Sunday, February 20, 2011

Korea’s Fiscal Management for Economic Development

The Republic of Korea (here within known as “Korea”) has nine provinces and seven administratively separate cities—Seoul, the capital, along with Busan, Daegu, Daejeon, Gwangju, Incheon and Ulsan. With 48.6 million people, Korea has one of the world’s highest population densities with the 81% of total population living in urban areas (CIA Factbook 2008). Major population centers are located in the northwest, southeast, and in the plains south of the Seoul-Incheon area.

The country has seen extraordinary growth rates over its recent history and much of this has been produced due to major planned action by the public administration. This paper will describe the economic growth, fiscal policy and the planning models that the country has conducted. Furthermore, it will review the countries decentralization attempts and review its current fiscal policies as it strives to continue growth into the twenty-first century.

The market
Originally uploaded by heydee

Early economic development planning and political struggles

Before Korea was known for the “Asian Miracle” by the World Bank and others in the international community, there were several long passes of uncomfortable historical moments which explain the incredible growth figures. This included exploiting the working class and managing a deeply inter-connected business clan called the “chaebol.” Vittas and Je Cho (1996) highlighted the different phases of directed state efforts to shape the national economy. They included mainly in the 1950s and 1960s assemble of export and industrial investments; the 1970s focus on particular industries targeting specifically heavy and chemical industries; 1980s concentrated on industrial and financial restructuring of companies and sectors in distress.

Even before Park Chung-hee’s 1961 military coup established strong state interventions to meet its goal of rapid industrialization (Minns 2001). The strong state approach began with the Japanese as they colonized the peninsula in 1910, especially when they abolished the Korean aristocratic landowners—yagban. Additional separation of workers and elites was declared after large protests in 1946, just as the national government announced its title of the People’s Republic. The national labor unions were organized and therefore sought political demands, which made the state’s role stronger (Minns 2001). More radical left sympathizers simple left the country for the north as the developmental state was transforming.

Unlike the Syugman Rhee’s administration in the 1950s when the country began its rebuilding efforts after the war, the military did not use foreign aid to industrialize (Minns 2001). Instead, highly orchestrated finding from state run banks like the Korea Reconstruction bank used both principle and interest on foreign loans that the government guaranteed. Furthermore heavy sough was Foreign Direct Investment (FDI) for major sectors of the economy. The Park regime used Free Export Zones (FEZs) and managed major concessions and tax lifts in order to generate more investments from outside the country. Between 1961-1972, subsidized credit was easily available established to strengthen large firms. For examples Heavy and Chemical Industry Plan (HCIP) focused on largely defense-related products such as steel, petrochemicals, nonferrous metals, electronics and shipbuilding was an area of strong interest.

Beginning in 1974, major concessions were made due to the oil price shocks and the recession that hit the country, creating raising interest rates and unprecedented lack of necessary capital for further development. Therefore the country’s economy saw a major slow down. Minns (2001) highlights that the state became ruthless of selective firms allowing many to go bankrupt and strengthening mergers and accusations.

Monetary policy and Centralized control over financial services

Credit policy became a strong tool for development in Korea in the 1980s. “The government used a strong package of tax and financial incentives to encourage firms with minimal equity funds to enter priority industries and it used control of the banking system to exert strong leverage on the behavior of firms” (Vittas and Je Cho 1996). Centralized control of decisions made the state become a vital tool for the development of the country. The state run Economic Planning Board (EPB) gave the country an unprecedented power to organize and nationalize the banking system, targeting industrial sectors and managing fiscal policies.

The commercial banks in Korea functioned as development banks with large portfolios. Non-bank financial institutions operated freely, without sufficient regulation and expanded the financial operation of the country. In the 1980s the chaebol became so successful that there was regular discontent from the working class. With the excessive accumulation of wealth, the workers demanded more redistributive and welfare polices from the government.

The funding sources included deposits of the central bank, foreign capital for financing, loans from FDI into Korea and simple guarantees from the national government. Although encouraging huge inflows of foreign capital and technology, this also perpetuated government intervention in the banking sector. To avoid default, the government would absorb and reschedule the domestic bank loans, giving preference to larger firms and not providing accessible credit to small and medium size firms. This led to high-growth rates until the government became overambitious. High risk sharing schemes between creditors and borrowers led the Korean government to take on dangerous balance sheets leading to near financial collapse.

1997 Economic Crisis

Much like the current housing market collapse and financial stresses in the United State, the Korean government was hit hard in 1997. The central government was quick to assess their internal problems. Aided by the international community, the government took out internationally financed loans from the World Bank and others to meet the private sectors demands and reconstructing the national economy. Areas of the financial reforms included competition, export, and private sector ownership of some key industries. Another area of reforms included providing credit to small and medium businesses, which also served as a political reform and appeasement to the newly emerging middle class. Further decoupling of the business elite was done by applying pressure from the commandist state in the economic management of the country. “Ironically, an economy which had neoliberals enthusing about its export-led strategy now required the largest IMF bail0out in history: US$57 billion in December 1997 and another $10 billion to follow” (Minns 2001.) Furthermore international pressure, the economic crisis and the bailouts were all factors, which lead the decline of the developmentalist state in Korea.

Public Administration Reforms

Yet, not before Dae Jung Kim’s administration were there vast changes in the public administration (Suk Kim 2000.) Announced during the his inauguration in February 1998, were there major ambitions to respond to the crisis, which focused on for major sectors business, labor relations, finance and government administration. Reforms were taken most obviously to cutback the public sector and save in areas of the budget, but the Korean government also needed to overcome its highly centralized, non-transparent, ridged and low competitive government (Suk Kim 2000.) Coupled with global movement of new public management the government was able to embark on many of the trends of becoming a leaner and meaner government.

Nearly all types of reforms were implemented, including reorganization, providing autonomy for select government agencies, deregulation with the private sector, personal and pay reforms of government servants, downsizing and changing the cultural and behavior work environment. For example, Suk Kim 2000 sited that the “Dae Jung Kim Administration will let go 25,955 employees who account for 16.0% of the total central government workforce by the year 2001.” In additional attempts to make the government the less centralized, the government used the business like approach to public management and promoted entrepreneurial ideas to flow into the public sector.

Ha (2004) described the Korean governments efforts at decentralization, which began in the 1980s, as deconcentration, devolution and privatization. The Presidential Common on Devolution Promotion for Local Authorities was established in 1999 to transfer parastatal agencies from the national government to the local level. Some day-to-day management and operational activities were given away to local governments but genuine autonomy for making political decisions has yet to be granted. Additional in 1999 the Presidential Commission on Government Innovation was established to reduce the government workforce, implement privatization programs of the state own enterprises and finally introduce completion and performance oriented compensation packages for the public sector (Ha 2004).

Originally uploaded by heydee

Current financial industry reforms and development

The OECD reports (both from 2004 and 2007) major work is still needed for these policies to be taken serious. Particular areas of reform include the corporate and financial sectors and the fiscal policy of the country. Although, much has been done to fragment the private sector of the “chaebol,” Korean corporate leaders, there are still areas of reforms needed. For example corporate governance and transparency, promoting external auditing and improving reporting regulation for the private sector, particularly paying close attention to the financing industry. Much has been learned from the SK Global scandal, which forced the government to respond by establishing with the financial Supervisory Service (FSS), a non-profit organization that tracks corporate investments and spending patterns.

Furthermore the banking sectors capital adequacy rations need to be maintained. In the effort to not return to the necessity of the re-capitalizing the financial sector the OECD has recommended the banks to not fund such risky projects, but rather strengthen housing and mortgage financing, public funds and the like. One way to restructure this sector was by having a foreign financial service provide competition for nationalized companies. For example, OECD reports that 80 percent of the governments share in Hyundai ITC, the third largest financial service company, was sold to Prudential Financial in February 2004.

Additional developments include the recent establishment of the Korean Investment Corporation (KIC), the Korean Asset Management Corporation (KAMCO) and the Korean Deposit Insurance Corporation (KDIC), which are all areas for managing and regulating the financial sector. The OECD reports that foreign ownership in the fixed-income market is only 0.6 percent and more attraction of asset management firms could attract business development and make Korea into a desirable location for global investments.

Furthermore improved tax system will help the public sector manage their resources better. Priority is on broadening of the tax base for personal income tax, which is the lowest in the OECD, below 10 percent. One focus area is on the self-employed whose income is estimated at 50 percent higher than that in which is report. The government policy in this regard was announced in the Vision 2030 and seeks to encourage local tax systems to become more efficient. The OECD reports the need to simplify “the local tax system, which includes 16 different taxes compare to only four in Nordic countries thereby reducing compliance costs (OECD 2004:99).” These reforms are necessary if Korea will be able to set its heights on their goals established in the various five-year plans.

Seoul’s local public finances

Batten and Szilagyi (2007) suggest that Korea’s efforts at developing its bond market would be a “complementary to long term economic development while services the efficient financial and legal services.” In these efforts Seoul’s seeks to become a full international financial center, rivalry to those located Singapore and Hong Kong Current efforts are focusing on engaging the international private sector to invest in the local market. In part, reforms are still needed in the corporate coverage section, which includes creditor rights, bankruptcy procedures and contract enforcement. Furthermore additional regulations for foreign investor taxes, and stronger financial infrastructure for the reliable credit ratings and robust benchmarking yield curves still need development.


CIA Factbook, 2010, Retrieved Feb. 12

“Competitive Cities,” 1999, special issue of Urban Studies, v. 36, n. 5/6, especially articles by Begg, van den Berg & Braun, and Gordon.

Crotty, James and Kang-Kook Lee, 2002, A political-economic analysis of the failure of neo-liberal structuring in post-crisis Korea. Cambridge Journal of Economics, 26(5), 667-678

Batten, Jonathan A. and Peter G. Szilagyi, 2007, Domestic Bond Market Development: The Arirang Bond Experience in Korea. The World Bank Research Observer, 22, (2) 165-195.

Ha, Seong-Kyu, 2004, Housing poverty and the role of urbqan governance in Korea, Envormental and Urbanization 16 (1)139-154.

Hayo Bernd. 2005, Mass attitudes toward financial crisis and economic reform in Korea Socio-Economic Review 3 (3), 491–515

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Kim, Joong-Yang, 2006, The Korean Civil Service System. Bubwoosa.

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Minns, J., 2001, Of Miracles and Models: The Rise and Decline of the Developmental State in South Korea. Third World Quarterly, 22(6), 1025-1043.

Organisation for Economic Co-operation and Development (2007) OECD Economic Surveys: Korea OECD.

Sassen, S., 2006, Cities in a world economy (3rd ed.). Thousand Oaks, CA: Pine Forge Press.

Seoul Metropolitan Government website: (also Four-Year Master Plan at this site. Viewed Feb, 21. 2010.

Vittas, Dimitri and Yoon Je Cho (1996), Credit Policies: Lessons From Japan And Korea. The World Bank Research Observer, 11(2) 277-98.

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