The liberation from Japanese colonial rule in 1945 left Korea in economic chaos. The complementary economic structure between the northern and southern parts of the peninsula was lost. Most of the Japanese businessmen, managers and technicians returned to Japan, leaving many firms bereft of management or technical expertise. The closely-knit ties with the Japanese economy, a vast market for Korean goods, were broken. A stupendous growth in money supply around the time of the liberation period generated hyperinflation. Amid these difficulties, the newly independent Korean government was installed in 1948, and it immediately embarked on rebuilding the nation. Any serious effort, however, was delayed by the Korean War (1950-1953).
The American military government which was in charge of South Korea between 1945 and 1948 tried to introduce amodern market economy system.1) It outlawed the so-called “workers’ self-management” of factories abandoned by Japanese owners and barred workers from interfering with managerial responsibilities (Yong-deok Jeon, 1997a). The military government also began to sell confiscated Japanese-owned property despite calls for nationalization from both right- and left-wing political groups. The realized sales of companies and farmland during the three-year U.S. military rule were not large in size, but this was an important first step toward establishing a market economy based on private property ownership.
Divesture continued under the newly established Korean government, and sales reached a peak in 1951-1953. As a result, most of the Japanese-owned properties were converted into private ownership by 1958. They accounted for a large portion of the total national economy; for example, among the companies with 300 or more employees, the share of privatized ones was roughly 40 percent in the 1950s. This achievement is notable given the predisposition toward socialism even among right-wing politicians at the time. 2)
Land surveys and registration conducted by the colonial government in the 1910s established the first modern system of property rights in Korea and reduced land transaction costs significantly. But it was not accompanied by measures to protect small farmers, and led to a wide disparity in agricultural land holdings (Seok-gon Cho, 2001).
The Korean government responded to the increasing demand for agricultural land reform by enacting the Farmland Reform Act of 1949 and revising it in 1950. The reform was based on the principle of“compensated forfeiture and non-free distribution,” whereby the government bought farmland from landlords at forced prices and sold it to farmers at below-market rates.
The reform had many elements that ran counter to private property rights. The compensation to landlords was less than the market price, leading to big losses for the landlords (Yong-deok Jeon, 1997b). 3) The Farmland Reform Act also banned farmland ownership by non-farmers, stipulated the maximum amount of landholdings per farmer, and prohibited tenant farming. Nevertheless, from the perspective of private property rights, “compensated forfeiture and non-free distribution” was a better option than “uncompensated forfeiture and free distribution” as espoused by left-wing groups and “compensated forfeiture and free distribution” by centrist groups. The most pressing task at the time was state-building, based on the support of farmers who constituted by far the largest part of the Korean population, even if this meant some infringements on the private property rights of landlords.
Agricultural land reform contributed not only to state-building, but also to redistributing wealth and reducing income inequalities. Everyone was now placed on amore or less equal footing, and individual effort and ability rather than family wealth became the most important determinant for individual success. Many believe that the Koreans’ characteristic diligence and their emphasis on education were motivated by this perception of equal opportunity. On the negative side, however, restrictions on farmland holdings hampered the growth of large-scale farming and contributed to the low productivity growth of the agricultural sector in later years.
Rhee Syngman, the first president of the young republic, strived to rebuild the economy with a series of reconstruction plans. 4) These plans aimed to expand the economic infrastructure, build key industries (cement, steel, etc.) and increase the productive capacity of manufacturing (Sang-oh Choi, 2005, pp.358-359).
Rhee’s desire to construct aself-sufficient Korean economy with these plans was in direct conflict with the American government’s intention to rebuild an East Asian economic bloc with an industrialized Japan at its center. America urged Korea to liberalize its market, stabilize the value of the Korean currency, and expand cooperation with Japan. To Rhee, however, this implied nothing but the revival of the Greater East Asian Co-Prosperity Sphere and the re-colonialization of the Korean economy. Rhee made full use of Korea’s geopolitical value to frustrate America’s effort while promoting import-substitution industries through reconstruction plans.5)
The Korean government also differed with the Americans on what kind of foreign aid it would receive. There were two types, one being project assistance and the other non-project assistance. The former was to be used for reconstruction, while the latter was to be distributed to private enterprises for civilian use. Korea received a large amount of foreign aid from the United Nations and the U.S. in the 1950s and 1960s. 6) The Korean government preferred project assistance, while the American government preferred non-project assistance. In the end, the American preference prevailed; under ICA (International Cooperation Administration) aid, for example, project assistance made up 27 percent of the total and non-project assistance 73 percent. In any event, various reconstruction plans prepared by Rhee’s administration failed to spark economic growth in Korea. They remained just that－plans.
Throughout the 1950s, the Korean government maintained a complicated multiple exchange rate system (Frank, Kim and Westphal, 1975). In addition to the official rate, there were separate rates applied to the counterpart fund 7) and to military payments certificates (MPCs).8) 10 The overvaluation of the Korean won under these rates either reduced the government’s burden (as in the case of the counterpart fund rate) or increased its revenues (as in the case of the MPC rate). The government reluctantly adjusted exchange rates from time to time when it could no longer withstand pressure from America.
An overvalued exchange rate discouraged imports. Imports were further discouraged by quantitative restrictions that the Korean government employed to promote import-substitution industrialization. Trade Programs, which were published semi-annually by the Ministry of Commerce and Industry, listed three types of goods: (1) freely-imported items, (2) restricted items whose import required prior approval from relevant ministries, and (3) banned items (Sang-cheol Lee, 2001, p.459). Banned items referred to those that were produced domestically in sufficient quantity to meet all domestic demand. Restricted items were those whose domestic production could not meet all demand.
The tariff system was also geared to protecting domestic industry. From 1945 to 1949, a single tariff rate of 10 percent was levied on all items except for foreign aid goods. In 1950, the government enacted the Tariff Act that imposed different rates depending on whether the item was produced domestically or not, and whether the item was a finished good or not. Tariff rates were generally high, ranging between 27.4 and 66.5 percent in the latter half of the 1950s.
Export promotion was also pursued, but the focus was not on actively promoting exports but on mitigating the impediments to exports. An example is the Foreign Exchange Deposit System, which allowed exporters to deposit foreign currencies earned from exports at the Bank of Korea (BOK) and to use them to pay for imports or sell the foreign currencies to other importers at market rates. However, direct subsidies for exports were minimal.
According to Jung-en Woo (1991, p.60), Korea in the 1950s exhibited a textbook example of financial repression. The official lending rate by banks was capped at 20 percent when the curb market rate was well above that.9) 11 In addition, the credit priority regulation and the credit ceiling regulation enabled the government to control bank lending directly (Pyung-joo Kim, 1995, p.188).
In January 1954, the Korea Development Bank (KDB) was launched as a solely government-owned bank. Its mission was to provide long-term credits to key industries. It financed over 70 percent of total equipment loans and over 10 percent of total working capital loans made by financial institutions (Joon-kyung Kim, 1993). It raised funds by borrowing from the government fiscal loan program (50 percent of the funds in the 1950s) and issuing bonds (37 percent).
The real interest rate remained negative most of the time due to low official rates and high inflation, discouraging savings and increasing demand for credit. Credit demand always surpassed savings despite the regulations mentioned above, and commercial banks had to rely on the central bank rediscount facility to fill the gap. Before 1957, about half of bank lending was financed by the central bank in this way (Jung-en Woo, 1991, p.62).
The excessive reliance on the central bank rediscount facility inevitably generated high inflation. Money supply was increased further by central bank lending to the government o finance essential public services, such as defense and the police. Annual inflation fluctuated between 20 and 400 percent between 1946 and 1957 (Table 2-1). The root cause of high inflation lay in the lack of operational independence of the central bank. Arthur Bloomfield, an economist at the New York Fed, recommended the establishment of an independent central bank resembling the Federal Reserve Bank. Following his advice, the Bank of Korea Act and the Banking Act were enacted in May 1950. The Bank of Korea Act, however, failed to bestow full independence on the central bank.
Table 2-1. Price inflation
The implementation of the Banking Act was postponed until August 1954 due to the delay in the privatization and recapitalization of banks. From 1954, the government attempted five times to sell its shares in banks, but failed. It could finalize the sales in February 1957 only after relaxing the eligibility conditions for bids. In the end, each major chaebol came to own abank, which accelerated the concentration of economic power (Pyung-joo Kim, 1995, p.190). The military government re-nationalized the banks in 1961 shortly after seizing power.
Throughout the 1950s, the Korean government maintained an overvalued exchange rate, restricted imports, regulated interest rates and bank lending, and undermined central bank independence. These market interventions created economic rents, which amounted to 16-19 percent of GNP according to Nak-nyeon Kim (1999). Of these, the rents resulting from exchange controls amounted to 11-15 percent of GNP and those resulting from financial repression 3-8 percent of GNP.
The question is how much of these rents were utilized in productive activities. Sang-oh Choi (2005) observes that rents were distributed mostly to those who put them to productive use, and stimulated economic reconstruction at the time. He cites the case of the cotton spinning industry, which lost 66 percent of its facilities during the war, but recovered soon after and even encountered over-capacity in the latter half of 1956.
Younghoon Rhee (2007) also claims that the government maintained a certain degree of consistency and ethical standards in distributing dollars obtained from foreign aid and military payment advances to civilians. In fact, real output grew by 3.8 percent annually in 1953-1960. This is about half the rate witnessed in the 1960s and afterwards, but it can hardly be called “stagnation.” Contrary to these views, some authors believe that the government policies at the time encouraged zero-sum rent-seeking activities rather than positive-sum productive ones, leading to the underperformance of the Korean economy far below its growth potential.
Jones and SaKong (1980, pp.270-274) describe the rapid growth of the chaebol after the liberation, and declare that the major sources of accumulation were (1) non-competitive allocation of import quotas and import licenses, (2) the bargain price acquisition of former Japanese properties, (3) the selective allocation of aid funds and materials, (4) privileged access to cheap bank loans, and (5) the non-competitive award of government and U.S. military contracts for reconstruction activities. To be successful as an entrepreneur, one had to build close ties with politicians and return their favors with cash (Jung-en Woo, 1991, pp.65-69).
However plausible each of these contrasting views is, it is not possible to make any quantitative judgment on this issue. We will conclude this section by looking at policy changes taken in 1957. In the mid-1950s, the view gained wide support within America that the best way to win the war against communism lay in promoting the economic growth of its allies. The American government subsequently separated military and economic aid, and began to reduce the former while increasing the latter. In addition, it reduced unrequited transfers and introduced the Development Loan Fund in its place.
American aid to Korea peaked in 1957 and declined rapidly thereafter. At the same time, the American government pressed the Koreans to adopt the Financial Stabilization Program (1957-1960) to eliminate large budget deficits and curb rapid monetary expansion. Unlike previous efforts, stabilization under the Program relied on asystematic framework comprising annual targets for M1 growth and quarterly and monthly implementation plans. This provided the first opportunity for Korean officials to learn the techniques of controlling money supply (Pyung-joo Kim, 1995, p.187).
Source : SaKong, Il and Koh, Youngsun, 2010. The Korean Economy Six Decades of Growth and Development. Seoul: Korea Development Institute.
NOTE
1)The North was occupied by Soviet Union until a separate government was established in 1948.
2) In fact, the first Constitution of 1948 mandated companies of major importance to be nationalized or controlled by the government.
Following this mandate, the government designated 50 companies as state-owned enterprises in 1951. The Constitution, however, was revised in 1954 as agreed by the Korean and American governments, and divestures gained speed to encompass all industries except a few strategic ones.
3)The forced prices were well below market prices. In addition, the delay in payments due to the war, combined with high inflation, significantly eroded the real value of “land compensation securities” that had been given to landlords in exchange for their lands.
4) The Five-Year Industrial Reconstruction Plan (1949), Reconstruction Plan (1951), Comprehensive Reconstruction Plan (1954),Five-Year Economic Reconstruction Plan (1956), and Three-Year Economic Development Plan (1960). These kinds of development plans could be found not only in socialist economies, but also in capitalist ones such as France after the Second World War (Yergin and Stanislaw, 1998).
5) The Taiwanese government was much more cooperative than Korea was with the Americans (Jung-en Woo, 1991, p.52).
6) The amount of aid as a proportion to GDP corresponded to a low of 11 percent in 1954 and a high of 23 percent in 1957 (Sang-oh Choi, 2005, p.362).
7) The foreign aid often took the form of the right to import from America or other countries a certain amount of goods in dollar terms. A private importer or a government agency that was allocated these rights had to deposit Korean currencies in the counterpart fund held by the Bank of Korea. The low won/dollar value of the counterpart fund rate meant a smaller burden for the importer or the government agency (Younghoon Rhee, 2007, pp.302-303).
8)During the war, American and other military forces needed a means of payment for local goods and services they purchased. To facilitate this, the Korean government turned over to the United Nations Command a large amount of won in advance with the understanding that the terms of repayment in dollars would be negotiated later. In the negotiations, the Korean government tried to keep the won/dollar exchange rate at low levels to maximize its dollar receipts (Krueger, 1977).
9) The curb market rate was 48-120 percent according to Sang-cheol Lee (2001, p.463) and 150-240 percent according to Jung-en Woo (1991, p.61).
References
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