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Development Overview

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Overview of Korea’s development experience

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Development Overview
Official Aid Production

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Establishment of POSCO

1. Background
 
As development of the steel industry was considered indispensable for Korea’s industrialization, discourse on the possibility of creating a major steel plant in the country pervaded the postwar economic reconstruction atmosphere. Even so, not much movement was seen in this area until the early 1960s or so, leaving Korea’s steel industry in its cottage-like, pre-modern state for some years to come.

Korea’s first-ever plan for the construction of a steel mill involved building a plant in Mukho based on around USD 3 million in aid from the US International Cooperation Agency (ICA). The plan was proposed in June 1957 but never realized since Washington doubted its feasibility.

The Korean Ministry of Commerce and Industry then devised another plan, this time for setting up an integrated steel mill, capable of producing 200,000 tons of steel, in Yangyang in August 1958. The Ministry’s plan to secure a foreign investment of USD 37.45 million in total for its construction, however, also came to naught.

The Second Republic, which came into being in 1960, too envisioned the construction of a steel mill in its First Five-Year Economic Development Plan. Yet the plan for producing 250,000 tons of pig iron via a plant that would cost USD 32 million and 30 billion hwan also fell flat, as the Second Republic quickly disappeared by military coup. The leaders of the Third Republic sought to secure investments from Demas, Krupp, GHH (DKG) of Germany as well as from American financiers in the early 1960s for creating a steel plant in Korea. Again the attempts ended in vain.

By contrast, the European Community and other countries around the world had successfully begun to foster their steel industries based on the active support they had received since the late 1950s, increasing output from 100,000 tons in the early 1960s to 500,000 tons in the early 1970s. As the demand for steel and other basic industrial goods began to rise explosively in Korea in the early 1960s, Koreans came to perceive the need for establishing a modern steel industry in their country with amplified urgency.

Nevertheless, the West, having the means and capacity (financial and technical alike) to support the establishment of such a steel industry in Korea, was generally skeptical of the success of such efforts. Material industries tended to require massive amounts of capital investment as well as technical expertise, and the project of establishing such an industrial complex in Korea simply did not appear sufficiently feasible or prospective.

Notwithstanding the general pessimism abroad, the commitment of Korean policymakers to economic self-sufficiency and stronger national defense, via the routes of industrialization and modernization, continued to fuel the Korean government’s drive to kick-start the decades of development with the creation of a steel mill.
 
 
2. Planning and Implementation
 
A more specific plan for building a steel plant was included in the Integrated Development Plan of Taebaek Mountain, which was part of the First Five-Year Economic Development Plan announced in January 1962. The Economic Ministers’ Meeting, held in December 1964, passed a resolution on the Plan for Fostering Steel Manufacturing in Korea according to an earlier mid- to long-term plan, envisioning the creation of a steel mill capable of producing up to a million tons of steel per year.

The excessive ambition of the plan, however, was what left it out of the final version of the First Five-Year Plan. The Second Five-Year Plan, established in July 1966, required the construction of a first-phase general steel mill, capable of producing 500,000 tons of steel per year, by 1971. The plan led policymakers to seek support abroad for its realization, in particular, they sought to secure loans of USD 30 million from Yawata Steel of Japan, another USD 30 million from the US Agency for International Development (US AID), and another USD 20 million from West Germany’s fund for development loans.

These fundraising efforts culminated in the assembly of an international group of loan providers, led by Corpus of the United States, in December 1966. The representatives of seven companies in the United States, Germany, England, and Italy gathered together in Pittsburg, Pennsylvania, to review Korea’s plan. The meeting resulted in the creation of the Korea International Steel Associates (KISA), which soon after began to coordinate multilateral meetings on Korea’s steel plan.

The second KISA meeting was held in January 1967, with the KISA delegation visiting Korea in April that same year to sign a provisional agreement on setting up a steel plant. The Korean government and the KISA also signed a basic agreement in October 1967, marking significant progress.[1] However, the skeptical turn in the American parties to this project[2] and in international development organizations[3] left the fate of the plan hanging in mid-air. The agreement with the KISA became all but meaningless by April 1969, setting the steel mill construction plan back to its original point.

As unexpected setbacks continued to challenge the steel mill plan, Korea’s Economic Planning Board organized the Research Commission for the Construction of Pohang Iron and Steel Company Limited (POSCO) in June 1969 to conduct a comprehensive and thoroughgoing review of the plan from its outset and establish a new, more workable plan. The biggest obstacle, the researchers found, was the problem of garnering the massive funding required.

As it became clear that Korea could no longer expect funding from the likeliest sources—i.e., the United States and Germany—the Korean government necessarily turned its attention to a new candidate: Japan. However, the research committee was soon forced to conclude that it would be equally difficult to secure sufficient investment from Japan, too. The research committee’s new plan, revealed in June 1969, envisioned creating a steel mill on par with major steel mills worldwide, capable of producing one million tons of steel per year. The Korean government thus decided to withdraw money from the Japanese Reparation Fund for Korea (JRF) instead of seeking new investments.

The third Korean-Japanese Cabinet Officials Meeting, held in August 1969, saw much progress on this front. After several rounds of negotiations, the two governments finally signed the Basic Agreement on the Construction Finance of Pohang Iron and Steel Company Limited in December 1969. The plan obligated that Korea adjust its plan on the size, make-up, and process of construction according to the report of a Japanese investigators’ group, and that Japan provide Korea with USD 123.7 million of the JRF for construction. Deepening its resolve to foster a steel industry in Korea with the creation of POSCO, the Korean government enacted the Steel Industry Fostering Act in January 1970, and finally broke ground for the construction of the historic steel mill in April that year.

The first phase of the POSCO project, with a production capacity of 1.03 million tons of steel per year, was finally completed in July 1973, three years after the groundbreaking. The second, third, and fourth phases also proceeded without much interruption, culminating in the completion of a world-class steel mill by January 1982, capable of producing 9.1 million tons of steel yearly. As part of its heavy and chemical industries (HCIs) drive that began in the early 1970s, the Korean government also launched the construction of a second steel complex, in Gwangyang this time, in 1982, and completed the plant, with a production capacity of 11.4 million tons per year, by October 1992.
 

 
[1] Agreement between the Government of the Republic of Korea and Korea International Steel Associates, entered into on October 20, 1967. The parties to this agreement were Koppers Company and Blaw-Knox (a member of the Westing Electric International Group) of the United States, Demag and Siemens of Germany, Wellman Engineering of England, Societa Italiana Impianti of Italy, and ENSID of France, aside from the Korean government. The agreement provided for funding of USD 95.7 million in total for the construction of an early steel plant in Korea that would produce 600,000 tons of steel per year at first, and later expand to 1.1 million tons.
[2] USAID/K, Comment on Analysis of Pohang Iron and Steel Co. Financial Plan, April 8, 1969.
[3] Although the KISA had conducted a feasibility study during its visit to Korea in May 1967, its decision-makers concluded the project unworkable. When the International Bank for Reconstruction and Development (IBRD) submitted its Economic Surveys: Korea, 1968 in March 1969, they insisted that it was too early for Korea to build such a plant.

Source: Korea International Cooperation Agency. 2004. Study on Development Aid and Cooperation for South Korea: Size, Scope and Exemplary Effects. Seoul.

  ##PAGE##
 3. Progress
 
Plans multiplied and evolved as Korean policymakers struggled to find support for their steel mill vision. The plan that finally won the Japanese investors’ approval in 1969 was essentially an elaboration upon the KISA plan, taking into account part of the technical assessment rendered by the United Nations Development Program (UNDP) and the Battelle Memorial Institute, and the opinion of the Japan Group (JG).

The KISA originally proposed two construction projects, each for completing a plant capable of producing 500,000 tons of steel per year. The UNDP and the JG, on the other hand, suggested that only one plan for constructing a million-ton plant at once was feasible. Some also argued that governmental support was necessary for creating the infrastructure required for the construction and operation of the plant.

It was against this backdrop that Korean policymakers finally settled on the plan for building one million-ton plant at once, the feasibility of which was later reaffirmed by Japan’s Technical Evaluation Committee as well as the IBRD Assessment Group. The final, resulting plant was capable of producing 1.03 million tons of steel per year.

The plan, included in the Second Five-Year Economic Development Plan, envisioned creating a steel plant capable of producing 500,000 tons of steel per year based on an investment of KRW 22.7 billion (including USD 67 million in foreign capital and KRW 48 million in domestic capital) in total between 1968 and 1971. As the scale of the project expanded significantly to 1.03 million tons of steel per year and the groundbreaking was postponed by two years, the total amount of required investment also multiplied commensurably.

The investment plan at the time of groundbreaking—May 1970—projected USD 137.7 million and KRW 25.389 billion in total investment, from foreign and domestic sources, respectively. As the number and size of the facilities built increased and given the rise in inflation and currency exchange rate, the actual investment came to KRW 106.783, including USD 168.1 million from foreign sources and KRW 39.56 billion from domestic sources. Foreign capital made up 63 percent of all project investment. The domestic investment went to machinery and building material production and purchase in Korea, land purchase, site preparation, marine transportation, insurance premiums, engineering, and monitoring and auditing. The facilities, parts, and materials that could not be produced in Korea were purchased with foreign capital. Equipment, machinery, and materials produced in Korea made up only 12.5 percent of all goods used in the project, amounting to KRW 9.4 billion out of the total cost of KRW 79.2 billion.

In the meantime, the infrastructure required for the construction of the steel plant, including electricity and waterworks, and roads, ports and harbors, was supported by the government, which also provided other supports in the forms of tax and duty benefits, raising a number of issues in terms of equity and economic/fiscal feasibility. Although such serious governmental involvement was necessary for the creation of such a major industrial facility in a developing country like Korea, free-market advocates worried that the special tax and financial privileges provided by the government might interfere with the steel market in the long run, destroying the self-regulating mechanisms of the market.[1] However, the decision-makers in the POSCO project insisted that it was impossible to ensure the economic and financial feasibility of the project to a sufficient extent without the government’s backing of the surrounding infrastructure. The JG, which visited Korea in September 1969 to conduct a feasibility study on the POSCO project, concluded that the project would not make any economic sense unless the Korean government provided tax and other benefits in support.[2]

The IBRD Investigators Group that visited Korea in October 1969 raised another issue with the POSCO project and the Korean government’s involvement in it. The IBRD argued that the businesses involved in the project should have to bear the cost of creating infrastructure—ports, railroads, and other such facilities—as part of the overall construction cost. The Korean government, on the other hand, justified its involvement in the project as one of necessity—arguing that it was providing the necessary public infrastructure. The IBRD investigators eventually came around, accepting the particularities that surrounded the promotion of such a project in a developing country like Korea.[3]

During the first phase of construction, the Korean government invested KRW 14.866 million in total, including KRW 11.442 million in ports and harbors; KRW 1.553 billion in industrial waterworks; KRW 715 million in railroads; and KRW 1.156 billion in civil engineering.[4]
 
<Details of the First-Phase Construction Cost>
 
Item Five-Year Plan Construction Plan Actual amount
Resulting scale (steel production in tons) 500,000 1,030,000 1,030,000
Domestic capital (in KRW 1,000,000, %) 4,824
(21.3)
25,389
(31.5)
39,560
(37.0)
Foreign capital (in USD 1,000, %) 67,333
(78.7)
137,714
(68.5)
168,058
(63.0)
Total (in KRW 1,000,000)1 22,694 80,475 106,783
Note: 1. Excluding the cost of building the surrounding infrastructure.
Source: 10-Year History of POSCO, POSCO, 1979.
 
Foreign capital, which made up two-thirds of the total first-phase construction cost, mostly came from the JRF and other international commercial loans. The JRF provided long-term loans at much more favorable rates (almost free) than those of commercial loans.
 
<Foreign Capital in the First Phase of Construction>
(Unit: USD 1,000)
 
Source Amount Conditions For purchases of:
JRF 77,228    
Grants-in-aid (PAC) 30,800 Free grants Raw material processors, steelmaking facilities, port and harbor facilities, railway facilities, water supply facilities, etc.
Loans (ECOP) 46,428 3.5% per annum, 7-year grace period, repayment over 13 years Incinerating facilities, cutting facilities, steel plate facilities, local transport facilities, steam gas and crude oil facilities, etc.
Commercial loans      
Japan Exim Bank 52,498 5.875% per annum, 1-year grace period, repayment over 11.5 years Oxygen facilities, water and energy transmission facilities, hot rolling facilities, etc.
Suppliers’ credits 38,323    
Toyo Cotton (Japan) 13,987 6.5% per annum, 1-year grace period, repayment over 10 years Corks facilities
VOEST (Austria) 24,345 6.5% per annum, 3.4-year grace period, repayment over 8.5 years Medium heavy plate facilities
Total 168,058    
Source: 20-Year History of POSCO, POSCO, December 1989.
 
 4. Evaluation and Implications
 
The POSCO project is widely praised for being a leading example of a development project spearheaded and championed by the recipient from the outset, and for its remarkable success despite the pessimistic and skeptical forecasts that shadowed the project in the international arena.

As Korean decision-makers were forced to learn from their mistakes through the process of proposing the project, they were able to devise a more feasible, yet ambitious, plan in the final phase of negotiations instead of thwarting their resolve to establish a steel industry in Korea. The POSCO project carries significant implications for international development cooperation.

First, the POSCO project teaches us that, notwithstanding the dearth of capital and technical resources in the recipient country, the feasibility of a development project can still be ensured when the recipient country adopts, adjusts, and improves upon technology from abroad according to its own particularities and conditions. Foreign resources provided as part of development cooperation can allow recipient countries to overcome the seemingly insurmountable problems of financial difficulties and capital gaps.

As Korea’s steel projects proceeded, starting with POSCO in the early 1970s and continuing well into the 1990s, the absolute capital and technical gaps that had first divided Korea from other advanced economies around the world gradually narrowed and closed. Whereas two-thirds of the cost for the POSCO project, until its second phase, came from foreign sources, the proportion decreased over time to less than 50 percent by the project’s fourth phase. In the 1980s, Korea began to build other steel mills with domestic funds, private loans, and the like.
 
<Capital Procured for Korea’s Steel Mill Projects>
(Unit: KRW 1 billion)
 
Project / type POSCO 19851 1990
Phase 1 Phase 2 Phase 3 Phase 4 Phase 5
Foreign capital (in USD 1,000) 168.1 348.2 766.0 665.9 162.6 134.8 -
Domestic capital 39.6 96.6 299.6 435.4 148.7 416.7 1,752.1
(Proportion, %) (37.0) (36.6) (44.6) (52.2) (57.6) (78.4) (100)
Total 106.7 265.4 671.2 835.0 258.0 531.5 1,752.1
Note: 1. Annual investment in POSCO and Gwangyang Steel Company.
Sources: POSCO, December 1989, and Gwak Sanggyeong et al., POSCO and the National Economy, 1992.
 
We may infer the narrowing technological gap from the proportion of domestically produced goods, equipment, and machinery in these construction projects. Whereas such domestic goods made up only 12.5 percent of all goods required in the first phase of the POSCO project, the ratio reached beyond 60 percent by the time the Gwangyang project was completed in the early 1990s.
 
<Changes in the Proportion of Domestic Goods in Steel Mill Construction Projects>
(Unit: KRW 1 billion)
 
Project / type POSCO Gwangyang Steel Company
Phase 1 Phase 2 Phase 3 Phase 4-1 Phase 4-2 Phase 1 Phase 2 Phase 3 Phase 4
Output (in 10,000t)1 103 260 550 850 910 270 540 810 1,140
Total cost (A) 75.2 161.4 446.9 446.4 184.8 939.0 510.5 1,070.2 1,213.8
Cost of domestic goods (B) 9.4 25.0 100.8 156.7 76.6 464.2 282.6 655.9 765.8
Proportion (B/A, %) 12.5 15.5 22.6 35.1 41.5 49.4 55.5 61.3 63.1
Note: 1. Cumulative total.
Source: Gwak et al., 1992, pp. 47 and 54.
 
In the interests of the market, the export-oriented and open investment policy of the Korean government turned out to be a much more productive direction than an inward-looking, passive investment policy based on the limited state of domestic technology at the time. The POSCO project involved creating something massive and future-changing out of almost nothing. Its success attests to the importance of the basic material manufacturing industries and the bold decisions by Korean policymakers in favor of future-oriented investments.

POSCO invests its capital and technical resources in steel and other industries in Korea and abroad. Having successfully closed the capital and technical gaps with its counterparts in advanced economies worldwide, POSCO now invests in various programs for helping developing countries foster their steel industries. As of June 2003, POSCO had a total of 13 steelmaking companies in seven countries worldwide, including China and Vietnam, established with a total investment of USD 1.9213 billion.[5]

Perhaps the most pertinent implication that developing countries can draw from POSCO’s example is that political leadership plays a decisive role in determining the industrial and investment policies of a given nation. President Park Chunghee possessed the right long-term vision, and applied himself thoroughly to realizing that vision against all odds. Instead of abandoning his plan when the KISA finally refused to help him, he reformed his Cabinet and began to prepare a new plan with newfound vigor. With the Cabinet reform, the Senior Secretary to the President for Economic Policy was promoted to the positions of Vice-Prime Minister and the head of the Economic Planning Board.[6] Strong leadership and political will are especially important for developing countries that are latecomers to industrialization because the right amount of investment must be made at the right moment.

Nevertheless, the governmental involvement in the POSCO project continues to raise controversies between market proponents and government advocates to this day. We can see from the POSCO case, however, that governmental support is indispensable for creating the infrastructure needed to foster and protect the target industry in countries that are still trapped in the early phases of industrialization. Large development projects in developing countries with little financial and technical resources require both direct and indirect forms of governmental involvement, if only to help the private sector overcome the hardships and challenges that it cannot overcome on its own.

The problem is deciding when the government ought to withdraw the privileges and special treatments it has provided so as to restore the market to a self-functioning state. Another important question is how to redistribute the benefits and burdens of the governmental investment in such development projects, in ways that ensure returns to the national economy as a whole. The various programs of governmental support that were provided in the early days of Korea’s steel industry disappeared long ago. The Korean government sold the shares that it and its financial institutions held in POSCO to the general public at large at a discounted price so as to return some of the profits that the company had generated to the public.

The POSCO project and the international development cooperation it attracted offer invaluable insights and implications for the industrialization and development of developing countries worldwide today.
 
 
[1] USAID/K, 1969, p. 1.
[2] 20-Year History of POSCO, POSCO, Dec. 1989, p. 151.
[3] POSCO, 1989, p. 152.
[4] POSCO, 1989, p. 180.
[5] As of June 2003, POSCO was running 13 steelmaking companies as well as 24 local enterprises for producing raw materials and distribution of exported goods worldwide.
[6] POSCO, 1989, p. 143.

Source: Korea International Cooperation Agency. 2004. Study on Development Aid and Cooperation for South Korea: Size, Scope and Exemplary Effects. Seoul.