The Korean Economic System

Governments, Big Business and Financial Institutions

Jae-Seung Shim, Moosung Lee

• Publisher: Routledge
• Year: 2016
• ISBN:
  9781317026464
• Edition: 1
• Topic: Economics
• Subtopic: Economic Theory
• Index: Economics

Focusing on the formation of the Korean economic system, this book presents a fascinating and comprehensive analysis of economic development outside of the traditional neo-classical, developmental-state and dependency perspectives. It examines in detail the evolution of institutions that contributed to economic growth and the formation and the workings of the economic system. With an emphasis on the interaction between government, private institutions (Chaebol and financial institutions) and the influence of Japan, it offers one of the most stimulating and distinctive views of Korean economic development to date. It will be of key interest to scholars and researchers of financial growth and development, Asian finance, and regional and heterodox economics.

Chapter 1
Introduction1

Although a large number of developing countries in the Third World today have purported to achieve growth through industrialisation, most of their experiences have revealed growth to be a ‘myth’ of economic development. With the hope of building a self-sustaining economy, these countries have tried to get over longstanding economic backwardness by introducing foreign capital and technology. However, such a move has fallen far short of expectation and little progress has still been witnessed in most of the developing countries. Faced with continued economic stagnation and political instability, despite efforts at industrialisation, the hope of economic independence and stability has sometimes faded away.

The so called Four Tigers, namely, Hong Kong, the Republic of Korea, Singapore and Taiwan,2 however, have been considered exceptional to this general rule. They have indeed achieved an astonishing rate of economic growth and prolonged development. As a World Bank report (1993) illustrated, annual growth in these countries over the past three decades was approximately 5.5 per cent, faster than in all other regions of the world. Among these newly industrialized countries, the Republic of Korea, actually South Korea, has succeeded in transforming herself into an economic powerhouse. As the 11th largest trading country in the world, Korea has succeeded in manufacturing and exporting such advanced goods as automobiles and semiconductors. Ascribed to these export-oriented development policy, Korea has achieved a strikingly high growth performance for a prolonged period and has finally become a member of a ‘rich countries’ club, such as the Organisation for Economic Cooperation and Development (OECD), at the turn of the twentieth century.

The rapid economic development achieved by Korean can easily be grasped if the growth rates between Korean and Japan (which was considered another model of economic miracle of the post World-War II era) are compared. Between 1970 and 1997, Korean GDP grew at an annual average of 8.4 per cent (The Economist, 1998), drawing economists and others to explain what led to her economic success. Compared with advanced countries today, for example, Japan which attained economic growth only after at least 100 years of accumulated effort, Korea’s economic growth in less than five decades has attracted much attention.

Against this backdrop, we are forced to ask a number of important and also intriguing questions: what has made the Korean economy work? How can the country’s remarkable economic development be explained? Are there lessons from this for other developing countries?

Various theoretical approaches have shown their relevance and limitations in explaining Korea’s success, some more than others. Prominent amongst the louder voices are the neoclassical, focusing on the free market system; the developmental-statist, stressing the effective role of government; and the dependency approach, focusing on continued dependence on foreign capital and technology.

Neoclassical economists, mainly supported by the World Bank (1987, 1993) and the IMF (1996), point out the importance of an efficient allocation of resources corresponding to market forces and outward-oriented strategies. Based on the law of comparative advantage, neoclassical economists contend that Korea has attained rapid and sustained economic growth by adopting an outward-oriented policy since the mid-1960s. However, just as the developmental-statists severely criticize, neoclassical economists seem not to understand the role played by the government in the Korean economy. In fact, they argued that the market would be allowed to play a part in the distribution of resources when the government was highly interventionist (Amsden 1989; Wade 1990).

On the other hand, a critique of dependency theorists should not go unchecked. Influenced by Latin American radical economists, dependent theorists assert that successful economic development in Korea has been achieved by heavy dependence on foreign capital, technology and trade (Evans 1979; Kim 1988; Castley 1997, 1998). Since the fortune of Korea’s economic development ties with that of external forces, the ups and downs of the global economy have ample chances of leading Korean economy to stagnation and even to underdevelopment (Cardoso 1977). However, the argument of dependency scholars does seem to underestimate the dynamics of changes in the relationships. Indeed, Korea’s economic relationship with Japan has changed gradually from vertical to horizontal by reflecting a convergence to interdependence, which is mutually beneficial. Moreover, Korea has experienced continued high economic performance without any alarming signs of significant stagnation or underdevelopment, apart from a relatively short period of financial crisis which started in 1997 and officially ended around 2000.

The common factor for the neoclassical and the developmental-statist analysts is the importance which they both place on internal factors, particularly focusing on whether or not the government has followed market principles. In the analyses of these two perspectives, external factors have been relatively neglected (Castley, 1997). By contrast, dependency economists have focused on external factors while internal factors have been given relatively less weight.

None of the existing theories of economic development is sufficient, in itself, to explain the economic success of Korea. Indeed, there is considerable controversy over the factors which have most contributed to it. This research, therefore, aims to derive a different explanation by combining and modifying elements in the existing theoretical perspectives with a view to fitting the special features of the Korean experience. A middle way is chosen: based on a cautious use of the developmental-state view which is seen as particularly relevant to Korea, this research combines all of the relevant explanations of the three perspectives mentioned so far, in particular bearing in mind the assumption that most of the internal factors affecting development have been chosen and determined by government.

Korea’s rapid and sustained economic performance can be explained by a complex interplay of many variables such as political stability, a favourable international environment, competent bureaucrats, a skilled labour force, timing, and dependency. The relationship between these variables has changed over time. In analysing economic development, it is meaningless to focus on several particular factors in a particular period in the sense that various factors have various facets. Economic development is an evolutionary process of institutions mixed with internal and external factors and to explain it adequately, the focus of attention should be on the institutions of development rather than on the selection of specific factors considered most relevant to rapid economic development.

In addition, the argument on the Korean model3 is the method of universalisation, teaching us that we can learn from Korean economic development negatively as well as positively. Here some questions will be raised for the study of Korean economic development. Can economic development be explained in a different way from the main three perspectives and if so, what is the best way to explain the process of Korean economic development? And is the Korean economic development model applicable as a strategy for other developing countries?

Purpose

There are three main explanations of economic development: the neoclassical view, the developmental-state view and the dependency view. The former two see government and market as alternative mechanisms for the allocation of resources, whereas the latter focuses on the cut-off of an unequal exchange relationship from the core as an alternative way of breaking away from dependency. The neoclassical view is that Korea has attained astonishing economic growth in spite of heavy government intervention, while the developmental-state view sees Korea’s success as a consequence of heavy government intervention (World Bank 1993; Amsden 1989; Jwa 1999). In other words, the former does not abandon its belief in market efficiency while the latter insists on the efficiency of government intervention. However, if a country based on a market economy achieved rapid and sustained economic development despite market inefficiencies caused by government intervention, two possible assumptions will be proposed: 1) the market is more efficient than government intervention; 2) there are some other factors that compensate for the failure of government intervention. In other words, under the condition that the market needs a certain level of visible hand, it can be said that the evolution of institutions not only trades off the distortion of resource allocation caused by government intervention, but results in economic development (North 1990; Aoki 1995). Here, interest is focused on an evolutionary process of institutions affected by internal and external factors. Indeed, there is no more revealing argument concerning the process of economic development than the synergy between internal and external factors.

Internal factors are an insufficient condition for economic development in general and for an economy with poor natural resources and a small domestic market, in particular. By the same token, external factors are insufficient for an economy which hardly possesses a receptacle for the adaptation of the external factors. Thus, economic development is likely to be caused by the interplay of internal and external factors rather than by internal or external factors alone. Indeed, a positive linkage between internal and external factors results in a favourable pattern of economic development. In particular, in the course of economic development, the role of internal and external factors becomes symbiotic initially, but can become competitive over time. For example, the role of government as the main internal factor has its own limits in overcoming market malfunctions.4 To solve market malfunctions, government chooses strategic alliances with private institutions. However, private institutions are not capable of solving various market malfunctions in general and this is particularly obvious for less developed countries. This is why an initially complementary relationship between government and other institutions may become competitive over time. Furthermore, external factors can become gradually embedded into domestic economic institutions creating certain patterns of a unique economic system. In this process, each institution grows and evolves, leading to economic development. For that reason, an analysis of the evolutionary process of each institution by exploring the interaction between internal and external factors through time will be needed.

The purpose of this book is to analyse the process of Korean economic development, especially in the period from post-World War II to 2002 when Kim Dae-Jung government claimed to have successfully overcome the financial crisis hitting Korea in 1997. The book does not cover the years since 2002 when the Noh Moo-Hyun government started its reign because it is still too early to assess rapidly changing political economic environments in Korea. The book focuses on an analysis of the evolutionary process of institutions by exploring the interplay of internal factors, particularly the role of government and external factors, and the influence of Japan in the process of Korean economic development. Specifically, the book intends to:

1) examine the formation and the workings of the economic system, with an emphasis on the close interaction between government, private institutions (chaebol and financial institutions) and the influence of Japan;

2) analyse the outcomes of the economic system;

3) assess the progress of Korea’s economic system and the changing relationship with Japan.

In doing so, the study will suggest some important implications for other developing countries. Korea has experienced a unique process of economic development with mechanisms and outcomes that are different from those suggested by the three major perspectives. Furthermore, in this study, it will be shown that Japan has had a much deeper effect than the US on the formation of the Korean economic system (see Table 1.1).

Table 1.1 Japan: characteristics favourable to the Korean Economy

For example, Japan’s foreign investment mainly by small and medium sized firms concentrating on labour-intensive industries was much more suitable for the creation of employment and for technology transfer than that of American firms which centred on capital-intensive industries. According to Kojima (1977) and Ozawa (1972), American firms produce consumer goods, requiring economies of scale and high technology that are less appropriate for developing countries, at the stage of downstream technology and with a shortage of capital. Castley (1997) and Hattori (1988) argue that unlike the US, Japan sent industries to Korea that produce products in the declining stage of the product cycle. Korea was able to accept and benefit from such industries.

Theoretical Explanations

The basic theoretical explanations for understanding Korean economic development in this study stem from a review of the theories of the three major perspectives. The previous studies in connection with this one are very helpful in deriving a model of economic development. They include studies on the free market approach in the international economy (World Bank 1986, 1987, 1993; Balassa 1971, 1981, 1988; Little 1982; Krueger 1978, 1980, 1990; Westphal 1990; Hong 1976; Corbo and Suh 1992; Sachs 1987; Krause 1992; IMF 1996); on the effective role of government (Amsden 1989; Jones and Sakong 1980; Sakong 1981, 1993; Deyo 1987; Haggard and Moon 1990; Haggard 1990; Taniura 1989; Wade 1990; Johnson 1982, 1987; Weiss and Hopson 1995; Kim 1997; Whang 1997); on dependency and development (Cardoso 1977; Evans 1979; Frank 1969, 1979; Nurkse 1959; Kim 1988; Honda 1990; Nakagawa 1987; Park 1990; Bernard 1995; Castley 1997); and on comparative institutional analysis (Aoki 1988, 1992; Aoki and Dore 1994; Aoki and Okuno-Fujiwara 1997; Aoki and Okuno 1996; Jwa 1999; North 1990, 1992; Eggertsson 1990; Fukagawa 1997).

In particular, the evolutionary analysis of each institution in explaining economic development needs a historical perspective. Historical observation allows an explanation of the interplay of internal and external factors. In particular, it helps to focus on the ways in which economic development has formed the Korean economic system by a deepening economic relationship with Japan. If there were no institution capable of expanding the Korean economy, it would have been impossible to industrialise itself by dependence on foreign capital and technology alone. Japan’s presence with capital, advanced technology and previous experience has been beneficial to the Korean economy.

This case study of South Korea analyses how the country internalised her dependent position in order to become a self-sustaining economy. Indeed, the long historical observation adopted in this case study provides a deeper and more accurate understanding of Korea’s economic development. It should be significant for other developing countries and for the theory of development economics to find out how the success story of the Korean economy can be explained and for an understanding of public policy in relation to the evolution of the economic system.

Research Methods

An Evolutionary Analysis of the Economic System

This study assumes that with the existing theories, it is difficult to explain the process of economic development as well as changing structural characteristics of institutions, while each theory shows its own relevance. Thus, an analysis is introduced of the economic system, which is formed in a gradual evolutionary process of institutions. In addition, Korea’s political economic relationship with Japan is emphasised because Japan’s influences have been progressively integrated into the formation of the Korean economic system.

Five arguments are offered in this research, which differ from the three main views of economic development.

1) In the case of Korea, economic development is achieved by a strategic alliance between a strong government and a leading economic institution (chaebol) in the market system. This alliance is complementary (symbiotic) initially and competitive over time. It plays as an independent variable that affects the whole economy in the process of economic development. Other economic institutions are relatively excluded by the strategic alliance fr...