Industrial policy and economic development: Korea's experience.

Author:Mah, Jai S.

The Korean economy has recorded rapid economic growth rates for the past four decades with the exception of the economic crisis in the late 1990s. As a result, per capita gross national product (GNP) increased from less than US$100 in 1960 to more than US$14,000 in 2004. The period of rapid economic growth was accompanied by active industrial policy by the government, especially in the early phase of economic development. According to Westphal (1990, 41) for instance, "Korea's government has selectively intervened to affect the allocation of resources among industrial activities." The government provided direct subsidies including fiscal and financial incentives as well as indirect support like the provision of infrastructure, to promote certain selected industries. The share of manufacturing output by heavy and chemical industries (HCI), which were promoted by the government especially in the 1970s, increased from 23 percent in 1960 to 54 percent in 1980 and to 79 percent in 2002.

Although the Korean government provided various kinds of taxation and financial incentives during this period, the current World Trade Organization (WTO) system regulates or even prohibits most governmental provisions or incentives to promote specific industries. Therefore, many of the promotional measures taken by the Korean government during the rapid economic growth period, cannot be used by developing countries now. This paper explains policy measures taken by the Korean government to promote certain industries during its economic development process, analyzes the strengths and weaknesses of Korea's industrial policy, and provides developing countries with implications for their economic development under the World Trade Organization's (WTO) system drawn from Korea's experiences with industrial policy.

The paper is structured so that the following section explains the tendencies of Korea's industrial policy since the 1960s. This is followed by a section describing incentives provided by the Korean government to promote certain industries. The fourth section evaluates the industrial policy in the sense of the appropriateness of governmental intervention and provides developing countries with implications based on Korea's experience. Conclusions are provided in the final section.

Evolution of the Industrial Policy of Korea

In the early 1960s, Korea's industrial policy was characterized by import substitution policy emphasizing the production of consumption goods. The Ministry of Commerce and Industry (MCI) regulated imports using the discretionary import licensing system. To relieve the shortage of foreign exchange and technologies, private companies tried to borrow from abroad; this was strictly controlled by the government. The Government Debt Guarantee Act promulgated in July 1962, guaranteed the private companies' debts borrowed from abroad (Oh 1996, Vol. 1). The MCI chose fertilizer, PVC, cement, and petroleum refineries as the main industries to develop in the early phase of economic development and constructed industrial estates equipped with the appropriate infrastructure. The government established the first integrated steel mill in Korea--Pohang Iron and Steel Company, Ltd. (POSCO), in the late 1960s--which became one of the best-performing steel companies in the world a few decades later.

Korea's industrial policy went hand in hand with export promotion policies especially from the 1960s through the early 1980s. Export promotion policies began to be pursued in 1964 with the slogan "Export Number One." The government increased the direct subsidy to export and emphasis was placed on exporting products produced by labor intensive Light Industries (LI) such as textiles and clothing, where the Korean economy had a comparative advantage (Oh 1996, Vol. 1; and Lee, Kim, and Han 1989). In the mid-1960s, various export promotion measures such as tax deductions and export finance schemes were introduced.

In addition to the various taxation and financial measures used to promote exports in the 1960s and to provide the infrastructure necessary for economic development, the government developed sites for industrial complexes and provided them inexpensively to firms entering the complex (Lee 1995). The government also established institutions relating to the promotion of exports--the Korea Trade and Investment Corporation (KOTRA), and the Korea International Trade Association (KITA). KOTRA supports international marketing and technology imports and KITA promotes exports by maintaining training programs, research activities, exhibitions and developing foreign markets. The government also expressed the desire to export; for example, since 1965 it has conducted monthly Export Promotion Meetings attended by the President; high ranking government officials, including the MCI; and leaders of the private sector. The MCI awarded commendation letters to firms showing good export performances on the Day of International Trade.

In the 1970s, the main focus of the industrial policy of Korea shifted from LI to the build-up of high value-added HCI. Rising wage levels that tended to undermine the price competitiveness of labor intensive LI, forced the government to abandon it as the engine of growth. The HCI Promotion Plan was devised in 1971 and the President formally declared the HCI Drive in 1973 (Oh 1996, Vol. 4). The National Investment Fund (NIF) was established in 1974 to support the HCI Promotion Plan. The government chose six strategic industries--steel, shipbuilding, machinery, electronics, non-steel metal, petroleum and chemical industries--based on criteria such as forward and backward linkages, contribution to economic growth and foreign exchange earnings. The HCI promotion policies consisted of preferential. policy loans, selective protection, entry regulations, and corporate tax deductions. The HCI sector grew rapidly with the promotion program and its share of the manufacturing sector as a whole increased from 39 percent in 1970 to 54 percent in 1980. Many products produced in the HCI sector were exported. As shown in Table 1, the rapid economic growth of Korea in the 1960s and 1970s was accompanied by an increase in export growth.

As a result of excessive HCI promotion policies, the capacity utilization ratio of the HCI declined substantially in the late 1970s and early 1980s resulting in the real GDP (gross domestic product) growth rate dropping to a negative value in 1980. Therefore, the government took HCI Rationalization Measures from 1979 to 1981, which included the postponement or withholding of capacity expansion schedules with respect to diesel engines, tires, machinery, and shipbuilding (Lee, Kim, and Han 1989). The direction of industrial policy changed again in the first half of the 1980s. That is, in 1981, the government began to emphasize the importance of research and development (R&D) in economic development. It reflected policymakers' recognition that it was necessary for the Korean economy to overcome the stage of imitating techniques developed by advanced countries. In this context, the government chose several strategic sectors which appeared to be important with respect to R&D and were expected to guarantee long term economic growth: semiconductors, automotives, shipbuilding, metal, and small-sized aircrafts. The government, in pursuing the fifth Five-Year Economic Development Plan for 1982 to 1986, also promised to continue the export-led growth strategy.

Since 1983, Korea's industrial policy shifted away from sector-oriented support such as the HCI Drive toward function-oriented support for R&D (Lee, Kim, and Han 1989). Policy changes were formalized by the Industrial Development Law approved in December 1985. Despite governmental efforts to strengthen the market mechanism, it still provided loans at preferential rates to large conglomerates heavily involved in shipbuilding and machinery, among others (Cho and Kim 1997). The government established the Five-Year Plan for Development of Cutting-Edge Industries in 1989 and was determined to support them by providing funding and investments in projects relating to cutting-edge industries. Beginning in 1995, various measures were introduced to promote Information Technology (IT) industries, where the share of R&D expenditures to total manufacturing costs--2.03 percent as of 1995--has been the highest among various manufacturing industries (Kang et al. 1998 and Kim et al. 1998, 110).

Considering the increasing importance of capital goods, the government decided to promote them in the late 1990s. Therefore, in 1995, the Capital Goods Industries Promotion Plan was announced, which was expected to promote the high value-added capital goods industries by supporting the development of new products and establishing them as the main export industries. Emphasis has also been placed on the development of small and medium enterprises (SMEs). Efforts to raise the technological capability to Organization for Economic Co-operation and Development (OECD) levels have included the enactment of the Special Law on Innovation of Science and Technology in 1997 and the formation of the Five-Year Plan for Science and Technology Innovation for the period 1997-2001 (WTO 2000, Ch. 3, para. 137). Governmental support of R&D expenditures was concentrated on the IT industry during the 1990s. Under the leadership of then President Kim Dae Jung, the share of governmental R&D expenditures on the IT industry increased to 42 percent of the total in 1998 (Korea Information Strategy Development Institute (KISDI) 2003).

Since 1998, the government has emphasized building a knowledge-based society and has chosen six technologies as promising next-generation technologies to promote, including IT and Biotechnology, among others. (1) Most of these have been granted tax benefits. Due to the emphasis on R&D, the ratio of R&D expenditures to sales in the manufacturing sector increased from...

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