The 1970s was a decade of global inflation accompanied by resource war. ##MORE_LAYER_BOX##The Bretton Woods system, a cornerstone of the international financial order for more than 20 years, collapsed in the beginning of the decade. It was obvious that the abolition of the Bretton Woods system generated a great deal of uncertainty in international transactions, but it also eroded the discipline of monetary policy. Since the ultimate reference of the value of money vis-à-vis gold was lifted, monetary policy was more likely to be accommodative and global inflation surged. By the end of the 1970s, the inflation rates of many advanced countries recorded double digit figures for the first time in history.##MORE_LAYER_BOX_END## In particular, the oil price hikes were devastating for a resource-poor country such as Korea that followed an energy-intensive industrialization strategy. ##MORE_LAYER_BOX##Major oil-producing countries formed a strong cartel, Organization of Petroleum Exporting Countries (OPEC), and quadrupled oil prices to exploit monopoly rents in 1973. For a resource-poor country such as Korea that followed an energy-intensive industrialization strategy, it was a devastating shock.##MORE_LAYER_BOX_END##
From the perspective of international relations, the 1970s was also a decade of hardship for President Park’s regime. President Park, who had long been in power and severely suppressed opposition leaders, could not get along with US leaders who emphasized peace and democracy in international diplomacy. The more the Korea-U.S. relations deteriorated, the more the Park’s regime had to cling to self-defense from North Korea. ##MORE_LAYER_BOX##Since President Nixon of the U.S., declared the Guam Doctrine in 1969 that urged Asian countries to rely more on themselves for their own security, the U.S. reduced by one-third the ground troops that used to be stationed in South Korea. During the U.S. presidential campaign eventually won by Carter, the idea was further advocated that the U.S. should make another significant reduction of its ground forces in Korea.##MORE_LAYER_BOX_END##
It is alleged that this political tension led Park’s regime to shift the main strategic industries from light industries to heavy and chemical industries (HCI) such as steel, petrochemicals, shipbuilding, machinery, nonferrous metals, electronics, and so forth. In order to promote HCI, every possible policy measure was mobilized. ##MORE_LAYER_BOX##The push given by President Park toward HCI was truly unprecedented. Perkins (1997, pp.81-82) describes the situation as follows: “The Blue House staff made decisions as to which industries should form the core of the HCI drive. … Projects were not put out for bids. Instead individual chaebol companies were asked to carry out each project. If they agreed, the government saw to it that they got wide ranging support. There was a major diversion of state bank loans to the HCI sector at preferential interest rates. Favorable access to import licenses was guaranteed. The tax authorities would treat the companies gently using a corporate tax system that was quite “flexible.” And the government was prepared to do more if necessary. When Hyundai ships rolled into the water and into a dead market for supertankers, the government took steps to create a market giving advantages to oil imports brought in on Korean made ships. Where positive incentives failed, there was President Park’s big stick --- the implied threat of the removal of this support system from a company’s existing enterprises.”##MORE_LAYER_BOX_END## Among many, financial policy tools were very actively utilized. Naturally, financial markets were severely repressed to serve these government policies and provide cheap credits to the strategic industries. ##MORE_LAYER_BOX##Out of total loans by deposit money banks, the share of policy loans, mainly for heavy and chemical industries, rose to approximately 50 percent by the end of the 1970s. Policy loans to the strategic industries included foreign exchange loans, export loans, and loans to development institutions such as the Korea Development Bank and the Korea Export-Import bank. Bank interest rates were also regulated at low levels in an effort to stimulate investment. The real rate of return on time deposits with one-year maturity was rarely positive during the 1970s, and policy loans in particular carried preferential interest rates that were even lower than those on general bank loans, so that the average borrowing cost to firms remained below the inflation rate during the 1970s.
[Policy Loans of Banks and Interest Rates]
(Period Average, Percent)
Portion of Loan Amount
(Deposit Money Banks)
|Average Interest Rate|
(1-Year Time Deposit)
|Policy Loan||Loan to Manuf.||Loan to HCI||Nominal||Real1)||Nominal||Real2)|
1) Nominal interest rate – GNP deflator inflation rate.
2) Nominal interest rate – CPI inflation rate.
Source: Nam and Kim (1995, p.133)##MORE_LAYER_BOX_END## In this context, monetary policy was also mobilized as a tool for providing, so called, “growth money.” ##MORE_LAYER_BOX##The government attempted to direct the maximum amount of credit to the target industries at low interest rates, and the resulting losses of banks were often bailed out by the money-printing power of the BOK. For example, the commercial banks’ policy loans were automatically rediscounted at the window of the BOK, implying that the costs of policy loans were largely borne by inflation tax.##MORE_LAYER_BOX_END## Fiscal resources were no exception. The government substantially increased its own spending for this purpose and applied various tax incentives, including preferential depreciation allowances, tax reductions and exemptions for exporters and strategic industries.
Under this environment superimposed by the government, it was a truly formidable task to control money supply. By directly controlling the amount of bank credits, the BOK tried to achieve two contradictory goals, supplying a sufficient amount of cheap money and suppressing the amount of money under control. Yet, the government’s priority for the industrial policy rather than inflation control increased the money supply with its growth rate hovering around 30 percent per annum. As a result, double digit inflation was taken for granted and economic agents began to reflect inflation in their economic activities such as wage bargaining and financial contracts. A typical pattern of a vicious circle of inflation --- inflation expectation and actual inflation reinforcing each other --- was set off in the second half of the 1970s. While accelerating inflation under the rigid exchange rate management was weakening exporters’ competitiveness, the Second Oil Shock broke out in 1979. The trade deficit was sharply expanded again and the Korean government had to hurry borrowing from abroad to cover the deficit. Foreign loans were rapidly accumulating, driving the Korean economy to the edge of its balance-of-payments crisis.