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After two major wars, the country even with a food shortage experienced lack
of capital. There was no source for savings and investment to finance economic
growth domestically, so it depended heavily on foreign capital which inflow in a
form of mostly aid and loan in the early stage of economic growth. The
proportion of foreign capital to total capital formation in 1965 was
approximately 40 percent. In addition to inflow of foreign capital, the
government faced allocation of capital with using its financial system. Before
the military government in 1961, the loan decisions of commercial banks were
heavily influenced by political interference (Haggard, 26). Well, in fact the
loan decisions in Korea mostly were affected by political interference rather
than bank themselves until recent time, but during the 1948 ~ 1961 period, the
rent generated by low interest rate was used for its political activities rather
than economic growth. Government’s Export Promotion Policies In the economic
development, the government’s creation of economic rent for certain segments of
business takes critical role.
It can be either a source of political and
bureaucratic corruption, but if wisely used, it can be a useful or powerful
policy instrument in supporting business operation and government policies.
Furthermore, it can increase capital formation in the country if it effects a
redistribution of income from consumption to investment activities (Haggard,
23). Since the mid 1960s, the military government used regulated finance as one
of tool to create rent and achieve exports expansion. What it did were
nationalizing commercial banks and amending the Bank of Korea so that it can
control financial systems directly. In general, the Bank of Korea, in its role
as the country’s central bank, determines the allocation of loans, interest rate
level and the supply of money but the decision making in these area is
controlled by the Minister of Finance. In other words, it was government’s
responsibility generating monetary and fiscal policy, not by the central bank.
Since foreign aid started to decline later 1960s, the government reformed
interest rate.
It raised the interest rate
on (one-year) time deposits from 15% per year to 30% per year and general loan
rate from 16% to 26%. The reform successfully attracted private saving. In the
first three months after reform, saving deposits increased by 50%. More
importantly, this meant more rent, in other words, more capital to be
distributed under government influence. In addition, the financial reform
contributed to a massive inflow of foreign loans due to the existence of gap
between domestic and international interest rate and since the Korea Development
Bank guaranteed to pay back to foreign lender, the inflow of the loans were
accelerated. Also this gap of interest rate was used to promote export expansion
which was the most economic priority. For example, while domestic interest rate
was so high comparing with international rates, the exporters, mostly big
business in heavy industry, were able to get loan at little interest rate.
They
were not only able to get low interest rates, but variety of supports that the
government could do such as tax break and easy approval of the loans for
exporters. For example, profits earned on exports have been exempt from
corporate or individual income tax and the short-term export credit system gave
borrowers holding export letters of credit (L/C) “automatic approval”. As a
result, an increase in domestic savings and huge inflow of foreign borrowings
had positive effect on economic growth in Korea due to an increase in capital
accumulation.
Controlling exchange rate is another good example to describe the
effect of government’s role on Korean economic development. After switching its
economic policy from import substitution to export expansion in the mid-1960s,
the Korean government officially moved from a fixed parity to a unitary floating
exchange rate system. Although the exchange rate system has been “floating”, its
actual (real) rate was managed by government’s market control and Korean
currency “won” was undervalued mostly against the U.S. dollar so that the price
of exports remain cheap. Followings are the plans that the Korean government set
over time period as a guide for economic growth. They are quite helpful to
understand how major government’s policies on financial sector have been varied
with given the world economic situations like oil crisis and its own economic
recession. The First Five Year plan (1962 – 1966) The first plan was prepared in
a hurry by the military government that took power in 1961.
The major contents
of fiscal and financial policies as stated in the plan document were largely
about the tax, budget, and monetary system, financial market and foreign
exchange system. During this period, its main purpose was, however, to expand
exports as much as possible by providing export firm with cheap loans, tax
benefits, export compensation schemes, and various administrative support.
Economic growth in this period was result by an increase in export and output
and as well as price level (since output and price level are positively
correlated), so there was inflationary pressure at the end of the first plan-
actually the inflation rate exceeded 23 percent in 1964. The Second Five-Year
Plan (1967 –1971) During this period, the major reforms include a financial
reform assuring positive interest rate in 1965, and exchange rate reform
normalizing highly overvalued exchange rate, and trade reform allowing wide
imports of parts and machinery used for the production of export goods.
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