Mohsin Khan, Morris Goldstein, and Vittorio Corbo
Published Date:
September 1987
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Korea’s Adjustment Policies and Their Implications for Other Countries

Kim Mahn Je

Deputy Prime Minister

Republic of Korea

I would like to begin by thanking the World Bank and the International Monetary Fund for inviting me as the guest speaker this evening on the occasion of the Bank/Fund Joint Symposium on Growth-Oriented Adjustment Programs. In 1980, I was here in Washington, then as the President of the Korea Development Institute, with a policy proposal package for Korea’s first structural adjustment loan. I am both personally honored and proud to be here again some seven years later to tell Korea’s success story on structural adjustment.

In these times of rapid technological changes and growing importance of world trade, countries that undergo slow changes in their structures in investment, production, or consumption are bound to face inefficiencies in their economies. When structural adjustment efforts designed to eliminate or minimize these inefficiencies are delayed, a country could experience slow economic growth, widening trade imbalance, or rising inflation.

In recent years, on the one hand, we see developing countries that suffer from balance of payments deficits and a growing debt burden, while on the other hand, there are developed countries concerned about either large trade deficits or surpluses. I do not believe that there is any country that does not know what efforts are required for structural adjustment. It is the how that poses the problem. This is because structural adjustments in any country involve a process of difficult and painful compromise between interests of various groups in society for the good of the nation as a whole.

I would like to spend a few minutes with you discussing Korea’s experience with structural adjustment in the 1980s and its implications for the current problems in other developing countries.

Structural adjustment in Korea has, in fact, been a continuous process over the past quarter of a century. Since Korea undertook its First Five-Year Development Plan in 1962, the process has involved a series of policy and institutional reforms aimed at shifting the economy from an inward-looking model of development to an outward orientation. Today, however, I will focus my remarks on Korea’s more recent experiences in the 1980s.

During the past six years, Korea has been able to regain its growth momentum, reduce its inflation rate, and improve its balance of payments position significantly. The Korean Government’s approach to adjustment had three prongs: stabilization, promotion of market efficiency, and balanced growth.

Stabilization naturally received the greatest attention. In 1980, Korea registered a current account deficit of $5.3 billion, or 9 percent of the GNP, and annual wholesale price increases reached almost 40 percent. Under such circumstances, painful structural adjustment involving a certain amount of belt tightening for everyone was inevitable in order to reduce inflation and improve the balance of payments position.

With inflation soaring, the government concentrated on using macroeconomic tools—a conservative monetary policy and tight fiscal measures—to restrain aggregate demand. In particular, the Government saw fiscal restraint as a key to price stability and concentrated on reducing the public sector deficit.

The fiscal restraint has had greater effect than what textbooks tell us about controlling inflation; it had the important side effect of promoting a spirit of frugality in the whole society. When the Government voluntarily froze the salaries of its civil servants at one point, workers agreed to lower wage increases without serious complaints, and farmers tolerated smaller increases in grain procurement prices.

Nevertheless, as in every country, reductions in government programs entailed significant political risks, meeting strong resistance from groups of people that suffered directly from the cutbacks.

Positive effects, meanwhile, were widespread and indirect. The Korean Government tried to tackle this dilemma through a public information campaign and discussion programs, rather than yielding to political pressures.

Introducing new discipline in monetary management has not been an easy task, either. Excessive monetary growth in the 1970s led the nation’s businessmen to take measures to hedge against inflation. They had always tried to increase bank borrowings in order to purchase real assets that would increase in value without inflation. Stable prices and the spirit of social frugality, however, have gradually changed the businessmen’s attitude toward and patterns of investment financing, and the Korean Government has been able to contain annual monetary growth from 30 percent in the late 1970s to around a 15 percent level in more recent years.

The success of the stabilization program has been outstanding. The rate of consumer price increase fell dramatically, and it has been in the 2-3 percent range since 1983. The balance of payments also continued to improve, finally turning the nation into a surplus country in 1986 for the first time in history.

Notwithstanding the success of our stabilization program, we were not single minded about stability, for it was clear that drastic measures would have been politically unsustainable. Therefore, at least a 5 percent growth rate was maintained during the recession years, and the average growth rate turned out to be 7-8 percent between 1981 and 1985. Of course, our foreign debt increased substantially as a result during this period. In short, achieving stability was necessarily a step-by-step process, with flexibility built into policy formulation and implementation.

The second major feature of our adjustment strategy was improving efficiency through the promotion of market competition. Externally, the Government reduced barriers to imports and foreign investment; domestically, it fostered competition by introducing anti-monopoly and fair trade legislation, denationalizing commercial banks, and simplifying regulations on private sector activities. In short, the market mechanism was strongly emphasized over government intervention in every facet of economic decision making.

Policymakers in many developing countries, when faced with balance of payments difficulties, are always tempted to increase government intervention either to promote new export industries or to support import-substituting industries. Korea was no exception. During the 1970s, the Korean Government promoted the development of heavy and chemical industries with many tax and financial incentives. The result was gross misallocation of resources and increased dependence on the government by private entrepreneurs.

This valuable lesson led the policymakers in Korea to adopt a market-oriented liberalization program in the early 1980s. As a result, businessmen strengthened their efforts to diversify their products, improve quality, and increase investment in technological development. Consequently, investment in R&D has doubled in the last five years, from 1 percent of GNP to a 2 percent level, and this increase was mostly due to private sector investment. Enhanced competitiveness because of price instability and technological development enabled Korea to increase its exports and finally to achieve a trade surplus last year.

The improvement in the balance of payments position has also enabled Korea to begin reducing its external debt, which stood at $47 billion at the end of 1985. Equally important, the liberalization of imports has had few of the dire effects predicted by its critics. By and large, competition has forced domestic firms to increase their efficiency, in some cases so successfully that they are now ready to begin exporting.

The third major goal of structural adjustment in the early 1980s was more balanced growth of the economy. As the Korean economy was reaping the fruits of structural adjustment, balanced growth became another important task. This is because, if disparities continue to widen between big cities and rural areas, large and small businesses, and income groups, the Government could not expect cooperation from a wide range of people, and structural adjustment efforts would not be sustainable.

The most important task facing the Government was reducing the income gap between urban areas and the countryside. Although the gap was narrowing, further improvements were delayed because stabilization policy necessarily involved limiting agricultural price increases and reducing farm subsidies. In order to promote rural development, the Government introduced the idea of agro-industrial complexes and encouraged small and medium-size businesses to locate their plants in rural areas. This helped create employment opportunities and non-farm income sources for farmers.

Balanced regional growth and income distribution, as well as more even development of large and small firms, are long-term goals. The Korean Government will place top priority on this area in the next several years, now that price stability and the balance of payment improvements have been achieved.

Many lessons may be drawn from the Korean experience of the last seven or eight years, but I will concentrate on those that strike me as most applicable to other developing nations.

The broadest lesson concerns the basic conditions of achieving structural adjustment. The Korean experience shows that, in order to undertake successful adjustment programs, we need flexibility in policy choices, social adaptability to new policies, and strong political commitment to structural reforms.

Flexibility in policy choices, and effective and expeditious policy coordination are very important, because international and domestic environments constantly change. If policies do not adjust effectively and rapidly enough to accommodate changing conditions, structural reforms cannot be sustained. In Korea, a unique institutional setting in which an agency called the Economic Planning Board encompasses planning, budgeting, and coordination functions, turned out to be very effective in coordinating economic policies.

In addition to flexibility, consensus should be established among various economic players in the society with respect to policy direction. If these players constantly resist or are nonconforming to government policies and programs, it is obvious that structural adjustment cannot succeed. Above all, however, strong political leadership is needed to guide the nation in the right direction for structural adjustment. Structural adjustment is, after all, sacrificing specific group interests for national interests or sacrificing short-term for long-term goals. Such programs cannot be pursued satisfying every interest group.

Let me now say a few words about general policy lessons from the Korean experience in the context of the continuing Third World debt problem. Broadly speaking, I believe that the developing debtor nations should focus their adjustment efforts on three areas: stabilization based on monetary and fiscal restraint to achieve price stability, reforms in the public sector to minimize waste and increase efficiency, and industrial policies that stress less government intervention and promote the working of the market mechanism.

Fiscal restraint, in addition to helping stabilize prices, will have the effect of transferring more resources to the private sector and enhancing government credibility. This will also create a favorable environment for implementing income policies. Structural deficits incurred by public corporations, which are among the most vexing problems in many developing countries, should be corrected through reduction of government subsidies and price rationalization. A onetime increase in prices will far outweigh the costs of continuously rising government subsidies in future years, however difficult the political realities may be for such reforms. Above all, private initiatives should be promoted, and government intervention discouraged as much as possible, in all investment decisions. Businessmen should be allowed to make their own decisions according to market signals.

A program that combines stabilization, public sector reforms, and reduced government intervention will definitely achieve positive results, particularly when the basic conditions, which I mentioned earlier, prevail. Among other things, it would greatly increase domestic savings, promote greater investment efficiency, and bring about balance of payment surpluses to repay external debts.

In addition to these internal measures, trade policies of the debtor countries deserve closer inspection. Often, the inclination of developing-country policymakers in the midst of economic crisis is to close markets to competition, in the hopes of protecting domestic industry and reducing the external payments deficit. This is a vain hope, however. In the long run, adding barriers to the domestic market will only lead to deteriorating export competitiveness, thereby worsening the external balance. Instead, developing countries must reduce both domestic and external barriers to competition in the economy.

As for the developed countries, a concerted effort to assist adjustment programs in the debtor nations is essential not only for these countries but also for the developed countries themselves. Most importantly, industrial countries must keep their markets open to exports from the debtor nations, and should allow them to run some trade surpluses. The indebted countries need such access and surplus in order to be able to maintain and improve their debt-servicing capacity.

At the same time, new funds should be made available to debtor countries, in coordination with international commercial banks and multilateral institutions like the Fund and the World Bank. Developing debtor countries need some flexibility to institute long-term structural adjustment, and adjustment policies cannot be sustained without some investment and growth. In this regard, Secretary Baker’s initiative seems like a very positive idea.

In addressing the Third World debt problems, we need to adopt a long-term approach, as the Baker Initiative suggests. We should avoid the temptation to apply a “quick fix” and accept the fact that it takes time to achieve results. In Korea, there is a saying that “the more you are in a hurry, the more you should go the roundabout way.” The seriousness and immediacy of the debt problem tempts us to find a fast solution, but a less direct and slower method may be more effective.

In addition to providing continued market access and new funds, major industrial countries should cooperate for greater macroeconomic policy coordination among themselves. This is because imbalances among industrial countries have disruptive effects on the orderly growth of world trade and economy, thereby obstructing speedy structural adjustment for developing countries. Special attention should be paid to keeping international interest rates low and stabilizing exchange rate movements.

Much of what I have spoken of and what you’ve discussed at this conference bears witness to the growing interdependence of the world economy. The international trade network and global financial market make it certain that economic problems in one country will be felt, sooner or later, in others. Therefore, we must all be willing to cooperate and share the burden of adjustment.

In closing, let me note that Korea is still a developing country that faces many tasks for continuous structural adjustment. Korea has been successful so far in growth-oriented adjustment, having become a $100 billion economy and the twelfth largest trading country in the world whose exports now range from automobiles to semiconductors. Still, there is a great deal of work to be done. As a next step, we plan to launch a “growth and distribution-oriented structural adjustment program.” If Korea is just as successful in this task, then I may be invited back to Washington for a similar symposium in another ten years, but perhaps not as a representative of a debt-ridden developing country.

Note: The text of this address, delivered before an invited audience on February 26, appeared in Korea’s Economy (Washington), Vol. 3, No. 2 (April 1987), pp. 3-6.

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