Overview of official foreign assistance for Korea: 1960-79

Background

The 1960s witnessed sharp changes both domestically and internationally. A new government was established in Korea in 1961 through a bloodless military coup. This new government embarked on industrialization of the Korean economy through the introduction of successive 5-year economic development plans, starting from 1962. The plans aimed to provide momentum for the Korean economy based on industrialization, pursued first through export-oriented labor-intensive light industries in the 1960s, and next in export-oriented heavy and chemical industries in the 1970s.
 
As a means of mobilizing capital needed for the implementation of the 5-year economic development plans, the government first strengthened the Foreign Capital Promotion Law in 1962 to encourage foreign direct investment and promote private sector borrowing overseas supported by government guarantees. Second, the government in 1962 launched negotiations with the Japanese government for rapprochement and reparation. The government anticipated that domestic savings would be insufficient to finance the ambitious investment programs of the economic development plans, and made all-out efforts to mobilize foreign savings (grants, loans, and foreign direct investment, etc.). Furthermore, ore in 1965, the government undertook drastic tax reforms to increase tax revenues and eradicate corruption. Finally, in that same year, the government pursued interest rate reform, raising the 1-year savings account interest rate from 15 to 30 percent to encourage domestic savings.
 
Externally, the Organization of European Economic Cooperation (OEEC) and its Development Assistance Group (DAG) were reorganized in 1962 as the Organization of Economic Cooperation and Development (OECD) and the Development Assistance Committee (DAC), respectively, with the participation of other major economies like the United States, Japan, and Australia. This reorganization reflected the full recovery of the European economies from World War II and aimed furthering economic growth through expansion of economic relations (trade, investment, aid, etc.) with developing countries.
 
The UN designated the 1960s as the First Development Decade for the economic growth of developing countries, promoting economic cooperation and opening. Besides the traditional loan window (with interest at concessional rates) of the International Bank of Reconstruction and Development (IBRD), in 1960 the World Bank Group created a credit (soft loan without interest charges) window for low income countries.
 
The United States, which had served as the major donor for rehabilitation and recovery of the Korean economy in the 1950s, also made a strong commitment to the economic growth of developing countries through the Foreign Assistance Act of 1961. The Kennedy administration, however, shifted the focus of its assistance policy from providing grants to offering loans, emphasizing the responsibilities of recipient countries, and combined its two major aid agencies, the International Cooperation Agency (ICA) and Development Loan Fund (DLF), into one agency called the Agency for International Development (AID). Several European countries also established their own bilateral aid agencies.
 
In the academic arena, the traditional Harrod-Domar growth theory, which emphasized physical capital accumulation as the main source of growth, was challenged by the neoclassical growth modeling of R. Solow and the human capital theories of T. Schultz and B. Becker, which emphasized population growth, technological progress, and human capital accumulation as the major sources of growth.
 
Objectives of Assistance

The 1960s marked a turning point in the history of official foreign assistance in Korea. The scale of aid increased compared with the 1950s, with the objective shifting from rehabilitation and reconstruction in the aftermath of the Korean War to economic growth through industrialization and exports. The assistance, in other words, was no longer for emergency relief, but for investment and economic growth to attain higher living standards. Compared with the 1950s when donors took the initiative in identifying where aid funds were needed and applied them accordingly, from 1962 the government of Korea began to take that initiative, basing its assistance requests on the needs of its successive 5-year economic development plans.
 
Scale and Type of Aid

During the development decades (1962-92), total capital inflows to Korea amounted to about $82 billion, of which public capital inflows, i.e., public development grants and public development loans, amounted to only $21 billion or about 26 percent of total capital inflows. The rest consisted of private capital inflows such as commercial loans, financial institution borrowings, private sector bonds, and foreign direct investment. However, public capital inflows played an important role in leading Korean economic development initially. As development progressed, the role of public capital inflows declined, as private capital inflows began to take a leading role. The share of official foreign assistance declined from 38 percent of total capital inflows during the first half of the development decades (1962-78) to 22 percent during the second half (1979-92), due to the rising share of private capital inflows. Increased public capital inflows and investment at the initial stage crowded in private capital inflow and investment at the later stage, a unique feature of Korean economic development.
 
Another feature of the capital inflows in the Korean economic development is that public and private loans dominated capital inflows, over foreign direct investment. Many development studies claim that FDI contributes more to economic growth than loans. This was not so in Korea’s case, where fast economic growth and industrialization were attained through loans. Thus for Korea, efficiency in the use of capital, rather than the type of capital, was more important for the nation’s economic development at that time.
 
While most assistance during the 1940s and 1950s was provided in the form of grants, they accounted for only half the total official development assistance (ODA) during the first half of the development decades (1962-78). Moreover, as Korean's per capita income increased during the second half of the development decades (1979-1992), grants were stopped, and the majority of the public development loans provided during this same period were OOA-type loans (other official assistance with a grant element less than 25 percent), not ODA-type loans (with a grant element greater than 25 percent). In 1975, Korea graduated from the World Bank Group's IDA loans, which was the country’s main window for soft loans (i.e., ODA-type loans).
 
Throughout Korea’s development decades (1962-92), public grants ($1.5 billion) accounted for only 1.8 percent of total capital inflows. This is another unique feature of Korean economic development. That is, Korea’s high growth and successful industrialization occurred through the use of public development loans rather than public grants. This is also the reason why some studies on Korean economic development cite public development loans as contributing more to the high economic growth rate of Korea than grants. This occurred not because loans were particularly more effective in promoting economic growth, but because few grants were available, and loans were the main source of development finances.
 
[Table 1]  Capital Inflows to Korea: 1945-1992 (Unit: US$ million in current prices; %)
 

 
The public capital inflows (official foreign assistance) can be divided into public grants and public loans. The latter can be further disaggregated into the ODA-type loan (with a grant element greater than 25 percent of the total loan amount) and the OOA-type loan (with a grant element less than 25 percent). Since 1962, foreign capital inflows had sharply increased during the next 16-year period ($16.4 billion), compared with the previous 16-year period ($3.1 billion). Moreover, the composition of the capital inflows changed substantially. During 1960-1990, while public grants decreased from the previous period (1945-60), accounting for only 13 percent ($2.7 billion) of total public capital inflows ($21.3 billion), the ODA-type loan increased sharply to $4.7 billion, making up 22 percent of total public capital inflows. Therefore, total ODA (grants plus ODA-type loans) of $7.4 billion, constitutes only 35 percent of the total public capital inflows. This means that OOA-type loans amounting to $13.9 billion dominated (65 percent) total public capital inflows (official foreign assistance) during the same period.
 
[Table 2]  Public Capital Inflows: 1960-90 (Unit: US$ billion in current prices)
 

 
During the period 1962-1982, the Korean economy grew on average 8.2 percent per year. Government studies show that a high level of the foreign capital inflows including official foreign assistance—especially public development loans (with a less than 25 percent grant element)—contributed about 3.3 percentage points (or 40 percent) to the high growth rate (compared with the hypothetical growth rate of 4.9% per year without foreign capital inflows). In fact, the GDP growth rate during 1945-1951, when foreign capital inflows were at a much lower level, averaged only 4.4 percent per year. Thus, the higher growth rate during 1962-1982 can be attributed to the higher investment rate, which in turn can be attributed to the higher level of foreign savings inflows including official foreign assistance.

During the 1960s, general government revenues still depended heavily on foreign savings, especially official foreign aid, and almost one half of total investment was financed by foreign savings, i.e., net transfers from grants and public development loans. Even during the 1970s, when dependence on aid declined, total investment was still dependent on public development loans, especially OOA-type loans, since domestic saving rates were much lower than total investment rates. The gap was filled by public development and commercial loans. For example, in 1974, while total investment was 31.6 percent of GDP, the domestic savings rate was only 20.6 percent of GDP, leaving a gap of 11 percent. This investment gap had to be financed by commercial and public development loans, especially OOA-type loans. Domestic savings rates were not yet high enough, and grants or soft loans were no longer available in large amounts. It was only after 1986 when domestic savings rates became high enough to cover the high total investment rates.  
 
[Table 3]  Aid Dependency: 1950s-60s (Unit: US$ million in current prices; %)
 

¹Transfer fund originated from grants (AID, PL480, etc)
 
[Table 4]  Aid Dependency: 1960s-80s (Unit: % of GDP)
 

 
The Korean government played an active role in systematically coordinating donor contributions and in mobilizing aid funds. One mechanism initiated by the government for this purpose in 1966 and proved to be especially effective was the International Economic Consultative Group for Korea (IECOK). , This is an annual (or bi-annual) meeting participated by major bilateral and multilateral donors and chaired by the World Bank for briefing donors on the government's development strategy and investment programs, identifying specific aid needs, and for discussing the implementation progress of existing aid-financed projects. This mechanism was used until the beginning of the 1980s, and was replicated by the World Bank for many other developing countries.
 
Major Donors of Aid

Though the United States continued to be a significant donor, during the development decades (1962-92), other developed countries, especially Japan, began to play equally important roles as donors. Moreover, together with the bilateral source, multilateral banks such as the International Development Association (IDA) and the International Bank for Reconstruction and Development (IBRD) of the World Bank Group, and the Asian Development Bank (ADB), also became major sources of assistance. Between 1961 and 1999, the IDA/IBRD financed more than 120 investment projects and structural adjustment programs, giving a total of $14.9 billion in loans and credits. The ADB for its part supplemented $5.6 billion in credits and loans. Consequently, the type of aid funds during this period more concentrated on credits (no-interest loans) or loans (with interest), instead of grants. Even the US government shifted its aid from grants to loans under the Kennedy administration’s Foreign Assistance Act of 1961.
 
By 1960, US aid, mostly in the form of grants, was declining from its peak in 1957. The United States and Japan each provided more or less the same amount of ODA (grants and ODA-type loans) of $3.0 billion during 1961-1990. While the United States played a much more active role (64 percent) during the first half of the development decades (1961-75), Japan played a more dominant role (58 percent) during the second half (1976-90). Moreover, during the period from 1959 to 1999, when all public development loans were fully disbursed, Japan provided a somewhat larger amount of public development loans (a total of $6.1 billion ODA and OOA loans) than the United States ($5.2 billion). Besides the United States and Japan, a major bilateral donor was France, which provided solely public development loans ($3.5 billion).
 
[Table 5]  ODA Donors: 1961-90 (Unit: US$ million in current prices: %)
 

 
Aid from Japan during the first half of the development decades (1961-75) was given through the Reparation Fund, agreed to by both countries in 1965. This fund was composed of $300 million in public grants, and $200 million in public concessional loans at a 3.5 percent annual interest rate (with a 20-year repayment period including 7 years' grace). In addition, $300 million in commercial loans were also promised. These loans were to be disbursed equally over a 10-year period starting from 1965. Therefore, Japanese development loans accounted for about half the total development loans during this period (1965-75). Also, total grants and loans including commercial loans from Japan during the period were equivalent to about 23 percent of Korea's total exports, and more than one-third of total capital inflow including commercial loans.
 

[Table 6]  Public Development Loans by Donor: 1966-92 (Unit: US$ million in current prices; %)

 
 
Sectoral Distribution of Aid

Between 1945 and 1961, most aid was in the form of food, materials and other consumable goods. Since these were by and large sold in the domestic market, converted into cash, and deposited into the Counterpart Fund, which was used mainly for general fiscal expenditures and partly for the special investment and finance account, it is difficult to determine the specific sectoral allocation of aid funds. During this period, aid funds allocated to specific investment projects constituted a rather minor part of the total aid fund. However, beginning from 1962 aid dependency of the general fiscal account declined, and most assistance was provided in the form of loans. Therefore, official foreign assistance funds tended to be earmarked for the specific investment projects of certain sectors.
 
The government’s aid allocation concentrated on economic infrastructure and the manufacturing sectors in accordance with its economic d development plans. During the first half of the development decades (1962-78), economic infrastructure (and other services) and the manufacturing sectors accounted for 73 percent of total public development loans received, and the agricultural sector for 26 percent. The Japanese Reparation Fund was originally intended to be allocated to the agricultural/rural sector. However, as pressure for financing manufacturing and economic infrastructure mounted, a significant portion of the fund also ended up being used toward economic infrastructure investment including the construction of roads, power plants, the POSCO steel factory, and the Seoul-Busan Expressway. Moreover, during the second half of the development decades (1979-92), economic infrastructure (and other services) and the manufacturing sectors accounted for 94 percent of total public development loans received, and the agricultural sector for only 6 percent. Therefore, in contrast to the period from 1945 to 1959, the higher growth rates and successful industrialization that occurred in Korea during the development decades (1962-92) can be attributed to the strategic sectoral allocation of public development loans received, which financed a substantial part of total investment.
 
Moreover, this sectoral allocation of official development assistance during the development decades in Korea differed sharply from the average OECD/DAC members' aid fund allocation by sector. In 2010, DAC members' ODA funds were allocated on a priority basis to social and administrative infrastructure and service sectors by about 49 percent, and to economic infrastructure and the manufacturing sectors by only about 24 percent.
 
[Table 7]  Public Development Loans by Sector: 1962-92 (Unit: US$ million in current prices, %)

* Data on sectoral allocation is unavailable.
 
The government of Korea paid special attention to the implementation of aid-financed investment projects and programs. In 1961, the government established the Planning and Coordination Officer in the Prime Minister’s Office to monitor and evaluate all important government policies and projects. In 1965, the Evaluation Professors Group was commissioned to reinforce the system. The Group was responsible for monitoring and evaluating the implementation of the 5-year economic development plans, a substantial portion of which was financed through official foreign assistance. Since then, the monitoring and evaluation of all important government policies and investment projects had been assisted by the external and semi-independent Evaluation Professors Group, the results of which were reported at a meeting attended by the president, cabinet members, and key members of the National Assembly as well as by the heads of decentralized public agencies and public enterprises four times a year. Initially, the Evaluation Professors Group was composed of only 15 members; however, when the Group was transferred from the Prime Minister’s Office to the Economic Planning Board in 1981, its membership reached 107 professors.

Source: Written by Lee, Kye Woo(KDI School) in 2014 for K-Developedia (Revised July 2, 2014)