious instance of repression of the banking system. As an economist, I am sympathetic with this criticism, but some doubt lingers in my mind. If President Park had not embarked on such ventures when he did, would Korea have ever had a better chance of building heavy industry? Without detailed analysis, I refrain from giving a definite answer to this question, but many people around me say "no," pointing to the fact that since the time of their construction, there has been an enormous escalation in costs in international markets as well as a skyrocketing of land prices and construction costs in Korea relative to the increase in product prices. Moreover, they say, international conditions following the two oil crises as well as the domestic political turmoil following the "Fourth Republic," which ended with the assassination of President Park in 1979, were anything but favorable for undertaking such grand projects.
Economic history abounds with examples in which fortuitous or noneconomic factors played important roles, often defying the usual conclusions of short-term economic analysis. The experience of Japan with its own heavy industry is a case in point. There was strong opposition from economists as well as the governor of the central bank against the idea of initiating three major heavy industry projects: steel making, automobiles, and shipbuilding. They were criticized as out of touch with the economic reality in the postwar Japan of the early 1950s. But today we see that Japan dominates the world market in all three of these industries. The hostile governor of the Bank of Japan was a renowned economist, while those who were pushing the risky projects were far-sighted and courageous business leaders. Japan's success in heavy industry was aided by the outbreak of the Korean War as well as the climate created by the Cold War and East-West confrontation.
In the Korean case, fortuitous factors, notably the two oil crises, nearly derailed the program. Yet the tenacious leadership of President Park played an offsetting role, leading the government to pursue the program in the face of all sorts of difficulty. I recall what he told me, when I expressed my concern over the uncertain financial outlook for the heavy industry program: "Japan has risen again from the ashes of the lost war for which its leaders risked the entire nation, but what I am now risking is only part of our economy, so let us try." In retrospect, one thing is very clear: Without his determination and leadership, Korea would not now have its success in heavy industry, agriculture, and exports. As for the agricultural strategy, to my knowledge, no economist at the time questioned the validity of the policy of self-sufficiency in the two staple grains, rice and barley, or predicted that it would become a source of trade friction with Korea's major trading partners, leading them to demand the opening of the Korean market for their grain exports. Admittedly, economists-including myself-do not seem to be very good at predicting future events.
Much has been said about government intervention in the operation of the banking system in Korea. From the start of Korea's planned development, the common-sense view held by all from the top leader down to low-level bureaucrats and businessmen was that it was necessary for the government to intervene in the operation of the banking system to ensure that limited financial resources were channeled to priority sectors such as exports and basic industries. The tertiary or service industry received the least emphasis, being regarded as "nonproductive" or "nonessential."
According to economic textbooks, private banks can allocate limited financial resources to competing uses in a rational way if they are allowed to pursue their own interest subject to minimum regulation, while the government can pursue its industrial policies through a limited number of national banks to make up for possible "market failure." As a naive economist who became finance minister overnight, I was one of the few who held this view and openly proposed a banking reform that would have divested the equity holdings of the government in commercial banks; I met with strong opposition from my colleagues and the president. So my proposal ended with a face-saving compromise in which only one commercial bank was privatized as a test case. The bank showed notable improvement in its management for a time following privatization, but that did little to change the overall climate of interventionism in the banking system.
Following this failure, I turned my attention to developing the part of the financial sector that could be left largely outside of government control. In the meantime, Korea's internal and external conditions deteriorated rapidly following the fall of Vietnam, and the heightened sense of crisis within and outside of the government led President Park to make two drastic reforms. One was political, aimed at consolidating his authoritarian power further to enable him to exercise tighter control over party politics. Another was economic, aimed at laying a foundation for his new economic strategy emphasizing price stability and construction of heavy industry.
The extraordinary economic measure took the form of the Presidential Emergency Decree for Economic Stabilization and Growth, which was announced on August 3, 1972. One of the major provisions of the measure was to freeze the curb market and require creditors to swap their high interest loans for equity in firms owing them money under conditions specified by the decree. This drastic measure was thought necessary to rescue business firms from a usurious debt burden and remove a major obstacle preventing business firms from making new investments in growth industries. The measure originated from an appeal by a business organization that immediately caught the imagination of President Park, who decided to have his secretaries and me work out a plan for the reform in complete secrecy.
I was not very enthusiastic about the original proposal to freeze the curb market. Apart from its short-run effects, it would not put an end to the operation of the curb market, which is deeply rooted in Korea's economic culture, unless the financial sector were fully liberalized to the degree that the curb market is absorbed into a single open market in which a uniform rate of interest will prevail.
However, I thought that the decree might provide an opportunity to introduce the legal framework needed for developing a secondary financial market that I had had in mind ever since my failure to privatize commercial banks. So I worked to incorporate in the decree a number of financial schemes, including laws establishing short-term finance companies, mutual trust funds, credit unions, and a repayment guarantee fund for small businesses. Although these schemes were overshadowed in the mass media by the dramatic freezing of the curb market, these new institutions reduced the scope of the curb market operation significantly, and, together with the reform of the stock exchange, they have had far-reaching effects on the development of the Korean financial market. The secondary financial market-the second financial sphere, as it is called officially-has flourished ever since, growing to the point where it has superseded the traditional banking system in terms of business volume and efficiency. Ironically, the government is now trying to restore a balance between these two sectors in favor of the traditional banking sector.
Despite these financial innovations, however, it was clear from the beginning that the financial resources forthcoming from the banking institutions in the absence of government intervention would fall far short of the requirements for heavy industry even if a liberal introduction of foreign capital was taken into account. To cope with this situation, I had to introduce a new device called the National Investment Fund. The main point of the fund was to pool various nonbudgetary public funds-the pension fund of the government employees, for example-into a special account by means of selling National Investment Bonds to the funds with the option to convert the bonds to equity in later years.
In addition to the public funds, the banks were also required to contribute a small fraction of the increments of saving deposits in a specified period to buy the bonds. This fund was channeled into the ongoing heavy industry projects following the plan of the Ministry of Trade and Industry. Understandably, this has been criticized as an example of government repression of the banking system. Yet I have to say that given the imperative of the heavy industry program, that was the only way open to me to help finance the projects and at the same time minimize unpredictable and ad hoc requests for funds placed on banks by government ministries that seriously disturb banking operations. The fund also served to prevent all parties concerned, fully aware of the budgetary constraint of the fund account, from placing undue claims on the already overloaded banking system.
It was ironic that the author, a financial liberal , had to turn around and play a role in the so-called financial repression, compelled by the dictates of the heavy industry program. Critics often contend that excessive government intervention in the banking system encouraged overinvestment in heavy industries and in overseas construction projects, which in turn led to several large-scale business failures in the early 1980s that hurt the banking system. To be more accurate, the causal connection should run the other way around: Financial repression was not the cause but the result of the overcommitments in the heavy industry and overseas construction. What is most regrettable is the fact that government intervention delayed the banking system from becoming a more responsible and efficient mobilizer of domestic savings and a regulator of the resource allocation on the basis of sound banking principles and discipline enforced on the business community. As a result, the liberalization of the financial sector remains one of the major issues yet to be resolved in the Korean economy. In conclusion, I have to admit that government intervention continued for too long and constitutes the single most evident setback in Korea's experience of economic development.