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Overview of Korea’s development experience

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Development Overview
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Globalization of Korean economy

The Asian financial crisis of 1997 caused a great economic turmoil in Korea. Some of the factors cited for the crisis included Korea’s failure to take appropriate measures to counter reckless management of banks and moral hazard problems resulting from close ties between politicians and businesses, and a belief that large business groups were“too big to fail.” Korea had failed to establish a fair and transparent economic system in the process of pursuing dramatic economic growth (Chang Young Chung and Tae Kyu Park, 1995). High economic growth depended on an excess amount of foreign loans, which reached 180 billion dollars, most of which were short-term debts. In 1997, Korea’s manufacturing sector had a debt-to-equity ratio of 400 percent, which was twice that of the U.S. or Japan, and five times higher than that in Taiwan (Kyu Sung Lee, 2006).

The IMF bailout agreement accelerated the liberalization of the Korean economy. Korea agreed to eliminate trade-related subsidies, restrictive import licensing, and the import diversification program, in addition to streamlining and improving the transparency of import certification procedures. Moreover, Korea agreed not to postpone liberalization plans for reasons of its international balance of payments.

From the late 1990s, Korea began pursuing a FTA (Free Trade Agreement) policy, turning away from a trade policy that focused only on the WTO’s multilateral trade liberalization. In an environment where FTAs were rapidly spreading all over the world, it was vital that Korea improve its economic efficiency. In addition, Korea needed to pursue an FTA policy in response to the regionalization trend in other regions, such as the EU and NAFTA (North American Free Trade Agreement), which posed the threat of trade discrimination in Europe and the U.S. The FTA policy also was seen as necessary to secure export markets and promote the efficiency of Korea’s economic system. With the launch of the FTA policy, Korea has concluded FTAs with Chile, Singapore, EFTA (European Free Trade Association), ASEAN, the U.S., India and the EU. The Korea-U.S. FTA signed in April 2007 was notable since it is the largest one in terms of trade volume among the FTAs concluded between countries around the Pacific Rim.

Korea now ranks very high in terms of trade openness, although its FDI openness still ranks very low. The openness of the Korean economy measured as the sum of exports and imports as a percentage of GDP increased from 79 percent (exports 45 percent and imports 34 percent) in 1998 to 92 percent (exports 45 percent and imports 47 percent) in 2008. However, FDI as a percentage of GDP was only 3 percent in 1990, and remained low relative to other countries (Table 4-4). As of 2007, Korea ranked 52nd in terms of FDI stock as a percentage of GDP among 55 countries, lower than most developed countries and major developing countries. Even after receiving more policy attention, the amount of FDI is still very small. The future agenda of trade policy should therefore be closely related to how Korea can make its domestic market investment-friendly. This will require an improvement of domestic institutions and the elimination of border barriers.

The liberalization process met with domestic opposition by groups that were adversely affected by the measures. Institutional assistance and an expansion of the social safety net became important in minimizing the opposition to the liberalization policy. The trade adjustment assistance system was introduced immediately after the conclusion of the Korea-U.S. FTA.

The global economy recently suffered one of the worst recessions since the Great Depression of the 1930s triggered by the bankruptcy of Lehman Brothers in September 2008. Korea, the G20 chair country for 2010, has demonstrated its commitment to combat protectionism. Korea played asignificant role in eliciting the political initiative of global leaders to prevent protectionism during the first and the second summits of the G20.


Table 4-4. Openness ranking of major countries 1)


Over the past several decades, Korea has taken actions to lower tariffs and to remove non-tariff barriers. While it has observed international trade rules and made much progress in market liberalization, more work needs to be done, in particular, in the liberalization of the agricultural and service industries. It should also improve the investment environment. By attracting more foreign investment, Korea can promote structural reforms that will help the country in its transformation from a manufacturing-based economy to a knowledge-based one. In addition, Korea needs to improve the trade adjustment assistance system and make the social welfare infrastructure more relevant to an open market economy.

Korea was one of the greatest beneficiaries of the open and rule-based multilateral trading system. Korea, now one of the world’s leading trading nations, should play aleading role in the conclusion of the Doha Development Agenda (DDA) negotiations in order to maintain the momentum for continued global liberalization. Moreover, Korea should contribute to promoting APEC (Asia-Pacific Economic Cooperation) as an effective regional organization.

The exchange rate was an important part of Korea’s export promotion policy. Before the 1980s, Korea had afixed exchange rate system with its currency pegged to the U.S.dollar. This system, however, created ahuge impact on the economy every time the rate was adjusted. Thus the government adopted amultiple currency basket peg system. As Korea started building acurrent account surplus, however, major trading partners, especially the U.S., became vocal in opposition to the system, designating Korea as an exchange rate manipulator.

In March 1990, the exchange rate system was switched to amarket average rate system with anarrow band of intraday fluctuation. With the trading band, the system was not able to reflect fully foreign currency supply and demand conditions and caused the won to remain overvalued against the dollar despite current account deficits. This led to arise in foreign debt and afall in foreign exchange reserves.

The 1997 financial crisis caused asharp depreciation of won. In an attempt to defend the currency, the government widened its won trading band and finally abolished the band to allow the won to float freely. Since 1997, the elasticity of exports with respect to the exchange rate has declined, as the pass-through effects of the exchange rate were reduced, meaning exporting firms tend to adjust won export prices rather than dollar prices in response to exchange rate fluctuations.

As seen in the Figure 4-5, there is another notable feature in Korea’s exports related to the exchange rate. Since 1997, while real effective exchange rates have continued to appreciate, Korea’s exports by value or quantity have maintained high growth of about 20 percent.


Figure 4-5. Export growth and real effective exchange rates


Source : SaKong, Il and Koh, Youngsun, 2010. The Korean Economy Six Decades of Growth and Development. Seoul: Korea Development Institute.

References


· Chung, Chang Young and Tae Kyu Park, Substantial Growth of Korean Economy, Jipmoondang, 1995 (in Korean).
· Lee, Kyu Sung, Financial Crisis of Korea. Pakyoungsa, 2006 (in Korean).
· Lee, Junkyu and Hongshik Lee, “Feasibility and Economic Effects of a Korea-U.S. FTA,” Policy Analysis, 2005.

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