Getting Intervention Right: How South Korea and Taiwan Grew Richby Dani Rodrik

Miae HwangGovinda ShahLy SievleangTaejun (TJ) ChaTitus Obiezue

Introduction

In 1960s – The two countries was poorer than many sub-Saharan countries

But increase in average per capita income of South Korea and Taiwan – 6.8% and 6.2% respectively since then.

Which left not only African Countries but also Mexico and Argentina far behind.

Orthodox economics believes the miraculous growth happens due to export promotion

But is it true? Need to think again.

Because profitability of exports during 1960s too insignificant for aggregate economic performance

The main reason of economic take off is investment boom under sound investment environment and the government efficient intervention in industrial development and market

Main Discussion of the paper

The shortcomings of the export-based explanations

Distinct initial conditions – relative abundance of human capital and equitable income and wealth distribution

Role of government in removing Coordination failure

Investment stimulating policies

Detailed interventions carried out efficiently by both governments

Chapter 2: THE CONTOURS OF A MIRACLE

1. Per-capita growth rate, 1954-1960

2. Export/GDP ratios, 1952-90

This sections contains statistics only

3. Investment/GDP ratio, 1951-90

4. Comparative Productivity Growth Statistics(1966-1970)

Chapter 3: WHAT IS WRONG WITH THE EXPORT-LED GROWTH HYPOTHESIS?

What is Wrong with the Export-Led Growth Hypothesis ?

• Message from Ian Little :

• The outstanding success of Korea and Taiwan from the early 1960s to the mid-1970s was based on:

• Phenomenal growth of labor-intensive manufactures

• Exports were profitable

• Well-educated hard working docile labor force

• High profits and increased earnings for recruits to the industrial labor force led to a very rapid in savings.

• The Switch in relative incentives towards exports in the early 1960s was not significant enough to account for the export boom

• Both South Korea and Taiwan, most of the important export incentives had already been in place for several years before the export started.

KOREA

• Under the Rhee government of the 1950s: • Korean was preoccupied by largely political considerations, and the

government attached no particular importance to either economic growth or exports ( Jones and Sakong, 1980)

• There were multiple exchange rates and a haphazard, ineffective programme of export subsidies ( Frank et al., 1975).

• After 1958, export incentives were increased :• exporters were given tariff exemption on imports of raw materials and

spare parts in 1959.

• Subsidized credit was made available to exporters for up to 75% of their production cost.

• Devaluation of the currency in 1961 brought the official exchange rate close to the free-market rate.

• Under President Park, 1961 : • The scope of export subsidization was greatly enlarged. • The income tax on export earnings was reduced. • There were also direct cash grants on export, but phased out

in 1965.• Rising of inflation in 1962-3 and a renewed gap between

official and parallel exchange rates in 1963. • The large devaluation in 1964 served once again to unify the

currency • After 1965, export subsidy programs were expanded further.

• Giving priority to exporters in acquiring the import license • Exporters were allowed to automatic access to duty-free imports

of raw material and intermediate inputs • Wastage allowance

KOREA

Export-oriented policies were responsible for the increase in exports ?

Trade and exchange rate policies in the 1960s were not overtly discriminate against exports.

Frank et al. 1975, calculated the ratio of the effective exchange rate for imports and noticing that the resulting number is around 1 or somewhat larger during 1960s; thus, the export spurt was not associated with a significant increase in the relative profitability of exports.

Malson et al. : The industrial policy changes

that took place in first half of the 1960s did not clearly result in a significant increase in the measurable incentive to export.

Taiwan

• The export incentives were put in place in the mid-1950s

• The currency was unified during 1958-61.

• 1954-1955, the system of import duty and commodity tax rebates for exportable production had already been implemented.

• The multiple exchange rate system was unified during 1958-1961 in : • April, 1958, the multiple buying rates were consolidated into

two buying rates, in parallel with two selling rates• November, 1958, exports and imports under the lower rate

were brought up into the higher rate, • Further minor devaluations and simplifications were

undertaken during 1958-61

Taiwan

The Rising Share of Exports in GDP is Consistent with Investment-Led Growth

The Rising Share of Exports in GDP is Consistent with Investment-Led Growth

The Role of Savings

• In both countries saving rose alongside investment and therefore enabled growth to proceed without hitting balance of payments constraints.

• Most accounts view the increase in savings in Korea and Taiwan as having been the result of economic growth itself and of a comparatively early demographic transition ( Collins and Park, 1989; Collins 1991; World Bank, 1993)

• Government policy was helpful. Real interest rates were raised for deposit, Taiwan in 1950s, Korea 1960s.

• An increase in public savings made an important contribution to total savings in both countries. Korea was rapidly increasing contribution of government savings enabled Korea to achieve very high rate of investment.

Recapitulation

•The switch towards export-oriented policies cannot account for the sustained export boom since the mid-1960s, and even less for the equally impressive and sustained investment boom.

•The increasing share of exports in GDP is quite consistent with a story of investment rather than export-led growth.

Chapter 4:Importance of Initial Conditions

Initial Condition #1 - High Social Indicators

Initial Condition #1 - High Social Indicators:

1.Extent of dualism

2.Urbanization

3.Indigenous middle class

4.Social mobility

5.Literacy

6.Mass communications

7.Cultural and ethnic homogeneity

8.Fertility

9.National integration

10. Sense of national unity

11. Modernization of outlook

Socioeconomic Development and Income

Index of socioeconomic

development (1960s)Per-capita GNP, 1961 ($)

South Korea 0.85 73

Taiwan 1.05 145

Brazil 0.79 186

Cambodia -0.55 101

Ivory Coast -0.98 184

Morocco -0.57 150

Cyprus 1.08 416

Jamaica 1.06 436

Sources: Adelman and Morris, 1967

Initial Condition #1 - High Social Indicators

Initial Condition #2Considerably Better Educated Labor Force

• Universal primary school enrolment (almost 100%, whilst the norm was around 60%)

• Double the literacy rates and secondary school enrolment ratios

Educational Indicators

Primary School

Enrolment Ratio

Secondary School

Enrolment RatioLiteracy Rate

KoreaPredicted = 0.57

Actual = 0.94

Predicted = 0.10

Actual = 0.27

Predicted = 0.31

Actual = 0.71

TaiwanPredicted = 0.62

Actual = 0.96

Predicted = 0.12

Actual = 0.28

Predicted = 0.36

Actual = 0.54

Sources: Adelman and Morris, 1967

Initial Condition #2Considerably Better Educated Labor Force

Initial Condition #3Equal Distribution of Income and Wealth

• Korea and Taiwan both had exceptionally equal distributions of income and wealth that were due to:

1. Long-standing historical reasons

2. Serious land reforms

Sources: Alesina and Rodrik, 1994

Measures of Income and Land Distribution

Initial Condition #3Equal Distribution of Income and Wealth

Importance of the Initial Conditions

• These initial conditions account, in a statistical sense, for a large part of the two countries’ economic performance since 1960.

• The primary enrolment rate has a positive and statistically significant coefficient.

• There is also a strong negative association between inequality and subsequent growth.

Growth Regressions

Note that investment as an explanatory variable is excluded

Importance of the Initial Conditions

Proportion of Growth Explained by Initial Conditions

• In a statistical sense, there is nothing “miraculous” about the experience.

• In fact, the real outliers are countries such as Argentina and India (whose actual growth is vastly overpredicted) or Brazil (whose growth is vastly underpredicted).

Importance of the Initial Conditions

Chapter 5:The Coordination Failure Interpretation

The Argument

• Explanations to account for the economic performance.

• Explanations are constructed along the following lines:

1. Advantageous social infrastructure

2. Under decentralised market conditions, a situation of coordination failure occurred

3. Government interventions since the late 1950s

4. Private investors and entrepreneurs responded well to the government measures and brought about profits (both financial and social).

5. Favourable initial conditions for the leadership and government

6. Investment as a share of GDP and imports of capital goods rose, and with appropriate macroeconomic and exchange rate policies, exports rose alongside

7. Increase in exports compensated the increase in imports of capital goods. Nonetheless, the increase in exports was a consequence of the increase in investments

A Framework of Analysis

• Two claims in the explanation:

1.Both countries were ready for an economic take-off but was hindered by coordination failure.

2.Government intervention was critical in overcoming the coordination failure problem.

• Prerequisites for the problem of coordination failure to become a critical issue:

• Some degree of non-tradability in the technologies and goods associated with the modern sector

• Economies of scale

• Skilled labor force

• Low physical capital

Case Studies: Hyundai and Lucky-Goldstar

• The cases of both Hyundai and Lucky-Goldstar illustrate the following:

• The importance of specialised labor skills

• Korean government policies were highly partial to conglomerates

• Imperfect tradability of technology and its interaction with scale economies

• Korean policy-makers viewed the economy and their role in it has parallels with the logic of the coordination failure

Chapter 6:GOVERNMENT POLICIES TO SUBSIDIZE AND COORDINATE PRIVATE INVESTMENT

GOVERNMENT POLICIES TO SUBSIDIZE AND COORDINATE PRIVATE INVESTMENT (TO INCREASE THE PROFITABILITY OF INVESTMENT)

1. Improving the investment climate

2. Investment subsidies

3. Direct co-ordination of investment decisions

4. Use of public investment and public enterprise

the Nineteen-Point Reform Programme simplifiedadministrative procedures and liberalized the regulativemeasures.

Locking Up Strategy; the episode served to underline theexpectation that entrepreneurs were to invest in productiveactivities rather than rent seeking.

1. Improving the investment climate

2. Investment subsidies (Korea)

The most important direct subsidies in Taiwan came in the form of tax incentives.

The maximum business income tax paid by enterprises was reduced to 18% of annual income (from a previous maximum of 32.5%);

the tax holiday for new investments was extended from three to five years;

tax exemption was given to undistributed dividends for reinvestment, to 2% of foreign exchange earnings, and to proceeds of export sales;

'productive' real estate was made either exempt from stamp tax and deed tax, or taxable at reduced rates;

Investment subsidies (Taiwan)

3. Direct co-ordination of investment decisions

In addition to providing subsidies, the Korean and Taiwanesegovernments played a much more direct, hands-on role by organizingprivate entrepreneurs into investments that they may not otherwise havemade.

'Mr Kim [the founder of Daewoo] found himself in shipbuilding in 1978,when the government twisted his arm to take over a near-bankrupt projectto build a giant shipyard at Okpo, on Koje island near the southern port ofPusan. The Okpo Shipyard is now 'at the heart of... [Korea's] achievement'in shipbuilding.

4. Use of public investment and public enterprise

Why interventions have been successful in Taiwan and Korea and not elsewhere?

The availability of relatively skilled labor,enabling the formation of a competent bureaucracy.

An exceptionally high degree of equality in income and wealth

8. SOME FREQUENTLY ASKED QUESTIONS

■Korean and Taiwan governments both exports and investment

None of this is very helpful in understanding what made these countries take off

Investment booms would not have been possible in the presence of gross policy biases against exports, but that these booms were compatible with a wide range of trade policy options.

1. Can we really distinguish between export and investment strategies?

However

Why did investment and exports respond so vigorously to government policies, and which of these served as the driving force behind economic growth?

2. Doesn't the experience of many other countries show that investment is notenough for sustained growth?

■Comparing with the Soviet Union & Soviet-type economies is not good

Because..

Economic systems lacking markets and private property, and in which both the level and allocation of investment are determined by central planners, to market systems where investment decisions are made on the basis of profitability.

all theories of growth are based at least in part on capital accumulation

First, There is nothing implausible about the presence of these conditions in the South Korea and Taiwan of the 1960s.

Second, The framework I have proposed here helps us make sense of the findings of this case study literature, something that is hard to do with the conventional approach. This approach also clarifies why 'picking winners' was not so difficult in the early years of the Korean and Taiwanese experience.

Third, Hong Kong was already a high-investment country by 1960 (20% of GDP) →double the figure for Korea and Taiwan at the time.

And the absence of government policy in this regard reveals itself in an investment ratio that has remained virtually flat since 1960.

3. Isn't the evidence on coordination failures too weak in view of failed government interventions elsewhere?

How is it possible for governments to 'pick the winners'? -And what about the example of free-market, yet successful, Hong Kong?

A

Q

4. Doesn't the initial imbalance between human and physical capital suggest an even simpler story of catch-up, with little role for government policy?

■ Growth show that an initial imbalance between human and physical capital speeds up growth

It would seem plausible that the difference in outcomes has much to do with differing government policies in the two sets of countries.

Conclusion

1. Government policy was a hindrance, but this countries overcame it nonetheless

2. It was irrelevant, not helping growth but not hindering it either

3. It was helpful, though not essential

4. It was necessary for the growth experience of these countries

Proposition

1. Government policy was a hindrance, but this countries overcame it nonetheless

2. It was irrelevant, not helping growth but not hindering it either

3. It was helpful, though not essential

4. It was necessary for the growth experience of these countries

The experience of Taiwan and South Korea was far from exemplary throughout the 1950s

Proposition

What they were doing is Important

Coordinating and encouraging private investments with a

high degree of linkage within the modern sector.

Export-oriented policies

(and chief among them exchange rate policies)

→steady rise in imported capital goods

Having high payoff because they helped remove coordination failures in economies where the latent return to investment was already high

OPINION

The reason for the beginning of rapid export expansionwas (1) the reform of foreign exchange system frommultiple exchange rates to unified exchange rate, and (2)won overvaluation was almost eliminated

the rapid export expansion in the early 1960s wasfollowed by the big surge in investment in the second halfof the 1960s. The investment surge was as a result of therepayment guarantee of foreign loans and financialreform in 1965.

Exports do not automatically increase simply becauseimports increase. Korea’s rapid growth was export-led,not investment-led.

Thank you