Doug Irwin on the Korean miracle
Doug Irwin has an excellent new paper describing how the Korean economy took off in the late 1960s:
In the early 1960s, South Korea was close to being considered a failed state. It suffered from political turmoil and economic stagnation. One of the poorest countries in the world, it had a lower per capita income than North Korea, and its standard of living was not much higher in 1959 than it had been in 1945. Domestic savings were virtually nonexistent, and foreign assistance was required to finance most domestic investment. Exports were less than 1 percent of GDP, and it could afford imports of about 10 percent of GDP only because of US foreign aid.
Today, South Korea is an economic success story and an export powerhouse. The key transition period is widely agreed to have been the mid-1960s, when it began a sustained period of rapid economic growth. Although the many factors behind the country’s transformation are still debated, the decision to promote exports is generally accepted to have been a key part of its success. In 1959, South Korean exports were just 0.7 percent of GDP. A decade later exports were about 10 percent of GDP, and by the early 1970s they reached 20 percent of GDP.
The key policy initiative was a move toward less restrictions on trade:
The United States opposed the military government’s initial policy stance and withheld aid to force it to devalue the won and liberalize the foreign exchange regime. With US encouragement, the previous, short-lived administration of Chang Myŏn had introduced these liberalizing reforms to stimulate exports and reduce the rent-seeking that came with government allocation of foreign exchange. Although these changes were deeply unpopular in Korea and resisted by government officials, the United States wanted a return to those policies and had enormous leverage because it financed most of the country’s desperately needed imports. In 1964, the Park government, in a weakened position because of domestic crop failures, relented and appointed an economic reform team that was strongly committed to export promotion as a national priority. Expanding exports was seen as a way of earning foreign exchange to pay for imports and ending the country’s excessive dependence on the United States.
The financial sector was also liberalized:
In September 1965, Korea lifted interest rate controls that had depressed savings and financial development. The cap on deposit rates was lifted from 15 percent to 30 percent and that on loan rates was raised from 16 percent to 26 percent, though the rate on export credit remained 6.5 percent. The result was a dramatic increase in private savings, which were channeled through the banking system and produced an astonishing increase in investment that further propelled exports. Gross domestic investment rose from 15 percent of GDP before the reform to more than 25 percent of GDP after, reaching nearly 30 percent by 1969.
There are no economic miracles. Rather there are countries held far below their potential due to bad government policies. South Korea in the early 1960s was one example, while China under Mao was another. In the Korean case, economic success resulted from following the recommendation of US policymakers. In the German case, economic success came after domestic policymakers ignored the advice of US policymakers and freed up domestic prices (in 1948).
The common thread is that almost all economic “miracles” involve some form of economic liberalization. What looks like a “miracle” is the rapid growth after the removal of growth constraints.
HT: David Levey