Overview of Korea’s Rapid Industrial Development:

Miracle on the Han River

Tae-Shin KWON

President & CEO, Korea Economic Research Institute

Miracle on the Han River and BeyondOverview of Korea’s

Rapid Industrial Development

and the Future

President & CEO Tae-shin KwonKorea Economic Research Institute

Vanderbilt University, September 22nd, 2016

Contents

I. Overview of the Korean Economy

II. Key Drivers of Sustained Growth

III. Foreign Exchange (“FX”) Crisis of 1997

IV. Current Status of Korean Economy

V. Future Challenges

VI. Opportunities Ahead

2

I. Overview of the Korean Economy

3

Colonization: 1910-45

Disruption in economic activities due to the departure of Japanese

Territorial division: economic complementarity lost

Korean War: 1950-53

President Rhee: 1948-60

Lower priority on economic development

4

The Korean Economy Before its Take-off

In 1961, Korea had:

– Per capita income of US$82, approximately

the same level as Ghana and Sudan

– Scarce natural resources

– Infrastructure damaged from Korean War

– Low level of savings (8%) and high level of

poverty

– US aid accounted for 50% of its budget,

70% of imports, 80% of foreign exchanges

Korea also had a number of advantages

– Abundant labor with high level of literacy

– Relatively equal income distribution

A Brief Summary of Korean Development History:

Initial Conditions

5

0

5,000

10,000

15,000

20,000

25,000

30,000

1945 1955 1965 1975 1985 1995 2005 2015

105607

2,355

11,735

17,531

Joined

OECD

Asian

Financial

Crisis

Six 5-Year Economic

Development Plans

Liberation from

Japanese

Colonial Rule

Global

Financial

Crisis

Korea’s Rapid Economic Growth

27,340(2015)

Korea Over the Last Five Decades

7

1961 2015

Per Capita GNI (US$) 82 27,340 330 times

Commodity Exports (US$) 41 million 527 billion 13,000 times

Trade/GDP Share (%)3.3% 69.8% 66.5%p ↑

Trade $33million $96.3billion 6006 time

Life Expectancy 55 (1960) 82 27 years ↑

Enrollment Rate (%)

High School

University/College

29.3 (1970)

9.0 (1970)

93.5

70.8

3.2 times

7.9 times

Strong economic growth with outward-looking strategy (1960~1980)

– Government-led development

– Transition from import substitution to export-driven industrialization

– Heavy and Chemical Industries (“HCI”) drive in the 1970s

Changes in development strategy (1981~1997)

– Stabilization policy in the early 1980s

– Market-oriented reforms (phasing-out of policy loans, interest rate

deregulation, investment adjustment in HCI, etc.)

Financial crisis in 1997 and the swift recovery (1998~1999)

Paving the way for an advanced economy

Economic Policies During the Development Period

8

II. Key Drivers of Sustained Growth

9

Key Drivers of Sustained Growth

Human capital: High investment in education, high quality workers and

entrepreneurs

– Population with tertiary education(2014)

• 17%(55~64 year olds) vs 68%(25~34 year olds)

10

24 25 25 28 30 30 31 32

38 38 39 40 40 40 41 41 42 43 44 44 46 46 46 46 48 49 49 51 53 58 59

68

12 13 10

25

14 15 13

17 18 21 21

34 29

36

29

21

29

14

26 27

41

30 31

47

33 32 35

24

32

45

35

17

0

10

20

30

40

50

60

70

80

ITA

ME

X

TU

R

DE

U

SV

K

CZ

E

PR

T

HU

N

SV

N

AU

T

GR

C

FIN

NZ

L

ES

T

ISL

ES

P

DN

K

PO

L

BE

L

NL

D

US

A

SW

E

CH

E

ISR

AU

S

NO

R

GB

R

IRL

LU

X

CA

N

JPN

KO

R

25~34 year olds 55~64 year olds

< Population with tertiary education >(unit: %)

Key Drivers of Sustained Growth

Policy

– Sound macroeconomic policies

– Adoption of export-oriented, pro-

growth policies

– Responded rapidly and flexibly to

external shocks

– Some policies right, some wrong;

learning through trial and error

– Government intervention,

ingredient for growth?

• may differ at different

stages of development

Institution

11

2.9

58.3

0.0

10.0

20.0

30.0

40.0

50.0

60.0

70.0

19

53

19

56

19

59

19

62

19

65

19

68

19

71

19

74

19

77

19

80

19

83

19

86

19

89

19

92

19

95

19

98

20

01

20

04

20

07

20

10

20

13

< export / GNI >(unit: %)

Strong Top Leadership During the Development Period

Strong leadership commitment to economic development

Monthly meetings presided by the President: Economic Conditions Review

Meetings, Meetings for Export Performance Monitoring

Strong support from think tanks such as KIST and KDI

Partnership with big businesses (Korea, Inc.)

– Strong incentives provided while closely monitoring big businesses

– Largely free from corruption and interest group pressures

12

Government: coordination, monitoring, resource allocation

Large business groups: implicit development partners

Conditions for success

– Effective monitoring: top leadership with vision and commitment; strong

and relatively clean bureaucracy

– Strong incentives: subsidized credit, etc.

– Sensible performance criteria: export performance, etc.

13

Efficiency of Korea, Inc. in the Early Stage

Promotion of Exports and Industrialization: Export-Oriented

Economic Takeoff in the 1960s

Export incentives

– Industry neutral: based on export performance

– Exchange rate realignment

– Credit & tax incentives, export-import link system, etc.

Institutions for export promotion

– Export-targeting; monthly meetings for monitoring

– KOTRA

– General trading companies

– Free export zone

14

Foreign Direct Investment

FDI playing only a minor role

– Fear of foreign domination

– Gradual liberalization since the

1980s

Was it a good policy?

– Missed chance of technology

transfers and skills training

– Too much dependence on

borrowing caused a crisis

– Borrowing cheaper than FDI?

– Better for deepening local

technological capabilities in the

long run?

15

US$20,910

0

5000

10000

15000

20000

25000

1962

1965

1968

1971

1974

1977

1980

1983

1986

1989

1992

1995

1998

2001

2004

2007

2010

2013

< FDI >(unit: million USD)

Heavy and Chemical Industry (“HCI”) Drive in the 1970s

Steel/shipbuilding/machinery/electronics/chemicals

Export/industrial structure upgraded

Macroeconomic policy distortions

– Interest rate control; significant preferential credit -> financial development

delayed; inflationary pressure

– Currency appreciation (due to increased repayment burden on foreign debt)

Inefficiency: excessive/duplicative investment; lack of technology & skills; import

protection, etc.

Concentration of economic power

16

1960 1970 1990 20001980

HCI Products

Agricultural

Products

Light Industry

Products

50%

Wig Automobile SemiconductorTextile

Semiconductor,

Mobile Phone, DTV,

Display,

Automobile,

Shipbuilding, etc.

80%

14%

6%

17

Changing Export Structure:

From Agriculture to Light Industry, and to HCI

Challenges of 2nd-Stage Import Substitution

Constraints on capital, technology & skills

Small domestic market -> not merely import substitution, but to grow as export

industries

Harder to identify the industries to be promoted

Concentration of economic power; monopolistic profits & corruption <- import

protection

Macroeconomic instability

18

Price Stabilization in the Early 1980s

Difficult to rely entirely on demand management (tight fiscal & monetary policies)

in recession

Incomes policy may be effective under some circumstances

– Credibility/consistency of the government policies

– Public economic education

– Tools: unofficial wage guideline through low salary increase for civil servants

19

Business Groups: Their Roles and Issues

Development partners of the government: capturing policy-induced profit

opportunities

National champions in the global market: undertaking long-term, risky R&D

investment

Seeking family and/or controlling shareholders’ interests first?

– Cross-shareholding, poor corporate governance

– Extensive diversification and internal transactions

– High dependence on debt; overinvestment

– Poor profitability (for smaller groups)

20

III. Foreign Exchange (“FX”) Crisis of 1997

21

Weak financial and corporate sectors due to continued government-bank-

chaebol tie-up:

– Moral hazard; poor governance; accumulated non-performing loans

Poorly managed (external) financial liberalization: prudential regulation;

financial safeguards, etc.

Poor management of the external sector

– Small FX reserves; high short-term debt

– Currency appreciation due to capital inflows

22

FX Crisis of 1997: Causes

Post-Crisis Reform

Financial reform

– Restructuring non-viable financial institutions

– Strengthening prudential regulation/supervision

Corporate restructuring

– Legal frameworks & practical methods of workout

– Reform of corporate governance

Strengthening social safety nets while redressing labor market rigidity

23

Comparison: Pre- and Post-Crisis Period

Pre-crisis period of 1990-1997:

Chronic overcapacity problems

– 8-year long trade deficits

– FDI inflows were insignificant

– Vulnerable external position

– Explosive corporate debt growth

– Weak financial sector

Post-crisis period since 1998:

Structural improvements

– Continued current a/c surplus

– FDI inflows increased ten times

– Much improved external position

– Significant de-leveraging trend

– Sound and efficient financial

sector

24

IV. Current Status of Korean Economy

25

26

Korea achieved a solid growth post-crisis.

Core inflation remains stable.

Real Sector: Korea’s economic fundamentals remain robust

GDP

Growth

% YOY

1997 1998 1999 2000 2011 2012 2013 20142015

(f)

US 4.4 4.3 4.1 3.8 1.6 2.2 1.5 2.4 2.4

Japan 1.8 -1.1 0.7 2.8 -0.5 1.7 1.4 0.0 0.5

Hong Kong 5.1 -5.0 3.4 10.2 4.8 1.7 3.1 2.6 2.4

Singapore 8.5 -0.9 6.4 9.4 6.2 3.7 4.7 3.3 2.0

South Korea 5.0 -6.7 10.9 9.3 3.7 2.3 2.9 3.3 2.6

Taiwan 6.7 4.6 5.4 5.9 3.8 2.1 2.2 3.9 0.7

India 5.0 6.9 6.0 4.0 6.6 5.6 6.6 7.2 7.3

China 8.8 7.8 7.1 8.0 9.5 7.7 7.7 7.3 6.9

EU 2.5 2.9 2.8 3.4 1.8 -0.4 0.3 1.4 2.0

G7 3.2 2.7 3.0 3.5 1.6 1.4 1.2 1.7 1.8

Latin Americ

a5.3 2.0 -0.1 4.0 4.9 3.2 3.0 1.3 -0.1

OECD 3.6 2.7 3.1 3.9 1.9 1.3 1.3 1.9 2.2

World 4.2 2.8 3.5 4.4 4.2 3.5 3.3 3.4 3.1 0

1

2

3

4

5

6

7

8

1997 2000 2003 2006 2009 2012 2015

(%)

Headline CPI Core CPI

External Sector: Strong Balance Supports Korea’s Stability

The current account surpluses continued since 1998 and hit record high at 105.9 billion US$ in 2015.

This enabled Korea’s FX reserves to rise from 4 billion US$ in 1997 to 368 billion US$ in 2015, the 7th

largest in the world.

27

(US$ billion)

-9.8

-23.8

-10.3

40.1

21.6

10.42.74.7

11.9

29.7

12.73.6

11.83.2

33.628.9

18.7

50.8

81.184.4

105.9

-40

-20

0

20

40

60

80

100

120

19

95

19

96

19

97

19

98

19

99

20

00

20

01

20

02

20

03

20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

20

13

20

14

20

15

Current Account Surplus

52

74

96 103

121

155

199 210

239

262

201

270

292 306

327

346

364 368

0.8

1.9

2.2

2.1

3.0

3.2

3.93.7

3.6

2.3

1.3

1.8

1.9

2.2

2.6

3.13.1

3.4

0.0

1.0

2.0

3.0

4.0

5.0

0

50

100

150

200

250

300

350

400

19

98

19

99

20

00

20

01

20

02

20

03

20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

20

13

20

14

20

15

FX Reserves (US$bn)(Left) FXR/ST Ext Debt(Right)

Debt-equity ratios dramatically declined and corporate profitability has significantly improved.

Corporate Sector: Sharp De-leveraging, Improved Profitability

Note: Corporate ordinary income/sales trend is only available until 2006 28

336

235221

196

144.66131.31

113.99110.86105.3114.94

129.8

159150 153 148 141 135

0

50

100

150

200

250

300

350

400

19

98

19

99

20

00

20

01

20

02

20

03

20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

20

13

20

14

Debt Equity Ratio (%)

126114

128136137

107115

64 71

141146

263.51

351.23

483.4460.3

413.86

380.96

331

241

311

280260

284285

-2

-1

0

1

2

3

4

5

6

7

8

0

100

200

300

400

500

600

19

91

19

92

19

93

19

94

19

95

19

96

19

97

19

98

19

99

20

00

20

01

20

02

20

03

20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

20

13

20

14

Interest Coverage (%)(Left) Ordinary Income/Sales (%)(Right)

Financial Sector: Restored Soundness

BIS ratios increased to the international standard and NPL ratios substantially lowered

Source: FISIS

BIS Ratio (%) NPL Ratio (%)

29Source: FISIS

7.0

11.8 12.1 12.3

14.614.0

14.3 14.514.0 13.9

13.1

0

2

4

6

8

10

12

14

16

19

97

19

99

20

04

20

07

20

10

20

11

20

12

20

13

20

14

20

15

20

16

.6

2.7

12.9

1.9

0.7

1.91.4 1.3

1.8 1.6 1.8 1.8

0

2

4

6

8

10

12

14

19

97

19

99

20

04

20

07

20

10

20

11

20

12

20

13

20

14

20

15

20

16

.6

Fiscal Sector: Low Indebtedness

30

Government debt increased substantially in the process of the crisis resolution, but stands at a low level at

an international standard

0

10

20

30

40

0

100

200

300

400

500

20

00

20

01

20

02

20

03

20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

20

13

Government Debt (US$m)(Left)

Government Debt / GDP

(%)(Right)

34.7%

247.0%

82.0%

119.0%113.0%

123.0%

0%

50%

100%

150%

200%

250%

300%

Kor('13) Jap Ger Fra UK US

Go

vern

men

t D

ebt

/ G

DP

20

14

(%

)

V. Future Challenges

31

Future Challenges

Our potential growth is slowing down very fast, and expected to continue to fall

unless we do something.

32

2.6(2015)1.48(2050)

-10

-5

0

5

10

15

19

81

19

84

19

87

19

90

19

93

19

96

19

99

20

02

20

05

20

08

20

11

20

14

20

17

20

20

20

23

20

26

20

29

20

32

20

35

20

38

20

41

20

44

20

47

20

50

actual growth rate potential growth rate

Source: OECD

Future Challenges

Low Birth Rate and Aging Society (Silver Tsunami)

33Source: Korea Statistics Bureau

18

24

73

40

115

8

12

21

37

40

Korea

Japan

US

Germany

France

Years taken Aging to Aged Years taken Aged to Super-Aged

2000 2018 2026

1970 1994 2006

1942 2015 2036

1932 1972 2009

1865 1980 2020

Aging (7%+)

Aged (14%+)

Post-Aged (20%+)

Future Challenges

Low Birth Rate and Aging Society (Silver Tsunami)

34Source: Korea Statistics Bureau

1970 17.5

1980 16.4

1990 13.5

2000 9.9

2010 6.7

2020 4.6

2030 2.7

2050 1.4

Number of Active Persons Supporting One Old Person

0

10

20

30

40

50

60

1950

1960

1970

1980

1990

2000

2010

2020

2030

2040

2050

2060

15~29 years old

Population Composition

15~65 years old

Over 65 years old

13.8%(2060)

48.8%(2060)

37.4%(2060)

Future Challenges

Household Debt Burden

- Aggregate Household Debt in 2015 = ₩1203 trillion = $973 billion

- Household Debt / GDP Ratio (2015) = 77%

• 85% (Spain), 61% (Greece)

35

0.0

2.0

4.0

6.0

8.0

10.0

12.0

14.0

0

200

400

600

800

1000

1200

1400

2004

120

04 2

2004

320

04 4

2005

120

05 2

2005

320

05 4

2006

120

06 2

2006

320

06 4

2007

120

07 2

2007

320

07 4

2008

120

08 2

2008

320

08 4

2009

120

09 2

2009

320

09 4

2010

120

10 2

2010

320

10 4

2011

120

11 2

2011

320

11 4

2012

120

12 2

2012

320

12 4

2013

120

13 2

2013

320

13 4

2014

120

14 2

2014

320

14 4

2015

120

15 2

2015

320

15 4

2016

120

16 2

amount(tril. KRW, left axis) growth rate(YoY, %)

Future Challenges

Increasing household debt causes domestic demand to shrink

– Household debt / GDP : 44.3%(1996) 80.8%(2014)

– Average Propensity to Consume in 2015 3Q was record low

36

3.6

97.8

44.3

145.8

43.0

100.5 80.8

224.3

0

50

100

150

200

250

gov't corporate household all

1994 2014 73.673.9 73.7

72.9

72.1 72.2

73.7

75.274.8

72.4

71.4 71.6

70.4 70.6

69.4

66

67

68

69

70

71

72

73

74

75

76

Debt / GDP (%) APC of the Households (%)

Future Challenges

Dual Labor Market, Inflexible Labor Union, and Absence of Social Dialogue

– Youth unemployment: UR 12.5% (2.6 times of aggregate UR)

– PT work, Discouraged young workers, Youth Labor Under-utilization 23.4%

– Group (D) (1.4 million workers) controls the whole labor market of 26 million

workers They refuse labor market reform to maintain their vested interests.

37

Composition of Employed

Workers

Regular(A)

67.9%Unionized(B)

25.4%

Large Firms(C)

12.1%

(D)

7.4%

(E)

26.4%

Future Challenges

Possibility of secular stagnation (Japanese style)

– Aging society, Housing market slump shrinking domestic demand

38

5.1

6.7

2.2

0.3 0.0-0.8

1.0

-0.4

0.1

0.0 0.0 0.0

-2.0

0.0

2.0

4.0

6.0

8.0

'81~'85 '86~'90 '91~'95 '96~'00 '01~'05 '06~'10

net export

domestic demand

3.93.4

2.0

0.9

0.8

1.2

0.0

1.0

2.0

3.0

4.0

5.0

'01~'05 '06~'10 '11~'14

net export

domestic demand

<Korea> <Japan>

Future Challenges

Superabundant Demand for Welfare

39Source: JK Hyun(2012)

% of Main Expenditures in Consolidated Finance

0

5

10

15

20

25

30

35

197

0

197

3

197

6

197

9

198

2

198

5

198

8

199

1

199

4

199

7

200

0

200

3

200

6

200

9

201

2

201

5

복지 경제 교육 국방

31%

16%

14%

10%

welfare economy education defense

Future Challenges

Weakened National Competitiveness

40

WEF National Competitiveness (rank)

11th13th

14th

22nd24th

19th

25th26th 26th

0

5

10

15

20

25

30

2007 2008 2009 2010 2011 2012 2013 2014 2015

VI. Opportunities Ahead

41

Opportunities Ahead

Thus, we need to strengthen growth potentials by

– Fostering business-friendly environment to successfully

• transform HCI to high value-added manufacturing (ICT)

• discover new engine of growth in IT, BT, NT

• and develop high value added service industries

– Enhancing labor market flexibility and social mobility

42

Opportunities Ahead

We need more than simple manufacturing

– Smart Factory, IoT

– IT, BT, NT

43

Opportunities Ahead

Service industry will be a source of another Economic Big Bang for Korea.

Osaka

KyotoKobe

Fukuoka

Busan

IncheonSeoul

Korea

Dalian

China

Taipei

Shanghai

Nanjing

Hangzhou

Zhengzhou Nagoya

Tokyo

17.9 mil.

1.48 tril. $

13,281 𝑘𝑚2

26.7 mil.

341 bil. $

14,399 𝑘𝑚2

25.2 mil.

314 bil. $

7,037 𝑘𝑚2

8.7 mil.

-

11,026 𝑘𝑚2

Qingdao

Japan

Population: 20.2 mil.

GDP: 314 bil. $

Area: 7,037 𝑘𝑚2 13.6 mil.

185 bil. $

11,760 𝑘𝑚2

Beijing

Tianjin

41 cities with population of more than 1 million within 2-hour flight distance from

Incheon Int’l Airport, Korea

Opportunities Ahead

De-regulation of service industry will be a new source of job and value-

added creation

– Deregulation will create about 350 thousand jobs in medical, education, law and

contents service sectors in 8 years.

Value-added (billion USD) Job creation (person)

Education 3.6 93,000

Medical 4.4 104,000

Law 2.7 43,000

Contents 4.5 108,000

total 15.2 349,000

< Effect of Service Industry Deregulation >

Source: “Service Industry Deregulation and Job Creation” KERI(2013)

Thank You

46