PATTERNS & TRENDS BY SYED AKHTAR MAHMOOD

The Three Koreas – and the lessons from each

No, I am not talking about South Korea, North Korea and a third unknown Korean country.

I am talking about three South Koreas.

Let me explain.

Many of us have heard about the role of the South Korean government in orchestrating the impressive growth performance and economic transformation of the country in the 1960s and 1970s.

It was a market economy with strong export-orientation.

But it was by no means a case of laissez-faire.

Rather the Korean government played an active role in governing the market.

It had a vision of where it wanted the economy to go, and it used various policy tools at its disposal to realize this vision. Increasing the export-orientation of the country was at the core of this vision.

To achieve this goal, the South Korean government provided different types of support to export-oriented industries in the 1960s and 1970s.

The focus of attention was the large conglomerates, the so-called chaebols.

The support provided to the chaebols and other exporters ranged from tariff protection to export subsidies, from preferential credit to restrictions on entry of new firms that could compete with them.

But the support came with discipline.

Firms had to meet certain pre-specified targets and, if they failed to do so, the support was taken away.

The government was quite ruthless about this and even large conglomerates, the chaebols, were not spared.

Such a strong performance-orientation of the government instilled a productivity culture in the private sector.

The result was a high rate of output, export, and productivity growth.

This is a Korea that we have much to learn from.

Lessons

The first lesson is the importance of export-orientation.

Export-orientation opens the global economy for firms.

Since firms need to be globally competitive to exploit the global market, export-orientation gives a boost to productivity growth by forcing companies to learn how to be competitive.

We have learned this lesson in Bangladesh but only partially.

We have made a breakthrough in global markets through our garment exports but have not been able to diversify beyond garments in a big way.

One reason: our policies still have an anti-export bias.

So that is the story of the first Korea, the South Korea of the 1960s and the 1970s.

Then came the second Korea.

The heavy reliance on the chaebols, the large industrial and financial conglomerates, had paid rich dividends to the Korean economy.

But this also came with a price.

As these conglomerates became economically powerful, they started acquiring political power as well.

The earlier relationship with the state, where the latter would provide a variety of support but impose strict performance disciplines on the chaebols, gave way to a cozier relationship where the conglomerates were able to extract privileges without concomitant disciplines that would ensure efficiency, innovation, and productivity growth.

The growth model followed was an investment-led model, characterized by the adoption of technologies developed elsewhere, not an innovation-led model where growth comes from inventing new technologies.

Firms, especially the chaebols, invested big time.

The fact that many chaebols also owned banks made it easier for their industrial units to get credit, especially access to subsidized finance, and explicit and implicit bailout guarantees).

The chaebols also used their political influence to restrict entry of independent firms and foreign direct investors.

Given such privileges, it is not a surprise that the conglomerates did not bother about innovations and productivity improvements, focusing rather on increasing their size through repeated investments.

As a result, the conglomerates became bigger and bigger.

By the early 1990s, the five largest chaebols, Hyundai, Samsung, Daewoo, LG, and the SK Group accounted for 10% of Korea's GDP.

But hidden behind the huge size were inefficiencies and vulnerabilities.

Firms driven by investments like to preserve the status quo and are often averse to seeing policies change in a way that encourages the emergence of innovative firms that may compete with them.

That’s what happened in South Korea.

The government played along, either because it was in the pocket of these large firms or because it was itself enamored by the rationale of the investment-led growth model.

Things go wrong

When times are good, people think that the party can go on forever.

Complacency and hubris set in.

No surprise that the Koreans did not pay attention to the brewing problems.

Their record of economic growth had earned the world’s praise.

It is natural that they wanted to rest on their laurels.

But they should have taken to heart the words of the English poet Shelly who had reminded us so eloquently, “nothing wilts faster than laurels that have been rested upon.”

It only took an external shock to provide the reality check. That came with the East Asian financial crisis of the late 1990s.

The weaknesses of the conglomerates came to the surface when the financial crisis hit in 1997 and 1998.

Some chaebols, such as Daewoo, went bankrupt; others were substantially weakened.

For those in Bangladesh who believe the party can go on forever, the story of the second Korea should give pause for thought.

Many Bangladeshi companies are growing bigger and bigger.

That is good news.

But we need to ask the key question: Is this growth in output and revenues accompanied by growth in productivity, aided by an innovation culture, or is it largely based on privileges?

By now, readers may be curious to know what happened after the East Asia financial crisis of the late 1990s was over.

Following the crisis, as the dust settled, the South Korean government moved away from its earlier policy stance and went for more pro-competition policies.

Prior to the crisis it was much easier for the chaebols to obtain credit than it was for non-chaebol firms.

That privilege ended or was substantially reduced after the crisis.

Prior to the crisis, credit availability was not linked to efficiency.

After the crisis, credit was directed more to the efficient firms.

This resulted in the entry of many new, innovative firms.

The noted French economist Philippe Aghion and his co-authors Sergei Guriev and Kangchul Jo have done detailed research on this subject.

In their 2019 paper "Chaebols and Firm Dynamics in Korea", they provide a revealing set of statistics.

They tell us that while at the beginning of the 1990s South Korea filed eight times fewer patent applications with the US Patent and Trademark Office than did Germany, in 2012 it filed 30% more applications than Germany.

Clearly Korean firms had become more innovative. Productivity, which was stagnating or dropping before the crisis, started rising fast after 1998.

Third and final Korea

This is the third Korea.

And it has important lessons for us at this important juncture in our growth trajectory as the global economy becomes increasingly challenging.

The government needs to take a hard look at the policies and programs it is adopting to provide support to businesses and ask the important question: will these policies lead to investment-led growth or innovation-led growth?

Let us consider the subsidies provided to the garment industry.

These subsidies, if continued, should be provided only to facilitate restructuring and diversification in the industry, not to artificially prop up factories that have neither the ability nor desire to become efficient. 

The government needs to establish a set of clear indicators and targets, to be monitored on a regular basis, which will tell the industry, government, and society whether the desired performance improvements are happening.

If the indicators tell a different story, the support may be withdrawn, and other measures contemplated.

Or take the case of tariff protection and other support to the electronic or automotive parts industry under the “Made in Bangladesh” strategy.

The "Made in Bangladesh" idea is appealing but needs to be pursued with caution.

It is not a good idea for countries to try to produce everything.

Rather they should focus on making things that they are, or could become, good at while importing other things. There is ample evidence demonstrating the benefits of international trade.

It is said that domestic manufacturers of electronics should be encouraged because they can supply the products at a cheaper price to the local consumers.

But there is a fallacy in this argument.

Domestic manufacturers are supplying at a lower price than imports because there are high tariffs on imports, not necessarily because they are lower-cost producers.

So, the support could be justified if it leads to innovation and productivity improvements that allow these manufacturers to supply the local market at lower prices and at some stage become exporters on a large scale.

I am not sure if the government has ever done a rigorous study of the effectiveness of such support in terms of achieving the desired results, such as increased investment or productivity growth.

But it should.

Any fiscal or other support given to domestic manufacturers of electronic products or any other industry that the government wants to promote under the "Made in Bangladesh" strategy must come with tough performance conditions, such as increasing the amount of value-addition in Bangladesh, increasing the share of output that is exported, and increasing efficiency of production thereby lowering production costs.

The manufacturers should be required to supply relevant data to the government so that an independent assessment can be made of whether they are meeting the specified performance targets.

Failure to achieve the targets (or even to produce such data) should result in withdrawal of such benefits unless it can be established that factors beyond their control prevented them from fulfilling such targets.

If such performance conditions are not imposed, the fiscal support will end up merely increasing profits of the local companies without bringing meaningful benefit to consumers and the country in general. This is what happened in the second Korea.

We don’t want to go that path. Instead, it is the first and third Koreas that we should seek guidance from.

 

The author is an economist, previously with an international development agency

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